Introduction to Economics

• Economics is a social science analyzing choices on using scarce resources to meet unlimited wants.

Core Economic Questions

• What and how much to produce is determined by resource allocation, costs, and technology.
• How to produce is determined by the consumer/capital goods mix, consumer demand, and resource availability.
• For whom to produce involves the distribution of output and income.

Factors of Production (FOP)

• Limited resources are categorized into land, labor, capital, and enterprise.
• The factor income return for land is rent.
• The factor income return for labor is wages.
• The factor income return for capital is interest.
• The factor income return for enterprise is profit.

Definitions

• Needs are essential for life.
• Wants are desired but not essential.
• Scarcity occurs when demand exceeds supply.
• Opportunity cost is the value of the next best alternative forgone.
• The law of opportunity cost states that as the output of one good increases, the opportunity cost of another good also increases.

Production Possibility Curve (PPC)

• PPC illustrates the maximum production potential with fixed resources.
• PPC illustrates opportunity cost.

PPC Assumptions

• Only two goods are produced.
• All resources are fully employed.
• Technology is constant.
• Resources are fixed but mobile.
• The PPC only shows beginning and end result.
• An efficient point lies on the PPC.
• An inefficient point lies inside the PPC.
• Ceteris paribus means all things being equal.

Economic Growth and GDP

• Economic growth reflects changes in a nation's output over time.
• Gross Domestic Product (GDP) measures a country's total production in a year.

Circular Flow of Income (CFY) Model

• The CFY model tracks money, goods, and services in an economy.

2-Sector CFY Model Assumptions

• Includes households and firms.
• Households supply FOP to firms and earn income (Y).
• Firms produce goods/services and sell them to households.
• Households spend all income (Y) on consumption (C).
• Firms sell all output (O) to households.
• Equilibrium: Y = C = O

Flows in CFY Model

• Real flow (outer flow) is the exchange of goods and services.
• Money flow (inner flow) is the monetary exchange.
• Consumption is C.
• Output is O.
• Income is Y.

Leakages and Injections

• Leakages are withdrawals that reduce flow.
• Savings, taxes, and imports are leakages.
• Injections are introductions of income that increase flow.
• Investment, government expenditure, and exports are injections.
• The Paradox of Thrift suggests that increased savings can reduce income and employment.

Economic Sectors

• A sector aggregates economic units with similar activities or functions.
• A closed economy lacks an overseas sector.
• An open economy includes an overseas sector with international trade.
• The household sector earns income and purchases goods/services.
• The firms sector produces and distributes goods/services, aiming to maximize profit.
• The finance sector engages in borrowing, lending, and financial services.
• The government sector provides collective goods/services using revenue from taxes, etc.
• The overseas sector involves firms that export and import goods/services.

Multi-Sector Models

• 3-sector model includes households, firms, and the financial sector, with equilibrium S = I
• 4-sector model adds the government sector, with equilibrium S + T = I + G
• 5-sector model includes the overseas sector, with equilibrium S + T + M = I + G + X

Key Economic Variables

• Savings (S) is income not spent on consumption.
• Investment (I) involves borrowed funds for business expenditure.
• Taxation (T) is government revenue.
• Government spending (G) is government expenditure.
• Exports (X) represent goods and services sold abroad.
• Imports (M) represent goods and services purchased from abroad.
• Government deficit occurs when spending exceeds taxes.
• Government surplus occurs when spending is less than taxes.

Disequilibrium

• If S + T + M > I + G + X, income, expenditure, and output fall, causing a recession.
• If S + T + M < I + G + X, income, expenditure, and output rise, causing a boom.

Government Policy

• Monetary policy deals with money supply and interest rates.
• Fiscal policy involves taxes and government spending.
• External policy involves trade

Economic Goals

• Productive efficiency means producing more of one good requires sacrificing another.
• Allocative efficiency means production aligns with consumer preferences.
• Economic sustainability is the ability to maintain economic production indefinitely.
• Environmental sustainability means meeting demands without reducing the environment's capacity.

CFY Model Dynamics

• Leakages > Injections lead to decreased output, income, and leakages, resulting in a new, lower equilibrium.
• Leakages < Injections lead to increased output, income, and leakages, resulting in a new, higher equilibrium.

Importance of CFY model

• National income can be measured by adding all the income of all the factors of production or expenditures of different sectors.
• Shows the interdependence among different sectors

Expenditure Formula

• Total expenditure is calculated as C + I + G + (X - M).

Business Cycle

• A natural rise and fall of economic growth over time.
• The 4 stages are expansion, peak, contraction, and trough.

Stages of Business Cycle

• Expansion: Economic factors such as production, employment, output, wages, profits, demand and supply, sales increase.
• Peak: Growth hits maximum limit, economic factors do not increase further.
• Contraction: Demand decreases, economic factors starts decreasing, supply exceeds the demand.
• Trough: Growth turns negative, rapid decline in income and expediture.

Recovery

• A recovery follows the trough, restarting the cycle.

Price Mechanism

• The linking mechanism between the sectors of the circular flow of income model.
• The system by which price changes bring about equality between supply and demand in the market.

Demand

• Demand is the quantities consumers are willing and able to buy at various prices.
• Individual demand refers to a single buyer.
• Market demand is the total demand from all individual buyers.
• The law of demand states that as price rises, demand falls (ceteris paribus).

Factors Underlying Law of Demand

• Income effect: changes in quantity demanded due to real income changes.
• Substitution effect: change in demand for substitute goods due to price changes.
• New buyers: emerge when prices fall.

Supply

• Supply is the quantity sellers offer at various prices.
• Suppliers are motivated by profit.
• The law of supply states that more of a commodity will be supplied at higher prices.

Shifts in Demand and Supply

• Expansions and contractions in demand occur due to price changes.
  • Price increase → contraction
  • Price decrease → expansion
• Expansions and contractions in supply occur due to price changes.
  • Price increase → expansion
  • Price decrease → contraction

Market Equilibrium

• Equilibrium occurs when demand equals supply.
• Market pressure pushes price and quantity towards equilibrium.
• A surplus occurs when quantity supplied exceeds demand.
• A shortage occurs when quantity demanded exceeds supply.

Non-Price Demand Factors

• Include changes in the price of substitutes or complements, income, tastes, population, age distribution, income distribution, consumer expectations, and technology.
• A decrease in demand shifts the curve to the left.
• An increase in demand shifts the curve to the right.

Non-Price Supply Factors

• Include changes in the price of other goods, factors of production, technology, producer preferences, producer expectations, number of firms, and seasons.
• A decrease in supply shifts the curve to the left.
• An increase in supply shifts the curve to the right.

Price Elasticity of Demand

• Measures the responsiveness of quantity demanded to price changes.

Factors Determining Elasticity

• Substitute's availability, necessity, urgency, proportion of income spent, and addiction.
• Inelastic demand is not sensitive to price (0-1).
• Unitary elasticity means change in price equals change in demand (1).
• Highly elastic demand is very sensitive to price (>1).

Elasticity Formula

• PED = % change in quantity / % change in price