Inflation

What is inflation?

Inflation means a sustained increase in the average or general price level in an economy. This means that the price level of the vast majority of the goods keeps on rising.

Inflation is one of the many economic problems facing Maldives.

There are several causes of inflation. The most noticeable factor behind inflation in Maldives is the exchange rate.

Causes of inflation

Inflation happens when too much money chases too few good and services. This is a concept agreed by almost all the economists today. This also matches the demand theory of the inverse relationship between the quantity demanded the the price, and the direct relationship between quantity supplied and the price.

Let’s see what happened in the Maldives. The lifting of the peg led to an immediate depreciation of Maldivian Rufiyaa against the US$.

The depreciation affected all the imports. Imports became expensive. Most of the goods at the market are imported goods, therefore the general price level in the shops in Male’ showed an immediate spike.

Exchange rate also affected the prices of locally produced goods too. The reason is the rise in the price of petrol and diesel.

The shop owners are clever too, they even charged the new prices on the stock they purchased when the US$ was still at the old exchange rate.

Now let us see the general causes of inflation

Demand-pull inflation

An increase in the aggregate demand in the economy will cause inflation if the suppliers are unable to increase supply to match the increase in demand.

Increase in income of the consumers, reduction in taxes, and increase in government spending are some of the reasons of demand-pull inflation.

Cost-push inflation

Rising in the prices of raw materials and other costs of production will make the producers and suppliers charge higher prices in-order to cover the increased costs.

Cost-push factors

Cost-push refers to the costs that a business has to meet, such as wages and raw materials. As costs rise, the business will often pass these on to consumers by increasing the prices for the product they are selling.

Food costs
The most significant rise in price in Maldives is seen on food items. This is largely due to the fact that Maldives imports much of the food items consumed by the people. As costs are given quite a high weight, increase in price of food items are felt more by the people.

Raw material costs
Despite the world recession in 2008 and 2009, the costs of raw materials such as steel, copper, oil and gas have risen. These raw materials are at the centre of modern economies, so as their prices rise, there is an effect on many other prices.

Wage costs
Wage costs are another major cause of cost-push infl ation. If food and fuel prices rise, people will press their
employers for higher wages. If, however, the wage increase is not matched by higher labour productivity, in other words, if the workers do not produce more goods to sell, production costs will rise.

Land costs
Land prices in many countries have risen as land is used more intensively. For example, the increase in rent in Male’ has led to the shop owners increase prices of the items they sell, in order to recover the increased expenses. The prices of meals served at the restaurants have also increased dramatically due to high rent.

Inflation in Maldives is partly cost-push. The increase in fuel prices lead to higher costs on electricity generation and transport. Therefore the costs of the farmers in agricultural islands have also increased. This is the reason why even the prices of domestically produced food items have gone up due to depreciation of Maldivian Rufiyaa against US Dollar.

The costs of inflation

Inflation affects the ‘real income’ of the people. Real income means what the money income can actually buy. With the increase in prices and the money income remaining the same, the people actually are poorer in real terms.

Inflation is a major problem faced by economies. As the price level increases, the workers usually tend to demand for higher wages. Sometimes this even leads to strikes and violent riots on the streets.

Will the increase in wages solve the problems?

Mostly no! The increase in wages will again increase the cost of production and the money that is able to chase the available goods, leading to still more inflation.

Therefore governments tackle with the problem with caution. Increasing the productive capacity is required to reach a long term and sustained solution.

Next Topic: Deflation

Elasticity of Demand & Supply

In Economics, elasticity is the ratio of the percent change in one variable to the percentage change in another variable.

The most frequently used elasticities in economics include:

  • Price Elasticity of Demand
  • Price Elasticity of Supply
  • Income Elasticity of Demand
  • Cross Price Elasticity

Price Elasticity of Demand(PED)

Price Elasticity of demand is the responsiveness of the quantity demanded of a particular product to a change in its price.

In simple words, PED measures  how far the quantity demanded of a product changes when the price of it goes up or down.

Price elasticity is calculated by the formula

PED = % change in demand of good X / % change in price of good X

If PED is greater than 1, then the good is price elastic. Suppliers and shop owners can increase revenue by reducing the price as long as the good is price elastic.

If PED is less than 1, then the good is price inelastic. Suppliers and shop owners can increase revenue by incrasing the price as long as the good is price inelastic.

Factors that determine the value of price elasticity of demand

1. Number of close substitutes within the market – If more substitutes are available, an increase in price of one item will make people switch to the other substitute goods. Therefore the quantity demanded will easily change therefore is termed as ‘elastic’. If substitutes are not available, people have no choice but to buy the item even if the price increases.

2. Luxuries and necessities – Necessities tend to have a more inelastic demand curve, whereas luxury goods and services tend to be more elastic. For example, the demand for motor cycles is more elastic than the demand for wheat flour.

3. Percentage of income spent on a good – It may be the case that the smaller the proportion of income spent taken up with purchasing the good or service the more inelastic demand will be.

4. Habit forming goods – Goods such as cigarettes and drugs tend to be inelastic in demand. Once a person is addicted to drugs, he will buy it even if the price increases so much, unless he gets rehabilitated.

5. Short run or long run – Demand tends to be more elastic in the long run rather than in the short run. This is because suppliers are usually able to introduce substitutes in the long run.

Price Elasticity of Supply(PED)

Price elasticity of supply is the responsiveness of the quantity supplied of a good to a change in its price.

Suppliers would want to increase the supply of a particular good if the price goes up. The more they are able to do so, the higher is the elasticity. Price elasticity of supply is affected by:

1. Whether suppliers have access capacity to accommodate a sudden need to increase production.

2. Some factors of production can be substituted for one another. Production can be done using labour intensive methods and capital intensive methods as well. The firms may not be able to invest in capital in the short run, but they can increase production by hiring more labour.

3. If the firms have a good stock ready for supply, they can put them in the market if the price increases, so that supply is elastic.

4. In the long run supply tends to be elastic since the firms can invest in capital and grow in size in the long run.

Next Topic: Inflation

Changes in Demand & Supply

Demand and Quantity Demanded

We know from the earlier topic that people tend to buy more of a particular item as the price goes down. In other words, Quantity Demanded goes up as price falls.

However, some students mistakenly say that “demand goes up as price falls”. In fact, the changes in price of an item does not change demand. It merely changes the quantity demanded of that particular item.

Now, Let’s see the difference between Demand and Quantity Demanded

Demand is the range of quantities that buyers are willing and able to buy at a range of demand prices. It is ALL the points that make up a demand curve. In fact, the whole demand curve itself is known as Demand.

Quantity demanded is a specific quantity that buyers are willing and able to buy at a specific demand price. It is but ONE point on a demand curve.

Change in Demand

A change in demand is a change in the ENTIRE demand relation. This means changing, moving, and shifting the entire demand curve. The entire set of prices and quantities is changing. In other words, this is a shift of the demand curve. A change in demand is caused by a change in the demand determinants. In other words, a change in demand is caused by any factor affecting demand EXCEPT price. The determinants which shift the demand curve include the following:

    1. Income

Income, or more precisely the buyer’s income affects the ability of the buyers to buy goods and services. An increase in the income increases the demand and shifts the demand curve to the right.

    1. Taste and Fashion(Preferences)

Demand will increase if a particular good or service becomes more popular. Likewise, outdated or out-of-fashion products will have a reduced demand in the market

    1. Substitutes and complementary goods

Substitutes are those goods or services which can be used instead of a particular good or service. Eg:- Margarine and butter. Petroleum and Natural gas.
The demand for a particular good will increase if the price of its substitutes increases and vice versa.
Complements are those goods which are usually consumed together. For example, tea and sugar are complements. If people in general develop a taste for more tea, they will naturally buy more sugar.

    1. Change in the quality

If the quality of a particular good or services improves, people will be willing to buy more of it even if the price doesn’t fall. Likewise, a fall in the quality will reduce the demand for the particular good.

    1. Advertising

A successful advertising can increase demand for the advertised product.

    1. Expected future price

If consumers expect higher prices in the future, their current demand will increase. If they expect lower prices in the future, their current demand will decrease.

Shift in Demand Curve

Shift in Demand Curve

Changes in Supply

A change in demand is a change in the ENTIRE supply relation. This means changing, moving, and shifting the entire supply curve. In other words, this is a shift of the supply curve. A change in supply is caused by a change in the supply determinants. In other words, a change in supply is caused by any factor affecting supply EXCEPT price. The determinants which shift the supply curve include the following:

    1. Prices of other commodities

The supply of one good may decrease if the price of another good increases, causing producers to re-allocate resources to produce larger quantities of the more profitable good.

    1. Number of suppliers/producers

More suppliers/producers result in more supply, shifting the supply curve to the right.

    1. Changes in the cost of production

If the cost of resources used to produce a good increases, sellers will be less inclined to supply the same quantity at a given price, and the supply curve will shift to the left.

    1. Technology and Technical Progress

Technological advances means improvements in the performances of machines. Technical progress includes the improvements in the skill of the workers, production methods, management and control. These improvements will reduce the cost of production and therefore producers will be able to supply more even if the price doesn’t go up.

    1. Expectations

If sellers expect prices to increase, they may decrease the quantity currently supplied at a given price in order to be able to supply more when the price increases, resulting in a supply curve shift to the left.

    1. Other factors

There are other factors which will affect the supply. For example, weather has a big impact on the supply of agricultural products. Government taxes and subsidies too have their respective affect on the supply. Therefore, any non-price factor which affects supply is a supply determinant and will shift the supply curve either to the left or to the right.

Changes in Supply

Change in Supply

Next Topic: Elasticity

Demand & Supply

Demand

In Economics, demand means the willingness and ability of people to buy goods and services. The people, referred as consumers, can demand for goods and services only if they have money to buy them. The producers will not produce if there is no demand for the product.

The amount of a good or a service that consumers are willing and able to buy is known as quantity demanded.

The law of demand states that the quantity demanded and the price of a commodity are inversely related, other things remaining constant. If the income of the consumer, prices of the related goods, and preferences of the consumer remain unchanged, then the change in quantity of good demanded by the consumer will be negatively correlated to the change in the price of the good.

In normal situations, consumers will demand less quantities of a product as the price of the product increases and vice-versa.

Supply

In economics, supply means willingness and ability of producers to make and sell goods and services. The producers will supply only those goods and services for which there is demand in the market.

The amount of a good or a service that producers are willing and able to sell is known as quantity supplied.

In normal situations producers will supply more goods and services as the price increases and vice-versa.

Demand Schedule

As we know, in normal circumstances, the consumers will demand more as the price of a particular product goes down. Economists gather information from the market about demand of goods and services and enter the data in a demand schedule. An example of a demand schedule is given below.

Demand for Apples

Price
1
2
3
4
5
Quantity Demanded
50
40
30
20
10

Demand Curve

From the above demand schedule, we can see that the quantity demanded by the consumers goes down as the price goes up. This can be shown by a graphical representation known as Demand Curve.

Demand Curve

Supply Schedule

As we know, in normal circumstances, the producers/suppliers will produce and supply more as the price of a particular product goes up and vice-versa. Economists gather information from the market about supply of goods and services and enter the data in a supply schedule. An example of a supply schedule is given below.

Supply of apples

Price
1
2
3
4
5
Quantity Supplied
10
20
30
40
50

Supply Curve

From the above supply schedule, we can see that the quantity supplied by the producers/suppliers goes up as the price goes up. This can be shown by a grapical representation known as Supply Curve.

Supply Curve

Market Equilibrium

Market equilibrium is where the quantity demanded equals the quantity supplied. This is the poit at which demand curve meets the supply curve.

Market Equilibrium

In the above diagram, the equilirium price is 3 and the equlibrium quantity demanded and supplied is 30.

Next Topic: Changes in Demand and Supply

Types of Business Ogranizations

A business is an organization that buys and sells goods or services with a view to make profit.

The structure of the business varies, depending on the number of people involved in a business and the nature of their operations.

The type of business organizations could be as follows:

  • Sole Trader or Sole Proprietorship
  • Partnership
  • Private Limited Companies
  • Public Limited companies
  • Co-operatives
  • Public Corporations
  • Multinational Businesses

Sole Proprietorships, Partnerships, Private and Public Limited Companies are all in Private Sector of the Economy.

Where as Public Corporations are in Public Sector.

Sole Proprietorship

A sole trader or a Sole Proprietorship is a small business owned and usually managed by a single person. It is the oldest and still the most popular form of businesses worldwide.

The popularity of sole proprietorships due to the advantages of this types of businesses compared to other forms of businesses.
The advantages include:

  1. Easy to set up – It is easy to start a sole trader business since the capital required to start this type of business is relatively small.
  2. Easy to manage – Small businesses are easy to manage. Sole trader has full control, therefore he finds it easy to take decisions and enforce them.
  3. Sole Trader is his own boss – Sole trader does not have to consult anybody to take any decisions and he is the only owner of the business. Therefore he keeps the profit to himself too, without having to share it with anybody.
  4. Personalized services – A sole trader usually can keep closer relationships with workers and customers. It usually happens in a friendly enviroment rather than a formal office environment.
  5. Flexibility – It is easy for a sole trader to switch and adjust his business by taking consideration of the market factors since decision making is easy and swift.
  6. Business secrecy is kept at maxium.

Sole proprietors have certain disadvantages too:

  1. A sole trader’s skills and abilities are limited to he himself. Specialization and economies of scale is difficult.
  2. Limited Capital – Capital for the sole trader business comes from the owner’s own savings. Therefore it is limited.The banks may not be so willing to give loans to a single person.
  3. A major disadvantage is that the liability of a sole trader is unlimited. He may lose his own properties to pay the creditors in case of financial distress.

Partnerships

A partnership is a business owned by two or more people. The maximum number of owners in a partnership can be twenty.

A partnership has certain advantages:

  1. A partnership can raise a bigger capital compared to a sole trader. Therefore expansion is possible.
  2. It is possible to have more skill in the business through pooling of ideas and expertise.
  3. Partnerships can get loans easily compared to sole traders, even though it may not be as good as a limited company.
  4. There is a greater possibility of division of labour, larger scale business and therefore economies of scale.
    Risk is greatly reduced since any loss will be shared by the partners.
  5. Business secrecy is kept since partnerships do not need to disclose financial reports. Disclosing is required by the limited companies.

Disadvantages of partnerships are:

  1. Just like sole traders, the liability of partnerships is unlimited. In case of financial difficulty, the partners too could lose their personal property.
  2. There is a limit on the number of partners the business can have and thus expansion has a limit too.
  3. The more partners the business has, the more likely it is to have disputes, and therefore the business may have to be dissolved.
  4. Partners have to share the profit, unlike the sole trader who keeps it all to himself

Joint Stock Companies: Private Limited Companies

A joint stock company sells shares to investors to raise money. These types of business organizations are known as limited companies.

The name of a limited company is always followed by the word ‘limited’ or letters ‘ltd’. The limited companies are called so because liability of the owners are limited to the amount of shares they hold in that particular company.

A limited company is an artificial entity created by law. Which means the company can sue and be sued.

A private limited company is smaller than public limited companies. The main difference between them is that private limited companies can not sell shares at the stock exchage, while public limited companies do.

The documents required to register a company in Maldives can be obtained from the website Ministry of Economic Development.

Advantages of private limited companies

  1. Share holders have limited liability. While sole traders and partnerships are at disadvantage because of unlimited liability, private and public limited companies are at an advantage due to their liability being limited.
  2. Share holders have no management worries. The owners and the management of the company is usually different. Share holders can elect a board of Management at the Annual General Meeting. Each share has one voting power.
  3. One of the reasons why companies are preferred is because they are separate legal entities. The owners have no worries over the debts and if there is any problem, it is the company which is taken to the court, not the owners.
  4. Bank are more willing to give loans to private limited companies compared to partnerships and sole traders

Disadvantages of private limited companies

  1. The companies have to disclose their business information:The companies are required to submit annual reports to the Ministry of Economic Development and all the details of profits and losses need to be disclosed to all the stake holders as well. Therefore business secrecy is lost.
  2. AGM: The Annual General Meeting is held with shareholders for the purpose of electing board of directors. This sometimes is a big expense.
  3. Private limited companies have advantages over sole traders in terms of size and capital. However it is still not as good as a public limited company. Private limited companies cannot sell shares on the stock exchange.

Wataniya and Villa Shipping are some of the famous private limited companies in Maldives.

Joint Stock companies: Public Limited Companies

The main difference between private and public limited companies are that public limited companies can sell shares to the general public, while private limited companies cannot. Therefore public limited companies are larger in size.

Shares are offered for sale on the Stock Exchange. Any member of the general public can buy and sell shares.

A public limited company usually must include the words “public limited company” or its abbreviation “plc” at the end and as part of its legal company name.

Public Limited companies are able to attract money from investors all over the world.

MTCC, Bank of Maldives, and STO are public limited companies from Maldives.

Co-operatives

A co-operative is where a number of individuals or businesses work together to achieve a common purpose. They are normally formed so individuals and small businesses can benefit from being part of a larger group, meaning they have more power to buy or bargain.

We already know that small businesses have certain disadvantages compared to larger join stock companies. Therefore, co-operatives could be a means to overcome those challenges faced by small businesses.

Types of co-operatives include housing co-operatives, building co-operatives, retailers’ co-operatives, worker co-operatives, consumers’ co-operatives and agricultural co-operatives.

Public Corporations

Public corporations are owned by government. These companies are formed by government to run the industries owned by the government. Maldives Post Limited and Maldives National Broadcasting Corporation are good examples.

Public Corporations too have separate legal entity just like other companies. That means the corporations can sue and be sued.

Multinational Businesses

A Multinational company(MNC) is a firm which has operations in more than one country. It maybe a private limited company or a public limited company. Ford and Sony are well known examples of Multinational companies.

Advantages of MNCs
1. Capital is often more mobile than labour and other factors of production. An can start operations in a country where there is availability of resources.
2. MNCs enjoy economies of scale by operating in a large scale.
3. MNCs can locate their operations near the potential market which results in lower transportation cost.

Advantage of MNCs to the host county
1. MNCs bring in capital and new technology to the country.
2. MNCs make it possible to start mega projects which otherwise may not be possible.
3. MNCs create jobs and thus employment increases.
4. MNCs bring revenue to the government through taxes.

Disadvantages of MNCs and to the host country
1. Expanding operations sometimes tend to increase costs if not managed properly.
2. Even though MNCs bring capital into the country, they will later remit funds out of the country in the form of profits.
3. The companies may pullout and relocate to another country where it can make more profit.
Next topic: Changes in the structure of business organisations

Economic Systems

As Economics deals in managing the available scarce resources, there are three basic questions that a country has to answer:

  • What to produce?
  • How to produce?
  • For whom to produce?

The answers to the above questions determine what type of an economic system that particular country has. Whatever the system a country may have, the ultimate purpose is to manage the available scare resources.
The following links will give u more details:

  1. Types of Economic Systems
  2. Advantages and Disadvantages of the market system

Stages of Production

Production means producing goods and services so that we can satisfy our wants. Any type of production is an economic activity. It is useful to classify the economic activities according to the nature of production they do.

Primary Economic Activities

Also known as the extractive industry, primary economic activities involve in extraction of natural resources. Firms which produce natural resources are called primary firms. Fishing and agriculture are good examples of primary economic activities in Maldives. Other examples in this sector include, mining, extraction of crude oil and logging. The output of the primary industries are usually input for the secondary industries.

Secondary Economic Activities

Secondary sector involves in the use of raw materials to make other goods. Secondary production is also known as ‘manufacturing’. While the normal fishermen catching fish from the sea is a primary economic activity, the fish cannery in Felivaru is in secondary sector of the economy. Any firm which manufactures by using primary goods or secondary goods from another firm as raw materials is doing secondary production. Other world examples include, manufacturing cars, ship building and refining oil etc.

Tertiary Economic Activities

Once primary and secondary industries complete their production of goods, there are activities necessary to bring them to the consumers. These activities are also called services. For example, travel boats from the agricultural islands bring farm products to the local market.
There are also support services which support the primary and secondary sector. For example, banking and insurance.
Tertiary sector involves in giving services. This is also called service sector. Tourism, which is the major economic activity in Maldives is a tertiary economic activity. Other tertiary economic activities in Maldives include, shipping, teaching, wholesaling and retailing.

Next Topic: Economic Systems

Factors of Production

Factors of Production are the resources used for the production of goods and services.

Production is known as any type of activity that has an economic value. Any activity that generates money or income.

Land

In Economics, land has a wider meaning compared to the English meaning of the word ‘land’. In economics, land consists of all the natural resources. For example, the atmosphere, the seas, soil, everything on the seabed etc.

The price given for the land is usually called ‘rent’

Labour

Labour is the all human efforts in the production. Labour does not only mean the labourers in an industrial site. If we take an example of a tourist resort, labour includes the receptionists, bell boys, bartenders, waiters, admin assistants, telephone operators etc.

The price given for the labour is usually called salaries and wages

Capital

Capital is the investment given to the business by the owner. It includes money input by the owner plus the fixed assets such as machinery and tools used for the production.

The price of the capital usually is interest payments.

Entrepreneur

An entrepreneur is a person or a group of people who bring together all the other factors of production. For example, the manager in a company gives direction to the plumbers, supervisors, admin assistants. He also manages the finance in the business and thinks of ways of increasing profit. The manager here is the entrepreneur.

Next Topic: Production Possibilities Frontier

The Nature of Economic Problem

Keeping in mind the meaning/definition of economics, let us see why we study economics. It is because of the basic economic problems facing every individual, society and country as well.

Scarcity

It is a known fact that human beings have unlimited wants. Wants are desires of oneself to do or have something. When one want it satisfied, another comes up and there is no end to it. To satisfy those wants we use ‘resources’. The problem, however, is that the resources we use to satisfy those wants are limited. Scarcity means limitation of supply of resources in relation to their wants

However scarcity does not mean that something is available in small quantities. It actually means that the available quantity is not enough to satisfy their appropriate wants. Because of this scarcity, we are all forced to make ‘choices’.

Choice

When we do not have enough resources to satisfy all our wants, we are forced to make choices. We choose which want we will satisfy with the available resource. For example, Habeeb had MRF25. He wanted to eat a fried noodles and would like to buy a small office notebook too. However, the money he had was not enough to buy both. He could buy either a fried noodles or the notebook, but not both. What would he choose to buy? He was hungry, therefore chose to eat the fried noodles and forget about the notebook. His choice was fried noodles.

Opportunity Cost

If we decide and choose which want to satisfy with the available resource, then there are other wants we have to leave unsatisfied. We have to forgo something in order to satisfy a want. The want that is forgone is called the ‘opportunity cost’. It is also known as ‘the next best alternative’.

Economic goods are scarce goods

If the resources were unlimited in supply, there would be no need to study economics. An economic good is anything that has a money value. Money value exists because it is scarce. Therefore anything that is not scarce has no economic value.

Next Topic: Factors of production

Economics: Meaning & Introduction

What is Economics?

Different scholars have given different definitions of Economics. Some of those definitions are easy to understand, while others could be a little difficult for a beginner to understand. Let us look at a few definitions:

Alfred Marshall, in his book Principles of Economics, described Economics as “a study of mankind in the ordinary business of life; it examines that part of individual and social action which is most closely connected with the attainment and with the use of the material requisites of wellbeing. Thus it is on one side a study of wealth; and on the other, and more important side, a part of the study of man.”

Lionell Robbins in 1935: “Economics is a science which studies human behavior as a relationship between ends and scarce means which have alternative uses.”

Now let us make a clearer definition from the above. Economics is the social science that examines how people choose to use limited or scarce resources in attempting to satisfy their unlimited wants.

Economics is a social science because it studies about human behaviour. In fact, Economics is regarded as ‘the darling queen of social sciences’ today.

Always remember the meaning/definition of Economics if you are studying any topic in the subject; it will make it easy for you to understand the topic well.

If the meaning/definition of economics is still not clear to you, or if you need a Dhivehi explanation, please use the Contact Me page to contact me.

If you have understood the definition of economics, Go to the Next Topic:<< The Basic Economic Problems >>