Advanced Diploma in Business Management

MICROECONOMICS

Module Guide

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 Microeconomics

Table of Contents
Preface 2
Unit 1: Introduction to Economics 12
Unit 2: The Circular Flow of Income and Spending 29
Unit 3: Demand, Supply and Prices 46
Unit 4: Demand and Supply in Action 75
Unit 5: Elasticity 93
Unit 6: Production and Cost 113
Unit 7: Perfect Competition 132
Unit 8: Monopoly and Imperfect Competition 148
Unit 9: Labour Market 164
Unit 10: Market Failure and Government Failure 180
References 220
Bibliography 222

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Preface
A. Welcome
Dear Student
It is a great pleasure to welcome you to Microeconomics (MES7). To make sure that you share our
passion about this area of study, we encourage you to read this overview thoroughly. Refer to it as
often as you need to, since it will certainly make studying this module a lot easier. The intention of
this module is to develop both your confidence and proficiency in this module.

The field of Microeconomics is extremely dynamic and challenging. The learning content, activities
and self- study questions contained in this guide will therefore provide you with opportunities to
explore the latest developments in this field and help you to discover the field of Microeconomics as
it is practiced today.

This is a distance-learning module. Since you do not have a tutor standing next to you while you
study, you need to apply self-discipline. You will have the opportunity to collaborate with each other
via social media tools. Your study skills will include self-direction and responsibility. However, you will
gain a lot from the experience! These study skills will contribute to your life skills, which will help you
to succeed in all areas of life.

Please note that some Activities, Think Points and Revision Questions may not have answers
available, where answers are not available this can be further discussed with your lecturer at
the webinars.

We hope you enjoy the module.

-------
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must obtain permission from the copyright owner.

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 Microeconomics

B. Module Overview
• The module is a 15 credit module at NQF level 7

The purpose of the module is to introduce you to the study of economics, more specifically that
branch of economics known as Microeconomics. An understanding of economics and how economic
decisions are made is essential for any person entering the field of Business Management. No
company exists in a vacuum. All companies operate within a larger economic environment, and are
shaped and influenced by the economic, social and political forces that operate within that
environment. Understanding these forces, how they affect a business, and more importantly, how to
respond to them is one of the major tasks of a business manager. This module equips you with some
basic economic tools that will help you to make informed business decisions.

We begin the module with an understanding of what economics is and how the problem of scarcity is
central to the way we define economics. This is followed by a discussion on how money and
products flow within the economy. The discussion then moves on to the important economic
concepts of demand and supply, and how prices of goods and services are determined in the
market. We then bring the focus on to the individual firm, and examine the concepts of production
and costs. This is followed by a discussion on the four types of market structures that typically exist in
an economy. Next, we examine the labour market, and how it functions. The module concludes with
a discussion on market and government failure in the economy, and some sources of this failure.

The module is divided into a number of units. We suggest that you approach each unit by first
reading the introduction to get a sense of what the unit covers. Then read the text, in conjunction with
the textbook. In the text, there are a number of exercises, for example Think Points, Activities etc.
that you should complete. It is important that you complete these exercises as they are designed to
help you apply what you learn. At the end of each unit, you will find some end-of-chapter questions,
which you should complete. Suggested answers to these questions are provided so that you can
assess your answers.

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C. Exit Level Outcomes and Associated Assessment Criteria of the

Programme

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D. Learning Outcomes and Associated Assessment Criteria of the Module

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E. Programme Notional Learning Hours

Learnin
Types of learning activities g Time
%

Lectures/Workshops (face to face, limited or technologically mediated) 10

Tutorials: individual groups of 30 or less 0

Syndicate groups 0

Practical workplace experience (experiential learning/work-based learning etc.) 0

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Independent self-study of standard texts and references (study guides, books, journal
65
articles)

Independent self-study of specially prepared materials (case studies, multi-media, etc.) 20

Other: Online 5

Total 100

F.Acronym
AD Aggregate Demand

AFC Average Fixed Cost

AP Average Product

AR Average Revenue

AS Aggregate Supply

AVC Average Variable Cost

CRS Constant Returns to Scale

DRS Diminishing Returns to Scale

ED Elasticity of Demand

ES Elasticity of Supply

IRS Increasing Returns to scale

LRAC Long Run Average Cost

LRMC Long Run Marginal Cost

MC Marginal Cost

MP Marginal Product

MR Marginal Revenue

MU Marginal Utility

PPC Production Possibility Curve

PPF Production Possibility Frontier

PPS Production Possibility Set

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RTS Returns to Scale

SAC Short Run Average Cost

SMC Short Run Marginal Cost

TC Total Cost

TFC Total Fixed Cost

TP Total Product

TR Total Revenue

TU Total Utility

TVC Total Variable Cost

G. How to Use this Module

This Module Guide was compiled to help you work through your units and textbook for this module,
by breaking your studies into manageable parts. The Module Guide gives you extra theory and
explanations where necessary, and so enables you to get the most from your module.

The purpose of the Module Guide is to allow you the opportunity to integrate the theoretical concepts
from the prescribed textbook and recommended readings. We suggest that you briefly skim read
through the entire guide to get an overview of its contents. At the beginning of each Unit, you will find
a list of Learning Outcomes. This outlines the main points that you should understand when you
have completed the Unit/s. Do not attempt to read and study everything at once. Each study session
should be 90 minutes without a break

This module should be studied using the prescribed and recommended textbooks/readings and the
relevant sections of this Module Guide. You must read about the topic that you intend to study in the
appropriate section before you start reading the textbook in detail. Ensure that you make your own
notes as you work through both the textbook and this module. In the event that you do not have the
prescribed and recommended textbooks/readings, you must make use of any other source that deals
with the sections in this module. If you want to do further reading, and want to obtain publications that
were used as source documents when we wrote this guide, you should look at the reference list and
the bibliography at the end of the Module Guide. In addition, at the end of each Unit there may be
link to the PowerPoint presentation and other useful reading.

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H. Study Material
The study material for this module includes programme handbook, this Module Guide, a list of
prescribed and recommended textbooks/readings which may be supplemented by additional
readings.

I. Prescribed Textbook
The prescribed and recommended readings/textbooks presents a tremendous amount of material in
a simple, easy-to-learn format. You should read ahead during your course. Make a point of it to re-
read the learning content in your module textbook. This will increase your retention of important
concepts and skills. You may wish to read more widely than just the Module Guide and the
prescribed and recommended textbooks/readings, the Bibliography and Reference list provides you
with additional reading.

The prescribed and recommended textbooks/readings for this module are:

Prescribed Reading(s)

Mohr. P. (2015) Economics for South African Students. Fifth Edition. Pretoria: Van Schaik
Publishers.

Recommended Reading(s)

Cloete, M. and Marimuthu, F. (2021). Basic Accounting for non- accountants. Third Edition.
Pretoria: Van Schaik.
Marx, J. (2022). Financial Management in Southern Africa. Sixth Edition. Cape Town: Pearson.

J. Special Features
In the Module Guide, you will find the following icons together with a description. These are designed to
help you study. It is imperative that you work through them as they also provide guidelines for
examination purposes.

~~~~~~~~~~~~~~

Special Feature Icon Description

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The Learning Outcomes indicate what aspects of the particular

LEARNING
Unit you have to master and demonstrate that you have
OUTCOMES
mastered them.

The Associated Assessment Criteria is the evaluation of student

ASSOCIATED
understanding with respect to agreed-upon outcomes. The
ASSESSMENT
Criteria set the standard for the successful demonstration of the
CRITERIA
understanding of a concept or skill.

A think point asks you to stop and think about an issue.

THINK POINT Sometimes you are asked to apply a concept to your own
experience or to think of an example.

You may come across activities that ask you to carry out specific
tasks. In most cases, there are no right or wrong answers to
ACTIVITY
these activities. The aim of the activities is to give you an
opportunity to apply what you have learned.

At this point, you should read the reference supplied. If you are
unable to acquire the suggested readings, then you are
READINGS
welcome to consult any current source that deals with the
subject. This constitutes research.

PRACTICAL
Real examples or cases will be discussed to enhance
APPLICATION
understanding of this Module Guide.
OR EXAMPLES

You may come across knowledge check questions at the end of

KNOWLEDGE
each Unit in the form of Multiple-choice questions (MCQ’s) that
CHECK
will test your knowledge. You should refer to the module for the
QUESTIONS
answers or your textbook(s).

You may come across self-assessment questions that test your

REVISION understanding of what you have learned so far. These may be
QUESTIONS attempted with the aid of your textbooks, journal articles and
Module Guide.

Case studies are included in different sections in this module

CASE STUDY guide. This activity provides students with the opportunity to
apply theory to practice.

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VIDEO You may come across links to videos as well as instructions on

ACTIVITY activities to attend to after watching the video.

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Unit
1: Introduction to
Economics
Unit 1: Introduction to Economics

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Unit Learning Outcomes

Prescribed and Recommended Textbooks/Readings

Prescribed Reading(s)
Mohr. P. (2015) Economics for South African Students. Fifth Edition.
Pretoria: Van Schaik Publishers.

Recommended Reading(s)
Cloete, M. and Marimuthu, F. (2021). Basic Accounting for non-
accountants. Third Edition. Pretoria: Van Schaik.

Marx, J. (2022). Financial Management in Southern Africa. Sixth Edition.

Cape Town: Pearson.

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1.1 Introduction
This unit introduces you to the study of economics. It begins with an examination of what economics
is, and how the concepts of scarcity and choice are central to the way economic decisions are made
by individuals and governments. We also examine the various definitions of economics as proposed
by different authors, and observe that the common thread that runs through all the definitions is the
relationship between the limited wants of human beings, and the limited resources that are available
to satisfy these wants.

The question whether economics is a science is examined in the next section. This is followed by a
study of the two broad areas of economics known as Microeconomics and Macroeconomics.
Microeconomics deals with the economic behaviour of individuals and firms, while Macroeconomics
studies the national economy as a whole. The unit ends with a discussion on the difference between
Positive Economics and Normative economics, and why understanding this difference helps us to
understand how the economy operates, and how economic policy decisions are made.

1.2 What is Economics?

The word economics is derived from the Greek word ‘Oikonomia’ which literally means ‘managing
the household’. Many people, especially those new to the field, have the perception that economics
is complicated, even intimidating. Nothing can be further from the truth. Alfred Marshal put it best
when he said that “Economics is a study of mankind in the ordinary business of life.”

More formally, economics is the study of how we make decisions regarding the use of our scarce
resources. Human wants and needs are limitless, but the means, or the resources to satisfy those
needs are limited.

You know this from your own experience. If you were asked to make a list of the things you need and
want in your life to keep you satisfied, the list will be endless. But how many of those things on your
list will you be able to afford, given your income. Only a small fraction we would imagine. Because of
your unlimited needs, and your limited income, you have to make choices on what you can buy, and
what you have to live without. Giving rise to the issue of Scarcity. For example, if you decide to spend
your money on a new jacket, then you most probably will have to sacrifice a night out with your
friends. This is termed an Opportunity Cost.

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Practical Example 1.1

The shortage (scarcity) in the supply of coal to Eskom has been one of the
contributing factors to load shedding.

Figure 1: Illustration of Scarcity, Choice and Opportunity Cost

Source: Shamase, 2018

If we move up the economic ladder and examine businesses, you’ll find that they are also faced with
the same problem that you faced, only on a much larger scale. Businesses need resources, for
example raw materials, labour, capital etc. in order to produce their goods and services. But there’s
always a limited supply of these resources that companies have access to. How they allocate these
scarce resources are some of the most important decisions that business leaders have to make. If
Eskom wants to build a new power station in Port Elizabeth, then it most probably won’t be able to
afford to build one in Pretoria, because of limited capital. Or if Toyota wants to install new machinery
at its Durban plant, it may have to cut back on hiring more staff.

Video Activity 1.1

https://www.youtube.com/watch?v=NwOYLV-L7pc
What is the opportunity cost of choosing an orange?

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Practical Example 1.2

You like both BOKOMO’s Muesli and Kellogg’s Special K. Each costs R50
and you only have R50 to spend. If you choose Muesli, you forgo Special K
and vice versa. The opportunity cost of Special K is Muesli.

Figure 2 below illustrates the funnel approach businesses will make around scarcity of
resources in guiding their product offerings.

Figure 2: Scarcity concept in business

Source: Mohr, 2015

Moving on to the national level, you know by just following the news, that governments are also
confronted with the problem of limited resources. Our government collects revenue in the form of
taxes, and uses this revenue to provide housing, education, health etc. and other services to improve
the quality of life of its citizens. But government is always limited in what it can do, by the amount of
resources at its disposal. This is the problem that the Minister of Finance has to deal with when he
delivers his annual budget speech. He has to make the best use of the limited resources (tax
revenue) available to him. Increasing the amount spent on say, housing, means that he will have less
to spend on education, for example.
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Activity 1.1
Make a list of 10 priorities that you believe that government should be
focusing on to improve the quality of lives of everyone. Now given the
limited resources of government, choose 5 interventions that you
believe are the most important.

What the examples discussed above show us, is that Economics is about scarcity. If there was no
scarcity of resources, then there will be no need for us to make choices. Choices need to be made
because our wants are unlimited, but the means or the resources to satisfy these wants are limited.
This is known as the Economic Problem; a concept we will be examining more closely in Unit Two.
This relationship between unlimited wants and limited means is the foundation of economics, and
that is why you will find that most definitions of economics revolve around this relationship.

Case Study 1

Fighting resource scarcity – sustainability in the education system of

Malawi – case study of Karonga, Mzimba and Nkhata Bay district.
From 1985 to 2011 the Malawian population doubled from 7.2 to 14.4 million
people and will reach 28 million in 2033. To maintain current food supply
which is already at a poor level the agricultural output would have to be
increased by 100% until 2033 without having any effect on poverty reduction.
All this leads to the situation that currently high population growth poses a
significant threat to agriculture, resources and any progress towards more
sustainability within Malawi’s agricultural system.
Population growth is likely to increase pressures on land and on wider natural
resources, such as forests and fisheries, with still more fragmented and
smaller landholdings, loss of land to housing, extension onto steeper slopes,
unsustainable cultivation methods, and soil loss.
Many studies have proven that growth in the agricultural sector has a higher
poverty reducing effect than economic growth in mining, manufacturing or any
other non-agricultural sector.
The extremely low levels of purchasing power in Malawi, poorly developed
marketing systems and limited export potential make rural livelihood
diversification difficult for most of the rural poor. Hence, they are caught in a
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maize poverty trap, unable to move beyond subsistence maize production

and constantly facing the threat of food shortages.
All generated electricity is supplied by a sole state-owned company, which is
also the sole grid operator. The Electricity Supply Corporation of Malawi
(ESCOM) delivers electricity only to around 8% of the Malawian population
and is still faced with regular load-shedding (Zalengera, 2014, p. 336).
Electricity is nearly to 99% produced through hydropower and only some
minor fossil-fuel run generators produce electricity, mainly for Likoma and
Chizumulu Island and Mzuzu city.
As hydroelectric power is the country’s only source for electricity, the erosion
of soil and the overgrowth of plants in the watershed due to excessive
fertilization frequently clogs the turbines, resulting in daily power outages.
Erosion, soil depletion, and flooding caused by deforestation prevent crops
from growing during the rainy season, hence contributing to widespread food
shortages. (Glasson, Frykholm, Mhango, & Phiri, 2006, p. 10)
Other sources of renewable energy like wind, solar energy or biomass are
nearly not used at all or only by private households or few companies like
Illovo Sugar (Illovo Sugar, 2015).
In terms of human resources, we can say, we are in a poor situation, because
most of the colleges here in Malawi don’t offer education in Agriculture as a
subject, so most of the teachers, who teach at secondary school level are not
teachers of Agriculture. “Just here as the four teachers, you can see we are
four teachers, but if you can ask, who did Agriculture at a college, none of us
did study it. We studied Mathematics, History, Biology or other subjects, but
none of us Agriculture.”
In another way I can say that this topic is important if somebody can really be
serious about this topic is very important, if you talk about Geography, maybe
you can compare it with Chichewa, Geography and other subjects. Agriculture
is important; even a Form 4 student can stop school from Form 4, but the
knowledge that he has learned in classics beneficial. He can raise animals,
do some cropping, etc. The knowledge can still help him or her in order to
harvest more yield.
“Now there are problems in teaching the subject because mostly we are
teaching agriculture … theoretically, we are using a lot of theory others than
practical because the skills can be transferred later if we apply or teach theory
plus, and then we go out into the gardens and then demonstrate how to do a
particular practical, so that they should be able to acquire that skill practical as

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well and if that was the approach then that would help in … excellent. But now
there is a shortfall in that, there is a problem in that, practical is lacking, we
are testing mostly theory and then even the practical which we conduct during
examinations they are … mostly theoretical, we don’t go to the gardens,
assess students in terms of what they are doing in the gardens. So … that is
weakening the subject a little.”
“In fact I can say that the equipment is not enough, mostly the thing that we
are doing in Malawi we just teach theory, we just say this is a plough, most of
the student they don’t know what is a plough they even, especially in this
maybe … remote areas they don’t know what is a plough, you just tell them a
plough has got this what parts, but they have not seen those things, so … I
can say that the situation is not very conducive, most of the things you just
teach them as a theory, but in order to see the most practical it is very difficult
and those practicals that are just very few, you can talk about soil, which is still
there, talk about maybe plants like tomatoes, goats, locally goats, those are
some of the things that are there, but the equipment and some things to do
practical they are not, … not really found in our schools.”
From: Kretzer, M.M., Engler, S., Gondwe, J. and Trost, E. (2017) Fighting
resource scarcity – sustainability in the education system of Malawi – case
study of Karonga, Mzimba and Nkhata Bay district, South African
Geographical Journal, 99(3), 235-251, DOI:
10.1080/03736245.2016.1231624
Questions
1. Establish whether there is scarcity of Agriculture educators/ teachers in
Malawi by using evidence from the case study.
2. What are the scarce resources identified in the case study?

The Following Box (1.1) provides some examples of how various economists have defined
economics. Notice how nearly all of them stress the idea of scarcity.

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Table 1: Economics Definitions

Source: Mohr, 2015

Activity 1.2
Study the various definitions of economics listed in Box 1.1. Choose one
that best defines economics in your opinion. Why did you make that
choice?

As we have seen, economics revolves around the issues of scarcity and choice. However, these are
not the only issues that economics is concerned with. Economics also seeks to understand, analyse
and predict a number of other phenomena. These include:

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Economic Growth
Inflation
Unemployment
Inflation
International trade
How Prices of goods and services are determined
Interest rates
Poverty
Wealth
Money
Business Cycles

Clearly, economics covers a very wide area, and touches nearly every aspect of our lives. However,
for the purposes of this module, we will focus primarily on the economic behaviour of individuals and
firms.

1.3 Economics as a Social Science

A question that often gets asked is whether economics is a science? The answer is yes. But
economics is not an exact science like physics or chemistry. Economics is regarded as a social
science, because it is concerned with human behaviour (Mohr, 2015).

All sciences seek to discover regular patterns of behaviour, which they articulate as scientific
theories. Once patterns are recognised, they can be used to explain and predict behaviour. For
example, when you throw a pencil in the air it falls to the ground. No matter how many times you
throw the pencil you will get the same result. This is a pattern which we call the Law of Gravity. You
can use this law to predict how the pencil, or any other heavier than air object, will behave when it is
thrown in the air.

Economics regarded is a science because it also seeks to discover similar patterns in the economy.
For example, it is common knowledge that when a store like Wool Worths has a sale, people flock to
the store in numbers. This is a pattern of behaviour that illustrates an economic law that when prices
drop, the demand for a product increases, and vice versa. Understanding this law allows us to
predict how consumers will behave if, say the price of butter rises.

It should be noted however, that human behaviour is unpredictable, and because this is so, not all
explanations or predictions in economics, or any of the other social sciences for that matter, will be
valid all the time. It is because of this unpredictability of human behaviour that economists use an
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assumption called Ceteris Paribus, which is the Latin term for “all things being equal”. Let’s examine
the Ceteris Paribus assumption using the changes in the price of butter as an example. Economists
will predict that the demand for butter will increase if the price of butter drops, but will always qualify
that prediction with the Ceteris Paribus condition. That means ‘all things being equal’ which assumes
that there are no other factors influencing the demand for butter.

Think Point 1.1

Economics is one of many social sciences that exist today. List 3 other
human disciplines that are also regarded as social sciences.

1.4 Microeconomics and Macroeconomics

The field of economics is very vast, as you would have discovered by now. That is why, for the
purposes of study, economics is divided into two broad areas, namely, Microeconomics and
Macroeconomics. ‘Micro’ means small, and so microeconomics takes a ‘close up’ view of the
economy. Microeconomics analyse the behaviour of individuals and firms. It is concerned with issues
like how a company goes about maximising profits, or why the price of butter fluctuates as it does. As
the title of this Module suggests, it is Microeconomics that we will be focusing on in this module. In
the rest of the units we will be examining the various microeconomic concepts in more detail.

‘Macro’ means large, and therefore Macroeconomics focuses on the operations of the economy as a
whole. It is concerned with issues like inflation, unemployment, interest rates, etc.

The table below summarises the differences between Microeconomics and Macroeconomics:

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Table 2: Microeconomics versus Macroeconomics: Some Example

Source: adapted from Mohr:2015

Activity 1.3
Assume that you are the manager of a company (any company that you
are familiar with). How will the study of Microeconomics help you
manage your business better?

1.5 Positive and Normative Economics

Positive economics is the branch of economics that deals with economic facts and data. It is
objective in its approach, and analyses the cause and effect relationship between variables. Positive
economic statements can be verified by observation and data. Here are some examples of positive

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statements.

The average inflation rate in South Africa last year was 6 percent
The rand depreciated against the dollar in 2017
In 2017 mining contributed 8 percent to GDP

Normative economics is subjective in its approach and is based on value judgments, and opinions
rather than on fact. It is prescriptive rather than descriptive in nature, and its statements cannot be
verified objectively. Here are some examples of positive economic statements:

The rate of inflation in South Africa is too high

South Africa should be investing more resources in the agricultural sector
The Reserve Bank should lower interest rates this year

Understanding the differences between positive and normative economics helps us to understand
how the economy operates, and how policy decisions are made.

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Knowledge Check Question 1.1

1. Which of the following statements about opportunity cost is/are true?

(a) The opportunity cost of the next best available alternative needs to
be identified in order to calculate opportunity cost of an action accurately
(b) The opportunity cost of a given action is equal to the value foregone
of all feasible alternatives
c) Opportunity cost measures actual expenditure
d) All of the above

2. Assume that bowling for 5 hours’ costs R750. Compensation for

invigilating and examination at MANCOSA is R100 per hour. The
opportunity cost of a 5-hour bowling game is:
(a) R1250
(b) R750
(c) R 500
(d) R850

3. Suppose the return on Treasury bills is 5% and the return on equity is

12%. If you have R100 000 to invest, the opportunity cost of investing in
equity is:
(a) R5 000
(b) R12 000
(c) R7 000
(d) None of the above

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Revision Question 1

1. How would you define economics?

2. Explain why the concept of scarcity is central to economics.

3. Besides the problem of scarcity, list 5 other issues that economics is

concerned with.

4. Why is economics regarded as a social science?

5. What is meant by the term Ceteris Paribus? What is its significance in

economic analysis?

6. Differentiate between Microeconomics and Macroeconomics.

7. What is the difference between Positive and Normative statements? Why is

it important that economists understand this difference?

8. Give three examples of positive statements.

9. Give three examples of positive statements.

10. Give an example that illustrate Scarcity, Choice and Opportunity Cost.

1.6 Summary
In this Unit you were introduced to some of the fundamental concepts in Economics. The aim was to
build a solid foundation from which to study some of the other economic concepts. We covered the
definition of economics, the problem of limited resources, and explained why economics is a social
science. We went further to understand the differences between Microeconomics and
Microeconomics, and ended with a discussion on the differences between positive and normative
economics. The focus for the rest of the module will be on Microeconomics. In the next unit, we will
expand on the economic problem, and learn some basic tools of economic analysis.

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Answers to Activities

Unit 1

Video Activity 1.1

Choosing an apple

Activity 1.1

To be discussed during the webinar(s) with lecturer

Case Study 1

1. Establish whether there is scarcity of Agriculture educators/ teachers in Malawi by using evidence
from the case study.

Most of the colleges in Malawi don’t offer education in Agriculture as a subject, so most of the
teachers, who teach at secondary school level are not teachers of Agriculture. None of the four
teachers of Agriculture did not study it. They studied Mathematics, History, Biology or other
subjects, but not Agriculture

2. What are the scarce resources identified in the case study?

Teachers of Agriculture, electricity supply, equipment, practical teaching of Agriculture,

availability of Agriculture as a subject, etc

Activity 1.2

To be discussed during the webinar(s) with lecturer

Think Point 1.1

1. Anthropology
2. Sociology
3. Psychology
4. Political Science, etc.

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Activity 1.3

To be discussed during the webinar(s) with lecturer

Knowledge Check Question 1.1

1. (a)
2. (a)
3. (a)

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Unit
2: The Circular Flow of Income and
Spending

Unit 2: The Circular Flow of Income and Spending

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Unit Learning Outcomes

Prescribed and Recommended Textbooks/Readings

Prescribed Reading(s)
Mohr. P. (2015) Economics for South African Students. Fifth Edition.
Pretoria: Van Schaik Publishers.

Recommended Reading(s)
Cloete, M. and Marimuthu, F. (2021). Basic Accounting for non-
accountants. Third Edition. Pretoria: Van Schaik.

Marx, J. (2022). Financial Management in Southern Africa. Sixth Edition.

Cape Town: Pearson.

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2.1 Introduction

In any society, no matter how advanced or primitive, this problem of scarcity arising from limited
resources and unlimited wants exists. Resources must be efficiently used to find answers to the
following basic economic questions:

1. What should be produced? Or what are the needs/wants of our society, and how much should we
produce?
2. How should these goods be produced? Or what methods of production must we use given
existing resources?
3. For whom should the goods be produced? Or how will the goods be distributed?

1. What goods and services and how much?

Scarcity of resources prevents us from producing every good and service we want. Hence, there is a
need to choose what to produce. In our economic system (mixed market) the price mechanism does
this for all goods produced by the private sector. Consumers indicate whether they need the goods
and whether they can pay for them. The price consumers are willing to pay acts as a signal to
producers whether to continue production or not. The demand or lack of it tells producers what to
produce or not to produce.

2. How to produce?
Having decided on what to produce, the question is how should the scarce resources be combined
to make the most efficient use of these resources. The main issue is around the use of existing
capital and labour (human resources). Again in the market system the price mechanism will decide
this. The principle is to keep the cost of production at a minimum given the price of all inputs. The
forms (producers) choose the most technically efficient and economically efficient methods of
production.

3. For whom to produce?

How will the goods and services produced be distributed in society? In the market economy this is
done by the price mechanism. The consumers spend their income on the goods and services they
need/want. This is regarded as the consumers voting for their choice of goods. Incomes depend on
how many resources individuals own or whether an individual possesses scarce skills. Higher
incomes mean greater ability to pay for goods. Consumers demand tells the producers who will buy
what goods and how much of these goods.

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 Microeconomics

2.2 The Three major flows in the Economy: Production, Income and Spending

The circular flow demonstrates the interaction between the two microeconomic decision making
units, the household and the firm (producer). The interaction between the households and firms
forms the foundation of the market economy at the microeconomic level. There are two sets of
markets in this circular flow, the factor market and goods market.

The circular Flow of Income shows the flow of inputs, outputs and payments between households
and firms within an economy. This model captures the essential essence of macroeconomic activity.

The economy is seen as nothing more than:

A revolving flow of goods,

Production resources, and
Financial payments

The three major flows are (Mohr, 2015):

Figure 3: The three major flows in the economy

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 Microeconomics

Video Activity 2.1

https://www.youtube.com/watch?v=mN5HPJYJzus

The circular flow model illustrates the mechanism by which income is generated from goods and
services and how this income is spent. This is best understood by analysing the diagram below:

A Simple Circular Flow Model of Income and Spending

Figure 4: The Circular Flow In The Economy

Source: Mohr, 2015

Contemplate households who are consumers, and firms who are manufacturers and sellers of goods
and services in the goods and services market: Firms are purchasers of factors of production and
households turn out to be sellers of factors of production in the factor market. The government, who
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 Microeconomics

is also a partaker, is responsible for providing public goods and services, such as roads, bridges, etc.
for usage by households and firms.

According to Mohr (2010) “For the government to deliver these public goods and services, it collects
tax revenue from households and firms. Therefore, we have movement of income in the form of tax
paid by firms and consumers and tax collected by the government. In addition, government provides
subsidies to firms and households - flow of income. Next, is the financial sector, which mostly
includes of financial organisations, where consumers and firms deposit funds and earn interest on
savings”. Mohr (2015) further states that “Firms and consumers take loans to invest in capital goods
and assets, and have to pay interest on loans. Finally, we present the foreign sector. In the foreign
sector, importing countries pay using foreign exchange for imported goods and services, and
exporting countries earn foreign currency for exporting goods and services”.

The circular flow model of income, output and spending characterises the mechanisms of a simple
economy, and demonstrates the significance of economic interdependence. In addition, it shows
the mutual dependence between the micro economy and the macroeconomy.

Knowledge Check Question 2.1

What are the leakages from the circular flow?

Think Point 2.1

What are goods and services markets?

Factor market

This is the market for factors of production (our scare resources). The households own the factors of
production. Through the factor market they make these resources available to the firms to produce
goods and services. The firms in turn pay for these factor services. This payment becomes income in
the hands of the households. They use this income to buy goods and services they need from the
firms.

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Knowledge Check Question 2.2

What is a factor market?

Goods and services market:

This is the market where firms sell their output to the consumers (households). The firms use the
factors of production to produce goods and services which the consumers buy. They pay for the
goods and services with the income they receive for the factors services to the firms. The firms use
these payments they receive to buy more factors of production.

Activity 2.1

Explain the difference between the goods and services market and the Factor
Market.

In each case there are two flows:

In the factor market there is a flow of resources to firms (called a real flow) and a corresponding
monetary flow to the households as income.
In the Goods and services market there is a flow of goods and services from the firma to
households (a real flow) and an opposite monetary flow to the firms as payment for the goods
and services.

Think Point 2.2

What is your definition of a virtual organisation? Does it have any
advantages?

2.3 The Factors of Production

There are four basic factors of production:

1. Land: Land refers to all natural resources, including minerals, air, water, land etc.
2. Labour: Labour refers to physical labour and skills.
3. Capital: Capital refers to final finished goods produced for use in further production, e.g. a factory

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 Microeconomics

machine to produce shoes.

4. Entrepreneurship: Entrepreneurship refers to the assembling of resources to produce new or
improved products and technologies.

Knowledge Check Question 2.3

What are the four factors of production?

Video Activity 2.2

https://www.youtube.com/watch?v=2wo3VVBMBrw
What are the four basic types of factor markets?

Think Point 2.3

How are the factors of production remunerated?

Case Study 1

Transformation of the Paradigm of the Economic Entities Development in

Digital Economy.
Introduction
Today, under the influence of digitization, the success of a company is
measured not by the size of its capital, its many years of existence, but by its
level of flexibility to respond to these changes and adapt the business to a
new environment. As noted by a group of scientists, a modern enterprise is a
complex integrated organisational and production system which components
are constantly changing, interacting with each other. Achieving these goals in
the context of increased competition among enterprises leads to an increase
in the volume and complexity of the production processes, analysis, planning,
management, internal and external relations with suppliers, intermediaries,
etc.
Digitization implies significant development of innovative technologies using
artificial intelligence, automation processes and digital platforms. Using the
Internet, you can save time and money on goods delivery by using rich
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 Microeconomics

information flows to streamline and optimise the flow of physical goods in the
supply chain. Experts of the Boston Consulting Group say that by 2020, about
25% of the global economy will be digitised, allowing the state, business and
society to function more efficiently.
Digitization changes models of the enterprise management and transforms
the classic enterprise into digital one – the enterprise that uses the
information technology as a competitive advantage in all areas of its activity,
changing product chains, consumer relationships and marketing strategies;
causes the emergence of new products and innovations; affects the provision
of business resources; reduces the cost of organisation, management and
communication, as well as the cost of obtaining, processing and storing
information, etc. The difference between the classic and digital enterprise is
presented in Table 1.
Table 1

Production factors. Rapid development of the digital economy is associated

with widespread use of digital-information and communication technologies
that have been able to transform a traditional resource-consuming economy
into a resource-creating economy. Therefore, the emphasis on traditional
factors of production (labour, capital, land and entrepreneurship) has shifted
to information (electronic and virtual data), providing electronic
communications with electronic devices, tools and systems) and science

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 Microeconomics

(availability of certain necessary knowledge, skills, individual competencies of

the employee, such as talents, creativity, experience, etc.), and ways to
access them).
With the development of science and technology, physical work has been
transformed into brainwork. In addition, experts predict that in the future, all
tasks will be completed by robots. Capital is no longer a determining factor in
starting your own business; now you can do it with minimal investment. Land
has ceased to be a major factor in production, as new types of products
(devices) that do not need it have emerged. Entrepreneurial capabilities (i.e.,
strategies for purely economic effect - profit) are no longer working in pure
form, instead, businesses are investing in social projects, which are first and
foremost beneficial to the population (provide useful information, the services
you need for free, and usually with environmental concerns), thus providing
social and environmental effects that can eventually create an economic
impact for the company.
For example, one company that has been operating in the market for a long
time is ready to invest in the implementation of a specific social action project,
acting only as a sponsor of the project. If the project is useful and gains
popularity, the sponsoring company’s rating can automatically rise and
increase the number of its clients. It is much easier for digital enterprises than
traditional businesses to find co-organisers, volunteers, material suppliers to
implement such projects, and invite a target audience for the event.
Form of business organisational. As a result of the society digitization, there is
a tendency to increase the number of self-employed persons, including those
engaged in entrepreneurship. At the same time, one person can be the
business owner, the manager, and the executor of all stages of the company’s
operation. Internet development provides unlimited opportunities for e-
business (business services, online sales, etc.), and this means that business
processes are carried out instantly anywhere and in any direction.
The purpose of this virtual organisational form of business is to ensure
competition for scarce resources and finance to meet customer needs as
quickly as possible. This form of employment significantly reduces the cost of
starting and running a business; significantly reduces time for communication
with consumers; does not depend on the location of the consumer; gives the
opportunity to cooperate with other specialists; reduces significantly the cost
of premises, because many types of economic activity can be carried out from
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 Microeconomics

home; allows you to plan and organised your working hours independently;
accelerates order fulfilment.
Questions
1. By making reference to the case study, illustrate the paradigm shift on the
following traditional factors of production as a result of developments in
science and technology.
a. Labour
b. Capital
c. Land
2. What are some of the benefits of a virtual organisation?

These resources are the inputs required to produce the desired outputs. With the concept of scarcity
in economics, it is implied that, at some stage, a decision or choice must be made on how to use the
scarce resources. In making this choice, we decide on the most efficient and effective allocation of
resources.

The concept of opportunity cost arises when we choose to use a scarce resource in one way
and give up the opportunity to use them in other ways.

See Examples of Factors of Production uses in various companies below:

Figure 5: Factors of Production use at Nike

Source: Shamase, 2018

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 Microeconomics

Practical Example 2.1

One of the factors of production is Land which includes natural resources.

Diamonds constitute natural resources used by the manufacturers of diamond
rings.

7Figure 6: Factors of Production use at Pepsico

Source: Shamase, 2018

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 Microeconomics

Figure 7: Factors of Production use at Coca-Cola

Source: Shamase, 2018

2.4 Remuneration of the Factors of Production

'Land' - all natural resources including water, land, soil, minerals. The remuneration for land is
rent
'Labour' – includes all the skills and experiences of the people. The remuneration for labour is
wages
'Capital' – These are the investments that owners of the business make such as buildings and
machinery. The remuneration for capital is interest
'Entrepreneurship – These are the people who are the driving force behind production and
ideas generators. The remuneration for enterprise is profit

Practical Example 2.2

Capital is a factor of production which manifests itself in the form of machines,

computers, plant, equipment, etc.

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Reading Activity
At this point, you should read 3.3 and 3.4 in the prescribed textbook in page
45. This section deals with the factors of production and their remuneration. If
you are unable to acquire the suggested readings, then you are welcome to
consult any current source that deals with the subject. This constitutes
research.

Activity 2.2

Explain how the owners of the factors of production are remunerated.

2.5 The Four Spending Entities of an Economy

Economies comprise the exchanges of large numbers of people and firms. These economic
participants form one of four classifications: business, households, government, and the foreign
sector. These categories form sectors of the economy (Conspecte, 2017).

Figure 8: Four Spending Entities in the economy

Source: Conspecte, 2017

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 Microeconomics

Revision Question 2

1. Briefly discuss the main components of total spending in the economy.

2.Identify the main injections into and withdrawals (or leakages) from the
circular flow of income and spending in the economy.

3. Use diagrams to illustrate how goods and services, income and spending
flow between households and firms.

4. Use a diagram to summarise the circular flow of income and spending

between households, firms, the government and the foreign sector.

5. These economic participants form one of four classifications, name and

discuss these.

2.6 Summary
All interactions in the marketplace involve the exchange of either factors of production or finished
goods. Although actual exchanges can occur anywhere, they take place in product markets (markets
where finished goods are bought and sold) or factor markets (markets where factors of production
are bought and sold), depending on what is being exchanged. Figures 4 & 8 above, illustrates the
importance of interdependence between participants in the economy.

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 Microeconomics

Answers to Activities

Unit 2

Knowledge Check Question 2.1

To be discussed during the webinar(s) with lecturer

Think Point 2.1

To be discussed during the webinar(s) with lecturer

Knowledge Check Question 2.2

To be discussed during the webinar(s) with lecturer

Activity 2.1

To be discussed during the webinar(s) with lecturer

Think Point 2.2

To be discussed during the webinar(s) with lecturer

Knowledge Check Question 2.3

To be discussed during the webinar(s) with lecturer

Video Activity 2.2

To be discussed during the webinar(s) with lecturer

Think Point 2.3

To be discussed during the webinar(s) with lecturer

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 Microeconomics

Case Study 1

1. With the development of science and technology

a. Labour: physical work has been transformed into brainwork. In addition, experts predict that in
the future, all tasks will be completed by robots
b. Capital: Capital is no longer a determining factor in starting your own business; now you can do it
with minimal investment
c. Land: Land has ceased to be a major factor in production, as new types of products (devices)
that do not need it have emerged

2. the benefits of a virtual organisation are that it:

a. reduces the cost of starting and running a business;

b. significantly reduces time for communication with consumers
c. does not depend on the location of the consumer;
d. gives the opportunity to cooperate with other specialists;
e. reduces significantly the cost of premises, because many types of economic activity can be
carried out from home;
f. allows you to plan and organise your working hours independently;
g. accelerates order fulfilment.

Activity 2.2

To be discussed during the webinar(s) with lecturer

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 Microeconomics

Unit
3: Demand, Supply and
Prices
Unit 3: Demand, Supply and Prices

46
 Microeconomics

Unit Learning Outcomes

Prescribed and Recommended Textbooks/Readings

Prescribed Reading(s)
Mohr. P. (2015) Economics for South African Students. Fifth Edition.
Pretoria: Van Schaik Publishers.

Recommended Reading(s)
Cloete, M. and Marimuthu, F. (2021). Basic Accounting for non-
accountants. Third Edition. Pretoria: Van Schaik.

Marx, J. (2022). Financial Management in Southern Africa. Sixth Edition.

Cape Town: Pearson.

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 Microeconomics

3.1 Introduction
The market economy is characterised by the forces of demand and supply. Interaction between
these forces occurs in different forms of markets. This interaction is known as the market mechanism.
Markets determine prices and the manner in which resources are employed.

Markets:

A market is an instrument that conveys together buyers and sellers of goods. The buyers demand
(indicate their choice of product) and the sellers (who produce the good) try to meet the demand.
There are different markets for different goods, and they vary in terms of sophistication. They may be
local, national or international in nature,

For our discussion we initially assume that the market is operating under settings of perfect
competition. This means that:

There are many buyers and sellers

None of them has the potential to influence prices
The interaction between demand and supply determines price
Products are homogeneous
Factors of production are fully mobile
All persons (buyers and sellers) in a market have perfect knowledge (Mohr,2015)

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Figure 9: Interaction between households and firms

Source: Mohr, 2015

3.2 What is Demand?

Demand is described as the ability and willingness to buy specific quantities of a good at alternative
prices in a given time period, ceteris paribus (holding all things else constant) (Mohr, 2015).

Demand theory forms the basis of how consumers behave in a specific market. The market demand
curve indicates the relationship between the quantities of goods and services that consumers are
willing and able to buy at different price levels, ceteris paribus. In economics, demand for a good or
service means that there is both the intent to buy it and the means (i.e. purchasing power) to do so.

Mohr (2015) also states that, “demand refers to the quantities of a good or service that potential
buyers are willing and able to buy. Furthermore, demand relates to the plans of households, firms
and other participants in the economy. It does not relate to events, which have already occurred. As
demand is concerned with plans and not events which have occurred, this means that the quantity
demanded, and the quantity actually bought may differ. Quantity demanded may in fact be equal
to, greater than, or less than the quantity bought”.

The Law of Demand

The Law of Demand states that, all other things being equal, consumers will buy more of a product if
the price of a product falls, and less if the price of the product is increased.”

The demand curve has a negative slope (slopes downwards), because the price and quantity are
inversely proportional. As the price of the product or service increases, the quantity demand for the
product/service will decrease, and vice versa.

Knowledge Check Question 3.1

Explain the law of demand.

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 Microeconomics

Practical Example 3.1

If the price of 10Gigabytes of data changes from R200 to R50, other things
being equal, more 10Gigabytes of data will be demanded.

3.3 The Individual Demand Curve

We will use the case of Anne Smith, in page 61 of the prescribed textbook. This shows a consumer
who demands tomatoes.
What are the determinants and properties, which will determine the quantity of tomatoes that Anne
plans to purchase in a particular period? According to Mohr (2015)

“The price of the product

Anne will be willing and able to buy a larger amount of tomatoes the lower the price, ceteris paribus.

The prices of related products

The price of related products will also influence Anne’s decision on how many tomatoes to purchase.
In the case of related products, we have to distinguish between complements and substitutes

Complements are goods that are used together with the good concerned. In our case bread (for
sandwiches) and onions (for cooking) are examples of goods that would complement tomatoes
Substitutes are goods that can be used instead of using the good concerned. For example,
tomatoes can be replaced with other ingredients in a salad

The income of the consumer

Income also affects Anne’s plans as it determines her purchasing power (her ability to purchase). A
higher income means that she can afford (plan) to buy more tomatoes.

The taste (or preference) of the consumer

Anne’s decision on how many tomatoes to purchase will also be influenced by her tastes. If Anne
has a liking for tomatoes or foods which require tomato, then she will plan to buy more tomatoes.
However, if she doesn’t like tomatoes, or if she has been ordered not to eat them by a doctor, this too
will affect her decision. These influences are non-measurable and are lumped together under “taste”.
They may also have a negative or positive impact on the quantity demanded.

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 Microeconomics

The size of the household

As households grow in size, they tend to purchase more goods and services. Likewise, smaller
households tend to purchase less” (Mohr, 2015)

Case Study 1

An investigation into food-away-from-home (FAFH) consumption in

South Africa.
This paper presents some of the first evidence of how income and socio-
demographic factors relate to FAFH expenditure in South Africa.
Understanding how income and socio-demographic factors affect FAFH
expenditure is fundamental for predicting impact of price changes and
adjusting to changes in food commodity markets. Ignoring FAFH demand will
lead to bad and incomplete policies that will not reflect consumer behaviour in
South Africa.
It can also be useful for developing appropriate marketing plans for new and
existing FAFH firms and identifying and targeting specific household types.
Consequently, these results will be useful to the food service sector and
policymakers in South Africa, to identify potential customers, respond to
current customers’ changing demands and develop marketing and
operational strategies, and address important nutrition and health
consequences, respectively.
Many results in this study agree with studies implemented in other countries
like China, Egypt, Spain and the USA. Income increases the likelihood of
participating in the FAFH market and the amount spent on FAFH. Male-
headed households are likely to have greater FAFH expenditures than
female-headed households, FAFH expenditures are likely to differ between
households headed by different population groups, decrease as the age of
the household head increases, decrease as households become larger and
are greater for households in urban areas than those in rural settings.
Furthermore, this study shows that FAFH expenditure has increased over the
survey period from 2005/6 to 2010/11, which agrees with global trends.
Given similar factors affecting FAFH expenditure in South Africa as other parts
of the world, South African foodservice companies in the formal sector can
apply similar business models to those of western markets where income
plays a less significant role in determining if households participate in the
market. However, differences will exist because of South Africa’s multicultural
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 Microeconomics

population, which is not typical of countries such as Spain and China. The
additional demand conditional on purchasing FAFH is more influential than
the participation effect. This means that growth in the South African FAFH
market will primarily be driven by consumers with existing expenditure.
The estimations performed and a review of players in the sector show that the
South African FAFH sector is operating in a mature market. This means that
the marketing strategies used should focus on brand diversification,
competitive pricing regimes to equal or defeat competitors, using intensive
centralised distribution centres or drop unprofitable outlets. Additionally, major
growth in the sector will come from increased expenditure by households
already spending on FAFH, which would require the sector, at large, to
consider lower priced, and healthier and more full-service offerings to cater
for lower and higher income households respectively. However, FAFH firms
have stated that consumers may say they want more healthy meals options,
but do not purchase these options, causing firms to discontinue these meal
options.
Policymakers need to acknowledge that expenditure on FAFH is inelastic,
thus lower income households that are already consuming FAFH are likely to
consume less healthy alternatives such as fast food. Therefore, taxing FAFH
may not be effective in reducing FAFH consumption. This is of concern
because individuals susceptible to overeating are likely to become obese and
suffer from other nutrition-related illnesses. Seguin et al. (2016) found that
higher frequency of purchasing FAFH was associated with higher body mass
index (BMI) in the USA, after adjusting for age, income, education, race,
smoking, marital status and physical activity.
The results of this study indicate that households headed by younger white
males with small household sizes and living in urban settlements need to be
targeted for nutrition education. This is especially important considering the
trend of increasing FAFH consumption. This requires nutrition policy,
education and promotion strategies to prioritise improving the nutritional
quality of FAFH and consumers’ food choices.
This education should include warnings of the often-higher levels of sodium,
cholesterol and saturated fats present in FAFH meals, and advice on healthier
FAFH meal options such as fruits, vegetables and grilled or baked rather than
fried foods. At present, it seems that consumers value the nutritional content
of FAH more so than FAFH. In a developing country such as South Africa, the
availability of FAFH is an additional worry as far as nutrition and health is

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 Microeconomics

concerned.
This is because FAFH can be purchased from both informal and formal
vendors. Furthermore, informal vendors charge lower prices, which makes
FAFH readily accessible to lower income earners. A healthy diet may be
prohibitively expensive for most South Africans. Therefore, the ingredients
used and the method of preparation used in less healthy FAFH options need
to be monitored, such that households that are unable to afford healthier
options do not consume food that has significant adverse health risks.
From: Blick, M., Abidoye, B.O. and Kirsten, J.F. (2018) An investigation into
food-away-from-home consumption in South Africa, Development Southern
Africa, 35(1), 39–52.
Question
1. Discuss the factors affecting the demand for FAFH outlined in the Case
study.

Figure 10: Example of Anne Smith`s weekly demand for tomatoes

Source: Mohr, 2015

In figure 10 above, the price of tomatoes (rand per kg) is on the vertical (y) axis and the quantity of
tomatoes demanded (kg per week) is listed on the horizontal (x) axis.

Mohr (2015) states that, “it is crucial that you label the axis of these graphs correctly as they form the

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 Microeconomics

basis of the diagram. Each point on the diagram represents a combination of both price and quantity
demanded. For example, at point a, 6kg of tomatoes will be demanded if the price of tomatoes is R1
per kg. By joining all the various points which express the relationship between the price of a good
and the quantity demanded, we obtain the demand curve”.

The negative slope of the demand curve (point e to point a), indicates that there exists a negative
or inverse relationship between price and quantity demanded (ie the law of demand).

We plot the demand curve for a good or service on the assumption that, all other determinants are
constant (ceteris paribus) (Mohr, 2015: 63).

Activity 3.1

Plot a demand curve using the data tabulated below:

Price Quantity Demanded in Units
R1000 5
R800 10
R600 20
R400 30
R200 50

Demand versus Quantity Demanded

The demand and the quantity demanded are important concepts to grasp, and is best illustrated
graphically. The quantity demanded is directly swayed by a change in the price, whereas the
demand is swayed by factors in the market, e.g. changes in taste.

Knowledge Check Question 3.2

What is the quantity demanded swayed by?

In figure 11, below a movement along the demand curve from A to B represents a change in the
quantity demanded. There is one demand curve for the market (D1), and the quantity demanded is
influenced solely by the price. As the price decreases (P0 to P1) demand increases (Q0 to Q1). This
is represented by a movement along the demand curve (D1) from A to B.

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 Microeconomics

11Figure 11: Movement Along The Demand Curve

Source: Mohr, 2015

The outcome of certain factors in the market, new demand could be created at the same price level.
At a constant price level (P0), more demand could be created through, say increases in disposable
income. A new demand curve can hence be drawn (D2) as shown in Figure 12, and this is illustrated
through a shift in the demand curve from A to C. So, for the same price level (P0), a greater quantity
of the product could be demanded (Q0 to Q1).

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 Microeconomics

Figure 12: Shifts in the Demand Curve

Source: Mohr, 2015

3.4 The Market Demand Curve

The market demand curve is merely the sum of all of the individual demand curves for a particular
good or services, Mohr, (2015). Hence as per page 64 in the prescribed textbook Mohr (2015) further
alludes that, “in a situation where the market comprises of three prospective buyers, Anne Smith,
Helen Rantho and Purvi Bhana, to obtain the market demand curve we would add all their demand
curves together. The market demand curve is therefore obtained by adding the individual demand
curves horizontally (i.e. at a price of R5 Anne demands 2 tomatoes, Helen 0 and Purvi 1, therefore
market demand at R5 = 3 tomatoes demanded). This process of adding up the demand curves
horizontally is demonstrated in figure 4-2 below, where the individual demand curves are shown to
the left and the market demand curve (the sum of the individual curves) is on the right” (Mohr, 2015).

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 Microeconomics

Figure 13: The market demand curve

Source: Mohr,2015

3.5 Movements along the Demand Curve and Shifts of the Demand Curve

“Movements along the demand curve are related to changes in the price of the good or service.
When the price of a product changes, the quantity demanded will also change, ceteris paribus (all
other factors remaining constant),” according to Mohr (2015) study of the demand curve.

In Mohr (2015) he further demonstrates the movements of the curve by stating that “to determine by

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 Microeconomics

how much quantity demanded changed, we compare the movement along the demand curve, i.e. we
compare two points. (Refer to figure 14 below). For example, if the price of tomatoes had to change
from R4 per kg to R3 per kg, demand would change from 6 kg per week to 9 kg per week.
Consumption of tomatoes is now 3 kg per week more than it was previously. Remember, these
conclusions are based on the assumption that all other things remain the same, i.e. ceteris paribus!
Therefore, when dealing with movements along the demand curve, we are dealing with the
relationship between the price of the product and the quantity demanded, ceteris paribus”.

Figure 14: A movement along a demand curve

Source: Mohr, 2015

Shifts in the demand curve

“Shifts in the demand curve occur when factors influencing the nature of demand change. Then, if a
factor which determines the demand for a product changes (other than price of course), the demand
curve for the product will shift. This occurs because price has been placed as the cornerstone of the
demand curve (i.e. it is on the vertical axis). Changes in determinants other than price are therefore
reflected as shifts of the demand curve”, states Mohr (2015).

The prices of related goods

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Related goods fall into two categories, substitutes and complements. In Mohr (2015) he identifies,”
Substitutes, are exactly what the name suggest, they are products, which can be used in the place of
another good to satisfy the consumers wants. Examples of substitutes include, Nike and Reebok
shoes, butter and margarine, beef and mutton. Differences in the prices of these goods will
determine, to an extent, the level of demand for the product in question. Ceteris paribus, an increase
in the price of a substitute will result in an increase in the quantity demanded for the product in
question”.

This will result in a shift of the demand curve to the right, indicating that there is a greater
quantity demanded of the product at each price range. Increases in the prices of substitutes are
therefore displayed as shifts of the demand curve to the right for the product concerned, likewise
decreases in the prices of substitutes are displayed as shifts to the left. Remember, this is under the
ceteris paribus condition, all demand curves are plotted under this condition. Figure 15 below shows
a graphical representation of how an increase in the price of a substitute shifts the demand curve for
the product concerned to the right.

Figure 15: Example of shifts by two substitutes: butter and margarine

Source: Mohr,2015

In page 68 of the prescribed textbook, Determinants of shifters of the Demand Curve are:

1. A change in the price of a related good – either compliments or substitutes

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2. A change in consumer taste or preferences

3. A change in population
4. Other influences such as distribution of income (Mohr, 2015)

3.6 Factors that lead to a change in Demand

There are many factors which could influence the demand curve in the market. In reality, all of these
factors have an influence on the demand curve at a point in time.

It is, however, impractical to quantify the effect of each of these factors, and, hence, we only consider
the effect of a given factor at any one point in time.

1 Changes in Income levels

According to the law of demand, we noted that the demand for a product was a function of the
change in the price. The lower the price, the greater the quantity demanded. Consider the case,
however, where the price of the product remains constant, and the consumer has a greater
disposable income.

This means that the consumer has more money to spend on the product, and hence, the demand for
the product would increase. A change in the income levels would thus cause a shift in the demand
curve.

2 Prices of Complementary / Substitute Products

Complementary products are goods, which are consumed in combination with other goods, e.g.
petrol is consumed with motorcars. Increases in the prices of petrol may influence the demand for
petrol- driven cars. Customers could opt for diesel- driven vehicles (a substitute product).

3 Changes in the Number of Buyers

The number of buyers in an area influences demand. This is most clearly evident during holiday
periods where demand for goods and services at holiday destinations increase. The same situation
arises during international conferences. If an international conference was being held in Lusaka, the
demand for accommodation in Lusaka increases way above the normal levels.

4 Changes in Preferences and Tastes

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Over time, consumers’ preferences and tastes may change. This may be as a result of “fashion” or a
trend in the marketplace or may be as a result of influence. In recent times, health consciousness
has been heightened creating a preference for healthier, more nutritious products. Consequently, the
demand for health-based goods and services has increased, e.g. gym memberships, healthier foods
etc.

5 Expectation of Future Prices

Short-term demand is created /destroyed by the expectation of future prices. If it is anticipated that
the price of a product would increase in the near future, consumers inherently react by purchasing
more of the product while the price remains constant. This effect is most evident over the short-term
as, in time, consumers adjust to the new level of prices to stabilise demand. The expectation of future
prices thus causes a short-term shift in the demand curve.

Activity 3.2

Explain the difference between moving along the demand curve and shifting
the demand curve.

Table 2.1:Summary of the market demand curve

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Source: Mohr, 2015

3.7 What is Supply?

“Supply is defined as, the quantities of a good or service that producers plan to sell at each
price during a period”, (Mohr, 2015). He also further states that “Just as demand refers to the plans
of consumers who are willing and able to purchase, supply refers to the plans of producers who
are willing and able to supply the quantities of the product concerned. Worth noting is the fact that
producers are not guaranteed to sell the quantity that they supply, as this depends to a large extent
on demand” (Mohr, 2015).

3.7.1 What determines supply?

Individual supply is determined by a few factors; these include:

Table 2.2

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Source: Mohr, 2015

Johnny`s annual supply of tomatoes – see page 73 of the textbook

Figure 16: Johnny’s annual supply of tomatoes

Source: Mohr, 2015

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The positive slope in the graph above shows that more goods/services will be supplied to the market
as the price of the goods/services increase. Sellers use prices as an indicator of market activity. The
Figure 16 above is simply a graphical representation of this relationship.

Figure 16 graphically demonstrates the law of supply, which states that the relationship between
price and supply is a positive one. More goods will be supplied at higher prices and fewer goods will
be supplied at lower prices, ceteris paribus, (Mohr, 2015).

3.8 The Market Supply Curve

To move from the individual supply to market supply, the individual supplies are added together
horizontally (Mohr, 2015). Assume Anne, John and Slindoh are willing to supply 10, 20 and 30 pairs
of shoes if the market price is R70, then to obtain the market supply we simply add these values for
the price of R70. Hence, at a price of R70, the market supply will be 60 pairs of shoes. This can be
done at all prices. The market supply is the connection between the price of the product and the
quantities supplied, by all firms, over a specific period. Market supply and individual supply are
therefore very much the same, with the major difference being that market supply refers to all the
prospective sellers of a product in a particular market (Mohr,2015)

Reading Activity
At this point, you should read Page 73 of the prescribed textbook on Market
Supply. If you are unable to acquire the suggested readings, then you are
welcome to consult any current source that deals with the subject. This
constitutes research.

In principle the market supply curve is the same as the individual curve. The only real difference
is that the market supply pertains to all the prospective sellers of the product in a particular market.
There are other factors that may influence supply in the market and those are:

Government Policy
Natural Disasters
Joint products and by-products
Productivity (Mohr, 2015)

3.9 Movements along the Supply Curve and Shifts of the Supply Curve
“Market supply and individual supply are therefore very much the same, with the major difference
being that market supply refers to all the prospective sellers of a product in a particular market. The

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supply curve (Figure 17), below demonstrate that at a price of P1 the quantity demanded is Q1,
these two values are represented by point an on the graph. Should the price of the good concerned
increase to P2 then the quantity supplied will increase to Q2, point b. As can be seen, price changes
result in movements along the supply curve, just as price changes result in movements along the
demand curve. Remember, movements along the supply curve due to price changes, are subject to
the ceteris paribus assumption. Changes in price therefore result in a change in quantity supplied”,
Mohr (2015).

18Figure 17: A movement along a supply curve: change in quantity supplied

Source: Mohr, 2015

Shifts of the supply curve however, are not as a result of price changes, but are due to
changes in the other determinants of supply. Shifts in the supply curve are therefore due to
changes in factors other than price.

Those factors are demonstrated in the table below:

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5Table 2.3

Source: Mohr, 2015

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19Figure 18: Shift of the supply curve: changes in supply

Source: Mohr, 2015

Figure 18 is a graphical illustration of shifts in the supply curve. At a price of P1 the quantity supplied
differs for each supply curve.

3.10 Market equilibrium

Market equilibrium occurs where the quantity of a good/service demanded is equal to the quantity
supplied of that good/service. Equilibrium between households (demanders) and firms (suppliers)
will occur at a certain price, known as the equilibrium price, Mohr, (2015). At the equilibrium price,
the plans of households and the plans of firms will match. The result of this matching of plans is that
the market will come to a state of rest, this state occurs as the two opposing forces (demand and
supply) are in a state of balance, Mohr, (2015). Mohr (2015) states that “Before a market arrives at a
state of equilibrium we need to understand disequilibrium. Disequilibrium occurs when the price
charged is at level other than the equilibrium price level, i.e. any price other than the equilibrium
price will bring about disequilibrium in the market”.

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Figure 19: Demand, supply and market equilibrium

Source: Mohr, 2015

As can be seen in Figure 19 at a price above R5/kg, the quantity supplied will be greater than the
quantity demanded, there will therefore be excess supply at prices above R5/kg. This occurs as the
higher price encourages producers to increase supply in the hope of making greater profits,
however, at prices greater than R5/kg consumers plan to purchase less of the good than they would
have at R5/kg.

The result is that there will be more of the good on the market than consumers are willing and able to
purchase, excess supply. Similarly, should the price fall below R5/kg then the quantity demanded will
exceed the quantity supplied. This occurs because (as you know) cheaper prices result in more of
the good being demanded, ceteris paribus (the law of demand) (Mohr,2015).

See full text in page 76 to 77 of the prescribed textbook.

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Market equilibrium then happens at the crossing of the demand and supply curves. This point is
typical of both buyers and sellers agreeing upon both the quantity of goods that will be bartered on
the market and the price which these goods will be exchanged for (Mohr, 2015).

Video Activity 3.1

https://www.youtube.com/watch?v=2Wp-diDRVKI
Define market equilibrium.

Knowledge Check Question 3.3

1. If the price of a commodity increases, it is highly likely that the quantity

demanded will

a. Decrease

b. Increase

c. Not be affected

2. Ceteris paribus, if the price of a commodity increases, the quantity

demanded of a substitute commodity will.

3.11 Consumer and Producer Surplus

Consumer surplus is the difference between what consumers pay and the value they receive,
indicated by the maximum amount they are willing to pay (Mohr, 2015).

For example, at price P, the total private benefit in terms of utility derived by consumers from
consuming quantity, Q is shown as the area ABQC in the diagram.

The amount consumers actually spend is determined by the market price they pay, P, and the
quantity they buy, Q - namely, P x Q, or area PBQC. This means that there is a net gain to the
consumer, because area ABQC is greater that area PBQC. This net gain is called consumer surplus,
which is the total benefit, area ABQC, less the amount spent, area PBQC. Hence, ABQC - PBQC =
area ABP (Economics online, 2018).

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Practical Example 3.2

You went to purchase a 2021 Rolls-Royce Ghost expecting to pay

R7 495 360.10 and find that it is retailing at R7 000 000. The difference
between what you expected to pay and what you actually paid is
R495 360.10. This difference is consumer surplus.

Video Activity 3.2

https://www.youtube.com/watch?v=L7fRDkDEy3w
Define consumer surplus.

Figure 20: Consumer Surplus

Source: Economicsonline, 2018

Producer surplus is the additional private benefit to producers, in terms of profit, gained when the
price they receive in the market is more than the minimum they would be prepared to supply for. In
other words, they received a reward that more than covers their costs of production. The producer
surplus derived by all firms in the market is the area from the supply curve to the price line, EPB
(Economicsonline, 2018).

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Figure 21: Producer Surplus

Source: Economicsonline, 2018

Figure 22: Consumer and Producer Surplus at Market Equilibrium

Source: Economicsonline, 2018

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Knowledge Check Question 3.4

What is producer surplus?

Revision Question 3

1. Distinguish between demand, wants and needs. What are the two basic
requirements for demand to exist?

2. What is the “law of demand”?

3. List four determinants of the demand for a good.

4. Use diagrams to distinguish clearly between a change in demand and a

change in the quantity demanded.

5. List three determinants of supply.

6.Use diagrams to explain how each of the following can change the supply of
a good:
(a) An increase in the wages of the workers producing the good.
(b) An increase in the productivity of the workers producing the good.
(c) An increase in the price of imported components required to produce the
good

3.12 Summary
Supply and demand is one of the most important theories of economics and it is the mainstay of a
market economy. Demand refers to how much (quantity) of a product or service is desired by buyers.
The quantity demanded is the amount of a product people are willing to buy at a certain price; the
relationship between price and quantity demanded is known as the demand relationship. Supply
signifies how much the market can offer. The quantity supplied refers to the amount of a certain good
producers are willing to supply when receiving a certain price. The correlation between price and
how much of a good or service is supplied to the market is identified as the supply relationship. Price,
therefore, is an echo of supply and demand.

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Answers to Activities

Unit 3

Knowledge Check Question 3.1

1. (a)
2. (a)

Case Study 1

Discuss the factors affecting the demand for FAFH outlined in the Case study.

Income increases the likelihood of participating in the FAFH market and the amount spent on FAFH.
Male-headed households are likely to have greater FAFH expenditures than female-headed
households, FAFH expenditures are likely to differ between households headed by different
population groups, decrease as the age of the household head increases, decrease as
households become larger and are greater for households in urban areas than those in rural
settings.

Activity 3.1

To be discussed during the webinar(s) with lecturer

Knowledge Check Question 3.2

To be discussed during the webinar(s) with lecturer

Activity 3.2

To be discussed during the webinar(s) with lecturer

Video Activity 3.1

Market equilibrium is a state in the market when, at a particular price and with all other factors
remaining unchanged, no buyer or seller has any incentive or desire to change the quantity of a
product that is demanded or supplied.

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Knowledge Check Question 3.3

To be discussed during the webinar(s) with lecturer

Video Activity 3.2

To be discussed during the webinar(s) with lecturer

Knowledge Check Question 3.4

To be discussed during the webinar(s) with lecturer

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Unit
4: Demand and Supply in
Action
Unit 4: Demand and Supply in Action

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Unit Learning Outcomes

Prescribed and Recommended Textbooks/Readings

Prescribed Reading(s)
Mohr. P. (2015) Economics for South African Students. Fifth Edition.
Pretoria: Van Schaik Publishers.

Recommended Reading(s)
Cloete, M. and Marimuthu, F. (2021). Basic Accounting for non-
accountants. Third Edition. Pretoria: Van Schaik.

Marx, J. (2022). Financial Management in Southern Africa. Sixth Edition.

Cape Town: Pearson.

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4.1 Introduction

In unit 3 we looked at the number of factors which causes changes in market demand and supply.
We now look at these changes in detail as well as government intervention strategies when markets
fail to self-regulate fairly.

4.2 Changes in Demand

An increase in demand will result an increase in the price of the product and an increase in the
quantity exchanged. This is illustrated in Fig,23

27Figure 23: Changes in demand

Source: Mohr, 2015

“The change in demand from DD to D1D1 (right shift), results in excess demand at the current
market price of P0. This can be seen by extending the line P0E through to the demand curve D1D1.
Then, at a price of P0, demand for the product is greater than the amount of product being sold and
as such consumers bid up the price. As the price rises, firms increase their quantity supplied of the
good. At the same time demand slows and eventually equilibrium is reached at point E1.

The characteristics of point E1 are: a higher price (P1) and a larger quantity supplied (Q1). The
move to equilibrium is therefore characterized by a movement along the supply curve from E to E1
and a movement along the new demand curve (D1D1) from where the extended P0E would intersect
D1D1 to the point E1. Similarly, there is the case of a decrease in demand. Like the case before, this

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occurs when there is a change in any of the determinants of demand, except the price of the product”
states Mohr (2015).

See full text in page 84 of the prescribed textbook.

Think Point 4.1

Think Point 1 What are complementary products?

The possibilities include:

1. the price of a substitute fall

2. the price of a complementary product increase
3. the consumer’s income fall
4. there be a reduced preference for the product
5. the price of the product be expected to fall (Mohr, 2015)

Practical Example 4.1

Consider the two coffee brands, Nescafe and Jacobs. These are substitute
brands of coffee. An increase in the price of Nescafe will result in an increase
in the demanded for Jacobs.

Knowledge Check Question 4.1

1. A decrease in quantity demanded will be graphically represented by

(a) A movement up to the left along the demand curve
(b) A movement down to the right along the demand curve
(c) A leftward shift of the demand curve
(d) A rightward shift of the demand curve

Practical Example 4.2

An increase in the demand for iPhones will result in the demand for apple
applications (aps). This displays the impact of the changes in the demand for
complementary goods.

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4.3 Changes in Supply

An increase in demand will result an increase in the price of the product and an increase in the
quantity exchanged. This is illustrated in Fig,23

Figure 24: Changes in demand

Source: Mohr, 2015

As in figure 24 above Mohr (2015) illustrates that, “an increase in supply can be seen on the graph of
the left. Like in our examples of changes in demand, changes in supply do not change the position of
the demand curve. The increase in supply from SS to S1S1 results in there being an excess supply
of the product at the market price of P0. This can be seen by extending the line P0E through to the
new supply curve S1S1. As can be seen, the quantity demanded at P0 is Q0 (corresponding to point
E) whilst the quantity supplied would be greater (the quantity corresponding to the point at which
extended P0E intersects S1S1)”.

He further states that “The result of the excess supply is that the price of the product will fall as firms
compete for market share. The falling price will result in a rise in the quantity demanded and the
quantity supplied will slow. Market equilibrium will be reached at point E1, this point characterized by
a lower price P1 and a higher output Q1. The move to equilibrium is therefore characterized by a
movement along the demand curve from E to E1 and a movement along the new supply curve
(S1S1) from where the extended line P0E would intersect S1S1 to the point E1 “, Mohr, (2015).

“A decrease in supply is shown as a shift of the supply curve to the left. This can be seen on the
graph on the right hand side of figure 24, and is depicted as a shift from SS to S2S2. The shift in the

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supply curve results from a change in any of the determinants of supply, other than price that is”
Mohr, 2015.

In 2015, Mohr wrote that “Changes in the determinants to the effect that:

1) should the price of an alternative product increase or should there be a fall in the price of a joint
product

2) should there be an increase in the price of any of the factors of production (ie should the cost of
production increase)

3) should there be a deterioration in the productivity of the factors of production (this raises the cost
of production).

The decrease in supply results in an excess demand at the original market price P0. This can be
seen by referring to the graph on the right of figure 24. If we look at the broken line P0E, what can be
seen is that where it intersects the new supply curve S2S2, the quantity which would be sold at that
price is less than the quantity demanded or Q0 (the quantity corresponding to point E)”.

See full text in page 86 of the prescribed textbook.

4.4 Simultaneous changes in Supply and Demand

If we are dealing with changes in demand or supply, then it is possible to predict what will happen to
equilibrium prices and equilibrium quantities in the market. However, should both demand and
supply change simultaneously, then the precise outcome cannot be predicted.

Mohr (2015) illustrate the simultaneous changes looks like, “should there be an increase in demand
(due to a positive change in preferences toward the product), accompanied by a decrease in supply
(due to an increase in the price of the factors of production), then only the thing that is certain is that
the price of the product will rise. This is due to the fact that both of the changes result in an increase
the equilibrium price in the market. What the equilibrium quantity will be however is uncertain. This is
due to the fact that as far as equilibrium quantity is concerned, the two forces work in opposition to
each other. An increase in demand works to raise the equilibrium quantity, ceteris paribus, whilst a
decrease in supply lowers the equilibrium quantity, ceteris paribus”.

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Reading Activity
At this point, you should read Chapter 5 of the prescribed textbook in detail.
This will give a complete perspective of Demand and Supply. This is crucial to
understand.

Case Study 1

An improved method for assessing mismatches between supply and

demand in urban regulating ecosystem services: A case study in Tabriz,
Iran.
Regulating ecosystem services provided by urban forests are of great
importance for the quality of life among city dwellers. To reach a maximum
contribution to well-being in cities, the urban regulating ecosystem services
(URES) must match with the demands in terms of space and time. If we
understand the matches or mismatches between the current urban dwellers’
desired quality conditions (demand) and the supply of URES by urban forests
(UF) in the cities, this will facilitate integrating the concepts of ecosystem
services in urban planning and management, but such an assessment has
suffered from major knowledge limitations.
This study was carried out in Tabriz (244.8 km2; 1.56 million inhabitants with
49.8 thousand households), northwestern Iran, in East Azerbaijan Province.
Urban air quality deterioration caused by high concentration of air pollutants
(e.g. NOx, S O2, O3, C O a n d P M10 and 2.5) is considered as a key
environmental problem which induces adverse effects on human health (it is
responsible for about 11.6% of all global deaths). Therefore, there is a need
for opportunities to mitigate and reduce urban air pollution. Planting and
maintaining UF is one of the most considerable strategies developed and
evaluated to mitigate, adapt, and overcome urban air pollution problems.
Supply and demand for global climate regulation:
Trees and shrubs in Tabriz sequester 29.20 thousand tons of carbon, which
corresponds to about 1.4 t ha−1 year−1. In comparison, there was a demand
for 674.32 tons of CO2-eq per hectare in 2015.
The findings of the study regarding matches and mismatches:
The contribution of urban trees to climate change mitigation is very low and
accounts for about 0.2% of the overall GHG (Green House Gas) emissions,
corresponding to a significant mismatch. The matches and mismatches
between the air purification service supplies and demands were identified.
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Only in eight cases of air purification, the ES demand was not met by supply.
Here, we illustrate the procedure by discussing the results of the assessment
o f N O2 regulating services with respect to the WHO (World Health
Organisation) standard; The WHO annual limitation value for NO2 is 40 μg m
−3 and the annual NO2 concentration as measured by air pollution monitoring
station was 86.79 μg m−3. Hence, there was a 46.79 μg m−3 exceedance of
the WHO value. The amount of air quality improvement for NO2 by urban
trees and shrubs was 4.98 μg m−3 per year. Thus, the contribution of UF to
reduce the WHO exceedance (10.62%) is lower than 20%, and a significant
mismatch is identified. The results of the match and mismatch assessment of
the URES air quality improvement showed a huge variation among the
different pollutants. None of the assessment standards of EQS values were
met for PM2.5, which is in fact due to the negative improvements; the air
quality improvement value for PM2.5 was -0.03% (as discussed below) (Fig 6).
Hence, PM2.5 can be considered the most problematic pollutant in Tabriz. In
contrast, CO seems the least problematic pollutant in the study area. Tabriz
did not comply with Iran’s standard for O3 and the EU reference value for
SO2. NO2 levels were below the EPA and Iran’s regulations but above the EU
and WHO limits.
For Tabriz, the major mismatch in the regulating services shows that Tabriz
struggles to comply with the current regulating ES demands. This mismatch
suggests that what is needed to decrease the mismatch is probably both a
major investment to reduce the rate of pollution and carbon emissions and a
major increase in the provision of URES through urban greenery. The latter
would be more cost-effective if synergies are considered along with other
urban ES.
Adapted from: Amini Parsa, V., Salehi, E., Yavari, AR,. van Bodegom, PM.
(2019) An improved method for assessing mismatches between supply and
demand in urban regulating ecosystem services: A case study in Tabriz, Iran.
PLoS ONE 14(8): e0220750. https://doi.org/10.1371/journal. pone.0220750
Questions
1. Using evidence from the case study, establish whether the supply and
demand in urban regulating ecosystem services is at equilibrium.
2. “Planting and maintaining UF is one of the most considerable strategies
developed and evaluated to mitigate, adapt, and overcome urban air pollution
problems”. Using evidence from the case study, comment on the impact of UF

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in mitigating air pollution problems.

4.5 Government Intervention in the Economy

Governments have numerous approaches accessible with which to mediate in the economy.
According to Mohr (2015), this mediation can take the form of:

setting maximum prices (also known as price ceilings)

setting minimum prices (also known as price floors)
subsidising certain products or activities
taxing certain products or activities”

Think Point 4.2

What is the objective of setting a price ceiling?

4.5.1 Maximum prices

According to Mohr (2015), “Governments can set maximum prices to:

keep the prices of basic foodstuffs low (this may form part of policy to assist the poor)
avoid the exploitation of consumers by producers (producers may be charging “unfair” prices) •
combating inflation
limit the amount production of certain goods and services in times of war”

“Should the maximum price be set above the market clearing price (equilibrium price), then the
intervention will not have any effect on the outcome of the market. The market will therefore arrive at
the equilibrium price and equilibrium quantity. However, when the maximum price is set below the
market clearing (equilibrium price), the intervention disrupts the market mechanism (price
mechanism) and therefore causes instability in the market. In figure 25 below, we can see that if the
market were left alone the forces of demand and supply (remember, excess demand and excess
supply) will result in the market achieving equilibrium with a price P0 and a quantity supplied of Q0
“Mohr (2015).

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Activity 4.1

Why would a government set a maximum price?

Video Activity 4.1

https://www.youtube.com/watch?v=0TstHHMBVHI
A price ceiling/ maximum price is set below the equilibrium price to be
effective. Is this statement true or false? Why?

Figure 25: Maximum prices

Source: Mohr, 2015

As in Figure 25 above, “the government has set a maximum price of Pm which is below the
equilibrium price of P0. At the price Pm producers are willing to sell Q1 units whilst consumers are
demanding a quantity of Q2, this can be seen if we follow the line Pm across to the supply curve
(point a) and then across to the demand curve (point b). The quantity demanded by consumers at a
price of Pm is clearly greater than the quantity which producers are willing to produce (Q1). As such
there is now excess demand in the market (market shortage) and this excess demand is equal to the
difference between Q2 and Q1, i.e. Q2 – Q1. If the market were left alone then the market
mechanism would raise the price until this excess demand was eliminated (remember the example
of excess demand earlier)” Mohr (2015).

The elementary difficulty is how to distribute Q1 worth of product amongst consumers who demand

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Q2?
Mohr (2015) states that there are various ways for this allocation to take place, these are:
1) “Consumers are served on a “first come, first served”, the result is queues and waiting lists.
2) An informal rationing system may be set up by suppliers. This system can take the form of limiting
the amount of goods sold to each customer or only selling goods to regular customers.
3) Government itself may introduce an official rationing system. This can be done by issuing tickets
or coupons which have to be submitted when purchasing the product”.

See full text in page 91 of the prescribed textbook.

Fixing price below the equilibrium price of a product it would:

1) cause a shortage
2) prevent the market from allocating the quantity of product available among consumers
3) result in black market, Mohr, (2015).
In figure 26, Mohr (2015) illustrates that “at the equilibrium price of P1 consumer surplus is
represented by the area DP1E and producer surplus is represented by the area 0P1E. However,
when the government implements the maximum price on the market these areas change. Consumer
surplus is now represented by the area DRUPm and producer surplus is now represented by the
area 0PmU. (Remember, consumer surplus is the area below the demand curve, above the price
line and with the quantity supplied. Likewise, producer surplus is the area above the supply curve,
below the price line and within the quantity supplied). With the price maximum imposed, consumers
have now lost the area indicated by triangle A, but have gained the area B. The loss of triangle A
occurs as a result of the decrease in the quantity supplied from Q1 to Qm, whereas the gain of the
rectangle B occurs from the fact that the those who obtain the product now pay less for it”.

See full text in page 95 of the prescribed textbook.

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Figure 26: The welfare cost of maximum price fixing

Source: Mohr, 2015

“In the case of the new producer surplus, we have shown that the new producer surplus is now
represented by the area 0PmU as opposed to the area 0P1E. Producers have therefore lost the area
represented by triangle C as a result of the loss of production and the rectangular area B as a result
of it being transferred to consumers. The end result is that the total welfare loss to society is
represented by both triangles A and C, and this is referred to as a deadweight loss. Worth noting is
the fact that this area was not transferred, unlike the area represented by rectangle B which was
transferred from producers to consumers.

The area made up of triangles A and C has been lost to society and this comes about due to the fact
that less is being produced in society, and society itself is made up of both producers and
consumers” illustrates Mohr, (2015).

4.5.2 Minimum prices

Minimum prices are those set above the equilibrium, this is usually true for agricultural goods.

Think Point 4.3

When the government sets a minimum wage, what is it trying to achieve?

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Activity 4.2

Give an example of a minimum price (price floor).

Figure 27: A Minimum price

Source: Mohr, 2015

In Figure 27 above Mohr (2015) further illustrates that, “the market is at equilibrium at a price of R30
per kilogram and at this price a quantity of 7 million kilograms is being sold. The government sets a
minimum price (price floor) of R40 per kilogram on the product. At a price of R40 per kilogram
consumers demand a quantity of 4 million kilograms, however producers are producing 9 million
kilograms of beef. Therefore, there is a surplus of 5 million kilograms of beef in the market (the
difference between point an and point b). By setting a minimum price above the equilibrium market
price (market clearing price) the government creates an excess supply in the market. This excess
supply will usually require further government intervention and the result may be one of the following:

The surplus product may be purchased by government and exported

The surplus product may be purchased by government and stored (provided it can be stored)
Production quotas are introduced by government to limit the quantity supplied to the quantity
demanded (at the minimum price). In our example government would try to limit production of
beef to 4 million kilograms. In doing so the surplus is illuminated
The surplus is purchased and destroyed by government
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Producers destroy the surplus “

“The setting of minimum prices is often a characteristic of agricultural markets as these markets are
characterised by large fluctuations in supply. Although demand for agricultural products is stable, the
large fluctuations in supply result in the incomes of farmers being unstable as the prices received for
the product fluctuate as well. Governments therefore tend to set minimum prices to stabilise the
incomes of farmers. However, this is not an efficient way of assisting small or poorer farmers” Mohr
(2015).

Mohr (2015) further demonstrates that “Minimum prices are inefficient due to the following facts:

All the consumers in the market have to pay artificially high prices (this includes the poor)
Large farmers receive the bulk of the benefits which are forthcoming
Firms that are inefficient are now protected by the minimum price and manage to survive
Disposal of the surplus which is generated from the minimum price usually imposes a further cost
to taxpayers and results in welfare losses”

(Mohr, 2015)

Figure 28: The welfare costs of minimum price fixing

Source: Mohr, 2015

“In the case of the new producer surplus, we have shown that the new producer surplus is now

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represented by the area 0PmRT as opposed to the area 0P1E. Producers have therefore lost the
area represented by triangle C as a result of the loss of production, but gained the rectangular area
A at the expense of the consumers. The end result is that the total welfare loss to society is
represented by both triangles B and C, this is referred to as the deadweight loss. The area made up
of triangles B and C has been lost to society and this comes about due to the fact that less is being
produced in society, and society itself is made up of both producers and consumers”, Mohr (2015).

Video Activity 4.2

https://www.youtube.com/watch?v=1EzY4Vl460U

Revision Question 4

1. Use a diagram to illustrate what will happen to the equilibrium price and
quantity of a product if the demand for the product increases. Also mention
three factors that can cause an increase in demand.

2. Use diagrams to illustrate what will happen to the equilibrium price and
quantity of a product in each of the following cases (clearly indicate instances
where the impact cannot be predicted):
(a) a simultaneous increase in demand and supply
(b) a simultaneous decrease in demand and supply
(c) an increase in demand along with a decrease in supply
(d) a decrease in demand along with an increase in supply

3. Explain, with the aid of a diagram, what happens in the market for (say)
electricity if the government fixes a maximum price below the equilibrium
price.

4. Governments have various methods available with which to intervene in the

market. Name these.

5. Why would the Governments set maximum prices?

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4.6 Summary

Markets are not always free and efficient to determine what the equilibrium prices and quantities will
be. Governments have various mechanisms available with which to get involved in the market. This
intervention can take the form of: setting maximum prices (also known as price ceilings) and setting
minimum prices (also known as price floors) as well as imposing taxes, tariffs and other various
quotas. These interventions get dictated by the fact that markets are not perfect and demand and
supply’s invisible hand sometimes needs correction to counter market injustices.

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Answers to Activities

Unit 4

Think Point 4.1

To be discussed during the webinar(s) with lecturer

Knowledge Check Question 4.1

1. (a)

Case Study 1

Questions:

1. Using evidence from the case study, establish whether the supply and demand in urban
regulating ecosystem services is at equilibrium

Solution:

For Tabriz, the major mismatch in the regulating services shows that Tabriz struggles to comply with
the current regulating ES demands. This mismatch suggests that what is needed to decrease the
mismatch is probably both a major investment to reduce the rate of pollution and carbon emissions
and a major increase in the provision of URES through urban greenery. This mismatch is evidence
that the demand and supply are not at equilibrium.

Questions:

2. “Planting and maintaining UF is one of the most considerable strategies developed and
evaluated to mitigate, adapt, and overcome urban air pollution problems”. Using evidence from
the case study, comment on the impact of UF in mitigating air pollution problems

Solution:

The contribution of urban trees to climate change mitigation is very low and accounts for about 0.2%
of the overall GHG (Green House Gas) emissions, corresponding to a significant mismatch. The
impact of UF is very minimal.
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Think Point 4.2

To be discussed during the webinar(s) with lecturer

Activity 4.1

To be discussed during the webinar(s) with lecturer

Video Activity 4.1

To be discussed during the webinar(s) with lecturer

Think Point 4.3

To be discussed during the webinar(s) with lecturer

Activity 4.2

To be discussed during the webinar(s) with lecturer

Video Activity 4.2

To be discussed during the webinar(s) with lecturer

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Unit
5:
Elasticity

Unit 5: Elasticity

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Unit Learning Outcomes

Prescribed and Recommended Textbooks/Readings

Prescribed Reading(s)
Mohr. P. (2015) Economics for South African Students. Fifth Edition.
Pretoria: Van Schaik Publishers.

Recommended Reading(s)
Cloete, M. and Marimuthu, F. (2021). Basic Accounting for non-
accountants. Third Edition. Pretoria: Van Schaik.

Marx, J. (2022). Financial Management in Southern Africa. Sixth Edition.

Cape Town: Pearson.

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5.1 Introduction

Mohr (2015) defines Elasticity as “the responsiveness or sensitivity of a dependent variable to

changes in an independent variable. In this unit we will unpack forms of elasticity and determine how
consumers react to price changes”.

5.2 Definition of Elasticity

“The degree to which demand or supply reacts to a change in price is called elasticity. Elasticity
varies from product to product because some products may be more essential to the consumer than
others. Demand for products that are considered necessities is less sensitive to price changes
because consumers will still continue buying these products despite price increases. On the other
hand, an increase in price of a good or service that is far less of a necessity will deter consumers
because the opportunity cost of buying the product will become too high”, Mohr (2015).

To determine the elasticity of the supply or demand the equation below is used:

Elasticity = (% change in quantity / % change in price)

If the elasticity is greater than or equal to 1, the curve is considered to be elastic. If it is less than one,
the curve is said to be inelastic.

As we saw previously, the demand curve has a negative slope. If a large drop in the quantity
demanded is accompanied by only a small increase in price, the demand curve will appear looks
flatter, or more horizontal. People would rather stop consuming this product or switch to some
alternative rather than pay a higher price. A flatter curve means that the good or service in question
is quite elastic, Mohr, (2015).

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Figure 5.1:
Source: Investopedia, 2013

Meanwhile, inelastic demand can be represented with a much steeper curve: large changes in price
barely affect the quantity demanded.

Figure 5.2
Source: Investopedia, 2013

“Elasticity of supply works similarly. If a change in price results in a big change in the amount
supplied, the supply curve appears flatter and is considered elastic. Elasticity in this case would be
greater than or equal to one. The elasticity of supply works similarly to that of demand. Remember
that the supply curve is upward sloping. If a small change in price results in a big change in the
amount supplied, the supply curve appears flatter and is considered elastic. Elasticity in this case
would be greater than or equal to.

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Figure 5.2

One ” Investopedia (2013.Source: Investopedia, 2013

On the other hand, if a big change in price only results in a minor change in the quantity supplied, the
supply curve is steeper, and its elasticity would be less than one. The good in question is inelastic
with regard to supply.

Figure 5.3
Source: Investopedia, 2013

5.3 The Price Elasticity of Demand

“The price elasticity of demand measures the consumer’s response (reaction) to a change in price.
Schiller (2013) formally defines the price elasticity of demand as the response of consumers to a
change in price. The price elasticity of demand refers to the percentage change in the quantity
demanded divided by the percentage change in the price. Price elasticity of demand is a useful tool
because it can be used to show how much total expenditure by consumers on a product will change
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should the price of the product change. Furthermore, total expenditure by consumers is also the total
revenue of the firms who produce that product. Because of its usefulness in analysing the responses
of both consumers and producers to situations in the market, price elasticity of demand serves as a
useful tool in decision making” Mohr (2015).

Price elasticity of demand is calculated as follows:

ep = % change in the quantity of a products

% change in the price of a product

Where ep = price elasticity of demand

“Total revenue (TR) is therefore P x Q or PQ. Should a producer decide to change the price of the
product then the effect on total revenue will depend on the relative sizes of the change in price and
the change in quantity demanded, i.e. the size of the price change with respect to the size of the
change in quantity supplied. Remember, price and quantity demanded move in the opposite
direction. How exactly do changes in the relative sizes of price (P) and quantity supplied (Q) affect
total revenue (TR)?

In the case where a change in the price of a product leads to a proportionately larger change in
the quantity demanded (i.e., if we change the price of the product by 10% and the result is that
quantity demanded changes by 20%, in the opposite direction of course), then the price elasticity
of demand is greater than one or ep>1 and as such the total revenue will change in the opposite
direction to the price change (i.e., decrease price = increase total revenue). Remember, total
revenue is calculated as TR = PQ. So long as the price elasticity of demand is greater than 1
(ep>1), total revenue will increase as the quantity sold (Q) increases.
In the case where the change in price leads to an equip-proportional change in the quantity
demanded (i.e. if we change the price of the product by 10% and the result is that quantity
demanded changes by 10% as well, in the opposite direction of course), then the ep = 1 and total
revenue will remain unchanged. In the case where the price elasticity of demand is equal to one
(ep = 1) the total revenue (TR) of the firm has reached its maximum.
In the case where a change in the price of the product leads to a proportionately smaller change
in the quantity demanded (i.e. if we change the price of the product by 10% and the result is that
quantity demanded changes by 5%, in the opposite direction of course), then ep < 1 and total
revenue will change in the same direction as the price (i.e., raise the price = raise the total
revenue). If the price elasticity of demand is less than one (ep < 1) then total revenue (TR) will fall

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as the quantity sold (Q) increases”, Mohr (2015)

Video Activity 5.1

https://www.youtube.com/watch?v=nOlOf_KEnrw&pbjreload=101
Does a price elasticity of demand of 1.75 represents an elastic or an inelastic
demand?

See full text in page 107 to 109 of the prescribed textbook.

Figure 29 illustrates the relationship between total revenue (TR), price (P), quantity sold (Q)
and price elasticity of demand (ep).

Figure 29: The relationship between price elasticity of demand and total revenue

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(Mohr, 2015)

Figure 30: Price elasticity of demand at different points along a linear demand curve

Source: Mohr, 2015

As can be seen in figure 29 and 30 above, Mohr (2015) illustrates that “the price elasticity of demand
(ep) varies from an infinity (∞) to zero. The value of price elasticity of demand (ep) is infinity where
the demand curve intersects (meets) the price axis and zero where the demand curve intersects the
quantity axis. If we move down the demand curve, from left to right, the price elasticity of demand
falls from infinity (∞) to zero. It is worth noting that this will be the case for any demand curve which
intersects both the price and quantity axis. In the case of any demand curve which intersects both
axis, the value of the ep will be infinity (∞) where the graph intersects the price axis, one in the
middle of the curve (midpoint) and zero where the curve intersects the quantity axis”, Mohr (2015).

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Activity 5.1
For a numerical example on how to obtain the different values of price
elasticity of demand (ep), the reader is referred to Mohr (2015) page 106
to 107. Calculate Elasticity as demonstrated in Box 6.1.

5.4 The Five Categories of the Price Elasticity of Demand

There are five categories into which we can place our price elasticity of demand (ep) values, these
five categories are:

ep = 0 –––> perfectly inelastic demand

0 < ep < 1 (i.e., ep is greater than 0 but less than 1) –––> inelastic demand
ep = 1 –––> unit elastic demand or unitary elasticity of demand
1 < ep < ∞ (i.e., ep is greater than 1 but less than infinity [∞]) –––> elastic demand
ep = ∞ –––> perfectly elastic demand, (Mohr, 2015)

Perfectly inelastic demand (ep = 0), consumers will plan to purchase a fixed amount of the product
regardless of the price which is charged. This can be shown graphically by drawing the demand
curve as a vertical line, as illustrated in figure 6-3 (a). In this case, producers can raise their revenue
by increasing the price charged for the product. As the quantity demanded does not change, raising
price results in an increase in total revenue. Remember TR = PQ.

Activity 5.2

Give an example of a product which has a perfectly inelastic demand.

Inelastic demand (0 < ep < 1), the percentage change in quantity demanded is smaller than the
percentage change in price (remember, in the opposite direction!). The demand curve which
illustrates this case is that of a steeply sloped demand curve (figure 6-3 b). The steep slope of the
demand curve serves to illustrate the fact that the percentage change in quantity is smaller than that
of the price change. As a result of the fact that the quantity demanded changes proportionately less
than the change in price, producers have an incentive to raise their prices in order to increase their
revenue (remember what was said earlier). Likewise, there is no reason why producers would
decrease the price of their product as the revenue received from the increase in quantity demanded

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will not offset the revenue lost due to the decrease in price.

Practical Example 5.1

The quantity demanded for tobacco & alcohol during covid 19 Level 4
lockdown in South Africa remained high regardless of the increase in prices.
This illustrates an inelastic demand.

Unitary elasticity (ep = 1), the demand curve used to illustrate the properties of unitary elasticity is a
rectangular hyperbola, as illustrated in figure 6-3 (c). What this graph illustrates is that the
percentage change in quantity demand is equal to percentage change in the price of the product. In
this case, as the proportional (i.e. percentage) changes in quantity demanded and price are the
same, producers would not gain anything by increasing or decreasing the price of the product.

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Figure 31: The different categories of price elasticity of demand

Source: Mohr, 2015

Elastic demand (1 < ep < ∞), is illustrated by a relatively flat demand curve (Figure 31 (d)). “The
demand curve graphically illustrates the property of elastic demand, this being the fact that the
percentage change is quantity demanded is greater than the percentage change in price. When
producers are faced with elastic demand, decreasing the price of the product will raise the total
revenue received by producers (this is as a result of the property of elastic demand, also remember
TR = PQ). There is no incentive to raise the price charges for the product as this would decrease
total revue (the opposite of decreasing the price will occur)”, Mohr (2015).

Practical Example 5.2

If increase in the price of a chocolate bar from R7 to R8 results in a decrease

in quantity demanded from 20 units to 10 units; it means that the percentage
in price brings about a more than a percentage change in quantity
demanded. This is an elastic price elasticity of demand.

“Perfectly elastic demand (ep = ∞) is the case where consumers are willing to purchase any
quantity of goods at a certain price, raising the price of the good will result in the quantity demanded
falling to zero (even if the price is only raised slightly). Perfectly elastic demand is shown graphically
as a horizontal line, as in figure 31 (e)”, Mohr (2015).

Note: It should be kept in mind that an increase in total revenue (TR) is not the same as an increase
in total profit. Total revenue is simply the income received from selling a certain amount of product

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(Q) at a price of (P), that is why TR = PQ. Total profit however, is not only a function of these two
variables, but also a function of cost, which can change with output (Mohr, 2015).

Video Activity 5.2

https://www.youtube.com/watch?v=tMp3yJywdJc
If revenues decrease when the price of a good increases, the price elasticity
of this good is:
1. A : Elastic.
2. B : Inelastic.
3. C : Unit elastic

5.5 Determinants of the Price Elasticity of Demand

There are various determinants if elasticity, some are:

Number of substitutes
Degree of complementarity
Type of want satisfied
Time
Proportion of income spent
Definition of the market

See page 112 to 115 to read on these determinants in detail.

5.6 Income Elasticity of Demand and Cross Elasticity of Demand

Income elasticity of demand refers to the sensitivity of the quantity demanded for a certain good to a
change in real income of consumers who buy this good, keeping all other things constant. The
formula for calculating income elasticity of demand is the percent change in quantity demanded
divided by the percent change in income.

Income elasticity of demand measures the responsiveness of demand for a particular good to
changes in consumer income. The higher the income elasticity of demand in absolute terms for a
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particular good, the bigger consumers' response in their purchasing habits — if their real income
changes. Businesses typically evaluate income elasticity of demand for their products to help predict
the impact of a business cycle on product sales.

Cross Elasticity of Demand

Cross elasticity of demand is an economic concept that measures the responsiveness in the quantity
demanded of one good when the price for another good changes. Also called cross price elasticity of
demand, this measurement is calculated by taking the percentage change in the quantity demanded
of one good and dividing it by the percentage change in price of the other good.

Cross elasticity of demand (XED) measures the percentage change in quantity demand for a good
after a change in the price of another.

5.7 The Price Elasticity of Supply

Price elasticity of supply (PES) measures the responsiveness of quantity supplied to a change in
price. It is necessary for a firm to know how quickly, and effectively, it can respond to changing
market conditions, especially to price changes. The following equation can be used to calculate PES.

The price elasticity of supply (PES) is measured by % change in Q.S divided by % change in price.

If the price of a cappuccino increases 10%, and the supply increases 20%. We say the PES is 2.0
If the price of bananas falls 12% and the quantity supplied falls 2%. We say the PES = 2/12 =
0.16

While the coefficient for PES is positive in value, it may range from 0, perfectly inelastic, to infinite,
perfectly elastic.
Mohr (2015) states that “the price elasticity of supply has a range of values:

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PES > 1: Supply is elastic

PES < 1: Supply is inelastic
PES = 0: The supply curve is vertical; there is no response of demand to prices. Supply is
“perfectly inelastic”
PES = ∞∞ (i.e., infinity): The supply curve is horizontal; there is extreme change in demand in
response to very small change in prices. Supply is “perfectly elastic”

Inelastic goods are often described as necessities. A shift in price does not drastically impact
consumer demand or the overall supply of the good because it is not something people are able or
willing to go without. Examples of inelastic goods would be water, fuel, housing, and food. Elastic
goods are usually viewed as luxury items. An increase in price for an elastic good has a noticeable
impact on consumption. The good is viewed as something that individuals are willing to sacrifice in
order to save money. An example of an elastic good is movie tickets, which are viewed as
entertainment and not a necessity”.
“The price elasticity of supply is determined by:

Number of producers: ease of entry into the market

Spare capacity: it is easy to increase production if there is a shift in demand
Ease of switching: if production of goods can be varied, supply is more elastic
Ease of storage: when goods can be stored easily, the elastic response increases demand
Length of production period: quick production responds to a price increase easier
Time period of training: when a firm invests in capital the supply is more elastic in its response to
price increases
Factor mobility: when moving resources into the industry is easier, the supply curve in more
elastic
Reaction of costs: if costs rise slowly it will stimulate an increase in quantity supplied. If cost rise
rapidly the stimulus to production will be choked off quickly” Mohr (2015)

Think Point 5.1

Think about the price of Data. How much GIGs are you willing to buy when
a GIG cost R10 or R150? It is clear that the cheaper the goods are we are
willing to always buy more. But Data is now a basic necessity in the global
context where we always want to be connected. Are you willing to always
have the data no matter the price?

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Figure 32: Different Categories Of Price Elasticity Of Supply

Source: Mohr, 2015

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Knowledge Check Question 5.1

1. In price inelasticity, a small change in price brings about

a. A proportional change in demand

b. A less than proportional change in demand

c. A larger change in demand

Case Study 1

Elasticity Analysis of Fossil Energy Sources for Sustainable Economies:

A Case of Gasoline Consumption in Turkey
The automobile industry plays a crucial role in the Turkish economy.
According to the report of the presidency of the Republic of Turkey, there has
been a significant increase in the development of vehicle production in the
last 30 years. In this framework, average vehicle production for the period
1990–1999 was 298, whereas this number radically increased to 1550 in
2018. On the other side, according to the data obtained from Organisation
Internationale des Constructeurs d’Automobiles (OICA), Turkey was the
leader of vehicle production in Central and Eastern Europe (CEE) in 2018. In
addition, Turkey is among the first 15 countries in the World Auto Production
list.
While considering these aspects, it can be understood that the automobile
industry has a great importance for the Turkish economy. Therefore, it is also
significant to understand gasoline demand in Turkey. Many different factors
can influence gasoline demand. However, most of the researchers expect that
gasoline price is the most important driver. Thus, it is very important first to
analyse gasoline prices.
Based on the findings of empirical estimations, the elasticities can be
interpreted as follows: In the long-run a 1% increase in income results, on
average, in 0.25% increase in gasoline demand, while a 1% increase in price
level decreases gasoline demand by 0.27%. This response is 0.80%
decrease for auto stock. In the short-run gasoline demand does not respond
to the changes in the drivers.

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In the short-run, gasoline demand does not respond to changes in income,

price and auto stock. For any deviance from the long-run common trend, it
takes just less than three quarters to be adjusted back. As a result, the price
of gasoline demand in the case of Turkey is understood to be inelastic. In
other words, the decrease in gasoline demand is less than the increase in
gasoline price. This situation indicates that it can be possible in Turkey to
increase government revenues by increasing the tax rate on gasoline prices.
On the other hand, when the price of gasoline increases, there is a decrease
in gasoline consumption, albeit to a lesser extent. In addition, the increase in
gasoline prices can increase the demand for alternative fuel types. From this
point of view, it is understood that the tax increases in gasoline prices should
be paid attention to in order to generate income. There is a risk that the
increase in tax revenues will not be as high as expected, as consumption will
decrease, albeit less. Therefore, in order to increase tax revenues, it should
be ensured that gasoline prices are not raised radically. Another important
point in this process is the taxes imposed by the state to other elements. For
example, if the tax on the purchase of private cars is increased, this will
reduce the sales of these cars. In this case, as fewer cars are used, the
demand for gasoline will also be reduced. In addition to this, improving the
quality of public transport will also reduce people’s use of private vehicles.
This will have similar effects on gasoline demand. It can be understood from
these points that if the government wants to use gasoline prices to increase
tax revenues, it is necessary to take into account many different factors at the
same time. Otherwise, the state’s aim to increase this tax revenue will fail.
Adapted from: Mikayilov, J. I., Mukhtarov, S., Dinçer, H., Yüksel, S., and Aydin,
R., (2020), Energies, Elasticity Analysis of Fossil Energy Sources for
Sustainable Economies: A Case of Gasoline Consumption in Turkey.
Question:
Using evidence from the case study establish whether the price elasticity of
gasoline demand is elastic or inelastic.

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Revision Question 5

1.What does elasticity mean? Why are economists interested in measures of

elasticity?

2. Define price elasticity of demand.

3. Describe in words what each of the following means:

(a) perfectly inelastic demand
(b) unitary elastic demand
(c) elastic demand

4.Suppose you are the supplier of Thingama and that you are in a position to
decide at which price you will offer these products for sale. What would your
pricing strategy tend to be if you have determined that the price elasticity of
the demand for Thingama is:
(a) greater than one
(b) equal to one
(c) smaller than one
Explain your decision in each case.

5. Define price elasticity of supply.

6. For each of the following pairs of goods, which good would you expect to
have a greater price elasticity of demand and why?
(a) Beyoncé recordings or pop recordings in general
(b) Prescribed textbooks or science fiction novels. Airline tickets purchased by
business travellers or airline tickets purchased by tourists.

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5.8 Summary
A summary of Elasticities is illustrated in the table below:

Table 3: Different Elasticities

Source: Mohr, 2015

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Answers to Activities

Unit 5
Video Activity 5.1
To be discussed during the webinar(s) with lecturer
Activity 5.1
To be discussed during the webinar(s) with lecturer
Activity 5.2
To be discussed during the webinar(s) with lecturer
Video Activity 5.1
1A
Think Point 5.1
To be discussed during the webinar(s) with lecturer
Knowledge Check Question 5.1

To be discussed during the webinar(s) with lecturer

Case Study 1

To be discussed during the webinar(s) with lecturer

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Unit
6:
Production and Cost

Unit 6: Production and Cost

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Unit Learning Outcomes

Prescribed and Recommended Textbooks/Readings

Prescribed Reading(s)
Mohr. P. (2015) Economics for South African Students. Fifth Edition.
Pretoria: Van Schaik Publishers.

Recommended Reading(s)
Cloete, M. and Marimuthu, F. (2021). Basic Accounting for non-
accountants. Third Edition. Pretoria: Van Schaik.

Marx, J. (2022). Financial Management in Southern Africa. Sixth Edition.

Cape Town: Pearson.

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6.1 Introduction
Here we are looking at the production aspect or the supply side of the market. In the production
process the factors of production are combined to produce goods and services. We shall examine
production costs and efficient production, supply decisions, and the opportunity costs of production.

6.2 Basic revenue, cost and profit concepts.

“In economics we consider both explicit costs and implicit costs:
Explicit Costs: This the actual cost of acquiring inputs by the firm for producing goods and services.

Implicit Costs: This refers to the value of inputs owned by the firm and used in to produce goods.
These are not free although the firm does not pay for them at the time of production. They include
the highest salary the entrepreneur could have earned in a similar position elsewhere, the best
return that could be earned on the firm’s own capital and the rent the firm could earn by renting out
its land and other inputs it owned. The values (or imputed cost) of these inputs must be taken into
account”, Mohr (2015).

In a business it could include cost of electricity, water, property tax, use of private vehicle, etc.,
calculated proportionately to running the business. Therefore, the economic cost to the firm is:
Explicit costs + Implicit costs = opportunity cost of producing.

Activity 6.1

Distinguish between implicit costs and explicit costs.

Normal profit, Economic Profit and Accounting Profit

Normal Profit: This is the minimum amount the entrepreneur will earn that will persuade him/her to
employ his own resources in his/her own business rather than hire them out.

Economic Profit: (excess profit) This is the difference between what the firm is earning and the
normal profit. It means that the firm is earning more than what it could earn by employing its
resources elsewhere.

Accounting Profit: Total or accounting profit is the difference between the firm’s total income from
sales and its explicit costs.
Therefore:

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Economic profit = total income less total costs (Implicit + explicit) Accounting profit = total income less
explicit costs.

Figure 33: Economic and accounting profit

Source: Mohr, 2015

Knowledge Check Question 6.1

Suppose a firm generated Total Revenue to the value of R20 000 000 while
incurring Explicit Costs of R5 000 000 and Implicit Costs of R7 000 000.
1. The economic profit is ...
(a) R20 000 000
(b) R15 000 000
(c) R8 000 000
(d) R13 000 000

2. The Accounting profit is ...

(a) R20 000 000
(b) R15 000 000
(c) R8 000 000
(d) R13 000 000

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Short-Run and Long-Run

Short-run is the period in which the firms plant size does not change. It will have some fixed costs
(capital) and some variable costs (labour).

Long-Run: Plant size changes and all costs are variable.

The actual duration of a short or long run cannot be stated in terms of time.

Think Point 6.1

How does average revenue differ from marginal revenue?

Goal of the firm

The main goal of every firm is to maximise profits. If a firm is not profitable it will not be able to
operate in the long run.
The concept of Revenue

Total revenue(TR) is defined as the total value of sales and is equal to price (P) multiplied by
quantity(Q).
TR = P X Q (or simply PQ)
Average revenue is equal to total revenue (TR) divided by the quantity.
AR = TR = PQ (=P)
QQ
Marginal revenue (MR) is the additional revenue earned by selling an additional unit of the product.
MR = TR (or PQ)
QQ

Video Activity 6.1

https://www.youtube.com/watch?v=lt6LpwBNSlM
What is the impact of hiring an additional waiter?

The concept of profit

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Profit is the difference between revenue and cost:

Profit = Revenue - Cost

In other words, a firm's profit is the difference between the revenue it earns by selling its product and
the cost of producing it. The economist's definition of profit is, however, not the same as the
accountant's definition of profit.

As economists, we distinguish between total (or accounting) profit, normal profit and economic profit:
- Total (or accounting) profit is the difference between total revenue from the sale of the firm's
product(s) and total explicit costs.

6.3 Production in the short-run

The production function indicates the relationship between the quantity of inputs and the quantity of
output obtained from the use of these inputs.

Short-Run Production: In the short run some inputs are fixed and others variable. A farmer may
have a hectare of land on which he grows maize. The land is size is fixed. The number of workers
(labour) may be varied.

In a given state of technology, there is a relationship between the quantity of inputs and the
maximum output that can be obtained from these inputs. This relationship is called a production
function and can be expressed in the form of a table (or schedule), an algebraic equation or a graph.
A maize farmer's simple production function is presented as a schedule in Table 4.
Also see full text in page 151 of the textbook.

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Table 4: Production schedule of a maize farmer with one variable input

Source: Mohr, 2015

The production function (or schedule) shows that if no labour is applied to the 20 units of land, no
maize will be produced. The production function further illustrates that if one unit of labour is
employed, 16 tons of maize can be produced.

The production schedule can also be represented in the form of a graph. The total product of labour
in Table 4 is presented graphically in Figure 34 (a). To facilitate reference, Figures 34(a) and 34(b)
are presented together.

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Figure 34: Total, average and marginal product of labour

Source: Mohr, 2015

The table and graph show that as the quantity of labour is increased, total product (TP) increases
from zero at an increasing rate, then starts increasing at a decreasing rate until a maximum point is
reached, after which TP declines. This S-shape of the total product curve reflects the law of
diminishing returns, or the law of diminishing marginal returns.

To formulate the law of diminishing returns, we need to first explain average product and marginal
product.

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6.4 The Law of Diminishing Returns

The law of diminishing returns states that as more of a variable input is combined with one or more
fixed inputs in a production process, points will eventually be reached where first the marginal
product, then the average product and finally the total product will start to decline, Schiller, Hill and
Wall (2013).

This law is clearly illustrated in Figure 35 below.

Figure 35 : The law of diminishing returns

Source: Mohr,2015

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Case Study 1

The Diminishing Returns for Longer Healthcare Provider Video

Biographies
As healthcare organisations seek ways to provide improved patient
experiences for their customers, it is imperative they develop effective,
patient-centred tools to help patients more efficiently choose the provider who
can best meet their needs (Davis et al., 2005). This study shows healthcare
organisations how they might be able to best achieve this through the
development of short online provider video introductions. As the results
indicate, “longer” does not necessarily equal “better.” Shorter videos of around
46- seconds with accompanying complementary text about the provider were
just as effective at eliciting the lowest levels of patient uncertainty, and the
highest levels of selection ease, satisfaction, likability, and trust as lengthier
videos. Not only do these findings highlight the positive qualities of having at
least some form of video of providers available for prospective patients to
view, but they also reveal that creating these types of videos does not need to
be an overly expensive or onerous ordeal. A 46-second video is really only
enough time for a provider to introduce him or herself, and possibly answer
one or two questions – nothing more. Yet, as participants indicated in this
study, 46-s of video is not too thick or too thin, but instead feels “just right.”
Source: Evan K. Perrault (2020): The Diminishing Returns for Longer
Healthcare Provider Video Biographies: A Thin Slice Examination of Patient
Decision-Making, Health Communication, DOI:
10.1080/10410236.2020.1733230
Question
1. In your own words, explain how the law of diminishing returns applies to
this case study.

Think Point 6.2

What do you think these terms mean? (a) Average product (b) Marginal
product

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6.5 Average and Marginal Product

The average product (AP) of the variable input is simply the average number of units of output
produced per unit of the variable input. It is obtained by dividing total output (TP) by the quantity of
the variable input (N). The calculation of AP is illustrated in Table 5.

Table 5: Production schedule of a maize farmer with one variable input.

Source: Mohr, 2015

The marginal product (MP) of the variable input is the number of additional units of output produced
by adding one additional unit (the marginal unit) of the variable input.

The highest marginal product shown in Table 5, namely 35 tons, occurs when the fourth unit of
labour is employed. The marginal product of the fifth unit of labour is less than 35 tons. Once the
maximum marginal product is reached, it keeps on declining. The marginal product of 9 units is
equal to zero. The marginal products of additional units of labour are negative, which means that
their employment causes total product to decline. Once a limit is achieved, the workers get in each
other's way, are given jobs too specialised to keep them occupied each day, or get onto each other's
nerves.

Comparison of total, average and marginal product

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The total, average and marginal product of labour are all based on the same basic information and
are, therefore, interrelated.

TP is S-shaped. In other words, as the variable input is increased, TP increases from zero at an
increasing rate, then at a decreasing rate, reaches a unique maximum point and then decreases
AP and MP are shaped like inverted "U"s, i.e. as the variable input is increased, they rise at
declining rates, reach maximum points and then decrease at increasing rates
MP reaches its maximum before AP reaches its maximum. (Figure 36)

Figure 36: Marginal product and average product

Source: Mohr, 2015

Before AP reaches a maximum, MP lies above AP.

MP equals AP at its maximum point

After the maximum point of AP is reached, MP lies below AP
MP equals zero where TP reaches its unique maximum

6.6 Costs in the short-run

Fixed costs remain constant irrespective of the quantity of output produced (TP). Variable costs
change when TP changes – it represents the cost of the variable input(s) (Mohr, 2015).

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See full text in page 153 of the prescribed textbook.

TC = TFC + TVC
Where TC = Total costs
TFC = Total fixed costs
TVC = Total variable costs
The relationship between production and costs in the short-run is illustrated in Figure 37.

Figure 37: The relationship between production and cost.

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Source: Mohr,2015.

6.7 Fixed and Variable costs

“A fixed input cannot be altered in the short-run. Since the number of units of land is fixed and the
price (rental) of using a unit of land is given, the cost of using the land is fixed.

Fixed costs remain constant irrespective of the quantity of output produced. The quantity of the
variable input can be varied in the short-run. In the case of the maize farmer, labour is the variable
input. The cost of labour to the firm for the relevant period can, therefore, be calculated by
multiplying the number of units of labour employed, by the price per unit of labour.

Think Point 6.3

What is your understanding of the term fixed costs?

Activity 6.2

If the Total Costs (TC) amount to R250 000 and the Total Fixed Costs (TFC)
are R80 000. Determine the Total Variable Costs (TVC).

Practical Example 6.1

The rental that you pay for premises for your factory is payable whether you
have produced any goods or not. Rent is therefore a fixed cost.

Variable cost is defined as cost that changes when total product changes - it represents the cost of
the variable input(s)”, Mohr, (2015).

Practical Example 6.2

If you have not produced any goods, you will not incur an electricity cost. The
more goods you produce, the higher the electricity cost. Electricity in this
context is therefore a variable cost.

Table 6 illustrates the relationship between the short-run production function and the short-run total
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cost function of the maize farmer.

Table 6: The relationship between production and cost

Source: Mohr, 2015

Assume that the cost of a unit of the fixed input (land) for the growth season is R450. Therefore, the
cost of twenty units is 20 x R450 = R9 000, irrespective of the quantity of maize produced during the
growth season or the quantity of the variable input (labour) used. This represents the total fixed cost
(TFC) of producing the various quantities of output indicated in Table 6.

Suppose the price of a unit of labour for the full growth season is R2 400. To obtain the cost of
labour, we have to multiply the units of labour (e.g. 3) by the price per unit of labour (e.g. 3 x R2 400
= R7 200). The total cost (TC) is the sum of the total fixed cost (TFC) and the total variable cost
(TVC) associated with each level of production.

The three cost schedules can be represented in graphical form (Figure 38) as cost functions or cost
curves.

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Figure 38: Three total cost curves

Source: Mohr, 2015

Video Activity 6.2

https://www.youtube.com/watch?v=E7qWYu0xJfg
Define the following:
Fixed costs

Variable costs

6.8 Production and costs in the long run

The long run is a period of time in which all factors of production and costs are variable. In the long
run, firms are able to adjust all costs, whereas, in the short run, firms are only able to influence prices
through adjustments made to production levels. Additionally, while a firm may be a monopoly in the
short term, they may expect competition in the long run (Mohr, 2015).

See full text in page 157 of the prescribed textbook.

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The long run is a time period during which a manufacturer or producer is flexible in its production
decisions. For example, a business with a one-year lease will have its long run defined as any period
longer than a year since it’s not bound by the lease agreement after that year. In the long run, the
amount of labour, size of the factory, and production processes can be altered if need be.
Businesses can either expand or reduce production capacity or enter or exit an industry based on
expected profits. Firms examining the long run understand that they cannot alter levels of production
in order to reach an equilibrium between supply and demand (Mohr, 2015).

Economies and Diseconomies of Scale:

Figure 6.7 is used to indicate economies and diseconomies of scale.

Figure 39: Alternative long run average cost curves

Source: Viljoen,1998

Scale refers to the size of production. As the scale of production increases we shift to a higher
isoquant showing a larger scale of production.

Constant Returns to Scale:

Figure 39 (purple area) the isoquants are equally apart showing that as one moves up the
indifference map the output increases by the same amount. This is called constant returns to Scale.

Increasing Returns to Scale:

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In figure 39 (blue area) The isoquants get closer as output increases showing increasing returns to
scale.

Decreasing Returns to Scale:

Figure 39 (yellow area) shows that as output is increased the isoquants get further apart. This means
that we have decreasing returns to scale.

Revision Question 6

1. What does normal profit mean? Explain the difference between normal
profit and economic profit.

2. How is the short run defined in production theory? How does it differ from
the long run?

3. Formulate the law of diminishing returns.

4. Use a diagram to explain the relationship between average product and

marginal product.

5. Differentiate between implicit and explicit costs.

6.9 Summary
Production is the process of combining inputs to make goods and services. Firms must incur costs
when buy inputs to produce the goods and services that they plan to sell. In this chapter we have
examined the link between a firm’s production process and its total cost.

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Answers to Activities

Unit 6

Activity 6.1

To be discussed during the webinar(s) with lecturer

Knowledge Check Question 6.1

1. (c)
2. (b)

Think Point 6.1

To be discussed during the webinar(s) with lecturer
Video Activity 6.1
To be discussed during the webinar(s) with lecturer
Case Study 1

To be discussed during the webinar(s) with lecturer

Think Point 6.2

To be discussed during the webinar(s) with lecturer

Think Point 6.3

To be discussed during the webinar(s) with lecturer

Activity 6.2

To be discussed during the webinar(s) with lecturer

Video Activity 6.2

To be discussed during the webinar(s) with lecturer

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Unit
7:
Perfect Competition

U n i t 7 : P e r f e c t C o m p e t i t i o n

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Unit Learning Outcomes

Prescribed and Recommended Textbooks/Readings

Prescribed Reading(s)
Mohr. P. (2015) Economics for South African Students. Fifth Edition.
Pretoria: Van Schaik Publishers.

Recommended Reading(s)
Cloete, M. and Marimuthu, F. (2021). Basic Accounting for non-
accountants. Third Edition. Pretoria: Van Schaik.

Marx, J. (2022). Financial Management in Southern Africa. Sixth Edition.

Cape Town: Pearson.

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7.1 Introduction
Perfect Competition has some unrealistic assumptions. However, an analysis of perfect competition
assists us to understand the other market forms. We shall deal with the short-run and long-run
implications of firms in this market structure. Differences in price, output and profits are important
points to note. Since perfect competition is the benchmark against which all other market structures
or types of competition are measured, this is an important study unit.

Think Point 7.1

What is the difference between monopoly and oligopoly?

7.2 Overview of the four market structures

There are four market forms:

1. Perfect Competition
2. Monopoly
3. Monopolistic Competition
4. Oligopoly

For each market form the following distinctions can be made:

The number and size of firms

The nature of the product
Accessibility into the market (barriers)
The firm’s influence over prices

All firms aim to maximise profits given the various constraints. Table 7 summarises the main
market forms
Table 7: Summary of Market Structure

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Knowledge Check Question 7.1

1. An industry dominated by some large firms is ...

(a) a monopoly
(b) an oligopoly
(c) a perfect competition

Activity 7.1

Differentiate between a monopoly and oligopoly.

7.3 The equilibrium conditions for firms

Firms operating in any market structure want to maximise profits. To examine the behaviour of the
firms, we have to examine and combine their revenue and cost structures. Once these are known the
firms can take any of these decisions:

Firm must decide whether it is worth producing at all or shut down

If it is worth producing, the firm must decide the level of production that will help them maximise
profits

Think Point 7.2

When would you decide to shut your business down?

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These decisions have to be taken in any firm. There are two rules for profit maximisation which apply
to all firms regardless of a market structure. The shutdown rule or the profit maximising rule.

i. The Shut- Down Rule

A firm in a competitive market may find itself experiencing economic losses if demand for its product
falls or if the supply from other firms increases too rapidly. No one likes losing money, but should a
firm get out of the market as soon as losses are experienced? Not necessarily. If the losses a firm
experience are relatively small, it may be better off sticking things out and hoping price rises,
returning the firm to a break-even level. However, if losses are greater than the firm’s fixed costs, the
firm can actually minimise its losses by shutting down (Mohr, 2015).
See full text in page 166 of the prescribed textbook.

The first rule is that a firm should produce only if Total Revenue (TR) is equal to, or greater than,
Total Variable Costs. A firm’s decision regarding closing down its operation in the short run is
governed by variable costs. It is so because fixed expenses have to be met in any case. This is why
some hotels in hill stations keep a few rooms open in the off-season. They also offer special discount
to their customers. The basic objective is to cover variable costs and, if possible, a portion of fixed
costs. Thus, fixed costs are irrelevant for business decisions.

Practical Example 7.1

Suppose you are paying R12 million a month on a mortgage loan used to
purchase a block of apartments which generated around R20 million per
month in rent. The introduction of Covid-19 lock down rules resulted in your
revenue declining to the level of R5 million. The shutdown rule holds that, if
the R5 million covers your variable costs, you should continue operating
because whether the apartments are occupied or not you still have to pay the
R12 million per month on mortgage loan.

Video Activity 7.1

https://www.youtube.com/watch?v=aPiZloqtlnc
Under perfect competition when should a firm shut down in the short run?

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Think Point 7.3

How would you maximise profits of your company?

ii. The Profit Maximising Rule

An assumption in classical economics is that firms seek to maximise profits. Profit = Total Revenue
(TR) – Total Costs (TC). Therefore, profit maximisation occurs at the biggest gap between total
revenue and total costs. A firm can maximise profits if it produces at an output where marginal
revenue (MR) = marginal cost (MC) (Mohr, 2015).

Activity 7.2

Differentiate between the shut-down rule and the profit maximising rule.

Figure 40: Profit Maximisation

Source: Economicshelp,2018

To understand this principle, look at the above illustration.

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If the firm produces less than Q1, MR is greater than MC. Therefore, for this extra output, the firm
is gaining more revenue than it is paying in costs, and total profit will increase.
Close to Q1, MR is only just greater than MC; therefore, there is only a small increase in profit,
but profit is still rising.
However, after Q1, the marginal cost of the output is greater than the marginal revenue. This
means the firm will see a fall in its profit level because the cost of these extra units is greater than
revenue, Economics help (2018).

Reading Activity
At this point, you should read the prescribed textbook Chapter 10, page 165
to 166 on topic. If you are unable to acquire the suggested readings, then you
are welcome to consult any current source that deals with the subject. This
constitutes research.

Knowledge Check Question 7.2

1. Profits can be determined by comparing:

(a) Total Revenue & Total Cost
(b) Marginal Revenue and Marginal Cost
(c) All of the above

7.4 Perfect competition defined

Perfect competition occurs when none of the individual market participants can influence the price of
the product. The price is determined by the interaction of demand and supply.
Characteristics

1. Many buyers and sellers

2. No individual can influence prices
3. Goods are homogeneous
4. Factors of production are fully mobile
5. All participants have complete knowledge
6. Free entry and exit
7. No Government interference
8. No collusion

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Practical Example 7.2

The market for fruits and vegetables in the form of street vendors is an
example of perfect competition. They all buy their produce from the early
morning market foe an example.

Perfect Competition is a good analytical tool. The assumptions are somewhat unrealistic, but the
model has practical value in explaining and making predictions. Since a single firm cannot influence
prices it sells at the market price. The firm is a price taker. Its demand curve is horizontal at the given
price level.

7.5 The conditions under which perfect competition exists

Perfect competition exists if the following conditions are met:

There must be a large number of buyers and sellers of the product.

Each firm only supplies a small quantity of the total market supply.
There must be no collusion between sellers.
All the goods in the market must be identical
Buyers and sellers must be completely free to enter or leave the market.
All the buyers and sellers must have perfect knowledge of market conditions.
There must be no government intervention influencing buyers or sellers.
All the factors of production must be perfectly mobile.

In these markets, no individual firm has any market power - all firms are price takers.

Case Study 1

The business of film music in mainstream Nollywood.

The business of composing for film in mainstream Nollywood arguably shows
that the devices of perfect competition are at work. In this context, the
Nollywood film composer embodies the firm, and the film music space
represents the market. True to the entrepreneurial nature of mainstream
Nollywood, the composer doubles up as the only, if not the most important,
supplier/seller, with the Executive Producer/ Marketer (EPM) as the sole
buyer of his creative merchandise. And so, within this framework exist four
main indicators of a perfectly competitive mainstream Nollywood film music

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market:
1. Freedom of entry and exit: in the absence of prohibitive entry costs,
economies of scale, or network effects, incumbents in an industry face porous
borders and permeable barriers to entry. Competition enters and exits the
industry freely. The ‘all-comers’ nature of Nollywood film music practice (as
mentioned earlier and supported by quotes from stakeholders) is a testament
to the presence of this characteristic. Barriers to entry are minimal and
malleable: they hinge only upon individual entrepreneurial ambition.
2. Uncontrolled access to resources and homogenous units of input: both the
established and novice film composer has access to the units of production. In
other words, in completing a mainstream Nollywood film music project, all
composers have access to readily available talent (sometimes self-sourced as
in when the vocals are supplied by the same composer), and equipment (if
not self-owned, can be sourced from a production studio and at short notice).
3. No informational asymmetry between buyers and sellers: all buyers have
complete information about products being sold as well as the fees charged
by each supplier. The resulting effects can be seen in mainstream Nollywood,
wherein the composer is a price taker; his price negotiating ability constrained
by the EPM’s high bargaining power and influence.
4. Firm output is homogenous, and the resultant product a commodity: the
transient, transactional, and one-directional relationship between the powerful
EPM and film composer (in which the EPM dictates the creative output),
coupled with the high substitutability of composers as suppliers, leads to a
homogenous film music output. Anyone can decide to enter the business of
film music composition; market share is fragmented across several
composers – self-acclaimed, reputable, and all else besides. There is thus a
high substitutability of suppliers: EPMs themselves barely pause to
contemplate the need to switch composers.
These dynamics, including the absence of an established guild of film music
composers, pre-qualifications for composing for film, and lack of recognition
by professional bodies, are the salient ingredients acting against the erection
of barriers to entry. From the arguments so far, we posit that mainstream
Nollywood film composers are currently competing without advantage.
No doubt, the factors that drive the flow of work in mainstream Nollywood are
money and film projects. However, whereas both composers and filmmakers
seek out one another in Hollywood, the situation in Nollywood is one-
directional: it is the filmmakers or producers (EPMs) who seek out the
composers. This is, again, due to the high volume of films produced. And this
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overwhelming volume of production has only one implication: composers are

weighed down by film projects, and business relationships are at once
transactional and transient. Nollywood’s transient filmmaker–film composer
relationship further disputes Faulkner’s notion of ‘inner-circles’ – of EPMs and
composers who, together, ‘form an open system model of social structure’ in
order to ‘reduce uncertainty, narrow complexity of choices’, and enhance
chances of ‘securing control over a turbulent environment’ (Faulkner 2005, p.
11). To be clear, only the Nollywood EPMs function as a union – a very strong
one. On the contrary, Nollywood film composers do not yet operate as a
‘community’. And this is evidenced in their recent failed attempts to regulate
film project contracts and fees
Source: Emaeyak Peter Sylvanus & Obiocha Purity Eze-Emaeyak (2018) The
business of film music in mainstream Nollywood: competing without
advantage, Journal of Cultural Economy, 11:2, 141-153, DOI:
10.1080/17530350.2017.1409131
Question
1. By making reference to the case study show that Nollywood’s film music
industry depicts perfect competition.

7.6 Short-run equilibrium under perfect competition

We now examine the short run equilibrium (or profit-maximising) position of the firm under conditions
of perfect competition. Since the firm under perfect competition does not have to make any pricing
decisions (price-taker) - it can only choose the output at which it will maximise its profits, i.e. where
MR = MC or where the positive difference between TR and TC is at its maximum.

Figure 41: The demand curve for a product of the firm under perfect competition

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Mohr, 2015: 169

Equilibrium in terms of total revenue and total cost

The total cost curve is shaped like a reversed S, as illustrated in Figure 8.3. In the short-run, the total
cost curve does not start at the origin, since part of the firm's cost is fixed.

Figure 42: Total short-run costs of the firm

Mohr,2015

Total revenue of the firm under perfect competition was illustrated in Figure 41 as a straight line with
a positive slope which starts at the origin and has a slope equal to the price of the product. In Figure
43, we combine such a total revenue (TR) curve with the total cost (TC) curve.

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Figure 43: Total revenue, total cost and total economic profit
Mohr, 2015

Economic profit is the difference between TR and TC. Graphically, it is measured by the vertical
distance between the TR curve and the TC curve. At levels of output below Q1 in Figure 43, TC is
greater than TR and the firm, therefore, incurs economic losses (indicated by the shaded area). At
Q1, the firm's total economic profit is zero (since TR = TC). Between Q1 and Q2, the firm makes an
economic profit at each level of output (indicated by the shaded area), since TR > TC.

At Q2, total economic profit is zero once more and at higher levels of output the firm again incurs
economic losses. The firm's profit will be maximised where the positive vertical distance between TR
and TC is the greatest (i.e. somewhere between Q1 and Q2).

7.7 Long-run Equilibrium Under Perfect Competition

To conclude the analysis of perfect competition, we refer briefly to the equilibrium of the industry (i.e.
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the collection of firms that supply a specific product in the market). The industry will only be in
equilibrium in the long-run if all the firms are making normal profits. Only then will there be no
inducement for new firms to enter the industry or for existing firms to leave the industry. With
complete freedom of entry and exit, there will always be some movement (i.e. disequilibrium) in the
industry when firms are making economic profits or losses.

Figure 44: The firm and Industry in long run equilibrium

Mohr, 2015

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Revision Question 7

1. List five requirements for perfect competition to exist.

2. Explain why any firm maximises profit, or minimises losses, when marginal
cost is equal to marginal revenue.

3. Illustrate the demand curve for the product of the firm under perfect
competition.

4. Explain, with the aid of diagrams, why perfectly competitive firms earn
normal profits only when the industry is in equilibrium.

5.Use diagrams to illustrate the fact that perfectly competitive firms are price
takers. How are prices determined in perfectly competitive markets?

6. What is the point of studying perfect competition if it does not exist, or exists
only very rarely, in the real world?

7.8 Summary
A perfectly competitive market is a hypothetical market where competition is at its greatest possible
level. Neo-classical economists argued that perfect competition would produce the best possible
outcomes for consumers, and society.

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Answers to Activities

Unit 7

Think Point 7.1

To be discussed during the webinar(s) with lecturer

Knowledge Check Question 7.1

1. (b)

Activity 7.1

To be discussed during the webinar(s) with lecturer

Think Point 7.2

To be discussed during the webinar(s) with lecturer

Video Activity 7.1

Perfect Competition: Oranges

Monopolistic Competition: Fast Food

Oligopoly: Cars, Cell Phones

Monopoly: De Beers Diamonds

Think Point 7.3

To be discussed during the webinar(s) with lecturer

Activity 7.2

To be discussed during the webinar(s) with lecturer

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 Microeconomics

Knowledge Check Question 7.2

1. (c)

Case Study 1

By making reference to the case study show that Nollywood’s film music industry depicts perfect
competition.

1. Freedom of entry and exit: in the absence of prohibitive entry costs, economies of scale, or
network effects, incumbents in an industry face porous borders and permeable barriers to
entry. Competition enters and exits the industry freely. The ‘all-comers’ nature of Nollywood
film music practice (as mentioned earlier and supported by quotes from stakeholders) is a
testament to the presence of this characteristic. Barriers to entry are minimal and malleable:
they hinge only upon individual entrepreneurial ambition
2. Uncontrolled access to resources and homogenous units of input: both the established and
novice film composer has access to the units of production. In other words, in completing a
mainstream Nollywood film music project, all composers have access to readily available
talent (sometimes self-sourced as in when the vocals are supplied by the same composer),
and equipment (if not self-owned, can be sourced from a production studio and at short
notice)
3. No informational asymmetry between buyers and sellers: all buyers have complete
information about products being sold as well as the fees charged by each supplier. The
resulting effects can be seen in mainstream Nollywood, wherein the composer is a price taker;
his price negotiating ability constrained by the EPM’s high bargaining power and influence
4. Firm output is homogenous, and the resultant product a commodity: the transient,
transactional, and one-directional relationship between the powerful EPM and film composer
(in which the EPM dictates the creative output), coupled with the high substitutability of
composers as suppliers, leads to a homogenous film music output. Anyone can decide to
enter the business of film music composition; market share is fragmented across several
composers – self-acclaimed, reputable, and all else besides.

There is thus a high substitutability of suppliers: EPMs themselves barely pause to contemplate
the need to switch composers.

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Unit
8: Monopoly and Imperfect
Competition

Unit 8: Monopoly and Imperfect Competition

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Unit Learning Outcomes

Prescribed and Recommended Textbooks/Readings

Prescribed Reading(s)
Mohr. P. (2015) Economics for South African Students. Fifth Edition.
Pretoria: Van Schaik Publishers.

Recommended Reading(s)
Cloete, M. and Marimuthu, F. (2021). Basic Accounting for non-
accountants. Third Edition. Pretoria: Van Schaik.

Marx, J. (2022). Financial Management in Southern Africa. Sixth Edition.

Cape Town: Pearson.

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8.1 Introduction

In a pure monopoly there is only one producer of the good. There are no close substitutes. As the
monopolist is the sole supplier he/she can decide where he/she wants to be on the market demand
curve and sets the price and quantity accordingly. Like perfect competition a pure monopoly is
seldom exists. In this section we examine the monopolist’s equilibrium position and profit
maximisation position, how the monopolist can apply price discrimination and why and how the
government regulates monopolies.

8.2 What is a monopoly?

In its pure form, monopoly is a market structure in which there is only one seller of a good or
service that has no close substitutes. Another requirement is that entry to the market should be
completely blocked. The single seller is called a monopolist and the firm is called a monopoly.

Characteristics of a monopoly:
1. There is only one producer.
2. There are no close substitutes for the product.
3. There are barriers to entry into the industry.

Natural Monopoly: A monopoly comes about because of economic or geographic reasons, e.g.,
high development costs, exclusive ownership of raw materials, or only one firm can serve a market
efficiently.

Practical Example 8.1

The domination of the diamond industry by De Beers provides an example of

natural monopoly.

Think Point 8.1

Think of an example of a natural monopoly?

Artificial Monopoly: The barriers to entry are not economic factors. An example is a patent whereby
the firm has the sole right legally to produce the good. Another example is a licence to operate as the
only supplier.

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Practical Example 8.2

The retail licence issued by the Department of energy gives a company or an

individual exclusive rights to sell petroleum products in a specific area. This is
an example of artificial monopoly.

Although the monopolist has considerable power, market forces influence production and sale of the
product.

Activity 8.1

Define the following:

a. Natural Monopoly
b. Artificial Monopoly

Knowledge Check Question 8.1

What is a monopoly?

8.3 The equilibrium position of the monopolist

In principle, the profit maximising decision of a monopoly is exactly the same as that of any other
firm.
Like any other firm, a monopoly should produce where marginal revenue (MR) is equal to marginal
cost (MC) - (the profit maximising rule), provided that average revenue (AR) is greater than minimum
average variable cost (AVC) - (the shut-down rule).

Total, average and marginal revenue under monopoly

Since the monopoly is the only supplier of the product of the industry, the demand curve for the
product of a monopolistic firm is the market demand curve for the product of the industry. Since the
market demand curve slopes downward, the monopoly can only sell an additional quantity of output
if it lowers the price of its product. (See Table 8).

Table 8: Average, total and marginal revenue when the demand curve for a firm's product
slopes downward

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Source: Mohr, 2015

Figure 45 demonstrates that under monopoly, a firm faces a downward-sloping demand curve which
is also its average revenue curve AR, as shown in (a).

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Figure 45: Marginal, average and total revenue under monopoly (or any other form of
imperfect competition)
Source: Mohr,2015

The marginal revenue curve MR is also downward-sloping and lies halfway between the AR curve
and the price axis. The corresponding total revenue curve TR is shown in (b). When MR is positive,
TR increases; when MR is zero, TR remains unchanged; and when MR is negative, TR falls. These
relationships apply to all forms of imperfect competition.

The equilibrium of the firm under a monopoly

The equilibrium position of the firm under monopoly is illustrated in Figure 46.

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Figure 46: The equilibrium of the firm under monopoly

Source: Mohr,2015

The figure shows the average revenue AR, marginal revenue MR, average cost AC and marginal
cost MC of a monopoly. The monopolist's profit is maximised by producing a quantity Q1 at a price
P1. The economic profit per unit is the difference between M1 and K1 (or between P1 and C1). The
firm's total economic profit is the shaded area C1P1M1K1. See full text in page 184 of the prescribed
textbook

Think Point 8.2

What do you think monopolistic competition is?

8.4 What is monopolistic competition?

After the study of Perfect Competition and Monopoly we turn to imperfect competition. There are two

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market forms: Monopolistic competition and oligopoly. In this section we look at monopolistic
competition. Monopolistic competition is a combination of monopoly and perfect competition.
Characteristics:

1. Product differentiation: Each firm produces a differentiated product

2. Each has some monopolistic power over its competitors.
3. Each firm has its own downward sloping demand curve for its product
4. There are many firms in the industry.
5. There are no barriers to entry and exit.

8.5 The equilibrium of the firm under monopolistic competition

The short-run equilibrium and the long-run equilibrium of a monopolistically competitive firm is
illustrated in Figure 47.

Figure 47: The equilibrium of the firm under monopolistic competition

Source: Mohr,2015

“Short-run and long-run equilibrium positions of a monopolistically competitive firm are illustrated in
(a) and (b), respectively. In both cases, D is the demand curve for the product of the firm (or average
revenue AR), MR is marginal revenue, MC is marginal cost and AC is average cost. The firm is in
equilibrium where MR = MC. In the short-run conditions illustrated in (a), the firm is in equilibrium at
output Q1 and price P1. The firm's total profit is illustrated by the shaded rectangle. In the long-run,
however, the firm only makes a normal profit at an output of Qe and a price of Pe. At that price-output
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combination, AR is tangent to AC, MR = MC and AR = AC” Mohr 2015.

The firm has some competitive power as well as some monopoly power. The demand (AR) curve is
downward sloping. Because of lack of barriers to entry and exit the long-run economic profits will
attract new firms into the market.

Think Point 8.3

Compare the graphical presentation of a monopoly (figure 8.2) and the
graphical presentation of a short run equilibrium of a monopolistic
competition (Figure 8.3); and comment on the findings of your analysis.

Activity 8.2

In monopolistic competition, what is different between the short run and the
long run?

Knowledge Check Question 8.2

What is monopolistic competition?

8.6 Oligopoly
Oligopoly is the other form of imperfect competition. In this case the scale tilts more in favour of
monopoly power. In oligopoly there are a few large firms in the industry. These firms have
considerable economic power. Oligopoly is a market structure found in all parts of the modern world
(Mohr, 2015).

Characteristics:

1. There are a few large firms

2. The product could be homogeneous (e.g. cement) or heterogeneous(differentiated)
3. Entry is free.
4. The firms are interdependent
5. There are uncertainties in the market result in cartels and collusion.

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Knowledge Check Question 8.3

What is oligopoly?

Reasons Why Oligopolies Exist:

Economies of scale lead to a few firms dominating the market

Large Scale capital investments can be made by firms with economic power. • This acts as a
natural barrier to entry
Firms may possess patients for certain products
The quality of product and service may result in few firms dominating
A few possess the strategic raw materials
The government may have granted them concessions to operate

Video Activity 8.1

https://www.youtube.com/watch?v=15CcRWmZOMA
Define oligopoly.

“Under oligopoly, a few large firms dominate the market. A duopoly exists when there are only two
firms in the industry. The product may be homogeneous (e.g. steel, cement, petrol) but it is mostly
heterogeneous (e.g. motorcars, cigarettes, household appliances, electronic equipment, household
detergents). When the product is homogeneous, the market is described as a pure oligopoly, and
when the product is heterogeneous (or differentiated) the market is called a differentiated
oligopoly. Oligopoly is the most common market form in modern economies. When people talk
about "big business" and "market power", they are usually referring to oligopolists”, Mohr (2015).

The main feature of oligopoly is the high degree of interdependence between the firms. Each
oligopolist, therefore, always has to consider how its rivals will react to any action that it takes. The
other important feature of oligopoly is uncertainty. To reduce this uncertainty, oligopolistic firms often
collude (enter into agreements) about prices and output, Mohr (2015).

Like a monopolist and a monopolistic competitor, the oligopolist faces a downward-sloping demand
curve. However, the slope of the curve is uncertain, since this depends on how its competitors will
react to price changes - they may decide to follow or not to follow any price change. Since oligopoly
is dominated by some powerful firms, the entry of new firms is more difficult than under perfect
competition or monopolistic competition. However, in contrast to monopoly, entry is possible.

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Competition is often intense, although it tends to be non-price competition, rather than price
competition. The more intensely oligopolists compete, the closer they are likely to come to perfectly
competitive output, Mohr (2015).

Case Study 1

Restructuring South Africa’s gas sector

The Competition Commission is of the view that deregulation of the price
charged for liquefied petroleum gas (LPG) could lead to greater competition
and lower prices for consumers, which would boost uptake of the product.
However, it also insists that the South African LPG market is not ready for
deregulation yet. In fact, it is calling for greater monitoring and regulation.
A 2012 department of energy (DoE) survey highlighted the fact that only some
high-income households uses gas for cooking and heating. This was one of
the concerns for the commission when it launched a market inquiry into the
sector in 2014. In its final report, released at the end of April, the commission
argues that the sector's structure is conducive to collusion and has numerous
bottlenecks that need to be addressed.
The commission argues that the LPG market is highly concentrated, with only
five refineries currently producing LPG in South Africa: Enref, Chevref, Natref,
PetroSA and Sapref.
At a wholesale level, the market has four large wholesalers in Afrox, Totalqaz,
Oryx and Easigas, accounting for 90% of the market share, with new entrants
and small existing firms having to overcome high barriers to entry in the
wholesale market.
The commission recommends the market needs to be "monitored" as its
structure is "conducive for collusive behaviour". The report makes a number
of recommendations to address these concerns in the market, calling on
sector players to comply between now and 2019. However, these
recommendations are non-binding.
The commission also claims to have uncovered some evidence of existing
collusion. It announced on 24 April that a separate investigation into an
alleged gas cylinder cartel had been launched in response to information
received during the market inquiry.
The gas cylinder cartel
"Doe Soap" is the name given by the commission to its informant, an
anonymous distributor who has spilt the beans on an alleged gas cylinder

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cartel in the LPG market.

Doe Soap forwarded a number of letters from his LPG suppliers to the
commission that were dated between 28 February 2014 and 4 Dune 2015.
"The letters, coming from Afrox, Totalgaz, Oryx and Easigas, all notified their
distributors of a pending increase in the cylinder deposit fee, while at the
same time introducing a non-refundable rental fee for using their cylinders,"
reads the commission's report.
As the commission points out in the document, the DoE is the regulatory
authority responsible for the determination of the cylinder deposit fee
applicable in the LPG sector. The body approached the DoE to enquire
whether it had reviewed and changed the cylinder deposit rate in Dune 2015.
It emerged that the department had not reviewed the rate since 2010 and had
not mandated any changes to the deposit rate.
"The commission has reason to believe that collusion in fixing cylinder
deposits has taken place in this sector and that this conduct is likely to be
continuing," the body noted in its report.
The commission recommends shifting regulation away from the DoE to the
National Energy Regulator of South Africa (Nersa), because the national
department does not seem to have the capacity to fulfil the regulatory role. It
recommends that Nersa, rather than the DoE, should be responsible for the
determination of deposit fees and the subsequent annual reviews.
From: Gedye, L. (2017) Restructuring South Africa’s gas sector. Finweek.
Pp12-13
Questions
1. By making reference to the case study, show that there exists an
oligopolistic market structure at both production and wholesale level of the
gas sector in South Africa.
2. In your opinion, will the suggested solution of moving the regulation
responsibility from the Department of Energy to Nersa be effective.

8.7 Comparing monopoly with imperfect competition and perfect competition

Mohr (2015) states that “between the extremes of monopoly and perfect competition, there is a range
of actual market organisations. Some industries (like the brick manufacturing industry) consist of a
few large firms and many small ones. Other industries (like motor manufacturing) consist of a few
large firms only. In some industries (like the clothing industry), there are many firms producing a
variety of similar products. In other industries (like the cement industry), a few large firms produce
virtually identical products”.

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The first type of market in the spectrum between the extremes of perfect competition and monopoly
is monopolistic competition. The conditions for monopolistic competition can be summarised as
follows:

Each firm produces a distinctive, differentiated product;

Each firm, therefore, faces a downward-sloping demand curve for its particular product;
There are many firms in the industry; and
There are no barriers to entry (or exit).

A market structure is efficient if marginal cost MC is equal to price P and if production occurs where
average cost AC is at its minimum. These two types of efficiency are called allocative efficiency and
productive efficiency. The long-run equilibrium of a monopolistically competitive firm occurs when
only normal profits are made. In this respect, there is no difference between monopolistic competition
and perfect competition.

However, in long-run equilibrium, the monopolistically competitive firm produces where price is
higher than marginal cost and where average cost is not at a minimum. Therefore, monopolistic
competition is neither allocative nor productively efficient. Although the monopolistically competitive
firms do not make economic profits in the long-run (as monopolists do), monopolistic competition is
also characterised by an inefficient use of resources. Consumers pay a higher price and less output
is produced than under perfect competition, Mohr (2015).

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Revision Question 8

1. What are the main differences between monopoly and oligopoly?

2. Give three examples of oligopolistic markets in South Africa.

3.Give South African examples of:

(a) Monopoly
(b) Monopolistic competition
(c) Oligopoly

4. Use a diagram to illustrate the equilibrium position of a monopolistic firm.

Clearly indicate the economic profit or loss.

5. Discuss the concept of monopoly, its characteristics and types.

8.8 Summary
The following table offers a summary and some key differences in various market structures
as observed in the past 2 units.

Table 9: A summary of different market structures

Mohr,2015

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Answers to Activities

Unit 8
Think Point 8.1

To be discussed during the webinar(s) with lecturer

Activity 8.1

To be discussed during the webinar(s) with lecturer

Knowledge Check Question 8.1

To be discussed during the webinar(s) with lecturer

Think Point 8.2

To be discussed during the webinar(s) with lecturer

Think Point 8.3

To be discussed during the webinar(s) with lecturer

Activity 8.2

To be discussed during the webinar(s) with lecturer

Knowledge Check Question 8.2

To be discussed during the webinar(s) with lecturer

Knowledge Check Question 8.3

To be discussed during the webinar(s) with lecturer
Video Activity 8.1

An industry dominated by a small number of large companies

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Case Study 1

1. By making reference to the case study, show that there exists an oligopolistic market structure at
both production and wholesale level of the gas sector in South Africa.

Production level:

The commission argues that the LPG market is highly concentrated, with only five refineries currently
producing LPG in South Africa: Enref, Chevref, Natref, PetroSA and Sapref.

Wholesale Level:

At a wholesale level, the market has four large wholesalers in Afrox, Totalqaz, Oryx and Easigas,
accounting for 90% of the market share, with new entrants and small existing firms having to
overcome high barriers to entry in the wholesale market.

2. In your opinion, will the suggested solution of moving the regulation responsibility from the
Department of Energy to Nersa be effective.

A fact/ evidence backed argument will suffice.

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Unit
9:
Labour Market

U n i t 9 : L a b o u r M a r k e t

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Unit Learning Outcomes

Prescribed and Recommended Textbooks/Readings

Prescribed Reading(s)
Mohr. P. (2015) Economics for South African Students. Fifth Edition.
Pretoria: Van Schaik Publishers.

Recommended Reading(s)
Cloete, M. and Marimuthu, F. (2021). Basic Accounting for non-
accountants. Third Edition. Pretoria: Van Schaik.

Marx, J. (2022). Financial Management in Southern Africa. Sixth Edition.

Cape Town: Pearson.

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9.1 Introduction
Labour is an important factor of production. The cost of labour is the largest cost factor in the
economy. Changes in the cost of labour tend to cause significant impact on production. Most
economics would agree that the creation of jobs is the most important economic policy objective of
any country. Labour issues are highly politicised. South Africa is no exception to this politics and the
needs to correct previous apartheid injustices. We are seeing 2019 starting with the official minimum
wage of R20 per hour or R3500 a month. We will discover what does all these mean in economic
terms.

9.2 The differences between the labour market and the goods market

The circular flow of income and expenditure shows the flow of goods and factors between
households and firms. Firms are the demanders of the factors and households are the suppliers of
the factors, Mohr (2015).

The Demand for Factor of Production:

Mohr (2015) states that “the demand for factors of production (like labour) is a derived demand,
because it is “derived” from the goods market. For e.g., the demand of labour increases when the
demand for a labour-intensive good rises, and as firms try to produce more of that good by
employing more labour.

The labour market, unlike the product market supplies labour/workers which are a factor of
production. Factors of production are the inputs that are used to produce a product or service that
are sold in the product market. The demand for labour from the labour market is a derived demand,
meaning that in this case the labour is being demanded since the products that the labour can
produce are in demand. Unlike the labour market, the product market produces final goods, these
goods are not factors of production. Demand in the product market is not a derived demand, in
reality the product market creates the derived demand from the labour market as well as other factor
markets”.

Practical Example 9.1

Product markets (goods market) include farmers markets, supermarkets,

websites like Alibaba, ebay, etc. Factor markets on the other hand include
career fairs, employment websites like job-mail, Pnet, careerjet, etc.

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9.3 Equilibrium in the labour market

Think Point 9.1

Why do people work?

9.3.1 The individual supply of labour

Schiller, Hill & Wall (2013) state that the motivation to work arises from social, psychological and
economic forces. People need income to pay their bills, but they also need a sense of achievement.
As a consequence, people are willing to work – to supply labour. The determinants of labour supply
include tastes (for leisure, income and work); income and wealth; expectations (for income or
consumption); prices of consumer goods and taxes. There is an opportunity cost involved in working
– namely, the amount of leisure time one sacrifices. By the same token, the opportunity cost of not
working (leisure) is the income and related consumption possibilities thereby forgone. Everyone
confronts a trade-off between leisure and income, Mohr (2015).

Activity 9.1

Differentiate between the goods market and the factor markets.

Higher wage rates induce people to work more, that is, to substitute labour for leisure. However, this
substitution effect may be offset by an income effect. Higher wages also enable a person to work
fewer hours with no loss of income. When income effects outweigh substitution effects, the labour
supply curve bends backward, as illustrated in Figure 48

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Figure 48: The individual supply of labour

Source: Mohr,2015

Figure 48 illustrates that the quantity of labour supplied increases up to a certain point (B) and then
declines as the wage rate increases further. This is called the backward-bending individual supply
curve of labour.

According to Economics help (2018), the Two factors that influence a workers supply of labour
are:

1. “Substitution effect of a rise in wages

With higher wages, workers will give greater value to working than leisure. With work more profitable,
there is a higher opportunity cost of not working. The substitution effect causes more hours to be
worked as wages rise.

2. Income effect of a rise in wages

This occurs when an increase in wages causes workers to work fewer hours. This is because

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workers can get a higher income by working fewer hours. Therefore, they may work less”.

Therefore, after wage rise, workers may work less because they can get their target income with
fewer hours spent working.

Think Point 9.2

When income effect outweighs substitution effect, the supply curve bends
backwards. Does this exhibit the same behaviour as the Law of
Diminishing returns?

9.3.2 The market supply of labour

“Market supply of labour for a particular vocation depends upon:

1. The number of qualified people

For example, the number of qualified accountants is low, therefore supply is quite inelastic. For a job
such as fast food operator, the number of potentially qualified people are a high percentage of the
labour force, therefore supply is much more elastic.

2. Difficulty of getting qualifications

If it is difficult to get particular qualifications, supply will be inelastic. For example, even if wages of
economics teachers rose, the supply would be quite inelastic – to become qualified would take
several years.

3. The non-wage benefits of a job

Unpleasant jobs will have fewer people willing to do them therefore supply will be relatively lower.
Although many unpleasant jobs, such as cleaning are relatively low-skilled so may still be low paid.

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Practical Example 9.2

Non-wage benefits of a job include the following:

Use of a company vehicle

Free or subsidised canteen

Gym membership/ gym facilities

4. The wages and conditions of other jobs

If many jobs in a local area are considered unpleasant – e.g. fruit pickers, then the supply of
alternatives will be relatively higher.

5. Demographic changes and immigration

Some jobs, such as fruit picking are unpopular with native-born workers and rely on immigrant
labour. If immigration slows down, there can be vacancies in these particular jobs. Post-Brexit vote,
farmers reported difficulty in filling labour vacancies due to a slowdown in immigration” Economics
help (2018).

Figure 49: Market Supply of Labour

Source: Mohr,2015

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Video Activity 9.1

https://www.youtube.com/watch?v=CJtkEOnqmIs
Is the supply of labour curve downward sloping or upward sloping curve?

Activity 9.2

List non-wage benefits of a job.

9.3.3 The individual firm’s demand for labour

“The most important aspect of the demand for labour is that it is a derived demand. This means that
labour is 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 other factors of production. For example, if there is an
increase in demand for visiting coffee shops, it will lead to an increase in demand for baristas
(people who make coffee). The demand for labour will also depend on labour productivity, the price
of the good and their overall profitability to a firm.

Many factors influence how many people a business is willing and able to take on. But we start
with the most obvious – the wage rate or salary
There is an inverse relationship between the demand for labour and the wage rate that a
business needs to pay as they take on more workers
If the wage rate is high, it is costlier to hire extra employees
When wages are lower, labour becomes relatively cheaper than for example using capital inputs.
A fall in the wage rate might create a substitution effect and lead to an expansion in labour
demand”, Mohr, (2015).

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Figure 50: A perfectly competitive labour market

Source: Mohr,2015

Reading Activity
At this point, read the excerpt in page 213 of the prescribed textbook
describing the labour market and its demand.

9.3.4 The market demand for labour

A firm’s demand for labour reflects labour’s marginal revenue product, which refers to the change in
total revenue associated with one additional unit of input. A profit-maximising employer won’t pay a
worker more than the worker produces (Schiller, Hill & Wall, 2013). Figure 51 shows the demand for
labour.

Figure 51: Labour Demand

Source: Schiller, Hill & Wall (2013)

According to Figure 51, the higher the wage rate, the smaller the quantity of labour demanded
(ceteris paribus). At the wage rate W1, only L1 of labour is demanded. If the wage rate falls to W2, a
larger quantity of labour (L2) will be demanded. The labour demand curve obeys the law of demand.

Figure 52 clearly illustrates that the marginal revenue product curve is the labour demand
curve.

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Figure 52: The Marginal Revenue Product Curve Is the Labour Demand Curve
Source: Schiller, Hill and Wall (2013)

According to Schiller, Hill & Wall (2013), “an employer is willing to pay a worker no more than the
marginal revenue product. With reference to Figure 52, an employer will gladly hire a second worker
because the worker’s MRP (point B) exceeds the wage rate ($4). The sixth worker won’t be hired at
that wage rate since the MRP (at point D) is less than $4. Therefore, the MRP curve is the labour
demand curve. Hence, in keeping with the law of diminishing returns, the MRP of a variable factor
declines as more of it is employed with a given quantity of other (fixed) inputs”.

Knowledge Check Question 9.1

1. Marginal Revenue Product refers to:

(a) Change in Total Revenue per change in total output
(b) Change in Total Revenue associated with one additional unit of
output
(c) Average change in total revenue

9.3.5 Changes in labour market equilibrium

The unit of the market supply and demand curve establishes the equilibrium wage in a competitive
labour market, as illustrated in Figure 53.

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Figure 53: Equilibrium wage

Source: Schiller, Hill & Wall ,2013

All the firms in the industry can hire as much labour as they want at the equilibrium wage. In terms of
Figure 53, the firm can hire all the workers it wants at the equilibrium wage we. It chooses to hire qo
workers, as determined by their marginal revenue product within the firm.

Video Activity 9.2

https://www.youtube.com/watch?v=002_HEC2l-4
What is the equilibrium wage rate and employment?

9.4 Government intervention in the labour market

Mohr (2015) state that “wage determination is an emotional process. When the pay of those at the
bottom end of the wage structure is an issue, concepts such as basic needs, minimum wage levels,
living wages and calls for minimum wages tend to become emotionally loaded. Figure 54
demonstrates the impact of the imposition of a minimum wage in a perfectly competitive labour
market. This is what we are likely to see in the economy with the new minimum wage implemented”.

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Figure 54: The impact of the imposition of a minimum wage in a perfectly competitive labour
market
Source: Mohr,2015

In Figure 54, DD and SS are the demand and supply of labour, respectively. The original equilibrium
wage is we and the quantity of labour employed is Ne. The imposition of a minimum wage at wm
decreases the quantity of labour demanded to Nm and thus causes unemployment equal to the
difference between Ne and Nm. At the minimum wage wm, there is an excess supply of labour equal
to the difference between N1 and Nm.

Think Point 9.3

Is the imposition of a minimum wage an example of a price floor or a price
ceiling? Why?

Case Study 1

Labour market interventions to assist the unemployed in two townships

in South Africa.
Given the absence of organised and accessible information on programmes
relating to unemployment in South Africa, it may be difficult for beneficiaries to
derive value from existing programmes; and for stakeholders to identify
possible gaps in order to direct their initiatives accordingly.

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The purpose of this study was to conduct a review of existing employment

initiatives within two low-income communities in South Africa, with the aim of
identifying possible gaps in better addressing the needs of the unemployed.
This article explored existing unemployment programmes, projects and
interventions implemented in two Gauteng Province townships: Orange Farm
and Emfuleni.
Findings
In this study, it was found that 19.6% of elements of programmes comprise
either workplace readiness, job-search assistance and/or soft skills
development. A hindsight discovery is that many of these programmes
(particularly those implemented by the CSOs) mainly consist of providing the
unemployed with basic life skills, such as youth recreation, HIV and family
reproduction services, with few programmes focussing on employment
services. Although it was known from the outset that, compared to expertise
and entrepreneurship development, employment services are a neglected
component in labour market inventions, finding that even less than 19.6%
truly contribute to providing these services is a concern.
Findings also suggest that, in most cases, stakeholders themselves had
limited knowledge of employment programmes, indicating that, even for them,
information is not widely distributed. Role players’ inability to provide this
information is particularly concerning, as the mere purpose of their
programmes is to assist those who need this information most.
The most time-consuming tasks of this study were to find documents
containing relevant information, and to get hold of available stakeholders who
are knowledgeable about the topic. Firstly, in the process of searching for
relevant documents, it was evident that information regarding programmes
was not readily accessible. It was challenging to find this information online, in
hard copy or in correspondence with stakeholders, as responses to enquiries
about information regarding employment programmes and government
expenditure on these programmes indicated that not much information was
available. Secondly, getting hold of stakeholders was a major barrier in the
study. The average response rate, calculating all stakeholders and different
approaches used to make contact, was less than 30%, and the majority could
not provide any relevant information.
Unemployment in South Africa does not appear to be the result of a lack of
initiatives or a lack of stakeholder involvement, but rather the result of
haphazard implementation of interventions. In order to intervene more
effectively, addressing the identified gaps, organising and better distribution of
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information for beneficiaries is suggested.

Adapted from: Paver, R., Rothmann, S., Van den Broeck, A., & De Witte, H.
(2019). Labour market interventions to assist the unemployed in two
townships in South Africa. SA Journal of Industrial Psychology/SA Tydskrif vir
Bedryfsielkunde, 45(0), a1596. https://doi.org/ 10.4102/sajip.v45i0.1596
Question
“ In order to intervene more effectively, addressing the identified gaps,
organising and better distribution of information for beneficiaries is
suggested.” In your opinion, what are your suggested solutions to address
this challenge?

Revision Question 9

1. List three factors which may cause an increase in the market supply of
labour in the clothing industry.

2. Explain the relationship between the marginal product of labour and the
marginal revenue product of labour.

3. Use a diagram to explain the impact of the imposition of a minimum wage

above the equilibrium wage in a perfectly competitive labour market.

4. Discuss the Individual Supply and its curve.

5. Discuss the determinants of Market supply of labour.

9.5 Summary
The labour market is very important to the growth of economies as all production relies on labour.
With more use of technology and shifts to more service economies which are less labour intensive
than agricultural and mining, it remains to be seen what the future holds on the SA economy and if
any future growth will help tackle the high unemployment rates.

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Answers to Activities

Unit 9
Think Point 9.1

To be discussed during the webinar(s) with lecturer

Activity 9.1

To be discussed during the webinar(s) with lecturer

Think Point 9.2

To be discussed during the webinar(s) with lecturer

Video Activity 9.1

It is the intersection of demand for labour and supply of labour

Activity 9.2

To be discussed during the webinar(s) with lecturer

Knowledge Check Question 9.1

1. (b)

Video Activity 9.2

To be discussed during the webinar(s) with lecturer

Think Point 9.3

To be discussed during the webinar(s) with lecturer

Case Study 1

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Question

“In order to intervene more effectively, addressing the identified gaps, organising and better
distribution of information for beneficiaries is suggested.” In your opinion, what are your suggested
solutions to address this challenge?

Solution

The substantiation on how the suggested solution will address the problem at hand is acceptable.

ledge

Think Point 3

Student to apply his or her own knowledge

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Unit
10: Market Failure and Government
Failure

Unit 10: Market Failure and Government Failure

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Unit Learning Outcomes

Prescribed and Recommended Textbooks/Readings

Prescribed Reading(s)
Mohr. P. (2015) Economics for South African Students. Fifth Edition.
Pretoria: Van Schaik Publishers.

Recommended Reading(s)
Cloete, M. and Marimuthu, F. (2021). Basic Accounting for non-
accountants. Third Edition. Pretoria: Van Schaik.

Marx, J. (2022). Financial Management in Southern Africa. Sixth Edition.

Cape Town: Pearson.

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10.1 Introduction

“Market failure is the economic situation defined by an inefficient distribution of goods and services in
the free market. Furthermore, the individual incentives for rational behaviour do not lead to rational
outcomes for the group. Put another way, each individual makes the correct decision for him/herself,
but those prove to be the wrong decisions for the group. In traditional microeconomics, this is shown
as a steady state disequilibrium in which the quantity supplied does not equal the quantity
demanded”, Mohr (2015).

10.2 What is market failure?

Mohr (2015) states that “Market failure occurs when there is an inefficient allocation of resources in a
free market. Market failure can occur due to a variety of reasons, such as monopoly (higher prices
and less output), negative externalities (over-consumed) and public goods (usually not provided in a
free market). Market failure is the economic situation defined by an inefficient distribution of goods
and services in the free market. Furthermore, the individual incentives for rational behaviour do not
lead to rational outcomes for the group. Put another way, each individual makes the correct decision
for him/herself, but those prove to be the wrong decisions for the group. In traditional
microeconomics, this is shown as a steady state disequilibrium in which the quantity supplied does
not equal the quantity demanded”.

Types of market failure according to Mohr (2015) are:

1. “Positive externalities – Goods/services which give benefit to a third party, e.g. less congestion
from cycling
2. Negative externalities – Goods/services which impose cost on a third party, e.g. cancer from
passive smoking.
3. Merit goods – People underestimate the benefit of good, e.g. education
4. Demerit goods – People underestimate the costs of good, e.g. smoking
5. Public Goods – Goods which are non-rival and non-excludable – e.g. police, national defence.
6. Monopoly Power – when a firm controls the market and can set higher prices.
7. Inequality – unfair distribution of resources in free market
8. Factor Immobility – E.g. geographical / occupational immobility
9. Agriculture – Agriculture is often subject to market failure – due to volatile prices and externalities.
10. Information failure – where there is a lack of information to make an informed choice.
11. Principal-agent problem – Two agents with different objectives and information asymmetries”

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Think Point 10.1

Think of an example of a negative externality.

Practical Example 10.1

Eskom enjoyed monopoly of being the sole supplier of electricity in South

Africa. The dawn of democracy exposed the market failure, since this
monopoly was not supplying electricity to the rest of the country.

10.3 Market failure as a reason for government intervention in the economy

According to Jain, (2017), “most economic arguments for government intervention are based on the
idea that the marketplace cannot provide public goods or handle externalities. Public health and
welfare programs, education, roads, research and development, national and domestic security, and
a clean environment all have been labelled public goods”.

Practical Example 10.2

The South African government realised that Eskom was not providing
electricity to the whole population. To address this market failure, the
government intervened by instructing Eskom to roll out the supply of electricity
to the rest of the country. This was done without increasing the generation
capacity result in the shortage of electricity supply in the country; giving rise to
government failure, namely, load shedding.

Activity 10.1

Define market failure.

He further eludes that “externalities occur when one person’s actions affect another person’s well-
being and the relevant costs and benefits are not reflected in market prices. A positive externality
arises when my neighbours benefit from my cleaning up my yard. If I cannot charge them for these
benefits, I will not clean the yard as often as they would like. (Note that the free-rider problem and
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positive externalities are two sides of the same coin.) A negative externality arises when one
person’s actions harm another. When polluting, factory owners may not consider the costs that
pollution imposes on others”.

Video Activity 10.1

https://www.youtube.com/watch?v=13JOGWzY8kE&t=98s
Give an example of market failure.

“The government is the entity that wields the maximum power to pursue multiple objectives for the
welfare of society. No one doubts the importance of a well-oiled state machinery; however, unbridled
state intervention raises reasonable doubts on its need and requirement in the various situations
concerned. Four market failure categories cover the areas where intervention by the government is
required and the provision of services and goods cannot be left to the forces of free markets” Jain
(2017).

Think Point 10.2

What is your understanding of “laissez-faire”?

“In the realm of economics, there exists the concept of "laissez-faire". In plain speak, laissez-faire is a
system where the incentives of private players to provide services are not shaped by government
interventions and all economic activities can take place without being encumbered by coercive
measures such as tariffs, subsidies and taxes. Laissez-faire was defined by the following three
axioms that were proposed by economist Adam Smith in 1776:

The Invisible Hand: The notion that an individual's efforts to maximise her own gains in a free
market benefits society even when her ambitions have no benevolent intentions
Advantage of Competition: Natural competition amongst private entities, instead of closely
controlled state companies and organisations, fosters better and cheaper product development
for the end consumer
Dynamics of Supply and Demand: The producers of good in a free market will produce enough
to meet the demands of the consumers and this potential equilibrium will rationalise and
modulate the prices in an economy” Jain (2017)

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Jain (2017) further states that “The idea of laissez-faire is a powerful one; one that injects innovation,
energy and dynamism into an economy for it prevents the meddlesome state from resorting to
desultory means of imposing and structuring licensing paraphernalia, like the Fabianis-tic policies
that India witnessed during the license-raj era and which looks set to return with the inefficacious
demonetisation roll-out. However, as beautiful a concept laissez-faire is, its limitations and failures in
fostering crony capitalism and in imposing a distinct lack of focus on the welfare of the
underprivileged are well documented and tested. This then begs the fundamental question of when
the state should react and respond to these failures of the free market”.

Case Study 1

COUNTRY CASE STUDY OF MARKET FAILURE: SIERRA LEONE

Market failure is a common phenomenon to all types of economic system, and
for which its acuteness is heavily prevalent in developing / underdeveloped
regions of the world due to the absence of prudent democratic governance
structure. In developed economies like the UK, USA and Western Europe, the
presence of critical voices from opposing factions in politics and also the
educated masses are making it possible for acute market failure to be brought
under control, while the situation is different in underdeveloped economies,
mostly located in the Southern region of Africa, Latin America and Asia.
A particular case of country specific market failure is that of Sierra Leone; the
country is a former British colony, once considered as the Athens of West Africa
(Jackson, 2018). Successive bad governance in the early part of 1980’s has
progressively spearheaded the collapse of a well-structured colonial nation,
which was practically viewed as a model of the West African subregion.
Scholarly arguments from writers like von Hayek (1944, reprinted in 2001) have
argued his points to imply “that market failure does not imply that government
should attempt to solve market failures, because the costs of government
failure might be worse than those of the market failure it attempts to fix
(Cunningham, 2011)”. This situation is typical in many of the underdeveloped
economies around the West African sub-region where poor intervention of
governments and their agents normally result in the inefficient allocation of
goods and resources than would have considered in situations of planned
intervention.
Specific to Sierra Leone, failed governance system can be directly associated
with the concept of Market Failure (also referred to as government failure),
which prevent an economy from making effective use of available resources to

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facilitate growth and development. As emphasised by McMillan (2002) and

Fligstein (2001:3), it is thought that the prevalence of strong market requires
the existence of strong government, which has been a complete opposite with
many of the postcolonial governance structure seen in Sierra Leone.
The existence of skewed and corrupt governance system in Sierra Leone
between 2007 -2018 have made it possible for public officials in key ministries
and parastatals to become ‘patronisers’ of a failed market system, despite
successive interventions made by international bodies like the International
Monetary Fund [IMF] to support the country’s pathway of failed market system.
Heterodox economics views around post-colonial occurrences of the
successive failed governance systems would testify deliberate failure of a
corrupt governance system to deliberately deviate from program activities
devised by international institutions like the IMF aimed at shaping the country’s
failed market structure, already burdened by high fiscal indiscipline. The result
of this was seen where further loan disbursement was halted, thereby leaving
the economy in a state of nearly collapse, while at the same time government
officials were seen moving around negotiating unsustainable loan programs
that would have almost placed the country in an endless state of indebtedness
to a country like China.
As stated by Messner & Meyer-Stamer (1992), efficient markets require strong
government and transparent institutions to ensure economic agents are acting
in the best interests of the nation. Sierra Leone for over decades after
independence has been battered by weak and corrupt governance structure,
which ultimately have placed the country and its citizens in a precarious
situation. Corruption in politics by successive government has infiltrated into the
fabrics of the Sierra Leone economy to an extent where there seem to have
being little or no confidence on the part of citizens on their leaders in managing
the affairs of the economy.
Selfishness manifested by successive corrupt governments in Sierra Leone to
protect themselves in power normally result in asymmetric market information,
given the fact that government would mostly provide weak measures like
subsidy to services that are not economically viable to effectively drive
developmental efforts in the country.
Over the years, the country has witnessed an almost complete state of anarchy,
more so as a result of the politicisation of institutions that seek to support the
operation of illegal activities. This was clearly seen lately with the breakdown of
confidence on the part of international institutions like International Monetary
Fund’s [IMF] to suspend loan agreement to a reigning regime given the
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undisciplined nature of public servants’ abuse of public funds (Thomas,

February 2018), and even the collapse of government owned parastatals like
commercial banks, which nearly brought a sink in the country’s financial
system.
The deliberate and almost wicked manifestation of elected and public servants
in ministries and parastatals to become prudent in their act of public services is
almost tantamount to the death of a nation, where institutions are almost
considered non-existent due to failed market system. Such type of inept
manifestation of public services requires strong individuals or citizens to
transform institutions and one way this can be achieved is through the
establishment of strong legislations and high level of discipline infused in public
servants to deliver on merit as opposed to being considered politically
connected.
As emphasised by Cunningham (2011: 28-29), there are serious
consequences for market failure by a nation, and particularly in a small and
endowed country like Sierra Leone and some of these are highlighted below: -
- High level of uncompetitive market situation: As dictated by the corrupt
political system that was established by past regimes since the early 1980s,
poor governance created a situation whereby new entrants were prevented
from entering essential markets, hence creating an artificial monopolistic
market system. The direct consequences of this is seen where prices of basic
commodities have risen to an unsustainable level, with salaries of low-income
earners not sufficient to match the high / inflated cost of living. Politically
connected market players were able to step up their influences in the corrupt
system to an extent of preventing (local) competitiveness as witnessed in the
case with business investors like Dangote, who was prepared at first time of
entering the market from selling Cement at a reduced price compared to that of
already established competitors.
- Generation of low-level equilibrium: this makes it very highly possible for
productivity to remain relatively low as connected players reinforces their
influences in the market, thus keeping others away from entry, while also
making it possible for them to continue dictating market prices. The impact of
this is evident with producers in rural areas who are almost kept away from the
market and hence making it impossible for them to increase their income
potential on account of the mired condition and almost deplorable investment
environment they are exposed to. The corrupt level of connectedness instilled
by successive regimes meant that, collapse of important industry like the Iron

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Ore market resulted in serious knock-on effect for other investors, who were not
able to find ways around the embargo that confront their access into the
market.
- Creation of sub-optimal delivery of critical investment: this is apparent in
the face of the country’s very low research potential at national and as well as
individual businesses limited scope of expanding competitively through
research innovations at national and international levels in a dynamic market
environment. In the midst of corrupt and cabal establishment(s) created by
successive regime-change witnessed in the country, potential investors are
more scared of hedging their risks when considering investment potential in a
country like Sierra Leone.
- Market failure create reduced scope for the establishment of welfare
opportunities: in a country like Sierra Leone, market failures have resulted in
the country’s lagged state of development, with bleak scope for the creation of
growth in the midst of monopolistic environment, artificially established through
corrupt governance structure. This comes with high level of poverty as
witnessed in the country’s low record of Human Development Index produced
more lately by the United Nations Development Program (UNDP, 2018).
Intervention by successive governments to establish watch-dog institutions like
the Anti-corruption Commission (ACC) and more recently, the Ombudsman
Office have made little or no impact in addressing the acute level of market
failure witnessed in the country due to the high nature of corruptive
connectedness that continues to manifest itself in every corner of the country’s
institutional setup.
Conclusion
In conclusion, countries around the world considered to be blighted by failed
market system as in the case with Sierra Leone are equally capable of
achieving such state of progressive development of effective market system,
but only through the manifestation of Practical Wisdom, a translated Greek
terminology from the word 'Praktisches Wissen' in the early days of Gadamer
(Dottori, 2009 and Jackson, 2016: 3) of public officials to deliver high level
services that are free of the vices of corruption and nepotism. The effort of such
nations should be geared towards ensuring that the 16 SDGs are placed at the
heart of governance, where leaders are made to be seeking the good of a
nation by promoting safe and secure working environments capable of
improving much-needed inclusive and sustained economic growth.
FROM: Abraham, J.E. and Mohamed, J (2019) Understanding market failure in
the developing country context. Encyclopedia of the UN Sustainable
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Development Goals.
Questions
1. What have been the consequences of market failure in Sierra Leone?
2. In your opinion, can any parallels be drawn between the Sierra Leone case
and South Africa?

10.4 The Ways in which Government Intervenes in The Economy

1. To correct for market failures

2. To achieve a more equitable distribution of income and wealth

3. To improve the performance of the economy

Table 10: Tabulation of market failure and government intervention

Source: Economics online,2018

10.5 What is Government failure?

Government failure refers to when the government intervenes in the economy to fix a problem, but

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only ends up creating more problems. That means it harms social welfare and/or makes the market
less efficient. In order for government failure to occur, there first has to be a market failure. That
means that the market is failing to produce positive outcomes for society. The government will then
decide whether and how to intervene. If the government intervenes and only makes the problems
worse, then it has failed.

The term originated in the 1960's when economists began to criticize any government intervention or
regulation of the economy. At that time, economists who believed in laissez-faire capitalism argued
that the free market was inherently efficient. They began to argue that government always created
inefficiency, and was always a problem.

These economists believed that government intervention often leads to government failure because
it interferes with the invisible hand that guides the free market. First described by Adam Smith, the
invisible hand is the result of individuals following their own self-interest in the economy often leading
to positive outcomes for society. The invisible hand was the reason why competitive free markets
distribute resources fairly. Individuals will try to improve their lives and become wealthier through
buying and selling goods and services in the most efficient way possible. This will keep the market
efficient, and improve social welfare.

Knowledge Check Question 10.1

State whether the following statements are true or false: In order for
government failure to occur, there first has to be a market failure.
1. True
2. False

10.6 Causes of Government Failure

“Public choice is the study of government decisions and how those decisions can be imperfect and
inefficient. These efficiency problems can be attributed to four different players in the political game --
politicians, voters, interest groups, and bureaucracies.

Think Point 10.3

How can politicians cause government failure?

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Politicians: These are members of society who seek elected offices. Problems and inefficiencies
arise because politicians, like all human beings, seek to maximise their own utility. This pursuit
can and does conflict with doing what's best for the economy. Elected politicians often fall victim
to the principal-agent problem
Voters: People, citizens of a nation, also seek to maximise their own utility. Two rational choices
they make in this pursuit are to NOT be informed (rational ignorance) and to NOT participate in
the political process (rational abstention). Such "apathy" means that elected leaders can ignore
their preferences
Interest Groups: While some people have little or no involvement in the political process, others
have a great deal of involvement. These people, who also seek to maximise utility, have more to
gain or lose from particular government actions and are thus motivated to act accordingly, usually
by forming special interest groups
Bureaucracies: Government policies are usually implemented by complex organisations. Those
who work in these bureaucracies are also, you guessed it, utility maximisers. Their pursuit of
utility can and does conflict with the efficient implementation of government policies”, Mohr (2015)

Video Activity 10.2

https://www.youtube.com/watch?v=ZcPNn6SuEE8
Based on this video, define government failure.

Revision Question 10

1. Give examples of government failure.

2. List the four main components of the government or public sector in South
Africa.

3. Give three valid reasons for government intervention in the economy.

4. Define nationalisation and privatisation.

5. Give three reasons for the increase in government spending in South Africa
since the 1960s.

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10.7 Summary
When an industry in the private sector is not performing efficiently or effectively, there is said to be
“market failure”. Economists usually recommend government actions to combat such failure, such as
taxes to help reduce pollution. The analysis of market failure may be correct, but the call for
government intervention may be unsuitable.

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Answers to Activities

Unit 10
Think Point 10.1

To be discussed during the webinar(s) with lecturer

Activity 10.1

To be discussed during the webinar(s) with lecturer

Video Activity 10.1

A government intervening in the market by supplying food parcels to fight hunger brought about by
Covid-19 only to find that these food parcels do not reach the intended recipients due to fraud by
politicians.

Think Point 10.2

To be discussed during the webinar(s) with lecturer

Case Study 1

1. What have been the consequences of market failure in Sierra Leone?

High level of uncompetitive market situation

Generation of low-level equilibrium

Creation of sub-optimal delivery of critical investment

Market failure create reduced scope for the establishment of welfare opportunities

2. In your opinion, can any parallels be drawn between the Sierra Leone case and South Africa?

As long as the student can support her/ his opinion with evidence.

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Knowledge Check Question 10.1

1. True

Think Point 10.3

To be discussed during the webinar(s) with lecturer

Video Activity 10.2

A government intervening in the market by supplying food parcels to fight hunger brought about by
Covid-19 only to find that these food parcels do not reach the intended recipients due to fraud by
politicians.

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Answers to Revision Questions

UNIT 1

1. Economics is the study of how society uses its scarce resources to satisfy the unlimited wants of
humans.

2. Society has insufficient productive resources to satisfy all the wants of its citizens. The central
question around which economics revolves is how to make the best use of these scarce resources,
in the best interests of society.

3.

Inflation
Unemployment
International Trade
Economic growth
Money

4 Ecomomics is regarded as a social science because it is essentially the study of human

behaviour.

5. The term Cetris Paribus literllay means “all things being equal.” It is an important assumption in
economic analysis because of the unpredictability of human behaviour. There are many variables
that influence the way people make decisions. In economic analysis, it is important to keep all
other variables, except the one being considered, constant.

6. Microeconomics is that branch of economics that studies economic behaviour at an individual or

company level. On the other hand, Macroeconomics is the study of the behaviour and
performance of the national economy as a whole.

7. A Postitive economic statement is based purely on objective facts and data, that are verifiable.
A normative statement is a subjective interpretation of facts, and is based on value judgments.
Knowing the difference between the two helps us to understand how policy decisions are made.

8. Examples of Normative statements

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The rate of inflation in South Africa is too high

South Africa should be investing more resources in the agricultural sector
The Reserve Bank should lower interest rates this year

9. Examples of positive economic statements:

The rate of inflation in South Africa is too high

South Africa should be investing more resources in the agricultural sector
The Reserve Bank should lower interest rates this year

UNIT 2

1. Briefly discuss the main components of total spending in the economy.

There are basically four sectors or spending units in the economy: households, firms, government
and the foreign sector. Households spend on consumer goods and services. This is called
consumption spending (C). Firms purchase capital goods. This is called investment spending (I).
Government spending is indicated by G. The foreign sector spends to purchase our exports (X), but
we spend on imports (Z) from the rest of the world. When we calculate total spending on South
African (domestic) production, imports have to be subtracted from exports.

2. Identify the main injections into and withdrawals (or leakages) from the circular flow of income and
spending in the economy.

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There are three main withdrawals (or leakages) from the circular flow of income and spending. The
first one, which is not explicitly stated in the textbook, is saving (S). Households and firms can save
part of their income and when they save there is a leakage from the circular flow of income and
spending. The second is taxes. Taxes (T) are also withdrawn from the circular flow, thereby reducing
the flow of income and spending. The same applies to imports (Z), in which case the leakage or
withdrawal is to the rest of the world. The goods and services come into the country, but the
spending and income go to the rest of the world. The main injections into the circular flow are
investment spending by firms (I), government spending (G) and exports (X). It may seem strange to
classify exports as an injection, since the goods and services leave the country. However, the
spending on the exports and the resultant income enter the county from the rest of the world.

3. Use diagrams to illustrate how goods and services, income and spending flow between
households and firms.

4. Use a diagram to summarise the circular flow of income and spending between households, firms,
The government and the foreign sector.

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5. The economic entities are: business, households, government, and the foreign sector. Discussed
in great detail in page 46 of the prescribed textbook.

UNIT 3

1. Wants are what people desire (want), needs are what people require (for example, shelter, food,
clothing) and demand refers to what people are willing and able to buy. Formally, demand may be
defined as “the quantities of goods and services that potential buyers are willing and able to buy
during a particular period”. For demand to exist there must thus be both a willingness and an ability
to buy. In other words, the items must be desirable and affordable to the potential buyer.

2. Other things being equal (i.e. ceteris paribus), the higher the price of a good, the lower the
quantity demanded (or the lower the price of a good, the greater the quantity demanded). There is
thus an inverse relationship between the price and the quantity demanded.

3. The price of the good, the prices of related goods (complements and substitutes), the income of
the households/consumers, taste (preference), the number of households/consumers.

4. “A change in demand means that different quantities of the good than before will be demanded at
each price. For example, an increase in demand means that a greater quantity will be demanded at
each price than before. This is illustrated in the first diagram below by a shift to the right of the whole
demand curve (from DD to D’D’)” Mohr (2015).

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“A change in the quantity demanded means that a different quantity is demanded at a different price.
For example, an increase in the quantity demanded means that a greater quantity is demanded at a
lower price than before. In the diagram below this is illustrated by a movement from A to B along the
existing demand curve. In this case the demand curve remains unchanged. There is simply a
movement from one point on the demand curve to another point. This is a change in the quantity
demanded. (The demand curve, that is, demand, does not change.) “Mohr (2015). See pages 65-70
of the textbook.

a. The price of the good, the prices and productivity of all the inputs (e.g. the various factors of

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production), the prices of related goods (e.g. substitutes in production), the state of technology and
expected future prices. See pages 70-75 of the textbook.

6.

a. If workers’ wages increase (ceteris paribus), then costs increase, which means that each quantity
will be supplied at a higher price than before. This is illustrated by an upward (or leftward) shift of the
supply curve, as in the diagram below.

(b) An increase in productivity without any change in wages will reduce the costs of production. This
will enable suppliers to supply more at each price level, or to offer each quantity at a lower price than
before. This is illustrated by a rightward or downward shift of the supply curve, as in the diagram.

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(c) An increase in the price of imported components raises the costs of production in the same way
as wage increases raise costs. The impact can be illustrated by an upward or leftward shift of the
supply curve, as in (a) above.

UNIT 4

1. Use a diagram to illustrate what will happen to the equilibrium price and quantity of a product if the
demand for the product increases. Also mention three factors that can cause an increase in demand.

The answer is illustrated in the figure on the right.

Any factor other than a change in the price of the product can cause a change in demand. An
increase in demand could be the result of an increase in the price of a substitute product, a decrease
in the price of a complementary product, an increase in consumers’ income, a greater consumer
preference for the good and an expected increase in the price of the product..

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2. Use diagrams to illustrate what will happen to the equilibrium price and quantity of a product in
each of the following cases (clearly indicate instances where the impact cannot be predicted):

a simultaneous increase in demand and supply

a simultaneous decrease in demand and supply
an increase in demand along with a decrease in supply
a decrease in demand along with an increase in supply

a. In the diagram below demand increases from DD to D’D’ and supply increases from SS to S’S’.
The equilibrium quantity increases (from Q0 to Q1 in this case) but the impact on the equilibrium
price is uncertain and will depend on how much demand and supply increase, respectively.

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Figure 4.7

(b) In the diagram below demand decreases from DD to D’D’ and supply decreases from SS to S’S’.
The equilibrium quantity decreases (from Q0 to Q1 in the figure) but the impact on the equilibrium
price will depend on the relative sizes of the shifts in demand and supply.

(c)

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Figure 4.8

(d)

This case is dealt with extensively on pages 88-89 of the textbook. The figures below clearly illustrate
that the impact on the equilibrium quantity depends on the relative sizes of the shifts in demand and
supply. The impact on the equilibrium price, however, is clear. In this case the equilibrium price will
increase.

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Figure 6.1

(e) This case is similar to the previous one. In the diagram below it is clear that the equilibrium price
level will decrease. However, the impact on the equilibrium quantity is uncertain and depends on the
relative sizes of the shifts in demand and supply.

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Figure 4.10

3. Explain, with the aid of a diagram, what happens in the market for (say) electricity if the
government fixes a maximum price below the equilibrium price.

See Fig 5-8 on page 91 of the textbook and the accompanying explanation. The key points are the
following: there will be an excess demand for the product (i.e. a shortage); the available quantity
supplied has to be rationed in one way or another; and a black market can develop.

4. Governments have various methods available with which to intervene in the market. This
intervention can take the form of:

setting maximum prices (also known as price ceilings)

setting minimum prices (also known as price floors)
subsidising certain products or activities
taxing certain products or activities

5. Governments can set maximum prices to:

Keep the prices of basic foodstuffs low (this may form part of policy to assist the poor)

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Avoid the exploitation of consumers by producers (producers may be charging “unfair” prices)?
Combating inflation limit the amount production of certain goods and services in times of war.

UNIT 5

1. What does elasticity mean? Why are economists interested in measures of elasticity?

Elasticity is a measure of responsiveness or sensitivity. If two variables are related, elasticity

indicates how responsive or sensitive the one is to changes in the other one. Economists deal with
relationships between variables and naturally often wish to know how responsive one variable is to
changes in another variable. Price elasticity of demand is a good example.

2. Define price elasticity of demand.

Price elasticity of demand is a measure of how responsive the quantity demanded of a product is to
changes in the price of the product. More formally, the price elasticity of demand is the percentage
change in the quantity demanded if the price of the product changes by one per cent, ceteris paribus.

3. Describe in words what each of the following means:

a. perfectly inelastic demand.

b. unitary elastic demand.
c. elastic demand.

a. The quantity demanded remains unchanged as the price changes. Or, the quantity demanded is
unaffected by changes in the price.
b. If the price changes by a certain percentage, the quantity demanded changes by the same
percentage in the opposite direction so that the total spending on the product remains
unchanged.
c. This means that the percentage change in the quantity demanded is greater than the percentage
change in the price of the product. In other words, the elasticity coefficient is greater than one.

4. Suppose you are the supplier of Thingama and that you are in a position to decide at which price
you will offer these products for sale. What would your pricing strategy tend to be if you have
determined that the price elasticity of the demand for Thingama is:

a. Lower the price. Total revenue will increase if the price is reduced.
b. Leave the price unchanged. Total revenue will remain unchanged if the price changes.

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c. Increase the price. Total revenue will increase if the price is increased.

5. Define price elasticity of supply.

Price elasticity of supply is the percentage change in the quantity supplied if the price of the product
changes by one per cent.

6. For each of the following pairs of goods, which good would you expect to have a greater price
elasticity of demand and why?

a. Beyoncé recordings, because they can be substituted by other pop recordings. The key factor
here is the definition of the product.
b. Science fiction novels. Prescribed textbooks will tend to have a lower price elasticity of demand
since students have to buy them. They are a greater necessity than science fiction novels.
c. Airline tickets purchased by tourists. Business travellers have no alternative, no substitutes and
airline tickets are a greater necessity for them.

UNIT 6

1. What does normal profit mean? Explain the difference between normal profit and economic profit.

Normal profit means that all the firm’s resources are earning as much as they could have earned in
their best alternative uses. Normal profit is earned when a firm is just covering all its economic costs.
Thus, if total revenue is equal to total economic costs, the firm is earning normal profit.

Economic profit is the difference between total revenue and total costs (including normal profit). It is
sometimes also called pure profit, abnormal profit, excess profit or supernormal profit. See pages
147-149 of the textbook.

2. How is the short run defined in production theory? How does it differ from the long run?

The short run is the period in which at least one of the firm’s inputs are fixed, while the long run is
defined as the period in which all the firm’s inputs are variable. Note that the difference is not a
matter of calendar time. The difference between the short run and the long run may vary from
industry to industry.

3. Formulate the law of diminishing returns.

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As more of a variable input is combined with one or more fixed inputs in a production process, points
will eventually be reached where first the marginal product, then the average product and eventually
the total product of the variable input will start to decline.

4. Use a diagram to explain the relationship between average product and marginal product.

The marginal product of a variable input or factor of production (e.g. labour) is the additional output
(units) produced by employing one additional unit of the variable input.

The average product of a variable input or factor of production (e.g. labour) is the average output
(units) produced per unit of the variable input employed. As long as the marginal product is greater
than the average product, the average product increases. As long as the marginal product is lower
than the average product, the average product decreases. The two are equal where the average
product is at a maximum. See the diagram below.

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UNIT 7

1. List five requirements for perfect competition to exist.

Large number of buyers and sellers.

No collusion.
Product must be homogeneous (identical).
Freedom of entry and exit.
All participants must have perfect knowledge.
No government intervention.
Complete factor mobility.

(Any five)

2. Explain why any firm maximises profit, or minimises losses, when marginal cost is equal to
marginal revenue.

If marginal revenue (MR) is greater than marginal cost (MC), it implies that the last unit adds to total
profit. Conversely, if MC is greater than MR the last unit reduces the total profit (because a loss is
made on the last unit).

As long as MR > MC, it pays to expand production. As long as MC > MR, it pays to reduce
production. Where MR = MC maximum total profit (or minimum total loss) is achieved and there is no
incentive to expand or contract production.

3. Illustrate the demand curve for the product of the firm under perfect

4.

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Figure 7.6

5. Explain, with the aid of diagrams, why perfectly competitive firms earn normal profits only when the
industry is in equilibrium

This question is answered in detail on pages 174-176 of the textbook (including Figures 10-6 to 10-
8). The short answer is as follows: If firms are earning economic profits, these profits will attract new
entrants to the industry. This will increase the supply of the product, causing the price to drop. This
process will continue until all economic profit has been eliminated and only normal profit will be
earned.

If firms are suffering economic losses, some will leave the industry. The supply of the product will
thus decrease and this will cause the price to increase. As the price increases, the losses will
decrease and this process will continue until normal profit is earned.

When normal profit is earned, there will be no incentive for existing firms to leave the industry, or for
new firms to enter the industry and equilibrium will thus exist.

6. Use diagrams to illustrate the fact that perfectly competitive firms are price takers. How are prices
determined in perfectly competitive markets?

Prices are determined by the interaction of demand and supply, as illustrated in the first part of
Figure 10-2 on page 169 of the textbook. Once the price has been determined, an individual firm can
only decide how much to produce at that price. A perfectly competitive firm is a price taker and has
no control over the price of its product. This is illustrated in the second part of Figure 10-2 by the

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horizontal demand curve facing the firm.

7. What is the point of studying perfect competition if it does not exist, or exists only very rarely, in the
real world?

Four reasons are provided in the textbook on page 168. These reasons may be summarised as
follows:

We may apply our knowledge to markets where many of the requirements for perfect competition
are met.
It is a useful starting point for analysing markets.
It serves as a basis or standard against which other markets may be compared.

If we know how perfectly competitive markets work, we can use that knowledge to analyse other
markets.

UNIT 8

1. What are the main differences between monopoly and oligopoly?

In the case of monopoly there is only one supplier, while an oligopoly refers to a situation where
there are a few large suppliers (but more than one). Monopoly also requires perfect knowledge,
while oligopoly is characterised by imperfect knowledge. See also Table 10-1 on page 164 of the
textbook.

2. Give three examples of oligopolistic markets in South Africa.

The banking sector, the retail sector (supermarkets), the cellular phone industry, the motor industry,
the cement industry, the fuel industry and many more. See also Table 11-2 on page 205 of the
textbook.

3. Give South African examples of:

a. Monopoly.
b. Monopolistic competition.
c. Oligopoly.

a. Few, if any, pure monopolies. Eskom, Transnet, Rand Water, local monopolies.
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b. Many examples: clothing and footwear, household furniture, restaurants and many other
industries.
c. Many examples: banking, cellular phones, large retailing, motor manufacturing, cement, fuel and
many others.

See Table 11-2 on page 205 of textbook.

4. Use a diagram to illustrate the equilibrium position of a monopolistic firm. Clearly indicate the
economic profit or loss.

The answer is illustrated clearly in Figure 11-2 on page 184 of the textbook. See also the
accompanying discussion.

5. In its pure form, monopoly is a market structure in which there is only one seller of a good or
service that has no close substitutes. Another requirement is that entry to the market should be
completely blocked. The single seller is called a monopolist and the firm is called a monopoly.

Characteristics of a monopoly:

1. There is only one producer.

2. There are no close substitutes for the product.
3. There are barriers to entry into the industry.

Natural Monopoly: A monopoly comes about because of economic or geographic reasons, e.g.,
high development costs, exclusive ownership of raw materials, or only one firm can serve a market
efficiently.

Artificial Monopoly: The barriers to entry are not economic factors. An example is a patent
whereby the firm has the sole right legally to produce the good. Another example is a licence to
operate as the only supplier.

Although the monopolist has considerable power, market forces influence production and sale of the
product.

UNIT 9

1. List three factors which may cause an increase in the market supply of labour in the clothing
industry.
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An increase in the population; an increase in immigration; a decrease in the wages paid by other
industries; an improvement in working conditions in the clothing industry.

2. Explain the relationship between the marginal product of labour and the marginal revenue product
of labour.

The marginal product of labour (or the marginal physical product) is a physical concept, which
relates to the quantity of output produced by an additional worker. The marginal revenue product is a
monetary concept, which indicates the monetary value of the output produced by an additional
worker. It is obtained by multiplying the marginal physical product by the price of the product: MRP =
MPP x P.

3. Use a diagram to explain the impact of the imposition of a minimum wage above the equilibrium
wage in a perfectly competitive labour market.

If a minimum wage is imposed above the equilibrium wage in a perfectly competitive labour market,
there will be an excess supply of labour (i.e. unemployment). In the diagram below, the equilibrium
wage rate (determined by demand DD and supply SS) is P0. If a minimum wage of P1 is imposed
above the equilibrium wage, there will be an excess supply of labour equal to the difference between
an and b: 0b workers will be supplied, but only 0a will be demanded and employed at a wage rate
P1. There will thus be unemployment equal to the difference between a and b.

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Figure 9.8

4. The individual supply of labour

People need income to pay their bills, but they also need a sense of achievement. As a
consequence, people are willing to work – to supply labour. The determinants of labour supply
include tastes (for leisure, income and work); income and wealth; expectations (for income or
consumption); prices of consumer goods and taxes. There is an opportunity cost involved in working
– namely, the amount of leisure time one sacrifices. By the same token, the opportunity cost of not
working (leisure) is the income and related consumption possibilities thereby forgone. Everyone
confronts a trade-off between leisure and income, Mohr (2015).

Higher wage rates induce people to work more, that is, to substitute labour for leisure. However, this
substitution effect may be offset by an income effect. Higher wages also enable a person to work
fewer hours with no loss of income. When income effects outweigh substitution effects, the labour
supply curve bends backward, as illustrated in the Figure below.

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Figure 66

5. The market supply of labour

Market supply of labour for a particular vocation depends upon:

a. The number of qualified people

For example, the number of qualified accountants is low, therefore supply is quite inelastic. For a job
such as fast food operator, the number of potentially qualified people is a high percentage of the
labour force, therefore supply is much more elastic

?b. Difficulty of getting qualifications

If it is difficult to get particular qualifications, supply will be inelastic. For example, even if wages of
economics teachers rose, the supply would be quite inelastic – to become qualified would take
several years.

c. The non-wage benefits of a job

Unpleasant jobs will have fewer people willing to do them therefore supply will be relatively lower.
Although many unpleasant jobs, such as cleaning are relatively low-skilled so may still be low paid.

d. The wages and conditions of other jobs

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If many jobs in a local area are considered unpleasant – e.g. fruit pickers, then the supply of
alternatives will be relatively higher.

e. Demographic changes and immigration

Some jobs, such as fruit picking are unpopular with native-born workers and rely on immigrant
labour. If immigration slows down, there can be vacancies in these particular jobs. Post-Brexit vote,
farmers reported difficulty in filling labour vacancies due to a slowdown in immigration.

UNIT 10

Examples of government failure include:

“Government can award subsidies to firms, but this may protect inefficient firms from competition
and create barriers to entry for new firms because prices are kept ‘artificially’ low. Subsidies, and
other assistance, can lead to the problem of moral hazard.
Taxes on goods and services can raise prices artificially and distort the efficient operation of the
market. In addition, taxes on incomes can create a disincentive effect and discourage individuals
from working hard.
Governments can also fix prices, such as minimum and maximum prices, but this can create
distortions which lead to:
Shortages, which may arise when government fixes price below the market rate. Because
public healthcare is provided free at the point of consumption there will be long waiting lists for
treatment.
Surpluses, which may arise when government fixes prices above the natural market rate, as
supply will exceed demand. For example, guaranteeing farmers a high price encourages
over-production and wasteful surpluses. Setting a ‘minimum wage’ is likely to create an
excess of supply of labour in markets where the ‘market clearing equilibrium’ is less than the
minimum.
Information failure is also an issue for governments, given that government does not necessarily
‘know’ enough to enable it to make effective decisions about the best way to allocate scarce
resources. Many economists believe in the efficient market hypothesis, which assumes that the
market will always contain more information than any individual or government. The implication is
that market prices and market movements should be free from interference because markets
cannot be improved upon by individuals or governments.
Excessive bureaucracy is also a potential government failure. This is caused by the public sector
when it tries to solve the principal-agent problem. Government must appoint bureaucrats to
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ensure that its objectives are pursued by the managers of public sector organisations, such as
the NHS.
Finally, there is the problem of moral hazard associated with the payment of welfare benefits. If
individuals know that the state will provide unemployment benefit, or free treatment for their poor
health, they are less likely to take steps to improve their employability, or to avoid activities which
prevent poor health, such smoking, a poor diet, or lack of exercise” Economics online (2018).

2. List the four main components of the government or public sector in South Africa.

National government, provincial government, local government, public corporations.

3. Give three valid reasons for government intervention in the economy.

To correct market failure (that is, where markets do not produce efficient outcomes). To try to achieve
equitable outcomes (something markets are not very good at). To achieve macroeconomic stability
(given the tendency of markets to create instability).

4. Define nationalisation and privatisation.

Nationalisation is the transfer of ownership from private enterprise to government (with or without
compensation). Privatisation is the opposite, namely the transfer of ownership of assets from the
public sector to the private sector. Modern examples in South Africa include the full or partial
privatisation of Sasol, Iscor and Telkom.

5. Give three reasons for the increase in government spending in South Africa since the 1960s.

See the discussion on pages 290-291 of the textbook. Among the important reasons were increases
in military and other security spending prior to the political transformation in 1994, sharp increases in
social spending (e.g. on education, health, housing and welfare payments) prior to and after the
political transformation, population growth and urbanisation.

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