Unit 1 Basic Economic Problems

Our wants are UNLIMITED but resources are LIMITED……… So there is SCARCITY Hence we have to make CHOICES

3 major economic questions: What to produce How to produce Whom to produce

WHAT TO PRODUCE Food or Clothes Cars or hospitals ipods or Cosmetics or military strength Basic Economic Problem- 3 decisions

 techniques used.  least cost method of production  labour intensive or capital intensive Basic Economic Problem- 3 decisions HOW TO PRODUCE

Production: Creating goods and services Consumption: Using the goods and services to satisfy want

Labor

The Enterprise: - Organizes the 3 factors and production process - Takes the risk (Profit and Loss)

Opportunity Cost If I ask you, what will you choose??

DEMAND DEFINED What is Demand? Demand is the different quantities of goods that consumers are willing and able to buy at different prices. What is the Law of Demand? The law of demand states There is an INVERSE relationship between P and QD. 12

Income 2. Inferior Goods – As income increases, demand falls – As income falls, demand increases – Ex: instant noodles, used cars, used clothes, 1.Normal Goods – As income increases, demand increases – As income falls, demand falls – Ex: cars, jewelry, homes, TV’s The incomes of consumer change the demand, but how depends on the type of good. 13

Prices of Related Goods 2. Complements are two goods that are bought and used together. – If the price of one increase, the demand for the other will fall. (or vice versa) – Ex: If price of skis falls, demand for ski boots will... 1.Substitutes are goods used in place of one another. – If the price of one increases, the demand for the other will increase (or vice versa) – Ex: If price of Pepsi falls, demand for coke will… The demand curve for one good can be affected by a change in the price of ANOTHER related good. 14

What Causes a Shift in Demand? 5 Determinates (SHIFTERS) of Demand : 1.Market size 2.Expectations of future price 3.Related goods price 4.Income 5.Tastes and preferances Changes in PRICE don’t shift the curve. It only causes movement along the curve. 15

6 Determinants (SHIFTERS) of Supply 1.Prices/Availability of inputs (resources) 2.Number of Sellers 3.Technology 4.Government Action: Taxes & Subsidies 5.Expectations of Future Profit 6.Other – War, weather Changes in PRICE don’t shift the curve. It only causes movement along the curve. 16

Q o $ P Demand Schedule PQd $510 $420 $330 $250 $180 Supply Schedule PQs $550 $440 $330 $220 $110 Supply and Demand are put together to determine equilibrium price and equilibrium quantity Equilibrium Price = $3 (Qd=Qs) Equilibrium Quantity is 30 D S

Q o $ P Demand Schedule PQd $510 $420 $330 $250 $180 Supply Schedule PQs $550 $440 $330 $220 $110 Supply and Demand are put together to determine equilibrium price and equilibrium quantity D S What if the price increases to $4?

Q o $ P Demand Schedule PQd $510 $420 $330 $250 $180 Supply Schedule PQs $550 $440 $330 $220 $110 D S At $4, there is disequilibrium. The quantity demanded is less than quantity supplied. Surplus (Qd<Qs) How much is the surplus at $4? Answer: 20

Q o $ P Demand Schedule PQd $510 $420 $330 $250 $180 Supply Schedule PQs $550 $440 $330 $220 $110 D S How much is the surplus if the price is $5? Answer: 40 What if the price decreases to $2?

Q o $ P Demand Schedule PQd $510 $420 $330 $250 $180 Supply Schedule PQs $550 $440 $330 $220 $110 D S At $2, there is disequilibrium. The quantity demanded is greater than quantity supplied. Shortage (Qd>Qs) How much is the shortage at $2? Answer: 30

Q o $ P Demand Schedule PQd $510 $420 $330 $250 $180 Supply Schedule PQs $550 $440 $330 $220 $110 D S Answer: 70 How much is the shortage if the price is $1?

Q o $ P Demand Schedule PQd $510 $420 $330 $250 $180 Supply Schedule PQs $550 $440 $330 $220 $110 D S When there is a surplus, producers lower prices The FREE MARKET system automatically pushes the price toward equilibrium. When there is a shortage, producers raise prices

Where do you get the Market Demand? Q Frank PriceQ Demd $51 $42 $33 $25 $17 Yao MingOther Individuals PriceQ Demd $50 $41 $32 $23 $15 PriceQ Demd $59 $417 $325 $242 $168 PriceQ Demd $510 $420 $330 $250 $180 Market 3 P Q 2 P Q 25 P Q 30 P $3 DDDD

What you DO NOT CHOOSE is your Opportunity Cost Opportunity Cost is the 2’nd best option

Production Possibility Curve (PPC) Every decision/choice we make has an Opportunity Cost This idea of Opportunity Cost can be illustrated using a PPC

A Typical PPF …………. Unattainable Inefficient Opportunity cost of is increasing…

PPC is also tells you: What you can and cannot produce What is the cost of producing the other good

Bikes Computers A B C D E G Inefficient= Unemployment Impossible (given current resources) Efficient Production Possibilities How does the PPC graphically shows trade-offs, opportunity costs, and efficiency? 30

2 Bikes 2.The opportunity cost of moving from b to d is… 4.The opportunity cost of moving from f to c is… 3.The opportunity cost of moving from d to b is… 7 Bikes 4 Computer 0 Computers 5.What can you say about point G? Unattainable 1. The opportunity cost of moving from a to b is… Example: Opportunity Cost 31