Economics is the study of how individuals’ and nations make choices on how 2 use scarce resources 2

fulfill their needs and wants.

Economic systems

A. Traditional economy
Characterized by subsistence farming in which land is owned communally
Use of such resources requires communal consent
In such
 production is very low
 Very little mechanization
 Use of science n technology is limited
Most of the economy in this economy is extractive industries such as:-

 Forestry  Subsistence farming

 Fishing  Hunting n gathering
 Limited form of mining

Loss of production is not well known n prices of goods n services may not reflect the cost of production.

Merits

 It is simplified economic system where deciding what is 2 b produced by whom n where is

reachable by consensus

Demerits

 Low production
 Since there is no application of science n technology, the quality of goods n services is poor.
 Labour is mostly unskilled ,thus specialized labour is law

B. Market economy/ capitalist economy

 Major characteristic is that demand n supply of goods n services is determined by
private firms n individuals
 Factors of production are owned by private economic splits
 Production is determined by private units
 Profit motive is a major element
 Private economic units engage in production in anticipation of profit
 In the perfect form of this economy, the government has little or no participation n
decisions on prices of commodities, interests rates, wages n profit made by private
economic units.
 Prices of goods n services are free from government control. N will be determined by
demand n supply.
 There r no controls over exports n imports n in most cases, taxes n duties would be
reduced to minimum. Also foreign exchange is freely available, with no control over
foreign exchange.

Merits
 There is freedom of movement of factors of production
 There is a wide choice of goods n services available 2 consumers
 Prices move up down depending on market conditions
 Since there r no restrictions, consumers can choose better quality over poor quality
products.
Demerits
 Fluctuation in commodity prices may be to the dis-advantage of the consumer if
constantly rising. This may increase poverty n increase welfare
 Many poor countries may be forced to change their consumption paterns so as 2
consume more imports than locally produced goods
 There may b very little 2 check on private sector greed who may use unethical trading
methods to maximize profits.

C. Socialist economy/ communism/central command

 The government has complete controls over wht is produced, how n where it is
produced.
 There r controls on prices, wages n salaries, interest rates n on rent
 The government also owns the factors of production n all tht is produced is sold 2 the
government.
 In such pple r organized into social group (communes) which will make decisions on all
economic matters.

Merits
 Bcoz of controls, commodity prices r low n therefore poverty levels r usually low
 Since production is for the state, profiteering is discouraged
 Theres a general sharing of resources through communes n this creates a social safety 4
poor groups.

Demerits
 There is no motive 2 increase ur effort in production sinc there is no profit motive
resulting in law production levels
 Since private enterprise is discouraged, innovation is also low
 Since the govnt controls the economy, decisions r always inefficient as red-tape/
bureaucracy delays the process of decision making.

D. Mixed economy
Is a mix b2n a market n a central command economy.
Is characterized by a large number of state corporations involved in production
A mixed economy is also characterized by substantial govnt control on prices, intrest rates,
wages e.t.c but there may be free movmnt of labour n freedom of private enterprise.
It shares both the merits n demerits of both market n central command economy.

Demand and supply

The theory of demand supply enables us 2 understand the determination of prices n quantities sold in
the market place.
Demand

 Is the quantity of a commodity thet consumers r willing n able 2 buy at a given price over a
given period of time.
 Willingness 2 buy measures expression of a need while ability 2 pay measures the purchasing
power of the consumer.
 The combination of these of these 2 factors is known as effective demand.

price

P1 Demand schedule

P2

quantity
Q1 Q2

 The law of demand states that ceteris peribus (holding all other facters constant), the lower
the price of the price of the commodity, the greater the quality demand by the consumer n
vice-versa.
 This means that price n quantity are inversely related n the demand schedule is negatively
sloped 2 reflect this law of demand.this law however only applies 2 normal goods

This law only applies 2 normal goods n expectations include:-

a) Giften goods e.g basic food stuffs n other basic necessities of life
b) Goods of ostentation i.e. luxuries

Factors determining demand of a substance

I. Price of the product
The price of a product will determine whether or not demand will change n in accordance to the
law of demand the price of a product is inversely related 2 the law of demand the price of a
product is inversely related 2 the change in demand.
In a competitive market with more than one product, consumers tend to compare price levels n
thus a slight reduction in price may be attractive 2 consumers.
II. Price of other products
Where the product is a perfect substitute, the demand 4 one product, X will be determined by a
change in price of its substitute, Y, so that if the price of the substitute, Y rises , then the
demand for X may increase if its price remains law relative 2 its substitute.
Complementary goods are those whose use is linked 2 a totally different product. Therefore if
1 product, B is a complement to another product, A then a rise in its demand will be dependent
on a rise in demand of its compliment, A n vice versa.

III. Income (disposable income)

Demand is influence by changes in income n an increase in income leads 2 higher purchasing
power which then leads 2 an increase in demand.

Normal goods
demand

Inferior goods

Basic goods

Income affects demand differently so that demand forincome

different goods tends 2 remain constant
while demand for inferior goods rises 2 a point b4 falling off since they are considered cheap or
un-necessary products.
For normal goods demand tends 2 rise with income.

IV. Tastes/preferences/fashion
Personal tastes,fashion n preferences play an important role in determining a consumers
demand for certain products.tastes may change bcoz of population characteristic, gender
difference,age, geographic location, changes in income n social values.
V. Advertising
Generally increased advertising tends 2 increase demand of product thru persuation n provision
of information.
VI. Availability of credit
For many fast moving consumer goods as well as durable products, demand tends 2 increase
when more credit is available in the financial systems.
VII. Government policy
Government policy may affect demand by means of taxation n legislation where the govt. may
increase taxes n duties on products n this may reduce demand on these product.
price
Shift due 2 increased income A to A₁

P1 A A₁

B₁ Boom
P2 B
recession

Q1 Q2 Demand (Q)

Change in demand – change along same demand curve.

Shift in demand – change of demand from 1 curve to another e.g A B to A₁B₁

A change in demand is most along the same demand curve in which the consumer is making
substitutions in quality demand as price of product changes.
However, an increase in income may lead 2 a complete shift of the demand curve so that a
consumer gets more of everything at the same price.

boom

recession

depression

THEORY OF SUPPLY
Supply can be defined as the quality of a given commodity that a produce is willing n able 2 sell
at a given price over a specific period of time.
Therefore the relationship b2n price n supply is that when price is increasing, then supply also
tends 2 increase since suppliers expect higher profits when prices are rising.
Determinant of supply
A. Price
As the price of production increases, with all costs held constant, the production of a
commodity becomes mmore profitable n attractive, therefore producers will increase
their out put n offer more 2 the market in particular, future prices are important to
producers so that if future prices are predicted to rise, then producers will invest in
supply system n provide more production capacity.
B. Price of other products (competitors)
Changes in the price of other competing goods may affect the supply of a product
whose supply does not change. E.g if the price of product X declines, then suppliers will
be unwilling to increase its production and instead they will invest in another product, Y,
whose price is rising so that they earn higher profits.
C. Price of factors of production (land, labour, capital, e.t.c)

As the prices of factors of product used intensively by producers rise, so will the cost of
production of that firm. If the production costs rise, then the supply will decline as more
firms reduce their output. Thus, an increase in any one factors of production will force
producers to

I. Reduce their output to levels where production costs are manageable

II. Close down production units
III. Substitute the expensive factors of production to relatively cheaper factors of
production.
IV. To relocate the location of production to a cheaper zone from an expensive zone.
D. State of technology
Technological improvements tend to reduce the cost of production. These
improvements may be machine performance, management strategies, organization of
production or improvements in quality of raw materials.all these tend to reduce cost of
production n thus increase the output.
E. Indirect taxes(VAT, Cess, Import duty)
When these taxes are imposed on products, prices tend to rise. However it is also
considered a cost of production n If producers are unable to pass it on to consumers,
then it becomes a cost burden to them n may result in reduced supply.
F. Climate conditions
It usually affects production of agricultural commodities such that crops tend to be
seasonal. Good weather may increase supply n vice versa.
G. Industrial action (labour, unrest/strikes)

Market equilibrium
The equilibrium point is defined as the price n quality at which both consumers n producers are
satisfied that in making a sale, this position enables them to achieve the highest possible level of
satisfaction.
At this point consumers maximize welfare while producers maximize profits.
This is the price that clears the market because at this point all that is offered by producers or
suppliers will be purchased by consumers.
P

P₀ Point of equilibrium

S Q₀ D Q

Elasticity concept
Elastisticity of demand n supply refers to the degree of responsiveness of the quantity
demanded n quantity supplied that is due to change in price or income.
In general, demand will increase if there is a decrease in price while supply will increase when
there is an increase in price. On the other hand, demand will increase when there is increase in
income and supply will also increase with increase in income.
Ways of measuring elasticity
i. Elastic
If the demand for a product rises more than proportionately to the decrease in price,
then the price elasticity or demand is elastic. When the change in demand or supply is
higher than the proportionate change in price or income, then the elasticity is said to be
elastic.
ii. Inelastic
Products are said to be inelastic when the quantity demanded changes less than
proportionately in response to a given change in price. E.g. if a price of a product falls by
10%, the increase in demand rises by less than 10%.
iii. Unitary elasticity
Products with unitary elasticity are those where the change in demand is equal to the
change in price. The concept of elasticity also applies to supply so that it measures the
change in supply response to a change in either price or income.

Factors that determine elastity of demand.

A. Availability of substitutes
If a substitute to a given product is available in a given price range, then demand will usually be
elastic , however, if there are no close substitutes, then demand may be inelastic.
B. Proportion of income spent on commodity
When this proportion is small then the product tends to be inelastic but if this proportion is
high, then the demand tends to be elastic.
C. Length of adjustment time
When there is a price change, it takes some time for new prices to be known n 4 consumers to
the actual switch. In general, the longer the period allowed 4 adjustments in demand, the
greater its elasticity. Products with a short adjustment time such as food may be inelastic in the
short run. However, they may become elastic in the long run.
D. The number of uses of a particular product
When a product has more than one use then its demand becomes elastic.

Factors that affect elasticity of supply

A. Availability of spare capacity of production

Plant capacity utilization affects the way producers respond to changes in price n income. When
a firm has a large spare capacity, then it can quickly respond to an increase in demand bi
increasing its production. If a firm has very little spare capacity, then it has to install production
lines.
B. Inventories/stock
When producers are holding stock, or inventories, then they can respond to a change in demand
by drawing down their stocks. however, if there are no stocks/inventories, then they may need
more time to increase their production to meet new demand levels, therefore firm large unsold
stocks/products tends to be more elastic than those with law stock levels.

UNDERSTANDING MARKET ECONOMY STRUCTURES

 Organizations generally operate in different market systems where they procure factors
of production and also where they sell their output. Therefore every firm is faced by
input and output market.
 Understanding of market structures enables us to analyse and organize the way firms
should be located and operated. Understanding of market structures also offer the
analyst a chance to understand the way costs n revenues behave in a different market.
 The behavior of the firm then will depend on how revenues and costs change within
different market structures and how the firm should respond to these changes.
Types of market structures include:
I. Perfect competition
Described by a structure in which firms are the main producers of goods and services
and government presence is very small.
Firms will usually operate in competition with one another and firms will usually use
price as the major strategy through which they can outdo their competitors.
A market is said to be perfectly competitive when the following conditions are met:
There are many buyers and sellers and the actions of one individual firm cannot
influence the rest of the market. In such a situation, each firm is small and the price of
the product is set by the market collectively. In a perfectly competitive market, there is
no price leader and each firm is a price taker
The product is homogenous and buyers do not have a preference of one product over
another. The buyer cannot tell the difference b2n the products n the buyer is indifferent
in selecting b2n the product choices.
In a perfectly competitive market, factors of production are perfectly mobile and they
can move from one industry to another.
There is free entry n free exit to and from an industry. In such a market, there are no
patents, copyrights or other factors that hinder firms from entering or exiting.
Producers, consumers and others have a perfect knowledge of the prevailing conditions
of the market. this means there are no hidden charges of the product, prices are well
known, quantities are well known. Availability of information enables consumers and
producers to eliminate market distortions so that both consumers and producers have
sufficient knowledge of the conditions of the market. In a perfect competitive market,
firms seek to maximize their profits while consumers seek to maximize their utility and
welfare.
Profit maximization occurs when a firm is able to maximize its revenue and minimize its
cost and in general, profit maximization will occur when;
Marginal revenue = marginal cost (MR = MC)
At this point each firm is able to understand the behavior of the last unit of output in
the market. If the marginal cost is rising beyond marginal revenue, then the firm is
loosing business (profit). If marginal revenue is increasing beyond marginal cost, then
the firm is increasing its profits.

II. Monopoly
This is a structure where production is under the control of a single supplier.
In such a situation, the monopolist is also the whole industry.
The monopolist has the major advantage of deciding the price of the product and the
quantity to be supplied to the market at the same time
This is unlike perfect competition where the firm can only decide price or quantity to be
supplied to the market.
Sources of monopoly power
I. Legal barriers
 Some are created by law such as parastatal firms. Also some firm may
be protected by patents copyrights which make it difficult for other
firms to produce similar products.
 Environment law may also create monopoly and also firms nationalized
by the state.
II. Tariffs, duties and transport costs.
Some firms may enjoy monopoly positions created by means of import duties,
taxes and tariff barriers such tariffs may protect local industries from foreign
competition enabling them to operate as monopoly firms
III. Product differentiation
This may be due to creating a unique product or formula, product branding
which makes the product unique and different.
IV. Economies of scale
Economies of scale barriers can also create a monopolistic tendency.this may
arise when a firm operating a large plant is able to reduce its cost and remain
profitable bcoz of its large- scale production. New firms entering the market
with a smaller plant may find that they are forced with high cost and therefore
bcome unprofitable, leaving the large plant as a monopoly.

III. Monopolist completion

IV. Oligopoly

Methods of measuring national income

A. Income method
This approach assumes that ea…. Engage in an economic activity generates an
income return therefore factors of production generate income from their use n
this method takes the summation of all this as national income.
Xamples of income
 Rent frm land: rent income to owners of land from productive use of
land as a factor of production
 Interest payment to capital as well as returns due to entrepreneur
investment in form of profits and dividends.
 Payment of labour and related allowances but only to those types of
labour engaged fully in production
The income method also captures income frm employment (public + private)I.e
payment 2 workers n also income frm subsistence production.
Also captures income from abroad workers, ncome frm rent/investments
abroad
All this items shld generate an aggregate sum of national income but for it to be
accurate adjustments to be done:
1. Subtraction of transfer payments r all excluded from N.I 2 avoid double
counting.
2. Calculation of net (income from abroad)( net income = wht is paid out –
wht is paid in therefore net difference is included in N.I)
3. Net property income (rent frm abroad)owned by local citizens is
included only when difference b2n out put payment and in payment is
made.
Limitations of income method

Economic units may not voluntary disclose income from substinece and may lead to underaccounting.

Double counting when economic units report transfer units as expenses other than donations

Problems of data availability n accuracy on income esp. for private firms which may want 2 understate
their profit earning so as to evade tax.

Problems of handling activities that in parallel economy- usually illegal activities which generate income

B. Expenditure method

This approach –economic units spend money/income to acquire goods n services n this expenditures
can collectively summed up to generate a measure of income.

Expenditure include: C= household consumption

G= government expenditure (construction, wages, running expenses,

maintenance)

I = investment by individuals, government, all economic units in the country

(savings)

Exports – imports(X-M): exports>imports

National Income, N.I = C+G+I+(X-M)

Adjustments

1. Imports are only included as a net of exports n if imports are higher then the figure is –ve. If
exports are higher fig. is +ve.
2. Indirect taxes are not included in this method bcoz they r not supported by the factor of
production.
3. Capital consumption/depreciation is deducted frm this method bcoz it is usually deducted from
the asset value.
4. Subsidies – are eliminated frm accounting bcoz they add an unreasonable value to the product
which should be deducted.

Disadvantages

No accurate records of expenditure kept by economic units – some cases have deliberate hiding due to
tax.

Only includes expenditure on final products but quite often economic units may report intermediate
products as final products which may lead to double counting of both final n intermediate parts.
Evaluation of imports and exports when exchange rates are fluctuating introducing diffnt evaluation
figures and causes

C. Product approach(value added)

This approach focuses on net- value added on a product on each stage of production therefore N.I is
derived by a summation of value added in all product process therefore N.I is value added to output.

Raw materials are deducted from final price while the profit margin is also deducted frm the final price
2 detrmine value of goods n services.

Adjustments

 Deduct stock appreciation value which may occur when a product in stock is eventually sold at a
higher price n this may lead to a situation where an increase in price is not supported by
increase in product value.
 deduct value of depreciation of assets espessialy of capital goods that may occur due to normal
wear n tear over time.
 Adjsustmnt 4 taxes n cost of financial services bcoz although they contribute to final price the y
do actually represent actual production cost.

Limitations

Data: availability(inaccurate) esp on calculating cost of input

Reporting by producers may not be accurate since they may hide info due to taxation.

Equilibrium National Income

Payment of factors of production

Goods + services
Firms Households

Factor services

Expenditure of goods + services

Above illustrates a market with no/little government influence

Equal working of all arms = balanced economy

Circular flow of income and expenditure describes working of an economic system suggesting that for a
balanced economy then all units must be fitting at their optimum levels.

C+I+G+(X-M) = C+S+T (T- taxes which come back as improved social amenities)

Economy is equilibrium when both sides of expenditure are equal and the 3 methods of measuring
income yield the same aggregate income.