UNIT 4

THEORY OF DEMAND AND SUPPLY

Text 1. The discoverers of the laws of Demand and Supply

The law of demand was discovered by A.A.Cournot (1801-1877), a professor of

mathematics at the University of Lyon, France, and he was who drew the first de-
mand curve in the 1830s.
The first practical application of demand theory, by Jules Dupuit (1804-1866), a
French engineer and economist, was the calculation of the benefits from building a
bridge and, given that, a bridge had been built of the correct toll to charge for its use.
Dionysius Lardner (1793-1859), an Irish professor of philosophy at the Universi-
ty of London, first worked out the laws of demand and supply and the connection be-
tween the costs of production and supply.
Dionysius Lardner showed railway companies how they could increase their
profits by cutting rates on long-distance business, where competition was fiercest. In
addition, how they could raise rates on short-haul business, where they had less to
fear from other suppliers.
Economists working for the major airline companies today to work out the
freight rates and passenger fares that will give the airline the largest possible profit
now use the principles first worked out by Lardner in the 1850s. Moreover, the rates
that result have a lot in common with those of the nineteenth century in principle.
Tasks for Independent Work
1. Read the text.
2. Agree or disagree:
a) It is very easy to calculate such rates knowing the law of demand and supply.
b) This principle of calculation is also applied to hotel charges for accommoda-
tion.
c) This principle is applied in very many cases.

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 Text 2. Demand and Supply Curves

Demand is the total quantity of a good or service which buyers are prepared to
purchase at a given price. Demand is always taken to be effective demand, backed by
the ability to pay, and not just based on want or need.
Demand curve is a line showing the relationship between the price of a product
or factor of production and the quantity demanded per period, as in the figure be low.

The typical market demand curve slopes downwards from left to right, indicating
that as the price falls more is demanded (that is, a movement along the existing de-
mand curve). Thus, if price falls from OP1 to PP2 the quantity demanded will in-
crease from OQ1 to OQ2.
The demand curve interacts with the supply curve to determine the equilibrium
market price. Supply curve is a line showing the relationship between the price of a
product or factor of production and the quantity supplied per time period. "Supply"
means the total quantity of a product or factor that firms or factor owners are pre-
pared to sell at a given price.

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 The above typical market supply curve for a product slopes upwards from left to
right, indicating that as the price rises more is supplied (that is, a movement along the
existing supply curve). Thus, if the price rises from OP1 to OP2 in the above figure,
the quantity supplied will increase from OQ1 to OQ2.
The figure shows the supply curve for the market as a whole. This curve is de-
rived by aggregating the individual supply curves of all of the producers of the goods,
which in turn are derived from the producers’ cost curves.

Tasks for the Students

1. Read the text.
2. Write out the definition of the terms:
demand;
demand curve;
supply;
supply curve;
3. Find the terms in the text:
...? – a line which shows the cost of production at different levels of output. The
curve might relate to average cost and marginal cost, or total cost.
...? – the inputs of resources used in production.
...? – the price at which the quantity demanded of a good is exactly equal to the
quantity supplied.

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 Text 3. Demand and Supply

Demand is the quantity of a good that buyers wish to buy at each price. Other
things equal, at low prices the demanded quantity is higher.
Supply is the quantity of a good that sellers wish to sell at each price. Other
things equal, when prices are high, the supplied quantity is high as well.
The market is in equilibrium when the price regulates the quantity supplied by
producers and the quantity demanded by consumers. When prices are not as high as
the equilibrium price, there is excess demand (shortage) raising the price. At prices
above the equilibrium price, there is excess supply (surplus) reducing the price.
There are some factors influencing demand for a good, such as the prices of oth-
er goods, consumer incomes and some others.
An increase in the price of a substitute good (or a decrease in the price of a com-
plement good) will raise at the same time the demanded quantity.
As consumer income is increased, demand for a normal good will also increase
but demand for an inferior good will decrease. A normal good is a good for which
demand increases when incomes rise. An inferior good is a good for which demand
falls when incomes rise.
As to supply, some factors are assumed as constant. Among them are technolo-
gy, the input price, as well as degree of government regulation. An improvement in
technology is as important for increasing the supplied quantity of a good as a reduc-
tion in input prices.
Government regulates demand and supply, imposing ceiling prices (maximum
prices) and floor prices (minimum prices) and adding its own demand to the demand
of the private sector.
Tasks for the Students

1. Read the text.

2. Answer the questions:

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 a) What is demand?
b) What is supply?
c) How are prices and the supplied and demanded quantities regulated by the
market?
d) Which factors influence demand?

Text 4. The Law of Demand

Demand is a key concept in both macroeconomics and microeconomics. In the

former, consumption is mainly a function of income; whereas in the latter, consump-
tion or demand is primarily, but not exclusively, a function of price. This analysis of
demand relates to microeconomic theory.
The theory of demand was mostly implicit in the writings of classical econo-
mists before the late nineteenth century. Current theory rests on the foundations laid
by Marshall (1890), Edgeworth (1881), and Pareto (1896). Marshall viewed demand
in a cardinal context, in which utility could be quantified. Most contemporary econ-
omists hold the approach taken by Edgeworth and Pareto, in which demand has only
ordinal characteristics and in which indifference or preferences become central to the
analysis.
Much economic analysis focuses on the relation between prices and quantities
demanded, the other variables being provisionally held constant. At the various prices
that could prevail in a market during some period of time, different quantities of a
good or service would be bought. Demand, then, is considered as a list of prices and
quantities, with one quantity for each possible price. With price on the vertical axis
and quantity on the horizontal axis, the demand curve slopes downward from left to
right, signifying that smaller quantities are bought at higher prices and larger quanti-
ties are bought at lower prices. The inverse relation between price and quantity is
usually called the law of demand. The law rests on two foundations. One is the theory
of the consumer, the logic of which shows that the consumer responds to lower prices
by buying more. The other foundation is empirical, with innumerable studies of de-

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mand in actual markets having demonstrated the existence of downward-sloping de-
mand curves.
Exceptions to the law of demand are the curiosa of theorists. The best-known
exception is the Giffen effect – a consumer buys more, not less, of a commodity at
higher prices when a negative income effect dominates over the substitution effect.
Another is the Vehien effect – some commodities are theoretically wanted solely
for their higher prices. The higher these prices are, the more the use of such commod-
ities fulfills the requirements of conspicuous consumption, and thus the stronger the
demand for them.

Tasks for Independent Work

1. Read the text.

1. Which is not true about the law of demand:
a) Consumption is the key concept of microeconomics.
b) Classical economists contributed a lot to the development of the theory of
demand.

Text 5. Law of Supply

Supply is a fundamental concept in both macro-and microeconomic analysis. In

macroeconomic theory, aggregate supply is mainly a function of expected sales to
consumers, businesses, and governments. In microanalysis, supply is mainly a func-
tion of prices and costs of production. A more complex view of the supply curve for a
commodity is its relation between quantities forthcoming and the possible current
prices of that commodity, its expected future prices, the prices of alternative goods
and services, the costs of the producer, and time.
Opportunity Costs

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 Incorporated in the supply curve of goods and services are opportunity costs.
Economists differ from accountants and from the Internal Revenue Service by includ-
ing both explicit and implicit costs, and opportunity costs. Implicit costs are mainly
business costs for wages, rents, and interest, whereas opportunity costs are the alter-
native costs of doing something else. A sole proprietor or the owners of businesses
should calculate what they forgo in wages, rents, and interest by not working for
someone else, or by renting the property they use to others, or by the possibility of
converting plant and equipment to alternative investment projects.

The Shape and Position of Supply Curves

In competitive markets the shape, or elasticity of supply, reflects time in the pro-
duction process, such as the immediate or market period, the short run, and the long
run. Elasticity of supply is the relative change in price that induces a relative change
in quantity supplied. The supply curve is a line on a diagram where the vertical axis
measures price and the horizontal axis is quantity. Usually the coefficient of elasticity
is positive, meaning that a rise in price induces an increase in the quantity supplied.
In the immediate or market period, a given moment, time is defined as too short to al-
low for a change in output. The supply curve is vertical, and the coefficient of elastic-
ity is zero.
The short run is defined as a period sufficiently long to permit the producer to
increase variable inputs, usually labor and materials, but not long enough to permit
changes in plant and equipment. The supply curve in the short run is less inelastic or
more elastic than in the immediate period. The long run permits sufficient time for
the-producer to increase plant and equipment. The longer the time, the greater the
elasticity of supply.
Changes in supply are shifts in the position of supply curves. An increase in
supply is a rightward movement of a supply curve, with more of the commodity be-
ing offered for sale at each possible price. Conversely, a decrease in supply shifts the
supply to the left. An increase in supply can occur because sellers expect lower prices

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in the future, or, as in the agricultural sector, because of bountiful crops. The reverse
is true of a decrease in supply. Over periods long enough for production processes to
change, improvements in technology and changes in input prices and productivities
are the main causes of changes in supply.

Tasks for Independent Work

1. Answer the questions:
a) What is the difference of the concept of supply in macro- and microeconomics?
b) What are opportunity costs?
c) What are implicit costs?

Text 6. Price Elasticity of Demand and Supply

There is a relationship between demand and price. How much demand for a
commodity is affected by a change in prince is called elasticity of demand. If a small
change of price results in a large change in demand, the demand is called elastic, if
the demand changes only a little, it is called inelastic. The price elasticity of demand
coefficient is negative as demand usually falls with a rise in price.
The price elasticity of supply shows the percentage change in the quantity sup-
plied resulting from a one-percent change in price.
As an increase in the quantity supplied is normally a result of a rise in price, the
coefficient is usually positive. We have a "0" (zero) elasticity when a price change re-
sults in no quantity supplied change. This is called a perfectly inelastic supply. Pro-
vided the elasticity varies between zero and one, the supply is called inelastic. With
coefficients greater than one, the supply is called elastic. The percentage change in
quantity is larger than the corresponding percentage change in price.
Agricultural supply is mostly inelastic because of the high proportion of such in-
puts as land, buildings, and machinery. The elasticity of agricultural commodities
(potatoes, wheat, fruits, eggs and milk) varies greatly. Because of increasing speciali-

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zation of production, of farm animal products, in particular, elasticity for such com-
modities as pigs or broilers have decreased in recent years.

Tasks for the Students

1. Read the text.
2. Answer the questions:
a) Which demand is called elastic?
b) In what units is elasticity of supply shown?
c) Why is the price elasticity of demand coefficient negative and the corre-
sponding coefficient for supply positive?
d) What supply is called inelastic?
Text 7. Labour Market

Labour market is a factor market that provides for an exchange of work for wag-
es. Individual workers or trade unions bargaining on a collective basis represent the
supply side of the market. Firms who are requiring labour as a factor input in the pro-
duction process represent the demand side of the market.
The determination of wage rates in labour markets depends upon the supply of,
and demands for, labour. The supply of labour depends upon the size of the popula-
tion, school leaving and retirement ages, geographic mobility, skills, training and ex-
perience, entry barriers to professions and jobs and many other things.
The demand for labour is influenced by, for example, the size and strength of
demand-for the goods and services produced by workers, the proportion of total pro-
duction costs accounted for by wages, and the degree of substitutability of capital for
labour in the production process.

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 Because of these factors, the labour market cannot be regarded as a single ho-
mogeneous market but must be seen as a number of separate labour markets each
with its own particular characteristics. For example, as the above figure shows, a
group of workers such as surgeons, whose skills are in limited supply and the demand
for whose services is high, will receive a high wage rate; by contrast, office cleaners,
who require little or no training or skill, are usually in plentiful supply in relation to
the demand for their services, so their wage rates are comparatively low. The wage
differential between these two groups is Ws-Wo.

Tasks for Independent Work

1. Read the text

UNIT 5
MACROECONOMICS PROBLEMS

Text 1. GDP and GNP

Gross Domestic Product (GDP) is the total money value of all final goods and
services produced in an economy over a one-year period. Gross domestic product can
be measured in three ways:
(a) the sum of the value added by each industry in producing the year's output

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(the output method);
(b) the sum of factor incomes received from producing the year's output (the in-
come method);
(c) the sum of expenditures on the year's domestic output of goods and services
(the expenditure method).
Gross National Product (GNP) is the total money value of all final goods and
services produced in an economy over a one-year period plus net property income
from abroad (interest, rent, dividends and profits). GNP is an important measure of a
country's general economic prosperity. Here is a comparison of countries' general
economic well-being for one of the recent years:
Developed countries GNP (in US$ millions)
UK 975,200
Germany 1,488,200
Japan 2,942,900
USA 5,392,300
Developing countries
Somalia 890
Mozambique 1,300
Nepal 2,900
India 254,500

Tasks for the Students

1. Answer the following questions:

a) Which country had the highest GNP that year?
b) Which of them ran the lowest GNP then?
c) Is the GNP of a country always higher than the GDP?
d) Which of the three methods is the most often applied to measure GDP, as far
as you know?

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 Text 2. Government's Role in the Economy

While consumers and producers obviously make most decisions that mould the
economy, government's activities have at least four powerful effects on the US econ-
omy.
Direct services
Each level of government provides direct services. The postal system, for exam-
ple, is a federal system serving the nation, as is the large military establishment. By
contrast, state, county or city governments primarily pay for the public education sys-
tems.
Regulation and control
The government regulates and controls private enterprise in many ways in order
to ensure that business serves the best interests of the people as a whole. Regulation
is usually considered necessary in areas where private enterprise has been granted a
monopoly, such as in electric or local telephone service, or in any other areas where
there is limited competition, as with the railroads. Public policy permits such compa-
nies to make reasonable profits, but limits their ability to raise prices "unfairly", be-
cause the public depends on their services.

Stabilization and growth

Branches of government, including Congress and such entities as the Federal

Reserve System attempt to control the extremes of boom and bust, and of inflation
and depression, by adjusting tax rates, the money supply and the use of credit. They
can also affect the economy by changing the amount of public spending by the gov-
ernment itself. Normally, the aim is a balanced federal budget.

Direct assistance

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 The government provides many kinds of help to businesses and individuals. For
example, tariffs permit certain products to remain relatively free from foreign compe-
tition; imports are sometimes taxed or limited by volume so that American products
can better compete with foreign goods. Government also provides aid to farmers by
subsidizing prices they receive for their crops.
In quite a different area, government supports individuals who cannot adequately
care for themselves by making grants to low-income parents with dependent children,
by providing medical care for the aged and indigent, and through social insurance
programs that assist the unemployed and retirees. Government also supplies relief for
the poor and help for the disabled.

Tasks for the Students

1. Read the text

Text 3. Monetary System and Monetary Policies

Today every country has a Central Bank. It acts as a lender to commercial banks
and its acts as a banker to the government. It takes responsibility for the funding of
the government’s budget deficit and the control of the money supply, which includes
currency outside the banking system Thus, money supply is partly a liability of the
Central Bank (currency in private circulation) and partly a liability of commercial
banks (chequing accounts of the general public).
The Central Bank controls the quantity of currency in private circulation and the
one held by the banks through purchases and sales of government securities. In addi-
tion, the Central Bank can impose reserve requirements on commercial banks, that is,
it can impose the minimum ratio of cash reserves to deposits that banks must hold.
The demand for money is a demand for real money, that is, nominal money deflation
by the price level to undertake a given quantity of transactions. Hence, when the price
level doubles, other things equal, we expect the demand for nominal balances to dou-

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ble, leaving the demand for real money balances unaltered. People want money be-
cause of its purchasing power in terms of the goods it will buy.
The quantity of real balances demanded falls as the interest rate rises. On the
other hand, when interest-bearing assets are risky, people prefer to hold some of the
safe asset, money. When there is no immediate need to make transactions, this leads
to a demand for holding interest-bearing time deposits rather than non-interest-
bearing sight deposits. The demand for time deposits will be larger with an increase
in the total wealth to be invested.
Interest rates are a tool to regulate the market for bonds. Being sold and pur-
chased by the Central Bank, bonds depend on the latter for their supply and price.
Interest rates affect household wealth and consumption. Consumption is believed
to depend both on interest rates and on taxes. Higher interest rates reduce consumer
demand.
There also exists a close relationship between interest rates and incomes. With a
given money supply, higher income must be accompanied by higher interest rates to
keep money demand unchanged.
A given income level can be maintained by an easy monetary policy and a tight
fiscal policy or by the converse.

Tasks for the Students

1. Read the text.
2. Answer the questions:
a) How does the ratio between the amounts of money holdings and interesting
deposits vary?
b) What are the responsibilities of the Central Bank?
c) How can the Central Bank regulate money supply and money market?
d) What is monetary policy?

Text 4. Inflation

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 Inflation is a steady rise in the average price and wage level. The rise in wages
being high enough to raise costs of production, prices grow further resulting in a
higher rate of inflation and, finally, in an inflationary spiral. Periods when inflation
rates are very large are referred to as hyperinflation.
The causes of inflation are rather complicated, and there is a number of theories
explaining them. Monetarists, such as Milton Friedman, say that inflation is caused
by too rapid increase in money supply and the corresponding excess demand for
goods.
Therefore, monetarists consider due government control of money supply to be
able to restrict inflation rates. They also believe the high rate of unemployment to be
likely to restrain claims for higher wages. People having jobs accept the wages they
are being paid, the inflationary spiral being kept under control. This situation also ac-
counts for rather slow increase in aggregate demand.
On the other hand, Keynesians, that is, economists following the theory of John
M. Keynes, suppose inflation to be due to processes occurring in money circulation.
They say that low inflation and unemployment rates can be ensured by adopting a
tight incomes policy.
Incomes policies, though, monetarists argue, may temporarily speedup the tran-
sition to a lower inflation rate but they are unlikely to succeed in the end.
The costs of inflation depend on whether it was anticipated and on the extent to
which the economy's institutions allow complete inflation adjustment.
The longer inflation continues, the more the economy learns to live with it. In-
dexation is a means to reduce the costs of some inflation effects. Indexed wages or
loans mean that the amount to be paid or repaid will rise with the price level. Indexa-
tion has already been introduced in countries that had to live with inflation rates of 30
or 40 percent foe years. Moreover, the more countries adjust their economies to cope
with inflation, the closer they come to hyperinflation. Indexation means that high
rates of inflation are much more likely to continue and even to increase.

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 Tasks for Independent Work

1. Read the text.

2. Answer the questions:
a) Which two schools of thought are mentioned in the text? What is the differ-
ence between them?
b) What do monetarists think to be effective in restraining inflation rates?
c) Why is aggregate demand low?
Text 5. Fiscal Policy

Fiscal policy in an instrument of demand management, which is used to influ-

ence the level of economic activity in an economy through the control of taxation and
government expenditure.
The government can use a number of taxation measures to control aggregate
demand or spending: direct taxes on individuals (income tax) and companies (corpo-
ration tax) can be increased if spending has to be reduced, for example, to control in-
flation. Spending can also be reduced by increasing indirect taxes: an increase in the
VAT on all products or excise duties on particular products such as petrol and ciga-
rettes will result in lower purchasing power.
The government can change its own expenditure to affect spending levels as
well: a cut in purchases of products or capital investment by the government can re-
duce total spending in the economy.
If the government is to increase spending, it creates a budget deficit, reducing
taxation and increasing its expenditure.
A decrease in government spending and an increase in taxes (a withdrawal from
the circular flow of national income) reduce aggregate demand to avoid (избегать)
inflation. By contrast, an increase in government spending and/or decrease in taxes –
an injection (денежное вливание) into the circular flow of national income stimu-
lates aggregate demand and creates additional jobs to avoid unemployment.

16
 In practice, however, a number of problems can reduce the effectiveness of fiscal
policy. Taxation rate changes, particularly changes in income tax, take time to make;
considerable proportion of government expenditure on, for example schools, roads,
hospitals and defense cannot easily be changed without lengthy political lobbying.
Tasks for the Students
1. Read the text.
Text 6. Taxes and Public Spending

In most economies, government revenues come mainly from direct taxes on per-
sonal incomes and company profits as well as indirect taxes levied on purchase of
goods and services such as value added tax (VAT) and sales tax. Since state provision
of retirement pensions is included in government expenditure, pension contributions
to state-run social security funds are included in revenue, too. Some small component
of government spending is financed through government borrowing.
Government spending comprises spending on goods und services and transfer
payments.
A transfer is a payment, usually by the government for which no corresponding
service is provided in return. Examples are social security, retirement pensions, and
unemployment benefits and, in some countries, food stamps.
In most countries, there are campaigns for cutting government spending. The
reason for it is that high levels of government spending are believed to exhaust re-
sources that can used productively in the private sector Lower incentives to work are
also believed to result from social security payments and unemployment benefits
Whereas spending on goods and services directly exhausts resources that can be
used elsewhere, transfer payments do not reduce society’s resources. They transfer
purchasing power from one group of consumers, those paying taxes, to another group
of consumers, those receiving transfer payments and subsidies.
Another reason for reducing government spending is to make room for tax cuts.

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 Government intervention manifests itself in tax policy, which is different in dif-
ferent countries. In the United Kingdom, the government takes nearly 40 percent of
national income taxes. Some governments take a larger share, others a smaller share.
The most widely used progressive tax structure is the one in which the average
tax rate rises with a person's income level. Because of progressive tax and transfer
system most is taken from the rich and most is given to the poor.
Rising tax rates initially increase tax revenue but eventually result in such large
falls in the equilibrium quantity of the taxed commodity or activity that revenue starts
to fall again. High tax rates are said to reduce the incentive to work. If half of all we
earn goes to the government, we may prefer to work fewer hours a week and spend
more time in the garden or watching television.
Cuts in tax rates will usually reduce the deadweight tax burden and reduce the
amount of taxes raised but might increase eventual revenue.
If governments wish to reduce the deadweight tax burden and balance spending
and revenue, they are supposed to reduce government spending in order to cut taxes.

Tasks for the Students

1. Read the text.
2. Answer the questions:
a) How is government spending financed?
b) What do governments pay for?
c) What are the three reasons for cutting government spending?

UNIT 6
MICROECONOMICS. THE BASIC OF ENTERPRISE

Text 1. Types of Businesses in the UK and the USA

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 A business may be privately owned in three different forms. These forms are the
sole proprietorship, the partnership and the corporation. The sole proprietorship is the
most common in many western countries. For example, more than 80 per cent of all
businesses in the United States are sole proprietorships.
However, it is evident that sole proprietorships do not do the greatest volume of
business. They account for only 16 percent of all business receipts, for example, in
America. What kind of business is likely to be a sole proprietorship? First, service in-
dustries such as beauty shops, different repair shops, restaurants.
Most businesses in the United Kingdom operate in one of the following ways:
– Sole trader;
– Partnership;
– Limited Liability Company;
– Branch of a foreign company.
The sole trader is the oldest form of business. There are many one-man owners,
for example: a farmer, doctor, solicitor, estate agent, garage man, jobber, builder,
hairdresser etc.
The partnership is a firm where there are a few partners. They are firms of solic-
itors, architects, auditors, management consultants etc. The names of all the partners
of the firm are printed on the stationery of a partnership.
The most common type of company in the United Kingdom is the Limited liabil-
ity Company. At the end of the name of such a company, the word Ltd. is used. For
example, Wilson and Son Ltd.
Many of such companies are joint-stock companies owned by shareholders.
Limited liability companies are divided into public and private ones. Only public
companies may offer shares to the public at the stock exchange. The names of such
companies end p. l. c., which stands for public limited company. For instance, John
and Michael p. l. c.
Private limited companies may not offer shares to the public. The names of such
companies end simply in Ltd.

19
 A branch of a foreign company is a part of a company incorporated outside
Great Britain but acting under the law of the U.K. Usually these companies act in the
U.K. under their normal foreign names.
Businesses in the U.S.A. may be organized in one of the following forms:
– Individual business;
– General partnership;
– Limited partnership;
– Corporation;
– Alien Corporation.
One person owns an individual business.
A general partnership has several owners. They all are liable for debts and they
share in the profits.
A limited partnership has at least one general owner and one or more other
owners. They have only a limited investment and a limited liability.
Persons, called stockholders, own a corporation. The stockholders usually have
certificates showing the number of shares which they own. The stockholders elect a
director or directors to operate the corporation. Most corporations are closed corpora-
tions, with only a few stockholders. Many stockholders who buy and sell their shares
at will own other corporations. Usually they have little interest in management of the
corporations.
Alien corporations are corporations of foreign countries.
All the corporations are to receive their charters from the state authorities. The
charters state all the powers of the corporation. Many corporations try to receive their
charters from the authorities of the State of Delaware, though they operate in other
shares. They prefer the State of Delaware because the laws are liberal there and the
taxation is rather low. Such corporations, which receive their charters from an out-
side, are called foreign corporations.
All the corporations require a certificate to do business in the state where they
prefer to operate.

20
 Tasks for Independent Work

1. Answer the following questions:

a) What is the most common type of company in the USA?
b) Are all limited liability companies joint-stock ones?

Text 2. Partnership

A partnership is an association of two or more persons to carry on a business for

profit. When the owners of the partnership have unlimited liability they are called
general partners. If partners have limited liability, they are "limited partners". There
may be a silent partner as well – a person who is known to the public as a member of
the firm but without authority in management. The reverse of the silent partner is the
secret partner – a person who takes part in management but who is not known to the
public.
Any business may have the form of the partnership, for example, in such profes-
sional fields as medicine, law, accounting, insurance and stock-brokerage. Limited
partnerships are a common form of ownership in real estate, oil prospecting, quarry-
ing industries, etc.
Partnerships have more advantages than sole proprietorships if one-needs a big
capital or diversified management. Like sole proprietorship, they are easy to form and
often get tax benefits from the government.
Partnerships have certain disadvantages too. One is unlimited liability. It means
that each partner is responsible for all debts and is legally responsible for the whole
business. Another disadvantage is that partners may disagree with each other.

Tasks for the Students

1. Answer the questions:

21
 a) What is the difference between a general partnership and a limited partner-
ship?
b) Is there any difference between a silent partner and a secret partner?
c) In what professional fields are the partnerships found?

Text 3. Corporations

A business corporation is an institution established for the purpose making prof-

it. Individuals operate it. Their shares of ownership represented by stick certificates.
A person who owns a stock certificate r, called a stockholder.
There are several advantages of the corporate form of ownership. The first is the
ability to attract financial resources. The next advantage is 11 corporation attracts a
large amount of capital it can invest it in plants, equipment and research. And the
third advantage is that a corporation can oil u higher salaries and thus attract talented
managers and specialists.
The privately owned business corporation is one type of corporal ion. There are
some other types too. Educational, religious, charitable institute can also incorporate.
In some western countries, cities, states, federal government and special agencies can
establish governmental corporations. Governmental corporations are state universi-
ties, state hospitals. Governmental corporations are non-profit as a rule usually they
do not issue stock certificates.

Tasks for the Students

1. Answer the questions:
a) Who can own a corporation?
b) Is a corporation necessarily larger than a sole proprietorship?
c) What are the advantages of the corporate form of ownership?
d) What can you say about the disadvantages of the corporate form of owner-
ship?

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 Text 4. Accounting

Accounting shows a financial picture of the firm. An accounting department rec-

ords and measures the activity of a business. It reports on the effects of the transac-
tions on the firms’ financial condition. Accounting records give a very important da-
ta. Management, stockholders, creditors, independent analysts, banks and government
use it.
Most businesses prepare regularly the two types of records. That is the income
statement and balance sheet. These statements show how money was received and
spent by the company.
One major tool for the analysis of accounting records is ratio analysis. A ratio
analysis is the relationship of two figures. In finance, we operate with three main cat-
egories of ratios. One ratio deals with profitability, for example, the Return on In-
vestment Ratio. It is used as a measure of a firms operating efficiency.
The second set of ratios deals with assets and liabilities. It helps a company to
evaluate its current financial position. The third set of ratios deals with the overall fi-
nancial structure of the company. It analyses the value of ownership of the firm.

Tasks for Independent Work

1. Answer the questions:
a) What is the purpose of accounting?
b) Who uses the data provided by accounting firms?
c) What are the two types of records, which most businesses prepare?
d) What can you know analyzing the income statement and balance sheet of a
company?

Text 5. The Balance Sheet

Financial statements are the final product of the accounting process. They pro-
vide information on the financial condition of a company. The balance sheet, one

23
type of financial statement, provides a summary of what a company owns and what it
owes on one particular day.
Assets represent everything of value that is owned by a business, such as proper-
ty, equipment, and accounts receivable. On the other hand, liabilities are the debts
owed by a company – for example, to suppliers and banks. If liabilities are subtracted
from assets (assets-liabilities), the amount remaining is the owners' share of a busi-
ness. This is known as owners' or stockholders' equity.
One key to understanding the accounting transactions of a business is to under-
stand the relationship of its assets, liabilities, and owners' equity. This is often repre-
sented by the fundamental accounting equation: assets equal liabilities plus owners'
equity.
ASSETS = LIABILITIES + OWNERS’ EQUITY

These three factors are expressed in monetary terms and therefore are limited to
items that can be given a monetary value. The accounting equation always remains in
balance; in other words, one side must equal the other.
The balance sheet expands the accounting equation by providing more infor-
mation about the assets, liabilities, and owners equity of a company at a specific time
(for example, on December 31, 1996). It is made up of two parts. The fist part lists
the company assets, and the second part details liabilities and owners' equity. Assets
are divided into current and fixed assets. Cash, accounts receivable, and inventories
are all current assets. Property, buildings, and equipment make up the fixed assets of
a company. The liabilities section of the balance sheet is often divided into current li-
abilities (such as accounts payable and income taxes payable) and long-term liabili-
ties (such as bonds and long-term notes).
The balance sheet provides a financial picture of a company on a particular date,
and for this reason, it is useful in two important areas. Internally, the balance sheet
provides managers with financial information for company decision-making. Exter-

24
nally, it gives potential investors data for evaluation of the company’s financial posi-
tion.
Tasks for the Students

1. Read the text.

Text 6. Classification of Costs

Costs as we all know are usually measured in monetary terms and include such
items as wages, rent, rates, interest, and the amounts paid for raw materials, fuel,
power, transport and so on.
Just as some inputs are fixed and others variable, so some costs are fixed and
others variable.
Fixed Costs

These are costs, which do not vary as output varies. They are obviously the costs
associated with the fixed factors of production, and include such items as rent, rates,
insurance, interest on loans, and depreciation.
A major item in fixed costs, especially in capital – intensive industries, is the
item known as depreciation. It may seem rather illogical to classify depreciation
charges, as a fixed cost for many people will think that the rate of depreciation of a
capital asset is directly related to the extent to which it is used (i.e. output). In fact,
the life of capital assets tends to be measured in economic rather than technical terms.
Machinery depreciates even when even not in use and, even more important, it be-
comes obsolete. It is normal practice, therefore, to fix an annual depreciation charge,
which will write off the cost of equipment over some estimated working lifetime.
There are many ways of doing this, but the simplest is to make an annual charge
equal to a fixed proportion of the total value. If a machine costs 20 000 pounds and

25
has an expected life of 5 years, then 4 000 pounds per annum will be added to costs
and placed in a depreciation fund to cover the expenses of renewal.
Fixed costs (sometimes described as overhead or indirect costs) are not influ-
enced by changes in output. Whether a firm is working at full capacity or half capaci-
ty the items of costs mentioned above will be unaffected. Thus, when a super-tanker
is lying empty in port, a Jumbo-jet is standing in the hanger, or your new car is
locked away in the garage, costs are still being incurred.
Variable Costs

These are the costs, which are related directly to output. The most obvious items
of variable costs are the wages of labour, the costs of raw materials, and fuel and
power. Variable costs are often described as direct or prime costs.

Total Costs

Total costs represent the sum of fixed and variable costs. When output is zero,
total costs will be equal to fixed costs since variable costs will be zero. When produc-
tion commences, total costs will begin rise as production increases, because there
must be some increase in variable costs as output expands. What is important, how-
ever, is the rate at which total costs increase; if they are rising at a slower rate than
output, average costs must be falling.

Average Cost

Average cost (or cost per unit) is equal to total Costs/Output. When output is
small, average cost will be spread over a small number of units of output. As output
increases, average cost will tend to fall as each unit is 'carrying' a smaller element of
fixed cost. Average cost will also fall because, for a time, there will be increasing re-
turns to the variable factors as more of them are employed and more specialized

26
methods adopted. There will come a point, however, when diminishing returns are
encountered and average cost begins to rise.

Marginal Cost

The economist is interested in marginal quantities because most economic deci-

sions involve changes in some existing situation. Marginal cost tells us what happens
to total costs when we vary output by some small amount. More precisely, marginal
cost is the extent to which total costs change when one unit changes output.
Marginal cost — Total cost of N units — Total cost of (N — 1) units.
Since marginal cost is a measurement of changes in total cost it is obviously in-
fluenced by variable costs but not by fixed costs.

Summary

1. Total cost = Fixed costs + Variable cost

2. Average cost = Total costs / Total output
3. Marginal cost = Change in total cost when output is varied by one unit.

Tasks for the Students

1. Read the text.

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