Documente Academic
Documente Profesional
Documente Cultură
Economics in Perspective
Economics as a social science
It is a systematic study that focuses in the activities of man in relation to his environment. It studies
the societys allocation of scarce resources to meet unlimited needs and wants. Scarcity is a general
characteristic of resources, basically due to a resources alternative uses.
Economics as the science of choice
From the households choice to purchase goods to the firms choice of production, everything in our
world now is a result of the many decisions individuals made in the past. Economics studies these choices
and how and why these choices are made.
The concept of Opportunity Cost
In economics, the full cost of making a certain choice includes the value of what we give up by
not choosing the alternative choice. For example, the opportunity cost of studying in college is the
time you could have used to do other things or the money you could have earned if you decided to
work as a high school graduate.
Ceteris Paribus
Translated to English, this means all else equal. This concept allows one variable to change as
other variables are held constant.
Three basic questions in economics:
What to produce?
How is it produced?
For whom is it produced?
Microeconomics
The branch of economics that examines the behaviour of an individual decision-making units, e.g.
the household and the firms.
Macroeconomics
The branch of economics that deals with the behaviour of aggregates (income, employment,
output etc.) on a national level.
*ECONONE is a course that serves as an introduction to Microeconomics.
In a market economy, individual consumers make plans of consumption and individual firms make plans of
production based on the changes in market prices.
A demand schedule is a table showing the quantities of a good that a consumer would buy at all
different prices. Below is an example of a demand schedule.
Table 1.1 Demand Schedule for Candy
Price
0
1
2
3
4
Quantity Demanded
20
15
10
5
0
In mathematics, price & quantity demanded have a functional relationship. (In a demand function,
price is called the independent variable and quantity demanded the dependent variable). A demand
curve shows the above relationship in a graph.
Figure 1.1 Demand Curve for Candy
P
4.00
3.00
2.00
1.00
0
5
10
15
20
Qd
Demand curves are downward-sloping due to the negative relationship of price and demand, thus
the Law of Demand applies.
Income
A rise in income leads to a higher purchasing power or ability to buy of the consumers.
( If nominal income and prices increase by the same percentage, the real income is unchanged.)
If a rise in income leads to a rise in demand of a good by a consumer, the good is called a
normal good or superior good.
If a rise in income leads to a fall in demand of a good, the good is called an inferior
good. Inferior does not refer to the quality of the good.
Summary:
Table 1.2
Type of Good
Normal
Inferior
Income
Increases
Decreases
Increases
Decreases
Demand
Increases
Decreases
Decreases
Increases
Price of good 1
Increases
Decreases
Increases
Decreases
Table 1.3
Type of Good
Substitute
Complement
Change in demand.
A supply schedule is a table showing the quantities of a good that a firm or producer would
produce (sell) at all different prices within a time period, ceteris paribus.
Table 2.1 Supply Schedule for candy
Price
2
4
6
8
10
Quantity Supplied
0
1
2
3
4
A supply curve shows the relationship of price and quantity supplied in graph, in a similar manner
with the demand curve.
Change in supply
Market Equilibrium
P
3
P
3.5
2.5
20 25
40
10
30
35
(Fig. 3.1) The equilibrium point e is when P = 3. When P= 2, a shortage or excess demand of 20 units is
present.
(Fig. 3.2) The equilibrium point e is when P = 2.5. When P=3.5, a surplus or excess supply of 25 units is
present.
Supply Function: Qs = 20 + 2P
Since Qd = Qs when e
100 2P = 20 + 2P
P = 20
Qs = 20 + 2(20) = 60
Qd = 100 2(20) = 60
Indifference Curves
A set of points that shows different combinations of consumption of commodities that gives
the consumer the same level of satisfaction.
Fig. 4.1 Indifference Curves for Chips and Juice
Curves
Chips
CA
A
A
CB
D
B
C
E
CC
JA
JB
JC
U1
U2
Juice
Good 2
(Fig. 4.1) In this indifference curves, the combinations A (CA amount and JA), B and C will give the
same level of total utility. The curve has a negative slope implying that in order for the individual to
have the same total utility, he has to reduce consumption of chips to increase consumption of juice.
The curve is convex because of the diminishing marginal rate of substitution. This means that the
rate at which Chips is being replaced by Juice is decreasing.
(Fig. 4.2) U1 and U2 intersect at point B. Points A, B and C are indifferent along U1 while points D, B
and C are indifferent along U2. If B is indifferent to both U1 and U2, then applying the assumption of
transitivity in consumption, then A is indifferent to D and so on. This does not hold however because
U2 has a higher level of Total Utility. Therefore, indifference curves should not intersect.
Consumer Equilibrium When the slope of the indifference curve and the budget line are equal,
then the marginal utility per amount of money derived from good1 is equal to the marginal utility per
amount of money derived from good2.
Price
Increases
Decreases
Increases
Decreases
Inferior
Substitution Effect
- (buy less)
+ (buy more)
- (buy less)
+ (buy more)
Income Effect
- (buy less)
+ (buy more)
+ (buy more)
- (buy less)
Consumer Surplus
The excess utility derived by an individual when consuming a good or service. It is the
difference between the amounts he/she is willing to pay from the actual amount he/she paid for the
good or service.
Fig. 4.3 Consumer Surplus
Price
A
P1
Q1
Quantity
Elastic Demand:
Negative
substitute goods (e.g. an increase in the price of beef will increase the
demand for pork.)
complementary goods (e.g. price increase in sugar would decrease the demand
for coffee.)
Negative
normal good
superior good
inferior good
Labor
L
1
2
3
4
5
6
7
Fixed Input:
Machine
Variable Input
Variable Input: Labor L
1st Stage of Production:
2nd Stage of Production:
Total Product
TP
15
40
75
90
85
85
77
K
Average Product
AP
15
20
25
22.5
17
14.17
11
Marginal Product
MP
15
25
35
15
5
0
-8
Costs of Production
Total Fixed
Cost
TFC
Total
Variable Cost
TVC
Total Cost
TC
Average
Fixed Cost
AFC
Average
Variable Cost
AVC
Average
Total Cost
ATC
100
100
100
100
100
100
100
0
50
75
115
170
210
240
100
150
175
215
270
310
340
5.00
3.33
2.50
2.00
1.67
1.43
2.50
2.43
2.88
3.40
3.50
3.43
7.50
5.83
5.38
5.40
5.17
4.86
TC = TFC + TVC
AFC = TFC/TP
AVC = TVC/TP
ATC = TC/TP
Isoquants
- A curve showing different combinations of variable inputs that will give the same level of
production.
Marginal Rate of Technical Substitution : Rate at which capital is being substituted for labor.
Isocosts
- A locus of points showing combinations of variable inputs that will result in the same total cost for
the firm.
E
Q1
B
L*
Q2
Labor L
(Fig. 5) At point E, the isoquant line Q 1 is tangent to the isocost line. This is the condition for efficient
production. It means that the marginal productivity of capital per amount spent and marginal
productivity of labor per amount spent will give the same marginal productivity. The firm should
therefore produce at K* and L*. Production at isoquant Q2 will not be efficient because at point A nor
at point B where it meets the isocost line.
Market Structures
Monopoly
- Single producer of a product or service in the market.
- Product sold is differentiated/unique.
- Barriers to entry in the market are present.
The market demand curve is the AR curve, and since there is only one producer, it is also the firms
demand curve.
Profit Maximization in a monopoly is when MR=MC.
The monopolist will produce where MR=MC. There is an incentive to gain profit if it produces at
MC<MR while losses will be incurred if it produces at MC>MR.
Discriminating Monopolist is a firm that gives the same output or service at different price levels,
by dividing its market to maximize profit.
Consumers with an inelastic demand curve will be charged a higher price while those with an elastic
demand curve will be charged a lower price.
Oligopoly
- Price and output of one firm is based on the actions of competitors in the market.
- Few sellers present in the market.
Reaction of Competitors and Kinked Demand Curve
Fig. 6.1 Market Reaction Function
Qty.
Price
XA1
XA2
B
P1
J
XAC
RFA
Quantity
RFB
Qty.
Q1
MR
(Fig. 6.1) If firm A produces at quantity XA1 firm B reacts to this and produces at X B1 to maximize its
profit based on its reaction function. In turn, firm A adjusts to production level XA2, and firm B
produces at XB2. The intersection of RFA and RFB is the equilibrium amount to be supplied by each
firm in the market, XAE and XBE.
(Fig. 6.2) The kinked demand curve BCD is broken at point N. At this point, market price is at P1. If
prices are set above P1, the portion of the demand curve is more elastic, thus if one firm increases
price others will not follow, and that firm will lose consumers. If one firm decreases price it is on the
portion wherein the demand curve is more inelastic, meaning that % increase in demand < %
decrease in price.
Monopolistic Competition
- Numerous sellers present in the market.
- Products are differentiated through advertising, packaging, etc.
The most efficient production level cannot be achieved because of the firms ability to influence price
through product differentiation. Price is set where it is higher than the MC of the firm. It cannot
operate on the lowest AC because its demand curve has an negative inclination.
-END-
Prepared by:
The Academics Committee
Economics Organization