________________________________________________________________________

Faculty

: Commerce and Administration

Department

: Economics

Module

: Microeconomics

Module Code

: ECN 111

Module Author

: Gershon Sibinda

Date of Publication : 12 January 2005

1

Economics 1

ECN 111

Contents MODULE 1 – Microeconomics Page

2

1. Introduction to Economics

6

2. Economic resources

16

3. The role of the market

23

4. Shifts in demand and supply curves

35

5. Elasticity

44

6. Output supply by firms

54

7. Market structures

61

1. Study Guide Title: Microeconomics 2. Module structure: Qualification

B. Com

Credits

12 credits

NQF Level

6

Type

Core/fundamental/elective

Duration

10 weeks

Semester

One

3. Module outcomes On completion of this module, you should be able to •

Explain the nature, scope and methodology of economics

•

Describe the principles of microeconomics

•

Define and explain different forms of economic systems.

•

Explain and differentiate among different market structures

4. Module Introduction/Overview/Purpose Welcome to the first module of Economics 1. Studying Economics is not difficult; however it requires a great deal of time and commitment from you and quite a lot of patience and creativity from your lecturer. These notes are not meant to replace the prescribed text book but to guide you through it. Economics cannot be studied from notes only. The subject is too dynamic for this.

5. Prior Learning/ Learning in Place Basic numerical skills will be required as the study of this module entails some calculations and graphical illustration. A background in matriculation mathematics and, or basic statistics should be enough.

3

6. Module Content Unit 1

Introduction to Economics

Unit 2

Economic Resources

Unit 3

The role of the market

Unit 4

Shifts in demand and supply

Unit 5

Elasticity

Unit 6

Output supply by firms

Unit 7

Market Structures

7. Module Assessment 7.1 The structure of the assessment is as follows: •

Two written tutorial work - 10% per written work (Total = 20%)

•

One group assignment - 40 %

•

One Test – 40%

•

Examination

7.2 Assessment criteria In assessing submitted work, the following will carry more weight: originality, knowledge, insight, application, analysis ability, comprehension, and acknowledgement of your sources. The examination at the end of this module is going to test whether you can meet the set standard. What does this standard mean? •

Firstly, the questions will be based on the module. This means that the questions will represent the whole module and that you must have sufficient knowledge of everything that appears in it.

•

Secondly, the questions will also be based on the learning outcomes set in every study unit.

•

Thirdly, your general knowledge regarding the economy is tested. This is why it is so important that you read more than just the course material and talk to people about economics.

4

8. Moderation Two internal examiners and one moderator will be appointed for this module by the Department of Economics. Once the internal examiners have assessed the examinations, the moderator will undertake a similar exercise to finalise the results

9. Prescribed Text book •

Mohr,P., Fourie, L & Associates (2004), Economics for South African Students, Third Edition, Van Schaik. Pretoria

9.1 •

Recommended Readings. Begg D, Fischer S & Dornbusch R (1997), Economics, McGraw-Hill, London

•

Smit et al (1996), Economics. A Southern African Perspective, Juta, Kenwyn.

•

Sloman, J. (1991) Economics. Prentice Hall. London

•

Local news papers business portions (Sunday Times, City Press, Sowetan, Mail & Guardian, and The Star.

•

Financial Magazines – Financial Times, The Economist (Available in the journal section of the library, enquire with librarian). Also listen to daily news on market updates!

•

The following web addresses will be relevant for assignments and references:

www.resbank.co.za;www.dti.gov.za;www.absa.co.za, www.treasury.gov.za, www.jse.co.za , www.omam.co.za many more.

5

and

UNIT ONE 1. Unit Title: The Nature and scope of Economics 2. Learning outcomes On completion of this study unit, you should be able to •

Define economics as a subject

•

Discuss the fundamental economic problem

•

Distinguish between microeconomics and macroeconomics

•

Distinguish between positive and normative statements

•

Explain the tools of economic analysis

3. Introduction/Overview Most of you have probably wondered how the prices of the products in your local store are determined. You have probably also wondered why you have to pay tax and have also asked why our television sets are imported from Japan if we can produce them ourselves in South Africa or your resident country. After studying Economics you will be able to answer these questions. At this stage it should be obvious that economics is about our daily activities. Your study of economics will enable you to understand the financial reports in the newspapers. This course follows a more formal and scientific approach to economics. The nature and scope of economics are studied with special reference to economics as a social science. We will also deal with the economic problems and the ways in which solutions can be found for them.

3.1 Key Concepts Economics Scarcity

6

Needs

Microeconomics

Wants

Macroeconomics

Allocation process

Positive statements

Production process

Time series data

Normative statements

Cross section data

Distribution process

4. Learning in place As this is an introductory phase of your study of economics, basic numeric skills are a prerequisite for this unit. A good grasp of definitions will also be required as a lot of terminology is introduced.

5. Unit Content 5.1

Economics as a science

The scientific fields of study are divided into two categories: Natural sciences, such as, chemistry, physics, astronomy and zoology. These involve the study of natural phenomena which we can observe and from which we can draw conclusions. In the natural sciences we work with set law which always hold. For example, it is possible mathematically determine the speed of a car on a particular day. Human sciences, such as theology, psychology, sociology and economics. In these fields man is the central concept. In the human sciences, no set of laws can be laid down for all people, because all individuals determine their own behaviour. Economics can suggest the most effective behaviour but people cannot be forced to follow the advice of economists. Economics is that part of the human sciences which studies human actions (in other words a social science).

7

Economics can be defined, as a human science which studies the principle, which governs the effective utilisation of, limited means with numerous alternative applications to satisfy multiple needs. In economics the scientific investigation of human behaviour starts with the problem of scarcity and the related choices. All other problems arise from the problem of scarcity. Economics, therefore deals with the way in which man has to satisfy his unlimited needs with limited resources.

5.2 Basic Economic Problem The economic problem is therefore the constant increase of man’s needs on the one hand and on the other hand the limited means at man’s disposal. The natural resources such as oil, agricultural land and fish are not available in unlimited quantities. Another limitation is the ability to exploit the available natural resources. For example, there might be natural resources in the desert, which cannot be exploited because the terrain is inaccessible for vehicles, and machines, which are required to exploit the resources. Additional economic problems arise when decisions must be made on the production of goods and services. The following questions arise: •

How must the goods and services be produced?

Resources are scarce and there are various methods of production and therefore it must be decided how and by whom production will take place. It must be decided in which quantities means of production will be used and who will use them. The furniture manufacturer, for example, periodically requires a certain amount of wood to manufacture the number of furniture items, which keep him in the market. •

8

Which and how many goods and services are produced?

Scarce resources must be used in such a way that different needs can be satisfied. The demand , or need, for the product must be taken into account as must the resources which are available. •

How is the production of goods and services distributed among members of the community?

The members of the community who make the biggest contribution to production receive better benefits or income. They can therefore retain more of the goods and services. •

Are the community resources fully utilised?

In the market economy we often find that not all resources are fully employed in the production process. Prices are determined by supply and demand. In this way a situation develops in the economy where not all available labour or capital resources are employed. Fewer goods are produced and the prosperity of the community decreases. •

Does the production capacity of the community always remain the same or does it increase?

Scarce resources of the community are employed to produce the largest possible quantity of goods and services. This production of goods and services is the measure of the welfare of the community. Production can increase or decrease over a period of time. The problems discussed above can be summarised as three issues confronting the economy, namely:

9

•

The allocation process

•

The production process

•

The distribution process

Alternatively, we could say economics deals with the choices that people have to make, e.g. What to produce, How to produce, for Whom to produce. Therefore, economics is concerned with the ordinary business of life. Economics also studies the decisions of firms, government and other decision makers in the society. For example, firms’ decisions to produce, government spending on goods and services, government decision to increase taxation etc.

5.3 A distinction between Microeconomics and Macroeconomics The study of economics is usually divided into two parts viz.: Microeconomics and Macroeconomics. In microeconomics the focus is on individual parts of the economy. “Micro” means small. In microeconomics the decisions or functioning of decision makers such as individual

consumers,

households,

firms, or other

organisations, are considered in isolation from the rest of the economy. The individual elements of the economy are examined in detail. For example, the study of the decisions of individual households, (what to do, what to buy etc.) and of individual firms, (what goods to produce, how to produce them, what prices to charge etc.). Microeconomics also includes the study of the demand, supply and prices of individual goods and services like petrol, jeans, houses etc. Macroeconomics is concerned with the economy as a whole. “Macro” means large. In macroeconomics we focus on the “big picture” of the economy. That is, total or aggregate economic behaviour is studied. For example, in macroeconomics we study, total production, total income and spending, economic growth, aggregate unemployment, the general price level and the balance of payments.

10

Some examples: Microeconomics •

VS

Price of a single product

Macroeconomics •

Overall prices of goods and services (CPI)

•

•

Production of jeans

Total output of goods and services

•

Market for individual goods

•

The market for all goods and services

•

A firms decision to export its

•

product •

Decisions

Total exports of all goods and services to foreigners

of

individual

consumers

•

Combined

decisions

of

all

consumers in the country

5.4 Positive and Normative Economics A positive statement is an objective statement or fact. A normative statement involves an opinion or value judgement. Examples of positive statements: •

The inflation rate in Zimbabwe is at 500%

•

UNW and Potch University have merged to form Northwest University.

•

The Governor of the South African Reserve Bank is Mr Tito Mboweni.

•

The Tsunami devastated the Asian countries.

•

As from 01 January 2002 the Euro is the official currency of the European Union countries.

Examples of Normative statements:

11

•

Government is not doing enough about poverty.

•

Road accidents are caused by speeding drivers.

•

Economic policy should be aimed at reducing unemployment.

•

President Mbeki is a very sweet fellow.

•

South Africans are hospitable.

•

Poverty is the direct result of the apartheid system.

Positive statements can be proved or disproved by comparing them with facts. Normative statements/issues can be debated but they can never be settled by science or by an appeal to facts. Therefore economics cannot be a value free science. Human behaviour can never be analysed totally objectively and policy always involves judgement.

5.5 Economic Data Data (facts) interacts with models in two ways: i. Data help us quantify the relationship to which our theoretical models draw attention. ii. Data help us to test our models since economists must check their theories against the relevant facts. Economic data can be reorganised or presented in two ways in order to solve a problem viz: Time series and Cross section. A Time series is a sequence of measurement of a variable at different points in time. It shows how a variable changes over time.

12

Example, Average price of bread in SA from 2002 to 2005 (in SA cents) 2002

2003

2004

2005

Brown bread

340

380

400

450

White bread

350

390

410

460

Whereas time series data record the way a variable changes over time, cross section data record at a point in time the way an economic variable differs across different individuals or groups of individuals e.g. Average price of bread amongst countries in 2005 (in SA cents) Brown bread

White bread

SA

450

460

USA

730

750

UK

680

700

CANADA

732

755

6. Sources / References Study chapter 1 dealing with introduction to economics in your prescribed text book. Other relevant sources are the business times of local newspapers, and financial magazines, this should help you get a feel of how economic issues are addressed and how economic data is presented. The web sites listed above should also be useful.

7. Learning Tasks/ Activities

13

This is not to be formally submitted as an assignment; however you are welcome to share your findings with me in class or office.

ACTIVITY 1 In the table below, indicate which are macroeconomic issues, which are microeconomic issues, and which issues could be either, depending on the situation, give reason for your answer. Description

Microeconomics

Inflation Low wages in certain

service

industry The

rate

of

exchange between the SA Rand and US$ Why the price of cabbage fluctuates more than the price of cars. The SA growth rate of this year compared

with

last year. Why there are fewer firm that manufacture products hand

14

by

Macroeconomics

Both

Reason

ACTIVITY 2 Think of the positive and normative statements of your own and supply reason for your statement.

8. Assessment 8.1 Assessment criteria Unit one introduces basic concepts of economic theory, and since this is the case, you will be assessed on your knowledge of the concepts, ability to differentiate between concepts and classification of data as it is given to you. All this will be written work either in tests, assignments or examination.

15

UNIT TWO 1. Unit Title: Factors of production and Economic resources 2. Learning Outcomes On completion of this study unit, you should be able to: •

Distinguish between the production factors

•

Explain the remuneration of every factor of production

•

Define and draw the production possibility curve (PPF)

•

Define opportunity cost

•

Differentiate between economic systems

3. Introduction Production refers to the creation of goods and services with which needs can be satisfied. During production, utilities (economic goods) are created and consumers are prepared to pay a price for these. Economic resources refer to all the natural human and manufactured resources that go into the production of goods and services.

3.1 Key concepts Factors of production

Capital

Capital goods

Labour

Land

Consumer goods

Factor incomes

Entrepreneurship

PPF

Market system

Socialist system

Scarcity

Communist system

law of increasing costs

Law of diminishing returns choice

4. Learning in Place 16

Unit one is a prerequisite for learning unit two since economic concepts and illustrations build on one another.

5. Unit content 5.1 Different kinds of Economic Resources. •

Land – this refers to all natural resources, which are used in the production process. E.g., arable land, minerals, oil deposits and water.

•

Capital - this refers to all manufactured aids to production. E.g. machinery, equipment, storage transport etc.

•

Labour – this refers to all physical and mental talents of people which are usable in producing goods and services.

•

Entrepreneurial ability – the entrepreneur takes the initiative in combining the resources of land, capital and labour in the production of goods and service. He does this with the hope of establishing a profitable venture.

Capital goods differ from consumer goods in that consumer goods are used directly to satisfy our wants, while capital goods facilitate the production of consumable goods.

5.2 Remuneration of Economic Resources Resources are provided to business institutions in exchange for money income. •

Income received from supplying land is called rental.

•

Income received form supplying capital is called interest or rental.

•

Income received by those who supply labour is called wages (i.e. salaries and various wage and salary supplements in the form of bonuses, commission etc.)

•

17

Income received by an entrepreneur is called profits

Economic resources or factors of production have a fundamental characteristic in common, viz. scarcity, i.e. they are scarce or limited in supply.

5.3 The Production Possibility Curve / Frontier The production possibility frontier shows for each level of the output of one good, the maximum amount of the other good that can be produced. OR the frontier shows the maximum combinations of output that the economy can produce using all available resources. Example: Consider an economy with four workers who can produce either food or guns. The next table shows how much of each good can be produced. The answer depends on how workers are allocated between the two industries.

Production possibilities Food

Guns

Worker

Output

4

25

0

0

3

22

1

9

2

17

2

17

1

10

3

24

0

0

4

30

18

Worker

Output

The production possibility curve

The frontier displays a trade-off; more of one commodity implies less of the other. Points above the frontier are unattainable with current resources. E.g. H. They need more inputs than the economy has available. Points inside the frontier show inefficient use of resources. E.g. point G. Opportunity cost of a good is the quantity of other goods which must be sacrificed to obtain another unit of that good. Output exhibits the following characteristics or laws: •

The law of increasing costs

In terms of this law, the production cost per unit of output increases as the level of output increases, all other things remaining the same (the ceteris paribus assumption) •

The law of diminishing returns

This can be defined as the increase that occurs in the marginal or additional output when equal unit of a variable input, combined with fixed inputs, are added consecutively the production process.

19

Table 1: Increasing, constant and decreasing marginal returns (output) Units of labour

Total output

Marginal output as a result of additional

(bags of wheat)

units of labour while capital and land are kept constant

0

0

1

5

5 – increasing marginal returns

2

11

6 – increasing marginal returns

3

18

7 – increasing marginal returns

4

25

7 – constant marginal returns

5

32

7 – constant marginal returns

6

38

6 – decreasing marginal returns

7

43

5 – decreasing marginal returns

8

47

4 – decreasing marginal returns

5.4 Introduction to Economic systems Economic systems are some of the mechanisms that are used to solve the central economic questions e.g. what to produce, how to produce and for whom to produce. There are three forms of economic systems i.

Socialist system

ii.

Communist system

iii.

Capitalist system or Market system

A communist or command economy is a society where the government makes all the decisions about production and consumption. A government planning office decides what will be produced, how it will be produced and for whom it will be produced. A socialist economic system is closely related to the command system. The only difference is that in this case the level of government intervention is less 20

intense e.g. government only controls scarce resources like electricity, water etc. Government allows markets to take charge of demand and supply of some goods and services. Markets in which government does not intervene are called free markets. Individuals in free markets pursue their own interests. The forces of demand and supply play a role in deciding what, how and for whom to produce.

6. Sources /Reference Study chapters 2 and 5, dealing with factors of production, production possibility frontier and economic systems in your prescribed book.

7. Learning Task / Activity This is not to be formally submitted as an assignment; however you are welcome to share your findings with me in class or office.

ACTIVITY 1 A typical problem that all governments face is to choose between military expenditure and social expenditure. Suppose government of a country X, can choose to use its production factors for building houses, or for producing guns. Country X only has labour as a factor of production Production

Number of houses

Number

Possibility

built

produced

of

guns

Opportunity cost of producing

more

houses in terms of gun production A

0

1500

B

1000

1400

C

2000

1200

D

3000

900

E

4000

500

F

5000

0

21

8. Assessment 8.1 Assessment criteria This unit involves definitions and illustration through graphs. Therefore assessment will be based on exactly that, i.e. your knowledge of terminology, ability to illustrate economic models in graphical illustrations and minor calculations of opportunity cost. Mostly, this will be written work in tests, assignments or examination.

22

UNIT THREE 1. Unit title: The role of the market 2. Learning Outcomes On completion of this study unit you should be able to •

Distinguish between economic goods and free goods

•

Differentiate between needs and wants

•

Define a market

•

Define demand and give factors affecting quantity demanded

•

State the law of demand and draw a demand curve

•

State the law of supply and draw a supply curve

•

Give factors affecting quantity supplied

•

Explain equilibrium price and equilibrium quantities

3. Introduction In this unit, we firstly need to distinguish free goods from economic goods. This is important since the study of economic revolves around economic goods or goods that command a price. Market theory deals with goods that are usually limited in nature and thus command a certain price. The unit breakdown is as follows: firstly we make a distinction between needs and wants, economic goods and free goods, a market is then defined followed by definitions and illustrations of demand and supply and the laws. The second part covers what impacts on demand and supply and how these influence prices

3.1 Key concepts Need

Market

Want

Economic good

Demand

Quantity demanded

Free good

Supply

23

Quantity supplied

Equilibrium price

Equilibrium quantity

4. Learning in Place Ensure that you familiarise yourself with the terminology and illustrations in unit two before moving on to this unit. Also the basic linear equations you learnt in matric or elsewhere are going to be useful in this unit.

5. Unit Content 5.1 Free goods and Economics goods, Wants and Needs, and Markets Free goods are goods that are free and the supply exceeds the demand for them. These goods are available in unlimited quantities and do not have a price. Free goods have useful value but no exchange value since nobody will accept these goods in exchange for something else. Examples: air around us, water in the ocean. Economic goods are goods that are manufactured in an economic system. The supply of these goods is limited in relation to their demand and consumers must pay for them. Economic goods have useful value and an exchange value. Wants are human desires for goods and services. Human wants are unlimited; we all want everything, e.g. biological, spiritual and material wants. Also, we all want law and order, education, health etc. Needs are necessities i.e. the things that are essential for survival e.g. food, water, clothing, shelter etc. Needs unlike wants are not absolutely unlimited.

24

5.2 A market A market is a set of mechanism or arrangement through which buyers and sellers get into contact for the purpose of exchanging goods and services for some form of payment. There are three stages in the operation of a market mechanism: i.

Buyers and sellers meet

ii.

There is an agreed upon price

iii.

The goods or services are exchanged for some form of payment

Markets can exist in different ways: e.g. personal contact, telephone, Internet, public media etc. Examples of markets are; Johannesburg Stock Exchange (JSE), beauty salon, cinema, bar lounges etc. Different markets exist under different economic systems. The command system may have the controlled markets, and quite opposite, the capitalist system would have free competitive markets, i.e. where there is no interference from authorities. For the purpose of our study, we shall focus on the free or perfect competitive markets. Characteristics of competitive markets •

Lots of buyers and sellers

•

Products are identical

•

Individuals (buyers and sellers) cannot themselves determine the price (ruling price).

5.3 Demand Demand refers to the need for goods and services coupled with willingness and ability to pay.

25

The quantity that consumers want to buy (demand) is called the quantity demanded or the market demand. The quantity demanded can vary with price, i.e. the higher the price the lower the quantity demanded or the lower the price the higher the quantity demanded. There are other factors that affect the quantity demanded. Examples: •

Change in income - A rise in income of consumers ceteris paribus (assuming that other things remain constant), usually causes a rise in quantity demanded.

•

Availability and prices of substitute goods and services – This refers to goods used for the satisfaction of similar needs, e.g. butter and margarine, beef and mutton, coffee and tea etc.

•

Change in taste of consumers – If the change is to the advantage of a product, then the quantity demanded will increase and vice versa. Example, if it becomes a health hazard to consume beef due to mad cow disease, the quantity demanded of beef will drop at every conceivable price.

•

Change in the price of complimentary products – These are the goods that supplement the satisfaction of needs e.g. cars and petrol, electric appliances and electricity etc.

•

Expectation/perception of consumers about a product – goods which do not deliver what they promise or satisfy the need that they promise may lead to less of them being demanded. E.g. viagra, slimming tablets etc. Also, if consumers anticipate a shortage of a good in future, this leads to more of a good being demanded.

•

Change in population – An ever-increasing population puts an upward pressure on limited goods and services. Therefore the will be an increase in demand for housing, services etc.

26

At this point we can now state the law of demand! The law of demand states that, at lower prices, a greater quantity will be demanded than at a higher price, all other things remaining constant. OR At higher price, lesser quantity will be demanded than at a lower price all other things being equal. Thus the law of demand tells us that the quantity demanded of any commodity is inversely or negatively related to that commodity’s price all other things being equal. The relationship between price and quantity demanded can be explained by the following demand schedule/table

Price

Market Demand

Quantity Demanded

(Rand)

(Total Demand) A

B

C

10

20

10

20

50

15

15

8

17

40

20

10

6

14

30

25

5

5

10

20

30

1

2

7

10

Graphically it can be represented as follows: -

27

Price 30

A

25 20 15

Demand Curve

10

B 10

20

30

40

50 Quantity

The demand curve shows the relationship between price and quantity demanded ceteris paribus. The price is measured vertically along the vertical axis; the quantity demanded is measured horizontally along the horizontal axis. The line AB is called the demand curve and normally declines from left to right (negative decline) that indicate that more will be demanded when price is low. A change in the price of the product will lead to a change in the quantity demanded. This change in price causes an upward or downward movement on the demand curve while the demand curve stays constant. For example, when the price changes from R30 to R20 the quantity demanded is shown as a change from point A to point C.

5.4 Supply Supply refers to the quantity of goods or services that are offered at different prices on the market. OR Supply refers to making goods and services available to satisfy needs.

28

The quantity that producers or sellers want to supply at a given price is called quantity supplied. There are other factors that affect the quantity supplied. Examples: •

Change in the prices of factor inputs – If the prices of factor inputs increase, then it becomes too expensive to produce more of that good. Therefore, the quantity supplied decreases and vice versa.

•

Change

in

technology

–

Technological

improvement

in

the

manufacturing of a good can lead to a decrease in the production costs. This implies increased profits and more quantity supplied. •

Change in the price of other products – If a producer is producing two commodities, say, X and Y. If the price of Y increases, the producer is likely to produce more of Y than X to maximise profits.

•

Government

regulation – strict safety regulation

or

production

processes, which are dangerous to workers, may hamper firms’ profits. We can now state the law of supply! The law of supply states that, at higher price, greater quantities will be offered and at lower price lower quantities will be offered. Thus the law of supply tells us that the quantity supplied of any commodity is directly related or positively related to that commodity’s price, all other things being equal. The relationship between price and quantity supplied can be explained by the following schedule/table:

29

Quantity Supplied

Price

Market Supply

(Rand)

(Total supply) Firm A

Firm B

Firm C

10

3

4

3

10

15

6

7

7

20

20

9

12

9

30

25

14

14

12

40

30

16

17

17

50

Graphically it can be represented as follows:

Price 30 25 20 15 10 10

20

30

40

50

Quantity

The price is measured vertically and the quantity supplied is measured horizontally. The line (curve) AB is called the supply curve and normally declines form right to left (positive decline). That indicates more will be produced when the price increases. A change in the price of a product will lead to a change in the quantity supplied of a product. E.g. when the price of a product increases from R10 to R20, the quantity supplied is shown as a change from B to C. 30

5.5 Equilibrium Price and Equilibrium Quantities N.B A demand curve indicates how much of a product will be demanded at a certain price and time; the supply curve shows how much of a product will be supplied at a certain price and time. In principle only one price can exist on the market. The behaviour of buyers and sellers can be combined to model how the market would actually work. Price (R)

Total Demand

Total Supply

10

50

10

15

40

20

20

30

30

25

20

40

30

10

50

Graphically it can be represented as follows:-

31

Price

D S

Excess supply

30 25 20 15 10

D

Excess demand S 10

20

30

40

50

Quantity

The price on which buyers and sellers agree is called the equilibrium price while the quantity negotiated at that price is called equilibrium quantity. At a price of R20, buyers are prepared to purchase 30 units of a product (Demand), while suppliers are prepared to sell 30 units on the market. Therefore, the quantity demanded is exactly equal to the quantity supplied on the market at a price of R20 The market is therefore in equilibrium as far as demand and supply is concerned. This position of equilibrium is indicated by point E on the graphs above. At prices below R20, then there is excess demand e.g. AB at price, P = R10. At prices above the equilibrium price (R20), there is excess supply (e.g. FG at P = R30)

6. Sources / References

32

Study chapter 7, dealing with markets in your prescribed book. Also check the business portion of any local news paper and see how they trace markets. Other websites discussed above will be relevant.

7. Learning tasks / Activities This is not to be formally submitted as an assignment; however you are welcome to share your findings with me in class or office.

ACTIVITY 1 In the table below, tick the right column to indicate, which of the items are economic goods, which are free goods, and which are services. Item

Economic good

Free good

Services

Desert Sand A

visit

to

the

from

the

dentist Meat

butchery Houses Bottled sea water at the flea market The help from the bank cashier Street lamps

ACTIVITY 2 In the next three sentences, can you explain the meaning of the words “need”, “want” and “demand”? I need a car. I want a car

33

There is a great demand for cars in the country In the table below, tick in the right column to indicate which are needs and which are wants. Item

Need

Want

Food A five bedroom house at the coast An X5 4x4 vehicle Shelter Clothes Rolex watch Satellite TV

Activity 3 Trace the Rand/dollar exchange for the day, for a period of one month and try to plot a graph(s) out of that data. N.B each exchange rate is the equilibrium price for the day.

8. Assessment 8.1 Assessment Criteria Most of the assessment in this unit will entail written work which will test your knowledge of terminology, your ability to draw and interpret graphs.

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UNIT FOUR 1. Unit title: Shifts in Demand and Supply curves 2. Learning Outcomes On completion of this study unit, you should be able to: •

Differentiate between movements along a curve and shifts in the curve

•

Explain what affects shifts in the demand and supply curves

•

Illustrate by means of graphs, shifts in the demand and supply curves

3. Introduction Changes in demand (also called market demand), is caused by factors other than price i.e. income, substitute goods, taste and preference etc. To understand this we need to differentiate between movements along the demand curve and shift in the demand curve. Since economics uses tools like graphical illustrations and figures, we will learn how to employ those to explain changes in demand and supply.

3.1 Key concepts Movement along a demand curve Shift in a curve Movement along a supply curve Price floors Price ceilings

4. Learning in Place Unit three is a prerequisite for learning unit four. This serves as a continuation of unit three. Familiarise yourself with concepts and illustration before attempting this unit.

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5. Unit Content 5.1 Movements along a Demand Curve Here we are concerned with the effect of prices on the quantity demanded.

Price

D

D Quantity

5.2 Shift in the Demand Curve Suppose, for example, butter and margarine, are regarded as substitute goods. If the price of butter increases, people will demand more margarine. At each margarine price there is a larger quantity of margarine demanded when butter prices are high. Therefore, change in butter prices lead to a shift in the demand curve. The entire demand curve shifts to the right since a higher quantity is demanded at each price. The effect of an increase in the price of a substitute good for margarine. Graphically: 36

D’ P

D

D’ D Q Recap: A market is a set of arrangements or mechanisms through which buyers and sellers interact by exchanging goods and services for some form of payment. Margarine market D’ P

D E’ E

D’ D

Q Butter and margarine are substitutes, therefore, when the price of butter increases, then more of margarine will be demanded. This is because margarine is more affordable.

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In the market for margarine, this process is illustrated by a rightward shift in the demand curve, thereby indicating that more margarine will be demanded. When the demand curve shifts to the right, a new equilibrium point, E’ is formed and a new equilibrium price and quantity are established at a higher level than they were at initial equilibrium point. Shifts to the left are also possible! Suppose, for example video recorders and televisions are complimentary goods/ goods that are used jointly. If the price of Televisions increase, the demand for video recorders will drop, assuming other things remain constant. The market for video machines will be thus: Market for video recorders D D’

S

Pe Pe’

E E’

Qe’

Qe

When the price of televisions increases, then less videos will be demanded. This is because it becomes more expensive to run videos.

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In the market for videos, this process is illustrated by a leftward shift in the demand curve, thereby indicating that less videos will be demanded. When the demand curve shifts to the left, a new equilibrium point, E’, is formed, and a new equilibrium price, Pe’, and quantity, Qe’, are established at a lower level than they were at initial equilibrium point.

5.3 Movement along a Supply Curve Here we are concerned with the effect of prices on the quantity supplied.

P

S

Q

5.4 Shifts in the Supply Curve The supply curve will only shift if any of the “other things” are changed. i.e. technology, factor inputs, government regulation etc. Suppose an improvement in technology leads to much faster machines and thus higher quantities of a product are being produced. Therefore change in technology will lead to a shift in the supply curve. The entire supply curve will shift to the right, since higher quantities are supplied at each price.

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Shift from S to S’

S

P

S’

Q

Let us assume that an improvement in technology has boosted a market for shoes. Shoes market S

P

S’

Pe

E

Pe’

E’

D

Qe

Qe’

Q

Technology has improved the production of shoes (greater supply). In the market for shoes, a rightward movement of the supply curve illustrates this, thereby indicating more shoes will be supplied.

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When the supply curve shits to the right, a new equilibrium point E’, is formed and anew equilibrium price Pe’, and Quantity Qe’, are established at lower level than they were at the initial equilibrium point. Shifts to the left are also possible! Suppose government imposes strict laws/regulation in the shoe industry. That will result in fewer shoes supplied. Therefore, the market for shoes could be thus: Market for shoes

S’

P

S

Pe’

E’

Pe

E

D

Qe’

Qe

Q

The equilibrium point moves from E to E’. The equilibrium price and quantity shift from Pe to Pe’ and Qe to Qe’ respectively, implying an increase in equilibrium price but a decrease in equilibrium quantity.

5.5 Government intervention One assumption that we raised is that there is no government intervention in the process of determining the ruling price. At times governments may intervene and 41

influence the ruling prices. If consumers, trade unions, farmers and politicians are not satisfied with the prices and quantities determined by the market forces, government is usually compelled to intervene. This intervention can take different forms, including: •

Setting maximum prices (price ceilings)

•

Setting minimum prices (price floors)

•

Subsidising certain products or activities

•

Taxing certain activities or products.

Government set maximum prices, usually below the equilibrium price (see figure 8-9 in text book) to: •

Keep the prices of basic foodstuffs low, as part of policy to assist the poor

•

Avoid the exploitation of consumers by producers, that is, to avoid “unfair” prices.

•

To combat inflation

•

To limit the production of certain goods and services in war time

Government set minimum prices, usually above equilibrium price to support agricultural products since farmers are vulnerable to exploitation. When government fixes a minimum price, it creates a market surplus. This usually requires further government intervention. These are the options: •

Governments purchases the surplus and exports it

•

Government purchases the surplus and stores it (provided it is non perishable)

•

Government introduces production quotas to limit the quantity supplied to the quantity demanded at minimum price. See fig 8-12 in text book

•

Government purchases and destroys the surplus

•

Producer destroys surplus

6. Sources/ References Study chapter 8, covering demand and supply in action and government intervention in your prescribed text book.

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7. Learning Task This is not to be formally submitted as an assignment; however you are welcome to share your findings with me in class or office.

ACTIVITY 1 Below are some of the extracts from newspaper headlines or reports. In each case, the supply of a product or products will be affected. Explain how the supply will be affected and draw a graph to illustrate the change. Where applicable, also mention which factors caused the change in supply or demand. 1. “Research shows that salmon (a type of fish) reduces wrinkles on persons face” 2. “Iscor workers strike successful: trade union negotiates an 8% increase for all workers” (explain how the supply of steel will be affected.) 3. “SA winemakers decide to export more wine to overseas countries, but harvests are affected by a severe drought in the Western Cape.” 4. Illustrate how the concepts, price ceiling and price floors function.

8. Assessment 8.1 Assessment Criteria Written work on the interpretation of demand and supply graphs will assessed. Also your ability to grasp concepts and definitions will be assessed.

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UNIT FIVE 1. Unit Title: Elasticity 2. Learning Outcomes On completion of this study unit, you should be able to: •

Explain the elasticity of demand, and illustrate the different values in graphic form

•

Define and explain income elasticity

•

Define and explain cross price elasticity

3. Introduction When we describe changes in demand or supply in graphical illustrations, it is usually not enough and could be misleading at times, since we may not know precisely by how much either variable has changed. The study of elasticity puts substance to this problem. Once we have defined elasticity, we will look into its types and calculations. This will then be followed by illustration of demand elasticity on a graph.

3.1 Key concepts Elasticity

Price elasticity of demand

Perfectly elastic demand

Perfectly inelastic demand

Income elasticity of demand

Cross price elasticity of demand

Normal good

Inferior good

4. Learning in Place Unit four is a prerequisite for unit five as these are closely related. Ensure that you understand the graphical illustrations before you start looking into the following calculations.

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5. Unit Content 5.1 Elasticity of Demand From the study of demand and supply curves, we observed that quantity demanded and quantity supplied change as prices change. The question is however, by how much the quantity demanded and supplied will change if prices change. That is, how sensitive (responsive) is demand and supply to price changes? Therefore, Elasticity of Demand is concerned with the extent of responsiveness in quantity demanded as a result of changes in goods prices (or consumer income).

5.2 Types of demand Elasticities i.

Price Elasticity of Demand

ii.

Cross – Price Elasticity of Demand

iii.

Income Elasticity of Demand

5.3 Price elasticity of Demand Price elasticity of Demand is the measure of the sensitivity (or responsiveness) of the quantity demanded to changes in price. When commodities are measured in different units, it is often best to examine the percentage change, which is unit free. Thus, Price elasticity of Demand (often denoted by a Greek symbol η, pronounced “eeta”) is measured as: P.E.D, η = Percentage change in quantity demanded / Percentage change in price Since demand and price are inversely related, the elasticity has a negative value, but it is usual to ignore the minus sign for analysis purposes. Alternatively, Price Elasticity of demand can be written in this form:

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η = %∆Qd / %∆P, where the symbol “∆” denotes change. Example: If the price of X rises from R1.00 to R1.50 and demand fall from 1000 to 600 units, calculate the P.E.D between these two points on the demand curve. Solution: Price elasticity of demand = Percentage change in quantity demanded / Percentage change in price

Old demand -------------------1000 units New demand-------------------600 units % change in demand = (Old demand – New demand / Old demand) * 100 = (1000 – 600 / 1000) * 100 = 400 / 1000 * 100 = 40% or 0.4 Old price-------------------R1.00 New price------------------R1.50 % change in price = (Old price – New price / Old price) * 100 = (R1.00 – R1.50/ R1.00) * 100 = - R0.50 / R1.00 * 100 = -50% or –0.5 Price elasticity of demand, η = - 40% / 50% =- 0.8 Ignoring the negative sign, η = 0.8

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5.4 Elastic and inelastic demand Elasticity of demand may take any value from zero to infinity, but there are important dividing lines: P.E.D, η = 1

- usually referred to as Unit elasticity or just unity

P.E.D, η > 1

- Elastic demand

P.E.D, η < 1

- Inelastic demand

Where demand is unit elastic, η = 1, the quantity demanded falls (rises) by the same percentage (or in proportion) to the percentage rise (fall) in price. Where demand is elastic, η > 1, the quantity demanded falls by a larger percentage than the percentage rise in price. Where demand is inelastic, η < 1, the quantity demanded falls by a smaller percentage than the percentage rise in prices. Example: The price elasticity of demand for tickets.

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Price

Quantity of tickets

Price elasticity of

(Rands)

demanded

demand, η

12.50

0

10.00

20

4

7.50

40

1.5

5.00

60

0.67

2.50

80

0.25

0

100

0

Demand curve for tickets

The price elasticity changes as we move along a demand curve, and we can expect the elasticity to be high at high prices (i.e. quantity demanded is sensitive to changes in prices) and low at low prices (Quantity demanded is less responsive to changes in price) Sometimes demand can either be perfectly elastic or perfectly inelastic. A perfectly elastic demand curve has an elasticity coefficient of infinity and is depicted by a horizontal line. A perfectly inelastic demand has elasticity coefficient of zero and is depicted by a vertical line (see fig. 9-4 in text book).

5.5

Ticket Demand, Elasticity and Revenue Price

Quantity of tickets

(Rands)

demanded

12.5

48

0

P.E.D Total spending (R) (Price x Qd of tickets) 0

10.0

20

4

200

7.5

40

1.5

300

6.25

50

1

312.5

5.00

60

0.67

300

2.50

80

0.25

200

0

100

0

0

At higher prices, e.g. R12.50, P.E.D is very elastic i.e. η >1 so that quantity demanded becomes sensitive to price changes. Thus total spending (price * Qd) 12.5 * 0 becomes 0. When P.E.D is elastic, i.e. η > 1, a decrease in prices from R12.50 to R10.00 results in an increase in total spending (because Qd is sensitive to price changes) so that total spending becomes R200. As prices keep on decreasing e.g. R7.50 to R6.25 with P.E.D, η > 1, total spending on the commodity (tickets) increases. Also, when P.E.D is inelastic, i.e. η < 1 e.g. at Price = R5.00, a further decrease in prices from R5.00 to R2.50 results in a decrease in total spending (2.50 * 80 = 200). N.B As prices increase from 0 to 12.50, P.E.D changes from being inelastic, η < 1, to elastic η > 1 and that is accompanied by an increase in total spending. But total spending declines as P.E.D becomes very elastic, i.e. η > 1.

5.6 The Slope of the demand curve and elasticity If a demand curve becomes steeper over a particular range of quantity, then demand is becoming more inelastic. A shallower demand curve over a particular range indicates more Elastic demand.

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Graphically these can be represented thus:-

Business people can make use of Elasticity to establish how consumers will react to pricing policies.

5.7 Cross Price Elasticity of Demand Sometimes it happens that a change in price of one product (commodity) causes a change in the demand for another product. Thus, for example an increase in the price of butter may result in an increase in the demand for margarine assuming that other things remain constant. In this case the responsiveness of the quantity demanded should be measured with regard to the change in the price of a related product. Therefore, the Cross Price elasticity of Demand measures the sensitivity (responsiveness) of demand for one good to changes in the price of another good. Cross price elasticity of demand, often denoted by η xy , where x and y refers to good x and good y respectively is measured as:-

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Cross P.E.D, ηxy = Percentage change in quantity demanded of good x / Percentage change in price of good y If the two goods are substitutes, cross prise elasticity of demand will be positive. A rise in a price of one will increase the amount demanded of another. E.g. an increase in the price of coffee, ceteris paribus, will raise the demand for tea. If the two goods are compliments, cross price elasticity of demand will be negative. An increase in the price of one will reduce demand for the other. E.g. a rise in the price of petrol, ceteris paribus, will reduce demand for big cars. Cross price elasticity can also be written as: ηxy = %∆Qx / %∆Py, where x and y denote related goods e.g. butter and margarine for substitutes and TV and VCR for compliments.

5.8 Income Elasticity of Demand The Income elasticity for a good indicates the responsiveness of demand to changes in household income. The Income Elasticity of demand is measured as: Income Elasticity of Demand = Percentage change in quantity demanded / Percent change in Income The I.E.D, also denoted by µ = %∆Qd / %∆I The income elasticity of demand, measures how far the demand curve shifts horizontally when income changes.

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D’’ P

D’’’

D

Po

A

B

C

Q At the given price, Po, a shift to the point B on the demand curve D’D’ reflects lower income elasticity than a shift to the point C on the demand curve D’’D’’. Leftward shifts in the demand curve when income rises would indicate negative income elasticity. An inferior good has negative income elasticity. An inferior good is a good that a consumer buys less of as income increases and more of as income decreases A normal good has positive income elasticity. A normal good is one that an individual buys more of as his income increases and less of as income decreases. Luxury goods have income elasticity > 1, and necessities have income elasticity < 1

6. Sources /references Study chapter 9 dealing with elasticity in your prescribed book. Also check the business portion of any local news paper and read how markets are sensitive to changes in economic variables. Websites discussed above will be relevant.

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7. Learning tasks / Activities 7.1 This is to be formally submitted as a group assignment. Activity 1 How much does /did it cost to subscribe to the Economist magazine (any year) if you were in these countries. Convert the said currency to US dollars equivalent (of that particular day/ month) and plot a graph that shows on one axis, countries and US$ price on the other, with appropriate headings and labels. Austria

Belgium

Denmark

Finland

France

Germany

Irish Republic

Italy

Netherlands

Portugal

South Africa

Sweden

Norway

Spain

7.2 Assignment format. •

Introduction : Brief description of what the project entails

•

Theory and calculations : Your data and relevant calculations

•

Analysis of the graph: Comment on which country seems to be expensive /cheap in terms of subscription.

•

Conclusion : Appropriate summary

•

References: Who are your sources?

•

Names of group participants (Surname & Initials) with student numbers.

•

Please see criteria for marking written work!

7.3 Submission modes

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•

Group leaders to personally submit written work.

•

Due date: 11 March 2005, (Friday) 12h00!

•

Late submissions will incur a penalty of 5 marks on a daily basis

UNIT SIX 1. Unit Title: Output supply by firms 2. Learning Outcomes On completion of this study unit, you should be able to: •

Define and calculate revenue, costs and profits

•

Define and calculate Marginal Concepts of production

•

Define and calculate Total Concepts of production

•

Define and calculate Average Concepts of production

•

Illustrate the use of marginal and total concepts in production

3. Introduction Businesses or firms decisions about how much to produce and supply depends on the costs of production (expenses incurred in production), and the revenue they receive from selling the output. It is from revenue and costs that firms are able to calculate their profitability and thus determine their long term viability. Costs and revenue are defined, followed by the concept of profit. Once this is done marginal concepts are introduced.

4. Learning in place Since this is an independent unit, some basic calculation skills should be sufficient in learning this unit.

5. Unit content 5.1 Costs Production costs refer to prices of inputs necessary for the production of output. For example, a shoe manufacturer would be interested in knowing the prices of inputs to produce shoes, viz: -

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Price of leather Price of strings Price of rubber Price of glue Price of labour The revenue obtained from selling output (shoes), depends on the demand curve faced by the firm. The demand curve determines the price for which any given output quantity can be sold, and hence the revenue that the firm will earn. Example: Consider the following demand schedule for shoes. Output

Price (R)

Revenue (price * Q)

0

150

0

5

100

500

10

40

400

15

10

150

When the price is R150, demand is zero and hence revenue is zero. When the price is R100, demand is 5, and revenue is R500 etc.

5.2

Revenue, and Profits

Revenue refers to the amount that the firm earns by selling goods or services in a given period such as a year. It is measured as: -

Revenue = Price * Quantity OR TR = P * Q

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Costs refer to the expenses that a firm incurs in producing goods or services during a particular period. They are measured as: Total Costs = Variable costs + Fixed Costs OR TC = VC + FC Variable costs are costs that vary with output. For example, in a shoes production firm, the costs will vary with respect to shoe sizes and design. Fixed costs are costs that do not change irrespective of output. Such costs are usually associated with the costs of setting up capital or machinery for production.

Profits are the excesses of revenues over costs. They are measured as: Profits, Π = Total Revenue – Total Costs OR

Π = TR – TC N.B Any firm maximising profits would want to produce its chosen output level at the maximum possible cost.

5.3 Marginal Costs and Marginal Revenue At each output level, a firm needs to decide whether it should keep on increasing output by additional units. There is a need to know the additional costs of producing an extra unit of output and the accompanying additional revenue from that extra unit of output to keep on making profits.

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Marginal cost is the amount by which total cost increases when one extra product is produced. Or Marginal cost = Change in total cost/ Change in output MC

= ∆TC / ∆Q

Marginal revenue is the amount by which total revenue increases when one extra of a product is produced. Or Marginal revenue = Change in total revenue / Change in output MR

= ∆TR / ∆Q

Example: Output (Q)

Total costs (TC)

Marginal cost (MC)

0

10

-

1

25

15

2

36

11

3

44

8

4

51

7

5

59

8

When output = 1 and TC = 25, MC = ∆TC / ∆Q = 25 – 10 / 1 – 0 = 15 When output = 2. TC = 36 MC = ∆TC / ∆Q = 36 – 25/ 2 –1

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= 11 Example: OUTPUT (Q)

PRICES (R)

TOTAL REVENUE

MARGINAL REVENUE

0

-

0

-

1

21

21

21

2

20

40

19

3

19

57

17

4

18

72

15

5

17

85

13

When output = 1, at a price of R21, TR = 1 * 21 = 21 and Marginal Revenue, MR = ∆ TR / ∆Q = 21 – 0 / 1-0 = 21 When output = 2, at a price of R20, TR = 2 *20 = 40 MR = ∆TR / ∆Q = 40 – 21/2-1 = 19 In order to calculate if it is still profitable, to produce an extra unit of output, we need to equate MR to MC given the same output. Example: Using MR and MC to determine output

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Output

MR

MC

MR – MC

Output decision

0

-

-

-

Increase

1

21

15

6

Increase

2

19

11

8

Increase

3

17

8

9

Increase

4

15

7

8

Increase

5

13

8

5

Increase

6

11

10

1

Increase

7

9

12

-3

Decrease

8

5

11

-6

Decrease

At an output where: MR > MC, the firm may increase output by an additional unit. E.g. when output = 1, MR = 21 and MC = 15. Therefore MR > MC MR < MC, the firm should cut (decrease) production or close business as it is not profitable to produce, i.e. the costs of production exceed the revenue. E.g. at output = 7, MR = 9 and MC = 12 Therefore, MR < MC MR = MC, this is the profit maximisation level. At this output where MR = MC a firm realises the maximum profits possible, i.e. if profits are positive.

6. Sources/References Study chapter 11 dealing with output supply by firms in your prescribed book.

7. Learning tasks Activity 1 As this topic deals with a lot of calculations, it is advisable to practice most questions in your prescribed book and recommended books. And feel free to discuss the outcomes with me, in office or class

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8. Assessment 8.1 Assessment criteria Your knowledge of concepts will be assessed formally in tests or examination. Some calculations will also be done to test your ability to apply knowledge acquired in this unit.

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UNIT SEVEN 1. Unit Title: Market Structures 2. Learning Outcomes On completion of this unit, you should be able to: •

Define a market structure

•

Define perfect and imperfect competition and their existence.

•

Explain a monopoly, oligopoly, monopolistic competition

3. Introduction A market structure is an important theory in economics since it allows us to understand how buyers and or sellers influence the prices. This also helps government to form policies that would protect consumers from exploitation from sellers or vice versa. In each economy there are a number of market structures in existence, and depending on the sector, influence our daily livelihood.

3.1 Key Concepts Perfect competition Imperfect competition Structure of a market Monopoly Oligopoly Monopolistic competition

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4. Learning in Place This is also an independent unit, a lot of terminology will be introduced, as such your ability to grasp terminology should be useful in this unit.

5. Unit Content 5.1 Market structures The structure of a market is a description of the behaviour of buyers and sellers in that market. Different market structures occur in every capitalist-oriented system. One such structure is that of perfect competition although strictly speaking, it does not exist anywhere in the world. However, it is useful to study this structure, as it is the norm or ideal against which all other structures are measured. The reason why this market form does not exist anywhere is the strict requirements with which such markets must comply. One of these is that producers and consumers must have perfect knowledge of everything happening in the market. This is clearly unrealistic. The difference between perfect and imperfect competition is the ability of the buyers and sellers to influence prices. Perfect competition occurs when there are so many buyers and sellers that no single individual can influence the price. Imperfect competition occurs when any buyer or any seller is able to influence the price.

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5.2 Perfect competition In a perfectly competitive market, no individual buyer or seller has any influence on the market, so that market forces have complete control over production and prices.

The model for perfect competition is only used as a criterion against which other market structures may be compared. The characteristics of a perfect competition are the following: •

A large number of buyers and sellers – neither group is big enough to exercise any influence on the market.

•

Free entry and withdrawal – no obstacles exist, legally or otherwise, to prevent firms from participating in that sector

•

Perfect mobility of factors of production – all factors of production are free to move from one firm to another

•

Perfect knowledge – consumers and producers are fully informed about everything that is happening and that is available in the market, for example, prices and quality. No advertisements are therefore necessary.

•

Homogeneous product – the products of the different producers are identical, including the service, the packaging, trademarks, and so on.

The existence of many sellers means that no individual firm can control the market. Every firm is small compared to the size of the market and can therefore sell everything it produces on the market without influencing the prevailing market price in any way. Consequently such a firm is a price taker. If the firm were to set its price higher than the market price, it would not sell anything because the consumers, with their perfect knowledge, would buy from other producers.

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5.3 Imperfect Competition It is possible to distinguish several types of imperfect competition. A large enterprise can, for example, pursue a greater market share by buying out smaller enterprises. Because of its size it can limit entry into the market by temporarily lowering its prices to an absolute minimum so that competitors are simply eliminated by this strategy. Imperfect competition may occur on the supply side or on the demand side of the markets. On the supply side of the market there is no competition at all. On the demand side there may be only one buyer and a large number of sellers. There are various reasons why competition is necessarily imperfect in practice. These include economic, natural, legal, technological and spatial reasons. •

Economic reasons – the provision of a product or service may require an exceptionally large capital outlay, which makes the existence of more than one enterprise almost impossible, for example transport services and national road construction. Also, established brand names (e.g. OMO, BMW etc), stood the test of time. Therefore it would be expensive and difficult to persuade consumers to buy another brand name.

•

Natural resources – an enterprise may be the only owner of certain scarce resources. For example, oil minerals gas deposits etc. Also, cartels like Organisation of Petroleum Exporting Countries, OPEC have been established, since oil is found in large quantities in these countries and there are a few competitors. Prices can therefore be set arbitrarily.

•

Legal reasons – Free competition can be restricted legally by government action. For example, the provision of water and electricity. In so doing government protects consumers against exploitation by firms.

•

Technological reasons – technological developments may lead to an enterprise temporarily gaining a lead on its competitors.

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•

Spatial reasons – A favourable situation may make it easier for a firm to serve local consumers. Firms from outside the area will find it difficult and often expensive to compete effectively, either due transport problems or tourist attraction sites.

5.4 Monopoly In a monopoly there is only one supplier of a product. In a pure monopoly there is no competition at all. This situation can only arise if consumers cannot choose between alternative products. A pure monopoly occurs where there is only one supplier of a product for which there are no substitutes and in which it is very hard or impossible for another firm to coexist. The following may give rise to a monopoly: •

Sole owner of resources – the monopolist may be the sole owner of strategic resources, which other firms do not have access (for example De Beers is the only company which has access to diamonds).

•

Patent/Copy rights – a monopolist may have a patent or copyright which means that competitors may not legally copy his product or provide similar services (for example telecommunication, water and electricity)

•

Exclusive rights – a monopolist may be granted exclusive rights by the government to sell his product in a certain geographic area (for example transport services and casinos)

•

Brand loyalty – a monopolist may produce a popular brand which widely accepted by consumers (e.g. SA Breweries)

•

Scale of activity – certain products can only be produced profitably on a very large scale and therefore there is no room for competitors (e.g. ISCOR)

•

Financial input – many potential competitors are excluded because entry to a market may require extensive financial input. (e.g. SASOL)

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5.5 Monopolistic Competition Characteristics of a monopolistic competition can be listed as follows: •

There are a large number of competing firms active on the market

•

The product traded is heterogeneous

•

Entry to this market by new firms is possible, but there is no free movement to entry.

•

Each seller has control over part of the total market.

•

An increase in the price of the product by one firm will not make the firm lose its share of the market to its competitors since some buyers will still prefer its product.

•

Firms use advertising to make their products seem “different” and to attract new buyers.

5.6 Oligopoly An oligopoly is the most common market form in a large number of production sectors, for example mining, the manufacturing industry and the distribution industry. An oligopoly refers to a market condition where the number of sellers is so small that there is a high degree of interdependence with regard to their market action. There are only a few firms in the market which compete with each other and which either offer the same product or a differentiate product. Entry to this market is usually very expensive and difficult because the competing firms are large and established. Products, which are produced by oligopolies, include motor vehicle, aircraft, construction equipment, minerals, fuel (petrol) and computers. Each firm has a certain degree of control over the price of the product, which is sold. If a firm, which produces steel, decreases its production there will be a decrease in the supply of steel on the market if steel imports do not eliminate 66

the difference. This will cause the price of steel to increase. The ability, which a firm has to influence the price of a product, is, however, limited by the available substitute products.

6. Sources/ References Study chapter 13, covering market structures in your prescribed book. Also visit the following web site to learn how the competition tribunal resolves issues of unfair competition in our country. www.compcom.co.za

7. Learning Tasks This is not to be formally submitted as an assignment; however you are welcome to share your findings with me in class or office.

Activity 1 Visit the department of trade and industry, www.dti.gov.za. And look into what policies is government putting in place to encourage competition in our country. For example the introduction of the second fixed line operator, unbundling of Eskom, and privatisation of other previously owned state enterprises. Answer these questions: who is benefiting from restructuring, why is government doing it, what are the problems with the process?

8. Assessment 8.1 Assessment Criteria Your knowledge of concepts will be assessed formally in this unit, either through tests or examination.

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References 1. Mohr, P., Fourie, L & Associates (2000), Economics for South African students. Van Schaik. Pretoria 2. Begg D, Fischer S & Dornbusch R (1997), Economics, McGraw-Hill, London 3. Botha RF, Greyling L, J vd S Heyns, Loots AE, Schoeman C, J vd Bergh, G van Zyl (2001). Introductory Economics. Principles and Issues from a South African Perspective. Second Edition. Library of Congress Cataloging-in-Publication Data 4. Smit et al (1996), Economics. A Southern African Perspective, Juta, Kenwyn. 5. Sloman, J. (1991), Economics. Pretoria. Prentice Hall. London 6. John Pape, (2000), Economics An Introduction For South African Learners, Juta & Co, Ltd 7. Phillip Black, Trudi Hartzenberg, Barry Standish (2000), Economics. Principles & Practice, A Southern African Perspective. Second Edition. Pearson Education South Africa.

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