1. Basic Concepts in Economics: Theory of Demand and Supply
Discussant :
Md. Alamgir
Assistant Professor, BIBM

2. Definition of economics
Economics, the Science of Scarcity
The science of how individuals and societies deal with the fact that wants are greater than the limited resources available to satisfy those wants.
The study of how individuals and societies use limited resources to satisfy unlimited wants.

3. Fundamental economic problem
Scarcity.
The condition in which our wants are greater than the limited resources available to satisfy those wants.
Individuals and societies must choose among available alternatives.

4. Opportunity Costs
The most highly valued opportunity or alternative forfeited when a choice is made.
Economists believe that a change in opportunity cost can change a person’s behavior.
The higher the opportunity cost of doing something, the less likely it will be done.

5. Marginal Benefits Is additional benefits.
The benefits connected to consuming an additional unit of a good or undertaking one more unit of an activity.

6. Marginal Costs Is additional costs.
The costs connected to consuming an additional unit of a good or undertaking one more unit of an activity.

7. Building A Definition of Economics ~ Goods and Bads ~
Good - Anything from which individuals receive utility or satisfaction.
Utility - The satisfaction one receives from a good.
Bad - Anything from which individuals receive disutility or dissatisfaction.
Disutility - The dissatisfaction one receives from a bad.

8. Economic goods, free goods, and economic bads
economic good (scarce good) - the quantity demanded exceeds the quantity supplied at a zero price.
free good - the quantity supplied exceeds the quantity demanded at a zero price.
economic bad - people are willing to pay to avoid the item

9. Positive vs. Normative Economics
Positive - The study of “what is” in economic matters.
Cause Effect
Normative - The study of “what should be” in economic matters
Judgment and Opinion
Examples?

10. Microeconomics
Microeconomics deals with human behavior and choices as they relate to relatively small units—an individual, a business firm, an industry, a single market.

11. Macroeconomics
Macroeconomics deals with human behavior and choices as they relate to highly aggregate markets (e.g., the goods and services market) or the entire economy.

12. Barter vs. monetary economy
Barter – goods are traded directly for other goods
Problems:
requires double coincidence of wants
high information costs
Monetary economy has lower transaction and information costs

13. Relative and nominal prices
Relative price = price of a good in terms of another good
Nominal price = price expressed in terms of the monetary unit
Relative price is a more direct measure of opportunity cost

14. Markets
In a market economy, the price of a good is determined by the interaction of demand and supply

15. Demand
The willingness and ability of buyers to purchase different quantities of a good at different prices during a specific time period.
A relationship between price and quantity demanded in a given time period, ceteris paribus.
Demand Schedule:The numerical tabulation of the quantity demanded of a good at different prices.
A demand schedule is the numerical representation of the law of demand.

16. Downward Slopping Demand Curve
The graphical representation of the demand schedule and law of demand.

17. Demand schedule

18. Demand - Schedule and Graph

19. Law of demand
An inverse relationship exists between the price of a good and the quantity demanded in a given time period, ceteris paribus.

20. Law of Demand Quantity Price
As the price of a good rises, the quantity demanded of the good falls, and as the price of a good falls, the quantity demanded of the good rises,
ceteris paribus.
Quantity
Price

21. Ceteris Paribus A Latin term meaning “all other things
constant” or “nothing else changes.”
Ceteris paribus is an assumption used to
examine the effect of one influence on an outcome while holding all other influences constant.

22. Change in quantity demanded vs. change in demand
Change in quantity demanded Change in demand

23. Market demand curve
Market demand is the horizontal summation of individual consumer demand curves

24. Determinants of demand
tastes and preferences
prices of related goods and services
income
number of consumers
expectations of future prices and income

25. Tastes and preferences
Effect of fads:

26. Prices of related goods
substitute goods – an increase in the price of one results in an increase in the demand for the other.
complementary goods – an increase in the price of one results in a decrease in the demand for the other.

27. Change in the price of a substitute good
Price of coffee rises:

28. Change in the price of a complementary good
Price of DVDs rises:

29. Income and demand: normal goods
A good is a normal good if an increase in income results in an increase in the demand for the good.

30. Income and demand: inferior goods
A good is an inferior good if an increase in income results in a reduction in the demand for the good.

31. Demand and the # of buyers
An increase in the number of buyers results in an increase in demand.

32. Expectations
A higher expected future price will increase current demand.
A lower expected future price will decrease current demand.
A higher expected future income will increase the demand for all normal goods.
A lower expected future income will reduce the demand for all normal goods.

33. International effects
exchange rate – the rate at which one currency is exchanged for another.
currency appreciation – an increase in the value of a currency relative to other currencies.
currency depreciation – a decrease in the value of a currency relative to other currencies.

34. International effects (continued)
Domestic currency appreciation causes domestically produced goods and services to become more expensive in foreign countries.
An increase in the exchange value of the U.S. dollar results in a reduction in the demand for U.S. goods and services.
The demand for U.S. goods and services will rise if the U.S. dollar depreciates.

35. Factors Causing a Shift in the Demand Curve
Income
Preferences
Prices of substitute goods
Prices of complementary goods
Number of buyers
Expectations of future prices

36. Supply
The relationship that exists between the price of a good and the quantity supplied in a given time period, ceteris paribus.
The willingness and ability of sellers to produce and offer to sell different quantities of a good at different prices during a specific time period.

37. Law of Supply Quantity Price
As the price of a good rises, the quantity supplied of the good rises, and as the price of a good falls, the quantity supplied of the good falls, ceteris paribus.
Quantity
Price

38. Supply Curve The graphical representation of the law of
supply, which states that price and quantity
supplied are directly related, ceteris paribus.

39. Supply Schedule
The numerical tabulation of the quantity supplied of a good at different prices.
A supply schedule is the numerical representation of the law of supply.

40. Supply schedule

41. Change in Quantity Supplied
A change in quantity supplied refers to a movement along a supply curve.
The only factor that can directly cause a change in the quantity supplied of a good is a change in the price of the good, or own price.

42. Law of supply
A direct relationship exists between the price of a good and the quantity supplied in a given time period, ceteris paribus.

43. Reason for law of supply
The law of supply is the result of the law of increasing cost.
As the quantity of a good produced rises, the marginal opportunity cost rises.
Sellers will only produce and sell an additional unit of a good if the price rises above the marginal opportunity cost of producing the additional unit.

44. Change in supply vs. change in quantity supplied
Change in supply Change in quantity supplied

45. Individual firm and market supply curves
The market supply curve is the horizontal summation of the supply curves of individual firms. (This is equivalent to the relationship between individual and market demand curves.)

46. Determinants of supply
the price of resources,
technology and productivity,
the expectations of producers,
the number of producers, and
the prices of related goods and services
note that this involves a relationship in production, not in consumption

47. Price of resources
As the price of a resource rises, profitability declines, leading to a reduction in the quantity supplied at any price.

48. Technological improvements
Technological improvements (and any changes that raise the productivity of labor) lower production costs and increase profitability.

49. Expectations and supply
An increase in the expected future price of a good or service results in a reduction in current supply.

50. Increase in # of sellers

51. Prices of other goods Firms produce and sell more than one commodity.
Firms respond to the relative profitability of the different items that they sell.
The supply decision for a particular good is affected not only by the good’s own price but also by the prices of other goods and services the firm may produce.

52. International effects
Firms import raw materials (and often the final product) from foreign countries. The cost of these imports varies with the exchange rate.
When the exchange value of a dollar rises, the domestic price of imported inputs will fall and the domestic supply of the final commodity will increase.
A decline in the exchange value of the dollar raises the price of imported inputs and reduce the supply of domestic products that rely on these inputs.

53. Factors that Cause the Supply Curve to Shift
Prices of relevant resources
Technology
Number of sellers
Expectation of future prices
Taxes and subsidies
Government restrictions

54. Market equilibrium

55. Surplus and Shortage
Surplus (Excess Supply) - A condition in which quantity supplied is greater than quantity demanded.
Surpluses occur only at prices above equilibrium price.
Shortage (Excess Demand) - A condition in which quantity demanded is greater than quantity supplied.
Shortages occur only at prices below equilibrium price.

56. Move to Market Equilibrium

57. Market Demand and Supply

58. Moving to Market Equilibrium

59. Demand and Supply as Equations
Let’s now look at demand and supply as equations. Here is a demand equation: Qd = 1,500 − 32P
To see what this equation says, we let price (P ) in the equation equal $10 and then solve for quantity demanded Qd. We get Qd = 1,180.
Qd = 1, (10) = 1,180
So this equation says that if price is $10, it follows that quantity demanded is 1,180 units.
We could find other quantities demanded by plugging in different dollar amounts for price (P).

60. Demand and Supply as Equations (Cont.)
Now here is a supply equation: QS = 1, P
To find what quantity supplied (QS) equals at a particular price, we let $5 equal price (P ) and solve for quantity supplied. We get 1,415.
QS = 1, (5) = 1,415
Now suppose we want to find equilibrium price and quantity given our demand and supply equations. How would we do it?

61. Demand and Supply as Equations (Cont.)
First, we know that in equilibrium the quantity demanded (Qd ) of a good is equal to the quantity supplied (Qs ), so let’s set the two equations equal to each other this way:
1, P = 1, P
Now we can solve for P. We add 32P to both sides of the equal sign and subtract 1,200 from both sides. We are left with: 75P = 300 ; It follows then that P = 300/75 or $4.00.

62. Demand and Supply as Equations (Cont.)
Once we know equilibrium price is $4.00, we can place this value in either the demand or supply equation to find the equilibrium quantity. Let’s place it in the demand equation: Qd = 1, (4.00) = 1,372
Just to make sure that 1,372 is also the quantity supplied, we put the equilibrium price of $4.00 into the supply equation: QS = 1, (4.00) = 1,372
In summary, given our demand and supply equations, equilibrium price is $4.00 and equilibrium quantity is 1,372.

63. Consumer Surplus CS = Maximum buying price - Price paid
CS = the difference between the maximum price a buyer is willing and able to pay for a good or service and the price actually paid.

64. Consumer Surplus

65. Producer Surplus PS = Price received - Minimum Selling Price
PS = the difference between the price sellers receive for a good and the minimum or lowest price for which they would have sold the good.

66. Consumer and Producer Surplus

67. Total Surplus (TS)
TS = CS + PS
Total Surplus (TS) is the sum of consumers’ surplus and producers’ surplus.

68. Total Surplus
Equilibrium

69. Utility
Utility = level of happiness or satisfaction associated with alternative choices
utility maximization

70. Total and marginal utility
total utility - the level of happiness derived from consuming the good
marginal utility - the additional utility that is received when an additional unit of a good is consumed

71. Marginal utility # of slices of pizza total utility marginal utility - 70 40 20 10 5 -5

72. Law of diminishing MU
law of diminishing marginal utility - marginal utility declines as more of a particular good is consumed in a given time period, ceteris paribus
even though marginal utility declines, total utility still increases as long as marginal utility is positive. Total utility will decline only if marginal utility is negative

73. Demand rises

74. Demand falls

75. Supply rises

76. Supply falls