Lecture 1

Scarcity Principle
- Unlimited wants, limited resources
- Have to analyse cost-benefit (take action only if benefit > cost)
- Economic surplus → benefit - cost
- Goal is to maximise surplus
- Opportunity cost → value of the next best alternative forgone
- Only considers best alternative → one factor
- Must be included when calculating cost
- Eg: giving up working to pursue further studies → opportunity cost = salary
forgone = $3000/month x 4 years
- Sunk cost → costs beyond recovery after decision made
- Irrelevant to future decision making
- Marginal cost/benefit → cost/ benefit of one additional unit of activity
- Average cost/benefit → total cost/benefit divided by number of units

Demand

- Buyer’s reservation price → highest price an individual is willing to pay for a

good
- ↑ price, ↓ quantity demanded
- ↓ price, ↑ quantity demanded

What happens when price ↑

- Substitution effect: Buyers switch to cheaper substitutes
- Income effect: Buyer’s purchasing power ↓
- In both cases, quantity demanded ↓
Supply

- Seller’s reservation price → lowest price the seller is willing to sell the good for
- ↑ price, ↑ quantity supplied (increase price, want more profit so supply more)
- ↓ price, ↓ quantity supplied

Market Equilibrium

- Equilibrium → no tendency for it to change

- Market equilibrium → occurs when all buyers and sellers are satisfied with their
respective quantities at the market price → quantity supplied = quantity
demanded
- Equilibrium price → price where supply and demand curve intersect
- Equilibrium quantity → quantity where supply and demand curve intersect
Surplus and Shortage

Surplus → Supply > Demand

- Supplier has incentive to decrease price in order to sell more
- As price decreases,
- Quantity offered for sale decreases along supply curve
- Quantity demanded increases along demand curve
- (according to graph)
- Lower prices decreases surplus
- ↓ price : ↓ supply, ↑ demand

Shortage → Demand > Supply

- Supplier has incentive to increase price in order to make more profit
- As price increases,
- Quantity offered for sale (supplied) increases along supply curve
- Quantity demanded decreases along demand curve
- (according to graph)
- Higher prices decreases shortage
- ↑ price : ↑ supply, ↓ demand
Price Ceiling

- Price ceiling → maximum allowable price set by law

- If price ceiling lower than equilibrium price,
- Quantity demanded increases
- Quantity supplied decreases
- Results in a shortage

Shifts in Demand

● Price decrease, demand increase

● Whole demand curve shifts right

Causes of shift in demand

- Price of complementary goods (products that must be consumed together)
- Price of substitute goods (products that can replace each other)
 - Income (normal or inferior goods)
- Preferences
- Number of buyers in market (larger quantity demanded)
- Future expectations (expect that price will increase in future, buy now →
increase in demand)

Shifts in Supply

- Supply increase → whole curve shifts right

- Supply decrease → whole curve shifts left

Causes of shift in supply

- Weather (eg. storms, lesser crops → decrease in supply)
- Expectation of future price change (suppliers expect prices to go up in the future
→ decrease supply and save inventory to sell for a higher price in the future → decrease
in supply)
- Technology (can increase supply)
- Price of input (increase in price of input → decrease in supply)
- Number of sellers in the market (more sellers → increase supply)