ECONOMICS MBPM 1043 Page i ECONOMICS Nurnaddia Nordin Nurhaiza Nordin Mohammed Rizki Moi
ECONOMICS MBPM 1043 Page ii MBPM 1043 ECONOMICS Nurnaddia Nordin Nurhaiza Nordin Mohammed Rizki Moi
ECONOMICS MBPM 1043 Page iii Economics Copyright © 2022 by NurNaddia Nordin and NurHaiza Nordin All rights reserved. Without limiting the rights under copyright reserved above, no part of this publication may be produces, stored in or introduces into a retrieval system, or transmitted, in any form or any means (electronic, mechanical, photocopying, recording or otherwise), without the prior written permission of the copyright owner and the above publisher of this book. Economics Nurnaddia Nordin Nurhaiza Nordin Mohammed Rizki Moi Printed By: Corner Printing Sdn Bhd
ECONOMICS MBPM 1043 Page iv TABLE OF CONTENTS MICROECONOMICS CHAPTER 1 : INTRODUCTION TO ECONOMICS ..................................................... 1 CHAPTER 2 : THE ECONOMICS PROBLEMS ........................................................ 16 CHAPTER 3: DEMAND AND SUPPLY .................................................................... 36 CHAPTER 4: ELASTICITY AND ITS APPLICATION .............................................. 71 CHAPTER 5: PRODUCTION AND COST THEORY ................................................ 96 CHAPTER 6: PERFECT COMPETITION ............................................................... 123 CHAPTER 7: MONOPOLY ..................................................................................... 132 CHAPTER 8: OLGOPOLY ..................................................................................... 147 CHAPTER 9: MONOPOLISTIC COMPETITION .................................................... 150 MACROECONOMICS CHAPTER 10 : INTRODUCTION TO MACROECONOMICS ................................. 153 CHAPTER 11 : NATIONAL INCOME ..................................................................... 176 CHAPTER 12: KEYNESIAN ECONOMICS ............................................................ 210 CHAPTER 13: INFLATION .................................................................................... 271 CHAPTER 14: UNEMPLOYMENT ......................................................................... 287 CHAPTER 15: MONETARY ANALYSIS ................................................................ 301 CHAPTER 16: INTERNATIONAL TRADE AND EXCHANGE MARKET ............... 339
ECONOMICS MBPM 1043 Page v MICROECONOMICS CHAPTER 1 : INTRODUCTION TO ECONOMICS CHAPTER 2 : THE ECONOMICS PROBLEMS CHAPTER 3 : DEMAND AND SUPPLY CHAPTER 4 : ELASTICITY AND ITS APPLICATION CHAPTER 5 : PRODUCTION AND COST THEORY CHAPTER 6 : PERFECT COMPETITION CHAPTER 7 : MONOPOLY CHAPTER 8 : OLGOPOLY CHAPTER 9 : MONOPOLISTIC
ECONOMICS MBPM 1043 Page 1 CHAPTER 1 INTRODUCTION TO ECONOMICS 1.1 WHAT ECONOMICS IS ALL ABOUT Scarcity: the limited nature of society’s resources Economics: The study of how society manages its scarce resources, e.g. • How people decide what to buy. • How much to work, save, and spend. • How firms decide how much to produce. • How many workers to hire. • How society decides how to divide its resources between national defense, consumer goods, protecting the environment, and other needs. Resources • Inputs is a factors of production – Used to produce goods and services • Goods and services are scarce because resources are scarce • Example resources 1. Labor 2. Capital 3. Natural resources 4. Entrepreneurial ability Labor is a human effort. Can be divided by two 1. Physical effort 2. Mental effort The Payment for labor is in terms of wage Capital is a human creation. Can be divided by two 1. Physical capital 2. Human capital
ECONOMICS MBPM 1043 Page 2 The Payment in terms of Interest (ex: the interest the get from the investment of capital) Natural resources is a gifts of nature • Renewable • Exhaustible Payment in term of Rent Entrepreneurial ability • Talent, idea • Risk of operation Payment in term of Profit Goods and Services • Good: is the item that can see, feel, touch • Service: intangible • Scarce good/service – The amount people desire exceeds the amount available at a zero price • Choice – Give up some goods and services
ECONOMICS MBPM 1043 Page 3 1.2 TEN PRINCIPLES IN ECONOMICS THE PRINCIPLES OF HOW PEOPLE MAKE DECISIONS Decision-making is at the heart of economics. The individual must decide how much to save for retirement, how much to spend on different goods and services, how many hours a week to work. The firm must decide how much to produce, what kind of labor to hire. Society as a whole must decide how much to spend on national defense (“guns”) versus how much to spend on consumer goods (“butter”). PRINCIPLE 1: PEOPLE FACE TRADEOFFS All decisions involve tradeoffs. Examples: • Going to a party the night before your midterm leaves less time for studying. • Having more money to buy stuff requires working longer hours, which leaves less time for leisure. • Protecting the environment requires resources that could otherwise be used to produce consumer goods. Society faces an important tradeoff: (efficiency vs. equality) • Efficiency: when society gets the most from its scarce resources • Equality: when prosperity is distributed uniformly among society’s members Tradeoff: To achieve greater equality, could redistribute income from wealthy to poor. But this reduces incentive to work and produce, shrinks the size of the economic “pie.” “Redistribute income from wealthy to poor” is accomplished through the progressive tax system, as well as social programs like food stamps and unemployment insurance that try to provide a safety net for people at the low end of the income distribution.
ECONOMICS MBPM 1043 Page 4 “But this reduces the incentive to work” – the reward for working hard is a high income. Taxes reduce this reward, and therefore reduce the incentive to work hard. PRINCIPLE 2: THE COST OF SOMETHING IS WHAT YOU GIVE UP TO GET IT Making decisions requires comparing the costs and benefits of alternative choices. The opportunity cost of any item is whatever must be given up to obtain it. It is the relevant cost for decision making. Examples: The opportunity cost of… 1. going to college for a year is not just the tuition, books, and fees, but also the foregone wages. 2. seeing a movie is not just the price of the ticket, but the value of the time you spend in the theater. PRINCIPLE 3: RATIONAL PEOPLE THINK AT THE MARGIN Rational people Systematically and purposefully do the best they can to achieve their objectives. Make decisions by evaluating costs and benefits of marginal changes incremental adjustments to an existing plan. Examples: • When a student considers whether to go to college for an additional year, he compares the fees & foregone wages to the extra income he could earn with the extra year of education. • When a manager considers whether to increase output, she compares the cost of the needed labor and materials to the extra revenue.
ECONOMICS MBPM 1043 Page 5 PRINCIPLE 4: PEOPLE RESPOND TO INCENTIVES Incentive: something that induces a person to act, i.e. the prospect of a reward or punishment. Rational people respond to incentives. Examples: • When gas prices rise, consumers buy more hybrid cars and fewer gas guzzling SUVs. • When cigarette taxes increase, the number of smoking will falls. THE PRINCIPLES OF HOW PEOPLE INTERACT Whether we’re talking about the Malaysia economy, or the local economy, the term “economy” simply means a group of people interacting with each other. These interactions play a critical role in the allocation of society’s scarce resources. For example, the interaction of buyers and sellers determines the prices of goods and the amounts produced and sold. These interactions are an important part in the economic. PRINCIPLE 5: TRADE CAN MAKE EVERYONE BETTER OFF Rather than being self-sufficient, people can specialize in producing one good or service and exchange it for other goods. Countries also benefit from trade and specialization: • Get a better price abroad for goods they produce • Buy other goods more cheaply from abroad than could be produced at home
ECONOMICS MBPM 1043 Page 6 If each person had to grow his own food, make his own clothes, cut his own hair, we would have a world full of skinny, unfashionable poor people having bad hair days every day of the week. It’s far more efficient for each person to specialize in producing a good or service, and then exchanging it with other people for the things they produce. The same principles apply at the national and international level: International trade allows countries to sell their exports abroad and get a higher price, and to buy things from abroad more cheaply than they could produce at home. In addition, trade gives a country’s consumers access to a greater variety of goods – including goods they might not be able to get at all. PRINCIPLE 6: MARKETS ARE USUALLY A GOOD WAY TO ORGANIZE ECONOMIC ACTIVITY Market is a group of buyers and sellers (need not be in a single location) “Organize economic activity” means determining • What goods to produce • How to produce them • How much of each to produce • Who gets them? A market economy is “decentralized,” meaning that there is no government committee that makes the decisions about what goods to produce and so forth. Instead, many households and firms make their own decisions: • Each of many households decides who to work for and what goods to buy. • Each of many firms decides whom to hire and what goods to produce. A market economy allocates resources through the decentralized decisions of many households and firms as they interact in markets.
ECONOMICS MBPM 1043 Page 7 Famous insight by Adam Smith in The Wealth of Nations (1776): • Each of these households and firms acts as if “led by an invisible hand” to promote general economic well-being. The invisible hand works through the price system: • The interaction of buyers and sellers determines prices. • Each price reflects the good’s value to buyers and the cost of producing the good. • Prices guide self-interested households and firms to make decisions that, in many cases, maximize society’s economic well-being. PRINCIPLE 7: GOVERNMENTS CAN SOMETIMES IMPROVE MARKET OUTCOMES Important role for government: enforces property rights (with police, courts). People are less inclined to work, produce, invest, or purchase if large risk of their property being stolen. Market failure happen when the market fails to allocate society’s resources efficiently Causes: Externalities, when the production or consumption of a good affects by standers (e.g. pollution). Market power, a single buyer or seller has substantial influence on market price (e.g. monopoly). In such cases, public policy may promote efficiency. Government may alter market outcome to promote equity If the market’s distribution of economic well-being is not desirable, tax or welfare policies can change how the economic “pie” is divided.
ECONOMICS MBPM 1043 Page 8 THE PRINCIPLES OF HOW THE ECONOMY AS A WHOLE WORKS PRINCIPLE 8: A COUNTRY’S STANDARD OF LIVING DEPENDS ON ITS ABILITY TO PRODUCE GOODS & SERVICES. Huge variation in living standards across countries and over time: Average income in rich countries is more than ten times average income in poor countries. The U.S. standard of living today is about eight times larger than 100 years ago • “Rich countries” refers to countries like the U.S., Japan, and Germany. • “Poor countries” refers to countries like India, Indonesia, and Nigeria. The most important determinant of standards of living is productivity (the amount of goods and services produced per unit of labor). Productivity depends on the equipment, skills, and technology available to workers. Other factors (e.g, labor unions, competition from abroad) have far less impact on standards of living. PRINCIPLE 9: PRICES RISE WHEN THE GOVERNMENT PRINTS TOO MUCH MONEY. Inflation happens when there are increases in the general level of prices. In the long run, inflation is almost always caused by excessive growth in the quantity of money, which causes the value of money to fall. The faster the government creates money, the greater the inflation rate. PRINCIPLE 10: SOCIETY FACES A SHORT-RUN TRADEOFF BETWEEN INFLATION AND UNEMPLOYMENT In the short-run (1 – 2 years), many economic policies push inflation and unemployment in opposite directions. Other factors can make this tradeoff more or less favorable, but the tradeoff is always present. While the long-run effect of increasing the quantity of money is inflation, the short- run effects are more complicated and controversial. However, most mainstream economists believe the following: An increase in the quantity of money causes spending to rise, which causes prices to rise, which induces firms to produce more goods and services, which requires that they hire more workers. Hence, in the short-run, increasing the quantity of money causes inflation to rise, but
ECONOMICS MBPM 1043 Page 9 unemployment to fall. Of course, REDUCING the quantity of money would have the opposite effects (inflation would fall, while unemployment would rise) in the short run. 1.3 THINKING LIKE AN ECONOMIST The Economist as Scientist Economists play two roles: 1. Scientists: try to explain the world 2. Policy advisors: try to improve it In the first, economists employ the scientific method, the dispassionate development and testing of theories about how the world works. Assumptions & Models Assumptions simplify the complex world, make it easier to understand. Example: To study international trade, assume two countries and two goods. Unrealistic, but simple to learn and gives useful insights about the real world. Model: a highly simplified representation of a more complicated reality. Economists use models to study economic issues.
ECONOMICS MBPM 1043 Page 10 FIRST MODEL IN ECONOMIC: 1.4 THE CIRCULAR-FLOW DIAGRAM The Circular-Flow Diagram: A visual model of the economy, shows how money (Ringgit Malaysia (MYR)) flow through markets among households and firms. Assumptions: • Two types of “actors”: ➢ households ➢ firms • Two markets: ➢ the market for goods and services ➢ the market for “factors of production” • Factors of production: the resources the economy uses to produce goods & services, including labor, land and capital (buildings & machines used in production) FIGURE 1: The Circular-Flow Diagram Households: ▪ Supply resources to resource market; earn income ▪ Demand goods and services from product market; spend income Firms: ▪ Demand resources to produce goods and services; payment for resources ▪ Supply goods and services to product market; earn revenue
ECONOMICS MBPM 1043 Page 11 In this diagram, the green arrows (outer arrow) represent flows of income/payments. The red arrows (inner arrow) represent flows of goods & services (including services of the factors of production in the lower half of the diagram). SECOND MODEL IN ECONOMICS: THE PRODUCTION POSSIBILITIES FRONTIER The Production Possibilities Frontier (PPF) is a graph that shows the combinations of two goods the economy can possibly produce given the available resources and the available technology Example: • Two goods: computers and wheat • One resource: labor (measured in hours) • Economy has 50,000 labor hours per month available for production.
ECONOMICS MBPM 1043 Page 12 Explanations: This PPF curve shows the combination of two goods that is computer and wheat. At point E, show the 50, 000 labors produced 5000 wheat and no production of computers, means that with the one resource only produce one production, at point D, with the 50,000 labor can produce 4000 wheat and 100 computers. 1.6 POSITIVE AND NORMATIVE ECONOMICS Positive economic analysis: addresses factual questions, typically about economic choices or market outcomes. What is currently happening in the world or how the world is operating? Might be right or wrong and can be tested • What did happen? What will happen? What would happen? • Historical fact-finding • Forecasting • Cause-and-effect analysis of actions and their consequences • Questions that deal with explanation and prediction ➢ What will be the impact of an import quota on foreign cars? ➢ What will be the impact of an increase in the gasoline excise tax?
ECONOMICS MBPM 1043 Page 13 Example: ➢ If the price of Pepsi increases, then the quantity demanded will decrease. ➢ An increase in the minimum wage will cause a decrease in employment among the least-skilled. ➢ Higher federal budget deficits will cause interest rates to increase. Normative economic analysis: addresses questions that involve value judgments concerning the allocation of resources cannot be tested (someone’s opinion) • What ought to happen? • Should the government impose a larger gasoline tax? • Should the government decrease the tariffs on imported cars? Example: ➢ The distribution of income in the Malaysia should be more equal ➢ The income gains from a higher minimum wage are worth more than any slight reductions in employment. ➢ State governments should be allowed to collect from tobacco companies the costs of treating smoking-related illnesses among the poor.
ECONOMICS MBPM 1043 Page 14 1.7 MICROECONOMICS AND MACROECONOMICS Microeconomics is the study of how households and firms make decisions and how they interact in markets. • Concerns individual decision making and its collective effect on allocation of a society’s resources. • Individual economic choices. • Markets coordinate the choices of economic decision makers. • Individual pieces of the puzzle. Macroeconomics is the study of economy-wide phenomena. • Including inflation, unemployment, and economic growth. • Performance of the economy as a whole • Concerns aggregate phenomena • Big picture
ECONOMICS MBPM 1043 Page 15 TUTORIAL QUESTIONS CHAPTER 1 Question 1 Discuss these two models: a. Circular Flow Diagram b. Production Possibility Frontiers Question 3 Briefly explain the difference between microeconomics and macroeconomics. Question 4 Describe at least three of the key concepts in economics introduced in Chapter 1 of the text that define how an economist views the world. Question 5 Describe the difference between positive and normative economics. Give an example of each. Question 6 List and describe the four broad categories of resources. Cite an example of each to help support your answer.
ECONOMICS MBPM 1043 Page 16 CHAPTER 2 THE ECONOMIC PROBLEM 2.1 PRODUCTION POSSIBILITIES A production possibility is used to explain the basic economic concepts of production efficiency, trade off and opportunity cost. The Production Possibilities Frontier (PPF) Or Production Possibilities Curve (PPC) The Production Possibilities: a graph that shows the various combinations of two goods the economy can possibly produce given the available resources (labor, land and capital) and the available technology. Assumptions under production possibility: • The economy is operating in full employment and full production capacity (full efficiency). • The amount of resources available is fixed. • The state of technology does not change throughout the production. The Shape of the PPF The PPF could be a straight line, or bow-shaped Depends on what happens to opportunity cost as economy shifts resources from one industry to the other. ▪ If opportunity cost remains constant, PPF is a straight line. (In the example, opp. cost of a computer was always 10 tons of paddy) ▪ If opportunity cost of a good rises as the economy produces more of the good, PPF is bow-shaped. Example: • Two goods: computers and paddy. • One resource: labor (measured in hours). • Economy has 50,000 labor hours per month available for production. ➢ Producing one computer requires 100 hours labor.
ECONOMICS MBPM 1043 Page 17 ➢ Producing one ton of paddy requires 10 hours labor. Explanations of tables: The second and third column is the combination if distributed the total hours of labor for the two productions (computers and paddy). • Combination A, if we use all the 50,000 hours labor to produce computer and no hours of labor to produce paddy. • Combination B, if we use 40,000 hours labor to produce computer and 10,000 hours of labor to produce paddy. • Combination C, if we use 25,000 hours labor to produce computer and 25,000 hours of labor to produce paddy. • Combination D, if we use 10,000 hours labor to produce computer and 40,000 hours of labor to produce paddy. • Combination E, if there is no allocation hours of labor to produce computer and 50,000 of labor to produce paddy. Then based on the assumption that to produce one computer requires 100 hours labor and to produce one ton of paddy requires 10 hours labor. So, we can find the production of computer and paddy. Employment of labor hours Computers Paddy A 50,000 0 B 40,000 10,000 C 25,000 25,000 D 10,000 40,000 E 0 50,000
ECONOMICS MBPM 1043 Page 18 Employment of labor hours Production Computer s Paddy Computers Paddy Computer s Padd y A 50,000 0 50,000/100 = 500 C 0/10 = 0 P 500 0 B 40,000 10,000 40,000/100 = 400 C 10,000/10 = 1000 P 400 1000 C 25,000 25,000 25,000/100 = 250 C 25,000/10 = 2500 P 250 2500 D 10,000 40,000 10,000/100 = 100 C 40,000/ 10 = 4000P 100 4000 E 0 50,000 0/100 = 0 C 50,000 /10 = 5000 P 0 5000 From the combination of the production, the curve of production possibities can be draw as below: (The curve maybe straight line or bowed out depends opportunity cost)
ECONOMICS MBPM 1043 Page 19 FROM THE PPF: WE CAN KNOW THAT Points on the PPF (like A – E) • Possible • efficient: all resources are fully utilized Points under the PPF • possible • not efficient: some resources underutilized (e.g., workers unemployed, factories idle) Points above the PPF (like G) • not possible Example for the production possibilities of concave (bowed out) The production possibility (point A - F): Economy uses all resources and technology efficiently The shape of curve is bowed out based on the law of increasing opportunity cost. The Inefficient point: inside PPF (point I). The unattainable point (point U) outside of PPF.
ECONOMICS MBPM 1043 Page 20 2.2 OPPORTUNITY COST The opportunity cost of an item is what must be given up to obtain that item. Moving along a PPF involves shifting resources (e.g., labor) from the production of one good to the other. Society faces a tradeoff: Getting more of one good requires sacrificing some of the other. The slope of the PPF tells you the opportunity cost of one good in terms of the other. The slope of a line equals the “rise over the run,” the amount the line rises when you move to the right by one unit. Here, the opportunity cost of a computer is 10 tons of paddy. Here, the “rise” is a negative number, because, as you move to the right, the line falls (meaning wheat output is reduced). Moving to the right involves shifting resources from the production of wheat (which causes paddy output to fall) to the production of computers (which causes computer production to rise). Producing an additional computer requires the resources that would otherwise produce 10 tons of paddy.
ECONOMICS MBPM 1043 Page 21 Example of Calculation opportunity cost Production Combinations A B C D E Computer (million) 0 50 100 150 200 Radio(million) 200 180 150 60 0 Calculate the opportunity cost of 1. Producing 50 millions Computer 200 – 180 = 20 millions radio 2. Producing 150 millions Radio 200 – 60 = 140 millions radio 3. When the production of computer increases from 100 million to 200 millions 150 – 0 = 150 millions radio THREE MAIN POINTS FROM PPF: • Production efficiency • Tradeoff • Opportunity Cost 1. Production efficiency • is when we cannot produce more of one good without producing less of some other good. When production is efficient, we are at a point on the PPF. • If the point is inside PPF- production is inefficient because there are some unused resources • If the point is outside the PPF – it is unattainable with the existing resources 2. Tradeoff
ECONOMICS MBPM 1043 Page 22 • Happen when the point is on the PPF, every choice involve tradeoff, we must give up something to get something (e.g. on the PPF we must give up some computer to get more paddy. 3. Opportunity Cost • All tradeoffs involve a opportunity cost. The opportunity cost of an action is the highest-value alternative forgone. • The opportunity cost of producing additional capital goods is the number of consumer goods that we must forgo. • Since the PPF is bowed outward the opportunity cost is increasing – implies that each additional increment of one good requires the economy to sacrifice successively larger and larger increments of other good (law of increasing opportunity cost). WHAT CAN SHIFT THE PPF? 2.3 ECONOMIC GROWTH An economic growth means that an expansion in the economy’s production possibilities and reflected by shift of the PPF. There are four conditions that will change the production possibilities. 1. Changes in resource availability • Outward shift of PPF – increase in: • Size, health of labor force • Skills of labor force • Availability of other resources 2. Increases in capital stock • More output; outward shift of PPF 3. Technological change • Employs resources more efficiently • Outward shift of PPF
ECONOMICS MBPM 1043 Page 23 4. Improvements in the rules of the game • Formal and informal institutions • Economic growth • Outward shift of PPF STRAIGHT LINE PPF With additional resources or an improvement in technology, the economy can produce more computers, more paddy or any combination in between. Economic growth causes a parallel outward shift of the PPF. Since the new PPF is parallel to the old one, the tradeoff between the two goods is the same. However, this need not always be the case. For example, if a new technology had more impact on the computer industry than on the paddy industry, then the horizontal (computer) intercept would increase more than the vertical (paddy) intercept, and the PPF would become flatter. The opportunity cost of computers would fall, because the technology has made them relatively cheaper (relative to paddy).
ECONOMICS MBPM 1043 Page 24 BOW SHAPE PPF Shifts of the economy’s PPF (a) Increase in available resources (b) Decrease in available resources Outward shift of PPF - increase in available resources; better technology - enhanced production of both capital and consumer goods Inward shift of PPF - decrease in available resources - decreased production of both capital and consumer goods
ECONOMICS MBPM 1043 Page 25 (c) Change in resources that benefit for paddy production (d) Change in resources, technology, or rules that benefits for computer production. Upward shift of Paddy curve - Because the increase of resources give benefit only to paddy production, so only paddy production will increase Upward shift of Computer curve - Because the increase of resources give benefit only to computer production, so only computer production will increase.
ECONOMICS MBPM 1043 Page 26 2.4 The Economic System An economic system is a way of organizing the relationship among individuals, firms and government agencies on how to make choices when confronted with basic economic questions (what to produce, how to produce and for whom to produce). There are three types of economic systems: 1. Capitalism or Market Economy 2. Socialism or Command Economy 3. Mixed Economy CAPITALISM SOCIALISM MIXED ECONOMY Definition: Capitalism or free market economy is an economic system where individuals make all the main economic decisions without any government intervention. In this market, buyers and sellers will meet and enter into transactions. The price system is the main mechanism for any economic activity. This economy is characterized as economic freedom, where an individual can be a buyer, seller, employee or employer at his/her own Socialism is an economic system where all the economic decisions are made by the government or a central authority. There will be no private property rights since the government officially owns all resources. It is also known as a command economy or a planned system. This is an economic system which combines both capitalism and socialism to solve basic economic problems. A mixed economy is an economy in which both the public and private sectors play a role in the economy. In the real world, most countries practice mixed economy.
ECONOMICS MBPM 1043 Page 27 wish and without any governmental control. This system is also known as laissez-faire, market economy or free enterprise. Characteristic: Ownership of resources Private ownership of resources. Every individual in the country has a right to acquire private ownership of resources. Private individuals or private institutions can own resources. They can accumulate property and use it as they choose. For example, if Faizal wants to buy a bungalow in Taman Cempaka, he can purchase the property if he has sufficient money. Faizal can also buy more properties depending on purchasing power. There is no restriction on the number of properties Faizal can own. Public ownership of resources All the resources are owned and operated by the state or the government in the interest of society as a whole. This is to ensure equal opportunity of all citizens regardless of their income. Public ownership also aims to fully utilize the country's resources. Public and private ownership of resources The private and public sectors play important roles in a mixed economy. Private enterprises conduct business freely and the government encourages the private sector by providing them with infrastructure and facilities.
ECONOMICS MBPM 1043 Page 28 There is freedom to own private property. However, all governmental laws and regulations must be followed in the process. There are also certain public facilities provided by the government for public usage such as roads, clinics, and schools. Price Mechanism The price mechanism is a system used to make economic decisions. Price mechanism means the free operation of demand and supply forces without any intervention. All economic processes of consumption, production,exchange, savings, investment and distribution, work under this price mechanism system, which is labeled as the Invisible Hand by Adam Smith. Price mechanism of lesser importance Socialism gives less importance to market forces. Prices are fixed by the government and riot determined by demand and supply. Private profits are not allowed and public interest is emphasized in the command economy. Price mechanism and economic plans in making economic decisions The price mechanism is used to price both goods and services. However, commodities such as sugar, oil and rice are declared as controlled items in Malaysia and the government fixes their prices. Most of the mixed economies accept economic planning as an instrument of economic growth and social justice.
ECONOMICS MBPM 1043 Page 29 Freedom Individuals are free to own resources as well as to establish any enterprise of their choice. They are free to trade, invest, and organize to produce within the country's legal framework. For example, if John wants to open his own business selling mobile phones, he has the economic freedom to operate this business. Central control and ownership A socialist economy is a fully planned economy where the government intervenes in all aspects of economic activity. The government controls production, consumption, and the distribution of goods and services. Government helps to control income disparity In most mixed economies, the government controls income disparity through income taxes and welfare payments. The government also has direct control over profits, wages and rents. Thus, the government helps to narrow the income gap between the rich and the poor. Role Consumer sovereignty In capitalism, consumers' sovereignty plays an important role. Consumers' taste and preferences will affect the production of goods and services. Producers have to produce goods and services to meet consumers' tastes and services, otherwise they will be unable to sell what they produce. Central planning authority The central authority is responsible for making economic decisions for society. The authority plans and allocates- resources between current consumption and investment for the future. Government intervention in the economy. The government will not intervene in the economy except for particular industries. In a mixed economy, the government uses legislation for unsafe goods categorized as illegal products such as military items. The government also uses direct provision, for example education defense and health to increase the standard of living.
ECONOMICS MBPM 1043 Page 30 Economic Decisions What to produce Capitalism, an entrepreneur will only produce goods and services for which there is a demand from consumers so as to enjoy higher profits. Production depends on the goods demanded by the consumer. For example, mobile phones have been in high demand in the country for the last few gars. Many producers have allocated their resources to respond to this wand and to produce various kinds of mobile phones. In socialism, planning authorities decide what to produce. The Central Planning Authority will collect detailed statistics on the resource availability in the country and link it with national priorities. If the planning feels that the nation needs more computers for current and future consumption, more resources will be allocated for the production of computers over other products. In mixed economies, the question of what to produce is decided by both the public and private sectors. The goods produced and the services provided depend on the consideration of social welfare and economic growth. How to produce Firms can produce any product or provide any service using more than one method. The method depends on the relative price of the resources involved. As resources become scarce relative to demand, prices will rise and discourage their usage. The Central Planning Authority also decides on the techniques to be used in the production of different goods and services. The choice is between traditional and modern techniques of production. For example, the planning authority has a choice of producing computers using more labor or more machinery. The public and private sectors will decide on the techniques of production to be used in the production of the different goods and services.
ECONOMICS MBPM 1043 Page 31 For example, a designer of mobile phones has identified three methods of producing the product: by machinery, by hand or by a combination of labor and machinery. Only the cheapest method of production and the most efficient techniques will be adopted in the production of the phone. For whom to produce The third economic decision as to who will be receiving goods and services in the capitalism system is answered through the price system. Goods and services are obtained by anyone who can afford them. Goods and services are distributed among the residents of the country. For example, mobile phones are purchased by consumers who are willing to buy them at that selling price. The distribution of the national product is decided by the Central Planning Authority. The distribution of various commodities among citizens is done through a set of administered fixed processes. Necessity goods are fixed at lower prices, and luxury goods at higher prices. The purpose of these fixed prices is to reduce inequalities in the distribution of income. The distribution of goods and services is also decided by the public and private sectors. The price mechanism does not fully function in mixed economies. In many mixed economies, the government intervenes directly through price controls and indirectly through the imposition of indirect taxes and subsidies.
ECONOMICS MBPM 1043 Page 32 TUTORIAL 2 Question 1 Based on the table below Choice Industrial goods Agriculture goods A 14 0 B 12 2 C 9 4 D 5 6 E 0 8 a. Draw the production possibility frontier (PPF) b. Calculate the opportunity cost. c. State the points are efficient. d. Plot the points is not efficient but attainable. e. Plot the points is impossible to achieve. f. Give two factors that might cause the country to produce less industrial goods and agriculture goods than the combination on the PPF. Question 2 The production possibility frontier is linear and opportunity cost is constant. Choice Car Motorcycle A 0 24 B 1 23 C 2 21 D 3 18 E 4 14 F 5 8 G 6 0 a. Draw the production possibility frontier (PPF) b. Calculate the opportunity cost. c. State the points are efficient. d. Which points is not efficient but attainable. e. Which points is impossible to achieve. f. If the technology in production car increases, what happen to the PPF? g. If the technology in production motorcycle increases, what happen to the PPF? h. If the technology in both production increases, what happen to the PPF?
ECONOMICS MBPM 1043 Page 33 Question 3 The diagram below depicts the production possibilities curve for a Alesya bakery producing cakes and buns. The usual assumptions regarding PPC are implied. a. Calculate the opportunity cost of: i. Producing 2500 buns. ii. Increasing the production of cake from 500 to 1000. b. Is the value of opportunity cost s constant. Justify your answer. c. illustrate in separate diagrams the effects of the following situation in PPC i. Price of flour increase. ii. Demand for cake increase. d. List two assumptions used in the construction of PPC. Question 4 The following table shows the combination of banana and tapioca that Family Garden is capable to produce for a week. Banana (KG per week) Tapioca (KG per week) 205 0 100 10 90 20 75 30 55 40 30 50 0 60 1000 500 2000 Bun 2500 Cake
ECONOMICS MBPM 1043 Page 34 a. Plot the production possibility curve. Banana on vertical axis and Tapioca on horizontal axis. b. When the production of banana is reduced from 90 units to 75 units, by how many units can the production of Tapioca be increased. c. What are the conditions to be considered in order to be on PPC. d. Explain briefly two factors that would cause the PPC to shift. Question 5 A production possibilities table in Country ZZ for two products, grain and automobile is given below. Combinations Grain Automobile A 0 7 B 14 6 C 26 5 D 36 4 E 44 3 F 50 2 G 54 1 H 56 0 a. Plot the production possibilities curve for Country ZZ. b. On the same diagram, shows the adjustment in the production possibility curve in each of the following situations. i. Technological advancement in automobile industry. ii. Decrease in population. c. Draw two production possibility curve that reflect increasing and constant opportunity cost. d. What is the economic implication when a country produces a combination inside the curve.
ECONOMICS MBPM 1043 Page 35 Question 6 Figure shows the production possibility curve for a country. a. The opportunity cost of producing 100,000 tonne of rice is ______________ units of cars and the opportunity cost of producing 80,000 units of cars is _________ of rice. b. What is the opportunity cost of increasing the output of cars from 40,000 to 65,000. c. What points represent productively efficient combination? d. Why point B is unattainable? What might cause it become attainable?. e. What situation in the economy is represented by point A?. f. As more and more rice is produced, what happens to the opportunity cost of an additional tone of rice? 80 40 80 Rice (‘000) tones 100 Cars (‘000)units 65 50 D C B A
ECONOMICS MBPM 1043 Page 36 CHAPTER 3 DEMAND AND SUPPLY MARKETS AND COMPETITIONS Supply and demand are the two words that economists use most often. Supply and demand are the forces that make market economies work. Modern microeconomics is about supply, demand, and market equilibrium. WHAT IS A MARKET? A market is a group of buyers and sellers of a particular good or service. The terms supply and demand refer to the behavior of people, as they interact with one another in markets Buyers determine demand and sellers determine supply. WHAT IS COMPETITION? A competitive market is a market in which there are many buyers and sellers so that each has a negligible impact on the market price. The Competition market may be perfect and otherwise. 1. Perfectly competitive market: • Goods offered for sale - exactly the same • Buyers and sellers are numerous • No single buyer or seller has any influence over the market price • Must accept the price determined on the market • Price takers • At the market price • Buyers will buy all they want • Sellers will sell all they want 2. Monopoly: • One seller • The seller controls price (price maker)
ECONOMICS MBPM 1043 Page 37 3. Oligopoly: • Few sellers • Not always aggressive competition 4. Monopolistic Competition: • Many sellers • Slightly differentiated products • Each seller may set price for its own product In this chapter, we assume markets are perfectly competitive. 3.2 DEMAND WHAT IS DEMAND: The quantity consumers are willing and able to buy at each possible price during a given time period, other things constant. • Amounts purchased per period at each possible price. • Willing and able to buy or purchase • At a specific period LAW OF DEMAND The law of demand claims that the quantity demanded of a good falls when the price of the good rises, other things equal. The Demand Schedule The demand schedule is a table that shows the relationship between the price of the good and the quantity demanded. Example: Haiza demand for cup cake. Notice that Haiza preferences obey the Law of Demand.
ECONOMICS MBPM 1043 Page 38 Price Quantity RM 0 16 RM 1 14 RM 2 12 RM 3 10 RM 4 8 RM 5 6 RM 6 4 DEMAND CURVE The demand curve is a graph of the relationship between the price of a good and the quantity demanded. The demand curve shows: • How much buyers of the product want to buy at each possible price • Holding fixed all other factors that affect demand. • On a graph: vertical axis shows RM per unit of the good, horizontal axis shows quantity demanded per unit of time. • Downward sloping (buying the product is less attractive when the price is high than when the price is low) Based on the quantity and price, the demand curve will be
ECONOMICS MBPM 1043 Page 39 Market Demand versus Individual Demand Market demand refers to the sum of all individual demands for a particular good or service. Graphically, individual demand curves are summed horizontally to obtain the market demand curve. Suppose Haiza and Farah are the only two buyers in the Cupcake market.(Qd = quantity demanded) Price Haiza Qd Farah Qd Market Qd RM 0 16 8 24 RM 1 14 7 21 RM 2 12 6 18 RM 3 10 5 15 RM 4 8 4 12 RM 5 6 3 9 RM 6 4 2 6 The market demand curve is the horizontal sum of the individual demand curves When the price is RM2.00, Haiza will demand 12 cup cake When the price is RM2.00, Farah will demand 6 cup cake = The market demand at RM2.00 will be 18 cup cake Haiza Demand Farah demand Market demand =
ECONOMICS MBPM 1043 Page 40 Change in Demand Change in Quantity Demanded • Movement along a fixed demand curve. • Caused by a change in the price of the product. Shift in the Demand Curve • A shift in the demand curve, either to the left or right. • Caused by any change in the determinant other than price : • Consumer income • Prices of related goods • Tastes • Expectations • Number of buyers When the price is RM 1.00, Haiza will demand 14 cup cake. When the price is RM 1.00, Farah will demand 7 cup cake. = The market demand at RM1.00 will be 21 cupcake.
ECONOMICS MBPM 1043 Page 41 Changes in Quantity Demanded Shifts in the Demand Curve A raise in the price of cupcake, results in a movement along the demand curve.
ECONOMICS MBPM 1043 Page 42 1. Consumer Income • As income increases the demand for a normal good will increase. • As income increases the demand for an inferior good will decrease. Demand for a normal good is positively related to income. • Increase in income causes increase in quantity demanded at each price, shifts D curve to the right. Demand for an inferior good is negatively related to income. • An increase in income shifts D curves for inferior goods to the left.) Consumer Income Normal Good An increase in income
ECONOMICS MBPM 1043 Page 43 Consumer Income Inferior Good An increase in income 2. Prices of Related Goods When a fall in the price of one good reduces the demand for another good, the two goods are called substitutes. • Two goods are substitutes if an increase in the price of one causes an increase in demand for the other. • Example: pizza and hamburgers. An increase in the price of pizza increases demand for hamburgers, shifting hamburger demand curve to the right. • Other examples: Coke and Pepsi, laptops and desktop computers, CDs and music downloads
ECONOMICS MBPM 1043 Page 44 Example: Suppose the quantity of pizza and hamburger Q = 1000 when P = RM5. If pizza becomes more expensive, but price of hamburgers does not change, what would happen to the quantity of hamburgers demanded? Would it remain at 1000, would it increase, or would it decrease? Solution: People will want more hamburgers when the price of pizza rises. Note that the increase in the price of pizza caused an increase in the quantity demanded of hamburgers, because pizza and hamburger are “substitutes” goods. When a fall in the price of one good increases the demand for another good, the two goods are called complements. • Two goods are complements if an increase in the price of one causes a fall in demand for the other. • Example: computers and software. If price of computers rises, people buy fewer computers, and therefore less software. Software demand curve shifts left. • Other examples: college tuition and textbooks, bagels and cream cheese, eggs and bacon 3. Tastes Anything that causes a shift in tastes toward a good will increase demand for that good and shift its D curve to the right. o Example: The LCD TV became popular, caused an increase in demand for LCD TV, shifted the LCD TV demand curve to the right.
ECONOMICS MBPM 1043 Page 45 4. Expectations Expectations affect consumers’ buying decisions. Examples: • If people expect their incomes to rise, their demand for meals at expensive restaurants may increase now. • If the economy sours and people worry about their future job security, demand for new autos may fall now. 5. Number of Buyers Suppose the number of buyers increases. Then, at each P, Qd will increase (by 5 in this example) Summary: Variables That Influence Buyers Variable A change in his variable Price cause a movement along the DD curve Number of buyer shifts the DD curve Income shifts the DD curve Price of related goods shifts the DD curve Tastes shifts the DD curve Expectation shifts the DD curve
ECONOMICS MBPM 1043 Page 46 Demand Functions Product’s demand function is a mathematical representation of its demand. Describes the amount of the product buyers demand for each possible combination of price and other factors. Can be determined by applying statistical techniques to historical data The basic demand function is Qd = a – bp Where Qd is the quantity demand, a is a intercept, b is the slope and p is the price. The sign Negative from this function show the negative relationship between the price and quantity that based on the law of demand where when the price increase the quantity demanded will decrease. Given the data of price and quantity demand Price Quantity demand RM 2.00 60 RM 4.00 50 RM 6.00 40 RM 8.00 30 RM 10.00 20 RM 12.00 10 Given Q d = a – b p Step 1: Take the two point At P = RM 6.00 and Q d = 40 At P = RM 8.00 and Q d = 30
ECONOMICS MBPM 1043 Page 47 Step 2: Calculate the value of b b = ∆𝑄 ∆𝑃 = 30−40 8−6 = -5 Step 3: Find the value of a Take one point At P = RM 6.00 and Q d = 40 40 = a – 5 (6) 40 = a – 30 a = 40 + 30 a = 70 Now, we already know the value of a and b, so the demand equation will be Qd = 70 – 5p 3.3 Supply Supply show • How much producers are willing and able to offer for sale per period at each possible price, other things constant • Willing and able • Specific period Law of supply: Claim that the quantity supplied of a good rises when the price of the good rises, other things equal • Higher price: higher quantity supplied • Higher reward, profit • More willing to increase quantity supplied; • Can afford to cover the marginal costs • Increasing opportunity cost • More able to increase quantity supplies
ECONOMICS MBPM 1043 Page 48 Supply Schedule • The supply schedule is a table that shows the relationship between the price of the good and the quantity supplied. Price Quantity supply RM 0 0 RM 1.00 3 RM 2.00 6 RM 3.00 9 RM 4.00 12 RM 5.00 15 RM 6.00 18 Supply Curve The supply curve is the graph of the relationship between the price of a good and the quantity supplied.
ECONOMICS MBPM 1043 Page 49 MARKET SUPPLY VERSUS INDIVIDUAL SUPPLY The quantity supplied in the market is the sum of the quantities supplied by all sellers at each price. Suppose Ali and Abu are the only two sellers in this market. (Qs = quantity supplied) Price Ali Qs Abu Qs Market Qs RM 0 0 0 0 RM 1.00 3 2 5 RM 2.00 6 4 10 RM 3.00 9 6 15 RM 4.00 12 8 20 RM 5.00 15 10 25 RM 6.00 18 12 30
ECONOMICS MBPM 1043 Page 50 Change in Quantity Supplied Movement along a fixed supply curve. • Caused by a change in the price of the product. Shift in the Supply Curve A shift in the supply curve, either to the left or right, caused by a change in a determinant other than price: • Input prices • Technology • Expectations • Number of sellers Change in Quantity Supplied A rise in the own price of good results in a movement along the supply curve
ECONOMICS MBPM 1043 Page 51 SHIFTS IN THE SUPPLY CURVE Supply Curve Shifters: 1. Input Prices Examples of input prices: wages, prices of raw materials. A fall in input prices makes production more profitable at each output price, so firms supply a larger quantity at each price, and the S curve shifts to the right. 2. Technology Technology determines how much inputs are required to produce a unit of output. A cost-saving technological improvement has the same effect as a fall in input prices, shifts S curve to the right. Variable A change in his variable Price cause a movement along the SS curve Input Price shifts the SS curve Technology shifts the SS curve Expectation shifts the SS curve Number of sellers shifts the SS curve
ECONOMICS MBPM 1043 Page 52 3. Number of Sellers An increase in the number of sellers increases the quantity supplied at each price, shifts S curve to the right. 4. Expectations Example: • Events in the Middle East lead to expectations of higher oil prices. • In response, owners of Texas oilfields reduce supply now, save some inventory to sell later at the higher price. • SS curve shifts left. In general, sellers may adjust supply* when their expectations of future prices change. (*If good not perishable) Sample Supply Function The basic supply function is Q s = c + bp Where Q s is the supply function, c is the intercept, b is the slope and p is the price. The positive sign in this function show that the positively relationship between the price and quantity based on the law of supply which when the price increase the quantity supply also will increase at the same time. Given the data of price and quantity supply. Price Quantity supply RM 2.00 0 RM 4.00 20 RM 6.00 40 RM 8.00 60 RM 10.00 80 RM 12.00 100
ECONOMICS MBPM 1043 Page 53 Step 1: Find the value of b Take the two point and develop the equation based on the basic supply function At P = RM 6 and Qs = 40 At P = RM 8.00 and Qs = 60 We know that Q s = c + bp Develop the equation 40 = c + 6b……………… (1) 60 = c + 8b ………………(2) Step 2: Now , you should eliminate the value of c to get the value of b by using the operation either add or subtract the both equation. Subtract the equation 1 to equation 2 40 = c + 6b……………… (1) 60 = c + 8b ………………(2) -20 = 0C – 2b ……………(3) Step 3: Solve the equation 3 -20 = - 2b b = -20 / -2 = 10 ( - )
ECONOMICS MBPM 1043 Page 54 Step 4 : Find the value of c Take one point At P = RM 6.00 and Q = 40 Substitute the P and Q in the basic function of supply, then will get 40 = c + 10 (6) 40 = c + 60 c = 40 – 60 c = -20 Step 5 : Develop the supply function based on the value of b and c Q s = - 20 + 10p 3.4 Market Equilibrium Equilibrium refers to a situation in which the price has reached the level where quantity supplied equals quantity demanded. Equilibrium Price • The price that balances quantity supplied and quantity demanded. • On a graph, it is the price at which the supply and demand curves intersect. Equilibrium Quantity • The quantity supplied and the quantity demanded at the equilibrium price.
ECONOMICS MBPM 1043 Page 55 On a graph it is the quantity at which the supply and demand curves intersect. The Equilibrium of Supply and Demand Price Market Qd RM 0 24 RM 1 21 RM 2 18 RM 3 15 RM 4 12 RM 5 9 RM 6 6 Price Market Qs RM 0 0 RM 1.00 5 RM 2.00 10 RM 3.00 15 RM 4.00 20 RM 5.00 25 RM 6.00 30 At RM 3.00, the quantity demanded is equal to the quantity supplied (Q = 15)
ECONOMICS MBPM 1043 Page 56 Excess Supply, Excess Demand Surplus When price is higher equilibrium price, then quantity supplied more quantity demanded. There is excess supply or a surplus. Surplus: excess quantity supplied • Downward pressure on price. • Decrease quantity supplied. • Increase quantity demanded Using the mathematical to find the equilibrium Based on the demand and the supply function that we calculated before, we can find the equilibrium The demand function: Qd = 70 – 5P The supply function Qs = - 20 + 10 P The equilibrium condition when the demand equal to supply (DD = SS) So, Qd = Qs 70 – 5P = - 20 + 10 P 70 + 20 = 5P + 10P 90 = 15P P = 6
ECONOMICS MBPM 1043 Page 57 To find the value of Q, substitute P = 6 in either demand and supply function. Qs = - 20 + 10 (6) Qs = - 20 + 60 Qs = 40 So the equilibrium is Q = 40 and P = 6. This also can be see in the table Price Quantity supply Quantity Demand RM 2.00 0 60 RM 4.00 20 50 RM 6.00 40 40 RM 8.00 60 30 RM 10.00 80 20 RM 12.00 100 10 Markets Not in Equilibrium Suppliers will lower the price to increase sales, this causes QD to rise and Qs to fall, thereby moving toward equilibrium which reduces the surplus.
ECONOMICS MBPM 1043 Page 58 Prices continue to fall until market reaches equilibrium. Shortage: excess quantity demanded when quantity demanded is greater than quantity supplied Upward pressure on price • Increase quantity supplied • Decrease quantity demanded
ECONOMICS MBPM 1043 Page 59 Example: At price equal to RM 1.00, the quantity demand is 21 and quantity supply is 5, resulting the shortage 16. Facing a shortage, sellers raise the price causing QD to fall which reduces the shortage and QS to rise Prices continue to rise until market reaches equilibrium.
ECONOMICS MBPM 1043 Page 60 Law of supply and demand The claim that the price of any good adjusts to bring the quantity supplied and the quantity demanded for that good into balance. Three steps to analyzing changes in equilibrium 1. Decide: the event shifts the supply curve, the demand curve, or both curves 2. Decide: curve shifts to right or to left 3. Use supply-and-demand diagram • Compare initial and new equilibrium • How the shift affects equilibrium price and quantity Terms for Shift vs. Movement Along Curve Change in supply: a shift in the S curve occurs when a non-price determinant of supply changes (like technology or costs) Shift of Supply Curve Determinants of supply 1. Technological change 2. Price of a relevant resource 3. Price of an alternative good 4. Producers expectations 5. Number of producers
ECONOMICS MBPM 1043 Page 61 Increase in Supply Rightward shift of S curve • Surplus; Downward pressure on P • QD increases; QS decreases • New equilibrium: P decreases; Q increases Decrease in supply • New equilibrium: • P increases; Q decreases Effects of an increase in supply S Change in the quantity supplied: a movement along a fixed S curve occurs when P changes Change in demand: a shift in the D curve occurs when a non-price determinant of demand changes (like income or number of buyers) Increase in supply: Rightward shift to S’ At P=RM9: QS>QD; surplus Downward pressure on P QD increases QS decreases New equilibrium at d Higher Q and Lower P
ECONOMICS MBPM 1043 Page 62 Shifts of the Demand Curve Determinants of demand 1. Money income of consumers 2. Price of a substitute or a complement 3. Consumer expectations 4. Number of consumers 5. Consumer tastes Increase in demand • Rightward shift of D curve • Shortage; Upward pressure on P • QD decreases; QS increases • New equilibrium: Increase in P and Q Decrease in demand • Surplus; Downward pressure on P • New equilibrium: Decrease in P and Q Effects of an increase in demand Increase in demand: Rightward shift to D’ At P=RM 9: QD>QS; shortage Upward pressure on P QD decreases, QS increases New equilibrium at g Higher P and Higher Q
ECONOMICS MBPM 1043 Page 63 Change in the quantity demanded: • a movement along a fixed D curve • occurs when P changes 3.5 PREDICTING CHANGES IN PRICE AND QUANTITY A shift in both supply and demand 1. Here we observe a simultaneous increase in demand and decrease in supply. Two outcomes are possible. In panel (a), the equilibrium price rises from P1 to P2, and the equilibrium quantity rises from Q1 to Q2. In panel (b), the equilibrium price again rises from P1 to P2, but the equilibrium quantity falls from Q1 to Q2.
ECONOMICS MBPM 1043 Page 64 What happens to price and quantity when supply or demand shifts? No change In Supply An increase In Supply A decrease In supply No change In demand P same Q same P down Q up P up Q down An increase In demand P up Q up P ambiguous Q up P up Q ambiguous A decrease In demand P down Q down P Down Q ambiguous P ambiguous Q down Size of Changes in Market Equilibrium What determines the size of changes in market equilibrium? 1. Size of change in demand (or supply) • The larger the shift in demand (or supply), the larger the effect on price) 2. Steepness of the curve that does not shift • If the supply curve shifts, the steeper demand curve the more the price changes the less the amount bought and sold changes • Steepness reflects responsiveness to prices Changes in Equilibrium for Two Extreme Demand Curves
ECONOMICS MBPM 1043 Page 65 Changes in Equilibrium for Two Extreme Supply Curves
ECONOMICS MBPM 1043 Page 66 TUTORIAL 3 QUESTION 1 a. What is a demand schedule? What is a demand curve? b. Why is there a negative relationship between quantity demanded and price? QUESTION 2 Price of Ice cream Nadia Haiza Market $0.00 30 15 45 $0.50 25 10 35 $1.00 20 9 29 $1.50 15 8 23 $2.00 10 5 15 $2.50 5 4 9 $3.00 0 1 1 Table show the demand for individual and demand for market. Based on the table, draw the graph for: a. Nadia b. Haiza c. Market QUESTION 3 Price of Ice cream Paa Maa Market $0.00 0 0 0 $0.50 0 0 0 $1.00 2 0 2 $1.50 4 2 6 $2.00 6 4 10 $2.50 8 6 14 $3.00 10 8 18 Table show the supply for individual and demand for market. Based on the table, draw the graph for: a. Paa
ECONOMICS MBPM 1043 Page 67 b. Maa c. Market QUESTION 4 The market for pizza has the following demand and supply schedules: Price Quantity Demanded Quantity supply $4 135 26 $5 104 53 $6 81 81 $7 68 98 $8 53 110 $9 39 121 Draw the graph of a. Demand curve and find the function of demand. b. Supply curve and find the function of supply. c. What is the equilibrium price and quantity in this market? QUESTION 5 The prices of basketball tickets at your college are determined by the market forces. The demand and the supply schedule are as follows: Price Quantity Demanded Quantity supply $4 10,000 8,000 $8 8,000 8,000 $12 6,000 8,000 $16 4,000 8,000 $20 2,000 8,000 Draw the graph of a. Demand curve and find the function of demand. b. Supply curve and find the function of supply. c. What is the equilibrium price and quantity in this market?
ECONOMICS MBPM 1043 Page 68 QUESTION 6 The demand and supply functions for golf lesson at KUIS Club are: Demand function: P=200 – 5Qd Supply function: P = 92 + 4Qd Calculate the equilibrium price and quantity, and draw the graph. QUESTION 7 The demand and supply functions for golf lesson at KUIS Club are: Demand function: P= -4Qd + 120 Supply function: P = 1/3 Qs + 29 Calculate the equilibrium price and quantity, and draw the graph. QUESTION 8 The table below shows the demand and supply schedule of sugar per week at Bandar Seri Putra, Kajang, Selangor. Price (RM per Kg) Quantity Supplied (Kg) Quantity Demanded (Kg) 1.35 20 100 1.40 45 80 1.45 75 70 1.50 90 65 1.55 110 60 1.60 125 55 1.65 140 50 1.70 150 45 a. Plot the demand and supply curve of sugar and determine the equilibrium market price and quantity at Bandar Seri Putra. b. Derive the demand function and supply function.
ECONOMICS MBPM 1043 Page 69 c. By using demand and supply function in (b), find the equilibrium of price and quantity. QUESTION 9 The following tables show the individual demand and supply schedules for mandarin oranges per week at Kampung Kota. Price (RM) per box Quantity Supplied (boxes) Alesya Neena Faris 11 10 20 30 12 15 25 40 13 20 30 50 14 25 35 60 15 30 40 70 Price (RM) per box Quantity Demanded (boxes) Nadia Haiza Amira 11 40 40 60 12 32 38 50 13 24 36 40 14 16 34 30 15 8 32 20 a. Draw the market demand and supply curve b. Determine the equilibrium price and quantity at Kampung Kota. c. Derive the demand function and supply function. d. By using demand and supply function in (c), find the equilibrium of price and quantity.
ECONOMICS MBPM 1043 Page 70 QUESTION 10 The demand and supply of pizza per month is as follow. Price (RM per pizza) Quantity Supplied (thousands) Quantity Demanded (thousands) 20 500 100 16 400 200 12 300 300 8 200 400 4 100 500 a. Draw the market demand and supply curve b. Determine the equilibrium price and quantity of pizza. c. Derive the demand function and supply function. d. By using demand and supply function in (c), find the equilibrium of price and quantity. QUESTION 11 The following are hypothetical demand and supply schedules for computer in Kangar. Price (RM) Quantity Demanded (unit) Quantity Supplied (unit) 3000 400 100 4000 350 200 5000 300 300 6000 250 400 7000 200 500 a. Draw the market demand and supply curve b. Determine the equilibrium price and quantity of pizza. c. Derive the demand function and supply function. d. By using demand and supply function in (c), find the equilibrium of price and quantity.
ECONOMICS MBPM 1043 Page 71 CHAPTER 4 ELASTICITY Elasticity measures how much one variable responds to changes in another variable. ▪ One type of elasticity measures how much demand for your websites will fall if you raise your price. Definition: Elasticity is a numerical measure of the responsiveness of Qd or Qs to one of its determinants. 4.1 Price Elasticity of Demand Price elasticity of demand measures how much Qd responds to a change in P. Measure of how much quantity demanded of a good responds • To a change in the price of that good Percentage change in quantity demanded • Divided by the percentage change in price Measures how willing consumers are to buy less of the good as its price rises. It measures the price-sensitivity of buyers’ demand. Price elasticity of demand = 𝑃𝑒𝑟𝑐𝑒𝑛𝑡𝑎𝑔𝑒 𝐶ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑄𝑑 𝑃𝑒𝑟𝑐𝑒𝑛𝑡𝑎𝑔𝑒 𝐶ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑃 Price elasticity of demand = (𝑄2− 𝑄1)/ [(𝑄2+𝑄1)/2 ] (𝑃2− 𝑃1)/ [(𝑃2+𝑃1)/2 ]
ECONOMICS MBPM 1043 Page 72 Example: Given the percentage change in quantity demand is 15% and percentage change in the price is 10%, so Price elasticity of demand equals 15% 10% = 1.5 Along a D curve, P and Q move in opposite directions, which would make price elasticity negative. We will drop the minus sign and report all price elasticities as positive numbers.
ECONOMICS MBPM 1043 Page 73 Calculating Percentage Changes A scenario You design websites for local businesses. You charge RM200 per website, and currently sell 12 websites per month. Your costs are rising (including the opportunity cost of your time), so you consider raising the price to RM250. Demand for your websites Standard method of computing the percentage (%) change: 𝐸𝑛𝑑 𝑣𝑎𝑙𝑢𝑒−𝑠𝑡𝑎𝑟𝑡 𝑣𝑎𝑙𝑢𝑒 𝑆𝑡𝑎𝑟𝑡 𝑣𝑎𝑙𝑢𝑒 x 100% Going from A to B, the % change in P equals (RM 250–RM200)/$200 = 25% Problem: The standard method gives different answers depending on where you start From A to B, P rises 25%, Q falls 33%, elasticity = 33/25 = 1.33 From B to A, P falls 20%, Q rises 50%, elasticity = 50/20 = 2.50
ECONOMICS MBPM 1043 Page 74 So, we instead use the midpoint method: 𝐸𝑛𝑑 𝑣𝑎𝑙𝑢𝑒−𝑠𝑡𝑎𝑟𝑡 𝑣𝑎𝑙𝑢𝑒 𝑚𝑖𝑑 𝑝𝑜𝑖𝑛𝑡 x 100% The midpoint is the number halfway between the start and end values, the average of those values. It doesn’t matter which value you use as the “start” and which as the “end” – you get the same answer either way! Calculating Percentage Changes Using the midpoint method, the % change in P equals 250−200 225 x 100% = 22.2% The % change in Q equals 12−8 10 x 100% = 40.0% The price elasticity of demand equals 40 / 22.2 = 1.8 4.2 The Variety of Demand Curves The price elasticity of demand is closely related to the slope of the demand curve. Rule of thumb: The flatter the curve the bigger the elasticity, the steeper the curve, the smaller the elasticity.
ECONOMICS MBPM 1043 Page 75 There are five different classifications of D curves. 1. “Perfectly inelastic demand” Price elasticity of demand = % ∆ 𝑄𝑑 % ∆ 𝑃 = 0 % 10 % = 0 2. “Inelastic demand” Price elasticity of demand = % ∆ 𝑄𝑑 % ∆ 𝑃 = <10 % 10 % = < 1 D curve: is vertical Consumers’ price sensitivity: None Elasticity: 0 D curve: is relatively steep Consumers’ price sensitivity: relatively low Elasticity: < 1
ECONOMICS MBPM 1043 Page 76 3. “Unit elastic demand” Price elasticity of demand = % ∆ 𝑄𝑑 % ∆ 𝑃 = 10 % 10 % = 1 This is the intermediate case: The demand curve is neither relatively steep nor relatively flat. Buyers are neither relatively price-sensitive nor relatively insensitive to price. 4. “Elastic demand” Price elasticity of demand = % ∆ 𝑄𝑑 % ∆ 𝑃 = >10% 10 % = > 1 D curve: is intermediate slope Consumers’ price sensitivity: Intermediate Elasticity: 1 D curve: is relatively flay Consumers’ price sensitivity: relatively high Elasticity: > 1
ECONOMICS MBPM 1043 Page 77 5. “Perfectly elastic demand” Price elasticity of demand = % ∆ 𝑄𝑑 % ∆ 𝑃 = 𝑎𝑛𝑦 % 0 % = infinity “Extreme price sensitivity” means the tiniest price increase causes demand to fall to zero. Elasticity of a Linear Demand Curve D curve: is horizontal Consumers’ price sensitivity: extreme Elasticity: infinity The slope of a linear demand curve is constant, but its elasticity is not.
ECONOMICS MBPM 1043 Page 78 4.3 DETERMINANTS OF PRICE ELASTICITY OF DEMAND ED (elasticity of demand) is greater: • The greater the availability of substitutes, and the more similar the substitutes • The more important the good as a share of the consumer’s budget • The longer the period of adjustment (time) • 4.4 PRICE ELASTICITY OF SUPPLY Price elasticity of supply measures how much Qs responds to a change in P. it measures sellers’ price-sensitivity. Again, use the midpoint method to compute the percentage changes. Price elasticity of supply = 𝑃𝑒𝑟𝑐𝑒𝑛𝑡𝑎𝑔𝑒 𝐶ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑄𝑠 𝑃𝑒𝑟𝑐𝑒𝑛𝑡𝑎𝑔𝑒 𝐶ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑃 Price elasticity of supply = 𝐸𝑛𝑑 𝑣𝑎𝑙𝑢𝑒−𝑠𝑡𝑎𝑟𝑡 𝑣𝑎𝑙𝑢𝑒 𝑚𝑖𝑑 𝑝𝑜𝑖𝑛𝑡 Example: Given the percentage change in quantity supply is 16% and percentage change in the price is 8%, so Price elasticity of supply equals 16% 8% = 2
ECONOMICS MBPM 1043 Page 79 The Variety of Supply Curves The slope of the supply curve is closely related to price elasticity of supply. Rule of thumb: • The flatter the curve, the bigger the elasticity. • The steeper the curve, the smaller the elasticity. There are five different classifications of supply curves. 1. “Perfectly inelastic” Price elasticity of supply = % ∆ 𝑄𝑠 % ∆ 𝑃 = 0 % 10 % = 0 S curve: vertical Sellers’ price sensitivity: None Elasticity: 0
ECONOMICS MBPM 1043 Page 80 2. “Inelastic” Price elasticity of supply = % ∆ 𝑄𝑠 % ∆ 𝑃 = <10 % 10 % = <1 3. “Unit elastic” Price elasticity of supply = % ∆ 𝑄𝑠 % ∆ 𝑃 = 10 % 10 % = 1 S curve: relatively steep Sellers’ price sensitivity: Relatively low Elasticity: < 1 S curve: intermediate slope Sellers’ price sensitivity: intermediate Elasticity: 1
ECONOMICS MBPM 1043 Page 81 4. “Elastic” Price elasticity of supply = % ∆ 𝑄𝑠 % ∆ 𝑃 = >10 % 10 % = >1 5. “Perfectly elastic” Price elasticity of supply = % ∆ 𝑄𝑠 % ∆ 𝑃 = 𝑎𝑛𝑦 % 0 % = infinity S curve: relatively flat Sellers’ price sensitivity: relatively high Elasticity: > 1 S curve: horizontal Sellers’ price sensitivity: extreme Elasticity: infinity
ECONOMICS MBPM 1043 Page 82 4.4 THE DETERMINANTS OF SUPPLY ELASTICITY Ability of sellers to change the amount of the good they produce. • The more easily sellers can change the quantity they produce, the greater the price elasticity of supply. • Example: Supply of beachfront property is harder to vary and thus less elastic than supply of new cars. • Time period • For many goods, price elasticity of supply is greater in the long run than in the short run, because firms can build new factories, or new firms may be able to enter the market. 4.5 OTHER ELASTICITY 1. Income elasticity of demand: measures the response of Qd to a change in consumer income Income elasticity of demand = % ∆ 𝑄𝑑 % ∆ 𝑖𝑛𝑐𝑜𝑚𝑒 An increase in income causes an increase in demand for a normal good. • but lowers the quantity demanded for inferior goods Hence, for normal goods, income elasticity > 0. For inferior goods, income elasticity < 0 Income Elasticity Goods consumers regard as necessities tend to be income inelastic • Examples include food, fuel, clothing, utilities, and medical services. • Goods consumers regard as luxuries tend to be income elastic. • Examples include sports cars, furs, and expensive foods.
ECONOMICS MBPM 1043 Page 83 2. Cross-price elasticity of demand: Measures the response of demand for one good to changes in the price of another good Cross price elasticity of demand = % 𝑐ℎ𝑎𝑛𝑔𝑒 𝑄𝑑𝑜𝑓 𝑔𝑜𝑜𝑑 1 % 𝑐ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑝𝑟𝑖𝑐𝑒 𝑜𝑓 𝑔𝑜𝑜𝑑 2 For substitutes, cross-price elasticity > 0 (e.g., an increase in price of beef causes an increase in demand for chicken) For complements, cross-price elasticity < 0 (e.g., an increase in price of computers causes decrease in demand for software)
ECONOMICS MBPM 1043 Page 84 TUTORIAL 4 1. What does the “price elasticity of demand” measure? What does a price elasticity of demand coefficient of 1.2 mean? Does the product have an elastic, unitary elastic or inelastic demand? 2. What happens to total revenue given a price increase and demand is inelastic? Why? 3. What are the characteristics of the product that has an inelastic demand? MULTIPLE CHOICE 1. Suppose the Pleasant Corporation cuts the price of its American Girl dolls by 10 percent, and as a result, the quantity of the dolls sold increases by 25 percent. This indicates that the price elasticity of demand for the dolls over this range is: A. 2.5. B. 0.4. C. 0.5. D. 5.0. 2. Suppose that Starbucks reduces the price of its premium coffee from $2.20 to $1.80 per cup, and as a result, the quantity sold per day increased from 350 to 450. Over this price range, the price elasticity of demand for Starbucks coffee is: A. 0.40. B. 0.80. C. 1.25. D. 2.50.
ECONOMICS MBPM 1043 Page 85 3. Suppose you are the manager of a local water company, and you are instructed to get consumers to reduce their water consumption by 10 percent. If the price elasticity of demand for water is 0.25, by how much would you have to raise the price of water? A. 10 percent B. 25 percent C. 40 percent D. 100 percent 4. If the quantity demanded increases by 20 percent in response to a 10 percent decrease in price, demand is classified as: A. unstable. B. relatively inelastic. C. relatively elastic. D. of unitary elasticity. 5. A local Krispy Kreme doughnut shop reduced the price of its doughnuts from $4 per dozen to $3.50 per dozen, and as a result, the daily sales increased from 300 to 400 dozen. This indicates that the price elasticity of demand for the doughnuts was: A. elastic. B inelastic. C. of unitary elasticity. D. indeterminate; more information is needed to determine the price elasticity of demand.
ECONOMICS MBPM 1043 Page 86 6. If a demand curve for a good were completely vertical, it would be considered: a. perfectly elastic. b. perfectly inelastic. c. of unitary elasticity. d. relatively inelastic. 7. If the demand for cigarettes is highly inelastic, this indicates that: a. higher cigarette prices will increase the demand for cigarettes. b. the price elasticity coefficient of cigarettes exceeds 1. c. the price elasticity coefficient of cigarettes equals 1. d. the quantity of cigarettes purchased by consumers is not very responsive to a change in the price of cigarettes. 8. The price elasticity of demand for gasoline measures the: a. responsiveness of gasoline producers to changes in the quality of gasoline. b. responsiveness of customers to changes in the price of gasoline. c. responsiveness of consumer preferences to changes in the quality of gasoline. d. both a and c above. 9. When demand is price inelastic: a. price and total revenue move in the same direction. b. price and total revenue move in the opposite direction. c. total revenue increases whether price goes up or down. d. total revenue decreases whether price goes up or down.
ECONOMICS MBPM 1043 Page 87 10. If demand is inelastic, an increase in the price of a good will cause total revenue to: a. fall. b. remain constant since the decrease in quantity sold is exactly offset by the price increase. c. rise. d. rise if it is a normal good and fall if it is an inferior good. 11. Price elasticity of demand refers to the ratio of the: a. percentage change in price of a good in response to a percentage change in quantity demanded. b. percentage change in price of a good to a percentage increase in income. c. percentage change in the quantity demanded of a good to a percentage change in its price. d. none of the above. 12. Price elasticity of demand is defined as the ratio of the: a. percentage increase in price to an increase in quantity demanded. b. unit change in quantity demanded to the dollar change in price. c. maximum amount that consumers will pay to increase quantity. d. percentage change in quantity demanded to the percentage change in price, other things being equal.
ECONOMICS MBPM 1043 Page 88 13. Price elasticity of demand refers to the: a. percentage increase in price in response to a percentage increase in quantity demanded. b. percentage decrease in price in response to a percentage increase in income. c. minimum amount that consumers will pay for a percentage change in quantity demanded or supplied. d. responsiveness of quantity demanded to a change in the price of a good. 14. If demand is price elastic, a decrease in price causes: a. an increase in total revenue. b. a decrease in total revenue. c. no change in total revenue. d. an increase in quantity, but anything can happen to revenue. 15. If a decrease in the price of movie tickets increases the total revenue of movie theaters, this is evidence that demand is: a. price elastic. b. price inelastic. c. unit elastic with respect to price. d. perfectly inelastic. 16. A perfectly elastic demand curve has an elasticity coefficient of: a. 0. b. 1. c. less than 1. d. infinity.
ECONOMICS MBPM 1043 Page 89 17. Over the elastic portion of a demand curve, a decrease in price causes: a. an increase in total revenue. b. a decrease in total revenue. c. no change in total revenue. d. an increase in quantity demanded, but anything can happen to revenue. 18. Using the midpoints formula, what would be price elasticity of demand for a gallbladder operation if the number of operations fell from 6,000 to 4,000 per week after its price increased from $6,000 to $10,000? a. 0.25. b. 0.50. c. 0.80. d. 1.25 19. If the percentage change in the quantity demanded of a good is less than the percentage change in price, price elasticity of demand is: a. elastic. b. inelastic. c. perfectly inelastic. d. unitary elastic. 20. If the percentage change in the quantity demanded of a good is greater than the percentage change in price, price elasticity of demand is: a. elastic. b. inelastic. c. perfectly inelastic. d. perfectly elastic.
ECONOMICS MBPM 1043 Page 90 STRUCTURE QUESTION Question 1 The table below shows the relationship between the price of a product A and the quantity demand for products A and B Price of A (RM) Quantity Demand for A (kg) Quantity Demand for B (kg) Consumer Income (RM) 6.00 100 20 2000 6.50 90 30 1800 7.00 70 50 1600 7.50 40 70 1400 8.00 10 85 1200 a. Calculate the price elasticity of demand for A if the price of A increase from RM7.00 to RM 8.00 per kg and indicate whether the demand is elastic or inelastic? b. Calculate the cross elasticity of demand for B when the price of A decrease from RM7.50 to RM6.50. Are A and B complements or substitutes goods? c. When the income of consumers increase from RM1400 to RM1800, calculate the income elasticity demand for A and B. What types of products are A and B? Question 2 The table below shows the relationship between the price of a A and the quantity demand for A and B Price of A(RM) Quantity demanded for A(kg) Quantity demanded for B(kg) 4.00 150 100 5.00 120 80 6.00 100 70 7.00 80 50 a. Calculate the price elasticity of demand if the price of A increases from RM5 to RM7. State whether the demand for A is elastic or inelastic.
ECONOMICS MBPM 1043 Page 91 b. Calculate the cross elasticity of demand for B when the price of A decrease from RM 6 to RM 4. What is the relationship between A and B. Question 3 Use the information given in the table below to calculate the cross elasticity and state is the relationship between X and Y Percentage change in price of X Percentage change in quantity demanded of Y Cross elasticity of demand Relationship 5% 10% 10% -7% 8% 0% -2% 5% 4% 4% 0% 5% Question 4 The table shows the relationship between the price of X and the quantity demand for A, B and C as consumed by a household. Price of X (RM) Quantity Demanded (unit) Product A Product B Product C 10 80 100 100 20 60 120 90 30 40 140 80 40 20 160 70 50 0 180 60 Based on the information in the above table, answer the following questions: a. Define: i. Cross elasticity of demand
ECONOMICS MBPM 1043 Page 92 ii. Income elasticity of demand b. If the price of X decrease from RM40 to RM20, calculate the cross elasticity of demand for i. X and A ii. X and B c. Determine how A and B are related to X. d. Given that when the income of household increase from RM1000 to RM1400, the demand for C decrease from 80 to 60 units. Calculate the income elasticity of demand for C and explain what type of product C is. Question 5 The following table shows demand schedule for compact disc. Price Quantity demanded (Income = RM10,000) Quantity demanded (Income = RM12,000) 8 40 50 10 32 45 12 24 30 14 16 20 16 8 12 a. Use the midpoint formula method to calculate your price elasticity of demand as the price of compact disc increase from RM8 to RM12 if: i. Your income is RM10,000 ii. Your income is RM12,000 b. Calculate your income elasticity of demand as your income increase from RM10,000 to RM 12,000 if; i. The price is RM8 ii. The price RM16
ECONOMICS MBPM 1043 Page 93 Question 6 Define: a. The price elasticity of demand. b. The price elasticity of supply. c. The income elasticity of demand. d. The cross price elasticity of demand. Question 7 The following table shows the amount of good A and B demanded by the citizens of a particular country at different prices and consumer income levels. Price of Good A (RM per unit) Quantity demanded for good A (unit) Quantity demanded for good B (unit) Income of consumers (RM) 60,000 100,000 20,000 4,500 65,000 90,000 30,000 3,500 70,000 70,000 50,000 2,500 75,000 40,000 70,000 1,500 80,000 10,000 85,000 500 a. Calculate the price elasticity of demand for good A if the price of good A increases from RM 70,000 to RM 75,000. Is the demand elastic or inelastic? b. Calculate the cross elasticity of demand for good B when the price of good A decrease from RM80,000 to RM 70,000. What is the relationship between the two goods? c. If the consumers income level increase from RM 500 to RM 4,500, determine the income elasticity demand for: i. Good A ii. Good B d. State two factor that influence the price elasticity of demand.
ECONOMICS MBPM 1043 Page 94 Question 8 Based on table below, answer the following questions. Income (RM) Price of Good A (RM) Quantity demanded for good A (unit) Quantity demanded for good B (unit) 1000 8.5 450 300 1100 7.0 475 370 1200 6.5 502 480 1300 6.0 548 620 a. Calculate the income elasticity of demand for good B if the consumer income increase from RM 1100 to RM 1300. b. What type of good B. Why? c. If income is constant, calculate price elasticity of demand for good A if it’s price falls from RM 8.50 to RM 6.5. Explain your answer. d. Is the demand for good A elastic or inelastic? e. List two factors that influence elasticity of demand for good A. Question 9 Calculate the cross elasticity of demand for good X and Y. Determine their relationship. Increase in Price of Good X Quantity of Good Y Cross elasticity coefficient Relationship 6% Decrease by 12% 6% Increase by 6% 6% Does not change
ECONOMICS MBPM 1043 Page 95 Question 10 The schedule shows the relationship between price and quantity supplied of good Y. Point A B C D E Price 12 10 8 6 4 Quantity supplied 700 650 550 400 100 a. Calculate the elasticity of supply when: i. Point D move to point B ii. Point A moves to point C iii. Point A moves to point E iv. Point B moves to point E v. Point C moves to point A b. State the type of elasticity.
ECONOMICS MBPM 1043 Page 96 CHAPTER 5 ORGANIZING PRODUCTION 5.1 PRODUCTION Production means the process of using the factors of production to produce goods and services. Productions can be meaning as transformation of inputs and outputs. The term inputs refers to those things that a firm buys for use in production such as land, labor, capital and entrepreneur. Output refers to what we get at the end of the production or refers to finished products. 5.2 CLASSIFICATION OF FACTORS OF PRODUCTION Inputs for the production of a given product have been classified into the four factors of production, namely, land, labor, capital and entrepreneur. Land Land refers to all those natural resources or gifts of nature which are available for free such as land surface, air, lakes, water, minerals, forests, seas, mountain, etc. Land is the means of supporting human beings, plants and animals. Therefore, land is the source of all matter and the starting point of all production. Labor Labor refers to all activities, physical or mental, which are undertaken by man in exchange for monetary reward. Labor consists of all human efforts of body or of mind which are undertaken in the expectation of a reward. Labor plays a very important roe in production. The natural resources of a country cannot be utilized in the absence of labor. The works of lecturers, doctors, contractors, farmers, lawyers, prime minister are all examples of labors.
ECONOMICS MBPM 1043 Page 97 Capital Capital refers to that part of man-made wealth, which is used in further producing wealth. A country capital is producing its stocks of produced or man-made means of production, consisting of such items as buildings, factories, machinery, tools, equipment and inventories of goods in stock. Factories, machinery, tools, building, trucks and railroads are example of capitals. Money that is employed in business and production is considered to be capital. Therefore all money is not capital. Capital is basically all wealth other than land, which is used to produce more wealth. For example, a sewing machine does not give the profit if we use for our own, but if we used this machine to make a business(production of shirts) this machine known as capital goods. Entrepreneurship Entrepreneurship refers to the combining of the three factors of production; land, labor and capital together, organizing and bearing the risk and uncertainties in production and coordinating work. An entrepreneur is a persons who combines the different factors of productions and initiates the process of production and also and bear the risk. 5.3 COST Costs as opportunity costs: The cost of something is what you give up to get it Firm’s cost of production includes all the opportunity costs to making its output of goods and services • Explicit costs Input costs that require an outlay of money by the firm • Implicit costs Input costs that do not require an outlay of money by the firm Interest income not earned • On financial capital
ECONOMICS MBPM 1043 Page 98 • Owned as saving • Invested in business • Not shown as cost by an accountant Explicit costs • Input costs that require an outlay of money by the firm Implicit costs • Input costs that do not require an outlay of money by the firm Example You need RM100,000 to start your business. The interest rate is 5%. Case 1: borrow RM 100,000 ▪ explicit cost = RM 5000 interest on loan Case 2: use RM 40,000 of your savings, borrow the other RM 60,000 ▪ explicit cost = RM 3000 (5%) interest on the loan ▪ implicit cost = RM 2000 (5%) foregone interest you could have earned on your $40,000. In both cases, total (exp + imp) costs are $5000
ECONOMICS MBPM 1043 Page 99 5.4 TOTAL REVENUE, TOTAL COST, PROFIT Total revenue • Amount a firm receives for the sale of its output Total cost • Market value of the inputs a firm uses in production Profit • Total revenue minus total cost We assume that the firm’s goal is to maximize profit, so profit can be calculated Profit = Total revenue – Total cost 5.5 ECONOMIC PROFIT VS. ACCOUNTING PROFIT • Economic profit :Total revenue minus total cost Including both explicit and implicit costs • Accounting profit : Total revenue minus total explicit cost Economists include all opportunity costs when analyzing a firm, whereas accountants measure only explicit costs. Therefore, economic profit is smaller than accounting profit
ECONOMICS MBPM 1043 Page 100 Example: The equilibrium rent on office space has just increased by RM500/month. Compare the effects on accounting profit and economic profit if a. you rent your office space b. you own your office space Solution: a. You rent your office space. Explicit costs increase RM500/month. Accounting profit & economic profit each fall RM500/month. b. You own your office space. Explicit costs do not change, so accounting profit does not change. Implicit costs increase RM500/month (opportunity Cost of using your space instead of renting it), so economic profit falls by RM500/month
ECONOMICS MBPM 1043 Page 101 5.6 PRODUCTION FUNCTION Production function refers to the relationship between inputs (factors of production) and outputs (goods and services). It can be represented by a table, equation, or graph. Production function can be represented in the form of mathematical equations such as 𝑸 = 𝒇 ( 𝑲, 𝑳 , 𝑴 , 𝒆𝒕𝒄) where Q is the amount of output per unit time that depends on the quantity inputs, where K is capital, L is labor, M is the raw materials and so on. Example 1: Farmer Jamil grows paddy. He has 5 acres of land. He can hire as many workers as he wants. Farmer Jamil Production Function L (no. of workers) Q (bushels of paddy) 0 0 1 1000 2 1800 3 2400 4 2800 5 3000
ECONOMICS MBPM 1043 Page 102 5.7 MARGINAL PRODUCT If Jamil hires one more worker, his output rises by the marginal product of labor. The marginal product of any input is the increase in output arising from an additional unit of that input, holding all other inputs constant. Notation: ∆ (delta) = “change in…” Examples: ∆Q = change in output, ∆L = change in labor Marginal product of labor (MPL) = ∆𝑄 ∆𝐿
ECONOMICS MBPM 1043 Page 103 EXAMPLE: Total & Marginal Product L (no. of workers) Q (bushels of paddy) MPL 0 0 1 1000 1000 2 1800 800 3 2400 600 4 2800 400 5 3000 200 MPL = Slope of Prod Function ∆L= 1 ∆L= 1 ∆L= 1 ∆L= 1 ∆L= 1 ∆Q = 1000 ∆Q = 800 ∆Q = 600 ∆Q = 400 ∆Q = 200
ECONOMICS MBPM 1043 Page 104 Why MPL Is Important Recall one of the Ten Principles: Rational people think at the margin. When Farmer Jamil hires an extra worker, his costs rise by the wage he pays the worker, his output rises by MPL. Comparing those helps Jamil decide whether he would benefit from hiring the worker Why MPL Diminishes Farmer Jamil output rises by a smaller and smaller amount for each additional worker. Why?. As Jamil adds workers, the average worker has less land to work with and will be less productive. In general, MPL diminishes as L rises whether the fixed input is land or capital (equipment, machines, etc.). Diminishing marginal product: the marginal product of an input declines as the quantity of the input increases (other things equal) Law of Diminishing Marginal Returns Production function is the relationship between amount of resources employed and total product. Marginal product is a change in total product from an additional unit of resource Increasing marginal returns is marginal product increases. Diminishing marginal returns is when marginal product decreases.
ECONOMICS MBPM 1043 Page 105 Example: The short-run relationship between units of labor and tons of furniture moved Units of the variable resource (worker days) Total Product (tons moved per day) Marginal Product (tons moved per day) 0 0 - 1 2 2 2 5 3 3 9 4 4 12 3 5 14 2 6 15 1 7 15 0 8 14 -1 Marginal product increases as the firm hires each of the first three workers, reflecting increasing marginal returns. Then marginal product declines, reflecting diminishing marginal returns. Adding more workers may, at some point, actually reduce total product (as occurs here with an eighth worker) because workers start getting in each other’s way.
ECONOMICS MBPM 1043 Page 106 EXAMPLE : Farmer Jamil Costs Farmer Jack must pay RM1000 per month for the land, regardless of how much paddy he grows. The market wage for a farm worker is RM 2000 per month. So Farmer Jamil costs are related to how much paddy he produces. Farmer Jamil Costs L (no. of workers) Q (bushels of paddy) Cost of land Cost of labor Total Cost 0 0 RM 1000 RM 0 RM 1000 1 1000 RM 1000 RM 2000 RM 3000 2 1800 RM 1000 RM 4000 RM 5000 3 2400 RM 1000 RM 6000 RM 7000 4 2800 RM 1000 RM 8000 RM 9000 5 3000 RM 1000 RM 10000 RM 11000
ECONOMICS MBPM 1043 Page 107 So, the total cost curve as drawn below 6.8 MARGINAL COST Marginal Cost (MC) is the increase in Total Cost from producing one more unit: MC = ∆𝑇𝐶 ∆𝑄 Q (bushel of paddy) Total cost (TC) Marginal cost (MC) 0 1000 1000 3000 RM 2 1800 5000 RM 2.50 2400 7000 RM 3.30 2800 9000 RM 5.00 3000 11000 RM 10.00 Q (bushels of paddy) Total Cost 0 RM 1000 1000 RM 3000 1800 RM 5000 2400 RM 7000 2800 RM 9000 3000 RM 11,000 ∆Q = 1000 ∆Q = 800 ∆Q = 600 ∆Q = 400 ∆Q = 200 ∆TC = RM2000 ∆TC = RM2000 ∆TC = RM2000 ∆TC = RM2000 ∆TC = RM2000
ECONOMICS MBPM 1043 Page 108 The Marginal Cost Curve Why MC Is Important Farmer Jamil is rational and wants to maximize his profit. To increase profit, should he produce more or less wheat? To find the answer, Farmer Jamil needs to “think at the margin.” If the cost of additional wheat (MC) is less than the revenue he would get from selling it, then Jamil profits rise if he produces more. 5.9 FIXED AND VARIABLE COSTS Fixed costs (FC) do not vary with the quantity of output produced. ▪ For Farmer Jamil, FC = RM 1000 for his land ▪ Other examples: cost of equipment, loan payments, rent Variable costs (VC) vary with the quantity produced. ▪ For Farmer Jamil, VC = wages he pays workers ▪ Other example: cost of materials Total cost (TC) = FC + VC
ECONOMICS MBPM 1043 Page 109 EXAMPLE 2 Our second example is more general, applies to any type of firm producing any good with any types of inputs. Q FC VC TC 0 RM 100 RM 0 RM 100 1 RM 100 RM 70 RM 120 2 RM 100 RM 120 RM 220 3 RM 100 RM 160 RM 260 4 RM 100 RM 210 RM 310 5 RM 100 RM 280 RM 380 6 RM 100 RM 380 RM 480 7 RM 100 RM 520 RM 520 TC VC FC
ECONOMICS MBPM 1043 Page 110 5.10 SHORT RUN VERSUS LONG RUN It takes time for a firm to adjust production from one set of inputs to another. Firms must consider not only what inputs can be varied but over what period of time that can occur. We must distinguish between long run and short run. Short Run where the period of time in which quantities of one or more production factors cannot be changed, these inputs are called fixed inputs. Long-run is an amount of time needed to make all production inputs variable. Production in the Short Run In the short run the variable resources can be varied quickly and the fixed resources cannot be altered easily. In the short run at least one resource is fixed Costs in the Short Run Fixed cost (FC) noted for fixed resources. Variable cost (VC) noted for variable resources. The total cost TC = FC + VC. The Marginal cost MC = ∆TC/∆q which is the change in TC to produce one more unit of output Changes in MC reflect the changes in marginal productivity Increasing marginal returns happen when the MC falls and diminishing marginal returns happen when MC increases.
ECONOMICS MBPM 1043 Page 111 Short-run TC and MC data First 3 workers: increasing marginal returns: MC declines. With the 4th worker: diminishing marginal returns: MC increases. TC and MC curves (1) Tons moved per day (q) (2) Fixed cost (FC) (3) Workers per day (4) Variable cost (VC) (5) Total cost (TC=FC+VC) (6) Marginal cost MC=∆TC/∆q 0 RM 200 0 RM 0 RM 200 RM - 2 RM 200 1 RM 100 RM 300 RM 50.00 5 RM 200 2 RM 200 RM 400 RM 33.33 9 RM 200 3 RM 300 RM 500 RM 25.00 12 RM 200 4 RM 400 RM 600 RM 33.33 14 RM 200 5 RM 500 RM 700 RM 50.55 15 RM 200 6 RM 600 RM 800 RM 100.00
ECONOMICS MBPM 1043 Page 112 Average Cost in the Short Run Average variable cost (AVC) can be calculated by variable cost divided by quantity. AVC = VC / q Average total cost (ATC) can be calculated by total cost divided by the quantity. ATC = TC / q When marginal cost (MC) is less than average cost (AC), the marginal cost will pulls down the average cost. When marginal cost (MC) is greater than average cost (AC), the marginal cost will pulls up the average cost. U-shape of average cost curves exist because of the law of diminishing marginal returns. (1) Tons moved per day (q) (2) Variable cost (VC) (3) Total cost (TC=FC+VC) (4) Marginal cost MC=∆TC/∆q (5) Average variable cost (AVC=VC/q) (6) Average total cost (ATC=TC/q) 0 RM 0 RM 200 - - ∞ 2 RM 100 RM 300 RM 50.00 RM 50.00 RM 150.00 5 RM 200 RM 400 RM 33.33 RM 40.00 RM 80.00 9 RM 300 RM 500 RM 25.00 RM 33.33 RM 55.55 12 RM 400 RM 600 RM 33.33 RM 33.33 RM 50.00 14 RM 500 RM 700 RM 50.55 RM 35.71 RM 50.00 15 RM 600 RM 800 RM 100.00 RM 40.00 RM 53.33
ECONOMICS MBPM 1043 Page 113 From the table we can see that marginal cost (MC) first falls then increases (increasing then diminishing marginal returns). As long as marginal cost (MC) is less than average cost (AC), average cost declines. Once marginal cost (MC) is greater that average cost (AC), average cost increases. Average and marginal cost curves Costs in the Long Run In the long run a firm can change all of its inputs. In making cost minimizing choices, must look at the cost of using capital and labor in production decisions. In the long run the curve will be U-shaped long-run average cost curve because of the economies of scale, which show that the long run average cost (LRAC) falls as output expands. Diseconomies of scale happen when the long run average cost (LRAC) will increases as output expands.
ECONOMICS MBPM 1043 Page 114 Short-run ATC curves form the LRAC curve Many short-run ATC curves form firm’s LRAC curve Each point of tangency represents the least cost way of producing that level of output
ECONOMICS MBPM 1043 Page 115 A firm’s long-run average cost curve Costs in Short Run and in Long Run Economies of scale • Long-run average total cost falls as the quantity of output increases • Increasing specialization Constant returns to scale • Long-run average total cost stays the same as the quantity of output changes Diseconomies of scale • Long-run average total cost rises as the quantity of output increases • Increasing coordination problems
ECONOMICS MBPM 1043 Page 116
ECONOMICS MBPM 1043 Page 117 TUTORIAL 5 QUESTION 1 Based on the table below, answer the following questions Quantity TVC TFC TC MC AC AVC AFC 0 360 1 540 2 600 3 630 4 675 5 780 6 990 a. Complete the table above b. What is the fixed cost incurred by the firm? QUESTION 2 Based on the table below, answer the following questions Output (Unit) TC (RM) AC (RM) TVC (RM) MC (RM) AFC (RM) AVC (RM) 1 33 24 2 8 3 16 4 30 5 7 6 69 4 a. Complete the above table. b. Calculate the fixed cost for the firm.
ECONOMICS MBPM 1043 Page 118 QUESTION 3 Table below shows the production cost of an electric company in Puchong TP AVC AC TC AFC MC 0 500 - 1 700 200 2 100 3 250 4 400 6 510 a. Complete the above table. b. Draw the AFC, AVC, and AC in one diagram. QUESTION 4 The following table shows the production costs of the firm in RM Output TC TVC TFC AVC ATC AFC MC 0 1000 1 1100 2 1180 3 1240 4 1320 5 1420 6 1550 Complete the above table.
ECONOMICS MBPM 1043 Page 119 QUESTION 5 The table below shows the production cost of company BATA. Output TFC TVC TC MC AFC AVC ATC 0 60 1 100 2 120 3 80 4 400 5 500 a. Complete the following table. b. sketch the following curves in a diagram: i. AFC ii. AVC iii. AC iv. MC QUESTION 6 The table below shows the cost of production for a firm that sells its product at RM10 each. Output Fixed Cost (RM) Variable Cost (RM) Total Cost (RM) Marginal Cost (RM) 0 - 1 23 2 8 3 6 4 5 5 7 6 10 7 14 Based on the data given, complete the table.
ECONOMICS MBPM 1043 Page 120 QUESTION 7 Based on the table answer the following questions. Price (RM) Quantity Demanded (kg/day) Total Revenue Marginal Revenue Quantity produced (kg/day) Total Cost (RM) Marginal Cost 2200 5 5 8000 2000 6 6 9000 1800 7 7 10200 1600 8 8 11600 1400 9 9 13200 1200 10 10 15000 Based on the data given, complete the table. QUESTION 8 Output Total variable Cost Average Fixed Cost Average Variable Cost Total Cost Average Cost Marginal Cost 0 0 100 1 50 2 42 3 36 4 32 5 30 6 30 7 31 8 33 Based on the data given, complete the table.
ECONOMICS MBPM 1043 Page 121 QUESTION 9 From the data given, answer the following questions. Output Price (RM) Total Cost (RM) Average Cost (AC) AVC AFC MC Total Revenue Marginal Revenue Profit/Loss Complete the table above. Question 10 From the data given, answer the following questions. Output TFC TVC AFC AVC TC MC 0 - 1 12 2 12 10 3 12 4 14 Complete the table.
ECONOMICS MBPM 1043 Page 122 Question 11 The table below shows the Average Fixed Cost (AFC) and Average Cost (AC) for a company XYZ. Output (unit) Average Fixed Cost Average Cost 7 8.57 49.00 8 7.5 48.13 9 6.67 50.00 10 6.0 52.50 a. From the table above, calculate i. The average variable cost for the 7th unit of output. ii. The marginal cost when output increase from 9 units to 10 units. iii. The total cost for the 8th unit of output. b. If the output sells for RM50.00 per unit, calculate the profit earned by this firm if it sells 9 units of output.
ECONOMICS MBPM 1043 Page 123 CHAPTER 6 PERFECT COMPETITION 6.1 MARKET STRUCTURE Many of firm’s decisions depend on the structure of the market in which it operates. Market structure describes the important features of a market such as: • number of suppliers/producers • product degree of uniformity • do firms in the market produce identical products or differentiated products? • Ease of entry into market • can new firms enter easily or are they blocked by barriers? • forms of competition among firms • do firms compete only through prices or use advertising & product differences? 6.2 CHARACTERISTICS OF PERFECT COMPETITION 1. Many buyers & sellers Each buys & sells only a small fraction of the total amount exchanged in the market. Individual firm of producers do not have influence on price. Price is determined by market demand (DD) and supply (SS). The perfectly competitive firm is a price taker. Price taker means that must accept the market price but free to produce whatever quantity 2. Homogenous product (close substitute) 3. Buyers & sellers are fully informed about the price & availability of products 4. Firms can freely enter or exit the industry
ECONOMICS MBPM 1043 Page 124 6.3 MARKET EQUILIBRIUM & FIRM’S DEMAND CURVE IN PERFECT COMPETITION For example market price of paddy =$5 is determined by intersection of the market demand (DD) and supply (SS) curve. Once market price (P) is established, producers can sell all they want at the market price (P). Perfectly competitive firm so small and how much the firm produce has no effect on the market price 6.4: THE REVENUE OF A COMPETITIVE FIRM The profit for the firm can be calculated by total revenue minus total cost. Profit = Total revenue (TR) – Total cost (TC) Total revenue for a firm is the selling price times the quantity sold. TR = (P Q) TR is proportional to the amount of output. Average revenue (AR) tells how much revenue a firm receives for the typical unit sold. AR = TR / Q AR = P × Q / Q AR = P Marginal revenue is the change in total revenue from an additional unit sold.
ECONOMICS MBPM 1043 Page 125 MR =TR/Q For competitive firms, MR=Price Thus in perfect competition, P =AR = MR Example: Given the table below, fill the table. Q P TR AR MR 0 RM 10 n.a 1 RM 10 2 RM 10 3 RM 10 4 RM 10 5 RM 10 Answers Q P TR (P x Q) AR(TR / Q) MR (∆𝑇𝑅/∆𝑄) 0 RM 10 RM 0 n.a 1 RM 10 RM 10 RM10 2 RM 10 RM 20 RM10 3 RM 10 RM 30 RM10 4 RM 10 RM 40 RM10 5 RM 10 RM 50 RM10 For A Competitive Firm marginal revenue (MR) is equal to price (P). RM10 RM10 RM10 RM10 RM10
ECONOMICS MBPM 1043 Page 126 A competitive firm can keep increasing its output without affecting the market price. So, each one-unit increase in Q causes revenue to rise by P, i.e.,MR = P. MR = P is only true for firms in competitive markets 6.5 PROFIT MAXIMIZATION What Q maximizes the firm’s profit?.To finds the answer, “think at the margin.” If increase quantity (Q) by one unit, revenue rises by marginal revenue (MR), cost rises by MC. If marginal revenue (MR) is greater than MC, then increase in quantity (Q) to raise profit. If marginal revenue (MR) is less than marginal cost (MC), then reduce quantity (Q) to raise profit. At any quantity (Q) with marginal revenue (MR) is greater than marginal cost (MC) this will show that increasing quantity (Q) will raises profit. At any quantity (Q) with marginal revenue (MR) is less than marginal cost (MC), this will show that reducing quantity (Q) will raises profit. Marginal cost (MC) and the Firm’s Supply Decision MC and the Firm’s Supply Decision Rule: MR = MC at the profit-maximizing Q At Q a, MC < MR. So, increase Q to raise profit. At Q b, MC > MR. So, reduce Q to raise profit. At Q1, MC = MR. Changing Q would lower profit.
ECONOMICS MBPM 1043 Page 127 6.6 SHUTDOWN AND EXIT THE MARKET Shutdown: Firm will shut down the market at the short-run when the firm does not produce anything because of market conditions. Exit: Firm will exit the market at long run that is leaving the market. A key difference: • If firm shut down in short run (SR), the firm must still pay fixed cost (FC). • If exit in LR, zero costs. A Firm’s Short-run Decision to Shut Down When the firm makes the decision to shutting down, firm will face the cost of shutting down, that is revenue loss (TR). But firm will get the benefit of shutting down that is cost savings. The cost saving in terms of variable cost (VC) but firm must still pay fixed cost (FC). If price rises to P2, then the profit maximizing quantity rises to Q2. The MC curve determines the firm’s Q at any price. Hence, the MC curve is the firm’s supply curve
ECONOMICS MBPM 1043 Page 128 So, shut down if total revenue (TR) is less than variable cost (VC) If divide both sides by Q: TR Q < VC Q = P < AVC So, firm’s decision rule is: Shut down if P < AVC A Competitive Firm’s SR Supply Curve 6.7 THE IRRELEVANCE OF SUNK COSTS Sunk cost is a cost that has already been committed and cannot be recovered Sunk costs should be irrelevant to decision; you must pay them regardless of your choice. Fixed cost FC is a sunk cost: The firm must pay its fixed costs whether it produces or shuts down. So, FC should not matter in the decision to shut down. The firm’s SR supply curve is the portion of its MC curve above AVC. If P > AVC , then firms produces Q where P = MC If P < AVC , then firm shut down (produce Q = 0)
ECONOMICS MBPM 1043 Page 129 6.8 A Firm’s Long-Run Decision to Exit Cost of exiting the market refer to the revenue loss will equal to TR. Benefit of exiting the market is cost savings will equal TC (zero FC in the long run). So, firm exits if total revenue (TR) is less than total cost (TC). Divide both sides by Q to write the firm’s decision rule as: Exit if P is less than average total cost (ATC). 6.9 A NEW FIRM’S DECISION TO ENTER MARKET In the long run, a new firm will enter the market if it is profitable to do so: if total revenue (TR) is grater than total cost (TC). Divide both sides by Q to express the firm’s entry decision as: Enter the market if P > ATC 6.10 THE COMPETITIVE FIRM’S SUPPLY CURVE The long run supply curve is the portion of its MC above LRATC
ECONOMICS MBPM 1043 Page 130 Example : Identifying a firm’s profit Determine this firm’s total profit. Identify the area on the graph that represents the firm’s profit. Answers Profit per unit = P – ATC = 10 – 6 = 4 Total profit = (P – ATC) x Q = 4 x 50 = 200
ECONOMICS MBPM 1043 Page 131 Example: Identifying a firm’s loss Determine this firm’s total loss, assuming AVC < 3. Identify the area on the graph that represents the firm’s loss. Determine this firm’s total loss, assuming AVC < 3. Identify the area on the graph that represents the firm’s loss. Total loss = (ATC – P) x Q = 2 x 30 = 60
ECONOMICS MBPM 1043 Page 132 CHAPTER 7 MONOPOLY A monopoly firm has market power, the ability to influence the market price of the product it sells. A competitive firm has no market power. Monopoly is a sole supplier of a product with no close substitutes. 7.1 WHY MONOPOLIES ARISE The main cause of monopolies is barriers to entry that is other firms cannot enter the market. Three sources of barriers to entry: 1. Legal restrictions 2. Control of essential resources 3. Natural monopoly Legal restrictions The government gives a single firm the exclusive right to produce the good. For example, patents and invention incentives, patent is an exclusive rights for 20 years. Licenses and other entry restrictions like Federal license and State license. Control of essential resources A single firm owns a key resource. For example DeBeers owns most of the world’s diamond mines Natural Monopoly
ECONOMICS MBPM 1043 Page 133 A single firm can produce the entire market Q at lower cost than could several firms. Example: 1000 homes need electricity ATC is lower if one firm services all 1000 homes than if two firms each service 500 homes. This can be seeing in the curve. The horizontal axis of the graph measures number of homes provided electricity. The vertical axis measures the average total cost of providing electricity per home. 7.2 THE DEMAND CURVE FOR MONOPOLY AND PERFECT COMPETITION. In a competitive market, the market demand curve slopes downward. But the demand curve for any individual firm’s product is horizontal at the market price. The firm can increase quantity (Q) without lowering price (P), so MR = P for the competitive firm. ATC slopes downward due to huge FC and small MC
ECONOMICS MBPM 1043 Page 134 A competitive firm is a price-taker, means that the firm can sell as much as it wants at the market price. In effect, the competitive firm sells a product for which there are many perfect substitutes, so demand for its product is perfectly elastic; if it raises its price above the market price, demand for its product falls to zero. The relationship between P and MR is what distinguishes a competitive firm from a monopoly firm, in terms of both firm behavior and welfare implications. A monopolist is the only seller, so it faces the market demand curve that downward sloping. To sell a larger quantity (Q), the firm must reduce price (P). Thus, marginal revenue is not equal to price (MR ≠ P). A competitive firm demand curve A monopolist demand curve
ECONOMICS MBPM 1043 Page 135 Example: Tenaga National Berhad (TNB) is the only supplier of electricity in town. The table shows the market demand for cappuccinos. Fill in the missing spaces of the table. What is the relation between P and AR? Between P and MR? Q P TR AR MR 0 RM 4.50 RM 0 n.a 1 RM 4.00 RM 4.00 RM 4.00 2 RM 3.50 RM 7.00 RM 3.50 3 RM 3.00 RM 9.00 RM 3.00 4 RM 2.50 RM 10.00 RM 2.50 5 RM 2.00 RM 10.00 RM 2.00 6 RM 1.50 RM 9.00 RM 1.50 From the table we can see that, P is equal to AR, same as for a competitive firm and but for marginal revenue in monopoly market the MR is less than P, whereas MR is equal to P for a competitive firm. RM 4.00 RM 3.00 RM 2.00 RM 1.00 RM 0.00 RM -1.00
ECONOMICS MBPM 1043 Page 136 7.3 DEMAND, MARGINAL REVENUE AND MARGINAL COST FOR MONOPOLY From the above curve we can see that the curve for the price (P) is always above the marginal revenue curve (MR).
ECONOMICS MBPM 1043 Page 137 Understanding the Monopolist’s MR Increasing in quantity (Q) has two effects on revenue: • Output effect: higher output raises revenue • Price effect: lower price reduces revenue To sell a larger quantity (Q), the monopolist must reduce the price on all the units it sells. Hence, marginal revenue (MR) will be less than price (P). MR could even be negative if the price effect exceeds the output effect. Profit-Maximization Like a competitive firm, a monopolist maximizes profit by producing the quantity where MR = MC.Once the monopolist identifies this quantity, it sets the highest price consumers are willing to pay for that quantity. It finds this price from the D curve. The profit-maximizing Q is where MR = MC. Find P from the demand curve at this Q.
ECONOMICS MBPM 1043 Page 138 7.4 THE MONOPOLIST’S PROFIT 7.5 A MONOPOLY DOES NOT HAVE AN S CURVE A competitive firm takes price (P) as given, therefore in competitive firm has a supply curve that shows how its quantity (Q) depends on price (P). A monopoly firm is a “price-maker,” not a “price-taker”, therefore quantity (Q) does not depend on price (P); rather, quantity (Q) and price (P) are jointly determined by marginal cost (MC), marginal revenue (MR), and the demand curve. So there is no supply curve for monopoly. 7.6 THE WELFARE COST OF MONOPOLY In competitive market equilibrium, price (P) is equal marginal cost (MC) and total surplus is maximized. In the monopoly equilibrium, price (P) is greater than marginal revenue (MR) when marginal revenue (MR) equal to marginal cost (MC). The value to buyers of an additional unit (P) exceeds the cost of the resources needed to produce that unit (MC). At this point, the monopoly quantity (Q) is too low .Thus, monopoly results in a deadweight loss. As with a competitive firm, the monopolist’s profit equals (P – ATC) x Q
ECONOMICS MBPM 1043 Page 139 From the above figure, in the perfect competition, the output is equilibrium at Qc and the price is P = MC. As the monopoly, the equilibrium is when MR = MC, and the quantity equilibrium is at QM and price at P. The black area is the dead weight loss. As we know that monopoly will charge higher prices, than a perfect competition the monopoly gets more surplus and consumers get fewer surpluses. The figure shows that the monopoly by producing less than the socially efficient quantity and causing a deadweight loss. Competitive equilibrium: Quantity = QC at P = MC Total surplus is maximized Monopoly equilibrium: Quantity = QM at P > MC, Exist deadweight loss
ECONOMICS MBPM 1043 Page 140 7.7 DEMAND CURVE AND ELASTICITY OF DEMAND. As shown in figure, the total revenue for a monopolist is related to the marginal revenue. When the marginal revenue is positive (MR > 0), the demand is elastic where the price decrease and the total revenue will increase. If the marginal revenue is negative (MR < 0), demand is inelastic because the decline in price will cause the total revenue fall. When the marginal revenue is zero (MR=0), the demand is unit elastic. The change in price does not change the total revenue and the total revenue is at its maximum.
ECONOMICS MBPM 1043 Page 141 Example : A monopolist’s gain and loss in total revenue from selling one more unit From the figure, if there is increase quantity supplied from 3 to 4, the gain in revenue is 6,750 and the loss in revenue is 750. The selling the first three units for 6,750 each instead of 7,000 each. Then the marginal revenue (MR) is total gain minus total loss = 6,750 - 750 = 6,000. So, marginal revenue (MR) (6,000) less than the price (P) 6,750).
ECONOMICS MBPM 1043 Page 142 7.8 MONOPOLY DEMAND, MARGINAL AND TOTAL REVENUE The first figure shows the per-unit cost and revenue. The monopoly equilibrium can be achieve when the MR = MC, The quantity at 10 and price at 5250. The profit is 12,500 [(5250 – 4000) (10)]. Then the second figure shows the total cost and revenue. The monopoly market will maximize profit where TR exceeds TC by the greatest amount: Q=10. So the maximum profit equal to TR-TC = 52500 - 40000= 12,500
ECONOMICS MBPM 1043 Page 143 Monopoly situations 1. If price is greater than total average cost (p>ATC) at equilibrium (MR = MC), the monopoly firm will get the profit. 2. If price is lest than average total cost and greater than average variable cost (ATC>p>AVC), the monopoly firm faces the economic loss. In this situation the firm still can produce the output in short run 3. If price is less than average variable cost (p<AVC) and average variable cost curve (AVC) above D curve. In this situation monopoly form faces the economic loss and must shut down in short run 7.9 SHORT-RUN LOSSES; SHUTDOWN DECISION From the figure, the equilibrium for the monopoly is when the MR = MC. From this condition the quantity equilibrium is at Q and price equilibrium at p. From the figure we know that the monopoly will get losses and must shut down the firm, because price is less than average variable cost (P<ATC), monopolist suffers a loss by the shaded area.
ECONOMICS MBPM 1043 Page 144 7.10 PRICE DISCRIMINATION Discrimination means that treating people differently based on some characteristic, example based on the. race or gender. Price discrimination is selling the same good at different prices to different buyers. The characteristic used in price discrimination is willingness to pay (WTP): A firm can increase profit by charging a higher price to buyers with higher WTP. Perfect Price Discrimination versus Single Price Monopoly Example 1 Here, the monopolist charges the same price (PM) to all buyers. There are deadweight loss results. This example assumes constant marginal cost.
ECONOMICS MBPM 1043 Page 145 Example 2 Here, the monopolist produces the competitive quantity, but charges each buyer his or her willingness to pay (WTP). This is called perfect price discrimination. The monopolist captures all CS as profit. But there’s no DWL. Here, there is no horizontal price line. The “price line”, is the demand curve. At each Q, the height of the demand curve shows the marginal buyer’s willingness to pay, which is the price the monopolist charges that buyer under perfect price discrimination. By setting the price of each unit equal to the maximum amount consumers are willing to pay for that unit (shown by the height of the demand curve), the monopolist can earn a profit equal to the area of the shaded triangle. Consumer surplus is zero. Ironically, this outcome is efficient because the monopolist has no incentive to restrict output, so there is no deadweight loss
ECONOMICS MBPM 1043 Page 146 Price Discrimination in the Real World In the real world, perfect price discrimination is not possible because no firm knows every buyer’s willingness to pay (WTP) and the buyers do not announce it to sellers. So, firms divide customers into groups based on some observable trait that is likely related to WTP, such as age. Examples of Price Discrimination 1. Movie tickets Discounts for seniors, students, and people who can attend during weekday afternoons. They are all more likely to have lower WTP than people who pay full price on Friday night. 2. Airline prices Discounts for Saturday-night stay over help distinguish business travelers, who usually have higher WTP, from more price-sensitive leisure travelers. 3. Discount coupons People who have time to clip and organize coupons are more likely to have lower income and lower WTP than others. 4. Need-based financial aid Low income families have lower WTP for their children’s college education. For example schools price-discriminate by offering need- based aid to low income families. 5. Quantity discounts A buyer’s WTP often declines with additional units, so firms charge less per unit for large quantities than small ones. Example: A movie theater charges RM4 for a small popcorn and RM5 for a large one that’s twice as big.
ECONOMICS MBPM 1043 Page 147 CHAPTER 8 OLIGOPOLY INTRODUCTION We had discussed on three different market structures in the earlier chapter: perfect competition, monopoly and monopolistic competition. In this we will look into oligopolistic market. Monopoly is the market structure that has only one seller; if two sellers exist in the market, we called it duopoly. So, what is an oligopolistic market? More than two firms existing in the market is called oligopoly. We will explore more into oligopoly in this chapter. We will also analyze why an oligopolistic firm faces a kinked demand curve and what is meant by game theory, prisoner's dilemma and Nash equilibrium. 8.1 DEFINITION AND CHARACTERISTICS Similar to other market structures, we will discuss the definition and characteristic of an oligopolistic market. An oligopoly market has some unique characteristics that can differentiate it from other markets. DEFINITION Oligopoly is a market structure in which there are only a few firms selling either standardized or differentiated products and it restricts the entry into and exit from the market. Under this market structure, some or all the firms industry can earn abnormal profits in the long run. This is because the entry of new firms is difficult or impossible. The oligopolistic firms can impose barriers to entry in terms of patents or access to a certain technology in the market. The purpose is to control excess production of output, which is unprofitable for the oligopolistic firms. Examples for this market are cigarettes, automobiles, electrical equipment and cement.
ECONOMICS MBPM 1043 Page 148 CHARACTERISTICS i. Few numbers of firms Under oligopoly, the number of firms is small but size of the firms is large. The market share of each firm is large enough to dominate the market. Few firms control the overall industry under oligopoly. Here, few firms refer to the number of firms (two or more than two) that dominate the market. There is no specific number of firms that must control before becoming oligopolistic. The main criterion to become oligopolistic is the mutual interdependence between these firm. Under this, market, firm will consider the reactions of its rivals in decision making to create interdependence. There will be strong interdependence among the firms in the oligopolistic market as the number of the firms becomes smaller. However, if the number of the firms becomes larger, then the interdependence among these firms will diminish. As a result, the description for this market does not hold as oligopoly can be described as monopolistic competition. ii. Homogeneous or differentiated product A product sold under oligopoly can be either a homogeneous or a differentiated product. For example, cement or electrical appliances produced by one firm are identical to another firm. Similarly, oil sold by Malaysia is identical to the oil sold by Middle East countries such as Iran, Saudi Arabia and Kuwait. On the other hand, automobiles produced by major automakers are different in terms of design, technology, performance and prices.
ECONOMICS MBPM 1043 Page 149 iii. Mutual interdependence Firms in an oligopolistic market always consider the reaction of their rivals when choosing price, sales target, advertising budgets and other business policies. This is one of the most important characteristics of an oligopoly firm, which differs from other market structures. Since the number of firms is small, changes in price or output by one firm can have direct effect on another firm. Let us say, Honda changed its design and increased the price; its rivals Toyota and Nissan will also respond by changing their design and prices. iv. Barriers to entry Under oligopolistic market, there are various barriers to entry. Similar to monopoly market, the oligopoly firms will restrict new entrants into the market. The types of barriers to entry are control of certain resources, ownership of patent and copyright, exclusive financial requirements and other legal barriers. In addition, large firms may take drastic actions to prevent the entry of new firms by flooding the market. These large firms will produce the output at excess production capacity, which would drive the price down. As a result, new firms would be unable to survive because sometimes the price set by these large firms is below the cost price. Once the new firms are out of the market, these large firms reduce the production capacity and increase the price.
ECONOMICS MBPM 1043 Page 150 CHAPTER 9 MONOPOLISTIC COMPETITION 9.1 INTRODUCTION Monopolistic competition is characterized by a large number of firms, no barriers to entry and product differentiation. Firm cannot influence market price by virtue of their size. Instead, firm gain control over price by differentiating their products. Monopolistic competitions have some features of competition and some features of monopoly. 9.2 FEATURES OF MONOPOLISTIC COMPETITION 1. Many Sellers There are many firms competing for the same group of customers. Product examples include books, CDs, movies, computer games, restaurants, cookies, furniture’s etc. 2. Product Differentiation Each firm produced a product that is at least slightly different from those other firms in term of packaging, brand, quality and service. There is a high degree of substitute among products, hence each firm face an elastic downward sloping demand curve. 3. Free entry or exit Firm can enter or exit the market without restriction. Firm is monopolistically competitive industry are small relative to the total market. New firms can enter the industry in pursuit of profit and relatively good substitutes for the firm product are available. The number of the firms in the market adjust until economic profits are zero.
ECONOMICS MBPM 1043 Page 151 4. Non-price competition Firms create demand from consumer by providing more advertising, product differentiation, sales promotion and product advancement, rather than decreasing the price 5. Price Maker The firm have relative power to determine the price. 9.3 DERIVATION OF DEMAND CURVE The demand curve for monopolistic competitive firm is downward sloping and more elastic. i. Downward Sloping: Each firm in this industry has considerable control over its products. ii. Elastic: The availability of many close substitutes for the products Although the demand curve faced by monopolistic competitors is likely to be less elastic than the demand curve faced by a perfectly competitive firm, it is likely to be more elastic than the demand curve faced by monopoly. D MR Output RM
ECONOMICS MBPM 1043 Page 152 MACROECONOMICS CHAPTER 10 : INTRODUCTION TO MACROECONOMICS CHAPTER 11 : NATIONAL INCOME CHAPTER 12 : KEYNESIAN ECONOMICS CHAPTER 13 : INFLATION CHAPTER 14 : UNEMPLOYMENT CHAPTER 15 : MONETARY ANALYSIS CHAPTER 16 : INTERNATIONAL TRADE AND EXCHANGE MARKET
ECONOMICS MBPM 1043 Page 153 CHAPTER 10 INTRODUCTION TO MACROECONOMICS Macroeconomics looks at the big picture not the demand for the i-Phones but the demand for everything produced in the economy; not the price for gasoline but the average price for all goods and services produced in the economy. Macroeconomists develop and test theories about how the economies as a whole works-theory that can help predict the impact of economic policies and event. Macroeconomists are concerned not only with what determines such big picture indicators as production, employment and the price level but also with understanding how and why they change overtime. Macroeconomists are especially interested in what makes an economy grow, because the economy growing create more jobs and more goods and services- and more growth means a rising standard of living. THE NATIONAL ECONOMY Macroeconomics concerns the overall performance of the economy. The term economy describes the structure of economies life, or economic activities, in a community, a region, a country, a group of countries or the world. We measure an economy’s size in different ways, such as the amount produced, the number of people working and their total income. The most common of measure is gross product, which measures the market value of final goods and services produced in particular geographical region during a given period, usually one year. If we focus the U.S economy, we consider gross domestic product, or GDP which measures the market value of all final goods and services produced in U.S during a given period, usually one year. We can used the GDP to compare the different economies at the same time or to tract the same economy over final goods and services produced in the world during a given period, usually a year. But the focus of macroeconomics is usually the national economy.
ECONOMICS MBPM 1043 Page 154 Do you still remember what study of economics all about when studied microeconomics? Remember how difference economists gave different definition of economics? Regardless of difference definitions given by them, all of them agree that the study of economics needs be done because of scarcity. Our resources are limited but our wants are unlimited. Thus the study of economics can be defined as study of how individual and society choose to allocate the scare resources to produce goods and services, and how those goods and services are allocated among individuals. The studies of economics can be divided into microeconomics and macroeconomics. The term micro means something small while micro indicates something that is comprehensive or large. In general microeconomics studies the functioning the individual markets and the behavior of individual decision making units such as consumers, firm, resources, owner and other. Macroeconomics studies the activity of economics at the aggregate level such as total level of output, national income, level of employment and unemployment, general price level and so on. 10.1 DEFINITION OF MICROECONOMICS AND MACROECONOMICS MACROECONOMICS Study the activity of economy at the aggregate level such as total level of output, national income, level of unemployment, general price level and etc. Macroeconomic views the economy as the whole that also known as the “aggregate economics”. MICROECONOMICS Microeconomics studies the functioning of individual markets and the behavior of individual decision making units such as consumers, firms, resources, owners and others.
ECONOMICS MBPM 1043 Page 155 10.2 COMPARISON BETWEEN MICROECONOMICS AND MACROECONOMICS Macroeconomics and Microeconomics both deals with the decision of households and firms. 1. Microeconomics deals with individual decision and macroeconomics deals with aggregate decision. Aggregates are the sum of behavior of all individuals in the economy. 2. In microeconomic study about demand and supply of individuals goods but in macroeconomics study about the aggregate demand and aggregate supply. 3. If microeconomics studies on how a price level for one particular goods is determine, the macroeconomics study about the general price level of all goods and services in the economy. 4. When microeconomics looks at the most optimum level of production of one firm, the macroeconomic will measure the total production of all goods and services in the economy as the national output. MICRO: Small MACRO: Comprehensive or Large
ECONOMICS MBPM 1043 Page 156 10.3 MACROECONOMICS GOALS MACROECONOMICS GOALS FROM CONVENTIONAL PERSPECTIVE There are five major objectives / goals why studies done by economist at macro level. That is full employment, price stability, economic growth, equally of income distribution and equilibrium in balance of payments. 1. Full employment. The important goal of macroeconomics is achieve the full employment. At the full employment all the factors like labor, capital, land and entrepreneurs are use efficiently. Full employment does not mean that 100% of labor force is employed but there will be a small percentage of unemployed labor, this small fraction of unemployed labor known as the “frictional unemployment”. Frictional unemployment is temporarily only. There are individuals who are not satisfied with their present jobs and they resigned to look for other better job. Graduates also included in this unemployment, where graduates might take some times looking for job opportunities before they are employed. This type of unemployment cannot be eliminated and will still exist between 2% – 3%. The full employment is achieved with the existence of frictional unemployment at the rate less that 3%. When the economy achieves the full employment, the economy is known as the potential output. FRICTIONAL UNEMPLOYMENT?? Full Employment: All the factors are fully utilized and only frictional unemployment exist
ECONOMICS MBPM 1043 Page 157 Other types of unemployment: i. Cyclical unemployment. Occurs when there is the lack of jobs that results because of the downswing in a business cycle or a recession. When the economy fall in the downswing or recession, the real GDP falls, the demand for goods and services decrease, companies close down and workers are laid off. Cyclical unemployment is a serious problem compare to the frictional unemployment because it will continuous until the economy comes out of the recession and takes several years to recover. ii. Structural Unemployment. Arise due to structural changes in the economy of a country. A worker loses a job because that a job is no longer a part of the structure of economy. Structural unemployment exist because a composition of the labor force does not response quickly to meet changing demands, technological changes or competition from imported goods and so on. The workers find that their skills, talents and experience are obsolete and unwanted due to changes in technology and consumer demand. For example, in the agricultural sector, many unskilled and inadequately educated workers are laid off because of the machine modernization. iii. Seasonal Unemployment. This unemployment arise due to a seasonal variation in the activities of particular industries. This may be caused by climatic changes or changes in fashion or by inherent nature of the industries themselves. For example, fisherman who is unable to catch fish in winter or in rainy weather.
ECONOMICS MBPM 1043 Page 158 2. General Price Stability. The another macroeconomic goals is maintaining general price stability. General price stability represent the overall average price levels of goods and services in the economy. The general price also represents the rate of inflation in the economy. Inflation occurs when there is an increase in the overall price level. If the overall price level increases, the rate of inflation is shown as positive. If the rate of inflation is 5 percent, it does not mean that all price increase by 5 percent. Inflation can reduce the purchasing power of consumers. The quantity of goods and services purchased will be less if the inflation is high. If the inflation rate is high, the value of the money can be decrease. When the price of goods and services becomes more expensive, consumers only can buy the fewer amounts of goods and services using the same amount of money. 3. Economic growth. To achieve economic growth, the economy must be operating at the maximum capacity. Economic growth refers to an increase in the full production output level of nation over time so at the same time will increase the national income over a period of time. The positive economic growths indicate that the countries national income increases over the years. When economy faces the positive economic growth, this will increase the country’s standard of living. Price stability: Keep the inflation rate low to keep the value of money stable and secure Standard of living: Total amount of goods and services that individuals in the economy can enjoy
ECONOMICS MBPM 1043 Page 159 TROUGH Real GDP Economic growth of a nation does not move constantly, which means that in the short run there is up and down in the economy, this is known as the “business cycle”. In the business cycle economic growth is measured by the aggregate output and unemployment rate. There are four phases in the business cycle: peak, recession, trough and recovery. Figure 1: Phase of business cycle The Figures 1 show the expansion and contraction periods. Expansion is the period in a business cycle where it moves from through to a peak, where at this time output and employment is increase. Contraction is the period in the business cycle when it moves from a peak to a through during which output and employment is decline. i. Peak. During this time period, the economy is at full employment where all available resources are employed. The economy will experience a high level of output and trade, increasing effective demand and higher employment levels and income. There could be a situation where the numbers of jobs are more than the numbers of workers and this situation is known a overfull employment. As a result there will be an increase in prices, wages, interests and profit. This period known as “PROSPERITY” period. PEAK PEAK RECESSION RECOVERY Year
ECONOMICS MBPM 1043 Page 160 ii. Recession. The recession will take place after the peak period ends. The situations happen at this phase is a decrease in the volume of output, trade and transaction, an increase in the level of unemployment, a reduction in the aggregate income in terms of wage and profit and a decline in the consumption expenditure and investment level. This phase is known as “CONTRACTION”. iii. Trough. The recession ends when the real GDP stop falling. The minimum points is called a trough. The trough will last until there is an increase in real GDP. In this phase, the overall level of economic activity will fall to the lowest level. Unemployment rates during this phase will be higher and will create many problems. Thus, it is a period of great suffering and hardship to society and the worst phase of a business cycle. iv. Recovery. The trough is followed by a recovery. Recovery is the period of revival lending to an upturn of the economy. The economy’s level of output and employment expands towards full employment during this phase. The recovery period is initiated by government expenditure, change in production techniques, new innovations and exploitation of new sources of energy. The increase in the government expenditure will stimulate the demand for consumption of goods and thus will increase the demand for capital goods. As a result, the employment level, output, income, wages, price and profits will start to increase. Economic growth: Positive economic growth will increase the country’s standard of living and welfare.
ECONOMICS MBPM 1043 Page 161 4. Equitable distribution of income. All the country tries to make sure that the gap between the higher income and lower income group is small. This is to ensure that all the people are equals in terms of standard of living. Unequal distribution of income will create social friction. In this situation government play an important role by impose the government income taxes to the higher income groups. When the government received the taxes payment by these groups, government can provide the subsidies, making transfer payments and providing education scholarships for the lower income groups. 5. Equilibrium balance of payment. Balance of payments concerns with the payment and income receive by the economy from its international trade activities. Payments to the other countries are made when buy or import goods from those countries. On the other hand, when we sell the goods or exports we will receive the money and there will be the inflow of money to our economy. If the total amount of inflows is higher than the outflow, the surplus of balance of payment will exist and vise versa. Equitable distribution of income: Government will impose the taxes to higher income groups and government will provide the subsidies to lower income groups. Equilibrium balance of payments: Total amount inflows equals to total amounts of outflows.
ECONOMICS MBPM 1043 Page 162 10.4 MACROECONOMIC GOALS FROM ISLAMIC PERSPECTIVE Islam is a complete way of life. It consist of the believe in Allah (aqidah), law and regulation (syariah) and lastly moral and ethics (akhlaq). Fiqh al- muamalat or Islamic economic is governed under the Syariah. The main principle of Islamic economic is full utilization of the property and wealth according to Allah’s instruction and human welfare. Hence according to the Islamic framework, the basic policy objectives are: 1. SOCIAL JUSTICE Social justice is defined as a minimum standard of living guaranteed by the Islamic State. The goals of social justice are an integral part of the moral philosophy of Islam and the commitment to human brotherhood (ukhuwwah). The old folks, the handicapped and the poor are guaranteed a minimum standard of livelihood in an Islamic nation. In order to achieve above objective, the government and society must work hand in hand. The function of the government is to implement the laws and that of society to follow and obey those laws. Social justice can attain its objective via: • Satisfaction of human basic needs • The implementation of zakat • Removal of all major sources of hardship and discomfort. • Improvement in the quality of life, moral and materially. 2. THE BALANCE BETWEEN THE NEEDS OF THE INDIVIDUAL AND SOCIETY. Islam perceives the needs of an individual as very important especially from the perspective of the personal right of an individual. However the needs of society far outweigh that of an individual. When conflict arises between the need of an individual and those of society, the need of society are given prominence and therefore are more important than that of an individual’s need.
ECONOMICS MBPM 1043 Page 163 3. OPTIMUM RATE OF ECONOMIC GROWTH. Since interest (riba) is prohibited, the aim of achieving the optimum rate of economic growth in Islam has become very limited. Economics growth in an Islamic economy is qualitatively different from the growth paths of all other economic system. Unlike other system, the Devine Guidance from Allah embodied in Islamic teachings in order to help human being in the realization of this objective. The government, financial institution and society must act together in order to achieve the optimum rate of economic growth. Accordingly, several strategies have to undertaken in order to achieve this objective through distribution, production and consumption of the following: • An appropriate allocation of material resources • An equitable distribution of income and wealth • Mobilization of investment and savings for economic development in equitable manner such that a just return is ensure to all parties concerned • Effective rendering of all services normally expected from the private and public sectors. 4. FULL AND EFFICIENT EMPLOYMENT OF HUMAN RESOURCES The optimum growth of the economy through the efficient usage of material resources will bring about full and efficient employment of human resources. In Islamic economics, the government plays an important role in providing employment opportunities and this attempt must be supported by society. Ensuring sufficient employment also includes the need to provide educational opportunities and the right to vocational training in specific technical field. The government ten has to monitor these right and monetary rewards that should be received by the workers so that it is in accordance to their contribution as mentioned in the hadith (saying) of the Prophet SAW: “Pay your workers before their sweat dries out”
ECONOMICS MBPM 1043 Page 164 10.5 MACROECONOMICS POLICIES Government plays an important role to achieve the macroeconomics goals. The government managed the economy by implementing two types of policies. 1. Fiscal Policy. Fiscal policy refers to the government policy concerning taxes and expenditure. The government collects taxes from households and firms and uses these funds on public expenditure such as building of schools, highways, hospital and so on. The purpose of fiscal policy is to stabilize the economy. There are two types of fiscal policies, that is contractionary fiscal policy and expansionary fiscal policy. i. Contractionary fiscal policy. The government used this policy to bring the economy out of inflation by increasing taxes and decreasing the government expenditure. This measure the slows down growth. ii. Expansionary Fiscal Policy. This policy is implemented to get the economy out of a slump. The government implements this policy by reducing taxes and increasing government expenditure. This measure will increase the disposable income which will lead to increase in consumption. a. Decrease in taxes. To control unemployment, government reduces the general burden of taxation on community. A reduction in excise duty, sales tax, service tax and other types of taxes will increase the consumption expenses of the people. A reduction in business and corporate tax will promote an increase in investment, thus employment will increase.
ECONOMICS MBPM 1043 Page 165 b. Increase in government expenditure. Increase in government expenditure will directly affect aggregate demand. For example increase in the salary for the civil servants creates more development projects which may reduce the unemployment. 2. Monetary Policy. Monetary policy refers to the tools used by the government through the central bank to control the supply of money. Monetary policy is to maintain the overall price level, achieve higher economic growth, removed the fluctuation in the production and to achieve full employment. There are two types of monetary policies that is contractionary monetary policy and expansionary monetary policy. i. Contractionary Monetary Policy The government curb use this policy to curb inflation where the amount of money supplied will be reduced. ii. Expansionary Monetary Policy The policy is implemented when there is deflation or recession where the government will increase the supply of money. The following are some of the tools of monetary policy used: i. Open market operations. The central bank may bur a short term bonds or governments securities and treasury bills from individuals as well as from institutions. The purchase of these will increase the money supply and will increase the purchasing power of individuals and firms.
ECONOMICS MBPM 1043 Page 166 ii. Lowering the reserve requirement. Reserves requirements refer to the amount of reserves commercial banks are required to keep in the central bank. During the period of unemployment, the central bank lowers these reserve requirements to increase the cash resources of commercial bank, thereby encouraging the bank to offer more loans to the public and businessmen. iii. Lowering the discount rate. The discount rate also known as the bank rate, a decline in the discount rate is followed by a decline in other interest rates which leads to increased borrowing and increased investment by private businessman. iv. Lowering the interest rate. The central bank will persuade the commercial banks to decrease their rates of interest on deposits from the public. The action from commercial banks will reduce the level of savings and increase the purchase of goods and services from the public. For Example, when commercial bank reduce the interest rate on fixed deposits from 8% to 3%, this will results the consumers saving less and use more on spending. 10.6 COMPONENTS OF MACROECONOMICS Macroeconomics focuses on the four sectors that are households, firms, governments and the rest of the word fir example international sectors. These four sectors interacts each other in different ways that involve either receipt or payment of income. i. Households. Household own all the factors of production like land, capital, labor and entrepreneur. Households provide the services of the factors of production to firms and government and receive the payments in terms of the rent, wages, interest and profit.
ECONOMICS MBPM 1043 Page 167 ii. Firms. Firms is the organization that buy the factors of production by the households, and then by using this factors of production to produce goods and services then sell it to the households and firm will earn the revenue from the sales. Firms will pay to the household all the factors of production that used and at the same time firms also pay the taxes to government. iii. Government. Government will receive the taxes payment from households and firms. The government revenue will be spent on development and operational purposes. Government also buys the factors of production from households to produce the public goods. iv. The rest of the world (International Institution). The rest of the world refers to the foreign sector which involve in the export and import of goods and services. For example, Malaysia country spends much money to buy the goods from the foreign countries. Components of Macroeconomics: Households, firms, governments and international economics.
ECONOMICS MBPM 1043 Page 168 THE CIRCULAR FLOW DIAGRAM The circular flow will show the economic interaction between the four sectors in the economy. This circular flow involves the income receive and income payments made by these sectors to the economy. Households Government Firms The rest of the world Supply factors of productions Pay wages, rent, interest and profit Payment for goods and services Wages, transfer payments Pay Taxes Pay Taxes Imports Imports Exports Exports Figure 2: Circular flow Diagram
ECONOMICS MBPM 1043 Page 169 10.7 AGGREGATE DEMAND AND AGGREGATE SUPPLY Aggregate demands refer to the total quantity of output demanded at alternative price levels in a given period of time. In other words aggregate demand is the total demand for good and services. Aggregate supply refers to the total quantity supplied at alternative price level at the given period of time. Aggregate supply also refers to the total supply of goods and services. Aggregate demand and aggregate supply curve are shown in Figure 3. Aggregate demand is downward slope and aggregate supply is upward sloping. The y-axis refer to the overall price index and x-axis refer to the aggregate output. Aggregate Output Price Index P* Y* AS AD Figure 3: Aggregate demand and aggregate supply
ECONOMICS MBPM 1043 Page 170 TUTORIAL 10 Question 1 Differentiate between macroeconomic and microeconomics. Question 2 Briefly explain the macroeconomics goals. Question 3 Define circular flow, and briefly explain the four sectors circular flow. Question 4 Discuss the monetary policy and fiscal policy. Question 5 Discuss about the components of macroeconomics and give the example.
ECONOMICS MBPM 1043 Page 171 1. Macroeconomists study A. the decisions of individual households and firms. B. the interaction between households and firms. C. economy-wide phenomena. D. regulations imposed on firms and unions. 2. Which of the following newspaper headlines is more closely related to what microeconomists study than to what macroeconomists study? A. Unemployment rate rises from 5 percent to 5.5 percent. B. Real GDP grows by 3.1 percent in the third quarter. C. Retail sales at stores show large gains. D. The price of oranges rises after an early frost. 3. Which of the following questions is more likely to be studied by a microeconomic than a macroeconomic? A. Why do prices in general rise by more in some countries than in others? B. Why do wages differ across industries? C. Why do national production and income increase in some periods and not in others? D. How rapidly is GDP currently increasing?
ECONOMICS MBPM 1043 Page 172 4. We would expect a macroeconomist, as opposed to a microeconomist to be particularly interested in A. explaining how economic changes affect prices of particular goods. B. devising policies to deal with market failures such as externalities and market power. C. devising policies to promote low inflation. D. identifying those markets that are competitive and those that are not competitive. 5. Which of the following is not a question that macroeconomists address? A. Why is average income high in some countries while it is low in others? B. Why does the price of oil rise when war erupts in the Middle East? C. Why do production and employment expand in some years and contract in others? D. Why do prices rise rapidly in some periods of time while they are more stable in other periods? 6. Which of the following statistics is usually regarded as the best single measure of a society’s economic well-being? A. the unemployment rate B. the inflation rate C. gross domestic product D. the trade deficit
ECONOMICS MBPM 1043 Page 173 7. In a simple circular-flow diagram, total income and total expenditure are a. never equal because total income always exceeds total expenditure. B. seldom equal because of the ongoing changes in an economy’s unemployment rate. C. equal only when the government purchases no goods or services. D. always equal because every transaction has a buyer and a seller. 8. In a simple circular-flow diagram, A. households spend all of their income. B. all goods and services are bought by households. C. expenditures flow through the markets for goods and services, while income flows through the markets for the factors of production. D. All of the above are correct. 9. In a simple circular-flow diagram, households buy goods and services with the income they get from A. wages. B. rents. C. profits. D. All of the above are correct. 10. Macroeconomics is concerned with the study of A. Malaysian’s response towards changes in the price of sugar B. production method and costs C. the effects of reduction of wages on services sector D. the general price level
ECONOMICS MBPM 1043 Page 174 11. Which of the following is deal with macroeconomics analysis? A. Individual firms B. Individual consumers C. Government units D. The entire economy 12. Equilibrium in macroeconomics refers to A. aggregate demand is greater than aggregate supply B. aggregate supply is greater than aggregate demand C. aggregate demand is equal to aggregate supply D. total value of output is produced more than total value of expenditure 13. Which of the following issues a macroeconomist would concentrate on? A. The price of pizza B. The profit of the Air Asia Bhd C. The market for Proton Saga car D. The unemployment rate in Malaysia. 14. These are all conventional macroeconomics objectives except A. full employment B. price stability C. extremely high economic growth D. equitable distribution of income
ECONOMICS MBPM 1043 Page 175 15. Macroeconomics theory studies the following except how A. to determine international trade activities B. to determine the equilibrium income in an economy C. to determine the unemployment and inflation rate D. to determine type and quantity of goods to produced
ECONOMICS MBPM 1043 Page 176 CHAPTER 11 NATIONAL INCOME How do we measure the economy’s performance? During much of the 17th and 18th centuries, when the dominant economy policy was mercantilism, many through that economic prosperity was best measured by the stock of precious metal of nation accumulated in the public treasury. Mercantilism led to restriction on international trade, with the unintended consequence of reducing the gains from comparative advantage. In a latter half of the 18th century, Francois Quesnay became the first to measure the economic activity as flow. In 1758 he published the Tableau Economique, which describe the circular flow of output and income through the different sectors of the economy. NATIONAL INCOME ACCOUNTING 11.1 DEFINITION OF NATIONAL INCOME. National income can be defined as the total income received by all economic agents in the economy based on the goods and services produced in the economy in the certain period of time. 11.2 CONCEPT OF NATIONAL INCOME i. Gross Domestic Product (GDP). Gross domestic product is the total money value of all final goods and services produced within a country in the given period of time. GDP can be measure at current price or constant price. GDP excludes goods and services produced by Malaysia citizen working overseas as well as intermediate goods. The output produces by foreign workers in Malaysia such as by Indonesian or Filipinas will be included in the GDP accounting. The net income from abroad will make the difference between gross domestic product and gross national product. GDP: Total market value of final goods and services produced by the factors of production in a country over a given period of time.
ECONOMICS MBPM 1043 Page 177 ii. Gross National Product (GNP) Gross National product (GNP) is defined as the total market value of all final goods and services produced by the residents of a country during a given period of time. GNP is the total amount of income earned by nationals of the country regardless of where there are. For example, income earned by Malaysia residents that work at US, Australia, Singapore and etc will be included in the GNP. The income earned by foreign workers working in Malaysia will not be included in the GNP. GNP also can be defined as the sum of the GDP and the net factor income from abroad. Net factor income from abroad is the difference between the income received from abroad and the income paid abroad. GNP = GDP + (factor income receive from abroad – factor income paid abroad) iii. Market Price and Factor Cost GDP can be measure at market price, which market price refers to the current price in the market through the forces of demand and supply. Market prices are actual price paid by consumer. Market price includes indirect taxes and excludes subsidies given to producers. Market price does not reflect the real price. GNP: Total market value of final goods and services produced by the residents of a country during a given period of time GDP at factor cost = GDP at market price – indirect taxes + subsidies Market price: Refers to the current price in the market through the forces of demand and supply Factor cost: The real price earned by producer or sellers
ECONOMICS MBPM 1043 Page 178 iv. Net National Product (NNP) Net national product is defined as the market value of the net output of final goods and services produced by a nation during a year. NNP is the GNP minus the value of capital consumption and depreciation during the year. NNP also refer to the national income at the market price. v. National Income at Factor costs (NI). National income at factor cost (NI) is defined as the total of all income payment made to factors of production (land, labor, capital and entrepreneur). NI can be derived from the NNP at market price by including subsidies and excluding the indirect taxes. vi. Personal Income (PI) Personal income is the income that is actually received by individuals and households in economy in a year. PI can be spent, used to pay taxes or to saves. vii. Disposable Income (DPI). DPI can obtain by deducting the personal income by the personal income taxes. NNP: the market value of the net output of goods and services produced by a nation in a year. NI = NNP at market price + subsidies – Indirect taxes PI = National Income + transfer payment – corporate income taxes – retained earnings – social security contributions – insurance premium DPI = Personal Income – Personal Income Tax
ECONOMICS MBPM 1043 Page 179 11.3 METHODS OF CALCULATING THE NATIONAL INCOME National income can be calculated using three approaches: i. Expenditure approach ii. Product approach iii. Income approach EXPENDITURE APPROACH By using this method national income is obtained by adding all the expenditure on goods and services in a year. According this method national income expenditure come from four economics sectors. i. Personal consumption (C) Includes the purchasing of goods and services produced by firms, individuals and households. The goods that purchased by individuals and output should include in accounting national income as well as the services such as paying insurance, obtaining legal advise, medical services and etc. ii. Investments (I) Investments refer to the purchase of capital goods by firms for use in production and also changes in the firm inventories. Inventories refer to the stock of raw materials, semi finished product and unsold product. iii. Government spending (G) Government spending is the expenditures made by federal, states and locals governments for final goods and services. The purchased of governments goods and services includes the cost of providing national defense, construction of new buildings such as schools and hospitals and the payments of the salaries to public servants
ECONOMICS MBPM 1043 Page 180 iv. Net Exports (X – M) Net export is the difference between the value of exports and the value of import. In the expenditure method, gross domestic product is calculated by adding up all the four expenditure: The following are formula for calculating national income and disposable personal income. 1. GDP market price = C + I + G + (X – M) 2. GNP market price = GDP market price + net factor income abroad 3. GNP factor cost = GNP market price – indirect taxes + subsidies 4. National income = GNP factor cost – Depreciation 5. PI = National income + transfer payments – corporate income taxes – retained earnings – social security contributions – insurance premium 6. DPI = Personal Income – personal income taxes 7. GDP factor cost = GDP market price –taxes + subsidies GDP at market price: C + I + G + (X – M)
ECONOMICS MBPM 1043 Page 181 Table 1: National Income Calculated using Expenditure approach. ITEMS Sign Value Private expenditure (C) + Public Expenditure(G) + Private Investment (I) + Change in stock (I) + / - Export of goods and service (X) + Imports of goods and services (M) - GROSS DOMESTIC PRODUCT AT MARKET PRICE XXXX Factor income receive from abroad + Factor income paid abroad - GROSS NATIONAL PRODUCT AT MARKET PRICE XXXX Indirect Taxes - Subsidies + GROSS NATIONAL PRODUCT AT FACTOR COST XXXX Depreciation - NATIONAL INCOME XXXX Transfer payment + Social security contribution - Retained earnings - Corporate taxes - PERSONAL INCOME XXXX Personal Income tax - DISPOSABLE PERSONAL INCOME XXXX
ECONOMICS MBPM 1043 Page 182 INCOME APPROACH Income approach measure national income by adding all the various types of income paid to firm and households in terms of wages, rent, interest and profits. Income approach only measures that item of factor cost because only earning of factor production can be calculated. There are four classifications of factors that are land, labor, capital and entrepreneurs. i. Wages and Salaries. The income receives by the labor from the firms for services rendered. The income also includes social security or pension funds. ii. Net Interest The difference between total interest payments received by households for borrowed funds that finance investments purchases and total interest payment made by households on their own borrowing. iii. Rental Income The payment for rented inputs. For example, the income receives when supplying land and buildings to others. iv. Profits Refer to the corporate profit earnings by business or payments of dividends to shareholders. The transfer payment such as pensions, scholarships, unemployment benefits, any present received by housewife or any pocket money given to the children must not be included in calculation the national income. All these items are not real output or services in producing national output. GDP = Wages + Salaries + Rent + Profit + Interest + Dividend
ECONOMICS MBPM 1043 Page 183 The following are formula for calculating national income and disposable personal income. 1. GDI = Wages + Salaries + Rent + Profit + Interest + Dividend 2. GNP = GDI + net factor income abroad 3. National income = GNP – Depreciation 4. PI = National income + transfer payments – corporate income taxes – retained earnings – social security contributions – insurance premium – undistributed profit 5. DPI = Personal Income – personal income taxes
ECONOMICS MBPM 1043 Page 184 Table 2: National Income Calculated using Income Approach. ITEMS Sign Value Income from employment (salaries and wages) + Income from self employment + Income from rent, dividend and interest + Companies profit (distributed and undistributed) + GROSS DOMESTIC INCOME XXXX Factor income receive from abroad + Factor income paid abroad - GROSS NATIONAL PRODUCT XXXX Depreciation - NATIONAL INCOME XXXX Transfer payment + Social security contribution - Undistributed profit - Corporate taxes - PERSONAL INCOME XXXX Personal Income tax - DISPOSABLE PERSONAL INCOME XXXX
ECONOMICS MBPM 1043 Page 185 PRODUCT APPROACH Under Product Approach, national Income is measured by net value of all final goods and services produced by a nation during a year. The product approach is also known as output approach or Value Added Approach. Only the value of money of final goods and services are included in the calculation. The value of raw materials and intermediate goods are subtracted from the value of gross domestic product to avoid double counting. In Malaysia country, there are three sectors that contributing to the GDP: i. Primary Sector; Mining, Agriculture, Forestry and Fishing. ii. Secondary Sector; Manufacturing and Constructions. iii. Tertiary Sector; Electricity, Gas and Water, Finance, Insurance, Retail Trade, Transport, Communication, Government services and etc. GDP = Final products in the economy
ECONOMICS MBPM 1043 Page 186 The following are formulae for calculating national income and disposable personal income 1. GDP market price = All final products in the economy 2. GNP market price = GDP market price + net factor income abroad 3. GNP factor cost = GNP market price – indirect taxes + subsidies 4. National income = GNP factor cost – Depreciation 5. PI = National income + transfer payments – corporate income taxes – retained earnings – social security contributions – insurance premium 6. DPI = Personal Income – personal income taxes 7. GDP factor cost = GDP market price – taxes + subsidies
ECONOMICS MBPM 1043 Page 187 Table 3: National Income Calculated using Product Approach ITEMS Sign Value Agriculture, Forestry, Fishing + Manufacturing + Construction + Electricity, Gas and Water + Government services + Others + GROSS DOMESTIC PRODUCT AT MARKET PRICE XXXX Factor income receive from abroad + Factor income paid abroad - GROSS NATIONAL PRODUCT AT MARKET PRICE XXXX Indirect Taxes - Subsidies + GROSS NATIONAL PRODUCT AT FACTOR COST XXXX Depreciation - NATIONAL INCOME XXXX Transfer payment + Social security contribution - Retained earnings - Corporate taxes - PERSONAL INCOME XXXX Personal Income tax - DISPOSABLE PERSONAL INCOME XXXX
ECONOMICS MBPM 1043 Page 188 11.4 USES OF NATIONAL INCOME National Income accounting is very important both to individuals and the government. It helps to identify sources of income and control the expenditures. The national income data is calculated for many reasons. The data is very important to the government policy makers. i. To measure the economic growth. The national income calculated show the performance of an economy over time by comparing the national income of one time period to the other time. The national income shows either economy is growing stagnant or declining. In Malaysia, the national income has been steadily improving over time. The country is said to experience a satisfactory rate of economic growth if there is an increase in the real GNP over the years. When there are positive economic growths, there is increase the amount of goods and services in the country, and individuals can enjoys the goods and services in their life. The continuing the economic growth over the year show that the positive effect to country’s development. ii. To indicate the standard of living. National income data helps us to compare the standard of living in the different country to people living in the same country at different times. The standard of living reflects the individuals welfare because it shows how much of the goods and services that can be consumed by each individual in a country. The more goods and services that can be consumed, the higher their standard of living is and the better their life will be. The standard of living can be measure based on the per capita income (PCI). Real NI = 𝑅𝑒𝑎𝑙 𝐺𝑁𝑃𝑡𝐻𝑖𝑠 𝑦𝑒𝑎𝑟 −𝑅𝑒𝑎𝑙 𝐺𝑁𝑃𝑝𝑟𝑒𝑣𝑖𝑜𝑢𝑠 𝑦𝑒𝑎𝑟 𝑅𝑒𝑎𝑙 𝐺𝑁𝑃𝑝𝑟𝑒𝑣𝑖𝑜𝑢𝑠 𝑦𝑒𝑎𝑟 x 100
ECONOMICS MBPM 1043 Page 189 iii. Distribution of Income. National Income shows the distribution of income among the different sector and among different factors of production in the form of rent, wages, interest and profits. There should be equal distribution of income between the rich and poor people in the country. iv. Government Planning. Based on the national income data, government can find which sectors in the economy that contributes more to the economic growth and which sector need adjustments and assistance. National income statistics are very important for the government to formulate the short term and long term planning. Based on the trends of national income, government can formulate the planning. The Malaysian government used the national income statistics to draft the country’s Malaysia Plan for every five year period. v. Economic Policy. National Income statistics is very useful to the economist to develop the policy that will encourage the economic growth. National income estimates are the most comprehensive measures of aggregate economic activity in an economy. By using this statistics, future economies policies for development nation can be formulated. vi. Public sector. National income contains the figures of consumption, savings, investment, imports and exports. These figures will show the relative performance of PCI = 𝐺𝑁𝑃 𝑃𝑂𝑃𝑈𝐿𝐴𝑇𝐼𝑂𝑁
ECONOMICS MBPM 1043 Page 190 both public and private sectors. The pattern of an expenditure can show the types of economics that the country practicing. vii. Inflationary and deflationary gaps. National income data helps us to know the purchasing power of money and helps government implement anti-inflationary and anti-deflationary measures to stabilize the value of money. 11.5 REAL INCOME, PER CAPITA INCOME AND GROWTH RATE REAL INCOME National income is measured in term of money but the value of money often changes over a period of time. This can create difficulties in comparing the national income of the country over different years. To overcome this problem, real income is used to measure the economic growth of a country. Real income or real Gross National Product (GNP) is GNP measured on a fixed price or base year. Nominal GDP is measured in current price. We can convert the nominal GNP to Real GNP by using a GNP deflator. A GNP deflator is obtained by comparing the base year index with the current year price index. To obtain the GNP deflator, the following formula can be used: To find the Real Income or Real GNP, the following formula can be used: 𝐺𝑁𝑃 𝑑𝑒𝑓𝑙𝑎𝑡𝑜𝑟 = 𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝑦𝑒𝑎𝑟 𝑝𝑟𝑖𝑐𝑒 𝑖𝑛𝑑𝑒𝑥 𝐵𝑎𝑠𝑒 𝑦𝑒𝑎𝑟 𝑝𝑟𝑖𝑐𝑒 𝑖𝑛𝑑𝑒𝑥
ECONOMICS MBPM 1043 Page 191 𝑹𝒆𝒂𝒍 𝑮𝑵𝑷 = 𝑩𝒂𝒔𝒆 𝒚𝒆𝒂𝒓 𝒑𝒓𝒊𝒄𝒆 𝒊𝒏𝒅𝒆𝒙 𝑪𝒖𝒓𝒓𝒆𝒏𝒕 𝒚𝒆𝒂𝒓 𝒑𝒓𝒊𝒄𝒆 𝒊𝒏𝒅𝒆𝒙 𝑿 𝑵𝒐𝒎𝒊𝒏𝒂𝒍 𝑮𝑵𝑷 = 𝑵𝒐𝒎𝒊𝒏𝒂𝒍 𝑮𝑵𝑷 𝑮𝑵𝑷 𝒅𝒆𝒇𝒍𝒂𝒕𝒐𝒓 For the example, if the current price index is 160 while the base year price index is 100 and the nominal GNP is RM10,000 million, then the real GNP is: 𝑅𝑒𝑎𝑙 𝐺𝑁𝑃 = 100 160 𝑋 10,000 = 𝑹𝑴𝟔𝟐𝟓𝟎 𝒎𝒊𝒍𝒍𝒊𝒐𝒏 PER CAPITA INCOME Per capita income refers to the average income per head of population. Per capita income is used as an index of change in the standard of living of a country. The per capita income can be calculated using the following formula. 𝑃𝑒𝑟 𝑐𝑎𝑝𝑖𝑡𝑎 𝐼𝑛𝑐𝑜𝑚𝑒 = 𝑁𝑎𝑡𝑖𝑜𝑛𝑎𝑙 𝐼𝑛𝑐𝑜𝑚𝑒 𝑇𝑜𝑡𝑎𝑙 𝑃𝑜𝑝𝑢𝑙𝑎𝑡𝑖𝑜𝑛 For example, the national income of a country with a total population of 20 million is RM50,000 million. So, the per capita income is Per capita income= 50,000/20 = RM2500 GROWTH RATE
ECONOMICS MBPM 1043 Page 192 The economic growth rate of a country can be measured as a gross domestic product (GDP) or gross national product (GNP) based on real income. The growth rate is the percentage change in the quantity of goods and services produced from one year to another. Formula to measure growth rate is as follow: 𝑮𝒓𝒐𝒘𝒕𝒉 𝒓𝒂𝒕𝒆 (𝒈) = 𝑹𝒆𝒂𝒍 𝑮𝑵𝑷 𝒉𝒊𝒔 𝒚𝒆𝒂𝒓 − 𝑹𝒆𝒂𝒍 𝑮𝑵𝑷 𝒍𝒂𝒔𝒕 𝒚𝒆𝒂𝒓 𝑹𝒆𝒂𝒍 𝑮𝑵𝑷 𝒍𝒂𝒔𝒕 𝒚𝒆𝒂𝒓 𝑿𝟏𝟎𝟎 This formula can be used to calculate Real GDP. For example, if the real GDP for year 2003 is RM232,359 million and RM248,954 million for year 2004. The growth rate from year 2003 to 2004 is 𝒈 = 𝟐𝟒𝟖, 𝟗𝟓𝟒 − 𝟐𝟑𝟐, 𝟑𝟓𝟗 𝟐𝟑𝟐, 𝟑𝟓𝟗 𝑿 𝟏𝟎𝟎 = 𝟕. 𝟏𝟒% 11.6 DIFFICULTIES IN MEASURE NATIONAL INCOME Calculation of national income are complicated and complex. These problems can affects the accuracy of the national income data. Among the major problem are: i. Double counting. Double counting implies the possibility of intermediate goods being included in the national income more than once. To avoid this problem, only the value of final goods must be counted or the added value at each stage of production of all goods should be counted. ii. Lack of data. Some activities in the economy are not record in the national data. For example the illegal activities and some productive goods and services
ECONOMICS MBPM 1043 Page 193 produced are used for personal consumption. For example farmer will consume rice and vegetable they produced as the household consumption. There are no proper records of the value of these items and that will make the national income as understated. iii. False information. These problems arise because people do not disclose their income or underestimate their income to avoid paying higher taxes. This will affect the national income accounting. iv. Allowance and depreciation. Depreciation of machine used in the production is difficult to be estimated. If the depreciation is over estimated, it will make the national income figure is understated. v. Illiteracy. A large number of small producer in third world countries are illiterate and unable to keep accounts of their production activities. Most of the products that they produced are for self consumption and not for the market and records are not keep of their productive activity. Thus they fail to provide accurate information to the government for the national income accounting purpose. 11.7 THE CONCEPT OF NOMINAL NATIONAL INCOME AND REAL NATIONAL INCOME
ECONOMICS MBPM 1043 Page 194 Nominal national income is measured based on current prices/values, whereas Real national income is measured based on standard prices/values. Real NI = 𝑁𝑜𝑚𝑖𝑛𝑎𝑙 𝑁𝐼 𝑃𝑟𝑖𝑐𝑒 𝐼𝑛𝑑𝑒𝑥 x 100