Principles of Economics

Principles of Economics Class 1 Introduction to Economics State and Market Supply and Demand

PRINCIPLES OF ECONOMICS • ECONOMICS is a science which investigates how societies use scarce resources in order to produce useful goods and how they are distributed among them. • ECONOMY is the overall economic activity in a country (region) • If resources were not scarce, there would have been no economics -> scarcity is the main trait of ECONOMIC GOODS. • Resources are used efficiently if no additional unit of any good can be produced without reducing production of the other good.

MICROECONOMICS AND MACROECONOMICS • MICROECONIMICS is a branch of economics which analyses the behaviour of individual entities (companies, consumers) and their intercation on the market. • Found in 1776 (Adam Smith – Wealth of the Nations) • MACROECONOMICS is a branch of economics which analyses the sum of economic activity. • Found in 1936 (John Maynard Keynes – General Theory of Employment, Interest Rate and Employment).

ECONOMY TYPES • MARKET ECONOMY is an economy where conumers and producers freely set prices and quantities. It boosts efficiency, but fails to solve situations like monopoly and lacks justice. • PLANNED ECONOMY is an economy where consumption and production is commanded by the state (e.g. communistic economies) • MIXED ECONOMY is the most common type where majority of the market is self-regulated, but state interferres when it is needed to provide justice.

Positive vs. Normative economy POSITIVE ECONOMY – description of economic phenomena – the answer provided by economic analysis Example: Why housekeepers earn less than doctors? NORMATIVE ECONOMY –value or normative judgments about economic fairness or what the outcome of the economy or goals of public policy ought to be – the answer provided by political discussion and political decisions. Example: Should production of some arms and drugs be made illegal?

INPUTS AND PRODUCTS INPUTS are the goods used in production of the other goods and services. Basicinputs are labour, capital, land. PRODUCTS are useful goods and services that are either consumed or used for production of other goods.

The three basic economic questions • What goods and services should be produced? Those that bring producers the most profit. • How should the goods and services be produced? To stay competitive, one has to minimize costs and produce efficiently. • For whom should the goods and services be produced? It depends on the input market – the product of all factors and its prices define the income of consumers,

Production possibility frontier • PPF shows the maximum amount of production that a country can produce using a given technology and avaialble inputs. q2 q2 EconomicGrowth Inefficiency Efficiency A B q1 q1 0 0

Capital & Consumer goods • Economic growth depends on the choice between consumer goods and capital goods. Consumergoods PPF2018 A B PPF2018 PPF 2013 0 Capital goods

Exercise 1: PPF curve coconut 4 3 2 1 PPF – production possibility frontier 0 2 4 6 8 fish

Exercise 2 • Country can produce the following combination of goods using all the inputs: • a) Draw PPF. • b) Is country efficiently using its inputs if it produces X = 70, Y = 90 • c) Due to technological advances a production of X is doubled and the production of Y increases by 50%. Draw new PPF curve.

Solution c) New PPF

Appendix 1 - Graphs • A Graph is a picture that shows a relationship between 2 or more variables. • 2D graphs – linear or nonlinear. • The slope of the curve shows by how much y changes if x changes by 1 small unit. The sign of the slope tells whether an increase in x causes an increase in y (+), or a decrease (-).

Linear function(y = ax + b) y y 1 z z 1 0 0 x x Inverse relation Direct relation Nonlinear functions -slope changes = slope at point and slope on segment is different y Δy α Δx y* β 0 x x*

Exercise 3 Draw the following graphs: y = 2x - 3 y = -0.5x +1 y = -x2 +4 Then find slopes for x = 0, 1 and 2.

Market and State • Market is a system in which sellers and buyers interact in order to determine prices and quantities of goods and services. • Price is the value of a good or service in money. • Market equilibrium is a situation in which sellers are willing to sell just as much consumers are willing to buy at certain price.

Market system Labour, savings, land money Households Companies money Goods and services

Exchange, money and capital • Exchange of goods is based on the specialisation and money is the mean for exchange. • Specialization and division of labour increases productivity of labour which increases the amount of goods and thus the welfare of consumers. • Capital is an input which is an accumulation of labour but more productive. Capital is made by sacrificing current consumption. • Ownership of capital is protected – it is the foundation of capitalism.

Economic role of the state • Laissez-faire (Fr.) – “let it be” – classical economics, today revised. • EFFICIENCY – best in perfect competition (invisible hand) but sometimes regulation of market competition needed: • Imperfect competition appear – antitrust laws • Externalities - levying costs or benefits to others. • Public goods – financed by the state. • Taxes – price of the public goods.

2. JUSTICE • Unregulated markets can lead to the unjust differencies bewteen the incomes. 3. MACROECONOMIC GROWTH AND STABILITY • Fiscal policy (public spending, taxes) and monetary policy (supply of money) affect the employment, GDP growth rate, inflation, etc.

DEMAND • DEMAND is a purchasing ability of consumers at different prices of some good on certain market at certain time. • LAW OF DEMAND: when price increases, quantity demanded decreases. p Movement along a demand curve: when price or quantity of the observed good changes (variables on the axes) A shift of demand occurs when anything else changes (prices of other goods, income, tastes,…) d 0 q

RELATION BETWEEN GOODS • Goods x and y are independent if change in price of x does not affect demand of y. • Goods x and y are dependent if an increase in price of x affects causes a outward shift of demand (SUBSTITUTES) or an inward shift (COMPLEMENTS)

FACTORS THAT AFFECT DEMAND INCOME POPULATION PRICES OF RELATED GOODS TASTES OTHER

Price elasticity of demand • Own price elasticity of demand tells what is a % change of demanded quantity caused by a 1% change in price. 0 1 +∞ inelastic elastic Perfectly inelastic Unit elastic Perfectly elastic

Own price ARC elasticityofdemand

p Elasticdemand Unitelasticdemand Inelasticdemand d q 0

p Perfectlyinelasticdemand d d Perfectlyelasticdemand q 0

Cross price elasticity of demand • C.p.e. tells the percentage change in quantity demanded of the observed good caused by a 1% change in the price of the other good. -∞ 0 +∞ complements substitutes Independent goods

Income elasticity of demand • Income elasticity tells what is a % change in demanded quantity caused by 1% change in the income. necessary luxurious -∞ 0 1 +∞ Absoultely inelastic demand Inferior goods Normal goods

Income ARC elasticityofdemand

SUPPLY • SUPPLY is a selling ability of the seller at all prices on certain market at certain time. • LAW OF SUPPLY: when price rises, supplied quantity rises. p Movement along the curve: when price of a good rises, only supplied quantity changes. A shift of the curve: when there is a change in anything else except the price of the observed good. s 0 q

FACTORS THAT AFFECT SUPPLY COSTS OF PRODUCTION TECNOLOGY PRICE OF INPUTS PRICE OF COMPLEMENTS AND SUPBSTITUTES MARKET ORGANIZATION OTHER

Elasticity of supply • EoS shows what is a %change in supplied quantity if price changes by 1%. 0 1 +∞ inelastic elastic Perfectly inelastic Unit elastic Perfectly elastic

p Inelastic supply Perfectly inelastic supply Unit elastic supply Elastic supply s Perfectly elastic supply s s s s q 0

Equilibrium price and quantity • EQUILIBRIUM is the intercept of demand and supply (price and quantity) p s surplus d shortage 0 q

Changes in the equilibrium • S ↑ => Q↑, P↓ • S ↓ => Q↓, P↑ • D↑ => Q↑, P↑ • D↓ => Q↓, P↓ • D↑, S↑ => Q↑, P? • D↓, S↑ => Q?, P↓ • D↓, S↓ => Q↓, P? • D↑, S↓ => Q?, P↑ p s d 0 q

Taxation and equilibrium • Taxes are prices of public goods • Taxes can be imposed on wages, profit, capital gain, consumption or some special goods like alcohol, tobaco and gas. • Taxes cause total surplus of the economy to fall.

Taxesandelasticities • WhenEs > Edthenconsumerspay more • WhenEs < Edthenproducerspay more p s d 0 q

Exercise 4 • Demand equation is Qd=200000-80000P, and supply equation is Qs=110000+40000P. Find the equilibrium price and quantity and draw these curves.

Solution • Equilibrium quantity • 200000 – 80000P = 110000 + 40000P • P* = 0,75 • Q* = 200000 – 80000*0,75 • Q* = 140000

Exercise 5 • Demand is Qd(X)=3848-2Px+0,004I+3Py ,where Qd(X) is demanded quantity of X, Px its price, I the income, and Py the price of a related good Y. • Express demand table if price is 400, 500, 600, 700 and 800 kunas at fixed income I = 12000 kn and Py=600kn. • Draw this demand.

Solution • Qd(x)=3848-2*Px+0,004*12000+3*600 Qd(x)=5696-2Px

Demandcurve

Exercise 6 • Supply and demand for milk on a certain market are as follows: Milk price Demanded quantity (Mill.Lit.) Supplied Quantity (Mill. Lit.) • a) What is the surplus/shortage at each price? • b) What is the equilibrium quantity?

a) Demand surplus=Qd-Qs; Supply surplus=Qs-Qd • P=3.60kn => Qd-Qs=37-16 = 21 mil. lit. • P=3.70kn => Qd-Qs=32-20 = 12 mil. lit. • P=3.80kn => Qd-Qs=28-23 = 5 mil. lit. • P=4.00kn => Qs-Qd=28-23 = 5 mil. lit. • P=4.10kn => Qs-Qd=33-20 = 13 mil. lit. • P=4.20kn => Qs-Qd=38-16 = 22 mil. lit. b) Qd=Qs => 25=25 mil. lit. At P=3.90kn

Exercise 7 • Let demand for bananas be Qd=4000-20Pand supply Qs=400+40P. • a) Find equilibrium price and quantity. • b) Let demanded quantity increase by 20 at each price due to the increase in income. Find new equilibrium. • c) Find new eequilibrium price and quantity. • d) Find shortage/suprlus at prices p = 50 and P = 70.

Exercise 8 • Demand is given with the following table. Find: • a) Find price elasticity at p = 3 • b) Find arc elasticity when price goes from 3 to 5.

Exercise 9 • Find arc elasticity: • (own price): Price of hamburgers has risen from 0.5$ to 0.7$, and quantity demanded fell from 1000 to 900. • (income): Price of cheese fell from 1.1$ to 0.9$ when income fell from 214.5$ to184.5$.

Exercise 10 • The income is I = 10000 kn, price of y is 10, price of x is 12 and quantity demanded of x is 100. • If income rises to 11000 kn, quantity demanded falls to 90. Find income elasticity. • If price of x falls to 11 kn, quantity demanded rises to 150. Find own price elasticity. • If price of Y increases by 2 quantity demanded remains unchanged. Find cross price elasticity.

Principles of Economics