Economics 1

ECO162
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 SCHOOL OF COMMERCE
Assignment Code SF1
Assignment Type Assignment
Individual Assignment
Total Marks 75

Module Name Economics I

Module Code ECO162

- Consult the Learning Management System (LMS), i.e. Canvas or ECI, for the due dates,
the Assessment Guidelines for Students document, the Assignment Overview, and other
updated detail. Check the Announcements by your lecturer and use the Module Q&A
forum to ask questions related to this assignment.
- For rules and regulations applicable to assessments, refer to the Student Handbook.
- Note STADIO’s rules relating to plagiarism and cheating. Do not hesitate to seek help if
you are unsure of how to reference your sources. Make use of the STADIO Referencing
Guide, available from the Online Library.

INTRODUCTION
This formal assignment will require that you do extensive research to relate the day-to-day
events to the content covered in class. You will need to familiarise yourself with Economics
concepts and know how best to apply it to explain why Economists forecast the difference
phenomena the way they do.

DESCRIPTION

Task Description Submission format Marks

1A Economic Markets Pdf submission 34
1B Economic Systems Pdf submission 15
2 2023 BRICS summit Pdf submission 26

Task 1A (34 marks)

Market structures refer to how different industries are classified according to the
characteristics they have. In Economics we have four different market structures, namely
perfect competition, monopolistic competition, oligopoly and the monopoly structure. These
structures differ based on the nature of the products they produce, the number of firms in the
industry as well as the competition which takes place within the firms.

STADIO ASSIGNMENTS 2024 SEMESTER 1 Economics I/ECO162/SF1

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 INSTRUCTIONS

Choose two companies of your choice and explain the barriers that they have implemented
to prevent or control the level of competition they have under the following markets:

Oligopoly competition and monopolistic competition.

a. Based on your research, explain the market structures above using the companies of
your choice (1 x 2)
b. Discuss the barriers put in place in that industry to mitigate competition (5 x 2)
c. Discuss whether the barriers have had a positive or negative impact on the industry. (5
x 2)
d. Discuss the impact of the barriers implemented on the households and the economy (6
x 2)

Task 1B (15 marks)

(Wendy Mbatha, 2022)

STADIO ASSIGNMENTS 2024 SEMESTER 1 Economics I/ECO162/SF1

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Magaxa opened the debate on “building a mixed South African economy” during a mini-
plenary session this afternoon.

The theme of the debate is “building a state-led South African mixed economy, with the
participation of both public and private sectors, to contribute towards a new trajectory of
inclusive growth and to address the Apartheid legacy of exclusion”. Political parties had
mixed views on the mixed economy.

Magaxa says when compared to other mixed economies in the developing world, South
Africa’s mixed economy does not live up to the economic potential attributed to mixed
economies. “To put a mixed economy’s success into perspective, consider the case of
Sweden. It boosts strong property rights and it’s also open to international trade and foreign
direct investment, yet Sweden has a strong aggressive social insurance and robust
distribution based on public expenditure on Public Social welfare programme such as old
age pensions, family allowances, health insurance and housing subsidies.”

When he participated in the debate, DA MP Jan De Villiers touched on cadre deployment

against failed state-owned entities. “ANC cadre deployment is the root cause of every single
failure of government to even attempt to creating a more inclusive society. The failure of
Eskom, SAA, PRASA, SABC, the list goes on and on. What do all these failed state
institutions have in common? ANC cadre deployment and corruption, because the only way
the ANC fat cats can enrich themselves is through the mechanisms of cadre deployment.”

But Co-operative Governance and Traditional Affairs Deputy Minister, Thembisile

Nkadimeng, hit back at De Villiers over cadre deployment.

“Listening to you telling us about cadre deployment in the Democratic Alliance, let me
refresh their memory, Marietta Steenkamp, 16 May 2018, City of Tshwane, not qualified.
Wow, was that enough? Pravin Govender falsified his certification of a fire official in 2019.
De Villiers, a body builder in the City of Ekurhuleni, was fired previously from the City of
Tshwane, but is currently employed,” says Nkadimeng.

EFF MP Yoliswa Yako says the ANC cannot speak about a state-led mixed economy when
every part of the economy is controlled by the private sector, under its watch.

“What is more troubling is that at a time when the ANC together with its alliances, COSATU
and the SACP are going full steam ahead with privatisation and liquidation of a strategic
owned enterprise, the former Western Cape Secretary of the SACP still thinks that there
could be a state led mixed economy when the private sector controls all strategic sectors of
the economy, including energy generation, transport, ports, telecommunications, finance
and mineral resources”, says Yako.

IFP MP Elphas Buthelezi, says the ANC has not been interested in building an inclusive
economy.

Buthelezi says the governing party’s actions over its years in power has demonstrated how
it failed to build the economy. “South Africa currently ranks 82 in doing business ranking in
comparison with our business counterparts. As the IFP we have always believed that strong
partnership between government and the private sector is what we need to build a strong
economy. And overall, a prosperous country.”

Freedom Front Plus MP Frederik Mulder says South Africa needs an economy that is more
inclusive and stable.

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“For the economy to function at its best, it needs to be growing, sustainable, and stable. But
there is more to it. It’s not simply that the economy should be merely growing, but that it’s
growing for all people. It is not just creating stability for some people but creating stability so
that every person is free from worry about financial roadblocks and unforeseen issues.”

The ACDP Chief Whip, Steve Swart, says a capable state is also key to ensuring a thriving
economy. “Alongside a capable state, the country needs a thriving public sector, and a
private sector that is investing in productive capacity. As private sector employment
increases, more livelihoods are supported and sustained. “

Al Jama-Ah Leader, Ganief Hendricks, says South Africa consists of a first and third world
economy, which defines the economic status of the country.

“Considering these, one may argue that South Africa continues to have a mixed economy
despite the fact that it continues to own state-owned entities such as Sasol and Iscor,
entities that unfortunately have been sold off to the private sector and this has been with no
tangible financial return to the public. In fact, it is the latter that supported it financially for
several years with the purpose of transforming South Africa’s commercial sector into a
viable independent one. This sadly, honourable House chair, did not happen. For the record,
while Iscor has been stripped of its assets, Sasol was conveniently privatised.”

The African Independent Congress or AIC’s Steven Jafta, says South Africa has to accept
that it is part of the global economy.

“The South African economy exists in a globalised economic order. This means we can no
longer prescribe solutions to our economic realities due to the pressures of the global world.
In this regard, we have to move away from mere slogans and sound bites to radical
economic policies with real traction to improving the lives of our people.”

National Freedom Party Parliamentary Leader Ahmed Shaik-Emam says while the NFP
supports a mixed economy, the cost of doing business is very expensive, especially for
small businesses.

“If we want economic growth in a mixed economy, we must create an environment. If you
look, chairperson, at the cost of doing business, particularly for small businesses, and the
red tape that exists, it makes it very difficult for them to survive.”
Source: https://www.sabcnews.com/sabcnews/political-parties-divided-on-mixed-south-
african-economy/
(Wendy Mbatha, 2022) - emended

a. Discuss why most countries are investing in pursuing the mixed system instead of the
capitalist system. (10)
b. Explain the disadvantages of having the central authority determine what goods and
services would be produced, how the goods and services will be produced and for
whom the goods and services would be produced. (5)

FORMAT
Document your answers for Tasks 1A and 1B in a Word document, clearly numbered as
indicated in the tasks.
Once you have completed both Task 1 and Task 2, print your Word document to pdf and
submit to Canvas.

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 TECHNICAL REQUIREMENTS
Remember to include in-text referencing as well as a reference list for all sources consulted
(including the AI tool used, if applicable).

Task 2 (26 marks)

Read and analyse the cartoon below and answer the questions that follow regarding the
recent BRICS summit held in South Africa, 2023.

Source: https://www.cagle.com/tag/brics/ [Accessed: 06/11/2023]

INSTRUCTIONS

Consult your study material as well as articles from accredited journals available on Google
Scholar or STADIO’s online library and answer the following questions.

2.1 Discuss the three pillars of cooperation established by the BRICS organisation.
(2 x 3)
2.2 Discuss the difference between the G7 organisation and BRICS. (2 x 3)
2.3 Explain the benefits of BRICS for the four participants under the following headings:
Households, Business, Financial Markets and Government. (4 x 3)
2.4 Examine the dynamics of the rand/dollar exchange rate both prior to and following the
BRICS summit, considering total economic growth. (2)

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 FORMAT
Document your answers for Task 2 in a Word document, clearly numbered as indicated in
the task.
Once you have completed both Task 1 and Task 2, print your Word document to pdf and
submit to Canvas.

TECHNICAL REQUIREMENTS
Remember to include in-text referencing as well as a reference list for all sources consulted
(including the AI tool used, if applicable).

STADIO ASSIGNMENTS 2024 SEMESTER 1 Economics I/ECO162/SF1

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 Table of contents

Heading Page number

MODULE PURPOSE AND OUTCOMES 1

TOPIC 1 THE ROLE OF ECONOMICS IN A SOCIETY 2

1.1 Introduction 2
1.2 Economic concepts 2
1.3 the functioning of the economy 4
1.4 Analysing economic problems 6
Summary 7
Self-Assessment Questions 8

TOPIC 2 SYSTEMS AND ROLE PLAYERS IN THE ECONOMY 9

2.1 Introduction 9
2.2 economic systems 9
2.3 Markets, Government, business, consumers and society 10
2.3 solving economic problems 16
Summary 19
Self-Assessment Questions 21

TOPIC 3 BASIC MICROECONOMIC TOOLS 22

3.1 Introduction 22
3.2 Demand, supply and market equilibrium 22
3.3 Consumer preferences 27
3.4 Consumer choice 30
3.5 Time Value of Money 32
3.6 The theory of demand 34
Summary 36
Self-Assessment Questions 37

TOPIC 4 ECONOMIES WITH AND WITHOUT PRODUCTION 38

4.1 Introduction 38
4.2 Economies with production 38
4.3 Economies without production 47
Summary 49
Self-Assessment Questions 50

TOPIC 5 MARKET FORMS AND INEFFICIENCIES 51

5.1 Introduction 51
5.2 Overview of market structures 51
5.3 Perfect competition 53
5.4 Monopoly 55
5.5 Imperfect Competition 57
5.6 Comparison of the different market structures 59
Summary 60
Self-Assessment Questions 61

TOPIC 6 CHANGING ECONOMIC PARADIGM FOR INDUSTRIES 62

6.1 Introduction 62
6.2 The digital or ‘new’ economy 62
6.3 Digital business models 63
6.4 New economic models 64
6.5 Financial disintermediation 65
6.6 Success factors in the digital economy 67
6.7 Developing countries’ challenges with regard to new paradigms 68
Summary 69
Self-Assessment Questions 70

GLOSSARY OF TERMS 71

REFERENCES 74

ANSWERS TO SELF-ASSESSMENT QUESTIONS 81

Topic 1 Self-assessment answers 81
Topic 2 Self-assessment answers 82
Topic 3 Self-assessment answers 85
Topic 4 Self-assessment answers 85
Topic 5 Self-assessment answers 87
Topic 6 Self-assessment answers 87
 Module purpose and outcomes

Module Purpose

This first Economics module aims to introduce you to the role of economics for a
society as well as to different economic systems to set the context. It also aims
to familiarise you with the relevant microeconomic tools relating to supply and
demand, the production of goods and services, as well as the different market
forms. Finally, you will learn about non-traditional economic models, for
example, the platform economy and how businesses operate in this ‘new’
economy.

Module Outcomes

Upon successful completion of this module, you will be able to:

1. Reflect on and explain the impact of economics on society.

2. Discuss a set of economic problems against the background of the
institutional framework of the economy.
3. Apply microeconomic tools to case scenarios of economies with and
without production, and draw relevant conclusions.
4. Read case studies with different market forms and identify possible
problems.
5. Explain success factors for companies operating in non-traditional
environments.

Note

The following prescribed and recommended reading sources are referenced in

the study guide. Note that the prescribed textbook is a requirement. The
recommended readings are optional, but you are encouraged to access these, to
enrich your learning.

Prescribed Reading

The following prescribed reading sources referenced in the study guide are
compulsory and need to be purchased by the students:

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Mohr, P., Seymore, R. and Yu, D. 2018. Understanding Microeconomics, 2nd ed.,
Van Schaik Publishers.
Fourie, J. and Mohr, P. 2022. Mzansinomics — Understanding the basics of the
South African economy, Van Schaik Publishers.

Recommended reading
The following recommended reading sources referenced in the study guide are
available for free in STADIO electronic library – Scholartext:

1. Tirole, J. 2017. Economics for the common good. Princeton University Press

2. Williamson, P.J. and De Meyer, A. 2019. Ecosystem Edge. Palgrave Macmillan.

3. Besanko, D. and Braeutigam, R.R. 2014. Microeconomics, 5th ed. Wiley.

The following recommended reading sources referenced in the study guide are
available for free online on the internet:

Anderson, L. & Wladawsky-Berger, I. (Producer/owner) (24 March 2016). The 4

things it takes to succeed in the digital economy. [Online].
https://hbr.org/2016/03/the-4-things-it-takes-to-succeed-in-the-digital-
economy [Accessed: 25.11.2022]
Devrix. (Producer/owner) (15 October 2021). Top 10 Digital business models for
Online companies [Examples). [Online].
https://devrix.com/tutorial/top-10-digital-business-models-online-companies-
examples/ [Accessed: 23.11.2022]
NEMODE. (Producer/owner) (Not dated.) [Online].
http://www.nemode.ac.uk/?page_id=51#_ftn1 [Accessed: 01.12.2022]
Ruby, D.A. (Producer/owner) (6 May 2020). The Edgeworth box and Exchange.
[Online].
http://www.digitaleconomist.org/microeconomics/edgeworth_box.html
[Accessed: 17.11.2022]

All your activities and tasks going forward must be recorded in a writing pad as
you progress through this module. When completing the activities that are
identified within each topic, and when answering the Self-Assessment Questions
at the end of each topic, you will be asked to record your answers under a
particular heading. To keep track of your progress, we suggest that you add the
date to each record.

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Discussions or summaries that are added to your writing pad during activities
should be limited to a maximum of one page (approx. 300–500 words). You are
expected to summarise and not copy and paste answers from a resource. When
summarising, you should reflect on the specific topic or body of work.

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 Topic 1
The role of economics in a society

1.1 INTRODUCTION

This topic relates to the following module outcome:

1. Reflect on and explain the impact of economics on society.

On completion of this topic on the role of economics in a society, satisfying

Module Outcome 1, you should be able to describe the meaning of economics,
basic economic concepts, and the application of it in your daily life. You should
also become aware of the various mechanisms, including markets, which are
used by different societies to allocate resources and direct economy activity.
Lastly, you should be able to understand how different tools are used for
analysing economic problems.

In this topic, you will gain knowledge in the following areas:

1. Economic concepts
2. The functioning of the economy
3. Analysing economic problems

1.2 ECONOMIC CONCEPTS

"Economics is not particularly difficult. […] Much of the economic theory […] is
simply common sense. But it is structured common sense.” (Mohr, Seymore and
Yu, 2018, p. 22). In order to understand some of the key economic concepts,
areas of economics, the meaning of the “economic problem” and how it can be
tackled, read the prescribed pages below.

Prescribed reading

Read Chapter 1, pp. 1–7 in the prescribed textbook on a basic introduction into
economic concepts in Fourie, J. & Mohr, P. 2022. Mzansinomics — Understanding
the structure of the South African economy.

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1.2.1 Definitions and concepts in Economics

Economics can be defined as “the science that deals with the allocation of limited
resources to satisfy unlimited wants” (Besanko & Braeutigam, 2014:4). Everyone
can relate to this definition. We can write an ‘infinite’ list of the things we want
in life. Just think about all the different kinds of foods you want to eat, the cars
you wish to drive, the various places you want to visit, and so on. However, the
reality is that we don’t have enough resources to get the things we want. In other
words, resources are scarce or limited. Scarcity is the basic economic problem.

Because of scarcity, individuals must make choices daily about which wants to
satisfy, and which wants to sacrifice. Opportunity cost is the term used to
describe the best alternative forgone. In economics, it is assumed that people
are rational, which means they make choices that maximise their welfare (Tirole,
2017:19). The society, faced with a scarcity of productive resources like labour
and capital, must also choose the goods and services it will produce. As such,
economics is a science of constrained choice. Therefore, on a day-to-day basis,
individuals and societies are faced with scarcity and must make choices.

Read further about scarcity, choice and opportunity costs in the prescribed
textbook as per below.

Prescribed reading

Read Chapter 1, pp. 5-13 in the prescribed textbook on scarcity, choice,

opportunity cost in Mohr, P., Seymore, R. and Yu, D. 2018. Understanding
Microeconomics, 2nd ed., Van Schaik Publishers.

As stated above, all societies face scarcity. As a result, each society must design
an economic system that manages scarcity by answering the important
questions: what goods and services will be produced; how these goods and
services will be produced; and who will receive the goods and services (Besanko
& Braeutigam, 2014:5). There are four different economic systems, namely,
traditional, command (or centralised), market (or decentralised), and mixed
(Mohr, Seymore & Yu, 2018:34). In the centralised system, economic activity is
directed by the government, and in the decentralised system, the allocation of
resources is done by the free markets (Besanko & Braeutigam, 2014:5).

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According to Tirole (2017:24), scarcity has historically been managed through
queues, drawing lots, administrative distribution to preferred groups, price
controls, corruption, favouritism, violence, and wars.

If you would like to gather a more in depth understanding of the subject matter,
refer to the recommended reading below.

Recommended reading

Read:
• Chapter 1, pp. 4–5 in the prescribed textbook: Besanko, D. &
Braeutigam, R.R. 2014. Microeconomics, 5th ed.
• Chapter 1, pp. 18–28 in the prescribed textbook: Tirole, J. 2017.
Economics for the common good.

1.3 THE FUNCTIONING OF THE ECONOMY

1.3.1 Production, Income and Spending

When understanding the economic problem (what to produce, etc.), the focus is
on production. However, production creates income, which allows participants in
the market to purchase products (Fourie & Mohr, 2022). Engage in the prescribed
reading below for an introduction into the basic flows of the economy.

Prescribed reading

Read Chapter 1, pp. 7 to 20 in the prescribed textbook on basic flows in the

economy in Fourie, J. & Mohr, P. 2022. Mzansinomics — Understanding the
structure of the South African economy.

1.3.2 Production possibilities

Scarcity, choice and opportunity cost culminate in an illustration called the

production possibilities curve (Mohr, Seymore and Yu, 2018). This curve is
important for analysing economic opportunities. The prescribed reading below
will illustrate how this curve can be used in practice.

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 Prescribed reading

Read Chapter 1, pp. 13-20 in the prescribed textbook on production possibilities

in Mohr, P., Seymore, R. and Yu, D. 2018. Understanding Microeconomics, 2nd
ed., Van Schaik Publishers.

1.3.3 Moral limits of the market

The market is one of many ways of managing scarcity. The jury is out on whether
the market is the best and most efficient way to manage scarcity. Some believe
it is the only efficient one (Tirole, 2017:25). Others, (although they acknowledge
the efficiency of the market), accuse economists of ignoring certain problems
that markets can create for a society. These problems are often referred to as
the moral limits of a market (Tirole, 2017:34).

Activity

To get an insight into the moral limits of the market, watch the video on YouTube
at https://www.youtube.com/watch?v=3nsoN-LS8RQ (Sandel, 2013). In your
writing pad, write the heading ‘The moral limits of the market’. Then summarise
the contents of this video using bullet points. Pause the video as you write down
the key points. Remember that your summary should not be more than one
page.

More information about how markets function is covered in Topic 5. However, if

you would like to learn more about moral limits of markets, access the
recommended reading below.

Recommended reading

Read Chapter 2, pp. 33–61 in the prescribed textbook on the moral limits of the
market: Tirole, J. 2017. Economics for the common good.

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1.4 ANALYSING ECONOMIC PROBLEMS

1.4.1 Economic models and tools

When studying complex real-world problems, economists develop models that

abstract reality by specifying the most fundamental variables or factors relevant
to the situation they are addressing (Besanko & Braeutigam, 2014:5).

In order to analyse economic problems, it is necessary to argue in a logical and

disciplined fashion (Mohr, Seymour and Yu, 2018). Engage with the prescribed
reading below, for a basic introduction into economic analysis tools used to tackle
economic problems.

Prescribed reading

Read Chapter 1, Appendix A, pp. 22–31 in Mohr, P., Seymore, R. and Yu, D.
2018. Understanding Microeconomics, 2nd ed., Van Schaik Publishers.

1.4.2 Economics is a social science

Economists need to study behaviour of human beings, in an environment that

constantly changes. This is one of the reasons why economists often disagree
(Mohr, Seymore, and Yu, 2018).

Prescribed reading

Read Chapter 1, pp. 20-22 in the prescribed textbook on why economists argue
in Mohr, P., Seymore, R. and Yu, D. 2018. Understanding Microeconomics, 2nd
ed., Van Schaik Publishers.

Read Chapter 1, pp. 23-26 in the prescribed textbook on the traps when
reasoning about the economy in Fourie, J. & Mohr, P. 2022. Mzansinomics —
Understanding the structure of the South African economy.

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 Summary

This topic introduced you to the field of economics and how it helps societies and
individuals to solve economic problems. The basic economic problem is scarcity,
and every person and society must deal with it daily. There is no limit to the
things we want as human beings. Our means to satisfying what we want are
severely limited. As a result, we must make choices and sacrifices. Opportunity
cost is the term used to describe the best alternative forgone. Similarly, society’s
productive resources like capital, skilled labour, and raw materials are limited in
supply.

Any society must design an economic system that decides what, how, and for
whom to produce. The system can be decentralised or centralised, depending on
what the society prefers. Many societies around the world use the market system
to organise economic activity because it is efficient. However, it is not perfect.
The production possibility curve (PPC) is an illustration of the combination of any
two goods or services that are attainable when a community’s resources are fully
and efficiently employed (in other words, the maximum attainable combinations
of those two goods - potential output).

Economists deal with a complex world, and hence they often disagree on matters.
This leads them to develop models that represent reality, after which they apply
appropriate analytical tools to the models. These models and analytical tools are
used in positive analysis where the task is to find the causes or impact of an
economic problem.

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 Self-Assessment Questions

1. Define economics.

2. Define opportunity cost and use an example to explain it.

3. Define a production possibility curve and use such a curve to illustrate

scarcity, choice and opportunity cost.

4. Distinguish between macro and microeconomics.

5. Explain why economics is a social science.

6. Draw your own mindmap of the functioning of the economy.

7. Explain the role of ‘ceteris paribus’ in economic analysis.

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 Topic 2
Systems and role players in the economy

2.1 INTRODUCTION

This topic relates to the following module outcome:

2. Discuss a set of economic problems against the background of the

institutional framework of the economy.

On completion of this topic on different role players in the economy, satisfying

Module Outcome 2, you will be able to understand how different economic
systems operate. Against this background, you will be introduced to the different
roleplayers in the economy, namely markets, government, business, households
and society at large. You will then be familiar with how different roleplayers work
together to solve economic problems in differing economic systems.

In this topic, you will gain knowledge in the following areas:

1. Economic systems
2. Markets, Government, Business, Households and Society
3. Solving economics problems

2.2 ECONOMIC SYSTEMS

In section 1.2.1 we briefly spoke about economic systems. Depending on the

economic system that an economy prescribes to, the questions of what, how and
for whom the economy must produce will be answered differently. While there
are selected main categories of economic systems that you will be introduced to
in the prescribed reading below, you will get to understand that many countries
use a mix and match of different economic systems, based on their individual set
up and needs (Mohr, Seymore and Yu, 2018). Also, economic systems that
countries use can change over time, they are not cast in stone.

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 Prescribed reading

Read Chapter 1, pp. 33-43 in the prescribed textbook on economic systems in

Mohr, P., Seymore, R. and Yu, D. 2018. Understanding Microeconomics, 2nd ed.,
Van Schaik Publishers.

Activity
To gain a deeper understanding of economic systems, read the opinion piece
Russia’s Tragic Failure to Reform Its Economy - The Moscow Times. Go to a fresh
page in your writing pad and make a new heading ‘Changing economic systems’.
Then list and briefly describe the changes discussed in the article, and reflect on
whether you agree.

Shatz, H.J. 2022. Russia’s tragic failure to reform its economy. The Moscow
Times. Available on: https://www.themoscowtimes.com/2022/04/07/russias-
tragic-failure-to-reform-its-economy-a77258. Accessed 15 July 2023.

2.3 MARKETS, GOVERNMENT, BUSINESS, CONSUMERS AND

SOCIETY

In any economy multiple role-players work together to resolve economic

problems. Depending on the chosen economic system, some will take on more
responsibility than others. Many economic discussions revolve around the control
that the government or the state as some economists refer to it should be
allowed to have. Linked to this, questions are raised about whether the market
(you were briefly introduced to markets in Topic 1) or the state are in a better
position to produce positive outcomes for the economy, and the society. Equally,
there are disagreements about the role of businesses towards creating an equal
and sustainable society. We can conclude that roleplayers work in a complex net
of relationships to influence the success of the economy.

In the following sections, we will uncover the roleplayers categorised into

markets, government, business and society further.

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2.3.1 Markets and Government

Each economic system has its advocates. Because of this, public debate between
proponents of the state and market is based on the incorrect assumption that
they are competing alternatives (Tirole, 2017:160). The two systems are
complementary. In fact, most countries have mixed economies in which the
markets operate with varying degrees of state intervention. Understanding the
role of the state requires understanding both market failure and the pitfalls of
state intervention (Tirole, 2017:156).

Market Failure

As you may recall, market exchanges are inefficient at times. The role of
government in this regard is to correct failure. Here is a list of the categories of
market failure:

• The exchange can affect non-consenting third parties. This is the classic
case of negative externalities, such as pollution.
• The exchange would not take place if the buyer had complete
information.
• Buyers can be a danger to themselves. This is a problem of internalities
where buyers are focused on short-term well-being while neglecting
future wellness.
• An individual buyer lacks the capacity to implement the exchange.
• Businesses are abusing the market power. This happens in markets with
little to zero competition, in the case of imperfect competition and
monopolies, which allows players to exploit consumers.
• Market is increasing inequalities.

Activity
To gain a deeper understanding of market failure, watch the video on YouTube
at https://www.youtube.com/watch?v=D6rP6aBCN4A&t=410s (Welker, 2016).
Go to a fresh page in your writing pad and make a new heading ‘Market failure’.

Then list and briefly describe the different market failures discussed in the video.

If you wish you learn more about market failure, access the following
recommended reading.

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 Recommended reading

Read Chapter 6, pp. 157–160, in the recommended textbook to understand

market failure: Tirole, J. 2017. Economics for the common good.

State failure

Now that we understand market failure, let’s look at state failure. When the state
(government) intervenes to correct failure, it can fail.

Example
Here is a list of some of the reasons for state failure:
• Regulatory capture: In the regulation of businesses, personal
relationships between regulators and corporate elites create complicity.
• Distortion of decision-making due to the incentives for election or re-
election: Politicians will exploit the lack of knowledge of voters.
• It is not easy to make political action responsive to public interest. This
is the case when the failure is not visible to voters, making electoral
sanctions ineffective.
• Limited by geographical jurisdiction. Regulation is national in the absence
of international agreements.

If you wish you learn more about state failure, access the following recommended
reading.

Recommended reading
Read Chapter 6, pp. 162–163 in the recommended textbook to understand state
failure: Tirole, J. 2017. Economics for the common good.

Towards a positive role for the state

Given the important role the state plays in the economy, it is vital that it functions
properly. For this to happen, the state must be organised in such a way that it
separates the roles of elected decision-makers from administrators or
technocrats who are placed in charge of independent administrative bodies
(Tirole, 2017:163).

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As you may be aware, in most cases, politicians are elected to government based
on affiliation to a party and not always competence. Moreover, they are also
rational beings whose incentives are driven by the quest for election and re-
election. Thus, politicians will, for the sake of being popular, shun causes which
do not conform to public opinion or the interests of pressure groups. As a result,
there is a need for independent authorities who make better technical decisions
than politicians.

Example
The following list relates to some of South Africa’s regulatory bodies:
• Competition Commission of South Africa
• Financial Services Conduct Authority
• South African Reserve Bank

Independent authorities are not independent in the absolute sense. As you can
imagine, they are run by people who may have their own incentives or can make
reckless and negligent decisions. Because appointed technocrats do not worry
about electoral processes and are afforded great autonomy to execute their
mandates, there is a lack of accountability. To solve this problem, state
authorities must be placed under a legislative body vested with powers to dismiss
technocrats for misconduct (Tirole, 2017:168–169).

Reforming the state

As economies are becoming sophisticated and market-oriented in modern times,

the idea of the state has evolved. The traditional roles of the state are to provide
jobs through public service and produce goods and services through state-owned
enterprises (Tirole, 2017:170). However, in its modern form, the government
has new roles. Firstly, it must set in place the necessary rules and regulations,
and correct market failure instead of assuming control of enterprises. Secondly,
it is responsible for creating equal opportunities, healthy competition, and a
stable financial system that does not rely on bailouts. Thirdly, it needs to ensure
that the natural environment and employees are protected.

You should note that the transition to become a modern state is not an event.
Rather, it is a process that requires a shift in mindset and a return to the
fundamentals of state performance. The transformation requires that (Tirole,
2017:170):
• Bureaucrats must see themselves as servants of the citizens and not of
the state

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• The state must transition from being a producer and employer to an
arbitrator
• The state must have adequate financial resources to sustain social
welfare programmes and
• Public expenditure must be reduced or stabilised.

2.3.2 Business and Society

In the same way that the state needs to be held in check regarding their role in
the economy, businesses have the same requirement. Given that businesses
have such an important role to play in the economy, it is important that they
take control and decision-making in many aspects of business, including human
resources, risk management, and marketing, seriously.

Different forms of governance

There are different forms of governance, and a healthy economy requires each
business to select a form that is best suited for its context (Tirole, 2017:175).

• Capitalist governance
In this governance form, decision-making is vested with investors or
shareholders or owners of the company who in turn delegate this decision-
making power to a management team called the board of directors. However, it
is the responsibility of owners to approve or reject the decisions made by
management.

• Cooperative governance
Here, a service is owned by users who must first agree on how to manage and
share it. This form is most suitable for professional services, which include
accountants, lawyers, architects, and engineers.

• Other forms of governance

Employees are important stakeholders in business operations. As such, other
models of governance encourage employee participation in corporate
administration. The extreme form of these employee-oriented models is
employee-run firms where businesses are under the complete control of
employees. In moderate versions, employees may be allowed to contribute to
decision-making by participating in board meetings. Alternatively, they may be
an integral part of the board (Tirole, 2017:76).

The driving need for finance

Businesses must have access to finance in order to maintain or expand their

operations, and the biggest source of these funds is investors — creditors and

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shareholders. As you might have guessed, the governance structure is an
important consideration in investment decisions. Corporations in which financiers
make decisions find it easy to raise funds in the short run. In the long run,
however, they will face difficulties in recruitment and attracting new investors.
Key personnel will not join a business that does not prioritise their interests, and
this situation makes the business an unattractive investment opportunity.

On the other hand, businesses that grant decision-making power to employees

do not attract investors easily. The fear of the investors is that their investments
will not generate the required returns since employees will look after their own
interests first. The result is that employee-run companies may be forced to close
due to lack of funding. We can see that the interests of employees and investors
need to be aligned.

The separation of ownership and control

Managers of corporations are not the owners of these businesses. In fact, they
are appointed by owners to run the business on their behalf. From this
relationship, management is vested with control of the business.

Activity

There is a divorce between ownership and control of corporations. To gain a

deeper understanding of this concept, watch the video on YouTube at
https://www.youtube.com/watch?v=WiB0qSr6_q8 (Ingr Nomics, 2020a). In
your writing pad, write a heading ‘The separation of ownership and control’. Then
summarise the video.

Now, managers have incentives to behave in ways that are not consistent with
the interests of investors. As such, the task of investors is to ensure there is
minimal deviation between the actions of management and their interests. This
can be done in various ways (Tirole, 2017:180–185):
• Ultimate control rests with shareholders when things are good, but
passes to creditors when things go bad.
• Management of businesses with fragile balance sheets seeking funding
to make concessions to investors, which keeps them in check.
• Managers are given incentives that reduce risky behaviour, like having
their benefits subjected to clawback.
• Subjecting the business to scrutiny of external powers, like auditors, the
media, and regulators.

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Social responsibility

Businesses are generally set up to create profits for owners. However, the
success of these businesses depends on the relationships they have with external
parties or stakeholders, which include its customers, the government, and
society at large. For example, when the operations of a business harm the
community, social responsibility calls the business in question to engage with the
community and find ways of compensating, as opposed to ignoring these
impacts.

Activity

What is corporate social responsibility? Watch the video on YouTube at

https://www.youtube.com/watch?v=1bpf_sHebLI (Servier International, 2019).
In your writing pad, add the heading ‘Business social responsibility’. Then
summarise the video.

2.2.3 Businesses and Consumers

Businesses (or firms as economists call this component of the economy) and
consumers (or households as economists call this component of the economy)
have an important relationship in the flow of the economy that you are going to
learn about in the prescribed reading below.

Prescribed reading

Read Chapter 1, pp. 44-48 in the prescribed textbook on the interdependence

between households and firms in Mohr, P., Seymore, R. and Yu, D. 2018.
Understanding Microeconomics, 2nd ed., Van Schaik Publishers.

2.3 SOLVING ECONOMIC PROBLEMS

In the digital era we are living in, the economy is changing at a rapid rate. AI is
creating its own rules for the economic game, and how to resolve problems
differently. Topic 6 will give you a glimpse into this matter. One of the tools that

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is currently revolutionising different industries is the use of Open AI. The
summary below was produced using chat.openai. We encourage students to use
AI tools in their learning journey, and share their experiences with us.

In an economy, different role players, such as individuals, businesses,

governments, and financial institutions, interact with each other to address
economic problems. Here's how they typically come together to resolve these
issues:

Individuals: As consumers and workers, individuals play a vital role in the

economy. They can contribute to problem-solving by making informed choices
and engaging in economic activities. For example, individuals can adjust their
spending patterns to stimulate demand during an economic downturn or
participate in job retraining programs to adapt to changing market conditions.

Businesses: Private enterprises drive economic growth and provide goods and
services. They actively participate in resolving economic problems by adapting
their strategies and operations. For instance, businesses may innovate to
address market demands, adjust production levels to manage supply and
demand imbalances, or invest in research and development to enhance
productivity and competitiveness.

Governments: Governments have the authority and resources to influence and

regulate the economy. They can address economic problems through various
policy measures. For example, fiscal policy involves government spending and
taxation to stabilize the economy, while monetary policy involves managing
interest rates and the money supply to control inflation and stimulate growth.
Governments can also implement regulations and provide economic incentives
to encourage desired behaviors or discourage harmful activities.

Financial Institutions: Banks, central banks, and other financial institutions play
a critical role in the economy by providing financing, managing money supply,
and facilitating transactions. They can help resolve economic problems by
extending credit during liquidity crunches, implementing monetary policies, and
ensuring stability in the financial system.

International Institutions: International organizations like the International

Monetary Fund (IMF), World Bank, and World Trade Organization (WTO) foster
global economic cooperation and address international economic issues. They
provide financial assistance, policy advice, and promote trade and economic
integration among nations.

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Academia and Think Tanks: Researchers, economists, and experts from
academic institutions and think tanks contribute to problem-solving by
conducting studies, analyzing data, and proposing policy recommendations.
Their research and expertise help inform economic policies and strategies.

To resolve economic problems effectively, these role players often engage in

dialogue, cooperation, and collaboration. They may participate in forums,
conferences, and public-private partnerships to exchange ideas, share
knowledge, and develop coordinated strategies. Additionally, policymakers may
seek inputs from various stakeholders and consult with experts to make informed
decisions.

It's important to note that the specific actions taken by these role players to
address economic problems can vary based on the nature of the problem, the
economic system in place, and the prevailing socioeconomic conditions.

Activity
Critique the summary above. Is there anything you would take away or add?
Which prevalent economic system does the summary describe, and why?

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 Summary

In this topic, you were introduced to systems and roleplayers in the economy.

Economic systems refer to the way societies organize and manage their
resources, production, distribution, and consumption of goods and services.
There are primarily three types of economic systems: market economy, planned
economy, and mixed economy.

In a market economy, also known as capitalism, the allocation of resources and

the determination of prices are primarily driven by market forces of supply and
demand. Private individuals and businesses own and control the majority of
resources and make decisions based on profit motives.

A planned economy, often associated with socialism or communism, is

characterized by central government planning and control over resource
allocation and production. The state decides what to produce, how much, and at
what prices.

A mixed economy combines elements of both market and planned economies. It

features a blend of private ownership and government intervention. The
government regulates certain sectors, provides public goods and services, and
implements economic policies to address market failures and promote social
welfare.

The choice of an economic system depends on cultural, historical, and political

factors. Most countries today have mixed economies, varying in the degree of
government involvement and market influence.

No matter which system, most economies have two main fundamental

institutions, namely, the state and market, which must complement each other
to maximise societal welfare. This complementarity is necessary because both
the state and market can fail. Where the market fails, it becomes the state’s
responsibility to regulate the market and correct its failures. However, the state
also fails, at times. In South Africa, we are aware of the problem of state or
regulatory capture.

The emphasis on regulation of failing markets is consistent with the role of a

modern state. Providing employment and producing goods through public

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enterprises are roles for the traditional state. In its modern form, the state must
create equality of opportunity, make private business environmentally
responsive, and so on. This means there is need for reform in some countries,
such as South Africa where the government is seen as an employer.

The role of business is to take the lead in providing employment and producing
goods and services. To do this effectively, businesses need to be managed
properly, which entails choosing the right governance structure. The capitalist
form of governance gives decision-making to investors, while the employee-run
firms give decision-making to employees. A healthy economy requires that
businesses adopt different modes of governance. The success of a business
cannot be measured in financial terms alone. Businesses must not operate in
ways that increase market failure and the need for regulation. In other words,
they need to voluntarily internalise the costs of their actions to the environment
and stakeholders. This is the core of social responsibility.

Lastly, businesses (firms) and consumers (households) engage in a circular flow

of goods and services. Households sell their factors of production to firms, who
transform these factors into goods and services, which are in turn sold to
households. You will learn in Topic 6 that some new forms of exchanging and
trading with goods have evolved.

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 Self-Assessment Questions

1. Briefly outline the four types of economic systems. To help you answer
the questions, watch the video on YouTube at:
https://www.youtube.com/watch?v=5vTdPNY7P2w (Think Econ, 2021).

2. Is South Africa a modern state? Justify your answer.

3. Does state capture impact the economy’s performance? Do some

research and provide practical examples in your answer. For help with
answering the question, visit the link:
https://www.dailymaverick.co.za/article/2019-03-01-state-capture-
wipes-out-third-of-sas-r4-9-trillion-gdp-never-mind-lost-trust-
confidence-opportunity/ (Merten, 2019).

Prescribed reading
Answer question 3 below after reading the text in the link:
https://www.investopedia.com/terms/c/corporategovernance.asp (Chen,
2022).

4. What are the benefits of good corporate governance? Explain.

5. Distinguish between the Anglo–US and Japanese models of governance.

Access the link at:
https://www.investopedia.com/ask/answers/051115/what-are-some-
examples-different-corporate-governance-systems-across-world.asp#:
(Ross, 2021) to support your answer.

6. Access one of the AI tools and ask the following question: Should
corporates get involved in corporate social responsibility? What are
arguments in favor and against?

7. Draw your own mindmap of the circular flow of goods and services
between firms and households.

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 Topic 3
Basic microeconomic tools

3.1 INTRODUCTION

This topic relates to the following module outcome:

3. Apply microeconomic tools to case scenarios of economies with and

without production, and draw relevant conclusions.

On completion of this topic on the basic microeconomic tools, you will understand
demand and supply and how they interact to form market equilibrium. You will
be able to explain and illustrate how shifts in demand and supply curves affect
equilibrium price and quantity. In addition, you will discover how rational
consumers maximise utility, given budgetary constraints. You will also be able to
extend one-period optimal choice analysis into an intertemporal optimal choice
analysis, where the consumer maximises utility for two periods. You will then see
how the concept of time value of money applies to consumer choices. Finally,
you will learn to relate changes in consumer choice to demand curves.

In this topic, you will gain knowledge in the following areas:

1. Demand and supply

2. Consumer preferences and choice
3. Time value of money
4. The theory of demand

3.2 DEMAND, SUPPLY AND MARKET EQUILIBRIUM

Prescribed reading
Read Chapter 4, pp. 85–91 of Mohr, P., Seymore, R. & Yu, D. 2018.
Understanding Microeconomics, 2nd ed.; and Chapter 2, pp. 35–44 of Fourie, J.
& Mohr, P. 2022. Mzansinomics — Understanding the basics of the South African
economy.

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3.2.1 Demand

Demand is defined as the quantity of a product that consumers are willing and
able to buy at every given price. The law of demand says that there is an inverse
relationship between price and quantity demanded, i.e. the higher the price, the
lower the quantity demanded, and vice versa. The demand curve is downward
sloping to reflect the law of demand.

Example

A demand curve is constructed by plotting the different quantities demanded and

different prices which are given in a table called a demand schedule. Price (P)
will be on the vertical axis and quantity (Q) will be on the horizontal axis.

Figure 4.1 Demand schedule and demand curve

The dots represent the points in the demand schedule. By drawing a line that
connects these points, we get the demand curve.

Activity

The quantity of a good demanded is determined by many factors. Watch the

video on YouTube at https://www.youtube.com/watch?v=-hbVW2OTJ4Q
(Cartwright, 2015a). In your writing pad, write a subheading ‘Demand’. List all
the determinants of demand. Then discuss and illustrate how changes in price
and non-price determinants affect the demand curve.

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3.2.2 Supply

Supply is defined as the quantity of a product that producers are willing and able
to sell at every given price. The law of supply says that there is a direct
relationship between price and quantity supplied, i.e. the higher the price, the
higher the quantity supplied, and vice versa. The supply curve slopes upwards
to reflect the law of supply.

Example

A supply curve is constructed by plotting the different quantities supplied and

different prices which are given in a table called a supply schedule. Price (P) will
be on the vertical axis and quantity (Q) will be on the horizontal axis.

Figure 4.2 Supply schedule and supply curve

The dots represent the points in the supply schedule. By drawing a line that
connects these points, we get the supply curve.

Activity
The quantity of a good supplied is determined by many factors. Watch the video
on YouTube at https://www.youtube.com/watch?v=Sp3gJS8NyAc&t=20s
(Cartwright, 2015b). In your writing pad, write a subheading ‘Supply’. List all the
determinants of supply. Then discuss and illustrate how changes in price and
non-price determinants affect the supply curve.

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3.2.3 Market equilibrium

Market equilibrium is where the quantity demanded is equal to the quantity

supplied, ceteris paribus, graphically illustrated where the demand curve and
supply curve intercept. Market equilibrium is presented as E.

Example
The market for oranges is represented below. Market equilibrium is formed at
point E, where the demand curve intersects with the supply curve, meaning that
the quantity demanded is equal to the quantity supplied. The equilibrium price is
R10 and the equilibrium quantity is 30 tonnes. The market is in disequilibrium at
prices below or above R10. At R5, 20 tonnes are supplied but consumers demand
40 tonnes. This means that there is excess demand of 20 tonnes, and this forces
the price to rise until it reaches R10. At R15, consumers demand 10 tonnes, but
suppliers bring 50 tonnes. This means that there is excess supply of 40 tonnes,
and this forces the price to fall until it reaches R10.

Figure 4.3: Market equilibrium and disequilibrium

Activity

To refresh your memory about demand, supply, and market equilibrium, again
watch the video by Marginal Revolution University (2015) on YouTube at
https://www.youtube.com/watch?v=7eZcPs9z9OA. In your writing pad, make a
heading ‘Demand, supply, and market equilibrium’. Then summarise the video.

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3.2.4 Comparative statics: Single shifts in demand and supply

Shifts in either supply or demand cause the equilibrium to change, and the impact
on market equilibrium is determinate. In other words, you can tell if equilibrium
price and quantity have increased or decreased.

Activity

To see the impact of separate shifts of demand and supply curves, watch the
video on YouTube at https://www.youtube.com/watch?v=T6kr-70IaHE
(Economics Mafia, 2015a). In your writing pad, write a subheading ‘Comparative
statics: Separate shifts’. Illustrate and discuss the impact of the shifts in these
curves on market equilibrium.

Activity

The impact of double shifts of the demand and supply curves causes
indeterminate impact on equilibrium price and quantity. To learn more on this,
watch the video on YouTube at
https://www.youtube.com/watch?v=K0AQ9rK8MN4 (Clifford, 2015b). In your
writing pad, write a subheading ‘Comparative statics: Double shifts’. Illustrate
and discuss the impact of the double shifts on equilibrium price and quantity.

3.2.5 Elasticity of demand and supply

We know that a change in a determinant of demand or supply causes the quantity

demanded or supplied to change, ceteris paribus. When the relative (or
percentage) change in a determinant is compared to the relative change in
quantity, we get an idea of how responsive the quantity of a product is to changes
in the determinant. This is referred to as elasticity. From the demand side, there
are three common types of elasticities, namely, price, income and cross. From
the supply side, the common elasticity is price.

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 Example

Suppose that a consumer with an income of R10 000 buys 100 units of a product
at the prevailing price. After the consumer’s income increases to R12 000, ceteris
paribus, the number of units demanded rises to 150. This means the income
increased by 20% (R2 000 ÷ R10 000 × 100) and quantity purchased increased
by 50% (50 ÷ 100 × 100). The income elasticity of demand is calculated as
follows:

%𝐶𝐶ℎ𝑎𝑎𝑎𝑎𝑎𝑎𝑎𝑎 𝑖𝑖𝑖𝑖 𝑞𝑞𝑞𝑞𝑞𝑞𝑞𝑞𝑞𝑞𝑞𝑞𝑞𝑞𝑞𝑞 𝑑𝑑𝑑𝑑𝑑𝑑𝑑𝑑𝑑𝑑𝑑𝑑𝑑𝑑𝑑𝑑 50%

𝐸𝐸𝐸𝐸 = = = 2.5
% 𝐶𝐶ℎ𝑎𝑎𝑎𝑎𝑎𝑎𝑎𝑎 𝑖𝑖𝑖𝑖 𝑖𝑖𝑖𝑖𝑖𝑖𝑖𝑖𝑖𝑖𝑖𝑖 20%

The coefficient is positive, which means the good is a normal good. It is also
above 1. This means that the product is a luxury good. Note that, if the elasticity
lies between 0 and 1, the product is a necessity or basic good. Now, goods with
a negative income elasticity of demand are called inferior goods. This means that
the demand for inferior goods, like two-minute noodles, decreases as income
increases.

Recommended reading

Read Chapter 5, pp. 113–130 of Mohr, P., Seymore, R. & Yu, D. 2018.
Understanding Microeconomics, 2nd ed.

3.3 CONSUMER PREFERENCES

3.3.1 Consumer preferences

We know that consumers have unlimited wants, and this is why they consume
different types of goods in combinations referred to as a bundle or basket. The
preference of one bundle to another is based on the level of utility or satisfaction
derived from the bundle. As such, consumer preferences indicate the ranking of
any two bundles in terms of utility by individual, assuming that the baskets are
free (Besanko & Braeutigam, 2014:77).

There are two standard approaches to ranking bundles. In the cardinal approach,
ranking is quantitative since consumers can give a quantitative measure, usually
utils, of the utility associated with a bundle. Conversely, in the ordinal approach,

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consumers cannot measure utility quantitatively, but they can order the
satisfaction from the bundles from the highest to the lowest. Moreover, there are
three important assumptions used to analyse consumer preferences. These are
completeness, transitivity (or consistency), and non-satiation (more is better).

Prescribed reading

Read Chapter 7, pp. 151–153 of the prescribed textbook: Mohr, P., Seymore, R.
& Yu, D. 2018. Understanding Microeconomics, 2nd ed.

Activity

To learn more about the assumptions of consumer preferences, visit the video
on YouTube at https://www.youtube.com/watch?v=SebLaPtVtgs (Eloriaga,
2021). In your writing pad, write a heading ‘Consumer preferences’ and a
subheading ‘Assumptions of preferences’. Then summarise the video.

3.3.2 Utility functions

Prescribed reading

Read Chapter 7, pp. 152–156 of Mohr, P., Seymore, R. & Yu, D. 2018.
Understanding Microeconomics, 2nd ed. to understand indifference curves.

These are graphical or algebraic representations of consumer preferences. To

simplify economic analysis, we assume that there are only two goods in the
economy. This allows us to look at the case of preference with one good and
preferences with multiple goods.

Utility function with one good: Total and marginal utility

A utility function with one good is graphically represented as the total utility (TU)
function, and it gives the total satisfaction derived from the consumption of a
given quantity of the good. To understand how a consumer behaves as
consumption increases, we use the concept of marginal utility. Marginal utility is
defined as the change in total utility as consumption increases by one extra unit.
A consumer will stop consumption when marginal utility is zero. This is where
total utility is at the maximum. Disutility is where the marginal utility is negative.

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Utility functions with two goods: Indifference curves

A utility function with two goods can be graphically represented by an

indifference curve (U), which is defined as a curve connecting different
combinations of two goods yielding the same level of satisfaction. The consumer
can consume a different bundle by substituting one good for the other. The
marginal rate of substitution (MRS) is the amount of one good that must be
sacrificed to get one extra unit of the other good so that the consumer remains
on the same indifference curve. The diagram below illustrates the indifference
curve for a consumer who consumes bundles of bananas and burgers. For
example, a bundle with 10 bananas and 1 burger yields the same utility as a
bundle with 5 bananas and 2 burgers.

Figure 4.4 An indifference curve

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 Prescribed reading

Read Chapter 7, pp. 152–156 of Mohr, P., Seymore, R. & Yu, D. 2018.
Understanding Microeconomics, 2nd ed.

Activity

To gain a better understanding of indifference curves, watch the video on

YouTube at https://www.youtube.com/watch?v=iOmDo5jLFw8 (Marginal
Revolution University, 2017a). Open your writing pad and add a heading
‘Indifference curves’. Then summarise the video.

3.4 CONSUMER CHOICE

Prescribed reading

Read Chapter 7, pp. 156–160 of the prescribed textbook: Mohr, P. Seymore, R.

& Yu, D. (2018). Understanding microeconomics, 2nd ed.

3.4.1 The budget constraint

As mentioned above, preferences are not influenced by the level of income or

prices of the two goods. But as you know, what you eventually buy, or your
choice, is constrained by your income and the price you must pay. When the
consumer’s income is fixed, the set of the bundles that can be bought when all
the income is spent on the two goods is referred to as the budget constraint. It
is graphically represented by a budget line, as shown below. Here, we assume
that the consumer has R100, the price of a banana is R10 and the price of a
burger is R25. For example, the consumer can buy 10 bananas and no burgers
(R10 × 10 = R100); 5 bananas and 2 burgers (R10 × 5 + 2 × R25 = R100) or 4
burgers only (R25 × 4 = R100).

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 Figure 4.5 A budget line

Prescribed reading

Read Chapter 7, pp. 156–160 of Mohr, P. Seymore, R. & Yu, D. 2018.

Understanding microeconomics, 2nd ed.

Activity

To understand more about the budget line, view the video on YouTube at:
https://www.youtube.com/watch?v=sNRZE0kwNGI (Marginal Revolution
University, 2017b). In your writing pad, discuss how budget line represents
affordability, and draw diagrams to differentiate shifts due to changes in income
(parallel shift) from shifts due to changes in the prices of one of the two goods.

3.4.2 Optimal choice or consumer equilibrium

You will recall that constrained optimisation applies when an economic agent
seeks to maximise benefits given a constraint. As such, the optimal choice is the
bundle that maximises the consumer’s utility given the budget constraint. In the
ordinal approach, to get the optimal choice, the budget line must be a tangent
to the highest possible indifference curve. This means that the equilibrium
condition is that the slope of the indifference curve is equal to the slope of the
budget line:

𝑀𝑀𝑀𝑀𝑥𝑥 𝑃𝑃𝑥𝑥
𝑀𝑀𝑀𝑀𝑀𝑀𝑀𝑀𝑀𝑀 = =
𝑀𝑀𝑀𝑀𝑦𝑦 𝑃𝑃𝑦𝑦

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At equilibrium, the ratio of the marginal utility of product x and product y is equal
to the ratio of their prices. The figure below illustrates consumer equilibrium.

Figure 4.6 Consumer equilibrium

Activity
Watch the video on YouTube at https://www.youtube.com/watch?v=MXIgp-P-
FeY (Marginal Revolution University, 2017c) to learn more about the utility
maximisation problem. Go to your writing pad, make a heading ‘Optimal choice’,
then summarise the video.

3.5 TIME VALUE OF MONEY

3.5.1 Present and future value

The value of money over time is not the same. One rand you receive today is
worth more than one rand you will receive next year. For a person to be able to
choose whether to receive money today or in the future, or whether to borrow
or lend, present and future values need to be calculated. The process of making
future values comparable to present values is called discounting. The interest
rate which is used in the discounting process is called the discount rate.

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 Recommended reading

Read Chapter 4, pp. 146–149 of Besanko, D. & Braeutigam, R.R. 2014.

Microeconomics, 5th ed.

Example

To understand how future and present values are calculated, watch the video at
https://www.youtube.com/watch?v=cy4PiY5ERTI (The Organic Chemistry Tutor,
2020).

3.5.2 Intertemporal optimal consumption choice

Now that you understand the concepts of present and future value, let’s see how
present and future values apply to optimal choice. Our consideration of consumer
choice thus far involved making decisions in one period under the assumptions
that the consumer has a fixed income and cannot borrow or save. In the
intertemporal choice, the consumer’s optimal consumption choice is considered
over two periods, income is expected grow in period two and the consumer can
borrow or save. The optimal choice problem of the consumer is to choose the
levels of consumption in period one (C1) and period two (C2) that maximise his
total utility in the two periods.

The decision to borrow and consume more in the current period or save and
consume more in the future period depends on the consumer’s impatience, which
is measured by the rate of time preference. This rate of time preference is used
as the discount factor. Consumers with a higher time preference derive little
utility from future consumption. Hence, they maximise utility by borrowing and
consuming more in period one. The opposite is true for consumers with a lower
time preference.

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 Recommended reading

Read Chapter 4, pp. 128–131, 150–151 Besanko, D. & Braeutigam, R.R. 2014.
Microeconomics, 5th ed.

3.6 THE THEORY OF DEMAND

Optimal choice is closely related to the theory of demand. We know that the
consumer’s choice is constrained by income and the prices of goods, which are
incidentally factors of demand. Changes in consumer equilibrium brought about
by changes in income and prices can be reflected as shifts of or movements along
the demand curves, respectively. Let’s now link comparative statics of optimal
choice to demand curves.

3.6.1 The effects of a change in price

Prescribed reading

Read Chapter 7, pp. 162–164 of Mohr, P., Seymore, R. & Yu, D. 2018.
Understanding Microeconomics, 2nd ed.

When the price of one good changes, ceteris paribus, the customer will move to
a new equilibrium. Changes in consumer equilibrium following a price change can
be used to derive a demand curve. This is done by plotting the equilibrium
quantities against the associated prices (Besanko & Braeutigam, 2014:154). This
indicates a movement on the demand curve.

Example

To learn more about how the demand curve is derived from changes in consumer
equilibrium due to price changes, watch the video on YouTube at
https://www.youtube.com/watch?v=QLihGATv-0o (Economics in Many Lessons,
2021).

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3.6.2 The effects of a change in income

Changes in consumer equilibrium due to changes in income can be used to

analyse shifts in the demand curve. When the consumer’s income increases, she
moves to a higher equilibrium point. Since the price of the goods has remained
constant, but quantities have changed, we draw a demand curve for each of the
equilibrium points at the constant price. A higher income is associated with a
higher demand curve, which shows shifts in the demand curve. This indicates a
movement of the demand curve. You should note that this is true when the good
in question is a normal good. For inferior and Giffen goods, however, an increase
in income will cause demand to fall, which is indicated by a downward movement
of the demand curve.

Prescribed reading

Read Chapter 7, pp. 162–163 of Mohr, P., Seymore, R. & Yu, D. 2018.
Understanding Microeconomics, 2nd ed.

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 Summary

This topic showed how the economic tools introduced in Topic 1 are applied in
different scenarios. The intersection of the demand and supply curves gives the
equilibrium price and quantity. Excess demand and supply are disequilibrium
situations that arise due to inequality between demand and supply. The market
adjusts to correct these excesses without changing the market equilibrium.

Changes in the equilibrium price and quantity are brought about by separate or
simultaneous shifts of the demand and supply curves. With separate shifts, the
change in the equilibrium price and quantity are definitive. In contrast, both
shifts in demand and supply curves result in an indeterminate change in either
price or quantity. Changes in non-price factors of demand and supply cause these
shifts in curves.

Consumers are faced with a utility optimisation problem. Their preferences,

formed in a world where goods and services are for free, are constrained by the
reality that goods have prices and income is fixed. The optimal choice, the bundle
that maximises utility, is obtained when the budget line (representing the
constraint) is a tangent to one of the many indifference curves in an indifference
map (which represents the preferences).

Changes in consumer equilibrium brought by changes in the price of goods or

income are closely linked to theory of demand. A demand curve is derived when
the initial and new optimal choice quantities are plotted against corresponding
prices. Shifts in the demand curve are shown when the changes in optimal choice
quantities following income changes are plotted against the fixed price.

Lastly, the utility optimisation problem is applied to two periods. In this

intertemporal choice problem, the consumer must choose the levels of
consumption in period 1 and period 2 that maximise utility for the two periods.
Utility associated with the future period is discounted by the rate of time
preference. Consumers with a big rate of time preference will consume more in
the current period and thus less in the future period. In situations where
borrowing and saving is allowed, such a consumer will borrow.

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 Self-Assessment Questions

Attempt the revision questions in your prescribed textbook, and share your
answers or any questions you might have to the Q&A Forum on Canvas. In
addition to those, attempt the questions below.

1. Briefly explain the three types of elasticity of demand.

Recommended reading

Read Chapter 2, pp. 45–55 of Besanko, D. & Braeutigam, R.R. 2014.

Microeconomics, 5th ed. to get an overview of elasticity and its different types
before answering questions 2, 3 and 4.

2. How is total utility calculated from marginal utility figures?

3. Explain how the consumer achieves equilibrium using the cardinal utility
approach. Assume that there are two goods.

4. Use the concepts of total, income, and substitution effects to distinguish

between normal, inferior, and Giffen goods. Assume that the price is
fallen. Hint: Use a table and indicate whether the effect is positive or
negative.

Recommended reading

Read Chapter 5, pp. 164–174 of Besanko, D. & Braeutigam, R.R. 2014.

Microeconomics, 5th ed.

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 Topic 4
Economies with and without production

4.1 INTRODUCTION

This topic relates to the following module outcome:

3. Apply microeconomic tools to case scenarios of economies with and

without production, and draw relevant conclusions.

On completion of this topic on economies with and without production, satisfying

Module Outcome 3, you will be able to understand production functions with
different numbers of inputs. You will also be able to describe the different costs
faced by a firm and draw relevant curves. In addition, you will be able to depict
and do comparative statics for the cost minimisation problem. This is not all. You
will also learn how exchange takes place in an economy without production.
Lastly, you will understand the difference between discrete and continuous
goods.

In this topic, you will gain knowledge in the following areas:

1. Input and production functions

2. Costs and cost minimisation
3. Cost curves
4. Exchange
5. Discrete or continuous goods

4.2 ECONOMIES WITH PRODUCTION

Economic production involves the transformation of resources into finished goods

and services by combining the factors of production in some ratio, which
represents the technology (the fifth production factor). You will recall that there
are four main factors of production: labour, capital, land, and entrepreneurship.
Now, the production function is a mathematical representation of how these
different factor inputs are combined by a firm in its production process, and it
indicates the maximum output the firm can produce, given these different input
combinations (Besanko & Braeutigam, 2014:206).

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Although there are four factors of production, economic analysis is centred
around labour (L) and capital (K). Therefore, the production function is
represented as: Q = f(L, K).

Prescribed reading

Read Chapter 8, pp. 176–183 and pp. 189–192 of the prescribed textbook: Mohr,
P., Seymore, R. & Yu, D. 2018. Understanding Microeconomics, 2nd ed.

4.2.1 Production functions with a single input

In the short run, capital is assumed to be the fixed factor. This leaves output as
a function of a single unit, labour, i.e. Q = f(L). This short-run, single-input
production function is referred to as the total product (TP) function (Besanko &
Braeutigam, 2014:206). As such, the TP function shows how output changes as
the quantity of labour changes.

The productivity of labour is measured in two ways. Firstly, the average product
of labour (APL), which is simply total product divided by the quantity of labour.
Secondly, the marginal product of labour (MPL) is the change in total output as a
result of employing an extra labourer. The MPL is subject to the law of diminishing
marginal returns, which states that as more labour is added to a fixed capital,
the contribution of each additional labourer will eventually start decreasing to
the point that the total and average product will start falling (Mohr et al.,
2018:181–182).

Activity

To learn more about the relationship between total, marginal, and average
product, watch the video at https://www.youtube.com/watch?v=MAsGhGkckT8
(Economicsfun, 2012a). In your writing pad, go onto a fresh page and make a
heading ‘Production in the short run’. Then draw these curves, clearly marking
the three regions or stages of production and explain what is happening in each
region.

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 Example

Marginal and average product can be calculated manually. To see how this is
done, watch the video at https://www.youtube.com/watch?v=A78lu9JDmgo
(Economicsfun, 2012b).

4.2.2 Production functions with more than one input

In the long run, when capital is a variable factor, the production function will
have two factors and will be represented as Q = f(L, K). In this case, the
production function will be represented by a total product hill, which is a three-
dimensional graph showing the relationship between quantity and the two
variable inputs employed (Besanko & Braeutigam, 2014:215).

Depending on prevailing conditions, a firm will alter the combinations of its

inputs. For example, an increase in the cost of labour will make the firm
substitute capital for labour. According to Besanko and Braeutigam (2014:216),
the trade-offs are best illustrated by an isoquant, which is a curve showing
different combinations of labour and capital that produce the same quantity. The
rate at which one input is substituted for another while remaining on the same
isoquant is called the marginal rate of technical substitution (MRTS). It is the
slope of the isoquant and its rate of change as we move along the isoquant that
indicates the easiness or opportunities for substitution (Besanko & Braeutigam,
2014:225–226).

Activity

To learn more about different shapes of isoquants and the marginal rate of
technical substitution (MRTS), watch the video at
https://www.youtube.com/watch?v=LY5fXomMZIk by Policonomics (2014a). In
your writing pad, write down the heading ‘Production in the long run’. Then draw
the different shapes of isoquants and comment on the MRTS associated with each
shape.

4.2.3 Costs

As a business produces goods and services, it incurs costs. Now, there are
different ways of analysing production costs. Firstly, costs are differentiated in

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terms of relevancy to decision-making: Sunk costs refer to costs that have been
incurred already and thus are not relevant to the decision. Conversely, non-sunk
costs are those costs that will be incurred because of taking a particular decision.
Secondly, costs can also be looked at as accounting versus economic costs.
Lastly, perhaps the most important classification in economic analysis, costs can
be classified as variable or fixed. The criterion here is the behaviour of the cost
as output changes. Now, fixed and variable costs can be looked at in terms of
three magnitudes, namely, total, average and marginal. You should also note
that classifying costs by behaviour distinguishes the short run from the long run.
Fixed costs exist in the short run only.

Example

Total fixed costs (TFC) do not change as the volume of production increases.
Examples of fixed costs include rent and salaries of cleaners and security guards
in a factory. Total variable costs (TVC) change with production. Examples of
variable costs include electricity and raw materials consumed. If we add total
fixed and variable costs, we get total costs (TC), i.e. TFC + TVC = TC. If we
divide TFC, TVC and TC by quantity, we get AFC (average fixed cost), AVC
(average variable cost) and ATC (average total cost), respectively. The marginal
cost (MC) measures the change in TC as output increases by one extra unit. The
table below shows the relationship between these costs.

Table 3.1: Short-run costs

We can clearly see that TFC remains the same but all the other costs, including
AFC, change as quantity changes. Assume that the table has figures in the first
three columns only. Let’s see how all the other costs can be calculated:

TC = TFC + TVC e.g. R5 500 = R1 000 + R4 500

AFC = TFC ÷ Q e.g. R500 = R1 000 ÷ 2
AVC = TVC ÷ Q e.g. R1 375 = R4 500 ÷ 4

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ATC = TVC ÷ Q e.g. R2 200 = R2 200 ÷ 1.
Also note, ATC = AFC + AVC (R2 200 = R1 000 + R1 200).

MC = Change in TC ÷ Change in quantity. For the third unit, MC = (R4 900 − R3

500) ÷ (3 − 2) = R1 400.

Prescribed reading

Read Chapter 8, pp. 172–173, 183–192 of Mohr, P., Seymore, R. & Yu, D. 2018.
Understanding Microeconomics, 2nd ed.

Activity

Accountants and economists look at costs differently. To see how, view the video
on YouTube at https://www.youtube.com/watch?v=FgttpKZZz7o (MJMFoodie,
2008). In your writing pad, create a new heading ‘Cost concepts’. Then
summarise the contents of the video.

4.2.4 Cost minimisation

For a firm to maximise profit, it must produce its output at the lowest cost. As a
result, the firm is faced with a constrained optimisation situation in which it must
choose the optimal input combination that minimises the total cost of producing
a given level of output. You should note that the cost minimisation problem is
applied to both the long and short run.

Long-run cost minimisation

Recommended reading

Read Chapter 7, pp. 257–261 of Besanko, D. & Braeutigam, R.R. 2014.

Microeconomics, 5th ed.

Since the firm uses labour and capital to produce goods, total costs are made up
of labour costs and capital costs. The cost function is TC = wL + rK where w is

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the wage rate (the remuneration for Labour), L is the amount of labour, r is the
interest rate (the remuneration for Capital) and K is the amount of capital
employed. Remember that capital and labour are variable in the long run. The
cost minimisation problem is set as:

Min TC = wL + rK

subject to: Q0 = f(L, K), where TC = wL + rK is the objective function and Q0 is

the level of desired output (the constraint).

Graphically, the constraint is represented by the isoquant, and the objective

function is represented by an isocost line. The firm’s solution to the cost
minimisation occurs at the point of tangency between the isocost and the
isoquant (Besanko & Braeutigam, 2014:260).

Activity

What is an isocost? To understand more about the isocost line, visit the video on
YouTube at https://www.youtube.com/watch?v=xsiczUggCq4 (Policonomics,
2014b). Open your writing pad to a fresh page, and add a heading ‘Isocost’. Then
discuss what an isocost is and draw the graph.

Activity

To learn more about cost minimisation in the long run, watch the video at
https://www.youtube.com/watch?v=ohZN7_EuK10 (Policonomics, 2014c). In
your writing pad, write the heading ‘Long-run cost minimisation’. Then
summarise the video and draw the graph.

Long-run comparative statics

Recommended reading

Read Chapter 7, pp. 264–270 in the prescribed textbook on comparative statics:

Besanko, D. & Braeutigam, R.R. 2014. Microeconomics, 5th ed.

You already know that comparative statics is applied when there are changes to
the constraint in optimisation problems. As such, when the prices of factors of

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production change, or when the company decides to produce a higher level of
output, the equilibrium position will change.

Comparative statics with change in input prices

Activity

To understand how a producer’s optimal input mix changes as a result of

changing input prices, watch the video on YouTube at
https://www.youtube.com/watch?v=nitj9uBm9mM&t=261s (Intermediate
Economics, 2022). In your writing pad, summarise the video under the heading
‘Comparative statics with changes in input prices’.

Comparative statics with changes in output

When the firm increases its production level while factor prices remain the same,
it moves to a higher isoquant. To produce this higher output, the firm will
increase the quantity of factor inputs employed. This results in an upward shift
of the isocost. The firm will move onto a higher equilibrium. A curve joining the
initial and new equilibrium points is called an expansion path.

Activity

The expansion path depicts changes in input ratios as production expands. To

learn more about comparative statics with changes in output, watch the video
on YouTube at https://www.youtube.com/watch?v=shzsFVoN5iY
(EconProfessorKate, 2012a). In your writing pad, distinguish between normal
and inferior inputs under the heading ‘Comparative statics with changes in
output’.

Short-run cost minimisation

We know that, in the short run, capital is fixed but labour is variable. Labour
costs are regarded as variable costs and capital costs are regarded as fixed costs.
The cost minimisation problem becomes:

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 �
Min TC = wL + rK
�)
subject to: Q0 = f(L, K

Activity

In the short run, the optimisation problem of the firm is slightly different. Watch
the video on short-run cost minimisation
https://www.youtube.com/watch?v=opYQ4uZo9To (EconProfessorKate, 2012b).
In your writing pad, add a heading ‘Short-run cost minimisation’ and then
compare short run to long run.

Short-run comparative statics

In the short run, the company can only increase output by increasing the quantity
of the variable factor. The short-run expansion path is a horizontal line.

4.2.5 Cost curves

We know that costs are a function of output. Cost curves are used to depict the
behaviour of the cost in question as output changes. Since we have long-run and
short-run production periods, we will have long-run and short-run cost curves.

Long-run cost curves

Prescribed reading
Read Chapter 8, pp. 189–192 of Mohr, P., Seymore, R. & Yu, D. 2018.
Understanding Microeconomics, 2nd ed.

There are three cost curves in the long run. Firstly, the long-run total cost curve,
LRTC, is derived by plotting the quantities of the optimal points on the expansion
path against the corresponding total cost, as measured by the relevant isocost.
As such, it shows the minimum cost of producing a given level of output, while
input prices are held constant (Besanko & Braeutigam, 2014:292).

Secondly, the long-run marginal cost curve (LRMC) depicts the cost of producing
an extra unit of output. Graphically, the marginal cost is measured by the slope
of the LRTC, which in turn is measured by the slope of a tangent drawn at each

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point on the curve. Lastly, the long-run average total cost curve (LRAC) depicts
the total cost per unit. Graphically, average total cost is derived by measuring
the slope of the ray drawn from the origin at each point on the LRTC.

Activity
A typical real-world LRAC curve is saucer-shaped due to economies of scale. To
learn more about this relationship, watch the video on YouTube at
https://www.youtube.com/watch?v=JdCgu1sOPDo&t=5s (Clifford, 2015a).
Open your writing pad and write the heading ‘LRAC’. Then draw the LRAC and
clearly show the type of economies of scale associated with each section.

Short-run cost curves

As mentioned above, short-run total costs are decomposed into variable costs
and fixed costs. Variable costs vary with output and fixed costs do not. As such,
the short-run total cost curve, SRTC, has two components. Firstly, the total
variable cost curve, TVC, which is upward sloping. Secondly, the total fixed cost
(TFC) which is a horizontal line.

If we divide the total costs, total variable costs and total fixed costs by quantity,
we get average total cost (ATC), average variable cost (AVC), and average fixed
cost (AFC). These three average curves are derived from the total cost curves in
the same way as the LRAC is derived from the LRTC. Similarly, short-run
marginal cost curve (SMC) depicts the marginal cost which is derived from the
SRTC as its slope.

Prescribed reading
Read Chapter 8, pp. 183–188 of Mohr, P., Seymore, R. & Yu, D. 2018.
Understanding Microeconomics, 2nd ed.

Activity

To see the shapes of the different cost curves in the short run, watch the video
at https://www.youtube.com/watch?v=qYKJdooEnwU (Clifford, 2014a). In your
writing pad, go to the page with formulas and definitions of the various costs and
draw the curve for each type of cost.

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 Activity

The LRAC can be used to reveal a special relationship between long-run and
short-run cost curves. To understand more about this relationship, watch the
video on YouTube at https://www.youtube.com/watch?v=xnu6Jj2x3XI
(Policonomics, 2015). Under the heading ‘Relationship between long- and short-
run cost curves’ describe the relationship between LRAC, LRMC, SRATC and
SRMC.

4.3 ECONOMIES WITHOUT PRODUCTION

Note

This section is an extension of consumer theory covered extensively in Topic 4.

Before you proceed, you need to go through section 4.3 to get the basics of
preferences, indifference curves, and indifference maps.

4.3.1 Exchange

So far in this topic, we have focused on economic activity involving production.

We will now look at a pure exchange economy where there is no production. It
is assumed that there are two consumers and two goods in the economy. You
should note that one of the goods can be money. Each consumer has an initial
endowment of the two goods, which means that he owns some units of the goods
in the economy. The preferences of the consumers are represented by an
indifference map. The only economic activity that happens is that the consumers
engage in trade with each other using their initial endowments to increase their
individual well-being or utility.

An Edgeworth box is a tool that is used to analyse the trade between the two
consumers. You should note that exchange will only happen if mutually beneficial
trades exist. As such, trade will stop when the mutually beneficial trades have
been exhausted. This happens at the point of tangency between the indifference
curves of the consumers. This allocation of resources is Pareto efficient.

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 Recommended reading
Read the text by Ruby (2020) to learn more about exchange and the Edgeworth
box:
http://www.digitaleconomist.org/microeconomics/edgeworth_box.html.

Activity
To learn more on the construction of the Edgeworth box and Pareto efficiency,
watch the video at https://www.youtube.com/watch?v=osvoVuESEKY (Silz-
Carson, 2015). In your writing pad, add a heading ‘Exchange’. Then summarise
the video.

4.3.2 Discrete and continuous goods

As we saw above, the indifference curve is a smooth curve showing many

combinations of the two goods. It is drawn on the assumption that the two goods
are divisible, which makes it possible to consume fractions of the goods. We call
such goods continuous goods. This is contrary to discrete goods which are not
divisible, and therefore are consumed in integer values.

Activity
To understand what discrete goods are and how their indifference is drawn, visit
the video at https://www.youtube.com/watch?v=0NqtfoWZze4&t=4s
(Jochumzen, 2018). Make a heading ‘Discrete goods’ in your writing pad, and
then summarise the video.

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 Summary

This topic looked at economic activity that happens in economies with and those
without production. A firm combines the inputs of labour and capital to produce
goods. How the firm uses these inputs is given by the production function and
depends on the production period. In the short-run production period, the
amount of capital is fixed. Hence, production is a function of labour, meaning
that the production function will have one input. In the long run, the production
function will have two inputs, since capital and labour are variable.

The services of labour and capital are not free. The firm incurs labour and capital
costs as it produces goods. Accountants and economists measure these costs
differently. Accountants measure costs as the explicit monetary payments from
a firm’s bank accounts. In contrast, economists add the implicit or opportunity
costs to explicit costs to arrive at economic costs. In the short run, total economic
costs are divided into fixed and variable costs. The fixed costs are capital
services, and the variable costs are the labour costs. In the long run, all costs
are variable. The behaviour of costs as production increases is depicted by cost
curves. The total fixed cost curve is horizontal, while the total cost and total
variable cost curves are upward sloping.

The firm’s objective is to maximise profits. This requires that it produces its
targeted output at minimal costs. Thus, the firm has a constrained optimisation
problem. To solve this problem, the firm will use the labour–capital input
combination at the point of tangency between the isocost and the isoquant.
Changes in the price of inputs and the desired output level will cause the firm to
adjust the optimal choice of labour and capital.

In economies that do not have production, economic activity is centred on trade

or exchange between two consumers. Each consumer is given an initial
endowment of two goods. Given the consumers’ different preferences, exchange
allows both consumers, or at least one, to increase their utility. An Edgeworth
box is used to analyse the exchanges by the two consumers. The final allocation
that will be obtained after trade is Pareto efficient.

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 Self-Assessment Questions

Attempt the revision questions in your prescribed textbook, and share your
answers or any questions you might have to the Q&A Forum on Canvas. In
addition to those, attempt the questions below.

1. With the aid of a diagram(s), distinguish between the cost minimisation

and production maximisation versions of the firm’s constrained
optimisation problem.
Hint: Open the link below for help with answering the question:
https://policonomics.com/production-maximisation/ (Policonomics,
n.d.).

2. Complete the table below with the various short-run costs.

Q TFC TVC TC AFC AVC ATC MC

0
1 300
2 350
3 420
4 320
5 200 470

Watch the YouTube video at

https://www.youtube.com/watch?v=acvmog553uc (Ingr Nomics,
2020b) to answer the question. Also read Chapter 8, pp. 183–186 of the
alternate prescribed textbook by Mohr et al. (2016) to improve your
answer.

3. Explain the nature of the relationship between short-run production and

costs. Open the link at https://www.economicsdiscussion.net/theory-of-
cost/short-run-costs-and-production-with-diagram/19956 for help with
answering the question (Rekhi, n.d.).

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 Topic 5
Market forms and inefficiencies

5.1 INTRODUCTION

This topic relates to the following module outcome:

4. Read case studies with different market forms and identify possible
problems.

On completion of the topic on market forms and inefficiencies, satisfying Module

Outcome 4, you will be able to differentiate between the various forms of markets
based on their features. You will also be able to describe and draw the graphs
depicting short-run and long-run equilibrium positions of perfect competition,
monopoly, and monopolistic competition. In addition, you will be able to
understand the efficiency of perfect markets and how government intervention
causes deadweight loss. Lastly, you will learn how market power and cooperation
of firms are sources of inefficiencies.

In this topic, you will gain knowledge in the following areas:

1. Perfect competition
2. Monopoly
3. Imperfect competition

5.2 OVERVIEW OF MARKET STRUCTURES

Prescribed reading

Read Chapter 9, pp. 199–204 of Mohr, P., Seymore, R. & Yu, D. 2018.
Understanding Microeconomics, 2nd ed. to get an idea of the different market
forms.

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There are four standard forms of market structures: perfect competition,
monopoly, monopolistic competition, and oligopoly. The market structure has an
important bearing on behaviour of a firm.

5.2.1 Features

Activity

Each market structure has features that determine the behaviour of the firm
operating in it. To learn more about these features, watch the video at
https://www.youtube.com/watch?v=frHyR9FiKt4 (PrepNuggets, 2021a). In your
writing pad, write a heading ‘Features of market structures’, then list the features
of each market.

5.2.2 Equilibrium conditions

A firm is in equilibrium when it is maximising economic profits or when it is

minimising losses. There are two conditions that need to be satisfied and these
rules apply to all market structures. The first is the profit maximising rule which
says that the firm will maximise profits when it is producing a quantity where the
marginal revenue is equal to marginal cost, i.e. MR = MC. The second is the
shutdown rule which says a company must shut down if it fails to cover its
variable costs. This happens when the price (average revenue) is lower than the
average variable cost (AR < AVC) or where total revenue is lower than total
variable cost (TR < TVC).

Activity

To learn more about the profit maximising and shutdown rules, watch the video
on YouTube at https://www.youtube.com/watch?v=w0HbGX0KFFM (Clifford,
2021a). In your writing pad, write down a heading ‘Equilibrium conditions’. Then
explain and illustrate these conditions.

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5.3 PERFECT COMPETITION

5.3.1 Equilibrium

We know that perfectly competitive firms are price takers. Therefore, in order to
maximise profit, firms adjust the level of production. The equilibrium position of
perfect competition is analysed for the firm and industry, and in the short and
long run.

Short-run equilibrium

In the short run, market equilibrium is determined by the intersection of the

market demand and supply curves. You should note that for perfect competition,
price is equal to MR, i.e. P = MR. Therefore, the firm is in equilibrium when it
produces the level of output that equates MC to the market equilibrium price. In
the short-run equilibrium, the firm can be making an economic profit, economic
loss, or normal profit. The figure below shows a short-run equilibrium when profit
is being made. As you can see, the profit maximising output, Q*, is produced
where MR = MC.

Figure 5.1 Short-run equilibrium with profit for perfectly competitive firm

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 Prescribed reading

Read Chapter 9, pp. 205–213 of Mohr, P., Seymore, R. & Yu, D. 2018.
Understanding Microeconomics, 2nd ed.

Long-run equilibrium and comparative statics

We know that there are no barriers to entry in perfect competition. Assuming

that firms are making profits in the long run, new firms enter the market. This
results in the market supply curve shifting to the right, thereby causing the
market price to fall. The entry of firms will only stop when there are no economic
profits. At this point, the firm has attained long-run equilibrium. In the long run,
perfectly competitive firms only earn normal profits.

Prescribed reading

Read Chapter 9, pp. 215–218 of Mohr, P., Seymore, R. & Yu, D. 2018.
Understanding Microeconomics, 2nd ed.

Economic efficiency

Activity

Perfectly competitive markets are economically efficient. To learn more about

the economic efficiency of perfectly competitive firms, watch the video at
https://www.youtube.com/watch?v=ZtSZNcaWbf4 (Clifford, 2021b). In your
writing pad, add a heading ‘Perfect competition equilibria and efficiency’. Then
summarise the video.

5.3.2 Government intervention and inefficiency

Free markets are efficient because they maximise economic benefits as

measured by consumer and producer surplus. As you may recall, government
intervention is necessary only when markets fail to achieve economic efficiency.
As such, when the government intervenes where markets are efficient, it will
produce inefficiencies referred to as deadweight loss, which is a reduction in
economic benefits resulting from a misallocation of resources (Besanko &

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Braeutigam, 2014:395). Government intervention takes many forms, including
excise taxes, subsidies, price ceilings and floors, and production quotas.

Recommended reading

Read Chapter 10, pp. 392–420 of Besanko, D. & Braeutigam, R.R. 2014.
Microeconomics, 5th ed.

Activity

To understand how excise taxes cause deadweight losses, watch the video on
YouTube at https://www.youtube.com/watch?v=9gwTH4Yme8I (Clifford, 2014).
In your writing pad, with the aid of a diagram, summarise the impact of excise
duties on economic efficiency.

5.4 MONOPOLY

5.4.1 Equilibrium and inefficiency

Prescribed reading

Read Chapter 10, pp. 222–230 of Mohr, P., Seymore, R. & Yu, D. 2018.
Understanding Microeconomics, 2nd ed.

Just like perfect competition, we consider the short- and long-run position of a
monopolist. In the short run, the firm maximises profits by producing the
quantity where MR = MC. Because of barriers to entry, the monopolist can defend
its position and continue to make economic profits in the long run. As a result,
there is no difference between the short-run and long-run positions of a
monopolist. In terms of efficiency, a monopolist is inefficient. It is both
allocatively and productively inefficient, which leads to deadweight loss to
society. The diagram illustrates the equilibrium position of a monopolist making
profit.

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 Figure 5.2 Short-run (or long-run) equilibrium for a monopoly market

The firm will maximise profit if it is producing Q* which is at the point where MR
= MC. Notice how the MR curve lies below the AR or demand curve. Please note
that MR is not equal to AR for monopolistic competition and oligopoly markets as
well. Thus, the graph above applies to these markets as well.

Activity

To understand the difference between monopoly and competitive equilibria,

watch the video at https://www.youtube.com/watch?v=vieagRfVYf8
(PrepNuggets, 2021b). In your writing pad, add a heading ‘Deadweight loss’.
Then, draw a diagram clearly showing the deadweight loss of monopoly.

5.4.2 Market power and price discrimination

A key feature of monopolies is that they have market power. This means they
have discretion over the price, unlike perfectly competitive firms which are price
takers. When we looked at the equilibrium position of a monopolist, we saw that
consumer surplus exists. A monopolist may decide to capture consumer surplus
and turn it into economic profits by charging consumers different prices for the
same product. This practice is called price discrimination. There are three types
of price discrimination: first-degree, second-degree and third-degree.

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 Prescribed reading

Read Chapter 10, pp. 230–232 of Mohr, P., Seymore, R. & Yu, D. 2018.
Understanding Microeconomics, 2nd ed.

Activity

To gain a deeper understanding of price discrimination, watch the video on

YouTube at https://www.youtube.com/watch?v=--9Wc7hoL3M (Economics
Online, 2017). In your writing pad, outline the three types and conditions
necessary for price discrimination.

5.5 IMPERFECT COMPETITION

Between the extremes of perfect competition and monopoly on the competition

spectrum are monopolistic competition and oligopoly. These two markets are the
broad categories of imperfect competition (Mohr, Seymore & Yu, 2018:221).

5.5.1 Monopolistic competition

Prescribed reading

Read Chapter 10, pp. 232–237 of Mohr, P., Seymore, R. & Yu, D. 2018.
Understanding Microeconomics, 2nd ed.

Activity

To learn more about the short-run and long-run equilibrium and the inefficiencies
of monopolistic competition, watch the video on YouTube at
https://www.youtube.com/watch?v=T3F1Vt3IyNc&t=2s (MJMFoodie, 2011). In
your writing pad, add a heading ‘Monopolistic competition equilibria’. Then
summarise the video.

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5.5.2 Oligopoly

Prescribed reading

Read Chapter 10, pp. 237–237 of Mohr, P., Seymore, R. & Yu, D. 2018.
Understanding Microeconomics, 2nd ed.

We know that oligopoly is a market structure with a small number of firms due
to barriers to entry. An example of oligopoly markets in South Africa is the
petroleum industry, which includes Engen, Shell, BP, and Total. A key feature of
oligopoly is interdependence among firms. Each firm is affected by the actions of
another firm. As a result, a firm in the market must anticipate and react to the
actions of its competitors. In other words, firms in oligopoly act strategically in
order to maximise profits. The strategy can either be to cooperate (collude) or
compete.

Cooperation and inefficiency

Firms cooperate by colluding. This is where they enter into an agreement called
a cartel in which they agree to limit competition with the aim of maintaining high
profits in the industry. The terms of the cartel might be to limit prices, set prices,
or share the market. This anticompetitive behaviour leads to inefficiencies and is
illegal in South Africa. The Competition Commission is tasked with monitoring
cartel behaviour.

Competition

Oligopolists tend to engage in non-price competition to protect industry

profitability. Most of the competition is in product development and advertising.

Recommended reading

Read Chapter 13, pp. 537–561 of Besanko, D. & Braeutigam, R.R. 2014.
Microeconomics, 5th ed. to understand the different oligopoly models.

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5.6 COMPARISON OF THE DIFFERENT MARKET STRUCTURES

Now let’s bring together the key distinguishing aspects of the different markets.
These aspects are shape or elasticity of the demand curve, market power or price
discretion, and the equilibrium or profit situation (Mohr, 2020:224–225).

Table 5.1 The different market structures: a summary

Example in the real

Market Shape of demand curve/control over
world
structure price/profit situation
(approximations)
Horizontal (perfectly elastic demand
curve. No control over price — firms International
are price takers. / Economic profits commodity markets
Perfect
possible only in the short run. These (e.g. oil)
competition
are wiped out in the long run due to
freedom of entry. / Firms earn normal Financial markets
profits. (e.g. JSE)

Downward sloping but relatively elastic

demand curve. / Limited power over
Clothing stores
the price. / Economic profits possible
Monopolistic Restaurants
only in the short run. These are wiped
competition Furniture shops
out in the long run due to freedom of
entry. Firms earn normal profits.

Downward-sloping demand curve.

Elasticity depends on the cooperative
or competitive behaviour of firms. / Car manufacturers
Oligopoly Firms have relatively strong discretion Petroleum companies
over the price. / Economic profits are
possible in both the short run and long
run due to barriers to entry.
Monopoly Downward-sloping but highly inelastic
demand curve. / Firms have complete
discretion over the price. / Economic
Eskom
profits are possible in both the short
run and long run due to barriers to
entry.
Adapted from: Mohr, 2020:224–225

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 Summary

This topic introduced you to the four market structures: perfect competition,
monopoly, monopolistic competition, and oligopoly. The goal of any firm,
regardless of the market it operates in, is to make a profit. To achieve this goal,
the firm must produce the profit-maximising output which is obtained at the point
where MR = MC. A firm making a loss must only shut down if it is unable to
cover its variable costs.

The desirability of a firm to the society, and of a market structure by extension,

is determined by the economic efficiency associated with the market structure.
Perfectly competitive markets are efficient. In the short run, firms are only
efficient in allocating resources. However, the profitability situation in the
industry determines whether firms enter or leave the market. This results in the
adjustment to the long-run equilibrium in which the firms become productively
efficient. Firms will operate at the minimum point of the ATC curve. However, if
government interferes with perfect markets through instruments like taxes and
quotas, deadweight losses will arise.

In contrast, monopoly and imperfect competition are inefficient markets.

Monopolies have complete market power. They charge very high prices and can
defend their highly profitable positions by making entry into the industry
impossible. This makes short-run and long-run equilibria the same. Because
monopolists charge prices above MC, and do not operate at the minimum point
of ATC, they cause deadweight losses.

Monopolistically competitive firms have some control over the price they charge.
In the short run, firms in this market have equilibrium analytically comparable
to that of monopolists. They can make profits, losses, or break even. The lack of
barriers to entry means that firms enter or leave the market, resulting in a long-
run equilibrium in which only normal profits are made. Compared to that of the
monopolist, the deadweight losses of monopolistic competition are smaller. For
oligopolies, the inefficiencies are worsened by the collusive behaviour of firms.
This is when they choose to cooperate rather than compete.

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 Self-Assessment Questions

Attempt the revision questions in your prescribed textbook, and share your
answers or any questions you might have to the Q&A Forum on Canvas. In
addition to those, attempt the questions below.

1. What is the impact of a production quota on free competitive equilibrium?

2. Complete the table below:

Marginal revenue Average revenue

Q Total revenue (TR)
(MR) (AR)
0 0
1 25
2 45
3 60
4 70
5 75

3. In the short run, firms in a perfectly competitive industry are possibly

making economic losses. Explain how firms will achieve long-run
equilibrium.

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 Topic 6
Changing economic paradigm for industries

6.1 INTRODUCTION

This topic relates to the following module outcome:

5. Explain success factors for companies operating in non-traditional

environments.

On completion of this topic on changing economic paradigms, satisfying Module

Outcome 5, you will understand the meaning of the digital economy and how it
is causing industries to change their traditional business models. You will also
know the different digital business models. In addition, you will be able to
describe the success factors for firms operating in the digital economy. Lastly,
you will understand the challenges that developing countries face in the new
economic paradigm.

In this topic, you will gain knowledge in the following areas:

1. Digital business models

2. Financial disintermediation
3. New economic models
4. E-commerce and payment
5. Developing countries’ challenges with regard to new paradigms

6.2 THE DIGITAL OR ‘NEW’ ECONOMY

Advances in information technology have disrupted many industries, from

education and manufacturing to financial services. This has given rise to the
‘digital economy’, which can be defined as economic activities that are dependent
on the use of digital technologies, infrastructure, services, and data. The digital
economy is the ‘new economy’. As noted by Williamson and De Meyer (2020:4),
this disruption has necessitated companies to radically transform their traditional
business models. For example, traditionally a retailer would sell merchandise
from a physical or ‘brick and mortar’ shop. Because of the internet, smart phones

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and techno-savvy consumers, retailers now operate online shops where
customers can buy goods without having to go into the shop.

At the heart of the digital economy and managing disruption is ecosystem

thinking. Here, businesses engage with different partners who bring new
competencies and capabilities that spur innovation and catalyse business and
industry transformation.

Recommended reading

Read Chapter 1, pp. 1–22 of the prescribed textbook: Williamson, P.J. & De
Meyer, A. 2020. Ecosystem Edge.

6.3 DIGITAL BUSINESS MODELS

In general, a business model describes how a business makes money. A digital

business model is how a business makes money online. There are several digital
business models that a business which is transforming from the traditional model
can choose from.

Recommended reading

To get an overview of the various digital models, read the following text:
https://devrix.com/tutorial/top-10-digital-business-models-online-companies-
examples/ (Devrix, 2021).

6.3.1 Platform models

Platforms are computer systems that provide a stage where buyers and sellers
can meet and transact. The platform itself does not own the product or service;
it simply links providers with consumers. For example, Uber does not own taxis.
It owns the platform that allows riders to be matched to drivers. All economic
activities happening on the different platforms form the platform economy.

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 Activity

To understand more about the platform model, watch the video on YouTube at
https://www.youtube.com/watch?v=tJfptNJy6Yw (Applico, 2021). In your
writing pad, add a heading ‘Platform economy’. Then describe the platform
economy and give examples of companies operating in it.

6.3.2 E-commerce and payment

The e-commerce model involves the sale of goods and services online rather than
from a physical shop. When you buy a pizza online, you have participated in an
e-commerce transaction.

Activity

To understand more about the e-commerce model, watch the video on YouTube
at https://www.youtube.com/watch?v=qF1FMTT17tQ (D & V Phillipines, 2022).
In your writing pad, add a heading ‘E-commerce’ and summarise the video.

An e-commerce transaction is finalised once payment has been received by the

seller in their merchant account. Now, the traditional way of online payments is
for the client to submit financial information, such as bank account or credit card
information, to the seller. Of course, this is risky especially if the transaction is
consumer-to-consumer (C2C) and the seller is unknown to the buyer. As a way
of increasing security for buyers using bank cards, e-commerce makes use of
payment gateways and processors that act as an intermediary between online
buyers and sellers. Examples of payment gateways include Payfast, Yoco, and
Ozow.

6.4 NEW ECONOMIC MODELS

Now that you understand business models, let’s look at economic models. An
economic model differs from a business model in that it focuses on value
proposition, creation, and capture at the level of industry or sector, while the
business model is at a lower level of a single business.

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An economic model defines the role of each firm participating in the ecosystem
and determines what it gets in return. Thus, ‘who does what’ and ‘who takes
what’ are two important questions answered by an economic model. It should be
noted, however, that a business model is nested with an economic model. This
is because the firm’s role in an ecosystem affects how it does business (Ng,
2013:4).

Let’s consider the new economic model. The traditional economic model
separates businesses into sectors. Value created in the industry is distributed to
the customer through a vertical or linear value chain. The new economic model
adopts a more horizontal organisation of business, allowing previously separate
user experiences to be combined. You can take, for example, smart TVs which
allow users to stream music, browse the internet, and view photos. As such, the
smart TV combines the capabilities of computers, televisions, and digital media
players. At the heart of the new economic model are customer data and digital
technologies.

Recommended reading

Read the text provided by the following link to help you understand the new
economic models: http://www.nemode.ac.uk/?page_id=51#_ftn1 (NEMODE,
n.d.).

6.5 FINANCIAL DISINTERMEDIATION

Prescribed reading

To understand the traditional role of commercial banks and the South African
Reserve Bank (SARB) in the economy, read Chapter 3, pp. 61–62 of the
prescribed textbook: Fourie, J. & Mohr, P. 2022. Mzansinomics — Understanding
the basics of the South African economy.

Financial intermediation is provision of a middleman between two parties to a

financial transaction. It is the domain of financial institutions, of which the most
important are banks. For example, if you want to borrow money, the traditional
way is to approach a bank. Now, the money loaned out by the bank belongs to

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savers who deposit money into savings accounts. In this way, the bank is an
intermediary between savers and borrowers who do not have direct contact.

Innovation in financial technology (Fintech) has enabled the provision of services

that compete with those offered by financial intermediaries. This has resulted in
financial disintermediation, which refers to the removal of financial institutions
from financial transactions, allowing parties to transact directly. Banks have been
removed from lending and payments, two of their most important services.

6.5.1 Disintermediating banks from lending

Peer to peer (P2P) lending platforms allow individuals to get loans directly from
other individuals without approaching a bank. Prospective borrowers apply for a
loan on the platform, which then assesses the creditworthiness of the applicants
as well as the riskiness of the project. After this, the platform assigns a ‘loan
grade’ to the application. Investors (lenders) bid on the application. Finally, the
platform will gather the funds from investors into a pool and originate the loan
with set terms and rates (Kaja, Martino and Pacces, 2020:6).

6.5.2 Disintermediating banks from money and payments

On the payments side, blockchain technology has seen the development of

cryptocurrencies such as Bitcoin that are not under the control of central banks.
In addition, payments made in cryptocurrency are verified in the network, which
means no banks are required (Hayes, 2022).

Activity

To gain a better understanding of cryptocurrencies, visit the video on YouTube

at https://www.youtube.com/watch?v=1YyAzVmP9xQ (Simplilearn, 2021). In
your writing pad, add a heading ‘Cryptocurrencies’. Then summarise the video.

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6.6 SUCCESS FACTORS IN THE DIGITAL ECONOMY

Recommended reading
Read the following text by Anderson and Wladawsky-Berger (2016) to help you
understand more about the critical success factors:
https://hbr.org/2016/03/the-4-things-it-takes-to-succeed-in-the-digital-
economy

As mentioned above, digital transformation is critical to the survival of business

in modern times. To succeed in the digital economy, there are things that a
business must pay attention to.

6.6.1 Customer expectations

Customers in the highly interconnected digital world have access to different

markets, product choices, and experiences that make them knowledgeable,
demanding, and difficult to satisfy. Moreover, they want to conveniently interact
with the business, and prefer engagement through direct and customised
experiences. Therefore, customer expectations have gone beyond the traditional
ease of use to proactive experiences enabled by data. Companies must then
continuously use data and digital technologies to meet the changing customer
expectations.

6.3.2 Product enhancements

Product enhancements are crucial if customer experiences are to be enhanced.

Successful companies are combining related products and services into complex
industry solutions, resulting in massively expanded and restructured industries,
if not entirely new industries. For example, car manufacturers are fitting vehicles
with technologies that monitor performance of the car, thereby detecting any
service requirements before breakdowns occur. This information allows the car
makers to schedule technicians and mechanics in advance.

6.3.3 Organisational leadership

The flow of information and decision-making in a business is determined by the

organisational structure. To thrive in the fast-paced digital economy, companies
need to move away from the traditional hierarchical structure in which decision-
making is in the hands of a few executives who use their opinions and experience
to make decisions, and adopt adaptive cultures in which decision-making is based
on data. Algorithms, artificial intelligence, and robotics make decisions faster.

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Moreover, organisations must employ data analysts to improve organisational
learning.

6.3.4 Collaborative innovations

The global business environment is very competitive, which means there is ever-
increasing pressure to reduce costs. As a result, business must be innovative.
However, the scale and pace of innovation needed in a complex digital world is
often beyond the capabilities of a single organisation. To this end, businesses
need to collaborate both internally within the business and externally with
customers, partners, research institutions, and competitors.

6.7 DEVELOPING COUNTRIES’ CHALLENGES WITH REGARD TO

NEW PARADIGMS

The digital economy is particularly important to developing countries which are

faced with many socio-economic problems. Digital technologies have the
potential to drive economic growth and job creation, as well as availing many
opportunities to transform these weak economies into sophisticated, high-value
information economies that can compete with advanced economies at an
international level (Lazovic and Đuričković, 2014:1582). As such, not
transitioning to the digital economy is not an option.

However, developing countries face severe challenges with regard to creating

and developing a digital economy (Lazovic and Đuričković, 2014:1582–1584):

1. There is a lack of access to latest technologies and internet connection,

resulting in low internet usage.
2. Telecommunications infrastructure is underdeveloped. An example is
broadband internet which allows for speedy, cheaper, and secure data
transfer.
3. There is low computer literacy among the people in developing countries,
resulting in a small number of people transacting with businesses that
have embraced doing business online, i.e. ‘e-businesses’.
4. Political governance in most developing countries is mainly autocratic
rather than democratic. Democracy permits transparency and equal
access to information, which is why democratic societies are open to
information technologies.
5. There are some conservative cultural and religious beliefs which
discourage or even prohibit the use of the internet.

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 Summary

Continuous advancement in digital technologies has made the consumer more

sophisticated, demanding, and powerful. In turn, this has caused a paradigm
shift in many industries. To meet the needs of the techno-savvy customer,
businesses have been forced to move away from their traditional ways of creating
value and making money. The result is a digital or new economy in which
economic activity is supported by digital technologies. In this digital economy,
there is a plethora of business models to choose from. Examples include e-
commerce, platforms, and ecosystems.

At the industry or sector level of the economy, traditional economic models have
been changed by technology. One sector that has been severely disrupted by
digital technologies is the banking and financial services sector. Through the
process of financial disintermediation, banks are no longer needed by people
wanting to borrow money or make payments. Financial technology has made
crowdfunding possible.

Although it is important that a business operates in the digital economy, mere

participation does not guarantee success. To succeed, the firm needs to meet
the ever-changing needs of customers and continuously improve its product or
service offerings. These efforts require the business to, firstly, form collaborative
partnerships with customers and competitors, and secondly, to abandon the
traditional hierarchical organisational structure in favour of a structure that
allows management to only use data as the tool of decision-making and not
experience (or feelings).

The transition to the digital economy is not only important to industries in

developed countries. The digital economy can be seen as an opportunity for the
developing economies to match the competitiveness of developed countries.
However, developing countries face many challenges in this regard. They lack
the required latest technologies, telecommunications infrastructure, and
computer-literate human resources.

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 Self-Assessment Questions

1. What is the role of government in making the digital economy a success

in developing countries?

Recommended reading

Read Chapter 3, pp. 38–42 of the prescribed textbook: Williamson, P.J. & De
Meyer, A. 2020. Ecosystem Edge to answer the following question.

2. What are the benefits of creating an ecosystem?

Recommended reading

Read Chapter 3, pp. 48–58 of the prescribed textbook: Williamson, P.J. & De
Meyer, A. 2020. Ecosystem Edge to answer the following question.

3. Discuss the role of ecosystem leaders in discovering new value.

4. Reflect on the role of AI tools and how they are used in businesses today.
Are there ethical limitations of using them? Should businesses be open
to their customers about using them?

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 Glossary of terms

Administrative distribution to preferred groups refers to the allocation of goods

and services by the state to a particular group of people in a society on the basis
of some criteria that identifies the group as the most suitable recipients.

Barriers to entry refers to factors that existing firms in an industry can use to
block the entry of other firms.

Budget line is the locus of combinations of two goods that a consumer can buy if
she spends all the income she has.

Business model refers to the ways in which a business creates value and makes
money.

Comparative statics is an analytical tool used to analyse the effects of changes

in exogenous variables on equilibrium values of endogenous variables in a model.

Constrained optimisation refers to an analytical tool where an economic agent

must make the most rational decision, given some constraints or limitations.

Consumer preference refers to ranking of different bundles of two goods in terms

of desirability, assuming that the bundles could be acquired for free.

Corporate social responsibility refers to the voluntary actions of a firm in which

it takes into account the social and environmental impacts of its actions that
affect external stakeholders.

Corruption refers to a situation where a person obtains goods or services in an

improper way. Bribery is one form of corruption in which a person gives money
to someone else to make them act in a desired way.

Deadweight loss is a reduction in consumer or producer surplus that arises from

an inefficient allocation of resources.

Digital economy refers to economic activities that take place in platforms

supported by digital technologies.

Drawing lots refers to practice where each person in a group of people who are
all interested in a scarce commodity puts an item into a container, and the person

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who receives goods or services is the one whose item is selected at random from
the container. The items must be the same in all aspects to avoid cheating.

Economic costs are the total of the firm’s explicit costs and implicit costs.

Economic model refers to the ways in which all firms create value and share
profits in the industry.

Edgeworth box is a graph showing the possible allocation of the total supply of
two goods between two economic agents.

Favouritism is a situation in which a person with the power to allocate goods

chooses to give the goods to people they know or like, at the expense of those
who are not close to them.

Financial disintermediation refers to the process of removing banks and other

financial institutions from financial transactions by fintech, allowing parties to
transact directly.

Financial technology (fintech) refers to the use of information technology to

provide alternative financial services to those financial intermediaries.

State failure refers to worsening of inefficient allocation of resources and of

economic welfare caused by the government’s intervention intended to fix
market failure.

Indifference curve is a graph plotting many sets of consumption baskets that

yield the same level of utility to the consumer.

Isocost is a curve depicting different capital–labour combinations that cost the

same amount.

Isoquant is a graph depicting different capital–labour combinations that produce

a given quantity of output.

Marginal cost is the change in total cost that arises from increasing production
by one extra unit.

Marginal revenue is the revenue that accrues to the firm after selling an
additional unit of a product.

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Market power is the degree of influence an economic agent has over the
prevailing market price.

Market failure refers to the situation in which free markets fail to allocate
resources efficiently.

Monopolistic competition is a market structure with many firms selling

differentiated products to many customers.

Oligopoly is a market structure with a few big firms that sell differentiated or
homogenous goods.

Price control refers to the action of the government of setting an upper or lower
limit on the price of a good or service.

Production function is a function that measures the maximum quantity of a good

that a firm produced by employing a given level of inputs efficiently.

Queue refers to many people who are standing in a line waiting for their turn to
buy or get something that is in short supply.

Rate of time preference is the discount rate used to reduce utility derived from
future consumption to its present value.

Time value of money refers to the idea that money received today is worth more
than money to be received in the future.

Utility function is an algebraic expression that measures the total utility a

consumer derives from consuming specific quantities of a good or bundle of
goods.

Violence and war occur when people use force to get things they want from other
people who are often in a weaker position.

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 Answers to Self-Assessment Questions

TOPIC 1 SELF-ASSESSMENT ANSWERS

1. Economics can be defined as the social science that studies the

production, distribution, and consumption of goods and services. It
examines how individuals, businesses, and governments make choices
to allocate scarce resources to fulfill their unlimited wants and needs.
2. Opportunity cost refers to the value of the next best alternative that is
foregone when a decision is made. It represents the trade-off involved
in choosing one option over another. For example, if you have $20 and
you decide to spend it on a movie ticket, the opportunity cost is the value
of the alternative use of that $20, such as buying a book or going out for
dinner.
3. A production possibility curve (PPC), also known as a production
possibility frontier (PPF), is a graphical representation of the different
combinations of two goods or services that can be produced given the
available resources and technology in an economy. The curve illustrates
the concept of scarcity, choice, and opportunity cost. The concave shape
of the curve indicates that as more resources are allocated to the
production of one good, the opportunity cost of producing an additional
unit of that good increases. This is because resources are not equally
suited for producing both goods, and producing more of one requires
sacrificing the production of the other.
4. Macroeconomics and microeconomics are two branches of economics
that focus on different levels of analysis:
• Microeconomics examines the behavior of individual economic
agents, such as households, firms, and markets. It analyzes how
they make decisions regarding consumption, production, pricing,
and resource allocation. Microeconomics also studies the
interactions between these agents and their impact on the overall
economy.
• Macroeconomics, on the other hand, deals with the economy as a
whole. It studies aggregate phenomena, such as national income,
unemployment, inflation, economic growth, and government
policies. Macroeconomists analyze the factors that influence the
overall performance of the economy and aim to understand and
manage issues affecting the entire society.

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5. Economics is considered a social science because it applies scientific
methods to study human behavior in the context of economic activities.
It focuses on understanding how individuals, institutions, and societies
make choices to allocate scarce resources. Economics incorporates
elements of mathematics, statistics, and empirical analysis to develop
theories and models that explain economic phenomena and predict their
outcomes. However, unlike natural sciences, economics deals with
human behavior, which is influenced by social, cultural, and
psychological factors.
6. Your mindmap could contain the following aspects:
• At the core of the economy are individuals and businesses that
interact through markets. Individuals act as consumers who
demand goods and services, while businesses supply these goods
and services. The economy operates based on the principles of
supply and demand, with prices serving as signals of relative
scarcity and value.
• The government plays a significant role in the economy by
implementing policies, regulations, and taxes that influence
economic activities. It may also provide public goods, such as
infrastructure and education, and intervene during times of
economic instability or market failures.
7. 'Ceteris paribus' is a Latin term used in economic analysis, meaning
"other things being equal" or "all other things held constant." It is a
simplifying assumption used to isolate the relationship between two
variables while assuming that all other relevant factors remain
unchanged. By holding other factors constant, economists can focus on
the specific cause-and-effect relationship between the variables of
interest.

TOPIC 2 SELF-ASSESSMENT ANSWERS

1. Four types of economic systems. Watch the video on YouTube at:

https://www.youtube.com/watch?v=5vTdPNY7P2w (Think Econ, 2021).

2. The South African government, through the public service, is the biggest
employer in the country. It also contributes significantly to the provision
of goods in the country through state-owned enterprises like Eskom and
Transnet. Now, employment creation and providing goods via state-
owned enterprises are the traditional roles of government. Modern states
do not do this. Rather, they focus on regulating markets. Therefore,
South Africa has a traditional government which must be reformed.

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3. Regulatory or state capture negatively impacts the performance of the
economy. For the South African experience, visit the link:
https://www.dailymaverick.co.za/article/2019-03-01-state-capture-
wipes-out-third-of-sas-r4-9-trillion-gdp-never-mind-lost-trust-
confidence-opportunity/ (Merten, 2019) to further clarify your answer.

4. The benefits of good corporate governance include:

• Creates transparent rules which align the interests of all
stakeholders
• Fosters trust between investors and the community
• Increases the business’s share price
• Makes it easy to raise capital
• Ensures long-term survival of the business.

5. The focus of the Anglo–US model is companies that are listed on the
stock exchange, while the Japanese model focuses on banks and credit
markets. Visit the link:
https://www.investopedia.com/ask/answers/051115/what-are-some-
examples-different-corporate-governance-systems-across-world.asp#:
(Ross, 2021) to further clarify your answer.

6. Arguments in favor of CSR:

• Stakeholder expectations: Many stakeholders, including
consumers, employees, investors, and communities, increasingly
expect corporations to act responsibly and contribute positively to
society beyond their economic activities.
• Reputation and brand image: Engaging in CSR initiatives can
enhance a company's reputation and brand image, leading to
increased customer loyalty, employee satisfaction, and long-term
profitability.
• Sustainable development: Corporations have the resources and
influence to address social and environmental issues. By integrating
CSR practices, they can contribute to sustainable development,
such as reducing environmental impacts, promoting ethical
sourcing, or supporting social causes.
• Risk management: Proactive CSR strategies can help companies
manage risks associated with regulatory compliance, public
scrutiny, and potential damage to their reputation.

Arguments against CSR:

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 • Profit maximization: The primary goal of a corporation is often
considered to be maximizing shareholder value and generating
profits. Some argue that diverting resources towards CSR initiatives
may hinder profitability and undermine the company's core
mission.
• Lack of expertise: Critics contend that corporations may lack the
expertise and accountability to effectively address complex social
and environmental challenges, and their CSR efforts may be
superficial or primarily driven by public relations motives.
• Government responsibility: CSR initiatives should not substitute or
relieve governments of their responsibilities to address societal
issues through proper regulation and governance.
• Focus on core business: Skeptics argue that corporations should
focus on their core competencies, innovation, and job creation,
which ultimately contribute to societal welfare through economic
growth.

Compare the answer that you sourced to the one above. What are
similarities and differences?

8. Your mindmap could contain the following aspects:

Firms, households, goods, services, factors of production, selling,
buying.

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TOPIC 3 SELF-ASSESSMENT ANSWERS

1. Visit the link https://www.analyticssteps.com/blogs/elasticity-demand-

and-its-types (Pathak, 2021) to obtain answers. Also read Chapter 2, pp.
45–56 of Besanko and Braeutigam (2014): Microeconomics, 5th ed. and
Chapter 5, pp. 113–130 of Mohr, Seymore & Yu (2018): Understanding
microeconomics, 2nd ed.

2. Total utility is the sum of marginal utilities. Visit the link:

https://courses.byui.edu/econ_150/econ_150_old_site/lesson_05.htm
to further clarify your answer. Note: Read the first section. Also read
Chapter 6, pp. 138–139 of Mohr, Seymore & Yu (2018): Understanding
microeconomics, 2nd ed. to supplement your understanding.

3. Access the link https://www.youtube.com/watch?v=LOjyVoGTGj8 (The

Sagar Raut Chanel, 2017) to obtain your answer. Alternatively, read
Chapter 6, pp. 142–146 of Mohr, Seymore & Yu (2018): Understanding
microeconomics, 2nd ed. to answer the question.

4.
Price Nature of Substitution Income Total
change product effect effect effect
Decrease Normal good + + +
Inferior good + - +
Giffen good + - -

Visit the link https://www.youtube.com/watch?v=pLhh_D5b_Lg

(Economicsfun, 2013) to see the effects of a price increase.

TOPIC 4 SELF-ASSESSMENT ANSWERS

1.

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 Figure 3.1 Cost minimisation vs. production maximisation

Panel a shows the cost minimisation problem. The firm has a set level of
production, given by the isoquant Q0, that it wants to produce at the lowest
possible cost, which is given by the middle budget line. Panel b shows the
production maximisation problem. The firm has a given budget and it must use
it to produce the highest possible output, which is given by isoquant, Q0.

2.

Q TFC TVC TC AFC AVC ATC MC

0 200 0 200 - - - -
1 200 100 300 200 100 300 100
2 200 150 350 100 75 175 50
3 200 210 410 66.67 70 136.67 60
4 200 320 520 50 80 130 110
5 200 470 670 40 94 134 150

3. In the short run, there is an inverse relationship between average

variable cost (AVC) and average product (AP), as well as between the
marginal cost (MC) and marginal product (MP). If workers are
productive, although the wage rate is fixed, the effective cost of labour
is falling. The relationships between cost and production are given below:

𝑤𝑤 𝑤𝑤
𝐴𝐴𝐴𝐴𝐴𝐴 = , 𝑀𝑀𝑀𝑀 =
𝐴𝐴𝐴𝐴 𝑀𝑀𝑀𝑀

In terms of curves, the cost curves are a mirror image of the production
curves.
Hint: You must draw these curves to complete your answer.

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TOPIC 5 SELF-ASSESSMENT ANSWERS

1. Visit the link https://www.youtube.com/watch?v=D2tnwcpUFVY

(Welker, 2018) to get your answer.

2.

Total revenue Marginal revenue Average revenue

Q
(TR) (MR) (AR)
0 0 - -
1 25 25 25
2 45 20 22.50
3 60 15 20
4 70 10 17.50
5 75 5 15

3. The feature of a perfect competitive firm states that there is entry to and
exit of the market is easy/free. Therefore, short-run economic losses
cause some firms to leave the market. As a result, market supply
decreases (supply shift to the left), causing the price to go up and losses
to decrease. Exit of firms will stop when there are normal profits in the
industry. Long-run equilibrium is achieved at this stage.

TOPIC 6 SELF-ASSESSMENT ANSWERS

1. Visit the link at https://etradeforall.org/news/the-digital-roadmap-how-

developing-countries-can-get-ahead/ to find your answer.

To answer Questions 2 and 3 properly, summarise the content from the

prescribed readings under the headings below.

2. a) New product bundles

b) New customers’ solutions
c) New platform economies
d) New industries

3. a) Focus internally
b) Concentrate on the overall value an ecosystem can create
c) Making new connections

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 d) Looking for value potential from network economies
e) Attracting a more diverse set of partners
f) Promoting value creation by enhancing the quality of the
interactions

4. Businesses are using AI tools to operate more efficiently. Tasks that were
previously completed by staff members, can now be automated, and
fulfilled by AI tools. For example, a marketing campaign that previously
would have been designed by a digital marketing specialist, could now
be designed by an AI tool. The question is whether businesses should be
open and honest about these changes. If producing the service ends up
being cheaper for the business, customers might demand to pay less. At
the same time, businesses might argue that the expenses incurred for
using AI tools are not as yet much cheaper than employing a human
being.

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