Lecture 1

Introduction to Economics

Decision

Society

 A society must find some way to decide what jobs will be done and who will do them. It
needs some people to grow food, other people to make clothing, and still others to design
computer software. Once society has allocated people (as well as land, buildings, and
machines) to various jobs, it must also allocate the output of goods and services.

Scarcity

 Scarcity means that society has limited resources and therefore cannot produce all the
goods and services people wish to have.
 Just as each member of a household cannot get everything he or she wants, each
individual in a society cannot attain the highest standard of living to which he or she
might aspire.

Economics

 It is the study of how society manages its scarce resources.

 Economists therefore study how people make decisions: how much they work, what they
buy, how much they save, and how they invest their savings.

How People Make Decisions

1. People Face Trade-offs - To get one thing that we like, we usually have to give up
another thing that we like. Making decisions requires trading off one goal against
another.
2. The Cost of Something Is What You Give Up to Get It - Because people face trade-
offs, making decisions requires comparing the costs and benefits of alternative courses of
action.
 QUESTION: Juan dela Cruz decides to spend three hours working overtime
rather than watching a movie with his friends. He earns P200 an hour. His
opportunity cost of working is
a. a. the P200 he earns working.
b. b. the P200 minus the enjoyment he would have received from watching
the movie.
c. c. the enjoyment he would have received had he watched the movie.
d. d. nothing, since he would have received less than P200 of enjoyment
from the movie.
*The opportunity cost of an item is what you give up to get that item.

3. People Respond to Incentives – An incentive is something that induces a person to act,

such as the prospect of a punishment or a reward.

 EXAMPLE: For example, when the price of an apple rises, people decide to eat
fewer apples. At the same time, apple orchards decide to hire more workers and
harvest more apples.

Economic Systems

 Every economy needs to develop an economic system – a particular set of

institutional arrangements and a coordinating mechanism – to respond to the
economic problems.
 The economic system has to determine what goods are produced, how they are
produces, how much to produce and who gets them.

Command Economy

 The command system is also known as socialism or communism. Government owns most
property resources and economic decision making occurs through a central economic
plan.

Market Economy

 A market economy allocates resources through the decentralized decisions of many firms
and households as they interact in markets for goods and services.
 Free markets contain many buyers and sellers of numerous goods and services, and all of
them are interested primarily in their own well-being. Yet despite decentralized decision
making and self-interested decision makers, market economies have proven remarkably
successful in organizing economic activity to promote overall economic well-being.

Adam Smith

 In his 1776 book An Inquiry into the Nature and Causes of the Wealth of Nations,
economist Adam Smith made the most famous observation in all of economics:
Households and firms interacting in markets act as if they are guided by an “invisible
hand” that leads them to desirable market outcomes.

How the Economy as a Whole Works

1. A Country’s Standard of Living Depends on Its Ability to Produce Goods and

Services – large variation in average income is reflected in various measures of the
quality of life. Citizens of high-income countries have more TV sets, more cars, better
nutrition, better healthcare, and a longer life expectancy than citizens of low-income
 countries. Almost all variation in living standards is attributable to differences in countries’
productivity—that is, the amount of goods and services produced from each unit of labor input.
2. Prices Rise When the Government Prints Too Much Money – Inflation is an increase
in the overall level of prices in the economy. When a government creates large quantities
of the nation’s money, the value of the money falls.

Ceteris Paribus

 Ceteris paribus or other-things-equal assumption assume that all factors other than those
being considered do not change.
o EXAMPLE: If the price of milk increases, ceteris paribus, people will purchase
less milk.

Economic Models

 Economists also use models to learn about the world they are most often composed of
diagrams and equations. However, an economist’s model does not include every feature
of the economy.

The Circular Flow Diagram

 A visual model of the economy that shows how money flow through markets among
households and firms.
 The circular-flow diagram offers a simple way of organizing the economic transactions
that occur between households and firms in the economy.

4 Factors of production

1. Land – includes all natural resources (“gifts of nature”) used in the production process
2. Labor – physical and mental talents and efforts of people used to produce goods and
services.
3. Capital – human-made resources
4. Entrepreneurial ability – human talent that combines the other resources to produce a
product, make strategic decisions and bear risk.
Microeconomics and Macroeconomics

Microeconomics

 Is the study of how households and firms make choices, how they interact in markets, and
how the government attempts to influence their choices.

Macroeconomics

• Is the study of the economy as a whole, including topics such as inflation,

unemployment, and economic growth.

Positive versus Normative Analysis

 When economists are trying to explain the world, they are scientists. When they are
trying to help improve it, they are policy advisers. For example, suppose that two
people are discussing minimum-wage
o Polly: Minimum-wage laws cause unemployment.
o Norm: The government should raise the minimum wage.
 In general, statements about the world come in two types. One type, such as Polly’s, is
positive. Positive statements are descriptive. They make a claim about how the world
is. A second type of statement, such as Norm’s, is normative. Normative statements are
prescriptive. They make a claim about how the world ought to be.
 EXAMPLE
o Statement 1: The government should take measures to reduce inflation.
o Statement 2: The inflation should be kept at 0%.
o Statement 3: An ascent in average temperatures will build interest in
sunscreen items.
 Lecture 2
Demand, Supply and Equilibrium

Significance

 The tools of demand and supply can be applied to a range of important topics such as:
o Evaluating how global weather conditions will affect agricultural production and
market prices of agricultural commodities;
o Assessing the impact of government rent control on dormitory space;
o Understanding how taxes, subsidies, and other government policies affect both
consumers and producers.

The Concept of DEMAND

 Demand – refers to the various quantities of a good or service that consumers are willing
to purchase at alternative prices, ceteris paribus. Dasiren for something , backed up with
sufficient purchasing power
o Conveys both the elements of desire for the commodity and capacity to pay (must
be willing and able).
o Emphasizes the relationship between quantity bought and its price, although there
may be other factors that determine how much a consumer wants to purchase.
 Asserts that the quantity demanded of a good or service is negatively or inversely
related to its own price.
o When the price increases, less of the good or service will be bought
o When the price decreases, more of the commodity will be purchased.

WHY SO?

Two Reasons for the Inverse Relationship

 Substitution Effect
o When price of a good decreases, the consumer substitutes the lower priced
good for the more expensive ones.
 Income Effect
o When price decreases, the consumer’s real income (or purchasing power)
increases, so he tends to buy more.
 Substitution Effect
o When price of a good increases, the consumer tends to substitutes it with the
lower priced goods.
 Income Effect
o When price increases, the consumer’s purchasing power (or real income)
decreases, so he tends to buy less.
Factors Affecting Demand

1. Price of the Commodity 4. Tastes and Preferences

2. Prices of related Commodities 5. Number of Consumers
(substitutes and complements) 6. Price Expectations
3. Consumer Incomes

Changes in Quantity Demanded VS Change in Demand

 Changes in Quantity Demanded – is a movement along the same demand curve, due
solely to a change in price, i.e., all other factors held constant.
 Change in Demand – is a shift in the entire demand curve (either to the left or to the
right as a result of changes in other factors affecting demand.

Other Factors Affecting Demand

 Income: as income changes, demand a commodity usually changes.

 o Normal Goods – are goods whose demand respond positively to changes in
income.
 Most goods are normal goods. As income increases, more of shoes, TVs,
clothes are bought.
o Inferior Goods – are goods whose demand respond negatively to changes in
income.
 Few but existent. Examples are firewood, “tuyo”, “adidas or chicken feet”,
bicycles, etc.
 Prices of Related Commodities in Consumption:
o Substitutes – are good that are substitutable with each other (not necessarily
perfect).
 Examples are coffee and tea, Coke and Pepsi, beer and ginebra.
 When the price of a substitute increases, quantity bought of a good
increases Py Qx (direct relationship).
o Complements – are goods that are used or consumed together.
 Examples are coffee and sugar, bread and butter, tennis rackets and tennis
balls.
 When the price of a complement increases, quantity bought of a good
decreases. --- Py Qx (inverse relationship)
 Consumer Tastes and Preferences:
o When consumer tastes shift towards a particular good, greater amounts of a good
are demanded at each price.
 Example: consumers preference for drinking mineral water increases so its
demand curve will shift rightward.
o If consumer preferences change away from a good, its demand will decrease; at
every possible price, less of the good is demanded than before.
 Example: the demand for VCDs and VHS tapes decreases due to
preference for DVDs.
 Consumer Expectations: Expectations about future prices and income affect our current
demand for many goods and services.
o If we expect prices of dried fish to increase with coming of the rainy season, we
might stock up on the good demand for dried fish might increase.
o Those who expect to lose their jobs due to bad economic conditions, will reduce
their demand for a variety of goods in the current period.
 Number of Consumers: affects the total demand for a good.
o Total demand is also known as market demand. It is the summation of the
individual demand of all consumers
 An increases in the number of consumers shifts the market demand curve to the right.
o Example: demand for housing and transportation increases with an increase in
population.
  On the other hand, less consumers will cause the market demand to decrease, resulting in
a shift to the left of the entire demand curve.

The Concept of SUPPLY

 Supply – refers to the various quantities of a good service that producers are willing to
sell at alternative prices, ceteris paribus.
o Obviously, firms are motivated to produce and sell more at higher prices.
o Emphasized the relationship between quantity sold of a commodity and its price.
However, there are other factors that determine how much a producer would like
to produce and sell.

The Law of Supply

 States that the quantity sold of a good or service is positively or directly related to its own
price.

o When the price increases, o When the price decreases,

more of the good or service less of the commodity will be
will be sold purchased.

Change in Quantity Supplied VS Change in Supply

 Change in Quantity Supplied – is a  Change in Supply – is a shift in the

movement along the same supply entire supply curve (either to the left
curve, due solely to a change in or to the right) as a result of changes
price, i.e., all other factors held in other factors affecting supply.
constant.
Other Factors Affecting Supply

 There are other factors aside from price that affect the supply schedule. These are:

1. Resource Prices 4. Expectations

2. Price of Related Goods in 5. Number of Sellers
Production 6. Weather
3. Technology

Resources Prices:

 When prices of inputs to production  Decreases in resource prices,

increase, the supply of the firm’s however, translate to an increase in
product decreases. supply. The entire supply curve
shifts to the right.

Price of Related Goods in Production:

 Resources can be employed to produce several alternative goods and services.

 Examples from agriculture:
o A piece of farmland can be used to grow rice, corn or sugarcane. An increase in
price of sugarcane may result in decreased supply of rice and corn.
o Farmers can use their land and labor to produce ornamental flowers instead of
vegetables. If vegetable prices decrease, the supply of ornamental flowers may
increase.

Technology: A change in production techniques can lower or raise production costs and affect
supply.

 Improvements in technology shift the supply curve to the right.

 o A cost-saving invention will o New high yielding crop
enable firms to produce and varieties will increase
sell more goods than before production on the same
at any given price. amount of land.

Producer Expectations:

 When producers expect the price of
their product to increase in the
future, they may hoard their output
for later sale, thus reducing supply in
the present period. Thus the supply
curve shifts to the left.
 If firms expect that the price of their
product will fall in the next future,
supply may increase in the current
period as firms try to increase
production as well as to dispose of
their inventory.

Number of Sellers: As the number of sellers increases, so will total supply.

 The Market Supply is the horizontal
summation of the supply schedules
of individual producers.
 As more firms enter the market,
more will offered for sale at each
possible price, thus shifting the
supply curve to the right.
 Similarly, the supply curve shifts to
the lefts when firms exit the market.

Market Equilibrium

 Market Equilibrium is that state in which the quantity that firms want to supply equals the
quantity that consumers want to buy.
o The price that clears the market is called the equilibrium price and the quantity
(sold and bought) is called the equilibrium quantity.
o The Market is said to be “at rest” since the equilibrium price and equilibrium
quantity will stay at those levels until either demand or supply changes.

 At prices Above the equilibrium price, quantity supplied is greater than quantity
demanded, resulting in a temporary surplus.
 o In a surplus situation, producers will try to reduce price to entice consumers to
buy more denim pants. Actions by both producers and the public will wipe out the
temporary surplus.
 At prices Below the equilibrium price, consumers desire to buy more denim pants than
are available, creating a temporary shortage.
o Consumers will try to outbid each other, thus pushing up the price. As price rises,
firms increase their production while some consumers reduce their purchases.

Efficiency produce more than the desire output

Effected produces desire output

Equity justice

Factor affect efficiency

 Skills
 Level of literacy
 Health
 Experience

Labor intensive

Capital intensive