Download economics 1a - Together We Pass

ECONOMICS 1A
Only study guide for ECS1501
Revised edition
AMENDED AND ADAPTED BY
Mr T van der Vyver
Contributors
Ms AM Pretorius
Prof PJ Mohr
Mrs MD Uys
Prof RP Viljoen
Mr T van der Vyver
DEPARTMENT OF ECONOMICS
UNIVERSITY OF SOUTH AFRICA
© 2010 University of South Africa
All rights reserved
Printed and distributed by the
University of South Africa
Muckleneuk, Pretoria
Compiled by the Department of Economics
ECS1501/1/2011
ACKNOWLEDGEMENT
Special thanks to
Ms AM Pretorius
Mr J Inggs
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ECS1501/1/2011
Contents
Page
Introduction to this module ....................................................................................................... vii
Purpose of the module .............................................................................................................. vii
Module outcomes...................................................................................................................... vii
Critical cross-field outcomes .................................................................................................... viii
The prescribed textbook ............................................................................................................. ix
The study guide .......................................................................................................................... x
How to use the study guide ....................................................................................................... xii
Important verbs ........................................................................................................................ xiii
Using diagrams (or figures) ...................................................................................................... xiv
Module contents........................................................................................................................ xv
The layout of the module......................................................................................................... xvii
STUDY UNIT 1
WHAT ECONOMICS IS ALL ABOUT
Economics in action ....................................................................................................................2
Contents .....................................................................................................................................3
1.1 Scarcity, choice and opportunity cost .................................................................................4
1.2 Economics as a science.....................................................................................................7
1.3 Some common mistakes made in reasoning about economic issues .................................9
Economics in action (looking back) ...........................................................................................10
Further reading .........................................................................................................................10
Answers: study unit 1 ................................................................................................................11
Checklist: study unit 1. ..............................................................................................................14
STUDY UNIT 2
A CLOSER LOOK AT THE ECONOMIC PROBLEM
Economics in action ..................................................................................................................17
Contents ...................................................................................................................................19
2.1 What should be produced?. .............................................................................................19
2.2 How should it be produced? .............................................................................................23
2.3 For whom should it be produced? ....................................................................................24
2.4 Solutions to the central questions: an introduction to economic systems .........................25
Economics in action (looking back) ...........................................................................................27
Further reading .........................................................................................................................27
Answers: study unit 2 ................................................................................................................29
Checklist: study unit 2. ..............................................................................................................33
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STUDY UNIT 3
THE INTERDEPENDENCE BETWEEN THE MAJOR SECTORS,
MARKETS AND FLOWS IN THE MIXED ECONOMY
Economics in action ..................................................................................................................36
Contents ...................................................................................................................................38
3.1 Production, income and spending ....................................................................................38
3.2 The interdependence between households and firms ......................................................40
Economics in action (looking back) ...........................................................................................41
Further reading .........................................................................................................................41
Answers: study unit 3 ................................................................................................................42
Checklist: study unit 3. ..............................................................................................................43
STUDY UNIT 4
DEMAND, SUPPLY AND PRICES
Economics in action ..................................................................................................................45
Contents ...................................................................................................................................47
4.1 Demand and supply: an introductory overview .................................................................48
4.2 Demand ...........................................................................................................................48
4.3 Supply..............................................................................................................................53
4.4 Market equilibrium............................................................................................................58
Economics in action (looking back) ...........................................................................................60
Further reading .........................................................................................................................62
Answers: study unit 4 ................................................................................................................63
Checklist: study unit 4. ..............................................................................................................75
STUDY UNIT 5
DEMAND AND SUPPLY IN ACTION
Economics in action ..................................................................................................................78
Contents ...................................................................................................................................80
5.1 Changes in demand .........................................................................................................80
5.2 Changes in supply ...........................................................................................................81
5.3 Simultaneous changes in demand and supply. ................................................................82
5.4 Interaction between related markets ................................................................................83
5.5 Government intervention ..................................................................................................85
5.6 Agricultural prices ............................................................................................................86
Economics in action (looking back) ...........................................................................................87
Further reading .........................................................................................................................88
Answers: study unit 5 ................................................................................................................90
Checklist: study unit 5. ..............................................................................................................95
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STUDY UNIT 6
ELASTICITY
Economics in action ..................................................................................................................98
Contents ................................................................................................................................. 100
6.1 A general definition of elasticity ...................................................................................... 100
6.2 The price elasticity of demand........................................................................................ 102
6.3 Other demand elasticities............................................................................................... 106
Economics in action (looking back) ......................................................................................... 109
Further reading ....................................................................................................................... 109
Answers: study unit 6 .............................................................................................................. 111
Checklist: study unit 6. ............................................................................................................ 114
STUDY UNIT 7
BACKGROUND TO DEMAND: THE THEORY OF CONSUMER CHOICE
Economics in action ................................................................................................................ 117
Contents ................................................................................................................................. 118
7.1 Introduction to the indifference approach ....................................................................... 119
7.2 Indifference curves......................................................................................................... 120
7.3 The budget line .............................................................................................................. 121
7.4 Consumer equilibrium according to the indifference approach ................. ………………122
7.5 Changes in equilibrium .................................................................................................. 123
Economics in action (looking back) ......................................................................................... 126
Further reading ....................................................................................................................... 126
Answers: study unit 7 .............................................................................................................. 127
Checklist: study unit 7. ............................................................................................................ 130
STUDY UNIT 8
BACKGROUND TO SUPPLY: THE THEORY OF PRODUCTION AND COST
Economics in action ................................................................................................................ 133
Contents ................................................................................................................................. 135
8.1 Introduction .................................................................................................................... 135
8.2 Basic cost and profit concepts........................................................................................ 136
8.3 Production in the short run ............................................................................................. 139
8.4 Costs in the short run ..................................................................................................... 140
Economics in action (looking back) ......................................................................................... 142
Further reading ....................................................................................................................... 143
Answers: study unit 8 .............................................................................................................. 144
Checklist: study unit 8. ............................................................................................................ 149
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STUDY UNIT 9
PERFECT COMPETITION
Economics in action ................................................................................................................ 152
Contents ................................................................................................................................. 154
9.1 Perfect competition ........................................................................................................ 154
9.2 The demand for the product of the firm .......................................................................... 155
9.3 The equilibrium of the firm under perfect competition ..................................................... 157
9.4 The supply curve of the firm and the market supply curve .............................................. 159
9.5 Long-run equilibrium of the firm and the industry under perfect competition ................... 161
Economics in action (looking back) ......................................................................................... 163
Further reading ....................................................................................................................... 164
Answers: study unit 9 .............................................................................................................. 165
Checklist: study unit 9. ............................................................................................................ 170
STUDY UNIT 10
MONOPOLY AND IMPERFECT COMPETITION
Economics in action ................................................................................................................ 173
Contents ................................................................................................................................. 175
10.1 Market structure ............................................................................................................. 175
10.2 Perfect competition ........................................................................................................ 178
10.3 Monopoly ....................................................................................................................... 179
10.4 Monopolistic competition ................................................................................................ 185
10.5 Oligopoly ........................................................................................................................ 189
Economics in action (looking back) ......................................................................................... 196
Further reading ....................................................................................................................... 196
Answers: study unit 10 ............................................................................................................ 197
Checklist: study unit 10. .......................................................................................................... 202
STUDY UNIT 11
THE LABOUR MARKET
Economics in action ................................................................................................................ 205
Contents ................................................................................................................................. 206
11.1 The labour market versus the goods market .................................................................. 207
11.2 A perfectly competitive labour market ............................................................................ 208
11.3 Imperfect labour markets ............................................................................................... 211
Economics in action (looking back) ......................................................................................... 213
Further reading ....................................................................................................................... 213
Answers: study unit 11 ............................................................................................................ 214
Checklist: study unit 11. .......................................................................................................... 218
SELF-EVALUATION ASSIGNMENT ...................................................................................... 220
SOLUTIONS TO THE SELF-EVALUATION ASSIGNMENT .................................................. 227
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INTRODUCTION
TO THIS MODULE
Welcome to Economics 1A, the first part of the introduction to Economics. There is
only one prescribed textbook. The study guide forms a vital part of the prescribed
material.
PURPOSE OF THE
MODULE
The purpose of this module is to gain insight into



how the basic economic problem is solved in different economic systems
how households and firms take decisions
how prices are determined under conditions of perfect and imperfect
competition
This module will equip you to analyse, interpret and apply knowledge relating to
basic microeconomic concepts and principles.
MODULE
OUTCOMES
After you have studied this module, you should have a fundamental understanding of
economics. You should be able to



demonstrate your understanding of basic economic concepts
analyse how market forces of demand and supply determine equilibrium
compare the advantages and disadvantages of different market structures
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CRITICAL CROSSFIELD
OUTCOMES
As a student enrolled for a tertiary qualification, you will be exposed to a formative
learning experience that should not only educate you in the chosen discipline but
also form your character.
The formative nature of the qualification is described in the critical cross-field
outcomes that all tertiary qualifications aim to achieve. Critical cross-field outcomes
refer to broad generic cross-field outcomes encompassing various areas, which all
qualifications and standards should strive to promote.
After you have completed this tertiary qualification, you should be able to
 identify and solve problems in such a way that you will display responsible
decision making using critical and creative thinking
 work effectively with others as a member of a team, group, organisation or
community
 organise and manage yourself and your activities responsibly and effectively
 collect, analyse, organise and critically evaluate information
 communicate effectively using visual, mathematical and/or language skills in the
modes of oral and/or written persuasion
 use science and technology effectively and critically, showing responsibility
towards the environment and health of others
 demonstrate an understanding of the world as a set of related systems by
recognising that problem solving does not happen in isolation
In order to contribute to your full personal development of you as a learner (and to
that of every other learner) and to the social and economic development of society
as a whole, any programme of learning should have the underlying intention of
making an individual aware of the importance of
o reflecting on and exploring a variety of strategies to learn more
effectively
o participating as responsible citizens in the life of local, national and
global communities
o being culturally and aesthetically sensitive across a range of social
contexts
o exploring education and career opportunities
o developing entrepreneurial opportunities
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THE PRESCRIBED
TEXTBOOK
The following textbook is prescribed for this module:
Mohr, P, Fourie, L & Associates. 2004. Economics for South African students. 3rd edition.
Pretoria: Van Schaik.
OR
Mohr, P, Fourie, L & Associates. 2007. Economics for South African students. 4th edition.
Pretoria: Van Schaik.
Chapters 1, 2, 3, 7, 8, 9, 10, 11, 12, 13 (as set out in this study guide) and 14 are prescribed
for this module, ECS1501.
Chapters 3, 4, 15, 16, 17, 18, 19, 20, 21, 22 and 23 are prescribed for ECS1601.
For many of you, this will probably be your first encounter with the formal study of
economics. Economics is an interesting, challenging and topical subject, and we
trust that you will find it worthwhile and stimulating.
When paging through the prescribed textbook, some of you may be alarmed to see
symbols, equations and graphs. However, this module requires no specialised
knowledge of mathematics. Apart from drawing and interpreting simple graphs, all
that is required is addition, subtraction, multiplication and division. Each time you
come across equations or calculations you will be shown in detail how to obtain the
answer.
The main requirements for the study of economics are a willingness to think and an
active approach to learning. Economics is not a subject that can simply be
memorised – it has to be understood. This means that you will always have to think
about what you are studying and that you must try to understand the work. The
solution is to study actively. You must use a pen (or pencil) and paper, and work out
each argument by drawing diagrams (figures), doing calculations and writing out the
logic of the argument. It is simply not enough to read the prescribed textbook and
underline or highlight the key concepts.
Do not omit any of the prescribed chapters. The chapters follow a logical pattern and
if you skip some of them, you will not be able to follow or understand the reasoning
in the study guide as a whole.
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THE STUDY
GUIDE
The study guide has been designed in such a way that it will lead you through the
prescribed textbook in a systematic and informative way. It will also help you get to
know the economist’s analytical toolkit. Therefore, you cannot study the textbook
without consulting the study guide. We have tried as far as possible not to duplicate
any unnecessary material in the prescribed textbook. You will be required to read or
study some parts of the prescribed textbook. We will provide you with some guiding
remarks or activities (questions) to ensure that you have grasped the contents of the
passages you have studied. We may also provide additional material or explanations
to you.
The study guide has three basic functions:
■
It outlines the contents of the module. In other words, it indicates which parts of
the prescribed textbook are prescribed for the examination.
■
It indicates how you should approach each chapter and shows the most
important topics and diagrams (figures) you will have to master.
■
It provides a series of questions you must answer to assess your progress and
prepare for the examination.
The study guide is divided into eleven study units that cover the prescribed
chapters in the prescribed textbook. In these study units, we will deal with the
following topics:
Prescribed textbook
Study guide
Chapter 1
Study unit 1
Chapter 2
Study unit 2
Chapter 3
Study unit 3
Chapter 7
Chapter 8
Chapter 9
Study unit 4
Study unit 5
Study unit 6
Chapter 10
Study unit 7
Chapter 11
Study unit 8
Chapter 12
Chapter 13
Chapter 14
Study unit 9
Study unit 10
Study unit 11
Topic
What economics is all about
A closer look at the economic
problem
The interdependence between the
major sectors, markets and flows in
the mixed economy
Demand, supply and prices
Demand and supply in action
Elasticity
Background to demand: the theory of
consumer choice
Background to supply: the theory of
production and cost
Perfect competition
Monopoly and imperfect competition
The labour market
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In each study unit, you will encounter the following:
■
Economics in action
In this section, we will try to indicate how economics influences our everyday lives.
Under this heading, we introduce relevant issues in our field of study as we
encounter them in newspapers, or in discussions on the bus, in the taxi or amongst
friends debating, say, the latest change in the price of petrol. The idea of this section
is therefore to stimulate some critical and creative thinking. In this way, we try to
contextualise the topic(s) covered in the study unit. Sometimes this section will
present you with a clear problem statement of the topic under consideration.
This section concludes with a number of outcomes you should have mastered after
having studied the study unit.
■
Contents
The contents section will guide you through the study material. Each subsection has
a heading and study instruction. If the study instruction tells you to study a section,
you need to make sure that you know the section well because your knowledge and
understanding of the topic covered in the subsection will be tested in the
examination.
We have all learned at some stage by memorising definitions or formulas. However,
only by actually doing something, you will realise that you can describe or define it!
Therefore, after each section or subsection, activities are included to help you
practise your newly acquired knowledge, skills and values.
■
Economics in action (looking back)
In this section, you will be referred back to the introduction or “Economics in action”
section. We will determine whether your views on the topic under consideration have
changed after you have studied the prescribed material.
■
Further reading
Here students are referred to additional reading material that they may consult to
obtain more information on one or more of the topics dealt with in the study unit. This
section does not form part of the prescribed study material.
■
Answers to the activities
Answers to some of the questions (marked with an asterisk*) and to the "True or
false questions" are provided to guide you to the most appropriate answer.
To succeed in this module, it is essential that you take responsibility for your learning
and practise your newly acquired skills.
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Checklist
To help you with your preparation for the examination we have compiled a checklist.
Work through a study unit in the study guide, say, study unit 1. Do all the activities
and answer all questions. Then consult the checklist for study unit 1 to determine
your level of preparedness.
The checklist is based on the study unit outcomes listed in the study guide. In other
words, it indicates the things you should be able to do after you have worked through
each study unit. The outcomes are divided into different categories: Concepts,
Explanations, Diagrams and Calculations. These should give you a good indication
of the kind of questions you can expect from each study unit.
Next to the items in the checklist are a number of check boxes: "Well", "Satisfactory",
"Must redo" and "Need help". If you think that you are able to do something really
well, for instance, explain scarcity, choice and opportunity cost with the aid of a
diagram, mark the "Well" box. If you think you are able to explain the concepts but
are unsure about certain aspects or find it a bit difficult, mark "Satisfactory". If you
are a bit lost but know something about the topic and will benefit from spending more
time on it, mark "Must redo". If you really do not know what is going on, mark the
"Need help" box. In so doing, you will get an indication of what you know well, what
you are coping with, on which of the sections you need to spend some more time,
and with what you need help. Do not hesitate to contact one of the lecturers should
you need their assistance. See Tutorial Letter 101 for the contact details of the
lecturers.
Do not leave this until the evening before the examination. Start as soon as possible
with your preparation.
HOW TO USE THE
STUDY GUIDE
The following steps (or learning strategy) in using the study guide are suggested:
■
■
■
■
■
Start with a study unit in the study guide and mark the indicated prescribed
sections in your prescribed textbook clearly.
Read the outcomes stated in the introductory "Economics in action".
Read and/or study the introductory remarks and explanations about the
prescribed section in the study guide.
Study the prescribed section in the textbook.
Do the activities at the end of each section. Compare your answers to those
provided at the end of the study unit. Repeat the activities if necessary until you
understand all the work.
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■
■
■
■
ECS1501/1
Complete the checklist. The correct use of the checklist is to start with your
study guide. Work through a study unit in the study guide, say, study unit 1, and
do all the activities. Then consult the checklist for study unit 1 to determine your
level of preparedness. Once you have worked through the first study unit,
proceed to the second study unit in the study guide. Work through it, do all the
activities and again consult the checklist for study unit 2. Work through all the
study units in this way. Repeat the activities where necessary or contact your
lecturer(s) if you need help.
Once you have studied a section, return to the study guide and repeat the
process by progressing to the next prescribed section. Follow this procedure
until you reach the section on "Economics in action (looking back)".
Repeat the procedure for the other study units.
Work through the self-evaluation assignment (and its solutions) at the back of
the study guide.
In this study guide (under the heading "Activity"), we sometimes use roman
numbering. For those of you not familiar with roman numbers, please see the
following explanation:
1
2
3
4
5
i
ii
iii
iv
v
6
7
8
9
10
vi
vii
viii
ix
x
11
12
13
14
15
xi
xii
xiii
xiv
xv
IMPORTANT
VERBS
As a student, you should know exactly what is expected when certain verbs are
mentioned in an activity, checklist or examination question. In economics, the most
common verbs used are as follows:
Verb
Description
compare
Identify the similarities or differences between facts, viewpoints,
concepts or ideas
contrast/distinguish/what
is the difference
between?
Point out the differences between certain objects or concepts
define
Give a short and concise description of a subject or topic
describe
Name and give a short discussion of the characteristics of an
object or topic
discuss
Discuss a topic by examining its various aspects
explain
Explain and clarify to ensure that the reader clearly understands
you
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Verb
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Description
Draw a fully annotated diagram. Make sure all the axes and
explain with the aid of (a) curves are labelled. Then explain the diagram in such a manner
diagram(s)
that the reader can follow and understand it – in other words, tell
the reader what is happening in the diagram.
give/identify/list/name
Give only the facts without any discussion
illustrate
(Usually) explain your answer with the aid of a diagram (or figure)
USING
DIAGRAMS
(OR FIGURES)
To be able to use a diagram (or figure) correctly you must learn to read, draw and
explain a diagram:
■
Read: This means understanding the determinants (or factors) of each curve
and the way in which they affect the specific curve.
■
Draw: Each diagram, all axes and the curves must be labelled. The initial point
of equilibrium must be indicated. If it changes, this must also be noted on the
diagram.
■
Explain: You should be able to explain the diagram in words.
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MODULE CONTENTS
Scarcity, choice and opportunity cost
What economics
is all about
(Study unit 1)
Economics as a science
Some common mistakes made in reasoning about
economic issues
What should be produced?
A closer look at the
economic problem
(Study unit 2)
How should it be produced?
For whom should it be produced?
Solutions to the central questions: an introduction to
economic systems
The interdependence
between the major
sectors, markets and
flows in the mixed
economy
(Study unit 3)
Production, income and spending
The interdependence between households and firms
Demand and supply: an introductory overview
Demand, supply
and prices
(Study unit 4)
Demand
Supply
Market equilibrium
Changes in demand
Changes in supply
Demand and supply
in action
(Study unit 5)
Simultaneous changes in demand and supply
Interaction between related markets
Government intervention
Agricultural prices
A general definition of elasticity
Elasticity
(Study unit 6)
The price elasticity of demand
Other demand elasticities
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Continued from
previous page
Introduction to the indifference approach
Background to
demand:
the theory of consumer
choice
(Study unit 7)
Indifference curves
The budget line
Consumer equilibrium
Changes in equilibrium
Introduction
Background to supply:
the theory of
production
and cost
(Study unit 8)
Basic cost and profit concepts
Production in the short run
Costs in the short run
Perfect competition
The demand for the product of the firm
Perfect competition
(Study unit 9)
The equilibrium of the firm under perfect competition
The supply curve of the firm and the market supply curve
Long-run equilibrium of the firm and the industry under
perfect competition
Market structure
Monopoly and
imperfect competition
(Study unit 10)
Perfect competition
Monopoly
Monopolistic competition
Oligopoly
The labour market versus the goods market
The labour market
(Study unit 11)
A perfectly competitive labour market
Imperfect labour markets
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THE LAYOUT OF
THE MODULE
Module outcomes
Study units
1: What economics is all about
Outcome 1:
Demonstrate your
understanding of
basic economic
concepts
2: A closer look at the economic
problem
3: The interdependence between the major
sectors, markets and flows in the mixed
economy
4 to 11
4: Demand, supply and prices
Outcome 2:
5: Demand and supply in action
6: Elasticity
Analyse demand,
supply and the way in
which markets
function
7: Background to demand: the theory of
consumer choice
8: Background to supply: the theory of
production and cost
11: The labour market
Outcome 3:
Compare the
performance of
different market
structures
9: Perfect competition
10: Monopoly and imperfect competition
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STUDY UNIT 1
Scarcity, choice and opportunity cost
What economics
is all about
Economics as a science
Some common mistakes made in reasoning about
economic issues
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What economics
is all about
1
STUDY UNIT
ECONOMICS
IN ACTION
The following are extracts from an article that appeared in a local newspaper:
Modise's gunboats are heading for rough seas
Battle of the billion rand patrol boats
Joe Modise wants to buy four gun
boats that cost as much as
the entire RDP
Jay Naidoo can think of other
ways to spend more than
R2 billion
A cabinet tussle looms over where South Africa's priorities lie.
Weekly Mail & Guardian, Main heading, 13 January 1995
The following is a single extract from quite a few articles published on the
weapon scandal:
The people in South Africa and millions
around the world are incomprehensible that
the ANC government’s first decision to buy
warships and warplanes when there is no
conceivable foreign military threat and when
the real threat to consolidation of democracy
is poverty. Instead of houses school and
clinics being built, instead of money to tackle
Aids, South Africa bought submarines.
According to a study being conducted by Prof
Schlemmer, 62% of ANC voters wanted the arms
deal being cancelled, 19% wanted the expenditure
to be reduced and only 12% supported the deal
Review of African Political Economy 100. 2004:
324–329.
The South African Navy received the first of the four corvettes at the end of
October 2003. Therefore, in the end, the Defence Minister got his way. Which
choice would you have made? Yes, I am sure you would rather build houses.
Why would that be your choice? Let us go a step further. What arguments can
you list in favour of buying corvettes?
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The answers to these questions are not as obvious as you may have thought
initially. Choices are often difficult to make, and numerous factors have an impact
on our choices. Economics is all about making choices. In order to make an
informed decision about the choice between houses and corvettes we first need
to know why choices must be made. Economics is concerned with the utilisation
of scarce means (or resources), and in view of our limited resources, we need to
make choices to satisfy numerous needs.
Not only ministers of parliament have to make choices. Each of us makes
choices every day about what to wear, about what to do this evening or about
what career to follow. At the workplace, choices are made regularly: what, how
many and for whom should we produce? How many people should be
employed?
The purpose of this study unit is to give you a better understanding of the
science of economics, to explain how you can benefit from studying it, and to
describe what the basic economic problem is.
OUTCOMES
After you have studied this study unit, you will know what economics is all about.
You must be able to









define the term “economics”
explain the difference between wants, needs and demand
identify the three main elements of the basic economic problem
define the concept of opportunity cost
explain the economic problem by using a production possibilities curve
explain why economics is a social science
distinguish between microeconomics and macroeconomics
distinguish between positive and normative statements
distinguish between levels and rates of change
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This introductory chapter of the textbook explains what economics is all about
and introduces a number of fundamental concepts in economics.
1.1 Scarcity, choice and opportunity cost
STUDY
The introductory part and section 1.1 of the prescribed
textbook
The introduction discusses the concept of economics and explains what it
involves.
Section 1.1 introduces the important concepts of wants (desires), needs,
demand, choice and opportunity cost. Opportunity cost (the trade-off between
two goods) can be illustrated graphically with the aid of a production
possibilities curve.
Figure 1-1 is important. Make sure that you are able to draw this figure in the
examination and explain it. Note the difference between wants, means, scarcity
and choice – the essential elements of the economic problem.
ACTIVITY 1.1
Note:
(a)
(b)
Solutions to the questions marked with an asterisk (*) are provided at the end
of this study unit.
Define economics (in one sentence).
What is the difference between wants and demand (in one or two
sentences)?
(c)* In table 1-1 below, make a tick in the appropriate column to indicate which
of the items are needs and which are wants.
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TABLE 1-1
Item
Need
Want
Food
Satellite TV
A five-bedroom house at the coast for a
person staying in Alexandra
A 4x4 vehicle (for example, a Pajero), if
you are unemployed
Shelter
Clothes
A Raymond Weill watch
(d)* What is the relationship between wants (on the one side) and means or
resources (on the other)?
(e)* Answer the following questions based on figure 1-1 below:
FIGURE 1-1
i.
ii.
iii.
iv.
v.
(f)*
What is the title of the above figure (or diagram)?
What is 0 on the diagram called?
Label the horizontal axis.
Label the vertical axis.
Label the curve indicated by JN.
Can you think of an example from your own life that explains opportunity
cost?
(g) Use the principle of opportunity cost to explain why students watch more
television during the week after the examination than the week before it.
(h)* Use a production possibilities curve to illustrate scarcity, choice and
opportunity cost.
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(i)*
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Answer the questions based on figure 1-2 below, which illustrates an
economy’s production possibilities curve for pillows and blankets.
FIGURE 1-2
i.
ii.
iii.
iv.
v.
vi.
vii.
What does the movement from point B to point C on the curve
represent?
Look at the movement from point D to point E. How many pillows need
to be sacrificed in order to produce more blankets per day?
Study the movement from point D to point C. How many blankets need
to be sacrificed in order to produce how many more pillows per day?
What principle is illustrated by the movement from point B to point C or
by the movement from point E to point C in the above diagram?
What does this principle mean?
How would you describe the shape of curve AF?
What does the shape of curve AF imply?
Indicate whether each of the following statements is true (T) or false (F):
Note:
The answers are provided at the end of this study unit.
T
(1)
(2)
(3)
(4)
(5)
Scarcity and choice are central elements of economics.
Scarcity is a problem in poor countries only.
The problem of scarcity arises when wants are unlimited and the resources (or
means) to fulfil these wants are limited.
The capacity of an economy to produce is limited by the quantity and quality of
available resources.
The opportunity cost of a choice is the value of the best, foregone opportunity
(or alternative).
F
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T
(6)
Leisure time sacrificed to study economics is an example of an opportunity
cost.
(7) If Johannes resigns from his salaried job to open his own business, the salary
he earned previously must be included in the opportunity cost of the business.
(8) A production possibilities curve indicates combinations of goods or services,
which can be produced when the community's resources are employed fully
and efficiently.
(9) A country's production possibilities curve illustrates a particular combination of
goods and services which is most desirable for the inhabitants of that country.
(10) Any point on the production possibilities curve represents an attainable
combination of goods and services.
(11) Any point outside, to the right or beyond the production possibilities curve
represents an unattainable combination of goods and services.
(12) Any movement from one point on a production possibilities curve to another
point on the curve illustrates the principle of opportunity cost.
The production possibility curve (PPC) is very important not only for this module,
but also for other economics modules that you may study in future. You must be
able to analyse this diagram. The axes of the PPC represent quantities that differ
from other graphs because the quantity is normally represented on the horizontal
axis. You may name the axes as you wish, since both represent quantity. Ensure
that your intervals are similar for each axis. In other words, consecutive numbers
must increase by the same amount. If we provide you with a PPC, then you
should be able to show which movement represents opportunity cost. A
movement from point A to point B in figure 1-2, or vice versa, represents
opportunity cost since you have to reduce the production of one of the products
in order to increase the production of the other product. The PPC line is very
important because it indicates the effective use of resources. This implies that we
are using our resources, for example, labour and capital to their optimum levels
and that points A to F represent the maximum combination of fish and potatoes
that we can produce given the available resources.
F
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1.2 Economics as a science
STUDY
Section 1.2 of the prescribed textbook
Subsection, "Why economists disagree", is not
prescribed for the examination.
Box 1-2: Microeconomics versus macroeconomics:
some examples.
This section deals with certain aspects of economics as a science. Note the
differences between economics (as a social science) and natural sciences.
The field of economics can be divided into two parts, namely microeconomics
and macroeconomics. It is also important to distinguish between positive and
normative economics. The fact that economics is a social science implies that
value judgements or opinions (normative statements) play a vital role in many
economic issues – which is one reason why economists sometimes disagree on
certain matters. Positive statements, on the other hand, are objective facts that
can be proved right or wrong, based on science or facts.
Activity 1.2
Note: The solution to the question marked with an asterisk (*) is provided at the end of
this study unit.
(a)
What is the difference between the following:
i.
microeconomics and macroeconomics?
ii.
natural science and social science?
iii. positive economics and normative economics?
iv. value judgements and objective facts?
(b)* Why do we consider the total production and export of maize as a
microeconomic issue?
(c) Give one example each of a microeconomic issue and a macroeconomic
issue.
(d) Distinguish between positive and normative statements and give an
example of each.
Indicate whether each of the following statements is true (T) or false (F):
Note: The answers are provided at the end of this study unit.
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T
(1)
Economics studies human behaviour and is therefore classified as a social
science.
(2) Economics studies human behaviour and is therefore classified as a natural
science.
(3) The ceteris paribus assumption means “all other things being equal”.
(4) Macroeconomics deals with phenomena such as total production, total
employment and inflation.
(5) Microeconomics focuses on specific parts of the economy while
macroeconomics is concerned with the economy as a whole.
(6) The study of the total output of the motorcar industry is an example of
macroeconomics.
(7) In respect of the motorcar industry, microeconomics is only concerned with
the output of a specific factory (for example, the Volkswagen factory in
Uitenhage).
(8) An increase in the price of tomatoes is a macroeconomic issue.
(9) The total production of beer in South Africa is a macroeconomic issue.
(10) If somebody says that the current Minister of Finance is doing a good job, he
or she is making a positive statement.
(11) “Unemployment is the only important economic problem in South Africa” is
an example of a normative statement.
(12) “In 2009, the official unemployment rate in South Africa was 24,5 per cent” is
an example of a positive statement.
Ensure that you know the difference between macroeconomics and
microeconomics as well as between normative and positive statements. We will
include these concepts as multiple-choice questions in the assignment and the
examination. We normally use real-life examples, similar to questions 6 to 12 in
activity 1-2 to ensure that you really understand these concepts.
1.3 Some common mistakes made in reasoning about economic
issues
STUDY
Section 1.3 of the prescribed textbook, only the last
section, "Levels and rates of change"
Box 1-3: Levels and rates of increase: some
numerical examples
F
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When dealing with numbers you must be very careful. One of the most common
mistakes is to confuse levels with rates of change (or percentages). You should
note the difference between levels and rates of change. Box 1-3 refers to the
consumer price index. The consumer price index is a yardstick for price changes
in the economy. This topic will be discussed in detail in Economics 1B.
Activity 1.3
Note: The solution to this question is provided at the end of this study unit.
(a)* Suppose that you earn R8 000 per month while your friend earns R15 000.
Your annual salary increase is 10 per cent, while your friend receives only 8
per cent.
i.
What is 10% of R8 000?
ii.
What is 8% of R15 000?
iii. Why is your friend’s salary increase, in rand terms, greater than your
increase in rand terms?
Indicate whether each of the following statements is true (T) or false (F):
Note: The answers are provided at the end of this study guide.
T
(1)
(2)
(3)
(4)
(5)
Rates of change are usually indicated as percentages (%).
Maria earns R5 000 per month and Sarah earns R10 000 per month. Maria
receives an increase of 20 per cent and Sarah an increase of 10 per cent.
Both Maria and Sarah therefore receive an increase of R1 000 per month.
If the economic growth rate in Uganda is 10 per cent in a particular year and
the economic growth rate in Australia is 2 per cent in the same year, it follows
that the level of production in Uganda is higher than the level of production in
Australia.
40 per cent of 100 are greater than 76 per cent of 50.
An increase from 150 to 165 is an increase of 10 per cent.
The above calculations are important practice for the assignment and the
examination. You can expect similar questions and are allowed to use a
calculator for these calculations, even in the examination. If you battle with these
calculations, you should once again work through the examples in Box 1-3 of the
prescribed textbook.
ECONOMICS IN ACTION
(LOOKING BACK)
Now that you have worked through this study unit and have gained a better
F
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understanding of what economics and choices involve, would you still make the
same choice about houses and corvettes that you made at the start of this study
unit? Do you see that one has to make choices?
FURTHER READING
As stated in the introduction to this study guide, this section is not prescribed
for the examination.
Read the section "Why economists disagree" in chapter 1 of the prescribed
textbook.
Can you think of an example (something that you heard on the radio and/or
television or read in a newspaper and/or magazine) where economists held
different views on the economy and made different forecasts on what is going to
happen? Consider different views of South Africa’s inflation rate and the
rand/dollar exchange rate. For example, compare the views of Gill Marcus,
Governor of the South African Reserve Bank, with those of other economists.
This again proves that economics is a social science that studies humans and
their behaviour and tries to explain it. This is why analysts sometimes have
different interpretations of the same (positive) economic indicators and suggest
different “solutions”. It is because their normative judgement differs.
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ANSWERS: STUDY UNIT 1
ACTIVITY 1.1
(c)
The completed table 1-1 should look like this:
Item
Food
Satellite TV
A five-bedroom house at the coast if you
stay in Alexandra
A 4x4 vehicle (for example, a Pajero), if
you are unemployed
Shelter
Clothes
A Raymond Weill watch
Need
X
Want
X
X
X
X
X
X
(d)
Wants are numerous (unlimited), while the available means to satisfy these needs
are scarce (limited).
(e)
i.
ii.
iii.
The production possibilities curve
The origin (Here the two axes [horizontal and vertical] cross [or intersect] at
the value 0.)
The horizontal line (the “flat” line from left at the origin to right in the graph) is
called the horizontal axis (or x-axis). In this module, we will only work with
positive values (like 1, 2, 3, 4, etc). To the right of the origin (the value of 0),
the values become positive and increase as we move to the right. The
production of two goods or services is indicated on the two axes of the
production possibilities curve. You could therefore indicate any good or
service on the horizontal axis, such as vehicles, pens, or apples (as in the
diagram below).
30
iv.
v.
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The vertical line (the line going upwards from the bottom to the top in the
graph) is called the vertical axis (or y-axis) and is measured from the bottom
to the top. Because we only use positive values in this module, the values
increase from 0 at the bottom (or the origin) to plus (or positive) infinity at the
top (in the above diagram: 5, 10, 15, 20, 25, 30, 35 ...). You could indicate
any good or service on this axis (in our diagram above we used the
production of pears).
The production possibilities curve
(f)
Consider the choices you make regarding your leisure time: to watch television or
to play football; to study Economics rather than Accounting; to work full time and
study part time or study full time; or to choose between two products like ice cream
and chocolates.
(h)
See figure 1-1 in your prescribed textbook.
Scarcity is illustrated by the fact that all the points to the right of the curve (like
point G) are unattainable.
Choice is illustrated by the need to choose between the available combinations (in
this case, a choice between two products, potatoes and fish) along the curve (for
example, choose between point B and point C).
Opportunity cost is illustrated by what we refer to as the negative slope of the
curve, which means that more of one good can only be produced by producing
less of the other.
(i)
See figure 1-2, study unit 1.
i.
It means that the production of a certain number of pillows per day has to be
sacrificed in order to produce more blankets per day – in other words, more
of one product and less of the other.
ii.
The production of 15 pillows (35 minus 20 = 15) has to be sacrificed daily
(which means we have to produce fewer of them) in order to produce 1 more
blanket (4 minus 3 = 1) daily.
iii.
We have to sacrifice the production of 1 blanket (3 minus 2 = 1) in order to
31
iv.
v.
vi.
vii.
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produce 7 more pillows daily (42 minus 35 = 7).
The principle of opportunity cost that is illustrated by any movement from one
point to another point on the production possibilities curve.
It means that more of one product can only be produced if less of the other
is produced.
The curve bulges outwards from the origin (0). We say the curve is concave
to the origin. It is therefore not a straight line, but an inverse, non-linear (or
curvilinear) relationship between two goods produced, in this case pillows
and blankets.
As we move from point A to point B and on to point F on the production
possibilities curve, the production of blankets increases while the production
of pillows decreases. In order to produce the first blanket society has to
sacrifice 3 pillows (from 50 to 47). To produce the second blanket another 5
pillows have to be sacrificed (from 47 to 42). For the third blanket, 7 pillows
have to be sacrificed. Thus, as we move from point A to point F on the
production possibilities curve the opportunity cost increases and the shape
of the production possibilities curve indicates increasing opportunity cost.
TRUE OR FALSE QUESTIONS
(1)
(2)
T
F
(3)
(4)
(5)
(6)
(7)
(8)
(9)
(10)
(11)
(12)
T
T
T
T
T
T
F
T
T
T
(It is a problem that faces all countries: rich or poor, developed or
underdeveloped; it also applies to people.)
(Also see question (c), activity 1.1 above.)
(This is the definition of the production possibilities curve.)
(See the definition of the production possibilities curve.)
ACTIVITY 1.2
(b)
Microeconomics studies individual goods and services, like wheat and bananas.
The example is about the total production and exports of an individual good,
namely maize production and exports. Macroeconomics deals with the production
and export of total (all) products and services in the economy (see box 1-2).
TRUE OR FALSE QUESTIONS
(1)
(2)
(3)
(4)
(5)
T
F
T
T
T
(See statement 1.)
(See box 1-2.)
32
(6)
F
(7)
F
(8)
(9)
(10)
(11)
(12)
F
F
F
T
T
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(The motorcar industry is one specific industry and thus a microeconomic
issue.)
(The motorcar industry would include all manufacturers of motorcars, for
example, Volkswagen, BMW, and Audi.)
(Tomatoes are one product and thus a microeconomic issue.)
(Beer is one product and thus a microeconomic issue.)
(It is an opinion or value judgement.)
(It is an opinion or value judgement.)
(It is a fact.)
ACTIVITY 1.3
(a)
i.
ii.
iii.
10 per cent of R8 000 is R800 (rate of change is expressed in %).
8 per cent of R15 000 is R1 200 (rate of change is expressed in %).
It is important to note the initial levels of the two salaries. Your salary of
R8 000 is lower than the initial level of your friend’s salary of R15 000. A
large percentage of a low number is still a low number, while a small
percentage of a large number can be quite large.
TRUE OR FALSE QUESTIONS
(1)
T
(2)
T
(20% of R5 000 is R1 000 and 10% of R10 000 is also R1 000)
20
100
x
5 000
1
10
 1 000 and
100
x
10 000
1
 1 000
(3)
F
(Uganda is a very poor country and shows a much lower level of growth than
the level of production in Australia, a wealthy, developed country.)
(4)
T
(40% of 100 equals 40, and 76% of 50 equals 38. 40 is more than 38.)
40
100
(5)
T
x
100
 40 and
1
 165  150

 150
76
x
100
x
100
1

15
150
50
 38
1
x
100
1


 10% 
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CHECKLIST: STUDY UNIT 1
Well
Concepts
I am able to
describe the term "economics"
define the terms "wants", "needs" and "demand"
identify the three main elements of the basic
economic problem
describe the concept of opportunity cost
distinguish between social science and natural
science
distinguish between microeconomics and
macroeconomics and give examples of each
distinguish between positive and normative
statements and give examples of each
distinguish between levels and rates of change and
give examples of each
Explanations
I am able to
explain the difference between wants, needs and
demand
explain the economic problem by using a production
possibilities curve
explain why economics is a social science
Diagrams
I am able to
(i)
show on a diagram
(ii) explain with or without the aid of a diagram
scarcity, choice and opportunity cost (figure 1-1)
Calculations
I am able to
calculate rates of change
Satisfactory Must Need
redo help
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STUDY UNIT 2
What should be produced?
A closer look at the
economic problem
How should it be produced?
For whom should it be produced?
Solutions to the central questions: an introduction to
economic systems
35
A closer look at the
economic problem
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2
STUDY UNIT
ECONOMICS
IN ACTION
The following are excerpts from different magazines:
Discover How to be an Effective Entrepreneur Yourself
Success in the business industry was never too much for newcomers to stop the
innovation. If people could understand their roles and specifics, they’ll discover the
different paths our economy could offer despite its downfalls. Our entrepreneurs have
played an essential role throwing a lifeline in this economic society. Aside from the profit,
entrepreneurs are also recognized and awarded for their contributions and success.
To be one, you should act like one. Not just by making people believe that you are an
entrepreneur, you should give them the benefit of recognizing your worth as someone
who once dreamed and now conquered. Instincts must never be put to a shut as
responsibilities come with a price.
These modern day businessmen and women have different roles to establish. A role in
the market industry, a role for his people, a role to make a new discovery making the
world perceive change amidst economic struggle, a role to his fellow laborers, a role to
his suppliers, a role to his competitors and a role to self-fulfilment.
The market industry has always been crowded with buyers and sellers. The thrill of
discovering a new product would entice clients to want more than expected. Satisfaction
should be guaranteed.
One of the most important roles of an aspiring entrepreneur is to always keep customer
satisfaction at its highest point. They should understand the difference between the
wants and needs of their consumers. Providing the available resources is not enough to
satisfy a need because people are born to crave for more than the usual amount given.
An entrepreneur should always be on the lookout for new creations and new ideas, not
missing a spot. If worse comes to worse, he could always revitalize his resources by
trying special strategies to cope up with liabilities.
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As an owner and a manager of his own company, an entrepreneur should also think
about his employee’s welfare. It is not only important to achieve customer satisfaction
but also a good employee-employer relationship. Now nobody wants people banging on
their doors in the middle of the night just because of unfair salaries.
Where would you get materials, machineries and facilities needed for production? From
suppliers. With the constant price hike, an honest negotiation would bring much
advantage. An entrepreneur should be capable of assembling all the elements into one
and at the same time treat each element equally.
Entrepreneur, February 2010
Entrepreneurship: Stories of Famous Entrepreneurs
Bill Gates. As a billionaire dropout not finishing his education during his junior year at
Harvard University, Gates is considered as one of the most famous individuals of our
time. With a vision of personal computers emerging out of the mainstream, he teamed
out with his colleague, Paul Allen who also studied in Harvard. Together, both of them
left the university in exchange for a dream that led them both to their multibillion
business, Microsoft Corporation.
Oprah Winfrey. At a very young age of 19, Oprah started her anchoring career for a TV
station situated in Nashville, Tennessee. From there, she pursued her dream and
traveled to Chicago. Not more than a month, The Oprah Winfrey Show was born and
talk show was never the same. Surpassing other local networks, it was tagged as one of
the best talk shows that entered national television. Aside from being a host, Oprah
founded Harpo, Inc. and O, The Oprah Magazine.
Walt Disney. Snow White, Cinderella, Sleeping Beauty, Beauty and the Beast,
Pinocchio, Fantasia… need I say more? The man behind the world’s most famous
mouse used to be a Red Cross volunteer during World War I.
With his talent as a cartoonist, Disney made his 1st debut with Plane Crazy, introducing
our beloved black and white mouse. Riding with the flow of Hollywood revolution, he
advanced from a silent cartoon to a talking Mickey Mouse. Then everything followed. His
enthusiasm made him sit on top of Disneyland garnering 26 Oscars.
Entrepreneur, February 2010
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What is the topic of these two excerpts? Did you notice that the focus is on one
of the four factors of production? Can you recall the four production factors that
are needed to produce goods and services? They are natural resources, labour,
capital and entrepreneurship.
It is clear that these two excerpts focus on entrepreneurship. The availability of
the other three production factors does not guarantee economic success. Do you
realise that the entrepreneur is the one who has to combine and organise these
factors of production? Entrepreneurs are the driving forces behind production,
innovators and risk-bearers. South Africa has a severe lack (or shortage) of
entrepreneurs. This shortage is often cited as one of the fundamental problems
in the South African economy.
Do you think a manager is the same as an entrepreneur? No, an entrepreneur is
much more than just a manager. The last article clearly states that entrepreneurs
should display special characteristics. Their reward for displaying these special
characteristics and using their abilities to combine the other three production
factors successfully is profit.
Although only one factor of production has been singled out, the other three are
equally important. Without natural resources, quality labour or enough capital (to
produce other goods or services) it is impossible for an entrepreneur to be
successful and he/she could run a loss or even go bankrupt.
The purpose of this study unit is to focus on a number of important economic
concepts, the production of goods and services, the combining of the four factors
of production, and how the three central economic questions of what, how and
for whom to produce are answered within the different economic systems.
OUTCOMES
After you have studied this study unit, you will have gained a better
understanding of production and you should be able to








describe the three central economic questions
describe the different kinds of goods in the economy
distinguish between the different types of goods by giving examples of each
illustrate, by using a production possibilities curve, the different
combinations of goods and services which can be produced, and
distinguish between efficient, inefficient and unattainable combinations
illustrate, by using a production possibilities curve, how a better production
technique or increased resources (or the better utilisation of them) affect
production
distinguish between the four factors of production and their remuneration
distinguish between the two production techniques
distinguish between the different sectors of the economy in which the
38

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production of goods and services occur
describe the main characteristics of a traditional economy, a command
economy, a market economy and a mixed economy
The three central economic questions of what, how and for whom are used to
introduce a variety of concepts, distinctions, factors of production, economic
systems and ideas of famous economists.
2.1
What should be produced?
STUDY
Section 2.1 of the prescribed textbook
The question of “What should be produced?” is not answered in this section.
Instead, various categories of goods and services that can be produced are
defined and production possibilities curves are used to explain certain aspects of
the production problem.
Take particular note of the definition of capital goods and the distinction
between final goods and intermediate goods. These concepts are used on
numerous occasions in the rest of the module. You should remember that we
introduced the production possibilities curve in study unit 1. As far as the
production possibilities curve is concerned, the important point here is the
significance of points not situated on the curve. What does a point lying inside
the curve indicate? What do points beyond the curve indicate? You should also
understand the possible causes of shifts of the production possibilities curve.
Figures 2-1 to 2-4 are important. Make sure that you can indicate economic
growth and unemployment (in other words, the inefficient use of the production
factor labour) graphically by means of the production possibilities curve.
Activity 2.1
Note: Solutions to the questions marked with an asterisk (*) are provided at the end of
this study unit.
(a)
Explain the difference between the following:
i.
consumer goods and capital goods
ii.
final goods and intermediate goods
iii. private goods and public goods
iv. economic goods and free goods
v.
homogeneous goods and heterogeneous goods
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(b)* “Air, seawater, sunshine, free education, and health services cannot always
be regarded as free goods.” What do you think of this statement? Can you
think of reasons why this may be true?
(c)
Complete the following table:
TABLE 2-1
Kind of good
Consumer good
Capital good
Final good
Intermediate good
Private good
Public good
Economic good
Free good
Homogeneous good
Heterogeneous good
Give one example of each
(d)* Use a production possibilities curve to distinguish between
i.
maximum attainable combinations
ii.
attainable but inefficient combinations
iii. unattainable combinations
of the production of two goods.
(e)* Use production possibilities curves to illustrate unemployment and
economic growth.
(f)*
Use figure 2-1, which shows a production possibilities curve, to indicate the
changes that are asked:
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FIGURE 2-1
i.
ii.
iii.
(g)
Indicate an improvement in the production techniques of only pens.
Indicate an improvement in the production techniques of only pencils.
Indicate an improvement in the production techniques of both pens
and pencils.
Mention two possible reasons for a rightward shift of the production
possibilities curve.
Indicate whether each of the following statements is true (T) or false (F).
Note: The answers are provided at the end of this study unit.
T
(1)
(2)
The three central questions in economics are what, how and for whom.
The distinction between goods and services is that goods are tangible
while services are intangible.
(3) Capital goods are goods used in the production of other goods.
(4) Consumer goods are goods used in the production of goods that
consumers will ultimately purchase.
(5) Capital goods lose their value (depreciate) over time.
(6) Intermediate goods are goods used as inputs in the production of other
goods.
(7) The beans bought by a factory to produce tins of baked beans are
intermediate goods.
(8) The beans bought by Mrs Jones to prepare bean soup for her family
are intermediate goods.
(9) All the goods a family purchases for own consumption at Pick n Pay
are final goods.
(10) All the goods purchased at a Shoprite Checkers store are not private
goods since any member of the public may purchase goods at such a
F
41
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store.
(11) Scarce goods are called economic goods.
(12) Goods that are not scarce and therefore have no price are called free
goods.
(13) Washing powder is a heterogeneous good since there are different
varieties or brands of washing powder, like Omo, Surf and Skip.
(14) An increase in the available resources can be illustrated by a rightward
shift of the production possibilities curve.
(15) Economic growth can be illustrated by a rightward shift of the
production possibilities curve.
(16) The impact of the discovery of new economically viable gold deposits
in South Africa can be illustrated by an outward (rightward) shift of the
production possibilities curve.
(17) The utilisation of previously unemployed resources will shift the
production possibilities curve outward (to the right).
(18) Unemployment is indicated by a leftward shift of the production
possibilities curve.
(19) Unemployment is indicated by a rightward shift of the production
possibilities curve.
(20) Unemployment is indicated by a point inside the production
possibilities curve.
It is important to focus on the shift of the PPC in the above activity. You must be
able to differentiate between the two shifts, namely where the production
technique of one of the products increases. This shift implies that the quantity
produced of only the product with the improved production technique increases,
while the output of the other product remains the same (see figure 2-2 in the
prescribed textbook). If the productivity of the inputs improves or more resources
are available, then the quantity produced of both products will increase (see
figure 2-4 in the prescribed textbook). The rightward shift of the PPC represents
economic growth. Questions (d) to (g) are very important exercises in this regard.
2.2
How should it be produced?
STUDY
Section 2.2 of the prescribed textbook
This section deals mainly with the different factors of production, which are
among the most important basic concepts in economics.
Study this section carefully. The first two factors, natural resources and labour,
require little explanation, but capital as a factor of production has a very specific
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meaning that you must study in detail. Note that money is not regarded as a
factor of production. Make sure that you know what entrepreneurship means.
You should also know the distinction between capital-intensive and labourintensive production.
Activity 2.2
Note: Solutions to the questions marked with an asterisk (*) are provided at the end of
this study unit.
(a) Name the four factors of production.
(b)* Read the passage below.
One of the best-known entrepreneurs in South Africa is Sol Kerzner who developed the
Sun City/Lost City hotel complex near Rustenburg. He saw the opportunity to provide a
service through which he could help satisfy people's needs for tourism and
entertainment. He bought land on which to build the hotel complex. He then bought or
hired the necessary machines and tools to have the complex built and employed people
to construct the hotels and maintain them afterwards. Services are constantly being
supplied to the guests by means of devices such as cleaning equipment, refrigerators,
buses, boats for pleasure rides, and so on.
Complete the table below by giving examples of each of the types of production
factors that were used in building the hotel complex.
Factors of
production
Natural resources
Capital
Labour
Entrepreneurship
Examples from the building of the Sun City complex
(c)* In the table below, show, by marking the relevant column, which goods are
capital goods and which are not capital goods.
Item
A printing machine used by book printers
Cement (to construct an office building)
Bread
A teacup
A shop like Shoprite/Checkers
A cash register in a shop
A highway
Capital goods
(d)* Why is money not regarded as a factor of production?
Not capital goods
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Indicate whether each of the following statements is true (T) or false (F):
Note:The answers are provided at the end of this study unit.
T
F
(1)
The four factors of production are natural resources, labour,
entrepreneurship and money.
(2) There is an unlimited supply of natural resources.
(3) The term “human capital” refers to the number of workers.
(4) The entrepreneur is the driving force behind the production process.
(5) Capital refers to all tangible goods used to produce other goods.
(6) A pair of scissors used in a factory where clothes are produced is an
example of a capital good.
(7) A pair of scissors used at home to cut paper is an example of a
consumer good.
(8) The N3 highway connecting Johannesburg and Durban is an example
of a capital good.
(9) Money is a means of exchange and not a factor of production.
(10) A labour-intensive production process is dominated by capital.
Most of the students confuse production factors and production sectors with each
other. Remember, the production factors are the inputs required to manufacture
the product, while the productions sectors represent the different economic
sectors where the production factors are transformed into usable goods and
services. See section 2.3 below for a detailed explanation of the various
production sectors.
2.3 For whom should it be produced?
STUDY
Section 2.3 of the prescribed textbook
Box 2-2: The primary, secondary and tertiary sectors
This section covers the income earned by the different factors of production
and explains how this income is used. These are some of the most important
core concepts in economics. Note, in particular, the terms that are used for
income earned by the various factors of production (that is, rent, wages and
salaries, interest, and profit).
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Activity 2.3
(a)
(b)
Name the four factors of production and the income earned by each.
Explain the difference between the primary, secondary and tertiary sectors
of the economy.
Indicate whether each of the following statements is true (T) or false (F):
Note: The answers are provided at the end of this study unit.
T
F
(1)
(2)
(3)
(4)
(5)
(6)
Rent is the income earned by the capital production factor.
Interest is the income earned by the capital production factor.
Wages and salaries are earned by the labour production factor.
The entrepreneurship production factor earns profit.
Wealth and income have the same meaning.
Wealth, for example, includes a large house and a savings account at
a commercial bank.
(7) Income is earned by the four factors of production.
(8) The service sector is called the secondary sector.
(9) The primary sector is the sector where raw materials are used in the
production process to produce other goods.
(10) In the secondary sector, the products of the primary sector (like wood),
among other things, are used for the manufacturing of consumer
goods (like furniture).
2.4 Solutions to the central questions: an
economic systems
introduction
to
STUDY
Section 2.4 of the prescribed textbook
This section deals with the different types of economic systems. Essentially,
three mechanisms provide answers to the three central questions listed at the
beginning of the study unit. These mechanisms are tradition, command and the
market, and they form the basis of the three fundamental types of economic
systems, namely the traditional system, the command (or centrally planned)
system, and the market system. In practice, however, all systems are mixed
systems that contain elements of tradition, command and the market. Nowadays
there is a widely held view that the market should be the most important
ingredient of this “mix”. Note the definition of a market and make sure that you
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understand how this institution (which Adam Smith compared with an invisible
hand) provides answers to the three central questions.
Activity 2.4
Note: The solution to the question marked with an asterisk (*) is provided at the end of
this study unit.
(a)
Name the three basic coordinating mechanisms that can be used to solve
the three central economic questions.
(b) What is the essential difference between capitalism and socialism?
(c) Name two characteristics of a capitalist market economy.
(d) What is a mixed economy?
(e)* Compare the advantages of the market system over the traditional system
and command system.
Indicate whether each of the following statements is true (T) or false (F):
Note: The answers are provided at the end of this study unit.
T
(1)
(2)
(3)
(4)
(5)
(6)
(7)
(8)
(9)
(10)
(11)
(12)
(13)
The purpose of an economic system is to solve the three central
economic questions (what,? how? for whom?).
Economic systems are based on any or a combination of three
coordinating mechanisms: tradition, command and the market.
Many modern economic systems are based largely on tradition.
The distinction between socialism and capitalism is to be found in the
predominant type of ownership of the productive assets.
The distinction between a market economy and a centrally planned
economy lies in the type of coordinating mechanism used to solve
the central economic questions.
Many countries have switched to command systems in recent years.
Many countries have moved from planned socialism to marketoriented economic systems in recent years.
For a market to exist physical contact must take place between the
prospective buyers and the prospective sellers of the good or service
in question.
In market capitalism, each participant in the economic process
pursues his or her self-interest.
In a market system, no agency instructs the various participants
about what they should produce and how to produce it.
Competition and negotiation are synonymous (have the same
meaning).
Competition occurs on one side of the market (that is, between
buyers or between sellers) while negotiation occurs across the
different sides of the market (that is, between buyers and sellers).
Most economic systems are mixed systems, rather than pure
F
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T
F
traditional, command or market systems.
(14) South Africa has a mixed economic system.
Section 2.5 of the prescribed textbook, "The men behind the systems: Smith,
Marx and Keynes", is not prescribed for the examination.
ECONOMICS IN ACTION
(LOOKING BACK)
Now that you have worked through the contents of this study unit, you should
have a better understanding of what the production of goods and services
involves. In addition, you should realise that production is impossible without the
four factors of production and should understand the role of the different
economic systems in answering the three central economic questions (“what?”,
“how?” and “for whom to produce?”).
FURTHER READING
As stated in the introduction to this study guide, this section is not prescribed
for the examination.
The article below tells us how the Chinese economy has been deliberately
transformed since 1992 to be more market oriented. This is but one example of
the various countries that have been moving towards a more market-oriented
system during the last decade or two. There are many more examples of
countries that are still moving from a command system towards a more marketoriented system. Many of these countries are found in Eastern Europe, such as
Hungary, Croatia and Romania. Eritrea is an example of an African country that
is taking the same route. Each of these countries is doing it in its own way and at
its own pace, depending on its unique situation.
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China’s economic transition, a great success
During the process of economic transition over
the past two decades, China has been pursuing
a path of development in line with the reality of
the country.
Thanks to this approach, China successfully
combined a market mechanism with its cardinal
public ownership system and in so doing ushered
in an era of unprecedented progress. China’s
gross domestic product (GDP), on average,
advanced by 9.3 percent each year from 1978 to
2000.
The wide shortage of commodities at the time of
the planned economy has gone and the
livelihood of Chinese residents has improved
significantly.
China opted to carry out economic transition in a
step-by-step way, rather than by radical reforms
or even shock therapy as used in some other
economies. This route proved to be the key to
the success of transition, because it limited the
negative impact of reforms to an acceptable
extent and avoided social unrest.
China’s economic restructuring started in its vast
rural areas and was later introduced to cities
gradually.
In 1992, China fixed the goal of establishing a
market-orientated economy. The move was a
natural result of the ever-deepening reforms as
commodity and labour prices were freed up and
the capital, real estate and technology markets
took shape.
Today the market mechanism is playing
fundamental role in the economic life of China.
a
While the market system was introduced to replace
a rigidly planned economy, the Chinese
Government was also taking steps to adapt its role
and establish an effective macro-control system in
line with the new economic structure.
The government reformed the financial system and
strengthened the central bank’s power to supervise
the market and safeguard the stability of currency. It
also implemented a proactive fiscal policy to
maintain steady economic growth.
The government is learning to manage the
economy through economic and legal measures,
rather than direct interference, to create a sound
market environment.
During the transition of the past two decades, China
has not only achieved rapid economic progress, but
also maintained social stability because the pace of
reform was kept within an acceptable range for
society.
Reform is the engine of social development, but it
must be soundly based on stable political and social
foundations. China has learnt from its experience of
the past two decades that it is only by striking a
balance between reform, development and stability
that economic transition can succeed.
People’s Daily, 13 November 2002
(http://english.peopledaily.com.cn/200211/13)
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ANSWERS: STUDY UNIT 2
ACTIVITY 2.1
(b)
Normally, air and seawater are regarded as free goods. However, clean air and
seawater are actually hard to find nowadays owing to of pollution! Polluted air
particularly poses a serious problem in some parts of South Africa in winter, for
example, in cities like Alexandra, Soweto, Vanderbijlpark and Witbank. If we really
want completely clean air and water, we will have to do something like boil the
water (which consumes electricity), or purify the air using air conditioners. This will
involve a cost, and therefore clean air and water will not be entirely free.
The same argument is true of sunshine. Sunshine could be scarce in cities with
high-rise buildings, for example New York in the USA. If you want to enjoy more
sunshine in these cities, you cannot stay in a flat on the ground floor; you have to
rent a flat on the top floor of the building. Normally these flats are more expensive
than those on the ground floor are. In such a situation, sunshine will actually cost
something.
(d)
(e)
Education and primary health services are classified as free services. How does
government manage to provide these services? Government uses the money of
taxpayers. These services are therefore not actually free because taxpayers bear
the expense of providing them.
You should have drawn a figure like figure 2-1 in the prescribed textbook.
i. Points A, B, C, D, E and F are maximum attainable combinations.
ii. Point H is an attainable, but inefficient combination.
iii. Point G is an unattainable combination.
Unemployment refers to an inefficient combination (see table 2-1 in the paragraph
above and the table itself in the prescribed textbook). Revise the definition of a
production possibilities curve in chapter 1 of the prescribed textbook.
Point D indicates unemployment. Any point inside the production possibilities
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curve indicates that some resources are unemployed or not fully or efficiently
utilised. See also figure 2-1 in the prescribed textbook. Point H also indicates
unemployment.
Economic growth is indicated by figure 2-4 in the textbook. More of both goods
(consumer and capital goods, in this example) can be produced because the
quantity and/or quality of the production factors has increased. The whole curve
moves to the right.
(f)
i.
ii.
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iii.
TRUE OR FALSE QUESTIONS
(1)
(2)
(3)
(4)
T
T
T
F
(5)
(6)
T
T
(7)
(8)
(9)
(10)
T
F
T
F
(11)
(12)
(13)
(14)
(15)
(16)
(17)
T
T
T
T
T
T
F
(18) F
(19) F
(20) T
(Consumer goods are not used in the production of goods. Consumer goods
are meant for final consumption.)
(For example, the flour used by the baker to bake bread that will be sold later
is an intermediate good.)
(See statement 6.)
(It is a final good.)
(It is bought and consumed by individuals or households and is therefore a
private good.)
(Because it is scarce; there is a cost linked to it.)
(A point inside the production possibilities curve indicates previously
unemployed resources. The utilisation of such unutilised resources will move
the point inside the curve closer to the curve – or even onto the curve - but it
will not move the curve.)
(See statement 20.)
(See statement 20.)
(A point inside the curve indicates unemployment, an inefficient
combination.)
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ACTIVITY 2.2
(b)
The completed table should look like this:
Factors of production
Natural resources
Capital
Labour
Entrepreneurship
(c)
Examples from the building of the Sun City complex
Land
Machines, tools, cleaning equipment, buses, refrigerators,
and boats
People to construct the building and to render services
Planning, organisation, decision making, controlling
The completed table should look like this:
Item
A printing machine used by book printers
Cement (to construct an office building)
Bread
A teacup
A shop like Shoprite/Checkers
A cash register in a shop
A highway
(d)
Capital goods
x
x
Not capital goods
x
x
x
x
x
Money is a medium of exchange because we can exchange it for goods and
services (using it to buy goods and services). Money is not a factor of production
because you cannot use money on its own to produce goods and services. In
order to produce, the factors of production such as natural resources, labour,
capital and entrepreneurship are required.
TRUE OR FALSE QUESTIONS
(1)
F
(2)
(3)
(4)
(5)
(6)
(7)
(8)
(9)
(10)
F
F
T
T
T
T
T
T
F
(Money is a medium of exchange and not a factor of production – see
statement 9.)
(It is limited.)
(The term refers to the quality of labour.)
(Capital is the same as capital goods.)
(It is dominated by the use of labour.)
ACTIVITY 2.3
TRUE OR FALSE QUESTIONS
(1)
(2)
F
T
(See statement 2.)
52
(3)
(4)
(5)
T
T
F
(6)
(7)
(8)
(9)
T
T
F
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(Wealth is a stock variable that includes all assets, while income is a flow
variable including the income of all factors of production. Also, see
statements 6 and 7. The terms "stock" and "flow" are covered fully in the next
study unit.)
(The service sector is called the tertiary sector.)
(Raw materials are used in the production of other goods in the secondary
sector.)
(10) T
ACTIVITY 2.4
(e)
Traditional system:
i.
It is a rigid system, slow to adapt to changing conditions.
ii.
Subsistence economies tend to stagnate.
iii.
Economic activity is secondary to religious and cultural values.
Command system:
i.
Political planners decide what to produce. They own all the factors of
production – no motive for improvement.
ii.
It has no profit motive – leads to inefficient production relative to the market
system.
Market system:
i.
Adapt and innovate in the pursuit of profit.
ii.
Self-interest promotes economic activity.
iii.
Co-ordination occurs without any planning.
TRUE OR FALSE QUESTIONS
(1)
(2)
(3)
(4)
(5)
(6)
(7)
(8)
(9)
T
T
F
T
T
F
T
F
T
(10)
(11)
(12)
(13)
(14)
T
F
T
T
T
(It is based mainly on mixed systems. Also, see statement 13.)
(See statement 7.)
(Contact can be personal, by means of telephone or computer, etc.)
(Own interest is the main driving force behind economic activities in market
capitalism.)
(See statement 12.)
(In practice, most systems are mixed, although one of the mechanisms
usually dominates.)
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CHECKLIST: STUDY UNIT 2
Well
Concepts
I am able to
describe the three central economic questions
(what?, how?, and for whom?)
distinguish between consumer goods and capital
goods and give examples of each
distinguish between different categories of
consumer goods and give examples of each
distinguish between final goods and intermediate
goods and give examples of each
distinguish between private goods and public
goods and give examples of each
distinguish between economic goods and free
goods and give examples of each
distinguish between homogeneous and
heterogeneous goods and give examples of each
define the four factors of production and give
examples of each
distinguish between the incomes of the factors of
production
distinguish between the two production techniques
distinguish between income and wealth
distinguish between the different economic
systems
define the term "market"
list the conditions for a market to exist
distinguish between privatisation and
nationalisation
Explanations
I am able to
explain the difference between the primary,
secondary and tertiary sectors of an economy
(box 2-2)
explain why money is not seen as a factor of
production
explain the main features of a traditional economy,
a command economy, a market economy and a
mixed economy
explain the differences between the three
economic systems
Satisfactory Must
redo
Need
help
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Well
Diagrams
I am able to
distinguish, by using a production possibilities
curve, between maximum attainable combinations,
attainable but inefficient combinations, and
unattainable combinations (figure 2-1)
illustrate, by using a production possibilities curve,
unemployment and economic growth (figure 2-1)
distinguish, by using a production possibilities
curve, an improvement in the production
techniques of only one good or both goods
(figures 2-2, 2-3, and 2-4)
Satisfactory Must
redo
Need
help
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STUDY UNIT 3
The interdependence
between the major
sectors, markets and
flows in the mixed
economy
Production, income and spending
The interdependence between households and firms
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The interdependence
between the major sectors,
markets and flows in the
mixed economy
3
STUDY UNIT
ECONOMICS
IN ACTION
The following tables are extracts from the Income and expenditure survey.
Statistics SA conducts this survey regularly. You can visit their website for the
latest economic data at www.statssa.gov.za.
Average household income in 2006 as released in August 2008
Source of Income
Income from work
Household salaries and wages
Household self-employment and business
Income from capital
Pensions, social insurance, family allowances
Income from individuals
Alimony, palimony and other allowances
Other income from individuals
Total in Rand Millions
48 152
7 300
865
6 510
888
314
Other income
Other income
Benefits, cash, donations and gifts
3 179
298
Imputed rent on owned dwelling (7% per year of dwelling)
7 081
Total
74 589
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TABLE 1
SUMMARY OF AVERAGE ANNUAL HOUSEHOLD EXPENDITURE ACCORDING TO
INCOME GROUP IN 2006 AS RELEASED IN AUGUST 2008
Main Expenditure Group
1.
Food and non-alcoholic beverages
2.
Alcoholic beverages and tobacco
3.
Clothing & footwear
4.
Housing, fuel and power
5.
Furniture, equipment and maintenance
6.
Health
7.
Transport
8.
Communication
9.
Recreation, sport, etc
10. Education
11. Restaurants, bars, etc
Rands
Percentage
contribution
Millions
Average
100 971
8 065
34 639
165 003
48 181
11 620
139 278
8 105
647
2 781
13 245
3 868
933
11 180
14,4
1,2
5,0
23,6
6,9
1,7
19,9
24 534
32 160
16 894
15 354
1 969
2 582
1 356
1 232
3,5
4,6
2,4
2,2
The above tables illustrate the flow of income and spending of South African
households. The two main participants in the economy are households (or
consumers) and firms. The households are the owners of the factors of
production. These factors of production are sold to the firms that combine them
for the production of goods and services. The goods and services are sold to
generate income for the firms. Households receive payment for their production
factors in the form of salaries and wages, profit, rent and interest. Can you recall
the income earned by the factors of production? In the income table above, you
can see that salaries and wages are by far the largest component of income.
Without income, spending is impossible, and if either one of the two is missing
there can be no flow of income and spending in the economy.
The table on expenditure above (table 1) paints a picture of how the different
income groups spend their income. Households in higher-income groups spend
more on luxury items like recreation, restaurants and holidays. The lower-income
groups do not have the financial means and will rather buy essential goods to
satisfy basic needs.
The above example focused on the income and expenditure of households. The
income that households earn is spent on goods and services produced by firms.
The purpose of this study unit is to emphasise the interdependence between
households and firms, to introduce the most important markets and flow
variables, and to show how these elements are interdependent.
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OUTCOMES
After you have mastered the prescribed sections of this study unit, you should
have gained a better understanding of the flow of income and spending, and you
should be able to





identify the three major flows in the economy and show the relationship
between them
distinguish between a flow and a stock and give examples of each
explain the interdependence between households and firms
distinguish between the goods market and the factor market
explain the interaction between households and firms by means of the
circular flow of goods and services and the circular flow of income and
spending
After you have worked through this study unit, you will have a better
understanding of the interdependence between the two sectors (households and
firms) and the markets for goods and factors.
3.1 Production, income and spending
STUDY
Section 3.1 of the prescribed textbook
Box 3-1: Stocks and flows
You will find the three major flows that are important in the economy in figure 3-1.
Note that economists view total production and total income as two sides of
the same coin (in other words, they are always equal), while total spending is a
completely different concept. This is a diagrammatic illustration of the economic
process without the participants. This process is valid for South Africa, the USA
and all other countries. The obvious question is what are the magnitudes of these
flows?
Spending: How can we classify spending? What type of goods can we buy? We
can buy consumption goods (let us abbreviate it to C) and investment goods (I).
In this module, only these two components and their interaction are discussed.
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Government also spends (G); foreigners buy goods from South Africa – in other
words, exports (X) – and South Africa buys from foreigners – in other words,
imports (Z). Government spending, exports and imports are dealt with in detail in
Economics 1B.
Income: The four factors of production were discussed in study unit 2. Think of
the income (not gifts) you can earn:
1
salaries and wages
2
interest on your savings earned at the bank
3
shares (unit trusts) which earn dividends, and businesses that earn profits
4
rent
We can classify all income of a household under these four headings. The total
income includes wages and salaries, interest, profit and rent.
You must also understand the difference between a stock and a flow.
Activity 3.1
(a)
(b)
(c)
(d)
What is the difference between production and income?
What is the difference between production and income (on the one hand)
and spending (on the other)?
Name the three major flows in the economy as a whole and explain how
they are related.
What is the difference between a stock variable and a flow variable? Give
one example of each.
Indicate whether each of the following statements is true (T) or false (F):
Note:
The answers are provided at the end of this study unit.
T
(1)
The three major flows in the economy as a whole are total production,
total income and total spending.
(2) The two basic sets of participants in any economy are households and
firms.
(3) Production is a stock and income is a flow.
(4) The annual maize harvest is a flow variable.
(5) The total number of motor vehicles manufactured in South Africa in
2009 is a stock variable.
(6) The number of parking bays available at Unisa's main campus is a stock
variable.
(7) The monthly expenditure of a household is a flow variable.
(8) The balance on your savings account on a particular day is a stock
variable.
(9) The number of foreign visitors to the country during a particular year is a
stock variable.
(10) Consumption is a flow variable.
F
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T
F
(11) Investment is a stock variable.
(12) Capital is a stock variable.
Box 3-1 in the prescribed textbook is extremely important since it clearly
differentiates between a stock and a flow variable. We also list the various
economic concepts as either a stock or a flow variable. Box 3-1 will help you
answer questions 3 to 9 in the above activity.
3.2 The interdependence between households and firms
STUDY
Section 3.2 of the prescribed textbook
You have now been introduced to the various participants in the economic
process. Households and firms are the two basic sectors of a market economy
that includes the goods market and the factor market. The households and
firms are interrelated via the circular flow of goods and services and the
circular flow of income and spending.
Figure 3-1 does not show the participants, only the process. Figures 3-2 and 3-3
indicate the participants as well as the markets. These figures can be used to put
most of the prescribed textbook into perspective. It is imperative that you
understand how the two basic sectors and the goods market and factor market
are related.
Activity 3.2
Note: Solutions to the questions marked with an asterisk (*) are provided at the end of
this study unit.
(a) What are the two basic sets of markets in the economy?
(b)* Study the example below and then answer the questions.
Imagine that you have a friend, James, who works for a furniture factory called
Oregon Pine Manufacturers. He is a skilled carpenter and assists in the making of
tables, wall units, TV cabinets, and so on. On the last Saturday of every month,
James takes his family to the Hyperama where they do their monthly shopping. At
the tills, James usually pays cash for the food and other products they are buying.
i.
Make a list of all the transactions taking place in this example. A
transaction can be described as a business activity that takes place
when something is exchanged for something else. (Hint: There are
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two transactions here, not only one!)
We say that transactions take place in a market. In the example, two
markets are involved in the transactions taking place. Try to think what
these markets could be and name each of them. This may sound
difficult, but it is really just common sense!
(c)* Explain the goods and services circular flow by means of a figure.
(d)* Explain the income and spending circular flow by means of a figure.
(e)* What is the difference between the circular flows in questions (c) and (d)
above?
(f)* Does the monetary value differ between the two circular flows?
Indicate whether each of the following statements is true (T) or false (F):
Note: The answers are provided at the end of this study unit.
T
(1)
(2)
(3)
(4)
(5)
(6)
(7)
(8)
F
Members of households are called consumers.
Consumers are rational, in other words they will always try to
maximise their satisfaction, given the means at their disposal.
Households are responsible for the spending on consumer goods.
Firms purchase capital goods.
Firms are mainly involved in consumption while households are mainly
involved in production.
There are two sets of markets in the economy, goods markets (for
example, the market for tomatoes) and factor markets (for example,
the labour market).
Firms purchase in the factor markets and sell in the goods markets.
Households sell in the factor markets and purchase in the goods
markets.
In the above activity, it is important to know the characteristics of the households and the
firms. Furthermore, the direction of each flow is important. The goods cycle commences
at the households, while the income and expenditure cycle starts at the firms.
Sections 3.3 to 3.6 in the textbook are not prescribed for this module. They form part of
Economics 1B.
ECONOMICS IN ACTION
(LOOKING BACK)
Now that you have worked through the study guide, the first two tables of this
study unit should make much more sense. Now you have the bigger picture and
know how income and spending fit into the economy as a whole and how they
are related. You should have noted that the income table lists more types of
income than the four about which you have learned under the remuneration of
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production factors. Most of these extra income categories are not income that
factors of production earned, but they are mere transfers. Typical examples of
transfers are old-age pensions and social pensions. You will learn more about
them in other modules.
FURTHER READING
As stated in the introduction to this study guide, this section is not prescribed
for the examination.
Only a limited part of chapter 3 of the prescribed textbook is prescribed for the
examination. You will have a better understanding of the interdependence
between the most important sectors, markets and flows in a mixed economy after
you have read the whole chapter. The layout of the prescribed textbook will be
clearer because you would know how the different parts fit into the whole. In
other words, you will have a complete picture of the core elements of the
economic circular flow and their mutual interdependence, and you will
understand the functioning of the economy better.
ANSWERS: STUDY UNIT 3
ACTIVITY 3.1
TRUE OR FALSE QUESTIONS
(1)
(2)
(3)
T
T
F
(4)
(5)
T
F
(6)
(7)
(8)
(9)
(10)
(11)
(12)
T
T
T
F
T
F
T
(In economics, production and income are always equal. They are both
flows.)
(“Annual” refers to a period.)
(The production of the motorcars took place throughout the year. It is
therefore a flow variable.)
(It can be measured at a specific moment.)
(“Monthly” refers to a period.)
(It can be measured at a specific moment.)
(“In a specific year” refers to a period. It is thus a flow variable.)
(It can only be measured over a period.)
(Investment is measured over a period.)
(It is measured at a specific moment.)
ACTIVITY 3.2
(b)
i.
The most obvious transaction in the example is, of course, that James and
his family buy goods from the Hyperama. James takes some of the
Hyperama's goods, and in exchange, gives the shop money. What is the
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other transaction? Consider how James got his money in the first place. It
obviously comes from the wages Oregon Pine Manufacturers pays him.
What does James give them in turn? He provides them with his skills as a
carpenter, in other words, his labour. The second transaction, thus, is the
money James receives in exchange for his labour.
The market that is created between James's household and the Hyperama
concerns the selling and buying of goods, and is called a market for goods
and services, or the goods market. But what kind of market is present in the
transaction between James and his employer, Oregon Pine Manufacturers?
Remember that labour is a factor of production. Here a factor of production is
therefore bought and sold, and we call this market the market for factors of
production, or the factor market.
The relationship between households and firms, which involves two different
markets, is the most basic element of the circular flow.
(c)
(d)
(e)
(f)
See figure 3-2 in the prescribed textbook. A short explanation is given below the
figure.
See figure 3-3 in the prescribed textbook. A short explanation is given below the
figure.
The flow is reversed (flowing in the opposite direction). The one flow is of goods
and services while the other is a monetary flow (a flow of money).
No, in money terms, the magnitudes are the same. The value of what is produced
(in money terms) is equal to (or the same as) what is spent (or bought).
TRUE OR FALSE QUESTIONS
(1)
(2)
T
T
(3)
(4)
(5)
(6)
(7)
(8)
T
T
F
T
T
T
(Consumers aim at maximum satisfaction or maximum total utility,
while firms strive for maximum profit.)
(Households buy on the goods market.)
(Firms are involved in production and households in consumption.)
(Firms buy factors of production in the factor markets.)
(Households sell their factors of production in the factor markets.)
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CHECKLIST: STUDY UNIT 3
Well
Concepts
I am able to
name the three major flows in the economy
distinguish between a stock variable and a flow
variable, and give examples of each
identify the different participants in the economy
define households
define firms
distinguish between the two basic markets in the
economy
Explanations
I am able to
identify the three major flows in the economy and
explain the interdependence between them
explain the difference between production and
income (on the one hand) and spending (on the
other)
explain the interdependence between households
and firms
explain the difference between the circular flow of
goods and services and circular flow of income and
spending
Diagrams
I am able to illustrate by using diagrams
the major flows in the economy (figure 3-1)
the circular flow of goods and services (figure 3-2)
the circular flow of income and spending (figure 33)
Satisfactory Must
redo
Need
help