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ng

COURSE CODE: AEM 102

COURSE TITLE: Principle of Economics
NUMBER OF UNITS: 2 Units
COURSE DURATION: Two hours per week

COURSE DETAILS:
COURSE DETAILS:

Course Coordinator: Prof. (Mrs.) C.A. Afolami, B.Sc., M.Sc., PhD

Email: [email protected]
Office Location: Agric. Econs & Farm Mgt. Department, COLAMRUD
Other Lecturers: Dr. S.A. Adewuyi, Dr. O.F. Ashaolu, Dr. A.E. Obayelu,
Dr. Soji Vaughan

COURSE CONTENT:
Definition of economics; The economic problem: the problem of scarcity, production
possibility frontier, principle of increasing costs, scarcity and the market system; Micro
economics: demand, supply, equilibrium price, shifts in supply and demand, government
and price determination; Macro economics: gross domestic product, aggregate demand,
aggregate supply, equilibrium output, unemployment, inflation, national income,
consumption investment and net exports, money and banking.

COURSE REQUIREMENTS:
This is a compulsory course for all students in the university. In view of this, students are
expected to participate in all the course activities and have minimum of 75% attendance to
be able to write the final examination.

READING LIST:
Salvatore, D. and Diulio, E.A. (1996) Schaum’s Outlines of Theory and Problems of
principles of Economics 2nd ed. 400pp

E
LECTURE NOTE
AEM 102: PRINCIPLES OF ECONOMICS
WEEKS
1 INTRODUCTION TO ECONOMICS
2 THE ECONOMIC PROBLEM
3 DEMAND, SUPPLY AND EQUILIBRUM
4 – 5 DEMAND, SUPPLY AND ELASTICITY
6 – 7 UNEMPLOYMENT, AND NATIONAL INCOME
8 MID-SEMESTER: CONTINUOUS ASSESSMENT TEST (CAT)
9 CONSUMPTION, INVESTMENT AND EXPORTS
10 INFLATION, DEFICITS AND DEBT
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GROUND RULES
• Switch off all mobile phones.
• No side talking/no conversations.
• No loitering in the auditorium.
• Talk only when the lecturer approves it.
• No strolling into the auditorium during lecture i.e. lateness to lecture is not allowed.
• No form of disturbance during lectures.

1.0. Introduction to Economics

1.1. The Subject Matter of Economics
1.2. The Methodology of Economics
1.3. The Use of Tables, Graphs and Equations

1.1. The Subject Matter of Economics

Economics is a social science. It studies individuals and organizations engaged in production,
distribution and consumption of goods and services (using scarce resources of land, labour, capital).
Its tools are: Principles, Theories and Models.

Principles are basic laws of the discipline e.g. an increase in the demand for a commodity results in
rise of its price, ccccccc ppppppp (other things being equal).

Theories: – these are further explanations of the general principles e.g. The law of diminishing
returns, the consumer theory etc.

The models – are mathematical relationships between economic variables e.g. C =f (Q)
Where: C= cost of production,
Q=Output e.g. maize in tonnes
f=function
• These are developed around the cause and effect of economic events. Also, they isolate a few of
the most important determinants or causes of the economic events.
• They are to:
i. predict economic occurrences
ii. Develop policies that will prevent or correct economic problems e.g. Unemployment,
inflation, forex supply, forex demand, wastages in the economy.

Economics is subdivided into branches:

- Microeconomics
- Macroeconomics
Microeconomics studies the economic behavior of individual decision-making units e.g. farmers,
consumers, companies and resource owners.
Macroeconomics studies the behavior of aggregates of economic activities e.g. aggregate demand,
aggregate output, aggregate unemployment, the general price level and the balance of payment.

Relevance of economics
– The performance of the economy (economic condition) affects all members of the nation.
– Economic conditions determine where we live, what we eat, where we eat, the school attended,
whether we work or not and how much we earn.
– Economic conditions affect the peace and stability in our cities, nation and in the world –
unemployment, inflation and corruption.
– Economics gives a better understanding of how the economy operates and what can be done to
avoid, correct and alleviate unemployment, inflation and waste.

1.2 Methodology of Economics

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Economic phenomena are complex, so economists model economic behaviors. In constructing a

model, economists:
(i) make assumptions which cut away unnecessary details; and
(ii) reduce the complexity of the economic behavior.
The economic behavior is then presented as a relationship between a dependent variable and a few
independent variables
The economic behavior being explained is the dependent variable while the variables explaining that
economic behavior are the independent variables.
Frequently, the dependent variable is presented as depending upon one independent variable, with
the influence of the other independent variables held constant. e.g. C= f (Q/T,W,D) that is, C
depends upon Q ( while other independent variables T, W and D are held constant).

An economic model will, also, specify the type of relationship between the dependent and
independent variables. This can be: (a.) positive or (b.) negative
(a.) Positive relationship: when the dependent variable moves in the same direction as the
independent variable e.g. positive relationship between price (independent variable) and supply
(dependent variable), ceteris paribus.
(b.) Negative relationship: when the value of the dependent variable increases as the value of the
independent variable decreases e.g. as the price of a commodity increases, its demand decreases,
ceteris paribus.

1.3 The use of Tables, graphs and equations

Models which simplify real economic relationships provide the frame work for organizing data,
empirically testing economic hypotheses and forecasting economic behaviour.
Below is a consumer spending model with data on consumer spending for a hypothetical economy,
we shall:
* graph the data with consumption in the y-axis
*establish an equation for consumer spending; &
*use the equation to forecast consumer spending.

Table 1: Consumption and Disposable Income Data

Individual Disposable Income Consumption y= Y- e=E-Ē
(Yd) (E)
1 20,000 20,000
2 21,000 20,750
3 22,000 21,500
4 24,000 23,000
5 27,000 25,200
TOTAL 114,000 110,000
Average 22,800 21,100

From Table 1, it is evident that consumption and disposable income display a positive relationship.
Note: a table /schedule is made up of a number of rows and columns.
The following must be specified for a table: a title, a (table) number, units of measurement of the
data and the source of the data.
In a graph, the following must, also, be specified: a title, a (figure) number, scale and axes (vertical
and horizontal) identities with units of measurement.

The equation for above set of data:

A linear relationship is evident in the graph. The appropriate equation is, therefore of the form:
E = a + bYd

Where: a is the intercept

and b is the coefficient of Yd, or the slope

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b = Σye
Σy2
a=Ē–b d
e = deviations from the mean of E
y = deviations from the mean of Y
Σ is summation
E is mean of E
is mean of Y

2. LECTURE NOTE
ECONOMIC PROBLEMS
Contents
• The Problem of scarcity
• The Production possibility Frontier
• The Principle of Increasing Costs
• Scarcity and Market system

Learning Objectives
At the end of the lecture, students should be able to
• Identify the various types of economic resources
• Explain scarcity as a fundamental economic problem
• Explain the basic questions in economics due to the problem of scarcity
• Explain Production Possibility Frontier (PPF) and it applications
• Explain the principle of increasing costs
• Identify the characteristics of various economic systems and how the economic problems can be
solved?

What are economics resources?

• Economic resources consist of Natural resources such as minerals, forests, rivers and agricultural
land
• Capital is human-made resources which consist of tools, equipment, machinery, buildings, financial
instruments and transportation networks to facilitate production
• Labour is human resources which consists of human beings who possess a wide array of skills
needed to produce goods and services.
Entrepreneurial ability is a special labour skill

What is Scarcity?
• The Central Problem of all economies is scarcity
• Limited Resources + UnlimitedWants = Scarcity
• Scarcity is the basis of many economic concepts because it constrains or limits our behavior
• Scarcity exists worldwide because people want more goods and services than can be produced by
each economy’s limited supply of economic resources
• Scarcity forces individuals, firms, governments and societies to make choices
• Economics is therefore defined as the study of scarcity – the study of the allocation of scarce
resources to satisfy human wants

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LIMITED RESOURCES UNLIMITED WANTS AND

NEEDS

SCARCITY

We make choices about

 What will be produced?

 By whom will be produced?
 For whom will be produced?

The choices we make will determine

CENTRALLY
PLANNED MIXED
MARKET
ECONOMY ECONOMY
ECONOMY

Basic Economic Decisions as a result of Problem of scarcity

 What to produce – This involves decisions about the kinds and quantities of goods and
services to produce
 How to produce – This requires decisions about what techniques to use and how the
economic resources are to be combined in producing output
 And for whom to produce – this involves decisions on the distribution of output among the
members of a society.

The Production Possibilities Frontier (PPF)

• In economics, the PPF also known as the production Possibility Curve (PPC) or transformation
curve is the maximum amount of alternative combinations of goods and services that a society can
produce at a given time when there is full utilization of economic resources and technology.
• It is a curve that is convex from the origin, showing attainable levels of production assuming
resources and technology stays constant
• The opportunity cost of an activity is the value of the resources used in that activity when they are
measured by what they would have produced when used in their next best alternative.

The slope of PPF

• The slope of the PPF at any given point is called the marginal rate of transformation or marginal
opportunity cost. That is, the opportunity cost of good X in terms of good Y at the margin
• A person with the lower marginal opportunity cost of an activity has the comparative advantage at
that activity.
• That is, a person with the comparative advantage can produce the activity by giving up the
smallest amount of the alternative activity.

The applications of PPF

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• The Production Possibilities Frontier is a basic workhorse in economics.

• It is important for understanding some basic issues in economics.
• Great application is with international trade theory.
• Helps one to understand and distinguish between comparative advantage and absolute advantage.
• Great application is with international trade theory.
• Helps one understand and distinguish between comparative advantage and absolute advantage.
• An important historical figure in all this is David Ricardo.

Absolute vs. Comparative Advantage Applied to Trade

• Absolute advantage: if your country uses fewer resources to produce a given unit of output than
the other country.
• Comparative advantage: if your country can produce the output at a lower marginal cost in terms
of other goods foregone than the other country.
• Every country (or person, or economy) has a comparative advantage at some activity.
• Absolute advantage is not important and may not always happen. Sometimes people or countries
have the absolute advantage in nothing! Yet trade possibilities still exist.

Points to Note on PPF

• The PPF curve divides production space into 3 distinct areas, points on the PPF curve, points
outside the curve and points on the inside of the curve
• The PPF curve also illustrates scarcity by dividing production space into attainable and unattainable
levels of production

A Typical PPF Picture

The marginal
opportunity cost of
Butter
guns in terms of
just attainable unattainable
butter is increasing as
we move down the
PPF!
The PPF is typically
inefficient bowed-out or linear.
just attainable
It is not bowed-in

Guns

PPF
• The PPF shifts outward overtime as more resources become available and technology is improved
• Points on a PPF are efficient; points within the frontier are inefficient and points outside the
frontier are unattainable
• Points on PPF are efficient because all available resources are utilized and there is full use of
existing resources.
• Position outside the PPF are unattainable since PPF define the maximum amount that can be
produced at a given time
• Position within a PPF are inefficient because some resources are either unemployed or
underemployed

Assignment 1

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• (a) Use the data from Table 1 to draw a PPF. Plot clothing production on the vertical axis and food
production on the horizontal axis. Label the production alternatives A, B, C, D,E and F on the curve
• (b) On the same figure, label as point U the production of 3 thousand units of clothing and a 3
million units of food and as point H the production of 6 thousand units of clothing and 3.5 million
units of food. What do point U and H indicate?
• (c) What is the difference between unemployed and underemployed economic resources?
• (d) When is the production efficient?

Table 1
Alternative or point Units of food Units of Costs of additional
(millions) clothing units of foods
(thousands)
A 0 8.0
B 1 7.5 0.5
C 2 6.5 1.0
D 3 5.0 1.5
E 4 3.0 2.0
F 5 0.0 3.0

Principles of increasing opportunity costs

• Resources are not equally efficient in the production of goods and services
• When decision is made to produce more of a commodity (e.g guns) and less of other (butter), the
resources reallocated to the production of the first are usually less productive
• Implying that larger amounts of resources are transferred from the production of the 2nd to the
production of the 1st
• Increasing units of the 2nd are given up for fewer incremental units of the 1st
• Increasing opportunity cost of production of the 1st commodity illustrates the principle of
increasing costs
• The law of increasing opportunity costs states that as production of a product increases, the cost
to produce an additional unit of that product increases as well.

Scarcity in a Free Market economy system or a capitalist market economy/ laissez-faire system
• Free market is a market with no government interference.
Government only provide defense and core services
• Households own resources, allocate resources through the workings of the price mechanism
• Prices resolves the three fundamental economic questions of what, how and for whom to produce
• The only goods and services produced are those which individuals are willing to purchase at a price
sufficient to cover the cost of producing them

Scarcity in a Free Market economy system

• There is competition which affects the price of the goods and services produced
• Because of scarce resources, goods and services are produced under this system using the
technique and resource combination that minimizes the cost of production
• Goods and services produced are distributed or sold to those who are willing and have the money
to pay their prices
• What then develops is a circular flow
Scarcity in a command economy/systems
• In Command systems like Eastern Europe, former Soviet Union, what to produce, how to produce
it, and who gets what's produced are controlled by a central planner.

Scarcity in a mixed economy system

• Under this system, government replaces, regulates or modifies the price mechanism
• For instance, in US, government produces some goods itself (police protection, road)

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• government finances these expenditures by taxing the income of individuals and businesses
• Government also influences what to produce by imposing direct regulations on producers or on
specific goods and services

3. Demand, Supply and Equilibrium

 Demand
 Shifting of the market demand curve
 Supply
 Shifting of the market supply curve
 Equilibrium price and quantity
 Equilibrium when market demand and/ or market supply shifts
 Government and price determination

Demand
• The term demand refers to the number of units of a particular good or service that consumers
(households) are willing to purchase at a particular period.
• This refers to actual quantities purchased at a certain price at a point in time.
Table 1: DEMAND SCHEDULE
Px( ) 2 4 6 8 10 12
Qx(Kg) 12 8 6 4 2 0
• A market schedule shows the units of a good or service that individuals are willing and able to buy.

Factors that determine the quantities of goods and services demanded include:
• Price of the commodity.
• Price of other goods and services.
• Average household disposable income.
• Wealth
• Taste and preferences.
• Size of the population

Quantity
Fig 1: INDIVIDUAL’S DEMAND CURVE

• Price of the commodity: stated differently Qx = f (px) i.e. the quantity of commodity x demanded is
a function of the price of x.
• The relationship between price and quantity demanded is inverse. This is due to a substitution and
an income effect.

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• As price falls, an individual purchases more of this good to replace others whose price has
remained unchanged.
• When the purchase price of a good falls, an individual with a given income can buy more of that
commodity.
• The demand curve above is drawn on the assumption that other variables are held constant.
• A change in demand refers to a shift of the demand curve because a variable other than price has
changed.
• A change in quantity demanded occurs when there is change in the price of the commodity,
leading to a movement along an existing demand curve.
• A change in any of these other variables:- price of other goods and services, average household
disposable income, wealth, taste and preferences and size of the population will cause a change in
demand and consequently a shift of the demand curve.
• Such shifts could be inward signifying a decrease in demand or outward indicating an increase in

Figure 2 : MARKET DEMAND CURVE

demand.
SUPPLY
• The quantity of a commodity that producers wish to sell at various prices is the quantity supplied.
The supply schedule specifies the units of good or service that a producer is willing to supply at
alternative prices.
Table 2: Supply Schedule
Price per kg (p) Quantity Supplied (s)
20 5
40 46
60 70
80 100
100 115
120 122

• The graphic presentation of the supply schedule is the supply curve. The curve has a positive slope
indicating that suppliers must have a higher price to increase supply.

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Figure 3 : AN INDIVIDUAL PRODUCER’S SUPPLY CURVE

• The determinants of the quantity supplied of goods and services are:

– The commodity’s own price.
– Number and /or size of producers.
– Factor prices (wages, interest or rent paid to economic resources}.
– Cost of factors of production
– Technological progress
– Government subsidy/or taxes on output

• A change in quantity supplied indicates a change in the price of the commodity leading to
movement along the supply curve.
• A change in supply denotes a shift in the supply curve
The curve shifts to the right when more producers enter the market, decreases in factor prices,
improvement in technology and government subsidy.

Equilibrium price and quantity

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• To consider how prices are determined in a competitive market by the forces of supply and
demand, we assume first that other factors except the commodity’s own price are held constant.
• Equilibrium price is the price at which quantity demanded equals quantity supplied.
• It is a situation in which there is no tendency for price or quantity to change.
Table 3:
Price( ) Quantity demanded Quantity supplied
20.00 110 5
40.00 90 46
60.00 77 77
80.00 67 100
100.00 62 115
120.00 60 122
At P =60.00; Qs = Qd
• Graphically, the equilibrium point is that point where the market demand and market supply
curves intersect.

Figure 5 : DEMAND SUPPLY AND EQUILIBRIUM

• At prices below the equilibrium there will be shortages and rising prices. And at points above the
equilibrium there will be surpluses and falling prices.
Equilibrium when demand and /or supply changes
• Equilibrium price and /or equilibrium quantity change when the market demand and /or market
supply curve shifts.
• An increase in market supply without a corresponding increase in market demand will lead to a fall
in equilibrium price and an increase in equilibrium quantity – market supply curve shifts down and to
the right and demand is unchanged.

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Figure 6: Equilibrium when supply curve shifts

• Equilibrium price and equilibrium quantity both rise when there is an increase in market demand
• An increase in both market demand and market supply result in a higher equilibrium quantity.
• The change in equilibrium price is indeterminate, when the magnitude of the demand and supply
shift is unspecified.

Government and price Determination

• Government sometime intervenes in the market by setting a minimum price (price floor) or a
maximum price (price ceiling) for a good or service.
• Price ceilings are usually set below equilibrium while price floors are set above the equilibrium.
• An example of price floor is minimum wage and price ceiling is pump price of (PMS) Petrol
• These result in disequilibria.
• When there is a price ceiling, market demand will be greater than market supply resulting in
shortages.
• The government can restrict demand by rationing.
• The market can respond to the shortages through the development of black markets
• In rationing, a consumer must possess a coupon authorizing the purchase of a good in addition to
having the willingness and financial capacity to purchase the good or service.
• A price floor results in excess supply
• Government can control the excess supply by shifting the market supply curve to the left through
taxes. This will increase equilibrium price of the commodity and reduce equilibrium quantity.
• Government can subsidize the produce leading to a fall in equilibrium price and increase in
equilibrium quantity.
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4 – 5 DEMAND AND SUPPLY OF ELASTICITY.

Elasticity of demand is the responsiveness of a change in the quantity demand due to a change in
many independent variables such as prices, income.
Mathematically, this can be represented as shown below: -
E = Δ Q/ ΔX
Where E = Elasticity,
Q = Quantity demanded;
X = independent variable.
ΔQ =Change in quantity
ΔX =change in independent variable
• Price elasticity of demand is the percentage in the quantity demanded in response to a percentage
change in the price of that good.

•Elasticity (E) = - % change in Quantity demanded

% Change in price.
• The value of the elasticity is negative because the slope of the demand curve is negative or
downward slopping.

Illustrations
• If the price of gari decreases by 10%, and the quantity demanded is less than 10%, the demand is
inelastic
• If the price of meat decreases by 10%, and the quantity demanded decreases by more than 10%,
the demand is elastic
• If the price of salt decreases by 10%, and the quantity demanded increases by 10%, the demand is
unitary elastic
• To determine the price elasticity, we calculate the total revenue (TR.). If there is no change in the
TR at different prices, then there is unitary elasticity. When TR2 > TR1; the element is elastic
• When TR2< TR1 then the demand is inelastic.

• Example
• At 25 bottle 100 bottles of coca-cola are sold. If the price drops to N20 / bottle, the week sales
increase to 110 bottles. Is the demand elastic or inelastic?
• Solution:
• P1 = 25; Q1 = 100; P2 20; q2 = 110
TR1 = P1 x Q2 = 25 x100 =2500.
TR2 = P2 x Q2 = 20 x 110 = N2200.
• Since TR2 < TR1, the demand is elastic.
• Income elasticity (EY)
• Income elasticity is the percentage in quantity demanded due to a percentage change in income.
• EY = ΔQ / ΔY = ΔQ . Y
• Q / Y ΔY Q

Income elasticity (EY)

• Income elasticity is the percentage in quantity demanded due to a percentage change in income.
• EY = ΔQ / ΔY = ΔQ. Y
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Q/Y ΔY Q
• If Ey > o => Normal good
•Y = New income
• Ey > o => inferior good
•ΔY = Change in income
•Ey < 1 => income inelastic
• Q = Original quantity
• Ey > 1 => income elastic
• ΔQ = change in quantity demanded.

Cross elasticity
• The cross elasticity of demand B.A is the responsiveness of the quantity demanded of good B to a
change in the price of another good A.
• εB, A = ΔQB / QB
• ΔPA / PA.
• ε A, B is the change in quantity of A demanded with respect to change in the price of commodity.
• If ε A, B is positive, it implies that as price of good B increases, the quantity of commodity A
demanded increases.
• Therefore, commodities A&B are substitutes.
• If on the other ε A, B is negative, it shows that as the price of commodity B increases the quantity
of commodity A demanded decreases.
•Therefore, they are complements. Example is bread and butter.

• Exercise 1
• Define the following terms giving appropriate equations.
•a. (i) Price elasticity
(ii) Income elasticity
(iii) Cross price elasticity
• b. An economist conducted a study on the consumption of eggs in Kebbi State, Nigeria. His report
shows that the quaintly of eggs demanded varies from time to time. He equally reported a demand
function as:
q = 24 – 0.2p
Where q = quantity of eggs demanded
p = price
• Using the above information;
• i. If the price of egg falls from N70/crate to N50/crate determine the price elasticity of demand
• ii. What conclusion can you draw from the result obtained in (ii) above?

• Solution
• (i) q = 24 – 0.2p
P1 = 70; P2 = 50
q1 = 24 –0.2P1
= 24 – 0.2 (70)
= 10
• q2 = 24 – 0.2P2
= 24 – 02 (50)
= 14
• Ep= q2 – q1 P1
P1 – P2 P2
= 14 – 10 70
70 – 50 10
= 4 x 7= 28 = 1.4
20 20

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• ii. Conclusion:
• Since the price elasticity is greater than one i.e Ep > 1, it shows that the demand is elastic.
• Therefore, a small increase in the price of egg will significantly affect the quantity of egg
demanded.

• ELASTICITY, TOTAL EXPENDITURE AND TOTAL REVENUE

• The amount of money consumers spend in purchasing goods and services is the gross revenue of
suppliers.
• Changes in the price of a commodity will either lead to an increase or decrease in the gross
revenue of the producers depending on the value of elasticity.
• If the demand is elastic, i.e when own price elasticity of demand is greater than 1.
• A fall in price will lead to an increase in total expenditure of consumers and total revenue of
producers
• But an increase in price will lead to a decrease in total expenditure of consumers and a decrease in
total revenue of producers.
• When demand is inelastic i.e when elasticity is less than 1, a fall in price will cause a decrease in
total expenditure and consequently
• A fall in total revenue, but an increase in the price of the commodity will increase total expenditure
and total revenue.

• Value of elasticity Price of commodity Quantity of commodity Total revenue

• Greater than one Fall Increase Increase
• Greater than one Rise Decrease Decrease
• Less than one Fall Decrease Decrease
• Less than one Rise Increase Increase
• Equal to one Rise/fall Unchanged Unchanged

• When elasticity of demand is unity , an increase or decrease in the price of a commodity leaves
total expenditure and hence revenue unaffected.
• A fall in price will generally lead to an increase in total quantity demanded
• But total revenue will decrease with elastic demand curve but increase with elastic demand curve.
• The most important determinant of elasticity is whether or not the product has close substitute e.g
fish and beef and margarine.
Substitution is possible only if the price of the substitutes remain constant.
• We expect little decrease in quantity demanded when the price of such commodities go up. The
degree of elasticity depends to a great extent on how widely or narrowly a commodity is defined.

6–7 UNEMPLOYMENT AND NATIONAL INCOME

LABOUR AND UNEMPLOYMENT
Labour Market may be defined as an organization in which buyers and sellers of labour are in close
contact. Where the wages and conditions of service are stated and agreed upon.
•The Concept of Labour Force: Labour refers to all human efforts used in the labour force is the
production of goods and services on the other hand the total number of the employed, the self-
employed and the unemployed.
•That is, those who are working and those who are looking for work.
• Labour force can also be described as the numbers of people allowed by law to work.
•The Labour force falls into the age bracket of18-65 years.

• Demand for Labour.

• Demand for labour may be defined as the total number of workers that are being engaged by
employers at a particular time.
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• Factors that determine the Demand for Labour.

• Demand for goods and services. Demand for labour can be stimulated by an increase in the
demand for goods and services.
• Expansion of purchasing power: When the purchasing power expands as a result of increase in
wages, the demand for labour increases and viz versa.
• The market size: The size of the market for the goods and services produced determines thee
demand for labour.
• Rate of Substitution. Demand for labour is affected by the availability of possible substitutes, such
as machines etc. that can actually do the job of labour.
• Labour efficiency. If labour is high, there would be high propensity for producers to hire more
labour and vice versa.
• The price size of labour (wages rate).
• The tastes of consumer, which define their trade-off between leisure and work.
• The size of population.
• The labour force participation rate.
• The occupational, educational and geographical distribution of the labour force.

• Efficiency of Labour.
• Efficiency of labour may be defined as the ability of labour to increase output without increasing
the quantity of labour.
• Efficiency of labour is actually referring to an increase in the level of production per capital.
Factors that determines variation of wages:
• (i) Difference in hours of work:
• (ii) Difference in the cost of training
• (iii) Job Demand some jobs demand a very high sense of responsibility.
People in such occupations are paid higher.
• (iv) Government policies:
• (v) Scarcity of Labour Supply

Types of Wages:
• Nominal wage: This can be described as the total amount of money a labour is paid at a particular
period of time.
• Real wage: This means the purchasing power of labour. It is the amount of goods and services the
labour can use his money to buy.

CONCEPT OF UNEMPLOYMENT
• The inability of labour to move creates unemployment. This unemployment cannot separate from
labour.
• Types of unemployment
(i) Mass Unemployment: This is the most serious of all types of unemployment because it affects
nearly all the industries at the same time. Mass unemployment is caused by a general deficiency in
demand.
(ii) Frictional Unemployment: This is caused by change in demand. This type of unemployment
occurs as a result of immobility of labour.
(iii) Structural Unemployment: This type of unemployment occurs due to technological progress.
The immediate effect of labour saving machinery is to make some workers redundant, thereby
causing unemployment.
(iv) Seasonal Unemployment: This type of unemployment occurs in some kind of work for instance,
bad weather and caused a temporary suspension of work in the construction industries which at that
time render the worker redundant with a resultant effect of unemployment.
(v) Residual Unemployment. This occurs due to all other causes. This includes those people termed
as unemployable due ill health or disability.

Causes of unemployment

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(i) Lack of industrialization: when a country is not industrialized, it has limited employment
opportunity; this makes it difficult for the available labour to be fully absorbed.
(ii) Over Population: This is one of the major causes of unemployment. It is an indication that
demand is higher than supply.
(iii) Lack of development plans: Some countries do not have a functional development plan and this
creates a lot of problems, as the government does not know how to make provision for the labour
force
(iv) Geographical immobility of labour: In some cases, workers find it very difficult to move from
one geographical area to another and this result in unemployment.
• (v) High Cost of Education: In most developing countries, the cost of acquiring education is very
high people can afford it and be engaged in skilled job, hence unemployment

Supply of labour
Supply of labour may be defined as the total number of men. Women and children of workingage in
a country.
Supply of labour can also be described as services of labour available for production or available in
the labour market.

Factors that Determine Supply of Labour:

• Age distribution of population.
• Population: The size of the population is directly related to the supply of labour.
• The reward for labour:
• Number of hours worked:
• Factors Affecting the Size of Labour Force.
• The size of country’s population: The higher the size of the population the higher the amount of
labour that would be available in the labour force.
• Total number of labour force willing to work
• Mandatory age of retirement:
• The age distribution of the population.
• The number of disabled and sick persons of working age.
• School leaving age
• Number of those retiring before retirement age
• The number of working women
• Number of working Hours.

Consequences of unemployment
(i) Social problem: Unemployment increases crime rate in a country
(ii) Migration: When people are not engaged in meaningful employment in a particular area by they
would be forced to move to other areas in search of jobs
(iii) Threat to Peace and stability: If people are not employed, there is the tendency for them to
engage in activities that will create instability and a breakdown of law and order is very high.
(iv) Reduction in investment: Unemployment reduces the propensity to invest in a country.
(v) High Rate of dependency: Unemployment increases the rate of dependency.

• NATIONAL INCOME
• Definition: The total amount of goods and services (in value terms) available to the people over a
given period of time which is usually a year.
• Gross National Product: The value of goods and services produced by the nationals of the country
whether currently residing in the country or living abroad
• Gross Domestic Product: The value of goods and services produced by residing in the country
irrespective of their nationality.
•Disposable income: This is calculated by deducting taxes from personal income.
• Disposable income = Personal income - Taxes

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•Personal income: This is the current income of households or persons from all sources which
include receipts such as transfer payments from which no productive services are produced by
recipients.
•Transfer payment: Money given by the government to its citizens. Example includes social security,
unemployment compensation and welfare.
• Methods of Measurement: There are 3 methods of measurements namely:
1. Output- This is obtained by adding the value of all goods and services produced by all sectors of
the economy during the year. Only final goods and services are included. Intermediate goods and
services are excluded to avoid double counting.
2. Expenditure-This is obtained by adding the spending on all final goods and services produced in
the economy.
3. Income: This is done by adding up all the income paid out to the owners of factors of production
i.e rent for land, interest for capital, salaries and wages for labour and profit for management.
• Problems of Measuring National income
• Products to be included
• Excluded market sanctions
• Valuation of products
• Stock appreciation
• Depreciation

• Uses of National Income statistics

•Measuring the level of production of an economy at appoint in time.
• Measuring the standard of living of different countries using per capita income
• Per capita income = National income/population size.
• Planning and Policy formulation

9. CONSUMPTION, INVESTMENT AND NET EXPORTS

DISCUSSION CONTENTS
• Consumption
• The Consumption Function
• The average and Marginal Propensity to Consume and Save.
• Investment
• The Investment Demand Curve
• Gross Exports and Gross Imports

CONSUMPTION
 Consumption is the amount a consumer spends in the purchase of goods and services.
 Consumer spending could be Autonomous (spending irrespective of receipt of income) or
Induced (spending resulting from income increase).

Determinants of Consumption
 personal income
 income taxes
 consumer expectations
 consumer indebtedness
 wealth
 the price level

Consumption is impossible without one earning income either through employment or transfers
from businesses or government.
Although, personal income is the most important variable of consumption, it is also affected by
personal income taxes which actually reduces the actual amount available for spending (disposable
income).
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The relationship between consumption and disposable income however is not a perfectly linear
one showing that other variables influence the consumers decision to consume.

THE CONSUMPTION FUNCTION

The consumption function depicts the relationship between consumption and disposable income.
C = f (Yd), Ceteris paribus.
That is, it is usually expressed as a positive and linear relationship when all other non-income
determinants of consumption are held constant.
The consumption function shifts when these non-income determinants change.

Table 1: Hypothetical Consumption Function for an Economy.

Disposable income (Yd) Consumption (C) Savings (S=Yd-C)
(Billion Naira) (Billion Naira)
500 500 0
550 540 10
600 580 20
650 620 30
700 660 40
750 700 50
800 740 60

The table can also be presented in a graphical form with consumption on the vertical axis and
disposable income on the horizontal axis.
The values of consumer saving (column 3) in table 1 is obtained by subtracting consumption from
disposable income.
The table initially shows that the consumer spends all his disposable income and as his disposable
income increases he saves more.

income-consumption relationship

800
700
c o n s u m p ti o n (C )

600
500
400
300
200
100
0
500 550 600 650 700 750 800
disposable income (Yd)

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THE AVERAGE AND MARGINAL PROPENSITY TO CONSUME AND SAVE

The ratios used to express the relationship between consumption, Savings and disposable income
include: Average Propensity to Consume (APC): this is the ratio of consumption to disposable income
at a specific level of income.
{APC = C/Yd}
Marginal Propensity to Consume (MPC): this is the ratio of the change in consumption relative to the
change in disposable income.
{MPC = ΔC/ΔYd}
Average Propensity to Save (APC): this is the ratio of saving to disposable income.
{APS = S/Yd}
Marginal Propensity to Save (MPS): this is the ratio of the change in saving relative to the change in
disposable income.

{MPS = Δ S/ΔYd}
APC + APS = 1
MPC + MPS = 1

Table 2: Ratios computed from the hypothetical example in Table 1

APC (C/Yd) APS Yd C MPC (ΔC/ΔYd) MPS
500/500 = 1.0 0 500 500 - -
540/550 = 0.98 0.02 550 540 40/50 = 0.80 0.20
580/600 = 0.97 0.03 600 580 40/50 = 0.80 0.20
620/650 = 0.95 0.05 650 620 40/50 = 0.80 0.20
660/700 = 0.94 0.06 700 660 40/50 = 0.80 0.20
700/750 = 0.93 0.07 750 700 40/50 = 0.80 0.20
740/800 = 0.92 0.08 800 740 40/50 = 0.80 0.20

From Table 2, the APC decreases from

1.0 to 0.90 as disposable income increases from N500b to N800b but save 8% of their income at
N800b.
The MPC is constant throughout at 0.8 while the MPS (1-MPC) is 0.2.
Note also from the Table that APC + APS= 1 and MPC + MPS = 1 102

INVESTMENT
Gross investment is the sum of residential construction, non residential construction, the purchase
of producers’ durable equipment by businesses, and the net change in business inventories.
It is the least stable component of aggregate spending and a principal cause of the business cycle.
In the national income accounts, investment consists of residential construction, nonresidential
construction, producers’ durable equipment, and changes in business inventories.
Generally speaking, the decision to invest is a negative function of the rate of interest, holding all
other factors (non-interest variables) constant.
Other non-interest variables affecting investment demand include:
(a) Residential construction i.e. purchase of housing units. This is also influenced by:
 demographics
 buyer’s level of indebtedness
 wealth of buyers
 current and expected income level
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 willingness to incur new debt

 ability of buyers to obtain loan
 cost of housing units, and
 mortgage rate of interest.
(b) non-residential construction i.e. offices, hotels and other commercial real estate. Their demand is
also influenced by:
 the rate of interest
 the vacancy rate of existing units
 needs for additional commercial space
 ability of business units to meet
 increased rental costs
(c) producers’ durable equipment is influenced by:
 borrowing costs
 utilization of existing productive capacity
 availability of more efficient technology
 current and expected sales
 existing and future competition

(d) changes in business inventories are linked to:

 rate of interest
 current and expected sales
 current and expected inventory prices
 certainty of inventory deliveries

THE INVESTMENT DEMAND CURVE

 It is a curve that shows the relationship between gross investment and the rate of interest,
while other variables affecting investment spending are held constant.
 Investment spending is inversely related to the rate of interest i.e. the higher the investment
the lower the rate of interest and vice versa.

GROSS EXPORTS AND GROSS IMPORTS

 Gross exports are the value of goods and services produced in a home country and sold
abroad.
 Gross imports are the value of goods and services purchased by a home country from
abroad. Imports usually lower the aggregate spending of a nation on domestically produced
goods.
 Net exports are the value of gross exports less gross imports.
 Net exports might be negative or positive. It is positive when the country exports more than
it imports and negative when it imports more than it exports.

Factors affecting Imports and Exports

 Level of income
 Foreign exchange rate
 Domestic price relative to prices in foreign countries
 Import tariffs
 Restrictions on imported goods
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10. INFLATION, DEFICITS AND DEBT

DISCUSSION CONTENT
• Meaning of inflation
• Types of inflation
• Causes of inflation
• Effects of inflation
• Control of inflation
• Phillips curve
• Government deficit
• Public debt

MEANING OF INFLATION
• In economics, inflation is a continuous rise in the general level of prices of goods and services in an
economy over a period of time
• An increase in the general level of prices implies a decrease in the purchasing power of currency
• Inflation is usually estimated by inflation rate of price index (consumer price index)
Other related economic concepts to inflation
• Inflation rate is the % rate of change of price index overtime of the entire basket of goods in the
economy
• Deflation – an annual fall in the general price level
• Disinflation – a decrease in the rate of inflation
• Hyperinflation – an out-of control inflationary spiral
• Stagflation – a combination of inflation + slow economic growth and high unemployment
• Reflation – an attempt to raise the general level of prices to counteract deflationary pressure

CLASS WORK
• Does increase in petroleum product prices in Nigeria a signal of inflation? Discuss.
• What relationship do you think inflation has on interest rate?
• In year 2009, the price level was N200 and in year 2010, the price level was N210, the annual
percentage of inflation will be what?
• Inflation is always and everywhere a monetary phenomenon. Do you agree with this statement?
• The task of keeping the rate of inflation low & stable is a responsibility of what body?

TYPES OF INFLATION
• Creeping or chronic inflation – A period of gentle but continuous rise in the general price level of ≤
5%/yr
• Hyper or galloping inflation – Rapid rise in the general price level causing serious instability in the
economy.
• Walking inflation – price s rise moderately and annual inflation rate is a single digit of between 5-
10%
• Running inflation – prices rise at the rate of 10-20% /annum
• Pure inflation – A situation in which all prices including wages and other sources of income rise at
an equal rate
• Shock inflation – a sudden change in the price level that is caused by a rise in price of an important
good
CAUSES OF INFLATION
• Demand pull/demand-induced/Excessive demand inflation – This is characterized by a sharp
increase in demand that is not matched with increase in supply
 It arises from increase in population, increase in incle or combination of both
 A case was the Udoji award of 1975 and the 1981 minimum wage Acts which led to rapid
increase in dd without corresponding increase in ss
• Cost-push (supply-push) inflation – Originates from increase in the cost of production

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 It is usually associated with increase in price level, decrease in aggregate output and
increase in unemployment
 A case is if the Nigeria Labour Congress (NLC) is able to get significant increase in wages
without corresponding increase in production due to higher cost
• Rural-urban drift / migration leading to the neglect of agricultural sector
• War effect- Efforts are diverted from production of goods to production of war equipment/
armament
• Bad weather/ drought such as the 1973 drought
• Imported inflation (i.e. importing large quantities of goods and services from countries which have
inflation)

EFFECTS OF INFLATION
• Effect on income and standard of living
 Value of money falls
 Fixed income earners such as recipients of transfer payments (pensions, unemployment
insurance, social security, recipients of interest & rent lose
 Those of flexible income group like businessmen, shareholders, industrialists, traders real
estate holders, speculators gain
• Effects on income distribution: the rich tends to be richer & the poor poorer during inflation
• Effects on borrowers and lenders (creditors and debtors)
The creditors are generally worse off because the real value of their future claims is reduced to the
extent of inflation
 Debtors tend to pay less in real terms than they had borrowed. So inflation favours debtors
• Effects on wage earners- these set of people may gain or lose depending on the speed with which
their wages adjust to rising prices
• The tasks of both fiscal & monetary policies makers are complicated during inflation

CONTROL OF INFLATION
• Contract the economy by using monetary and fiscal policies
 forcing a recession / auterity measures/cutting down spending which may lead to hardship,
reduction of unemployment benefits
 Indexation. Here people become partially/ wholly immunized from chanh=ges in the general
price level through things like cost- of- living adjustment
• Tax-based income policy: This involves subsidizing companies whose wages and prices are rising
slowly and taxing those that boost inflation
• Price control measure: This involves setting up a price control board by government which fixes
maximum prices of certain commodities experiencing inflation
• Total ban on importation of certain items
• Increase in the production of goods and services. Example is the food security program ongoing in
Nigeria

WHAT IS PHILLIPS CURVE?

• The Phillips Curve is a graphical representation of the inverse, or negative, economic relationship
between the rate of unemployment (or more precise, the rate of change in unemployment) and the
percentage rate of change in money wages (Inflation rate).
• The theory behind this is fairly straightforward. Falling unemployment might cause rising inflation
and a fall in inflation might only be possible by allowing unemployment to rise.
• A low inflation and low unemployment are incompatible; therefore, governments have to choose
the best combination of both.
• If the Government wants to reduce the unemployment rate, it could increase aggregate demand
but, although this might temporarily increase employment, it could also have inflationary
implications in labour and the product markets.

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CONCEPT OF THE NAIRU

• NAIRU is Non-Accelerating Inflation Rate of Unemployment
• The concept was introduced by Milton Friedman, who criticized the original Phillips curve
• NAIRU is defined as the rate of unemployment when the rate of wage inflation is stable.
• NAIRU arose to explain how stagflation could occur.
• NAIRU also known as the "natural rate of unemployment", distinguishes between the "shortterm"
Phillips curve and the "long-term" one
• According to the proponents of the concept of the NAIRU, the equilibrium level of unemployment
is the outcome of a bargaining process between firms and workers.
DEFICIT SPENDING
• Deficit spending can simply be called "deficit," or "budget deficit," the opposite of budget surplus.
• Deficit spending is the amount by which a government, private company, or individual's spending
exceeds income over a particular period of time
PUBLIC DEBT
• Public debt, sometimes called national debt
• It is the cumulative amount money owed at any given time by any branch of the government.
• public debt is distinct from a budget deficit in that it is cumulative, whereas deficit refers to a
particular budget year's shortfall
• It encompasses the one owed by the federal government, the state government, and even the
municipal and local government
• Public debt is made up of external debt, which is money that is owed by the government to foreign
lenders, either in the form of international organizations, other governments, or groups like
sovereign wealth funds.
• It is also made up of internal debt, where citizens and groups within the country lend the
government money to continue operating.
• In some ways, this is a lot like lending to oneself, since ultimately the responsibility for public debt
falls back on the very people lending money.
• Public debt can also be broken down by the length of the loan made

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• Short-term public debt last only one or two years, and the turnover rate is fairly high
• Mid-term public debt lasts anywhere between three and ten years.
• Long-term public debt is designed to last more than ten years, with some long term debt lasting
considerably longer than that.

ASSIGNMENT
• What do you think are some reasons for Government Indebtedness?
• In what ways do you think a nation can correct its deficit spending?
• What do you think are the advantages of public debt?

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