1.

Introduction to Economics
Scarcity Excess wants to amount Opportunity cost - Cost of the next best alternative Economic growth, free goods, competitive market, factor endorsements (quantity and quality) Market economy, command economy, mixed economy Production possibilities frontier

Endowed economic with fixed amount of resources is characterized by given level of technology, producing 2 goods. What an economy can do, not what it choices to do, it reflects scarcity because the economy is constrained to choices and not unlimited wants. Negative slope in order to produce more of the good, resources have to be diverted away from the production of the good so that less of it is produced. There is an opportunity cost in producing that extra unit of good. Bowed towards the origin because resources tend to be specialized. Bows get steeper, reflecting that the opportunity cost of producing more of good X is increasing, and the law of increasing costs. Actual growth Amount of goods and services it actually produces Potential growth Rate at which a countrys economy could grow if all its resources were fully employed. Growth occurs if there is an increase in Land, Labour, Human capital, Capital and Technology and institutions improve.

2.Microeconomics
Market process or an institution in which producers and consumers interact in order to sell and buy a good or service. Market economy market forces answer to the three fundamental questions and in which private property rights are well defined and enforced. No government intervention beyond setting and enforcing property rights. Participants consumers and producers (interaction of consumers and producers sets market price) Demand The relationship between various possible prices of a good and the corresponding quantities that consumers are willing and able to purchase per time period, ceteris paribus. Price per unit of the product decrease consumers will be willing and able to buy more per period. Law of demand A demand curve can be for an individual consumer or the whole market. The law of demand holds because of: The substitution effect (if the price of good X rises, all other goods automatically become relatively cheaper, thus people will tend to substitute other goods for X) or the income effect (if the price per unit of good X rises, consumers real income drops, thus people tend to buy less. The size of the substitution depends primarily on the number of closeness of available substitute goods and the size of the income effect depends primarily on the proportion of the income spent on the good. Consumers try to maximize their utility (satisfaction derived from consuming a good or a bundle of goods). The consumer will choose he bundle which maximizes their satisfaction and which they can afford. Consumer surplus The consume greater and greater amounts per period, the market price must decrease as consumption of more and more units per

period is worth less and less to consumers. Law of diminishing marginal utility (The extra satisfaction derived from the consumption of greater amounts per period typically decreases) What a consumer is willing to pay and what a consumer actually pays for them in the market is known as the consumer surplus.

Factors shifting demand: Changes in consumers incomes (normal vs inferior goods), Changes in distribution of income, Changes in preferences, Changes in the price of other goods (Complements and substitutes), Size of the market, Age distribution of the population, Expectations Shift in demand occurs when determinant other than the price changes (change in demand), a movement along the demand curve occurs when there is a change in price, we say that there is a change in quantity demanded. Exceptions to the law of demand Giffen goods: they are very strongly inferior goods (Rice in China), they are consumed by the very poor, expenditure on these goods must represent a very significant proportion of the total consumer expenditure.

Veblen goods: they are valued because their high price is beyond the reach of other individuals, these are goods viewed as status symbols.

Role of expectations: Quantity demanded of a product rises as the price rises because of expectations that the price will rise even more in the future. Bandwagon effect.

Supply The relationship between various possible prices and the corresponding quantities that firms are willing to offer per time period, ceteris paribus. At higher prices, a firms profit margin is greater, thus it will be willing to offer more of the good per period. Also, since it becomes more and more difficult for a firm to produce more per period using existing capacity, it will be willing to do so only if the price per unit rises. Producer surplus, what the firm earns when producing and selling Q units and the minimum amount of money it requires to be willing to offer these units. Factors affecting supply Changes in input prices, changes in technology, changes in productivity, changes in government policy, size of the market, expectations, weather conditions, terrorist attack, war (for example affect the supply of oil) Equilibrium Price at which a good will be sold in a competitive market will be determined by the interaction between consumers and producers, interacts of demand and supply. If some price excess supply exists, then the price will tend to drop, vice versa. Excess demand, price will rise.

There will be no tendency for the price to change if there is neither excess supply nor excess demand in the market. Quantity demanded per period at that price is equal to quantity supplied, the market clearing price, corresponding quantity is the equilibrium quantity. Allocation of scarce resources in a market economy The very last unit of a good that society would want to be produced is that unit which is valued as much as it costs to produce it. The value of that good to the society it must be higher than the value of producing that good. Power of relative price changes Changing relative pries thus have signaling power, some consumers will drop out of the market or will cut down of their purchases. As a result quantity supplied per period rises but it should be realized that for this to happen more resources would have to shift into the production of the good. The price mechanism thus leads to a change in resource allocation as rising relative prices and profits provide the signal and the incentive for firms to produce more.

Elasticity Price elasticity of demand: The responsiveness of quantity demanded to a change in price. % Change in Quantity demanded% Change in Price The ratio of the changes of two variables (price and quantity demanded) that move in opposite directions: if the price of the good goes up, then the quantity demanded goes down and vice versa, implying that if the denominator has a plus sign then the numerator have a negative sign. The PED is always a negative but the minus sign is ignored. Elastic demand PED >1, change in price leads to a proportionally greater change in quantity demand Inelastic demand 0< PED <1, change in price leads to a proportionately smaller change in quantity demanded Unit elastic demand, PED = 1, change in price equal change in quantity demanded

Perfectly elastic demand, PED = , if he price rises even slightly, nothing will be bought by consumers. Perfectly inelastic demand, PED = 0, price changes have no effect on the amount purchased per period

Case that PED = 0, Demand curve is vertical, as any change in price will lead to no change in demand:

Case that PED =

Demand that is a perfectly competitive firm faces, such a firm is so tiny in size compared to the market that it can sell any amount at the going market price.

Case that PED = 1 The demand curve is a regular hyperbola, it is asymptotic (never touches either axis)

Relationship between PED and total revenues Price change when PED > 1: If P rises then Q falls proportionately more, thus TR will fall. Vice versa Price changes when 0< PED< 1: If P rises then Q falls proportionately less, thus TR rises. But if P falls, Q rises proportionately, thus TR falls. Price changes when PED = 1: Price and quantity change in exactly same proportion. On a graph it is straight parallel to the horizontal axis.

The percentage increase in quantity demanded is equal to the percentage decrease in price. As a result total revenues remain unchanged. PED = The firm is so tiny that it can sell all it wants at the market price, it follows that the total revenue curve is a rising straight line starting from the origin as the revenues from one unit sold will be $1.00, then the revenues of two sold will be $2.00, ect.

PED and the shape of the TR curve At zero quantity, total revenues are zero and at zero price total revenues are also zero. As price decreases, quantity demanded increases, since demand for that price range is price elastic resulting an increase in quantity demanded and quantity demanded is a proportionately greater so total revenue rise. Since demand is now price inelastic, the resulting increase in quantity demanded is proportionately smaller, so total revenues decrease.

Revenues rise all the way to the midpoint m, then right after m, they decrease. Thus, right below the midpoint of the linear demand curve where PED = 1, total revenues are maximized. Marginal revenue: the extra revenue from selling one more unit of output. MR is the change in Total revenue because of a change in quantity so I is the slope of the total revenue curve. If demand is a negative sloped line then marginal revenue has double the slope.

Determinants of price elasticity of demand: The number of closeness of available substitutes (the more substitutes and the closer these are, there greater the price elasticity of demand), the proportion of income spent on the good (the higher the proportion of income spent, the more consumers will be forced to decrease consumption when price rises, and the more elastic the demand would be), the time period involved (the longer the time period after a price change, the more price elastic the demand is likely to be), the nature of the good (demand for additive products is relatively price inelastic).

Uses of price elasticity of demand Permits a firm to predict the direction of change of its total revenues given a price change. Firms wishing to increase revenue will lower price if demand is price elastic and increase price if prince inelastic. Allows comparison of quantity changes with monetary changes. Permits a firm to employ price discrimination, the higher price will be charged in the market with the relatively inelastic demand. Help a firm determine what proportion of an indirect tax can be passed on to the consumer. Permits a government to estimate the size of the necessary tax required to decrease consumption of a demerit good. Permits the government to determine the incidence of an indirect tax. Helps a government predict the effect of a currency devaluation on the trade balance of a country. Income elasticity of demand: The responsiveness of demand when consumer income changes % change in quantity demanded% change in income YED > 0: the good is a normal good, since demand increases as a consumer income increases. YED < 0: the good is an inferior good since demand decreases as consumer income increases. 0 < YED < 1: This implies that %Qd < %Y therefore we say that demand is income inelastic as a rise in income leads to a slower rise in demand. Basic goods are usually income inelastic (demand for food as a broad category is income inelastic). YED > 1: this implies that %Qd > %Y therefore we can say that demand is income elastic as a rise in income leads to a faster rise in demand. Luxury good usually are considered income elastic. YED = 0, then the good is not affected by a change in income. YED = 1, then the percentage change in income is equal to the percentage change in quantity demanded. Curves: Vertical intercept is income elastic throughout its length. Going through the origin 0 has an income elasticity of demand equal to one.

Horizontal intercept is income inelastic throughout its length.

Income in a country rises over time, the demand for potatos may increase, then become constant, and then begin to fall as people begin to buy superior products instead, such as pasta. Determinants of income elasticity of demand The degree of necessity of the good, the living standards of the economy Incomes increase, a declining proportion is spent on food because the fixed capacity of the human stomach. Demand for food is therefore income inelastic. Uses of income elasticity of demand Firms like to know whether demand for their product is highly income elastic or rather income inelastic to help them plan their investments. A government may also be interested in knowing income elasticity of demand in various sectors in order to plan ahead training for displaced workers.

Cross price elasticity of demand The responsiveness of demand for one good (x) to a change in price of another good (y)

% Change in quantity demanded of good xPercentage change in the price of good y XPE > 0, then the two goods x and y are substitutes meaning that they are in competitive demand XPE < 0, then the two goods x and y are complements meaning that they are jointly demanded. XPE = 0, then the two goods are unrelated. The graph for substitutes looks like a supply curve, and the graph for complements look like a demand curve. Price elasticity of supply The responsiveness of quantity supplied when the price of the good changes. % Change in quantity supplied% Change in price PES > 1 supply is price elastic, if the percentage change in quantity supplied is larger than the percentage change in price. Change in price leads to a proportionately greater change in quantity supplied. (Graph on the vertical axis, supply curve) 0 < PES < 1 supply is inelastic as a change in price leads to a proportionately smaller change in quantity supplied. (Graph on horizontal axis, supply curve) PES = 1, percentage change in quantity supplied = percentage change in price. (Graph starting from the origin) PES = - small change in price leads to an infinitely large change in quantity supplied. The firm will be willing to offer as much as the market demands at the current price. (Graph is horizontal parallel to the x-axis.) PES = 0 price changes have no effect on the amount offered per period. (Graph is vertical parallel to y-axis). A vertical curve should be drawn if there are time lags, or available of seats (in farms or a tennis court booking system) Determinants of price elasticity of supply The time period, extent of excess capacity, skilled or unskilled labour (firms employing), long or short time lags characterize the production process, speed by which costs rise as output expands In the momentary run, supply is perfectly inelastic (vertical). If the demand increases the quantity supplied remains unchanged, it will only be expressed in terms of a higher price. In the short run, the increased demand will be partially expressed as an increase in price

while in the long run, when all factors are variable output could expand even more. The further below full capacity a firm is operating the greater the price elasticity of supply is expected to be Importance It determines the extent to which an increase in demand will affect the price and/or quantity of the good in the market. Price controls maximum price Sets a maximum price (price ceiling). Aims to protect the buyers of the product, set on sensitive products that mostly lower income households buy. A shortage thus result, some consumers will end up not enjoying the good even though they are both willing and able to pay the price. Price mechanism fails to perform its rationing function. Allocation on a first come, first served basis leads to queues or firms adopting waiting lists. Discrimination may result as they get to choose The product could be allocated on a random basis Coupons can be used to ration the good, ie. in war A major problem with maximum prices is the likely emergence of a black market (illegal market). They will be able to buy it in a illegal market to consumers prepared to pay a much higher price. In the long run additional costs may emerge, the quality of certain products may worsen, as producers may be tempted to use cheaper inputs. Policies to reduce: governments may attempt to reduce the shortages by encouraging supply, by granting subsidies or tax reliefs to firms. Also, they may attempt to reduce demand by encouraging the production of more and cheaper substitutes. Minimum price Aims at protecting producers, known as a price support. The government is forced to buy this surplus if it doesnt then the market price will fall below the equilibrium price as sellers will want to get rid of the extra units not bought at Pmin!

Tax incidence or tax burden

Given PES, the more price-elastic demand is, the greater the tax incidence on producers. Because there are more alternatives, consumers will be substitutes to resort to, greater the number of closeness of available substitutes to consumers. Market price will rise more and hence the consumers share of tax will be larger, the less elastic demand is and the more elastic supply is. Inelastic = consumers Elastic = producers Subsidy who gets money? Given PES, the producer benefits more, the more price elastic demand for a good is. Market failure Types of market failures: the existence of monopoly power, the existence of externalities, and the case of public goods. A market failure exists if market forces fail to reach efficient outcomes, in such a case either too much or not enough is produced or consumed so scarce resources are not allocated in the socially optimal way. Monopoly power as a source of market failure Firms with monopoly power are able to restrict output below the competitive ideal and charge a higher price, leading to welfare loss. Solutions to monopoly power: Government should ensure that competitive conditions prevail in markets, no merger or acquisitions materialize that excessively increase monopoly power of any firm. Tax or fine firms found guilty of such practices, break up firms that have anti-competitive practices Large monopolies have faster rates of innovation and technological change and economies of scale. Liberalizing international trade. Free trade automatically increases competition, leading to increased efficiency and lower prices. Externalities as a source of market failure Externality is present if an economic activity (production or consumption) creates benefits or imposes costs on third parties for which the latter do not pay or do not get compensated for. Whenever there is a divergence between private and social costs of production or between private and social benefits of consumption.

Present if either more or less is produced or consumed than the socially optimal amount. Market forces alone fail to lead to an efficient resource allocation. Solutions to externalities Assigning and enforcing property rights over assets Imposing taxes Granting subsidies Tradable pollution permits However, initial allocation of permits maybe difficult for the government to determine Monitoring compliance is expensive Governments can directly regulate output, prices, location, operating hours of production and who has the right to smoke, but it may also lead to costly and inefficient outcomes. Increasing awareness of the external costs or benefits of certain activities they undertake. Public goods as a case of market failure Consumption is non-excludable if once the good is available to even one consumer it is automatically available to all, so no one can be excluded from consuming it. Individuals have the incentive to conceal their true preferences and behave as free riders because they know that they can enjoy the good without having to pay for it once it becomes available for others Consumption is non-rival if consumption of the good by one does not decrease the amount available for all others. Public goods are a case of market failure because consumers have the incentive o conceal their true preferences, hoping to benefit as free riders. As a result private profit-orientated firms will not have the incentive to produce and offer such goods and services through the market. The market fails. Taxation and provision by the government is the typical solution.

Accelerator principle Level of investment in an economy Level of investment depends on the changes in national income (changes in output, demand, or sales) theory explaining the existence of the business cycle. Rests on assumption that firms wish to maintain a fixed captain to output ratio