History of Economics Economics originated from the Greeks, it was first known as “OIKONOMIA” (OIKONOMICOS) which means household management. The father of economics is Adam Smith Definition Here we will look at three definitions given by famous economists.
Adam Smith His definition was called as the ‘Wealth Definition’. He defined economics as a study of wealth in his famous book “Wealth of Nation” published in the year 1776.
Alfred Marshall Marshall’s definition was known as the ‘Welfare Definition’. He defined economics as “Economics is a study of mankind in the ordinary business of life ”.
Lionel Robin Robin’s definition was known as the ‘Scarcity Definition’. According to Robin “Economics is a science, which studies human behavior as a relationship between ends and scarce means which have alternative uses”.
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His definition can be summarized as: - (ends) human wants are unlimited - (scarce means) resources are limited - (alternative) different
In short, he means, human wants are unlimited but the resources are limited but all these limited resources have many uses.
BASIC ECONOMIC CONCEPTS
Needs These are basic requirements or necessities of life. These are things people can’t live without. Example, food, clothing, shelter…etc
Wants These are things people would like to have over and above their needs. Wants are unlimited. Example, to have expensive perfume
Scarcity When a particular commodity is not enough to satisfy all human wants completely it is known as scarcity. It means the supply of a commodity is limited in relation to its demand.
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Resources These are the factors of production used to produce other goods and services. Resources can also be called as the factors of production. Resources can be classified into three: Natural Resources: these are gifts of nature example, trees, air, land…etc Human Resources: all efforts of human, whether physical, mental, skilled or unskilled. Manufactured Manufactured Resources: these are man-made ma n-made resources example, machinery • •
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Economizing Economizing is making the most of what we have, that is using the limited resources in such a way that it gives the maximum benefit and reduces wastage. Example, a paper is economized if we use both sides of it to write.
Choice It is the selection between two or more commodities. We are forced to make choices because our resources are limited and wants are unlimited. When we make a choice we select the commodity that gives us the maximum satisfaction.
Opportunity Cost Opportunity Opportunity cost is the next best alternative forgone. It the real cost of choosing something. When we make a choice we have to give up or forgo something, the forgone thing is the opportunity cost. For example, suppose you have only RF 100 and you want to buy a CD and story book. Can you buy both? No you can’t because your resource (money) is not enough here. So you have to make a choice , which means you have to forgo something. Let’s say, you decided to buy the story book so you are giving up the CD hence, the opportunity cost of buying the story book is the CD that you have forgone.
Opportunity cost is not how much money we spend on goods, but the other goods and services we could have bought with the money. Opportunity cost should also include other relevant costs like the value of time spend and the value of the opportunities we forgo.
For example: suppose you are considering on visiting an aunt (who is willing to help you in the economic assignment) or going to Athena to watch a movie. Your aunt does not charge you for helping you out but you would have to spend around 2 hours at her house. The movie cost RF 25 and the movie goes on for 2 hours. Is tutorial free? No, because it comes at the expense of missing the movies plus some other works which you could do at t hat time. The opportunity cost of going to watch the movie is the goods which you could buy with RF 25 and the missed tutorial session with your aunt.
Services These are intangible things which we can’t see, feel or touch. Example, service of a teacher, doctor...etc
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Resources These are the factors of production used to produce other goods and services. Resources can also be called as the factors of production. Resources can be classified into three: Natural Resources: these are gifts of nature example, trees, air, land…etc Human Resources: all efforts of human, whether physical, mental, skilled or unskilled. Manufactured Manufactured Resources: these are man-made ma n-made resources example, machinery • •
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Economizing Economizing is making the most of what we have, that is using the limited resources in such a way that it gives the maximum benefit and reduces wastage. Example, a paper is economized if we use both sides of it to write.
Choice It is the selection between two or more commodities. We are forced to make choices because our resources are limited and wants are unlimited. When we make a choice we select the commodity that gives us the maximum satisfaction.
Opportunity Cost Opportunity Opportunity cost is the next best alternative forgone. It the real cost of choosing something. When we make a choice we have to give up or forgo something, the forgone thing is the opportunity cost. For example, suppose you have only RF 100 and you want to buy a CD and story book. Can you buy both? No you can’t because your resource (money) is not enough here. So you have to make a choice , which means you have to forgo something. Let’s say, you decided to buy the story book so you are giving up the CD hence, the opportunity cost of buying the story book is the CD that you have forgone.
Opportunity cost is not how much money we spend on goods, but the other goods and services we could have bought with the money. Opportunity cost should also include other relevant costs like the value of time spend and the value of the opportunities we forgo.
For example: suppose you are considering on visiting an aunt (who is willing to help you in the economic assignment) or going to Athena to watch a movie. Your aunt does not charge you for helping you out but you would have to spend around 2 hours at her house. The movie cost RF 25 and the movie goes on for 2 hours. Is tutorial free? No, because it comes at the expense of missing the movies plus some other works which you could do at t hat time. The opportunity cost of going to watch the movie is the goods which you could buy with RF 25 and the missed tutorial session with your aunt.
Services These are intangible things which we can’t see, feel or touch. Example, service of a teacher, doctor...etc
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Goods Good is anything that is tangible which has the power to satisfy human wants. Tangible things are those things which we can see, feel and touch. Goods can be mainly categorized into the following: Goods Free Goods
Economic Goods
Consumer Goods
Durable Goods
Producer Goods
Non-Durable Goods
Free Goods These are gifts of nature for which are available in abundance (large quantities) and does not have any cost of production, therefore we don’t have to pay a price for it hence, there is no opportunity opportunity cost. Example, river water, sunlight, air…etc
Economics Goods These are man-made goods which involves a cost of production so we have to pay a price for these goods and they are limited in supply and have an opportunity cost. Example, pen, clothes…etc
Consumer Goods These are goods produced for direct consumption. Consumption means using up of goods and services.
Producer Goods These are goods used to produce other goods and services, these goods are not used for direct consumption. consumption. Example, machineries
Durable Goods These are goods which last for long period of time. Example, cars, TV…etc
Non-Durable Goods These are goods which do not last for a long period of time; they have a very short life. Example, fruits, batteries, pens…etc.
Production Any kind of work that helps to satisfy people’s wants and for which the consumers are willing to pay a price for it is known as production. It includes both the output of goods and services. For example, education, health services, work done in factories…etc.
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Consumption Consumption refers to the using up of goods and services to satisfy human wants. It can be either direct consumption or indirect consumption. Direct consumption means using up of goods and services directly e.g. food, clothing…etc Indirect consumption means using up of goods and services indirectly e.g. using of an airport or railway station...etc. •
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Distribution Distribution is dividing of different resources into different sectors of production, in the most efficient way.
Exchange Exchange is buying and selling of goods and services for money.
Income Income is the flow of money in a given period of time. Example, salary
Wealth Wealth refers to the stocks of goods which have a money v alue. It can be: Private wealth: the stock of goods possessed by an individual person e.g. car, deposits…etc Social wealth: wealth which is owned by the community e.g. roads, parks, schools…etc National wealth: everything that is owned by the people of the country which has money value. It is the sum of private and social wealth. •
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Utility We buy goods and services to satisfy our wants. When we use the good or service we are consuming it, this is known as utility. When we speak of consuming a good, we are describing the using-up of the utility the good provides rather than of the good itself. For example, we enjoy the programmes in the TV (we consume it) not the television set itself.
Merit Goods Merit goods are those goods that the government thinks people should have, and if not provided by the government these goods and services will be underprovided by the private sector. Example: Education and Health.
Public Goods Public goods are those goods which wh ich are non-exhaustible (non-rivalry) and non-excludable. This means that consumption of the good by one individual does not reduce the amount of the good available for consumption by others; and no one can be effectively excluded from using that good. For example, if one individual eats a cake, there is no cake left for anyone else, and it is possible to exclude others from consuming the cake; it is an exhaustible (rival) and excludable private excludable private good. But, street-lights neither reduce the amount of brightness available to others, nor can people be effectively excluded from using the light . This makes it a public good. • •
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Factors of production are the resources used to produce goods and services. Factors of production are broadly classified into: 1- Land 2- Labour 3- Capital 4- Entrepreneur
1- LAND (Natural Resource)
Land refers to all the natural resources on Earth which are available to us for the satisfaction of our wants. It refers to everything in atmosphere, in the sea and in the ground. It is the gifts of nature. The price paid for the use of land is rent. The supply of land is limited, this means the supply of land does not increase or decrease on its own. But land has alternative uses, since the same piece of land can often be put into different uses. There are renewable and non-renewable resources found in the land. It is true that there is strictly limited supply of minerals in the earth’s surface like oil, oil once used up we cannot bring it back these are known as non-renewable or non-replaceable resources. Replaceable resources are such as wood, which can be grown again within a period of time. Land is occupationally mobile, that means a piece of land can be used for various purposes, like to farm or to build a house or to have a shop…etc. Land is geographically immobile, that means land cannot be moved from one place to another.
2- LABOUR (Human Resource)
Labour refers to all kinds of human effort whether physical, mental, skilled or unskilled which is done for a reward other than the p leasure derived from it. Labour is one of the active factors of production. The reward for labour is wage or salary.
Supply of Labour Supply of labour refers to the number of labour hours offered by a labourer at an agreed wage rate over a given period of t ime. It is the service of the labourer that is bought and sold not the labourer. The supply of labour depends on certain factors such as: Size of the working population: Increase in the size of the working population will increase the supply of labour Number of holidays, leave, strikes…etc: Increase in the number of holidays, leaves and strikes will decrease the supply of labour Wage rate: An increase in wage rate will increase the supply of labour and vice-versa. Aminiya School 1st Term Grade 8 Economics
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Efficiency of labour
Efficiency of labour refers to the amount of work that a worker can do during a given period of time. Efficiency of labour is also known as productivity . Productivity of labour can be measured in terms of output per worker per hour. Efficiency of labour is one of the factors which influence the output of a country. Factors that affect efficiency of labour (productivity)
Education and training facilities Education and training is one of the factors that affect the efficiency of labour. A worker with good educational background would be more productive than an uneducated worker. If good education and training facilities are available the country’s working population would be more efficient.
Working conditions Good working condition is important for a worker to work efficiently. If the workers are working in a damp, badly-lit, badly-ventilated place the workers cannot give their best to work. But if they work in a good working condition it will he lp the workers to increase their productivity.
Management and equipment Workers in firms which are well-managed, well-organized, and which use latest equipments will generally be more productive than those employed in firms which are poorly equipped and badly managed.
Motivation Motivation should be given in order to make the workers more efficient as motivation affect the productivity. Motivation can be of material incentives or moral incentives. Material incentives like a bonus, or a fully-paid vacation trip...etc and moral incentives like letting the worker know that he did a good job, or ask the worker to keep up the good work…etc.
Mobility of labour Mobility of labour refers to the movement of the labour from one place to another and one occupation (job) to another. Mobility of labour can be classified into two:
Geographical Mobility of Labour Occupational mobility of labour
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Geographical Mobility of Labour Geographical mobility of labour refers to the movement of labour from one place to another for better rewards or convenience. For example, a pilot in Maldives goes to America as a pilot.
Climatic condition: it might be difficult for a worker who is in a warm weather country to go for a job in a cold country.
Scarcity of infrastructure: a worker may not be willing to move to a country where the basic infrastructures like good roads, good transport systems are lacking.
Lack of employment opportunities: the worker can geographically move if jobs are available in the other parts of the country and other parts of the world. Lack of job opportunities will be a barrier for the workers to move from one place to another.
Lack of economic development: workers may not be willing to move to a country if that country is economically backward.
Lack of technological development: lack of technological development could also be a barrier to geographical mobility of labour as workers always like to work at places where they have upto-date technology and equipment as it affects their productivity.
Slow urbanization: urbanization refers to the process whereby cities grow and societies become more developed. So workers already in area which is very less developed they need to stay in order to develop that area.
Providing more employment opportunities: by providing more job opportunities in the other parts of the country we can increase the geographical mobility of labour. Job opportunities can be increased by starting up new industries and also expanding the existing ones. For example: “Herethere” project in Maldives that is, the opening of the resort in S.Atoll. Opening of this resort will create lots of job opportunities in the S outhern part of Maldives.
Technological development: improving the technological status of the country will bring in more workers to the country, thereby increasing the geographical mobility of labour.
Providing better education and health facilities: provision of better education and health facilities in other countries will enhance the geographical movement of labour.
Government policy to reduce congestion : sometimes an area of the country get congested, so in order to reduce the congestion the government can take measures and create other places to live where there are jobs available and also with good education and health. In Maldives, the
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introduction of Hulhumale and Villingili has increased the geographical mobility of labour thereby reducing the congested level in the capital Male’.
Providing better transport facilities: easy transportation from place to place will increase the geographical mobility of labour
Providing better accommodation: by providing better accommodation for the workers in the others parts of the country will enhance the geographical mobility of labour.
Occupational mobility of labour Occupational mobility of labour refers to the movement of the worker form one occupation to another for better rewards or convenience. For example, an Economics teacher becoming an Economist,
Lack of inherent skills and intelligence: a worker cannot move to another job if he/she does not have the necessary skills or intelligence required. For example, a teacher cannot just become a singer if the teacher does not possess the talent. Cost and length of training: sometimes in order to change from one job to another additional education and training may be required which involves cost and time which some workers may not be able to afford. Discrimination based on gender, age, marital status…etc: some technical jobs like engineering or refrigeration…etc are mostly target for male workers so a female worker may not be able to get a job in these areas. For certain jobs they require people who fit to a certain age group or who are single. This sort of discrimination becomes a barrier for those workers who want to move from one job to another. Lack of job opportunities: even though the worker wants to move to another job unavailability of jobs makes it impossible for the worker to move to another job. Restrictive practices by trade unions: a trade union is a group of workers who negotiates on the behalf of workers. Sometimes the trade union may insist the worker to join for an apprenticeship first.
Providing information about job opportunities: information regarding the available jobs can be given through Job Centres or by publication in the local newspaper which would help in increasing the occupational mobility of labour.
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Providing more education and training facilities : if more education and training centres are provided the workers can become more mobile. Financial assistance: as acquiring more education and training involves a cost in it, financial assistance such as loans could be provided to the workers. Providing better promotion prospects: if jobs provide better promotion prospects workers will move towards those jobs where they can get better chances of promotion. Providing better wages and good working conditions: if better working conditions and good salaries are provided workers will move towards those jobs hence, it will increase the occupational mobility of labour.
3. CAPITAL (MAN-MADE RESOURCE)
Capital refers to man-made resources which are used in the production of goods and services. It can also be referred as the money invested by owner for the use of production The reward for capital is interest. Capital is categorized into two:
Fixed capital Working capital
Fixed Capital
Fixed capital refers to things which are long-lasting and which do not change their form in the production process. Example, factory building, machinery…etc
Working Capital
These include those things which change their form in the production process of production. Example, raw materials such as seed and fertilizers change their form in the production process. Other examples include stock of leather in the production of shoes and bags, stock of money held for running expenses.
CAPITAL ACCUMULATION Capital accumulation means addition to the existing stock of capital. Higher the capital accumulation, higher will be the amount of production and higher the economic development and vice-versa.
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SUPPLY OF CAPITAL The supply of capital goods depends on the extent to which the society is prepared to forgo the consumption of consumer goods currently. In order to use capital goods people in the society must produce them. As we already learnt we have limited resources so we have to distribute the factors of production that we have to different sectors, hence, factors of production used to produce capital goods may have been used to produce consumer goods. Therefore, the opportunity cost of capital goods are the consumer goods that has to be forgone. Why is the community prepared to make this sacrifice? It is because the use of capital goods increases the productivity of industries and workers hence, enhance the development of the country. INVESTMENT Investment means the production of real capital goods in a country during a year. Investment is said to have taken place when capital goods are produced. Example, construction of factory buildings. There are three major terms related to investment: a) Gross Investment Gross investment is the total output of real capital goods produces in a country during a ye ar b) Depreciation Depreciation refers to the reduction in the value of capital assets (capital goods) due to wear and tear resulting from continuous use c) Net Investment Net investment is the annual increase in the total stock of capital. This is always less than gross investment because net investment refers to the sum of capital after deducting depreciation from gross investment. Increase in net investment increases future productivity. Net Investment = Gross Investment – Depreciation
4. Entrepreneur (human resource) Entrepreneurs refers to the person who undertakes the responsibility and risks of employing the land, labour, capital and who decides on how these resources are to be used. The reward for the entrepreneur is profit or loss.
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Planning and organizing the production process Combining the factors of production Deciding what and how much of goods to be produced Bearing the risk involved in running the business. Rewarding other factors of production (like paying, rent, wages and interest) Putting new ideas into the production process (innovation)
PRODUCTION
Production refers to the output of goods and services which satisfy human wants for which we are prepared to pay a price. Production also means transformation of inputs (raw materials) into outputs (finished or semifinished goods). It also means the output of demanded goods.
PRODUCTIVITY
Productivity of labour is usually measured in terms of output per worker-hour Productivity is a measure of the efficiency with which goods and services are produced. Productivity of labour is also known as efficiency of labour. Productivity = Output Input
Output refers to the number of items produced while input refers to the number of hours worked A simple example will make this clear: Suppose two workers, Aishath and Fathmath, are making identical articles, both of them using exactly the same equipment. In a 40-hour week, Aishath produces 400 articles In a 40-hour week, Fathmath produces 600 articles Aishath’s productivity = 400 articles 40 hours = 10 articles per hour Fathmath’s productivity = 600 articles 40 hours = 15 articles per hour This simple example shows that productivity of Fathmath is greater than Aishath Aminiya School 1st Term Grade 8 Economics
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The many different industries producing goods and services are divided into four broad groups. They are: 1) Primary sector (extractive industries) 2) Secondary sector (manufacturing industries) 3) Tertiary sector (service industries) 4) Quaternary sector (research and development industries)
1. Primary sector (extractive industries)
The primary sector is called ‘primary’ because it is the first stage of production. This industry generally involves changing natural resources into primary products either through extracting them from ground or growing them. Most products from this sector are considered raw materials for other industries. Major businesses in this sector include agriculture, fishing, forestry, mining and quarrying industries
2. Secondary sector (manufacturing industries)
The secondary sector is the second stage of production process. This industry includes those economic sectors that create a finished or usable product in the manufacturing and construction industries. This sector of industry generally takes the output of the primary sector (raw material) and manufactures (converts) it into finished or semi-finished goods. Examples include industries producing steel, chemicals, furniture, and construction of buildings…etc.
3. Tertiary sector (service industries)
The tertiary sector of industry (also known as the service sector or the service industry) is the third stage in the production process. Services are defined in economics as "intangible goods" that is those things which we cannot see, feel or touch. The tertiary sector of industry involves the provision of services to businesses, the other sectors of production as well as final consumers. Services may involve the transport, distribution and sale of goods from producer to a consumer. In a modern society, the firms in the primary and secondary sectors would find it impossible to function without the services supplied by banks, insurance companies and post office…etc. education and health services are also classified as tertiary industries.
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4. Quaternary sector (higher order service industries)
The quaternary industry involves research and development industries which come under high order service. It includes all those services which are concerned with the collection, processing and transmission of information. The quaternary sector can be seen as the sector in which companies invest in order to ensure further expansion. Research will be directed into cutting costs, producing innovative ideas, new production methods...etc. Example: micro technology
In the developing countries a large percentage of the working population is employed in the primary sector (mainly agriculture).
In the developed countries a large percentage of the working population is employed in the tertiary sector
In the early stages of development there is a movement of workers from agriculture (primary industry) to manufacturing industries (secondary i ndustries).
As a country develops, improvement in the productivity of the manufacturing industries plus the increasing demand for services, leads to movement of workers to the service sector.
The fall in the percentage of working population in the primary and secondary sectors does not necessarily mean that output in these sectors are falling.
These changes in employment are often due to technological developments which have greatly increased the productivity of labour in all the sectors of the economy.
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Distribution of working population among different sectors of the Economy of the Maldives Amount of working population 4236 8388 339 19259 1229 5930 11711 12090 7098
Industry
Sectors of the economy Primary Primary Primary Secondary Secondary Secondary Tertiary Tertiary
Agriculture and Forestry Fishing Quarrying Manufacturing Electricity, Gas & Water Construction Wholesale & Retail Trade Hotels & Restaurants Transport, Storage and Communication Tertiary Financing, insurance, business and 31741 real estate Tertiary Community, social and personal 3464 services Tertiary Not Stated 4746 Total working population of 110231 Maldives Source: Employed Population by Industry, Census of Maldives 2006
Sector Percentage of the Working population
Primary Sector
Secondary Sector
Tertiary Sector
Not Stated
12%
24%
60%
4%
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In Maldives 60% of the working population is employed in the tertiary sector, while only 12% of the working population is employed in the primary sector.
No, Maldives is having less percentage of working population in the primary sector because we don’t have the natural resources for primary sector work; we only have fishing and very few islands doing agricultural work. But Maldives is blessed with beautiful white beaches and sea, which attracts lots of tourists. Therefore, more people are employed in the tourism industry which belongs to the tertiary sector. Employment of working population in different sectors is not the only key indicator to decide whether the country is a developed or developing country; there are many other factors to be considered. Hence, Maldives is considered as a developing country.
DIVISION OF LABOUR AND SPECIALIZATION Division of labour takes place when the process of production is broken down into a large number of separate and simple operations whereby each worker is responsible for and spends his/her time carrying out one of these operations. For example, division of labour can be applied in the production of chairs. One worker can cut the wood, one worker can work on the legs of the chair, while another on the hands of the legs, and another on the seat of the chair, another on the back of the chair, and then there could be one worker who assembles all the parts of the chair. Another one can paint the chair and so on. Each worker will be specialized in doing only one distinct job.
Division of labour can be applied when the process of production is complex and can be broken down into separate and simple operations.
It can also be applied where the mass production takes place that is where a specialized product is manufactured. And mostly there will be an assembly line in the factory where each worker does a separate task.
Examples of division of labour can mainly be found in secondary and tertiary industries. In manufacturing cars, television sets and domestic electrical appliances each worker fits a single component as the product moves down the assembly line. This system of production is commonly known as mass production.
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A picture of an assembly line Another example of division of labour is found in banking industry where some staff may deal directly with customers, receiving and paying cash, while some others are dealing with cheques and other documents while others deal with customers seeking loans and so on.
1. ‘Practice makes perfect’ As division of labour enables workers to do only one simple task continuously, the worker develops the ability to do the work with great speed and more effectively hence, increasing the output of the workers as well as the firm. 2. Saves time If a worker has to carry out all the tasks in a production process the worker may have to move from one machine to other or from one part of the workshop to another. But in specialized production where division of labour takes place, the product moves around in the assembly line, the worker does not need to move around to pick tool or change machines. Hence, its saves a lot of time as no time is wasted due to the movement of workers. 3. Creates more suitable jobs for the workers No two people have exactly the same abilities and interests. But by creating a large number of small jobs, the division of labour makes it easier for the workers to choose between jobs which suit them better with their abilities and interests. 4. Greater use of machinery When a worker has to carry out all the operations in a production process the worker may not be able to use all the tools and machineries at the same time and therefore, some machineries or tools maybe left idle (as the worker cannot do two tasks simultaneously). When work is specialized each worker only needs one set of tools and these will be in constant use. 5. Innovation of ideas and machinery Division of labour enables a worker to do only one simple task, as the worker keeps on doing the same job, the worker may come up with an idea to create a tool or machine to perform that operation making the job more faster and more efficient hence, increasing the output.
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1. Boredom and frustration (monotony) Nobody likes to do the same work over and over. Constant repetition of same work all the time will make the workers bored and frustrated. 2. Loss of craftsmanship (skill) It is said that specialization has lead to the loss of skills. Products which were made by craftsman are made by machines today. A worker does not get the satisfaction of saying ‘I made that’ as one whole product is not done by one worker alone, it is more like a combined effort with machines and other workers, as each worker does only a simple operation of the production process. 3. Standardized products Division of labour can be applied on the products which are standardized. For example, thousands of motorcars, washing machines, and television set…etc which are of the same quality, style and design and hence, lack variety. 4. Greater risk of unemployment In division of labour the workers get trained and skilled in one skill, and they may find that their skills cannot be used in another industry. Such workers are liable to unemployment in a rapidly changing world. 5. Inter-dependency Division of labour has made the workers to be very dependent on each other. As each worker is doing a specialized task in the production process, each section depends on the other, and if there is a break in the production line it could affect the whole production process.
The division of labour can be categorized into: 1. Occupational Division of Labour (simple division of labour ) Occupational division of labour is when a worker gets specialized to a particular occupation. Example, a teacher, lawyer, fisherman, doctor...etc 2. Geographical Division of Labour When a part of a country, or when a region specializes in the production of a particular commodity. Example, Thoddu in Maldives for growing Watermelon, 3. Complex Division of labour The division of a complicated production process of a product into simple tasks. For example, a factory like MIFCO in Maldives which produces ‘canned fish’ dividing its production process into simple tasks like one worker cutting fish, another cleaning, another removing the bones and so on. Aminiya School 1st Term Grade 8 Economics
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4. International Specialization International specialization is when a country concentrates in the production of one or more products according to their availability of factors of production (factor endowments). For example, Maldives specializes in fish products, Middle East country specializes in the production of oil, Sri Lanka specializes in growing tea leaves, Japan specializes in electronic products…etc
Division of labour cannot be applied to all production types. I t depends on the following: 1. Size of market
This is the main factor that limits division of labour. Division of labour can mostly be effectives only in the case of mass production. Mass production only makes sense if there is a mass market for the product. So if there is a small market it is not feasible to apply division of labour, but the larger the market (more consumers), means more demand so greater the scope for specialization. One of the main reasons for limiting the size of the market is transportation cost.
2. Transportation cost
Transportation cost is one factor that limits the size of the market as mentioned earlier, that means if transport cost is high; it may not be possible to deliver the products to different regions of the country hence, limiting the size of the market. Specialization is possible with a good transport network. This will make it easier to deliver the products to different parts of the country to different consumers. And sometimes the specialized work areas could be located in different areas, so without good transportation network it may not be possible to adopt division of labour.
3. Nature of the product
The production process of some goods and services cannot be broken down into small series of tasks. For example, repair work of vehicles.
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There are some concepts which you should know first before starting cost of production. The factors of production can also be classified as Fixed factors Variable factors Fixed Factors
Fixed factors are those factors which do not change with the change in output. Its form do not change during the production process The supply of fixed factors cannot be changed easily and quickly Examples include, machineries, factory buildings…etc Fixed factors apply only in the short-run
Variable factors
Variable factors are those factors which changes with the change in output (that means if output increases the variable factors also increase and vice-versa). Most variable factor’s form change during the production process (e.g. raw materials) The supply of variable factors can be changed easily and quickly Examples include, raw materials, labour, fuel…etc
There are two time-periods in Economics:
The Short-Run The Long-Run
The Short Run
Short Run refers to a short period of time over which at least one factor would be fixed. If a firm wants to change its output in the short run, they would be able to change only its variable factors to bring a change in its output. There are fixed factors in the short-run.
The Long Run
Long Run refers to a longer period of time over which the firm can change all its factors. If a firm wants to change its output in the long run, they would be able to change all its factors There are no fixed factors in the long-run. In the long-run all the factors are variable.
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Total Product (TP) It is the total number of products (output) produced by a firm during a given period of time by a given number of workers. It is also known as total output. The following formula could be used to find t otal product: TP = Average Product × No. of workers Average Product (AP) It is the output per worker. It is also known as the productivity of labour. The following formula could be used to find average product: AP =
Total Product No. of workers
Marginal Product (MP) It is the change in output due to an additional worker. That is, how much more can the firm produce by adding one more worker to the firm. It is calculated by subtracting the new output from the previous output. MP = TP 2 – TP 1 For example: a firm’s total output increased from 300 to 450 units when the firm increased their th number of workers from 3 to 4. So the marginal product of the 4 worker is 450 (TP 2 ) – 300 (TP 1 ) which is equal to 150 units. THE LAW OF DIMINISHING RETURNS (The law of variable pr oductions)
It states if more of one variable factor increased to a fixed quantity of fixed factors, marginal product will first increase and then it will start decreasing.
The main reason for this decline could be that the fixed factors are not sufficient to cater the increased no. of variable factors.
For example, in a factory the machineries and factory building remain as fixed factors, the firm is increasing its no. of workers (variable factor), which would increase the marginal output first, but if the firm kept on increasing its no. of workers, after sometime the machineries may not be enough to cater all the workers, the factory building may get overcrowded which could result in less efficiency and productivity which then result in the fall in the marginal product which is known as diminishing returns.
Diminishing returns occur only in the short-run as in the long run there are no fixed factors so the firm will have enough time to increase their fixed factors to cater for the increased no. of workers if it’s necessary.
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EXERCISE Complete the table No. of workers 1 2 3 4 5 6 7 8
TP 30 90 170 285 400 480 550 610
AP
MP
Cost of production refers to the cost incurred in the production of goods and services. Costs can be broadly classified as: Fixed Cost Variable Cost Fixed Cost (FC, TFC)
Fixed costs are those cost which are related to the fixed factors of production. Fixed costs are those factors which do not change with the change in output. That means even if output is increasing or decreasing fixed cost would remain unchanged (even if output is zero fixed costs remain same). Fixed costs are also known as indirect expenses or overhead cost. Fixed cost include such expenses as rent, insurance, interest on loans…etc Fixed costs arise only in the short run.
Average Fixed Cost (AFC) Average Fixed Cost is the fixed cost per unit o f output. It can be calculated by the following formula: AFC = __TFC__ Output Variable Cost (VC, TVC)
Variable costs are those costs which are related to the variable factors of production. Variable costs are those costs which changed with the change in output. That is if output is increasing variable costs also increase and vice-versa. (If output is zero variable cost is also zero). Variable costs are also known as direct cost, as variable costs vary directly with the o utput.
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Variable costs include such expenses as wages, fuel cost, power, cost of raw materials, transport…etc In the long run all costs are variable.
Average Variable Cost (AVC) Average Variable Cost is the variable cost per unit of output. It can be calculated by the following formula: AVC = __TVC__ Output
Total Cost (TC)
Total cost is the total cost incurred in the production of a good or service. It includes the sum of fixed cost and variable cost. When output increase the total cost also increase and vice-versa. This is because when output increase variable cost increases so this increase in variable cost is also shown in the total cost. The formula to calculate total cost: TC = TFC + TVC
Average Total Cost (AC/ATC) Average total cost is the total cost per unit of output. It can be calculated by the foll owing formula: ATC = __TC__ Output If TC, TVC and TFC are represented on a graph the curve would always look as follows:
costs
TC TVC
TFC
units of output
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Marginal Cost (MC) Marginal cost refers to the additional cost incurred by employing an additional unit of factor of production. This is a measure of the amount by which the total cost changes, when output changes by one unit. Marginal cost can be calculated by the following formula: MC = TC 2 – TC 1 Total Revenue (TR) Total revenue refers to the total amount earned by selling a good or service. Revenue can be calculated by the following formula: TR = price × output
Average Revenue (AR) Average revenue is revenue per unit of output. Average revenue is equal to price. Average revenue can be calculated by the following formula:
Average Revenue = Revenue_ Output
Total Profit (TP) Total profit refers to the amount earned after costs subtracted. Profit can be calculated by the following formula: Profit = TR -TC Average Profit Average profit refers to the profit earned per unit of output. It can be calculated by the following formula: Average Profit = Profit_ Output
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Exercise 1 Complete the following table Output 0 1 2 3 4 5 6 7 8
FC 1000
VC 0 350 560 740 1000 1400 2000 2850 3960
TC
AC
MC
AFC
AVC
Exercise 2 Complete the following table Units of output 0 1 2 3 4 5 6 7 8
Price
FC
VC
100 100 100 100 100 100 100 100 100
100
0 35 56 74 100 140 200 285 396
TC
TR
Profit
Exercise 3 Complete the following table Units of output 0 1 2 3 4 5 6 7 8
Price
TR
FC
550 550 550 550 550 550 550 550 550
Aminiya School 1st Term Grade 8 Economics
VC
TC
AC
MC
Profit
Profit per unit
1000 1350 1560 1740 2000 2400 3000 3850 4960
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Exercise 4 No. of workers 1 2 3
Total Product 100
Average Product 100
360
120
Marginal Product 100 120
WHY MARGINAL COST (MC) AND AVERAGE COST (AC) CURVES ARE "U” SHAPED
AC,MC
AC MC
output
The MC and AC curves reflect the law of diminishing returns.
Initially, as output increases Marginal Product and Average Product increases, this means that Marginal Cost and Average Cost will be falling.
But if the output continues to increase after some point, the productivity starts to decline (Average Product and Marginal Product decreases) which increases the cost as more output is produced, hence, Marginal Cost and Average Cost starts increasing.
Marginal Cost has a negative relationship with Marginal Product. When output increases Marginal Product increases and the Marginal Cost decrease. And if output kept on increasing after the optimum level, diminishing returns sets in and Marginal Product decreases but Marginal Cost still increase. Hence, that is the reason why Marginal Cost curve is “U” shaped.
Likewise, Average Product and Average Cost also have a negative relationship. When output increase, the productivity of the worker increases (Average Product increases) but the Average Cost decrease. And if output kept on increasing after the optimum level, productivity of the worker declines (Average Product starts falling) but the cost per unit increases (Average Cost starts increasing). Hence, that is the reason why Average Cost curve is “U” shaped.
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Exercise: By using information from the table given in Ex.3 on page 22 draw the AC and MC curves.
BREAK–EVEN POINT
Break-even point is related to short-run production. It is the point where total revenue (TR) equals total cost (TC). At this point profit and loss both will be equal to zero. This is the point where the producer covers the cost of producing that particular product. After the break-even point the producer starts earning profit. Before the break-even point the producer has loss. Profit maximization point is where the vertical distance between the TR curve and TC curve is the maximum and also at the point where marginal cost (MC) equals marginal revenue (MR). In the long-run, firms will continue to produce if it’s making a profit.
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CLASS EXERCISE Complete the table and draw the TR and TC curves. Units of output 0 1 2 3 4 5 6 7 8
Price 0 550 550 550 550 550 550 550 550
TR
TC
Profit
Profit per unit
1000 1350 1560 1740 2000 2400 3000 3850 4960
a) What is the range of output for which the firm earns profit? ----------------------------------------------------------------------------------b) What is the firm’s most profitable output? ----------------------------------------------------------------------------------c) What is the break-even point? -----------------------------------------------------------------------------------
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BASIC ECONOMIC PROBLEMS The main economic problem faced by every s ociety is:
Resources are limited Human wants are unlimited
Our resources (land, labour, capital and entrepreneur) are limited. Therefore, we cannot produce all the goods and services required by all the people. So we need to distribute our resources in the most efficient way that is, economizing the scarce resources. In other words, the basic economic problem is to decide the best use of our limited resources.
In order to economize the scarce resources, every society must solve the three basic economic problems. They are:
What to produce? How to produce? For whom to produce?
What goods and services are to be produced and in what quantities? A society cannot produce all the wants of all the people. It should therefore decide what particular goods and services to be produced. Basically, major two types of goods the country can produce falls under the category of consumer goods and producer goods. Therefore, the society should decide whether they should produce more producer goods or more of consumer goods. The production of goods also depends on the availability of factors of production and consumer demand. How should the goods and services be produced? Commodities can be produced by using different methods of production. They are:
Labour-intensive method: this is a method of production in which more labours would be used than machines Capital-intensive method: this is a method of production in which more machinery would be used than labour.
Some manufactured goods can be produced either by small-firms using lots of skilled labour or by mass-production using lots of machineries. So the society has to decide whether they should produce the goods using labour-intensive methods (using more labour) or by using capital-intensive methods (using more machineries). For whom should the goods and services be produced? This question is related the problem of distribution. How should the th ings which have been produced, be shared among the members of the community or among the factors of production. Aminiya School 1st Term Grade 8 Economics
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RESOURCE ALLOCATION Resource allocation means the distribution (allocation) of the resources among the different sectors of the economy according to priority so as to maximize the output. This is to choose goods and services on the basis of priority and allocate the scarce resources for their production. THE PRODUCTION POSSIBILITY FRONTIER (PPF) PPF shows the different combinations of two goods a country can produce at full employment using all the available resources, given the level of technology. If the country is producing at any point along its PPF curve, the country is using all of its resources and producing the maximum possible output of both goods. But if it is producing inside its PPF, it is not using all the resources fully. Therefore, the output of both the goods will be low. There are some assumptions that need to be taken when we talk about PPF. They are:
The economy (country) is producing two g oods that is, consumer goods and producer goods. Technology is fixed in the short run so that the country cannot produce beyond the production possibility frontier (PPF). When all the resources of an economy are fully employed, the economy will be producing at a point on the PPF. Consumer goods
Production Possibility Frontier (PPF)
A
. Producer goods
WHEN WILL RESOURCE ALLOCATION WILL BE EFFICIENT? Resource allocation will be efficient when a re-allocation (re-distribution) of resources do not bring any higher level of output than before or when it produces the maximum possible level of output. Resources will be efficiently allocated when the economy is producing anywhere on the production possibility frontier (PPF). At point ‘A’ (in the diagram) the resources are not allocated efficiently as the country is not fully using all its resources, there is still space to increase the output.
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DEMAND Demand is the quantity of a commodity consumers are willing and able to buy at a given price over a given period of time. Demand in economics means effective demand. Demand is effective when demand is backed by purchasing power (that is the ability to pay). SUPPLY Supply is the quantity of a commodity producers are willing to offer at a given price over a given period of time. Supply = Output-Stock
The main economic problem is that there are limited resources in relation to unlimited wants. This problem brings about the need for a system to answer questions like what to produce, how to produce, how much to produce and how to distribute production. An economic system is the organizational and institutional pattern through which choices are made about which wants to satisfy, and how to allocate resources to do this.
An economic system can be defined as a mechanism which deals with the basic economic problems of production, distribution and consumption of goods and services in a particular society.
The economic systems which have been adopted to deal with economic problems differ from country to country. The different economic systems include:
Traditional economic system Command economic system Market economic system and Mixed economic system
Traditional Economic System Traditional economic system is an economic system where they live life according to how their ancestors have been living. These communities have relatively low living standards as their way of life has remain unchanged for centuries. The basic economic problems of what to produce, how to produce and how it is to be shared out are not seen as problems as these things have been decided long ago by their ancestors.
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These economies are also known as subsistence economies because they are self-sufficient, that means they produce goods only which is enough for their survival. Examples of traditional economies can be found in isolated villages of Af rica and Asia.
The community with relatively low living standards. The ways of life remain unchanged for centuries. They don’t have to answer the three basic economic problems, as it has been answered long time ago by their ancestors. Exchange if necessary is mostly carried out through barter system.
Market Economic System Market economic system is an economic system where there is considerable freedom for people to buy what they want and sell what they produce. It is also known as Free-enterprise economies, Capitalist economies and Laissez-Faire economies.
Private property Individuals have the right to own, control and dispose of land, buildings, machinery and other natural and manufactured resources. In addition, individuals have the right to earn income from that property in the form rent, interest and profit.
Freedom of choice Individuals are free to set up their own businesses, firms are free to decide what and how they should produce, workers are free to enter and leave occupations and consumers are free to spend their incomes as they wish.
Self-interest Market economic system encourages people to do what is best for them. Firms will try to maximize their profit, workers will try to maximize their income and consumers will try to maximize their satisfaction.
Profit motive The aim of all the firms in a market economy is to earn maximum profit, rather than welfare of the people.
Price mechanism Price mechanism refers to the determination of price through the market forces of demand and supply. And this price will determine the allocation of resources.
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For example, if the demand for a commodity increases, the commodity becomes scarce and its price will increase. This increase in price will make it more profitable to produce. An increase in demand, therefore, will cause more resources to be used in t he production of this commodity.
A very limited role for the government In a market economy the government has very few economic functions. The main business of government will be mainly to secure the defense of the country and to maintain law and order.
Consumer sovereignty It means under a market economy, producers will produce only those goods and services demanded by the consumers. As the aim of producers is to maximize profit, they can do so by producing what the consumers demand. Hence, the consumers are treated as ‘uncrowned kings’
There is more freedom of choice for producers and consumers.
A market economy encourages competition between firms. This results in more efficient goods and services.
Profit motive encourages firms to find better methods of production so as to minimize their average cost of production, so that they can charge a low price as t o increase demand.
Market economy helps to achieve efficiency in resource allocation, as the producers are producing the goods and services which are demanded by the consumers.
Freedom of enterprise encourages producers to produce what consumers want; as there is high competition between firms, consumers would get a wide variety of quality goods and services at low price.
The existence of private property and profit motive enables some people to become rich. Therefore, the gap between the rich and poor widens.
Factors of production will be employed only if it is profitable to do so, so there is a chance that some of the resources may be left idle.
As all the firms in a market economy are profit motive, they might fail to provide public goods which have the feature of non-excludability and non-exhaustibility.
Welfare of the people might be ignored.
As it allows freedom of choice, it may encourage the consumption of harmful goods.
As the resource allocation is based on the price mechanism, the economy is more unstable.
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COMMAND ECONOMIC SYSTEM The command economy is a system in which all the means of production are owned and controlled by the state. Production and distribution are aimed at maximizing the welfare of the people. A command economy is so named because the government has the power to command the nation’s economic resources. These economies are also known as centrally planned economies.
State ownership In a command economy all the resources are owned and controlled by the state.
Planned production Production is carried out according to a national plan. Resources are allocated to various sectors of production through government directives.
Prices are fixed by the government Prices do not change in response to changes in demand and supply. Prices are fixed by the government. If there is any shortage for a commodity, the government will enforce physical rationing. (Rationing is dividing the goods equally among people so that no one person can buy bulk amount of a commodity).
Welfare motive Since the means of productions are owned and controlled by the state, there is no profit motive. The motive behind all the production is welfare of the society.
As private property is absent, no person can become richer by owning more property, hence, there is more equal distribution of income and wealth in the society.
As there is welfare motive, the people are well taken care of.
Economic activities are well planned so the resources are allocated efficiently.
Economic activities are more stable as everything is planned ahead by the state and as there is no price mechanism.
Loss of consumer sovereignty, consumers do not have much choice in a command economy as everything planned by the state.
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There is no competition in a command economy as everything is produced by the state; this reduces the quality of products.
In a command economy mostly shortage of goods arises (that is demand more than supply) but prices do not change with the change in demand or supply as prices are fixed by the government. So the government has to use a physical rationing of the goods.
High degree of government influence lead to larger bureaucracy and this may lead to corruption and bribery…etc
IN SHORT, THE DIFFERENCES BETWEEN MARKET ECONOMIES AND COMMAND ECONOMIES MARKET ECONOMIES Freedom of choice Free market economy Profit motive Prices are determined by the market forces of demand and supply Limited role for the government
COMMAND ECONOMIES No freedom of choice Planned economy Welfare motive Prices are fixed by the government Major role for the government
MIXED ECONOMIC SYSTEM A mixed economy is an economic system in which both private and public sector exist side by side and operate for the welfare of the people.
Co-existence of private and public sector Major industries of the economy will be owned and controlled by the public sector. Public sector is owned, controlled and funded by and accountable to the government. The aim of this sector is for the welfare of the community. Private sector is owned and controlled by the private individuals or firms for profit. The aim of the private sector is to earn profit.
Centralized planning There is a central planning authority that fixes the targets for production of goods and services and allocates the resources to achieve those targets. They also coordinate for both private and public sector.
Co-existence of the features of market and command economy Features of market economy like freedom of choice, private property, competitions…etc are found in mixed economies. Similarly, features of command economies like social security, social justice, equality in the distribution of income and wealth, absence of exploitations…etc are found in mixed economies.
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The presence of freedom of choice will increase the economic efficiency in mixed economy.
Since mixed economy is a planned economy, it can avoid wastage of resources.
Price mechanism is allowed to operate in a mixed economy. Hence, it helps to allocate the scarce resources in an efficient manner.
Strategic industries like gas, water and electricity in most mixed economies are owned and controlled by the state hence, country is stable.
Mixed economy is difficult to operate, because balancing both private and public sector is difficult.
Excessive control imposed by the government over the private sector may discourage the private sector and reduce their production.
Public sector has certain inborn defects like corruption, bribery...etc which may reduce its productivity which could affect the national income of the country.
In a mixed economy, the infrastructure facilities and public utilities (like transport, communication, energy and water) are controlled by the government and these services may not be provided efficiently. In that case, it will affect the private sector negatively as they have to depend on the government for these services. This will reduce the efficiency of the private sector, and reduce its productivity, finally leading to the domination of public sector.
HOW DIFFERENT ECONOMIC SYSTEMS ANSWER THE BASIC ECONOMIC PROBLEMS TRADITIONAL ECONOMIES
MARKET ECONOMIES
COMMAND ECONOMIES
MIXED ECONOMIES
What to produce, how to produce and for whom to produce are not seen as economic problems as they have been decided long ago by their ancestors.
What to produce, how to produce and for whom to produce are decided by the price mechanism of demand and supply.
What to produce, how to produce and for whom to produce are decided by the government directives as specified in the national plan.
What to produce, how to produce and for whom to produce are decided by the price mechanism and government directives.
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THE ECONOMY OF THE MALDIVES The economy of the Maldives is based on the following principal activities:
Tourism
Fishing
Shipping
Agricultural sector does not play a major role due to poor soil in Maldives but agriculture can be found to some extent.
Tradition activities such as mat weaving, jeweler making and lacquer work are also found in Maldives
The key characteristics of the economy of Maldives
A fragile (poor or weak) environmental base. Dependence on fishing and tourism industry for income. Slow rate of economic growth especially at island levels. Government expenditure is more than the government revenue.
Primary Activities
Fishing Agriculture
Secondary Activities
Manufacturing Construction
Tertiary Activities
Distribution, transportation, communication, tourism, real estate, health services, educational services, banking services, postal services, government administration…etc.
Modern Activities
Manufacturing of garments Construction of fiber glass boats Production of PVC pipes Bottling of aerated water
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A business refers to a person or groups of people obtaining a profit by supplying a good or service. Firm: a firm is a single unit of business organization producing a particular good or service under a particular name. Industry: an industry refers to a group of firms producing a particular good or service. Example: when we refer to all the resorts, we can call it the tourism industry, but if we take one resort like Bandos Island Resort, it is a firm in the tourism industry
Types of business organizations
Public ownership
Public Corporations
Private ownership
Municipal Enterprises
Sole Proprietorship
Cooperatives
Consumer Cooperatives
Worker Cooperatives
Partnership
Limited Companies
Public Limited Companies
Private Limited Companies
Sole Proprietorship In this type of business, the whole business is owned and controlled by a single person. This is the simplest and the oldest form of business organization. A sole trader is the person who runs a sole proprietorship.
This type of business organization is easy to start, as it does not require huge investment and other formalities.
It is owned and controlled by one person for profit.
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The owner can enjoy all the profit; he doesn’t have to share the profit with anyone as it is a one-man business.
It has the flexibility in decision making.
Liability of the owner is unlimited. Unlimited liability means the owner is liable for all his debts even if that means he has to sell his private properties to pay off the debts.
It is easy and inexpensive to start a sole trade business: any single person can start a sole trade business as it requires very less capital, and it doesn’t require lots of complicated legal formalities so it is very easy to start.
Flexibility in decision making: as this is a one-mane business, the owner can make the decisions whenever he wants, therefore, he has the flexibility in making quick decisions.
Can provide personal service to the customers: normally sole trade businesses are very small in size and there are not much employees, so mostly the owner would have the chance to meet with customers.
Greater incentive to be efficient: as the owner gets all the profits and bears all the losses, the owner would be very motivated to run the business more efficiently to earn more profit and avoid any loss.
Unlimited Liability: the sole trader has unlimited liability, that means if the business goes bankrupt, the sole trader is personally liable for the debts of the firm. That is the sole trader may have to sell off the personal possessions in order to pay the debts.
Difficult to manage if the business expands: when the business expands, the sole trader will not be in a position to supervise the entire business; hence, there is a need of a partner to share the management of the business.
May take inefficient decisions: as the sole trader has to make the business related decisions on his own, he may not always make the right decisions. As the sole trader also has the advantage of flexibility in decision making, he may sometimes make hasty (hurry) decisions, which may not be so efficient, which could affect the business adversely (negatively).
Difficult to obtain financial assistance: as sole trader businesses are more risky as they are small in size, hence, it might be difficult for the sole trader to obtain loans or other financial assistance.
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Partnership Partnership is a voluntary association of 2 to 20 people which is formed to carry on a business in order to make profit. But some of the professions like medicine, law and accountancy…etc there is no upper limit on the number of partners, these partnerships are known as professional partnerships.
There are mainly two types of partnerships. They are:
Ordinary partnership (general partnership): In a general partnership all the partners have equal responsibilities in the running of the business. And all the partners have unlimited liability.
Limited partnership: in a limited partnership there are limited partners and ordinary partners. At least one partner should be an ordinary partner. o Limited partners are those who have limited liability. Limited liability means if the business goes bankrupt, the liability of the partners will be limited to the amount of capital that the partner has contributed to the business. And these partners do not take part in the running of the business.
It is owned and managed by 2 – 20 partners.
In an ordinary partnership the members have unlimited liability whereas in a limited partnership the members have limited liability.
Profits and losses are shared among the partners according to the partnership agreement.
An agreement made by one partner on behalf of the partnership is binding and has to be accepted by all the partners.
If one of the partners dies or is declared bankrupt the partnership will dissolve.
More capital than a sole trader: with several people putting money into the business, a partnership can raise more capital than a sole trade business.
The management of the firm can be made more specialized: can apply division of labour in the running of the business, by making each partner responsible for a specialized department such as, sales, administration, production and so on.
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Losses can be shared: in the case of ordinary partnership all the partners have unlimited liability hence, the losses can be shared among all the partners.
It is easy to start and close the partnership: the partnership can be formed very easily as it doesn’t involve complicated legal formalities. And can also be closed down easily if all the partners agree for it.
Partnership can be unstable: as there are many people in a partnership, there can be difference of opinion among the partners and this may lead to fai lure of the business.
Difficult to maintain business secrets: as all the discussions of the business has to be done with all the partners it might be difficult to maintain the business secrets, as there is chance that one of the partner may release the secrets of the business.
Unlimited liability: in an ordinary partnership all the partners have unlimited liability, that is, during a loss the partners are liable to pay the debts even after selling their private property.
No perpetual succession: life of the partnership is uncertain. Withdrawal of a partner from the partnership will dissolve the partnership.
Limited companies (Joint-stock companies) Limited companies can be defined as an incorporated association which is an artificial person created by law with a common seal having perpetual succession.
An incorporated association means that it a registered with the registrar of companies Once it is registered it is treated as an artificial person by law that means the company can sue and be sued. Having a common seal means that the company should have a common name or seal which can be used in the letter heads Perpetual succession means the company can continue as long as it is making profit.
Limited companies are also known as joint-stock companies, as a group of people is contributing the capital to a common fund. The capital of a company is divided into small units which are called as shares. And therefore, the owners of the company are called as share holders, as they are buying shares in order to join the company. There should be a minimum of two shareholders to start a l imited company. The shareholders in a limited company have limited liability. Limited liability means that the liability of a shareholder is limited to the value of shares held, during a loss. Aminiya School 1st Term Grade 8 Economics
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In a limited company ownership and control are in two different hands. The owners of the company are called as shareholders and the shareholders elect a board of directors, and this board of directors would be taking part in the running of the business. The profits paid to the shareholders are known as dividend.
There are two types of limited companies. They are:
Public Limited Company (PLC) Private Limited Company (Pvt. Ltd)
Public Limited Company (PLC) Public limited companies are very large companies whose shares can be sold to the general public. And these shares can be freely transferable (bought and sold) by the general public in the stock exchange. Companies which are public limited should have PLC after the company’s name. For example, Bank of Maldives PLC Private Limited Company (Pvt. Ltd) Private companies are usually small in scale compared to the public limited companies. Private limited companies are mostly owned by a group of friends or family. Private limited companies cannot sell their shares to the general public. The shares of a private limited company are not quoted in a stock exchange, hence, is not available to freely transfer the shares. Companies which are private limited should have Pvt. Ltd after its name. For example, Sun Travels and Tours Pvt. Ltd
Public Limited Company Can invite the general public to buy their shares
Private Limited Company Cannot invite the general public to buy their shares
Shares can be freely transferable (bought and sold) in the stock exchange
Shares cannot be freely transferable, if a shareholder want to change the ownership of shares he/she has to get permission of all the shareholders More large in size than private limited companies Small in size than public limited companies in in terms of: terms of: No. of people employed No. of people employed The value of assets The value of assets The value of output The value of output •
•
•
•
•
•
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Share A small unit of capital of a j oint-stock company
There are two main types of shares. They are:
Ordinary Shares Preference Shares
Ordinary Shares These shares do not carry a fixed rate of interest. For this reason the holder’s of this type of shares are considered to be the main risk-bearers. They have no guaranteed income and they are at the end of the queue for a share in the profit, as they are paid last. Dividend varies according to the amount of profit made. Dividend is the profit given to share holders. This type of shareholders has the votingrights of the company.
Preference Shares These shares carry a fixed rate of interest. Preference shareholders have a right to a share of profit before all the other types of shareholders. This type of shareholders does not have the voting-rights. There are two types of preference shares: Cumulative Preference Shares Participating Preference Shares
Cumulative Preference Shares These shareholders will be paid dividend for any arrear years (unpaid years), which have accumulated during years when the company did not earn enough profit to pay the fixed rate of interest.
Participating Preference Shares These shareholders carry a right to a fixed rate of interest and additional payments out of profits when the company makes a huge profit and distribute a bonus.
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Formation of Companies Promoters
(people who wish to start the limited company)
Solicitor (lawyer)
The Memorandum of Association And The Articles of Association
Registrar of Companies
Statutory Declaration (after approval of documents)
Certificate of Incorporation (the private limited companies can start business) Certificate of Trading
In order to form the limited company the promoters have to submit two main documents that it, The Memorandum of Association and The Articles of Association to the Registrar of Companies with the approval of a solicitor.
Then the Registrar of Companies goes through the two documents and if satisfactory will issue a Statutory Declaration which states that all the documents are satisfactory.
Then the Registrar of Companies issues the Certificate of Incorporation, which states that the company has been registered.
At this point the Private Limited Companies can start their business but the Public Limited Companies have to wait until the Registrar of Companies issues the Certificate of Trading.
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The Memorandum of Association The Memorandum of Association contains the external information about the company. It is the bio data of the company. It contains the following:
Name and address of the company. Objectives and aim of the company. Amount of capital which the company wishes to raise by issuing shares (in case of public limited companies) The name of the company must include “Pvt. Ltd” in case of private limited companies and “Plc” in case of public limited companies.
The Articles of Association The Articles of Association contains the internal information about the company. It shoes the details of rules that will be used to control and organize the company. It must contain the rights of shareholders and rights and duties of board of directors.
The Certificate of Incorporation This is a certificate to state that the company has been registered. This is certificate is also called as the “birth certificate” of the company. This certificate will be issued only when the promoters submit the two above mentioned two certificates (The Memorandum of Association and The Articles of Association). This certificate gives the company a legal existence. A private limited company can start the business after getting the certificate of incorporation. But a public limited company has to wait until they get a certificate of trading.
The Certificate of Trading Once the public limited companies get the certificate of incorporation, they have to submit a copy of its prospectus. Prospectus is a document which invites the general public to buy shares from the company. This prospectus should also be submitted in the newspapers. After approval of the prospectus the Registrar of Companies will issue the certificate of trading, then the public limited company can start the business.
By law all the registered companies should publish annual accounts and their copies must be submitted to the Registrar.
Aminiya School 1st Term Grade 8 Economics
Page 44
