Economics Lecture notes- Semester 1:

Size: px

Start display at page:

Download "Economics Lecture notes- Semester 1:"

Buck Price
5 years ago
Views:

1 Economics Lecture notes- Semester 1: Lecture 1: What is economics? The word economy comes from the Greek word meaning one who manages a household. Households and economies have much in common; both face the same fundamental problem: Available resources cannot produce all the goods and services people desire (scarcity). Economics is the study of how society manages its scarce resources. A more detailed definition: The social science that studies the choices that individuals, businesses, governments make as they cope with scarcity and the incentives that influence those choices. Microeconomics focuses on individual agents in the economy How households and firms make decisions and how they interact Aims to understand how scarce resources are allocated among alternative uses, the role of prices and markets and how economic policy can lead to better outcomes for society Macroeconomics looks at the economy as a whole Focuses on economy-wide phenomena, including inflation, unemployment and economic growth Lesson 1: People face trade-offs: Because of scarce resources, making decisions requires trading off one goal for another Simply, to get one thing that you like, you have to give up something else (e.g. limited time and money) Trade-off between efficiency (getting the largest output from available resources) and equity (distributing outputs fairly to increase overall well-being in society) Lesson 2: The cost of something is what you give up to get it: In economics the cost of something is what you give up to get it, not just in terms of monetary costs but all opportunity costs The opportunity cost of an item is the value of the best opportunity that you give up to obtain that item When making any decisions, individuals compare costs and benefits To make a sound decision, it is necessary to be aware of the opportunity cost of that decision (the true cost of the decision)

2 Lesson 3: Rational people think at the margin: Rational people choose the best option from available alternatives by comparing costs and benefits at the margin. Example: Suppose that flying a 200-seat plane from Brisbane to Perth costs the airline $100,000, an average cost of $500 per seat. The plane is minutes from departure, there are several vacant seats and a person is willing to pay $300 for a seat. Should the airline sell the seat for $300? Yes: As long as the marginal benefit (the revenue from an extra seat sold, here $300) exceeds the marginal cost (the cost of providing the seat to one additional passenger, here close to $0), selling the ticket is profitable. Marginal change: a small incremental adjustment to a plan of action. Rational people compare the marginal cost of a decision with its marginal benefit. Lesson 4: People respond to incentives: An incentive is a reward or punishment that induces a person to act (or not to act) in a certain way. Examples: Penalties Bonus to an employee Rewards and punishments associated with a given decision alter the benefits and costs of that decision. Summary of lesson 1-4: Scarcity forces people to make decisions/choices about what to give up and what to get (we face trade-offs). The true cost of what we choose is what we give up to get it (opportunity cost). Making the right decisions implies comparing costs and benefits. This comparison is made at a margin. Since incentives alter the costs and/or benefits of our choices, we do respond to incentives. Economics as a scientist: Economics is a social science. It is a science because it makes use of the scientific method: Observation Theory more observation and so on Develops theories Collects and analyses data to evaluate ( test ) the theories An obstacle in testing economic theories arises because it is difficult to use experiments to analyse social/economic phenomena Physicists test theories in a laboratory Economists can often rely on observations the world happens to give them

3 Assumptions and economic models: Assumptions are employed to make the world easier to understand The art in scientific thinking is deciding which assumptions to make. Assumptions are good if they simplify the problem at hand without substantially affecting the answer. A model is a simplified representation of reality intended to facilitate the understanding of a complex problem. Models are built on assumptions Production Possibilities Frontier (PPF: The Production Possibilities Frontier (PPF) is a graph showing the combinations of output that an economy can possibly produce given the available factors of production; and the available production technology. The economist as policy adviser: When economists try to explain the world, they are scientists. When they try to improve the world, they are policy advisers. Positive versus normative analysis Positive statements try to describe the world as it is. Positive statements are objective statements that can be tested, amended or rejected by referring to the available evidence. Positive economics deals with objective explanation and the testing and rejection of theories. called descriptive analysis. Normative try to describe how the world should be Normative statements are subjective statements rather than objective statements i.e. they carry value judgments called prescriptive analysis. Examples of positive and normative statements When economists make normative statements, they are acting more as policymakers.

4 Economists in government: Serve as advisers in the policymaking process in all branches of government and independent agencies. Examples include Treasury Reserve Bank OECD Economists also work in or advise the private sector: financial institutions, industries and NGOs Lecture 2: Markets and competition: A market is a group of buyers and sellers of a particular good or service Whenever you have a group of buyers and sellers interacting to trade a good/service, you have a market This interaction can occur in an physical place or in a virtual one A competitive market is a market in which there are so many buyers and so many sellers that each has a negligible impact on the market price. The smaller the ability of each buyer/seller to affect the market price, the more competitive the market. Throughout this subject we will assume that markets are perfectly competitive (PC). To reach this highest form of competition, a market must have two characteristics: The goods being offered for sale are all exactly the same (homogeneous) The buyers and sellers are so numerous that none can influence the market price. Because buyers and sellers accept the market price as given, they are often called price takers How competitive are real-world markets? There are some markets in which the assumptions of perfect competition apply well (e.g. agricultural markets) However, there are some markets in which there is no competition at all. In markets with only one seller (a Monopoly), the seller sets the price (price setter). The theory of S&D that we study today does not apply to these cases. Most real world markets fall between the extremes of perfect competition and monopoly.

depends on many factors such as the price of the good, tastes, income and many others Law of demand.

5 Demand: Quantity demanded of a good is the amount of a good that buyers are willing and able to purchase. Willing = A buyer wants to buy that amount (given his/her tastes and preferences) Able = Given the price of the good, a buyer has enough income to buy the desired amount Quantity demanded of a good depends on many factors such as the price of the good, tastes, income and many others Law of demand. Other things equal, the quantity demanded of a good falls (rises) when the price of the good rises (falls). Other things equal (or Ceteris paribus) = Holding constant all other factors (other than price) that may affect quantity demanded. Two ways of representing the relationship between price and quantity demanded: Demand Schedule: A Table showing the relationship between the price of a good and the quantity demanded. Demand Curve: A Graph showing relationship between the price of a good and the quantity demanded. Market demand is the sum of all individual demands for a particular good or service. A change in the price of the good generates a movement along the demand curve. A change in one or more of these other factors generates a shift in the demand curve, either to the left or right In this case we say that there is a change in demand (as opposed to a change in quantity demanded). With a change in demand, the quantity demanded changes at every price.

6 Shifts in the demand curve: What are those factors other than price that affect demand? Income - The relationship between income and demand depends on what type of good the product is. Normal good a good for which, other things being equal, an increase in income leads to an increase in demand Inferior good a good for which, other things being equal, an increase in income leads to a decrease in demand Prices of related goods - The relationship between the price of a related good and demand depends on what type of goods the products are. Substitutes two goods for which a decrease in the price of one good leads to a decrease in the demand for the other good. Complements two goods for which a decrease in the price of one good leads to an increase in the demand for the other good. Also: Tastes - If you like something you buy more of it. Economists do not normally try to explain people s tastes, however, they do examine what happens when tastes change Expectations Eg About your future income Eg About the future price of the good Number of buyers - Because market demand is derived from individual demands it positively depends on the number of buyers Supply: Quantity supplied is the amount of a good that sellers are willing and able to sell Willing = Producer wants to sell that amount Able = The amount is feasible given resources and technology Law of supply The law of supply states that, other things being equal (ceteris paribus) the quantity supplied of a good rises when the price of the good rises, and vice versa Two ways of representing the relationship between price and quantity supplied: Supply Schedule: Table showing relationship between the price of a good and the quantity supplied.

Economics for Business. Lecture 1- The Market Forces of Supply and Demand

Economics for Business. Lecture 1- The Market Forces of Supply and Demand Economics for Business Lecture 1- The Market Forces of Supply and Demand The theory of supply and demand (S&D): Considers how buyers and sellers behave and interact with one another in competitive markets