Study Guide

ECON 112 VEC
INTRODUCTION TO MICRO ECONOMICS

Faculty of Economic & Management Sciences
Study guide compiled by:

Copyright © 2018 edition. Review date 2018.
North-West University
No part of this document may be reproduced in any form or in any way without the written permission of the publishers.
MODULE CONTENTS
Module information ......................................................................................................................... iii
Word of welcome ............................................................................................................................ iii
Module outcomes............................................................................................................................ iii
How to study the contents ............................................................................................................... iii
How to use the study guide .............................................................................................................iv
The contact lecture sessions ........................................................................................................... v
Study action words.......................................................................................................................... v
Prerequisites ................................................................................................................................. viii
Prescribed material ....................................................................................................................... viii
Work program .................................................................................................................................ix
Icons ...............................................................................................................................................ix
Warning against plagiarism ............................................................................................................. x
Study unit 1 First Encounter with Economics ................................................................. 1

Study section 1.1 What is economics? ........................................................................................ 3
1.1.1 Scarcity and opportunity cost .......................................................................... 4
1.1.2 The production possibility curve ...................................................................... 7
1.1.3 Economics as a science .................................................................................. 9
1.1.4 The place of economics in God’s creation ..................................................... 10
1.1.5 Positive and normative economics ................................................................ 11
1.1.6 Common mistakes in economic reasoning .................................................... 11
Study section 1.2 The Economic Problem, Economic Systems and Pioneers ........................... 14
1.2.1 The basic economic problem ........................................................................ 15
1.2.2 Factors of production .................................................................................... 16
1.2.3 Economic systems ........................................................................................ 16
1.2.4 Important pioneers in economics................................................................... 18
Study section 1.3 The Economic Circular Flow Model ............................................................... 20
1.3.1 Production, income and expenditure ............................................................. 20
1.3.2 Interdependence of households and firms ..................................................... 21
1.3.3 The public sector ........................................................................................... 21
1.3.4 The foreign sector ......................................................................................... 22
1.3.5 The role of financial institutions ..................................................................... 22
Study unit 2 Equipment of the economist, demand and supply .................................. 25

Study section 2.1 Demand and supply ...................................................................................... 26
2.1.1 The law of demand........................................................................................ 27
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2.1.2 Supply in the economy .................................................................................. 30
2.1.3 Equilibrium between supply and demand ...................................................... 31
2.1.4 Consumer and producer surplus ................................................................... 36
Study section 2.2 Demand and Supply in Action ....................................................................... 39
2.2.1 Movement of demand and supply ................................................................. 40
2.2.2 Simultaneous changes in demand and supply .............................................. 42
2.2.3 Interaction between related markets.............................................................. 43
2.2.4 Price setting by the government .................................................................... 44
Study unit 3 Elasticity ..................................................................................................... 47

3.1.1 Elasticity of demand ...................................................................................... 48
3.1.2 Other demand elasticities .............................................................................. 52
3.1.3 Price elasticity of supply ................................................................................ 55
Study unit 4 Theory of consumption ............................................................................. 61

4.1.1 Total utility and marginal utility ...................................................................... 62
4.1.2 Consumer equilibrium ................................................................................... 65
4.1.3 Derivation of the consumer's demand curve .................................................. 69
Study unit 5 Theory of production and market structures ........................................... 72

Study section 5.1 Theory of production ..................................................................................... 75
5.1.1 Marginal revenue, production and profit ........................................................ 75
5.1.2 The production function ................................................................................. 79
5.1.3 Cost functions ............................................................................................... 81
5.1.4 Production in the long-run ............................................................................. 85
Study section 5.2 Perfect Competition....................................................................................... 88
5.2.1 Perfect concurrence ...................................................................................... 89
5.2.2 Production equilibrium under perfect competition .......................................... 90
5.2.3 Supply curve of the producer ........................................................................ 93
5.2.4 Long-term equilibrium ................................................................................... 95
Study section 5.3 Monopoly and Imperfect Competition ............................................................ 96
5.3.1 Monopoly and other imperfect market forms ................................................. 97
5.3.2 Profit-maximisation of a monopoly ................................................................ 97
5.3.3 Price discrimination and elasticity .................................................................. 99
5.3.4 Natural monopolies ..................................................................................... 100
5.3.5 Comparison between perfect competition and monopoly ............................ 100
5.3.6 The merits of monopolies and competition policy ........................................ 100
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Module information
Module code ECON 112
Module Credits
Module name Introduction to micro economics
Name of lecturer(s)
Office telephone
Email address
Building and Office nr
Consulting hours
Word of welcome
Welcome to the wonderful world of Economics! Welcome also to this module in
Economics, this is going to set you on track to become literate in economics in no time!
The aim of the module is to introduce you to Economics and to provide you with an
insight into the functioning, composition and interdependence of the distinguishable
decision-makers and sectors in the economy.
Module outcomes
After completion of this module, you as the learner should be able to:
 understand the basic functioning of the economy and know its various
components
 demonstrate an understanding of the economic problem and how different
economic systems try to solve it
 demonstrate an analysis of the behaviour of the principal economic agents such
as consumers and producers
 explain different market structures
 apply the above outcomes to the South African situation
 participate effectively in groups
 distinguish positive economics from normative economics and identify unethical
behaviour in an economic system and its related activities
How to study the contents

Your success in Economics 111 depends on your inputs, through active self-study.
Your self-study will be guided with the use of this study guide. The study guide will give
you enough information and directions to pass this module successfully. Independent
study and preparation of the learning material before each lecture are both essential.
There is however a vast difference between the reading of economic texts and studying
and understanding economics. The aim of this module is not only to inform you about
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the economy, but also to enable you to use economics to analyse and address
economic problems.
When you study economics, you need to learn actively. Reading is not enough. You
will need to question and analyse the text critically and evaluate yourself with self-
testing and assignments, on a regular basis. Each step in any economic analysis must
be understood. Regularly ask "why?" between the different steps. If a curve has a
certain slope in a certain manner, ask "why?" Do not merely memorise, but ensure that
you also understand the work. Make it a game. For instance, when a graph shows what
happens when government expenditure expands, try to sketch a graph in which it
declines and determine what the results are going to be. When an equation is used in
the work, make your own calculation and try to apply it. Also, try to establish where the
subsection fits into the entire picture. At the end, you need to ask yourself what have
you learnt and how does it link up with the rest of the total module material.
The organisational information is set out on the first few pages, and the module
material follows later. You will need to buy the prescribed textbook, because the
module material is not incorporated into this study guide.
Icons are used throughout the study guide to lead you through the self-study process.
At the beginning of each Study unit the icons will for instance indicate that you will first
have to do preparation by reading a section of the textbook, then complete any
required assignments/case studies and attend the lecture sessions according to the
schedule. While working through the module material, icons will indicate when to test
your current knowledge, do individual work; participate in group-discussions and
complete any assignments/ case studies. In order to pass this module you will have to
complete all these required actions. Make sure therefore, that you know the meaning of
the different icons as well as what is expected from you.
The module material is structured into six Study units. Each Study unit covers certain
economic topics and consists out of different study sections. Each Study unit contains
assignments and other requirements, which will be announced during the contact
lecture sessions.
Before each of the lecture sessions you will have to-

 complete all the preparation of the Study unit, and
 complete the individual exercises, any assignment(s) and/or case studies that
may be required.
Try to study some of this module every day. A little bit of work, each day has much
more value than a crash course the night before a test. (It just does not work that way
and you will be sure to fail!) Remember this is one year past matric and you are
supposed to work just that extra bit harder.
How to use the study guide

 The following steps can be identified when working through the contents of a
Study unit:
 Read the Study unit outcomes and understand how the study section deals with
the Study unit outcomes
 Start with the first study section of the Study unit by reading its’ relevant goal,
structure and study outcomes
 Read through the text of the study section and complete any current knowledge
evaluations
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 Read the summary to obtain an overview
 In the case of uncertainty, consult the suggested readings
 Try to find definitions for all the important concepts – this is a first year level
module!
 Evaluate yourself by completing any self-evaluation /self-reflecting questions and
individual exercises given. These help you to apply your new knowledge.
 Follow the same steps for each of the study sections in the Study unit
 Complete any assignment(s) and case studies relevant to the Study unit and
hand it in during class on the due date
The contact lecture sessions

The contact lecture sessions will not give a verbatim account of the theory of the
subject during lectures. Most of the material is put to you in such a way that you will be
able to master it with the assistance of the study guide. The section of the learning
material, which may create problems, will be discussed during lectures. The lecture
sessions will also give a more detailed discussion on the results of any assignments /
evaluations / changes to the contents of the material and actual happenings in the real
world. It is therefore necessary that you do the preparation and / or any assignments
that might be required.
Write down the following information in connection with your lecturer,
when you receive it in class:
Name of lecturer: _______________________________________________________
Office number: _________________________________________________________
Telephone number: _____________________________________________________
Consulting hours: _______________________________________________________
Venue of lectures (room-number): __________________________________________
Contact sessions: ______________________________________________________
Study action words

These action verbs are included to provide clarity of what is expected of you as a
student when writing tests, exams or doing assignments. Please study them and make
sure that you understand the exact meaning of each.
 Analyse:
Identify parts or elements of a concept and describe them one by one.
EXAMPLE: Analyse a typical free market economic system and describe each aspect
of the structure in detail
 Compare
Point out the similarities (things that are the same) and the differences between
objects, ideas or points of view. The word "contrast" can also be used. When you
compare two or more objects, you should do so systematically - completing one aspect
at a time. It is always better to do this in your own words.
EXAMPLE: Compare the Monetary and Fiscal policy views about the rate of economic
growth
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 Criticise
This means that you should indicate whether you agree or disagree about a certain
statement or view. You should then describe what you agree or disagree with and give
reasons for your view (motivate!).
EXAMPLE: Write critical comments about the impact of a change in the nominal stock
of money upon real output and the price level in the economy
 Define
Give the precise meaning of something, very often definitions have to be memorised
word for word. Definitions are formal phrasings of theoretical concepts and form the
base of any science.
EXAMPLE: Define the aggregate demand schedule
 Demonstrate
Include and discuss examples. You have to prove that you understand how a process
works or how a concept is applied in real-life situations.
EXAMPLE: Give a written demonstration of the application of full employment in the
market for labour services.
 Describe
Say exactly what something is like; give an account of the characteristics or nature of
something; explain how something works. No opinion or argument is needed.
EXAMPLE: Describe the characteristics of the equation for commodity equilibrium.
 Discuss
Comment on something in your own words. It often requires debating two or more
viewpoints or possibilities.
EXAMPLE: Discuss the differences between the interest elastic and interest inelastic
demand for money
 Distinguish
Point out the differences between objects, different ideas, or points of view.
EXAMPLE: Distinguish between the supply of labour and the demand of labour.
 Essay
An extensive description of a topic is required.
EXAMPLE: Write an essay about the effect that shifts in the IS and LM schedules will
have upon the equilibrium level of income
 Example
A practical illustration of a concept is required.
EXAMPLE: Give an example of Keynes' formulation of the speculative demand for
money in practice.
 Explain
Clarify or give reasons for something, usually in your own words. You must prove that
you understand the content. It may be useful to use examples or illustrations.
EXAMPLE: Briefly explain the creation of demand deposit money.
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 Identify
Give the essential characteristics or aspects of a phenomenon e.g. a good research
design.
EXAMPLE: Identify the characteristics in new housing investment that are believed to
be inversely related to the rate of interest.
 Illustrate
Draw a diagram, or graph that represents a phenomenon or idea or theory.
EXAMPLE: Explain the theory of investment demand. Write a short essay and illustrate
this theory or model.
 List
Simply provide a list of names, facts or items asked for. A particular category or order
may be specified.
EXAMPLE: List the successive steps to compute the present value of a future sum of
money.
 Motivate
You should explain the reasons for your statements or views. You should try to
convince the reader of your view.
EXAMPLE: Write an essay about the Post-war theories of consumption demand. You
should motivate your points of view.
 Name or mention
Briefly describe without giving details.
EXAMPLE: Name three types of income theories in Macro-economics.
 Outline
Emphasize the major features, structures or general principles of a topic, omitting
minor details. Slightly more detail than in the case of naming, listing or stating of
information is required. (List and briefly describe)
EXAMPLE: Outline the major features of consumption and disposable income.
 State
Supply the required information without discussing it.
EXAMPLE: State the major objective functions affecting the aggregate consumption
function.
 Summarise
Give a structured overview of the key (most important) aspects of a topic; it must
always be done in your own words.
EXAMPLE: Give a summary of the core characteristics of the spending and savings
functions and the effect it has upon the value of the expenditure multiplier.
 Formulate
To set forth systematically.
EXAMPLE: Formulate the marginal propensity to consume in Macro-economics.
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Prerequisites
A calculator (be cautious not to get a too complicated calculator that you do not know
how to use. Also take note that you will not be allowed to use the calculator on your cell
phone during tests) A calculator that can convert fractions to decimals is suggested.
Economics as school subject is not a prerequisite to achieve success in this course.
Some of your lecturers did not take Economics at school either. All you need is:
An open mind & enthusiasm for your studies!
Prescribed material
 MOHR, F. & FOURIE, L. 2015. Economics for South African students. Pretoria:
Van Schaik.
 VAN WALBEEK, C., KRUGELL, W. & SAMOUILHAN, N. South African workbook
for Economics. Pretoria: Van Schaik.
Additional Material
If you want to find out more about the issues in this module, you can consult the
following additional resources:
1. BURNINGHAM, D. Economics. Teach Yourself Books. London: Hodder &
Stoughton.
2. LIPSEY, R.G. 1978. An introduction to Positive Economics. London: Weidenfeld
& Nicolson. [An excellent work. Early editions are easier].
3. MANKIW, N.G. Principles of Economics. Fort Worth: Harcourt. [A very excellent
and beautiful book].
4. STAPELBERG, N.H. & STEYN, F.G. Economics: An introductory study. Pretoria:
N.H.S. Publishers. Chapter 8.
5. THOMPSON, S.P. Calculus made easy. [Library: 515 THO] [probably the best
introduction to differentiation and integration ever written].
6. VIVIERS, W; VAN DER MERWE, S.J. & LOTRIET, R.A. 2003. The Mechanics of
the South African Economy. Orkney Printers. [Was distributed by Prof. R.A.
Lotriet: tel. (018) 299 1200].
7. WHITEHEAD, G. Economics Made Simple. London: Heinemann.
Handy Websites:
1. Development Bank of SA; see: http://www.dbsa.org
2. SA Government information; see: http://www.polity.org.za/
3. Statistics South Africa, see: http://www.statssa.gov.za/
4. SA Local Government Association (SALGA) – see: http://www.salga.net/
5. SA Revenue service (receiver - SARS), see: http://www.sars.gov.za/
6. Financial and Fiscal Commission, see: http://www.ffc.co.za/
7. The SA Reserve Bank, see: http://www.reservebank.co.za/
8. National Treasury, see: http://www.treasury.gov.za/ .
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9. Infrastructure Financiering Corporation Limited see http://www.inca.co.za/
10. IDASA; see: http://www.idasa.org.za/
11. The government http://www.gov.za/ [with handy link to government departments]
12. Industrial Development Corporation (IDC): http://www.idc.co.za/
Work program
Planned date of Actual
Week ending Study unit/ Section
completion completion date
Icons
Time allocation Learning outcomes
Assessment /
Study material
Assignments
Individual exercise Group Activity
Example Reflection
ix
Warning against plagiarism
ASSIGNMENTS ARE INDIVIDUAL TASKS AND NOT GROUP ACTIVITIES.
(UNLESS EXPLICITLY INDICATED AS GROUP ACTIVITIES)
Copying of text from other learners or from other sources (for instance the study guide,
prescribed material or directly from the internet) is not allowed – only brief quotations
are allowed and then only if indicated as such.
You should reformulate existing text and use your own words to explain what you
have read. It is not acceptable to retype existing text and just acknowledge the source
in a footnote – you should be able to relate the idea or concept, without repeating the
original author to the letter.
The aim of the assignments is not the reproduction of existing material, but to ascertain
whether you have the ability to integrate existing texts, add your own interpretation
and/or critique of the texts and offer a creative solution to existing problems.
Be warned: students who submit copied text will obtain a mark of zero for the
assignment and disciplinary steps may be taken by the Faculty and/or
University. It is also unacceptable to do somebody else’s work, to lend your work
to them or to make your work available to them to copy – be careful and do not
make your work available to anyone!
For the NWU link for plagiarism, go to http://www.nwu.ac.za/webfm_send/25355
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Study unit 1
Study unit 1
FIRST ENCOUNTER WITH ECONOMICS
Study time
The time scheduled for this Study unit is approximately 12 hours
Study material
This Study unit is based on the textbook:
MOHR, F. & FOURIE, L. Chapters 1, 2 and 3.
Study outcomes
At the end of this Study unit you as the learner should be able to:
 demonstrate a sound knowledge of the economic problem and how it is
experienced by the different participants in an economy
 demonstrate an understanding of the different ways in which societies can
solve the economic problem through economic systems
 Identify ethical issues in economics in general and in economic systems in
particular.
 You should go through the learning outcomes given at the start of the relevant
chapter in the textbook when starting each new study section and verify that
you achieve them all.
Introductory statements
You may never have studied economics before, and yet when one opens a newspaper
one sees reports on taxes, interest rates or on the high level of poverty in our country.
Turn on the television news and you see items on the state of the economy, strikes
over wage disputes and the fiscal budget. Talk to friends and often the topic will turn to
the high level of prices, employment and investments.
The fact is that economics affects our daily lives. We are always being made aware of
local, national and international economic problems, and are continually faced with
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Study unit 1
economic problems and decisions of our own. So just what is economics about? Many
people think that economics is about money. Well, to some extent it is true. Economics
has to do with money, but despite the large role money plays in our lives, economics is
more than just the study of money. In this Study unit it will be determined what the
crucial ingredient is for a problem to be an economic one. The answer is that there is
one central problem faced by all individuals and all societies. All the other economic
problems stem from this one problem that we shall concentrate on throughout the
course.
The subject of Economics is about the art of making the most out of life. People have
an unlimited number of needs, desires and wishes, but there are never enough
resources, means or time. Not all human needs can therefore be fulfilled and choices
have to be made. Some needs and desires will be met while others will not be met.
Resources therefore have to be allocated in such a way that one will be able to meet
most of the needs that prevail. Economics is thus concerned with the best utilisation of
the resources that one has in order to reach the greatest number of objectives.
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Study unit 1
Study section 1.1

What is economics?
Study time
The time scheduled for this study section is approximately 4 hours
Study material
This study section is based on the textbook: MOHR, F. & FOURIE, L. Chapter 1.
It is important to read the accompanying Boxes in each chapter as it renders
additional assistance, insight and background information. In chapter 1 Box 1-3 is
very important. The other Boxes may be read through if you wish. (You may leave
Box 1.1)
Study outcomes
At the end of this study section you as the learner should be able to:
 discuss what the economic problem entails
 describe the different participants in the economy and how they interact
 give a detailed definition of economics
 discuss the elements of economics (scarce resources, unlimited needs and
economic application)
 define and distinguish between a social science and a natural science
 describe economics as a science with its problems and how to overcome these
problems
 name the value of economic studies
 apply a production possibilities schedule
 explain opportunity cost using production possibility graphs
 know all relevant concepts
 note the specific learning outcomes stated at the start of Chapter 1 of the
textbook.
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Study unit 1
Have you ever wondered about the following?
 What problem does the study of economics try to solve?
 Which institutions and people have to face up to this economic problem?
 What methods do economists use to practice the science of economics. How
does economics differ from other sciences?
 What is the value to me of studying economics?
This first section of your economics study will try to give answers to these questions.
Important information
DEFINITION: Economics is a social science that focuses on the optimal allocation
of limited and scares resources to obtain the most or highest level of
needs satisfaction of a society’s infinite needs.
1.1.1 Scarcity and opportunity cost

The central problem of economics can be summarised in one word: scarcity. You
might argue that we do not have rationing or empty shops. We rarely have to queue for
things, or order things a long time in advance. You might further argue that economics,
when dealing with scarcity, only has application in poor and lesser-developed societies.
However, despite these objections, economists still argue that scarcity is the central
economic problem, not only in Ethiopia, Sudan and South Africa, but also in the USA
and Switzerland.
Scarcity affects all of us. Take for instance your salary or income. What is your monthly
income? Compare this income now with the costs involved in satisfying all your
material needs/wants. Do you have enough money? I am sure that all of you would
agree that our income is not enough to satisfy all our needs. We will have to make
choices as to how to spend our scarce income optimally. Now this is economics!
Do you now understand that all of us have to deal with the scarcity problem and
therefore also with the problem of economics? The scarcity problem is not only related
to money. Take “time”, for instance. We all want to do many things in one day such as
work, eat, gym, relax at the movies, study, sleep, etc. There are, however, just twenty-
four hours in a day. Time is therefore scarce and we must make an optimal allocation
choice with regard to the way we are going to spend our day. The study of economics
will help us make the most of our scarce and limited resources. We can therefore agree
with George Bernard Shaw who said:
“Economy is the art of making the most out of life”.
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Study unit 1
Individual activity
Can you identify other aspects of life that will benefit from a study in economics?
Write down some other resources. Determine whether or not they are scarce and
why.
RESOURCE IS IT SCARCE? WHY?
Take the answers with you to the contact session (in other words: Take it to class).
Individual activity
In the discussion above regarding the scarcity of income and time, it was clear that
income and time are scarce resources-
 But what are resources?
 Do you agree that production factors are scarce? Think of natural resources.
Write those down that you can think of.
It is clear that the stocks of trees and minerals are limited. The amount of machinery
and tools is also limited. Labour is also limited. We have a scarcity in highly educated
workers in our country. Entrepreneurs are also scarce. People are afraid to take risks
and start new business ventures. That is why there are not many Sol Kerzners and
Anton Ruperts in a country.
If production factors are scarce, and production factors are used to produce products, it
is logical that products are also scarce.
Study the following attentively

Scarcity would not have been a problem if we did not need products. In the absence of
a need for products, the production of products would have been irrelevant. If we, for
instance, did not need food to survive, the production of food and the scarcity of food
production factors would not be an issue. We therefore have to examine people’s
needs.
Individual activity
Write down a few of your material needs on a piece of paper. Supply a product that
will satisfy each of the specific needs. Try to classify these needs into different
groups.
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Study unit 1
Answers
Did you get the same groups from your classification as the other students?
The first group of needs are individual needs. The second group of needs are
collective needs. No person can consume such a product or service individually.
Take the answers with you to the contact session for discussion.
The scope of man’s needs depends on the economic level of development.
Individual activity
 But how does a person’s needs develop? Does the need ‘package’ of a person
in Rwanda differ from that of a person in the United Kingdom?
 Would we ever get to a point where all our needs are satisfied?
It is undoubtedly true that some needs are not satisfied completely in a less-developed
country like Africa, for example. As a person gets richer, he/she will not be satisfied
with the basic diet of vegetables and the water needed to sustain life. We know that the
rich love savouring exotic foods in a stylish atmosphere. People that are more affluent
will not be satisfied by a lean-to shelter that provides the minimum protection from the
elements. A big mansion will be much more essential. A basic minimum wardrobe
needed to protect one from the cold will not be suitable either. The fashion of the
season will be more important.
The human species will therefore never get to a point of full need satisfaction.
The optimal allocation of limited resources is the root of the economic problem.
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Study unit 1
Example
Suppose a baker has a limited amount of ingredients. With these ingredients, he can
bake either a pizza or a pie. If he allocates the baking ingredients according to the
pizza recipe, a pizza will be the final product. When the ingredients are allocated to
bake a pie, a pie will be the final product. The baker’s ingredients, however, are
limited and he can only make one of these tasty treats. He will therefore have to
make a choice.
To make such a decision as the baker or the student, you should determine the
relative importance of every need in your life. What need is the greatest - food,
clothes, relaxation or all your other needs? The baker had to determine what he
would like most, a pizza or a pie. The student had to decide the most important need
at that time, to study or to go to the movies. You will have to place all your needs
within a hierarchy of importance. If you were the baker and you like pizza more than
pies, pizza will be higher in your hierarchy of importance.
The definition of ECONOMICS is about:
 Scares Resources
 Unlimited number of needs and
 The optimal allocation of those scarce resources to satisfy the most of those
needs.
1.1.2 The production possibility curve

In making optimal allocation choices all the costs and advantages have to be taken into
account.
One realizes when choosing one’s option that one will be losing the advantage of the
other. This is a cost associated with every choice. If the baker chooses a pizza, he will
lose the good taste of a pie. If the student chooses to study, he will lose the
entertainment value and relaxation of a movie. Can you identify a cost factor in every
choice? The opportunity cost of going to the movies will be two-and-a-half hours of
study time lost. The opportunity cost of choosing a pizza instead of a pie would be the
pie.
Example
Let’s consider another example to explain the concept of opportunity cost: If the
workers on a farm can produce either 1000 tons of wheat or 2000 tons of maize, then
the opportunity cost of producing 1 ton of wheat is the 2 tons of maize foregone. The
opportunity cost of buying a textbook is the new pair of jeans you wanted that you
have to forfeit. The opportunity cost of working over-time is the leisure you have
sacrificed.
Consider the following problem that deals with opportunity cost. Any individual working
in their own business should take into account the cost of their labour time spent in the
business. A self-employed sole trader might draw up an income statement and find a
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Study unit 1
profit of R20000 per month, and conclude that this business was a good thing.
However, this conclusion neglects the opportunity cost of the individual’s labour, the
money he could have earned working elsewhere. If that individual could have earned a
salary of R25000 per month working for someone else, being self-employed actually
means losing the person R5000 per month even though the business is making an
accounting profit of R20000. The opportunity cost of earning an income of R20000 in
self-employment will then be a R25000 salary earned in employment.
Individual activity
1. Suppose a friend who operates a store has asked you to analyze her business.
Her breakdown of costs seems to confirm her view that she has a good thing
going. With revenue of R102000 and costs of R74000, she is earning an
accounting profit of R28000. But you dig deeper. You discover that she could
earn a salary of R24000 by accepting a job from an insurance company. When
considering the opportunity cost, is it worthwhile for her to have her own
business? Motivate your answer!
2. A typical problem all governments face is to choose between military
expenditure and social expenditure. Suppose the government of Nambabwe
has a choice to use its production factors either to build houses or to produce
guns. To simplify the exercise, let us assume that Nambabwe is a country
without any machines, only labour. There are a thousand labourers. What
possibilities do they have between the production of guns and houses? The
table shows the different production possibilities. Try to calculate the
opportunity cost of each possibility and complete the table.
3. Now try to draw the production possibility curve from the table.
4. What will be the case if we produce at G?

5. How many of each product will we produce at H? Will it be possible for
Nambabwe to produce this amount of guns and houses?
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6. The government of South Africa is currently faced with the following problem: The
disadvantaged communities demand different collective goods and services to
fulfil their basic needs. Think of housing, water, sanitation and roads. On the
other hand, we find that the tax income of the government is relatively small.
Individuals and businesses are already over-taxed. Do you think that the
government is facing an economic problem? Use the different elements of the
economic problem to answer this question.
Take the answers with you to the contact session.
1.1.3 Economics as a science

Economists assert that they are busy with a science. Do you think this scarcity problem
is a science such as physics and chemistry? Well, let’s find out. To answer this
question we must first determine what a science is.
Individual activity
 What makes Economics different from natural sciences like Chemistry or
Physics?
 What problems do the social components of Economics present to the study
thereof?
 Why can it be said that Economics is an empirical science and what are the
implications thereof?
Deduction means the following: using a theory to draw conclusions about specific
circumstances. If we have a theory that states that demand will increase when prices
fall, the following can be concluded deductively: If car prices increase, the demand for
cars will decrease. On the other hand, induction is when conclusions or laws are
derived from experiments or experience.
Individual activity
Can we control people like chemicals in an experiment?
Why, do you think, can economics be called a science?
Individual activity
1. List the number of factors that you will have to take into account when
determining the relationship between the bread price and bread sales.
2. Give examples that illustrate the difference between Micro-economics and
Macro-economics.
Take the answers with you to the contact session for discussion
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Study unit 1
Individual activity
Which of the following are Macro-economic issues, which are Micro-economic ones
and which could be either, depending on the context?
MICRO- MACRO-
STATEMENT
ECONOMIC ECONOMIC
Inflation
Low wages in certain service industries
The rate of exchange between the South African
Rand and the USA Dollar
Why does the price of cabbages fluctuate more than
the price of cars?
The rate of economic growth this year compared with
last year
The decline of traditional manufacturing industries
1.1.4 The place of economics in God’s creation

God created the earth and the universe. Rom. 12:26 states: “For of him, and through
him, and to him, are all things”. Everything that God created is good. Why is that the
case? God also appointed humans as guardians over His creation to develop and
protect it.
Individual activity
 The earth was created perfectly and yet there exists a problem of scarcity. How
can one explain that? What role does the Fall of Man into sin and the salvation
by Jesus Christ play in this?
 Where does man and his needs fit into the entire creation?
 People have to ensure that wastages, damage and exploitation do not occur.
However, how does one decide what is right and what is wrong?
 Is the religious function decisive for all the other modalities? In which way will it
influence an ethical point of view?
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1.1.5 Positive and normative economics
Study material
Study section 1.2 in the textbook of Mohr & Fourie, which discusses positive and
normative economics, as well as the section on why economists disagree.

One cannot avoid being influenced by one’s preconceived notions in one’s daily
activities. When one decides which actions in the economic world are ethical, one is
dealing with normative economics. You will learn more about that in Business Ethics. In
Economics one aims to study the hard facts objectively, and tries not to be influenced
by one’s own value judgements. This is called positive economics. Such a treatment of
science is of course impossible because your own subconscious preconceived notions,
beliefs, life and worldview always colours the way in which one looks at the world. One
always tries to prevent one’s own value judgements to manipulate scientific results to
suits one’s beliefs, because this could lead to incorrect results. One wishes to stand
objective and neutral to determine what the real facts are. It must however be admitted
that we practice science from a Christian perspective because no one can free him or
herself totally from his or her own preconceived ideas and beliefs.
Individual activity
 What is the difference between normative and positive economics?
 Are ethical issues important in the world of business?
 Are ethical issues important when you are only harming yourself?
 Are normative issues important to ensure sustainable economic growth and
development of a country and the world?
 What other aspects cause economists to differ?
1.1.6 Common mistakes in economic reasoning

Prejudice might lead to a blinkered or biased approach to the subject causing faulty
reasoning. Mistakes can also occur when arguments are not conducted logically, or
when there are faults in the structure of the analysis. People might for instance reason
in circles or contradict themselves. The fallacy of composition where the same results
are added more than once, for instance, should be avoided. Often several events
happen at the same time and people then assume that there is a correlation between
them; or that one event caused another while no causal relationship actually exists, or
the direction of causality is in the other direction. Flows, rates and levels are also
commonly confused. For example, an interest rate, which is a percentage, might be
expressed as an amount, which is wrong and it makes further calculations impossible.
Such common mistakes in economic reasoning should be avoided.
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Individual activity
Make a list of common mistakes in reasoning that often occur in Economics and say
why it is important to avoid them.

From this study section, we learned that economics has to do with scarcity. Scarcity is
part of our every day life and does not only involve money, but also elements such as
time. We encounter the scarcity problem due to limited resources or production
factors. These production factors can be identified as labour, capital, natural
resources and entrepreneurship. These production factors are used in production
processes to produce goods and services. They are, however, limited. On the other
hand, we encounter the fact that our wants are unlimited. We always want more and
better things. With high levels of wants and low levels of resources for production, we
have a scarcity problem. We will have to make optimal choices to ensure that our
living standard is maximized. A choice always implies some benefits that have to be
sacrificed. This cost is called opportunity costs. Production possibility curves were
also utilised to explain opportunity cost.
Besides the definition of the economic problem, this study section also investigated
whether economics is a science or not. It was found that economics is a social
science, because it gathers as much verified knowledge as possible of mankind in an
environment limited by scarcity. We also investigated certain problems that
economists encounter when dealing with their science. The place of economics in
God’s creation was noted as well as the role that normative economics plays in
business. The difference between Micro- and Macro-economics was explained and the
study section concluded by discussing common mistakes that often occur in economic
reasoning.
Key Concepts
Remember, this is a first year course. A thorough comprehension of all the key words
and concepts is therefore very important. Ensure that you understand every word that
you find in the text and that you are able to define it. It is often best to learn definitions
word for word as it is given in the text, but you must also be able to translate it into your
own words to be able to understand and use it. In most tests, you will also have to give
a few definitions. Key concepts are printed in bold in the textbook and the important
concepts are listed at the end of each chapter. When you are doing revision, you have
to ensure that you know these concepts well. Also, go through the questions at the end
of the chapter and make sure that you can answer them all.
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Reflection
Read the outcomes at the beginning of chapter 1 in the textbook (Mohr & Fourie) and
make sure that you have mastered all the outcomes. If not, revise it once again.
Ensure that you are able to define the words in the text in bolt print, as well as the list
of important concepts at the end of each chapter.
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Study section 1.2

The Economic Problem, Economic Systems and
Pioneers
Study time
Study material
This study section is based on the textbook (Mohr & Fourie) Chapter 2.
Study outcomes
 comply with the learning outcomes given at the beginning of chapter 2 of the
textbook
 explain the economic problem
 differentiate between the most important factors of production
 analyse and explain what different economic systems are all about
 identify the distribution issues, outcomes, importance and relevant problems of
economic systems
 explain the various economic system with their origin, definition, advantages
and disadvantages
 describe the main contributions that pioneers like Adam Smith, Marx and
Keynes made to economic science
The basic economic problem must first determine which products are needed and
with what inputs they have to be produced. This study section will consider that first.
How many and what should be produced, and which factors are necessary for
production is important. It is also important to determine for whom it should be
produced and how they will obtain it, in other words the distribution issue deserves
attention. Thereafter the question is of course how a community should be organised to
ensure that the scarce resources of the country are optimally allocated and utilised to
fulfil most of the needs of that community’s people. It is necessary to have insight into
the economic systems of various countries. This will give an indication of how every
country addresses the scarcity problem. The point of departure is to determine what
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economic frame of reference or system a country has at its disposal. The

organisational manner in which a community employs its resources to satisfy needs
determines its economic system and will eventually determine how much progress a
community will enjoy.
1.2.1 The basic economic problem
Study material
Study the introductory part of chapter 1 of Mohr & Fourie carefully and pay special
attention to the use of production possibility curves in the discussion of the basic
economic problem.
Individual activity
 Into which categories are consumer goods divided?
 What do economists mean with the term “capital”?
 What are homogeneous goods?
 What are economic goods?
 How can production possibility curves be used to explain the question of what
to produce and how production should take place?
 The distribution issue
Note that economists use the term “capital” different from other people. They use it
differently than bankers and accountants. With the word capital, economists usually
mean “capital goods” like machinery, which facilitates production. It this sense capital is
not money. Money is financial capital. This means that economists sometimes mean
money when they talk about capital and sometimes mean capital goods. You should be
careful to ensure you know what they are talking about. If not, errors in reasoning could
occur.
Individual activity
Any society, whether it consists of a very collectivized communist state, a tribe of
islanders, a capitalist industrial nation, a commune or even a colony of bees, must
somehow confront three fundamental and interdependent economic problems. Can
you identify them? Write them down!

These fundamental economic problems would not be problems if resources were
unlimited. If an infinite amount of every good could be produced, or if human needs
were fully satisfied, it would not matter if too much of any particular good is produced.
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Most goods are not free and scarcity remains the central problem. Although many
people are affluent, the world is crowded with billions of people who are living in
absolute poverty.
The economy deals with the central question of resource-allocation and the
determining of prices and production levels in the economy.
1.2.2 Factors of production
Individual activity
 Distinguish between the four main production factors
 Also note the Box on labour specialisation and division of labour
 Is money a factor of production? Why do you say so?
 Your time is also scarce and has value. Is time a factor of production?
1.2.3 Economic systems

The distribution issue
The primary, secondary and tertiary sectors
The definition of an economic system
Classification of economic systems
Individual activity
Do you think that the study of economic systems is of any relevance in the current
South African situation? In times of political elections, we often listen to debates
between pro-socialists, free-marketers and communists. They all propose different
economic systems as solutions to the South African economic problem. Such a study
is therefore relevant.
Try to answer the following questions.
Think of different ways, in the past local elections, of how opposing political
candidates promised to solve the lack of amenities in your community. Can you
identify parties with the following opinion?
1. Let the community first grow from higher industrial development, and then we
can use taxes from those profits to build houses and schools. The primary role
player is therefore the private sector that facilitates economic growth.
2. Let’s first build houses and schools and then people will be more productive
and make the local economy grow faster. The primary role player will be the
state that must first provide infrastructure.
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Individual activity
Why is the Free-Market system generally seen as being superior?
Individual activity
In a free market economy resources are allocated by using the price mechanism.
What is a defect of such a system?
Choose your answer from the following:
1. Consumer sovereignty
2. Externalism
3. Advertising
4. Full employment
5. High prices
Some political parties and other observers try to use the private sector to promote
economic well-being, while the others believe that the government should be the major
participant in the economy of a country.
Economic systems differ considerably with regard to the degree of government control
in the economy.
Do you think that there are countries with no government intervention or countries
where individuals have absolute no choices? Can you think of countries where the
government played a larger role as in others?
It is nevertheless useful to analyse the extremes, in order to put the different mixed
economies of the real world in perspective. One should realize however, that it is not
only the level of government intervention that is important but also the type of
intervention.

Do you think communities in remote areas, such as the Indians living in the forests
around the Amazon River, have a free-market or a planned economic system?
The same fundamental problems also have to be solved by all the types of economic
systems.
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Example
Governments can intervene in an economy in numerous ways like for example - with
nationalisation, taxes, subsidies, regulations etc. Each of these intervention methods
will have different impacts on the economy. In one the intervention can be the public
ownership of large firms, in other, it could be through rules and regulations governing
the behaviour of private industries. Thus, two countries can have the same level of
government intervention, but different types.
1.2.4 Important pioneers in economics

Adam Smith and John Maynard Keynes are the most important founders of economics
as it is known today. Their contributions were explanations of the free market system
although their works also offer understanding to command systems. The works of Dr.
Karl Marx, especially “Das Capital” did, however, provided the main foundation on
which socialist and communist systems were built. These pioneers all provided some
light to the economic problem and one should never be too hasty to ignore the
advantages of any economic system. No system is perfect and with so much poverty,
unemployment and hardship in the world the search for a better economic system must
continue.
Individual activity
1. What is the most important contribution that Classical Economics and Adam
Smith with his book “The Wealth of Nations” made to Economics?
2. Do the works of Karl Marx contribute anything towards solving the basic
economic problem?
3. According to his book “The General Theory” Keynes sees some faults in the
reasoning of the Classical Economists. What was the most important
contribution Keynes made to Economics?
1. Adam Smith argued that a government is not needed to ensure the whole
society’s well-being. He stated that although households act for the maximization
of their own utility levels, and producers for their own profit levels, the society
would still benefit from these egotistic actions.
2. In deciding on an economic system, we will have to compare the different
systems’ advantages and disadvantages.
3. The advantages of a free-market economic system are that it leads to a good
environment of freedom of choice for economic growth and the effective use of
production factors.
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Summary of main learning points

In this study section economic systems were placed in perspective. It was shown that
economic systems are important to solve the economic problems in societies.
Economic systems provide answers for questions such as what to produce, how to
produce and for whom to produce. It is therefore important to study different
economic systems.
At the two extreme points, countries can either follow the path of a free-market
economy or a planned economic system. A free-market economy is based on no
government intervention in the economy. Such a system relies solely on the market-
mechanism, which states that the unhindered price determination of supply and
demand will ensure that living standards will be maximized. The planned economic
system relies on the total intervention of the state. They believe that the state can only
approved a system where all people are handled equally with total justice. The
advantage of the free-market economy is the disadvantage of the planned economy.
Free-market economies have effective production factor utilization and high
economic growth, while the planned economy cannot assure such results. Planned
economies have a much more equal distribution of income, while the free-market is
hindered by high levels of inequalities.
These extreme economic systems are mostly theoretical and do not really occur in
practice. Usually a mixture of these systems is used, which is called mixed
economies.
*Please note: Never be too shy to as questions during the contact sessions. Even if
you think it is a stupid question. Dim-witted questions do not exist. Remember the
things you are now wondering about, are facts that your professor did not know either
once. To obtain a very thorough basis in this subject to build on is very important. If you
cannot or do not wish to ask a question in class, you should go to your lecturers office
and ask him or her there. Do not let things that you do not understand or wonder about
just slip by.
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Study section 1.3

The Economic Circular Flow Model
Study time
Study outcomes
 comply with the learning outcomes given at the beginning of chapter 3 of the
textbook of Mohr and Fourie
This chapter considers the mutual relations between the most important role players,
sectors, markets and flows in the economy. The flow of production factors between
private households, firms, the government, financial institutions, like banks, and the
rest of the world will be shown; as well as the flow of remuneration, money and/or
funds between these sectors. Ensure that you are able to sketch this circuit, discuss
the different participants as well as the interaction between them. The last mentioned
task also requires insight into the economy, which you will learn about in your next
courses in Economics. This study section only serves as a foundation and is important
for the work that follows.
1.3.1 Production, income and expenditure
Study material
Study section 3.1 of chapter 3 of the Mohr & Fourie textbook.
Boxes 3-1 & 3-4 should be studied. The other Boxes are only for background
reading. You may ignore it if you wish.

Note the flows between production, income and expenditure. Note the key concepts
and their role in the total economic picture. Make sure you understand the difference
between stocks and flows correctly.
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1.3.2 Interdependence of households and firms

Note the role of households and firs in the economy. Households own all factors of
production, because the owners of land, capital, labour and the factory owners all have
houses they return to after work in the evenings. Companies need these production
factors of households, while households need the products that the businesses supply.
There is therefore a mutual interdependence and that is the reason why factor markets
and product markets exist. The one market buys and sells factors of production and the
other goods and services. Note that the goods and services circuit moves in one
direction, while income and expenditure moves in an opposite direction. Also note the
various types of firms that exist.
In the studying of Economics we will usually talk about factories and businesses as if
they are the same thing. It would even sound as if shops are producers. Differences do
exits of course and there are various types of businesses. In most courses of
Economics we will ignore these differences. We will not differentiate between a
business that produces new goods and a business that only resell those goods (not in
this module anyway). Manufacturers add value and shops too in the sense that they
make a product available to consumers. This also requires effort, transport and other
costs. A product out of your reach has no value to you.
1.3.3 The public sector

Note the role of the government in the economy. As well as his most important
functions and how the South African government is organised. Note the various levels
of government at national, provincial and local level, as well as the existence of public
corporations. The government is the country’s Fiscal Authority and the most important
fiscal instruments available to manipulate the economy are: Government expenditure
(G) and taxes (T). Make sure that you are able to draw and explain the economic
circular flow model.
The circular flow model illustrates how expenditure and income are equal in the
economy. Try to understand the figure without looking at our discussion. When
studying the figure it might help to try to establish transactions where money payments
flow in the one direction and goods or services in the other.

A market usually has these three elements – derive it from the following:
If you want to buy groceries (if you demand it) and you go to the shop that supplies it,
and you pay a price for it, you are operating in a market. If you buy oranges from a
street vendor, you represent the demand for oranges, the street vendor represents the
supply of oranges, and the price you pay represents the price involved in this market.
In each of our examples we saw that products (groceries and oranges) are exchanged
for money.
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Non-products can, however, also be traded on a market. If the producer pays the
member of the household a wage, we have determined a price for labour. Voila, and
there we have a market!
From the circular-flow model it is important to note that the value of the flow in
one direction will equal the flow in the other. If you buy a product for R10, the flow
of money in one direction will be R10. The flow in the other direction is the product with
a value of R10. This means that the flow of payments always equals the value of
products/production. Let us consider the transaction of production factors. If you sell
your labour to a producer for R100 an hour, you will receive R100 of money per hour.
This will be your income. In the opposite direction, you will give a service to the value of
R100 per hour. The payment you receive will be equal to the value you will put
into production.
1.3.4 The foreign sector

Observe the importance of Imports (I) and Exports (Z) in the economy. Income harms
the local economy in the sense that it causes money to flow out of the country to others
in the exchange for goods. The advantage of exports lays in the fact that our people
have to manufacture those goods that are exported. Higher exports therefore imply job
creation. Note the effect of international economic relations on the balance of
payments. Also give special attention to the Box discussing lower-income and industrial
countries.
1.3.5 The role of financial institutions

Financial institutions play an important role in the economy as they guard the funds of
investors and promote savings, while they also provide these funds as loans to
investors and consumers.
Note that economists often use the term “investments” different from bankers. (In
Afrikaans we would say: “Daar bestaan ’n verskil tussen investering en beleggings”).
Investment means an increase in capital (I = ∆K). Investment is when a producer buys
more capital goods. Usually a producer borrows money from a bank and buys more
machinery or buildings to increase production and profits. If I put my money in a bank
in a fixed deposit to gain interest, it is called a “financial investment”. The buying of
shares implies that one is buying a little piece of that company (including their
machinery etc.) and that would be investment (“capital investment”), while the buying of
interest bearing obligations are not (that would be “financial investment”). If interest
rates increase, for example, savings at banks (financial investment) would rise while
investments would decline.
Use of the internet

The internet is a handy source of information. Gain access to the internet en
investigates some of the economic websites given at the end of chapter 1 of the
textbook. Also investigate some of the links on those websites. Make sure that you are
well- acquainted with it so that you could use it later comfortably when it is needed. .
Popular search engines that are often used are:
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http://www.google.com/
http://www.metacrawler.com/
http://www.yahoo.com/
http://www.altavista.com/
http://www.dogpile.com/
Search engines specific for South -Africa are:
http://www.ananzi.co.za/
http://www.aardvark.co.za
http://www.mweb.co.za/home/default.aspx
http://www.loot.co.za/
http://www.kalahari.net
Useful websites that give access to economic journals – of which many give full text,
are:
EbscoHost Web – which can also be accessed through the website of the library, as
well as:
http://www.jstor.org/search
http://www.econlit.org/
A very useful address that is easy to remember is the site of the government. From
there one can get access to all state departments and many other institutions like the
IDC en Statistics South -Africa:
http://www.gov.za
The Faculty’s own websites, some with good links are for instance:
http://www.puk.ac.za/fakulteite/ekon/ser/index_e.html
Take the internet addresses of good websites that you discover to with you to you next
contact session and tell your lecturer and fellow students about it.

This Study unit served as a basic introduction to Economics. It defined the study field
and explained what science is. The place of Economics in God’s creation was
discussed as well as the difference between normative and positive economics.
Scientific study from a Christian perspective is important to most people, and while we
try to study positive economics, it will always be coloured by a student’s preconceived
notions in his or her subconscious mind. Economics involves the optimal allocation of
scares resources available to fulfil the unlimited needs of people. Because of scarcity,
it is necessary to utilise what is available in the best possible way. Economics is
therefore the art of making the most out of live. The subject is therefore also a useful
social science to investigate the behaviour of people. Common errors that often occur
in economic reasoning were also discussed.
In the second place, the basic economic problem was studied, as well as the various
factors of production. Next, attention was given to the various ways in which
economic systems address the scarcity problem for communities. The merits of the
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different economic systems were evaluated and then the contribution of Adam Smith,
Karl Marx and Keynes as founders of economic theory and systems was discussed.
The last study section gave attention to the basic circular flow model, income,
production and expenditure; as well as the interaction between the different role
players in the economy. Special attention was given to the role of households and
firms, the government, the foreign sector and the role of financial institutions. The
final section concluded by studying the total circular flow model and plain calculations
of total expenditure of a country and the gross domestic product (GDP). The next
Study unit considers the basic equipment that economists use. The calculation of
important economic indicators, the use of theories, tables and graphs, as well as
supply, demand and equilibrium will enjoy attention.
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Study unit 2
EQUIPMENT OF THE ECONOMIST, DEMAND AND SUPPLY
Study time
The time scheduled for this Study unit is approximately 20 hours
Study material
This Study unit is based on the textbook of Mohr & Fourie Chapters 4 & 5.
Study outcomes
At the end of this Study unit you as the learner, should be able to:
 interpret basic economic equations and graphs
 calculate demand and supply schedules
 illustrate demand and supply schedules graphically
 apply this concepts to real-life situations
 demonstrate the value of ethical behaviour to all role players in the supply and
demand sides of the economic equation.
This study gives attention to Supply and Demand, which are the basic building blocs of
the economy. Equilibrium prices and quantities give an indication of the needs that
exist in the community and how to address it. Demand and supply graphs are a useful
instrument and show what the effect of prices and quantities are if equilibrium between
supply and demand changes in the market. This study section provides the basis for
further study and analysis of the economy.
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Study section 2.1

Demand and supply
Study time
Study material
This study section is based on Mohr & Fourie Chapter 4 with the heading:
“Demand, Supply and Prices”.
The accompanying Boxes is not important. You may read it as background
information if you wish.
Study outcomes
 master to the learning outcomes given at the beginning of chapter of the
textbook
 name the determinants of demand and explain changes in demand
 draw the individual and market demand curves and use it in analysis
 interpret tables and demand curves
 distinguish between changes in demand and changes in the quantity
demanded
 explain the influence demand and price changes of products have on its
compliments and substitutes and illustrate it graphically
 sketch and apply supply curves
 explain the income and substitution effects of price changes
 understand market equilibrium and illustrate it graphically
 show the effect on supply and demand when equilibrium is disturb
 explain consumer surplus and producer surplus and illustrate it graphically
In Demand and supply and equilibrium between demand and supply are investigated in
this study section. Demand reverses to the buyers in the market and supply to the
producer or sales area. Consumers and producers meet in the market place and
eventually come to an agreement to trade a product at a certain price. This price is
known as the equilibrium price (or market clearance price) and at that price only a
certain equilibrium amount will be sold. Thus, in this study section the discussion is
about the buying and selling of a single product; so we are talking “micro-economics”
now! Demand-and-supply is the most basic instrument that economists utilise to
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Study unit 2
analyse the economy. The same principles will also apply in Macro-economics when
the total demand and supply of the entire country are considered.
We will study demand of consumers first. As the saying goes: “the customer is king”.
Consumers are the buyers of products and services. Demand is, however, more than a
need. Only when a person has a need and the ability to pay for it and willing to pay for
it, will it be called “demand” The modern world is often described as a society of
consumers. Economic theory tries to explain the behaviour of consumers. Although the
individual behaviour of people differs, the rational human being can be seen as the
“normal” case (Homo Economicus).
A theory on consumer behaviour enables one to understand why individuals have
certain buying and spending patterns, and why certain products and services are
higher in demand than others are. Such knowledge can be valuable to the business
manager and could be used to determine the demand for a particular product.
In his influential work “The Wealth of Nations” Adam Smith (1776:119) says: “It is not
for the benevolence of the butcher, the brewer, or the baker that we expect our dinner,
but from their regard to their own interest”. Entrepreneurs will notice the needs of
others and try to provide it to them, for his own sake and to maximise his profits in such
a way. In this way, the needs of everyone will be addressed. Because someone else
thinks that he would be able to make a living and generate profits, by selling bread for
instance, others do not have bake their own bread or search for someone who has
extra bread. The consumer can now just go to the shop.
The reaction of producers to the needs of consumers leads to a wide range of products
and services being offered in the market. When the economy is systematically being
investigated, one of the functions that can be recognised is production – or rather, the
basic task of society to organise a system through which enough goods and services
will be produced to ensure survival of the society.
Equilibrium is reached in the market when demand equals supply. Surpluses or
shortages will result if equilibrium is disturbed and marker forces will then lead the
market back to equilibrium. Consumer and producer surpluses are generated at the
point equilibrium, which implies that the market mechanism is to everyone’s advantage.
This study sections concludes by looking at those surpluses.
2.1.1 The law of demand

Give special attention to:
 what the concept of demand entails
 determinants of demand and price
 demand equations
 tables that show demand or demand schedules
 individual demand and the graphical representation and interpretation of it
 market demand and the deriving it graphical
 the difference between changes in demand and changes in the quantity
demanded
 the influence that demand and price changes of products have on its
compliments and substitutes, and graphically illustration of it
 the effect of changing income on demand
 the algebraic analysis of demand in the appendix to the chapter
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Study unit 2
Individual activity
From the demand function P = 6 – ½ Qd (P is given in Rand), give the following:

1. The demand schedule, by choosing a few quantities (e.g. 0 to 12); and
2. Draw the demand curve.
3. What is the maximum quantity this individual will ever demand of this
commodity?
[ Hint: Qmax is where P = 0 ]
Answers
1. Table: The demand schedule: P = 6 – ½ Qd
Qd 0 1 2 3 4 5 6 7 8 9 10 11 12
P (Rand) 6 5.5 5 4.5 4 3.5 3 2.5 2 1.5 1 1.5 0
2. Graph: The Demand Curve.
Note the slope is – P/Q = (R3 – R2) / (6 - 8)

=–½
or = – 0.5 which is also given in the equation P = 6 – ½ Qd
implying a slope of 1 block horizontal and a ½ vertical (or
2 h & 1v);
and the Price line intercept is 6 because P = 6 – ½ Qd
Remember we were taught at school that the slope is the change of the Y-axis
divided by the X-axis: thus Slope = ΔY/ΔX and for the demand curve the
Slope = ΔP/ΔQ
We can also determine the slope by differentiating the equation of the demand
curve.
3. The maximum quantity of this commodity that the individual will ever demand is
12 units. This occurs at a price of zero Rand. This is called the saturation point
for the individual. Additional units of the product will result in a storage and
disposal problem for the individual.
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Study unit 2
Economists cannot equate "demand" with "wants" or "needs", because an industry
cannot be expected to supply goods and services without payment. Man's needs are
unlimited, but his demand for a particular item is very often limited if the price he must
pay is too high.
Individual activity
Do you think that a need can become a demand? Motivate your answer in writing!
Individual activity
Make a schedule and draw the demand curve for fuel or hamburgers that you are
consuming as the price thereof changes over time.
Bring the graph with you to the contact session for assessment.
When considering and/or comparing prices over time, the effect of inflation have to be
removed first. Older prices always look cheaper although the purchasing power differs.
For this reason, economists always use real prices when analysis is made.
(In the previous assignment, it was of cause not expected from the student to take out
the effect of inflation. However, take note of the fact that the shape of the demand
curve was not totally correct in that case, as nominal prices were used).
Individual activity
Do you think that a change in factors such as substitute and complementary
products' prices; or consumer's income; and tastes, will influence the demand curve?
If so, write it down in what ways it could happen.
It is important not to get confused with the concepts of quantity demanded and a
change in demand
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Study unit 2
2.1.2 Supply in the economy

Give special to:
 the definition of supply
 determinants of individual supply
 supply schedules and graphs
 markets supply and determinants of supply
 changes in the quantity supplied and changes in supply
 the substitution- and income effect due to changes in price
 the algebraic analysis of supply in the appendix to the chapter
 In the study of Economics they usually refer to production when speaking of
supply. However, it also involves a shop that is only reselling goods. In the
modules this year, we will not make a distinction between retail businesses and
manufacturers.
 In Economics a “product” is also called a “commodity”.
Individual activity
Use the supply function PS = 1 + 2 QS and give the following:

1. The producer’s supply schedule;
2. The supply curve;
3. What are being kept constant in the given supply function?
4. What is the minimum price that this producer must be offered in order to induce
him to start supplying the commodity to the market?
Answers
1. Table: The supply schedule: PS = 1 + 2 QS
QS 0 1 2 3 4 5
PS (R) 1 3 5 7 9 11
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Study unit 2
2.
Note the slope is P/Q = (R5 – R3) / (2 - 1)
= 2/1
= 2 which is also given in the equation PS = 1 + 2 QS
implying a slope of 1 block horizontal and 2 vertical;
and the Price intercept is 1 because P S = 1 + 2 QS
The shape and location of a producer’s supply curve (if it exists) depend on
production and cost conditions and on the type of market organisation in which
the producer is operating. From now on and unless otherwise specified, the
supply curve will be taken to be positively sloped (it usual shape).
3. The things that are kept constant in defining a producer’s supply schedule and in
drawing his supply curve are e.g.: the technology in the production of the
commodity, the supplies of the inputs necessary to produce this commodity and
the features of nature, if it is an agricultural product for instance.
4. Any price above one Rand will induce the producer to place some quantity of the
commodity on the market.
Individual activity
Write down the implications for business people of the law of supply.
2.1.3 Equilibrium between supply and demand

Pay special attention to:
 the meaning of equilibrium
 graphical representation of market equilibrium between demand and supply and
the accompanying equilibrium price and quantity
 the effect of prices which are above and prices below the point of equilibrium
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Study unit 2
 how market forces in a free market always rectify disturbances back to market
equilibrium
 the role prices play in the market
You have now investigated demand and supply algebraically. Equilibrium is where
demand and supply are equal and consequently equilibrium is also where the algebraic
equations of demand and supply are equal to each other.
Note: Do not study the appendix at the end of chapter 7. Although it is mathematically
correct, students find it confusing. Rather write demand and supply functions in the
form of: PD = a – b QD and PS = c + QS.
Example
Further explanation
In school mathematics, the equation of a straight line is usually given as:
Y = mX + c
where: m is the slope of the line and c the intercept
In Economics, due to convention, the position of the depended and independent
variables usually change places, and the intercept is written first:
Y = c + mX (1)
That means that the equation of a Demand curve would be written as:
P = a - b QD
where P = price of the product
QD = quantity of the product that will be demanded at that price
a = intercept
and b = the slope, of which the sign in equation (1) is negative, because the
relationship between price and quantity demanded is negative. When
the price rises for instance the quantity demanded would decline.
That is why the slope is negative.
The slope of a graph is usually the tangent of the line and at school we were taught
that:
tan = ∆Y/∆X
In equation (1) the slope of the line would thus be: b = ∆P/∆QD
One can of course also find the slope by differentiating the equation P = a - b QD as:
dY/dX or dP/dQD
The slope is then graphically equal to b = ∆P/∆QD where b is the vertical part against
One on the horizontal section, as shown on the graph below.
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Study unit 2
0
Q
The Supply function will then be: P = c + d Qs

There is a positive relation between price and the quantity presented (Qs) and the
slope is then positive then.
It is always very important to make sure what the different symbols of the variables in
that particular situation stand for. P and Q for price and quantity are more or less
standard, but a and b where, for instance, chosen above for convenience and c and d
chosen to prevent confusion because it was not used elsewhere yet.
Individual activity
Now put the forces of demand and supply together in the following exercise:
Given a demand function as PD = 9 – QD and supply function PS = 1 + 3 QS of product
X
1. Find the demand schedule and the supply schedule of commodity X and from
that find the equilibrium price and equilibrium quantity.
2. Sketch the demand and supply curves, on one set of axes, and show the point
of equilibrium.
3. Derive the equilibrium price and equilibrium quantity mathematically.
Answers
1. Table: Demand and Supply schedules
PD = 9 – QD and PS = 1 + 3 QS
Q 0 1 2 3 4 5
PD 9 8 7 6 5 4
PS 1 4 7 10 13 16
From the table it can already been noted that demand and supply are equal at an
equilibrium price of R7. Equilibrium price and equilibrium quantity are then:
PE = R7 and QE = 2 units of commodity X
This can also be read from the graph.
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Study unit 2
2. Figure: Demand and Supply Curves
PE = R7 and QE = 2
3. At equilibrium demand and supply are equal:
Thus PD = 9 – QD and PS = 1 + 3 QS are equal
PS = PD
1 + 3 QS = 9 – QD
1+3Q=9–Q
4Q=8
Q=2
And P = 1 + 3 QS
= 1 + 3(2)
P=7
 PE = R7 and QE = 2
Test: PD = 9 – QD
=9–2
PD = 7
Individual activity
Can you explain how the free-market economy ensures that no production surplus or
shortage occurs? Write it down!
Write a short essay in which you explain how the demand-and-supply mechanism
works. (This exercise is very important, as students usually do not possess the
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Study unit 2
necessary skills to use the facts that they have learned in sentences and to write
scientifically. You should therefore also get exercise in these skills as often as
possible.
Example
EXAMPLE: Simulations Equations

Assume that the following demand and supply functions exist in the market for a
particular product:
PD = 6 – 2QD
PS = 1 + 3 QS
Calculate the equilibrium price at which this product will be sold and the equilibrium
quantity that will be sold. Also illustrate it on a graph.
Answers
SOLUTION:
PD = 6 – 2QD and PS = 1 + 3 QS
and at equilibrium demand and supply prices are equal:
PD = PS
 6 – 2Q = 1+3Q
5Q = 5
QE = 1
And
PD = 6 – 2QD
P = 6 – 2(1 )
=6–2
PE = 4
 PE = 4 and QE = 1
Market clearance price will be R4 and only one item will be sold.
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PE = 4 and QE = 1
2.1.4 Consumer and producer surplus
Individual activity
Imagine higher poverty allowances from government, shifts the total market demand
curve of a certain product to the right:
1. Make a free-hand sketch of the original demand- and supply curves, indicating
the consumer and producer surplus.
2. Then sketch, on the same graph, the new demand curve and point of
equilibrium, and show how large the consumer and producer surplus are now.
3. Who won the most owing to the higher government grant?
(This depends of cause, on the slope of the lines, and the elasticity (sensitivity)
of supply and demand.
Take your answers with you to the next contact session in class for discussion.
Individual activity
ADDITIONAL EXERCISES
Determine the equilibrium price and quantities at which the following commodities will
trade:
(1) PD = 18 – 2 QD (2) PD = 6 – 2 QD
PS = 3 + 0.5 QS PS = 1 + 3 QS
(3) PS = 2 + 3 QS (4) PS = 12 + 5 QS
PD = 8 – 2 QD PD = 34 – 0.5 QD
(5) P = 5 + 2 QS (6) PS = 16 + 3 QS
P = 20 – QD PD = 24 – QD
(7) PS = 1 + 1.5 QS
PD = 6 – QD
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Study unit 2
Answers
Answers:
(1) At equilibrium:
PD = PS so:
18 – 2 QD = 3 + 0.5 QS
QE = 6 PE = 6
(2) PE = 4 QE = 1
(3) P=4 Q=2
(4) P = 32 Q=4
(5) P = 15 Q=5
(6) P = 22 Q=2
(7) P=4 Q=2
Reflection
Make sure that you can define the important concepts given in the list at the end of
chapter 7 and answer the revision exercises.
Check the learning outcomes of this study section again and evaluate your progress.
Take your answers to the next contact session for discussion.

Attention was given in this study section to the basic equipment that economists use in
the study and analysis of economic events. Attention was first given to the Macro-
economic objectives and national accounts. Attention was given to the calculation
of the GDP and other national indicators of production, income and expenditure,
economic growth, unemployment, inflation, transactions with the rest of the world
and measures of income-inequality.
Subsequently attention was also given to the relationships between economic
variables, the use of theories, tables and graphs. Equilibrium, comparative statics
and the ceteris paribus principle were studied next.
Thirdly, attention was given to the principle of supply-and-demand, which is the
fundamental instrument of all economic analysis. In most cases, Economics is
concerned with the variations of equilibrium price and quantity, which changes
because of the interaction between supply and demand. Whether it is the determination
of wage rates (the price of labour), interest rates (the price of credit of money), or
the exchange rate (the price of foreign currency), it is every time supply and demand
who are the main role players that manipulate equilibrium prices and -quantities.
Supply-and-demand is therefore an essential piece of equipment of anyone wishing to
study the encounters of the economy.
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Study unit 2
Additional study material

An enjoyable way to learn how economists think is to read the following storybook:
JEVONS, M. Murder at the margin. Princeton University Press. [Library: 823 JEV].
[Available at our university Library or buy it from your nearest bookshop,
http://www.loot.co.za or http://www.kalahari.net on the internet].
A book that explains the basic concepts of economics in a nice to read way is:
Turner, C.A. 2002. Economics for the Impatient. Clearwater Publishers. ISBN-13: 978-
0-9627815-1-3 [Library: 330 TUR].
Another interesting book, although much more formal, is:
WHEELAN, C. 2003. Naked Economics: Undressing the Dismal Science. New York:
Norton. [In our library at: 330 WHE]
Assessment
Complete the assignments given by your lecturer and keep to the date of submission.
Write the class test according to the time schedule.
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Study unit 2
Study section 2.2

Demand and Supply in Action
Study time
Approximate study time is 10 hours.
Study material
Study Chapter 5 of the textbook of MOHR, P. & FOURIE, L.
Study outcomes
After studying this study section, you should be able to:
 Explain how changes in demand and/or supply will influence the equilibrium
price and
–quantities on the market and illustrate it graphically
 Predict what the consequences will be when demand and supply changes
simultaneously and illustrate it by means of graphs
 Explain the interaction between markets and illustrate it graphically
 Indicate what the effect of government interventions in the price mechanism,
like setting prices for example, would be
General overview
Did you ever wonder why:
1. Why could a war in the Middle East lead to higher fuel prices?
2. Why does the maize price decline when excellent yields are expected in a year?
3. Why could an over-supply of maize lead to cheaper milk and meat prices?
4. Why do house prices rise fast when the university figures increases rapidly?
This and other similar questions concerning economic issues are investigated in the
study section.
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Study unit 2
2.2.1 Movement of demand and supply
Individual activity
Do you know how the price of a typical product is determined? Or what causes prices
to rise? Or how do producers decide on the quantities of products to supply to the
market?
General overview
In this study section we will address these and other questions concerning the
individual demand and supply of a product in the market. Thus, we will look at the
actions of individual consumers and producers of a product and illustrate how the
quantity and the price of the product is determined. (So, we are talking “micro” now).
The objective of this study section is to analyse the role of prices in the economic
system and to explain how the price and the quantity of a product is determined in the
market.

Note how changes in demand influences the equilibrium position in the market and how
it influences the equilibrium price and equilibrium quantities sold. The use of graphs
eases investigations and predictions. Also note that the ceteris paribus principle is
applicable here. We assume that all other factors are held constant or have no effect
on the market price and the quantity demanded.
Also note the effect of movements on prices and quantities.
Note that curves do not move if one of the variables on one of the two axis’s of a graph
changes. When the price or quantity on a demand & supply graphs (of sections 8.1 &
8.2) would change, the curves would not move. Then there would only be a slide along
one of the curves.
Also notice that that an increase in supply, when more are produced for instance, or
more offered for sale, would shift the supply curve to the left. Do not get confused. If
supply drops, the supply curve does not move up, even though it might look that way. It
moves left. You can verify it for yourself by remembering that after a decline in supply
the point of equilibrium would be at a smaller quantity on the quantity axes, closer to
the origin of the graph.
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Study unit 2
Individual activity
 Draw a neat graph to illustrate what would happen to the price of cell phones if
good advertisements increase people’s need for cell phones.
 Draw a graph that shows what happens to the equilibrium quantity of motor
vehicle sales if better education leads to more productive workers and this
cause manufacturing costs to decline and this leads total supply of motors on
the market to rise.
Answers
An increase in the demand for cell phones would increase demand and the demand
curve would shift to the right. This means that the equilibrium quantity would increase
to the right on the horizontal axes and the point of equilibrium where demand and
supply curves intersect each other is higher now higher on the graph, which implies a
higher price on the vertical axes. Thus, if people what more phones, – they will have to
PAY for it, and the price will increase!
When manufacturers increase their supply of motor vehicles, it would imply that the
supply curve would to the right (notice carefully, it might seem as if the curve is
dropping, but NO, the supply curve shifts to the right). If demand remained constant (in
other words ceteris paribus!) the demand and supply lines would intersect more to the
right on the graph, which shows that a larger quantity of motor vehicles is sold (on the
horizontal axes) and the price would be lower. The equilibrium point has dropped lower
and is therefore next to a lower point on the vertical price axes. So motor vehicle prices
have dropped. Well, if they produce more, they would only get it sold if they make it a
bargain, so they decrease the price. They can also afford it because the more
productive workers led to cost savings in production. But the bosses could also have
decided to pocket the money for themselves, but then their supply price would not have
to drop, and competitors who decreased their vehicle prices could take over the market
and they might be bankrupted in the long-run.
The slope of the demand curve like the on in Figure 8.1 in your textbook indicates the
relationship between the change in the price ∆P (e.g. of apples) and the change in the
quantity demanded ∆Q that customers wish to buy in the market. The slope of the
demand curve can be derived by the following equation: Slope = dP ÷ dQ
Slope = ∆P ÷ ∆Q
(In ECON111 we said this is the “tan” of the curve or the slope = dP ÷ dQ)
Incidentally: Remember “∆” means “the change in”
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Study unit 2
Example
If the price of apples, would for example, decrease from R10 (P1) to R8 (P2), the
quantity of apples demanded would increase from 50 (Q1) to 100 (Q2). Thus the
slope of the buyer’s demand curve between a price of R10 and R8 would be:
Slope = ∆P ÷ ∆Q
= (P2 – P1) ÷ (Q2 – Q1)
= (8 – 10) ÷ (100 – 50)
= -2 ÷ 50
Slope = -0,04
You would remember from ECON111 that the slope of the supply curve can be
calculated similarly, except that the supply curve has a positive slope.
2.2.2 Simultaneous changes in demand and supply
Individual activity
But what is the effect of a movement in the demand and supply curves on
equilibrium?
Answers
We distinguish between four situations:
1. Demand changes, while supply stays the same
If demand increases the demand curve moves to the right. The demand curve
moves, so that the new equilibrium is at a higher price (P1 to P2) and the
equilibrium quantity has increased from Q1 to Q2. For example, when the demand
for coffee increases and the supply stays the same (supply curve remains S), the
equilibrium price and quantity of coffee will increase.
2. Supply changes, while demand stays the same
If there is an increase in the supply of a product, the supply curve moves to the
right. The supply curve moves from S1 to S2 and the new equilibrium price
decreases from P1 to P2. The equilibrium quantity increases from Q1 to Q2. For
example, when the supply of coffee increases, but the demand remains
unchanged, the equilibrium price of coffee will decrease and the equilibrium
quantity will increase.
3. Demand changes more than supply
When there is an increase in demand (the demand curve moves to the right) and
an increase in supply (the supply curve moves to the right), but the increase in
demand is greater than the increase in supply. Thus, the demand curve has
moved from D1 to D2 and the supply curve has increased from S1 to S2. Thus, the
equilibrium price has increased from P1 to P2 and the equilibrium quantity has
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Study unit 2
also increased (Q1 to Q2), but the net effect of this increase in demand and
supply is an increase in the equilibrium price and quantity.
4. Supply changes more than demand
This illustrates a situation where the increase in supply is greater than the
increase in demand. The supply curve has increased from S1 to S2 and the
demand curve has increased from D1 to D2. The new equilibrium price is at a
lower level (P1 to P2) and the equilibrium quantity has increased from Q1 to Q2.
Thus, the net effect of this increase in demand and supply is a decrease in the
equilibrium price and a increase in the equilibrium quantity.
Individual activity
Draw a few graphs from your own life experience and show how changes in demand
and supply moved the demand and supply curves and explain what happened to
equilibrium, prices and quantities: for example cinema tickets in Potch, or beer or
class fees. Play with the graphs and make your own scenarios to get acquainted with
it and use it in your arguments.
Take your answers with you to the next contact session or group meeting for
discussion.
2.2.3 Interaction between related markets

Notice how movements of prices and quantities on the graphs of one commodity
(good), shifts the demand and supply curves of related products.
Also give attention to the substitution of meat for fish, and the complimentarity of tyres
and motor vehicle, as well as the effect of exchange rate changes on the goods market
and consumption.
Substitute products are similar products, where one can easily substitute another; for
example butter and margarine. When an increase in price of one product occurs, like
margarine, the quantity of the other product demanded (butter) would rise. This will
shift the demand curve of butter to the right, while the demand curve of margarine
remains unchanged.
Complementary products are products which are used together, such as tennis rackets
and tennis balls. If there is an increase in the price of one of the products, for example
tennis rackets, it would cause a decrease in the quantity demanded of the other
product, tennis balls. Thus, the demand curve for tennis balls will move to the left.
Individual activity
Name two substitute and two complementary products for hamburgers.
Substitute products Complementary products
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Study unit 2
Example
If the consumer, for example, became aware of fitness, his demand for running
shoes and training clothes would increase, while his demand for chocolates and junk
food may decrease.
Individual activity
1. Explain, Using graphs, why the taxi fare that people pay their servants, would
increase if the price of rubber increases.
2. Imagine you are at a fate fête and there is strong competition between the
hamburger and hotdog booths.
3. Draw graphs to show how pricing decisions of the one vendor will influence the
sales of the other.
4. Also illustrate what will happen to the sales margarine, if the hamburger and
hotdog booths both raise their sales, due to their innovative competition.
discussion.
2.2.4 Price setting by the government

 Ceiling prices and its graphical representation
 Maximum prises or floor prices
 Rent control and administered prices
 The loss in welfare and deadweight loss in consequence of price setting
 Rationing and the cause of black markets
 Self-fulfilling expectations
In Economics we often talk about goods in this course, but we mean goods and
services.
Where we talk about production, it is not only applicable to manufacturers, but it can
also revere to a business that only buy goods in the wholesale trade and then only sell
it again in its shop. The general principles stay the same.
Individual activity
 Explain, using graphs, why there exists such long waiting-lists for subsidised
housing.
 Explain, using graphs, why minimum wages can lead to unemployment.
 Explain, using graphs, why too low prices in the goods market can lead to
shortages.
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Study unit 2
 Determine, using graphs, whether a surplus or a shortage will develop if the

government would set a floor price for bread above the equilibrium price.
 Illustrate, with the aid of graphs, what the loss in welfare of a tariff on imported
maize would be.
discussion.

This chapter served as an introduction to this course module and also revision of the
Demand & Supply mechanism, which you already encountered in the previous
course in Economics. It was shown what the outcomes of changes in Demand and
Supply would are. The interaction between demand and supply leads to new points of
equilibrium, as well equilibrium quantities and equilibrium prices in the market for
each product and services. When prices are higher than the equilibrium point,
surpluses develop in the market and market forces will push prices down again
towards equilibrium via the market mechanism. This will, for instance, occur when
floor prices are set to protect producers. When prices are set too low, like in the case
of ceiling prices to protect consumers, shortages will develop and the market
mechanism would once again push prises up towards the point of equilibrium. If prices
are however set by legislation the surpluses or shortages will continue. Government
intervention in the free market economy occurs, like the setting of tariffs or ceiling
prices, it will cause a loss in welfare, with a deadweight-loss that benefits no one.
The extend to which consumers or producers react to changes in price is known as
elasticity, and are indicated by the slopes of the demand and supply curves and is the
topic of the following study section.
Key Concepts
Remember the first year is an introductory course. A thorough comprehension of a of
all the keywords and concepts is therefore vital. Ensure that you are able to define
each term that you met along the way. It is often best to learn definitions by heart, word
for word, but you should also be able to translate it in your own words in order to
understand and apply it. Most tests would expect of you to give a few definitions.
Keywords in the textbook are printed in bold and listed at the end of each chapter as a
list of Important Concepts. When doing revision you must make sure that you know
these concepts well. Also consider the questions given at the end of each chapter and
make sure that you can answer them. You should also make your own summaries
throughout and play with the graphs and calculations, in order to become acquainted
with it, as it is very important in this module.

A book that explains the basic concepts of economics in a nice to read way is:
TURNER, C.A. 2002. Economics for the Impatient. Clearwater Publishers. ISBN-13:
978-0-9627815-1-3 [Library: 330 TUR].
45
Study unit 2
Another interesting book, although a bit more formal, is:

WHEELAN, C. 2003. Naked Economics: Undressing the Dismal Science. New York:
Norton [In our library at: 330 WHE].
[Available at our university Library or buy it from your nearest bookshop,
http://www.loot.co.za or http://www.kalahari.net on the internet].
46
Study unit 3
Study unit 3
ELASTICITY
Study time
Study material
This study section is based on Chapter 6 of the textbook (Mohr & Fourie).
Study outcomes
 Define elasticity and discuss the price elasticity of supply and demand
 Explain the meaning and significance of price elasticity
 Measurement of the price elasticity of demand and supply and calculate
elasticities using the appropriate formulas
 Explain the determinants of price elasticity of demand
 Define and discuss income elasticity and cross elasticity of demand
 Explain the meaning and significance of price elasticity of supply
 Discuss the relationship between price elasticity and total income
 Discuss and compute both point and arc elasticity of demand and supply
 Identify and discuss various values that price elasticity coefficients could have
 Discuss the related concepts and definitions
The objective of this study section is to introduce you to the price elasticity of demand
and supply and to discuss, analyse and calculate related aspects and values.
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Study unit 3
Elasticity is about the sensitivity that buyers and sellers have for changes in price.
Elasticity of demand is defined as the percentage change in the quantity, relative to
the percentage that the price of that product has changed. Did you ever wonder what
determines the degree to which the demand or supply for a product would change
when the price of a product changes? A price increase of one product sometimes leads
to a remarkable decline in the amount that consumers will buy of a certain product,
while an increase in the price of another product would hardly lead to any reaction
from the consumers at all. Phenomena like these are concerned with the price
elasticity of a product and are the focus of this study section.
3.1.1 Elasticity of demand

Pay meticulous attention to:
 Definition of Elasticity
 The price elasticity of demand
 The calculation of elasticity
 Elasticity differ at various points on a demand curve
 Note the difference between elasticity and the slope of the demand curve
 Point elasticity and Arc elasticity
 The calculation of Arc elasticity
 Price elasticity of Demand and Total Income
 Various categories of price elasticity of demand and the interpretation thereof
 Graphical illustration of Demand curves of various elasticities
 The effect of supply side changes on demand elasticity
 Determinants of the price elasticity of demand
 Applications

The effect of a price change differs from product to product. For example, when the
price of salt increases by 10% if would not effect the amount of salt that consumers will
by notably. But if the price of yoghurt increases by 10%, consumers will buy definitely
much less.
A price increase will lead to a decline in the amount demanded. Due to this negative
relationship the value of the price elasticity of demand will always be negative (-).
When interpreting the value of elasticity only the absolute value thereof is considered
and the negative sign is ignored. Elasticities larger than 1 are then relatively elastic,
even when the value is -8, because 8 is larger than 1.
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Study unit 3
Example
The next example illustrates how elasticities can differ when various points are
utilised in calculating the price elasticity of demand.
Imagine that at a price of R160, 1 000 blankets are sold (demanded). If the price
declines to R140, then 2 000 blankets will be demanded. Thus:
Price (P) Quantity (Q)

1. 160 1000
2. 140 2000
If the original price (P1) and quantity (Q1) are used, the point elasticity are:
Ed = (Q2 – Q1) ÷ Q1
(P2 – P1) ÷ P1
= (2000 – 1000) ÷ 1000
(140 – 160) ÷ 160
= 1000 ÷ 1000
- 20 ÷ 160
 Ed = -8
But if the final price (P2) and quantity (Q2) are used, the point elasticity will be:
Ed = (Q2 – Q1) ÷ Q2
(P2 – P1) ÷ P2
= (2000 – 1000) ÷ 2000
(140 – 160) ÷ 140
= 1000 ÷ 2000
- 20 ÷ 140
 Ed = - 3.5
The difference in elasticity on various points is obvious.
1. The initial values of price and quantity are usually to calculate point elasticity.
2. The slope of the demand curve is determined by dividing the change in price (P 2
– P1) by the change in quantity (Q2 – Q1), thus (∆P ÷ ∆Q) or (dP ÷ dQ).
3. Elasticity measurers the percentage change in quantity [(Q2 – Q1) ÷ Q] relative to
the percentage change in price [(P2 – P1) ÷ P], thus (%∆Q ÷ %∆P).
4. The price elasticity of a straight line with a constant (linear) slope differs from one
point to another and becomes smaller as one move down on the curve. On a
demand curve with a constant slope the price elasticity of demand will be larger
at points where the price is higher, and thus larger than one. (Ed > 1). At points
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Study unit 3
lower on the demand curve (at lower prices) the price elasticity of demand is
smaller; Ed < 1 and consumers is less sensitive for price changes (inelastic).
Example
1. Calculate point elasticity of demand and interpret your results, when: (2)
P Q
A R20 840
B R45 315
2. Calculate arc elasticity of demand and interpret your results, when: (2)
Answers
1. Point elasticity of demand at point A:
ED = ( Q / Q) / ( P / P)
= ([840 - 315] / 840) / ([20 - 45] / 20)
= (0.625) / (-1.25)
ED = - 0.5
THE ABSOLUTE VALUE IS LESS THAN 1 WHICH POINTS TO RELATIVE
INELASTICITY. BUYERS WOULD NOT CARE MUCH ABOUT THIS PRICE
CHANGE. THE SELLER COULD INCREASE HIS PROFITS IF HE INCREASES
HIS PRICE.
POINT ELASTICITY OF DEMAND AT POINT B:
ED = ( Q / Q) / ( P / P)
= ([315 - 840] / 315) / ([45 - 20] / 45)
= (-1.66) / (0.55)
ED = - 3
THE ABSOLUTE VALUE IS LARGER THAN 1 SUGGESTS RELATIVE
ELASTICITY (3 > 1). BUYERS WOULD REACT STRONGLY TO PRICE
CHANGES.
(IT WAS NOT NECESSARY TO CALCULATE THE ELASTICITY OF BOTH
POINTS. IF THE QUESTION DID NOT SPECIFY, ONE WOULD USUALLY
CALCULATE THE FIRST ONE).
2. Arc elasticity of demand when the price changes from R20 to R45:
ED = ( Q / AVE. Q) / ( P / AVE. P)
= ( [Q2 - Q1] / [½ (Q2 + Q1)] ) / ( [(P2 - P1) / [½ (P2 + P1)] )
= ( [315 - 840] / [½ (840 + 315)] ) / ( [(45 - 20) / [½ (45 + 20)] )
= (-0.9091) / (0.769)
ED = - 1.182
THE VALUE IS MORE THAN 1 AND DEMAND IS THEREFORE ELASTIC.
BUYERS WOULD REACT STRONGLY TO PRICE CHANGES.
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Study unit 3
Individual activity
Calculate the following:

1. Use the graph in Box 9-1 and calculate the slope of the demand curve
2. Calculate the point elasticity of demand at point 1 and point 2 and interpret your
answer
3. Calculate the arc elasticity between points B and C in figure 9-1
4. As well as the arc elasticity between points C and D
5. Proof that point elasticity at point C in figure 9-1 is unit elastic by calculating it
discussion.
Total (infinite) inelastic demand (Ed = 0)
For example, a R5 increase in the price of bread rolls will have no effect on the amount
of bread rolls demanded. Thus, the quantity bread rolls demanded are not influenced
by their price.
Relative inelastic demand (Ed < 1)
The demand curve will therefore have a very steep slope. For example: an increase of
R4 in the price of beef will only cause the quantity beef demanded to decrease by two
units.
Individual activity
Can you think of any other examples of products that would have an inelastic
demand?
1. Unitary elastic demand (Elasticity of one) (Ed = 1)
The demand curve will therefore have a slope of (-)1 For example, a R2
decrease in the price of coffee causes the quantity of coffee demanded to
increase by 2 cups.
2. Relative elastic demand (Ed > 1)
The demand curve would have a flat slope. For example: a decrease in the
price of Coke from R4 to R2 causes an increase in the quantity of Coke
demanded from 2 to 6 cans.
3. Total (infinite) elastic demand
If the price elasticity of demand is infinite it means that there could be a change
in the quantity of the product demanded without any change in the price of the
product. Thus, the demand curve would be horizontal. The demand for tomato
sauce, for example, increases from 2 to 4, while price of tomato sauce
remained R2.
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Study unit 3
The demand for products such as matches, newspapers and shoe laces, tend to be
inelastic because only a small percentage of a consumer's income is spent on it. A
huge increase in the price of matches would have virtually no effect on the demand for
matches. The demand for products such as vehicles, bicycles and television sets tends
to be elastic, for a great percentage of a consumer's income is spent on such products.
A significant increase in the price of vehicles would decrease the demand for vehicles.
Individual activity
Say whether the following products have an elastic or inelastic demand.
Motivate your answer.
Product Elastic / Inelastic Reason
Colgate toothpaste
Water
Fashion clothes
Bread
CD players
discussion.
Note that the slope of a demand curve, flat or steep, is not always an indication of the
elasticity of that demand curve.
3.1.2 Other demand elasticities

 Income elasticity
 Graphical way to illustrate the relationship between Total Income and Elasticity
 Cross-price elasticity
 Cross Elasticity of Substitutes and Compliments
 Law of Engel
Example
We have just learned that the price elasticity coefficient gives us an indication of how
the demand for a product would change if the price of the product changes. For
example, if the price elasticity coefficient is greater than one (Ed > 1), the increase in
the quantity of Coke demanded would be greater than the decrease in the price of
Coke.
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Study unit 3
The total expenditure on a product can be calculated by multiplying the price and the
quantity demanded. Thus:
Total expenditure (TE) = P x Q
Think about it this way: If you buy 10 hamburgers each week and the price of a
hamburger is R5, your total expenditure on hamburgers is 10 x R5 = R50 per week.
Individual activity
But what about total revenue?
Answers
Total expenditure is equal to total revenue, for the amount that consumers spent on a
product is equal to the amount that producers receive for that product. Thus,
Total revenue (TR) = P x Q
Let's take the example of the hamburger again. Suppose you are the only consumer of
hamburgers in the market and Big T is the only producer of hamburgers in the market.
If you buy 10 hamburgers at R5 per week, it means that Big T sells 10 hamburgers at a
price of R5 per week. Thus, your total expenditure, as well as Big T's total revenue, is
equal to R50 per week.
Individual activity
If there is a change in the price of a product, what effect would it have on the total
expenditure and total revenue of that product?
Answers
The effect which the price change would have on total revenue depends on the price
elasticity of the product.
Example
Suppose the price of hamburgers decreases to R4 and the demand for hamburgers
is relative elastic (Ed > 1), the change in the demand for hamburgers would be
greater than the change in the price. The quantity hamburgers demanded would, for
example, increase to 15 hamburgers. Thus, the total revenue from hamburgers is
now:
TR = PxQ
= R4 x 15
TR = R60
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Study unit 3
The total revenue increased from R50 to R60 when the price of hamburgers decreased
from R5 to R4. We can conclude that if the demand for a product is relative elastic, a
decrease in the price of the product leads to an increase in the total revenue.
Individual activity
1. Suppose the price of beer decreases from R3 to R2 and the quantity beer
demanded increases from 200 to 250 cans. Calculate:
a) The arc elasticity of beer
b) The effect of this price change on total revenue
2. Suppose that the change in the beer price from R3 to R2 caused the quantity of
beer demanded to increase from 200 to 300 cans. Calculate:
a) The arc elasticity of demand
b) The effect of this change in price on total revenue.
discussion.
TAXATION.
When taxes are levied on products, it increases the price of the product but also
serves as a source of revenue to the government. The effect that the tax has on the
price and demand of the product, as well as the revenue of the government, is
influenced by the price elasticity of the product.
Example
For example – where the demand is relatively elastic and an increase of R1 in the
price of cheesecake (from R2 to R3) decreases the demand for cheesecake by 200
units (350 to 150). The total expenditure on cheesecake would also decrease if the
demand is relative elastic.
Individual activity
Why would the government want to decrease the demand for a product?
Answers
The government levies import taxes on products to discourage people from importing
luxury products but rather to buy domestically produced products. If the demand for
imported products is elastic, the tax reduces the total expenditure on imports and the
country could save on foreign exchange. The governments also use this tax on imports
to protect domestic industries.
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Study unit 3
The taxes which are levied on products serve as a source of income to the
government. The income which the government receives is equal to the amount of tax
multiplied by the quantity of products sold.
Example
If the demand for the product is inelastic, the increase in the price would not seriously
affect the demand for the product and the total expenditure on the product would
increase.
For example, suppose the tax on fuel is 10c per litre and the consumption of fuel is
1000 litres per day. If the government increases the tax on fuel to 15c, the demand
(consumption) would decrease to 990 litres per day. The tax has increased with 50%,
but the demand has not decreased by 50%, thus the demand for fuel is inelastic.
Let's see what happened to government revenue. Initially, government revenue was:
Revenue = Tax x Quantity
= 10c x 1000
= R100 per day
But when the tax levy increased, the revenue of the government increased to:
Revenue = 15c x 990
= R148,50 per day.
3.1.3 Price elasticity of supply

 Definition of Price Elasticity and Equations
 The calculation of Price Elasticity
 Various Categories of Price Elasticity
 Determinants of Price Elasticity
 Graphical illustrations of Supply Curves of various elasticity

Study the following conscientiously.
The influence that a change in the price of a product has on the supply of that product
varies from one product to another. When the price of sugar increases, for example, by
5%, there would not be a substantial increase in the supply of sugar. But when the
price of refrigerators increases by 5%, the supply of refrigerators would increase
considerably.
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Study unit 3
Example
The point elasticity of supply if the original price (P1) and quantity (Q1) is used, will be:
Es = (Q2 – Q1) ÷ Q1
(P2 – P1) ÷ P1
If the final price (P2) and quantity (Q2) is used, the point elasticity will be:
Es = (Q2 – Q1) ÷ Q2
(P2 – P1) ÷ P2
Usually the original price and quantity are used to calculate the point elasticity of
supply.
Individual activity
Given the following table, calculate the point elasticity of supply by using:
1. a) the original price and quantity
b) the final price and quantity
50 1000
60 2000
2. How do your answers in (a) and (b) compare to each other?
discussion.
Individual activity
Calculate the arc elasticity of supply using the following information:
50 1000
60 2000
discussion.
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Study unit 3

We can also make certain deductions from the value of the price elasticity coefficients
of supply. The different values which the price elasticity coefficients can attain,
determine the effect that a change in the price of the product would have on the
quantity of that product supplied. Again we distinguish between five price elasticity
coefficients:
Total (infinite) inelastic supply (Es = 0):
Thus, the quantity of the product supplied is not influenced by the price of the product.
The supply curve would, therefore, be vertically illustrated. An increase in the price of
silver, from R5 to R10 per gram, has no effect on the quantity of silver supplied.
Relative inelastic supply (Es < 1):
Thus, a one percent decrease in the price of a product gives rise to a less than one
percent decrease in the quantity of the product supplied. The supply curve will
therefore have a very steep slope. For example: a 100% increase in the price of salt
(R2 to R4) only increases the supply of salt by 50% (10 - 15 units).
Unitary elastic supply (Es = 1):
Thus, a one percent increase in the price of the product would lead to a one percent
increase in the quantity of the product supplied. The supply curve will therefore have a
positive slope equal to 1. For example: a R2 (200%) increase in the price of butter
causes an increase of 2 units (200%) in the quantity of butter supplied.
Relative elastic supply (Es > 1):
Thus, a one percent decrease in the price of the product would lead to a more than one
percent decrease in the quantity supplied of that product. Thus, the supply curve would
have a flat slope. For example: a R1 increase in the price of coffee causes the quantity
of coffee supplied to increase by 3 cups.
Total (infinite) elastic supply:
If the elasticity of supply is infinite it means that there could be a change in the quantity
of the product supplied without any change in the price of the product. Therefore, the
supply curve would be horizontal. For example: the quantity of maize supplied
increased by 3 units, while the price of maize remained at R5.
Again note that the slope of the supply curve, steep or flat, is not always an indication
of the elasticity of supply!
Individual activity
What is the effect of the elasticity of supply in connection with the availability of
production factors?
Answers
An increase in production cannot occur when the production factors are scarce and
thus, the supply would be inelastic. The only way in which production can increase
when the supply of the production factors is scarce, is by increasing the efficiency of
the production process. But the increase in production would not be excessive.
If the production factors are readily available, production can easily increase and
therefore the supply is more elastic.
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Study unit 3
Example
The substitutive ability in production

If the same manufacturing structure is used to produce two different products (such
as square and round containers) and the producer can easily switch from the
production of one product to another, the supply will tend to be elastic. The more
specialised the production process, the more inelastic the supply of the product.
Individual activity
1. State whether the supply of the following products are elastic or inelastic.
Motivate your answer in writing.
Product Elastic / Inelastic Reason

Product
Gold
Leather and Plastic shoes
2. Which of the following is not true regarding the price elasticity of demand:
a) it is the proportional change in the quantity of the product demanded
divided by the proportional change in the price of the product.
b) it is equal to the % change in the quantity demanded
% change in the price
c) it always has a positive value.
d) it can be calculated by the following equation: (∆Q ÷ ∆Q) ÷ (∆P ÷ ∆P).
discussion.

In this study section attention was give first to the Price Elasticity of Demand. It can
be defined as the percentage change in the quantity of a product demanded
relative to (thus divided by) the percentage change in the Price of that product. It
was shown that the Price Elasticity of Demand is usually negative (-), although only
the positive value thereof (or the absolute value) are used. In measuring it distinction is
made between point and arc elasticity. Point elasticity measures the elasticity of a
certain point on the demand curve, while arc elasticity measures the elasticity
between two points on the demand curve, like an average. The utility of the Price
Elasticity coefficients was investigated and five different Price Elasticity coefficients
was mentioned, specifically total inelasticity (infinite), inelasticity, unitary elasticity,
elasticity and total (infinite) elastic demand. A value larger than one relatively
elastic and smaller than one is relatively inelastic or insensitive for changes in price.
It was further shown that with an elastic demand, the total income of business would
increase if the price of the product decreases, while total income would decline if
the price of a product with an inelastic demand increases. When the price elasticity
of demand is unitary elastic, total income will remain unaltered, when the price of a
product rises or falls. The factors that influence the Price Elasticity of demand were
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Study unit 3
also identified and discussed. Attention was also given to Cross Elasticity that
indicates to what extend the demand for a product increase or decline when the prices
of substitutes and compliments change.
The section was concluded by studying the Price Elasticity of Supply, which was
defined as the percentage change in the quantity of a product supplied, relative to
(thus divided) as the percentage change in the price of that product. It was also
shown that the price elasticity of supply has as positive (+) value. The coefficients can
be categorised into five groups, namely, total (infinite) inelastic, inelastic, unitary
elasticity, elastic and total (infinite) elastic supply. The section was concluded with
a section on factors which influence the price elasticity of supply.
Reflection
Read the outcomes of study section 1.2 given at the start of chapter 8 of the textbook
again. Have you achieved all the outcomes? If not, revise it!
Make sure that you know all the basic concepts and try to answer the revision
questions at the end of chapter 2.
* Please note: Never be too shy to as questions during the contact sessions. Even if
you think it is a stupid question. Dim-witted questions do not exist. Remember the
things you are now wondering about, are facts that your professor did not know either
once. To obtain a very thorough basis in this subject to build on is very important. If you
can’t or do not wish to ask a question in class, you should go to your lecturers office
and ask him or her there. But do not let things that you do not understand or wonder
about just slip by.

If you wish to improve your math skills, wish to understand some concepts better, or
just enjoy maths, you might consider reading one of the following books. They are all
excellent, easy to use and mostly fun:
NEILL, H. & ABBOTT, P. Teach Yourself Calculus. ISBN-13: 978-0-340-86743-3.
Published by Teach Yourself [Excellent algebra book to prepare you for university
maths].
AMDAHL, K. 1995. Algebra Unplugged. ISBN-13: 978-0-9627815-7-5. Published by
Clearwater Pub. Co.
NEILL, H. & P Abbott, P. 2003. Teach Yourself Calculus. ISBN-13: 978-0-340-86747-1.
Published by Teach Yourself.
THOMPSON, S.P. GARDNER, M. 1999. Calculus Made Easy. ISBN-13: 978-0-333-
77243-0, Published by Palgrave Macmillan. (Sub-title: Being a very-simplest
introduction to those beautiful methods of reckoning which are generally called by the
terrifying names of the differential calculus and the integral calculus.) The 1920-edition
from Saint Martin's Press is just as good and much cheaper [Best book on Calculus
ever!] [In library: 515 THO].
AMDAHL, K. & LOATS, J. 2001. Calculus for Cats. ISBN-13: 978-0-9627815-5-1.
Published by Clearwater Publishing Co.
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Study unit 3
PICKOVER, C.A. 2003. The Calculus and Pizza - A Cookbook for the Hungry Mind.
ISBN-13: 978-0-471-26987-8. Published by John Wiley & Sons.
KELLEY, W.M. 2007. The Humongous Book of Calculus Problems: For People Who
Don't Speak Math. ISBN-13: 978-1-59257-512-1. Published by Alpha Books. [Lovely
book. Excellent explanations, shows every step and reasonable price].
Find most of them at our university library or buy it from your nearest bookshop,
http://www.loot.co.za or http://www.kalahari.net on the internet.
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Study unit 4
Study unit 4
THEORY OF CONSUMPTION
Study time
The estimated study time for this study section is about 10 hours.
Study material
This study section is based on chapter 7 of the textbook of Mohr & Fourie.
Study outcomes
At the end of this study unit you as the learner should be able to:
 Discuss the aim or utility of consumer’s choices and need satisfaction
 Describe consumer utility, marginal utility and weighted marginal utility
 Derive marginal and total utility and illustrate it by means of graphs
 Explain the relationship between total, average and marginal values
 Derive the law of diminishing marginal utility and illustrate it with graphs
 Formulate the conditions for consumer equilibrium and illustrate it by means of
graphs
 Derive the demand curve by means of weighted marginal utility
 Proof that consumer equilibrium represents maximum total utility of the
consumer
 Calculate the combinations of any two products where total utility is maximised
and consumer equilibrium exists
 Discus the related concepts and definitions
 Apply the definitions and terminology in practice
The objective of this study section is to derive consumer equilibrium and the demand
curve.
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Study unit 4
Consumer behaviour is investigated in greater depth in this study section. In the
previous section the extent to which consumers will react to price changes was
determined as well as the factors that determine it. In this study section the focus will
be on the utility approach with which the demand function and consumer equilibrium
can be derived. This study section is about consumer demand theory according to the
utility approach. The satisfaction or use that a consumer receives from the
consumption of a product is investigated. This also implies that a saturation point and a
budget constraint exists, which should also be taken into regard on the demand side.
Utility can also be negative due to storage requirements or other problems with
shortages. It is also true that too much of something good is usually bad. All people are
consumers and that emphasises the importance of this study section.
4.1.1 Total utility and marginal utility

 What is meant with utility here. It is usually best to study Definitions by heart, but
also ensure that you know what it means and that you can explain it in your own
words.
 We prefer to rank utility ordinal, which means we determine what is being
preferred more that something else, according to one’s ranking order of
preference, because it is difficult to measure utility. Now it is much easier to say I
prefer this one above that and another one even more.
 Total utility increases as more of a product is being consumed
 Marginal utility is very important, make sure you understand the concept well and
that you are able to calculate marginal utility from total utility given in the table (or
schedule). “Marginal” means additional or extra. It is every time the extra use that
you would obtain by consuming an additional unit of that product.
(MU2 = TU2 –TU1 and TU2 = TU1 + MU2)
 Note the Law of Diminishing Marginal Utility. As one uses more of a product the
extra value that you get out of it is becoming constantly less.
 Box 10.1 explains the concepts further and Box 10.2 looks at the advantages of
the utility approach in determining “value”
While the total utility increases when one is using a product, the marginal utility is
declining all the time. If a person is very thirsty, one glass of water would be of much
value to him, the value of the second glass of water would also be welcome, but not as
valuable as the first. If that person drinks a third glass of water, it would be a bit difficult.
The person will only drink a fourth glass of water if he or she is being forced to do so,
and a fifth glass of water would be painful. The extra value would be negative then.
This implies that marginal utility is declining all the time as more of the product is being
consumed and later the marginal utility would even have a negative value. Marginal
utility consequently declines continually as more of a product is being consumed and
later marginal utility becomes negative. See the table in the textbook and you will
notice that the figures of marginal utility declines as you move down the table.
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Study unit 4
Example
Consumption is for example, when you have a need for something sweet, you may
eat (consume) an economic product, such as a chocolate to satisfy your need.
Utility is for example, if you feel twice as satisfied when driving a BMW instead of
your Uno, your utility would double when you buy yourself a BMW.
Total utility increases as the unit’s consumption increases. When you eat, for
example, a box of chocolates, your total utility increases with each chocolate you eat
from the box. In other words:
TU = Utility1 + Utility2 + Utility3 +.....Utilityn, where
Utility1 = the utility that you get by consuming the first chocolate in the box.
Utility2 = the utility that you get by consuming the second chocolate in the box.
Utilityn = the utility that you get by consuming the last chocolate in the box.
Marginal utility is the difference between the total utility you had before consuming
the additional product and the total utility you have after consuming the additional
product. Let's take the box of chocolates example again. The marginal utility is that
extra utility which you get by eating one more chocolate out of the box. Thus, the
marginal utility of the sixth chocolate that you eat out of the box is equal to:
MU6 = TU6 – TU5
Note that the total utility increases and that the marginal utility decreases.
Individual activity
Draw a graph of Table 10-1 of your textbook with marginal Utility (MU) and Total
Utility (TU) on the vertical axis and the amount consumed on the horizontal axis.
Notice that when TU reaches a maximum MU = 0.
Take your graph with you to the contact session / group meeting for discussion.
Individual activity
What can we gather by looking at table 10-1 in your textbook?
Answers
From the table you can see that marginal utility is zero when total utility is at its highest
point.
The marginal utility is equal to the difference between the two total utilities. For
example, the marginal utility of the fifth banana is:
MU5 = TU5 - TU4
= 144 - 132
MU5 = 12
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Study unit 4
The total utility is equal to the sum of all the marginal utilities. For example, the total
utility of the first three bananas is:
TU3 = MU1 + MU2 + MU3
= 50 + 35 + 29
 TU3 = 114
Total utility tend to increase, but at a decreasing rate. For example, the increase in total
utility between the first and the banana is 35 (85 – 50), while the increase in the total
utility between the fifth and the sixth banana is 6 (150 – 144).
Individual activity
Use Table 7-1 in your textbook and write an equation to derive

1. The marginal utility of the second banana consumed.
2. The total utility of the first six bananas.
3. At which number of bananas is marginal utility zero and total utility at its highest
point?
discussion.
Individual activity
Duncan has eight plates of pizza in front of him. The following table indicates some
values of his marginal and total utility when he eats all the plates of pizza.
Plates of Pizzas Total Utility (TU) Marginal Utility (MU)
1 10
2 18
3 6
4 4
5 30
6 0
7 -2
8 23
1. Complete the table.
2. Draw Duncan's marginal utility curve.
discussion.
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Study unit 4
Marginal values have special meaning in Economics. Marginal refers to the “additional”
or “extra” which is consumed or produced. It is that extra consumer that considers the
price and rather decides not to buy a product, or not to go to a movie cinema, because
it is too expensive, which eventually determines the price and quantity. A person must
ensure that he or she gets value for their money. It must be ensured that the extra
spent equals the extra value or utility obtained. Then resources are optimally allocated.
This is true for the consumer, investor and producer. Maximum profits are also realised
at the point where the extra costs (MC) equals the extra or additional income (MR),
which are obtained from the production or sales of an additional unit. (MC = MR).
4.1.2 Consumer equilibrium

Pay special meticulous attention to:
 The concepts of marginal utility and weighted marginal utility
 The calculation of total nut, marginal utility and weighted marginal utility in tables
 The sketch of graphs of total and marginal utility
 The two conditions of consumer equilibrium.
Consumer equilibrium is where a consumer maximizes his total utility, given his
income.

The marginal utility which a consumer gets when consuming different products, such
as wine and beer, determines in which order the consumer will arrange his
preferences. Everyone tries to obtain the best value for their money. One buys a
smaller quantity of products which are less useful to us and a greater quantity of the
product which provide us with more satisfaction of our needs. If there are only two
products in the economy for example, wine and beer, and Chris prefers wine above
beer, she would buy a greater quantity of wine than beer.
Example
The following example will show that the total utility of a consumer is maximised if
(MUx ÷ Px) = (MUY ÷ PY)
and the consumer experiences equilibrium. Remember, when total utility is
maximised the consumer also experiences equilibrium.
Assume that Duncan’s income is R12,00 and there are only two products in the
economy, apples and bread. Suppose that the price of an apple is R2 (Pa = 2) and
the price of bread R1 (Pb = 1). The following table shows Duncan’s marginal utilities
of the two products:
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Study unit 4
Table: Duncan’s Marginal Utility
Quantity Marginal Quantity Marginal

Price (Pa) Price (Pb)
apples Utility (Mua) bread Utility (Mub)
1 16 R2 1 11 R1
2 14 R2 2 10 R1
3 12 R2 3 9 R1
4 10 R2 4 8 R1
5 8 R2 5 7 R1
6 6 R2 6 6 R1
7 4 R2 7 5 R1
8 2 R2 8 4 R1
To prove that Duncan’s utility is maximised where (MUa ÷ Pa) = (MUb ÷ Pb), we must
execute four steps:
Step 1: Determine the combinations of apples and bread which Duncan

can afford:
The assumption that Duncan has a fixed income of R12 is called the budget
constraint. The budget line is a graphical presentation of the budget constraint and
indicates the various combinations of the two products which Duncan can purchase
with his given income.
Remember, the price of bread is R1 and the price of an apple is R2, thus if Duncan
spends all his income on apples he would be able to buy 6 apples (R12 ÷ R2) and 0
loafs of bread. If he spends all his income on bread, he would be able to buy 12 loafs of
bread (R12 ÷ R1) and no apples.
The possible combination of apples and bread which can be bought with R12 is
illustrated by the budget line. If Duncan consumes 3 apples and 4 loaf of bread, he
would only spend:
(3a x R2) + (4b x R1) = R7
Thus, he would still have R5 left to spend and, therefore, he hasn't reached maximum
utility. On the other hand, if Duncan consumes 5 apples and 7 loaf of bread, he would
spend:
(5a x R2) + (7b x R1) = R17
Thus, Duncan doesn't have enough money to consume B's combination.
Individual activity
Draw the budget line from the data and write down all the combinations of apples and
bread that Duncan can afford.
discussion.
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Study unit 4
Step 2: Calculate die total utility of every product:

In order to calculate the total utility for each combination of apples and bread that
Duncan can afford, the total utility after each additional loaf of bread and apple that
Duncan consumes must first be calculated.
Individual activity
Use the table and calculate Duncan’s total utility for apples as well as bread after his
consumption of each additional apple or bread.
Quantity Total Utility Total Utility

Quantity Bread
Apples (TUa) (TUb)
1 1
2 2
3 3
4 4
5 5
6 6
7 7
8 8
Step 3: Calculate the total utility for each combination of products:

If we use the total utility of each product which we calculated in the previous step (step
2) and the combinations of bread and apples Duncan can afford (as calculated in the
exercise, the total utility of each combination can be calculated. For example, if Duncan
consumes 2 apples and 8 loaf of bread, his total utility would be:
2a + 8b = 30 + 60
= 90
(The 30 and 60 is acquired from the table in the exercise, where 2 apples gave Duncan
a total utility of 30 and 8 loafs of bread gave him a total utility of 60).
Individual activity
1. Calculate the total utility for each combination of apples and bread which
Duncan can afford, given his budget constraint and the data in the tables.
2. At which combination of apples and bread is Duncan’s total utility at a
maximum?
discussion.
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Study unit 4
You will see that there is only one combination of apples and bread where the total
utility is at a maximum, given Duncan’s budget constraint of R12.
Step 4: Calculate (MUa ÷ Pa) and (MUb ÷ Pb) of the optimum combination
The marginal utility (MUa) of the third apple is 12 and the marginal utility (MUb) of the
sixth loaf of bread is equal to 6 (see the table). If MUa is divided by the price of apples
(Pa = R2) and MUb is divided by the price bread (Pb = R1), then one gets:
MUa ÷ Pa = 12 ÷ 2
= 6
and MUb ÷ Pb = 6÷1
= 6
You can see that the (MUa ÷ Pa) as well as (MUb ÷ Pb) are both equal to 6 when 3
apples and 6 loafs of bread are consumed, thus
(MUa ÷ Pa) = (MUb ÷ Pb) = 6
This proves that the optimum combination of products in a state of consumer
equilibrium can be calculated by the ratios of (MUa ÷ Pa) and (MUb ÷ Pb).
Individual activity
1. Complete the table if the price of apples is still R2 and the price of bread R1
and Duncan’s marginal utilities are:
Qa MUa MUa ÷ Pa Qb MUb MUb ÷ Pb

1 16 1 11
2 14 2 10
3 12 3 9
4 10 4 8
5 8 5 7
6 6 6 6
7 4 7 5
8 2 8 4
2. Select all the possible combinations where (MUa ÷ Pa) = (MUb ÷ Pb).
3. Calculate the amount that each of the possible optimum combinations would
cost and indicate the maximum combination which Duncan can afford if his
income is only R12..
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Study unit 4
Consumer equilibrium is where:
The extra utility (marginal utility) obtained from the last Rand spent on each product is
equal, thus:
(MUx ÷ Px) = (MUY ÷ PY)
The consumer spends all his or her income
4.1.3 Derivation of the consumer's demand curve

In the previous section we indicated the way in which a consumer maximises his total
utility with his available income and existing prices. It is realistic to assume that a
consumer will be willing to pay a higher price for the first unit of a product, such as
a cup of coffee, than for the second or the third cup of coffee. This is because the
marginal utility a consumer receives by consuming the first cup of coffee is usually
higher than the marginal utility of the second and third cup of coffee. And a consumer
would not be willing to pay a high price for a low level of utility!
The higher the marginal utility a consumer receives from using a product, the more he
is willing to pay for that product. Thus, high marginal utility coincides with high prices.
The relationship between marginal utility and the quantity of a product consumed is
substituted by the relationship between the price and quantity of a product consumed
to derive the individual (consumer's) demand curve. The individual demand curve
was defined as a graphical presentation of the quantity of a product or service
which a consumer is willing to buy at various prices.
It was also showed that it indicates the relationship between the quantity of a product
demanded and the price of the product and it normally has a negative slope. In the
example of Duncan (the previous section), it was apparent that 3 apples and 6 loafs of
bread yielded the highest total utility. If a demand curve for apples needs to be derived,
one point on the demand curve will be a quantity of 3 apples at a price of R2.
To derive a demand curve, one needs to determine at least one more point.
Individual activity
Assume that the price of apples rises to R4, while the price of bread remains the
same. Which amount of apples will Duncan be prepared to buy at a price of R4?
Answers
If Duncan wants to maximise his utility, he must consume these quantities of apples
and bread where (MUa ÷ Pa) = (MUb ÷ Pb). Remember, the price of apples has
increased from R2 to R4!
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Study unit 4
Individual activity
Complete the table if the price of apples is R4 and the price of bread is R1 and
Duncan’s marginal utilities are
Qa MUa MUa a Qb MUb MUb b
1 16 1 11
2 14 2 10
3 2 3 9
4 10 4 8
5 8 5 7
6 6 6 6
7 4 7 5
8 2 8 4
1. Select all the possible combinations where (MUa ÷ Pa) = (MUb ÷ Pb).
2. Calculate the amount that each of the possible optimum combinations would
cost and indicate the maxim
Answers
From your calculation it is clear that if the price of apples increases from R2 to R4,
Duncan would only demand (buy) one apple, instead of three (see the Law of
Demand). Thus, we have derived another point on Duncan’s demand curve for apples,
a quantity of one apple if the price is R4.
Individual activity
1. Why is water, which is essential to life, cheaper than diamonds which is not as
essential to life?
2. Which of the following is not true regarding marginal utility?
(a) It is the extra utility received through using one additional unit of the
product.
(b) MUn = TUn - TUn-1
(c) MU = Utility1 + Utility2 + Utility3 ... + Utilityn
(d) It tends to decrease when more and more of a product is used.
discussion.
Make sure you know how to derive a demand curve from a table with TU and MU
figures and illustrate it on a graph.
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Study unit 4

At the commencement of this study section a distinction was made between four
important concepts, namely consumption, utility, total utility (TU) and marginal
utility (MU). The relationship between total and marginal utility was discussed and
graphically illustrated. Total utility increases when more is being consumed of a
product, while marginal utility tend to decline when more units of a product are
consumed. From this observation the Law of Diminishing Marginal Utility is derived.
Next it was indicted that consumer equilibrium occurs at the point where the
consumer maximises total utility, with his or her income. When a consumer maximises
his or her total utility, it can be represented as (MUx ÷ Px) = (MUy ÷ Py). Four steps were
performed to indicate this state of equilibrium.
The first step is to determine the different combinations of two products which the
consumer can afford, given his income, also called his budget constraint. A budget
line is drawn which indicates the combinations of the two products which the consumer
can afford. The second step is to calculate the total utility for each product and in the
third step the total utility of each combination of products is calculated and the
optimum combination which the consumer can afford, is chosen. In the fourth step the
(MUx ÷ Px) and the (MUy ÷ Py) of the optimum combination is calculated.
The study section was concluded by deriving the consumer's demand curve. At
consumer equilibrium, one point on the demand curve is already know. By changing
the price of the product, the equilibrium condition (MUx ÷ Px = MUy ÷ Py) is disturbed.
The quantity of the product which the consumer will demand changes, to ensure that
he is experiencing equilibrium, and a second point on the demand curve is derived. By
combining these two points, the demand curve for a consumer can be drawn.
In study unit 1 attention was first given to the dynamic interaction of Demand-and-
Supply in the market. Then it was determined how elastic consumers and producers
are for changes in price thirdly consumer theory was studied. The following study
section focuses on the supply side by studying the theory of production.
Reflection
Read through the learning outcomes of study section 1.3 once more and make sure
that you reached all the objective outcomes. If not, go through the work once more.
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Study unit 5
Study unit 5
THEORY OF PRODUCTION AND MARKET STRUCTURES
Study time
The estimate time allocated for the completion of this study unit is about 40 hours.
Study material
This study unit is based on the textbook:
MOHR, P. & FOURIE, L. Chapters 9 to 11.
Study outcomes
At the end of this study unit, you should be able to:
Define, discuss, illustrate and calculate concepts about the production function of a
producer, as well as the cost aspects of the producer, in the short and long-term
 identify and explain different forms of market competition
 describe the assumptions of perfect competition
 draw and explain the demand curve of an individual firm in a perfect
competitive market, As well as a monopoly
 distinguish between perfect competition, monopolistic competition, oligopoly
and monopoly and define them all
 Distinguish between income concepts and profit maximisation of the producer
in the context of perfect competition, as well as the monopolist. Discuss it and
illustrate it with the aid of graphs.
 evaluate the merit of monopolies and the criticism against them
 explain the purpose of competition policy
 evaluate various forms of competition using criteria of efficiency as well as
ethics
 explain how a perfect competitive labour market function
 illustrate demand and supply in the labour market graphically and utilise it to
explain changes in the labour market
 Discuss, calculate and illustrate the ways that compensation of labour as a
factor of production is determined in the labour market.
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Study unit 5
 discuss Macro-economic aspects of the labour market in South Africa briefly

 explain Malthus’ view of overpopulation, implement the ideas and give criticism
 illustrate the markets for natural resources, capital goods and entrepreneurship
graphically and explain the basic concepts
 Participate effectively in groups
In the previous study unit the utility and demand of the consumer were analysed. But in
a micro-economic model, there is not only a consumer who exercises a demand –
there is also a producer. The producers supply products and services to the
consumers. The first economic assumption is maximum profit. The motive of the
producer is to make a profit. This motive is valid for the farmer, the shoe-producer, the
pharmacists, the hairdresser and any other producer of products and services.
The questions faced by the producer are addressed in this study unit. These questions
include:
 The quantity of products to produce;
 The price which must be asked for the products;
 The costs associated with the production of these products;
 The maximum revenue and profit which the producer can receive.
Although the costs associated with production influences the decisions of the producer,
the market structure in which the producer finds himself also influences the price of
his product, his profit and the quantity he produces. If the industry is for instance a
monopoly, the quantity produced are usually less and prices higher than it would have
been in a perfectly competitive free market. In the free market all the producers and
consumers are price takers and no single one can push the price up or down, because
there are just too many market participants. With monopolistic competition, as one
finds with different types of toilet soap, or at an oligopoly, where there are only a few
firms in the industry, like the motor vehicle industry, production decisions of one firm
would effect the conduct of another firm or market participants.
The purpose of this Study unit is to introduce the student to various forms of
competition and to learn the basic assumptions of the various forms of competition on
the market. This Study unit is concerned with the basic principles of competition. The
more technical features of production theory and aspects like equilibrium of individual
businesses and profit maximisation will be addressed in the next module. In this study
section students should primarily get acquainted with the characteristics, advantages
and shortcoming of perfect competition, monopolistic competition, oligopoly and
monopoly. Free markets with perfect competition are today regarded as superior, and
the student must be able to explain why that is the case, or why he or she differs from
that view, and discuss the purpose of competition policy. The final section of the Study
unit pays special attention to the labour market, because labour (also called: human
capital) is one of the most important production factors; and it will improve the student’s
insight into the operation of the economy, and especially supply-and-demand.
This study unit therefore also gives attention to the various forms of competition. The
basic assumptions of the various forms of competition on the market is important, as
well as the basic principles of competition. Students should get acquainted with the
characteristics, advantages and shortcoming of perfect competition, monopolistic
competition, oligopoly and monopoly. Free markets with perfect competition are today
regarded as superior, and the student must be able to explain why that is the case, or
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Study unit 5
why he or she differs from that view, and discuss the purpose of competition policy.
The final section of the Study unit pays special attention to the labour market, because
labour (also called: human capital) is one of the most important production factors; and
it will improve the student’s insight into the operation of the economy, and especially
supply-and-demand.
In the next section attention is given to production in the free market.
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Study unit 5
Study section 5.1

Theory of production
Study time
The time scheduled for this study section is about 10 hours.
Study material
This study section is based on Mohr & Fourie Chapter 9.
Study outcomes
 Identify and explain various forms of competition
 Define income, cost, and profit concepts
 Describe the assumptions of perfect competition
 Distinguish between total, average and marginal product of a variable input
factor
 Explain the relationship between the law of diminishing returns and shape of
the short-term total, average and marginal product curves and illustrate it with
graphs
 Distinguish between total, average and marginal cost
 Explain the relationship between short-term production and cost curves
 Explain the nature of long-term production and costs and illustrate it by means
of graphs
The objective of this study section is to determine the production output as well as the
different short- and long-term costs of a typical producer.
5.1.1 Marginal revenue, production and profit

You already encountered and evaluated various forms of market competition in the
using efficiency and ethical criteria. In this study unit the profit maximising position of
the producer is studied in more detail. The characteristics of the various market forms
that were studied in the previous Economics module are still relevant. In this study
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Study unit 5
section the focus is on the production functions and cost functions of producers in a
free competitive market.
Pay special attention to the following:

 The first economic assumption is maximum profit
 Total Income (TR); definition and calculation of it
 Average income (AR); definition and calculation of it
 Marginal- of grensinkome (MR); definition and calculation of it
 Total-, average and marginal cost (TC, AC & MC) and the calculation of it
 Economic concept of profit
Note the difference between the Economic concept of profit and cost, and Accountants
interpretation of these concepts. Why? Read Box 11-3 and the explanation of it.
Example
For example: the following table indicates the different quantities of tomato sauce
which consumers will demand (and thus a producer will sell) at different prices and
his total revenue which the producer will receive.
Table: Total Revenue of a Tomato Sauce Producer
Price (Rand) Quantity Total Income

20 96 20 x 96 = R1920
18 97 18 x 97 = R1746
16 98 16 x 98 = R1568
14 99 14 x 99 = R1386
12 100 12 x 100 = R1200
If the Price of tomato sauce is R20, the total revenue of the tomato sauce producer is:
TR = PxQ
= R20 x 96
TR = R1 920
If the price of tomato sauce is R18, the total revenue of the tomato sauce producer is:
TR = PxQ
= R18 x 97
TR = R1 746
Consider this example again. The following table indicates the total and average
revenue of the tomato sauce producer.
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Study unit 5
Table: The Total and Average Revenue of a Tomato Sauce producer
Price Total Income Average Income

Quantity
(Rand) (Rand) (Rand)
20 96 1 920 1 920 ÷ 96 = 20
18 97 1 746 1746 ÷ 97 = 18
16 98 1 568 1568 ÷ 98 = 16
14 99 1 386 1386 ÷ 99 = 14
12 100 1 200 1200 ÷ 100 = 12
If the price of a bottle tomato sauce is R20, the average revenue of the tomato sauce
producer is:
AR = TR ÷ Q
= R1 920 ÷ 96
AR = R20
If the price of tomato sauce is R18 per bottle, the average revenue of the producer is:
AR = TR ÷ Q
= R1 746 ÷ 97
AR = R18
This shows that AR = P.
Individual activity
The following table indicates the quantity pencils which will be sold at different prices.
Complete the table.
Quantity Average
Price of pencils Total Income
pencils Income
50c 500
R1 450
R1,50 400
R2 300
discussion.
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Study unit 5
Example
For marginal revenue, take the example of the tomato sauce producer again. The
marginal revenue of the tomato sauce producer is calculated in the next table.
Table: The Marginal Revenue of the Tomato Sauce Producer
Price Total Income Marginal Income

Quantity
(Rand) (Rand) (Rand)
20 96 1 920 -
18 97 1 746 - R174
16 98 1 568 - R178
14 99 1 386 - R182
12 100 1 200 - R186
If the producer decides to produce and sell 97 bottles tomato sauce instead of 96, his
marginal revenue for the extra tomato sauce is:
MR = ∆TR ÷ ∆Q
= (1 746 - 1920) ÷ (97 - 96)
= - 174 ÷ 1
MR = - R174
If the producer decides to produce and sell one more bottle tomato sauce, thus 98, his
marginal revenue for the extra bottle tomato sauce is:
MR = (1 568 - 1 746) ÷ (98 - 97)
= - 178 ÷ 1
MR = - R178
The negative sign shows us that the producer’s total revenue decreases if he produces
and sells an extra bottle tomato sauce.
Individual activity
Complete the following table:
Price Marginal Revenue
Quantity
(Rand) (Rand)
10 1
9 2
8 3
7 4
6 5
Take your answers without to the next contact session or group meeting for discussion.
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Study unit 5
Example
In the case of a perfect competitor, the price of the product equals the average and
marginal revenue of the product. The following example illustrates this: Assume that
the price of coffee is fixed at R5 a pack. If a producer sells 50 packs of coffee, the
total revenue would be:
TR = P x Q
= R5 x 50
TR = R250
The average revenue that the producer receives is:
AR = TR ÷ Q
= R250 ÷ 50
AR = R5.
If the producer decides to increase his production to 51 packs of coffee, his total
revenue would now be:
TR = P x Q
= R5 x 51
TR = R255
Remember, the price is fixed at R5. Thus the extra revenue (marginal revenue) that
he receives from the extra pack of coffee produced is:
MR = ∆TR ÷ ∆Q
= (255 - 250) ÷ (51 - 50)
= 5÷1
MR = R5
From this example, it can be seen that the P = AR = MR = R5.
5.1.2 The production function

The production function indicates the amount of products or services which a
producer can produce (output) with a certain combination of production factors
(inputs), given the current technology. The production function shows the relationship
between input and output. The production function of motor vehicles, for example,
indicates the quantity of motor vehicles which can be produced by using a certain
amount of labourers, buildings, iron, leather and machinery.
In the production of wheat, land and expensive machinery are examples of fixed
production factors, because it cannot easily be increased or decreased in a short
time period.
Take special note of the following:
 Notice of the Neoclassical assumptions that as made with the theory of
production
 The difference between fixed and variable inputs
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Study unit 5
 In the short-term certain inputs, like capital goods and contracts, are fixed
 The production function depends on the current state of technology
 In the long-term everything can change
Study Box 11-6. The marginal product is basically the slope of the total production
function. At school we were taught that the slope of a graph, or the rate at which the
slope changes, can be calculated by determining the tangent (MP = ∆TP/∆N), or by
differentiating the function, in other words: MP = dTP/dN.
Individual activity
Think for a moment about the difference between the following concepts: total,
average and marginal. Write down what you understand about each.
The total physical product is the total output which is generated by combining a certain
amount of a variable input (labour), with a certain amount of a fixed input (capital).
Thus, it is also known as total production.
Example
The following table indicates the amount of labourers and capital (machinery) which
is used in a motor vehicle assembly plant. It also indicates the total output, or in other
words the quantity of products produced.
Table: Input and Output of a Motor Vehicle Assembly

Factory
Number of Quantity of
Total Output
Labourers Capital Goods
1 3 100
2 3 210
3 3 330
4 3 405
5 3 475
6 3 500
7 3 490
From the table we can see that:
 The quantity of capital used in the production process remains the same (capital
is a fixed production factor over the short-term).
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Study unit 5
 The number of labourers which the factory employs differs and the more
labourers the factory employs, the more motor vehicles are produced (up to a
certain point).
 If the factory uses one labourer, the total output would be 100 motor vehicles. If
the factory employs two labourers, the total output would be 210 motor vehicles,
until the seventh labourer is employed.
The total product increases up to a certain point (6 labourers) and then decreases.
5.1.3 Cost functions

Take note of the following:
 The difference between fixed and variable cost
 In the long-run some costs fixed, especially the costs of capital goods and
contracts
 Ensure that you are able to derive the figures of the Total Cost (TC) from the
Total Fixed Cost and the Total Variable (TC = TFC + TVC). You should also be
able to calculate the average costs from the other columns as well as the
marginal cost MC. Notice that there are several ways to calculate AC from the
table, For example: AC = TC/TP or AC = AFC + AVC. Marginal cost is the
additional cost to manufacture additional output. MC = ∆TC/∆TP If thuis is only
one additional unit more that is produced, the marginal cost is just the extra cost
for that product, (∆TP = 1) and that equals the difference in total cost: MC = ∆TC
Cost theory is to a large extent a mirror image of production theory. Production
functions are parabola with its concave area showing to the top (curved in), while the
ball of die parabola of production functions points to the top. MP cuts AP in its
maximum point (turning point), while the MC curve cuts the AC and AVC curves at their
minimum point (turning point). The shapes of both MP and MC are due to the law of
diminishing returns.
When only the marginal cost or income of the following unit produced is considered,
the part below the line in the equations
MR = ∆TR/∆TP and MC = ∆TC/∆TP
may be omitted. (Remember we represent production as TP or Q so TP= Q)
Then: MR = ∆TR and MC = ∆TC or MR2 = TR2 - TR1 and MC2 = TC2 - TC1
Take note: Do not get confused: MR and MC are income and cost per output, we
obtain it by dividing with the output. But Marginal Product (MP) is about the productivity
per worker, we calculate it thus by dividing with the amount of input, usually labour (N):
MR =∆TR/∆TP and MC = ∆TC/∆TP but MP = ∆TP/∆N
Example
 Examples of fixed costs include the rent of a building, interest on borrowed
capital and insurance premiums. From the examples of fixed costs, we can see
that the fixed costs are usually associated with fixed production factors.
 Because the amount of total fixed cost does not change as the quantity
produced changes, the total fixed cost curve is a straight horizontal line.
Thus, for every quantity produced, total fixed cost remains the same.
 Note that even if no products are produced, the producer still has to pay the
total fixed cost.
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Study unit 5

The total variable cost will increase when production increases and will decrease when
production decreases. Examples of variable costs include raw material costs and
labour costs (wages). We can see that variable costs are associated with all the
variable production factors (inputs) that are used, such as labour.
The total variable cost curve is a positive function, because an increase in the
quantity of a product produced will increase the variable cost.
Total cost will increase if the quantity produced increases, because of total variable
cost which increases with an increase in production. Thus, total cost (TC) will only
change when total variable cost (TVC) changes. But the total cost curve will not start at
the zero mark, because of the presence of total fixed cost.
Individual activity
Total Total
Total Product Total Cost
Fixed Cost Variable Cost
0 100
1 200
2 250
3 180
4 200
5 310
discussion.

The average costs refer to the cost per unit of production. These costs are important
for short-term analysis, because average costs are used to determine the producer's
production output, maximum profit and the quantity of variable production factors which
will be employed.
The average variable cost curve first slopes downwards and then upwards. This
downward and upward movement can be explained by the following example. Suppose
that labour is the only variable production factor.
If the producer employs 2 labourers for a R100 per week, he can produce 4 motor
vehicles per week. Thus, the average variable cost is 200 ÷ 4 = R50.
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If the producer employs 4 labourers for a R100 per week, he can produce 10 motor
vehicles per week. Thus, the average variable cost per motor vehicles is R400 ÷ 10 =
R40.
There was a downward movement from R50 to R40 per motor vehicles.
But if the producer employs 8 workers, they would start to get into each other's way,
and they would only produce 16 motor vehicles. Thus, the average variable cost per
motor vehicles has increased to 800 ÷ 16 = R50.
The average fixed cost curve has a negative slope – which is due to the fact that total
fixed cost remains the same, regardless of the quantity of products produced. For
example: If the total fixed cost is R100 and only 1 product is produced, the average
fixed cost will be 100 ÷ 1 = R100. But if 4 products are produced, the average fixed
cost declines to 100 ÷ 4 = R25.
Individual activity
Complete the following table: (2)
Total Total Ave. Ave.
Quantity Total Marginal
Fixed Variable Fixed Variable
Produced Cost Cost
Cost Cost Cost Cost
0 70 0
1 70 25
2 70 50
3 70 75
4 70 100
5 70 125
Answers
Remember:
TC = TFC + TVC
AFC = TFC / Q
AVC = TVC / Q
MC = TC
Total Total Ave. Ave.

Quantity Total Marginal
Fixed Variable Fixed Variable
Produced Cost Cost
Cost Cost Cost Cost
0 70 70 0 - 0 -
1 95 70 25 70 25 25
70+50 70/2= 50/2= 120-95=
2
= 120 70 50 35 25 25
3 145 70 75 23.3 25 25
4 170 70 100 17.5 25 25
5 195 70 125 8 25 25
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Individual activity
Total Product Total Cost TVC AFC AVC AC
0 100
1 120
2 150
3 180
4 190
5 190
discussion.
Individual activity
Use the information to calculate the marginal cost and complete the table:
Total Product Quantity Labourers Wage Marginal Cost
10 2 10
11 4 10
12 7 10
13 11 10
14 15 10
13 20 10
discussion.
From the relationship between the marginal, average variable and average total cost
curves, the following can be derived:
 The MC-curve reaches its turning point before the AVC and AC-curves.
 The MC-curve intersects the AVC-curve at its minimum point.
 The MC-curve intersects the AC-curve also at its minimum point.
 The MC-curve lies below the AC-curve when average cost is decreasing and MC
lies above the AC-curve when the average cost increases.
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Study unit 5
Individual activity
1. Complete the following table:
TP TFC TVC TC AFC AVC AC MC

1 60 30
2 40
3 45
4 55
5 75
6 120
2. Use the information in the table and graphically illustrate the AVC, AC and MC
curves on the same graph.
3. What do you observe regarding the intersection of the three curves?
discussion.
The marginal cost curve (MC) is very important because the rising section above the
AVC is in fact the individual produce’s supply curve.
Individual activity
Now we know what the revenue of a producer includes, but what is meant by the
profit of a producer?
Answers
Profit is the remuneration for the production factor entrepreneurship. This profit forms
part of the total cost of the producer.
5.1.4 Production in the long-run

Take special note of the following:
 What is meant by the long-term
 In the long-run all inputs and variables variable
 Long-term marginal cost and its graphical representation
 The relationship between short and long-run cost curves
 Take note what is meant with economies of scale
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Study unit 5
Notice that the LRAC is an envelope curve of the short-term cost curves of plants of
various sizes.

Each level of output has a different optimal plant size associated with it.
Suppose that 10 products (output = 10) are produced. The producer would rather
produce these 10 products in the plant size where the short-term average cost curve
(SRAC) implies the lowest level of costs to the producer.
Individual activity
Choose the one best correct answer from the following:
A production factor which cannot easily be altered over the short-term, is known as
a) Fixed production factor.
b) Average fixed cost.
c) Variable production factor.
d) Average variable cost.
discussion.

This study section commenced by defining the production function as the amount of
products and services which a producer can produce with a certain combination
of production factors, given the current technology. Distinction was made between
two types of production factors, namely fixed and variable production factors. An
example of a variable production factor is labour, while fixed production factors include
capital and land. Distinction was also made between total, average and marginal
product by means of their definitions, calculation and graphical presentation. The law
of diminishing returns explains why the marginal physical product of a producer first
increases, and then decreases after a maximum point is reached.
Secondly, we looked at the costs of production of a producer, over the short-term. In
this regard total costs, average costs and marginal costs are important concepts.
Under total costs, distinction is made between total fixed cost, total variable cost
and total cost by means of their definition, calculation and graphical presentation.
Fixed costs are costs which have to be paid even if no products are produced, and it
remains constant for every level of output. Variable costs, on the other hand, increase
when the quantity of products produced increases. The average costs of a firm include
average variable cost, average fixed cost and average total cost. Each of these
represents different costs of production per unit produced. The marginal cost of a
producer was defined as the additional cost associated with the production of one
additional product. In our discussion on marginal cost, we calculated and illustrated
marginal cost and indicated the relationship between marginal cost and marginal
product.
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This study section was concluded by considering long-term production costs. It was
shown that all the costs of a producer are variable over the long-term, because
enough time is available to adapt production to the changing economic environment.
By taking the short-term average total costs of different production plants, the long-
term average cost curve was derived as an envelope curve.
internet
Find information on the internet for self-study about Production functions and the theory
of the Firm. Also use http://www.jstor.org/search on the website of the library.
Assessment
Make sure that you hand in the class and home assignments on time.
Write the class test according to schedule.
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Study unit 5
Study section 5.2

Perfect Competition
Study time
Study material
Study outcomes
 State the assumptions of prefect competition
 Explain the demand curve of a prefect competitive firm
 Explain why price, average and marginal income are equal for a perfect
competitor
 Explain the short-term equilibrium position of a firm under a perfect competitive
market
 Illustrate the short-term profit maximising of a perfect graphically, calculate and
discuss it
 Illustrate the lowest point at which a producer will continue production by
means of graphs
 Derive and explain the supply curve of a perfect competitive producer
 Illustrate and explain profit maximisation of the perfect competitor in the long-
term
 Explain long-run equilibrium of a firm and the industry under perfect competition
 Apply the relevant concepts and terminology in practice
 Explain allocation and production efficiency
The objective of this study section is to give an exposition of profit maximisation for the
perfect competitive producer
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In the previous study section the production function and the costs associated with
production of products and services was studied. For the producer production costs are
very important. The producer wishes to estate the income and thus the profit of selling
a product or service will deliver. Remember that profit is the difference between total
income and total cost. This study section addresses the various concepts of income
and profit of a producer within free market structures. In the introductory Economics
course module you studied the characteristics of the perfect competitor and
investigated income and costs in the previous study section. Now the focus is on the
equilibrium position where the free market producer maximises profits.
5.2.1 Perfect concurrence

 conditions for perfect competition (= prefect concurrence)
 applications thereof
 demand for a product of a firm
 demand curve of a product of an individual firm under perfect competition
The “Marginal” is of particular importance in the economy. Marginal refers to the
“additional” or “extra” that are being consumed or manufactured. It is that extra
consumer that looks at the price and rather decides not to buy a product, or not to see
a movie because it is too expensive, that eventually determines the price and quantity.
One must ensure that he or she gets value for their money. One must make sure that
the extra that is spent, equals the extra value or utility received. Only then are
resources optimally allocated. This goes for the consumer, investor and producer.
Maximum profits are then also made at the point where the extra cost (MC) equals the
extra revenue (MR) that is gained from the production or sale of an addition unit. (MC =
MR).
Individual activity
Imagine you manufacturing cell phone covers. Draw a graph that shows the market
demand and supply for cell phone covers, as well as the specific demand curve for
the cell phone covers that you are selling. The man in front of the bank is also selling
cell phone covers. Should his individual demand curve differ from yours? Remember
his price might differ from yours. Also draw a supply curve on your graph that already
shows the individual demand curve of your product (this should be the total market
supply curve. Or isn’t it?)
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Study unit 5
Individual activity
Suppose you want to sell oranges at a street market. There are many other sellers
around you. You are able to hear the prices that the other sellers shout. Try to
answer the following questions.
 Will you sell you oranges at a higher price than the other sellers? Why?
 How can you sell your oranges at a lower price and still make a profit?
(That is where your income is higher than your costs).
 Will you sell more oranges if another seller increases his/her price?
 Would the situation change if you were the only seller of oranges on the street?
 Suppose your oranges were of a higher quality than those of the other orange
sellers, will you be able to increase your price without reducing your sales?
Why?
The example of the orange market is an example of a perfect competitive market.
Individual activity
Can you think of a few businesses in your area that you consider operating in
competitive markets? Write them down!
In the example of the street orange market, the perfect competition will be gone; if one
orange seller sells oranges of a better quality. The oranges will not be homogeneous,
and imperfect competition will exist. Consumers will be willing to pay more for higher
quality products.
5.2.2 Production equilibrium under perfect competition

 The shape of the demand curve which confronts the individual producer
 With the demand curve that faces the individual producer’s production:
Price = AR = MR
 The equilibrium position of the individual producer
 The total cost curve of the producer
 Calculation of Total, Average and marginal Revenue
 The equilibrium conditions of the individual producer
 The Shutdown Rule and the Profit-Maximising Rule
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 Production-equilibrium according to Total Income and Total Cost and the

graphical representation of it
 Calculation of Total and Marginal Revenue, Total and Marginal Cost and the
profit it yields.
 Equilibrium according to Marginal Revenue and Marginal Cost and the graphical
illustration of it
 Take not that equilibrium and maximum profits, both in the free market and
imperfect markets, are realised at the point where MR = MC
 Ensure that you can illustrate with graphs how much will be prodused in a market
and at what price. You must be able to draw the MC and MR curves, as well as
the price line, AC and AVC
 You must also be able to show on the graph with Price, MC, MR, AC and AVC
curves what the Total Income of a firm would be and to calculate it (TR = P x Q),
as well as what costs will be (TC = AC x Q) and show the area which represents
profit on the graph and calculate it:
Profit = TR – TC or Area of (P x Q) – (AC x Q) = Profit
 You must be able to distinguish between economic (or abnormal) profit, normal
profit, the brake-even point and loss. To define it, illustrate it on graphs and
calculate. As well as the price-level below which a firm would stop production.
Normal Profit: TR = TC
But if the total revenue from sales is greater than the total cost an abnormal profit is
made:
Abnormal Profit: TR > TC
A producer maximises its profit over the short-term if the difference between the total
revenue (TR) and total cost (TC) is the greatest. Thus, abnormal profit is made when:
Profit = TR – TC
Individual activity
1. Complete the following table:
TP TFC TVC TC AFC AVC AC MC

1 60 30
2 40
3 45
4 55
5 75
6 120
2. Use the information in the table and graphically illustrate the AVC, AC and MC
curves on the same graph.
3. What do you observe regarding the intersection of the three curves?
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A price taker means that there are so many producers in the market that one individual
producer cannot influence the price of the product.
The horizontal individual demand curve implies that if the producer asks a higher price,
he/she will sell no products, because other producers supply the same product more
cheaply.
He/she would also not ask a lower price, because consumers are willing to pay a
higher price, which increases profits. At a lower price production costs will usually not
being covered in the long-run and the firm would become bankrupt.
Although the producer cannot influence the price, he/she can still decide what quantity
he or she would like to sell at the given price. At the given price P, any quantity can be
sold.
Example
To explain where a perfect competitive producer maximises profits, observe a simple
example: The condense milk producer plans an increase in production. An increase
in production will increase costs, but the expectations are that sales will increase.
This would lead to an increase in revenue.
The important aspect to the producer is thus the additional revenue which he or she
expects to receive compared to the additional costs which need to be incurred.
Individual activity
Profit maximisation occurs where MR = MC.

Assume that Nescafé is a perfect competitive producer in the coffee market and that
the price of coffee is fixed at R10 a tin. Complete the following table:
Quantity Total Ave. Marginal - Total Ave. Marginal

Income Income Income Cost Cost Cost
(Q) (TR) (AR) (MR) (TC) (AC) (MC)
1 15
2 24
3 32
4 38
5 43
6 49
7 56
8 64
9 74
10 87
11 110
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Study unit 5
1. Draw the following curves on the same graph: marginal cost; average cost;
average
revenue; marginal revenue
2. What is Nescafé's profit maximising price and quantity? Indicate your answer
also on
the graph above.
discussion.
5.2.3 Supply curve of the producer

Notice that:
 This section builds directly on the precious section. U sketched the firm’s cost
curves and calculated income and costs. The supply curve now forms that
section of the marginal cost curve above the shut-down point where the price line
is lower than the average cost curve. Below the minimum turning point of the
AVC the firm can not pay the variable costs, like wages, from the sale of its
products (P < AVC) and production will have to stop. (You can’t expect workers
to work without pay!).
 In Chapter 7 it was shown that the market supply curve is horizontal sum of the
individual supply curves. The market supply curve is thus the horizontal sum of
the respective AVC curves of all the individual firms in the industry and the
market.
The Supply curve of the individual producer is the rising section of the marginal cost
curve (MC) above the minimum of the AVC curve.
Individual activity
The question that arises is: At what price will the producer stop production?
Answers
The producer will have to retire from the market if he cannot at least cover total variable
cost (TVC): the costs of the variable production factors (inputs), such as labour.
A producer will still continue production over the short-term, because if he/she can still
cover average variable cost, such as wages. The producer will continue production,
because he/she would rather tolerate this loss over the short-term (and hope for better
prices in the future) than closing his business down. But if a producer cannot cover at
least the average variable cost, he/she must stop production and retire from the market
because losses are so great that to withdraw from the market must be the best option
available.
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Study unit 5
The supply curve of a producer in the perfect competitive market can be represented
by the increasing section of the marginal cost curve, above the average variable
cost curve.
Example
1. Sketch a graph to illustrate the equilibrium price and –quantity at which a firm
would produce. (2)
2. Show on the graph at which point the firm would realise normal profit and
where economic or abnormal profits will be made. (1)
3. At which point will the producer be forced to stop production and why? (1)
Answer:
1. Equilibrium for a perfect competitive firm is where marginal revenue (which is the
price per item sold), equals the marginal cost per item manufactured (where P =
MR = MC). On the graph the equilibrium price is thus at Pf and Q will be sold.
2. At normal profit no profits are actually made, although everyone has been paid as
part of the company’s variable costs. This includes the pay of the managers and
the boss. Normal profit occurs when the price is equal to the minimum point of
the average cost curve (N) where Ac intersects MC (where AC = P) – also called
the long-run break even point. Any price above that would yield abnormal profits
or extra profit because revenue would then be more than costs. On the curve
revenue is equal to price multiplied with quantity (area OQGPf). Equilibrium
quantity line (QG) cuts the average cost curve (AC) at point B, which implies that
the production cost of the firm equals area OQBD. The profit equals area BGP fD.
It is all above AC’s minimum implying abnormal profits.
3. Shut down point is at SD, - When price drops to the minimum of the average
variable cost curve (AVC). It is also where AVC cuts the MC curve. When price
decreases to below the average variable costs it implies that the firm can’t pay its
variable costs like the wages. Workers would not normally work without pay and
thus production will have to stop, while production will cost the fixed cost plus the
wages, without any profit.
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Study unit 5
5.2.4 Long-term equilibrium

In the short-term it is possible for the perfect competitive producer to make an
abnormal profit. Over the long-term, this abnormal profit attracts other producers who
enter the market in search of profit possibilities. Their entry causes the market supply
to increase and the market supply curve moves to the right a new equilibrium market
price lower than the original market price, is established. This new market price is given
to the individual producers in the market. This decreases their profits until only normal
profits are made.
The producer maximises profits when the marginal cost equals his marginal revenue
(MR = P) and this is equal to his long-term average total cost (LRAC), which indicates
that only normal profits are made.
 Long-term equilibrium of the firm
 In the long-run only normal profit is possible
 Graphical representation of long-term equilibrium and normal profit in the industry
 How expansion of production can realise economies of scale
 Also notice that perfect free competition is used as the norm to evaluate
allocative and productive efficiency.

This study unit introduced production theory by studying the basic concepts of
production output and production cost in the first study section. In this study section
production equilibrium and profit maximising of die individual firm under a perfect
competitive market was investigated and the supply curve was derived. In following
chapter profit maximisation under imperfect competition, like with monopolies,
monopolistic competition and oligopolies are investigated.
Reflection
Make sure that you managed all the learning outcomes which were given at the
beginning of this study section. Work through the list of important concepts at the end
of chapter 12 of your textbook and ascertain whether you can define and explain all
the terms and concepts.
internet
Make your study of economics more interesting by searching on the internet for
arguments why the free market and perfect competition are regarded as superior.
Assessment
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Study unit 5
Study section 5.3

Monopoly and Imperfect Competition
Study time
Study material
Study outcomes
 Distinguish between perfect competition, monopolistic competition, oligopoly
and monopoly and define each market form
 Calculate Total, average and marginal income of a monopoly and illustrate it
with graphs
 Analyse and explain the equilibrium position of a monopoly
 Explain long-term equilibrium position of a monopoly
 Discus price discrimination
 Explain natural monopolies and represent it by means of graphs
 evaluate the merit of monopolies and the criticism against them
 explain the purpose of competition policy
 Compare perfect competition with other market forms, especially the monopoly
 evaluate various forms of competition using criteria of efficiency as well as
ethics
 Apply relevant concepts and terminology in practice
The objective of this study section is in the first place to give an exposition of profit
maximisation position of a monopoly.
In the previous study section equilibrium and profit maximisation of a firm under a
perfect competitive market was investigated. In this study section the focus is on the
equilibrium position of a firm which is the single producer of a commodity or service,
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Study unit 5
with the effect that it possesses the entire market demand for itself. The demand curve
for its product is the also the Total market demand curve, with its characteristic
negative slope. This leads the monopolist to set the price under the demand curve,
higher than it would normally be, because there are no competitors and less will be
produced that would be the case under perfect competition. Inputs of the monopolist
are, however, still being bought in a free market and the monopoly has less control
over it. The assumption then is that the monopolist has identical cost curve that those
firms operating under perfect competition. Profit maximisation is still at the point where
the additional cost spent to produce an additional unit is equal to the additional revenue
that the product or service is going to yield, thus: MR = MC.
5.3.1 Monopoly and other imperfect market forms
Study material
Study the chapter 11 in the textbook of Mohr & Fourie:

In this section you should make certain that you know the differences between perfect
competition, monopolistic competition, oligopoly and monopoly very well, can define
them all and evaluate the merits of each.
 Characteristics of every market structure and the differences between them
 Market concentration
 Market structure, conduct and performance
 The monopoly and barriers to entry
5.3.2 Profit-maximisation of a monopoly

 The equilibrium position of the monopolist where maximum profits are generated
 Total, average and marginal income of a monopolist, and the calculation of it from
a table (schedule)
 Graphical representation of the total, average and marginal income curves of a
monopolist
 Short-term equilibrium of a monopoly, graphical representation of it and the
illustration and calculation of total income, total cost and profit
(TR = P x Q, TC = AC x Q and
Profit = TR - TC or (area. of P x Q) - (area. AC x Q) = Profit, where MR = MC).
 Long-term equilibrium of a monopoly
 A Monopoly do not have a supply curve, a monopolist is a price setter and
determines the quantities it wishes to produce at each price. A monopoly is,
however, restricted to the cost and the location and shape of the demand curve.
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Study unit 5
It can not charge any price it likes, because no one will buy its products anyway if
the price is too high. A monopoly is still to some extend restricted by the demand
curve.
Example
Suppose SASOL is the only supplier of petrol in South Africa. The quantity and price
of petrol are given by the following table:
Quantity Marginal
Total Income
Petrol Price of Petrol Income
Demanded (P x Q)
(TR ÷ ∆Q)
0 8 0 0
1 7 7 7
2 6 12 5
3 5 15 3
4 4 16 1
5 3 15 -1
6 2 12 -3
7 1 7 -5
8 0 0 -7
 If you go and draw the demand and marginal revenue curve of SASOL on one
graph, you will be able to see that the marginal revenue curve (MR) also slopes
downwards, but it lies on the inside of the demand curve (D). The MR-curve of
the monopolist is not a straight horizontal line (as with the perfect competitor) but
it has a negative slope. This is because the demand curve has a negative slope.
 The quantity which the monopolist will produce to maximise his profits, is where
his marginal cost equals his marginal revenue, thus a quantity of Qe products.
 The price which the monopolist will ask for this quantity of products is determined
by the consumers in the market. The price which they are willing to pay for that
quantity of products is the price which the monopolist will ask. Thus, the price is
read from the demand curve - the monopolist will ask a price of Pe.
 The monopolist makes an abnormal profit if his average revenue is greater than
his average total cost (AC).
Individual activity
Sketch a graph of die total and marginal income shown in the table above:
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Study unit 5
5.3.3 Price discrimination and elasticity

 What is meant by price discrimination
 Degrees of discrimination
 When is discrimination possible and why is it sometimes imposed. Marginal
income and the Price Elasticity of demand. Notice the relationship between the
monopoly’s marginal revenue curve and the demand curve. Unlike with perfect
competition they do not coincide. When MR = O is demand elasticity ep = 1. A
monopolist functions therefore only on the section where demand is relatively
elastic.
Note that it is possible for the monopolist to also make abnormal profits in the long-
term, because he is a price setter.
Individual activity
The following table indicates the total revenue and total cost of a monopolist at
different quantities. Complete the table:
Total Marginal- Total Ave. Marginal -

Quantity
Income Income Cost Cost Cost
(Q)
(TR) (MR) (TC) (AC) (MC)
1 300 400
2 575 575
3 825 700
4 1 050 835
5 1 250 985
6 1 425 1 160
7 1 575 1 370
8 1 700 1 700
9 1 800 2 180
10 1 875 2 860
1. Draw the average revenue, marginal revenue, average total cost and marginal
cost curves on the same map.
2. Indicate the profit maximisation price and quantity of the monopolist on the graph
above.
3. Is the monopolist making a normal profit, an abnormal profit or a loss? Motivate
your answer.
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Study unit 5
discussion.
5.3.4 Natural monopolies

 Conditions when natural monopolies are possible and why
 Graphical representation and explanation of natural monopolies
1. One of the reasons that a monopoly is created is because the monopolist
produces on a very large scale and competitors cannot produce smaller
quantities profitably.
2. Because the monopolist is the only producer of the product in the market,
he can change the price as he wishes. Thus, the monopolist is a price setter.
3. The demand curve for a monopolist's product, is a normal demand curve with a
negative slope because the demand curve has a negative slope, the marginal
revenue of the monopolist also has a negative slope.
5.3.5 Comparison between perfect competition and

monopoly
 Allocation and production efficiency, which were studied at the end of chapter 12
and how it is applied here.
 Graphical illustrations to evaluate the free market and monopolies
 Die social cost of monopoly power
 The deadweight-loss which might be found with monopolies.
5.3.6 The merits of monopolies and competition policy

 Evaluation of monopolies
 Misconceptions about monopolies
 Criticism against monopolies
 Government policy with regard to monopolies and imperfect competition
 Competition policy
Individual activity
Can you explain how a free market economy can ensure that no shortages or surplus
production exists? Write it down.
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Study unit 5
Individual activity
Write a report in which you spent a paragraph on each of the various market
structures, explaining the most important features or criteria of each. (Also take note
of the tables in the beginning and end of the chapter).
Individual activity
Can you name any monopolies in South Africa?
Answers
ESCOM is a monopoly because it is the sole supplier of electricity in the bigger part of
South Africa.
Monopolists need not only be large industries. If there is only one orange seller in a
city, that orange seller will be a monopolist. Such a business enterprise will have no
competition.
What do you think are the reasons for the existence of monopolies?
Individual activity
 Do monopolies have any advantages?
 Are the railways a monopoly? Does this exhibit any disadvantages to the
consumer?
 Is the privatisation of state assets and public corporations a good thing?
Motivate your answer.
Individual activity
Think of the following two scenarios.

 Scenario 1: Four cafes in a shopping centre
 Scenario 2: The only café in a 5 km radius
Where do you think the price of chocolates will be the cheapest? Why do you think
so?
Answers
Would you agree that the cafes in the shopping centre will have cheaper prices? One
reason may be that of higher levels of competition exist in the shopping centres. In
scenario 2 with only one café in a 5 km radius, no competition will exist and prices will
be higher.
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Study unit 5
Due to the difference in market structure, the nature of price determination will differ.
Individual activity
Give reasons why it would be difficult for you as an individual to enter as a supplier
into the following markets.
 Electricity provision
 Gold mining
 The production of a product that is patented by someone else
 A game farm in the centre of the Kruger National Park
 Give examples of industries where technology is a barrier to entry for a new
firm.
 Can you think of industries or organisations where economies of scale exist?
Give examples:
Answers
Electricity provision and gold mining has barriers with respect to set up costs and
economies of scale, while patented products and game farming in the Kruger National
Park have policy created barriers.
Individual activity
Can you give the meaning of a “differentiated product”? Write it down!
Example
Remember, a differentiated product must be clearly distinguishable from similar
products or a customer must have a specific reason for buying it. For the corner
café’s this differentiation is based on location, i.e. because it is more convenient for
the customers. Due to its close access, consumers will rather buy at the corner, than
in a far away area. Brand loyalty exists because of product differentiation. Many
consumers will buy the same amount, in spite of a price difference, because of their
loyalty to a certain brand.
A few large firms dominate some markets. The big three automobile manufacturers in
the USA, General Motors, Ford and Chrysler produce over 70 per cent of all cars
sold in the USA.
Individual activity
In on one stage there were two cell phone suppliers in South Africa. This market form
is called a duopoly. With the introduction of a third company, namely Cell-C, there is
now another market form in this market. What is it called?
Take your answer to the next contact session.
102
Study unit 5
Individual activity
Use a page to make a comparison between the perfect competitive producer and the
monopolistic producer. This will help you to review what you've just learned. Refer to
the following aspects:
 The graphs and curves
 Profit maximisation price and quantity
 Normal/abnormal profit
Individual activity
Which one of the following equations cannot be used to calculate average

revenue?
(a) AR = P ÷ Q
(b) AR = P
(c) AR = TR ÷ Q
(d) AR = (P x Q) ÷ Q
discussion.
Individual activity
Draw a graph to illustrate equilibrium price and quantity of a monopoly.
Show the demand, MC, AC and MR curves clearly.
Indicate on the same graph:
1. What the free market price would have been at equilibrium.
2. Indicate the area on the graph that represents total revenue (P x Q) for the
monopoly, total costs (Cost x Q) and the monopoly’s profit area. (Write it
underneath).
3. Also show what the difference in total income (P x Q) between the monopoly
and a free market would be. (6)
103
Study unit 5
Answer:
THE GRAPH OF THE MONOPOLY: EQUILIBRIUM PRICE = PM AND EQUILIBRIUM
QUANTITY = QM
1. The free market price will be Pf where MC = MR

2. Total Revenue monopoly = P x Q
= Area OQmEPm
Total Cost m = Ave Cost x Q
= Area OQmBD
Profit monopoly = TR - TC
= Area BDEPm
3. Difference between the total income (TR) of the monopoly and free market is
= Area PfGEPm
(THE ASSUMPTION THAT WAS MADE HERE, HOWEVER, IS THAT THE
MARGINAL COST CURVES (MC) OF THE MONOPOLIST AND THE FREE MARKET
FIRM ARE THE SAME. THIS IS NOT NECESSARILY TRUE IN THIS CASE. BEING A
LARGE BUYER THE MONOPOLIST MIGHT HAVE SOME BARGAINING POWER.
THE MR CURVE OF THE FREE MARKET FIRM WILL ALSO BE HORIZONTAL).
Reflection
Make sure that you managed all the learning outcomes which were given at the
beginning of this study section. Work through the list of important concepts at the end
of chapter 13 of your textbook and ascertain whether you can define and explain all
the terms and concepts.
104
Study unit 5
internet
Search for court cases on the internet, which were made by the Competition
Commission against large companies.
Assessment
105

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ECON 112 VEC

INTRODUCTION TO MICRO ECONOMICS

Study guide compiled by:

Study unit 1 First Encounter with Economics ................................................................. 1

Study unit 2 Equipment of the economist, demand and supply .................................. 25

Study unit 3 Elasticity ..................................................................................................... 47

Study unit 4 Theory of consumption ............................................................................. 61

Study unit 5 Theory of production and market structures ........................................... 72

Module name Introduction to micro economics

Building and Office nr

How to study the contents

Before each of the lecture sessions you will have to-

How to use the study guide

The contact lecture sessions

Study action words

Time allocation Learning outcomes

Individual exercise Group Activity

Study section 1.1

1.1.1 Scarcity and opportunity cost

Study the following attentively

1.1.2 The production possibility curve

4. What will be the case if we produce at G?

1.1.3 Economics as a science

1.1.4 The place of economics in God’s creation

1.1.5 Positive and normative economics

Study the following attentively

1.1.6 Common mistakes in economic reasoning

Study the following attentively

Study section 1.2

economic frame of reference or system a country has at its disposal. The

1.2.1 The basic economic problem

Study the following attentively

1.2.2 Factors of production

1.2.3 Economic systems

Study the following attentively

1.2.4 Important pioneers in economics

Summary of main learning points

Study section 1.3

1.3.1 Production, income and expenditure

Study the following attentively

1.3.2 Interdependence of households and firms

1.3.3 The public sector

Study the following attentively

1.3.4 The foreign sector

1.3.5 The role of financial institutions

Use of the internet

Summary of main learning points

Study section 2.1

2.1.1 The law of demand

From the demand function P = 6 – ½ Qd (P is given in Rand), give the following:

Note the slope is – P/Q = (R3 – R2) / (6 - 8)

2.1.2 Supply in the economy

Use the supply function PS = 1 + 2 QS and give the following:

2.1.3 Equilibrium between supply and demand

The Supply function will then be: P = c + d Qs

2. Figure: Demand and Supply Curves

EXAMPLE: Simulations Equations

2.1.4 Consumer and producer surplus