Revision
For Test 1
1
Chapter 1
Ten Principles of Economics
Principles related to how people make decisions:
People face trade-offs
Giving up something and getting something in return
The cost of something is what you give up to get it
Opportunity cost
Rational people think at the margin
Compare marginal benefits and marginal costs
People respond to Incentives
Positive incentives vs. negative incentives
Principles related to how people Interact
Trade can make everyone better off
But can make it worse with wrong deals
Market are usually a good way to organize economic activity
Invisible hand (supply and demand forces)
Government can sometimes improve market outcomes
In the case of market failures and externalities (positive and negative)
Principles related to how the economy as a whole works
A country’s standard of living depends on its ability to produce goods and services
Production value wise
Prices rise when government prints too much money
Inflation causes lower value of money causing high prices
There is short-run trade off between inflation and unemployment
When prices are high, suppliers produce more goods and thus hire more workers causing low unemployment (assume other things are constant)
Chapter 2
Thinking like an Economist
Economics is a social science
Can
oadly be divided into Microeconomics and Macroeconomics
Micro is the study of individuals
Macro is study of aggregates
In economics we make assumptions just like in other sciences to keep things focused and simple
Here we conclude on the basis of past data as we cannot produce data as per our wish
Economic Models
Economic models are often composed of diagrams and equations
They like science models omit many details to allow us to concentrate on important things
These models does not include every feature of the economy
Two models in this chapter: Circular Flow Diagram and Production Possibility Frontier
First Model
A Circular Flow Diagram
It shows the flow of goods and services, factors of production and monetary payments between households and firms
Households are both suppliers and buyers
Firms are also both suppliers and buyers
Factors or production are land, labor an capital
Factors of payments are rent for capital, wages for labor and interest for capital
Monetary payments are price paid and received for the goods and services exchanged
Second Model
The Production Possibility Frontie
It’s a graph which shows the combinations of output the economy can possibly produce given the available factors of production and the available technology
Points inside the PPF are although attainable but inefficient
Points on the PPF are both attainable and efficient including intercept points
Points outside of PPF are not possible to reach
Producers face trade off when they move from one point to another on the same PPF
A shift in the PPF to right is Economic Growth
Positive vs. Normative Statements
Positive Statements
Are descriptive statements that explain the world as it is. These are facts supported by evidence
When economists makes such statements they are called as scientist
Negative Statements
Are prescriptive statements that provides solutions or suggestion for a problem
When economists makes such statements they are called as policy advisers
Chapter 3
Interdependence and Gains from Trade
People and countries can rarely be completely self sufficient
Interdependence arises when people depend on each other for various goods and services
Gains arises when people specializes in the production of those goods in which they are expert and then exchange with others
This can allow everyone to gain from trade
Important Terms
Opportunity Cost: Whatever must be given up to get something else
Comparative Advantage: The ability to produce a good at a lower opportunity cost than another produce
Absolute advantage: It’ the ability to produce a good using fewer inputs than another produce
Formula When Input Information is Given
Absolute Advantage: When input information is given, just look for the lower number.
Comparative Advantage: First find out the opportunity cost by using the formula below:
Opportunity Cost for Product A
Calculate Opportunity Cost for Both Countries for product A and compare. Whoever has lower opportunity cost has the comparative advantage.
Formula When Output Information is Given (Including Graph Questions)
Absolute Advantage: When output information is given, just look for the higher number.
Comparative Advantage: First find out the opportunity cost by using the formula below:
Opportunity Cost for Product A
Calculate Opportunity Cost for Both Countries for product A and compare. Whoever has lower opportunity cost has the comparative advantage.
Gains From Trade
Calculate consumption before trade
Calculate consumption after trade
Formula for consumption after trade = Production after trade + imports – exports
Gains from trade = Consumption after trade – consumption before trade
Notes:
If positive then there is gain, if negative there is a loss. If zero then no gain, no loss.
On a PPF the consumption points after the trade may reach outside the PPF when there is gain from trade
Production points will still be on the PPF even after trade
Chapter 4
The Market Forces of Demand and Supply
Market
A group of buyers and sellers of a particular good or service. A market can be organized or less organized.
Forms of Markets
Perfectly Competitive Market
Imperfect Competition (monopoly, monopolistic competition, oligopoly)
Characteristics of a Perfectly Competitive Market
There are a large number of buyers and sellers
The price of the product is given therefore, here buyers and sellers are called as “price takers”
No single buyer or seller can influence the price of product
The goods sold are homogeneous (identical)
Close examples: Stock exchange market, foreign exchange market
Demand
The quantity demanded is the amount of a good that buyers are willing and able to purchase
It is inversely related to the price of the product
Law of Demand: It’s the claim that other things equal, the quantity demanded of a good falls when the price of the good rises and vice-versa
.
Demand Schedule: A table that shows the relationship between the price of a good and the quantity demanded
Demand Curve: A graph that shows the relationship between the price of a good and the quantity demanded
In a demand curve price is shown on Y axis and quantity demanded is shown on Y axis
It is mostly downward sloping from left to right due to inverse or negative relationship
Market Demand versus Individual Demand
The market demand is the sum of all individual demands for a particular good or service
The demand curves are summed horizontally
Out of two demand curves, the one relatively steeper is individual demand curve (for one buyer)
The curve which is relatively flatter would be for the market demand due to larger quantities (all the buyers together)
Determinants of Demand
The Income of the consume
Normal goods
Inferior goods
Price of related goods
Substitutes
Complements
Expectations/Tastes/Fashion
Fluctuate depends on various conditions
Number of buyers
More buyers – high demand
Less buyers – less demand
.
Change in Quantity Demanded vs. Change in Demand
Change in Quantity Demanded (movement)
When the price of the product itself changes
Causes demand curve will move along the same (fixed) demand curve
When price increases it will be movement up
when price decreases it will be movement downward
Change in Demand (shifting)
When there is a change in determinants other than the price of the product itself such as income, price of related goods, expectations and number of buyers
Causes shifts in the demand curve towards the right or left
An increase in demand will result in shifting the demand curve to the right (or upward).
A decrease in demand will result in shifting the demand curve to left (or downward)
Supply
The amount of a good that sellers are willing and able to sell
It is positive related to the price of the product
A supply schedule shows the relationship between the price of a good and the quantity supplied
A supply curve is a graph of the relationship between the price of a good and the quantity supplied
A market supply is the summation of individual supplies
Determinants of Supply
Input Prices
High input price – lower supply of output
Low input price – high supply of output
Technology
Advanced technology – high supply
Obsolete technology – low supply
Expectations
Fluctuate depends on various conditions
Number of sellers
More suppliers – High supply
Less suppliers – Low supply
Change in Quantity Supplied vs. Change in Supply
Change in Quantity Supplied (movement)
When the price of the product itself changes
Causes the supply curve will move along the same (fixed)
When price increases then there is movement up
When price decreases then there is movement down
Change in Supply (shifting)
When there is a change in determinants other than the price of the product itself such as input prices, technology, expectations and number of sellers
Causes the supply curve to shift to the right or left
A increase in supply causes rightward shift also called as downward shift
A decrease in supply causes leftward shift also called as upward shift
Supply and Demand togethe
It helps in determining the price of the product
Equili
ium: A situation in which the market price has reached the level at which quantity supplied equals quantity demanded
It is the point where supply and demand curve intersect each othe
The quantity demanded at this point is called equili
ium quantity and
The price at this point is called as equili
ium price
Surplus
If the actual market price is higher than the equili
ium price then there will be surplus of good
In this situation the quantity supplied is greater than quantity demanded
The remedy for surplus is that the producers will lower the prices of product until the market reaches equili
ium
Shortage
If the actual price is lower that the equili
ium price than there will be shortage of good
In this situation the quantity demanded is more than quantity supplied
In order to overcome this situation the sellers will rise the price of the product until market reaches equili
ium
Changes in Equili
ium
No Change in
Supply Increase in
Supply Decrease in
Supply
No Change in Demand Price – No Change
Quantity – No Change Price – Decrease
Quantity- Increase
Price - Increase
Quantity - Decrease
Increase in
Demand Price – Increase
Quantity- Increase Price - Ambiguous
Quantity - Increase
Price – Increase
Quantity- Ambiguous
Decrease in Demand Price – Decrease
Quantity- Decrease
Price - Decrease
Quantity- Ambiguous
Price – Ambiguous
Quantity - Decrease
Chapter 10:
Measuring a National Income
The economy of income and expenditure
It can be measured by GDP (Gross Domestic Product)
GDP measures the total income of everyone in the economy
GDP measures total expenditure on an economy’s output of goods and services
For an economy as a whole total income must be equal to total expenditure.
The Measurement of Gross Domestic Product
Definition of GDP: It is the market value of all the final goods and services produced within a country in a given period of time.
Explanation of the GDP definition
GDP is the market value
“…………… of all…………………”
“………….final ……………………”
“…………Goods and Services……………..”
“…………….within a country……………….”
“………….in a given period of time…….”
Note:
The above definition focuses on GDP as total expenditure in the economy.
But every dollars that is spent is income for some other.
Thus, if we add up all such incomes, then we will get exactly the same answer.
Others measures of Income
Gross National Product (GNP): It is the total income earned by the nation’s permanent residents.
Net National Product (NNP): GNP - Depreciation
National Income: NNP – Indirect Taxes +