Economics

It is the "study of use of scarce resources that have alternative uses."

Scarcity
Limited resources but unlimited wants.
Problem of scarcity
The imbalance between limited resources and unlimited wants is the source of the
economic problem. The economic problem exists because, although the needs and wants of
people are endless. We cant have everything we want!! Because of this, we need to make
choices.

Branches
Economics is divided into two broad categories
Microeconomics
Macroeconomics

It is the study of individual households and companys behaviour in decision

making and allocation of resources.
It is the study of a national economy as a whole e.g. inflation, un- employment,
economics growth, decline and relationship between all.

Demand
The amount of a good that buyers are willing and able to purchase.
Law of Demand

(Other things equal)

The quantity demanded of a good falls () when price of the good rises () vice versa.

Demand Schedule
Price

Quantity

10

50

20

40

30

30

40

20

50

10

Movement along the demand curve

1. It is inverse relation and downward
sloped or negative sloped
2. The law of demand explains the
inverse relationship between quantity
demanded and price.

Expansion
When the quantity demanded is increased
with the decrease in price
Contraction
Decrease of quantity demanded with an increase in price shows contraction of demand.

Factors that Shift in Demand Curve

The position of the demand curve will shift to the left or right following a change in an
underlying determinant of demand.
1. Income
Income increase then price and quantity increase and then law of demand does not apply.

2.

3.
4.
5.

Normal Good: A good for which other things equal an increase in income leads to an
increase in demand.
Inferior Good: A good for which other things equal an increases in income leads to
decease in demand.
Prices of Related Goods
Change in the price of substitute or complementary goods etc. makes law of demand
inapplicable.
Substitutes: Two goods for which an increase in the price of one lead to an increase
in the demand for the other.
Complements: Two goods for which an increase in the price of one lead to a decrease
in the demand for the other.
Taste
It is also assumed that the taste of the consumer remains unchanged.
Expectations
Your expectations about future may affect your demand for good or services today.
Number of buyers
A change, increase or decrease in the no. of consumers in the market, shift the demand curve.

Individual and Market demand curve

Price of Good X
($)
5
4
3
2
1

Individual Demand
A (units)
B (units)
1
1
2
4
3
7
4
10
5
13

Market Demand
(units)
2
6
10
14
18

The demand curves for A and B are represented by DA and DB respectively.

Adding the two demand curves horizontally, we get the market demand curve for Good:
DA+DB.

Supply
The amount of a good that sellers are willing and able to sell.
Law of supply (Other things equal)
The quantity supplies of a good rises when the price of the good rises and vice versa.
Supply schedule
Price
5
10
15
20

Supply
5
10
15
20

Movement Along the supply curve

A movement along the supply curve from point A to point B is called a change in the quantity
supplied.

Expansion
When the quantity supplied is increased
Contraction
Decrease of quantity supplied

Factors that Shift in Supply Curve

1. Input Prices
Supply negatively related to prices of inputs
2. Technique of production
If the technology used to produce a good improves then supply increase.
3. Price Expectations
Expectations about the future price will shift the supply.
4. Number of Supplier
Supply decrease if the number of producers falls
5. Changes in the price of related goods or services
If the price of a compliment in production raises or fall.

Market Equilibrium
A situation in which the market price has
reached the level at which quantity
supplied equals quantity demanded.

Shortage
A shortage occurs when the quantity
demanded is greater than the quantity
supplied. Shortages put pressure on
prices to rise.

Surplus
A surplus occurs when the quantity
demanded is less than the quantity
supplied. Surpluses put pressure on
prices to fall.

Surplus

Excess supply
Downward pressure on price

Shortage

Excess demand
Upward pressure on price

Change in equilibrium
There are three steps to analysing changes in equilibrium
1. A change in demand
2. A change in supply
3. A change in both (demand & supply)
A change in Market equilibrium due to shift in Demand
An increase in demand shifts the demand curve to the right, and raises price and output.
Demand shifts to the right

Demand shifts to the left

A decrease in demand shifts the demand curve to the left and reduces price and output.

A change in Market equilibrium due to shift in Supply

Supply shifts to the right
An increase in supply shifts the supply curve to the right, which reduces price and increases
output.

Supply shifts to the left

A decrease in supply shifts the supply curve to the left, which raises price but reduces output.

Shift in Both Supply and demand

The equilibrium price and quantity in a market will change when there shifts in both market
supply and demand. Two examples of this are shown in the next diagram:

The equilibrium price and quantity in a market will change when there shifts in both market
supply and demand.

In the left-hand diagram above, we see both supply and demand decrease then fall in
quantity, but the rise in the market price.
The second example on the right shows a rise in demand from D1 to D3 but a much
bigger increase in supply from S1 to S2. The net result is a fall in equilibrium price
(from P1 to P3) and an increase in the equilibrium quantity in the market.

For example

Elasticity
Elasticity measures the degree of responsiveness of one variable due to a percentage
change in another variable.
Elasticity in Demand
A measurement of how much the quantity demanded of a good response to a change
in the price of that good.

Ep =

21
100
1
21
100
1

Price elasticity of demand

It measures the degree, how much quantity demanded responds to a change in price.

Types of Price elasticity of demand

There are three types of Price elasticity of demand:
1. Elastic or More Elastic
When the percentage change in quantity of a good is greater than the percent
change in its price, the demand is said to be elastic. When elasticity of demand
is greater than one, a fall in price increases the total revenue and a rise in price
lowers the total revenue. Ep>1
2. Inelastic or Less elastic
When the percent change in quantity of a good demanded is less than the
percentage change in its price, the demand is called inelastic. When elasticity
of demand is inelastic or less than one, a fall in price decreases total revenue
and a rise in its price increases total revenue. Ep<1
3. Unitary Elasticity
When the percentage change in the quantity of a good demanded equals
percentage in its price, the price elasticity of demand is said to have unitary
elasticity. When elasticity of demand is equal to one or unitary, a rise or fall in
price leaves total revenue unchanged. Ep=1
Example: The demand schedule for milk is given in Table:

Calculate the price elasticity of demand and determine the type of price elasticity.

Solution:
P= 15

P1 = 20

Q = 100

Q1 = 90

Therefore, change in the price of

milk is:

Similarly, change in quantity

demanded of milk is:

P = P1 P

Q = Q1 Q

P = 20 15

Q = 90 100

P = 5

Q = -10

The change in demand shows a negative sign, which can be ignored.

Price elasticity of demand for milk is:
ep = Q/P P/Q
ep = 10/5 15/100
ep = 0.3
The price elasticity of demand for milk is 0.3, which is less than one. Therefore, in such a
case, the demand for milk is relatively inelastic.

The Mid Point Method OR UP versus Down Problems

Determinants of price elasticity of demand

Various factors effects the price elasticity of demand. Here are some of them:
1. Availability of class Substitutes: If a product can be easily substituted, its demand is
elastic, like Gap's jeans. If a product cannot be substituted easily, its demand is inelastic,
like gasoline.
2. Luxury Vs Necessity: Necessity's demand is usually inelastic because there are usually
very few substitutes for necessities. Luxury product, such as leisure sail boats, are not
needed in a daily bases. There are usually many substitutes for these products. So their
demand is more elastic.
3. Price/Income Ratio: The larger the percentage of income spent on a good, the more
elastic is its demand. E.g. Clothing. On the other hand, the smaller the percentage of
income spent on a good, the less elastic is its demand. E.g. Newspaper.
4. Time Horizon: The longer the time after the price change, the more elastic will be the
demand. It is because consumers are given more time to carry out their actions. A one
day sale usually generate less sales change per day as a sale lasted for 2 weeks.

Total Revenge
The amount paid by buyers and received by sellers of a good.
Total Revenge = Price Quantity
Total Revenue
1. Ed > 1, total revenue will decrease as price increases. P and TR moves in opposite
directions.
2. Ed < 1, total revenue will increase as price increases. P and TR moves in the same
direction.
3. Ed = 1, total revenue will same due to change in price.

Income elasticity of demand

A measure of how much the quantity demanded of a good responds to a change in
income.

Normal good have negative relationship with income

Inferior good have positive relationship with income

Cross price elasticity of demand

A measure of how much the quantity demanded of a good responds to a change in the
price of another good.

Complements = inelastic demand and negative relationship with Cross price elasticity of demand
Substitutes = elastic demand and positive relationship with Cross price elasticity of demand

Price Ceiling
The legal maximum on the price at
which a good can be sold. An example of a
price ceiling is rent control, a situation where
a government sets a maximum amount that
can be charged for rent in an area. This leads
to excess demand.

Price Floor
A legal minimum at which a price can be sold. One well-known price floor is the
minimum wage, which sets a minimum price that an employer can pay a worker for an hour
of labour. Leads to excess supply.
Price ceiling

Not binding : Above the equilibrium price and No effect

Binding constraint: Below the equilibrium price and Shortage

Price floor
Not binding Below the equilibrium price No effect
Binding constraint Above the equilibrium price Surplus

Taxes
When the government levies a tax on a good who bear the burden of the tax.
Why tax?

To raise Government Revenue or

To decrease consumption of a good (cigarettes)

How taxes on sellers and buyers affect the market outcomes

When a good is taxed, the quantity sold is smaller Buyers and sellers both share the tax
burden

Elasticity and Tax Incidents

Tax incidence is the study of who bears the burden of a tax
Buyers and sellers share the burden of the tax but how much is the burden divided?
It depends on the elasticity of demand & the elasticity of supply

Indirect and direct tax

Direct tax
A tax levied directly on the tax payer such as income, property. These taxes are not
transformable.
Indirect Tax
A tax levied on goods and services rather than individuals such as sales tax and custom tax

Tax Systems
Progressive
A tax for which high income taxpayers pay a larger fraction of their income
Regressive
A tax for which high income taxpayers pay a smaller fraction of their income
Proportional
A tax for which high income and low income groups pay the same proportion of their
income as tax

Welfare of economic agents

Consumer surplus
A buyers willingness to pay minus the amount the buyer actually pays.
Area of consumer surplus
The area of below the demand curve and above the price line.
Producer surplus
The amount a seller is paid for a good minus the seller cost.
Area of producer surplus
The area of above the supply curve and below
the price line.

Price Elasticity of Supply

It measures the degree, how much quantity supplied responds to a change in price.
Determinants:
1. Time lag: How soon the cost of increasing production rises and the time elapsed since
the price change influence the Es. The more rapidly the production cost rises and the
less time elapses since a price change, the more inelastic the supply. The longer the
time elapses, more adjustments can be made to the production process, the more
elastic the supply.
2. Storage possibilities: Products that cannot be stored will have a less elastic supply.
For example, produces usually have inelastic supply due to the limited shelf life of the
vegetables and fruits.