Economics: Economics is the social science that studies the production, distribution, and consumption of goods and services. Economics is the study of how societies use scarce resources to produce valuable goods and services and distribute them among different individuals. Economics focuses on the behavior and interactions of economic agents and how economies work. Microeconomics analyzes basic elements in the economy, including individual agents and markets, their interactions, and the outcomes of interactions. Individual agents may include, for example, households, firms, buyers, and sellers. Macroeconomics analyzes the entire economy (meaning aggregated production, consumption, saving, and investment) and issues affecting it, including unemployment of resources (labor, capital, and land), inflation, economic growth, and the public policies that address these issues (monetary, fiscal, and other policies). Micro vs Macro: The difference between micro and macroeconomics is simple. Microeconomics is the study of economics at an individual, group or company level. Macroeconomics, on the other hand, is the study of a national economy as a whole. Microeconomics focuses on issues that affect individuals and companies. This could mean studying the supply and demand for a specific product, the production that an individual or business is capable of, or the effects of regulations on a business. Macroeconomics focuses on issues that affect the economy as a whole. Some of the most common focuses of macroeconomics include unemployment rates, the gross domestic product of an economy, and the effects of exports and imports. It(micro) is also known as the price theory because it explains the process of economic resources allocation on the foundation of relative prices of several goods and services. It(macro) is also known as the income theory because it explains the changing levels of national income of an economy during a period of time. Economic Efficiency: Economic efficiency requires that an economy produce the highest combination of quantity and quality of goods and services given its technology and scarce resources. An economy is producing efficiently when no individual’s economic welfare can be improved unless someone else is made worse off. Economic efficiency implies an economic state in which every resource is optimally allocated to serve each individual or entity in the best way while minimizing waste and inefficiency. When an economy is economically efficient, any changes made to assist one entity would harm another. Scarce Resource: Adding the word "scarce" before the word "resource" signifies that a resource has limited availability relative to desired use and is thus subject to economic analysis. A scarce resource is typically exchanged through a market. Buyers pay a price to obtain the resource and sellers give up the resource in exchange for payment. Scarce resources are the workers, equipment, raw materials, and organizers used to produce scarce goods. Scarcity: As the term suggests, a scarce resource can be traced to the fundamental problem of scarcity. Scarcity is the widespread condition of limited resources and unlimited wants and needs. A scarce resource is more specifically a resource with limited availability relative to desired use. The two concepts are closely related. Scarcity is the general problem underlying the study of economics and a scarce resource is a specific resource that reflects this general scarcity condition. Production-possibility frontier (or PPF ): The production-possibility frontier (or PPF ) shows the maximum quantity of goods that can be efficiently produced by an economy, given its technological knowledge and the quantity of available inputs. A production–possibility frontier (PPF) or production possibility curve (PPC) is a curve which shows various combinations of the amounts of two goods which can be produced within the given resources and technology/a graphical representation showing all the possible options of output for two products that can be produced using all factors of production, where the given resources are fully and efficiently utilized per unit time. Graphically bounding the production set for fixed input quantities, the PPF curve shows the maximum possible production level of one commodity for any given production level of the other, given the existing state of technology. By doing so, it defines productive efficiency in the context of that production set: a point on the frontier indicates efficient use of the available inputs (such as points B, D and C in the graph), a point beneath the curve (such as A) indicates inefficiency, and a point beyond the curve (such as X) indicates impossibility. Opportunity cost: Opportunity costs represent the benefits an individual, investor or business misses out on when choosing one alternative over another. While financial reports do not show opportunity cost, business owners can use it to make educated decisions when they have multiple options before them. Production possibility frontier and opportunity cost: Moving from Point A to B will lead to an increase in services (21-27). But, the opportunity cost is that output of goods falls from 22 to 18. Therefore, the opportunity cost of increasing consumption of services is the 4 goods foregone. At point D, the economy is inefficient. We can increase both goods and services without any opportunity cost. C is currently impossible. Example: Here's an example. Let's say you have $15,000 and your choice is to either buy shares of Company XYZ or leave the money in a CD that earns only 5% per year. If the Company XYZ stock returns 10%, you've benefited from your decision because the alternative would have been less profitable. However, if Company XYZ returns 2% when you could have had 5% from the CD, then your opportunity cost is (5% 2% = 3%). Why does Opportunity Cost matter? Opportunity cost is all about the most basic of economic concepts: trade-offs. It's a notion inherent in almost every decision of daily life and of investing: if you make a choice, you forgo the other options for now. And what's been given up can sometimes turn out to have been the wiser choice, which is why opportunity cost is best measured in hindsight -- after all, it is impossible to know the end outcome of any investment. Opportunity costs are a factor not only in consumer decisions, but in production decisions, capital allocation, time management, and lifestyle choices. What will happen to the economic growth on a country's PPF for poor nation and high nation for choosing luxurious and necessary goods: Productive efficiency: Productive efficiency occurs when an economy cannot produce more of one good without producing less of another good; this implies that the economy is on its production-possibility frontier. Chapter 2 Market: A market is a mechanism through which buyers and sellers interact to determine prices and exchange goods, services, and assets. A market economy is an elaborate mechanism for coordinating people, activities, and businesses through a system of prices and markets. It is a communication device for pooling the knowledge and actions of billions of diverse individuals. Without central intelligence or computation, it solves problems of production and distribution involving billions of unknown variables and relations, problems that are far beyond the reach of even today’s fastest supercomputer. Nobody designed the market, yet it functions remarkably well. In a market economy, no single individual or organization is responsible for production, consumption, distribution, or pricing. How do markets determine prices, wages, and outputs? Originally, a market was an actual place where buyers and sellers could engage in face-to-face bargaining. The marketplace—fi lled with slabs of butter, pyramids of cheese, layers of wet fi sh, and heaps of vegetables—used to be a familiar sight in many villages and towns, where farmers brought their goods to sell. In the United States today there are still important markets where many traders gather together to do business. For example, wheat and corn are traded at the Chicago Board of Trade, oil and platinum are traded at the New York Mercantile Exchange, and gems are traded at the Diamond District in New York City. The central role of markets is to determine the price of goods. Prices coordinate the decisions of producers and consumers in a market. Higher prices tend to reduce consumer purchases and encourage production. Lower prices encourage consumption and discourage production. Prices are the balance wheel of the market mechanism. Product market MONEY: THE LUBRICANT OF EXCHANGE: Money is the means of payment in the form of currency and checks used to buy things. Money is a lubricant that facilitates exchange. When everyone trusts and accepts money as payment for goods and debts, trade is facilitated. If specialization permits people to concentrate on particular tasks, money then allows people to trade their specialized outputs for the vast array of goods and services produced by others. Money is the medium of exchange. Proper management of the financial system is one of the major issues for government macroeconomic policy in all countries. Governments have three main economic functions in a market economy: 1. Governments increase efficiency by promoting competition, curbing externalities like pollution, and providing public goods. 2. Governments promote equity by using tax and expenditure programs to redistribute income toward particular groups. 3. Governments foster macroeconomic stability and growth—reducing unemployment and inflation while encouraging economic growth—through fiscal and monetary policy. Externalities: Externalities (or spillover effects) occur when firms or people impose costs or benefits on others outside the marketplace. Negative externalities get most of the attention in today’s world. As our society has become more densely populated and as the production of energy, chemicals, and other materials increases, negative externalities or spillover effects have grown from little nuisances into major threats. This is where governments come in. Government regulations are designed to control externalities like air and water pollution, damage from strip mining, hazardous wastes, unsafe drugs and foods, and radioactive materials. Public goods: Public goods are commodities which can be enjoyed by everyone and from which no one can be excluded. The classic example of a public good is national defense. Suppose a country decides to increase spending to defend its borders or to send peacekeepers to troubled lands. All must pay the piper and all will suffer the consequences, whether they want to or not. Chapter 3 Demand schedule: There exists a definite relationship between the market price of a good and the quantity demanded of that good, other things held constant. This relationship between price and quantity bought is called the demand schedule, or the demand curve. THE DEMAND CURVE: The graphical representation of the demand schedule is the demand curve. Law of downward-sloping demand: When the price of a commodity is raised (and other things are held constant), buyers tend to buy less of the commodity. Similarly, when the price is lowered, other things being constant, quantity demanded increases. Quantity demanded tends to fall as price rises for two reasons: 1. First is the substitution effect, which occurs because a good becomes relatively more expensive when its price rises. When the price of good A rises, I will generally substitute goods B, C, D, . . . for it. For example, as the price of beef rises, I eat more chicken. 2. A higher price generally also reduces quantity demanded through the income effect. This comes into play because when a price goes up, I find myself somewhat poorer than I was before. If gasoline prices double, I have in effect less real income, so I will naturally curb my consumption of gasoline and other goods. Market Demand: The market demand curve is found by adding together the quantities demanded by all individuals at each price. Does the market demand curve obey the law of downward-sloping demand? It certainly does. If prices drop, for example, the lower prices attract new customers through the substitution effect. In addition, a price reduction will induce extra purchases of goods by existing consumers through both the income and the substitution effects. Conversely, a rise in the price of a good will cause some of us to buy less. Factors affecting demand curve: 1. 2. 3. 4. 5. Substitute Products and Services Consumer Preference Changes Market Size Changes Increased Job Creation Price Expectations 1. Normal Goods When there is an increase in the consumer’s income, there will be an increase in demand for a good. If the consumer’s income falls, then, there will be a fall in demand. 2. Change in Preferences If there is a change in preferences, then there will be a change in demand. For example, yoga became mainstream a couple of years ago, and health enthusiasts promoted its benefits. This trend led to an increase in demand for yoga classes. 3. Complimentary Goods When there is a decrease in the price of compliments, then the demand for its compliments will increase. Complementary goods are goods you usually buy together, like bread and butter, tea and milk. If the price of one goes up, the demand for the other good will fall. For example, if the price of yoga classes fell, then there would be an increase in demand for yoga mats. 4. Substitutes An increase in the price of substitutes will affect the demand curve. Substitutes are goods that can consumers buy in place of the other like how Coca-Cola & Pepsi are very close substitutes. If the price of one goes up, the demand for the other will rise. For example, if meditation classes became more expensive, then there would be an increase in demand for yoga classes. 5. Market Size If the size of the market increases, like if a country’s population increases or there is an increase in the number of people in a certain age group, then the demand for products would increase. Simply put, the higher the number of buyers, the higher the quantity demanded. For example, if the birth rate suddenly skyrocketed, then there would be an increase in demand for baby products. 6. Price Expectations When there is an expectation of a price change, this means that people expect the price of a good to increase shortly. These people are then more likely to purchase sooner, which would increase demand for the product. For example, if people are expecting the price of a laptop to fall, then they will delay their purchase until the price lowers. Shifts in Demand: When there are changes in factors other than a good’s own price which affect the quantity purchased, we call these changes shifts in demand. Demand increases (or decreases) when the quantity demanded at each price increases ( or decreases). A change in demand occurs when one of the elements underlying the demand curve shifts. Supply schedule: The supply schedule (or supply curve) for a commodity shows the relationship between its market price and the amount of that commodity that producers are willing to produce and sell, other things held constant. Shifts in supply: When changes in factors other than a good’s own price affect the quantity supplied, we call these changes shifts in supply. Supply increases (or decreases) when the amount supplied increases (or decreases) at each market price. Factors affecting supply curve: 1. A decrease in costs of production. This means business can supply more at each price. Lower costs could be due to lower wages, lower raw material costs 2. More firms. An increase in the number of producers will cause an increase in supply. 3. Investment in capacity. Expansion in capacity of existing firms, e.g. building a new factory 4. Related supply. An increase in supply of a related good e.g. beef and leather 5. Weather. Climatic conditions are very important for agricultural products 6. Technological improvements. Improvements in technology, e.g. computers, reducing firms costs 7. Lower taxes. Lower direct taxes (e.g. tobacco tax, VAT) reduce the cost of goods 8. Government subsidies. Increase in government subsidies will also reduce the cost of goods, e.g. train subsidies reduce the price of train tickets. When automobile prices change, producers change their production and quantity supplied, but the supply and the supply curve do not shift. By contrast, when other infl uences affecting supply change, supply changes and the supply curve shifts. Increased Supply of Automobiles: EQUILIBRIUM OF SUPPLY AND DEMAND: A market equilibrium comes at the price at which quantity demanded equals quantity supplied. At that equilibrium, there is no tendency for the price to rise or fall. The equilibrium price is also called the market-clearing price. This denotes that all supply and demand orders are filled, the books are “cleared” of orders, and demanders and suppliers are satisfied. EQUILIBRIUM WITH SUPPLY AND DEMAND CURVES: The equilibrium price and quantity come where the amount willingly supplied equals the amount willingly demanded. In a competitive market, this equilibrium is found at the intersection of the supply and demand curves. There are no shortages or surpluses at the equilibrium price. Effect of a Shift in Supply or Demand: When the elements underlying demand or supply change, this leads to shifts in demand or supply and to changes in the market equilibrium of price and quantity. Effect on price and quantity of different demand and supply shift: Shifts and movement of demand curve: Chapter 4 PRICE ELASTICITY OF DEMAND: The price elasticity of demand (sometimes simply called price elasticity) measures how much the quantity demanded of a good changes when its price changes. The precise definition of price elasticity is the percentage change in quantity demanded divided by the percentage change in price. The price elasticities of demand for individual goods are determined by the economic characteristics of demand. Price elasticities tend to be higher when the goods are luxuries, when substitutes are available, and when consumers have more time to adjust their behavior. By contrast, elasticities are lower for necessities, for goods with few substitutes, and for the short run. rmula: Now we can be more precise about the different categories of price elasticity: ● When a 1 percent change in price calls forth more than a 1 percent change in quantity demanded, the good has price-elastic demand. For example, if a 1 percent increase in price yields a 5 percent decrease in quantity demanded, the commodity has a highly price-elastic demand. ● When a 1 percent change in price produces less than a 1 percent change in quantity demanded, the good has price-inelastic demand. This case occurs, for instance, when a 1 percent increase in price yields only a 0.2 percent decrease in demand. ● One important special case is unit-elastic demand, which occurs when the percentage change in quantity is exactly the same as the percentage change in price. In this case, a 1 percent increase in price yields a 1 percent decrease in demand. We will see later that this condition implies that total expenditures on the commodity (which equal P Q ) stay the same even when the price changes. Math: TABLE 4-1. Example of Good with Elastic Demand Consider the situation where price is raised from 90 to 110. According to the demand curve, quantity demanded falls from 240 to 160. Price elasticity is the ratio of percentage change in quantity divided by percentage change in price. We drop the minus signs from the numbers so that all elasticities are positive. Price Elasticity in Diagrams: In Figure 4 -2 ( a), a halving of price has tripled quantity demanded. Like the example in Figure 4 -1 , this case shows price-elastic demand. In Figure 4 -2 ( c ), cutting price in half led to only a 50 percent increase in quantity demanded, so this is the case of priceinelastic demand. The borderline case of unitelastic demand is shown in Figure 4 -2 ( b); in this example, the doubling of quantity demanded exactly matches the halving of price. Perfectly elastic demand: Figure 4 -3displays the important polar extremes where the price elasticities are infi nite and zero, or completely elastic and completely inelastic. Completely inelastic demands, or ones with zero elasticity, are ones where the quantity demanded responds not at all to price changes; such demand is seen to be a vertical demand curve. By contrast, when demand is infi nitely elastic, a tiny change in price will lead to an indefi nitely large change in quantity demanded, as in the horizontal demand curve in Figure 4 -3. Elasticities cannot be inferred by slope alone. The general rule for elasticities is that the elasticity can be calculated as the ratio of the length of the straight-line or tangent segment below the demand point to the length of the segment above the point. ELASTICITY AND REVENUE: The relationship between price elasticity and total revenue . Total revenue is by defi nition equal to price times quantity (or P* Q). If consumers buy 5 units at $3 each, total revenue is $15. If you know the price elasticity of demand, you know what will happen to total revenue when price changes: 1. When demand is price-inelastic, a price decrease reduces total revenue. 2. When demand is price-elastic, a price decrease increases total revenue. 3. In the borderline case of unit-elastic demand, a price decrease leads to no change in total revenue. Price discrimination: Price discrimination is the practice of charging different prices for the same service to different customers. PRICE ELASTICITY OF SUPPLY: The price elasticity of supply is the percentage change in quantity supplied divided by the percentage change in price. Figure 4 - 6displays three important cases of supply elasticity: (a) the vertical supply curve, showing completely inelastic supply; (c), the horizontal supply curve, displaying completely elastic supply; and (b), an intermediate case of a straight line, going through the origin, illustrating the borderline case of unit elasticity. What factors determine supply elasticity? The major factor infl uencing supply elasticity is the ease with which production in the industry can be increased. If all inputs can be readily found at going market prices, as is the case for the textile industry, then output can be greatly increased with little increase in price. This would indicate that supply elasticity is relatively large. On the other hand, if production capacity is severely limited, as is the case for gold mining, then even sharp increases in the price of gold will call forth but a small response in gold production; this would be inelastic supply. Another important factor in supply elasticities is the time period under consideration. A given change in price tends to have a larger effect on amount supplied as the time for suppliers to respond increases. For very brief periods after a price increase, fi rms may be unable to increase their inputs of labor, materials, and capital, so supply may be very price in elastic. However, as time passes and businesses can hire more labor, build new factories, and expand capacity, supply elasticities will become larger. We can use Figure 4 - 6to illustrate how supply may change over time for the fi shing case. Supply curve (a) might hold for fi sh on the day they are brought to market, where they are simply auctioned off for whatever they will bring. Curve (b) might hold for the intermediate run of a year or so, with the given stock of fi shing boats and before new labor is attracted to the industry. Over the very long run, as new fi shing boats are built, new labor is attracted, and new fi sh farms are constructed, the supply of fi sh might be very price-elastic, as in case (c) in Figure 4 -6 . Chapter 5 Marginal utility: The expression “marginal” is a key term in economics and always means “additional” or “extra.” Marginal utility denotes the additional utility you get from the consumption of an additional unit of a commodity. Law of diminishing marginal utility: The law of diminishing marginal utility states that, as the amount of a good consumed increases, the marginal utility of that good tends to decline. Relationship of Total and Marginal Utility: Equimarginal principle: The fundamental condition of maximum satisfaction or utility is the equimarginal principle. It states that a consumer will achieve maximum satisfaction or utility when the marginal utility of the last dollar spent on a good is exactly the same as the marginal utility of the last dollar spent on any other good. Formula: Why Demand Curves Slope Downward : Using the fundamental rule for consumer behavior, we can easily see why demand curves slope downward. For simplicity, hold the common marginal utility per dollar of income constant. Then increase the price of good 1. With no change in quantity consumed, the fi rst ratio (i.e., MUgood 1 / P1 ) will be below the MU per dollar of all other goods. The consumer will therefore have to readjust the consumption of good 1. The consumer will do this by ( a) lowering the consumption of good 1, thereby ( b) raising the MU of good 1, until (c) at the new, reduced level of consumption of good 1, the new marginal utility per dollar spent on good 1 is again equal to the MU per dollar spent on other goods. A higher price for a good reduces the consumer’s desired consumption of that commodity; this shows why demand curves slope downward.