General
- UNIT 1 MARKET STRUCTURES File Uploaded 2/11/21, 16:15
Key unit Competency: Analyse the operation of firms under different market structures.
INTRODUCTORY ACTIVITY
Rwanda has many industries operating in different forms. Given the table below, analyze these industries in terms of their number, the nature of products they produce and the degree of advertisment, arrange your findings in a table to enable you categorize according to their similarities.
INDUSTRIES:
Air travel industry; Hotel industry; Banking industry; Water and sanitation services; Petroleum products industry; Newspaper industry; Hydro power industry; Telecommunication industry;
1.1. Introduction to market structure
ACTIVITY 1.1
Analyse the activities taking place in the pictures below. Identify the commodities being sold in there.
Do you notice any relationship between the markets in the pictures in terms of nature of commodities sold and the number of firms dealing in these commodities etc. Then identify the type of market structures in the picture shown below.
1.1.1. Meaning of market structures.
A market is any arrangement that brings buyers and sellers into close contact
to transact business with an aim of making profits. It may be a physical place,
communication through telephone, fax and mail. Different markets have
different characteristics, participants and conditions; thus markets differ in
many ways. The conditions that prevail in the market which determine how
the market players operate are what we call the market structures. Therefore,
market structure is a range of unique features or characteristics which
influence the behaviour, conduct and performance of firms which operate in a particular market.
1.1.2. Categories of market structures.
Market structures are classified into two categories:
1. Perfect markets: These are markets where buyers and sellers are
numerous and price cannot be manipulated. These include perfect
competition markets.
2. Imperfect markets: These are markets where individual buyers and
sellers can influence prices and production. These include monopoly,
oligopoly, monopolistic competition etc.
The market structures mentioned above differ depending on:
- The number of firms in the market; either one, few or many.
- Nature of the product dealt with; whether homogeneous or differentiated or heterogeneous.
- Entry and exit restrictions; either free entry, limited or highly restricted.
- Cost conditions.
- Degree of market information; Consumer informed or not informed about the market.
- Firms ability to influence demand through advertising.
- Degree of government interference.
APPLICATION ACTIVITY 1.1
1. a) Identify the firms operating in the banking sector.
b) Which types of products do they offer?
c) What means do they use to attract customers?
2. a) Identify the firms operating in the energy sector?
b) Which types of product do they offer?
c) What means do they use to attract customers?
3. Determine the difference in the structure of the two sectors above.
ACTIVITY 1.2
Considering market conditions in Rwanda, Describe the firms in which the features in the chart below exist.
1.2.1 Meaning of perfect competition.
Perfect competition is a market structure where there are several buyers and
sellers (firms) dealing with homogeneous commodity and possessing perfect
information of market conditions at that particular time.
At times a distinction is made between pure competition and perfect competition.
Pure competition Perfect competition is a market structure where there are
several buyers and sellers (firms) dealing with a homogeneous commodity but
consumers and sellers do not possess perfect knowledge of market conditions
and there is no perfect mobility of factors of production.
Perfect competition, on the other hand, requires the fulfilment of two
additional conditions: Perfect mobility of factors of production and perfect knowledge of market conditions.
Therefore, perfect competition is a wider term than pure competition.
1.2.2. Features of perfect competition.
Perfect competition is said to exist where there are the following conditions or features:
- There are many buyers and sellers in the market. Firms are many such
that none of them controls the market conditions independently. Each firm
in the market is free to put to the market as much output as it can or wishes
at the ruling market price but cannot independently influence the price of
the commodity. Therefore, firms under perfect competition are price takers
i.e. they take the price that is determined by automatic forces of demand and
supply.
- There is product homogeneity i.e. all the commodities supplied in the market
are identical (the same). All firms in the industry produce homogeneous or the
same product such that no consumer has preference for the product of one firm over the other.
- There is free entry and exit in the market. Any firm with capital is free
to enter the market and start producing and any existing firm is free to stop
production and leave the market if it so wishes. On expectation of making
profits, firms can freely join the industry and can also freely leave the industry if they make losses.
- There is no government intervention in form of fixing prices. All participants in the market abide by the price that is set by forces of demand and supply. Such a price rules all over the market.
- There is stiff competition among firms such that less efficient firms are always kicked out of the business.
- The major aim of firms is profit maximization. This is attained at a point where the marginal cost is equal to the marginal revenue (MC= MR) as the necessary condition though not sufficient at lower levels of output, but becomes sufficient at higher levels of output.
- The firms under perfect competition do not incur transport costs. Under perfect competition it is assumed that the raw materials, the firm, the consumers, are all found in the same place or locality.
- There is perfect mobility of factors of production from one production unit
to another. Factors of production can easily move from low paid economic
activities to high paid economic activities.
- Buyers and sellers have perfect (complete) information about the
market conditions. It is assumed that the price, quality, quantity and the
location of the product in question are known by all the participants in
the market. If one firm charges a higher price than others, it would not
make any sales.
- There is no persuasive advertising since firms are producing homogeneous
products and the consumers have perfect knowledge about the market
conditions. However, there may be some informative advertisements to make
the consumers aware of the products.
- Under perfect competition, AR=MR because selling an extra unit of output
adds the same amount to the total Revenue since price is constant, In other
words; for the firm to sell an extra unit of output, has to sell it at the same
price like previous one..
- The demand curve of a perfect competitive firm is perfectly elastic. This
indicates a constant price for the whole industry. At this point the demand curve
is equal to marginal revenue (MR), equals to average revenue (AR) which is
equal to the price. (DD=MR=AR=P). Therefore, the firms in the industry are
price takers not price makers. No any firm in the industry can set its own price
but they all sell at the constant price set by forces of demand and supply.
NOTE: Entry barriers refer to economic, procedural, regulatory, or
technological factors that restrict entry of new firms into market. Such barriers may take the form of:
1. Clear product differentiation, necessitating heavy advertising expenditure to introduce new products.
2. Economies of scale necessitating heavy investment in large plants to achieve competitive pricing.
3. Restricted access to distribution channels.
4. Collusion on pricing and other restrictive trade practices by the producers or suppliers.
5. Limit pricing i.e. fixing the price so low to avoid entry of new competitors.
6. Well established brands. A brand is a name, term, design, symbol, or
any other feature that identifies one seller’s good or service as distinct from those of other sellers.
Barriers to exit also serve as barriers to entry because they make it difficult for a firm that make losses to exit the industry.
Examples of perfect competition;
In the real world, it’s hard to find examples of industries which fit all the criteria of ‘perfect information’. However, some industries are close and these may include:
1. Foreign exchange markets. Here currency is all homogeneous and traders will have access to many buyers and sellers and there will be good information about relative prices.
2. Agricultural markets. In some cases, there are several farmers selling identical products to the market e.g. potatoes, cassava, pineapples, Irish potatoes, tomatoes, maize, bananas etc. and many buyers.
3. Internet related industries. It is easy to compare prices quickly and efficiently and entry barriers are lower.
1.2.3. The demand curve for a firm under perfect competition
Each firm in a perfectly competitive market faces a perfectly elastic demand curve
because variations in the firm’s output have no noticeable effect on price. The
perfectly elastic demand curve does not indicate that the firm could actually sell
an infinite amount at the prevailing price. It only indicates that the variations in
production will leave price unchanged because their effect on total industry output
will be negligible. The firm’s output variation has only a tiny percentage effect
on industry output. The price is determined by the industry through forces of demand and supply
As shown in the figure above, the demand curve is equal to the average revenue
curve and equal to marginal revenue curve. (AR=MR=D) The AR curve is the
same as MR curve under perfect competition. This is because selling an extra
unit of output adds the same amount to the total revenue since price is constant.
ACTIVITY 1.3
Basing on your knowledge about the perfect competition,
Explain the meaning of the following terms and illustrate their curves.
i. MC
ii. MR under perfect competition.
iii. Illustrate the two curves on the same graph and identify the point
where they meet to determine the equilibrium.
1.2.4.1. Equilibrium position of the firm under Perfect competition.
Equilibrium can be defined as a state of balance when variables under
consideration have no tendencies to change. A firm is in equilibrium at the
point where MC= MR at this point, the firm is able to determine the output to
be produced and the price of that output. The firm maximises its profits by
equating its MC with its MR i.e MC= MR.
Conditions of Equilibrium of the firm and industry under Perfect competition
i. The MC curve must equal to MR curve. This is the first order and necessary
condition. But this is not a sufficient condition at lower output levels but
becomes sufficient condition at a higher output levels.
ii. The MC curve must cut the MR curve from below and after the point of
equilibrium it must be above the MR. This is the second order condition.
As shown in figure above at point A (output 0Q1), the firm is in equilibrium
i.e. MC = MR. However, this is not sufficient. It therefore requires the firm to
increase output to a higher output e.g. 0Q2 in order to fetch more revenue compared to the cost incurred in its production.
At point B the firm fulfils the sufficient condition of equilibrium by producing a
high output 0Q2 where MC= MR and MC is rising. Therefore, the equilibrium is at
point “B” where MC=MR and MC is rising thus fulfilling the necessary condition.
At equilibrium, the firm may either make abnormal profits or incur losses (subnormal
profits) depending on the level of average cost (AC).
1.2.4.2. Short run profit maximisation under perfect competition.
The firm will be in equilibrium at a point where marginal cost (MC) is equal to
marginal revenue (MR) and it will come under the following conditions:
- The average revenue (AR) must be greater than average cost (AC) i.e.
Average cost curve must be below the Average revenue curve.
- The average revenue curve determines the price while the Average cost curve determines the cost of the firm.
- Where AC curve meets the price-output line, we determine costs to the vertical axis.
- Marginal cost curve cuts the Average cost curve at the lowest point to mark the optimum point of the firm.
Illustration of short run profit maximisation under perfect competition
Output: The output that the firm produces is determined at the equilibrium
point where MC=MR at the biggest level of output. Thus output 0qo is the
equilibrium output.
Cost: The average cost of producing each unit of output 0qo is determined at a
point where the output line meets the AC curve. Thus 0co is the average cost of
producing each unit of output 0qo.
Price: The price at which the firm sells its output is determined at a point where
the output line meets the AR. Thus price 0po is the equilibrium price.
Profit: Along the equilibrium, AR is greater than AC and therefore the firm
earns Abnormal profits in the short run, as shown by the shaded area C0P0AZ
above
Example:
The marginal cost of paper bag making industry in Kayonza is given by,
MC = 20+2Q (which is always rising), where Q=100 paper bags.
Find the cost-maximizing quantity if P=30 or P=40
Answer:
P=D=AR=MR=MC
PC=MC, P-30
30=20+2Q
30-20=2Q
10=2Q
5=Q
P=MC, 40
40=20+2Q
10=Q
1.2.4.3. Long run equilibrium position under perfect competition.
Because of freedom of entry of new firms into the industry, in the long run, new
firms enter the market being attracted by the abnormal profits enjoyed in the
short run. As new firms enter, supply of the commodity increases leading to a reduction in the price level.
The increase in the number of firms will also result into increased competition
for factors of production which will cause the costs of production to rise. This
will push AC and MC curves upwards in the long run.
As prices in the market fall, abnormal profits will continue to reduce. Thus
firms make normal profits in the long run where AR=AC.
Long run situation comes under the following conditions;
- The average revenue (AR) must be equal to the average cost (AC) i.e.
Average cost curve must be tangent to the Average revenue line.
- The average revenue curve determines the price while the Average cost curve determines the cost of the firm.
- Where AC curve meets the price-output line, we determine costs to the
vertical axis. Since this time AC and AR are equal, the price line is the same as the costs line.
- Marginal cost curve cuts the Average cost curve at the lowest point to mark the optimum point of the firm.
Output: The output that the firm produces is determined at the equilibrium
point where MC=MR at the point x, at the biggest level of output. Thus output
0qo is the equilibrium output.
Cost: The average cost of producing each unit of output 0qo is determined at a
point where the output line meets the AC curve. Thus 0co is the average cost of
producing each unit of output 0qo.
Price: The price at which the firm sells its output is determined at a point where
the output line meets the AR. Thus price 0po is the equilibrium price.
Profit: Along the equilibrium, AR is equal to AC (C0=P0) and therefore the firm earns Normal profits in the long run.
1.2.5. Loss making under perfect competition.
The firm can be in equilibrium under perfect competition but when making
losses making firm. Some firms can be able to make abnormal profits while some
others are likely to earn losses. Losses come under the following conditions:
- The average revenue (AR) must be less than average cost (AC) i.e. Average
cost curve must be above the Average revenue curve (AR).
- The average revenue curve determines the price while the Average cost curve determines the cost of the firm.
- Where AC curve meets the price-output line, we determine costs to the
vertical axis. This time the price-output line is prolonged to meet/ touch the AC curve since its higher above the AR curve.
- Marginal cost curve cuts the Average cost curve at the lowest point to mark the optimum point of the firm.
As shown in the figure above, the firm produces output 0Q1 at Total cost
0CeXQ1 and sales it at price 0Pe getting Total Revenue 0PeYQ1 hence making
losses PeCeXY because the AC is greater than the AR.
Losses = TR- TC. Thus from the above curve, losses= 0PeYQ1- 0CeXQ1 = PeCeXY.
Example
Given the firm’s total cost function as TC = 100+20Q+Q2.
a. Calculate the firm’s supply curve
b. If firm’s market price is 25Frw, calculate firm’s production.
c. Calculate firm’s profit/loss if P=25
Answer
TVC= 20Q+Q2
AVC= 20+Q
MC= 20 + 2Q
a. Therefore,
P = MC
P = 20+2Q
qs = ½P - 10
b. If P=25, therefore,
qs = ½P - 10
qs = ½(25) – 10
qs = 2.5
c. Profit/loss
qs = 2.5
π= TR-TC
π= PQ-(100 + 20q + q2)
π= (25)2.5-(100 + 20(2.5) + (2.5)2)
π= 62.5-(100 + 50 + 6.25)
π=-93.75Frw
In long run, firms push their profit to zero and sometimes, they start making losses.
1.2.6. Breakeven and shut down points of a firm.
Breakeven point is a point where the firm is neither earning abnormal profits
nor making losses. i.e. it is earning normal profits where the average revenue
is equal to average cost (AR =AC). The firm can only cover the costs of production without earning any profit.
Example
Assume an industry producing 1000 kg (Q) of biscuits daily, and selling at price
50Frw per kg. Calculate the profit of the firm, and interpret what will happen to the firm.
P= 50, Q = 1000
TR = P x Q
TR 50x1000= 50000
TC = ATC x Q
ATC=50,
Q=100TC = 50 X 1000 = 50000
Profit = TR - TC = 50000 – 50000 = 0
Therefore the industry is at breakeven point where AC=AR and the industry is making 0 profits.
When normal profits are earned, no more firms will be attracted to the industry and
the existing firms will have no desire to leave. As new firms may enter the industry
more would be supplied to the market. Prices will fall even further and firms will
begin to incur losses. Firms may continue to operate even when they are incurring
losses so long as they can pay for variable costs of production. This implies that
firms can operate even below the breakeven point until such a point when they may
be forced to close down. This point of a firm is referred to as Shut down point of a firm.
Shut down point is a point below where the firm only covers variable costs and
below this point, the firm cannot continue operation. At shut down point AR= AVC.
Example
Given that the firm is producing 7500 kg(Q) of maize floor, and selling at price
30Frw per kg, given also that the ATC=50. Calculate the profit of the firm, and interpret what will happen to the firm.
P = 30,
Q = 7500
TR = P x Q
TR = 30x7500 = 22500
Given, ATC = 50
So,
TC = ATC x Q
50 x 7500 = 375000
Profit = TR - TC = 225000 - 375000 = -150000
A firm will be at shutdown point since it will be making loss at AVC point.
As shown in the figure above, In the long run, many firms join the business
because of the abnormal profits in the short run (at point A in the above
figure). As new firms enter the industry, supply of the commodity increases
creating more competition in the market leading to a reduction in the price. In
the end all firms get normal or zero profit at point (B). They are only able to
cover costs of production as shown by the AC curve. Point B is the breakeven
point where the firm earns normal profits and AR=AC.
Other firms will still join the business up to when the firm is not able to cover
all the costs of production but only covers variable costs as shown by the AVC
curve. (Point C in the above figure)
Point C is the shutdown point where the firm only covers variable costs. Below
this point, the firm cannot continue operation.
Example
Fill in the missing cells. Assume the firm operates in a perfectly competitive environment in both, the input and output markets. Calculate the profit (loss) when the firm receives 0.40Frw for the product.
APPLICATION ACTIVITY 1.2.
Equilibrium of a firm is at point where MC = MR and the optimum point is the lowest point of the AC.
i. Using the following below, determine the equilibrium and optimum output.
ii. Illustrate the MR and MC curves of the above firm.
Why firms continue to operate even when it is not covering all the costs.
ACTIVITY 1.4
Make research around. Look for a firm that has not been performing well
in the recent years. It may be a firm loosing market to a competitor or
has run out of resources. Find out the reasons for its poor performance
and why it has not yet closed?
A firm may continue to operate even if total costs of production are not covered because of the following factors:
- Some firms may not want to lose their good customers thus they continue
to operate even when total costs are not covered in order to keep such customers.
- Firms continue to operate because they fear to lose their suppliers of raw materials for their industry.
- Some firms may fear to lose their suppliers of raw materials for their
industry thus they continue to operate even when total costs of production are not covered.
- The firm may be newly established when it is still at its infancy stage
and expects to make profits in the long run thus it accepts to continue to operate even when total costs are not covered.
- Some firms fear to lose their skilled man power which it would have trained
at a high cost, which labour may be necessary in the near future thus they continue to operate.
- Firms may be expecting to get loans the nearby in future from the financial institutions to boost its business.
- Some firms fear to be taken over by the state through nationalization
when they stop operating thus they continue to operate even when the total costs are not covered.
- The firm may be newly established when it is still at its infancy stage
and expects to make profits in the long run thus it accepts to continue to operate even when total costs are not covered.
- The firm may have invested heavily in fixed assets like buildings, machines
and land which it cannot leave idle thus continue to operate when even total costs are not covered.
- Some firms keep operating when they hope to change or restructure management, if it
- believes current losses are due to poor management
- A loss making firm may be a branch of a bigger firm (subsidiary firm)
which is making profits and the losses can be shared by the other firms so as to cover the costs.
- Some firms are not meant to be making profits but to give services like welfare improvement, in case of government organizations.
- Some firms may be set up for research/ experimental purposes so they operate even if they are making losses.
- If a firm had earned abnormal profits before and is still surviving on them.
- Difficulties might be short run and therefore hope to make improvements in the long run.
- Some firms keep operating when they fear to lose their reputation or good name in society.
Under certain conditions, a firm may decide to close business because of;
- Appearance of new and strong firm thus out competed.
- Exhaustion of raw materials.
- Persistent labour unrest or inadequate labour supply.
- Absence of spare parts or failure to get them.
- New government regulations e.g. total ban of production of a given commodity.
- Change in fashion and design hence demand shifts to fashionable goods.
- Lack of raw materials e.g. during war times and economic decline.
1.2.7. Advantages and disadvantages of perfect competition.
Perfect competition has the following advantages:
- Encourages optimum use of resources because factors of production
can freely move from one place to another
- Production of better quality goods because of high levels of competition within the industry
- No wastage of resources because of no advertisement costs incurred. This reduces prices for final commodities.
- There is no consumer exploitation because prices are determined by the forces of demand and supply.
- There is a lot of output because of many suppliers and buyers.
- Producers are able to expand their firms and use modern technology because of the abnormal profits in the short run.
- Eliminates income inequality because in the long run all firms earn normal profits. On the other hand, everyone with capacity if free to join production.
- The plant is used to full capacity in the long run. This is mainly because firms
operate at the least average cost and so there is no resource wastage.
- There is price stability due to homogeneous products and all producers selling at the same price.
Disadvantages or shortcomings of perfect competitive firms:
- No variety of commodities since they are homogeneous; this limits consumers’ choice.
- The existence of perfect knowledge doesn’t motivate firms to incur expenses on research and development.
- Unemployment is likely to occur because of the inefficient firms leaving the production after being outcompeted.
- Consumers have little or no choice because the goods produced are the same.
- There are no abnormal profits in the long run so expansion of the firm is hard.
- Research is difficult because of little of no profits in the long run.
- Firms aim at profit, maximization and this discourages the production of public utilities like water supply which are vital for society but are non-profit making
- Profits are reduced because the seller is supposed to sale at the same price as others.
- Perfect competition cannot exist in reality and so cannot be relied upon for development.
- Sellers cannot carryout price discrimination since demand is perfectly elastic and prices tend to be constant and this limits the profit levels of the firm.
APPLICATION ACTIVITY 1.3
Identify a firm that declined and eventually closed. Make research and find
out the cause of its decline and closure.
1.3. Monopoly
ACTIVITY 1.5
REG is composed of EUCL and EDCL as its subsidiaries.
Write down what you know about EUCL and EDCL.
Why do you think REG is the only firm responsible for handling all electricity issues in the country?
1.3.1. Meaning and characteristics.
Under imperfects there are many market situations including:
- Monopoly.
- Monopolistic competition.
- Oligopoly.
Monopoly is a market situation where there is one producer or supplier of a product, which has no close substitutes and entry into the market is highly restricted.
Examples of monopoly firms include;
- Water and Sanitation Corporation Limited (WASAC)
- Rwanda Energy Group (REG)
- National Bank of Rwanda (BNR)
Extreme forms/ types of monopoly may include;
- Pure /absolute monopoly: This is a market situation where there is single seller or producer of a commodity that has no substitutes at all. In practice, there is no pure monopoly because people can always forge substitutes for that commodity.
- Monopsony: This is market situation where there is only one buyer of a commodity or a factor of production. E.g. one employer.
- Bilateral monopoly: This is a market situation consisting of a single seller and a single buyer of a commodity.
- Imperfect/ simple monopoly: this is a market situation where there is a single firm which produces a commodity that can be substituted to some extent though they are not perfect substitutes.
- Discriminatory monopoly: this is a type of monopoly where the seller has the ability to charge different prices from different customers for basically the same commodity.
- Collective monopoly: this is a market situation where a few firms producing similar products decide to come together so as to determine price and output.
- Natural monopoly: this is a market situation where a firm exclusively owns and controls a source of raw material and it is impossible for other firms to produce similar commodities that require similar raw materials. i.e. such firms become monopolies because other firms cannot enter the industry.
- The market demand for such an industry is only sufficient for one firm to operate at its minimum efficiency.
- Statutory monopoly: this refers to a type of monopoly which is set up by
an act of the parliament to provide a certain economic product/service
and such a service or product cannot be duplicated by firms.
- Spatial/local monopoly: This is a type of monopoly which arises from distance between the producers of a given product. Therefore, this when a firm becomes a monopoly due to the long distance between that firm and others firms.
Characteristics (features/assumptions) of monopoly market conditions.
Under monopoly market conditions,
- There is only one single seller/ producer and many buyers.
- The commodity produced has no close substitutes.
- Entry of new firms in the market is restricted/ highly blocked.
- There is no persuasive advertising instead there is informative advertising where the public is just informed about the existence of the commodity but not being persuaded to purchase it.
- The firm aims at profit maximization.
- Firms are price makers but not price takers. I.e. they can determine the price at which to sale their products
- The demand curve of a monopolist is inelastic because its products have no close substitutes. In other words, a big percentage increase in prices of such products lead to a small percentage reduction in the quantity demanded.
1.3.2. Sources of monopoly power.
- Patent rights: this where a firm/ producer has exclusive knowledge of a given production technique and the law forbids other firms/ producers to deal in the same commodity. e.g. authors, artists, inventors etc. copy rights and patent rights prevent other firms or producers from imitating
the products of others which leads to temporary monopolies.
- Strategic ownership or control of a source of raw materials which makes it impossible for other firms or producers to produce similar product that require similar raw materials. Thus such firms become monopolies because other firms cannot enter the industry leading to natural monopoly.
- Long distance among producers where each producer monopolizes the market in his/her locality. This leads to spatial monopoly.
- Advantages of large-scale production which do not allow small firms to compete successfully with large firms.
- Protectionism: This is where trade barriers are imposed on the product to exclude foreign competitors. In such cases, the home producer may become a monopolist.
- Take over and mergers: Take-over’ is when one firm takes over the assets and organization of another whereas mergers are formed when firms combine their assets and organizations into one to achieve strong market position. Both situations may result into a monopolist firm.
- Collective monopoly or collusive e monopoly: This is where firms come together in a formal or informal agreement (cartel) to achieve monopoly power. Such firms can fix quotas (maximum output each may put on the market). They may also set the price very low with the objective of preventing new entry of other firms. This is called limit pricing.
- Small market: where the market demand is small or limited, a single seller or supplier is most appropriate In other words, a firm becomes a monopoly because the market size is too small to allow more than one firm to operate in it.
- Long-time of training/acquiring skills: where entry into business or rofession is restricted by long-time of training, it means that a person who joins the profession will remain the sole supplier for some time e.g. doctors, judges etc.
- Talent: Individuals with talent tend to develop peculiar products or services hence development of monopoly in marketing of such commodities. E.g. designers, musicians etc.
1.3.3. Equilibrium position and profit maximization under monopoly. The demand curve under monopoly is downward sloping from left to write. It is inelastic because of lack of competition.
Under monopoly:
- The firm produces at excess capacity both in the short run and long run because it must restrict output to charge a high price especially when it a private monopoly that aims at maximising profits. State monopolies created to provide strategic services to the population may optimally utilise their resources to provide more services.
- There is no supply curve under monopoly because the producer bases his production plans on the demand curve which is fixed and known to him/ her.
- There is no difference between a firm and an industry.
- The firm is in equilibrium when the marginal cost curve is equal to the marginal revenue curve. (MC=MR)
The AR and MR curves under monopoly
The AR and MR curves under monopoly are downward sloping from left to right. Marginal revenue curve is below the Average revenue curve because for monopoly firm to increase revenue, it has to lower the price
The equilibrium position under monopoly.
In the short run period, the monopolist behaves like any other firm. It will maximize profits or minimize losses by producing that output for which marginal cost (MC) equals marginal revenue (MR). Whether a profit or loss is made or not depends upon the relation between price and AC. It may be made clear here that a monopolist doesn’t necessarily make profits. The firm may earn super normal profits or normal or even produce at a loss in the short run.
Conditions for the equilibrium of a monopoly firm are that,
The firm under monopoly will still earn abnormal profits because it is the only firm in the production process. The firm will be in equilibrium where the marginal cost curve is equal to marginal revenue curve. (MC=MR). This is shown below:
Conditions:
- The average revenue (AR) must be greater than average cost (AC) i.e.
Average cost curve must be below the Average revenue curve.
- The average revenue curve determines the price while the Average cost curve determines the cost of the firm.
- Where AC curve meets the price-output line, we determine costs to the vertical axis.
- Marginal cost curve cuts the Average cost curve at the lowest point to mark the optimum point of the firm.
At point E, MR =MC and there that is the equilibrium point.
Short-run profit maximisation under monopoly
In the short run period, if the demand for the product is high, a monopolist increases the price and quantity of output. He can increase output by increasing labour, using more raw materials, increasing working hours etc. In case demand falls, he can reduce the use of variable inputs.
A monopolist is a price maker; therefore the firm can set a price which earns profits i.e a price greater than AC.
Conditions for short run normal profits under monopoly:
- The firm is in equilibrium where MC=MR.
- The average revenue (AR) must be equal to average cost (AC)
- The average revenue curve determines the price while the Average cost curve determines the cost of the firm.
- Where AC curve meets the price-output line, we determine costs from the vertical axis. However, since AC=AR, the price line is the same as the costs line.
- Marginal cost curve cuts the Average cost curve at the lowest point to mark the optimum point of the firm.
Illustration of normal profits under monopoly
The firm is in equilibrium at a point where MC=MR. The price is tangent to the AC. The firm charges OP0 price per unit for units of output 0Q. The firm earns only normal profits and keeps on operating.
Losses under monopoly in the short run
A monopolist can also make losses in the short run, provided the variable costs of the firm are fully covered. The loss minimizing condition in the short run can happen under the following conditions;
Conditions
- The average revenue (AR) must be less than average cost (AC) i.e. Average cost curve must be above the Average revenue curve.
- The average revenue curve determines the price while the Average cost curve determines the cost of the firm.
- Where AC curve meets the price-output line, we determine costs from the vertical axis. Since AC is greater than AR, the price-output line is extended up to touch the AC curve so as to determine the costs to the vertical axis.
- Marginal cost curve cuts the Average cost curve at the lowest point to mark the optimum point of the firm.
Losses of a firm under monopoly in the short run
As shown in figure above, the firm produces the best short run level of output which is given by point where MC=MR. A monopolist sells output 0Qo at price 0Po. Total revenue of the firm equal to 0P0BQ0 and total cost of producing it is 0C0AQ0. The monopoly firm suffers a net loss equal to the area P0C0AB. The firm in the short run prefers to operate and reduce its losses to P0C0AB only. In the long run, if the loss continues, the firm shall have to close down
Equilibrium position of a firm under monopoly in the long run.
In the long run the firm under monopoly will still earn abnormal profits because it is the only firm in the production process. The firm will be in equilibrium where the long run marginal cost curve is equal to long run marginal revenue curve. (LMC=LMR). This is shown below:
Conditions
- The average revenue (AR) must be greater than average cost (AC) i.e. Average cost curve must be below the Average revenue curve.
- The average revenue curve determines the price while the Average cost curve determines the cost of the firm.
- Where AC curve meets the price-output line, we determine costs to the vertical axis.
- Marginal cost curve cuts the Average cost curve at the lowest point to mark the optimum point of the firm.
Illustration of Equilibrium position of a firm under monopoly in the long run.
In the figure above, the firm is in equilibrium at point “E” where it produces output 0Qe at Total cost 0C0NQe and sells it at price 0P0 getting Total revenue 0P0MQe hence getting abnormal profits C0P0MN.
Profits = TR-TC. I.e. 0P0MQe - 0C0NQe = C0P0MN.
The firm under monopoly, in the long run, still operates at excess capacity since
its equilibrium output (0Qe) is less than optimum output (0Qo).
1.3.4. Advantages, disadvantages and control of monopoly.
ACTIVITY 1.6.
Discuss the view that monopoly market is better than a perfectly competitive market.
1.3.4.1. Advantages of monopoly.
Monopoly has the following advantages.
- There is no duplication of services and this saves resources e.g. if there is one energy firm providing power, there may not be the need to set up another one in the same area
- Economies of scale can be enjoyed by the firm because it is capable of expanding using the abnormal profits earned.
- There is a possibility of price discrimination. (Parallel pricing). This refers to the selling of the same commodity at different prices to different customers which benefits the low-income earners.
- Research can easily be carried out using the abnormal profits which in turn leads to an increase in the quality and quantity of goods produced.
- There is no wastage of resources in persuasive advertising which may increase leads the prices.
- Public utilities like roads, telephones, etc, are easily controlled by the government as a monopolist
- Infant industries can grow up when they are monopolies and are protected from foreign competition.
- It encourages innovations by protecting copyright and patent owners.
1.3.4.2. Disadvantages of monopoly
- Because there is no competition, the firm can become inefficient and
produce low quality products.
- Monopoly firms produce at excess capacity i.e. they under utilize their
plants so as to produce less output and sell at a high price.
- Monopoly firms may charge higher price than firms in perfect competition.
- In case a monopolist stops operating, there would be shortage of the commodity.
- Monopoly firms tend to exert pressure on the government and sometimes they can influence decision making because they are the controllers of production.
- Discrimination of consumers. This may be based on political or religious affiliation other than the factors respected by economics
- Leads to income inequality. The monopolies who over charge earn more compared to others
- Restriction of choices. A monopolist normally produces one type of commodity thus consumers are denied a chance to choose among alternatives
1.3.4.3. Measures to control monopoly
Because of the above disadvantages of monopolies, the following methods can be used to control their activities.
- The government can fix prices of commodities through price legislation.
- Anti-monopoly (antitrust) Legislation i.e. laws imposed to control monopolies. Such laws can prohibit monopolization, and collusion among firms to raise prices or inhibit competition.
- Nationalization of monopoly firms by the government so as to lower the prices.
- Subsidization of new firms. This can help them to compete with the already established firms favorably.
- Resale price maintenance where by the producers set prices at which sellers should sale the goods to avoid charging high prices
- Encouraging imports to compete with the commodities of monopoly firms in the country.
- Setting up government owned firms to compete with the monopoly firms.
- Removal of deliberate monopoly bases like protectionism and taxation to encourage competition among the firms.
- Taxation. The government can impose taxes to reduce the profits of the monopolists. Such taxes may include:
1. Surtax. This refers to the tax charged on producers or people who earn more than a particular large amount. This helps to reduce on the profit levels of a monopoly firm which reduces monopoly power.
2. Advalerem tax. This is a tax levied on the value of the commodity
3. Specific tax. This is a tax charged per unit of output and will therefore vary as output varies. It will increase the cost of production of additional unit (MC) and AC of every unit.
4. Lump sum tax. This is a tax charged especially on monopolists regardless to their level of outputs or any circumstance.
1.3.5. Price discrimination
ACTIVITY 1.7
Mutamuliza is an entrepreneur operating a number of enterprises in Gatsibo district. She runs a poultry firm where she produces eggs for sale. When traders from Kigali come, she sells to them at 5000rwf a tray while those from Gatsibo she charges them 3000rwf per tray.
She also produces pineapples and sells each at 1000rwf. But when Students from a nearby secondary school come to buy, she sells to them at 500rwf each. Some times during bumper harvest she exports some to Tanzania and sells each at 700rwf in Tanzania markets.
a. In your opinion, why do you think i. She charges Kigali traders more than what she does to those from Gatsibo for a tray of eggs?
ii. She sells pineapples to students at a lower price than others?
iii. She sells pineapples in Tanzanian markets at lower prices than what she charges in domestic markets?
1.3.5.1. Meaning
It is where the producer sells a commodity to different customers at different prices irrespective of the costs of production. It can also be referred to as parallel pricing. Price discrimination takes place at the following degrees of price discrimination,
Price discrimination occurs in the following degrees:
- First degree discrimination where a producer is able to charge each customer the maximum price he/ she is prepared to pay for the good or service depending on consumers’ demand.
- Second degree of price discrimination where a firm sells off excess output or supply that could be remaining at a lower price than normal price.
- Third degree price discrimination where the producer sells / separates markets according to elasticity of demand and charge a high price where there is inelastic demand and a low price where there is elastic demand.
1.3.5.2. Forms of price discrimination.
- Discrimination according to personal income. For example, income differentiation among buyers, e.g. doctors charging low prices on the poor and high prices on the rich for the same services.
- Discrimination according to age: e.g. charging low prices on the young people than old people on tickets to watch football or for a film show.
- Discrimination according to sex: where different prices are charged to females and males e.g. for discotheques where for ladies’ nights, ladies enter for free and males are made to pay.
- Discrimination according to geographical e.g. dumping where commodities are sold cheaply in other countries compared to prices in the home country.
- Discrimination according to the time of service e.g. tickets for video shows charged high prices in afternoons when there are many people than in morning hours when there are few people.
- Discrimination according to nature of the product e.g. a soft cover book may be cheaper than a hard cover book.
- Discrimination according to the number of uses of the product e.g. electricity used for industrial purposes is cheaper to electricity for domestic use.
- Discrimination by differentiation of commodities e.g. high prices on travellers in first class in the train and low charges of other classes like the economy class.
1.3.5.3. Conditions for Price Discrimination to be successful.
- The commodity must be sold by a Monopolist so that even when the price is increased, the buyer has nowhere else to go
- Elasticity of demand should be different in different markets. A higher price should be charged in the market where elasticity of demand is low than where elasticity of demand is high.
- The cost of dividing the markets should be very low e.g. in case of dumping costs of transport should be low.
- Buyers should not know how much is charged on others. This is possible especially where goods are sold on orders with no advertising.
- It should be impossible for buyers to transfer the commodity from where the price is low to where the price is high. This is possible especially with services of doctors, teachers, etc.
1.3.5.4 Advantages and disadvantages of price discrimination.
ACTIVITY 1.8
Discuss the view that customers with different income status should be charged different prices for the same commodities.
Advantages of price discrimination
- It enables the poor to get essential services at low prices e.g. cheap houses to civil servants and doctors charging low prices on poor patients.
- To the sellers, it increases total revenue because output sold increases.
- It is one way in which the rich subsidize the poor thus a method of income distribution. The rich are charged highly on commodities while the poor are subsidized on the same commodities
- It increases sales and consumption e.g. for air time, the first units, may be charged higher price than other extra units. Therefore, the more units of air time you use, the less the charges you pay for any extra units.
- It helps producers to dispose-off surplus and poorly manufactured commodities e.g. dumping.
- Increased efficiency. The increased profits from the higher charges make the firms efficient and such profits are reinvested
Disadvantages of price Discrimination
- It may encourage consumption of some commodities in undesirable excessive amounts. For example, when children are charged less for entrance in film halls, they may spend more time watching films than on studies or leisure.
- It can lead to low quantity of products/services for example in some airlines, travellers in the economy class (where fares are lower) are sometimes not well treated like those in the first class (where fares are higher) by airline staff.
- Discrimination in form of dumping discourages local industries.
- It increases monopoly powers of firms by limiting entrance of other firms
in the market. One firm serves all categories of customers irrespective of
their incomes, ages or sex cause consumers’ exploitation.
- Poor quality output normally arises; such output is sold to the less privileged who yearn for the less prices
- Misallocation of resources. Price discrimination may bring about divergence of resources from their socially optimal uses to produce for those who can reward highly because producers aim at profit maximisation.
APPLICATION ACTIVITY 1.4
The table below shows electricity tariffs from REG. Analyse the tariffs
and answer the questions that follow
Tariffs for non-industrial customers.
a. In your own view, why do you think
i. REG charges low tariffs for residential customers using below
15 kWh and higher tariff for those using 50 and above kWh?
ii. Water treatment plants are charged lower tariffs than telecom towers.
b. How is the above system of charging different tariffs by REG helpful to
i. REG.
ii. The customers
1.4. Monopolistic competition
1.4.1. Meaning and characteristics.
ACTIVITY 1.9.
Identify the 3 star and 4 star hotels in Rwanda. Make research on them in terms of
i. Their number.
ii. The means they use to compete against each other.
iii. Their services and their quality.
iv. Their prices.
Make class presentations on your discoveries.
Monopolistic competition market structure has characteristics similar to that of perfect competition except that the commodity dealt with in monopolistic competition is not homogeneous. It is a market structure in which a large number of firms sell differentiated products that are close substitutes.
Because of product differentiation, the seller has some control over the market price thus the firm is a price maker. Examples of monopolistic firms include:
- Soap industry.
- Bread industry
- Hotel industry
- Hair salons
- Restaurants etc.
Characteristics of firms under monopolistic competition
There are many firms in the industry.
- Firms deal in differentiated products though they remain close substitutes.
- There is freedom of entry and exit of new firms into and out of the industry.
- There is stiff competition due to production of close substitutes.
- There is a lot of intensive persuasive and informative advertising.
- The firms exercise a lot of non-price competition due to the stiff competition.
- There is production at excess capacity.ie production less than the required
output so as to charge at a high price.
- The firms in the industry are large but none of them dominates the market.
- The major aim is to maximize profits and this done at a point where marginal revenue is equal to marginal cost (MR=MC)
- There exists brand loyalty/ fidelity ie consumers exercise a lot of loyalty/fidelity by sticking on a particular commodity believing that a particular brand is superior.
- The demand curve is fairly elastic in nature because of the presence of many substitutes. When a firm makes a small increase in the price of the commodity, there is big reduction in quantity demanded because of the existence of many other firms in the market.
- The AR curve is greater than the MR curve, i.e. the MR curve is below the AR curve because the firm gets marginal revenue when it sells extra units of the commodity at the low price than the previous one.
1.4.2. Short run and long run profit maximisation under monopolistic competition.
1.4.2.1. The demand curve, AR and MR curve under monopolistic competition.
The demand curve under monopolistic competition is elastic because of competition. MR is below the AR
Equilibrium position of a firm under monopolistic competition
The firm under monopolistic competition is in equilibrium when the MC=MR and in the short run the firm will either make abnormal profits or losses. The supernormal profits will exist in the short-run because new firms cannot enter the industry. In the short run, the firms may attempt to maximize their profits by changing the quality and the nature of the product and by increasing advertisement expenditure.
Point E in the figure above shows the equilibrium point where MC=MR
1.4.2.2: Price and output determination of a firm under monopolistic competition in the short run.
Price and output determination of a firm under monopolistic competition in the short run.
To determine price and output under monopolistic competition, we need to first determine equilibrium where profits are maximized. Thus, unit cost curves are super imposed on the unit revenue curves to determine where MC=MR (equilibrium point). From there, a perpendicular line is dropped to the horizontal axis to determine output and to the vertical axis, another line is dropped to determine price.
A firm under monopolistic competition in the short run the firm can either make abnormal profits or losses. Abnormal Profits are made as seen below
Conditions
- The average revenue (AR) must be greater than average cost (AC) i.e. Average cost curve must be below the Average revenue curve.
- The average revenue curve determines the price while the Average cost curve determines the cost of the firm.
- Where AC curve meets the price-output line, we determine costs from the vertical axis.
- Marginal cost curve cuts the Average cost curve at the lowest point to mark the optimum point of the firm.
Abnormal profits of a firm under monopolistic competition in the short run.
Output: The output that the firm produces is determined at the equilibrium point
(point E) where MC=MR at the biggest level of output. Thus output 0qo is the equilibrium output.
Cost: The average cost of producing each unit of output 0qo is determined at a point where the output line meets the AC curve (Point B). Thus 0co is the average cost of producing each unit of output 0qo.
Price: The price at which the firm sells its output is determined at a point where the output line meets the AR (Point A). Thus price 0po is the equilibrium price.
Profit: Along the equilibrium, AR is greater than AC and therefore the firm earns Abnormal profits in the short run represented by area C0P0AB.
NOTE: Firms under monopolistic competition produce at excess capacity/below their optimum point (point X) i.e equilibrium output oq0 is less than optimum output oq1
1.4.2.3. Losses under monopolistic competition in the Short run.
- The firm can also make losses. This is shown below.
Conditions
- The average revenue (AR) must be less than average cost (AC). I.e. The AC curve is higher above the AR curve.
- The average revenue curve determines the price while the Average cos curve determines the cost of the firm.
- Where AC curve meets the price-output line, we determine costs from the vertical axis. Since AC is greater than AR curve, the price-output line is extended up to touch the AC curve so as to determine the costs to the vertical axis.
- Marginal cost curve cuts the Average cost curve at the lowest point to mark the optimum point of the firm.
Losses of a firm under monopolistic competition in the short run
From the figure above, the firm produces output 0Q0 at cost 0C0 and sells it at lower price 0P0 getting total revenue 0P0BQ0. Hence the firm makes losses P0C0AB because total cost (AC) is greater than Total revenue (AR)
1.4.2.4. Equilibrium of the firm under monopolistic competition in the long run
Due to the supernormal profits in the short run, new firms join the industry with new brands, output increases, product differentiation increases, consumer choice widens and the firms reduce the level of their output since the market has remained the same.
The firms that were previously incurring losses leave the industry. Therefore, the demand curve would keep on shifting to the left until a point is reached where the demand curve is tangent to the long run average cost curve (LAC).
Equilibrium is attained at point where long run marginal cost curve (LMC) is equal to long run marginal revenue (LMR).
Conditions
- The average revenue (AR) must be equal to average cost (AC). I.e. The AC curve is tangential to the AR curve.
- The average revenue curve determines the price while the Average cost curve determines the cost of the firm.
- Where AC curve meets the price-output line, we determine costs from the vertical axis. Since AC is equal to AR curve, the price line is the same as the AC curve.
- Marginal cost curve cuts the Average cost curve at the lowest point to mark the optimum point of the firm.
Normal profits of a firm under monopolistic competition in the long run:
Output: The output that the firm produces is determined at the equilibrium point (point E) where MC=MR at the biggest level of output. Thus output 0qo is the equilibrium output.
Cost: The average cost of producing each unit of output 0qo is determined at a point where the output line meets the AC curve. Thus 0co is the average cost of producing each unit of output 0qo.
Price: The price at which the firm sells its output is determined at a point where the output line meets the AR. Thus price 0po is the equilibrium price.
Profit: Along the equilibrium, AR is equal to AC and therefore the firm earns Normal profits in the long run. The firm is operating at excess capacity since equilibrium output (0Q0) is less than optimum output 0Q1.
1.4.3. Advantages and disadvantages of monopolistic competition.
ACTIVITY 1.10
Discuss the view that monopolistic competitive market conditions are suitable for the Rwandan economy.
Advantages of monopolistic competition
- Product differentiation enables consumers to get a variety of products to choose from.
- Due to existence of many sellers in the market as a result of free entry of new firms, there are high quantities in the market. This makes prices lower than monopoly.
- Due to high level of competition, firms produce better quality output which improves people’s welfare.
- In case one firm collapses, substitutes are available for the consumers.
- Consumers buy at a lower price because of the presence of close substitutes which makes it difficult for sellers to charge very high prices.
- The freedom of entry gives a chance to any willing entrepreneur to enter the industry which creates employment opportunities in the country.
- Individual firms gain a lot of popularity due to specialization in their own brands.
- In the short run abnormal profits earned are used to improve on the quality of products, undertake research and expand the size of the firm.
- Disadvantages of monopolistic competition
- Advertising may mislead the public into paying higher price for the commodity when there is no improvement on the quality of the product.
- Firms produce at excess capacity in the short run and long run as they operate at less than optimum. Thus there is resource under utilisation.
- In the long run, there is no profit to make improvements because the firm earns normal profits. So it may not expand to enjoy economies of scale.
- The wide variety of commodities in the market often confuses consumers who may not make right choices in the end.
- The price charged on buyers is higher than in perfect competition which reduces consumers’ welfare.
- In the long run, there are no profits to invest in research since the firm earns normal (zero) profits.
- To maintain the market share, the seller has to persuasively advertise and this may increase costs and the price.
- There are limited employment opportunities as firms operate at excess capacity
- The output produced is less than that in perfect competition
1.4.4. Product differentiation under monopolistic competition
Product differentiation is a situation where a firm is in position to make its products appear different from other products of other firms. It may take the following forms; Packaging. Design/shape. Branding. Colour. Scent. Labelling, Salesmanship. Size. Quality, Advertising, Blending, Giving credit etc.
It is intended to win market for a firm by trying to make its commodities superior than those of rival firms. Therefore, there is need for persuasive advertising in monopolistic competition.
APPLICATION ACTIVITY 1.5
List down the mineral water producing firms you know.
i. Which one do you think takes the largest market share? Why?
ii. Which methods has it used to out-compete others?
iii. Are their products different? If yes, what makes them different?
1.5. Oligopoly
1.5.1. Meaning and features of oligopoly.
ACTIVITY 1.11
Identify the petroleum companies operating in Rwanda.
i. How many are they?
ii. Which one do you like and why?
iii. Is the petrol they sell different?
iv. Do they sell their products at the same price?
v. Are the lubricant oils they sell the same?
vi. What means do they use to compete against each other?
It is a market structure that is dominated by few, unequal and interdependent firms producing either a homogeneous product or a differentiated product.
a. Forms of oligopoly:
1. Perfect oligopoly occurs where there are few, unequal and interdependent firms in the industry producing a homogeneous product for instance Petroleum firms in the sale of petrol.
2. Imperfect oligopoly occurs when there are few, unequal and interdependent firms in the industry producing differentiated products for instance soft drinks firms.
3. Duopoly. This is an extreme form of oligopoly where there are only two firms in the market. For example in the telecommunication industry in Rwanda where Airtel and MTN are the only companies.
4. Duopsony. This is a form of oligopoly where there are two buyers in the market.
5. Oligopsony. This is a form of oligopoly where there are a few buyers in the market.
Examples of firms under oligopoly are;
- Mobile telephone companies: like MTN, Airtel.
- Petroleum companies like Kobil, SP, Mount Meru, Hass etc.
- Soft drink companies like Bralirwa Ltd, Azam Bakhresa Group etc.
- Newspaper firms. TAALIFA RWANDA, DOVE MAGAZINE LIMITED, Igihe Ltd., Rwanda Printing and publishing company, Nonaha Ltd, Inyarwanda Ltd, The Kigali Today group, Mucuruzi Online Market, Muhabura Ltd, The
New Times Publications, Umuseke Ltd, Digital Focus Limited.
b. Features/ characteristics of oligopoly.
Oligopoly markets have the following main features.
- There are few, unequal, competing firms. Each firm, though faced with competition from other firms, has enough market power and therefore cannot be a price taker.
- There is non-price competition such as advertising, quality of services etc. if one firm reduces the price, others would do the same and all firms would end up losing.
- There is interdependence among firms. Each firm is concerned with the activities of other firms so as to act accordingly, e.g. it can reduce the price when others reduce the price.
- In most cases there is product differentiation where firms produce similar products but each firm makes its product appear different from other firms’ products by using different colours, size, shape, labeling, quality etc.
- Presence of monopoly power. There are very few oligopoly firms and this makes it easy for collusion as a form of price determination leading to monopoly.
- Uncertainty. There is a lot of uncertainty in oligopoly industry, as one firm takes a decision say to increase the price, it cannot be certain of the reaction of other firms
- There is limited entry into the production process because most oligopoly firms operate at large scale, therefore this requires a lot of capital which others firms may not have.
- There is price rigidity. I e prices tend to be stable for a long period of time.
- There are price wars i.e. when one firm reduces the price other firms reduce theirs even lower.
- The demand curve under oligopoly is kinked. i.e. a curve that has a bend (kink) and it is elastic above the kink and inelastic below the kink.
c. The demand curve of an oligopoly firm
The demand curve is kinked because the demand for their products largely depends on the behaviors of other rival firms. This brings in uncertainties in the industry because no single firm can predict reaction of another firm in case they take their own decision. The kinked demand curve is elastic above the kink and inelastic below it.
It is drawn on the assumption that there is an administered price, asymmetry in the behavior of oligopoly firms such that if one firm reduces its price, other firms will reduce their prices even further and if one raises its price others will not follow. Therefore, above the administered price, demand is fairly elastic while below the administered price demand is fairly inelastic. That is why demand curve has two parts joined together at the administered price (at the kink) i.e. one fairly elastic and another fairly inelastic. This is shown below
Illustration of the demand curve of an oligopoly firm:
From the curve above, P is the market price or administered price. Should any firm increase its price above that price, it would lose its customers to other firms. If a firm decides to set price below P, other firms will react by reducing their price even further or lower to win more customers hence increase in quantity sold will be lower than the reduction in price. Hence the demand curve
has a kink (at point E) meaning that the prices will remain rigid/ stable for a long period of time.
d. The MR curve under oligopoly
The MR curve will also have a kink with 3 parts. It will be fairly elastic before the kink and inelastic after the kink. Below the kink, MR curve is discontinuous and straight indicating that MR is falling although the price is constant. When the price remains rigid for a long time, there will be other changes in the market that may lead to changes in costs of production.
MR curve under oligopoly
The figure above shows the MR curve which has three parts i.e. a part which is fairly elastic when AR is fairly elastic (before the kink),, a part that is vertical at the kink and a part that is fairly inelastic when AR is fairly inelastic (after the kink)..
e. Equilibrium position under oligopoly
The equilibrium under oligopoly occurs at a point where MR = MC. The MC cuts the MR in the vertical section of the MR. the position of the MC does not affect the equilibrium output as long as the MC passes through the vertical section of MR as illustrated below.
From the above figure, equilibrium is at any point between the vertical part of MR curve “R” to “Z”. The position of MC in the vertical MR doesn’t affect the equilibrium. At any point on this part of MR, MC=MR and there is equilibrium.
1.5.2: Profit maximization abnormal profits under oligopoly
A firm under oligopoly both in the short run and long run markets abnormal profits.
Conditions
Abnormal Profits are made in the following conditions as seen below:
- The average revenue (AR) must be greater than average cost (AC) i.e. Average cost curve must be below the Average revenue curve.
- The average revenue curve determines the price while the Average cost curve determines the cost of the firm.
- Where AC curve meets the price-output line, we determine costs from the vertical axis.
- Marginal cost curve cuts the Average cost curve at the lowest point to mark the optimum point of the firm.
Illustration of profit maximisation by an oligopoly firm.
Output: The output that the firm produces is determined at the equilibrium
point (at point E), where MC=MR at the biggest level of output. Thus output
0qo is the equilibrium output.
Cost: The average cost of producing each unit of output 0qo is determined at a point where the output line meets the AC curve. Thus 0co is the average cost of producing each unit of output 0Qo.
Price: The price at which the firm sells its output is determined at a point where the output line meets the AR. Thus price 0po is the equilibrium price.
Profit: Along the equilibrium, AR is greater than AC and therefore the firm earns Abnormal profits in the short run and the long run shown by C0P0AB in the above figure.
1.5.3. Advantages and disadvantages of oligopoly
ACTIVITY 1.12
Discuss the view that oligopoly market is better than a monopolistic market.
Advantages of oligopoly.
- Stable prices are charged due to presence of price rigidity.
- The high level of competition leads to better quality commodities.
- There are low prices to the consumers due to existence of intensive competition and fear of other firm’s reaction.
- Eases consumer budgeting due to due to price stability.
- Most oligopoly firms operate on large scale which enables the firm to enjoy economies of scale. This together with stiff competition reduces price in the market.
- Widens consumer choice due to production of a variety especially with imperfect oligopoly due to branding and product differentiation.
- Increase innovation and inventions in the economy due to competition and use on non-price competition measures to win market share.
- Provision of gifts by different competitive firms to customers improves people’s welfare.
- There is increased output due to production on large scale.
- Consumer awareness of the commodity is high due to extensive advertising.
- A lot of abnormal profits earned are spent on research and development which leads to technological advancement and a high standard of living in the country.
- Branding and product differentiation gives the consumer a wide variety of commodities to choose from.
Demerits of oligopoly firms:
- Consumers are denied a variety to choose from in case of perfect oligopoly.
- Consumer exploitation through over charging due to collusion.
- Profits are limited due to price rigidity and this may affect further expansion.
- There is a lot of duplication of commodities due to stiff competition hence wastage of resources and losses.
- Collapse of small firms when they are out competed due to stiff competition leading to unemployment.
- There is under exploitation of resources due to production at excess capacity which reduces the chances of firms to enjoy economies of scale.
- Industries with large firms exert pressure on government due to their large capital base and large market share.
- Distorts consumer choices due to excessive advertisements thus may end up consuming unwanted commodities.
- Worsens income inequality due to limited entry of other firms.
- Some firms at times engage in price wars where each firm keeps on reducing on prices of its products to outcompete rival firms which results into losses
- Firms incur high costs on advertising which increases on the price of the commodity.
- The market structure is characterized by uncertainties about the reactions and activities of other firms which limit the ability of an individual firm to make independent decision.
- Due to limited entry of firms, there may be lack of competition leading to inefficient and poor-quality products
1.5.4. Non price competition under oligopoly.
ACTIVITY 1.13
Identify the means used by the two firms below to attract more customers
Non price competition refers to the situation where firms in the industry compete using other means other than price. The price is kept constant but firms use other means of attracting customers. This can be done through,
- Persuasive advertisement using various media like radios, television, newspapers etc. to make people aware of the commodity and attracted to it
- Branding and blending i.e. use of appealing brand names like Rwanda tea……
- Offering credit facilities to customers to encourage them keep buying
- Offering gifts and free samples to encourage them buy more like petrol stations giving soap to customers
- Opening many branches in different locations in the country
- Offering after sales services like free transport to customer’s premises, guaranteeing spare parts all which attract customers to the firm involved
- Sponsoring social events like sports and music thus winning market etc.
- Organizing promotions through raffle draws which are intended to increase the number of customers who are attracted to buy the commodity in order to join the draw.
- Organizing trade fairs and exhibitions to make their products known to customers.
- Offering mobile shops. This is where the firm puts its products in a vehicle/ bicycle and moves from place to another selling its products e.g. bread firms
- Renovation of premises of customers by rival firms e.g. telecommunication networks (MTN, Airtel), beer firms (primus, Skol)
- Use of stop shopping centres at fuelling stations
- Use of differentiated attractive packaging and convenient designs of products by firms to outcompete each other.
- Quality improvement and introduction of new variables in order to increase their market share.
- Use of appealing slogans which attract commodities customers to their products e.g. MTN- everywhere you go, Airtel- express yourself, Coca- Cola- taste the feeling etc.
- Free distribution of samples and large purchases to customers’ premises.
1.5.5. Advantages and disadvantages of non-price competition.
Advantages.
1. It ensures quality products on the market. If consumers must choose between two products of the same price but they can see that one is of a higher quality, they generally pick the product of higher quality.
2. It increases total sales. Consumers may even pay more for goods perceived as higher quality with similar outward features. For instance Apple, makers of iPhones, and producers of organic food benefit from this phenomenon.
3. It encourages producers to reduce costs through innovations. If a firm can figure out how to produce an item at a cost comparable to what its competitor incurs, it widens its profit margins.
4. Perception and branding creates market for the commodity. A number of producers compete by manufacturing a perception of high quality with their brands. This allows some companies to charge higher prices for seemingly identical products because consumers see value in the brand itself.
5. Competition by product differentiation helps to widen market. By offering a range of similar products geared toward different market sectors firms can expand their market base.
Disadvantages of non-price competition
1. Competing by improving quality requires more time and resources. The problem with this approach is that it may take some time for consumers to realize any difference in quality.
2. It may be difficult to compete through maintaining brand loyalty. Long-term sustainability of a brand name may be difficult because, as such brand advantages arise through consumer trends, consumer trends may also lead to their demise. For instance, if consumers no longer see a clothing brand as fashionable, the market share may reduce.
3. Competing through product differentiation can result in significantly higher overhead costs for production.
APPLICATION ACTIVITY 1.6
Fill the table below with a summary of the difference and similarities between the following market structures.
END UNIT ASSESSMENT
1. With the help of illustrations, explain how profits are maximized under monopolistic competition in the
i. Short run.
ii. Long run.
2. Examine the differences between perfect competition and oligopoly.
3. Describe the factors that may make a firm to continue in operation though it is operating below the breakeven point.
UNIT 11 POPULATION
Key Unit Competency: Analyse the impact of population growth on economic development
INTRODUCTORY ACTIVITY
Hospital attendant: These days we receive many expecting mothers. They all deliver well and in around two days, they are discharged. I don’t know why? I think the number of people living in this country is going to increase.
Sector executive secretary: In my sector, the number of residents has increased. There are many people coming to reside here these days. But other residents migrated and left this village. I cannot tell exactly the number of people living in this sector now.
Hospital attendant: And of course, this being an urban area, it receives many people during the day who come for businesses and then go back to their respective areas in the evening.
Sector executive secretary: There is improvement in medical care, nutrition, public awareness, and others
Read through the conversation above and find out the meaning of population as implied therein.
11.1. Meaning of population and population census
ACTIVITY 11.1
Make research and describe the following terms as used in demographic
studies..
i. Population explosion.
ii. Fertility rate.
iii. Birth rate.
iv. Death rate.
v. Child mortality rate.
vi. Infant mortality rate.
Population is the number of people living in a given area at a certain point in time.
Population explosion. This is a geometric rapid increase in the size of a population caused by such factors as a sudden decline in infant mortality or an increase in life expectancy. It signifies an increase in the number of people that reside in a certain area, or country. It is determined by the formula: (birth rate + immigration) - (death rate + emigration). Population explosion may be a result of
i. High Birth Rate which may be due to early marriages.
ii. Polygamy a cultural practice where a man marries more than one wife.
iii. Poverty where majority of poor populations consider children as asset and they earn at a very low age and bring wages. It helps in the rapid population growth.
iv. Illiteracy which limits the use of contraceptives, encourages the belief in superstitions that promotes a culture of producing more children.
v. Limited access to contraceptives. This may be due to poverty and lack of information.
vi. Improvements in medical care. Advancement in medical facilities and public health service helped reduce death rate. Immunization has helped to check epidemics like measles, cholera, malaria, influenza, TB, Polio, etc, and this has reduced death rate tremendously.
- Crude Birth Rate is expressed as the number of births per 1000 people in a given population.
It is used to make population projections over a period of time.
- Fertility rate (FR) is the average number of children that would be born to
a woman if she were to live to the end of her childbearing years and bear
children in accordance with current age-specific fertility rates. It can also
be Total period fertility rate (TPFR) of a population. Age specific fertility
rates is number of births occurring during a given year or reference period
per 1,000 women of reproductive age classified in single-or five-year age
groups
- Child mortality rate is the probability per 1,000 that a newborn baby will
die before reaching age five, if subject to age-specific mortality rates of the
specified year.
- According WHO, globally, under-five mortality rate has decreased by
53%, from an estimated rate of 91 deaths per 1000 live births in 1990
to 43 deaths per 1000 live births in 2015. With the end of the MDG era,
the Sustainable Development Goals (SDGs) period have set in where the
target is to end preventable deaths of newborns and children under 5
years of age.
- The proposal is for all countries to aim reduce under-five mortality to at
least as low as 25 per 1000 live births.
- Infant mortality rate is the number of infants dying before reaching one
year of age, per 1,000 live births in a given year.
11.2. Reasons for population census.
ACTIVITY 11.2
Census in Rwanda dates back to the 1970s. To date, four modern censuses have successfully been conducted in Rwanda, in 1978, 1991, 2002 and 2012…
The RPHC4 is a reliable and comprehensive source of data which compared to other official statistics data sources (administrative data, surveys, etc.) allows for disaggregation to the lowest geographical level. The RPHC4 was undertaken to update the national mapping and demographic databases, to provide indicators for monitoring poverty reduction strategies and achievement of international development goals (MDGs, ICPD-PoA, NEPAD, etc.) and to strengthen the technical capacity of the National Institute of Statistics of Rwanda (NISR)…
In order to ensure focused functioning during the whole period of Census
execution, a Census Unit was created within the NISR, as an executing
unit, and benefiting from other financial, logistical and technical support
services from the NISR
Following the preparatory phase of the Census, which consisted of the
production of the project documents, schedule and Census budget, the
following technical activities were undertaken:
- Census mapping;
- A Pilot Census;
- Questionnaire and manual development;
- Census publicity and sensitization campaign;
- Recruitment and training of field staff;
- Census enumeration; and
- Post-enumeration activities...
This Atlas is organized into 4 main parts: Administrative Structures, Physical characteristics, , Socio Economic Infrastructures and Thematic indicators. The 4th part is the main one, dealing with thematic indicators organized into 11main themes:
• Migration
• Economic Activity and Labour Force Participation
• Non-Monetary Poverty
• Education
• Gender Status
• Socio-economic characteristics of persons with disabilities
• Socio-economic Status of Children
• Socio-economic Status of Youth
• Socio-economic Status of Aged People
• Housing
(source: Fourth Population and Housing Census, Rwanda, 2012. CENSUS ATLAS January 2014)
a. Read the passage above and determine the meaning of population census.
b. Apart from the number of people, what other important variables does a population census identify?
11.2.1. Meaning of population census:
This is the counting/ enumeration of people living in a certain area at a certain time. Population census: This is the counting/ enumeration of people living in a certain areas at a certain time.
11.2.2. Reasons for carrying out population census
The reasons for carrying out population census are:
- To determine the population growth rates i.e the speed at which the population is changing.
- To determine the correct size of population. This is helpful in planning for services that the government intends to provide to the public.
- To establish the quality of population in terms of skills, health, education etc. a quality population is essential for the growth of an economy.
-- To determine population distribution in terms of sex, age, region etc. this
helps to determine the degree of dependence and its important in the
planning process.
- To determine the rate of employment and unemployment.
- To establish the rate of internal and external migrations.
- To help in the planning processes.
- Collect data at the national level to facilitate calculation of essential
demographic rates, especially rates for fertility and infant and child
mortality, and to analyze the direct and indirect factors that determine
levels and trends in fertility and child mortality
11.3. Difficulties met when carrying out population census
- Lack of adequate number of skilled enumerators to conduct the
exercise effectively. This calls for training the enumerators first. Such
trainings increase the cost of conducting a census.
- Inadequate funds. In most cases, developing countries lack enough
funds to finance population censuses. They are forced to borrow money
for the exercise. This increases the debt burden. On other occasions, the
population census is postponed and the country only relies on estimated
figures/projections.
- Unwilling population. The population may not be supportive of the
exercise. The people may give it a wrong interpretation and/or relate it
with politics. This makes them give wrong information which will give
wrong analyses. This calls for massive sensitisation before the exercise
commences which in turn increases the cost.
- Hard to reach areas. A population census covers all areas of the country.
In developing economies where communication infrastructures are
not fully developed, there are areas that are so remote and accessing
populations there is difficult. This delays the exercise. It may even bring
in some inaccuracies where the unserious enumerators may be tempted
to get information from second hand sources.
- Questionnaires that ask inappropriate questions. Some questions
given by on the questionnaire may not bring out the suitable required
information. This is when they are not designed by competent firms.
- Corruption in the agencies concerned. In most developing economies,
corruption is a common evil. Finances meant for census activities may
be embezzled and put to private use, tenders for the supply of materials
like questionnaires, stationary, etc may be offered to incompetent firms
at inflated costs etc. This increases the total cost of the exercise and may
bring in inconsistencies which affects the final outcome.
- Political instability. In most developing countries, there are instabilities
that cannot allow population censuses to go on successfully. For instance,
the conflicts in Burundi, Central Africa Republic, South Sudan, DRC,
Alshabab activities in Somalia, Boko Haram in Nigeria to mention but a few
cannot allow a successful census if it was to take place in such countries.
- People giving incorrect information. Some people, for different reasons,
ranging from political inclinations, illiteracy, to limited sensitisation may
give wrong information. This misguides policy makers.
APPLICATION ACTIVITY 11.1
Rwanda has strategically chosen to look at its population as a vital
human resource, the desired outcome for which is a creative, healthy
and wealthy population. The 2012 census
showed annual population growth for Rwanda slowing from 3.2% in
2002 to 2.6% in 2011,
though it remains among the highest in Africa. Over the same period, the
population has
increased from 8.1 million to 10.5 million while population density
increased from 321 persons
per square kilometre to 416 persons per square kilometre. This is the
highest in Africa and
among the highest in the world. The decline in the population growth
rate indicates the
success from the sustained campaign on responsible family planning, the
increased uptake of contraceptive methods for both men and women,
and improved living conditions including universal access to health and
basic education…(EDPRS 2)
Read the information above and answer questions that follow:
i. Discuss reasons why Rwanda looks at its population as a vital human resource.
11.4. Population growth.
Table 11.1 World population by region today.
ACTIVITY 11.3
Study the table11.1 above showing world population by region and
discuss the following:
i. Why is the annual percentage change in population very high in
Africa and low in Asia, yet Asia has the largest population?
ii. Asia has the bigger land area than North America, yet it has the
biggest population density. In your own view, what causes that
phenomenon?
iii. Why do you think Africa has the lowest percentage of urban
population and what is the economic effect of this on Africa’s
economy?
iv. Why do you think the fertility rate is highest in Africa?
v. Africa and Latin America and the Caribbean have a negative in
Migrants. Explain the meaning, causes and its impact of increasing
population to the economies of those areas.
11.4.1 Meaning population growth
Population growth is the increase or decrease in population of a given area/ region/country over time. It is measured by percentage change in the population.
There are three types of population growth.
1. Artificial population growth rate. This is the increase or decrease in population coming as a result of the differences between immigration and emigration. When a country receives more immigrants, the population increases. But when there is a high number of emigrants, the population reduces.
2. Natural population growth. This is increase or decrease in population as a result of changes in birth rates and death rates.
3. Actual population growth: This is population growth resulting from combination of natural and artificial growth.
Actual population growth = Birth Rate (BR)-Death Rate (DR) + Net migration (Immigration-Emigration).
11.4.2. Factors responsible for high population growth rate.
There are three major determinants of population growth:
- Birth rate.
Birth rate is the number of births in a year per thousand of the population. If
the birth rate increases, other things remaining constant, the size of population
increases. While if the birth rate decreases, other things equal, the size of the
population reduces.
- Death rate.
Death rate is the number of deaths in a year per thousand of the population. If
the death rate increases, other things remaining constant, the population size
will decline. While if the death rate decreases, other things remaining constant,
the population size will increase.
- Migration.
The change in population due to migration is referred to as artificial population
growth rate. The population will increase if immigrations exceed emigrations
and vice versa. Migration could be due to a number of reasons including: search
for employment; search for a better living condition; political and insecurity
problems in the home country.
11.4.3 Calculation of population growth
There are three types of population growth.
a. Artificial population growth rate. This is the increase or decrease in
population coming as a result of the differences between immigration and
emigration. When a country receives more immigrants, the population
increases. But when there is a high number of emigrants, the population
reduces.
b. Natural population growth. This is increase or decrease in population
as a result of changes in birth rates and death rates.
Natural population growth rate =
a. Actual population growth: This is population growth resulting from
combination of natural and artificial growth.
Actual population growth = Birth Rate (BR)-Death Rate(DR) + Net migration(
Immigration-Emigration)
Example1:
In 2017, there were 3,250 births in Kigali city with population of 223,000.
Estimate the Crude Birth rate.
CBR = (Live births ÷total population) X 1,000.
CBR = (3,250 ÷ 223,000) X 1,000
CBR = 14.57.
So, there were 14.57 births for every 1,000 people in Kigali city.
Example 2:
In Kayonza district, in 2018, there were 5663 births. The total population was
149,442. Estimate crude birth rate.
CBR = (Live births ÷total population) X 1,000.
CBR = 5663/149,442 * 1000 = 37.9.
So, there were 37.9 births for every 1,000 people in Kayonza district.
Example 3:
In Kayonza district, in 2016, there were 6889 deaths. The total population was
149,442. Estimate crude birth rate.
CDR = (Deaths ÷total population) X 1,000.
CDR = 6889/149,442 * 1000 = 46.09.
So, there were 46.09 death for every 1,000 people in Kayonza district.
Example 4:
In 2016, Country “Z” had 8,320 immigrants and 7249 emigrants, according to
their international arrivals and departure statistics. The total population (June
2016) was estimated as 1,258,000. Calculate the crude net migration rate at that time.
Crude net migration rate = I – E / P * 1,000
Where;
I is the number of immigrants or in-migrants
E is the number of emigrants or out-migrants
P is the total midyear population of the country or designated area.
The NMR is (8,320-7249)/1258000 * 1000 = 0.85.
Example 4:
Given that Country “X’s” birth-rate is 82 and its death rate is 57, its net migration
rate is 35.
Estimate
i. Natural population growth rate.
ii. Actual population growth rate.
Solution:
i. Natural population growth rate = (BR – DR) /1000 *100
= NPGR = (82 - 57) / 1000 * 100
NPGR = 2.5.
ii. Actual population growth rate.
Actual population growth = Birth Rate (BR)-Death Rate (DR) + Net migration
(Immigration-Emigration) / 1000 *100.
= (82 – 57) + 35 / 1000 *100
Actual population growth rate = 6.
11.4.4. Effects and measures to control population growth
a. Effects of high population growth rate
i. Positive effects:
- Labour supply. Labour supply increases leading to an increase in the
level of output. Output will only increase if there is an abundance of
complementary factors — land, capital, otherwise the law of diminishing
returns may occur. An increasing population means that the majority of
the people are young. Many people will be entering the labour force. Young
people are energetic, initiative, inventive and willing to accept new ideas.
An increasing population results into greater mobility of labour. All in all,
an increasing population results into economic growth and development.
- Wider market. The market size becomes bigger provided the additional
population is employed. If the market enlarges, then investment, savings
and output will all increase. Economies of scale will be enjoyed. Economic
growth and development will be attained.
- Increased investment. An increasing population stimulates investment
and therefore, more employment opportunities will be created.
- Revenue. Due to an increase in investment, government revenue is bound
to increase.
- Security. A growing population leads to the creation of big armies which
are crucial for the country’s security. However, this will depend on whether
the army is using up to-date modern military equipment.
ii. Negative effects:
- Low capital accumulation. Population growth retards capital
accumulation. People are required to feed more children with the same
level of income and hence a decline in the per capita income. This reduces
the already low savings and consequently a low level of investment.
Besides, a large amount of resources is diverted from productive projects
to the setting up of social infrastructure facilities. As a result, capital
accumulation is adversely affected. Employment opportunities are also
limited.
- Balance of payments problem. When population increases rapidly,
domestic consumption of exportable goods increases and consequently
there is a decline in the exportable surplus. Less foreign exchange is
therefore obtained. On the other hand, to meet the demand for a rising
population, more food and other consumer goods are required. It leads
to an increase in the volume of imports. More foreign exchange is spent.
Reduction in the volume of exports and an increase in the volume of imports
lead to a balance of payments deficit. Consequently, the government may
be forced to reduce the importation of capital goods and hence capital
accumulation is affected. Economic growth and development are retarded.
- Problem of inflation. As population increases, demand for goods and
services also increases. Failure of supply to match the demand leads to an
inflationary situation.
- Problem of unemployment. A rapidly increasing population growth
rate leads to the problem of unemployment. As population increases,
the proportion of workers to the total population increases. Due to the
absence of complementary factors (land, capital), it is difficult to increase
the employment opportunities.
- Adoption of poor technology. As a rapidly growing population reduces
the rate of capital accumulation, the technology is kept at a low level. A
rising population growth rate reduces incomes, saving and investment
and consequently the people are compelled to use poor technology, which
retards capital accumulation.
- Environmental threats. The expansion of human activity and associated
loss of habitat are the leading causes of the unprecedented extinctions of
plant and animal species worldwide. The loss of biological diversity leads
to instability of ecological systems, particularly those that are stressed by
climate change or invasion of non-native species.
- Problem of poverty and dependants. Rapid population growth
aggravates poverty in developing countries by producing a high ratio of
dependent children for each working adult. This leads to a relatively high
percentage of income being spent on immediate survival needs of food,
housing, and clothing. A rapidly growing population necessitates larger
investment in the social infrastructure. Lack of available capital continues
to frustrate the attempts of many developing countries to expand their
economies and reduce poverty. Resources are diverted from directly
productive assets (industries) to the setting up of the social infrastructure.
Education, health, medical, transport and housing facilities are not
enough due to the scarcity of resources. Too many people are chasing too
few of these social facilities. Consequently, the quality of the population
declines. Children attain a low level of education and start working at an
earlier age. Families are acquired at an earlier age and hence the problem
of dependants is aggravated. Consequently’ a low standard of living is
experienced.
- Massive Rural Urban migration problems. Increasing numbers and
declining resources have caused ever increasing migration from rural to
urban areas. Cities in developing countries are growing much faster than
their administrations can cope with. Consequently, there is overcrowding
and shortages of housing, water and sanitation in urban areas. With a
growing proportion of citizens living in slums and shanty towns, diseases
are of very serious concern.
- Threats to internal and international security. Population growth is a
major contributor to economic stagnation through its depressing effect
on capital formation. With growing numbers of young people attempting
to enter the labour force, many developing countries have extraordinarily
high levels of unemployment. Often high rates of unemployment give
rise to severe political instability, which ultimately threatens national
and international security. The combination of poverty and violence
is adding rapidly to the number of refugees seeking to move into more
stable and prosperous areas. Growth of refugee and migrant populations
are contributing to political instability and economic dislocation in many
countries.
11.4.5: Measures to control population growth
ACTIVITY 11.4
Basing on the photo below, explain what you think those people are
demonstrating about? What do you think should be done to ensure that
the population achieves a healthy and wealthy nation?
- Introducing sex education in the school curriculum to educate the youths/
teenagers about the dangers of early sex which normally results into
unwanted pregnancies which increases birth rate.
- Encouraging family planning which includes the use of contraceptives.
- Promoting girl child education since educated people produce few
children because of different reasons.
- Discouraging early marriage by raising the age of consent and punishing
those who break the law.
- Legalize abortion to prevent unwanted pregnancies where marriage laws
are difficult to enforce.
- Encouraging international migrations so that people can move to different
countries
- Setting up institutions to encourage population control e.g. family
planning clinics, hospitals etc.
- More campaigns to discourage polygamy which results into high birth
rates
- Improve health facilities to reduce infant mortality rates to assure parents
that the few children produced will survive.
- Reducing the demand for children by reducing their incentives like free
education and bursaries. Etc.
- Rural development programs e.g. modernization of agriculture and
establishing socio- economic infrastructure.
- Use of coercive measures e.g. fines, penalties, jail sentences or sterilization
of men who break population laws.
- Increasing government expenditure so as to increase productivity such
that economic growth copes with population growth.
- Encouraging social mobility among women by taking up formal jobs.
- Provision of social and economic incentives to small families as a means
of discouraging people from having large families e.g. giving free child
education to the first 2 children in a family, housing and free medical
facilities to such families.
- Economic disincentives are instituted on large families’ e.g. denial of free
education, medical care, high taxes on such families etc.
- Encouraging internal migrations from areas of dense population to
sparsely populated areas.
- Massive sensitization to the public by the government and nongovernment
organization about the dangers of high population growth
rate and consequences of many children.
APPLICATION ACTIVITY 11.2
Rwanda Education Board (REB), through its department of curriculum
development has of recent taken a decision of revising the schools’
curriculum in all subjects at all levels. One of the cross cutting issues
addressed in all subjects at all levels is comprehensive sexuality
education.
1. What do you think was the intention of REB to tackle this issue?
2. Why is it necessary for your country to control the rapid population
growth rate?
3. What measures can be taken by the government of Rwanda to
control population growth.
11.5. Theories of population
ACTIVITY 11.5
1. Study the information in the table below and answer questions
below it.
a. Plot the information on a single graph (Population growth and
Food supply against Time) to determine a point (Lo) where
Population growth is equal to Food supply.
b. identify the conditions that are likely to set in after time (Lo).
c. Suggest measures that can be used to avoid the conditions
identified above.
11.5.1 Malthusian population theory
11.5.1.1. Introduction to the Malthusian population theory
This theory was put up by Reverend Thomas Robert Malthus an English
Economist (1798 — 1823) who pointed out the dangers of over population
in relation to the supply of food. It explains the relationship between the
population growth in relation to food supply. i.e. Population depends on food
supply.
When food supply increases, population growth increases and vice versa. The
theory states that population increases faster than food supply and if unchecked
leads to misery. Man’s biological capacity to reproduce himself exceeds his
physical capacity to increase the food supply.
2. Different economists came up with different theories on
population. Make research on the following population theories:
a. The Malthusian population theory
b. The theory of demographic transition
c. The theory of optimum population
11.5.1.2. Assumptions of the Malthusian population theory
Reverend Malthus assumed that:
- Population growth depends on food growth and that when food supply
increase, population also increases
- The supply of land is fixed thus the operation of the law of diminishing
returns.
- Population grows at a geometric rate i.e. doubles itself per period of time
e.g. 4, 8, 16, 32, 64 etc.
- Food increases at an arithmetic rate i.e. adds a constant figure per period of
time e.g. 8, 16, 24, 32, 40 etc.
- At time ‘Lo’ population will be equal to food supply and this is what he calls
the population trap.
- Beyond the population trap, people be subjected to conflicts, starvation,
famine, death, accidents, wars etc. and he calls these positive checks i.e.
positive checks control population growth by increasing death rates
- Man’s capacity to reproduce himself is greater than his capacity to
produce food. Malthus therefore concluded that at one time population
growth will be too much to be fed by the available food and this will lead
to misery, suffering and death.
- Every effort to improve the conditions of people through state subsidies
and private charity would fail because of the increased population growth
it generates.
- He advocated for negative checks like late marriages, moral restrictions,
celibacy that control population growth by reducing birth rate.
From the figure 11.1 above, line bcd represents the growth of population in the
absence of any checks. Line ace represents Food growth. The actual population
growth rate is represented by line bce in the presence of checks. Beyond time
L0, population growth exceeds food supply, and therefore people are likely to
starve to death. Malthus indicates that always there are positive and negative
checks operating.
11.5.1.3. Applicability/ Relevance of the Malthusian theory in LDCs.
To a small extent, the Malthusian population theory is applicable in LDCs
economies in the following ways;
- Family planning measures are being used in many countries as suggested
by Malthus to control population growth
- The positive checks like diseases, accidents etc. exist in many countries
- In many parts of the world, pressure on land forces many people into
disputes and migration
- Some areas in the world face food shortages as suggested by Malthus and
this has led to deaths as a result of positive checks
- Land being a fixed factor, faces diminishing returns in that when population
increases, productivity of the land decreases and so food supply may
reduce as population increases.
11.5.1.4. Criticisms/ limitations of Malthusian theory
To a big extent the theory is criticized because of the following reasons.
- He did not consider the role of foreign aid and charitable organisations
in assisting the increasing population through provision of food to over
come hunger in such areas affected by
- Malthus never stated the time when population growth would equal the
food supply such that the country enters a population trap. It does not
give a yardstick to determine the time when the population trap will be
reached. If the time were known, then probably the government would
devise ways and means of either increasing food supply or controlling
population.
- Food is not the only determinant of population growth as suggested by
Malthus but there are other causes like migration, level of education,
cultural values etc.
- He underrated the agricultural technological developments in the
production of food. He could not foresee the unprecedented improvements
in agricultural technology. Due to this rapid improvement in agricultural
technology, the food supply has increased much faster than the arithmetical
progression.
- The theory did not put into consideration international trade which can
increase food supply by importation but considered a closed economy.
Food supply can be increased through international trade where food
production in one country may be limited by limited supply of land.
However, with free trade and regional integration, supply can be increased
through international trade so as to avoid positive checks setting into
motion.
- The possibility of modernizing agriculture to increase agriculture was not
foreseen by Malthus. i.e. Productivity of land can be increased application
fertilizers and use of high yield varieties to increase food supply.
- There is no mathematical relationship between food growth and
population growth
- International migrations were ignored by the theory. The population
could not outstrip the food supply due to international migrations. I.e. he
didn’t not consider people moving from one country to another to reduce
population pressure
- Malthus never thought of the possibility of getting additional supplies of
land by opening up new areas.
- According to Malthus, preventive checks possibility only pertains to moral
restraint and late marriages. Malthus never thought of the introduction of
modern techniques of family planning devices.
- Malthus takes the increase in population as a result of rising birth rate.
Population, however, has increased tremendously due to a decline in
the death rate. He could not foresee the rapid improvements in medical
facilities.
- Population figures available do not support the view that population
grows geometrically
- The theory is based on subsistence production but current production is largely monetized.
11.5.2. The theory of demographic transition
ACTIVITY 11.6
Carry out research on the following questions and then present to the class.
1. What is demography transition theory?
2. Explain with the aid of illustration, the stages of demographic transition.
3. Which stage do you think Rwanda belongs and why?
4. Differentiate between demographic dividend and demographic trap
Demography is the study of population characteristics like birth rates and
death rates and their effects on population changes.
The theory of demographic transition was first developed by the American
demographer Frank W. Notestein in the mid-twentieth century, but it has
since been expanded upon by many others. The demographic transition theory
is a description of the changing pattern of mortality, fertility and population
growth rates as societies move from one demographic era to another. It is an
explanation of population growth in a historical manner.
Frank W. Notestein (1902-1983)
Figure 11.2: The five stages of demographic transition.
b. Stages and Illustration
Stage One
This stage dominated most of the pre-industrial societies. In stage one, death
rates and birth rates were both high, and influenced by natural events, such as
drought and disease, to produce a relatively constant and young population.
The majority of deaths were concentrated in the first 5–10 years of life. Family
planning and contraception were virtually non-existent; therefore, birth rates
were essentially only limited by the ability of women to bear children. Death
rates tended to match birth rates and population growth was small.
Reasons for high birth rate include:
- Limited birth control
- high infant mortality rate encourages the birth of more children
- Children are seen as a future source of income, therefore it would be more
economically beneficial to have more kids.
Reasons for high death rate:
- high incidence of disease
- poor nutrition and famine
- poor levels of hygiene
Stage Two
This is the early expanding stage of population growth. There is a decline in
death rate but birth rate remains high leading to an increase in population.
The changes leading to this stage in Europe were initiated in the Agricultural
Revolution. In the 20th century, the falls in death rates in developing countries
tended to be substantially faster.
The decline in the death rate is due initially to two factors:
- Improvements in the food supply brought about by higher yields in
agricultural practices.
- Significant improvements in public health reduce mortality, particularly
in childhood.
- Improvement general personal hygiene, growing scientific knowledge
through improved education and social status of mothers.
A consequence of the decline in mortality, there is rapid rise in population
growth that equalled to a population explosion. The gap between deaths and
births widens. This growth is a result of a decline in deaths.
In Stage Two of the demographic transition there is change in the age structure
of the population. The age structure of the population becomes increasingly
youthful and more of these children enter the reproductive cycle of their lives
while maintaining the high fertility rates of their parents.
Reasons for falling death rate:
- Improved public health.
- Better nutrition.
- Lower child mortality.
Stage Three
Stage Three moves the population towards stability through a decline in the
birth rate. Several factors contribute to this eventual decline, although some of
them remain speculative:
- Increasing changes the traditional values placed upon fertility and the
value of children in society.
- Due to education and access to family planning, people begin to reassess
their need for children and their ability to raise them.
- In both rural and urban areas, the cost of maintaining children raised due
to the introduction education and the increased need to educate children
so they can take up a respected position in society.
- Increasing female literacy and employment lowers the uncritical
acceptance of childbearing and motherhood as measures of the status of
women.
- Improvements in contraceptive technology are now a major factor.
Fertility decline is caused by changes in values about children and sex as
by the availability of contraceptives and knowledge of how to use them.
- In stage three there is a change in the age structure of the population.
There is;
1. A reduction in the youth dependency ratio.
2. An increase population aging.
3. An increase in the ratio of working age to dependent population.
Demographic dividend is the change in the population structure where there
is an increase the working age population and a decline in the dependent
population.
Demographic trap is where there is a decline in the death rate that is not
followed by a corresponding decline in birth rates.
Stage Four
This occurs where birth and death rates are both low, leading to a total
population which is high and stable.
Death rates are low for a number of reasons, primarily lower rates of diseases
and higher production of food. The birth rate is low because people have
more opportunities to choose if they want children; this is made possible by
improvements in contraception or women gaining more independence and
work opportunities.
Because of low birth rate and low death rate, population growth is small and
fertility continues to fall. There are changes in personal life styles, and more
women are in the work force, therefore less couples are having kids.
Stage Five.
at this stage, death rate slightly exceeds the birth rate, and this causes population
decline. This stage has only been recently recognised, and there are very few
countries that are considered in stage 5.
Reasons for low birth rate include:
1. A rise in individualism
2. Greater financial independence of women
3. Lack of resources for future generations
11.5.2.3. Limitations of demographic transition theory in developing
countries
- Developing countries differ in many aspects from western nations as they
moved through the demographic transitions.
- Population growth is higher now days in many countries than before.
- Mortality rate declines have been much more rapid.
- Fertility levels are much higher.
- Migration does not serve as a safety value
11.5.3. Theory optimum population
ACTIVITY 11.7
Study the picture above, comparing the number of hands fetching from
a single tap.
1. Interpret such a situation and explain the effect such a situation
could have on the economy.
2. What is the name given to a situation where population growth
matches with available resources?
3. Illustrate the situation mentioned in question 2 above?
4. What are the effects for reducing population in Rwanda?
11.5.3.1: Theory of optimum population:
Optimum population This is the population which provides enough labour to
optimally utilize the available resources to give maximum average product i.e
population is equal to resources and average product is at its maximum.
Optimum population yields the highest quality of life. Each person has access
to adequate food supply, water, energy, quality air, adequate medical care,
recreational facilities etc.
Given a certain amount of resources, the state of technical knowledge and a
certain stock of capital, there is a definite size of the population at which the
real incomes per capita is the highest
In the figure 11.3 above, before point P0, the population is still low compared
to the resources available. At point p0 there is optimum population where the
population matches the available resources and after that point the population
exceeds the available resources and utilisation of resources.
11.5.3.2. Under population.
Under population is a situation whereby available population is so small that it
cannot put the available resources to full utilization i.e resources are greater
than population. Average product increase with any increase in population. It
is a situation whereby the size of the population is small in relation to available
resources of the country. It is situation where the size of the population is below
the equilibrium.
i. Positive effects of under population
- There is no congestion in the country. The country’s population has
enough space to utilise and enjoy.
- The rate of employment of the population is high. The population is low
and has more resources work on.
- The available population has an increased social and infrastructural
access i.e there is a high per capita in terms of social and infrastructural
facilities.
ii. Negative effects of under population:
- Underutilisation of resources. There is less labour to exploit the available
resources. Some resources especially land remains idle.
- Lack of innovativeness and dynamism in the economy. There is no
competition in the economy since the supply of resources is more than
enough. The population feels satisfied with the existing conditions.
- There is low aggregate demand. The population is so low that it cannot
stimulate an increase in aggregate demand. This has an effect of keeping
production very low.
- There is a high average contribution per person for establishing
certain ventures that are needed by the public. Because the population is
small, the cost per head for establishing public utilities is high.
- It slows economic progress. Production is low and this does not
stimulate progress in the economy.
- Low tax revenue. Economic activity also remains low. This is because
there is no aggregate demand to stimulate production. The tax base
remains low and this keeps tax revenue very low.
- Excess capacity in production. Resource utilization operates below full
capacity. This is because aggregate demand is low.
11.5.3.3. Over population.
Overpopulation is a situation where the available resources are not enough
to sustain the population i.e population is greater than the resources. Average
product reduces as population increases.
Over population may be a result of,
- Rapid increase in birth rate. This increases the total population. This may
be due to ignorance about family planning, early marriages etc.
- Rapid reduction in death rates. This may be due to improvement in
medical care and public health.
- Skewed distribution of arable lands. This created regional imbalances in
access to land as a resource, which breeds over population in some areas.
- Culture (polygamy). Marrying many wives goes in hand with producing
many children. In situations where children are valued as a source of
security against any eventualities, couples produce very many children.
- Immigration i.e people from other countries settling into the country.
i. Merits of over population.
- High supply of labour. There is enough population to supply the necessary
labour force that is essential for production to expand.
- Large market. The large population provides a ready market for firms.
Ready markets encourage the expansion of the scale of production in
different industries. This increases the country’s GDP and tax base.
- Increased pressure for development which created innovative spirit.
There is high competition for commodities, utilities, space, and social
services. This makes everybody competitive and innovative which makes
the economy dynamic.
ii. Demerits of overpopulation
- High dependence ratios. The individuals who do not have any resources
depend on others. The country also depends mostly on donor funding.
This dependence syndrome limits the scale of personal and public savings
and investments. This impacts on the growth of the economy at large.
- Increased government expenditure. The government has to increase
spending on social services to carter for high population. Spending on
crime prevention, law and order, education, health and guarding against a
number of social costs multiplies.
-- Congestion. Because of very many people, there is a likelihood of
congestion. This breeds poor and unhygienic living conditions.
-- Food shortages. The population exceeds supply of food. This is because
the resources that would be used to produce food are over exhausted by
the excess population.
-- Low standards of living. Food shortages, overcrowding and social
tensions as well as unemployment imply a poor standard of living.
-- Social tension and conflicts. Competition for land, food and social
services results into conflicts quarrels and rifts. This undermines the
social cohesion of the society.
-- Over utilization of resources. The available population will be strained.
The y will be over exhausted. This affects all efforts towards sustainable
development.
-- Inflationary tendencies. Because of low production that is strained by
limited resources, aggregate supply remains low. Yet due to a high number
of consumers, and government spending on non-productive ventures,
aggregate demand increases. This brings inflationary conditions in the
economy.
-- Unemployment. High numbers of people will be idle. This is because
they lack resources to use to create more employment opportunities.
-- Land fragmentation. Shortage of land for both settlement and agriculture
increases. Competition sets in all of which results into fragmentation. This
also brings further decline in agricultural output.
-- Environmental degradation. Competition for resources may result into
over exhaustion and degradation of the environment.
APPLICATION ACTIVITY 11.3
1. Write proposals to the Ministry of Health on how best positive checks and negative checks as suggested by Malthus can be adopted in Rwanda as a long term solution for population growth and food shortage.
2. Suggest the factors that make population increase geometrically and food increase arithmetically.
END UNIT ASSESSMENT
1. Rwanda has an estimated 12.63 million people in 2019.The growth rate is 2.64%, its density of 479.42/km2 at a fixed area
26,338/km2. http://worldpopulationreview.com/countries/rwanda-population/
a. Is it a benefit to have this population growth rate or a threat to the future of Rwanda?
b. Explain the impact this growth rate will have on the general welfare of Rwandans
2. Rwanda believes that early pregnancies among the youth is a major cause of high population growth rate and poverty. Discuss.
3. To what extent has Malthusian population theory failed to solve manpower problems in developing countries like Rwanda?