Economics, Welfare & Distribution
Lecture 1 – Introduction, Demand & Supply, Consumer Behaviour
Economic perspective
- Abstract modelling, assumptions and vocabulary
- Scarcity & welfare
- Allocation
Demand & supply
- What are they and how to construct them?
- What if things change?
Consumer behaviour
- Choice & utility
Adam Smith (1776)
- The things which have the greatest value in use have frequently little or no value in
exchange, and on the contrary, those which have the greatest value in exchange have
frequently little or no value in use.
o Water is necessary to survive, but costs hardly anything
o Diamonds are not necessary, but are very expensive
Economic perspective
Economics is the study of the allocation of scarce resources to meet unlimited human
wants.
Decisions mean foregoing other benefits = opportunity costs
- Micro-economics: studies individual consumers and producers. Supply and demand
at separate markets. Aggregation of individual welfares to reach collective welfare.
- Macro-economics: aggregate performance of the entire economic system.
Three questions that any economy must face:
- What goods and services should be produced?
- How should these goods and services be produced?
- Who should get the goods and services that have been produced?
Resources to satisfy these questions:
- Land: all the natural resources of the earth
, - Labour: the human effort (mental and physical) that goes into production
- Capital: the equipment and structures used to produce goods and services
How people make decisions:
- Trade-off: the loss of the benefits from a decision to forego or sacrifice one option,
balanced against the benefit incurred from the choice made.
- Efficiency: ways in which society gets the most it can from its scarce resources
- Equity: the extent to which the benefits of outcomes are distributed fairly among
society’s members
- Opportunity cost: the measure of the options sacrificed in making a decision
o Opportunity cost of good y = sacrifice of good x / gain in good y
Ultimate objective: well-being (welfare)
Economic well-being = degree of satisfaction with command over
material resources
Some people may prioritize the pursuit of their overall well-being
primarily in terms of material well-being (M), but at the expense of
their relational (R) and subjective well-being (S).
- Others can choose or be forced to prioritize relational or
subjective well-being
Well-being can also be pursued by means of a concerted effort in two dimensions, most
realistic is a combination of all three dimensions together (R, S & M)
- Realisation of well-being can be assessed in an integrated and comprehensive
manner by looking at this intersection
Human as economic agent
- Economic agents: an individual, firm or organization that has an impact in some way
on an economy
- Preference interdependence
o Positive: an individual's preference for a good or service increases as more
people prefer or use it
o Negative: an individual's preference for a good or service decreases as more
people prefer or use it
- Norms & values (human is no ‘rational fool’)
Human is individualist (self-interest important) and social being (well-being of others and
dedication to society important).
Micro-economics
- Objective mode of analysis
- Models are based on assumptions
o Simplifications that permit rigorous analysis
o No irrelevant complications
- The best model (abstraction from reality) is the one that best describes reality and is
the simplest
- Assumptions do not always reflect reality
- Models allow inferences: conclusions, consequences or explanations can be drawn
based on evidence provided by the model
,Assumptions in micro-economics
- Economic agents pursue self-interest:
o Producers pursue maximum profits
o Consumers pursue maximum utility (well-being)
Preferences are given
No attention for existing inequality, power, culture, etc.
- Economic agents behave rational, i.e. choice behaviour is consistent:
o Completeness of alternatives (a > b or b > a or a = b)
o Transitivity of alternatives (if a > b and b > c, then a > c)
- Analysis is often based on marginal decision-making: thinking at the margin means
that decision-makers choose a course of action such that the marginal cost is equal to
the marginal benefit
- Analysis is often simplified for graphic representation
- Ceteris paribus clause (all other things are assumed constant, partial reasoning)
- Method of decreasing abstraction
o Models can easily be made more complex
- Monotonicity: more is preferred to less
Consistency with reality vs. usefulness
Economic system: the way in which resources are organized and allocated to provide for the
needs of an economy’s citizens to address the economic problem.
- Capitalist economic system: private ownership of factors of production to produce
goods and services which are exchanged through a price mechanism, production is
primarily for profit
- Planned economic systems: communist system, central planners guide economic
activity in a way that promoted economic well-being for the country as a whole and
led to a more equitable outcome
Market failure: a situation in which the market on its own fails to produce an efficient
allocation of resources.
- Externality: the uncompensated impact, both negative and positive, of one person’s
actions on the well-being of a bystander
- Market power: the ability of a single person or business to unduly influence market
prices or output
Model/demand schedule:
Q = demand: endogenous/dependent variable, is determined by price
P = price: exogenous/independent variable, is not determined by demand
Why quantity demanded rises when the price of a good decreases:
Income effect: real income, what a given amount of money can buy at any point in time,
increases when the price decreases and the income remains constant
- Movement to a new indifference curve
- To find it: what would demand be if income was adjusted to keep purchasing power
constant calculate substitution effect change in demand - substitution effect
Substitution effect: the price of the good is lower than the price of substitution goods
, - Moving to a new point on the same indifference curve with a different marginal rate
of substitution (slope)
- To find it: substituting the equivalized income and new price into the demand
function find new demand take off the old demand
When the price of a good changes change in the quantity supplied/demanded
When something else changes change in supply/demand
Joint supply: an increase in the supply of a good (e.g., lamb) leads to an increase in the
supply of another good (e.g., wool)
Total expenditure: the amount paid by buyers, computed as the price of the good times the
quantity purchased (p x q)
- Price inelastic: increase in price causes increase in total expenditure
- Price elastic: increase in price causes a decrease in total expenditure
- Unit price elastic: total expenditure remains constant when the price changes
Total revenue: the amount received by sellers of a good, computed as the price of the good
times the quantity sold (p x q)
- Price inelastic: an increase in price causes an increase in total revenue
- Price elastic: an increase in price brings about a much larger than proportionate
increase in supply and an increase in total revenue
Price elasticity of supply:
- Price elastic: the quantity supplied responds substantially to changes in the price
- Price inelastic: the quantity supplied responds only slightly to changes in the price
Key determinants of the price elasticity of supply:
- The time period: the long or short run
- Productive capacity: can the output be expanded?
- The size of the firm/industry
- The mobility of factors of production (mobility, land)
- Ease of storing stock/inventory
Standard economic model: humans behave rationally when making consumption choices
and seek to maximize utility subject to the constraint of a limited income.
Willingness to pay: how much of our limited income we are prepared to pay, this is a
reflection of the value we put on acquiring a good.
Budget constraint: shows the consumption bundles of two products that the consumer can
afford given a specified income.
Ratio of the prices of the goods being considered: Px/Py
Indifference curve: a curve that shows consumption bundles that give the consumer the
same level of satisfaction.
Four properties of indifference curves:
- Higher indifference curve is preferred to a lower indifference curve
- Indifference curves are downwards sloping
- Indifference curves do not cross
- Indifference curves are bowed inwards (convex)
Lecture 1 – Introduction, Demand & Supply, Consumer Behaviour
Economic perspective
- Abstract modelling, assumptions and vocabulary
- Scarcity & welfare
- Allocation
Demand & supply
- What are they and how to construct them?
- What if things change?
Consumer behaviour
- Choice & utility
Adam Smith (1776)
- The things which have the greatest value in use have frequently little or no value in
exchange, and on the contrary, those which have the greatest value in exchange have
frequently little or no value in use.
o Water is necessary to survive, but costs hardly anything
o Diamonds are not necessary, but are very expensive
Economic perspective
Economics is the study of the allocation of scarce resources to meet unlimited human
wants.
Decisions mean foregoing other benefits = opportunity costs
- Micro-economics: studies individual consumers and producers. Supply and demand
at separate markets. Aggregation of individual welfares to reach collective welfare.
- Macro-economics: aggregate performance of the entire economic system.
Three questions that any economy must face:
- What goods and services should be produced?
- How should these goods and services be produced?
- Who should get the goods and services that have been produced?
Resources to satisfy these questions:
- Land: all the natural resources of the earth
, - Labour: the human effort (mental and physical) that goes into production
- Capital: the equipment and structures used to produce goods and services
How people make decisions:
- Trade-off: the loss of the benefits from a decision to forego or sacrifice one option,
balanced against the benefit incurred from the choice made.
- Efficiency: ways in which society gets the most it can from its scarce resources
- Equity: the extent to which the benefits of outcomes are distributed fairly among
society’s members
- Opportunity cost: the measure of the options sacrificed in making a decision
o Opportunity cost of good y = sacrifice of good x / gain in good y
Ultimate objective: well-being (welfare)
Economic well-being = degree of satisfaction with command over
material resources
Some people may prioritize the pursuit of their overall well-being
primarily in terms of material well-being (M), but at the expense of
their relational (R) and subjective well-being (S).
- Others can choose or be forced to prioritize relational or
subjective well-being
Well-being can also be pursued by means of a concerted effort in two dimensions, most
realistic is a combination of all three dimensions together (R, S & M)
- Realisation of well-being can be assessed in an integrated and comprehensive
manner by looking at this intersection
Human as economic agent
- Economic agents: an individual, firm or organization that has an impact in some way
on an economy
- Preference interdependence
o Positive: an individual's preference for a good or service increases as more
people prefer or use it
o Negative: an individual's preference for a good or service decreases as more
people prefer or use it
- Norms & values (human is no ‘rational fool’)
Human is individualist (self-interest important) and social being (well-being of others and
dedication to society important).
Micro-economics
- Objective mode of analysis
- Models are based on assumptions
o Simplifications that permit rigorous analysis
o No irrelevant complications
- The best model (abstraction from reality) is the one that best describes reality and is
the simplest
- Assumptions do not always reflect reality
- Models allow inferences: conclusions, consequences or explanations can be drawn
based on evidence provided by the model
,Assumptions in micro-economics
- Economic agents pursue self-interest:
o Producers pursue maximum profits
o Consumers pursue maximum utility (well-being)
Preferences are given
No attention for existing inequality, power, culture, etc.
- Economic agents behave rational, i.e. choice behaviour is consistent:
o Completeness of alternatives (a > b or b > a or a = b)
o Transitivity of alternatives (if a > b and b > c, then a > c)
- Analysis is often based on marginal decision-making: thinking at the margin means
that decision-makers choose a course of action such that the marginal cost is equal to
the marginal benefit
- Analysis is often simplified for graphic representation
- Ceteris paribus clause (all other things are assumed constant, partial reasoning)
- Method of decreasing abstraction
o Models can easily be made more complex
- Monotonicity: more is preferred to less
Consistency with reality vs. usefulness
Economic system: the way in which resources are organized and allocated to provide for the
needs of an economy’s citizens to address the economic problem.
- Capitalist economic system: private ownership of factors of production to produce
goods and services which are exchanged through a price mechanism, production is
primarily for profit
- Planned economic systems: communist system, central planners guide economic
activity in a way that promoted economic well-being for the country as a whole and
led to a more equitable outcome
Market failure: a situation in which the market on its own fails to produce an efficient
allocation of resources.
- Externality: the uncompensated impact, both negative and positive, of one person’s
actions on the well-being of a bystander
- Market power: the ability of a single person or business to unduly influence market
prices or output
Model/demand schedule:
Q = demand: endogenous/dependent variable, is determined by price
P = price: exogenous/independent variable, is not determined by demand
Why quantity demanded rises when the price of a good decreases:
Income effect: real income, what a given amount of money can buy at any point in time,
increases when the price decreases and the income remains constant
- Movement to a new indifference curve
- To find it: what would demand be if income was adjusted to keep purchasing power
constant calculate substitution effect change in demand - substitution effect
Substitution effect: the price of the good is lower than the price of substitution goods
, - Moving to a new point on the same indifference curve with a different marginal rate
of substitution (slope)
- To find it: substituting the equivalized income and new price into the demand
function find new demand take off the old demand
When the price of a good changes change in the quantity supplied/demanded
When something else changes change in supply/demand
Joint supply: an increase in the supply of a good (e.g., lamb) leads to an increase in the
supply of another good (e.g., wool)
Total expenditure: the amount paid by buyers, computed as the price of the good times the
quantity purchased (p x q)
- Price inelastic: increase in price causes increase in total expenditure
- Price elastic: increase in price causes a decrease in total expenditure
- Unit price elastic: total expenditure remains constant when the price changes
Total revenue: the amount received by sellers of a good, computed as the price of the good
times the quantity sold (p x q)
- Price inelastic: an increase in price causes an increase in total revenue
- Price elastic: an increase in price brings about a much larger than proportionate
increase in supply and an increase in total revenue
Price elasticity of supply:
- Price elastic: the quantity supplied responds substantially to changes in the price
- Price inelastic: the quantity supplied responds only slightly to changes in the price
Key determinants of the price elasticity of supply:
- The time period: the long or short run
- Productive capacity: can the output be expanded?
- The size of the firm/industry
- The mobility of factors of production (mobility, land)
- Ease of storing stock/inventory
Standard economic model: humans behave rationally when making consumption choices
and seek to maximize utility subject to the constraint of a limited income.
Willingness to pay: how much of our limited income we are prepared to pay, this is a
reflection of the value we put on acquiring a good.
Budget constraint: shows the consumption bundles of two products that the consumer can
afford given a specified income.
Ratio of the prices of the goods being considered: Px/Py
Indifference curve: a curve that shows consumption bundles that give the consumer the
same level of satisfaction.
Four properties of indifference curves:
- Higher indifference curve is preferred to a lower indifference curve
- Indifference curves are downwards sloping
- Indifference curves do not cross
- Indifference curves are bowed inwards (convex)
