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 12 LABOUR AND WAGES
Key Unit Competency: Explain the impact of labour mobility on the economy.
INTRODUCTORY ACTIVITY
Isimbi is a senior mechanic in the ministry, Kagabo is a porter at a construction site, Uwase is an architect with a construction company in Kigali, Ishimwe is a secondary school teacher, Mukama is a rice farmer, Mbabazi is a Pilot with a reputable air flight company and Rangira works as a maid servant.
i. Can you identify the daily activities done by each of the above workers?
ii. Do you think Ishimwe and Mbabazi can exchange their jobs and work effectively? If no, why?
iii. Do you think the above categories of workers earn the same level of payments? If no, who earns more and why? Who earns less and why?
iv. What do you think can be done to make those who earn less also increase the rewards of their work?
v. What in your own view can be done to protect Kagabo and Rangira from being overworked by their employers and to improve their economic welfare?
12.1. LABOUR
ACTIVITY 12.1
i. Identify what is taking place in the pictures above.
ii. Do the people in the two pictures have and use the same skills?
Explain your answer.
iii. Of all the people in the two pictures, who is using
a. Physical energy?
b. Mental energy?
12.1.1. Meaning of labour .
In unit 26.2 of Year one book, we looked at factors of production. Production of goods and services require resources that we call factors of production and labour is one of them.
Labour refers to all human effort both mental and physical that is used in the production process in return for some reward. Labour is paid/rewarded with wage which may be in cash or kind. Labour is an important factor of production because,
- Labour is an active factor of production. Production from land and capital starts only when labour is applied. Production begins with the active participation of labour force. Therefore, Labour is an active factor of production.
- Labour is perishable is a commodity. Labour is more perishable and cannot be stored. For instance the labour of an unemployed worker is lost for the time when he does not work.
- Labour cannot be separated from the labourer. Labour and labourer are indispensable for each other. For example, it is not possible to bring the ability of a teacher to teach in the school, leaving the teacher at home.
Land and capital can be separated from their owner, but labour cannot.
- Labour force refers to the number of all economically active persons lying between the age group of 15-64 year less the disabled and others who are inactive (unemployable). The labour force comprises all those who work for gain, whether as employees, employers, or as self-employed, and it includes the unemployed who are seeking work.
- Labour economics involves the study of the factors affecting the efficiency of these workers, their deployment between different industries and occupations, and the determination of their pay
12.1.2. Categories of labour.
Labour force may be:
Unskilled labour.
This is labour which has received no special training and has few specific skills. As our society has grown into an increasingly technological one, the members of this group have developed more and more skills. A mechanic, for example, used to be considered unskilled labour. Today that is no longer the case. Mechanics require a great deal of skill and training to work with today’s modern engines.
Semi-skilled labour.
This refers to labour which has some training to handle certain tasks but with little or no skills.
Skilled labour.
This is labour that has received specialised training to do their jobs. They have developed a special skill and may or may not need to be licensed or certified by the state. Some examples of skilled labour are: carpenters, plumbers, electricians, business executives and managers, artisans, accountants, engineers, police, mechanics, etc.
Professionals.
These are the elite of the labour grades and include those workers who need an advanced training to do their jobs. The three primary groups of professionals are doctors, lawyers and teachers. These are white collar workers.
Labour can also be grouped under:
a. Productive and unproductive labour: Productive labour is that labour which is actively involved in the production process and it is paid wage or salary.
b. Unproductive labour is one that isn’t involved actively in the production of goods and services.
12.1.3. Labour force.
Labour force refers to the number of all economically active persons lying between the age group of 15-64 year less the disabled and others who are inactive (unemployable). The labour force comprises all those who work for gain, whether as employees, employers, or as self-employed, and it includes them unemployed who are seeking work.
Labour economics involves the study of the factors affecting the efficiency of these workers, their deployment between different industries and occupations, and the determination of their pay.
12.1.4. Characteristics of labour force in LDCs
Different countries have different population structures and labour force characteristics. But there are general characteristics of labour force that are common to developing countries and these include among others the following;
-- It is dominated by young people below 35 years of age due to high population growth rate
-- Male dominate the labour force especially this is due to cultural ties that limit women from working.
-- A big percentage of the labour force is illiterate and is classified as unskilled.
-- Low levels of productivity due to low levels of education and skills
-- Most of the labour force is employed in agriculture sector
-- Excess supply of labour compared to demand for it thus high unemployment rate
-- Wage differentials especially between the skilled and unskilled labour
- High rate of absenteeism due to lack of work ethics
- Labour is generally immobile due to cultural and tribal beliefs and ties and poor communication network
- The largest single employer is the government though private sector is taking up quickly at a faster rate.
12.1.5. Determinants of the size of the labour force
- Population size i.e. holding other factors constant, the higher the population size, the bigger the size of labour force and vice versa
- Age structure of the population; A population which is composed of the very young and the very old will have a small labour force than a
population which constitute a large number of people who constitute a large number of people in the working age group
- Retirement age; A higher retirement age results into a large labour force compared to a lower retirement age
- Government policy on child labour and effectiveness of the labour laws; where the working age is low, labour force is large and vice versa
- Health conditions of the population; if health conditions in a given society are good, there will be a large labour force and vice versa
- Duration of training i.e. the longer the students take at school, the smaller the labour force in the short run and vice versa
- Working conditions; Favourable working conditions lead to a larger labour force and vice versa
- Life expectancy at birth; If it is low, labour force will be small and vice versa.
12.1.6. Labour Demand
ACTIVITY 12.2
List down the factors you think can make your school to,
i. Employ more workers.
ii. Reduce the number of workers it employs now.
12.1.6.1. Meaning of Labour Demand
This refers to the total number of workers that employers are ready and willing to offer employments at the prevailing wage rates. Demand for labour is derived demand. It is derived from the demand for goods and services that labour helps to make.
The labour demand curve is downward sloping due to:
- A substitution effect i.e substitution of other resources for a resource that
becomes relatively more expensive.
- A scale effect. The scale effect associated with a wage increase leads to
i. Higher wages resulting in higher average and marginal costs of production.
ii. An increase in the equilibrium price of the product.
iii. A reduction in the quantity of the product demanded.
iv. A reduction in the use of all inputs used to produce the product.
12.1.6.2. Factors that determine demand for labour.
Demand for labour depends on the following,
- The price (wage) for labour. The higher the price for labour, the lower the demand for labour. The lower the price for labour, the higher the demand for labour.
- The degree of substitutability of labour by other factors. If labour can easily be substituted by other factors, its demand reduces. But if it cannot be easily substituted, demand for labour becomes inelastic.
- Demand for labour is a derived demand. It is derived from the demand for the commodities and services that labour helps to produce. If the demand for a product is high in the market, the demand for labour producing that particular type of product will also be high. In case, the demand for a commodity is small, the demand for that labour will also be low.
- The capacity of the employer/firms. If firms are strong and have a big capital base, the demand for labour increases. The existence of small, young and high cost firms.
- The number of firms (employers) available. If the number of employers is high, there is competition among them for labour. Thus, demand for labour is high.
- Proportion of labour cost to total cost. If the wages of workers account for only a small proportion to total cost of a product, then the demand for labour will high because the firm can employ more workers.
- Government labour policies. The labour policies of the government influence demand for labour, for instance, minimum wage legislation may reduce demand for labour by making it expensive.
- Elasticity of demand for the product. If the demand for a particular product is inelastic, the demand for the type of labour that produces this product will also be inelastic. The demand for labour will be elastic, if the product has substitutes and its demand is elastic.
12.1.7. Labour supply
ACTIVITY 12.3
Use the data below to answer the questions that follow.
a. Illustrate the above information on graphs.
b. How are the two curves different?
c. Discuss the factors other than wage that can make more labour force ready and willing to work as shown in table one.
d. What do you notice in the second table after wage increases beyond 30000rwf? What do you think causes it?
12.1.7.1: Meaning of labour supply.
Labour supply refers to the quantity of labour that is used in the production process measured in the number of hours worked per day. It can also be taken to mean the number of people who are able and willing to do work at a certain time and ruling wage rate.
12.1.7.2. The labour supply curve:
The labour supply curve is upward sloping from left to right showing that as the wage increases, the quantity of labour supplied also increase.
The market labour supply curve is expected to be upward sloping because an increase in the wage in a particular labour market may;
- Cause some workers in this market to work additional hours.
- Induce some workers to shift from other labour markets to this relatively more remunerative alternative employment.
- Will cause some individuals who are not currently in the labor force to enter this market.
In the second table in activity 12.3, labour is willing to work for 6 hours a day at a wage rate of 10000frw per hour. When the wage rate increases to 20000frw per hour, he puts in 8 hours of work. If wage rise to 30000frw per hour, he works for 10 hours. When the wage is pushed to 40000frw per hour, he then prefers leisure to work and is willing to work for 9 hours only. As the rises to 50000rwf per hour, he reduces the hours to 7.The supply curve shows that a worker puts in less labour when wage rate rises above 30000frw per hour. . This leads to the
supply curve of labour to bend backwards, as illustrated below;
The above curve is due to:
- Substitution of leisure for work when workers’ incomes increase.
- The worker in effect prefers leisure at higher wages.
- It is also the case with target workers. After achieving the target, the worker either reduces effort or stops to work despite an increase in the wage.
- Desire to live on accumulated wealth.
- Old age where even if the wages are high, labour may not increase supply etc.
12.1.7.3. Determinants of labour supply.
- Heath conditions labour force. When labour force is in good health, it is capable of working for more hours.
- Working conditions. Good and favourable working conditions encourage workers to stay at work and spend more hours. But when the working conditions are hostile, workers lose morale and would take any chance available to work for fewer hours.
- Total size of population and its structure. The bigger the population, the bigger the number of working population. But this depends on the age structure of the population.
- Mobility of labour. The ease with which labour can move from job to job or from one geographical area to another increases the supply of labour
- Nature of job. Heavy duty jobs that require allot of energy make workers work for fewer hours of time, for instance crushing and lifting rocks using hand labour in a stone quarry. But when the job is simple and does not require allot of energy, workers can spend more hours on work.
- Immigration and emigration. When the migration laws are relaxed, for instance under regional integration, labour force can easily move within the region without restrictions. This influences labour supply.
- Trade unions. A closed shop trade union reduces labour supply by requiring the employment of members only while an open shop trade union that has no any restriction on employment increases the supply of labour.
- Level of wages. Wage levels influence the supply of labour. High wages attract more labour force to the industry.
- Political situation. Stability of the country guarantees security to person and their properties. This will increase labour supply by even attracting emigrants from insecure areas.
- Period of training. The longer the period of training, the lower the supply of labour in that field.
- Job security. Permanent and pensionable kinds of employments attract more labour force than the temporary jobs.
12.1.8. Labour efficiency.
ACTIVITY 12.4.
Ntwali and Mugabo are considered the strongest men in their community.
Recently they competed against each other in planting seeds. The executive secretary of their cell gave them seedlings of trees to plant. By the end of the exercise that took three hours, Mugabo had planted 500 more seedlings than Ntwali.
In your groups brainstorm and make a list of your views on,
i. Why Mugabo planted more seeds than Ntwali?
ii. If you were Ntwali what would you do to plant more trees than Mugabo?
12.1.8.1. Meaning of Labour efficiency:
Different people doing the same of kind of work may not produce the same output or may not take the same amount of time to produce a certain amount of output. Efficiency of labour refers to the amount of output that each unit of labour can produce per period of time (it can also be called labour productivity). The more efficient units of labour produces more output in the shortest possible time.
12.1.8.2. Determinants of efficiency of labour.
- Health of labour. When labour force is healthy and energetic, efficiency increases. The reverse is true.
- Work Incentives. Motivations stimulate the work effort of labour force. Motivated workers are likely to produce more output than those who are less motivated.
- Other co operant factors. The quality of other resources used affects the output of labour force. For instance the machines used.
- Education (skills). The higher the skills that labour force has the higher the output produced.
- Supervision. In most cases labour force requires close supervision. If workers are not self-motivated and are left to work on their own, how much they produce per period of times may reduce.
- Wage. High wages encourage workers to settle and work efficiently. Under paid workers may feel grumbled, this may reduce their output.
- Degree of specialisation. The higher the degree of specialisation the higher the output. This is because specialisation saves time and widens workers experience.
- Organization of work. The extent to which the work is properly organised influences the level of output produced. It reduces wastage of resources and saves time.
- Working conditions. Better working conditions encourage workers to work better and produce more.
- Technology used. The methods of production used
- Experience. The higher the experience the higher the output produced.
Efficiency of labour is related to labour productivity is a measure of how much value a firm can create with its workforce. It can be looked at as how much output comes as a result of the efforts of a unit of labour per hour. It depends on how much value is created by the employee per hour of his work.
Labour productivity can be measured as a ratio of the total output to the number of man-hours to produce the output. It can also measure labour productivity as the ratio of total output to the number of workers used to produce the output. Labour productivity may be calculated using the formulae below.
or
12.1.9. Mobility of labour.
ACTIVITY 12.5
“Most people who work in Kigali city are born outside. Agasaro lives and
works in Kigali but she is born in Huye district. She previously worked
as an accounts assistant in one of the districts in the southern province.
Today she works as a social worker with an NGO in Kigali…”
From the above passage, it can be noted that Agasaro,
i. Worked in the southern province and later changed the location to Kigali city.
ii. Worked as an accounts assistant and later changed to a social worker.
Discuss the factors that made it possible for the Agasaro to change her job and job locations.
12.1.9.1. Meaning of labour mobility:
Mobility of labour refers to the ease with which labour as a factor of production can move from one area to another or one job to another. Labour mobility can therefore be geographical or occupational. Labour can either be;
a. Specific labour. This is labour that cannot be changed from one production
activity to another for example doctors
b. Nonspecific labour. This is labour that can be transferred from one use to another for example unskilled labour like car washers.
12.1.9.2. Forms of labour mobility:
a. Occupational mobility of labour. This refers to the ease with which labour can move from one job to another of job. Normally according to the job search theory, labour will never stay in one area or job but it will still keep on looking for other jobs that my pay more .
It involves two categories:
i. Horizontal mobility. A situation where labour changes from one occupation to another but it does not change its status e.g. from a teacher from good hope high school to a teacher in corner stone leadership academy
ii. Vertical mobility of labour. A situation where labour changes from one occupation to another but affects or changes its status e.g. from a teacher to a headmaster. The movement of labour form one area to another is
influenced by many factors are seen below.
Factors determining occupational mobility of labour:
- Level of education, Because of the low level of education, labour may not be able to move to another job that may require higher qualifications.
But where labour is highly educated, it can easily change jobs. However,
highly educated and specialised labour becomes occupationally immobile
because it cannot be substituted.
- Degree of advertising, where the workers are knowledgeable about the existing jobs, labour mobility will be high to take up such jobs and if the workers are ignorant about the existing jobs mobility will be low.
- Cost and length of training, jobs which involve high cost and long duration of training don’t experience much labour mobility but where the cost and the length of training is low, mobility will be high.
- Skills required, jobs where highly specialized skills are required such as accountancy, and doctoring, mobility of labour is low but jobs where specialization is not required, mobility of labour is high.
- Age of the workers, as workers grow old, they tend to settle down on their jobs and they are unwilling to change occupation thus they become immobile but where workers are young, they tend to move from one job to another.
- Government policy of retrenchment, when such a policy is carried out by the government, labour mobility will be high but if such policies are not carried out, labour will be immobile.
b. Geographical mobility of labour. This refers to the ease with which labour can move from one geographical area to another in search for work. People always move from one place to another depending on the activities that may interest them. Some move for economic reasons, social reasons and political reasons among others. The movement of labour form one area to another is influenced by many factors are seen below;
Factors influencing geographical mobility of labour:
- Transport and communication. The lower the transport cost, the easier for labour to move from one area to another and the higher the transport costs, the harder for labour to move from one place to another.
- Degree of ignorance, in cases where people are ignorant about the available jobs, the lesser the rate of movement but if people are aware of the available jobs, mobility of labour will be high
- Nature of climate, areas with good climate tend to attract more labour
compared to areas which have harsh climate ie too hot and too cold
- Level of wages, areas with high wages attract more labour than areas which give low wages
- Cost of living, labour tends to move away from areas with a high cost of living to areas with low cost of living
- Degree of advertising, if the rate of advertising is high, labour will tend to move to those areas where the jobs are but when the rate of advertising
is low, labour will be immobile.
- Institutional barriers, this includes things like language barrier and if this exists, immobility of labour will be low because it becomes hard to communicate
- Political situation; areas which are stable tend to attract more labour than those which are unstable.
NB: Social mobility. All societies are composed of social classes like
- The peasants who are tied to land.
- The working class (proletariats).
- The middle class.
- The capitalist class (entrepreneurs) who are the business owners.
Social mobility is the movement of worker from one social class to another for instance, a member of the proletariats climbing the social ladder to join the middle class.
APPLICATION ACTIVITY 12.1
For the income generating activity your economics club created,
i. What kind of and how many workers do you intend to employ?
ii. How do you intend to make them produce more output per hour?
iii. What will you do to make them stay with you for long?
12.2. WAGES
ACTIVITY 12.6
Read the following dialogue and answer the questions that follow.
Mrs Gatera: Every day, you shall be doing general cleaning. You clean the rooms, the restaurant and that hall. You know we usually have many people here. I want you to keep this place very clean. Will you manage?
Twahirwa: Oh yes I will. I have been doing this kind of work for the last 10 years. I have accumulated a lot of experience.
Mrs Gatera: So how shall I pay you? In think I will pay you per month? That’s what I prefer.
Twahirwa: No Madam. I request we count the rooms and the hall separately.
Mrs Gatera: So how much do you want per room?
Twahirwa (keeps quiet for a moment): Each of the 10 rooms I will be cleaning it for 500rwf per day and the 1000rwf for the hall.
Mrs Gatera: Okay. You can start tomorrow.
i. Of the two people in the conversation above, who is the employer and who is the employee.
ii. How much shall Twahirwa be rewarded for the services offered if he spends 30days doing the work? What do you call his rewards?
iii. What things do you think Twahirwa considered before he arrived at the money he demanded for the work?
12.2.1. Meaning and forms of wages.
• Wage is the payment for labour as a factor of production. It is a reward for labour for what it renders during production process. Wages may be;
i. Nominal wage refers to the total amount of money earned by a unit of labour as payment for services rendered during production expressed in units of a currency e.g. Francs, shillings, dollars. For instance, you employ a worker and pay him/her 300000frw per month for the services he/she renders to you. This amount which is paid in terms of money is what is called nominal wage.
ii. Real Wage refers to the purchasing power of nominal wage. The amount of goods and services that nominal wage can purchase at a certain price ruling in the market. It is the total amount of satisfaction labour receives in return for the services offered.
Real wage is a good determinant of the standard of living of the workers.
Forms of wages
Wages can be described in three forms as shown below:
- Living wages: it is a wage that is enough for the provision of the bare necessities plus certain amenities considered necessary for the wellbeing of the workers in terms of his social status.
- Minimum wages: The minimum wage may be defined as the lowest wage necessary to maintain a worker and his family at the minimum level of subsistence, which includes food, clothing and shelter. When the government fixes minimum wage in a particular trade, the main objective is not to control or determine wages in general but to prevent the employment of workers at a wage below an amount necessary to maintain the worker at the minimum level of subsistence.
- Fair wages: A fair wage is something more than the minimum wages. Fair wage is a mean between the living wage and the minimum wage. While the lower limit of the fair wage must obviously be the minimum wage, the upper limit is the capacity of the industry to pay fair wage whichompares reasonably with the average payment of similar task in other trades or occupations.
- Nominal wage refers to the total amount of money earned by a unit of labour as payment for services rendered during production.
- For instance, you employ a worker and pay him 300000frw per month for the services he renders to you. This amount which is paid in terms of money is
what is called nominal wage.
Real Wage refers to the purchasing power of nominal wage. The amount of
goods and services that nominal wage can purchase at a certain price ruling in
the market. It is the total amount of satisfaction labour receives in return for
the services offered.
Real wage is a good determinant of the standard of living of the workers
Factors that influence the level of wages in an economy.
- Cost of living. When the cost of living is high, trade unions demand for wage increments. This is meant to enable workers maintain their usual kind of life that they have been accustomed to irrespective of the rise in cost of living.
- Experience. With a high experience, labour can produce more output in the shortest possible time. This makes their rewards to increase.
- Work done. Labour paid according to piece rate system earns according to the work done. The bigger the work done, the higher the wage
- Bargaining strength of workers. When workers have a strong bargaining power, their wages may be increased. For instance, if they are form a trade union.
- Employer’s ability/capacity. Big and low cost firms enjoying economies of scale have the capacity to raise the wages of their employees unlike young small and high cost firms.
- Trade union activity.
- Time worked. Workers who are rewarded according to the time rate system will earn more if they spend more time at work and vice versa
- Nature of the job.
- Responsibilities held by the worker. Those workers who handle big and sensitive responsibilities in the organisation earn more.
- Demand and supply of labour. When demand for labour exceeds its supply, wages increase, assuming there are no controls.
- Level of education and skills. The higher the skills, the higher the wage and vice varsa.
12.2.2. Methods of wage determination.
ACTIVITY 12.7
Discuss the view that rewarding workers according to the amount of work done is better than rewarding them according to time spent on work”
There are different ways through which wages are determined some of which are seen below:
a. Time rate
This is where workers are paid according to the time they work in the period of time. In here a fixed sum of money is paid to a worker for a certain period of time say an hour or a month. The period is agreed upon by both parties
- the employer and the worker.
Advantages of time rate
- High quality of work. Workers do not rush to finish the work and be paid. They take their time and therefore produce quality work.
- Delicate machinery may not be destroyed since the workers are not rushing.
- The system is more applicable where output is difficult to measure. For instance in the service sector.
- It is easy to arrange for workers to work in shifts.
- Government can easily tax income of workers to raise revenue. This is because it is convenient to determine the tax base.
- The system gives the employer ample time to look for money to pay workers when the period of payment is due.
Disadvantages of time rate
- It does not give incentives for better workers, since what is considered for payment is only time spent on work.
- There is need for closer supervision in order to ensure that worker produce more output per period of time.
- Workers can decide to work slowly knowing their wages will not be affected.
- Workers have to wait for a long time until they are paid. They are only
paid at the end of the agreed time e.g at the end of the month.
- Employers pay a lot of money at ago
b. Piece rate
This is where workers are paid according to amount of work they do. Here a wage is given to the worker basing on how much work he or she has done. The wage very much depends on the effort of the worker — the greater the effort, the higher the wage and vice versa
Advantages of piece rate:
- Better workers get more remuneration
- It eliminates the need for constant supervision
- Workers do work at their own pace
- Workers are encouraged to work well and quickly
- Workers get a chance of working in several places
- No full time staff when work is periodically
- Workers are paid immediately as they complete a task
- Part time and temporary staff do not form trade union
- Employer does not spend money for social security of workers
Disadvantages of piece rate
- Workers may over work themselves in order to earn more i.e the more
you work the more you earn.
- Workers do not bargain for higher wages
- Misunderstandings usually arise over payment. The worker needs
payment immediately the work is finished.
- The employer has no control over the workers
- Employers must have the money all the time to pay
- Workers produce low quality because they hurry to finish
- Sometimes work is difficult to measure
- When the worker is sick he cannot be paid
- No minimum wage for workers
- It is difficult to tax income from piece rate
- Workers cannot form trade union
c. Sliding Scale
This is a method of wage payment, which is related to the cost of living. Workers are paid more if the cost of living increases, and they are paid less if the cost of living decreases.
It is beneficial in that
- The worker does not have to suffer from the effect of high prices. It protects workers from the effect of rising cost of living.
- It maintains the real income of the workers.
d. Minimum wage legislation.
This is where the government fixes the wage above the equilibrium/ ruling market wage below which it is illegal to pay the workers. The wage set is known as a minimum wage. The goal in establishing minimum wages is to protect the workers from exploitation by their employers through paying very low wages.
From figure above, the minimum wage is fixed at W1 above the equilibrium
e. Through Trade unions.
A trade union is a legally accepted association comprised of workers who come together in order to achieve specific objectives. The trade union as said earlier is made up of workers. These elect leaders who run the union on behalf of others. These trade unions through their representatives hold round table discussions (collective bargaining) with the employers in an attempt to achieve their objectives. Some of these may be increase in wages and good standard of living. So wages can be determined through the trade unions.
12.3. Wage theories
ACTIVITY 12.8
Undertake research and find the various theories that explain something on wage. Write down a brief description of what the theories say about wage.
Different economists have come written a lot about wages. There are many theories that explain how wages are determined in the labour market. They include the following,
12.3.1. The marginal productivity theory of wages.
Different economists have written a lot about wages. There are many theories that explain how wages are determined in the labour market. They include the following,
The marginal productivity theory of wages states that, there is a direct functional relationship between the level of wages and the level of employment, and that a rational employer will attempt to adjust one or both of these variables so that the marginal product of labour is equal to the wages of labour.
The marginal-productivity theory maintains that employers will only pay a wage that is, at most, equal to the amount of extra value added to the total product by one additional worker. The theory states that under conditions of perfect competition, every labour will receive a wage equal to the value of its marginal product. By marginal product of a labour is meant net addition or net subtraction made to the value of the total produce of a firm when one unit is
added or withdrawn from it. Thus labour should be paid a wage which is equal to the value of its marginal product i.e
W=MRPL
Where,
W = Wage.
MRPL = Marginal revenue product of labour.
The marginal product of one unit of labour is determined by adding to, or by withdrawing one unit of labour from a business, provided the supply of other factors of production is kept fixed. Assuming the supply of other factors of production constant and the price of the product remaining the same, the employment of more and more units of labour in a firm will increase the total product at a diminishing rate. The entrepreneur will go on adding more and more units of labour. The marginal productivity diminishes until a point will come when the increase in product due to the employment of the additional unit of labour is equal to the wages paid to the workers. That unit of labour is the marginal unit and since all labour units are homogeneous, they will be paid the same wage rate equal to the marginal product of the value of the marginal product of labour (or simply marginal revenue product (MRP)). If the wages are greater than the value of marginal product of labour (VMPL), the employers will reduce employment they offer. Similarly, if the wages are below the VMPL, the employers will employ more labour units. Thus in equilibrium, the value of marginal product of labour is equal to the wage. This can be illustrated by
Figure below;
Equilibrium wage according to marginal productivity theory of wages
From the figure above’ it can be seen that the supply of labour is perfectly elastic because all labour units are homogeneous. The demand curve of labour is represented by DL. It is down sloping due to diminishing marginal productivity of labour. The equilibrium wage and units of labour is obtained at a point where DL is equal to SL. It is a point where VMPL = W. At this point, the firm employs 0L0 units of labour and pays 0W0 wage. Before 0L0, VMPL, and the firm gets profits, if it employs more units of labour. Beyond 0L0, VMPL, the firm is incurring losses as it employs more units of labour. It will benefit the firm to reduce employment until VMPL = W.
The marginal revenue product of labour (MRPL) is the increase in the total revenue of the firm per unit increase in labour. When a firm employs an extra unit of labour, how much he pays to him as wages depend upon the addition which this unit of labour makes to the total revenue of the firm. If the addition made by this unit of labour to the total revenue is 45000 frw, the wages paid will be equal to 45000 frw. The firm will not pay a wage that is more than the return which the unit of labour contributes to the total production.
MRPL = ΔTR/ΔL
MR = ΔTR/ΔQ
MPL = ΔQ/ΔL
MR x MPL = (ΔTR/ΔQ) x (ΔQ/ΔL) = ΔTR/ΔL
It assumes that
- Labour can measure its marginal product.
- There is perfect competition in the labour market.
- Labour units are homogeneous.
- The bargaining power of workers and employers is equal.
- Labour is mobile.
Assumptions of the Marginal productivity theory of wages.
- Employers are able to measure and predict in advance the marginal product of labour.
- There is a free and complete competition among the employers for workers.
- There is a free and complete competition among workers for jobs
- Labour knows its marginal product.
- Capital and labour are perfectly mobile.
- Labour and capital are fully employed.
- Labour is homogeneous.
- Government does not interfere in wage determination. It is the forces of demand and supply that determine the wage.
- The bargaining power of labour and management are equal. Weaknesses of the theory
- In some employments, it is difficult to measure the marginal product of labour especially in the service sector. Therefore it becomes impossible to determine the wage when one cannot measure the marginal product of each unit of labour employed.
- It is erroneous to assume that all units of employed are homogeneous. Labour has different skills, different competences, experiences and strengths. So it is not homogeneous as the theory assumes.
- The theory assumes that there is perfect competition among employers and workers. In real world, there is no perfect competition in the labour market as the theory suggests.
- The theory assumes that there is perfect mobility amongst labour. This also is not always correct in the labour market. Labour can be geographically or occupationally immobile.
- The assumption that employers and workers have equal bargaining power also is faulty. Employers usually have strong bargaining power than workers in the labour market. This is especially so where the supply of labour is elastic.
- Government usually intervenes and fixes minimum wage. The wage fixed by the government may be based on other considerations and not MRPL. So it may not be equal to the MRPL
- The theory emphasises the demand side of the problem and makes a wrong assumption that the supply of labour remains constant.
It can be said that the marginal productivity theory of wages is true only under certain assumed conditions. In spite of the weaknesses that have been discussed above, it offers a satisfactory explanation of the level of wages in a labour market.
12.3.2. Wage fund theory
The theory of wage fund first introduced in Economics by Adam Smith and later on it was developed by J.S. Mill.
The theory suggests that Wages depend upon the number of workers and capital (wage fund). This wage fund is that amount of floating capital which is set apart by employers for paying wages to the labour.
It is from this pool (fund) that wages are paid such that the size of the pool determines the wage. The size of the fund depends on the past accumulation of capital. If there size of this pool is high, then wages are increased.
Formula for Wage Fund Theory:
The wage rate can be changed either by increasing the wage fund or reducing the number of workers. This theory has the following weaknesses.
- The theory is inadequate to explain the differences in wages among workers in a firm and in different occupations.
- The theory assumes that labour is homogeneous but in real life units of labour differ in a variety of ways. For instance in skills, experience etc.
- Wage levels are usually influenced by the productivity of labour and do
not necessarily depend on the size remunerator capital.
- In real world of production and employment, there is no special fund which is particularly meant for the payment of wages to the workers. The wages are paid out of the total return on production which is a flow and not fixed like that of fund.
- The theory emphasises the supply side. It makes wrong assumption that
the demand for labour remains constant.
12.3.3. Bargaining theory of wages.
This states that the level of wages depends on the bargaining capacity of trade
union in the industry. It thus implies that there are wage differences because of
different strengths of trade unions in different industries.
I2.3.4. Iron law of wages.
This states that labour should be paid a wage which is enough to cater for their basic needs of life (Subsistence life). It is also called the subsistence theory of wages.
It is argued that if wages are increased beyond the subsistence level, the labour will marry earlier and will produce more children. This will result in the increase in population and labour supply will exceed demand. So the money wages will fall to the level of subsistence.
If wages remain below the subsistence level, the labour will not be able to maintain their families. Due to starvation and malnutrition, etc. the death rate
will increase. The-supply of labour will fall short of demand. This will lead to increase in wages.
Increase in wages will be followed by increase in population which will lead to increase in the supply of labour resulting into a reduction in wages again to the subsistence level.
Criticism of the Subsistence Theory of Wages
This theory has been criticized on the following grounds,
- The theory does not explain the differences wages in different employments. According to the theory, the wage rate tends to be equal to the subsistence level of all the workers. Then, why is it that wages differ
from industry to industry, worker to worker and occupation to occupation.
- The theory does not take into account the influence that trade unions have in the determination of wage rate in the labour market. Trade union activity is vital factor in wage determination.
- There is no direct relationship between change in money incomes and marriage. It is incorrect to assume that when the money income of a person increases above the subsistence level, then he marries early and the birth rate increases. On the other hand, the trend in modern life is that that when the income increases, it is generally followed by a higher
standard of living and the workers do not produce more children.
- The Subsistence theory of wages entirety ignores the demand side of the labour and emphasizes only the supply side for the determination of the wages
12.3.5. Residual claimant theories.
This was developed by an American economist Walker. According to Walker: “Wages equal to whole product minus rent interest and profit”. Workers are meant to share what is left after rent, interest, and profit are catered for. Labour is rewarded after all other factors of production have taken their share of national output.
The problem associated with this theory is that :
- In actual sense, the residual claimant is the entrepreneur and not the labour. The entrepreneur takes what is left after all other costs of production including wages have been catered for. Payment for labour is a cost of production and so it is paid during the production process.
- It does not consider the influence of supply side in the determination of wages i.e how increase in supply of labour in the labour market influences the wage level.
- Trade unions have an influence on wages of the workers. This theory seems not to have any explanation on this.
12.3.6. Market theory of wages.
Wages in the labour market depends on the forces of demand and supply of labour. Increase in demand for labour increases its price (wage) while increase in the supply of labour reduces its price (wage). The price of skilled labour is usually high. This is because its demand is greater than its supply. It assumes perfect competition in the labour market.
The determination of wage rate is explained with the help of diagrams.
The supply of labour and its demand in the market are equal at wage rate OW0 and the quantity of labour demanded and supplied at this wage rate is 0L0
APPLICATION ACTIVITY 12.2
Basing on the marginal productivity theory of wages determine the wage that should be paid to extra units of labour employed.
12.4. Wage differentials
ACTIVITY 12.9
Make research on the wages earned by the following categories of
workers.
A technician working with a private firm, a graduate teacher working in a government aided public school, a porter on a construction site, a doctor in a government hospital, a social worker working with a relief organization, and an engineer with a private firm, cleaner in a government ministry.
List their wages down and make a comparison.
Discuss why the above workers earn different wages. Wage differential is a situation where different people in different or the same occupations or places earn different wages.
It is very common experience that earnings in different occupations are strikingly different. There are occupations where the earnings are extremely low. There are others where the earnings are exceptionally high. The causes of such disparities lie on the side of both demand for labour and supply of labour. If demand for a certain type of labour is very high, the earnings must also be correspondingly high. If, on the other hand, a particular type of labour is not much in demand, their earnings are bound to be very low. The
chief causes of variations in wages are:
Causes of wage differentials
- Differences in Skills. Workers with more skills require more payment than those with little skills.
- Differences in elasticity of supply of labour: Supply of workers in companies tend to be inelastic thus earning high wages while in some others it tends to be elastic thus earning low wages.
- Differences in prices of products produces: Workers whose products produced command higher prices are paid more than those whose prices are low.
- Differences in Marginal productivity of labour. Labour whose marginal product is high is paid more than those whose marginal products are low.
- Differences in Trade Unions’ strength: strong trade unions can demand higher wages than weak trade unions.
- Government interfere in the determination of wages. Government normally set different wages for different occupations and sectors causing wages differences.
- Differences in job locations: People whose jobs are located in urban areas normally are paid high wages than those in rural areas. This is normally due to differences in cost of living between the two areas.
- Differences in Risks involved: Working in some occupations is more risky than in others thus some jobs may prove dangerous to a worker and hence the worker must be paid a higher wage than the less risky ones.
- Differences in occupations.
- Occupational mobility.
- Period of training differ.
- Existence of non- monetary benefits
- Size of the firm.
- Difference in productivity of occupation.
- Gender bias.
- Differences in cost of living.
- Differences in talents.
APPLICATION ACTIVITY 12.3
From your knowledge of wage differentials, write what do you think can be done to reduce the gap between high wage earners and low wage earners. Make a class presentation.
12.5. Wage controls
ACTIVITY 12.10
a. RURA fixes transport fares in the public transport sector throughout the country. How is this important to the public?
b. Discuss what would be the benefits and demerits to the public if RURA was to fix wage for workers.
12.5.1. Meaning and Rationale of wages controls
Wage controls refer to the setting of a wage by the government above or below the equilibrium/ ruling market wage, below or above which it is illegal to pay the workers. There are different reasons why this may be done by the government but it is mainly to;
a. Reduce exploitation of the workers by the employers through paying them a very low wage. This is reduced by setting a minimum wage by the government at which to pay the workers.
b. Reduce exploitation of the employers by the employees through requesting and being paid very high wages. This is reduced by setting a limit beyond which the employers should not pay though this is not common.
Minimum Wage
A minimum wage is a payment for labour that is fixed by the government above the equilibrium wage below which the employer is by law not allowed to pay the worker. It is a form of price legislation. The price here, being the price for labour.
The government or the trade union may fix a minimum wage of all the workers on a national scale or in a few sweated industries. This step is taken to avoid or reduce the industrial friction.
When the government fixes the minimum wage at Wm, the demand for labour reduces because labour becomes expensive. However, the supply of labour rises because the wage is high. This creates unemployment.
Advantages Minimum Wage.
- Minimum wage increases purchasing power of workers. This improves their general standard of living, aggregate demand and production in general.
- It ensures Minimum Standard of Living for the workers. If minimum wages are fixed for all the workers, it will ensure minimum standard of living for all. Workers will be sure of their payments and this reduces exploitation of the profit oriented employers.
- It motivates workers. When the workers have a measurable standard of living, they feel contented and work, more efficiently.
- Minimum wage maintains industrial peace. It avoids the occurrence of strikes by trade unions when demanding wage increments.
- Inefficient, high cost firms are pushed out of business. Those that pay low wages to the workers because he is not able to manufacture the goods at the competitive price may have to close when the minimum wage is fixed.
Disadvantages Minimum Wage.
- Unemployment. When minimum wage is fixed, the employers try to increase the prices of the commodities in order to cover their increased labour costs. If the demand for the commodities whose prices are raised is elastic, then the total quantity demanded will fall. When the commodities are not disposed off at a profit, some of the firms will close down others may reduce the number of the workers. Some of the firms may try to substitute labour saving machines. The result of this will be that there will be greater unemployment in the country.
- It is difficult to fix. It is very difficult to fix a minimum wage for all the workers at different places in a country and different industries. If a higher minimum wage is fixed at one place, then it may not suit the other employers. They may refuse to employ labour or they may try to substitute machinery for labour. If they succeed in their mission, it will, result in mass unemployment in the country. If a minimum wage is fixed low, then it may not serve the purpose for which it is fixed.
- Employers may resort to using machines instead of labour. This may create technological unemployment
- Minimum wages increase the cost of production. This reduces the volume of production and may cause scarcity of commodities.
- It is difficult to put into practice. If a minimum wage is fixed, then difficulties may arise in its enforcement. If the labour is unemployed, they may agree to work at a wage lower than that fixed by the government.
- It discourages the most efficient workers. The most efficient workers may not be paid a wage that is more than the minimum wage. This may reduce the morale of the most efficient workers. This is because that amount is often considered to be the maximum by the employers.
APPLICATION ACTIVITY 12.4
RURA regulates prices of certain services like transport, energy, water and sanitation etc.
Basing on your knowledge of wage controls, discuss how this helps the economy.
12.6. Trade unions
ACTIVITY 12.11
A labour union is a group of workers who form an organization to gain:
- A voice in improving socio-economic interests and rights at workplaces.
-- Respect on the job.
- Decent wages and benefits.
- More flexibility to meet work and family needs.
- Protection against occupational safety and health at work.
Unions have made life better for workers by improving wages and working conditions, helping to formulate laws, fighting child labour, establishing mechanisms for solving labour-management disputes and protecting workers′ safety and health. When workers form unions, their companies and communities also benefit.
Read the passage above. Note down according to the passage,
i. What you think a labour union is?
ii. Why it may be formed?
iii. Who forms it?
iv. How unions make life better?
v. Who gains from a labour union?
12.6.1 Meaning and objectives of trade unions.
Trade unions are associations of workers who use collective bargaining to protect the interests of their members e.g increase in wages and improvement in working conditions. They are a continuing and permanent democratic organisation, voluntarily created by and for the workers to protect them at their work. Normally they carry out their work through round table discussions through their representatives and the employers
In Rwanda the trade union movement is organized by the CESTRAR (Rwanda Workers’ Trade Union Confederation) which is affiliated to International Trade Union Confederation. CESTRAR was formed in 1985. After 1996, the trade union movement expanded. It has continued to expand since then. Some of the trade unions that are affiliates of CESTRAR include,
- SPS: Health sector workers’ union
- STAVER: Workers union in Agriculture, fishing, veterinary and
environment in Rwanda
- SNER: Rwanda National Teachers’ Union
- RMNU: Rwanda Nurses and Midwives Union
12.6.2 Objectives of trade unions.
Trade unions in general possess the following objectives.
- To bargain for increase in wage of workers
- To demand for improvement in working conditions.
- To sensitise their members on their rights through seminars.
- To protect workers from unfair dismissal
- To ensure security of job for workers.
- To carry out advocacy for workers’ interests and negotiate with the government to make some legislation that is in support of workers interests for instance fixing a minimum wage.
12.6.3. Types and tools of trade unions.
ACTIVITY 12.12
It’s a duty of everybody to protect the rights of domestic workers.
1. Study the above pictures. What can you say about it?
2. What do you think can such workers as shown above do to,
i. Protect themselves from any form of harassment.
ii. Improve their working conditions.
iii. To improve their wages.
Trade unions are categorised into,
A craft union. This is the simplest form of trade union. It is formed by workers belonging to the same craft, occupation or specialisation for instance plumbers, electricians, weavers, etc. Members have a common skill though they are employed in different industries. In a craft union,
- Workers with identical training, educational background and similar working experiences and problems are easier to organise. They can share their everyday work experiences and are more united.
- Members have a high bargaining power since they share a common skill and cannot easily be replaced in case of a strike. Industrial union. This is a union of all workers in a particular industry. Members have different skills and occupy different positions but in the same industry. It brings together workers with different skills into working together as a union for instance, a union of workers in the tea industry, or rail workers.
General Union
This is a union that brings together all workers in different industries and with
different skills. The only uniting factor is that they are all workers.
White collar unions.
These are unions that represent certain professions like teachers, doctors. It registers all members in that profession who are willing to join. Trade unions can also be categorised according to the requirements for recruitment of workers. This gives the following,
- An open shop trade union does not require union membership in order to employ or keep workers. Where a union is active, workers who do not contribute to a union may include those who approve of the union contract and those who do not. This affects the function and services of the union.
- A closed shop is the type of trade union which employs only people who are already union members. In this case the employers recruit directly from the union, as well as the employees working strictly for unionized
employers.
- A union shop trade union employs both union and non-union workers, but sets a time limit within which new employees must join a union.
- An agency shop trade union is where non-members can access services of the trade union in negotiating for their contract when getting employment but on a fee
12.6.4. Tools used by trade unions to achieve their objectives.
Trade unions use a diversity of methods which are either peace or violent or both to achieve their objectives. Such methods include, among others the following:
Collective bargaining
This refers to the negotiation process between employers and employees association regarding establishment of procedures that concern conditions of work, terms and rates of pay. This is a peaceful method/ process that aim at strengthening worker employer relationship.
Giving ultimatum/ Grace period
Employers are given a time limit to respond to the workers’ demands beyond which workers may withdraw their labour services.
Go slow tactics
Workers in here slow down their pace of working by reducing their pace of working and reduce their productivity and total output as well. This is done by reducing hours of work and output so as to make the employer feel the impact of it on the organisation.
Sit down strike
Here workers lay down their tools, they will report at their work place but they
will not work at all.
Demonstration
These are open protests against unfair treatment of workers e.g. marching through the streets. They carry placards/posters along. The aim is to shame the employer, attract attention and sympathy from the public and government against the employer. Picketing
This is whereby the trade union members prevent their fellow members from working, by positioning or deploying of members at the entrance of business premises stop any potential workers from proceeding to work. This is designed to make the organisation feel the impact of the workers absence.
Boycott of the firm’s product/ sabotage
Trade unions may campaign against the firm’s product openly in the public so that the product loses market, pack wrong weights or members may also boycott from consuming any of the product. This is aimed at causing severe loss of revenue to the firm. This method however requires a lot of finance or it may be expensive.
Mediation or arbitration
This involves the intervention of a neutral party acceptable to both parties (employers and employees/ Trade unions) to resolve the industrial dispute or make the recommendations for resolving the disputes for example ministry of labour and social welfare. It is normally agreed beforehand that the two parties will accept and respect the decisions and recommendations of the arbitrator.
Industrial court
Here workers can present their claims or case to the industrial court which examines the case or dispute and makes the recommendations or ruling which is binding to both parties. The court may award or reject their claims.
Mass media campaign against the firm (press war)
Here, trade union members can approach are known radio, television newspaper etc. so as to get their demands clearly spelt out and it is intended to capture sympathy as well as public support.
Further education and training
Trade unions may organise seminars and workshops for members so as to improve their skills required in the labour market hence increasing labour productivity. This is aimed at improving their bargaining power as well as increased demand.
Restricting labour supply
This is where trade unions restrict employers to employ more new workers without permission. i.e. members require a particular employee to first join a given union in order to retain or obtain employment. This is aimed at strengthening the bargaining power of trade union members. Industrial strike This is done as a last resort in case all the above peaceful methods fail. It is a violent process which involves withdrawal of labour, putting down tools. It is intended to force employers to accept the needs of employees immediately.
12.6.5. Benefits and disadvantages of trade unions.
ACTIVITY 12.13
Discuss the view that “The economic welfare of the unionized workers is always better off than that of non-unionized workers”
a. Benefits of trade Unions
-- Trade unions negotiate for Increase in wages for their members. Industries with trade unions tend to have higher wages than nonunionised industries.
- Trade unions represent workers. Trades Unions can also protect workers from exploitation, and help to uphold health and safety legislation. Trades unions can give representation to workers facing legal action.
- They increase the bargaining power of workers. Trades Unions can help workers to negotiate with employers. This means they help the firm to increase output; this enables the firm to be able to afford higher wages. Trades unions can be important for implementing new working practices which improve productivity.
- To sensitise their members on their rights through seminars. They protect workers from unfair working conditions, unfair dismissal, and ensure security of job for workers.
- Trade unions carry out advocacy for workers’ interests and negotiate with the government to make some legislation that is in support of workers interests for instance fixing a minimum wage.
b. Disadvantages of trade union.
- Through force, trade unions coerce the workers to support the unions view by joining strikes etc. which affect production on the one hand and loyalty of honest workers to the group on the other hand.
- A powerful union of workers in a particular industry can secure higher wages. This may induce the workers in other industries to put an unreasonable demand for higher wages.
- Trade unions ignore the social interests. They never advocate for the increase in production and productivity and thus take one-sided view.
- Create Unemployment. If labour markets are competitive, higher wages will cause unemployment. Trades unions can cause wages to go above equilibrium through the threat of strikes etc. However when the wage is above the equilibrium it will cause a fall in employment.
- Ignore non-members. Trades unions only consider the needs of its members. They often ignore the plight of those excluded from the labour markets, e.g. the unemployed.
- Lost productivity. If unions go on strike and work unproductively (work to rule) it can reduce output. Therefore their company may go out of business and be unable to employ workers at all.
- Trade unions may cause wage Inflation. At times, powerful unions can bargain for higher wages that are beyond the rate of inflation. This may contribute to general inflation.
- If unions become too powerful and they force wages to be too high, then they may cause unemployment and inflation
12.5.6. Weaknesses of trade unions in developing economies.
ACTIVITY 12.14
i. As a member of the economics club in your school. List down the problems that you think may limit the progress of your club.
ii. With reference to the problems identified above, discuss the factors that can make trade unions in developing economies weak.
Trade unions in most developing economies have failed to achieve their objectives because of both internal and external factors. Such factors include,
- Workers have no keen interest in the trade union. Trade unions represent a small proportion of the total labour force and therefore, they are in a weak bargaining position.
- Leadership problem. Trade unions may have poor leadership as they fail to present their wage claims in the right manner. When they have no correct approach, their wishes have not always been granted.
- Unemployment: There is open unemployment in LDCs. There is a large surplus of labour in the agricultural sector. On top of this, there are so many job seekers migrating from the countryside to the urban sector. In a position like this, where the possible supply of workers is much greater than demand, it will be quite difficult for the trade unions to push wages up.
- Financial difficulties: Trade unions are always in financial difficulties. To begin with, the incomes of union members are generally low, and they are therefore reluctant
- to pay union dues.
- A high proportion of migrants within the work force: The composition of the labour force changes continuously. Organisation of a trade u n i o n becomes particularly very difficult. People are not interested in becoming members of a trade union. This puts a trade union in a weak bargaining position.
- Fear of the effects of high wages on the economy. There may be a fear of the effect of high wages on general price level. This may limit the activities of trade unions and bring down their success.
- At times, trade unions are regarded as strike tools only because trade unions are always busy in organising strikes. Due to this, they have lost public sympathy. Employers take chance of this to ignore their genuine demands.
- Supply for labour especially the unskilled is elastic. Trade unions cannot emphasise their action because employers threaten workers with dismissal. They are assured of cheaper alternatives in case the current workers leave.
- Employers earning profits. This limits their capacity to increase workers remunerations, offer other benefits that may be demanded by trade unions.
APPLICATION ACTIVITY 12.5
a. Make a research on the problems workers in the community around your school face.
b. Write a report and make recommendations. Present it to a community leader near your school.
END UNIT ASSESSMENT
1. (a) State the difference between demand for labour and labour supply.
(b) Analyse the factors that influence the supply and demand for labour in a labour market.
2. (a) What do you understand by the term labour efficiency?
(b) State and explain the factors that influence the efficiency of labour in an economy.
3. (a)Distinguish between time rate and piece rate systems of wage determination.
(b)Analyse the merits that piece rate system has over time rate.
4. (a)What do you understand by the marginal revenue product of labour?
(b)How relevant is the marginal productivity theory of wages in your country.
5. (a)Examine the factors that limit the success of trade unions in developing countries.
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