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INTRODUCTION TO ECONOMICSAS – F581
INTRODUCTION Background Why study economics? What to expect from this unit? What is expected of you?
Plagiarism Homework Mock Exam
WHAT IS ECONOMICS? Economics is the study of how people choose to use resources. "Economics is the study of people in the ordinary business of life."
-- Alfred Marshall, Principles of economics; an introductory volume (London: Macmillan, 1890)
"Economics is the science which studies human behaviour as a relationship between given ends and scarce means which have alternative uses."-- Lionel Robbins, An Essay on the Nature and Significance of Economic Science (London: MacMillan, 1932)
Economics is the "study of how societies use scarce resources to produce valuable commodities and distribute them among different people."-- Paul A. Samuelson, Economics (New York: McGraw-Hill, 1948)
ECONOMICS IS….. Economics is the study of how we choose to use limited resources to obtain the
maximum satisfaction of unlimited human wants.
This definition has four parts that we need to discuss:
the "study of" economics choice scarcity maximizing satisfaction
OH CHOICES!!! aa
VS
ACTIVITY 1 Make a in your own words of some of the
economic choices at Your personal level Your family level Organisational Level The country level
SCARCITY….. The reason why I didn't have a castle, or the reason why you
don't have everything that you want is because of SCARCITY. Scarcity highlights another point…….the point of demand.
Scarcity in economics doesn’t mean that something is limited in resources but it means that something in limited and is not wanted/demanded.
SCARCITY EXAMPLE Scarcity does not mean that only a little of something is available.
For example, I grew up in Multan, Pakistan . About 30 miles away from my hometown was the town of Murkaan. Just outside of town a certain type of rock exists that occurs nowhere else in the world. They have named it “Murkanite". Murkanite is only found near Murkaan, Pakistan and only a little of it has ever been found. BUT IT IS NOT SCARCE. -- WHY? - -
Because nobody wants it. For there to be scarcity things must be LIMITED and WANTED. There is plenty of MURKINITE and it IS NOT SCARCE because nobody wants it.
If I own a PS3 I would want unlimited games or the latest model of PS3.
WANTS AND NEEDS They are unlimited A need is something that can be seen as being essential to
survival, such as food, water, shelter and warmth. A want is something that we would like to have but which is
not essential to survival - a car, the latest version of the PlayStation, that new top you have seen in Top Shop, the
mobile phone with all the latest gadgets on etc.
COORDINATION PROBLEM With so many decision makers in the economy how do we coordinate
the wants and needs for all of them? How do we make them coherent? For this we need to understand the economic systems.
Market Economy Centrally Planned Economy Mixed Economy
Economy? The ways people try to fulfil their wants and needs. Incentives: Tax Breaks? Scrap car scheme? Money?
ECONOMY TYPES Market economy: Market forces are allowed to guide the allocation (distribution?)
of resources. Prices play an important role. Role of competition
Centrally Planned Economy: Government undertakes the coordination role (allocation). Administratively a costly option Soviet bloc in 1990s, North Korea, Chavez, Cuba.
Mixed Economy: Market Forces + Government Intervention Should governments be market friendly? Incentives VS. State Directives
SOME BASIC QUESTIONS. http://www.youtube.com/watch?v
=t0rvubUAc7Y&feature=related
Watch for 2 minutes.
MICRO AND MACRO Microeconomics is the study of how
households and firms make decisions in markets.
Macroeconomics is the study of issues that affect economies as a whole, i.e., unemployment, fiscal, monetary etc.
ACTIVITY 2 Divide issues you came up with in Activity one
in Micro and Macro. BBC website economics articles The Economist article
http://www.economist.com/businessfinance/economicsfocus/
Problem revolves around three Concepts
1 Scarcity2 Choice 3 Opportunity Costs
SO WHAT IS A RESOURCE? Finite, scarce or limited Renewable, Perishable, Natural, Basic Types:
Land Labour Capital Entrepreneurship/Enterprise
Resources available in an economy are called factors of production.
RESOURCES.
http://www.harpercollege.edu/mhealy/eco212i/lectures/5es/5es.htm
HOMEWORKExplain and make a mind map, poster, or
other presentation of the economic problem as it affects yourself, your family or country.
AS ECONOMICSLecture 2
RECALL - SO WHAT IS A RESOURCE? Finite, scarce or limited Renewable, Perishable, Natural, Basic Types:
Land Labour Capital Entrepreneurship/Enterprise
Resources available in an economy are called factors of production.
LAND
Land includes all of the natural physical resources – for example the ability to exploit fertile farm land, the benefits from a temperate climate or the ability to harness wind and solar power and other forms of renewable energy. Some nations are richly endowed with natural resources and then specialise in the extraction and production of these resources – for example – the development of the North Sea oil and gas in Britain and Norway or the high productivity of the vast expanse of farm land in Canada and the United States and the oil sands in Alberta, Canada. Other countries have a smaller natural factor endowment and may be more reliant on importing these resources. Japan for example is the world’s second largest economy but remains heavily dependent on imported oil.
LABOUR Labour is the human input into the production
process. It is inevitable that some workers are more productive than others because of the education, training and work experience they have received. What matters is the size and quality of the workforce. An increase in the size and the quality of the labour force is vital if a country wants to achieve economic growth. In recent years the issue of the migration of labour has become important, can migrant workers help to solve some of the labour shortages that many countries experience? And what of the long-term effects on the countries who suffer a drain or loss of workers through migration?
CAPITAL
To an economist, investment is not the money that people put into the stock market or into bank and building society accounts. Instead, in economics the term capital means investment in capital goods that can then be used to produce other consumer goods and services in the future. Fixed capital includes machinery, plant and equipment,
new technology, factories and other buildings. Working capital refers to stocks of finished and semi-
finished goods (or components) that will be either consumed in the near future or will be made into finished consumer goods.
CAPITAL CONTINUED…Capital inputs and productivity New items of capital machinery, buildings or technology are
generally used to enhance the productivity of labour. For example, improved technology in farming has vastly increased the productivity of our agricultural sector and allowed people to move out of working on the land into more valuable jobs in other parts of the economy. And, investment in information and communication technology can increase the efficiency of workers across many industries.
Infrastructure Infrastructure is the stock of capital used to support the entire
economic system. Examples of infrastructure include road & rail networks; airports & docks; telecommunications eg cables and satellites to enable web access. The World Bank regards infrastructure as an essential pillar for economic growth in developing countries.
The Gatwick Express – the railway infrastructure is an essential part of our transport network
The global oil and gas industry uses a huge amount of capital equipment to get the product – crude oil – to the refineries and processing stages.
ENTREPRENEURSHIP
An entrepreneur is an individual who seeks to supply products to a market for a rate of return (i.e. to make a profit).
Entrepreneurs will usually invest their own financial capital in a business (for example their savings) and take on the risks associated with a business investment. The reward to this risk-taking is the profit made from running the business.
Many economists agree that entrepreneurs are in fact a specialised part of the factor input 'labour'.
OPPORTUNITY COST The cost of next best alternative thing forgone
when a choice is made.
EXERCISE 1.1 Andrew has just started his AS courses, and
has chosen to take economics, mathematics, geography and French. Although he was certain about the first three, it was a close call between French and English. What is Andrew’s opportunity cost of choosing French?
SOLUTION 1.1
TRADE-OFFS A trade-off (or tradeoff) is a situation that
involves losing one quality or aspect of something in return for gaining another quality or aspect. It implies a decision to be made with full comprehension of both the upside and downside of a particular choice.
It is a situation that involves calculation. Same value??
Opportunity Cost and the PPC Economists love making models and assumptions.
Why? Because the world is complicated and models provide simplified versions of reality.
For example, If I am to measure how many of you would get A grades if you just take notes then I would have to make model whereby I could assume that in that model (unreal world) no book exists, no other academic help exists, no websites, you get the picture. The reason I am modelling this is because you could learn from other resources if you want to but there is no way of measuring the relationship between taking notes and getting grades if I don’t take out the other factors.
Curves Economists rely heavily on diagrams to help
in their analysis. Production possibility curve (PPC) shows the
maximum combinations of quantities between two goods or services that can be produced in a set period of time given the available resources and technology.
Production Possibility Frontiers Show the different combinations of goods and services that can
be produced with a given amount of resources No ‘ideal’ point on the curve Any point inside the curve – suggests resources are not being
utilised efficiently Any point outside the curve – not attainable with the current level
of resources Useful to demonstrate economic growth and opportunity cost
0
1
2
3
4
5
6
7
8
0 1 2 3 4 5 6 7 8Units of clothing (millions)
Un
its o
f foo
d (
mill
ion
s)
Units of food Units of clothing (millions) (millions)
8m 0.0 7m 2.2m 6m 4.0m 5m 5.0m 4m 5.6m 3m 6.0m 2m 6.4m 1m 6.7m 0 7.0m
A production possibility curveA production possibility curve
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8
0 1 2 3 4 5 6 7 8Units of clothing (millions)
Un
its o
f foo
d (
mill
ion
s)
Units of food Units of clothing (millions) (millions)
a 8m 0.0 7m 2.2m 6m 4.0m 5m 5.0m 4m 5.6m 3m 6.0m 2m 6.4m 1m 6.7m 0 7.0m
a
A production possibility curveA production possibility curve
0
1
2
3
4
5
6
7
8
0 1 2 3 4 5 6 7 8Units of clothing (millions)
Un
its o
f foo
d (
mill
ion
s)
Units of food Units of clothing (millions) (millions)
8m 0.0b 7m 2.2m 6m 4.0m 5m 5.0m 4m 5.6m 3m 6.0m 2m 6.4m 1m 6.7m 0 7.0m
b
A production possibility curveA production possibility curve
0
1
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7
8
0 1 2 3 4 5 6 7 8Units of clothing (millions)
Un
its o
f foo
d (
mill
ion
s)
Units of food Units of clothing (millions) (millions)
8m 0.0 7m 2.2mc 6m 4.0m 5m 5.0m 4m 5.6m 3m 6.0m 2m 6.4m 1m 6.7m 0 7.0m
c
A production possibility curveA production possibility curve
0
1
2
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5
6
7
8
0 1 2 3 4 5 6 7 8Units of clothing (millions)
Un
its o
f foo
d (
mill
ion
s)
Units of food Units of clothing (millions) (millions)
8m 0.0 7m 2.2m 6m 4.0m 5m 5.0m 4m 5.6m 3m 6.0m 2m 6.4m 1m 6.7m 0 7.0m
A production possibility curveA production possibility curve
0
1
2
3
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5
6
7
8
0 1 2 3 4 5 6 7 8Units of clothing (millions)
Un
its o
f foo
d (
mill
ion
s)A production possibility curveA production possibility curve
0
1
2
3
4
5
6
7
8
0 1 2 3 4 5 6 7 8Units of clothing (millions)
Un
its o
f foo
d (
mill
ion
s)
x
A production possibility curveA production possibility curve
w
Andrew has to finish his homework of 5 economics questions and 5 maths questions in limited time period----What to do? Add fig 1.1
Homework Hand ins Recap
Production Possibility Frontiers
Capital Goods
Consumer Goods
Yo
Xo
A (Xo, Yo)
BY1
X1
Assume a country can produce two types of goods with its resources – capital goods and consumer goods
If it devotes all resources to capital goods it could produce a maximum of Ym.
If it devotes all its resources to consumer goods it could produce a maximum of Xm
Ym
Xm
If the country is at point A on the PPF It can produce the combination of Yo capital goods and Xo consumer goods
If it reallocates its resources (moving round the PPF from A to B) it can produce more consumer goods but only at the expense of fewer capital goods. The opportunity cost of producing an extra X1 - Xo consumer goods is Yo – Y1 capital goods.
Units of clothing (millions)
Un
its o
f foo
d (
mill
ion
s)Increasing opportunity costsIncreasing opportunity costs
x
y
0
1
2
3
4
5
6
7
8
0 1 2 3 4 5 6 7 8
1
1
z1
2
Economic Growth Growth is triggered by investment in capital
goods.Total output in an economy in a given period is measured by its GDP (Gross Domestic Product)
Production Possibility Frontiers
Capital Goods
Consumer Goods
Yo
Xo
A
.B
CY1
X1
Production inside the PPF – e.g. point B means the country is not using all its resources
It can only produce at points outside the PPF if it finds a way of expanding its resources or improves the productivity of those resources it already has. This will push the PPF further outwards.
Fig 1.2
Scarcity
Inefficiency
Increase in one variable Increase in television productivity
Activity The car production industry in an economy is
facing increasing competition from producers elsewhere. In order to offset this, car manufacturers have developed more advanced robots to carry out production.
1. Draw PPC assuming1200 cars can be produced
2. Approximately how many more cars can be produced when the number of television sets made is 1,000?
3. How does the number of cars that can be produced change as television production falls below 1,000?
Increase in productive capacity – Both variables Productive Potential – Positive Growth
Decrease in productive capacity Productive Potential – Negative Growth
SPECIALISATION & DIVISION OF LABOUR How many workers does it take to make a pin? 18th century economist, Adam Smith suggested
that 10 people are needed to make a pin. A worker on its own produced 20 pins if he/she
carried out all the steps by himself. But, 10 workers produced 200 pins If pin process broken down into 10 different
stages then number produced shot up to 48,000. This is called Division of Labour.
COLIN AND DEBBIE’S PRODUCTION TABLE 1.1
Colin
Pots Bracelets
12 0
9 3
6 6
3 9
0 12
Debbie
Pots Bracelets
18 0
12 12
6 24
3 30
0 36What strategy (combination) be used to get the maximum productivity and avail from their respective specialisation?
ACTIVITY Calculating Opportunity cost for Debbie
To make pots; 18/36 = 0.5 To make bracelets; 36/18 = 2 Calculating Opportunity cost for Colin To make pots; 12/12 = 1 To make bracelets; 12/12 = 1
It doesn’t really matter for Colin but as Debbie is extremely good at making bracelets Colin would be better off concentrating on making pots. Resulting in 6 extra bracelets in the same time period.
MONEY AND EXCHANGE In order for a barter (exchange) to occur there has
to be a double occurrence of wants in at least two parties.
Money makes life simpler by becoming a portable medium of exchange. Money has the following characteristics; Store of Value: Money should be able to be used in
the future. Unit of account: everybody in the market should
agree on the units, dollars? Pounds? Dollar = ? Standard of deferred payment: People may need to
enter into a contract. I am paid after a month, good from a factory may be paid upon arrival or after 30 days.
HOMEWORK Essay on specialisation. How does it address
the problem of scarcity?
Would you like to go through the book? Any questions from the book? Next Week Mock Exam
AS ECONOMICSThe Nature of Demand and Supply
Administrative Functions and Learning Outcome Homework Mark sheet 5-10 minutes. Mock Exam on Wednesday. Do you need extra
time for your homework submission? Anonymous feedback questionnaire. Frontor Apology!!! Problems with Graphs?
LEARNING OUTCOMES
Introduction to the notion of demand for a good or service
Relationship between price and demand Law of demand demand curve Movement along the curve and a shift in the
curve Normal and inferior goods
WHAT IS DEMAND The quantity of a good or service that
consumers choose to buy at any possible price in a given period.
4 things influence demand for a good Price Price of other things (substitutes) Income Other personal preferences
CHOICES INDIVIDUALS CHOOSE DIFFERENT PEOPLE VALUE THINGS
DIFFERENTLY PEOPLE USE MARKETS TO EXCHANGE WHEN YOU STUDY THE MARKET, YOU
STUDY YOURSELF
DEMAND
THE AMOUNT OF A GOOD OR SERVICE THAT A CONSUMER IS WILLING AND ABLE TO BUY AT
VARIOUS POSSIBLE PRICES DURING A GIVEN TIME PERIOD
Expressed in quantity on demand curve.
QUANTITY DEMANDED
THE AMOUNT OF A GOOD OR SERVICE THAT A CONSUMER IS WILLING AND ABLE TO BUY AT EACH PARTICULAR PRICE
DURING A GIVEN TIME PERIOD
CETERIS PARIBUS Latin. other things being equal. http://dictionary.reference.com/browse/ceteris+paribus A ceteris paribus assumption is often fundamental to the
predictive purpose of scientific inquiry. In order to formulate scientific laws, it is usually necessary to rule out factors which interfere with examining a specific causal relationship. Under scientific experiments, the ceteris paribus assumption is realized when a scientist controls for all of the independent variables other than the one under study, so that the effect of a single independent variable on the dependent variable can be isolated. By holding all the other relevant factors constant, a scientist is able to focus on the unique effects of a given factor in a complex causal situation.
Such assumptions are also relevant to the descriptive purpose of modeling a theory. In such circumstances, analysts such as physicists, economists, and behavioral psychologists apply simplifying assumptions in order to devise or explain an analytical framework that does not necessarily prove cause and effect but is still useful for describing fundamental concepts within a realm of inquiry.
THE DEMAND CURVE
The demand curve is the downward-sloping line that shows in graph form the quantities demanded at each possible price.
DEMAND AND THE PRICE OF A GOOD
• Inversely proportional
LAW OF DEMAND
AN INCREASE IN A GOODS PRICE CAUSES A DECREASE IN THE QUANTITY DEMANDED AND A DECREASE IN PRICE CAUSES
AN INCREASE IN THE QUANTITY DEMANDED
FACTORS THAT EFFECT DEMAND
INCOME EFFECT – Any increase or decrease in consumer’s purchasing power caused by a change in price
SUBSTITUTION EFFECT – The substitution of similar, lower priced products.
DIMINISHING MARGINAL UTILITY – Satisfaction declines as more is consumed
DETERMINANTS OF DEMAND CONSUMER TASTES AND PREFERENCES MARKET SIZE INCOME PRICE OF RELATED GOODS
SUBSTITUTE AND COMPLEMENTARY
CONSUMER EXPECTATIONS
HOMEWORK Mock Exam
http://www.bized.co.uk/educators/16-19/economics/markets/activity/demandsupply.htm
SHIFT AND MOVEMENT ALONG THE DEMAND CURVE
Change in priceChange
in quantity
DEMAND AND CONSUMER INCOMES Normal Goods
Goods where the quantity demanded increases in response to an increase in consumer incomes e.g. foreign holidays.
Inferior Goods Goods where the quantity demanded
decreases in response to an increase in consumer incomes, e.g. bus journeys
DEMAND AND CONSUMER INCOME
If you have more income, you could then demand certain things more, such as more of holidays.
Notice that demand curve shifts to the right because of the change in the quantity demanded.
DEMAND AND CONSUMER INCOME But then there are certain
goods or service that you would demand less if your income rises.
If you can afford a car then you would probably travel less by bus.
Such goods are known as inferior goods.
Notice the shift towards the left in the curve.
DRAWING A GRAPH BETWEEN INCOME AND QUANTITY DEMANDED For a normal good demand and income are directly
proportional For an inferior good the demand and income are inversely
proportional
SNOB EFFECT Pointed out by Thorstein Veblen at the end of
nineteenth century. Conspicuous (attracting special attention)
consumption The argument is that some people would regard
some goods highly simply because they are expensive. Rolex Watches, Luxusry Cars etc.
It is to do with the joy people get when other people around them notice them wearing those goods.
DEMAND AND THE PRICE OF OTHER GOODS Substitutes
Two goods are said to be substitutes if the demand for one good is likely to rise if the price of the other good rises.
CONSUMER SURPLUS The extra amount that a consumer is willing to
pay for a product above the price that is actually paid.
Lets look at the Supply Side of Things. Supply
Quantity Supplied by a firm Firm
An organisation that brings together the factors of production to in order to produce output.
Sole proprietor, partnership, public, private, limited etc. Competitive Market
A market in which individual market can not influence the price of good or service they are selling because of competitions from other firms.
Price war, price aggression discussed leter
SUPPLYTHE QUANTITY OF GOODS
AND SERVICES THAT PRODUCERS ARE WILLING
TO OFFER AT VARIOUS POSSIBLE PRICES DURING A
GIVEN TIME PERIOD
QUANTITY SUPPLIED
THE AMOUNT OF A GOOD OR SERVICE THAT A PRODUCER IS
WILLING TO SELL AT A PARTICULAR PRICE
The Supply Curve A graph showing the
quantity supplied at any given price.
The Supply Curve is the upward-sloping line that shows in graph form the quantities supplied at each possible price.
LAW OF SUPPLYPRODUCERS SUPPLY MORE GOODS
AND SERVICES WHEN THEY CAN SELL THEM AT HIGHER PRICES AND
FEWER GOODS AND SERVICES WHEN THEY MUST SELL THEM AT
LOWER PRICES
PROFIT
THE AMOUNT OF MONEY REMAINING AFTER
PRODUCERS HAVE PAID ALL OF THEIR COSTS
Exercise 3.1
Determinants (Influences) of Supply Production Cost The technology of production Taxes and subsidies Price of related goods Firms’ expectations about future prices
COSTS OF PRODUCTION WAGES AND SALARIES
RENT INTEREST ON LOANS
BILLS RAW MATERIALS
ANY OTHER GOODS AND SERVICES
Fixed Costs VS Variable Costs
Supply curve shift to the left Shifts to the
left when production costs increase.
Technology Firms are there to
maximise profits Improved
technology means firms can produce more cost effectively i.e. cheaper
Taxes and Subsidies VAT The price paid by consumers will be higher than the
revenue received by the firms.
Prices of other goods Substitution in firm’s factors of production i.e.
a firm may be able to produce a range of different products. For example, a farmer may switch to growing swedes from potatoes if there is no price difference between potatoes and swedes.
Expected Prices Production is time consuming that is why
firms take supply decisions on the basis of expected future prices.
With greater time period comes higher risk therefore higher returns e.g. commodity, oil, wine, bonds, financial instruments.
Movements along and shifts of the supply curve If price changes there
would be a movement along the curve
However, as with demand curve, a change with any other influences (tax, cost & technology etc.) would cause a shift in the curve. As firms decisions to supply would depend on these influences (determinants)
GROUP DISCUSSION The Heatwave of 2003 During the summer of 2003, the UK experienced record temperatures as a heatwave
swept across the country. The hot weather encouraged people to visit coastal regions for the weekend, to take short break holidays in the UK rather than abroad and to get outside to enjoy the sunny weather. Such a scenario is likely to have an impact on the demand and supply of a number of different items.
Look at the items below: Ice creams Pimms Beer Wheat Hotel rooms Lettuce Barley Barbeque charcoal Beef burgers Maize Garden swings Explain what you think is likely to happen to the demand and the supply of these items.
Try to offer some ideas as to how far the demand and supply would change and why. What would you expect to happen to the price of these items? Explain your answer
fully.
Now you have made some predictions, let's look at some facts:
Sales of ice cream doubled in some parts of the country. Hardware stores reported sharp increases in the sales of
garden swings and barbeque charcoal. Sales of Pimms rose by 300% compared to the same
period the year before; beer sales also rose dramatically. Sales of salad items and barbeque food rose by around
40%. Hotel bookings at many resorts were significantly up on last
year and in many places a reservation was hard to find! Supply of wheat, rice, maize and barley look as though they
could be hit badly as predictions for harvests look gloomy. The price of most ice creams, salad items and so on did not
rise in general during the heat wave although there may have been some differences on a regional basis. The likes of Tesco and Sainsbury would almost certainly not have raised prices but some local ice cream sellers may well have done. How would you explain this?
The price of grain following the summer was predicted to rise. What impact might this increase in price of wheat, barley and maize have on other markets?
HOMEWORK Lets play!! Know your group. Check Fronter. Exchange email contact
details. Here are the rules:
No group would have more than 12 minutes of presentation.
It is up to you to determine how many slides you want to go through.
Every one in the group would have to take part in the group presentation.
If any member of the group is not contributing, let me know.
GROUP PRESENTATION COMPETITION I want you to give me a group presentation on any
of the topics that we have gone through so far. Winner Decision:
Content of the presentation Delivery of the presentation. Popular/democratic vote. Weightage of my assessment. Presentation due next Wednesday!!
Winner group would get a ‘commendation statement on their profile on centime’. This would prove extremely useful in your university references.
DEMAND AND SUPPLY MODELChapter 4
AS Economics
108
Equilibrium: Putting Supply and Demand Together When a market is in equilibrium
Both price of good and quantity bought and sold have settled into a state of rest
The equilibrium price and equilibrium quantity are values for price and quantity in the market but, once achieved, will remain constant Unless and until supply curve or demand curve shifts
The equilibrium price and equilibrium quantity can be found on the vertical and horizontal axes, respectively At point where supply and demand curves cross i.e. Qd = Qs
109
Figure 1: Market Equilibrium
E
HJ1.00
£3.00
D
S
50,000 75,00025,000
Excess Demand
4. until price reaches its equilibrium value of £3.00
.
2. causes the price to rise . . .
3. shrinking the excess demand . . .
1. At a price of £1.00 per bottle an excess demand of 50,000 bottles . . .
Number of Bottles per Month
Price per Bottle
110
Excess Demand
Excess demand At a given price, the excess of quantity demanded
over quantity supplied Price of the good will rise as buyers compete
with each other to get more of the good than is available
111
Figure 2: Excess Supply and Price Adjustment
3. shrinking the excess supply . . .
K L
E3.00
D
S
£5.00
50,00035,000 65,000
Excess Supply at £5.00
2. causes the price to drop,
4. until price reaches its equilibrium value of £3.00.
Number of Bottles per Month
Price per Bottle
1. At a price of £5.00 per bottle an excess supply of 30,000 bottles . . .
112
Excess Supply
Excess Supply At a given price, the excess of quantity supplied
over quantity demanded Price of the good will fall as sellers compete
with each other to sell more of the good than buyers want
113
Solve for Equilibrium Algebraically Suppose that demand is given by the
equation , where is quantity demanded, P is the price of the good. Supply is given by where is quantity supplied.
What is the equilibrium price and quantity?
PQD 10140
PQS 580
DQ
sQ
114
Income Rises: What Happens When Things Change Income rises, causing an increase in demand
Rightward shift in the demand curve causes rightward movement along the supply curve
Equilibrium price and equilibrium quantity both rise
Shift of one curve causes a movement along the other curve to new equilibrium point
115
Figure 3
1. An increase in demand . . .E
F'
3.00
D1
D2
S
£4.00
50,000 60,000
3. to a new equilibrium.
5. and equilibrium quantity increases too.
2. moves us along the supply curve . . .
Number of Bottles of Maple Syrup per Period
Price per Bottle
4. Equilibrium price increases
116
An Ice Storm Hits: What Happens When Things Change
An ice storm causes a decrease in supply Weather is a shift variable for supply curve
Any change that shifts the supply curve leftward in a market will increase the equilibrium price And decrease the equilibrium quantity in that market
117
Figure 4: A Shift of Supply and A New Equilibrium
E'
E3.00
D
£5.00
50,00035,000
S2 S1
Number of Bottles
Price per Bottle
118
Using Supply and Demand: The Invasion of Kuwait Why did Iraq’s invasion of Kuwait cause the
price of oil to rise? Immediately after the invasion, United States led
a worldwide embargo on oil from both Iraq and Kuwait
A significant decrease in the oil industry’s productive capacity caused a shift in the supply curve to the left Price of oil increased
119
Figure 5: The Market For Oil
P2
D
E'
P1E
Q2 Q1
S2
S1
Barrels of Oil
Price per Barrel of Oil
120
Using Supply and Demand: The Invasion of Kuwait Why did the price of natural gas rise as well?
Oil is a substitute for natural gas Rise in the price of a substitute increases demand
for a good Rise in price of oil caused demand curve for
natural gas to shift to the right Thus, the price of natural gas rose
121
Figure 6: The Market For Natural Gas
Cubic Feet of Natural Gas
Price per Cubic Foot of Natural
Gas
P4
P3
F
Q3 Q4
S
D2
F'
D1
122
Figure 7: Changes in the Market for Handheld PCs
1. An increase in supply . . .
2. and a decrease in demand . . .
5. and quantity decreased as well.
A
B£400
D2003
S2002
S2003
D2002
£500
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4. Price decreased . . .
3. moved the market to a new equilibrium.
123
Both Curves Shift
When just one curve shifts (and we know the direction of the shift) we can determine the direction that both equilibrium price and quantity will move
When both curves shift (and we know the direction of the shifts) we can determine the direction for either price or quantity—but not both Direction of the other will depend on which curve shifts by
more
124
The Three Step Process
Key Step 1—Characterize the Market Decide which market or markets best suit problem being
analyzed and identify decision makers (buyers and sellers) who interact there
Key Step 2—Find the Equilibrium Describe conditions necessary for equilibrium in the
market, and a method for determining that equilibrium Key Step 3—What Happens When Things Change
Explore how events or government polices change market equilibrium
Examples of MarketsThe Labour Market Firms demand labour and employees supply
labour The demand for labour is derived demand. Derived Demand:
Firms want labour not for themselves but for the output it produces
125
Labour market Firms would demand more
if the price for labour is low More people would tend to
offer themselves for work when the wages are high
Price of labour = wages Demand for labour is
downward sloping Supply for labour is
upward sloping
126
Labour Market - Unemployment
If the wage rate is set above the equilibrium level at w1 employers would only demand Ld.
At this point there are people who are offering themselves for work but can not find employment. i.e. There is unemployment in the market. Which is caused here by the higher wage rate.
127
The Foreign Exchange (FX) Market
There is a market where ‘buying’ (transaction) is going on.
When you go to Spain for holidays, you need to buy Euros. Similarly, when Spanish want to come to UK they need to buy pounds.
So the demand for £s (by Spanish) or Euros (by British) is dependent upon the exchange rate between Euros and Pounds.
When the exchange rate for pounds is high, people would have fewer Euros to buy pounds, i.e. Demand would be relatively low.
128
FX Similarly, when the pound is
weak against Euros foreigners would be able to afford more pounds. Demand would increase.
We could also derive from here the fact that when pound is strong, UK exports would not be that competitive and vice versa ceteris paribus.
Pounds are supplied by Britishers wanting to buy Euros. When Euro/Pound rate is high, Britishers get more euro goods for their pounds and will tend to supply more.
e* is the equilibrium point.
129
The Money Market People have a demand for money due to operations of
markets. Think of functions of money,
Medium of exchange Store of value Unit of account Standard of deferred payment
Demand for money predominantly depends upon income which influences the number of transactions people are willing to take.
Is there a price of money? The price of money can be viewed in terms of opportunity
cost. When people choose to hold money they incur an
opportunity cost. Why? Rate of interest? Return? Pleasure?130
Money Money Money Supply of Money
Discussed in detail later in the course
BOE takes charge of supply Assume for now that supply of
money doesn't depend on the interest rate.
Greater the interest rate, greater will be the sacrifice by holding money. Hence the downward sloping demand curve.
At r* money market is at equilibrium
131
AS F581 MARKETS IN ACTIONWeek 5
COMPARATIVE STATICS Comparative static analysis examines the effect on equilibrium
of a change in the external conditions affecting a market. As opposed to ceteris paribus where factors are kept constant,
comparative static analysis looks at the before and after affects of a factor.
A MARKET FOR DRIED PASTA Let us consider a
simple basic staple foodstuff obtainable in any food store.
Consider the graph as the ‘before’ position.
We shall now measure the effect of different factors by disturbing the equilibrium.
A CHANGE IN CONSUMER PREFERENCES
Suppose a new study proposes that Pasta is the next best food to caviar and this study is further strengthened by marketing campaign.
People would buy more demand curve to the right market adjusts to new equilibrium both prices and quantity have increased.
Movement along the supply curve
CHANGE IN THE PRICE OF SUBSTITUTE If substitute (fresh pasta?)
goes cheaper people would probably start buying more fresh pasta demand curve would shift towards left.
Movement along supply curve.
Market would reach a new equilibrium with lower price and lower quantity.
IMPROVEMENT IN PASTA TECHNOLOGY
With improved technology, cost is lowered.
Firms would be willing to supply more.
Now the supply curve would shift to the right.
Comparative static analysis will show that new equilibrium reached is lower than the original one.
AN INCREASE IN LABOUR COST Pasta Worker Union
negotiates a higher wage or H&S regulations have become stricter.
Both would raise production costs.
Which means firms would be willing to supply less pasta.
Shift to the left New equilibrium Greater price but lower quantity
GROUP EXERCISE Ex 4.3 printoffs
ELASTICITY Elasticity is a measure of responsiveness Many elasticities can be measured: price
elasticity of demand, cross price elasticity of demand, income elasticity of demand, and elasticity of supply
Elasticity measures are measures of proportionate responsiveness and are unit free
WHAT IS ELASTICITY? If my firm wants to raise revenue, should we
decrease or increase the price? The answer relies on elasticity “Elasticity” is similar to “responsiveness” Price Elasticity of Demand – a measure of how
responsive quantity demanded is to a price change
Price Elasticity of Supply – a measure of how responsive quantity supplied is to a price change
PRICE ELASTICITY OF DEMAND
Mathematically…
pricein change Percentage
demandedquantity in change Percentage demand of elasticity Price
2/)'(
'
2/)'(
' demand of elasticity Price
pp
pp
EXAMPLE
What is the price elasticity of demand for CDs?
At a price of $14 per CD, there are 10,000 CDs sold
When the price is decreased to $12 per CD, 11,000 CDs are sold
Pri
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Thousands of CDs
D
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$12
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D
KEEP THIS IN MIND… Because price and quantity are inversely
related, the price elasticity of demand will be negative
This is because a price decrease will cause an increase in quantity demanded (and vice versa)
Most of the time, then, I will refer to the absolute value of the elasticity
The magnitude is most important
CATEGORIES OF PRICE ELASTICITY OF DEMAND
1. Inelastic Demand – a change in price has very little effect on the quantity demanded (-1 < ED < 0)
• These goods are often necessities
2. Elastic Demand – a change in the price has a relatively large effect on the quantity demanded (ED < -1)
• These are often more “unnecessary”
3. Unit-Elastic Demand – the percentage change in quantity demanded equals the percentage change in price (ED = -1)
0-1
InelasticUnit-ElasticElasti
c
Elasticity of Demand
ELASTICITY…
1. Varies along the demand curve for the same product
• You respond differently if the price changes from 1 cent to 2 cents, than you do if the price changes from $5 to $10 (both are 100% increases)
2. Varies across products• Regardless of where we are on the demand
curve, you might expect the demand for milk to be less elastic than the demand for BMWs
Demand Curve
More Elastic
More InelasticP
Q
ELASTICITY AND TOTAL REVENUE
Total Revenue – the amount of money a firm collects through sales
TR = Price * Quantity How is Total Revenue related to Elasticity? Recall that a lower price leads to an increase in
quantity demanded… Whether Total Revenue increases or decreases
change (due to a price decrease) will depend on whether the percentage increase in the quantity demanded is less than or greater than the price decrease
Unit Elastic
Inelastic
ElasticP
Q
TR
Q
WHAT DOES THIS GRAPH SHOW? Should you increase or decrease price to
increase Total Revenue??? In the elastic portion of the demand curve, the %
change in quantity demanded is greater than the % change in price, so you should decrease price in order to increase total revenue
In the inelastic portion of the demand curve, the % change in quantity demanded is less than the % change in price, so you should increase price in order to increase total revenue
Total revenue is maximized at the unit elastic point
CONSTANT-ELASTICITY DEMAND CURVES For a downward sloping linear demand curve, the
price elasticity changes as you move along the demand curve
Some demand curves have an elasticity that does NOT vary along the demand curve
1. Perfectly Elastic Demand Curve – an increase in price reduces the quantity demanded to zero (horizontal demand curve)
2. Perfectly Inelastic Demand Curve – price changes have no effect on the quantity demanded (vertical demand curve)
Q
P P
Q
D
D
Perfectly Elastic Demand
Perfectly Inelastic Demand
DETERMINANTS OF THE PRICE ELASTICITY OF DEMAND Availability of Substitutes – the more
substitutes are available for a good, the more elastic the demand (if the price increases, you might be likely to switch to another good)
Proportion of a Consumer’s Budget Spent on the Good – the larger the percentage of a consumer’s budget, the greater the price sensitivity (ex. comparison shopping for cars)
Time – the longer you have to make your choice, the more elastic your demand will be (ex. what if your refrigerator breaks down?)
Price Elasticity of Supply
Mathematically…
pricein change Percentage
suppliedquantity in change Percentage supply of elasticity Price
2/)'(
'
2/)'(
' supply of elasticity Price
pp
pp
Categories of Price Elasticity of Supply
1. Inelastic Supply – a change in price has very little effect on the quantity supplied (0 < ES < 1)
2. Elastic Supply – a change in the price has a relatively large effect on the quantity supplied (ES > 1)
3. Unit-Elastic Supply – the percentage change in quantity supplied equals the percentage change in price (ES = 1)
0 1
ElasticUnit-ElasticInelastic
Elasticity of Supply
ELASTICITY OF SUPPLY ALSO VARIES…
Just as the elasticity of demand varied both along the demand curve and across products, so does the elasticity of supply
Supply Curve
More Elastic
More InelasticP
Q
Constant-Elasticity Supply Curves
• For an upward sloping linear supply curve, the price elasticity changes as you move along the supply curve
• Some supply curves have an elasticity that does NOT vary along the supply curve
1. Perfectly Elastic Supply Curve – at the right price, any amount of the product will be supplied (horizontal supply curve)
2. Perfectly Inelastic Supply Curve – price changes have no effect on the quantity supplied, which is likely a fixed amount (vertical supply curve)
Q
P P
Q
S
S
Perfectly Elastic Supply
Perfectly Inelastic Supply
Determinants of the Price Elasticity of Supply
Both depend on how easy it is to alter output when price changes
• Cost of Supplying Additional Output – if it is costly to increase output, then a price increase won’t cause the firm to expand output significantly (therefore, supply is inelastic)
• Time – how long does the firm have to make the output change? The longer the time, the more elastic the supply
OTHER ELASTICITY MEASURES Income Elasticity of Demand – a measure
of the responsiveness of demand to changes in income
Cross-Price Elasticity of Demand- a measure of how responsive one good’s quantity demanded is to a change in the price of another good (i.e. how do brand X’s sales respond to changes in the price of brand Y)
INCOME ELASTICITY OF DEMAND Normal Good – a good with an income
elasticity greater than zero Why is the elasticity greater than zero? Because
the demand curve shifts out with income increases Most goods are normal goods
Inferior Good – a good with an income elasticity less than zero Why is the Income Elasticity of Demand negative?
Because the demand curve shifts in with income increases
CROSS-PRICE ELASTICITY OF DEMAND
Substitutes – if an increase in the price of one good leads to an increase in the demand for another good, they are substitutes The Cross-Price Elasticity is POSITIVE Example: Coke and Pepsi have a positive cross-
price elasticity
Complements – if an increase in the price of one good leads to a decrease in the demand for another good, they are complements The Cross-Price Elasticity is NEGATIVE Example: Peanut butter and jelly or hot dogs and
buns
ELASTICITY EXAMPLES
To help us think about elasticity concepts, we are going to look at four different industries/products: Cars, soft drinks, cereal, and beer Your book has a ton of other examples
When you look at the elasticities, try to explain the differences among brands and products Substitutability, proportion of income spent on
the item, and time to make your decision
ELASTICITY OF AUTOMOBILES
Price elasticity of demand: BMW 735i = -9.376 Honda Accord = -51.637 Ford Escort = -106.497
Cross-price elasticity of demand: BMW 735i & Lexus LS400 = 0.336 BMW 735i & Honda Accord = 0.203 BMW 735i & Ford Escort = 0.009
Which cars are close substitutes? What role does income play? Which consumers are most price sensitive?
ELASTICITY OF BREAKFAST CEREAL
Price elasticity of demand: Kellogg’s Corn Flakes = -3.379 Lucky Charms = -2.536 Rice Krispies = -2.340
Cross-price elasticity of demand: Corn Flakes & Wheaties = 0.242 Corn Flakes & Lucky Charms = 0.019 Corn Flakes & Cinnamon Toast Crunch = 0.026 Lucky Charms & Cin. Toast Crunch = 0.102
ELASTICITY OF SOFT DRINKS
Price elasticity of demand: Coke (2-liter bottle) = -3.89 7-Up (2-liter bottle) = -4.25 Mountain Dew (2-liter bottle) = -3.75
Cross-price elasticity of demand: Coke & Pepsi = 0.63 Coke & Mountain Dew = 0.12 Coke & Diet Coke = 0.81
ELASTICITY OF BEER
Price elasticity of demand: Miller Lite = -2.10 Budweiser = -3.80 Heineken = -0.42
Cross-price elasticity of demand: Miller Lite & Bud Light = 1.26 Miller Lite & Heineken = 0.12 MGD & Bud = 1.68
QUESTIONS TO THINK ABOUT?
Why is the price elasticity of the Ford Escort lower than the BMW?
Why is the price elasticity of cereal less than the price elasticity of cars?
Why is the cross-price elasticity greater for Corn Flakes & Wheaties than it was for Corn Flakes & Lucky Charms?
Are Miller Lite and Bud Light closer substitutes than Miller Lite and Heineken?
Income IncomeProduct Elasticity Product Elasticity
Private education 2.46 Physicians’ services 0.75
Automobiles 2.45 Coca-Cola 0.68
Wine 2.45 Beef 0.62
Owner-occupied housing 1.49 Food 0.51
Furniture 1.48 Coffee 0.51
Dental service 1.42 Cigarettes 0.50
Restaurant meals 1.40 Gasoline and oil 0.48
Shoes 1.10 Rental housing 0.43
Chicken 1.06 Beer 0.27
Spirits (“hard” liquor) 1.02 Pork 0.18
Clothing 0.92 Flour –0.36
Selected Income Elasticities of Demand
IN-CLASS PROBLEM TO SOLVE
Last year, Homer had an income of $40,000 from his job at the Springfield Nuclear Power Plant. At that level of income, Homer consumed 15 units of Good X. This year, Homer received a $15,000 raise. After his raise, he consumed 18 units of Good X.
a. Using the above information, please calculate Homer’s income elasticity of demand.
b. Is Good X a normal or inferior good?
c. If Homer’s boss gave him an additional 10% raise, what would happen to Homer’s consumption of Good X?
SOLUTIONS
Normal good => EI > 0
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