Basic Concepts in Economics: Theory of Demand and Supply

1. Basic Concepts in Economics: Theory of Demand and Supply Discussant : Md. Alamgir Assistant Professor, BIBM

2. Definition of economics • Economics, the Science of Scarcity • The science of how individuals and societies deal with the fact that wants are greater than the limited resources available to satisfy those wants. • The study of how individuals and societies use limited resources to satisfy unlimited wants.

3. Fundamental economic problem • Scarcity. • The condition in which our wants are greater than the limited resources available to satisfy those wants. • Individuals and societies must choose among available alternatives.

4. Opportunity Costs • The most highly valued opportunity or alternative forfeited when a choice is made. • Economists believe that a change in opportunity cost can change a person’s behavior. • The higher the opportunity cost of doing something, the less likely it will be done.

5. Marginal Benefits • Is additional benefits. • The benefits connected to consuming an additional unit of a good or undertaking one more unit of an activity.

6. Marginal Costs • Is additional costs. • The costs connected to consuming an additional unit of a good or undertaking one more unit of an activity.

7. Good - Anything from which individuals receive utility or satisfaction. Utility - The satisfaction one receives from a good. Bad - Anything from which individuals receive disutility or dissatisfaction. Disutility - The dissatisfaction one receives from a bad. Building A Definition of Economics~ Goods and Bads ~

8. Economic goods, free goods, and economic bads • economic good (scarce good) - the quantity demanded exceeds the quantity supplied at a zero price. • free good - the quantity supplied exceeds the quantity demanded at a zero price. • economic bad - people are willing to pay to avoid the item

9. Positive vs. Normative Economics • Positive- The study of “what is” in economic matters. Cause Effect • Normative - The study of “what should be” in economic matters Judgment and Opinion Examples?

10. Microeconomics • Microeconomics deals with human behavior and choices as they relate to relatively small units—an individual, a business firm, an industry, a single market.

11. Macroeconomics • Macroeconomics deals with human behavior and choices as they relate to highly aggregate markets (e.g., the goods and services market) or the entire economy.

12. Barter vs. monetary economy • Barter – goods are traded directly for other goods • Problems: • requires double coincidence of wants • high information costs • Monetary economy has lower transaction and information costs

13. Relative and nominal prices • Relative price = price of a good in terms of another good • Nominal price = price expressed in terms of the monetary unit • Relative price is a more direct measure of opportunity cost

14. Markets • In a market economy, the price of a good is determined by the interaction of demand and supply

15. Demand The willingness and ability of buyers to purchase different quantities of a good at different prices during a specific time period. • A relationship between price and quantity demanded in a given time period, ceteris paribus. • Demand Schedule:The numerical tabulation of the quantity demandedof a good at different prices. • A demand schedule is the numerical representation of the law of demand.

16. Downward Slopping Demand Curve • The graphical representation of the demand schedule and law of demand.

17. Demand schedule

18. Demand - Schedule and Graph

19. Law of demand • An inverse relationship exists between the price of a good and the quantity demanded in a given time period, ceteris paribus.

20. As the price of a good rises, the quantity demanded of the good falls, and as the price of a good falls, the quantity demanded of the good rises, ceteris paribus. Law of Demand Quantity Price

21. Ceteris Paribus • A Latin term meaning “all other things constant” or “nothing else changes.” • Ceteris paribusis an assumption used to examine the effect of one influence on an outcome while holding all other influences constant.

22. Change in quantity demanded vs. change in demand Change in quantity demanded Change in demand

23. Market demand curve • Market demand is the horizontal summation of individual consumer demand curves

24. Determinants of demand • tastes and preferences • prices of related goods and services • income • number of consumers • expectations of future prices and income

25. Tastes and preferences • Effect of fads:

26. Prices of related goods • substitute goods – an increase in the price of one results in an increase in the demand for the other. • complementary goods – an increase in the price of one results in a decrease in the demand for the other.

27. Change in the price of a substitute good • Price of coffee rises:

28. Change in the price of a complementary good • Price of DVDs rises:

29. Income and demand: normal goods • A good is a normal good if an increase in income results in an increase in the demand for the good.

30. Income and demand: inferior goods • A good is an inferior good if an increase in income results in a reduction in the demand for the good.

31. Demand and the # of buyers • An increase in the number of buyers results in an increase in demand.

32. Expectations • A higher expected future price will increase current demand. • A lower expected future price will decrease current demand. • A higher expected future income will increase the demand for all normal goods. • A lower expected future income will reduce the demand for all normal goods.

33. International effects • exchange rate – the rate at which one currency is exchanged for another. • currency appreciation – an increase in the value of a currency relative to other currencies. • currency depreciation – a decrease in the value of a currency relative to other currencies.

34. International effects (continued) • Domestic currency appreciation causes domestically produced goods and services to become more expensive in foreign countries. • An increase in the exchange value of the U.S. dollar results in a reduction in the demand for U.S. goods and services. • The demand for U.S. goods and services will rise if the U.S. dollar depreciates.

35. Factors Causing a Shift in the Demand Curve • Income • Preferences • Prices of substitute goods • Prices of complementary goods • Number of buyers • Expectations of future prices

36. Supply • The relationship that exists between the price of a good and the quantity supplied in a given time period, ceteris paribus. • The willingness and ability of sellers to produce and offer to sell different quantities of a good at different prices during a specific time period.

37. Law of Supply • As the price of a good rises, the quantity supplied of the good rises, and as the price of a good falls, the quantity supplied of the good falls, ceteris paribus. Quantity Price

38. Supply Curve • The graphical representation of the law of supply, which states that price and quantity supplied are directly related, ceteris paribus.

39. Supply Schedule • The numerical tabulation of the quantity supplied of a good at different prices. • A supply schedule is the numerical representation of the law of supply.

40. Supply schedule

41. Change in Quantity Supplied • A change in quantity supplied refers to a movement along a supply curve. • The only factor that can directly cause a change in the quantity supplied of a good is a change in the price of the good, or own price.

42. Law of supply • A direct relationship exists between the price of a good and the quantity supplied in a given time period, ceteris paribus.

43. Reason for law of supply • The law of supply is the result of the law of increasing cost. • As the quantity of a good produced rises, the marginal opportunity cost rises. • Sellers will only produce and sell an additional unit of a good if the price rises above the marginal opportunity cost of producing the additional unit.

44. Change in supply vs. change in quantity supplied Change in supply Change in quantity supplied

45. Individual firm and market supply curves • The market supply curve is the horizontal summation of the supply curves of individual firms. (This is equivalent to the relationship between individual and market demand curves.)

46. Determinants of supply • the price of resources, • technology and productivity, • the expectations of producers, • the number of producers, and • the prices of related goods and services • note that this involves a relationship in production, not in consumption

47. Price of resources • As the price of a resource rises, profitability declines, leading to a reduction in the quantity supplied at any price.

48. Technological improvements • Technological improvements (and any changes that raise the productivity of labor) lower production costs and increase profitability.

49. Expectations and supply • An increase in the expected future price of a good or service results in a reduction in current supply.

50. Increase in # of sellers