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Economics Notes
Economics Notes
INTRODUCTION
This module unit is intended to equip the trainee with knowledge, skills and attitudes to enable
him/her apply the economic concepts in day to day life.
General objectives
At the end of this module unit, the trainee should be able to:
a) Recognize the role of economics in day to day life
b) Apply the concept of demand and supply in economics analysis
c) Demonstrate an understanding of price determination
d) Apply production theory concept in a financial institution
e) Demonstrate an understanding of market structures
f) Relate the concept of money and banking to banking and financial services business
environments
g) Demonstrate an understanding of public finance concept
h) Assess the relationship of population and unemployment in an economy
i) Cope with emerging issues and trends in economics.
Module Unit Summary and time allocation
Code Sub-module Content Time
units ( hour
s)
8.1.01 Introduction Meaning of economics 6
to Scope of economics
Economics Human wants
Economic resources
Concepts of scarcity and choice
Economic systems
Concept of demand 6
8.1.02 Demand Factors affecting demand of a product
analysis Demand curve derivation
Shift and movement along a demand curve
Definition of elasticity of demand
Types of elasticity of demand
Total 130
ECONOMICS.
DSM1; 2902/105.DCM 1;2903/105;DBM1;2906/105.CBM
2;1906/205.CCM2;1903/205.CSM2;1902/205.DHRM3;2908/305.CPA 2/ATD3.
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TOPIC 1 INTRODUCTION TO ECONOMICS.
Introduction to Economics
Economics is a social science which studies the allocation of scarce resources which have
alternative uses among competing and usually limitless wants of the consumers in the society. It
is thus concerned with the way people apply their knowledge, skills and effort to the gift of nature
in order to satisfy human their material wants
It is also defined as the study of how human beings strive to satisfy their unlimited wants using
limited resources.
Basic Economic Concepts
1 HUMAN WANTS.
This are basic needs that human beings need to function normally this include; food, shelter,
clothing and air. Things like radio, education, watches, and vehicles are not very basic. They are
meant to have an individual have a happy and comfortable and luxurious life.
Form utility-This is created through changing the form of a raw material to a finished product.
It is usually done during various manufacturing processes. The finished goods are in a better
form for use than the raw materials.
Time utility-this is created through warehousing or storage
Possession utility-This is created through trade or exchange.
Place utility-this is created through distribution. After goods have been produced, they must
be moved to the places where they are required for use.
Characteristics of human wants.
They are many, numerous and unlimited.
They continually change with time and other factors.
Some are repetitive e.g. supper, lunch etc.
Wants are competitive
Wants are complementary-Used together e.g. shoe polish and a shoe.
Wants are habitual that they always occur e.g. toothpaste, perfume etc.
Wants are universal-Everybody wants them.
Characterisics of basic wants.
One can’t do without them.
They are felt needs
Can’t be postponed
They are satisfied before secondary wants.
Difficulties in satisfying human wants.
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Although human wants are there to satisfy man with lives requirements, it is not always possible
to have them this is because;
They are too many and new ones keep cropping up.
Resources to satisfy them are never enough (limited).
They are repetitive hence people will always strive for more resources.
They continually change with time and other factors like age and gender.
Some are habitual making life unbearable without them.
Due to scarcity of resources, a problem of deciding which want to satisfy first with scarce
resources arise.
Types of human wants.
They are classified into two groups.
1.Basic human needs-This are things one cannot do without e.g. food. They always come at the
top for the scale of preference and failure to satisfy them one can lead a miserable life or even die.
2. Secondary human wants-they are things one cannot do without. They help one lead a happy
meaningful and comfortable life e.g. TV set, radio, cars, education, sodas etc.
NB.one must satisfy basic needs before attaining secondary wants.
Since the resources to satisfy human wants are scarce, one has to select on what wants are to be
satisfied first and which can wait.
2 Economic Resources These are ingredients that are available for providing goods and services
in order to certify the human wants. A resource must be scarce and have money value.
Characteristics of economic resources.
1. They are scarce in relation to their uses
2. They have a monetary value.
3. They have alternative uses.
4. They are unevenly distributed
5. They have utility
6. Can be combined to produce goods and services. They are transferrable from one place to
another.
Types of economic resources.
There are three main ways of classifying economic resources namely;
1. Natural resources-They are also called the gifts of nature and are fixed in such by they are
held in trust by the government for the citizens. They include; forest, river, mountain,
minerals and lakes.
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2. Artificial resources-They are created by people through various production activities e.g.
machinery,tools,roads,railway,airport,dams,bridges,h.e.p,harbours,soaps,books.
3. Human resources-They are mental/physical efforts offered by people to the production
society. These efforts cannot be separated from their providers e.g. teaching, health services,
mechanics, carpentry, engineers etc.
3Natural Resources refer to anything given by God or nature such as fertile soil, rivers, lakes,
mountains etc.
4 Man Made Resources refers to anything created by man to assist in further production such as
tools, equipment’s, roads and buildings etc.
5 Scarce and Choice if the resources available are not enough to produce goods and services to
satisfy all the wants then they are said to be scarce. As a result, individuals and society cannot
have all the things that they want. Since resources are limited, choices have to be made. The
choice to satisfy one want implies others are forgone. Individuals have to make choices e.g.
consumers with their limited income and unlimited wants have to choose how they spent their
income.
Importance of scarcity.
i. Makes people to work hard
ii. Stimulates usage of available resources
6 Opportunity Cost refers to the value of benefit expected from the best second alternative
forgone. It is based on the fact that resources being scarce have competing alternative uses. The
choice to satisfy one alternative means that another is forgone. The value of the second best
forgone alternative is the opportunity cost.
7 Utility-this is the quality of that commodity that satisfies human want.
8.Economics-subject/discipline.
9.Economy-this is the country’s financial position.
10. Economies-this are the benefits of large scale.
11.Ceteris paribus-this is a major concept meaning, other factors held constant
12. Pareto efficiency-this is a situation in which it is not possible to make someone better off
without making someone worse off.
13.Consumer sovereignity-this refers to the freedom of individuals and households to decide for
themselves what they want to buy in a given market.
14.Production Possibility Frontier/Capacity (PPF/PPC)
It provides a graphical illustration of the problem of scarcity and choice which is the basic
economic problem. The curve shows what a country produces with existing supply of land,
capital and entrepreneurship ability. With limited supply of economics resources a country has a
wide variety of options and variety of goods and services it can produce. Assume a simple
hypothetical economy where a country produces two types of goods i.e. agriculture and
manufactured goods. The two extreme possibilities are:
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a) The country commits all its resources to the production of agriculture and non to
manufacturing.
b) All the resources are put to manufacture and none to agriculture.
These two extreme cases are unlikely and the country will most likely choose to produce goods of
both commodities. The opportunity cost of producing either of them is increasing which the law
of diminishing return.
The ppf is a locus of all combination points which represents goods and services that a country
can produce if all resources are utilized fully and efficiently. At point Q the economy can still
produce but some resources will be underutilized. This means that resources will be unemployed.
The points outside the curve are not attainable with the country’s present productive capacity. The
country can only achieve this if,
It’s productive capacity has been increased up to maximum level.
A country has to choose between point q,a,b and c.
Ppf is concave to the origin indicating the concept of increasing opportunity cost.
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that determine the prices and quantities of television sets sold. Microeconomics can be considered
as the ultimate cellular structure of economics. It is the study of individuals, households and
firms. The major areas are
demand and supply analysis , market equilibrium ,consumer theory , theory of the firm , market
structure and distribution theory
2.Macroeconomics
This is the study of bigger and complex systems. Macroeconomic theory is the study of the
behavior of the economy as a whole whereby the relationship is considered between broad
economic aggregates such as national income, employment and prices. The economy is
disaggregated into broadly homogenous categories and determinants of the behavior of these
aggregates are integrated to provide a model to the entire economy.
Macroeconomics focuses on the economic stabilization whereby government policy is used to
moderate business cycles and encourages real economic growth. Macroeconomics became a
separate topic of discussion in the aftermath of John Maynard Keynes and the great depression.
The line between microeconomics and macroeconomics is, however, blurred and there are many
areas of overlap between the two. Key areas of macroeconomics are:
national income ,economic growth and development , money and banking , public finance
unemployment ,inflation and international trade
Why Study Economics?
It is useful to study economics for the following reasons
i. Economics provides the underlying principles of optimal resource allocation and thus enables
individuals and firms to make economically rational decisions. Thus for example the
preparation of budgets involves knowledge of demand and elasticity analysis. The making of
price policy decisions draws heavily on the concept of elasticity in economics. Additionally,
the theory of production in economics is concerned with the principles that facilitate the
optical combination factors of production.
ii. A study of economics enables individuals and organizations to appreciate the constraints
imposed by the economic environment within which any entity operates. Thus an individual
or firm is more fully enabled to appreciate the implications of the annual budget considering
how for example the increased liberation of the economy will affect a particular business
entity and the economy in general. Additionally, the student of economics is able to appreciate
the effects of such economic variables as inflation, exchange rates, interest rates money
supply and so on.
iii. The area of development economics is fundamentally concerned with the reasons why
societies develop and means of accelerating development. It is vital for individuals as citizens
to appreciate the parameters that determine the development process so that they contribute
more fully to facilitate and contribute to solving the economic problems that characterize their
society.
iv. Economics is an analytical subject and its study can help develop logical reasoning which is
never superfluous.
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v. It is an examinable and mandatory for students perusing business courses
vi. Students appreciate the effect of economic variables e.g. inflation, exchange rate, interest rate,
money and supply etc.
The Methodology of Economics
The methodology used in studying and applying economics can be divided into three. This are
basically the methods of solving economic problems.
1. Positive economics is concerned with what is, or how the economic problem facing societies
are actually solved.it deals with facts using positive statements. for example; “Kenya is a
member of the East African community” and “Uganda is currently Kenya’s major trading
partner” are positive statements. For example a dispute over whether Uganda is currently
Kenya’s major trading partner can be settled by looking at the statistics of Kenya’s trade with
its partners.
2. Normative economics refers to the part of economics that deals with the value of judgments.
This implies that normative deals with what ought to be, or how the economic problems
facing the society should be solved. Normative statements usually reflect people’s moral
attitudes and are expressions of what particular individuals group thinks ought to be done. A
statement such as “Uganda to should join the Southern Africa
Development Community” or “upper income classes ought to be taxed heavily”, are normative
statements.
3. Scientific method
Economics make use of scientific method to develop theories. Inquiry is generally confined to
positive questions. One of the major objectives of sciences is to develop theories. A theory is a
general or unifying principle that describes and explains the relationship between things observed
in the world around us. The purpose of a theory is to predict and explain. The search for a theory
begins whenever a regular pattern is observed in the relationship between two or more variables
and one asks why this should is so. A theory refers to a hypothesis that has been successfully
tested. It is important to note that economics hypothesis is not tested by realism of its assumptions
but its ability to predict accurately and explain. The following procedures are adopted in the
scientific method:
i. The concepts are defined in such a way that they can be measured in order to be able to test the
theory against the facts.
ii. A hypothesis formulated..
iii. The hypothesis is then used to make predictions.
iii. The hypothesis is tested by considering whether its predictions are supported by facts.
Economic Systems
These refer to the way in which different societies solve the three different basic economic
problems which are: which goods should be produced and in what quantities?
b. How should various goods and services be produced?
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c. How should various goods and services be distributed?
To answer this question, various political and economic structures have been put in place,
whereby we have;
(a) Free market/capital system/laser faire economy
It refers to a system where decisions about allocation of resources are made by individuals on the
basis of prices generated by forces of market prices of demand and supply.
FEATURES /CHARACTERISTICS
1. Private property individuals have the right to own or dispose off their property as they may
consider it fit.
2. Freedom of choice and enterprise Individuals have the right to buy or hire economic
resources, organize them for production purpose and sell them in the market of their choice.
Such persons are referred to as entrepreneurs.
3. Self interest in the pursuant of personal goals. The individuals are free to do as they wish and
have the motive of economic activity in self-interest.
4. Competition There is a large number of buyers and sellers such that each buyer and seller
accounts for but is insignificant to influence the supply and demand and hence prices.
5. Reliance on price mechanism .This is an elaborate system of commerce in which numerous
choices of consumers and producers are aggregated and balanced against each other. The
interaction of demand and supply determine prices.
6. No government intervention hence no price controls, taxes and subsidies.
7. There are property rights provided and enhanced by the government through copy rights
patents, trademarks etc. e.g. on innovating and inventing one is protected from absorption and
thus you enjoy the benefits.
8. There is excessive advertising.
Advantages of free market economy
1. There is the matching of demand and supply. Production takes place in response to demand
hence a balance between what is produced and consumed. No wastage.
2. There is flexibility of the market in responding to changes in demand and supply conditions
thus variety products are offered.
3. There are no resources wasted in planning as no planning is required
4. Consumer sovereignty and competition gives rise to a wide variety of goods and services
giving consumers a wide range to choice from.
5. Higher rates of economic growth due to the incentive available for hard work which is
motivated by profits.
6. No wastage of resources on unrealistic projects because investment decision are based on
profits.
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7. The costs associated with government bureaucracy are highly reducing encouraging
entrepreneurship in the economy.
8. Better quality products are produce due to innovation and inventions
9. Intensive innovation and invention is prevalent due to competition.
10. Affordable prices of products.
Disadvantages of free market economy
1. Income inequality the ability of some people and firms to acquire excessive market power
leads to greater inequality in income and wealth.
2. There is likelihood of developing Monopoly powers whereby one firm controls the production
and distribution of commodities.
3. The price mechanism on its own cannot allocate resources to production of public goods e.g.
schools, security etc.
4. Instability in economy and unemployment. This is due to trade cycle i.e. recession,
depression, recovery and boom.
5. The inability to deal with structural changes caused by wars, natural calamities among others.
6. Inadequate provision of merit goods. Merit goods are goods of importance to the community
such as health, education, security among others
7. Due to excessive advertising consumers are likely to make irrational choices at the expense of
moral life/health
8. Over-exploitation of resources
(b) Planned economy/command/government controlled/socialism/communism
It refers to an economic system where the crucial decisions are determined a body appointed by
the state. The body takes up the role of mechanism which prevails in a free market economy
Features of a command economy
1. Leadership and control of economies. All important means of production (resources) are
publicly owned such as land, power generation, housing among others.
2. Rationing of certain commodities if supply of such fall below demand.
3. Existence of production targets for different sectors of the economy. The government
determines how resources are allocated through planning.
4. Fixing of prices and wages
5. Occasional existence of restricted labor market in which workers take up jobs assigned to them.
6 Government decides what is to be produced, how it will be produced and for whom to produce.
Advantage of planned economy
1. Avoids economic instability
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2. Minimize negative externalities
3. Makes adequate provision of public and merit goods ie education, health and safety.
4. Facilitate the shift of resources in pursuant of grand schemes such rapid industrialization
5. Puts checks on monopoly power which are controlled by state monopolies (Parastatals).
6. Ensures there is full employment.
7. Low inflation rate is being experienced.
8. Minimum waste of resources.
9. Minimum inequalities of wealth and income
10. Easier government control.
Disadvantages of Planned economy
1There is wastage of resources in production because consumers demand is judged in advance
without the use of price mechanism.
2 The cost of gathering information for planning is expensive to the state.
3 There is no individual incentives and initiative for hard work and innovation.
4 The power of consumer sovereignty is curtailed.
5 There is no incentive for hard work and this discourages the suppliers
6 Some resources may end up being underutilized
7. Difficulty in estimating demand due to different time frames i.e. Decembers and end month and
sometimes during certain occasions such as valentine demand tends to rise.
(c) Mixed economy
Refers to an economic system where resource allocation is determined by the state-i.e. the
government and price mechanism. Both the government and private sector have a role to play in
resource allocation.it is widely adopted in many countries and results varied depending on nature
of the economy. The government normally intervenes when the private sector of market fails to
allocate resources effectively as long as the objective of the economic growth and development is
achieved.
Advantages of mixed economic systems.
1. Optimal utilization of nations resources
2. Relatively wider tax base
3. Consumers are protected from consumption of harmful products
4. A considerable degree of consumer sovereignity.
5. High quality products and services due to competition
6. More equal istribution /allocation of resources.
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7. Relatively stable prices.
Role of government.
1. Checking quality of products.
2. Offering government subsidies
3. Offering import and export tariffs.
4. Ensuring price controls
5. Foreign exchange market
6. Taxation by ensuring there is redistribution of income through a system of taxation.
7. To create a framework of regulations and rules to ensure fair competition thus promoting
competition between firms both small and big ones.
8. Government intervention can prevent market failures in price mechanism.
9. Stabilization of the economy.
10. The government is able to maintain competition by controlling monopoly power.
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The theory of demand and supply enables us to understand the determination of prices and
quantities in different markets. For example, why the prices of agricultural commodities such as
tomatoes, apples, mangoes and cabbages increase and decrease at certain times of the year, why
have the prices of computers, music systems and television sets been steadily declining over time.
An understanding of the working of the price system provides us with the answers to some of
these questions. The price system provides the basis for determining the prices of factors of
production.
Definition of Demand
Demand refers to the quantity of a commodity that consumers are willing and able to purchase at
any given price over a given period of time, holding other factors constant. It is important to
realize that demand is not the same thing as want, need or desire. Only when want is supported by
the ability and willingness to pay the price does it become an effective demand and have an
influence on the market price. Hence demand in economics means effective demand. It is
different from desire in that it has to be supported by the ability to purchase the product/service.
The price of a commodity is most important factor/determinant of demand. All factors affecting
demand other than the price are referred to as conditions for demand. While analyzing the
relationship between price and quantity of demand economists assume that all factors affecting
demand remain constant. An individual demand for a given good can be presented in a form of a
demand schedule. A demand schedule is a table showing quantity of a commodity that could be
purchased at various prices. The Table 2.1 shows an individual’s demand for commodity X.
From the table, 65 units of commodity X will be demanded per week if the price is Kshs 6 per
unit.
A demand schedule can be represented in the form of a graph known as a demand curve. Figure
2.1 shows the demand curve for commodity X. The curve shows graphically the relationship
between quantity demanded and the price of the commodity. A demand curve has a negative
slope. It slopes downwards from left to right showing that as the price of a commodity falls
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demand increases. The inverse relationship between the price of a commodity and the quantity
demanded is what is referred as the law of demand.
This law states that, “ceteris paribus (other things remaining constant), the lower the price of a
commodity the greater the quantity demanded by the individual and vice versa”.
Exceptions to the Law of Demand
There are some demand curves that slopes upwards from left to right showing that as the prices
of a product rise more is demanded and vice versa. This type of demand curve is known as
regressive, exceptional or abnormal demand curve and occurs in the following situations:
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1. When there is fear of a more drastic price changes in the future. This will causes consumers to
increase their quantity demanded to avoid paying a higher price in the future. This situation is
often found in the stock exchange where there is often an increase in the demand of shares of
a company if its shares are expected to increase.
2. In the case of giffen goods. This refers to basic foodstuffs that constitute a high proportion of
the budget of low income families. When the price of a giffen good rises, the proportion of the
total income of individuals who consumes these giffen goods rises and since such consumers
are worse off in real terms, they can no longer afford to consume other more expensive
commodities like meat and fruits. To make up for the goods they can no longer afford to buy,
they are more likely to purchase more of basic foodstuffs; conversely when the price of basic
foodstuffs falls. They become better of in real terms and are likely to buy more or relatively
more expensive foodstuffs and less basic foodstuffs. Ie ugali and meat.
3. Goods of ostentation (Veblen goods). These are commodities whose prices falls in the upper
price ranges and that have a snob appeal. The wealthy are usually concerned about status.
Believing that only goods at high prices are worth buying and worth the effect of
distinguishing them from other consumers. In the case of such commodities, a firm increasing
its prices may find that the sales of its product increase and at lower prices less of the
commodity may be bought as the commodity is rejected as being substandard. Consumers
often in making comparisons between similar products with different prices opt for relatively
more expensive product believing it to be better. As prices increase demand increases this is
referred to as snob effect. Examples of goods of ostentation are expensive perfume, jewellery,
cars clothes, etc. The demand curve will be positively slopping as indicated in Figure 2.2.
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4.inferior goods- these are goods assumed to be of low quality compared to others available that
can be used to satisfy same want.an increase in price of an inferior good may be taken to mean an
improvement in quality. Demand for such commodities will hence tend to increase with increase
in prices.
5. Expectation of future shortages
6. Necessities-they are necessary for life. Demand will not change even if prices go up.
7.Habitual goods and services-a consumer will consume certain goods and services at same
quantity at any price because these goods have become habitual and one can’t do without them
e.g. addictive’s ie drugs.
The Determinants of Demand
The demand of the product can be considered from the standpoint of either individual demand or
market demand. Demand for any commodity can be considered from two points of view:
(a) Individual demand is the amount the individual is willing and able to buy at a given price and
over a given period of time. Factors affecting individual demand are;
1. The price of the product.
When deciding whether or not to buy a particular product, an individual will compare the price of
the product and the amount of utility or satisfaction expected to be received from the product. If
the price is considered worth the anticipated utility the individual will buy the product and if not
will not buy. A decrease in the price of a product will probably increase individual’s demand for
it since the amount of utility obtained is likely to be worth the lower price. Conversely a rise in
the price of a product will probably result in a fall in demand, as the amount of utility received is
less likely to be worth the higher price to be paid. An example of this phenomenon is the hotel
industry in Kenya. There is usually an increase in domestic tourism during the low season when
many Kenyans consider the lower hotel prices to be worth the level of satisfaction they are
receiving. During the high season when the hotel prices are high, many do not consider the
satisfaction they are receiving to be worth. If the amount a consumer is willing and able to
purchase due to change in the price, a change in the quantity demanded is said to take place. If on
the other hand the amount the consumer is willing and able to purchase changes because of a
change in the price of a given commodity leads to a change in the quantity demanded will be
undertaken later in utility analysis and indifference curve analysis.
2. The prices of related goods.
The demand for all goods is interrelated in that they are competing for consumer‟s limited
income. Two peculiar interrelationships can be;
1.Substitutes goods such as tea and coffee butter and margarine, beef and mutton, a bus ride and
a matatu ride, a mango and an orange, CDs and cassettes. Two goods, X and Y are said to be
substitutes if a rise in the price of one commodity, say Y, leads to a rise in the demand of the other
commodity X. If the price of tea increases consumers will find coffee relatively cheaper to tea as
a result demand for coffee increases. Substitutes are commodities that can be used in place of
other goods. This phenomenon is illustrated in Figure 2.3. The graph shows the relationship
between the prices of tea over the quantity for coffee. If the price of tea increases from P1 to P2
the quantity of coffee demanded increases from Q1 to Q2.
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3. Complimentary goods such as shoe and polish, pen and ink cars and petrol, computers and
software, bread and margarine, hamburgers and chips, tapes and tape recorders. Demand for
some commodities can also be affected by changes in the prices of the complementary if a rise
in the price of one of the goods, say A leads to the fall in the demand of another food, say B.
Complimentary goods are usually jointly demanded in the sense that the use of one requires or
is enhanced by the use of the other. Figure 2.4 illustrates the relationship between
complementary goods graphically. For example if the price of cars is lowered demand for
petrol increases because more cars will be bought/demanded. The curve shows the
relationship between the price and of a car and quantity demanded for petrol. If the price of
cars falls from P2 to P1 the quantity demanded for petrol increases from Q1 to Q2.
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4. Changes in disposal real income.
An individual’s level of income has an important effect on the level of demand for most
products. If income increases demand for the better quality goods and services increases. This
relationship however, depends on the type of goods and level of consumers‟ income. The three
types of are goods; Normal goods these are goods whose demand increases as income increases.
The demand for normal goods increases continuously with increase in income. It tends to become
gently as people reach the desired level of satisfaction.
Inferior goods refer to goods for consumers with low income levels such that as income increases
its demand falls. At low level of income, these individuals will tend to consume large amount of
these goods but as income increases they buy other goods which they consider superior thus
demanding less of the inferior goods. At very low level of income an inferior good behave like a
normal good only to behave inferior as income increases. Necessities these are goods which
consumers cannot do without such as salt, match boxes among others. Their income demand
curve tends to remain constant other than at the lowest levels of income as indicated in Figure 2.5
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5. Changes in consumer tastes, preferences and fashion
Personal tastes play an important role in governing the consumer’s demand for certain goods. For
example, preferring to consume imported commodities despite them being extremely expensive.
Prevailing fashions are an important determinant of tastes. The demand for clothing for example,
particularly is susceptible to changes in fashion.
6. Level of advertising is also an important determinant of demand. In highly competitive
markets, a successful advertising campaign will increase the demand of a particular product while
at the same time decreasing the demand for competing products. Increase in advertising will
increase demand in the following ways;
- it helps inform about the product of a firm
- Can introduce new products to the market.
- Induce individuals to frequently use the product/service
Factors affecting advertising policies
- cost of advertising
- mode of advertising
- impact of advertising on the demand of the product
- The target group (old, young)
- number of competitors and quality of their products
- The market share of the firm and the degree of competition
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- Future expectations in price changes
- Government policies and taxes
- Appropriate time to make advertisements
- Cultural background
- Language
6.The availability of credit consumers.
This factor especially affects the demand for durable consumer goods which are often purchased
on credit. For example a decrease in availability of credit or the introduction of more stringent
credit terms is likely to lead to a reduction in the demand of some durable consumer goods.
7.The government policy
The government may influence the demand of a given commodity through legislation. For
example making it mandatory for everyone to wear seatbelts. The consumers inevitably get to
purchase more seatbelts as a result. Subsidies it’s the opposite of taxation. When the government
grants subsidies prices of goods falls leading to increase in demand and vice versa. Price controls
and legislations are also government methodologies that will affect demand
8.Climate change demand of various goods varies depending on weather. For instance there is
high demand for woolen clothes during rainy reasons
(b) MARKET FACTORS AFFECTING INDIVIDUAL DEMAND
It’s a horizontal demand sum of the demands for individual consumers. It refers to quantity
demanded in the market at each price by individual consumers. For this reason all the factors
affecting individual demand will affect market demand. The market demand for a commodity can
be derived graphically as in Figure 2.6.
Where P1, P2 and P3 are individual prices Q1, Q2 and Q3 are individual quanties demanded.
Pmk is the market price qmk is market quantity demanded. Other factors affecting market demand
Change in population market demand is influenced by the size of the population, the composition
of the population in terms of age sex as well as geographical distributions. Distribution of income
more evenly distribution of income may increase demand for normal goods while at the same
time it may lower the demand for luxuries.
Movement Along and Shift in Demand Curve
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Demand is a multi- variant function in the sense that it is influenced by so many factors such as
the price of the commodity, the price of other related commodities, consumer incomes etc. The
price of the commodity is the most important determinant of demand and its relationship with the
quantity demanded give rise to a demand curve. Movement along demand curve is demonstrated
by a change in the price of a good as shown in Figure 2.7 by movement from one point to another
on the same demand curve.
A change in price of a good from P1 to P2 causes a movement from point A to B along the
demand curve. This movement along demand curve shows a change in quantity demanded which
is an increase or a fall in the quantity demanded. A shift in the demand curve is caused as a result
of a change in any factor affecting demand other than price such as changes in consumer income
tastes and preferences. For this reason all other factors affecting demand other than price of the
product are also referred to as shifting factors as illustrated in Figure 2.8 Any change in the
shifting factors will cause changes in demand (an increase or a fall in demand). A shift to the right
(dd to d1d1) shows an increase in demand while a shift from (dd to d2d2) shows a decrease in
demand.
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TERMS USED IN DEMAND
(a) Joint demand it is the demand whereby two commodities are always demanded together. One
good cannot be demanded in the absence of the other such as car and petrol.
(b) Competitive/rival goods it is the demand for goods which are substitutes such tea and coffee.
(c) Derived demand where goods are demanded in order to provide goods such as cotton is
required to produce cotton wool
(d) Composite demand (several uses) where some goods are used for different purposes such as
steel for cars machine etc.
Elasticity of Demand
It can be defined as the ratio of the relative change of a dependent variable to changes in another
independent variable. Elasticity can be analyzed in terms of demand and supply. It can also be
defined as a measure of responsiveness of quantity demanded of a good in to changes in income
or prices of other related goods. There are three types of elasticity; price elasticity of demand,
cross elasticity of demand and income elasticity of demand. Price elasticity of demand it‟s the
measure of responsiveness of the quantity demanded of a commodity to changes in its own price.
It is also referred to as own price elasticity. It abbreviated as PED/ED. It is calculated as follows
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If changes in prices cause more than proportionate change in quantity demanded it is said to be
price elastic, in this case ED >1. If changes in the price causes less than proportionate change in
quantity demanded, then demand is said to be price inelastic this is represented by ED < 1. If
changes in price causes proportionate change in quantity demanded then, demand is said to be
unit elastic or unitary elastic where ED= 1
To illustrate price elasticity consider the Table 2.3 which shows demand schedule of commodity
X.
This price elastic because 3 >1 The price elasticity of demand is classified into two:
(i) Point elasticity
(ii) Arc elasticity
The point elasticity of demand measures elasticity at a particular point along the demand curve. It
is calculated using the formulae
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Calculate the point elasticity of demand given that Qd= 4P +2p3 -3 Q = 4+2-3 =3Where P =1
Calculate point elasticity of demand given Qd = 1/p = P2 + 1 when P = 2
Arc Elasticity of demand
This measures the elasticity of demand between two points on the demand curve. Arc elasticity is
the coefficient of the price elasticity between two points on the demand curve. It is therefore an
estimate of the elasticity along a range of the demand curve. This estimate improves as the arc
becomes small and approaches a point in the limit. Arc elasticity can calculated for both linear
and non-linear demand curves using the following formula: It is illustrated as in Figure 2.26
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The demand for a commodity is 5 units when the price is Sh.1000 per unit. When the price per
unit falls to Sh.600 the demanded rise to 6 units. Calculate the arc and price elasticity of demand
TYPES OF ELASTICITY
There are five types of elasticity of demand.
(i) Perfectly elastic demand. Demand is said to be perfectly elastic when the consumers are
willing to buy an amount of a commodity at a given price, but non at a slightly higher price. In
this case elasticity of demand is equally to infinity. The will be a horizontal straight line as
illustrated in Figure 2.28. This is a case of a commodity in a perfectly competitive market. Where
an increase in price may lead to a loss of all customers.
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(ii) Elastic demand. Demand is said to be price elastic when a charge in price causes more than
proportionate change in quantity demanded. In this case the value of elasticity of demand is
greater than 1 and the demand curve will be gently sloped as indicated in Figure 2.29. This
implies that if prices increase from P1 to P2 the quantity demanded falls in greater proportion
from Q1 to Q2 and vice versa. This is a case of luxury commodity which consumes can do
without or a case of a substitute
(iii) Unity elastic demand. Demand is said to unit elastic if changes in price cause proportionate
change in quantity demanded. If price increase quantity falls in the same proportion and vice
versa. ED = 1 and the demand curve will be rectangular hyperbola as illustrated in Figure 2.30.
This is a case of a good that lies between a luxury and necessity such as soap opera film or movie
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(iv) Inelastic demand. Demand is said to be price inelastic if changes in price causes less than
proportionate change in quantity demanded. If prices increases the quantity falls in less proportion
and if the prices falls the quantity demanded increases in less proportion ED < 1 as illustrated in
Figure 2.31. This is a case of a good which is a necessity. These are goods which consumers
cannot do without but need not be consumed in fixed amount like an absolute necessity such a
staple food like ugali and milk. It also applies in the case of habit forming goods like beer and
cigarettes
Page 28 of 198
(v) Perfectly inelastic demand. Demand is said to be perfectly price inelastic if changes in price
has no effect on the quantity demand (ED= 0). In this case the demand curve will be vertical
straight as illustrated in Figure 2.32. This is a case of a good which is an absolute necessity. A
good that consumes cannot do without and have to consume in fixed amounts such as salt.
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(vii) Necessities and luxuries Demand for luxury is likely to be price elastic while the demand for
necessities is generally price inelastic. However, this depends with availability of close
substitutes.
(viii) Width/size of the market the wide definition of the market of a good, the lower is the price
elasticity of demand. Thus for wide markets demand will tend to be price inelastic while for a
small market demand will tend to be price elastic.
(ix) Time demand for most goods and services tend to be more elastic in the long run as compared
to the short run period. This is because consumers will take some time to respond to price
changes. For instance, if the price of petrol falls relative to diesel, it will take long for motorists to
respond because they are locked in existing investment in diesel engines.
(x) Durability of the commodity durable goods have low elasticity of demand or they are price
elastic while perishable goods are price inelastic.
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(v) Monopolists apply price discrimination by understanding the demand elasticities. High price is
charged to those markets with lower price elasticity
The sign of cross elasticity of demand is positive if the good X and Y are substitutes and
negative if X and Y are complimentary. The higher the absolute value of cross elasticity of
demand the stronger the degree of substutability or complimentaribility. The main determinant of
cross elasticity is the nature of the commodity relative to their uses. If two goods can certify
equally the same need the cross elasticity will be high and vice versa.
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TOPIC THREE SUPPLY ANALYSIS
Definition of Supply
Individual supply refers to the quantity of a given commodity that a producer is willing and able
to sell at a given price over a specific time period.
Market supply refers to horizontal summation of individuals producers/firms supply in the
market. The supply schedule and the supply curve demonstrate the relationship between market
prices and quantities that suppliers are willing to offer for sale. Supply differs from “existing
stock” or the amount available because it is concerned with amounts actually brought to the
market.
The basic law of supply states that, “a greater quantity will be supplied at a higher price than at a
lower price”, holding other factors An individual producer’s supply schedule shows alternative
quantities of a given commodity that a producer is willing and able to sell various alternative
prices for that commodity ceteris paribus (other things remaining constant).
This can be represented by the use of a graph referred to as a supply curve as shown in
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A supply curve show the relationship between the price of the commodity and the quantity
supplied. The relationship is a direct one as the supply curve slopes upwards from left to right.
The direct relationship is a graphical representation of the law of supply which states that other
things remaining constant a greater quantity will be supplied at higher prices and vice versa.
DETERMINANTS OF SUPPLY
The supply of a good is influenced by the following factor
1. Price of the good as the price of a given commodity say X rises, with the costs and the prices
of all other goods remaining unchanged, the production of commodity X becomes more
profitable. The existing firms are therefore likely to expand their profit and new firms are to
be attracted into the industry. It should be noted however, that not just the current rise but also
expectations concerning the future increases prices may motivate producers. The total supply
of goods is expected to increase as the prices rise.
2. Prices of other related goods changes in the prices of other commodities may affect the supply
of a commodity whose price does not change. Substitutes; two goods X and Y are said to be
substitutes in production if the supply of good X is inversely/negatively related to the price of
Y. For instance barley and wheat or tea and coffee. If a firm producing both tea and coffee
notices that the price of tea is rising may decide to allocate more resources to tea at the
expense of coffee. The supply of coffee will therefore fall as the price of tea increases.
However, the movement of resource from one use to the other is dependent on the mobility of
factors of production. Complimentary goods; two goods X and Y are said to be compliments
if an increase in the price of X causes an increase in the supply of Y such as a vehicle and
petrol. Jointly supplied goods; two goods X and Y are said to be jointly supplied if an increase
in the price of X causes an increase in the price of Y such as petrol and paraffin. If the demand
for petrol increases the supply of petrol will rise and at the same time the supply of paraffin
Page 33 of 198
will increase. N/B The extent to which firms can move from one industry to another in search
of higher profits depends on occupational and geographical mobility of the factors of
production.
3. Prices of factors of production as the prices of factors of production used intensively by
producers of a certain commodity rise, so do the firm costs. This will cause the supply to fall
since some firms will eventually leave the industry. Similarly, if the price of one factor of
production, say land, increases, some firms may move out of the production of land intensive
products into the production of goods that are intensive in other factors of production which
are relatively cheaper. Finally other less efficient firms will make losses and eventually leave
the market.
4. The state of technology
This refers to a a society’s pool of knowledge concerning industrial activities and its
improvements. Technological improvements or progress such as improvements in machine
performance, management and organization or an improvement in quality of raw materials leads
to lower costs through increased productivity and increases the profit margin in every unit sold.
This leads to increase in supply.
5.Future expectations of price change Supply of a good is not only influenced by the current
prices but future expected price as well. For example, if the price of a good is expected to rise the
firm may decide to reduce the amount of supply in the current period. This is to enable them pile
stock which they can offer for sale when prices increase in the future. This is known as hoarding.
6.Government policies
through tax imposition on goods increases the cost of production hence decline in production
and supply
Through subsidies -a grant to citizens of a country which lowers the cost of production hence
encourages production and increases in supply.
Through price control can either by price minimization where prices are fixed above
equilibrium encouraging producers to produce more hence increase in supply. It may be
undertaken through price maximization where prices are fixed below equilibrium
discouraging production hence decline in supply.
Though quotas where the government puts restriction or limit production of various goods
which leads to decline in supply.
7.Weather /climate
The supply of agricultural products is considerably affected by changes in weather conditions.
Output in agriculture is subject to variations in weather from year to the next. An excellent
growing season associated with favorable weather conditions will result in a bumper harvest
leading to an increase in supply. An unfavorable season that results in a poor harvest may be
viewed as an increase in the average costs of production because a given expenditure on inputs
yields a lower input than it would in a good/ favorable season. A bad harvest is represented by a
leftward shift of the supply curve.
8.Objectives of the firm
a business may pursue several objectives such as sales maximization, market leadership, quality
leadership, survival, profit maximization, social responsibility. Firms with sales maximization as
an objective aim at supplying greater quantities of its product than a firm aiming at profit
maximization where the later supplies less quantities but at a higher price in order to maximize
the profit.
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9. Incidence of strikes lead to a reduction in supply of a product. The supply of manufactured
goods is particularly likely to be affected by industrial disputes because of generally stronger
unions in the industrial sector.
MARKET SUPPLY
The market supply curve represents the alternative amount of a good supplied per period of time
at various alternative prices by all the producers of goods in the market. The market supply of
goods therefore will be influenced by all the factors that determine individual producer supply
and all the number of producers of goods in the market. This concept is illustrated in Figure 2.10
It therefore follows that the market supply curve will have a gently slope than individual supply
curves. Figure 2.10 Derivation of market supply curve
MOVEMENT ALONG AND SHIFT IN SUPPLY CURVE
The relationship between price of a commodity and quantity supplied give rise to a supply curve.
Any changes in the price of a good causes change in the quantity supplied. This can be traced by
the movement along supply curve as shown in Figure 2.11 The movement from point A to B is
caused by changes in price from P1 to P2 which bring fourth the movement along the supply curv
A shift of supply curve is caused by a change in any other factors affecting supply other than the
price of the goods. This shift indicates changes in supply as a result of e.g. advances in
technology which makes it cheaper to produce goods and services and therefore their supply will
increase. Similarly incase of increase in cost of production will lead to a fall in quantity supplies
as shown in Figure 2.12. A shift to the right from S1S1 to S3S3 shows a fall in supply.
Page 35 of 198
ELASTICITY OF SUPPLY
It is the measure of responsiveness of quantity supplied of a commodity to change in the factors
affecting supply. Price elasticity of supply -It is the measure of responsiveness of quantity
supplied of a commodity to change in its own price. It is abbreviated as ES and calculated as:
ES will have a positive value because of the direct relationship between the price of the product
and quality supplied.
If ES is greater than 1, then the supply is said to be price elastic
If Es <1 then supply is price inelastic
If Es =1 then supply is unit elastic.
TYPE OF PRICE ELASTICITY OF SUPPLY
1. Perfectly elastic supply
2. Elastic supply
3. Unit elastic supply
4. Inelastic supply
5. Perfectly inelastic supply.
FACTORS AFFECTING PRICE ELASTICITY OF SUPPLY
a) Mobility of factors of production If they are highly mobile then supply will be price elastic
since more factors can be employed quickly when the prices increase thus increase in supply
b) The level of employment of resources It refers to the utilization and allocation of resources. If
the factors are fully utilized supply will be price inelastic due to the fact that all the facts are
Equilibrium can be defined as a state of rest or balance in which no economic forces are being
generated to change the situation. These economic forces are excess demand and supply and are
illustrated in Figure 2.14. At P1, the quantity demanded by consumers is Q1 units but producers
are willing to supply at price a quantity of Q2 units. Therefore there is an excess supply equal to
(Q2 –Q1). Excess supply refers to a situation where quantity demanded is less than quantity
supplied at prevailing market price. Producers may therefore react to the excess supply by
lowering prices of their products so as to sale the unsold stocks. Excess supply is referred to as a
buyer’s market since suppliers may be obliged to lower their prices in order to dispose of excess
output a situation which is favorable to buyers. Excess supply represents an economic force that
C/O SMK Page 38
exerts downward pressure on prices. At P2 the quantity demanded is Q2 but producers are willing
to supply Q1 units of goods. Therefore, there will be excess demand equal to (Q2-Q1). This
situation of excess demand is referred to as sellers’ market because competition among buyers
will force up the price due to the existing shortage Excess supply is a situation where quantity
demanded is greater than quantity supplied at prevailing market prices.
In this case, the price of goods will rise because of competition among buyers. Excess demand
represents an economic force on prices which exerts upward pressure. Prices P1 and P2 are
disequilibrium prices and market is said to be at disequilibrium. Therefore, the general rule for eq
The following economic function has been derived by the finance manager of Kenya Breweries
ltd. Qa = 3p2 - 4p
6p – 4 – supply
Q6 - 24 – p2
Where P represents prices and Q represents quantity
Which of the two function could represent in demand curve and supply curve and why. At what
value of price and quantity is the market in equilibrium?
EQUILIBRIUM
In studying equilibrium, our objective is to determine the market price and quantity and try to
identify the forces that influence such a price and quantity.
Equilibrium can be defined as a state of rest. It is a situation whereby quantity demanded
( Qd ) is equal to quantity supplied ( Q s ) i.e. Qd=Q s
In this case, we say that the market is clearing and there are no economic forces generated to
change this point hence it is stable.
We determine this graphically by the interpretation point of the demand and supply curves as
below.
C/O SMK Page 39
Price
Excess supply S
p1 pe
Qe
pe E
p2
D
Excess demand
Quantity
0Q3Q1 Qe Q2 Q4
In the above diagram it can be seen that the forces of demand and supply determine the price
in the market, i.e. a price at which both consumers and sellers are happy and where quantity
supplied equals quantity demanded. That price is known as the equilibrium price.
In the diagram, should the price be above the equilibrium price, forces of demand and supply
will work together and lower the price towards the equilibrium price until the equilibrium
price is reached. For example at
p1 consumers will only be willing to buy 0Q1 from the
0Q
market while sellers will by willing to supply 2 . In this case an excess supply equals to
Q1 Q2 will be created. Because of this excess supply, sellers will have to reduce the price in an
p
attempt to encourage consumers to buy more. Prices will be reduced until e is reached where
quantity demanded equals quantity supplied.
Demand function:
Qd =3550−266 p
Supply function:
Qs =1526+240 p
At equilibrium
Qd =Q s
Price
Qs 1526 240 p
pe sh 4
QD 3550 266 p
Quantity
0 Qe 2486
TYPES OF EQUILIBRIUM
1. Stable equilibrium
2. Unstable equilibrium
3. Neutral equilibrium
Stable equilibrium: if there is a force that disrupts the market equilibrium, then there would be
adjustments that bring back to the initial equilibrium. This type of equilibrium is well explained in
the previous section.
A fall in supply Consider the Figure 2.19 which illustrates the effect of a fall in supply on the
market equilibrium. A fall in supply is represented by a shift of supply curve to the left from S1S1
to S2S2. The immediate effect will be shortage and thus will force the prices to go up leading to a
fall in quantity demanded until a new equilibrium is established at Pe1, Qe2.
Out put.
Total production
curve.
0
0 2 4 6 8 10
-5
Labor
Conclusion
1. When APL is rising MPL>APL
2. When APL is falling, MPL <APL
3. When APL is at maximum MPL = APL
4. When TPL is at maximum, MPL = 0
Both graphs initially increase, reach a maximum before finally declining. This is because of the
law of diminishing returns
Long run refers to a period of time in which all variables are able to settle at their equilibrium
and all economic processes have time to work in full Average product (AP) is the output per unit
of the variable factors and it‟s given by: AP = Total product (TP) Number unit of variable factors
E.g. the average product of workers and capital are given by: AP = TP; AP = TP L K Marginal
products it is changes in the total product brought about by varying the employment of the
variable factors by one unit e.g. increasing employment by 1 person. MP = Change in total
product Change in quality of labour employment = ΔTP ΔL
Fixed Costs – are costs that do not change as output varies. They are associated with fixed factors
of production and include; rent rates, insurance, interest on loans and depreciation. Fixed costs
remain the same whether output is one unit or output is 1,000 units. Fixed costs are also referred
to as overhead costs or unavoidable costs.
Depreciation, especially in capital intensive industries usually constitute a major item in fixed
costs since the life of capital tends to be measured in economic rather than technical terms and
machinery, for example, depreciates even when not in use. Variable Costs- are costs that are
related directly to output and include the wages of labour, the costs of raw materials, fuel and
power. Variable costs are alternatively known as direct or prime costs. Total Costs represent the
sum of fixed costs (FC) and variable costs (VC). TC = FC+VC When output is equal to zero, total
Output
This explains the three stages of production namely:
1. The increasing returns.
2. Constant returns /decreasing rate and
3. Decreasing/declining returns.
returns.
Increasing
returns
Constant
Decreasing returns
Economies
of scale. Diseconomies of
scale.
Optimum
point.
MC
Output
AVC
AFC
Explanation
Qe Output
AC
M
C
Losses
Pe MR = AR = D
E1
MC
Normal profits AC
Price
AR = MR = D
x
Pe
Output
Qe
The firm is at equilibrium when it produces the level of output at point at X where MR = MC and
produces output Qe.
At point X, AR = AC meaning TR = TC; TR - TC = O (normal profits)
Why normal profits are generated in the long run in perfect competitive market
Firms in this market at first make abnormal profits attracting many firms since entry is free.
Supply increases and prices start decreasing and now firms start making losses.
C/O SMK Page 75
Losses force some firms to exit the market since exit is also free. This consequently reduces
supply and prices start increasing such that in the long run firms are at equilibrium when they
make normal profits.
Normal profits are experienced when TR = TC meaning TR - TC = 0 (normal profits). At this
point existing firms cannot quit the market and new firms cannot enter the market.
ADVANTAGES OF PERFECT COMPETITIVE MARKET
1. Consumers have choice in terms of many sellers to choose from
2. No monopolies who may overcharge consumers by overcharging
3. Entry is free
4. Exit is free
5. Competition among seller’s leads to production of high quality products enjoyed by
consumers
6. No wasteful competition.
DISADVANTAGES
1. Consumers lack variety of products because products are homogeneous.
2. Stiff competition among firms causes weak firms to close down.
3. Closing down of weak firms causes unemployment in the country.
4. Firms make only normal profits in the long run.
5. There is no room to produce public goods to benefit the public since the aim of the firm is
to make profits.
6. Since firms aim at making profits, they might not account for externalities. E.g. pollution.
2.IMPERFECT MARKETS.MONOPOLIES.
This market which does not satisfy perfect competition market conditions. For example a
monopsony market which is a market structure characterized by a single buyer e.g. KPLC which
buys electric power from Kengen
This is a market having many buyers and one seller selling a product which has no close
substitute and there are barriers to entry preventing other firms from entering the market.
CHARACTERISTICS
1. Many buyers.
2. One seller.
3. There are barriers to entry. For example trade licenses.
4. There is no direct competition from sellers since there is only one seller.
5. Total control of essential resources or strategic resources.
REVENUE /
PRICE
The monopolist misallocates resources because he adheres to the principle of MR = MC. but
restricts output and charges more price than a perfectly competitive market. He also does not
produce at the lowest point of ATC therefore does not gain productive efficiency.Also the
monopoly does not have a supply curve because the same quantity is sold at market at different
prices.
MC
Price /
revenue
AC
C
P
D = AR = P
MR
The long run equilibrium
O Quantity
In the long run, the monopolisticqhas
m enough time to adjust output with change price. He can do
this by building another plant or a smaller one depending on price and demand.
At the long run a monopolistic will produce at a point where long run marginal cost is equal to
long run marginal revenue.
If the total demand for the product does not change, the demand for any product of the firm will
fall. This shifts the demand curve shifts to the left until the abnormal profits are eliminated and
this point there are no incentives for new firms to enter the market.
MC
LAC
AC
C
P1 P2
V
A
E1
E0 AR1
Long run price and output determination
AR = under
D monopolistic competition
If firms in a monopolistic competition earn economic profits in the short run, more firms MR1will
MR
enter the market in the long run. This shifts the demand curve facing each monopolistic
competitor to the left (as its market share decreases) until it becomes tangent to the firm’s LAC
0curve. Thus in the long run all monopolistically competitive firms break even (earn normal
Q1 Quantity Q2 Quantity
profit) and produce on the negatively sloped portion of their LAC curve (rather than at the lowest
point, as in the case of perfect competition). This is shown in figure b above. The condition to be
Short Run
satisfied Equilibriumb)Long
for profit RuninEquilibrium
maximization the long run is MR=MC and P=AC.
Product differentiation
Cost /
revenue MC
A
AC
P1
C
B
D = AR
MR
Output
0
Q1
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iii) THE NATIONAL EXPENDITURE because whatever we receive we spend, or lend to the
banks to invest it, so that the addition of all the expenditure should come to the same as the
other two figures.
Put in its simplest form we can express this as an identity:
National output National Income National Expenditure.
THREE APPROACHES TO MEASUREMENT OF NATIONAL INCOME.
A) OUTPUT / PRODUCT METHOD/VALUE ADDED/NET OUTPUT
In this method value of output of all the firms in the economy is added together to arrive at
national income figure.
To aid in this the economy is divided into different productive sectors eg farming, fishing,
mining etc. It is a useful method where a census of production of the economy is required.
It is important that only the value added at each stage of production or by each firm is counted in
order to avoid double counting.
The term value added of the firm may be defined as the difference between the total value at
each stage and the value of the previous stage.
For example: Consider a case of wheat bread production shown below;
Kshs. Value Added
Farmer 100,000 100,000
Miller 150,000 50,000
Bakers 180,000 30,000
Retailers large / wholesalers 190,000 10,000
Retailers 200,000 10,000
820,000 200,000
To avoid double counting we use value added only or the other approach is to add the final
product only. Imports if and only if included in the total output should be excluded and exports
if excluded should be included.
The figure obtained is further adjusted by adding net factor income from abroad.
This is the most direct method of calculating national income.
ADJUSTMENTS TO BE MADE.
Stock appreciation-subtracted.
Residual errors-subtracted.
Net factor income from abroad-added if positive and subtracted if negative.
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depreciation
B) INCOME METHOD
Income method approach is from the distribution side.In this approach national income is got by
adding together all the rewards earned by all factors of production for a given period. We
include only those particular income flows that originate with the production of goods and
services whose total we seek to estimate.
Only then will the total income flows equal the total of the goods and services.
In an economy income is earned as follows;-
1. Land receives rent (R)
2. Labour receives wages (w)
3. Capital receives interest (r)
4. Enterprenuer receives profit (π)
So that Y = R + W + r + π, however the following also should be taken into account:
5. Retained earnings – (re) that part of profit retained by firms should be taken into account
6. Subsistence income (sy) – this occurs in a case where income is not paid but services are
rendered eg services of housewives, self provided services etc
THE FOLLOWING SHOULD BE EXCLUDED:-
7. Transferred payment (tp) – Payment made without satisfying ‘Quid Pro Quo’ criteria ie
income for which the recipient provides no good or service.
8. We should exclude income received from people who sell building, automobiles or things
produced in a previous period, because what they receive in payment is ‘not income’ in
the sense of something generated in the cause of producing the output of the current
period (py)
9. Anything for which neither a good or a service is supplied in exchange and for which
there is therefore no corresponding for example receipts of people who sell bonds and
debentures (SB)
Therefore National Income will be expressed as follows:-
Y = R + W + r + Re + π + Sy – tp – Py – SB
Y = C + S + T + Rpf
C) EXPENDITURE METHOD
In this approach we add together all types of spending on finished goods and services in an
economy. It involves counting each unit produced at the time of purchase and valuing it at the
actual purchase price. If we add up total expenditure on goods and services, we will have
(subject to a number of qualifications). The total we seek and also a total in which each unit of
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output is valued at what appears to be the best available indicator of the value of that unit to the
society ie the price actually paid for it.
Different types of spending in an economy are identified and added together:-
10. Personal consumption expenditure (C)
Spending in food items, services, durable goods by households.
11. Private domestic investment (Gross) (I)
This includes all purchases of machinery, tools and equipment, all construction whether
residential as commercial and changes in inventory.
Inventory changes as investments are produced and not sold or sold when not produced in the
present period. If at the end of the year firms have more stock on the shelves than at the end of
the year it means that the economy has produced more than it has consumed. Therefore positive
changes should be added when GNP is determined. For inventory decline we subtract from GNP
since GNP is a measure of the current year’s output and we must omit anything produced in past
or previous years.A fall in inventory means that the economy consumed more than it produced in
a given year, thus consuming previous years production.
12. The Government (G)
All government spending on final goods and services should be included but exclude spending
on transferred payments as well as subdsidies.
13. Exports and Imports
Spending by foreigners on goods and services produced in a country should be included.
Export is symbolized by (X)
Imports is spending on foreign goods and services produced in other countries. It is symbolized
by (M).
Net export (Xn) is the amount by which foreign spending on our goods and services exceed the
amount of spending on goods and services exceed the amount of spending on goods and services
produced by foreigners.
Therefore, GNP = C + I + G + X – M also measures aggregate demand of an economy.
EXCLUSIONS FROM EXPENDITURE.
The desired total measures the amount of output produced by an economy in a specified period
of time. Thus it must clearly indicate only expenditures on the purchase of goods and services
produced in that period.
The exclusions include:-
(i) Any part of billion of shillings spent during that period on goods produced in earlier
periods. All expenditures of this kind merely reflect changes in the ownership of pre-
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existing output. As such they are not part of the total of expenditure that measures
the values of total output.
(ii) It must exclude all expenditures of things that are neither goods nor services and
therefore do not reflect production at all either current or past. For example spending
on stocks and bonds. There is no production or output of goods and services
corresponding to expenditure on mere pieces of paper.
(iii) All expenditure by central and local government for which the government does not
receive a good or services in exchange eg transfer of payments.
(iv) Spending on intermediate products so as to avoid double counting.
(v) Taxes.
(vi) Depreciation.
SOME DIFFICULTIES/PROBLEMS IN MEASURING NATIONAL INCOME
National Income Accounting is beset with several difficulties. These are
1) Making decisions on what goods and services to include
Although the general principle is to take into account only those products which change hands
for money, the application of this principle involves some arbitrary decisions and distortions. For
example, unpaid services such as those performed by a housewife are not included but the same
services if provided by a paid housekeeper imputed value is usually assigned to this income.
Many durable consumer goods render services over a period of time. It would be impossible to
estimate this value and hence these goods are included when they are first bought and subsequent
services ignored. Furthermore, there are a number of governmental services such as medical
care and education, which are provided either 'free' or for a small charge. The solution is that all
unpaid services are excluded.
2) Danger of Double Counting
The problem of double counting arises because of the inter-relationships between industries and
sectors. Thus we find that the output of one sector is the input of another. If the values of the
outputs of all the sectors were added, some would be added more than once, giving an
erroneously large figure of national income. This may be avoided either by only including the
value of the final product or alternatively by summing the values added at each stage which will
give the same result.Some incomes such as social security benefits are received without any
corresponding contribution to production. These are transfer payments from the taxpayer to the
recipient and are not included. Taxes and subsidies on goods will distort the true value of goods.
To give the correct figure, the former should not be counted as an increase in national income for
it does not represent any growth in real output.
3) Inadequate Information
The sources from which information is obtained are not designed specifically to enable national
income to be calculated.
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4) It is easy to value the goods that are sold in market but those which aren’t sold in market
have no price attached to them.
5) Activities that are considered illegal eg making illicit brews are also not included when
measuring national output although they involve echange of money.
6) The value to put on goods that have been ket as stock becomes difficult.one has to decide
whether to use the cost of goods /the price to be paid for them.price is different from cost
of similar goods being produced due to a rise /fall in the production costs.
7) Prices of some resources keep fluctuating in markets
8) It is difficult to measure the cost of wear and tear or depreciation of equipment inorder to
arrive at net national income
FACTORS AFFECTING THE SIZE/LEVEL OF NATIONAL INCOME
The size of a nation’s income depends upon the quantity and quality of the factor endowments
at its disposal. A nation will be rich if its endowments of natural resources are large, its people
are skilled, and it has a useful accumulation of capital assets. The following points are of
interest:
1. Natural Resources
These include the minerals of the earth; the timber, shrubs and pasturage available; the
agricultural potential (fertile soil, regular rainfall, temperature or tropical climate); the fauna
and flora; the fish; crustaceaetc of the rivers and sea; the energy resources, including oil, gas,
hydro-electric, geothermal, wind and wave power.
2. Human Resources(labour supply).
A country is likely to prosper if it has a large population; literate and numerate sophisticated and
knowledgeable about wealth creating processes. It should be well educated and skilled, with a
nice mixture of theory and practice. It should show enterprise, being inventive, energetic and
determined in the pursuit of a better standard of living.
3. Capital Resources
A nation must create and then conserve capital resources. This includes not only tools, plant and
machinery, factories, mines, domestic dwellings, schools, colleges, etc, but a widespread
infrastructure of roads, railways, airports and ports. Transport creates the utility of space. It
makes remote resources accessible and high-cost goods into low-cost goods by opening up
remote areas and bringing them into production.a country that uses modern equipments eg
tractors in ploughing would be able to produce more than a county using simple jembes.
4. Self-sufficiency
A nation cannot enjoy a large national income if its citizens are not mainly self-supporting. If
the majority of the enterprises are foreign –owned there will be a withdrawal of wealth in the
form of profits or goods transferred to the investing nation.
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5. Political Stability-the government that maintains conducive political atmosphere may
attract both local and foreign investors who in turn contribute to increasing size of
national income.Inorder to plan and execute production plans,firms require a stable
political environment.
6. Level of technology-this refers to the techniques in production of goods and services
determining quality and quantity of goods and services provided.the higher the level of
technology used in production prcess,the higher its output and hence higher national
income.
7. Entrepreneurship-availability of entrepreneurs who have the ability to organise the
factors of production will have a bearing on countys national income.
8. Land-a country with abundant resources is likely to have a high national income relative
to a country without.
9. The quantity and quality of factors of production.
USES OF NATIONAL INCOME FIGURES/STATISTICS.
1. We need national income statistics to measure the size of the "National cake' of goods
and services available for competing uses of private consumers, government, capital
formation and exports (less imports).
2. National Income statistics are also used in comparing the standard of living of a country
over time
3. And also the standards of living between countries.
4. National Income Statistics assists in investment decisions and this is possible because the
data from this statistics may show the sectors which are declining and those
growing.investors would save in growing sectors to save him/her time and cost of
conducting market research.
5. If National Income Statistics are disaggregated it would enable us to assess the relative
importance of the various sectors in the economy. This is done by considering the
contribution of the various sectors to Gross National Product over time. Such information
is crucial for planning purposes for it reveals to planners where constraints to economic
development lie. It therefore becomes possible to design a development strategy that
eventually would overcome these problems. This central contribution could be in the
form of employment or the production of goods and services.
6. By assessing exports and imports as a percentage of Gross national Product i.e. using
national statistics, it is possible to determine the extent to which a country depends on
external trade.
7. Provides a breakdown of consumer expenditure, government expenditure,levels of
investment and total taxes paid to the government. This helps the government to plan for
development activities using taxes collected e.g. social amenities provision helps
government when making policies regarding investment.
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8. To provide information on the relative sizes of the various sectors of the economy and
their contribution e.g. agriculture and manufacturing. This will be determined by the
share of each sector in relation to total national output.
9. Provide information on performance of the economy over a given period of time and this
forms a basis of comparison between different periods.
10. Provide information which is used in making economic policies, preparing annual
budgets and preparing development plans.
11. This statistics provide information on the distribution of income which helps the
government to address income disparities e.g. through subsidies and tax relief.
12. G.D.P is a measure of economic growth. If G.D.P goes up it indicates that the economy is
growing.
13. Provides information on the types of factor incomes within the economy and this can be
an indicator of shrinking/growing sectors of the economy.
14. Used as a measure of standard of living of people in a country.
15. Assists in comparing standards of living,although this method has a number of drawbacks
ie different currencies are used and conversion may be tedious,definition of goods and
services used in computing national income may also differ in different
countries,disparity in income distribution and different needs and taste of citizens.
PER CAPITA INCOME/G.N.P.
By National Income is meant the value of outputs produced within a year. Income per capita is
simply the National Income divided by the population of the country in a year.
INCOME PER CAPITA = National Income
Population
It shows the standard of living a country can afford for its people. The level of income per capita
is determined by the size of a country’s population. The higher is the rate of growth of
population, the lower is the rate of growth of income per capita.
Per capita income is a theoretical rather than a factual concept. It shows what the share of each
individual’s National Income would be if all citizens were treated as equal. In a real world
situation there exists considerable inequality in the distribution of income especially in the third
world countries
NATIONAL INCOME AND STANDARDS OF LIVING
Standard of living refers to the quantity of goods and services enjoyed by a person. These goods
may be provided publicly, such as in the case of health care or education or they may be acquired
by direct purchase. It also includes the less easily quantifiable aspects of living such as terms and
conditions of employment and general living environment.
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National Income figures can be used to measure the standard of living at a particular point of
time and over time. This is done by working out the per capita income of the country. By per
capita income we mean: the value of goods and services received by the average man. Per
capita income is obtained by dividing the National Income by the Total population. If the per
capita income is high, it can be deduced that the standard of living is high.
PROBLEMS OF USING PER CAPITA INCOME TO COMPARE STANDARD OF
LIVING OVER TIME
1) The composition of output may change. e.g. more defence-related goods may be produced
and less spent on social services, more producer goods may be made and less consumer
goods, and there may be a surplus of exports over imports representing investment overseas.
Standards of living depend on the quantity of consumer goods enjoyed.
2) Over time prices will change. The index of retail prices may be used to express the GNP in
real terms but there are well known problems in the use of such methods.
3) National Income may grow but this says nothing about the distribution of that income. A
small group may be much better off. Other groups may have a static standard of living or be
worse off.
4) Any increase in GNP per capita may be accompanied by a decline in the general quality of
life. Working conditions may have deteriorated. The environment may have suffered from
various forms of pollution. These non-monetary aspects are not taken into account in the
estimates of the GNP.
5) Finally the national income increases when people pay for services which they previously
carried out themselves. If a housewife takes an office job and pays someone to do her
housework, national income will increase to the extent of both persons' wages. Similarly a
reduction in national income would occur if a man painted his house rather than paying a
professional painter to do the same. Changes of the above type mean that changes in the GNP
per capita will only imperfectly reflect changes in the standard of living.
PER CAPITA INCOME AND INTERNATIONAL COMPARISONS
Per capita income figures can also be used to compare the standards of living of different
countries. Thus if the per capita income of one country is higher than that of another country, the
living standard in the first country can be said to be higher. Such comparisons are made by aid
giving international agencies like the United Nations and they indicate the relevant aid
requirements of different countries.
But there are major problems in using real income per head (per capita income) to measure the
standard of living in different countries. First there is the whole set of statistical problems and,
secondly, there are a number of difficult conceptual problems or problems of interpretation.ie
LIMITATIONS OF NATIONAL INCOME AS A MEASURE OF WELFARE.
1. Inaccurate estimates of population: The first statistical problem in calculating income per
head particularly in less developed countries is that we do not have very accurate population
figures with which to divide total income.
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2. Specific items which are difficult to estimate: Another data problem, as already
mentioned, is that data for depreciation and for net factor income from abroad are generally
unreliable. Hence although we should prefer figures for “the’ national income, we are likely
to fall back on GDP, which is much less meaningful figure for measuring income per head.
Inventory investment and work-in-progress are also difficult items to calculate.
3. Non-marketed subsistence output and output of government: some output like
subsistence farming and output of government are not sold in the market. These are
measured by taking the cost of the inputs. In one country, however, salary of doctors for
instance, might be higher and their quality low compared to another country. Although the
medical wage bill will be high, the "real consumption” of medical care in the former might
be lower. Since “public consumption” is an important element in national income, this
could affect comparisons considerably.Also in making international comparisons it is
assumed that the complied national income figures of the countries being compared are
equally accurate. This is not necessarily the case. If, for example, in one country there is a
large subsistence sector, a lot of estimates have to be made for self-provided commodities.
The national figures of such a country will, therefore, be less accurate than those of a country
whose economy is largely monetary or cash economy.
4. Different degrees of income distribution: large population may be contributing a small
proportion of national output while a few contribute a higher percentage.the many people
who share only a small proportion will have a low standard of living.
5. Different Types of Production: If one country devotes a large proportion of its resources in
producing non-consumer goods e.g. military hardware, its per capita income may be higher
than that of another country producing largely consumer goods, but the standard of living of
its people will not necessarily be higher.
6. Different forms of Published National Income figures: The per capita income figures used
in international comparisons are calculated using the published figures of national income
and population by each country. For meaningful comparisons, both sets of national income
figures should be in the same form i.e. both in real terms or both in money terms, the latter
may give higher per capita income figures due to inflation, and thus give the wrong picture of
a higher living standard. On the other hand, if both sets are in money terms the countries
being compared should have the same level of inflation. In practice, this is not necessarily
the case.
7. Exchange Rates: Every country records its national income figures in its own currency. To
make international comparisons, therefore, the national income figures of different countries
must have been converted into one uniform currency. Using the official exchange rates does
this. Strictly speaking, these apply to internationally traded commodities, which normally
form a small proportion of the national production. The difficulty is that these values may
not be equivalent in terms of the goods they buy in their respective commodities i.e. the
purchasing power of the currencies may not be the same as those reflected in the exchange
rate.
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8. Difference in Price Structures: Differences in the relative prices of different kinds of
goods, due to differences in their availability, mean that people can increase their welfare if
they are willing to alter their consumption in the direction of cheaper goods. The people in
poor countries probably are not nearly as badly off as national income statistics would
suggest, because the basic foodstuffs, which form an important part of their total
consumption, are actually priced very low.
9. Income in relation to Effort: increased gross national output may have resulted from an
increase in the number of hours worked.G.N.P is a measure of production and consumption
not necessarily indicating an improvement in peoples welfare.the citizens may be working in
unhealthy conditions and leisure time denial thus G.N.P does not take into account peoples
welfare.
10. Differences in size: A problem which is both conceptual and statistical is due to the
transport factor. If two countries are of different sizes, the large country may devote a large
proportion of its resources in developing transport and communication facilities to connect
the different parts of the country. This will be reflected in its national income, but the
standard of living of its people will not necessarily be higher than that of smaller country,
which does not need these facilities to the same extent.
11. Differences in Taste: Another formidable difficulty is that tastes are not the same in all
countries. Also in different countries the society and the culture may be completely different
thus complicating comparisons of material welfare in two countries. Expensive tastes are to
some extent artificial and their absence in poor countries need not mean a corresponding lack
of welfare. Tastes also differ as regards the emphasis on leisure as against the employment
of the fruit of labour:
12. Different climatic zones: If one country is in a cold climate, it will devote a substantial
proportion of its resources to providing warming facilities, e.g. warm clothing and central
heating. These will be reflected in its national income, but this does not necessarily mean
that its people are better off than those in a country with a warm climate.
13. Income per head as index of economic welfare: We cannot measure material welfare on
an arithmetic scale in the same way as we measure real income per head. For instance, if per
capita income increases, material welfare will increase; but we cannot say by how much it
has increased, and certainly that it has increased in proportion.
14. It does not take into consideration the effects of production activities on environment eg
environmental degradation and pollution.
15. It just measures economic growth as opposed to economic development .
16. Quality of Life
National income figures do not reflect the quality of life. An increase in national income may be
the result of linger working houses, inferior working condition, increase in housewives (which
means less comfort). Generally national income has no provision for leisure time.
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TOPIC NINE.
MONEY AND BANKING.
Money is any asset that is generally acceptable as a means of payment to settle transactions as
well as a medium of exchange.it is anything that is generally acceptable for payment of debts.
Stages in development of money
Historically, the development of money in the present form has evolved through the following
stage;
1. Commodity money
This is the money that has a value apart from its use as money. In primitive agricultural stages,
domestic animal like cattle, goat, horses, cow etc were used as money. These commodities
lacked the essentials of durability; homogeneity etc so could be used any more. Later, there was
the use of precious metals of gold, silver and copper i.e. metallic money. The uncoined metals as
a medium of exchange further created difficulties. People were unable to know the eight and
value of pieces of bullion at sight. This led to the replacement of the unstandardized metal ingots
with a standardized coinage. The metallic coin had a quarantined weight of value by a competent
authority. Thereafter, the coins also proved a failure as a good medium of exchange. They were
clipped, abraded and melted down. Efforts were then made to find out a better unit o account.
2. Convertible paper money
This was the second stage where paper was used to substitute commodity at rate specified on the
currency. Before 1914, the bulk of bank notes were convertible into gold. The bank had to pay
the bearer a specific amount of gold on demand. In today’s economy the paper notes are
convertible notes. They are neither fully or fractional convertible into gold.
3. Deposit money.
This consists of deposit at bank and financial institution which are subject to withdrawals by
Cheques are a safe way of transferring the ownership of deposit in financial institutions.
CHARACTERISTICS OF MONEY.
For a commodity to perform as money it has to have the following characteristics.
1) Acceptability-money must be acceptable to everyone for it to be used as a medium of
exchange
2) Durability-should be able to last for a long time without getting torn,defaced or losing its
shape and texture. The material used to make money should therefore be of a quality that
resists wear and tear.
3) Divisibility-should be easily divisible into smaller denominations but still maintain its value.
This enables the buyer to purchase various quantities of goods and services.
4) Cognizability-should be made of a special material that is easily recognizable to minimize
risk of forgery and printing of fake notes and mint coins.this cognizability of money enables
people to differentiate various denominations of the currency.
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5) Homogeneity-should be made using a similar material so that it appears identical e.g. 500
notes should be printed using the same material and have identical security features to
eliminate risk of confusion and forgeries.all notes of the same denomination should be
identical.
6) Portability-should be convenient to carry even if it has a high face value.it should neither be
too bulky to carry around as this would hamper trade.ie should be light.
7) Stability in value-should last for a long time without changing in value so that it maintains
credibility and acceptability.money that fluctuates in value makes people want to hold their
wealth in form of goods.
8) Liquidity-should be easy to convert into other forms of wealth.one should be able to quickly
convert money into properties or other forms of assets.
9) Scarcity-should be relatively scarce in supply.if money was abundant in supply then it would
lose value.
10) Malleability-the material used to make currency coins should be easy to cast into required
shapes.
FUNCTIONS OF MONEY.
1) Medium of exchange-money is generally acceptable by everybody in exchange for goods and
services.it therefore enables trade to be carried out conveniently hence reducing drawbacks
of barter trade
2) Measure of value-when commodities are valued in terms of money,a problem of fixing
exchange rate is solved.this is because money provides a common denominator in which the
values of various goods and services are expressed.
3) A unit of account-money can be held for no other purpose than accounting.money is a unit by
which goods and services are valued.
4) Store of value-this is because it is easily convertible into other forms of assets.money can
also be kept as savings for future transactions since it is durable and relatively stable in value.
5) Standard of deferred payment-a debt incurred today can be paid at a later date using money.ie
used to settle future payments.
6) Transfer of immovable properties-using money,we are able to transfer the value of a
commodity from one person or place to another.eg a piece of land in Mombasa can be sold
and the money received used to acquire a piece of land of an equivalent value in another
province.
7) Measure of wealth-wealth can be measured in monetary terms.
BARTER TRADE.
This refers to exchange of goods and services for goods and services.this trade has several
drawbacks.
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i. It is difficult to estimate the value of one good with another
ii. It depended on double coincidence o wants between traders.
iii. Perishability of some commodities tomatoes,fruits and milkcould go bad very easily hence
could not be stored.
iv. Divisibility aspect was a problem ie it wasn’t easy to divide some commodities into smaller
goods.
v. Portability-it was difficult to transport goods since some were heavy and bulky.
MERITS OF BARTER TRADE.
1. Buyers and sellers are able to get the goods and services they require immediately after the
exchange.
2. A country/person is able to dispose off the surplus.
3. Promotes social relations among the trading communities,through negotiations
4. Promotes specialization in the production of goods and services ie concentrate on what you
can offer best.
DEMAND AND SUPPLY OF MONEY.
Demand for money refers to the tendancy or desire by an individual or general public to hold
onto money instead of spending it.it is also known as liquidity preference.money can be hold by
individuals in various forms and these include;currency notes and coins,securities e.g. treasury
bills and bonds,demand deposits held in current accounts of banks,time deposits held in fixed
deposit accounts.
DEMAND FOR MONEY(DESIRE TO KEEP MONEY INSTEAD OF ASSETS)DEPENDS
ON THREE MOTIVES.
1. The transaction motive-here one holds money with a motive of meeting normal daily
expenses e.g. buying food,entertainment ,paying wages,postage,travelling,buying raw
materials etc
2. The precautionary motive-this is where people tend to hold money to meet expenses that
might occur unexpectedly or emergencies e.g. sickness,accident,or loss of property through
theft.it is obvious that optimistic and risk takers will keep less money while pessimistic /risk
averse will keep more money.
3. The speculative motive.money may be held to be used in future especially when people
anticipate that the prices of goods and services will be lower than they are presently and one
plans to invest in opportunities that will bring more gains/returns. such money is said to be
held in a speculative motive.money held for this purpose depends on levels of income and
how optimistic/pessimistic people are about future happenings.
SUPPLY OF MONEY.
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This refers to the stock of monetary items that are in circulation in an economy at a particular
point in time.these items basically consists of;total currency ie notes and coins issued by central
bank and the total demand deposits.the following variables affects money supply;
i. Policies of commercial banks-if more loans are ooffered to individuals and firms,money
money is released in economy and the vice versa is true.
ii. Increase in national income-this increases economic activities resulting to money level in
economy to increase and vice versa is true.
iii. Increase in foreign exchange-increased export earnings arising from increased export trade
leads to an increase in money supply in an economy and the vice versa is true.
iv. Coins and notes offered by commercial banks
v. Central bank guidelines to commercial bank on cash reserve requirements.
vi. Government policies ie can be geared towards expenditure,borrowing which increases money
supply,
vii. Open market operations activities.
viii. Intrest rate policies
ix. Special deposits requirement by CBK.
x. A change in the public desired cash holdings.
xi. Balance of payment equilibrium or disequilibrium-disequilibrium transalates to a net outflow
of currency which leads to a reduced money supply.
Money supply is best understood through the concept of MONETARY POLICY.this can be
defined as a deliberate move by government through the central bank to manipulate the
supply ,availability and cost of money inorder to achieve the desired economic levels.The
following are the various instruments /tools that commercial banks use in conjuction with the
centaral bank to regulate the level of money supply/Methods of credit control.
1) The bank rate policy/bank intrest rates.
During inflation the Central Bank increases the commercial bank lending rates on loans
making borrowing expensive ;translating to reduced money supply and during deflation the
rates are lowered thus promoting borrowing.
Increased rates decrease the amount of currency in circulation while a decrease in rates
increase the amount of money in circulation as in individuals are charged low intrest rates
2) Open market operation:
This refers to sale and purchase of securities in the stock market. During inflation the central
bank sells government securities (treasury bills and bonds)to withdraw an amount of money
from the general public and during deflation it buys back the securities to increase currency
in circulation.
The following are some of the factors that cause demand pull
i. Increase in government expenditure
The government finances its activities from the revenue it collects mainly from taxes, levies and
fines. In situation where the government is not able to raise enough money from its main
sources, it can resort to borrowing from the central Bank or in the very extreme cases, it may
print more money.When the government spends the money, it in effect makes more money
available to people thus increasing aggregate demand, which in turn may lead to upward pressure
on the prices of goods and services.ie current debt stands at 900 billion
ii. Effects of credit creation by the commercial banks
Credit creation is the process through which banks lend out money to individuals and businesses.
Through this process, commercial banks can lend out more money that the deposits they hold.
This process increases the money supply, which in turn leads to an increase in consumers
purchasing ability. The increased consumer’s ability to purchase more goods and services
increases the aggregate demand which eventually leads to inflation.
Providing appropriate education and training that provides relevant skills & knowledge
Delocalization of firms to reduce urban unemployment which is brought about by rural-urban
migration
Ensure there is political stability to boost foreign investors’ confidence
Protect local industries from unfair foreign competition
Promote the informal sector
14. Increasing government expenditure on projects that can create more jobs.
15. Development of the informal sector.
16. Favorable government policies i.e. raising money through taxes, training programs to the
unemployed on how they can raise their skills
17. Marketing and research (information).-this leads to better prices that encourages
producers or investors to expand production scale and creates need for labor reducing
unemployment.