BEC 111 Principles of Micro Economics Module

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BEC 111: Principles of microeconomics
Course objective:
The purpose of this course is to provide an adequate exposition of the basic concepts
and techniques of microeconomics analysis. The consumer, the producer and the theory
of markets will be covered mathematically and diagrammatically. Furthermore, pure
aspects of General equilibrium theory will be covered.
Learning outcomes:
At the end of this course unit, the learner is expected to:
1. Explain the basic economic concepts

2. Appreciate supply and demand as key issues in the study of economics
3. Explain the concepts of equilibrium, elasticity and market structures as used in
economics
4. Comprehend the utility theory.
5. Explain the factors of production.
Course content
Introduction of Economics
Meaning, nature and scope of economics, scarcity, wants and opportunity cost
The basic market economies
The central economic issues, free enterprise economy, centrally controlled

economy, mixed economy.
The theory of demand

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Meaning, the law of demand, movement along the demand, shifts of the
demand curve, individual factors that affect the demand for products,
assumptions of the law of demand, Price elasticity demand, Meaning and types
of elasticity, influence of price on demand, computing price elasticity of demand,
Factors affecting price elasticity of demand, Income and cross elasticity,
interpreting various elasticities of demand, significance of the concept of
elasticity
The theory of supply
Meaning of supply, The law of supply, Movement along the supply curve, shift of
the supply curve, individual supply curve and market supply curve factors that
affect the supply for products. Change in quantity supplied vs change in supply,
Price elasticity of supply, meaning, types of elasticity of supply, factors
influencing price elasticity of supply, computing price elasticity of supply.
Consumption theory
Definition of consumption, utility analysis,
law of diminishing marginal utility
Indifference curve analysis
Definition of indifference curves, budget lines, Price income and substitution

effect.
The theory of the firm/ production
Factors of production, mobility of factors of production, Division of labour,

Forms of business organisations, demand and supply factors of production, the
law of variable proportions, the law of return to scale, production techniques,
isoquant curves, cost of production.
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Price determination in markets
Meaning and main characteristics of: Perfect competition monopoly,

monopolistic competition and oligopoly, Price and output determination
profit/Loss, Determination in each market structure
Suggested texts
Ackello Ogutu, C and Waelti J. J., (2009), Basic concepts of micro economics: With special
reference to Kenya (2nd Edition). University of Nairobi Press, Nairobi
Begg D., Fischer S. and Dornbusch R., (2003), Economics (7th Edition), McGraw-Hill
Education, United Kingdom
Case E.K., Fair C.R. and Oster S. M., (2012), Principles of Economics (10th Edition),
Pearson Education Limited, United Kingdom
Livingstone I. and H. W Ord, ( 1994), Economics for Eastern Africa, Heinemann
Educational Books
Mankiw N.G. and Taylor .M.P. (2011) Economics (2nd Edition), Cengage Learning EMEA,
Hampshire, United Kingdom
Solomon J., (2006), Economics (6th Edition), Pearson Education Limited, United kingdom
Tucker, I. B (2010), Survey Economics (7th Edition), South Western Cengage Learning,
Mason (SET TEXT)
Recommended Further References:
Hardwick P, Khan B and Langmeed, J. (1999), An introduction to modern economics, (5th

Edition), Prentice Hall, Harlow and others
Harvey, J and Jowsey, E., (2007), Modern Economics: An Introduction (8th Edition).
Palgrave Macmillan,
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Lipsey R and Chrystal K, A, (1999), Introduction to positive Economics, Oxford University

Press, Oxford
Mudida R. (2003), Modern economics, (1st Edition). Nairobi Focus Books
William J. Baumol, Alan S. Blinder, (1985), Economics: Principles and Policy, Harcourt
Brace Jovanovich, Florida, USA,
Methodology
The course will be taught through the use internet interactions
Assessment:
Tests, Term Papers – 30% and Final Examination – 70%

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PART I: INTRODUCTION TO ECONOMICS

Learning Outcomes
By the end of this Part 1, you should understand:
Economics is the study of how society resolves the problem of scarcity
Ways in which society decides what. How, and for whom to produce
The concept of opportunity cost
Positive and normative economics
Microeconomics and macroeconomics
Suggested Texts:
Education, United Kingdom (Chapter 1: pg 4-12)
Case E.K., Fair C.R. and Oster S. M., (2012), Principles of Economics (10th Edition), Pearson
Education Limited, United Kingdom (Chapter 1: pg 2)
Hampshire, United Kingdom (Chapter 1: pg 33-57)
(Chapter 1: pg 4-27)
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Chapter One: Meaning and scope of Economics
Like any other discipline the definition of Economics has evolved over time.
Adams Smith defined Economics as an inquiry into the native and causes of the
wealth of actions this is popular know as the wealth definition.
Other Economists who adopted his view call Economics a science wealth, however
this definition was criticized as teaching selfishness and economic was referred to
as dismal science.
Alfred marshal the study of man everyday business of life that is how man obtain
his income how he uses it. This definition was criticized to be too vague in this that
man‟s activity were not defined and didn‟t scarcity it was referred to as the material
definition of economic
Lord Robbin (1933) discussed Economics as the study of human behavior as a
relationship between ends (wants) and the scarce means (resource) which have
alternative uses from this definition there are three implications:
a) Human beings have unlimited wants that can‟t be completely satisfied at any
one time
b) The means to meet this wants resources must be available to fulfill these
wants.
c) Those resources have various alternative and competing uses.
The first two implications resource are said to be that is limited in supply. Scarcity
of resources passes a problem of choice that is how to make the best use of the
scarce resource.
Economics is therefore defined as a study of scarcity and choice
Choice and opportunity cost
Opportunity cost is associated with the choice it is defined as the cost of the next
best alternative or the cost of an opportunity forgone to illustrate the concept of
opportunity cost consider a producer who produces only 2 products; A and B using
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some scarce resource as shown in the diagram:

Product B
B1
Y PPF/PPC B2
B2
.X
O A1 A2 B
Product B
A PPF shows combinations o product A and B that he can produce using the scarce
resource efficiently. A line that joins together such possible combinations is called
a Production Possibilities frontier /curve (PPF/PPC) ALL combinations that lie
below the PPF are attainable or achievable but reflect inefficiency e.g. combination
X it is reflection of inefficiency because its underutilized All combination above
the PPF are not achievable given the scarce resource combination Y is an
achievable . However, all combination along the ppf are achievable and reflect
efficiency.
The slope of the PPF is referred to as rate of product transformation (PPT). It

measures the rate at which one product can be transformed into another i.e. it‟s the
number of units of one product that must be given up in order to release resources
enough to produce a unit of another product it is an estimate of the opportunity
cost.
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Chapter Two: Economic goals and problems
The economic problem is one of allocation of scarce resource and seeks to answer
three fundamental questions:
a) What goods and service are to be produced with the scarce resources
(consumption theory)?
b) How? Given that we have basic resource such as land, labour, capital, land
entrepreneurship. How should they be combined to produce the goods and
services (production theory?)
c) For whom? Once we have produced the goods and services we have to
decide how to distribute them to the end users. (Theory of markets)
Approaches to the study of economics:

There are two main approaches to the study of economics. They are as follows:
Positive approach:- concerned with the investigation of this ways in which

different economic agents in the society seek to achieve their goods it relates to
statements such as –what is?
a) What was?
b) What will be?
It employs economic theory in explaining circumstances.
The theories are tested against observations and other information and used to
construct models from which predictions are made. A theory is a reasoned
assumption intended to explain an occurrence or a phenomenon a model on this
other hand is a mathematical representation based on economic theory any
disagreement are appropriately settled.
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Normative approach: It is very subjective and depends on value judgment on what

is desirable its concerned with making suggestions about the ways in which society
goals might be more efficiently realized it relates to statement such as:
a) What should be?
b) What ought to be?
It‟s concerned with alternative policy action that helps to illuminate and sharpen
debates
Activity:
Examine the normative and positive approaches to the study of economics. Think
through the approach that the United Nation uses to solve the problems of the
developing countries.
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Chapter Three: Economic systems
Different economic system tackle the basic economic problems in different ways to
economic system is concerned with the ownership and control of scarce resources. There
are many economic problems which we encounter everyday – poverty, inflation,
unemployment etc. However if we use the term The Economic Problem we are referring to
the overall problem of the scarcity of resources. Each society has to make the best use of
scarce resources. There are three main types of Economic Systems:
1. Free Enterprise or free price system

2. Planned Economic Systems
3. Centrally Planned Economic Systems
Free Enterprise or free price system
The free market system is where the decision about what is produced is the outcome of
millions of separate individual decisions made by consumers, producers and owners of
productive services. The decisions reflect private preferences and interests.
The major price and allocation decisions are made in the markets. The market being the
process by which the buyers and sellers of a good interact to determine its price and
quantity.
For the free enterprise to operate there must be a price system/mechanism.
The price system is the situation where the vital economic decisions in the economy are
reached through the workings of the market price.
The free market thus gives rise to what is called Consumer Sovereignty – a situation in
which consumers are the ultimate dictators, subject to the level of technology, of the
kind and quantity of commodities to be produced. Consumers are said to exercise this
power by bidding up the prices of the goods they want most; and suppliers, following the
lure of higher prices and profits, produce more of the goods.
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The features of a free market system are:
1. Ownership of Means of Production
Individuals are free to own the means of production i.e. land, capital and enjoy incomes
from them in the form of rent, interest and profits.
2. Freedom of Choice and Enterprise
Entrepreneurs are free to invest in businesses of their choice, produce any product of their
choice, workers are free to sell their labour in occupations and industries of their choice;
Consumers are free to consume products of their choice.
3. Self Interest as the Dominating Motive
Firms aim at maximising their profits, workers aim at maximising their wages, landowners
aim at maximising their return from their land, and consumers at maximising their
satisfaction
4. Competition
Economic rivalry or competition envisages a situation where, in the market for each
commodity, there are a large number of buyers and sellers. It is the forces of total demand
and total supply which determine the market price, and each participant, whether buyer or
seller, must take this price as given since it's beyond his or her influence or control.
5. Reliance on the Price Mechanism
Price mechanism is where the prices are determined on the market by supply and
demand, and consumers base their expenditure plans and producers their production plans
on market prices.
Price mechanism rations the scarce goods and services in that, those who can afford the
price will buy and those who cannot afford the price will not pay.
6. Limited Role of Government

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In these systems, apart from playing its traditional role of providing defence, police service
and such infrastructural facilities as roads for public transport, the Government plays a very
limited role in directly economic profit making activities.
7. Resource allocation in a free enterprise
Although there are no central committees organising the allocation of resources, there is
supposed to be no chaos but order.
Advantages of a Free Market System
1. Incentive: People are encouraged to work hard because opportunities exist for
individuals to accumulate high levels of wealth.
2. Choice: People can spend their money how they want; they can choose to set
up their own firm or they can choose for whom they want to work.
3. Competition: Through competition, less efficient producers are priced out of the
market; more efficient producers supply their own products at lower prices for the
consumers and use factors of production more efficiently. The factors of
production which are no longer needed can be used in production elsewhere.
Competition also stimulates new ideas and processes, which again leads to efficient
use of resources.
A free market also responds well to changes in consumer wishes, that is, it is
flexible.
Because the decision happen in response to change in the market there is no need to
use additional resources to make decisions, record them and check on whether or
not they are being carried out. The size of the civil service is reduced.
Disadvantages of a Free Economy

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The free market gives rise to certain inefficiencies called market failures i.e. where the
market system fails to provide an optimal allocation of resources. These include:
1. Unequal distribution of wealth: The wealthier members of the society tend to

hold most of the economic and political power, while the poorer members have
much less influence. There is an unequal distribution of resources and sometimes
production concentrates on luxuries i.e. the wants of the rich. This can lead to
excessive numbers of luxury goods being produced in the economy. It may also
result to social problems like crimes, corruption, etc.
2. Public goods: These are goods which provide benefits which are not confined to
one individual household i.e. possess the characteristic of non-rival consumption
and non-exclusion. The price mechanism may therefore not work efficiently to
provide these services e.g. defence, education and health services.
3. Externalities: Since the profit motive is all important to producers, they may
ignore social costs production, such as pollution. Alternatively, the market system
may not reward producers whose activities have positive or beneficial effects on
society.
4. Hardship: Although in theory factors of production such as labour are “mobile”

and can be switched from one market to another, in practice this is a major problem
and can lead to hardship through unemployment. It also leads to these scarce
factors of production being wasted by not using them to fullest advantage.
5. Wasted or reduced competition: some firms may use expensive advertising

campaigns to sell “new” products which are basically the same as many other
products currently on sale. Other firms, who control most of the supply of some
goods, may choose to restrict supply and therefore keep prices artificially high; or,
with other suppliers, they may agree on the prices to charge and so price will not be
determined by the interaction of supply and demand.
The operation of a free market depends upon producers having the confidence that
they will be able to sell what they produce. If they see the risk as being
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unacceptable, they will not employ resources, including labour and the general
standard of living of the country will fall..
Planned Economic Systems
Is a system where all major economic decisions are made by a government ministry
or planning organisation. Here all questions about the allocation of resources are
determined by the government.
Features of this system
The command economy relies exclusively on the state. The government will
decide what is made, how it is made, how much is made and how distribution takes
place. The resources – factors of production – on behalf of the producers and
consumers. Price levels are not determined by the forces of supply and demand but
are fixed by the government.
Although division of labour and specialisation are found, the planned economies
tend to be more self-sufficient and tend to take part in less international trade than
market economies.
Advantages of Planned System
i. Uses of resources: Central planning can lead to the full use of all the factors of
production, so reducing or ending unemployment.
ii. Large scale production: Economies of scale become possible due to mass
production taking place.
iii. Public services: “Natural monopolies” such as the supply of domestic power or
defence can be provided efficiently through central planning.
iv. Basic services: There is less concentration on making luxuries for those who can
afford them and greater emphasis on providing a range of goods and services for
all the population.
v. Equality- There are less dramatic differences in wealth and income distribution
than in market economy
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Disadvantages of the Planned System
The centrally planned economies suffer from the following limitations:
i. Lack of choice: Consumers have little influence over what is produced and
people may have little to say in what they do as a career.
ii. Little incentive: Since competition between different producers is not as
important as in the market economy, there is no great incentive to improve existing
systems of production or work. Workers are given no real incentives to work
harder and so production levels are not as high as they could be.
iii. Centralized control: Because the state makes all the decisions, there must be
large influential government departments. The existence of such a powerful and
large bureaucracy can lead to inefficient planning and to problems of
communication. Furthermore, government officials can become over privileged
and use their position for personal gain, rather than for the good of the rest of the
society.
iv. The task of assessing the available resources and deciding on what to produce,
how much to produce and how to produce and distribute can be too much for the
central planning committee.
v. Managing Costs: Also the maintenance of such a committee can be quite costly.
Mixed Economic Systems
There are no economies in the world which are entirely „market‟ or planned, all will
contain elements of both systems.
The degree of mix in any one economy is the result of a complex interaction of
cultural, historic and political factors. For example the USA which is a typical
example of a largely work-based society, but the government still plans certain
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areas of the economy such as defence and provides very basic care for those who
cannot afford medical insurance.
Features of this system
The mixed economy includes elements of both market and planned economies.
The government operates and controls the public sector, which typically consists of
a range of public services such as health and education, as well as some local
government services. The private sector is largely governed by the force of
mechanism and “market forces”, although in practice it is also controlled by various
regulations and laws.
Some services may be subsidized, provided at a loss but kept for the benefit of
society in general(many national railways, for example, are loss making), other
services such as education or the police may be provided free of charge (though
they are paid for through the taxation system).
The private sector is regulated, i.e. influenced by the price mechanism but also
subject to some further government control, such as through pollution, safety and
employment regulation.
Advantages of the Mixed Economy
i. Necessary services are provided in a true market economy, services which were
not able to make profit would not be provided.
ii. Incentive: Since there is a private sector where individuals can make a lot of
money, incentives still exist in the mixed economy.
iii. Competition: Prices of goods and services in the private sector are kept down
through competition taking place.
Disadvantages of Mixed Economy

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i. Large monopolies can still exist in the private sector, and so competition does not
really take place
ii. There is likely to be a lot of bureaucracy and “red tape” due to existence of a public
sector.
Branches of Economics
The discipline of economic is divided into 2 classes:
a) Micro economic
b) Macro economic
Micro economic deals with the behavior of individual economic units or

agents this agent include consumer, producer (firms) and workers.
Micro economic explains why and how these agents make decisions. It
deals with the problems of resource allocation and is mainly interested in
the action of relative prices of goods and services.
Macroeconomic deals with aggregate economic quantities such as the rate

of economic growth of national output, interest rates, unemployment,
inflation, national trade etc
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SUMMARY
a. Economics analyses what, how, and for whom society produces. The key
economic problem is reconcile the conflict between people‟s virtually
unlimited demands with society‟s limited ability to produce goods and
services to fulfill these demands
b. The opportunity cost of a good is the quantity of other goods sacrificed to
make an additional unit of the good. It is the slope of the PPF.
c. In a command economy, decisions on what, how and for whom are made in a
central planning office. No economy relies entirely on command.
d. A free market economy has no government intervention. Resources are

allocated entirely through markets in which individuals pursue their own
self-interest. Adam Smith argued that an invisible hand would nevertheless
allocate resources efficiently.
e. Modern economies are mixed, relying mainly on the market but with a large
dose of government intervention. The optimal level of intervention is hotly
debated.
f. Positive economic studies how the economy actually behaves. Normative
economics recommends what should be done.
g. Microeconomics offers a detailed analysis of particular activities in the
economy. For simplicity, it may neglect some interactions with the rest of
the economy. Macroeconomics emphasizes these interactions at the cost of
simplifying the individual building blocks.
REVIEW QUESTIONS
1. Using practical examples, discuss the role of economics in your country
2. Using examples, define the economics systems that are used in your country.
Explain why that system is applicable to your country setting.
3. An economy has five workers. Each worker can make 4 cakes or 3 shirts,
however many others work in the same industry. (a) Draw the production
possibility frontier. (b) How many cakes can society get if it does without
shirts? (c) What points in your diagram are inefficient? (d) What is the
opportunity cost of making a shirt?
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PART II: ELEMENTARY THEORIES OF DEMAND

AND SUPPLY AND THE THEORY OF CONSUMER
BEHAVIOUR
Learning outcomes
By the end of this chapter, you should understand
The concept of a market
Demand and supply curves
Equilibrium price and equilibrium quantity
How price adjustment reconciles demand and supply in a market
What shifts demand and supply curves
Price legislations
How consumers demand goods and services
The Cardinal and ordinal approaches to consumer demand
Equilibrium of the consumer in the theories of consumer demand
Suggested Texts:
Education, United Kingdom (Chapter 3,4 5,: pg 26, 41,55)
Education Limited, United Kingdom (Chapter 4, 5, 6: pg 11, 130, 153)
Hampshire, United Kingdom (Chapter 4, 5, 6: pg 68, 94, 118 and 139)
Solomon J., (2006), Economics (6th Edition), Pearson Education Limited, United Kingdom
(Chapter 2, 4, 5: pg 33, 91, 119)
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Chapter Four: Demand for Goods and Services
Demand refers to the quantity or amount of a commodity that a consumer is able

and willing to buy at a given price and over a specified period.
a) Quantity imply that demand is measurable

b) Commodity: both goods and services
c) Consumer : create the demand for goods and services
d) Ability and willing ; imply that the demand is effective as opposed to an
expression of desire
e) Price: Most important determinant of demand and other determinants are
assumed constant. This is referred to as assumption of ceteris paribus.
Factors that influence quantity demand
a) Price of the commodity (x) commodity (PX): It is expected as the price rises
the quantity demand falls and vice versa.
b) Price of related commodities (Pr): Goods may be related in two ways e.g.
substitutes- those used for the purpose e.g. coffee and tea. A rise in price of
one leads to a fall in the demand of the other.
c) Consumer income (Y): An Increases in consumer income will normally
increase the income rise is a normal good while on the other hand a good
whose demand falls as income rises is a inferior good.
d) Taste and preferences (T): A change in taste preferences in favor of a good
will increase its demand and vice versa.
e) Advertisement /Salesmanship (A): The demand of an advertised
commodity increase while the demand of competing goods falls
f) Weather changes (W): A change in weather in favor of a commodity will
increase its demand and vice versa.
g) Government policy (G): An introduction of tax will reduce demand while
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government subsidies will boost the demand of a product.

h) Population (Pop): An increase in population increases the demand for
commodities.
i) Social cultural values (S): Muslim don‟t eat pork hence the demand of it
will be low. These are social values that would affect demand.
j) Future price expectation (Pf): When consumers anticipate a rise in price of
the good in the future the demand will rise and vice –versa.
In summary the quantity demanded of a commodity is dependent on:

QX = ƒ( Px, Pr, Y, T, A,W, G, Pop, S, Pf………..)
Law of demand
State that Ceteris paribus, an increase in the price of a commodity will lead to a fall
in the quantity demanded and vice versa holding the other factors constant.
Demand schedule
Table that list the different quantities of product demanded at various price levels:
Price of commodity Quantity of demand

10 100
20 80
30 60
40 40
50 20
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Demand curve
A graphical presentation of the demand schedule
Observation – demand curve slopes downwards from the left to the right impliying
that more is demanded as the price falls and vice versa.
Demand functions
This is a mathematical statement of the law of demand that expresses the
relationship between the quantity demanded of product and its own price Ceteris
Paribus. It is generally stated in linear form as follows:
Q =a- b P
Where:
Q = quantity demanded
P = Price per unit
a = intercept of the demand function which represent the quantity demanded that is
independent of price i.e. it‟s the demand dependent on other factors.
b = slope of the demand function. It‟s negative implying an inverse relationship
between demand and price. It‟s the amount by which the demand change when
the price change by one unit.
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e.g an increase in price by one unit reduce demand by b units
The slope will be:
∆p = (50-30) = 20
∆Q (20-60) -40
= - ½ or – 0.5
Take one point say, (20,50) and substitute in the equation

and get the y intercept (in our case a)
Q P
(20, 50)
P= a – b Q d
50 =a - (- 0.5x20)
50 =a - -10
a =50+10
a=60
Thus substituting the constants in our equation, we get:
P = 60-0.5Q
0.5Q =60-P
Divide everywhere by 0.5 we get:

Q =120 -2P
This is the demand function
From the above demand schedule /curve, consider any two points on the slope (50,
20) and (30, 60)
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Movement Along The Demand Curve
All that a demand curve shows the relationship between the quantity demanded of
product and its price while holding all other factors constant.
If the price of the product result in a change in the quantity demanded this change
in demand is shown as a movement along the demand curve. E.g. an increase in
price result in a fall in quantity demanded and this fall is shown is shown as a
movement up along the demand curve. On the other hand a fall in price results in
an increase in the quantity demanded which is a movement down along the demand
curve as shown in the following diagram
Price
Increase in Quantity demand

40
Decrease in Quantity demand
20
20 60 (Quantity)
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Shift of The Demand Curve
A change in other factors of demand will cause a shift in the demand curve an
outward shift of the dc (shift to the right ) represent an increase in demand at any
price level while an inward shift (shift to the left) represent a decrease in demand
this is shown below:
Price
Shift to left shift to the right (increase in demand) D1
D2
D0
Increase in Demand
D1
Q1 Q0 Q2 Quantity
Expectation of the Law of Demand
Under normal circumstances the demand curve slope downward from the left to
right showing more is demand as the price falls and vice verse however , some
product violate this principle how . e.g. of such product
a) Giffen goods – one that is the inferior that a fall in price leads to a fall in the
quantity demanded
b) Veblen goods – luxury activities of presentations or goods for the rich. For
these goods an increase in price result in an increase in the quantity
demanded.
c) Necessities- these are goods whose demand isn‟t affected by changes in
price.
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The demand curve is vertical e.g. of such goods such as medicine;
Q
Elasticity of Demand
The term elasticity of demand refers to the degree of responsiveness of the quantity
demanded of product resulting from a change in any of the factors of demand e.g.
a) Own price elasticity of demand: It‟s the degree of responsiveness of the

quantity of product resulting from a change in its own price cross price
elasticity demand which is the degree of responsiveness of the quantity of
product resulting from a change in its own price.
b) Cross price elasticity demand It is the degree of responsiveness of the

quantity demanded of the product(X) resulting from a change in the price of
related commodity (X).
c) The income of elasticity of demand: Degree of responsiveness of the

quantity demanded of a product resulting from a change in income
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Own price elasticity of demand(P.E.D)
Given by a percentage change in the quantity demanded by a percentage change in

price
Percentage change in quantity demanded

Percentage change in price
P.E.D=
The above formula is referred to as point elasticity because it‟s

computed on one point along the demand curve.
The first part of the formula that is represents the slope of the
demand function /curve. Since the demand Curve is negatively sloped

the co-efficient of elasticity is always negative however, in
interpreting the co-efficient the negative sign is ignored.
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Arc elasticity
Also referred to as the average elasticity this is an elasticity computed on a range
along the demand curve. It uses the mid-point of the two points along the demand
curve.
Interpretations
a) P.E.D =1 The demand is unitary elastic meaning a one percentage change in price
result in one percentage change in the quantity demanded
b) P.E.D > 1 The demand is elastic means that a one percentage change in price
result in a more than one percentage change in the quantity demanded
c) P.E.D < 1 the demand is inelastic means that a one percentage change in price
result in a less than one percentage change in the quantity demanded
d) P.E.D = 0 than the demand is sold to be perfectly inelastic
e) P.E.D = ∞ (more than one) than demand is perfect elastic
Price quantity P.E.D P.E.D

10 100 - -
20 80 0.2 0.33
30 60 0.5 5/7
40 40 1 1.4
50 20 2 3
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Point elasticity = ∆Q * P1 = ∆Q = 80 -100 X 10

∆P QP 20 -10 100
= 20 * 10 = -0.2
10 100
=0.2
Arc formula = ∆Q * P1 +P2 = 20* 30 = 10
∆P Q1 +Q2 10 180 30
=0.33
Activity:
Suppose the demand function is Q = 120-2P. Find the price elasticity
of demand when the price is 20
Answer:
P =20
P.E.D = ∆Q * P
∆P Q
Q =120 2P
Q =120 -40
Q =80
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Cross –price elasticity of demand (C.E.D)
Computed as % change in the quantity demanded of goods (X) divided by %

change in the price in Y Where X and Y are related commodities
Percentage change in the Qx

Percentage change in Py
= Q2X –Q1X X 100

QX = ∆QX
P2 Y – P 1 y X100 QX
∆PY
PY
C.E.D= ∆Qx * Py1

∆ Py Qx1
a) C.E.D > 0 meaning great than zero means that X and Yare substitute
b) C.E.D< 0 means than X and Y are compliments
c) C.E.D =0 Means than X and Y are unrelated
Illustration:
Suppose the C.E.D is -3
Means the goods are compliment
The demand for goods X is elastic meaning that a change in the price of goods Y by one
percent results in a three percent change the quantity demanded of goods X
34
Price tea Quantity of Coffee

25 2000
20 180
Compute the cross elasticity demand for coffee
∆QX PY = 180 - 200 * 25

∆PY QX 20-25 200
= 0.5
i. They are substitute goods

ii. The demand for coffee is inelastic
iii.When the price of tea changes by one percent the quantity demand for coffee
change by 0.5 percent
∆QX * P1 +P2
∆ PY Q1 +Q2
-20 * 45 = 9 = 0.47
-5 380 19
Income elasticity of demand
% change in the quantity demand

% change in income
Q2 –Q1 X 100
Q1 = ∆Q
Y2 –Y1 X 100 Q1 = ∆Q * Y1
35
Y1 ∆Y Q1 ∆YX
∆Y1
= ∆Q * Y1 (point income elasticity of demand)

∆Y Q1
= ∆Q * (Y1 +Y2) ( Arc income elasticity of Demand)

∆Y (Q1 +Q2)
Y.E.D= ∆Q * Y1
∆Y Q
The Y.E.D <0 the good in inferior good

0. < Y.E.D <D = normal goods – necessities
Y.E.D.≥/ the goods are luxuries
Price of good Y Quantity of demand

10 100
good X
15 200
Factors that influence elasticity of demand

a) Availability of close substitute – a product it has close substitute will have
an elastic demand and vice-versa.
b) Degree of necessities – necessities have more inelastic demand.
c) Durability of a product –the more durable a product is the more inelastic its
demand.
d) Preposition of income to spend on the product - a product that takes a
substantial share of income has an elastic demand.
e) Influence habits demand for habitual goods is inelastic e.g. a genetic
Importance of the concept of elasticity of demand

36
1. Government planner in tax policy the government impose tax for two
reasons
a) To raise revenue
b) To discourage consumption
2. The impact of a tax is felt through increased prices for gas and service.
If the government objective is to raise revenue success is only guarantee
if the demand of the product is inelastic on the other hand if objective is
to discourage consumption of a product success is guaranteed if the
demand of the product is elastic.
3. Entrepreneur‟s sales decision- It is in the interest of the entrepreneur‟s

to increase revenue or sale this possible through increasing the output or
raising price the impact of a price increase revenue depend on how
elastic demand is if the demand for the product is elastic the
entrepreneur is better of reducing prices however if the demand is
inelastic an increase in price will increase revenue.
37
38
Chapter Five: Supply of Goods and Services
Supply refers to the amount or the quantity of a commodity that a producer is using
to offer for sale at a given price and over a specified period of time.
Factors That Influence Supply

a) Price of the product (P): That the higher the price in the market the more the
produce is usually to produce for sale other factors remaining constant
b) Technology (T): An improvement in technology increases production and hence
supply
c) Cost of production (C): An increase in cost of production hinders production and
hence reduces supply and vice versa.
d) Government policy (G): The government may influence supply in different ways
(Through taxes the introduction of a tax is a distinctive to production and hence
reduce supply).Through subside which is incentive to production and hence
increase supply which is a quantitative restriction placed by the government on the
amount of a commodity to be supplied.
e) Price expectation (Pf): If the producer expect an increase in the supply now falls
cause there is holding of goods and service favorable change in weather increases
production and hence supply.
Law of supply
States that the higher the price in the market the higher the supplier but holding
other factors constant and vice versa.
39
Supply schedule
This is a table that shows the quantity supply at various price levels
price Quantity supply(„000‟)
10 20
20 450
30 60
40 80
50 100
Supply curve
Graphical presentation of the supply schedule
60
50
40
Pric e per Uni t
30
20
10
0 10 20 30 40 50 60 70
Numberof Uni ts Suppli ed (i n 00' s)
Supply curve slope upward from left to the right. Implying that more is supplier
the price rises and vice versa.
40
Supply function
This is a mathematical relationship between the quantity supplied of a product and
its pace while other factors remains constant
It is in the form of Q=a+bP
Consider the above supply schedule and take any 2 point

P Q P Q
(20, 40) (30, 60)
The linear expression of a supply function is
Q =a + bP
A = intercept of the function
B = Slope of the supply function
The slope is positive because the price increase leads to an increase
in the quantity supply
The slope will be:
∆Q = (60-40) = 20
∆P (30-20) 10
=2
Take one point say, (20,50) and substitute in the equation and
get the y intercept (in our case a)
P Q
(20, 40)
P= a + b Q d
40 =a + (2x20)
40 =a +40
a =40-40
a=0
Thus substituting the constants in our equation, we get:
Q =0+2P
Q=2P
This is the Supply function

41
Movement along the supply curve

The quantity supplied is affected by the price of the product among other factors
.a change in the price of the product result to a change in the quantity supply and
this change is affected as a movement along the supply curve e.g. an increase in
price result in an increase in the quantity supply this increase in supply is a
movement up along the supply curve. On the other hand a fall in price results in a
fall in the quantity supply reflected as a movement down along the supply curve
this is shown below:
Shift of the supply curve

A shift of the supply curve is caused by change in their factor that influence supply
shift of t he supply curve to the right (outward shift) is an increase in supply at any
price level. While a shift to the left (inward shift) in a decrease in supply at any
price level.
42
Elasticity of supply
Degree of responsiveness of the quantity supplied of product resulting from change
in the factors that influence supply. E.g. the price elasticity of supply less to the
degree of responsiveness of the quantity supplied resulting from a change in the
price of a product.
P.E.S =% change in the quantity supply

% change in price
43
Factors that influence elasticity of supply
a) Availability of space as excess capacity- If a firm has not fully utilized its
resources in production an increase demand can easily be met by utilizing
the idle capacity
b) Availability of stock /inventory- As a long as a stock at supply will be
elastic availability of stock
c) Gestation period- Time taken to produce a commodity the longer the
gestation period the more the inelastic the supply and vice versa.
d) Availability of factors of production
e) If the factors of production are easily available supply is highly elastic.
f) The case of entry into the industry- Increased production results from either
r the existing firms expanding production or more firms using the industry.
However there are barriers that exist in joining the industry the more the
barriers the more the inelastic becomes
44
Chapter Six: Determination of equilibrium price
Equilibrium is a state of rest that there are no force being generated in the
market and quantity demanded of product is equal to the quantity.
Consider a demand supply schedule:
Price Quantity Quantity

10 100 20
ce sold
20 80 40
30 60 60
40 40 80
50 20 100
At a price of Ksh.30 the quantity demand is equal to quantity supply such a state is
referred to as market equilibrium. The price corresponding to the equilibrium point
is referred to as equilibrium price (30) while the corresponding quantity is referred
to as equilibrium quantity (60)
Price
50
40
E
30
20
10
0 20 30 40 50 60 70 80 90 100
45
Quantity
Point E is referred to as equilibrium point the point of intersection between

the demand curve and supply curve the market equilibrium price is
determined by the interaction of demand and supply. At point E the
quantity demanded is equal to quantity supply. That‟s there is no excess
demand and excess supply. The market is said to clear or rest at any price
above the equilibrium say Ksh 40 due to excess supply over demand. The
force of excess supply exacts pressure on price to fall.
As the pace fall the quantity demanded rises from 40 units along the
demand curve while the quantity supplied falls from 80 units along the
supply curve. The fall in price continues until the equilibrium price is
restored. At the price below the equilibrium say Ksh 20 there is excess
demand over supply. The force of excess demand exerts pressure on price
upwards .as the price rises the quantity demanded falls along the demand
curve while the quantity supply increase along the supply curve. The sale
price continues until the equilibrium price is restored.
NB: Any disequilibrium as a result of a price change will trigger forces of demand
and supply that will automatically restore the equilibrium such an equilibrium that
is automatically restore is shown as a stable equilibrium.
Equating the two;
P=30 and Q=60

46
The Neutral Equilibrium
In the above stable equilibrium , it is assumed that the price of the product is
changing to cause a disequilibrium .When other factors that influence demand and
supply change, the equilibrium shift from one point to another such equilibrium are
referred to as neutral equilibrium e.g. consider a market equilibrium represented in
the following diagram;
Price
S1
SO
P1
P2
D1
D0
QE Q1
The consumer income increases, ceteris paribus .an increase in income

results in an increase in the quantity demand .The increase is demand shift
the demand curve to the right from Do to D1 it‟s a result the equilibrium
point shift from Pe to a higher equilibrium point P1.
Increase in cost of production results to an increase in cost of production
resulting in a fall in production and hence supply. The fall in supply, shift
47
the supply curve to the left from S to SS.

48
Interventions
The market equilibrium it is assumed to be at the equilibrium price is
determined the market force of demand and supply however such a price
will not lead to efficient and equitable allocation of resource or scarce e.g.
the price may be too high for some consumer or too low for producer. Its
therefore necessary for the government to intervene and ensure equitable
allocation of resource.
Taxes – government will improve taxes on goods and service for various
reasons among them is to raise revenue for day two day running of the
nations activity the affected of a tax is negative on both demand and supply
side. The consumer will pay a higher price the market equilibrium while
product will receive a lower than the equilibrium price the difference
between the consumer price the producer price is the tax.
Illustrations;
QD = 100 - 2P
QS = 40 + 4P
At Equilibrium QD = QS;
100 -2P = 40 + 4P
Hence Q = 80 and P = 10.
49
Price Legislation
The government fixes maximum price (price ceiling) and minimum prices (price
floor) for goods and services.
Price Floor
Refers to minimum pace legislation fixed by the government usually two protect
producers and wage earners. The government fixes price floor above the market
equilibrium due to the fact that the equilibrium price is too low for the producer as
shown below.
P S
S D
Q1 QE Q2
Q
Q2 – Q1= Excess Supply
A price floor results in excess supply over demand. This excess supply cannot be
corrected by the market force of demand and supply because of the minimum price
legislation. This resultant excess supply results in consumers withdrawing some
demand and producers increasing supply. In such cases the government has an
obligation to clear the market by buying off the excess supply in the market. This
50
scenario is common in the agricultural sector where the excess supply becomes a
buffer stock.
Price Ceiling
It is the maximum price legislation imposed by the government below the
equilibrium price to protect consumer from exploitation.
Price S
PE
Q1 QE Q2
Results in excess demand over supply in the market. This excess demand cannot be
corrected by the market forces of demand of supply. The excess demand result from
increased demand of goods and services and reduced supply in agricultural
commodities. Such a price ceiling is supported by the government running down its
stock to meet the excess demand.
51
Chapter Seven: The theory of consumer behavior
The consumer choice between goods and services is guided by the anticipated
satisfaction derived from consuming these goods and services. The anticipated
satisfaction is known as Utility.
Utility is defined as the ability in a good or services to satisfy the consumer e.g. a
consumer will chose a bundle of goods A and B because A promise a higher utility
than B.
There are 2 approaches to other study of utility cardinal approach

a. Cardinal Approach
b. Ordinal Approach
The cardinal approach
In this approach, utility is assumed to be measurable in units called Utils or in

monetary terms. The total utility that a consumer derives in consuming goods
and services is dependent on the number of units consumed. The more the units
consumed, the greater the overall amount of total utility.
On the other hand the extra utility from consuming an extra of a good is
diminishing. The additional utility resulting from consumption of an extra unit of a
product or good is known as Marginal Utility.
Therefore, the Cardinal Approach is based on the concept of Diminishing Marginal

Utility. This means that the additional benefit derived from consumption of an
52
extra unit of a product continuously diminishes or goes down until it results in

Disutility.
Consider the following consumption schedule:
Units consumed Total Mu

0 - 0
utility
1 27 27
2 39 12
3 47 8
4 52 5
5 55 3
6 57 2
7 58 1
8 58 0
9 56 -2
Activity:
Plot the above Schedule on the same plane

.
When the given schedule is plotted, the total utility increases as more and more
units of the goods are consumed. At around 8 units of the goods the total utility
reaches maximum and falls thereafter. From the marginal utility, the total utility
increases at a decreasing rate and this is depicted from the downward sloping
marginal utility curve. This is the extra satisfaction (Mu) derived from consuming
more and more units of a good and it keeps on getting smaller and smaller. This is
referred to as the concept of diminishing marginal of utility. When the total utility
reaches maximum, the marginal utility turns negative, this implies that product or
the good becomes a disutility.
53
The cardinal approach is based therefore on the following assumptions:
1) The consumer is rational - this means that the consumer‟s objective to

maximize utility subject to a given level income.
2) Utility is cardinal - this means that utility is measurable and money is used
to measure its units. The amount of money that a consumer is willing to
sacrifice for an extra unit of a product is seen as a perfect measure of the
value attached to the product.
3) Marginal utility of money is constant – that since money is used as a unit of

measurement its value to the consumer should remain constant and
unchanged.
4) Marginal utility depends on the quantity of a commodity consumed – that

the more the units are consumed the more the total utility.
5) Diminishing marginal utility- the additional satisfaction / utility derived

from consuming an extra unit of product gets smaller and smaller.
Consumer Equilibrium
According to the Cardinalist approach a consumer is at equilibrium where:
Marginal Utility of a good x is equal to its price. Depicted as:
MUX=PX
54
When MUx < Px the consumer tendency in this case is reduce consumption of the
product and hence increase the marginal utility units until the equality is restored.
When MUx > Px the consumer tendency is to increase consumption and hence the,
marginal utility diminishes until the utility equality is restored.
Generally given to consumer goods X and Y equilibrium requires
MUx = Px
MUy = Py
Then:
The above equation depicts the equilibrium condition according to the Cardinalist
Approach.
Suppose the price of good X raises other factors remaining then the
acts to restore the equilibrium. Mux must rise. This is only possible if
the consumer reduces the consumption of good X. from this illustration, law of
demand is seen to work to maintain the consumer at the equilibrium point. That
should the price rise the consumer must reduce consumption for the equilibrium to
be maintained.
55
On the other hand should the price fall the consumer must increase consumption to
maintain the equilibrium. The concept of the Mu is used to derive the consumer
demand curve and this demand curve is identical to the positive portion of the Mu
utility curve as shown below.
DIAGRAM
NB: The negative position of Mu curve cannot reflect the demand curve because
prices can never be negative.
Illustration Question
Suppose a consumer consumption schedule for three goods A, B and C is given the
following table:
Units MU MU/ MU MU/P MU of MU/P
of A PA of B B C C
1 100 10 96 19.2 90 15
2 90 9 80 16 72 12
3 80 8 72 14.4 64 10.6
7
4 70 7 60 12 42 7
5 60 6 45 9 36 6
6 50 5 40 8 30 5
7 40 4 35 7 24 4
The price of goods A is Ksh 10 per unit, B Ksh 5 per unit and C is Ksh 6 per unit.
Determine the amount of each good that the consumer must consume to maximize
utility. How much income must the consumer have to maximize utility?
Suppose the price of good B rises to Ksh 10 per unit how will the curve above
change?
56
A = 4 Units
B = 7 Units
C = 4 Units
Income = 4 x 10 = 40
7 x 5 = 35
4 x 6 = 24
= Ksh 99
Ordinalist Approach (Indifference Curve Analysis)
One of the major criticisms of cardinalist approach is that utility can be measured.
According to the Ordinalist the consumer isn‟t capable of assigning quantitative
units of utility to commodity but he /she is only able to rank commodities in the
order of preference.
This means that given a choice between A and B, the consumer is only able to rank
them so that either A is preferred or B is preferred to A or the consumer is in
different between A and B. A is preferred to B and B is preferred to A.
Assumptions
1) Consumer is rational: The consumer aims is to maximize utility subjected
to the given level of income.
2) Utility is ordinal: Meaning that utility isn‟t measureable but the consumer is
able to rank commodities in on order of preference.
3) Completeness: Assumes that a consumer is capable of making a choice.

That is given a choice between A and B the consumer must make one of the
following decisions either he prefers A to B, or prefers B to A or he is
indifferent between A and B.
57
4) Consistency: If the consumer is choosing between A and B and he prefers A

to B then the consumer must not prefer B to A at any other time as long as
both A and B are available.
5) Transitivity: means that if he prefers A to B and B to C then A must be

preferred to C. (APC)
The consumer level of preference is represented by an indifferent curve. An

indifference curve is a locus or a curve that joins together different combination of
goods that yield the same level of utility to a consumer .e.g. suppose the consumer
consumes two goods X and Y and that utility is obtained by;
U = x + y.
If U =12 it‟s possible to obtain different combinations of X and Y that satisfy the
utility equation.
X Y
0 12
2 10
4 8
6 6
12 0
The schedule above shows the different combination of goods X and Y that the
consumer would be indifferent to. The indifference schedule produces an
indifferent curve as shown:
Properties Of Indifference Curves

58
1) They are everywhere dense. On the quadrant every point is a combination

of goods and every combination must lie on the Indifference Curve.
2) Indifference Curve should not intersect this is because one combination
cannot yield more than one level of utility to the consumer.
3) Higher indifference curves yield higher levels of utility - that is the higher
the Indifference Curve the higher is the level of utility it represents.
Good X
Good Y
The Indifference Curve slopes downward from the left to the right. This means that
if the consumer wishes to consume more units of one of the goods and maintain the
utility level some units of the other goods must be sacrificed. That is there must be
substitution.
59
The Indifference Curve must be convex to the original. This implies that as the
consumer give up more and more units of one good, successfully larger unit of the
other good must be obtained to compensate the consumer for the loss of the utility
level.
Slope of Indifference Curve
It is referred to as a Marginal Rate of Substitution (MRS). It‟s the ratio which two
goods can be substituted without changing the level of utility. It measures the
number of units of one good that must be given up in order consume one extra
unit of the other goods, utility remaining constant.
Consider an indifference Slope:
Good X Good Y
1 12
2 6
3 4
4 3
6 2
12 1
MRS = ∆y = 4-6 = -2 = -2
∆x 3- 2 1
From, a utility function point of view the slope of an IC is the negative ratio of the
Mux of the two goods.
60
Consumer Budget Constant
The consumer‟s objective to maximize utility is subject to the constraints of his

income. Considering two goods X and Y let Px and Py represent the units price of
Good X and Y respectively and let M represent the consumer level of income. The
consumer budget assuming only two goods X and Y will be stated as:
Px + Py ≤ M
Assuming no other goods than x and y:
Px + Py = M
Let Px = Ksh 20 and Py be Ksh 10 and income M =100
The consumer‟s budget constraint is given by:
20X +10Y =100
It‟s possible to identify different combination of X and Y that meets the budget
constraint:
Budget Schedule
X Y
0 10
61
1 8
2 6
3 4
4 2
5 0
Slope of the budget line

Consider the budget constraint:
Px X +PyY = M
Py Y =M - PxX
Y = M – PxX
Py Py
The slope of a budget line is a relative price or a ratio of prices. It measures the
amount of one good that must be given up in order to use an extra unit of the other
good income remaining constant.
The above example depicts the slope of the budget line.
20x +10y =100

10y =100 -20x
62
Y =10 -2x
∆y = -2
∆x
Using the above budget schedule it produces a budget line.
Good Y
B
A
63
Good X 5 10
Combination (A) is achievable and affordable because the some of the consumer‟s
income will remain unspent.
Suppose the price of good X falls by 50%, the new budget line will be:
10x +10y =100

X =0 Y =10
Y =0 X =10
Suppose Px Increase by 50% then:
30X +10Y =100

X =0 Y = 10
Y =0 X = 3.3
A change in the price of commodity pivots the budget line along the bundle of the
goods whose price is changing. Specially a fall in price pivots the budget line
outwards while an increase in price pivots the budget line inwards.
From the above example, suppose the income increase by50%, holding the price
constant:
20x +10y = 150

X =0 y =15
X =7.5 y =0
64
GOOD Y
15
10
Increase in Income
Falling Income
5
GOOD X
Changing the consumer income results in a shift of the budget line. Specifically an
increase in income shifts the budget line to the right while a fall in income shifts
the budget line to the left.
Consumer Equilibrium
Consumer Indifference Curves are drawn on the same graph with the budget, the
following will be the configurations:
Good Y
YE e
65
Budget Line
XE
Good X
The tangency of indifference curve and budget line is referred to as the consumer
equilibrium price. It is the tangency that depicts a point of contact between the
consumer budget line and the highest possible IC. The combination of goods that
maximizes utility subject to the budget constraints. At the point e, the slope of the
budget line is equal to that of the IC that is:
(Equilibrium condition for utility maximization)
a. The condition is used to be the first and necessary for utility maximization.
Here it is not sufficient.
b. The second and the sufficient condition for utility maximization is that the
IC must be convex to the origin.
Income Consumption /Offer Curve
Consider the consumer equilibrium point:
Good Y
66
Good X
A change in income results to a shift in the budget line either to the right or left.
An increase in income shifts the budget line to the right. Along every new budget,
as income changes, there is a point of tangency with the respective indifference
curves. Such points of tangency are all consumer equilibrium points as shown in
the diagram:
Good Y
Good X
A curve which joins together all the different consumer equilibrium points as
income change is referred as an income offer curve /consumption curve.
Price Offers /Consumption Curve

A change in price pivots the budget line along the axis of the good whose price is
changing.
Along every new budget line as the price changes, there a point of tangency with
the respective indifference curve. A curve which joins together the different
consumer equilibrium points as the pace changes is a price offer curved
/consumption curve.
Good Y
67
Good X
SUMMARY
Demand is the quantity that buyers wish to buy at each price. Other things equal,
the lower the price, the higher the quantity demanded. Demand curves slope
down.
Supply is the quantity of a good seller‟s wish to sell at each price. Other things
equal, the higher the price, the higher the quantity. Supply curves slope upwards.
Elasticity of the demand and supply showing the degree of responsiveness of

demand and supply due to changes in the factors of production.
The market clears, or is in equilibrium, when the price equates the quantity
supplied and the quantity demanded. At prices below the equilibrium price there is
excess demand (shortage), and at prices above the equilibrium price there is excess
supply (surplus), which itself tends to reduce the price.
In the consumer theory, there are two main consumption analyses. That is the
Ordinal and cardinal approaches. The Cardinal approach assumes consumers can
68
PART III: THE THEORY OF PRODUCTION AND

BEHAVIOR OF THE FIRM
Learning outcomes
By the end of this Part 3, you should understand
The concept of a Production
A production function
Technology and a technique of production
How the choice of technique depends on input prices
Total, average, and marginal cost, in the long run and short run
Fixed and variable factors in the short run
The laws of production: Law of diminishing returns and Law of Return to scale
The Markets: Monopoly, Duopoly, Oligopoly, Monopolistic and Perfect competition
The equilibrium in the Perfect competition and monopoly markets
Suggested Texts:
Education, United Kingdom (Chapter 7, 8, 9: pg 86, 101, 119)
Education Limited, United Kingdom (Chapter 7, 8, 9, 13: pg 285, 301, 345)
Hampshire, United Kingdom (Chapter 13, 14, 15,: pg 265, 288, 308, 338, 355)
Solomon J., (2006), Economics (6th Edition), Pearson Education Limited, United Kingdom
(Chapter 6, 7: pg 156, 177)

69
70
Chapter Eight: Introduction to Production
Production refers to the transformation of input into an output or outputs. The agent
that aids the process of production is referred to as the firm.
A firm is a single entity which transforms inputs into output and a group of firms
producing a homogeneous product is referred to as an industry.
Inputs in production are referred as facts of production. They include:
1) Land- represents all the natural resource used in the process of production
e.g soil, oceans, rainfall, lakes the reward /payment for land is rent.
2) Capital – any man-made resource which aids in further production of

goods and services. They are intermediate products which increase
efficiency of other factors with which it‟s used the reward for the use of
capital is interest.
3) Labour: refers to any human, mental or physical effort which goes in the
production of goods. The reward is wage and salary.
4) Entrepreneurship: refers to the ownership of the process of production.

An entrepreneur takes responsibility of all the risks involved. He acts as the
organizer of the other factors of production, the reward them takes
responsibility for profits or loss the reward is profit or losses.
There two type of production:
Direct production (Subsistence Production)

This is production for domestic or private use /production not for sale.
Indirect production
Refers to production for trade sale. It is production is based on division of labour
(specialization). Division of labour /specialization is the concentration of labour on
71
a particular skill.
Advantages of specialization
1) Its time saving
2) Increased production in terms of quality and quantity
3) Saves on tools and implements
4) Leads to innovations and inventions
Disadvantages
1) Monotonous hence boring
2) Expose labour to unemployment
3) Labour becomes mechanized
4) A small description in the process leads to a description in the whole
process.
Definition Of Terms
a. Production function – refers to a mathematical presentation of the technical

relationship between factors of production and output. It is generally stated
as:
Q = ƒ(L, K, E, L) where Q is the output and other are the factors of

production.
Traditionally labour and capital are the basic factors of production hence:
Q =ƒ(L, K)
b. Technology – refer to a combination of inputs that produce any one unit of

output.
72
Consider two technologies A and B when:
A B
L 2 2
K 1 2
A is said to be technically efficient since its using at least less of one of the input
and no more of the input to reduce a unit of output
The amount of a factor or input in a technology is referred to as factor intensity
e.g. a technology which makes more use of labour than capital to produce a unit of
output is said to be labor intensive wile one that makes more use of capital than
labour is capital intensive.
C D
L 3 2
K 1 3
Technology C is labor intensive while D is capital intensive.
In the choice of technology a firm must consider the availability of a factor or

abundance of a factor. A technology is said to be appropriate if it makes intensive
use of abundant factors.
c. The Production Horizon /Period
This refers to the production life of a firm which is divided into two factors:
1) The short run period - A period within which all factors at least one factor
of production is fixed.
73
2) The long-run period - - The period within which all at least on factor of
production are variable.
74
Chapter Nine: Theories of Production
These are laws which examine or explain the changes in output either in short run
or in long –run. The law which examines how output changes when at least one
factor of production is fixed are referred to as the law of variables proportions
/law of diminishing return. On the other hand the law which examines how
output changes in all factors of production are changing by the same proportion is
referred to as the law of return to scale.
Law of Diminishing Return
The law state that as more and more units of a variable factor are employed against
some amount of a fixed factor, the total products increase first at one increasing
rate then continues at a decreasing rate and eventually falls.
Consider the following concepts:
1. Total physical product (T.P.P): Refers to the output produced given any
level of input. It is abbreviations as Q.
2. Average physical product (A.P.P): Refers to the output per unit of input
given by:
3. Marginal physical product (M.P.P): Refers to the additional output

resulting from an extra unit input e.g.
75
4. Input Elasticity Of Output (El)
This refers to the degree of responsiveness of output resulting from a

change in the input e.g. labour
Illustration:
Consider the following production data where labour is the variable factors of
production:
Labour T.P A.P.P M. EQ
1 15 15 15 1
.P P.P
2 35 17.5 20 1.14
3 60 20 25 1.25
4 90 22.5 30 1.33
5 120 2.4 30 1.25
6 144 2.4 24 1
7 158 22.6 12 0.62
8 160 20 2 0.1
9 160 17.8 0 0
10 158 15.8 -2 -
0.13
Obtain the column of:
1) A.P.P
2) M.P.P
3) EQ
76
From the M.P.P, the total physical product increase first at an increasing rate up to
about 4 units of labour, after that the T.P.P continuous to increase but at a
decreasing rate as depicted by the M.P.P. At the maximum point of the T.P.P the
M.P.P turn zero. Thereafter the total falls and the M.P.P turns negative. The A.P.P
and the M.P.P are both rising at first with the M.P.P higher than the A.P.P the
M.P.P reaches a maximum earlier and when it‟s falling; it cuts the A.P.P on its
maximum point. When they are both fall the A.P.P, is higher than the M.P.P. The
relationship between the three is best represented in a diagram.
T.P.P
M.P.P
A.T.P
T.P.P
A.P.P
M.P.P
The above diagram reveals three stage of production in the short run:
77
Stage 1
Referred to as the stage of increasing returns. The T.P.P is increasing at an
increasing rate and both marginal and average` physical product are increasing.
The output is elastic. This implies there is a high productivity if a labour in the first
stage.
Stage 2
Referred to the stage of diminishing returns. That is the total physical product
increases at a decreasing and reaches a maximum. Both M.P.P and A.P.P are
falling throughout the stage. The output becomes inelastic. This is known as the
Economics stage of operation because the firm realizes it‟s potential. That is all
resource is fully utilized. The firm, acquire an input balance between the variable
factor and the fixed factor.
Stage 3
Referred to as the stage of negative return. The T.P.P is falling and M.P.P turns
negative. Output becomes negatively elastic. It‟s not feasible at all for any firm to
operate in stage 3 because the fixed factors already had been exhausted and more
labour beyond this point simply lead to negative production.
The Law Of Return To Scale (Long Run)
This is the law that examines how output change when all factor of production are
changing by the same proportion. The relationship between output and input in the
long run is best described by an isoquant.
An isoquant is a locus /curve that joins together different combinations input that
78
yield the same level of output.
NB: An isoquant is analogous to the indifferent curve. (It has the properties of an
Indifference Curve)
There are 3 levels of return to scale if a firm:
1. Constant returns to scale – in this curve proportionality change in input

leads to a proportional‟s change in output e.g. if inputs are doubled output
also double output also doubles.
L K Q
2 1 100
4 2 200
2. Increasing returns to scale - in this case a proportional change in input

leads to a more than proportional change in output e.g. If all inputs are
doubled output more than doubles.
L K Q
2 1 100
4 2 300
3. Decreasing returns to scale – A proportional change in input leads to a

less than proportional change output e.g. if input are doubled output less
doubles.
L K Q
2 1 100
4 2 180
79
Chapter Ten: The Theory of Costs
Cost of production comprise of payment to factors of production. E.g. wage and

salaries paid and the use of labour, interest paid for the use of capital, rent for land,
profit and losses for entrepreneurship.
Production cost include the cost of raw material, repair and maintenance,
depreciation etc
There two type of cost:
Fixed cost prime cost: Cost incurred b a firm regardless of whether there output or
not. That is cost independent of output. Cost when output is zero. E.g. Rent,
insurance, salary etc
Variable cost: Those cost directly related to output. The more the output the more
will be the cost.
Total cost of production = fixed variable cost
T.C = F.C + V.C
Slopes of The Cost Curve

80
1. Fixed cost curve is a horizontal line.

2. Variables cost curve takes the shape of a n inverted S beginning from the
origin while the total cost curve has the same shape as the variable cost
curve only that it is displaced upward by the amount of the fixed cost.
TC Total Cost
VC
FC
Variable Cost
Fixed Cost/Prime Cost
Output
Average cost and marginal costs

81
Average cost is the cost per unit of output that‟s the:
A.TC = T.C
Q
ATC = T.C = FC+ VC = FC + VC
Q Q Q Q Q
Marginal cost is the additional cost producing an extra unit of output:
M.C = Δ T.C
ΔQ
Consider the following production cost data
F.C V.C T.C A.T.C M.C

100 20 120 120 120
100 120 220 110 100
100 200 300 100 80
100 260 360 90 60
100 300 4000 80 40
100 320 420 70 20
100 390 490 70 70
100 460 560 70 70
100 620 720 80 160
100 900 1000 100 280
A.T.C
M.C
M.C
82
A.T.C
Output
Observation
M.C.C and A.C.C are both U. shaped. When they are both falling, the M.C is lower
than the A.C at any level of output.
M.C reaches a minimum point and when rising cuts the A.C.C at its minimum
point. When they are both rise the M.C are higher than the A.C at any level of
output. The optimal point of every firm is when at level M.C and A.C are falling
and are minimum.
Profit Maximization
A profit is a difference between revenue and cost
Profit = T.R –T.C
T.R =price * output per unit
If the price is constant in the market, the total revenue curve is a straight line from
the origin but if the price varies than the total revenue curve will take different
shape assuming constant price.
T.R
TR = PQ
83
Output
Operating the Total Cost Curve
Losses
TR =PQ
TR TC
Profits
Losses
t
84
Output
If the level of output Q1 and Q2, total revenue equal total cost and there no excess
profit. The excess profit is zero the point is known as a breakeven point.
That T.R =T.C
Profit =T.R –T.C = 0

Profits are maximized at the point where the difference between the AC and T.C is
widest. In mathematics the gap between any two curve widest at the points where
the slope of the curve is equal. The above diagram, profits are maximum where the
slope of the T.R (marginal revenue) is equal to the slope of the T.C marginal cost)
that‟s profits are maximum where:
Marginal revenue = Marginal Cost
The point where profits are maximum is referred to as an equilibrium point. In the
diagram Qc is the profit maximizing level of output.
Consider that:
Profit = T.R –T.C
Profits are maximum at the point where the slope of the function is zero.
π =T.R –T.C
Δ π =ΔT.R- ΔT.C
ΔQ ΔQ ΔQ
MR-MC =0
MR =M.C is the 1st and necessary condition for profit maximization however it‟s
not sufficient condition for profit maximization.
85
That the slope of the marginal cost be greater than the slope of the marginal revenue
that‟s the M.C.C must cut the M.R.C from below.
The 2nd order derivation for a maximum should be negative. That‟s
Δ 2π =ΔT.R- ΔT.C
Δ2Q ΔQ ΔQ
ΔMR < ΔMC

ΔQ ΔQ
86
Chapter Eleven: Markets
A market is defined as the presence of a willing buyer or buyers and a willing seller
/sellers.
A market structure is defined from two major characteristics:
a) Number of competitors
b) Nature of products
From these two characteristics for different market structure can be identified.
Number competitors Nature of product Market structure
Infinite (uncountable) Identified /homogenous Perfect competitive
Many (countable) Slightly differentiated Monopolistic market

/highly
substitutable
A few but large Identical Oligopoly market
one No close substitute Monopoly
Perfect Competition
This is a market structure with an infinite number of competitors dealing with

homogenous products. Other characteristics include:
a) Free entry and fee exit.
b) Every firm is a price taker that‟s no single firm has any influence over the price in
the market end or takes the price as given in the market.
c) There are no transport costs.
d) Free mobility of factors of production e.g. labours.
e) No-government interventions.
87
Price is fixed = Marginal Revenue (MR) =Average Revenue (AR)

P
TR = PQ
MR = =P
AR = P
The above characteristic implies that the firms demand curve is perfectly elastic. It yields
the average revenue and marginal revenue curve of a perfectly competitive firm.
88
Equilibrium in the perfect market

Recall that at the equilibrium MR =MC
In combining the revenue and cost curve we have:
P A B MR= AR
Q1 Q2 Q
Point R meets the 1st condition for profit maximization however since the M.C is falling it
benefits the firm to increase production beyond Q1, however at point B the M.C are rising
and doesn‟t benefit the firm, to increase the reduction beyond Q2. Q2 Therefore is the
equilibrium point. A firm in the perfect market may make excess profit or losses in the
short run; this depends on the firms‟ level of average cost. If the A.C falls below a market
price, the firm makes excess profit as shown in the following:
89
Revenue
&
Costs
MC AC
P E AR =
MR
C B
0 Q1 Qe Output
TR = 0Qe * 0P = area 0Qe EP

T.C = 0Qe * 0C =Area 0 QeBC.
Excess profit =CBEP
90
On the other hand if the A.C falls above the market price the firm makes a loss a shown in
the diagram.
Revenue and Cost
C D
P E
0 QE Q
TR = 0Qe* 0P = 0QeEP
TC = 0QE*0C = Area 0QeDC
Loss = PEDC
91
In the long run there are either excess profits or losses. If excess profits exist in the short
run, more firms will join the industry using the level of AC until all excess profits are
exhausted. If losses exist in the short run some firms will exit or leave the industry and the
AC will fall until the losses are eliminated. The long run equilibrium will looks as shown in
the diagram:
MC
C&R
AC
P MR = AR
Q
92
The Monopoly Market
This is a market structure dominated by one firm and whose products have no close
substitute. Other features include:
a) The presence of barriers to entry into the industry

b) The firm is a price maker, which is the firm may directly set prices for goods services
in which case the quantity is determined by the market or the firm may set the
quantity in a way that it influences the price.
c) Presence of government intervention because monopolist are known to exploit.
Source of Monopoly Power
a) Ownership of strategic raw material or production technology.

b) Patent right and license – patent right is a temporarily exclusive right that allows the
individual firm to be the only producer or supplier of a product .The license is of a
permanent nature.
c) Market size- if the market of a product is too small as to not allow more than one firm
of an optimal size than there is some monopoly behavior.
d) Pricing strategy – An existing firm may crowd out competitors using a price strategy. It
may take advantage of economy of scale and lower its profit margin to an extent that
any new comer will not break even.
e) Mergers and acquisitions – where the firm dissolves to form a bigger firm that enjoys
economies of scale.
f) Product Differentiation Barriers – These may for example, take the form of
advertising and branding whereby an existing monopolist may exploit his position as
a supplier of an established product which the consumer may persuaded to believe is
better.
93
g) Economies of Scale Barriers – These would arise when the existing firm are already
operating on a vast scale of production and enjoying economies of scale. New
entrants into the market would have to achieve substantial market share before
breaking even therefore acting as a barrier.
Equilibrium in Monopoly Market
Recall that a monopolist is a price maker and how much is bought in the market depends
on the price. The higher the price the lower is the quantity bought and vice versa. This
shows that a monopolist demand curve is downward sloping.
Given an inverse function:
P = a – bQ = AR
Total Revenue (TR) = PQ
TR = (a – bQ) Q
TR = aQ – PQ2
AR = =
Hence:
P=a–bQ
AR = a – b Q
MR =
NB: The AR and MR. and demand function share a common intercept a. However the
MR. is twice as steep as the AR and the demand function.
94
Price
0 MR P = AR
Output
Equilibrium requires that MR = MC and therefore incorporating the MC curve we obtain
the equilibrium of the firm in monopoly.
The monopolist like any other firm finds its profit maximizing level of output where:
Marginal Revenue = Marginal Cost. This is shown as follows:
95
Illustration of a profit maximizing level of output of a monopolist.
MC
P A AC
C B
MR AR (DD)
0 Q Output
Explanation:
The monopolist maximizes profits at the level of output Q where the necessary and
sufficient conditions for profit maximization are satisfied. The supernormal profits earned
by the monopolist are represented by the shaded are PCAB.
However unlike the supernormal profits earned under perfect competition, these
monopoly profits will persist in the long run since there are barriers to entry and exit in
the industry.
96
Demerits of Monopoly
a) The supernormal profits earned by the monopolist are at the expense and general
welfare of consumers who usually have to cope with high prices and lower levels of
output than in a competitive market.
b) Monopolists usually carry out restrictive practices such as price discrimination in
order to increase their total profits.
c) Monopolists are likely to become complacent and take the customer for granted in
absence of credible competition or alternatives for the consumer.
d) They may stifle possible competition by engaging deliberately in measures designed
to take over smaller enterprises and exploiting barriers to entry in the market.
e) Large monopolies may lead to diseconomies of scale with associated and
unmanageable rising costs of production.
f) A monopolist may make decisions contrary to public interest when they control
strategic and important resources. This explains the overlying needs of governments
to control these resources for the welfare of the people.
Example:
Suppose a monopolist demand function is given by
Q=100-2P
The cost function is
50 +40Q
Determine the profit maximizing levels of price and output for the monopolist
P=50-0.5Q
TR=PQ=50Q-0.5Q2 MC=MR
MR=50-Q 50-Q=40
Q=10
TC=50+40Q
MC=40 P=50-0.5(10)=45
97
Monopolistic Competition
It is a form of imperfect competition which lies between the extremes of perfect

competition and monopoly and includes elements of both. Monopolistic competition is
common in the services sector e.g. in personal services sector.
Monopolistic competition has the following features:
a) A firm in this competition has a certain monopoly power over its own brand because
no one else can produce it, although the products are differentiated by substitutes.
b) As in monopoly, firms in a monopolistic competition face a downward sloping curve.
c) There are many buyers and sellers.
d) There is free entry and exit in the industry.
Illustration of short run equilibrium in monopolistic competition:
MC
P A AC
C B
MR AR (DD)
0 Q Output
98
In the above illustration the firm operating in monopolistic competition will make
supernormal profits shown PCAB. The supernormal profits earned by the monopolist are
represented by the shaded area. However, the supernormal profit earned is unlikely
persist in the long run as it will attract new players in the industry.
However in the long run the situation will change as follows:
Revenue & Costs

LMC
LAC
P A
AR
MR
0 Q1 Q2 Output
99
A firm in monopolistic competition in the long run will make normal profits since:
Average Revenue = Average Cost
In monopolistic competition the existence of many brands enhances consumer choice and
utility.
Oligopoly
It refers to a market structure dominated by a few sellers. The entire output in an

oligopolistic industry is produced by a few large firms and the contribution of each firm is
sufficiently large to be of significance to the entire market. Examples of oligopolistic
firms are usually found in mobile telephony, oil and beer industries.
In an oligopoly the firm‟s pricing and output decisions will incorporate the perceived or
expected reaction of competitors. This implies that the policies of the firms in
oligopolistic structures are interdependent.
This interdependence helps to explain the major characteristic of price rigidity. Prices do
not change often and are regarded as sticky. This is explained through the kinked
demand curve.
According to this theory it is suggested that firms in an oligopoly face two sets of demand
curves, one for increases and another for price reductions which is highly inelastic.
D
Price
d
100
E
P
Q1
Quantity
Diagram: Kinked demand Curve.
In the above diagram, price increases of the firm occur on the more elastic demand curve
dd and for price decreases it is on the inelastic demand curve DD. This implies that the
firm‟s actual demand curve is represented by dEB. This demand curve is said to have a
kink at point E associated with the Price P 1 and Q1. All the firms in the industry are
assumed to be in a similar position. This implies that when the firm raises its prices, and
its competitors fail to follow suit, then it will lose a large proportion of sales and
revenues. This firm is therefore on the elastic portion of the demand curve dE.
If one of the firms attempts to reduce its prices by itself, its competitors would have to
reduce their prices by at least as much or even more so as to retain their market share.
This implies that the firm is on the inelastic portion of the curve ED.
Price reductions could trigger a price war which could have disastrous consequences to
some firms. This is a possibility all firms would like to avoid thus making price reduction
to P1 highly unlikely. The actual demand curve is therefore represented by dED with
prices tending to be inflexible around the kink at point E. the kinked demand curve
provides one explanation for price rigidity in oligopoly.
As a result, firms in oligopolistic markets frequently engage in collusion in order to
maximize their joint profits and to reduce uncertainty. Collusions may take the form of
cartels, non price competition and consortiums.
101
MC
Y D
MR Output
In the above diagram the MR. curve is discontinuous at the output level where there is a
kink in the demand curve. The kink in the demand curve explains the nature of the MR.
curve. At the Price P and Output Q the MR falls vertically since at higher prices the
MR. corresponds to the more elastic demand curve and at prices below P the MR. curve
corresponds to the less elastic demand curve. The firms maximizes its profits where MC
= MR.
It is very likely that the MC curve will cut the MR curve somewhere between the
points X and Y which correspond to the discontinuous parts of the MR curve
102
SUMMARY
This part discusses short-run and long decisions, based on corresponding cost curves.
In the long-run, a firm can fully adjust all its inputs. In the short-run, some inputs are
fixed. The length of the short run varies from industry to industry.
The production function shows the maximum output that can be produced using
given quantities of inputs. The inputs are machines, raw materials, labour, and any
other factors of production. The production function summarizes the technical
possibilities faced by a firm.
The total cost curve is derived from the production function, for given wages and
rental rates of factors of production. AC and MC is typically U-shaped. As output
rises, at first average cost fall because of indivisibilities in production, the benefit of
specialization, and advantages of large scale.
Much of manufacturing has economies of scale. For some industries, particularly
personal services, economies of scale run out at quite low output levels.
When marginal cost is below average cost, average cost is falling. When marginal
cost is above average cost, average is rising. Average and marginal cost are equal
only at the lowest point on the average cost curve. The MC curve cuts the AC at their
minimum points.
The markets are divided by the type of product produced and the number of
participants in the market.
The perfect competition market and the monopoly market are on the extreme ends of
each other. The equilibrium in the monopoly is determined by the quantity
demanded, while in the perfect competition the equilibrium price is determined by
the market itself.
103
REVIEW QUESTIONS
1. What information dos the production function provide? (b) Explain why the
production function does not provide enough information for anyone actually to run a
firm.
2. Calculate the marginal and average cost for each level of output from the following
total cost data. (a) Show how marginal and average costs are related. (b) Are these
short-run or long-run cost curves? Explain how you can tell.
Output 1 2 3 4 5 6 7 8 9
TC 12 27 40 5160 70 80 91 104 120
3. Identify four sources of monopoly power
4. Using well-labeled diagrams, explain how a monopoly firm determines its equilibrium
price and output.
104
Appendixes:
Learner’s Feedback: Each module will have a template for learner feedback at the end of each course
topic. The feedback will be sent directly to the module instructor and will not replace the final course
evaluation form that is expected to be completed at the end of the module.
105
References:
Ackello Ogutu, C and Waelti J. J., (2009), Basic concepts of micro economics: With special
reference to Kenya (2nd Edition). University of Nairobi Press, Nairobi
Education, United Kingdom
Education Limited, United Kingdom
Hardwick P, Khan B and Langmeed, J. (1999), An introduction to modern economics, (5th
Edition), Prentice Hall, Harlow and others
Harvey, J and Jowsey, E., (2007), Modern Economics: An Introduction (8th Edition). Palgrave
Macmillan,
Lipsey R and Chrystal K, A, (1999), Introduction to positive Economics, Oxford University
Press, Oxford
Livingstone I. and H. W Ord, (1994), Economics for Eastern Africa, Heinemann Educational
Books
Hampshire, United Kingdom
Mudida R. (2003), Modern economics, (1st Edition). Nairobi Focus Books
Tucker, I. B (2010), Survey Economics (7th Edition), South Western Cengage Learning, Mason
(SET TEXT)
William J. Baumol, Alan S. Blinder, (1985), Economics: Principles and Policy, Harcourt Brace
Jovanovich, Florida, USA,
106
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1

BEC 111: Principles of microeconomics

At the end of this course unit, the learner is expected to:

1. Explain the basic economic concepts

The basic market economies

The central economic issues, free enterprise economy, centrally controlled

The theory of demand

The theory of supply

Definition of consumption, utility analysis,

law of diminishing marginal utility

Indifference curve analysis

Definition of indifference curves, budget lines, Price income and substitution

The theory of the firm/ production

Factors of production, mobility of factors of production, Division of labour,

Price determination in markets

Meaning and main characteristics of: Perfect competition monopoly,

Recommended Further References:

Hardwick P, Khan B and Langmeed, J. (1999), An introduction to modern economics, (5th

Lipsey R and Chrystal K, A, (1999), Introduction to positive Economics, Oxford University

Mudida R. (2003), Modern economics, (1st Edition). Nairobi Focus Books

The course will be taught through the use internet interactions

Tests, Term Papers – 30% and Final Examination – 70%

PART I: INTRODUCTION TO ECONOMICS

By the end of this Part 1, you should understand:

Economics is the study of how society resolves the problem of scarcity

The concept of opportunity cost

Positive and normative economics

Microeconomics and macroeconomics

Chapter One: Meaning and scope of Economics

Choice and opportunity cost

some scarce resource as shown in the diagram:

The slope of the PPF is referred to as rate of product transformation (PPT). It

Chapter Two: Economic goals and problems

Approaches to the study of economics:

Positive approach:- concerned with the investigation of this ways in which

Normative approach: It is very subjective and depends on value judgment on what

Chapter Three: Economic systems

1. Free Enterprise or free price system

Free Enterprise or free price system

For the free enterprise to operate there must be a price system/mechanism.

The features of a free market system are:

1. Ownership of Means of Production

2. Freedom of Choice and Enterprise

3. Self Interest as the Dominating Motive

5. Reliance on the Price Mechanism

6. Limited Role of Government

7. Resource allocation in a free enterprise

Advantages of a Free Market System

Disadvantages of a Free Economy

1. Unequal distribution of wealth: The wealthier members of the society tend to

4. Hardship: Although in theory factors of production such as labour are “mobile”

5. Wasted or reduced competition: some firms may use expensive advertising

Planned Economic Systems

Features of this system

Advantages of Planned System

Disadvantages of the Planned System

The centrally planned economies suffer from the following limitations:

Mixed Economic Systems

Features of this system

Advantages of the Mixed Economy

Disadvantages of Mixed Economy

The discipline of economic is divided into 2 classes:

Micro economic deals with the behavior of individual economic units or

Macroeconomic deals with aggregate economic quantities such as the rate