Ten Principles of Economics PDF

Unit: 1 INTRODUCTION  Ten Principles of Economics 1 Copyright © 2004 South-Western/Thomson Learning  Economy...... The word economy comes from a Greek word for “one who manages a household.”...

Unit: 1 INTRODUCTION  Ten Principles of Economics 1 Copyright © 2004 South-Western/Thomson Learning  Economy...... The word economy comes from a Greek word for “one who manages a household.” Copyright © 2004 South-Western/Thomson Learning  TEN PRINCIPLES OF ECONOMICS A household and an economy face many decisions: Who will work? What goods and how many of them should be produced? What resources should be used in production? At what price should the goods be sold? Copyright © 2004 South-Western/Thomson Learning  TEN PRINCIPLES OF ECONOMICS Society and Scarce Resources: The management of society’s resources is important because resources are scarce. Scarcity... means that society has limited resources and therefore cannot produce all the goods and services people wish to have. Copyright © 2004 South-Western/Thomson Learning  TEN PRINCIPLES OF ECONOMICS Economics is the study of how society manages its scarce resources. Copyright © 2004 South-Western/Thomson Learning  TEN PRINCIPLES OF ECONOMICS How people make decisions. People face tradeoffs. The cost of something is what you give up to get it. Rational people think at the margin. People respond to incentives. Copyright © 2004 South-Western/Thomson Learning  TEN PRINCIPLES OF ECONOMICS How people interact with each other. Trade can make everyone better off. Markets are usually a good way to organize economic activity. Governments can sometimes improve economic outcomes. Copyright © 2004 South-Western/Thomson Learning  TEN PRINCIPLES OF ECONOMICS The forces and trends that affect how the economy as a whole works. The standard of living depends on a country’s production. Prices rise when the government prints too much money. Society faces a short-run tradeoff between inflation and unemployment. Copyright © 2004 South-Western/Thomson Learning Principle #1: People Face Tradeoffs. “There is no such thing as a free lunch!” Copyright © 2004 South-Western/Thomson Learning Principle #1: People Face Tradeoffs. To get one thing, we usually have to give up another thing. Guns v. butter Food v. clothing Leisure time v. work Efficiency v. equity Making decisions requires trading off one goal against another. Copyright © 2004 South-Western/Thomson Learning Principle #1: People Face Tradeoffs Efficiency v. Equity Efficiency means society gets the most that it can from its scarce resources. Equity means the benefits of those resources are distributed fairly among the members of society. Copyright © 2004 South-Western/Thomson Learning Principle #2: The Cost of Something Is What You Give Up to Get It. Decisions require comparing costs and benefits of alternatives. Whether to go to college or to work? Whether to study or go out on a date? Whether to go to class or sleep in? The opportunity cost of an item is what you give up to obtain that item. Copyright © 2004 South-Western/Thomson Learning Principle #3: Rational People Think at the Margin. Marginal changes are small, incremental adjustments to an existing plan of action. People make decisions by comparing costs and benefits at the margin. Copyright © 2004 South-Western/Thomson Learning Principle #4: People Respond to Incentives. Marginal changes in costs or benefits motivate people to respond. The decision to choose one alternative over another occurs when that alternative’s marginal benefits exceed its marginal costs! Copyright © 2004 South-Western/Thomson Learning Principle #5: Trade Can Make Everyone Better Off. People gain from their ability to trade with one another. Competition results in gains from trading. Trade allows people to specialize in what they do best. Copyright © 2004 South-Western/Thomson Learning Principle #6: Markets Are Usually a Good Way to Organize Economic Activity. A market economy is an economy that allocates resources through the decentralized decisions of many firms and households as they interact in markets for goods and services. Households decide what to buy and who to work for. Firms decide who to hire and what to produce. Copyright © 2004 South-Western/Thomson Learning Principle #6: Markets Are Usually a Good Way to Organize Economic Activity. Adam Smith made the observation that households and firms interacting in markets act as if guided by an “invisible hand.” Because households and firms look at prices when deciding what to buy and sell, they unknowingly take into account the social costs of their actions. As a result, prices guide decision makers to reach outcomes that tend to maximize the welfare of society as a whole. Copyright © 2004 South-Western/Thomson Learning  Principle #7: Governments Can Sometimes Improve Market Outcomes. Market failure occurs when the market fails to allocate resources efficiently. When the market fails (breaks down) government can intervene to promote efficiency and equity. Copyright © 2004 South-Western/Thomson Learning Principle #8: The Standard of Living Depends on a Country’s Production. Standard of living may be measured in different ways: By comparing personal incomes. By comparing the total market value of a nation’s production. Copyright © 2004 South-Western/Thomson Learning Principle #8: The Standard of Living Depends on a Country’s Production. Almost all variations in living standards are explained by differences in countries’ productivities. Productivity is the amount of goods and services produced from each hour of a worker’s time. Copyright © 2004 South-Western/Thomson Learning Principle #8: The Standard of Living Depends on a Country’s Production. Standard of living may be measured in different ways: By comparing personal incomes. By comparing the total market value of a nation’s production. Copyright © 2004 South-Western/Thomson Learning Principle #9: Prices Rise When the Government Prints Too Much Money. Inflation is an increase in the overall level of prices in the economy. One cause of inflation is the growth in the quantity of money. When the government creates large quantities of money, the value of the money falls. Copyright © 2004 South-Western/Thomson Learning Principle #10: Society Faces a Short-run Tradeoff Between Inflation and Unemployment. The Phillips Curve illustrates the tradeoff between inflation and unemployment: Inflation  Unemployment It’s a short-run tradeoff! Copyright © 2004 South-Western/Thomson Learning Figure 1 The Circular Flow MARKETS Revenue FOR Spending GOODS AND SERVICES Goods Firms sell Goods and and services Households buy services sold bought FIRMS HOUSEHOLDS Produce and sell Buy and consume goods and services goods and services Hire and use factors Own and sell factors of production of production Factors of MARKETS Labor, land, production FOR and capital FACTORS OF PRODUCTION Wages, rent, Households sell Income and profit Firms buy = Flow of inputs and outputs = Flow of dollars Copyright © 2004 Copyright South-Western/Thomson © 2004 South-Western Learning Our First Model: The Circular-Flow Diagram Firms Produce and sell goods and services Hire and use factors of production Households Buy and consume goods and services Own and sell factors of production Copyright © 2004 South-Western/Thomson Learning Our First Model: The Circular-Flow Diagram Markets for Goods and Services Firms sell Households buy Markets for Factors of Production Households sell Firms buy Copyright © 2004 South-Western/Thomson Learning Our First Model: The Circular-Flow Diagram Factors of Production Inputs used to produce goods and services Land, labor, and capital Copyright © 2004 South-Western/Thomson Learning  Elasticity... … allows us to analyze supply and demand with greater precision. … is a measure of how much buyers and sellers respond to changes in market conditions Copyright © 2004 South-Western/Thomson Learning  THE ELASTICITY OF DEMAND Price elasticity of demand is a measure of how much the quantity demanded of a good responds to a change in the price of that good. Price elasticity of demand is the percentage change in quantity demanded given a percent change in the price. Copyright © 2004 South-Western/Thomson Learning Computing the Price Elasticity of Demand The price elasticity of demand is computed as the percentage change in the quantity demanded divided by the percentage change in price. Percentage change in quantity demanded Price elasticity of demand = Percentage change in price Copyright © 2004 South-Western/Thomson Learning Determinants of Elasticity of Supply Ability of sellers to change the amount of the good they produce. Beach-front land is inelastic. Books, cars, or manufactured goods are elastic. Time period. Supply is more elastic in the long run. Copyright © 2004 South-Western/Thomson Learning Computing the Price Elasticity of Supply The price elasticity of supply is computed as the percentage change in the quantity supplied divided by the percentage change in price. Percentage change in quantity supplied Price elasticity of supply = Percentage change in price Copyright © 2004 South-Western/Thomson Learning  THREE APPLICATIONS OF SUPPLY, DEMAND, AND ELASTICITY Can good news for farming be bad news for farmers? What happens to wheat farmers and the market for wheat when university agronomists discover a new wheat hybrid that is more productive than existing varieties? Copyright © 2004 South-Western/Thomson Learning  THREE APPLICATIONS OF SUPPLY, DEMAND, AND ELASTICITY Examine whether the supply or demand curve shifts. Determine the direction of the shift of the curve. Use the supply-and-demand diagram to see how the market equilibrium changes. Copyright © 2004 South-Western/Thomson Learning Forms of Business Organizations Copyright © 2004 South-Western/Thomson Learning Forms of Business Organizations Sole Proprietorship Partnership Corporation Franchisee Limited Liability Company (LLC) Copyright © 2004 South-Western/Thomson Learning  Sole Proprietorships The Original Form of Business Advantages Disadvantages Simple Unlimited liability Single Taxation Limited Growth Attracting Capital This form of business happens “automatically” when a person does business of his or her own and does not have some other type of business org. Copyright © 2004 South-Western/Thomson Learning  Partnerships The Other Common Law Form of Business Advantages Disadvantages Still Simple Unlimited Liability* Single Taxation Growth Potential People Attracting Resources Capital The Uniform Partnership Act (UPA) – adopted in most states Copyright © 2004 South-Western/Thomson Learning Partnerships- Basic Concepts Partners in a business are like spouses, they depend greatly upon each other, must cooperate, can create liability for each other, and often end up with irreconcilable differences Forming a partnership- no formality required!!! Characteristics of partnership – no limited liability - but also no double taxation Rights and duties of partners – lots of default stuff if not specified in a partnership agreement Managing a partnership Ending (Termination) of a partnership Copyright © 2004 South-Western/Thomson Learning  Corporations A statutory form of business, heavily regulated and complex in creation and operation Advantages Disadvantages Limited Liability Double Taxation Growth Complexity People Resources Laws Governing Corporations Securities Laws (Federal and State) Antitrust Law (Federal and State) Tax Laws (Federal and State) Corporate Law (Federal and State) Copyright © 2004 South-Western/Thomson Learning  Corporations- Basic Concepts A statutory immortal being. Shareholders/ Directors/ Officers/ Employees “Exists” in one particular state Shareholders vote and elect Directors Directors are called the “Board of Directors” and must meet regularly, vote to approve or disapprove actions and must have meeting minutes Officers execute the orders of the Board Copyright © 2004 South-Western/Thomson Learning  Limited Liability Company (LLC) A very new creation that merges the basic sought after benefits of Limited Liability and Single Taxation with little administrative complexity Advantages Disadvantages Limited Liability Growth (perhaps) Single Taxation Legal People Resources Uncertainty Ease of Creation Flexibility Copyright © 2004 South-Western/Thomson Learning  LLC- Basic Concepts Owners are called “Members” Usually created by filing “Articles of Organization” with state. Many states allow single owner LLC’s Often an “operating agreement” is created between members to govern their relationship, obligations and rights. Copyright © 2004 South-Western/Thomson Learning  Sole Partnership Corporation Proprietorship LLC Copyright © 2004 South-Western/Thomson Learning  Private Company A company which has a min. paid-up capital of Rs.100,000 and by its Articles – (a) restricts the right to transfer its shares; (b) limits the number of its members to fifty; (c) prohibits any invitation to subscribe for any shares in, or debentures of the company; and (d) prohibits any invitation or acceptance of deposits from public. [Sec 3(1)(iii)] Must necessarily have its own Articles of Association. Should have at least two directors. The word 'Private Limited' must be added at the end of its name. Copyright © 2004 South-Western/Thomson Learning  Public Company A Public Company means a company which - is not a Private Company; has a minimum paid-up capital of Rs 5 lakhs or such higher capital as may be prescribed; is a private company which is a subsidiary of a company which is not a private company. [S. 3 (1) (iv)] It consists of not less than seven members and three directors. Copyright © 2004 South-Western/Thomson Learning  Government Company A Government Company means any company in which not less than 51 per cent of the paid-up share capital is held by (a) the Central Government, or (b) any State Government or Governments, or (c) partly by the Central Government and partly by one or more State Governments. A subsidiary of a Government company is also called a Government company. Copyright © 2004 South-Western/Thomson Learning  Foreign Companies Incorporated in a country outside India and has a place of business in India. Every foreign company shall, within 30 days, file with RoC the following documents: A certified copy of the Charter, Statutes, Memorandum and Articles of the company in English. The full address of the registered or principal office of the company. A list of the directors and secretary of the company. The names and addresses of any person/s resident in India, authorised to accept notices. Copyright © 2004 South-Western/Thomson Learning  Demand forecasting Dr. Sandip Chandra Copyright © 2004 South-Western/Thomson Learning  Why demand forecasting? Planning and scheduling production Acquiring inputs Making provision for finances Formulating pricing strategy Planning advertisement Copyright © 2004 South-Western/Thomson Learning  Steps Specifying the objective Determining the time perspective Making choice of method Collection of data Estimation and interpretation of results Copyright © 2004 South-Western/Thomson Learning CLASSIFICATION OF DEMAND FORECASTING QUALTITATIVE QUANTITATIVE TECHNIQUES TECHNIQUES 1)EXPERT OPINION Delphi method. 1)Time Series Analysis. 2)SURVEY 2)Barometric Analysis. 3)MARKET EXPERIMENT a) leading indicators Test marketing b)Coincident indicators Controlled c) Taste indicators. experiments. Copyright © 2004 South-Western/Thomson Learning  Expert Opinion The expert opinion method, also known as “EXPERT CONSENSUS METHOD”, is being widely used for demand forecasting. This method utilizes the findings of market research and the opinions of management executives, consultants, and trade association officials, trade journal editors and sector analysts. When done by An expert, qualitative techniques provide reasonably good forecasts for a short term because of the expert’s familiarity with the issues and the problems involved. DELPH I METHOD:- The Delphi method is primarily used to forecast the demand for “NEW PRODUCTS”. Copyright © 2004 South-Western/Thomson Learning  SURVEY A firm can determine the demand for its products through a market survey. It may launch a new products, if the survey indicates that there is a demand for that particular product in the market. For example, Coke in India expanded its product range beyond carbonated drinks, after the company conducted a nationwide survey. The survey revealed that about 80% of the youth preferred to drink tea or coffee rather than carbonated drinks at regular intervals. The remaining 20% preferred to have milk products while only 2% preferred to drink carbonated drinks like coffee. The company is now trying to bring tea and coffee brands to India by installing vending machines. It is also planning to introduce a coconut flavored drink in Kerala and a black currant in Tamilnadu named portello. Copyright © 2004 South-Western/Thomson Learning  Market Experiment Market Experiment can help to overcome the survey problems as they generate data before introducing a product or implementing a policy. Market Experiments are two types:- 1) Test marketing:- 2) Controlled experiments:- Copyright © 2004 South-Western/Thomson Learning  Controlled experiments Controlled experiments are conducted to the test demand for a new product launched or to test the demands for various brands of a product. They are selected some consumers. Copyright © 2004 South-Western/Thomson Learning  Time Series Analysis The time series analysis is one of the most common quantitative method used to predict the future demand for a product. Here the past sales and demand are taken into considerations. TIME SERIES ANALYSIS IS DIVIDED INTO FOUR CATEGORIES: 1)TREND 2)SEASONAL VARIATIONS. 3)CYCLICAL VARIATIONS. 4)RANDOM FLUCTUATIONS. Copyright © 2004 South-Western/Thomson Learning  METHODS OF TIME SERIES ANALYSIS 1)TREND:- Past data is used to predict the future sales of firm trend is a long term increase or decrease in the variable. 2)SEASONAL VARIATIONS:- It is taken into account the Variations in demand during different seasons. Eg:- The sale of cotton dresses increases in summer. The sale of Woolen clothes increases in winter. 3)CYCLICAL VARIATIONS:- This variations in demand due to the fluctuations in the business cycle – Boom, recession and depression. 4) RANDOM FLUCTUATIONS:- It may happen due to Natural calamities like flood, earthquake, etc. Which cannot be predicted accurately. Copyright © 2004 South-Western/Thomson Learning  Conclusion Accurate demand forecasting requires Product knowledge Knowledge about the customer Knowledge about the environment Copyright © 2004 South-Western/Thomson Learning  Supply and Demand Copyright © 2004 South-Western/Thomson Learning  Demand is the desire, willingness, and ability to buy a good or service. Supply refers to the various quantities of a good or service that producers are willing to sell at all possible market prices. Copyright © 2004 South-Western/Thomson Learning  The Law of Demand The law of demand holds that other things equal, as the price of a good or service rises, its quantity demanded falls. The reverse is also true: as the price of a good or service falls, its quantity demanded increases. Copyright © 2004 South-Western/Thomson Learning  Demand Curve The demand curve has a negative slope, consistent with the law of demand. Copyright © 2004 South-Western/Thomson Learning  The Law of Supply The law of supply holds that other things equal, as the price of a good rises, its quantity supplied will rise, and vice versa. Why do producers produce more output when prices rise? They seek higher profits They can cover higher marginal costs of production Copyright © 2004 South-Western/Thomson Learning  Supply Curve The supply curve has a positive slope, consistent with the law of supply. Copyright © 2004 South-Western/Thomson Learning  Equilibrium In economics, an equilibrium is a situation in which: there is no inherent tendency to change, quantity demanded equals quantity supplied, and the market just clears. Copyright © 2004 South-Western/Thomson Learning  Equilibrium Equilibrium occurs at a price of $3 and a quantity of 30 units. Copyright © 2004 South-Western/Thomson Learning  Shortages and Surpluses A shortage occurs when quantity demanded exceeds quantity supplied. A shortage implies the market price is too low. A surplus occurs when quantity supplied exceeds quantity demanded. A surplus implies the market price is too high. Copyright © 2004 South-Western/Thomson Learning  Shift in the Demand Curve A change in any variable other than price that influences quantity demanded produces a shift in the demand curve or a change in demand. Factors that shift the demand curve include: Change in consumer incomes Population change Consumer preferences Prices of related goods: Substitutes: goods consumed in place of one another Complements: goods consumed jointly Copyright © 2004 South-Western/Thomson Learning  Shift in the Demand Curve This demand curve has shifted to the right. Quantity demanded is now higher at any given price. Copyright © 2004 South-Western/Thomson Learning  Equilibrium After a Demand Shift The shift in the demand curve moves the market equilibrium from point A to point B, resulting in a higher price and higher quantity. Copyright © 2004 South-Western/Thomson Learning  Shift in the Supply Curve A change in any variable other than price that influences quantity supplied produces a shift in the supply curve or a change in supply. Factors that shift the supply curve include: Change in input costs Increase in technology Change in size of the industry Copyright © 2004 South-Western/Thomson Learning  Shift in the Supply Curve For an given rental price, quantity supplied is now lower than before. Copyright © 2004 South-Western/Thomson Learning  Equilibrium After a Supply Shift The shift in the supply curve moves the market equilibrium from point A to point B, resulting in a higher price and lower quantity. Copyright © 2004 South-Western/Thomson Learning  Price Ceilings & Floors A price ceiling is a legal maximum that can be charged for a good. Results in a shortage of a product Common examples include apartment rentals and credit cards interest rates. A price floor is a legal minimum that can be charged for a good. Results in a surplus of a product Common examples include soybeans, milk, minimum wage Copyright © 2004 South-Western/Thomson Learning  Price Ceiling A price ceiling is set at $2 resulting in a shortage of 20 units. Copyright © 2004 South-Western/Thomson Learning  Price Floor A price floor is set at $4 resulting in a surplus of 20 units. Copyright © 2004 South-Western/Thomson Learning Copyright © 2004 South-Western/Thomson Learning  Elasticity and Its Application Dr. Sandip Chandra Rai University, Amedabad Copyright © 2004 South-Western/Thomson Learning  Elasticity...  … is a measure of how much buyers and sellers respond to changes in market conditions  … allows us to analyze supply and demand with greater precision. General Question-Name 3 necessities and 3 luxuries that you would buy. Copyright © 2004 South-Western/Thomson Learning  Price Elasticity of Demand Price elasticity of demand is the percentage change in quantity demanded given a percent change in the price. It is a measure of how much the quantity demanded of a good responds to a change in the price of that good. Copyright © 2004 South-Western/Thomson Learning Computing the Price Elasticity of Demand The price elasticity of demand is computed as the percentage change in the quantity demanded divided by the percentage change in price. Price Elasticity = Percentage Change in Qd Of Demand Percentage Change in Price Copyright © 2004 South-Western/Thomson Learning Elasticity, Percentage Change and Slope Because the price elasticity of demand measures how much quantity demanded responds to the price, it is closely related to the slope of the demand curve. But instead of looking at unit change, elasticity looks at percentage change. What do we mean by percentage change? Copyright © 2004 South-Western/Thomson Learning Computing the Price Elasticity of Demand Percentage change in quatity demanded Price elasticity of demand  Percentage change in price Example: If the price of an ice cream cone increases from $2.00 to $2.20 and the amount you buy falls from 10 to 8 cones then your elasticity of demand would be calculated as: (10  8 )  100 10 20 percent  2 ( 2.20  2.00 ) 10 percent  100 2.00 Copyright © 2004 South-Western/Thomson Learning  Ranges of Elasticity Inelastic Demand Percentage change in price is greater than percentage change in quantity demand. Price elasticity of demand is less than one. Elastic Demand Percentage change in quantity demand is greater than percentage change in price. Price elasticity of demand is greater than one. Copyright © 2004 South-Western/Thomson Learning  Perfectly Inelastic Demand - Elasticity equals 0 Price Demand 1. An $5 increase in price... 4 100 Quantity 2....leaves the quantity demanded unchanged. Copyright © 2004 South-Western/Thomson Learning  Inelastic Demand - Elasticity is less than 1 Price 1. A 25% $5 increase in price... 4 Demand 90 100 Quantity 2....leads to a 10% decrease in quantity. Copyright © 2004 South-Western/Thomson Learning  Unit Elastic Demand - Elasticity equals 1 Price 1. A 25% $5 increase in price... 4 Demand 75 100 Quantity 2....leads to a 25% decrease in quantity. Copyright © 2004 South-Western/Thomson Learning  Elastic Demand - Elasticity is greater than 1 Price 1. A 25% $5 increase in price... 4 Demand 50 100 Quantity 2....leads to a 50% decrease in quantity. Copyright © 2004 South-Western/Thomson Learning  Perfectly Elastic Demand - Elasticity equals infinity Price 1. At any price above $4, quantity demanded is zero. $4 Demand 2. At exactly $4, consumers will buy any quantity. 3. At a price below $4, Quantity quantity demanded is infinite. Copyright © 2004 South-Western/Thomson Learning  Determinants of Price Elasticity of Demand  Necessities versus Luxuries  Availability of Close Substitutes  Definition of the Market  Time Horizon Copyright © 2004 South-Western/Thomson Learning  Determinants of Price Elasticity of Demand Demand tends to be more inelastic If the good is a necessity. If the time period is shorter. The smaller the number of close substitutes. Copyright © 2004 South-Western/Thomson Learning  Determinants of Price Elasticity of Demand Demand tends to be more elastic : if the good is a luxury. the longer the time period. the larger the number of close substitutes. the more narrowly defined the market. Copyright © 2004 South-Western/Thomson Learning  Elasticity and Total Revenue Total revenue is the amount paid by buyers and received by sellers of a good. Computed as the price of the good times the quantity sold. TR = P x Q Copyright © 2004 South-Western/Thomson Learning  Elasticity and Total Revenue Price $4 P x Q = $400 P (total revenue) Demand 0 100 Quantity Q Copyright © 2004 South-Western/Thomson Learning An Example of an Inelastic Good Oil and Oil Prices Insert Economics Video This video will show File 1 and play Arab Oil the supply side issues clip. with getting oil out of the ground. Then the video will focus on the demand (us!) issues of using oil. Copyright © 2004 South-Western/Thomson Learning  Income Elasticity of Demand Income elasticity of demand measures how much the quantity demanded of a good responds to a change in consumers’ income. It is computed as the percentage change in the quantity demanded divided by the percentage change in income. Copyright © 2004 South-Western/Thomson Learning Computing Income Elasticity Percentage Change Income in Quantity Demanded Elasticity = of Demand Percentage Change in Income Copyright © 2004 South-Western/Thomson Learning  Income Elasticity - Types of Goods - Normal Goods Income Elasticity is positive. Inferior Goods Income Elasticity is negative. Higher income raises the quantity demanded for normal goods but lowers the quantity demanded for inferior goods. Copyright © 2004 South-Western/Thomson Learning