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Principles of Economics

Session 1

Topics To Be Covered
Introduction
Definition of Economics
Market Definition
Demand Schedule, Curve, and Functions
Supply Schedule, Curve, and Functions

Topics To Be Covered
Change in Quantity Demanded versus
Change in Demand
Change in Quantity Supplied versus
Change in Supply
Equilibrium of Supply and Demand
Price Ceiling
Price Floor

Objectives
Objectives of bilingual education
To learn

useful and practical knowledge of


economics.
To improve English proficiency

Advantages of Samuelson and Nordhaus


Economics

Arrangement
Revision of the previous session
Weekly quiz
Students presentation on the
knowledge learned in the previous
session
New contents
Summary
Assignment

Requirements
Attendance
Participation
Curiosity and Practice

Grading
Attendance (20%)
Class performance (10%)
Quiz (20%
Final Examination (50%)

Definition of Economics
Economics is the study of how societies
choose to use scarce productive
resources that have alternative uses, to
produce commodities of various kinds,
and to distribute them among different
groups.

Scarcity vs. Efficiency


Economic goods are scarce or limited in supply.
Free goods like air exist in such large
quantities. Thus, their market price is zero.
Scarcity means that an economic good is not
freely available for the taking.
Efficiency refers to the use of economic
resources to maximize satisfaction with the
given inputs and technology.

Microeconomics vs.
Macroeconomics
Microeconomics is the study of how
individual households and firms make
decisions and how they interact with one
another in markets.
Macroeconomics is the study of the
economy as a whole with respect to
output, price level, employment, and
other aggregate economic variables.

Adam Smith & John


Maynard Keynes
Smith authored The Wealth of Nations in
1776.
Founder

of modern economics.
Research into pricing of land, labor, and
capital.
Invisible hand.

Keynes authored General Theory of


Employment, Interest and Money in 1936.

What, How, and For Whom


What is the problem of decision to produce
possible goods or services.
How is the choice of the particular technique
by which each good of the what shall be
produced.
For whom refers to the distribution of
consumption goods among the members of
that society.

Normative vs. Positive


Economics
Normative economics considers
what ought to bevalue
judgments, or goals, of public policy.
Positive economics, by contrast, is
the analysis of facts and behavior in
an economy, or the way things are.

Market Definition
A market is an arrangement
whereby buyers and sellers
interact to determine the prices
and quantities of a commodity.

Demand and Supply Cycle


Supply
Goods &
Services
sold

Market for
Goods
and Services

Firms

Deman
d
Goods &
Services
bought

Households

Inputs for
production
Deman
d

Market for
Factors
of Production

Labor, land,
and capital
Supply

Demand
Quantity demanded
is the amount
of a good that buyers are
willing and able
to purchase.

The Law of Diminishing Demand


The law of demand states
that there is an inverse
relationship between price
and quantity demanded.

Demand Schedule
Price
$0.00
0.50
1.00
1.50
2.00
2.50
3.00

Quantity
12
10
8
6
4
2
0

Demand Curve
P
$3.0
0
2.5
0
2.0
0
1.5
0
1.0
0
0.5
0

Qd=12 4P

0 1

2 3 4 5 6 7 8 9 1
0

Price
$0.00
0.50
1.00
1.50
2.00
2.50
3.00

1
1

1
2

Quantity
12
10
8
6
4
2
0

Qd

Determinants of Demand
Market price (P)
Consumer income (M)
Prices of related goods (Pr)
Tastes (T)
Expectations (Pe)
Number of consumers (N)

Demand Functions
Qd = f (P, M, Pr, T, Pe, N)
Qd = a + bP + cM + dPr+ eT
+ fPe + gN
Qd = f (P, M, Pr, T, Pe, N)
Qd = f (P)
Qd = a + bP

Ceteris Paribus
Ceteris paribus is a Latin phrase that
means all variables other than the
ones being studied are assumed to be
constant. Literally, ceteris paribus
means other things being equal.
The demand curve slopes downward
because, ceteris paribus, lower prices
imply a greater quantity demanded!

Market Demand
Market demand refers to the sum of
all individual demands for a
particular good or service.
Graphically, individual demand
curves are summed horizontally to
obtain the market demand curve.

Change in Quantity Demanded


versus Change in Demand
Change in Quantity Demanded
Movement along the demand curve.
Caused by a change in the price of
the product.

Changes in Quantity Demanded


P

$4.0
0

2.00

D1
0

12

20

Qd

Change in Quantity Demanded


versus Change in Demand
Change in Demand
A shift in the demand curve, either
to the left or right.
Caused by a change in a
determinant other than the price.

Changes in Demand

Increase in
demand

2.00

Decrease in
demand

D2
0

D3

20

D1
30

Qd

Consumer Income
As income increases the demand
for a normal good will increase.
As income increases the demand
for an inferior good will decrease.

Consumer Income
Pric
e

$3.0
0
2.5
0
2.0
0
1.5
0
1.0
0
0.5
0

Normal Good
An
increase
in
income...

Increase
in demand

D1
0 1

2 3 4 5 6 7 8 9 1
0

1
1

1
2

D2
Quantity

Consumer Income
Inferior Good

Price

$3.0
0
2.5
0
2.0
0
1.5
0
1.0
0
0.5
0

An
increase
in
income...

Decrease
in demand

D2
0 1

2 3 4 5 6 7 8 9 1
0

D1
1
1

1
2

Quantity

Prices of Related Goods


When a fall in the price of one good
reduces the demand for another good,
the two goods are called substitutes.
When a fall in the price of one good
increases the demand for another
good, the two goods are called
complements.

Change in Quantity Demanded


versus Change in Demand
Variables that
Affect Quantity
Demanded

A Change in
This Variable . . .

Price

Represents a movement
along the demand curve

Income

Shifts the demand curve

Prices of related Shifts the demand curve


goods
Tastes

Shifts the demand curve

Expectations

Shifts the demand curve

Number of
buyers

Shifts the demand curve

Supply
Quantity supplied
is the amount of a good
that sellers are
willing and able
to sell.

Law of Supply

The law of supply states that


there is a direct (positive)
relationship between price
and quantity supplied.

Supply Schedule
Price
$0.00
0.50
1.00
1.50
2.00
2.50
3.00

Quantity
0
0
1
2
3
4
5

Supply Curve
Qs = - 1 + 2P

$3.0
0
2.5
0
2.0
0
1.5
0
1.0
0
0.5
0

Price
$0.00
0.50
1.00
1.50
2.00
2.50
3.00
0

1 2 3 4 5 6 7 8 9 1
0

Quantity
0
0
1
2
3
4
5
1
1

1
2

Qs

Determinants of Supply
Market price (P)
Input prices (PI)
Related goods prices (Pr)
Technology (T)
Expectations (Pe)
Number of firms (F)

Supply Functions
Qs = g (P, PI, Pr, T, Pe, F)
Qs = h + kP + l PI + mPr+ nT
+ rPe + sF
Qs = g (P, PI, Pr, T, Pe, F)
Qs = g (P)
Qs = h + kP

Market Supply
Market supply refers to the sum of
all individual supplies for all sellers
of a particular good or service.
Graphically, individual supply
curves are summed horizontally to
obtain the market supply curve.

Change in Quantity Supplied


versus Change in Supply
Change in Quantity Supplied
Movement along the supply curve.
Caused by a change in the market price
of the product.

Change in Quantity Supplied


P

S
C

$3.0
0

1.00

A rise in the price


results in a
movement along
the supply curve.

Qs

Change in Quantity Supplied


versus Change in Supply
Change in Supply
A shift in the supply curve, either to the
left or right.
Caused by a change in a determinant
other than price.

Change in Supply
S3

S1

S2

Decrease
in Supply
Increase
in Supply

Qs

Change in Quantity Supplied


versus Change in Supply
Variables that
Affect Quantity Supplied

A Change in This Variable . . .

Price

Represents a movement along


the supply curve

Input prices

Shifts the supply curve

Technology

Shifts the supply curve

Expectations

Shifts the supply curve

Number of sellers

Shifts the supply curve

Supply and Demand Together


Equilibrium Price
The price that balances supply and
demand. On a graph, it is the price at
which the supply and demand curves
intersect.

Equilibrium Quantity
The quantity that balances supply and
demand. On a graph it is the quantity at
which the supply and demand curves
intersect.

Supply and Demand Together


Demand
Schedule

Price
$0.00
0.50
1.00
1.50
2.00
2.50
3.00

Quantity
19
16
13
10
7
4
1

Supply
Schedule

Price
$0.00
0.50
1.00
1.50
2.00
2.50
3.00

Quantity
0
0
1
4
7
10
13

At $2.00, the quantity demanded is


equal to the quantity supplied!

Equilibrium of
Supply
and
Demand
P
Qd=19 6P
$3.0
0
2.5
0
2.0
0
1.5
0
1.0
0
0.5
0

Supply

Equilibriu
m
Qd= Qs

Qs = - 5 + 6P
0

1 2 3 4 5 6 7 8 9 10 11 12

Demand

Three Steps To Analyzing


Changes in Equilibrium
Decide whether the event shifts the
supply or demand curve (or both).
Decide whether the curve(s) shift(s) to the
left or to the right.
Examine how the shift affects
equilibrium price and quantity.

How an Increase in Demand


Affects the Equilibrium
Price

1. Hot weather increases


the demand for ice cream...

Supply
$2.50

New equilibrium

2.00
2. ...resulting
in a higher
price...

Initial
equilibrium

D2

D1
0

7
3. ...and a higher
quantity sold.

10

Quantity

Shifts in Curves versus


Movements along Curves
A shift in the supply curve is called a change
in supply.
A movement along a fixed supply curve is
called a change in quantity supplied.
A shift in the demand curve is called a
change in demand.
A movement along a fixed demand curve is
called a change in quantity demanded.

How a Decrease in Supply


Affects the Equilibrium
Price

S2

1. An earthquake reduces
the supply of ice cream...

S1
New
equilibrium

$2.50
2.00

Initial equilibrium

2. ...resulting
in a higher
price...

Demand

1 2 3 4

7 8 9 10 11 12 13
3. ...and a lower
quantity sold.

Quantity

What Happens to Price and


Quantity When Supply or
Demand Shifts?
No Change
I n Demand
An I ncrease
I n Demand
A Decrease
I n Demand

No Change
I n Supply

An I ncrease
I n Supply

A Decrease
I n Supply

P
Q
P
Q
P
Q

P
Q
P
Q
P
Q

P
Q
P
Q
P
Q

same
same
up
up
down
down

down
up
ambiguous
up
down
ambiguous

up
down
up
ambiguous
ambiguous
down

Excess Supply
Supply

Surplus

$3.0
0
2.5
0
2.0
0
1.5
0
1.0
0
0.5
0

Demand
0

1 2 3 4 5 6 7 8 9 1
0

11 12

Surplus
When the price is above the equilibrium
price, the quantity supplied exceeds the
quantity demanded. There is excess supply
or a surplus. Suppliers will lower the price
to increase sales, thereby moving toward
equilibrium.

Excess Demand
Price

Supply
$2.00
$1.50

Shortage

5 6

8 9 10 11 12 13

Demand

Quantity

Shortage
When the price is below the equilibrium
price, the quantity demanded exceeds the
quantity supplied. There is excess demand
or a shortage. Suppliers will raise the price
due to too many buyers chasing too few
goods, thereby moving toward equilibrium.

Price Ceilings & Price Floors


Price Ceiling
A legally established maximum price at
which a good can be sold.

Price Floor
A legally established minimum price at
which a good can be sold.

A Price Ceiling That


Creates Shortages
P

Supply
Equilibrium
price
$3
2

Price
ceiling
Shortage

Demand
0

75

125

Quantity Quantity
supplied demanded

Effects of Price Ceilings

Shortages
Non-price rationing
Black market
Corruption

Rent Control
Rent controls are ceilings placed on the
rents that landlords may charge their
tenants.
The goal of rent control policy is to help
the poor by making housing more
affordable.
One economist called rent control the
best way to destroy a city, other than
bombing.

Rent Control in the Short Run


Rental
Price of
Apartme
nt

Supply and
demand for
apartments
are relatively
inelastic

Supply

Controlled rent
Shortage

Demand
0

Quantity of
Apartments

Rent Control in the Long Run


Rental
Price of
Apartme
nt

Because the
supply and
demand for
apartments are
more elastic...

Supply

rent control
causes a
large
shortage

Controlled rent

Shortage

Demand
0

Quantity of
Apartments

A Price Floor That


Creates
Surplus
P
Supply
Surplus
$4

Price floor

$3
Equilibriu
m
price

Demand
0

80

120

Quantity Quantity
demanded supplied

The Minimum Wage


An important example of a price
floor is the minimum wage.
Minimum wage laws dictate the
lowest price possible for labor that
any employer may pay.

The Minimum Wage


Wage

A Free Labor
Market

Labor
supply

Equilibriu
m
wage

Labor
demand
0

Equilibrium
employmen
t

Quantity of
Labor

The Minimum Wage


Wage

A Labor Market with a


Minimum Wage
Labor surplus
(unemployment)

Labor
supply

Minimum
wage

Labor
demand
0

Quantity
demanded

Quantity
supplied

Quantity of
Labor

Assignment
Review Part One (P1- 59)
Do Exercises on P58-59
Preview Chapter 4 (P62-79)

Thanks