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IK 335 Business English I
Autumn Semester
Dr.Dilek Seymen
Course I
I. What is Economics?
II.What is the differences between Economics and the Economy?
III.Main economic terms to understand Economics: Scarcity,
Resource &Commodities, Choice, Opportunity Cost.
IV. Possitive & Normative Economics
V. Microeconomics & Macroeconomics.
Economics and the Economy
Every group of people must solve three basic problems of daily living;
- what goods and services to produce
- how to produce these goods and services
- for whom to produce these goods and services.
Society must answer all three questions. By emphasizing the role of society,
economics is a social science that stuy and explain human behaviour. The subject
matter of economics is human behavior in the production, exchange and use of goods
and services. The central economic problem for society is how to reconcile the conflict
between people's virtualy limitless desires for goods and services and the scarcity of
resources (labour, machinery and raw materials) with which these goods and services
can be produced. In aswering the questions, what, how, and whom to produce,
economics explains how scarce resources are allocated between competing claims on
their use. Economics is the study of the use of scarce resources to satisfy unlimited
human wants. Economics is the social science that deals with problems such as
what, how, and for whom to produce.
An Economy, is defined as a set of interrelated production and consumption activities.
It may refer to this activity in a region of one country (for example the Economy of New
England ) in a country (the American economy) or in a group of countries (the economy
of Western Europe). In any economies the allocation of resources is determined by the
production, sales and purchase decision made by firms, house holds and government.
Scarcity
Scarce good is a commodity for which the quantity demanded exceeds the quantity
supplied at a price of zero; and therefore a good that commands a positive price in a
market economy.
Scarcity is inevitable and is central to economics problems. In relation to desires,(for
more and better foods,clothing, housing, schooling, entertainment etc.) existing
resources are woefully inadequate; there are enough to produce only a small fraction of
the goods and services that are wanted.
Resources&Commodities
A society’s resources consist of natural gifts such as land, forests and minerals; human
resources, both mental and physical, and manufactured aids to production such as
tool, machinery and buildings. Economists call such resources factors of production,
because they are used to produce those thing that people desire. The thing produced
are called commodities. Commodities may be divided in to goods and services.
Goods are tangible and services are intangible.
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What are goods? Goods are physical commodities such as steel, pencil and book
etc.
What are services? Services intangible commodities such as hair cut or medical care.
People use goods and services to satisfy many of their wants The act of making goods
and services is called production, and the act of using them to satisfy wants is called
consumption.
Choice
Because resource are scarce, all societies face the problem of deciding what to
produce, and how to divide the product among their members. Societies differ in who
makes the choices and how they are made, but the need to choose is commen to all.
Just as scarcity ipmlies the need for choice, so choice implies the existence of cost.
Opportunity Cost
The opportuniy cost is the cost of using resources for a certain purpose, measured by
the benefit given up by not using them in an alternative way; that is, measured in terms
of other commodities that could have been optained instead. Every time scarcity forces
one to make a choice. These cost are measured in terms of forgone alternatives.
Positive &Normative Economics
The success of modern science rest partly on the ability of scientists to separate their
views on what does happen from their views on what they would like to happen.
Positive statements concern what is, was or will be. Normative statements concern
what one bleives ought to be. Positive statements or theories may be simple or
complex, but they are basically about matters of fact. Normative statements, because
they concern what ought to be, are bound up with philosophical, cultural, and religious
systems. A normative statement is one that makes or is based on a value judgement -a
judgement about what is good what is bad.
In studying economics, its important to distinguish two branches of the subject,
"positive" and "normative" economics.
Positive economics deals with objective or scientific explanations of the economy.
The aim of the positive economics is to explain how society makes decisions about
consumption, production and exchange of goods.
Normative economics offers recomendations based on value judgements. Normative
economics is based on subjective value judgements, not on the research for any
objective truth.
The following statements combines positive and normative economics:
"The elderly have very high medical expenses, and the government should subsidize
their health bills."
The first part of the proposition- the claim that the aged have relatively high medical
bills- is a statement in positive economics. It is a statement about how the world works,
and we can imagine a research programme that could determine whether or not it is
correct. Broadly speaking this assertion happens to be correct. The second part of the
proposition- the recommendation about what the government should do- could never
be proved to be correct or false by any scientific research investigation. It is simply a
subjective value judgement based on the feelings of the person making the statement.
Many people might share this subjective judgement. But other people might reasonably
disagree. You might belive that it is more important to devote society’s scarce resource
to improve the environment.
There is no way that economics can be used to show that one of these normative
judgements is correct and the other wrong. It all depends on the preferences or
priorities of the individual or the society that has to make this choice.
Microeconomics&Macroeconomics
We can classify branches of economics according to the approach that is used.
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Microeconomics analysis offers a detailed treatment of individual decisions about
particular commodities.
Microeconomics is the study of the allocation of resources and the distribution of
income as they are affected by the working of the price system and by government
policies. Microeconomics deal with the determination of prices and quantities in
individual markets and with the relations among these market. Thus it looks at the
details of the economy.
In contrast, Macroeconomics focuses on much broader aggregates.It looks at such
thing as the total number of people employed and unemployed., the average level of
price and how it changes over time, national output, and aggregate consumption.
Macroeconomics emphasizes the interactions in the economy as a whole.
Macroeconomics is the study of the determination of economic aggregates and
averages such as total output, total employment, the price level and rate of economic
growth.
Whereas microeconomics looks at demand and supply with regard to particular
commodities, macroeconomics looks at aggregate demand and aggregate supply.
Course II
I Graphical Explanation of Scarcity, Choice and Opportunity Cost
II. Alternative Economic Systems: Command Economy, Free Market Economy,
Mixed Economy.
IV. The Decision Makers; Households, Firms, Government.
I.Graphical Explanation of Scarcity, Choice and Opportunity Cost
A decision to have more of one thing requires a decision to have less of something
else. It is this fact that makes the first decision costly. The opportuniy cost is the cost
of using resources for a certain purpose, measured in terms of the benefit given up by
not using them in an alternative way; that is, measured in terms of other commodities
that could have been obtained instead.
Industrial Goods
d
Production Possibility
Boundary
b
c
a
Agricultural Products
Consider for example the important social choice between agricultural products and
industrial products.It is not possible to produce an unlimited quantity of both agricultural
and industrial products. If resources are fully employed and the government wishes to
produce more industrial goods, then less agricultural goods must be produced. The
opportunity cost of increased industrial goods production is forgone production of
agricultural goods.
The choice is illustrated in Figure above. The downward-sloping boundary shows the
combinations that are just attainable when all of the society's resources are efficiently
employed. The quantity of agricultural goods produced is measured along the
horizontal axis, the quantity of industrial goods produced along the vertical axis. Thus,
any point on the diagram indicates some amount of each kind of good produced. The
production possibility boundary separates the attainable combinations such as a,b,and
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c from unattainable combinations such as d. It slopes downwards because resources
are scarce. More of one good can be produced only if resources are freed by producing
less of the other goods. Points a and b represents either efficient use of society's
resources. Point c represents either inefficient use of resources or failure to use all the
available resources.
A production possibility boundary illustrates three concepts; scarcity, choice, and
opportunity cost. Scarcity is indicated by the unattainable combination above the
boundary, choice by the need to choose among the alternative attainable points along
the boundary and opportunity cost by downward slope of the boundary.
The allocation of scarce resources among alternative uses called resource allocation,
determines the quantities of various goods that are produced. Choosing to produce a
particular combination of goods means choosing a particular allocation of resources
among the industries or regions producing the goods because, for example, producing
a lot of one good requires that a lot of resources be allocated to its production.
Further, because resources are scarce it is desirable that they be used efficiently.
Hence it matters which of the available methods of production is used to produce each
of the goods that is to be produced.
The capacity to produce commodities to satisfy human wants grows rapitly in some
countries, slowly in others and actually declines in still others. Growth in productive
capacity
can be represented by a pushing outward of the production possibility
boundary as shown in Figure above. If an economy’s capacity to produce goods and
services is growing, combination that are unattainable today will become attainable
tomorrow. Growth makes it possible to have more of all goods.
II.Alternative Economic Systems
The role of the market in allocating resources differs vastly between countries. In the
command economy resources are allocated by central government planning. In the
free market economy there is virtually no government regulation of the consumption,
production and exchange of goods, ın between lies the mixed economy, where market
forces play a large role but the government intervenes extensively.
All economies face scarcity, and all must decide how to allocate scarce resources and
distribute goods and services; all may face problem of inflation, unemployment, and
unsatisfactory rates of growth.
Because all economies faces many common problems, economic analysis can
contribute valuable insights even where familiar instutitions are modified or absent.
Economies can differ from one another in many ways and such classification as
"capitalism" "socialism" or "mixed economy", represent simplification of complex
matters.
The Command Economy (centrally planned economy-socialism)
A command economy is a society where the government makes all decisions about
production and consumption. A government planning office decides what will be
produced, how it will be produced, and for whom it will be produced. Detailed
instructions are then issued to household, firms, workers.
Such planing is very complicated task, and there is no complete command economy
where all allocation decisions are undertaken in this way. However in many countries,
for example those in Chine, Cuba, and those formerly in the Soviet Bloc, there was
large measure of central direction and planning. The state owned factories and land
made the most important decisions about what people should consume, how goods
should be produced, and how much people should work.
Free Market Economy: The Invisible Hand (market oriented system-capitalism)
Markets in which government do not intervene are called free markets. Individual in
free markets pursue their own interests trying to do as well for themselves as they can
without any government direction or interference. Smith argued that individuals
pursuing their self-interest would be led 'as by an invisible hand' to do things that are in
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the interest of society as a whole. The idea that such a system could solve the what,
how, and for whom to produce problem.
The Mixed Economy
The free market allows individuals to pursue their self interest without any government
restrictions. The command economy allows little scope for individual economic freedom
since most decisions are taken centrally by the government. Between these two
extremes lies the mixed economy.
In a mixed economy the government and private sector interact in solving economic
problems. The government controls a significant share of output through taxation,
transfer payments, and the provision of goods and services such as defence and the
police force. It also regulates the extend to which individuals may pursue their own selfinterest.
III. The Decision Makers
Economics is about the behavior of people. There are millions of individual in most
economies. To make a systematic study of their behaviour more manageable, we
categorize them into three important groups: households, firms, government.
A household is defined as all the people who live under one roof and who make or are
subject to others making for them, joint financial decisions. The members of household
are often referred to as concumers.
A firm, is defined as the unit that employes factors of production to produce
commodities that it sells to other firms, to households, or to government. For obvious
reasons a firm is often called a producer.
The term government is used in economics in a broad sense to include all public
officials, agencies, government bodies and other organization belonging to or under the
direct control of state.
Course III.
I. The Market
II. Demand&Supply
III. The Market and Equilibrium Price
I. The Market
A market is a set of arrangements by which buyers and sellers are in contact to
exchange goods or services. Some markets physically bring together the buyer and
seller. Other markets (the stock exchange) operate through intermediaries (stock
brokers) who transact business on behalf of clients.
To understand this process more fully, we require a model of a typical market. The
essential features are demand , the behhaviour of buyers, and supply, the behaviour of
sellers. We can study the interaction of these forces to see how a market works in
practice.
II. Demand& Supply
Demand is the quantity of a good buyers wish to purchase at each conceivable price.
The first column of Table below, shows a range of prices for bars of chocolate. The
second column shows the quantities that might be demanded at these prices. Even
when chocolate is free, only a finite amount will be wanted. People get sick from eating
too much chocolate. As the price of chocolate rises, the quantity demanded falls, other
things equal. We have assumed that nobady will buy any chocolate when the price is
more than 1000 TL.per bar. Taken together, columns (1) and (2) describe the demand
for chocolate as a function of its price.
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Table: The Demand for and supply of chocolate
(1)
Price
(TL/ bar)
(2)
Demand
(million
bars/year)
(3)
Supply
(million
bars/year)
0
200
0
150.000
160
0
250.000
120
40
400.000
80
80
600.000
40
120
1000.000
0
160
Supply is the quantity of a good seller wish to sell at each conceivable price. The third
column of the Table shows how much seller wish to sell at each price. Chocolate can
not be produced for nothing. Nobody would wish to supply if they receive a zero price.
In our example, It takes a price of 250.000 TL. before there is any incentive to supply
chocolate. At a higher prices it becomes increasingly lucrative to supply chocolate bars
and there is a corresponding increase in the quantity of bars supplied.Taken together
columns (1) and (3) describe the supply of chocolate bars as a function of their price.
The demand schedule relating price and quantity demanded and the supply schedule
relating price and quantity supplied are each constructed on the assumption of "other
things equal"(ceteris paribus). Other things equal, the lower the price of chocolate, the
higher the quantity demanded. Other things equal, the higher the price of chocolate the
higher the quantity supplied. A campaign by dentist warning of the effect of chocolate
on tooth decay, or a fall in household incomes, whould change the "other things"
relevant to the demand for chocolate. Either of these changes would reduce the
demand for chocolate, reducing the quantities demanded at each price. Cheaper cocoa
beans, technical advances in packaging chocolate bars, would change the "other
things" relevant to the supply of chocolate bars. They would tend to increase the supply
of chocolate bars, increasing the quantity supplied at each possible price.
III. The Market and Equilibrium Price
For the moment, we assume that all these other things remain constant. We combine
the behavior of buyers and sellers described in the Table to model how the market for
chocolate bars would actually work. At low prices, the quantity demanded exceeds the
quantity supplied but the reverse is true at high price. At some intermadiate price,
which we call the "equilibrium price" the quantity demanded just equal the quantity
supplied. The equilibrium price clears the market for chocolate It is the price at which
the quantity supplied equals the quantity demanded. Table shows that the equilibrium
price is 400.000TL=80 million bars per year is the quantity buyers wish to buy and
sellers wish to sell at this price. We call 80 million bars per year the equilibrium
quantity. At prices below 400.000 TL. the quantity demanded exceeds the quantity
supplied, and some buyers will be frustrated.There is a shortage: what we call excess
demand. You will realize that when economists say there is excess demand they are
using a convenient shorthand for the more complicated expression: the quantity
demanded exceeds the quantity supplied at this price. Conversely, at any price above
400.000TL. the quantity supplied exceeds the quantity demanded. Sellers will be left
with unsold stock. To describe this surplus, economists use the sorthand excess
supply, it being understood that this means excess in the quantity supplied at this
price.
Is the market for chocolate bars automatically in equilibrium? If so, what bring this
about ? Suppose the price of chocolate is initially 1000.000TL, higher than the
equilibrium price, Producers wish to sell 160 million bars per year but nobody wishes to
buy at this price. To recoup the money spent in producing chocolate, seller have to cut
the price to clear their stock. Cutting the price to 600.000 TL. has two effects: It
increases the quantity demanded to 40 million bars per year and it reduces the
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quantity producers wish to supply to 120 million bars per year. Both effects reduce the
excess supply. The process of price cutting will continue until the equilibrium price of
400.000 TL. is reached and excess supply has been eliminated. At this price the
market clears.When the price lies below the equilibrium price the process works in
reverse. In this sense, market are self correcting.
IV.Demand and Supply Curve
Table shows demand and supply conditions in the chocolate market and allows us to
find the equilibrium price and quantity. It is convinient to approach the same problem
diagrammatically using demand and supply curve.
The demand curve shows the relation between prices and quantity demanded, holding
other things constant. In Figure I, we measure on the vertical axis prices of chocolate
bars. Corresponding quantities demanded in millions of bars per year are measured
on the horizontal axis. The demand curve plots the data in the first two column of the
Table. The points A shows that 160 million bars per year are demanded at a price of
150.000 TL. The point B shows that 120 million bars per year are demanded at a price
of 250.000 TL. plotting all the point and joining them up, we obtain the demand curve.
In our example this curve happens to be a straight line. As expected, it has a negative
slope showing that larger quantities are demanded at lower prices.
Price (000. TL)
Price (000.TL)
Figure I
Figure II
Quantity Demanded
(million bars/year)
Quantity Supplied
(million bars/year)
The supply curve shows the relation between price and quantity holding other things
constant. In FigureII. We plot columns (1) and (3) of the Table. Again we join up the
different data points. In FigureIII, we show the demand curve labelled DD, and the
supply curve labelled SS, in the same diagram. We can now re-examine our analysis
of excess supply, excess demand, and equilibrium. Consider a particular prices as
represented by a height on the vertical axis. At a price below the equilibrium price the
horizontal distance between the supply curve and the demand curve at this height
shows the excess demand at this price. For example, at 250.000 TL. the quantity
supplied is 40 million bars per year the quantity demanded 120 million bars per year
and the distance AB represents the excess demand of 80 million bars per year.
Conversely, at a price above the equilibrium price there is excess supply. At 600.000
TL. 40 million bars per year are demanded, 120 million bars Per year are supplied and
the horizontal distance FG measures the excess supply of 80 million bars per year at
this price.
Price(000 TL)
Figure III
Quantity (million bars/year)
Market equilibrium is shown by the intersaction of the demand curve DD and the
supply curve SS, at a price of 400.000 TL , at which 80 million bars per year are
transacted. At any other price the quantity traded is the smaller of the quantity
demanded and the quantity supplied. We can now reconsider price determination in the
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chocolate market. Figure III, implies that there is excess supply at all prices above the
equilibrium price of 400.000 TL. Seller react to unsold stocks by cutting prices. Only
when prices have been reduced to the equilibrium price will excess supply be
eliminated. The equilibrium position is shown by the point E. Conversely at prices
below 400.000 TL. there is excess demand, which bids up the price of chocolate,
gradually eliminating excess demand until the equilibrium point E is reached. In
equilibrium buyers and sellers can trade as much as they wish at the equilibrium price
and there is no incentive for any further price change.
Course IV
I. Movements Along the Demand Curve Versus Shifts of the Whole Curve
II. Movements Along the Supply Curve Versus Shifts of the Whole Curve
III. The Laws of Demand and Supply
IV. Demand and Supply: What Really Happens
V. Prices in Inflation
I. Movements Along the Demand Curve Versus Shifts of the Whole Curve
Suppose you read in today’s newspaper that a soaring price of carrots has been
caused by a greatly increased demand for that commodity. Then tomorrow you read
that the rising price of carrots is greatly reducing the typical household’s purchases of
carrots as shoppers switch to potatoes, yams and peas. The two statements appear to
contradict each other.The first associates a rising price with a rising demand; the
second associates a rising price with a declining demand. Can both statements be
true? The answer is that they can be because they refer to different things. The fist
describes a shift in the demand curve; the second describes a movement along a
demand curve in response to a change in price.
Consider first the statement that the increase in the price of carrots has been caused
by an increased demand for carrots. This statement refers to a shift in the demand
curve for carrots. In this case the demand curve must have shifted to the right,
indicating more carrots demanded at each price. This shift will increase the price of
carrots.
Now consider the statement that fewer carrots are being bought because carrots have
become more expensive. This refers to a movement along a given demand curve and
reflects a change between two specific quantities being bought, one before the price
rose and one afterward.
So what lay behind the two stories might have been something like the following;
1) A rise in the population is shifting the demand curve for carrots to the right as more
and more demanded at each price. This in turn is raising the price of carrot. This
was the fist newspaper story.
2) The rising price of carrots is causing each individual household to cut back on its
purchase of carrots. This causes a movement upward to the left along any
particular demand curve for carrots. This was the second newspaper story.
To prevent the typ of confusion caused by our two news paper stories economist have
developed a specialized vacabulary to distinguish shift of curves from movements
along curve.
Economist reserve the term change in demand to describe a shift in the whole curve,
that is a change in the amount that will be bought at every price. Any one point on a
demand curve represent a spesific amount being bought at a specified price. It
represents, therefore a particular quantity demanded. A movement along a demand
curve is refered to as a change in the quantity demanded.
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II. Movements Along the Supply Curve Versus Shifts of the Whole Curve
As with demand, it is important to distinguish movements along the supply curves from
shifts of the whole curve. The term change in supply is reserved for a shift of the whole
supply curve. This means a change in the quantity supplied at each price of the
commodity. A movement along the supply curve indicates a change in the quantity
supplied in response to a change in the price of the commodity. Thus an increase in
supply means that the whole supply curve has shifted to the right; an increase in the
quantity supplied means a movements upward to the right along a given supply curve.
III. The Law of Demand and Supply
Change in any of the variables other than price that influence quantity demanded or
supplied will cause a shift in the supply curve or the demand curve or both. There are
four possible shifts: 1) a rise in demand (a rightward shift in the demand curve). 2) a fall
in demand (a leftward shift in the demand curve) 3) a rise in supply 4) a fall in supply.
Each of these shifts causes changes that are described by one of the four "laws" of
demand and supply. Each of the laws summarizes what happens when an initial
position of equilibrium is upset by some shift in either the demand or the supply curve
and a new equilibrium position is then established.
To discover the effects of each of the curve shifts that we wish to study, we use the
method known comparative statics. We start from a position of equilibrium and then
introduce the change to be studied. The new equilibrium position is determined and
compared with the original one.
The four laws of demand and supply are derived in the Figures below, which
generalizes our specific discussion (about carrots.)
The laws of supply and demand are:
1) A rise in demand causes an increase in both the equilibrium price and the
equilibrium quantity exchanged.
2) A fall in demand causes a decrease in both the equilibrium price and the equilibrium
quantity exchanged.
3) A rise in supply causes a decrease in the equilibrium prices and an increase in the
equilibrium quantity exchanged.
4)A fall in supply causes an increase in the equilibrium price and a decrease in the
equilibrium quantity exchanged.
We have studied many forces that can cause demand and supply curves to shift. By
combining this analysis with the four laws, we link many real world events that cause
demand or supply curves to shift with changes in market prices and quantities.
The usefulness of this theory in interpreting what we see in the world around us is
further discussed.
IV.Demand and Supply: What Really Happens
What Really Happens
"The theory of supply and demand is neat enough", said the skeptic, "but tell me what
really happens."
"What really happens," said the economists "is that fist, demand curves slope
downward; second, supply curve slope upword; third, prices rise in response to excess
demand, and fourth, prices fall in response to excess supply."
"But that's theory", insisted the skeptic. "What about reality?"
"That is reality as well", said the economist.
"Show me" said the skeptic.
The economist produced, the fallowing passages from articles in the New York Times.
***
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Increased demand for macademia nuts causes price to rise above competing nuts.
Major producer now plans to double the size of its orchards during the next five years.
***
OPEC countries once again fail to agree on output quotas. Output soars and price
plummet.
***
Last summer, Rhode Island officials reopened the northern side of Narragansett Bay, a
9500-acre fishing ground that had been closed since 1978 because of pollution.
Suddenly clam prices dropped, thanks to an underwater population explosion that had
transformed the Narragansett area in to a clam harvester's dream.
***
Increasing third world agricultural production threatens the stability of American
agriculture, In the 1970's American farm prosperity was built on rising demand due to
world prosperity and on falling output in Eastern Europe. Farm experts now, worry that
the prosperity will prove fragile in the face of major increases in world output.
***
The effects of (the fist year of) deregulation of the nation's airlines were spectacular:
cuts in air fares of up to 70 percent in some cases, record passanger jam-ups at the
airports, and spectacular increase in the average load factor (the proportion of
occupied seats on average commercial flight.)
***
The skeptic's response is not recorded, but you will have no trouble telling which of the
economist's four statements about "what really happens."
V. Prices in Inflation
Up to now, we have developed the theory of the prices of individual commodities under
the assumption that all other prices remained constant. Does this mean that the theory
is in applicable to an inflationary world when almost all prices are rising? Fortunately
the answer is no.
The key lies in what are called relative prices. We have mentioned several times that
what metters for demand and supply is the price of the commodity in question relative
to the prices of other commodities. This is called a relative price.
In an inflationary world we are often interested in the price of a given commodity as it
relates to the average price of all other commodities. If during a period when the
general price level rose by 40 percent, the price of carrots rose by 60 percent, then the
price of carrots rose relative to the price level as a whole. Carrots became relatively
expensive. However, if carrots had risen in price by only 30 percent, when the general
price level rose by 40 percent then the relative price of carrots would have fallen.
Although the money price of carrots rose substantially, carrots became relatively
cheap.
In price theory, whenever we talk of a change in the price of one commodity, we mean
a change relative to other price.
If the price level is constant, this change, requires only that the money price of the
commodity in question should rise If the price level is itself rising, this change requires
that the money price of the commodity in question should rise faster than the price
level.
We have been analyze a change in a particular price in the context of a constant price
level. The analysis easily extended to an iflationary peirod. By remembering that any
force that raises the price of one commodity when other price remain constant will,
given general inflation raise the price that commodity faster than the price level is
rising. For example a change in tastes in favor of carrots that would raise their price by
20 percent when other price were constant, would raise their price by 32 percent if at
the same time the general price level goes up by 10 percent . In each case the price of
carrots rises 20 percent relative to the average of all price.
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Course V
I. Price Elasticity of Demand
II. Price Elasticity and Changes in Total Expenditure
III. What Determines Elasticity of Demand?
IV. Cross Elasticity of Demand
V. Income Elasticity of Demand
VI. What Determines Income Elasticity?
VII.Elasticity of Supply
I. Price Elasticity of Demand
Elasticity of demand is the measure of responsiveness of quantity demanded to price
changes.
De 
percentage change in quantity demanded
percentage change in price
This measure is frequently called demand elasticity. When it is necessary to distinguish
it from other related concepts, it may however be called price elasticity of demand,
since the variable causing the change in quantity demanded is the commodity's own
price. Because demand curve slope downward, an increase in price is associated with
a decrease in quantity demanded and vice versa. Since the percentage changes in
price and quantity have opposite signs, demand elasticity is a negative number.
The numerical value of elasticity can vary from zero to infinity. Elasticity is zero, when
quantity demanded does not respond at all to a price change. As long as the
percentage change in quantity is less than the percentage change in price the elasticity
of demand has a value of less than unity (less than one). When the elasticity is less
than one, the demand is said to be inelastic. When the two percentage changes are
equal to each other, elasticity is equal to unity. When the percentage change in
quantity exceeds the percentage change in price, the value for the elasticity of demand
is greater than unity. If the elasticity is more than unity, the demand is said to be
elastic. If purchasers (sellers) are prepared to buy (sell) all they can at some price and
none at all at an even slightly higher (lower) price, the demand is said to be infinitely
elastic.
Table: EstimatedPrice Elasticities of Demand in the US
Commodities
Elasticities
Potatoes
0.3
Sugar
0.3
Public Transportation
0.4
All foods
0.4
Gasoline
0.6
Beef
0.9
Furniture
1.2
Automobiles
2.1
II.Price Elasticity and Changes in Total Expenditure
The total amount spent by purchasers is also the total revenue received by the sellers.
How does this revenue or expenditure react when the price of a product is changed?
What happens to total revenue or expenditure depends on the price elasticity of
demand. If elasticity is less than unity, the percentage change in price exceeds the
percentage change in quantity. The price change will then dominate so that total
revenue will change in the same direction as the price changes. If, however, elasticity
exceeds unity the percentage change in quantity exceeds the percentage change in
11
price.The quantity change will then dominate so that total revenue will change in the
same direction as quantity changes ( that is , in the opposite direction to the change in
price.)
The general relations between elasticity and change in price can be summarized as
follows:
1.If demand is elastic, a fall in price increases total revenue and a rise in price reduces
it.
2.If deman is inelastic a fall in price reduces total revenue and a rise in price increases
it.
3. If elasticity of demand is unity a rise or a fall in price leaves total revenue unaffacted.
III.What Determines Elasticity of Demand?
The Table above, shows some measured elasticities of demand. Evidently, they can
vary considerably. The main determanent of elasticity is the availability of substitutes.
Some commodities, such as margarine, cabbage, lamb have quite close substitutesbutter, other green vegetables, beef. A change in the price of these commodities, the
price of substitutes remaining constant, can be expected to cause much substitution. A
fall in price leads consumers to buy more of the commodity and less of the substitutes,
and a rise in price leads consumers to buy less of the commodities and more of the
substitutes.A commodity with close substitutes tend to have an elastic demand, one
with no close substitutes an inelastic demand.
The degree of response to a price change, and thus the measured price elasticity of
demand, will tend to be greater the longer the time span considered, as well.
IV.Cross Elasticity of Demand
The responsiveness of demand to changes in the prices of other commodities is called
cross elasticity of demand. Complementary goods such as cars and gasoline have
negative cross elasticities. A large rise in the price of gasoline will lead to a decline in
the demand for cars as some people decided to do without a car and others decided
not to buy a second car. Substitute commodities such as car and public transport,
have positive cross elasticities. A large rise in the price of cars (relative to public
transport) would lead to a rise in the demand for public transport as some people
shifted from cars to public transport.
V.Income Elasticity of Demand
One of the most determinants of the demand is the income of the potantial customers.
The responsiveness of demand to changes in income is termed income elasticity of
demand.
Ge 
percentage change in quantity demanded
percentage change in income
For most goods increases in income lead to increases in demand and income elasticity
will be positive. These are called normal goods. Goods for which consumption
decreases in response to a rise in income have negative income elastisities and are
called inferior goods.
The income elasticity of normal goods may be greater than unity (elastic) or less than
unity (inelastic), depending on whether the percentage change in the quantity
demanded is greater or less than the percentage change in income. It is also common
to use the terms income-elastic and income inelastic to refer to income elasticities of
greater or less than unity.
Table: Estimated Income Elasticities of Demand in the US
12
Commodities
Elasticities
Whole Milk
-0.5
Pig Products
-0.2
Starchy roots
0.3
Poultry
0.3
Cheese
0.4
Beef
0.5
Gasoline
1.1
Restaurant Meals
2.4
VI.What Determines Income Elasticity?
Does the distinction between luxuries and necessities explain differences in income
elasticities? The Table above suggests that it does. The more basic an item in the
consumption pattern of households, the lower its income elasticity. Income elasticities
for any one commodity also vary with the level of a households's income. When
incomes are low, households may eat almost no meat and consume lots of starchy
foods such as bread and potatoes; at a higher income levels they may eat the cheaper
cuts of meat and more green vegatables along with their bread and potatoes; at yet
higher levels they are likely to eat more (and more expensive) meat to substitute frozen
for canned vergetables and to eat greater variety of foods.
VIII. The Elasticity of Supply
The elasticity of supply measures the responsiveness the quantity supplied to a change
in the price of that commodity.
Se 
percentage change in quantity supplied
percentage change in price
Because supply curves slope upwards, the elasticity of supply is positive. As we move
along a supply curve, positive price changes are associated with positive output
changes. An increase in price causes an increase in quantity sold. The more elastic is
supply the larger the percentage increase in quantity supplied in response to a given
percentage change in price. Thus elastic supply curves are relatively flat and inelastic
supply curves relatively steep.
There are important special cases. If the supply curve is vertical, -the quantity suplied
does not change as prices changes- elasticity of supply is zero. A horizontal supply
curve has an infinitely high elasticity of supply: A small drop in price would reduce the
quantity producers are willing to supply from an indefinetely large amount to zero.
Course VI
I. The Theory of Consumer Choice
II. Total Utility& Marginal Utility
III Diminishing Marginal Utility
IV. Maximizing Utility
V.Consumers’ Surplus, Diminishing Marginal Utility and Demand Curve
I. The Theory of Consumer Choice
Early economists, struggling with the problem of what determines the relative prices of
commodities, encountered what they came to call the paradox of value: Necessary
commodities, such as water have prices that are low compared with prices of luxury
commodities, such as diamonds. Water is necessary to our existence, while diamons
used as ornaments are frivolous and could disappear from the face of the earth
13
tomorrow without causing any great loss. Does it not seem odd then, these economists
argued, that water is so cheap and diamonds are so expensive? It took along time to
resolve this apperent paradox, so it is not suprising that even today the confusion
persist and in different forms clouds many current policy discussions. The key to
resolving the apparent paradox lies in the important distinction between marginal and
total utulity.
II.Total Utility& Marginal Utility
The satisfaction someone receives from consuming commodities is called utulity.Total
utility refers to the total satisfaction from consuming some commodity. For example,
the total utility of consuming 10 units of any commodity is the total satisfaction those 10
units provide. Marginal utility refers to the change in satisfaction resulting from
consuming a little more or a little less of the commodity. The marginal utulity of the
tenth unit consumed is the additional satisfaction provided by the consumption of that
unit, or in other words, the difference in total utility gained by consuming 9 units and by
consuming 10 units.
The significance of this distinction can be seen by considering two questions: (1) If you
had to give up consuming one of the following commodities completely, which would
you choose: water or the movies? (2) If you had to pick one of the following, which
would you choose: increasing your water consumption by 35 gallons a month (the
amount required for an average bath) or attending one more movie a month?
In (1) you are comparing the value you place on your total consumption of water with
the value you place on all your attendance at the movies. You are compering the total
utility of your water consumption with the total utility of your movie attendance. There is
little doubt that everyone would answer (1) in the same way revealing that the total
utility derived from consuming water exceeds the total utility derived from attending the
movies.
In (2) you are compering the value you place on a small addition to your water
consumption with the value you place on a small addition to your movie attendances.
You are compering your marginal utility of water with your marginal utility of movies. In
responding to (2), some might select the extra movie; others might select the extra
water. Furthermore, their choice would depend on whether it was made at a time when
water was plentiful so that they placed a low value on obtaining a little additional water.
(low marginal utility of water) or when water was scarce, so that they might put quite
high value on obtaining a little more water. (high marginal utility of water)
Choices of type (1) are encountered much less commonly than are choices of type (2).
If our income rises a little, we have to decide to have some more of one thing or
another. If we find that we are overspending or if our income falls, we have to decide
what to cut down on. Do we have a little less of this or a little less of that?
Real choices are rarely conditioned by total utilities; it is marginal utilities that
are relevant to choices concerning a little more or a little less.
Now cosidering marginal utility approach, to understand the case of water and
diamonds, remember that water is cheap because there is enough of it that people
consume it to the point at which its marginal utility is low, they are not prepared to pay
a high price to obtain a little more of it. Diamond are expensive because they are
scarce (the owners of diamond mines keep diamonds scarce by limiting output) and
those who buy them have to stop at a point where marginal utility is still high; they are
prepared to pay a high price for an additional diamond.
III. Diminishing Marginal Utility
The basic hypothesis of utility theory, sometimes called the law of of diminishing
marginal utulity, is:
The utility any household derives from successive units of a particular
commodity diminishes as total consumption of the commodity increases while
the consumption of all other commodities remains constant.
14
Consider water once again some minimum quantity is essential to sustain life, and a
person would , if necessary, give up all his or her income to obtain that quantity of
water. Thus the marginal utility of that much water is extremely high. More than this
bare minimum will be drunk, but the marginal utility of successive glasses of water
drunk over a period will decline steadily.
How much money would induce you to cut your consumption of water by one glass per
week? The answer is very little. How much would induce you to cut it by a second
glass? By a third glass? To only one glass consumed per week? The aswer to the last
quaestion is quite bit. The fewer glasses you are consuming already, the higher the
marginal utility of one more or less glass of water.
IV. Maximizing Utility
A basic assumption of the economic theory of household behaviour is that household
try to make themselves as well off as they possibly can in the circumtances in which
they find themselves. In other words, the members of a household seek to maximize
their total utility.
How can household adjust its expenditure so as to maximize the total utility of its
members?
The household maximizing its utility will allocate its expenditure among commodities so
that the utility of the last lira spent on each is equal.
MUx MUy

px
py
This says that the household will allocate its expenditure so that the utility gained from
the last lira spent on each commodity is equal.
IV.Consumers' Surplus, Diminishing Marginal Utility and Demand Curve
Assume that you would be willing to pay as much as 100TL. a month for the amount of
a commodity for 60TL. instaed of 100TL. What a bargain! You have paid 40TL. less
than the top figure you were willing to pay. Yet this sort of bargain is not rare; it occurs
every day in any economy where prices do the rationing. Indeed it is so common that
the 40TL.saved in this example has been given a name: consumers' surplus.
Consumers' surplus is a direct consequence of diminising marginal utility. We can
explain it with an example: If you were getting no milk at all, how much would you be
willing to pay for one glass per week? With no hasitation you might answer 300TL. We
than ask: If you had already consumed that one galss how much would you pay for a
second glass per week? After a bit of thought you might answer 150TL. Adding one
glass per week with each question, we discover that you would be willing to pay 100TL
to get a third glass per week and 80TL., 60TL, 50TL, 40TL, 30TL, 25 TL, and 20TL. for
successive glasses per week. The progressively lower valuation on each additional
glass of milk illustrates the general concept of diminising marginal utility.
But you dont have to pay a different price for each glass of milk you consume each
week. You can buy all the milk you want at the prevailing market price. Suppose the
price is 30 TL. You will buy eight glass per week, because you value the eight glass
just at the market price, while valuing all earlier glasses at higher amounts. Because
you value the fist glass at 300 TL, but get it for 30, you make a "profit" of 270TL. on that
glass Between your 150TL valuation of second glass and what you have to pay for it
you clear a "profit" of 120TL. You clear 70 TL on the third glass, and so on. These profit
amounts are called your consumers' surpluses on each glass. (The total suplus is
570TL. per week.)
The data in columns 1 and 2 of the Table below give your deman curve for milk It is
your demand curve because, you will go on buying glasses of milk as long as you
value each glass at least as much as the market price you must pay for it. When the
market price is 300 TL. per glass you will buy only one glass when it is 150 TL., you will
15
buy two glasses and so on. The total valuation is the area below your demand curve
and consumers' surplus is that part of the area that lies above the price
Table: Consumers' Surplus on Milk Consumption by One Consumer
Glass of milk
consumed (1)
Amount the consumer
would pay to get this
glass (2)
Consumers' Surplus on
each glass if milk costs 30
TL per glass (3)
First
Second
Third
Fourth
Fifth
Sixth
Seventh
Eight
Ninth
Tenth
300 TL
150 TL
100 TL
80 TL
60 TL
50 TL
40 TL
30 TL
25 TL
20 TL
270 TL
120 TL
70 TL
50 TL
30 TL
20 TL
10 TL
00 TL
-
Course VII
I. Indifference Curve Analysis of Consumer Choice
II.The Budget Constraint
III. Indifference Curve
IV.Utility Maximization and The Equilibrium of the Consumer
V.The Analysis of the Firm’s Input Decision
VI.A Single Isoquant
VII..Isocost Line
VIII..Conditions for Cost Minimization
Indifference Curve Analysis of Consumer Choice
The model’s fourth elements describe both the consumer and the market environment:
 The consumer’s income
 The prices at wich goods can be bought
 The consumer’s preferences, wich rank different bundles of goods by the
satisfaction they yield.
 The behavioural assumption that consumers do the best they can for themselves.
The Budget Constraint
The bugget constraint describes the different bundles that the consumer can afford.
Which bundles are feasible, or can be afforded, depends on two factors: The
consumer's income and the prices of different goods.
16
The budget constraint shows the maximum affordable quantity of one good given the
quantity of the other good being purchased. ( we assume that all income is spent on
goods. There is no saving.)
Budget line; Graghic representation of all combinations of commodities that a
household may obtain if it spends a given amount of money at fixed prices of the
commodities. Also called isocost line. The slope of the budget line depends only on the
ratio of the price of two goods. A change in the price of one commodity changes
relative prices and thus changes the slope of the budget line. Variations in the
household’s money income, with prices constant, shift the budget line parallel to itself
Y
Y
Y
B/Py
o
B/Px
x
x
o
o
x
Indifference Curve.
An indifference curve, shows all the consumption bundles which yield the same utility.
Along each same indifference curve, consumer utility is constant. Since more is
preferred to less any point on a higher indifference curve is preferred to any point on a
lower indifference curve. Indifference curve slope downwards. Otherwise the consumer
would have more of both goods and be better off.
The marginal rate of substitution of one good for another good, is the quantity of
one good the consumer must sacrifice to increase the quantity of other good by one
unit without changing total utility.
Consumer tastes exhibit a diminising marginal rate of substitution when, to hold utility
constant, diminishing quantities of one good must be sacrificed to obtain successive
equal increases in the quantity of the other good.
A set of indifference curves is called an indifferences map. It specifies the
household’s preferences by showing its rate of substitution between the two
commodities for every level of current consumption of these commodities.
Y
Y
B/Py
A
Y1
B
Y2
I3
I2
o
X1
X2
x
I1
o
x
Utility Maximization and The Equilibrium of the Household
The budget line shows affordable bundles given the consumer's market environment
(the budget for spending and the price of different goods). The indifference map
describe the preferences of consumers. To predict what households will actually do,
both sets of information must be put together.To complete the model, we assume that
consumers chooses the affordable bundle that maximizes their utility. The household’s
satisfaction is maximized at the point where an indiference curve is tangent to the
budget line. At such a tangency position the slope of the indifference curve (the
17
consumers marginal rate of substitution of the goods) is the same as the slope of the
budget line (the relative prices of the goods in market) The consumer cannot afford
(unaffordable points) points that lie above the budget line, and will
Y
B
Y1
I3
I2
I1
o
X1
x
A
never choose points that lie below the budget line where it is possible to purchase
more of one good without sacrificing any of the other good.
The Analysis of the Firm’s Input Decision
The production function, gives the relation between the factor inputs that the firm
uses and the output that it obtains. In the long run, the firm can choose among many
different combinations of inputs that will yield the same output. The production function
and the choices open to the firm can be represented graphically using the concept of
an isoquant.
A Single Isoquant
Isoquant shows the whole set of technologically efficient possibilities for producing a
given level of output. In other words, an isoquant describes the firm’s alternative
methods for producing a given output.
(It is analogous to an indifference curve that sows all combinations of commodities that
yield an equal utility)
K
K
A
K1
B
K2
o
O3
O2
O1
L1
L2
L
o
L
As we move from one point on an isoquant to another, we are substituting one factor
for another while holding output constant. The marginal rate of substitution
measures the rate at which one factor is substituted for another with output held
constant. Graphically, the marginal rate of substitution is measured by the slope of the
isoquant at a particular point.
Isoquant are downword-sloping and convex. The downword slope reflects the
requirement of technological efficiency. A method that uses more of one factor must
use less of the other factor if it is to be technologically efficient. The marginal rate of
substitution has a negative value. Decreases in one factor must be balanced by
increases in the other factor if output is to be held constant. The isoquant is convex
18
viewed from the origin. The convex shape of the isoquant reflects a diminishing
marginal rate of substitution.
Each isoquant refers to a specific output and connects combination of factors that are
technologically efficient methods of achieving that output. If we plot, a representative
set of these isoquants on a single graph, we get an isoquant map. The higher the
level of output along a particular isoquant, the farther the isoquant is from the origin.
Isocost line
Isocost line is used to show alternative combinations of factors a firm can buy for a
given outlay. The slope of isocost reflects, relative factor prices, just as the slope of the
budget line represented relative product prices (in the theory of consumer choice). For
the given factor prices a series of parallel isocost lines will reflect the alternative level of
expenditure on factor purchases that are open to the firm. The higher the level of
expenditure, the farther the isocost line is from the origin.
K
C/PK
o
C/PL
L
Conditions for Cost Minimization
Finding the efficient way of producing any output requires finding the least-cost factor
combination. To find this combination when both factors are variable, factor prices
need to be known.
The economically most efficient method of production position (the least cost position)
is given graphhically by the tangency point between the isoquant and isocost lines.
The slope of the isocost line is given by the ratio of the prices of the two factors of
production. The slope of the isoquant is given by the ratio of their marginal products.
When the firm reaches its least-cost position, it has equated the price ratio (which is
given to it by the market prices) with the ratio of the marginal products (which it can
adjust by varying the proportion in which it hires the factors)
K
C
E
K1
Q3
Q2
Q1
o
L1
C
L
19
Course VIII.
I. Costs: Total, Average, Marginal Costs, Variable&Fixed Cost.
II. Revenue
III. Profit, Profit Maximization
How do firms decide how much to produce and offer for sale? For each possible output
level, a firm needs to answer two questions: how much will it cost to produce this
output and how much revenue will be earned by selling it. For each output level,
production costs depend on technology that determines how many inputs are needed
to produce this output, and on input prices that the firms have to pay for these inputs.
The revenue obtained from selling output depends on the demand curve faced by the
firm. The demand curve determines the price for wich any given output quantity can be
sold and hence the revenue that the firm will earn.
Profits are the excess of revenues over cost. The key to the theory of supply is the
assumption that all firms have the same objective: to make as much profit as with
possible. By examining how revenues and costs change with the level of output
produced and sold, the firm can select the output level which maximizes its profits. To
understand how firms make output decisions we must therefore analyse the
determination of revenues and costs.
Revenues, costs, and profits.
A firms revenue, is the amount it earns by selling goods or services in a given period
such as a year. The firms costs are the expenses incurred in producing goods or
services durind the period.
Profits are the excess of revenues over costs.
Cost, to the producing firm, is the value of inputs used in producing its outputs.
Total cost (TC), is the total cost of producing any given level of output. Total cost is
diveded into two parts; total fixed cost (TFC), total variable cost (TVC).
A fixed cost is one that does not vary with output; it will be the same if output is 1 unit
or one million units. Such a cost is also refered as an overhead costs or unavoidable
cost. A cost that varies directly with output, rising as more is produced and falling as
less is produced, is called a variable costs (also a direct or avoidable cost).
Avarega total cost (ATC), also called averega cost is the total cost of producing any
given output divided by that output. Average total cost may be divided into average
fixed cost (AFC) and average variable cost (AVC) in the same way that total costs
were.
Although average variable costs may rise or fall as production is increased (depending
on whether output rises more rapidly or more slowly than total variable costs), it is clear
that average fixed costs decline continuously as output increases. A doubling of output
always leads to a halving of fixed costs per unit of output. This is a process popularly
known as spreading one's overhead.
Marginal cost (MC), is the increase in total cost resulting from raising the rate of
production by one unit. Because fixed cost don't vary with otput marginal fixed costs
are always zero. Therefore marginal cost are necessarily marginal variable costs, and
a change in fixed costs will leave marginal costs unaffected. For example, the marginal
cost of producing a few more potatoes by farming a given amount of land more
intensively is the same, whatever the rent paid for the land.
20
Marginal cost is the increase in total cost when output is increased by 1 unit. Marginal
revenue is the increase in total revenue when output is increased by 1 unit (when an
additional unit of output is sold).
Firms have costs even when no output is produced. This cost includes the expenses of
being in bussiness at all runing an office, renting a telephone and so on. Thereafter,
cost rise with the level of production. Total cost of production is higher the more is
produced. At the begining costs rise quite slowly as output rises. At high levels of
output, costs rise sharply as output increases.
Profit Maximization&Cost Minimization
Economist assume that firms make supply and output decisions so as to make as
much money as possible, in other words to maximize profits.
Any firm maximizing profits certainly wants to produce its chosen output level at the
minimum possible costs. Otherwise, by producing the same output at lower cost it
could increase profits. Thus a profit maximizing firm must produce its output at
minimum cost.
Economies and Diseconomies of Scale
There are economies of scale (or increasing return to scale), when long run average
costs decrease as output rises. There are diseconomies of scale (or decreasing
return to scale) when long run average costs increase as output rises. In these
definitions, scale refers to the size of the firm as measured by its output.
There are some reasons for economies of scale. The first is indivisibilities in the
production process, some minimum quantity of inputs required by the firm to be in
business at allwhether or not output is produced. These are called fixed costs,
because they don’t vary with the output level. To be in business a firm requires a
manager, a telephone, an accountant, a market research survey. The firm can not have
half a manager and half a telephone merely because it wishes to operate at low output
levels. Begining from small output levels, these cost don’t initially increase with output.
The manager can organize three workers as easly as two. As yet there is no need for a
second telephone. There economies of scale because these fixed cost can be spread
over more units of output as output is increased, reducing average cost per unit of
output.
Sophisticated but expensive machinery also has an element of indivisibilty. No matter
how productive a robot assembly line is, it is pointless to install one to make five cars a
week. However at high output levels the machinery cost spread over a large number of
units of output and this production technique may produce so many cars that average
costs are low.
The second reason for economies of scale is specialisation. A sole trader must be
undertake all the different tasks of business. As the firm expands and takes on more
workers, each worker can concentrate on a single task and handle it more efficiently.
The main reason for diseconomies of scale is that management becomes more difficult
as the firm become larger: there are managerial diseconomies of scale. The company
becomes bureaucratic, coordination problems arise, and average cost may begin to
rise.
Geography may also explain diseconomies of scale. If the first factory is located in the
best side, to minimize the cost of transporting goods to the market, the site of a second
factory must be less advantageus. To take a different example in extracting coal from a
mine, a firm will extract the easiest coal first. To increase output deeper coal seams
have to be worked and these will be more expensive.
21
Course IX
I. Market Structure
II. Perfect Competitive Market
III. Monoply
IV. Monopolistic Competition
V. Oligopoly
Market Structure
The term market structure refers to all aspects of a market, such as the number of
firms and the type of product sold, that may affect the behavior and performance of the
firms in that market. The structure of a market is a description of the behavior of buyers
and sellers in that market.
First it is useful to establish two benchmark cases, the opposite extremes between
which all other types of market structure must lie. These limiting cases are perfect
competition on the one hand, monopoly on the other hand.
A perfectly competitive market is one which both buyers and sellers believe that their
own buying or selling decision have no effect on the market price. A monopolist is the
only seller or potential seller of the good in that industry.
Perfect Competitive Market, The extreme of competitiveness occurs when each firm
has zero power.In such a case there are so many firms that each must accept the price
set by the forces of market demand and supply. This extreme is called the perfectly
competitive market structure. In it there is no need for individual firms to compete
actively with one another since none has any power over the market. One firm's ability
to sell its product does not depend on the behavior of any other firm.
Assumptions of Perfect Competition, The theory of perfect competition is built on
two critical assumptions, one about the behavior of individual firm and one about the
nature of the industry in which it operates. (An industry is the set of all firms making the
same product.)
The firm is assumed to be a price taker; A firm operating in a perfectly competitive
market has no power to influence that market trough its own individual actions. It must
passively accept whatever price happens to be ruling.
The industry is assumed to be characterized by freedom of entry and exit; that is, any
new firm is free to set up production if it so wishes, and any existing firm is free to
cease production and leave the industry. Existing firms can not bar the entry of new
firms, and there are no legal prohibitions on entry or exit.
In a perfectly competitive economy there are many firms and many households. Each
is a price taker. No single firm and no single consumer has any power over the market.
Individual consumers and producers are quantity adjusters who respond to market
signals. The perfectly competitive model is almost too good to be true.
Because the market mechanism works, it is not necessary for the government to
intervene. Market reaction, not public policies, will eliminate shortages or surpluses.
There is no need for regulatory agencies or bureaucrats to make arbitrary decisions
about who may produce what, how to produce it, or how much it is permissible to
charge for the product. If there are no government officials to make such decisions,
there will be no one to bribe to make one decision rather than another.
In the impersonal decision-making world of perfect competition, neither private firms
nor public officials wield economic power. The market mechanism, like an invisible
hand determines the allocation of resources among competing uses.
Monoply, The word monopoly comes from the Greek words, monos polein, which
mean "alone to sell". It is convenient for now to think of monopoly, as the situation in
which the output of an entire industry is controlled by a single seller. This seller will be
called the monopolist. Because the monopoly firm is the only producer of a particular
22
product, its demand curve is identical with the demand curve for that product. The
market demand curve, which shows the aggregate quantity that the monopolist will
purchase at every price, also shows the quantity that the monopolist will be able to sell
at any price it sets. The importance of this is that the monopoly, unlike the firm in
perfect competition, faces a downward-sloping demand curve. The firm therefore faces
a trade-off between price and quantity: Sales can be increased only if price is reduced,
while price can be increased only if sales are reduced. A monopolists is the sole
supplier and the potantial supplier of the industry's product. The firm and the industry
coincide.
A monopoly will persist only if entry of new firms does not occur. Impediments that
prevent entry are called entry barriers; they may be either natural or created. Natural
barriers most commonly arise as a result of economies of scale. If the long run average
cost declines over a large range of output big firms will have significantly lower average
total cost than small firms. The cost to the new firm of entering the market, developing
its product, and establising such things as its brand image and its dealer network may
be such that entry is rendered unprofitable.
Barriers to entry may be created by the conscious action of participants in some
markets. Some are created by the government and are therefore condoned by it.
Patent laws, for instance, may prevent entry by conferring on the patent holder the sole
right to produce a particular commodity.
Cartels As Monopolies, A second way in which a monopoly can arise is for the firms
in an industry to agree to cooperate with one another, to behave as if they were a
single firm, and thus to eliminate competitive behavior among themselves. Such a
group of firm is called a cartel. A cartel that includes all of the firms in the industry can
behave in just the same way as would a single firm monopoly that owned all of these
firms. The firms can agree among themselves to restrict their total output to the level
that maximize their joint profits.
Monopolistic Competition; The theory of monopolistic competition was developed in
two famous books of the early 1930's one by the British economist Joan Robinson, the
other by the American economist Edward Chamberlin.
The market envisaged in this theory is similar to perfect competition in that there are
many firms with relatively easy entry and exit. But it defers in one important respects;
Each firm has some power over price because each sells a product that is
differentiated significantly from those of its competitors. One firm's soap might be
similar to another firms soap, but it differs in chemical composition, color, smell,
softness, reputation, and a host of other characteristics that matter to customers. This
is the phenomenon of product differentiation.It implies that each firm has a certain
degree of local monopoly power ower its own product. It could raise its price, even its
competitors did not, and not lose all of its sales. This is the monopolistic part of the
theory. The monopoly power is severely restricted, however by the precense of similar
products sold by many competing firms and by easy entry and exit. As a result the
monopolistically competitive firm's demand curve is very much flatter than the industry
demand curve.The demand curve highly elastic because, similar products sold by other
firms provide many close substitutes. This the competition part of the theory.
Firm in monopolistic competition, sell a differantiated products, which means a group of
commodities similar enough to be called the same product, but dissimilar enough that
the producer of each has some power over its own price. This dissimilarity leads to,
and is enhanced by, establisment of brand names and advertasing.Monopolistic
competition produces a wider range of products, but at somewhat higher cost per unit,
than perfect competition.(because of advertising cost and product differentiation cost).
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Oligopoly
Such industries have three major characteristics; (1) there are more competing firmsthus the industry is not a monopoly. (2) Each firm faces a downward-sloping demand
curve for its own product –thus the industry is not perfectly competitive. (3) There is at
least one large firm that is aware that its competitors will react to any move it makesthus the industry is not monopolistically competitive.
Collusion is an explicit or implicit aggreement between existing firms to avoid
competition with one another.
Under perfect competition or monopolistic competition, there are so many firms in the
industry that no single firm need worry about the effect of its own actions on rival firms.
However, the very essence of an oligopolistic industry is the need for each firm to
consider how its own actions will affect decision of its relatively few competitors.
OPEC: A Real World Oligopoly
The Organization of Petroleum Exporting Countries (OPEC) is an example of the
attempted cartelization of a formerly competitive industry. It illustrates many of the
problems of oligopolistic industries.
The oil industry in the years before 1973 was not perfectly competitive. However, there
were many oil producing countries, so many, indeed that no one of them could
significantly influence the price of oil by witholding its own output from the market. They
were price takers in the market in which they sold their oil. OPEC did not become a
cartel nor attract world attention until 1973. In that year, however members of OPEC
placed a temporary embargo on the export of Middle Eastern oil.(The embargo was in
retaliation for support, particularly by the US, for Israel in the Arab-Israeli was that
broke out in that year.)
After the embargo ended, the OPEC members voluntarily restricted their outputs by
negotiating quotas among themselves. At the time OPEC countries accounted for
about 70 percent of the world’s supply of crude oil and 87 percent of world oil exports.
So although it was not quite a complete monopoly, the cartel had substantial monopoly
power. The world oil market contained one large oligopolistic producers’ organization
surrounded by a competitive fringe of many smaller producing countries.
Course X
I.What do governments do?
II.What should governments do?
Most resources in market economies are allocated through markets in which
individuals and private firms trade with other individuals or firms. However governments
play a major role. They set the legal rules, they buy goods and services, they produce
goods and services, and they make payments such as pensions. Through taxation and
borrowing, governments exert a major influence on prices, interest rates, and
production.
This course, adresses some basic questions about the government’s role in economic
life. What do governments actually do? How can governments in principle improve the
allocation of resources in the economy ? How do governments decide what to do?
I.What do governments do?
Create Laws, Rules and Regulations
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Goverments determine the legal frame work that sets the basic rules for ownership of
property and the operation of markets. Even in the most capitalist economies, there
are limits to the rights of ownership. Not everyone can own a gun. It is usually illegal to
build a factory in a residental area. In addition, governments at all levels regulate
economic behaviour, setting detailed rules for the operation of businesses. Regulations
include, planing permission (how land can be used and where businesses can locate),
health and safety regulations, and attempts to prevent some types of business, such as
the sale of heroin.
Buy and sell goods and services
Governments buy and produce many goods and services, such as defence, education,
parks and roads which they provide to firms and households. Most of these goods,
such as defence and education are provided to users free of direct charge. Some, such
as local bus rides and government publications are paid for directly by the user.
Governments also produce and sell goods. In some countries, the phone company is
government-owned; in most countries, the government owns and operates urban
transport such as buses and the undergraund.
Make transfer payments
Governments also make transfer payments such as social security, and unemployment
benefits to individuals.
Transfer payments are payments for which no current direct economic service is
provided in return.
A firemans’s salary is not a transfer payment; a social security cheque is, as are
unemployment benefits and interest payments on government borrowing.
Impose taxes
Governments pay for the goods they buy and for the transfer payments they make by
levying taxes or by borrowing. Taxes raised at national level such as income tax or
VAT, are usually supplemented by local taxes assessed on property values or
household size.
Try to stabilize the economy
Every market economy suffers from business cycles.
The business cycle consists of fluctuations of total production, or GDP, accompanied
by fluctuations in the level of unemployment and the rate of inflation.
Governments often attempt to modify fluctuations in the business cycle. The
government may reduce taxes in a recession in the hope that people will increase
spending and thus raise the GDP. When inflation is high, the central bank may reduce
the rate of money growth with the aim of reducing inflation. These are macroeconomic
policies through which the government attemps to stabilize the economy. Keeping it
close to full employment but with low inflation.
Affect the allocation of resources
By spending and taxing, the government plays a major part in allocating resources in
the economy. In terms of what, how, and for whom, governments chooses much of
what gets produced, from defence expenditures to education to its support for the arts.
It affects how goods are produced through regulation and through the legal system. It
affects for whom goods are produced through its taxes and transfers, which take
income away from some people and give it to others.
II. What should governments do?
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Why should government intervene in a market economy? There are some theoretical
justifications for government intervention;
The general argument for government intervantion is market failure. Sometimes
markets do not allocate resources efficiently, and government intervention may
improve economic performance. Government could, in theory, improve the allocation
of resources. Economic theory, identifies the types of market failures;
The business cycle
The business cycle has many external causes, from wars or oil price changes to bursts
of new inventions. Government policies also affect it. Increases in taxes and reductions
in government spending generally reduce GNP, increases in the money stock increase
GNP and prices. Government policy can make the business cycle worse, lenthening
recessions and creating inflations, or it can reduce economic fluctuations. Since the
government does control a large share of total spending and the quantity of money, it
must make its decisions with their effect on the business cycle in mind. And it does:
taxes may be cut when the economy is in a recession, and the growth rate of money
may be reduced when the inflation rate is too high or be increased when the economy
is in a recession.
Public goods
There are goods we can all consume simultaneously. These are called public goods.
A public good is a good that, even if it is consumed by one person, is stil available for
consumption by others.
A private good, if consumed by one person, can not be consumed by another.
Clean air is a public good. So is national defence, or public safety. It is no coincidence
that most public goods are not provided in private markets. Because of the free rider
problem, private market have trouble ensuring that the right amount of a public good
will be produced. A free-rider is some one who gets the consume a good that is costly
to produce without paying for it. The free-rider problem applies particularly to public
goods because if everyone were to buy the good, it would then be available for
everyone else to consume.
Externalities
Markets work well when the price of a good equals society’s cost of producing that
good and when the value of the good to the buyer is equal to the benefit of the good to
society, However the cost and benefits are sometimes not fully reflected in market
prices.
An externalities exist when the production or consumption of a good directly affects
businesses or consumers not involved in buying and selling it and when those spillover
effects are not fully reflected in market prices.
Externalities might be negative or positive; Such as pollution or views of newly painted
houses. When externelities are present, market prices do not reflect all the social costs
and benefits of the production of a good. Government intervention may improve the
functioning of the economy, for example by requiring firms to treat their waste products
in certain ways before dumping them.
Monopoly and market powers
Competitive markets generally work well, but markets where either buyers and sellers
can manipulate prices generally do not. In particular to little will be produced and price
will be to high in a market where a single seller controls supply.
Some monopolies are almost unavoidable. Most public utilities (gas for exaple) are
potantial monopolies. The government can regulate such companies by controlling the
prices they are allowed to charge, or it may elect to supply the products itself. Other
monopolies may be artificial, brougth about through manupilation by firms. Here
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governments intervene with competition laws, seeking to make competition more
vigorous and to prevent monopolies or other attemps to control supply.
Income redistribution and merit goods
In practice modern governments engage in large scale redistribution of income.
Government spending on transfer payments represents government redistribution of
income- towards the elderly (through social security), the unemployed (through
unemployment benefits), farmers (through price supports) and other beneficiaries.
There is difference between government intervention to effect the distribution of income
and intervention to ensure the right level of production of public goods or to make
market prices reflect externalities. In the later cases the government is taking actions
that at least in principle can make every one in society beter off. But when the
government intervenes to affect the income distribution, it make some people better off
by making others worse off.
Governments are concerned not just with the distribution of income, but also with the
consumption of particular goods and services.
Merit goods are goods that society thinks people should consume or receive, no matter
what their incomes are.
Merit goods typically include health, education shelter, and food.
Course XI
I. Factors Market: Some terms on factors of production.
II.The Functional Income Distribution
The demand for factors of production is derived demand because it is derived from the
demand for the output that the factors are used to produce.
Labour
Lobour, a factor of production consisting of all physical and mental contributions
provided by people.
Labour supply, the number of workers (or more generally the number of labour-hours)
available to an aconomy. The principle determinants of labour supply are population,
real wages, and social traditions.
The labour force, is all individuals in work or seeking employment.
Minimum wages, legally specified minimum rate of pay for labour in covered
occupations
Unemployment, the number of persons who are not employed and are actively
searching for a job.
Trade Unions are worker organizations designed to affect pay and working conditions.
Lobour boycott, an organized attempt to pursuade customers to refrain from purchasig
the products of a firm or industry whose employees are on strike.
Strike, the concerted refusal of the members of a union to work.
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Bread and butter unionism, is a union movement whose major objectives are better
wages and conditions of employment rather than political and social ends.
Capital
Capital, A factor of production consisting of all manufactured aids to further production.
Physical capital is the stock of produced goods that contribute to the production of
other goods and services. Physical capital consists of durable produced goods that are
in turn used in production. The major components of capital are equipment, structures,
and inventory. When signifiying capital goods reference is also made to real capital.
Portfolio capital or financial capital, means the total amount of money subscribed by
the shareholder-owners of a corporation, in return for which they receive shares of the
company’s stock.
Capital deepining; adding capital to the production process in such a way as to
increase the ratio of capital to labour and other factors of production. In economic
growht theory, an increase in the capital labour ratio (contrast with capital widening)
Capital widening, A rate of growth in real capital stock just equal to the growth of the
labour force, so that the ratio between total capital and total labour remains unchanged.
(contrast with capital deepining)
Capital gains, the rise in value of a capital asset, such as land or common stocks, the
gain being the difference between the sale price and the purchase price of the asset.
Capital consumption allowance; depreciation of an asset: A decline in the value of an
asset in both business and national accounts, depreciation is the money estimate of
the extend to wich capital has been used up or worn out over the period in question.
Capital markets, markets in which financial resources (money bonds, stocks) are
traded, These along with financial intermediaries, are institution through which savings
in the economy are transfered to investors.
Capitalist; one who owns capital goods.
Capitalist economy; an economy in which capital is predominantly owned by privately
rather than by the state.
Capital-labour ratio, a measure of the amount of capital per worker in an economy.
Capital-output ratio, The ratio of the value of capital to the annual value of output
produced by it. In economic growth theory, the ratio of the total capital stock to annual
GDP.
Capital stock, The aggregate quantity of a society’s capital goods or the total of a firm’s
capital goods.
Human Capital, is the stock of expertise accumulated by a worker. It is valued for its
income earning potential in the future.
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Nature, Land
Land is the factor of production that nature supplies. Land is a factor of production
consisting of all gifts of nature, including raw materials and “land” as conventionally
defined.
Land is one of the three basic factors of production in clasical and neoclasical
economies; More generally land is taken to iclude land used for agricultural or industrial
purposes as well as natural resources taken from above or below the soil.
Rent is the price of using a piece of land for a period of time.
The functional income distribution, tells us how an economies total income is
divided between factors of production. For example it tells the share going to labour
through wages and salaries, the share going to landowners through property rents, the
share going to capital owners through the interest earning.
REFERENCES
Begg, D., S.Fischer, R.Dornbush, Economics, Mc Graw Hill, 1994.
Lipsey, R.G., P.O. Steiner, Economics, Harper International Edition, 1987.
Samuelson, P.A., W. Nordhaus, Economics, Mc Graw Hill, 1995.
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