The English word economics is derived from the ancient Greek word oikonomia—meaning the

management of a family or a household

Economics was first considered as the “study of wealth”, and mercantilist in Europe between 16th
and 18th century. Mercantilism is a nationalist economic policy that is designed to maximize the
exports and minimize the imports for an economy. In other words, it seeks to maximize the
accumulation of resources (precious metals like gold and silver) within the country and use those
resources for one-sided trade
The definitions of Economics can conveniently be grouped into three:
1) Adam Smith’s Wealth Definition:
Father of Economics ,“The wealth of Nation”.
As a science of wealth which studies the process of production, consumption and
accumulation of wealth.
Economic growth doesn’t lie in accumulation of resources like metals, gold, and silver and
the accumulation of wealth but also the distribution of wealth

2) Marshall’s Welfare definition:

Economics is the study of man in ordinary business of life. It enquires how he gets his income
and here he uses it for his betterment (Welfare). A man earns money to collect wealth and
spends those earnings to get maximum satisfaction.
Material welfare includes things & money. Non material welfare include information,
intellectual property, copyrights.

3) Robbins’ Scarcity definition:

His definition runs in terms of scarcity: “Economics is the science which studies human
behaviour as a relationship between ends and scarce means which have alternative uses’.
“Allocation of scare resources in such a way to satisfy unlimited human wants”.

Economists therefore study

How people make decisions: how much they work, what they buy, how much
they save, and how they invest their savings.

10 principles of Economics:
PRINCIPLE 1: PEOPLE FACE TRADE-OFFS:
“There aren’t no such thing as a free lunch.” To get one thing that we like, we usually have to give up
another thing that we like. A student studying economics psychology: Trade off hour by studying one
and giving up another. gives up an hour that she could have spent napping, bike riding, watching TV,
or working at her part-time job for some extra spending money.
When people are grouped into societies, they face different kinds of trade-offs.
The classic trade-off is between “guns and butter.” The more a society spends on national defence
(guns) to protect its shores from foreign aggressors, the less it can spend on consumer goods (butter)
to raise the standard of living at home.

PRINCIPLE 2: THE COST OF SOMETHING IS WHAT YOU GIVE UP TO GET IT:

Or the Opportunity Cost:
Consider the decision to go to college. You get intellectual enrichment, professional development and
a lifetime of better job opportunities. But what are the costs? Add up money, college fee, food,
transportation, books, rent/hostels.
But we miss another cost related to this: The opportunity cost of an item is what you give up to get
that item. The best alternative forgone.

PRINCIPLE 3: RATIONAL PEOPLE THINK AT THE MARGIN:

Economists normally assume that people are rational. Rational people systematically and purposefully
do the best they can to achieve their objectives, given the available opportunities.
Objective: Buy smart phone
Available Opportunities: budget constraint, various smartphone options in the market, and access to
online reviews and ratings.
Research: researches different smartphones within her budget, considering specifications, customer
reviews, and expert opinions.
Budget Planning: Sarah evaluates her financial situation and determines the maximum amount she can
spend without compromising her other financial goals
Comparative Analysis: compares features, prices, and customer satisfaction of different phones to
identify the one that best aligns with her needs.
Based on her research and budget, Sarah selects a smartphone that offers the best combination of
features within her financial constraints.
Marginal changes small incremental adjustments to a plan of action.
Drinking glass to satisfy thirst.
As you study economics, you will encounter firms that decide how many workers to hire and how
much of their product to manufacture and sell to maximize profits.
PRINCIPLE 4: PEOPLE RESPOND TO INCENTIVES:
An incentive is something that induces a person to act, such as the prospect of a punishment or a
reward.
A tax on gasoline, for instance, encourages people to drive smaller, more fuel-efficient cars. That is
one reason people drive smaller cars in Europe, where gasoline taxes are high, than in the United
States, where gasoline taxes are low.
For example, when the price of an apple rises, people decide to eat fewer apples.

PRINCIPLE 5: TRADE CAN MAKE EVERYONE BETTER OFF:

Trade between two countries can make each country better off.
Country A: Country A is known for its efficient agricultural practices and can produce a surplus of
wheat.
Country B: Country B has a highly skilled workforce and can produce clothing at a lower cost than
Country A.
Trade Agreement:
Country A exports wheat to Country B.
Country B exports clothing to Country A.
Benefits:
Country A: By importing clothing from Country B, Country A can acquire clothing at a lower cost
than producing it domestically. This allows Country A to allocate more resources to its efficient
agricultural sector, increasing overall productivity.
Country B: By importing surplus wheat from Country A, Country B can obtain a key agricultural
resource without the need to produce it domestically. This enables Country B to focus on its
comparative advantage in clothing production and enhance its economic efficiency.

PRINCIPLE 6: MARKETS ARE USUALLY A GOOD WAY TO ORGANIZE ECONOMIC

ACTIVITY:
An economy that allocates resources through the decentralized decisions of many firms and
households as they interact in markets for goods and services.
Soviet Union: Communist countries worked on the premise that government officials (centralized
government) were in the best position to allocate the economy’s scarce resources. These central
planners decided what goods and services were produced, how much was produced, and who
produced and consumed these goods and services.
Most countries that once had centrally planned economies have abandoned the system and are instead
developing market economies (WHERE BUYER AND CONSUMER MEET AND IS
CONTROLLED BY INVISABLE HAND).

PRINCIPLE 7: GOVERNMENTS CAN SOMETIMES IMPROVE MARKET OUTCOMES:

If the invisible hand of the market is so great, why do we need government?
The government enforces the rules and maintains the institutions that are key to a market economy.
Most important, market economies need institutions to enforce property rights.
Road, bridges, subsidies, taxes are use to facilitate the market.

PRINCIPLE 8: A COUNTRY’S STANDARD OF LIVING DEPENDS ON ITS ABILITY TO

PRODUCE GOODS AND SERVICES:
GDP or National Income: the value of all goods and services produces in a country in a year.
The greater the national income/GDP the healthy the economy is:
Per Capita Income = Total GDP / Total Population
Per Capita Income = $21.43 trillion / 328 million
Per Capita Income ≈ $65,298 USD
If total annual expenditure per capita is $50,000. Everyone is well off.

PRINCIPLE 9: PRICES RISE WHEN THE GOVERNMENT PRINTS TOO MUCH MONEY:
What causes inflation? It is the quantity of money.
When we don’t produce many goods and services. And only produce or supply money.

PRINCIPLE 10: SOCIETY FACES A SHORT-RUN TRADE-OFF BETWEEN INFLATION

AND UNEMPLOYMENT:
• Increasing the amount of money in the economy stimulates the overall level of spending and thus the
demand for goods and services.
• Higher demand may over time cause firms to raise their prices, but in the meantime, it also
encourages them to hire more workers and produce a larger quantity of goods and services.
• More hiring means lower unemployment.
The field of economics is divided into two categories i.e.
microeconomics and macroeconomics.
Microeconomics is the study of economics on a small scale. This includes studying the behav
ior of firms (businesses), households, and industries.
Macroeconomics is the study of economics on a much larger scale; it is the study of the entir
e economy, including government economic policies and international trade.

Goods:
Goods are tangible, physical objects that satisfy human wants and needs. They are items that
can be seen, touched, and generally held. Goods can be classified into two main categories:
Durable Goods: These are goods that have a long lifespan and are not used up in a single use.
Examples include cars, appliances, and furniture.
Non-durable Goods: These are goods that are consumed in a short period or with a single use.
Examples include food, clothing, and paper products.

Services:
Services are intangible activities or performances that one party provides to another in
exchange for money or some other form of compensation. Unlike goods, services cannot be
touched or held. They are actions, efforts, or processes that deliver value to the recipient.
Examples: Services encompass a wide range of activities and can include things like haircuts,
education, healthcare, legal advice, transportation, and consulting.

PRODUCTION
The transformation of inputs in to outputs by firms in order to earn profit.

CONSUMPTION
The act of using goods and services to satisfy wants. This normally involve purchasing of
goods and services.

Factors of Production:
Factors of production is the inputs used in the production of goods or services in order to
make an economic profit.
They are:
land,
labour,
capital
entrepreneurship
land - includes space (i.e., location), natural resources, and what is commonly thought of as
land.
land is paid rent
capital - are the physical assets used in production - i.e., plant and equipment.
capital is paid interest
labor - is the skills, abilities, knowledge (called human capital) and the effort exerted by
people in production.
labor is paid wages
entrepreneurial talent - (risk taker) an individual who takes on the risk of starting and
operating a new business venture with the aim of making a profit.
entrepreneurial talent is paid profits.

The basic questions of economics become:

What to produce?
Given limited resources of FOP economic agents have to decide what to produce.
Firm aim is to maximize profit.
How to produce?
The entrepreneur will try and produce goods for the most profitable and cost-effective
method.
For whom to produce?
In a free market, goods are provided for those with the ability to pay.
ASSUMPTIONS:
Assumptions can make the world easier to understand. To study the effects of international
trade, for example, we may assume that the world consists of only two countries and that each
country produces only two goods.
For instance, physicist want to drop and ball from the roof-top to the ground and Assume that
there is no friction. They want to find speed/mass/acceleration/gravity in this assumed
scenario. They might be interested in finding a body speed/mass/acceleration/gravity in the
space.
In Economics, we make similar assumptions. Such as to understand international trade, where
we assume Two Countries, and trade Two products. Which in reality is not the case.
Similarly, Deman of a product with Price. Keeping other factors constant.

ECONOMIC MODELS:
In biology teachers teach basic anatomy with plastic replicas of the human body. These
models have all the major organs—the heart, the liver, the kidneys, and so on. The models
allow teachers to show their students in a simple way how the important parts of the body fit
together.
These models are stylized, and they omit many details. The model does not include all of the
body’s muscles and capillaries.
Economists also use models to learn about the world, but instead of being made of plastic,
they are most often composed of diagrams and equations.

OUR FIRST MODEL: THE CIRCULAR-FLOW DIAGRAM:

A visual model of the economy that shows how dollars/money flow through markets among
households and firms.
The economy consists of millions of people engaged in many activities—buying, selling,
working, hiring, manufacturing, and so on. To understand how the economy works, we must
find some way to simplify our thinking about all these activities.

For that reason, we use a simplified version of an economy, a visual model of the economy,
called a circular-flow diagram.
In this model, the economy has two types of decisionmakers—households and firms.

Firms: produce goods and services using factors of production.

Households: Own the factors of production and consume all the goods and services that the
firms produce.

Households and firms interact in two types of markets:

Markets for goods and services: households are buyers and firms are sellers.
Markets for the factors of production: households are sellers and firms are buyers.

The circular-flow diagram offers a simple way of organizing all the economic transactions
that occur between households and firms in the economy.
Decisions are made by households and firms.
Households and firms interact in the markets for goods and services (where households are buyers and
firms are sellers) and in the markets for the factors of production (where firms are buyers and
households are sellers).
The outer set of arrows shows the flow of dollars.
The inner set of arrows shows the corresponding flow of goods and services.

OUR SECOND MODEL: THE PRODUCTION: POSSIBILITIES FRONTIER:

Although real economies produce thousands of goods and services, let’s consider an economy that
produces only two goods—cars and computers.
Together, the car industry and the computer industry use all of the economy’s factors of production.
The production possibilities frontier is a graph that shows the various combinations of output—in this
case, cars and computers.

If the economy uses all its resources in the car industry, it produces 1,000 cars and no computers. If it
uses all its resources in the computer industry, it produces 3,000 computers and no cars. The two
endpoints of the production possibilities frontier represent these extreme possibilities.
More likely, the economy divides its resources between the two industries, producing some cars and
some computers. For example, it can produce 600 cars and 2,200 computers, shown in the figure by
point A. Or, by moving some of the factors of production to the car industry from the computer
industry, the economy can produce 700 cars and 2,000 computers, represented by point B.

The resources are scarce, not every conceivable outcome is feasible. For example, no matter how
resources are allocated between the two industries, the economy cannot produce the amount of cars
and computers represented by point C.
With the resources it has, the economy can produce at any point on or inside the PPF curve.
People face trade-offs. The production possibilities frontier shows one trade-off that society faces.
Once we have reached an efficient point on the frontier, the only way of producing more of one good
is to produce less of the other. When the economy moves from point A to point B, for instance, society
produces 100 more cars at the expense of producing 200 fewer computers.
The production possibilities frontier shows the opportunity cost of one good as measured in terms of
the other good. When society moves from point A to point B, it gives up 200 computers to get 100
additional cars. That is, at point A, the opportunity cost of 100 cars is 200 computers.
Put another way, the opportunity cost of each car is two computers.

Efficient Production: An outcome is said to be efficient if the economy is getting all it can from the
scarce resources it has available. Points on the production possibilities frontier represent efficient
levels of production.
Inefficient: Point D represents an inefficient outcome. For some reason, perhaps widespread
unemployment, the economy is producing less than it could from the resources it has available: It is
producing only 300 cars and 1,000 computers
Unattainable: Point C is unattainable. You can produce more than your resources available to you.
A country would require an increase in factor resources, an increase in the productivity or
an improvement in technology to reach point C.
Growth will change the potential output of the economy, hence the shift of the entire curve.

The production possibilities frontier simplifies a complex economy to highlight some basic but
powerful ideas: scarcity, efficiency, trade-offs, opportunity cost, and economic growth.
Economic System:
Capitalist Economy:
Definition: In a capitalist economy, (free Market Economy) individuals and businesses own
and control the means of production. The government's role is limited, and the market largely
determines what is produced, how, and for whom.
Laissez faire - government hands-off.
Poverty, inequity and several social ills are associated with the lack of protection afforded by
government
Example: The United States and most Western countries operate under a capitalist system.
Private businesses compete in the market, and prices are determined by supply and demand.
Command Economy - Government makes the decisions - with force of law (and sometimes
martial force) Often associated with dictatorships.
A command economy is where a central government makes all economic decisions. The
government or a collective owns the land and the means of production. It doesn't rely on the
laws of supply and demand that operate in a market economy.
Example is Communism and Socialism
Communism: It is a socio-economic ideology that expects a classless, stateless society where
the means of production are collectively owned. However, during the transitional phase (often
called socialism), the state may control the means of production on behalf of the people. But
the centralized state is expected to be temporary, gradually fading away as communism is
fully realized.
The former Soviet Union and China under Mao Zedong attempted to implement communist
principles-- envisioned by theorists like Karl Marx.
Socialism: In socialism, the means of production (such as factories, businesses, and land) are
often owned or controlled by the state or the community as a whole. The goal is to eliminate
or significantly reduce economic inequality by ensuring that wealth and resources are shared
more equally among the population.
The government plays a substantial role in economic planning and decision-making. It
determines what goods and services are produced, how they are produced, and for whom they
are produced. Central planning is a common feature, and there may be limited room for
private enterprise.
Mixed Economy: A mixed economy combines elements of both command and capitalist
systems. The government and private sector coexist, with the government regulating certain
industries and providing public goods.
 Closed Economy: A closed economy is one that has no trade activity with outside economies.
A closed economy is self-sufficient, which means no imports come into the country
and no exports leave the country. A closed economy's intent is to provide domestic consumers
with everything they need from within the country's borders.
Open Economy: An economy in which participants are permitted to buy and sell goods and
services with other countries.
Supply and Demand.
Supply:
Definition: Supply refers to the quantity of a good or service that producers are willing and able to
offer for sale at various prices during a specific period.
Demand:
Definition: Demand is the quantity of a good or service that consumers are willing and able to
purchase at various prices during a specific period.

What Is a Market?
A market is a group of buyers and sellers of a particular good or service. The buyers as a group
determine the demand for the product, and the sellers as a group determine the supply of the product.
What Is Competition?
Take example of ice-cream or milk sellers. Each buyer knows that there are several sellers from which
to choose, and each seller is aware that his product is similar to that offered by other sellers.
As a result, the price and quantity of ice cream/milk sold are not determined by any single buyer or
seller. Rather, price and quantity are determined by all buyers and sellers as they interact in the
marketplace.
Economists use the term competitive market to describe a market in which there are so many buyers
and so many sellers that each has a negligible impact on the market price.
Each seller of ice cream has limited control over the price because other sellers are offering similar
products. A seller has little reason to charge less than the going price, and if he charges more, buyers
will make their purchases elsewhere.
Similarly, no single buyer of ice cream can influence the price of ice cream because each buyer
purchases only a small amount.
Law of Demand:
The Law of Supply and the Law of Demand are fundamental principles in economics that describe the
relationship between the price of a good or service and the quantity supplied or demanded.
Law of Demand: When the Price Increases, the quantity demanded decreases, ceteris Paribas (Other
things keep constant) and vice versa.
A demand schedule a table that shows the relationship between the price of a good and the quantity
demanded.
Market Demand versus Individual Demand: To
To analyse how markets work, we need to determine the market demand, the sum of all the individual
demands for a particular good or service.

Other Variables Affecting Quanty Demanded:

Taste: The more desirable people find the good, the more they will demand. Taste are affected by
advertising, by fashion, by observing other consumers etc.
Price of Related Goods: When a fall in the price of one good reduces the demand for another good,
the two goods are called substitutes. Pepsi and coca cola.
When a fall in the price of one good raises the demand for another good, the two goods are called
complements. Complements are often pairs of goods that are used together, such as gasoline and
automobiles, computers and software, bat and ball.
Income: As people income rises, their demand for most goods will rises. Such goods are called
normal goods. However, when people get richer, they spend less of inferior goods. An example of an
inferior good might be bus rides. As your income falls, you are less likely to buy a car or take a cab
and more likely to ride a bus.
Future Expectations: Your expectations about the future may affect your demand for a good or
service today. If you expect to earn a higher income next month, you may choose to save less now and
spend more of your current income buying ice cream. If you expect the price of ice cream to fall
tomorrow, you may be less willing to buy an ice-cream cone at today’s price.
Number of Buyers: Th number of buyers in a market for a product increases, the price of that product
will also increase.

Movement along and shift in demand curve:

Demand curve is constructed on the assumption that other things being equal. It assumes that none of
the determinants changes other than prices.
So, when price changes, we see changes along the curve. When other determinants changes, the
demand curve shifts outward or inward.
Shifts in the Supply Curve:
Because the market supply curve is drawn holding other things constant, when one of these factors
changes, the supply curve shifts. For example, suppose the price of sugar falls. Sugar is an input in the
production of ice cream, so the fall in the price of sugar makes selling ice cream more profitable. This
raises the supply of ice cream: At any given price, sellers are now willing to produce a larger quantity.
As a result, the supply curve for ice cream shifts to the right.
Input Prices: When the price of one or more of inputs (cream, sugar, flavouring, ice-cream machines,
the buildings etc.) rises, producing ice cream is less profitable, and firms supply less ice cream. Thus,
supply curve shifts inward.
Technology: The invention of the mechanized ice-cream machine, for example, reduced the amount
of labor necessary to make ice cream. By reducing firms’ costs, the advance in technology raised the
supply of ice cream.
Future Expectations: If firm expects the price of ice cream to rise in the future, it will put some of its
current production into storage and supply less to the market today.
Number of Sellers: if the number of sellers reduces or were to retire from the ice-cream business, the
supply in the market would fall.
Law of supply: the claim that, other things being equal, the quantity supplied of a good rises when
the price of the good rises.
Supply schedule a table that shows the relationship between the price of a good and the quantity
supplied.

Market Supply versus Individual Supply:

Shifts in the Supply Curve:
1. Cost of Production:
a. Change in input prices.
b. Change in Technology
c. Organizational Changes
d. Govt. Policy
2. Random Shocks:
a. Weather
b. Disease
c. Earthquake
f. Machinery Breakdown.
3. Aim of Producers:
4. Expectations of the future Price:
5. Number of Suppliers:
6. Substitute in Supply:
Market Equilibrium
The equilibrium price is the only price which producers’ and consumers’ wishes are mutually
reconciled: where the producers’ plan to supply exactly match the consumers’ plan to buy.
The point where quantity supplied become equal to quantity demanded
Also called market clearing price: when supply matches demand, leaving no shortages and no surplus.

Change in demand:
If one of the determinants of the demand changes (other than price).
The Elasticity of Demand:
When price goes up, quantity demanded will fall. But how much fall ? Or how responsive demand is
to rise in price?
Two product: Oil and Cauliflower. If oil prices goes up, people demand will slightly fall. They pay
high prices for oil. If cauliflower price goes up, quantity demand will substantially fall, because
alternatives are available.
We call this response of demand to the change in price, as the “price elasticity of demand”. (PED).
Demand for a good is said to be elastic if the quantity demanded responds substantially to changes in
the price. Demand is said to be inelastic if the quantity demanded responds only slightly to changes
in the price.
PED is important for formulating government policies, producers’ profit maximization aim etc.
Computing the Price Elasticity of Demand:
Economists compute the price elasticity of demand as the percentage change in the quantity
demanded divided by the percentage change in the price.
price elasticity of demand = percentage change in quantity demanded/percentage change in price.
suppose that a 10 percent increase in the price of an ice-cream cone causes the amount of ice cream
you buy to fall by 20 percent.
, the elasticity is 2, reflecting that the change in the quantity
demanded is proportionately twice as large as the change in the price.

PED =

= (New-Old) = (Q2-Q1) or (P2-P1)

The Midpoint Method: A Better Way to Calculate Percentage Changes and Elasticities .
point A: price $4 quantity 120
point B: price $6 quantity 80
Going from point A to point B, the price rises by 50 percent and the quantity falls by 33
percent, indicating that the price elasticity of demand is 33/50, or 0.66. Going from point B to
point A, the price falls by 33 percent and the quantity rises by 50 percent, indicating that the
price elasticity of demand is 50/33, or 1.5. This difference arises because the percentage
changes are calculated from a different base.

Mid-Point Formula:
One way to avoid this problem is to use the midpoint method for calculating elasticities.
Price elasticity of demand =

1.If Ped is between 0 and 1 (i.e. the percentage change in demand from A to B is smaller
than the percentage change in price), then demand is inelastic.
2.If Ped = 1 (i.e. the percentage change in demand is exactly the same as the percentage
change in price), then demand is said to unit elastic. A 15% rise in price would lead to a 15%
contraction in demand leaving total spending by the same at each price level.
3.If Ped > 1, then demand responds more than proportionately to a change in price
i.e. demand is elastic. For example a 20% increase in the price of a good might lead to a 30%
drop in demand. The price elasticity of demand for this price change is –1.5.
4. Perfect Inelasticity. This shows a perfectly elastic demand curve. The horizontal line
shows that an infinite quantity will be demanded at a specific price. The quantity demanded is
extremely responsive to price changes, moving from zero for prices close to P to infinite
when prices reach P.
5. Perfect Elastic or Ped = 0 demand is said to be perfectly inelastic. This means that
demand does not change at all when the price changes – the demand curve will be drawn as
vertical.
Show your work. Find out elasticities at each point using Mid-Point Formula:

Price Quantity
 demanded
2 40
4 30
6 20
8 12
10 1

Total Revenue and the Price Elasticity of Demand:

If demand is inelastic, then an increase in the price causes an increase in total revenue. Here
an increase in price from $4 to $5 causes the quantity demanded to fall from 100 to 90, so
total revenue rises from $400 to $450.
We obtain the opposite result if demand is elastic: An increase in the price causes a decrease
in total revenue. For instance, when the price rises from $4 to $5, the quantity demanded falls
from 100 to 70, so total revenue falls from $400 to $350.

Elasticity and Total Revenue along a Linear Demand Curve

Other Demand Elasticities:
The Income Elasticity of Demand The income elasticity of demand measures how the quantity
demanded changes as consumer income changes.

income elasticity of demand = percentage change in quantity demanded/percentage change in income

Higher income raises the quantity demanded. Because quantity demanded and income move in the
same direction, normal goods have positive income elasticities.

A few goods, such as bus rides, are inferior goods: Higher income lowers the quantity demanded.
Because quantity demanded and income move in opposite directions, inferior goods have negative
income elasticities.
The Cross-Price Elasticity of Demand:
The cross-price elasticity of demand measures how the quantity demanded of one good responds to a
change in the price of another good.
It is calculated as the percentage change in quantity demanded of good 1 divided by the percentage
change in the price of good 2.
Whether the cross-price elasticity is a positive or negative number depends on whether the two goods
are substitutes or complements.
Complementary goods are items that are often used together, and the consumption of one tends to
enhance the consumption of the other. Coffee and sugar are complements. When you consume coffee,
you might use sugar to enhance its taste. An increase in the consumption of coffee might lead to an
increase in the consumption of sugar.
Or computers and software. In this case, the cross-price elasticity is negative, indicating that an
increase in the price of computers reduces the quantity of software demanded.
Substitutes are goods that are typically used in place of one another. Substitute goods are items that
can be used in place of each other, and the consumption of one can replace the consumption of the
other. Tea and coffee are substitutes. If the price of coffee increases significantly, consumers may
choose to switch to tea as a more affordable alternative. Because the price of coffee and the quantity
of tea demanded move in the same direction, the cross-price elasticity is positive.
The Elasticity of Supply:
Price elasticity of supply a measure of how much the quantity supplied of a good responds to a change
in the price of that good, computed as the percentage change in quantity supplied divided by the
percentage change in price.
Supply, Demand, and Government Policies

Controls on Prices:
Wheat production in Pakistan. Supply and demand makes and equilibrium price.
Price might be high for some people and low for other. Lobbyist influence government to either
increase the price or reduce the price. If supplier’s lobbyist succeed, the government imposes a legal
maximum on the price at which wheat can be sold. Because the price is not allowed to rise above this
level, the legislated maximum is called a price ceiling.
By contrast, if the consumer lobbyist are successful, the government imposes a legal minimum on the
price. Because the price cannot fall below this level, the legislated minimum is called a price floor.
Examples of price flood and ceiling is given below but for ice-cream taken from the book.
Consumer Surplus:
Consumer surplus a buyer’s willingness to pay minus the amount the buyer actually pays.
Willingness to pay is the maximum amount that a buyer will pay for a good.
Suppose the price of a good/product is $80, and the following consumers are willing to pay the
following prices for that product.
BUYER WILLINGNESS TO PAY
John $100
Paul 80
George 70
Ringo 50
Thus, consumer surplus is a good measure of economic well-being if policymakers want to respect the
preferences of buyers.
Producer surplus:
Producer surplus is an economic concept that represents the difference between the price at which
producers are willing to sell a good or service and the price they actually receive in the market.
Willingness to Sell:
Producers have a minimum price, known as the "reservation price" or the price at which they are
willing to sell their products.
Total surplus—the sum of consumer and producer surplus.
The equilibrium price determines which buyers and sellers participate in the market. Now, those
buyers who value the good more than the price (represented by the segment AE on the demand curve)
choose to buy the good; those buyers who value it less than the price (represented by the segment EB)
do not.
Similarly, those sellers whose costs are less than the price (represented by the segment CE on the
supply curve) choose to produce and sell the good; those sellers whose costs are greater than the price
(represented by the segment ED) do not.
Production and Costs: Short run
The cost of production will depend on the amount of inputs used. Let’s focus on the quantity of input
used.
Short run and long run changes in production: if a firm want to increase production, it will take
time to acquire a greater quantity of certain inputs e.g. a manufacturer can use more electricity or raw
materials, but it might take long time to install more machines, and longer time to build a second
factory.
In hurry a company may increase some quantity i.e. raw materials, labour, more fuel, more tools etc.
but it will make these changes in existing buildings and most of its machinery.
Fixed factors: Input that can’t be increased within a given time period e.g. building
Variable factors: Inputs that can be increased in a given time period e.g. raw material, tools, labours
etc.
The distinguish between fixed and variable factors allow us to distinguish between short run and long
run.
Short run: time period during which at least one factor of production is fixed. In this case output can
be increased by using more variable factors. E.g. shipping line wanted to carry more passengers due to
rise in demand, it could, accommodate more passengers, frequent trips, hire more crew, use more fuel.
But in short run it cannot build/buy more ships: no time for that. (Fixed=ship, variable=crew, fuel)
Long run: is a time period long enough for all inputs to be varied.
Production Function: This relationship between the quantity of inputs (workers) and quantity of
output (cookies) is called the production function.
Marginal product the increase in output that arises from an additional unit of input.
Diminishing marginal product the property whereby the marginal product of an input declines as the
quantity of the input increases.
 Cost and output
Average cost:
Average Cost is cost per unit production
AC = TC/Q
If cost of firm is £2000 and it produces 100 units, average cost would be £20 for each unit.
AC can also be divided in to (Average fixed cost + Avg. Variable Cost)
AC = AFC + AVC
• Average Fixed cost: This falls continuously as output rises, since total fixed cost are being
spread over a greater and greater output. (TFC/Q)
• Average Variable Cost: Since, AVC = ATC – AFC, the AVC curve is simply the vertical
distance between the AC and AFC. As AFC gets less, the gap between AVC and ATC narrows.
TVC /Q
Marginal Cost:
Extra cost of producing one more unit: that is the rise in total cost per one unit rise in out put
MC =∆𝑇𝐶/∆𝑄
E.g. firm producing 10000 boxes of matches a month. The total cost is 100. It’s now increased by
6000 boxes. The total cost is now 180.
∆𝑄 = (10000-6000 = 4000)
∆𝑇𝐶 = (180 – 100 = 80)
MC = 0.02
 • Scale of production: if firm were to double all of its inputs-would it double the outputs? Or
output more than double or less than double? We can distinguish three possible situations:
• Constant return to scale: when a given percentage increases in inputs will lead to the same
percentage increase in output.
• Increasing return to scale: when a given percentage increase in inputs will lead to a larger
percentage increase in output.
• Decreasing return to scale: when a given percentage increase in inputs will lead to a smaller
percentage increase in output.

Economies of Scale:
Definition:
Economies of scale refer to the cost advantages that a business can achieve as a result of an increase
in its level of production or output.

Explanation:
When a firm expands its production and increases output, it can benefit from cost savings per unit of
production. These cost savings arise due to various factors:

Bulk Purchasing: Buying materials in larger quantities often leads to lower unit costs.
Specialization: Larger-scale production allows for specialized machinery and division of labor,
leading to increased efficiency. Assembly Line Workers: attaching doors, installing windows.
Engine Technicians, experts in engine-related tasks. Quality Control Inspectors. inspecting finished
vehicles for defects.
Technological Advancements: Larger firms can afford to invest in advanced technologies, improving
efficiency and reducing costs.
Marketing Efficiencies: Advertising and marketing costs can be spread over a larger production
volume, reducing the cost per unit. Cost per unit= Total Cost/ Output

Example: Consider a bakery that produces 100 loaves of bread a day. If it increases production to
1,000 loaves a day, it can negotiate better deals with suppliers for raw materials, utilize more efficient
machinery, and benefit from lower average costs per loaf, leading to economies of scale.
 Diseconomies of scale
Definition:
Diseconomies of scale occur when a business experiences an increase in average costs per unit as the
scale of production expands.

Explanation:
As a firm continues to grow, it may encounter challenges that lead to higher per-unit costs:

Complexity: Larger organizations may become more complex, leading to coordination and
communication challenges that increase costs.
Bureaucracy: Increased size can result in more layers of management and bureaucracy, slowing
decision-making processes. E.g. hierarchy of Pakistan bureaucracy. Chief secretary, additional chief
secretary, secretaries, additional secretaries, commissioners, deputy commissioners, assistant
commissioners.
Resource Misallocation: With a larger scale, there may be inefficiencies in resource allocation and
utilization.
Communication Issues: Larger teams may experience difficulties in effective communication,
affecting productivity.
Example:
If a software development company grows rapidly, it may face diseconomies of scale due to increased
bureaucracy and communication challenges. Decision-making processes may slow down, leading to
higher costs per unit of output.
In summary, economies of scale bring cost advantages with increased production, while diseconomies
of scale involve rising costs per unit as a business expands. Understanding these concepts is crucial
for businesses aiming to optimize their production and operational efficiency.
 Total profit = Total cost – Total revenue
• We discussed cost and now turn to revenue
• We distinguish between three revenue concepts:
1) Total revenue (TR)
2) Average Revenue (AR)
3) Marginal revenue (MR)

Total Revenue
• Is the firm’s total earnings per period of time from the sale of a particular amount of output
(Q).
TR = P X Q
Average Revenue

It is the amount that the firm earns per unit sold. Thus:
AR = TR/Q

Marginal Revenue:
Marginal revenue is the additional revenue generated by producing and selling one more unit of a
product or service. It represents the change in total revenue when the quantity sold increases by one
unit
 MR =
Example:
Suppose a firm produce and sell 5 units of its product (Q = 5). Price of each product is $10 (P = $10).
Now, in a perfectly competitive market, the marginal revenue (MR) is equal to the market price (P)
because the firm can sell each additional unit at the same price.
Total Revenue (TR) for selling 5 units: TR = P * Q = $10 * 5 = $50
Total cost of producing 6 units: 6 * $10 = $60
Marginal Revenue: T2-T1/Q2-Q1 $60-$50/6-5 = $10
Average Revenue = TR/Q = $50/5 = $10.
MR = AR = P = $10 under perfect competition.
 Market structure:

The degree of competition

• Perfect competition
• Monopoly
• Oligopoly
• Monopolistic competition
• Duopoly
To distinguish between these categories, we must consider:
How freely the market can enter the industry: Is entry free or restricted?
The nature of the product: Identical or differentiated goods?
The degree of control the firm has over the price.

Examples of Perfect Competition:

The foreign exchange market, where currencies are bought and sold, can be considered an example
of perfect competition.
Markets for agricultural commodities such as wheat, rice, and soybeans often exhibit characteristics
of perfect competition.
Street markets where vendors sell identical goods, such as fruits, vegetables.
Labor markets for unskilled or low-skilled workers in certain industries may approach perfect
competition
Examples of Monopolistic Competition:
Fast-food chains, such as McDonald's, Burger King, KFC, Subway, and Taco Bell, compete by
offering differentiated products, branding, and unique menu items.
Soft Drink Industry: coca cola, Pepsi, Fanta, Mirinda, sprite, 7-up.
Clothing retailers like H&M, Zara, Forever 21, and Gap compete.
Example of Oligopoly:
Oil and Gas Industry: Shell, PSO, Byco, Attock. Significant control over oil distribution.
ExxonMobil, Royal Dutch Shell, Chevron, and BP have significant control over oil exploration,
production, and distribution.
Mobile Telecommunications: Jazz, Ufone, Zong
Computer Operating Systems: Microsoft's Windows and Apple's macOS are dominant players
Pharmaceutical Industry: Pfizer, Johnson & Johnson, Abbott, GSk
Perfect competition
Illustrates an extreme example of capitalism
In it firms are entirely subject to market forces. They have no power to affect the price of the product.
The price is determine by the interaction of supply and demand in the whole market.
Assumptions:
Firms are price takers. So many small firms in the industry that each one produce insignificantly
small proportion of total industry supply, and therefore, no power to influence the price. Price
determined by supply and demand interaction
Complete freedom of entry into the industry for new firms. Existing firms are unable to stop new
firms setting up the businesses. Setting up a business take time, therefore, freedom of entry applies in
the long run
All firms produce identical products i.e. homogenous products. Therefore, there is no branding or
advertisements
Producers and consumer have perfect knowledge of the market i.e. producers are full aware of the
prices, costs and market opportunities. Consumers are fully aware of price, quality, and availability of
product
These assumptions are very strict a few markets might be very close to perfect competition e.g.
market of fresh vegetables such as potatoes.
Monopoly :
A monopoly is a market structure where a single seller or producer dominates the entire market for a
particular product or service. In other words, there is only one company that controls the supply and
distribution of a specific good, and there are no close substitutes available.
Key Features of a Monopoly:
1. Single Seller:
 In a monopoly, there is only one firm that produces and sells the product or service.
This firm is the exclusive provider in the market.
2. Unique Product:
 The monopoly firm usually offers a unique product that doesn't have close substitutes.
Consumers have limited alternatives.
3. High Barriers to Entry:
 Barriers such as high startup costs, exclusive access to resources, or government
regulations make it difficult for new competitors to enter the market.
4. Price Maker:
 The monopoly firm has significant control over the price of its product. It can set the
price without worrying about competition.
5. No Perfect Competition:
 Monopolies contrast with perfect competition, where many small firms compete with
identical products. In a monopoly, there is no direct competition.

Monopolies are not common because rules and laws in many countries promote competition.
However, there are cases where one company has a big influence in a market.
The post office before 2006 had a monopoly over the delivery of letters, but it faced competition in
the communications from telephone, faxes, and email.
Oligopoly:
• A few firms shares a large portion of the industry
• Firms may produce virtually identical products. Most oligopolistic however, produce
differentiated products (cars, toiletries, soft drinks, electrical appliances)
• Much of the competition between such oligopolists is in terms of the marketing of their
particular brands
• Despite the differences, two crucial features that distinguish oligopoly from other market
structures
• A) Barrier to Entry: unlike monopolistic firm, it has various barriers to the entry of new
firms. These are similar to those under monopoly (as discussed)
• B) Interdependence of Firms: as there are only few firms, each firm has to take account of
the others. It means they are mutually dependent or interdependent. It means, each firm is
affected by its rivals’ actions. E.g. if a frim changes the price or specification of its product
 e.g. amount of advertising, the sales of its rival will be affected. The rival may then respond
by changing their price, specification or advertising. No firm can therefore, ignore the actions
and reactions of other firms
Oligopolists are pulled in to two different directions
The interdependence of firms may make them wish to collude with each other and act as if they were
a monopoly, they could jointly maximize industry profit
On other hand, they will be tempted to compete with their rivals to gain bigger share of the industry
profit for themselves
These two policies are incompatible. The more strongly firms compete to gain bigger share of the
industry profits, the smaller these industry profits will become. E.g. with competition drives down the
average industry prices, and advertisements rises the industry costs. Either way industry profits falls
Thus we have, collusive oligopoly and non-collusive oligopoly.
Firms under oligopoly engage in collusion they limit competition and agree on prices, market share,
advertisement expenditure etc. such collusion reduces the uncertainty they face.
cartel: A formal collusive agreement is called a cartel, which maximizes the firms profit and act like
monopoly.
Oligopolist might not collude with each other, they will take to account of rivals’ like behavior when
deciding their own strategy. In doing so they look at rivals past behavior and make assumptions based
on it. E.g. Cournot Model
 There are several assumptions in Cournot's model:
1. Firms are rational, and their objective is to maximize their profits;
2. Firms produce homogeneous products;
3. Firms compete by setting output quantities;
4. There are several assumptions in Cournot's model:
5. Firms are rational, and their objective is to maximize their profits;
6. Firms produce homogeneous products;
7. Firms compete by setting output quantities;
8. Firms make decisions simultaneously;
9. Firms treat their competitor's output as fixed;
10. There is no cooperation between the firms;
11. Firms have enough market power such that their output decision can affect the market
price.
12. Firms make decisions simultaneously;
13. Firms treat their competitor's output as fixed;
14. There is no cooperation between the firms;
15. Firms have enough market power such that their output decision can affect the market
price.