Prelim Reviewer - Introduction to Economics PDF

UNIT 1 – INTRODUCTION OF ECONOMICS A. Etymology of Economics Economics – oeikonomia → art of household management → budgeting. Adam Smith (1776) – economics became a science when his famous treatise the “Wealth of Nation” – An Inquiry into the Nature and Causes o...

UNIT 1 – INTRODUCTION OF ECONOMICS A. Etymology of Economics Economics – oeikonomia → art of household management → budgeting. Adam Smith (1776) – economics became a science when his famous treatise the “Wealth of Nation” – An Inquiry into the Nature and Causes of the Wealth of Nations. Concept of Wealth – related to resources of the country and the first two resources identified by Adam Smith are Land and Labor. Later additional resources such as Capital and Entrepreneurial Ability were identified by other economists. Resources in general are classified into two groups: Non-economic – free and abundant and no need for efficient allocation. Economic – scarce or limited, have a price attached to them, versatile and need to be allocated. Economic Resources or Factors of Production are divided into two types: Human Resources Labor – mental and physical effort exerted = salaries or wages. Entrepreneurial Ability – organizer of production activity → risk-taker = profit, royalties. Non-human Resources Land – all natural resources (God-given) = rent or lease. Capital – man-made goods to produce other goods = interest. Economics – social science that deals with the efficient allocation of scarce resources in order to satisfy man’s unlimited needs and wants. Scarcity – economics’ basic problem. Man’s Needs and Wants – unlimited, insatiable and constantly changing and dynamic. According to Importance According to Origin According to Scope Basic Built-in Private Secondary Created Public Luxury Needs and Wants – must be satisfied by utilizing resources and creating products. In utilizing resources, a certain resource-mix or technology is used which can be: Labor-intensive Technology – needs a significant amount of labor to operate. Capital-intensive Technology – requires a large amount of capital to operate. Products are those that can satisfy needs and wants, which can either be: Goods – tangible and material Consumer or Direct or Final – for end-use or consumption. Product or Capital Goods – for the production of other goods. Raw Materials Intermediate or Semi-finished or Semi-processed Services – intangible and immaterial Fundamental Economic Activities: Production – creation of products. Distribution – making the goods available to the consumers through the different channels. Exchange – giving money in return for the products. Consumption – utilization of products. Public Finance – sourcing and using of funds by the government. Fundamental Economic Questions: What to produce? How to produce? How much to produce? For whom to produce? Economic Systems: Traditional, Command, Market, and Mixed. Traditional Economic System – the fundamental economic questions are answered by customs and traditions and how these were handed down from one generation to another. Command Economic System –the basic economic questions are answered and dictated upon by the government or a central-planning body. Market Economic System – the economic questions are answered through the price system founded on the invisible hands. B. Methodology of Economics 5 Steps in the Methodology of Economics or Scientific Method: 1. Observation – identify the specific problem and collect or gather relevant data; tools used are common sense, five senses and survey tools. 2. Definitions and Assumptions – give the operational meaning of the terms used and the condition set; tools used are review of related literature, e.g., ceteris paribus concept. 3. Deductions – analyze and formulate generalizations or conclusions or hypotheses or theories or models; tools used are logic and mathematics. 4. Empirical Verification – hypothesis-testing or validation of the hypothesis; tools used are Statistics (inferential) or Econometrics (regression analysis). 5. Policy Formulation and Application – formulation of the solution or action plan for the problem and apply or implement the said policy. 3 Phases of Economics: 1. Descriptive Economics – refers to observing what, when, where, who and how of the events. 2. Theoretical Economics or Economic Analysis – it involves definitions and assumptions, deductions and empirical verifications; refers to answering the question why. 3. Applied Economics or Economic Policy – it relates to the formulation of solution or action plan for the problem and apply or implement the said policy. 2 Branches of Analysis in Economics: 1. Positive Economics – deals with “what is” and relies heavily on facts only; it is related to step 1 – observations and descriptive economics. Positive statements are Objective. 2. Normative Economics – deals with “what should be” or “what ought to be” and uses both facts and value judgements; it is related to steps 2 to 5 as well as to theoretical economics and applied economics. Normative statements are prescriptive but also subjective. Value Judgments – these are belief systems, customs and traditions, environmental considerations that are considered in the formulation of solutions that are considered in the formulation of solutions and policies to address economic issues. 2 Approaches in the Study of Economics: 1. Microeconomics – study of an individual or specific or particular unit of the economy, e.g., consumer or firm.  2. Macroeconomics – study of the aggregate economy or the economy as a whole or all of the units of the economy, e.g., household sector, business firm sector, foreign trade sector, and the government sector. Why Economists Disagree or Appear to Give Conflicting Advice: 1. Economists may disagree about the validity of alternative positive theories about how the world works or differences in scientific judgments. 2. Economists may have different values and therefore different normative views about what policy should try to accomplish or differences in perceptions versus reality. C. Ten Principles of Economics How Individuals Make Decisions (P1-P4) P1: People Face Trade-Offs People are likely to make good decisions only if they understand the options they have available – acknowledging life’s trade-offs. There is no such a thing as a “free lunch”. Economic goals, such as Efficiency vis-à-vis Equality. Equality – the benefits are uniformly distributed among the members of the society. Efficiency – it means that society is getting the maximum benefits or the most it can from its scarce resources. ✓ Allocative Efficiency – when consumers pay a market price that reflects the private marginal cost of production, MC = P. ✓ Productive Efficiency – when a firm combines resources in such a way as to produce a given output at the lowest possible average total cost – cost minimization. ✓ Technical Efficiency – relates to how much output can be obtained from a given input – output maximization. ✓ X-Efficiency Efficiency – occurs when the output of firms, from a given amount of input, is the greatest it can be. Originated from Harvey Leibenstein in 1960s. ✓ Dynamic Efficiency – it means technological progressiveness and innovation and associated with Austrian economist Joseph Schumpeter. ✓ Social Efficiency – it exists when all private and external costs and benefits are considered when producing an extra unit. P2: The Cost of Something is What You Give Up to Get It Making decisions requires comparing cots and benefits of alternative courses of action. The cost of an action is not only limited to its explicit costs or out-of-pocket costs but also its opportunity costs or implicit costs or wat you give up to get what you want, otherwise knows as your foregone benefit. P3: Rational People Think at the Margin Rational People – people who systematically and purposefully do the best they can to achieve their objectives. Marginal Change – a small incremental adjustment to a plan of action. A rational decision maker takes an action if and only if the marginal benefits (marginal revenue) exceed the marginal costs. Marginal decision making can help explain some otherwise puzzling economic phenomena such as the Water-Diamond Paradox, wherein the willingness of a person to pay much more is based on the marginal benefit or marginal utility that an extra unit yields rather than its total utility or usefulness. P4: People Respond to Incentives Incentives – something that induces a person to act or things that induce people to alter their actions or behaviors. Related to reinforcements which can be positive (rewards/merits) or negative (punishments/demerits). How People Interact (P5-P7) P5: Trade Can Make Everyone Better-Off Trade allows countries to specialize in what they do best. By trading with others, people can buy a grater variety of goods and services at a lower cost. P6: Markets are Usually a Good Way to Organize Economic Activity Market Economy – an economy that allocates resources through the decentralized decisions of many firms and households as they interact in the factor and product markets. The price system is the signal light to all market activities and the price is determined by the invisible hands of demand and supply. P7: Governments can Sometimes Improve Market Outcomes Governments are regulatory agencies and are needed to enforce rules and maintain the institutions that are key to the market system. Enforce Property Rights – the ability of an individual to own and exercise control over scarce resources. Market Failure – a situation in which a market left on its own fails to allocate resources efficiently. Externality – the impact of one person’s action on the well-being of a bystander such as the case of pollution which is a negative externality. There are also positive externalities such as a park or basketball court established by the company in its area of operation or the employment it generates in the community. Market Failure – the ability of a single entity (person or group) to have a substantial influence or control on market prices. How Economy as a Whole Works (P8-P10) P8: A Country’s Standard of Living Depends on its Ability to Produce Goods and Services Standard of Living – Human Development Index (HDI) which includes per capita GDP, income distribution or income equality measured by Gini coefficient or Lopez Curve, life expectancy, functional literacy rate, unemployment rate. Standard of Living is Attributed to Productivity – the amount of goods and services produced from each unit of labor input. Growth rate of productivity determines the growth rate of its average income. Labor productivity is brought about by ensuring well-educated workforce, presence of tools needed to produce products and access to the best available technology. P9: Prices Rise When the Government Prints Too Much Money Inflation – an increase in the overall level of prices in the economy. Monetary inflation is brought about by government’s overprinting of money which in turn leads to excessive spending (demand-pull inflation). The relationship of price level and quantity of money are observed to be direct or positive. P10: Society Faces a Short-run Trade-off between Inflation and Unemployment Phillips’ Curve – short-run trade-off between inflation rate and unemployment rate; inverse or negative relationship between inflation rate and unemployment rate. This short-run trade-off plays a key role in the analysis of the business cycle – the irregular and largely unpredictable fluctuations in economic activity, as measured by the production of goods and services or the number of people employed.  UNIT 2 – MARKET FORCES A. EVOLUTION OF LAWS Market – a transaction of exchange between a group of buyers and sellers of a particular products. Market – a place or area where a group of buyers and sellers of a particular good or service trade. Market – how is the price of the good or service be determined? Labor Theory of Value – the price of the good is determined by the amount of labor spent in its production. Formulated by David Ricardo and Karl Marx (classical economists). Cost of Production Theory – the price of the good is determined by the sum/total of all the costs spent in its production plus a certain mark-up. Formulated by Alfred Marshall and Leon Walras. Utility Theory – the price of the good is determined by the additional satisfaction or additional utility derived from the good. B. DEMAND Demand – the entire relationship between price and quantity demanded as shown in a table or graph. Demand – shows various quantities of commodities buyers are willing and capable of buying given specific prices, in a specific market for a specific period of time. 2 Kinds of Demand: Potential Demand – willingness to buy or desire to buy only. Effective Demand – willingness to buy or desire to buy plus capability to buy due to the presence of purchasing power. Quantity Demanded – the specific number of commodities buyers are willing and capable of buying given specific prices, in a specific market for a specific period of time. P-pesos Qd-kilos Demand Curve (downward sloping to the right) 9 1 8 3 7 5 6 7 5 9 4 11 3 13 2 15 Law of Demand – as the price of a commodity decreases, the quantities of commodities buyers are willing and capable of buying increases and vice versa, assuming ceteris paribus. Law of Demand – price and quantity demanded have an inverse or negative relationship. Why do people buy less when prices increase? Income Effect – as the price of a commodity increases, nominal income remains the same, real income falls. Substitution Effect – as the price of a commodity increases, its relative attractiveness falls causing consumers to purchase lower-priced alternatives. Abnormal Demand: Giffen Goods (Robert Giffen) – low-priced products, the demand for which rises along with the price. These products are necessary to fulfill the need for food, and the have only a few substitutes. Potatoes, bread, wheat, and rice are examples. Veblen Goods (Thorstein Veblen) – high-quality premium goods, the demand for which increases along with its price. This is caused by the exclusive nature of these products. Examples include sports cars, expensive accessories, luxury clothing and bags. The exclusiveness of these goods shows people’s success and demonstrates their wealth. Demand Function Inverse Demand Function 𝑄𝑑 = 𝑎 − 𝑏𝑃 𝑃 = 𝑎 − 𝑏𝑄𝑑 Qd=dependent variable P=dependent variable; Qd=independent variable a=autonomous demand or Qd when price is zero/free a=autonomous price at which the buyers are not b=the decrease in Qd due to a one unit increase in P willing to buy anything P=independent variable b=the decrease in P due to a one unit increase in Qd Movement Along the DC – a change in price brings about a change in Qd and movement along the same DC. Movement – an increase in price results to an upward movement along the same DC causing a decrease in Qd. Movement – a decrease in price results to a downward movement along the same DC causing an increase in Qd. Shift in the DC – a change in one or more non-price factors of demand brings about a change in demand and shift in the demand curve. Shift in the DC – a shift to the right means an increase in demand, assuming price is constant. Shift in the DC – a shift to the left means a decrease in demand, assuming price is constant. Movement Along the DC Shift in the DC to the Right Shift in the DC to the Left NON-PRICE FACTORS OF DEMAND NON-PRICE FACTORS SHIFT TO THE RIGHT SHIFT TO THE LEFT Wealth Increase Decrease Income Increase Decrease Population Increase Decrease Price of Substitutes Increase Decrease Price of Complements Decrease Increase Consumer Tastes and Preferences Favorable Change Unfavorable Change Quality of the Good Improvement Decrease Advertising and Promotions Favorable Unfavorable Expectations of Future Prices Increase Decrease Terminologies: Normal Good – other things equal, an increase in income leads to an increase in demand. Inferior Good – other things equal, an increase in income leads to a decrease in demand. Substitutes – goods that serve as a replacement or alternative to the other. Complements – goods that go together.  C. SUPPLY Supply – the entire relationship between price and quantity supplied as shown in a table or graph. Supply – shows a various quantities of commodities sellers are willing to sell given specific prices, in a specific market for a specific period of time. Quantity Supplied – a specific amount or quantity of commodities sellers are willing to sell given a specific price, in a specific market for a definite period of time. P-pesos Qd-kilos Supply Curve (upward sloping to the right) 9 10 8 9 7 8 6 7 5 6 4 5 3 4 2 3 Law of Supply – as the price of a commodity increases, the quantity of commodities sellers are wiling to offer for sale likewise increases, and vice versa, assuming ceteris paribus. Law of Supply – price and quantity demanded have a direct or positive relationship. Supply Function Inverse Demand Function 𝑄𝑠 = 𝑎 + 𝑏𝑃 𝑃 = 𝑎 + 𝑏𝑄𝑠 Qs=dependent variable P=dependent variable; Qs=independent variable a=autonomous supply or Qs when price is zero/free a=autonomous price at which the sellers are not b=the increase in Qs due to a one unit increase in P willing to sell anything P=independent variable b=the increase in P due to a one unit increase in Qs Movement Along the SC – a change in price brings about a change in Qs movement along the same SC. Movement – an increase in price results to an upward movement along the same SC causing an increase in Qs. Movement – a decrease in price results to a downward movement along the same SC causing a decrease in Qs. Shift in the SC – a change in one or more non-price factors of supply brings about a change in supply and shift in the supply curve. Shift in the SC – a shift to the right means an increase in supply, assuming price is constant. Shift in the SC – a shift to the left means a decrease in supply, assuming price is constant. Shift in the SC to the Left Movement Along the SC Shift in the SC to the Right  NON-PRICE FACTORS OF SUPPLY NON-PRICE FACTORS SHIFT TO THE RIGHT SHIFT TO THE LEFT Price of Factors Inputs Decrease Increase Producer’s Motives Favorable Unfavorable Improvement in Technology Advancement Stagnant Taxes Decrease Increase Budget of the Firm Increase Decrease Subsidies Increase Decrease Expectations of Future Prices Decrease Increase Weather/Climate Favorable Unfavorable Available of Resources Available Not Available Numbers of Sellers Increase Decrease D. EQUILIBRIUM Equilibrium (state of rest) – the point where buyers and sellers agree on the quantity of commodities bought and sold at a particular price. Equilibrium – intersection of the DC and SC = equilibrium quantity and equilibrium price. P Qd Qs 9 1 10 8 3 9 7 5 8 6 7 7 5 9 6 4 11 5 3 13 4 2 15 3 Algebraic Computation of the Equilibrium Price and Equilibrium Quantity: Equilibrium Price Equilibrium Quantity 𝑄𝑑 = 𝑄𝑠 𝑄𝑑 = 100 − 20(2.5) 100 − 20𝑃 = 20𝑃 𝑄𝑑 = 100 − 50 100 = 20𝑃 + 20𝑃 𝑄𝑠 = 20(2.5) 100 40𝑃 𝑄𝑠 = 50 = 40 40 𝐸𝑞𝑢𝑖𝑙𝑖𝑏𝑟𝑖𝑢𝑚 𝑄𝑢𝑎𝑛𝑡𝑖𝑡𝑦 = 50 𝑝𝑐𝑠 𝐸𝑞𝑢𝑖𝑙𝑖𝑏𝑟𝑖𝑢𝑚 𝑃𝑟𝑖𝑐𝑒 = 𝑃2.50 Disequilibrium: Surplus – if the price goes higher than the equilibrium price, 𝑄𝑑 < 𝑄𝑠. Shortage – if the price goes lower than the equilibrium price, 𝑄𝑑 > 𝑄𝑠. Price Ceiling – maximum price a commodity may be sold in the market. It aims to protect consumers against unscrupulous businessmen. The ceiling price is below equilibrium market price (pro-buyer). Price Floor – minimum price a commodity may be sold in the market. Its main objective is to protect producers or sellers from abusive buyers. The floor price is above the equilibrium market price (pro-seller). Stable Equilibrium – the type of equilibrium where any deviation from equilibrium position brings into operation market forces which push as back toward equilibrium. Unstable Equilibrium – the type of equilibrium where any deviation from equilibrium position brings into operation market forces which push as further away from equilibrium. Comparative Statistics – interested only in the equilibrium values of the variables involved in the analysis. Comparative Dynamics – interested in the movement over time of the variables involved in the analysis, as one equilibrium position evolves into another. Partial Equilibrium Analysis – isolates for study specific decision-making units and markets and abstract from the interconnections that exists between them and the rest of the economy. General Equilibrium Analysis – examines the interconnections that exist among all decision-making units and markets and shows how all parts of the economy are linked together into an integrated system. E. ELASTICITY Elasticity – the responsiveness of quantity to changes in the factors affecting it, namely: the price of the good itself, income and price of related goods (which can be substitutes or complements). Elasticity of Demand – the responsiveness of Qd to changes in the factors affecting it, namely: the price of the good itself, income and prices of related goods (which can be substitutes or complements). Price Elasticity of Demand – the responsiveness of Qd when there is a change in the price of the good itself. 𝑄𝑑2 −𝑄𝑑1 𝑄𝑑1 +𝑄𝑑2 𝑃1 +𝑃2 𝑄𝑑2 −𝑄𝑑1 𝐸𝑝 = 2 𝑃2 −𝑃1 or 𝐸𝑝 = 𝑄𝑑1+𝑄𝑑2 × 2 𝑃2 −𝑃1 𝑃1 +𝑃2 2 2 Interpretation of the Results of Price Elasticity of Demand: The sign of the coefficient of Ep of demand is always negative to reflect the inverse relationship. There is a (Ep)% increase in Qd for every 1% decrease in the price of the good. There is a (Ep)% decrease in Qd for every 1% increase in the price of the good. Ep=1, then the degree of elasticity is unitary. The nature of the good is secondary. Ep1, then the degree of elasticity is relatively elastic. The nature of the good is luxury or non-essential. Factors Governing the size of the Coefficient of Price Elasticity of Demand: Number and closeness of substitutes for the commodity Number of uses of the commodity Expenditures on the commodity Adjustment time Level of price Income Elasticity of Demand – the responsiveness of Qd when there is a change in the income of the consumer. 𝑄𝑑2 −𝑄𝑑1 𝑄𝑑1 +𝑄𝑑2 𝑌1+𝑌2 𝑄𝑑2 −𝑄𝑑1 𝐸𝑦 = 2 𝑌2 −𝑌1 or 𝐸𝑦 = 𝑄𝑑1 +𝑄𝑑2 × 2 𝑌2 −𝑌1 𝑌1 +𝑌2 2 2 Interpretation of the Results of Income Elasticity of Demand: The sign of the coefficient of Ey of demand can be positive or negative. It the sign of the coefficient is positive and greater than 1, then the nature of the good is superior. It the sign of the coefficient is positive and equal or less than 1, then the nature of the good is normal. There is a (Ey)% increase in Qd for every 1% increase in the income of the consumer. There is a (Ey)% decrease in Qd for every 1% decrease in the income of the consumer. It the sign of the coefficient is negative, then the nature of the good is inferior or cheap. There is a (Ey)% increase in Qd for every 1% decrease in the income of the consumer. There is a (Ey)% decrease in Qd for every 1% increase in the income of the consumer. Engel’s Curve – the graphical illustration showing the relationship between the demand for a certain good and income of the buyer or consumer. Cross-Price Elasticity Demand – the responsiveness of Good Y when there is a change in the price of Good X. 𝑄𝑑𝑌2 −𝑄𝑑𝑌1 𝑄𝑑𝑌1 +𝑄𝑑𝑌2 𝑃𝑋1+𝑃𝑋2 𝑄𝑑𝑌2 −𝑄𝑑𝑌1 𝐸𝑥𝑦 = 2 𝑃𝑋2 −𝑃𝑋1 or 𝐸𝑥𝑦 = 𝑄𝑑𝑌1+𝑄𝑑𝑌2 × 2 𝑃𝑋2 −𝑃𝑋1 𝑃𝑋1 +𝑃𝑋2 2 2 Interpretation of the Results of Cross-Price Elasticity of Demand: The sign of the coefficient of Exy of demand can be positive or negative. If the sign of the coefficient is positive, then the nature of the good is substitutes. There is a (Exy)% increase in the demand for Good Y for every 1% increase in the price of Good X. There is a (Exy)% decrease in the demand for Good Y for every 1% decrease in the price of Good X. If the sign of the coefficient is negative, then the nature of the good is complements. There is a (Exy)% increase in the demand for Good Y for every 1% decrease in the price of Good X. There is a (Exy)% decrease in the demand for Good Y for every 1% increase in the price of Good X. Elasticity of Supply – the responsiveness of Qs to the change in the factor affecting it, namely: the price of the good itself. 𝑄𝑠2−𝑄𝑠1 𝑄𝑠1+𝑄𝑠2 𝑃1 +𝑃2 𝑄𝑠2 −𝑄𝑠1 𝐸𝑝 = 2 𝑃2−𝑃1 or 𝐸𝑝 = 𝑄𝑠1+𝑄𝑠2 × 2 𝑃2 −𝑃1 𝑃1+𝑃2 2 2 Interpretation of the Results of Price Elasticity of Demand: The sign of the coefficient of Ep of supply is always positive to reflect the direct relationship. There is a (Ep)% increase in Qs for every 1% increase in the price of the good. There is a (Ep)% decrease in Qs for every 1% decrease in the price of the good.  UNIT 3 – THEORY OF CONSUMER BEHAVIOR A. Utility Approach or Cardinal Approach Utility Approach – satisfaction derived from a good or service is measurable and is rated, and the unit of measurement is called util. Total and Marginal Utility Total Utility – the total satisfaction derived by the consumer for consuming specific units of goods. The TU increases as more units of goods are consumed until a certain point, the maximum point – known as the saturation point, after which the TU decreases. Marginal Utility – the additional or incremental satisfaction derived from consuming an additional unit of the good. The MU decreases as an additional unit of the good is consumed. At the saturation point, MU is assumed to be zero after which MU becomes negative because of storage or disposal problems. Law of Diminishing Marginal Utility – the values of the MU decreases as an additional unit of the good is consumed. In Filipino, this is aptly called “nagsasawa/nauumay” which is a very normal behavior of a consumer. That is why people look for a variety of food to eat, clothes to wear and even activities. Q TU MU ∆ 𝑖𝑛 𝑇𝑈 Shape of the TU and MU Curves ∆ 𝑖𝑛 𝑄 0 0 --- 1 10 10 2 18 8 3 24 6 4 28 4 5 30 2 6 30 0 7 28 -2 Water-Diamond Paradox Water – essential to life, the TU received from water is greater than that of the TU from diamonds. However, the price that people are willing to pay is not based on the TU of the good but depends on the MU. Diamond – people purchase so few, so the MU of the additional unit of diamond is very high, therefore, people are willing to pay a high price for the additional diamond they will have due to the good’s rarity and prestige status. Consumer Equilibrium – Equi-Marginal Principle – a rational consumer aims to attain total satisfaction from the goods he consumes when he spends his income. Equi-Marginal Principle – in order to attain this goal of consumer equilibrium, the two conditions must be fulfilled: 𝑀𝑈𝑎 𝑀𝑈𝑏 1. The marginal utilities per peso spent on all goods to be purchased are equal. = =⋯ 𝑃𝑎 𝑃𝑏 2. The purchases are equal to the budget or income to be spent by the consumer. 𝑃𝑎 𝑄𝑎 + 𝑃𝑏 𝑄𝑏 + ⋯ = Budget or Income.  B. Indifference Curve Approach or Ordinal Approach Indifference Curve Approach – derived from a good or service is not measurable. The goods can only be ranked based on the satisfaction derived from them. Indifference Curve – shows the various combinations of Good A and Good B which yield equal utility or satisfaction to the consumer. A higher indifference curve shows a greater amount of satisfaction. Characteristics of Indifference Curves: 1. Negatively Sloped 2. Convex to the Point of Origin 3. Non-Intersecting Transitivity of Preferences – fundamental principle shared by most major contemporary principle shared by most major contemporary rational, prescriptive, and descriptive models of decision making. Budget Constraint Line – shows all the different combinations of the two goods that a consumer can purchase, given the money income and the prices of the two goods. Consumer Equilibrium – Least-Cost Product Combination – the consumer is in equilibrium at the point where the budget constraint line is tangent to the indifference curve. This point of tangency, the consumer’s equilibrium, is also known as the Least-Cost Product Combination (LCPC). Income-Consumption Line and The Engel’s Curve Income-Consumption Line – by changing the consumer’s money income while keeping constant the tastes and the prices of the goods, the budget constraint line shifts parallel to the original, to the right if the money income increases and to the left if the money income decreases. The new budget lines can be tangent to different indifference curves resulting in a new LCPC. It is the line connecting the different LCPCs. Engel Curve – derived from the Income-consumption line. Each good has its own Engel curve. The Engel curve is based on the equilibrium quantity of the good given a particular budget or money income. If the Engel curve is upward sloping, then the good is a normal or superior good, otherwise, if it is downward sloping, then the good is inferior or cheap. Price-Consumption Line and the Demand Curve Price-Consumption Line – by changing the price of one of the goods while keeping the price of the other good constant and the budget or money income, a new budget line is created and therefore a new tangency point or LCPC. It should be noted that there is a change in the intercept on only one axis – the one with a change in price. The other axis remains the same because there was no change in the price of the goods. It is the line connecting the different LCPCs. Demand Curve – derived from the LCPC in relation to the good whose price has changed. Using Price and quantity demanded as the variables, the points in the demand curve are represented by the original price of the good and its LCPC value and the new price and its new LCPC value. By connecting the points, the demand curve is derived.