Chapter 1 & 2

Introductory Economics

Chapter 1: Nature, Scope, and Methodology of

Economics a.1. Opportunity Cost

• Alternative uses that are sacrificed in making
1. The Origin of Economics a choice

- Greek word Oikonomia

• Alternative action that should have been
• Household management —> became known undertaken instead

as state management
• Measures things that must be given up or
- John Maynard Keynes Father of sacrificed when one chooses one alternative
Microeconomics
over the other

- Adam Smith - Father of Modern Economics

B. Economics as a Social Science - How society
• 1776; “An Inquiry into the Nature and and individuals generally make Choices.
Causes of the Wealth of Nations”
C. Economics and Human Wants - The study of
economics helps us to make decisions on how
2. Definitions of Economics to maximize the use of our resources to satisfy
• wealth getting and wealth using activities of man
most of our wants
• Deals on how human beings go about the D. Economics and the Concept of Scarcity -
business of organizing consumption and Scarcity is the fundamental problem in any
production activities.
society. It limits our options to choose.
• Study of people’s way of earning and enjoying life
such that it improves societies and makes human 3. Importance of Economics
civilization possible
• Students improving their analytical skills

• A social science which deals with production, • Business managers and executives will be able to
exchange, distribution, and consumption of goods maximize the ROI and profit.

and services
• Helps employees and buyers make better
• A social science that deals with efficient allocation employment and buying decisions, respectively

of scarce resources in order to satisfy unlimited • Being efficient in financial investment decision

and in satiable human wants.

• Essential for well informed citizenship

• A social science that studies human behavior as a

relationship between ends and scarce means 4. Macroeconomics VS. Microeconomics
which have alternative uses
• Close Economics - no trade between countries

- Ends —> satisfaction of unlimited needs and

wants
A. Macroeconomics
• Shows economic imbalance
• Concerned with the study of the aggregate
economy or the economy of one’s country as a
A. Economics as a Science - A systematized whole

body of knowledge that follows a scientific • Considers the four sectors in the economy

approach in dealing with economic issues. - Household

• Step 1: Know and Understand the problem
- Business
• Step 2: Formulate the hypothesis
- Government
• Step 3: Gather real-world data or facts that - Foreign sectors (Rest Of the World Sector)
are relevant to the problem

• Step 4: based on the gathered facts, • Deals with the Gross Domestic Product, inflation,
Observe, Analyze, and make Interpretation
unemployment, imports, exports, General price
level (consumer price index)

• Step 5: Generalization and

Recommendations as to whether Accept,
Reject, or Modify the hypothesis

• *providing a solution to the problem

(economic policy)

1
 B. Microeconomics • Normative Economics
- Concerned with the study of the behavior of - Involves the use of value judgements to
individual consumer and firm or industry in the assess the performance of the economy
economy or it looks only at specific economic and economic policies

units of a country
- Based on value judgement and cannot be
- Examines the factors that influence individual tested, confirmed, or refuted (What should
economic choices and how the choices of be)

various decision makers (individual consumers, - Applied Economics

firm or industry, and government agency) are

coordinated by markets
b. 3 Areas of Economic Policy
- Explains how the demand and supply of certain
I. Descriptive Economics - Helps understand
product determine equilibrium price in the
problem by gathering the data
market.

- Deals with the price of a specific product, the II. Theoretical Economics (Economic
number of employees employed in a specific Analysis) - formulating theories, analyzing
firm, or the expenditure of a specific term
data/facts.

- Focuses on specific units of the economy

- the process of deriving theories and
5. Economic Methodology principles.

• Primary Data - are collected for one’s present
purpose using direct observation, surveys, and
interviews
• Secondary data - are collected from statistical
agencies like data on prices, employment, interest,
and national income. Or the Gross Domestic
Product.
observations to generalized explanations
• Economic Theory - is a generalization based on a
- objective
- Method of Economic Analysis
A. Logical Method
• Inductive Method or empirical method
- Is applied when researches are conducted
from facts to theory or from specific
about the observed phenomenon

variety of facts about why or how an economic - Economic generalizations are derived on
event occurs
the basis of experiences and observations

- Consists of examination of facts and

• *Economic theory or principle which is put into development of general principles

action becomes an economic policy

- *empirical - verifiable by observation or
• Policies are courses of action based on economic experience rather than theory or pure logic

principles and are intended to solve a specific - ex: consumption depends upon income
economic problem and to achieve economic goals
(consumption function)

- Pinalaki
• Economic Policies - Solutions to an economic
problem • Deductive Method or Hypothetical Method
• Policy Economics - Study of policies that are - Precedes from general behavior to
solution to the problem
particular behavior of from theory to facts

- Pinaliit
• Project Evaluation - if a policy is effective or not

B. Economic Abstraction or economic

• Function of Economist - to analyze, to model
recommend policy

- Simplification of realities

a. Positive vs Normative - Economic models: an abstraction of reality

• Positive Economics • Can be shown graphically, regression

- attempts to describe how the economy and models

economic policies work without resorting to

C. Ceteris Paribus Assumption
value judgements (What is)

- can be tested and either confirmed or • with other conditions remaining the
same;

rejected based on facts

- Descriptive Econ & Theoretical Econ

• All other things being equal

• Cause and effect relationship

2
 D. Graphical Method (4) Entrepreneur
• Mathematical method
• who combines land, labor, and capital

• Tabular representation
• The one who assumes the risks in the quest
• Theoretical analysis
for profit

• Rectangular coordinate system

• Also the manager and the supervisor

• the innovator. Also the risk-bearer

III. Applied Economics/Policy Economics - • Income payment: Normal Profit

use of the theories to come up a solution to • Characteristics of Entrepreneur

the economic problem - Risk-taker

Chapter 2: Scarcity and Economic System - Innovator - commercializes new product,
new production, new technique, new
1. Scarcity market; “nova” —> new

- Imbalance between limited resources and

unlimited needs and wants
3. Needs and Wants

• Needs - satisfy survival

2. Resources • Wants - satisfy desire

2.1. Definition of Resources

• Used to produce commodity

3.1.Characteristic of Needs and Wants

• Factors of production - Unlimited

• Production inputs or means of production
- Wants create other wants
2.1.1. Cost of Production - payment for the - Multiple and varied
factors of production
• Factors: Age, Lifestyle, Physical Environment
- Insatiable - impossible to satisfy, incapable of
2.2. Characteristics of Resources
being satisfied
(1) Limited
(2) Has alternative uses 4. Basic Problem in Economics - Fundamental
(3) Can be combined in varied proportions (2 Economic Questions

methods of production) • Must be answered first before undergoing

(4) Some are renewable, some are not
economic activity

4.1.What to Produce
2.3. Classification of Resources to produce goods - A decision as to the types of goods and services
and services

society desires

(1) Land - What kind of goods to be produce

• Refers to God-given resources used in • Characteristics

production
- Tangible - products or commodities

• all natural resources

- Intangible - services

• Income Payment: Rent

• 2 types of goods

(2) Capital - Consumer Good - directly satisfy wants

• Man-made resource
and needs, for consumption

• All types of structures used in the production • Durable Goods (phone, house)

such as buildings, equipment, machineries,

land improvements, raw materials and tools
• Non-durable goods (food)

- Capital Good - indirectly satisfy needs and

• Income Payment: Interest wants, Man-made goods used to produce
• Types of Capital other goods

- Physical Capital - machine, buildings

equipment • Factors to consider

- Human Capital - refers to knowledge and - Availability of resources (Cost-efficient)

skills; professionals

- Needs and wants of the population

(3) Labor 4.2. How to Produce
- Physical and mental exertions of man
- A question on the technique of production and
- Income Payment: Wages the manner of combining resources to come up
with the desired output.

- Needs to produce at lowest cost

- Method/process of production

3
 • 2 Method of Production/Factor Intensive
5.4. Behavior of PPC

- Labor Intensive - labor > capital/ - Downward sloping to the right

machineries • As you produce more of good x, you have to
- Capital Intensive - machineries > labor
produce less of good y (trade-off)

• Factors to consider
- Shape: Concave to the point of origin
- Availability of resources (Cost-efficient) • The slope is increasing as the opportunity
- Methods of production cost is increasing

- PPC shifting outward to the right shows

4.3.For whom to Produce economic growth

- The determination of how output is to be divided

or allocated among members of the society
5.5.Full Employment of resources

- Allocation of goods
- All scarce resources are fully and efficiently
- Target Market
employed

- The economy is employing its available

Economic Activities resources

(1) Production

- Midpoint - points of full production and full

employment

(2) Resource Allocation

(3) Consumption
5.6.Inefficient point (Inside the PPC)

(4) Distribution
- Unemployment - all resources are not fully
(5) Exchange (Growth over time)
utilized and some are wasted

- Underemployed - resources are not fully

5. The Production Possibilities Curve employed, not enought (e.g. they produce less
• Graphical presentation of the different combination working hours than 8 hours)
of two goods or services that can be produced,
given a fixed amount of resources and technology 5.7.Unattainable point (Outside the PPC)

and full employment of resources

- Beyond the capacity of the economy

• A curve which depicts the trade-off between two - Attainable through

commodities
• Innovation of technology

• Shows resource allocation

• Increase in the supply of resources

• Shows Trade-off - sacrifice a certain quantity of

good to produce more of another good
6. Economic System

- a balance achieved between two desirable but - A set of economic institutions that dominates a given
incompatible features
economy with the main objective of solving the
economic problems

5.1. Assumptions in analyzing the PPC - Institutions - set of rules of conduct, established
(1) The economy produces only two ways of thinking, or ways of doing things

commodities - Solve the basic economic problem

(2) Resources available for use in the

A. Traditional Economic System
economy are fixed
• Economic decisions are made based on customs
(3) The state of technology is constant and traditions

(4) Full employment of Resources • Generally repeats the decisions made at an earlier
5.2. Opportunity Cost of good X
time or by an earlier generation

• (OCx) = (Y2 - Y1)/(X2 - X1)

• Basic problems are decided by customs and
traditions

5.3. Law of increasing opportunity Cost • e.g. Barter System

- As the production of a particular good

increases, the opportunity cost of producing B. Modern Economic System
additional unit rises

- As more of one good is produce, the more units

of the other good you have to sacrificed

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 1. Capitalism • GOCC - Government Owned and Controlled
• Capital resources are owned by private Corporations

sectors
• State corporations, public land

• Market Economy - market Force is in the • price floor, price ceiling for emergencies

Market

6.1.Emerging Economies
• Free Enterprise Economy - Freedom to
engage in any economic activity
• BRIC - Brazil, Russia, Indonesia, China
• Laissez-Faire (Let it be) - keeping • TRIP - Turkey, Russia, Indonesia, Philippines

government from interfering with the • Asian Tiger - Singapore, Malaysia, Hong
economy. Only legal framework or laws
Kong, Japan, Taiwan
• Basic problem are decided by the market 7. Economic Goals
system or simply the demand and supply
1) Economic growth
condition.

• an increase in the total output produced in the

1.1. Characteristics of Capitalism
economy measured in terms of the Real
- Private Ownership - resources owned by Gross Domestic Product.

private individual • Happens when the economy increase its

- Presence of Competition production capacity and develop better ways
- Forces of demand and supply of producing and developing new products
and services

(interaction) - in determining the price

2) Equitable distribution of income
- Wide usage of money
• To ensure that no group of citizen faces
• money economy - use of money as a extreme poverty while others enjoy
medium of exchange abundance and prosperity

- Self-interest - invisible hand, consumer • Government can impose heavy taxation from
and producer maximize their satisfaction the rich and spend this for social services

and profit, respectively 3) Price stability

- Profit-motivated • To prevent increases in the general price level
- Economic Freedom/Freedom of choice known as inflation, as well as decreases in the
- Active but limited government general price level known as deflation

- *Outcome: unequal distribution of income 4) Full Employment

• To provide suitable jobs for all citizens who
2. Communism are willing and able to work

• Relies on the government to decide how the • Not only confined to employment of labor but
country’s resources would be best allocated
also full utilization of land, capital, and
• Command System - Government’s Decision, entrepreneur that will propel to more
all orders are from government, econ system production in the economy, hence, economic
relies on the gov’t.
growth

• Centrally Planned Economy - answers the 5) Economic Freedom

fundamental economic question, interest of • To guarantee that businesses, workers and
everyone is put into consideration
consumers have a high degree of freedom in
• Communism - common interest, common their economic activities

welfare is promoted
6) Economic Security
2.1. Characteristics of Communism
• To provide for those who are disabled,
chronically ill, aged, handicapped or
• No private ownership otherwise dependent.

• Pricing system from the government 7) Balance of Trade

• No free competition • International trade and financial transaction

• No profit-motivation • Profits from exports are used to pay imports

• Central economic planning • Trade Balance: Import and export are balance

3. Mixed Economy
- Trade Deficit - imports > exports
• Public and private ownership of Resources - Trade Surplus - exports > imports

and enterprise
• Peso will be strengten

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 8) Economic Development
• Improvement in the quality of life and people

• HDI: Human Development Index

(1) Standard of Living - GDP per

Capita = GDP/population
(2) Level of Education/Literacy
(3) Health index
8. 17 Sustainable Development Goals
1) No Poverty
2) Zero Hunger
3) Good health and well-being
4) Quality education
5) Gender equality
6) Clean water and sanitation
7) Affordable and clean energy
8) Decent work and economic growth
9) industry, innovation and infrastructure
10) Reduced inequalities
11) Sustainable cities and communities
12) Responsible consumption and production
13) Climate action
14) Life below water
15) Life on land
16) Peace, justice, and strong institutions
17) Partnership for the goals

6
Chapter 3 & 4
Introductory Economics

II. Circular Flow for Microeconomics

- Factor Payments - payments for the factors of Resource Market Product Market
production

• Rent:Rent,
Seller Consumer Producer
• Labor:Wages, salaries
Buyer Producer Consumer
• Capital:Interest

• Entrepreneur:Normal profit

- Factor Owners - also the consumer • Free Good (zero priced goods) - a resource, such
• Labor —> laborer
as sunlight or air, which is so abundant that its
• Land —> Landlord/land owner
availability is not a constraint on economic activity

• Capital —> Capitalist

• Economic Good (positive priced goods) - goods
• Entrepreneurial ability —> entrepreneur
or services which command a price
- Resource Market (Factor Market)
• where resources or the services of resource Chapter 3: Market Demand and Market Supply
owner are bought and sold.

• Labor Market —> wages

1. Definition of Market
• Land Market —> real estate
• a situation where you find buyers and sellers
- Product Market making transactions

• goods, product, services

• Bring together buyers and sellers in the
- product market or resource market

Revenue - income received by the producer

from the sale of goods and services • Forces of demand and supply


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2. Supply and Demand

Demand Supply

Definition A schedule (list) of different quantities of a good A schedule (list) of different quantities of a good
that a consumer/s is/are able and willing to that a supplier/s is/are able and willing to sell
buy at various alternative prices over a given at various alternative prices over a given period
period of time, ceteris paribus (all other things of time, ceteris paribus (all other things constant)

constant)

Quantity Demanded - the amount of a good/ Quantity Supplied - the amount of a good/
service that buyers desire to purchase at a service that sellers desire to sell at a particular
particular price during some period price during some period
Law The higher the price of the good, the lesser the The higher the price of the good, the higher the
quantity demanded, and vice versa, ceteris quantity supplied and vice versa, ceteris paribus
paribus
As As a algebraic function
Function
- Mathematical equation that shows the inverse - Mathematical equation that shows the direct
relation between price and Qd cetpar.
relation between price and Qs cetpar.

- Qd = a - bP where:
- Qs = -c + dP where:

• Qd = quantity demanded
• Qs = quantity supplied

• a = constant value, the maximum quantity • -c = constant value

the market can absorb when the price is - Minimum quantity that producer are
zero or free
willing and able to sell

• -b = non-price determinants
- Qs of a good if the price is zero or free

- for every peso increase in P price, there is - for the Qs to be positive, the price must
b units decrease in quantity demanded be greater than 0

Slope of the equation —> negative slope

• d = constant, non-price determinants

- Shows inverse relationship between - For every increase in P price there is b

quantity and price units increase in quantity supplied
As As a tabular presentation
Schedule
- A list or table that shows the inverse relation
- A list or table that shows the direct relation

- Demand is the entire schedule

- supply is the entire schedule

- Qd - the is the specific quantity demanded at a specific P price

- Qs - the specific quantity supplied at a specific P price

- Demand - is represented by the entire schedule - Supply - is represented by the entire schedule
As Curve as a graphical presentation
- Locus of points that shows the inverse relation
- Locus of points that shows the direct relation

- Downward sloping
- upward sloping

• As price decreases, quantity demanded • As price increases, quantity supplied

increases
increases

- Qd - specific point of a curve

- Qs - specific point of a curve

- Demand - represented graphically by the whole demand curve - Supply - represented graphically by the whole supply curve

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 Demand Supply

Non- 1. Income 1. Resource price (Inverse)

Price • Superior or Normal goods (Direct relation) • High payment for land, labor, capital, &
Determin - as income rises the demand for this good entrepreneur (cost of production; rent,
ants also increases, vice versa
wages, interest, normal profit) discourages
• Inferior or giffen goods (Inverse relation) sellers hence a decrease in supply.

- as income declines, the demand for this 2. Technology (direct)

good increases, vice versa
• Improved technology encourages
2. Tastes and preferences (Direct relation) producers, hence there will be an increase in
• Social Environment —> culture
supply

• Demographic profile —> population

3. Prices of related goods or price of
• religion, tradition, age
competing products (Inverse)
3. Prices of related goods and services • Suppliers will rather sell goods with a higher
• Substitute goods (direct) price than a competing product with lower
- can be used in place of another good.
price to increase profit.

- If the price of a good increases, the 4. Firm’s Expectation about future price
demand for another good increases
(Inverse)
- e.g. rice and corn
• If the price of a good is expected to
• Complementary goods (inverse)
increase, it will be hoarded, hence a
- used together with another good.
decrease in supply

- If the price of a good increases, the 5. Number of Suppliers (direct)

demand for another good decreases
• The more the number of sellers, the higher
- e.g. bread and butter
the supply

4. Buyer’s expectation about future prices 6. Taxes and Subsidy

(Direct) • ↑Taxes (cost) (inverse)

• Price is expected to increase, the demand - ↑ cost of production—↓ supply

increases
• ↑subsidy (income) (direct)

5. Number of Buyers (Direct) - ↓ cost of production —↑supply

• the more the number of buyers, the higher
the demand
Versus △Qd vs △D △Qs vs △S

Change in quantity demand (△Qd) Change in quantity supplied (△Qs)

- Occurs when there is a change in the price of - Occurs when there is a change in the price of
the good itself all other things constant
the good itself all other things constant

- A movement along a given demand curve - A movement along a given supply curve from
from point A to point B.
point A to point B.

Change in demand (△D) Change in supply (△D)

- Occurs when there is a change in any of the - Occurs whenever any of the other
other determinants of demand
determinants of supply changes.

- The shift of the entire demand curve either to - The shift of the entire supply curve either to
the left or to the right the left or to the right

△P —> △Qd
△P —> △Qs

↓ P —> ↑ Qd —> downward movement along the Demand Curve

↑ P —> ↑ Qs —> upward movement along the Demand Curve

↑ P —> ↓ Qd —> upwards movement along the demand curve ↓ P —> ↓ Qs —> downward movement along the demand curve

9
Type of Demands
- Individual demand - the demand schedule/curve of a single buyer
- Market Demand - the sum of individual demand, the demand schedule/curve of all buyers of a goods or
services

Individual Demand Market Demand

Demand of Juan dela cruz for Rice over a week Demand of Brgy. Maginhawa for Rice over a week
Price per kilo Quantity demanded (kilos) X1000 Quantity demanded (kilos)

P0 60 1,000 60,000

10 50 1,000 50,000

20 40 1,000 40,000

30 30 1,000 30,000

40 20 1,000 20,000

50 10 1,000 10,000

Theory of consumer behavior

- Assumption of consumer rationality

- Assumes that all consumer are rational

- Consumers always maximize their satisfaction;

3. Market Equilibrium

• Equilibrium
- This is why economics is a predictive science

- Means that all forces in the market are in balance

- Attained where the quantity demanded is equal to quantity supplied Qd = Qs.

• Equilibrium point - point of intersection

• Equilibrium price

- outcome of transaction

- The result of market transaction

- Price which the seller and buyer agreed upon

• Finding Equilibrium Price (Ps) and equilibrium quantity (Qe) through

a. Mathematical analysis (Qd = Qs)

b. Tabular analysis
c. Graphical analysis
• Surplus - the excess of the quantity supplied over quantity demanded. (Qd < Qs; ↑P)

• Shortage - when the quantity demanded is higher than quantity supplied (Qd > Qs; ↓P)

10
 Sample Problem:

Demand Function: Supply Function
Given: Qd = 10-2P
Given: Qs = -5+3P

Demand Schedule Supply Schedule

Demand schedule of Good X over a month
Supply schedule of Good X over a month

Prices/Unit Quantity Demanded Prices/Unit Quantity Supplied

0 10 1 -2

1 8 2 1

2 6 3 4

3 4 4 7

4 2 5 10

5 0

Demand Curve Supply Curve


Market Equilibrium

Mathematical analysis:
Tabular analysis: Graphical analysis:
• Qd = 10-2P ; Qs = -5+3P
Prices Quantity Quantity
• Qd = Qs
/Unit Demanded Supplied
Qs - Qd

• 10-2P = -5+3P

1 8 -2 -10
• 10+5 = 2P+3P

• 15 = 5P
2 6 1 -5
• 3 = Pe
3 4 4 0
Therefore, (substitute)
• Qd = 10-2(3) = 4
4 2 7 5
• Qs = -5+3(3) = 4
5 0 10 10
We can conclude that Pe = 3
and Qe = 4 units

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4. Effect of a change in Demand or change in B. Elasticity
supply on Market Equilibrium (4 Generalizations) • It measures the sensitivity of one variable to
• Determinants with direct relation, Increase in income to normal goods; another.

change of taste (vice versa)

• A number that tells us the percentage change that
a. ↑D S —> ↑Pe ↑Qe will occur in one variable in response to a 1
b. ↓D S —> ↓ Pe ↓ Qe percent increase in another variable

c. ↑S D —> ↓ Pe ↑Qe (Improvement in technology) • As to how responsive is the dependent variable

with respect to change in independent variable

d. ↓S D —> ↑Pe ↓ Qe (Increase in tax)

•
5. Effect of a Simultaneous Change in Demand and a. Price Elasticity of Demand
Supply - Measures the degree of responsiveness of
a. S↑, D↑ quantity demanded due to changes in the price
- S↑ = D↑ —> -Pe ↑Qe
Th:
of the good itself, other things constant.

- S↑ > D↑ —> ↓Pe ↑Qe

↑↓ D - direct to Pe and Qe
- Always negative because of inverse relationship
↑↓ S is inverse to Pe but
between Qd and Price

- S↑ < D↑ —> ↑Pe ↑Qe

- Elastic or Relatively Elastic
b. S↑, D↓ ** For equal same ↑↓ in S & D, • Has flatter demand curve

- S↑ = D↓ —> ↓Pe -Qe

same ↑↓ for Qe but — for Pe
• If a specific percentage change in price
- S↑ > D↓ —> ↓Pe ↑Qe
for equal opposite ↑↓ in S & D, results in a larger percentage change in Qd.
- S↑ < D↓ —> ↓Pe ↓Qe
↑↓ Pe = ↑↓ D but — for Qe

Then εd will be > 1.

c. S↓, D↑ For unequal ↑↓ in S & D, • To increase total revenue, price should be

- S↓ = D↑ —> ↑Pe -Qe
whichever is bigger is the ↑↓ of reduced because demand is very responsive
- S↓ > D↑ —> ↑Pe ↓Qe
Pe & Qe, applying the TH. to a change in price

- S↓ < D↑ —> ↑Pe ↑Qe

- Unitary or Unit Elastic Demand
d. S ↓, D ↓ — (constant)
• percentage change in price and the resulting
- S↓ = D↓ —> -Pe ↓Qe
↑↓ - increase/decrease
percentage change in quantity demanded are
Direct - same direction

- S↓ > D↓ —> ↑Pe ↓Qe

inverse the same.

- S↓ < D↓ —> ↓Pe ↓Qe

- opposite direction • Any change in price has no effect on total

revenue because demand changes
Chapter 4: Application of Demand and Supply and proportionately to a price change

Concept of Scarcity
- Inelastic or Relatively Inelastic Demand
1. Government Intervention in the Market • A steep curve

a. Price Control or Price Ceiling

• If a specific percentage change in price
produces a smaller percentage change in Qd,
- Maximum legal price fixed by the government demand is inelastic. Then εd will be <1

on consumers’ goods like rice, oil and sugar to • To increase total revenue, sellers may increase
keep prices from further
the price causing buyers to reduce demand
- Protecting the consumers and their interest
by a little but not a tremendous decline
- Creates shortage
because the demand is not very responsive
- Creates black market due to shortage
to changes in price

b. Price Support or Floor Price - Perfectly Elastic Demand

- Minimum price set by the government on • Horizontal demand curve

producer’s good to keep prices from further • Regardless of Qd the price is set at a specified
decline
given level

- Creates surplus
- Perfectly Inelastic Demand
c. Minimum Wages • Vertical demand curve

- The lowest daily wage that employers may • A change in price will have no influence on
legally pay to workers
quantity demanded

- The lowest wage workers may receive for the b. Price Elasticity of Supply
services rendered
- Measures the degree of responsiveness of
- Surplus of labor, causes unemployment
quantity supplied due to changes in the price of
the good itself, other things constant.

12
 c. The Income Elasticity of Demand
- Measures the degree of responsiveness of
quantity demanded due to changes in the
consumer’s income, other things constant
of related goods, other things constant
d. The Cross (price) Elasticity of Demand
- Measures the degree of responsiveness of
quantity demanded due to changes in the price

• Normal VS Inferior Goods

• Substitute VS complimentary goods


e. Factors that Affect Elasticity Demand Elastic Inelastic

Nature of Product Luxuries Necessity

Number of close substitutes available Higher Number Lesser Number

Percentage of income spent on a good High-priced goods on income High-priced goods on income

Time period under consideration Long-run Short-tun

Elasticity Coefficient; if ε = %△Q/%△P Examples

Price Elasticity of Supply and Measures the degree of responsiveness of quantity of quantity
demanded due to changes in the price of the good itself, other things
Demand
constant. +ε for supply, -ε for demand

Elastic or Relatively Elastic εd > 1; %△Q > %△P Luxury goods

Unitary or Unit Elastic Demand for a load in their

εd = 1; %△Q = %△P
Demand cellphone

Inelastic or Relatively
εd < 1; %△Q < %△P Basic goods/necessities
Inelastic Demand

Perfectly Elastic Demand εd = ∞ Pure competition

Perfectly Inelastic Demand εd = 0 medicine/doctors’ prescriptions

The Income Elasticity of Demand (εy)

Normal Good + %△Y, + %△Qd ↑Y —> ↑D

Qd of the product changes in the SAME
εy > 0
DIRECTION as change in income
Positive elasticity coefficient - %△Y, - %△Qd ↓Y —> ↓D

Inferior Good + %△Y, - %△Qd ↑Y —> ↓ D

εy < 0
Qd of the product changes in the OPPOSITE
DIRECTION as change in income
Negative elasticity coefficient - %△Y, + %△Qd ↓ Y —> ↑D

The Cross Elasticity of Demand (εxy)

Substitute Goods ↑Py —> ↑Dx

Qd of X changes in the SAME DIRECTION as

εxy > 0
change in price of Y
Positive cross elasticity coefficient ↓Py —> ↓Dx

Complementary Goods ↑ Py —> ↓Dx

Qd of X changes in the OPPOSITE DIRECTION

εxy < 0
as change in price of Y
Negative cross elasticity coefficient ↓ Py —> ↑Dx

Qd of X has NO EFFECT on price of Y εxy = 0 Unrelated goods

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 Perfectly inelastic and
elastic demands.
Demand curve D1 in (a) represents
perfectly inelastic demand (Ed 0). A
price increase will result in no
change in quantity demanded.
Demand curve D2 in (b) represents
perfectly elastic demand. A price
increase will cause quantity
demanded to decline from an infinite
amount to zero (Ed ).

• gold+orange area - total revenue

• Gold area - revenue loss
• Brown area - Revenue gain

- Total Revenue Test - the easiest way to infer • Elasticity of Demand can be measured by

whether demand is elastic or inelastic A. Point Elasticity of Demand

B. Arc Elasticity
- Total revenue (TR) is the total amount the seller
receives from the sale of a product in a particular
time period; it is calculated by multiplying the
product price (P ) by the quantity sold (Q), or

TR = P X Q
- Elastic Demand
• If demand is elastic, a decrease in price will
increase total revenue. Even though a lesser price
is received per unit, enough additional units are
sold to more than make up for the lower price.

• also, a price increase will reduce total revenue. The

revenue gained on the higher-priced units will be
more than offset by the revenue lost from the lower
quantity sold.

• bottomline: Other things equal, when price and

total revenue move in opposite directions, demand
is elastic.

- Inelastic Demand
• If demand is inelastic, a price decrease will reduce
total revenue. The increase in sales will not fully
offset the decline in revenue per unit, and total
revenue will decline

• a price increase will increase total revenue. So,

other things equal, when price and total revenue
move in the same direction, demand is inelastic.

- Unitary Demand
• an increase or a decrease in price leaves total
revenue unchanged.

• The loss in revenue from a lower unit price is

exactly offset by the gain in revenue from the
accompanying increase in sales. Conversely, the
gain in revenue from a higher unit price is exactly
offset by the revenue loss associated with the
accompanying decline in the amount demanded.

• Other things equal, when price changes and total

revenue remains constant, demand is unit-elastic
(or uni- tary).

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