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What Is Economics?

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AB 106

Instructor:

Microeconomics -- Associate Prof Rosalind Chew

Macroeconomics -- Prof Chew Soon Beng

Two quizzes: one in Week 7 and one in Week 12

Format: 10 multiple choice questions

Duration: 30 minutes

Venue: Your Tutorial Classroom

u or a par c pa on:

Each quiz: 10%

http://wps.aw.com/aw_parkin_economics_8/0,13296,4324270-,00.html

Available FREE to students with the text.

For each chapter, students can access:

(1) Answers to odd-numbered problems in the text(2) Quick multiple-choice quizzes2

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Understanding Our Changing World

You are studying economics at a time of enormous.

Much of the change is for the betterthe information age,lobalization and all the benefits that the brin .

But they also bring challenges: inflation, unemployment,

etc.

Did you know that there was a financial meltdown in theUSA in October 2008? And the labour market felt the

impact throughout 2009. Today it has recovered from theimpact.

our econom cs course w e p you o un ers an e

powerful forces that are shaping and changing our world. 3

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Definition of Economics

All economic questions arise because we want more than.

Our inability to satisfy all our wants is called scarcity.

Because we face scarcity, we must make choices.

Choices mean making a tradeoffThinking about a choice as a tradeoff emphasizes cost asan opportunity forgone.

ence, e c o ces we ma e epen on e ncen ves weface.

4

penalty that discourages an action.

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Economics is the social science that studies the choicesthat individuals, businesses, overnments, and entire

societies make as they cope with scarcity and theincentives that influence and reconcile those choices.

But scarcity of what? Scarcity of resources and time!

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Microeconomics

and businesses make, the way those choices interact inmarkets, and the influence of governments.

Macroeconomics

Macroeconomics is the study of the performance of thenational and global economies.

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Economics: A Social Science

Economics is a social science.

What ispositive statements

a oug o enorma ve s a emen s

A positive statement can be tested by checking it against.

A normative statement cannot be tested.

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The task of economic science is first to discover positivestatements that are consistent with what we observe in the

world and that enable us to understand how the economicworld works and then seek to improve the outcome.

The first part is Positive Economics and the second partis Normative Economics

os t ve conom cs s arge an rea s nto t ree steps:

Observation and measurement

o e u ng Testing models

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Obstacles and Pitfalls in Economics

economic behavior has many simultaneous causes.

To isolate the factor of interest economists use thelogical device called Ceteris Paribus or other things

being equal.Economists try to isolate cause-and-effect relationshipby changing only one variable at a time, holding all other

.

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Obstacles and Pitfalls in Economics

Fallacy of CompositionA false statement that what istrue for the arts is true for the whole or that what is truefor the whole is true for the parts.

Post Hoc Fallacy From the Latin term Post hoc, ergopropter hoc, which means after this, therefore becauseof this. The error of reasoning that a first event causes

second.

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Conclusions of Chapter 1

Society is very competitive for individuals, firms andalso for overnments

Economics will help every economic agent to makeinformed decisions

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The Economic Problem

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Production Possibilit ies and Opportunity

Cost

The production possibilities frontier(PPF) is theboundary between those combinations of goods andservices that can be produced and those that cannot.

To illustrate the PPF, we focus on two goods at a timean o e quan es o a o er goo s an serv cesconstant.

,remains the same (ceteris paribus) except the two goodswere considering.

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Production Possibilit ies and Opportunity

Cost

Production Possibili ties

The figure shows the PPFfor two goods: CDs andpizza.

Any point on the frontierefficiency) and any pointinside the PPF such as Z

.Points outside the PPFare unattainable.

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All the oints alon the PPF are efficient.

To determine which of the alternative efficient quantitiesto produce, we compare costs and benefits.

The PPF and Marginal Cost

The PPF determines opportunity cost.

The marginal cost of a good or service is the opportunitycost of producing one more unit of it.

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Using Resources Efficiently

As we move along thePPF from A to F, theopportunity cost of

.

The opportunity

cost of producingone more pizza is

the marginal cost of

.

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Hi her MC

The black dots andthe line labeled MCshow the marginalcost of pizza.

e curvepasses through thecenter of each bar.

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Why do we produce pizza?

Preferences and Marginal Benefit

Preferences are a description of a persons likes and.

To describe preferences, economists use the concepts of.

The marginal benefit of a good or service is the benefitreceived from consumin one more unit of it.

We measure marginal benefit by the amount that aperson is willing to pay for an additional unit of a good orservice.

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It is a eneral rinci le that the more we have of an

good, the smaller is its marginal benefit and the less weare willing to pay for an additional unit of it.

We call this general principle the principle of decreasingmarginal benefit.

The marginal benefit curve shows the relationshipbetween the marginal benefit of a good and the quantity ofthat ood consumed.

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At oint B with izza

production at 1.5million, people are

a pizza.

,production at 4.5million, people are

w ng o pay ora pizza.

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Efficient Use of Resources

When we cannot produce more of any one good withoutgiving up some other good, we have achieved productive

.

All points on the PPF are production efficient.

u on y one po n s a oca on e c en : we ac eveallocative efficiency at this point.

.

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If we produce exactly2.5 million pizzas,marginal cost equalsmar inal benefit.

We cannot get more

value from our.

On the PPF at pointB we are roducin

the efficient quantitiesof CDs and pizzas.

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Determination of Allocative Efficienc

Marginal Cost and Marginal Benefit (cds per pizza)

MC$

A C

B

MB

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Pizza2.5

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Economic Growth

The ex ansion of roduction ossibilitiesand increase

in the standard of livingis called economic growth.Two key factors influence economic growth:

Technological change

Capital accumulationTechnological change is the development of new goodsand of better ways of producing goods and services.

Capital accumulation is the growth of capital resources,which includes human capital.

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Economic Growth

The Cost of Economic Growth

o use resources n researc an eve opment anto produce new capital, we must decrease our

roduction of consum tion oods and services.

So economic growth is not free.

The o ortunit cost of economic rowth is lesscurrent consumption.

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Economic Growth

The figure illustrates.

We can produceizzas or izza ovens

along PPF0.

By using someresources o pro ucepizza ovens today,the PPF shifts

ou war n e u ure.What happens toPPF1 if A wasc osen

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Conclusions of Chapter 2

Concept of PPF

Productive efficiency and allocative efficiency

Will PPF shift?

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From Chapter 1: Two Big Economic

Questions

Two big questions summarize the scope of economics:

(1) How much to produce? How to produce and forwhom to produce?

Examples: (a) investment goods or consumption goods;

(b) Weapons or food; rice or healthcare (2) When do choices made in the pursuit of self-interest

also promote the social interest?

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How much to produce?

Production Possibilities

Frontier We can choose anypo n on e

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How to produce?

resources that economists call factors of production.Factors of roduction are rou ed into four cate ories:

Land

Labor

Capital

Entrepreneurship

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How to produce?

The gifts of nature that we use to produce goods andservices are land.

The work time and work effort that people devote toproducing goods and services is labor.

The quality of labor depends on human capital,which is the knowledge and skill that people obtain

from education on-the- ob trainin and workexperience.

The tools, instruments, machines, buildings, and other

are capital.

The human resource that or anizes land labor andcapital is entrepreneurship.

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How to produce?

The figure shows ameasure o e grow o

human capital in theUnited States over the lastcenturythe percentageof the population that has

of education.

Economics ex lains thesetrends.

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Employed Residents by Education and Gender,

Singapore: 1996, 2006

Education/Year 1996

Total

2006

Total

1996

Male

2006

Male

Primary and

Below

373.6

24.7

295.7

15.7

243.4

65.1

178.0

60.2

Lower Secondary212.7

(14.1)

236.7

(12.6)

150.5

(70.8)

153.5

(64.9)

Secondary 458.6 456.1 247.2 242.8. . . .

Upper Secondary175.1

(11.6)

236.6

(12.6)

95.6

(54.6)

127.4

(53.8)

Polytechnic 117.5 215.0 77.3 128.1

uca on . . . .

Degree 173.9

(11.4)

440.6

(23.4)

102.7

(59.1)

251.3

(57.0)

1,511.5 1,880.8 916.6 1,081.2

(100%) (100%) (60.6) (57.5)

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For whom we produce?

For Whom?

Who gets the goods and services depends on theincomes that people earn.

an earns rent.

Labor earns wages. (Raw labour earns

high salary.)

Ca ital earns interest.

Entrepreneurship earns profit.

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Self-Interest vs Social Interest

-

that you think are best for you.

be in the social interest.

Is it ossible that when each one of us makes choicesthat are in our self-interest, it also turns out that thesechoices are also in the social interest?

For example, when we choose to drive a car, itcontributes to pollution. Choices that affect the

in economics.35

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Demand and Supply

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Markets and Prices

A market is any arrangement that enables buyers and.

A competitive market is a market that has many buyers

the price.

The mone rice of a ood is the amount of moneneeded to buy it.

The relative price of a goodthe ratio of its money price

to the money price of the next best alternative goodis itsopportunity cost.

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Demand

If you demand something, then you

. ant t,

2. Can afford it, and

. .

Wants are the unlimited desires or wishes people have

for oods and services. Demand reflects a decision aboutwhich wants to satisfy.

The quantity demanded of a good or service is the

amount that consumers plan to buy during a particulartime period, and at a particular price.

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Demand

A rise in the price,o er ngs rema n ng

the same, brings adecrease in thequantity demandedand a movement

curve.

Known as Law of

Demand

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Demand

Demand Curve and Demand Schedule

between the price of the good and quantity demanded ofthe good.

A demand curve shows the relationship between thequantity demanded of a good and its price when all other

n uences on consumers p anne purc ases rema n esame.

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Why Law of Demand

Substitution effect

When the relative price (opportunity cost) of a

good or service rises, people seek substitutes for

service decreases.

Income effect

When the rice of a ood or service rises relative

to income, people cannot afford all the things theypreviously bought, so the quantity demanded of

.

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Demand

Willingness andAbilit to Pa

A demand curve isalso a willingness-- - -

curve.

The smaller thequantity available,the higher is theprice that someone

is will ing to pay foranother unit.

Willin ness to ameasures marginal

benefit.42

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Demand

A Change in Demand

price of the good changes, there is a change in demandfor that good.

The quantity of the good that people plan to buy changesat each and every price, so there is a new demand curve.

When demand increases, the demand curve shiftsrightward.

When demand decreases, the demand curve shiftsleftward.

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Demand

Six main factors that change demand are

The prices of related goods

Expected future prices

Expected future income

Population Preferences

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Demand

Prices of Related Goods

another good. another good.

when the price of a complement of an energy bar falls, thedemand for energy bars increases.

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D d

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Demand

Expected Future Prices

If the price of a good is expected to rise in the future,

current demand for the good increases and the demandcurve shifts ri htward.

Income

,goods and the demand curve shifts rightward.

A normal ood is one for which demand increases as

income increases.An inferior good is a good for which demand decreases as

.

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D d

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Demand

Expected Future Income

When income is expected to increase in the future, thedemand might increase now.

Population

The larger the population, the greater is the demand forall goods.

Preferences

People with the same income have different demands ifthey have different preferences.

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D d

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Demand

The fi ure shows anincrease in demand.

Because an energybar is a normal good,an increase in income

for energy bars.

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A M t l th D d C

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A Movement along the Demand Curve

good changes andeverything elserema ns e same, equantity demanded

changes and there isa movement along thedemand curve.

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A Shift of the Demand Curve

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A Shift of the Demand Curve

If the price remainsthe same but one ofthe other influences

on buyers plans,

changes and the

demand curve shifts.Caused byparameters such as

change in incomeprice of related

taste 50

Demand Curve

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Demand Curve

Ceteris Paribus

Inverse relationship

between price anduantit demanded

provided taste (T),income (Y) and prices

s complements (Pc)remain unchanged

(T,Y, Ps ,Pc )

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Supply

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Supply

If a firm supplies a good or service, then the firm

1. Has the resources and the technology to produce

it,

. ,

3. Has made a definite plan to produce and sell it.

to produce.

Supply reflects a decision about which

technologically feasible items to produce.The quantity supplied of a good or service is the amount

a pro ucers p an o se ur ng a g ven me per o a aparticular price. 52

Supply Curve

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Supply Curve

A rise in the price ofan energy ar, o er

things remaining thesame, brin s anincrease in thequantity supplied.

Known as Law ofSupply

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Supply

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Supply

The Law of Supply

e aw o supp y s a es:

Other things remaining the same, the higher the price of a,

the lower the price of a good, the smaller is the quantity

supplied.The law of supply results from the general tendency forthe marginal cost of producing a good or service to

, .

higher because more is at stake (Chapter2, page 37).

Producers are willin to su l a ood onl if the can atleast cover their marginal cost of production.

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Supply

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Supply

Supply Curve and Supply Schedule

the quantity supplied and the price of a good. quantity supplied of a good and its price when all otherinfluences on producers planned sales remain the same.

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S l

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SupplyMinimum Supply Price

A supply curve is also aminimum-supply-price

curve.

As the quantityproduced increases,

mar inal cost increases.The lowest price atwhich someone is willing

to sell an additional unitrises.

This lowest price is themarginal cost. 56

Supply

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Supply

A Chan e in Su l

When some influence on selling plans other than theprice of the good changes, there is a change in supply ofthat good.

The quantity of the good that producers plan to sellc anges a eac an every pr ce, so ere s a new supp ycurve.

, .

When supply decreases, the supply curve shifts leftward.

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Supply

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Supply

The five main factors that change supply of a good are

The prices of related goods produced Expected future prices

The number of suppliers

Technology

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Supply

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Supply

Prices of Productive Resources

,

minimum price that a supplier is willing to accept forproducing each quantity of that good rises.

So a rise in the price of productive resources decreasessupply and shifts the supply curve leftward.

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S l

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Su l

Prices of Related Goods Produced

A substitute in production for a good is another good thatcan be produced using the same resources.

The supply of a good increases if the price of a

substitute in production falls.

produced together.

complement in production rises.

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Supply

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pp y

Expected Future Prices

If the price of a good is expected to rise in the future,supply of the good today decreases and the supply curveshifts leftward.

The Number of Suppliers

The larger the number of suppliers of a good, the greateris the supply of the good. An increase in the number of

.

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Supply

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pp y

Technology

the cost of producing existing products, so advances intechnology increase supply and shift the supply curverightward.

A natural disaster is a negative technology change, whichecreases supp y an s ts t e supp y curve e twar .

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An increase in supply

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pp y

An advance in thetechnology for

producing energy

supply of energybars and shifts the

rightward.

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A Movement Along the Supply Curve

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g pp y

en t e pr ce o t e

good changes andother influences onsellers plans remainthe same, the quantity

there is a movementalong the supplycurve.

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A Shift of the Supply Curve

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If the price remains

other influence onsellers plans changes,

the supply curve shifts.

Caused bparameters such aschange in wages,im rovement in

technology

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Supply Curve

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Ceteris Paribus

, , ,

A positiverelationship betweenprice and quantitysupplied provided

,wage rate (W), Oilprices and govtpo cy o rema n

unchanged

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Market Equilibrium

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Equilibrium is a situation in which opposing forcesbalance each other. E uilibrium in a market occurs whenthe price balances the plans of buyers and sellers.

The equilibrium price is the price at which the quantitydemanded equals the quantity supplied.

The equilibrium quantity is the quantity bought and soldat t e equ r um pr ce.

Price regulates buying and selling plans.

Price adjusts when plans dont match.

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Market Equilibrium

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Price as a Re ulator

.bar, the quantitysupplied exceeds the

quan y eman e .

There is a surplus of.

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Market Equilibrium

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Price Adjustments

At prices above theequ r um pr ce, a surp us

forces the price down. equilibrium price, ashortage forces the priceup.

At the equilibrium price,

plans agree and the pricedoesnt change until someevent changes eitherdemand or supply. 69

Predicting Changes in Price and Quantity

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An Increase in Demand

When demand

increases the demand

B

.

The price rises, and

Aincreases along thesupply curve from A to

.

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An Increase in Supply

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An Increase in Supply

When supply

increases the supply.

The price falls, and

the uantit demandedincreases along thedemand curve from A

B .

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Increase in Both Demand and Su l

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Increase in Both Demand and Su l

An increase indemand and an

increase in supply

increase the

from A to B.

A B

equilibrium price is

uncertain because the

raises the equilibriumprice and the increase

in supply lowers it.72

Summar

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Su a

S(W left;P

D(Y right;

A is the equilibrium point

r g ;

Ps right;

Pc left)

Q

Difference between demand and quantity demanded

73Difference between supply and quantity supplied

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Elasticity

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Elasticity

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When price falls,

rises by different

amounts depending Total Revenue is P.QTR is affected as price fallson pr ce sens v y

Impacts on revenue P0

on price sensitivity P1

D1D2

Q0 Q1 Q2 Q

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Price Elasticity of Demand

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An increase in supply can bring about a large P and asmall Q or a small P and a large Q

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The contrast between the two outcomes in the figuresearlier hi hli hts the need for

A measure of the responsiveness of the quantity demandedto a price change.

The price elasticity of demand is a units-free measureof the responsiveness of the quantity demanded of a good

buyers plans remain the same.

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Measures the sensitivity of quantity demanded to price

chan es.

It measures the percentage change in the quantitydemanded of a good that results from a one percentc ange n pr ce.

QE

DD

P

%

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The ercenta e chan e in a variable is the absolute

change in the variable divided by the original level of

the variable.ere ore, e as c y can a so e wr en as:

PQPPE

D

P

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A negative number, because price and quantity move

As price increases, quantity decreasess pr ce ecreases, quan y ncreases

When EP > 1, the good is price elastic

When EP < 1, the good is price inelastic

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But it is the magnitude, or absolute value, of the

measure that reveals how res onsive the uantit

change has been to a price change.

is the availability of substitutes.

If there are many substitutes, demand is price elastic

Can easily move to another good with price increases

If there are few substitutes, demand is price inelastic

Necessities, such as food or housing, generally haveinelastic demand.

Luxuries, such as exotic vacations, generally have

elastic demand.

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Linear Demand Curve

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If we move down a linear demand curve slo e is the

same but price is lower and quantity is larger

Hence, E is smaller

Elasticity will change along the demand curve

PQPPE

D

P

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Linear Demand Curve84


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Given a linear demand curve

Elasticity depends on slope and on the values of P and Q

The top portion of the demand curve is elastic

Price is high and quantity small

The bottom portion of the demand curve is inelastic

Price is low and quantity high

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Price = -4

Elastic

Demand Curve

Q = 8 2P

-p

Inelastic

E = 0

86

Q84


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The steeper the demand curve becomes, the moreinelastic the ood.

The flatter the demand curve becomes, the more elasticthe good

Two extreme cases of demand curves

Com letel inelastic demand verticalInfinitely elastic demand - horizontal

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e pr ce e as c y o eman equa s an e goohas unit elastic demand. 89


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The price barely changes the price elasticity of demand is infinite and the good has aperfectly elastic demand.

A horizontal demand curve.90


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Total Revenue and Elasticity

equals the price of the good multiplied by the quantity

sold.

When the price changes, total revenue also changes.

If a price cut increases total revenue, demand is elastic.

If a price cut decreases total revenue, demand isinelastic.

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Link between Elasticity and Total Revenue

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Other Demand Elasticities

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Cross-Price Elasticity of Demand

Measures the percentage change in the quantity

demanded of one good that results from a one percent.

m

b

b

m

mm

bb

PQPQPP

Emb

93

Other Demand Elasticities

C l t C d T

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Complements: Cars and Tyres

-

Price of cars increases, quantity demanded of carsfalls leadin to smaller uantit demanded of tires

Substitutes: Butter and Margarine

Cross-price elasticity of demand is positive

Price of butter increases, quantity demanded ofbutter falls leading to higher quantity of margarine

demanded

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How to study for AB 106

7/24/2019 AB 106 Lecture 1 2010

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Ste 1: Stud the conce ts used in lectures and

examples in tutorials

Step 2: Study the materials according to the Courseu ne

Step 3: Study the whole book

Remember: Study in this order

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AB 106 Lecture 1 2010