SDL
Economics – Learner Controlled
Instruction
1. Define Economics (5)
A social science (1) that studies how individuals, governments, firms and nations make choices (1) on allocating scarce resources to satisfy their unlimited wants (1). Economics can generally be broken down into: macroeconomics, which concentrates on the behaviour of the aggregate economy; and microeconomics, which focuses on individual consumers (1).
Two of the major approaches in economics are named the classical and Keynesian approaches. Classical economists believe that markets function very well, will quickly react to any changes in equilibrium and that a "laissez faire" government policy works best. Keynesian economics suggest an active role for governments (1).
2. Distinguish between microeconomics and macroeconomics (10)
Macroeconomics (from Greek prefix "makros-" meaning "large" + "economics") is a branch of economics dealing with the performance, structure, behaviour, and decision-making of the whole (national and global) economy. (1)
Macroeconomists study aggregated indicators (1) such as GDP (1), unemployment rates (1), and price indices (1) to understand how the whole economy functions. Macroeconomists develop models (1) that explain the relationship between such factors as national income, output, consumption, unemployment, inflation, savings, investment, international trade and international finance (1).
Microeconomics is primarily focused on the actions of individual agents, such as firms and consumers (1), and how their behaviour determines prices (1) and quantities (1) in specific markets
3. State what is meant by the “economic problem” (6)
The “economic problem” says that there is scarcity (1), or that the finite resources at our disposal (such as land, labour, capital and entrepreneurship) (1) are insufficient to satisfy all human wants and needs (1). The problem then for individuals, firms and indeed countries, becomes how to determine what (1) is to be produced and how these factors of production are to be allocated (1). Economics revolves around methods and possibilities of solving the economic problem. This has translated into various economic systems that vary from free market to socialist and all the shades of “mixed” economies in between. It has however been found that there is a positive relationship between economic freedom (a market economy consisting of private property ownership, democratic institutions, flexible labour laws, sound money) and economic prosperity and well being.
In short, the economic problem is the choice (1) one must make, arising out of limited means and unlimited wants.
4. Explain what the Production Possibilities Frontier sets out to illustrate (5)
(Do not explain what it is and how it works)
The PPF represents the points at which an economy is most efficiently producing its goods and services (1) and, therefore, allocating its resources in the best way possible. It shows in a graphical way the points at which it is possible to combine production outputs and where the optimum quantities level are and illustrates the opportunity cost(1) of producing one item as opposed to another by maximising the use of the limited resources available. It also illustrates how, through technolgical improvements (1) the frontier can shift and change the relationship between products.
It shows that there are limits to production, so an economy, to achieve efficiency, must decide (1) what combination of goods and services can be produced. The specific optimum point is determined by the value of the products relative to another and the resultant optimum will be at the point where the marginal value of the one product is equal to the marginal value of the other (1).
5. Explain what is meant by “marginal” and give two examples of how the concept is used (6)
The marginal utility of a good the value gained in the consumption of one unit of that good.
It is for example found in the “law of diminishing marginal utility (or return)”, meaning that the first (or initial) unit(s) of consumption of a good or service yields more utility than the second (and subsequent units).
The marginal decision rule states that a good or service will be consumed at a quantity at which the marginal utility is equal to the marginal cost. A consumer will also allocate his income between to products where the marginal value of the one equals the marginal value of the other.
The concept of marginal utility led to the replacement of the labour theory of value by neoclassical value theory in which the relative prices of goods and services are simultaneously determined by marginal rates of substitution in consumption and marginal rates of transformation in production.
6. What is meant by the “law of diminishing returns” (4)
It is the decrease in the marginal (per-unit) output of a production process as the amount of a single factor of production is increased, while the amounts of all other factors of production stay constant (2).
It states that in all productive processes, adding more of one factor of production, while holding all others constant ("ceteris paribus"), will at some point yield lower per-unit returns. The law of diminishing returns does not imply that adding more of a factor will decrease the total production at first, though negative returns may also result at some point (1).
The law of diminishing returns is a fundamental principle of economics and plays a central role in production theory (1).
7. Explain why property rights and markets have evolved. (8)
Property rights unleash the productive capacity of individuals (1) and markets, through the price system lead to the most efficient allocation of resources (2). The market economy allows people who may not even like each other to cooperate in the production of goods and services (wealth creation) (1).
In a market economy all transactions are voluntary and force and fraud is not allowed. Consensual trade is the basis of wealth creation (2)
A market economy is one where all individuals own property and the means of production, the role of the state is minimised (limited to justice, security and foreign affairs and a few others such as property registration and patent protection). (1)
Markets depend on the rational self interest of individuals that ensure that each party is better of as result of trade that takes place at the margin.(1)
Adam Smith was one of the first to describe the process of the market and wealth creation – “the invisible hand” that guide the actions of people to improve their situation.
8. Draw a diagram outlining the key economic role players and through that illustrate the circular flow within an economy. Mention the remuneration of the production factors. (15)
9. Describe what is meant by “perfect market conditions” (8)
a) Perfect competition describes markets such that no participants are large enough to have the market power to set the price of a homogeneous product.
The conditions for perfect competition are strict, there are in reality few if any perfectly competitive markets.
b) Infinite buyers and sellers – Infinite consumers with the willingness and ability to buy the product at a certain price, and infinite producers with the willingness and ability to supply the product at a certain price.
c) Zero entry and exit barriers – It is relatively easy for a business to enter or exit in a perfectly competitive market.
d) Perfect factor mobility - In the long run factors of production are perfectly mobile allowing free long term adjustments to changing market conditions.
e) Perfect information - Prices and quality of products are assumed to be known to all consumers and producers. The result of a change in information happens immediately – time lapse is not taken into account.
f) Zero transaction costs - Buyers and sellers incur no costs in making an exchange (perfect mobility).
g) Profit maximization - Firms aim to sell where marginal costs meet marginal revenue, where they generate the most profit.
h) Homogeneous products – The characteristics of any given market good or service do not vary across suppliers.
i) Constant returns to scale - Constant returns to scale ensure that there are sufficient firms in the industry. (p83)
10. Define the concept “market” and explain by using a diagram. how prices are formed in a market “under perfect market conditions”. (8)
At a given price a certain quantity will be demanded and a certain quantity be produced.
So once one has a supply and a demand curve for a given product or service one can turn to the question how price and the quantity bought and sold is determined.
The first step is to draw the two curves in one diagram. These graphic representations will aid a person in analysing what the likely behaviour of the participants in the market would be under different price conditions.
It is important to note that in terms of the underlying assumptions (such as the instant availability of information) there can only be one prevailing price at any given time on the market.
Suppose the ruling price is R 120 as depicted in the graph below, the quantity demanded will be 10. At that price the quantity supplied will be 100. The quantity supplied will be more than the quantity demanded - there will be an excess supply on this market (an oversupply of 90 units).
Where one has an excess supply on a market it will lead to sellers wanting to rather sell at a lower price than to return from the market with unsold goods. Excess supply causes suppliers to compete with each other by offering their goods at prices below the original ruling price - since only one price can prevail on the market, which price will it be? - it will be the lower price, since the products are homogeneous and thefore it is assumed no brand loyalty, the purchaser will purchase from the lower priced supplier - so all sellers will have to drop their prices to sell anything.
Suppose on the other hand, that a price level of R 10 is taken as a starting point. At this price the quantity demanded is 100 units and the quantity supplied 100 units . In this case the quantity demanded exceeds the quantity supplied by 90 units .This difference is called excess demand or a shortage.
Excess demand causes many buyers and few products on the market - competition between buyers who would rather pay more for a product than return from the market empty handed and potentially unfulfilled needs.
The seller lowers the price until the oversupply is eliminated.
If the ruling price is low, buyers will bid up the price in order to ensure that they do not return from the market empty-handed.
The point where there are no forces at play influencing quantity and price, is called the equilibrium price.
11. How do governments intervene in markets (4); Why and what are the logical consequences. You can add onto the diagram in the previous question to illustrate your points.
12. Explain the difference between “a shift along a supply curve” and a “shift of the demand curve” (10)
A shift along the supply curve is as a result of a change in price – the quantity demanded changes because the price has changed. A shift of the curve itself is as a result of preference and/or demographic changes as well as changes in the price of complementary and supplementary products.
A shift in the supply curve can thus be explained as follows. The supply and demand of a good (or service) may change for various reasons (more buyers or more sellers entering the market).
In the figure below D is the original demand curve and S represents the supply curve. N is the level of equilibrium that has been reached on that market.
The price will be OR and the quantity changing hands will be RN.
Suppose there is an increase in demand. This is represented by a shift to the right (or upwards) of the original demand curve. D1 is now the new demand curve. The point at C now becomes the point of intersection with the supply curve and this means that OR1 is the price and R1C the quantity sold. One can see that an increase in demand results in an increase in price as well as the quantity bought and sold.
D2 represents a decrease in demand (one needs to know what cause less buyers to be in a market). Now the intersection is L. The new price is OR2 and the quantity sold drops from RN to R2L. A decrease in demand results in both a fall in price and in quantity.
Two things can be said relating to the above analysis – The immediate effect of an increase in demand if there were not total and immediate knowledge present would be that the price would remain at R and there would be an excess of demand (shortage) of NM which is a position of disequilibrium. Likewise a fall leads to an oversupply of KN which is also a position of disequilibrium. The normal forces in the market will lead to a move towards equilibrium.
13. Explain “price elasticity” and give some examples. Also relate price elasticity with total income. Draw a diagram to illustrate your understanding. (8)
When the price elasticity of demand for a good is relatively inelastic (- 1 < Ed < 0), the percentage change in quantity demanded is smaller than that in price. Hence, when the price is raised, the total revenue rises, and vice versa.
When the price elasticity of demand for a good is unitary (Ed = -1), maximum income is derived.
When the price elasticity of demand for a good is relatively elastic (- ∞ < Ed < - 1) -2,3-,4, the percentage change in quantity demanded is greater than that in price. Hence, when the price is raised, the total revenue falls, and vice versa.
14. Explain what is meant by the concepts “consumer surplus” or “producer surplus” (4)
A deadweight welfare loss occurs whenever there is a difference between the price the marginal demander is willing to pay and the equilibrium price. The deadweight welfare loss is the loss of consumer and producer surplus. In other words, any time a regulation is put into place that moves the market away from equilibrium, beneficial transactions that would have occurred can no longer take place. In the case of a price floor, the deadweight welfare loss is shown by a triangle on the left side of the equilibrium point, The area of the triangle is the amount of money that society loses.
Economics – Learner Controlled Instruction
1. Define Economics (5)
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2. Distinguish between microeconomics and macroeconomics (10)
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3. State what is meant by the “economic problem” (6)
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4. Explain what the Production Possibilities Frontier sets out to illustrate (5)
(Do not explain what it is and how it works)
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5. Explain what is meant by “marginal” and give two examples of how the concept is used (6)
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6. What is meant by the “law of diminishing returns” (4)
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7. Explain why property rights and markets have evolved. (8)
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8. Draw a diagram outlining the key economic role players and through that illustrate the circular flow within an economy. Mention the remuneration of the production factors. (15)
9. Describe what is meant by “perfect market conditions” (8)
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10. Define the concept “market” and explain by using a diagram how prices are formed in a market “under perfect market conditions”. (8)
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11. How do governments intervene in markets (4); Why and what are the logical consequences. You can add onto the diagram in the previous question to illustrate your points.
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12. Explain the difference between “a shift along a supply or demand curve” and a “shift of the demand curve” (10)
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13. Explain “price elasticity” and give some examples. Also relate price elasticity with total income. Draw a diagram to illustrate your understanding. (8)
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14. Explain what is meant by the concepts “consumer surplus” or “producer surplus” (4)
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This self-assessment takes us up to page 66 in the Student Guide.