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What Is Economics?
Economics is the study of how people choose to use resources.
Resources include the time and talent people have available,
the land, buildings, equipment, and other tools on hand, and
the knowledge of how to combine them to create useful
products and services.
Important choices involve how much time to devote to work, to
school, and to leisure, how many dollars to spend and how
many to save, how to combine resources to produce goods and
services, and how to vote and shape the level of taxes and the
role of government.
Often, people appear to use their resources to improve their
well-being. Well-being includes the satisfaction people gain
from the products and services they choose to consume, from
their time spent in leisure and with family and community as
well as in jobs, and the security and services provided by
effective governments. Sometimes, however, people appear to
use their resources in ways that don't improve their well-being.
Definitions of Economics
In short, economics includes the study of labor, land, and
investments, of money, income, and production, and of taxes
and government expenditures. Economists seek to measure
well-being, to learn how well-being may increase overtime, and
to evaluate the well-being of the rich and the poor.
The most famous book in economics is the Inquiry into the
Nature and Causes of The Wealth of Nations written by Adam
Smith, and published in 1776 in Scotland.
The term wealth has a special meaning in Economics. In the
ordinary language, by wealth, we mean money, but in
economics, wealth refers to those goods which satisfy
human wants. But we should remember all goods which satisfy
human wants are not wealth. For example, air and sunlight are
essential for us. We cannot live without them. But they are not
regarded as wealth because they are available in abundance
and unlimited in supply. We consider only those goods which are
relatively scarce and have money value as wealth.
Macro and microeconomics are the two vantage points from which
the economy is observed.
Macroeconomics looks at the total output of a nation and the
way the nation allocates its limited resources of land, labor and
capital in an attempt to maximize production levels and
promote trade and growth for future generations. After
observing the society as a whole, Adam Smith noted that there
was an "invisible hand" turning the wheels of the economy: a
market force that keeps the economy functioning.
Microeconomics looks into similar issues, but on the level of the
individual people and firms within the economy. It tends to
be more scientific in its approach, and studies the parts that
make up the whole economy. Analyzing certain aspects of
human behaviour, microeconomics shows us how individuals
and firms respond to changes in price and why they
demand what they do at particular price levels.
Managerial Economics
The
Thenature
natureof
ofmanagerial
managerialeconomic
economicdecision
decisionmaking
making
The
Therole
roleof
ofmanagerial
managerialeconomics
economicsin
inmanagerial
managerialdecision
decisionmaking
making
Economic
Economicconcepts
concepts
Theory
Theoryof
ofconsumer
consumer
behaviour
behaviour
Theory
Theoryof
offirm
firm
Theory
of
market
structures
Theory of market structures
and
andpricing
pricing
Managerial Economics
Is a Tool for Improving
Management Decision
Making
Managerial
Managerialdecision
decision
problems
problems
Product
Productprice
priceand
andoutput
output
Make
or
buy
Make or buy
Production
Productiontechnique
technique
Internet
strategy
Internet strategy
Advertising
Advertisingmedia
mediaand
and
intensity
intensity
Investment
Investmentand
andfinancing
financing
Managerial
ManagerialEconomics
Economics
Use
of
economics
Use of economicsconcepts
concepts
and
decision
making
and decision makingtools
toolsto
to
solve
managerial
decision
solve managerial decision
problems
problems
Optimal
Optimalsolutions
solutions
Decision
Decisionmaking
makingtools
tools
Numerical
Numericalanalysis
analysis
Statistical
analysis
Statistical analysis
Forecasting
Forecasting
Game
Gametheory
theory
Optimisation
Optimisation
Categories of Basic
Principles of Economics
How do people make decisions?
How do people interact?
How does the economy work overall?
Principles of Economics
How Do People Make
Decisions?
Principle #1 - People face tradeoffs
Mercantilists perspectives
Markets
productivity
Markets
In economics, a market is not a place but
rather a group of buyers and sellers with
the potential to trade with each other
Defining Macroeconomic
Markets
Goods and services are aggregated to
the highest levels
Defining Microeconomic
Markets
Markets are defined narrowly
Households
Business firms
Government agencies
All three can be both buyers and
sellers in the same market, but are
not always
Demand
Demand is: the willingness and ability of
buyers to purchase different quantities of
a good at different prices during a
specific period of time.
Demand
A households quantity demanded of a good
2.00
D
40,000
60,000
Number of Bottles
per Month
Q2
Q1
Q3
Quantity
In Figure 2
An increase in income
shifts the demand curve for
maple syrup from D1 to D2.
At each price, more bottles
are demanded after the
shift
$2.00
60,000
C
D1
D2
80,000
Number of Bottles
per Month
Example
Example
Expected Price
Tastes
Small Summary
-- Factors Affecting Demand
Income (depends on goods nature:
normal or inferior)
Wealth (depends on goods nature)
Prices of substitutes (positively related)
Prices of complements (negatively
related)
Population (positively related)
Expected price (positively related)
Tastes (positively related)
D2
D1
Quantity
D1
D2
Quantity
Supply
Supply is the willingness and
Supply
A firms quantity supplied of a good is the
specific amount its managers would choose to
sell over some time period, given
$4.00
2.00
G
At $4.00 per bottle,
quantity supplied is
60,000 bottles (point G).
40,000
60,000
Number of Bottles
per Month
In Figure 4
A rise (fall) in price would cause a rightward
(leftward) movement along the supply curve
In Figure 5
Supply curve has shifted to the right of the old
curve (from Figure 4) as transportation costs
have dropped
A change in any variable that affects supply
except for the goods pricecauses the supply
curve to shift
Price per
Bottle
A decrease in transportation
costs shifts the supply curve for
syrup from S1 to S2.
S1
S2
60,000
80,000
Number of Bottles
per Month
Technology
Cost-saving technological advances
increase the supply of a good, shifting the
supply curve to the right
Expected Price
Favorable weather
Increases crop yields
Causes a rightward shift of the supply curve for
that crop
Unfavorable weather
Destroys crops
Shrinks yields
Shifts the supply curve leftward
P2
P1
P3
Q3
Q1
Q2
Quantity
S1
S2
Quantity
S2
S1
Quantity
3. shrinking the
excess demand . . .
S
E
$3.00
1.00
H
Excess Demand
D
Number of Bottles
per Month
Excess Demand
Excess demand
$5.00
2. causes the
price to drop,
3.00
K
E
3. shrinking the
excess supply . . .
Number of Bottles
per Month
Excess Supply
Excess Supply
Figure 9
Price per
Bottle
4. Equilibrium
price
increases
3. to a new
equilibrium.
S
F'
$4.00
3.00
2. moves us along
the supply
curve . . .
1. An increase in
demand . . .
D2
D1
50,000 60,000
Number of Bottles of
Maple Syrup per Period
3.00
S2
S1
E'
D
35,000 50,000
Number of Bottles
S2
S1
E'
P2
E
P1
D
Q2
Q1
Barrels of Oil
F'
P4
P3
D2
D1
Q3
Q4
Cubic Feet of
Natural Gas
4. Price
decreased . . .
$500
B
$400
S2002
S2003
1. An increase in
supply . . .
D2002
5. and quantity
decreased as well.
D2003
2.45 3.33
rent($)
quantity
demanded
quantity
supplied
800
30
10
1000
25
14
1200
22
17
1400
19
19
1600
17
21
1800
15
22
Summaries
Through the study of the chapter, you will be able to
Characterize a market.
Use a demand schedule and a demand curve to demonstrate the law of
demand.
Explain the difference between a change in demand (shift of the curve)
and a change in quantity demanded (movement along the curve).
List the factors that will lead to a change in demand, and give
examples of each.
Similar analysis for supply side.
Explain how equilibrium price and quantity are determined in a
competitive market.
Explain what will happen in a competitive market after a shift in the
supply curve, the demand curve, or both.
Describe the three steps economists take to answer almost any
question about the economy.
Demand
and Supply
Elasticities
78
THE ELASTICITY OF
DEMAND
The price elasticity of demand is a
measure of how much the quantity
demanded of a good responds to a change
in the price of that good.
When we talk about elasticity, that
responsiveness is always measured in
percentage terms.
Specifically, the price elasticity of demand
is the percentage change in quantity
demanded due to a percentage change in
the price.
Q2 Q1
ep
Q2 Q1
P2 P1
P2 P1
P e rc e n ta g e c h a n g e in q u a n tity d e m a n d e d
P e rc e n ta g e c h a n g e in p ric e
P e rc e n ta g e c h a n g e in q u a n tity d e m a n d e d
P e rc e n ta g e c h a n g e in p ric e
(1 0 8 )
100
20%
10
2
( 2 .2 0 2 .0 0 )
100 10%
2 .0 0
(Q2 Q1 ) /[(Q2 Q1 ) / 2]
( P2 P1 ) /[( P2 P1 ) / 2]
(10 8)
22%
(10 8) / 2
2.32
(2.20 2.00)
9.5%
(2.00 2.20) / 2
Elastic Demand
ED
Price
$5
4
Demand
50
(4.00 5.00)
(100 50)/2
(4.00 5.00)/2
67 percent
3
22 percent
100 Quantity
Perfectly Elastic
Unit Elastic
100
Quantity
$5
4
1. A 25%
increase
in price . . .
Demand
90
100
Quantity
$5
4
Demand
1. A 25%
increase
in price . . .
80
100
Quantity
$5
4
Demand
1. A 25%
increase
in price . . .
50
100
Quantity
Demand
2. At exactly $4,
consumers will
buy any quantity.
0
3. At a price below $4,
quantity demanded is infinite.
Quantity
TR P Q
Price
$4
P Q = $400
(revenue)
Demand
100
Q
Quantity
Price
An Increase in price
from $1
to $3
leads to an Increase
in total revenue from
$100 to $240
$3
Revenue = $240
$1
Demand
Revenue = $100
0
100
Quantity
Demand
0
80
Quantity
Price
An Increase in price
from $4
to $5
leads to an decrease
in total revenue from
$200 to $100
$5
$4
Demand
Demand
Revenue = $200
50
Revenue = $100
Quantity
20
Quantity
Note that with each price increase, the Law of Demand still
holds an increase in price leads to a decrease in the quantity
demanded. It is the change in TR that varies!
Elasticity of a Linear
Demand Curve
Price
$
7
6
5
4
3
2
1
1
0
1
2
1
4
Other Demand
Elasticities
Computing Income Elasticity
P e rc e n ta g e c h a n g e
in q u a n tity d e m a n d e d
In c o m e e la s tic ity o f d e m a n d =
P e rc e n ta g e c h a n g e
in in c o m e
Types of Goods
Normal Goods
Inferior Goods
THE ELASTICITY OF
SUPPLY
Price elasticity of supply is a measure
of how much the quantity supplied of a
good responds to a change in the price of
that good.
Price elasticity of supply is the
percentage change in quantity supplied
resulting from a percentage change in
price.
100
Quantity
100
110
Quantity
4
1. A 25%
increase
in price . . .
100
125
Quantity
100
200
Quantity
Supply
2. At exactly $4,
producers will
supply any quantity.
0
3. At a price below $4,
quantity supplied is zero.
Quantity
Time period
P e rc e n ta g e c h a n g e
in q u a n tity s u p p lie d
P ric e e la s tic ity o f s u p p ly =
P e rc e n ta g e c h a n g e in p ric e