1 Lecture 1 Basic Concerns of Economics What is Economics! Economics is the study of how society manages its scarce resources. o Economic Problem: How a society can satisfy unlimited wants with limited resources available.! Two Aspects: o Microeconomics focuses on individual agents in the economy o Macroeconomics looks at the economy as a whole 1. People face trade-offs! Because of scarce resources, making decisions requires trading off one goal for another o Simply, to get one thing that you like, you have to give up something else o Trade-off between efficiency (getting the largest output from available resources) and equity (distributing outputs fairly to increase overall well-being in society) 2. The cost of something is what you give up to get it! Opportunity Cost: Represents the alternative use of a resource. o The real cost, regarding satisfying one want over an alternative want. o individuals compare costs and benefits o The opportunity cost of an item is the value of the best opportunity that you give up to obtain that item 3. Rational people think at the margin! Rational people choose the best option from available alternatives by comparing costs and benefits at the margin. o Rational people compare the marginal cost of a decision with its marginal benefit.! Marginal change: a small incremental adjustment to a plan of action. 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. o This alters the benefits and costs of that decision. The economist as policy adviser! Positive statements try to describe the world as it is. o Descriptive analysis.! Normative try to describe how the world should be o Prescriptive analysis. Lecture 2 The market forces of and Markets and competition! A market is a group of buyers and sellers of a particular good or service, interacting to trade a good/service o 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 Characteristics of Perfectly Competitive Markets (Simplified Economic Assumption): o The goods being offered for sale are all exactly the same (homogeneous) o The buyers and sellers are so numerous that none can influence the market price. o Because buyers and sellers accept the market price as given, they are often called price takers Demand! Involves Consumer willingness and ability to purchase a good or service! Law of : Other things equal, the quantity ed of a good falls (rises) when the price of the good rises (falls).! Two ways of representing the relationship between price and quantity ed: o Demand Schedule: A Table showing the relationship between the price of a good and the quantity ed. o Demand Curve: A Graph showing relationship between the price of a good and the quantity ed. Demand Curve
2 ! Market is the sum of all individual s for a particular good or service. o Graphically, individual curves are summed horizontally to obtain the market curve! Movements along the curve (change in quantity ed) o A change in the price of the good generates a movement along the curve.! Factors causing Shifts in the Demand curve o Income - The relationship between income and varies according to product: 0 Normal good : a good for which, other things being equal, an increase in income leads to an increase in 0 Inferior good: a good for which, other things being equal, an increase in income leads to a decrease in 0 Substitutes: two goods for which a decrease in the price of one good leads to a decrease in the for the other good. 0 Complements: two goods for which a decrease in the price of one good leads to an increase in the for the other good. o Tastes Involve iindividual preferences, which are constantly changing o Expectations About your future income, the future price of the good etc. Supply! Quantity supplied is the amount of a good that sellers are willing and able to sell! Law of : The law of states that, other things being equal 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: o Supply Schedule: Table showing relationship between the price of a good and the quantity supplied. o Supply Curve: Graph showing relationship between the price of a good and the quantity supplied. Supply Curve! Market is the sum of all individual supplies for a particular good or service. o Graphically, individual curves are summed horizontally to obtain the market curve! Movement along the curve (change in quantity of ) o Thus, the total quantity supplied of a good varies with the price of the good! Factors causing Shifts in the curve o Input prices - The quantity supplied is negatively related to the price of inputs used to make the good: If the price of an input rises (falls), the decreases (increases) o Technology - An improvement in production technology increases productivity: with the same inputs, the producer can more o Expectations If suppliers expect the price to rise they will be more likely to store some of the good and less to the market today Equilibrium! Equilibrium a situation in which and have been brought into balance o Where and curves intersect o Law of and : The claim that the price of any good adjusts to bring the and for that good into balance! Markets not in equilibrium Surplus o When market price is higher than the equilibrium price, then there is a surplus (or excess ): 0 Quantity supplied is larger than quantity ed. 0 Suppliers lower price to increase sales, thereby moving toward equilibrium! Markets not in equilibrium Shortage o When market price is lower than the equilibrium price, then there is a shortage (or excess ): 0 quantity supplied is smaller than quantity ed o Suppliers raise price due to too many buyers chasing too few goods, thereby moving toward equilibrium. Changes in equilibrium P Price Q Quantity No change in An increase in A decrease in
3 No change in P same Q same An increase in P ambiguous Q ambiguous A decrease in Q ambiguous P ambiguous How prices allocate resources! Market mechanism of S and D means that any buyer who is willing to and able to pay the equilibrium price can purchase the good.! Similarly, any seller who is willing and able to produce and sell the good at the equilibrium price will do so. o This is known as the rationing function of prices or prices as a mechanism for rationing resources. Lecture 3 Elasticity, Market and Government Policies Elasticity! Elasticity of : measures how much responds to changes in its determinants (Price and/or income)! Elasticity of : measures how much responds to changes in its determinants(price and/or income) The price elasticity of Percentage change in quantity ed Price elasticity of = Percentage change in price! N.B. determining percentage change in : (D2 D1)/ D1 0 If greater than 1, is said to be elastic (Buyers respond strongly to a change in price) 0 If less than 1, is said to be inelastic (If less than 1, is said to be inelastic) 0 If equal to 1, is said to have unitary elasticity (A given percentage change in Price leads to a proportionally equal change in quantity ed)! Example: You have determined that the price elasticity of for exclusive paintings is 0.8. What will happen to your total revenue from selling these paintings if you raise your prices? 0 Answer: The price elasticity of for these paintings is less than one, so an increase in price will generate an increase in total revenue (as is relatively constant, consumers pay more).! Suppose the price elasticity of for tomatoes is 0.2. An 8 per cent increase in price will result in: 0 a 1.6 per cent decrease in the quantity of tomatoes ed Reasons for price elasticity of! Price elasticity tends to be higher when there are many close substitutes! Necessities versus Luxuries (e.g. Elasticity tends to be higher for luxuries)! Elasticity tends to be higher when market is defined narrowly ( food versus ice cream ) 0 Food is inelastic whereas ice cream is elastic! Elasticity tends to be higher the longer the time period considered 0 E.g. increase price of petrol leads to increase investment in fuel efficient cars over time etc. Price elasticity and curves! Rule of thumb: the steeper (flatter) the curve that passes through a given point, the lower (greater) the price elasticity of! Midpoint method: computes a percentage by dividing the change by the midpoint of the initial and final levels. 0 E.g 1 Point A: P=$4 Q=120. Point B: P = 6 Q=80. Therefore, midpoint is P=$5 Q=100. Therefore, a change from $4 to $6 is considered a 40% ((6-4)/5 x 100) rise in price and 40% fall in quantity.
4 0 The following formula for price elasticity of between two points: Price elasticity of = (Q2 Q1) / (Q2 +Q1) / 2 (P2 P1) / (P2+ P1) / 2 0 Therefore, the price elasticity of (in both directions) equals 1. Total revenue and the price elasticity of! Total Revenue (TR) is the product of price and quantity ( amount paid by buyers/amount received by sellers) o TR = P x Q If is inelastic " an increase in P " a less than proportional decrease in Q " increase in TR If is elastic " an increases in P " a proportionally larger decrease in Q " decrease in TR If has unit elasticity " a change in P " proportionally equal change in Q " TR are unaffected Income elasticity of! Income elasticity of measures how much the quantity ed of a good responds to a change in consumers income. Income elasticity of = Percentage change in quantity ed Percentage change in Income o positive income elasticity (greater than 0) 0 Normal goods and Necessities tend to be income inelastic, i.e. low positive income elasticity (less than 1) e.g. food o negative income elasticity (less than 0) 0 Inferior goods and Luxuries tend to be income elastic, i.e. high positive income elasticity (greater than 1) e.g. expensive cars Cross-price elasticity of! Cross-price elasticity of measures how much the quantity ed of a good (say good 1) responds to a change in the price of a related good (say good 2) Percentage change in quantity ed of good1 Price elasticity of = Percentage change in price of good 2 o o Complements have negative cross-price elasticity. Substitutes have positive cross-price elasticity. - E.g. In an imaginary economy, the price of hizzle decreased by 20% and the quantity of hizzle sold subsequently increased by 15%. Also, the quantity of Vort ed increased by 10%. Therefore, the cross-price elasticity of between Vort and hizzle is -0.5 Price elasticity of! Price elasticity of is a measure of how much the quantity supplied of a good responds to a change in the price of that good. Percentage change in quantity supplied Price elasticity of =! Supply is said to be: Percentage change in price o Elastic if price elasticity of is greater than 1 o Inelastic if price elasticity of is smaller than 1 o Unit elastic if price elasticity of is equal to 1 Reasons for price elasticity of
5 ! Ability of suppliers to change the amount of the good they sell! Time period being considered (time taken to produce a product) Markets and government policies Controls on prices! Price controls are used when policymakers believe the market price is unfair to buyers or sellers. o Price ceiling: a legal maximum on the price at which a good can be sold 0 If the ceiling is below the equilibrium price (i.e. it is binding) " Shortage and non-price rationing (long lines and queuing, discrimination by sellers) o Price floor: a legal minimum on the price at which a good can be sold. 0 If the floor is above the equilibrium price (i.e. it is binding) " Surplus and non-price rationing (discrimination by buyers). Taxes and market outcomes A tax on sellers! Represents an additional production cost.! At any given quantity, sellers increase the price in order to cover the extra cost of the tax.! The curve shifts up by an amount equal to the tax! Though the sellers physically pay tax to the government, they share the burden of the tax with buyers. In the new equilibrium buyers pay more for the good and sellers receive less. A tax on buyers! Buyers have to pay the price to the seller plus any tax to government! To induce buyers to any given quantity, the market price must be lower than it was before.! Though the buyers physically pay the tax to the government, they share the burden of the tax with sellers. In the new equilibrium buyers pay more for the good and sellers receive less. Impact of taxes! Taxes result in a change in market equilibrium. o In the new equilibrium quantity sold is lower, regardless whom the tax is levied. 0 Conclusion: Taxes discourage market activity; But they are necessary to raise revenue to finance some projects and services (again, no free lunch). o Buyers pay more and sellers receive less, regardless of whom the tax is levied. 0 Conclusion: Buyers and sellers share the tax burden regardless of whom the tax is levied on. Elasticity and tax incidence! The burden of a tax falls more heavily on the side of the market that is less elastic (When the good is taxed, the side of the market with fewer good alternatives cannot easily leave the market and must, therefore, bear most of the burden of tax. 123(!42'/&"(',55467(&$-42'/&"(8-%2$8(0(/92/(&'7('-44-*'( 2*-(:-*6(*-'5#$'&:-(/#(/9-(5*&"-(#)(/9-(;##87( <9-*-2'(=,6-*'(2*-($#/(:-*6(*-'5#$'&:->(?9,'7(/9-( 5*&"-(*-"-&:-8(=6('-44-*'(8#-'($#/()244(%,"97('#( 5*&"-(52&8(=6('-44-*'()244'(',='/2$/&2446>(?9,'7('-44-*'( =-2*(%#'/(#)(/9-(=,*8-$(#)(/2A>( (