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Lecture notes

Fundamentals of Economics

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Basics of economics including visual examples. Demand and supply, Pigovian taxes, subsidies etc.

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  • September 22, 2022
  • 42
  • 2020/2021
  • Lecture notes
  • Dr shazaib butt
  • All classes
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Fundamentals of Economics
03/02/2021
Business Economics

What is Business?
The business of turning land, labour and capital into a product or service sold to customer – turning
input into output. Businesses can be classified through size, what products or services are produced,
and organisation’s ownership and its primary aim:
 Private sector business: Profit
 Public sector organisation: To maximise opportunities to access products and services like
roads, education, transport, and healthcare
 Third sector organisation: To meet the needs of its beneficiaries

What is Economics?
Economics is the study of how society manages its scarce resources; governments get involved and
most economies are a mix of private and public ownership. Businesses allocate scarce resources
among competing uses, considering a range of stakeholder wants and needs.

Decisions
The management of scarce resources is down to people’s individual and group decisions; people
want to get the most from scarce resources whether they are buyers, producers, or sellers. The
economy is the collective interaction between producers and consumers making and carrying out
those decisions. There are key decision-making principles:
1. Decision making involves trade-offs
Getting the most from scarce resources means facing different trade-offs such as: time management,
deciding whether to employ more people or more machines, whether to have more capital or more
consumer goods, and whether to have more goods or a cleaner environment.
2. Opportunity Cost
The opportunity cost is whatever is given up obtaining some item, measuring the value of what is
foregone - is the value of the best next alternative foregone when a choice is made.
3. Rational people and businesses think at the margin
Marginal changes describe small incremental adjustments, many decisions are made at the margins.
4. People and businesses respond to incentives
People compare the costs and benefits when making decisions, people as consumers, businesses as
suppliers, governments as policy makers.
5. Trade can make everyone better off
Trade between two economies can make each economy better off; countries benefit from the ability
to trade with one another. Trade allows countries to specialise in what they do best and enjoy a
greater variety of goods and services.
6. Markets are usually a good way to organise economic activity
Communist countries adopted central planning, however in a market economy, the decisions of a
central planner are replaced by the decisions of millions of firms and households.
7. Governments can sometimes improve market outcomes
Market failure is when the market on its own fails to produce an efficient allocation of resources.
Externalities are the uncompensated impact of a person or firm’s action on the well being of a third
party. Market power is when an economics agent can influence market prices.
8. An economy’s standard of living depends on its ability to produce goods and services
Economic growth is the increase in the amount of goods and services in an economy over a period.
Gross domestic product per head is one useful indicator of measuring living standards. Standard of
living measures welfare based on the amount of goods and services a person’s income can buy.
Productivity is directly related to living standards.

,9. Prices rise when the government prints too much money
Inflation measures the overall increase in prices. Printing money leads to price rises because the
value of money falls.
10. Society faces a short-run trade-off between inflation and unemployment
In the short-run there is a trade off between unemployment and inflation as shown in the Phillips
curve. Increasing the money supply and therefore inflation can lower unemployment in the short-
term (can last several years). Business cycle is the irregular and largely unpredictable fluctuations in
employment and output of goods and services.

10/02/2021
Supply and Demand

Market forces
- Supply and demand are the forces that make market economies work
- Supply and demand determine the quantity of each good produced and selling price
- Price is different from cost
Assumptions of the Supply Demand Model
1. Many buyers and sellers, 2. Homogenous goods, 3. Perfect information, 4. Freedom of entry/exit,
5. Buyers and sellers clearly defined, 6. Clearly defined and enforced property rights,
7. Zero transaction costs, 8. Rational behaviour

Types of Markets
- A competitive market offers homogenous goods
- Buyers and sellers unable to influence market prices
- Oligopoly: few sellers not always aggressively competing
- Imperfect: many sellers offering slightly different products
- Monopoly: one supplier or buyer

Relationship Between Price & Quantity Supplied
- Quantity supplied is the amount that sellers are willing and able to sell
- Law of supply: when price of a good rises, the quantity producers are willing to supply also
rises, and vice versa
- Supply schedule shows the relationship between price and the quantity supplied
- Supply curve is a graphical display of the supply schedule

Market Supply Versus Individual Supply
- Market supply is the sum of the supplies of all sellers; behaviour of one individual business
may be different from the whole industry
- Movement along the supply curve is caused by a change in price
- A shift in the supply curve is caused by a factor affecting supply other than change in price

Causes of Shifts in the Supply Curve
- Input Prices (cheaper input increase supply at each price
level)
- Technology
- Expectations
- Number of sellers
- Natural/external factors (bad weather reduces supply of crops etc.)


Relationship Between Price and Quantity Demanded

, - Quantity demanded is amount of goods that buyers can purchase at each price level
- Law of demand: when price of a good rises, quantity demanded of the good falls, vice versa
- Demand schedule shows the relationship between price of a good and quantity demanded
- Demand curve is a graphical display of the demand schedule

Market Demand Versus Individual Demand
- The market demand, which is the sum of all individual demands for a good/service
- A movement along the demand curve occurs when there is a price change
- Shift/movement in demand curve is caused by a factor other than price change

Causes of Shifts in Demand Curve
- Income (normal goods, inferior goods)
- Prices of related goods (substitutes, complements)
- Tastes and expectations
- Size and structure of the population

Demand Function
Qd = Qd (P, Ps, Pc, Y, T…)
Where, Qd is quantity demanded per period
P is price, Ps is price of substitutes, Pc is price of complements, Y is income, T is taste

Supply Function
Qs = Qs (P, Pf, Ta, Te, W…)
Where, Qs is quantity of supply per period
P, is price of product, Pf is price of factors of production, Ta is taxes, Te is technology, W is weather




Demand and Supply
- Equilibrium: price where quantity supplied equals quantity demanded
- Horizontal line provides equilibrium price, vertical line provides equilibrium quantity
- If market price was set below equilibrium price, there would be shortage
- If market price was set above equilibrium price, there would be surplus
- Law of supply and demand claims that price adjusts so that equilibrium point is reached

Analysing Changes in Equilibrium
1. Decide whether event shifts the supply, demand, or both
2. Decide in which direction the curve shifts
3. Use a supply & demand diagram to see how the shift changes equilibrium price and quantity




Understanding Movement and Shifts

, - Movement along either the demand or supply curve are caused by price changes
- Movement along supply curve is called change in quantity supplied
- Movement along demand curve is called change in quantity demanded
- Shift is referring to either a change in demand or change in supply

How Prices Allocate Resources
- Markets are dynamic and changing all the time
- Equilibrium point is continually changing
- Scarce resources have to be allocated among competing uses; therefore prices are the
signals that guide the allocation of resources




17/02/2021
Elasticity &
Its

Applications

Price Elasticity of
Supply
The price elasticity of supply measures how much quantity supplied responds to
changes in price. Inelastic means supply isn’t very responsive to changes in price.
Elastic means supply is responsive to changes in price.
Elasticity can take any value greater than or equal to
zero; closer to zero = more inelastic,
closer to infinity = more elastic.

Determinants of Price Elasticity of
Supply
1. The Time Period
Supply is usually more elastic in
the long run
In the short run, firms cannot easily
change productive capacity
2. Productive Capacity
Firms are more likely to operate at full capacity when there is economic growth

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