WORKSHOP

BASIC ECONOMICS
MODULE OUTCOMES

Introduction to Economics
Supply and demand
Short term versus long term
Markets in action
Microeconomics & macroeconomics
Macroeconomics theory
Economic growth & development
Labour market
Examination
INTRODUCTION TO
ECONOMICS
 THE ECONOMIC PROBLEM OF
SCARCITY, CHOICE & OPP COST
When wants exceed the resources available to satisfy
them, there is scarcity.
The condition that arises because the available
resources are insufficient to satisfy wants.
Faced with scarcity, people must make choices.
Choosing more of one thing means having less of
something else.
The opportunity cost of any action is the best alternative
forgone.
 WHAT IS ECONOMICS?

Economics
The social science that studies the choices that we make
as we cope with scarcity and the incentives that influence
and reconcile our choices.

Here are some examples of scarcity and the trade-offs associated with
making choices:
You have a limited amount of time. If you take a part-time job, each
hour on the job means one less hour for study or play.
A city has a limited amount of land. If the city uses an acre of land
for a park, it has one less acre for housing, retailers, or industry.
You have limited income this year. If you spend R70 on a music CD,
thats R70 less you have to spend on other products or to save.
MICRO VS MACRO
Microeconomics
Microeconomics: The study of the choices that
individuals and businesses make, the way these
choices interact, and the influence that
governments exert on these choices.
Macroeconomics
Macroeconomics: The study of the aggregate (or
total) effects on the national economy and the
global economy of the choices that individuals,
businesses, and governments make.
 WHAT IS ECONOMICS?

The Three Key Economic Questions: What, How,

and Who?
The choices made by individuals, firms, and
governments answer three questions:
1 What products do we produce?
2 How do we produce the products?
3 Who consumes the products?
 PLANNED, MARKET &
MIXED ECONOMIES
Planned economy the government decides how
resources are allocated to the production of particular
goods.

Market economy - the government plays no role in

allocating resources.

Mixed economies the government and the private

sector jointly solve economic problems
 WHY ECONOMICS IS
WORTH STUDYING
Understanding
Economic ideas are all around you. You cannot ignore
them. As you progress with you study of economics,
youll gain a deeper understanding of what is going on
around you.
Expanded Career Opportunities
Knowledge of economics is vital in many fields such as
banking, finance, business, management, insurance, real
estate, law, government, journalism, health care and the
arts.
PRODUCTION POSSIBILITIES
The PPF is a valuable tool for illustrating the
effects of scarcity and its consequences.
Production Possibilities Frontier
The boundary between the combinations of
goods and services that can be produced and the
combinations that cannot be produced, given
the available factors of production and the state
of technology.
 PRODUCTION POSSIBILITIES

Figure 1 shows the

PPF for bottled water
and CDs.

Each point on the graph

represents a column of
the table.

The line through the

points is the PPF.
PRODUCTION POSSIBILITIES
The PPF puts three features of production
possibilities in sharp focus:
Attainable and unattainable combinations
Full employment and unemployment
PPF are faced with opportunity costs
Opportunity cost is the cost of the next best
alternative sacrificed when a choice is made
 OPPORTUNITY COST
Moving from C to B, the 1 CD costs 1/2 of a bottle of water.
 EXPANDING PRODUCTION POSSIBILITIES

A sustained expansion of production possibilities is

called economic growth.
The key factors that influence economic growth are:
Technological change
Expansion of human capital

Capital accumulation

Technological change is the development of new goods and

services and better methods of production.
Expansion of human capital comes from education and on-the-
job training.
Capital accumulation is the increase in capital resources.
 THE PRINCIPLE OF OPPORTUNITY COST

FIGURE 2.2
Shifting the Production
Possibilities Curve
An increase in the quantity of
resources or technological
innovation in an economy
shifts the production
possibilities curve outward.
Starting from point f, a nation
could produce more steel
(point g), more wheat (point h),
or more of both goods (points
between g and h).
SUPPLY & DEMAND
 DEMAND
The relationship between the quantity
demanded and the price of a good when all
other influences on buying plans remain the
same.

Illustrate
a table with a price and quantity
demanded.
 LAW OF DEMAND
The Law of Demand
Other things remaining the same,
If the price of a good rises, the quantity demanded of
that good decreases.
If the price of a good falls, the quantity demanded of
that good increases.
Demand curve versus demand schedule
DEMAND
DEMAND
Changes in Demand
Change in the quantity demanded
A change in the quantity of a good that people
plan to buy that results from a change in the
price of the good.
Change in demand
A change in the quantity that people plan to buy
when any influence other than the price of the
good changes.
 DEMAND
The main influences on buying plans that change demand are:

Prices of complementary/substitute goods

Consumer Income (normal goods e.g. laptop & inferior
goods e.g. Sasco bread)
Price Expectations
Number of buyers the greater the no. of buyers in a mkt,
the larger the dd for any good
Tastes & Preferences when prefs change, the demand
for items increases & dd for another item decreases
 DEMAND
Demand: A Summary
 SUPPLY
Quantity supplied
The amount of a good, service, or resource that people are
willing and able to sell during a specified period at a specified
price.

The Law of Supply

Other things remaining the same,
If the price of a good rises, the quantity supplied of
that good increases.
If the price of a good falls, the quantity supplied of that
good decreases.
SUPPLY
SUPPLY
Changes in Supply
Change in quantity supplied
A change in the quantity of a good that suppliers
plan to sell that results from a change in the price
of the good.
Change in supply
A change in the quantity that suppliers plan to
sell when any influence on selling plans other
than the price of the good changes.
 SUPPLY
Figure 4.7 shows
changes in supply.

1. When supply decreases,

the supply curve shifts
leftward from S0 to S1.

2. When supply increases,

the supply curve shifts
rightward from S0 to S2.
 SUPPLY
The main influences on selling plans that change supply are:
Prices of related goods
Prices of resources and other Inputs
Expectations
Number of sellers
Productivity
Microeconomics: Principles, Applications, and Tools OSullivan, Sheffrin, Perez 6/e.

of Responsiveness
Elasticity: A Measure
 THE PRICE ELASTICITY OF DEMAND

price elasticity of demand (Ed)

A measure of the responsiveness of the quantity
demanded to changes in price; equal to the absolute
value of the percentage change in quantity demanded
divided by the percentage change in price.

Elasticity
Elastic > 1
Inelastic < 1
Unitary = 1
 THE PRICE ELASTICITY OF DEMAND

Price Elasticity and the Demand Curve

perfectly inelastic demand
The price elasticity of demand is zero.

FIGURE 5.1 (contd.)

Elasticity and Demand Curves
 THE PRICE ELASTICITY OF DEMAND

Price Elasticity and the Demand Curve

perfectly elastic demand
The price elasticity of demand is infinite.

FIGURE 5.1 (contd.)

Elasticity and Demand Curves
 THE PRICE ELASTICITY OF DEMAND

Computing Percentage Changes and Elasticities

 THE PRICE ELASTICITY OF DEMAND

Other Determinants of the Price Elasticity of Demand

SHORT RUN VS LONG TERM
 SHORT RUN vs LONG RUN

The Short Run: Fixed Plant

The short run is a time frame in which the quantities
of some resources are fixed.
In the short run, a firm can usually change the quantity
of labor it uses but not the quantity of capital
The Long Run: Variable Plant
The long run is a time frame in which the quantities of
all resources can be changed.
A sunk cost is irrelevant to the firms decisions.
SHORT-RUN COST
SHORT-RUN PRODUCTION
To increase output with a fixed plant, a firm
must increase the quantity of labor it uses.
We describe the relationship between output
and the quantity of labor by using three related
concepts:
Total product (total quantity produced)
Marginal product
Average product
SHORT-RUN PRODUCTION
Total Product
Total product (TP) is the total quantity of a
good produced in a given period.
Total product is an output ratethe number of
units produced per unit of time.
Total product increases as the quantity of labor
employed increases.
 SHORT-RUN PRODUCTION
Figure 9.2 shows the total
product and the total
product curve.
Points A through H on the
curve correspond
to the columns of the
table.
The TP curve is like the
PPF: It separates
attainable points and
unattainable points.
 SHORT-RUN PRODUCTION
Marginal Product
Marginal product is the change in total product
that results from a one-unit increase in the
quantity of labor employed.
It tells us the contribution to total product of
adding one more worker.
When the quantity of labor increases by more (or
less) than one worker, calculate marginal product
as: Change in
Marginal = Change in
product total product quantity of labor
 SHORT-RUN PRODUCTION

The table calculates

marginal product
and the orange bars in
part (b) illustrate it.

Notice that the steeper

the slope of the TP
curve, the greater is
marginal product.
 SHORT-RUN PRODUCTION
The total product and
marginal product curves in
this figure incorporate a
feature of all production
processes:
Increasing marginal
returns initially
Decreasing marginal
returns eventually

Negative marginal
returns
SHORT-RUN PRODUCTION
Increasing Marginal Returns
Increasing marginal returns occur when the
marginal product of an additional worker
exceeds the marginal product of the previous
worker.
Increasing marginal returns occur when a small
number of workers are employed and arise
from increased specialization and division of
labor in the production process.
SHORT-RUN PRODUCTION
Decreasing Marginal Returns
Decreasing marginal returns occur when the
marginal product of an additional worker is less
than the marginal product of the previous
worker.
Decreasing marginal returns arise from the fact
that more and more workers use the same
equipment and work space.
As more workers are employed, there is less
and less that is productive for the additional
worker to do.
 SHORT-RUN PRODUCTION
Decreasing marginal returns are so pervasive that
they qualify for the status of a law:
The law of decreasing returns states that:
As a firm uses more of a variable input,
with a given quantity of fixed inputs, the
marginal product of the variable input
eventually decreases.
SHORT-RUN PRODUCTION
Average Product
Average product is the total product per worker
employed.
It is calculated as:

Average product = Total product Quantity of

labor
Another name for average product is
productivity.
 SHORT-RUN PRODUCTION
When marginal product is less than
average product, average product is
decreasing.
When marginal product equals
average product, average product is
at its maximum.
9.3 SHORT-RUN COST
To produce more output in the short run, a firm
employs more labor, which means it must
increase its costs.
We describe the relationship between output
and cost using three cost concepts:
Total cost
Marginal cost

Average cost
9.3 SHORT-RUN COST
Total Cost
A firms total cost (TC) is the cost of all the
factors of production the firm uses.
Total cost divides into two parts:
Total fixed cost (TFC) is the cost of a firms
fixed factors of production used by a firmthe
cost of land, capital, and entrepreneurship.
Total fixed cost doesnt change as output
changes.
9.3 SHORT-RUN COST
Total variable cost (TVC) is the cost of the variable
factor of production used by a firmthe cost of
labor.
To change its output in the short run, a firm must
change the quantity of labor it employs, so total
variable cost changes as output changes.
Total cost is the sum of total fixed cost and total
variable cost. That is,
TC = TFC + TVC
Table 9.2 on the next slide shows Sams Smoothies
costs.
SHORT-RUN COST
 SHORT-RUN COST
Figure 9.6 shows Sams
Smoothies total cost curves.

Total fixed cost (TFC) is

constantit graphs as a
horizontal line.
Total variable cost (TVC)
increases as output increases.

Total cost (TC) also increases

as output increases.
 SHORT-RUN COST
The vertical distance between
the total cost curve and the
total variable cost curve is
total fixed cost, as illustrated
by the two arrows.
SHORT-RUN COST
Marginal cost
A firms marginal cost is the change in total
cost that results from a one-unit increase in total
product.

Marginal cost tells us how total cost changes as

total product changes.

Table 9.3 on the next slide calculates marginal

cost for Sams Smoothies.
SHORT-RUN COST
Average Cost
There are three average cost concepts:
Average fixed cost (AFC) is total fixed cost per
unit of output.
Average variable cost (AVC) is total variable
cost per unit of output.
Average total cost (ATC) is total cost per unit of
output.
 SHORT-RUN COST
The average cost concepts are calculated from the
total cost concepts as follows:
TC = TFC + TVC
Divide each total cost term by the quantity produced,
Q, to give
TC = TFC + TVC
Q Q Q
or,
ATC = AFC + AVC
SHORT-RUN COST
 SHORT-RUN COST
The vertical distance between
these two curves is equal to
average fixed cost, as illustrated by
the two arrows.

The marginal cost curve (MC) is

U-shaped and intersects the
average variable cost curve and the
average total cost curve at their
minimum points.
 LONG-RUN COST
Plant Size and Cost
When a firm changes its plant size, its cost of
producing a given output changes.
Each of these three outcomes arise because when a
firm changes the size of its plant, it might
experience:
Economies of scale
Diseconomies of scale
Constant returns to scale
 PRODUCTION AND COST IN
THE LONG RUN
Economies of Scale, Diseconomies of scale and constant returns

economies of scale
A situation in which the long-run average cost of production decreases as
output increases.

diseconomies of scale
A situation in which the long-run average cost of production increases as
output increases.

Constant return s to scale

Exist when a firm increases plant size and labour employed by the same
percentage, its output increases by the same percentage and average total cost
remains constant
9.4 LONG-RUN COST
The Long-Run Average Cost Curve
The long-run average cost curve shows the
lowest average cost at which it is possible to
produce each output when the firm has had
sufficient time to change both its plant size and
labor employed.
 LONG-RUN COST
In the long run, Samantha can vary both capital and labor
inputs.
The long-run
average cost curve,
LRAC, traces the
lowest attainable
average total cost of
producing each
output.
 12.4 LONG-RUN COST
Sams experiences economies of scale as output increases to 9
gallons an hour,
constant returns to
scale for outputs
between 9 gallons
and 12 gallons an
hour,
and diseconomies of
scale for outputs that
exceed 12 gallons an
hour.
MARKETS IN ACTION
 MARKET EQUILIBRIUM
market equilibrium
A situation in which the quantity
demanded equals the quantity
supplied at the prevailing market
price.

1. Excess demand cause the

price to rise

2. Excess supply cause

the price to drop
 DEMAND
Demand: A Summary
 SUPPLY - SUMMARY
Supply: A Summary
 ELASTICITY & CHANGES IN THE EQUILIBRIUM

Equilibrium price and equilibrium quantity in a

given market are determined by the intersection of
the supply and demand curves.

Depending on the elasticities of supply and demand,

the equilibrium price and quantity can behave
differently with shifts in supply and demand.
 ELASTICITY & CHANGES IN THE EQUILIBRIUM

If demand is very elastic, then shifts in the supply curve will

result in large changes in quantity demanded and small
changes in price at the equilibrium point.
 ELASTICITY & CHANGES IN THE EQUILIBRIUM

If demand is very inelastic, however, then shifts in the supply curve

will result in large changes in price and small changes in quantity at
the equilibrium point.
MACRO VS
MICROECONOMICS
MICRO VS MACRO
Microeconomics
Microeconomics: The study of the choices that
individuals and businesses make, the way these
choices interact, and the influence that
governments exert on these choices.
Macroeconomics
Macroeconomics: The study of the aggregate (or
total) effects on the national economy and the
global economy of the choices that individuals,
businesses, and governments make.
 Macroeconomics questions

Will tomorrows world be more prosperous than

today?
Will jobs be plentiful?

Will the cost of living be stable?

Will the government and the nation remain in

deficit?

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 Macroeconomic Policy Challenges
and Tools
Five widely agreed policy challenges for
macroeconomics are to:
1. Boost economic growth
2. External stability/balance of payments
3. Lower unemployment / Full employment
4. Price stability
5. Equitable distribution of wealth (income)
 Macroeconomic Policy
Challenges and Tools
Two broad groups of macroeconomic policy tools
are :
Fiscal policymaking changes in tax rates and
government spending
Monetary policychanging interest rates and changing
the amount of money in the economy
 The Circular Flow
This model captures the essential essence of
macroeconomic activity
The circular flow model illustrates the
mechanism by which income is generated from
goods and services and how this income is spent.
This provides the basis for the way economists
think about the interactions between different
parts of the economy and the measurement of
economic activity
The Circular Flow of income n spending
MACROECONOMICS
THEORY
MACROECONOMIC
VARIABLES
Gross Domestic Product (GDP)
Inflation

Unemployment

Balance of payments
 Gross Domestic Product
GDP Defined
GDP or gross domestic product, is the market
value of all final goods and services produced in a
country in a given time period.
This definition has four parts:
Market value
Final goods and services

Produced within a country

In a given time period

Gross Domestic Product
Market Value
GDP is a market value goods and services are
valued at their market prices.
To add apples and oranges, computers and ice
cream, we add the market values so we have a
total value of output in rands.

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Gross Domestic Product
Final Goods and Services
GDP is the value of the final goods and
services produced.
A final good (or service) is an item bought by
its final user during a specified time period.
A final good contrasts with an intermediate
good, which is an item that is produced by one
firm, bought by another firm and used as a
component of a final good or service.
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Gross Domestic Product
Excluding intermediate goods and services avoids a
problem called double counting.
Produced Within a Country
GDP measures production within a country domestic
production.
In a Given Time Period
GDP measures production during a specific time period
Excluding intermediate goods and services avoids
double counting normally a year or a quarter of a
year.
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 GDP, INCOME, AND
EXPENDITURE

Figure 1
shows the
circular flow
of income
and
expenditure.
Nominal vs Real GDP
Real GDP is the value of final goods and
services produced in a given year when valued
at constant prices.
The first step in calculating real GDP is to
calculate nominal GDP.
Nominal GDP
Nominal GDP is the value of goods and
services produced during a given year valued at
the prices that prevailed in that same year.
 Inflation
Inflation is a a continuos and considerable rise in
price level in general.
The commonly used indicator of general price
level is the CPI
To calculate inflation rate - is the percentage
change in the price level.

(P1 P0)
P0 100
 Inflation
Is Inflation a Problem?
Unpredictable changes in the inflation rate are a problem
because they redistribute income in arbitrary ways between
employers and workers and between borrowers and
lenders.
A high inflation rate is a problem because it diverts
resources from productive activities to inflation forecasting.
Eradicating inflation is costly because it brings a period of
greater than average unemployment.

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When an inflation occurs ____________.
all prices are rising
oil prices are rising

all families are spending more money on food

prices on the average are rising

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 Unemployment
defined

Unemployment is a state in which a person

does not have a job but is available for work,
willing to work, and has made some effort to
find work within the previous four weeks.
Types of Unemployment
Frictional unemployment
Structural unemployment

Cyclical unemployment

Seasonal unemployment

Disguised/ Hidden unemployment

 Unemployment

Frictional unemployment This is

unemployment caused by people moving in
between jobs, e.g. graduates or people
changing jobs. There will always be some
frictional unemployment.
 Unemployment

Structural unemployment is
unemployment created by changes in
technology and foreign competition that
change the skills and location match
between jobs and workers.
Cyclical unemployment is the fluctuation
in unemployment caused by the business
cycle e.g. in a recession AD & thus output
falls.
 Unemployment

Seasonal unemployment is occurs when

employees only work during a certain time(s) of
the year and therefore during other months they
are regarded as unemployed.
Disguised/Hidden unemployed is said to exist if
people who were previously fully employed,
have had their hours.(& salaries) reduced
because of poor business performance
 Costs of unemployment
Why Unemployment Is a Problem
Unemployment is a serious economic, social, and
personal problem for two main reasons:
Lost production and incomes
Lost human capital

Lost production and income is serious but

temporary.
Lost human capital is devastating and permanent.
 Balance of payments
A countrys balance of payments accounts
records its international trading, borrowing and
lending. It consists of 4 basic accounts:
1. Current account reflects the rand value of the goods and
services exported and imported during the period
2. Capital account records all international borrowing and
lending.
3. Financial account-international transactions involving
financial assets including the borrowing & lending of funds
4. Unrecorded transactions- all errors & ommissions that occur
in compiling the individual components of the BOP.
ECONOMIC GROWTH &
DVPT
 Economic Growth
Economic growth is the expansion of the economys
production possibilitiesan outward shifting PPF.
We measure economic growth by the increase in real
GDP.
Real GDPreal gross domestic productis the
value of the total production of all the nations farms,
factories, shops, and offices, measured in the prices of
a single year.
 The Causes of Economic
Growth: A First Look
For economic growth to persist, people
must face incentives that encourage them to
pursue three activities
Saving and investment in new capital
Investment in human capital
Discovery of new technologies
An increase in labour supply
Decrease in human capital

Increase in productivity Pear
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The Causes of Economic Growth
Saving and Investment in New Capital
The accumulation of capital has dramatically increased
output and productivity.
Investment in Human Capital
Human capital acquired through education, on-the-job
training, and learning-by-doing has also dramatically
increased output and productivity.
Discovery of New Technologies
Technological advances have contributed immensely to
increasing productivity.
Ongoing economic growth requires all of
the following except _____________.
saving and investment in new capital
the discovery of new technologies

population growth

investment in human capital

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 Measuring Economic Growth
When GDP increases, we know that either
We produced more goods and services or
We paid higher prices

Producing more goods and services contributes

to an improvement in our standard of living.
Expansion of production is economic growth.
Economic growth is not a smooth process and
hence is related to a phenomenon called

business cycle Pear
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Business Cycle Patterns

The business cycle is a pattern of upswing

(expansion) and downswing (contraction) in the
economy.
These cycles differ according to the role of
outside force and basic system design.
 BUSINESS CYCLE
Figure 1.1
shows a
business
cycle.
An expansion
ends at a peak
and a recession
ends at a
trough.
 Economic Growth
Every business cycle has two phases:
1. A recession - is a period during which real
GDP decreases for at least two successive
quarters.
2. An expansion - is a period during which real
GDP increases.
and two turning points:

1. A peak

2. A trough
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 Cycle Patterns, Impulses
and Mechanisms

All theories of the business cycle agree that

investment and the accumulation of capital play
a crucial role.
Recessions begin when investment slows and
recessions turn into expansions when
investment increases.
Investment and capital are crucial parts of
cycles, but are not the only important parts.
 Causes of fluctuations in
actual growth

Causes of fluctuations in actual growth

In the short-run
Variations in the growth of aggregate demand total
spending on goods and services made within a country
In the long-run
The growth in Aggregate demand. This determines
whether potential output will be realised
The growth in potential output
 Economic Growth
Benefits and Costs of Economic Growth
The main benefit of long-term economic growth is
expanded consumption possibilities, including more health
care for the poor and elderly, more research on cancer and
AIDS, better roads, more and better housing and a cleaner
environment.
The costs of economic growth are forgone consumption in
the present, more rapid depletion of non-renewable natural
resources, and more frequent job changes.
THE LABOUR MARKET
 The Labour Market
The market for a factor of
production - labour
Refers to the demand for
labour by employers and
the supply of labour
(provided by potential
The demand for labour is dependent on the
employees) demand for the final product that labour
produces.The greater the demand for office
space the higher the demand for construction
workers.
Copyright: Bo de Visser, stock.xchng
The Labour Market
The labour market is an example of a factor market
Supply of labour those people seeking employment
(employees)
Demand for labour from employers
A Derived Demand not wanted for its own sake but for what it
can contribute to production
Demand for labour related to productivity of labour and the level
of demand for the product
Elasticity of demand for labour related to
the elasticity of demand for the product
The Labour Market
At higher wage rates
the demand for labour
will be less than at
lower wage rates
Reason linked to
Marginal Productivity
Theory
The demand for labour is highly dependent on the
productivity of the worker the more the worker
adds to revenue, the higher the demand.
Copyright: iStock.com
 The Labour Market
Wage Rate ( per hour)
10
There is an inverse
relationship between the
wage rate and the number
of people employed by the
firm.

The MRP curve

7
therefore represents the
demand curve for labour
illustrating the derived
4 demand relationship.

DL

10 15 19 Number Employed
The Labour Market
The market demand for labour will shift or
change due to:
The number of firms or employers changes
The number of product changes
The productivity of labour changes
There is a new substitute for labour
The price of substitute changes
The price of a complementary factor of production
changes
 The demand for labour
The Labour Market will shift if:
Productivity of labour
increases
Wage Rate ( per week) At
Thea relatively
demand for high
labour
New
At amachinery
wage lower wage
rate of 250
isper
rate used
the
is downward sloping
which
firm increases
week,
from can afford
the
left value
to toadded
right take on
250 more workers.
productivity
by the worker The
must demand
be
for labourtoiscover
greater inversely
the cost
related to the wage
If there is an increase
of hiring that rate
labour.
Demand is likely to be
in the demand for the
lower.
good/service itself
If the price of the
good/service increases

100
DL1

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Q1 Q3 Q2 Q4
Quantity of labour employed
The Labour Market
The Supply of Labour
The amount of people offering their labour
at different wage rates.
Involves an opportunity cost work v. leisure
Wage rate must be sufficient
to overcome the opportunity cost
of leisure
The Labour Market
The market supply of labour will shift or
change due to:
Tastes (for leisure, income and work)
Income and wealth
Expectations (for income or consumption)
Skill levels required
Size and structure of the population age, gender, etc.
Opportunity cost of work income and substitution
effects
The Labour Market
Income effect of a rise in wages:
As wages rise, people feel better off and therefore may not feel a
need to work as many hours
Substitution effect of a rise in wages:
As wages rise, the opportunity cost of leisure rises (the cost of
every extra hour taken in leisure rises). As wages rise, the
substitution effect may lead to more hours being worked.
The net effect depends on the relative strength of the
income and substitution effects
 A rise in the demand for
labour would force up

The Labour Market the wage rate as there

would be excess
demand for labour.
Wage Rate ( per hour)
SL The market wage
rate for a particular
occupation therefore
will occur at the
7.50 intersection of the
demand and supply
of labour.
6.00
The wage rate will
alter if there is a shift
in either or both the
demand and supply
of labour.
Excess Demand

DL1
DL
Q1 Q2
Number employed
 The Labour Market
Wage Rate ( per hour)
SL An increase in the
supply of labour
would lead to a fall
in the wage rate as
there would be an
Sexcess
L1 supply of
6.00 labour.

5.00
Excess Supply

DL

Q1 Q2
Number employed
GOODLUCK WITH YOUR
EXAM