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Economic Environment
Economic
Environment
NQF Level 4
NQF Level 4
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Economic
Environment
NQF Level 4
Student’s Book
ISBN 978 177030 480 2
D Bekker, M Richards,
FHB Serfontein & A Smith
STUDENT’S BOOK
EE4SB Prelims.qxl:EE4SB Prelims 7/2/15 3:56 PM Page i
Economic Environment
Student’s Book
TVET FIRST
NQF Level 4
D Bekker, M Richards,
FHB Serfontein, A Smith
EE4SB Prelims.qxl:EE4SB Prelims 7/2/15 3:56 PM Page ii
TVET FIRST Economic Environment Level 4 Student’s Book
TVET FIRST series
© D Bekker, M Richards, FHB Serfontein, A Smith 2008
© Illustrations and design Macmillan South Africa (Pty) Ltd 2008
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Contents
Module 1:
Basic economic principles.........................................
2
Module 2:
Measure the macro economy ...................................
35
Module 3:
Trends in the world economy ..................................
61
Module 4:
Role of money and monetary policy.......................
74
Module 5:
Fiscal policy ................................................................
87
Module 6:
Basic economic concepts central to local
economic development in South Africa .................
106
The role of government in the South Afican
economy ......................................................................
117
The nature of development economics
with specific reference to South Africa ...................
128
Presentation to illustrate the key economic
concepts central to local economic
development...............................................................
139
The purpose of local economic development
in South Africa ...........................................................
146
Legislation that has an impact on local
economic development.............................................
156
The current challenges for local economic
development...............................................................
165
The role of municipalities in local economic
development...............................................................
172
Module 7:
Module 8:
Module 9:
Module 10:
Module 11:
Module 12:
Module 13:
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Module 14:
International trade.....................................................
183
Module 15:
Basic international finance .......................................
204
Module 16:
Compare import/export factoring with
Letter of Credit ...........................................................
217
The process of initiating import/export
factoring ......................................................................
232
Risk management principles associated
with import/export factoring ..................................
239
.......................
249
Module 17:
Module 18:
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Topic 1
Macro economic
principles as they
apply to the South
African business
environment
1
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Module 1
Basic economic
principles
Overview
In this module you will …
• Explain the concepts of scarcity, choice, efficiency, use of
marginal analysis and opportunity cost.
• Distinguish the concept of macro economics from that of micro
economics.
• Identify the common errors in economic thinking and sources
of disagreement amongst economists.
Range: Bias, fallacy of composition, cause and effect between economic
variables, levels and rate of change, value judgements, interpretation
of facts and data, opinion, the impact of time perspectives and ceteris
paribus.
• Explain the concepts of supply and demand and the elasticity of
supply and demand with the use of a graphical illustration.
• Identify the impact of different economic systems
Range: Market economy, command economy and mixed economy.
• Explain the role of the economy in producing goods and
services.
Range: Capital, entrepreneurship, labour and natural resources.
2
Topic 1
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Introduction
In this module you will learn about basic economic principles that are
used by economists when they discuss or explain economic issues. For
example you will learn about the concepts of scarcity, choice, efficiency
and opportunity costs as they pertain to economics. You will also be
introduced to marginal analysis. The difference between micro and
macro economics will be briefly explained, and you will be introduced
to some common errors in economic thinking. This is followed by an
explanation of the laws of demand and supply as well as the elasticity
of demand and supply. You will then also look at the impact of
different economic systems, specifically the market economy, the
command economy and the mixed economy. Lastly you will be
looking at the role supply factors play in producing goods and services
in the economy.
1.1 Concepts in economics
Words &
Terms
Economic
s: the stu
dy of how
limited re
sources a
re used to
satisfy un
limited ne
eds and
wants
Needs: th
e es
services th sential goods and
at we hav
e to have
order to s
in
urvive
Wants: th
ose goods
an
that we w
ould like to d services
have
Scarce: n
ot often fo
und; rare
short sup
; in
ply
Scarcity
Economics is often defined as the study of using limited resources to
satisfy unlimited needs and wants. This definition implies scarcity of
resources. But what do we mean by scarcity? A dictionary definition of
scarce is “rare or in short supply”.
In economics we mean that the inputs or resources used to make
products are limited whereas what people need or want is unlimited.
Once people have their basic needs or necessities for survival met, for
example food, water and shelter, then their needs for security, love and
social recognition becomes important. Once these needs are met,
people start wanting things because they derive pleasure from them or
because they think owning them may give them status. These needs or
wants are unlimited.
The resources that are used to make goods and services are limited.
There is a limit to some natural resources like the raw materials we
take out of the ground. One day there will be no
more coal, iron-ore or oil. It may still take a
number of decades or even centuries before
we start running out of these inputs
for our production processes,
but because these
minerals take so long
to be formed by
nature they will
eventually run
out. Such
resources are
known as nonrenewable
resources.
Words &
Terms
Resource
s: land, la
bour, cap
and entre
ital
preneurs
hip neede
to produc
d
e the good
s an
services in
an econom d
resource
y. The
“land” inc
ludes all
natural re
sources
Natural re
so
resources urces: all the
supplied b
y nature
including
water, air
, land,
minerals
and the e
nvironme
nt
Non-rene
wable res
ource:
resources
that cann
ot
replaced
or increas be
ed by natu
or human
re
s
Think about it
Most of us are becoming
aware that oil is a limited
resource mainly because of
the price that we pay for
petrol. In addition, oil is a nonrenewable resource. What is
going to happen when the
world runs out of oil?
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A non-renewable resource is one that cannot be replaced in our
lifetime. It just takes far too long for such a resource to develop. Oil
takes a very long time to become oil. Once we have tapped the last
drop of oil out of the planet’s depths there will be no more oil,
certainly not in our lifetime. When there is no more oil then humans
will have to use some other source of energy to drive their vehicles.
One alternative that is already being explored is biofuels.
Words &
Terms
Renewab
le resourc
es:
natural re
sources th those
at are able
to replace
themselv
es if
humans g
ive them th
e chance
to do so
Words &
Terms
Acid rain:
ra
acid conte in that has a high
nt often b
ecause of
sulphur d
ioxide tha
t is in the
smoke em
itted by so
me
factories
Global wa
rm
for the atm ing: the tendency
osphere a
round the
planet to
warm up,
because o
the heat fr
f
om the su
n being
trapped b
y pollutan
ts in the a
ir
Potable w
ater: wate
r that is
clean eno
ugh for hu
man
consumpti
on
4
Topic 1
There are other resources that are known as renewable resources, for
example wheat, fish and trees. These are resources that are able to
grow and replace what we have used in quite a short period of time.
However, in order that these resources are able to renew themselves
humans must use these resources
wisely so that they have the time
and opportunity to do this. If we
catch fish that have not had a
chance to grow to adulthood
and spawn, then there will be
no younger generation of fish
to renew the resource. If we
cut down trees without giving
young trees a chance to grow
big and make seeds, there
will be no trees in the future.
If we cut down all our wheat
crops without letting some
go to seed there will be no
seeds to plant.
There are other mostly
renewable resources which we
tend to take for granted because
we do not pay for them and they
just always seem to be there. The
air that we breathe, the rain that falls and fills our rivers and the sun
that shines and helps the plants to grow and provide us with food are
all resources we barely notice. Some of these resources are becoming
polluted. The air that we breathe in cities especially is not very clean
anymore, the rain that falls is often acidic especially in urban areas,
and according to scientists, global warming is becoming a real
problem. The heat from the sun is not escaping from our atmosphere
as fast as it is supposed to and the air is slowly warming up. This
could affect and change our weather patterns, which in turn could
negatively impact on the supply of food crops. Clean air, rain for our
crops, healthy potable water and sunshine that helps plants to grow
are all natural resources. Some of these natural renewable resources
may become scarce if we do not use them wisely. What this means in
some cases is that we have to give these renewable resources a chance
to get rid of the pollutants that are a result of our human activities.
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Choice
Although economic theory argues that people would like to buy as
many products as possible, one thing that limits your ability to buy is
your income. Your income limits your demand for goods and services.
What this means is that you have to make choices. What will you buy
and what will you not buy even though you would like to have them?
Producers also have to make choices. What type of products should a
producer make? How will these products be made? Where should a
producer locate a factory? How many people should the producer
employ? Who will buy the products that are made? At what price
should the producer sell the products? Bear in mind that any producer
who makes or produces a product does so in order to earn their own
income. It is therefore important that a producer or any business
person is able to make a profit from their business.
Not only do individuals have to make choices, society also has to make
choices. One way in which society expresses some of its choices is
through the voting process. In this way society ultimately chooses
under which type of economic system the country will live and
operate and therefore what macro economic goals are important. As a
society we choose whether or not we live in a country that respects
human rights and the rule of law.
Words &
Terms
Choice: a
n act of de
ciding wh
to take/do
at
and there
fore also
what to le
ave/not d
o
Words &
Terms
Efficiency
: use of in
puts in a
way that e
nsures th
e maximu
output an
m
d profits
Efficiency
Another thing that a producer has to bear in mind is that the
production process must be efficient. The way in which the products
are made must be at the least cost possible to the producer, because the
producer has to compete with other producers. If one producer is
wasteful and as a result the price of the product is higher than the
competitors, who would you buy from? I think you will agree that you
will rather buy from the more efficient producer, in other words from
the one who uses resources efficiently and so can sell at a lower price.
Think about it
Efficiency is an important
concept in a market economy
because producers have to pay
for their inputs.
Activity 1.1
1.
2.
3.
Indicate whether the following statements are true or false:
a) Scarcity is one of the concepts used in economics because limited resources are used to
satisfy unlimited wants and needs.
b) Non-renewable resources are those resources which are able to renew themselves.
c) Consumers, producers and society all are faced with choices.
d) Producers who use their inputs efficiently are more competitive than those who are
wasteful.
Correct the sentences you decided were false.
Choose one of the sentences you decided was true and write a few lines explaining why.
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Opportunity cost
Words &
Terms
Opportun
ity cost: th
e cost of
making a
choice, th
e loss of n
choosing
ot
the other
Another important concept that is used in economics is that of
opportunity cost. Opportunity cost implies choice because if a person
decides on one thing they have to give up something else. For
example, if you would like to be a doctor and lawyer you will have to
decide which it will be. You cannot be both at the same time! If you
decide to be a doctor, then you give up the opportunity of being a
lawyer. Your opportunity cost of being a doctor is that of being a
lawyer. A person may have to choose between spending their time
writing a book or frying chicken pieces and selling them because there
is just not enough time to do both. If that person decides to write
rather than fry and sell chicken pieces then the opportunity cost of
writing the book is the possible income he or she may have earned
from frying and selling chicken pieces.
Examples:
If you decide to go on holiday to Cape Town instead of going to Durban, your opportunity cost of
going to Cape Town is what you give up.
Question: What are you giving up in order to go to Cape Town?
Answer:
The chance or opportunity of going to Durban.
If you decide to buy a new car instead of going on an overseas trip your opportunity cost of buying
the new car is what you give up.
Question: What is your opportunity cost of buying a new car?
Answer:
The overseas trip that you give up. It is all a matter of choice!
Producers also face opportunity costs. If the machines at a factory are
used to produce one type of motor vehicle then no other motor vehicle
can be produced during that time.
On a macroeconomic level, choices also have to be made with regards
what products we produce in the country and what we import. In this
respect government may become involved to direct the economy in a
certain direction. If it decided to concentrate on the production of
motor vehicles for export then the production of other products may
not be possible. Government also makes choices in respect of how to
spend taxpayers’ money. If money is spent on education then that same
money cannot be spent on health issues. The opportunity cost of
providing the education are the health issues that cannot be addressed.
Activity 1.2
Assume that you decide to start you own business.
What sort of business would you like to have?
Running this business takes all your time and effort.
Can you start another business at the same time all by yourself?
Why not?
Decide which business you will concentrate on.
What is the opportunity cost of the business that you have decided on?
6
Topic 1
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People will usually choose whatever gives them the most satisfaction
(in the case of a consumer) or income (in the case of a producer this
would be the profits). According to some economists, if we assume
that people have the necessary information in order to make correct
choices then they will not make mistakes. In other words in economics
terminology, people (consumers and producers) are rational and if
they have perfect information they will choose whatever gives them
the most satisfaction, income or profits.
Marginal analysis
Economics assumes that in most cases each person prefers more of
something rather than less. Economists explain this is by using a
theory known as marginal analysis.
Words &
Terms
Rational:
ability to th
in
carefully
about som k
ething an
then to m
d
ake the co
rrect choic
e
Perfect in
formation
:
a
informati
on availab ll the
le and
needed to
make the
sensible o
rational c
r
hoice
According to marginal analysis, if your level of satisfaction increases
by consuming one more of a good, then you will want to consume that
extra one. If a producer can add to his or her profits by making and
selling one more product then it is worth producing
one more. Let’s use eating ice cream as an example.
Firstly we need to pretend
that you can give a value
or a number to the level of
satisfaction derived from
eating an ice cream. We call
this value utils. The word
utils comes from the word
utility and the word
“utility” is the official
word that economists use
instead of “level of
satisfaction”. Let us now
pretend that eating an ice
cream will give you a
utility of 200 utils. The
marginal utility of the first
ice cream is 200 utils.
Words &
Terms
Marginal
value of g
oods: the
extra valu
ea
value whe dded to the total
no
is consum ne more of a good
ed or prod
uced
Words &
Terms
Utils: the
term used
in
economic
s to denote
the level o
satisfactio
f
n
Utility: le
vel of sati
Eating an ice-cream provides one with a
certain level of satisfaction
sfaction
Once you have finished that ice cream, you feel like another one. The
level of satisfaction you get from eating this second ice cream is a bit
less than the first ice cream. Let’s make it 130 utils. According to
marginal analysis, eating the second ice cream has increased your level
of satisfaction by 130 utils. The marginal utility of the second ice cream
is 130 utils. Remember that eating the first ice cream increased your
utility by 200 utils. Your total level of satisfaction after eating two ice
creams is therefore 330 utils (200 + 130 = 330).
Now you eat a third ice cream. You still enjoy it but not nearly as much
as the first or even the second ice cream. Let us say the marginal utility
you gained from eating this third ice cream is 25 utils. Your total utility
after eating three ice creams is therefore 355 utils (200 + 130 + 25 = 355).
So each additional ice cream you consume adds to your total utility. As
long as the marginal utility of eating ice creams is positive you will
consume more ice creams.
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Words &
Terms
Disutility:
a level of
dissatisfa
ction
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Now you may be thinking “what if I eat a fourth ice cream, I may be
sick!” Yes you are quite correct and economics has an answer for that!
If you get sick after eating ice cream number 4 you will then be
experiencing dissatisfaction or disutility! Dissatisfaction or disutility
will reduce your total level of satisfaction. So you will stop eating ice
creams after ice cream number three!
However, if ice cream number 4 has a marginal utility of 1 for you,
then you will eat number 4. Why? Because by consuming one more ice
cream your total utility will increase by 1 util.
Activity 1.3
Using the above example assume that ice cream number 4 has a marginal utility of 1. In the
following table write in the marginal values for eating ice creams.
Write in the total utility after each ice cream.
Now assume that ice cream number 4 has a marginal disutility of -37utils.
How will that change your total utility?
Ice creams consumed
Marginal utility in utils
Total utility in utils
1
2
3
4
Marginal analysis can also be used when we look at how producers or
sellers make decisions. In this case we would look at whether or not a
seller can add to total profits by producing and selling one more item.
A lot of economic analysis is based on marginal analysis. What is
important for you to understand is that economists look at the change
in total utility or total profit after the consumer consumes one more of a
product or after a seller sells one more of a product. The change in the
total utility or profit is the marginal utility or marginal profit.
1.2 Microeconomics versus
macroeconomics
Words &
Terms
Microeco
nomics: lo
oks at the
individual
consumer
or
producer
to unders
tand what
motivates
their econ
omic
choices
8
Topic 1
In economics we look at the individual consumer or producer in order
to understand what motivates their behaviour in terms of demand and
supply. When we focus on the consumer or the producer as individuals
we call it microeconomics. In microeconomics we look at what
influences a consumer’s decision to buy a certain product and how
changes in price will affect such a decision. We also consider the effect
of the profit motive on a producer’s decision whether or not to produce
a certain product. Price plays an important role in a producer’s or
supplier’s decisions as the selling price will affect what profit is made.
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It is also important as economists to look at what influences the
economy as a whole. In macroeconomics we look at the total
spending, the total income or the total production in the economy. The
terms economists use are aggregate spending, aggregate income and
the gross domestic product. Macroeconomists investigate what causes
changes in the aggregate spending, income or production in the
economy. Factors like the rate of inflation, the overall rate of
unemployment, exchange rates and interest rates and how changes to
these affect the economy as a whole are all examined. Issues that affect
developing countries are unemployment and the related problem of
poverty. Macroeconomists in developing countries must therefore also
consider how fiscal policy can be applied to solve the problems faced
by such countries.
Words &
Terms
Macroeco
nomics: s
tudies the
economic
system as
a whole
Aggregate
spending
: total
spending
in a countr
y
Aggregate
in
in a countr come: total income
y
Aggregate
productio
n: total
productio
n in a cou
ntry
Activity 1.4
1.
2.
Are the following statements true or false:
a) Micro economics is the study of the individual’s economic decisions.
b) In micro economics we look at why a consumer would buy a certain product at a certain price.
c) Macro economics is the study of the whole economic system.
d) In macro economics we could look at why there is unemployment in a country and how this
problem can be solved.
e) In macro economics we study amongst other things, how fiscal policy can be used to
alleviate poverty.
Explain why the study of the price and quantity of cold drinks is a micro economic issue while
the total output and general price level are macro economic issues.
1.3 Common errors in economic thinking
Fallacy of composition
The fallacy of composition arises when an argument is based on the notion
that what is true for the parts is also true for the whole. In economics, for
instance, this takes the form of arguing that because something is true for a
household or firm it is also true for the system as a whole. One might
argue that it is good for a household to save and even to increase its
savings. This is indeed true. The fallacy of composition occurs when one
argues that because it is good for a household to save it is good for all
households and the economy as a whole. This might not necessarily be the
case. From a macroeconomic point of view an increase in savings by all
households causes less consumption spending by households. As
households spend less, firms respond by producing less. As firms produce
less they employ fewer factors of production and the income of
households declines. By saving more we end up with less income.
As an example, take the case of a potato farmer. By planting and selling
more potatoes the farmer will be able to increase his or her total revenue. If
all potato farmers increase their production, the individual farmer as well
as all the other farmers might end up with less income. As they increase
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the market supply of potatoes the market price for potatoes will fall and
this lower price might lead to lower total revenue for the farmers.
In this instance, you can see that what is true for the micro level is not
necessarily true for the macro level.
Ceteris paribus
Economics is a social science and unlike the natural sciences it cannot
do experiments under controlled conditions.
In a laboratory a scientist can control the environment and keep it
constant. This makes it easier to measure the effect, for instance, of one
chemical on another and to repeat the process to confirm results and
prove formula.
Economists do not have this luxury - we are confronted by a complex
world in which many things change in the same instant all the time. It
would be much easier if we could freeze everything else while we are
busy with our experiment, but in this complex and ever-changing
world of ours it is just not possible.
What we do is to invoke the ceteris paribus condition which allows us to
assume that all other factors remain constant or unchanged, so that we
can better understand the impact of the one factor we’re examining. It is
an old Latin term meaning “all other things being equal”.
As an example, when dealing with the law of demand we assume that
all the other factors that influence the demand for a product are
unchanged and then ask what will happen to the demand if the price
changes. In this way we are able to trace and model the impact of a
change in the price on the demand for a product.
Rates and levels of change
In economics we work with a lot of figures. We are sometimes
interested in levels and sometimes in changes in these levels. If we
want to know what the per capita gross domestic product (GDP) is in
South Africa, we are interested in the level of per capita real GDP. If we
want to know what happens to the per capita real GDP over time we
are interested in the change in per capita real GDP.
In the following table the level of per capita GDP and the change in the
per capita GDP is provided.
Year
Level of per capita GDP (Rands)
Change in per capita GDP
1991
21 044.86
-3.1
1992
20 169.60
-4.2
1993
19 995.66
-0.9
1994
20 214.46
1.1
1995
20 411.64
1.0
1996
20 848.20
2.1
1997
20 955.48
0.5
1998
20 625.41
-1.6
TABLE 1.1: Level and change in real per capita GDP for South Africa
Source: South African Reserve Bank, Quarterly Bulletin Time series
10
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From the above table you can see that the level for per capita real GDP
for 1992 was lower than the real per capita GDP in 1991. This is
reflected in a negative change in the per capita real GDP of -4.2%. For
1994 the level of per capita real GDP was higher than the per capita
real GDP for 1993 and this is reflected as positive change of 1.1%. As
long as the change is positive the level increases. If the change is
negative the level decreases. If you know the change in per capita real
GDP for 1998 was -1.6% you also know that the level of real GDP for
1998 is lower than the level of real GDP for 1997.
When working with rates of change it is also important to take into
account the base from which it occurs. For instance, the average
growth rate of Japan for the 2000-2005 period was 1.6% while for
Uganda it was 7.1%. Japan is, however, still a much richer country
than Uganda even though its growth rate was much lower. This is
because the growth in Uganda started from a very low base while that
of Japan started from a much higher base.
Words &
Terms
Rate of ch
ange: cha
nge in the
variable o
ver a spec
ific period
of time
?
??
Did you know?
The statement that the
inflation rate has declined
from 10% to 5% means that
the price is still rising but at a
lower rate. The level of prices
is still 5% higher
Cause and effect
When one thing makes something else happen we have a cause and
effect relationship. If the price of fried chicken pieces increases, the
demand for it decreases. In this case the cause is the increase in price
and the effect is the decrease in quantity. It is however important to
note that just because two things occur together and are therefore
correlated, it does not automatically mean that the one caused the
other.
A well know example of this confusion between correlation and
causation is the observation that while the number of births in an
imaginary town has been increasing over time, the number of storks
has also increased. The fact that the number of births and the number
of storks have increased means there is correlation between the two.
However, it would be incorrect to conclude that storks bring babies. To
establish causality more than just correlation is needed. You must have
a logical theory that is able to explain the effect of one variable on
another.
The theory of the market provides an understanding of the cause and
affect relationship in the market for fried chicken pieces. According to
this theory an increase in the income of consumers causes an increase
in the demand for fried chicken pieces. Between income and an
increase in the demand for fried chicken pieces there is not only
correlation but also causation. An increase in income is the cause and
the increase in the demand for fried chicken pieces is the effect. But
the relationship does not end here. An increase in demand causes an
increase in the price of fried chicken pieces. The increase in demand is
now the cause and the increase in price the effect. In addition, the
increase in the price causes a decrease in the quantity demanded and
increase in the quantity supplied.
Words &
Terms
Correlati
on:
which eco the degree to
nomic vari
ab
observed
to move to les are
gether. If
they move
in the sam
e directio
there is p
n
ositive co
rrelation;
they move
if
in opposit
e
directions
there is n
egative
correlatio
n
Causation
: when a c
hange in
one varia
ble is not
only
correlate
d with, bu
t actually
causes a
change in
another
variable
Module 1: Basic economic principles
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Disagreement amongst economists
Economist and non-economists disagree about the causes of economic
problems and appropriate solutions. Apart from the fact that
economics is a relativity young science there are various reasons for
this disagreement. These include:
• A disagreement about what ought to be
• Disagreement about the facts
• Biased thinking
• Different time perspectives
In order to understand the world, economists developed simplified
models that contain what they regard as the most important economic
variables. They then use these models not only to explain the world
but also to identify what policy measures can be used to improve the
economy. Since there is no agreement about the correct model to use, a
variety of different points of views and disagreement about economic
issues arises in the world. President Ronald Reagan of the United
States of America once commented on the different advice he got from
economists by joking that if the game of Trivial Pursuit were designed
for economists it would have 3 000 answers for 100 questions.
?
??
Did you know?
In spite of disagreement
between economists there is
some consensus about certain
policy measures.
About 90% of economists
agree that:
Tariffs and import quotas
reduce general economic
welfare
Rent controls reduce the
quantity and quality of housing
About 80% of economists
agree that:
Cash payments increase the
welfare of recipients more
that transfers-in-kind
A minimum wage increases
unemployment amongst
young and unskilled workers
12
Topic 1
The different world views that are embedded in the different economic
models results in the same set of facts being interpreted differently by
different economists. When a Keynesian economist looks at the
unemployment figures for a country he or she might conclude that the
cause of this unemployment is an inadequate demand for goods and
services and that the solution is increasing in the demand for goods
and services. A classical economist looking at the same facts might
conclude that the problem of unemployment is in reality a problem of
poverty since the wages are too low and that the solution for the
problem is to fight poverty and not simply to increase in the number of
low earning jobs.
Sometimes economists agree on the objective to achieve but disagree
about the how it is to be done. There might be agreement that
households should be taxed but disagreement on whether the tax
should be an income tax or a consumption tax such as VAT.
Economists might also be biased in their thinking and their providing
of solutions to economic problems when they base their opinions on
their own particular experience and values, interest and preference for
a particular point of view. Workers tend to blame business for all their
problems and businesses blame the labour force for their problems.
Politicians blame the opposition or the past regimes for current
problems. Consumers blame the suppliers for high prices and
suppliers blame the government for the problems they experience. In
this way of practising economics, objectivity is the first causality.
Another source of disagreement is the time period used when
economic problems are analysed. The focus could be on short term
fixes or long terms goals. This is particularly important when the issue
of economic growth, unemployment and inflation are analysed.
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Activity 1.5
1.
2.
Indicate whether the following statements are true or false:
a) The fallacy of composition occurs when it is argued that what is true for a part is also true
for the whole.
b) In economics it is possible to repeat experiments in order to determine the impact of one
variable on another.
c) If the economic growth rate for a country is positive we can conclude that the level of
economic activity has increased.
d) If the inflation rate falls from 8% to 5% it means that prices are now 3% lower.
e) If two things are correlated it always implies that the one event causes the other event.
f) All economists use the same economic model and therefore agree on how to analyse
economic problems.
Give some reasons why economists might disagree on how to solve the unemployment problem
in South Africa.
1.4 The concepts of demand and supply
The demand for a
product and its price
There are a number of
factors that influence the
demand for a product.
These include the
income of consumers,
the number of
consumers, the taste and
preferences of
consumers, the price of
related goods and the
price of the product
itself.
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Price of the product and the quantity demanded
A very important factor in determining the quantity of a product or
services demanded is the price of that product or service. This
relationship is often presented with the aid of a graph called the
demand curve. To explain this demand curve we will make use of the
demand for fried chicken pieces by the Dlamini household.
Activity 1.6
In groups, discuss the following questions before reporting-back to the class:
1. What will happen to the quantity of fried chicken pieces demanded by the Dlamini household if
the price of fried chicken pieces increases? Explain your answer.
2. What will happen to the quantity of fried chicken pieces demanded by the Dlamini household if
the price of fried chicken pieces decreases? Explain your answer.
The law of demand
As the price of fried chicken pieces increases, the Dlamini family will
demand a lower quantity because they will be less able to afford it.
But, as the price of fried chicken decreases, the family will be able to
afford to buy more fried chicken pieces. Thus, they will demand a
higher quantity.
Take note: The relationship between the price and the quantity
demanded of a product is a very important relationship in economics.
In fact, it is so important that economist call it a law – the law of
demand.
The law of demand states that if all other things remain the same, but the price of a product
increases, the quantity demanded thereof will decrease. Similarly, if the price of a product
decreases, the quantity demanded thereof will increase.
The resulting conclusion is that between the price of a product and the
quantity demanded a negative or inverse relationship exists.
Read the definition of the law of demand again. It also says if all other
things remain the same. This refers to the ceteris paribus condition you
learned about previously. This means that the relationship between
price and quantity will always be the same if all the other variables that
may influence the demand for a product do not change. In other
words, when you thought about how a change in the price of fried
chicken pieces affects the quantity demanded by the Dlamini family,
you assumed that their income, taste and the number of family
members stayed the same. You also assumed that the prices of other,
related goods did not change either.
14
Topic 1
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Activity 1.7
Complete the following statement on the law of demand:
Given that all other things remain the (i)________, if the price of a product increases, the quantity
demanded thereof will (ii)_______ , and if the price of a product decreases, the quantity demanded
thereof will (iii) ________. This indicates that a (iv) __________ or (v) __________ relationship exists
between the price of a product and the quantity demand thereof.
Using a demand schedule
The law of demand can be expressed using a demand schedule. A
demand schedule is a table that shows the quantity demanded of a
product at each price. Look at the example below. The left hand
column shows different prices for fried chicken pieces. These prices are
referred to as the independent variables as they determine the quantity
demanded. The right hand column shows the quantity of fried chicken
pieces that the Dlamini family would demand at each price. These
quantities are called the dependent variables because they depend on
the price of fried chicken pieces.
Price of fried chicken per piece
(Rand)
Quantity of fried chicken pieces
demanded (per week)
5
4
4
8
3
12
2
16
1
20
Price of fried chicken pieces and quantity demanded
According to the above table, at a price of R5 per fried chicken piece,
the family will demand four pieces of chicken per week; and at a price
of R4, they will demand eight pieces per week.
Looking at the demand schedule above, you can see that the lower the
price of fried chicken pieces goes, the higher the quantity demanded is;
and that the higher the price of fried chicken pieces goes, the lower the
quantity demanded is. Thus, the demand schedule clearly shows the
law of demand.
Drawing a demand curve
It is also possible to demonstrate the law of demand using a graph.
Look at the graphs below. The first graph shows the axes of a graph,
namely the vertical and horizontal axes. The vertical axis shows the
price (P) of the product or service and in this example, is labelled
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“Price of a fried chicken piece”. This is the independent variable. The
horizontal axis indicates the quantity demanded (Qd) and is in this
example is labelled “Quantity demanded of fried chicken pieces (per
week)”. This is the dependent variable.
Price of a fried chicken piece (Rand)
Using the information in the above schedule the following demand
curve can be drawn.
Vertical axis
Horizontal axis
es
op
Sl
s
d
ar
nw
w
do
Price of a fried chicken piece (Rand)
Quantity demanded of fried
chicken pieces (per week)
Quantity demanded of fried
chicken pieces (per week)
Words &
Terms
A demand
curve: a g
raph that
shows ho
w the qua
ntity
demande
d for a pro
du
a specifie
d period o ct during
f time wil
change as
l
the price
of that
product c
hanges
16
Topic 1
The demand curve is labeled DD. The demand curve shows how many
pieces of fried chicken (the quantity demanded) the family plans to buy
at each price. The demand curve slopes downwards from left to right.
This slope shows the law of demand – as the price of fried chicken
pieces decreases, the quantity demanded by the family increases. Thus,
the graph shows P↓→ Qd↑.
Similarly, an increase in the price of fried chicken pieces can be
illustrated using an upward movement along the demand curve. Thus,
an upward movement will show P↓→ Qd↑.
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d
ar nt
w e
Up vem
o
m
Price of a fried chicken piece (Rand)
EE4SB Topic 1:EE4SB Topic 1
Think about it
Quantity demanded of fried
chicken pieces (per week)
An upward movement along the demand curve occurs when the price increases
It is important to note that a change in the price of fried chicken pieces
causes a downward or upward movement along the demand curve
(DD) and not a shift of the demand curve itself. This is because the
demand curve shows the relationship between the price of a product
and the quantity demanded of it at each price.
A well-known economist was
once asked what he thought is
the most important lesson for
an economics student to
remember. His answer was
that the most important
lesson to remember is that a
demand curve is a downward
sloping curve that shows how
a lower quantity is demanded
at a higher price than at a
lower price.
Activity 1.8
1.
Use the following demand schedule to copy and complete the graph to show Peter’s demand for
cold drinks.
Quantity of cold drinks demanded (per week)
6
6
5
8
4
10
3
12
2
14
2.
With a partner, discuss the following
questions:
a) What does the demand curve (DD) look
like?
b) Indicate on the graph how many cold
drinks Peter demands at a price of
R5 per can?
c) Indicate on the graph how many cold
drinks Peter demands at a price of
R2 per can?
Price of a cold drink
(Rand)
Price of a can of cold drink (Rand)
Price of a
can of cold
drink and
quantity
demanded
Quantity demanded of cold drinks
(per week)
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d) In which direction does the demand curve go to indicate a decrease in the price of cold
drinks?
e) Why does Peter demand more cold drinks when the price of cold drinks decreases?
f) In which direction does the demand curve go to show an increase in the price of cold
drinks?
g) Why does Peter demand fewer cold drinks when the price of cold drinks increases?
The downward sloping demand curve for fried chicken pieces by the
Dlamini family is also valid for most other goods and services that are
consumed by households in the economy. The demand curves for
meat, bread, shampoo and books are all downward sloping indicating
that the higher the price the lower the quantity demanded.
The market demand curve is the demand curve for all potential
customers. It is also downward sloping indicating that as the price
rises, the quantity demanded falls and as the price declines the
quantity demanded rises.
The law of supply
The relationship between the price of a product and the quantity
supplied is very important in economics. This relationship is called the
law of supply.
The law of supply states that given that all other things remain the same, if the price of a product
increases, the quantity supplied thereof will increase; and if the price of a product decreases, the
quantity supplied thereof will decrease.
Words &
Terms
A positive
relations
hip: a
change in
one varia
ble will be
the same
in
direction
as a chan
in the oth
ge
er variable
As with the law of demand, in the law of supply the relationship
between price and quantity supplied assumes that there are things that
remain the same – in this case, technology, the prices of inputs, the cost
of production, and the price of alternative products. Unlike with the
law of demand, in the law of supply, the relationship between the price
of a product and the quantity supplied thereof is a positive
relationship – both variables either go up or go down. They always
move in the same direction.
In a positive relationship, a change in one variable goes in the same direction as a
change in the other variable
18
Topic 1
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Activity 1.9
Complete the following statement:
The law of supply states that given that all other things remain the (i)__________, if the price of a
product increases, the quantity supplied thereof will (ii)___________, and if the price of a product
decreases, the quantity supplied thereof will (iii)____________. This indicates a (iv)__________
relationship between the price of a product and the quantity supplied thereof.
Using a supply schedule
Like the law of demand, the law of supply can also be expressed using
a supply schedule. A supply schedule is a table that indicates the
quantity of a product supplied at each price. Look at the example
below. The left hand column states the price of a piece of fried chicken
– this is the independent variable because it determines the quantity
supplied. The right hand column shows the quantity of fried chicken
pieces that Chick Roast is willing to supply at each price – this is called
the dependent variable because it depends on the price of fried chicken
pieces.
Words &
Terms
A supply
schedule
: a table th
shows the
at
quantity s
upplied a
each and
t
every pric
e
Price of fried chicken per piece (Rand) Quantity of fried chicken pieces
supplied (per week)
5
20
4
16
3
12
2
8
1
4
Price of fried chicken pieces and quantity supplied
Can you see how at R5, Chick roast will supply 20 pieces of fried chicken
per week, and at R4, it will supply 16 pieces of fried chicken per week?
Activity 1.10
Study the following supply schedule which represents the supply of cold drinks by Coco Drinks.
Answer the questions that follow.
Price of a can of cold drink (Rand)
Quantity of cold drinks supplied (per week)
6
14
5
12
4
10
3
8
2
6
Price of a can of cold drink and quantity supplied
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1) How many cans of cold drink is Coco Drinks willing to supply at a price of:
a) R6 per can
b) R5 per can
c) R4 per can
d) R3 per can
e) R2 per can
2) How many more cans of cold drink is Coco Drinks willing to supply if the price of cold drink
cans increases from R5 to R6?
3) How many fewer cans of cold drink is Coco Drinks willing to supply if the price of cold drink
cans decreases from R5 to R3?
4) As the price of cold drink cans increases, what happens to the quantity supplied?
5) As the price of cold drink cans decreases, what happens to the quantity supplied?
Using a graph
op
es
up
w
ar
ds
The information from the supply schedule is plotted along the axes and
the supply curve is drawn by joining the plotted points. The supply
curve shows the quantity of fried chicken pieces supplied at each price.
Sl
A supply
curve: a g
raph that
shows ho
w the qua
ntity
supplied fo
r a produc
t during a
specified
period of
time will
change as
the price
of that
product c
hanges.
It is also possible to demonstrate the law of supply using a graph. To do
this, you use the information in the supply schedule. Look at the graph
below.
Price of a fried chicken piece (Rand)
Words &
Terms
Quantity demanded of fried
chicken pieces (per week)
The supply curve slopes upwards from left to right. This shows that as the price
increases, the quantity supplied also increases
The fact that the supply curve slopes upwards indicates that there is a
positive relationship between the price of fried chicken and the
quantity of fried chicken supplied. An increase in the quantity of pieces
supplied is shown by an upward movement along the supply curve.
20
Topic 1
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ar
d
m
ov
em
en
t
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w
Price of a fried chicken piece (Rand)
EE4SB Topic 1:EE4SB Topic 1
Quantity demanded of fried
chicken pieces (per week)
An upward movement along the supply curve occurs when the price increases.
t
en
em
ov
m
n
w
Do
Price of a fried chicken piece (Rand)
Similarly, a decrease in the price of fried chicken pieces will be shown
as a downward movement along the supply curve. This is shown on
the graph below.
Quantity demanded of fried
chicken pieces (per week)
A downward movement along the supply curve occurs when the price decreases.
Activity 1.11
1.
Use the following supply schedule to complete a graph with a supply curve.
Price of a can of cold drink (Rand)
Quantity of cold drinks supplied (per week)
6
14
5
12
4
10
3
8
2
6
Price of a can of cold drink and quantity supplied
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2.
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Answer the following questions:
a) Describe the supply curve.
b) Highlight on your graph how many cans of cold drink Coco Drinks is willing to supply at
R5 and at R2.
c) Draw an arrow to show the direction of the supply curve when the price increases.
d) Draw an arrow to show the direction of the supply curve when the price decreases.
The upward sloping supply curve as shown for fried chicken pieces by
Chick Roast is also valid for most other goods and services that are
supplied in the economy. This indicates that the higher the price the
higher the quantity supplied and the lower the price the lower the
quantity supplied.
The market supply curve, that is the supple curve for all potential
suppliers, is also upward sloping indicating that as the price rises, the
quantity supplied increases and as the price declines the quantity
supplied falls.
Price elasticity of demand
Businesses know that a change in the price of their product will cause a
change in the quantity demanded. In most instances an increase in the
price will cause a decrease in the quantity demanded while a decrease
in the price will cause an increase in the quantity demanded. They face
a downward sloping demand curve and the law of demand is in
operation. They might not know the exact form of the demand curve,
but they know that the law of demand applies to them.
Think about it
What do you think will happen
to total revenue if an increase
in the price does not cause a
significant decrease in the
quantity?
22
Topic 1
An increase in the price causes a decrease in the quantity demanded and a decrease in
the price causes an increase in the quantity demanded
Does this mean they should never increase the price of their products
but rather always think of ways and means to decrease the price of
their products? The answer to this question depends on what will
happen to the total revenue of the firm if it raises or decreases the
price of its products. Total revenue (TR) is equal to price (P) times
quantity (Q).
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Imagine the following scenario:
Case Study
It is 2010 and Bafana Bafana is set to play in the final match of the Soccer
World Cup. The soccer stadium in which the final match is to take place has a
capacity of 100 000 seats. If the tickets sell for R100 each the total revenue
from this match will be R100 x 100 000 = R10 million. What if the price of the
tickets is R150? If they still sell 100 000 tickets the total revenue will be
100 000 x R150 = R15 million. Can you see how an increase in the price,
given that they still sell the same number of tickets, increases their
total revenue from R10 million to R15 million? But what if for some
reason they are only able to sell 90 000 tickets at a price of R150? In this
case, their total revenue is 90 000 x R150 = R13, 5 million, which is still
an increase of R3, 5 million. Can you see how their total revenue
increases even if they sell fewer tickets?
And what if they decide to sell the tickets at a lower price than R100,
say for R90? They will most probably sell all 100 000 tickets, but their
total revenue will decline to R9 million. In this case the demand is
said to be price inelastic. This means that buyers do not significantly
change their behaviour if the price of the product changes.
How much do you think they should charge for a ticket?
What will happen if an increase in the price does in
fact cause a significant decrease in the quantity?
At the same match, there are a number of food
vendors and outlets which sell fast food including
hamburgers, hot dogs, boerewors rolls, fried
chicken pieces and chicken burgers. Chick
Roast is an outlet that sells fried chicken
pieces. If they sell a fried chicken piece at
R4 per piece, they will sell 10 000 pieces.
Their total revenue will be R4 x 10 000
pieces = R40 000. If they sell a fried chicken
piece for R4,40 per piece, and they sell 8
000 pieces, their total revenue would be
R4,40 x 8000 = R35 200. As they increase
their price, their total revenue would
decline from R40 000 to R35 200. In this
example, we would say that the demand for
fried chicken pieces is price elastic. This means that buyers do significantly change their behaviour if the price
of the product changes.
This relationship between a change in price and a change in the
quantity demanded is captured by the price elasticity of demand. In the
case study of the final match of the Soccer World Cup, the number of
tickets demanded was unresponsive to changes in the price of tickets.
In economics this is referred to as price inelastic demand. In the case of
fried chicken pieces, the quantity of fried chicken pieces demanded was
very responsive to a change in its price. In economics this is referred to
as a price elastic demand.
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Activity 1.12
1.
In groups, discuss whether you would expect demand to be price elastic or price inelastic in
each of the following examples:
a) The demand for petrol.
b) The demand for hamburgers.
c) The demand for anti-retroviral medication.
d) The demand for fried chips.
Price elasticity of supply
According to the law of supply, an increase in the price of a product
increases the quantity supplied and businesses face an upward sloping
supply curve.
An increase in the price of a product causes an increase in the quantity supplied and a
decrease in the price causes a decrease in the quantity supplied.
P↑→ Qs↑
P↓→ Qs↓
Price elasticity of supply provides us with a measure of how sensitive
or responsive the quantity supplied is to a change in the price. Just like
with price elasticity of demand, it is possible to distinguish between an
elastic supply and an inelastic supply.
In the case of an elastic supply the change in price has a significant
impact on the quantity supplied; a small increase in the price leads to a
large increase in the quantity supplied.
In the case of an inelastic supply a change in price does not have a
significant impact on the quantity supplied; a large increase in price
leads to a small increase in quantity supplied.
24
Topic 1
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1.5 The impact of different economic
systems
The basic questions that are studied in economics are:
• What is to be produced and in what quantities?
• How are the goods to be produced?
• For whom are the goods produced?
• Who makes economic decisions and how?
Market economy
In a pure market economy the decisions of what products to produce,
how to produce them and for whom to produce them are dictated by
the forces of supply and demand which in turn establish prices.
Economic activity is therefore regulated by the pricing mechanism.
Consumers buy what they want according to what they can afford and
according to the price they are prepared to pay. Producers produce and
sell according to what they are able to sell and still make an acceptable
profit. The main objective for any production in a market economy is
profit. Changes in the price of any good or services result in consumers
and producers having to reconsider their decisions or choices
according to their situation.
Words &
Terms
Market ec
onomy: a
n econom
system th
ic
at is regu
lated by th
forces of
e
supply an
d demand
which inte
ract to es
tablish
prices
No single producer or group of producers can influence these
decisions. No single consumer or group of consumers is powerful
enough to dictate to other consumers or the producers.
A further defining aspect of a market economy is that factors of
production are owned by individuals, not the state. The state’s role is
limited to certain functions including the provision of national defence
and national health services.
According to the theory of the market economy, the forces of supply
and demand work to ensure that the resources used in the production
processes are used efficiently, and the goods that are provided by the
system are also distributed fairly amongst consumers. The argument is
that if the market system works properly most people should have jobs
and therefore be able to buy what they need. This type of system is
also called the free-market system because the forces of supply and
demand are allowed to work freely in the market. There is no
interference from government.
Any interference by government is not only unnecessary when these
market forces work well but would probably result in inefficiency. The
result of inefficiency is waste. Waste could well lead to some
companies going bankrupt resulting in job losses.
Unfortunately economic reality does not always match the economic
theory. In some instances the market system can also be the cause of
inefficiencies because the market sometimes fails to produce the product
that people need. We will look at market failures in more detail in a later
module (see module 6). Inequality in the distribution of income and
wealth is also a problem under a market system because the interests of
the individual are more important than the interests of the community.
Words &
Terms
Market fa
ilure: whe
n the
market fa
ils for vari
ous reaso
to provide
ns
pro
consumers ducts that
need or w
ant
Inequality
: unequal
distributio
of income
n
and wealt
h
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Command economy
Words &
Terms
Command
economy:
an
economic
system un
der which
the state
makes all
the
decisions
related to
the
economic
process
In a pure command economy, the government or the state decides
what products must be produced, how the products must be produced
and for whom they are produced. The motive behind this type of
system is to provide all the citizens of a country with what they need.
Moral considerations are supposed to be the driving force behind
production and consumption decisions.
The government decides what the citizens of a country need and want.
The government also decides who will produce these products, where
the factories will be located, what raw materials will be used in the
production process and ultimately what price the consumer will pay
for each good. Another name for this type of system is a centrally
planned system. Under such a system all the factors of production are
owned by the state.
In addition, in a command economy housing, water and electricity,
transport, health and education are provided free of charge. People
have to work for a government department or in a state run factory in
order to compensate the government for providing them with their
basic needs. The people who are in charge of running the factories
have to make sure that they provide the necessary products as
ordered. Unlike a market economy, in a command economy the need
to make a profit is not the main reason why a producer will start a
factory and carry on producing goods. This is the type of system that
was used in socialist countries.
One of the positive results of living under a socialist system was often
a very good education. One of the negative results though, was that
this education and subsequent employment was often not what an
individual may have chosen. That was decided by the state. What the
individual wanted to do or enjoyed doing was not often considered.
One of the goals of this type of system is equity. Everyone earns more
or less the same income. Although the idea can often be appealing, the
problem that occurred in reality was that everyone ended up being
rather poor, except for some politicians. Most people had their basic
needs met but there was very little in the way of choice when it came
to goods in the shops.
An important thing we learn from both the market and the command
system is that neither system is perfect. Experience has taught us that
it is a good idea to take the best from both systems. This is what we
have tried to do in South Africa.
Activity 1.13
1.
26
In small groups, discuss the differences between a pure market and a pure command economy
or system. Create a presentation using the following as a starting point:
• Who decides what must be produced in these two systems?
• Who decides how goods must be produced in these two systems?
• Who decides what consumers may or may not buy in these two systems?
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•
•
2.
Name one good aspect of both the market and the command economy or system.
Looking at the reality, name one negative aspect of both the market and the command
economy.
• Do you think that South Africa can have an economic system that takes the best from both
the market and command economies?
Some of you may be asked to make your presentation to the rest of the class.
Mixed economy
In South Africa we have what is called a mixed economy. Although the
market dictates most production and consumption decisions in the
economy, many goods and services are provided by the state. For
example we have public hospitals, clinics and schools. A person who
has no money at all can still receive medical attention at a clinic or a
public hospital. A child whose parents cannot pay school fees is still
allowed to attend school.
In a later module you will look at the Minister of Finance’s budget. You
will see that the government allocates quite a large proportion of the
budget to education and health. A mixed economy tries to address the
needs of those people who are really struggling. In this way we have
some of the characteristics of a command economy. In most cases
though, we have to pay for the goods or services that we need or want.
However, we do not always pay the full price. Tertiary education is a
good example of this. Although people who study through a university
pay a lot of money in fees to the institution, much of the money needed
to run a university still comes from the government.
Words &
Terms
Mixed eco
nomy: an
economic
system th
at has cha
racteristi
of both a
cs
market an
da
command
economic
system
In a mixed economy, if you decide you want to buy a new TV set or a
new cell phone, the government is not going to help you pay for it!
Here you are at the mercy of the market system. If you have some form
of income then you can go to the shop and buy the product that you
want. If you do not have the money to pay for the product then you
cannot have it. In South Africa we have an economy that is market
oriented but with some government intervention.
But when is an economy a mixed economy and not a market or a
command economy? In Diagram 1.1 you will see an illustration of the
difference between theory and reality. In theory we may have a pure
market economy, illustrated by the arrow head on the left of the
straight line. The arrow head on the right hand side of the straight line
illustrates the theoretical pure command economy. In between we may
find a variety of practical examples.
Diagram 1.1
Mixed but more market
USA
Pure market
Economy
RSA
50/50
Sweden
Mixed
economy
Mixed but more command
China (1990s)
USSR
Pure command
economy
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The economies of some countries may be more market-oriented but
may include a little bit of command style. Such an economy would be
placed on the left hand side of the line but not quite on the arrow head.
An example of this may be the USA. The old socialist countries like the
USSR and China before the 1970s, would have been placed close to the
right hand arrow head but also not on it. A country like Sweden which
is a market economy but which also has a very strong social welfare
system may be illustrated by the midpoint, shown as 50/50. Other
countries may have a more command economy while market forces
play an important role in the economy for example China during the
1990s, and such a country could be illustrated just slightly to the right
of the midpoint.
South Africa’s economy is a market economy but government plays an
important role in development issues. South Africa (RSA) could be
placed just to the left of the midpoint. It is for this reason that it is
important that you understand what markets are and how the forces of
supply and demand interact in the market. South Africa is classified as
a developing country and the role played by government will
therefore not be the same as it would be in a developed country like
the USA. It is important that you understand the role of government in
a developing country.
Unfortunately even a mixed economy is not perfect and fails many
people. There are still people who are poverty stricken and who do not
get enough to eat and who cannot find employment. There are also
other problems that are not solved by having a mixed economy. The
environment is still being polluted and in some cases misused, and
global warming has become a very real and frightening threat to the
future of humanity. We will look at these different problems in the later
modules.
Activity 1.14
You will complete this activity in two groups.
Debate the following statement: A mixed economy is always the best option for a country.
Your lecturer will tell you whether your group is in favour or against the statement. Divide the class
into small groups. Your lecturer will also explain how a debate works and allow you time to research
your group’s point of view before the debate. One aspect you may want to research is the problems
that even a mixed economy cannot solve.
1.6 The role of the economy in producing
goods and services
To produce goods and services a country must have production
capacity. A country’s capacity to produce goods and services is directly
related to the availability and quality of the factors of production.
Remember that these are natural resources, capital, labour and
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entrepreneurship. These are the supply factors that influence economic
growth and economic development.
The greater the quantity of factors of production a country has, the
higher the potential output of the country. It is possible to increase the
potential output of a country by ensuring an increase in the
productivity of the factors of production. With the same volume of
factors of production, the potential output increases if these factors are
used more efficiently.
Natural resources
Natural resources are all those resources supplied by nature and used
in the production of goods and services. These resources can be
regarded as a ‘gift of nature’ since we did not have to do anything to
create them. They include things such as agricultural and residential
land, water, wildlife, natural beauty, vegetation, air, climate, sunshine,
mineral deposits and soil nutrients.
An important characteristic of natural resources is that the supply is
fixed. It is not possible for us to increase the supply of these natural
resources by our own efforts. It is possible, however, to discover new
natural resources and improve the quality of some of these natural
resources. Through exploration we can discover new deposits of oil.
Through irrigation projects and the use of fertiliser we can turn more
land into productive agricultural land.
While South Africa is in the fortunate position of having a wide variety
and quantity of mineral resources, these resources are non-renewable.
Once they are used they cannot be replaced. The rates at which they
are exploited are therefore a cause for concern. In the past, the
exploitation of our mineral resources was the single most important
contributor to economic growth. It would be a mistake to continue to
base our economic growth and economic development strategies on
the exploitation of our mineral wealth. Future economic growth and
development will have to depend more on other factors as the mineral
supply is depleted.
Labour
Labour is any human effort that is put into the production of goods
and services with the aim of receiving a reward. Labour includes both
physical and mental effort.
There are mainly three factors that determine the quantity and supply
of labour available in a country:
The population growth rate (the birth rate minus the death rate)
If the birth rate exceeds the death rate, the size of the population
increases. Since there are more people, there is more labour. The effect
of an increase in the population growth rate is not felt immediately but
only when the children reach working age.
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The labour force participation rate
This figure gives us an idea of the proportion of the population that is
economically active. The economically active population (EAP)
comprises every person in the working age group between the ages of
15 and 65 who is willing and able to work. This excludes those people
of working age that are not available for work, such as students, ‘fulltime home workers’, retired people, and those that are unwilling or
unable to work.
Migration
This is the movement of groups of people from one locality to another
and we differentiate between immigration and emigration.
Quantity of labour
Workers who move from one country or area to another immediately
add to the labour force of the destination country or area. According to
official data provided by Statistics South Africa, immigration was an
important source of skilled labour for South Africa in the past, but the
trend has changed and we are now experiencing an outflow of skilled
labour.
Even more important than the quantity of labour is the quality of
labour.
Quality of labour
The quality of labour refers to the skills, knowledge and health of
workers. The quality of labour is often referred to as human capital.
Many economists believe that the difference in living standards
between countries is mainly a result of the differences in the quality of
their human capital. The better the quality of human capital in a
country, the higher the productivity of labour, and the more goods and
services are produced to satisfy needs and wants.
Factors that impact positively on the quality of the labour force are:
education, training and retraining, managerial skills, health, nutrition
and attitude to work. In the past, South Africa paid far too little
attention to the development of its human capital. Education and
training, particularly of non-whites, was neglected. Consequently,
South Africa is now suffering from an over-supply of unskilled labour
and a shortage of skilled labour.
Capital
Capital comprises all manufactured resources such as machines, tools
and buildings that are used in the production of other goods and
services. A distinction can be made between the capital required to
build up the production structure of a country and the capital required
to build up the infrastructure of a country.
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Infrastructure Capacity
The production capacity directly contributes to the production of goods and services, while the
infrastructure capacity contributes indirectly to the production of goods and services. Both are
important for economic growth and economic development.
The capital goods required to build up the production structure are
those goods that directly contribute to the production of goods and
services, such as factories, buildings, machines and tools. The more
machines, factories and tools we have, the more goods and services we
can produce. The better the quality of these capital goods, the more
productive we can be. The more productive we are, the higher our
economic growth will be. Appropriate capital goods also improve the
productivity of labour. It is believed that some countries fail to develop
because they do not have the necessary capital goods to start modern
manufacturing and production processes.
The infrastructure of a country contributes indirectly to the production
of goods and services. For effective production to take place in a
country, it needs to have roads, electricity, water, sanitation,
educational institutions, telecommunications networks and law and
order. These are things that government undertakes to develop and
maintain.
To achieve economic growth and economic development, we also need
to create new capital goods continuously and replace outmoded and
worn-out capital on a regular basis. Sufficient funding must be
available to finance the creation and replacement of capital goods.
Important sources of finance are the personal savings of households,
firms, government and loans from the rest of the world. All savings
form the basis of investments. Formulating policies to improve
economic growth and economic development must therefore take
financing into account. One of the causes of underdevelopment is the
low rate of savings in developing countries.
The fact that most of the capital goods used in the production of goods
and services in South Africa are imported from the rest of the world
must be taken into account when economic growth and development
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polices are designed. The availability of foreign exchange to purchase
these capital goods is a crucial requirement for economic growth and
development in South Africa.
An important factor that can make a positive contribution to economic
growth and development in South Africa is foreign direct investment
(FDI). The potential benefits of foreign direct investment in South
Africa is that as foreign reserves increase, a transfer of skills and
technology takes place, export markets are created and the domestic
market expands and is made more competitive. Part of the growth and
development strategy in South Africa is to attract more foreign direct
investment.
Technology
Sustained economic growth requires technological progress. Those
economies that are able to sustain a higher rate of technological
progress will eventually be the ones with the highest economic growth
rates and the highest level of economic development. Technological
progress is important because it enables a country to:
• increase the level of production without increasing the quantity of
factors of production
• improve the quality of the goods and services produced
• produce new products
• produce a wider variety of goods and services.
Examples of the technological breakthroughs that have had a major
impact on economic growth rates in the world are the printing press,
the steam engine, the internal combustion engine and computers.
Technological progress not only implies new kinds of capital goods but
also new production processes.
Technological progress can only contribute to economic growth in a
country that has a highly educated and skilled labour force and the
managerial competence to ensure that the technology is implemented,
operated and maintained efficiently.
Technological innovations do not occur overnight. They are developed
and adopted over a long period of time. One of the factors that play a
significant role in the discovery of new technology is scientific research
in both the public sector and the private sector. Developed countries
spend between 2% and 3% of their GDP on research and development.
In the United States of America about 75% of its scientist and
researchers are in the employment of private firms. In order to
stimulate technological progress, a country must ensure that it has
sufficient funding and qualified researchers available.
Entrepreneurship
All the economies of the world face the challenge of combining
resources in the most efficient way in order to produce goods and
services that will satisfy some of the unlimited needs and wants of
their citizens. In a market economy, it is the entrepreneurs that take up
this challenge, as well as the risks and rewards associated with it.
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In a market economy, the entrepreneurs are the driving force in the
economy. Their actions result in the production of more goods and
services, and the creation of employment and wealth for the whole
country. The more entrepreneurial activity there is in a country, the
higher the economic growth rate. A good economic growth rate is
essential for development and an increase in living standards.
Entrepreneurs are also the innovators. They develop new products and
services and change the processes of production by implementing new
technologies, which create further opportunities for other
entrepreneurs. Think of the many opportunities created by the
development of information technology. Computers changed the way
in which we do business.
A lack of entrepreneurial activity causes a low level of economic
activity. The economy then tends to stagnate and economic
development suffers. In the earlier stages of development it might be
necessary for government to act as an entrepreneur if there is an
overall lack of entrepreneurship in the country. At the very least,
government should ensure that there are no impediments, such as
unnecessary laws and regulations, to stifle entrepreneurship.
Activity 1.15
1.
Which one of the supply factors do you thing needs urgent attention in South Africa in order to
make a difference? Write a short essay in which you substantiate your answer.
Module assessment
1.
Briefly explain the following concepts: scarcity, choice, efficiency,
opportunity cost and marginal analysis.
2. Distinguish between microeconomics and macroeconomics.
3. Give examples of the following:
a) Fallacy of composition
b) Cause and effects
c) Rates of change and levels
4. Explain why economists make use of the ceteris paribus
assumption.
5. Use an example to explain the law of demand graphically.
6. Use an example to explain the law of supply graphically.
7. Explain the impact of the different economic systems.
8. Distinguish between price inelastic demand and price elastic
demand.
9. Distinguish between price inelastic supply and price elastic supply.
10. List the different supply factors and indicate why each one of them
is important for economic growth and economic development.
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Module summary
Certain basic economic concepts were explained in this module. You dealt with scarcity, choice,
efficiency, opportunity costs and marginal analysis as they pertain to economics. The difference
between micro- and macroeconomics was also briefly explained. This was followed by a discussion
of some common errors in economic thinking and the reasons why economists disagree. We also
explain the law of demand and law of supply with the aid of diagram and distinguish between
price elasticity of demand and supply. You also looked at the impact of different economic systems,
specifically the market economy, the command economy and the mixed economy. The section was
ended with a discussion of important supply factors in the production of goods and services.
Self assessment
I am able to define the different concepts of
scarcity, choice, efficiency, opportunity cost
and marginal analysis
I am able to explain the difference between
microeconomics and macroeconomics
I am able to identify and explain common
errors in economic thinking
I am able to explain why economist disagree
I am able to explain the law of demand with
words and a graph
I am able to explain the law of supply with
words and a graph
I am able to describe price elasticity of
demand and distinguish between price
inelastic and price elastic
I am able to describe price elasticity of supply
and distinguish between price inelastic and
price elastic
I am able to distinguish between the different
economic systems, market, command and
mixed economies
I am able to explain how supply factors
contribute to the production of goods in the
economy
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Topic 1
Outstanding
Highly
competent
Competent
Not yet
competent
Not achieved
80–100%
70–79%
50–69%
40–49%
0–39%