ECONOMIC ENVIRONMENT

GulRukh Zahid
Consumer goods

■ Consumer goods are products bought for consumption by the

average consumer. Also called final goods, consumer goods are
the end result of production and manufacturing.
■ There are two types of consumer goods: durable goods and non-
durable goods. Durable goods are products that have a longer
lifespan, usually lasting for three or more years, while non-durable
goods are products that are consumed quickly and have a shorter
lifespan.
■ Examples of durable goods include automobiles, appliances,
furniture, and electronics. These goods are usually more expensive
and are considered long-term investments by consumers.
■ Examples of non-durable goods include food, clothing,
personal care items, and cleaning supplies. These goods are
typically less expensive and are used up quickly, requiring
consumers to purchase them on a regular basis.
■ Consumer goods play a significant role in the economy as they
represent a major portion of the demand for goods and
services. The production and consumption of consumer goods
drive economic growth and are a key indicator of the overall
health of the economy.
Producer goods

■ producer goods, also called intermediate goods, in

economics, goods manufactured and used in further
manufacturing, processing, or resale. Producer goods either
become part of the final product or lose their distinct identity
in the manufacturing stream.
■ Examples of producer goods include machinery, equipment,
tools, and raw materials. These goods are often used to
produce other goods, such as cars or furniture, or to provide
services, such as transportation or construction.
■ Unlike consumer goods, which are purchased by individuals or
households, producer goods are typically purchased by
businesses or organizations. The production of these goods is a
key component of the supply chain and is critical to the success
of many industries.
■ From an economic perspective, the production and
consumption of producer goods is important for driving
economic growth and productivity. Investment in capital
goods, such as new machinery or equipment, can help
businesses increase their production capacity and improve
efficiency, leading to increased profits and economic growth.
■ Producer goods play a crucial role in the economy by enabling
businesses to produce the goods and services that are
consumed by individuals and households.
Goods and services
■ Goods and services are the output of an economic system.
Goods are tangible items sold to customers. while services are
tasks performed for the benefit of the recipients.
■ Examples of goods are automobiles, appliances, and clothing.
Examples of services are legal advice, house cleaning, and
consulting services. The output of a business can lie
somewhere between these two concepts. For example, a
landscaping company could sell a homeowner a tree (goods)
and also mow the lawn (a service).
Demand

■ Demand reflects a decision about which wants to satisfy.

■ The quantity demanded of a good or service is the amount
that consumers plan to buy during a given time period at a
particular price. The quantity demanded is not necessarily the
same as the quantity actually bought. Sometimes the quantity
demanded exceeds the amount of goods available, so the
quantity bought is less than the quantity demanded.
The law of Demand

■ The law of demand states Other things remaining the same,

the higher the price of a good, the smaller is the quantity
demanded; and the lower the price of a good, the greater is the
quantity demanded.
■ Figure 3.1 shows the demand curve for energy bars. A demand
curve shows the relationship between the quantity demanded
of a good and its price when all other influences on consumers’
planned purchases remain the same.
Supply
■ A supply is more than just having the resources and the
technology to produce something. Resources and technology
are the constraints that limit what is possible.
■ The quantity supplied of a good or service is the amount that
producers plan to sell during a given time period at a particular
price. The quantity supplied is not necessarily the same amount
as the quantity actually sold. Sometimes the quantity supplied
is greater than the quantity demanded, so the quantity sold is
less than the quantity supplied
The law of supply

■ The law of supply states:

■ Other things remaining the same, the higher the price of a
good, the greater is the quantity supplied; and the lower the
price of a good, the smaller is the quantity supplied
Production possibility frontier

■ The production possibilities frontier shows the combinations of

output—in this case, cars and computers—that the economy
can possibly produce. The economy can produce any
combination on or inside the frontier. Points outside the
frontier are not feasible given the economy’s resources. The
slope of the production possibilities frontier measures the
opportunity cost of a car in terms of computers. This
opportunity cost varies, depending on how much of the two
goods the economy is producing
Market Equilibrium
■ An equilibrium is a situation in which opposing forces balance
each other. Equilibrium in a market occurs when the price
balances buying plans and selling plans. The equilibrium
price is the price at which the quantity demanded equals the
quantity supplied. The equilibrium quantity is the quantity
bought and sold at the equilibrium price. A market moves
toward its equilibrium because
■ Price regulates buying and selling plans.
■ Price adjusts when plans don’t match.
■ The table lists the quantity demanded and the quantity supplied
as well as the shortage or surplus of bars at each price. If the
price is $1.00 a bar, 15 million bars a week are demanded and
6 million bars are supplied. There is a shortage of 9 million
bars a week, and the price rises.
■ If the price is $2.00 a bar, 7 million bars a week are demanded
and 13 million bars are supplied. There is a surplus of 6 million
bars a week, and the price falls. If the price is $1.50 a bar, 10
million bars a week are demanded and 10 million bars are
supplied. There is neither a shortage nor a surplus, and the
price does not change. The price at which the quantity
demanded equals the quantity supplied is the equilibrium price,
and 10 million bars a week is the equilibrium quantity.
Normal good
■ A normal good is a type of good whose demand increases when
consumer income increases, while other factors such as price
and availability remain constant. As income increases,
consumers are able to afford more goods and services, and
therefore, they are more likely to purchase more of the normal
goods that they desire.
■ Examples of normal goods may include clothing, food,
housing, and transportation. As consumers' income increases,
they may be more likely to purchase higher-quality products or
upgrade their living arrangements, such as buying a bigger
house or a nicer car.
 Inferior Goods
■ An inferior good is a type of good whose demand decreases when
consumer income increases. This is in contrast to normal goods, where
demand increases when consumer income increases. An inferior good is
often considered a lower-quality or less desirable product, and consumers
may switch to purchasing more expensive, higher-quality goods as their
income increases.
■ Examples of inferior goods may include generic or store-brand products,
fast food, and low-quality clothing. As consumer incomes rise, they may
choose to purchase name-brand products, healthier food options, and
higher-quality clothing items, making these goods normal goods.
■ Inferior goods can be an important factor to consider in economic
analysis and forecasting, as changes in consumer income levels can affect
overall demand and market trends for different products.
Luxury good
■ luxury good is a product or service that is considered to be of high
quality, rare, exclusive, and expensive, often exceeding the purchasing
power of most consumers. Luxury goods are generally associated with
status, prestige, and a high social or cultural value.
■ Examples of luxury goods include high-end designer clothing, luxury
watches, luxury cars, private jets, yachts, fine jewelry, and high-end
electronics. These goods are often marketed to wealthy individuals who
have the purchasing power to afford them, and are often associated with
symbols of wealth and success.
■ The demand for luxury goods is driven by a variety of factors, including
social status, wealth, exclusivity, and the desire for unique or high-quality
products. As such, luxury goods are often considered to be a status
symbol and are purchased as a means of displaying one's wealth or social
status.
Demand equation
■ Initially, the price is $20 a pizza, and the quantity sold is 10 pizzas an
hour. Then the demand for pizza increases. The demand curve shifts
rightward to D1. In part (a), the price rises by $10 to $30 a pizza, and the
quantity increases by 3 to 13 pizzas an hour. In part (b), the price rises by
only $1 to $21 a pizza, and the quantity increases by 10 to 20 pizzas an
hour. The price change is smaller and the quantity change is larger in case
(b) than in case (a). The quantity supplied is more responsive to a change
in the price in case (b) than in case (a).
Solve for the function

■ From the demand function Qdx = 12-2P x (P x is given in dollars), derive (a) the
individual’s demand schedule and (b) the individual’s demand curve, (c) What is the
maximum quantity this individual will ever demand of commodity X per time period?
■ Table below gives two demand schedules of an individual for commodity X. The second
(Qd0x) resulted from an increase in the individual’s money income (while keeping
everything else constant)
■ (a) Plot the points of the two demand schedules on the same set of axes and get the two
demand curves
■ (b) What would happen if the price of X fell from $5 to $3 before the individual’s
income rose?
Marginal propensity to consume
■ The marginal propensity to consume (MPC) is a concept in
economics that measures the increase in consumer spending
that results from an increase in income. It represents the
proportion of additional income that is spent on consumption.
■ The MPC is calculated as the change in consumption divided
by the change in income. For example, if a $100 increase in
income leads to a $60 increase in consumption, the MPC is 0.6
($60/$100).
■ The equation for marginal propensity to consume (MPC) is the change
in consumption (ΔC) divided by the change in income (ΔY):
MPC = ΔC / ΔY
■ The MPC represents the increase in consumer spending that results
from an increase in income. It is the proportion of additional income
that is spent on consumption. For example, if a $1,000 increase in
income leads to a $700 increase in consumption, the MPC is:
MPC = $700 / $1,000 = 0.7
■ This means that for every additional dollar of income, consumers will
spend 70 cents on consumption.
■ Why does a higher price reduce the quantity demanded? For
two reasons:
■ Substitution effect
■ Income effect
Substitution Effect

■ When the price of a good rises, other things remaining the

same, its relative price—its opportunity cost—rises. Although
each good is unique, it has substitutes—other goods that can be
used in its place. As the opportunity cost of a good rises, the
incentive to economize on its use and switch to a substitute
becomes stronger.
Income Effect

■ When a price rises, other things remaining the same, the price
rises relative to income. Faced with a higher price and an
unchanged income, people cannot afford to buy all the things
they previously bought. They must decrease the quantities
demanded of at least some goods and services. Normally, the
good whose price has increased will be one of the goods that
people buy less of.
Income effect
■ The income effect refers to the change in an individual's purchasing
power or consumer behavior resulting from a change in their income
level, while holding prices constant. In other words, when an individual's
income increases, they may purchase more goods and services than
before, or when their income decreases, they may purchase fewer goods
and services than before.
■ For example, suppose an individual receives a pay raise, increasing their
income. In that case, they may choose to spend more money on leisure
activities, such as dining out or taking vacations, or on luxury goods,
such as a new car or designer clothing. Alternatively, if an individual
experiences a decrease in income, they may choose to cut back on
expenses by reducing the number of restaurant meals or buying cheaper
clothes.
A Shift of the Demand Curve

■ If the price of a good remains constant but some other

influence on buying plans changes, there is a change in
demand for that good. We illustrate a change in demand as a
shift of the demand curve. For example, if more people work
out at the gym, consumers buy more energy bars regardless of
the price of a bar. That is what a rightward shift of the demand
curve shows—more energy bars are demanded at each price.
A Change in Supply
■ When any factor that influences selling plans other than the
price of the good changes, there is a change in supply. Six
main factors bring changes in supply.
They are changes in
■ The prices of factors of production
■ The prices of related goods produced
■ Expected future prices
■ The number of suppliers
■ Technology
■ The state of nature
Question to plot demand curve
■ For example, suppose the price of coffee increases significantly. As a result, some
consumers may decide to switch to tea or other cheaper beverages, because the relative
price of coffee has gone up. This substitution effect occurs because consumers are
always seeking to maximize their satisfaction or utility, and they do so by choosing the
best combination of goods or services based on their available income and the prices of
those goods or services.
Supply equation
■ From the specific supply function Qs x = 20P x (P x is given in dollars), derive
■ (a) the producer’s supply schedule and
■ (b) the producer’s supply curve.
Elasticity
■ Consumers usually buy more of a good when its price is lower,
when their incomes are higher, when the prices of its
substitutes are higher, or when the prices of its complements
are lower. Our discussion of demand was qualitative, not
quantitative. That is, we discussed the direction in which the
quantity demanded moves but not the size of the change. To
measure how much consumers respond to changes in these
variables, economists use the concept of elasticity.
■ A measure of the responsiveness of quantity demanded or
quantity supplied to a change in one of its determinants
Price Elasticity of Demand

■ A measure of how much the quantity demanded of a good

responds to a change in the price of that good, computed as the
percentage change in quantity demanded divided by the
percentage change in price.
Elasticity of demand

■ The price elasticity of demand is a units-free measure of the

responsiveness of the quantity demanded of a good to a
change in its price when all other influences on buying plans
remain the same.
■ Elasticity is a units-free measure because the percentage
change in each variable is independent of the units in which
the variable is measured. The ratio of the two percentages is a
number without units.
■ Demand is said to be elastic if e >1, inelastic if e <1, and
unitary elastic if e =1.
■ If the elasticity of demand is greater than 1, the demand is
considered elastic, meaning that a small change in price leads
to a large change in quantity demanded. If the elasticity of
demand is less than 1, the demand is considered inelastic,
meaning that a change in price has little effect on the quantity
demanded. If the elasticity of demand is equal to 1, the demand
is considered unit elastic, meaning that a change in price leads
to an equal change in quantity demanded.
Calculating Price Elasticity of Demand
The Factors That Influence the Elasticity of
Demand

The elasticity of demand for a good depends on

■ The closeness of substitutes
■ The proportion of income spent on the good
■ The time elapsed since the price change
The Elasticity of Supply

■ The elasticity of supply measures the responsiveness of the quantity

supplied to a change in the price of a good when all other influences on
selling plans remain the same. It is calculated by using the formula:
The Factors That Influence the Elasticity of Supply

The elasticity of supply of a good depends on

■ Resource substitution possibilities
■ Time frame for the supply decision
INCOME ELASTICITY OF DEMAND

■ The coefficient of income elasticity of demand (eM) measures the

percentage change in the amount of a commodity purchased per unit time
(DQ/Q) resulting from a given percentage change in a consumer’s
income (DM/M). Thus
■ When eM is negative, the good is inferior. If eM is positive, the
good is normal. A normal good is usually a luxury if its eM . 1,
otherwise it is a necessity. Depending on the level of the
consumer’s income, eM for a good is likely to vary
considerably. Thus a good may be a luxury at “low” levels of
income, a necessity at “intermediate levels of income and an
inferior good at “high” levels of income.
Average Cost

■ Average cost (AC) is the total cost of producing a unit of output,

divided by the total number of units produced. In other words, it is
the total cost of producing all goods and services divided by the
total quantity produced.
■ The formula for average cost is:
■ AC = TC/Q
■ Where: AC = Average cost TC = Total cost Q = Total quantity
produced
Marginal Cost

■ The cost of producing one more unit of a good or service is its

marginal cost. Marginal cost is the minimum price that
producers must receive to induce them to offer one more unit
of a good or service for sale. But the minimum supply-price
determines supply. A supply curve is a marginal cost curve.
■ Marginal Cost = Change in Total Cost / Change in Quantity
Fixed Cost

■ Fixed costs are expenses that remain constant, regardless of the level
of production or sales volume. These costs do not vary with changes
in the volume of output or sales, at least in the short run. In other
words, they are costs that a business incurs regardless of whether it
produces or sells any goods or services.
■ Examples of fixed costs include rent, property taxes, salaries and
wages of permanent employees, insurance premiums, and loan
repayments. These expenses must be paid by the business, regardless
of the level of activity or revenue.
■ Fixed costs remain constant over a wide range of activities, but
variable costs vary in total with the volume of output (Section
2.1.1). Thus, at any demand D, total cost is
Consumer surplus

■ We don’t always have to pay as much as we are willing to pay.

We get a bargain. When people buy something for less than it
is worth to them, they receive a consumer surplus. Consumer
surplus is the excess of the benefit received from a good over
the amount paid for it. We can calculate consumer surplus as
the marginal benefit (or value) of a good minus its price,
summed over the quantity bought.
Producer surplus

■ When price exceeds marginal cost, the firm receives a producer

surplus. Producer surplus is the excess of the amount
received from the sale of a good or service over the cost of
producing it. It is calculated as the price received minus the
marginal cost (or minimum supply-price), summed over the
quantity sold.
Average Revenue
■ In economics, average revenue is the total revenue generated
by a business divided by the quantity of goods or services sold.
It is also known as the revenue per unit of output. Average
revenue is calculated by dividing the total revenue by the
quantity sold, using the following formula:Average Revenue =
Total Revenue / Quantity Sold
■ For example, if a company generates $10,000 in revenue by selling 500
units of a product, the average revenue per unit would be:
■ Average Revenue = $10,000 / 500 = $20
■ Therefore, the average revenue per unit for this company is
$20.
■ Average revenue is an important concept in economics as it
helps businesses understand the relationship between the
quantity of goods or services sold and the revenue generated.
By analyzing their average revenue, businesses can determine
the optimal price and quantity of products to sell in order to
maximize their profits.
Marginal Revenue
■ Marginal revenue is the additional revenue generated by
selling one additional unit of a product or service. It is the
change in total revenue that results from producing and selling
one more unit of output. The formula for calculating marginal
revenue is:
■ Marginal Revenue = Change in Total Revenue / Change in
Quantity Sold
■ In other words, marginal revenue is the slope of the total
revenue curve at a given point.
■ For example, suppose a company sells 1,000 units of a product
for $10 each, generating a total revenue of $10,000. If the
company sells an additional unit for $10, its total revenue
increases to $10,010. The marginal revenue of that additional
unit would be:
■ Marginal Revenue = Change in Total Revenue / Change in
Quantity Sold Marginal Revenue = ($10,010 - $10,000) / (1
unit) Marginal Revenue = $10
■ Therefore, the marginal revenue of selling the additional unit is
$10
■ Marginal revenue helps businesses determine the optimal
quantity of output to produce and sell in order to maximize
their profits. Businesses can use marginal revenue to determine
whether producing an additional unit of output will increase
their total revenue or not.