Economics Introduction
The economic problem – how to satisfy unlimited wants with scarce resources.
There are four factors of production
- Land including all natural resources in and on it, this includes water, non-renewable
resources and animals and is almost always scarce. Even air which may be seen as a free
good is not since not all air is of good quality.
- Labour is the work done by people contributing to production.
- Capital is equipment used in production.
- Enterprise is the willingness to take a risk to make a profit and usually involves investing time
and money.
Economic activity involves combining the factors to create outputs which can increase economic
welfare and includes both making things and consuming them. The three basic questions are thus;
what to produce, who to produce it for, and how to produce it.
There are three main economic agents with different basic assumed objectives.
- Consumers want to maximise their own welfare.
- Governments want to maximise the welfare of their peoples (benevolent govt.)
- Businesses wish to maximise profits.
MARKETS AND ECONOMIES
A free market allocates resources based on supply and demand and prices them based on the price
mechanism. Any god can be sold at any price if there is someone willing and able to pay for it.
- Advantages include
o Efficiency as only those firms offering good value prices will sell anything.
o Entrepreneurship is increased as there is the potential to make lots of money.
o There is lots of choice as producers constantly close gaps in the market.
- However
o There can be great inequality and even those who cannot work through no fault of
their own will receive nothing.
o Non-profitable yet vital goods may not get produced as there is no profit motive.
o Monopolies may develop and abuse their power.
The opposite to a free market economy is a command economy where everything is centrally
planned by the government, not by the actions of consumers.
- Advantages include
o Supposedly maximised welfare because the govt. can prevent inequality.
o No involuntary unemployment.
o No monopoly abuse.
- Minor disadvantages include
o Poor decision making due to a lack of information and incentive to be accurate.
o Restricted choice as the govt. needs not allow people choice.
o Lack of risk taking or efficiency because there is no incentive for these.
,The attempt to combine the best of both worlds – of free market choice and enterprise but without
market failure and inequality is called a mixed economy, with both a public and private sector.
DEMAND
The non-price determinants of demand which shift the demand curve are
- Price of Substitutes
- Price of Complements
- Income
- Taste/Fashion
Changes in other markets can affect demand
- Derived demand is demand for something needed to make something else e.g. wood for
fencing.
One can also talk of effective demand vs latent demand (that which is already present and expressed
vs that which is not yet present but is potential demand)
SUPPLY
Non-price determinants are
- Costs
- Expectations
- Technology
- Legislation
- Indirect taxes
As price increases, supply does too as producers dedicate more factor inputs to this output as it is
relatively more profitable than other outputs.
Joint Supply – when production of one good includes that of another e.g. oil and plastics, so if more
oil is refined then more butane will also be supplied
ELASTICITY
Price elasticity of demand = PED = % change in quantity Demanded/%change in Price
PED is equal to the gradient of the demand curve. When more than 1 it is elastic, when less than 1
inelastic, when equal to 1 unitary. It is usually negative when dealing with a normal downward
sloping demand curve.
Several factors influence its elasticity
- No. of substitutes. The more substitutes the more elastic the PED as people can use other
goods easily if prices rise.
- Type of good or service, if it is a necessity then it will be inelastic as people cannot simply
stop using it e.g. food.
- Percentage of income spent on good, for if more is spent then people will look harder for
better deals.
,Income elasticity of demand is similar but refers to quantity demanded varying with income not
price.
- If this is positive then it means it is a luxury or superior good, if it is negative then it is an
inferior good.
Cross elasticity of demand
- This is how quantity demanded of one good varies with a change in that of another
good.
- %change quantity of A/%change price of B
- If the goods are substitutes then XED is positive.
- If they are complements then XED is negative.
Price Elasticity of Supply
- Firms aim to make their supply as elastic as possible to best react to changes in price and so
encourage flexible work patterns and having spare production capacity.
- In the short run it is inelastic because capacity is fixed because at least one factor is fixed,
usually capital because it takes time to build more machinery. In the long run it is variable.
BUSINESS ECONOMICS
Productivity
- Output per factor employed. The inputs can be both tangible such as land or intangible such
as creativity or knowledge.
- You can calculate total productivity or for individual factor inputs e.g. labour productivity
calculated in terms of unit output in unit of time per unit labour employed. It can be
improved through training, experience, equipment and specialisation.
Specialisation
- While people could be self-sufficient and do everything themselves, this is inefficient so
people, firms and countries specialise, leading to a division of labour.
Advantages
o People specialise in what they do best leading to higher quality and quantity for the
same input so higher productivity.
o Achieve economies of scale.
o Training costs reduced.
Disadvantages
o Repetitive tasks lead to boredom.
o Countries become less self-sufficient and susceptible to greater disruption as a result
of anything preventing trade.
o Lack of flexibility.
This leads to trade between countries so that they can swap their surplus in their
specialisation for goods they need. They do not however swap directly, or ‘barter,’ instead
they use money as a medium of exchange, money having four functions
o Medium of exchange
, o Store of value
o Measure of value
o Standard of deferred payment
Money also has characteristics which forms of money will exhibit most of
o Durability
o Portability
o Divisibility
o Hard to counterfeit
o Generally accepted
o Valuable
Business costs
Firm – any business organisation looking to make a profit.
Industry – all the firms providing similar goods and services.
Market – all the firms supplying and consumers of a certain good or service.
Firms create revenue by selling their output which they produce using factors of production which
have a cost. Their profit is total revenue minus total cost, which in the long run must be positive for
the firm to survive.
COSTS
When talking about cost of production economists include the opportunity cost of production, the
next best alternative foregone. This means any enterprise will include in its cost of production the
opportunity cost of another job.
In the short run, some costs are fixed because firms commit to certain things e.g. employment
contracts and it also takes time to increase capital. The definition of short run varies from firm to
firm depending on what factors it uses – capital intensive processes have a longer short run than
labour intensive processes. In the long run all costs are variable as all factors can be varied.
Variable costs – costs which vary with output
Fixed costs – those which do not e.g. rent
Total cost – total fixed cost +total variable cost
Average cost (or ATC) = cost per unit produced
AC = ATC + AVC
MC = cost of next unit produced or Change in TC/Change in Q
Short run average cost curve
The economic problem – how to satisfy unlimited wants with scarce resources.
There are four factors of production
- Land including all natural resources in and on it, this includes water, non-renewable
resources and animals and is almost always scarce. Even air which may be seen as a free
good is not since not all air is of good quality.
- Labour is the work done by people contributing to production.
- Capital is equipment used in production.
- Enterprise is the willingness to take a risk to make a profit and usually involves investing time
and money.
Economic activity involves combining the factors to create outputs which can increase economic
welfare and includes both making things and consuming them. The three basic questions are thus;
what to produce, who to produce it for, and how to produce it.
There are three main economic agents with different basic assumed objectives.
- Consumers want to maximise their own welfare.
- Governments want to maximise the welfare of their peoples (benevolent govt.)
- Businesses wish to maximise profits.
MARKETS AND ECONOMIES
A free market allocates resources based on supply and demand and prices them based on the price
mechanism. Any god can be sold at any price if there is someone willing and able to pay for it.
- Advantages include
o Efficiency as only those firms offering good value prices will sell anything.
o Entrepreneurship is increased as there is the potential to make lots of money.
o There is lots of choice as producers constantly close gaps in the market.
- However
o There can be great inequality and even those who cannot work through no fault of
their own will receive nothing.
o Non-profitable yet vital goods may not get produced as there is no profit motive.
o Monopolies may develop and abuse their power.
The opposite to a free market economy is a command economy where everything is centrally
planned by the government, not by the actions of consumers.
- Advantages include
o Supposedly maximised welfare because the govt. can prevent inequality.
o No involuntary unemployment.
o No monopoly abuse.
- Minor disadvantages include
o Poor decision making due to a lack of information and incentive to be accurate.
o Restricted choice as the govt. needs not allow people choice.
o Lack of risk taking or efficiency because there is no incentive for these.
,The attempt to combine the best of both worlds – of free market choice and enterprise but without
market failure and inequality is called a mixed economy, with both a public and private sector.
DEMAND
The non-price determinants of demand which shift the demand curve are
- Price of Substitutes
- Price of Complements
- Income
- Taste/Fashion
Changes in other markets can affect demand
- Derived demand is demand for something needed to make something else e.g. wood for
fencing.
One can also talk of effective demand vs latent demand (that which is already present and expressed
vs that which is not yet present but is potential demand)
SUPPLY
Non-price determinants are
- Costs
- Expectations
- Technology
- Legislation
- Indirect taxes
As price increases, supply does too as producers dedicate more factor inputs to this output as it is
relatively more profitable than other outputs.
Joint Supply – when production of one good includes that of another e.g. oil and plastics, so if more
oil is refined then more butane will also be supplied
ELASTICITY
Price elasticity of demand = PED = % change in quantity Demanded/%change in Price
PED is equal to the gradient of the demand curve. When more than 1 it is elastic, when less than 1
inelastic, when equal to 1 unitary. It is usually negative when dealing with a normal downward
sloping demand curve.
Several factors influence its elasticity
- No. of substitutes. The more substitutes the more elastic the PED as people can use other
goods easily if prices rise.
- Type of good or service, if it is a necessity then it will be inelastic as people cannot simply
stop using it e.g. food.
- Percentage of income spent on good, for if more is spent then people will look harder for
better deals.
,Income elasticity of demand is similar but refers to quantity demanded varying with income not
price.
- If this is positive then it means it is a luxury or superior good, if it is negative then it is an
inferior good.
Cross elasticity of demand
- This is how quantity demanded of one good varies with a change in that of another
good.
- %change quantity of A/%change price of B
- If the goods are substitutes then XED is positive.
- If they are complements then XED is negative.
Price Elasticity of Supply
- Firms aim to make their supply as elastic as possible to best react to changes in price and so
encourage flexible work patterns and having spare production capacity.
- In the short run it is inelastic because capacity is fixed because at least one factor is fixed,
usually capital because it takes time to build more machinery. In the long run it is variable.
BUSINESS ECONOMICS
Productivity
- Output per factor employed. The inputs can be both tangible such as land or intangible such
as creativity or knowledge.
- You can calculate total productivity or for individual factor inputs e.g. labour productivity
calculated in terms of unit output in unit of time per unit labour employed. It can be
improved through training, experience, equipment and specialisation.
Specialisation
- While people could be self-sufficient and do everything themselves, this is inefficient so
people, firms and countries specialise, leading to a division of labour.
Advantages
o People specialise in what they do best leading to higher quality and quantity for the
same input so higher productivity.
o Achieve economies of scale.
o Training costs reduced.
Disadvantages
o Repetitive tasks lead to boredom.
o Countries become less self-sufficient and susceptible to greater disruption as a result
of anything preventing trade.
o Lack of flexibility.
This leads to trade between countries so that they can swap their surplus in their
specialisation for goods they need. They do not however swap directly, or ‘barter,’ instead
they use money as a medium of exchange, money having four functions
o Medium of exchange
, o Store of value
o Measure of value
o Standard of deferred payment
Money also has characteristics which forms of money will exhibit most of
o Durability
o Portability
o Divisibility
o Hard to counterfeit
o Generally accepted
o Valuable
Business costs
Firm – any business organisation looking to make a profit.
Industry – all the firms providing similar goods and services.
Market – all the firms supplying and consumers of a certain good or service.
Firms create revenue by selling their output which they produce using factors of production which
have a cost. Their profit is total revenue minus total cost, which in the long run must be positive for
the firm to survive.
COSTS
When talking about cost of production economists include the opportunity cost of production, the
next best alternative foregone. This means any enterprise will include in its cost of production the
opportunity cost of another job.
In the short run, some costs are fixed because firms commit to certain things e.g. employment
contracts and it also takes time to increase capital. The definition of short run varies from firm to
firm depending on what factors it uses – capital intensive processes have a longer short run than
labour intensive processes. In the long run all costs are variable as all factors can be varied.
Variable costs – costs which vary with output
Fixed costs – those which do not e.g. rent
Total cost – total fixed cost +total variable cost
Average cost (or ATC) = cost per unit produced
AC = ATC + AVC
MC = cost of next unit produced or Change in TC/Change in Q
Short run average cost curve
