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FBMT 1043
FOUNDATION OF ECONOMICS

References:

1) O' Sullivan & Shaffrin (1998).

Microeconomics:Principles,Applications& Tools.
Prentice Hall.

2) Blancard,O.J.(2009). Macroeconomics(8th Ed.).

Prentice Hall.

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CHAPTER 1: INTRODUCTION TO THE KEY

CONCEPTS OF ECONOMICS
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DEFINITION OF ECONOMICS
● The study of how factors of production
(resources) are distributed for the production of
goods and services within a social system. (Adam
Smith)

●Social science which studies the behaviour of

mankind as a relationship between ends and
scarce means which have alternative uses. (L.
Robbins)
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FACTORS OF PRODUCTION
There are four factors of production. They are;

a) Land; natural resouces such as the forests,

minerals, water and other things that are not
made by people.
b) Labour; the physical and mental abilities that
people use to produce goods and services.
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FACTORS OF PRODUCTION

There are four factors of production. They are;

c) Capital; the fund used to get the natural and

labour resources needed.
d) Entrepreneur; a person who make use all three
factors (land, labour and capital) of production
to maximize profit.
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ECONOMICS PROBLEM

Scarcity is the core economic problem. It states

that society has insufficient factors of production
to fulfill all human wants and needs. So, scarcity
implies that not all of society's goals can be
pursued at the same time; trade-offs are made of
one good against others which results in
opportunity cost.
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ECONOMICS PROBLEM

Trade – off = a situation that involves losing

something (product or service) in return for
gaining the best product or services.

Opportunity cost = the opportunity cost of an

activity is the value of what must be forgone in
order to undertake the activity.
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PRODUCTION POSSIBILITY
CURVE (PPC)
●A curve that shows the maximum specified
production level of one commodity that results
given the production level of the other. By doing
so, it defines productive efficiency in the context of
that production set.

●A PPC can represent some economic concepts,

such as scarcity, opportunity cost, productive
efficiency and economies of scale.
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ASSUMPTION OF PPC

In order to create a PPC, some assumptions need

to be acknowledge;

a) Technology level is fixed

b) Factor of production's quantity is fixed
c) All factor of productions has been maximize
d) Only 2 product is produced
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PPC

There are two types of PPC;

a) Concave (increasing opportunity cost )

b) Straight (the same quantity opportunity cost)
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PPC TABLE

Production Alternative Rice(tonne) Butter(tonne)

A 15 0

B 14 1

C 12 2

D 9 3

E 5 4

F 0 5
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PPC DIAGRAM (CONCAVE)

●

Rice (unit)

15 A B
C G: What happen here?
14
12
D
9

E
5
H: What happen here?

F Butter
0 (tonne)
1 2 3 4 5

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ECONOMIC PROBLEM
Based on the PPC diagram (concave) above;

Point A until F = Efficient and achieve-able

Point G = Scarcity and unachieve-able

Point H = Achieve-able but inefficient,

waste and shows
unemployment

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PPC TABLE
Production Alternative Rice(tonne) Butter(tonne)

A 15 0

B 12 1

C 9 2

D 6 3

E 3 4

F 0 5

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PPC DIAGRAM (STRAIGHT LINE)

Rice (tonne)

A
15
B
12

C
9
D
6

E
3
F Barang
0 modal
1 2 3 4 5 (unit)

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CHAPTER 2: THEORY OF DEMAND

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DEFINITION OF DEMAND

The number of goods and services that

consumers are willing to buy at different prices at
a specific time.
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LAW OF DEMAND

●The law of demand states that consumers will

buy more goods (Qd) when its price (P)
decreases and less when its price increases
(ceteris paribus).

● Ceteris paribus is a Latin phrase, literally

translated as "with other things the same," or "all
other things being equal or held constant.
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LAW OF DEMAND

Law of demand states that the amount demanded

of a good and its price are inversely related, other
things remaining constant. For example, if the
income of the consumer remain unchanged, the
consumer’s demand for the good will move
opposite to the movement in the price of the good.
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DEMAND TABLE
Based on the table, a demand curve can be plot;

Point Price (RM) Quantity (Q)

A 15 0
B 12 10
C 9 20
D 6 30
E 3 40
F 0 50
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Price ■ DEMAND CURVE

(RM)

1 D
5

D Quantity
5 (Q)
0
Diagram 1
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EXPLANATION OF CURVE

The demand curve above shows the relationship

of price and quantity demand for an individual
demand. In practical, there will always be more
than one consumer, so the demand made by all
these consumers is known as market demand.
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FACTORS DETERMINE DEMAND

There are many other factors (other than price),
that could determine demand;

a) The price of related goods

b) Consumer's income
c) Consumer's taste and preference
d) Number of buyers in the market
e) Expectation about future price
f ) Weather
g) Availability of credit facilities
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FACTORS DETERMINE DEMAND

a) Price of related goods;

There are 2 types of goods;

● Substitute = If a good can be replaced by
another good such as Coffee and Tea, Pepsi and
Cola, Oats and Corns. Positive relationship.

●Complementary = If goods is needed to be use

together with another goods such as car and
petrol, pen and ink. Negative relationship.
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FACTORS DETERMINE DEMAND

b) Consumer's income
If consumer's income increases, the purchasing
power will also increase so demand will also
increase.

c) Consumer's taste and preference

As preference change, demand will also change.
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CHAPTER 3: THEORY OF SUPPLY

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DEFINITION OF SUPPLY

The number of goods and services that business

are willing to sell at different prices at a specific
time, ceteris paribus.
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LAW OF SUPPLY

The Law of Supply state that an increase in price

(P) results in an increase in quantity supplied
(Qs). This means that producers are willing to
offer more products for sale on the market at
higher prices by increasing production as a way of
increasing profits.
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LAW OF SUPPLY

Law of supply had a direct relationship between

its price (P) and quantity supply (Qs). Why?

a) The desire for profit maximization.

b) Higher price will attract more sellers to the
market.
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SUPPLY TABLE

Price (RM) Quantity (unit)

A 2 20

B 3 30

C 4 40
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SUPPLY CURVE
Price(RM) S

S
Quantity(unit)
20 30
40
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EXPLANATION OF CURVE

Law of supply can be shown by a supply schedule

and a supply curve. A market supply schedule
shows the total quantity which sellers are willing to
offer at different prices.
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FACTORS DETERMINE SUPPLY

There are many other factors (other than price)

affecting supply;

a) The price of other goods

b) The price of raw materials
c) Government policies
d) Price expectation
e) Weather
f ) Quantity of producers in market
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FACTORS DETERMINE SUPPLY

a) The price of other goods

Especially those goods which use the same raw
materials. For example, the supply of rubber is
also influenced by palm oil. So when price of palm
oil increase, farmer will produce more oil than
rubber.
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FACTORS DETERMINE SUPPLY

b) The price of raw materials

If raw materials are expensive, production cost will
increase and thus supply will decrease.

c) Government policies
Tax impose on import goods will reduce their
supply in the market but Subsidy will increase
supply of local production.
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CHAPTER 4: ELASTICITY OF DEMAND AND

SUPPLY
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ELASTICITY OF DEMAND

●It is a measure to show the responsiveness of the

quantity demanded (Qd) of a good or service to a
change in its price.

●More precisely, it gives the percentage change in

quantity demanded in response to a one percent
change in price (holding constant all the other
determinants of demand, such as income).
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CALCULATION
Formula:

Ed = (-) percentage change in quantity demand

percentage change in price

Ed = (-) (Q1 – Q0) x P0

(P1 – P0) Q0
Where;
Q0 = old quantity P0 = old price
Q1 = new quantity P1 = new price
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TYPES OF ELASTICITY

There are 3 types of elasticity of demand;

a) Price elasticity of demand

b) Income elasticity of demand
c) Cross elasticity of demand
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a) Price elasticity of demand

It measures the responsiveness of the quantity

demanded due to a change in its price. So when
price increases, quantity demanded will decrease.
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a) Price elasticity of demand

Formula;
Ed = (-) (q1 – q0) x p0
(p1 – p0) q0
Where;
q0 = old quantity p0 = old price
q1 = new quantity p1 = new price
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b) Income elasticity of demand

A measure of the responsiveness of demand for a
●

product to a change in income.

● If the value is between 0 to 1 its a normal good.

● If the value is greater than 1, its a luxury good.

● If its negative it is an inferior goods.

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b) Income elasticity of demand

Formula;
EY = percentage change in quantity demand
percentage change in income
Ey = (q1 – q0) x Y0
(Y1 – Y0) q0
Where;
q0 = old quantity y0 = old income
q1 = new quantity y1 = new income
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c) Cross elasticity of demand

A measure of the responsiveness of demand for
●

one product to a change in the price of a related

price.

● If the elasticity is positive its a substitute.

● If its negative its a complement.

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c) Cross elasticity of demand

Formula;
ExY = percentage change in quantity demandX
percentage change in priceY
Exy = (qx1 – qx0) x py0
(Py1 – Py0) qx0
Where;
qx0 =old quantity good X Py0 = old price good Y
qx1 =new quantity good X Py1 = new price good Y
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DEGREES OF ELASTICITY

There are five degrees of elasticity;

a) Perfectly inelastic (Ed = 0)
b) Inelastic (-1 < Ed < 0)
c) Unit elasticity (Ed = 1)
d) Elastic (infinity < Ed < 1)
e) Perfectly elastic (Ed = infinity)
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FACTORS DETERMINE Ed

There are many determinants of elasticity of

demand;

a) Availability of substitute goods

b) Percentage of income
c) Necessity
d) Duration
e) Brand loyalty
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ELASTICITY OF SUPPLY

A measure used in economics to show the

responsiveness, or elasticity, of the quantity
supplied (Qs) of a good or service to a change in
it's price.
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CALCULATION

Formula;

Es = percentage change in quantity supply

percentage change in price
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DEGREE OF ELASTICITY

There are five degrees of elasticity;

a) Perfectly inelastic (Ed = 0)

b) Inelastic (-1 < Ed < 0)
c) Unit elasticity (Ed = 1)
d) Elastic (infinity < Ed < 1)
e) Perfectly elastic (Ed = infinity)
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FACTORS DETERMINE Es
There are 6 determinant of Es;

a) Length and complexity of production:

b) Mobility of factors
c) Time to reponse
d) Excess capacity
e) Inventories
f ) Complexity of production
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CHAPTER 5: COST OF PRODUCTION

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PRODUCTION COST IN SHORT

RUN
There are 2 types of inputs so there are 2 types of
costs; fixed cost and variable cost.

a) Fixed cost (FC) = the firm's total expenditure for

fixed inputs per period of time.

b) Variable cost (VC) = the firm's total expenditure

on variable inputs per period of time.
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PRODUCTION COST IN SHORT

RUN

Total Cost (TC) = the sum of fixed cost and

variable cost

TC = FC + VC
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SHORT-RUN AVERAGE COST

In average, there are also 2 types of cost;

a) Average fixed cost (AFC) = FC / Q

b) Average variable cost (AVC) = VC / Q

So the total of both average cost will be;

AC = AFC + AVC
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SHORT-RUN AVERAGE COST

Marginal Cost (MC) = the addition to total cost

resulting from the addition of one unit of output.

MC = Changes in TC
Changes in Quantity(Q)
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PRODUCTION COST IN LONG

RUN

Economies of scale Diseconomies of scale

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ECONOMIES OF SCALE
After a long period, companies will have lower AC
but than beyond some point succesively larger
plants will mean higher AC. This can happens
because of several factors;

a) Labor specialization
b) Managerial specialization
c) Efficient capital or technology
d) Raw materials
e) By-products
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DISECONOMIES OF SCALE

But in time the expansion of a firm may lead to

diseconomies and therefore higher per unit costs
due to several problems;

a) Managerial problems
b) Technological problems
c) Input problems
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BREAK EVEN ANALYSIS

The break-even point (BEP) is the point at which

cost or expenses and revenue are equal. So
there is no net loss or gain.
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CHAPTER 6: PERFECT COMPETITION AND

MONOPOLY MARKET
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DIFFERENT MARKET

The markets will be differentiated by;

a) Characteristic of market
b) Demand curve
c) Profit maximisation in the short run
d) Long run profit
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PERFECT COMPETITION
MARKET (PCM)

The market structure that exists when there are

many small businesses selling one standardized
product. For example, agriculture products.
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CHARACTERISTICS PCM

● Infinite buyers and sellers

● No entry barriers
● Perfect factor mobility
● Homogeneous products
● Price taker
● Perfect information
● Perfect mobility – zero transaction costs
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DEMAND CURVE PCM

Since a perfect competition firm is a price taker, its

demand curve is a horizontal straight line or
perfectly elastic curve.
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DEMAND CURVE PCM

Price (RM)

RM 20 AR = MR = DD

Quantity (unit)
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PROFIT MAXIMISATION IN SHORT

RUN

In short run, PCM may earn 3 types of profits;

a) Normal Profit
b) Supernormal or economic profit
c) Subnormal or economic loss
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LONG RUN PROFIT PCM

In the long run, a PCM would normally earned

Normal Profit because there is no barrier for
entry or exit in the market.
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MONOPOLY MARKET

The word monopoly comes from Greek (monos)

that means alone or single. Hence monopoly
market is defined as when there is only one
business providing a given market. Such as
Tenaga Nasional Berhad (supplier of electricity in
Malaysia)
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CHARACTERISTICS

● Profit Maximiser
● Price Maker
● Single seller
● Price Discrimination
● Product has no close substitute
● High Barriers to Entry: Other sellers are unable
to enter the market of the monopoly.
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DEMAND CURVE MONOPOLY

The demand curve is a downward sloping, as
illustrated;
Price (RM)

MR AR = DD
Quantity (unit)
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PROFIT MAXIMISATION IN SHORT

RUN

Similarly, a monopoly can either earn normal,

supernormal, and subnormal profit in short run.
However, as the demand curve for Monopoly is
different from PCM, these graph looks different.
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PROFIT MAXIMISATION IN SHORT

RUN
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LONG RUN PROFIT

In long run, monopoly will

likely be able to maintain a
supernormal profit because
there is no close substitute
product. So it is difficult for
other firms to enter market.

DIFFERENTIATION
PCM MARKET MONOPOLY MARKET
Marginal revenue and Price (P) equals Marginal
price Revenue (MR)
Product differentiation The same product (perfectly
homogeneous and a perfect
substitute).
Number of competitors Many
Barrier of entry None
Elasticity of demand Perfectly elastic demand curve.
Excess profit Excess profits in the short term
but in long term profits will
become zero.
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Marginal Revenue (MR) is
less than Price (P)
A customer either buys from
the monopoly company or
does without.
None
Relatively high barriers to
entry, strong enough to
prevent any potential
competitor.
Inelastic demand curve
A monopoly can preserve
excess profits because
barriers to entry prevent
competitors from entering the
market
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CHAPTER 7: OLIGOPOLY MARKET

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DEFINITION OLIGOPOLY

The market structure that exists when there are

very few but large firms selling a product.
Because there are few sellers, each oligopolist is
likely to be aware of the actions of the others.
Such as Proton, Toyota and Nissan in automobile
industry.
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CHARACTERISTICS

● Profit maximisation conditions

● Ability to set price

● Entry and exit: Barriers to entry are high.

● Number of firms: Few large firm control markets

● Product differentiation: Product may be

homogeneous (steel) or differentiated

● (automobiles).

● Perfect knowledge
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KINKED DEMAND CURVE-

SWEEZY'S MODEL

Assumptions of oligopolist demand curve;

a) If a firm's price increase, others will not follow

for fear of losing their customers.
b) If a firm reduce its price, others will follow.
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KINKED DEMAND CURVE

Price (RM)
There is a kink at E. This is known
as kinked demand curve.
D

Quantity (unit)
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CHAPTER 8: INTRODUCTION TO
MACROECONOMICS
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MACROECONOMICS

The study of the structure and performance of

national economies as a whole and of the policies
that goverment use to try to affect economic
performance.
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CIRCULAR FLOW IN INCOME

A model that shows how money moves
throughout an economy, between business and
people.
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CIRCULAR FLOW OF INCOME

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EXPLANATION
● The above diagram shows that Household buy
goods and services from firms.
● Firms use their revenue from sales to pay
wages to workers. Also firms pay taxes to
Government.
● Households do saving in Bank (Financial
Institution).
●
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MACROECONOMICS OBJECTIVE
The objective of macroeconomic policies is to
maximize the level of national income, providing
economic growth to raise the standard of living in
the economy. There is also secondary objectives;

a) Sustainability- in long run, the sustainability of

raw resources is vital.
b) Full employment – for a maximum production,
fully utilised labour is important.
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MACROECONOMICS OBJECTIVE
c) Price stability- achieved when demand and
supply is equal.
d) Increasing productivity-for a better standard of
living, the productivity must keep increasing.
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MACROECONOMICS POLICIES

Macroeconomic policies affect the performance of

the economy as a whole. The two major types of
policies would be Fiscal Policy and Monetary
Policy.
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MACROECONOMICS POLICIES

a) Fiscal Policy = about the Government's

adjustment on the country's spending and
taxation.

b) Monetary Policy = determine the rate of growth

of the nation's money supply and is under the
control of Central Bank.
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CHAPTER 9: CONSUMPTION AND SAVING

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DEFINITION

Consumption ( C ) = Spending by domestic

households on final goods and services, including
those produced abroad.

Saving (S) = Current income minus spending on

current needs.
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FUNCTIONS

Consumption function:
C = a + bY

Saving function:
S = -a + (1 – b)Y

a = Autonomy consumption
b = MPC or MPS
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FUNCTIONS

Formulate the function for Consumption and

Saving.
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DETERMINATION OF C & S

a) Income (Yd)
b) Interest rate ( r )
c) Access to credit
d) Consumer's prediction
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RELATIONSHIP BETWEEN C & S

In an economy with no foreign trade, the goods

market is in equilibirium when desired national
savings (S) equal desired investment (I). So does
when the aggregate quantity of goods supplied
(AS) equals aggregate quantity demand (AD).
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RELATIONSHIP OF I & S

Real interest rate, r

Saving, S

Investment, I

Desired national Saving and Investment, Id

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CHAPTER 10: INFLATION AND

UNEMPLOYMENT
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DEFINITION OF INFLATION

A condition characterized by a continuing rise in

prices. When the price level rises, each unit of
currency buys fewer goods and services. Hence,
inflation also reflects a decrease in the purchasing
power of money.
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MEASUREMENT OF INFLATION
Inflation rate = IH1 – IH0 X 100%
IH0
Year Inflation rate (%)
2006 3.2

2007 3.2

2008 2.3

2009 3.9

IH0 = Inflation rate base year

IH1 = Inflation rate current year
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CAUSES OF INFLATION

There could be many reasons for inflation to

happen;

a) Excess printing of money

b) Rise in cost of production
c) International lending and national debt
d) Federal taxes
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CONSEQUENCES OF INFLATION

High inflation gives a negative impacts such as;

a) Hyperinflation
b) Allocative efficiency
c) Set of business cycle
d) Social unrest and revolts
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UNEMPLOYMENT DEFINITION

The condition in which a percentage of the

population wants to work but is unable to find
jobs. This doesn't include children and students
who is studying.
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TYPES OF UNEMPLOYMENT

There are 4 types of unemployment;

a) Frictional unemployment
b) Seasonal unemployment
c) Structural unemployment
d) Cyclical unemployment
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CONSEQUENCES OF
UNEMPLOYMENT

There are negative effects of unemployment;

a) Low production
b) Rise of social problems
c) Waste of labour
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PHILLIPS CURVE
Inflation rate (%)

Phillips curve

Unemployment
rate (%)
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PHILLIPS CURVE
● A curve that shows the short run trade-off
between inflation and unemployment.
● The Phillips Curve illustrates a negative
relationship between inflation rate and
unemployment rate.
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CHAPTER 11: MONETARY AND FISCAL

POLICY
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DEFINITION OF MONETARY
POLICY

Because of all the economic problems, some

policies would be needed to solve them. One of it
is Monetary Policy which is considered as
Government's control over the supply of money
(Ms) and interest rate (r).
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MONETARY POLICY
● Policymakers can influence agregate demand
(AD).
● An increase in Ms reduces the equilibirium
interest rate for any given price level. Also lower
interest rate will stimulate investment, AD curve
will shift to the right.
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DEFINITION OF FISCAL POLICY

The setting of the level of of government spending

and taxation by governemnt policymakers. In the
short run, fiscal policy would affect aggregate
demand (AD).
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FISCAL POLICY
● An increase in the government purchases or a
cut in taxes will shift the AD curve to the right.
● A decrease in government purchases or an
increase in taxes shift the AD curve to the left.
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OBJECTIVE OF FISCAL POLICY

There are two objetive of fiscal policy;

a) Achieve ongoing stabil economic growth with

low unemployment (4%) and inflation rate.
b) Fair income distribution and close the gap of
income
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AUTOMATIC STABILIZERS
● Changes in fiscal policy that stimulate AD when
the economy goes into a recession without
policymakers having to take any deliberate
action.
● The most important automatic stabilizer is the
tax system. For example, when recession
happens, tax will fall automatically because
almost all tax are tied to economic activity.