ECONOMICS 1501

1: What economics is all about

**Economics is the study of the use of scarce resources to satisfy unlimited wants**

 Wants – desires for goods and services - unlimited

 Needs – necessities, essential for survival, eg food and water.
 Demand – can only demand if you can afford it (purchasing power)
 Opportunity cost - value to the decision maker of the best option that could
have been taken but wasn’t, eg watch a movie instead of studying for an exam
 Scarcity - time, space and money

Product Possibility Curve (PPC Curve)

Combinations of any 2 goods that are attainable when resources are fully and
efficiently employed (always concave to the origin)

 Any point outside the curve (G) - unattainable

 Any point on the curve - choice and efficiency
 Any point between the points - movement between A and B - opportunity
cost
 Any point inside the curve - inefficient but attainable, causes
unemployment

Economics is considered a social science (can predict people)

 Micro-economics and Macro-economics

Micro-economics - individual parts of the economy in isolation

Macro-economics - overall economy

Micro economics Macro economics

Price of single prod Consumer price index, inflation
Changes in price of single product Total output of goods
Decisions of indiv cons and firms Combined outcome of decisions of all cons and firms
Market and demand for indiv goods Market and demand for all goods
Indivs decision whether to work or not Total supply of labour
Firms decision to expand/ export/ import Total supply, exports and imports

Positive and Normative economics

 Positive statement - fact
 Normative statement - opinion

Levels and rate of change

 A small % (say 5%) of a large number (say R10 million) = R 500 000.
 A large % (say 90%) of a small number (say R 10) = R9

Deceptive to read into percentages - know what the original base is

Rate of change calculation

Share price goes from R10 to R20 a share, rate of change or profit percentage

End value (R20) – beginning value (R10)

= * 100
Beginning value (R10)
= 100%

2: Closer look at economic problem

3 central economic questions - what, how and for whom

Central economic question 1: What to produce?
1. Consumer goods – consumed by individuals - 3 types
 Non–durable goods, i.e. food, meds
 Semi-durable goods, i.e. clothing, tyres
  Durable goods, i.e. cars, furniture
2. Capital goods – used to produce other goods (depreciate) eg roads, rivers
3. Final goods – consumed by indivs eg flour to use at home
4. Intermediate goods – inputs to produce other goods eg flour for cakes to sell
5. Private goods – consumed by an individual (such as food, clothing, furniture)
6. Public goods – used by the community at large (public parks, libraries and
roads)
7. Economic goods – good produced at a cost from scarce resources (groceries)
8. Free goods – not considered scarce, therefore have no direct price (air and
sun)
9. Homogeneous goods –considered identical (ounce of gold has the same
weight in any calculation system)
10. Heterogeneous goods – different characteristics based upon ability to
differentiate the product (marketing a particular feature of a washing powder
to get a higher price)

The Production Possibility Curve once again….

Shifts of PPC Curve

1. Improvement in Productivity – Society works more efficiently

2. Improvement in Technology – New inventions that improve production

Swivels of the PPC Curve

Improvement of only Productivity OR Technology Eg improvement in technology

favours consumer goods only, then it will swivel the consumer goods curve
upwards, while capital goods remains the same
Applies in reverse if improvement in technology that will favour the capital good

*Summary of PPC

Attainable On/ inside PPC

Unattainable Outside PPC
Efficient On PPC
Inefficient Inside PPC
Increase in potential Outward shift of PPC

Central economic question 2: How should it be produced?

5 Factors of Production
1. Capital - used to produce other goods eg machinery (depreciates)
2. Natural resources & land
3. Labour
4. Entrepreneurship – entrepreneur is the driving force behind production
5. Technology

Money is NOT a factor of production

Capital intensive production uses machinery to convert materials into final
products, Labour intensive production uses manual labour to convert materials
into final products.

Central economic question 3: For whom should it be produced?

Goods and services will be produced for those people who earn an income for
producing them (functional distribution of income)

Income earned from the factors of production includes:

 Capital earns interest
 Land earns rent
 Labour earns wages or salaries
 Entrepreneurship earn profits

Primary, Secondary and Tertiary sector

 Primary sector - raw materials such as agriculture, fishing, forestry
 Secondary sector - raw materials are used as inputs to produce other goods
(such as steel production, canning of food, clothing, buildings and roads)
 Tertiary sector - services and trade sector (transport, education)

Solutions to the central economic questions

Economic Systems
1. Traditional economic system – production through custom (men do what
their fathers did), clear but rigid, economic activity is not 1st priority
2. Command or Centrally planned system – instructed by a central authority
which also determines how output is distributed
3. Market system – contact between potential buyers and sellers - for a market
to exist the following conditions have to be met:
 1 potential buyer and 1 potential seller
 item to sell
 buyer must be able to afford the item
 price for the item
 agreement guaranteed by law

Market prices - signals of scarcity which indicate to consumers what they have to
sacrifice to obtain the goods, also indicate to the owners of the factors of production
how the factors can best be employed

Invisible hands of market forces - selfish actions of individuals ensure that everyone
is better off
Mixed system – combination of above, substantial degree of gov control, eg SA

3: Interdependence btwn major

sectors, markets & flows in mixed
economy
3 major flows (PIS)
1. Production 2. Income 3. Spending

Differences between Stock and Flows

Stock has no time dimension, can only be measured at a particular moment

 Wealth  Capital
 A and L  Population

Flow has a time dimension, can be measured over a period

 Income  Investment
 Profit & loss  Births and deaths

Markets in an economy
1. Goods market – goods produced are supplied (such as furniture, clothing etc)
2. Factor market – factors of production are supplied to the producers

Sectors within an economy

1. Household/ consumers (abbreviation C), det what should be produced, sell
factors of production to firms in factor market
2. Firm (abbreviation I), buyers in factor market and sellers in goods market, det
how goods will be produced, sell goods to cons in goods market
3. Government (abbreviation G)
4. Foreign (Indicated by the abbreviation X – Z)

The injection and leakages from the circular flow on income and spending

Injection Leakage
Financial sector - Investment Savings
Foreign sector - Exports Imports
Government sector – Gov spending Taxes
The circular flow of goods and services (clockwise)

The circular flow of income and spending (anticlockwise)

Monetary flow, direction is opposite to the flow of goods and services

Spending of firms represents income of households

Spending by households represents income of firms

7: Demand, supply and prices

(flows)

DEMAND (CONSUMERS) **PPITSE**

Demand - which wants to satisfy, given the available means (purchasing power)

Demand curve - Downward sloping

The Law of Demand P Qd P Qd (inverse relat)

Ceteris paribus – all things being equal, higher the price of a good, lower the quantity
demanded.

 Consumers do not enjoy high prices

 Market demand curve – adding indiv demand curves horizontally

D = P1, P2, I, T, S, E

Movements along the Demand curve

(P1) Price of good itself (Px)

Movement along the Demand curve - change in Quantity Demanded

Eg increase in the price of tomatoes on the Demand curve for tomatoes

 Increase in price – upward movement

 Decrease in price – downward movement

Shifts of the Demand curve

P, I, T, S, E - shift of the demand curve - change/ shift in Demand

 Increase demand – rightward shift

 Decrease demand – leftward shift
(P2) Price of related goods (Pg)

Substitutes

Compliments
 (I) Income (Y)

(T) Tastes (T)

(S) Size of the household (N)

(E) Expected future price changes

 Anticipation that there will be an increase in price levels – rightward shift

Eg if petrol prices are increasing at midnight then there will be more of a demand at
the existing (cheaper) price

 Anticipation that there will be a decrease in price levels – leftward shift

Eg if petrol prices are decreasing at midnight then there will be less of a demand at the
existing (more expensive) price

*Summary of demand

Determinant Change Effect on demand curve Correct description of effect

P Price of good
Increase Upward movement Decrease in Qd
Decrease Downward movement Increase Qd

P Price of related goods

Increase Rightward shift Increase in D
- Substitutes
Decrease Leftward shift Decrease in D
Increase Leftward Decrease
- Complements
Decrease Rightward Increase

I Income
Increase Rightward Increase
Decrease Leftward Decrease

T Tastes
Increase Rightward Increase
Decrease Leftward Decrease

S Population
Increase Rightward Increase
Decrease Leftward Decrease

E Expected future price

Increase Rightward Increase
Decrease Leftward Decrease

SUPPLY (PRODUCERS) **PPPPTNE* (4 Ps in the tin e)

Supply - quantities of a good or service that producers plan to sell at each possible
price
Law of supply P Qs P Qs

Ceteris paribus – all things being equal, higher the price of a product, greater the
quantities the producers will manufacture (anticipating higher profits)

Supply curve is upwards sloping (to the sky)

S = P1, P2, P3, P4, T, N, E

Movements along the Supply curve

(P1) Price of the good itself (Px)

Movement along the supply curve – change in quantity supplied

 Increase in price – upward movement

 Decrease in price – downward movement

Shifts of the Supply curve

P, P, P, T, N, E - shift of the supply curve – change/ shift in Supply

 Increase supply – rightward shift

 Decrease supply – leftward shift

Golden Rule of Supply

 Increases cost of production – leftward shift

 Reduces cost of production – rightward shift
Eg if there are changes in weather conditions which disrupt the production of petrol,
this will cause the supply curve to shift to the left.

(P2) Price of alternatives in production (Pg)

Substitutes in production
Can sell apples or pears, both the same price - produce both items equally
If price of one of the goods increases (say, apples) then produce less of the alt (say,
pears) - always motivated to produce output with highest profitability

Price of complements in production

Some products are produced jointly like steel for cars - increase in the supply of steel
will result in an increase in its bi-product cars

(P3) Price of factors of production (Pc)

Capital, land, labour, entrepreneurship

 Incr costs of production (higher input prices eg petrol, steel) – leftward shift
(lower supply)
 Decr costs of production (lower input prices eg petrol, steel) – rightward
shift

(P4) Productivity

(T) Technology (T)

 Improvement in technology (decr cost of production) – rightward shift

 (N) Number of firms in the industry (N)

(E) Expected future prices (Pe) (I am Sasol)

 Anticipates prices to increase - rightward shift

Eg producer manufactures petrol and expects the price of petrol to increase
 Anticipates prices to decrease – leftward shift
Eg producer manufactures petrol and expects the price of petrol to decrease

*Summary of supply

Effect on supply
Determinant Change Correct description
curve

P Price of good Increase

Decrease
Upward movement
Downward movement
Increase in Qs
Decrease in Qs

P Price of substitutes Increase

Decrease
Leftward shift
Rightward shift
Decrease in S
Increase in S

P Price of complements Increase

Decrease
Rightward shift
Leftward shift
Increase
Decrease

P Price of inputs Increase

Decrease
Leftward shift
Rightward shift
Decrease
Increase

T Technology Cost reducing improvement

Cost increasing changes
Rightward shift
Leftward shift
Increase
Decrease

N Num of firms Increase

Decrease
Rightward shift
Leftward shift
Increase
Decrease

E Expected future prices Increase

Decrease
Rightward shift
Leftward shift
Increase
Decrease

MARKET EQUILIBRIUM

Equilibrium = Qd = Qs

The function of prices in a market economy

Rationing function of prices - ration scarce supplies of goods and services to those
who place the highest value on them (who can afford to pay them)

Allocative function of prices - signals which direct the factors of production among
their different uses in an economy (to avoid excess supply/ demand)
Excess supply and Excess demand

Excess supply - any point above equilibrium (ES = 300-120 = 180)

Excess demand - any point below equilibrium (ED = 320-50 = 270)
Equilibrium – 5*200 = 1000

8: Demand and supply in action

Demand

Normal good - income increases - demand increases

Inferior good - income increases - demand decreases eg paraffin, potatoes
Supply

Simultaneous changes in Demand and Supply

When only demand OR supply changes, it is possible to predict what will happen
to equilibrium price and quantity
If demand and supply change simultaneously, the precise outcome cannot be
predicted.

(P/Q either incr/ decr, other always uncertain)

Interaction between markets

Substitute good changes price

Government intervention

Maximum prices (price ceilings)(on the floor)

 Protect the consumer from high prices
 Consequence - excess demand that is created at the artificially lower price

ES Price floor

ED Price ceiling

If above equilibrium - no effect (still determined by supply and demand)

Eg if the max price you can charge per loaf of bread is R10 by law, and the market
price is R5, the max price is irrelevant.
If below equilibrium - excess demand
Eg if the market price is R10 and the maximum price is R5, excess demand

Governments set maximum prices to:

 Keep the basic price of food stuffs low for the poor
 Avoid the exploitation of consumers
 Prevent inflation
 To limit the wartime production of goods

To ration the limited output caused by the low prices

 Consumers are served on “first-come, first-serve basis”
 Informal rationing (limit quantity sold to each cust)
 Formal rationing (coupons)

Black market forces – supply and demand can't eliminate excess demand so buy and
sell at higher prices than max set price

Price fixing below equilibrium

 Creates shortages (ED)
 Prevents market mechanism from allocating available quantity among cons
 Stimulates black market activity

Minimum prices (price floors)(on the ceiling)

 Protect the producer from low prices
 Consequence - excess supply that is created from the artificially high prices

If above equilibrium – excess supply

If below equilibrium – no effect

Dealing with excess supply, gov can

 Purchase surplus and export, destroy/ store it
 Introduce production quotas to limit Qs to Qd
 Producers destroy surplus
Setting minimum prices above equilibrium prices inefficient way of assisting the
poor
 Everybody pays artificially high prices
 The bulk of the benefit goes to producers
 Inefficient producers can remain in the industry
 Disposal of surplus entails further costs to tax payers

9: Elasticity
Measure of responsiveness or sensitivity when two variables are related and want to
know how sensitive or responsive the dependent variable is to changes in the
independent variable eg size of crop dependent on rainfall

% dependent variable
E=
% independent variable

% change in dependent variable if relevant independent variable changes by 1%

Price elasticity of demand (Ep)

% Qd
Ep =
% P

% change in quantity demand when there is a 1% change in price

Price elasticity of demand differs along the demand curve

 A - ∞ - 10/0 = impossible
B = 32
C = 50 - ideal
D = 32
E – 0*20 = 0

Elasticity points along a demand curve are not constant

5 different categories of price elasticity of demand

1) Ep > 1 Elastic (eg cars, holidays)

2) Ep < 1 Inelastic (eg drugs, alcohol)

3) Ep = 1 Unitary elastic (EQUILEBRIUM)

4) Ep = ∞ Perfectly elastic

5) Ep = 0 Perfectly inelastic

If EP = 3: means that a 1% change in price will cause quantity demanded to change by

3%
 Therefore Ep = 1 means 1% change in price causes demand to change by 1% (max
rev)

Arc elasticity

Between 2 points on demand curve (Ignore negative answers)

(Q2 – Q1) / (Q1 + Q2)

Ep =
(P2 – P1) / (P1 + P2)

*Summary of price elasticity

Category Meaning Effect on TR (total revenue)

Ep > 1 % change in Q > P TR changes in opposite direction to P
Elastic (incentive for S to lower prices)
Ep < 1 % change in Q < P TR changes with P in same direction
Inelastic (incentive for S to raise prices)
Ep = 1 % change in Q = P TR doesn’t change
Unitary elastic
Ep = ∞ Indeterminate Q at given P, P increases, Q = 0, TR = 0
Perfectly elastic nothing D at fractionally higher P
Ep = 0 Q doesn’t change when P changes TR changes with P in same direction
Perfectly inelastic (incentive for S to raise prices)
Inelastic – Ep < 1 – salt, matches, cigs, bread, electricity, meds
(INelastic = INcrease price)
Elastic – Ep > 1 – cars, furniture, holidays, apples

Determinants of price elasticity of demand

 1. Substitution possibilities – More alternatives available, more elastic the good
tends to be (such as margarine instead of butter)
2. Degree of complementarity – Products that are used together are inelastic
(such as cars and tyres)
3. Type of want satisfied - Luxury items (eg holidays and electronics) tend to be
elastic. While necessities such as food and medicine tend to be inelastic
4. Time period under consideration - Longer the time period under
consideration, the more elastic a good tends to be (eg it’s cheaper to buy
tickets for an airline in advance as you have more options to travel alternatives
in the long-run).
5. Proportion of income spent on a product – Cheaper items tend to be more
inelastic (price is so insignificant as a proportion of your budget that even a
price double will have little effect on the decision to purchase an item)
 Other possible determinants
o Definition of prod – broader def = inelastic (reduces num of
substitutes) eg demand for food (broad) vs demand for burgers (narrow
so elastic)
o Advertising also creates an inelastic demand
o Durability – more durable – more elastic
o Num of uses of prod – more uses – more elastic
o Addiction – inelastic, even perfectly inelastic sometimes

Price discrimination – charging diff prices to diff cons according to diffs in price
elasticity

Income Elasticity of demand (Ey)

% Qd
Ey =
% y

Measures the responsiveness of the quantity demanded to changes in income

Ey > 0 Normal goods

Positive (incr y = incr Qd)

Ey < 0 Inferior goods

Negative (incr y = decr Qd)

Ey > 1 Luxury goods

Greater than 1 – income elastic (% change Qd > % change y)

Ey < 1 Essential goods

 Positive but less than 1 – income inelastic (% change in Qd < % change in y)

Cross elasticity of demand

Qd of prod depends on price of related goods, cross elasticity measures

responsiveness of Qd on good to changes in price of related goods

% Qd of good A (dependent)
Ec =
% P of good B (independent)

 Ec = 0 independent goods (no relationship)

 Ec = positive substitute
(Change in P = change in Qd of substitute prod in same direction) eg P of
butter incr, more margarine is D

 Ec = negative complement
(Change of P = change of Qd of complementary prod in opposite direction) eg
P of cars drops, Qd of cars incr as will D for tyres)

*Summary of elasticity

Type Definition Possibilities Description

Ep > 1 Elastic
% change in Qd Ep < 1 Inelastic
Price elasticity
Ep = 1 Unitary elastic
of demand
% change in P Ep = ∞ Perfectly elastic
Ep = 0 Perfectly inelastic
% change in Qd of good A Ec < 0 Complements
Cross elasticity
Ec > 0 Substitutes
of demand
% change in Qd of good B Ec = 0 Independent prods
Ey > 0 Normal good
% change in Qd
Income elasticity Ey < 0 Inferior good
of demand Ey > 1 Income elastic
% change in I
Ey < 1 Income inelastic

10: Background to demand: theory

of consumer choice
2 approaches to measure consumer satisfaction or utility (happiness)
 Ordinal utility - rank preferences, i.e. prefer A to B (indiff approach)
 Cardinal utility - measuring or quantifying the satisfaction (utility approach)

Utility approach
 Marginal utility (MU) - additional utility derived from consuming 1 additional
unit of a good, will decline until reaches 0, then becomes negative (disutility)
 Total utility (TU) – sum of all marginal utilities, increases as long as marginal
utility is positive

Law of diminishing marginal utility – marginal utility of good eventually declines

as more of it is consumed in given period

Total, marginal and average utility will always be the same in the 1st row (p178
textbook, p162 in study guide) **NB for block questions**

Indifference approach
 Distinguish graphically btwn income effect and substitution effect of price
change

3 basic assumptions
1. Completeness - able to rank the available combinations in order of preference
2. Consistency - assumes cons acts consistently
Eg if a consumer prefers A to B, and B to C - they will prefer A to C
3. Non-satiation - implies cons prefers more to less

Indifference curve (convex to origin)

All the combinations of 2 products that will provide equal levels of satisfaction
Cannot intersect (violates assumption of non-satiation)

Any point on the curve yields the same utility even though it’s different combination

Law of substitution – scarcer the good becomes, greater its substitution value
(As you move down the curve, consumer is prepared to substitute less of one good in
or order to choose more of another)

At any point the substitution ration is given by the slope of a tangent to the curve (line
which just touches the curve at that point)
Marginal Rate of Substitution (MRS)

Slope of the tangent indicates rate at which cons is willing to sacrifice small quantity
of 1 good for a little more of the other (MRS det slope of indiff curve)

Eg willing to sacrifice 3 loaves of bread for 1 extra portion of meat, once chosen an
additional portion of meat, only willing to sacrifice 1 loaf of bread for an additional
portion of meat

MU x Qy
MRS = =
MU y Qx

Extreme cases

Perfect complements – can only be used together eg pair of shoes, additional shoes
won't incr utility
Perfect substitutes – eg Sasol petrol and BP petrol, no diff so will always yield same
utility
The Budget line

Combinations of goods that the consumer can afford

Also called consumption-possibilities curve, expenditure curve, budget constraint

Can be drawn if the intercepts on the 2 axes are known (max num of each good cons
can afford by spending all money on that good only)

Eg if 0 meat and 6 breads were demanded, vertical intercept - 6 breads, if 4 meat and
0 breads are selected, horizontal intercept - 4 meats, exchange ratio is 6:4 (opp cost)

Consumer equilibrium

Equilibrium - indifference curve lies tangent to the budget constraint

Consumer will always choose the highest indifference curve as this represents a
greater combination of both goods (U3)

Equilibrium - slope of budget line is equal to slope of the indifference curve (B)
If ratio between MU and P is the same for all products then cons is in equilibrium
(maximising total utility with budget)

If ratio is not the same, higher level of TU can be achieved by changing buying
pattern

Changes in equilibrium

A change in income (shift)

Increase in income - shift budget constraint to the right onto a higher indiff curve

Income-consumption curve - effect of changing income on cons’ consumption of 2

goods

Normal good – income incr - rightward shift of budget constraint

Inferior good – income incr – leftward shift of budget constraint

Change in price (swivel)

Price-consumption curve – combos of 2 goods demanded if price of 1 good changes

Increase in the price - budget constraint swivel inwards

Decrease in the price - budget constraint swivel outward

Increase in real income – reach higher satisfaction by moving to higher indiff

curve (when price of goods fall, cons real income incr although nominal income
doesn’t)
Income effect – effect of change in real income on cons purchases of certain good
Substitution effect – substitute good that has become cheaper for 1 that has become
more expensive
11: Background to supply:
production and cost
Types of firms
 Close corporations  Companies
 Trusts  Partnership

Aim of any firm is to maximize profits (Profits = Revenue – Costs)

Total revenue (TR) = P*Q

P*Q
Average revenue (AR) =
Q

TR
Marginal revenue (MR) =
Q

 MR – additional rev earned by selling additional unit of prod (change in

totals)
 TR – value of sales (add marginals)

Economists Accountants
 Consider opportunity costs  Consider actual expenses
 Explicit and implicit costs  Explicit costs (monetary only)

True economic cost – value of the best alternative use sacrificed

Economic cost of production

 Explicit + implicit costs
 If rev can't cover – firm is not viable

Types of Costs
1. Explicit costs (monetary payments for capital, land, labour)
2. Implicit costs (opp costs eg diff job/ self-owned res)
 Opportunity cost
 Normal profit
Types of Profits
1. Accounting profit - Total Revenue – Explicit costs
2. Normal profit - monetary payments firm’s resources could earn in their best
alternative use
o Minimum profit req to operate
o Industry rate of return
o Part of firms’ costs of production
3. Economic profit - Total Revenue – Total costs (explicit + implicit costs +
normal profit)
o Earn coz of trademarks, patents and copyrights
o Also called excess profit, abnormal profit, supernormal profit, pure
profit

Economic profit - total revenue exceeds total economic cost

Normal profit – total revenue = total economic cost
Economic loss – total economic costs exceed total revenue

Production in the short run

 At least 1 input is fixed (land)

 Production – physical transformation of inputs into outputs
 Input – factors of production and intermediate inputs (any good other than
FOP - natural res, labour, capital, entrepreneurship to produce something else)
 Fixed input – can't be changed in short run eg buildings
 Variable input – can be changed in short and long run eg tools, labour

In SR - firm can expand output only by increasing quantity of its variable inputs

Production function – for a given state of tech, there is a relat btwn quantity of
inputs and max outputs that can be obtained from those inputs (depends on
technology)

Total product (TP)

Average product (AP) =
Variable input (N)

Marginal product (MP) = difference between totals (p209 in textbook)

Law of diminishing returns

As a more of a variable input (such as labour) is added to a fixed input (such as

machinery), points will eventually be reached when the Marginal product declines,
then the Average and finally the Total product (MAT)
Product curve

Exponential incr -
1 Division of labour
2 Specialization

Decrease
1 Bottle necks
2 Breakdowns

MP intercepts AP at
highest point

Costs in the short run

Total cost = TFC + TVC
Average fixed cost (AFC) = TFC / TP
Average variable cost (AVC) = TVC / TP P211 in textbook
Average cost (AC) = TC / TP P168 in study guide
Marginal cost (MC) = TC / TP

When Marginal product (MP) incr, Marginal Cost (MC) decr and vice versa

TFC – horizontal line

TVC – reversed S (starts at O)
TC – like TVC but starts at same point on vertical axis as TFC
AFC – L shaped (TP incr from 0, starts high then declines till max TP reached)
AVC, AC, MC – U shaped, TP incr from 0, starts high, declines, reach min point,
incr)

Why do the curves slope the way they do

1. AFC (Average Fixed Cost) is a downward sloping curve – why?

As output increases, fixed costs are absorbed by larger number of units

Example: R 10 000 is a fixed cost. If you produce 1 unit:

Average fixed cost = R 10 000 / 1 = R 10 000 per unit
However, if you produce 10 000 units:
Average fixed cost = R 10 000/ 10 000 = R 1 per unit

2. (AVC) Average Variable Cost is a U-shaped curve – why?

As output increases, variable costs drop because of economies of scale

Costs drop when production increases so moves towards its full

capacity When reaches capacity, any additional output will become
more expensive to produce
Eg pay overtime because staff has to work longer hours to produce the increased
output

3. (MC) Marginal Cost Curve

MC curve always intercepts the AC and AVC curve at the lowest point
Cost of producing 1 extra unit of output
4. Average Cost Curve always lies above the other curves – why?

Average Cost (AC) = Average Fixed Cost (AFC) + Average Variable Cost (AVC)

*product* - parabola

*cost*

12: Perfect competition

 Barriers to entry so economic
profit
 Patents
 Trademarks
 Copyrights
Price makers
US SA
A

Perfect competition Imperfect Oligopoly (small Monopoly

(doesn’t really exist) competition eg num of big suppliers) eg Eskom
quick shops, Spar = price fixing

None of the individual market participants (buyers or sellers) can influence the price
of the product (they are price takers – have to accept price)

Requirements
1. Large number of buyers and sellers - no buyer or seller can control the price
2. No collusion btwn sellers (all act independently)
3. Goods must be homogenous (identical) – no seller can try and raise the price
4. Freedom of entry and exit – if one seller is making an economic profit in
short run then other competitors will enter the industry eliminating economic
profits
5. Perfect knowledge – No firm can over charge for their goods because
consumers have perfect knowledge what the correct price should be
6. No government intervention (price fixing)
7. Factors of Production must be perfectly mobile (move from 1 market to
another)

Demand for product of firm

Price of prod is det by supply and demand, no firm will charge higher price else will
lose all cust, and won't gain by charging less

Consumers have a horizontal demand curve (perfectly elastic) (demand curve for
product of firm, firm’s sales curve, firm’s demand curve, demand curve facing firm)

D = MR = AR (market price = marginal rev = average rev)

TR = P*Q

In perfect competition, price is given so for each additional unit sold, TR will incr by
amount equal to price (P = MR = AR) (p226 in textbook)
 Whenever see this
know PERFECT
COMPETITION
and D=AR=MR

Firms – cost curve (perfectly

Industry – S and D curve elastic)

Equilibrium Condition for any Firm

Shut-Down Rule (worth producing at all)

Short-run (at least 1 input is fixed) cover at least its variable costs to continue
Long-run (all inputs are variable) cover all its costs (fixed and variable) to continue

 SR P ≥ VC
 LR P ≥ TC

Eg FC = 100 000 30 per unit

VC = 50 000 20 per unit
TC = 150 000 50 per unit

So P = 10 SR no LR no
P = 20, 30, 40 SR yes LR no
P = 50 SR yes LR yes (normal profit)
P = 60 SR yes LR yes (economic profit of 10)

Profit-Maximising Rule (level of production to maximise profits)

Profits are maximised when difference between revenue and costs are at their highest

MC = MR

MR > MC expand outputs

MR = MC max profits
MR < MC reduce output

Enables the firm to identify how many units of output to produce to maximise profits

Cost
D = AR = MR

Profit per unit = cost (10) - x

a = R6 profit per unit
b = R4 profit per unit
c = R2 profit per unit
d = MC = MR

5 steps

1. D = AR = MR
2. AC (start high absorb costs, overtime)
3. MC (intercepts AC at lowest point)
4. MC = MR
5. AC = AR (det profit)
 AR > AC
Economic profit

3
2
AR = AC
1 Normal profit
5

AR < AC
Economic loss

Supply curve of the firm

Part of MC curve above minimum AVC is its supply curve (above break-even
point)
 a = below VC so SR no
b = SR yes (AV = AR) LR no
D = AR = MR (AC > AR) economic loss = close
D = AR = MR c = SR yes LR no (AC > AR)
economic loss
D = AR = MR
d = SR yes LR yes (AC = AR)
D = AR = MR normal profit
D = AR = MR e = SR yes LR yes (AR > AC)
economic profit

Shut-Down point

Short-run - cover AVC (average variable costs) point B

Long-run - cover all costs (short-term and long-term) point D – Break Even point

Impact of entry and exit on the equilibrium of the firm and the industry

Num of firms in
industry (4P TNE)
Economic profit
(AR > AC)

Firms are making profits - new firms enter industry therefore market supply will
incr, reducing market price - supply curve shifts right with consequent decr in P

Firms making economic losses will leave industry in long-run, thus reducing supply
and raising price - leftward shift of supply curve (only normal profits now)
 In the short run, can make economic profit
In the long run, can only make a normal profit

Normal profits
(AC = AR)

Economic loss
(AC > AR)

Busn leave industry,

shifts left, price incr =
normal profits

13: Monopoly & imperfect

competition
Opposite extreme to perfect competition - sellers can alter market price (price setters/
price makers)

*Summary of market structures

Perfect Monopolistic/ Monopoly

Criteria competition imperfect Oligopoly
(EXTREME) competition (EXTREME)
Num of firms Many Many Few 1
Nature of prod Homogeneous Heterogeneous Homo/ hetero Heterogeneous
Entry Free Free Varies Blocked
Information Complete Incomplete Incomplete Complete
Collusion Impossible Impossible Possible Irrelevant
Firms control over
None – price takers Some Lots Lots – price makers
price
Demand curve for
Horizontal Downward sloping Downward sloping Downward sloping
firms prod
Long run profits Normal profit Normal profit Economic profit Economic profit
Monopolies

Single firm or seller capable of earning economic profits/ loss in both short-run and
long-run eg Eskom and Microsoft due to blocked entry into market

Demand for product of the industry is also demand for prod of single firm – quantity
sold depends on market demand, can't set price and sales independently (constrained
by D)

Equilibrium position
 MR = MC provided AR > AVC (profit max and shut down rule)
 Demand curve for prod is market demand curve for prod of industry
 Normal demand curve so if want to sell more, must lower price (main diff
btwn monopolies and perfect competition)
 Price discrimination – diff price for diff ppl eg airlines (1st class vs economy)
 MR (marginal rev) is change in totals (always less than price at which all units
of prod are sold)
o If MR + TR incr
o If MR = 0 TR remains same
o If MR - TR decr
 To det economic profit/ loss – compare TR with TC
 Average profit per unit of output is shown by diff of AR and AC
 D = AR lies above MR

Go up to D curve from
MC=MR for profit

C = normal profit
P = economic profit

Monopolistic/ imperfect competition

  Combines certain features of both monopoly and perfect competition
 Each firm is small enough (relative to total market) and total num of firms
large enough so each firm can ignore consequences of actions on other firms
in market
 Large num of firms produce similar but slightly different prods

Prod differentiation
 Diff varieties of a prod are produced (heterogeneous)
 Greater real/ perceived differentiation, less price elastic prod becomes (mainly
through non-price competition eg free samples in magazines)

Diff between monopolistic competition and monopoly is in barriers to entry

(not restricted in monopolistic comp, fully blocked in monopoly)

Difference between monopolistic comp and perfect comp is in nature of prod

(monopolistic comp is heterogeneous, perfect comp is homogeneous)

Oligopolies

 Few large firms dominate the market (most common)

 If goods are homogeneous – pure oligopoly (eg steel, cement)
 If goods are heterogeneous – differentiated oligopoly (eg cars, cigarettes)

Features
 High degree of interdependence between the firms (actions of one firm
affects the actions of other firms) coz so few firms
 Uncertainty coz interdependent, can't be certain of competitors policies
 Barriers to entry – varies in diff industries

2 broad strategies:
1. Collude (join together)
 Agree to limit competition and maintain high profitability
 Cartel – agree on price, market share, ad expenses, product dev
2. Compete (barriers to entry)
 Non-price eg prod dev, advertising, after-sale services
No general theory
 Interdependent, rivalrous, act strategically so no single theory on pricing and
output decisions (can't be predicted, uncertain demand curve)

14: Labour market

Differences between the labour and goods market

1. Non-monetary factors such as location and working cond are NB

2. Labour services can’t be transferred
3. Labour is rented, not sold
4. Non-economic factors eg loyalty, equity
5. Trade unions, collective bargaining and gov intervention
6. Governed by long-term contracts
7. Heterogeneous (can't be standardised)
8. Different varieties of labour markets – segmented
9. Non-wage benefits eg med aid, pension
10. Remuneration is affected by many factors not directly related to labour
cond eg tax

Nominal wage – not adjusted for inflation

Real wage – adjusted for inflation Real wage = nominal wage – inflation

Perfectly competitive labour market

Requirements
 Large num of buyers and sellers (no1 can infl wage rate – wage takers)
 Labour must be homogeneous (identical skills – impossible)
 Workers must be completely mobile
 No gov intervention
 All participants must have perfect knowledge
 Perfect competition in goods market (can't pass incr labour costs to cons in
higher prices)

Equilibrium in the labour market

D – Wage incr, more ppl want

to work (households)

S – Wage incr, hire less ppl

Perfectly competitive labour market in which all the requirements of perfect
competition are met, the equilibrium wage rate is determined by S and D

Supply of labour

Change in the wage rate will cause movements along the supply curve

Any of the non-wage determinant changes will cause shifts of the supply curve

 increase – rightward shift

 decrease – leftward shift

Market supply of labour is determined by (non-wage determinants)

 New workers enter the industry
 Number of workers decrease eg HIV/ AIDS
 Wages earned in other industries changes
 Non-monetary aspects of an industry change – benefits such as more
vacation time, med aid, job security

An individual firm’s demand for labour

Demand for labour is a derived demand – not demanded for its own sake, but
rather for the value of the goods and services that can be produced when labour is
combined with the other factors of production (only D labour if D for goods and is
profitable)

To analyse indiv firm’s demand for labour, must consider marginal cost of labour
(MCL) and marginal benefit of labour

In perfectly competitive labour market, wage rate is det in labour market by demand
and supply of labour (wage takers – no indiv can infl)

How much labour must firm employ at given rate to max profits? - examine
marginal benefit to firm of employing additional labour
 Physical productivity of labour
 Marginal revenue (price of prod)

Law of diminishing returns implies marginal product of labour has declining tendency

Marginal revenue product (p283 in textbook)

Incr in total rev of firm if employ additional unit of labour

MRP = MPP * MR
Marginal revenue prod = marginal physical prod * marginal revenue (MPP is change
in totals TPP)

Perfectly competitive firm

Revenue earned by the additional output produced is equal to the value to the firm of
employing an additional unit of labour multiplied by the price of the good

MRP = MPP * P

Equilibrium occurs when

Cost of employing a labourer is equal to the revenue earned by the output produced
(Marginal benefit exceeds marginal cost) (profit-max rule)

MRP = W (wage rate)

 S = MCL

Demand for labour

Change in the wage rate will cause movements along the demand curve

Any of the non-wage determinant changes will cause shifts of the demand curve

 increase – rightward shift

 decrease – leftward shift

Market demand for labour is determined by (non-wage determinants)

 Number of firms changes - more firms in the industry, greater demand for
labour
 Price of the product changes – higher prices implies higher profitability,
therefore more labour is demanded (change in P therefore MRP changes)
  Productivity (MPP) changes
 New substitutes for labour– i.e. ATM’s
 Price of a substitute factor of production changes – machinery becomes
cheaper, quantity of labour demanded decreases
 Price of a complementary factor of production decreases – price of trucks
fall, there will be a greater demand for truck drivers

Imperfect labour markets

Reasons why labour markets are imperfect

 Workers are organised in trade unions - monopolistic supplier of labour
 Only 1 buyer of labour (major employer) in particular market (monopsony)
 Labour is heterogeneous – each worker has own skills
 Labour is not completely mobile (segmented markets, can't move freely)
 Gov intervenes (cond of employment, legislation)
 Employers and employees have imperfect knowledge

Trade unions

Req for perfect competition in labour market is large num of independent suppl of
labour
Workers therefore band together to form trade unions to pursue aims and serve as
countervailing force to bargaining power of suppl (if can't be settled, mediation/
arbitration is used)

Craft union

Workers with a common set of skills (eg plumbers and electricians) that are joined
together by a common association, irrespective of where they work

Can control the supply of labour in particular professions by limiting members that
have particular training or qualifications (creates barriers to entry)

Supply is low so workers

can demand higher
wages eg CA

Industrial union

Organize all workers (skilled and unskilled) in a particular industry in a single

bargaining unit

Does not restrict membership by qualifications or experience like craft unions

Ultimate aim is to achieve complete control over the labour supply in a particular
industry, thereby forcing firms in the industry to bargain exclusively with it over
wages and other conditions of employment
Minimum wage protects
worker but causes excess
supply of labour (leads to
unemployment)