Lecture 1

•Ten Principles of Economics

•Thinking like an Economist

 • Economics is the study of
how society manages its
scarce resources.
• Resources
• Land
• Labor
What is
• Capital
Economics?
• Time
• The management of society’s
resources is important because
resources are scarce.
 The economy’ refers to all the
production and exchange
activities that take place every
day - all the buying and selling.

Economy &
Economics The economy exists at different
scales

• Local
• National e.g. the Turkish
• International e.g. EU
 Principle #1: People Face trade-offs.
To get one thing, we usually have to give up another thing.
Making decisions requires trading off one goal against another.
 Efficiency vs. Equity
Efficiency means society gets the most that it can from its scarce resources.
Equity means the benefits of those resources are distributed fairly among the
members of society.
Principle #2: The Cost of Something
Is What You Give Up to Get It.
•The opportunity cost of an item is what you give up to
obtain that item.
 Principle #3: Rational People Think at the Margin.

People make decisions by comparing costs and benefits at the margin.

Principle #4: People
Respond to
Incentives.

•Marginal changes in
costs or benefits
motivate people to
respond.
•Public policies can
create incentives or
disincentives that
alter behavior.
Principle #5: Trade Can Make Everyone Better Off.

People gain from their ability to trade with one another.

Competition results in gains from trading.
Trade allows people to specialize in what they do best.
 Principle #6: Markets
Are Usually a Good Way
to Organize Economic
Activity.

Market economy
Planned economy
Adam Smith made the observation
that households and firms
interacting in markets act as if
guided by an “invisible hand.”
 Principle #7:
Governments Can
Sometimes Improve
Market Outcomes.

• Market failure occurs when the

market fails to allocate resources
efficiently.
• Market failure may be caused by
• externality,
• market power.
 Microeconomics is the
study of how households
and firms make decisions
and how they interact in
markets.
Microeconomics
&
Macroeconomics
Macroeconomics is the
study of economy-wide
phenomena, including
inflation, unemployment
and economic growth.
Principle #8: The Standard of Living
Depends on a Country’s Production.
• Standard of living - a measure of welfare based on
the amount of goods and services a person’s income
can buy.
• Productivity is the amount of goods and services
produced from each hour of a worker’s time.
 Principle #9: Prices Rise When the
Government Prints Too Much Money.

•Inflation is an increase in the overall level of

prices in the economy.
•When the government creates large quantities of
money, the value of the money falls.
Principle #10: Society Faces a Short-run trade-off
Between Inflation and Unemployment.

•The Phillips Curve illustrates the

trade-off between inflation and
unemployment.
•It’s a short-run trade-off!
 Why do we learn
economics?
• Economics trains you to. . . .
• Think in terms of alternatives.
• Evaluate the cost of individual
and social choices.
• Examine and understand how
certain events and issues are
related.
 Uses abstract models to
help explain how a
complex, real world
operates.
How does
an
economist
work? Develops theories,
collects, and analyses data
to evaluate the theories.
 Economists make
assumptions in order
to make the world
easier to understand.
The Role of
Assumptions
The art in scientific
thinking is deciding
which assumptions
to make.
 • Economists use models to
simplify reality in order to
improve our understanding
of the world.
• A model will contain a
Models in number of variables:
economics • endogenous variable
• exogenous variable
• Cause and effect
 MARKETS
Revenue FOR Spending
GOODS AND SERVICES
Goods •Firms sell Goods and
and services •Households buy services
sold bought

FIRMS HOUSEHOLDS
•Produce and sell •Buy and consume
goods and services goods and services
•Hire and use factors •Own and sell factors
of production of production

Factors of MARKETS Labour, land,

production FOR and capital
FACTORS OF PRODUCTION
Wages, rent, •Households sell Income
and profit •Firms buy
= Flow of inputs
and outputs
= Flow of money
 The economist: a scientist or a policy advisor?
• When economists are trying to explain the world, they are scientists.
• Positive statements
• Descriptive analysis
• When economists are trying to change the world, they are policy advisors.
• Normative statements
• Prescriptive analysis
 Why economists disagree
• They may disagree about the validity of alternative positive theories
about how the world works.
• They may have different values and, therefore, different normative
views about what policy should try to accomplish.
 Exercise

• Define the conflict between “efficiency” and

“equity” using the following keywords:
• scarcity
• trade-off
• oppurtunity cost
ECO1211
IntroductIon
to EconomIcs
LECTURE 3
The Market Forces of Supply
and Demand
from MANKIW & TAYLOR
2014; Ch. 3

1
 Markets and Competition
▪ A market is a group of buyers and sellers of a particular good or
service.

▪ The terms supply and demand refer to the behavior of people . . .

as they interact with one another in markets.
▪ Buyers determine demand.
▪ Sellers determine supply

2
 Competition: Perfect and Otherwise
▪ A competitive market is a market in which there are many
buyers and sellers so that each has a negligible impact on the
market price.

▪ Perfect Competition
▪ Products are the same
▪ Buyers and Sellers are price takers
3
 Demand
▪ Quantity demanded is the amount of a good
that buyers are willing and able to purchase.
▪ Law of Demand
▪ The law of demand states that, other things equal, the quantity demanded
of a good falls when the price of the good rises.
▪ Demand Schedule
▪ The demand schedule is a table that shows the relationship between the
price of the good and the quantity demanded.
▪ Demand Curve
▪ The demand curve is a graph of the relationship between the price of a
good and the quantity demanded.

4
 >> Demand
Price of
Milk
$3.00

2.50

1. A decrease
2.00
in price ...

1.50

1.00

0.50

0 1 2 3 4 5 6 7 8 9 10 11 12 Quantity of
Milk
2. ... increases quantity 5
of milk demanded.
▪ Change in Quantity Demanded
▪ Movement along the demand Change in
curve. quantity
▪ Caused by a change in the price of
the product.
demanded

▪ Change in Demand
▪ A shift in the demand curve is
caused by a factor affecting
demand other than a change in
price.

6
>> Change in Quantity Demanded
Price of
Milk A tax that raises the
price of milk results in
B a movement along the
$2.00
demand curve.

1.00 A

D
0 4 8 Quantity of Milk
7
 >> Change in Quantity Demanded
▪ Assume the price of milk falls.
▪ More will be demanded because of the income and
substitution effects.

▪ The income effect. Assume that incomes remain constant

then a fall in the price of milk means that consumers can
now afford to buy more with their income.

▪ The substitution effect. Milk is lower in price compared to

other similar products so some consumers will choose to
substitute the more expensive drinks with the now cheaper
milk.
8
Shifts in the Demand Curve
▪ A shift in the demand curve, to the left or right.
▪ Caused by any change that alters the quantity demanded
at every price.

▪ Shifts caused by factors other than price.

▪ Consumer income.
▪ Prices of related goods (substitutes and complements.
▪ Tastes and fashions.
▪ Number of buyers (population).
▪ Expectations of consumers.

9
10
 >> Shifts in the Demand Curve
Price of
Milk

Increase
in demand

Decrease
in demand
Demand
curve, D2
Demand
curve, D1
Demand curve, D3
0 Quantity of
Milk 11
 >> Shifts in the Demand Curve
▪ Consumer Income
▪ As income increases the demand for a normal good will
increase.
▪ As income increases the demand for an inferior good will
decrease.

▪ Prices of Related Goods

▪ When a fall in the price of one good reduces the
demand for another good, the two goods are called
substitutes.
▪ When a fall in the price of one good increases the
demand for another good, the two goods are called
complements.
12
 Consumer Income: Normal Good
Price of shirt

$3.00 An increase
2.50 in income...
Increase
2.00 in demand

1.50

1.00

0.50
D2
D1 Quantity of
0 1 2 3 4 5 6 7 8 9 10 11 12 Shirt
13
>> Consumer Income: Inferior Good
Price of bread

$3.00

2.50

2.00
Decrease
An increase
1.50 in demand in income...
1.00

0.50

D2 D1 Quantity of
0 1 2 3 4 5 6 7 8 9 10 11 12 bread
14
Variables That Influence Buyers

15
 SUPPLY
▪ Quantity supplied is the amount of a
good that sellers are willing and able to
sell.
▪ Law of Supply
▪ The law of supply states that, other things equal, the quantity supplied of a
good rises when the price of the good rises.
▪ Supply Schedule
▪ The supply schedule is a table that shows the relationship between the
price of the good and the quantity supplied.
▪ Supply Curve
▪ The supply curve is the graph of the relationship between the price of a
good and the quantity supplied.
16
 Supply Schedule and Supply Curve
Price of
Milk

$3.00

2.50
1. An
increase
in price ... 2.00

1.50

1.00

0.50

0 1 2 3 4 5 6 7 8 9 10 11 12 Quantity of
Milk
17
2. ... increases quantity of milk supplied.
Changes in quantity supplied & supply curve
▪ Change in Quantity Supplied
▪ Movement along the supply curve.
▪ Caused by a change in the price of the product.

▪ Change in Supply
▪ A shift in the supply curve, either to the left or right.
▪ Caused by any change that alters the quantity supplied at every price.
▪ Input prices
▪ Technology
▪ Expectations
▪ Number of sellers

18
Change in Quantity Supplied
Price of
Milk S
C
$3.00
A rise in the price
of milk results in a
movement along
the supply curve.
A
1.00

Quantity of
Milk
0 1 5

19
20
 Shifts in the Supply Curve
Price of
Milk Supply curve, S3
Supply
curve, S1
Supply
Decrease curve, S2
in supply

Increase
in supply

0 Quantity of 21
Milk
Variables That Influence Sellers

22
Supply and Demand Together

▪ Equilibrium refers to a situation in which the price has reached

the level where quantity supplied equals quantity demanded.
▪ Equilibrium Price
▪ The price that balances quantity supplied and quantity demanded.
▪ On a graph, it is the price at which the supply and demand curves intersect.

▪ Equilibrium Quantity
▪ The quantity supplied and the quantity demanded at the equilibrium price.
▪ On a graph it is the quantity at which the supply and demand curves
intersect.

23
Supply and Demand Together
Demand Schedule Supply Schedule

At $2.00, the quantity demanded

is equal to the quantity supplied!
24
 The Equilibrium of Supply and Demand
Price of
Milk
Supply

Equilibrium price Equilibrium

$2.00

Equilibrium Demand
quantity

0 1 2 3 4 5 6 7 8 9 10 11 12 13
Quantity of Milk 25
Markets Not in Equilibrium
(a) Excess Supply
Price of
Milk Supply
Surplus
$2.50

2.00

Demand

0 4 7 10 Quantity of
Quantity Quantity Milk
demanded supplied
26
Markets Not in Equilibrium
(b) Excess Demand
Price of
Milk
Supply

$2.00

1.50
Shortage
Demand

0 4 7 10 Quantity of
Quantity Quantity Milk
supplied demanded
27
Law of supply and demand & change in the
market
▪ Law of supply and demand
▪ The claim that the price of any good adjusts to bring the quantity supplied
and the quantity demanded for that good into balance.

▪ Three Steps to Analyzing Changes in Equilibrium

▪ Decide whether the event shifts the supply or demand curve (or both).
▪ Decide whether the curve(s) shift(s) to the left or to the right.
▪ Use the supply-and-demand diagram to see how the shift affects
equilibrium price and quantity.

28
 How an Increase in Demand Affects the Equilibrium
Price of
Milk 1. Health news increases
the demand for milk . . .

Supply

$2.50 New equilibrium

2.00
2. . . . resulting
Initial
in a higher
equilibrium
price . . .
D

0 7 10 Quantity of
3. . . . and a higher Milk 29
quantity sold.
 How a Decrease in Supply Affects the Equilibrium
Price of
Milk 1. An increase in the
price of animal feed reduces
the supply of milk . .
S2
S1

New
$2.50 equilibrium

2.00 Initial equilibrium

2. . . . resulting
in a higher
price of milk …
Demand

0 4 7 Quantity of
3. . . . and a lower Milk 30
quantity sold.
 Key concepts of the lecture
▪ market ▪ ceteris paribus
▪ competitive market ▪ quantity supplied
▪ quantity demanded ▪ law of supply
▪ law of demand ▪ supply schedule
▪ normal good ▪ supply curve
▪ inferior good ▪ equilibrium
▪ substitutes ▪ equilibrium price
▪ complements ▪ equilibrium quantity
▪ demand schedule ▪ surplus
▪ demand curve ▪ shortage
▪ law of supply and demand
31
 Exercise
▪ Years ago through the growing fear of “pig
influenza”, people began to use more anti-
bacterial soaps.
However, unexpectedly the price of anti-
bacterial soap did not increase, even we
observed falling prices.

How it can happen? Justify your answer

with supply and demand diagram(s).

32
▪ LECTURE 4
▪ Elasticity and Its Applications
▪ from MANKIW & TAYLOR 2014; Ch. 4

1
 Elasticity . . .

▪ … allows us to analyze supply and demand

with greater precision.
▪ … is a measure of how much buyers or sellers
respond to changes in market conditions
▪ What is the effect of additional taxes on cigarette
consumption?
▪ Price elasticity of demand
▪ What is the effect of an increse in oil price on
production?
▪ Price elasticity of supply
▪ What is the effect of an increse in income on
demand?
▪ Income elasticity of demand

2
 The elasticity of demand

▪ Price elasticity of demand is a measure of how much the quantity

demanded of a good responds to a change in the price of that
good.
▪ The Price Elasticity of Demand and Its Determinants
▪ Availability of Close Substitutes
▪ Necessities versus Luxuries
▪ Definition of the Market
▪ Time Horizon

3
Computing the Price Elasticity of
Demand
▪ Example: If the price of a product
increases from $2.00 to $2.20 and
the amount you buy falls from 10 to
8, then your elasticity of demand
would be calculated as:
▪ % change in Q= -20
▪ % change in P= 10
▪ Price elasticity of demand (Ed) = -20
/ 10 = -2
▪ Generally treated in absolute terms:
|Ed | ➔ |-2 | = 2

4
Price elasticities of different
goods/services
Market Own Price Elasticity
Transportation -0,6
Motor vehicles -1,4
Motorcycles & bicycles -2,3
Food -0,7
Cereal -1,5
Clothing -0,9
Women’s clothing -1,2
Source: Baye et al. 1992 5
Using the Midpoint Method

6
The Variety of
Demand Curves
▪ Inelastic Demand
▪ Quantity demanded does
not respond strongly to price
changes.
▪ Price elasticity of demand is
less than one.

7
> The Variety of
Demand Curves
▪ Elastic Demand
▪ Quantity demanded
responds strongly to changes
in price.
▪ Price elasticity of demand is
greater than one.

8
 ▪ Perfectly Inelastic
▪ Quantity demanded does not
respond to price changes.
▪ Perfectly Elastic
▪ Quantity demanded changes
infinitely with any change in
>> The price.
Variety of ▪ Unit Elastic
▪ Quantity demanded changes
Demand by the same percentage as the
Curves price.

▪ Because the price elasticity of

demand measures how much
quantity demanded responds to
the price, it is closely related to
the slope of the demand curve.

9
 The Price Elasticity of Demand

(a) Perfectly Inelastic Demand: Elasticity Equals 0

Price
Demand

$5
4
1. An
increase
in price . . .

0 100 Quantity

2. . . . leaves the quantity demanded unchanged.

10
 > The Price Elasticity of Demand

(b) Inelastic Demand: Elasticity Is Less Than 1

Price

$5

4
1. A 25% Demand
increase
in price . . .

0 90 100 Quantity

2. . . . leads to an 10% decrease in quantity demanded.

11
>> The Price Elasticity of Demand

(c) Unit Elastic Demand: Elasticity Equals 1

Price

$5

4
1. A 25% Demand
increase
in price . . .

0 75 100 Quantity

2. . . . leads to a 25% decrease in quantity demanded.

12
>>> The Price Elasticity of Demand
(d) Elastic Demand: Elasticity Is Greater Than 1
Price

$5
4 Demand
1. A 25%
increase
in price . . .

0 50 100 Quantity

2. . . . leads to a 50% decrease in quantity demanded.

13
 >>>> The Price Elasticity of Demand

(e) Perfectly Elastic Demand: Elasticity Equals Infinity

Price

1. At any price
above $4, quantity
demanded is zero.
$4 Demand

2. At exactly $4,
consumers will
buy any quantity.

0 Quantity
3. At a price below $4,
quantity demanded is infinite.
14
Total Revenue and
the Price Elasticity
of Demand
▪ Total revenue is the
amount paid by buyers
and received by sellers of
a good.
▪ Computed as the price of
the good times the
quantity sold.

TR = P x Q

15
Total Revenue
Price

$4

P × Q = $400
P
(revenue) Demand

0 100 Quantity
16
Q
Elasticity and Total Revenue along a Linear Demand Curve

▪ With an inelastic demand curve, an increase in price leads to a

decrease in quantity that is proportionately smaller. Thus, total
revenue increases.
▪ Mona Lisa & Louvre Museum

▪ With an elastic demand curve, an increase in the price leads to

a decrease in quantity demanded that is proportionately larger.
Thus, total revenue decreases.
▪ a standard sedan car producer
17
How Total Revenue Changes When Price Changes: Inelastic
demand
Price
Price
An Increase in price from $1 … leads to an Increase in
to $3 … total revenue from $100 to
$240

$3

Revenue = $240
$1
Revenue = $100 Demand Demand

0 100 Quantity 0 80 Quantity

18
How Total Revenue Changes When Price Changes: Elastic
demand
Price
Price

An Increase in price from $4 … leads to an decrease in

to $5 … total revenue from $200 to
$100

$5

$4

Demand
Demand

Revenue = $200 Revenue = $100

0 50 Quantity 0 20 Quantity

19
 Income Elasticity of Demand

▪ Income elasticity of demand measures how

much the quantity demanded of a good
responds to a change in consumers’ income.
▪ It is computed as the percentage change in
the quantity demanded divided by the
percentage change in income.

Income el 20
Income Elasticity
▪ Types of Goods
▪ Normal Goods
▪ Inferior Goods

▪ Higher income raises the

quantity demanded for
normal goods but lowers the
quantity demanded for
inferior goods.
▪ Goods consumers regard as
necessities tend to be income
inelastic
▪ Examples include food, fuel,
clothing, utilities, and 21
medical services.
Exercise
▪ When a couple has a monthly income
of 4.000 TL, they would usually
consume 10 kg of apple. Now that
the couple makes 6.000 TL a month,
they consume 8 kg of apple.
a) Compute, by defining the formula,
the couple’s income elasticity of
demand for apple.
b) Explain your answer. (Is apple, a
normal or an inferior good to the
couple?)
22
 The elasticity of supply

▪ Price elasticity of supply is a measure

of how much the quantity supplied of
a good responds to a change in the
price of that good.

▪ Price elasticity of supply is the

percentage change in quantity
supplied resulting from a percent
change in price.

23
The Price Elasticity of Supply
(a) Perfectly Inelastic Supply: Elasticity Equals 0

Price
Supply

$5

4
1. An
increase
in price . . .

0 100 Quantity

2. . . . leaves the quantity supplied unchanged.

24
> The Price Elasticity of Supply
(b) Inelastic Supply: Elasticity Is Less Than 1

Price

Supply
$5

4
1. A 25%
increase
in price . . .

0 100 110 Quantity

2. . . . leads to a 10% increase in quantity supplied.

25
>> The Price Elasticity of Supply
(c) Unit Elastic Supply: Elasticity Equals 1
Price

Supply
$5

4
1. A 25%
increase
in price . . .

0 100 125 Quantity

2. . . . leads to a 25% increase in quantity supplied.

26
>>> The Price Elasticity of Supply
(d) Elastic Supply: Elasticity Is Greater Than 1
Price

Supply

$5

4
1. A 25%
increase
in price . . .

0 100 200 Quantity

2. . . . leads to a 100% increase in quantity supplied.

27
>>>> The Price Elasticity of Supply
(e) Perfectly Elastic Supply: Elasticity Equals Infinity
Price

1. At any price
above $4, quantity
supplied is infinite.

$4 Supply

2. At exactly $4,
producers will
supply any quantity.

0 Quantity
3. At a price below $4,
quantity supplied is zero.
28
 Determinants of Elasticity of Supply

▪ Ability of sellers to change the amount of the good they

produce.
▪ Beach-front land is inelastic.
▪ Books, cars, or manufactured goods are elastic.

▪ Time period.
▪ Supply is more elastic in the long run.

▪ An example: peak and off peak airline travel

▪ Peak: Demand is price inelastic, so tickets are expensive.
▪ Off peak: Demand is price elastic, so to maximise revenues ticket prices
are lowered.

29
30
Can good news for farming be bad news for farmers?
▪ What happens to wheat farmers and the market for wheat when
university agronomists discover a new wheat hybrid that is more
productive than existing varieties?
▪ Examine whether the supply or demand curve shifts.
▪ What about the elasticity of the demand of wheat?
▪ How the market equilibrium and farmers’ income changes?

31
> Can good news for farming be bad news for
farmers?
Price of
Wheat 1. When demand is inelastic,
2. . . . leads an increase in supply . . .
to a large fall S1
in price . . . S2

$3

Demand

0 100 110 Quantity of

Wheat
3. . . . and a proportionately smaller
increase in quantity sold. As a result,
32
revenue falls from $300 to $220.
Key concepts of the lecture
▪ elasticity
▪ price elasticity of demand
▪ total revenue
▪ income elasticity of demand
▪ cross-price elasticity of demand
▪ price elasticity of supply

33
 Exercise
▪ According to the study of the Ministry of
Health the price elasticity of demand of
cigarettes is -0,2. And people purchase about 500 million cigarettes
each year.
a. If the tax on cigarettes were increased enough to raise the
price of cigarettes by 50 percent, what would be the effect
on the quantity cigarettes demanded? Show your work
explicitly.
b. Is raising the tax on cigarettes a more effective way to reduce
smoking, if the demand of cigarettes is elastic or if it is
inelastic? Briefly explain and justify your answer with
diagrams.

34
ECON1211
IntroductIon
to EconomIcs
LECTURE 5
Supply,
Demand, and
Government
Policies
from MANKIW
& TAYLOR 2013;
Ch. 8

1
 Supply, Demand, and Government
Policies
▪ In a free, unregulated market system, market forces establish
equilibrium prices and exchange quantities.
▪ While equilibrium conditions may be efficient, it may be true
that not everyone is satisfied.
▪ One of the roles of economists is to use their theories to assist
in the development of policies.
▪ Government polies:
▪ Price Controls
▪ Taxation

2
Controls on prices
▪ Are usually enacted when
policymakers believe the market
price is unfair to buyers or sellers.
▪ Result in government-created price
ceilings and floors.
▪ Price Ceiling
▪ A legal maximum on the price at which a
good can be sold.
▪ Price Floor
▪ A legal minimum on the price at which a
good can be sold

3
How Price Ceilings Affect Market Outcomes

▪ Two outcomes are possible when the government imposes

a price ceiling:
▪ The price ceiling is not binding if set above the equilibrium price.
▪ The price ceiling is binding if set below the equilibrium price, leading
to a shortage.

4
 A Market with a Price Ceiling
(a) A Price Ceiling That Is Not Binding

Price

Supply

$4 Price
ceiling
3
Equilibrium
price

Demand

0 100 Quantity
Equilibrium
quantity 5
 A Market with a Price Ceiling
(b) A Price Ceiling That Is Binding

Price

Supply A binding price ceiling

creates shortages and
Equilibrium
price
nonprice rationing
• long lines
$3 • blackmarket

2 Price
Shortage ceiling

Demand

0 75 125 Quantity
Quantity Quantity
supplied demanded 6
 CASE STUDY: Lines at the Gas Pump

▪ In 1973, OPEC raised the price of crude oil in world

markets. Crude oil is the major input in gasoline,
so the higher oil prices reduced the supply of
gasoline.
▪ What was responsible for the long gas lines?

Economists blame
government regulations that
limited the price of oil that
companies could charge for
gasoline.

7
The Market for Gasoline with a Price Ceiling
(a) The Price Ceiling on Gasoline Is Not Binding

Price of
Gasoline

Supply, S1
1. Initially,
the price
ceiling
is not
binding . . . Price ceiling

P1

Demand
0 Q1 Quantity of
8
Gasoline
The Market for Gasoline with a Price Ceiling
(b) The Price Ceiling on Gasoline Is Binding

Price of S2
Gasoline 2. . . . but when
supply falls . . .

S1
P2

Price ceiling

P1 3. . . . the price
4. . . . ceiling becomes
resulting binding . . .
in a
shortage. Demand
0 QS QD Q1 Quantity of
9
Gasoline
CASE STUDY: Rent Control in the Short Run and Long Run

▪ Rent controls are ceilings placed on the

rents that landlords may
charge their tenants.
▪ The goal of rent control policy is
to help the poor by making housing
more affordable.

▪ One economist called rent

control “the best way to destroy
a city, other than bombing.”
10
Rent Control in the Short Run and in the Long Run
(a) Rent Control in the Short Run
(supply and demand are inelastic)
Rental
Price of
Apartment Supply … because the supply and
demand for housing units are
relatively inelastic, the rent-
control law causes only a
small shortage of housing.

Controlled rent

Shortage
Demand

0 Quantity of
Apartments 11
Rent Control in the Short Run and in the Long Run
(b) Rent Control in the Long Run
(supply and demand are elastic)
Rental …because the supply and
Price of demand for housing units
Apartment are more elastic, rent
control causes a large
shortage.
Supply

Controlled rent

Shortage Demand

0 Quantity of
Apartments 12
 How Price Floors Affect Market Outcomes

▪ When the government imposes a price floor, two outcomes

are possible.
▪ The price floor is not binding if set below the equilibrium price.
▪ The price floor is binding if set above the equilibrium price,
leading to a surplus.

13
 A Market with a Price Floor
(a) A Price Floor That Is Not Binding

Price

Supply

Equilibrium
price

$3
Price
floor
2

Demand

0 100 Quantity
Equilibrium
14
quantity
 A Market with a Price Floor
A binding price floor
(b) A Price Floor That Is Binding causes surplus &
nonprice rationing
Price
• the minimum
Supply wage
• agricultural
Surplus price supports
$4
Price
floor
3

Equilibrium
price

Demand

0 80 120 Quantity
Quantity Quantity
demanded supplied 15
How the Minimum Wage Affects the Labor Market

Wage

Labor
Supply

Equilibrium
wage

Labor
demand
0 Equilibrium Quantity of
employment Labor
16
 How the Minimum Wage Affects the Labor Market

Wage

Labor
Labor surplus Supply
(unemployment)
Minimum
wage

Labor
demand
0 Quantity Quantity Quantity of
demanded supplied Labor
17
 Exercise

▪ The government has decided that the free market price of

hazelnut is too low. And it imposes a binding price floor in
the hazelnut market.
a) Farmers complain that the price floor has reduced their
total revenue. How is it possible? Explain.
b) In response to the farmers’ complaints, the government
agrees to purchase all of the surplus hazelnut at the price
floor. Who benefits from this new policy? Who loses?
c) Show the amount purchased by the government on a
supply and demand diagram.

18
 TAXES
▪ Governments levy taxes to raise revenue for public projects.
▪ How Taxes on Sellers (and Buyers) Affect Market Outcomes
▪ Taxes discourage market activity.
▪ When a good is taxed, the quantity sold is smaller.
▪ Buyers and sellers share the tax burden.

▪ Tax incidence is the manner in which the burden of a tax is

shared among participants in a market.
▪ Tax incidence is the study of who bears the burden of a tax.

19
 A Tax on Sellers
Price
A tax on sellers
Price Equilibrium S2 shifts the supply
buyers with tax curve upward
pay by the amount of
$3.30 S1
Tax ($0.50) the tax ($0.50).
Price 3.00
without 2.80 Equilibrium without tax
tax

Price
sellers
receive

Demand, D1

0 90 100 Quantity

20
What was the impact of tax?
▪ Taxes discourage market activity.
▪ When a good is taxed, the quantity sold is smaller.
▪ Buyers and sellers share the tax burden.

21
 A Tax on Buyers
Price

Price Supply, S1
buyers
pay
$3.30 Equilibrium without tax
Tax ($0.50)
Price 3.00 A tax on buyers
without 2.80
shifts the demand
tax
curve downward
by the size of
Price Equilibrium the tax ($0.50).
sellers with tax
receive

D1
D2

0 90 100 Quantity

22
 A Payroll Tax
Wage

Labor supply

Wage firms pay

Tax wedge
Wage without tax

Wage workers
receive

Labor demand

0 Quantity
of Labor
23
Elasticity and Tax Incidence
▪ In what proportions is the burden of the tax divided?
▪ How do the effects of taxes on sellers compare to those
levied on buyers?
▪ The answers to these questions depend on the elasticity of
demand and the elasticity of supply.

24
 How the Burden of a Tax Is Divided
(a) Elastic Supply, Inelastic Demand

Price
1. When supply is more elastic
than demand . . .
Price buyers pay
Supply

Tax
2. . . . the
incidence of the
Price without tax tax falls more
heavily on
Price sellers consumers . . .
receive

3. . . . than
Demand
on producers.

0 Quantity

25
 How the Burden of a Tax Is Divided
(b) Inelastic Supply, Elastic Demand

Price
1. When demand is more elastic
than supply . . .
Price buyers pay Supply

Price without tax 3. . . . than on

consumers.
Tax

2. . . . the Demand
Price sellers incidence of
receive the tax falls
more heavily
on producers . . .

0 Quantity
26
Elasticity and tax incidence

So, how is the burden of the tax

divided?

The burden of a tax falls more

heavily on the side of the
market that is less elastic.

27
▪ price ceiling
▪ price floor
▪ shortage Key concepts
▪ surplus
of the lecture
▪ tax incidence

28
Exercise
▪ If the government places a significant amount of tax on
luxury goods, what do you expect about the share of the
tax burden?
▪ Explain your answer with a supply and demand diagram.

29
ECON1211
IntroductIon
to EconomIcs
Lecture 6
Consumers, Producers and
The Efficiency of Markets
Application: The Costs of
Taxation
from MANKIW & TAYLOR
2013; Chs. 7, 9

1
Welfare Economics

▪ Welfare economics is the study of how the

allocation of resources affects economic well-
being.
▪ Well-being is the happiness or satisfaction with
life as reported by individuals
▪ Equilibrium in the market results in maximum
benefits, and therefore maximum total welfare for
both the consumers and the producers of the
product.
▪ Consumer surplus measures economic welfare from the
buyer’s side.
▪ Producer surplus measures economic welfare from the
seller’s side. 2
CONSUMER SURPLUS
▪ Willingness to pay is the
maximum amount that a buyer
will pay for a good.
▪ It measures how much the
buyer values the good or
service.
▪ Consumer surplus is the buyer’s
willingness to pay for a good
minus the amount the buyer
actually pays for it.
▪ The market demand curve
depicts the various quantities
that buyers would be willing
and able to purchase at
different prices.
▪ The area below the demand
curve and above the price
measures the consumer surplus 3
in the market.
How the Price Affects Consumer Surplus
(a) Consumer Surplus at Price P
Price
A

Consumer
surplus
P1
B C

Demand

0 Q1 Quantity
4
How the Price Affects Consumer Surplus
(b) Consumer Surplus at Price P
Price
A

Initial
consumer
surplus
C Consumer surplus
P1
B to new consumers

F
P2
D E
Additional consumer Demand
surplus to initial
consumers
0 Q1 Q2 Quantity
5
National Bureau of Economic
Research (NBER)

6
PRODUCER
SURPLUS
Producer surplus is the
amount a seller is paid
for a good minus the
seller’s cost.
It measures the benefit
to sellers participating in
a market.
Cost is the value of
everything a seller must
give up to produce a
good.
Just as consumer surplus
is related to the demand
curve, producer surplus
is closely related to the
supply curve.
The area below the price
and above the supply
curve measures the
producer surplus in a
market.
7
How the Price Affects Producer Surplus
(a) Producer Surplus at Price P

Price
Supply

B
P1
C
Producer
surplus

0 Q1 Quantity
8
How the Price Affects Producer Surplus
(b) Producer Surplus at Price P

Price
Additional producer Supply
surplus to initial
producers

D E
P2 F

B
P1
Initial C
Producer surplus
producer to new producers
surplus

0 Q1 Q2 Quantity
9
 Consumer + Producer Surplus =
Total Surplus

Consumer Surplus = Value to buyers – Amount paid by buyers

&
Producer Surplus = Amount received by sellers – Cost to sellers

▪ Then,
Total surplus = Consumer surplus + Producer surplus
or
Total surplus = Value to buyers – Cost to sellers
10
 Consumer and Producer Surplus in the Market
Equilibrium
Price A

D
Supply

Consumer
surplus

Equilibrium E
price
Producer
surplus

Demand
B

0 Equilibrium quantity Quantity 11

The Efficiency of the Equilibrium Quantity
Price
Supply

Value Cost
to to
buyers sellers

Cost Value
to to
sellers buyers Demand

0 Equilibrium Quantity
quantity

Value to buyers is greater Value to buyers is less 12

than cost to sellers. than cost to sellers.
 Market equilibrium and efficiency
▪ Efficiency is the property of a resource
allocation of maximizing the total surplus
received by all members of society.
▪ Pareto efficiency occurs if it is not possible to
reallocate resources in such a way as to make
one person better off without making anyone
else worse off.
▪ A Pareto improvement occurs when an action
makes at least one economic agent better off
without harming another economic agent.
▪ However markets might be efficient but this
does not mean they are fair.
▪ Efficiency vs. Equity

13
1st Application: The Costs of Taxation
▪ Governments levy taxes to raise revenue for public
projects.

▪ How taxes affect market outcomes?

▪ Taxes discourage market activity.
▪ When a good is taxed, the quantity sold is smaller.
▪ Buyers and sellers share the tax burden.

▪ It does not matter whether a tax on a good is levied

on buyers or sellers of the good.
▪ But, the price paid by buyers rises, and the price
received by sellers falls. 14
 The Effects of a Tax
Price

Supply
Price buyers Size of tax
pay

Price
without tax

Price sellers
receive

Demand

0 Quantity Quantity Quantity

with tax without tax
15
 Government tax revenue
Price

Supply
Price buyers Size of tax (T)
pay
Tax
revenue
(T × Q)

Price sellers
receive

Quantity Demand
sold (Q)

0 Quantity Quantity Quantity

with tax without tax
16
 How a Tax Effects Welfare
Price
Consumer
Surplus
Supply
Price
buyers = PB
pay
Tax Deadweight Loss:
Price revenue the fall in total
without tax = P1 surplus that results
(T × Q)
Price from a market
sellers = PS
receive distortion, such as a
tax.
Producer Demand
Surplus

0 Q2 Q1 Quantity

17
Determinants of the deadweight loss
▪ Deadweight Loss is the fall in total surplus that results from
a market distortion, such as a tax.
▪ Taxes cause deadweight losses because they prevent
buyers and sellers from realizing some of the gains from
trade.
▪ What determines whether the deadweight loss from a tax
is large or small?
▪ Depends on the price elasticities of supply and demand.

18
 Tax Distortions and Elasticities
(a) Inelastic Demand

Price

Supply

Size of tax
When demand is
relatively inelastic,
the deadweight loss
of a tax is small.

Demand

0 Quantity
19
 Tax Distortions and Elasticities
(b) Elastic Demand

Price

Supply

Size
of
tax Demand

When demand is relatively

elastic, the deadweight
loss of a tax is large.

0 Quantity
20
The Deadweight Loss Debate

▪ Some economists argue that labor taxes are highly distorting

and believe that labor supply is more elastic.
▪ Some examples of workers who may respond more to
incentives:
▪ Workers who can adjust the number of hours they work
▪ Families with second earners
▪ Elderly who can choose when to retire
▪ Workers in the underground economy

▪ With each increase in the tax rate, the deadweight loss of

the tax rises even more rapidly than the size of the tax.

21
Deadweight Loss and Tax Revenue from Taxes of
Different Sizes
Price (a) Small Tax

Deadweight
loss Supply
PB
Tax revenue
PS

Demand

0 Q2 Q1 Quantity
22
Deadweight Loss and Tax Revenue from Taxes of
Different Sizes
Price (b) Medium Tax

Deadweight
PB loss
Supply

Tax revenue

PS Demand

0 Q2 Q1 Quantity
23
Deadweight Loss and Tax Revenue from Taxes of
Different Sizes
Price (c) Large Tax
PB
Deadweight
loss
Tax revenue Supply

Demand

PS
0 Q2 Q1 Quantity
24
How Deadweight Loss and Tax Revenue Vary with
the Size of a Tax
(a) Deadweight Loss

Deadweight
Loss

As the size of a tax

increases, its
deadweight loss
quickly gets larger.

0 Tax Size
25
How Deadweight Loss and Tax Revenue Vary with
the Size of a Tax
(b) Revenue (the Laffer curve)
Tax
Revenue

Tax revenue first

rises with the
size of a tax, but
then, as the tax
gets larger, the
market shrinks
so much that tax
revenue starts to
fall.
0 Tax Size
26
CASE STUDY: The Laffer Curve and Supply-side Economics

▪ The Laffer curve depicts the relationship between tax rates and
tax revenue.
▪ Supply-side economics refers to the views of Reagan and Laffer
who proposed that a tax cut would induce more people to
work and thereby have the potential to increase tax revenues.

Tax Revenue

0 Tax Size 27
 Key concepts of the lecture
▪ welfare economics
▪ willingness to pay
▪ consumer surplus
▪ cost
▪ producer surplus
▪ efficiency
▪ equity
▪ deadweight loss
▪ tax revenue
▪ Laffer Curve
28
Exercise
▪ In 2004 the Turkish government reduced the corporate tax
rates from 30% to 20%.
▪ What is the economic logic behind this policy?
▪ Explain and justify your answer with diagram(s), if
necessary.

29
Exercise
▪ Suppose that a tax is imposed on a market, and is left in
place for several years.
▪ What would you predict about
a) the size of the deadweight loss of the tax in the short run relative
to the long run, and
b) the amount of revenue collected from the tax in the short run
relative to the long run?
▪ Justify your answers with graphs for each case (short-run &
long-run)

30
ECON1211
IntroductIon
to EconomIcs
Lecture 7
Application: International
Trade

1
 International trade

▪ What determines whether a

country imports or exports a
good?
▪ Who gains and who loses from
free trade among countries?
▪ What are the arguments that
people use to advocate trade
restrictions?

2
The determinants of trade

▪ Equilibrium Without
Trade
▪ Assume:
▪ A country is
isolated from rest
of the world and
produces steel.
▪ The market for
steel consists of
the buyers and
sellers in the 3
The Equilibrium without International Trade
Price
of Steel

Domestic
supply

Consumer
surplus
Equilibrium
price Producer
surplus

Domestic
demand
0 Equilibrium Quantity
quantity of Steel 4
The World Price and Comparative
Advantage

▪ If the country decides to

engage in international trade,
will it be an importer or
exporter of steel?
▪ The effects of free trade can be
shown by comparing the
domestic price of a good
without trade and the world
price of the good.
▪ The world price refers to the
price that prevails in the
world market for that good.

5
 >> The World Price and Comparative Advantage

▪ If a country has a
comparative advantage, then
the domestic price will be
below the world price, and
the country will be an
exporter of the good.
▪ If the country does not have
a comparative advantage,
then the domestic price will
be higher than the world
price, and the country will be
an importer of the good.

6
International Trade in an Exporting Country
Price
of Steel

Price Domestic
after supply
trade World
price
Price
before
trade

Domestic
Exports demand
0
Domestic Domestic Quantity
quantity quantity of Steel
7
demanded supplied
How Free Trade Affects Welfare in an Exporting Country

Price
of Steel Consumer surplus
before trade
Domestic
Price supply
after
trade World
price
Price
before
trade
Producer surplus
before trade Domestic
demand
8
0 Quantity
How Free Trade Affects Welfare in an Exporting Country
Domestic producers of the good
are better off, and domestic
consumers of the good are worse
Price off.
of Steel Trade raises the economic well-
being of the nation as a whole.
Consumer surplus
after trade Domestic
Price supply
after Exports
trade World
price
Price Gains from
before trade
trade

Producer surplus Domestic

after trade
demand

0 Quantity 9

of Steel
The Gains and Losses of an Importing Country

▪ International Trade in an
Importing Country
▪ If the world price of steel is
lower than the domestic
price, the country will be an
importer of steel when
trade is permitted.
▪ Domestic consumers will
want to buy steel at the
lower world price.
▪ Domestic producers of steel
will have to lower their
output because the
domestic price moves to the
world price.
10
International Trade in an Importing Country
Price
of Steel

Domestic
supply
Price
before
trade

Price World
after price
trade
Domestic
Imports
demand
0 Domestic Domestic Quantity
quantity quantity of Steel
11
supplied demanded
How Free Trade Affects Welfare in an Importing Country

Price
of Steel
Consumer surplus
before trade Domestic
supply

Price
before trade
Price World
after trade price

Producer surplus Domestic

before trade demand
0 Quantity 12
of Steel
 How Free Trade Affects Welfare in an Importing Country
Domestic producers of the good are
worse off, and domestic consumers
Price of the good are better off.
of Steel Trade raises the economic well-
being of the nation as a whole…
Consumer surplus
after trade
Domestic
supply

Gains from
Price trade
before trade
Price World
after trade price
Imports
Producer surplus Domestic
after trade demand
0 Quantity
13
of Steel
The winners and losers from trade

▪ The gains of the winners exceed the losses of the losers.

▪ The net change in total surplus is positive.
14
The Effects of a Tariff
▪ A tariff is a tax on goods produced abroad and sold
domestically.
▪ Tariffs raise the price of imported goods above the world
price by the amount of the tariff.

15
The Effects of a Tariff
Price
of Steel

Domestic
supply

Equilibrium
without trade

Price
with tariff Tariff
Price World
without tariff Imports price
Domestic
with tariff
demand
0 QS QS QD QD Quantity
of Steel
Imports 16
without tariff
The Effects of a Tariff
Price
of Steel

Consumer surplus
before tariff Domestic
supply

Producer
surplus Equilibrium
before tariff without trade

Price World
without tariff price
Domestic
demand
0 QS QD Quantity
of Steel
Imports 17
without tariff
The Effects of a Tariff
Price
of Steel

Consumer surplus
with tariff Domestic
supply
Producer
surplus
after tariff
Tariff Revenue
Equilibrium
without trade

Price
with tariff Tariff
Price World
without tariff Imports price
Domestic
with tariff
demand
0 QS QS QD QD Quantity
of Steel
Imports 18
without tariff
 A tariff reduces the quantity of
The Effects of a Tariff imports and moves the domestic
market closer to its equilibrium
without trade.
Price With a tariff, total surplus in the
of Steel market decreases by an amount
referred to as a deadweight loss.

Domestic
supply

Deadweight Loss

Price
with tariff Tariff
Price World
without tariff Imports price
Domestic
with tariff
demand
0 QS QS QD QD Quantity
of Steel
Imports 19
without tariff
The Effects of an Import Quota

▪ An import quota is a limit on the quantity of a good that can

be produced abroad and sold domestically.
▪ With a quota, total surplus in the market decreases by an
amount referred to as a deadweight loss.
▪ The quota can potentially cause an even larger deadweight
loss, if a mechanism such as lobbying is employed to
allocate the import licenses.

20
 Tariff barriers Jun 19th 2008

▪ Hong Kong and Singapore

have the least restrictive
trade policies.
▪ Small, rich economies, such
as Switzerland, tend to be
the least protectionist.
▪ Turkey stands out as a big
country with low tariff
barriers—lower even than
America's.
▪ Mexico and South Korea and
(especially) India are
protectionist by comparison.
21
 The Lessons for Trade Policy

▪ Both tariffs and import quotas . . .

▪ raise domestic prices.
▪ reduce the welfare of domestic consumers.
▪ increase the welfare of domestic producers.
▪ cause deadweight losses.

▪ Other Benefits of International Trade

▪ Increased variety of goods
▪ Lower costs through economies of scale
▪ Increased competition
▪ Enhanced flow of ideas
22
The arguments for restricting trade

▪ Jobs

▪ National Security

▪ Infant Industry

▪ Unfair Competition

▪ Protection-as-a-Bargaining Chip

23
Trade Agreements and the World Trade Organization

▪ GATT ➔ WTO
▪ The General Agreement on Tariffs and Trade (GATT) refers to a
continuing series of negotiations among many of the world’s
countries with a goal of promoting free trade.
▪ GATT has successfully reduced the average tariff among member
countries from about 40 percent after WWII to about 5 percent
today.

24
NAFTA
▪ The North American Free
Trade Agreement (NAFTA)
is an example of a
multilateral trade
agreement.
▪ In 1993, NAFTA lowered
the trade barriers among
the United States,
Mexico, and Canada.

25
European Costums Union
▪ The European Union and Turkey are linked by a Customs
Union agreement, which came in force on 31 December
1995.

26
 Key concepts of the lecture
▪ World price
▪ Tariff
▪ Import quota

27
Exercise
▪ Suppose there is a free trade regime, and world price of
grain is quite lower than the domestic price in Homeland.
Then, in response for farmers’ complaints, Homeland’s
government decides to impose a tariff for imported grain.

a. What will be the impact of the tariff on consumers’ and

producers’ welfare? Justify your answer on a diagram.
b. Does government gain any revenue by imposing the
tariff? Is there any welfare loss? Justify your answer on
a separate diagram.

28
Exercise
▪ Because of deepening economic crisis, old fashioned
protectionism which is based on the use of trade barriers to
protect domestic firms from foreign competition has re-
emerged.
▪ Suppose a small country has increased its tariff for
automotive industry in order to protect its domestic firms
from lower world price because of Chinese and Indian
cheap cars.
▪ What will be the impact of the tariff on consumers’ and
producers’ welfare? Justify your answer on a diagram.

29