Introduction to Economics PDF

Lecture 1 úterý 5. listopadu 2024 18:14 Introduction to Economics Economics is a social science focused on understanding human behavior when faced with choices about allocating limited...

Lecture 1 úterý 5. listopadu 2024 18:14 Introduction to Economics Economics is a social science focused on understanding human behavior when faced with choices about allocating limited resources to satisfy unlimited needs. Why Study Economics? "No Free Lunch" Principle: Teaches us that every choice has a cost, even if something appears free, highlighting resource limitations. Defense Against Populism: Encourages critical thinking about political promises, helping us recognize potential aws in overly simplistic solutions. Key Concepts Opportunity Cost De nition: The value of the best alternative that is foregone when making a choice. Signi cance: Essential for evaluating trade-offs in decision-making, as resources allocated to one option cannot be used elsewhere. Scarcity and Choice In decision-making, individuals and societies are constrained by the availability of resources and the scope of their needs. Limited Resources (Inputs) 1. Time: Finite, irreplaceable 2. Money: Budget limited for individuals, rms, and governments. 3. Knowledge and Information: Imperfect and often limited, affecting decisions. 4. Natural Resources: Raw materials like water, minerals, land. 5. Experience and Skills: Human capital varies in expertise and ef ciency. Unlimited Needs Characteristics: In nite and evolving; needs vary in importance based on personal, social, and economic circumstances. De nition of Need: A feeling of lack or want that drives consumption. The Central Economic Problem Scarcity: The persistent tension between unlimited needs and limited resources. Economics helps in managing and making choices to resolve this con ict. Types of Goods 1. Goods: Tangible items that can be stored or used (e.g., food, clothing, cars). 2. Services: Intangible products provided by activities or expertise (e.g., healthcare, education, entertainment). Consumption and Utility Needs drive consumption, which is restricted by resource limitations. Utility: The satisfaction, bene t, or value derived from consuming goods and services. ◦ Goal: To maximize utility, or satisfaction, by making rational and ef cient choices. ◦ Marginal Utility: The added satisfaction from consuming one more unit of a good or service, which typically decreases with each additional unit (diminishing marginal utility). - ex.pizza Inputs (Factors of Production) The resources or inputs needed to produce goods and services: 1. Labor (L): Human effort in production, including physical and intellectual labor. fi fi fi fl fi fi fi fi fi fl  2. Capital (K): Man-made resources like machinery, tools, and infrastructure. 3. Land (P): Natural resources, including land and minerals. 4. Technology and Knowledge (A): Advances in technology and expertise that enhance production ef ciency. Note: The combination and ef ciency of these inputs determine production capacity. Production Possibilities Frontier (PPF) De nition: A curve that shows all possible combinations of two goods or services that an economy can produce with available resources and technology. Purpose: Illustrates trade-offs, opportunity cost, and the bene ts of economic growth. Ef ciency Productive Ef ciency: Achieved when resources are fully utilized, and no additional production of one good can occur without reducing another. Allocative Ef ciency: The speci c mix of goods and services that provides the most bene t to society. Optimal Output The most desired combination (balance) of goods and services from the perspective of consumers, balancing societal preferences. Economic Coordination Questions 1. What goods and services should be produced? 2. How should these goods and services be produced (e.g., labor-intensive vs. capital-intensive)? 3. For whom should these goods and services be produced (who receives them)? 4. How much of each good or service should be produced to satisfy societal needs without excess or shortage? Types of Economic Systems 1. Market Economy: Decisions about production and consumption are driven by the interactions of individuals and businesses through supply and demand. ◦ Characteristics: Price signals, competition, and consumer choice are central. 2. Centrally Planned Economy: The government makes all decisions regarding production and distribution. ◦ Outcome: Often leads to inef ciencies, shortages, and lack of consumer choice. 3. Mixed Economy: Combines elements of both market and planned economies. ◦ Function: Market mechanisms handle most production and consumption, while government intervenes to regulate markets, support social welfare, and address market failures. DIVISION OF LABOR & SPECIALIZATION Two primary ways to produce goods and services: 1. Natural Economy (DIY System): Individuals or households produce everything they need by themselves. Requires skills in all activities. Time-consuming and inef cient compared to modern systems. 2. Division of Labor and Specialization: Individuals focus on the tasks they are best at. Division of labor can occur by: Profession: Workers specialize in speci c jobs (e.g., farmers, blacksmiths). Speci c Operations: Workers specialize in particular steps of production (e.g., assembly line workers). Specialization increases productivity by allowing individuals to develop expertise and work faster. fi fi fi fi fi fi fi fi fi fi fi fi fi  Advantages Simplicity: tasks are broken down into smaller, more manageable parts. Increased productivity: faster and more ef cient production. Skill re nement: workers become experts in their roles. Disadvantages: Monotony of work: Repetitive tasks may lead to boredom or dissatisfaction. Interdependence: Producers rely on each other, creating vulnerability in the supply chain, both nationally and internationally. TRADE Trade involves the exchange of goods and services. Without division of labor and specialization, trade is less meaningful because everyone would be self-suf cient. Two Types of Trade: 1. Direct Exchange (Barter): Physical exchange of goods and services without using money. Double coincidence of wants problem: For trade to happen, both parties must want what the other has. Inef cient: Many unnecessary transactions; time-consuming. 1. Indirect Exchange (Money): Exchange of goods and services using money as a medium. More ef cient: Money eliminates the need for a double coincidence of wants, speeding up and simplifying transactions. MONEY De nition: Money is any asset widely accepted as a medium of exchange. Characteristics: Strong purchasing power: Must be valuable and accepted widely. Divisibility: Easy to divide into smaller units. Durability: Should withstand physical wear and last over time. Homogeneity: Units of money should have consistent quality (i.e., every coin or bill is of the same value). Forms of Money: 1. Commodity Money: * Has intrinsic value (value in itself) because it can be used for something other than exchange. * Examples: animal skins, spices, cattle, and later, precious metals like gold or silver. 2. Fiat Money: * Has no intrinsic value * Examples: CZK, USD, and EUR * Can exist in cash or cashless forms Q: Why do we use at money nowadays instead of commodity money? Fiat money is more practical: It can be produced and managed by governments to meet economic needs, is easier to transport, and doesn’t require intrinsic value (e.g., gold). Commodity money limitations: Its supply is limited, and its value can vary due to alternative uses. (e.g., gold for jewelry). fi fi fi fi fi fi fi  FUNCTIONS OF MONEY 1. Medium of Exchange: Money simpli es trade by being accepted as payment for goods and services. 2. Unit of Account: Money provides a common measure of value for goods and services, making it easier to compare prices. 3. Store of Value: Money holds purchasing power over time, allowing people to save and transfer value into the future. THE MARKET A market is any place (physical or virtual) where buyers and sellers exchange goods and services. MARKET PARTICIPANTS The main groups involved in markets are: 1. Households: Supply labor and other resources. Consume goods and services produced by rms. 2. Firms: Produce goods and services. Hire labor and other resources from households. 3. Government: In uences markets through regulation, taxation, and spending. Can also participate directly as a buyer or producer of goods and services. 4. External World (Foreign Sector): Includes foreign households, rms, and governments. Involved in international trade, investment, and exchange of goods, services, and capital. Supply, Demand, Market Equilibrium. Role of the Price Mechanism The principles of supply and demand govern how prices are set in a market and lead to a balance or market equilibrium. 1. Price and Its Types Price is the value assigned to goods and services in terms of currency or other goods and services. Absolute Price: ◦ The actual monetary cost of a good or service, often displayed as price tags in stores. Example: A bottle of water costs $2. Relative Price: ◦ A ratio of the absolute prices of two goods, representing how many units of one good you’d have to give up to obtain one unit of another. ◦ This is often the key price for consumers, helping to determine if an item is "expensive" or "cheap." Formula: Example: If Good X costs $10 and Good Y costs $5, the relative price of X in terms of Y is 2 units of Y per unit of X. Importance of Price Information Price signals scarcity, value, and affordability of goods, services, or production factors (like labor or resources). For consumers, one of the most common relative prices is their salary, which is effectively the cost of their time. fl fi fi fi  Supply Supply refers to the relationship between the quantity of a good or service offered by producers and its price. Generally, supply has a direct relationship with price: as price increases, quantity supplied also increases. Types of Supply Individual Supply: The supply of a good by one producer. Market Supply: Total supply in a market from all producers (focus here). Aggregate Supply: Total supply across all markets in an economy. The Supply Curve The supply curve is typically upward-sloping, indicating that as the price of a good rises, producers are willing to supply more. Reasoning: ◦ Higher prices incentivize producers to increase supply. ◦ Economically, this re ects the law of diminishing returns: as capital is xed, additional labor becomes less productive, making additional production more costly. Producers thus require a higher price to cover these increasing costs. Changes in Supply Change in Quantity Supplied: ◦ Triggered by a change in the price of the good. ◦ Re ected as movement along the supply curve. Shift in Supply: ◦ Caused by factors other than price, such as technology, input costs, or government policy. ◦ Shown as a shift of the entire supply curve. Demand Demand represents the relationship between the quantity of a good consumers are willing to buy and its price. Demand has an inverse relationship with price: as price decreases, the quantity demanded increases. Types of Demand Individual Demand: Demand from one consumer. Market Demand: Total demand from all consumers (focus here). Aggregate Demand: Total demand across all markets in an economy. The Demand Curve The demand curve is typically downward-sloping, indicating that as the price of a good falls, consumers buy more of it. Reasoning: ◦ Lower prices encourage greater consumption. ◦ The economic reasoning includes the law of diminishing marginal utility: as consumers purchase more of a good, the additional satisfaction (utility) from each extra unit decreases. They are therefore willing to pay less for additional units. Changes in Demand Change in Quantity Demanded: ◦ Triggered by a change in the price of the good. ◦ Re ected as movement along the demand curve. fl fl fl fi  Shift in Demand: ◦ Caused by factors other than price, such as income, preferences, or prices of related goods. ◦ Shown as a shift of the entire demand curve. Market Equilibrium Market Equilibrium occurs when the quantity supplied equals the quantity demanded, creating balance in the market. This is represented by the intersection of the supply and demand curves. Key Terms Market Price: The current price in the market, which may or may not be at equilibrium. Equilibrium Price: The price at which supply equals demand. Adjustments Toward Equilibrium If Market Price (P) > Equilibrium Price (PE): ◦ There is excess supply (surplus). ◦ The market price will decrease until supply equals demand. If Market Price (P) < Equilibrium Price (PE): ◦ There is excess demand (shortage). ◦ The market price will increase until demand matches supply. Shifts in Market Equilibrium Market equilibrium can be disturbed if there are shifts in supply or demand. Supply Shifts (e.g., due to new technology or input cost changes) cause the supply curve to move, creating a new equilibrium. Demand Shifts (e.g., due to changes in income or tastes) cause the demand curve to move, also leading to a new equilibrium. The Role of the Price Mechanism The price mechanism acts as a self-regulating system in the market, constantly adjusting prices in response to supply and demand changes to help restore equilibrium. This ongoing adjustment process ensures the market remains responsive to both consumer needs and producer constraints. Price Caps and Price Floors. Taxes and Subsidies Price regulation = intentional in uencing of prices of goods and services by the state (government) Several forms of price regulation: 1. Fixed prices 2. Price caps 3. Price oors 4. Taxes on production (consumption) 5. Subsidies on production (consumption) Reasons of price regulation: Correction of market failure (taxes/subsidies on production) Temporary measures during crises (price caps = cenový strop, price oors = minimální cena) During the energy crisis Some kind of social policy (price caps, price oors) Consequence of lobbyism (price oors, subsidies, tariffs) Trade wars (tariffs) fl fl fl fl fl  1. Fixed Price Governemnt sets the exact level of price, so the g&s may be sold only for exact price Examples: Vast majority of g&s during the socialist era in the eastern block Cigarettes today Impacts: Risk of lack or surplus of g&s in the market.....depends on the level of xed price in relation to the equilibrium price Surplus = přebytek Lack of = nedostatek 2. Price Caps (maximum costs) Government sets the maximal level of price the goods and services may be sold for (price must not increase above the cap) The purpose of price caps is to keep essential goods affordable for consumers, especially during times of high demand or shortages. Examples: Regulated rentals in the Czech Rep. (till 2012) Water and sewage payment Electricity and natural gas in 2023 Impacts: Lack of g&s in case the price cap is set below the equilibrium price – demand often exceeds supply - queues in front of stores, enforced savings, black market If the price cap is set at or above the equilibrium price, it doesn’t affect the market since the natural market price is lower than the cap 3. Price Floors Government sets the minimal level of price the goods and services may be sold for (price must not decrease below the oor) Examples: Minimum wage Minimum prices of agricultural products in the EU (until 1999) Impacts: Surplus of g&s in case the price oor is set above the equilibrium price – the government then purchases the surpluses, or they are wasted If the price oor at or below the equilibrium price, no impact – price would tend to the equilibrium level, so would the market fl fl fi fl  Tariffs The government sets the tariff on imported goods as a percentage of the declared import price Examples: Tariffs on steel pipes imported to the US from the EU EU tariffs on Chinese electric vehicles Impact: Decrease of the volume of imported goods Increase of the price in the home market Loss of welfare of home consumers Additional scal income 4. Taxes On Production(consumption) Refer to government-imposed charges on the use or purchase of certain goods or services Tax on quantity: A xed amount per unit, like a certain amount per liter of fuel (e.g., excise tax on gas) Tax on value (ad valorem tax): A percentage of the sale price, like VAT (Value Added Tax), applied as a proportion of the product’s price. Examples: Excise tax on fuels (CZK per litre of gas or diesel) VAT – Value Added Tax (ad valorem tax) Impacts: Equilibrium price increases: Taxes raise the equilibrium price in the market, making goods more expensive for consumers. Shared Tax Burden: The tax is technically paid by the supplier, but both suppliers and consumers share the burden as higher prices reduce demand. Dependence on Elasticity: The effect of the tax depends on price elasticity: Inelastic Demand: For essential goods (like alcohol or cigarettes), demand remains steady even as prices rise, so consumers bear most of the tax burden. 5. Subsidies on production (production) Governments sometimes provide nancial support, called subsidies, to producers of certain goods or services. This subsidy can be given as a xed amount per unit produced or as a percentage of the sale price (ad valorem). Examples: Agricultural Subsidies: Farmers receive support to produce crops, which helps stabilize food prices. Export Subsidies: Companies may get subsidies to encourage exports, boosting the country’s trade. Impacts: Equilibrium price decreases: Subsidies lower the cost of production, which reduces the market price of the product, making it more affordable for consumers. fi fi fi fi  Shared Income Bene t: Subsidies act like a “negative tax,” bene ting both producers (through increased income) and consumers (through lower prices). Elasticity In uence: The actual bene t depends on how responsive (elastic) the supply and demand are. For example, if demand is inelastic, consumers may bene t more from the subsidy. There are many types of governemnt interventions in prices. The hardest is setting the xed price. The most compatible measure - setting the taxes and subsidies - government is trying to make better market failures Elasticity Is a measure of how consumers (producers) respond in their quantities of purchased (supplied) g&s to the change in: Prices of those g&s Disposable income Prices of other g&s Important: elasticity (relative changes) vs. Slope (absolute changes) Note: elasticity is dimensionless quantity Elasticity in Supply: In case of SUPPLY we observe mainly: Price elasticity (of supply) Elasticity in Demand: In case of DEMAND we recognize: ◦ Price elasticity of demand ◦ Income elasticity of demand ◦ Cross elasticity of demand 1) Price Elasticity in Demand: = relative change of quantity demanded due to the relative change of price of particular good or service What is the percentage change of quantity demanded when the price of particular g&s changes by 1 percent fl fi fi fi fi fi  Price elasticity of demand usually takes the negative values (change of Q and P goes against each other) - sign of the negative slope of the D curve Giffen good or service - increase of price leads to the increase of quantity demanded TYPES OF DEMAND BY THE PRICE ELASTICITY Elastic ePD < 1 Relative change of Quantity > relative change of Price When price (P) decreases, consumers spend more for that good or service (and vice versa) -increase total spending Big reaction to price change, spending goes up or down a lot. Luxury goods Unit elastic ePD = 1 Relative change of Quantity = relative change of Price When Price decreases, consumers spend the same amount of money for that good or service Reaction matches price change exactly, spending stays the same. If the price of a certain type of clothing drops by 10% and quantity demanded rises by 10%, total spending remains the same Inelastic ePD > 1 Relative change of Quantity < relative change of Price When Price decreases, consumers spend less for that good or service (and vice versa) - decrease total spending Little reaction to price change, spending barely changes (people keep buying). Medicine, Gas Factors affecting the price elasticity of D The consumers‘ response to the change of price is usually affected by following factors: Necessity vs. luxusness of g&s – demand for necessary g&s is usually less elastic than for the luxuries, because consumers need them regardless of price changes. Availability of substitutes – demand for g&s with substitutes is usually more elastic, consumers can easily switch to a substitute if the price of one good increases Time horizon – the longer time for reaction the broader possibilities for consumers to react on the change of price. In the short term, demand tends to be less elastic - not have time to adjust their behavior. In long-term, demand becomes more elastic as consumers can make adjustments. Proportion of Household Budget Spent:– the greater, the more elastic demand  2) Income elasticity of demand Income elasticity of D (eID) = tells us how much the quantity demanded for a good changes in response to a change in income. Income elasticity of D may take whatever value – we can consider the character of particular good or service upon the value of income elasticity (negative, positive, zero) Types of g&s upon the income elasticyty of D: 1) Normal g&s eID > 0; when Income increases, Quantity increases as well (and vice versa) – changes of I and Q go hand in hand ◦ eID ϵ (0 ; 1) → necessary g&s : quantity purchased changes by slower pace than disposable income As income goes up, people buy a bit more, but not a lot more. The increase in demand is smaller than the increase in income. (ex. water, food) ◦ eID > 0 → luxury g&s : Quantity purchased changes faster than disposable income These are items people really want when they have more income (ex. expensive cars, vacation tour) 2) Inferior g&s eID < 0 – when Income increases, Quantity decreases (and vice versa) – changes of I and Q go against each other (ex. lower quality food - fast food - you purchase a dinner in the restaurant)  3) Cross elasticity of demand Cross elasticity of D (eCD) =The cross elasticity of demand (eCD) measures the responsiveness of the quantity demanded for one good (X) to a change in the price of another good (Y). Cross elasticity of D may take whatever value. We can then identify relationship between compared g&s. Independent g&s eCD = 0 → Price change of one good has no impact on the purchased quantity of the other good Substitutes eCD > 0 → When the price of one good increases, demand for the other good increases as well (when Coca-Cola becomes more expensive, demand for Pepsi increases), and vice versa – changes of prices and quantities go hand in hand Complements eCD < 0 → When the price of one good increases, demand for the other good decreases (when fuels become more expensive, demand for cars decreases), and vice versa – changes of prices and quantities go against each other Price elasticity of supply Price elasticity of supply measures how sensitive the quantity supplied of a good is to changes in its price. What is the percentage change of Q supplied when the P changes by 1 percent Elastic Percentage change of quantity is greater than the percentage change of price Example: Goods or services that can be produced or supplied quickly in response to price increases (e.g., manufactured products with exible production processes). ePS > 1 Unit elastic Percentage change of quantity equals to the percentage change of price Example: When producers can adjust supply proportionately to changes in price. ePS = 1 Inelastic Percentage change of quantity is smaller than the percentage change of price Example: Goods or services with production constraints or limited availability, like agricultural products or unique resources that take longer to produce. 0 < ePS < 1 The longer period the greater posibility to react on the increase of price fl  PRICE DISCRIMINATION Price discrimination = sale of identical g&s to different consumers for different prices without „production cost reasons“ Price discrimination as a consequence of certain monopolistic power Typical for imperfect competition markets ( rms) The aim: to acquire consumer´s surplus – sale for the maximum price the consumer is willing to pay Several forms of price discrimination FORMS OF PRICE DISCRIMINATION: 1. 1st degree price discrimination: every consumer purchases for different price – maximum price he/ she is willing to pay → rm (supplier) acquires the entire consumers´ surplus (very dif cult in practice; the auction system is close to that) 2. 2nd degree price discrimination: different quantities for different prices (quantity discounts) 3. 3rd degree price discrimination: rm sells to different consumer segments for different prices – upon their price elasticities of demand (ordinary consumers vs. students vs. seniors) - connected to their income Price skimming: new product is available for the highest price when it enters the market, then the prices decreases gradually (new iPhone, new model of Tesla, last minute tours) Peak and off-peak pricing: higher demand in peak hours/season leads to higher price than in off-peak hours/season (season vs. off-season tours, ski passes; tickets to the morning vs. evening theatre performance, etc.) In summary, economics is about the choices we make in response to the world around us—a blend of needs, wants, and the resources at our disposal. fi fi fi fi