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ECONOMICS ECONOMICS STUDENT TEXTBOOK GRADE 9 ECONOMICS STUDENT STUDENT...

ECONOMICS ECONOMICS STUDENT TEXTBOOK GRADE 9 ECONOMICS STUDENT STUDENT TEXTBOOK GRADE 9 TEXTBOOK GRADE 9 FEDERAL DEMOCRATIC REPUBLIC OF ETHIOPIA MINISTRY OF EDUCATION  Take Good Care of This Textbook This textbook is the property of your school. Take good care not to damage or lose it. Here are 10 ideas to help take care of the book: 1. Cover the book with protective material, such as plastic, old newspapers or magazines. 2. Always keep the book in a clean dry place. 3. Be sure your hands are clean when you use the book. 4. Do not write on the cover or inside pages. 5. Use a piece of paper or cardboard as a bookmark. 6. Never tear or cut out any pictures or pages. 7. Repair any torn pages with paste or tape. 8. Pack the book carefully when you place it in your school bag. 9. Handle the book with care when passing it to another person. 10. When using a new book for the first time, lay it on its back. Open only a few pages at a time. Press lightly along the bound edge as you turn the pages. This will keep the cover in good condition.  ECONOMICS STUDENT TEXTBOOK GRADE 9 Writers: Hussien Mohammed Oumer (M.Sc.) Tadesse Ababu Abebe (M.Sc.) Editors: Mesfin Ketema (M.Sc.) Enguday Ademe Mekonnen (Ph.D.) Birhanu Engidaw Getahun (Ph.D.) Illustrator: Endalkachew Mengesha Yasab (M.Sc.) Designer: Derejaw Lake Melie (M.Sc.) Evaluators: Mekonnen Bersisa Gadisa (Ph.D.) Tariku Mulushewa Dessea (M.Sc.) Ararssa Hora Dabi (M.Sc.) FEDERAL DEMOCRATIC REPUBLIC OF ETHIOPIA HAWASSA UNIVERSITY MINISTRY OF EDUCATION First Published August 2023 by the Federal Democratic Republic of Ethiopia, Ministry of Education, under the General Education Quality Improvement Program for Equity (GEQIP-E) supported by the World Bank, UK’s Department for International Development/DFID-now merged with the Foreign, Common wealth and Development Office/FCDO, Finland Ministry for Foreign Affairs, the Royal Norwegian Embassy, United Nations Children’s Fund/UNICEF), the Global Partnership for Education (GPE), and Danish Ministry of Foreign Affairs, through a Multi Donor Trust Fund. © 2023 by the Federal Democratic Republic of Ethiopia, Ministry of Education. All rights reserved. The moral rights of the author have been asserted. 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MOE/GEQIP-E/LICB/G-01/23 ,6%1  Table of Contents Contents Page Unit 1: Introducing Economics 1 1.1 Meaning of Economics.................................... 2 1.2 Branches of Economics.................................... 4 1.3 Methods and Approaches of Studying Economics............... 6 1.4 Decision Making Units.................................... 8 Unit Summary............................................. 10 Review Questions.......................................... 11 Unit 2: The Basic Economic Problems and Economic Systems 13 2.1 The Basic Economic Problems: Scarcity, Choice, and Opportunity Cost................................................. 14 2.2 Central Problems of Economies............................. 19 2.3 Economic Systems....................................... 21 Unit Summary............................................. 25 Review Questions.......................................... 26 Unit 3: Economic Resources and Markerts 29 3.1 Types of Resources and Factor Payments..................... 30 3.2 Renewable and Non-renewable Resources.................... 31 3.3 Types of Markets........................................ 32 3.4 Circular Flow of Economic Activities....................... 34 3.5 Land as an Economic Resource in Ethiopia................... 38 Unit Summary............................................. 40 Review Questions.......................................... 41 Unit 4: Introduction to Demand and Supply 43 4.1 Concept of Demand..................................... 44 4.2 Concept of Supply....................................... 47 4.3 Market Equilibrium...................................... 50 Unit Summary............................................. 52 Review Questions.......................................... 53 Unit 5: Introduction to Production and Cost 55 5.1 Definition of Production, Inputs and Outputs.................. 55 5.2 Periods of Production..................................... 57 5.3 Cost of Production....................................... 60 Unit Summary............................................. 64 Review Questions.......................................... 65 I Unit 6: Introduction to Money 67 6.1 Definition of Money...................................... 68 6.2 Evolution of Money..................................... 69 6.3 Functions of Money..................................... 73 6.4 Demand and Supply of Money............................. 74 6.5 Money and Electronic Money (e-money)..................... 77 Unit Summary............................................. 79 Review Questions.......................................... 80 Unit 7: Introduction to Macroeconomics 82 7.1 Definition of Macroeconomic Variales....................... 83 7.2 Macroeconomic Goals.................................... 85 7.3 Macroeconomic Problems................................. 86 Unit Summary............................................. 91 Review Questions.......................................... 92 Unit 8: Basic Entrepreneurship 94 8.1 Definition of Enterprise, Entrepreneur and Entrepreneurship..... 95 8.2 Creativity and Innovation in Solving Local Problems............ 97 8.3 Entrepreneurial Attitudes, Behaviour and Mind-set............. 99 8.4 Windows of Entrepreneurial Opportunities................... 102 8.5 Entrepreneurial Success, Teamwork and Diversity............. 103 8.6 Finance and Promotion of Entrepreneurship.................. 105 Unit Summary............................................ 108 Review Questions......................................... 109 II Introduction to the Book Any economy is composed of households, firms and the government. In order to understand the complex nature of the economy, one needs to have a deeper understanding of each of the components in different market settings to realise how the whole economy works. To this end, economists conventionally classify economics into microeconomics and macroeconomics. This student textbook covers basic topics in both microeconomics and macroeconomics. The microeconomics part of the textbook introduces the fundamental economic concepts such as scarcity, opportunity cost, and the laws of demand and supply. In addition, this part of the textbook covers the concepts of production and costs of production. The macroeconomics part of the textbook covers topics related to the concepts of measurement and problems of economy-wide performance. The objective of the textbook is to help students grasp the basic principles of Economics. It also introduces students to macroeconomic tools, which provide students with the necessary theoretical and analytical knowledge of basic economic concepts, thereby, increasing the students’ engagement in various practical and theoretical issues. Furthermore, it introduces students to the basic concepts of money, macroeconomics and entrepreneurship. Specifically, the textbook will: y Introduce the students to fundamental concepts of economics in general and the basics of microeconomics and macroeconomics in particular. y Acquaint the students with the basic concepts of demand, supply and market equilibrium. y Introduce the students to the concepts of production and costs as well, thereby to understand how firms organize their production process and decide to minimize their costs. y Introduce the students to the concepts of money, macroeconomics and entrepreneurship. The textbook is organized into 8 units. Unit 1 focuses on introducing economics. Unit 2 deals with the basic economic problems and economic systems. Unit 3 focuses on economic resources and markets. Unit 4 introduces the concepts of demand and supply. Unit 5 deals with the concepts of production and cost. Unit 6 introduces the concept of money. Unit 7 deals with introduction to macroeconomics. Finally, Unit 8 presents basic entrepreneurship. III  Unit Introducing Economics 1 Introduction Economics is an extremely useful subject, and its study and knowledge have acquired greater importance in recent times. As you know, an increasing number of countries all over the world are facing economic problems today, and this is one reason behind the growing importance of economics. Moreover, the study of economics advances logical thinking and analytical skills, and enhances our abilities for observation and judgment. So, we conclude that the study and knowledge of economics is useful to each of us and to the society as a whole. This unit deals with the definition and nature of economics, branches of economics, methods and approaches of studying economics, and decision-making units in an economy. Unit Objectives At the end of this unit, students will be able to: 6 Define economics. 6 Explain the difference between microeconomics and macroeconomics. 6 Describe the methods used to study economics. 6 Explain the characteristics of the three decision-making units. ✍ Start-up Activities 1. What comes to your mind when you hear the term economics? 2. The foundation of modern economics rests on its two major branches. In pairs, discuss what the two branches are. 3. Is economics a positive science or a normative science, or both? Give your justification. 4. What are the basic decision-making units of an economy? 👉 Key Concepts Economics, economic theory, efficient allocation, nature of economics, scarcity, microeconomics, macroeconomics, deductive method, inductive method, normative economics, positive economics, households, business firms, and government 1 Unit 1: Introducing Economics  1 1 Meaning of Economics At the end of this section, students will be able to: 6 Define the term economics and 6 Explain the nature of economics. ✍ Start-up Activity What comes to your mind when you hear the term economics? Definition of Economics The term economics is originally derived from the ancient Greek word oikonomia, meaning the management of a family or a household. This reveals that the subject of economics was first studied in ancient Greece. Economics is a branch of the social sciences. Economics is an important discipline, and its prominence has increased in recent years in response to worldwide economic problems. At present, poverty, unemployment, inflation, recession, population explosion, etc., are worldwide problems. In order to understand and find solutions to such problems, an in-depth knowledge of economics is essential. The definition of economics has developed through time. Economic theory has advanced over time, and different themes have gradually been included into the field. There is no completed definition of economics yet, and the definition is essentially under improvement in areas such as the wealth definition, the welfare definition and the scarcity definition. Based on the above considerations, economics can be defined as follows. Economics is a branch of social science that studies the efficient allocation of scarce resources so as to attain the maximum fulfillment of human needs. As a science of choice, economics studies how people choose to use scarce or limited productive resources (land, labour, equipment, technical knowledge, etc.) to produce various commodities. The following statements are derived from the above definition of economics: y Economics studies about scarce resources; y It studies about allocation of resources; y Allocation of resources should be efficient; Unit 1: Introducing Economics 2  y Human needs are unlimited. The objective of economics is to study how to satisfy the unlimited human needs up to the maximum possible degree through allocating the scarce resources efficiently. The Nature of Economics The lack of uniformity in defining economics emanates from the shifting views about the subject matter over time. Some economists consider economics a ‘science’ while others consider it an “art.” Economics as a Science Science produces a systematic and organised body of knowledge that links causes and effects. This knowledge can be regarded as the knowledge of “what is”. In economics, several facts are systematically collected, classified, analysed, and interpreted to make predictions about the future. In this sense, economics could be considered a science. Economics as an Art One of the important definitions of art is a technique or a way of doing or achieving something. When dealing with problems such as unemployment, poverty, and inflation, economics provides principles and methods through which these problems can be solved. Hence, economics extensively examines the nature and causes of economic problems and sets the procedures for finding their solutions. From this perspective, we can consider economics as an art. Ă Activity 1 1 1. What is meant by the term economics? 2. Describe the nature of economics. Is economics a science or an art or both? Why? 3 Unit 1: Introducing Economics  1 2 Branches of Economics At the end of this section, students will be able to: 6 Distinguish between microeconomics and macroeconomics. 6 Describe the fundamental problem of microeconomics and macroeconomics. ✍ Start-up Activity The foundation of modern economics rests on its two major branches. In pairs, discuss what the two branches are. The field and scope of economics is growing rapidly and has come to encompass a wide range of themes. Accordingly, different new branches of the subject have emerged over time. Some of these branches are: development economics, environmental economics, industrial economics, international economics, labor economics, mathematical economics, monetary economics, welfare economics, resource economics, behavioural economics, experimental economics, health economics, etc. However, the foundation of modern economics rests on two of its major branches, namely, microeconomics and macroeconomics. Microeconomics Microeconomics is concerned with the economic behavior of individual decision making units such as households, firms, and governments and their interactions and organizations through markets and industries. In other words, it deals with how households and firms make decisions and how they interact in specific markets. For example, the economic activities of a consumer, a producer, a firm or an industry, the income of individuals, the determination of prices of various products and factors of production, etc. fall under the scope of microeconomics. The fundamental problem of microeconomics is associated with resource allocation or the problem of price- determination. Macroeconomics Macroeconomics is a branch of economics that deals with the effects and consequences of the aggregate behaviour of all decision-making units in an economy. In other words, it examines the interrelations among various aggregate economic variables. For example, total employment, total output, national income, total investment, total consumption, etc. in an economy. In general, macroeconomics investigates the interrelationships of numerous aggregate economic variables, as well as their determination and the causes of their fluctuations over time. The fundamental problem of macroeconomics Unit 1: Introducing Economics 4 is associated with full employment of economyic resources. Difference Between Microeconomics and Macroeconomics Microeconomics is the study of individual decision-making units of an economy, like individual households and business firms. In contrast, macroeconomics is the study of an economy as a whole, and its focus is the study of broad, economy-wide aggregates. For example, when we study the price determination of a commodity in a market, our study is micro-analysis and is treated by microeconomics, but if we study the trend of the general price level of commodities over time in a country, our study is macro- analysis and is treated by macroeconomics. Note that both microeconomics and macroeconomics are complementary to each other. In other words, macroeconomics cannot be studied independently of microeconomics. Table 1.1 summarises the main differences between microeconomics and macroeconomics. Table 1.1 Main differences between microeconomics and macroeconomics Microeconomics Macroeconomics 1. Studies individual economic units in 1. Studies an economy as a whole and an economy. its aggregates. 2. Deals with income, prices, outputs, 2. Deals with national income and etc. output and general price level. 3. Its central problem is price 3. Its central problem is determination determination and allocation of of level of income and employment. resources. 4. Its main tools are the demand and 4. Its main tools are aggregate demand supply of particular commodities and aggregate supply of an economy and factors. as a whole. 5. It helps to solve the central 5. Helps to solve the central problem of problems of what, how and for full employment of resources in the whom to produce. economy. 6. Discusses how equilibrium of 6. Deals with the determination a consumer, a producer or an of equilibrium income and industry is attained. employment at aggregate level. Examples: Price of Teff, price of Examples: GDP of Ethiopia, general Orange, income of Aberash, saving of price level in Ethiopia, etc. Chala, etc. Ă Activity 1 2 1. Make a distinction between microeconomics and macroeconomics. 2. Explain the fundamental problems of microeconomics and macroeconomics. 5 Unit 1: Introducing Economics  1 3 Methods and Approaches of Studying Economics At the end of this section, students will be able to: 6 Explain the methods of studying economics; and 6 Distinguish between positive and normative economics. ✍ Start-up Activity Is economics a positive science or a normative science, or both? Give your justification. 1 3 1 Methods of Studying Economics The fundamental objective of economics, like any science, is the establishment of valid generalisations about certain aspects of human behaviour. Those generalisations are known as theories. A theory is a simplified picture of reality. Economic theory provides the basis for economic analysis, which uses logical reasoning. There are two methods of logical reasoning, namely, deductive and inductive methods. Deductive Method The deductive method proceeds from general to particular. It involves reasoning from certain principles to the analysis of specific facts. In effect, it enables one to arrive at a particular conclusion starting from a general statement. The conclusions are then verified against observed facts. Example: man is mortal. Abebe is a man. Therefore, Abebe is mortal. Inductive Method The inductive method is a process of reasoning from a part to the whole. This means it involves reasoning from the particular to the general or from the individual to the general. In this method, economists approach problems of science from a practical angle, reducing the gulf between theory and practice. The inductive method develops economic theories on the basis of observations and experiments. In this method, comprehensive data about the prevailing economic conditions is collected. Then, an attempt is made to arrive at a hypothesis based on the observations and the collected data. Example: During the harvest period, one may observe that the prices of grains decrease. This may be associated with an increase in the supply of grain at that time of the year. From this observation, a generalisation can be made: “keeping other factors constant, an increase in supply leads to a fall in prices.” Unit 1: Introducing Economics 6 Note that deductive and inductive methods are complementary, i.e. one supports the other. They are not competing methods. Induction and deduction always complement each other in reasoning, but proper induction is not necessary for the truth of deduction. Induction generates general conclusions from specific instances, whereas deduction generates knowledge of specific instances from general knowledge. 1 3 2 Approaches of Studying Economics Economics can be analysed from the point of view of two perspectives, namely, positive economics and normative economics. Positive economics is like a science that deals with knowledge and facts, while normative economics entails value judgment in applying the knowledge to solve problems. Positive economics is concerned with the analysis of facts and attempts to describe the world as it is. It tries to answer the questions: what is; what was; or what will be? It does not judge a system as good or bad, better or worse. Examples: 1. The number of secondary schools in Ethiopia is increasing. 2. The current inflation rate in Ethiopia is 12 percent. Both of the above statements are known as “positive statements.” These statements are concerned with real facts and information. Any disagreement on positive statements can be cleared up with reference to the facts. Normative economics is concerned with questions such as, “what the economy ought to be?” Or what the economy should be? It evaluates the desirability of alternative outcomes based on one’s value judgments about what is good and what is bad. In this case, since normative economics is loaded with value judgments, what is good for an individual may not be good for another. Normative analysis is a matter of opinion that cannot be proved or disproved with reference to facts. As a result, any disagreement on a normative statement can be resolved through voting. Examples: 1. The government should introduce school feeding programmes in all schools. 2. There should be government intervention in the economy, whenever necessary. Ă Activity 1 3 1. Describe the methods used to study economics. 2. Explain the difference between positive and normative economics. 7 Unit 1: Introducing Economics 1 4 Decision Making Units At the end of this section, students will be able to: 6 Identify the decision-making units of an economy, and 6 Explain the objectives of each decision-making unit. ✍ Start-up Activity What are the basic decision-making units of an economy? An economy is divided into different sections. These sections are sometimes known as decision-making units of the economy. Customarily, they are described as economic agents. The basic decision making units of an economy are households, business firms, and the government. We discuss each of these decision making units of an economy as follows. 1 Households Households are the chief owners of the factors of production, which encompass land, labour, capital, and entrepreneurship. They sell the services of these factors (termed “factor service”) to producers and, in return, receive their income in the form of rent, wages, interest, and profit. They spend an enormous portion of their income on purchasing goods and services from the producers.Nonetheless, they save part of their income, and also pay taxes to the government out of their income. 2 Business Firms In economics, we use the terms “business firms” and “producers” alternately. Firms hire the services of factors of production from households to produce commodities that they sell to households, to other firms, to the government or to other countries. Firms are the principal buyers of factors of production, and they are the leading producers of commodities. Business firms consist of both private and government enterprises. 3 Government In economics, government is taken in the sense of ‘general government’ in order to disregard government enterprises. The government purchases goods and services from producers and factors services from households. It uses these commodities and factor services to provide free services, such as police, education, medical facilities, sanitation facilities, judicial services, etc., to the people in order to satisfy their combined needs for those services. The general government gets its income mainly from taxes levied on households and on business firms in the form of direct and indirect taxes. Unit 1: Introducing Economics 8 The government imposes compulsory tax levies on individuals or firms. Taxes are levied in almost every country of the world, primarily to raise revenue for government expenditures, although they serve other purposes as well. The primary goal of a national tax system is to generate revenues to pay for government expenditures. Because public expenditures tend to grow with the national product, taxes are the main vehicles of government to finance the public expenditure. Consequently, every citizen is responsible to pay tax for the government to sustain the activities of public investments to ensure sustainable development of a country. Ă Activity 1 4 1. What are the decision-making units of an economy? 2. Discuss the objectives of decision-making units in an economy. 9 Unit 1: Introducing Economics  Unit Summary Economics is a social science that studies the efficient allocation of scarce resources in order to attain the maximum fulfillment of unlimited human needs. Economics has two main branches: microeconomics (deals with the economic behaviour of individual economic units and individual economic variables) and macroeconomics (deals with the functions of the economy as a whole). The central objective of economics is the efficient utilisation of scarce resources to satisfy unlimited human needs. Economics uses two methods of logical reasoning: deductive (involves reasoning from certain principles to the analysis of specific facts) and inductive (involves reasoning from the particular to the general) methods. Further, economics uses two approaches: positive economics (which deals with knowledge and facts) and normative economics (which entails value judgment in applying the knowledge to solve problems). An economy is divided into different parts, which are sometimes called decision- making units. The basic decision making units of an economy are households (which are the chief owners of factors of production: land, labour, capital, and entrepreneurship), business firms (which hire the services of factors of production from households to produce commodities), and the government (which gets its income mainly from taxes levied on households and business firms in the form of direct and indirect taxes). Unit 1: Introducing Economics 10  Review Questions Part I: Write ‘True’ if the statement is correct or ‘False’ if it is not correct for each of the following statements. 1. Microeconomics deals with the determination of prices in individual markets. 2. Macroeconomics deals with the behaviour and decisions of individual economic units. 3. Microeconomics is also known as the theory of income and employment. 4. Microeconomics studies the decisions of individual people and firms, while macroeconomics studies the entire national economy. 5. The deductive method entails reasoning from certain principles to the analysis of facts. 6. Normative economics offers recommendations based on value judgments. 7. A household can be one person or more people who live under one roof but make separate financial decisions. 8. Businesses take the initiative to combine resources in order to produce goods and services. Part II: Choose the correct answer among the alternatives for the following questions 1. Microeconomics concerns itself with all of the following topics except: A. Economic activities of individual firms, households, and other organizations. B. Forces of supply and demand in a particular market. C. Consumer behaviour and firms’ output decisions. D. The behaviour and operation of the economy as a whole. 2. Which of the following is a normative statement? A. Falling prices are good for consumers. B. Falling prices encourage consumer spending. C. The falling price of housing affects real income. D. Rising prices encourage production. 3. Which of the following would best be described as a positive statement about economics? A. Free markets are inherently unfair institutions. B. Countries normally experience higher unemployment during recessions. C. Business profit should be redistributed through taxes to benefit more of society. D. Increasing taxes is positively wrong. 11 Unit 1: Introducing Economics 4. Which of the following is a normative statement? A. Not all resources experience price rises. B. Poverty is something society should reduce. C. An increase in house prices is likely to cause a reduction in demand D. Some of the earth’s scarce resources are non-renewable. 5. Which of the following is the basic decision making unit of an economy? A. Households C. Business firms B. Government D. All of the above 6. Households spend an enormous portion of their income in purchasing goods and services from the A. producers C. other consumers B. government D. none of the above 7. Which of the following statements would best describe firms? A. They are the main buyers of factors of production B. They are the leading producers of commodities. C. They consist of both private and government enterprises. D. All of the above 8. General government gets its income mainly from taxes levied on A. households and business firms in the form of direct and indirect taxes B. goods and services it provides to the producers C. factor services it provides to households. D. none of the above Part III: Answer the following questions briefly and to the point. 1. Define economics from the perspective of wealth, welfare, and scarcity. Which definition better suits economics? Why? 2. “Study and knowledge of economics are extremely useful and important.” Explain. 3. Why do we study economics? Have you gained anything from this unit? Discuss them. 4. Explain the distinction between microeconomics and macroeconomics. 5. What do you understand by “positive economics” and “normative economics”? 6. Explain why economics deals with the allocation and efficient utilisation of scarce resources only. 7. In recent years, especially around big cities, there is the problem of air pollution and the likelihood of poisoning is high. Given this scenario, do you think that air is a free resource? Justify your answer. 8. Explain the main features of the various decision-making units of an economy. Unit 1: Introducing Economics 12  Unit The Basic Economic Problems 2 and Economic Systems Introduction Obviously, you have heard about economics, and perhaps you have talked a lot about it in your day-to-day activities. You may have questions like: “What is an economic problem?” What does “efficient allocation” mean? What are human needs? This unit will answer these questions and introduce you to the fundamental concepts of economics at large. This unit focuses on the basic economic problems, the central problems of economies, and economic systems. Unit Objectives At the end of this unit, students will be able to: 6 Describe the basic economic problem. 6 Recognize how the basic economic problems affect individuals, firms, and society. 6 Compare and contrast the main economic systems. ✍ Start-up Activities 1. What basic concepts in economics can you mention? What do you mean by these concepts? 2. Discuss in pairs the basic economic problems and report the results of your discussion to the whole class. 3. What are the main types of economic systems? How do you classify them? 👉 Key Concepts Choice, economic problem, opportunity cost, scarcity, shortage, allocation of resources, choice of technique, problem of distribution, capitalism, command economy, freedom of choice, mixed economy, private property, profit motive, and traditional economy. 13 Unit 2:The Basic Economic Problems and Economic Systems  2 1 The Basic Economic Problems: Scarcity, Choice, and Opportunity Cost At the end of this section, students will be able to: 6 Define concepts like scarcity, choice, opportunity cost, and production possibility frontier 6 Explain the difference between scarcity and shortage of resources 6 Calculate the opportunity cost of a good. ✍ Start-up Activity What basic concepts in economics can you mention? What do you mean by these concepts? Clearly, the scarcity of resources relative to unlimited human wants is a plain fact of life. Households, producers, and the whole economy are faced with the problem of scarcity of natural and human-made resources. Consequently, it is necessary to use resources as efficiently as possible. In effect, resources should be allocated efficiently among the prevailing choices. Some basic economic concepts are described as follows. 1 Scarcity The fundamental economic problem that any human society faces is the problem of scarcity. Scarcity refers to the fact that all economic resources that a society wants to use to produce goods and services are finite or limited in supply. However, their being limited should be expressed in relation to human wants. Thus, the term “scarcity” reflects the imbalance between our wants and the means to satisfy those wants. Scarcity of resources generates economic problems. If resources were fully abundant, there would be no economic problems at all. Note: Scarcity does not mean shortage. A good is said to be scarce if the amount available is less than the amount people wish to have at zero price. On the other hand, we say that there is a shortage of goods and services when people are unable to get the amount they want at the prevailing price. A shortage is a specific and short term problem, while scarcity is a universal and endless problem. 2 Choice If resources are scarce, output will be limited. If output is limited, we cannot satisfy all of our wants. So, a choice must be made. Due to the problem of scarcity, individuals, Unit 2:The Basic Economic Problems and Economic Systems 14 firms, and governments are forced to choose as to what output to produce, in what quantity, and what output not to produce. In short, scarcity implies choice, which, in turn, implies an opportunity cost. Scarcity → limited resource → limited output → unlimited human want → Choice involves costs → opportunity cost 3 Opportunity Cost In a world of scarcity, a decision to have more of one thing, at the same time, means a decision to have less of another thing. Thus, the value of the next best alternative that must be sacrificed is the opportunity cost of the decision. Definition: Opportunity cost is the amount or value of the next best alternative that must be sacrificed (forgone) in order to obtain one more unit of a product. For example, suppose the country spends all of its limited resources on the production of cloth or computer. If a given amount of resources can produce either one meter of cloth or 20 computers, then the opportunity cost of one meter of cloth is the value of 20 computers. Note the following points about opportunity cost: y It is measured in terms of goods and services but not in terms of money. y It should be in line with the principle of substitution of one activity for another. To sum up, when the opportunity cost of any activity increases people substitute other activities in its place. In effect, the cost of producing a quantity of a commodity is measured in terms of the quantity of some other commodity that could have been produced in its place. In short, opportunity cost comes into being due to the problem of scarcity of resources and the fact that resources have alternative uses. 4. The Production Possibilities Frontier The production possibilities frontier or curve (PPF/PPC) is a curve, which shows the various possible combinations of goods and services that the society can produce given its resources and technology. To draw the PPF/PPC we need the following assumptions. 1. The quantity and quality of economic resource available for use during the year is fixed. 2. There are two broad classes of output to be produced over the year. 3. The economy is operating at full employment and is achieving full production. 15 Unit 2:The Basic Economic Problems and Economic Systems  4. Technology does not change during the year. 5. Some inputs are better adapted to the production of one good than to the production of the other (specialization). Definition of terms: y Production efficiency is an economic concept that indicates the maximum level of output a manufacturer can produce without lowering the output of another product. y Resource allocation is the distribution of finite resources to specified purposes selected from among several feasible possibilities. Suppose a hypothetical economy produces food and computer given its limited resources and available technology (see Table 2.1). Table 2.1: Alternative production possibilities of a certain nation Production alternatives Types of products Unit A B C D E Food Metric tones 500 420 320 180 0 Computer Number 0 500 1000 1500 2000 We can also display the above information with a graph as follows. Figure 2.1 Production possibilities frontier/curve for Food and Computer Note the following points: y All points on the curve are both attainable and efficient. y Any point inside the curve (for example, point Q) is attainable but inefficient. Unit 2:The Basic Economic Problems and Economic Systems 16  y Any point outside the curve (for example, point R) is unattainable. The PPF describes three important concepts: i) The concept of scarcity: even if a society employs all of its resources and uses them optimally, it cannot produce an infinite amount of output. ii) The concept of choice: any movement along the curve denotes a shift in preference. iii) The concept of opportunity cost: when the economy produces on the PPF, producing more of one good necessitates sacrificing some of another, as reflected by the PPF’s downward slope. Related to the opportunity cost, we have a law known as the law of increasing opportunity cost. This law states that as we produce more and more of a product, the opportunity cost per unit of the additional output increases. This makes the shape of the PPF concave to the origin. Opportunity costs increase when we produce more of one good because economic resources are not completely adaptable to alternative uses (specialization effect). Referring to Table 2.1 above, if the economy is initially operating at point B, what is the opportunity cost of producing one more unit of computer? Moving from production alternative B to C, we have: Note: we take absolute value of opportunity cost as we are interested to interprete its magnitiude. 5. Economic Growth and the PPF Economic growth, which is an increase in the total output level, occurs when one or both of the following conditions occur. 1. Increase in the quantity and quality of economic resources. 2. Advances in technology Economic growth is represented by the outward shift of the PPF as depicted in Figure 2.2 below. 17 Unit 2:The Basic Economic Problems and Economic Systems  Figure 2.2 Economic growth with a new PPF An economy can grow because of an increase in productivity in one sector of the economy. For example, improved technology applied to either food or computers would be illustrated by a shift of the PPF along the Y- axis or X-axis. This is called asymmetric growth. Figure 2.3 Effects of technological advancements in: a) food production and b) computer production Ă Activity 2 1 1. Explain the following concepts briefly. a. Choice b. Opportunity Cost c. Scarcity 2. What is the main difference between scarcity and shortage of resources? Unit 2:The Basic Economic Problems and Economic Systems 18  2 2 Central Problems of Economies At the end of this section, students will be able to: 6 Describe the basic economic problems. 6 Explain how the basic economic problems affect individuals, firms, and society. ✍ Start-up Activity Discuss in pairs the basic problems of economics and report the results of your discussion to the whole class. Basic Economic Questions Economic problems, which an economic system faces owing to scarcity of resources are known as basic economic problems. These problems are common to all economic systems. They are also referred to as central problems of an economy. Consequently, every modern society should answer the following three basic questions: 1. What goods and services are to be produced? 2. How to produce goods and services? 3. For whom goods and services are to be produced? Each of these basic questions is briefly discussed as follows. 1 What goods and services are to be produced? This question is also called the problem of the allocation of resources. It implies that every economy must decide on the type and quantity of goods to be produced. The economy must make choices between the productions of: consumption and capital goods, civil and military goods, and necessity and luxury goods. 2. How to produce goods and services? This question is also referred to as the problem of choice of technique. Once an economy has reached a decision regarding the types of goods and services to be produced, and has determined their respective quantities, it must decide how to produce them, which entails choosing between alternative methods or techniques of production. For example, wheat can be produced using primitive tools and manual labour, or using modern machinery and some labour. The various techniques of production can be classified into two groups: labour- 19 Unit 2:The Basic Economic Problems and Economic Systems intensive techniques and capital-intensive techniques. A labour-intensive technique involves the use of more labour, relative to capital, per unit of output. In contrast, a capital-intensive technique involves the use of more capital, relative to labour, per unit of output. The choice between these techniques depends on the available supplies of diverse production factors and their relative prices. Making a good choice is important for making the best possible use of limited resources to produce the maximum number of goods and services. 3. For whom are goods and services to be produced? This problem is also called the problem of the distribution of the national product of a country. It relates to how a material product is to be distributed among the different members of a society. The economy should decide, for instance, whether to produce for the benefit of a few rich people or for the majority of poor people. An economy that wants to produce for the benefit of the maximum number of people would first try to focus on the production of necessary goods for the whole population, and then on the production of luxury goods. All these, and other fundamental economic problems, focus on human needs and wants. Many human efforts in modern society are directed towards the production of goods and services in order to satisfy human needs and wants. These human efforts result in economic activities that occur within the framework of an economic system. Ă Activity 2 2 1. What is the basic economic problem of all societies? 2. How does the fundamental economic problem affect individuals, firms, and society? Unit 2:The Basic Economic Problems and Economic Systems 20  2 3 Economic Systems At the end of this section, students will be able to: 6 Define an economic system. 6 Compare and contrast the main types of economic systems. ✍ Start-up Activity What are the main types of economic systems? How do you classify them? The way a society tries to answer the basic economic questions mentioned above can be summarized by a concept known as the “economic system.” An economic system is a set of organizational and institutional arrangements established to answer the basic economic questions. The different types of economic systems are classified on the basis of ownership of economic resources. The main types of economic systems are: traditional economy or subsistence, capitalist economy, command economy, and mixed economy. These economic systems are discussed as follows. 1 Traditional Economy A traditional economy is a system that relies on customs, history, and time-honored beliefs. Tradition guides economic decisions such as production and distribution. Societies with traditional economies depend on agriculture, fishing, hunting, gathering, or some combination of them. They use barter instead of money. Most traditional economies operate in emerging markets and developing countries. They are often in Africa, Asia, Latin America, and the Middle East. Traditional economies can also be found in pockets throughout the world, even in developing countries. Main features of Traditional Economy y Traditional economies centre on a family or tribe, and they use traditions gained from the elders’ experiences to guide day-to-day life and economic decisions. y A traditional economy exists in a hunter-gatherer and nomadic society: These societies cover vast areas to find enough food to support them. They follow the herds of animals that sustain them, migrating with the seasons. These nomadic hunter-gatherers compete with other groups for scarce natural resources. There is little need for trade since they all consume and produce the same things. y Most traditional economies produce only what they need. There is rarely a surplus or leftovers. That makes it unnecessary to trade or create money. 21 Unit 2:The Basic Economic Problems and Economic Systems  y When traditional economies do trade, they rely on barter. It can only occur between groups that do not compete. For example, a tribe that relies on hunting exchanges food with a group that relies on fishing. Because they just trade meat for fish, there is no need for cumbersome currency. y They start to evolve once they start farming and settling down. They are more likely to have a surplus, such as a bumper crop, that they use for trade. When that happens, the groups create some form of money. That facilitates trading over long distances. 2 Capitalist Economy (Capitalism) Capitalism is the oldest formal economic system in the world. It became widespread in the middle of the 19th century. In this economic system, all means of production are privately owned, and production takes place at the initiative of individual private entrepreneurs who work mainly for their own profit. Government intervention in the economy is negligible. This system is also referred to as a free market economy, simply a market economy, or laissez faire. Main features of Capitalist Economy y The Right to Private Property: This is the central feature of a capitalist economy. According to the principle of capitalism, all economic or productive factors, including land, factories, machinery, mines, etc. are under private ownership. y Freedom of Choice by Consumers: Consumers can buy the goods and services that suit their tastes and preferences. Producers produce goods in accordance with the demands of consumers. This is called the principle of consumer sovereignty. y Competition: In a capitalist economy, competition exists among sellers or producers of similar goods to attract customers. Among buyers, there is competition to obtain goods. Among workers, the competition is to get jobs. Among employers, it is to get workers and investment funds. y Limited government involvement : The government does not interfere in day- to-day economic activities but confines itself to defence and the maintenance of law and order. y Self-Interest: Self-interest guides and motivates individuals in the economy to strive for economic gain. y Inequalities in income: In the capitalist economy, there is a large income inequality between the rich and the poor. Unit 2:The Basic Economic Problems and Economic Systems 22 3 Command Economy (Socialism) A command economy is also referred to as a socialist economy. In a command economy, the economic institutions that are engaged in the production and distribution of goods are owned and controlled by the state and are put to use under a centralised plan. Socialism started in Russia with the outbreak of the Great October Revolution in 1917. Since then, many countries in the world, including China, Vietnam, former East Germany, Poland, Hungary, Cuba, and Ethiopia, have adopted it. Several countries adopted this system after the Second World War. Nevertheless, socialism lost its acceptance and most of the former socialist countries adopted free market economies. Main features of Command Economy y Collective Ownership: All means of production are owned by society as a whole, and there is no right to private property. y Central Economic Planning : Resource allocation is done by the controlling authority based on socio-economic goals. y Strong Role of Government: Government has complete control over all economic activities. y Relative Equality of Incomes: Private property does not exist in a command economy, the profit motive is absent, and there are no opportunities for the accumulation of wealth. In comparison to capitalism, all these factors lead to greater equality in income distribution in income terms. 4 Mixed Economy A mixed economy is one of the economic systems having the combination of both the characteristics of capitalism and socialism: a combination of private and public ownership of the means of production, with some measures of control by the government. It incorporates some of the features of both capitalist and command economies and allows private and public sectors to co-exist. Main Features of Mixed Economy y Co-existence of Public and Private Sectors: Public and private sectors co- exist in this system. Their respective roles and aims are well-defined. Industries of national and strategic importance, such as heavy and basic industry, defence services, power generation, etc. are set up in the public sector, whereas the consumer-goods industry and small-scale industry are developed in the private sector. 23 Unit 2:The Basic Economic Problems and Economic Systems y Economic Planning: The government uses instruments of economic planning to achieve coordinated rapid economic development, making use of both the private and the public sectors. y Economic Equality: Private property is allowed, but rules exist to prevent the concentration of wealth. It is the belief that people should receive the same rate of pay for a job, regardless of race, gender, or other characteristics that are not related to their ability to perform the task. Ă Activity 2 3 1. What is meant by an economic system? 2. Explain the differences and similarities between capitalism and socialism. 3. Choose the economic system that is more relevant to the Ethiopian economy today and explain why it is so. Unit 2:The Basic Economic Problems and Economic Systems 24  Unit Summary Basic economic problems are the problems facing an economy today due to the scarcity of resources. These problems are common to all economies in the world. They are also known as central problems of economies. These problems originate from the scarcity of resources. Scarcity is the imbalance between unlimited human wants and limited available resources. In effect, it is the tension between the unlimited human wants and the means of satisfying them. The fundamental economic problem focuses around the unlimited human wants and limited means of satisfying those wants. Many human efforts in any society are directed towards the production of goods and services in order to satisfy the demand of the society for those goods and services. Production Possibility Curve (PPC) is a curve that depicts all possible combinations of the maximum output that can be produced in an economy with given resources and technology. The PPC describes the concepts of scarcity, choice and opportunity cost. Linked to the opportunity cost, there is a law known as the law of increasing opportunity cost, which states that as we produce more and more of a product, the opportunity cost per unit of the additional output increases. This makes the shape of the PPC concave to the origin. The way a society tries to answer the basic economic questions is summarised by a concept known as an economic system. An economic system is a set of organisational and institutional arrangements established to answer basic economic questions. In economics, there are four basic economic systems. These are traditional, capitalist, command, and mixed economies. 25 Unit 2:The Basic Economic Problems and Economic Systems  Review Questions Part I: Write ‘True’ if the statement is correct or ‘False’ if it is not correct for each of the following statements. 1. Economics is best described as the study of how people, businesses, governments, and societies make choices to cope with scarcity. 2. Although a resource exists in unlimited supply, it can be considered as scarce. 3. Opportunity cost is the cost of a decision expressed in terms of the next best alternative. 4. Points lying outside the production possibility frontier represent combinations of two goods that correspond to the maximum possible output. 5. Economic growth can be achieved only through technological advancement. 6. Asymmetric growth occurs when an economy can grow due to an increase in productivity in one sector of the economy 7. A command economy allows economic freedom for consumers and producers. 8. A capitalist economy is one in which resources are jointly allocated through the price mechanism and the government. 9. Societies with traditional economies depend on agriculture, fishing, hunting, gathering, or some combination of them. 10. Most traditional economies produce surplus product which necessitates trade. Part II: Choose the correct answer among the alternatives for the following questions 1. The concept of opportunity cost is based upon the principle of A. peoples need C. scarcity B. consumption D. profit 2. The concept of choice would become irrelevant if A. a very simple economy is considered C. capital was eliminated B. poverty were eliminated D. scarcity was eliminated 3. Which of the following statements best describes the economic problem? A. The fact that economies often go into decline. B. The presence of high level of unemployment. C. Matching endless wants with limited resources. D. The problem that high exchange rates discourage exports. 4. The production possibility frontier can be considered as a measure of A. potential output C. nominal output B. Real output D. total output Unit 2:The Basic Economic Problems and Economic Systems 26 5. Any point lying on a production possibility curve indicates: A. inefficient utilisation of resources C. full utilisation of resources B. unattainable goods to be produced D. none of the above 6. A production possibility curve is: A. a horizontal straight line C. an upward sloping curve B. a vertical straight line D. a downward sloping curve 7. Which of the following is not a feature of a capitalist economy? A. right to private property C. collective ownership B. inequality of income D. None of the above 8. Which of the following is a feature of a command economy? A. maximum social welfare C. central economic planning B. collective ownership D. All of the above 9. Which of the following features persist in a mixed economy? A. All resources are allocated through the price mechanism. B. Resources are allocated through the price mechanism and the government. C. There is a big income inequality between the rich and the poor. D. The government commands how all resources are used. 10. Which of the following best captures the three basic economic questions of every society? A. What, when, and why? C. How much, how often, and for whom? B. What, how, and for whom? D. When, where, and why? Part III: Work out the following problems based on the given information. 1. Assume that a certain simplified economy produces only two goods, X and Y, with given resources and technology. The following table gives the various possible combinations of the production of the two goods (all units are measured in millions of tons). Table 2.2: The production possibilities schedule of the two goods, X and Y. Production Possibility Good X Good Y Opportunity Cost of Good X A 0 100 B 2 90 C 4 60 D 6 20 a) Calculate the opportunity cost of the production of good X at each point and fill the answers in the table above. What law does the trend in those values exhibit? b) What changes are required for this economy to shift the PPF outward? 27 Unit 2:The Basic Economic Problems and Economic Systems 2. Calculate the opportunity cost, per unit of sugar in terms of cloth, at the different production possibilities for the hypothetical data on a country shown in the table below. Table 2.3 Hypothetical production possibility schedule for cloth and sugar Production possibilities Cloth (million metres) Sugar (million kg) A 0 50 B 1 45 C 2 38 D 3 30 E 4 20 F 5 6 Part IV: Answer the following questions briefly and to the point. 1. What are the central problems of an economy? Discuss them in detail. 2. Define scarcity, choice and opportunity cost. Can you link them to your day to day lives? 3. What do you understand by the term economic system? How can economic systems be classified on the basis of ownership of resources? 4. Discuss the economic systems in Ethiopia during the FDRE, Military and Imperial regimes. 5. What is capitalism? Describe its main features. 6. Discuss the basic characteristics of a command economy. 7. Explain the concept of mixed economy, giving its main features. 8. Which economic system provides the right to private property? 9. Distinguish between labour intensive and capital intensive production techniques. Unit 2:The Basic Economic Problems and Economic Systems 28  Unit Economic Resources and Markets 3 Introduction The vital economic problem that any human society faces is the scarcity of resources. Scarcity refers to the fact that all economic resources that a society needs to produce goods and services are limited in supply. The term scarcity reflects the imbalance between the unlimited human wants and the means to satisfy those wants. This unit deals with types of resources and factor payments, renewable and non-renewable resources, types of markets, circular flow of economic activities and land as economic resource in Ethiopia. Unit Objectives At the end of this unit, students will be able to: 6 Describe resources. 6 Describe the types of resources and factors of payment. 6 Make a distinction between renewable and non-renewable resources. 6 Recognize the important role of land in Ethiopia as a resource. ✍ Start-up Activities 1. Can you explain the meaning of resources? 2. How do you define renewable and non-renewable resources? 3. How do you describe the term “market”? 4. What is the circular flow of economic activities? 5. How do you define land in the context of agriculture in Ethiopia? 👉 Key Concepts Economic resources, free resources, factor payments, fossil fuels, natural gas, non-renewable resources, recycling, renewable resources, renewal process, replenished, solar energy, wind energy, labour market, financial market, households, business firms, government, money flows, real flows, good soil, and suitable climates. 29 Unit 3: Economic Resources and Markets  3 1 Types of Resources and Factor Payments At the end of this section, students will be able to: 6 Define resources. 6 Explain the types of resources and factor payments of each category of resources. ✍ Start-up Activity Can you explain the meaning of resources? Resources are inputs used in the process of production in order to make goods and services available to the society. There are two types of resources; namely, free resources and economic resources. Free resources: A resource is said to be free if the amount available to a society is greater than the amount people desire to have at zero price. In other words, free resources are the free gifts of nature, which are unlimited in supply and have no prices. For example, air, sunshine, solar energy, and a mountain stream. Economic (Scarce) Resources: A resource is said to be economic or scarce when the amount available to a society is less than what people want to have at zero price. Since economic resources are scarce or not available in plenty, they have non-zero prices. Price is the test of whether a resource is an economic or a free good. Examples of scarce resources are: y All types of human resources: manual, intellectual, skilled and specialized labor; y Most natural resources, like land (especially fertile land), minerals, clean water, forests, and wild animals, y All types of capital resources (like machines, intermediate goods, and infrastructure) and y All types of entrepreneurial resources. Generally, we can divide economic resources into four broad categories. These are land, labour, capital, and entrepreneurship. Each of these categories is briefly described below. y Labour: refers to the physical as well as mental efforts of human beings in the production and distribution of goods and services. The reward for labour is wage. y Land: refers to the natural resources, or all the free gifts of nature, used in the production of goods and services. The reward for the services of the land is rent. Unit 3: Economic Resources and Markets 30  y Capital: refers to all the manufactured inputs that can be used to produce other goods and services. Example: equipment, machinery, transport and communication facilities, etc. The reward for the services of capital is interest y Entrepreneurship: refers to a special type of human talent that helps to organize and manage other factors of production to produce goods and services and takes the risk of making losses. The reward for entrepreneurship is profit. Ă Activity 3 1 1. Define resources and point out the two types of resources. 2. Describe the four categories of economic resources and cite their factor payments. 3.2 Renewable and Non-renewable Resources At the end of this section, students will be able to: 6 Define renewable and non-renewable resources. 6 Explain the difference between renewable and non-renewable resources. 6 Describe the concept of conservation of natural resources ✍ Start-up Activity How do you define renewable and non-renewable resources? There are many types of resources that go into producing goods and services. These resources have been broadly classified into two categories: renewable resources and non-renewable resources. Renewable resources are resources that have the potential to be replaced over time through natural processes. The renewal process may be relatively quick, as with sunshine, which comes on a daily basis. Or else, the renewal process may be very slow, as in the formation of soil, which may take hundreds of years. Examples of renewable resources are solar energy, wind energy, soil, trees, grass, geothermal pressure, and ground water. Non-renewable resources are resources whose stock or reserve is limited or fixed, and which are found in the ground. The available supply of non-renewable resources may be replenished through recycling, but the overall supply remains relatively constant. Examples of non-renewable resources are natural gas, coal, steel, aluminum, and oil. All natural resources should be used wisely. We must conserve natural resources. “Conserve means not misusing, spoiling, or wasting things. This is especially true for nonrenewable resources. However, even some renewable natural resources can be 31 Unit 3: Economic Resources and Markets depleted (run out) if they are all killed or overused. We must also protect our natural resources from pollution. Pollution occurs when people put harmful chemicals and other things into nature. Oil spilled into water, toxic chemicals in the air, or garbage dumped on the side of the road are examples of this problem. Conservation of natural resources To conserve natural resources, you can reduce, reuse, and recycle them. For example, turn off the lights when you are not in a room. This will reduce the use of fossil fuels used to generate electricity. Ride your bicycle and walk more, to reduce the amount of gasoline used to transport you. You can reuse things. Things like plastic jugs, jars, paper, and bags can be reused. Each time you reuse something, you conserve the natural resources that would have been used to make the new one. Finally, you can recycle. Recycling means reusing a natural resource or product to make something new. It also means collecting and sending these things for reuse. Items that can be easily recycled include: glass, some plastics, paper, cardboard, aluminum, and steel. Some plastics and metals are hard to recycle. They are often made from mixtures of materials. Mixtures can be hard to separate. Try to buy and use things that you can recycle. In general, natural resources, both renewable and nonrenewable, are important to all of us. We must conserve and carefully use natural resources. Our future depends on them. Ă Activity 3 2 1. What do you mean by renewable and non-renewable resources? 2. What is the difference between renewable and nonrenewable resources? 3. What can you do to take care of natural resources? 3 3 Types of Markets At the end of this section, students will be able to: 6 Define a market. 6 Distinguish among the financial market, goods and services market, and labour market. ✍ Start-up Activity How do you describe the term “market”? A market is an institution where two parties can meet to facilitate the exchange of goods and services. The parties involved are usually buyers and sellers. The market Unit 3: Economic Resources and Markets 32 may be physical, like a retail outlet, where people meet face-to-face, or digital, like an online market, where there is no direct physical contact between buyers and sellers. Although there are many types of markets, in this section we focus on three types of markets. These are the goods and services market, the labor market, and the financial market. We can briefly discuss each of these markets as follows. Goods and services market The goods and services market is where households purchase consumable goods and services and businesses sell their goods and services. This market includes stores, the Internet, and any other place where consumer goods and services are exchanged. When you go to the store, shop on the internet, or even just trade with your friend, you are dealing in the goods and services market. It is in this market that end products are traded. Consumers pay money to businesses to acquire something. Money flows from the consumer to the business firms continuously. Labour market The labour market is a market in which employees provide the labour services and employers provide the employment opportunities for labour. The labour market should be viewed at both the macroeconomic and microeconomic levels. For example, daily labourers, domestic workers, skilled workers, professionals, etc. provide labour services to the labour market. Financial market A financial market is any place where securities, currencies, bonds, and other financial assets are traded between two parties. This market is the basis of capitalist societies, and it provides capital formation and liquidity for businesses. It can be physical or digital. Examples of financial markets include bond, stock, share, etc. Activity 3 3 1. List down the different kinds of markets found in your surroundings and classify them into goods and services markets, labour markets, and financial markets, if any. 2. Explain the difference between the goods and services market and the labor market. 33 Unit 3: Economic Resources and Markets  3.4 Circular Flow of Economic Activities At the end of this section, students will be able to: 6 Define circular flow of income. 6 Explain the models of circular flow. 6 Construct a circular flow of economic activities and interpret them. ✍ Start-up Activity What is the circular flow of economic activities? The circular flow of economic activities is a simplified macroeconomic model of the basic economic relationships in a market economy. This model gives an overview of how households, businesses, and the government interact in different markets by exchanging goods and services, productive resources (inputs or the factors of production), and money. Production, exchange and consumption are three important activities of an economy. As people carry out these economic activities, transactions among different sectors of the economy occur. Because of these transactions, income and expenditure move in a circular way in an economy. This is called circular flow of income or circular flow diagram. Before we illustrate and explain the circular flow of income in an economy, let’s consider the different sectors into which an economy is divided for this purpose. These sectors are also sometimes known as decision-making units of the economy. Generally, they are called economic agents. Definition: A circular flow of income is a visual model of an economy that shows how a currency, such as the Birr, flows through markets among decision- making units. Circular flows of income and expenditure A circular flow is a pictorial representation of the continuous flow of payments and receipts for goods and services and factor services among different sectors of the economy. It also refers to the process whereby the income and expenditure of an economy flow in a circular manner continuously through time. Types of flows Economic transactions, like the sale and purchase of goods and factor services, generate two types of flows, namely, real flows and money flows. Real flow and money flow are the two main aspects of the circular flow of income model. Both refer to exchanges of goods and services for money, but the two concepts differ in how they refer to the opposite sides of these exchanges as they relate to individuals and companies. Unit 3: Economic Resources and Markets 34 Note that real flows and money flows are two sides of the same coin. A real flow of goods and services is matched by an equal but opposite money flow. Real flows Real flows consist of the flows of: y Factor services from the owners of factor services to the producers, and y Goods and services from the producers to the buyers. Money (financial) flows Money flows consist of the flows of: y Money incomes from factor services such as rent, wages, interest, etc., and y Money expenditures incurred for the purchase of goods and services. Figure 3.1 Circular flow of income: Real flow and money flow Models of circular flow For closed economies, we have two types of circular flow models: 1. a two-sector model, consisting of the flows between households and business firms, 2. three-sector model, consisting of the flows among households, business firms, and the government sector. 1. Two-sector circular flow model The two-sector model represents a private, closed economy with only two sectors, namely, the household sector and the business sector (firms). In this model, the underlying assumptions are: i. There are only two sectors in the economy: the household sector and business firms. ii. Household sectors are owners of factors of production, and they supply factor services to firms. iii. Firms produce goods and services and sell their entire output to households. iv. Households receive income for their factor services and spend the entire amount 35 Unit 3: Economic Resources and Markets  on consumption. v. There is no saving in the economy. vi. There is no government sector. vii. It is a closed economy, and therefore, there are no exports or imports. The circular flow in a two-sector economy is illustrated in the figure below. Figure 3.2: Circular flow of income in a two-sector economy Note that the above figure shows the two types of flows—real flow (of factor services and of goods and services) and money flow. There is a continuous flow of factor services (in the form of land, labour, capital, and entrepreneurship) from households to firms in the economy. Firms produce goods and services with the help of these factors and supply them to households for consumption. This is called the “real flow of goods and services.” The inner circle of the diagram shows that real flow. Since, in a monetary economy, all payments are made in money, the real flow is also the money flow of income, which is shown as the outer circle of Figure 3.2. When firms get factor services from households, they make monetary payments against them. Households spend this income on the purchase of goods and services from firms for their own consumption. Because, in this model, households spend all their income on consumption of goods and services, the total money receipts of the firms are the same as the total income of the households. Thus, money flows from firms to households (as payments for factor services) and back from households to firms (as payments for goods and services). This is the money flow of income shown by the outer circle of the diagram in Figure 3.2. Unit 3: Economic Resources and Markets 36  2. Three-sector circular flow model In the three-sector circular flow model, the economy has three sectors: households; firms; and government. In this model, the activities of the government (and those of the other two sectors) influence the flow of income. Government economic activities are divided into two categories: government revenue and government expenditure. The circular flow of income in a three-sector economy is shown in the figure below. Transfer Figure 3.3: Circular flow of income in a three-sector economy The above figure shows that firms make payments to households in return to factor services received from them. Households make payments to firms for goods and services purchased from them. Households’ savings are deposited in the capital market, which in turn, they give their savings to the firms for investment. Government gets its revenue by imposing taxes on households and on firms. Government pays back this revenue to the firms and households by purchasing goods and services from them. Also, government gives subsidies to the firms and transfer payments to the households. In this way, national income flows in a circular form among the three sectors of the economy. Ă Activity 3 4 1. What are the main models of circular flow? 2. Draw a two-sector economy circular flow diagram and discuss the role of each economic agent – the households and business firms. 3. Define circular flow diagram. 37 Unit 3: Economic Resources and Markets  3 5 Land as an Economic Resource in Ethiopia At the end of this section, students will be able to: 6 Explain the important role of land as an economic resource in Ethiopia. 6 Identify the two main soil types found in most of the Ethiopian highlands. ✍ Start-up Activity How do you define land in the context of agriculture in Ethiopia? For a country like Ethiopia, where agriculture is the backbone of the economy, land is a very important economic resource. In the context of agriculture, land refers to areal extent as well as its productivity of food crops and other crops. It is well-known that Ethiopia has a total area of 1,106,000 square kilometers of which 35 per cent is considered to be suitable for agriculture(CSA, 2007). The availability of this amount of land for agricultural purposes is directly or indirectly the result of good soil and suitable climate for the performance of agriculture. As far as the types of soil are concerned, most of the highlands have two main soil types that are generally believed to be suitable for agriculture. These soil types are: y Red-to-reddish brown soils: These soil types are well endowed with the required minerals for crops and they are found in areas of relatively good drainage. Further, these soil types are friable – easy to plough. y Brownish-to-grey and black soils with high clay content: With proper drainage and conditioning, these soils have excellent agricultural potentials. Regarding the climatic aspect, the formation of different agro-ecological zones due to altitude has multiplied the resource potential of the land of Ethiopia. The presence of different agro-climate zones results in the growth of different types of crops that increases Ethiopia’s potential for the production of exportable items in order to earn foreign currency. The Ethiopian people had been struggling for centuries with the inequitable land holdings of the country and effectively removed the feudal system in 1975. The socialist system that came into being in 1975 under the slogan “Land to The Tiller” paradoxically overturned the slogan and ended up in state ownership rather than giving it to the people. The existing government, which controlled power in 1991, was expected to remove land rights problems, among others by giving land to the people in tenure. But it maintained state ownership of land and controls all urban and rural land together with natural resources. Although state controls land ownership, rural peasants and pastoralists are guaranteed lifetime “holding” right that gives all Unit 3: Economic Resources and Markets 38 rights except sale and mortgage. Even if it is not mentioned in the constitution, urban residents are also provided with the right to get land for residence on a 99 years lease based agreement. The state ownership of land in the present-day Ethiopia is far from ideal since it restricts the different land rights of use, rent, lease, endowment, and inheritance for different reasons. Since redistribution of land is highly restricted, access to rural land is also almost non-existent. The constitution is commended for its protection of land holdings against arbitrary state eviction by inserting a provision that gives “commensurate” amount of compensation during expropriation. However, successive implementation of proclamations has violated this protection by denying market value (fair compensation) for loss of property. In short, the amount of compensation in the event of expropriation is insufficient. By creating more access to rural land, liberating the land holding rights, and by compensating fairly the loss of properties during expropriation, the current government could give more secure land rights compared to its predecessors. Ă Activity 3 5 1. Describe the important role of land as an economic resource in Ethiopia. 2. What are the two main soil types found in most Ethiopian highlands? 39 Unit 3: Economic Resources and Markets  Unit Summary Resources can be categorized as free resources (which are free gifts of nature and unlimited in supply) and economic resources (which are scarce in supply like land, labour, capital and entrepreneurship). A resource is said to be free if the amount available to a society is greater than the amount people desire to have at zero price. While a resource is said to be economic when the amount available to a society is less than what people want to have at zero price. Renewable resources are resources that have the potential to be replaced over time through the natural processes. While non-renewable resources are resources whose stock or reserve is limited or fixed, which are found in the ground. The available supply of non-renewable resources may be replenished by recycling but the overall supply remains relatively constant. A market is a place where two parties can meet to facilitate the exchange of goods and services. The parties involved are usually buyers and sellers. The market may be physical like a retail outlet, where people meet face-to-face, or digital like an online market, where there is no direct physical contact between buyers and sellers. There are three markets discussed in this section, namely, goods and services market, labour market, and financial market. The circular flow of economic activities is a simplified macroeconomic model of the basic economic relationships in a market economy. This model gives an overview of how households, businesses and government interact in different markets by exchanging goods and services, productive resources and money. For a country like Ethiopia, where agriculture is the backbone of the economy, land is a very important economic resource. In the context of agriculture, land refers to areal extent as well as its productivity of food crops and other crops. Unit 3: Economic Resources and Markets 40  Review Questions Part I: Write ‘True’ if the statement is correct or ‘False’ if it is not correct for each of the following statements. 1. By labour, we mean only the physical labour involved in the production of goods and services. 2. Recycle means to reuse a natural resource or product to make something new. 3. The goods market is the basis of capitalist societies, and it provides capital formation and liquidity for businesses. 4. The labour market is a market in which employees provide the labour services and employers provide the employment opportunities for labour. 5. Financial market is any place where securities, currencies, bonds, and other financial assets are traded between two parties. 6. Production, saving and making transfers are three important activities of an economy. 7. The two-sector model represents a private closed economy with only two sectors, namely, household sector and the business sector (firms). 8. Government gets its revenue through selling goods to households and firms in the three sector circular flow model. 9. Land is an example of a free resource at present in Ethiopia. 10. For a country like Ethiopia, where agriculture is the backbone of the economy, land is a very important economic resource. Part II: Choose the correct answer among the alternatives for the following questions 1. A resource is said to be free if the amount available is A. less than the amount people desire to have at a non-zero price. B. greater than the amount people desire to have at a non-zero price. C. greater than the amount people desire to have at a zero price. D. less than the amount people desire to have at a zero price. 2. Which of the following statements is correct? A. Air, sunshine, and solar energy are examples of economic resources. B. A resource is said to be economic when the amount available is plenty. C. Price is the test of whether a resource is economic or free. D. Since economic resources are plenty, they have a very low price. 3. All of the following are examples of scarce resources except A. a skilled and specialized labour C. minerals, clean water and forests B. a mountain stream D. all types of capital resources 41 Unit 3: Economic Resources and Markets  4. Which one of the following indicates all the manufactured inputs that can be used to produce other goods and services? A. Labour C. Land B. B. Entrepreneurship D. Capital 5. Which of the following is an example of a renewable resource? A. Solar energy C. Soil and forests B. Wind energy D. all of the above 6. ___________ occurs when people put harmful chemicals and other things into nature. A. Pollution C. Depletion B. B. Conservation D. Preservation 7. Which one of the following measures is necessary to take care of natural resources? A. Reducing their use C. Recycling them B. Reusing them D. All of the above 8. A closed economy does not allow: A. Sale of goods to households C. Sale of goods to other countries B. Sale of goods to government D. Sale of goods to business firms 9. Which of the following does not go with the three-sector circular flow model? A. Investment C. Households B. Firms D. Government 10. In three sector circular flow model, the main government economic activities are: A. Government revenue and expenditure. B. Government saving and payments. C. Government purchases and sales. D. Government transfers and expenditure. Part III: Answer the following questions briefly and to the point. 1. What is the basic difference between free and economic (scarce) resources? 2. Describe the four categories of economic resources. 3. How do you catgorise the types of resources go into producing goods and services? Explain each of the categories briefly and give examples. 4. Explain how pollution occurs and give examples of this problem. 5. What is the difference between financial mark and labour market? 6. Explain circular flows of income. Distinguish between real flows and money flows. 7. Describe circular flows of income in a three-sector economy. 8. Discuss the nature of land ownership rights in the context of Ethiopia during the pre-1974 period, from 1975 to 1991 and from 1991 to the present. Unit 3: Economic Resources and Markets 42  Unit Introduction to 4 Demand and Supply Introduction You may have questions such as next: What does demand mean? What does the law supply say? What does market equilibrium mean? The purpose of this unit is to explain what demand and supply are and show how they determine equilibrium price and quantity. We will also show how the concepts of demand and supply reveal consumers and producers sensitivity to price change. This unit deals with the concept of demand, the concept of supply and market equilibrium. Unit objectives At the end of this unit, students will be able to: 6 Define the concepts of demand and supply. 6 Explain the laws governing demand and supply. 6 Describe the equilibrium price and quantity ✍ Start-up Activities 1. How do you describe the term demand? 2. How do you define the term ‘supply’ in economics? 3. Can you define the concept of ‘equilibrium’? 👉 Key Concepts Ceteris paribus, demand, demand schedule, demand curve, demand function, law of demand, supply, supply schedule, supply curve, law of supply, equilibrium, market demand, market supply, market equilibrium, equilibrium price, and equilibrium quantity. 43 Unit 4: Introduction to Demand and Supply  4 1 Concept of Demand At the end of this section, students will be able to: 6 Define the concept of demand 6 Analyse the law of demand ✍ Start-up Activity How do you describe the term demand? Demand The terms demand, desire and want are frequently used synonymously to express what an individual needs and would like to acquire. Demand states that the consumer must be willing and able to buy a commodity which he or she desires at a given price during a given period of time. Accordingly, demand is distinct from a mere desire to acquire something. Human wants are unlimited and desires are numerous. However, only a desire backed up by the ability to pay the price for the commodity and the willingness to purchase it, is called a demand. We can say demand refers to an effective desire. A desire becomes an effective demand only when it is backed by the following three features: y ability to pay for the good desired, y willingness to pay the price of the good desired, and y availability of the good itself Furthermore, demand for a good is constantly stated relative to a specific price and certain time. For instance, an individual may be interested to buy a certain jeans at a price of Birr 500, but he or she could not absolutely demand it if its price is Birr 900. Likewise, an individual may be willing to buy a room heater at a price of Birr 1000 during a cold season, but he or she may not be interested in buying it at this price during a hot season. Based on the aforementioned considerations, we can define demand as follows: Demand for a commodity is the amount of it that a consumer is willing to buy at various given prices and a given moment of time. Quantity Demanded Quantity demanded is the amount of commodity a consumer must be willing and able to buy which he/she desires at a given price during a given period of time. Unit 4: Introduction to Demand and Supply 44 Law of Demand Law of demand states that, ceteris paribus, price of a commodity and its quantity demanded are inversely related. Ceteris paribus means other thing remain the same. In other words, the higher the price, the lower the quantity demanded. The law of demand is a fundamental principle of economics that states that at a higher price consumers will demand a lower quantity of a good. Demand Schedule A demand schedule is a tabular description, which presents various quantities of a commodity that would be demanded at different prices. Demand schedule refers to a tabular representation of the relationship between price and quantity demanded. It demonstrates the quantity of a product demanded by an individual or a group of individuals at specified price and time. Table 4.1: Individual household demand schedule for Oranges per week Price (Birr Per kg) Quantity Demanded/week 5 5 4 7 3 9 2 11 1 13 The above demand schedule shows the different quantities of oranges demanded by an individual household at different prices. At Birr 5 per kg, the consumer demands 5kg of oranges. However, an individual household’s demand becomes 13 kg of Oranges at Birr 1 per kg. Demand Curve A demand curve is a graphical representation of the relationship between different quantities of a commodity demanded by an individual at different prices per time period. 45 Unit 4: Introduction to Demand and Supply  Figure 4.1: Individual household demand curve Demand Function It is a mathematical representation of the relationship between price and quantity demanded, ceteris paribus. A typical demand function is given by: Qd = f(P) where, Qd is the quantity demanded and P is the commodity’s price, Market demand Market demand describes the demand for a given product and who wants to purchase it. This is determined by the willingness of consumers to spend a certain price on a particular good or service. As market demand increases, price also increases. When it decreases, price will decrease as well. Market demand is derived by a simple horizontal summation of the quantity demanded for a commodity by all buyers at each price. The market demand curve describes the relationship between various quantities of a commodity that consumers are willing to buy at different prices. Market demand curve is the horizontal summation of individual demand curves at the market price. Ă Activity 4 1 1. Define demand and state the law of demand. 2. Explain why the demand curve always slopes downwards from left to right. Unit 4: Introduction to Demand and Supply 46  4 2 Concept of Supply At the end of this section, stude