ECONOMIC ENVIRONMENT PAPER 2

Economics
The study of how the forces of supply and demand allocate scarce resources. Subdivided into microeconomics, which examines the behavior of firms, consumers and the role of government; and macroeconomics, which looks at inflation, unemployment, industrial production, and the role of government Economics is the social science that studies the production, distribution, and consumption of goods and services A definition of modern economics is that of Lionel Robbins in a 1932 essay: "the science which studies human behaviour as a relationship between ends and scarce means which have alternative uses." Scarcity means that available resources are insufficient to satisfy all wants and needs. Economic concepts Common problems among different types of economic systems include: * what goods to produce and in what quantities (consumption or investment, private goods or public goods, etc.) * how to produce them (coal or nuclear power, how much and what kind of machinery, who farms or teaches, etc.) * for whom to produce them, reflecting the distribution of income from output. The subject thus defined involves the study of choices as they are affected by incentives and resources Areas of economics may be divided or classified into various types, including: * microeconomics and macroeconomics * positive economics ("what is") and normative economics ("what ought to be") * mainstream economics and heterodox economics * fields and broader categories within economics. One of the uses of economics is to explain how economies, as economic systems, work and what the relations are between economic players (agents) in the larger society. Economic system Define. Set of principles and techniques by which a society decides and organizes the ownership and allocation of economic resources. At one extreme, usually called a free-enterprise system, all resources are privately owned. This system, following Adam Smith, is based on the belief that the common good is maximized when all members of society are allowed to pursue their rational self-interest. At the other extreme, usually called a pure-communist system, all resources are publicly owned. This system, following Karl Marx and Vladimir Ilich Lenin, is based on the belief that public ownership of the means of production and government control of every aspect of the economy are necessary to minimize inequalities of wealth and achieve other agreed-upon social objectives. No nation exemplifies either extreme. As one moves from capitalism through socialism to communism, a greater share of a nations productive resources is publicly owned and a greater reliance is placed on economic planning. Fascism, more a political than an economic system, is a hybrid; privately owned resources are combined into syndicates and placed at the disposal of a centrally planned state Explain the concept of opportunity cost and explainwhy accounting profits and economic profits are not the same. Scarcity Economics is the study of how people make choices under scarcity. What is scarcity? Scarcity means that resources are limited. There are not enough resources available to satisfy everyones wants. This is clearly true for individuals. Your income is limited. You cannot buy everything you want, so you must choose between different alternatives. Your time is also limited. You cannot do everything you want to, so you are forced to choose between different alternatives. If you choose to spend the day at the beach, you give up going to class or working. Opportunity Cost This concept of scarcity leads to the idea of opportunity cost. The opportunity cost of an action is what you must give up when you make that choice. Another way to say this is: it is the value of the next best opportunity. Opportunity cost is a direct implication of scarcity. People have to choose between different

alternatives when deciding how to spend their money and their time. Milton Friedman, who won the Nobel Prize for Economics, is fond of saying there is no such thing as a free lunch. What that means is that in a world of scarcity, everything has an opportunity cost. There is always a trade-off involved in any decision you make. The concept of opportunity cost is one of the most important ideas in economics. Consider the question, How much does it cost to go to college for a year? We could add up the direct costs like tuition, books, school supplies, etc. These are examples of explicit costs, i.e., costs that require a money payment. However, these costs are small compared to the value of the time it takes to attend class, do homework, etc. The amount that the student could have earned if she had worked rather than attended school is the implicit cost of attending college. Implicit costs are costs that do not require a money payment. The opportunity cost includes both explicit and implicit costs. Explicit costs are costs that require a money payment. Implicit costs are costs that do not require a money payment. Opportunity cost includes both explicit and implicit costs. The notion of opportunity cost helps explain why star athletes often do not graduate from college. The cost of going to school includes the millions of dollars they could earn as a professional athletes. If Kobe Bryant had decided to attend college for four years after high school instead of signing with the Lakers, his implicit cost would have been over $10 million, the salary he earned in his first four years as a Laker. Economic Profits and Accounting Profits Economists use opportunity costs to understanding the behavior of firms as well as individuals. The goal of the firm is to maximize profit. Profit is equal to revenue minus cost: Profit = Total Revenue - Total Cost When economists refer to cost, they mean opportunity cost. The firms cost of production includes explicit costs, like payroll, cost of raw materials and other direct costs. But it also includes implicit costs. One of the most important implicit costs is associated with the firms capital. For example, consider Josephine Csun, who starts a business with $100,000 she inherited from her rich uncle. The opportunity cost of this capital is what Josephine could have earned if she had taken the money and invested it elsewhere. If the rate of return on her best alternative investment opportunity is 10%, the implicit cost of capital is $10,000. This would be added to her other explicit costs of doing business to compute the opportunity cost. Accountants also compute costs. However, the costs that appear on an accountants balance sheet are only explicit costs. The firms accounting profit is equal to total revenue minus explicit costs. In the above example, an accountant would not count the $10,000 in income that Josephine is giving up because she chose to use her $100,000 to start her own business rather than investing it elsewhere. However, if Josephine had no rich uncle and had to borrow the $100,000 from the bank at 10% interest, the interest payment of $10,000 would appear as an explicit cost. Economic profit is total revenue minus opportunity cost. Accounting profit is total revenue minus explicit cost. Opportunity costs are higher than explicit costs because opportunity costs also include implicit costs. As a result, economic profits are lower than accounting profits. Accountants do not include implicit costs because they are difficult to measure. An accountant does not always know what investment opportunity was given up to use the money to start a business, but this does not mean opportunity costs are unimportant. Firms and individuals use them to make key decisions. For example, consider Farmer Jones who owns a 100-acre farm. Farmer Jones is also a well-known banjo player in the area and could earn $20 an hour giving banjo lessons. If he plants $100 worth of seed, which takes 10 hours, the wheat produced can be sold for $400. An accountant would count the cost of producing wheat as $100 and calculate an accounting profit of $300. However, an economist would calculate the cost of producing wheat as $300. This $300 opportunity cost includes both the $100 explicit cost of seed and the $200 implicit cost of Farmer Jones giving up teaching banjo lessons to plant wheat. Farmer Jones earns an economic profit of $100 ($400 minus $300), which is lower than his accounting profit of $300 ($400 minus $100). If Farmer Jones could hire a laborer to plant his wheat for $5/hour, he should do so. His economic profit would increase even though his explicit costs would rise, because he would now be free to earn $20/hour giving banjo lessons. Summary: The opportunity cost of any decision is what is given up as a result of that decision. Opportunity cost includes both explicit costs and implicit costs. The firms economic profits are calculated using opportunity costs. Accounting profits are calculated using only explicit costs. Therefore, accounting profits are higher than economic profits. Difference between macroeconomics and microeconomics Microeconomics is the study of decisions that people and businesses make regarding the allocation of resources and prices of goods and services. This means also taking into account taxes and regulations created by governments. Microeconomics focuses on supply and demand and other forces that determine the price levels seen in the economy. For example, microeconomics would look at how a specific company could maximize it's production and capacity so it could lower prices and better compete in its industry. (Find out more about microeconomics in Understanding Microeconomics.)

Microeconomics (from Greek prefix micro- meaning "small" + "economics") is a branch of economics that studies the behavior of how the individual modern household and firms make decisions to allocate limited resources.[1] Typically, it applies to markets where goods or services are being bought and sold. Microeconomics examines how these decisions and behaviours affect the supply and demand for goods and services, which determines prices, and how prices, in turn, determine the quantity supplied and quantity demanded of goods and services Macroeconomics, on the other hand, is the field of economics that studies the behavior of the economy as a whole and not just on specific companies, but entire industries and economies. This looks at economywide phenomena, such as Gross National Product (GDP) and how it is affected by changes in unemployment, national income, rate of growth, and price levels. For example, macroeconomics would look at how an increase/decrease in net exports would affect a nation's capital account or how GDP would be affected by unemployment rate. (To keep reading on this subject, see Macroeconomic Analysis.) While these two studies of economics appear to be different, they are actually interdependent and complement one another since there are many overlapping issues between the two fields. For example, increased inflation (macro effect) would cause the price of raw materials to increase for companies and in turn affect the end product's price charged to the public. The bottom line is that microeconomics takes a bottoms-up approach to analyzing the economy while macroeconomics takes a top-down approach. Regardless, both micro- and macroeconomics provide fundamental tools for any finance professional and should be studied together in order to fully understand how companies operate and earn revenues and thus, how an entire economy is managed and sustained.

Macroeconomics (from Greek prefix "macr(o)-" meaning "large" + "economics") is a branch of economics dealing with the performance, structure, behavior, and decision-making of the entire economy. This includes a national, regional, or global economy. [1][2] With microeconomics, macroeconomics is one of the two most general fields in economics. Macroeconomists study aggregated indicators such as GDP, unemployment rates, and price indices to understand how the whole economy functions. Macroeconomists develop models that explain the relationship between such factors as national income, output, consumption, unemployment, inflation, savings, investment, international trade and international finance. In contrast, microeconomics is primarily focused on the actions of individual agents, such as firms and consumers, and how their behavior determines prices and quantities in specific markets. While macroeconomics is a broad field of study, there are two areas of research that are emblematic of the discipline: the attempt to understand the causes and consequences of short-run fluctuations in national income (the business cycle), and the attempt to understand the determinants of long-run economic growth (increases in national income). Macroeconomic models and their forecasts are used by both governments and large corporations to assist in the development and evaluation of economic policy and business strategy

Economic Theories Macro and Micro Economics Macro Economics may be defined as that branch of economic analysis which studies the behaviour of not one particular unit, but of all the units combined together. Macroeconomics is a study of aggregates. It is the study of the economic system as a whole total production, total consumption, total savings and total investment. The following are the fields covered by macroeconomics: Theory of Income, Output and Employment with its two constituents, namely, the theory of consumption function, the theory of investment function and the theory of business cycles or economic fluctuations. Theory of Prices with its constituents of the theories of inflation, deflation and reflation. Theory of Economic Growth dealing with the long-run growth of income, output and employment. Macro Theory of Distribution dealing with the relative shares of wages and profits in the total national income. The study of macroeconomics is indispensable as it is the main agent for formulation and successful execution of government economic policies. It is also indispensable for the formulation of microeconomic

models. Microeconomics may be defined as that branch of economic analysis, which studies the economic behaviour of the individual unit, maybe a person, a particular household, or a particular firm. It is a study of one particular unit rather than all the units combined together. In microeconomics, we study the various units of the economy, how they function and how they reach their equilibrium. An important tool used in that of microeconomics is that of Marginal Analysis. In fact, it is an indispensable tool used in microeconomics. Some of the important laws and principles of microeconomics have been derived directly from marginal analysis. The following are the fields covered by microeconomics: Theory of Product pricing with its two constituents, namely, the theory of consumer behaviour and

the theory of production and costs. Theory of Factor pricing. Theory of Economic Welfare.

Price Theory price is the quantity of payment or compensation given by one party to another in return for goods or services. Theory of price asserts that the market price reflects interaction between two opposing considerations. On the one side are demand considerations based on marginal utility, while on the other side are supply considerations based on marginal cost. An equilibrium price is supposed to be at once equal to marginal utility (counted in units of income) from the buyer's side and marginal cost from the seller's side. Though this view is accepted by almost every economist, and it constitutes the core of mainstream economics, it has recently been challenged seriously.[by whom?] When an identical item (e.g. a commodity) is for sale in multiple locations, the Law of one price is generally believed to hold, essentially stating that the cost difference cannot be greater than that incurred by shipping, taxes etc. Supply and demand is an economic model of price determination in a market. It concludes that in a competitive market, the unit price for a particular good will vary until it settles at a point where the quantity demanded by consumers (at current price) will equal the quantity supplied by producers (at current price), resulting in an economic equilibrium of price and quantity. The four basic laws of supply and demand are:[1] 1. 2. 3. 4. If demand increases and supply remains unchanged, then it leads to higher equilibrium price and quantity. If demand decreases and supply remains unchanged, then it leads to lower equilibrium price and quantity. If supply increases and demand remains unchanged, then it leads to lower equilibrium price and higher quantity. If supply decreases and demand remains unchanged, then it leads to higher price and lower quantity.

The graphical representation of supply and demand The supply-demand model is a partial equilibrium model representing the determination of the price of a particular good and the quantity of that good which is traded. Although it is normal to regard the quantity demanded and the quantity supplied as functions of the price of the good, the standard graphical representation, usually attributed to Alfred Marshall, has price on the vertical axis and quantity on the horizontal axis, the opposite of the standard convention for the representation of a mathematical function. Determinants of supply and demand other than the price of the good in question, such as consumers' income, input prices and so on, are not explicitly represented in the supply-demand diagram. Changes in the values of these variables are represented by shifts in the supply and demand curves. By contrast, responses to changes in the price of the good are represented as movements along unchanged supply and demand curves. Supply schedule The supply schedule, depicted graphically as the supply curve, represents the amount of some good that producers are willing and able to sell at various prices, assuming ceteris paribus, that is, assuming all

determinants of supply other than the price of the good in question, such as technology and the prices of factors of production, remain the same. Under the assumption of perfect competition, supply is determined by marginal cost. Firms will produce additional output as long as the cost of producing an extra unit of output is less than the price they will receive. By its very nature, conceptualizing a supply curve requires that the firm be a perfect competitorthat is, that the firm has no influence over the market price. This is because each point on the supply curve is the answer to the question "If this firm is faced with this potential price, how much output will it be able to and willing to sell?" If a firm has market power, so its decision of how much output to provide to the market influences the market price, then the firm is not "faced with" any price, and the question is meaningless. Economists distinguish between the supply curve of an individual firm and the market supply curve. The market supply curve is obtained by summing the quantities supplied by all suppliers at each potential price. Thus in the graph of the supply curve, individual firms' supply curves are added horizontally to obtain the market supply curve. Economists also distinguish the short-run market supply curve from the long-run market supply curve. In this context, two things are assumed constant by definition of the short run: the availability of one or more fixed inputs (typically physical capital), and the number of firms in the industry. In the long run, firms have a chance to adjust their holdings of physical capital, enabling them to better adjust their quantity supplied at any given price. Furthermore, in the long run potential competitors can enter or exit the industry in response to market conditions. For both of these reasons, long-run market supply curves are flatter than their short-run counterparts. The determinants of supply follow: 1. 2. 3. 4. 5. Production costs The technology used in production The price of related goods Firm's expectations about future prices Number of suppliers

Demand schedule The demand schedule, depicted graphically as the demand curve, represents the amount of some good that buyers are willing and able to purchase at various prices, assuming all determinants of demand other than the price of the good in question, such as income, tastes and preferences, the price of substitute goods, and the price of complementary goods, remain the same. Following the law of demand, the demand curve is almost always represented as downward-sloping, meaning that as price decreases, consumers will buy more of the good.[2] Just as the supply curves reflect marginal cost curves, demand curves are determined by marginal utility curves.[3] Consumers will be willing to buy a given quantity of a good, at a given price, if the marginal utility of additional consumption is equal to the opportunity cost determined by the price, that is, the marginal utility of alternative consumption choices. The demand schedule is defined as the willingness and ability of a consumer to purchase a given product in a given frame of time. As described above, the demand curve is generally downward-sloping. There may be rare examples of goods that have upward-sloping demand curves. Two different hypothetical types of goods with upwardsloping demand curves are Giffen goods (an inferior but staple good) and Veblen goods (goods made more fashionable by a higher price). By its very nature, conceptualizing a demand curve requires that the purchaser be a perfect competitor that is, that the purchaser has no influence over the market price. This is because each point on the demand curve is the answer to the question "If this buyer is faced with this potential price, how much of the product will it purchase?" If a buyer has market power, so its decision of how much to buy influences the market price, then the buyer is not "faced with" any price, and the question is meaningless. As with supply curves, economists distinguish between the demand curve of an individual and the market demand curve. The market demand curve is obtained by summing the quantities demanded by all consumers at each potential price. Thus in the graph of the demand curve, individuals' demand curves are added horizontally to obtain the market demand curve. The determinants of demand follow: 1. Income

2. Tastes and preferences 3. Prices of related goods and services 4. Buyer's expectations about future prices 5. Number of Buyers Microeconomics Equilibrium Equilibrium is defined to the price-quantity pair where the quantity demanded is equal to the quantity supplied, represented by the intersection of the demand and supply curves. Market Equilibrium: A situation in a market when the price is such that the quantity that consumers wish to demand is correctly balanced by the quantity that firms wish to supply. Comparative static analysis: Examines the likely effect on the equilibrium of a change in the external conditions affecting the market. Changes in market equilibrium Practical uses of supply and demand analysis often center on the different variables that change equilibrium price and quantity, represented as shifts in the respective curves. Comparative statics of such a shift traces the effects from the initial equilibrium to the new equilibrium. Demand curve shifts Main article: Demand curve

An outward (rightward) shift in demand increases both equilibrium price and quantity When consumers increase the quantity demanded at a given price, it is referred to as an increase in demand. Increased demand can be represented on the graph as the curve being shifted to the right. At each price point, a greater quantity is demanded, as from the initial curve D1 to the new curve D2. In the diagram, this raises the equilibrium price from P1 to the higher P2. This raises the equilibrium quantity from Q1 to the higher Q2. A movement along the curve is described as a "change in the quantity demanded" to distinguish it from a "change in demand," that is, a shift of the curve. In the example above, there has been an increase in demand which has caused an increase in (equilibrium) quantity. The increase in demand could also come from changing tastes and fashions, incomes, price changes in complementary and substitute goods, market expectations, and number of buyers. This would cause the entire demand curve to shift changing the equilibrium price and quantity. Note in the diagram that the shift of the demand curve, by causing a new equilibrium price to emerge, resulted in movement along the supply curve from the point (Q1, P1) to the point Q2, P2). If the demand decreases, then the opposite happens: a shift of the curve to the left. If the demand starts at D2, and decreases to D1, the equilibrium price will decrease, and the equilibrium quantity will also decrease. The quantity supplied at each price is the same as before the demand shift, reflecting the fact that the supply curve has not shifted; but the equilibrium quantity and price are different as a result of the

change

(shift)

in

demand.

The movement of the demand curve in response to a change in a non-price determinant of demand is caused by a change in the x-intercept, the constant term of the demand equation. Supply curve shifts Main article: Supply (economics)

An outward (rightward) shift in supply reduces the equilibrium price but increases the equilibrium quantity When the suppliers' unit input costs change, or when technological progress occurs, the supply curve shifts. For example, assume that someone invents a better way of growing wheat so that the cost of growing a given quantity of wheat decreases. Otherwise stated, producers will be willing to supply more wheat at every price and this shifts the supply curve S1 outward, to S2an increase in supply. This increase in supply causes the equilibrium price to decrease from P1 to P2. The equilibrium quantity increases from Q1 to Q2 as consumers move along the demand curve to the new lower price. As a result of a supply curve shift, the price and the quantity move in opposite directions. If the quantity supplied decreases, the opposite happens. If the supply curve starts at S2, and shifts leftward to S1, the equilibrium price will increase and the equilibrium quantity will decrease as consumers move along the demand curve to the new higher price and associated lower quantity demanded. The quantity demanded at each price is the same as before the supply shift, reflecting the fact that the demand curve has not shifted. But due to the change (shift) in supply, the equilibrium quantity and price have changed. The movement of the supply curve in response to a change in a non-price determinant of supply is caused by a change in the y-intercept, the constant term of the supply equation. The supply curve shifts up and down the y axis as non-price determinants of demand change. Elasticity Main article: Elasticity (economics) Elasticity is a central concept in the theory of supply and demand. In this context, elasticity refers to how strongly the quantities supplied and demanded respond to various factors, including price and other determinants. One way to define elasticity is the percentage change in one variable (the quantity supplied or demanded) divided by the percentage change in the causative variable. For discrete changes this is known as arc elasticity, which calculates the elasticity over a range of values. In contrast, point elasticity uses differential calculus to determine the elasticity at a specific point. Elasticity is a measure of relative changes. Often, it is useful to know how strongly the quantity demanded or supplied will change when the price changes. This is known as the price elasticity of demand or the price elasticity of supply, respectively. If a monopolist decides to increase the price of its product, how will this affect the amount of their good that customers purchase? This knowledge helps the firm determine whether the increased unit price will offset the decrease in sales volume. Likewise, if a government imposes a tax on a good, thereby increasing the effective price, knowledge of the price elasticity will help us to predict the size of the resulting effect on the quantity demanded. Elasticity is calculated as the percentage change in quantity divided by the associated percentage change in price. For example, if the price moves from $1.00 to $1.05, and as a result the quantity supplied goes from 100 pens to 102 pens, the quantity of pens increased by 2%, and the price increased by 5%, so the price elasticity of supply is 2%/5% or 0.4.

Since the changes are in percentages, changing the unit of measurement or the currency will not affect the elasticity. If the quantity demanded or supplied changes by a greater percentage than the price did, then demand or supply is said to be elastic. If the quantity changes by a lesser percentage than the price did, demand or supply is said to be inelastic. If supply is perfectly inelastic; that is, has zero elasticity, then there is a vertical supply curve. Short-run supply curves are not as elastic as long-run supply curves, because in the long run firms can respond to market conditions by varying their holdings of physical capital, and because in the long run new firms can enter or old firms can exit the market. Elasticity in relation to variables other than price can also be considered. One of the most common to consider is income. How strongly would the demand for a good change if income increased or decreased? The relative percentage change is known as the income elasticity of demand. Another elasticity sometimes considered is the cross elasticity of demand, which measures the responsiveness of the quantity demanded of a good to a change in the price of another good. This is often considered when looking at the relative changes in demand when studying complements and substitute goods. Complements are goods that are typically utilized together, where if one is consumed, usually the other is also. Substitute goods are those where one can be substituted for the other, and if the price of one good rises, one may purchase less of it and instead purchase its substitute. Cross elasticity of demand is measured as the percentage change in demand for the first good divided by the causative percentage change in the price of the other good. For an example with a complement good, if, in response to a 10% increase in the price of fuel, the quantity of new cars demanded decreased by 20%, the cross elasticity of demand would be -2.0. In a frictionless economy, the price and quantity in any market would be able to move to a new equilibrium position instantly, without spending any time away from equilibrium. Any change in market conditions would cause a jump from one equilibrium position to another at once. In real economic systems, markets don't always behave in this way, and markets take some time before they reach a new equilibrium position. This is due to asymmetric, or at least imperfect, information, where no one economic agent could ever be expected to know every relevant condition in every market. Ultimately both producers and consumers must rely on trial and error as well as prediction and calculation to find the true equilibrium of a market. [edit] Vertical supply curve (perfectly inelastic supply)

When demand D1 is in effect, the price will be P1. When D2 is occurring, the price will be P2. The equilibrium quantity is always Q, and any shifts in demand will only affect price. If the quantity supplied is fixed in the very short run no matter what the price, the supply curve is a vertical line, and supply is called perfectly inelastic. Other markets The model of supply and demand also applies to various specialty markets. The model is commonly applied to wages, in the market for labor. The typical roles of supplier and demander are reversed. The suppliers are individuals, who try to sell their labor for the highest price. The demanders of labor are businesses, which try to buy the type of labor they need at the lowest price. The equilibrium price for a certain type of labor is the wage rate. [4]

A number of economists (for example Pierangelo Garegnani, [5] Robert L. Vienneau,[6] and Arrigo Opocher & Ian Steedman[7]), building on the work of Piero Sraffa, argue that that this model of the labor market, even given all its assumptions, is logically incoherent. Michael Anyadike-Danes and Wyne Godley [8] argue, based on simulation results, that little of the empirical work done with the textbook model constitutes a potentially falsifying test, and, consequently, empirical evidence hardly exists for that model. Graham White [9] argues, partially on the basis of Sraffianism, that the policy of increased labor market flexibility, including the reduction of minimum wages, does not have an "intellectually coherent" argument in economic theory. This criticism of the application of the model of supply and demand generalizes, particularly to all markets for factors of production. It also has implications for monetary theory [10] not drawn out here. In both classical and Keynesian economics, the money market is analyzed as a supply-and-demand system with interest rates being the price. The money supply may be a vertical supply curve, if the central bank of a country chooses to use monetary policy to fix its value regardless of the interest rate; in this case the money supply is totally inelastic. On the other hand, [11] the money supply curve is a horizontal line if the central bank is targeting a fixed interest rate and ignoring the value of the money supply; in this case the money supply curve is perfectly elastic. The demand for money intersects with the money supply to determine the interest rate.[12] Empirical estimation Demand and supply relations in a market can be statistically estimated from price, quantity, and other data with sufficient information in the model. This can be done with simultaneous-equation methods of estimation in econometrics. Such methods allow solving for the model-relevant "structural coefficients," the estimated algebraic counterparts of the theory. The Parameter identification problem is a common issue in "structural estimation." Typically, data on exogenous variables (that is, variables other than price and quantity, both of which are endogenous variables) are needed to perform such an estimation. An alternative to "structural estimation" is reduced-form estimation, which regresses each of the endogenous variables on the respective exogenous variables. Macroeconomic uses of demand and supply Demand and supply have also been generalized to explain macroeconomic variables in a market economy, including the quantity of total output and the general price level. The Aggregate Demand-Aggregate Supply model may be the most direct application of supply and demand to macroeconomics, but other macroeconomic models also use supply and demand. Compared to microeconomic uses of demand and supply, different (and more controversial) theoretical considerations apply to such macroeconomic counterparts as aggregate demand and aggregate supply. Demand and supply are also used in macroeconomic theory to relate money supply and money demand to interest rates, and to relate labor supply and labor demand to wage rates. In economics, elasticity is the ratio of the percent change in one variable to the percent change in another variable. It is a tool for measuring the responsiveness of a function to changes in parameters in a unitless way. Frequently used elasticities include price elasticity of demand, price elasticity of supply, income elasticity of demand, elasticity of substitution between factors of production and elasticity of intertemporal substitution. Elasticity is one of the most important concepts in neoclassical economic theory. It is useful in understanding the incidence of indirect taxation, marginal concepts as they relate to the theory of the firm, and distribution of wealth and different types of goods as they relate to the theory of consumer choice. Elasticity is also crucially important in any discussion of welfare distribution, in particular consumer surplus, producer surplus, or government surplus. In empirical work an elasticity is the estimated coefficient in a linear regression equation where both the dependent variable and the independent variable are in natural logs. Elasticity is a popular tool among empiricists because it is independent of units and thus simplifies data analysis. Generally, an "elastic" variable is one which responds "a lot" to small changes in other parameters. Similarly, an "inelastic" variable describes one which does not change much in response to changes in other parameters. A major study of the price elasticity of supply and the price elasticity of demand for US products was undertaken by Hendrik S. Houthakker and Lester D. Taylor. [1] Mathematical definition The definition of elasticity is based on the mathematical notion of point elasticity. In general, the "x-elasticity of y", also called the "elasticity of y with respect to x", is:

The approximation becomes exact in the limit as the changes become infinitesimal in size. Sometimes the elasticity is defined without the absolute value operator. A context where this use of a signed elasticity is necessary for clarity is the cross-price elasticity of demand the responsiveness of the demand for one product to changes in the price of another product; since the products may be either substitutes or complements, this elasticity could be positive or negative. Specific elasticities Elasticities of demand Price elasticity of demand Main article: Price elasticity of demand Price elasticity of demand measures the percentage change in quantity demanded caused by a percent change in price. As such, it measures the extent of movement along the demand curve. This elasticity is almost always negative and is usually expressed in terms of absolute value (i.e. as positive numbers) since the negative can be assumed. In these terms, then, if the elasticity is greater than 1 demand is said to be elastic; between zero and one demand is inelastic and if it equals one, demand is unit-elastic. Income elasticity of demand Main article: Income elasticity of demand Income elasticity of demand measures the percentage change in demand caused by a percent change in income. A change in income causes the demand curve to shift reflecting the change in demand. IED is a measurement of how far the curve shifts horizontally along the X-axis. Income elasticity can be used to classify goods as normal or inferior. With a normal good demand varies in the same direction as income. With an inferior good demand and income move in opposite directions.[2] Cross price elasticity of demand Main article: Cross price elasticity of demand Cross price elasticity of demand measures the percentage change in demand for a particular good caused by a percent change in the price of another good. Goods can be complements, substitutes or unrelated. A change in the price of a related good causes the demand curve to shift reflecting a change in demand for the original good. Cross price elasticity is a measurement of how far, and in which direction, the curve shifts horizontally along the x-axis. A positive crossprice elasticity means that the goods are substitute goods. Cross elasticity of demand between firms Main article: Conjectural variation Cross elasticity of demand for firms, sometimes referred to as conjectural variation, is a measure of the interdependence between firms. It captures the extent to which one firm reacts to changes in strategic variables (price, quantity, location, advertising, etc.) made by other firms. Elasticity of intertemporal substitution Main article: Elasticity of intertemporal substitution Combined Effects It is possible to consider the combined effects of two or more determinant of demand. The steps are as follows: PED = (Q/P) x P/Q. Convert this to the predictive equation: Q/Q = PED(P/P) if you wish to find the combined effect of changes in two or more determinants of demand you simply add the separate effects: Q/Q = PED(P/P) + YED(Y/Y)[12] Remember you are still only considering the effect in demand of a change in two of the variables. All other variables must be held constant. Note also that graphically this problem would involve a shift of the curve and a movement along the shifted curve. Elasticities of supply Price elasticity of supply Main article: Price elasticity of supply The price elasticity of supply measures how the amount of a good firms wish to supply changes in response to a change in price. [3] In a manner analogous to the price elasticity of demand, it captures the extent of movement along the supply curve. If the price elasticity of supply is zero the supply of a good supplied is "inelastic" and the quantity supplied is fixed. Elasticities of scale Main article: Returns to scale Elasticity of scale or output elasticities measure the percentage change in output induced by a percent change in inputs.[4] A production function or process is said to exhibit constant returns to scale if a percentage change in inputs results in an equal percentage in outputs (an elasticity equal to 1). It exhibits increasing returns to scale if a percentage change in inputs results in greater percentage change in output (an elasticity greater than 1). The definition of decreasing returns to scale is analogous.[5]

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Applications The concept of elasticity has an extraordinarily wide range of applications in economics. In particular, an understanding of elasticity is fundamental in understanding the response of supply and demand in a market. Some common uses of elasticity include:

Effect of changing price on firm revenue. See Markup rule. Analysis of incidence of the tax burden and other government policies. See Tax incidence. Income elasticity of demand can be used as an indicator of industry health, future consumption patterns and as a guide to firms investment decisions. See Income elasticity of demand. Effect of international trade and terms of trade effects. See MarshallLerner condition and Singer Prebisch thesis. Analysis of consumption and saving behavior. See Permanent income hypothesis. Analysis of advertising on consumer demand for particular goods. See Advertising elasticity of demand

Utility In economics, utility is a measure of relative satisfaction. Given this measure, one may speak meaningfully of increasing or decreasing utility, and thereby explain economic behavior in terms of attempts to increase one's utility. Utility is often modeled to be affected by consumption of various goods and services, possession of wealth and spending of leisure time. The doctrine of utilitarianism saw the maximization of utility as a moral criterion for the organization of society. According to utilitarians, such as Jeremy Bentham (17481832) and John Stuart Mill (18061873), society should aim to maximize the total utility of individuals, aiming for "the greatest happiness for the greatest number of people". Another theory forwarded by John Rawls (19212002) would have society maximize the utility of the individual initially receiving the minimum amount of utility. Utility is usually applied by economists in such constructs as the indifference curve, which plot the combination of commodities that an individual or a society would accept to maintain a given level of satisfaction. Individual utility and social utility can be construed as the value of a utility function and a social welfare function respectively. When coupled with production or commodity constraints, under some assumptions, these functions can be used to analyze Pareto efficiency, such as illustrated by Edgeworth boxes in contract curves. Such efficiency is a central concept in welfare economics.

Price mechanism is an economic term that refers to the buyers and sellers who negotiate prices of goods or services depending on demand and supply.[1] A price mechanism or market-based mechanism refers to a wide variety of ways to match up buyers and sellers through price rationing. An example of a price mechanism uses announced bid and ask prices. Generally speaking, when two parties wish to engage in a trade, the purchaser will announce a price he is willing to pay (the bid price) and seller will announce a price he is willing to accept (the ask price). The main advantage of such a method is that conditions are laid out in advance and transactions can proceed with no further permission or authorization from any participant. When any bid and ask pair are compatible, a transaction occurs, in most cases automatically

Price mechanism is also a System of interdependence between supply of a good or service and its price. It generally sends the price up when supply is below demand, and down when supply exceeds demand. Price mechanism also restricts supply when suppliers leave the market due to low prevailing prices, and increases it when more suppliers enter the market due to high obtainable prices. Also called price system. The price mechanism as you put it, is actually the way that goods are exchanged for money. If the price is too high not many goods are sold, if it is too low, stocks quickly depleate. So this mechanism is the methods by which the price and the quantity being sold over a specific short time become equivalent to

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the

rate

at

which

the

goods

are

being

currently

produced.

The result of this mechanism being in action in a pure competitive setting is that supply and demand are equal which is called Say's law. Effects of Price Mechanism Price Mechanism causes many changes in the economic environment. If there is an increase in demand, then prices will go higher causing a movement along the supply curve.[2] An example of price mechanism in the long term is the oil crisis during the 1970s. The crisis caused more nations to start producing its own oil due to dramatic price increases of oil. Since more nations started to produce oil, the supply curve shifted more to the right meaning there was more supply of oil. Price Mechanism affects every economic situation in the long term. Another good example of price mechanism in the long run is fuel for cars. If fuel becomes more expensive, then the demand of fuel would not decrease fast but eventually companies will start to produce alternatives such as biodiesel fuel and electrical cars.[3] Stock market When trading in a stock market, a person who has shares to sell may not wish to sell them at the current market price (quote). Likewise, a person who wishes to buy shares may not wish to pay the current market price either. Some negotiation is necessary in order for a transaction to occur. The negotiation often comes in the form of adjusting the bid prices and the ask prices as the value of the share goes up and down. For example, if the share is worth $10, a buyer may "bid" $9.97 (3 cents less), and a seller may ask for $10.02 (2 cents more). If the value of the stock goes down, a seller may be forced to reduce his asking price. Conversely, if the value of the stock goes up, a buyer may be forced to increase his bidding price. Most of the time, the bid and ask prices remain very close to the market value of the share, often separated by only a couple of cents. The difference between the bid and ask price is called the Bid/ask spread. In actual trading, the parties involved might use a limit order to specify which bid or ask price he wishes to trade at. The trader specifies the number of shares and his bid/ask price (depending on whether he is buying or selling). Such orders can have execution limits, such as "by end of day" or "all or nothing". Auctions Main article: Auction An auction is a price mechanism where bidders can make competing offers for a good. The minimum bid may or may not be set by the seller, who may choose to predetermine an ask price. The highest bidder, or the first one to reach a preset ask price, would be awarded the transaction. Other Applications If the terms "pay" and "sell" are understood very generally, then, a very broad range of applications and different market systems can be enabled this way. Internet dating for instance could be based on offers to talk for a period of time, accepted by those who are compensated not in money but in additional credits to keep using the system. Or, a political party could trade support for different measures in a platform, perhaps using allocation voting to "bid" a certain amount of support for a measure that a leader has "asked" them to support: if the measure has enough support in the party, the leader will proceed; a very explicit model of so-called "political capital". Though there are many concerns about liquidating any given transaction, even in a conventional market, there are ideologies which hold that the risks are outweighed by the efficient rendezvous. In greenhouse gas emissions trading, companies doing the "bidding" argue that Earth's atmosphere can be seen as affected almost uniformly by emissions anywhere on Earth. They argue further that, as a result, there are almost no local effects, and only a measurable and widely agreed climate change effect, of a greenhouse gas emission, justifying a "cap and trade" approach. Somewhat more controversially, the approach was applied even earlier to sulfur dioxide emissions in the United States, and was quite successful in reducing overall smog output there. In most applications of such methods, however, the comprehensive outcome of the transaction is not so easily measured or universally agreed. Some theorists assert that, with appropriate controls, a market

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mechanism can replace a hierarchy, even a command hierarchy, by ordering actions for which the highest bid is received: An infamous example is the assassination market proposed by Timothy C. May, which were effectively bets on someone's death. This has since been generalized into the prediction market idea which the Pentagon proposed to operate as part of Total Information Awareness; however, this proved controversial as it would theoretically let assassins predict and then benefit from their predictions, which they would cause to come true. This is a problem even with the commodity markets and any other financial markets, where a single person's choices or fate might be influenced, predicted, or decided by someone already in the market. Less controversial applications of bid and ask matching include:

industrial process control various applications in social networks (including dating above) calculating interest in court judgments or homestead credit determining which of several assets in a divorce are most prized by each party, and accordingly, who should receive what for maximum amiability and minimum capital asset sale and lifestyle disruption

Application to price theory Marginalism and neoclassical economics typically explain price formation broadly through the interaction of curves or schedules of supply and demand. In any case buyers are modelled as pursuing typically lower quantities, and sellers offering typically higher quantities, as price is increased, with each being willing to trade until the marginal value of what they would trade-away exceeds that of the thing for which they would trade. Demand Demand curves are explained by marginalism in terms of marginal rates of substitution. At any given price, a prospective buyer has some marginal rate of substitution of money for the good or service in question. Given the law of diminishing marginal utility, or otherwise given convex indifference curves, the rates are such that the willingness to forgo money for the good or service decreases as the buyer would have ever more of the good or service and ever less money. Hence, any given buyer has a demand schedule that generally decreases in response to price (at least until quantity demanded reaches zero). The aggregate quantity demanded by all buyers is, at any given price, just the sum of the quantities demanded by individual buyers, so it too decreases as price increases. [edit] Supply Both neoclassical economics and thorough-going marginalism could be said to explain supply curves in terms of marginal cost; however, there are markd differences in conceptions of that cost. Marginalists in the tradition of Marshall and neoclassical economists tend to represent the supply curve for any producer as a curve of marginal pecuniary costs objectively determined by physical processes, with an upward slope determined by diminishing returns. A more thorough-going marginalism represents the supply curve as a complementary demand curve where the demand is for money and the purchase is made with a good or service. [10] The shape of that curve is then determined by marginal rates of substitution of money for that good or service. [edit] Markets By confining themselves to limiting cases in which sellers or buyers are both price takers so that demand functions ignore supply functions or vice versa Marshallian marginalists and neoclassical economists produced tractable models of pure or perfect competition and of various forms of imperfect competition, which models are usually captured by relatively simple graphs. Other marginalists have sought to present more realistic explanations, [11][12] but this work has been relatively uninfluential on the mainstream of economic thought. NB In microeconomics, principal concepts include supply and demand, marginalism, rational choice theory, opportunity cost, budget constraints, utility, and the theory of the firm. Production theory

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Production refers to the economic process of converting of inputs into outputs. Production uses resources to create a good or service that is suitable for exchange. This can include manufacturing, storing, shipping, and packaging. Some economists define production broadly as all economic activity other than consumption. They see every commercial activity other than the final purchase as some form of production. Production is a process, and as such it occurs through time and space. Because it is a flow concept, production is measured as a rate of output per period of time. There are three aspects to production processes: 1. 2. 3. the quantity of the good or service produced, the form of the good or service created, the temporal and spatial distribution of the good or service produced.

A production process can be defined as any activity that increases the similarity between the pattern of demand for goods and services, and the quantity, form, shape, size, length and distribution of these goods and services available to the market place. Factors of production Main article: Factors of production The inputs or resources used in the production process are called factors of production by economists. The myriad of possible inputs are usually grouped into five categories. These factors are:

Raw materials Machinery Labour services Capital goods Land

In the long run, all of these factors of production can be adjusted by management. The short run, however, is defined as a period in which at least one of the factors of production is fixed. A fixed factor of production is one whose quantity cannot readily be changed. Examples include major pieces of equipment, suitable factory space, and key managerial personnel. A variable factor of production is one whose usage rate can be changed easily. Examples include electrical power consumption, transportation services, and most raw material inputs. In the short run, a firms scale of operations determines the maximum number of outputs that can be produced. In the long run, there are no scale limitations. Total, average, and marginal product

Total Product Curve The total product (or total physical product) of a variable factor of production identifies what outputs are possible using various levels of the variable input. This can be displayed in either a chart that lists the output level corresponding to various levels of input, or a graph that summarizes the data into a total product curve. The diagram shows a typical total product curve. In this example, output increases as more inputs are employed up until point A. The maximum output possible with this production process is Qm. (If there are other inputs used in the process, they are assumed to be fixed.)

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The average physical product is the total production divided by the number of units of variable input employed. It is the output of each unit of input. If there are 10 employees working on a production process that manufactures 50 units per day, then the average product of variable labour input is 5 units per day.

Average and Marginal Physical Product Curves The average product typically varies as more of the input is employed, so this relationship can also be expressed as a chart or as a graph. A typical average physical product curve is shown (APP). It can be obtained by drawing a vector from the origin to various points on the total product curve and plotting the slopes of these vectors. The marginal physical product of a variable input is the change in total output due to a one unit change in the variable input (called the discrete marginal product) or alternatively the rate of change in total output due to an infinitesimally small change in the variable input (called the continuous marginal product). The discrete marginal product of capital is the additional output resulting from the use of an additional unit of capital (assuming all other factors are fixed). The continuous marginal product of a variable input can be calculated as the derivative of quantity produced with respect to variable input employed. The marginal physical product curve is shown (MPP). It can be obtained from the slope of the total product curve. Because the marginal product drives changes in the average product, we know that when the average physical product is falling, the marginal physical product must be less than the average. Likewise, when the average physical product is rising, it must be due to a marginal physical product greater than the average. For this reason, the marginal physical product curve must intersect the maximum point on the average physical product curve. Notes: MPP keeps increasing until it reaches its maximum. Up until this point every additional unit has been adding more value to the total product than the previous one. From this point onwards, every additional unit adds less to the total product compared to the previous one MPP is decreasing. But the average product is still increasing till MPP touches APP. At this point, an additional unit is adding the same value as the average product. From this point onwards, APP starts to reduce because every additional unit is adding less to APP than the average product. But the total product is still increasing because every additional unit is still contributing positively. Therefore, during this period, both, the average as well as marginal products, are decreasing, but the total product is still increasing. Finally we reach a point when MPP crosses the x-axis. At this point every additional unit starts to diminish the product of previous units, possibly by getting into their way. Therefore the total product starts to decrease at this point. This is point A on the total product curve. (Courtesy: Dr. Shehzad Inayat Ali). Diminishing returns Diminishing returns can be divided into three categories: 1. Diminishing Total returns , which implies reduction in total product with every additional unit of input. This occurs after point A in the graph. 2. Diminishing Average returns , which refers to the portion of the APP curve after its intersection with MPP curve. 3. Diminishing Marginal returns , refers to the point where the MPP curve starts to slope down and travels all the way down to the x-axis and beyond. Putting it in a chronological order, at first the marginal returns start to diminish, then the average returns, followed finally by the total returns. Diminishing marginal returns These curves illustrate the principle of diminishing marginal returns to a variable input (not to be confused with diseconomies of scale which is a long term phenomenon in which all factors are allowed to change). This states that as you add more and more of a variable input, you will reach a point beyond which the resulting increase in output starts to diminish. This point is illustrated as the maximum point on the marginal physical product curve. It assumes that other factor inputs (if they are used in the process) are held constant. An example is the employment of labour in the use of trucks to transport goods. Assuming the number of available trucks (capital) is fixed, then the amount of the variable input labour could be varied and the resultant efficiency determined. At least one labourer (the driver) is necessary. Additional workers per vehicle could be productive in loading, unloading, navigation, or around the clock

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continuous driving. But at some point the returns to investment in labour will start to diminish and efficiency will decrease. The most efficient distribution of labour per piece of equipment will likely be one driver plus an additional worker for other tasks (2 workers per truck would be more efficient than 5 per truck). Resource allocations and distributive efficiencies in the mix of capital and labour investment will vary per industry and according to available technology. Trains are able to transport much more in the way of goods with fewer "drivers" but at the cost of greater investment in infrastructure. With the advent of mass production of motorized vehicles, the economic niche occupied by trains (compared with transport trucks) has become more specialized and limited to long haul delivery. P.S.: There is an argument that if the theory is holding everything constant, the production method should not be changed, i.e., division of labour should not be practiced. However, the rise in marginal product means that the workers use other means of production method, such as in loading, unloading, navigation, or around the clock continuous driving. For this reason, some economists think that the keeping other things constant should not be used in this theory. Many ways of expressing the production relationship The total, average, and marginal physical product curves mentioned above are just one way of showing production relationships. They express the quantity of output relative to the amount of variable input employed while holding fixed inputs constant. Because they depict a short run relationship, they are sometimes called short run production functions. If all inputs are allowed to be varied, then the diagram would express outputs relative to total inputs, and the function would be a long run production function. If the mix of inputs is held constant, then output would be expressed relative to inputs of a fixed composition, and the function would indicate long run economies of scale. Rather than comparing inputs to outputs, it is also possible to assess the mix of inputs employed in production. An isoquant (see below) relates the quantities of one input to the quantities of another input. It indicates all possible combinations of inputs that are capable of producing a given level of output. Rather than looking at the inputs used in production, it is possible to look at the mix of outputs that are possible for any given production process. This is done with a production possibilities frontier. It indicates what combinations of outputs are possible given the available factor endowment and the prevailing production technology. Isoquants

Isoquant Curve/Isocost Curve

Two Isoquants (Interior and Corner Solutions) An isoquant represents those combinations of inputs, which will be capable of producing an equal quantity of output; the producer would be indifferent between them. The isoquants are thus contour lines, which trace the loci of equal outputs. As the production remains the same on any point of this line, it is also called equal product curve. Let, Q0 = f(L,K) is a production factor. Where, Q0 = A fixed level of production. L = Labour K = Capital

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If three combinations of labour and capital A, B and C produces 10 units of product, than the isoquant will be like Figure 1. Here we see that the combination of L1 labour and K3 capital can produce 10 units of product, which is A on the isoquant. Now to increase the labour keeping the production same the organization have to decrease capital.In Figure 1 B is the point where capital decreases to K2, while labour increases to L2. Similarly, 10 units of product may produce at point C on the isoquant with capital K1 and labour L3. Each of the factor combinations A, B and C produces the same level of output, 10 units.

The marginal rate of technical substitution

Marginal Rate of Technical Substitution Isoquants are typically convex to the origin reflecting the fact that the two factors are substitutable for each other at varying rates. This rate of substitutability is called the marginal rate of technical substitution (MRTS) or occasionally the marginal rate of substitution in production. It measures the reduction in one input per unit increase in the other input that is just sufficient to maintain a constant level of production. For example, the marginal rate of substitution of labour for capital gives the amount of capital that can be replaced by one unit of labour while keeping output unchanged. To move from point A to point B in the diagram, the amount of capital is reduced from Ka to Kb while the amount of labour is increased only from La to Lb. To move from point C to point D, the amount of capital is reduced from Kc to Kd while the amount of labour is increased from Lc to Ld. The marginal rate of technical substitution of labour for capital is equivalent to the absolute slope of the isoquant at that point (change in capital divided by change in labour). It is equal to 0 where the isoquant becomes horizontal, and equal to infinity where it becomes vertical. The opposite is true when going in the other direction (from D to C to B to A). In this case we are looking at the marginal rate of technical substitution capital for labour (which is the reciprocal of the marginal rate of technical substitution labour for capital). It can also be shown that the marginal rate of substitution labour for capital, is equal to the marginal physical product of labour divided by the marginal physical product of capital. In the unusual case of two inputs that are perfect substitutes for each other in production, the isoquant would be linear (linear in the sense of a function ). If, on the other hand, there is only one production process available, factor proportions would be fixed, and these zero-substitutability isoquants would be shown as horizontal or vertical lines. Factors of production In economics, factors of production (or productive inputs or resources) are any commodities or services used to produce goods and services. 'Factors of production' may also refer specifically to the primary factors, which are stocks including land, labor (the ability to work), and capital goods applied to production. The primary factors facilitate production but neither become part of the product (as with raw materials) nor become significantly transformed by the production process (as with fuel used to power machinery). 'Land' includes not only the site of production but natural resources above or below the soil. Recent usage has distinguished human capital (the stock of knowledge in the labor force) from labor.[1]

y = a bx

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Entrepreneurship is also sometimes considered a factor of production. [2] Sometimes the overall state of technology is described as a factor of production. [3] The number and definition of factors varies, depending on theoretical purpose, empirical emphasis, or school of economics.[4] Differences are most stark when it comes to deciding which factor is the most important. For example, in the Austrian viewoften shared by neoclassical and other "free market" economiststhe primary factor of production is the time of the entrepreneur, which, when combined with other factors, determines the amount of output of a particular good or service. However, other authors argue that "entrepreneurship" is nothing but a specific kind of labor or human capital and should not be treated separately. The Marxian school goes further, seeing labor (in general, including entrepreneurship) as the primary factor of production, since it is required to produce capital goods and to utilize the gifts of nature. But this debate is more about basic economic theory (the role of the factors in the economy) than it is about the definition of the factors of production Supply Introduction

Diagram 1. The supply curve. Added by GregLoutsenko Supply is complete description of quantity of particular good or service which a firm is able and willing to at each possible price. Generally, assuming all other factors are constant, quantity supplied increases as price increases. This is because higher price justifies the higher costs of larger volume of production for a firm and more importantly higher price allows for greater revenue which means that there is an increased potential for more profit to be made. The generalisation can be shown on a graph of price against quantity of sales in a certain time period. This is shown in diagram 1. If price rises from P1 to P2 in diagram 1 then one may expect most producers in that market to raise production in order to gain more revenue. Thus the shift along the supply curve results in overall quantity sold to become Q2. This conclusion is made on the assumption that stock levels of this good are negligible and that economies of scale as well as diseconomies of scale play no part in production. Factors affecting Supply Edit

Diagram 2. Added by GregLoutsenko There are several factors which affect supply. Fundamentally the higher the cost of production the lower the output will be per each possible price. Thus anything which affects the cost of factors production will affect supply. Thus the following factors may affect supply:

Technology.Generally in classical economic theory any improvement in technology will probably reduce unit cost of a good or service. Thus any innovation or improvement in technology may be accompanied by an increase in supply. This can be demonstrated in diagram 2. An improvement in technology may shift the supply curve from S to S2. Thus one can expect there to be an increase in quantity supplied by the market, that is, an increase from Q1 to Q2. However classical economics assumes that firms are run purely for profit and that the owners of firms will desire only more profit. This may not be so in real life. For example an improvement in technology could increase profitability thus allowing people to work less and thus reducing supply, from S to S2 in diagram 2, while maintaining similar levels of profit.

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Diagram 3. Effect of Tax. Added by GregLoutsenko Government regulations. If laws and regulations complicate production supply will decrease.

Tax. An increase in tax, cooperate or indirect tax, will decrease supply. This can be seen in diagram 3. Profitability . If it is more profitable to produce a good or service then other goods and services which a firm may produce then that firm may increase supply in order to take advantage of higher profitability.

Factors affecting PES Edit Supply can experience change in price elasticity of supply. This means that the gradient of the supply curve changes. Factors which may contribute to such a change are as follows:

Spare production capacity. Time. Mobility of factors of production.

Diminishing returns In economics, diminishing returns (also called diminishing marginal returns) refers to progressive decrease in the marginal (per-unit) output of a production process as the amount of a single factor of production is increased, while holding the amounts of all other factors of production constant. The law of diminishing returns (also law of diminishing marginal returns or law of increasing relative cost) states that in all productive processes, adding more of one factor of production, while holding all others constant, will at some point yield lower per-unit returns. [1] The law of diminishing returns does not imply that adding more of a factor will decrease the total production, a condition known as negative returns, though in fact this is common. For example, the use of fertilizer improves crop production on farms and in gardens; but at some point, adding more and more fertilizer improves the yield less and less, and excessive quantities can even reduce the yield. A common sort of example is adding more workers to a job, such as assembling a car on a factory floor. At some point, adding more workers causes problems such as getting in each other's way, or workers frequently find themselves waiting for access to a part. In all of these processes, producing one more unit of output per unit of time will eventually cost increasingly more, due to inputs being used less and less effectively. The law of diminishing returns is one of the most famous laws in all of economics. [2] It plays a central role in production theory. SPECIALISATION Economics is about the production, distribution and consumption of goods. A key decision facing workers, firms and nations is what goods to produce. The economic concept of specialization helps answer this question. Under specialization, economic actors concentrate their skills on tasks at which they are the most skilled. Specialization has both micro- and macroeconomic applications. Specialization in an economic sense refers to individuals and organizations focusing on the limited range of production tasks they perform best. This specialization requires workers to give up performing other tasks at which they are not as skilled, leaving those jobs to others who are better suited for them. An assembly line, where individual workers perform specific tasks in the production process, is the best example of specialization The DIVISION OF LABOUR is a system whereby workers concentrate on performing a few tasks and then exchange their production for other goods and services. This is an example of specialisation. ADVANTAGES OF SPECIALISATION / DIVISION OF LABOUR

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To the business: Specialist workers become quicker at producing goods Production becomes cheaper per good because of this Production levels are increased - Each worker can concentrate on what they are good at and build up their expertise To the worker: Higher - Improved skills at that job. pay for specialised work

DISADVANTAGES OF SPECIALISATION / DIVISION OF LABOUR To the business: Greater cost of training -Quality may suffer if workers become bored by the lack of variety in their jobs To the worker: Boredom as they Their quality and - May eventually be replaced by machinery OTHER TYPES OF SPECIALISATION REGIONAL Certain areas have specialised in certain industrial production e.g. coal mining in Yorkshire, pottery in Stoke INTERNATIONAL Certain countries have advantages in producing certain goods. They may have natural resources or they may be able to produce goods more cheaply. e.g. Sri Lanka Tea, Japan electronics. They then trade these goods for those produced in other countries. Economies of scale do the same may job suffer workers

skills

Economies of scale, in microeconomics, refers to the cost advantages that a business obtains due to expansion. There are factors that cause a producers average cost per unit to fall as the scale of output is increased. "Economies of scale" is a long run concept and refers to reductions in unit cost as the size of a facility and the usage levels of other inputs increase. [1] Diseconomies of scale are the opposite. The common sources of economies of scale are purchasing (bulk buying of materials through long-term contracts), managerial (increasing the specialization of managers), financial (obtaining lower-interest charges when borrowing from banks and having access to a greater range of financial instruments), marketing (spreading the cost of advertising over a greater range of output in media markets), and technological (taking advantage of returns to scale in the production function). Each of these factors reduces the long run average costs (LRAC) of production by shifting the short-run average total cost (SRATC) curve down and to the right. Economies of scale are also derived partially from learning by doing.

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Economies of scale is a practical concept that may explain real world phenomena such as patterns of international trade, the number of firms in a market, and how firms get " too big to fail." The exploitation of economies of scale helps explain why companies grow large in some industries. It is also a justification for free trade policies, since some economies of scale may require a larger market than is possible within a particular country for example, it would not be efficient for Liechtenstein to have its own car maker, if they would only sell to their local market. A lone car maker may be profitable, however, if they export cars to global markets in addition to selling to the local market. Economies of scale also play a role in a " natural monopoly." Diseconomy of scale Diseconomies of scale are the forces that cause larger firms and governments to produce goods and services at increased per-unit costs. They are less well known than what economists have long understood as "economies of scale", the forces which enable larger firms to produce goods and services at reduced per-unit costs. The concept may be applied to non-market entities as well. Some political philosophies, such as libertarianism, recognize the concept as applying to government

The rising part of the long-run average cost curve illustrates the effect of diseconomies of scale. Beyond Q 1 (Ideal firm size), additional production will increase per-unit costs.

Causes Some of the forces which cause a diseconomy of scale are listed below: ] Cost of communication Ideally, all employees of a firm would have one-on-one communication with each other so they know exactly what the other workers are doing. [citation needed] A firm with a single worker does not require any communication between employees. A firm with two workers requires one communication channel, directly between those two workers. A firm with three workers requires three communication channels (between employees A & B, B & C, and A & C). Here is a chart of one-on-one communication channels required: Worker s 1 2 3 4 5 n Communication Channels 0 1 3 6 10

The one-on-one channels of communication grow more rapidly than the number of workers, thus increasing the time, and therefore costs, of communication. At some point one-on-one communications between all workers becomes impractical; therefore only certain groups of employees will communicate with one another (salespeople with salespeople, production workers with production workers, etc.). This reduced communication slows, but doesn't stop, the increase in time and money with firm growth, but also costs additional money, due to duplication of effort, owing to this reduced level of communication. [edit] Duplication of effort A firm with only one employee can't have any duplication of effort between employees. A firm with two employees could have duplication of efforts, but this is improbable, as the two are likely to know what each other is working on at all times. When firms grow to thousands of workers, it is inevitable that someone, or even a team, will take on a project that is already being handled by another person or team. General Motors, for example, developed two in-house CAD/CAM systems: CADANCE was designed by the

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GM Design Staff, while Fisher Graphics was created by the former Fisher Body division. These similar systems later needed to be combined into a single Corporate Graphics System, CGS, at great expense. A smaller firm would neither have had the money to allow such expensive parallel developments, or the lack of communication and cooperation which precipitated this event. In addition to CGS, GM also used CADAM, UNIGRAPHICS, CATIA and other off-the-shelf CAD/CAM systems, thus increasing the cost of translating designs from one system to another. This endeavor eventually became so unmanageable that they acquired (and then eventual sold off) Electronic Data Systems (EDS) in an effort to control the situation. Smaller firms typically choose a single off-the shelf CAD/CAM system, with no need to combine or translate between systems. [edit] Top-heavy companies The more employees a firm has, the larger percentage of the workforce will be "management" (this refers to management of people, as opposed to management of other resources). A company with a single worker doesn't need any managers. A firm with five employees might employ one as a manager and the other four as workers. If that manager does nothing other than manage the workers under them, then the productivity of the firm has been reduced by 20%. A firm with 21 employees might have 16 workers, 4 supervisors, and 1 manager. If neither the manager nor supervisors do anything but manage the people under them, then we now have reduced productivity by 5/21 or 23.8%. Thus, the larger the firm, the lower the percentage of "line workers". To be sure, companies with higher worker-to-manager ratios and that have "working managers" (who perform other important tasks in addition to managing the people under them) will have their productivity less negatively impacted by growth, but the effect is still there. Managers are necessary to manage a large, complex company, but should be considered a "necessary evil" as they also reduce overall productivity. Also note that higher level managers get higher level pay, and thus cost the company more than their numbers would indicate. For example, a company with 16 workers at $10/hr, 4 supervisors at $20/hr and 1 manager at $30/hr is spending $270/hr, $110/hr (41%) of which is on management. [edit] Office politics "Office politics" is management behavior which a manager knows is counter to the best interest of the company, but is in his personal best interest. For example, a manager might intentionally promote an incompetent worker knowing that that worker will never be able to compete for the manager's job. This type of behavior only makes sense in a company with multiple levels of management. The more levels there are, the more opportunity for this behavior. At a small company, such behavior would likely cause the company to go bankrupt, and thus cost the manager his job, so he would not make such a decision. At a large company, one bad manager would not have much effect on the overall health of the company, so such "office politics" are in the interest of individual managers. [edit] Isolation of decision makers from results of their decisions If a single person makes and sells donuts and decides to try jalapeo flavoring, they would likely know that day whether their decision was good or not, based on the reaction of customers. A decision maker at a huge company that makes donuts may not know for many months if such a decision worked out or not. By that time they may very well have moved on to another division or company and thus see no consequences from their decision. This lack of consequences can lead to poor decisions and cause an upward sloping average cost curve. [edit] Slow response time In a reverse example, the single worker donut firm will know immediately if people begin to request healthier offerings, like whole grain bagels, and be able to respond the next day. A large company would need to do research, create an assembly line, determine which distribution chains to use, plan an advertising campaign, etc., before any change could be made. By this time smaller competitors may well have grabbed that market niche. [edit] Inertia (unwillingness to change) This will be defined as the "we've always done it that way, so there's no need to ever change" attitude (see appeal to tradition). An old, successful company is far more likely to have this attitude than a new, struggling one. While "change for change's sake" is counter-productive, refusal to consider change, even when indicated, is toxic to a company, as changes in the industry and market conditions will inevitably demand changes in the firm, in order to remain successful. A recent example is Polaroid Corporation's refusal to move into digital imaging until after this lag adversely affected the company, ultimately leading to bankruptcy.[citation needed] [edit] Cannibalization A small firm only competes with other firms, but larger firms frequently find their own products are competing with each other. A Buick was just as likely to steal customers from another GM make, such as

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an Oldsmobile, as it was to steal customers from other companies. This may help to explain why Oldsmobiles were discontinued after 2004. This self-competition wastes resources that should be used to compete with other firms. [edit] Large market share A small company with only a 1% market share could potentially double market share, and hence revenues, in a year. A large company with 90% market share will find it difficult to do so well, as this would require that they control 180% of the original market. Unless the total market size in increasing rapidly, this isn't possible. [edit] Large market portfolio A small investment fund can potentially return a larger percentage because it can concentrate its investments in a small number of good opportunities without driving up the price of the investment securities.[1] Conversely, a large investment fund like Fidelity Magellan must spread its investments among so many securities that its results tend to track those of the market as a whole. [2] [edit] Inelasticity of supply A company which is heavily dependent on its resource supply will have trouble increasing production. For instance a timber company can not increase production above the sustainable harvest rate of its land. Similarly service companies are limited by available labor, STEM (Science Technology Engineering and Mathematics professions) being the most cited example. [edit] Public and government opposition Such opposition is largely a function of the size of the firm. Behavior from Microsoft, which would have been ignored from a smaller firm, was seen as an anti-competitive and monopolistic threat, due to Microsoft's size, thus bringing about public opposition and government lawsuits. Other effects related to size Large firms also tend to be old and in mature markets. Both of these have negative implications for future growth, as well. Old firms tend to have a large retiree base, with high associated pension and health costs, and also tend to be unionized, with associated higher labor costs and lower productivity. Mature markets tend to only offer the potential for small, incremental growth. (Everybody might go out and buy a new invention next year, but it is unlikely they will all buy cars next year, since most people already have them.) Solutions Solutions to the diseconomy of scale for large firms involve changing the company into one or more small firms. This can either happen by default when the company, in bankruptcy, sells off its profitable divisions and shuts down the rest, or can happen proactively, if the management is willing. Returning to the example of the large donut firm, each retail location could be allowed to operate relatively autonomously from the company headquarters, with employee decisions (hiring, firing, promotions, wage scales, etc.) made by local management, not dictated by the corporation. Purchasing decisions could also be made independently, with each location allowed to choose its own suppliers, which may or may not be owned by the corporation (wherever they find the best quality and prices). Each locale would also have the option of either choosing their own recipes and doing their own marketing, or they may continue to rely on the corporation for those services. If the employees own a portion of the local business, they will also have more invested in its success. Note that all these changes will likely result in a substantial reduction in corporate headquarters staff and other support staff. For this reason, many businesses delay such a reorganization until it is too late to be effective. In business, revenue is income that a company receives from its normal business activities, usually from the sale of goods and services to customers. In many countries, such as the United Kingdom, revenue is referred to as turnover. Some companies receive revenue from interest, dividends or royalties paid to them by other companies.[1] Revenue may refer to business income in general, or it may refer to the amount, in a monetary unit, received during a period of time, as in "Last year, Company X had revenue of $42 million." Profits or net income generally imply total revenue minus total expenses in a given period. In accounting, revenue is often referred to as the "top line" due to its position on the income statement at the very top. This is to be contrasted with the "bottom line" which denotes net income. [2] For non-profit organizations, annual revenue may be referred to as gross receipts.[3] This revenue includes donations from individuals and corporations, support from government agencies, income from activities related to the organization's mission, and income from fundraising activities, membership dues, and financial investments such as stock shares in companies.

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In general usage, revenue is income received by an organization in the form of cash or cash equivalents. Sales revenue or revenues is income received from selling goods or services over a period of time. Tax revenue is income that a government receives from taxpayers. In more formal usage, revenue is a calculation or estimation of periodic income based on a particular standard accounting practice or the rules established by a government or government agency. Two common accounting methods, cash basis accounting and accrual basis accounting, do not use the same process for measuring revenue. Corporations that offer shares for sale to the public are usually required by law to report revenue based on generally accepted accounting principles or International Financial Reporting Standards. In a double-entry bookkeeping system, revenue accounts are general ledger accounts that are summarized periodically under the heading Revenue or Revenues on an income statement. Revenue account names describe the type of revenue, such as "Repair service revenue", "Rent revenue earned" or "Sales Business revenue Business revenue is income from activities that are ordinary for a particular corporation, company, partnership, or sole-proprietorship. For some businesses, such as manufacturing and/or grocery, most revenue is from the sale of goods. Service businesses such as law firms and barber shops receive most of their revenue from rendering services. Lending businesses such as car rentals and banks receive most of their revenue from fees and interest generated by lending assets to other organizations or individuals. Revenues from a business's primary activities are reported as sales, sales revenue or net sales. This includes product returns and discounts for early payment of invoices. Most businesses also have revenue that is incidental to the business's primary activities, such as interest earned on deposits in a demand account. This is included in revenue but not included in net sales. [5] Sales revenue does not include sales tax collected by the business. Other revenue (a.k.a. non-operating revenue) is revenue from peripheral (non-core) operations. For example, a company that manufactures and sells automobiles would record the revenue from the sale of an automobile as "regular" revenue. If that same company also rented a portion of one of its buildings, it would record that revenue as other revenue and disclose it separately on its income statement to show that it is from something other than its core operations. [edit] Financial statement analysis Main article: Financial statement analysis Revenue is a crucial part of financial statement analysis. A companys performance is measured to the extent to which its asset inflows (revenues) compare with its asset outflows (expenses). Net Income is the result of this equation, but revenue typically enjoys equal attention during a standard earnings call. If a company displays solid top-line growth, analysts could view the periods performance as positive even if earnings growth, or bottom-line growth is stagnant. Conversely, high income growth would be tainted if a company failed to produce significant revenue growth. Consistent revenue growth, as well as income growth, is considered essential for a company's publicly traded stock to be attractive to investors. Revenue is used as an indication of earnings quality. There are several financial ratios attached to it, the most important being gross margin and profit margin. Also, companies use revenue to determine bad debt expense using the income statement method. Price / Sales is sometimes used as a substitute for a Price to earnings ratio when earnings are negative and the P/E is meaningless. Though a company may have negative earnings, it almost always has positive revenue. Gross Margin is a calculation of revenue less cost of goods sold, and is used to determine how well sales cover direct variable costs relating to the production of goods. Net income/sales, or profit margin, is calculated by investors to determine how efficiently a company turns revenues into profits.... [edit] Government revenue Main article: Government revenue Government revenue includes all amounts of money received from sources outside the government entity. Large governments usually have an agency or department responsible for collecting government revenue from companies and individuals.[6]

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Government revenue may also include reserve bank currency which is printed. This is recorded as an advance to the retail bank together with a corresponding currency in circulation expense entry. The income derives from the Official Cash rate payable by the retail banks for instruments such as 90 day bills.There is a question as to whether using generic business based accounting standards can give a fair and accurate picture of government accounts in that with a monetary policy statement to the reserve bank directing a positive inflation rate the expense provision for the return of currency to the reserve bank is largely symbolic in that to totally cancel the currency in circulation provision all currency would have to be returned to the reserve bank and cancelled In business, retail, and accounting, a cost is the value of money that has been used up to produce something, and hence is not available for use anymore. In economics, a cost is an alternative that is given up as a result of a decision. [1] In business, the cost may be one of acquisition, in which case the amount of money expended to acquire it is counted as cost. In this case, money is the input that is gone in order to acquire the thing. This acquisition cost may be the sum of the cost of production as incurred by the original producer, and further costs of transaction as incurred by the acquirer over and above the price paid to the producer. Usually, the price also includes a mark-up for profit over the cost of production. Costs are often further described based on their timing or their applicability. Accounting vs opportunity costs In accounting, costs are the monetary value of expenditures for supplies, services, labour, products, equipment and other items purchased for use by a business or other accounting entity. It is the amount denoted on invoices as the price and recorded in bookkeeping records as an expense or asset cost basis. Opportunity cost, also referred to as economic cost is the value of the best alternative that was not chosen in order to pursue the current endeavouri.e., what could have been accomplished with the resources expended in the undertaking. It represents opportunities forgone. In theoretical economics, cost used without qualification often means opportunity cost. [citation needed] Comparing private, external, social, and psychic costs When a transaction takes place, it typically involves both private costs and external costs. Private costs are the costs that the buyer of a good or service pays the seller. This can also be described as the costs internal to the firm's production function. External costs (also called externalities), in contrast, are the costs that people other than the buyer are forced to pay as a result of the transaction. The bearers of such costs can be either particular individuals or society at large. Note that external costs are often both non-monetary and problematic to quantify for comparison with monetary values. They include things like pollution, things that society will likely have to pay for in some way or at some time in the future, but that are not included in transaction prices. Social costs are the sum of private costs and external costs. For example, the manufacturing cost of a car (i.e., the costs of buying inputs, land tax rates for the car plant, overhead costs of running the plant and labour costs) reflects the private cost for the manufacturer (in some ways, normal profit can also be seen as a cost of production; see, e.g., Ison and Wall, 2007, p. 181). The polluted waters or polluted air also created as part of the process of producing the car is an external cost borne by those who are affected by the pollution or who value unpolluted air or water. Because the manufacturer does not pay for this external cost (the cost of emitting undesirable waste into the commons), and does not include this cost in the price of the car (a Kaldor-Hicks compensation), they are said to be external to the market pricing mechanism. The air pollution from driving the car is also an externality produced by the car user in the process of using his good. The driver does not compensate for the environmental damage caused by using the car. A psychic cost is a subset of social costs that specifically represent the costs of added stress or losses to quality of life. Cost estimates and cost overrun Main article: Cost overrun When developing a business plan for a new or existing company, product, or project, planners typically make cost estimates in order to assess whether revenues/benefits will cover costs (see cost-benefit analysis). This is done in both business and government. Costs are often underestimated resulting in cost overrun during implementation. Main causes of cost underestimation and overrun are optimism bias and

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strategic misrepresentation (Flyvbjerg et al. 2002). Reference class forecasting was developed to curb optimism bias and strategic misrepresentation and arrive at more accurate cost estimates. [2] Cost Plus, is where the Price = Cost plus or minus X%, where x is the percentage of built in overhead or profit margin. Path cost Also seen as a term in networking to define the worthiness of a path, see Routing. Manufacturing Costs VS. Non-manufacturing costs Manufacturing Costs are those costs that are directly involved in manufacturing of products. Examples of manufacturing costs include raw materials costs and charges related workers. Manufacturing cost is divided into three broad categories: 1. 2. Direct materials cost. Direct labor cost. Manufacturing overhead cost.

3.

Non-manufacturing Costs are those costs that are not directly incurred to manufacture a product. Examples of such costs are salary of sales personnel and advertising expenses. Generally nonmanufacturing costs are further classified into two categories: 1. 2. Marketing and Selling Costs. Administrative Costs

Market structures In economics, market structure (also known as the number of firms producing identical products).

Monopolistic competition, also called competitive market, where there are a large number of firms, each having a small proportion of the market share and slightly differentiated products. Oligopoly, in which a market is dominated by a small number of firms that together control the majority of the market share. Duopoly, a special case of an oligopoly with two firms. Oligopsony, a market, where many sellers can be present but meet only a few buyers. Monopoly, where there is only one provider of a product or service. Natural monopoly, a monopoly in which economies of scale cause efficiency to increase continuously with the size of the firm. A firm is a natural monopoly if it is able to serve the entire market demand at a lower cost than any combination of two or more smaller, more specialized firms. Monopsony, when there is only one buyer in a market. Perfect competition is a theoretical market structure that features unlimited contestability (or no barriers to entry), an unlimited number of producers and consumers, and a perfectly elastic demand curve.

The imperfectly competitive structure is quite identical to the realistic market conditions where some monopolistic competitors, monopolists, oligopolists, and duopolists exist and dominate the market conditions. The elements of Market Structure include the number and size distribution of firms, entry conditions, and the extent of differentiation. These somewhat abstract concerns tend to determine some but not all details of a specific concrete market system where buyers and sellers actually meet and commit to trade. Competition is useful because it reveals actual customer demand and induces the seller (operator) to provide service quality levels and price levels that buyers (customers) want, typically subject to the sellers financial need to cover its costs. In other words, competition can align the sellers interests with the buyers interests and can cause the seller to reveal his true costs and other private information. In the absence of perfect competition, three basic approaches can be adopted to deal with problems related to the control of market power and an asymmetry between the government and the operator with respect to objectives and information: (a) subjecting the operator to competitive pressures, (b) gathering information on the operator and the market, and (c) applying incentive regulation. [1] Quick Reference to Basic Market Structures Market Structure Seller Entry Seller

Buyer

Entry Buyer

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Perfect Competition Monopolistic competition Oligopoly Oligopsony Monopoly Monopsony

Barriers No No Yes No Yes No

Number Many Many Few Many One Many

Barriers No No No Yes No Yes

Number Many Many Many Few Many One

The correct sequence of the market structure from most to least competitive is perfect competition, imperfect competition,oligopoly, and pure monopoly. The main criteria by which one can distinguish between different market structures are: the number and size of producers and consumers in the market, the type of goods and services being traded, and the degree to which information can flow freely. Price discrimination or price differentiation [1] exists when sales of identical goods or services are transacted at different prices from the same provider. [2] In a theoretical market with perfect information, perfect substitutes, and no transaction costs or prohibition on secondary exchange (or re-selling) to prevent arbitrage, price discrimination can only be a feature of monopolistic and oligopolistic markets,[3] where market power can be exercised. Otherwise, the moment the seller tries to sell the same good at different prices, the buyer at the lower price can arbitrage by selling to the consumer buying at the higher price but with a tiny discount. However, product heterogeneity, market frictions or high fixed costs (which make marginal-cost pricing unsustainable in the long run) can allow for some degree of differential pricing to different consumers, even in fully competitive retail or industrial markets. Price discrimination also occurs when the same price is charged to customers which have different supply costs. Types of price discrimination In first degree price discrimination , price varies by customer's willingness or ability to pay. This arises from the fact that the value of goods is subjective. In second degree price discrimination , price varies according to quantity sold. Larger quantities are available at a lower unit price. This is particularly widespread in sales to industrial customers, where bulk buyers enjoy higher discounts. Additionally to second degree price discrimination , sellers are not able to differentiate between different types of consumers. Thus, the suppliers will provide incentives for the consumers to differentiate themselves according to preference In third degree price discrimination , price varies by attributes such as location or by customer segment, or in the most extreme case, by the individual customer's identity; where the attribute in question is used as a proxy for ability/willingness to pay. In price skimming, price varies over time. Typically a company starts selling a new product at a relatively high price then gradually reduces the price as the low price elasticity segment gets satiated. Combination These types are not mutually exclusive. Thus a company may vary pricing by location, but then offer bulk discounts as well. Airlines use several different types of price discrimination, including:

Bulk discounts to wholesalers, consolidators, and tour operators Incentive discounts for higher sales volumes to travel agents and corporate buyers Seasonal discounts, incentive discounts, and even general prices that vary by location. The price of a flight from say, Singapore to Beijing can vary widely if one buys the ticket in Singapore compared to Beijing (or New York or Tokyo or elsewhere). Discounted tickets requiring advance purchase and/or Saturday stays. Both restrictions have the effect of excluding business travelers, who typically travel during the workweek and arrange trips on shorter notice. First degree price discrimination based on customer. It is not accidental that hotel or car rental firms may quote higher prices to their loyalty program's top tier members than to the general public

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Examples of price discrimination

o o o o o o o o o o

Retail price discrimination Travel industry Coupons Premium pricing Segmentation by age group and student status Discounts for members of certain occupations Employee discounts Retail incentives Incentives for industrial buyers

Gender-based examples

o o o o o o

4.10.3 Haircutting Financial aid in education Haggling International price discrimination Academic pricing Dual pricing Wage discrimination

4.10.1 "Ladies' night" 4.10.2 Dry cleaning

Price and output decisions

Price and output decisions of firms that want to maximize profits always depend on costs. Profits are always maximized at the point where marginal revenue is equal to marginal cost, with marginal cost being a function of variable cost. If, by cost structure, you mean the size (scale), the ratio of capital to labor, etc., then these are also factors in the price and output decisions, but they can be long run, not short run decisions. In the long run, all costs are variable. So the firm will have short run decisions and long run decisions. In imperfect competition, the profit maximizing firm can, and will, set a price that is higher than marginal cost. This will allow for potential economic profits, but it is true based on the fact that the demand curve that the firm faces in imperfect competition is downward-sloping. They still will equate marginal revenue with marginal cost, but the price will be higher. In oligopoly, the firm can, short run, try to undermine the competition by setting a price below cost. It will lose money in the short run, but this is a long run strategy designed to increase market share (by eliminating some of the competition). If this strategy works, in the long run it will have the power to set a price that is even more above marginal cost; but the long run profit maximizing point will be where marginal revenue equals marginal cost. As far as social implications, imperfect competition always yields a price that is higher than, and an output level that is lower than, what would occur under perfect competition. But there can be social advantages to imperfect competition: the cost structure of the industry might make having fewer firms be more efficient than having more competition (think of natural monopolies, where one electrical company in a town can supply electricity cheaper than having two companies both investing in startup costs; or for oligopoly, too many restaurants in a neighborhood will mean that some will go out of business, which happens quite frequently). Another potential social advantage to imperfect competition is a higher standard of living: with imperfect competition, firms compete in areas other than price, and research and development is one of those areas. This can lead to technological advances as well as increased consumer choices. It depends on the industry whether the social disadvantages outweigh the social advantages. This is why government often gets involved with regulating certain industries; to bring the consumer prices that reflect competition. Even antitrust laws don't always prohibit mergers; the government uses them to weigh whether fewer firms in an industry will do more harm than good.

Marginal revenue In microeconomics, marginal revenue (MR) is the extra revenue that an additional unit of product will bring. It is the additional income from selling one more unit of a good; sometimes equal to price. [1] It can also be described as the change in total revenue divided by the change in the number of units sold. Marginal cost In economics and finance, marginal cost is the change in total cost that arises when the quantity produced changes by one unit. That is, it is the cost of producing one more unit of a good

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Variable costs are expenses that change in proportion to the activity of a business. [1] Variable cost is the sum of marginal costs over all units produced. It can also be considered normal costs. Fixed costs and variable costs make up the two components of total cost. Direct Costs, however, are costs that can easily be associated with a particular cost object.[2] However, not all variable costs are direct costs. For example, variable manufacturing overhead costs are variable costs that are indirect costs, not direct costs. Variable costs are sometimes called unit-level costs as they vary with the number of units produced. Direct labor and overhead are often called conversion cost,[3] while direct material and direct labor are often referred to as prime cost. Advantages and disadvantages of price discrimination Advantages of Price 1. Firm will be able to increase revenue. This business who may have otherwise have made price discrimination to offer 2. Increased revenue can be used 3. Some Consumers will benefit from lower advantage of cheaper Disadvantages of

Discrimination

may enable some firms to stay in a loss. E.g. train companies need off peak travel for Research and Development fares. E.G. old people can take fares on trains. Price Discrimination

1. Some Consumers will face higher prices, leading to allocative inefficient and a loss of consumer surplus. 2. Often those who benefit from lower prices may not be the poorest. For example some old people may be quite rich, but unemployed will have to pay the full adult fare. 3. There may be administration costs involved in separating the markets National Income The total net value of all goods and services produced within a nation over a specified period of time, representing the sum of wages, profits, rents, interest, and pension payments to residents of the nation. Economics the total of all incomes accruing over a specified period to residents of a country and consisting of wages, salaries, profits, rent, and interest Gross national income (GNI) comprises the value within a country (i.e. its gross domestic product), together with its income received from other countries (notably interest and dividends), less similar payments made to other countries

Net national income (NNI) is an economics term used in national income accounting. It can be defined as the net national product (NNP) minus indirect taxes. Net national income encompasses the income of households, businesses, and the government. It can be expressed as: NNI = C + I + G + (NX) + net foreign factor income - indirect taxes - depreciation where:

C = Consumption I = Investments G = Government spending NX = net exports (exports minus imports)

This formula uses the expenditure method of national income accounting A variety of measures of national income and output are used in economics to estimate total economic activity in a country or region, including gross domestic product (GDP), gross national product (GNP), and net national income (NNI). All are specially concerned with counting the total amount of goods and services produced within some "boundary". The boundary is usually defined by geography or citizenship, and may also restrict the goods and services that are counted. For instance, some measures count only goods and services that are exchanged for money, excluding bartered goods, while other measures may attempt to include bartered goods by imputing monetary values to them

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Gross domestic product (GDP) refers to the market value of all final goods and services produced within a country in a given period. It is often considered an indicator of a country's standard of living.[1][2] Gross domestic product is related to national accounts, a subject in macroeconomics Gross National Product (GNP) is the market value of all products and services produced in one year by labor and property supplied by the residents of a country. Unlike Gross Domestic Product (GDP), which defines production based on the geographical location of production, GNP allocates production based on ownership. GNP does not distinguish between qualitative improvements in the state of the technical arts (e.g., increasing computer processing speeds), and quantitative increases in goods (e.g., number of computers produced), and considers both to be forms of "economic growth". [1] Circular flow of income

In this simplified image, the relationship between the decision-makers in the circular flow model is shown. Larger arrows show primary factors, whilst the red smaller arrows show subsequent or secondary factors. Measures of national income and output National accounts Main article: National accounts Arriving at a figure for the total production of goods and services in a large region like a country entails a large amount of data-collection and calculation. Although some attempts were made to estimate national incomes as long ago as the 17th century, [2] the systematic keeping of national accounts, of which these figures are a part, only began in the 1930s, in the United States and some European countries. The impetus for that major statistical effort was the Great Depression and the rise of Keynesian economics, which prescribed a greater role for the government in managing an economy, and made it necessary for governments to obtain accurate information so that their interventions into the economy could proceed as much as possible from a basis of fact. Market value In order to count a good or service it is necessary to assign some value to it. The value that the measures of national income and output assign to a good or service is its market value the price it fetches when bought or sold. The actual usefulness of a product (its use-value) is not measured assuming the usevalue to be any different from its market value. Three strategies have been used to obtain the market values of all the goods and services produced: the product (or output) method, the expenditure method, and the income method. The product method looks at the economy on an industry-by-industry basis. The total output of the economy is the sum of the outputs of every industry. However, since an output of one industry may be used by another industry and become part of the output of that second industry, to avoid counting the item twice we use not the value output by each industry, but the value-added; that is, the difference between the value of what it puts out and what it takes in. The total value produced by the economy is the sum of the values-added by every industry. The expenditure method is based on the idea that all products are bought by somebody or some organisation. Therefore we sum up the total amount of money people and organisations spend in buying things. This amount must equal the value of everything produced. Usually expenditures by private individuals, expenditures by businesses, and expenditures by government are calculated separately and then summed to give the total expenditure. Also, a correction term must be introduced to account for imports and exports outside the boundary.

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The income method works by summing the incomes of all producers within the boundary. Since what they are paid is just the market value of their product, their total income must be the total value of the product. Wages, proprieter's incomes, and corporate profits are the major subdivisions of income. The output approach The output approach focuses on finding the total output of a nation by directly finding the total value of all goods and services a nation produces. Because of the complication of the multiple stages in the production of a good or service, only the final value of a good or service is included in total output. This avoids an issue often called 'double counting', wherein the total value of a good is included several times in national output, by counting it repeatedly in several stages of production. In the example of meat production, the value of the good from the farm may be $10, then $30 from the butchers, and then $60 from the supermarket. The value that should be included in final national output should be $60, not the sum of all those numbers, $100. The values added at each stage of production over the previous stage are respectively $10, $20, and $30. Their sum gives an alternative way of calculating the value of final output. Formulae: GDP(gross domestic product) at market price = value of output in an economy in a particular year intermediate consumption NNP at factor cost = GDP at market price - depreciation + NFIA (net factor income from abroad) - net indirect taxes[3] The income approach The income approach equates the total output of a nation to the total factor income received by residents of the nation. The main types of factor income are:

Employee compensation (= wages + cost of fringe benefits, including unemployment, health, and retirement benefits); Interest received net of interest paid; Rental income (mainly for the use of real estate) net of expenses of landlords; Royalties paid for the use of intellectual property and extractable natural resources.

All remaining value added generated by firms is called the residual or profit. If a firm has stockholders, they own the residual, some of which they receive as dividends. Profit includes the income of the entrepreneur - the businessman who combines factor inputs to produce a good or service. Formulae: NDP at factor cost = Compensation of employees + Net interest + Rental & royalty income + Profit of incorporated and unincorporated firms + Income from self-employment. National income = NDP at factor cost + NFIA (net factor income from abroad). The expenditure approach The expenditure approach is basically an output accounting method. It focuses on finding the total output of a nation by finding the total amount of money spent. This is acceptable, because like income, the total value of all goods is equal to the total amount of money spent on goods. The basic formula for domestic output combines all the different areas in which money is spent within the region, and then combining them to find the total output. GDP = C + I + G + (X - M) Where: C = household consumption expenditures / I = gross private G = government consumption and X = gross exports of M = gross imports of goods and services

personal consumption domestic gross investment goods and

expenditures investment expenditures services

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Note: (X - M) is often written as XN, which stands for "net exports" Definitions The names of the measures consist of one of the words "Gross" or "Net", followed by one of the words "National" or "Domestic", followed by one of the words "Product", "Income", or "Expenditure". All of these terms can be explained separately. "Gross" means total product, regardless of the use to which it is subsequently put. "Net" means "Gross" minus the amount that must be used to offset depreciation ie., wear-andtear or obsolescence of the nation's fixed capital assets. "Net" gives an indication of how much product is actually available for consumption or new investment. "Domestic" means the boundary is geographical: we are counting all goods and services produced within the country's borders, regardless of by whom. "National" means the boundary is defined by citizenship (nationality). We count all goods and services produced by the nationals of the country (or businesses owned by them) regardless of where that production physically takes place. The output of a French-owned cotton factory in Senegal counts as part of the Domestic figures for Senegal, but the National figures of France. "Product", "Income", and "Expenditure" refer to the three counting methodologies explained earlier: the product, income, and expenditure approaches. However the terms are used loosely. "Product" is the general term, often used when any of the three approaches was actually used. Sometimes the word "Product" is used and then some additional symbol or phrase to indicate the methodology; so, for instance, we get "Gross Domestic Product by income", "GDP (income)", "GDP(I)", and similar constructions. "Income" specifically means that the income approach was used. "Expenditure" specifically means that the expenditure approach was used. Note that all three counting methods should in theory give the same final figure. However, in practice minor differences are obtained from the three methods for several reasons, including changes in inventory levels and errors in the statistics. One problem for instance is that goods in inventory have been produced (therefore included in Product), but not yet sold (therefore not yet included in Expenditure). Similar timing issues can also cause a slight discrepancy between the value of goods produced (Product) and the payments to the factors that produced the goods (Income), particularly if inputs are purchased on credit, and also because wages are collected often after a period of production. GDP and GNP Main articles: GDP and GNP Gross domestic product (GDP) is defined as "the value of all final goods and services produced in a country in 1 year".[4] Gross National Product (GNP) is defined as "the market value of all goods and services produced in one year by labour and property supplied by the residents of a country." [5] As an example, the table below shows some GDP and GNP, and NNI data for the United States: [6] National income dollars) Period Ending and output (Billions of

Gross national product

2003 11,063. 3

Net U.S. income receipts from rest of the 55.2 world U.S. income receipts 329.1 U.S. income payments -273.9 11,008. Gross domestic product 1 Private consumption of fixed capital 1,135.9 Government consumption of fixed capital 218.1 Statistical discrepancy 25.6 National Income 9,679.7

NDP: Net domestic product is defined as "gross domestic product (GDP) minus depreciation of capital",[7] similar to NNP. GDP per capita: Gross domestic product per capita is the mean value of the output produced per person, which is also the mean income.

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[edit] National income and welfare GDP per capita (per person) is often used as a measure of a person's welfare. Countries with higher GDP may be more likely to also score highly on other measures of welfare, such as life expectancy. However, there are serious limitations to the usefulness of GDP as a measure of welfare:

Measures of GDP typically exclude unpaid economic activity, most importantly domestic work such as childcare. This leads to distortions; for example, a paid nanny's income contributes to GDP, but an unpaid parent's time spent caring for children will not, even though they are both carrying out the same economic activity. GDP takes no account of the inputs used to produce the output. For example, if everyone worked for twice the number of hours, then GDP might roughly double, but this does not necessarily mean that workers are better off as they would have less leisure time. Similarly, the impact of economic activity on the environment is not measured in calculating GDP. Comparison of GDP from one country to another may be distorted by movements in exchange rates. Measuring national income at purchasing power parity may overcome this problem at the risk of overvaluing basic goods and services, for example subsistence farming. GDP does not measure factors that affect quality of life, such as the quality of the environment (as distinct from the input value) and security from crime. This leads to distortions - for example, spending on cleaning up an oil spill is included in GDP, but the negative impact of the spill on well-being (e.g. loss of clean beaches) is not measured. GDP is the mean (average) wealth rather than median (middle-point) wealth. Countries with a skewed income distribution may have a relatively high per-capita GDP while the majority of its citizens have a relatively low level of income, due to concentration of wealth in the hands of a small fraction of the population. See Gini coefficient.

Because of this, other measures of welfare such as the Human Development Index (HDI), Index of Sustainable Economic Welfare (ISEW), Genuine Progress Indicator (GPI), gross national happiness (GNH), and sustainable national income (SNI) are used

Income inequality and distribution In economics, income distribution is how a nations total economy is distributed amongst its population.
[1]

Income distribution has always been a central concern of economic theory and economic policy. Classical economists such as Adam Smith, Thomas Malthus and David Ricardo were mainly concerned with factor income distribution, that is, the distribution of income between the main factors of production, land, labour and capital

Economic inequality (or "wealth and income differences") comprises all disparities in the distribution of economic assets and income. The term typically refers to inequality among individuals and groups within a society, but can also refer to inequality among countries Income inequality The unequal distribution of household or individual income across the various participants in an economy. Income inequality is often presented as the percentage of income to a percentage of population. For example, a statistic may indicate that 70% of a country's income is controlled by 20% of that country's residents. It is often associated with the idea of income "fairness". It is generally considered "unfair" if the rich have a disproportionally larger portion of a country's income compared to their population The causes of income inequality can vary significantly by region, gender, education and social status. Economists are divided as to whether income equality is ultimately positive or negative and what are the implications of such disparity. Per capita income

Per capita income or income per person is the numerical quotient of income divided by population, in monetary terms. It is a measure of all sources of income in an economic aggregate, such as a country or city. It does not measure income distribution or wealth.

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Per capita income as a measure of prosperity Per capita income has several weaknesses as a measurement:

Economic activity that does not result in monetary income, such as services provided within the family, or for barter, are usually not counted. The importance of these services varies widely between different economies, both between countries and among different groups within a country. If the distribution of income within a country is skewed, a small wealthy class can increase per capita income far above that of the majority of the population. International comparisons can be distorted by skewed exchange rates. The same good, e.g., one pound of rice may sell for a much different price in two countries. If goods cost twice as much in country A and A has twice the per capita income, the countries may be equally prosperous despite the income figures.

Median income is a more widely accepted measure of prosperity, because it is not biased by wealthy outliers. Cost-of-living index

regions. It is an index that measures differences in the price of goods and services, and allows for substitutions to other items as prices vary. [1] There are many different methodologies that have been developed to approximate cost-of-living indexes, including methods that allow for substitution among items as relative prices change. A Kons index is a type of cost-of-living index that uses an expenditure function such as one used in assessing expected compensating variation. The expected indirect utility is equated in both periods. Application to price index theory The United States Consumer Price Index (CPI) is a price index that is based on the idea of a cost-of-living index. The US Department of Labor's Bureau of Labor Statistics (BLS) explains the difference: "The CPI frequently is called a cost-of-living index, but it differs in important ways from a complete cost-ofliving measure. BLS has for some time used a cost-of-living framework in making practical decisions about questions that arise in constructing the CPI. A cost-of-living index is a conceptual measurement goal, however, not a straightforward alternative to the CPI. A cost-of-living index would measure changes over time in the amount that consumers need to spend to reach a certain utility level or standard of living. Both the CPI and a cost-of-living index would reflect changes in the prices of goods and services, such as food and clothing that are directly purchased in the marketplace; but a complete cost-of-living index would go beyond this to also take into account changes in other governmental or environmental factors that affect consumers' well-being. It is very difficult to determine the proper treatment of public goods, such as safety and education, and other broad concerns, such as health, water quality, and crime that would constitute a complete cost-of-living framework." [2] Economic theory The basis for the theory behind the cost of living index is attributed to Russian economist A.A. Kons. [3] The economic theory behind the cost of living index assumes that consumers are optimizers and get as much utility as possible from the money that they have to spend. These assumptions can be shown to lead to a "consumer's cost function", C(u,p), the cost of achieving utility level u given a set of prices p.[4] Assuming that the cost function holds across time (i.e., people get the same amount of utility from one set of purchases in year as they would have buying the same set in a different year) leads to a "true cost of living index." The general form for Kons's true cost of living index compares the consumer's cost function given the prices in one year with the consumer's cost function given the prices in a different year:

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Since u can be defined as the utility received from a set of goods measured in quantity, q, u can be replaced with f(q) to produce a version of the true cost of living index that is based on price and quantities like most other price indices:

[5]

In simpler terms, the true cost of living index is the cost of achieving a certain level of utility (or standard of living) in one year relative to the cost of achieving the same level the next year. Utility is not directly measurable, so the true cost of living index only serves as a theoretical ideal, not a practical price index formula. However, more practical formulas can be evaluated based on their relationship to the true cost of living index. One of the most commonly used formulas for consumer price indices, the Laspeyres price index, compares the cost of what a consumer bought in one time period (q 0) with how much it would have cost to buy the same set of goods and services in a later period. Since the utility from q0 in the first year should be equal to the utility from q 0 in the next year, Laspeyres gives the upper bound for the true cost of living index. [6] Laspeyres only serves as an upper bound, because consumers could turn to substitute goods for those goods that have gotten more expensive and achieved the same level of utility from q 0 for a lower cost. In contrast, a Paasche price index uses the cost of a set of goods purchased in one time period with the cost it would have taken to buy the same set of goods in an earlier time period. It can be shown that the Paasche is a lower bound for true cost of living index. [7] Since upper and lower bounds of the true cost of living index can be found, respectively, through the Laspeyres and Paasche indices, the geometric average of the two, known as the Fisher price index, is a close approximation of the true cost of living index if the upper and lower bounds are not too far apart. [8] Price index

A price index (plural: price indices or price indexes) is a normalized average (typically a weighted average) of prices for a given class of goods or services in a given region, during a given interval of time. It is a statistic designed to help to compare how these prices, taken as a whole, differ between time periods or geographical locations. Price indices have several potential uses. For particularly broad indices, the index can be said to measure the economy's price level or a cost of living. More narrow price indices can help producers with business plans and pricing. Sometimes, they can be useful in helping to guide investment. Some notable price indices include:

Consumer price index Producer price index GDP deflator

Multiplier (economics) In economics, a multiplier is a factor of proportionality that measures how much an endogenous variable changes in response to a change in some exogenous variable. For example, suppose a one-unit change in some variable x causes another variable y to change by M units. Then the multiplier is M. Common uses Two multipliers are commonly discussed in introductory macroeconomics. Money multiplier Main article: Money multiplier See also: Fractional-reserve banking In monetary macroeconomics and banking, the money multiplier measures how much the money supply increases in response to a change in the monetary base. The multiplier may vary across countries, and will also vary depending on what measures of money are considered. For example, consider M2 as a measure of the U.S. money supply, and M0 as a measure of the

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U.S. monetary base. If a $1 increase in M0 by the Federal Reserve causes M2 to increase by $10, then the money multiplier is 10. Fiscal multipliers Main article: Fiscal multiplier Multipliers can be calculated to analyze the effects of fiscal policy, or other exogenous changes in spending, on aggregate output. For example, if an increase in German government spending by 100, with no change in taxes, causes German GDP to increase by 150, then the spending multiplier is 1.5. Other types of fiscal multipliers can also be calculated, like multipliers that describe the effects of changing taxes (such as lump-sum taxes or proportional taxes). In economics, fiscal policy is the use of government expenditure and revenue collection (taxation) to influence the economy Accelerator in term of managerial economics Accelerator comes from the Principle of Acceleration. In managerial Economics, Acceleration Principle means, the rate of change in aggregate Demand to the Rate of Change in Investment. Eg: A company manufactures 100 pieces of cloth with a textile Manufacturing Equipment. The demand for the textile good is 60. So the firm's investment is much higher than the demand. Suppose the demand increases to 120 pieces. The company can produce only 100 with existing machinery. It will still continue to provide the existing 100 pieces output (without investing in additional machinery) Reason: the diff between demand and Supply is only 20. The investment will be a huge expense against this differential. But when the demand reaches, 180 or 200, the company may plan to invest in a new machinery. The differential is higher. Thus acceleration in aggregate demand leads to acceleration in the rate of Investment. This is a concept of Macro Economics. Inflationary gap An inflationary gap, in economics, is the amount by which the real Gross domestic product, or real GDP, exceeds potential GDP.[1] The real GDP is also known as GDP "adjusted for inflation", "constant prices" GDP or "constant dollar" GDP, because it measures the aggregate output in a country's income accounts in a given year, expressed in base-year prices. On the other hand, the potential GDP is the quantity of real GDP when a country's economy is at full-employment. When an initial increase in aggregate demand produces inflation (so called demand-pull inflation) and real GDP increase, the price level and real GDP are determined at the point where the new aggregate demand and the short-run aggregate supply meet. This point is known as above full-employment equilibrium [1], since the short-run aggregate supply is above the long-term aggregate supply, i.e. above the aggregate supply at full employment. The gap created between real GDP and potential GDP is the consequence of inflation, this is one of the reasons this type of gap is called an inflationary gap. Obviously, this situation cannot last forever, because there is a shortage of labour. The shortage of labour produces the rise of wage rates, which makes the short-run aggregate supply decrease, until it reaches the full-employment level. The short-run aggregate supply decrease makes an upward pressure on the price level, consequently causing inflation. The once created gap between real GDP and potential GDP was the sign of forthcoming inflation, this is another reason this type gap is called an inflationary gap. See also Recessionary gap. Deflationary gap Economics) Economics a situation in which total spending in an economy is insufficient to buy all the output that can be produced with full employment Economic term describing the situation when Gross Domestic Product is below its full-employment level. In theory, such a situation would lead to the existence of unemployed resources, which should lead to falling prices (deflation) for those resources as the unemployed ones compete in the market What are the causes of inflationary gap?

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Inflationary gaps can arise when the economy has grown for a long time on the back of a high level of aggregate demand. Total spending may rise faster than the economy's ability to supply goods and services. As a result, actual GDP may exceed potential GDP leading to a positive output gap in the economy. Saving is income not spent, or deferred consumption. Methods of saving include putting money aside in a bank or pension plan.[1] Saving also includes reducing expenditures, such as recurring costs. In terms of personal finance, saving specifies low-risk preservation of money, as in a deposit account, versus investment, wherein risk is higher The concept of investment states that any activity that makes an individual more productive or more potentially more productive is worthwile

Investment
1. In finance, the purchase of a financial product or other item of value with an expectation of favorable future returns. In general terms, investment means the use money in the hope of making more money. 2. In business, the purchase by a producer of a physical good, such as durable equipment or inventory, in the hope of improving future business

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