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 8 UNEMPLOYMENT
Key Unit competence: Analyze the impact of unemployment on economic development.
INTRODUCTORY ACTIVITY
When you move in the streets of Kigali/or the cities in Rwanda:
- What do you normally observe people doing?
- What do young women and men normally carry on those streets?
- How can the puzzle of people carrying files looking for job be solved?
- Many young people graduate with high hopes of getting a job, do they really get the job?
- What do you think are causes of not getting the job they want?
8.1. Introduction to unemployment
On any given day, during economic busts and economic booms alike, many people are unable to find desirable employment despite their best efforts to look for employment. Understanding the reasons for this fact is a primary concern for economists and policymakers, since it is necessary for designing good labor market policies. Unemployment not only creates hardships for those it encompasses, but it also seems to represent a vast pool of idle economic resources.
Unemployment is one of the economic problems facing countries and their governments.
ACTIVITY 8.1
Visit a nearby firm/industry/hotel/restaurant/trading Centre/market/
construction company and ask some of the young people in those areas
who are looking for jobs, the nature and kind of jobs they are looking
for. What do you notice? Are all those people willing to take any kind of
the job at any given wage? Why do you think some are selective in taking
the job
8.1.1. Meaning and Nature of unemployment (voluntary and involuntary )
Unemployment is an economic condition where resources (labour) lies idle and is not doing any work irrespective of the ability and willingness to do work. All resources (factors of production) can be unemployed. However, unemployment is usually used with labour force. It is used with the active population and does not consider the sick, the very old, fulltime students etc.
Classical economists believed that unemployment was a result of excess supply of labour at high wages. High wages reduce the demand for labour. The difference between labour supply and labour demand causes unemployment. A reduction in wages will enable employers to absorb the excess labour and drive the economy towards full employment.
Keynesian economists however explain unemployment from demand side. A deficiency in demand for goods and services leads to unemployment. Demand for labour is derived demand and rises out of demand for goods and services that labour helps to produce.
8.1.2: Nature of unemployment:
Keynesian economists divide unemployment into many different categories. The two broadest categories of unemployment are voluntary and involuntary unemployment.
a. Voluntary unemployment
This refers to the situation where jobs are available but people are not willing to work at the ongoing wage rate.
Causes of voluntary unemployment
- Presence of low wages: The low wages may not attract the labour to work even if the job is available.
- Desire to live on personal or family wealth: Sometimes labour may live on already accumulated wealth that may be personal or for the family. So even if the jobs are available, the labour may not prefer to work.
- Presence of target workers: These are people who work for a specific period of time because they want to achieve a certain target. After achieving their target, they may not go back to work even if the jobs are available.
- Poor working conditions: Sometimes workers prefer to work in luxuries or good working conditions so when the conditions of work are poor, they may not work even if the jobs are available.
- Too much desire for leisure: Some people prefer to enjoy leisure to work since it is part of welfare. Those who prefer leisure may not work even when the jobs are available. To them the opportunity cost for leisure is work.
- Unfavourable geographical conditions: Some jobs are located in remote areas which may not be accessed by road because of the relief. Workers may not be willing to work in areas that are not accessible even if the there are jobs.
- High risks involved in doing the jobs: Some jobs are risky for the workers. For example jobs like mining, digging pit latrines, fishing among others. Some of these may be risky since they may involve death in case of accidents. So even if there are wages being offered, labour may not work.
- Early retirement by an individual: Different countries have different retirement ages, for example in Rwanda the current retirement age is 55 years while the normal retirement age is 65 years. If the people have reached the retirement age, they may not be legible to work even if the jobs are available.
b. Involuntary unemployment
This is a situation where members of the labour force are idle but are willing to work in the existing situations at the current wage. Individuals want to work but there is no employment.
Business cycles and growth are directly related to unemployment in any given country’s economy. When an economy is growing, unemployment usually falls and; when an economy is in a downturn, unemployment usually rises. The causes of involuntary unemployment are the causes of unemployment in general.
8.1.3. Types and Causes of unemployment
There are many different possible causes of unemployment, though it is never easy for policy makers to identify which is the most important and what to do about it. The causes of unemployment can be split into two main types:
a. Demand-side
The first cause of unemployment (demand-side) is simply a lack of aggregate Demand. When there is not enough demand, employers will not need as many workers, and so demand-deficient unemployment results. Keynesian economists in particular focus on this cause.
b. Supply-side
Unemployment caused by supply-side factors results from imperfections in the labour market. A perfect labour market will always clear and all those looking for work will be working—supply will equal demand. However, if the market does not clear properly, there may be unemployment. This may happen because wages do not fall properly to clear the market. These two types can further be divided into different categories as shown below;
i. Open urban unemployment
This is when the members of the labour force are unemployed in the urban areas—both voluntary and involuntary. Open urban unemployment can best be explained by the theory of rural-urban migration. Rural-urban migration is a process whereby individuals move from rural to urban areas. It occurs as a result of a combination of push and pull factors.
Rural-urban migration is brought about by push and pull factors (from towns), which are both economic and non-economic. Some of them are; unequal distribution of resources and services, social problems and population pressure among others. This can be basically reduced or controlled by developing rural areas such that people are no longer attracted to urban areas since all the services are equally distributed.
ii. Seasonal unemployment
Seasonal unemployment is unemployment which is caused by economic slowdowns related to seasonal variations. Certain jobs, like fruit packing, may be seasonal. At the end of the season, the workers may become unemployed. Agricultural workers are employed during clearing, planting, weeding and harvesting periods but are unemployed for the rest of the year. Others are construction workers, people who fish for a living.
This kind of unemployment can be solved by:
- Offer employees yearly contracts to avoid lay off of workers;
- Diversify agriculture sector to allow the full employment opportunities
throught the year;
- Set up a comprehensive industrial program to provide part-time employment.
iii. Disguised unemployment
This type of unemployment does exist mainly in countries which are overpopulated. It is the type where labour’s productivity tends to zero. Or the capacity of labour to work is underutilised. E.g. office messengers. The marginal product of labour is either zero or negative. One finds that there are more workers than those that are needed for a particular job. Less labour could have done the same work and therefore labour is said to be underutilised. In some cases, labour works less time than desired due to poor methods of production and poor capital equipment. Disguised unemployment is common in Rwanda, especially in the agricultural sector, service industry and government.
This kind of unemployment can be solved by:
- Introduce a comprehensive industrial program to facilitate redudant people;
- Introduce better methods of production by use of modern tools;
- Prompt the idle land and make it productive.
iv. Frictional unemployment
Frictional unemployment is essentially short-term unemployment. It results when the people are switching from one job to another. This may occur when people constantly change their jobs, some quit or others are fired. These constant changes result in frictional unemployment. There are always some firms with unfilled vacancies and some people looking for work. The period of unemployment between losing one job and finding another is included under frictional unemployment. There are a variety of reasons to explain the existence of frictional unemployment but these can be explained in the two categories below;
- Normal labour market turnover. This arises from two sources. First, people are constantly changing their economic activities —young people are leaving school and joining the labour force and secondly, old people are retiring and leaving the labour force temporarily for some other reason, and then joining it.
- The fortunes of businesses are constantly changing—some are
closing down and laying off their workers; new firms are starting up and are hiring.
- This kind of unemployment can be solved by:
- Provide information about job opportunities to available workers.
Employers should be fully informed of the potential labour supply. Unemployed workers should be informed of the availability of employment opportunities. There should be an efficient system of job notification and placement and there should be job centres in all small townships;
- The remedy of occupational immobility is to provide retraining facilities so that workers learn new skills. However, the problem could be lessened in the first place if the education system gave the potential workforce more appropriate training. Considering the changes in technology and the growth in demand for skilled and professional workers, retraining program will be of increasing importance in the future;
- Barriers to geographical labour mobility should be reduced. This should be either moving the unemployed to the jobs or moving the jobs to the unemployed. The government may give moving grants, provide information of jobs in other areas; and set up houses, schools and hospitals in those areas where employment exists. To move firms into the depressed regions, the government may attract them there with grants, tax relief, rent-free factories etc;
- Human resource planning. Human resource planning should be undertaken so that workers can be guided as to what skills are required by the economy.
v. Structural/secular unemployment
ACTIVITY 8.2
Umucyo company in Nyamagabe has been specialized in making dresses and it has been employing many workers. However with the change in trend, where ladies have resorted to putting on trousers, the company has lost market hence laying off workers.
1. What do you understand by the terms structural unemployment?
2. What are the causes of this type of unemployment?
3. What can be done to reduce this type of unemployment?
This is unemployment caused by changes in structural set up such as change in demand. For example if there is a change in demand from dresses to trousers, the workers in the dress industry will become unemployed.
Structural unemployment represents a mismatch between supply of labour and demand for workers. Because the economy is constantly changing and adapting, at any moment there will always be some mismatch between the characteristics of the labour force and the characteristics of the available jobs.
The mismatch may occur, for example, because labour does not have the skills that are in demand or because labour is not in the part of the country where there is demand. Individuals who fall into this category have trouble finding jobs because of a lack of adequate skills or regional employment problems. This is because of the immobility of labour. There are three distinct reasons for such immobility; occupational, geographical/regional (within a country), and international competition.
1. Occupational unemployment results from a mismatch between the demand and supply of labour in specific industries. The demand for workers in growing fields such as health care may exceed the supply of available workers, while the supply of labour in declining areas may be in surplus. As a result, there is high unemployment in stagnant or declining job areas, while demand is strong for alternative occupations.
2. Geographical/regional imbalance between the supply and demand for labour also occurs geographically, and is known as regional unemployment. For many countries, growth is not uniform across the landscape. Some areas may enjoy rapid growth and thus have a strong demand for labour, while other locations are stagnant and the surplus labour leads to high local unemployment rates. The unemployed workers will not move to a different area due to social ties, housing problems and social problems.
3. International competition is an additional source of long-term structural unemployment. The argument is that less-skilled workers in developed countries are increasingly being displaced by foreign workers in less-developed countries (LDCs) who are paid significantly lower wages. In developed countries, the average wage for less-skilled workers is relatively high compared to that in LDCs due to greater living costs, union power, and tradition.
4. Structural unemployment is the most difficult for economic policy makers to deal with, and solutions evolve slowly, and below are some of the solutions:
- Individuals stuck in occupations that allow for little future growth need to be retrained and educated to gain the skills necessary to work productively in areas where they are needed. Time, information, and money are required to deal with structural unemployment;
- The government can take an active role in providing vital information about jobs and help in financing education and training for displaced workers;
- There should be facilities for the retraining of workers whose skills are no longer in demand;
- It is important to identify in advance where shortages will occur in the future, so that retraining of unemployed workers can be in the right direction. This will enable workers to move to other expanding industries.
vi. Technological unemployment
This is the type brought about by machines replacing people because of
technological advancement.
Figure 18: Technological unemployment
As firms introduce new technologies into their production processes, they may replace labour with machines. This has been occurring with computerization, automation and robotics in many industries as seen above in figure 2. For the firm, costs are cut and output and profits raised but for labour the demand is decreased.
This kind of unemployment can be solved by:
To cure this type of unemployment is not easy. Either the policy makers stops the technological developments, which would slow down economic growth, or find alternative work for those who have lost their jobs. The main solution would involve retraining.
vii. Casual/ Erratic unemployment
Figure 19: Casual Unemployment This is a form of unemployment that results from expiry of contracts and target workers. It commonly occurs to people like private doctors, lawyers, and car washers, who work if they have clients. The private doctor works when he has a patient to attend to. If he has no patients, he becomes unemployed and hence casual unemployment. This type of unemployment is hard to cure because it comes at irregular intervals. It cannot be predicted unlike the seasonal unemployment.
viii. Residual unemployment
This is a type of un employment that occurs to a factor of production especially labour because it is mentally or physically handicapped like the lame, with mental health issuers among others. Labour may become unemployed when the work that is available needs someone who is physically and mentally able.
ix. Transitional unemployment/ Normal unemployment
This is brought about by production stopping temporarily for sometime. Production may always stop because of many different reasons like repairing due to breakdown, renovation, and painting the industry among others.
8.1.4. Effects and Solutions to unemployment
Being unemployed can lead to depression, low self-esteem, anxiety and other mental health issues, especially if an individual truly wants a job but can’t find employment. Tension can occur, causing stress and strain on the body. Below are some of the effects of unemployment:
1. Increases dependence. Unemployment widens the dependence ratio. The unemployed rely on the working members of the public. This reduces personal savings and investments.
2. It kills personal esteem and dignity. Unemployed people may be looked at as a disgrace to the society. Employed members of the society under look them. They lose their self esteem and some may even become desperate in their lives.
3. It changes the attitude of the public towards education and training. The public may take education as wastage of time and resources. This may bring about large numbers of school drop outs. In the long run it may create a society that is dominated by the less educated.
4. Deterioration of the skills and knowledge of the unemployed. The skills of those who are unemployed will tend to disappear due to lack of practice. In the long run they will find it more difficult to get work in the future. This is what is known as the hysteresis effect.
5. The volume of production reduces. Unemployment keeps low the total volume of output that is produced. Because some resources are idle, and there is no output produced by them, GDP remains low.
6. Tax revenue reduces. The unemployed members of the public do not earn any incomes. Their taxable capacity tends towards zero.
7. Political oppositions may use the vulnerable unemployed especially the youth to lure them into activities that endanger the security of the country. Most anti government activities in developing countries involve the unemployed youth.
8. Income inequality. The income gap between the employed and the unemployed widens with time. This also creates its own evils.
9. Increase in government spending. The government incurs a lot of expenses on availing social services to the unemployed members of the public. Government spending on services like education and health facilities increase yet there is no tax revenue accruing to the government from the unemployed members.
10. Crime rates. The unemployed especially the youth are vulnerable and can easily be taken over by criminal behavior. Prostitution, theft and robberies, and other forms of criminality usually involve unemployed youth.
8.1.5. Solutions of Unemployment
1. Applying an expansionary fiscal policy. This involves stimulating aggregate demand, by:
- Lowering taxes to increase disposable incomes and increase aggregate demand.
- Increasing government spending to increase money supply which also widens aggregate demand.
- Increase in aggregate demand stimulates expansion of production and employment of more resources only if there if there is excess capacity in production.
2. Applying an expansionary monetary policy. This involves using the different instruments of the monetary policy to increase money supply and aggregate demand. For instance.
- Reducing interest rates to reduce the cost of borrowing. This encourages people to borrow and invest which in turn increases aggregate demand.
- Buying securities from the public to increase money supply.
3. Carrying out educational reforms and promoting vocational education. It helps to create relevant skills that suit the demands in the labour market. The creation of WDA , TVET and he introduction of the competence based curriculum is in this direction.
4. Modernize agriculture. This helps to reduce rural urban migration and therefore checks open urban unemployment. For instance changing the land tenure system to create private ownership builds producer and investor confidence which stimulates agricultural expansion and modernization. The system of land consolidation avails enough land for agricultural expansion. This will increase the rate of employment creation in the agricultural sector.
5. Reduce the power of trade unions. If trade unions are able to increase wages above the market clearing levels, they will cause real wage
unemployment. thus reducing the power of trade unions helps to fight this kind if unemployment.
6. Expand the industrial sector. This widens employment opportunities and helps to absorbs both skilled and unskilled labour force.
7. Promote local and foreign investors. This helps to increase the rate of job creation in the economy.
8. Check population growth rates. This helps to match it with the rate of job creation.
9. Economic integration. It expands markets by giving local producers to access markets in the region. A ready and wider regional market encourages the producers to expand the scale of production thereby creating employment opportunities.
10. Diversification of the economy. This helps to create different employment opportunities in different sectors. It helps to solves seasonal unemployment.
11. Increase wages and improvement in working conditions reduces voluntary unemployment.
12. Provide information about labor markets and jobs. This reduces frictional unemployment. It helps to improve the flexibility in the labour market. For instance making it easier to recruit labour.
13. Provide free universal education. This helps to increase skills development in the economy.
14. Encourage private sector. This also increases the rate of employment
creation in the economy by expanding production.
APPLICATION ACTIVITY 8.1
“It is idleness that is the curse of man - not labour. Idleness eats the heart
out of men as of nations, and consumes them as rust does iron” Samuel
Smiles, a Scottish author. Justify this statement.
Assess the causes and effects of unemployment in the Rwandan economy.
8.2. Under and full employment
ACTIVITY 8.2
Visit the library or any other source of information and make research
on the following items below and present your findings to the class.
1. Differentiate between full employment and Under employment.
2. Identify the measures that can be adopted to increase resource
employment so as to drive the economy towards full employment.
8.2.1. Meaning of under and full employment
Full employment has been defined differently by different economists.
- Lord Maynard Keynes calls it “The absence of involuntary unemployment.”
- Lord Beveridge defines it as “Having always more vacant jobs than men.”
However, what is evident is that no economy world over can attain 100% full employment. Some element of unemployment has to exist in one way or another. For instance,
- There is always involuntary unemployment in any economy.
- Frictional unemployment has to occur because labourforce keeps changing from one job to another.
Underemployment occurs when the capacity of a resource (labour) is not fully utilized. The capacity of a unit of labour to perform work is not fully put to use. This lowers the output that it produces.
8.2.2. Causes of under employment
Under employment occurs when:
Nothing is being added to total output by the extra units of labour employed i.e disguised unemployment. This can be illustrated as shown below.
The above diagram shows that units of labour OL3 and OL4 are disguisedly unemployed because they are not adding anything to total product. Even if units of labour oL3 and oL4 are taken away from the production process, total product remains the same. Their MP is zero.
- Labour is using poor equipment such that the capacity to produce disrupted by the poor tools e.g using a spoon to load sand on a lorry as illustrated in the activity above. In this illustration, the second man is being unemployed. His strength, skill and will are not being used fully because of using a poor tool. This affects his total output.
- Labour is working on socially unacceptable activity. There are activities that are unacceptable to the society. For instance, prostitution. Prostitutes earn incomes from the “sale of their services” but their business cannot be taken to employment. More so, most prostitutes enter into that business not by will but are pushed into it by the unbearable conditions like low remuneration, unemployment and poverty.
- Labour is doing a job it is not trained for. Many workers are employed in fields that they were not trained for. A mechanical technician in a business of selling clothes, a professional teacher working in the local government as sector executive secretary etc.
- Lack of skills: Underemployment often illustrates the employment of workers with skilled backgrounds in low-wage or hourly jobs that do not require such prerequisites, thus undertaking jobs that undermine their skills.
- Lack of experience: Recent graduates may find themselves underemployed while looking for their first job after college. Even entry-level jobs sometimes require more experience than students may have to offer right after graduation. Job seekers who find themselves in this position might have to take part-time work while doing additional internships, taking classes, or networking their way to a new position.
- Credentials aren’t acceptable: In many cases, highly skilled individuals look for work, but face underemployment because their credentials cannot be accepted nor considered to be an equivalent fit for the position in question, so many professional individuals such as doctors, lawyers, or engineers take necessary jobs that would otherwise be seen as inferior positions.
- Discrimination issues: for example, people with disabilities, mental illnesses, or former inmates are often discriminated against and are forced to take the first job made available to them for fear of not finding another.
- Low demand: Some individuals with acceptable experience and skills are underemployed because of low demand in their local job market. They have to take a part-time job until they are able to move to a location that can better accommodate their skill set.
- Poor economy: In addition, anyone can find themselves underemployed if the economy takes a turn for the worse. During a recession, many skilled workers who would ordinarily have little trouble landing a good job in their field may wind up underemployed.
- Market changes: Underemployment can also be caused by larger market changes. For example, automation has affected workers in industries ranging from retail to manufacturing to transportation and warehousing.
8.2.3. Measures to attain full employment
For any economy to flourish towards full employment, it requires a number of policy interventions. The following policies can be applied to attain full employment.
1. Fiscal policy.
2. Monetary policy.
3. Through pump priming policy.
- Offering tax exemptions and tax holidays to potential investors. This attracts both foreign and domestic investments. Local production expands which increases resource utilization. More employment opportunities are created as production expands.
- Reduction of tax rates on production and inputs. This reduces the costs of production which stimulates expansion of the scales of production. This increases demand for inputs and widens employment opportunities.
- Offering subsidies to infant domestic firms. Subsidies to young firms help them to grow and expand their scales of production and employ more resources. Subsidizing consumers also has an effect on demand. Demand increase which stimulates further production and employment of resources.
- Reducing direct taxes to increase people’s disposable incomes. This helps to stimulate consumption. It offers a ready market to producers who are encouraged to increase their production. Increasing production implies utilizing more resources.
- Reduction and or removal of export tariffs. This offers producers in the export sector free access to foreign markets and to promote production of exports.
- Increasing government spending on productive ventures. Government spending on infrastructure like roads, power, water and sanitation and telecommunication sector facilitates domestic production and promotes utilization of the available resources.
- Use of expansionary monetary policy. This helps to increase money supply to stimulate aggregate demand. It can be done by buying securities from the public, lowering the central bank lending rate, lowering the variable reserve ratio etc. This has an impact of stimulating investmentand production aggregate demand.
- Liberalising the economy. This helps to improve private sector participation in production activities. Employment creation expands and helps to drive the economy towards full employment.
8.2.4. Why is it difficult to attain full employment in Rwanda
In macroeconomic concept, there is no economy that attains full employment due to the following:
1. Low levels of skills. Because of low levels of education a proportion of labour force which is unskilled cannot be employed irrespective of the expansion in production.
2. Lack of information on labour markets. When the labour market is imperfect, some units of labour force remain unemployed irrespective of the availability of job vacancies. This makes it difficult to attain full employment in the economy.
3. Existence of voluntary unemployment. Either because of attitude towards work or the prevailing wage rate some units of labour force may prefer to remain unemployed irrespective of the availability of job opportunities.
4. Changes in seasons. There are activities that are done on a seasonal basis especially in the agricultural sector. This brings about seasonal unemployment especially in the agricultural sector. Thus it becomes difficult to get resources employed fully in the free season, for instance in the period between harvesting and the next planting season.
5. Limited markets. Domestic markets are low because the consumers have low incomes. There are obstacles to accessing foreign markets. This keeps production low leaving some resources unemployed.
6. Political instabilities. Political disagreements, unrest and conflicts disrupt settled life and productive activities. Potential investors are scared away. This reduces the possibility of moving the economy towards full employment
7. Attitude of the public towards work. if the attitude towards work, especially among the youth, who under look employments, who want to get rich quick, etc, makes it difficult to achieve full employment.
8. Dependence on primary production. LDCs produce and export unprocessed output. This limits the rate of job creation.
APPLICATION ACTIVITY 8.2
Rwanda is determined to create 1,500,000 (over 214,000 annually)
decent and productive jobs for economic development by 2024
(MINECOFIN: NST1-7YGP 2018/2024).
1. Assume you are among the policy makers planning for the GoR,
what will you do for Rwanda to realize that milestone.
2. What do you consider as bottlenecks for Rwanda to realize that
activity.
8.3. Keynesian theory of unemployment
ACTIVITY 8.3
Visit the library or any other source, make research about the following:
1. The meaning and causes of unemployment according to LM Keynes.
2. The solutions put forward by Keynes to lessen unemployment.
3. Critically argue on the relevancy and limitations of Keynesian theory in Rwanda.
8.3.1. Assumptions and Illustration
The Keynesian economics argues that economies are boosted when there is a healthy amount of output driven by sufficient amounts of economic expenditures. Keynes believed that unemployment is caused by a lack of expenditures within an economy, which decreased aggregate demand.
This exists when individuals lose their jobs as a result of a downturn/reduction in aggregate demand (AD) especially during a depression when incomes and output fall which results into employers laying off workers. The demand for most goods and services falls, less production is needed and consequently fewer workers are needed, wages are sticky and do not fall to meet the equilibrium level hence unemployment.
If the decline in aggregate demand is persistent, and the unemployment longterm, it is called either demand deficient, general, or Keynesian unemployment.
This type results from fluctuations in the business cycle. Cyclical unemployment rises significantly during economic downturns (recessions) and falls during growth phases. It is therefore natural to refer to the high unemployment, in these recurring periods of recession as cyclical. The term “cyclical” means that such unemployment occurs periodically.
When there is a fall in aggregate demand, the entrepreneurs will find themselves with unsold goods. They will be forced to reduce investment and consequently lay off workers.
Keynes stressed two concepts, the marginal propensity to consume (MPC)
and the investment multiplier. If individuals consume a greater proportion of the additional income, entrepreneurs will be encouraged to increase their investment and hence more employment opportunities. However, if MPC is low, unemployment is bound to occur since the investment multiplier process will be small.
Figure 20: Keynesian Unemployment
From Figure 20 above, E1 is the equilibrium point with employment level Y1;
some of the workers willing to work have not been absorbed. It means that E1
(effective demand point) is an under employment equilibrium and Y1 is under
employment level of income.
The unemployed workers can be absorbed if the aggregate demand increases
from Agg dd1 to Agg dd2 and a new equilibrium point E2 is established with
employment level Y2 which we assume is the full employment level. Hence
increase in aggregate demand from Agg dd1 to Agg dd2 leads to increase in
employment (Y2-Y1).
To curb down this type of unemployment according to Keynes, aggregate
demand should be increased in the following ways:
1. Increase government expenditure, to increase in the demand and in the end, incomes if the firms will increase and finally may need more workers to producet he needed goods;
2. Reduce tax on people’s incomes which will lead to more disposable income, and hence an increase in demand that will stimulate the producers to set up more investments and create more employment in turn;
3. Buy securities from the public. This will lead to increased money in the hands of the public and in end their demand will increase hence the need for increased output will cause the producers to demand for more workers;
4. Reduce the bank rate. This will attract people to seek for loans from the financial institutions which will further increase money in circulation, increase demand and employers will react by increasing the demand for workers;
5. Reduce legal reserve requirements. This is the amount that is by law supposed to be kept by commercial banks in the central bank. Reducing implies that there will be enough money held by commercial banks to lend to the public which will further increase aggregate demand;
6. Encouraging exports. This could be through lowering the tax rates and joining regional cooperation for an extended market. It will increase incomes and investment and in turn create employment opportunities;
7. Improvement in investment climate. This is through encouraging investors to invest in the country through giving them subsidies like tax holidays, gazetted land in economic zones among others. These investors will in turn create employment opportunities for the people;
8. Increasing wages of the people so as to increase their demand.
8.3.2. Applicability and Limitations
a. The Keynesian theory is relevant in the following ways:
i. As suggested by Keynes, in LDCs, demand for labour is derived demand. This implies that a fall in demand for goods and services will lead to a fall in incomes of the employers because their products have no market and in the end they will react by laying off workers.
ii. Through exports, new markets are got for the local goods and this implies that the local investors will earn more income. They will be able to set up more investments in order to satisfy the market and hence they will need to employ more workers.
iii. Reduction in tax as suggested by Keynes can lead to increase in household income and expenditure. This will in turn increase aggregate demand, the investors will react by needing to produce more to satisfy the increased demand and in the end they will need to hire and employ more workers leading to increased employment opportunities.
iv. Increasing government expenditure as suggested by Keynes increases money supply in the economy. This will further increase aggregate demand provoking producers to increase production which they can only do after employing more workers.
v. A conducive investment climate as suggested by Keynes encourages investment through attracting investors. These will in turn need to increase production and in the end they will end up employing more workers.
b. Limitation Keynesian theory of unemployment
i. Keynes viewed unemployment from the demand side when he said that unemployment is as a result of reduction in aggregate demand. This cannot be applicable in developing countries because in these countries unemployment is mostly as a result of inadequate capital.
ii. Increasing government expenditure as suggested by Keynes so as to increase aggregate demand will instead worsen the problem. This is because the increased money in circulation will instead shoot up the prices and it may further be too high for the people to buy hence the goods will lack market and still the employers may lay off the workers which will cause inflation.
iii. Keynes didn’t consider institutional and structural problems in LDCs such as poor road network, poor land tenure system which affect the level of investment and job creation.
iv. Increasing government expenditure will not increase employment opportunities especially in the agricultural sector. This is because people prefer white collar jobs than blue collar jobs so there may not be increase in employment despite increase in expenditure by the government.
v. Assumes a fully monetarised economy. This is because according to him, the aggregate demand can only be increased when there is increase in money in circulation but he does not consider the fact that in LDCs there is a large subsistence sector where people survive on the foods that they grow and they don’t take it to the market to earn incomes.
vi. Investments in industries may not absorb all the labour. This is because the need to increase output by these industries to gain more profits, may force the industries to use capital intensive techniques of production as opposed to labour intensive techniques and so unemployment may persist
vii. LDCs have got inelastic demand for imports. Even if the prices increase, their demand remains almost the same. Increase in aggregate demand means that the they will be more investments in those countries that supply the goods and employment will be created there and not in the countries where they export their goods. Thus unemployment will persist in the countries that receive the goods.
viii. Increasing money supply may not increase aggregate demand. This is because people in developing countries prefer to hold money in form of wealth or cash. Therefore there will still be deficiency in demand and unemployment.
ix. Keynes didn’t consider the causes and solutions to other types of unemployment. He only considered deficiency in demand yet we know that unemployment is broad with many causes and needs a variety of solutions if full employment is to be achieved.
APPLICATION ACTIVITY 8.3t
The Keynes way of thinking has brought to the attention of the most economies in the 20th century. As a student teacher in social studies who may also progress to economics in furthering your studies, how can you influence the economy of your country to pursue the trend of Keynes theory?
Do you think the theory is still applicable in 21st century given the advancement in technology where demand for goods and services keeps on changing? If yes/no, justify.
8.4. Theory of Rural Urban Migration
ACTIVITY 8.4
Using the photographs in figure below, describe the following:
1. What do you think caused such situations in the photos below?
2. The activity of people moving from a rural area to an urban area
to stay is known as ......
3. What do you think are the effects of such an activity in (1) above?
4. What do you think should be done to limit the movement of people
from rural areas to urban areas with an intention of staying?
8.4.1. Meaning of Rural Urban Migration
Rural-urban migration is a process whereby individuals move from rural to urban areas with an intention of staying. It occurs as a result of a combination of push and pull factors. This causes three things to happen;
- Urban growth - towns and cities are expanding, covering a greater area of land.
- Urbanization - an increasing proportion of people living in towns and cities.
- Depopulation in the rural areas because of people constantly moving to urban areas.
8.4.2. Causes of Rural-Urban Migration
a. Unequal distribution of economic activities. Unequal distribution of economic activities with urban areas having more than the rural areas. The government tends to allocate more development expenditures in the urban areas and forget the country sides where the majority of the people stay hence individuals have then tended to move to urban areas in hope of getting highly paid jobs.
b. Unequal distribution of social services. Unequal distribution of social services with urban areas having more than the rural areas. More and better education, medical, cinema halls, night clubs and transport facilities are allocated to urban areas than in the rural areas. Individuals then move to urban areas to enjoy these facilities.
c. Population pressure. Population pressure in the rural areas has also contributed to rural-urban migration. There is limited fertile land in the rural areas and yet there are increasing numbers of people on land. This causes diminishing returns. Individuals who have no access to land move to urban areas in search of employment.
d. Formal and inappropriate education. Theoretical subjects which lack any practical bias and prepare students for white collar jobs are being taught in schools. The school-leavers lack any specific qualifications. They search for jobs appropriate to their kinds of formal education received in schools. Therefore, after leaving school, individuals tend to stay in urban areas unemployed.
e. Minimum wage. To a small extent, there can be migration to urban areas arising from the setting up of minimum wages far above the average wage in the rural areas. Individuals tend to migrate to urban areas whenever they hear of any increase in the urban minimum wage. Unfortunately, the number of jobs in the urban areas is not increased. In some cases, the number of jobs is decreased.
f. Standard of living. The rural people view the urban standard of living to be better than the rural standard of living and hence rural-urban migration. The rural people have a belief that the urban standard of living is far much better than the rural one.
g. Social problems. This also plays a minor role towards rural urban migration and urban unemployment. Fear of witchcraft, circumcision and others are in most cases associated with rural areas. Individuals then try to escape to the urban areas where such are least experienced.
8.4.3. Effects/Consequences of Rural-Urban Migration
a. Open urban unemployment. Because of the constant movement of people from rural areas, there will be an increase in the number of people in urban areas who will be idle without jobs.
b. The problem of dependents. Normally when the people move to urban areas, they tend to stay with their relatives. Therefore they may cause increased dependency on the side of their hosts which leads to low standards of living.
c. Creation of slums. The presence of many people from villages to towns may cause scarcity of housing facilities. This in conjunction with low incomes, may cause the people to develop shanty housings leading to creation of slums.
d. Government expenditure on social services increases. There will be
increase in government expenditure on social services like hospitals and schools among others to cater for the growing population in the urban centers.
e. High cost of living in urban areas. The increase in the number of people in urban centers will lead to an increase in the demand for the goods and services. This may not be accompanied by corresponding increase in the supply of goods. In the end, the prices will go up.
f. The demand for social services exceeds the supply. There will be strain on the social services in the urban centers. This is because there is increase in the number of users and in the end there will be high costs of maintenance.
g. Food prices increase as well as house rents. The prices of food as well as house rent will shoot up due to the increase in the number of users and in the end problems of poor standards of living and welfare will come up.
h. Low agricultural output. Agriculture is mostly carried out in rural areas, therefore the increase in rural-urban migration means that the number of energetic young men and women who would stay and produce food will be moving to urban centers. Therefore there will be reduced productivity in rural areas.
i. Rural development will be delayed. This is because as more and more people move to urban centers, the government will concentrate on the urban centers and neglect the rural areas since there are fewer people hence rural under development.
8.4.4. Measures to control Rural-Urban Migration
i. Rural development policy: This can be through:
- The economic base of the rural areas must be strengthened so that productivity and earnings from agriculture are raised. A big percentage of the export earnings should be returned to the rural areas in form of farm implements so that increased capital formation can take place in the rural areas. Agricultural output can be improved by provision of more and better tools; provision of credit facilities; improvement of transport facilities; higher agricultural prices to farmers etc.
- A comprehensive industrial program to employ otherwise redundant people should be introduced. Small-scale labour-intensive industries should be set up.
- Special attention should be paid to building in small-country towns in rural areas, schools, hospitals, cinema halls and the like since people are more likely to remain in the countryside when amenities are reasonably close to where they live. In other words, rural areas should be made attractive.
ii. Population control: The high population growth rates must be brought to a halt using various policies like use of family planning methods, giving a maximum number of children per family, reducing incentives like free education among others.
iii. Education policy: To overcome the problem of school leavers, educationalists should change the educational curriculum to subjects with a more practical bias like farming, carpentry, simple mechanics and the like, to create more job seekers.
iv. Financial infrastructure: The government should create an effective financial infrastructure that can assist people in rural areas with micro loans that are to be paid back with a small interest rate. This will help in the mobilisation of savings, which can be loaned to the farmers and they will be able to stay in rural areas.
v. Wage policy: The minimum wage policy should either be abolished or made effective throughout the country such that even in the rural areas, people can earn the same wage as their colleagues in towns. This will reduce their movements to towns.
vi. Rural-rural migration: There should be rural-rural migration. For instance, moving from Nyamirama to Ruramira not from Nyamirama to Kayonza town. However, this is difficult to manage.
APPLICATION ACTIVITY 8.4
In most developing world, you notice many young people in rural areas carrying their bags heading to cities. What do you think are the reasons pushing those young people in towns. What will happen to villages that those young people have left and what will happen to the cities where those people go. Assume you are one of policy makers in Rwanda, what measures will you put in place to reduce that practice of rural-urban migration.
END UNIT ASSESSMENT
1. Examine reasons why some people in Rwanda do not want to work.
2. Why is it difficult to get all people in Rwanda employed?
3. What do you think the Rwandan government should do to reduce the unemployment problem?
4. How has the unemployment problem affected the development process in Rwanda?
5. With reference to Rwanda, critically assess the Keynesian theory of unemployment.
6. In your views what are the pull factors for rural-urban migration and how can curb down the rural-urban migration.