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Applied-Economics 2 - Lecture notes 2
Accountancy (FMAN2)
St. Paul University Quezon City
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MICROECONOMICS
Lesson 1: Basic Economic Concepts
Why Study Economics?
Economics is an integral part of our everyday life and it affects our daily life. Understanding economics, human beings become better informed and better equipped to analyze the human behavior. Economics allows us to intelligently and confidently debate on government policies and consequences.
What is Economics?
A social science concerned with using scarce resources to obtain maximum satisfaction of the unlimited material wants of society (Walstad and Bingham). The study of how societies use scarce resources to produce valuable commodities and distribute them among different people (Samuelson and Nordhaus). A social science concerned with using scarce resources to obtain the maximum satisfaction of the unlimited material wants of society (McConnell and Brue). The study of how people use their limited resources to try to satisfy unlimited wants (Parkin and Bade).
Economics and Scarcity
Economics is a social science that studies the allocation of scarce resources to satisfy unlimited human wants. Economics came from the Greek word oikonomia, which means “ household management .” Allocation means making decisions about choices. Scarcity refers to a condition wherein most things that people want are available only in limited supply.
Why Economics is a Science?
Neville Keynes defines it as “a body of knowledge concerning what is.” It enables to explain different situations, experiences and occurrences. It examines the activities of consumers, producers, and the governments how the resources are allocated. It applies a framework or a way of thinking to interpret, understand and make conclusions about certain facts, figures and phenomena. Economics is a social science because it deals with human behavior through its theory of how people make choices. It seeks to explain the “why” of things in the world of economic behavior – production, consumption, and distribution.
The Economic Resources
Land – one of the factors of production that include land and natural resources. Labor – basic factor of production which are productive services embodied in human physical effort, skill, intellectual powers, and others. Capital - refers to durable goods to produce another goods. (buildings, plant and machinery, roads, computers, ships and many more) Entrepreneurial ability - is the ability to use the three factors of production to produce the required goods and services. The brains behind the business Note: There is no such thing as a noneconomic resource. Everything is economical (including air)
Economic Models
A main tool used by economists to explain economic phenomena. They use economic variables to explain relationships.
ŷ = a + bx + e
Where ŷ = is the predicted value (dependent variable) a = y - axis intercept (constant value) b = slope of the regression x = activity (independent variable) e = error term Models are simplifications of reality. The ultimate test of the validity of an economic model is not how close it can depict reality but how accurate it can predict real-world events. Best Example: Law of Supply and Demand
Common Phrases
Ceteris paribus assumption (other things being equal/constant).
The assertion that economic agents are optimizers (they want to make the most of everything).
The distinction between normative and positive economics. Positive economics – explanation of economic phenomena Normative economics – the application of positive economics to create policy
Economic Goals
- Economic growth – high standard of living translated which is translated into the production of more and better quality of goods and services.
- Full employment – there must be an available job for individuals who are willing and able to work
- Economic efficiency – makes use of the resources to maximize the benefit for the society.
- Price level stability – it able to avoid huge price fluctuation.
- Economic freedom – freedom to do any economic activity; engaging into the exchange of goods.
- An equitable distribution of income
- Economic security
- Balance of trade
Types of Economic Systems
Capitalism.
An economic system mainly characterized by private individuals owning and operating the majority of businesses that produce goods and services. Pure Capitalism - no government intervention - competition determine the good and services needed by the society - survival of the fittest Modified capitalism - has government intervention - regulates business to certain extent
Rights of capitalism
Private property Profits Business decisions Choice
Communism.
A society in which the government owns all the nation’s resources. The exact opposite of capitalism.
Socialism.
The government owns and operates the basic industries. (transportation, communications, water service, banking and other selected manufacturing business) It is the government will decide what goods and services to produce, how to produce and how they are distributed. A good example on what this does is an election.
Mixed
It has elements of more than one economic system. The economic problems are answered predominantly by the price mechanism and modified through government intervention.
Classification of Economics
Microeconomics
Is the study of how individual consumers and firms behave, and how the market system allocates scarce resources. It does not concern itself to the temporary fluctuations in the economy. Also known as Price Theory
Macroeconomics
Studies the economy as a whole. Seeks to explain why fluctuations happen and then investigate policies that can mitigate them. Studies four essential phenomena of the economy. All of which rely on the interactions of the goods, labor, and assets markets of the economy. o unemployment – people capable of work but no job o inflation – increase of value of monies o poverty – what the poor people are suffering o growth – of the entire economy GDP (Gross Domestic Product) – made in country Example: Mcdo sa Pinas GNP (Gross National Product) – made by country Example: Jollibee sa USA
Lesson 2: Principles of Economics
10 Principles of Economics (Expounded)
How People Make Decisions
People face trade-offs “There is no thing such as a free lunch.” To get one thing that we like, we usually have to give up another thing that we like. Making decisions requires trading one goal for another. Examples include how students spend their time, how a family decides to spend its income, how the government spends revenue, and how regulations may protect the environment at a cost to firm owners. A special example of a trade-off is the trade-off between efficiency and equality. Efficiency - the property of society getting the maximum benefits from its scarce resources. Equality - the property of distributing economic prosperity fairly among the members of society. Recognizing that trade-offs exist does not indicate what decisions should or will be made. Significance of opportunity cost in decision making Because people face trade off, making decisions requires comparing the costs and benefits of alternative courses of action. Opportunity Cost : whatever must be given up in order to obtain some item. or last best alternative forgone When making any decision, decision makers should consider the opportunity costs of each possible. Rational People Think at the Margin Economists generally assume that people are rational. Rational: systematically and purposefully doing the best you can to achieve your objectives. Consumers want to purchase the bundle of goods and services that allow them the greatest level of satisfaction given their incomes and the prices they face. Firms want to produce the level of output that maximizes the profits. Rational people often make decisions by comparing marginal benefits and marginal costs. If the additional satisfaction obtained by an addition in the units of a commodity is equal to the price a consumer is willing to pay for that commodity, he achieves maximum satisfaction, which is the main goal of every rational consumer. People respond to incentives Incentive is something that induces a person to act [by offering rewards to people who change their behavior]. Because rational people make decisions by comparing costs and benefits, they respond to incentives. Incentives may possess a negative or a positive intention. It may be in a positive or a negative way.
How People Interact With Each Other
Trade can make everyone better off Trade is not like a sports competition, where one side gains and the other side loses. Countries benefit from trading with one another as well. Trade allows for specialization in products that benefits countries (or families) Markets are usually a good way to organize economic activity Many countries that once had centrally planned economies have abandoned this system and are trying to develop market economies Market Economy : an economy that allocates resources through the decentralized decisions of many firms and households as they interact in markets for goods and services. Market prices reflect both the value of a product to consumers and the cost of the resources used to produce it. Centrally planned economies have failed because they did not allow the market to work. Laissez-Faire - Adam Smith’s 1776 work suggested that although individuals are motivated by self- interest, an invisible hand guides this self-interest into promoting society’s economic well-being. Government can sometimes improve market outcomes There are two broad reasons for the government to interfere with the economy: the promotion of efficiency and equality. Government policy can be most useful when there is market failure.
Market Failure: a situation in which a market left on its own fails to allocate resources efficiently. - Examples of Market Failure Externality: the impact of one person’s actions on the well-being of a bystander. (Ex.: Pollution) Market Power: the ability of a single economic actor (or small group of actors) to have a substantial influence on market prices. Because a market economy rewards people for their ability to produce things that other people are willing
to pay for, there will be an unequal distribution of economic prosperity. Note that the principle states that the government can improve market outcomes. This is not saying that the government always does improve market outcomes.
The Forces and Trends That Affect How the Economy
as a Whole Works
A Country's Standard Of Living Depends On Its Ability To Produce Goods And Services Differences in the standard of living from one country to another are quite large. Changes in living standards over time are also quite large. The explanation for differences in living standards lies in differences in productivity. P roductivity: the quantity of goods and services produced from each hour of a worker’s time. Prices rise when the government prints too much money Inflation : sustained increase in the overall level of prices in the economy. When the government creates a large amount of money, the value of money falls. Society faces a short-run tradeoff between inflation and unemployment (Phillip’s Curve) Most economists believe that the short-run effect of a monetary injection (injecting/adding money into the economy) is lower unemployment and higher prices. An increase in the amount of money in the economy stimulates spending and increases the demand of goods and services in the economy. Higher demand may over time cause firms to raise their prices but in the meantime, it also encourages them to increase the quantity of goods and services they produce and to hire more workers to produce those goods and services. More hiring means lower unemployment. Some economists question whether this relationship still exists. The short-run trade-off between inflation and unemployment plays a key role in analysis of the business cycle. Business cycle : fluctuations in economic activity, such as employment and production. Policymakers can exploit this trade-off by using various policy instruments, but the extent and desirability of these interventions is a subject of continuing debate.
10 Principles of Economics (Summary)
DECISIONS
- Trade – offs - When individuals make decisions, they face tradeoffs among alternative goals.
- Opportunity Cost - The cost of any action is measured in terms of foregone opportunities.
- Rationality - Rational people make decisions by comparing marginal costs and marginal benefits.
- Incentives - People change their behavior in response to the incentives they face.
INTERACTIONS
- Benefits - Trade can be mutually beneficial.
- Laissez – Faire - Markets are usually a good way of coordinating trade among people.
- Government - can potentially improve market outcomes if there is some market failure or if the market outcome is inequitable.
WHOLE
- National Economy - Productivity is the ultimate source of living standards.
- Inflation - Money growth is its ultimate source
- Philip’s Curve - Society faces a short-run tradeoff between inflation and unemployment.
Production Possibility Frontier - PPF
It is sometimes called a production-possibility curve or product transformation curve , it is a graph showing the production of goods and/or services that an economy can produce during a specified period of time with the consideration of the existing technology. A PPF shows all possible combinations of two goods that can be produced simultaneously during a given period of time, Diminishing marginal returns. States that in all productive processes, adding more of one factor of production, while
Consumers buy more goods and services as income increase Demand for the goods and services decline as income decreases The direction in which the demand will shift in response to a change in income depends on the type of goods. a. Normal good – quantity demand increases as income increases b. Inferior good – quantity demand decreases as income increases 3. Consumer’s expectation of future prices – consumers tend to buy more if the price expectation in the future will increase and buy less if the price of goods will decrease 4. Prices of related commodities/goods Substitute goods Complementary goods 5. Consumer’s taste and preference 6. Population
Law of Demand
Reasons for an inverse or negative of price-quantity relationship 1. Price is an obstacle to consumptions 2. Purchasing power or budget of the consumer 3. Successive unit of good consumed yields less satisfaction at any certain period of time. Holding all other things constant, the quantity demanded for a commodity or service is negatively or inversely related to its own price. price of a good goes up the quantity demanded goes down price of a good goes down the quantity demanded goes up
Justification for the Law of Demand
- Income effect. When the price of the goods decreases, the consumers can buy more.
- Substitute effect. It is expected that the consumers will buy goods with lesser price. Consumers tend to look for a substitute within their capacity to pay
Supply
The maximum units/quantity of goods/services producers can offer. The quantity supplied refers to the amount or quantity of goods and services producers are willing and able to supply at a given price, at a given period of time.
Determinants of Supply
- Change in Technology – increases the supply of goods at a reduced cost of production
- Cost of inputs used – the lower the price of the inputs, the more the goods and services supplied.
- Expectation of future price - supply for goods increases if producers expect prices to increase and vice versa.
- Change in the price of related goods -
- Government regulation and taxes – the higher the tax on the goods and services the lower the supply of such goods and service.
- Government subsidies – encourages supplier to produce more due to subsidies
- Number of firms in the market
Law of Supply
The law of supply states that as price increases, quantity supplied also increases; and As price decreases, quantity supplied also decreases. The relationship of the price and quantity supply is directly proportional.
Validity of Supply
The law of supply is correct only if the assumption of ceteris paribus is applied.
Ways to Represent Them
Tabular Form
Price Quantit y Demand
Deman d Point
Price Quantit y Supply
Supply Points
0 12 (0,12) 0 2 (0,2)
2 10 (2,10) 2 4 (2,4)
4 8 (4,8) 4 6 (4,6)
5 7 (5,7) 5 7 (5,7)
6 6 (6,6) 6 8 (6,8)
8 4 (8,4) 8 10 (8,10)
10 2 (10,2) 10 12 (10,12)
12 0 (12,0) 12 14 (12,14)
Graphical Form
Changes Involving the Graph Change in quantity demanded/supplied – movement along the curve. - The points going down (demand) & up (supply) Change in Demand/Supply – a shift from one demand/supply curve to another as brought by the changes in the determinants of demand/supply except for price - Increase: line shifts to the right w/o rotation - Decrease: line shifts to the left w/o rotation
Equational Form
Demand Function Supply Function
Qd = a - bP Qs = c +
dP
Qd = quantity demanded Qs = quantity demanded a = the intercept of the equation or the quantity demanded at price 0
c = the intercept of the equation or the quantity demanded at price 0 b = slope of the function d = slope of the function P = price P = price Example: Find the slopes of The two lines from first 2 point b = b = b = -
b = b = b = - Example: From the graph abov e, find the equilibrium Qd = a – bP Qd = 12 - P
Qs = c + dP Qs = 2 + P Qd = Qs 12 – P = 2 + P 10 = 2P P = 5
Qd = 12 – P; P = 5 Qd = 12 – 5 Qd = 7 Qs = 7 Example: Find the quantities When P = 8 Qd = 12 – P; P = 8 Qd = 12 – 8 Qd = 4
Qs = 2 + P; P = 8 Qs = 2 + 8 Qs = 10
Republic Act 7581: Price Act
Price Floor - Minimum price of a product - Protects the producers - Shortage – the result of price floor (too much demand) Price Ceiling - Maximum price of a product - Protects the consumers - Surplus – the result of price ceiling (too much supply)
Lesson 4: Elasticity
The responsiveness (or sensitivity) of consumers and producers to price and income changes.
Demand Elasticity
Elasticity Value Equation Perfectly Elastic Infinity Δy will have an infinite effect on Δx Elastic > 1 Δx > Δy Unit Elastic = 1 Δx = Δy Inelastic < 1 Δx < Δy Perfectly Inelastic = 0 Δy will have no effect on Δx
PRICE
QUANTITY
Surplus
Price Ceiling
Market Equilibrium
Price Floor
Shortage
Price Elasticity of Demand
It tells us the degree of responsiveness of consumers to a price change of the commodity.
Where P 1 and QD1 represents the original price and quantity and P 2 and QD2 represents the new price and quantity Points Price Quantity Demanded A 4 700 B 5 475 C 9 430 D 12 400 E 15 393 F 20 344 G 26 310 H 30 300 I 39 150 Determinants of Price Elasticity of Demand
- The importance or degree of necessity of the goods or services. Inelastic - Essential Elastic - Not so essential
- Number of available substitutes for goods and services Inelastic Less or no substitutes Elastic Huge number of substitutes
- Proportion of income in price changes Inelastic Change in price of product that has no effect on income or budget Elastic With effect on income or budget
- Time period. The longer the time period, the more elastic or inelastic the demand will be. Consumers have the time to adjust.
Cross Price Elasticity of Demand
It is the degree of responsiveness of consumers to a price change of another commodity.
If EXY is positive, goods X and Y are substitute goods, i., sales of good X move in the same direction as the change in the price of good Y. When EXY is negative, the two goods are complementary goods, i., an increase in the price of good Y decreases the demand for good X. A near zero or zero coefficient of EXY would tell us that goods X and Y are unrelated or independent goods, i., an increase in the price of good Y will have no effect on the demand for good X**. Commodit y**
Before After Price Quantity Price Quantity X 1000 90 1000 100 Y 900 45 950 80
Income Elasticity of Demand
The degree to which buyers respond to a change, in their incomes.
EI is positive when the good is a normal good such that more of the good is demanded when income increases- and -vice versa. A negative income elasticity of demand suggests that the good is an inferior good, i., demand for the good decreases as income increases. Second-hand clothes maybe considered as inferior goods while newly-made shoes may be considered as normal goods. Types of Goods Income Elasticity Normal goods Positive elasticity > 0 Inferior goods Negative elasticity < 0 Normal, luxury goods Positive elasticity > 1 Normal, necessity good Positive elasticity < 1 Income Qd 400 20 500 35 600 43 700 47 800 50 900 48 1000 47
Supply Elasticity
Elasticity Value Inelastic > 1 Unit Elastic = 1 Elastic < 1
Price Elasticity of Supply
It indicates the responsiveness of producers’ supply following a change in the price of the product
Where P 1 and QS1 represents the original price and quantity supplied and P 2 and QS2 represents the new price and quantity supplied The price elasticity of supply is always positive since the price and quantity supplied are positively related.
Applied-Economics 2 - Lecture notes 2
Course: Accountancy (FMAN2)
University: St. Paul University Quezon City
