14, Sept 2010
Economics - the story of the choices people make and the actions that they take in
order to make the best use of scarce resources in meeting their wants and needs.
Consider some activity X, then a simple rule of Economics is....
• If... Beneﬁts (activity X) > Costs (activity X)... Then do activity X
• If... Costs (activity X) < Beneﬁts (activity X)... Then do not do activity X
Microeconomics - the study of the choices and actions of individual households, ﬁrms,
Macroeconomics - the study of the behavior of the economy as a whole, including
issues like unemployment, inﬂation and changes in the level of national income.
Judging Economic Allocations
Allocations of resources can be...
1. Efﬁciency (is present when the present value of net beneﬁts is maximized)
2. Equity (distributing goods and services in a manner considered by society to
3. Moral and political consequences
Positive Economics - involves a statement about “What is” (can be tested by checking
the statement against observed facts).
Normative Economics - involves statements about “What ought to be” (invlovles
beliefs and ethics) *Cannot be tested*
Economic is a Science
Economics is a social science that seeks to explain how people act. Like any other
science, it uses models, theories and assumptions to describe how people behave. A
model is simpliﬁed description of the way things work. Models and theories are meant
to provide an understanding and explanation, they also should be useful in predicted
Assumptions are made in the formulation of all models. Essentially, assumptions
simplify complexities. The true test of a model is not the realism of the assumption it uses but rather the ability of the model to explain and predict behavior. The model used
in this course are called... Neoclassical Paradigm.
Economics is an empirical science...can be proven by facts.
Some caution is to be used...
1. Correlation Fallacy - incorrect view that correlation implies
2. The Post Hoc Fallacy - an error of reasoning that a ﬁrst event causes a
second event because the ﬁrst one occurred before the second.
3. Fallacy of Composition - the incorrect view that what is true for an individual
is also true for a group of people.
Production Possibility Frontier - is a graph that shows all of the combinations of
goods that a society can produce when its factors of productions are utilized to their full
Points a,b,c,d are attainable
Points e and f are unattainable 16, Sept 2010
Opportunity Cost - the beneﬁt given up by not using the resources in the next best
Example... Total cost of a 4 year degree at the U of A
! ! ! Tuition - $6500.00/yr.
! ! ! Books - $2000.00/yr.
! ! ! ! $8500.00/yr.
! ! ! 4 years - $34000.00
Suppose that individual goes to work instead of the U of A, an individual could work at
Therefore the Opportunity Cost of a 4 year degree is
! ! ! Work - $120000.00
! ! ! Degree - $34000.00
! ! ! ! $154000.00
The additional gain in bottled water = BW = BWc - BWb
has the opportunity cost of = CD = CDb - CDc Example...
Possibility Bottles of Water CDʼs
A 0 15
B 1 14
C 2 12
D 3 9
E 4 5
F 5 0
Calculating Opportunity Costs
Bottles of CDʼs Opportunity Cost
Water (Millions) (Millions) (One Bottle of
0 15 -
1 14 1
2 12 2
3 9 3
4 5 4
5 0 5
Law of Increasing Costs - in order to produce extra amounts of one good, you must
give up over increasing amounts of the other good.
*This occurs because not all resources are not equally productive in all activities* PPF would shift out because...
1. Technology improved
2. Increase in resources
3. Increase in population
4. Economic growth
Market - a set of rules for the negotiation of exchange between buyers and sellers.
The Rationality Assumption - individuals do not intentionally make decisions that will
leave them worse off. 21, Sept 2010
Law of Demand - as a products relative price increases (decreases), the quantity
demanded decreases (increases).
The law of demand is also called the law of downward sloping demand curve as it
describes the shape of the demand curve.
Changes in commodities prices correspond to movements along the demand curve
which are referred to as changes in quantity demanded.
*Price is the only variable that changes quantity demanded*
Variables that Inﬂuence Demand
1. Prices of Substitutes
! - two goods are substitutes if they satisfy the same needs.
- if the prices of a substitute for good A increases, the demand for good A
" *Demand Curve shift out* 2. Price of Compliments
- two goods are compliments if they are consumed together.
- if the prices of a compliment of good A increases, the demand for good A
" *Demand Curve shifts in*
3. Number of Buyers
- if the number of buyers increases, demand increases.
4. Preferences (taste)
- when preferences change, demand changes.
- the consumers views of future market conditions can inﬂuence current demand.
! a.) Normal goods
- when consumers income increases, demand increases.
! b.) Inferior goods
- when consumers incomes increases, demand decreases.
Law of Supply - as the relative price of a community increases, the quantity supplied
As the relative price of a commodity decrease, the quantity supplied decreases. Changes in the price of commodity X cause changes in the quantity supplied which
correspond to movement along the curve.
Variables Affecting Supply
1. Cost of Inputs
- as costs increase (decrease), the supply curve for the commodity shifts in (out)
! which corresponds to a decrease (increase) in supply.
2. Technology and Productivity
- a better, cheaper production technology allows the producer to supply more of
! a product at every price level, thus increasing supply.
3. Number of Firms
- as the number of ﬁrms increases, supply increases.
4. Taxes and Subsidies
! - taxes are effectively an addition to production costs and results in decreases
! ! supply.
! - subsidies work in the opposite fashion, decreasing production costs and
! ! increasing supply.
- the producers view of the future may change the supply.
6. Prices of Substitutes in Production
- substitutes in production are goods that can be produced using the same inputs
! *If the price of a substitute in production for good X increases (decreases),
" the supply of good X decreases (increases)*
7. Prices of Compliments in Production (Joint Products)
- compliments in productions in productions are products, which by the nature of
! production, are produced together
! *If the price of a compliment in production for good X increases
" (decreases), the supply of good X increases (decreases)* 30, Sept 2010
Regulations on Price
1. Price Ceiling - the government sets the maximum price that can be charged for
a good or service.
2. Price Floor - the government sets the minimum price that can be charged for a
good or service.!
*Effective Price Ceiling Causes Shortage*
*Effective Price Floor Causes Surplus* Elastics of Supply and Demand
Price Elasticity of Demand - measures the responsiveness of quantity demanded to a
change in the price.
Nd = % Change in Quantity Demanded / % Change in Price
- the elasticity of demand is usually a negative number. However, we often drop the
- the elasticity of demand generally changes as we move along a demand curve
when Nd > 1, demand is elastic, quantity is relatively responsive to price changes
when Nd < 1, demand is inelastic, quantity is relatively unresponsive to price changes
when Nd = 1, demand is unit elastic
! *Demand is perfect Inelastic*!! ! *Demand is perfectly Elastic*
- if good X has more substitutes then good Y then the demand for good X will be more
elastic than the demand for good Y. Total Revenue Rule
R = P x Q
1. if demand is elastic, total revenue moves in the opposite direction of price.
2. if demand is inelastic, total revenue moves in the same direction as price.
3. if demand is unit elastic, total revenue does not change as price changes. 5, Oct 2010
Income Elasticity of Demand - measures the responsiveness of quantity to changes
in income, as well measures the size of the shift in the demand curve.
Ni = % Change in Quantity / % Change in Income
if Ni > 0, then the good is a normal good
if Ni < 0, then the good is an inferior good
Cross Price Elasticity - measures the responsiveness of the demand of good A to a
change in the price of good B.
Nab = % Change in Quantity of Good A / % Change in Price of Good B
if Nab > 0, then goods A and B are substitutes
if Nab < 0, then good A and B are compliments
Elasticity of Supply - measures the responsiveness of quantity supplied to a change in
Ns = % Change in Quantity Supplied / % Change in Price
if Ns > 1, supply is elastic
if Ns < 1, supply is inelastic
if Ns = 1, supply is unit elastic 12 Oct, 2010
Utility - the satisfaction, happiness or need fulﬁllment that consumers receive from the
goods and services they consume.
Marginal Utility - the change in utility that results from an incremental change is the
consumption of a good.
Mu = Change in Utility (U) / Change in Quantity Consumed (Q)
The Law of Diminishing Marginal Utility - the greater is the amount consumed of a
good or service, the smaller is the increase in utility from an incremental increase in
consumption of that good.
the more consumed of a good or service, the smaller the marginal utility. the less of a
good or service you consume the greater the marginal utility.
The consumer equilibrium is deﬁned as those levels of the quantities such that the
consumers utility is maximized. A consumer equilibrium is reached when the consumer
has no incentive to reallocate his/her budget or to buy a different bundle of goods. 19, Oct 2010
Legal Organization of Firms
1. Sole Proprietorship
- business is owned by a single person.
! ! adv. i) easy to form and dissolve.
! ! ii) all decision making power resides with sole owner.
! ! iii) only taxed once, as proﬁts are part of an individuals net
! ! ! income.!
! ! dis. i) unlimited liability.