Introduction To Economics PDF

INTRODUCTION TO ECONOMICS JOSIELYN M. MENDOZA, PhD.  Learning Objective To be able to define and understand economics and some of important terms related to it. To discuss and analyze the basic concepts and compositions of Micro and Macro. To be able to analyze and interpret speci...

INTRODUCTION TO ECONOMICS JOSIELYN M. MENDOZA, PhD.  Learning Objective To be able to define and understand economics and some of important terms related to it. To discuss and analyze the basic concepts and compositions of Micro and Macro. To be able to analyze and interpret specific problems in the community and provide or recommend possible resolutions  Ask yourself the following Yes to y , read questions our self ! What is economics? What is the purpose or the importance of economics? The difference between Micro and Macro; Normative and Positive Economics? The Bare elements of demand and supply? Measuring the economy? Half Empty? Half Full?  Common quotes in economics A recession is when your neighbor is out of work. A depression is when you are out of work. - Harry Truman When buying and selling is controlled by legislation, the first ones to be bought are the legislators. - Anonymous  Common quotes in economics Teach a parrot to say demand and supply, and you have created an economist. - Anonymous  Common quotes in economics I have observed that we all get the same amount of ice. The rich get it in the summertime and the poor get it in the winter. - Bat Masterson  Common quotes in economics “The curious mind embraces science; the gifted and sensitive, the arts; the practical, business; the leftover becomes an economist” ― Nassim Nicholas Taleb What is economics? Economics comes from the ancient Greek word “oikonomikos” or “oikonomia.” Oikonomikos literally translates to “the task of managing a household.” French mercantilists used “economie politique” or political economy as a term for matters related to public administration  Adam Smith’s Definition of Economics Adam Smith was a Scottish philosopher widely considered as the first modern economist. Smith defined economics as “an inquiry into the nature and causes of the wealth of nations.”  Alfred Marshall’s Definition of Economics British economist Alfred Marshall defined economics as the study of man in the ordinary business of life. Marshall argued that the subject was both the study of wealth and the study of mankind. He believed it was not a natural science such as Physics or Chemistry but a social science. Lionel Robbin’s Definition of Economics Lionel Robbin, another British economist, defined economics as the subject that studies the allocation of scarce resources with countless possible uses. In his 1932 text, “An Essay on the Nature and Significance of Economic Science,” Robbins said the following about the subject: – “Economics is the science which studies human behavior as a relationship between ends and scarce means which have alternative uses.”  Modern Definition of Economics According to Samuelson, “Economics is the study of how people and society choose, with or without the use of money, to employ scarce productive resources which could have alternative uses, to produce various commodities over time and distribute them for consumption now and in the future among various persons and groups  What is economics for you? Importance of Economics Economic Literacy Matters A lot of issues that affect us require a certain level of Economic sense needed to comprehend and evaluate critical issues such as:  Rising prices of oil and basic necessities  K to 12  Global financial meltdown  Or as simple as buying a product, getting a loan, voting a candidate and etc.  Surveys have shown that what people know about basic economics affect what they think about an economic issue  Similarly, people who have no basic knowledge of economics are almost always willing to state an opinion.  Economics is… people’s incentives and choices and what happens to coordinate their decisions and activities Organization and information are crucial aspects Economic failures are mostly failures of coordination Social Institutions are involved Principle # 1. How People Make Decisions Principle 1: People face trade-offs Making decisions – Trade off one goal against another – Society National defense vs. consumer goods Clean environment vs. high level of income Efficiency vs. equality 22  Principle No. 1 OPPORTUNITY COST – You cannot be in two places at the same time! Watching a movie does not cost you the price of the ticket alone but the time spent watching How People Make Decisions Principle 2: The cost of something is what you give up to get it People face trade-offs – Make decisions Compare cost with benefits of alternatives – Opportunity cost Whatever most be given up to obtain one item PPF – Opportunity cost is what you give up as you produce more of another good 24  Principle No. 2 WE ALL FACE TRADE OFFS IN MAKING DECISIONS The choice of one, lets go of another Being here – means no lunch date How People Make Decisions Principle 3: Rational people think at the margin Rational people – Systematically & purposefully do the best they can to achieve their objectives Marginal changes – Small incremental adjustments to a plan of action Rational decision maker – take action only if – Marginal benefits > Marginal costs 26  RATIONAL PEOPLE DECIDE ON THE MARGIN (Cheaper by the Dozen) Why do people take graduate studies? What do managers think of when they increase production? Why can airlines offer piso fares? How People Make Decisions Principle 4: People respond to incentives Incentive – Something that induces a person to act – Higher price Buyers - consume less Sellers - produce more – Public policy Change costs or benefits Change people’s behavior 28  RATIONAL PEOPLE RESPONDS TO INCENTIVES Why not a license discount if there are no traffic violations? Incentive structure requires strict implementation of rules  How People Interact Principle 5: Trade can make everyone better off Trade – Specialization Allows each person/country to specialize in the activities he/she does best – People/countries can buy a greater variety of goods and services at lower cost 30 WE ARE ALL MADE BETTER OFF BY TRADING Why is it better to eat out or take out food? You cannot cut your own hair!  How People Interact Principle 6: Markets are usually a good way to organize economic activity Communist countries – central planning – Government officials (central planners) Allocate economy’s scarce resources – Decided » What goods & services were produced » How much was produced » Who produced & consumed these goods & services Theory: only the government could organize economic activity to promote economic well-being for the country as a whole 32 Principle 6: Markets are usually a good way to organize economic activity Market economy - allocates resources – Decentralized decisions of many firms and households – As they interact in markets for goods and services – Guided by prices and self interest – Adam Smith’s “invisible hand” 33  How People Interact Principle 7: Governments can sometimes improve market outcomes We need government – Enforce the rules – Maintain institutions - key to market economy Enforce property rights Property rights – Ability of an individual to own and exercise control over scarce resources 34  Principle 7: Governments can sometimes improve market outcomes Government intervention – Change allocation of resources – To promote efficiency Avoid market failure – To promote equality Avoid disparities in economic wellbeing 35  How People Interact Market failure – Situation in which the market on its own fails to produce an efficient allocation of resources Causes for market failure – Externality Impact of one person’s actions on the well-being of a bystander – Market power Ability of a single person (or small group) to unduly influence market prices 36  1 How the Economy as a s Whole Works 8: A Country’s Standard of Living Depends on Its Ability to Produce Goods and Services 9: Prices Rise When the Government Prints Too Much Money 10: Society Faces a Short-Run Trade-off between Inflation and Unemployment 37 What is micro and macro?.  Microeconomics Micro – Micro comes from Greek word mikros, meaning “small” Microeconomics – Study of behavior of individual households, firms, and governments Choices they make Interaction in specific markets Focuses on individual parts of an economy, rather than the whole 39  Macroeconomics Macro – Macro comes from Greek word, makros, meaning “large” Macroeconomics – Study of the economy as a whole Focuses on big picture and ignores fine details Lieberman & Hall; Introduction to 40 Economics, 2005  Positive Economics Study of how economy works Statements about how the economy works are positive statements, whether they are true or not Accuracy of positive statements can be tested by looking at the facts— and just the facts 41  Normative Economics Study of what should be – Used to make value judgments, identify problems, and prescribe solutions – Statements that suggest what we should do about economic facts, are normative statements Based on values – Normative statements cannot be proved or disproved by the facts alone 42 Why Economists Disagree In some cases, the disagreement may be positive in nature because – Our knowledge of the economy is imperfect – Certain facts are in dispute In most cases, the disagreement is normative in nature because – While the facts may not be in dispute Differing values of economists lead them to dissimilar conclusions about what should be done 43  Why Study Economics To understand the world better – You’ll begin to understand the cause of many of the things that affect your life To gain self-confidence – You’ll lose that feeling that mysterious, inexplicable forces are shaping your life for you 44  Why Study Economics To achieve social change – You’ll gain tools to understand origins of social problems and design more effective solutions To help prepare for other careers – You’ll discover that a wide range of careers deal with economic issues on many levels To become an economist – You’ll begin to develop a body of knowledge that could lead you to become an economist in the future 45  Demand and Quantity demanded Demand is the continuous flow of purchases measured in a specific period of time. Quantity demanded is the amount (number of units) of a product that a household would buy in a given time period if it could buy all it wanted at the current market price.  Economic models A demand schedule is a table showing how much of a given product a household would be willing to buy at different prices The demand curve is a graph illustrating how much of a given product a household would be willing to buy at different prices The Demand Curve – The relationship between the quantity of a good that consumers are willing to buy and the price of the good. – Measures quantity on the x-axis and price on the y-axis Q D Q D(P)  The Demand Curve Price ($ per unit) The demand curve slopes downward demonstrating that consumers are willing to buy more at a lower price as the product becomes relatively cheaper. P2 P1 D Q1 Q2 Quantity 49  The Demand Curve Changes in quantity demanded – Movements along the demand curve caused by a change in price. Changes in demand – A shift of the entire demand curve caused by something other than price. Income Preferences 50  Change in Demand Other Variables Affecting Demand – Income Increases in income allow consumers to purchase more at all prices – Consumer Tastes – Price of Related Goods Substitutes Complements ©2005 Pearson Chapter 2 51 Education, Inc. Population Advertising and promotions Special influences  Change in Demand D Income Increases P D’ – Purchased Q0, at P2 and Q1 at P1 P2 – Now purchased Q1 at P2 and Q2 at P1 – Same for all prices P1 – Demand Curve shifts right Q0 Q1 Q2 Q 53 The Law of Demand The law of demand states that there is a negative, or inverse, relationship between price and the quantity of a good demanded and its price. This means that demand curves slope downward. Other Properties of Demand Curves Demand curves intersect the quantity (X)-axis, as a result of time limitations and diminishing marginal utility. Demand curves intersect the (Y)- axis, as a result of limited income and wealth.  Income and Wealth Income is the sum of all households wages, salaries, profits, interest payments, rents, and other forms of earnings in a given period of time. It is a flow measure. Wealth, or net worth, is the total value of what a household owns minus what it owes. It is a stock measure.  Related Goods and Services Normal Goods are goods for which demand goes up when income is higher and for which demand goes down when income is lower. Inferior Goods are goods for which demand falls when income rises.  Related Goods and Services Substitutes are goods that can serve as replacements for one another; when the price of one increases, demand for the other goes up. Perfect substitutes are identical products. Complements are goods that “go together”; a decrease in the price of one results in an increase in demand for the other, and vice versa. Shift of Demand Versus Movement Along a Demand Curve A change in demand is not the same as a change in quantity demanded. In this example, a higher price causes lower quantity demanded. Changes in determinants of demand, other than price, cause a change in demand, or a shift of the entire demand curve, from DA to DB. A Change in Demand Versus a Change in Quantity Demanded When demand shifts to the right, demand increases. This causes quantity demanded to be greater than it was prior to the shift, for each and every price level.  A Change in Demand Versus a Change in Quantity Demanded To summarize: Change in price of a good or service leads to Change in quantity demanded (Movement along the curve). Change in income, preferences, or prices of other goods or services leads to Change in demand (Shift of curve). From Household to Market Demand Demand for a good or service can be defined for an individual household, or for a group of households that make up a market. Market demand is the sum of all the quantities of a good or service demanded per period by all the households buying in the market for that good or service.  Supply A supply schedule is a table showing how much of a product firms will supply at different prices. Quantity supplied represents the number of units of a product that a firm would be willing and able to offer for sale at a particular price during a given time period.  The Supply Curve and the Supply Schedule A supply curve is a graph illustrating how much of a product a firm will supply at different prices. CLARENCE BROWN'S 6 Price of soybeans per bushel ($) SUPPLY SCHEDULE FOR SOYBEANS 5 QUANTITY SUPPLIED 4 PRICE (THOUSANDS 3 (PER OF BUSHELS BUSHEL) PER YEAR) 2 $ 2 0 1.75 10 1 2.25 20 3.00 30 0 4.00 45 5.00 45 0 10 20 30 40 50 Thousands of bushels of soybeans produced per year  The Law of Supply 6 Price of soybeans per bushel ($) 5 The law of supply 4 states that there is a 3 positive relationship 2 between price and 1 quantity of a good 0 supplied. 0 10 20 30 40 50 This means that supply Thousands of bushels of soybeans produced per year curves typically have a positive slope. Determinants of Supply The price of the good or service. The cost of producing the good, which in turn depends on: – The price of required inputs (labor, capital, and land), – The technologies that can be used to produce the product, The prices of related products.  A Change in Supply Versus a Change in Quantity Supplied A change in supply is not the same as a change in quantity supplied. In this example, a higher price causes higher quantity supplied, and a move along the demand curve. In this example, changes in determinants of supply, other than price, cause an increase in supply, or a shift of the entire supply curve, from SA to SB.  A Change in Supply Versus a Change in Quantity Supplied When supply shifts to the right, supply increases. This causes quantity supplied to be greater than it was prior to the shift, for each and every price level.  A Change in Supply Versus a Change in Quantity Supplied To summarize: Change in price of a good or service leads to Change in quantity supplied (Movement along the curve). Change in costs, input prices, technology, or prices of related goods and services leads to Change in supply (Shift of curve).  From Individual Supply to Market Supply The supply of a good or service can be defined for an individual firm, or for a group of firms that make up a market or an industry. Market supply is the sum of all the quantities of a good or service supplied per period by all the firms selling in the market for that good or service.  Market Equilibrium The operation of the market depends on the interaction between buyers and sellers. An equilibrium is the condition that exists when quantity supplied and quantity demanded are equal. At equilibrium, there is no tendency for the market price to change. Market Equilibrium Only in equilibrium is quantity supplied equal to quantity demanded. At any price level other than P0, the wishes of buyers and sellers do not coincide. Market Disequilibria Excess demand, or shortage, is the condition that exists when quantity demanded exceeds quantity supplied at the current price. When quantity demanded exceeds quantity supplied, price tends to rise until equilibrium is restored. Market Disequilibria Excess supply, or surplus, is the condition that exists when quantity supplied exceeds quantity demanded at the current price. When quantity supplied exceeds quantity demanded, price tends to fall until equilibrium is restored.  THEORY OF CONSUMER BEHAVIOR  UTILITY Is a term for satisfaction in economics. There is a functional relationship between utility and consumption as a need arises. TU = f (Q) MU = TU Q Where : TU = Total Utility f = is a function of MU = Marginal Utility Q = Units of consumption = Infinitisimal Change NOTES: The symbol for change carries a positive sign if the variable increases and a negative sign if the variable decreases. As the consumption level increases, Marginal Utility (MU) carries a positive sign when Total Utility (TU) level rises and a negative sign when the level declines.  MARGINAL UTILITY Is also defined as the utility or dissatisfaction from the last unit of consumption depending whether MU carries a positive sign or negative.  An additional unit of consumption registers a positive change and therefore an increase in Total Utility (TU) so long as MU is positive.  Eventually, the TU curve registers a Negative change and therefore, a decline as MU is negative.  In conclusion, the Diminishing Marginal Utility (MU) causes the Total Utility (TU) to decline eventually for which reason Maximum Consumption is only up to the point of maximum utility. TABLE 1 Consumption TU MU 1 7 7 2 13 6 3 18 5 4 22 4 5 25 3 6 27 2 7 28 1 8 28 0 9 27 -1 10 25 -2 11 22 -3 12 18 -4 13 13 -5 14 7 -6 15 0 -7  THEORY OF PRODUCTION  THEORY OF PRODUCTION  Is an analysis of input – output relationship in the short run as well as in the long run.  SHORT RUN  Is where a firm adjusts its variable input only.  LONG RUN  Is where a firm adjusts both fixed and variable input.  PRODUCTION FUNCTION  Contains the functional relationship between output and a basic factor in the form of land, labor or capital, assuming the other factors of fixed size. FUNCTIONAL RELATIONSHIP TP = f (I) MP = TP I AP = TP I Where: TP = Total Product or output MP = Marginal Product AP = Average Product f = Function of I = Input  The symbol for change carries a positive sign if the variable increases and a negative sign if the variable decreases.  Hence, as the input level increases. MP carries a positive sign when the output level increases and a negative sign when the output level declines.  MARGINAL PRODUCT OR OUTPUT  Is also the product yield or product foregone from the last unit of input, depending on whether MP carries a positive or negative sign.  PHASE I  MP increases to outpace and increase AP as … AP1 < MP results: AP2 > AP1 but < MP Q < Q results: Q + Q > Q but < Q I I I + I > I I Where: Q = Total Output I = Total Input = Change AP1 = Average Product before the AP2 = Average Product before the MP = Marginal Product  PHASE 2  MP declines but AP continues to increase until it goes down. AP is less than MP causing the former to continuously increase despite the decrease in the latter.  However the AP registers a decline following MP in which the opposite relationship. AP1 > MP results: AP2 < AP1 but > MP Q < C results: Q + Q > Q but < Q Q > Q I + I I I I I  PHASE 3  MP carries a negative value, AP decreasing, TP diminishing.  THE LAW OF DIMINISHING RETURNS  States that as you place in input, output increases. Additional input yield to additional output until such time adding more input no longer yield to additional output.  PRODUCTION FUNCTION Labor Input (in Total Product MP AP max hours 1 5 5.00 2 10 5 5.00 3 16 6 5.33 4 21 5 5.25 5 24 3 4.80 6 24 0 4.00 7 21 -3 3.00 8 16 -5 2.00 THE INDIFFERENCE CURVE There is a varying combination in the consumption of commodities that yield the same level of Total Utility (TU), an Indifference Curve illustrates this property assuming two commodity items such as e.g. food and clothing. The points along the Indifference Curve correspond to the different combinations in the consumption of food and clothing that yield the same level of their aggregate utility. Between any point to another along the curve, an inverse relationship exists between the commodity units in as much on the utility foregone by consuming less of one is gained by consuming none of the other. It is the equality between utility gained and utility foregone that holds the total utility level from both commodity items as constant.  THE LAW OF DIMINISHING MARGINAL UTILITY Between any point to another along the indifference curve, the ratio between utility gained and utility foregone is always equal to 1 and therefore constant. However, this is not true of the corresponding substitution between the commodity items, the Marginal Rate of Substitution (MRS) of food (Y axis) to clothing (X axis) measured as follows: MRS = Food consumption Clothing consumption  A continuous increase in clothing consumption and therefore a decrease in food consumption.  The MU of clothing ( util / consumption) decreases while the reciprocal ( in consumption / util) increases due to influence of the Law of Diminishing Marginal Returns. The MU of food consumption increases while the reciprocal decreases due to the opposite influence of this law as consumption declines. Therefore, for every unit of utility foregone and then regained by continuously decreasing food consumption. Relationship should be… + Clothing consumption - Consumption Therefore: MRS = Food Clothing  SHAPE OF THE INDIFFERENCE CURVE Convex to the point of origin due to the influence of the Law of Diminishing Marginal Utility on the Marginal Rate of Substitution between commodity items. INDIFFERENCE SCHEDULE Food Consumption Clothing Consumption MRS 56 1 - 46 2 (10) 37 3 (9) 29 4 (8) 22 5 (7) 16 6 (6) 11 7 (5) 8 8 (4) 5 9 (3) 3 10 (2) 2 11 (1) PRODUCTION ISOQUANT There is a varying combination or mix-in the utilization of resource inputs corresponding to the same level of output. (A production isoquant illustrates this property assuming two variable inputs, examples are labor and capital).  The points along the isoquant curve represents the different combinations of capital and labor inputs corresponding to the same plant capacity.  Inverse relationship exists between these resource inputs as the output that production foregoes by utilizing less of one is regained by utilizing more of the other.  It is the inequality between output gained and output foregone that holds the total output from both resource input as constant.  However, the substitution between labor and capital inputs is true only up to a certain extent as no resource input is capable of independent utilization and therefore basically complements the other.  Between any point to another along the isoquant curve, the ratio between output gained and output foregone is equal to 1 and therefore constant. This is not true of the substitution between the corresponding resource inputs.  MEASUREMENT OF MRS MRS = Capital Input Labor Input LABOR INPUT CAPITAL INPUT MRS 1 30 - 2 26 4 3 22.5 3.5 4 19.5 3 5 17 2.5 6 15 2 7 13.5 1.5 8 12.5 1 9 12.5 10 12 0  The decrease in capital input diminishes for every additional unit of labor inputs.  The shape of the production isoquant is convex to the point of origin of the graph due to the influence of the law of diminishing returns on the rate of substitution between resource inputs.  THE ISOCOST LINE An isocost line contains infinite combinations of resource inputs that the same budget can purchase at constant prices. B = Pk Qk + Pl Ql Max Qk = B Max Ql = B Pk P Where: B = Given budget Pk = Given price of capital Pl = Given price of labor Qk= Inputs of capital Ql = Inputs of labor Max = Maximum purchase An inversely proportional relationship exists between the input variables along the isocost line given a budget size and the unit costs of the inputs as constant. A hierarchy of isocost lines where a directly proportional relationship, however exist between the level of the isocost line and the overall purchase quantity of inputs. The point along every isocost line that coincides with the straight line drawn represents the same ratio of combination between labor and capital inputs. The difference between the points lies in their overall input purchase levels that vary in direct proportion with the size of the budget and therefore the level of the isocost line.  PROPERTIES OF THE ISOCOST LINES  Constant rate of substitution between resource inputs at any point of combination along the isocost line. MRS = Change in capital inputs Change in labor inputs The capital inputs foregone in shifting this amount to but additional unit of labor input is the alternative meaning of the said ratio of substitution and expand as follows. MRS = Price of labor inputs Price of capital inputs The other property exhibits the isocost lines as parallel to one another in the hierarchy. Any budget line which corresponds to an isocost line, exhibits the same ratio of substitution between the resource inputs so long as prices and hence, price ratios as constant. Constancy should therefore bring the isocost line as parrallel to one another in the hierarchy where their overall purchase vary in direct proportion with the size of the budget.  ISOCOST SCHEDULES Budget P10k Budget P20k Budget P40k CAPITAL LABOR CAPITAL LABOR CAPITAL LABOR INPUTS INPUTS INPUTS INPUTS INPUTS INPUTS 5 0 10 0 20 0 4 40 8 8 16 16 3 8 6 16 12 32 2 12 4 24 8 48 1 16 2 32 4 64 0 20 0 40 0 80 Price of capital input = P2,000 Price of labor input = P500 Rate of substitution of capital to labor = ¼ or 0.25 NOTE: The percentage in the budget is the same as the corresponding change in quantity of each resource for the same ratio of combination which is 100%  Little Story This story is about four people named EVERYBODY, SOMEBODY, ANYBODY and NOBODY There was an important job to be done and EVERYBODY was sure that SOMEBODY would do it.  Little Story ANYBODY could have done it, but NOBODY did it. SOMEBODY got angry about that because it was EVERYBODY’s job. EVERYBODY thought ANYBODY could do it, but NOBODY realized EVERYBODY wouldn’t do it. It ended up that EVERYBODY blamed SOMEBODY when NOBODY did what ANYBODY could have be done… There are two kinds of people, those who do the work and those who take the credit. Try to be in the first group; there is less competition there. Finished!!! You did it!!!  Thank You Dominus Vobiscum….