“Economics Final Syllabus Notes”
Economic Introduction and Economic Problem:
The word economy comes from the Greek word oikonomos,
which means “one who manages a household.” Economic introduction refers to
the initial phase of studying and understanding the principles and concepts of
economics. It involves learning about the production, distribution, and
consumption of goods and services, as well as the factors that influence economic
behavior.
The economic problem, also known as the fundamental
economic problem, refers to the scarcity of resources in relation to unlimited
human wants and needs. It arises from the fact that resources, such as land, labor,
capital, and entrepreneurship, are limited, while people's desires and demands are
infinite. This scarcity creates the need for individuals, businesses, and societies to
make choices about how to allocate these limited resources efficiently and
effectively to satisfy their needs and wants.
Micro and Macro-economics:
Microeconomics
The study of how households and firms make decisions and how they
interact in markets.
Macroeconomics:
The study of economy wide phenomena, including inflation,
unemployment, and economic growth.
Define public and private goods and their characteristics and also
explain why market fails to provide the pubic goods and the free rider
problem which emerge it.
Public goods are non-excludable and non-rivalrous. Nonexcludability means that once a public good is provided, it is difficult to exclude
anyone from benefiting from it. Non-rivalry means that one person's consumption
of a public good does not diminish its availability for others. Examples of public
goods include street lighting, national defense, and public parks.
Private goods, on the other hand, are excludable and rivalrous.
Excludability means that access to a private good can be restricted to those who
pay for it. Rivalry means that the consumption of a private good by one person
reduces its availability for others. Examples of private goods include food,
clothing, and cars.
The market often fails to provide public goods due to two main reasons:
1. Non-excludability:
Since public goods are difficult to exclude people from using once
they are provided, individuals have an incentive to "free ride" and enjoy the
benefits without contributing to their provision. This leads to underinvestment in
public goods as individuals expect others to pay for them.
2. Lack of profit motive:
Public goods typically do not generate direct profits for private
businesses because they cannot charge individual consumers for their usage. As a
result, there is little incentive for private firms to invest in the production of public
goods.
The free rider problem arises when individuals benefit from a public
good without contributing to its provision. This behavior is rational from an
individual's perspective, as they can enjoy the benefits without incurring any costs.
However, if everyone adopts this free riding behavior, the provision of
public goods becomes inadequate, leading to a market failure.
Explain the concept of aggregate demand and supply demand with
their relevance and to economic fluctuations and further explain why
aggregate demand curve is downward sloping and aggregate supply
curve is upward sloping.
Aggregate demand (AD) represents the total demand for goods and
services in an economy at a given price level and within a specific time period. It is
the sum of consumption, investment, government spending, and net exports
(exports minus imports). AD shows the relationship between the overall price level
and the quantity of goods and services demanded in the economy.
Aggregate supply (AS) represents the total supply of goods and
services that producers are willing and able to provide at different price levels. It
shows the relationship between the overall price level and the quantity of goods
and services supplied in the economy.
The aggregate demand curve is downward sloping due to the
wealth effect, interest rate effect, and international trade effect.
1. Wealth effect:
As the overall price level decreases, the purchasing power of consumers
increases. This leads to higher consumption spending, which increases aggregate
demand.
2. Interest rate effect:
A decrease in the overall price level reduces the demand for money,
leading to lower interest rates. Lower interest rates stimulate investment and
borrowing, which increases aggregate demand.
3. International trade effect:
A decrease in the overall price level makes domestic goods relatively
cheaper compared to foreign goods. This leads to an increase in net exports, as
exports become more attractive and imports become relatively more expensive.
This increase in net exports boosts aggregate demand.
On the other hand, the aggregate supply curve is upward sloping due
to the sticky wages, sticky prices, and resource availability.
1. Sticky wages:
In the short run, wages are often fixed or slow to adjust. When the
overall price level increases, firms' production costs rise, but wages remain
constant. This leads to a decrease in firms' profits and a decrease in the quantity of
goods and services supplied.
2. Sticky prices:
Similar to wages, prices of inputs or raw materials may be slow to adjust
in the short run. When the overall price level increases, firms' costs increase, but
they may not be able to immediately pass on these higher costs to consumers. This
results in a decrease in the quantity of goods and services supplied.
3. Resource availability:
In the long run, the availability of resources, such as labor and capital,
is relatively fixed. As the overall price level increases, firms may not be able to
increase their production capacity due to limited resources, leading to a less elastic
supply curve.
In summary, the aggregate demand curve is downward sloping due to
the wealth effect, interest rate effect, and international trade effect, while the
aggregate supply curve is upward sloping due to sticky wages, sticky prices, and
resource availability. These concepts help explain how changes in price levels
affect the overall demand and supply of goods and services in the economy,
leading to economic fluctuations.
Ten principle of economics:
1. People face trade-offs.
2. The cost of something is what you give up to get it.
3. Rational people think at the margin.
4. People respond to incentives.
5. Trade can make everyone better off.
6. Markets are usually a good way to organize economic activity.
7. Governments can sometimes improve market outcomes.
8. A country’s standard of living depends on its ability to produce goods and
services.
9. Prices rise when the government prints too much money.
10. Society faces a short-run trade-off between inflation and unemployment.
For further explanations see chapter 1
Consumer and producer Surplus, Price Floor and Price Ceiling and
Market Equilibrium:
Consumer Surplus:
Consumer surplus is a concept in economics that measures the benefit
or value that consumers receive when they are able to purchase a product or
service at a price lower than what they are willing to pay. It represents the
difference between the maximum price a consumer is willing to pay for a good or
service and the actual price they pay.
Producer Surplus:
Producer surplus is the measure of the benefit or value that producers
receive when they are able to sell a product or service at a price higher than their
minimum acceptable price. It represents the difference between the price at which
producers are willing to supply a good or service and the actual price they receive.
Price Floor:
A price floor is a government-imposed minimum price set above the
equilibrium price in a market. It is designed to prevent prices from falling below a
certain level, typically to protect producers or ensure a minimum income for
certain goods or services. When a price floor is set above the equilibrium price, it
can lead to a surplus of the product or service.
Price Ceiling:
A price ceiling is a government-imposed maximum price set below the
equilibrium price in a market. It is usually implemented to make goods or services
more affordable for consumers. When a price ceiling is set below the equilibrium
price, it can lead to a shortage of the product or service.
Market Equilibrium:
Market equilibrium refers to the state of balance in a market where the
quantity demanded by consumers equals the quantity supplied by producers. At
equilibrium, there is no shortage or surplus, and the market clears without any
upward or downward pressure on prices. The equilibrium price and quantity are
determined by the intersection of the demand and supply curves in a market.
Demand, Law of demand, Elasticity of demand, Shifts in demand
curve and Supply, Law of supply, Elasticity of supply and Shifts in
supply curve:
Demand:
In economics, demand refers to the quantity of a good or service that
consumers are willing and able to purchase at a given price and within a specific
time period.
Law of Demand:
The law of demand states that, all else being equal, there is an inverse
relationship between the price of a good or service and the quantity demanded. In
other words, as the price of a product increases, the quantity demanded decreases,
and vice versa.
Elasticity of Demand:
Elasticity of demand measures the responsiveness of the quantity
demanded to changes in price. It indicates how sensitive consumers are to price
changes. If demand is elastic, a small change in price leads to a proportionately
larger change in quantity demanded. If demand is inelastic, a change in price has a
relatively smaller impact on quantity demanded.
Shifts in Demand Curve:
The demand curve represents the relationship between price and
quantity demanded. A shift in the demand curve occurs when there is a change in
factors other than price that influence the quantity demanded at each price level.
These factors can include changes in consumer income, preferences, population,
prices of related goods, and expectations.
Supply:
Supply refers to the quantity of a good or service that producers are
willing and able to offer for sale at a given price and within a specific time period.
Law of Supply:
The law of supply states that, all else being equal, there is a direct
relationship between the price of a good or service and the quantity supplied. In
other words, as the price of a product increases, the quantity supplied also
increases, and vice versa.
Elasticity of Supply:
Elasticity of supply measures the responsiveness of the quantity supplied
to changes in price. It indicates how sensitive producers are to price changes. If
supply is elastic, a small change in price leads to a proportionately larger change in
quantity supplied. If supply is inelastic, a change in price has a relatively smaller
impact on quantity supplied.
Shifts in Supply Curve:
The supply curve represents the relationship between price and
quantity supplied. A shift in the supply curve occurs when there is a change in
factors other than price that influence the quantity supplied at each price level.
These factors can include changes in production costs, technology, input prices,
government regulations, and expectations.
GDP, Measures of GDP through product, Income and Expenditure
Approach, GNP, NNP, NI, PI, DPI
Gross Domestic Product (GDP) is a measure of the total value of all final goods
and services produced within a country's borders during a specific time period,
typically a year. It is used as an indicator of a country's economic performance.
There are three main approaches to measuring GDP;
1. Product Approach: This approach calculates GDP by summing up the value of
all final goods and services produced in an economy. It includes the value of goods
and services at market prices.
2. Income Approach: This approach calculates GDP by summing up all the
incomes earned by individuals and businesses in an economy. It includes wages,
salaries, profits, rents, and interest.
3. Expenditure Approach: This approach calculates GDP by summing up all the
expenditures made on final goods and services in an economy. It includes
consumption, investment, government spending, and net exports (exports minus
imports).
Gross National Product (GNP) is a measure similar to GDP, but it includes the
value of goods and services produced by a country's residents, both domestically
and abroad. It takes into account the income earned by a country's citizens,
regardless of their location.
Net National Product (NNP) is derived from GNP by subtracting depreciation
(the wear and tear on capital goods) from the total value of goods and services
produced. It provides a measure of the net output of an economy after accounting
for capital consumption.
Personal Income (PI) is the total income received by individuals from all sources,
including wages, salaries, rental income, dividends, and government transfers.
Disposable Personal Income (DPI) is derived from personal income by
subtracting personal taxes. It represents the income available to individuals for
consumption and saving after taxes have been paid.
In summary, GDP measures the total value of goods and services produced within
a country, while GNP includes the value of production by a country's residents
both domestically and abroad. NNP adjusts GNP for depreciation, PI measures
total income received by individuals, and DPI represents income available for
consumption and saving after taxes.
Circular Flow of Income, Unemployment and its Types, Inflation and
types and Measurement of CPI:
The circular flow of income is a concept in economics that illustrates
the flow of money and goods between different sectors of an economy. It shows
how households, businesses, and the government interact through the exchange of
income, goods, and services. In this model, households provide labor and other
factors of production to businesses in exchange for income. They then use this
income to purchase goods and services produced by businesses, completing the
circular flow.
Unemployment refers to the situation where individuals who are willing and able
to work are unable to find employment. There are several types of unemployment;
1. Frictional unemployment:
This type of unemployment occurs when individuals are in the process
of transitioning between jobs or entering the workforce for the first time.
2. Structural unemployment:
Structural unemployment arises from a mismatch between the skills
and qualifications of workers and the available job opportunities. It can occur due
to changes in technology, shifts in industries, or changes in the structure of the
economy.
3. Cyclical unemployment:
Cyclical unemployment is caused by fluctuations in the business
cycle. During economic downturns or recessions, businesses may reduce their
workforce, leading to higher unemployment rates.
Inflation refers to the sustained increase in the general price level of goods and
services in an economy over time. It erodes the purchasing power of money. There
are different types of inflation:
1. Demand-pull inflation: Demand-pull inflation occurs when aggregate demand
exceeds the available supply of goods and services, leading to an increase in prices.
2. Cost-push inflation:
Cost-push inflation happens when the cost of production, such as wages or
raw materials, increases, causing businesses to raise prices to maintain their profit
margins.
3. Built-in inflation:
Built-in inflation is a result of expectations of future inflation. It occurs
when workers and businesses anticipate higher prices and adjust wages and prices
accordingly, leading to a self-perpetuating cycle of inflation.
The Consumer Price Index (CPI) is a commonly used measure of inflation. It
measures changes in the average price level of a basket of goods and services
consumed by households. The CPI is calculated by comparing the current prices of
the basket of goods to a base period. It provides a way to track and compare
changes in the cost of living over time.
Characteristics of Perfect Competition and Monopoly, GDP and its
Components and GDP Deflator:
Characteristics of Perfect Competition:
1. Large number of buyers and sellers:
In perfect competition, there are numerous buyers and sellers in the
market, none of whom have significant market power.
2. Homogeneous products:
The goods or services offered by firms in perfect competition are
identical or very similar, with no differentiation.
3. Free entry and exit:
Firms can freely enter or exit the market without any barriers,
ensuring that there is no artificial restriction on competition.
4. Perfect information:
Buyers and sellers have complete knowledge about prices, quality, and other
relevant factors in the market.
5. Price takers:
Individual firms in perfect competition have no control over the
market price and must accept the prevailing price determined by market forces.
Characteristics of Monopoly:
1. Single seller:
In a monopoly, there is only one seller or producer in the market, giving
them significant control over the market.
2. Unique product:
The monopolist offers a product or service that has no close substitutes,
giving them a monopoly power.
3. High barriers to entry:
Monopolies often have barriers to entry, such as patents, exclusive access
to resources, or high start-up costs, which prevent or limit competition.
4. Price maker:
The monopolist has the power to set prices based on their own discretion,
as they face no competition.
5. Imperfect information:
Monopolies may have an information advantage over buyers, as they
control the market and can manipulate information to their advantage.
Gross Domestic Product (GDP) and its Components:
Gross Domestic Product (GDP) is a measure of the total value of all final goods
and services produced within a country's borders during a specific period, usually a
year. It is composed of four main components;
1. Consumption (C):
This includes the spending by households on goods and services, such as
food, clothing, and healthcare.
2. Investment (I):
Investment refers to spending on capital goods, such as machinery, equipment, and
construction, by businesses and households.
3. Government Spending (G):
This component includes the expenditure by the government on public
goods and services, such as infrastructure, defense, and education.
4. Net Exports (NX):
Net exports represent the difference between a country's exports and
imports. If exports exceed imports, it is a positive contribution to GDP, while if
imports exceed exports, it is a negative contribution.
GDP Deflator:
The GDP deflator is a measure of the overall price level in an economy. It is
calculated by dividing nominal GDP (measured at current prices) by real GDP
(measured at constant prices) and multiplying by 100. The GDP deflator reflects
the average price change of all goods and services produced in an economy over
time. It is used to adjust nominal GDP for inflation and obtain real GDP, which
allows for a more accurate comparison of economic output across different time
periods.
Characteristics of Monopolistic Competition and Oligopoly:
Monopolistic competition and oligopoly are two types of market structures that
exist between perfect competition and monopoly. Here are the characteristics of
each:
Monopolistic Competition:
1. Many Sellers:
There are numerous firms operating in the market, each offering slightly
differentiated products.
2. Product Differentiation:
Firms engage in product differentiation through branding, marketing, or
other means to make their products appear unique.
3. Easy Entry and Exit:
Firms can enter or exit the market relatively easily, leading to low barriers
to entry.
4. Non-Price Competition:
Firms compete based on factors other than price, such as product quality,
advertising, customer service, or design.
5. Limited Control over Price:
Each firm has some control over the price of its product due to product
differentiation, but the market is still influenced by overall supply and demand.
Oligopoly:
1. Few Sellers:
There are only a few dominant firms in the market, often referred to as
oligopolists.
2. Interdependence:
The actions and decisions of one firm directly impact the others, leading to
strategic behavior and mutual interdependence.
3. Barriers to Entry:
Oligopolies typically have high barriers to entry, making it difficult for new
firms to enter the market.
4. Product Differentiation:
Firms may differentiate their products, but it is not as pronounced as in
monopolistic competition.
5. Price Rigidity:
Oligopolistic firms often engage in price rigidity, where they avoid
frequent price changes to maintain stability in the market.
6. Collusion and Competition:
Oligopolistic may engage in collusion to fix prices or limit competition,
but competition among them still exists.