Economics 101
Economics 101 Week 1 Scarcity Not all needs can be satisfied due to limited resources and unlimited wants Opportunity Cost The value of the next best thing foregone. Every decision involves and opportunity cost. These costs arise because time and resources are scarce. Can be measured in dollars or time. Production Possibility Frontier (PPF of PPC) 100#
• • • • • • •
Unattainable# This concept deals with a static point in time (a given level of resources and technology). Illustrates scarcity, choice and opportunity cost. Unattainable due to insufficient resources or Inefficient# incompetent technology. Inefficient due to an under utilisation of resources. Should always be on the PPF line. Opportunity cost when you opt for more of good Y instead of good X 100# PPF line can be moved to either blue line by: o Discovery of new resources o Improved technology (helps you produce more with the same amount of resources)
Marginalism The consideration of only additional costs or benefits that arise from a decision, not any sunk cost or benefit. Sunk Costs cannot be avoided, as they have already been incurred. Economists ignore sunk costs when making decisions. Efficient Markets These occur when profit opportunities are eliminated almost instantaneously. Supply and Demand The forces that make market economies work. As price increases, supply goes up, and Demand goes down. Demand is based on the need for satisfaction. This is called utility.
Marginal Utility A psychological concept, but is measured by how much people are willing to pay for it. Price = Marginal Utility. Law of diminishing MU: the more we consume of something, the less we want of it. E.g. after a game of tennis, I would be willing to pay $5 for a sip of water. After one sip, the price I’m willing to pay would reduce to $4. After a number of sips, I would not be willing to pay anything for another sip. After this point, I would feel bloated and would want to be paid to have another sip. Disutility: Negative marginal utility Demand Schedule Table that shows the relationship between the price of the good and the quantity demanded. The demand curve has the form: P=c+mQ and is downward sloping Market Demand The sum of all individual demands for a particular good or service. Individual demand curves are summed horizontally to obtain the market demand curve. Ceteris Paribus All variables other than the ones being studied are assumed to be held constant. E.g. The demand curve slopes downward because, ceteris paribus, lower prices imply a greater quatity demanded. Determinants of Demand • • • • •
Price (only determinant of quantity demanded, not demand itself) Tastes and Fashion Income Price of related goods (compliments, substitutes) Size and nature of population
Changes in Price cause movement along the demand curve
Changes in the bottom 4 shift the demand curve
Increase#in# Demand# Decrease#in# Demand#
Changes in Income Normal Good – when demand is positively related to income (cars, wine) Inferior Good – when demand is inversely related to income (public transport) Substitutes and Complements Substitutes – when a rise in the price of one increases demand for the other (Xbox & PlayStation) Complements – when a rise in the price of one decreases demand for the other (DVD players and DVDs) Supply Schedule Table that shows the relationship between the price of the good and the quantity supplied. Profit is the motive for suppliers. The supply curve has the form: P=c+mQ and is upward sloping Market Supply The sum of all individual supplies for all sellers of a particular good. Individual supply curves are summed horizontally to obtain the market supply curve. Determinants of Supply • • • • •
Price (only determinant of quantity supplied, not supply itself) Costs of production Environment Number of suppliers Technology
Changes in Price cause movement along the supply curve
Changes in the bottom 4 shift the supply curve
Decrease#in# Supply# Increase#in# Supply#
Equilibrium Well functioning market will settle at the equilibrium price. Equilibrium Price – Price that balances supply and demand. Intersect between supply and demand curves. Equilibrium Quantity – Quantity that balances supply and demand. The quantity at which the two curves intersect. Disequilibrium When market is not at equilibrium. Shortage of goods = Excess demand Surplus of goods = Excess supply
Economics Week 2 # Shifts in the supply and/or demand curves affects the equilibrium. Price Elasticity of Demand !"# =
%!∆!!"#$%&%'!!"#$%!"! ! 1 =! × %!∆!!"#$% ! !"#$%!!!"#
%$Tells us the degree of sensitivity of a customer to a change in price. This helps us predict the effect on the supplier if they raise or lower the price. Elasticity is negative, but we ignore the sign and focus on absolute number. The larger the price elasticity, the more sensitive the person’s quantity demanded is to price changes. PED can be calculated for any point on the demand curve. Important results: • PED at Midpoint = 1 (Unitary elasticity) • Left of Midpoint > 1 (Elastic) • Right of Midpoint < 1 (Inelastic) Elastic: PED > 1, large reaction to change in price because product is a non-essential & there are many satisfactory substitutes Inelastic: PED < 1, little reaction to change in price because product is an essential with no satisfactory substitutes Flatter curves are generally more elastic, however, elasticity changes over the linear demand curve. Perfectly inelastic demand. Essential good (oxygen in space)
Perfectly elastic demand (impossible)
Revenue and Elasticity Seller’s market: when inelastic. Essential goods with no satisfactory substitutes (E.g. electricity). Increase in price will have little effect on quantity sold. Therefore, revenue gained by increasing price.
Buyer’s market: when elastic. Non-essential goods with many satisfactory substitutes (E.g. movies). Increase in price will drastically reduce quantity consumed. Therefore, loss in revenue from increasing price. When there is unitary elasticity, change in price is exactly proportional to the change in quantity. Therefore, no revenue can be gained or lost by changing price. Determinants of PED • • • • •
Fraction of income Availability of substitutes Nature of good (luxury/necessity) Time (taken to replace electricity with gas etc) Attitude/advertising
Price Elasticity of Supply !"# =
%!∆!!"#$%&%'!!"##$%&' ! 1 =! × %!∆!!"#$% ! !"##$%!!"#
%$Indicates how responsive quantity supplied is to a change in price. PES can be calculated for any point on the demand curve. Depends on: • Time period • Whether there is an input that is fixed in quantity • Price at which elasticity is evaluated Cross-price Elasticity of Demand !"#$ =
%!∆!!"#$%&%'!!"#$%!"!!!"!!""#!! %!∆!!"#$%!!"!!""#!!
Measures the response of quantity demanded of one product to a change in price of a related product (e.g. DVD players and DVDs). Positive XPED: increase in price of good 1 results in increase in quantity demanded of good 2. Therefore, goods are substitutes. Negative XPED: increase in price of good 1 results in decrease in quantity demanded of good 2. Therefore, goods are complements. Zero XPED: increase in price of good 1 has no effect on quantity demanded of good 2. Therefore, goods are unrelated.
• • • • • • •
Unattainable# This concept deals with a static point in time (a given level of resources and technology). Illustrates scarcity, choice and opportunity cost. Unattainable due to insufficient resources or Inefficient# incompetent technology. Inefficient due to an under utilisation of resources. Should always be on the PPF line. Opportunity cost when you opt for more of good Y instead of good X 100# PPF line can be moved to either blue line by: o Discovery of new resources o Improved technology (helps you produce more with the same amount of resources)
Marginalism The consideration of only additional costs or benefits that arise from a decision, not any sunk cost or benefit. Sunk Costs cannot be avoided, as they have already been incurred. Economists ignore sunk costs when making decisions. Efficient Markets These occur when profit opportunities are eliminated almost instantaneously. Supply and Demand The forces that make market economies work. As price increases, supply goes up, and Demand goes down. Demand is based on the need for satisfaction. This is called utility.
Marginal Utility A psychological concept, but is measured by how much people are willing to pay for it. Price = Marginal Utility. Law of diminishing MU: the more we consume of something, the less we want of it. E.g. after a game of tennis, I would be willing to pay $5 for a sip of water. After one sip, the price I’m willing to pay would reduce to $4. After a number of sips, I would not be willing to pay anything for another sip. After this point, I would feel bloated and would want to be paid to have another sip. Disutility: Negative marginal utility Demand Schedule Table that shows the relationship between the price of the good and the quantity demanded. The demand curve has the form: P=c+mQ and is downward sloping Market Demand The sum of all individual demands for a particular good or service. Individual demand curves are summed horizontally to obtain the market demand curve. Ceteris Paribus All variables other than the ones being studied are assumed to be held constant. E.g. The demand curve slopes downward because, ceteris paribus, lower prices imply a greater quatity demanded. Determinants of Demand • • • • •
Price (only determinant of quantity demanded, not demand itself) Tastes and Fashion Income Price of related goods (compliments, substitutes) Size and nature of population
Changes in Price cause movement along the demand curve
Changes in the bottom 4 shift the demand curve
Increase#in# Demand# Decrease#in# Demand#
Changes in Income Normal Good – when demand is positively related to income (cars, wine) Inferior Good – when demand is inversely related to income (public transport) Substitutes and Complements Substitutes – when a rise in the price of one increases demand for the other (Xbox & PlayStation) Complements – when a rise in the price of one decreases demand for the other (DVD players and DVDs) Supply Schedule Table that shows the relationship between the price of the good and the quantity supplied. Profit is the motive for suppliers. The supply curve has the form: P=c+mQ and is upward sloping Market Supply The sum of all individual supplies for all sellers of a particular good. Individual supply curves are summed horizontally to obtain the market supply curve. Determinants of Supply • • • • •
Price (only determinant of quantity supplied, not supply itself) Costs of production Environment Number of suppliers Technology
Changes in Price cause movement along the supply curve
Changes in the bottom 4 shift the supply curve
Decrease#in# Supply# Increase#in# Supply#
Equilibrium Well functioning market will settle at the equilibrium price. Equilibrium Price – Price that balances supply and demand. Intersect between supply and demand curves. Equilibrium Quantity – Quantity that balances supply and demand. The quantity at which the two curves intersect. Disequilibrium When market is not at equilibrium. Shortage of goods = Excess demand Surplus of goods = Excess supply
Economics Week 2 # Shifts in the supply and/or demand curves affects the equilibrium. Price Elasticity of Demand !"# =
%!∆!!"#$%&%'!!"#$%!"! ! 1 =! × %!∆!!"#$% ! !"#$%!!!"#
%$Tells us the degree of sensitivity of a customer to a change in price. This helps us predict the effect on the supplier if they raise or lower the price. Elasticity is negative, but we ignore the sign and focus on absolute number. The larger the price elasticity, the more sensitive the person’s quantity demanded is to price changes. PED can be calculated for any point on the demand curve. Important results: • PED at Midpoint = 1 (Unitary elasticity) • Left of Midpoint > 1 (Elastic) • Right of Midpoint < 1 (Inelastic) Elastic: PED > 1, large reaction to change in price because product is a non-essential & there are many satisfactory substitutes Inelastic: PED < 1, little reaction to change in price because product is an essential with no satisfactory substitutes Flatter curves are generally more elastic, however, elasticity changes over the linear demand curve. Perfectly inelastic demand. Essential good (oxygen in space)
Perfectly elastic demand (impossible)
Revenue and Elasticity Seller’s market: when inelastic. Essential goods with no satisfactory substitutes (E.g. electricity). Increase in price will have little effect on quantity sold. Therefore, revenue gained by increasing price.
Buyer’s market: when elastic. Non-essential goods with many satisfactory substitutes (E.g. movies). Increase in price will drastically reduce quantity consumed. Therefore, loss in revenue from increasing price. When there is unitary elasticity, change in price is exactly proportional to the change in quantity. Therefore, no revenue can be gained or lost by changing price. Determinants of PED • • • • •
Fraction of income Availability of substitutes Nature of good (luxury/necessity) Time (taken to replace electricity with gas etc) Attitude/advertising
Price Elasticity of Supply !"# =
%!∆!!"#$%&%'!!"##$%&' ! 1 =! × %!∆!!"#$% ! !"##$%!!"#
%$Indicates how responsive quantity supplied is to a change in price. PES can be calculated for any point on the demand curve. Depends on: • Time period • Whether there is an input that is fixed in quantity • Price at which elasticity is evaluated Cross-price Elasticity of Demand !"#$ =
%!∆!!"#$%&%'!!"#$%!"!!!"!!""#!! %!∆!!"#$%!!"!!""#!!
Measures the response of quantity demanded of one product to a change in price of a related product (e.g. DVD players and DVDs). Positive XPED: increase in price of good 1 results in increase in quantity demanded of good 2. Therefore, goods are substitutes. Negative XPED: increase in price of good 1 results in decrease in quantity demanded of good 2. Therefore, goods are complements. Zero XPED: increase in price of good 1 has no effect on quantity demanded of good 2. Therefore, goods are unrelated.
