ASSIGNMENT COVER SHEET Surname
Mamathuntsha Mashudu Valcano
First Name/s
130641 Student Number
Economics Subject
6 Assignment Number
Shepherd Muzamba Tutor’s Name
Pretoria, UNISA Campus Examination Venue
11.04.2016 Date Submitted √ Submission (√)
First Submission
.resubmission
1ST Floor AFGRI Building Postal Address
12 Byls Bridge Boulevard Highveld Ext 73 Centurion
0157
[email protected] E-Mail (Work) 011 063 2162 (Home) N/A
Contact Numbers
Course/Intake
(Cell) 076 621 7907 MBA Year One July 2015
Declaration: I hereby declare that the assignment submitted is an original piece of work produced by myself.
Date: 11.04.2016 Signature:
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Table of contents
Question 1………………………………………………………………………………………..3-8 Question 2………………………………………………………………………………………..9-13 Question 3……………………………………………………………………………………….14-18 Question 4……………………………………………………………………………………….19-26 References……………………………………………………………………………………….27-28
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Section A Question 1: 1.1 Critically discuss the differences between economic growth, economic development and social development: Economic growth: According to diffen.com (2016), economic growth is an increase in a country's real level of national output which can be caused by an increase in the quality of resources (by education etc.), increase in the quantity of resources & improvements in technology or in another way an increase in the value of goods and services produced by every sector of the economy. Economic Growth can be measured by an increase in a country's GDP (gross domestic product). Economic development: According to Mohr and Fourie (2008: 520), economic development refers to the improvement of living conditions in the less developed countries. It is also ―a normative concept i.e. it applies in the context of people's sense of morality (right and wrong, good and bad). The definition of economic development given by Michael Todaro is an increase in living standards, improvement in self-esteem needs and freedom from oppression as well as a greater choice‖ (Diffen.com, 2016). It tries to see how well off people are in ways that include more than just income. Social development: According to Ask.com, social development is defined as prioritizing human needs in the growth and progression of society – focusing on improving the lives of regular citizens, especially the poor, to make society a better place for everyone (Ask.com, 2016). Social development issues determine the citizens‘ access to resources – who gets what, where and how.
When comparing economic development and growth within Brazil or Costa Rica itself, it is extremely important to look at the change in both GDP and HDI over the years because each indicator is important to show either economic growth (GDP) or development (HDI). Economic growth in Brazil /Costa Rica is simply an increase in the real output of the country‘s economy over a period of time, while economic development in Brazil /Costa Rica would come from an increase in peoples freedoms, the reduction of poverty, the bettering of the public provisions of health and
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education, the guarantee of civil liberties and the maintenance of law and order. The measuring of economic growth is quantitative. An increase in real gross domestic product (GDP) will show that Brazil /Costa Rica have economic growth. A noticeable increase in one of the components of GDP, which are consumption, government spending, investments, or net exports, will most likely cause economic growth in Brazil /Costa Rica. On the other hand, the measuring of economic development is based more on qualitative data. Economic development ―entails an improvement in the quality of life of the majority of the population as a result of economic growth, reduction of inequality and eradication of absolute poverty‖ (Mohr, P. and Fourie, L., 2008:520).This clears shows that economic growth is one of the components of economic development. Development can be seen through changes in the human development index (HDI), gender related index (GDI), literacy rate, infant mortality rate, the human poverty index (HPI), genuine progress indicator (GPI), etc. Development relates to growth of human capital indexes, a decrease in inequalities figures within Brazil /Costa Rica and structural changes that lead to an increase standard of living for these countries. Comparison chart: Economic Development versus Economic Growth comparison chart Economic Development
Economic Growth
Implications
Economic development implies an upward movement of the entire social system in terms of income, savings and investment along with progressive changes in socioeconomic structure of country (institutional and technological changes).
Economic growth refers to an increase over time in a country`s real output of goods and services (GNP) or real output per capita income.
Factors
Development relates to growth of human capital indexes, a decrease in inequality figures, and structural changes that improve the general population's quality of life.
Growth relates to a gradual increase in one of the components of Gross Domestic Product: consumption, government spending, investment, net exports.
Measurement
Qualitative. HDI (Human Development Index), Quantitative. Increases in real gender- related index (GDI), Human poverty GDP.
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index (HPI), infant mortality, literacy rate etc. Effect
Brings qualitative and quantitative changes in the economy
Brings quantitative changes in the economy
Relevance
Economic development is more relevant to measure progress and quality of life in developing nations.
Economic growth is a more relevant metric for progress in developed countries. But it's widely used in all countries because growth is a necessary condition for development.
Scope
Concerned with structural changes in the economy
Growth is concerned with increase in the economy's output Source: www.diffen.com , 2016.
Economic growth is obtained by an efficient use of the available resources and by increasing the capacity of production of a country. It facilitates the redistribution of incomes between population and society.
In conclusion, although social development , economic development and economic growth have some similarities, but do differs.
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1.2. Evaluating factors that have led Costa Rica to economic and social development: Introduction: There are many factors contributing to economic and social development. Amongst them are the ones evaluated below: Gini coefficient(Income inequality) : ―It is a standard economic measure of income inequality, based on Lorenzo curve. Higher the number over 0 higher the inequality and the score of 1.0 (or 100) indicates inequality where one person corners all the income‖ (Businessdictionary.com, 2016).Costa Rica has a Gini coefficient of 0.46 and it is close to 0. This means that the issue is not really that bad (i.e. there is some income equality in Costa Rica). A Gini coefficient close to zero means that more people have income available to spend. Growth happens when lots of people spend money. The 2000 per capita income in Costa Rica was about $ 3960.00 (equivalent to R 59 400.00 based on the latest exchange rate of R15/USD). This contributes to improved standard of living and ultimately, increased economic development. Political stability: According to Martin Paldam (1995), political instability is often associated to low economic growth. There is no military force interfering in the running of Costa Rica as a country. The elections are also free and open. A country with political instability is less likely to experience both economic growth and economic development. Costa Rica is very politically stable and such conditions permit the economy to experience economic growth and improved social development. Mandatory Education: Costa Rica has implemented the policy of mandatory education. Education alone, of course, cannot transform an economy. According to Alejandro Ramirez, Gustav Ranis and Frances Stewart (1997:10), the quantity and quality of investment, domestic and foreign, together with the overall policy environment, form other important determinants of economic performance and the level human development. Costa Rica also has 95% adult literacy rate. Costa Rica also six years of school attendance are mandatory and 99% attendance is reported. Mandatory education give poor
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countries the human capital boost necessary to bring large segments of the population out of poverty Export promotion: Export promotion has been defined as ―those public policy measures which actually or potentially enhance exporting activity at the company, industry, or national level‖ (Chand, S., 2016). This means that the country put its interests first and ensures that the local producers (exporters) are well protected against imports. This can be in the form of export subsidies and import quotas. Brazil has had an export policy stressing incentives for manufacturing exports. Costa Rica‘s exports have been more concentrated in agriculture. The more Costa Rica exported its produce, the more foreign income they earn and more people will be employed. This contributes to increasing the economic growth as well as improving the worker‘s standard of living (as a result of the income they earned from rendering the service). Poverty Reduction and Human Development performance: According to the case study, Fields concluded that the proportion of Costa Ricans below the absolute poverty line fell from 20% to 10% from the early sixties to the early seventies. With more people above the absolute poverty line, their standard of living also improved as they are now able to afford most of the essential services they couldn‘t afford before. Costa Rica also has better human development performance in relation to its Latin American neighbors is due in no small part to its agrarian system. People of Costa Rica have benefited from its comparatively better agrarian system, including its better opportunities for rural economic mobility; the agrarian system is an incomplete explanation for the country's human development performance. Regressive taxation system: This includes taxes on cigarettes, alcohol & fuel tax. This discourages the society from consuming these goods and ultimately, not only improving the health status of the society but also increasing saving lot of money. This also helps the government to save on social spending on addressing the social ills that comes with the consumption of these goods. This is good for social development as it is attempts to redress the social ills facing the society. Press freedom:
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This refers to the right to obtain and publish information or opinions without government censorship or fear of punishment. This means that Costa Ricans have more access to the information about what‘s happening in their country and the information will actually aid them in their decision-making about the life choices, careers, health etc. Press freedom promotes social development. Health performance: According to the case study, Costa Rica's life expectancy at birth in 2000 was 77 years, the same as in the United States. This just goes to show that the Costa Rica now has quality health care facilities and the citizens are able to access these facilities. A healthy population translated to a productive workforce as well as reduced cases of pre-mature deaths. Majority of the population are able to make meaningful contribution to the Costa Rican economy. Ecotourism promotion and preventation of rainforest destruction: According to Untamedpath.com (2016), ecotourism is a promising means of advancing economic and environmental objectives in developing countries. Costa Rica experienced the benefits offered by Ecotourism and such benefits includes: investment for small-enterprises, employment and increased national stake in protecting biological resources. Ecotourism promotion and the preventation of rainforest destruction not only protect the environment, but also contribute to economic development. Agricultural infrastructure and extension programs: Costa Rica also had quality agricultural infrastructure and extensive programs. This actually also allow them the increase their agricultural exports as well as contributing to both economic and social development. Democratic system: ―Every individual has the right to enjoy and experience, political and social rights and the state is not allowed to discriminate citizens on the standard of sex, caste, property and religion‖ (Apecsec.org, 2014). Costa Rican citizens are enjoying economic and social benefits that come with a democratic system. In conclusion, the above factors contributed to both social and economic development in Costa Rica. 8
Question 2: 2.1. Critically evaluate the notion that development is not necessarily the same as growth although in poor countries is generally a precondition for meeting important development goals: Introduction: Development refers to a general improvement in living standards and enhancement of people‘s well-being and freedom. Growth can be very helpful in achieving development, but this requires active public policies to ensure that the fruits of economic growth are widely shared, and also requires—and this is very important—making good use of the public revenue generated by fast economic growth for social services, especially for public healthcare and public education. It is possible to have economic growth without development. This actually means an increase in GDP with no actual improvements in living standards and it often a case where only benefits a small % of the country population. Growth in many developing countries also requires external capital inflows. Without reasonable flows, the prospect for any improvements in living standards is bleak. As a result, the poor will be forced to overuse the environment to ensure their own survival. ―Economic growth does not automatically lead to social progress. The Social Progress Index shows that if we are to tackle problems such as poverty and inequality economic growth alone is not enough.‖ (Michael, Green, 2014). Meaning, it is very important that we address the issues affecting economic and social development before think about economic growth. According to Mohr and Fourie (2008:521), economic growth is regarded as one of the components of economic development and development requires changes in structures, institutions and attitudes, including a specific focus on the conditions and needs of the deprived majority.
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It is very important to note that there are measures of both economic growth and development and these measures are different.
i.
How economic growth is measured?
According to Mohr and Fourie (2008:510), we measure it by the percentage change in the level of national income, often over the period of one year. ii.
How economic development is measured?
According to the case study, the developmental criteria are: the meeting of basic needs (i.e. reduction of absolute poverty), the creation of modern employment opportunities, and the achievement of a less unequal distribution of income, human development index, political & market freedom, enhanced self-esteem and self-actualization. Development measures are a broader measure than the simple economic growth measures. We get more information with the development measures than a simple reliance on economic growth. A mere increase in flows of capital to developing countries will not necessarily contribute to development. Domestic efforts are of paramount importance. More external funding is also required, but it must come in ways that are sensitive to the environmental impacts. The point is that the reduction of poverty itself is a precondition for environmentally sound development. And resource flows from rich to poor flows improved both qualitatively and quantitatively are a precondition for the eradication of poverty. Growth in the poor countries often comes at the expense of the environment or natural resources. An example of this would be Brazil‘s growth without no changes or improvement in the standard of living.
In conclusion, growth and development are not necessarily same thing.
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2.2 Critically discuss some of the main features and problems facing Brazil and Costa Rica: Brazil is a beautiful country; rich in cultures, colours, flavours, languages and customs. But, as with any country in the world, Brazil and Costa Rica have their fair share of social issues, which their people and government no doubt work hard to resolve. Both countries are developing countries with no massive economic powers. Below are the features and problems facing Brazil and Costa Rica: Government failures: ―This occurs when the government intervention in the economy causes an inefficient allocation of resources and a decline in economic welfare‖ (Economicshelp.org, 2016). According to the case study, the Brazilian government has been characterized by the problem of government failures. This is evidenced when ―President Fernando Collorde Mello ordered a price freeze and the temporary seizure of 80 percent of private savings savings—over $110 billion—in an attempt to squeeze out liquidity, which he assumed would cause hyperinflation‖ (Case study). This, however, backfired as “the savings seizure destroyed confidence in financial assets and in the government itself‖. High debt levels: Brazil‘s massive debt level also means that instead of diverting funds to economic & social development projects, it now faces a challenge of serving debt. According to debtbombshell.com (2016), the more a country borrows, the bigger the interest payments get. This clears means that the country, just like Brazil, will have fewer funds available for future investment. Brazil labors under one of the developing world's highest debt levels. High levels, as explained in the case study, also increases the country‗s poverty (9% of Brazil‘s population struggle to make ends meets). Child Labour: Both Brazil and Costa Rica are experiencing problem of child labour. Children are supposed to be in school receiving quality education to ensure that they become useful to the economies of both countries and not the other way around – working to provide for their families. Children are the future of any country and if, any, country fails to look after them; the chances are the country will struggle to eradicate the poverty issue. Therefore, both Brazil and Costa Rica must put in place the
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systems and programme that will ensure that kids are only protected against abuse, but also ensure that they are receiving quality education. Environmental Issues: Between Brazil and Costa Rica, the latter ensured that it had adequate policies & regulations to protect its environment. Not looking after the environment can have devastating consequences to the economy of any country including Brazil. Brazil also exported commodity in high volumes as a way to get rid of their debt level. However, doing so left the country with high environmental costs. Instead of the country directly funds to projects or initiatives that will improve the country‘s citizens‘ lives and the economy, Brazil has to deal with the damages that had been caused to the environment‘s ecosystem. Race and racial discrimination: African or Mulatto in origin, are being treated unfairly in Brazil and are not considered in poverty discussions. The Brazilian government is failing to practice what they preach as they have already classified racism as a crime, but has never incarcerated anyone being a racist. ―Though there is widespread racism and discrimination against blacks, they have achieved a great deal of upward mobility compared with most countries in Latin America‖(Case study).This shows that although both countries suffer same social ills , Costa Rica citizens are more economically empowered compared to the Brazilians (Africans). Poverty: It is quite interesting to note that the poverty line (10%) in Costa Rica is way much better than the situation in Brazil, where it is 35.5%.This means that majority of the population are unable to meet their basic needs, access to quality education , quality health care , access proper shelter etc.. Poverty in both Costa Rica is caused by many factors, such as lack of education and immigration and leads to many diseases. The biggest issue is probably the lack of education as it leads to a
chain of consequences. Inequality: Brazil‘s Gini coefficient (0.59) is close to 1.00, meaning that the income Inequality in Brazil worse in comparison to Costa Rica (0.46). This does not mean that Costa Rica does not income inequality, it only means that it‘s better than it is in Costa Rica. The land Gini coefficient, a standard measure 12
of inequality, was a staggering .86, exceeded elsewhere in Latin America but perhaps nowhere else. Therefore, both countries have income and land inequality. High population growth: Brazil‘s population growth has been higher than the regional average, somewhat reducing the per capita growth gap with its neighbors. This is also putting pressure on the country‘s fiscal budget. Land reforms: In Brazil, unequal land distribution produces political incentives to encourage poor farmers to establish inefficient rain forest settlements. Brazil and Costa Rica are still faced with the problem of land redistribution. Poor health system: Child mortality rate in Brazil is quite poor by the standards of comparable countries.
In conclusion, the above-mentioned are the features and problems are facing both Brazil and Costa Rica. These issues are detrimental to not only the development of both countries, but also to their economic growth prospects.
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Section B: Question 3: 3.1 I will use the simultaneous equation solving method (Substituting one equation into another) to find the equilibrium price. The equilibrium in the market is where the quantity demanded (Qd) equals to the quantity supplied (Qs) for goods and services in any given market. This is where the demand and supply curves interact, and determines the equilibrium price and equilibrium quantities that are bought and sold in a particular market. Demand: Qd =100 000 – 4p………….Equation 1. Supply: Qs = 75 000 + P………………Equation 2. Substitute equation 2 into equation 1: Qd = Qs………………………….Market equilibrium. 100 000 – 4P = 75 000 + P 100 000-4p-100 000 -4P -4P-P -5P P
= 75 000 + P -100 000……..Subtract 100 000 on both sides. = P - 25 000 = P-25 000-P……………Subtract P both sides on both sides = -25000 ………………………Divide both sides by minus 5. = 5000 US Dollars.
Therefore, the equilibrium price is 5000 US Dollars. 3.2 Equilibrium Quantity (Qe) at 5000 Dollars (equilibrium price): Qd = 100 000 – 4p = 100 000 – 4(5000) = 100 000 – 20 000 Qd = 80 000 rental accommodation units. Qs = 75 000 + P = 75 000 + (5000) Qs = 80 000 rental accommodation units. 14
Graphical Presentation:
The above market demand curve indicates the relationship between quantities of rental accommodations “that the consumers are willing and able to buy at different price levels, ceteris paribus” (Mohr and Fourie, 2008: 114). As the price of rental accommodation goes up, the quantity of rental accommodation demanded goes up down (Ceteris paribus – holding all things else constant)-vice versa. In other words, the price of the rental accommodation directly influences the quantity of rental accommodation demanded. On the other hand, “The law of supply states that the quantity of a good or service supplied increases as its price increases, ceteris paribus” (Mohr and Fourie, 2008: 117). In reference to the above graph, at a rental price of 5000 US Dollars, the quantity demanded (Qd) equals to the quantity supplied (Qs) for the rental accommodation. This therefore means that the market is in equilibrium and the equilibrium quantity is 80 000 units.
3.3 Price Controls: What is meant by ‘rent control’ or ‘price ceiling’? ―A price ceiling occurs when the government puts a legal limit on how high the price of a product can be. In order for a price ceiling to be effective, it must be set below the natural market equilibrium‖ (Mohr and Fourie, 2008:143). This can also be referred to as ‗Maximum price‘—in other words, the maximum allowable price. The main reason for the government to have this type 15
of price control in place to make sure that the product or service can accessed by everyone in the market and not just the those of who are well-off. Another reason is ―to protects tenants from being exploited by the owners of rented accommodation‖ (Mohr and Fourie, 2008:146). Graphical Presentation:
As a result of the passed ‗rent control‘ law, the rental (price) must not exceed 2000 US Dollars. Quantity Demanded (Qd) = 100 000 – 4P = 100 000 – 4(2000) = 100 000 – 8000 Qd
Quantity Supplied (Qs)
= 92 000 rental accommodation units.
= 75 000 + P = 75 000 + (2000) 16
Qs
= 77000 rental accommodation units.
Impact of setting the price at 2000 USD: In reference to the above market demand and supply curves, the quantity demanded in the rental accommodation market (92000 units, Qd) exceeds the rental accommodations available (77000 units, Qs) and thus, the result is excess demand and the market for rental accommodation is now in disequilibrium. This is due to the quantity demanded for rental accommodation now exceeds the quantity supplied for rental accommodation by 15000 units i.e. shortage of rental accommodation. Therefore, there is no equilibrium quantity (Qe) since the market is in disequilibrium because of the introduced price controls by the US government. Due to demand exceeding the supply by 15000 rental accommodation units, there will be potential or actual tenants or customers who will be willing to pay the rental at a higher price. This will lead to existence of black market. ―Black market is often defined as an illegal market in which goods are sold above maximum price set by the government‖ (Mohr and Fourie,2008:146).
Government intervention to introduce maximum rental in this case did more harm than its intended objectives. 3.4. Whether price control is beneficial or detrimental to a market? ―Price controls are invariably implemented in the sincere belief that they are in the best interests of society- They are motivated by an honest concern for the well-being of poor consumers or low income citizens‖ (Mohr and Fourie, 2008:146). Price control is both beneficial and detrimental to a market. They are very unsustainable, sooner or later they are often abolished. Benefits of price controls are as follows: Protects consumers (in this case, tenants) against exploitations by the landlords. Combats inflation. Keeps the price of basic goods or services low as a way to assist the poor. Disadvantages of price controls: 17
According to Mohr and Fourie (2008:146), when rent control is in force, the following occurs in the market: Shortages are created (or excess demand). The market mechanism gets prevented from allocating the available quantity among consumers. Price control stimulates black market by providing an incentive for people to obtain the good and resell it at a higher price those tenants who are willing to pay higher prices to obtain it. When rent control is in force, prospective tenants are at the mercy of agents and landlords and often resort to bribery to get their names moved up on the long waiting list, corruption and favouritism are rife. Prospective tenants often have to pay ―black market prices‖ in the form of key deposits or finder‘s fees. The longer the controls are maintained, the greater the difference between controlled rentals and market price rentals will become and the more difficult it becomes to lift the controls , since rentals will soar when the controls are abolished. The poor, who were supposed to be assisted, are the ones who suffer the most. In conclusion, the disadvantages of having price controls in place outweigh its benefits. The consumers are actually better without the price controls in place.
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Question 4. 4.1 Vodacom, MTN, 8.ta and virgin mobile. Introduction: ―When first introduced in South Africa in the early 1990s, mobile telecommunications was seen as a premium service that offered mobility of voice calls. Since then, its rapid penetration has challenged the voice monopoly traditionally held by Telkom – to the extent that South Africa now has far more mobile than fixed line telephones‖(Theron, N.M. and Boshoff,W.H.,2005:10). It is still a very young industry born out of the fixed line telecommunication sector. The market structure is based mainly on the number of firms in the industry. The market structure consists of four basic market structure models are: perfect competition, monopoly, Monopolistic competition and oligopoly (Mohr,P. and Fourie,L.,2008:241) . The primary distinguishing factor between these models is the number of firms on the supply side of a market. The key distinguishing features of any market are: The number of firms in the industry, the nature of the product produced, the degree of monopoly power each firm has, the degree to which a firm can influence price, profit levels, a firm‘s behaviour: Pricing strategies, non-price competition, output levels ; and the extent of barriers to entry. Here, we are concentrated on the South African mobile communication industry. Vodacom, MTN, Cell C, 8ta and virgin mobile are the service providers. I will determine each of the key distinguishing market structure features and should come to a conclusion as to which model (s) of a market structure the SA mobile communication industry is operating/ falls under.
The key distinguishing features for the South African mobile communication industry: The number firms in the industry: According to Mohr and Fourie (2008:242), the actual number of firm is not critically important – what matters is the behaviour of the firms, in particular whether or not an individual firm can influence the price at which its product is sold and the production costs. According to mybroadband.co.za (2015), the operators are able to influence the price at which their product are sold and this includes, but not limited to the data bundles packages. It is quite evident that these 19
operators are price makers or price setters. The number of firms in the South African mobile communication industry is very few and includes Vodacom, MTN, Cell C, 8ta and virgin mobile. This is one of the criteria for Oligopoly. The nature of the product produced/Service rendered: ―The product can be homogeneous (identical, standard) or it can be heterogeneous (differentiated, non-standardized)‖ (Mohr,P. and Fourie,L.,2008:242).
Source: www.markitects.co.za,2016.
Products in the South African mobile communication industry are very similar, and sold by a few companies. MTN and Vodacom may offer the two brands (e.g. Samsung and Huawei smartphone) of the same product that may be technically identical but different in the eyes of the customers; in this case the product they offered is classified as heterogeneous or differentiated. These are both smartphones, but may be different in processing capabilities, added features, etc. etc. According to Ian Rheeder (2016), the products are branded due to extreme competition, and because there are 20
huge long-term entry-barriers, the companies make exorbitant profits. The competing companies have an unusual ‗interdependence‘, to the point that they almost operate in unison. They have incredible difficulty making output/price decisions because of the competitor‘s obvious response. This criterion has also been met for this market to be classified as an oligopoly. The degree of monopoly power each firm has: Monopoly ‗power‘ is much more widespread, and can exist even when there is more than one supplier – such in markets with only two firms, called a duopoly, and a few firms, an oligopoly. These
mobile
operators
―have
exclusive
ownership
or
use
of
a
scarce
resource‖
(Economicsonline.com, 2016).
Source: South Africa ICT Report, 2011:38. “With a combined market share of 77%, Vodacom and MTN are the strongest contenders in the
mobile market. While in essence the market is characterized by an oligopoly, the force of duopoly between Vodacom and MTN is most dominant. The collective market power of the two completely undermines the potential of competition since the remaining actors barely feature‖ (Dr.Chiumbu,S. and Akinsanni,T., 2011:38). Although Cell C has made a noticeable dent in the market shares of the industry, the shift has unfortunately not been strong enough to compete with giants Vodacom and MTN.
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The degree to which a firm can influence price: According to Mohr and Fourie (2008:242), the perfectly competitive firm has no control over the price of its product (i.e. it‘s a price taker) and the imperfectly competitive firms have a varying degree of control over prices of their products (i.e. they are price setters/price makers). Profit levels: According to Mohr and Fourie (2008:242), perfectly competitive firms do not earn any economic profits in the long-run (only make normal profits); however, monopolistic competition and oligopoly may earn economic (abnormal) profits in the long-run. Firm‘s behaviour: Pricing strategies, non-price competition, output levels: When competing, these mobile operators prefer non-price competition in order to avoid price wars. A price reduction may achieve strategic benefits, such as gaining market share, or deterring entry, but the danger is that rivals will simply reduce their prices in response. The extent of barriers to entry: ―Entry (or mobility) refers to the ease or difficulty with which firms can enter and exit the market‖ (Mohr, P. and Fourie, L., 2008:242). This has an effect on the number of firms participating in any industry. According to a report issued by First Avenue Investment (Pty) Ltd(2012), the barrier of entry range from economies of scale, brand strength and availability of capital (but not limited to this) . i.
Economies of scale:
―A firm experiences economies of scale if cost per output falls as the scale of production increases. This may or may not be the result of increasing returns to scale‖ (Mohr and Fourie, 2008: 215). ii.
Brand strength:
The quality of a substitute generic product is generally unknown and requires one to experience it. It, therefore, becomes difficult for the users to switch to a new entrant on the market and the users often remain loyal to the more experienced and established mobile operator. 22
iii.
High initial fixed cost and availability of capital:
―We estimate that Vodacom has spent substantially more than R20 billion on network capital expenditure since inception. As a result, smaller operators have no choice but to roam on the network of bigger operators due to the prohibitive cost of rolling out their own network, thereby increasing operational costs‖ (Mohamed,N. and Magoro, B., 2012:7). It is clearly evident this is a very tough industry to operate in and can only accommodate those who have greater financial muscles. Spending money on Research and Development (R & D) is often a signal to potential entrants that the firm has large financial reserves and this industry, all these mobile operators send a lot in terms of R & D. In conclusion, it is clearly evident that the S.A mobile communication market meets the entire criterion for a market structure to be considered as an oligopoly.
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4.2 Marginal Cost (MC) can be defined as the cost of producing additional (marginal) units of output (Mohr,P., Fourie,L. and Associates, 2008:201) . It falls at first due to the law of diminishing returns, but then rises as the costs rises. Average Cost (AC) can be defined as the ―total cost (TC) divided by the number of units (or quantity) of product produced‖ (Mohr,P., Fourie,L. and Associates, 2008:201). The difference between the average cost and sales price does determine the profits per unit once the profit maximizing quantity is determined, but the profit maximizing quantity generally does not maximize profits per unit. It is therefore to note that firms maximize profits by considering the marginal cost, not the average cost. Marginal Revenue (MR): According to economicsonline.co.uk (2016), MR is the revenue generated from selling one extra unit of a good or service. It can be found by finding the change in total revenue following an increase in output of one of unit. The perfectively competitive firm seeks to maximize profits by producing the quantity of output at which MR =MC and because for the firm P= MR, It automatically achieves allocative efficiency (P=MC) when it maximizes profit (MR=MC). Abnormal profits are earned when the price exceeds the average cost curve at profit-maximizing output. According to economicsonline.co.uk (2016), the level of abnormal profits available to a firm is largely determined by the level of competition in a market (i.e. the more competition the less the chance there is to earn abnormal profits).
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Graphical presentation:
Source: http://www.economicsonline.co.uk/
On the two diagrams above, Quantity Q1 and price P1 shows both the firm‘s and industry‘s position where both are earning abnormal profits in the short run. Short run equilibrium: Short equilibrium is one where the graph shows the short run equilibrium with abnormal profits being earned. The price P1 allows them to earn abnormal profits. Average and marginal costs could be expected to be lower, but price, in the short run, remains the same. The lower AC and MC would imply that the firm is now earning an abnormal profit (AR>AC). Long-run Equilibrium: According to Mohr and Fourie (2008:234), two things changes in the long run and they are: 1. New firms can enter the industry and existing firms can leave. Because the model assumes perfect knowledge, the firm gains the advantage for only a short period of time before others copy the idea or are attracted to the industry by the existence of abnormal profits. As new firms enter the industry, market supply increases from S1 to S2, market price falls from P1 to P2 (this means that profits have also been reduced), ceteris paribus and the firm will be left making a normal profit once again. At this point there is no inducement for the new firms to 25
enter the industry (Mohr P and Fourie, L., 2008:234). In a case where the firms are making economic losses, these firms will exit the industry in the long run until all firms in the industry are making normal profits. At this point there is no inducement for the new firms to enter the industry (Mohr P and Fourie, L., 2008:234). Where the perfectly competitive firms are supposed to operate, no firm can earn abnormal profits in the long run. These profits will always be competed away because of the entry of new firms. This therefore means that the industry will only be in equilibrium in the long run if all firms are making normal profits and this is represented the new market equilibrium price P2 and new market quantity Q2. Now P=MC=AC. There is equilibrium at the price where normal profits are earned 2. All factors of production become variable and existing firms earning profit in the short run may decide to expand their plant sizes to realize economies of scale. ―If an existing firm is earning an economic profit and it can realize economies of scale (i.e. if average cost can be reduced), it will expand its scale of production‖ (Mohr, P. and Fourie, L., 2008:236). In the long-run, existing firms will continue to expand as long as there are economies of scale to be realized (i.e. as long as average costs can be reduced) and new firms will continue to enter the industry as long as positive economic profits are earned. In the long-run, the firm is in equilibrium where P= SRMC =SRAC=LRAC, as at Price P2 and quantity Q2 in the diagram below. No other price can represent equilibrium.
In conclusion, abnormal profits are not possible in a perfectly competitive market in the long run due to the factors discussed above. 26
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