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UNIVERSITY OF MAIDUGURI Maiduguri, Nigeria CENTRE FOR DISTANCE LEARNING MANAGEMENT SCIENCES ECON 101: ECONOMIC THEORY AND PRINCIPLE II UNIT: 3 ECON 101: ECONONIC THEORY AND PRINCIPLE II units Published 3 2005© All rights reserved. No part of this work may be reproduced in any form, by mimeograph or any other means without prior permission in writing from the University of Maiduguri. This text forms part of the learning package for the academic programme of the Centre for Distance Learning, University of Maiduguri. Further enquiries should be directed to the: Coordinator Centre for Distance Learning University of Maiduguri P. M. B. 1069 Maiduguri, Nigeria. This text is being published by the authority of the Senate, University of Maiduguri, Maiduguri – Nigeria. ISBN: 978-8133-43-6 ii CDL, University of Maiduguri, Maiduguri ECON 101: ECONONIC THEORY AND PRINCIPLE II units 3 PREFACE This study unit has been prepared for learners so that they can do most of the study on their own. The structure of the study unit is different from that of conventional textbook. The course writers have made efforts to make the study material rich enough but learners need to do some extra reading for further enrichment of the knowledge required. The learners are expected to make best use of library facilities and where feasible, use the Internet. References are provided to guide the selection of reading materials required. The University expresses its profound gratitude to our course writers and editors for making this possible. Their efforts will no doubt help in improving access to University education. Professor J. D. Amin Vice-Chancellor iii CDL, University of Maiduguri, Maiduguri ECON 101: ECONONIC THEORY AND PRINCIPLE II units 3 HOW TO STUDY THE UNIT You are welcome to this study Unit. The unit is arranged to simplify your study. In each topic of the unit, we have introduction, objectives, in-text, summary and self-assessment exercise. The study unit should be 6-8 hours to complete. Tutors will be available at designated contact centers for tutorial. The center expects you to plan your work well. Should you wish to read further you could supplement the study with more information from the list of references and suggested readings available in the study unit. PRACTICE EXERCISES/TESTS 1. Self-Assessment Exercises (SAES) This is provided at the end of each topic. The exercise can help you to assess whether or not you have actually studied and understood the topic. Solutions to the exercises are provided at the end of the study unit for you to assess yourself. 2. Tutor-Marked Assignment (TMA) This is provided at the end of the study Unit. It is a form of examination type questions for you to answer and send to the center. You are expected to work on your own in responding to the assignments. The TMA forms part of your continuous assessment (C.A.) scores, which will be marked and returned to you. In addition, you will also write an end of Semester Examination, which will be added to your TMA scores. Finally, the center wishes you success as you go through the different units of your study. iv CDL, University of Maiduguri, Maiduguri ECON 101: ECONONIC THEORY AND PRINCIPLE II units 3 INTRODUCTION TO THE COURSE Micro economics is a branch of economics that deals with individual economic unit such as individual consumption, saving, demand etc. Macro economics on the other hand deals with aggregated economic variables/units such as aggregate demand, inflation, unemployment etc. covering the entire economy. CDL, University of Maiduguri, Maiduguri - Nigeria 1 ECON 101: ECONONIC THEORY AND PRINCIPLE II units ECON 101: 3 ECONOMIC THEORY AND PRACTICE II 3 units T A B L E O F C O N T E N TS PAGES PREFACE - - HOW TO STUDY THE UNIT - - - - - - iii - - - - - - iv - - - - - 1 INTRODUCTION TO THE COURSE TOPIC 1: DISTINCITON BETWEEN ECONOMICS - - MICRO - AND MACRO - - - 3 TOPIC 2: CIRCULAR FLOW OF INCOME - - - 7 TOPIC 3: NATIONAL INCOME - - - 12 TOPIC 4: ECONOMIC GROWTH AND ECONOMIC - - DEVELOPMENT - - - - - 20 TOPIC 5: FISCAL POLICY - - - - - - 24 TOPIC 6: MONEY AND BANKING - - - - 29 TOPIC 7: INTERNATIONAL TRADE - - - - 36 SOLUTIONS TO EXERCISES CDL, University of Maiduguri, Maiduguri - Nigeria 2 ECON 101: ECONONIC THEORY AND PRINCIPLE II units 3 T O P I C 1: TABLE OF CONTENTS PAGES 1.0 DISTINCTION BETWEEN MICRO AND MACRO ECONOMICS - - - - - - - 1.1 INTRODUCTION - - - - - - 4 1.2 OBJECTIVES - - - - - - - 4 1.3 IN-TEXT - - - - - - - 4 - - - - - 4 1.3.2 LOCATION OF ERRORS - - - - 4 1.3.3 SUSPENSE ACCOUNT - - - - 4 1.3.4 WORKED EXAMPLES - - - - - 1.4 SUMMARY - - - - 5 1.5 SELF ASSESSMENT EXERCISE - - - - 6 1.6 REFERENCE - - - - - 6 1.7 SUGGESTED READINGS - - - - - 6 - 1.3.1 TYPES OF ERRORS - - - - - CDL, University of Maiduguri, Maiduguri - Nigeria 3 5 3 ECON 101: ECONONIC THEORY AND PRINCIPLE II units 1.0 TOPIC: DISTINCTION BETWEEN MICRO AND MACRO ECONOMICS 1.1 INTRODUCTION: 3 Micro economics is a branch of economics that deals with individual economic unit such as individual consumption, saving, demand etc. Macro economics on the other hand deals with aggregated economic variables/units such as aggregate demand, inflation, unemployment etc. covering the entire economy. 1.2 OBJECTIVES: At the end of this topic you should be able to i. Differentiate between the two branches of economic analysis. 1.3 IN-TEXT 1.3.1 DISTINCTION BETWEEN MICRO AND MACRO ECONOMICS Every society must allocate its scarce resources among alternative uses to solve the economic problems of production, distribution and growth. Since the mid 1930’s, it has become necessary to divide the subject matter of economics into two sub-fields i.e. Microeconomics and Macroeconomics. 1.3.2 MICRO ECONOMICS Micro is a Greek word micros meaning “small”. However, it is a special branch of economics which studies individual economic parts such as households, firms, markets etc. In short, micro economics studies: i. The manner in which consumers allocate their income among various goods and services and ii. The ways in which business firms decide what goods to produce and what prices to charge. 1.3.3 MACRO ECONOMICS Macro is also a Greek word meaning “Large” or pertaining to the whole. Macro economics studies the economy as a CDL, University of Maiduguri, Maiduguri - Nigeria 4 ECON 101: ECONONIC THEORY AND PRINCIPLE II units 3 whole. The subject matter of macroeconomics involves the behaviour of the economy as a whole. Macro economics deals with economic affairs in the “Large”. It studies the character of the “forest” of economic activities independent of the “tree” that compose it. Macro economics studies things such as unemployment, inflation, etc. Macro economics is primarily concerned with the study of fluctuations in the level of employment, aggregate income, the general price level and the ways to prevent such fluctuations. It is also interested in determining the economy’s total output and its growth overtime. 1.3.4 MICRO/MACRO ECONOMICS Students of economics must learn both branches very well because it is not possible to understand economic phenomenon without the knowledge of both micro and macro economics. For example, studying the twin evils of inflation and unemployment cannot be possible without examining micro and macro issues such as aggregate level of expenditure, pricing practices, behaviours of labour unions etc. However, one shall note that micro and macro economics complement each other. It is not possible to analyze economic issues without employing both fields. 1.4 SUMMARY The distinction between micro and macro economics is not a matter of wrong or right. This is because micro economic theory depends on macro economic analysis, the total is made up of the part. Therefore, they are complementary. However, the basic distinction between micro and macro economics deals with determination of relative prices and allocation of resources among completing ends under full employment condition. This largely depends on individual demand and supply while macro economics on the other CDL, University of Maiduguri, Maiduguri - Nigeria 5 ECON 101: ECONONIC THEORY AND PRINCIPLE II units 3 hand deals with determination of aggregate relative price and allocation of resources among completing ends. 1.5 SELF ASSESSMENT EXERCISES 1. Explain micro and macro economics? 2. Describe the scope of micro and macroeconomics 3. State the relationship that exist between micro and macro economics. 1.6 REFERENCES Friedman, M. (1953): The Methodology Of Positive Economics University of Chicago press. Pg 1-4. Lange, O. (1946); The Scope And Method Of Economics. 1.7 SUGGESTED READINGS Introduction To Positive Economics by R. G. Lipsey. CDL, University of Maiduguri, Maiduguri - Nigeria 6 ECON 101: ECONONIC THEORY AND PRINCIPLE II units 3 TOPIC 2: TABLE OF CONTENTS PAGES 2.0 CIRCULAR FLOW OF INCOME - - - - 2.1 INTRODUCTION - - - - - - 8 2.2 OBJECTIVES - - - - - - 8 - - - - - - 8 - - - 8 - 8 2.3 - IN-TEXT 2.3.1 CIRCULAR FLOW OF INCOME 7 2.3.2 THE FLOW OF INCOME IN A TWO SECTOR MODEL - - - - - - 2.3.3 THE CIRCULAR FLOW OF INCOME IN A THREE SECTOR MODEL - - - - 9 - - - - 10 2.4 SUMMARY - 2.5 SELF ASSESSMENT EXERCISE - - - - 10 2.6 REFERENCES - - - - - 10 2.7 SUGGESTED READINGS - - - - - 10 - - - - CDL, University of Maiduguri, Maiduguri - Nigeria 7 ECON 101: ECONONIC THEORY AND PRINCIPLE II units 2.0 3 TOPIC: CIRCULAR FLOW OF INCOME 2.1 INTRODUCTION: The circular flow of income is the process where by the national income and expenditure of an economy flow in a circular manner continuously among economics agents (households, firms, government etc.) 2.2 OBJECTIVES: At the end of this topic you should be able to: i. Describes what circular flow of income is. ii. Describe the pattern of flow of National income among economic agents in an economy. 2.3 IN-TEXT 2.3.1 CIRCULAR FLOW OF INCOME The circular flow of income provides a conceptual frame work for describing the relationship among three economic variables, that is to say output, income and spending (consumer expenditures). Starting with the simplest economy without external transactions and without government, the economy can be considered as made of two kinds of economic institutions or agents namely the households and firms. 2.3.2 THE CIRCULAR OF INCOME IN A TWO SECTOR MODEL A household is an agent which own factors of production and buys all final consumer goods. A firms, on the other hand, owns nothing, but buys factors of production from households, and pays any profit which it makes on its activities as wages to households. This relationship is illustrated as follows: INCOME (Y) Factors of Production Households owns factors of production as labour, land Goods and services Firms Owns goods and services. Manufactured goods CDL, University of Maiduguri, Maiduguri - Nigeria 8 ECON 101: ECONONIC THEORY AND PRINCIPLE II units 3 Consumer expenditures In the above illustration, two kinds of flow take place between households and firm. First, real things are supplied by household to firms and by firms to household. Second, money passes between household and firms in exchange for these real things. Households supplies factors of production to firms, while firms supply goods and services to households. Moving on the opposite direction to these real flows are the money flows. Firms pays income to households and households spend their income on consumer goods. Thus, the aggregate income (Y) is equal to the aggregate expenditure (E). E = I = value of output. So far we have been working on the circular flow of income in a two sector model of an economy. 2.3.3 THE CIRCULAR FLOW OF INCOME IN A THREE SECTOR MODEL To do this we add the government sector so as to make it a three sector closed model of circular flow of income and expenditure. For this we add taxation and government purchases or expenditure in our presentation. Taxation is a leakage from the circular flow and government purchases are injections into the circular flow. The relationship is illustrated below: Households owns factors of production s Government as institution producing social functions Firms own goods and services Income to household Consumer expenditure CDL, University of Maiduguri, Maiduguri - Nigeria 9 ECON 101: ECONONIC THEORY AND PRINCIPLE II units 3 However, there are three features of the “real world” which are not captured in the analysis of simple circular flow of income. Thus are: i. ii. iii. 2.4 Households typically do not spend all their income as consumer goods. They also save part of their income. Government consist of large institutions in the modern world which tax individuals income and which use their tax proceeds to pay large quantities of goods and services from firms. Economic activity is not restricted to trading with other domestic residents, international trade, traveling and capital movement are common in recent times. SUMMARY The circular flow of income describes the relationship that exists among three key economic variables that is to say output, income and spending by providing a conceptual frame work for it. The concept gives a clear picture of the economy in terms of movements of goods and services among economic agent (potential consumer and producer of economic goods and services) 2.5 SELF ASSESSMENT EXERCISES 1. Explain the concept of the “circular flow of income”. In what ways do international transaction affect this flow within a closed economy? 2.6 REFERENCES: M. L. JHIGAN: Micro And Macro Economics Samuel, P. A. (1947): Foundation Of Economic Analysis (Haward University Press. Pg 9). 2.7 SUGGESTED READINGS Micro And Macro Economics by M. L. JHIGAN CDL, University of Maiduguri, Maiduguri - Nigeria 10 ECON 101: ECONONIC THEORY AND PRINCIPLE II units CDL, University of Maiduguri, Maiduguri - Nigeria 3 11 ECON 101: ECONONIC THEORY AND PRINCIPLE II units 3 TOPIC 3 TABLE OF CONTENTS PAGES NATIONAL INCOME: CONCEPT, TERMS AND MEASUREMENT - - - - 11 3.1 INTRODUCTION - - - - - - 12 3.2 OBJECTIVES - - - - - - - 12 3.3 IN-TEXT - - - - - - - 12 3.3.1 THE CONCEPT OF NATIONAL INCOME - 12 3.3.2 THE TRADITIONAL DEFINITION - - 12 3.3.3 THE MODERN DEFINITION - - 13 - - 14 - 15 - 16 3.0 - - 3.3.4 CONCEPTS OF NATIONAL INCOME 3.3.5 MEASUREMENT OF NATIONAL INCOME 3.3.6 NATIONAL INCOME EQUILLIBRIUM DEFINIATION: THE TWO SECTOR MODEL 3.4 SUMMARY - 3.5 - - - - 18 SELF ASSESSMENT EXERCISE - - - - 19 3.6 REFERENCES - - - - - 19 3.7 SUGGESTED READINGS - - - - - 19 - - - - CDL, University of Maiduguri, Maiduguri - Nigeria 12 ECON 101: ECONONIC THEORY AND PRINCIPLE II units 3.0 3 TOPIC: NATIONAL INCOME: CONCEPT, TERMS AND MEASUREMENT 3.1 INTRODUCTION: National income is an uncertain term which is used interchangeably with National dividend, national output and National expenditure. On this basis, national income has been defined in a number of ways. In common parlance, National income means the total value of goods and services produced annually in a country over a specified period of time usually a year. 3.2 OBJECTIVES: At the end of this topic you should be able to: i. Understand the concept, terms of national income ii. Understand various methods of measuring national income 3.3 IN-TEXT: 3.3.1 THE CONCEPT OF THE NATIONAL INCOME The concept if national income is seen by many people in different perspectives. It is used interchangeably with national dividend, national output or national expenditure. As a result, there are so many definitions of the term. In common usage, the term means the total value of goods and services produced annually in a country over a period of one year. It includes payments made to all resources as in wages for labour, rent for land, interest for capital and profit for the entrepreneur. Technically, the definition of national income is classified into two: i. The traditional definitions. ii. The modern definition. 3.3.2 THE TRADITIONAL DEFINITION: These are definitions advanced by Marshal, Pigou and fisher. CDL, University of Maiduguri, Maiduguri - Nigeria 13 ECON 101: ECONONIC THEORY AND PRINCIPLE II units 3 To marshal, the labour and capital of a country annually produce certain net aggregate of commodities, materials and immaterial things including services of all kinds etc. This is the true net national income or revenue of the country or national dividend. Pigou, a devoted follower of marshalian thinking included the use of money as a measure of national income to the earlier definition made by marshal. To him, “national income is that part of objective income of the community including of course income dividend from abroad which can be measured in money”. This definition proved to be more practical than the marshalian definitions. This is because the use of money as a measure of national income may prevent double counting the value of a product. Fisher, completely deviated from the marshalian and pigourvian definitions of National income. He uses consumption” as the criterion of national income as opposed to marshalian and pigourian use of “production” as a measure of national income. To him, the national income dividend or income consists solely of services as received by ultimate consumers, whether from their material or human involvements. Thus, a piano or an over coat made for me this year is not part of this year’s income, but an addition to capital. Only the services rendered to me this year by this things constitute income”. Fisher’s definition of national income is considered to be more adequate than that of marshal or pigou, because Fisher’s definition provides an adequate concept of economic welfare which depends on consumption and consumption represent standard of living. However, the marshalian and pigouvian definitions give the reasons influencing economic welfare where as Fisher’s definition helps in comparing economic welfare in different years. 3.3.3 THE MODERN DEFINITION: From the modern point of view, Simon Kuznet defined national income as the “net output of commodities and services flowing during the year from the country’s productive system in CDL, University of Maiduguri, Maiduguri - Nigeria 14 ECON 101: ECONONIC THEORY AND PRINCIPLE II units 3 the hands of the “ultimate consumers”. The United Nations, in one of its reports, defined national income as the net national product, as addition to the shares of different factors and as net national expenditure in a country in a year’s time. The definitions advanced by both marshall and pigou, Fisher, and Kuznet should be considered to be because all are considered to give same result of national income when estimated. CDL, University of Maiduguri, Maiduguri - Nigeria 15 ECON 101: ECONONIC THEORY AND PRINCIPLE II units 3 3.3.4 CONCEPT OF NATIONAL INCOME There are a number of concepts that are associated with national income accounting. Common among such concepts are: ii. Gross National Product (GNP) iii. Net National Product (NNP) iv. Personal Income v. Disposable Income vi. Per Capita Income etc. 1. GROSS DOMESTIC PRODUCT: This is the total measure of the flow of goods and services at market value resulting from current production during a year in a country, including net income from abroad. Gross National Product (GNP) is a measure of money in which all kinds of goods and services produced in a country during one year are measured in terms of money at current prices and then added together. In estimating (GNP) however, the market prices of only the final product should be taken into account. 2. NET NATIONAL INCOME (NNP): This process of production uses up to a certain amount of fixed capital. Some equipments wear out, meaning that other components are damaged or destroyed. This is what is considered as depreciation or capital consumption allowance. In order to arrive at net national product (NNP), we deduct depreciation from GNP that is to say NNP = GNP – depreciation. 3. PERSONAL INCOME: Personal income is the total income received by individuals of a country from all sources. Personal income is never equal to national income because personal income includes transfer payments therefore, transfer payments are normally not included in national income. Personal income is derived from national income by deducting undistributed profits, profit taxes etc. 4. DISPOSABLE INCOME: Disposable income or personal disposable income means the actual income which can be spent CDL, University of Maiduguri, Maiduguri - Nigeria 16 ECON 101: ECONONIC THEORY AND PRINCIPLE II units 3 on consumption by individuals and families. To obtain disposable income, direct taxes are deducted from personal income. The whole of disposable income is not spent on consumption because part of it is annually saved. Therefore, disposable income is divided into consumption expenditure and savings. 5. PER CAPITA INCOME:The average income of the people of a country in a particular year is called per capita income for that year. This concept also refer to the measurement of income at current prices and at constant prices. For instance, in order to find out the per capita income for 1990, at current prices, the national income of a country is divided by the population of the country in that year. That is to say per capita income for 1990. = National income 1990 divided by the Population in 1990 The concept of per capita income enables us to know the average income and the standard of living of the people. But the concept is not very reliable because in every country due to unequal distribution of national income, a major proportion of it goes to the richer section of the society and thus income received by the common man is lower than the year’s per capita income. 3.3.5 MEASUREMENT OF NATIONAL INCOME There are four known methods of measuring national income. The choice of the method depends largely on data availability and the economic circumstances prevailing in the economy or country. The four method of national estimation are: i. Product method ii. Income method iii. Expenditure method iv. Value added method i. income measurement THE PRODUCT METHOD: This method uses the market prices of final goods and services produced in a country during a year. The data of all productive activities such as agricultural products, manufactured products, the CDL, University of Maiduguri, Maiduguri - Nigeria 17 ECON 101: ECONONIC THEORY AND PRINCIPLE II units 3 contribution of transportation, communication, doctors, teachers etc, are collected and assessed at market prices. Here, only the final goods and services are considered, while intermediate or semi-finished goods are excluded. INCOME METHOD: Here, the net income payments of the citizens of a country in a particular year are considered. Eg. Net wages, net interest and net profits of the citizens are considered while transfer payments are excluded. ii. iii. ENPENDITURE METHOD: Here, the personal consumption expenditure, net domestic investment, government expenditure on goods and services and net foreign investment are considered. Here, it is believed that national income is equal to national expenditure. iv. VALUE ADDED METHOD: Another method of measuring national income is the value added by industries. The differences between the value of materials output and inputs at each stage of production is the value added. If all such differences are added up for all industries in the economy, we arrive at the Gross domestic product. 3.3.6 NATIONAL INCOME EQUILIBRIUM DETERMINATION: TWO SECTOR MODEL ECONOMY Y=C+I C = 90 + 6yd Where Y = national income, C = Consumption 90 = autonomous consumption, Yd = disposable income, 6 = marginal propensity to consume. If C = 85 + 0.9y I = 55 Determine: i) Equilibrium income ii) Level of consumption iii) Marginal propensity to consume iv) Autonomous consumption v) Present your findings on a befitting graph. CDL, University of Maiduguri, Maiduguri - Nigeria 18 ECON 101: ECONONIC THEORY AND PRINCIPLE II units (i) 3 Equilibrium income. Y=C+I Y = 85 + 0.9y + 55 Collect like terms Y – 0.9y = 85 + 55 Y(1-0.9) = 140 0.1y = 140 Y = 140 0.1 Y = N1400 (ii) Level of consumption C = 90 + 6y C = 85 + 0.9y C = 85 + 0.9 (1400) C = 85 + 1260 C = N1345 Prof: Y = C + I 1400 = 1345 + 55 1400 = 1400 (iii) Marginal propensity to consume B = ∆C ∆Y = 1345 1400 B = 0.9 Or ∆C = d ∆C ∆Y (85 + 0.9y) = 0 + 0.9 (y1 – 1) = 0 + 0.9y0 = 0.9 (iv) Autonomous consumption C = 90 + 6y 90 = C – 6y CDL, University of Maiduguri, Maiduguri - Nigeria 19 ECON 101: ECONONIC THEORY AND PRINCIPLE II units 3 90 = 1345 – (0.9 x 1400) 90 = 1345 – 1260 90 = N85 (v) GI Y=E Y = C + I = 1400 1400 C = a + by = 1345 1345 90 = 85 a 0 I = 55 45 o 1345 1400 Y 3.4 SUMMARY: National income means the total value of goods and services produced annually in a country. In other words, it is the total amount of income accruing to a country from economic activities in a year’s time. The definition of national income is classified into two; namely the traditional and modern definition. The traditional definitions advanced by marshal, pigou and Fisher tells us the reasons influencing economic welfare and compares economic welfare in different years, where as the modern definition advanced by Kudnets and United Nation defined national income as the net output of commodities and services flowing during the year. However, for clarity sake different concepts has been used to explain the term national income. Such concepts include Gross Domestic Product (GDP), Gross National Product (GNP) Net National Product (NNP) etc. 3.5 SELF ASSESSMENT EXERCISES CDL, University of Maiduguri, Maiduguri - Nigeria 20 ECON 101: ECONONIC THEORY AND PRINCIPLE II units 3 1. Explain the various concepts of national income. Under what circumstances does national income tend to be underestimated? 2. What do you understand by the term “National income”. Explain the product and expenditure approaches of computing national income. 3. Discuss the traditional and modern definitions of national income, explaining their differences and interrelationships. 4. Point out the differences between the following concepts of national income. a. Gross national product and net national product b. Net national income at market prices and Net national income at factor prices. c. Net national product and net domestic product d. Disposable income and personal income. 5. Given Y = C + I where C = 55, I = 100 I = Investment C = Consumption, where Y = national income 90 = autonomous consumption Find a. Equilibrium National income b. Consumption level c. Marginal propensity to consume and d. Depict your findings on a befitting graph. 3.6 REFERENCES: Koopman, I. C “Measurement without Theory”, Review Of Economic And Statistics (1947) pg (161-72). Samuelson P. A., Foundation of Economic Analysis (Haward University) press, (1947). Samuelson P. A. “Economic Theory and Mathematics: An Appraisal”, American Economic Review (1952) pg 56-66. 3.7 SUGGESTED READINGS Samuelson P. A. “Economic Theory and Mathematics: An Appraisal”, American Economic Review (1952) pg 56-66. CDL, University of Maiduguri, Maiduguri - Nigeria 21 ECON 101: ECONONIC THEORY AND PRINCIPLE II units 3 TOPIC 4: TABLE OF CONTENTS PAGES 4.0 ECONOMIC GROWTH AND ECONOMIC DEVELOPMENT - - - - - - - 4.1 INTRODUCTION - - - - - - 21 4.2 OBJECTIVES - - - - - - - 21 4.3 IN-TEXT - - - - - - - 21 4.3.1 ECONOMIC GROWTH - - - - 21 4.3.2 SOURCES OF GROWTH - - - - 21 - - - 23 4.3.4 IMPEDIMENTS TO DEVELOPENT - - 23 4.4 SUMMARY - 4.5 - 20 4.3.3 DEVELOPED AND UNDERDEVELOPED COUNTRIES - - - - 24 SELF ASSESSMENT EXERCISE - - - - 24 4.6 REFERENCES - - - - - 24 4.7 SUGGESTED READINGS - - - - - 24 - - - - - - - CDL, University of Maiduguri, Maiduguri - Nigeria 22 ECON 101: ECONONIC THEORY AND PRINCIPLE II units 4.0 TOPIC: ECONOMIC GROWTH AND ECONOMIC DEVELOPMENT 4.1 INTRODUCTION: 3 This section discusses economic growth and economic development. Economic growth refers to the growth in national income, while economic development depict growth and structural changes in the economy. 4.2 OBJECTIVES At the end of this topic you should be able to: i. Define economic development and economic growth. ii. Know the differences between the two concepts 4.3 IN-TEXT 4.3.1 ECONOMIC GROWTH 1. It can be referred to growth in national output as measured by the Gross Domestic Product (GDP) or 2. it can referred to growth in individual standard of living as measured by Gross National Product per capita. Thus, total output of a given country grows because output per person grows. Growth in national output measures economic power of a given nation. On the other hand, growth in individual standard of living measures the well being of the citizens of a country. Theories of economic development analyze why some countries have failed to grow or develop and what strategies would promote faster economic growth. 4.3.2 SOURCES OF GROWTH Here, it is useful to distinguish between two types of growth namely extensive growth and intensive growth. CDL, University of Maiduguri, Maiduguri - Nigeria 23 ECON 101: ECONONIC THEORY AND PRINCIPLE II units 3 i. EXTENSIVE GROWTH: Extensive growth is growth in output resulting from increasing in inputs. For example, if employment of labour increases by 10 percent, output also grows by this percentage. ii. INTENSIVE GROWTH: Intensive growth results from improvements in factor quality, for example better education of the labour force, technology etc. Walter Rostow, an economic Historian who studies economic growth, gave pre conditions necessary for a country to take off. By “take off” He meant to move from a low level of development to sustained industrialization and economic growth. He presented four pre-conditions for development to occur. These pre-conditions are as follows: i. Entrepreneurs with enough capital to start small businesses. This class of entrepreneur must be well educated, urbanized and have adequate financial resources. ii. Adequate workforce: Large part of the workforce must be literate /educated to enable them work in modern factories. The workforce must be able to write, read and understand written materials. iii. Adequate infrastructure: Good transport system, communication etc, must exist to facilitate economic interaction within the country. Electricity and water supply must be reliable. iv. An appropriate institutional environments: Effective rule of law must be available. Political stability and social order are also important part of the environment. If these pre-conditions are not met, development is impended. ECONOMIC DEVELOPMENT The term development may mean different things to different people. It is important at the outset that we have some working definition or core perspective on its meaning. According to traditional economic measures, development means the capacity of a national economy, whose initial economic condition has been low or static for CDL, University of Maiduguri, Maiduguri - Nigeria 24 ECON 101: ECONONIC THEORY AND PRINCIPLE II units 3 a long time, to generate and sustain an annual increase in its Gross Domestic Product (GDP). There are, however, three cores values of development. CORES VALUES OF DEVELOPMENT There are three cores values of development 4 Life sustenance: The ability to meet basic needs. 5 Self esteem: To be a person and 6 Freedom from servitude: To be able to choose. This implies that a country is said to be developing economically if it can. i. Increase the availability and widen the distribution of basic life-sustaining goods and services such as food, shelter, health and protection. ii. Raise the levels of living including in addition to higher incomes, the provision of more jobs, better education and greater attention to cultural and human values, all of which will serve not only to enhance materials well being but also to generate greater individual and national self esteem and iii. To expand the range of economic and social choices available to individuals and nations by freeing them from servitude and dependence not only in relation to other people and nation states but also on the forces of ignorance and human misery. 4.3.3 DEVELOPED AND UNDERDEVELOPED COUNTRIES: The developed countries are those that have obtained a relatively high material standard of living. Traditionally, developed countries include the industrialized nations in North America, Europe and Japan. The under developed or developing countries are countries that relatively have low standard of living. Among countries that are under developed, we have South America (Venezuela, Colombia, Argentina etc.) and the Caribbean’s. others include countries of Africa such as Nigeria, Niger, Chard, Uganda Ethopia, Egypt and the Sudan. These countries are sometimes referred to as “developing countries” or less developed countries”. CDL, University of Maiduguri, Maiduguri - Nigeria 25 ECON 101: ECONONIC THEORY AND PRINCIPLE II units 4.3.4 3 IMPEDIMENTS TO DEVELOPMENT Population growth Capital accumulation Other issues such as national resources endowment of the country and cultural and social values in the development process. ENHANCING THE POTENTIAL FOR DEVELOPMENT There is a need to enhance a nation’s potential for development. For a nation to developed some things have to be done. These includes: To overcome the obstacles to development Re-focusing expenditure on education Family planning i. e voluntary or corresive Infrastructural development Reforming the rule of law Encouraging the development of financial market and Political stability. 4.4 SELF ASSESSMENT EXERCISES: 1. Distinguish between economic growth and economic development. 2. What are the cores values of economic development? 4.5 SUMMARY Economic growth can mean two things. It can be referred to as growth in national output as measured by the Gross Domestic Product (GDP) or it can be referred to as growth in individuals standard of living. Economic development on the other hand means or may be defined as growth plus structural changes in the economy. 4.6 REFERENCES: Michel P. Todaro and Stephen Smith Theory of Economic Development 8th edition (2003) ML Jhingan Economic Development and Planning 36th revised edition, 1997 chapter 52. CDL, University of Maiduguri, Maiduguri - Nigeria 26 ECON 101: ECONONIC THEORY AND PRINCIPLE II units 3 C. P. Kindleberg and Helrich B. Economic Development pg 7580. 4.7 SUGGESTED READINGS: Michel P. Todaro and Stephen Smith “Theory of Economic Development” 8th edition (2003) CDL, University of Maiduguri, Maiduguri - Nigeria 27 ECON 101: ECONONIC THEORY AND PRINCIPLE II units 3 TOPIC 5: TABLE OF CONTENTS PAGES 5.0 FISCAL POLICY - - - - - - - 5.1 INTRODUCTION - - - - - - 26 5.2 OBJECTIVES - - - - - - - 26 5.3 IN-TEXT - - - - - - - 26 5.3.1 DEFINITION OF FISCAL POLICY - - 26 - 5.3.2 IMPLEMENTATION OF FISCAL POLICY 5.3.3 OBJECTIVES OF FISCAL POLICY 5.4 SUMMARY - 5.5 - - 27 - - 28 SELF ASSESSMENT EXERCISE - - - - 28 5.6 REFERENCES - - - - - 28 5.7 SUGGESTED READINGS - - - - - 28 - - 26 - - - 25 CDL, University of Maiduguri, Maiduguri - Nigeria 28 ECON 101: ECONONIC THEORY AND PRINCIPLE II units 5.0 3 TOPIC: FISCAL POLICY 5.1 INTRODUCTION: This section discusses fiscal policy. Fiscal policy is one of the major policies which government uses to regulate the affairs of the economy. 5.2 OBJECTIVES: At the end of this topic you should be able to: i. Define what fiscal policy is. ii. Understand the pattern of government generation and expenditure. revenue 5.3 IN-TEXT 5.3.1 DEFINATION OF FISCAL POLICY The term fiscal policy refers to the part of government policies concerning the raising of revenue through taxation and other means and deciding on the level and pattern of expenditure for the purpose of influencing economic goals. Fiscal policy therefore can be use for the allocation, stabilization and distribution of resources in an economy. In essence, the primary objective of fiscal policy is to balance the use of resources of the public and private sectors and by so doing, to avoid inflation, unemployment, balance of payments pressures and income inequality. 5.3.2 IMPLEMENTATION OF FISCAL POLICY Fiscal policy is implemented through budgets. A budget is a financial statement of the sources of income (revenue) and its uses (expenditure) of the government. When the governments expenditure is equal to its revenue, a balanced budget is obtained. When government expenditure is greater than its revenue, we have a deficit budget, but when government expenditure is less than its revenue, we have a surplus budget. Government may deliberately plan for a deficit budget or surplus as a way of influencing economic activity. When for example an economy is in recession, the government can CDL, University of Maiduguri, Maiduguri - Nigeria 29 ECON 101: ECONONIC THEORY AND PRINCIPLE II units 3 budget for a deficit budget. Such a deficit can come about in three ways. Reducing taxes:- A decrease in tax will increase individual disposable income. This will increase aggregate spending and hence national income. Increasing government component of aggregate demand. This is done by increasing its expenditure on projects like roads, hospitals etc. More employment will be created and through the multiplier aggregate demand will rise. Subsidizing firms: - The government can subsidize firms so that they may be able to invest more and there by increase their own component of aggregate demand. If however, the economy is going through a period of inflation, the government can budget for surplus budget. Such a surplus budget can be brought about in three ways. a. Increasing taxes:By increasing taxes, individual disposable income will decrease and aggregate spending will fall. b. Reducing expenditure:The government can reduce its own expenditure on projects. The multiplier effect of this will lead to reduction in government component of aggregate demand, hence national income. c. Reducing grants to firms:- By reducing grants and subsidies to firms, the government will be curtailing their ability to invest. This will reduce their component of aggregate demand hence national income. 5.3.3 OBJECTIVES OF FISCAL POLICY An extensive use of fiscal policy is indispensable for economic development. The major goals of fiscal policy are: a. To increase employment opportunities:- Fiscal policy aims at increasing employment opportunities and reducing unemployment and underdevelopment. For this, the nation expenditure should be directed toward providing social and economic over heads. CDL, University of Maiduguri, Maiduguri - Nigeria 30 ECON 101: ECONONIC THEORY AND PRINCIPLE II units b. c. d. e. f. 3 To promote economic stability:- Fiscal policy promotes the maintenance of reasonable economic stability in the face of short run international stability. To control inflation:- Fiscal policy aims at counteracting inflationary tendencies inherent in an economy. To increase the rate of investment:- Fiscal policy aims at the promotion and acceleration of the rate of investment in the private and public sectors of the economy. To ensure growth of national income:- Fiscal policy aims at promoting or increasing the national income of an economy. To improve equilibrium, balance of payment etc. 5.4 SUMMARY Fiscal policy is the use of government expenditure and taxation to control the level of economic activities. In essence, the primary objective of fiscal policy is to balance the use of resources, of both the private and public sectors and by so doing to avoid inflation, deflation, unemployment, balance of payment pressures, and income inequality. 5.5 SELF ASSESEMENT EXERCISES 1 What is fiscal policy? Distinguish clearly between the three main types of discretionary fiscal policy. 2. Define and discuss the objectives of fiscal policy in a developing economy like Nigeria. 3. Discuss fiscal policy as a device for controlling the level of economic activity. 5.6 REFERENCES: Pfouts, R. W. and C. E. Ferguson “Theory of operationalism and policy”. Southern Economic Journal (1961). M L Jhighan, Monetary Policy And Fiscal Policy fifth revised edition. 5.7 SUGGESTED READINGS: CDL, University of Maiduguri, Maiduguri - Nigeria 31 ECON 101: ECONONIC THEORY AND PRINCIPLE II units 3 M L Jhighan, Monetary policy and fiscal policy fifth revised edition. CDL, University of Maiduguri, Maiduguri - Nigeria 32 ECON 101: ECONONIC THEORY AND PRINCIPLE II units 3 TOPIC 6: TABLE OF CONTENTS PAGES 6.0 MONEY AND BANKING - - - - - 6.1 INTRODUCTION - - - - - - 30 6.2 OBJECTIVES - - - - - - - 30 6.3 IN-TEXT - - - - - - - 30 - - - - 30 6.3.2 QUALIFICATION OF GOOD MONEY - - 30 6.3.3 FUNCTION OF MONEY - - - - 31 6.3.4 BANKS -- 6.3.1 DEFINITION OF MONEY - - - - - - 32 6.3.5 TYPES OF BANKS - - - - - 32 6.3.6 COMMERCIAL BANKS - - - - 32 6.3.6.1 - 29 FUNCTIONS OF COMMERCIAL BANK 33 6.3.7 ROLE OF COMMERCIAL BANKS IN NIGERI - 34 6.3.8 PROBLEMS OF COMMERCIAL BANKS IN NIGERIA - - - - - - - - - - - - - 34 34 6.4 SUMMARY - 6.5 SELF ASSESSMENT EXERCISE - - - - 35 6.6 REFERENCES - - - - - 35 6.7 SUGGESTED READINGS - - - - - 35 - - CDL, University of Maiduguri, Maiduguri - Nigeria 33 ECON 101: ECONONIC THEORY AND PRINCIPLE II units 6.0 TOPIC: MONEY AND BANKING 6.1 INTRODUCTION 3 Money is a device that is generally acceptable as a medium of exchange. Banking is an institution that deals in money and other assets of value. 6.2 OBJECTIVES At the end of this topic you should be able to: i. Define money and banking. ii. Understand what is meant by money and banking. 6.3 IN-TEXT 6.3.1 DEFINITION OF MONEY Money has been defined in many ways. Some say money is what money does. In other words, anything that performs the function of money is money. In a wider sense, the term money includes all media of exchange. Gold, Silver, Copper, Paper, Cheques, Bills etc, have been called and used as money. The most commonly accepted view about money is that “all medium of exchange and payments, whose acceptance is legally backed by law may be properly called money.” Another definition of money is that “money is anything which is universally accepted in the discharge of business obligations because it acts as a measure of value of all other commodities. Money may be metallic or in paper. Metallic money are pieces of coins of metal of particular fineness and weight with both sides stamped with the symbol of the government, while the paper money applies to bank notes and government notes which pass from hand to hand without difficulty. 6.3.2 QUALITIES OF A GOOD MONEY In order to perform its functions most efficiently, the money material used must have certain qualities. Such qualities include: CDL, University of Maiduguri, Maiduguri - Nigeria 34 ECON 101: ECONONIC THEORY AND PRINCIPLE II units 3 1. General acceptability:- A commodity which is not universally accepted in a country cannot serves as money satisfactorily . 2. Portability: The material used for money or money should be easily transported from one place to another. 3. Cognisability: Cognisability is another essential quality of money. Cognisability implies that money must be easily recognized. 4. Divisibility: Money should be capable of being divided into smaller part without loss of value. 5. Durability: Perishable goods/commodities are not good for money. 6. Homogeneity: The material used for money should be of uniform quality. If the quality is not uniform, it will not contain the same value in the same bank. 7. Above all money should be comparatively stable in value, since it has to serve as standard for measuring value. 6.3.3 FUNCTION OF MONEY: Different commodities such as gold, silver, coins, and later paper have been used as money. The following are part of the functions of money: i. Medium of exchange ii. As a store of value iii. A unit of account iv. A measure of value v. A standard of payment vi. Money also serve as a differed means of payment. iii. Money as a medium of exchange: money solves the difficulties of barter system. Money serves as a means through which exchange of goods and services take place. iv. Money serves as a store of wealth or liquid assets: Money also serves as store of values, or more correctly, it CDL, University of Maiduguri, Maiduguri - Nigeria 35 ECON 101: ECONONIC THEORY AND PRINCIPLE II units v. vi. 6.3.4 3 enables a person to keep a portion of his liquid assets. Money as standard for differed payment: Money also serves as a standard of payments made after a lapse of time. Money also serves as a means of transferring values: This is another function which money performs. One can sell one’s immovable and movable belonging at one place and buy them elsewhere. BANKING: Bank is an institution which deals in money. Broadly speaking bank drains surplus money from the people who are not using it at the same time and lend to those who are in position to use it for productive purpose. 6.3.5 TYPES OF BANKS: Considerable specialization has taken place among banks with regards to the various sphere of their activities. The main type of bank are the following: a. Commercial banks:- Commercial banks are chiefly engaged in financing internal trade and also carry on other ordinary banking business of receiving deposits, advancing loans and discounting bills. b. Industrial banks: These banks specialize in financing of industries. They advance loans for long period to people who carry on industrial enterprise. c. Agricultural banks:- Agricultural banks give long and short term finance to agriculturalists. d. Exchange banks:- The main function of exchange bank is to buy and sell foreign currencies. e. Saving banks:- These banks provides facilities to people usually of limited financial resources to save their money. For example post offices in Nigeria carry on this function. CDL, University of Maiduguri, Maiduguri - Nigeria 36 ECON 101: ECONONIC THEORY AND PRINCIPLE II units 3 f. Central bank:- Central bank is the most important banking institution in a country. It directly or indirectly controls the activities of the other banks. Most of the functions of the banks belong to this categories. 6.3.6 COMMERCIAL BANKING Broadly speaking, there are three main functions which banks other than central banks perform (1) Receiving deposits (2) advancing loans and (3) Discounting bills of exchange. They are directly engaged in financing internal trade, and also carry on other ordinary banking business. 6.3.6.1 FUNCTION OF COMMERCIAL BANK Commercial bank perform the following functions:i. Commercial bank create credits:Commercial bank create credit by accepting special deposit and giving loans to their customers. ii. Commercial banks accept deposits:- Commercial bank receive money from their customers. iii. Commercial banks act as agent to their customers:- They collect cheques, bills of exchange and other things on behalf of the customers. iv. A commercial bank finances foreign trade of its customers by accepting foreign bills of exchange and collecting them from foreign banks. It also transacts other foreign exchange businesses and buys and sells foreign currency. v. Credit creation:- credit creation is one of the most important function of commercial banks. Like other financial institutions, commercial banks are profits oriented. For this purpose, they accept deposit and advance loans by keeping a small cash in reserve for day to day transaction. Besides the above noted services, the commercial bank perform a number of other functions. A commercial bank acts as the custodian of the valuables of its customers by providing them lockers where they can keep their Jewellery and valuable documents. It issues various form of credit instrument such as CDL, University of Maiduguri, Maiduguri - Nigeria 37 ECON 101: ECONONIC THEORY AND PRINCIPLE II units 3 cheque, drafts, travelers cheque etc, which facilitate transactions. The bank also issues letter of credit and act as reference to its customers. It underwrites shares and debentures of companies and helps in the collection of funds from the public. Some commercial banks also publish journals which provide statistical data/information about the money market and business trends of the economy. CDL, University of Maiduguri, Maiduguri - Nigeria 38 ECON 101: ECONONIC THEORY AND PRINCIPLE II units 6.3.7 3 ROLE OF COMMERCIAL BANKS IN NIGERIA The role of banking in economic development are many. These includes:i. Supply of necessary money for investment by the business sector for growth and development. ii. Promotion of the development of special banks for rapid economic development. iii. Management of foreign reserves in order to promote the necessary development in releasing the scarce resources for right priority project. iv. Promotion of export trades to earn necessary foreign exchange. v. Reduction of unemployment by providing/monotint employment generation activities. vi. It assists in monetary policy. vii. Financing of various sectors of the economy etc. 6.3.8 PROBLEM OF COMMERCIAL BANKING IN NIGERIA. i. ii. iii. iv. 6.4 Most of the Commercial banks are foreign banks and are less interested with the ordinary needs of a common man. Most Nigerians cannot easily offer acceptable collateral securities needed by the banks before they grant loans. Money default as far as repayments of borrowed money are concerned leading to banks reluctance to leading money to customers. The commercial banks are mainly located in urban areas and with this the rural drivellers tend to be ignorant of banking services. SUMMARY Money is any commodity that facilitates exchange of goods and services. It is a commodity that overcomes the disadvantages of barter. A bank on the other hand is an institution which accept deposit from the public in form of advances loans by creating credit. CDL, University of Maiduguri, Maiduguri - Nigeria 39 ECON 101: ECONONIC THEORY AND PRINCIPLE II units 6.5 SELF ASSESSMENT EXCERSICES 1. 2. 3. 4. 6.6 3 What is a commercial bank? Discuss the various functions performed by a commercial bank. Discuss the role of commercial banking in promoting economic development. Define money. What is its social significance? “Money is a good servant, but a bad master” examine this statement. REFERENCES M. L. Jhinghan Monetary Economics 5th revised edition Prouts R. W. and C. E. Ferguson “Theory of operationalism and policy” Economic Journal 1951. 6.7 SUGGESTED READINGS M. L. Jhinghan Monetary Economics 5th revised edition CDL, University of Maiduguri, Maiduguri - Nigeria 40 ECON 101: ECONONIC THEORY AND PRINCIPLE II units 3 TOPIC 7: TABLE OF CONTENTS PAGES 7.0 INTERNATIONAL TRADE - - - - - 7.1 INTRODUCTION - - - - - - 37 7.2 OBJECTIVES - - - - - - - 37 7.3 IN-TEXT - - - - - - - 37 - 37 - 7.3.1 DEFINITION OF INTERNATIONAL TRADE 7.3.1.1 ADVANTAGES OF INTERNATIONAL TRADE - - - - - 7.3.2 THEORIES OF INTERNATIONAL TRADE 7.3.2.1 37 - 37 - - 37 COMPARATIVE COST ADVANTAGE - 38 THE THEORY OF ABSOLUTE COST ADVANTAGE 7.3.2.2 36 7.4 SUMMARY - 7.5 - - - - 40 SELF ASSESSMENT EXERCISE - - - - 40 7.6 REFERENCES - - - - - 40 7.7 SUGGESTED READINGS - - - - - 40 - - - - - - - CDL, University of Maiduguri, Maiduguri - Nigeria 41 ECON 101: ECONONIC THEORY AND PRINCIPLE II units 7.0 7.1 3 TOPIC: INTERNATIONAL TRADE INTRODUCTION This section discusses international trade. International trade is the exchange of goods and services between countries or nations so as to create a smooth relationship between countries involved. 7.2 OBJECTIVES At the end of this topic you should be able to: i. Define what international trade is. ii. Explore the various theories propounded Economists on the theory of international trade. by 7.3 IN-TEXT 7.3.1 DEFINITION OF INTERNATIONAL TRADE International trade is the exchange of goods and services between two or more countries so as to create a smooth relationship between countries involved. However, international trade is more of international relations than international trade itself. 7.3.1.1 ADVANTAGES OF INTERNATIONAL TRADE i. ii. iii. iv. v. vi. It brings about specialization It generate revenue to the government. It assists in the efficient allocation of resources and factors of production. It offers employment opportunities. It creates competition among countries. There is also political and social benefits in international trade. 7.3.2 THEORIES OF INTERNATION TRADE There are many theories of international trade. We distinguish between the absolute cost advantage and comparative cost advantage. 7.3.2.1 THE THEORY OF ABSOLUTE COST ADVANTAGE. CDL, University of Maiduguri, Maiduguri - Nigeria 42 ECON 101: ECONONIC THEORY AND PRINCIPLE II units 3 This theory was propounded by Adam Smith. Adam Smith, the acclaimed father of Economics stressed that a country could gain by trading. According to him, the tailor does not make his shoes and the shoe maker does not make his suit. Smith argued in the same manner, that a country could gain from trade if it concentrated in the production of commodities in which it has absolute cost advantage compared to other countries or where its efficiency lies. Then nations can gain from trade by specializing in the commodity in which they have absolute cost advantage. For example, if Nigeria happens to be efficient in the production of cloth, and England is efficient in the production of wheat, it shows that Nigeria has an absolute cost advantage in the production of cloth than wheat and England has an absolute cost advantage in the production of wheat than cloth. So according to the theory, each of the nations should specialize in the production of the commodity of its absolute cost advantage and exchange the surplus for its absolute disadvantage. Let us consider the following to illustrate. Table 1 Commodities Wheat (A) unit Cloth (B) Nigeria 20 12 England 10 Resources used 1 20 1 unit From the above illustration, Nigeria produces 20 units of commodities “A” with one unit of resources while England produce 10 tones of the same commodity with the same unit of resources (A). On the other hand, Nigeria produces 12 (Yards) of commodities (B) with one unit of resources, while England produces 20 yards of the same commodity with the same unit of resources. Therefore, Nigeria has absolute cost advantage in the production of commodity (A) over England, while England has absolute cost advantage in the production of commodity (B) compared to Nigeria. CDL, University of Maiduguri, Maiduguri - Nigeria 43 ECON 101: ECONONIC THEORY AND PRINCIPLE II units 3 7.3.2.2 COMPARATIVE COST ADVANTAGE This law was first formulated by the great economist David Richardo (1772 – 1823). Richardos’ argument became more popular among economists. He used a model clearly stating their assumption and implications in explaining the theory. According to this theory, if one nation is less efficient than the other in the production of both commodities or in all lines of production, there is still basis for mutual trade to take place between the two countries. The country that has an absolute least advantage should specialize in that line of production and import the commodity in which its absolute disadvantage is greater. This theory shows that trade and work to raise productivity. For example Table 2 Commodities Wheat (A) 10/5 = 2 Cloth (B) 0.5 Nigeria 100 60 60/100 = 0.6 100/60 = 1.66 England 5 10 5.10 = Table 2 shows that Nigeria has absolute advantage in the production of both commodities, that is wheat and cloth. Though it has absolute advantage in both line of production, there is need for trade between Nigeria and England because the margin of advantage differs in the two commodities. Nigeria can produce (20) times as much wheat than England using the same quantity of resources but only six times as much cloth. Nigeria is said to have a comparative advantage in the production of wheat and comparative disadvantage in the production of cloth and while England can be said to have a comparative advantage in the production of cloth. Habeiler (1936) used the opportunity cost theory to explain further the theory of comparative advantage. In this form, the law is sometimes referred to as law of comparative cost. From table 2, let’s calculate the opportunity cost for wheat and cloth for the two countries. CDL, University of Maiduguri, Maiduguri - Nigeria 44 ECON 101: ECONONIC THEORY AND PRINCIPLE II units 3 The opportunity cost of a good is the quantity of other goods that must be sacrificed to make one or more units of that good. It tells about the relative cost of producing different goods. If resources are assumed to be fully employed, the only way to produce more of one commodity is to re-allocate resources and thus produce less of the other commodities. The opportunity cost of producing wheat in Nigeria is (60/100 = 0.6) while the opportunity cost of producing cloth in Nigeria is 100/60. The opportunity cost differs in both countries and both countries are producing both commodities. Based on this, it is always possible to produce to increase production of both by suitable reallocation of resources within each country. There are gains from trade given the opportunity cost as given in table 2. To produce one more tones of wheat, Nigeria must sacrifice 0.6 yards of cloths. To produce one more yard of cloth, England most sacrifice (0.5) tones of wheat. 7.4 SUMMARY International trade is the exchange of goods and services between two or more countries so as to create a smooth relationship between countries involved in it. Countries, however engage in international trade in order to gain from such trade. As a result of this, various theories have been postulated by various economists to explain its operations. Among such theories, we distinguish the cost advantage by Adam Smith, comparative cost advantage by David Richardo, etc. 7.5 SELF ASSESSMENT EXERCISES 1. What do you understand by international trade? Why do countries engage in trade. 2. Discuss briefly the theories of: a. Absolute Advantage b. Comparative Advantage. 7.6 REFERENCES Robbin, L; An Essay On The Nature And Significance Of Economic Science (Macmillian 1936). CDL, University of Maiduguri, Maiduguri - Nigeria 45 ECON 101: ECONONIC THEORY AND PRINCIPLE II units 3 Friedman, M. (1953); The Methodology Of Positive Economics; university of Chicago press pp1-4 Pfout T and Buchanon J. M., “principle of international finance” Southern Economic Journal (1958). 7.7 SUGGESTED READINGS Pfout T and Buchanon J. M., “principle of international finance” Southern Economic Journal (1958). CDL, University of Maiduguri, Maiduguri - Nigeria 46 ECON 101: ECONONIC THEORY AND PRINCIPLE II units 3 SOLUTION TO EXERCISES TOPIC 1 a. Explain micro and macro economics. These are major branches of economics. Microeconomics deals with individual economic units such as individual consumption, demand, etc. on the other hand, Macro-economics deals with aggregate economic variables such aggregate demand, inflation, unemployment, etc. b. Describe their scope. The scope of micro-economics is normal individual economic units. It studies individual economic parts such as households, firms, markets, etc. Macro-economics determines the manner in which consumers allocate services; it further determines the swap in which firms decide what goods to produce and what price to charge. c. State the relationship that exist between micro and macro economics. To understand economic phenomenon very well, both micro and macro economics must be understood properly. Without the knowledge of both micro and macro economics, it is not possible to understand the working of an economy. Micro and Macro economics complements each other. TOPIC 2 Circular flow of income provides a conceptual framework for describing the relationship among three key economy variables that is to say incomes and spending (consumer expenditure). It explain inter dependency among economic agents as far as the movement of goods and services is CDL, University of Maiduguri, Maiduguri - Nigeria 47 ECON 101: ECONONIC THEORY AND PRINCIPLE II units 3 concern. However, in a closed economy, government does not intervene in the production and consumption of goods and services. The economy can be considered as made of two kinds namely the households and firms. A household is an agent which owns factor of production and but all final consumer goods. A firm on the other hand, owns nothing, but hires factor of production from household, sells the goods which it produces to household and pays any profit which it makes on its activities on wages to households. TOPIC 3 i. i. ii. iii. iv. i. ii. iii. Explain the various concepts of national income, under what circumstances does national income tend to be under estimated. National income means the total value of goods and services produced annually in a country. In other words, it is the total amount of income accruing to a country from economic activities in a years time. The concept of national income includes: Gross National Product (GNP) Net National Product (NNP) Personal income Disposable income. Gross National Product:- This is the total measure of the flow of goods and services at market value resulting from current production during a year in a country including net income from Abroad. Net National Product:- Net national product is the Gross National Product less depreciation NNP = GDP – Depreciation. Personal income:- Personal income is the total income received by individuals of a country from all sources. Personal income is derived from national income by deducting undistributed profits, profit taxes etc. CDL, University of Maiduguri, Maiduguri - Nigeria 48 ECON 101: ECONONIC THEORY AND PRINCIPLE II units 3 ii.What do you understand by the “national income”. Explain the product and expenditure approach of computing national income. National income is the total value of goods and services produced annually in a country. It is often used interchangeably with national dividend, national output or national expenditure. It includes all payment to all resources in wages for labour, rent for land, interest for capital and profit for te entrepreneur. There are however various methods of measuring national income. These include product, expenditure, income and value added approach. The product method uses the market prices of final goods and services produced in a country during a year. The data of all productive activities such as agricultural product, manufactured product, the contribution of transportation, communication doctors, teachers etc. The expenditure approach takes into consideration aggregate consumption expenditure, net domestic investment, government expenditure on goods and services and net foreign investments. Here it is believed that national income is equal to national expenditure. iii.Discuss the traditional and modern definitions of National income explaining their differences and interrelationship. The traditional definition: are definition advanced by marshal, pigou and fisher. To marshal, the labour and capital of a country annually produced certain net aggregate of commodities, material and immaterial things. Pigou a devoted of marshallian thinking, included the use of money as a measure of national income while Fisher completely deviated from the marshallian. He however uses “consumption” as the criterion of national income as opposed to marshallian and pigouvian use of production as a measure of national income. CDL, University of Maiduguri, Maiduguri - Nigeria 49 ECON 101: ECONONIC THEORY AND PRINCIPLE II units 3 The modern definitions: from the modern point of view, Simon kuznet defined national income as the “net output of commodities and services flowing during the year from the country’s productive system in the hand of ultimate consumers” the united nations, in one of its reports, defined national income on the basis of the system of estimating national income as the net national product to the shares of different factors, as the net national expenditure in a country in a year’s time. The definitions advanced by marshal, pigou, Fisher and kuznet should be considered to be adequate and interrelated at least for theoretical purposes. This is so because all are considered to give the same result of income when estimated. iv.Point out the difference between the following concept of national income. i. Gross National Product is the total measure of the flow of goods and services at market value resulting from current production during a year in a country while net national product is gross national product less an amount equal to depreciation. ii. Disposable income means the actual income which can be spent on consumption by individual and families while personal income is the total income received by individuals of a country from all sources. iii. Net National Product is the total amount of goods produced by all the citizen of a country. It includes income from abroad of its citizen. Gross domestic product is the total amount of goods and services domestically produced in a country over a period of time. v.Equilibrium National income. a. Y = C+I where I = 100, C = 55 + 0.6y Y = 55 + 0.6y + 100 Collect like terms CDL, University of Maiduguri, Maiduguri - Nigeria 50 ECON 101: ECONONIC THEORY AND PRINCIPLE II units 3 Y – 0.6y = 55 + 100 Y(1-0.6) = 55 + 100 0.4y = 155 Divide both sides by 0.4 0.4y = 155 0.4y = 0.4 Yes = 77 5/2 Yes = N387.5 c. consumption level C = 55 + 0.6y = 55 + 0.6 (387.5) = 55 + 232.5 = 287.5 d. marginal propensity to consume MPC = DC DY Where C = 55 + 0.6y DC = D (55+0.6y) DY DY DC = 0.6 DY MPC = 0.6 e. CI Graphical presentation. Y=E Y=C+I CDL, University of Maiduguri, Maiduguri - Nigeria 51 ECON 101: ECONONIC THEORY AND PRINCIPLE II units 387.5 3 . Y=C 100 I TOPIC 4 i. Distinguish between economic growth and economic development. Economic growth can mean two things. It can be referred to growth in national output as measured by the Gross Domestic Product (GDP) and it can be referred to growth in individual standard of living as measured Gross National Product per capita. While development on the other means or may be defined as depict growth and structural growth/changes. An economy may be growing but without structural changes in not developing. This is because development is achieved when there is economic growth and structural changes. ii. There are three cores values of development. These are:4 Life sustenance: ability to meet basic needs. ii. Self esteem: To be a person Freedom from servitude: To be able to choose or free from external control. TOPIC 5 Q 1. What is fiscal policy? Distinguish clearly between the three main types of discretionary fiscal policy. Fiscal policy refers to that part of government policy concerning the raising of revenue through taxation and other means and deciding on the level and pattern of expenditure for the purpose of influencing economic activities or attaining some desirable macroeconomic goals. Fiscal policy can therefore be used for allocation, stabilization and distribution of resources in an economy. CDL, University of Maiduguri, Maiduguri - Nigeria 52 ECON 101: ECONONIC THEORY AND PRINCIPLE II units 3 Fiscal policy is implemented through budget. A budget is a financial statement of the sources of income (revenue) and its uses (expenditure) of the government. We have three types of budget: i. Balanced budget j. Deficit budget and k. Surplus budget. Q 2. Outline and discuss the objectives of fiscal policy in a developing economy like Nigeria. Fiscal policy refers to that part of government policy concerning the raising of revenue through taxation and other means and deciding on the level and pattern of expenditure for the purpose of influence economic activities. The objectives of fiscal policy include the followings:i. To increase employment opportunities ii. To promote economic stability iii. To control inflation iv. To increase the rate of investment v. To ensure growth of national income vi. To improve equilibrium balance of payment etc. i. To increase employment opportunities:- Fiscal policy aims at increasing employment opportunities and reducing unemployment and under employment. l. To promote economic stability:- Fiscal policy promotes the maintenance of reasonable economic stability in the face of short run international instability. m. To control inflation:- Fiscal policy aims at counteracting inflationary tendencies inherent in an economy. n. To increase rate of investment:- Fiscal policy aims at the promotion and acceleration of the rate of investment in theprivate and public sector. o. To ensure growth of national income:- Fiscal policy aims at promoting or increasing the national income of an economy. CDL, University of Maiduguri, Maiduguri - Nigeria 53 ECON 101: ECONONIC THEORY AND PRINCIPLE II units 3 Q 3. Discuss fiscal policy as a device for controlling the level of economic activity. Fiscal policy refers to the part of government policy concerning the raising of revenue through taxation and other means and deciding on the level and pattern of expenditure for the purpose of influencing economic activities. It is a device use in controlling the level of economic activities. Fiscal policy can therefore be use for the allocation, stabilization and distribution of resources in an economy through; ii. Reducing or increasing taxes iii. Increasing or decreasing government component of aggregate demand. iv. Subsidizing firms or removing subsidies. TOPIC 6 Q 1. What is a commercial bank? Discuss the various functions performed by a commercial bank. Commercial bank is an institution which deals in money. Broadly speaking, commercial bank draws surplus money from the people who are not using it at the same time lend it those who are in position to use it for productive purposes. Commercial banks chiefly engaged in financing international trade, and also carry on other ordinary banking business of receiving deposits, advancing loans and discounting bills. The commercial banks perform the following function:i. Commercial bank create credit ii. Act as agent iii. Finances foreign trade iv. Accept deposit i. Gives loans and advances etc. Q 2. Discuss the role of commercial banking in promoting economic development. CDL, University of Maiduguri, Maiduguri - Nigeria 54 ECON 101: ECONONIC THEORY AND PRINCIPLE II units 3 Commercial bank is an institution which deals in money. Commercial bank however perform the following role in promoting economic development. i. Financing Agriculture ii. Financing foreign trade iii. Financing industrial growth iv. Management of foreign reserves v. Reduction of unemployment vi. Helps in monetary policy vii. Financing of various sectors of the economy. CDL, University of Maiduguri, Maiduguri - Nigeria 55 ECON 101: ECONONIC THEORY AND PRINCIPLE II units 3 Q 3. Define money What is its social significance. Money is a device that is generally acceptable as a medium of exchange. In other words, anything that performs the functions of money is money. In a wider sense, the term money includes all media of exchange. Different commodities such as gold, silver, coins and later paper have been used as money. The following are the function of money. v. A medium of exchange vi. As a store of value vii. A unit of account viii. A measure of value ix. A standard of payment etc. Q 4. Discuss the role of money. Money is any commodities that facilitates exchange of goods and services. It is a commodity that overcomes the disadvantage of barter. Its role is however significance. The following are the role of money. x. A medium of exchange xi. A unit of account xii. As a stock of value xiii. A measure of value xiv. A standard of payment etc. TOPIC 7 Q1 What do you understand by international trade? Why do country engage in trade. International trade is the exchange of goods and services between two or more countries so as to create a smooth relationship between countries involved. However, International trade is more of international relation than international trade itself. Countries engage in international trade because each countries of the world are not blessed with all the factor endowment (resources) to produce all countries needed by such country. As a result of this countries of the world have to engage in international trade. In other words, countries CDL, University of Maiduguri, Maiduguri - Nigeria 56 ECON 101: ECONONIC THEORY AND PRINCIPLE II units 3 engage in international trade in order to gain from such trade. Q 2. Discuss briefly the theories of a. Absolute Advantage b. Comparative Advantage a. absolute advantage:- theory is propounded by Adam Smith. He stressed that country could gain by trading if it concentrates in the production of commodities in which it has absolute cost advantage compared to their countries or where its efficiency lies. Then nations can gain from trade by specializing in the commodities in which they have absolute cost advantage. For example, If Nigeria happens to be efficient in the production of wheat and England is efficient in the production of cloths, it shows that Nigeria has absolute cost advange in the production of cloth than wheat. b. Comparative Advantage:This law was first formulated b Greek economist David Richards. According to him, if one nation is less efficient than the other in the production of both commodities or in all lines of production. There is still basis for mutual trade to take place between the two countries. The country that has an absolute least advantage should specialize in that line of production and import the commodity in which it absolute disadvantage is greater. This theory shows that trade and specialization work to raise productivity. For example in the table below. Commodities Nigeria England Wheat A 100 5 Cloth B 60 10 The table above shows that Nigeria has absolute advantage in the production of both commodities. Though, this absolute cost advantage in both lines of production heed for trade between Nigeria and England because the margin of advantage differs in the two commodities. Nigeria can produce (20) times as much wheat than England using the same quantity of resources but only six as much wheat than England. Nigeria is said to have a CDL, University of Maiduguri, Maiduguri - Nigeria 57 ECON 101: ECONONIC THEORY AND PRINCIPLE II units 3 comparative disadvantage in the production of cloth and a comparative advantage in the production of wheat. TUTOR MARK ASSIGNMENT 1. a) b) 2. Explain the concept of the circular flow of income in a tree sector model. 3. Write short notes on the followings:i. Gross Domestic Product (GDP) ii. Gross National Product (GNP) iii. Net National Product (NNP) iv. Per Capita Income 4 a. b. Distinguish between growth and development. List and discuss four (4) Impediments to economic development in Nigeria. 5 a. b What is fiscal policy? List and discuss four (4) objectives of fiscal policy in Nigeria. List and explain five (5) functions of a commercial c. bank. Distinguish between micro and macro economics. Describe the scope of micro and macro economics CDL, University of Maiduguri, Maiduguri - Nigeria 58