REVISION

Lecture 1 Introduction to
Economics
• Economics and the economy
• Economy and three organizational units
• Scarcity
• Opportunity cost
• Factors of production
• Positive and normative economics
• Microeconomics vs Macroeconomics
• Economic models and assumptions
• Production possibility frontier
 Lecture 2 Demand,
Supply and Market
Equilibrium
 Define the Market, Law of Demand and Supply;
 Sketch the Demand and Supply curves;
 Explain the meaning of Market Equilibrium;
 Identify the factors which affect Market Demand and Supply;
 Analyse government policies and the changes in the market
equilibrium.
 Other determinants of demand
• Income
• Price of related goods (substitute and complementary goods)
• tastes
• Expectations
• Number of buyers
 Other determinants of supply

• Technology.
• Input costs.
• Government intervention (taxes and subsidies).
• Expectations.
• Number of sellers
Shifts in the supply curve
What are the possible S0
P S1
causes of a rise in
supply?

Increase

O Q
Q Which way will the market
supply of pizzas shift if the price of
flour falls?

A. Right
B. Left
C. No shift (movement along the curve)
 Class Question????

The market for nexia

Q The diagram S2
shows the market for S0
nexia. Equilibrium is S1
currently at point x. 1
8 2
x 3

Price
To which equilibrium 7
point (1, 2, 3, 4, 5, 6, 6 4
7 or 8) will the 5
market move if there D1
is expectation that D0
the price of nexia will D2
fall in the future? Quantity
 Question
Given that the Demand function per year and the Supply function per year for Private Cars

in the market are the following:

Qd= 2,000,000 — 30P for the year 2014

Qs=-500,000 + 50P for the year 2014,

where Qd is the quantity demanded, Qs is the quantity supplied, and P is the price ($).

a) Determine the equilibrium price and equilibrium output for private cars at that price.
b) If the government decide to relief some traffic congestion and decides that for the year 2014, only a certain
quota of cars are available to be on the market and thus on the streets. The government set a limit of
800,000 cars for the year of 2014. What would then be the difference in the price of Cars before the quota
was imposed and after the quota is imposed for the year 2014?
 Lecture 3 Elasticity
 Define and apply the concepts of
 Price Elasticity of Demand,
 Income Elasticity of Demand,
 Cross Elasticity of Demand;
 Price elasticity of Supply
 Describe the relationship between total revenue and elasticity.
 Income elasticity of demand and types of goods (Normal goods, Luxury
goods, necessity goods, inferior goods)
 Cross elasticity of demand and Types of goods (substitute goods and
complementary goods)
 Measuring elasticity using the arc
10 method
P Ped
m
8
DQ DP
Ped = ¸
n mid Q mid P
6

2 Demand

0 Q (000s)
0 10 20 30 40 50
 Price Elasticity of
Demand
The value of PED:

PED > 1 (elastic demand)

PED < 1 (inelastic demand)

 PED = 1 (unit elasticity demand)

PED = 0 (perfectly inelastic demand)

PED = ∞ infinite (perfectly elastic demand)

 Question
If the price of good X rises from $9 to $11 and as a result quantity
demanded falls from 100 units to 60 units, what is the price elasticity of
demand between these prices?
 What is the net effect on TR if price is increased
from $4 to $5 in an elastic demand?

P
b
5
a
4
D

0 10 20
Q (millions of units per period of time)
 What will be the effect on TR of increasing the price?

c
8

a
4

0 15 20
Q (millions of units per period of time)
 Question
I have the following data about the demand for Motorola picture phones:

price elasticity of demand = -0.12

cross-price elasticity with digital cameras = +3
income elasticity = +0.15.

If the goal of Motorola was to increase total sales revenue (ignoring cost considerations), would it raise or lower
its selling price? Why?

What would happen to the demand for Motorola picture phones if the price of digital cameras rose by 2%? Are
the two goods substitutes or complements?

What would happen to the demand for Motorola picture phones if consumer income rose by 10%? Are picture
phones a normal or an inferior good?
 Income Elasticity of
Demand
•
 Income Elasticity of Demand:
types of goods
For income elasticity we can differentiate these goods:

 YED > 0  the good is normal

 YED > 1  the good is a luxury

 Consumers buy more when their income rises

 YED < 0  the good is inferior

 0 < YED < 1  the good is a necessity

 Cross Elasticity of
Demand

 Price Elasticity of
Supply
 Price Elasticity of Supply measures the responsiveness of
the quantity supplied of a good to its own price.
 The elasticity of supply is usually positive because price and
quantity supplied are directly related
 Measuring price elasticity of supply

PES

PES is always a positive number

 a) How much will the demand for meat change (in
percentages) if the price of coffee falls by 4 percent.
b) How much will the demand for chocolate change (in
percentages) if the income of consumers increase by
4 percent.
c) Which of the products given in the table are inferior
goods?
d) Which of the products given in the table are
complementary or substitute goods?
Cross price elasticities in respect
Price elasticity Income elasticity to:
fish salt Tea
Chocolate -1,24 1,62 0 0 -0,08
Coffee -0,25 1,78 - 0,08 0 0,23
Meat -0,14 0,44 0,5 -0,21 -0,04
Bread -0,65 -0,96 -0,25 0 -0,28
Salads -0,37 0,18 -0,15 -0,31 0
Petrol -0,21 - 0,13 0 0 0
 Lecture 4 Government
policies
• Price ceiling
• Price floor
• Elasticity and shortage or surplus amount
• Direct (payroll tax, income tax) and undirect taxes (per unit tax)
• The effect of taxes on equilibrium
• Tax incidence and elasticity
 Government Policies That
Alter the Market Outcome

• Price controls
• Price ceiling: a legal maximum on the price
of a good or service Example: rent control
• Price floor: a legal minimum on the price of
a good or service Example: minimum wage
• Taxes
• The govt can make buyers or sellers pay a specific
amount on each unit bought/sold.

We
We will
will use
use the
the supply/demand
supply/demand model
model to to see
see
how
how each
each policy
policy affects
affects the
the market
market outcome
outcome
(the
(the price
price buyers
buyers pay,
pay, the
the price
price sellers
sellers receive,
receive,
and
and eq’m
eq’m quantity).
quantity).
23
 How Price Ceilings Affect
Market Outcomes
The eq’m price P S
($800) is above
the ceiling and
therefore illegal.
$800
The ceiling
is a binding Price
$500
constraint ceiling
on the price, shortage
D
causes a Q
250 400
shortage.
 How Price Floors
Affect Market
Outcomes
labor
The eq’m wage ($4) W surplus S
is below the floor Price
$5
and therefore floor
illegal.
$4
The floor
is a binding
constraint
on the wage,
D
causes a L
surplus (i.e., 400 550
unemployment).
 A Tax on Sellers
New eq’m: Effects of a $1.50 per
unit tax on sellers
Q = 450 P S2
Buyers pay S1
PB = $11.00 PB = $11.00
Tax
Sellers $10.00
receive PS = $9.50
PS = $9.50
D1
Difference
between them
Q
= $1.50 = tax 450 500

26
 A Tax on Buyers
The
Hence,price
Hence, buyers
aa tax
tax on pay
on buyers
buyers Effects of a $1.50 per
is nowthe
shifts
shifts $1.50
the D higher
D curve
curve than
down
down unit tax on buyers
the
by market
by the
the amount
amountpriceofP.
of the tax. P
the tax.
P would have to fall S1
by $1.50 to make
buyers willing $10.00
Tax
to buy same Q
as before. $8.50
E.g., if P falls D1
from $10.00 to $8.50, D2
buyers still willing to Q
500
purchase 500 pizzas.
 Elasticity and Tax
Incidence
CASE 1: Supply is more elastic than demand

P It’s
It’s easier
easier
for
for sellers
sellers
PB S than
than buyers
buyers
Buyers’ share
of tax burden
to
to leave
leave the
the
Tax market.
market.
Price if no tax So
So buyers
buyers
Sellers’ share bear
bear most
most ofof
PS
of tax burden the
the burden
burden
of
of the
the tax.
tax.
D
Q

28
 Elasticity and Tax
Incidence
CASE 2: Demand is more elastic than supply

P It’s
It’s easier
easier
S for
for buyers
buyers
Buyers’ share than
than sellers
sellers
of tax burden PB to
to leave
leave thethe
market.
market.
Price if no tax
Tax Sellers
Sellers bear
bear
Sellers’ share most
most of of the
the
of tax burden PS burden
burden of of
D the
the tax.
tax.
Q

29
 Question
A market is described by the following supply and demand curves:
QS = 2P
QD = 300 - P.
a. Solve for the equilibrium price and quantity.
b. If the government imposes a price ceiling of $90, does a shortage or surplus (or neither) develop? What are
the price, quantity supplied, quantity demanded, and size of the shortage or surplus?
c. Instead of a price control, the government levies a $30 tax on producers. Does a shortage or surplus (or
neither) develop? What are the price, quantity supplied, quantity demanded, and size of the shortage or surplus?
 Question
Consider a market for computers where demand is elastic and
supply is inelastic.
a)Show in a graph of relatively elastic demand and inelastic
supply curves
b)Show graphically and explain how an increase of a tax for
the computer suppliers will change the market?
c)Explain why and whose tax burden will be bigger in this
market.
 Lecture 5. Consumers, Producers,
and the Efficiency of Markets
• What is consumer surplus? How is it related to the demand curve?
• What is producer surplus? How is it related to the supply curve?
• Do markets produce a desirable allocation of resources? Or could the
market outcome be improved upon?
 Evaluating the Market Equilibrium

P
Market eq’m: 60
P = $30
Q = 15,000 50 S
Total surplus 40
= CS + PS CS
Is the market eq’m 30
PS
efficient? 20
10
D
0 Q
0 5 10 15 20 25 30
33
 Economic surplus, if the
market is not in equilibrium

The reduction in economic surplus resulting from a market not

being in competitive equilibrium is known as deadweight loss.

Deadweight loss can be thought of as the amount of inefficiency in

a market. In competitive equilibrium, deadweight loss is zero.
 Question
• Consider a competitive market with demand given by P D = 100 − 2Q
and supply given by PS = 10 + Q.
a) Find competitive equilibrium price and quantity.
b) Find consumer surplus and Producer surplus.
c) If the government sets a price floor of $50, how the consumer and
producer surpluses change and how much will the DWL be?
Question:
calculate consumer and producer
surplus
 Lecture 6.
Application: The Costs of Taxation
• How does a tax affect consumer surplus, producer surplus, and total
surplus?
• What is the deadweight loss of a tax?
• What factors determine the size of this deadweight loss?
• How does tax revenue depend on the size of the tax?
Tax Revenue

38
 DWL and the
Elasticity of
Supply
When
When supply
supply P
is
is inelastic,
inelastic, S
it’s
it’s harder
harder for
for firms
firms
to
to leave
leave the
the market
market
when
when thethe tax
tax
reduces
reduces P PSS..
Size
So,
So, the
the tax
tax only
only of tax
reduces
reduces Q Q aa little,
little,
and D
and DWL
DWL isis small.
small.
Q

40
 DWL and the
Elasticity of
Supply
The
The more
more elastic
elastic is
is P
supply,
supply,
the
the easier
easier for
for firms
firms
to
to leave
leave the
the market
market S
when
when thethe tax
tax
reduces Size
reduces P PSS,,
of tax
the
the greater
greater QQ falls
falls
below
below the
the surplus-
surplus-
maximizing
maximizing quantity,
quantity, D
the
the greater
greater the
the DWL.
DWL. Q

41
 DWL and the
Elasticity of
Demand
P
When
When demand
demand
is
is inelastic,
inelastic,
S it’s
it’s harder
harder for
for
consumers
consumers to to leave
leave
Size
the
the market
market when
when the
the
of tax
tax
tax raises
raises P
PBB..
So,
So, the
the tax
tax only
only
reduces
reduces Q Q aa little,
little,
D and
and DWL
DWL isis small.
small.
Q

42
 DWL and the
Elasticity of Demand
The
The more
more elastic
elastic is
is
P demand,
demand,
S the
the easier
easier for
for buyers
buyers
to
to leave
leave the
the market
market
when
when thethe tax
tax
Size increases
increases P PBB,,
of tax
the
the more
more Q Q falls
falls
D
below
below the
the surplus-
surplus-
maximizing
maximizing quantity,
quantity,
and
and the
the greater
greater the
the
Q
DWL.
DWL.

43
How Deadweight Loss and
Tax Revenue Vary with the
Size of a Tax

44
 Tax Revenue and
the Size of Tax rate
The Laffer curve
Tax
The Laffer curve
shows the
relationship revenue
between
the tax rate and
tax revenue.

Tax rate

45
 Question
Consider a market for soft drinks with demand and supply
functions given as:

QD = 100 - P QS = 50 + P
a) Find equilibrium price and quantity.
b) Find consumer surplus and Producer surplus.
c) If the government sets a $10 tax, calculate the new equilibrium
prices and quantity.
d) Calculate the Consumer and Producer surplus and DWL after
tax.
e) What is the tax burden on consumers and on producers?
APPLICATION: THE COSTS OF TAXATION 46
 Question:
calculate consumer and
producer surplus after tax is
set
St
 Lecture 10: Production and
Costs
Distinguish between the Short-run (SR) and Long-run (LR)
time periods;
Explain the Law of Diminishing Marginal Returns;
Identify Fixed factors of production and Variable factors of
production;
Understand the various production cost elements and cost
behaviour;
Explain the concept of Returns to Scale;
Provide examples of the sources of Economies of Scale.

APPLICATION: THE COSTS OF TAXATION 48

 Costs and profit
 The profit is the difference between the Total sales revenue
(TR) and Total cost (TC):
TП = TR – TC
 The maximum profit is achieved when there is biggest
difference between these two values.
 As we increase the quantity of production the two values will
change. Therefore to find the maximum difference between
them we have to analyze how each one is changing
 Short-run Costs
 Short-run and long-run changes in production
 the short run is the time period in which at least one of the factors are
fixed
 the long run is the time period in which none of the factors are fixed
 Production in the short run
 the law of diminishing marginal returns
 when one of more factors are held fixed, there will come a point
beyond which the extra output from additional units of the variable
factor will diminish
 Short-run Costs
 Explicit costs require an outlay of money,
e.g., paying wages to workers.
 Implicit costs do not require a cash outlay,
e.g., the opportunity cost of the owner’s time.
 opportunity cost
 irrelevance of sunk costs (historic costs)
 Accounting profit: Total revenue minus total explicit cost
 Economic profit: Total revenue minus both explicit and implicit
costs.
 Short-run Costs

 Total cost
 total fixed cost (TFC) – sum of all fixed costs
 total variable cost (TVC) – sum of all variable costs
 TVC and the law of diminishing returns
 total cost (TC = TFC + TVC)
 Short-run Costs
Average cost
average fixed cost (AFC) = TFC/Q
average variable cost (AVC) = TVC/Q
average (total) cost (AC) = TC/Q = AFC

+ AVC
Marginal cost = ΔTC/ΔQ
 Revenue
 Defining total, average and marginal revenue
 total revenue: TR = P × Q
 average revenue: AR = TR / Q
 marginal revenue: MR = TR / Q
 AR and MR curves when firms are price takers (horizontal demand
curve)
 average revenue (AR)
 marginal revenue (MR)
 Profit Maximisation rule

 Finding the profit-maximising output

 profit maximised where MR = MC
 Long-run Costs
Economies of Scale:
 Economies of scale occur when average cost (AC) falls as the quantity of
output increase in the long-run.
 A doubling inputs of labour and capital more than doubles output.
 Therefore, average costs fall as we go from a small size firm to a medium
size firm. This may be due to greater specialisation of labour, capital and so
forth.
Diseconomies of Scale:
The average total cost of producing a good increases as the volume of
output increases, whilst producing with the optimal mix of inputs.
It is due to coordination problems in large organizations (management
becomes stretched, can’t control costs)
 A typical long-run average cost curve

Economies Constant Diseconomies LRAC

of scale costs of scale
Costs

O Output
Question 5. The production of tables has the following monthly costs:
Wages of 6 workers $1500
Wages of a manager and 2 accountants $1800
Cost of raw materials $5000
The cost of electricity and gas needed for the production $300
Depreciation cost of equipment and building $700
a) Calculate total fixed cost (TFC) and total variable cost (TVC) for a month.
b) If the quantity of a production in a month is 500 units, calculate total average cost
(AC).
c) If the price of a product is $20 per unit, calculate profit of the business (TП).
 Lecture 11: Perfect market
and Monopoly

By the end of this session you should be able to:

 Identify the criteria used in evaluating the competitiveness of markets;
 Explain the features/ characteristics of for each market structure;
 Discuss the short-run and long –run equilibrium of the firm in perfect and
monopoly market;
 Draw the relevant graphs showing the short-run and long-run profit
position of the firm under perfect and monopoly market;
 Features of the four market structures
Type of Number Freedom of Nature of Examples Implications for
market of firms entry product demand curve
faced by firm

Perfect Very Homogeneous Cabbages, carrots Horizontal:

competition many Unrestricted (undifferentiated) (approximately) firm is a price taker

Monopolistic Many / Builders, Downward sloping,

Unrestricted Differentiated but relatively elastic
competition several restaurants

Undifferentiated Cement Downward sloping.

Oligopoly Few Restricted Relatively inelastic
or differentiated cars, electrical (shape depends on
appliances reactions of rivals)

Local water Downward sloping:

Monopoly One Restricted or Unique company, train more inelastic than
completely operators (over oligopoly. Firm has
blocked particular routes) considerable
control over price
 Perfect Competition

 Accounting profit: Total revenue minus total explicit cost

 Economic profit: Total revenue minus both explicit and implicit costs.
 If company’s profit is higher than other opportunities or industries
economic profit is positive
 Then firms in other industries will enter this market since entry to this
market is free.
 Monopoly: Characteristics

 There is only seller and many buyers.

 The product of the monopolist does not have substitute.

 Entry to the market is blocked
 Monopolist is said to be price setter/maker.
 It will be able to make supernormal profits in the short-
run and long-run.
 However, monopolist could only control either price or
quantity and not both.
 Demand curve is downward sloping and relatively inelastic.

62
 Monopoly
 Barriers to entry
 economies of scale
 economies of scope
 product differentiation and brand loyalty
 lower costs for an established firm
 ownership/control of key factors
 ownership/control over outlets
 legal protection
 mergers and takeovers
 aggressive tactics
 Monopoly
 Disadvantages of monopoly
 high prices / low output: short run
 high prices / low output: long run
 lack of incentive to innovate
 X-inefficiency
 Advantages of monopoly
 economies of scale
 profits can be used for investment
 high profits encourage risk taking
 Lecture 12. Measuring a Nation’s
Income
What is Gross Domestic Product (GDP)?
How is GDP related to a nation’s total
income and spending?
What are the components of GDP?
How is GDP corrected for inflation?
Does GDP measure society’s well-being?

65
 Measures of economy
 GDP is the market value of all final goods and services produced
within a given period of time by factors of production located within a
country
 GNP is the market value of all final goods and services produced
within a given period of time by the citizen’s of a country

 Difference between them? Which one is more?

GDP = GNP + Net factor payments

 The Circular-Flow Diagram
Revenue (=GDP) Spending (=GDP)
Markets for
G&S Goods &
G&S
sold Services bought

Firms Households

Factors of Labor, land,

production Markets for capital
Factors of
Wages, rent, Production Income (=GDP)
profit (=GDP)
 The Components of GDP

 Recall: GDP is total spending.

 Four components:
 Consumption of households (C)
 Investment spending of firms(I)

 Government Purchases of goods and services (G)

 Net Exports = export minus imports (NX)

 These components add up to GDP (denoted Y): Y = C + I + G + NX

68
 Real versus Nominal GDP

 Nominal GDP
 Values output using current prices
 Not corrected for inflation

 Real GDP
 Values output using the prices of a base year
 Is corrected for inflation

 For the base year

Nominal GDP = Real GDP

69
Price indexes and the GDP deflator
 Question

 Calculate nominal and real GDP

 Calculate GDP deflator and inflation rate

Pizza Latte
year P Q P Q
2014 $10 400 $2.00 1000
2015 $11 500 $2.50 1100
2016 $12 600 $3.00 1200
 EXAMPLE:
Compute nominal GDP in each year: Increase:
2014:$10 x 400 + $2 x 1000 = $6,000
37.5%
2015:$11 x 500 + $2.50 x 1100 = $8,250
30.9%
2016:$12 x 600 + $3 x 1200 = $10,800

Pizza Latte
year P Q P Q
2014 $10 400 $2.00 1000
2015 $11 500 $2.50 1100
2016 $12 600 $3.00 1200

72
 GDP Does Not Value:

 The quality of the environment

 Leisure time
 Non-market activity, such as the child care

a parent provides at home

 An equitable distribution of income

73
 Lecture 13 Measuring the Cost of Living

 Consumer price index (CPI)

 Producer price index, PPI
 Comparison of CPI and Deflator
 Nominal and real interest rates
5

The Consumer Price Index

Consumer price index (CPI)

 Measure of the overall level of prices
 Measure of the overall cost of goods and

services
– Bought by a typical consumer
 Computed and reported every month by the
Bureau of Labor Statistics
6

The Consumer Price Index

Problems in measuring the cost of living
 Substitution bias
 Prices do not change proportionately
 Consumers substitute toward goods that have become
relatively less expensive
 Introduction of new goods
 More variety of goods
 Unmeasured quality change
 Changes in quality
7

GDP Deflator Versus CPI

GDP deflator
 Ratio of nominal GDP to real GDP

 Reflects prices of all goods & services

produced domestically
CPI
 Reflectsprices of goods & services
bought by consumers “The price may seem a
little high, but you have
to remember that’s in
today’s dollars.”
8

GDP Deflator Versus CPI

GDP deflator
 Compares the price of currently produced goods and

services
 To the price of the same goods and services in the base
year
CPI
 Compares price of a fixed basket of goods and
services
 To the price of the basket in the base year
 Interest Rates in the
Economy
Nominal interest rate
 Always exceeds the real interest rate

 U.S. economy has experienced rising consumer prices in

every year
Inflation is variable
 Real and nominal interest rates do not always move
together
Periods of deflation
 Real interest rate exceeds the nominal interest rate

79
 Lecture 14: Unemployment

 Calculation of Unemployment
 Types of unemployment
 Meaning of Natural rate of unemployment
 The costs of unemployment
 Unemployment-terminologies

Labor resources: People who are physically able to work

(population of working age)
Labor force: the number employed plus the number
unemployed (people economically active – want to work)
Unemployed: The unemployed are defined as people of
working age (able to work) who want to work (active),
actively seeking employment but cannot find it
Employed: people working either as a full time or a part time
basis
 Unemployment
Unemployment rate: the number unemployed expressed
as a percentage of the labor force

Participation rate: the fraction of the population of working age

who join the labor force (economically active population)
 Labor-force participation rate


83
 Types of Unemployment

 Natural rate of unemployment

 Unemployment never falls to zero
 Normal rate of unemployment around which the

unemployment rate fluctuates

 In US it is assumed t be approximately 4-5%

 Cyclical unemployment
 Deviation of unemployment from its natural rate

84
 Cyclical Unemployment

 Reasons of cyclical unemployment

 Business cycles (fluctuations) of the economy
 downward ‘stickiness’ of real wages
 fall in demand for labour
 efficiency wages
 Natural rate of Unemployment
 Types of Natural rate of Unemployment
 frictional (search) unemployment:
 It takes time for workers to search for the jobs that best suit their tastes and
skills
 Explain relatively short spells of unemployment
 structural unemployment
 changing pattern of demand
 technological unemployment
 regional unemployment
 When real-wage is set above equilibrium because of trade unions or
Minimum wage policy
 Costs of Unemployment

 The costs of unemployment

 loss of potential GDP
 loss in the earnings of the family
 The government loses tax revenues
 Loss of the skill if unemployed long periods
 crime and vandalism
 Question

The population of Greklandia is 80000. Out of them 55000 is

employed and 80000 is unemployed. Of the unemployed 5000 are
of frictional, 6000 are of structural type.
a) What is the quantity of labor force?
b) What is the unemployment rate?
c) What is the natural rate of unemployment?
 Question
The following is employment information about the country Badger Land.

Entire Population 800

People under the age of 16 75
Retired people 200
Number of people with full time job 250
Number of people with part time job 175
Number of people without a job but looking for one 75
Number of people without a job and not looking for one 25

a. What is the total number of labor resources?

b. What is the total number of labor force?
c. What is the labor force participation rate in Badger Land?
d. What is the unemployment rate of Badger Land?