BCOMSCM Economics 1 Module Guide PDF

ECONOMICS I BACHELOR OF COMMERCE IN SUPPLY CHAIN MANAGEMENT ECONOMICS I MODULE GUIDE Copyright © 2020 REGENT BUSINESS SCHOOL All rights reserved; no part of this book may be reproduced in any form or by any means, including photocopying machines, without the written permission of the publisher. BACHELOR OF COMMERCE IN SUPPLY CHAIN MANAGEMENT ECONOMICS I TABLE OF CONTENTS INTRODUCTION TO ECONOMICS.................................................................3 CHAPTER ONE: Introduction to Economics................................................................................8 CHAPTER TWO: Economics Systems.......................................................................................26 CHAPTER THREE: Demand, Supply, and Prices..........................................................................57 CHAPTER FOUR: Changes in Demand and Supply....................................................................68 CHAPTER FIVE: Elasticity.........................................................................................................88 CHAPTER SIX: The Theory of Demand: The Utility Approach..............................................103 CHAPTER SEVEN: Cost of Production........................................................................................109 CHAPTER EIGHT: Market Structures.........................................................................................132 CHAPTER NINE: Labour Market..............................................................................................149 CHAPTER TEN: Fiscal and Monetary Policy..........................................................................161 BACHELOR OF COMMERCE IN SUPPLY CHAIN MANAGEMENT 1 ECONOMICS I CHAPTER ELEVEN: Aggregate Demand and Aggregate Supply..................................................173 CHAPTER TWELVE: Economic Growth, Unemployment, and Inflation.........................................181 CHAPTER THIRTEEN: The Foreign Sector.......................................................................................201 LIST OF REFERENCES..............................................................................215 BACHELOR OF COMMERCE IN SUPPLY CHAIN MANAGEMENT 2 ECONOMICS I INTRODUCTION TO ECONOMICS 1. Introduction Welcome to the Bachelor of Commerce in Supply Chain Management Programme and the Economics 1 guide. As part of your studies, you are required to study and successfully complete a module on economics. 2. Module Overview The module, Economics, focuses on an introduction to Economics. Business professionals across South Africa and globally, play a critical and crucial role in the country's current economic affairs. 3. How to use the Guide This module should be studied using the prescribed textbook against sections presented in this guide. Read about the topic that you intend to study in the appropriate section before starting to read the textbook in detail. Ensure notes are made as you work through both the textbook and this module. You will find a list of objectives and outcomes at the beginning of each section. These outline the main points that you need to understand when you have completed the section/s. The purpose of this guide is to help you study. It is important for you to work through all the tasks and self- assessment exercises as they provide guidelines for examination purposes. Exercises and questions are listed at the end of each chapter. These allow you to reflect on the concepts and frameworks in the module and to gauge your current level of understanding and application. It is recommended that each chapter is studied in conjunction with the prescribed textbook so you have a solid understanding of the concepts introduced. 3.1 Essential (Prescribed) Reading Mohr, P. (2020). Economics for South African Students. 6th ed. Pretoria: Van Schaik Publishers. BACHELOR OF COMMERCE IN SUPPLY CHAIN MANAGEMENT 3 ECONOMICS I 4. Aim of the Module This module will introduce you to the theory of economics and aids in forming a solid understanding of foundational principles within a contemporary South African background. Theoretical frameworks of supply and demand will be explored, including the effect of the labour market. This will support your learning aspects of aggregate demand and supply. Fiscal and monetary policies will be discussed within the South African context, exploring the effects of unemployment and inflation on economic growth. 5. Module Specific Outcomes and Chapter Alignment Upon completion of this module, the student should be able to: Programme Specific Outcomes: Chapter Alignment SO1: Explain in detail the subject of economics from a theoretical perspective and apply the basic economic Chapter 1 problem to the first basic economic model SO2: Determine the typical characteristics and economic arrangement of the world's real economies Chapter 2 SO3: Proficiently analyse how buyers and sellers interact with each other to determine the prices and quantities Chapter 3-4 of goods and services in different market systems SO4: Explain in detail and sufficiently differentiate the varying measures of elasticity and how it influences the behaviour of buyers and sellers in a market for a Chapter 5 specific good or service SO5: Adequately gauge the measure of satisfaction that a consumer gets from buying a good or service Chapter 6 SO6: Examine with the required insight the relationship that exists between inputs used in production and the Chapter 7 resulting outputs and costs for firms characterised into the main theoretical market structures SO7: Comprehend how firms would be classified into the different market structures that exist in economic theory and fully explain their equilibrium positions Chapter 8 according to their various characteristics as per economic thought BACHELOR OF COMMERCE IN SUPPLY CHAIN MANAGEMENT 4 ECONOMICS I Programme Specific Outcomes: Chapter Alignment SO8: Clearly identify and explain the behaviour of labour, one of the main factors of production and to efficiently demonstrate the behaviour of this factor of production Chapter 9 in the labour market when it acts as an intermediary in the buying and selling of an economy’s workforce SO9: Proficiently explain the purpose of fiscal policy and monetary policy and how these policies are applied in order to influence the macroeconomic outcomes of a Chapter 10 national economy SO10: Demonstrate a thorough understanding of the underlying factors affecting the aggregate demand- aggregate supply model representative of a real Chapter 11 economy SO11: Effectively demonstrate the required level of knowledge of key macroeconomic challenges against the background of these challenges also being the Chapter 12 key macroeconomic objectives of a national economy SO12: Demonstrate a basic understanding of the theoretical notions, principles and protective measures involved in countries building strong economic links with the Chapter 13 rest of the world 6. Specific Outcomes and Assessment Criteria Assessment Criteria: Programme Specific The student should have demonstrated the Outcomes: ability to: SO1: Explain in detail the subject of Explained all the aspects of the subject of economics from a theoretical economics from an acceptable theoretical perspective and apply the basic viewpoint and applied the elementary economic problem to the first economic challenge to the first basic basic economic model economic model SO2: Determine the typical Presented a sound argument of the characteristics and economic distinctive characteristics and economic arrangement of the world's real systems of the world's real economies with economies reference to the production, purchase and flow of goods and services within an economy BACHELOR OF COMMERCE IN SUPPLY CHAIN MANAGEMENT 5 ECONOMICS I Assessment Criteria: Programme Specific The student should have demonstrated the Outcomes: ability to: SO3: Proficiently analyse how buyers Investigated and evaluated with insight how and sellers interact with each the main market participants interrelate with other to determine the prices and each other to ascertain the prices and quantities of goods and services quantities of goods and services in diverse in different market systems market systems SO4: Explain in detail and sufficiently Provided a differentiated clarification of the differentiate the varying several categories of elasticity and how it measures of elasticity and how it impacted the actions of buyers and sellers in influences the behaviour of a market for a specific good or buyers and sellers in a market for service a specific good or service SO5: Adequately gauge the measure Successfully measured the amount of utility of satisfaction that a consumer that a consumer derives from purchasing a gets from buying a good or product or service service SO6: Examine with the required insight Adequately studied the connection that is the relationship that exists present between inputs used in production between inputs used in and the resulting outputs and costs for firms production and the resulting falling into the core theoretical market outputs and costs for firms structures characterised into the main theoretical market structures SO7: Comprehend how firms would be Described with comprehension how classified into the different market businesses would be categorised into the structures that exist in economic various market structures that prevail in theory and fully explain their economic theory and wholly explained their equilibrium positions according to equilibrium situations according to their their various characteristics as per numerous characteristics in terms of economic thought economic standpoints. SO8: Clearly identify and explain the Demonstrated evident knowledge of the behaviour of labour, one of the economic conduct of labour, whilst main factors of production and to proficiently demonstrated the behaviour of efficiently demonstrate the this factor of production in the labour market behaviour of this factor of whereby it serves as a medium in the buying production in the labour market and selling of an economy’s labour when it acts as an intermediary in the buying and selling of an economy’s workforce BACHELOR OF COMMERCE IN SUPPLY CHAIN MANAGEMENT 6 ECONOMICS I Assessment Criteria: Programme Specific The student should have demonstrated the Outcomes: ability to: SO9: Proficiently explain the purpose of Competently explained the purpose of fiscal fiscal policy and monetary policy policy and monetary policy and how these and how these policies are applied policies function in order to steer the national in order to influence the economy in a desired direction of economic macroeconomic outcomes of a welfare national economy SO10: Demonstrate a thorough Provided a comprehensive description and understanding of the underlying explanation of the fundamental aspects factors affecting the aggregate influencing the aggregate demand- demand-aggregate supply model aggregate supply model illustrative of an representative of a real economy actual economy SO11: Effectively demonstrate the Demonstrated an acceptable level of required level of knowledge of key theoretical knowledge of key macroeconomic challenges macroeconomic challenges against the against the background of these simultaneous background of these challenges also being the key challenges serving as the main macroeconomic objectives of a macroeconomic goals of a national economy national economy SO12: Demonstrate a basic Sufficiently demonstrated an elementary understanding of the theoretical understanding of the theoretical concepts, notions, principles and protective principles and defensive measures involved measures involved in countries in countries building strong economic links building strong economic links with with foreign countries the rest of the world BACHELOR OF COMMERCE IN SUPPLY CHAIN MANAGEMENT 7 ECONOMICS I CHAPTER ONE: Introduction to Economics Learning Outcomes Upon completion of this chapter, the student should be able to: Define economics Understand the centralised economic challenge of scarcity and choice Illustrate scarcity, choice, and opportunity cost: The production possibilities curve Differentiate between microeconomics and macroeconomics Identify the key economic role players Describe the circular flow within an economy This chapter provides an introduction to economics, In other words, what Economics is all about. The introduction of important concepts of scarcity, choice and opportunity cost, and its relation to the production possibilities curve model are discussed. The aspects of microeconomics and macroeconomics are also discussed. Further understanding is garnered on learning that macroeconomics is the study of the performance, structure, behaviour and decision-making of an economy as a whole. Discussion of microeconomics is then presented in order to impart to the learner that this aspect focuses on economic interactions of a specific person, a single entity or a company. 1.1. Introduction to Economics Economics is the study of choices that individuals, businesses, governments, and other stakeholders in society make. Understanding economics can help individuals answer questions, such as, should Toyota increase its production of motor vehicles? Should taxes in South Africa be raised or lowered? Should the government prohibit the sale of alcohol and cigarettes during a global COVID-19 pandemic? Economic questions like these arise every day because we make choices. These choices are necessary because each of us faces the economic facts of life known as scarcity. We all have desires or wants (i.e., maybe a new Ferrari, a huge penthouse, a personal jet). However, the means to achieve these desires are scarce. Due to having scarce BACHELOR OF COMMERCE IN SUPPLY CHAIN MANAGEMENT 8 ECONOMICS I resources, we need to make choices. Therefore, we want to use these resources efficiently. (Mohr, 2020). Economics can be generally defined as: “the social science that studies the choices individuals, businesses, governments, and entire societies make as they cope with scarcity and the incentives that influence and reconcile those choices”. (Mohr, 2020). Table 1.1: Formal Definitions of Economics. Source: (Mohr, 2020:3) 1.2. Scarcity, Choice, and Opportunity Cost Economics is the management of scarcity. There are limited resources to satisfy everyone's wants. The points below outline the difference between needs and wants. Wants: These are human desires for goods and services. Our wants are unlimited (e.g., we want a huge mansion to live in, or a fancy sports car). Needs: These are things we cannot survive without, such as food, water, shelter, and clothing. These are considered to be necessities. BACHELOR OF COMMERCE IN SUPPLY CHAIN MANAGEMENT 9 ECONOMICS I Economics can be divided into two parts: Microeconomics is the study of choices that individuals and businesses make, the way these choices interact in markets, and the influence of government on those choices. Macroeconomics is the study of the effects on the national economy and the global economy of the choices that individuals, businesses, and governments make. (Mohr, 2020). Now that we have examined wants, let us examine why we say resources are limited. There are three types of resources: natural resources (such as agricultural land, minerals, and fishing resources), human resources (such as labour), and man-made resources (such as machines). These resources are the means with which goods and services can be produced. In economics, these resources are called factors of production. Factors of production are resources that are the building blocks of the economy. These include what people use to produce goods and services. In this regard, economists divide the factors of production into four categories: land, labour, capital, and entrepreneurship (Econ Ed, 2012). Land The first factor of production is land and anything that comes from the land. This may be a natural resource to produce goods and services. Examples of land may include water, oil, copper, natural gas, coal, and forests. Land resources are the raw materials in the production process. As such, these resources may be renewable, such as forests, or non-renewable such as oil or natural gas. Rent is the income that resource owners earn in return for land resources. Labour The second factor of production is labour in order to produce goods and services. Labour resources include the work done by the waiter who brings your food at a local restaurant as well as the engineer who designed the bus that transports you to school. It includes an artist's creation of a painting as well as the work of the pilot flying the airplane overhead. If you have ever been paid for a job, you have contributed labour resources to the production of goods or BACHELOR OF COMMERCE IN SUPPLY CHAIN MANAGEMENT 10 ECONOMICS I services. The income earned by labour resources is called wages and is the largest source of income for most people. Capital The third factor of production is capital such as machinery, tools and buildings humans use to produce goods and services. Some common examples of capital include hammers, forklifts, conveyer belts, computers, and delivery vans. Entrepreneurship: The fourth factor of production is entrepreneurship. An entrepreneur is a person who combines the other factors of production - land, labour, and capital - to earn a profit. Entrepreneurs thrive in economies where they have the freedom to start businesses and buy resources freely. The payment to entrepreneurship is profit. Since resources are limited, it follows that the goods and services with which we can satisfy our wants are also limited. All individuals and societies are confronted by the problem of unlimited wants and limited means. They must therefore make choices. Some wants will be satisfied, but many will be left unsatisfied. In each case, it must be decided which of the available alternatives will have to be sacrificed. Economic decisions are all difficult. The fact that we live in a world of scarcity forces us to make difficult choices (Econ Ed, 2012). When resources are used to produce a certain good, they are not available to produce other goods. A decision to produce more of one good, therefore, also means that less of another good can be produced. Scarcity must not be confused with poverty. Scarcity affects everyone. The rich are also subject to scarcity. Even the wealthiest person on earth will have unsatisfied wants and will have to make economic decisions. An example (provided below) is how Hendrik Mathi Bela, Anne van der Merwe, and the South African government were all faced with difficult choices between different alternatives. This is what the economic problem is all about. BACHELOR OF COMMERCE IN SUPPLY CHAIN MANAGEMENT 11 ECONOMICS I When we are faced with such a choice, we can measure the cost of the alternative we have chosen in terms of the alternatives that we have to sacrifice. This is called opportunity cost. Example Anne only must choose between studying and going to the movies; the opportunity cost of studying would be forgoing a visit to the movies. Likewise, if Hendrik must choose between a cool drink and chocolate; the opportunity cost of the cool drink would be the chocolate that he has to sacrifice (assuming that he cannot afford both). When there are more than two alternatives, the opportunity cost is somewhat more complicated. We then measure the opportunity cost of a particular alternative in terms of the best alternative that must be sacrificed. Source: (Mohr, 2015:5). The opportunity cost of a choice is the value to the decision-maker of the best alternative that could have been chosen but was not chosen. In other words, the opportunity cost of a choice is the value of the best-forgone opportunity. Every time a choice is made, opportunity costs are incurred. 1.3. Illustrating Scarcity, Choice, and Opportunity Cost: The Production Possibilities Curve Scarcity, choice, and opportunity cost can be illustrated with the aid of a production possibilities curve, also called a production possibilities frontier. Consider an isolated rural community along the Wild Coast whose main foods are potatoes and fish. The people have found that by devoting all their available time and other resources to fishing, they can produce five baskets of fish per working day. Alternatively, if they spend all their production time gardening, they can produce 100 kilograms (kg) of potatoes per working day. It is possible for them to produce either five baskets of fish or 100 kg of potatoes, but in each case, the entire production of the other good must be sacrificed. The only way that the inhabitants can enjoy a diet that includes both fish and potatoes is by using some of their resources for fish production and some for potato production. Resources must be shifted from one production possibility to produce the other. BACHELOR OF COMMERCE IN SUPPLY CHAIN MANAGEMENT 12 ECONOMICS I Combinations of fish and potatoes in Table 1.2 represent the maximum amounts that can be produced with all the available resources. If the people decide to produce Combination E they will be able to produce four baskets of fish and 40 kg of potatoes per day. However, in producing this combination, they have had to decide not to produce more fish or more potatoes. In producing four baskets of fish, they have had to forgo the additional 60 kg of potatoes they could have produced if they had used all their resources to grow potatoes. Likewise, in the production of 40 kg of potatoes, they have decided to forgo the extra (5th) basket of fish which they might have produced. The opportunity cost of producing the 40 kg of potatoes is the basket of fish, and the opportunity cost of producing the four baskets of fish is the 60 kg of potatoes that has to be forgone. The community, therefore, has to choose between more potatoes and less fish, or more fish and fewer potatoes. Table 1.2: Combinations of Fish and Potatoes Combination Fish (baskets) Potatoes (kgs) A 0 100 B 1 95 C 2 85 D 3 70 E 4 40 F 5 0 Given the available resources, it is impossible to produce more of one good without decreasing the production of the other good. The different combinations can be illustrated graphically in a production possibilities curve, as in Figure 1-1. The curve shows the possible levels of output in an economy with limited resources and fixed production techniques. The production possibilities curve indicates the combinations of any two goods or services that are attainable when the community's resources are fully and efficiently employed. BACHELOR OF COMMERCE IN SUPPLY CHAIN MANAGEMENT 13 ECONOMICS I As we move along the production possibilities curve from point A to point B through to point F, the production of fish increases while the production of potatoes decreases. To produce the first basket of fish, the community has to sacrifice 5 kg of potatoes (from 100kg to 95kg). To produce the second basket of fish, the sacrifice is an additional 10 kg of potatoes (the difference between 95kg and 85kg). To produce the third basket of fish, an additional 15 kg of potatoes have to be forgone (the difference between 85kg and 70kg). The opportunity cost of each additional basket of fish, therefore, increases as we move along the production possibilities curve. This is why the curve bulges outwards from the origin. The production possibilities curve is a very useful way of illustrating scarcity, choice, and opportunity cost. Figure 1.1: Production Possibilities Curve Source: Mohr (2020:6) Scarcity is illustrated by the fact that all points to the right of the curve (such as G) are unattainable. The curve thus forms a frontier or boundary between what is possible and what is not possible. Choice is illustrated by the need to choose among the available combinations along the curve. Opportunity cost is illustrated by what we refer to as the negative slope of the curve, which means that more of one good can be obtained only by sacrificing the other good. Opportunity cost, therefore, involves what we call a trade-off between the two goods. Also, note point H in the diagram. This point denotes 70 kg of potatoes and two baskets of fish. Such a combination is obtainable but inefficient. Why? Because more potatoes (85 kg) can be produced at C without sacrificing any production of fish. Alternatively, more fish (3 baskets) can be produced BACHELOR OF COMMERCE IN SUPPLY CHAIN MANAGEMENT 14 ECONOMICS I at D without sacrificing any production of potatoes. Point G illustrates an unattainable combination as it is outside and above the curve. The bulging shape of the curve illustrates increasing opportunity costs: as we move along the curve, more of the one good has to be sacrificed to obtain an extra unit of the other good. With a given level of resources and a given state of technology, the community can produce different combinations of potatoes and fish. But it cannot move beyond ABCDEF. That is why the curve is sometimes also called the production possibility boundary or frontier. It indicates the maximum attainable combinations of the two goods, also called the potential output. Given the available resources and the current production techniques, a combination such as that indicated by G is impossible. We only have enough resources to produce along the line, whilst also being efficient. However, the quantity of available resources may increase, or production techniques may improve over time. If this happens, it can be illustrated by a production possibilities curve that shifts outwards. Such an outward movement illustrates economic growth. (Mohr, 2020). Bloomenthal (2020) also states that in business analysis, the production possibility frontier (PPF) is a curve that illustrates the variations in the amounts which can be produced of two products if both depend upon the same finite resource for their manufacture. In macroeconomics, the PPF is the point at which a country’s economy is most efficiently producing its various goods and services and, therefore, allocating its resources in the best way possible. Think Point Economists use PPF’s to demonstrate that an efficient nation produces what it is most capable of producing and trades with other nations for the rest. Given the available resources and the current production techniques, a combination such as that indicated by G is impossible. We only have enough resources to produce along the line, whilst also being efficient. However, the quantity of available resources may increase, or production techniques may improve over time. If this happens, it can be illustrated by a production possibilities curve that shifts outwards. Such an outward movement illustrates economic growth. BACHELOR OF COMMERCE IN SUPPLY CHAIN MANAGEMENT 15 ECONOMICS I Consider the case of PPF on a National Scale As another example, consider the diagram below. Imagine a national economy that can produce only two goods: wine and cotton. According to the PPF, points A, B, and C on the PPF curve represent the most efficient use of resources by the economy. For instance, producing five units of wine and five units of cotton (point B) is just as desirable as producing three units of wine and seven units of cotton. Point X represents an inefficient use of resources, while point Y represents a goal that the economy simply cannot attain with its present levels of resources. Figure 1.2: Production Possibilities Curve Source: (Bloomenthal, 2020) As we can see, in order for this economy to produce more wine, it must give up some of the resources it is currently using to produce cotton (point A). If the economy starts producing more cotton (represented by points B and C), it would need to divert resources from making wine and, consequently, it will produce less wine than it is producing at point A. Moreover, by moving production from point A to B, the economy must decrease wine production by a small amount in comparison to the increase in cotton output. But if the economy moves from point B to C, wine output will be significantly reduced while the increase in cotton will be quite small. Keep in mind that A, B, and C all represent the most efficient allocation of resources for the economy. The nation must decide how to achieve the PPF and which combination to use. If more wine is in demand, the cost of increasing its output is BACHELOR OF COMMERCE IN SUPPLY CHAIN MANAGEMENT 16 ECONOMICS I proportional to the cost of decreasing cotton production. Markets play an important role in telling the economy what the PPF ought to look like. Consider point X on the figure above. Being at point X means that the country's resources are not being used efficiently or, more specifically, that the country is not producing enough cotton or wine given the potential of its resources. On the other hand, point Y, as we mentioned above, represents an output level that is currently unattainable by this economy. If there were an improvement in technology while the level of land, labour, and capital remained the same, the time required to pick cotton and grapes would be reduced. Output would increase, and the PPF would be pushed outwards. A new curve, represented in the figure below on which Y would fall, would show the new efficient allocation of resources. Figure 1.3: Production Possibilities Curve: Shift When the PPF shifts outwards, it implies growth in an economy. When it shifts inwards, it indicates that the economy is shrinking due to a failure in its allocation of resources and optimal production capability. A shrinking economy could be a result of a decrease in supplies or a deficiency in technology. An economy can only produce on the PPF curve in theory. In reality, economies constantly struggle to reach an optimal production capacity. As scarcity forces an economy to forgo some choice in favour of others, the slope of the PPF will always BACHELOR OF COMMERCE IN SUPPLY CHAIN MANAGEMENT 17 ECONOMICS I be negative. That is, if the production of product A increases then the production of product B will have to decrease. Source: (Bloomenthal, 2020) 1.4. A Discussion on Goods and Services Goods are real or concrete items such as property, cars, furniture and clothing. Services are abstract items like medical services, legal services, financial services, the services of an economics lecturer, and the services provided by public servants. Student Activity Complete the following student activity on the “Nature of Services” The definition of service is “any intangible product, which is essentially a transaction and is transferred from the buyer to the seller in exchange for some consideration (or no consideration). Provide the following examples of types of services: 1. Intangibility: 2. Inconsistency: 3. Inseparability: 4. Storage: Source: (Toppr.com, 2018). Economic activity is for the pursuit of satisfying human wants. Wants are satisfied with goods and services. Goods can be further broken into consumer goods and capital goods. Consumer goods are goods that are used or consumed by individuals or households (i.e., consumers) to satisfy wants. Examples include food, wine, clothing, shoes, furniture, household appliances, and motorcars. BACHELOR OF COMMERCE IN SUPPLY CHAIN MANAGEMENT 18 ECONOMICS I Capital goods are goods that are not consumed in this way but are used in the production of other goods. Example, machinery, plant, and equipment used in manufacturing and construction. Capital goods permit for more production and satisfaction in the future. 1.5. Different Categories of Consumer Goods Consumer goods can be classified into three groups: non-durable, semi-durable, and durable. Non-durable goods are goods that are used once only. Examples are food, wine, tobacco, petrol, and medicine. Semi-durable goods can be used more than once and usually last for a limited period. Examples are clothing, shoes, bedding, and motorcar tyres. Durable goods normally last for a number of years. Examples are furniture, refrigerators, washing machines, dishwashers, and motorcars. Apart from purchasing goods, individuals and households can also satisfy some of their wants by purchasing services such as those listed earlier. Student Activity 1. Consumer goods: Indicate the general lifespan of consumer durable goods. 2. Capital goods (tangible items such as buildings, machinery, and equipment produced and used in the production of other goods and services): what makes the service durable? Indicate examples of consumer durable goods. 1.5.1. Final Goods and Intermediate Goods Final goods are the goods that are used or consumed by individuals, households, and firms. A loaf of bread consumed by a household, for example, is a final good. Intermediate goods, on the other hand, are goods purchased to be used as inputs in producing other goods. Intermediate goods are thus processed further before they are sold to end-users. The flour used by a baker is an intermediate good. The baker does BACHELOR OF COMMERCE IN SUPPLY CHAIN MANAGEMENT 19 ECONOMICS I not consume it. The flour is processed into bread, cake, or something else. However, when a household purchases flour, it is a final good since the purpose is to consume it in some form or another. (Mohr, 2020) 1.5.2. Private Goods and Public Goods A private good is a product that must be purchased to be consumed, and consumption by one individual prevents another individual from consuming it. A good is considered to be a private good if there is competition between individuals in order to obtain it. Also, it is private if consuming the good prevents someone else from consuming it. Public goods are open for everyone’s use. Consumption by one party does not deter another party's ability to use it. Many public goods can be consumed at no cost. Drinking taps in public places would qualify as public goods, as they can be used by anyone and there is no reasonable possibility of it becoming fully used up. (Chen, 2020) 1.5.3. Economic Goods and Free Goods Mohr (2020) describes an economic good as a good that is produced at a cost from scarce resources. Economic goods are, therefore, also called scarce goods. As one would expect, most goods are economic goods. A free good is a good that is not scarce and therefore has no price. Air, sunshine, and seawater at the coast are usually regarded as free goods. Nowadays, however, air and seawater are often polluted, with the result that clean air and seawater are not always freely available. 1.5.4. Homogeneous Goods and Heterogeneous Goods Homogeneous goods are produce that has essentially the same physical characteristics and quality as similar products from other suppliers. Therefore, one product can easily be substituted for the other. BACHELOR OF COMMERCE IN SUPPLY CHAIN MANAGEMENT 20 ECONOMICS I Student Activity As a shopper, which items in the store of the same type would be homogenous? Note: If you were shopping to buy the 'best' product, a main difference would be price. The term is usually applied to agricultural products, and metal and energy- based commodities. An example: When you buy a bag of oranges, one is not sure where they are from. You base your selection on price alone. In contrast, a heterogeneous product is a product that is readily distinguishable from competing products and cannot be easily substituted for another. The buyer has to determine which features are the most important. For example, physical characteristics for similar items may vary between suppliers. Aspects such as advertising, brand names, packaging, and design elements, such as colour, size and shape, influences one’s decision. The price would vary significantly from one product to another because the suppliers are able to make their product seem different from the competition.(Michael, 2015) Figure 1.4: Improvement in Technique for Producing Capital Goods Source: Mohr (2020, pp.9) If an improved technique for producing capital goods is developed, it will be possible to produce more capital goods with the available factors of production. The original production possibilities curve is illustrated in Figure 1-2 as AB. If we assume that the BACHELOR OF COMMERCE IN SUPPLY CHAIN MANAGEMENT 21 ECONOMICS I available factors of production and the technique for producing consumer goods remain the same, the maximum potential production of consumer goods remains at A. However the maximum potential output of capital goods (if all available resources are used to produce capital goods) increases from B to C. The new production possibilities curve is thus indicated by AC. Except at point A, it is now possible to produce more capital goods and more consumer goods than before. For example, at point Y, more of both types of good is produced than at point X. Figure 1.5: Improved Technique in Producing Consumer Goods Source: Mohr (2020:10) If an improved technique for producing consumer goods is developed, while the available resources and the technique for producing capital goods remain the same, the maximum potential output of consumer goods will increase as shown in Figure 1- 5. The original production possibilities curve is again indicated as AB. But this time, the maximum potential output of consumer goods increases (from A to D), while the maximum potential output of capital goods remains unchanged (at B). Again, the production possibilities curve swivels, but this time on point B rather than on point A. Except at point B, it is now possible to produce more consumer goods and capital goods than before, as illustrated, by the movement from point X to point Y. BACHELOR OF COMMERCE IN SUPPLY CHAIN MANAGEMENT 22 ECONOMICS I Figure 1.6: Increase in the Quantity of the Available Resources for Production. Source: Mohr (2020:10) If the amount of available resources (e.g., the number of workers) or productivity of available resources increase, it will be possible to produce more consumer goods and more capital goods than before. This can be illustrated by a shift of the original production possibilities curve (AB) to the right (to EF), as in Figure 1-6. Figures 1-2, 1- 3, and 1-4 all illustrate economic growth. 1.6. Economics is a Social Science Economics is a social science. In this regard, economics has two important attributes. Economics studies human activities and constructions in environments with scarce resources. Economics also uses the scientific method and empirical evidence to build its base of knowledge. In evaluating human interactions as it relates to preferences, decision making and constraints is an important basis of economic theory. The complexity of the dynamics of human motivation and systems has led to the establishment of assumptions that form the basis of the theory of consumer and firm behaviour, each of which are used to model circular flow interactions within the economy. Economics provides frameworks in order to analyse complex societal interactions, which includes consumer and firm behaviour. Economics also allows individual agents to balance expectations. To get an understanding of the ebb and flow of the economy through dynamic business cycles, allows for the potential for emotional balance by reminding agents to limit desperation in downturns and exuberance in expansions. (Lumen, 2019) BACHELOR OF COMMERCE IN SUPPLY CHAIN MANAGEMENT 23 ECONOMICS I Economists cannot discover regular patterns of behaviour by conducting laboratory experiments, nor can they test their theories in this way. Economists study the behaviour of people in a constantly changing environment. They cannot place people in test-tubes to determine how they will react to any particular change. They cannot hold other things constant while the impact of one particular change is investigated. Economists, therefore, have to resort to other methods. (Mohr, 2020) 1.7. Positive and Normative Economics Another important distinction is between positive and normative economics. A positive statement is an objective statement of fact. A normative statement involves an opinion or value judgement. Positive statements can be proven or disproved by comparing them with the facts. Normative issues can be debated, but they can never be settled by science or by an appeal to facts. 1.8. Microeconomics and Macroeconomics The study of economics is usually divided into two parts: microeconomics and macroeconomics. In Microeconomics, the focus is on individual parts of the economy. The decisions or functioning of decision-makers such as individual consumers, households, firms, or other organisations are considered in isolation from the rest of the economy. The individual elements of the economy are, figuratively speaking, each put under the microscope and examined in detail. Examples include the study of the decisions of individual households (what to do, what to buy, etc.) and of individual firms (what goods to produce, how to produce them, what prices to charge etc.). It also includes the study of the demand, supply, and prices of individual goods and services like petrol, maize, haircuts, and medical services. Macroeconomics is concerned with the economy as a whole. In macroeconomics, we focus on the "big picture." We develop an overall view of the economic system, and we study total or aggregate economic behaviour. The emphasis is on topics such as total production, income and expenditure, economic growth, aggregate unemployment, the general price level, inflation, and the balance of payments. BACHELOR OF COMMERCE IN SUPPLY CHAIN MANAGEMENT 24 ECONOMICS I There are many overlaps with Macroeconomics and Microeconomics. What happens at the individual (micro) level affects the overall (macro) performance of the economy and vice versa. Think about the maths equation, 1+2+3+4 = 10. In Microeconomics we are concerned about 1+2+3+4 (individual components). On the other hand, Macroeconomics is only concerned with 10 (whole component). BACHELOR OF COMMERCE IN SUPPLY CHAIN MANAGEMENT 25 ECONOMICS I CHAPTER TWO: Economics Systems Learning Outcomes Upon completion of this chapter, the student should be able to: Identify the major role players in an open economy Describe the mechanics of the circular flow model of a country Know the different economy types that exist Know the main economic questions of an open economy Following the main economic central concepts, such as scarcity, choice and opportunity cost from Chapter 1 leads us to the next three central questions in Chapter 2. It is imperative to understand the aspects of Chapter 2 in order to understand the basic types of economic systems. The three questions focus on the type of goods and services being produced and their quantities; how will the goods and services be produced; whom the goods and services are produced for. 2.1. Introduction to Economic Systems Three main types of economic systems are then defined and described: the traditional system, the command system and the market system. Their key features, advantages, and disadvantages are discussed, and the mixed economic system is also defined. 2.1.1. The Economic Problem All societies face an economic problem. The problem usually centres on how best to use limited, or scarce, resources. The economic problem exists as there are less resources to satisfy the needs and wants of people. BACHELOR OF COMMERCE IN SUPPLY CHAIN MANAGEMENT 26 ECONOMICS I America’s first Nobel Prize winner for economics, the late Paul Samuelson, is often credited with providing the first clear and simple explanation of the economic problem – namely, that in order to solve the economic problem societies must endeavour to answer three basic questions: 1. What will be produced in a market system? 2. How will it be produced? 3. For whom will the goods and services be produced? These are the three central questions, which have to be solved in every society. ECONOMICSONLINE (n.d) 2.2. Economic Systems An economic system is the mixture of the various agencies and entities that provide the economic structure that defines the social community. An economic system may involve production, allocation of economic inputs, distribution of economic outputs, landlords and land availability, households (earnings and expenditure consumption of goods and services in an economy), financial institutions, firms, and the government. Furthermore, an economic system is the set of principles by which problems of economics are addressed, such as the economic problem of scarcity through allocation of finite productive resources (Boettke and Heilbroner, 2020) 2.2.1. The Traditional System The oldest solution to the three central questions is tradition. By this, we mean that the same goods are produced and distributed in the same way by each successive generation. In a traditional system, each participant's task and methods of production are prescribed by custom. Men do what their fathers did. Women do what their mothers did. People use the same techniques of production as their parents did, and production is distributed according to long-established traditions. A traditional economic system provides clear and easy answers to the three central questions. It is, however, a rigid system, which is slow to adapt to changing conditions and stubbornly resists innovation. Traditional systems tend to be subsistence economies. But this is usually not considered a drawback by the participants themselves. In traditional systems, economic activity is not the first priority. Economic BACHELOR OF COMMERCE IN SUPPLY CHAIN MANAGEMENT 27 ECONOMICS I activity is usually secondary to religious and cultural values and the desire to perpetuate the status quo. Student Activity 1. Indicate examples of the traditional system with regards to land. 2. Challenge how explorative or innovative the traditional system is. 3. Determine to what extent does the close family indulge in traditional systems and how, provide examples. 2.2.2. The Command System The second solution to the central questions is the command economy. In a command system, the participants are instructed what to produce and how to produce it by a central authority, which also determines how the output is distributed. Because the economy is governed and coordinated by a central authority, command systems are also called centrally planned systems. Central planning is obviously a tremendous task. Decisions have to be taken on how, where, and for what purpose every natural resource, every labourer, and every capital good are to be applied. The planners have to determine what consumer goods should be produced, how to produce them and how they are to be divided among consumers, how many resources should be allocated to the production of capital goods and how many to consumer goods, and what types of capital goods should be produced. Command economies are often described as socialist or communist systems. Although central planning has been used mostly in socialist or communist systems, central planning is not necessarily synonymous with socialism or communism. Student Activity 1. Provide a discussion of the command economies in the role of government. In your response, indicate countries of strong command and moderate command with justified examples. 2. Discuss the advantages and disadvantages of command economies. BACHELOR OF COMMERCE IN SUPPLY CHAIN MANAGEMENT 28 ECONOMICS I 2.2.3. The Market System The market system requires more detailed explanation. In a market system, the method of coordination is so subtle and intricate that it could not have been invented. It simply happened. To explain this, we first have to explain what a market is. Most people think of markets as specific places (or locations) where certain goods are bought and sold. Most of you have seen a meat market, fish market, vegetable market, fruit market, or flea market in action. These markets all have particular venues. But a market does not require a specific location. A market is any contact or communication between potential buyers and potential sellers of a good or service. This contact can be personal, or it can take place by means of a telephone, a fax machine, a computer, a smartphone, newspaper advertisements, or any other means. Any institution or mechanism which brings potential buyers ("demanders") and prospective sellers ("suppliers") of particular goods and services into contact with each other is regarded as a market. Markets can be local, regional, national, or international. The corner cafe and a spaza shop are examples of local markets. The JSE is a national market where shares are traded. The London gold market is an example of an international or world market. When we explain how markets work, in the rest of this guide, we shall often use concrete examples of markets with a specific location, such as fruit and vegetable markets. For a market to exist, the following conditions have to be met: There must be at least one potential buyer and one potential seller of the good or service The seller must have something to sell The buyer must have the means with which to purchase it An exchange ratio-the market price-must be determined The agreement must be guaranteed by law or by tradition Mohr and Fourie (2007) A market system is one in which individual decisions and preferences are communicated and coordinated through the market mechanism (i.e., the mechanism which meets the conditions listed above). The most important elements of this mechanism are market prices. Market prices are signals or indices of scarcity, which indicate to consumers what they have to sacriﬁce to obtain the goods or services concerned. At the same time, market prices also indicate to the owners of the various BACHELOR OF COMMERCE IN SUPPLY CHAIN MANAGEMENT 29 ECONOMICS I factors of production how these factors can best be employed. However, the types of goods and services produced also depend on the distribution of income – the consumers with the most "money votes" have the largest impact on demand, market prices, and the structure of production. They, therefore, dominate the outcome of the market processes. Market systems are often called capitalist systems. Like socialism, capitalism refers to a particular type of ownership of the factors of production. Whereas most factors of production in a socialist system are owned by the state (or by society at large), a capitalist system is characterised by private ownership. Market systems are, however, not necessarily capitalist systems. The market mechanism can also be used in socialist systems. It is thus possible to have market socialism. But just as the command mechanism tends to be used primarily in socialist systems, the use of the market mechanism tends to coincide with the capitalist system of ownership. Market mechanism works like an invisible hand that coordinates the selﬁsh actions of individuals to ensure that everyone is better off. Let us take a closer look at how this is achieved. 2.3. Three Central Questions 2.3.1. What will be produced in a market system? The answer is those goods and services that consumers are willing to spend their income on and which can be supplied proﬁtably. Goods that consumers do not want will not be produced. If some uninformed business person happens to produce unwanted goods, he or she will incur losses and cease to produce the goods in question. Only those goods which can be produced and sold proﬁtably will continue to be produced. 2.3.2. How will it be produced? In a market system, producers are forced to combine resources in the cheapest possible way (for a particular standard or quality). Their decisions on the combination of factors of production are governed by the prices of the various factors and their productivity. BACHELOR OF COMMERCE IN SUPPLY CHAIN MANAGEMENT 30 ECONOMICS I 2.3.3. For whom will the goods and services be produced? In a market system, the goods and services go to those who have the means to purchase them. This, in turn, is linked to the production process. Production generates income, and free marketeers argue that in a pure market system, the income earned will reﬂect the value placed on each person's resources. In other words, they argue that there is a direct link between what you put into the system and what you get out of it. Exceptions arise only if a society, through its government, chooses to assist certain individuals and groups, for example, the handicapped and the elderly. Competition is an important feature of market capitalism. It occurs on each side of the market, that is, among suppliers (sellers) or among buyers (consumers). Competition should not be confused with negotiation, which occurs between buyers and sellers, that is, across the different sides of the market. Competition among sellers protects consumers against exploitation and promotes efﬁciency and growth. Such competition creates order among suppliers. The successful ones are rewarded in the form of proﬁt while the unsuccessful ones make losses and are eliminated. Unfortunately, competition is not always free and fair. Most markets in the real world are characterised by imperfect competition (Mohr, 2020). Student Activity 1. Research the five elements that are needed for a market to work. 2. Read up on Rodrik (2000:5-10) who has identified 5 non-market institutions that are needed for markets to perform. In Table 2.1 the elements identified by McMillan and Rodrik in the preceding two bulleted lists are compared. BACHELOR OF COMMERCE IN SUPPLY CHAIN MANAGEMENT 31 ECONOMICS I Table 2.1: Comparison of McMillan’s five elements with Rodrik’s non-market institutions Source: (Cunningham, 2011) 2.4. The South African Mixed Economy The South African economy is a mixed economy in which private property, private initiative, self-interest, and the market mechanism all play an important role. The South African economy is, however, also characterised by a substantial degree of government intervention. In this section, we take a brief look at South Africa's mixed economy. In pure market capitalism, all factors of production are privately owned. 2.4.1. The Men Behind the Systems: Smith, Marx, and Keynes Adam Smith (1723–1790) Smith transformed the subject into a science who ﬁrst provided a detailed intellectual justiﬁcation for free markets, both domestically and internationally. He is, therefore, universally regarded as the intellectual father of the market system and of capitalism. As the title of his book indicates, Smith's primary aim was to ﬁnd the sources of the BACHELOR OF COMMERCE IN SUPPLY CHAIN MANAGEMENT 32 ECONOMICS I wealth of nations. Smith said that the purpose of economic activity is to satisfy human wants. To him, therefore, the wealth of a nation consisted of the annual production of goods that can be used to satisfy human wants. In other words, he emphasised the importance of total output or national product. As far as the sources of wealth (or the national product) are concerned, Smith emphasised the importance of three interrelated concepts: the division of labour, free trade, and a limited role for government. Karl Marx (1818–1883) Marx was a political scientist, historian, sociologist, and economist. The central theme of his work was the historical evolution of institutions. In particular, he regarded capitalism as a speciﬁc and temporary form of social organisation. He argued that capitalism was self-destructive and that it would be replaced by a classless system in which there would be no private property. His argument was briefly as follows- Labour is the source of all value. The value of every commodity ultimately depends on the labour embodied in it. Workers, however, are only paid enough to survive (i.e., a subsistence wage). Capitalists extract surplus value from the workers since the value of the workers' contribution exceeds the amount they receive in wages. The primary aim of capitalists is to increase this surplus-value. They attempt to achieve this by employing more machinery and equipment. This increases total production but causes technological unemployment, which Marx called the industrial reserve army of the unemployed. Unemployment succeeds in keeping wages down but cannot create surplus value. Surplus value can only be created by the employment of labour. John Maynard Keynes (1883–1946) Keynes main message was that the aggregate level of economic activity is determined by the aggregate demand for goods and services. This was directly in contrast to the idea of the classical economists that total production (or aggregate supply) would create its own demand. This was called Say's law, after the French economist Jean- Baptiste Say. BACHELOR OF COMMERCE IN SUPPLY CHAIN MANAGEMENT 33 ECONOMICS I 2.4.2. Production, Income, and Spending Economics is essentially concerned with what to produce, how to produce it, and how to distribute the products between the various participants. Note that the focus is on production. It stands to reason, therefore, that the total production of goods and services is of major concern to economists. But production is not pursued for its own sake. The aim is to use or consume the products to satisfy human wants. The logical sequence is, therefore, as follows: production creates income (earned in the production process by the various factors of production), and this income is then spent on purchasing the products. The sequence contains three major elements: production, income, and spending. In practice, of course, everything is happening at the same time: production occurs, income is earned, and all or part of the income is spent on buying the goods and services that are available. In other words, there is a continuous circular ﬂow of production, income, and spending in the economy. Figure 2.1: The three major ﬂows in the economy Source: Mohr (2020:53) Figure 2.1 highlights the Production, Income, and Spending which are all flows. To understand what this means, we have to distinguish between stocks (which are measured at a particular point in time) and flows (which are measured over a period). To illustrate this, consider the level of water in a dam. The level of the water in a dam can only be measured exactly at a particular point in time. For example, at 00:00 on BACHELOR OF COMMERCE IN SUPPLY CHAIN MANAGEMENT 34 ECONOMICS I 25 April 2014, the level of the Hazelmere dam was at 95.8% of its capacity. This kind of variable, which can only be measured at a particular point in time, is called a stock variable, or simply a stock. The ﬂow of water into the dam, on the other hand, can only be measured over a period, that is, as a rate, irrespective of how short such a period might be. Thus, the ﬂow into the Hazelmere dam can be expressed as so many cubic metres of water per second, per minute, per hour, or per day. For example, on 25 April 2014, the inﬂow into the Hazelmere dam was measured at 88 cubic metres per second. This kind of variable, which can only be measured over a period, is called a flow variable or simply a flow. Production, income, and spending all fall into this category – they are all ﬂows which can only be measured over a period. In practice, the total production, income, and spending in the economy are measured quarterly, but the main interest is in the annual levels of production, income, and spending. 2.4.3. Sources of Production: The Factors of Production 1. Natural Resources (Land) Natural resources (sometimes called land) consists of all the gifts of nature. They include mineral deposits, water, arable land, vegetation, natural forests, marine resources, other animal life, the atmosphere, and even sunshine. Natural resources are ﬁxed in supply. Their availability cannot be increased if we want more of them. It is, however, often possible to exploit more of the available resources. For example, new mineral deposits are still being discovered and exploited every year. But once they are used, they cannot be replaced. We, therefore, refer to minerals as non-renewable or exhaustible assets. As with all other factors of production, both the quality and the quantity of natural resources are important. Some countries cover a vast area, but the land is of limited value. A desert, for example, has little or no agricultural value. But it may contain valuable mineral deposits. Some countries have a relatively small geographical area but a plentiful supply of arable land and minerals. The situation can also vary within a country. For example, in South Africa, there are large areas with little or no agricultural or mineral value. But there are also areas that are rich in minerals or arable land. Because natural resources are in ﬁxed supply, the rate at which they are exploited is often a cause of concern. BACHELOR OF COMMERCE IN SUPPLY CHAIN MANAGEMENT 35 ECONOMICS I Nowadays, environmentalists are extremely concerned about pollution and the destruction of natural resources such as rain forests. 2. Labour Goods and services cannot be produced without human effort. Labour can be deﬁned as the exercise of human mental and physical effort in the production of goods and services. It includes all human effort exerted with a view to obtaining a reward in the form of income. The efforts of gold miners, rubbish collectors, professional boxers, civil servants, engineers, and university lecturers are all classiﬁed as labour. The quantity of labour depends on the size of the population and the proportion of the population that is able and willing to work. The latter, in turn, depends on factors such as the age and gender distribution of the population. The proportion of children, women, and elderly people all affect the available quantity of labour, which is called the labour force. The quality of labour is even more important than the quantity of labour. The quality of labour is usually described by the term human capital, which refers to the skill, knowledge, and health of the workers. Education, training, and experience are all important determinants of human capital. 3. Entrepreneurship The availability of natural resources, labour, and capital is not sufﬁcient to ensure economic success. These factors of production have to be combined and organised by people who see opportunities and are willing to take risks by producing goods in the expectation that they will be sold. An entrepreneur is the driving force behind production. Entrepreneurs are the initiators, the people who take the initiative. They are also the innovators, the people who introduce new products and new techniques on a commercial basis. And they are the risk-bearers, the people who take chances. They do this because they anticipate that they will make proﬁts. But they may also suffer losses and perhaps bankruptcy. The entrepreneur is more than a manager. The entrepreneur is dynamic, a restless spirit, an ideas person, a person of action who has the ability to inspire others. Because entrepreneurship is such an important factor of production, a lot BACHELOR OF COMMERCE IN SUPPLY CHAIN MANAGEMENT 36 ECONOMICS I of research has been done to identify the characteristics of successful entrepreneurs. Entrepreneurship is thus an important economic force. In countries where entrepreneurship is lacking, the government is sometimes forced to act as an entrepreneur in an attempt to stimulate economic development. 4. Technology Technology is sometimes identiﬁed as a ﬁfth factor of production. At any given time, a society has a certain amount of knowledge about the ways in which goods can be produced. When new knowledge is discovered and put into practice, more goods and services can be produced with a given amount of natural resources, labour, capital, and entrepreneurship. If this happens, we say that technology has improved. The discovery of new knowledge is called invention, while the incorporation of this knowledge into actual production techniques and products is called innovation. The wheel, the steam engine, and the modern computer are all examples of important inventions. For these inventions to be used in actual production, new machines (i.e., capital goods) have to be developed. In other words, the inventions have to be embodied in capital. The application of inventions also requires entrepreneurs to identify the opportunities and exploit them. Thus, while technology is important, it can be argued that it forms part of capital and entrepreneurship. In this book, we, therefore, do not deal with it as a separate factor of production. 5. Money is not a Factor of Production Money is often regarded as the key to everything else. People frequently say, "money can buy anything" or "money is power." Money is important, but it is not a factor of production. Goods and services cannot be produced with money. As we explain in more detail later, money is a medium of exchange. Money can be exchanged for goods and services. Money is, therefore, something that facilitates the exchange of goods and services. But money cannot be used to produce goods and services. To produce goods and services, we need factors of production, such as natural resources, labour, and capital. BACHELOR OF COMMERCE IN SUPPLY CHAIN MANAGEMENT 37 ECONOMICS I 6. The Choice of Technique The question of how the goods and services should be produced essentially involves choosing the best methods of production to produce various goods and services. Frequently, various techniques are available to produce a particular good. For example, a dam or a road may be built with large machines and relatively little labour, or it may be built with less sophisticated equipment and more labour. When the production process is dominated by machines, we talk about capital- intensive production. On the other hand, if the emphasis is on labour, the technique is labour intensive. The appropriate choice of technique will depend on the availability and quality of the various factors of production as well as their relative cost. In a rural community that does not have access to capital goods such as tractors, there may be no option but to use unsophisticated equipment and a lot of physical effort to produce food or other goods. However, in the modern economy, where different options are available, the choice of technique will depend, inter alia, on the relative prices of the factors of production (e.g., wages and interest rates). 2.4.4. Sources of Income: The Remuneration of the Factors of Production As indicated earlier, income is generated through production. The only way in which the total income in the economy can be raised is by increasing production. Individuals may, of course, beneﬁt at the expense of other individuals. For example, if Jabu wins the lottery, he beneﬁts, but at the expense of all those who bought tickets and won nothing. However, for the economy at large, income can be increased only by producing more. Total income and total production are two sides of the same coin. Broadly speaking, there are four types of income, each associated with a different factor of production. The remuneration of natural resources (or land) is called rent. Wages and salaries are the remunerations of labour, while the remuneration of capital is called interest. Finally, profit is the remuneration of entrepreneurship. The total income in the economy thus consists of rent, wages and salaries, interest and proﬁt, and the value of total income is identically equal to the value of total production. BACHELOR OF COMMERCE IN SUPPLY CHAIN MANAGEMENT 38 ECONOMICS I 2.4.5. Sources of Spending: The Four Spending Entities There are four basic sources of spending in the economy: households, ﬁrms, the government, and the rest of the world (the foreign sector). We now deal in turn with each of these entities. 1. Households A household can be deﬁned as all the people who live together and who make joint economic decisions or who are subjected to others who make such decisions for them. A household can consist of an individual, a family, or any group of people who have a joint income and make decisions together. Every person in the economy belongs to a household. The household is the basic decision-making unit in the economy. Members of households consume goods and services to satisfy their wants. They are, therefore, called consumers. The act of using or consuming goods and services is called consumption. The total spending of all households on consumer goods and services is called total or aggregate consumption expenditure, or simply total consumption. We use the symbol C to indicate total consumption or consumer spending in the economy. (Note that a symbol is merely an abbreviation or shorthand for a concept or a variable) Because households are the basic units in the economy, we often use the term households when we refer to individuals or consumers. In other words, the terms households, individuals, and consumers are used interchangeably. In a market economy, it is households or consumers who largely determine what should be produced. In a mixed economy, most of the factors of production are owned by households. Labour is obviously owned by the members of households. Many of the other means of production, such as capital goods, are also owned by individuals. For example, even large business concerns like Anglo American, Sanlam, and Pick n Pay are owned by their shareholders. The factors of production of these companies are, therefore, ultimately owned by individuals or households. Although households own the factors of production, these factors cannot satisfy human wants directly. Households, therefore, sell their factors of production (labour, capital, etc.) to ﬁrms that combine these factors and convert them into BACHELOR OF COMMERCE IN SUPPLY CHAIN MANAGEMENT 39 ECONOMICS I goods and services. In return for the factors of production that they supply, the households receive income in the form of salaries and wages, rent, interest, and proﬁt. This income is then used to purchase consumer goods and services that satisfy their wants. In economic analysis, we assume that consumers are rational. By this, we mean that households always attempt to maximise their satisfaction, given the means at their disposal. 2. Firms The next component of the mixed economy is the ﬁrm. A ﬁrm can be deﬁned as the unit that employs factors of production to produce goods and services that are sold in the goods markets. Firms are the basic productive units in the economy. A ﬁrm is actually an artiﬁcial unit. It is ultimately owned by or operated for the beneﬁt of one or more individuals or households. As mentioned above, even large ﬁrms are ultimately owned by their shareholders. Firms can take different forms. Whereas households are engaged in consumption, ﬁrms are engaged primarily in production. Firms are the units that convert factors of production into the goods and services that households desire. Firms are therefore the buyers in the factor markets and the sellers in the goods markets. In a market economy it is ﬁrms which largely decide how goods and services will be produced. Firms, like households, are also rational. By this we mean that ﬁrms always aim to achieve maximum proﬁt. Profit is the difference between revenue and cost. When analysing the decisions of ﬁrms, we ignore the differences between different types of ﬁrms. This enables us to treat the ﬁrm as the basic decision- making unit on the production or supply side of goods markets. One of the factors of production purchased by ﬁrms is capital. As explained earlier, capital goods are man-made factors of production, such as machinery and equipment, which are used to produce goods and services. The act of purchasing capital goods is called investment or capital formation, which is denoted by the symbol I. Whereas households are responsible for spending on consumer goods (C), ﬁrms are responsible for spending on capital goods (I). BACHELOR OF COMMERCE IN SUPPLY CHAIN MANAGEMENT 40 ECONOMICS I 3. The Government The third main source of spending in the economy is government. Government is a broad term that includes all aspects of local, regional (or provincial) and national government. In economics, we often refer to the public sector, which includes everything that is owned by government, as the representative of the people. Government includes all politicians, civil servants, government agencies, and other bodies belonging to or under the control of government. It, therefore, includes the President, cabinet ministers, provincial premiers, mayors, everyone working for central government, provincial governments and municipalities, and public corporations such as Eskom, Transnet, and the South African Reserve Bank. In their ofﬁcial capacities, the President, the Minister of Finance, all other politicians, and all civil servants are part of the government sector, but in their private capacities they are all members of households as well. When they decide which goods to consume, they are driven by the same motives as any other individual or household, but in their ofﬁcial capacities they are supposed to serve the community at large. Government also purchases factors of production (primarily labour) from households in the factor market and also purchases goods and services from ﬁrms in the goods market. In return, government provides households and ﬁrms with public goods and services such as defence, law, and order, education, health services, roads, and dams. These goods and services are ﬁnanced mainly by levying taxes on the income and expenditure of households and ﬁrms. Government also transfers some of its tax revenue directly to needy people such as old-age pensioners. Government's economic activity thus involves three important ﬂows: Government expenditure on goods and services (including factor services)-this is usually denoted by the symbol G. Taxes levied on (and paid by) households and firms-taxes are usually represented by the symbol T. Transfer payments, that is the transfer of income and expenditure from certain individuals and groups (e.g., the wealthy) to other individuals and groups (e.g., the poor). BACHELOR OF COMMERCE IN SUPPLY CHAIN MANAGEMENT 41 ECONOMICS I 4. The Foreign Sector The fourth major sector to consider is the rest of the world, which we call the foreign sector. The South African economy has always had strong links with the rest of the world. The South African economy is thus an open economy. Many of the goods produced in South Africa are sold to other countries, while many of the consumer and capital goods consumed and used in South Africa are produced in the rest of the world. In addition, many foreign companies operate in South Africa, while some South African firms also operate elsewhere. The various flows between South Africa and the rest of the world are summarised in the balance of payments. The foreign sector consists of all countries and institutions outside the country's borders. The flows of goods and services between the domestic economy and the foreign sector are exports, which we denote with the symbol X, and imports, which we denote with the symbol Z. Exports (X) are goods that are produced within the country but sold to the rest of the world. Imports (Z) are goods that are produced in the rest of the world but purchased for use in the domestic economy. South Africa's exports consist mainly of minerals, while the country's imports are mainly capital and intermediate goods that are used in the production process. 2.4.6. Putting Things Together: A Simple Diagram Figure 2.2: The Different Components of Production, Income, and Spending Source: Mohr (2020: 61) BACHELOR OF COMMERCE IN SUPPLY CHAIN MANAGEMENT 42 ECONOMICS I Figure 2.2 above shows that production is created by the factors of production (natural resources, labour, capital and entrepreneurship). These factors earn income (rent, wages and salaries, interest and profit). Spending is done by households, firms, government and the foreign sector (C + I + G + X – Z). 2.4.7. Illustrating Interdependence: Circular Flows of Production, Income, and Spending 1. Households and Firms Households and ﬁrms interact via the goods market and the factor market. The interaction may be illustrated with the aid of a simple diagram, called the circular flow of goods and services. In Figure 2.3, we show the households, the ﬁrms, the goods market, and the factor market. The households offer their factors of production for sale on the factor market where these factors are purchased by the ﬁrms. The ﬁrms combine the factors of production and produce consumer goods and services. These goods and services are offered for sale on the goods market, where they are purchased by households. Figure 2.3 shows the ﬂow of goods and services and factors of production between households and ﬁrms. The interaction between households and ﬁrms can also be illustrated by showing the circular flow of income and spending, as in Figure 2.4. The ﬂow of income and spending is usually a monetary flow, and its direction is opposite to the ﬂow of goods and services. Firms purchase factors of production in the factor market. This spending by ﬁrms represents the income (wages, salaries, rent, interest and proﬁt) of the households. The households, in turn, spend the income by purchasing goods and services in the goods market. The spending by households represents the income of the ﬁrms. BACHELOR OF COMMERCE IN SUPPLY CHAIN MANAGEMENT 43 ECONOMICS I Figure 2.3: The Circular Flow of Goods and Services Source: Mohr (2020:62) Households sell their factors of production to ﬁrms in the factor market. The ﬁrms transform these factors into goods and services which are then sold to households in the goods market. Figure 2.4: The Circular Flow of Income and Spending Source: Mohr (2020:63) Firms purchase factors of production in the factor market. Their spending represents the income of the households (i.e., the sellers of the factors of production). Households spend their income in the goods market on purchasing goods and services. Their spending represents the income of the ﬁrms. BACHELOR OF COMMERCE IN SUPPLY CHAIN MANAGEMENT 44 ECONOMICS I 2. Adding the Government As mentioned earlier, government's economic activity involves three important ﬂows: government spending G, taxes T and transfer payments. Unlike government spending and taxes, transfer payments do not directly affect the overall size of the production, income, and expenditure ﬂows. We, therefore, focus only on government spending and taxes. Government spending G constitutes an addition or injection into the ﬂow of spending and income, while taxes T constitute a leakage or withdrawal from the circular ﬂow of income between households and ﬁrms. The various links between government, on the one hand, and households and ﬁrms, on the other, are illustrated in Figure 2.5. Figure 2.5: The Government in the Circular Flow of Production, Income, and Spending Source: Mohr (2020:63) The government purchases factors of production (mainly labour) from households in the factor market, and goods from firms in the goods market. Government provides public goods and services to households and firms. Government spending is finances by taxes paid by households and firms. 3. Adding the Foreign Sector As mentioned earlier, the spending on exports originates in the rest of the world. Exports thus constitute an addition or injection into the circular ﬂow of income and BACHELOR OF COMMERCE IN SUPPLY CHAIN MANAGEMENT 45 ECONOMICS I spending in the domestic economy. In the case of imports, the production occurs in the rest of the world, while the spending originates in the domestic economy. Imports thus constitute a leakage or withdrawal from the circular ﬂow of income and spending in the domestic economy. As in the other cases, the ﬂow of income and spending is in the opposite direction to the ﬂow of goods and services. We concentrate on the ﬂow of income and spending between the domestic economy and the foreign sector rather than on the ﬂow of goods and services. This ﬂow of income and spending is shown in Figure 2.6. Figure 2.6: The Foreign Sector in the Figure 2.7: Financial Institutions in the Circular Flow of Income and Spending Circular Flow of Income and Spending Source: Mohr (2020:64) Source: Mohr (2020:64) Households and ﬁrms do not spend all their income. Part of their income is saved. The saving ﬂows to the ﬁnancial sector, which then lends funds to ﬁrms to ﬁnance investment spending. 2.4.8. Financial Institutions in the Circular Flow of Income and Spending Financial institutions include banks such as Standard Bank and Nedbank, insurance companies such as Old Mutual and Sanlam, pension funds such as the Mine Employees Pension Fund, and the JSE. These institutions are not directly involved in the production of goods. They act as links between households or ﬁrms with surplus funds and other participants that require funds, for example, ﬁrms that wish to expand BACHELOR OF COMMERCE IN SUPPLY CHAIN MANAGEMENT 46 ECONOMICS I their activities. In this regard, one can distinguish between surplus units (i.e., those who are in a position to save because they spend less than they earn) and deficit units (i.e., those who require funds because their spending exceeds their income). To indicate the position of ﬁnancial institutions or the financial sector in the economy, we use a simple circular ﬂow that excludes government and the foreign sector. Households and ﬁrms who do not spend all their income during any particular period (i.e., surplus units) save some of their income. We use the symbol S to indicate saving. As far as households are concerned, the decision to save is a decision not to consume. In other words, saving can be deﬁned as the act of not consuming. Likewise, ﬁrms can also save by not spending all their income. When saving occurs, there is a leakage or withdrawal from the circular ﬂow of income and spending. Saving is channelled to ﬁnancial institutions, for example, in the form of saving deposits with banks. These funds are then available to ﬁrms that wish to borrow to expand their productive capacity (i.e., deﬁcit units). Firms expand their productive capacity by purchasing capital goods such as machinery and equipment. Recall that this is called investment (I). When ﬁrms purchase capital goods, that is, when they invest, there is an addition or injection into the circular ﬂow of income and spending. The main function of the ﬁnancial sector is, therefore, to act as a funnel through which saving can be channelled back into the circular ﬂow in the form of investment spending. In Figure 2.8, we show the circular ﬂow of income and spending between households, ﬁrms, and the ﬁnancial sector. The ﬁnancial sector acts as an intermediary between those who save and those who wish to invest. Households and ﬁrms channel their savings to the ﬁnancial sector, which then lends the funds to those ﬁrms that wish to borrow to invest. Saving is a withdrawal or leakage from the circular ﬂow, whereas investment is an addition or injection. This also points to a connection between the expansion of the production capacity (through investment) and the decision to refrain from spending on consumer goods (saving). BACHELOR OF COMMERCE IN SUPPLY CHAIN MANAGEMENT 47 ECONOMICS I Everything Together Figure 2.8: The Major Elements of the Circular Flow of Income and Spending Source: Mohr (2020:65) This ﬁgure summarises the essence of the previous circular ﬂow diagrams. The basic ﬂow is between households and ﬁrms. This represents consumption expenditure (C). Saving (S), taxes (T), and imports (Z) are all leakages from the circular ﬂow. Investment spending (I), government spending (G), and exports (X) are all injections into the circular ﬂow. In this section, the main ﬂows and the four sectors have been combined to construct a number of pictures of how the main elements of the economy ﬁt together. All the details were not included in every picture. Many other possible pictures can, therefore, also be constructed. It is a combination of Figures 2.6, 2.7 and 2.8, and summarises most of the important concepts introduced in this chapter. BACHELOR OF COMMERCE IN SUPPLY CHAIN MANAGEMENT 48 ECONOMICS I Student Activity Based on Chapter 1-2 These questions were adapted from http://thinus.weebly.com/uploads/3/0/6/3/30633117/economics_5_mcq_c3_question s_only.doc. Answer the following questions by selecting the appropriate answer from the list below. Question 1 Simple economies can be described in terms of three major economic flows. These are: A. income, spending and saving. B. spending, production and saving. C. income, saving and production. D. income, spending and production. E. income, spending and net exports. Question 2 The two major market types in the simple circular flow of income and expenditure are: A. public markets and private markets. B. free markets and regulated markets. C. factor markets and foreign exchange markets. D. goods markets and service markets. E. goods markets and factor markets. Question 3 Complete the following statement. Households sell their ____________ in the __________ market. They then use their income to buy __________ in the __________ market. A. goods; goods; factors of production; factor B. factors of production; factor; goods; goods C. goods; factor; factors of production; goods D. factors of production; goods; goods; factor Question 4 Which of the following would not be viewed by economists as a firm? A. The University of South Africa B. Pizza Hut C. Spoornet D. The Consumer Council E. A cell phone service provider such as MTN BACHELOR OF COMMERCE IN SUPPLY CHAIN MANAGEMENT 49 ECONOMICS I Question 5 Which one of the following statements is incorrect? A. The three major flows in the economy are total production, total income and total spending. B. There are two sets of markets in a simple economy: goods markets and factor markets. C. In the simple circular flow of economic activity, “real” flows of goods and factors, and financial flows, move in opposite directions. D. Firms are buyers in goods markets and sellers in factor markets, while households are buyers in factor markets and sellers in goods markets. E. Firms are the largest purchasers of capital goods. Question 6 In the simple circular flow of economic activity, goods and services flow via: A. factor markets to goods markets. B. factor markets from households to firms. C. goods markets from households to firms. D. factor markets from firms to households. E. goods markets from firms to households. Question 7 In the circular flow of economic activity, ________ households in ________ markets represents ________ firms. Taxes and imports represent ________ the circular flow. A. expenditure by; goods; income to; injections into B. expenditure by; factor; income to; withdrawals from C. income to; factor; expenditure by; withdrawals from D. income to; goods; expenditure by; injections into E. expenditure by; factor; income to; injections into Question 8 In the circular flow of income and spending in South Africa, ________ firms in the factor market becomes ________ households, while ________ households in the goods market becomes ________ firms. Expenditure by foreigners on South African products constitutes ________ the circular flow. A. income to; spending by; income to; spending by; a leakage from B. income to; income to; spending by; spending by; an injection into C. spending by; income to; spending by; income to; an injection into D. spending by; spending by; income to; income to; a leakage from E. production of; spending by; production of; income to; a leakage from BACHELOR OF COMMERCE IN SUPPLY CHAIN MANAGEMENT 50 ECONOMICS I Question 9 In the context of the circular flow of economic activity, which of the following would NOT be a traditional activity of the government? A. Purchases of labour services from households. B. Purchases of capital goods from firms. C. Provision of public goods and services. D. Transfers of tax revenues to low-income groups or regions. E. Sales of consumer goods to foreign buyers. Question 10 In the circular flow of income and spending, ie the basic flow of income and spending between households and firms supplemented by the foreign, financial and government sectors: A. exports are leakages from the circular flow. B. investment is a leakage from the circular flow. C. savings are injections into the circular flow. D. imports are injections into the circular flow. E. taxes are leakages from the circular flow. Question 11 Which of the following is a leakage from the circular flow of income and expenditure in South Africa? A. Defence expenditure by the South African government, via contracts with local military suppliers. B. Government purchases of textbooks for state-run schools. C. The sale of export fruit to the European Union. D. Investment by South African Breweries in a new brewery. E. A decision by a major supermarket chain to sell Danish beer. Question 12 In a mixed economy, which of the following is not a legitimate area of government intervention? A. Expenditure on major infrastructure projects. B. Taxation of the profits of private companies. C. Taxation of the income of wage and salary earners. D. Control of prices that change in response to changes in demand. E. Transfers of tax revenues to poor communities. Question 13 In South Africa, the largest single component of aggregate expenditure is: A. net exports. B. private consumption spending. C. private investment spending. D. government spending on consumption and investment goods. E. private savings. BACHELOR OF COMMERCE IN SUPPLY CHAIN MANAGEMENT 51 ECONOMICS I Question 14 Aggregate spending on South African production comprises: A. private consumption, government spending, private investment and total savings. B. private consumption, government spending, private investment and net exports. C. private consumption, government transfers, private investment and net exports. D. private consumption, government investment, private savings and net exports. E. private consumption, government spending, private investment and spending by foreigners on South African goods. Question 15 Which one of the following statements is correct? A. The quality of the factors of production is insignificant; it is only the quantity that matters. B. The difference between capital goods and consumer goods is that the former maintain their full value over time. C. Capital as a factor of production refers to the amount of money required to produce a good or service. D. It is possible to increase the total income for the economy as a whole without increasing production. This is the miracle of the modern monetary economy. E. The total income in the economy is equal to the total remuneration of the factors of production. Question 16 Which one of the following statements is false? A. There are four broad groups of decision-making units in the economy: households, firms, government and the foreign sector. B. Imports are an important injection into the circular flow of income and spending in the economy. C. Taxes are a leakage or withdrawal from the flow of income and spending in the economy. D. Spending by households on consumer goods and services is called consumption spending. E. Spending on capital goods is called investment spending and is an important addition to, or injection into, the circular flow of income and spending in the domestic economy. Question 17 Which one of the following is NOT a major source of spending in the economy? A. Households B. Banks C. Firms D. Government E. The foreign sector BACHELOR OF COMMERCE IN SUPPLY CHAIN MANAGEMENT 52 ECONOMICS I Question 18 Which one of the following does NOT represent an injection into the flow of income and spending in the economy? A. Spending by local government.

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