Twin themes in Economics:
Scarcity and Efficiency refers to the Twin
themes of Economics;
Scarcity occurs where it's impossible to meet all unlimited the desires and needs of the peoples with limited resources i.e; goods and services. Society must need to find a balance between sacrificing one resource and that will result in getting other.
Efficiency denotes the most effective use of a society's resources in satisfying peoples wants and needs. It means that the economy's resources are being used as effectively as possible to satisfy people's needs and desires.
Thus, the essence of economics is to acknowledge the reality of scarcity and then figure out how to organize society in a way which produces the most efficient use of resources.
Scarcity occurs where it's impossible to meet all unlimited the desires and needs of the peoples with limited resources i.e; goods and services. Society must need to find a balance between sacrificing one resource and that will result in getting other.
Efficiency denotes the most effective use of a society's resources in satisfying peoples wants and needs. It means that the economy's resources are being used as effectively as possible to satisfy people's needs and desires.
Thus, the essence of economics is to acknowledge the reality of scarcity and then figure out how to organize society in a way which produces the most efficient use of resources.
Types of Economics:
Market Economy
- A market economy relies solely on the needs and wants of the consumer population. Three factors influence the development of a market economy: supply, demand and competition. Supply and demand vary inversely to one another; high supply means low demand and vice versa. Competition influences the drive to produce goods and services of higher quality or lower cost.
The government has little control in a market economy; this policy is
known as laissez-faire. Capitalism is an example of a market economy system.
The United States and most developed nations follow a market economy.
Command Economy
- A command economy is the opposite of a market economy: in a command economy, the governing body controls the majority of wealth and resources, distributing it among the population accordingly. Communism is an example of a system that relies on command economy. In a communist society, the government owns and controls the wealth and resources. Socialist governments, such as those in the European Union, allow private possession of wealth and businesses, but place limits on prices.
Mixed Economy
- A mixed economy is an economic system that takes elements from all three main economic systems into practice. For example, few economies fall purely under the market system or under the command system; instead, the relationship is a sliding scale rather than a choice between the two systems. Even market economies can maintain elements of traditional economies via family-owned and operated businesses.
Types of
economics in terms of fairness:
Positive economics (sometimes called
Descriptive Economics) is the study of economic reality and why the economy
operates as it does. It is biased purely on facts rather than opinions. This type
of economics is made up of positive statements which can be accepted or
rejected through applying the scientific method. "Americans bought five
million CDs last year" is a positive statement - a simple declaration of
fact.
Normative economics (also called Policy Economics) deals with how the world ought to be. In this type of economics, opinions or value judgments - known as normative statements - are common. "We should reduce taxes" is an example of a normative statement.
Normative economics (also called Policy Economics) deals with how the world ought to be. In this type of economics, opinions or value judgments - known as normative statements - are common. "We should reduce taxes" is an example of a normative statement.
Definition of 'Production Possibility Frontier - PPF'
A curve depicting all
maximum output possibilities for two or more goods given a set of inputs
(resources, labor, etc.). The PPF assumes that all inputs are used efficiently.
As indicated on the chart above, points A, B and C represent the points at which production of Good A and Good B is most efficient. Point X demonstrates the point at which resources are not being used efficiently in the production of both goods; point Y demonstrates an output that is not attainable with the given inputs.
Scope of Economics:
The scope
of economics is the area or boundary of the study of economics. In scope of economics we answer and analyze the
following three main questions:
(i) What is the subject matter of economics?
(ii)
What is the nature of economics?
(iii)
What are the limitations of economic?
(i) Subject Matter of Economics:
There
is a difference of opinion among economists regarding the subject-matter of
economics. Adam Smith, the father of modern economic theory, defined
economics as a subject, which is mainly concerned with the study of nature and
causes of generation of wealth of nation.
Marshall introduced the concept of welfare in the study of
economics. According to Marshall; economics is a study of mankind in the
ordinary business of life. It examines that part of individual and social
actions which is closely connected with the material requisites of well-being.
In this definition, Marshall has shifted the emphasis from wealth to man. He
gives primary importance to man and secondary importance to wealth.
The
Robinson’s concept of the subject-matter of economics is that: “economics
is a science which studies human behavior as a relationship between ends and
scarce means which have alternative uses”. According to Robbins (a)
human wants are unlimited (b) means at his disposal to satisfy these wants are
not only limited, (c) but have alternative uses. Man is always busy in
adjusting his limited resources for the satisfaction of unlimited ends. The
problems that centre round such activities constitute the subject-matters of
economics.
Paul
and Samuelson, however, include the
dynamic aspects of economics in the subject matter. According to them,
"economics is the study of how man and society choose with or without
money, to employ productive uses to produce various commodities over time and
distribute them for consumption now and in future among various people and
groups of society”.
(ii) Nature of Economics:
The
economists are also divided regarding the nature of economics. The following
questions are generally covered in the nature of economics.
(a)
Is economics a science or an art?
(b)
Is it a positive science or a normative science?
(iii) Economics As a Science or An Art:
Economics
is both a science and an art. Economics is considered as a science because it
is a systematic knowledge derived from observation, study and experimentation.
However, the degree of perfection of economics laws is less compared with the
laws of pure sciences.
An
art is the practical application of knowledge for achieving definite ends. A
science teaches us to know a phenomenon and an art teaches us to do a thing.
For example, there is inflation in Pakistan. This information is derived from
positive science. The government takes certain fiscal and monetary measures to
bring down the general level of prices in the country. The study of these
fiscal and monetary measures to bring down inflation makes the subject of
economics as an art.
After
arriving at a conclusion that economics is both a science as well as an art.
Here arises another controversy. Is economics a positive science or a normative
science?
(iv) Economics is Positive or Normative Science:
There
again difference of opinions among economists whether economics is a positive
or normative science. Lionel Robbins, Senior and Friedman have described
economics as a positive science. They opined that economics is based on logic.
It is a value theory only. It is, therefore, neutral between ends.
Marshall,
Pigou, Hawtrey, Keynes and many other economists regard economics as a
normative science. According to them, the real function of the science is to
increase the well-being of man. They have given suggestions in their works for
promotion of human welfare.
For
example, Malthus has given suggestions of checking the rising population. M.
Keynes has suggested measures to remove unemployment.
We
agree with Mr. Frazer, that an economist who is only an economist is a poor
pretty fish. An economist must come forward to give advice to the problems
facing the human being like depression, unemployment, high prices, etc., for
increasing his welfare.
Economics,
to conclude, has both theoretical as well as practical side. In other words, it
is both a positive and a normative science.
Market:
Market is a place where we go to buy & sell. Market is a mechanism where
buyer and seller interaction with each other. Everything in a market has value
or price. Price work for a market as a signal.
According to Chapman “Economically interpreted the term ‘market’ refers not to place but to
a commodity or commodities, the buyers or sellers of which are in competition
with one another”.
Demand: Demand
is nothing but it is not still satisfied.
Demand in economics means a desire to possess a good
supported by willingness and ability to pay for it. In the words of Prof.
Hibdon:
"Demand means the various quantities of goods
that would be purchased per time period at different prices in a given
market".
Characteristics
of Demand:
(i)
Willingness and ability to pay.
(ii)
Demand is always at a price.
(iii)
Demand is always per unit of time.
Statement of the Law of Demand:
Some well known statements of the law of demand are as
under.
According to Prof. Samuelson:
"The law of demand states that people will buy
more at lower prices and buy less at higher prices, other things remaining the
same".
E. Miller
writes:
"Other things remaining the same, the quantity
demanded of a commodity will be smaller at higher market prices and larger at
lower market prices".
"Other things remaining the same, the
quantity demanded increases with every fall in the price and decreases with
every rise in the price".
The Demand Curve
If other things remains constant the
relationship construct between product and demand is called demand curve.
The quantity demanded of a good usually is a
strong function of its price. Suppose an experiment is run to determine the
quantity demanded of a particular product at different price levels, holding
everything else constant. Presenting the data in tabular form would result in a
demand schedule, an example of which is shown below.Demand Schedule
|
Price
|
Quantity
Demanded |
|
5
|
10
|
|
4
|
17
|
|
3
|
26
|
|
2
|
38
|
|
1
|
53
|
Demand Curve
The law of demand states that quantity demanded moves in the opposite direction of price (all other things held constant), and this effect is observed in the downward slope of the demand curve.
For basic analysis, the demand curve often is approximated as a straight line. A demand function can be written to describe the demand curve. Demand functions for a straight-line demand curve take the following form:
Quantity
= a - (b x Price)
where a and b are constants that must be
determined for each particular demand curve.When price changes, the result is a change in quantity demanded as one moves along the demand curve.
Movement Vs. Shifts of Demand Curve:
Changes in demand for a commodity can be shown through
the demand curve in two ways:
(1) Movement Along the Demand Curve and (2) Shifts of
the Demand Curve.
(1) Movement along the Demand Curve:
Demand is a multivariable function. If income and
other determinants of demand such as tastes of the consumers, changes in prices
of related goods, income distribution, etc., remain constant and there is a
change only in price of the commodity, then we move along the same demand
curve.
In this case, the demand curve remains unchanged.
When, as a result of change in price, the quantity demanded increases or
decreases, it is technically called extension and contraction in demand.
The demand curve, which represents
various price quantity has a negative slope. Whenever there is a change in
the quantity demanded of a good due to change, in its price, there is a
movement from one point price quantity combination to another on the
same demand curve. Such a movement
from one point price quantity combination to another along the same demand
curve is shown in figure (4.3).
Diagram/Figure:
Here the price of a commodity falls from $8 to $2. As
a result, therefore, the quantity demanded increases from 100 units to 400
units per unit of time. There is extension in demand by 300 units. This
movement is from one point price quantity combination (a) to another point (b)
along a given demand curve. On the other hand, if the price of a good rises
from $2 to $8, there is contraction in demand by 300 units.
We, thus, see that as a result of change in the price
of a good, the consumer moves along the given demand curve. The demand curve
remains the same and does not change its position. The movement along the
demand curve is designated as change in quantity demanded.
(2) Shifts in Demand Curve:
Demand, as we know, is determined by many factors.
When there is a change in demand due to one or more than one factors other than
price, results in the shift of demand curve.
For example, if the level of income in community
rises, other factors remaining the same, the demand for the goods increases.
Consumers demand more goods at each price per period of me (rise or Increase in
demand). The demand curve shifts upward from he original demand curve
indicating that consumers at each price purchase more units of commodity per
unit of time.
If there is a fall in the disposable income of the
consumers or rise in the prices of close substitute of a good or decline in
consumer taste or non-availability of good on credit, etc, etc., there is a
reduction in demand (fall or decrease in demand). The fall or decrease in
demand shifts the demand curve from the original demand curve to the left. The
lower demand curve shows that consumers are able and willing to buy less of the
good at each price than before.
Schedule:
|
Pdx ($)
|
Qdx
|
Rise in Qdx
|
Fall in Qdx
|
|
12
|
100
|
300
|
50
|
|
6
|
250
|
500
|
200
|
|
4
|
500
|
600
|
300
|
Diagram/Figure:
In this figure, (4.4) the original demand curve is DD/.
At a price of $12 per unit, consumers
purchase 100 units. When price falls to$4 per unit, the quantity demanded
increases to 500 units per unit of time. Let us assume now that level of income
increases in a community. Now consumers demand 300 units of the commodity
at price of $12 per unit and 600 at price of $4 per unit.
As a result, there is an upward shift of the demand
curve DD2. In case the community income falls, there is then
decrease in demand at price of $12 per unit. The quantity demanded of a good
falls to 50 units. It is 300 units at price of $4 unit per period of time.
There is a downward shift of the demand to the left of the original demand
curve.
Summing
Up:
(i) Extension in demand is due to reduction in price.
(ii) Increase in demand occurs due to changes in
factors other than price.
(iii) Contraction in demand is the result of a rise in
the price commodity.
(iv) A decrease in demand follows a change in factors
other than price.
(v) Changes in demand both increase and decrease are
represent shifts in the demand curve.
(vi) Changes in the quantity demanded
Some of these demand-shifting factors are:
·
Customer
preference
·
Prices of related
goods
o
Complements - an
increase in the price of a complement reduces demand, shifting the demand curve
to the left.
o
Substitutes - an
increase in the price of a substitute product increases demand, shifting the
demand curve to the right.
·
Income - an
increase in income shifts the demand curve of normal goods to the right.
·
Number of
potential buyers - an increase in population or market size shifts the demand
curve to the right.
·
Expectations of a
price change - a news report predicting higher prices in the future can
increase the current demand as customers increase the quantity they purchase in
anticipation of the price change.
Why demand curve is downward sloping?
(i) Law of
diminishing marginal utility: The law of demand is based on the law of diminishing marginal
utility. According
to the cardinal utility approach, when a consumer purchases more units of a
commodity, its marginal utility declines. The consumer, therefore, will
purchase more units of that commodity only if its price falls. Thus a decrease
in price brings about an increase, in demand. The demand curve, therefore, is
downward sloping.
(ii) Income
effect: Other things
being equal, when the price of a commodity decreases, the real income or the
purchasing power of the household increases. The consumer is now in a position
to purchase more commodities with the same income. The demand for a commodity
thus increases not only from the existing buyers but also from the new buyers
who were earlier unable to purchase at higher price. When at a lower price,
there is a greater demand for a commodity by the households, the
Demand curve
is bound to slope downward from left to right.
(iii)
Substitution effect: The demand
curve slopes downward from left to right also because of the substitution
effect. For instance, the price of meat falls and the prices of other
substitutes say poultry and beef remain constant. Then the households would
prefer to purchase meat because it is now relatively cheaper. The increase in
demand with a fall in the price of meat will move the demand curve downward
from left to right.
(iv) Entry
of new buyers: When the
price of a commodity falls, its demand not only increases from the old buyers
but the new buyers also enter the market. The combined result of the income and
substitution effect is that demand extends, ceteris paribus, as the .price
falls. The demand curve slopes downward from left to right.
Factors affecting demand
Innumerable factors and circumstances could affect a buyer's willingness or ability to buy a good. Some of the more common factors are:
Good's own price: The basic
demand relationship is between potential prices of a good and the quantities
that would be purchased at those prices. Generally the relationship is negative
meaning that an increase in price will induce a decrease in the quantity
demanded. This negative relationship is embodied in the downward slope of the
consumer demand curve. The assumption of a negative relationship is reasonable
and intuitive. If the price of a new novel is high, a person might decide to
borrow the book from the public library rather than buy it.
Price of related
goods:
The principal related goods are complements and substitutes. A complement is a
good that is used with the primary good. Examples include hotdogs and mustard,
beer and pretzels, automobiles and gasoline.(Perfect complements behave as a
single good.) If the price of the complement goes up the quantity demanded of
the other good goes down. Mathematically, the variable representing the price
of the complementary good would have a negative coefficient in the demand
function. For example, Qd = a - P - Pg where Q is the
quantity of automobiles demanded, P is the price of automobiles and Pg
is the price of gasoline. The other main categories of related goods are
substitutes. Substitutes are goods that can be used in place of the primary
good. The mathematical relationship between the price of the substitute and the
demand for the good in question is positive. If the price of the substitute
goes down the demand for the good in question goes down.
Personal
Disposable Income:
In most cases, the more disposable income (income after tax and receipt of
benefits) you have the more likely you are to buy.
Tastes or
preferences:
The greater the desire to own a good the more likely you are to buy the good
there is a basic distinction between desire and demand. Desire is a measure of
the willingness to buy a good based on its intrinsic qualities. Demand is the
willingness and ability to put one's desires into effect. It is assumed that
tastes and preferences are relatively constant.
Consumer
expectations about future prices and income: If a consumer believes that the
price of the good will be higher in the future he is more likely to purchase
the good now. If the consumer expects that his income will be higher in the
future the consumer may buy the good now.
Population: If the
population grows this means that demand will also increase.
Nature of the
good:
If the good is a basic commodity, it will lead to a higher demand
Supply: In the words of Meyer:
“Supply
is a schedule of the amount of a good that would be offered fore sale at all
possible price at any period of time; e.g., a day, a week, and so on”.
Factors affecting Supply curve:
(i)
Technology changes. Technology
helps a producer to minimize his cost of production.
(ii) Resource supplies. The producer also has to pay for other resources such as raw materials and labor. If his money is short on supplying a certain number of products because of an increase in resource supplies, then he has to reduce his supply.
(ii) Resource supplies. The producer also has to pay for other resources such as raw materials and labor. If his money is short on supplying a certain number of products because of an increase in resource supplies, then he has to reduce his supply.
(iii) Tax/
Subsidy. A producer
aims to maximize his profit, but an increase in tax will only increase his
expenses, decreasing his capacity to buy resource supplies and forcing him to
reduce his supply.
(iv) Price
of other goods produced. A producer may not only produce on product but other products as well.
A producer's money is limited and if he increases his supply in one product, he
would have to decrease his supply in the other product, no unless his sales
increase.
Definition of Law of Supply:
There is direct relationship between the price of a
commodity and its quantity offered fore sale over a specified period of time.
When the price of a goods rises, other things remaining the same, its quantity
which is offered for sale increases as and price falls, the amount available
for sale decreases. This relationship between price and the quantities which
suppliers are prepared to offer for sale is called the law of supply.
What is Price Elasticity of Demand?
Definition:
Price
elasticity of demand measures the degree of responsiveness of the
quantity demanded of a good to a change in its price. It is also defined as:
"The
ratio of proportionate change in quantity demanded caused by a given
proportionate change in price".
Formula For Calculation:
Price
elasticity of demand is computed by dividing the percentage change in quantity
demanded of a good by the percentage change in its price.
Symbolically
price elasticity of demand is expressed as under:
Ed
= Percentage Change in Quantity Demanded
Percentage
Change in Price
Simple
formula for calculating the price elasticity of demand:
Ed
= %∆Q
%∆P
Here:
Ed
stands for price elasticity of demand.
Q
stands for original quantity.
P stands
for original price.
∆ stands
for a small change.
Example:
The
price elasticity of demand tells us the relative amount by which the quantity
demanded will change in response to a change in the price of a particular good.
For example, if there is a 10% rise in the price of a tea and it leads to
reduction in its demanded by 20%, the price elasticity of demand will be:
Ed
= -20
+10
Ed
= -2.0
Five cases
of Elasticity of Demand:
1. Perfectly
elastic demand
2. Perfectly
inelastic demand
3.
Relatively elastic demand
4.
Relatively inelastic demand
5. Unitary
elastic demand
1. Perfectly
elastic demand:
The demand
is said to be perfectly .elastic when a very insignificant change in price leads
to an infinite change in quantity demanded. A very small fall in price causes
demand to rise infinitely. Likewise a very insignificant rise in price reduces
the demand to zero. This case is theoretical which is never found in real life.
2. Perfectly
inelastic demand:
The demand
is said to be perfectly inelastic when a change in price produces no change in
the quantity demanded of a commodity. In such a case quantity demanded remains
constant regardless of change in price. The amount demanded is totally
unresponsive of change in price. The elasticity of demand is said to be zero.
3.
Relatively more elastic demand:
The demand
is relatively more elastic when a small change in price causes a greater change
in quantity demanded. In such a case a proportionate change in price of a
commodity causes more than proportionate change in quantity demanded. If price
changes by 10% the quantity demanded of the commodity change by more than 10%
i.e. 25%. The demand curve in such a situation is relatively flatter.
4. Relatively
inelastic demand:
It is a
situation where a greater change in price leads to smaller change in quantity
demanded. The demand is said to be relatively inelastic when a proportionate
change in price is greater than the proportionate change in quantity demanded.
For example If price falls by 20% quantity demanded rises by less than 20% i.e
15%.
5. Unitary
elastic demand:
The demand
is said to be unit when a change in price produces exactly the same percentage
change in the quantity demanded of a commodity. In such a situation the
percentage change in both the price and quantity demanded is the same. For
example if the price falls by 25% the quantity demanded rises by the same 25%.
It takes the shape of a rectangular hyperbola. Numerically elasticity of demand
is said to be equal to 1.(ed = 1).
Relationship
between elasticity and total revenue:
There exists
s relation hip between the elasticity and total revenue but it is different for
elastic and inelastic goods. As the formula for total revenue is:
TR = P × Q
Where P = price and Q = Quantity
Now the elasticity of demand is a direct effect of the changes in price on the quantity demanded. When there is a significant increase in Price then there is generally a significant decrease in Quantity and as a result of which Total Revenue is smaller. This shows that for goods that have a high price elasticity of demand, the decrease in total revenue is quite significant. This means that there is a negative relationship between elasticity and total revenue when the goods are elastic. For inelastic goods, the relationship may be positive. It will be positive if the price increase causes an increase in the total revenue as the quantity does not change.
TR = P × Q
Where P = price and Q = Quantity
Now the elasticity of demand is a direct effect of the changes in price on the quantity demanded. When there is a significant increase in Price then there is generally a significant decrease in Quantity and as a result of which Total Revenue is smaller. This shows that for goods that have a high price elasticity of demand, the decrease in total revenue is quite significant. This means that there is a negative relationship between elasticity and total revenue when the goods are elastic. For inelastic goods, the relationship may be positive. It will be positive if the price increase causes an increase in the total revenue as the quantity does not change.
In summary:
Elastic demand, price increase: total revenue decreases
Elastic demand, price decrease: total revenue increases
Inelastic demand, price increase: total revenue increases
Inelastic demand, price decrease: total revenue decreases
Unit elastic demand: total revenue does not change
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