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ECON 100: INTRODUCTORY ECONOMICS
TOPIC 1 INTRODUCTION
Economics - comes from the Greek word Oikonomia – which means the management of the household
...
It is a social science whose main objective is to study or
integrate the produce distribution and consumption of goods and services
...

Economic analysis is applicable to all society in business, finance and government
...
Microeconomics is mainly concerned in examining the economic behaviour between individual
economic agents (individual, households and firms)
b)
...
e
...

From a historical perspective, economics is built to consist of three schools of thoughts
 Classical economics
 Neo-classical economics
 Keynesian economics
Classical Economics
The classical era started in the public “Wealth of Nations” by Adam Smith in 1776
...
He described the market mechanism as
“The invisible Hand” meaning that he saw the ideal economic needs of a people within an economy
...
Other notable classical economists were Thomas Mathius (theory of population
and food produce) and David Ricardo (theory of comparative advantages)
...
The neo – classical economists coined the term economics previously what
is known as economics went by names, such as economic science and political economy
...

In microeconomics, neo-classical economists represented incentives and costs as playing a fundamental
role in strapping decision making
...

In macro economics, its reflected in the synthesis of Keynesian economics (consumer theory of demand –
for the market to clear, quantity demanded = quantity supplied)
...
In his book “the general theory of employment,
interest and money”, Keynes focused on the determinants of national income in the short term when
prices are relatively inflexible
...

POSITIVE ECONOMICS
Positive economics is an approach to economics that attempts to understand economics behaviour and the
operation of economic system without ascribing value judgment to the same
...

Example:
 Do MPs pay taxes?
 What determines the wage rate for unskilled workers?
 What would happen if income tax was abolished
i
...
it asks the question “what is”
NORMATIVE ECONOMICS
By contrast, normative economics looks at the outcomes of economic behaviour asks whether the
outcomes are good or bad and whether they can be bettered i
...
it asks the “what ought to be” question
...

Example:
 Should government subsidize or regulate the cost of higher education?
 Should medical benefits for the elderly only be available to those in incomes below a certain
threshold?
 Should MPs pay taxes?
Most normative questions involve positive questions e
...
whether MPs should pay taxes, positivistie
question as to the benefits and costs of undertaking such decisions must first be determined
...

In any economic system scarce resources leads to trade – offs between 2 or more competing resources
uses
...

The concepts of constrained choice and scarcity are central to the disciplines of economics
...

Opportunity cost - means the next best alternative foregone
...
The chosen to study implies time given up for leisure activities
...

Example 3: in the national budget, the opportunity cost for shillings allocated for defense is the next best
alternative use of the same shillings which could have been allocated to build more schools or construct
more dams in the ASALs
...

Consider a hypothetical two commodity economy producing clothes and butter
...

Point E: implies that the economy is using all its resources, to produce only butter
Point C and D: the economy is using its resources to produce different combination of clothes and butter
Point B: more clothes than butter are being produced while at d more butter than clothes are produced
...
g
...
These points represent either unemployment
of resources or production inefficiently
...

Production efficiency is a step in which a given mix of output produced at least cost i
...
resources aren’t
wasted or lying idle
...
An economy producing goods and services can choose only one point on the curve because an
economy’s choice are constrained by available resources and the existing technology, it can only for
example produce more clothes at the expense of reducing production of butter i
...
the opportunity cost of
the additional produce of clothes is the foregone production of butter
...
The
positive slope of the PPF illustrate the concept of scarcity of resources i
...
in moving from point E to F on
the PPF about production of capital goods increases from 550 to 800 units
...

It can therefore be concluded that the increase in capital good is only achieved by shifting resources out of
the produce of consumer goods
...

The slope of the PPF denotes the ratio of change in capital to the change in consumer goods
...

Apart from opportunity cost, other concepts that can be illustrated by PPF include:
 Economic growth represented b an outward shift of the PPF
 Comparative advantage
 Unemployment
 Inefficiency (production)


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ECON 100: INTRODUCTORY ECONOMICS
ELEMENTS OF ECONOMIC ACTIVITIES
Market – a market is an institution or arena where goods and services are exchanged
...

1) Product/Output market – goods and services that are intended for use by household are
exchanged in this market, firms supply and households demand
...
These resources are
supplied by households
...

In the circular flow diagram, the flow of economic activity is reflected by the direction through
which goods and services flow
...
In
addition, labour service flow from households to firms through input markets
...

2) Input market – households’ supply resources e
...
labour to firms that dd the same in turns, firms
pay workers for their time and skills
...

In the capital market, households supply the funds that firms use to buy capital goods
...


TOPIC 2 DEMAND THEORY
A theory in the scientific sense of the word is an analytical structure or framework designed to explain a
set of empirical observations
...

2) Making assertions about the underlying reality that brings about or influences class of
phenomena
...

Economic theory typically proceeds with an assumption of ceteris paribus i
...
holding other variables
constant
...

b) A theory That’s more precise in prediction
c) A theory that more fruitful in generating additional research than prior theories
Economic theory attempts to generalize about data and interpret the same
...

One of the main economic theories is the theory of demand
...
e
...
Conversely, a fall in the price of the same will result, ceteris paribus
...
Thus, for a normal good, there exists an inverse relationship between its own
price and the quantity demanded
...


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ECON 100: INTRODUCTORY ECONOMICS
A demand schedule is a table that shows the quantities of a product that an individual, household or firm,
is willing and able to purchase at different prices
...


Price
P1

Contraction demand

P2

Expansion demand

P3

Q1

Q2

Q3

Quantity dd
Terminologies
Price – is the coordinating mechanism in a free market system (a market system in which government
involvement in the market is minimal) Price is the amount that a product, goods or services sells off per
unit
...

Demand – as an economic concept, demand is the desire or want of a consumer to acquire a good or
service provided he/she is willing and able to pay for the same
...

Determinants of Demand
1
...
Conversely, a decrease in the price of the same leads to an increase in the
quantity demanded
...
Income
There is positive correlation between the level of income of a consumer and the level of demand he/she is
able to command
...
Accumulated Wealth
A consumer is anyone who has he ability to utilize a good or service
...

Ceteris paribus – the higher the level of accumulated wealth, the more the quantity of goods and services
a consumer is able to demand
...
Price of related Goods
Substitute goods – when an increase in the price of one good causes the demand for other goods to
increase, the two goods are referred to as substitutes
...
g
...
hostel cooking
...
Examples of such goods include bread and
butter, coffee and sugar, cars and petrol, mobile phones and airtime
...
Taste and Preferences
The shift in preference for healthy living over the lat few years has resulted in decrease in demand for
tobacco products
...

6
...
In deciding what kind of a house to buy, they presumably must
consider their present and future income
...

Demand curves illustrate the inverse relationship between the price of a good or service and the quantity
demanded in a given time period, ceteris paribus
...


Price

b

P2

a

P1

Page 7 of 38

Q2

Q1

Qd

ECON 100: INTRODUCTORY ECONOMICS

An increase in price from P1 to P2 moves the level of demand from point a
...
at the same time the
quantity decreases from Q1 to Q2
...
This is referred to as
change in demand
...
e
...


Price

Do

D1
Normal Goods

D1
Do
The demand curve shifts from DoDo to D1D1 reflecting the increase inQuantity
demand brought about by an
increase in income for a normal good
...


Price

Do
D1

Do
D1
Elasticity
Quantity
Elasticity is defined as the ratio of the percentage change in one variable to the percentage change of
another variable
...

Elasticity is a popular tool among empiricists because it is independent of units and thus simplifies data
analysis
...


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ECON 100: INTRODUCTORY ECONOMICS
Necessities are more insensitive to price changes because consumers continue purchasing these products
despite increase in price
...
Such a good
is said to be elastic
...

Price elasticity of demand
Simply defined, it’s the ratio of percentage change in quantity demanded to the percentage in price
...

where,
=Price elasticity of demand
P= own price of a good or service
Ln=natural logarithm Qd= quantity demanded
Perfect inelasticity
When the quantity demanded of a good a service doesn’t respond at all to a change in price, the
percentage change in quantity demanded is zero
...


Price

The Quantity demanded is the same even
after price changes from P1 – P2

=

P2

P1
ξρ=

Qod


...
=0

Quantity demanded

Perfect elasticity (infinite elasticity)
With perfect elasticity a small increase in price causes quantity demanded to drop immediately to zero
...


Price

Slope, ∆P =

0

∆Q Q1 - Q2
Po
Page 9 of 38

ξρ = dQ X P
dP Q
= Q1 - Q2 = 
0

ECON 100: INTRODUCTORY ECONOMICS

Unitary Elasticity
It is a demand relationship in which the percentage change in quantity demanded equals the percentage
change in price in absolute value
...

NB: For a good to be inelastic, it must lie within, it’s a necessity
E
...
ξρ = %∆Qd = 3% = 0
...
e
...

E
...
ξρ = %∆Qd = 8% = 1
...
e
...
Availability of Close Substitute
There’s a positive relationship between the number of close substitute a product has and the magnitude of
its elasticity, i
...
the higher the number of close substitutes, the higher its elasticity
...
Conversely, agricultural products tend to have
higher elasticity due to then having many close substitutes
...
Necessity
There is an inverse relationship between a products necessity and its elasticity i
...
, the more necessary a
good or service the low its elasticity as people will tend to purchase it no matter the price
...
The Duration/ Time Horizon
The larger the price increase of a commodity the higher its elasticity as more and more consumers would
tend to decrease the demand of the commodity, for example, if you set out to buy a particular brand of say
flour and you realize that the price has increased, you may purchase it because of need but at the next
time of purchase you may not buy it unless the price reduces
...
Proportion of purchase
Purchase which constitute a very small portion of total expenditure tend to be more inelastic because
consumers in most cases are not concerned about the extra expenditure e
...
salt
Other Elasticities of Demand
a) Income elasticity of demand
It measures the responsiveness of demand to change in income
ξ y = % change in dd

Page 10 of 38

ECON 100: INTRODUCTORY ECONOMICS
% change in income
b) Cross-price elasticity of demand
It measures the responsiveness of quantity demanded of one good (good x) to a change in priceof another
related good (good y)
...
A positive cross price elasticity (CPe) indicates
that an increase in the price of good x, cause the demand of good y to increase, implying that the two
goods are substitutes
...

↑Px ↑Qdy => substitutes
↑Px ↓Qdy => complimentary
SUPPLY
Quantity Supplied
This is the amount of goods or services that a firm would be willing and able to offer for sale at a
particular price in a given time period
...
e
...

↓Qs ceteris paribus
Supply Schedule
A supply schedule is a table showing how much of a good or service a firm may sell at different prices
...


Price
P2

P1

Q1

Page 11 of 38

Q2

Quantity supplied

ECON 100: INTRODUCTORY ECONOMICS
Determinants of Supply
1
...
Thus the supply decision of a firm
change in response to changes in the cost of production
...
The price and quantities of input by the firm
b
...
Price of related products
If for example, there is a rise in price of beef, its to be expected that farmers will raise more cattle
...
It therefore follows that an increase in cattle supply will increase
the supply of cowhides, hence leather
...
e
...


S

Price

NB: price is the only determinant of
movement along supply curve and

P2

demand curve

P1

S
Q1
Q2
Shifts
Quantity supplied
As earlier discussed, supply decisions are also influenced by other factors other than price
...
These changes cause either inward or outward shift in the
supply curve
...

ξ S = %∆ in Qs
%∆ in price
In output market the elasticity of supply is likely to be a positive number i
...
a high price leads to an
increase in quantity supplied and vice versa, ceteris paribus
...
An increase in wages makes workers better off them, can
work for the same amount of his and have higher income
...
The price of leisure will be the
wages lost
...

Price Determination
At any moment, 3 conditions prevail in every market:
1
...
Excess supply – this is where the quantity demanded is less than the quantity supplied at the
current market prices
...
Equilibrium – this is where the quantity equals quantity supplied at the current market prices
...

Equilibrium is the point at which supply curve and demand curve intersect
...
e
...
It is the equilibrium point
...

It is also the quantity demanded
...
From the graph, it is evident that
Q2 is greater than Q1
...
As a result, suppliers of goods and services are disincentivised from
supplying the same at the current market price
...
where quantity demanded = quantity supplied
...
At
this point, quantity supplied is greater than quantity supplied at the current market price
...
The rise in price incentivizes suppliers to increase production of the
good or service in question subject to the firm constraints
...
Implicitly,
economists assume that anything purchased will be consumed, unless the purchase is for a productive
activity
...
Thus, given two goods, say X & Y, If good X is
worth five utils and good Y worth 10 utils, the consumer will be deemed to prefer Y over X
...
Postulates that utility
cannot be measured empirically, but rather, consumers’ preferences can be ranked
...

Marginal Utility – is the additional satisfaction gained by the consumption of one more unit of a good or
service
...

Consider the following hypothetical example showing the relationship between total and marginal utility
...
Dimples club in Nakuru plays Mugithi music 7 days a week
...


Trips to Dimples
1
2
3
4
5
6

TU
12
22
28
32
34
34

MU
12
10
6
4
2
0

According to the schedule above, Mwangi’s first visit to dimples he generates 12 utils
...
This can be seen by the
MU dropping from 12 to 10
...

In general, utility maximizing consumers spread out their expenditures until the following conditions
hold
...
This is known as the utility maximizing rule
...
e
...
Preferences are complete
Given two bundles of goods X1 and X2, a consumer is able to unambiguously make the following
preferences;

Page 15 of 38

ECON 100: INTRODUCTORY ECONOMICS
a
...
X2
X1
c
...


2
...

3
...
This law of transitivity also implies that if a consumer is indifferent
between X1 and X2, and at the same time is indifferent between X2 and X3, then logically, he must be
indifferent between X1 and X3
...
Preferences are Continuous
Given 3 bundles of goods X1, X2 and X3, if X1 is preferred to
X2, and X3 is infinitesimally close to X2,
then X1 must be preferred to X3
...
Principle of Non – satiation
In other word, more is preferred less given to bundles X1 and X2
...

6
...

Marginal Rate of Substitution
Is the rate at which a consumer is ready to give up one good in exchange for another good while
maintaining the same level of utility
...

Indifference Curves

Slope of H = marginal rate of substitution
Marginal Rate of Substitution MRSXY =
MRSYX =
Properties of IC curve
i
...
Higher IC curves are preferred to lower IC curves, since more is preferred to less
...

iii
...
This property highlights the concept of diminishing marginal utility
...
ICs don’t intersect as this imply a contradiction
v
...
Consumers who seek to maximize utility spread out their
expenditure until
Graphically, a consumer optimizes his utility at a point where his/her indifference curve is tangential to
budget line
...

Through point C falls below the consumers budget line utility is not maximized at this point
...

Bundles of X1 and X2purchased at point B and D are not attained as they exceed the consumer budget
...

Slope of budget line;

Cross multiplying, we get

Page 17 of 38

ECON 100: INTRODUCTORY ECONOMICS
TOPIC 4 THEORY OF THE FIRM
1
...

In economics a cost is defined as an alternative that us given up as a result of a decision
...
During this period a producer is only
able to vary one factor
...
These costs are divided into two: fixed costs
and variable cost (VC)
...
E
...
guards pay, managers’
salaries, e
...
c
...
Fixed costs and variable costs together make
up a firms total cost
...
TC rises as output increases
...
At any given level, the
TVC depends on;
Production tech available
Price of input required by each technology

Page 18 of 38

ECON 100: INTRODUCTORY ECONOMICS
The shape of a TVC curve reflects increasing marginal returns at small quantities and decreasing marginal
return at large quantities
...

Marginal cost reflects changes in variable cost
...

Derivation of Marginal Cost
Consider a firms production schedule given below:
Quantity
Total Variable Cost
0
0
1
12
2
20
3
27
4
33
5
36

Marginal Cost
12 (12 – 0)
8 (20 -12)
7 (27 - 20)
6 (33 - 27)
3 (36 - 33)

Cost
MC

Page 19 of 38

Quantity

ECON 100: INTRODUCTORY ECONOMICS
Mathematical Derivation of Marginal Cost
C = 1000 – 5Q + 10Q2 – 0
...
15Q2 (from differentiation)
DQ
The MC is also the slope of the total variable cost curve
...
15Q2
Differentiate to get slope: dVc = -5 + 20Q – 0
...
05Q3
FC
VC
:AFC = FC = 1000 = 1000Q-1
Q
Q
AVC = -5Q + 10Q2 – 0
...
05Q
ATC = TC = 1000 – 5Q + 10Q2 – 0
...
05Q2
Q

Page 20 of 38

ECON 100: INTRODUCTORY ECONOMICS
TOPIC 5 THE PRODUCTION THEORY
Definition:
Production: is the process through which inputs are transformed into outputs
...
It is also referred to as
the law of variable proportions
...

Production Function
This is a numerical or mathematical expression of the relationship between inputs and outputs
...
Most of the 3rd world countries use the
latter
...
Inmost production
processes, the readily variable factor is labour thus average product
...

Relationship between TP,MP, & AP
Labour
0
1
2
3
4
5
6

Total Product
0
10
25
35
40
42
42

Marginal Average
10
15
10
5
2
0

Mathematical derivation of Average Product, Marginal Product
Consider the production fixation y = f(x)
Where y = firm’s output
x = firms input
Thus MP (Slope )
= dy = f’(x)
dx
AP = TP = y = f(x)
Q x
x
Consider production y = 50 + 6
...
5x + 10x2 = 50 + 6
...
5 + 10x

Page 21 of 38

Average Product
10
12
...
7
10
...
4
7

ECON 100: INTRODUCTORY ECONOMICS
MP = dy = 6
...
Is
represented by the symbol ξp
...
Conversely, elasticity that is less than 1 imply that a
unit increase in the variable input results in a less than a unit increase in output
...

Stages of Production

Q

Stage II
0<p<1
Stage I
p>1

Q

Stage III
p<0

Maxima

L

Maxima

AP

L1

Page 22 of 38

L2

MP

L

ECON 100: INTRODUCTORY ECONOMICS
Stage 1
In stage 1, the MP curve increase, reaches a maxima, then starts decreasing till it interests the average
product curve at its maximum point
...

After the MPs maximum point, i
...
when the slope of the MP changes from positive to negative during
stage 1, the firm totals product is said to be increasing but at a decreasing rate
...
Elasticity of production is defined as
the ratio of the firm’s MP to its average product (AP) i
...

p = MP
AP
A stage 1, it is possible to the firm to increase the production
...
It is therefore possible
At this stage, it is possible for the firm to increase output by increasing the variable input, say labour,
firms operating at this stage are said to be operating below their capacity level i
...
they are underutilizing
their various factors of production at their disposal
...

In stage II, the elasticity of product lies between 0 and 1
...
These
limits are realized at the end of the end of stage II when the firm MP tends to 0
...
No resources are lying idle and unused at this
stage till it reaches zero
...

Stage III
At the end of stage II, the TP curve reaches its maxima point beyond this maximum implies that with each
successive increase in variable input, output is declining rather than increase and the firm’s Marginal
product is positive
...
e
...

Both the efficiency of variable input and that of fixed input decline throughout this stage
...
e
...

Isoquants are used to show the trade offs between capital and labour in the production function
...


K
(Capital
)

IS3 = q3 = 150
Page 23 of 38

IS2 = q2 = 100
IS1 = q1 = 50
L

ECON 100: INTRODUCTORY ECONOMICS
In the graph above, isoquant IS1 representing the combination of capital and labour that yield an output
of 5 units
...

As you move and further and further from the origin isoquants plotted represent combination of K and L
that yield higher and higher level of output
...
e
...
g
...

Isoquants never intersect
Isoquants are convex to the origin
...

MRTS – measures the are at which K is substituted for labour while holding output constant
...


K

Slope = ∆K = MPL
∆L MPK

ISOCOSTS
L
Are graphs that illustrate different combination of K and L that are available for a given total cost
...


K
Equation of isocost line is given by:
PK
...
L = TC
Where PK is the price of the capital
PL is the price of the labour (wage rate)

PL
PK

TC3
TC2
TC1
Page 24 of 38
L

ECON 100: INTRODUCTORY ECONOMICS
TOPIC 6 MARKET STRUCTURES
Definition:
These are the interconnected characteristics of a market
...

Types of market structures
1
...

2
...

3
...
the seller exercises considerable control over the supply of goods and services and its
price e
...
KPLC
4
...
The main difference being that
while in perfect competition, the firm sell homogeneous, in a monopolistic competition the goods or
services sold are differentiated e
...
restaurant business
...
PERFECT COMPETITION
Perfectly competitive markets are characterized by the following attributes:
i
...

ii
...
They offer to sell their
good/service at the given market price
...
The market price is strictly determined by forces of supply and demand
...

There are no barriers of entry and exit from the market
...

Firms in perfect competition market sell homogeneous products such that no consumer preference
can be inferred between products sold by one firm from those sold by another
v
...
e
...

In reality, no market satisfies all the conditions of a perfectly competitive market
...
g
...
This is
because perfectly competitive market results in:
1
...
Efficient distribution of goods and services amongst households

Page 25 of 38

ECON 100: INTRODUCTORY ECONOMICS
3
...

P = MC
This is because when a firm weighs price and marginal cost, it weights the value of its products to society
against the value of a product that could otherwise be produced using the same resources if price is
greater than marginal cost, from value gained by producing less of the good
...
MONOPOLY COMPETITION
As opposed to perfect competition, all firms in an imperfectly competitive markets exercise market
power
...
A single firm that produces a good or service for which there are no close substitutes
ii
...

iii
...

These barriers of entry may be through:
i
...
g
...
g
...
Patents – a barrier to entry that grants exclusive use of the patented products or process to the
inventor
...

iii
...

iv
...
MONOPOLISTIC COMPETITION
This is a firm of market structure that has the following characteristics:
1
...
e
...
There are no barriers to entry
3
...
e
...
Product differentiation is in large part achieved through advertising
...
In addition as
opposed to monopoly, close substitution are available in a monopolistically competitive industry
...
Firms in all market structures maximize
profit at the point where the Marginal Revenue (MR) equals Marginal Costs (MC)
...
They are calculated by multiplying the price per unit with the quantity produced
...
Q

Page 26 of 38

ECON 100: INTRODUCTORY ECONOMICS
Average Revenue (AR) – are the total receipts divided by the number of unit of a good or service sold
...
For perfectly competition firms, prices are accepted as given i
...
“price takers”
...
On the firm depicted by the diagram
above profits are maximized by producing Q* quantity of goods or services at the market price P*
...
An economic profit – arises when total revenue exceeds the opportunity costs of input
...
Accounting profit – on the other hand is the difference between total revenue and total costs of a firm
i
...
accounting profit (π = TR – TC)
3
...

When economic profits are positive they are referred to as supernormal or abnormal profit and are
only observed in the short run
...


P, MR, MC
ATC

MC
Total π

A

P = MR
ATC

D
Firms make profit when Average total cost (ATC) curve is below the
marginal
revenue
Break
– even
pointcurve
...
This point is known as the break –
even point
...
In
other words, firms are just about able to cover their average total costs
...
In the long run as more and more firms enter the market, the market price is
pushed downwards
...
In other words in
the long run, there are no abnormal profits
...

Perfectly Competitive Firm Making Economic Losses

MC

P,MR,
ATC

ATC
LOSSES

P=MR=AR
AVC

Q

Q

When the firm’s average total cost curve lies above its marginal revenue curve at the profit maximizing
level of output the firm is said to be experiencing losses
...

In making this decision firms take into account their Average Variable Cost (AVC) curve rather than their
Average Total Cost (ATC) curve
...
This is
because when the firms AVC is less than MR, the firm is able to cover its Variable Cost in addition to a
portion of its fixed costs
...

The firms’ loss is indicated by the shaded area ABCD
...
This is a situation where
P = min ATC
When P = min ATC, its known as the break – even point
...
The converse
to inflation is the general decrease in the price level of goods and services in the economy is known as
deflation
...
There are mainly two types of inflation:
1
...
Cost push inflation
Demand pull inflation is caused by an increase in aggregate demand
...

In an open economy, aggregate demand is composed of the following;
 Consumption (C)
 Investment (I)
 Government Expenditure (G)
 Imports (M)
 Exports (X)
An increase in any of these components leads to a rise in inflation
Aggregated demand (AD) = C + I + G + X – M
Taking consumption for example,
C = c0 + c1Yd
Where c0 – autonomous consumption
Ci – marginal propensity to consumer
Yd – disposable income = Gross income minus Taxes
Cost – Push inflation occurs mainly as a result of increases in the firms cost of produce which in turn
occur due to increase in the cost of factor inputs (capital and labour)
...

AD/AS FRAMEWORK SHOWING DEMAND PULL INFLATION

P
P1

AS

A1

P1
P0

AD1
A
ADo

Y0
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Y1

Y

ECON 100: INTRODUCTORY ECONOMICS
The concept of demand pull and cost push inflation is best illustrated using AS/AD framework
...
As a result of this shift, the equilibrium price level increase from Po to P1
...
If the economy is operating on the steep portion of
the aggregated supply curve at the time of increase in aggregate demand; most of the inflationary effect
will be an increase in price level rather than an increase in output
...
In the long run, the curve increase in price level will cause the
aggregate supply curve to shift to the left
...
In the long run, the aggregate supply curve is vertical implying that increase in price results in
zero increase in output
...
An increase in costs results in a leftward shift of the
aggregate supply curve from ASo to AS1
...
A situation in which a fall in aggregate output is
experienced at the same time as can increase price level is known as stagflation
...
Redistribution of income and wealth within the economy
When a bank gives a loan it charges an interest rate based on projection of future inflation
...

2
...
If
almost all prices are rising rapidly there’s little incentive to search for cheaper substitute that would
help keep production costs low
...
Inflation Creates Uncertainty
If businessmen are unsure about the future level of prices and thus of interest rates, they’ll be less
willing to take risks and invest especially in long term projects
...

4
...
E
...
in the case of white farmers in Zimbabwe who relocated to other countries e
...
South
Africa
...
Inflationary uncertainty pushes up real interest rate as lenders demand a bigger risk premium on their
money
...

Full employment describes a situation in production and planned aggregate expenditure are initially at
equilibrium at AE1, Y1 and P1 (point A)
...
g
...
This will result in an increase in planned aggregate expenditure
...
At the same time the aggregate demand curve shifts from AD 1 to AD2
...


Page 32 of 38

ECON 100: INTRODUCTORY ECONOMICS
At AE2, production is at full employment if planned aggregate expenditure increases beyond YF, the curve
will shift to say AE
...

Normally the generic understanding of the term is with respect to one factor of production: labour
...
Fallow land, or land not directly used for productive activities is considered as
Unemployed land
...
For this unit, we will consider labour unemployment
...

Labour unemployment is measured by a tool known as the Unemployment Rate(UR), where,

Types of Unemployment
Open Involuntary Unemployment: Occurs when a person is willing and is qualified for full time
employment at the going market wage, and is not able to find work
...
e
...

Disguised(Hidden Unemployment) Occurs when labour is underutilized, such that the work available is
insufficient to keep it fully occupied
...
g Most civil services especially in Less Developed
Countries(LDCs) where, the number of people employed exceed the demamd for their services, leading to
a Marginal Product of labour of zero or negative
...
Results from an imbalalnce between the demand of a certain cadre of labour and the
supply of the same
...
g the advent of ICT, occur within an
economy, there is , ceteris paribus, less demand for jobs such as Secretaries, typists, etc
...

General unemployment: As opposed to structural unemployment, this is one which is widespread
throughout the economy, and is not confined to specific areas
...
g in
agricultural sectors
...

There notmally is a time lag between matching prospective employees with job opportunities for which
they are qualified for
...
Is essentially short term in
nature/
Cyclical (Demand-deficient unemployment) Associated with changes in an economy’s business cycle
...
The reverse is true during recession and depression phases
...

Causes of unemployment in Less Developed Countries(LDCs)
Lack of co-operating factors of production: Despite LDCs having abundant supplies of labour, they
more often than not lack other factors such as capital and land that go hand in hand with labour in the
production process
...


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ECON 100: INTRODUCTORY ECONOMICS
Distortion of relative factor prices: Caused by government policies aimed at fixing wages above the
going market prive, in addition to providing incentives aimed at making capital cheaper, e
...
t
...

Education systems: Education systems in LDCs, adopted from developed economies put an emphasis on
development of white collar jobs at the expense of other categories of jobs( e
...
blue collar jobs)
...

Seasonality in production: In Kenya for example, the sectors having the greatest contribution to GDP
are agriculture and tourism
...
In the case of
tourism, tourist may prefer to visit the country at certain times of the year, leading to increased demands
for labour
...

Limited product markets: Caused by low income inelasticity of demand for primary goods produced in
LDCs
...

This has the unfortunate implication that the possibility of expanding these industries, and corollarily
creating more job opportunities is limited
...

Consequences of unemployment
Waste of potentially productive human resources: When labour is unemployed, it implies that the
economy is not producing as much as it should, resulting in lower national income and welfare
...

Increase in social problems: e
...

Overcrowding in urban areas: Resulting from urban unemployment
...

Loss of human capital: When one is unemployed for an extended period of time, they gradually lose
skills acquired through formal and informal education
...

Increase in government social welfare programs: This constitutes a drain on resources that would
otherwise have been used for other, more productive development projects
...

Increase in job opportunities in the private sector: Mainly achieved through creating an enabling
environment for private sector development
...
Provision of incentives s for Microfinance
institutions(MFIs) that provide cheap loans to Small and Medium Enterprises will provide them
opportunities for growth and expansion and by so doing, aid in employment creation
...
Therefore, government policies should aim at lowering the relative factor price for labour so
as to create greater incentive for employment
...
Education expansion should for example balance the need for provision of
general education and the need for specific skills needed for the market
...
For example, regions heavily reliant on tourism may
consider introducing alternative such as labour intensive manufacturing industries
...
This may include value addition to primary products
...
Also, firms should seek new markets in cases where current markets are not expanding
substantially
...
Governments should
provide incentives for industries to relocate to rural areas, thereby increasing employment opportunities
and standards of living in the same
...

Encouraging the use of domestic resources: Should be encouraged as it tends to create employment
domestically
...

There are 3 methods of measuring national income:
i
...
Expenditure method
iii
...

Intermediate Goods – are goods produced by one firm for use in further processing by another firm
...

Gross domestic product can be thought of as a geographical concept in the sense that it considers the
market value of goods and services produced within a country or an economy regardless of whether the
producers are citizens of the country or not
...

Gross National Product (Gnp)
This is the total market value of all final goods and services produced within a given period by citizens
living within and outside the country
...

GNP = GDP + Net Income from Abroad (Export – imports)
The National Income
This is the total aggregate earnings by the factor of productions and which are earned from the current
production of goods and services within a given time period (usually one year)
...

NB: Net National Product (NNP) = GNP – depreciation
Approaches to National Income Account
1
...
All factors of
production have rewards
...
For land the reward is rent accrued from the land or
buildings
...
When using
this method, the aggregate of the returns to accord of production is added up
...
It also
excludes the income of persons who sell durable goods, not produced in the time period
...
g
...

2
...

Second hand items e
...
Mitumba are excluded in the calculation because they represent the transfer of
existing assets
...

c) Government expenditure
These are all the government payment for factor of production or services rendered to the government
...

d) Export expenditure
This is the expenditure occurring from the export of economic gods or services
...
Its normally deducted
from total final expenditure in order to arrive at the GDP (gross domestic product)
...
Double counting
The double account problem is experienced especially when adding up the intermediate goods or
services
...
g
...

2
...
g
...

3
...
This includes the
contribution by housewives in child rearing or their services around the home
...
It is a problem to determine the rate of depreciation when calculating national income
5
...

This has an effect on the final figures in GDP calculation
...
The GDP does not measure economic well being
...

7
...

FISCAL AND MONETARY POLICY
Fiscal Policy
Fiscal policy can be as the use of government spending and revenue collection to influence the productive
activities in the economy
...
e
...

The two main instruments of fiscal policy are:
 Government spending
 Taxation
Government expenditure is funded in the following ways:
i
...

Seignorage (printing money)
iii
...

Through consumption of fiscal reserves
v
...
A neutral fiscal policy implies a
balanced budget
...
This is achieved either
through increase in government spending, a fall in taxation revenue or a combination of the two
...

A contractionary fiscal policy occurs when net government spending is reduced either through higher
taxation revenue, reduced government spending or a combination of the two
...
Contractionary fiscal policy is usually associated in surplus

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