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Authored by Salman Ahmed Shaikh (Project Director: Islamic Economics Project)

Some Introductory Concepts in Economics


Concept of Scarcity
Scarcity refers to the tension between our limited resources and our unlimited wants and needs. For an
individual, resources include time, money and skill. For a country, limited resources include natural resources, capital,
labor force and technology.
Because all of our resources are limited in comparison to all of our wants and needs, individuals and nations have to
make decisions regarding what goods and services they can buy and which ones they must forgo. For example, if
you choose to buy one DVD as opposed to two video tapes, you must give up owning a second movie of inferior
technology in exchange for the higher quality of the one DVD. f course, each individual and nation will have different
values, but by having different levels of !scarce" resources, people and nations each form some of these values as a
result of the particular scarcities with which they are faced.
#carcity and unlimited wants force governments and individuals to decide how best to manage resources and
allocate them in the most efficient way possible.
Because of scarcity, people and economies must make decisions over how to allocate their resources. Economics
aims to study why we make these decisions and how we allocate our resources most efficiently.

Branches of Economics: Macro and Microeconomics
Macro and microeconomics are the two aspects from which the economy is observed.
$acroeconomics looks at the total output of a nation and the way the nation allocates its limited resources of land,
labor and capital in an attempt to maximi%e production levels and promote trade and growth for future generations.
&fter observing the society as a whole, &dam #mith noted that there was an 'invisible hand' turning the wheels of the
economy( a market force that keeps the economy functioning.
$icroeconomics looks into similar issues, but on the level of the individual people and firms within the economy. )t
studies the individual parts that make up the whole economy. &naly%ing certain aspects of human behavior,
$icroeconomics shows us how individuals and firms respond to changes in price and why they demand what they do
at particular price levels.
$icro and $acroeconomics are interrelated* as economists gain understanding of certain phenomena, they can help
nations and individuals make more informed decisions when allocating resources.
Supply & Demand
Supply and demand is one of the most fundamental concepts of economics.
Demand refers to how much (quantity) of a product or service is desired by
buyers. The quantity demanded is the amount of a product people are willing
to buy at a certain price the relationship between price and quantity
demanded is !nown as the demand relationship.
Supply represents how much the mar!et can offer. The quantity supplied
refers to the amount of a certain good producers are willing to supply when
receiving a certain price. The relationship between price and how much of a good or service is
supplied to the market is known as the supply relationship. +rice, therefore, is a reflection of supply and demand.
Authored by Salman Ahmed Shaikh (Project Director: Islamic Economics Project)
,he relationship between demand and supply underlie the forces behind the allocation of resources. Demand and
supply theory will allocate resources in the most efficient way possible. -ow. /et us take a closer look at the law of
demand and the law of supply.
The Law of Demand
The law of demand states that" if all other factors remain equal" the higher
the price of a good" the less people will demand that good. #n other words"
the higher the price" the lower the quantity demanded. The amount of a
good that buyers purchase at a higher price is less because as the price of a
good goes up" so does the cost of buying that good. $s a result" people will
naturally avoid buying a product that will force them to forgo the
consumption of something else they value more. The chart below shows that
the curve is a downward slope.
&, B and 0 are points on the demand curve. 1ach point on the curve reflects a direct correlation between quantity
demanded !2" and price !+". #o, at point &, the quantity demanded will be 23 and the price will be +3, and so on.
,he demand relationship curve illustrates the negative relationship between price and quantity demanded. ,he higher
the price of a good the lower the quantity demanded !&", and the lower the price, the more the good will be in
demand !0".
The Law of Supply
%i!e the law of demand" the law of supply demonstrates the quantities that
will be sold at a certain price. But unli!e the law of demand" the supply
relationship shows an upward slope. This means that the higher the price"
the higher the quantity supplied. &roducers supply more at a higher price
because selling a higher quantity at a higher price increases revenue.
Authored by Salman Ahmed Shaikh (Project Director: Islamic Economics Project)
$" B and ' are points on the supply curve. (ach point on the curve reflects a
direct correlation between quantity supplied ()) and price (&). $t point B"
the quantity supplied will be )* and the price will be &*" and so on.
Equilirium
+hen supply and demand are equal (i.e. when the supply curve and demand curve
intersect" the economy is said to be at equilibrium. &t this point, the allocation of goods is at its most efficient because
the amount of goods being supplied is exactly the same as the amount of goods being demanded.

,hus, everyone !individuals, firms, or countries" is satisfied with the current economic condition. &t the given price,
suppliers are selling all the goods that they have produced and consumers are getting all the goods that they are
demanding.
$s you can see on the chart" equilibrium occurs at the intersection of the
demand and supply curve" which indicates no allocative inefficiency !there is no
surplus or shortage". &t this point, the price of the goods will be +4 and the quantity will be 24. ,hese figures are
referred to as equilibrium price and quantity.
Disequilirium
Disequilibrium occurs whenever the price or quantity is not equal to +4 or 24.
Authored by Salman Ahmed Shaikh (Project Director: Islamic Economics Project)
,. (-cess Supply
)f the price is set too high, excess supply will be created within the economy and there will be allocative inefficiency.
$t price &, the quantity of goods that the producers wish to supply is
indicated by )*. $t &," however" the quantity that the consumers want to
consume is at )," a quantity much less than )*. Because )* is greater than
)," too much is being produced and too little is being consumed. The
suppliers are trying to produce more goods" which they hope to sell to
increase profits" but those consuming the goods will find the product less
attractive and purchase less because the price is too high.
*. (-cess Demand
1xcess demand is created when price is set below the equilibrium price. Because the price is so low, too many
consumers want the good while producers are not making enough of it.
#n this situation" at price &," the quantity of goods demanded by consumers
at this price is )*. 'onversely" the quantity of goods that producers are
Authored by Salman Ahmed Shaikh (Project Director: Islamic Economics Project)
willing to produce at this price is ),. Thus" there are too few goods being
produced to satisfy the wants (demand) of the consumers. .owever" as
consumers have to compete with one other to buy the good at this price" the
demand will push the price up" ma!ing suppliers want to supply more and
bringing the price closer to its equilibrium.
Shift in demand !s" Mo!ement #lon$ Demand Cur!e
#n 1conomics, the 5movements6 and 5shifts6 in relation to the supply and demand curves represent very different
market phenomena(
,. Movements along Demand 'urve
$ movement refers to a change along a curve. /n the demand curve" a
movement denotes a change in both price and quantity demanded from one
point to another on the curve. ,he movement implies that the demand relationship remains consistent. ,herefore,
a movement along the demand curve will occur when the price of the good changes and the quantity demanded
changes in accordance to the original demand relationship. )n other words, a movement occurs when a change in the
quantity demanded is caused only by a change in price.
%i!e a movement along the demand curve" a movement along the supply
curve means that the supply relationship remains consistent. Therefore" a
movement along the supply curve will occur when the price of the good
changes and the quantity supplied changes in accordance to the original
supply relationship. #n other words" a movement occurs when a change in
quantity supplied is caused only by a change in price, and vice versa.
Authored by Salman Ahmed Shaikh (Project Director: Islamic Economics Project)
*. Shift in Demand
& shift in a demand or supply curve occurs when a good7s quantity demanded or supplied changes even though price
remains the same. For instance, if the price for a 89: ml bottle of +epsi was ;s 39 and price for a 89: ml bottle
of 0oca 0ola !substitute of +epsi" increased to ;s 8: from ;s 39, then quantity of +epsi demanded would increase
from 23 to 28. ,here would be a shift in the demand for +epsi if there is change in other factors than price !like
income of the consumer, price of substitute etc". #hifts in the demand curve imply that the original demand
relationship has changed, meaning that quantity demand is affected by a factor other than price.
0. #hift in #upply
#f the price for a *12 ml bottle of &epsi was 3s ,1 and if the price of sugar
(raw material used for soft drin!) increases" then the quantity supplied
would decrease from ), to )*. There would be a shift in the supply of &epsi.
%i!e a shift in the demand curve" a shift in the supply curve implies that the
original supply curve has changed" meaning that the quantity supplied is
caused by a factor other than price. $ shift in the supply curve would occur
if" for instance" crop failure caused the sugar price to increase (which is a
raw material for a soft drin!) and hence it will increase the cost of the soft
drin! produced. #f price remains constant" the supplier will be willing to
supply less of the soft drin! due to decreased profit margins with increase in
cost of production.
Authored by Salman Ahmed Shaikh (Project Director: Islamic Economics Project)
Elasticity
The degree to which a quantity demanded or supply reacts to a change in price is the elasticity. 1lasticity
varies among products because some products may be more essential to the consumer. +roducts that are
necessities are more insensitive !less responsive" to price changes because consumers would continue buying these
products despite price increases.

'onversely" a price increase of a good or service that is considered less of a
necessity will have responsive change in quantity demanded because the
consumers could switch to cheap alternatives (substitutes).
$ good or service is considered to be highly elastic if a slight change in price
leads to a sharp change in the quantity demanded. 4sually these !inds of
products are readily available in the mar!et and a person may not
necessarily need them in his or her daily life.
/n the other hand" an inelastic good or service is one in which changes in
price bring about slight changes in the quantity demanded. These goods
tend to be things that are more of a necessity to the consumer in his or her
daily life. (.g. food items" clothing" shelter etc.
To determine the &rice elasticity of the demand" we can use this simple
equation5
Elasticity % &' chan$e in quantity demanded( ' chan$e in price)
#f elasticity is greater than or equal to one" the curve is considered to be
elastic. #f it is less than one" the curve is said to be inelastic.
The demand curve has a negative slope" and if there is a large decrease in
the quantity demanded with a small increase in price" the demand curve
Authored by Salman Ahmed Shaikh (Project Director: Islamic Economics Project)
loo!s flatter" or more hori6ontal. This flatter curve means that the good or
service in question is elastic.
Meanwhile" inelastic demand is represented with a much more upright !vertical
like" curve as quantity changes little with a large movement in price.
#" *actors #ffectin$ Demand Elasticity
There are three main factors that influence a demand7s price elasticity5
+" The a!ailaility of sustitutes , #n general" the more the substitutes"
the more elastic the demand will be. 8or e-ample" if the price of a cup of
coffee went up by 3s 1" consumers could replace their morning coffee with a
cup of tea. This means that coffee is an elastic good because a raise in price
will cause a large decrease in demand as consumers start buying more tea
instead of coffee.
But" if the price of a 3oti" &ublic transport for a lower income class person"
price of electricity" gas etc goes up" the change in quantity demanded will
not be much. #t shows that necessities have inelastic demand.
-" #mount of income a!ailale to spend on the $ood , This factor
affecting demand elasticity refers to the total a person spends on a particular
Authored by Salman Ahmed Shaikh (Project Director: Islamic Economics Project)
good or service. Thus" if the price of a lemon sandwich biscuit goes up from
3s ,* to 3s ,0 and if the income of the consumer is sufficiently high" the
consumer will not be forced to reduce his or her demand of lemon sandwich
biscuits. But" for other e-pensive goods" the demand could be elastic. 8or
e-ample" branded suits" airline travel etc.
." Time , The third influential factor is time. #f the price of cigarettes goes
up 3s 1 per pac!" a smo!er with very few available substitutes will most
li!ely continue buying his or her daily cigarettes. This means that tobacco is
inelastic because the change in price will not have a significant influence on
the quantity demanded. .owever" if that smo!er finds that he or she cannot
afford to spend the e-pensive cigarettes every day and begins to change the
habit over a period of time" the price elasticity of cigarettes for that
consumer becomes elastic in the long run.
B" Income Elasticity of Demand
#f price increases while income stays the same" demand will decrease. But" if
there is an increase in income" demand tends to increase as well. The
degree to which an increase in income will cause an increase in demand is
called income elasticity of demand" which can be e-pressed in the following
equation5
Income Elasticity % &' chan$e in quantity demanded( ' chan$e in income)
#f #ncome elasticity is greater than one" demand for the item is considered to
have high income elasticity. #f income elasticity is less than one" demand is
considered to be income inelastic. %u-ury items usually have higher income
elasticity because when people have a higher income" they become able to
afford them and hence their demand for those items increase.
+ith some goods and services" we may actually notice a decrease in demand
as income increases. These are considered goods and services of inferior
quality that will be dropped by a consumer who receives a salary increase.
$n e-ample may be the increase in the demand of branded clothing as
opposed to low quality clothing. &roducts for which the demand decreases as
income increases have an income elasticity of less than 6ero.
/tility
+e have already seen that the focus of economics is to understand the
problem of scarcity5 the problem of fulfilling the unlimited wants of
human!ind with limited or scarce resources. Because of scarcity" economies
Authored by Salman Ahmed Shaikh (Project Director: Islamic Economics Project)
need to allocate their resources efficiently. /tility represents the
ad!anta$e or fulfillment a person recei!es from consumin$ a $ood or
ser!ice"
/tility analysis, then, explains how individuals and economies aim to gain optimal satisfaction in dealing
with scarcity.
4tility is an abstract concept rather than a concrete" observable quantity.
The units to which we assign an 9amount: of utility" therefore" are arbitrary"
representing a relative value (no units). Total utility is the aggregate sum of
satisfaction or benefit that an individual gains from consuming a given
amount of goods or services in an economy. The amount of a person7s total
utility corresponds to the person7s level of consumption. 4sually" the more
the person consumes" the larger his or her total utility will be. Marginal
utility is the additional satisfaction" or amount of utility" gained from each
e-tra unit of consumption.
#lthou$h total utility usually increases as more of a $ood is
consumed0 mar$inal utility usually decreases with each additional
increase in the consumption of a $ood" This decrease demonstrates
the law of diminishin$ mar$inal utility" Because there is a certain limit
of satisfaction" the consumer will no longer receive the same pleasure from
consumption once that limit is crossed. #n other words" total utility will
increase at a slower pace as an individual increases the quantity consumed.
Ta1e0 for e2ample0 a chocolate ar" Let3s say that after eatin$ one
chocolate ar your sweet tooth has een satisfied" 4our mar$inal
utility &and total utility) after eatin$ one chocolate ar will e quite
hi$h" But if you eat more chocolate ars0 the pleasure of each
additional chocolate ar will e less than the pleasure you recei!ed
from eatin$ the one efore , proaly ecause you are startin$ to
feel full or you ha!e had too many sweets for one day"
This tale shows that total utility will increase at a much slower rate
as mar$inal utility diminishes with each additional ar" ;otice how the
Authored by Salman Ahmed Shaikh (Project Director: Islamic Economics Project)
first chocolate bar gives a total utility of <2 but the ne-t three chocolate bars
together increase total utility by only ,= additional units.
The law of diminishin$ mar$inal utility helps economists understand
the law of demand and the ne$ati!e slopin$ demand cur!e" The less
of somethin$ you ha!e0 the more satisfaction you $ain from each
additional unit you consume5 the mar$inal utility you $ain from that
product is therefore hi$her0 $i!in$ you a hi$her willin$ness to pay
more for it" 6rices are lower at a hi$her quantity demanded
ecause your additional satisfaction diminishes as you demand
more"