F LIMPOPO
YO
UN
I VERSIT
Faculty of Science and Agriculture
SCHOOL OF AGRICULTURAL & ENVIRONMENTAL SCIENCES
Department of Agricultural Economics & Animal Production
STUDY GUIDE
AGRICULTURAL ECONOMICS: MICROECONOMICS
(SAGB021)
YEAR: 2023
Number of credits: 16
Semester offered: (one) 1
Prepared by: Prof JJ Hlongwane, Dr R Nengovhela & Mr TK Thaba
Content evaluated by: Mr LJ Ledwaba
Copyright: Department of Agricultural Economics
and Animal Production
University of Limpopo
SAGB021
1.
1.1
Department of Agricultural Economics and Animal Production
2023
INTRODUCTION
Welcome
The course Microeconomics is facilitated by Prof JJ Hlongwane, Dr R Nengovhela & Mr TK Thaba,
and is designed to provide/presents the major theories concerning the central questions of
microeconomics. This course is an introduction of key concepts in microeconomics. Basic concepts
and relationships in economics such as, demand, supply and prices in the marketplace. Resource
allocation and efficiency. Elasticity. Theory of consumer choice and behaviour. Production and cost
theory. The market and market structures in which farmers operate and lastly the labour market.
Welcome to Agricultural Economics: Microeconomics (SAGB021) and I hope students will find the
course a most useful learning experience.
1.2
Course Objectives
The overall course objective is to introduce you to some managerial and decision-making tools and to
assist you in developing some degree of competency in applying these concepts to real life situations. Your
personal development as regards your ability to manage, advise or service agricultural production
businesses underlies the course purpose. Specific objective includes the following:
Modern students of agricultural and related field of study need several important microeconomics tools. The
main objective of this module is to introduce the students to the basic principles of microeconomics to
enable them to handle specialized undergraduate programmes in agriculture (BAG 01, BAF 01, BAS 01
and BAP 01) and related fields of study.
The philosophy of the course content is that communication and action are fundamental to the learning
process. Learning is facilitated by communication which is a two-way process. Students and facilitator are
both instructors.
1.3
Learning outcomes
Students should be able to demonstrate and apply contemporary knowledge of production economics and
skills to fulfil a variety of business (agribusiness) roles. Students should also be able to demonstrate an
understanding of how production economics can be used in solving the agricultural problems such as
inefficiency, profits loss and etc; organise and manage; analyse and critically evaluate information;
communicate effectively algebraic, graphical, tubular, using visual and language skills.
1.4
Prescribed and Recommended reading
Prescribed book (s)
Mohr, P. and R. Seymore. 2012. Understanding Microeconomics, first edition. Published by Van
Schaik publishers in South Africa.
Mohr, P., Fourie, L. and Associates.2004. Economics for South African Students, 3 rd edition, published by
Van Schaik publishers.
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Walbeek, C., Krugell, W. and N. Samouilhan. 2010. South African workbook for economics, fourth edition.
Published by Van Schaik publishers.
Suggested reading(s)
Mohr, P. 2012. Understanding the economy, third edition. Published by Van Schaik publishers in South
Africa.
Viljieon, R.P. 2002. Microeconomics, 1st edition fourth impression. Published by UNISA press.
Orley, M., and Amos, J.R.1994. Microeconomics: Concepts, analysis and application to modern
economics, 3rd edition
NB: Class notes/Handouts for this course will be pasted on the blackboard and students are requested to
print them. Students are advised and encouraged to go through the notes prior to each class so as to
facilitate discussions, learning and excellent grasp of the material.
1.5
ASSESSMENT METHODOLOGY
1) The module will be delivered over 16 weeks of four hours each. Each session will relate to a
specific chapter in the prescribed book.
2) The learners will prepare for each session by studying the relevant chapter.
3) The learners will submit a group assignment as required, based on the issues dealt with in the
previous session as a formative assessment.
4) The facilitator will lead the discussion on each session’s topic and will ensure understanding of the
learners by conducting an in-class tutorial in every session.
5) Individual students’ progress will be assessed after six sessions by means of a summative
assessment covering work as stated in the module outline covered.
6) The final summative assessment will be in the form of a three-hour closed book examination based
on all the work covered in the module.
The study guide is a brief summary of the major’s areas of discussion. Students should not expect
to pass on a thorough knowledge of the study guide
1.5
Student responsibility
The facilitator takes for granted that each student or a member of the group has:
1) Spent at least 2 hours in preparation prior to the session.
2) Summarised the articles for that sessions.
3) Discussed the tutorials within their groups.
4) A full understanding of the strategic issues under debate.
5) Read the relevant chapters in the prescribed text books.
6) Expanded the study guide to include those pertinent arguments in the relevant articles.
1.7
Completing assignments and assessments
In the process of studying, assignments and assessments are undertaken to assess the learners’
progress and application in the area of study. The following are general comments relating to the
completion of written assessments:
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Answering of questions
1) Read all the questions carefully
2) Underline
3) Number the instructions so that you can check that you have fulfilled the requirements when you
complete the question
1.7.2
Common mistakes to avoid
Ensure that:
1)
2)
3)
4)
5)
6)
1.7.3
Question numbering is visible, clear and accurate
Page numbering is noted
Rough work is indicated as such
Appendices are clearly marked
Questions are handled in chronological order
Questions are not rewritten on scripts
Spelling and grammar
Where possible, always use a dictionary to ensure correct spelling and word usage. On the
computer the incorrect application of grammar and spelling will be pointed out to you, but it is still
advisable to check your application if you are in any way unsure.
1.7.4
Presentation
Do not ever underestimate the impact that a good, clear and aesthetically pleasing written report
can make. Try to develop good presentation habits, as the reception of any written communication
will create more of an impact if the presentation is easy and pleasurable to look at and read
through. Write clearly and legibly.
A badly laid out presented assignment/assessment, with pages incorrectly numbered and rough
work not clearly indicated, can work against the writer, as the marker may not know which is the
final piece of work to be marked.
1.7.5
Mark allocations
Judge the length of your answer from the marks allocated. Sometimes a mark allocation is clearly
specified. A general guide is that 1 mark will be allocated for each new and relevant point.
1.8
ASSIGNMENT ADMINISTRATION
Assignment format:
1) Assignment, both group and individual, will be typed with 1.5 spacing on A4 paper in Arial 12
2) Group assignments must include a declaration indicating group members who participated in the
preparation thereof and who therefore due for an equal mark.
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3) Assignments will be stapled with one staple on the left corner
4) The front page of each assignment will reflect the following
Student Name: Surname, Initials
Student Number:
2022XXXX
Assignment Title:
Title
Date:
day-Month-2023
Course Code:
SAGB021
Programme:
Agricultural Economics
Lecturers:
Prof JJ Hlongwane, Dr R Nengovhela and Mr TK Thaba
5) Assignments are to be submitted to all the facilitators through their emails on /before the due date
no later than 13h00 (For remote learning) . Late submitted assignments will not be taken.
6) Individual assignments may not be the same to any other assignments
7) For group assignments there should be no less than 3 group members and no more than 15
members
8) Students who plagiarise work will appear before the facilitator and penalised
9) Students will receive 0% if they do not adhere to the above-mentioned rules.
1.8
MODULE GRADING
The coursework component comprises 60% of the production economics. The balance, 40% comprises
and individual closed book written assessment (examination) at the end of the module.
In order to successfully complete this module, students must attain an average of at least 50% for the
coursework. A minimum of 50% must be attained in the final summative assessment (examination).
The overall pass mark is 50%
Assessments
Average of 2 tests
Average of 2 assignments
1 quiz
Formative assessment mark
=
=
=
Contribution to formative assessment
60%
20%
20%
100%
Module overview
1. Introduction
o Economics versus Agricultural Economics
o Branches of economics
o Scarcity, Choice and Opportunity cost
o Illustrating scarcity, choice and opportunity cost on the Production Possibility curve
o Economics as a social science
Closed book class activity covering section 1 will be held at the end of this chapter.
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2. Important concepts, issues and relationship
o
o
o
o
Different economic system
Production, income and spending
The interdependence between households and firms
Few further concepts
Closed book class activity covering section 2 will be held at the end of this chapter.
3. Demand, supply and the price
o
o
o
o
o
Demand and supply: an introductory overview
Demand
Supply
Market equilibrium
Consumer surplus and producer surplus
Closed book class activity covering section 3 will be held at the end of this chapter.
4. Demand and supply in action
o
o
o
o
o
o
o
Change in demand
Change in supply
Simultaneous change in demand and supply
Interaction between related markets
Government intervention
Agricultural prices
Speculative behaviour: self-fulfilling expectation
5. Elasticity
o
o
o
o
Nature of elasticity
Price elasticity of demand
Other demand elasticity
The price elasticity of supply
Closed book class activity covering section 5 will be held at the end of this chapter.
Submission of assignment one is in 27 February 2023 before 13h00.
Closed book quiz covering section 1 to 3 will be written in 01 march 2023.
Closed book test covering section 1 to 5 will be written in March 2023.
6. The theory of demand: the utility approach
o Utility
o Marginal utility and total utility
o Consumer equilibrium in utility approach
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o Derivation of an individual demand curve for a product
o Consumer on the utility approach
7. The theory of demand: the indifference approach
o
o
o
o
o
Ordinal and cardinal utility
Indifference curves
The budget line
Consumer equilibrium
Change in consumer equilibrium
Closed book class activity covering section 6 to 7 will be held at the end of this chapter.
8. Background to supply: Production and cost
o
o
o
o
o
Introduction
Basic cost and profit concepts
Production in the short run
Costs in the short run
Production and costs in the long run
Closed book class activity covering section 8 & 9 will be held at the end of this chapter.
Closed book test covering section 6 to 9 will be written in 11 April 2023.
9. Market structure1: overview and perfect competition
o
o
o
o
o
o
o
Market structure: an overview
The equilibrium conditions (for any firm)
Perfect competition
The demand for the product of the firm
The equilibrium of the firm under perfect competition
The supply curve of the firm and the market supply curve
Long-run equilibrium of the firm and the industry under perfect competition
10. Market structure 2: monopoly and imperfect competition
o
o
o
o
Monopoly
Monopolistic competition
Oligopoly
Comparison of monopoly and imperfect competition with perfect competition
11. The labour market
o The labour market versus the goods market
o A perfectly competitive labour
Market
o Imperfectly competitive labour market
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Submission of assignment two is in 31 March 2023.
2.
INTRODUCTION TO STUDY GUIDE
The following pages will outline some of the ideas, concepts and techniques you should master week by
week as you progress through the course. The textbooks and study material are well suited to the course
and will provide you with most of the needed reading material. However, there are a few topics on which it
provides little or no help. On such occasions additional reference material will be indicated.
As will be clear from the course outline, the text, and the tutorials, tests and assignments, the course is a
challenging one and will require a planned and regular effort at completing the assignments and tutorials.
Experience indicates that it is only by actually doing the tutorials/exercises that students come to an
intuitive understanding of the methods and techniques involved. ‘Learning by doing’ is very much the
approach adopted for this course.
CHAPTER 1: INTRODUCTION TO AGRICULTURAL ECONOMICS
ECONOMICS VS AGRICULTURAL ECONOMICS
Economics
It is defined as the study of how limited resources can best be used to fulfil unlimited human wants
Agricultural Economics
It is defined as the study of how limited resources can best be used in the production, processing,
distribution and consumption of food and fibre.
TWO BRANCHES OF ECONOMICS
1. Microeconomics
Its focus is on the individual parts of the economy. It deals with the determination of prices and quantities in
the economy. Thus, why is sometimes called the price theory. It uses the forces of demand and supply to
achieve the objective of the consumer which it to maximize the level of utility and the objective of the
producers which is to maximize the profits.
2. Macroeconomics
Its focus is on the economy as a whole. It is the branch of economics which deals with the booms and
recession in the economy. It also deals with the aggregated demand and aggregated supply in the
economy.
HOW DO WE STUDY ECONOMICS?
There are two approaches of studying economics namely:
1. Positive economies
It explains how economy operate. It deals with the statement of facts. Its statement can be proved
2. Normative economics
It explains how economy should operate. It deals with value judgement or opinion.
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SCARCITY, CHOICE AND OPPORTUNITY COST
 Wants – human desires
 Needs – necessities
 Demand – wants, but backed by necessary means to buy
Scarce resource
Occurs when the available quantity of resources are not enough to be used in the production process.
Limited resource
Occurs when the available resources are finite in quantity.
 Because of scarcity, choices have to be made
 Every time a choice is made, opportunity cost is incurred
 Opportunity cost – the value to the decision maker of the best alternative that could have been
chosen but was not chosen or the value of the best forgone opportunity.
SCARCE RESOURCES: THE FACTORS OF PRODUCTION
Factors of production – scarce resources that are used to produce goods and services
 Natural resources (land)
 Labour
 Capital
 Entrepreneurship
 Technology
Money is not a factor of production!
ILLUSTRATING SCARCITY, CHOICE AND OPPORTUNITY COST: THE PRODUCTION POSSIBILITIES
CURVE
The production possibilities curve indicates the combinations of any two goods or services that are
attainable when the community’s resources are fully and efficiently employed
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FURTHER APPLICATIONS OF THE PRODUCTION POSSIBILITIES CURVE
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ECONOMICS IS A SOCIAL SCIENCE
Purpose of economic theory
Explanation: describe how different factors relate in real economy
Prediction: forecast what will happen if some factors changes
Economic policy: formulation and analysis of decision on economic policy
CHAPTER 2: Important concepts, issues and relationships
Different economic systems (fundamental task of economic system)
Three central economic questions
1. Output questions (WHAT to produce?)
2. Input questions (HOW to produce?)
3. Distribution questions (FOR WHOM are producing?)
Two additional central economic questions
1. Time questions (when to produce?)
2. Location questions (Where to produce?)
An economic system – a pattern of organisation which is aimed at solving the three central questions
Traditional system-
means that the same goods are produced and distributed in the same way
by each successive generation.
The command system-
the participants are instructed what to produce and how to produce it by a
central authority which also determines how the output is distributed.
Because the economy is coordinated by central authority, command
system are also called centrally planned systems.
The market system-
In the market system, the method of coordination is so subtle and intricate
that it could not have been invented. It simply happened. Market system is
one in which individual decisions and preferences are communicated and
coordinated through the market mechanism. The important elements of
this mechanism is the market price.
The mixed economy-
this economic system is the mixture of traditional behavior, central control
and market determination. South Africa’s mixed economy
CIRCULAR FLOW
It is a continuous and simultaneous flow of all final goods and services and factors of production in an
exchange of payment.



Production
Income
Spending
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There are two major sectors that participate in the operation of the micro - economy, namely household
sector and business sector.
There are two major markets that participate in the operation of the micro - economy, namely products
markets and factor markets
Products markets - are markets used to exchange final goods and services.
Factor markets - are markets used to exchange the service of the factors of production.
Figure 2-1: The three major flows in the economy (Textbook page 42)
The interdependence between households and firms
Household – all the people who live together and who make joint economic decisions or who are subjected
to others who make such decisions for them
Firm – the unit that employs factors of production to produce goods and services that are sold in the goods
market.
The circular flow of goods and services
Figure 2-2: The circular flow of goods and services (Textbook page 45)
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The circular flow of income and spending
Figure 2-3: The circular flow of income and spending (Textbook page 46)
A few further key concepts
 Specialisation and exchange
 Specialisation, opportunity cost and comparative advantage
 Absolute prices and relative prices
CHAPTER 3: Demand, supply and prices
Demand and supply: an introductory overview
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The interaction between households and firms
Figure 3-1: The interaction between households and firms (Textbook page 50)
Demand –
quantities of a good or service that the potential buyers are willing and able to buy at
particular price, ceteris puribus
Market demand –
the combined demand for all the households in a particular market
Determinants of market demand





The price of the product
The prices of related products
The income of the consumers
The taste (or preference) of the consumers
The number of households
The law of demand –
other things equal (ceteris paribus), the higher the price of a good, the
lower the quantity demanded
Various ways to express demand and the law of demand
Using words: demand theory (willing and able)
Using numbers: the demand schedule
Table 3-1: A demand schedule for tomatoes (Textbook page 54)
Using graphs: the demand curve
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Figure 3-2: Consumers’ weekly demand for tomatoes (Textbook page 55)
Using symbols: the demand equation
Equation 3-2 (Textbook page 57)
Movement along the curve vs. shift of the curve
Movement along the curve (change in the quantity demanded) relates to the slope of the curve
Figure 3-3: A movement along a demand curve (Textbook page 58)
Shift of the curve (a change in demand) relates to the position or intercept of the curve
Figure 3-4: Two substitutes: butter and margarine (Textbook page 60)
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Figure 3-5: Two complements: CD players and CDs (Textbook page 61)
Table 3-2: The market demand curve: a summary (Textbook page 63)
A linear demand curve is represented by the following equation:
Qd = a - bP
Where:
Qd = quantity demanded (dependent variable)
P = price of the product (independent variable)
a = quantity demanded when P = 0
-b = inverse of the slope of the demand curve
Figure 3-6: A change in the quantity demanded versus a change in demand (Textbook page64)
Determinants which will cause the demand curve to shift
A change in the price of a related good
 Substitutes
 Complements
A change in the income of consumers
A change in consumers’ tastes or preferences
A change in population
Other influences on demand
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Change in expected future prices
The distribution of income
SUPPLY
Supply –
the quantities of a good or service that producer plan to sell at each possible price during a
certain period
They must be willing AND able to sell
Determinants of market supply





The price of the product
The price of alternative products
Prices of factors of production and other inputs
Expected future prices
The state of technology
The law of supply – other things equal (ceteris paribus), the higher the price of a good, the higher the
quantity supplied
Various ways to express supply and the law of supply:
Using words
Using numbers: the supply schedule
Table 3-3: A supply schedule of tomatoes (Textbook page 67)
Using graphs: the supply curve
Figure 3-7: Firms’ weekly supply of tomatoes (Textbook page 67)
Using symbols: the supply equation
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Equation 3-6 (Textbook page 68)
A linear supply curve is represented by the following equation:
Qs = c + dP
Where:
Qs = quantity supplied (dependent variable)
P = price of the product (independent variable)
c = presumed quantity supplied when
P = 0 (intercept on the quantity axis)
d = inverse of the slope of the supply curve
Movement along the curve and shifts of the curve
Movement along the supply curve
Figure 3-8: A movement along a supply curve: a change in the quantity supplied (Textbook page 69)
Shift of the supply curve
Figure 3-9: Shifts of the supply curve: changes in supply (Textbook page 70)
Table 3-4: The market supply curve: a summary (Textbook page 71)
MARKET EQUILIBRIUM

Equilibrium (quantity demanded = quantity supplied)
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Excess demand (market shortage) occurs when the prices charged is below the market price.
Excess supply (market surplus) occurs when the prices charged is above the market price.
Figure 3-10: Demand, supply and market equilibrium (Textbook page 73)
Table 3-5: The demand and supply of tomatoes in a market on a particular day (Textbook page 72)
Equilibrium occurs when the quantity supplied in the market is equal to the quantity demanded in
the market, that is, Qs = Qd.
c + dP = a – bP
∴ dP + bP = a – c
∴P (d + b) = a – c
∴
Suppose that the market demand and supply curves are given by Qd= 200-2P and Qs= 50 + P. At
equilibrium Qd= Qs, therefore
200 – 2P = 50 + P
∴ –2P – P = 50 – 200
∴
∴
–3P
=
–150
P=50
Consumer surplus – the difference between what consumers pay and the value that they receive
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Figure 3-11: The consumer surplus (Textbook page 75)
Producer surplus – the difference between the lowest price producers are willing to accept and the price
they actually receive
Figure 3-12: The producer surplus (Textbook page 75)
Consumer surplus and producer surplus
Figure 3-13: Consumer surplus and producer surplus at market equilibrium (Textbook page 76)
CHAPTER 4: Demand and supply in action
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Changes in demand
An increase in demand will result in the following


Increase in the price of the product
Increase in the quantity exchanged
Figure 4-1(a): Changes in demand (Textbook page 82)
A decrease in demand will result in the following


Decrease in the price of the product
Decrease in the quantity exchanged
Figure 4-1(b): Changes in demand (Textbook page 82)
Changes in supply
An increase in supply will result in the following


Decrease in the price of the product
Increase in the quantity exchanged
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Figure 4-2(a): Changes in supply (Textbook page 84)
A decrease in supply will result in the following


Increase in the price of the product
Decrease in the quantity exchanged
Figure 4-2(b): Changes in supply (Textbook page 84)
Simultaneous changes in demand and supply
Simultaneous change in demand and supply ̶ 4 possible combinations
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Table 4-1: Simultaneous changes in demand and supply (Textbook page 85)
The outcome depends on the relative changes in demand and supply
Figure 4-3: A simultaneous increase in demand and decrease in supply (Textbook page 86)
Interaction between related markets
Case studies:
Fish and meat
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Figure 4-4: Interaction between the markets for fish and meat (Textbook page 88)
Motorcars and tyres
Figure 4-5: Interaction between the markets for motorcars and tyres (Textbook page 89)
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Government intervention
Different forms of government intervention:

Setting maximum prices (price ceilings)
It is a limit beyond which a price is not allowed to rise. It is meant to protect the Consumer.
Figure 4-6: Maximum prices (Textbook page 91)
Welfare cost
Deadweight Loss = A plus C
Rectangle B is transferred from producer surplus to consumer surplus
See Figure 4-7: The welfare costs of maximum price fixing (Textbook page 94)
Setting minimum prices (price floors) it is a limit beyond which a price is not allowed to fall.
It is meant to protect the producers.
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Figure 4-8: A minimum price (Textbook page 95)
Welfare cost
Deadweight Loss = B plus C
Rectangle A is transferred from consumer surplus to producer surplus
See, Figure 4-9: The welfare costs of minimum price fixing (Textbook page 97)
Subsidizing certain products or activities
Figure 4-10: A subsidy paid to suppliers (Textbook page 98)
Taxing certain products or activities:

A specific excise tax
Figure 4-11: The incidence of an excise tax on cigarettes (Textbook page 99)
For Welfare cost
See, Figure 4-12: The welfare costs of a specific excise tax (Textbook page 101)
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Production quotas- quantitative restriction on production of a particular product.
Figure 4-13: The impact of a production quota (Textbook page 102)
For Welfare costs: See, Figure 4-15: The welfare costs of a tariff (Textbook page 104)
Agricultural prices
The prices of agricultural products fluctuate much more than the prices of manufactured products.
Why?
Figure 4-16 an increase in supply as a result of an expected high price of potatoes (Textbook page 105)
Speculative behavior: self-fulfilling expectations
Speculation – the behaviour of looking into the future and making buying and selling decisions based on
expectations (or predictions)
Figure 4-17: Self-fulfilling expectations (Textbook page 107)
CHAPTER 5: Elasticity
A general definition of elasticity


Elasticity – a measure of responsiveness or sensitivity
Elasticity coefficient – the percentage change in a dependent variable if the relevant independent
variable changes by one per cent
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Types of elasticity




The price elasticity of demand
The income elasticity of demand
The cross price elasticity of demand
The price elasticity of supply
The price elasticity of demand


It is defined as the percentage change in the quantity demanded if the price of the product changes
by one per cent, ceteris paribus
It is a measure of responsiveness or sensitivity of the quantity demanded towards a change in
price.
Formulas of calculating price elasticity of demand:
1. Point elasticity (use for small price changes)
2. Arc elasticity (use for larger price fluctuations)
Different categories of price elasticity of demand:





Perfectly inelastic demand (ep = 0)
Inelastic demand (0 < ep < 1)
Unitary elastic demand (ep = 1)
Elastic demand (1 < ep < ∞)
Perfectly elastic demand (ep = ∞)
Table 5-2: Price elasticity of demand: a summary (Textbook page 117)
Figure 5-3: The different categories of price elasticity of demand (Textbook page 118)
The price elasticity of demand can be used to determine by how much the total expenditure by consumers
on a product changes when the price of the product changes
 Price elasticity of demand > 1
TR increases as Q increases
 Price elasticity of demand = 1
TR reaches a maximum
 Price elasticity of demand < 1
TR falls as Q increases
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Figure 5-2: The relationship between price elasticity of demand and total revenue (Textbook page 116)
Determinants of the price elasticity of demand:










Substitution possibilities
The degree of complementarity of the product
The type of want satisfied by the product
The time period under consideration
The proportion of income spent on the product
The definition of the product
Advertising
Durability
The number of uses for the product
Addiction
The combined effect of the determinants
The income elasticity of demand – measures the responsiveness of the quantity demanded to changes
in income


0 < ey
Normal good
0 = ey
Neither normal nor inferior good
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ey < 0
Inferior good
Q A
Y

Y
QA
Ey 
Ey 
(Q2  Q1 ) /( Q2  Q1 )
(Y2  Y1 ) /(Y2  Y1 )
Cross elasticity of demand – measures the responsiveness of the quantity demanded for a particular
good when the price of another good changes



0 < ec
Substitutes
ec < 0
Complements
ec = 0
Unrelated goods
Ec 
Ec 
Q A
PB

PB
QA
(Q A 2  Q A1 ) /( Q A 2  Q A1 )
( PB 2  PB1 ) /( PB 2  PB1 )
Price elasticity of supply – the ratio between the percentage change in the quantity supplied of a product
and the percentage change in the price of the product
By how much will the quantity supplied change if the price changes by one per cent?
Es 
Q A
PA

PA
QA
Es 
(Q1  Q2 ) /( Q1  Q2 )
( P1  P2 ) /( P1  P2 )
Different categories of price elasticity of supply:





Perfectly inelastic supply (es = 0)
Inelastic supply (0 < es < 1)
Unitary elastic supply (es = 1)
Elastic supply (1 < es < ∞)
Perfectly elastic supply (es = ∞)
Figure 5-4: The different categories of price elasticity of supply (Textbook page 128)
Determinants of the price elasticity of supply:
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Time
Expectations
Stockpiling
Excess capacity
Availability of inputs
CHAPTER 6: The theory of demand: the utility approach
THEORY OF CONSUMER CHOICE AND BEHAVIOUR




The objective of this chapter is to provide the producers and managers with an economic view of
the consumer’s decision making process.
Consumers must decide how to allocate a limited amount of money (budget) among various
commodities so as to maximize their level of satisfaction.
The consumers 'decisions of what and how much of a product to purchase have direct implications
for managers and producers.
Therefore, managers need to understand how consumers make their consumption decisions.
From observing consumer behaviour, economist have noted several characteristics exhibited by
consumers namely:
1.
2.
3.
4.
Consumer spend their entire budget
Consumer have unlimited wants
Consumers have limited income
Consumer desire variety of goods and services
Two approaches used in the study of consumer choice and behaviour.


Utility Approach - is based on the notion of cardinal utility. Cardinal utility involves the idea that
utility can be measured in some way
Indifference approach – is based on the notion of ordinal utility. Ordinal utility involves the ranking
of different bundles of consumer goods or services in order of preference.
UTILITY
It is defined as an economic term for the satisfaction and need fulfilment that people get from the
consumption of material goods and services.
Purpose of consumer behaviour – maximisation of utility
Two assumptions of the utility approach
1. Satisfaction (utility) is somehow measurable on a cardinal scale.
2. The difference in utility can be precisely quantified.
Utility approach
Cardinal utility – assumption: utility can be measured
Indifference approach
Ordinal utility – assumption: bundles of goods and services can be ordered
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Marginal utility and total utility



Marginal utility – the extra or additional utility that a consumer derives from the consumption of
one additional unit of a good
Total utility – the cumulative sum of all the marginal utilities
Disutility – negative utility
Marginal utility (MU)
It is defined as the extra or additional utility or satisfaction that a consumer derives from the consumption of
one additional unit of good.
MU= ∆ TU/ ∆Q
Where : ∆ is change
: TU is total utility
: Q is the quantity of good


The law of diminishing marginal utility – the marginal utility of a good or service eventually declines as
more of it is consumed during any given period
Weighted marginal utility: marginal utility divided (weighted) by the price of the product
CONSUMER EQUILIBRIUM IN THE UTILITY APPROACH



Equilibrium is a situation in which there is no incentive for the participants (consumers) to change
their plans of consumption to maximize utility.
It is assumed that every consumer attempts to maximize his/her satisfaction of wants by
consuming goods and services.
The aim is to obtain the highest attainable level of total utility.
EQUILIBRIUM CONDITION (UTILITY MAXIMIZATION POINTS


To obtain the consumer’s equilibrium position we must determine which combinations are
affordable and at which of these combinations the weighted marginal utility is the same for all the
goods in question.
TWO PRODUCT CASE
STEPS OF DETERMINING CONSUMER EQUILIBRIUM IN UTILITY APPROACH
1.
2.
3.
4.
5.
Check as whether is it a two or three or four product case
State the equilibrium condition equation
Calculate the marginal utility of each product
Determine the weighted marginal utility
Compare the weighted marginal utility in order to find where they are similar (same)
Consumer equilibrium in the utility approach
The aim – achieve the highest attainable level of total utility
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Table 6-2: Thabo Botha’s marginal utility and total utility from the consumption of apples during a specific
period (Textbook page 138)
Table 6-3: Winnie’s scale of preferences in respect of the weekly consumption of bread, meat and rice
(Textbook page 138)
Law of equalising the weighted marginal utilities – the consumer’s subjective valuation of the relative
importance of the two goods is the same as the objective valuation of the market, as reflected in the market
price of the goods concerned
Derivation of an individual demand curve for a product
Demand curve – shows the quantities demanded of a good or service at different prices
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Table 6-4: Helen Meyer’s utility from chocolates and yoghurt (per week) (Textbook page 140)
Table 6-5 Helen Meyer’s utility from the weekly consumption of chocolates and yoghurt at a lower price of
chocolates (Textbook page 141)
Figure 6-1: Helen Meyer’s demand curve for chocolates (Textbook page 142)
Comments on the utility approach


Key concept – marginal utility
Utility cannot be measured objectively
CHAPTER 7: The theory of demand: the indifference approach
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INDIFFERENCE APPROACH
The basic assumptions of indifference approach:
1. Completeness
It means that consumer is able to rank all possible combination of goods and services.
2. Consistency
Simply means that consumers are assumed to act consistently
3. Non-satiation
Simply mean that consumers are not yet fully satisfied and prefer more to less.
Indifference curves
Indifference curve: curve which shows all the combinations of two products that will provide the consumer
with
equal
levels
of
satisfaction
or
utility.
Table 7-1: Combinations of meat and bread that yield the same level of satisfaction to Koos van der Merwe
(Textbook page 147)
Figure 7-1: An indifference curve (Textbook page 148)
Indifference map
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Figure 7-2: An indifference map (Textbook page 150)
PROPERTIES OF AN INDIFFERENCE CURVE
1.
2.
3.
4.
Cannot intersect
Down-ward sloping (Negatively sloped)
Convex to the origin
Cannot pass through the vertical and horizontal axis
Indifference curves cannot intersect
Figure 7-3: Indifference curves cannot intersect (Textbook page 152)
The budget line
Budget line – all the combinations of the two products that a consumer can afford to purchase with the
amount of income at his/her disposal
Table 7-3: Affordable combinations of bread and meat (Textbook page 151)
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Budget constraint equation
I = PxX + PyY
Where: I = Income
X = level of good X
Y = Level of good Y
Px and Py = price of each goods
I
 PX X
P
Y Y
 I
 P
Y Y
 PX X
 PX X
P
Y
Y

I
Y

I
P
Y

PX
P
Y
X
Figure 7-4: The budget line (Textbook page 152)
Consumer equilibrium
At equilibrium, where the budget line is tangent to an indifference curve, the slope of the budget line is
equal to the slope of the indifference curve
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Figure 7-5: Consumer equilibrium (Textbook page 153)
Changes in equilibrium

A change in income
Figure 7-6: The effect of an increase in income (Textbook page 155)

A change in price
Figure 7-7(a): The impact of a price change and the derivation of a demand curve (Textbook page
157)
Income and substitution effects of a price change
Income effect – the effect of a change in real income on the consumer’s purchases of a certain
good
Substitution effect – the effect of a change in the relative price on the consumer’s purchases of a
certain good. Figure 7-8: The income and substitution effects of a price change (Textbook page
157)
CHAPTER 8: Production and cost
This chapter introduces the concept of production function and development of input-output and cost
relationship that are important to resource allocation problem in agriculture.
Economists determine the effect of input on the production of a particular commodity by holding all other
relevant inputs constant.
PRODUCTION FUNCTION
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It describes the technical relationship that transforms inputs into outputs. it is also refers to all of
the activities involved in the production of goods and services
Inputs are the resources used in the production process.
Two types of input are; fixed and variable inputs
Variable input: refer to the input that the manager can control or for which he or she can alter its
quantity during the production period are those that can be varied easily and on very short notice.
Variable inputs are mostly raw materials and unskilled labours.
Fixed input: refer to the input that the manager for some reason has no control or for which he or
she cannot alter its quantity during the production period.
PRODUCTION FUNCTION CAN BE EXPRESSED IN THE FOLLOWING FOUR WAYS
1.
2.
3.
4.
In written form: enumerating and describing inputs that have bearing on the output.
Tabular form: listing inputs and the resulting output numerically.
Graphically: using curves and slopes in explain input-output rapport.
An algebraic form: using mathematical expressions to explain input-output rapport.
A GENERAL WAY OF WRITING A PRODUCTION FUNCTION
Y = F(X)…………………………………… (2.1)
Where: Y = Output
X = Input
Given this general form (2.1), it is not possible to determine exactly “how much output (Y) would result from
a given level of input (X).the specific form will be needed, since no output can be produced using only one
inputs.
Y= f(x1, x2, x3,……, xn)………………(2.2)
Where: x1,….. , xn different inputs used in the production of Y.
Equation 2.2 does not tell which inputs are variable and which ones are fixed. Fixed inputs play an
important role in agricultural production, are often called technical units.
Y = f(x1/ x2,x3,……,xn)……………(2.3)
Equation 2.3 tells us that only one input, x1 is varied in the production process while the other inputs, x2
through xn are assumed to be fixed.
AVERAGE AND MARGINAL PHYSICAL PRODUCT
AVERAGE PHYSICAL PRODUCT (APP) IS defined as the ratio of output to input (Y/X). For all level of
inputs use app represents the average amount of output (Y) per unit of input (X) being used.
APP measure the efficiency of the variable input used in the production process or rate at which an input is
transformed into output.
Marginal Physical Product (MPP) is defined as the change in output resulting from an incremental
change in the use of an input.
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The increment in input use is usually taken to be one unit.
Therefore, MPP can be defined as the change in output resulting from a unit increment or unit change in
variable input.
MPP measures the amount by which total output increases or decreases as input increases or decreases.
MPP represent the slope of the total physical product.
GIVEN:
THE LAW OF DIMINISHING MARGINAL RETURN
It states that as units of variable inputs are added to a bundle of fixed inputs, a point is reached after which,
each incremental unit of the variable input produces less and less additional output.
The law does not apply when all inputs are variable.
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THREE TYPES OF PRODUCTION FUNCTIONS
1. CONSTANT MARGINAL RETURNS
It occurs when each incremental unit of input use produces the exact the same incremental output.
Y = 2X
2. INCREASING MARGINAL RETURNS
It occurs when each incremental unit of input use produces more and more additional unit of
output. Y =X2
3. DIMINISHING MARGINAL RETURNS
It occurs when each incremental unit of input use produces less and less additional output, Y=X0.7
THREE STAGE OF NEOCLASSICAL PRODUCTION FUNCTION
1. Stage one
Stage one of the classical production function includes input use from zero units up to the level
where marginal product is equal to average product (MP = AP). In stage one, total product (TP) at
first increases at an increasing rate.
Marginal product (MP) is also increasing indicating that each incremental unit of input use
produces more and more additional unit of output. Then a point of inflection occurs and marginal
product (MP) is maximum at this point.
From the point of inflection, total product (TP) changes from increasing at an increasing rate to
increase at a decreasing rate.
After the point of inflection, marginal product (MP) is falling indicating that each incremental unit of
input use produces less and less additional output.
Average product (AP) is increasing and is less than marginal product (MP) throughout stage one,
indicating the efficiency with which variable input is transformed into output.
Average product (AP) reaches its maximum at the end of stage one and where is equal to marginal
product (MP). Note that the elasticity of production is greater than one.
2. Stage two
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Stage two includes the inputs use from the point where marginal product is equal to average
product (MP = AP) to the point where total product (TP) is at its maximum and marginal product
(MP) is equal to zero.
In stage two, total product (TP) is increasing at a decreasing rate indicating that marginal product
(MP) is falling.
The implication is that each incremental unit of input use produces less and less additional output.
In this stage average product (AP) is falling but being greater than marginal product (MP).
The implication is that the efficiency with which variable input is transformed into output decreases.
Note that the elasticity of production is less than one.
3. Stage three
Stage three begins at the point where marginal product (MP) is zero and total product (TP) is at its
maximum.
Marginal product (MP) is negative throughout this stage.
Stage three occurs when excessive quantities of the variable input are combined with a bundle of
fixed inputs, so much that total product (TP) begins to decrease.
ELASTICITIES OF PRODUCTION
It is defined as the percentage change in output resulted from the percentage change in input.
EP = MPP/APP
Formulas
TVP = Py ×TPP or PY ×Y
AVP =PY ×APP
VMP = PY ×MPP
COSTS
Refers to the expenses incurred in organizing and carrying out the production process.
Explicit costs are the actual out-of-pocket expenditures of the firms to purchase or hire the inputs it
requires in production processes.
Implicit costs are the value of the inputs owned and used by the firm in its own production processes.
Specifically, implicit costs include the salary that the entrepreneur could earn from working for someone
else in a similar capacity (Say, as the manager of another firm) and other inputs to other firms.
SHORT-RUN TOTAL AND PER UNIT COST FUNCTIONS
In the short-run, total costs include fixed and variable costs whereas in the long-run all costs are variable
because all inputs are variable.
TC = TFC (Total fixed costs) + TVC (Total variable Costs)
Total fixed cost = constant costs derived from fixed inputs
Total variable costs = vary with the level of inputs used, derived from the variable inputs (It is calculated by
multiplying price of variable inputs by inputs:
)
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THE THREE COST CURVES
AVERAGE COSTS
There are three types of average costs namely;
1. Average fixed costs (AFC)
2. Average variable costs (AVC)
3. Average total costs (ATC)
AVERAGE FIXED COSTS
Unlike total fixed cost, average fixed costs depend on the level of output. It can be calculated by dividing
total fixed costs by the amount of output.
AVERAGE VARIABLE COSTS
It can be calculated by dividing total variable costs by the amount of output.
AVERAGE TOTAL COSTS
It can be calculated in two ways namely,
OR
Marginal Cost (MC)
Marginal Cost (MC) is defined as an increase in total cost (TC) when one additional unit of output (Q) is
produced. It is calculated by dividing the change in the total costs by the change in amount of output.
OR
Marginal and Average cost curves
IMPORTANT POINTS IN SMOOTHED CURVE
AFC is L-shaped indicating that TP increases from zero, AFC start at higher value and keep on declining
until TP reaches its maximum.
AVC, AC, MC are U-shaped indicating that TP increases from zero, they start at higher values, decline at
decreasing rates, reach minimum points and then increase at increasing rates.
MC equals AVC and AC at their respective minimum points.
PRODUCTION IN THE LONG-RUN
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In the long-run, a firm has to take decisions about the scale of its operations, the location of its operation
and the techniques of production it will use since all inputs are variable. Therefore, in the long-run TC =
TVC.
The decisions are based on the following analysis


Returns to size
Returns to scale
RETURNS TO SIZE describe what will happened to the costs of production as the firm expand the output.
Two categories of returns to size are:
Economies of size – refers to the situation where a firm expands the outputs, the costs per unit of output
decrease.
Diseconomies of size - refers to the situation where firm expands the outputs, the costs per unit of output
increases
RETURNS TO SCALE describe what will happen to the output as the input per unit of output increases.
Three categories of returns to scale
Increasing returns to scale - occurs when a given percentage increase in inputs lead to a larger
percentage increase in output.
Decreasing returns to scale - occurs when a given percentage increase in inputs lead to a lower
percentage increase in output.
Constant returns to scale - occurs when a given percentage increase in inputs lead to the same
percentage increase in output.
CHAPTER 9: Market structure Overview
Market structures: an overview
Four different market structures




Perfect competition
Monopolistic competition
Oligopoly
Monopoly
It refers to the competitive environment in which the buyers and sellers of the product operate.
Figure 9-1: Market structures (Textbook page 186)
Key features of a market structure:
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Table 9-1: Summary of market structures (Textbook page 187)
The equilibrium conditions (for any firm)
Two decisions:
1.
2.


Should we produce?
If yes, how much?
The shut-down rule – produce only if total revenue is equal to, or greater than, total variable cost
The profit-maximising rule – profit is maximised where marginal revenue is equal to marginal cost
If MR > MC, output should be expanded since it will add more to total revenue than it does on total cost.
If MR = MC, global point of profits maximization
If MR < MC, output should be reduced since it will add more to total costs than it add to total revenue
Perfect competition
Perfect competition occurs when none of the individual market participants can influence the price of the
product
The demand for the product of the firm


The firm is a price taker
The demand curve for the product of the firm is horizontal (perfectly elastic)
Different possible short-run equilibrium positions of the firm under perfect competition



Economic profit: MR>MC
Break-even/Normal profit: MR=MC
Economic loss: MR<MC
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Figure 9-4: Different possible short-run equilibrium positions of the firm under perfect competition (Textbook
page 199)
Long-run equilibrium of the firm and the industry under perfect competition
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The industry will be in equilibrium in the long run only if all the firms are making normal profits
Figure 9-6: The firm and industry in equilibrium (Textbook page 203)
If firms are making an economic profit – new firms enter the market
Figure 9-7: The individual firm and the industry when the firm initially earns an economic profit (Textbook
page 203)
If firms are making an economic loss – existing firms exit the market
Figure 9-8: The individual firm and the industry when the firm initially makes an economic loss (Textbook
page 204)
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Monopoly




It is the form of market organization in which a single firm sells a product for which there are no
close substitutes.
Government Regulation of a Monopolist firm
There is always a chance that a monopolist will exploit consumers (although this does not
necessarily always happen).
Authorities worldwide monitor the situation well and if a monopolist abuses his power (market
power), the government may decide to intervene and take action against him.
There are three objectives of government intervention namely;
1. To decrease the price of the product for the consumer
2. To increase the quantity of the product monopolist produces
3. To reduce the economic profits made by monopolist
THREE TAX METHODS USE BY GOVERNMENT TO REDUCE MONOPOLY’S PROFITS
1. Per-unit tax- where by monopoly must pay a tax for each unit sold.
2. Lump-sum tax-where by monopoly must pay lump-sum regardless of its revenue or size. It
regarded as a fixed costs.
3. Profit tax- where by monopoly must pay certain percentage of profit.
It is understandable that both lump-sum and profit tax are more preferred to the unit tax because they
reduce the monopoly’s profit.
MONOPOLISTIC COMPETITION





It is defined as the form of market organization in which there are many sellers of a heterogeneous
or differentiated product and entry into and exit from the industry are rather easy in the long-run.
Differential products are those that are similar but not identical and satisfy the same basic need.
There are few barriers to entry and exit. Producers have a degree of control over price.
Because the products in monopolistic competition are differentiated this makes it possible for a firm
in kind of market to use marketing campaigns and further product variation not only to cause the
demand for its products to increase but also to make it less price-elastic.
The product of monopolistic competition are differentiated in two ways namely;
1. Real differences
2. Imaginary differences
Monopolistic competitor has to keep the following three variables continually in mind-in his attempt
to maximise profit:
1. The price of the product
2. The nature of product
3. Sales promotion
Monopolistic competition differs with perfect competition in three ways namely;
1. PRICE
2. Excess capacity
3. Product variation
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OLIGOPOLY



It is the case where there are few sellers of a homogeneous or differentiated product. Although
entry into the industry is possible, it is not easy (as evidenced by the small number of firms in the
industry).
Obstacles to entry in the market.
High expenses of advertising and promotion.
There are four models of oligopoly namely:
1.
2.
3.
4.
The cournot model- highlighting interdependency
The kinked demand curve model- in an attempt to explain price rigidity
Cartel arrangements- for justifying collusion
The price leadership model- One way of making necessary adjustments in oligopolistic
markets without fear of starting a price war and without overt collusion
REFERENCES
Mohr, P. and R. Seymore. 2012. Understanding Microeconomics, first edition. Published by Van Schaik
publishers in South Africa.
Mohr, P., Fourie, L. and Associates.2004. Economics for South African Students, 3rd edition, published by
Van Schaik publishers.
Mohr, P. 2012. Understanding the economy, third edition. Published by Van Schaik publishers in South
Africa.
Orley, M., and Amos, J.R.1994. Microeconomics: Concepts, analysis and application to modern economics,
3rd edition
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