Micro economic

Chapter one: Introduction :

Basic concept of
Agricultural economics
 OUTLINE
 Foundation of economics

 Definition of economics

 Scope of economics( Branches of economics)

 Nature of economics

 Efficiency and production possibility frontier(ppf)

and economic growth

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 Economic problems and Economic system
 1.1 Foundation of
Economics
 The fundamental facts of economics foundation
consist or the basic question-why study economics?

Unlimited human wants

a)
• Infinite
• Insatisfiable
b) Limited Resource
 Resources are means of producing goods and
service that society wants on.

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 Resources can be divided in two:
a) Free resource:
- Like breathing air, wind, river water, and sunlight
- it is gift of nature and no ask of price( at zero
price)
- No opportunity cost( no scarification)
- Qdd < Qss
b) Scarce resource: limited in supply
o Qdd >Qss
o Positive opportunity cost
o They are economic resources factors of
production like land, capital ,labor or human
force etc…..

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Economic resource/ factors of production
classified
a) Land- all gifts of nature
 Reward  rent

b) labor: human resource

Skilled labour
Unskilled labou
c) Capital: refers to all manufactured inputs
usable in the production of other goods
and service
E.g Textile machinery: input for textile factory

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  Human capital: skill, talents and knowledge
embodied in people
 Is not pure capital but only a type of labour

 Financial capital: stocks, bonds, paper money

 Not directly production(not directly economic capital)
 The reward for it is interest

 Real capital: various durable manufactured

types of capital capable of producing other
goods and services. E.g machinery equipment

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 d)Entrepreneurship:
 is a special type of human expertise with the
objective of making profit(∏) that organizes
and manages factor of production and takes
risk of making loss(risk takers)
 The reward for entrepreneurship is profit

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Characteristics of entrepreneurship
Initiative
Decision makers
Risk takers  risks for effort, time, finance..
Entrepreneurship: organize factors of
production to get output for maximizing profit
Innovators: ability to create new type of business
after creating new type of business they may
produce new product and new market.
The difference b/n innovator and inventor is the
later create idea write it design it not
implement it but the former create, write,
design and implement

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 1.2 Definition of economics
 It deals with:
 How societies allocate scarce resources in
the production and distributes of goods and
services to attain the maximum fulfillment of
society’s material wants i.e  Limited resource
and unlimited human wants.

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 1.3 Scope of economics
• By scope of Economics mean:
o coverage or major areas of study
• The two main scopes or branches of
economics are:
1. Micro economics – from the Greece
prefix small
2. Macro economics- large

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 It is the study of the economy in the small
1. Micro economics

It deals with

Decision making of firms and individuals
Economic activities of individual
consumer and producers
Specific economic units
 It examines "the individual trees in the
forest”

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 2 Macro economics
It deals with the economics as a whole and
its aggregates and sub aggregates.
E.g Ethiopia GDP, GNP.
 It study“ the forest but not the individual
trees”
GDP is market value of all final goods and
services produced in a country in the a
given year.

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 1.4 Nature of economics
1.4.1 Goals of economics
1. Economic growth : means the production of more
output to increase the living standard of people
Economic development; broader and is social and
economic progress and seek to improve economic
well-being and quality of life for society
It has also multidimensional meaning. Eg Norway
is number one
 Quantitative: economic growth(GDP);e.g. 10%
 Qualitative: institutional set up, mass part
 e.g. – political participation of people must be developed
 Attitude of human being towards work
 Human resource activity
 Women participation in work
 Development index: income index, educational
13 index( enrolment index, literacy index)
 2. Economic security- welfare issue tele, water
 Provision of welfare; handicapped, disabled

3. Full employment
 All resource would be efficiently utilized
 Not resource would be idle
 Not worker should be involuntary out of work
 No( idle resource, -L, L, K, E fully utilized)

4.Economic efficiency; PPF production

possibility frontiers
5.Price stability
 They should not be fast fluctuation in price (stable)
 Two types of fluctuation
 Inflation;general price increase
 Deflation; general price decrease

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 6. Equity
 Fair distribution of national resource among the
citizens of the nation
 There should not be poverty gap(not great gap b/n
rich and poor)
 They should not be division b/n people

7. Balance of trade
 Trade deficit: export less than import
 X<M  high need of hard currency
 Trade surplus : export greater than import
 X>M
 Trade balance: export equal to import
 X=M
 As much as possible to try illuminate trade deficit for
development
 In minimum enter in trade balance for develop the
16 country.
 Scarcity ,Nature of Choice and
Opportunity Cost
What is the crucial ingredient that makes a problem an
economic one ?
 Scarcity:
is the central economic problems faced by all
individuals and all societies.
At any time the world can only produce a limited
amount of goods and services because of the
world only has a limited amount of resources.
o Good - is physical (tangible) things that
satisfies people’s wants and desires such as a
car or burger.
17 o Service- is something or any form of intangible
 Cont…….
So, scarcity : Is the imbalance between our wants
and resources.
The problem of scarcity lies in the inability of
people to produce the quantity and quality of all
goods and services (resources)that all people
want.
 Choice:
Because of scarcity or not enough resources,
people need be choice what should be produce
and what should not be produced.

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 Cont…….

The society must make choices about :

o What output to produce in what quantities and what
output not to produce
 involves decisions about the kinds and quantities
of goods and services to produce
o How to produce
 Requires decisions about what techniques to use
and how economic resources (or factors of
production) are to be combined in producing output .

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 Cont……
o For whom to produce.
 involves decisions on the distribution of output
among members of a society
 By deciding which goods and services to produce,
society will choose these at the expense of others.
 In other words, choice implies cost. i.e., choice
involves sacrifice(give up).
 This means that when choice is made an alternative
opportunity is sacrificed.

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 Cont…..
 opportunity cost :
 Is value of the next best alternative that must be
sacrificed or missed(forgone) in order to obtain one
more unit of a product.
Opp cost = Units given up of one
good
Units obtained
of another good

 Scarcity choice opportunity.

 The economics equation is clearly illustrated using

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the production possibilities curve
 Efficiency and production possibility frontier(ppf)

Economics is a science of efficiency

In order to understand efficiency we have to achieve
two things
1. full employment
2. full production
 Full employment; all factor of production(L,L,K,E)
efficiently utilized(no idle resource)
 Full production:
Is productive efficiency in which the goods and
services society desires are being produced in the
least costly way

22 Is producing goods and service at least cost.
 Cont…….
Production possibility frontier(PPF)
 is a curve or graph that shows the various
combination of goods and service that can
produced in a full employment and full production
economy in which case the available resources are
fixed, and technology is constant
 On the PPF curve, it is impossible to produce more
of one good without producing less of another or
without sacrificing production of another good.

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 Production possibility
curve

A
Unattainabl
e and
Efficient
attainable
Inefficient and
attainable

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 Production possibility schedule

Commodit Production possibility

y type

A B C D E

Machine 100 90 70 40 0

Bread 0 10 20 30 40

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 Cont…..…….
 The combination is attainable :
-The society can produce of both
commodities
 The combination is efficient:
- a society must achieve both full
employment and full production
 Unattainable : we cannot attain with limited factor of
production( with limited technology and fixed resources)
 It can only be achieved by increases in resource supply
and quality, and technological advance, or in general
economic growth
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 Cont……
Ex. If the society wants to produce more bread, say
20 loaves Bread, the society is forced to reduce its
production of machine from 90 to 70. Thus, we say
that the society is efficient at point B (and also at
points A, C, D and E)
 Ex B(10, 90) transfer to C( 20, 70) increase the
amount of bread produce, sacrifice machine
produce on PPF.

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 Cont…..

 Example, In moving from point B to point C in the above PPF, 20

units of machine must be given up (forgone) in order to obtain 10
additional loaves of bread. Thus, the opportunity cost is given by:

Opp cost = Units given up of one good

Units obtained of another good

 Numerical example of opportunity cost

Movement from B(10, 90) to C (20, 70)

Opportunity Cost: Sacrifice ( forgone) = 70-90

gain( obtain) 20-10
-20
10
=/-2/= 2
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Economic problems and Economic system
Three fundamental economic problems
1. What to produce ?
i.e by the interaction of dd and ss.
 This refers to the identification of what mix of
good and services to produce over a period of
time.

 What collection (kind) of goods and services will

mostly satisfy the needs of its citizens and what
quantities the goods and services to produced
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 2. How to produce?
 this problem refers to technical and
organizational problem of production.
 Choice of technique of production.

3. For whom to produce?

 Refers to distribution of outputs
 In market economy : Demand and supply
determined by the price system( profit oriented)
.

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 Economy system
 In a set of organizational and institutional
arrangements and coordinating mechanism
establishing to answer the three basic economic
question
There are three economic systems
1. Capitalism/ market economy
2. Command/ socialist/ planned economy
3. Mixed system.

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 1. Capitalism

 The three basic economic question are

answered by price system( market mechanism)

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 Specific characteristics of capitalism
1. Market determination : price is the main
determinant factor of the market
2. Freedom of enterprises and consumers
sovereignty ( free entry and exit the market.
3. Private ownership of resources
4. Competition and independence
5. Specialization of goods
6. Role of self interest or individual system
7. Profit motive( profit oriented)
8. High inequality( high marginality)

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 In capitalism system the gap b/n rich and poor is
high. The ownership of the means of production
is falls in the hands of a few wealthy persons.

2. Command system
 The 3 basic fundamental questions are
answered by central planning Authority( CPA)
appointed by the government.

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 This is a form of economic system in which
means of production except labor are owned by
the state and groups

Both resource allocation and pricing decision is

undertaken by a central planned decision.

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 Specific characteristics of command system
1. Central planning board determination
2. Restrictive policy ( no freedom of enterprise
and no consumer sovereignty)
3. High government intervention
4. No competition ; due to price is allocated by the
government
5. Public ownership of resources
6. No specialization
7. Role of social interest ( welfare point of view)
8. Social motives
9. Highly equity .
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 3. Mixed economic system

 In such a system both government and the

market mechanism answer the fundamental
economic questions.

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 Market and Gov’t - distribution of income
- provision of market goods
- correcting market failures
- stabilizing the economy etc..

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Chapter Two: Market model
Demand, Supply and Utility
Theories
 Market model
A market: is an institution or an established
arrangement or place or mechanism, which
brings together buyers (demanders) and sellers
(suppliers) of particular goods or services.
 It is a place where potential buyers and sellers
meet.
Or, market is an institution arrangement within
which a voluntary exchange is taking place
between buyers and sellers of goods and
services in specific place with a given period of
time.
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 Market model deals with the following theories.

Theory of demand

Theory of supply

Theory of equilibrium

Theory of elasticity

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2. 1. Definition, law and
determinants of demand of
agricultural commodities
 Demand in economics has different meaning as compared
to our day-to-day use ( ordinary meaning is want or desire)
 Demand in economics is defined as a schedule,
 Which shows the various amounts of a product
which consumers are willing and able to purchase
at each specific price in a series of possible prices
during some specified period of time in a specified
market.
Or in shortly it is:
 Amount of a good or service consumers are willing &
42 able to purchase during a given period of time
 Cont……….
 Important elements from the

definition of demand
Purchaser or demander for goods and
services.
Seller or supplier of goods and services.
Products/ goods and services.
Specific period of time
Specific price.
Willingness and ability.
.
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 Demand schedule and Curve
Demand schedule :
 Is a tabular presentation of the demand for a
commodity.
 It is simply a tabular statement of a buyer’s
plans, or intentions, with respect to the purchase
of a product.
E.g. Example Demand Schedules for a
Commodity X
Price per unit (in Birr/ Quantity
unit) Demanded/Week
(units/wk)

1 5
2 3
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3 1
 It is a graphic representation of preferences for a
particular good.
In other words, it is the graphic form of the demand
schedule- the quantity on the horizontal axis and
the price on the vertical axis.
The demand curve : shows an inverse
relationship between product price and quantity
demanded.
price

Vertical axis :Price

Horizontal axis: quantity

Quantitiy
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 The Law of Demand
 Keeping all other factors being constant
(ceteris paribus), as price falls, the
corresponding quantity demanded rises, or
as prices increases, the corresponding
quantity demanded falls.
 Qd/P must be negative
 The most important circumstance
affecting the demand for a good is the
price.
 People buy more if the price of a good
falls; they will buy less if the prices rise,
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 Factors/ Determinant / Influencing Demand
 Generally, there are two determinants.
1. Own-price determinant/demand mover/-the price of the product
2 . Non- Own-price determinants/demand shifters/
1. own- price
Law of demand P and Qdd= -ve slope.( inverse relation ship).
2. Non- Own-price determinants
1) The income of consumers (level of income of consumers)
 The relationship between income and demand will depend
upon
1. The type( nature of ) product considered
2. The level of consumers’ income.

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 Cont…………….
 Generally , for most goods and service as increase in
income(y) (purchasing power) will cause an increase
in demand, such type of goods are normal goods.
 y and dd of normal goods= they have direct (positive
relationship)
 Normal goods divide into luxury goods and necessity
goods.
But as y increase some the level goods and services
whose dd decrease such type of goods are inferior
goods.
ex. Bean Vs meat.
Dd of inferior goods and income= -ve ( inverse relationship)
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 2. Price of other related goods
The effect of the change in the price of other related
goods is dependent on the nature of the relationships
between the goods in consideration.
 The are two particular interrelationships of demand
which may be quantified,
a) substitutes goods : two goods are substitutes if
they satisfy similar needs or desires.
With substitutes, the demand for one rises as the price
of the other rises or the demand for one falls as the
price of the other falls

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For example, for many people butter is a substitute for
cooking oil and vice versa
ex : coca and Pepsi
tea and coffee
 If price of tea increase = demand of coffee
increase

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 b) Complementary goods: are those goods that are
jointly consumed or demanded.
With complements, the demand for one rises when the
price of the other falls and the demand for one falls as
the price of the other rises.
 Thus if two goods are complements, the price of one
good and the demand for the other are inversely
related.
Ex2: price of car increase = Qdd of fuel decrease
price of car decrease= Qdd 0f fuel increase

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 3.Tastes and preferences
These are usually subjective and changing.
Positive taste and preference favor the demand for
a commodity.
 A change in favor of a good shifts the demand
curve rightward.
A change in preferences away from the good shifts
the demand curve leftward.
Ex : fashion
4. Change in number of buyers
Since the market demand for a good or service is
the sum of all individual demands, an increase in
the number of buyers in a market increases
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demand.
 5. Size and composition of population
Composition Age composition
sex composition

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 Age composition= predominance youth – e.g price of
cosmetics
increase
predominance Adult- price of
normal good increase
 Sex composition= female( price of female material
increase)
6. Seasonal factors( time)
The demand for many products is influenced by the
season.
Example, demand for cloth during holidays; demand
for meat during fasting period.

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 7. Expectation of consumers about future income,
price and product availability affects demand.
Current demand depends heavily on long-term
expected income.
Expectation of rise in future income may initiate
consumers to increase their current spending.
An increase in future price= current dd for goods
and service increase.
e.g Teff in December
Future product availability= current dd for goods
and services decrease .

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8. Culture: Religious or traditional forbidden for some
products- either seasonal or permanent.
9. Government influences: prohibitions or restrictions
of some goods decrease the demand.

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 2.2 Definition, law and
determinants of supply of
agricultural commodities

 Supply of a commodity can be defined as the -

quantity that producers are willing and able to
offer for sale in a given time period.
 Supply is which tells us the quantities of a product,
which will be supplied at various prices, all other
factors being held constant.

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 The Supply Schedule:
Is a tabular presentation of the supply for a product.
It shows a series of alternative price-quantity supplied
combinations.
In other words, it lists the quantities supplied at each different
price, when other non-price factors are held constant.

E.g. Hypothetical supply schedules for commodity X

Price per quintal (in Quantity supplied/week
Birr)
1 2
2 4
3 6
This shows with an increase in price the quantity
supplied also increases.
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Supply curve: graphical representation of price and Qss
combination
P
ss

Qss

The supply curve has a positive slope showing the

positive or direct relationship between price and the
quantity supplied, holding everything else constant.
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 Law of Supply
 Other things being equal, the higher the price of a
good, the greater is the quantity supplied, i.e. price
and quantity supplied is directly related.
 As price rises, the corresponding quantity supplied
rises; as price falls, the quantity supplied also falls.

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 Factors Influencing Supply (Determinants of ss)
Two major determinants
1. Own-price determinant/supply mover/-the price of
the product
2. Non- Own-price determinants/supply shifters/
1. Own-price determinant
 P and Qss have +ve relationship movement
along the supply curve is change in Qss
P
ss

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Qss
2. Non- Own-price determinants
1. Price of related goods
a. Production substitutes
b. Production Complements

i. Production substitute
 Two products are substitutes in production when an increase in
the price of one product causes a reduction in the price of the
supply of the other product.
Eg: farmer use the plot of land for production of barley
and wheat
W B W B

substitute

50% 50% 75% 25%

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because price of wheat increase
 Generally if the price of one production substitute
increase, this will decrease the supply of other
substitute.
ii. Production complements:
 Are goods that are production together or jointly, or
one is a by- product of the other product.
 Their production process is inseparable.
 Generally two products are complements in the
production when an increase the price of one product
causes an increase the supply of the other product.
Eg1: p(beef) increase= ss(beef) increase
= ss skin increase
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so P(beef) increase= ss skin increase .
2. Change in price of inputs (factors of production)
Inputs are the things that are used in the production of
goods and services. Change in the price of inputs
directly affects the cost of production.
Input costs =cost of production =units of
inputs used X respective prices
An increase in the price of a factor will increase the
cost of production of a firm.
For a particular commodity, when the costs of
production are low, relative to market price, then it will
be profitable for producers to produce a great amount.
When production costs are varying high relative to
price, producers will produce little (or may stop
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producing).
3. Change in the level of technology
The state of technology affects the efficiency of
production.
Usually advancement or improvement in technology
allows producers to reduce their cost of production
per unit of output.
This would therefore, have the effect of shifting the
supply curve to the right. However, the effect of
technology on supply tends to be a long-term.
4. Number of Suppliers
The larger the number of suppliers the higher will be
the volume of supply, other things being constant.

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5. Change in the level of taxes and subsidies
Taxes are deductions from the profit of producers
or they are additional costs to producers.

So their effect is similar to increase in cost of

production.
Subsidies, however, are opposite of taxes.
Subsidies are expense for the government or
society but deductions from the cost of production
to the individual producer. The government, for
instance subsidies on fertilizer products.

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 6. Nature, especially weather and pests
Bad weather, pests and disease can greatly
reduce supplies of agricultural products, while
good weather and absence of pests can greatly
assist in increasing yields and hence supply.

7. Expectation of producers with regard to future

price and other specific factors

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 2.3 Market Equilibrium
 Equilibrium is determined by the interaction of Demand
and supply curves.
 The actual quantity that demanders get in the market
and the actual quantity that producers offer are only
determined when the two actors meet in a market

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69
 Determination of the equilibrium condition
In any market one of the following three conditions may
exist:
1. Equilibrium (balance) Point
Qss= Qdd at market price
PE= equilibrium price.
QE= equilibrium quantity
 Equilibrium price: is the price at which the
wishes of buyers and sellers coincide or the price
that exists when Qdd equals Qss in a given
market, in specific time period. .
 It is sometimes is called market- clearing price.

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 Equilibrium quantity:The quantity at which the
amount of good buyers are willing to buy equals
the amount sellers are willing to sale, provided
that both have the ability.

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2. Excess demand (shortage): a condition in which
quantity demanded is greater than quantity supplied.
When excess demand occurs in an unregulated
market, there is a tendency for price to rise as
demanders bid against each other for the limited
supply.
3. Excess supply (surplus): a condition in which
quantity supplied is greater than quantity demanded at
the current price.
When there is excess supply, price tends to fall as
competing suppliers attempt to sell their product by
lowering the price

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 2.4 Elasticity
 Elasticity is a general concept that can be used to quantify the
response in one variable when another variable changes.
 It denotes the responsiveness (sensitivity) of one variable to
changes in another.
 It is a measure of the responsiveness of a market to a stimuli
(change in a variable)
Types of Elasticity
A. Elasticity of Demand
 It is important to determine how much the amount demanded
will change in response to a change in one of its determinants.
 Three types of elasticity's of demand
 Priceelasticity of demand
 Income-elasticity of demand
73  Cross-price elasticity of demand
 1. Price Elasticity of Demand
Measures how sensitive or responsive consumers are
to a change in the price of the commodity under
consideration other factors held constant.
It is the percent of change in the quantity of a good
demanded that is bring on by a one percent change in
price,
Edp = Percentage change in quantity demand
Percentage change in price
Edp =  Q / Qi = % Q
 P /Pi % P
= =  Q . Pi
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P Qi
 Where, Q = Change in quantity
demand
P = Change in price
Qi = Initial quantity
Pi = Initial price

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 Example : Assume that a price of birr 5 per kg of x ,
the quantity of x demanded is 12 kgs when the price
decrease to birr 4 per kg the quantity of x demanded
increase to 14 kgs. Then calculate elasticity?
Given
Po =5 birr Qo= 12 kgs
P1= 4 birr Q1= 14 kgs
Ed= Q . Po
P Qo
= 2 .5
1 12
= 0.83

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 Degree of price elasticity of demand
i. perfectly elastic demand( ed= ∞)
 If Qdd keeps on increasing or decreasing and price
remains constant , elasticity of demand is said to be
perfectly elastic.
Here a slight change in price corresponds to an
infinitely large change in quantity .
ii. Perfectly inelastic(Edp=0)
Quantity demanded does not change as price
changes.
Quantity demanded is completely unresponsive to
changes in price
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 iii. Unitary elastic: (Edp = 1).
 This is the intermediate case.
In this situation quantity changes by the same
percentage as price, i.e. both changes in the
same proportion.
Ex if a 10% increase in price is accomplished by
a 10% decrease in qdd…. Price elasticity is
unitary.
 Q . Pi =1
 P Qi

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 iv. Elastic: (Edp > 1)
 Quantity of demand is changes by a lager
percentage than price,
i.e. it occurs when some percent change in price
results in a large percentage change in quantity .
Ex; if the price of a commodity increase by
10% ,then in responses to it the qdd falls by
>10%.

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Ex : price of x commodity = 7 to 9 P
=2
Qdd of x commodity = 24 to 20.3
 Q= /-3.5 /

 Q . Pi =< 1
P Qi
/-3.5 /. 7= 0.6
2 20

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Exercise one
1. The price of a stick of cigarettes increased from 20
cents to 30 cents per stick. A smoker who used to
smoke 30 sticks of cigarette per day before the
rice in price now decreased to 27 cigarettes.
Calculate the price elasticity of demand and
degree of elasticity?

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 2 . Income elasticity of demand
 It relates changes in the quantity demanded to changes in
income.
 It measures the degree of responsiveness of the quantity
demanded of a product to changes in income.
Edy = Percentage change in quantity demanded
Percentage change in income

Edy = % Q = Q . yi
%y y Qi

Where,
Q = Change in quantity demanded
Y = Change in income
Qi = Initial quantity
82
 Cont…….
If demand increases when income increases, the
income elasticity is a positive number and such goods
are superior or normal goods, (Edy > 0)
If demand decreases with an increase income, the
income elasticity is negative and such goods are
inferior goods, (Edy < 0).
If demand change is the same as income change, the
income elasticity is unit, (Edy =1).

83
 Exercise2
Consider that the average monthly income of an
average Ethiopian increase from birr 120 to 150.
as a result, average monthly dd for good x
increase from 20 to 30 units
a, calculate income elasticity
b, identify what type of goods.

84
 3. Cross elasticity of demand
 If two commodities X and Y are either substitute or
complement to each other, the demand for one of them
will be responsive to changes the price of the other.
 The extent of this responsiveness is called cross
elasticity of demand

Edxy = Proportionate change in the quantity

demanded of good X
Proportionate change in the price of good Y

Where, good X and good Y are related goods.

denotes = Qx . Pyi
Py Qxi
85
 Ex :quantity of film decrease when the price of
camera increase,( complementary good)
Exercise 3
 Suppose the price of Y rises from 8 to 10 birr per
Kg and as a result, the demand for x rises from 4
to 6 kg. what is the relationship of the two
goods? ( find the exy)

86
 B . Elasticity of supply
Is also applicable to measure the behavioral changes
of the supplier/seller/ in response to the changes in
the determinants.
 Two types of elasticity's of supply
Price elasticity of demand
Cross-price elasticity of demand

87
 1. Price Elasticity of Supply(PES)
 Is the measure of responsiveness of
producers in terms of output to changes in the
price of their products.
Essp = Percentage change in quantity supply
Percentage change in price
Essp =  Q / Qi = % Q
 P /Pi % P
=  Q . Pi
 P Qi
E.g. If Esp is 3, a 5% increase in price will result
in a 15% increase in quantity supplied.
88
2. Cross-elasticity of supply
 The percentage change in the supply of one good
in response to a one percent change in the price of
alternative product (a product with in the production
possibility of the producer).
Esx = % change in quantity supplied of a good “X”
% Change in price of good “Y”
Where ‘X’ and ‘Y’ being production alternatives .

89
 The Theory Of Consumer Behavior And Utility
Consumer preference, Choice, and Utility
A Consumer is one or more individuals consuming
a basket of goods and services.
Basket of goods and services refers to the
various types but in fixed quantities of commodities
available for consumption.

90
 Cont…
Preference and Utility
 Preference: is the choice among
commodities to satisfy consumer wants.
 A consumer’s choice to purchase more or less of
a good or service (or not purchase) depends partly
on:
 The ‘taste’ (preference) of the individual
 The relative price of various commodities
available for purchase.

91
 Cont…
Commodities (goods and services) are desired
because of their ability to satisfy wants.
Goods and services however differ in their ability to
satisfy a want.
Example: -An individual may prefer coffee to tea.
-Another person still may prefer tea to
coffee.
Both consumers are still deriving some level of
satisfaction by consuming the good they choose .

92
 Cont…
 Utility : Is the power of a good or service that
enable it to satisfy human wants or needs.

Utility : is the level of satisfaction that is need

by consuming a commodity .
For example: _ bread has the power to satisfy hunger
- water satisfy our thirst
- books fulfill our desire for knowledge
-a bed gives us a service for our desire
to sleep
All the goods that people consume have utility.
Thus, utility is the “want satisfying power’’ of a
commodity.
93
 Cont…

 All the persons need not derive utility

form all commodities.
For example: - Non-smokers do not derive any
utility form cigarettes
-Men do not drive utility by consuming a
Modes;
- No one in Ethiopia (of course ‘Ethiopian
by birth’) derives utility from eating dog’s or
donkey’s flesh, etc.

94
 Cont…
 The utility of a thing can be different at
different places and time.
Example: During fasting the utility that we
derive from meat is not the same as any time
else.
There are two major approaches to the
analysis of consumer behavior.
Cardinal utility Approach-(Neo-classical
approach)
Ordinal utility approach (Indifference curve
analysis)

95
 The cardinal utility Theory
This theory holds that utility can be assigned
cardinal number like, 1,2,3, etc
Utils- an util is a cardinal number like 1,2,3 etc
simply attached to utility.
Example: The first banana consumed might yield 6
utils of satisfaction and the second banana might
yield 10 utils.
 The utility that the consumer derived from
consumption of the second banana is 4 utils higher
than the first banana.

96
 Cont…
)
 The total utility is
TU=f ( X , X
1 2 ...... X N )

Total and Marginal Utility

Total Utility (TU): refers to the total amount of
satisfaction or pleasure a person derives from
consuming some specific quantities of a commodity at a
particular time
Marginal Utility (MU: is the additional utility
obtained from consuming an additional unit of a
commodity.
 It is the extra unit of satisfaction derived as a result of the
consumption of one more unit of a commodity.
MU = TU i.e. Marginal utility is the slope of the total
utility curve. Q
Total utility comes from all units consumed while marginal
97 utility comes only from the last unit consumed .
Law of Diminishing Marginal Utility (LDMU)
 States that as the quantity consumed of a
commodity increases per unit of time, the
utility derived from each unit decreases,
consumption of all other commodities
remaining the same.
The highest utility that an individual can get
from consuming a particular commodity is
called the saturation point.
Consuming more units of a commodity
past the saturation point leads to a
decline in total utility.
98
2.The ordinal utility Approach
(Indifference curve Analysis)
The ordinal utility approach holds that utility
cannot be measured absolutely; only ordering or
ranking of preferences is possible.

99
 Cont…

 The Ordinalist school postulated that

utility is not measurable, but is an
ordinal magnitude:

 It is practically possible for the consumers to

rank commodities in the order of their
preference as 1st 2nd 3rd and so on.

10
0
 Indifference Curves
Locus of points representing different bundles of
goods, each of which yields the same level of
utility (level of satisfaction) to the consumer.
The entire set of indifference curves is known as
an indifference map
Negatively sloped & convex

10
1
 Cont…
Example: The indifference curve, consider a
hypothetical household consuming two
commodities, X (meat) and Y (Potatoes), which are
substitutable for each other to some extent, in
consumption.
Assume this household obtains a given level of
satisfaction, , in consuming given level (say, 1X and
10Y) of meat and potatoes per day.
There are so many ways of combining X and Y in
consumption so as to give this same level of
satisfaction.
Some four bundles or combinations are given
below.
10
2
 Cont……

Table 2.2 Indifference Schedule

Bundle
(Combi A B C D
nation)
Meat 1 2 4 7
in
kg(X)
Potatoe 10 6 3 1
s in
kg(Y)

10
3
 Cont…..

 By transforming the indifference schedule into

graphical representation, we get an indifference
curve.

10
4
 Cont…
Characteristics of Indifference
Curves:
 Indifference curves have negative slope
(downward sloping to the right).
 Indifference curves do not intersect each
other
 The further away from the origin an
indifferent curve lies, the higher the level of
utility it denotes
 Indifference curves are convex to the origin.
Convexity is a reflection of decreasing
marginal rate of substitution,
10
5
 The Marginal Rate of Substitution (MRS)
 It refers to the amount of one commodity that an
individual is willing to give up to get an additional unit
of another good while maintaining the same level of
satisfaction

Slope of indifference y / x dy / dx MRS

curve = XY
The negative of the slope of an indifference curve at
any point is called the marginal rate of substitution of
the two commodities X and Y, and

10
6
 The consumer Budget Line
 The budget line is a line indicating different
combinations of two goods that a consumer can
buy with a given income at a given prices.

10
7
 Consumer Optimum: Utility Maximization
A rational consumer maximizes utility by trying to
attain the highest possible indifference curve,
given the budget line.
This occurs where an indifference curve is tangent to
the budget line so that the slope of the indifference
curve is equal to the slope of the budget line
Thus, the condition for constrained utility
maximization, consumer optimization, or consumer
equilibrium occurs where the consumer spends all
income (i.e. he/she is on the budget line) and

MRS XY PX / PY
10
8
 CHAPTER 3
THEORY OF PRODUCTION AND
COST IN RELATION TO
AGRICULTURAL FIRMS

10
9
3.1 CONCEPTS OF PRODUCTION
BEHAVIOR
 How a farmer/firm combines economic
resources to maximize output, given the technology.
Technique of production
A technique :– is any feasible method by which
inputs can be converted in to outputs.
Production :- is the transformation of resources
(inputs) in to outputs of goods and services.
Production technology : relates inputs to outputs-
specific quantities of inputs are required to produce
any given good or service.
Technique of production : how to produce
economics question answered by technique of production
11
0
Output :-is not only to final commodities like
automobiles, TV, bread, etc but also to intermediate
products like steel, wires, flour, etc that are used in
the production of final commodities.

 out put are classified in to two

Final commodity Intermediate

commodity

Final commodity: directly use for consumption

Intermediate commodity: this are out put of one
factory and input for other factory .
1 ex: wheat -> flour -> Bread
11
 Production Function
 Is shows the relationship between various
combinations of inputs and the maximum output
obtained from those combinations.
It represents the maximum output that can be
obtained from given combination of inputs, given
the state of technology.
 The general mathematical representation of
production function showing units of total output
as a function of units of inputs is given by:
Q= f(L, L,K, N, E)

11
2
 Types of inputs
Inputs are ingredient or means of production or
factors of production.
Two types of inputs
Variable Input: - is an input whose quantity can
be changed (Increased or decreased) during a
given period of time
Example: Unskilled labor, raw materials, etc
Fixed Input: - is an input whose quantity cannot
change during a given period of time.
Example: Highly skilled labor and capital (firms
plant and equipment) i.e. the factory, buildings,
Machinery, etc
11
3
 The short Run Production Function
(Production with one variable input)
 This period usually extends from 1-5 years
 A firm’s short run production function describes how
the maximum attainable output varies as the quantity
of labor employed in a given production plant varies.
 most of the time variable input is= labour
( K, L and, E, remain constant)
The increase or decrease in total output (Q) is
represented as, a function of, depends only on, the
quantity (and of course quality) of labor (L) available
on the given time period.
Short run production function Q= f(L), Where land,
capital and technical knowledge remain fixed.
11
4
 Key concepts in this function
Definition of TP, AP and MP
Total product (TP) –refers to the total quantity of output
that a given input can produce over a given period.
Average product (AP) –refers to output per unit of labor
input.
AP= TP/L
Average product is also called Labor productivity. (in
this case the only variable input is labour)
Out put per unit of labor
Marginal product (MP) –The marginal product of any
input is the increase in (additional) total product
resulting from an increase of one unit of that input.

11
5
MP= change in total production/change in labor
input
MP= ∆TP where ∆ signifies “change in”
∆L
 In order to determine which production technique,
i.e. which combination of inputs a firm/farm should
use it is necessary to consider:
 The Average product and marginal product.
This is because they imply productivity – If
labor productivity is high use labor –intensive
techniques of production. Otherwise, look for some
other technology.
Both marginal product and average product of the
variable factor (i.e labor) are derived from the total
11product of the factor.
6
The Law of Diminishing Marginal Returns
(LDRM)
State that as more and more (successive) units
of a variable input (say, labor, in our case) are
added to a fixed input (say, land or capital), after
some point, the extra or marginal product
attributable to each additional unit of the
variable input (labor) gets smaller and smaller.

In short ,if firm employ s more and more

labor with fixed input at given period, the
out put gets smaller and smaller.

11
7
 The Long Run Production Function
(Production with two variable Inputs)
The long run function, we will deal with
production behavior when we have two variable
input (Labor and Capital).
Assume
2 variable inputs = capital /K/
Labor / L/
Production function ( Q)= f(L ,K),

 Production function in the long run by using

Isoquant
and Isocosts.
11
8
Isoquant: is a curve that shows the different
combinations of labor and capital inputs that yield
the same output.
 In other words, an Isoquant is a graph that
shows all the possible combinations of two Inputs
(Labor and Capital) that yield the same maximum
output among which the producer is indifferent.

11
9
Graphically

 Isoquants are combination of different level of L and k that

give the same level of output
Mathematically ex: Q= 500√LK Q= 500 √4*1
= 500 √3*1 = 500
*2
12
= 870 =
0 1000
 Properties of Isoquants
1. An isoquant must be negatively sloped in the
relevant range.
 In means that if the firm wants to reduce
(increase) the quantity of one input used in
production, it must increase (reduce) the
quantity of the other input in order to continue
to produce the same level of output (remain on
the same isoquant).
2. An isoquant that lies further away from the origin
represents a greater output( high level of output).
3. Isoquants cannot intersect or be tangent to each
other.
This is because the point of intersection would
imply two different levels of output
12
1
4.Isoquants are convex to the origin.
 Convexity of isoquants implies i.e the slope decline
upward or downward in either direction.
 This follows from the fact that the two inputs are not
perfect substitutes.
5. Isoquants ( production Ics) show cardinal magnitudes….
Expressing in cardinal numbers.

Marginal Rate of Technical Substitution (MRTS)

 Is the slope of an isoquant
 Is the rate at which one input can be substituted for another
without changing the given output.
 When output is constant. For instance , the marginal rate of
technical substitution of capital(K) and labor( L) is the
amount by which labor (L) can be reduced per unit of
increase of capital (K) for maintaining a constant level of
output.
12
2
 Consider the following figure on an isoquant
which define the combination of labor and
capital used in the production of Q.
K
C1 A
C2 B C

o L1 L2
 We can see from the figure the quantity of capital
decreased from OC1 to OC2 and the quantity of labor
increased from OL1 to OL2. The rate at which capital
substitute by labor would be the ratio of change in
quantities of these units.
12
3
 Isocosts
To determine the combination of inputs that will
minimize the firm’s costs, one can use the
isocost concept.
Least cost combination of input
The Isocost Line shows all the alternative
quantity combinations of two inputs that the
producer is able to buy at current market prices
in a given period by fully using a given budget.

Shows the locus of input combinations that can

be purchased with a given amount of
expenditure.
12
4
 B= PL* L + PK. K
k=0
B= PL* L + PK. 0
B= PL* L
L= B
PL
L=0
B= PL* 0 + PK. K
B= PK* K
K= B
PK
 Point on the cost line and inside the cost line are
attainable and the cost above the Isocost line are
unattainable which means the producer has no capacity .

12
5
 Ex : Tc= LPL+ KPK
K 8

birr 350

B
10 L

 Suppose the unit of price of labor( PL)= 15 birr

and the unit price of capital(pk)= 25 birr, then
the total cost of labor and capital combined
together would be..
(15*10)+(8*25)= 350

12
6
 How can a firm minimize the cost of producing
any output it wishes to produce? How can a
firm maximize the quantity of output it wishes
to produce with a given budget?
Given both the isoquant and the isocost curves,
one can readily determine the input
combination that will minimize the firm’s cost.

In order to minimize the cost of

production, the producer must use
the input combination that is located
on the lowest isocost line that
enables a specific quantity of output
12
7
to be produced.
 i.e MPL = MPk
PL Pk

The producer Optimum occurs at the

tangency point of an isoquant and isocost
line. It means , when the slope of the isoquant
( MRTSLk) equals to the slope of isocost line
(PL/PK).

mathematically , MRTSLk(MPL/ MPk )= PL/PK

12
8
  The optimal input combination as such is thus the tangency
point.
 Let’s see why. The movement along the isoquant from C to A,
which leaves the output unchanged, costs the producer less
(because point A is on a lower isocost than point C).
 Again, movement from B to A costs the producer less to
produce still the same output.
 Therefore, the minimum cost that the producer has to incur
so as to produce a specified level of output occurs when the
12 isocost is tangent to the isoquant. This tangency point is said
9
to be the point of Producer optimum
 Shortly
A=B=C = 1120
I3> I2>I1 (Isocost)
Where the Isocost far from the origin the cost
of production increase

The Expansion Path

 The equilibrium path along which production
expands as production budget or expenditure
increases is called Expansion path.

13
0
 An expansion path shows the locus of the
least cost input combinations for producing
various levels of output when input prices
13
remain constant.
1
 Returns to scale
It refer to the increase in output those results
from increasing all inputs by some proportion
(percentage).
It is change of out put as the result of factor of
production (combination of input)change.
A. Constant Returns to Scale
It refers to the condition where output changes by
the same proportion as inputs.
Ex: if input increase by 5% then the output
increase by 5%.
this case, isoquants are equidistant apart.
 the size of the firm’s operation does not affect the
productivity of its inputs.
13
The average and marginal productivity of the
2
firm’s inputs remain constant.
 B. Increasing Returns to Scale
 It refers to the condition where output increases
by a larger proportion than inputs. is often called
economies of scale.
 Ex: if input increase by 5% then the output
increase > 5%.
 Isoquants get closer together (distance between
isoquants declines).
Increasing Returns to Scale can be made possible
by:
Greater division of labor and specialization, which
enhances productivity of labor.
Using more specialized and sophisticated
machines or equipment–more specialized
machines are more productive than less
13 specialized machines.
3
 C. Decreasing Returns to Scale
It refers to the condition where output
changes by a smaller proportion than
inputs.
Ex: if input increase by 5% then the
output increase < 5%.

 Isoquants become farther apart (distance

between isoquants increases).

Decreasing returns to scale occurs

because as the scale of operation
13
4
increases, it becomes difficult to manage
 Theory of cost in Agricultural
Firm

13
5
 As we observed in the market model, the basic
factor underlying the ability and willingness of the
firm to supply a product in the market is the cost
of production.

Cost refers to the amount a firm spend on

factors of production to produce goods and
services

Depending on various criteria, costs could be

classified as
 Implicit Vs Explicit costs by structure
 Privates Vs social costs by agriculture firms
 Economic Vs Accounting cost by analysis
 Fixed Vs Variable cost by input
13
6
 Short run Vs long run cost
Explicit costs(accounting cost): are the
actual pocket expenditures of the firm to
purchases or hire the inputs it requires in
production.
 Is monetary payments to owners of market-supplied
resources
Is payment for none owned factor of production.
Examples:
Wages & salaries of labor
Interest on borrowed capital
Rent on land & buildings
Expenditures or raw materials & semi finished
materials
Payments made for utilities, taxes, machines
13
7 etc.
Implicit costs: refer to the value of the inputs
owned and used by the firm in its own
production processes.
The value of thus self owned or self employed
inputs must be estimated from what thus
inputs could earn in their best alternative uses.
Examples:
 Wages of labor rendered by the owner
/entrepreneur
Interest on capital supplied by the owner
Rent of land and buildings belonging the owner
Normal profit of the entrepreneur’s this refers to
the minimum payment needed to the
entrepreneur in the business for the
13
8 entrepreneurial talent
 Short run cost
 Is expenditure incurred in the short run production process.
Long run costs
 Are costs incurred in the long run production process.
Economic cost
Is the cost to a firm in using any input (hired or owned) is
what the input could earn in its best alternative use.
 The sum of EC and IC, (Explicit cost+ implicit cost)
Accounting cost= explicit cost
Economic Profit= TR- Economic cost and
 Accounting profit=Total Revenue-Explicit cost

13
9
 Short run costs
Short run costs are the costs over a period
during which some factors of production
(usually capital equipment and
management/entrepreneurship) are fixed.
At least 1 fixed cost.
These costs are also subdivided in to:
Totals,
Units or averages
 Marginal
1. Totals
A. Total Fixed costs (TFC):
 Are those costs do not vary with changes
14
0 in output.
 They are payments for fixed inputs
They are independent of output
These include:
Insurance premiums
Property taxes
Interests on borrowed capital
Rental payment
A portion of depreciation (wear & tear) on
equipment & buildings
Fixed costs must be paid even the firms output is
zero.
 Fixed costs are unavoidable costs.
TFC= quantity of fixed inputs * price of fixed inputs

Ex: machinery buy 20000 birr always 20000birr do

14
1 not depend of quantity or price change .
Graphically
Cost

k TFC

Quantity

B. Total variable cost (TVC)

Costs that change with the level of output.
This refers to the payment for variable inputs.
TVC are dependent on the level of outputs.
It is also called avoidable cost or direct cost
These include
 Payment to raw materials
 Payment Fuel
 Payment most labor
14
2  Payment power & transportation etc
These costs are direct costs of output because when
output increase, total variable cost increases, when
output decreases total variable cost decrease, and
when out put is zero then total variable cost is zero.
TVC= quantity of variable inputs * price of variable inputs

Cost TVC

Quantity
C . Total cost
It is the sum of fixed cost and variable cost at each
level of output.
At zero levels of output, total cost is equal to the firm’s
fixed cost.
14
3
TC=TFC+TVC
The distinction between fixed and variable cost
is significant to the business manager.
Variable can be controlled or altered in the short
run by changing production levels.
Fixed costs are beyond the business executive’,
present control; they are incur in the short run
and must be paid regardless of output level
When TP= 0, TVC= 0 TC= TFC+ 0
TC= TFC……….TP=0

14
4
 2. Units ( Average cost)
A. Average fixed cost (AFC)
Is found by dividing TFC by the level of
output.
AFC= TFC/Q Where Q is out put
Since TFC is the same regardless of output,
AFC must decline as output increases AFC
graph is continuously declining curve as a
total output is increased.
B. Average variable cost (AVC)
Is found by dividing TVC by the level of
output.
AVC= TVC/Q
14
5
C. Average Total cost (ATC)
Is found by dividing total cost by output.
ATC= TC/Q = TFC +TVC/Q =AFC + AVC
3.Marginal cost (MC)
Is the additional or extra cost of producing one
more unit of output.
It measures the additional cost of inputs required
to produce each successive unit of output
MC equals the change in TC or in TVC per unit
change in output.
MC= ∆ TC/ ∆Q
MC = ∆ (TFC+TVC)/ ∆Q
MC= ∆ (0+TVC)/ ∆Q
MC= ∆ TVC/ ∆Q
14
6
Activities
 Suppose Abebe runs a small potter firm, the hires
one helper at 12,000 per year, pays an annual
rent of Birr 5000 for his shop, and spends 20,000
per year on materials, Abebe has 40,000 of his
own funds invested in equipment which could
earn him 4000 per year alternatively invested.
Abebe has been offered $ 15,000 per year to work
as a potter for a competitor. He estimated his
entrepreneurial talents as worth $ 3000 per year.
Total annual revenue from sales is $ 72,000.
A. Calculate the accounting Cost & economic
Cost for Abebe’s pottery.
B. Calculate the accounting profit & economic
profit for Abebe’s pottery.
14
7
C. What is his decision?
Explicit cost =12000+5000+20000=37000
Implicit cost=4000+15000+3000=22000
Total revenue = 72000
A, I, Accounting cost= explicit cost=37000
II, Economic cost =Explicit cost + Implicit cost=59000
B, I, Accounting profit=Total Revenue-Explicit cost
=72000-37000
=35000
II, Economic profit=Total Revenue-Economic cost
=72000-59000
=13000

C. By comparing the opportunity cost and economic profit,

it is possible to decide the decision of the firm. If
opportunity cost exceeds economic profit, the firm doesn’t
have to invest, otherwise. Thus here the firm has not to
14 invest.
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 CHAPTER-FOUR
Theory of the Firm/ Market
Structure
As discussed previous, A market is any
arrangement through which buyers & sellers
exchange goods & services

MARKET STRUCTURES
There is no universal agreement among
economists as to what is the best way to classify
various market forms.
Probably the most widely used method is to
classify alternative market structures on the
basis of number of sellers and buyers,
homogeneity or degree of differentiation of the
product and nature of the product
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 Based on the number of firms
participating, nature of the product and
nature of entry the general types of
market are:
Perfectly competitive
Monopolistic competition
Monopoly
Oligopoly

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 Perfect Competition
Perfect competition is a market structure
characterized by a complete absence of rivalry
among the individual firms.
General characteristics
 Large numbers of sellers and buyers
Product homogeneity
Price taker
Free entry and exit of firms
Profit maximization
Equilibrium condition, MR=MC=P
Efficient
Perfect mobility of factors of production
15  Perfect knowledge
2
 Monopolistic competition
General characteristics
Many sellers and buyers
Differentiated or heterogeneous products
Some but within rather narrow limits,
price maker
Relatively easy entry
Non-price competition with considerable
emphasis on advertising, brand names,
trade marks etc.
Equilibrium condition, MR=MC but P>MR
Inefficient
Imperfect/asymmetry information

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 Monopoly
General characteristics
Single/ one firm
Unique with no close substitution
products
Price power is considerable / price
maker
Entry is blocked
No non-price competition, mostly
public relation but not others
MR=MC but P>MR
Inefficient
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
 Oligopoly
General characteristics
A few firms
Standardized and Differentiated products
Price power is circumscribed by mutual
interdependence/collusion Or price maker
Condition of entry present with significant
obstacles such technology and economic
costs
Few none Price competition typically a great
deal esp. with product differentiation
MR=MC but P>MR
Inefficient
Imperfect/asymmetry information

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 CHAPTER- FIVE
The Tools of Macroeconomic
Problems and Policies
 Macroeconomics
5.1 Definition and objectives of
macroeconomics
Macroeconomics: is the is branches of
economics which study of behavior of
economy as a whole(deal general or aggregate
economic issue)
It examines and concerned with the combined
aggregate effects of million's of individual
choice on such variables as national output,
the overall level of employment, the general
level of price.
The summation of all individual economy
15 affect macro economics
7
Basic issues deals in macro economics (objective)
1. Aggregate price level
 Inflation: decreasing the purchasing power of
money(general price level increase)
 Deflation: increasing the purchasing power of
money( the general price level decrease)
2. Unemployment
 Is a situation in which there is an idle labors force
that is seeking for job and has the capacity and
willingness to work.
3. There is recession and depreciation
Recession: increase economic growth
Depreciation: decrease economic growth

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  The ultimate yardstick of a country
economic success is its ability to generate
a high level of production of economic
goods and service for its population.
 GDP and GNP increment.

4. Foreign exchange policy: To promote a

proper foreign economic policy. whether
there is deficit- trade deficit.

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 National income accounting
Basic concepts of Gross domestic product
(GDP) and Gross national product (GNP)
GNP: is the total market value of all final goods
and services produced in given country with in
a given year.
Nominal GDP and Real GDP
Nominal GDP: measures the value of output in a
given period in the price of that period (I,e GDP
measures at current period).
The problem with nominal GDP is that the
change nominal GDP can be due to either a
change in the production of goods and service,
16 or a change in price of those goods and services.
0
So an increase in price will cause nominal
GDP to increase, even if production has not
changed at all.
It also makes it difficult to compare production
from year to year.
 Real GDP: values of goods and services in any
given year by using the price of a set base
period. By holding using price constant, real
GDP measures only the change in production
from year to year.
Is measure that attempt to isolate changes in
the physical output in the economy b/n different
periods by valuing all goods produced in the two
periods at the same periods.
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 Macroeconomic policy instrument
1. Fiscal Policy
 The first instrument of macroeconomic management is
fiscal policy
 Consists of setting the levels of taxation and
government expenditure to affect macroeconomic
performance.
Expenditure : government spending for goods and
services
 Government spending affects the overall levels of
spending in the economy and can thereby affect the
level of GNP.
Taxation. In macroeconomics , taxation play two key roles.
 Taxes reduce people’s incomes.
 High taxes tend to reduce their consumption
spending, lowering aggregated demand and actual
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GNP.
 One important set of taxes are those
affecting the cost of investing in capital
goods.
2. Monitory Policy: the second major tool of
macroeconomic policy which
 Comprises the management of a nation’
central bank.
 By speeding or slowing the growth of
money supply:
 The central bank makes interest rates
lower or higher
 induces or retards investment in houses,
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 THANK
YOU!!!!!!!!!

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