PRINCIPLES OF ECONOMICS

 

 

 ACCOUNTING TECHNICIANS DIPLOMA

 

(ATD)

 

LEVEL 3

 

 

STUDY NOTES

 

GENERAL OBJECTIVES

 KASNEB SAMPLE NOTES

This paper is intended to equip the candidate with knowledge, skills and attitudes that will enable him/her to apply the fundamental principles of economics in decision making

9.0  LEARNING OUTCOMES

 A candidate who passes this paper should be able to:

• Apply basic mathematical and graphical techniques to analyse economic relationships and interpret the results
• Apply the knowledge of economics in decision making
• Analyse economic problems and suggest possible policy related recommendations
• Apply knowledge of economics in international trade and finance
• Apply economic principles in the development and implementation of policies in agriculture and industry
• Demonstrate an understanding of emerging economic

CONTENT

9.1 Microeconomics

9.1.1 Introduction to economics

• Definition of economics
• Micro and macro economics
• The methodology of economics and its basic concepts
• Economic descriptions and analysis
• Scarcity, choice, opportunity cost and production possibility frontiers and curves
• Economic systems: free economy, planned economy and mixed economy
• Specialisation and exchange

9.1.2  Demand, supply and determination of equilibrium

9.1.2.1 Demand analysis

• Definition
• Individual demand versus market demand
• Factors influencing demand
• Exceptional demand curves
• Types of demand
• Movement along and shifts of demand curves
• Elasticity of demand
• Types of elasticity: price, income and cross elasticity
• Measurement of elasticity; point and arc elasticity
• Factors influencing elasticity of demand

9.1.2.2 Supply analysis

• Definition
• Individual versus market supply
• Factors influencing supply
• Movements along and shifts of supply curves
• Definition of elasticity of supply
• Price elasticity of supply
• Factors influencing elasticity of supply

9.1.2.3 Determination of equilibrium

• Interaction of supply and demand, equilibrium price and quantity
• Mathematical approach to equilibrium analysis
• Stable versus unstable equilibrium
• Effects of shifts in demand and supply on market equilibrium
• Price controls

9.1.3 The theory of consumer behaviour

• Approaches to the theory of the consumer- cardinal versus ordinal approach
• Utility analysis, marginal utility (MU), law of diminishing marginal utility (DMU)
• Limitations of cardinal approach
• Indifference curve analysis
• Budget line
• Consumer equilibrium; effects of changes in prices and incomes on consumer equilibrium
• Derivation of a demand curve
• Applications of indifference curve analysis: substitution effect and income effect for a normal good, inferior good and a giffen good; derivation of the Engels curve
• Consumer surplus

9.1.4 The theory of a firm

9.1.4.1 The theory of production

• Factors of production
• Mobility of factors of production
• Production function analysis
• Short run analysis
• Total product, average and marginal products
• Stages in production and the law of variable proportions/ the law of diminishing returns
• Long run analysis
• Isoquant and isocost lines
• The concept of producer equilibrium and firm’s expansion curve
• Law of returns to scale
• Demand and supply of factors of production
• Wage determination theories
• Trade unions: functions and challenges
• Producer surplus/economic rent

9.1.4.2 The theory of costs

• Short run costs analysis and size of the firm’s total cost, fixed cost, average cost, variable costs and marginal cost
• Long run costs analysis
• Optimal size of a firm
• Economies and diseconomies of scale

9.1.5  Market structures

• Definition of a market
• Necessary and sufficient conditions for profit maximisation
• Mathematical approach to profit maximisation
• Output, prices and efficiency of: perfect competition, monopoly, monopolistic competition, oligopolistic competition

9.2 Macroeconomics

9.2.1 National income

• Definition of national income
• Circular flow of income
• Approaches to measuring national income
• Concepts of national income: gross domestic product (GDP), gross national product (GNP) and net national product (NNP), net national income (NNI) at market price and factor cost, disposable income
• Problems of measurement; uses of national income statistics and their limitations
• Analysis of consumption, saving and investment and their interaction in a simple economic model
• Determination of equilibrium national income
• Inflationary and deflationary gaps
• The multiplier and accelerator concepts
• Business cycles/cyclical fluctuations

9.2.2 Economic growth, economic development and economic planning

• The differences between economic growth and economic development
• Actual and potential growth
• The benefits and costs of economic growth
• Determinants of economic development
• Common characteristics of developing countries
• Role of agriculture and industry in economic development
• Obstacles to economic development
• The need for development planning
• Short term; medium term and long term planning tools
• Limitation of planning in developing countries

9.2.3    Money and banking

9.2.3.1 Money

• The nature and functions of money
• Demand and supply of money
• Theories of demand for money: The quantity theory, the Keynesian liquidity preference theory

9.2.3.2  The banking system

• Definition of commercial banks
• The role of commercial banks and non-banking financial institutions in the economy
• Credit creation
• Definition of central bank
• The role of the central bank; traditional and changing role in a liberalised economy, such as financial sector reform, exchange rate reform
• Monetary policy, definition, objectives, instruments and limitations
• Determination of interest rates and their effects on the level of investment, output, inflation and employment
• Harmonisation of fiscal and monetary policies
• Simple IS -LM Model
• Partial equilibrium and general equilibrium

  9.2.4 Emerging issues and trends

 

Table of contents                                                                                                       page number

Microeconomics

1. Introduction to economics………………………………………………………………….. 7
2. Demand, supply and determination of equilibrium………………………………. 22
3. The theory of consumer behaviour…………………………………………………….. 60
4. The theory of a firm………………………………………………………………………….. 80
5. Market structures……………………………………………………………………………. 115

Macroeconomics

6. National income…………………………………………………………………………….. 136
7. Economic growth, economic development and economic planning…….. 170
8. Money and banking………………………………………………………………………. 194

 

9 Emerging issues and trends…………………………………………………………………….

 

MICROECONOMICS

 KASNEB SAMPLE NOTES

 

CHAPTER 1 INTRODUCTION TO ECONOMICS

 

DEFINITION OF ECONOMICS

The modern word “Economics” has its origin in the Greek word “Oikonomos” meaning a steward. The two parts of this word “Oikos”, a house and “nomos”, a manager sum up what economics is all about. How do we manage our house, what account of stewardship can we render to our families, to the nation, to all our descendants?

There is an economic aspect to almost any topic we care to mention – education, employment, housing, transport, defence etc. Economics is a comprehensive theory of how the society works. But as such, it is difficult to define. The great classical economist Alfred Marshal defined economics as the “Study of man in the ordinary business of life“.

This, however, is rather too vague a definition. This is because any definition should take account of the guiding idea in economics which is scarcity. The great American economist Paul Samuelson thus defined it as: “The study of how people and society choose to employ scarce resources that could have alternative uses in order to produce various commodities and to distribute them for consumption, now or in future amongst various persons and groups in society. Virtually everything is scarce; not just diamonds and oil but also bread and water. The word scarcity as used in economics means that; All resources are scarce in the sense that there are not enough to fill everyone’s wants to the point of satiety.

 KASNEB SAMPLE NOTES

CHAPTER 2

DEMAND, SUPPLY AND DETERMINATION OF EQUILIBRIUM

 

DEMAND ANALYSIS

Introduction

In any economy there are millions of individuals and institutions and to reduce things to a manageable proportion they are consolidated into three important groups; namely

• Households
• Firms
• Central Authorities

These are the dramatis personae of the economic theory and the stage on which much of their play is acted is called the MARKET (see lesson three for definition of market).

Household

This refers to all the people who live under one roof and who make or are subject to others making for them, joint financial decisions. The household decisions are assumed to be consistent, aimed at maximizing utility and they are the principal owners of the factors of production. In return for the factors or services of production supplied, they get or receive their income e.g.

• Labour – wages and salaries
• Capital – interest
• Land – rent
• Enterprise – profit

 KASNEB SAMPLE NOTES

CHAPTER 3

THEORY OF THE CONSUMER BEHAVIOUR

 

 APPROACHES TO THE THEORY OF THE CONSUMER CARDINAL VERSUS ORDINAL APPROACH

Through the study of theory of consumer behaviour we can be able to explain why consumers buy more at a lower price than at a higher price or put differently why individuals or households spend their money as they do. We shall assume that the consumer is rational and aims at maximising his satisfaction, so given his income he consumes that basket of goods and services which produces maximum satisfaction. Two major theories explain the behaviour of the consumer, neither presents a totally complete picture. The first approach is the marginal utility, or cardinalist approach. The second approach centres on the indifference curve analysis or the ordinalist approach.

CARDINAL UTILITY APPROACH

The downward sloping nature of the demand curve can be explained by using the law of diminishing marginal utility. For instance, consider a consumer who ahs to choose between two goods, X and Y, which have prices Px and Py respectively. Assume that the individual is rational and so wishes to maximise total utility subject to the size of the income.

The consumer will be maximising total utility when his or her income has been allocated in such way that utility to be derived from the consumption of one extra shillings worth of X is equal to the utility to be derived from the consumption of one extra shillings worth of Y. In other words, when the marginal utility per shilling of X is equal to the marginal utility per shilling of Y. Only when this is true will it not be possible to increase total utility by switching expenditure from one good to another. This condition for consumer equilibrium can be written as follows:

 KASNEB SAMPLE NOTES

CHAPTER 4

 

THE THEORY OF PRODUCTION

 

 FACTORS OF PRODUCTION

The sum total of the economic resources which we have in order to provide for our economic wants are termed as factors of production. Traditionally economists have classified these under four headings. They are:

• Labour
• Land
• Capital
• Enterprise

The first two are termed primary factors since they are not the result of the economic process; they are, so to speak, what we have to start with. The secondary factors, however are a consequences of an economic system.

 KASNEB SAMPLE NOTES

CHAPTER 5

MARKET STRUCTURES

 

DEFINITION OF A MARKET

A Market may be defined as an area over which buyers and sellers meet to negotiate the exchange of a well-defined commodity. Markets may also mean the extent of the sale for a commodity as in the phrase, “there is a wide market for this or that commodity”. In a monetary economy, market means the business of buying and selling of goods and services of some kind.

Concepts to know:

1. Average Revenue (AR): This is the revenue per unit of the commodity sold. It is obtained by dividing Total Revenue by total quantity sold. For a firm in a perfectly competitive market, the AR is the same as price. Therefore, if price is denoted by P, then we can say:

P = AR

 KASNEB SAMPLE NOTES

MACROECONOMICS

CHAPTER 6

NATIONAL INCOME

 

 DEFINITION OF NATIONAL INCOME

National Income is a measure of the money value of goods and services becoming available to a nation from economic activities. It can also be defined as the total money value of all final goods and services produced by the nationals of a country during some specific period of time – usually a year – and to the total of all incomes earned over the same period of time by the nationals.

THE CIRCULAR FLOW OF INCOME AND EXPENDITURE

This is an economic model illustrating the flow of payments and receipts between domestic firms and domestic households. The households supply factor services to the firms. In return, they get factor incomes. With factor incomes, they buy goods and services from the firms. These flows can be illustrated diagrammatically as follows:

 KASNEB SAMPLE NOTES

CHAPTER 7

 

ECONOMIC GROWTH, ECONOMIC DEVELOPMENT AND ECONOMIC PLANNING

 

THE DIFFERENCE BETWEEN ECONOMIC GROWTH AND ECONOMIC DEVELOPMENT

Economic Growth is a narrower concept than economic development .It is an increase in a country’s real level of national output which can be caused by an increase in the quality of resources (by education etc.), increase in the quantity of resources & improvements in technology or in another way an increase in the value of goods and services produced by every sector of the economy. Economic Growth can be measured by an increase in a country’s GDP (gross domestic product).

Economic development is a normative concept i.e. it applies in the context of people’s sense of morality (right and wrong, good and bad). The definition of economic development given by Michael Todaro is an increase in living standards, improvement in self-esteem needs and freedom from oppression as well as a greater choice. The most accurate method of measuring development is the Human Development Index which takes into account the literacy rates & life expectancy which affects productivity and could lead to Economic Growth. It also leads to the creation of more opportunities in the sectors of education, healthcare, employment and the conservation of the environment.It implies an increase in the per capita income of every citizen.

Economic Growth does not take into account the size of the informal economy. The informal economy is also known as the black economy which is unrecorded economic activity.

Development alleviates people from low standards of living into proper employment with suitable shelter. Economic Growth does not take into account the depletion of natural resources which might lead to pollution, congestion & disease. Development however is concerned with sustainability which means meeting the needs of the present without compromising future needs. These environmental effects are becoming more of a problem for Governments now that the pressure has increased on them due to Global warming.

Economic growth is a necessary but not sufficient condition of economic development.

 KASNEB SAMPLE NOTES

CHAPTER 8

MONEY AND BANKING

MONEY

THE NATURE AND FUNCTIONS OF MONEY

The development of money was necessitated by specialization and exchange. Money was needed to overcome the shortcomings and frustrations of the barter system which is system where goods and services are exchanged for other goods and services.

Disadvantages of Barter Trade

• It is impossible to barter unless A has what B wants, and A wants what B has. This is called double coincidence of wants and is difficult to fulfill in
• Even when each party wants what the other has, it does not follow they can agree on a fair exchange. A good deal of time can be wasted sorting out equations of
• The indivisibility of large items is another problem. For instance if a cow is worth two sacks of wheat, what is one sack of wheat worth? Once again we may need to carry over part of the transaction to a later period of
• It is possible to confuse the use value and exchange value of goods and services in a barter economy. Such a confusion precludes a rational allocation of resources and promotion of economic
• When exchange takes place over time in an economy, it is necessary to store goods for future exchange. If such goods are perishable by nature, then the system will break
• The development of industrial economies usually depends on a division of labour, specialization and allocation of resources on the basis of choices and

Economic efficiency is achieved by economizing on the use of the most scarce resources. Without a common medium of exchange and a common unit of account which is acceptable to both consumers and producers, it is very difficult to achieve an efficient allocation of resources to satisfy consumer preferences.

For these reasons the barter system is discarded by societies which develop beyond autarky to more specialized methods of production. For such peoples a money system is essential.

Money may be defined as anything generally acceptable in the settlement of debts.

 

 KASNEB SAMPLE NOTES