ASSIGNMENT

It is stated that there are three fundamental questions

of economic organization- what, how and for whom. Based

on this statement,

a.Explain in your own words the economic meaning of

each of the above questions.

b.Graphically demonstrate and explain how the market

system solves those questions.

c.Where would you locate the leather goods industry

of Bangladesh in the above graph and explain its

role in addressing the above questions.

Economic Meaning of the Three Fundamental Questions of

Economic Organization

Every society must have a way of determining what

commodities are produced, how these goods are made, and

for whom they are produced? Indeed, these three

fundamental questions of economic organization what,

how, and for whom are as crucial today as they were at

the dawn of human civilization.

These three problems are as follows:

1.Societies have to determine the best combination of

goods and services to meet their needs. Each and

every society must determine what products and

services, and what volume of each, to produce and

when they will produce. A society has various needs

and wants. But the resource is always limited. So

to produce one, it has to sacrifice another. Also,

the quantity is important, the production of a

commodity may low down another commodity’s

production. So, it is a problem, that using the

scarce resources what to produce and in what

quantities. The most obvious needs of its member to

produce or to make the best use of the resources is

a must consideration of a society.

2.‘How to produce’ means which combination of

resources is to be used for the production-of goods

and which technology is to be made use of in

production. After deciding what goods and services

are to be produced and in what quantities, society

must then decide how these goods shall be produced.

There are various alternative methods of producing

a good and the economy has to choose among them.

For example, cloth can be produced either with

automatic looms or with power looms or with

handlooms. Fields can be irrigated by shallow tube

well or by deep tube well. Therefore, the economy

has to decide whether cloth is to be produced by

handlooms or power looms or automatic looms.

Similarly, it has to decide if the irrigation has

to be done by shallow tube well or by deep tube

well. Obviously, it is a problem of the choice of

production techniques.

So, it is the technique that is essential to

produce the commodity in the best way. The best way

depends on the cost of production, resources use

etc. Each society has to find out ways to produce a

commodity in low cost of production. As the

resources are limited, if these are used in much

amount to produce a commodity, it will become less

to produce another. So, the economy will have to

find out the best way to produce a commodity which

will decrease the cost of production, will use less

resources, electricity, man power etc.

3.The third of the three questions of allocation is:

Who receives the goods and services produced with

society's resources? All goods given to benevolent

economics instructors? Should goods be distributed

according to shoe size? What if people buy goods

with their incomes? Now, there is a thought. But,

what about people who have no income? With limited

resources, the production of goods is also limited.

With limited goods, everyone cannot have

everything. Society has to decide who gets what.

For whom to produce is a problem of distribution?

No society can produce a commodity as much as its

peoples need. So, they will have to find ways to

distribute the production. Though they cannot

satisfy all, but at least they will have to try to

distribute. This also has to be noticed, that all

kind of goods are not for all. Except the

fundamental goods or necessities, other goods get

targets to whom they will be distributed.

Here we are asking how the total resources of a

society should be shared among its people. It means

that, how the total income in a society distribute.

Should it involve an equal share for all, or should

it, perhaps, be based on people’s needs?

Alternatively, should it be based on the

contribution of each member of society? If so, how

should this contribution be measured—in numbers of

hours, or in skill level, or in some other way?

Further, how should we define what constitutes an

important skill and which ones are less important?

Graphically demonstrate and explain how the market

system solves these questions.

1.Determination of What goods and services will be

produced by the daily taka votes of buyers by their

daily purchase decisions. The money that they pay

into businesses cash registers ultimately provides

the payrolls, rents, and dividends that consumers,

as employees, receive as income. Firms are driven

by the desire of maximization profit being net

profit or the difference between total sales and

total cost.

Price mechanism is used to solve that problem which

includes thinking about supply and demand, and the

decisions which are taken get based on it. Those

commodities are produced for consumers who are

ready to pay and the payment will cover at least

the cost of production. Then the quantity of the

good is selected both on the resources and the

demand.

2.How things are produced is determined by the

different producer’s competition. To keep minimum

cost by adopting the most efficient production

methods is the best way for producers to meet price

competition and maximize profits. Incremental

change and consists of little more than tinkering

with the machinery or adjusting the input mix to

gain a cost advantage that can be very important in

competitive market. At other times there are major

shifts in technology.

The goods are produced by keeping many things in

mind. Before going to factory, the demand of the

good and the possible amount which may be paid gets

the importance. The production cost is also very

important. For good business, it is necessary to

keep the production cost low. By price mechanism,

the production of goods is a matter related mainly

with the production cost.

3.For whom things are produced who is consuming, and

how much depends, in large part, on the supply and

demand in the markets for factors of production.

Factor markets determine wage rates, land rents,

interest rates, and profits such prices are called

factor prices. The same person may receive wages

from a job, dividends from stocks, interest from a

certificate of deposit, and even rent from a piece

of property. By adding up all the revenues from

factors we can calculate peoples market incomes.

The distribution of income among the population is

thus determined by the amount of factors (person-

hours, acres, etc.) owned and prices of the factors

(wage rates, land rents, etc.).

One can produce goods for anyone he wants. That

means one can target a particular section of

society to sell his products. That means, the buyer

will be the one who will be able and willing to pay

for.

Now here we see how decision are made by householdsector and firm sector.

1.Households are the owners of factors of productionand consumer of goods and services.

2.Firms are the producer of goods and services andsell them to the households.

In order to make our analysis simple, we take some assumptions:

Household sector supplies factor of production onlyto firms and the firms hire factor of productiononly from households.

Firms produce goods and services and sell theirentire output to the households.

Households receive factor income for their servicesand spend the entire amount on consumption of goodsand services.

The figure shows flow of factor of production fromhouseholds to firms and corresponding flow of goods and

services from firms to households. The figure alsoshows flow of factor payments from firms to householdsand the corresponding flow of consumption expenditurefrom households to firms.

FIG: How the Market System Solve the Trio of EconomicProblem.

It must be noted that entire amount of money, which ispaid by firms as factor payments, is paid back by thefactor owners to the firms. So, there is a circular andcontinuous flow of money income. In the circular flowof income, production generates factor income, which isconverted into expenditure. This flow of incomecontinues as production is a continuous activity due tonever-ending human wants. It makes the flow of incomecircular.

Households Firms

Product

FactorMarket

Demand

Supply Demand

Ownership of Inputs

Supply

Where would you locate the leather goods industry of

Bangladesh in the above graph and explain its role in

addressing the above questions.

Leather Goods Industry in Bangladesh

Leather goods industry developed on a large-scale basis

from the 1970s in Bangladesh. About 95% of leather and

leather products of Bangladesh are exported, in the

form of crushed leather, finished leather, leather

garments, and footwear. Most leather goods export to

Germany, Italy, France, Netherlands, Spain, Russia,

Brazil, Japan, China, Singapore and Taiwan. More than

100 modern tannery units are now in operation in the

industry. These tannery units are located mostly in the

Hazaribagh area of Dhaka city. Some reputed tanneries

of Bangladesh are Dhaka Leather, Apex Tannery, Lexco,

Karim Lather, Samata Tannery, Bay Tannery, Lexco,

Reliance, Kalam Brothers, AL-Madina, Millat, Progoti,

Anwar, Amin, Crescent Kid Leather etc. In 2009, the

amount of leather products exports rose to US$ 288

million. The country's share in the world leather

market is 2%. The export of finished products such as

shoes, slippers, leather jackets, hand gloves, bags,

purses, wallets, and belts also earn a sizeable amount

of foreign exchange.

Locate Leather Goods Industry in the above Graph

About 40% of the supply of cowhide and goatskin comes

from animals slaughtered during the eid festival of

eid-ul azha. Again, daily consumption of meat,

festivals, Muslim weddings, and other celebrations

yield a significant supply of cowhide and goatskin. By

following the government decision to promote more value

addition in exports the tanning industry got a big

boost. The installed capacity for crust leather

production increased. At present, it is double the

domestic supply of raw hide and skin. Investments are

also made in installing new finishing capacity. The

trends encourage more tanneries to produce finished

leather on a commercial basis.

The main raw materials of the industry are cowhides and

goatskins. These cowhides and goatskins are supplied by

household though there has been some appreciable

improvement in animal husbandry and butcher's

techniques in Bangladesh. In recent years it may take

quite some time to reach the international standard.

Again, Bangladesh goatskins enjoy an excellent

reputation for quality and free from defects.

Now here we see how decision are made by two different

sectors, i.e. household sector and leather goods

industry.

1.Households are the owners of factors of production

like cowhides and goatskins and also consumers of

leather goods like finished leather products,

leather garments, footwear, etc.

2.Leather goods industry produce leather goods like

finished leather products, leather garments,

footwear, etc. and sell them to the households.

In order to make our analysis simple, we take some assumptions:

Household sector supplies factors of productionlike cowhides and goatskins to the leather goodsindustry and leather goods industry buy factors ofproduction from households.

Leather goods industry produce leather goods andsell their entire output to the households.

Households receive factor income for their supplies

factors of production and spend the entire amount

on consumption of leather goods.

FIG: How the Market System Solve the Trio of EconomicProblem for Leather Goods Industry of Bangladesh.

The figure shows flow of factor services from

households to leather goods industry and corresponding

flow of leather goods from leather goods industry to

Households Leather Goods

LeatherGoods

FactorMarket

Supply of cowhides and goatskins

Demand for cowhides and goatskins

Demand for leathergoods like finished leather products, leather

Ownership of RawMaterials

Supply of leather goods like finished leather products, leather

households.The figure also shows flow of factor

payments from leather goods industry to households and

the corresponding flow of consumption expenditure from

households to leather goods industry.

It must be noted that entire amount of money, which ispaid by leather goods industry as factor payments, ispaid back by the factor owners to the leather goodsindustry.

Role of Leather Goods Industry in Addressing the Three

Fundamental Questions

1.Like other industries Leather goods industries are

also driven by the desire of profit maximization

being net revenues or the difference between total

sales and total cost. The leather goods should

command positive prices in the market. Price

mechanism is a way that includes thinking about

supply and demand, and the decisions which are

taken get based on it. In this case, leather goods

are produced for consumers who are ready to pay and

the payment will cover the cost of production. The

quantity in which leather goods is to be produced

is set at that level where demand equals supply. If

quality produced is more or less, then there will

be dis-equilibrium in the market and price will

fluctuate. Hence, to maintain stable equilibrium

price it becomes necessary to make demand and

supply equal.

2.How leather goods are produced means ‘which

techniques are to be adopted’? It is determined by

the competition among leather goods industries. To

meet price competition and maximize profits is to

keep costs at a minimum by adopting the most

efficient methods of production is the best way for

leather goods industries. An incremental change and

consists of little more than tinkering with the

machinery or adjusting the input mix to gain a cost

advantage that can be very important in competitive

market of leather goods industry.

3.For whom leather goods are produced who is

consuming, and how much depends, in large part, on

the supply and demand in the markets for factors of

production and consumed only by people who have

more purchasing power. Raw materials of leather

goods industry determine wage rates, land rents,

interest rates, and profits. Price mechanism

determines the income of the workers of leather

goods industry, i.e.; purchasing power. The same

person may receive wages from a job, dividends from

stocks, interest from a certificate of deposit, and

even rent from a piece of property. We can

calculate consumers market incomes by summing up

all the incomes from factors. The distribution of

income among the population is thus determined by

the amount of factors (person-hours, acres, etc.)

owned and prices of the factors (wage rates, land

rents, etc.). Thus, when the price of leather goods

and every factor of production are determined, the

third problem will be solved.

Leather goods industry developed on a large-scale basis from the 1970s in Bangladesh.About 95% of leather and leather products of Bangladesh are exported, in the form ofcrushed leather, finished leather, leather garments, and footwear. Most leather goodsexport to Germany, Italy, France, Netherlands, Spain, Russia, Brazil, Japan, China,Singapore and Taiwan. More than 100 modern tannery units are now in operation in theindustry. These tannery units are located mostly in the Hazaribagh area of Dhaka city.Some reputed tanneries of Bangladesh are Dhaka Leather, Apex Tannery, Lexco, KarimLather, Samata Tannery, Bay Tannery, Lexco, Reliance, Kalam Brothers, AL-Madina,Millat, Progoti, Anwar, Amin, Crescent Kid Leather etc. In 2009, the amount ofleather products exports rose to US$ 288 million. The country's share in theworld leather market is 2%. The export of finished products such as shoes, slippers,leather jackets, hand gloves, bags, purses, wallets, and belts also earn a sizeableamount of foreign exchange.

Leather Industry  developed in Bangladesh on a large-scale basis from the1970s. About 95% of leather and leather products of Bangladesh are marketedabroad, mostly in the form of crushed leather, finished leather, leathergarments, and footwear. Most leather and leather goods go to Germany, Italy,France, Netherlands, Spain, Russia, Brazil, Japan, China, Singapore andTaiwan. Value addition in these exports averages 85% local and 15% foreign.About 100 modern TANNERY  units are now in operation in the industry. These arelocated mostly in the Hazaribagh area of DHAKA  city. In 1998, the sectorexported 178 million sq ft of leather and earned $160 million. Leatherexports in financial year 2007-08 accounted to US$ 284 million. In 2009, theamount of leather products exports rose to US$ 288 million. The country’sshare in the world leather market is 2%. The export of finished products suchas shoes, slippers, leather jackets, hand gloves, bags, purses, wallets, andbelts also earn a sizeable amount of foreign exchange. Bangladesh intends toincrease its range of leather products to penetrate new market segments.The country is endowed with luxurious vegetation encouraging a largelivestock population. The quality of the raw hide and skin is relativelygood, as barbed wire fencing that damage the skins of animals is not used inthe natural farms and fields. Black goatskin of KUSHTIA  is particularly noted

for its finegrain structure and tensile strength. The tradition of humanecare of domestic animals also contributes significantly to keeping theleather quality high. About 40% of the supply of hide and skin comes from animals slaughtered during the annual Muslim festival of EID-UL AZHA . In addition to daily consumption of meat, festivals, Muslim weddings, and other celebrations yield a substantial supply of hide and skin. The tanning industry got a big boost following the government decision to promote more value addition in exports. The installed capacity for crust leather production increased. At present, it is double the domestic supply of raw hide and skin. Investments are also made in installing new finishing capacity. The trends encourage more tanneries to produce finished leatheron a commercial basis.

 

  Leather Industry

 The government of Bangladesh provides a support to the leather industrythrough various steps, including monitoring the export market, evaluating theperformance of the sector by a permanent parliamentary committee, and liberalbank credit.During the 1990s, the export market for Bangladeshi leather grew at anaverage of 10-15% per annum. The average yearly exports accounted for $225million. Finegrain leather of Bangladesh enjoys preferential demand inWestern Europe and Japan. Low wage level and the ban on exporting wet blueleather helped the industry receive a new thrust in the country.Environmental concerns arising out of the high concentration of productionunits in a small area of the older part of Dhaka city are being addressedwith plans for their relocation outside the city.Leather goods producers in Bangladesh tend to be associated only withmanufacturing and exporting. They do not have much control over downstreamoperations. However, the success of a number of Bangladeshi firms inattracting such brand names as Puma, Pivolinos and Hugo Boss to source fromthis country proves that there is ample scope for the industry’s upwardmobility. [S M Mahfuzur Rahman ]

How to produce refers to the technique that is

necessary to produce the goods in the best way. The

best way depends on the production cost, use of

resources etc. Each society has to find out ways to

produce a commodity in low production cost and

resource saving. As the resources are limited, if

these are used in much amount to produce a

commodity, it will become less to produce another.

So the society or the economy will have to find out

the best way to produce a commodity which will low

down the production cost, will use less resources,

electricity, man power etc.

What is the most appropriate technology to employ?

We could reword this question by asking how we

should produce what we choose to produce. For

example, there is a variety of ways to produce 10

kilometres of highway. At one extreme, a labour-

intensive method of production could be used

involving rock crushed with hammers, roadbed carved

from the landscape with shovels, and material moved

in wheelbarrows. The capital equipment used in this

method is minimal. The labour used is enormous, and

the time it will take is considerable. At the other

extreme, a capital intensive method could be used

involving large earthmoving and tarmac-laying

machines, surveying equipment, and relatively

little but highly skilled labour. In between these

two extremes is a large variety of capital–labour

mixes that could also produce the new highway. The

answer to the question of how best to build the

highway involves, among other things, knowing the

costs of the various resources that might be used.

Remember that technology means the way the various

factors of production are combined to obtain

output. The most appropriate technology for a

society to use (the best way to combine resources)

depends, in general, on the opportunity costs of

these resources. Thus, in the example above, the

best way to build a highway depends on the

opportunity costs of labour and of capital as well

as the productivity of each factor.

The government of Bangladesh provides a support to the

leather industry through various steps, including

monitoring the export market, evaluating the

performance of the sector by a permanent parliamentary

committee, and liberal bank credit.

During the 1990s, the export market for Bangladeshi

leather grew at an average of 10 - 15% per annum. The

average yearly exports accounted for $225 million.

Finegrain leather of Bangladesh enjoys preferential

demand in Western Europe and Japan. Low wage level and

the ban on exporting wet blue leather helped the

industry receive a new thrust in the country.

Environmental concerns arising out of the high

concentration of production units in a small area of

the older part of Dhaka city are being addressed with

plans for their relocation outside the city.

Leather goods producers in Bangladesh tend to be

associated only with manufacturing and exporting. They

do not have much control over downstream operations.

However, the success of a number of Bangladeshi firms

in attracting such brand names as Puma, Pivolinos and

Hugo Boss to source from this country proves that there

is ample scope for the industry's upward mobility.

The leather industry in Bangladesh is well established

and is an important foreign exchange earner. Leather

production is based on the use of indigenous cowhides

and goatskins. Two opportunities for increasing export

value of the leather industry are: a) Increasing value

addition of the exported products through exporting

only finished leather and leather products; and B)

importing raw hides or skins if necessary, and

converting these to leather and leather products to

utilise the production capacity as much as possible.

The industry is entirely in the private sector which

has proved to be fully capable of handling it. At the

time of independence of Bangladesh the leather tanning

sector was already well established. About 30 tanneries

were abandoned by their non-Bengali owners and were

taken over by the government. Some of these were shut

down and the remainder was eventually transferred to

the Bangladesh Chemical Industries Corporation (BCIC).

Subsequently, the BCIC disinvested itself of all its

tanneries. A significant change in the orientation of

the leather industry occurred after 1982 with the

production of crushed and finished leather.

Industry Profile

With the exception of ten tanneries located in

Chittagong (and a few in other cities) the leather

tanning industry is concentrated at Hazaribagh area in

Dhaka. The industry, however, is in the process of

shifting to Savar (Nayarhat) in consideration of the

pollution in Dhaka city and lack of space for expansion

and modernisation. Most of the small tanneries are

family owned and operated as cottage type industries.

Many are established as proprietorship or partnership.

The larger tanneries are established as public or

private limited companies. Few tanneries have adequate

accounting practices and financial controls to define

their profitability and financial condition.

Marketing

At present leather sector accounts for 3-4 per cent of

total export earnings. Of the total 214 tanneries in

the country the majority are wet blue producers. Hardly

45 per cent of the total hides and skins is now

processed into finished leather -- 18 per cent low

grade for local consumption and 27 per cent for export

either in the form of finished leather or leather

products. Only a few tanneries are capable of producing

export quality finished leather for export. There are

about 15 export oriented shoe manufacturing units

located mostly in and around Dhaka city. There are more

than 2000 shoe making units supplying the domestic

market. Leather and leather products have the potential

to make a major contribution to export earnings and to

the economic development of the country.

In the leather processing industries there are three

categories of producers, large industries, small/medium

size industries and commercial exporters. The large

industries with bonded warehouses pay no import duties

or VAT. They are not eligible for duty draw-back and

have to operate on a virtual 100 per cent export basis.

There are 6-7 large producers, estimated to be 60 per

cent of the total country leather output. Small/medium

size industries pay import duties or VAT on chemical

and other items at differing rates. These industries

take duty draw-back at pre-fixed rates after each

consignment of export is executed. Commercial exporters

are engaged in the export of crust and finished leather

purely on a job-work basis. All their production inputs

are from local suppliers. They also claim duty draw-

back.

Leather footwear sector has two categories of

exporters, those with bonded warehouses and those with

no bonded warehouses. Those with bonded warehouses do

not pay import duties or VAT. They are not eligible for

duty draw-back but receive a cash incentive of 15 per

cent on the export (FOB) value of their products. Only

6-7 producers are responsible for 40 per cent of

footwear exports. The exporters without bonded

warehouse pay all import duties and VAT on duty paid

values. They are eligible for duty draw-back and

receive 15 per cent cash incentive on the export (FOB)

values.

Processing and Products

Leather processing and leather manufacturing in

Bangladesh is almost entirely export-oriented. 95-98

per cent of the leather produced is for export in one

form or the other because of the limited local

consumption. The essential import of many materials

such as chemicals, equipment, accessories, is subject

to delays and cumbersome custom duties and procedures.

Considering the very bright growth potential, the

government may seriously consider allowing all

necessary imports on a duty-free or on a flat rate

basis.

At present the larger producers operate well below

capacity. It is reported that misuse of the bonded

warehouse system is providing some illegal and

inappropriate income. As bonded warehouses are costly

to implement (involve more bureaucracy and provide

opportunity for corruption and additional costs)

majority of tanneries do not favour the system. Though

small units are more active their production costs are

distorted by leakage of chemical from the bonded

warehouses of the larger units. They also have to deal

with bureaucracy, unofficial costs and delays due to

importing and claiming draw-back.

To obtain maximum added value from leather exports a

radical change in the import controls has to be brought

in. The sector has good potential for growth but it

needs the right conditions for achieving full

potential.

The leather goods should command positive prices in themarket.

i) What to Produce:

Let us consider the first question: ‘which commodities are to beproduced and in what quantities? The commodities which do not

command positive prices in the market would not be produced. Therefore only those commodities with positive prices are to be produced and in such a way that would clear the markets.

The quantity in which a commodity is to be produced is set at that level where demand equals supply. If quality produced is more or less, then there will be dis equilibrium in the market and price will fluctuate. Hence, to maintain stable equilibrium price it becomes necessary to make demand and supply equal. Thisrule is applicable for each commodity. In this way, first central problem is solved.

(ii) How to Produce:

In context of this it is: ‘which techniques are to be adopted’? Technology means the correct proportion in which the different factors of production are to be employed. There are two types oftechniques. A labour-intensive technique would employ relativelymore labour and less capital. On the other hand, capital- intensive technique means more capital and less labour.

The choice of technique depends on the prices of the factors of production. That is, if labour is cheap and capital is expensive, a labour-intensive technique would be considered and vice-versa. The prices of labour and capital are determined by the demand for and supply of labour and capital respectively .Inthis way, the second problem will be solved.

(iii) For Whom to Produce:

The solution of this problem is very simple commodity can be consumed only by people who have more purchasing power. Price mechanism determines the income of the workers, i.e.; purchasingpower. The purchasing power of the owner of capital is determined in the same way. Thus, when the price of every commodity and every factor of production are determined, the third problem will be solved.

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