Economics

ATSWA ACCOUNTING TECHNICIANS SCHEME WEST AFRICA STUDY TEXT ECONOMICS PUBLICATION OF ASSOCIATION OF ACCOUNTANCY BODIES IN WEST AFRICA (ABWA)  ASSOCIATION OF ACCOUNTANCY BODIES IN WEST AFIRCA (ABWA)...

ATSWA ACCOUNTING TECHNICIANS SCHEME WEST AFRICA STUDY TEXT ECONOMICS PUBLICATION OF ASSOCIATION OF ACCOUNTANCY BODIES IN WEST AFRICA (ABWA)  ASSOCIATION OF ACCOUNTANCY BODIES IN WEST AFIRCA (ABWA) ACCOUNTING TECHNICIANS SCHEME WEST AFRICA (ATSWA) STUDY TEXT FOR ECONOMICS THIRD EDITION Copyright (c) 2009 by Association of Accountancy Bodies in West Africa (ABWA). All rights reserved. No part of this publication may be reproduced or distributed in any form or by any means, or stored in a database or retrieval system, without the prior written consent of the copyright owner. Including, but not limited to, in any network or other electronic storage or transmission, or broadcast for distance learning. Published by ABWA PUBLISHERS DISCLAIMER This book is published by ABWA; however, the views are entirely those of the writers. ECONOMICS ii  PREFACE INTRODUCTION The Council of the Association of Accountancy Bodies in West Africa (ABWA) recognised the difficulty of students when preparing for the Accounting Technicians Scheme West Africa examinations. One of the major difficulties has been the non-availability of study materials purposely written for the scheme. Consequently, students relied on text books written in economic and socio-cultural environments quite different from the West African environment. AIM OF THE STUDY TEXT In view of the above, the quest for good study materials for the subjects of the examinations and the commitment of the ABWA Council to bridge the gap in technical accounting training in West Africa led to the production of this Study Text. The Study Text assumes a minimum prior knowledge and every chapter reappraises basic methods and ideas in line with the syllabus. READERSHIP The Study Text is primarily intended to provide comprehensive study materials for students preparing to write the ATSWA examinations. Other beneficiaries of the Study Text include candidates of other Professional Institutes, students of Universities and Polytechnics pursuing undergraduate and post graduate studies in Accounting, advanced degrees in Accounting as well as Professional Accountants who may use the Study Text as reference material. APPROACH The Study Text has been designed for independent study by students and as such concepts have been developed methodically or as a text to be used in conjunction with tuition at schools and colleges. The Study Text can be effectively used as a course text and for revision. It is recommended that readers have their own copies. ECONOMICS iii  FORWARD The ABWA Council, in order to actualize its desire and ensure the success of students at the examinations of the Accounting Technicians Scheme West Africa (ATSWA), put in place a Harmonisation Committee, to among other things, facilitate the production of Study Texts for students. Hitherto, the major obstacle faced by students was the dearth of study texts which they needed to prepare for the examinations. The Committee took up the challenge and commenced the task in earnest. To start off the process, the existing syllabus in use by some member Institutes were harmonized and reviewed. Renowned professionals in private and public sectors, the academia, as well as eminent scholars who had previously written books on the relevant subjects and distinguished themselves in the profession, were commissioned to produce Study Texts for the twelve subjects of the examination. A minimum of two Writers and a Reviewer were tasked with the preparation of Study Text for each subject. Their output was subjected to a comprehensive review by experienced imprimaturs. The Study Texts cover the following subjects: PART I 1 Basic Accounting Processes and Systems 2 Economics 3 Business Law 4 Communication Skills PART II 1 Principles and Practice of Financial Accounting 2 Public Sector Accounting 3 Quantitative Analysis 4 Information Technology PART III 1 Principles of Auditing 2 Cost Accounting 3 Preparation of Tax Computation and Returns 4 Management ECONOMICS iv Although, these Study Texts have been specially designed to assist candidates preparing for the technicians examinations of ABWA, they should be used in conjunction with other materials listed in the bibliography and recommended text. PRESIDENT, ABWA STRUCTURE OF THE STUDY TEXT The layout of the chapters has been standardized so as to present information in a simple form that is easy to assimilate. The Study Text is organised into chapters. Each chapter deals with a particular area of the subject, starting with learning objective and a summary of sections contained therein. The introduction also gives specific guidance to the reader based on the contents of the current syllabus and the current trends in examinations. The main body of the chapter is subdivided into sections to make for easy and coherent reading. However, in some chapters, the emphasis is on the principles or applications while others emphasise method and procedures. At the end of each chapter is found the following: Summary Points to note (these are used for purposes of emphasis or clarification); Examination type questions; and Suggested answers. HOW TO USE THE STUDY TEXT Students are advised to read the Study Text, attempt the questions before checking the suggested answers. ECONOMICS v  ACKNOWLEDGMENTS The ATSWA Harmonisation and Implementation Committee, on the occasion of the publication of the first edition of the ATSWA Study Texts acknowledges the contributions of the following groups of people. The ABWA Council, for their inspiration which gave birth to the whole idea of having a West African Technicians Programme. Their support and encouragement as well as financial support cannot be overemphasized. We are eternally grateful. To The Councils of the Institute of Chartered Accountants of Nigeria (ICAN), and the Institute of Chartered Accountants, Ghana (ICAG), and the Liberia Institute of Certified Public Accountants (LICPA) for their financial commitment and the release of staff at various points to work on the programme and for hosting the several meetings of the Committee, we say kudos. We are grateful to the following copyright holders for permission to use their intellectual properties:  The Institute of Chartered Accountants of Nigeria (ICAN) for the use of the Institute’s examination materials;  International Federation of Accountants (IFAC) for the use of her various publications;  International Accounting Standards Board (IASB) for the use of International Accounting Standards and International Financial Reporting Standards;  Owners of Trademarks and Trade names referred to or mentioned in this Study Text. We have made every effort to obtain permission for use of intellectual materials in this Study Texts from the appropriate sources. We wish to acknowledge the immense contributions of the writers and reviewers of this manual; Our sincere appreciation also goes to various imprimaturs and workshop facilitators. Without their input, we would not have had these Study Texts. We salute them. Chairman ATSWA Harmonization & Implementation Committee ECONOMICS vi A new syllabus for the ATSWA Examinations has been approved by ABWA Council and the various PAOs. Following the approval of the new syllabus which becomes effective from the September 2017 diet a team was constitutes to undertake a comprehensive review of the Study Texts in line with the syllabus under the supervision of an editorial board. The Reviewers and Editorial board members are: REVIEWERS This Study text was reviewed by: - Professor J. A Fabayo Obafemi Awolowo University, Ile -Ife - Professor T.A Akinbobola Obafemi Awolowo University, Ile -Ife - Mr. S.A Adebayo Federal Polytechnic, Ilaro EDITORIAL BOARD The editorial Board Members are: - Deacon Solomon Oluwole. Adeleke, FCA Chairman, ATSWA Examinations Committee - Mr. Rotimi Akanni Omotoso, FCA ICAN, Registrar/Chief Executive - Mr. John Irabor Evbodaghe, FCA ICAN, Deputy Registrar, Technical Services - Mr. Ikhiegbia Braimoh Momoh, FCA ICAN, Deputy Director, Examinations - Mr. John Adeniyi Adeyemo Principal Manager & HOD, ATSWA Examinations Department ECONOMICS vii  TABLE OF CONTENTS TITLE PAGE............................................................................................................. i COPYRIGHTAND DISCLAIMERS.................................................................... ii PREFACE.............................................................................................................. iii FORWARD............................................................................................................ iv STRUCTURE OF THE STUDY TEXT................................................................. v ACKNOWLEDGEMENT..................................................................................... vi REVIEWER AND EDITORIAL BOARD....................................................... vii TABLE OF CONTENTS................................................................................... viii SYLLABUS AND EXAMINATION QUESTIONS xiv OUTLINE CHAPTER ONE AN INTRODUCTION TO ECONOMICS AND ECONOMY 1.0 LEARNING OBJECTIVES...................................................................... 1 1.1 DEFINITION AND SCOPE OF ECONOMICS..................................... 1 1.2 BASIC ECONOMIC CONCEPTS........................................................... 1 1.3 MICROECONOMICS AND MACROECONOMICS........................ 4 1.4 BASIC ECONOMIC PROBLEMS......................................................... 4 1.5 ECONOMIC SYSTEM........................................................................... 9 1.6 THE METHODOLOGY OF ECONOMICS....................................... 13 1.7 SUMMARY............................................................................................ 15 1.8 REVISION QUESTIONS....................................................................... 15 CHAPTER TWO THE PRICE SYSTEM 2.0 LEARNING OBJECTIVES............................................................... 22 2.1 INTRODUCTION.............................................................................. 22 2.2 THE CONCEPT OF DEMAND........................................................ 22 2.3 SUPPLY............................................................................................. 34 2.4 MARKET DETERMINATION OF EQUILIBRIUM & PRICE QUANTITY.................................................................... 42 2.5 SHIFT IN DEMAND AND SUPPLY.............................................. 43 2.6 PRODUCER SURPLUS.................................................................... 46 2.7 APPLICATIONS OF DEMAND –SUPPLY DIAGRAM................... 47 2.8 SUMMARY.................................................................................... 52 2.9 REVISION QUESTIONS................................................................ 53 ECONOMICS viii CHAPTER THREE ELASTICITY OF DEMAND AND SUPPLY 3.0 LEARNING OBJECTIVES..................................................................... 65 3.1 INTRODUCTION....................................................................................... 65 3.2 PRICE ELASTICITY OF DEMAND........................................................ 65 3.3 PRICE ELASTICITY OF SUPPLY......................................................... 72 3.4 INCOME ELASTICITY OF DEMAND.................................................... 77 3.5 CROSS PRICE ELASTICITY OF DEMAND.............................. 79 3.6 APPLICATION OF PRICE ELASTICITY OF 81 DEMAND: THE CASE OF INCIDENCE OF TAX............................. 3.7 SUMMARY.................................................................................................. 82 3.8 REVISION QUESTIONS............................................................................. 83 CHAPTER FOUR THE THEORY OF CONSUMER BEHAVIOUR 4.0 LEARNING OBJECTIVES..................................................................... 90 4.1 INTRODUCTION...................................................................................... 90 4.2 THE MARGINAL UTILITY THEORY.......................................... 90 4.3 THE INDIFFERENCE CURVE THEORY............................................ 97 4.4 SUMMARY............................................................................................. 107 4.8 REVISION QUESTIONS.......................................................................... 107 CHAPTER FIVE THE PRODUCTION PROCESS 5.0 LEARNING OBJECTIVES..................................................................... 115 5.1 INTRODUCTION.................................................................................. 115 5.2 TYPES OF PRODUCTION................................................................... 115 5.3 FACTORS OF PRODUCTION.............................................................. 116 5.4 PRODUCTION FUNCTION................................................................. 118 5.5 LAW OF DIMINISHING RETURNS................................................... 121 5.6 PRODUCTION ANALYSIS IN THE LONG RUN........................... 122 5.7 DIVISION OF LABOUR....................................................................... 124 5.8 LOCATION OF FIRMS................................................................. 125 5.9 LOCALIZATION OF INDUSTRY.................................................... 126 5.10 FORMS OF BUSINESS ORGANISATIONS........................... 128 5.11 PRIVATISATION AND COMMECIALISATION........................... 135 5.12 NATIONALISATION.......................... 136 5.13 DEREGULATIONS........................... 137 5.14 MERGERS AND ACQUISATION........................... 138 5.15 TYPES OF MERGERS........................... 138 ECONOMICS ix 5.16 MERITS OF MERGING.......................... 139 5.17 SUMMARY........................... 139 5.18 REVISION QUESTIONS......................... 140 CHAPTER SIX COSTS, REVENUE AND PROFIT MAXIMIZATION 6.0 LEARNING OBJECTIVES........................................................................... 149 6.1 INTRODUCTION........................................................................................... 149 6.2 COST OF PRODUCTION........................................................................... 149 6.3 SHORT RUN COST CONCEPTS................................................................ 150 6.4 LONG-RUN COST CONCEPTS.................................................................. 154 6.5 REVENUE CONCEPTS............................................................................... 160 6.6 PRICE TAKING FIRM................................................................................. 161 6.7 PRICE-MAKING FIRM.............................................................................. 163 6.8 PROFIT CONCEPTS................................................................................. 164 6.9 PROFIT MAXIMISATION..................................................................... 165 6.10 SUMMARY.............................................................................................. 166 6.11 REVISION QUESTIONS............................... 166 CHAPTER SEVEN MARKET STRUCTURE 7.0 LEARNING OBJECTIVES............................................................................... 175 7.1 INTRODUCTION.............................................................................................. 175 7.2 PERFECT COMPETITION............................................................................... 175 7.3 MONOPOLY..................................................................................................... 182 7.4 MONOPOLISTIC COMPETITION................................................................. 188 7.5 OLIGOPOLY.................................................................................................... 190 7.6 DUOPOLY....................................................................................................... 192 7.7 SUMMARY.................................................................................................... 192 7.8 REVISION QUESTION................................................................................ 193 CHAPTER EIGHT NATIONAL INCOME 8.0 LEARNING OBJECTIVES................................................................................ 199 8.1 INTRODUCTION.............................................................................................. 199 8.2 DEFINITION AND KEY NATIONAL INCOME................................... 199 CONCEPTS 8.3 METHODS OF COMPUTING NATIONAL INCOME.................................. 201 8.4 METHODS OF MEASURING NATIONAL INCOME................................. 204 8.5 PROBLEMS OF MEASURING NATIONAL INCOME............................... 205 8.6 USES OF NATIONAL INCOME ESTIMATES......................................... 206 8.7 SUMMARY................................................................................................. 207 REVISION QUESTIONS........................................................................... 207 ECONOMICS x CHAPTER NINE NATIONAL INCOME DETERMINATION 9.0 LEARNING OBJECTIVES....................................................................... 215 9.1 INTRODUCTION.................................................................................... 215 9.2 FACTORS DETERMINING THE SIZE OF NATIONAL INCOME............................. 216 9.3 COMPONENTS OF AGGREGATE EXPENSES............................. 216 9.4 EQUILIBRIUM LEVEL OF NATIONAL INCOME............................. 221 9.5 THE ACCELERATOR PRINCIPLE OF INVESTMENT.............................. 226 9.6 EMPLOYMENT OF NATIONAL INCOME............................. 230 9.7 SUMMARY............................ 232 9.8 REVISION QUESTION............................. 232 CHAPTER TEN MONEY 10.0 LEARNING OBJECTIVES............................................................................. 242 10.1 INTRODUCTION........................................................................................... 242 10.2 FUNCTIONS OF MONEY............................................................................ 243 10.3 CHARACTERISTICS OF MONEY.............................................................. 243 10.4 TYPES OF MONEY.................................................................................... 244 10.5 NATURE OF MONEY.............................................................................. 245 10.6 THE SUPPLY OF MONEY........................................................................ 245 10.7 DEMAND OF MONEY............................................................................... 246 10.8 THE QUANTITY DEMAND OF MONEY................................................ 247 10.9 SUMMARY................................................................................................. 247 10.10 REVISION QUESTIONS......................................................................... 247 CHAPTER ELEVEN FINANCIAL INSTITUTIONS 11.0 LEARNING OBJECTIVES....................................................................... 253 11.1 INTRODUCTION................................................................................... 253 11.2 COMMERCIAL AND MERCHANT BANKING.................................. 253 11.3 THE CONCEPT OF UNIVERSAL BANKING......................... 259 11.4 CENTRAL BANK OF NIGERIA........................................................... 260 11.5 DEVELOPMENT BANKING................................................................ 262 11.6 OTHER FINANCIAL INSTITUTIONS............................................... 262 11.7 MONEY AND CAPITAL MARKET................................................. 264 11.8 MONETARY POLICY...................................................................... 264 11.9 SUMMARY..................................................................................... 266 11.10 REVISION QUESTIONS................................................................ 266 CHAPTER TWELVE FUNDAMENTALS OF PUBLIC FINANCE 12.0 LEARNING OBJECTIVES................................................................... 272 12.1 INTRODUCTION.................................................................................. 272 12.2 GOVERNMENT REVENUE............................................................... 273 12.3 GOVERNMENT EXPENDITURE..................................................... 274 12.4 TAXATION..................................................................................... 276 12.5 GOVERNMENT BUDGET.............................................................. 281 ECONOMICS xi 12.6 PUBLIC DEBT.................................................................................. 282 12.7 FISCAL POLICY............................................................................... 284 12.8 SUMMARY........................................................................................ 285 12.9 REVISION QUESTIONS................................................................ 285 CHAPTER THIRTEEN INFLATIONS AND UNEMPLOYMENT 13.0 LEARNING OBJECTIVES............................................................... 289 13.1 INTRODUCTION............................................................................. 289 13.2 THEORIES OF INFLATION.............................................................. 289 13.3 CAUSES OF INFLATION........................................................... 291 13.4 EFFECTS OF INFLATION........................................................... 292 13.5 CONTROL OF INFLATION.......................................................... 293 13.6 UNEMPLOYMENT..................................................................... 295 13.7 SUMMARY.................................................................................. 296 13.8 REVISION QUESTIONS........................................................... 296 CHAPTER FOURTEEN INTERNATIONAL TRADE AND FINANCE 14.0 LEARNING OBJECTIVES............................................................ 304 14.1 INTRODUCTION.............................................................................. 304 14.2 BASIS OR REASONS FOR INTERNATIONAL TRADE............................. 304 14.3 THE THEORIES OF INTERNATIONAL TRADE............................ 306 14.4 ADVANTAGES AND DISADVANTAGES OF 310 INTERNATINONAL TRADE.............................. 14.5 TERMS OF TRADE............................................................................. 311 14.6 REASONS FOR TRADE PROTECTION........................................... 312 14.7 TRADE BARRIERS........................................................................... 312 14.8 BALANCE OF PAYMENT................................................................. 313 14.9 FOREIGHN EXCHANGE............................................................... 316 14.10 GLOBALISATION AND DEVELOPING COUNTRIES.......................... 318 14.11 SUMMARY............................................................................................. 320 14.12 REVISION QUESTIONS..................................................................... 320 CHAPTER FIFTEEN INTERNATIONAL AND REGIONAL ORGANISATION 15.0 LEARNING OBJECTIVES................................................................... 328 15.1 INTRODUCTION................................................................................ 328 15.2 WORLD BANK GRANT.................................................................. 328 15.3 INTTERNATIONAL MONETARY FUND................................................. 331 15.4 AFRICAN DEVELOPMENT BANK.......................................................... 333 15.5 EUROPEAN UNION................................................................................... 334 15.6 ECONOMIC INTEGRATION..................................................................... 336 15.7 ECOWAS.................................................................................................... 337 15.8 AGREEMENT ON TARIFF TRADE.......................................................... 338 15.9 WORLD TRADE ORGANISATION........................................................ 339 ECONOMICS xii 15.10 UNITED NATIONS CONFERENCE.......................................................... 340 15.11 OPEC........................................................................................................... 341 15.12 SUMMARY................................................................................................ 342 15.13 REVISION QUESTIONS........................................................................ 342 CHAPTER SIXTEEN ECONOMIC GROWTH AND ECONOMIC DEVELOPMENT 16.0 LEARNING OBJECTIVES.......................................................................... 347 16.1 INTRODUCTION...................................................................................... 347 16.2 ECONOMIC GROWTH............................................................................. 347 16.3 SOURCES OF ECONOMIC GROWTH.................................................. 347 16.4 COMMON CHARACTERISTICS OF ECONOMIC 348 GROWTH........................................................................................................ 16.5 ECONOMIC PLANNING............................................................................. 350 16.6 POPULATION........................................................................................... 352 16.7 SUMMARY................................................................................................ 353 16.8 REVISION QUESTIONS.......................................................................... 353 ECONOMICS xiii SYLLABUS AND EXAMINATION QUEST COURSE TITLE: ECONOMICS AIM To develop knowledge and understanding of basic principles and practice of economics required of an Accounting technician to function efficiently and effectively as a member of an organization in a dynamic and competitive global economy. OBJECTIVES At the end of this course, candidates should be able to know and understand: a. Basic economic concepts and principles in the analysis of economic issues. b. The features of the general economic environment in which economic agents (e.g individuals, firms and government) operate c. The basis for rational economic decisions by economic agents d. The activities of regional and international organizations and their impact on the domestic economy of member countries e. The increasing inter-connections among nations of the world and their economic implications. GENERAL RELATIONSHIP DIAGRAM ECONOMICS MACROECONOMICS MICROECONOMICS STRUCTURE OF THE PAPER The paper will be a three-hour paper divided into three sections Section A (50 Marks):This shall consist of 50 compulsory questions made up of 30 multiple- choice questions (MCQ) and 20 short Answer Questions (SAQs) covering the entire syllabus. Section B Microeconomics (25 marks): This shall consist of three questions, out of which candidates are expected to attempt any Two, each attracting 121/2 marks Section C: Macroeconomics (25 marks): This shall consist of three questions, out of which candidates are expected to attempt any Two, each attracting 121/2 marks ECONOMICS xiv CONTENTS SECTION A: MICRO ECONOMICS 45% 1. The Nature and Scope of Economics and the Economy 5% a. Definition and scope of Economics b. Basic economic concepts: economy, scarcity, choice, scale of preference, opportunity cost and production possibilities curve (PPC). c. Microeconomics versus Macroeconomics d. Basic economic problems of society e. Types, features and functions of an Economic System f. The Methodology of Economics 2. Theory of Value 10% a. The concepts of demand and supply b. Determinants of demand and supply, and the concepts of demand and supply functions c. Determination of equilibrium price d. Determination of consumer’s and producer’s surplus (using demand and supply diagrams) e. Distinction between change in quantity demanded/supplied and changes in demand/supply f. The effects of changes in demand and supply on the market situation. g. Exceptions to the laws of demand and supply h. Elasticity of demand and supply (determination , numerical evaluation and interpretation): i. Price elasticity of demand ii. Price elasticity of supply iii. Income elasticity of demand iv. Cross-price elasticity of demand i. Application of price elasticity of demand to incidence of tax j. Applications of demand-supply diagrams to: i. Price control ii. Minimum wage legislation 3. Theory of Consumer Behaviour 5% a. The marginal utility theory i. Utility concepts: total, marginal ii. Law of diminishing marginal utility iii. Proof of the law of demand b. The indifference curve theory i. Concepts of : indifference curve, indifference map, budget line ii. Prove of the law of demand 4. Theory of Production 15% a. Meaning and types of production ECONOMICS xv  b. Factors of production and their rewards c. Basic concepts in production analysis: i. Production function ii. Total product, average product, marginal product iii. Economic rent, quasi rent and transfer earnings iv. Short run and Long run d. Law of diminishing returns e. Law of returns to scale f. Economies of scale and Diseconomies of scale g. Cost concepts-total cost, average cost, marginal cost- their meaning, behaviours and relationships h. Revenue Concepts – total revenue, average revenue, marginal revenue- their meanings, behavours and relationships i. Division of labour - Meaning, advantages, disadvantages and limitations j. Location of Industry - meaning, location factors k. Localisation of industries - meaning, advantages and disadvantages. l. Forms of business organization –Sole proprietorship, partnership, private limited companies, public limited companies and public corporation. m. Concepts of privatization, commercialization, nationalization and deregulations. 5. Market Structures 10% a. The concept of market b. Meaning and features of perfect competition, monopoly, duopoly, oligopoly, monopolistic competition and monopsony. c. Price and output determination in the short run and long run under the conditions of perfect competition, monopoly and monopolistic competition. d. Product differentiation and price discrimination e. Sources and control of monopoly power f. Merger and acquisitions – meaning, advantages and disadvantages SECTION B MACROECONOMICS 55% 6. National Income 10% a. Basic National income accounting concepts: (i) Gross domestic Product (GDP), (ii) Gross National Product GNP) (iii) Net National Product (NNP), (iv) Personal disposable Income (PDI) b. Methods of computing national income. (i) Output/ Product method, (ii) Income method, and (iii) Expenditure method. c. The concept of circular flow of income d. Problems of measuring national income ECONOMICS xvi  e. Uses and limitations of national income statistics f. Factors determining the size of national income g. The concepts of consumption, savings and investment within the Keynesian’s macroeconomic framework h. Determination of equilibrium national income and the multiplier i. The concepts of full employment national income, inflationary gap and deflationary gap. 7. Money and Banking 10% a. Money - definition, functions, characteristics, types and nature b. Demand for and supply of money c. The quantity theory of money d. The Financial System: Commercial, Merchant and Universal Banks, the central bank’ and development banks e. Money market, Capital market and their instruments f. Monetary policy: meaning, instruments and targets 8. Fundamentals of Public Finance 10% a. The concept of public finance: government revenue and government expenditure b. Sources of government revenue and pattern of government expenditure c. Taxation i. elements, principles, classification and uses ii. Government expenditure – Classification and determinants d. National budget – types and role in the economy e. Public debts- meaning, types and sources of finance f. Fiscal policy- meaning, instruments and targets. 9. Inflation and Unemployment 5% a. Inflation – concepts, types, causes, effects and control b. Unemployment: concepts, types, causes, effects and control. c. Inflation and unemployment problems in West Africa and efforts to control them. 10. International Trade and Finance 10% a. Distinction between internal and international trade b. Reasons for international trade c. Theory of comparative cost advantage d. Advantages and disadvantages of international trade e. Terms of trade, balance of trade and balance of payments f. Trade barriers and the case for and against trade protection ECONOMICS xvii  g. The concepts of foreign exchange, foreign exchange rate, foreign exchange market and foreign exchange systems. (fixed and floating) h. Currency devaluation, revaluation depreciation, appreciation and their implications for the economy i. Globalisation and developing countries 11. International and Regional Organisations 5% a. Bank Group and their objectives i. The world Bank Group ii. The African Development Bank Group (AFDB) b. International Monetary Fund (IMF) c. Economic Integration – meaning and levels d. The Economic Community of West African States (ECOWAS) e. Organization of Petroleum Exporting countries (OPEC) f. United Nations Conference on Trade and Development (UNCTAD) g. General Agreement on Trade and Tariff (GATT) h. World Trade Organization (WTO) 12. Economic Growth and Development 5% a. Economic growth: Meaning and determinants b. The concept of Economic development c. Common characteristics of developing countries d. Development planning: meaning, objectives, types and problems RECOMMENDED TEXTS 1. ATSWA Study Text on Economics 2. Adebayo Ademola (2014 Reprint): Economics: A Simplified Approach: African International Publishing Ltd. Volume 1 & 2 3. Nkoom J.C: money Economics in Ghana ECONOMICS xviii  CHAPTER ONE AN INTRODUCTION TO ECONOMICS AND THE ECONOMY 1.0 LEARNING OBJECTIVES After studying this chapter, you should be able to: Understand the nature, scope and methodology of economics Have good grasp of the fundamental economic problems facing all societies and how the problems are solved in different economic systems. 1.1 DEFINITION AND SCOPE OF ECONOMICS A simple and most widely quoted definition of economics is that given by the British Economist, Lionel Charles Robbins (1898 – 1984): Economics is the science which studies human behaviour as a relationship between ends and scarce means which have alternative uses. In the above definition, the word ‘ends’ refers to human wants usually classified as goods and services. The word ‘means’ refers to productive resources otherwise called factors of production. In every society, the productive resources are combined in different ways to produce different types of goods and services. Economics is described as a science subject based on the way economists study and explain human behaviour concerning how best to allocate scarce resources among competing alternative uses. The economists adopt scientific method in which theories of human behaviour are developed and tested against the facts in a way similar to the practice in the pure sciences like Chemistry and Physics. However, economics is more appropriately placed within the social sciences because its subject matter, human behaviour in the production, distribution and consumption of goods and services can neither be controlled in the laboratory nor be predicted with absolute accuracy. 1.2 BASIC ECONOMIC CONCEPTS A number of basic concepts or terms lie at the heart of economic science. The most important ones are explained in this section. ECONOMICS 1  1.2.1 Economy The word is used to refer to a particular system of organisation of economic activities i.e. production, distribution, exchange and consumption of all things required to satisfy human wants. In this sense, we often speak of the Nigerian economy or the Ghanaian economy, developed or developing economy, capitalist, socialist or mixed economy. 1.2.2 Goods and Services In economics, the term goods refers to material or physical things which can be seen or touched and used to satisfy human wants. Examples include food items, cars, shoes, wristwatch, industrial equipment and machineries, etc. Goods are classified in different ways. One classification is economic goods and non- economic goods. Economic goods are those goods which have prices and their production requires scarce resources that have competing uses. On the other hand, the term non-economic goods refers to things that are unlimited in supply and can be obtained free-without paying a price. Examples of non-economic goods are stream water, gutter sand, sunshine, air, bush trees, etc. Economic activities other than manufacturing or primary goods production are referred to as services. Examples are banking, shipping, legal, insurance, tourism, medical care, etc. But it is also common in economics to use the term goods to refer to both material goods and services which, in this case, is regarded as non-material goods. 1.2.3 Resources These are things which are combined in numerous ways to produce goods and services required for the satisfaction of human wants. Such things are alternatively referred to as factors of production, and can be classified as: (i) Natural resources: There are free gifts of nature such as arable land, water, minerals (such as limestone, good etc), fishing ground, forests, hydroelectricity and solar energy potentials etc. Natural resources are collectively referred to as land in economics. ECONOMICS 2  (ii) Human resources: Human efforts in the production process which consist of various mental and physical abilities and skills. The term labour is used for human resources. (iii) Capital: Man-made resources such as roads, dams, buildings, equipments and machines which help in the production of other goods that satisfy human wants directly or indirectly. (iv) Entrepreneurship: The person (in case of one-man business) or the business owners/managers who co-ordinate the other factors of production to produce and market goods and services and possibly invent and innovate. 1.2.4 Utility This is the economist’s term for the satisfaction and need fulfilment that people derive from the consumption/use of material goods and services. 1.2.5 Stock and Flow The term stock refers to a variable which has no time dimension e.g. 1,000 bags of cement stored in a warehouse pending sales, which can occur anytime. On the other hand, if a variable has time dimension, it is called a flow. In other words, the term flow refers to the quantity of an economic variable measured over a particular period of time. It follows that 1,000 bags of cement produced or supplied per day by a cement company is a flow. 1.2.6 Ceteris Paribus This is a Latin phrase meaning “all other things being equal”. The ceteris paribus assumption is more commonly used in economic theory to isolate the effect of a change in one variable or influencing factor. This implies that “all other variables or determining factors are held constant”. Economic theories are simplified and their validity enhanced with explicit or implicit use of ceteris paribus. 1.2.7 Rational Behaviour As used in economics, behaviour in which economic agents (i.e. individuals, firms and government) do the best they can under given circumstances. For example, the assumption of consumer rationality implies that the average consumer in his purchasing decision will always prefer more to less, or the basket of goods that will give him the maximum utility given his money income and the ECONOMICS 3  unit prices of the goods. The assumption of rationality permits us to explain and predict how people will act under specific conditions. 1.3 MICROECONOMICS AND MACROECONOMICS Traditionally, economics is divided into two main branches: microeconomics and macroeconomics. 1.3.1 Microeconomics Microeconomics is concerned with specific segments of the economy, particularly the behaviour of individual consumer, firm and of groups of firms, in the industry. As a branch of economics, it examines how resources are organised, controlled and rewarded in various economic activities, as well as how relative prices of goods and services are determined. The main topics falling within microeconomics include the theory of price and wage determination, the theory of consumer behaviour, the theory of production, and welfare economics. 1.3.2 Macroeconomics Macroeconomic is the study of the economy as a whole. In macroeconomics; emphasis is on aggregate economic variables such as the economy’s level of employment, total output and income, total money supply, overall government spending, the levels of taxes, investments and saving, and so on. It follows that macroeconomics explores the problems of unemployment, inflation, external disequilibrium, sluggish economic growth, general poverty, and inequality in the macro economy. 1.4 BASIC ECONOMIC PROBLEMS The fundamental economic problems facing every society are discussed in this section. 1.4.1 Scarcity Economic scarcity means that people do not have as much as they desire. The problem of scarcity arises as a result of the fact that, at any point in time, the productive resources available in any society are limited, whereas human wants are unlimited. It follows that the amount of goods and services that can be produced are limited and inadequate to meet human wants. Therefore, every society must resolve four fundamental economic questions. ECONOMICS 4  (i) What is to be produced? Every society must determine in some manner what goods and services and how much of each to produce during any given period of time. (ii) How is the output to be produced? Each firm must decide how to utilise the inputs to achieve optimal resources allocation i.e. the manner of combination of factors of production in order to produce maximum output quantum of goods and services possible. (iii) For whom to produce? That is, for which category of consumers are the goods being produced? Is it for the young, the old or for both categories? (iv) How to facilitate future growth? The resources must be utilized at a rate that would enhance future production possibilities. Scarcity is the most fundamental economic problem facing every society. If resources are not scarce, goods and services would not be scarce and there would be no need to economise. Consequently, there would be no need to study economics. 1.4.2 Choice Choices become necessary as a result of scarcity. Making a choice implies giving up something in order to get something else. The concept of choice relates to all the three main economic agents in the economy. An individual consumer must choose among types of goods and services, between present and future consumption because of his limited money income. The firm must choose what to produce and how to produce within constraint imposed by its limited resources. The government must decide what public goods and services to provide for the people given its limited revenue as projected in the budget documents. 1.4.3 Scale of Preference It is described as a list of all wants to be satisfied arranged in order of priority or importance. The concept of Scale of Preference underscores the basic assumption in economics that every economic agent exhibits rational behaviour in the process of making a choice. ECONOMICS 5  1.4.4 Opportunity Cost Economists used the term opportunity cost to mean the next best alternative forgone in the process of making a choice. To an individual consumer, the opportunity cost of a commodity bought is the next most desirable commodity he could have bought instead. For example, a housewife desires a tin of rice and a tin of beans each selling for N200. But since she had only N200, she decided to buy a tin of rice. The opportunity cost of a tin of rice bought is a tin of beans forgone. The concept of opportunity cost is central to the study of economics because it guides the individual, the firm, and the government to make rational decision on the use of scarce resources. Opportunity cost is alternatively referred to as real cost or economic cost. Note that the accountant’s view of cost (i.e. accounting cost) is quite different from the economist’s view of cost (i.e. opportunity cost). To the accountants, the cost of a commodity purchased by the consumer or a factor of production purchased by the firm is the amount of money paid to have that commodity or productive resources. This is called money cost or accounting cost. 1.4.5 Production Possibilities Curve A production possibilities curve (PPC) shows the various combinations of two goods that can be produced in a country when all available resources are fully and efficiently utilized. Table 11: Production Possibilities Schedule Product Rice (Bags) Butter (Tins) Opportunity cost Combination of an additional bags of rice A 0 80 - B 1 76 -4 C 2 70 -6 D 3 60 - 10 E 4 40 - 20 F 5 0 - 40 The production possibilities schedule presented in Table 1.1 is shown graphically as production possibilities curve in Figure 1.1 ECONOMICS 6  The PPC in Figure 1.1 is drawn under the assumption that the society is using all its resources to produce only two goods – rice and butter. Fig 1.1 illustrates points (i – iv) below fig 1.2 illustrates point (v), while Figure 1.3 illustrates point (vi). 100 Butter 80 A B H C 60 D 40 G E 20 0 F 1 2 3 4 5 Rice Figure 1.1 Production Possibilities Curve (PPC) (i) Scarcity. The boundary formed by the curve joining points A and F indicates that there is a limit to the amount of both rice and butter that the country can produce at any point in time. (ii) Full – employment. Any point on the PPC (such as A to F) shows the combinations of the two goods that the economy can produce given that all available resources are fully and efficiently utilized. (iii) Unemployment or underemployment. Any point inside the PPC, such as G, shows that some resources are either left completely idle (unemployed) or are not efficiently utilized (underemployed). (iv) Unattainable output level. Any point outside the curve, such as H, shows the output level that cannot be achieved by the country. (v) Opportunity cost. The slope of the PPC usually referred to as marginal rate of transformation (MRT) measures the opportunity cost of a unit more or less of a commodity. ECONOMICS 7 (vi) Economic growth. It can be defined as a sustained increase in the production capacity of an economy which leads to a greater output of goods and services. This is represented by an outward shift in the production possibilities curve from PPC 1 to PPC2 in Figure 1.3. Butter b1 X(ri, bi) B b2 Y(r2, b2) PPC R 0 r1 r2 Rice Figure 1.2 The PPC’S Illustration of Opportunity Cost Figure 1.2, the opportunity cost of moving from output X (r1, b1) to output Y (r2, b2) is obtained as MRTbr = 0 (4.6) 4.3.1.4 The Law of Diminishing Marginal Rate of Commodity Substitution A typical indifference curve also illustrates the law of diminishing marginal rate of commodity substitution. The less of one good (beer) the consumer gives up and the more of another commodity (apple) he obtains in the process, the less willing he is to give up a unit of the former good (beer) for an additional unit of the latter good (apple). ECONOMICS 102  A careful inspection of Figure 4.6 will confirm the law of diminishing marginal rate of substitution. 4.3.2 Properties of Indifference Curves The main properties of indifference curves are outlined below: (i) An indifference curve has a negative slope: This means that as less quantity of one commodity is consumed (beer), a greater quantity of the other commodity (apple) must be consumed for the consumer to enjoy the same level of utility (ii) Indifference curves can never intersect: If two indifference curves intersect, the point of intersection will represent two different levels of utility. Which is illogical or a contradiction. Figure 4.8 shows two indifference curves for a consumer that intersect at point x, meaning that the consumer would be indifferent between x and y on IC2 and between x and z on IC1 and hence indifferent between y and z. Since z offers more of both goods than y, this violates the assumption that the consumer usually prefers more to less. Beer I x z IC1 Y IC2 O Apple Figure 4.7: Indifference Curves do not intersect. (iii) An indifference curve cannot touch either axis. If an indifference curve IC2 touches the apple axis at G as in fig 4.9, it implies that the consumer will be having OG quantity of apple and none of beer. Similarly, if an indifference curve IC1 touches the beer axis at F, the consumer will have only OF quantity of beer ECONOMICS 103  and none of apple. The assumption that the consumer buys two goods in combinations is violated. Beer IC2 F ICI G O Apple Figure 4.9: An indifference Curve cannot touch either axis. (iv) A higher indifference curve. An indifference curve to the right of another represents a higher level of utility and preferable combination of the two goods. In Figure 4.10, below, the indifference curve IC2, represents a higher level of utility than indifference curve IC1. Therefore, as the distance of the indifference curve to the origin increases, the level of utility represented by the indifference curve also increases. Beer IC4 IC3 IC2 IC1 0 Apple Figure 4.10: A higher Indifference Curve ECONOMICS 104  (v) Indifference curves are convex to the origin. This property is expressed in the axiom of diminishing marginal rate of commodity substitution which implies that, to obtain every additional unit of one commodity (apple), the consumer is willing to sacrifice increasing number of the other commodity (beer). 4.3.3 Consumer Equilibrium Under Indifference Curve Analysis Under the indifference curve approach, the consumer equilibrium is achieved when the consumer reaches the highest possible indifference curve (gets maximum satisfaction) given his budget constraint represented by his budget line. The consumer equilibrium position is illustrated in Figure 4.11. Beer R S X b1 T IC3 IC2 ICI U a1 Apple 0 V Figure 4.11: Consumer Equilibrium Position In Figure 4.11, the consumer can afford to buy any of the combinations of apple and beer described by points S, T, and U given his budget line RV. However, he prefers the combination on point T (i.e a1 quantity of apple and b1 quantity of beer) because it gives him greater utility (IC2) given his budget limitation than any of the combinations on points S and U (IC1). He should have preferred x on IC3 but this is beyond the limit of his budget. it follows, therefore that: A consumer maximizes his satisfaction at the point where the budget line is just tangent to an indifference curve In Figure 4.11, point T is called consumer equilibrium point or optimum consumption point. At that point, the slope of the indifference curve is equal to the slope of the budget line (see equation 4.7) ECONOMICS 105  = (4.7) Equation (4.7) is identical to equation (4.3) obtained for consumer equilibrium point under the marginal utility approach. 4.3.4 The Price – Consumption –Curve and Derivation of Demand Curve Suppose money income is held constant and the only thing allowed to vary is the elative price of the commodity (the price of apple relative to that of beer in this case). We can then define the price-consumption curve (PCC) as a curve joining the equilibrium consumption points of the consumer Bo a1 a2 a3 a4 PCC B0 B1 B2 B4 O Q q a1 q a2 q a3 q a4 Fig. 4.12a: Price Consumption curve Apple Pa Da a1 P a1 Pa2 a2 a3 Pa3 a4 Pa4 Da O q a1 qa2 qa3 q a4. (Qa) Quantity q a1 Fig. 4.12b: Demand curve for Apple ECONOMICS 106 It will be seen from fig 4.12a above that as the relative price of Apple falls from B0 to B3, the equilibrium quantity bought increases from q a1 to q a4. The curve joining the equilibrium points in fig 4.12a is the PCC. The importance of the PCC lies in the fact that the demand curve, which expresses the law of demand, can be derived from it as done in fig 4.12b. Each equilibrium point in fig 4.12a is projected into an appropriate point in the price-quantity (demand) diagram in fig 4.12b. The points a1, a2, a3 and a4 in fig 4.12a become points a1, a2, a3, a4 respectively in fig. 4.12b. The line joining the points a1,a2,a3 and a4 in fig 4.12b give the demand curve for apple (DaDa). As shown by DaDa, demand for apple is inversely related to its price. As the price of apple falls, the quantity of apple bought increases. 4.4 SUMMARY In this chapter, we presented two alternative approaches to the derivation of individuals demand curve for a normal commodity namely the marginal utility approach and the indifference curve approach. 4.5 REVISION QUESTIONS SECTION A : Multiple Choice Questions 1. The theory of consumer behaviour is propounded primarily to I. Validate the law of demand II. Disprove the law of demand III. Rationalize the downward sloping demand curve A. I only B. II only C. III only D. I and II only E. I and III only 2. The presumption that the average consumer will always maintain the utility maximization position in his spending is referred to as A. Cardinal utility B. Consumer equilibrium C. Consumer rationality D. Diminishing marginal utility E. Constant marginal utility of money 3. Which of the following indicates the negative slope of the indifference curve? A. Marginal rate of commodity substitution ECONOMICS 107  B. Axiom of transitivity C. Budget schedule D. Consumer equilibrium E. Ordinal utility 4. Which of the following gives the reason why it would be logically impossible for two indifference curves to cross? A. The law of diminishing marginal utility B. Axiom of transitivity C. Assumption of consumer rationality D. The negative slope of the indifference curve E. The law of diminishing marginal rate of commodity substitution 5. The adjustment of demand to the relative price change alone is called A. The substitution effect B. The income effect C. The total effect D. Market demand curve E. Individual demand curve Section A: Solutions to Multiple Choice Questions 1. A 2. C 3. A 4. B 5. A Short Answer Questions 1. The additional satisfaction which a consumer derives from the consumption of one more unit of a commodity is called ……………………… 2. The maximum combination of two goods that the consumer can buy given money income and unit prices of the goods is illustrated graphically by ……………. 3. The locus of points representing different combinations of two goods which gives the consumer the same level of satisfaction is ……………………… 4. The negative slope of the indifference curve is called……………………… 5. Under the indifference curve theory of consumer behaviour, the equilibrium position of rational consumer is illustrated graphically by…………………… Solution To Short Answers Questions ECONOMICS 108  1. Marginal utility 2. The budget line 3. Indifference curve 4. Marginal rate of commodity substitution 5. The point of tangency between the budget line and indifference curve. Question 4.1 (a) Make a clear distinction between a budget line and an indifference curve. (b) Outline the main properties of an indifference curve. Solution (a) A budget line shows different combinations of two goods that the consumer can afford, given his money income and market prices of the two goods. P1A + P2B =M Beer Budget line O Apple The above budget line is drawn on the assumption that the consumer’s income is M, unit price per apple is P1, and unit price of beer P2 An indifference curve, on the other hand, joins together all points representing different combinations of two goods which yield the same utility. ECONOMICS 109  Beer An indifference curve IC 0 Apple An indifference curve is illustrated in the above diagram. (b) The main properties of an indifference curve are highlighted below: (i) An indifference curve has a negative slope. This means that as less quantity of one commodity is consumed a greater quantity of the other commodity must be consumed for the consumer to enjoy the same level of utility. (ii) Indifference curves do not intersect. If two indifference curves intersect, the point of intersection will represent two different levels of utility, and this will be unreasonable and illogical. (iii) An indifference curve cannot touch either axis. The assumption that the consumer buys two goods in combination if it indifference curve touches either of the two axis. (iv) A higher indifference curve. An indifference curve to the right of another represents a higher level of utility and preferable combination of the two goods. (v) Indifference curves are convex to the origin. This property is expressed in the axiom of diminishing marginal rate of substitution which implies that, to obtain every additional unit of one commodity the consumer is willing to sacrifice increasing number of the other commodity. Note that It would be necessary to explain with relevant diagrams if it is explicitly stated in the question that the characteristics of the indifference curve should be discussed or explained fully. Question 4. 2 a) With the aid of relevant diagram describe an indifference map. b) Suppose a consumer has N1000 to spend on stick meat and soft drink in a particular outing. The unit prices of stick meat (Pm) and soft drink (Pd) are given as N200 and N100, respectively. And, the consumer must consume 3 pieces of stick meat and 4 bottles of soft drink to maximize his utility subject to his budget constraint. Illustrate and explain the above information using the indifference curve – budget line diagram. ECONOMICS 110 Answer a) An indifference map is a set of indifference curves each corresponding to a different level of satisfaction. The closer an indifferent curve is to the origin, the closer an indifferent curve is to the origin, the lower the level of satisfaction represented. The indifference curve IC4 represents the highest level of satisfaction in the diagram below. Thus an indifference map shows a complete picture of the individual consumer’s preference. Soft drinks IC4 IC3 IC2 IC1 0 Stick meat Figure: An indifference Map b) The information provided is illustrated in the following diagram. 10 D 8 6 Soft drinks 4 X  IC 2 M  0 1 2 3 4 5 Stick meant In the above indifference curve- budget line diagram, the budget line is labeled DM and the indifference curve IC pint D is obtained as: D= = = 10 Point M is obtained as: M= = =5 ECONOMICS 111  Under the indifference curve theory of consumer behavior, utility is maximized and consumer attains equilibrium at the point where the indifference curve is tangential to the budget line, marked as point X in the above diagram. Question 4.3 (a) State the law of diminishing marginal utility (b) The table below show a consumer’s utility form a malt drink Malt drink Total Utility Marginal Utility (bottles per day) (TU) (MU) 0 0 - 1 A 20 2 35 B 3 C 10 4 50 D 5 E 0 6 45 -5 You are required to: (i) Calculate the values of A,B,C,D and E and complete the table (ii) Determine whether or not the principle of diminishing marginal utility apply to the consumer’s consumption of malt drink. Explain your answer. Answer a. The law of diminishing marginal utility states that as more and more units of a commodity are consumed, during a specific period of time, total utility, increases but at a decreasing rate, the consumption of all other commodities being held constant. b. A to E are the missing values of total utility (TU) and marginal utility (MU) in the table. Therefore, using the relationship: M= To calculate A(TU): To calculate B(MU): To calculate A(TU): To Calculate B(MU) = 20 = 15 ECONOMICS 112  A = 20 To calculate C(TU) To calculate D(MU) =10 C = 45 = 5 To calculate E(TU): =0 Malt drink bottles per Total Utility (TU) Marginal Utility(MU) day(Q) 0 0 - 1 20 20 2 35 15 3 45 10 4 50 5 5 50 0 6 45 -5 The consumer’s consumption of malt drink validates the principle of diminishing marginal utility. A cursory of glance at the completed table reveals that as more and more bottles of malt drink are consumed, total utility increases a a diminishing rate, that is, from 20 to -5 (See the marginal utility column). PRACTICE QUESTIONS 1 (a) Explain the terms: total utility (TU) and marginal utility (MU) (b) State and explain the equimarginal principle (c) Explain the role of the marginal utility theory in economic analysis 2 (a) Outline the basic assumptions underlying the marginal utility theory (b) Explain the relationship between total utility and marginal utility and illustrate your answer with the aid of appropriate diagram. 3 (a) Describe the budget line and indifference curve (b) Explain the derivation of the downward sloping demand curve under the indifference curve theory. ECONOMICS 113  CHAPTER FIVE THE PRODUCTION PROCESS 5.0 LEARNING OBJECTIVES After studying this chapter, you should be able to: Define production and explain the types of production Discuss the factors of production Describe a production function Analyse short-run and long-run productions Explain division of labour Explain location of firms and localization of industries Describe the various forms of business organizations. 5.1 INTRODUCTION Production is a process that transforms factors of production or inputs (land, labour, capital and entrepreneurship) into output of goods and services. Goods are tangible items or physical things that we can touch and see with our eyes such as television, shirts and rice. Services, on the other hand, are intangible things we cannot touch, such as medical service, teaching, transportation and concerts. A production process is not complete until the good or service reaches the final consumer. 5.2 TYPES OF PRODUCTION Production may be categorized into three main types: primary, secondary and tertiary. 5.2.1 Primary This involves the gathering of raw materials from their natural locations. It may include mining, quarrying, farming, forestry and fishing. This type of production provides raw materials for manufacturing and may also be called primary production. ECONOMICS 114 5.2.2 Secondary This involves all stages that the good passes through after extraction to manufacturing. Examples include the transformation of limestone to cement, wheat to floor, flour to bread, cotton to textile materials and so on. 5.2.3 Tertiary These involve the services people give directly to members of society such as the services rendered by teachers, lawyers, the police, the armed forces, doctors, accountants, musicians, wholesales and retailers, so on. These services have indirect impact on the production of goods and services. 5.3 FACTORS OF PRODUCTION The factors of production or inputs that are used to produce goods and services are classified into land, labour, capital and entrepreneurship. 5.3.1 Land Land is the natural resource used in combination with the other resources to produce goods and services. Land includes the soils as well as all other resources that have been provided by nature (the water bodies, forest resources, etc). The price we pay to use land is rent. Land is a gift of nature, fixed in supply, geographically immobile (i.e. cannot be moved around) but may be occupationally mobile (its usage can be changed). 5.3.2 Labour Labour is the human resource used in production. It is human effort exerted in production. Hardly can production go on without labour. Labour can be skilled, meaning specialized intellectual or mental knowledge used in production. It can also be unskilled, meaning physical or mental effort undertaken by individuals in production. The reward or the price paid to hire labour is wage or salary. Labour is both geographically and occupationally mobile and it is impossible to separate both the ownership and use of labour. The supply of labour depends on the size of population which in turn depends on birth rate, death rate and level of migration. ECONOMICS 115 5.3.3 Capital Capital is a man-made resource which is used in production of goods and services. It is wealth which is set aside for the creation of further wealth. It includes machines, factory buildings, vehicles, etc. It may be classified into fixed capital and circulating capital. Fixed capital includes any man-made item (such as machines, factory buildings, vehicles, etc.) used in the production process but does not get exhausted in the process. The circulating capital, unlike the fixed capital, is used up in the production process and includes the stock of raw materials, partly finished goods (known commonly as work-in- progress and stock of finished goods waiting to be sold. The reward or the price of capital is interest. Capital is accumulated over a period of time and is subject to depreciation (wear and tear). 5.3.4 Entrepreneur Entrepreneur is a special factor of production in the sense that it is in charge of the organization of the other three factors of production (land, labour and capital) in order to produce goods and services, bears the risk involved in business and manages the business. The entrepreneur’s reward is profit or dividend. Functions of the entrepreneur (i) The entrepreneur is the owner of the business and provides the capital. The ownership of business may be one person or a group of persons who have provided the capital. (ii) The entrepreneur organizes and combines the other three factors of production for the production of goods and services which are used to satisfy human wants. (iii) The entrepreneur bears the risk of business failure when there is any. On the other hand, if there are any benefits, he enjoys them. (iv) The entrepreneur is the principal decision-maker in any production process, though this may be shared with other people. He makes the broad decision on policy and is at the nerve-centre of management control. ECONOMICS 116  (v) It is the main objective of every nation to achieve economic growth and development. A nation achieves economic growth when it is able to increase the final goods and services produced in the country over a given period of time usually one year. It is the entrepreneur who is the engine of economic growth in every nation because he produces these goods and services. 5.4 THE PRODUCTION FUNCTION The production process involves the transformation of inputs or factors of production into output of goods and services. A production function shows the maximum quantities of a product that can be produced using various sets of inputs and an existing technology at a given time period. It may be shown as a table or a mathematical equation. 5.4.1 Periods of Production Production is a process and goes on over a period of time. There are two main periods of production in economics namely, the short run and the long run. (a) Short-Run Period in Production Analysis This is a period of production during which some factors of production are fixed while some others are variable. The fixed inputs cannot be varied when demand conditions require a change in output. This period varies from firm to firm, depending on the type of production a firm undertakes and the inputs it uses. (b) Long-Run Period of Production This is a period of production within which all inputs are variable. This implies that if demand conditions warrant a change in production, all the inputs can be varied to achieve this. 5.4.2 Classification of Inputs In production theory, inputs are divided into Fixed and Variable inputs. The distinction is important in that it helps us to determine whether a firm which does not cover its total costs of production ( loss making firm) should stay open or shut down in the short-run. (a) Fixed Input A fixed input is an input whose quantity cannot be varied in the short-run when demand conditions require an increase or a decrease in production e.g. factory building, capital equipment, some skilled labour, etc. ECONOMICS 117  (b) Variable Input A variable input is that which can be changed at all times in the production process when demand conditions require a change in production e.g. raw materials, electrical power, unskilled labour, etc. 5.4.3 Production Analysis in the Short-run In the production process, the output or product may be described in three ways in economics: total product (TP), average product (AP) or marginal product (MP). (a) Total Product (TP) Total product is the maximum output that a firm can produce over a given period of time when it employs a given set of inputs. (b) Average Product (AP) Average product is the output per unit of the variable factor employed. In other words, it is the productivity of the variable factor. It is measured by dividing total product (TP) by the amount of variable factor employed i.e AP = Average product is measured in respect of a variable factor. For instance, where the variable factor is say labour (L), then it is the average product of labour (APL) or the productivity of labour that we can measure as: APL = (c) Marginal Product (MP) Marginal product is the change in total product resulting from the use of one more (or less) unit of a variable factor. It may also be explained as the rate of change in total product with respect to a variable factor. i.e. MP = where = change For example, the MP of labour (MPL) is measured as: MPL = ECONOMICS 118 (d) Production Schedule Table 5.1: A Short-run Production Schedule Capital Labour Units Total Product Of Average Product Marginal (K) (L) Labour of Labour product of (TPL) (APL) Labour (MPL) 10 0 0 0 - 10 1 100 100 100 10 2 240 120 140 10 3 390 130 150 10 4 520 130 130 10 5 610 122 90 10 6 660 110 50 10 7 660 94.3 0 10 8 620 77.5 -40 10 9 560 62.2 -60 10 10 460 46 -100 Table 5.1 shows a Short-run Production Schedule. It is a short-run schedule because it has fixed input (capital) as well as variable input (labour). From Table 5.1 it is observed that as the employment of the variable factor (labour) increases, total product also rises from zero (0) to six hundred and sixty (660) when employment of labour is seven (7). Any additional employment of units of labour i.e. when labour is eight units (8) and above causes the total product to decline to four hundred and sixty (460) when ten units of labour is employed. The average and the marginal products of labour as depicted in Table 5.1 increase, but both eventually decline. Marginal product declines to zero (0) and even turns negative after the employment of the seventh unit. Average product on the other hand declines but remains positive so far as total product remains positive. ECONOMICS 119 (e) Production Graphs product TPL APL O L1 units of Labour MPL Fig. 5.1: Total Product, Average Product and Marginal Product Curves. Figure 5.1 is sketched from Table 5.1, the Short-run Production Schedule. The figure shows the relationship between MPL, APL and TPL. The MPL curve cuts the APL curve at the maximum of the APL curve. The APL curve rises as long as the MPL curve is above it. At the highest point of the MPL curve, the TPL curve starts to experience diminishing returns to variable proportions. At the maximum of the TPL, MPL is equal to zero (i.e the MPL curve intersects with the horizontal axis). When APL begins to decline the MPL curve is below the APL curve. APL rises and falls, but never reaches zero (0) 5.5 THE LAW OF DIMINISHING RETURNS The Law of Diminishing Returns states that other things being equal – e.g. given technology, socio-cultural environment, etc. – as more and more units of a variable input (say labour) are employed in combination with a fixed input (say capital), initially MP increases but eventually it diminishes. The following are the conditions under which the law operates: (i) The law is a short-run phenomenon where the producer uses fixed and variable inputs. All other inputs, apart from the variable input are held fixed in quantity. ECONOMICS 120  (ii) The variable factor may be any input usually used in production (e.g. labour). (iii) The variable factor is applied unit by unit, and each unit is identical in quantity and quality. (iv) It applies in any production sector such as agriculture, manufacturing retailing, advertising, mining etc. It is a law that describes the behaviour of the marginal product (MP). Therefore, it is the MP that eventually diminishes and it does so only after increasing. When fixed and variable inputs are combined to produce a product, the fixed input (capital) helps the variable input (labour). The marginal output of the variable input depends on the amount of the fixed input the variable input has received. In the first instance, if the amount of the fixed input received by the variable factor is relatively plentiful marginal output of the variable factor increases. In the second instance, as the variable input increases beyond a certain unit, they obtain less and less amounts of the fixed input to combine with which leads to decrease in marginal output. Each extra unit of the variable input adds less and less to total product. In the third instance, if the employment of more and more units of the variable input continues, there will be a cluster of the variable input such that the amount of fixed input each unit of variable input gets to combine with becomes insignificant, invariably turning negative. In summary, there is a certain optimum combination of fixed and variable inputs which when exceeded will bring about diminishing returns. The law of diminishing returns, otherwise known as the law of variable proportion to variable proportion is important because it helps the producer to determine the best proportion in which to combine the fixed and variable inputs. If the MP is increasing it means there is too much of the fixed input in combination with the variable input. If the MP falls to zero, there is too little of the fixed input. This guides the producer in determining the best proportion between the fixed and variable inputs. 5.6 Production Analysis in the Long-run The long-run has been defined as a period of production within which all the inputs are variable. This implies that if demand conditions require a change in production, all the inputs could be varied to achieve this. The long-run production analysis, therefore, looks at the relationship between output and inputs based on the fact that all the factors of ECONOMICS 121  production are variable. A firm which varies all its inputs is described as changing its scale of production. 5.6.1 Returns To Scale The behaviour of output of a firm in the long run as its scale of operation (varying all inputs) is changed is called Returns to scale. In other words, returns to scale are the relationships between changes in scale and changes in output. When the scale of production is increased the resulting output displays three (3) stages of returns to scale: increasing returns to scale, constant returns to scale and decreasing returns to scale. These are depicted by the long-run production schedule below: Table 5.2: A Long-run Production Schedule Units of Units of Change in Total Change in Capital Labour Scale Product Total (K) (L) (%) (TP) Product (%) 1 2 1,000 100 2 4 2,500 150 4 8 100 6,000 140 8 16 12,000 100 100 16 32 21,600 100 80 32 64 32,400 100 50 Table 5.2 is a Long-run Production Schedule because both factors of production (labour and