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Basic Concepts in Economics: Theory of Demand and Supply. Discussant : Md. Alamgir Assistant Professor, BIBM. Definition of economics. Economics, the Science of Scarcity

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slide1
Basic Concepts in Economics: Theory of Demand and Supply

Discussant :

Md. Alamgir

Assistant Professor, BIBM

definition of economics
Definition of economics
  • Economics, the Science of Scarcity
  • The science of how individuals and societies deal with the fact that wants are greater than the limited resources available to satisfy those wants.
  • The study of how individuals and societies use limited resources to satisfy unlimited wants.
fundamental economic problem
Fundamental economic problem
  • Scarcity.
  • The condition in which our wants are greater than the limited resources available to satisfy those wants.
  • Individuals and societies must choose among available alternatives.
opportunity costs
Opportunity Costs
  • The most highly valued opportunity or alternative forfeited when a choice is made.
  • Economists believe that a change in opportunity cost can change a person’s behavior.
  • The higher the opportunity cost of doing something, the less likely it will be done.
marginal benefits
Marginal Benefits
  • Is additional benefits.
  • The benefits connected to consuming an additional unit of a good or undertaking one more unit of an activity.
marginal costs
Marginal Costs
  • Is additional costs.
  • The costs connected to consuming an additional unit of a good or undertaking one more unit of an activity.
building a definition of economics goods and bads
Good - Anything from which individuals receive utility or satisfaction.

Utility - The satisfaction one receives from a good.

Bad - Anything from which individuals receive disutility or dissatisfaction.

Disutility - The dissatisfaction one receives from a bad.

Building A Definition of Economics~ Goods and Bads ~
economic goods free goods and economic bads
Economic goods, free goods, and economic bads
  • economic good (scarce good) - the quantity demanded exceeds the quantity supplied at a zero price.
  • free good - the quantity supplied exceeds the quantity demanded at a zero price.
  • economic bad - people are willing to pay to avoid the item
positive vs normative economics
Positive vs. Normative Economics
  • Positive- The study of “what is” in economic matters.

Cause Effect

  • Normative - The study of “what should be” in economic matters

Judgment and Opinion

Examples?

microeconomics
Microeconomics
  • Microeconomics deals with human behavior and choices as they relate to relatively small units—an individual, a business firm, an industry, a single market.
macroeconomics
Macroeconomics
  • Macroeconomics deals with human behavior and choices as they relate to highly aggregate markets (e.g., the goods and services market) or the entire economy.
barter vs monetary economy
Barter vs. monetary economy
  • Barter – goods are traded directly for other goods
  • Problems:
    • requires double coincidence of wants
    • high information costs
  • Monetary economy has lower transaction and information costs
relative and nominal prices
Relative and nominal prices
  • Relative price = price of a good in terms of another good
  • Nominal price = price expressed in terms of the monetary unit
  • Relative price is a more direct measure of opportunity cost
markets
Markets
  • In a market economy, the price of a good is determined by the interaction of demand and supply
demand
Demand

The willingness and ability of buyers to purchase different quantities of a good at different prices during a specific time period.

  • A relationship between price and quantity demanded in a given time period, ceteris paribus.
  • Demand Schedule:The numerical tabulation of the quantity demandedof a good at different prices.
  • A demand schedule is the numerical representation of the law of demand.
downward slopping demand curve
Downward Slopping Demand Curve
  • The graphical representation of the demand schedule and law of demand.
law of demand
Law of demand
  • An inverse relationship exists between the price of a good and the quantity demanded in a given time period, ceteris paribus.
law of demand1
As the price of a good rises, the quantity demanded of the good falls, and as the price of a good falls, the quantity demanded of the good rises,

ceteris paribus.

Law of Demand

Quantity

Price

ceteris paribus
Ceteris Paribus
  • A Latin term meaning “all other things

constant” or “nothing else changes.”

  • Ceteris paribusis an assumption used to

examine the effect of one influence on an outcome while holding all other influences constant.

change in quantity demanded vs change in demand
Change in quantity demanded vs. change in demand

Change in quantity demanded Change in demand

market demand curve
Market demand curve
  • Market demand is the horizontal summation of individual consumer demand curves
determinants of demand
Determinants of demand
  • tastes and preferences
  • prices of related goods and services
  • income
  • number of consumers
  • expectations of future prices and income
tastes and preferences
Tastes and preferences
  • Effect of fads:
prices of related goods
Prices of related goods
  • substitute goods – an increase in the price of one results in an increase in the demand for the other.
  • complementary goods – an increase in the price of one results in a decrease in the demand for the other.
income and demand normal goods
Income and demand: normal goods
  • A good is a normal good if an increase in income results in an increase in the demand for the good.
income and demand inferior goods
Income and demand: inferior goods
  • A good is an inferior good if an increase in income results in a reduction in the demand for the good.
demand and the of buyers
Demand and the # of buyers
  • An increase in the number of buyers results in an increase in demand.
expectations
Expectations
  • A higher expected future price will increase current demand.
  • A lower expected future price will decrease current demand.
  • A higher expected future income will increase the demand for all normal goods.
  • A lower expected future income will reduce the demand for all normal goods.
international effects
International effects
  • exchange rate – the rate at which one currency is exchanged for another.
  • currency appreciation – an increase in the value of a currency relative to other currencies.
  • currency depreciation – a decrease in the value of a currency relative to other currencies.
international effects continued
International effects (continued)
  • Domestic currency appreciation causes domestically produced goods and services to become more expensive in foreign countries.
  • An increase in the exchange value of the U.S. dollar results in a reduction in the demand for U.S. goods and services.
  • The demand for U.S. goods and services will rise if the U.S. dollar depreciates.
factors causing a shift in the demand curve
Factors Causing a Shift in the Demand Curve
  • Income
  • Preferences
  • Prices of substitute goods
  • Prices of complementary goods
  • Number of buyers
  • Expectations of future prices
supply
Supply
  • The relationship that exists between the price of a good and the quantity supplied in a given time period, ceteris paribus.
  • The willingness and ability of sellers to produce and offer to sell different quantities of a good at different prices during a specific time period.
law of supply
Law of Supply
  • As the price of a good rises, the quantity supplied of the good rises, and as the price of a good falls, the quantity supplied of the good falls, ceteris paribus.

Quantity

Price

supply curve
Supply Curve
  • The graphical representation of the law of

supply, which states that price and quantity

supplied are directly related, ceteris paribus.

supply schedule
Supply Schedule
  • The numerical tabulation of the quantity supplied of a good at different prices.
  • A supply schedule is the numerical representation of the law of supply.
change in quantity supplied
Change in Quantity Supplied
  • A change in quantity supplied refers to a movement along a supply curve.
  • The only factor that can directly cause a change in the quantity supplied of a good is a change in the price of the good, or own price.
law of supply1
Law of supply
  • A direct relationship exists between the price of a good and the quantity supplied in a given time period, ceteris paribus.
reason for law of supply
Reason for law of supply
  • The law of supply is the result of the law of increasing cost.
    • As the quantity of a good produced rises, the marginal opportunity cost rises.
    • Sellers will only produce and sell an additional unit of a good if the price rises above the marginal opportunity cost of producing the additional unit.
change in supply vs change in quantity supplied
Change in supply vs. change in quantity supplied

Change in supply Change in quantity supplied

individual firm and market supply curves
Individual firm and market supply curves
  • The market supply curve is the horizontal summation of the supply curves of individual firms. (This is equivalent to the relationship between individual and market demand curves.)
determinants of supply
Determinants of supply
  • the price of resources,
  • technology and productivity,
  • the expectations of producers,
  • the number of producers, and
  • the prices of related goods and services
    • note that this involves a relationship in production, not in consumption
price of resources
Price of resources
  • As the price of a resource rises, profitability declines, leading to a reduction in the quantity supplied at any price.
technological improvements
Technological improvements
  • Technological improvements (and any changes that raise the productivity of labor) lower production costs and increase profitability.
expectations and supply
Expectations and supply
  • An increase in the expected future price of a good or service results in a reduction in current supply.
prices of other goods
Prices of other goods
  • Firms produce and sell more than one commodity.
  • Firms respond to the relative profitability of the different items that they sell.
  • The supply decision for a particular good is affected not only by the good’s own price but also by the prices of other goods and services the firm may produce.
international effects1
International effects
  • Firms import raw materials (and often the final product) from foreign countries. The cost of these imports varies with the exchange rate.
  • When the exchange value of a dollar rises, the domestic price of imported inputs will fall and the domestic supply of the final commodity will increase.
  • A decline in the exchange value of the dollar raises the price of imported inputs and reduce the supply of domestic products that rely on these inputs.
factors that cause the supply curve to shift
Factors that Cause the Supply Curve to Shift
  • Prices of relevant resources
  • Technology
  • Number of sellers
  • Expectation of future prices
  • Taxes and subsidies
  • Government restrictions
surplus and shortage
Surplus and Shortage
  • Surplus (Excess Supply) - A condition in which quantity supplied is greater than quantity demanded.
  • Surpluses occur only at prices above equilibrium price.
  • Shortage (Excess Demand) - A condition in which quantity demanded is greater than quantity supplied.
  • Shortages occur only at prices below equilibrium price.
demand and supply as equations
Demand and Supply as Equations
  • Let’s now look at demand and supply as equations. Here is a demand equation: Qd = 1,500 − 32P
  • To see what this equation says, we let price (P ) in the equation equal $10 and then solve for quantity demanded Qd. We get Qd = 1,180.

Qd = 1,500 - 32(10) = 1,180

  • So this equation says that if price is $10, it follows that quantity demanded is 1,180 units.
  • We could find other quantities demanded by plugging in different dollar amounts for price (P).
demand and supply as equations cont
Demand and Supply as Equations (Cont.)
  • Now here is a supply equation: QS = 1,200 + 43P
  • To find what quantity supplied (QS) equals at a particular price, we let $5 equal price (P ) and solve for quantity supplied. We get 1,415.

QS = 1,200 + 43(5) = 1,415

  • Now suppose we want to find equilibrium price and quantity given our demand and supply equations. How would we do it?
demand and supply as equations cont1
Demand and Supply as Equations (Cont.)
  • First, we know that in equilibrium the quantity demanded (Qd ) of a good is equal to the quantity supplied (Qs ), so let’s set the two equations equal to each other this way:

1,500 -32P = 1,200 + 43P

  • Now we can solve for P. We add 32P to both sides of the equal sign and subtract 1,200 from both sides. We are left with: 75P = 300 ; It follows then that P = 300/75 or $4.00.
demand and supply as equations cont2
Demand and Supply as Equations (Cont.)
  • Once we know equilibrium price is $4.00, we can place this value in either the demand or supply equation to find the equilibrium quantity. Let’s place it in the demand equation: Qd = 1,500 - 32(4.00) = 1,372
  • Just to make sure that 1,372 is also the quantity supplied, we put the equilibrium price of $4.00 into the supply equation: QS = 1,200 43(4.00) = 1,372
  • In summary, given our demand and supply equations, equilibrium price is $4.00 and equilibrium quantity is 1,372.
consumer surplus
Consumer Surplus
  • CS = Maximum buying price - Price paid
  • CS = the difference between the maximum price a buyer is willing and able to pay for a good or service and the price actually paid.
producer surplus
Producer Surplus
  • PS = Price received - Minimum Selling Price
  • PS = the difference between the price sellers receive for a good and the minimum or lowest price for which they would have sold the good.
total surplus ts
Total Surplus (TS)

TS = CS + PS

  • Total Surplus (TS) is the sum of consumers’ surplus and producers’ surplus.
total surplus
Total Surplus

Equilibrium

utility
Utility
  • Utility = level of happiness or satisfaction associated with alternative choices
  • utility maximization
total and marginal utility
Total and marginal utility
  • total utility - the level of happiness derived from consuming the good
  • marginal utility - the additional utility that is received when an additional unit of a good is consumed
marginal utility
Marginal utility

# of slices of pizza total utility marginal utility

0 0

1 70

2 110

3 130

4 140

5 145

6 140

-

70

40

20

10

5

-5

law of diminishing mu
Law of diminishing MU
  • law of diminishing marginal utility - marginal utility declines as more of a particular good is consumed in a given time period, ceteris paribus
  • even though marginal utility declines, total utility still increases as long as marginal utility is positive. Total utility will decline only if marginal utility is negative
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