Unit 1
Basic Economic
Problems
Our wants are UNLIMITED but resources
are LIMITED………
So there is SCARCITY
Hence we have to make
CHOICES
3 major economic
questions:
•What to produce
•How to produce
•Whom to produce
Basic Economic Problem- 3 decisions
• WHAT TO PRODUCE
• Food or Clothes
• Cars or hospitals
• ipods or Cosmetics or military strength
Basic Economic Problem- 3 decisions
HOW TO PRODUCE
 techniques used.
 least cost method of production
 labour intensive or capital intensive
• Production: Creating goods and
services
• Consumption: Using the goods
and services to satisfy want
Labor
The Enterprise:
- Organizes the 3 factors and production process
- Takes the risk (Profit and Loss)
Opportunity Cost
If I ask you, what will
you choose??
DEMAND DEFINED
What is Demand?
Demand is the different quantities of goods
that consumers are willing and able to buy at
different prices.
What is the Law of Demand?
The law of demand states There is an
INVERSE relationship between P and QD.
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Income
The incomes of consumer change the demand, but
how depends on the type of good.
1. Normal Goods
– As income increases, demand increases
– As income falls, demand falls
– Ex: cars, jewelry, homes, TV’s
2. Inferior Goods
– As income increases, demand falls
– As income falls, demand increases
– Ex: instant noodles, used cars, used clothes,
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Prices of Related Goods
The demand curve for one good can be affected by a
change in the price of ANOTHER related good.
1. Substitutes are goods used in place of one
another.
– If the price of one increases, the demand for the
other will increase (or vice versa)
– Ex: If price of Pepsi falls, demand for coke will…
2. Complements are two goods that are bought
and used together.
– If the price of one increase, the demand for the
other will fall. (or vice versa)
– Ex: If price of skis falls, demand for ski boots will...
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What Causes a Shift in Demand?
5 Determinates (SHIFTERS) of Demand:
1. Market size
2. Expectations of future price
3. Related goods price
4. Income
5. Tastes and preferances
Changes in PRICE don’t shift the curve. It
only causes movement along the curve.
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6 Determinants (SHIFTERS) of Supply
1.
2.
3.
4.
5.
6.
Prices/Availability of inputs (resources)
Number of Sellers
Technology
Government Action: Taxes & Subsidies
Expectations of Future Profit
Other – War, weather
Changes in PRICE don’t shift the curve. It only
causes movement along the curve.
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Supply and Demand are put together to determine
equilibrium price and equilibrium quantity
Demand P
Schedule $5
P Qd
S
P Qs
4
$5 10
$5 50
Equilibrium Price = $3
(Qd=Qs)
$4 40
3
$4 20
$3 30
$2 50
$1 80
Supply
Schedule
2
$3 30
1
o
D
10
20
30
40
50
60
70
Equilibrium Quantity is 30
80
Q
$2 20
$1 10
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Supply and Demand are put together to determine
equilibrium price and equilibrium quantity
Demand P
Schedule $5
P Qd
3
$4 20
$2 50
$1 80
S
P Qs
4
$5 10
$3 30
Supply
Schedule
2
What if the price
increases to $4?
1
o
$5 50
$4 40
$3 30
D
10
20
30
40
50
60
70
80
Q
$2 20
$1 10
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At $4, there is disequilibrium. The quantity
demanded is less than quantity supplied.
Demand P
Schedule $5
P Qd
How much is the
surplus at $4?
Answer: 20
$4 20
$1 80
P Qs
4
3
$2 50
S
Surplus
(Qd<Qs)
$5 10
$3 30
Supply
Schedule
2
$4 40
$3 30
1
o
$5 50
D
10
20
30
40
50
60
70
80
Q
$2 20
$1 10
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How much is the surplus if the price is $5?
Demand P
Schedule $5
P Qd
3
$4 20
$2 50
$1 80
S
P Qs
4
$5 10
$3 30
Supply
Schedule
2
What if the Answer:
price 40
decreases to $2?
1
o
D
10
20
30
40
50
60
70
80
Q
$5 50
$4 40
$3 30
$2 20
$1 10
20
At $2, there is disequilibrium. The quantity
demanded is greater than quantity supplied.
Demand P
Schedule $5
P Qd
S
P Qs
4
How much is the
shortage at $2?
Answer: 30
$5 10
3
$4 20
$3 30
$2 50
$1 80
Supply
Schedule
2
o
10
20
30
40
$4 40
$3 30
Shortage
(Qd>Qs)
1
$5 50
D
50
60
70
80
Q
$2 20
$1 10
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How much is the shortage if the price is $1?
Demand P
Schedule $5
P Qd
Supply
Schedule
S
P Qs
4
$5 10
Answer: 70
3
$4 20
$3 30
$2 50
$1 80
$5 50
$4 40
2
$3 30
1
o
D
10
20
30
40
50
60
70
80
Q
$2 20
$1 10
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The FREE MARKET system automatically pushes the
price toward equilibrium.
Demand P
Schedule $5
P Qd
Supply
Schedule
S
When there is a
surplus, producers P Qs
lower prices
$5 50
When there is a
shortage, producers $4 40
raise prices
$3 30
4
$5 10
3
$4 20
$3 30
$2 50
$1 80
2
1
o
D
10
20
30
40
50
60
70
80
Q
$2 20
$1 10
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Where do you get the Market Demand?
Frank
Yao Ming Other Individuals
Market
Price Q Demd
Price Q Demd
Price Q Demd
Price Q Demd
$5
$4
$3
$2
$1
$5
$4
$3
$2
$1
$5
$4
$3
$2
$1
$5
$4
$3
$2
$1
1
2
3
5
7
P
0
1
2
3
5
P
$3
P
$3
3
D
Q
9
17
25
42
68
P
$3
2
D
Q
10
20
30
50
80
$3
25
D
Q
30
D
Q
• What you DO NOT CHOOSE is your
Opportunity Cost
•
Opportunity Cost is the 2’nd best option
Production Possibility Curve (PPC)
• Every decision/choice we make has
an Opportunity Cost
• This idea of Opportunity Cost can be
illustrated using a PPC
A Typical PPF ………….
Unattainable
Opportunity
cost of is
increasing…
Inefficient
PPC is also tells you:
• What you can and cannot produce
• What is the cost of producing the
other good
Production Possibilities
How does the PPC graphically shows trade-offs, opportunity
costs, and efficiency?
Impossible
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(given current resources)
A
B
12
Bikes
G
C
10
8
Efficient
D
6
Inefficient=
Unemployment
4
2
E
0
0
2
4
6
8
10
Computers
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Opportunity Cost
Example:
1. The opportunity cost of
moving from a to b is… 2 Bikes
2.The opportunity cost of
moving from b to d is… 7 Bikes
3.The opportunity cost of
moving from d to b is… 4 Computer
4.The opportunity cost of
moving from f to c is… 0 Computers
5.What can you say about point G?
Unattainable
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