Introduction to Economics Quiz

Economics Marathon Session 1

• The term "Economics" originated from the Greek word "Oikonomia," meaning "household management." Until the 19th century, it was known as "Political Economy."
• The book An Inquiry into the Nature and Causes of the Wealth of Nations, by Adam Smith (1776), is considered the first modern work of economics.
• Early definitions focused on concepts of wealth and later transitioned to welfare.
• The subject evolved through classical, neoclassical and modern eras
• Economic Terminologies covered include wants (unlimited), resources (limited), scarcity, choice, and scale of preferences

Nature & Scope of Economics - Chapter 1

•  Economics is concerned with the allocation of scarce resources among competing uses.
• A core concept in economics is scarcity - limited resources cannot meet unlimited wants.
• The fundamental problem in economics involves choice.  Individuals, businesses, and governments must make decisions regarding the allocation of scarce resources to satisfy their preferences.
•  The goal of economics is often framed as efficient allocation of resources to achieve the most satisfaction given the resources available.

Terminologies You Must Know (Basics)

• Wants are unlimited desires for goods and services.
• Resources are limited items required to fulfill wants.
• Scarcity is the key problem of economics—the limited resources cannot fulfill every want.
• Choice is the decision-making process of allocating scarce resources.
• The scale of preferences is the ordering of choices according to priorities.

Wealth Definition

• Adam Smith's An Inquiry into the Nature and Causes of the Wealth of Nations defined wealth as the annual produce of the land and labour of a society.
• The concept developed through the industrial revolution in response to the idea of trade.

Welfare Definition

• Alfred Marshall defined economics as the study of mankind in the ordinary business of life.

Definition According to Era

• Classical era (18th century): Adam Smith and J.B. Say defined economics as a science of wealth.
• Neoclassical era (19th century): Alfred Marshall and A.C. Pigou saw economics as a science of welfare.
• Modern era (20th century): Lionel Robbins defined economics as a science of scarcity and Paul A. Samuelson emphasized the role of growth and development.

Economics as a Science and Art

• Economics is a social science; and also an artful science. It involves understanding complex systems, gathering data etc.
• It involves both scientific analysis and practical applications, making educated assumptions and using various models.

Micro vs Macro

• Microeconomics concentrates on individuals and individual businesses.
• Macroeconomics encompasses the entire economy's aggregates (such as unemployment, inflation, or GDP).
• Microeconomics focuses on individual choices & businesses - Macroeconomics focuses on the overall economy.

Macroeconomics

• Macroeconomics is the study of the economy as a whole, including aggregates such as GDP, inflation, and unemployment.

Positive vs Normative Economics

• Positive economics describes what is currently happening in an economy without any judgement.
• Normative economics describes what ought to be—it includes value judgments about what goals should be achieved and what policies are best to reach those goals.

Interdependence of Positive and Normative Science

• Positive and normative economics are interwoven. Normative judgments provide context and goals for positive analysis.

Business Economics

• Business economics is an applied approach using economic principles to solve business problems; while abstract theoretical principles are applied to real life problems.
• It incorporates aspects of Economics, Business administration, and other subjects of study.

Meaning of Economic Problems

• The presence of limited resources & unlimited wants creates economic problems.

Causes of Economic Problems

• Scarcity of resources
• Unlimited wants
• Uneven distribution of natural resources

What/How/For Whom to Produce

• WHAT TO PRODUCE - decisions are primarily taken by the private sector based on consumer preferences using demand & supply forces.
• HOW TO PRODUCE - choices of production techniques considered by businesses that aim for cost-effectiveness.
• FOR WHOM TO PRODUCE - how output is distributed among different groups in the society; distribution depends on factors like the productive contributions, relative needs, and overall goals.

Growth and Efficiency

• Analysis of economic growth and efficiency within a country.

Socialist Economy

• In a socialist economy, resources are allocated according to the commands of a central planning authority. (A planned economy)

Meaning of Socialist Economy

• It involves collective ownership of production resources – factories, capital etc, rather than by private individuals.
• Key objective is maximum welfare for everyone based on equal rights—the state coordinates overall production & distribution.
• It differs from a capitalist model in that it eliminates free-market mechanisms of allocation.

Features of Socialist Economy

• Collective ownership, which makes all members equally entitled to the fruits of socialized planned production.
• Economic planning, wherein a central planning authority allocates resources & directs production according to societal welfare;
• Absence of price-market mechanism; government control over production & distribution.
• Relative income equality.
• No consumer choice for the products.

Capitalist Economy

• In a capitalist economy, private property and profit motive are the driving forces of economic activity.
• Economic processes are largely guided by individual actions of buyers & sellers in the market.
• Individuals own the means of producing goods and services & make their own decisions about production and distribution; based on profit motives and cost-effectiveness.

Features of Capitalist Economy

• Right to private property, freedom of enterprise, & freedom of economic choices.
• Profit motive which guides the decisions of sellers and consumers
• Competition amongst firms.
• Limited government intervention in the economy.

Mixed Economy

• Mixed economies combine aspects of both capitalism and socialism.
• They involve both private and public sectors.

Meaning of Mixed Economy

• It is a blend of the features of capitalist and socialist economies in allocating resources, directing production, and managing the economy.
• Aims to combine the benefits of private enterprise & profit motives with the goals of a social good and the possible limitations of free markets.
• The government plays a greater role in the regulation of trade, & providing social services to citizens.

Features of Mixed Economy

• Co-existence of private and public sectors
• The role of pricing mechanism is significantly reduced;
• Importance of government planning and regulation—to overcome imperfections of the market.

How Central Problems Are Solved in Different Economies

• Discusses how the three primary economic problems (what to produce, how much, and for whom) are resolved in different economic models (capitalist, socialist, mixed).

Theory of Demand and Supply - Chapter 2

• This chapter deals with supply & demand theories in economics.

Unit 1: Law of Demand and Elasticity of Demand

• Demand refers to the willingness and ability of consumers to purchase a good or service at various price points, all else equal.
• Utility is an important concept in explaining demand - the usefulness or satisfaction consumers get from a product.
• Effective demand means that consumers not only have a desire but also the ability and willingness to pay for it. (desire + purchasing power/ability to pay)
• Consumer demand and price have a negative relationship, as one increases, the other decreases (all other factors equal)

Demand (Meaning)

• Demand is the desire for a commodity coupled with the ability to pay for it.
• It's differentiated from desire as it requires both a want and the purchasing power to back it.
• Utility is the satisfaction a consumer gets from a product; usefulness relates to a tangible purpose.

Price of the Commodity

• All else equal, higher price results in lower quantity demanded, based on the notion of diminishing marginal utility.
• Lower price results in higher quantity demanded.

Prices of Related Goods

• Price changes of related goods (substitutes—e.g., Coke and Pepsi—or complements—e.g., computers and software) affect demand.
• The price of a substitute good has a positive relationship with the demand of another product.

Substitute

• A substitute good has a positive relationship with the demand of another product; if the price of one rises, then the demand for the substitute will increase.

Complementary

• If the price of one good increases, the demand for related goods (complements) will decrease; and vice versa.

Joint and Derived Demand

• Joint demand refers to goods that are consumed together and, or necessary for the production of goods; increase of the use of one will increase the demand for another.
• Derived demand occurs when the demand for one product relies on the demand for another (e.g., demand for steel increases as demand for cars increases).

Income of the Consumer

• Income level impacts demand (e.g., higher income usually leads to higher demand for normal goods).
• Normal goods experience increased demand with increased income.
• Inferior goods experience decreased demand as income increases.

Normal Goods

• The demand for these goods increases as consumer income increases.

Inferior Goods

• Demands for goods decrease when consumer income increases.

Conclusion

• Factors affecting demand are multifaceted and can differ across consumers.

Nominal and Real Income Effect

• Nominal income is the amount a person receives. Real income considers the effect of inflation;
• Changes in real income may affect different consumers in various ways, depending on the goods they consume and the degree to which they view those goods as essential vs discretionary;
• This may also depend on current and future expectations of these goods.

Future Expectations about Prices

• If consumers believe the price of a good will increase in the future, they may increase their current demand.

Consumer Behavior

• It includes concepts of taste & preference; these are personal and can be affected by factors like marketing.
• Certain types of consumer behavior have been classified include demonstration effect, bandwagon effect, & snob effect.

Demonstration Effect

• Consumers desire to emulate the consumption patterns of others, which can influence demand.

Bandwagon Effect

• Demand for a commodity increases due to higher consumption by others; an example of trends.

Snob Effect

• Demand for a commodity decreases due to others increasingly consuming it, as the consumer views the product as less unique, less exclusive; hence less desired.

Other Factors Affecting Market Demand

• Factors like population size, composition, income distribution (even or uneven distribution) shape market demand.

Concept of Individual and Market Demand

• Individual demand schedules reflect the quantities consumers are willing to purchase at different price points.
• Market demand reflects the overall quantity demanded for across the entire market.

Reasons Behind Downward Slope of the Demand Curve (Law of Demand)

• Negative relationship between price and quantity demanded;
• Diminishing marginal utility: the pleasure derived from extra units of a product diminishes over time;
• Substitution effect, as price of one good rises consumer substitute with cheaper ones;
• Income effect, as price drops, purchasing power increases, demand will increase or vice versa

Law of Diminishing Marginal Utility

• Satisfaction from consuming additional units of a particular product decreases over time.

Substitution Effect

• The price effect on consumer purchases of a product; when price increases, quantity demanded falls.

Income Effect

• Consumers' spending patterns affected by change in buying power as a result of any price change.

New Consumers Creating Demand

• When commodity prices decrease, new potential consumers are attracted and demand rises.

Exceptions to the Law of Demand

• The law of demand has exceptions, such as Giffen goods, conspicuous goods, and speculative goods.

Paradox of Giffen Goods

• Giffen goods are typically inferior goods for which demand increases when price increases. This is a paradoxical exception to the law of demand.

Conspicuous Goods/Veblen Effect

• Consumers purchase expensive goods to display status or wealth and achieve social prestige.

Conspicuous Necessities

• A type of conspicuous commodity that consumers feel is essential, due to marketing & societal factors; status symbol.

Future Expectations about Prices

• Expected future price changes influence current demand; if an item is expected to be more expensive later, current demand increases at the current price.

Incomplete Information and Irrational Behavior

• Consumer behavior is impacted by their levels of information and thought-processes; potentially illogical.

Speculative Goods

• Goods whose demand is driven by anticipation of future price increases.

Demand for Necessities

• Demand for necessities is often unaffected by price changes due to their perceived essential nature.

Change in Demand and Change in Quantity Demanded

• The difference between a shift in the demand curve vs a movement along a demand curve due to changes in price.

Elasticity of Demand (Numerical Measurement)

• Techniques to quantify response of demand to different changes (price, income, advertising etc.)

Price Elasticity of Demand (PED)

• Percentage change in quantity demanded as a result of a percentage change in price.

Types of PED

• Elastic demand (PED > 1)
• Unit elastic demand (PED = 1)
• Inelastic demand (PED < 1)

Point Elasticity & Arc Elasticity

• Techniques to numerically measure PED at a particular point on a demand curve vs for a change along the curve (arc)

Expenditure method

• The expenditure method is another technique to calculate PED.

Income Elasticity of Demand (YED)

• Percentage change in quantity demanded caused by a percentage change in consumers' income.

Types of YED

• Normal goods are characterized by a positive YED.
• Inferior goods have a negative YED.

Cross Elasticity of Demand

• Percentage change in the quantity demanded of one commodity due to percentage change in the price of another commodity.

Types of CED

• Substitute goods (positive CED).
• Complementary goods (negative CED).

Point Elasticity/Geometric Method

• A technique to numerically measure the elasticity, as a slope of a demand curve at a particular point.

Expenditure Method

• A method to measure elasticity using the change in total expenditure resulting from a price change.

Advertisement Elasticity

• Percentage change in quantity demanded due to percentage change in advertising expenditure.

Elasticity of Supply

• Percentage change in quantity supplied as a result of a percentage change in price.

Theory of Production

Meaning of Production Function

• Production function defines the technical relationship between inputs and outputs; as quantity of inputs increase, output increases until a point beyond which output decreases.

Factors of Production

• Land: natural resources readily available & not dependent on human effort.
• Labour: mental/physical effort by workers toward production.
• Capital: manufactured goods used in production;
• Entrepreneurship: combines other input factors, organizing business, taking risks, & making profit.

Short-Run Production Function

• Short-run output relationships between inputs used, considering some input factors as fixed.

Long-Run Production Function

• Long-run output relationships between inputs used, wherein all input factors are variable.

Very Short-Run Production Function

• Immediate time period; no changes in input factors & production processes.

The Very Long Run/Secular Period Production Function

• Very long run; involves significant change in production and factor inputs

Economies of Scale and Diseconomies of Scale

• Economies of Scale (EOS) are decreases in unit costs as output increases
• Diseconomies of Scale (DOS) are increasing unit costs as output increases

Internal Economies and Diseconomies

• Internal economies/diseconomies relate to firm-specific factors & affect output and costs.

Concepts of Product

• Defining the product and describing the various aspects.

Shape of TP Curve

• Total Product (TP): output measured in total terms as various quantities of labor input, are combined in production in relation to fixed cost inputs.

Average Product (AP)

• Average product per unit of labor; calculated as Total Product/Labor input

Marginal Product (MP)

• Marginal product measures the change in output when an additional unit of input (e.g., labor) is added, holding other inputs constant.

Relationship Between TP, AP, and MP

•  Interrelationship between graphs.

Returns to Scale (Long Run Production Function)

•  Relationship between increases in output resulting from equal proportional increases in all inputs.

Law of Variable Proportion

•  Relationship between changing one input (e.g., labor) while holding other inputs (e.g., capital) constant.

Cobb Douglas Production Function

•  Mathematical function representing the relationship between labor and capital inputs and the resulting output (e.g. product).

Isoquant

• Isoquants represent all possible combinations of inputs (labor and capital) that produce a given level of output.

Isocost Line

• Isocost lines represent equal cost combinations of inputs, considering costs associated with factors involved in production (labor and capital).

Least Cost Combinations

• Shows how to minimize production costs while achieving a specific quantity of output (using factors like labor and capital).

Cost

• The total financial expenditure by any firm for all factors of production.

Explicit and Implicit Costs

• Economic costs include explicit costs (actual payments) and implicit costs (opportunity costs).

Explicit Costs

• Explicit costs represent the actual monetary payments made by a firm for production inputs (including labor wages, raw material costs, equipment rental etc.)—this is recorded in account statements.

Implicit Costs

• Implicit costs represent the opportunity costs of resource usage by any firm; these are costs that don't represent an accounting outlay of cash but that are associated when using inputs that the firms themselves own and, or could otherwise be used for alternative purposes by the firm (including owner's return for labor, capital used etc).

Opportunity Costs

• The cost of the next best alternative forgone when a choice is made.

Short-Run Costs

•  Costs associated with production in the short run, when at least one input is fixed.

Long-Run Costs

• Costs associated with production in the long run, when all inputs are variable.

Price Determination in Different Markets

• This section discusses methods of pricing in each type of market.

Meaning and Types of Market

• A market is a place where buyers & sellers interact for exchange of goods or services.
• Types including perfect competition, imperfect competition (monopoly, monopolistic competition, and oligopoly) and other less common forms of market structure.

Revenue

• Revenue is the total amount a seller earns from its sales or a firm earns in overall revenue.

Perfectly Competitive Market

• It is characterized by numerous buyers & sellers; homogeneous products; free entry and exit of companies, & perfect knowledge about market conditions.

Implications of Perfect Competition

• The price is set by the market and each firm accepts that price in this market configuration.

Features of Perfect Competition

• Large number of buyers & sellers.
• Homogenous (identical) products.
• Free entry and exit (no significant barriers to entering or leaving the market).
• Perfect knowledge (all participants have complete information about market conditions).
• Perfect mobility of factors of production.

Monopoly

• A market dominated by only one single seller, with no close substitutes for products.

Features of Monopoly

• One firm controls all the market output.
• No close substitutes for products.
• Significant barriers to entry, making it difficult for other companies to enter.

Monopolistic Competition

• A market in between perfect competition & monopoly—numerous firms selling related but differentiated products; some but not all aspects of a free market are preserved.

Features of Monopolistic Competition

• A large number of sellers and buyers
• Product differentiation occurs (each firm produces its own unique product)
• Firms can freely enter or leave the market.

Oligopoly

• A market structure controlled by a small number of dominant businesses (firms), & whose pricing & overall decisions affect both their own businesses and all other firms in the industry.

Features of Oligopoly

• Few dominant firms dominating the industry.
• Significant interdependence (decisions by one firm impact other firms).
• Barriers to entry

Demand Curve (Oligopoly)

• Demand curves in oligopoly are difficult to determine due to interdependence among firms.

Price Rigidity (Oligopoly)

• Prices are relatively stable. Any change in price or product distribution is likely to cause adverse competitive reactions.

Non-Price Competition (Oligopoly)

• Competition among firms does not depend on price adjustments alone; other factors like quality, advertising & overall services are also considered by firms.

Price and Output Determination under Different Market Forms

• Methods of price and output determination for the different types of market structures.

Equilibrium of the Firm

• The point where a firm maximizes its profit. Equilibrium point occurs when a firm’s output levels reach the balance between maximizing revenue & minimizing costs.

Conditions for Equilibrium of a Firm(Perfect Competition)

• Marginal revenue equals marginal cost (MR=MC).
• MC curve cuts MR curve from below (meaning MC has a positive slope).

Profits (Perfect Competition)

• Firm's revenues exceeds costs = profits
• When the price of a product reaches the average total cost, the firm is earning normal profits (no excess profits).

Losses (Perfect competition)

• When a firm's costs exceeds its revenue = losses

Can a Monopolist Incur Losses?

• A monopolist can experience losses. Their ability to set prices is greater than in other markets, but still constrained.

Price-Output Determination under Monopolistic Competition

• The process of setting prices and output for monopolistically competitive firms.

Business Cycles

• Recurring fluctuations in the economic activity of a region (or country)

Meaning of Business Cycles

• The natural rise and fall of economic growth over time.

Phases of Business Cycles

• These include expansion, peak, contraction, and trough phases (with various sub-phases within each).

Examples of Business Cycles

• Great Depression of 1930, dot-com bubble burst of 2000, & Global Economic Crisis.

Causes of Business Cycles

• Internal & external causes shape the cyclical fluctuations of the economy.

Economic Indicators

• Data used to track the economic changes, predict future directions & take measures to stabilize outputs or revenue.

Leading, Lagging, & Coincident Indicators

• Leading Indicators predict the future directions of markets
• Lagging indicators reveal market conditions after they have occurred
• Coincident Economic Indicators reveal market conditions as they are occurring