Date Purpose Drafted by : Validated by :

13/03/2021 Course Outline AKUM NDIP BAKIA I -

Course Title : GENERAL ECONOMICS 1 Course Code :

Language of instruction: ENGLISH Semester : SECOND

Academic year : 2020/2021 Course Duration : 30 HRS

Course Description
This course addresses the key issues in economic concepts and the impact of business operations. Some
of the topics to be considered are as follows:

SUMMARY OF COURSE CONTENT

- National income statistics

- National income equilibrium
- Calculations in national income equilibrium
- Introduction to economics
- Economic systems
- Production
- Demand and supply
- Theory of the firm
- Public finance
- Banking and finance
- International trade
II - Pre - requisite
None.
III - Pedagogic objectives
The course materials should enable students to :
a) Knowledge transmitted
At the end of this course, students must be able to understand;
- Economic concepts and business;
- Impact of Economic concepts decisions on profitability;
- Interpreting Economic concepts on real economic situations ;
- Corporate and social responsibility in and Economic concepts;
- Investment, operating regulatory risk and Economic concepts

b) Know-how developed

At the end of this course, the student must be able to:

• Implement the knowledge acquired in any Economic concepts

• Apply with due diligence, the principles of cost and revenue analyses in Economic concepts

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 c) Manners developed

At the end of this course, students will be interested and curious in ship representation
IV - Pedagogic methods, Evaluation modalities and Pedagogic tools.
The following pedagogic methods, tools and evaluation techniques will be used as distinguished
below;
a) Teaching Methods
• Lectures
• Tutorials
• Projects
b) Evaluation Modalities
• Group assignments/presentations
• Mid semester test
• Final examination
c) Pedagogic Tools
• Blackboard
• Handouts
• Application exercises
V - Course Content
This consists of the various chapters and materials to be covered as seen in the table below:

Title Content Hrs

General Introduction The background to ship finance

• The meaning of ECONOMICS AND ECONOMIC 5

PROBLEM
Chapter One:
• The PPC analyses
- National income
statistics • Problem solving

Chapter Two: • The meaning of ECONOMIC SYSTEMS

• The types of economic systems
- National income • Problem solving
equilibrium
• Case study: (Title of the case study)
5

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 • PRODUCTION
- Chapter Three: • The scale of production
- Calculations in • Problem solving
national income • Case study: (Title of the case study)
equilibrium
5

Chapter Four : • THE THEORY OF A FIRM

- Introduction to • The cost and revenue analyses
economics • Markets
5
• Problem solving
•

• Price and markets

Chapter Five: • Demand theory
- Economic systems • Supply theories
5
- Production • Market equilibrium analyses
- Theory of the firm • Problem solving
• Practical session: (Title of the practical session)

• Tutorials on ship finance using past HND questions

• Question and answer sessions on the five main chapters
• Practical session: (Title of the practical
5
session)
Chapter Six: assessment

Bibliography :
• All in one for transport management by ALEN RUSTLE
• Multidimensional economics by AKUM NDIP
• The hand book of logistics and distribution management by PETER BAKER
• SAP change and transport management SAMSUN PAKER

Appendix
Self assessment questions: ( at least 5-10 questions must be stated here based on the
entire course.

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 COURSE OUTLINE

- Nature and scope of economics

- Methodology of economics
- Positive and normative aspects
- PPC (production Possibility Curve)
- Economic system
- Production theory
- Price theory
- Demand supply
- Elasticity
- Consumer behavior
- Cardinal and ordinary approach
- Market structure

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 CHAPTER ONE
NATURE, SCOPE AND METHODOLOGY OF ECONOMICS

Economics is as old as human race. The word economics originated from a Greek work
‘’EKONOMIA’’ meaning household management. There are There are as many definitions as there are
many economists. There are some famous definitions postulated by different authors. Some definitions
include those of:
Alfred Marshall
He defined Economics in his book ‘’principles of Economics’’ as the study of mankind in his
ordinary business of life.
John Stuart mill
According to him; economics is the practical science of production and distribution of wealth.
Adam Smith
He defined economics in his book “an inquiry into nature” as an inquiry into nature and the causes
of wealth of nations. He is known as the founder of Economics.
The most acceptable and most credible definition of Economics was given by Lord Lionel Robbins
as a social science which studies human behavior as a relationship between ends & scarce means which
have alternative uses. The definition of L. Robbins is the most acceptable because it identifies the main
problems in economics which are scarcity and choice. His definitions specifies how means and wants
influence the attitude of human beings.

IMPORTANCE OF ECONOMICS
Economics is important from a social point of view and from an individual point of view. From an
individual point of view, we study economics in order to behave rationally, to gain employment, to manage
our resources, to derive maximum satisfaction and earnings from economic activities.
From a social point of view, the study of economics is to describe the alternatives available to
individuals, firms and the government. Furthermore, we study economics in order to correct the mistakes
made in the pass.

REASONS WHY ECONOMISTS SOMETIMES DISGREE

❖ The problem of value judgment
Economics deals with human behavior which differs from person to person. These differences in
behavior would result to differences in value judgment.
❖ Difficulty in testing economics theory
Unlike other disciplines in which experiments are in control conditions in the laboratory, economics
by its nature has no laboratory to test and verify its facts thus a possibility for disparity in conclusions.
❖ Differences in school of taught
The different school of thoughts such as the Keynesian and the monetarist schools of taught are
in strong disagreement on the aspect of government intervention in necessitating economic growth. The
monetarist believes that the monetary policy is efficient but the fiscal policy policy isn’t efficient.
Economist from each school of thought would likely disagree.

❖ Differences in definitions
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 There are many definitions in economics which has given a great depth in disagreement among
economists.
❖ Inadequacy of statistical data.
The inadequacy in statistical information in economics may make it difficult for conclusions to be
the same. This gives a base for disagreement.
❖ Economics is a young science
There are inadequate theories to explain Major and complex Economic phenomenon. This causes
disagreement because of the absence of experienced theories.
❖ Technical and economic changes.
The changing economic environment makes some Economic theories to become obsolete and
irrelevant because they may not be able to explain current economic events.

ECONOMICS METHODOLOGY

These are the tools of economic analysis. It is simply the manner in which theories and laws in
economics are drawned. There are several steps in developing an economic theory.
Step I: Observation of facts & definitions of concepts

The first step is to observe the fact relating to whatever interests us being it consumption, price and
production. After observation, definition of facts observed is the next concern.

Step II : Formulation of hypothesis

This comprises of verifying if the prediction from observation can explain the relationship between
cause and effect. Hypotheses are untested theories which are based on assumptions and predictions which
may not be true.

Step III : Testing the hypotheses

This is the verification of the hypothesis if they are supported by facts. The testing of the hypothesis
is done with an appropriate economic model. After testing, the observations are either applied as economic
theories or rejected.

Step IV : Application of economics theory & conclusion

This acceptable theory or model may be used to predict economic events.

ASSSIGNEMENT

1. Explain each of the following bellow in relation to economics

- Economics as a social science subject and not a science discipline
- Economics as a science discipline
- Differences between Macro and Micro Economics
- Differences between Induction and Deduction

2. - Explain the concept of scarcity and choice as we use in economy

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- How is this concept link to opportunity cost in relation to the government decision in producing
consumer goods?

PRODUCTION POSSIBILITY CURVE (P.P.C)

This is a line which shows the production combination of two goods produced by an economy with
its available resources. Economic resources are scarce meaning every choice made by economic agents
involves an opportunity cost. The concept of PPC explains the relationship which exist between scarcity,
choice and opportunity cost. The model of PPC analysis has some assumptions which are:

❖ The quantity & quality of economic resources are fixed overtime

❖ There are two goods produced with the country resources i.e consumer goods and producers (capital) goods.
❖ Some resources are better adapted in the production of one good than the other
❖ Technology is fixed and do not advance during the year.
❖ Perfect mobility of factors of production .

ILLUSTRATION OF THE P.P.C

Figure A

From the graph above (Figure A), the product combinations are shown from point A to E on the
PPC. Point’s inside the PPC like point F represents an insufficient use of resources, which implies some
resources are lying idle when producing at point F. The point F is that of under-employment of resources
and a movement from F to the PPC indicates economic development.
The points outside the PPC such as point G cannot be attained given the present level of resources
and technology. This indicates point G is unattainable. The conditions in which a country can produce at
G are:
❖ Increase in economic growth
❖ Improvement in technology
❖ Discovery and utilization of new resources
❖ Increase in the stock of goods
❖ Reallocation of resources
❖ Improvement in trading
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 EXPLANATION OF THE SHAPE & MOVEMENT IN THE PPC

A – THE DIFFERENT SHAPES OF THE PPC

There are three shapes of the P.P.C which are the concave, convex and a constant P.C.C.
1- A concave P.C.C. follows the assumption 3 which states that some resources are better adapted in the
production of ONE good than the other. This assumption indicates that there is an increasing opportunity
cost in order to produce more of any good. There is always an increasing opportunity cost in the concave
PPC because of the law of diminish returns to scale which requires more sacrifice (opportunity cost) in
order to increase the output of another good. It could be illustrated below.

Figure B

It is illustrated in the diagram above(Figure B) that an increase in capital goods from K to K1

requires more than proportionate opportunity cost from C-C1.
2- The constant PPC is also known as a straight line PPC. This is a PPC which assumes that all resources
are equally efficient. in a constant PPC there is a constant opportunity cost which implies an increase in
the production of one good will neither increase the production of the other good. This implies an
increase in one good will neither increase nor reduce the opportunity cost. This is a result of constant
return a scale. It could be illustrate below :
Figure C

In order to îse capital goods from K-K1, there is a constant sacrifice of C-C1.
3- A Convex PPC is one in which there is an increasing returns to scale. This means that there is a decreasing
opportunity cost in producing increasing units of another good. It could be illustrated below.
Figure D

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 From the illustration above, an increase in capital good from K-K1 requires a less than proportionate
opportunity cost from C-C1.

B – MOVEMENTS ON A P.C.C
1. There is an outward movement of the PCC indicating that an economy would be able to produce more goods
and services if it productive potential increases. This is as result of:
- Increase in technical know how
- Discovery and exploitation of resources
- Improvement in training
- Reallocation of resource

An outward shift in the PPC results from an increase in the production of both goods as illustrated below:

Figure E

There is an increase in the production of both consumer and capital goods from K to K1 and C to C1
respectively.
2. There is an inward shift in the PPC resulting from a decrease in productive potential. This may be as a
result of war which destroys both human and physical resources of a country. An economy cannot produce
at ZERO seven in the worst economy depression as illustrated below :
Figure F

There is a decrease in the production of both consumer and capital goods from K to K1 and C to C1
respectively.

3. Shift in a single good. There is a circumstance in which there is an increase in the input used in the
production of one good. This would cause a shift on the good in question as illustrated below :

C – A GROWTH PATH
This is a path that a country chooses to follow as it experiences economic growth. It could results
from an increase in the production of capital goods or consumer goods as illustrated below:
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 Figure E

Growth part K signifies an increase in future standard of living and a fall in present standard of
living because there are more capital goods than consumer goods. Growth path L indicates an increase in
current standard of living because there is more consumer goods produce than capital goods.

NORMATIVE AND POSITVE SATEMENTS

1- Normative statements are statements of economic phenomenon which ought or ought not to be. Such
statements cannot be verified because it is has no facts. Example is the salaries of civil servants in
Cameroon ought to be increased
2- Positive statements are statements of economic phenomenon with facts and truth which can be verified.
Examples of such statement include “Cameroon is a member of CEMAC”

APPLICATION EXERCISE No 3
1. Consider the PPC of an economy below.

producer goods

Consumer goods
0

a) What is(are) the basic Economic principle(s) does this PPC illustrates?
b) When is it possible for this institution to produce at i) point C ii)at point Y
c) If the economy is interested in long term growth, which growth path will it pursue ?
d) Compare points A and B in terms of
i. Current standard of living
ii. Future standard of living
e) Sketch a PPC to show a an increase in the inputs used in producing the consumer goods .

2. Suppose an economy is faced with the production possibility schedule.

Combination A B C D E
Capital goods (K) 0 1 2 3 4
Consumer goods (C) 50 45 25 10 0
a) Calculate the opportunity cost of the first unit of capital produced in this economy
b) What will be the consequence of choosing a combination 2K+25C instead of 3K +10C.
c) How might the economy be able to produce
i. 4K + 30C.?
ii. 2k + 20C?

3. Consider the table below relating to the production combination of two (2) goods produced by a country.
Combination Output of goods A Output of goods B
1 100 0
2 80 150

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 3 40 250
4 0 300
a) Draw a production possibility curve using the information from the table above
b) State Four assumptions on which the curve is based
c) What is the opportunity of increasing the output of goods A from 40 units to 80 units?
d) Consider goods A to be a Consumer good and goods B a capital good. Between combination 2 and 3,
which of the combination represent full employment and high standard of living in :
i) The short run
ii) The long run
e) Briefly account for when:
i) When it is possible to increase both goods at the same time.
ii) When it is impossible to increase both goods at the same time.
f) Briefly Account for the shape in ‘a’ above.
g) Explain the concept of isoquants and types of isoquants

CHAPTER TWO
ECONOMY SYSTEM
An economic system or an economy refers to the set of structures and institutions used by the
society to organize its resources for the production and distribution of goods and services. Because of the
basic economic problems in the society, each society has to decide what, how and for whom to produce
given that its wants are numerous. There exist the market economy, command economy, mixed economy
and traditional economy.

A – THE MARKET / CAPITALIST ECONOMY

A pure market economy is that which the production of goods & services is determined by the
market forces of demand and supply of goods and services. This implies the absence of state interference
in the economy. The basic economy problems in such an economy is resolved by market forces of demand
and supply (The price mechanism).This price mechanism plays a role in market economy such as :

- The rationing of goods

- The signalling function
- The rewarding function
- The induced function
- Allocation of resource function

ADVANTAGES OF A MARKET ECONOMY

Self regulatory: The price system helps to eliminate surplus and shortages in an economy as it indicates
which good ought to be produce and that which ought not to be produce. A price system in the market
economy does not require a host of officials to direct the decision of production.

Economic efficiency: This is because in the market economy, resources are allocated such that no one can
be better without making another person worst off. Therefore, there is Parito equilibrium in the economy.
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 Greeter freedom of choice: The price mechanism fulfills consumer choice more accurately. This is
because consumer sovereignty exists. Consumer sovereignty is the ability of consumers to determine what
is produced through their demands.

Competition: The competition between profit maximizing firm leads to the production of quality goods at
very low prices to the consumer.

Incentive to hard work : There is a reward to the risk bearers in the market economy. This motivation
might lead to economy advancement and increase in technology.

DISADVANTAGES OF MARKET ECONOMY

❖ There is the creation of negative externalities due to profit motive. An externality occurs when the
production and consumption decision directly affects the production and consumption of others other than
through the market price.
❖ The absence of Public and Merit goods. The price system is not well equipped to produce non-marketable
goods & services such as roads, defence etc.
❖ Wastage of resources. Through competitive advertisement, a country’s resource could be inefficiently
utilized. This is because firms seek to raise revenue above those of their rivals.
❖ Constant fluctuation in Demand and supply. This may lead to booms and slumps in the economy. This
may result from the inefficiency of the price system in estimating demand and supply.
❖ Idle resources. Some resources may be left idle when the prospects of profit making are low.
❖ The problem of inflation
❖ Unequal distribution of wealth and income
❖ Existence of monopoly

B – THE COMMAND ECONOMY

This is an economic system in which the decision of what, how & for whom to produce is
determined by the state through planning committees. An example of a command economy is the people’s
republic of North Korea, Libya etc.

The planned economy system is characterized by the motive of social welfare and not self interest.
In this economic system, there is the absence of freedom of choice and enterprise to what is to be produce,
how it will be produce etc. In this economic system the state owns and controls all factors of production
which ensure equality in the distribution of income and wealth. This will help to fully utilize economic
resources.

Production in the command economy cannot satisfy consumer’s real wants because the goods are
produce in regard to standard rather than individual taste.

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 There is also the absence of consumer so sovereignty. Since the planning committee decide what
has to be produce.

ADVANTAGES OF COMMAND ECONOMY

• There is the absence of negative externalities due to the absence of profit motive. Externalities such as
pollution and congestion is controlled by the planning committee.
• Absence of wasteful competition. This is because all fiems are owned by the government. There is no
need for competition
• A more stable economy. Consumers sovereignty is absent therefore consumers have less power to
influence the market.
• Increased in the production and consumption of merit and public goods: the government is having
total control of resources which can be diverted to the production of public and merit goods.
• Equal distribution of income and wealth. The decision of production and consumption is centrally
planned which ensures equality. There is also the absence of private entrepreneurs.

ADVANTAGES OF COMMAND ECONOMY

• Loss of consumers sovereignty: consumers do not have the right to influence production
• Absence of freedom of choice: consumption is planned by the committee. Therefore consumers do not
have the right to choose what they want.
• Expensive to planned the economy. It increases the cost of the government in collecting data for
production and distribution.
• Shortages and surpluses in production
• No incentives to efforts
• Production of low quality goods and a decrease in the standard of living

THE MIXED ECONOMY SYSTEM

This is an economic system that uses both market & non market signals. The allocation of
resources is highly determined by individuals and the price mechanism but the authorities however play
an important role in determining the level of aggregate output by means of monetary and fiscal policies.
The government may also take control of some important sectors of the economy through nationalization.
The mixed economy has the characteristics of most modern economy like France, Cameroon.

THE ROLE OF THE GOVERNMENT IN THE MIXED ECONOMY

• is to reduce consumers exploitation by producers through the price system,

• to provide public and merit goods which are not profitable,
• help to redistribute income by reducing the income gap between the rich and the poor,

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• to ensure stability (fair play) in the functioning of the price mechanism by setting laws to govern production
and consumption,
• to reduce negative externality.

Assignment
1. Explain the following concepts
i)Externalities ii)social cost iii)Social benefit iv)Public goods v)Merit goods
2. explain reasons for government supply of merit goods
3. reasons against government supply of merit goods
Application exercise NO 2
1. “In a pure market economy, the state has no role in deciding the basic production and consumption
decision but in a mixed and command economy, the state does.”
a) List four features of a pure market economy and three features of a mixed economy
b) What is the meaning of consumers sovereignty
c) Briefly explain three (2) reasons why the government intervenes in a market economy ?
d) Briefly explain three (3) role of price mechanism in resource allocation
e) Explain TWO reasons why countries move from planned to mixed economy

2. “Citizens need merit and public goods for their wellbeing. Despite the presence of these goods, other
goods like free and economic goods exist…”
a) Define and give examples of public and merit goods
b) Briefly explain three reasons why
i) Merit goods are to be supplied only by the price mechanism
ii) Merit goods are to be supplied only by the state
c) Distinguish between free good and economic goods.
d) Distinguish between Direct and Indirect production
e) Distinguish between short period production and long period production.
f) Explain four Benefits in specializing in the production of a particular economic good.

CHAPTER THREE
PRODUCTION
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 Production refers to the creation of utilities to satisfy human wants. Resources used in production
are known as factors of production. In the wider concept, production refers to the creation, distribution
and exchange of goods and services. There are 4 (four) stages in production which are Primary,
secondary, tertiary and Quaternary stage of production. Production can be classified into direct &
indirect production.

Direct production is the creation of utilities to directly satisfy the wants of the producer. This is
production not meant for exchange but for subsistence e.g. subsistence farming, a teacher teaching his
own children.

Indirect production is the creation of commodities to satisfy the wants of those who are ready to
pay the price of a commodity. This is production meant for exchange e.g. all goods found in the market
i.e. goods that commands a price.

LABOUR AS A FACTOR OF PRODUCTION

Labour is defined as all mental & physical efforts directed awards production. Labour is a human
resource used in production which receives a reward called wages. Labour cannot be separated from its
owner and is geographically &occupationally mobile.
Labour thruogh training can be more efficient. This means an unskilled labour can transform into
skill labour.
EFFICIENCY OF LABOUR is the ability of labour to produce a larger output within a short time
period without a fall in the value of the product.

DIVISION OF LABOUR & SPACIALIZATION

This refers to the splitting up of the production process into several small operations each of which
is undertaken by a specialized worker. The reason for splitting up a production process is to increase output
which will yield more profit.

SPECIFIC ADVANTAGE OF DIVISION OF LABOUR SPECIALIZATION

1. Increase in output
This is the main advantage of division of labour. The specialization, time is saved thus increasing
output.
2. Efficiency
As a worker does a specific task many times, he develops skills which enable him to become more efficient.
This explains a saying that “practice makes perfect”.

3. Time is save
The concentration on a single lask avoids the wastage of time in move from one task to another. It
also saves time in training a specialist.

4. It ease the administration of a production process

Since the production process is separated into parts, supervision is easier. Managers or supervisors
can monitor workers at closed range.
5. Facilitates the usage of machines
Division of labour encourages the use of machines thus an îse in production.
6. Less fatigue
Workers do not easily get tired since they have the opportunity to specialize in a task in which they
are efficient and comfortable.

SPECIFIC DISADVANTAGES OF DIVISION OF LABOUR SPECIALIZATION

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1. Over inter-dependence
In division of labour a stage of production or task depends on one another. A break down in one
section leads to a halt in the production process.
2. Monotony of work
A Worker loss interest for his job when he practice the same job for too long. This may increase laziness
and reduce the output.
3. Loss of skills & craftsmanship
Workers loss skills as division of labour is often accompanied by the use of machines in doing what
was formally done by work force.
4. High risks of unemployment
Specialization on the machine makes it difficult for a worker to gain employment in alternative
industries.
5. Division of labour may lead to fall in price
Division of labour leads to an îse in output, fall in price and a decrease in profit.

COMBINING LABOUR & OTHER FACTORS OFPRODUCTION

Factors of production such as land and capital when combined with labour by an entrepreneur, yields
output. The quantity of output depends on the different quantities of factors of production combined. The
factors of production must not e combined in the same quantities or proportions. The entrepreneur may use
more land, less labour& capital or more capital &less labour i.e. P = F(2K + 3L + 10LN) or P =
F(10K + 2L + 3LN)
The mathematical equation shows the production functions used by an entrepreneur in producing a
given quantity in output.
A- THE LAW OF VARIABLE PROPORTION
The returns of variable factors of production occurs only in a short run period where some factors are
fixed while others variable. This law is practically explained by a change in the marginal physical product
simply known as marginal product (MP).
When more of the variable factors are used on a fixed quantity of some fixed factors, and the total
output increases more than proportionately (increase in MP), which results to increasing returns to
variable factors.
Constant returns to variable factor occurs when MP is constant total product increases at a
constant rate.
If a firm continuous production by increasing its variable factor above the constant returns to
variable factors, it can have zero returns and possibly negative returns. This simply implies that additional
factors are adding nothing to the total product.
Example:

(VF) Fixed factor T.P MP A.P

Labour Land (m²° (00) (00) (00)
1 100 1 / /
2 100 4 3 2
6 100 8 4
4 100 12 4
5 100 14 2
6 100 14 0
7 100 12 -2

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 8 100 09 -3

∆𝑇𝑃 𝑇𝑃
MP= 𝑣𝑉 AP=𝑉𝐹

➢ Increasing returns ⇔ 3nd worker

➢ Constant returns⇔ 4𝑡ℎ 𝑤𝑜𝑟𝑘𝑒𝑟

➢ Decreasing returns ⇔ 5𝑡ℎ − 8𝑡ℎ 𝑤𝑜𝑟𝑘𝑒𝑟

➢ Zero returns ⇔ 6𝑡ℎ 𝑤𝑜𝑟𝑘𝑒𝑟

➢ Negative returns ⇔ 7𝑡ℎ 𝑤𝑜𝑟𝑘𝑒𝑟

THE IMPORTANCE OF RETURNS TO VARIABLE PROPORTION TO AN ENTREPRENEUR

- It helps a firm or an entrepreneur to determine the contribution of each worker to the total output it fives
the productivity of each worker.
- It guides the entrepreneur on deciding on the wage payment of each worker
- It guides the entrepreneur on the number of workers to employ. This is because employment has to stop
when MP is o as whereas there are negative returns.

o Generally, the law of variable proportion is explained by the law of diminishing returns which states that
“As more units of variable factors are added to the fixed factors of pdt total output increases to an extent
starts to fall “. For this law to hold, some assumptions are taken into considerations such as;
o The level of technology should be constant
o Labour should be equally efficient, labour is the only variable factor & land the only fixed factors.

A successful quantity of labour if added to land, total product and marginal product increases to an extent,
falls.

Figure A

Point A:zero returns (zero employment)

This situation is seen on a short-run A.C curve

B – Returns to scale

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 This refers to all the change in all the scale of Production including both fixed & variable factors of
Production . This situation occurs in the long run period where all factors are variable. To vary the scale
of production means varying the size of the business. There are 3 types of return of scale which are;
1) Increasing return to scale: This occurs when the percentage increase in output is greater than the
percentage increase in scale of production.
2) Constant return of scale: This is when the percentage in output is exactly the same as the percentage
increase in the scale of production. Eg 50% input resulting to 50% output.
3) Decreasing return to scale: This is when the percentage increase in output is less than the percentage
increase in the scale of production (input) e.g 100% input will lead to 100%. Out put.

The three types of returns to scale shall be shown on the table below.

Sixe Output Inputs % inputs % ∆ output

1 100 10 / /
2 140 12 20% 40%
3 250 18 50% 50%
4 294 36 100% 40%

𝑄1 −𝑄2 100
%∆ = x
𝑄1 1

12−10 100 18−12 100

Scale 2: % D = x x = 50%
10 1 12 1
2 100 36−18 100
= 10 x x = 100%
1 18 1
= 20%

The long run Average cost is used to explain the types of returns to scale.
Figure B

LAC = long run cost average

SAC = short run average

Application example 1

a) What do you understand by the law diminishing return (12mk)

b) How does it guides the firm in taking production decisions
c) Distinguish between diminishing returns & dis economies of scale (10mks)
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d) Crue a detail explanation o how long run average cost curve may be affected by ret urn to scale.
Application example 2
The table below shows the changes in average product per day as additional workers are employed
in an industry

No of workers per day Average product (Kg’s) per day

1 100
2 125
3 140
4 145
5 140
6 130
7 117
8 102
9 87

a) At what level of employment is marginal product highest

b) With what number of employment is production most efficient
c) What level of employment does total production start to fall?
d) Distinguish between return to scale and economies of scale
e) Sate the law of diminishing returns to variable proportion.

TUTORIAL TEST QUESTIONS

NATURE AND SCOPE +PPC +METHODOLOGY OF ECONOMICS + PRODUCTION
THEORY
SECTION A: each of the following has four possible answer. Select the one which is most accurate:

1. In a pure market economy production : c. Decreasing returns in the production of

a. Reflect the preference of household consumer goods
b. Reflect the preference of firms d. Decreasing economies of scale in the
c. Responds to directives production of consumer goods
d. Experience diminishing returns
4. If the economy is currently producing OP
Question 2 to 4 refer to the following diagram consumer goods, the opportunity cost is?
a. RT capital goods
b. OC consumer goods
c. PC consumer goods
d. OR capital goods

5. What is the opportunity cost of fully employed

2. An economy can eventually reach point L by? economy?
a. Moving to point V a. A fall in present consumption
b. Moving to point N b. A fall in present income
c. Employing idle resources c. A rise in savings
d. Printing more money d. A rise in the rate of interest

3. Moving from M to N results in The statements below relates to question 6 and 7

a. Constant returns in the production of both i. Can be tested empirically
goods ii. Make policy recommendations
b. Constant economies in the production of both iii. Depend on value judgments
goods
6. Normative statements in economics relates to ?

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a. i , ii and iii are correct
b. ,ii and iii are correct
c. i , and iii are correct
d. i only is correct

7. Normative statements in economics relates to ?

a. i , ii and iii are correct
b. ,ii and iii are correct
c. i , and iii are correct
d. i only is correct

8. Yaoundé – Douala high way is an example of

a. merit good
b. collective good
c. free good
d. durable good

9. University of Douala is an example of?

a. merit good
b. collective good
c. free good
d. durable good

10. consumers sovereignty means

a. goods are produced on the basis of needs
b. Consumers choose the composition of their
output
c. Consumers spend their money in the best
possible way
d. Small group of customers determine the
consumption and needs of the economy.

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 SECTION B: APPLICATION QUESTIONS (show all working)

1. An enterprise notice the value of sales and number of workers employed from one of its
shops.
No of workers 1 2 3 4 5 6 7
Total sales (000)Fcfa 75 210 300 360 390 390 350
a) Determine the average returns
b) After what level of employment does the extra return of employing an extra worker starts to fall.
c) At what level of employment will you advice the employer to stop employment? And Why?
d) Distinguish between diminishing returns and diseconomies of scale

2. The data below shows the variation in output resulting from variations in inputs.
Total inputs (units) %change in input Total output (units ) %change in output
200 400
400 1000
600 1600
800 2134
1000 2660
a. Complete the table above
b. State the law of i)diminishing returns ii) returns to scale
c. Identify the range of output within which there is
i) Increasing returns
ii) Decreasing returns
iii) Constant returns
e) Sketch a diagram to show the various returns to variable factors using :
i. Average product and marginal product
ii. Total product and marginal product curve
iii. Short run average cost curves

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 CHAPTER FOUR
PRICE THEORY
Prices are fixed by the interaction of demand and supply in the market. A market is any arrangement
between a buyer and seller for the exchange of goods and services. This chapter stresses on the
understanding of the forces of demand and supply and the determination of equilibrium price. It also
includes theories on consumer behaviour.

THE THEORY OF DEMAND

Introduction
This theory explains the behaviour of consumers in the market. It is a Micro concept which studies
a rational consumer in his attempt to maximize satisfaction from his limited budget. Consumers will
want to buy at the lowest price possible. The consumers in the market constitute what is known as
the force of demand.

The meaning of demand

Demand in economics does not simply means the desire, needs or wants of an individual. The desire
or want must be backed by the ability and the willingness to pay the price of a commodity. Hence,
demand in economics refers to effective demand which is the desire that is backed by the ability and
the willingness to pay the price. This means that demand s desire that has an influence on price.

Demand can therefore be defined as “the quantity of a commodity that people are willing to buy at
a given price over a given period of time”. The full definition of demand must contain quantity,
price and time.

THE LAW OF DEMAND:

In general, people will demand more of a commodity when the price is falling. Hence, the law of
demand states that more of a commodity is demanded at a lower price than at a higher price. This
law of demand can be illustrated on a demand schedule and the demand curve.

THE DEMAND SCHEDULE

This is a table which shows the quantity that people are wailing to buy at various prices over a
period of time.
An example: The table below shows a demand schedule of rice in a village.

Price (FCFA) 110 90 80 70 60

Quantity demanded 10 50 100 150 200
(kgs)
From the table, we can read the kilograms of rice that will be demanded at each and every price. lt
is clearly seen that quantity demanded increase as price falls.

THE INDIVIDUAL DEMAND SCHEDULE

It is a demand schedule for an individual buyer of a commodity in the market. It shows what
quantity an individual buyer can buy at each and every price for a given time period.

THE MARKET DEMAND SCHEDULE

The individual demand schedule does not determine price but it is the market demand schedule
that influence price. The market demand schedule of a commodity is a combination of the
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individual demand schedules of ail the buyers of that commodity in the market at a given time
period.

Example: The tables below show the individual demand schedules for fresh fish in a market. it is
assumed that there are only four buyers for fresh fish in that market.

Since the four buyers are the only buyers of fresh fish in that market, the market demand schedule
for fish can be derived as shown below:
The Market Demand Schedule

The quantity demanded at each price is the summation of the quantities demanded of all the
individual buyers in the market.

THE DEMAND CURVE

The demand curve is a graphical representation of the demand schedule. In order words, it is a
curve which shows the various quantities that will be demanded at different prices over a period of
time.

The prices are plotted or read on the vertical axis while the quantities demanded are plotted or read
on the horizontal axis.
An example of a demand curve is shown in the diagram below.

.
At the price of 75frs, quantity demanded is l0units. When price falls to 50frs, quantity demanded
increases to 20 units. This implies that more is demanded at a Lower price than at a higher price.
This relationship between price and quantity demanded is also implied in the demand curve which
slopes downward from left to right. The slope of the demand curve is an illustration of the law of
demand. The relationship between quantity demanded and price is an inverse relationship. When
price is rising, quantity demanded is falling and vice versa. This relationship can be presented in
an equation which is known as the demand function.
Qx = Y - PX
Example 1: The equation below describes the demand function for a commodity:
Qd = 600 — P
where Qd stands for the quantity demanded and P stands for price.
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A demand schedule can be derived from the demand function if a price range is given.
Determine the market demand from the demand function given a price range of 10frs to 50frs
Price
Quantity
demanded

Example 2: The following is a demand function for a commodity in the market. Qd = 1200 P.
Derived a demand schedule for a price range of 100 to 500frs assuming that price is changing by
l00frs.
Solution:

At a price of l00frs the quantity demanded is derived as Qd=1200—100 = 1100.

Example 3. The demand function for an individual buyer of a commodity is given as: Qd=6-P.
What is the market demand function if there are 10 buyers in whole market?

Solution: The market demand function is derived as: QD = (6-P)x10 buyers

QD=60—10P

REASONS WHY THE DEMAND CURVE SLOPES DOWNWARD FROM LEFT TO

RIGHT
These are the reasons why more of a commodity is demanded at lower prices than at higher prices.

1. The Law of Diminishing Marginal Utility: Utility is the satisfaction that a consumer derives
from consuming or buying a commodity. Marginal utility is the satisfaction of consuming an extra
unit of a commodity.
The price a consumer pays for a commodity reflects the marginal utility he derives. The law of
diminishing marginal utility states that as more of a commodity is consumed or purchased,
marginal utility fails’. Since marginal utility falls, people will only be willing to buy more at lower
prices. Hence, more is demanded at lower prices than at higher prices.

2. The Income Effect: When the price of a commodity changes, the real income of consumers will
also change. Real income is the actual -quantity of goods that money income can buy. When price
falls, real income will increase and this will enable the consumers to buy more. Hence, the lower
the price, the greater the quantity purchased. On the other hand, when the price of a commodity
increases, real income of consumers will fall and hence, they will bus’ less. At higher prices,
therefore, quantity demanded will fail.

3. Substitution Effect: There are goods which can be used to satisfy the same desire (substitute
goods) e.g. butter and margarine, fish and meat. When the price of a good changes, it affect the
quantity demanded of its substitutes. When the price of Fish falls, it will become cheaper
compared to Meat. Consumers will buy more fish and less meat. This means that as the price of
Meat increases, quantity demanded will reduce since consumers will switch to a cheaper
substitute.

EXCEPTIONAL DEMAND CURVES

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In general, a normal demand curve slopes downwards from left to right. This means that more will
-be demanded at a lower price than at a higher price. But there are some exceptional cases where
more will be demanded at a higher price and less demanded at lower prices. The demand curve for
this type of goods is known as exceptional or regressive demand curies. Such cases include:
1. Demand curve regressive at the bottom. There are two reasons for such abnormal demand
which are:
- Giffen Goods: These are goods which are inversely related to income. They are basic food
stuffs in society which are consumed mostly by low income earners. A fall in price will lead to an
increase in the real income of consumers. These consumers will instead reduce-the consumption
of such goods in order to switch to the consumption of richer food stuff. Example of Giffen goods
includes garri, salt etc.
The demand curie for Giffen good is regressive at the bottom as shown below. In order words, it is
abnormal at lower prices.

As price falls from P0 to P1, quantity demanded also falls from Q0 to Q1. Price and quantity are
moving. In the same direction which is a contradiction to the Law of demand.
- Expectation of future decrease in price: people will buy less of a commodity when price
falls if they are expecting a further fall in price in future. They will want to wait and buy cheaper
when price falls in future.
2. Demand curve regressive at the Top. There are two reasons to explain the demand cure
regressive at the Top.
- Goods of Ostentation (Veblen goods): These are prestigious goods which people demand
or buy to impress others. They demand such goods in order to displace their wealth. These goods
are demanded more when there is an increase in their prices. Examples are Jewellery products,
expensive sport cars.
The demand curve for goods 0f ostentation is regressive at the top. It becomes abnormal at higher
prices. They are goods which have ‘snob appeal’. Consumers attach more value to the goods
when their prices are rising. The demand curve is regressive at higher prices as shown in the
diagram below.

They will instead buy more at higher prices. If price is increased from Po to Pi, quantity demanded
will also increase from Qo to Q1. Quantity and price are moving in the same direction and this is a
contradiction to the law of demand.

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-Expectation of future increase in price: When there is a rise in the price of a commodity people
will demand more if they expect that this price will continue to rise in future. To buy more because
they want to avoid buying at a higher price in future.
INTER-RELATED DEMAN.( TYPES OF DEMAND )

1- Joint demand (complementary demand): This refers to the demand of two or more
goods which are required at the same time. Such goods are used together to satisfy a want or
desire. Such goods are called complements e.g. car and petrol, Cell phones and sim-cards.
For instance, if there is an increase in the price of cars, the quantity demanded will fall and this
will lead to a decrease in the demand of petrol. Cars will be expensive there will be a reduction in
the number of cars in the society and consequently demand of petrol will fall. The diagram below
illustrates this:

As the price of cars increases from po to p1 quantity of cars demanded reduces from Do to Qi. This
causes the demand of petrol to decrease and this is illustrated by a complete shift of the demand
curve of petrol to the left i.e. from Do to D1. Because ofhe decrease in demand for petrol, the price
falls from Po to Pi.
2- Competitive demand: This refers to the demand for goods which are substitutes. For
instance, the demand for butter and margarine, meat and fish etc they are described as substitute
demand. increase in the price of one good leads to and increase in the demand for one of the
good.
For instance, an increase in the price of meat will lead to a fall in its demanded and this will lead
to an increase in the demand of fish. The diagram illustrates this:

Some customers will switch from the purchase of meat to fish, leading to an increase in the
demand of fish. As the price of meat increases from po to p1, quantity demanded reduces from Qo
toQi. This causes the demand of fish to increase from Do ta Di. This increase in the demand of

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fish is shown by a complete shift of the demand curie to the right moving the equilibrium position
from Eo to E1.

3- Composite demand: This refers to the demand for a commodity which has many uses.
E.g. wood is demanded for roofing, for making chairs, for making beds, for construction etc. A
total demand for ail the uses is referred to as composite demand.
4- Derived demand: this is the demand of a good resulting from the demand of another
good. It is known as the demand for a good for the sake of another good.

MOVEMENTS IN DEMAND

A - CHANGE IN QUANTITY DEMANDED

A change can either be an increase or a decrease. A change in quantity demanded is a movement
along the same demand curve which is caused by a change in price.
An increase in quantity demanded is a movement on the demand curve to the right, it is also
known as an extension in demand. It is caused by a decrease in price as illustrated below.

There is an increase in quantity demanded from QQ ta Qi caused by a fall in price from Po to P1.
This is shown by a movement from A ta B on the same demand curve.
On the other hand, a decrease in quantity demanded is a movement on the same demand curve
ta the left which is caused by an increase in price. This is illustrated below.

This is a decrease in quantity demanded from Qo to Q2 caused by an increase in price from Po to

P2. This is described as a contraction in demand which is represented by a movement from A to C.

A CHANGE IN DEMAND
A shift in demand curve is caused by a change in other factors that influence demand other price.
The change in demand can be an increase or a decrease in demand.
- An increase in demand is a complete shift of the demand curve to the right. This implies
that more is now demanded at each and every price. This is illustrated in the dial below.

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A shift of the demand curve from Do ta D2 represents a decrease or a fail in demand. At the same
price Po, quantity demanded fails from Qo to Q2 due to the decrease in demand from Qo to Q2.
- A fall in demand may be due to a fall in income, a fall in the population of consumers, a
false in prices of substitute goods etc.

THE DETERMINANTS 0F DEMAND

These are factors influencing demand. Changes in these factors can cause an increase or a
decrease in demand.
1) Income: The more money that people have to spend, the mare demand is likely to be.
Large increases in salaries will cause great increase in the demand for some goads. When incomes
are reduced, demand will also fall .It is not the actual size of income that determines demand but
the disposable income. Disposable income is income left after direct taxes have been deducted.
This is money consumers have available for spending.

2) Changes in population: Generally, an increase in population will lead to an increase in

demand especially the demand for basic needs, such as food, shelter, and clothing. It is more
precise to talk of the population of consumers than the size of the population, since it is the latter
that can cause a change in demand.

3) Taste and Fashion: This s an important determinant of demand in the foot wear and clothing
industries. There will be an increase in the demand 0f a commodity that is in fashion. When people
develop mare liking for a commodity that is when they have an increasing taste for the commodity
they with turn to buy more. E.g. the introduction of home TV movies in entertainment had reduced
people’s taste for cinema entertainment. This means that an introduction of a new commodity will
change the demand of the existing ones.

4) Redistribution of Income: If incomes are redistributed evenly, there will be a change in the
demand for some commodity. The income of the poor will increase while that of the rich will fall.
Goods demanded by the poor will have an increase in demand because their income will increase.
On the other hand, there will be a fait in the demand of goods demanded by the rich because their
incomes will fail.

5) Advertising: A successful advertising campaign for a commodity will lead to an increase in

demand. Consumers will be attracted from other rival goods and the demand of the good that is
advertised will increase.

6) Non-human factors ( change in seasons ): These are factors out of human control which can
affect demand. E.g. a sudden change in weather from cold to hot weather wiII lead to a rise in the
demand for ice cream, cold drinks etc. Drinks sales respond immediately to temperature changes.
Also there will be an increase in the demand for umbrella during the rainy season.
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7) Changes in the prices of other goods: When the price of a commodity changes,
the demand for its substitutes and complements will be affected. For instance, the
demand for petrol will rise when there is a fall in the price of cars because cars and petrol are
compliments. Conversely, the demand for meat will fall when there is a fait in the price of fish
because meat and fish are close substitutes.

THE THEORY 0F SUPPLY

The theory of supply explains the behaviour of the supplier or the seller in his attempts to maximise
profit from sales. In order words, supply is concern with the intentions of sellers in the market and
their main aim is to maximize profits from sales.
Supply in economics does not mean the entire stock of the goods produced. It is the quantity that
producers are willing to take. To the market it can be defined as the quantity of a commodity that
producers are willing to sell at a given price over a given time period.

As one would expect, producers will generally take a greater quantity to the market at higher prices. In
other words, the higher the price the greater the quantity supplied and vice versa. This is the law of
supply which states that more will be supplied at higher prices than at Lower prices. This law can
be illustrated on a supply schedule or a supply curve.

THE SUPPLY SCHEDULE

On like demand, it is a table that shows that quantities of a commodity that producers will be willing
to sell at different prices. It is one way of showing the relationship between quantity supplied and
price. Such a table for an individual seller is known as an individual supply schedule. The
combination of ail the individual sellers’ schedules for a good in the market is known as the market
supply schedule.

Example: The table below shows a market supply schedule for apples per week in a certain market.

From the supply schedule, it is seen that producers will put more apples in the Market at higher prices.
Hence quantity supplied move in the same direction with price.

THE SUPPLY CURVE

This is a graphical representation of the various quantities producers will be willing to sell at different
prices. The graph below shows a supply curve.

The supply curve slopes upward from left to right. This ‘shows that more of a good will be supplied at
a higher price than at a lower price. For instance, the quantity supplied increases from Q1 to Q2 as
price increases from p1 to P2 thus confirming the law of supply.

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 REASONS WHY THE SUPPLY CURVE SLOPES UPWARDS FROM LEFT TO RIGHT.

This is the explanation of the law of supply. The main explanation is profit making motive of
producers. Producers are interested in making profit. A rise in price is an indicator. of high profit to
suppliers or producers. At higher prices therefore, producers are encouraged to supply more. They will
increase output, release stocks into the market and new producers will come into the market when price
is rising.
On the other hand, when price is falling, producers will be making less profit, hence at a lower price,
they will stock pile what they have produced, reduced production and some producers may even stop
production. All these lead to less being supplied at a lower price.

EXCEPTIONAL SUPPLY.CURVE
There is an exception to the law of supply where more will instead be supplied-at lower prices and
less supplied at higher prices. The supply curve will be regressive. This is the case of an individual
supply curve of labour.
When the wage rate of an individual worker starts rising, he will increase the number of hours
supplied. The price of labour is the wage rate and the quantity supplied is the number of hours he is
willing to supply. When the wage rate rises from a very low level, the worker will increase the number
of hours he offers for work. But when the wage rate rises above a certain level, he will instead reduce
the number of hours supplied. This is to have enough time for leisure and enjoy his high income. In
other word, his marginal utility of leisure will be greater than his marginal utility of work when the
wage rate rises above a certain level.

The wage rate W1 gives the target income of the worker. From this wage rate he will start substituting
work with leisure. When the wage rate rises from W1 to W2, the number of hours supplied instead falls
from n1 to n2.This is a contradiction to the law of Supply.
But it should be noted that in the industry as a whole the supply curve of labour will be a normal
supply curve. As the wage rate continues to increase the supply of labour will also continue to
increase: because workers will be attracted from other industries where wage rates are lower into the
industry where the wage rate is rising.

Revision question: Examine critically with reference to the supply of labour the view that more 0f a
good is supplied at a higher price than at a Lower price.

THE DETERMINANTS 0F SUPPLY

These are the factors affecting the supply of a commodity in the market. They are also known as the
condition of supply.
• The costs of production: The quantity of a commodity supplied depends on the cost of production.
lf the cost of producing a commodity falls; more will be produced at the same price and consequently,
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more will be supplied. On the other hand, supply will fall if there is an increase in the cost of
production.
• Technology: An improvement in technology will lead to a fall in unit cost and hence supply will
increase. New technology comes with a reduction in average cost and hence an increase in supply.
Also the improvement in technology increases output per worker thus increasing total supply.
• Weather: This factor is particularly important for the supply of agricultural products. During period
of good weather, there will be an increase in the supply of agricultural products because of good
harvest. On the other hand, supply of agricultural products will fall during period of bad weather.
Other natural conditions such as drought, pest, and diseases will reduce harvest in the agricultural
sector. This will all lead to a fall in supply. Changes in the supply of agricultural products will also
lead to changes in the supply of manufactured goods which are produced using agricultural products
as raw materials.

• Prices of other goods: This particularly affects the supply of those goods which could be produced
with the same factors of production. Tables and chairs are produced almost with the same factors of
production. Maize and beans are grown on a similar soil. If the price of beans increases, farmers will be
encouraged to switched their land out of the production of maize to the production of beans. This will
lead to a fall in the supply of corn. Hence, it is the price of beans that is affecting the supply of maize in
this case.

• Expectation of future price changes: Most producers or entrepreneurs produce in anticipation of

demand. If they think that the price of a good will rise in future, preparation to increase output will be
made now. This will lead to an increase in supply. Conversely, they will reduce supply if they expect
price to fall in future.

• Taxes and subsidies: Indirect taxes on production increase costsof production, thus leading f0 a fall
in supply. On the other hand, a subsidy will lower costs of production thus leading to an increase in
supply. A subsidy is a financial assistance from the government to a producer.

A CHANGE IN QUANTITY SUPPLIED

This is the movement along the same supply curve. It is caused by a change in the price of a commodity.
It can either be an increase in .quantity or a decrease in quantity supplied.

An increase in quantity supplied: This is a movement on the supply curve to the right which is caused
by an increase in price. On the other hand, a decrease in quantity supplied is a movement on the supply
curve to the left caused by a fall in price. These’ changes are illustrated in the diagram below:

A movement from point A to B is an increase in quantity supplied which is caused by a price increase
from Po to P2. Conversely, a decrease in quantity supplied, is a movement on the supply curve to the
left i.e. a movement downward from point A to point. This is caused by a fall in price from Poto P1.

A CHANGE IN SUPPLY

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A change in supply is a complete shift of the supply curve from one position to another. It can be an
increase or a decrease in supply.
An increase in supply: This is a complete shift of the whole supply curve to the right. An increase in
supply means more is supplied at each and every price. An increase in supply can be caused by changes
in the determinants of supply, such as:

• A fall in cost of production

• An improvement in technology
• Good weather conditions
• Subsidies granted to producers etc
A decrease in supply: This refers to a complete shift of the supply curve to the left. This implies that
less is supplied at each and every price. This can be caused by the following:
• Increase in indirect taxes
• Increase in the cost of production
• Bad weather condition etc

The shift of the supply curve from S0S0 to S1S1 described as an increase in supply. At the same price
Po, quantity supplied increases from Q0 to Q1.
The movement of the supply curve from SOSO to S2S2 is described as a decrease in supply or a.falls
in supply. At the same price Po, quantity supplied decreases or falls from Q0 to Q2.

TYPES OFSUPPLY
1) Competitive supply: This refers to a situation where an increase in the supply of one commodity
leads to a fall in the supply of another. This type of supply concerns these commodities that have the
same factors of production or the same raw materials. E.g. chairs and tables are made from wood. An
increase in the supply of chairs may lead to a fall in the supply of tables because more wood would be
diverted to the production of chairs.

2) Joint supply: This is a situation of supply where the supply of one commodity leads to the supply of
another commodity. This means that the commodities are produced together. E.g palm oil and palm
kernel, meat and hides. An increase in the supply of one will automatically lead to an increase in the
supply of the other.
The diagram below illustrates the effect of an increase in the price of palm oil on the quantity and price
of palm kernel.

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An increase in the price of palm oil in the market leads to an increase in the quantity supplied from qo
to q1. This causes an automatic increase in the supply of palm kernel from So to S1 and consequently the
price falls from Po to P1. This obviously causes quantity demanded ofpalm kernel to increase from qo to
q1.

1) Composite supply: This is a supply situation where many commodities are supplied to satisfy
a want. For instance, the supply of tea requires the supply of milk, sugar and coffee.

THE MARKET PRICE

The value in exchange or the price of a commodity is determined in a free market by the forces of
demand and supply. It is the price where quantity demanded is exactly equal to quantity supplied in the
market. This price is described as the market price or the equilibrium price. Graphically, it is where the
demand curie intersects the supply curve.

Pe is the market prices otherwise known as the equilibrium price. Qe is the equilibrium quantity. At
price Pe quantity demanded is equal to quantity supplied. At the equilibrium price the willingness of
sellers is the same as the willingness of buyers. What is brought to the market by sellers is ail purchased
by buyers.

CHANGES IN THE MARKET PRICE

The market price of a good is determined by the forces of demand and supply which are also known as
market forces. A change in any of the two forces will affect the market price ofa good.
An increase in demand: Other things being equal, an increase in demand will lead to an increase in price
and increase in quantity supplied.

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An increase in demand from D0 to D1, moves price upwards from Po to P1 and the equilibrium quantity
also increases from Qo to Q1.
A increase in demand: Other things being equal, a decrease in demand will lead to a fall in price and a
decrease in quantity supplied.

A decrease in demand from D0 to D1Ieads to a fall in price from P0 to P1 and an increase in equilibrium
quantity from Q0 to Q1.
An increase in supply: Other things being equal, an increase in supply decreases the equilibrium price
and increase equilibrium quantity.

An increase in supply from So to S1 forces price to move downward from Po to P1 with equilibrium
quantity increasing from Q0 to Q1.

A decrease in supply: Other things being equal, a decrease in supply will lead to an increase in price
and a fall in equilibrium quantity.

A decrease in supply from S0 to S2Ieads to an increase in price from Po to P2 and the equilibrium
quantity decreases from Qo to Q2

PRICE CONTROLS
Sometimes the government intervenes in the free functioning of the price mechanism by the use of price
controls or price legislations. The intention is to improve the economic and social welfare of the people.
The government uses the maximum price or the minimum price control to achieve this objective.

THE MAXIMUM PRICE CONTROL

The maximum price control is used when there is the belief that the free market price is too high for the
poor consumers. In other words, it is aimed at helping the poor consumers. The maximum price is a
price set below the equilibrium price by the government. It is also known as the ceiling price. When the
maximum price is imposed, shortages will occur.

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The equilibrium price is Pe and the maximum price is represented by Pmax. This creates shortages in
the market which is represented by the distance AB. This is because quantity demanded will increase
from Qe to QB while quantity supplied will fall from Qe to QA. This problem of shortages can be
resolved by rationing. This means that the government can Limit or restrict the quantity that each
consumer is willing to buy.
If the shortages persist, the maximum price will have other consequences as explained below:
1)Black market will develop: Black market is a situation where people sell a good above the maximum
price imposed by the government. It is an illegal practice in the economy.
2) Preferential treatment: Some sellers will keep their goods under the counter and sell only to friends
and relatives.
3) Lines or queues: Buyers will line-up in front of sellers or shops when ever the good is available and
this may lead to the establishment of waiting lists. That is, sellers will apply what is known as first come
first serve’.
4) It discourages production: The people selling the commodity will be discouraged because the
maximum price will reduce their profit margin.

The maximum price control can be used in the following situations:

1) During period of emergency or war: This is when shortages are common especially with basic
commodities like palm oil, salt, rice, fish , four, sugar etc.
2) Rent control: Sometimes the equilibrium rent in the market is too high because of shortage of houses.
The government may use the maximum rent control to help the poor tenants.

THE MINIMUM PRICE CONTROL

The government uses the minimum price control when the intention is to help producers. The minimum
price is the price set above the equilibrium price in the market. It is also known as the floor price.

The equilibrium price is Pe and the minimum price is represented by Pmin. This creates surpluses or
excess supply which is represented by the distance CD. When the minimum price is imposed, quantity
supplied will increase from Qe to QD while quantity demanded will fall from Qe to QC leading to
surpluses in the market. The government can only maintain the minimum price by buying the surpluses
or buying the excess supply. The main consequences are:

- Excess supply
-Unsold stocks
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 THE EFFECTS OF INDIRECT TAXES ON MARKET PRICE
An indirect tax imposed on a commodity increases cost of production. This will lead to a fall in supply
and consequently an increase in price. The producers or sellers will struggle to shift the tax onto the
consumers in the form of higher prices. This depends on the elasticity of demand and supply of the
product. This means that the indirect tax can be shared between the producers and the consumers
depending on the elasticity of demand arid supply. The share of the tax burden for each of them can be
calculated as:

PES stands for price elasticity of supply and PED for price elasticity of demand.
Example: A tax of60frs per unit is imposed on a commodity whose price elasticity demand is 0.5 and
price elasticity of supply is 1.5.
i) Calculate the consumers’ share of the tax
ii) Calculate the producers’ share of the tax

Solution

Or Producer’s share = 60-45 l5Frs

The consumer is paying a greater part of the tax because supply is more elastic thandemand. That is
demand is inelastic.

A diagrammatic representation of the effect of an indirect tax on the market price

ac or PP1 is tax per unit and total
Tax revenue is 0Q1x ac
ab or PoP1 is consumer’s share of
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The tax per unit and ab x 0Q1 is
the total tax borne by consumers.
bc or Po P is. producer’s share of the tax per unit and
bc x 0Q is the total tax borne by producers.

Po and OQ is the original equilibrium price and quantity respectively. After the tax, supply falls, which
is illustrated by the shift of the supply curve backwards from So to Si. The tax per unit is represented
by the vertical distance between the two supply curves.
The consumers were buying the good at P per unit before the tax but after the tax they now buy at Pi.
Hence their own share if the tax per unit is the increase in price from P0 to P1. On the other hand, the
producers were receiving Po per unit before the tax but after the tax they now receive only P. This means
a fail in their supply price from Po to P. The tax burden is the amount of the tax t0 be paid.
The impact of the tax is the person on whom the tax has been imposed or the person who is supposed
to pay the tax to the government.
The incidence of the tax is where the tax finally fails. lt is the final resting place of the tax or the person
who finally bears the tax burden. The incidence of the tax burden will depend on the elasticity of demand
and supply of the god.

SHARING 0F THE TAX BURDEN AND THE ELASTICITY 0F DEMAND

The producer will try to shift the burden of a tax that is imposed on him or on his good to the consumer
by increasing price. Normally the increase in price wilts lead to a fat! in quantity demanded. The
producer knows that the extent to which quantity demanded falls in respond to the price increase with
depend on the elasticity of demand. This is examined in the following cases of elasticity:
Case 1: When demand is elastic.

When demand is elastic, the producer bears a greater share of the tax burden. The producer will be very
careful or cautious in increasing price because consumers are very sensitive to any increase in price.
Price increase causes a significant fall in quantity demanded. He will be afraid to lose most of his
customers.
Illustration

Case 2: When demand is inelastic.

When demand is elastic, the consumer bears a greater share of the tax burden. The producer can
confidently shift a greater part of the tax to the consumer. This is also the case when supply is more
elastic than demand. Consumers will pay mare of the tax.

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Case 3: When demand is perfectly inelastic. When demand is perfectly inelastic, the consumer pays
all the tax. That is, the price will increase by the full amount of the tax. The producer knows that no
matter the increase in price, the consumer will not change the quantity that they buy.

Case 4: When the elasticity of demand is the same as the elasticity of supply.

When the elasticity of supply is equal to the elasticity of demand, the producers and the consumers share
the tax equally. This is also the case when demand is unitary.

THE EFFECTS 0F SUBSIDIES ON MARKET PRICE

A Subsidy is a financial assistance given to producers by the government. It is seen as a negative tax
because it has the opposite effects of an indirect tax. lt is also known as government subvention. This
means that subsidy reduces cost of production leading to an increase in supply. (The supply curve will
move to the right). The final effect is a fall in price.
A subsidy granted ta a producer will have the opposite effects as an indirect tax. It will normally lead to
an increase in supply and a fall in the market price. The consumer will benefit from the subsidy through
a fail in the market price. The producer will benefit through a fait in costs of production and an increase
in the supply price.
A subsidy on a commodity is shared between the consumer and the producer as shown in the diagram
below. Subsidy per unit is represented by the distance XZ.
The total amount of subsidy granted by the government is XZ x OQ1
The subsidy per unit for consumers will be represented by the distance YZ. That is, it shows a fall in
price from Poto P1. The total subsidy that consumers benefit will be YZ x 0Q1.

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The benefit of the subsidy per unit to the producer will be the distance XY. Total subsidy to the producer
will be XY x 0Q1.

When supply is elastic, consumers will benefit more from the subsidy than the producer.
REASONS: This is because there will be a significant increase in supply after the subsidy. Producers
will easily respond to that subsidy by producing more. This will also lead to a significant fall in price,
thus benefiting the consumers more. This is also the case when supply is more elastic than demand.
On the other hand, if supply is inelastic, producers will benefit more from the subsidy than the
consumers.
REASNS: Output may not increase significantly when the government grants a subsidy. Inelastic supply
means that producers cannot easily increase output. Hence, a subsidy will only cause a slight increase
in supply thus reducing the price just slightly. The sharing of a subsidy between the producer and the
consumer also depends on the nature 0f elasticity of demand. The various cases are illustrated below.

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Revision question: With the aid of diagrams, explain how the price elasticity of demand will influence
the distribution of a subsidy between the consumers and the producers.

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1. Supposed an indirect tax 20frs per unit is imposed on this good.
a) What is the new market price and quantity?
b) What is the tax per unit borne by consumers?
c) What is the total tax collected by the government?
d) What is the consumer total share cf the tax?
a) What is the total tax borne by producers? (l0marks)
2) Suppose now that instead 0f â tax, a subsidy cf 20 frs per unit is given to producers
â) What is theotaI -arnount of the subsidy that the government could pay ta producers?
b) What is the0sidy per unit that consiirners would benefit?
c)What-is’the:-neW rnarketprice after the subsidy? (l0marks)

PRICE ELASTICITY 0F DEMAND (PED)

Price elasticity of demand is the extent to which quantity demanded responds to slight change in
price. More precisely, price elasticity of demand is defined as the responsiveness of quantity
demanded to a change in price. In order words, it is the proportionate change in quantity demanded in
respond to a slight change in price. It measures the extent to which demand would respond to a change
in price.

The coefficient of price elasticity of demand

The elasticity of demand can be given a numerical value which is known as the coefficient of price
elasticity of demand. This value is calculated as:

Where Q= quantity; P= price; OQ= original quantity; OP = original price

∆Q=change in quantity and ∆P= change in price.

Interpretation of the coefficient of price elasticity of demand in general, the coefficient would be
negative because price and quantity move in opposite direction. But it is the absolute value that is
considered in interpretation. i.e. the negative sign is ignored.

• When the coefficient is greater than one, demand is said to be fairly elastic or elastic this means that
a little change in price brings a huge change in quantity demanded. In other words, the percentage
change in quantity demanded would be more than the percentage change in price.

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• When the coefficient of elasticity is less than one, demand is said to be inelastic on fairly inelastic.
This means that quantity demanded responds very slowly to a change in price. A change in price
would lead to a little change in quantity demanded. In other word, percentage change in quantity
demanded is less than the percentage change price.

•When the coefficient is equal to one, demand is said to be unitary (unit elasticity).In this case a change
in price leads to the same proportionate chance in quantity demanded.

• When the coefficient is equal to infinity, demand is said to be perfectly elastic. This means that a slight
change in price would lead to an infinite change in quantity demanded.

•When the coefficient of PED is equal to zero, demand is said to be perfectly inelastic. The change in
price would lead to no change in the quantity demanded. In this quantity demanded is fixed irrespective
of the change in price.

Elasticity of demand along a straight line demand curve

The coefficient of price elasticity of demand is constant along a straight line demand curve only for
two cases. This is the case of perfectly elastic and perfectly inelastic demand.

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 Price elasticity of demand remains the same as you move from one point to another on a straight line
demand curve above. This is because either the price or the quantity is not changing..
But a falling straight line demand curve will have different elasticity at different points. In other word,
price elasticity of demand changes as one moves along a falling straight line demand curve. This is
illustrated in the diagram below.

Geometrically, the elasticity of demand at a point can be calculated as the distance below the point
divided by the distance above the point.
- At point B, price elasticity of demand is unitary. It is the middle of the curve, meaning that the distance
below is equal to the distance above. Hence at point B, PED 1.
- For any point above point B demand becomes elastic. The distance below such a point will be longer than
the distance above. This means that the value of PED will be greater than one because it will be dividing
a longer distance by a shorter one. Another explanation is that at ‘higher prices the consumers are too
sensitive to price changes; hence, they are going to respond easily to changes in price. Demand becomes
inelastic for any point below point B because the distance below is shorter than the distance above (a
shorter distance will be divided by a longer one). At lower prices consumers do not very much care about
price changes, hence, demand becomes inelastic.

\
ARC ELASTICITY OF DEMAND AND POINT ELASTICITY OF DEMAND

- The arc elasticity of demand is the measure of the average elasticity of demand on a demand curve. It
is the ration of the percentage change in one variable between the two points to the percentage change in
the other variable. For example point B and C on the graph. Arc elasticity of demand can vary
depending on the starting point and ending point between the two points. It would be low when the
starting and ending points are high but High when the starting and ending points are low.
It is calculated as :
Arc elasticity = % Δ in quantity demanded
% Δ in price Arc elasticity = Q2 – Q1
Δ in quantity demanded = Q2 – Q1 (Q2 + Q1)
(Q2 + Q1) 2
2 P 2 – P1

Δ in price = P2 – P1 ( P2 + P1)
( P2 + P 1 ) 2
2
Application example: If the quantity demanded of beer at half time of a football game is measured at
Two different games at which Two different prices are charged. At one measurement, the quantity
demanded is 80 units and the other is 120 units. Suppose the change in the price of beer which led to

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this change in quantity demanded changes from 1000 to 500 Frs. Calculate the arc elasticity of
demand.
Solution

-point elasticity of demand : it is the limit of arc elasticity of demand as the distance between the two
points approaches zero. It is a single point rather than pair of points.

The main problem of Arc and point elasticity is the problem of approximating the points on the
demand curve.

Relationship between elasticity marginal revenue (MR) and total revenue (TR)

MR= ( 1 – 1/e) meaning when e>1 (elastic )----MR is +ve and TR is increasing
when e=1 (unit elastic )----MR is zero and TR is maximized (heigest)
when e<1 (inelastic )----MR is -ve and TR is decreasing

Graphical illustration;

Revision Question: With the help of demand diagrams prove that elasticity of demand not constant
along a straight line demand curve. (2Omarks)

INCOME ELASTICITY 0F DEMAND (YED)

This is the extent to which demand will respond to changes in incomes of consumers. More precisely,
it is the responsiveness of quantity demanded to a change in income.

When incomes of consumers change, they will equally change their quantity demanded of goods. For
normal goods, an increase in income will lead to an increase in quantity demanded. A fall in income
will lead to a fail in quantity demanded. Hence, income elasticity of demand for normal goods is
positive because income and quantity move in the same direction.
One the other hand, inferior goods have negative income elasticity of demand. This is because when
incomes are increasing, the quantity demanded for inferior goods will instead fall and quantity

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demanded will increase when incomes are falling. With inferior goods income and quantity move in
opposite direction.

CROSS ELASTICITY 0F DEMAND (XED)

This concept explains the relationship between the price of a good and the quantity demanded of another
good. It is the extent to which the demand of a good will responds to a change in the price of another.
This is calculated as:

Where QA=quantity of good A, QB=quantity of good B, OPA= original price of good A and OQB
=original quantity of good B.

The price of a commodity can only affect the demand of another commodity if they are related. Two
goods can be related as substitutes or complements.
For substitute goods, the coefficient of cross elasticity of demand is positive. This is because when the
price of a good falls the quantity demanded of the substitute will fall and when the price increases the
quantity demanded of the substitute will increase. Price and quantity demanded move in the same
direction. When the two goods are strong substitutes, the value of the coefficient will be high.
For complementary goods, the cross elasticity of demand is negative. This is because when the price
of a good is increased, the demand of its complements will fail and when the price is reduced the
quantity demanded of the compliment will increase. Price and quantity demanded move in opposite
direction. The value of cross elasticity will be zero if the two goods are not related.

FACTORS INFLUENCING PRICE ELASTICITY 0F DEMAND (DETERMINANTS)

1) The availability of substitutes: Goods that have close substitutes are very elastic in demand. This is
because an increase in price will cause consumers to switch to substitutes e.g. if the price of meat rises,
consumers Will begin to buy fish and the quantity demanded will fall significantly.

2) Habit forming: Goods which are habit forming are inelastic in demand e.g. if a person has formed a
habit of consuming a particular good, his demand for that good will be inelastic. This is common with
addictive goods such as alcohol, cigarettes cocaine etc.

3) The proportion of income spent on the good: The size of a customer’s income relative to the
price influences the customer’s respond to price change. A customer is less price-sensitive (inelastic
demand) when his expenditure for the good is a relatively low proportion of his total income. On the
other hand, A customer is more price-sensitive (elastic demand) when his expenditure for the good is a
relatively high proportion of his total income.

4) The degree of necessity: If a good is of great necessity to a consumer, his demand for it will be
inelastic because the consumer cannot live without such a good. Example include salt, a pen to a
student, chalk to teachers etc. On the other hand, the demand for luxury goods is elastic. These are
goods that consumers can do without.

5) The number of uses: A commodity with many uses has elastic demand. This is because a change
in price will lead to changes in demand for different uses. When all the changes are put together it will
represent a greater proportionate change. That is the demand foreach of the uses can be inelastic but
when they are combined it becomes elastic.
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6) The level of income: The more a person earns the less he complains about the rise in prices of
goods. Hence, rich people (people with high income) have inelastic demand for most goods. On the
other hand, the demand for poor people is very elastic. The poor will always complain bitterly about
price increase.

THE IMPORTANCE 0F THE CONCEPT 0F ELASTICITY 0F DEMAND

The concept of elasticity is very important in the practical decisions of the government and .to a
businessmen.

A. The importance to the government

In taxation policy: The government uses indirect taxes as a source af revenue. Consumers pay these.
Taxes when they buy goods which have been taxed. This policy is only effective when the goods
taxed are inelastic in demand. This is because consumers will
Still buy even when prices are increasing e.g. taxes on cigarettes and bear.
The government also uses indirect taxes to discourage the consumption of some goods. When a tax is
imposed on a good the price will rises and consumers are expected to be discouraged. This can only
succeed if the demand is elastic.

I. Devaluation Policy: Devaluation is the reduction in the exchange rate of a currency. Devaluation is
intended to bring down export prices and increase import prices in order to discourage imports and
encourage exports. This can only be successful if the demand for imports and exports are elastic. If
imports are elastic in demand, an increase in .their prices will significantly reduce demand and the
expenditure made on imports thus reducing the outflow of currency. If exports are elastic a fall in their
prices will significantly increase their demand and the revenue from exports thus increasing the inflow
of currency in international trade. The combined effect will be an improvement in the balance of
payments situation.

B. The importance to a businessman

A businessman may refer to a producer, a firm, a seller or a monopolist
1. Increasing their revenue. A businessman will reduce. The price of his good when demand is elastic.
This is because a sight falls in price will lead to a large increase in sales. The quantity demanded by
consumers will increase significantly when price is reduced by a relatively smaller proportion.

The increase in total revenue is more than the Loss in total revenue when price faits from Po to P1.
On the other hand, a businessman will increase the price of his good when demand is inelastic.
Quantity demand will fall slightly but total revenue will increase.

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There is an increase in total revenue as price is increased from Po to Pi. This is because the gain is
more than the loss in total revenue.
2. It helps producer in shifting the burden of an indirect tax to the consumer: An indirect taxis
considered by producers as cost of production. When such a tax is imposed on the producer, he will
try as much as possible to shift the tax to the consumers in the form of higher prices. The extent to
which he will shift the tax depends on the elasticity of demand.
He will shift a greater proportion of the tax to the consumers when demand S inelastic, in the form of
higher prices because consumers will hardly respond to an increase in price. On the other hand, he will
shift a very small proportion of the tax to the consumers when demand is elastic. He knows that
consumes will react to any slight increase in price.

When demand is perfectly inelastic, the producer shift ail the tax to the consumers i.e. he increases the
price of his goods by the full amount of the tax. On the other hand, when demand is perfectly elastic,
he knows that he will pay ail the tax alone. This is because he cannot increase the price of his good.
Consumers will not buy if he increases price.

2. The concept of elasticity is used by a monopolist in price discrimination: A discriminating

monopolist sells the same product in different market at different prices. He will sell at a higher price
in a market where the demand of his product is inelastic and at a Lower price in the market where
demand is elastic.
PRODUCTION AND INCOME ELASTICITY.

When salaries or incomes are increasing producers of normal goods will increase their output. These
are goods with positive income elasticity. Their demand will increase when incomes are rising. On the
other hand, they will reduce production when incomes are falling.

For inferior goods, the value of income elasticity is negative. Producers will reduce the production of
these goods when incomes are rising because less will be demanded. On the other hand, they will
increase their production when incomes are falling because more will be demanded.

PRICE ELASTICITY OF SUPPLY (PES)

This concept explains how producers will respond to price changes in the market by varying quantity
supplied. In other word, it explains the ease with which suppliers can respond to a change in price. Price
elasticity of supply is defined as the extent to which quantity supplied will respond to a change in price.
Price elasticity of supply can be given a coefficient or a numerical value using the formula below.

Where OP is original price and OQ is the original quantity.

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The nature of price elasticity of supply depends on the value of the coefficient.
• When the coefficient is more than one, it implies that supply is elastic or fairly elastic. This means that
a small increase in price will lead to a more than proportionate increase in quantity supplied and vice
versa. In other word, suppliers can easily increase the quantity they have in the market in respond to an
increase in price and vice versa.
When the coefficient is less than one, supply is fairly inelastic orinelastic. This means that producers
hardly vary the quantity they have in the market for sale in respond .to price changes.
• When the coefficient of price elasticity of supply is equal to one, supply is said to be of unit elasticity.
This means that a change in price will lead to the same proportionate change in quantity supplied. For
instance, a 10% increase in price that leads to the same 10% increase in quantity supplied.
• Supply will be described as perfectly elastic when a change in price will lead to an infinite change in
quantity supplied. In this case, the value of price elasticity of supply is infinity (∞).
• When the coefficient of price elasticity of supply is zero, supply is said to be perfectly inelastic. This
means that quantity supplied cannot respond to a change in price. In other words, producers cannot
increase or reduce what they have supplied in the market no matter the change in price. An example can
be the supply of a piece of land in a city Centre or the supply of a good in the momentary period.

Graphical representation of the various cases of elasticity ofsupply

Fairy elastic, PES> 1 Fairly inelastic, PES < 1,

The curve can be extended The curve can be extended
to touch the quantity line. to touch the quantity line.

Any supply curve that can be extended to touch the quantity line is fairly inelastic in nature. On the
other hand, a supply curve that can be extended to touch the price line is elastic.
Any straight line supply curve which is drawn from the origin or which can be extended to touch the
origin has unit price elasticity.

FACTORS AFFECTING THE ELASTICITY 0F SUPPLY

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These are the factors that determine changes in the elasticity of supply of a commodity. They are also
described as the determinants of elasticity of supply.

1) Availability of Stocks: Stocks are finished goods held by producers. If producers have a commodity
in stock, they will easily respond to any price increase. This means that supply will be elastic if stocks
are available. Conversely, supply will be inelastic if producers do not have the commodity in stock.

2) Availability of excess capacity: Excess capacity means producing below full capacity. In other words,
it means there are still the resources and raw materials which can be used to increase production. Hence,
supply will be elastic when producers still have excess capacity. Conversely, supply will be inelastic in
the industries which are already at full capacity.

3) The behavior of costs of production: Elasticity 0f supply depends on the behavior of costs in relation
to increasing output. If a slight increase in output causes a large increase in costs of production,
producers will be reluctant to increase supply. In this case, supply will be inelastic. Conversely, supply
will be elastic if increasing output leads to a very small increase costs of production.

4) The number of producers: The elasticity of supply of a commodity depends on the number of people
producing that commodity. Where there are many producers, quantity supplied in the market will easily
change when there is a change in price. This means that supply will be elastic if the commodity is
produced by many producers. Conversely, if very few people are producing a commodity, supply will
be inelastic.

5) The nature of the product: Elasticity of supply depends on the nature or the type of good. Perishable
goods are inelastic in supply. This is because producers cannot keep them in stock. Most agricultural
products are perishable in nature and producers hardly keep such goods in stock. Conversely, goods
which are not perishable are elastic in supply. This is because producers can easily keep them in stock.
This explains why thesuppIyof manufactured goods is elastic.

6) Time period: Elasticity of supply varies with time. The elasticity of supply will vary in the different
time periods:

• In the very short run or momentary period, supply will be perfectly inelastic. This means that producers
cannot change the quantity available in the market.
• In the short run, supply will be fairly elastic. This is because producers can release their stocks to
influence quantity supplied in the market. They can also vary the variable factors so as to change the
quantity supplied in the market.
• In the long run, supply becomes more elastic. This s because producers can change all the factors of
production. Existing producers can change their production capacity and new producers can also enter
or leave the industry in the long run.

Revision question: Explain why you will expect the supply of a commodity to be more elastic in the
long run than in the short run. (20marks)

PRICE AND VALUE

There are two types of value given to a good in Economics, namely: - value in use and value in exchange.
Value in use is the usefulness of a good. On the other hand, value in exchange refers to the price of a
good. Economists are concerned only with value in exchange. This is the amount of money that is paid

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 in exchange for the good. The value in use depends on the consumer of the commodity while the value
in exchange depends on the forces of demand and supply in the market.
The paradox of value.

A paradox is a contradiction. The paradox of value is an apparent contradiction where an essential good
commands a very low price while a non-essential good commands a high price. In other words, it is a
situation where non-essential goods have very high value in exchange while some essential goods have
very low value in exchange. An example is the case of water and wine. Water which is an essential good
commands a very low or no price in the market while wine is non-essential good compared to water but
commands a very high price.

This contradiction can be explained using the concept of marginal utility. The price of a good or the
exchange value reflects the marginal utility of that good. It is unfortunate that a commodity like water
which is very useful has a very 10w marginal utility. This is because it is abundant. Conversely, a good
like wine which people can do without is very scarce and has very high marginal utility. That is why
wine and other scarce goods like diamond, gold command very high prices.

Tutorial Questions

1.) Below is the demand and supply schedule for demand, the supply remained unchanged as in
coffee in a market. the initial situation before subsidy
Price Quantity Quantity c. From “(b.ii)” above, if the government decide
(00) DD Kg SS Kg to maintain the initial equilibrium after the
Fcfa increase in demand while supply remained
90 200 1000 unchanged.
80 300 900 i. What name is given to the price
70 400 800 ii. What will be the effect on the economy
60 500 700
50 600 600
40 700 500
30 800 400
a. If a subsidy of 2000Fcfa is granted in the
market
i. Determine the new equilibrium price and
quantity 2) The following information concern the
ii. Using sketch demand and supply curves demand and supply of mangoes
illustrate the portion of the profit enjoyed by Price Quantity Quantity
producers and consumers. demanded supplied
b. From “a “supposed the demand for coffee (Kg) (Kg)
increased by 200kg at all levels of prices. 700 1700 0
i. Determine the equilibrium price and quantity 400 800 1200
after the increase in both demand and supply 800 500 1700
ii. Determine the momentary and short run market 500 1400 200
price and quantity if after the increase in 600 1100 700

a. On a graph paper provided, determine the d. Calculate the elasticity of demand if price were
equilibrium price and quantity. to increase by 50 frs from the equilibrium
b. If the government guarantee price of 700 frs per determined in (a) above.
kg of mangoes what will be the likely e. Explain the concept of arc and point elasticity of
consequence demand curve for a commodity and explain the
c. Suppose that demand increases by 50% what problems of such.
will be the new equilibrium price and quantity Question 0ne of HND 2013

Page 50 of 71
 3) a. differentiate between changes in supply and immediately after the increase in
changes in quantity supplied demand(4mks)
b. explain the shape and gradient of a i. demand iv. Determine the equilibrium price and
curve ii. Supply curve quantity in the short period after the
c. if the Qd= 30 – 3p and Qs = 3p increase in the demand. (3 mks)
I. present the shape and gradient of the d. Enumerate four factors which accounts for
demand curve an increase in the demand for oranges other
II. determine the equilibrium price and than a change in season. (4mks)
quantity
III. if a tax of 2frs is imposed what will be
the equilibrium price and quantity
IV. calculate the total revenue to the state
from such a tax policy
Question 0ne of HND 2012
Q
4) a) what do you understand by change in demand
and change in quantity demanded
b) an individual demand and supply functions
are given as follows:
Qd= 15 – p and Qs=1/2P
If there are two customers and three suppliers in
the market
i. calculate the market price and quantity
ii. present the equilibrium situation
graphically
iii. if a tax of 2 frs is impose what will be
the new equilibrium price and quantity
iv. what will be the revenue to the
government
v. calculate the new equilibrium price and
quantity if a subsidy of 2frs is granted.
Question Two of HND 2011
5) The information below concerns the
individual demand and supply of oranges
in the NDOKOTI market.

Qs =1/2 p Qd = 20 – p
Qd and Qs: represents the individual demand and
supply functions.
P: represents the price of oranges in the market.
a. Determine the equilibrium price and
quantity if there are 5 people demanding
for oranges and 10 women are willing to
supply Oranges.
b. Construct a demand supply schedule over
a price range of 1 to 15 Frs.
c. From <b> above, if the market demand
increases by 10 oranges at all level of
prices in the dry season without an
increase in the market supply.
ii. Construct a new schedule to show the
increase (3 marks)
iii. Determine the new equilibrium price
and quantity in the market

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CHAPTER FIVE THE THEORY 0F THE FIRM

It is a theory that explains how a rational producer or firm analyses its output and pricing
decisions, in order to attain its objectives. Also the firm should take into consideration the market
form under which it is operating; perfect or imperfect. However the main objective of any
rational producer is to maximize profits i.e. by minimizing cost of production and maximize total
revenue or sales. Profits are the difference between Total revenue and total cost.
Apart from profit maximization other objectives pursue by firms include;
OTHER OBJECTS OF A FIRM
1. To gain a larger market share, so as to maximize total sales (MR=0). With this
objective the firm will be out to dominate the market and reduce the presence of
other rivals (competitors).This is mostly done by cutting down prices.
2. For development purposes; this is one objective of some firms where the owners will be
aimed at developing the area where the firm is situated rather embarking on profit
maximization. Such as the construction of roads, buildings, medical facilities, social
security
3. To maximize prestige; Firms may undertake certain projects simply to maximize their
prestige rather than profit maximization. Most managers consider the prestige of the firm
to be imperative or of great importance.
4. The firm might have the objective of living a quiet life rather than getting into
rigorous competition with other producers to gain a larger market share and realizes
more profits. In this case the firm will not get in to issues such as advertisement or
publicity. Which may be wasteful?
5. Also the aim of a firm might be to expand the size or capital ownership of the
business. In this case profits realized will be ploughed back rather than been distributed
to the shareholders as dividends
6. Lastly a firm may be aimed at maximizing the social welfare of the workers. In this
case the will tend to maximise workers’ salaries, improved working conditions, canteens,
medical and educational facilities, housing facilities. .rather than concentrating on profit
maximisation. This will improve workers’ productivity in the long run

COST STRUCTURE 0F A FIRM.

In order to produce goods or services a producer or firm has to employ or hire some factors of
production or resources, necessary to produce the desired level of output of the good or service.
Hence, cost of production is the expenses made by a firm on resources or factors of production
or inputs to produce a given level ofoutput.eg wages on labour, rent on land, interest on loans or
capital, cost of raw materials...etc. Thus the total cost of production is made up
of implicit and explicit costs.

EXPLICIT COST
Explicit cost, refers to the cost of hiring or employing the factors of production not owned by the
firm. It involves the monetary expenditures made by the firm or producer to obtain the inputs
necessary to produce the desired goods or services.eg cost of raw materials, wages paid to labour
services, interest on loans…etc. It is often known as cost of production according to the
Accountant.

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IMPLICIT COST
refers to the opportunity cost of using the factors of production, that the firm possessses.eg
the rents forgone when using ones premises for habitation, the interest forgone for using up one’s
capital for other purposes other than giving it out as loans. . .etc. However the Economist always
considers cost of production to be Implicit and Explicit costs.
ACCOUNTANT PROFIT AND ECONOMICS PROFIT
Therefore, in calculating profitability of a firm we have to consider the cost of production in both
the Accounting and Economic point of view. Hence the economic profit will be lesser than the
accounting profit, since the economist consider both implicit and explicit costs in calculating
profits while the accountant considers just the explicit cost. Thus, a firm may be making profits
according to the accountant but economic losses, Here, profit can be calculated in the
following ways;

ACCOUNTANTS PROFIT = Total revenue - explicit costs

ECONOMIST’S PROFIT = Total revenue - (implicit + explicit costs)

APPLICATION EXAMPLE:
1. Mr Ndip could earn 100 000Fcfa as a loan operator in a financial institution but he decides to
manage his retail shop which he puts in 24 Million Fcfa of his savings in the business. The
current rate of interest in remunerating savings is 5% per annum. His total revenue within a
defined trading period is 26,5 million Fcfa. What will be Mr Ndip’s profit from the point of
Accountants and Economist.
Solution
Accountant profit = TR – E. Cost i.e (26,5 M – 24 M) = 2,5 Million FCFA
Economics profit = TR – I+ E cost i.e {26,5 M – (24M + 1,2M +1,2M)} = 100 00
FCFA

2. Consider the data below relating to the operating cost and revenue of Mr AKO a retail shop
owner.

Total revenue ……………………………………550 000

Direct cost ……………………………………….270 000
Capital used in the business ……………………….200 000
Alternative salary earned elsewhere……………………..110 000
Market rate of interest ………………………..10%

Calculate the following

a) Accounting cost
b) Accounting profit
c) Opportunity cost of APIAHS time
d) Opportunity cost of Financial capital
e) Total economic cost

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f) Economic profit

Other cost includes;

Private cost (internal cost); involves internals costs incurred by a producer or supplier
for producing a particular good or service. It includes cost incurred for inputs, labour;
depreciation .etc. but exclude external costs incurred e.g. environmental damage.
Social cost(external cost); is the disruptions caused by firms from their activities of
production and consumption, which are borne by the society. It can equally be as a result
of a change in policy...e.g. various forms of pollution produced by firms.

CLASSIFICATION OF COSTS

A. The short run cost structure:

The cost of production in the short run can be classified under short run Total cost and
short run unit cost.

The short run Total cost

- Total fixed cost (TFC): is the costs of the fixed factors of production. It is a cost
that does not vary as output varies especially in the short run e.g. rent on land,
insurance, and provision for depreciation. .etc. It is also known as overhead or
indirect cost.

NB: When output is zero (O), Total fixed costs = Total cost.

- Total variable cost (TVC): is the costs associated with the variable factors of
production. It is a cost that increases directly as output increases e.g. wages or
salaries paid to workers, cost of fuel or power, cost of raw materials...etc. They are
also known as prime or direct costs.

NB: When output is zero (O), Total variable costs = zero (O)
- Total cost (TC): refers to the sum of the total fixed cost and total variable
cost.TC=TFC+TVC
- Marginal cost (MC): is the change in total cost resulting from a change in the level
of output .OR it is the additional cost incurred due to an additional output produced.

MC = where Q output

NB: The Total cost i.e. TFC, TVC and TC can be represented graphically as follows;

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The short run per unit costs or average costs

It is simple the corresponding total costs divided by the output. It includes the following;
o Average fixed cost (AFC): is the cost per unit of the fixed factor. AFC TFC/Q
o Average variable cost (AVC): is the cost per unit of the variable factor. AVC= TVC/Q
o Average total cost (ATC) or average cost: is the cost per unit of output produced. ATC=
TC/Q

NB: ATC = AFC+AVC

NB: The per unit costs can be represented graphically as follows;

TABULAR REPRESENTATION OF SHORT RUN COST OF PRODUCTION

Out TFC TVC TC AFC ATC AVC MC

put (000) (000) (000) (000) (000) (000) (000)
0 50
1 70
2 80
3 90

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4 95
5 105

Complete the table above.

EXPLANATION OF THE SHAPES OF THE PER UNIT COSTS:

The cost structure in the short run.

- The AFC is L-shaped because a constant cost is being divided by an increasing output.

ATC, AVC and MC are U-shaped because of the law of variable proportion or the law of
return to the variable factor that characterizes the short run production function; In the short run
“As more units of a variable factor is applied to a fixed factor, the firm will at first
experience increasing return to the variable factor; this is seen by increasing MP and AP, in
terms of costs it is reflected by falling MC, AVC and ATC. Later on when diminishing return
sets in, MP and AP will be falling, and in terms of costs it is reflected by rising MC, AVC and
ATC.

NB: Therefore, the law of returns to the variable factor that characterizes the short run
production function explains why MC, VC and ATC are U-shaped. Hence, the MP and AP are
mirror reflections of MC and ATC.

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NB: The MP curve always cut the AP curve at the maximum point of AP curve. Also, the MC
curve always cut the ATC curve at the minimum point of the ATC curve. This is known as the
optimum size of the firm, or technical optimum or the most efficient level of production or
employment of the firm.

COST STRUCTURE IN THE LONG RUN: The long run average cost (LA C)

The production function (or cost structure) in the long run is characterized by laws of return to
scale. Which states ‘As the scale of production increases (i.e. increase in both fixed and variable
factors), the firm will experience economies of scale where the LAC will be falling and after an
optimum size has been attained any further increase in the scale production will result to
diseconomies of scale, where the LAC will be rising.”

Suppose that the firm was operating at a given size, with short run average cost (SAC1),
producing output OQ1 and average cost AQ1...
cost(average cost)

Economies of scale diseconomies of scale

If the firm wishes to increase output from the technical optimum Q’ to Q2, ATC rises to However
if the scale of production is increased by SAC, the new scale will reduce to SAC2. Here
output Q2 will be produced at a lower cost CQ2. If the firm further wishes to increase production
to Qi while maintaining the second size (SAC2) the ATC will rise to DQ3 but by increasing the
scale of production, the same output (Q3) will be produced at a lower cost i.e. EQ3, on SAC3.
Suppose that this was the optimum size of the firm, any further increase in the scale of
production will result to diseconomies of scale, where the SAC will start to rise from one period
to another.

Given that a line is drawn passing via the various minimum points of the SAC curves as the firm
grows in size. It produces the LAC curve, which is an envelope of various SAC curves.

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Application Exercises
1. Given the cost structure of a firm; ATC=1200FCFA, AFC8OOFCFA and
TVC=2000FCFA. Determine the level of output (Q) of this firm.

2. A firm has the following cost structure, TC=200+4Q, if Q is the level of output, what is
the value of TFC, TVC, AVC, AFC,MC?

3. Given that in a firm, the AFC of producing 2books is 8Ofrs while the AVC is 75 FRS.
Equally, the AFC of producing the 3rd book is 6Ofrs and the AVC is 72frs.Calculate the
MC of producing the 3rd book.

4. A firm has the following cost structure, TC=100+2Q2, if Q is the level of output, what is
the value of TFC, TVC, AVC, AFC,MC?

LEAST COST COMBINATION ANALYSES (LCC)

In a general point of view entrepreneurs or firms are not only concerned with the physical
production of goods and services but also with the combination of inputs or factors of production
that will cost him the least ,in order to produce a given level of output. In this case the firm shah
emphasize on economic efficiency and not technical efficiency.

Approach 1: Simple Analyses

Assume a producer who is combining different units of land, labour and capital. Consider the
respective prices of factors as follows; Pland = 1000 FRS, Plabour = 1100fr and Pcapitail = 1200 FRS.
NB: The different units and costs of the various technical methods or combination can be given
as follows;

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The costs of various can be given as follows;

Combination C is technically inefficient because it uses more of all the factors of production and
is wasteful.

Combinations A and B are technically efficient because none of them uses more factors than the
other.

NB: A rational producer will settle for combination A which is the LCC and the combination
which is economically efficient. Economic efficiency means amongst the technically efficient
combinations, the combination that cost the least to the firm.

APPROACH 2: MARGINAL PHYSICAL PRODUCTIVITY (MPP)

THEORY.

MPP refers to the additional or supplementary output produced by an additional factor used in
production.

Unit of factor

With the MPP approach, The LCC can be attained at the level where the “Ratio of MPP of a
factor to its price is equal to the ratio of MPP to the price of the other factors of production...”

Consider three (3) factors of production; A, B and C and their respective prices PA, PB and Pc...
MPPA / PA MPPB / PB = MPPc / Pc ….. etc.

NB: Conditions of disequilibrium

If MPPA / PA < MPPB / PB (B is more productive than A) A rational producer would have to
cutback or reduce the use of A and increases the use of B .So that as more B is used the MPPB
will reduce and the price of B will increase. Thus, the equilibrium will be re-established.

• If MPPA / PA> MPPB / MPPB (A is more productive than B) A rational producer would have

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to cut-back or reduce the use of B and increases the use of A. As more A used the MPPA will
reduce and the price of A will increase. The original equality will be re-established.

Exercise: The following table shows the MPP of three (3) factors land, labour and capital of a
firm. With their respective prices Pland = 1lfrs, Plabour = 2 FRS and Pcapital = 3 FRS

Units of factors 1 2 3 4 6
MPP of land 2 4 6 7 4
MPP of labour 1 4 5 7 8
MPP of capital 4 5 6 8 5
Determine the LCC of this firm?

APPROACH 3: THE ISOQUANT / ISOCOST NOTIONS

ISOQUANT
Isoquant refers to a set of points showing the various combinations of two factors of production
that produce the same level output. They are also known as ‘equal product curve’. Example; the
graph below show the various combinations of labour and capital that can be used by a firm to
produce a given level of output.

Combination C1 L1 gives the same level of output as combination C2 L2 or any other combination
along the isoquant.

SOME CHARACTERISTICS OF ISOQUANT ;

• Along an Isoquant, in order to increase the use of one factor the firm has to reduce the use of
the other factor.eg to increase labour from Li to L2 , the firm has to reduce capital from C1 to
C2.Hence, the rate at which a factor is transformed or substituted for another along the isoquant
is known as the ‘Marginal rate of technical substitution “(MRTS).which is given as follows;
MRTS K/l = - change in K / change in L
• A right ward shift or movement of the isoquant indicates an increase in the level of production
or higher output. This involved the use of more inputs including both factors of production.

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• Isoquants are analogous to indifference curves. Hence, a combination of two or more isoquants
gives an isoquant map.

ISOCOST
Isocost refers to a line that shows the different combinations of two (2) factors of production that
give the same cost of production. (Equal cost line)

NB: With the use of the isoquant and isocost, the LCC can be determined at the input
combination where the isocost is tangential to the isoquant. That is (Le, Ce)

It can be demonstrated as follows

REVENUE STRUCTURE
Revenue refers to the total sales realized from a commodity at a particular period of time. It
consists of the amount of money received from selling a given level of output. Revenue is given
by the price per unit multiplied by the output or quantity demanded.

Revenue can be classified as follows;

o Total revenue (TR); refers to the total sales received from a given level of output.. TR=
price x output or TR price x quantity demanded.
o Average revenue(AR); is the revenue per unit of output produced. ICs also known as the price
per unit of the output... ÀR = TR / Q. where Q = output

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o Marginal revenue(MR); refers to the additional revenue obtained due to an additional unit of
output or a change in total revenue resulting from a change in the output.

MR =

NB: In order to illustrate TR, AR and MR graphically, we shah distinguish between the revenue
structure of a perfect competitive and an imperfect competitive market.

Revenue structure in a perfect competitive market(all firms sell at the same price)

Under perfect competition TR is rising at a constant rate, while AR or price is always equal to
MR. Hence AR and MR remain constant at all levels of output.

TABULAR REPRESENTATION OF REVENUE FROM PRODUCTION

Out TFC TVC TC TR1 AR MR MC TR2

put (000) (000) (000) (000) (000) (000) (000) (000)
0 50 90 0
1 70 80 10
2 80 70
3 90 60
4 95 50
5 105 40
6 115 30
7 135 20
8 160 10
9 200 0

complete the table considering TR 1 is the TR of an imperfect market while TR2 is that of a
perfect market with a constant price of 10 000FCFA.

GENERAL RULES (or NOTIONS) OF PROFIT MAXIMIZATION

The main objective of private business firms is to maximise profits. Profits of a firm are

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maximized (or losses are minimized) at the equilibrium or profit maximization output. There
are basically two methods or notions of determining the profit maximizing output of a firm:
1. The TR I TC approach: With this approach the firm’s profits are maximized at the output
level where TR - TC is maximum.
NB: When output (Q) = O, the firm will be making losses since TR < TC.
When TR - TC = O or TR = TC implies the firm is breaking even or making just normal profits.
2. The MR I MC approach: With this approach profits are maximised at the output level where
MC = MR that is additional revenue is the same or equal to additional cost incurred.
NB: When MR> MC, implies additional output adds more to revenue than to cost. In this case a
rational producer will continue to expand output.
When MR < MC, implies additional output adds more to cost of production than to revenue,
Here, the firm has to contract output. Therefore, when MR= MC the output of the firm will be
at equilibrium since there will be no tendency for income to rise or fall.
It is possible that for all levels of output; the firm is making losses, in this case the equilibrium
output or loss minimizing output will be the output where the negative profit is minimum.

Some related terms

- Normal profits; refers to the minimum profit that is necessary to keep a firm in the
same level in business. It’s the supply price of the entrepreneur. It is profit realised
when TR TC.
- Abnormal profits; refers to the profits realised when total revenue is greater than
total cost. Hence, it’s the excess profit realised above the normal profits. It is also
known as super normal or astronomical profit.
- Profit margin; refers to the ratio of profit after taxes expressed as a percentage of
the costs of sales. It is one of the measures of the profitability of a firm.

FORMS OF MARKET

I. PERFECT COMPETITION

It is a market situation in which there are no restrictions on competition. In this market the
decisions and actions of individual firms do not affect the market price. Its characteristics can be
explained as follows;

• There is a large number of buyers and sellers. Such that no individual buyer or seller can
influence the existing market price. Thus, ail the firms sell at the same price.
• Freedom of entry and exit of firms. In this market new firms are free to enter while existing
ones are free to exit or leave the market at any time. This is one of the most important
characteristic of this market because if there were barriers to entry, existing firms will become
monopoly. Therefore, this market is also called a “contestable market”
• The products are homogenous. The products in this market are identical in terms of trade
mark, brand names . . . etc. hence the products are perfect substitutes.
• There is perfect knowledge by buyers and sellers about market conditions e.g. information
about the prevailing market price of goods and the expected profits.
• The is absence of government regulations or intervention. This implies that there no control

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inflicted by the government on producers such as taxes, subsidies, price control. etc.
• There is perfect mobility of factors of production from one firm (or industry) to another.
Thus factors of production can be adapted to every firm.
e The main goal or objective of the firms is to maximise profits, they will tend to produce the
level of output that will maximise their profits.
e In this market there are no preferential treatments, in terms of favouritism, rebate, discount to
some customers etc. are ail absent.

CHARACTERISTICS OF AN 1NDIVIDUAL FIRM UNDER PERFECT

COMPETITION.
• The firm produces a only a small fraction of the total industrial output,
• The firm can produce any level of output k wishes but must sell at the existing market price.
• The firm is a price taker(follower) while the industry is the price giver or maker (leader)
• The AR or the demand curve of the firm is perfectly elastic, showing that despite the quantity
of output produced, the firm has to sell at the same price.

PRICE AND OUTPUT DETERMINATION UNDER PERFECT COMPETITION.

Prices are externally determined by the market forces of demand and supply of the industry as a
whole. The individual firms together produce the total industrial supply. This will respond to the
normal supply (positive slope or gradient) while the market demand for the products follows its
normal shape (negative slope or gradient), the market price will be determined by the
interaction(intersection) of demand and supply, beyond the control of any individual firm.

Each firm can produce whatever output it wishes, but must sell! At the existing market price
(P).The firm cannot sell above the rnarket price since it will lose all the market and has no
incentive to sell below the market price, since they are aimed at maximizing profits.

EQUILIBRIUM OUTPUT AND PROFIT MAXIMISATION UNDER PERFECT

COMPETITION

SHORT RUN EQUILIBRIUM:

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The firm’s profits will be maximise in the short run at the output level where MC=MR. i.e.
at Qe as shown below.

At the equilibrium or profit maximizing output (Qe) the price will be P and the average cost is
(AC). Profit per unit is the price minus AC. (P - AC), the total abnormal profit earned at this
output (Qe) is the profit per unit multiplied by Qe i.e. [(P - AC) x Qe].

NB: The optimum output or technical optimum is the level of output where MC = AC. At the
lowest point of AC. It is the most efficient output of the firm. It is the output QT.

NB: At output level Q’ and Q2 the firm is breaking even or making just normal profits i.e. AR =
AC

NB: Allocative efficiency is the level of output, where the firm is charging a price that is just
enough to cover the marginal cost je AR = MC

LONG RUN EQUILIBRIUM

In the short run, the industry was not yet at equilibrium because the abnormal profits earned by
the existing firms will continue to attract new firms in to the industry. As new firms enter the
industry the supply increases leading to a fall in price (AR). Price (AR) continues to fall until it
will become equal to average cost. In this case the firms will now be breaking even or making
just normal profits. The industry will now be at equilibrium since there will be no tendency for
new firms• to enter or existing firms to exit.

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Therefore, in the long run the firms will be breaking even or earning just normal profits. As
shown below;

Summary: MC = MR AR1= AC

OTHER RELATED CONCEPTS

1. LOW COST FIRM, HIGH COST FIRM AND MARGINAL FIRM

While some firm under perfect competition in short run, are making abnormal, others are making
losses, yet others are breaking even.
(A) Low cost firm is a firm that is earning abnormal profits in the short run. Here, the AR> AC at
the profit maximizing output (Qe)
(B) High cost firm is one that is making losses in the short run, In this case the AR < AC at the
profit maxirnising output(Qe).
(C)Marginal firm is a firm that is breaking even or marking just normal profits. Here, the
AR = AC at the profit maximizing output. (Qe) in this case Qe = QT
P2

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2.DECISION FOR A FIRM TO CLOSE(SHUT) DOWN

(i) Short run: Even if a firm is making losses in the short run, it will still continue production or
operation provided that, the firm is capable of covering its TVC of production.ie TR >TVC or
AR> AVC at the profit maximization output (Qe).

This is because the firm will be able to cover its variable costs and still have some excess to pay
its fixed cost. It will be an unwise decision for this firm to close down because it will still have to
pay back its fixed cost (TFC). The firm can only close down if it cannot cover its variable costs.

NB: The lowest possible price that the firm can charge in the short run to stay in business is the
lowest value of AVC.
(ii) Long run: Here the firm must be able to cover its total cost of production. i.e. TR > TC or
AR>ATC at the profit maximizing output (Qe).
If the firm cannot cover its total cost of production in the long run then it is advised to shut
down.
NB: The lowest possible price that the fin can charge in the long run to stay in business is the
lowest value of ATC or AC.

APPLICATION EXERCISE;
1. The following depicts the cost structure of a firm under perfect competition. Given that
the Price per unit is l000frs.

a) Determine the equilibrium price and output

b) Determine the market structure of the firm and give two reasons for your answer
c) State the conditions of (i)growth maximisation, (ii) sales maximisation (iii) optimum
point
d) Verify if the conditions in “C“ are met by the firm, and at what output level
e) Briefly explain the reason for the U shape in the unit cost curves

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2. Given the revenue function expressed as TR = 43Q and Total Cost = 100+3Q+ 2Q2 ,
what is the
a. Total variable cost
b. Average Variable Cost
c. Marginal cost
d. The profit maximizing output
e. Calculate the maximum profit

3. A firm producing a product at unit price 90 000 FCFA has fixed cost of 10 000 FCFA
and variable cost as follows:

Output Total variable

(kg) cost (TVC)
in 000
FCFA
0 0
1 50
2 80
3 101
4 128
5 160
6 200
7 250
8 340
9 530
10 800

a. Insert columns for TR,TC,MC,AC,MR. where TR is total revenue, TC is total

cost, MC is marginal cost AC is average cost and MR is marginal revenue.
b. Determine the market structure of the firm and give two reasons
c. State two advantages of this market structure
d. If price was to fall from 90 000Fcfa, below what price will the firm
i. Cease production in the short run?
ii. In the long run.

II. IMPERFECT MARKET

A. MONOPOLY

This is a market structure with a single supplier of a product without a closed substitute for
which there are many buyers. Monopolies are price makers. They determine their prices or
output but can’t determine both. This is because monopolies can only reduce output to increase

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price OR increase price independently but cannot control demand. An example of a monopoly
market is ENEO in the electricity market in Cameroon.
SHORT RUN EQUILIBRIUM UNDER PURE MONOPOLY
Based on the principles that all firms maximise profits when MC= MR, there for monopolies
will maximise their profits at an output level where MC=MR<AC<AR. As illustrated below

From the figure above, the equilibrium level f output is Qe where MC=MR<AC<AR the shaded
region represents the abnormal profit enjoyed at equilibrium.
LONG RUN EQUILIBRIUM IN MONOPOLY
In the long run, monopolist has the time to expand his firm depending on the elasticity of
demand for the product. A monopolist may reach the optimal scale or subnormal scale. A
monopolist has the possibility to continuously earn abnormal profit in the long run given that
entry of new firms into the industry is barred. Some monopolist such as state monopolist may
experience losses in the long run due to inefficiency . long rn equilibrium in a monopoly could
be illustrated below:

Long run equilibrium is determined at Qe where MC = MR < AC=AR. At LAC the monopolist
can make abnormal profits, at LAC1the monopolist break even in the long run, and at LAC2 the
monopolist make losses in the long run.
MONOPOLY POWER
It is the ability of a firm to earn abnormal profit in the long run. It is the ability of a firm to
determine the market price in the long run. Monopoly power has several sources.
SOURCES OF MONOPOLY POWER
1. Legal restriction

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2. Natural monopoly
3. Control over the supply of a specific factor of production
4. Organised market
5. Product differentiation
6. Transport cost
7. Trade restriction
8. Number of producers
Measure of monopoly power
1. The concentration ratio: the proportion of an industrial output produced by few giant
firms in an industry. The higher the concentration ratio, the higher the higher the degree
of monopoly power .
2. Profits: the higher the profit, the higher the monopoly power. Profits are high if the firm
exercise monopoly power.
3. The lerner index : it is the ratio of the difference between price and MC to price. The
lerner index rages from 0 from perfectly competitive industry to 1 for a monopolist.
L= P-MC
P

PRICE DISCRIMINATION
Assignment : 1. explain price discrimination and types
2.how is price discrimination beneficial and possible .
APPLICATION EXERCISE

3. Ndip and Sons LTD dealer in imported SAMSUNG smart phones, decides to discriminate the price of its
product in its two retail outlets found in Douala and Yaoundé. The price and cost structure in both markets
is given in the data below:

Markets Price per unit Total Cost per unit

A (Yaoundé ) P= 2Q – 4 TC = 10 + 20Q
B (Douala ) P= 2Q

a) Determine the Total revenue in both markets given that the total cost is constant
b) Determine the profit in both markets
c) Determine the market type which is more elastic and give a reason for your answer.

2. he following relates to the cost and revenue situation of Seven firms ( A to G) each producing
different output under different market conditions. Cost and revenue figures are in millions FCFA
Firm AR MR AC MC
A 10 4 10 4
B 12 5 9 5
C 20 20 18 20
D 18 0 20 25
E 20 20 20 25

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GENERAL ECONOMICS 1- LECTURE NOTES- AKUM NDIP

F 15 10 15 30
G 10 10 10 10
Given the situations above facing the seven firms, which firm will you consider to be
a) Profit maximizing monopoly
b) A growth maximizing monopoly or a Nationalized industry
c) The perfect competitor in the short run
d) The perfect competitor in the long run
e) An imperfect competitor in the long run
f) A sales revenue maximizing firm
Give reasons for your choice.

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