Economic is the study of how people satisfy their material needs and wants with the available resources. The primary focuses of economics are distinguished between needs & wants, fundamental economic problems.

Needs means something we have to have, ex foods, water, clothes. Wants are something we like to have. To produce these things society will face various problems. What to produce, how much to produce, how to produce, for whom to produce, when to produce. Basic economic problems are simply because wants are unlimited & resources are limited.

Resources can be mainly divided into two, natural & economic. So we have to make choices to select wants & needs. Its means unlimited wants & limited resources force us to make choices.

Evaluation of the total (life cycle) costs of alternative solutions to the problem of meeting the requirements of a particular client and choice of the best solution.



Q1.1.Market Economy

An economic system in which economic decisions and the pricing of goods and services are guided solely by the aggregate interactions of a country’s citizens and businesses and there is little government intervention or central planning. This is the opposite of a centrally planned economy, in which government decisions drive most aspects of a country’s economic activity.

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The main co- coordinating device is the price decided in the market place through the interaction between demand and supply. Hence this also called free market system because the price is the main device that solves all basic economic problems. This is called price system.

It is said that in a market economy, there is an invisible hand operating due to (a) economy is operated by the price system, (b) buyers and sellers respond to price system and accordingly both parties get coordinated, (c) basic economic problems are solved using the price system. In a market economy the basic economic problems are solved and resources are allocated in the following manner.

Solving the problem what to produce in which quantity

In a market economy this problem is addressed by the private sector entrepreneurs through the decisions made by them. Since they always have the profit motive the commodity and factor prices are considered in decision making. Consumers will create demand in the market by revealing their choice by purchasing goods. Suppliers create the supply force having considered the commodity price, cost and profit. Accordingly they will allocate more resources to produce more of goods with higher profits.

Solving the problem how to produce

This problem is concerned with the selection of production method by referring to the factor market. Since the private sector is concerned with profits they will select the most cost effective production method. Hence the factor with the lowest price will be applied more in the production in order to minimize the production cost.

Solving the problem whom to produce

This problem stresses how the economy’s total output gets distributed among people. This is decided by the distribution of income among people. Income distribution is determined by 2 factors which are (a) how much of factors are owned by the household units, (b) the price of such factors.

In the market economies individuals can own resources without being subjected to any limitations. The resource ownership is decided by factors such as merits, skills, inheritance and entrepreneurship. Factor price is decided by the demand and supply of the factors. Therefore this problem is solved by the operation of the factor market.

Command economy

In command or planned economies, questions on resource allocation are decided by a central authority often the government or a state controlled council. However since centralized decisions require plans set in advance for the desired outcome, these economies are called centrally planned economies. In these economies, economic activities such as what to produce and how much to produce take place as per the commands of the central planners.

E.g.: Cuba, North Korea

In command economies the basic economic problems are solved and resource allocation is done based on a preset plan. This plan is a descriptive statement that illustrates resources, operation of production activities, and distribution of income among households etc. with a view of achieving a set of selected objectives.

Solving the problem what to produce in which quantity

It is the central planning authority that decides the resource allocation between consumer and investment goods.

Solving the problem of how to produce

It is the central planning authority that decides the production method and they set the plan to match inputs.

Solving the problem for whom to produce

This is concerned with the distribution of income among household units. The only factor that is owned by households is “labour”. The only means of income available to the household units is salaries and wages. A disparity in income distribution arises to a certain extent due to the differences in quality of labour. Further the quantity of goods and services the households get does not depend solely on their income because government also supplies goods and services at subsidized prices or free of charge.


(a) Market equilibrium price : Rs.51

(b) Market equilibrium quantity : 490 units


Effect of taxes

The government imposes taxes on production or sale of commodities which are called indirect taxes. The indirect tax can be either a unit tax or an advoleram tax. If the government imposes an indirect tax on a commodity, it will shift the supply curve leftward by the amount of tax (i.e: if it is a unit tax, the supply curve will shift leftward by the amount of unit tax as supplier is supposed to pay the tax to the government). The effect of taxation will be that it increases the net cost of supplying a particular commodity. Therefore every quantity will be supplied at a higher price than earlier or in other words the quantity supplied at each price will be lesser than earlier.

Figure 2 depicts the incidence of an indirect tax.











Qty D





Incidence of tax on the buyers

Figure 2

Incidence of a tax on the sellers

The division of the tax burden between the buyers and sellers depends on the elasticity of supply and demand. Given the demand conditions, the greater the elasticity of supply, and the greater the incidence of tax resting on the buyers of a commodity. On the other hand the greater the elasticity of demand, and greater the incidence of tax resting on the sellers of a commodity. Figure 2 represents the case of a commodity with relatively elastic supply.

When the tax levied on this commodity, the supply curve shifts leftward from S1 to S2, the prices rise from P1 to P2 and the equilibrium quantity reduces from Q1 to Q2. P2 to P0 represents the unit tax. The price increase from P1 to P2 will be the incidence of tax on the buyers. P1 to P0 represents the burden of taxation (per unit) on the sellers. It should be noticed that in this case of elastic supply curve, the incidence of tax on the buyers is greater than that on the sellers.

Imposing a tax on commodity typically increase the price paid by the demanders and decrease the price received by the suppliers. This certainly represents a cost to demanders and suppliers, but from the real cost of the tax is the output that has been reduced. The lost output is the social cost of tax.

As per Figure 2, the concepts of consumer and producer surplus can be used to value the social cost of tax. The loss in consumer’s surplus is given by areas C+A and areas E+B represent the loss in producer surplus. Thus the total loss to the consumers and producers of the commodity is the areas C+A+E+B from which C+E is gained by the government as the tax revenue. The rest of the area A+B is known as the “Dead Weight Loss” of the tax or the excess burden of the tax. Basically, it is the lost value to the consumers and producers due to the reduction in sales of the commodity. Therefore the government does not get any revenue on the reduction in sales of the commodity. From the view point of society, it is a pure loss – dead weight loss.

Effect of Subsidies

Subsidies on production will shift the supply curve to the right until the vertical distance between the two supply curves is equal to the per unit subsidy. When other factors remain constant, this will decrease the price paid by the consumers and increase the price received by the producers. A subsidy will reduce the net cost of supplying a commodity. Therefore every quantity will be supplied at a lower price than earlier or in other words the quantity supplied at each price will be higher than earlier.

Figure 3 depicts the effect of subsidies.

Figure 3

(b) FV= $100000 r = 12% n = 5 PV= ?

PV = FV (1+r)-n

= 100000(1+0.12)-5

= $56742.69

(c)FVA= Rs. 500000 n= 15 r= 7% PMT =?

] *Payment

500000= [(1+0.07)15-1)/ 0.07]* Payment

Payment = Rs.19897.31 per annum



Imagine that the monopolist produced one more unit than Qm. The consumer surplus from that unit would be the difference between the demand curve and the price for that unit. Now imagine that the monopolist produced all of the additional units it would take to make the efficient quantity. The area of the blue triangle represents the additional surplus that consumers would get if the market were efficient. In other words, the area of the triangle is the loss in consumer surplus that results from the monopolist’s under-production. It is the true dead weight loss to the society. Therefore it is evident that monopoly is not good from the view point of the society as a whole.

A monopoly will be appropriate in a situation where there is a limited supply of a particular commodity which can be considered as a necessity good where it is required to be offered to the public at a reasonable price. In such situations the government will establish a monopoly. This will ensure that the particular product or service meets the required standards. E.g. Railway in Sri Lanka

Q.2.3. (a)

Labour per day

Output per day

Marginal Product

Variable cost

Average Cost

Marginal Cost






















































(c )



There are various types of economic systems practiced in the world. Such as Market economy, centrally – planed (Controlled) economy, Mixed economy. Each system has various types of advantages & disadvantages.

Demand & supply both determine the price of a good. Demand means willingness & capacity to pay. Supply is the quantity of goods that businesses willing to produce or sell. In demand & supply analysis the concept of equilibrium plays a major role. This is a concept which opposing dynamic forces cancel each other out.

When it comes to theory of the firm economic cost can be divided as, explicit, implicit, fixed & variable costs.

Explicit costs are the monitory payments it makes to those who supply labor services, material, fuel, transport service etc.

Firm’s implicit costs are the opportunity costs of using its employed resources. Fixed costs are not related directly to production rents, rates etc. they can change but not related to output. Variable costs that do change when we produce more & more.

There are 4 major types of market structures available. Each market consists of different features.

The market means any organization where buyers, sellers, & particular good are kept enclosed with each other.

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