Unit 1: Introducing Economics

1.1 Meaning of Economics

• Definition: Economics is the social science that studies how individuals, businesses,
governments, and societies make choices to cope with scarcity. It analyzes the production,
distribution, and consumption of goods and services.
• Key Concepts:
– Scarcity: The fundamental economic problem: limited resources vs. unlimited wants. This
forces us to make choices.
– Choice: Because of scarcity, individuals, businesses, and societies must choose how to allocate
their resources.
– Opportunity Cost: The value of the next best alternative given up when a choice is made.
– Efficiency: Getting the most out of available resources.
• Why Study Economics?
– Personal Decision-Making: Understanding economics helps you make informed choices about
spending, saving, investing, and career paths.
– Understanding Society: Economics provides insights into how markets work, the role of
government, and global economic issues.
– Critical Thinking: Economics develops analytical and problem-solving skills.
• Nature of Economics:
– Social Science: Economics uses scientific methods (observation, data analysis, models) to
study human behavior in the context of scarcity.
– Science vs. Art Debate:
∗ Science: Economics seeks to explain and predict economic phenomena (positive economics).
∗ Art: Economics also offers policy recommendations based on value judgments (normative
economics)
• Critical Thinking Prompt: What are some real-world examples of scarcity that you observe in
your daily life? How do these examples illustrate the concept of limited resources and unlimited
wants?
Explanation:
– Time: You only have 24 hours in a day. You must choose how to allocate that time between
studying, working, sleeping, leisure, etc.
– Money: Your income is limited. You must decide how to spend iton various goods and
services, knowing you can’t afford everything you might want.
– Natural Resources: Ethiopia has a finite amount of fertile land. Choices must be made about
how to use that land for agriculture, housing, or industry.
– Classroom Resources: There might be a limited number of textbooks or computers for
students. This creates scarcity and requires allocation decisions.
These examples show that resources are limited while our wants are not. We must make choices,
and those choices come with opportunity costs.
1.2 Branches of Economics
• Microeconomics:
– Focuses on individual economic units (households, firms, and markets).
– Analyzes how these units make decisions and interact.
– Examples: Price of a specific good, consumer behavior, production decisions of a firm, market
competition.
– Key problem: Resource allocation and price determination.
• Macroeconomics:
– Studies the economy as a whole.
– Examines aggregate economic variables (total output, inflation, unemployment, economic
growth).
– Examples: GDP of a country, inflation rate, government spending, trade balance.
– Key problem: Achieving full employment and stable economic growth.
• Interdependence: Microeconomics and macroeconomics are interrelated.
Macroeconomic conditions (e.g., recession) impact microeconomic decisions (e.g., hiring).
• Critical Thinking Prompt: Can you think of any recent choices you’ve made where you had to
consider the concept of scarcity? What were thealternatives you considered, and what was the
opportunity cost of your decision?
Explanation: This prompt encourages students to reflect on their own choices and connect them
to the core economic concepts.
Some possible examples:
– Choosing to Study vs. Go Out: If you choose to spend Saturday night studying, the opportunity
cost is the fun you could have had with friends.
– Buying a New Phone vs. Saving: If you buy the new phone, the
opportunity cost might be the money you could have saved for a future goal (like a trip).
– Allocating Time for School Subjects: If you spend more timestudying math, the opportunity
cost might be the time you could have spent improving your grades in other subjects.
Emphasize that opportunity cost isn’t just about money; it’s about the value of whatever you give
up.
1.3 Methods and Approaches to Studying Economics
• Methods:
– Deductive Method:
∗ Starts with general principles and applies them to specific situations.
∗ Example: The law of demand (general principle) can be used to explain why the price of
coffee falls when there is a surplus (specific situation).
– Inductive Method:
∗ Starts with observations and data, then seeks to develop general principles.
∗ Example: Observing that many people buy less coffee when the price increases might lead to
the formulation of the law of demand.
• Approaches:
– Positive Economics:
∗ Focuses on objective analysis and descriptions of how the economy works.
∗ Seeks to be value-free and testable.
∗ Example: ”An increase in the minimum wage will lead to higher unemployment among low-
skilled workers.”
– Normative Economics:
∗ Deals with value judgments and opinions about what economic policies should be.
∗ Example: ”The government should raise the minimum wage to improve the standard of living
for low-income earners.”
• Critical Thinking Prompt: How can understanding opportunity cost help you make better
economic decisions?
Explanation: Here’s how thinking about opportunity cost can improve decision-making:
– Prioritization: It helps you prioritize your wants and needs, focusing on those that offer the
greatest benefit relative to what you give up.
– Trade-Offs: It highlights that every choice involves trade-offs, and
there’s no such thing as a free lunch.
– Cost-Benefit Analysis: Opportunity cost encourages you to weigh the benefits of a decision
against its true costs, including what you forgo.
– Informed Decisions: By considering opportunity cost, you are making more informed and
rational economic decisions.
1.4 Decision-Making Units in an Economy
• Households:
– Consumers of goods and services.
– Suppliers of labor (workers) to firms.
– Savers (providing funds for investment).
– Objectives: Maximize satisfaction (utility) from consumption, given their income.
• Firms (Businesses):
– Producers of goods and services.
– Employers of labor.
– Investors (using funds to expand production).
– Objectives: Maximize profits, given costs and market conditions.
• Government:
– Sets economic policies (e.g., taxes, spending, regulations).
– Provides public goods (e.g., national defense, education, infrastructure).
– Redistributes income (e.g., through welfare programs).
– Objectives: Promote economic growth, stability, and social welfare.
• Interactions: These units interact in markets, where goods, services, and factors of production
are exchanged.
Unit 2: The Basic Economic Problems and
2.1 The Basic Economic Problems: Scarcity, Choice, and
Opportunity Cost
2.1.1 Scarcity
• Definition: Scarcity refers to the fundamental economic problem that arises because the human
desire for goods and services is unlimited, while the resources available to produce them are
finite.
• Key Points:
– Resources are limited: We have a finite amount of land, labor, capital, and entrepreneurial
ability.
– Wants are unlimited: Human needs and desires are constantly expanding.
– Impact: This imbalance between wants and resources creates the need for choices and leads to
the concept of opportunity cost.
• Explanation:
– Every society faces this problem, regardless of its level of development.
– Scarcity forces individuals, firms, and governments to make choices about how to allocate their
resources.
• Critical Thinking Prompt: What are some real-world examples of scarcity that you observe in
your daily life? How do these examples illustrate the concept of limited resources and unlimited
wants?
Explanation:
– Time: You only have 24 hours in a day. You must choose how to allocate that time between
studying, working, sleeping, leisure, etc.
– Money: Your income is limited. You must decide how to spend it on various goods and
services, knowing you can’t afford everything you might want.
– Natural Resources: Ethiopia has a finite amount of fertile land. Choices must be made about
how to use that land for agriculture, housing, or industry.
– Classroom Resources: There might be a limited number of textbooks or computers for
students. This creates scarcity and requires allocation decisions.
These examples show that resources are limited while our wants are not. We must make choices,
and those choices come with opportunity costs.
2.1.2 Choice
• Definition: Choice is the act of making a decision when faced with limited resources. It’s the
process of deciding which needs and wants to satisfy given the constraints of scarcity.
• Key Point: The problem of scarcity necessitates choice. We cannot have everything we want,
so we must prioritize and make decisions about what to acquire and what to forgo.
• Explanation:
– Individuals choose how to spend their time and money.
– Firms choose what goods and services to produce and how to produce them.
– Governments choose how to allocate public resources.
• Critical Thinking Prompt: Can you think of any recent choices you’ve made where you had to
consider the concept of scarcity? What were the alternatives you considered, and what was the
opportunity cost of your decision?
Explanation: This prompt encourages students to reflect on their own choices and connect them
to the core economic concepts. Some possible examples:
– Choosing to Study vs. Go Out: If you choose to spend Saturday night studying, the opportunity
cost is the fun you could have had with friends.
– Buying a New Phone vs. Saving: If you buy the new phone, theopportunity cost might be the
money you could have saved for a future goal (like a trip).
– Allocating Time for School Subjects: If you spend more time studying math, the opportunity
cost might be the time you could have spent improving your grades in other subjects.
Emphasize that opportunity cost isn’t just about money; it’s about the value of whatever you give
up.
2.1.3 Opportunity Cost
• Definition: Opportunity cost is the value of the next best alternative forgone when a choice is
made. It’s the cost of the ”opportunity” you give up when you choose one option over another.
• Key Points:
– Every choice has an opportunity cost.
– Opportunity cost is measured in terms of the value of the forgone alternative (not necessarily in
money).
• Explanation:
– Example: If you choose to spend your time studying economics, the opportunity cost might be
the income you could have earned from working.
– Opportunity cost helps us understand the true costs of decisions and makes us more aware of
the trade-offs involved.
• Critical Thinking Prompt: How can understanding opportunity cost help you make better
economic decisions?
Explanation: Here’s how thinking about opportunity cost can improve decision-making:
– Prioritization: It helps you prioritize your wants and needs, focusing on those that offer the
greatest benefit relative to what you give up.
– Trade-Offs: It highlights that every choice involves trade-offs, and there’s no such thing as a
free lunch.
– Cost-Benefit Analysis: Opportunity cost encourages you to weigh the benefits of a decision
against its true costs, including what you forgo.
– Informed Decisions: By considering opportunity cost, you are making more informed and
rational economic decisions.
2.1.4 Production Possibilities Frontier (PPF)
• Definition: The PPF (also called the production possibility curve) is a graphical representation
of the various combinations of goods and services that an economy can produce with its
available resources and technology, assuming full employment of resources.
• Key Concepts:
– Scarcity: The PPF shows that resources are scarce and that we cannot produce unlimited
quantities of everything.
– Choice: Every point on the PPF represents a different combination of goods and services,
implying that we must make choices.
– Opportunity Cost: The PPF’s shape reflects increasing opportunity costs, meaning that the
more we produce of one good, the more of another good we must give up.
• Explanation:
– The PPF is typically a downward-sloping, concave curve.
– Example: If a country can produce either 100 units of food or 50 units of clothing, the PPF
would show this trade-off. Points on the curve are efficient, while points inside the curve are
inefficient. Points outside the curve are unattainable with current resources.
• Critical Thinking Prompt: Why does the PPF curve become increasingly steeper as we move
along it? What does this tell us about the concept of opportunity cost?

Explanation:
– Resource Specialization: Resources are not perfectly adaptable to producing all goods. As an
economy produces more of one good (e.g., clothing), it has to shift resources that are less suited
for clothing production (e.g., land that’s better for farming) away from the other good(food).
– Increasing Costs: Shifting these less-suited resources leads to diminishing returns, meaning
that each additional unit of clothing produced requires giving up increasingly larger amounts of
food.
– Concave Shape: The increasing opportunity cost is reflected in the concave shape of the PPF.
The curve gets steeper because you need to give up more and more of one good to get one more
unit of the other.
2.1.5 Economic Growth and the PPF
• Definition: Economic growth is an increase in the productive capacity of an economy,
represented by an outward shift of the PPF.
• Key Causes:
– Increase in Resources: More or better land, labor, capital, or technology.
– Technological Advancements: Improvements in production processes.
• Explanation:
– Economic growth allows a country to produce more of both goods, which leads to a higher
standard of living.
– Example: If a country discovers new oil reserves or develops new farming techniques, its PPF
will shift outward.
• Critical Thinking Prompt: What are some of the challenges and opportunities associated with
economic growth?
Explanation:
– Opportunities:
∗ Higher Standard of Living: More goods and services available for consumption.
∗ Improved Infrastructure: Growth can fund better roads, schools, hospitals, etc.
∗ New Jobs: Expanding industries create more employment opportunities.
∗ Technological Advancements: Growth often spurs innovation.
– Challenges:
∗ Income Inequality: Growth can benefit some more than others, leading to a wider gap between
the rich and poor.
∗ Environmental Degradation: Increased production can strain natural resources and pollute the
environment.
∗ Inflation: Rapid growth can lead to higher prices.
∗ Social Dislocation: Growth can change traditional ways of life and cause social unrest.
Balancing the opportunities and challenges is crucial for sustainable economic development.
2.2 Central Problems of Economies
• Definition: Central economic problems are the fundamental questions that every economy must
answer due to the issue of scarcity. These questions relate to the allocation, production, and
distribution of resources.
• Key Questions:
– What to produce? What goods and services should the economy produce?
– How to produce? What production methods (labor-intensive, capitalintensive) should be used?
– For whom to produce? How should the output be distributed among members of society?
• Explanation:
– These questions are interconnected and influence each other.
– The way a society answers these questions determines its economic system.
• Critical Thinking Prompt: How do these central economic problems relate to the concepts of
scarcity, choice, and opportunity cost? Give examples.
Explanation: Here’s the connection:
– Scarcity: Because resources are scarce, we can’t produce everything.
This necessitates making choices about *what to produce.*
– Choice: Societies must decide *how to produce* goods, weighing the costs and benefits of
different methods (e.g., labor-intensive vs. capitalintensive).
– Opportunity Cost: The decision of *for whom to produce* involves considering trade-offs. If
you allocate more resources to producing luxury goods for the wealthy, you’ll have fewer
resources for basic necessities for the poor.
– Examples:
∗ What to produce? Should Ethiopia focus more on producing agricultural goods for export or
on manufacturing consumer goods for the domestic market?
∗ How to produce? Should Ethiopia invest in more advanced technology for agriculture or rely
on traditional labor-intensive methods?
∗ For whom to produce? Should the government implement policies to redistribute income and
ensure greater access to basic goods for the poor, or should it focus on creating a more favorable
environment for businesses and private investment?
2.3 Economic Systems
• Definition: An economic system is a set of institutional arrangements and rules that a society
uses to answer the central economic problems.
• Key Types:
– Traditional Economy: Based on custom, tradition, and bartering. Often found in less-developed
countries.
– Capitalist Economy (Free Market): Primarily based on private ownership of resources,
competition, and market forces.
– Command Economy (Socialist): Centralized planning and government control of resources.
– Mixed Economy: A combination of elements from capitalist and command economies.
• Explanation:
– Each economic system has different answers to the central economic problems, leading to
variations in how resources are allocated, production is organized, and distribution occurs.
• Critical Thinking Prompt: Compare and contrast the main features of the different economic
systems. How does the Ethiopian economy resemble or differ from these models?
Explanation:
– Comparison:
∗ Traditional: Custom and tradition guide decisions, often based on bartering. Limited role for
government.
∗ Capitalist: Private ownership, free markets, and competition determine resource allocation and
prices. Minimal government interference.
∗ Command: Centralized planning by the government, public ownership of resources. Limited
individual choice.
∗ Mixed: Combines elements of capitalism and command, allowing for both private and public
ownership and government regulation.
– Ethiopian Economy:
∗ Mixed System: Ethiopia currently has a mixed economy.
∗ Government Role: The government plays a significant role in economic planning, regulation,
and ownership of key sectors.
∗ Private Sector Growth: There is a growing private sector, but it faces challenges from limited
access to capital, infrastructure constraints, and bureaucracy.
∗ Traditional Elements: Traditional economic practices still persist, especially in rural areas.
– Conclusion: While Ethiopia’s mixed economy has elements of capitalism and government
intervention, it continues to evolve as the government seeks to promote private sector growth and
address challenges like poverty and inequality.
2.3.1 Traditional Economy
• Definition: A traditional economy is based on customs, traditions, and historical practices.
• Key Features:
– Subsistence: Focus on producing enough for basic needs, not surplus.
– Barter: Trade is often through barter, direct exchange of goods.
– Limited Technology: Often relies on traditional methods and tools.
– Social Roles: Economic roles are often determined by family or community.
• Examples: Many indigenous communities around the world, some rural areas in developing
countries.
2.3.2 Capitalist Economy (Free Market)
• Definition: Capitalism emphasizes private ownership of resources, free markets, and
competition.
• Key Features:
– Private Property: Individuals and firms own and control their resources.
– Free Markets: Prices are determined by supply and demand with minimal government
interference.
– Competition: Firms compete to attract customers, leading to innovation and efficiency.
– Profit Motive: Businesses aim to make a profit, motivating them to produce and sell goods and
services.
• Examples: The United States, the United Kingdom, Japan, and many other developed nations.
2.3.3 Command Economy (Socialist)
• Definition: A command economy is characterized by centralized planning and government
control of most economic activity.
• Key Features:
– Central Planning: Government sets production targets, prices, and resource allocation.
– Public Ownership: The government owns and controls major industries and resources.
– Limited Consumer Choice: Consumers have limited options as the government decides what is
produced.
• Examples: The former Soviet Union, Cuba, and North Korea.
2.3.4 Mixed Economy
• Definition: A mixed economy combines elements of capitalism and command economies,
allowing for both private and public ownership and control.
• Key Features:
– Co-existence of Sectors: Both private businesses and government-owned enterprises operate.
– Government Regulation: The government plays a role in regulating markets and providing
public goods and services.
– Economic Planning: Some level of planning and coordination may be present, but it’s typically
more market-oriented.
• Examples: Most modern economies, including Ethiopia, fall into this category.
2.4 Production Possibility Curve (PPC)
• Definition: The PPC is a graphical representation of the alternative combinations of two goods
that an economy can produce with its available resources and technology, assuming full
employment of resources.
• Key Points:
– Scarcity: The PPC shows that resources are limited, and we cannot produce unlimited
quantities of both goods.
– Choice: Every point on the PPC reflects a different combination of goods, implying that we
must make choices.
– Opportunity Cost: The slope of the PPC demonstrates increasing opportunity costs.
– Efficiency: Points on the PPC are efficient, while points inside the curve are inefficient.
• Explanation:
– The PPF is a curved line, usually bowed outward.
– Example: If a country can produce either 100 units of food or 50 units of clothing, the PPC
would show this trade-off. The slope of the curve shows how much food must be given up to
produce one more unit of clothing.
• Critical Thinking Prompt: How can the PPC be used to illustrate the concepts of economic
growth and technological advancements?
Explanation:
– Economic Growth: An outward shift of the PPC represents economic growth. This means the
economy can now produce more of both goods due to increased resources or technological
improvements.
– Technological Advancements: A technological advancement that improves the efficiency of
producing one good will cause the PPC to pivot outward, showing greater potential production
for that specific good.
– Example: If Ethiopia develops a new irrigation system that increases agricultural yields, its
PPC will shift outward, reflecting its ability to produce more food and other goods. If Ethiopia
implements a new technology that specifically improves the efficiency of textile production, the
PPC might pivot outward, showing a larger increase in clothing production than in food
production.
2.4.1 Economic Growth and the PPC
• Explanation: Economic growth is represented by an outward shift of the PPC, indicating that
the economy can now produce more of both goods.
This shift can be caused by:
– Increased Resources: More land, labor, or capital.
– Technological Advancements: Improved production processes or techniques.
2.5 Economic Systems in Ethiopia
• Historical Overview: Discuss the different economic systems that have been in place in
Ethiopia throughout its history, including:
– Imperial Era: A primarily feudal system with a strong role for the monarchy and a limited
market sector.
– Derg Regime (1974-1991): A socialist-leaning command economy with nationalization of
industries and land.
– Federal Democratic Republic of Ethiopia (1991-Present): A mixed economy with a move
toward greater private sector participation, but the government still plays a significant role.
• Current System: Explain the features of the mixed economy that currently exists in Ethiopia,
highlighting:
– Co-existence of Private and Public Sectors: Both private businesses and government-owned
enterprises are present.
– Government Regulation: The government plays a role in regulating markets and providing
public services.
– Economic Planning: The government uses planning instruments to promote economic growth
and development.
• Challenges: Discuss some of the challenges facing the Ethiopian economy, such as:
– Poverty and Inequality: Significant disparities in income and wealth.
– Limited Infrastructure: Challenges in transportation, energy, and communication.
– Political and Social Instability: Conflict can disrupt economic activity.
– Lack of Diversification: Heavy reliance on agriculture and limited industrial development.
• Opportunities: Explore some of the opportunities for economic growth and development in
Ethiopia, such as:
– Growing Population: A large and increasingly young population provides a potential
workforce.
– Natural Resources: Abundant natural resources, including land, minerals, and renewable
energy sources.
– Regional Integration: Participation in regional trade blocs can create opportunities for growth.
– Technological Advancements: Increasing access to technology and the
potential for innovation.
• Critical Thinking Prompt: What are some of the key factors that have
shaped the Ethiopian economy over time? How can Ethiopia leverage its resources and
opportunities to promote sustainable economic development?
Explanation:
– Key Factors:
∗ Geography and Climate: Varied geography from fertile highlands to arid lowlands, impacting
agricultural potential and resource distribution.
∗ History and Culture: Long history of trade and a diverse cultural landscape influence
economic practices and attitudes.
∗ Political System: Changes in political systems (from monarchy to socialism to mixed
economy) have significantly shaped economic policies and structures.
∗ Population Growth: Rapid population growth presents both challenges (strain on resources)
and opportunities (potential labor force).
∗ Globalization: Integration into the global economy brings both opportunities (trade,
investment) and challenges (competition).
– Promoting Sustainable Development:
∗ Invest in Human Capital: Improve education, healthcare, and skills training to enhance
productivity.
∗ Develop Infrastructure: Expand transportation, energy, and communication networks to
facilitate economic activity.
∗ Promote Diversification: Move beyond dependence on agriculture by developing
manufacturing, tourism, and other sectors.
∗ Encourage Innovation: Support research and development, foster entrepreneurship, and adopt
new technologies.
∗ Ensure Environmental Sustainability: Implement policies to conserve natural resources and
reduce pollution.
∗ Address Inequality: Promote policies that reduce income disparities and provide opportunities
for all Ethiopians.

Advanced Economics Notes - Grade 10

Unit 1: Theory of Consumer Behavior
1.1 The Concept of Utility
• Definition: Utility is the level of satisfaction or pleasure a consumer gets from consuming a
good or service. It represents a commodity’s ability to satisfy human needs.
• Relativity of Utility: Utility is subjective, varying among individuals based on their needs and
preferences, and also influenced by time and place.
• Utility vs. Usefulness: While usefulness concerns the product’s charac-teristics, utility is about
the satisfaction the consumer derives from it.
• Approaches to Measuring Utility:
– Cardinal Utility: Assumes utility is measurable, using quantifiable units known as ’utils’.
– Ordinal Utility: Assumes utility can be ranked relatively, without assigning numerical values.
• Critical Thinking Prompt: How does the subjective nature of utility in- fluence marketing
strategies? Explain with examples
Explanation: Understanding the subjective nature of utility helps mar- keters to segment markets,
tailoring their products and strategies based on varied consumer preferences. For example,
luxury goods are marketed to high-income individuals, while health supplements are targeted at
health- conscious consumers.
1.2 The Cardinal Utility Theory
• Definition: Assumes utility is measurable in quantifiable units, such as ‘utils’ or monetary
values.
• Assumptions:
– Rational Consumer: A consumer aims to maximize satisfaction with available resources.
– Cardinal Utility: Utility is measurable with a common unit.
– Constant Marginal Utility of Money: Utility derived from each additional unit of money is
constant.
– Diminishing Marginal Utility: Additional utility from successive units of a commodity
decreases.
• Measurement of Utility:
– Total Utility (TU): The sum of satisfaction from consuming a certain amount of a commodity.
– Marginal Utility (MU): The additional satisfaction gained from con- suming one more unit of a
commodity.
M U = ∆T U/ ∆Q
• Law of Diminishing Marginal Utility (LDMU): The utility from con- suming successive units
of a commodity decreases.
• Critical Thinking Prompt: How can the law of diminishing marginal utility inform pricing and
promotional strategies?
Explanation: LDMU indicates that higher quantities of goods are de- manded at lower prices,
because additional consumption brings reduced lev- els of satisfaction. This principle is applied
through price discounts on bulk purchases and promotional offers.
1.3. The Consumer Maximization Problem
• Definition: Consumers aim to maximize utility while adhering to their budget constraints.
• Consumer Equilibrium: Consumers achieve equilibrium when the last unit of money spent on
each commodity provides the same marginal utility.
• Consumer Budget: A consumer’s purchasing power, or available income.
• Assumptions:
– Rationality
– Cardinal Measurement of Utility
– Constant Marginal Utility of Money
– Diminishing Marginal Utility
– Given Constant Income
– Given Constant Commodity Prices
Mapping Preferences: Indifference Curves and Their Properties
 Indifference Curves (ICs): An IC is a graphical representation of all combinations of two
goods that provide a consumer with the same level of satisfaction or utility. The
consumer is indifferent between any two points on the same IC.
 Indifference Map: An indifference map is a collection of indifference curves, each
representing a different level of utility. ICs further from the origin represent higher levels
of utility.
Key Properties of Indifference Curves:
 Downward Sloping: ICs slope downward because to maintain the same level of
satisfaction, a consumer must reduce the consumption of one good if they increase the
consumption of the other.
 Convex to the Origin: This property reflects the diminishing marginal rate of substitution
(MRS).
  Do Not Intersect: If ICs intersected, it would violate the assumption of consumer
rationality.
 Marginal Rate of Substitution (MRS): The MRS measures the rate at which a consumer is
willing to give up one good in exchange for one more unit of another good while
maintaining the same level of utility. It is represented by the slope of the indifference
curve at a given point.
 Diminishing MRS: As a consumer consumes more of one good, they are generally
willing to give up less and less of another good to obtain additional units of the first good.
Consumer Equilibrium: The Case of one Commodity: Consumer
 equilibrium is reached when the marginal utility of commodity X equals its price.
 Consumer Equilibrium: The Case of Multiple Commodities:
M UA /PA = M UB/ PB = M UC/PC = ... = M UN/PN = M UM
Where, M UM = marginal utility of money
The Budget Constraint: Limiting Choices
Budget Line: The budget line represents all possible combinations of two goods that a consumer
can afford given their income and the prices of the goods. It is determined by the consumer's
budget constraint.
Slope of the Budget Line: The slope of the budget line is determined by the relative prices of
the two goods. It represents the opportunity cost of consuming one good in terms of the other.
Consumer Equilibrium: Balancing Desires and Constraints
The Goal: Utility Maximization: Consumers aim to maximize their satisfaction, given their
budget constraint. This occurs where the consumer reaches the highest possible indifference
curve while remaining within their budget line.
Conditions for Consumer Optimum: The consumer reaches equilibrium, or the optimal
consumption bundle, where: The budget line is tangent to the indifference curve. The MRS
between the two goods is equal to the ratio of their prices.
Beyond Equilibrium: Analyzing Changes in Income and Prices
Income Consumption Curve (ICC): The ICC traces the optimal consumption bundles for a
consumer as their income changes, holding prices constant. For normal goods, the ICC slopes
upward, indicating that as income rises, the consumer buys more of both goods.
Price Consumption Curve (PCC): The PCC traces the optimal consumption bundles for
a consumer as the price of one good changes, holding income and the price of the other good
constant.
Deriving the Demand Curve: Both the cardinal and ordinal approaches can be used to derive a
consumer's demand curve for a good. The demand curve shows the quantity of a good a
consumer is willing and able to buy at different prices.
• Budget Equation: The equation representing the budget constraint is : PxX+PyY = Income.
• Critical Thinking Prompt: How do changes in income and price affect consumer
equilibrium and overall welfare?
Explanation: Changes in income or price disrupt the balance of marginal utility and price, and
the consumer shifts to a new equilibrium point while maximizing utility within their altered
budget.
1.4 Introduction to the Ordinal Utility Theory
• Definition: Assumes utility can be ranked but not measured in absolute terms.
• Assumptions:
– Rationality
– Ordinal Utility: Utility can be ranked but not measured quantita- tively.
– Diminishing Marginal Rate of Substitution (DMRS): The will- ingness to substitute one
commodity for another decreases with the consumption of more of another good.
– Consistency and Transitivity of Choices: Consumer preferences are consistent and transitive in
their decision-making
• Critical Thinking Prompt: How does the ordinal utility theory explain consumer behavior
in real-world scenarios?
Explanation: The ordinal approach explains consumer behavior through preferences and
substitution without monetary values or measures of absolute utility.
For example, a consumer might prefer a bundle of goods that better satisfies certain preferences.
Unit 2: Theories of Demand and Supply
2.1 Theory of Demand
• Definition: Demand is the quantity of a commodity consumers are willing and able to buy at
various prices during a given period, represented by the equation : Demand = Willingness to buy
+ Ability to pay.
• Factors Affecting Demand:
A. Price of the Good
B. Prices of Related Goods (substitutes, complements)
C. Consumer Income
D. Taste and Habits
E.Population
F.Season
G. Future Price Expectations
• Demand Schedule: A tabular presentation showing quantities demanded at various prices.
• Demand Curve: A graphical representation of the inverse relationship be- tween price and
quantity demanded.
• Demand Equation: The relationship between price and quantity of a prod- uct using
mathematical symbols.
• Changes in Quantity Demanded: A movement along a demand curve due to changes in the
product’s own price.
• Changes in Demand: A shift in the demand curve due to changes in factors other than its own
price.
• Individual Demand: The quantity a single consumer wants at various prices.
• Market Demand: The sum of all individual demands at various prices.
• Critical Thinking Prompt: How do marketing strategies leverage under- standing of factors
affecting demand? Explain with examples
Explanation: Marketing strategies use information about factors affect- ing demand by creating
awareness through advertising, targeting specific demographics with personalized products and
promotion, and leveraging price sensitivity using various price-points.
2.2 Theory of Supply
• Definition: Supply is the quantity of a product that producers are willing and able to provide at
various prices, ceteris paribus.
• Supply Function: Shows the relationship between the quantity supplied and its determinants,
expressed using mathematical symbols
• Supply Schedule: A tabular representation of quantity supplied at different price levels.
• Supply Curve: A graphical representation of the positive relationship be- tween price and
quantity supplied.
• Changes in Quantity Supplied: A movement along a supply curve due to changes in the
product’s price.
• Changes in Supply: A shift in the supply curve due to factors other than price.
• Factors Affecting Supply:
A.Cost of Factors of Production
B.State of Technology
C.External Factors
D.Tax and Subsidies
E. Transport
F. Price of Other Goods
• Market Supply: The sum of all individual supplies at various prices.
• Critical Thinking Prompt: How can a technological change affect the supply curve for a
product?
Explanation: A technological change can increase or decrease supply, de- pending on whether it
lowers the cost of production, or reduces wastage. It will cause a rightward shift of the supply
curve in case of production cost reduction and it will cause a leftward shift if it reduces output at
the same input level.
2.3 Market Equilibrium
• Definition: A state of balance where quantity demanded equals quantity supplied.
• Market-Clearing Price: The price level at which equilibrium is reached.
• Surplus: A condition where quantity supplied is greater than the quantity demanded.
• Shortage: A condition where quantity demanded is greater than the quantity supplied.
• Market Equilibrium: Achieved at a point where the quantity demanded is equal to quantity
supplied.
• Excess Demand: Occurs when the quantity demanded exceeds the quantity supplied, causing
shortage.
• Excess Supply: Occurs when quantity supplied exceeds quantity demanded, causing a surplus.
• Effects of change in demand and supply on equilibrium:
– Increase in demand shifts the demand curve rightward, leading to higher price and quantity at
equilibrium.
– Decrease in demand shifts the demand curve leftward, leading to lower price and quantity at
equilibrium.
– Increase in supply shifts the supply curve rightward, leading to lower price and higher quantity
at equilibrium.
– Decrease in supply shifts the supply curve leftward, leading to higher price and lower quantity
at equilibrium.
• Critical Thinking Prompt: How can governments use market interven- tions to address both
shortage and surplus scenarios? Explain with examples
Explanation: Governments intervene using mechanisms like price floors to support agricultural
products or price ceilings to control prices of essential goods in times of shortage, which cause
the equilibrium level and quantityto change due to government intervention.
2.4 Elasticities of Demand and Supply
• Definition: Elasticity measures the sensitivity of one variable to a change in another.
• Types of Elasticity:
– Price Elasticity of Demand (Ed): The response of quantity de- manded to price changes.
∗ Point Elasticity: Elasticity at a specific point on a demand curve.
Ed = ∆Q/Q/ ∆P/P
∗ Arc Elasticity: Elasticity over a range on the demand curve.
Ed = ∆Q/(Q1+Q2) ∆P/(P 1+P 2)
– Interpreting Price Elasticity Values:
∗ Elastic Demand: (Ed > 1): Demand is highly responsive to price changes.
∗ Inelastic Demand:(0<Ed < 1): Demand is less responsive to price changes.
∗ Unitary Elastic Demand (Ed =1): Percentage change in price equals percentage change in
quantity demanded.
∗ Perfectly Inelastic Demand (Ed =0): Quantity demanded does not change with price.
∗ Perfectly Elastic Demand (Ed =infinity): A small change in price leads to infinite change in
quantity demanded.
– Cross Elasticity of Demand (Exy): Measures the response of demand to changes in the price
of another product.
Exy = Percentage change in quantity demanded for commodity X /percentage change in the price
of commodity Y
– Income Elasticity of Demand (Ei): The response of demand to changes in income levels
EI = Percentage change in quantity demanded/percentage change in Income
∗ Negative Income Elasticity: (Ei< 0): Inferior goods
∗ Income Elasticity >1: (Ei > 1): Normal and luxury goods
∗ Income Elasticity <1: (Ei < 1): Necessity goods
– Price Elasticity of Supply (Es): Measures the responsiveness of supply to changes in price.
Es = Percentage change in quantity supplied/percentage change in Price
∗ Elastic Supply: (Es> 1): Supply is highly responsive to price changes
∗ Inelastic Supply: (Es < 1): Supply is less responsive to price changes
∗ Unitary Elastic Supply:(Es=1): Percentage change in price is equal to the percentage change in
quantity supplied.
• Determinants of Price Elasticity of Demand:
– Nature of the Commodity
– Availability of close substitutes
– Proportion of income spent on the commodity
– Urgency of demand
– Durability of a commodity
– Product purchase frequency
– Time
• Determinants of the Price Elasticity of Supply:
– Expectation of future prices
– Production period
– Factor substitution
– Number of Sellers
• Critical Thinking Prompt: How can governments use information about elasticities to
formulate their taxation policies for different sectors?
Explanation: Using elasticity information, governments can impose higher taxes on inelastic
goods (such as tobacco or alcohol), because the tax can generate more revenue since the
quantities demanded remain relatively stable. For highly elastic goods, imposition of higher tax
might significantly reduce demand.
Unit 3: Theories of Production and Cost
3.1. Theory of Production
• Definition of Production: The process of transforming raw materials (inputs) into finished
goods and services (outputs) using available resources and technology.
• Production Function: Illustrates the maximum output achievable from various combinations of
inputs and technology.
• Short Run Production Function: Analysis of production when at least one input is fixed, like
capital, while others like labor, are variable.
– Production with One Variable Input: Focuses on the relation between variable input (like labor)
and outputs, assuming other inputs are fixed.
• Concepts of Production:
– Total Physical Product (TP): The total output produced from a given set of inputs.
– Average Physical Product (AP): The output per unit of the variable input (like labour).
APL = T P/L
– Marginal Physical Product (MP): The additional output obtained by adding one more unit of
the variable input.
M P = ∆T P/∆L
• Law of Diminishing Marginal Productivity: States that marginal prod- uct declines as
increasing quantities of variable input is used with fixed in- puts.
• Stages of Production:
– Stage I (increasing returns): Marginal product (MP) is increasing and output increases at an
increasing rate.
– Stage II (diminishing returns): MP is positive but decreasing, out- put increases at a
diminishing rate.
– Stage III (negative returns): MP is negative due to overuse of inputs and excess employment,
and output decreases.
• Long Run Production Function: An analysis of a production when all inputs are variable.
• Isoquant: A curve representing all possible efficient combinations of inputs which provide the
same level of output.
• Marginal Rate of Technical Substitution (MRTS): The rate at which one input can be
substituted for another while maintaining the same level of output.
• Returns to Scale:
– Increasing Returns to Scale: Output increases by a greater propor- tion than the increase in
inputs.
– Constant Returns to Scale: Output increases by the same proportion as the increase in inputs.
– Decreasing Returns to Scale: Output increases by a smaller pro- portion than the increase in
inputs.
• Technological Change and Production Curves: Technological advances will shift production
functions upwards by increasing the efficiency of inputs and creating higher outputs.
• Critical Thinking Prompt: How do diminishing returns impact a firm’s production decisions,
especially in the short-run?
Explanation: The law of diminishing returns makes marginal cost to in- crease. This will
prompt firms to either look for cost effective methods or scale back production, since further
output requires greater levels of input which in turn will increase costs.
3.2 Theory of Cost
• Definition of Cost of Production: The expenditures incurred by a firm to employ various
inputs to produce outputs.
• Short-Run Costs: Costs incurred when at least one input is fixed.
– Total Fixed Cost (TFC): Costs that remain constant irrespective of output.
– Total Variable Cost (TVC): Costs that change in direct proportion to the level of output.
– Total Cost (TC): The sum of total fixed costs and total variable costs.
TC=TFC+TVC
• Average Costs:
– Average Fixed Cost (AFC): Total fixed costs divided by the quantity
of output.
AF C = T F C/ Q
– Average Variable Cost (AVC): Total variable costs divided by the quantity of output.
AV C = T V C/ Q
– Average Total Cost (ATC): Total costs divided by the quantity of output or sum of average
fixed cost and average variable cost.
AT C = T C / Q or AT C = AF C + AV C
• Marginal Cost (MC): The additional cost incurred by producing one more unit of output.
M C = ∆T C/∆Q
• Long-Run Costs: Costs when all inputs are variable.
– Long-Run Total Cost Curve (LTC)
– Long-Run Average Cost Curve (LAC)
– Long-Run Marginal Cost Curve (LMC)
• Relationship Between Product and Cost Curves: The relationships between production and cost
curve are mirrored. When AP(MP) rises, AC(MC) falls and vice-versa. The AC and MC
intersect at the lowest points on each of the curves.
• Critical Thinking Prompt: How can a firm use cost curves to make decisions about
optimal output levels?
Explanation: By carefully considering the marginal and average costs, firms can identify the
most profitable production output level. These concepts help in analyzing per unit costs and the
overall profitability based on changes in output.
Unit 4: Market Structures
4.1 Perfectly Competitive Markets
• Definition: A market where numerous buyers and sellers exchange homogeneous products with
no barriers to entry or exit.
• Characteristics:
– Large number of buyers and sellers: No single participant can influence the price.
– Homogeneity of Products: Products are identical or indistinguishable.
– Free entry and exit: No barriers to new firms entering or existing firms exiting the market.
– Perfect Information: All market participants have access to complete knowledge of prices and
products.
– Price Takers: Individual firms have no control over market prices.
• Demand Curve: Firms face a perfectly elastic (horizontal) demand curve.
• Revenue Curve: Average Revenue (AR) equals price (P), and Marginal Revenue (MR) also
equals P.
• Critical Thinking Prompt: Is it feasible for real-world markets to achieve perfect
competition? What conditions are necessary to do so?
Explanation: Real world markets are seldom perfectly competitive due to challenges in
maintaining conditions such as perfect homogeneity, perfect information, and free entry/exit, due
to the high cost of information and presence of product differentiation.
Profit Maximization:
Short-Run: A firm maximizes profits (or minimizes losses) by producing the quantity where
marginal revenue (MR) equals marginal cost (MC). In the short run, a firm may earn economic
profits, losses, or break even.
Long-Run: In the long run, free entry and exit drive economic profits to zero. If firms are
earning profits, new firms enter, increasing supply and lowering the market price until profits are
eliminated. If firms are experiencing losses, some firms exit, decreasing supply and raising prices
until losses are eliminated
4.2 Pure Monopoly Market
• Definition: A market with a single seller of a product with no close sub- stitutes and significant
barriers to entry.
• Characteristics:
– Single Seller and Many Buyers: One firm is in control of the entire supply.
– No Close Substitutes: Products have very limited or no alternatives.
– Price Maker: The firm has significant control over market price by controlling its supply level.
– Price Discrimination: Charging different prices for the same product to different customers.
– Restrictions on Entry: Significant barriers preventing new firms from entering the market.
• Reasons for Monopolies:
– Absence of close substitutes
– Economies of scale in production
– Ownership of strategic resources
– Patent rights for products or production processes
• Demand curve: Downward sloping as firm has to lower prices to sell addi- tional output.
• Revenue Curve: Both average revenue (AR) and Marginal Revenue (MR) curves are
downward sloping with MR lying below AR.
• Critical Thinking Prompt: How do monopolies affect consumer surplus compared to
competitive markets?
Explanation: Monopolies can cause a reduction in consumer surplus because they produce lower
quantities at higher prices compared to competitive markets. They achieve higher profits at the
expense of overall consumer welfare.
4.3 Monopolistically Competitive Market
• Definition: A market with a large number of sellers offering differentiated products with free
entry and exit.
• Characteristics
– Product Differentiation: Products are slightly different, allowing firms to have market control.
– Many Sellers and Buyers: Has more competition than a monopoly but less than a perfect
competition.
– Free Entry and Exit: No barriers to new firms and exiting firms.
– Non-Price Competition: Competition occurs through advertising and product differentiation
not just price.
• Demand curve: Downward sloping due to product differentiation.
• Revenue Curves: Downward sloping Average Revenue (AR) and Marginal Revenue (MR)
curves, where MR is below AR.
• Critical Thinking Prompt: How does product differentiation affect firms’ pricing power
and marketing strategies in this market?
Explanation: Product differentiation gives firms some degree of pricing power. To make their
products unique, firms employ strategies to build brand loyalty and gain premiums, they also
make efforts to shift demand curves to the right by emphasizing their products uniqueness over
their competitors.
Profit Maximization
Monopolistically competitive firms also maximize profits where
MR = MC.
Short-Run vs. Long-Run
Short-Run: Firms may earn economic profits or losses in the short run.
Long-Run: In the long run, profits attract new firms to enter the market, increasing competition
and driving economic profits to zero.
4.4 Oligopoly Market
• Definition: A market structure with a few dominant firms producing iden- tical or differentiated
products.
• Characteristics:
– Few Dominant Firms: A small number of firms control a significant market share.
– Interdependence: Firms’ decisions are interrelated and affect each other.
– Barriers to Entry: Difficult for new firms to enter the market.
– Products: Can be homogeneous or differentiated.
• Demand curve: Downward sloping due to product differentiation or brand preference.
• Revenue Curves: Downward sloping Average Revenue (AR) and Marginal
Revenue (MR) curves, where MR is below AR.
• Critical Thinking Prompt: What are the challenges of applying standard economic models to
analyzing behavior of firms under oligopoly?
Explanation: Due to the interdependent behavior of the firms, standard economic models do not
work for oligopolies because these models do not capture this strategic element and do not
account for the varying responses of firms to each other’s pricing and output decisions.
Collusive vs. Non-Collusive Oligopoly:
Collusive Oligopoly: Firms in an oligopoly may engage in collusion, cooperating to reduce
competition and increase joint profits by acting like a monopolist.
Non-Collusive Oligopoly: In a non-collusive oligopoly, firms compete with each other,
independently setting prices and output levels. This can lead to price wars or strategic behavior
as firms anticipate and react to their rivals' actions.
Analyzing Oligopoly: Due to the complexity of strategic interactions, there is no single model
to analyze oligopoly. Game theory is often used to understand strategic decisionmaking in such
markets.
Unit 3:National Income Accounting (11th)
National income accounting is a system used to measure a country’s aggregate economic
activities, providing a snapshot of the economy's overall health and performance.
Economists and policymakers use national income accounting for several important purposes:
 To track the level and growth of a country's output of goods and services.
 To identify trends and patterns in economic activity over time.
 To inform economic policy decisions and assess the effectiveness of government
policies.
 To compare economic performance across different countries.
Key Concepts: GDP and GNP
Gross Domestic Product (GDP): GDP is the market value of all final goods and services
produced within a country's borders during a specific period, typically a year.
It measures the total value of production that takes place within a country's geographical
boundaries, regardless of who owns the factors of production. For example, the GDP of
Ethiopia would include the value of goods and services produced by both Ethiopian and foreign-
owned firms operating within Ethiopia.
Gross National Product (GNP): GNP measures the total market value of goods and services
produced by the residents of a country, regardless of where the production takes place. GNP
focuses on the nationality of the factors of production, while GDP focuses on the location of
production. For example, Ethiopia's GNP would include the value of production by Ethiopian
owned firms operating abroad but would exclude the production of foreign-owned firms
operating in Ethiopia.
Important Distinctions:
GDP is a measure of production within a country's borders.
GNP is a measure of production by a country's residents.
Both GDP and GNP are flow concepts, meaning they measure the value of production over a
period of time, not at a single point in time.
Three Approaches to Measuring GDP/GNP
The sources outline three approaches to calculating GDP (these approaches can also be applied
to GNP):
1. The Expenditure Approach:
This approach sums up the total spending on final goods and services produced in an economy.
Key Spending Categories (Components of GDP):
Consumption (C): Spending by households on goods and services.
Investment (I): Spending by businesses on capital goods (like machinery and buildings),
changes in inventories, and new residential housing.
Government Spending (G): Spending by all levels of government on goods and services.
Net Exports (NX): This is calculated as exports (X) minus imports (M) and represents the value
of a country's goods and services sold to other countries minus the value of goods and services
purchased from other countries.
Formula: GDP = C + I + G + NX
2. The Income Approach:
This approach sums up all the income earned in the production of goods and services.
Key Income Categories:
 Wages and Salaries: Income earned by labor.
 Rent: Income earned by owners of land and other natural resources.
 Interest: Income earned by lenders of capital.
 Profits: Income earned by businesses.
To calculate GDP using the income approach, you would add up all these income categories,
plus indirect business taxes (like sales taxes) and depreciation (the wearing out of capital goods).
3. The Value-Added Approach (Product Approach):
This approach measures GDP by summing up the value added at each stage of production.
Value Added: Value added at each stage is the difference between the value of the output
produced and the value of the intermediate goods used in production.
For example, imagine the production of a loaf of bread. The farmer who grows the wheat adds
value, the miller who grinds the wheat into flour adds value, and the baker who makes the bread
adds value. The value-added approach would sum up the value added at each of these stages to
arrive at the final value of the bread.
Note: All three approaches should, in theory, yield the same GDP value.
Challenges in GDP Measurement
Double Counting: This occurs when the value of intermediate goods is included in GDP
calculations. To avoid double-counting, GDP only considers the value of final goods.
Informal Sector Activities: Economic activities that are not officially recorded, such as
street vending or subsistence farming, can be difficult to measure accurately and are often
underestimated in GDP calculations.
Non-Market Activities: GDP does not fully capture the value of non-market activities,such as
unpaid household work or volunteer work, even though these activities contribute to well-being.
Environmental Impacts: GDP does not account for the depletion of natural resources or
environmental damage caused by economic activity.
Nominal GDP vs. Real GDP
Nominal GDP: Measures the value of goods and services using current market prices.
Real GDP: Measures the value of goods and services using constant prices from a base
year. This allows economists to track changes in the actual quantity of goods and services
produced, excluding the effects of price changes (inflation).
Real GDP is a more accurate measure of economic growth than nominal GDP because it
controls for the effects of inflation.
The GDP Deflator and Inflation
The GDP deflator is a price index that measures the overall price level of all goods and services
included in GDP. It is calculated as follows: (Nominal GDP / Real GDP) x 100.
Inflation refers to a general increase in the price level of goods and services in an economy over
a period of time. The GDP deflator is one way to measure inflation.
Other Key Measures
Net Domestic Product (NDP): NDP is calculated by subtracting depreciation (the
wearing out of capital goods) from GDP. NDP provides a measure of the nation's income that is
available for consumption and new investment.
National Income (NI): NI is calculated by subtracting indirect business taxes from NDP.
It measures the income earned by the factors of production (labor, capital, land) within a country.
Limitations of GDP and Alternative Measures
Income Distribution: GDP does not provide information about how income is distributed among
different groups within a country. A country with a high GDP per capital may still have high
levels of income inequality.
Alternative Measures of Well-being: Economists and policymakers increasingly recognize that
GDP alone is an incomplete measure of well-being. Alternative measures, such as the Human
Development Index (HDI), take into account factors like life expectancy, education, and income
to provide a broader perspective on human development.

Unit 4: Consumption, Saving, and Investment

Consumption
What is Consumption?
Consumption refers to the spending by households on goods and services to satisfy their current
needs and wants. It is a significant component of a country's GDP.
Disposable Income (Yd): The most crucial factor influencing consumption is disposable
income, which is the income households have left after paying taxes. The sources emphasize that
as disposable income rises, consumption tends to increase, but not necessarily at the same rate.
Key Concepts Related to Consumption
Average Propensity to Consume (APC): The proportion of disposable income that
households spend on consumption. It is calculated as:
APC = Total Consumption (C) / Total Disposable Income (Yd).
Marginal Propensity to Consume (MPC): The change in consumption spending resulting
from a change in disposable income. It is calculated as:
MPC = Change in Consumption (ΔC) / Change in Disposable Income (ΔYd).
MPC demonstrates how much of each additional unit of income households will spend on
consumption.
For example, if MPC is 0.8, and a household's income increases by Birr 100, they will spend Birr
80 of that increase on consumption.
Factors Influencing Consumption:
Interest Rates: Higher interest rates generally encourage saving and discourage
borrowing, potentially leading to a decrease in consumption.
Wealth: Households with higher levels of accumulated wealth tend to consume more, even if
their current income remains the same.
Expectations: Consumer confidence and expectations about future economic
conditions can significantly impact spending decisions. If households are
optimistic about the future, they are more likely to increase their consumption.
 Saving
What is Saving?
Saving represents the portion of disposable income that households do not spend on
consumption. In essence, it is the act of postponing current consumption for future use.
Key Concepts Related to Saving
Average Propensity to Save (APS): The proportion of disposable income that households save.
It is calculated as:
APS = Total Saving (S) / Total Disposable Income (Yd).
Marginal Propensity to Save (MPS): The change in saving resulting from a change in
Disposable income. It is calculated as:
MPS = Change in Saving (ΔS) / Change in Disposable Income (ΔYd).
MPS indicates how much of each additional unit of income a household will save.
For example, if the MPS is 0.2, and income rises by Birr 100, the household will save Birr 20 of
that increase.
Important Relationship: The sources highlight that the sum of APC and APS is always
equal to 1, and the sum of MPC and MPS is also always equal to 1. This reflects the fact that
disposable income is either consumed or saved.
Factors Influencing Saving:
Many of the factors influencing consumption also impact saving, but in the opposite direction.
 Income Levels: Generally, saving tends to rise as income increases, although the rate of
increase may vary.
 Interest Rates: Higher interest rates often incentivize saving as they provide a higher
return on saved funds.
 Wealth: Households with more wealth may save less as they feel more financially
secure.
 Taxes: Higher direct taxes on income can reduce disposable income, leading to lower
saving levels.
 Individual Behaviour: Personal characteristics and attitudes towards saving also
play a role. For example, individuals who are more future-oriented tend to save
more.
The Role of Iqub in Ethiopian Saving Culture
The sources provide an interesting example of a traditional saving mechanism in Ethiopia called
"iqub".
What is Iqub? Iqub is an informal, community-based saving and credit system where a group
of individuals regularly contribute a fixed sum of money into a collective pool.
Each member then takes turns receiving the entire pool, providing a lump sum that can be used
for consumption or investment.
Significance: Iqub demonstrates the importance of saving in Ethiopian culture and
highlights a community-driven approach to financial management, particularly in the absence of
formal banking systems.
Investment
What is Investment?
Investment, in an economic context, involves acquiring goods not for immediate consumption
but to generate wealth in the future. This typically involves businesses purchasing capital goods,
such as machinery and equipment, to increase production capacity.
Types of Investment
Induced Investment: Driven by changes in demand for goods and services. For example,
if consumer demand for smartphones increases, a company might respond by investing in new
factories and equipment to increase production.
Autonomous Investment: Investment that is not directly related to changes in current demand.
This might include investments in infrastructure projects or research and development, often
driven by government policies or long-term economic factors.
Factors Influencing Investment
 Interest Rates: Interest rates represent the cost of borrowing money. Higher interest rates
generally make investment less attractive as they increase the overall cost of borrowing.
 Expected Returns: Businesses make investment decisions based on the potential profits
they expect to earn from those investments. Factors influencing expected returns include:
Economic Growth: Expectations of strong economic growth often lead to higher
investment as businesses anticipate increased demand for their products.
  Technological Advancements: New technologies can create new investment
opportunities or make existing investments more profitable.
 Business Confidence: A positive and stable business environment, with clear regulations
and low risks, encourages investment.
The Accelerator Theory
This theory, mentioned in the sources, suggests a strong link between consumption and
investment. When consumption spending rises, it can lead to a disproportionately larger increase
in investment. For example, even a small increase in demand for a product might require a
company to invest heavily in a new factory to meet that demand.
Investment and Economic Growth
Investment is a crucial driver of long-term economic growth. By increasing the stock of capital
goods, investment expands a country's productive capacity, leading to higher output, income, and
employment in the long run.
The Importance of the Ease of Doing Business (EoDB)
What is the EoDB? The Ease of Doing Business (EoDB) index, mentioned in the context of
Ethiopia's investment climate, measures the regulations and conditions that impact businesses
operating within a country. A higher EoDB ranking suggests a more business-friendly
environment.
Significance for Investment: The EoDB can influence investment decisions. Countries with a
higher EoDB ranking are often more attractive to both domestic and foreign investors. Improving
the EoDB by streamlining regulations, reducing bureaucracy, and enhancing transparency can
boost investment and promote economic growth.