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Submitted By: Tambaoan, Angelica Rose D.
BSIT-IIB Drafting Technology
Submitted To: Mrs. Torralba, Bridgeta
Chapter I Economics: Its meaning and
importance
Introduction:
Enomics is the theories, principles, and models that deal with how the
market process works. It attempts to explain how wealth is created and
distributed in communities, how people allocate resources that are scarce
and have many alternative uses, and other such matters that arise in dealing
with human wants and their satisfaction.
Economics as science:
At its core, the field of economics tries to uncover basic universal facts.
Like many sciences, economics has a strong foundation in mathematics, and
it is developed by testing hypotheses. In many ways, economics can be
viewed as a field of applied psychology. Understanding how humans behave
in certain situations and respond to changes is essential for the field's
development.
Below are some of the most important factors considered when it comes to
economics:
Labor: the main contributors here are human beings. Labor may be in
three forms which are mainly unskilled, semiskilled and professional
labor.
History of Economics:
Evolution of Economics as a Discipline
The modern Economics, which we still study now, is the result of the efforts
of ancient or Pre classical (384BC-1776), classical (1776-1871) , Neoclassical
(1871-Today) and Islamic Economists.
Classical (1776-1871):
Neoclassical (1871-Today):
Islamic Economics:
The study of economic systems includes how these various agencies and
institutions are linked to one another, how information flows between them,
and the social relations within the system (including property rights and the
structure of management).
Demand:
If you demand something, then you
1. Want it,
2. Can afford it, and
3. Have made a definite plan to buy it.
The quantity demanded of a good or service is the amount that
consumers plan to buy during a particular time period, and at a particular
price.
The Law of Demand
The law of demand states:
Other things remaining the same, the higher the price of a good, the
smaller is the quantity demanded; and the lower the price of a good, the
larger is the quantity demanded.
The law of demand results from:
Substitution Effect: When the relative price (opportunity cost) of a
good or service rises, people seek substitutes for it, so the quantity
demanded of the good or service decreases.
A rise in the price, other things remaining the same, brings a decrease
in the quantity demanded and a movement up along the demand curve.
A fall in the price, other things remaining the same, brings an increase
in the quantity demanded and a movement down along the demand curve.
Willingness and Ability to Pay
A demand curve is also a
willingness-and-ability-to-pay curve.
The smaller the quantity available,
the higher is the price that someone is
willing to pay for another unit.
Willingness to pay measures
marginal benefit.
A Change in Demand
Six main factors that change demand are:
Prices of Related Goods-
substitute is a good that can be used in place of another good.
complement is a good that is used in conjunction with another
good.
When the price of substitute for an energy bar rises or when the
price of a complement of an energy bar falls, the demand for energy
bars increases.
Expected Future Prices
If the expected future price of a good rises, current demand for the
good increases and the demand curve shifts rightward.
Income
When income increases, consumers buy more of most goods and the
demand curve shifts rightward.
normal good is one for which demand increases as income
increases.
inferior good is a good for which demand decreases as income
increases.
Expected Future Income and Credit
When expected future income increases or when credit is easy to
obtain, the demand might increase now.
Population
The larger the population, the greater is the demand for all goods.
Preferences
People with the same income have different demands if they have
different preferences.
Supply:
If a firm supplies a good or service, then the firm
1. Has the resources and the technology to produce it,
2. Can profit from producing it, and
3. Has made a definite plan to produce and sell it.
Resources and technology determine what it is possible to produce.
Supply reflects a decision about which technologically feasible items to
produce.
The quantity supplied of a good or service is the amount that
producers plan to sell during a given time period at a particular price.
A Change in Supply
The six main factors that change supply of a good are:
"If I lower the price of a product, how much more will sell?"
"If I raise the price of one good, how will that affect sales of this other
good?"
"If the market price of a product goes down, how much will that affect
the amount that firms will be willing to supply to the market?"
An elastic variable (with elasticity value greater than 1) is one which
responds more than proportionally to changes in other variables. In contrast,
an inelastic variable (with elasticity value less than 1) is one which changes
less than proportionally in response to changes in other variables. A variable
can have different values of its elasticity at different starting points: for
example, the quantity of a good supplied by producers might be elastic at
low prices but inelastic at higher prices, so that a rise from an initially low
price might bring on a more-than-proportionate increase in quantity supplied
while a rise from an initially high price might bring on a less-than-
proportionate rise in quantity supplied.
Elasticity can be quantified as the ratio of the percentage change in one
variable to the percentage change in another variable, when the latter
variable has a causal influence on the former. A more precise definition is
given in terms of differential calculus. It is a tool for measuring the
responsiveness of one variable to changes in another, causative variable.
Elasticity has the advantage of being a unitless ratio, independent of the
type of quantities being varied. Frequently used elasticities include price
elasticity of demand, price elasticity of supply, income elasticity of
demand, elasticity of substitution between factors of
production and elasticity of intertemporal substitution.
Elasticity is one of the most important concepts in neoclassical economic
theory. It is useful in understanding the incidence of indirect
taxation, marginal concepts as they relate to the theory of the firm,
and distribution of wealth and different types of goods as they relate to
the theory of consumer choice. Elasticity is also crucially important in any
discussion of welfare distribution, in particular consumer surplus, producer
surplus, or government surplus.
In empirical work an elasticity is the estimated coefficient in a linear
regression equation where both the dependent variable and the independent
variable are in natural logs. Elasticity is a popular tool among empiricists
because it is independent of units and thus simplifies data analysis.
Determinants:
Determinants of Demand
When price changes, quantity demanded will change. That is a
movement along the same demand curve. When factors other than price
changes, demand curve will shift. These are the determinants of the demand
curve.
1. Income: A rise in a persons income will lead to an increase in demand
(shift demand curve to the right), a fall will lead to a decrease in demand for
normal goods. Goods whose demand varies inversely with income are called
inferior goods (e.g. Hamburger Helper).
2. Consumer Preferences: Favorable change leads to an increase in demand,
unfavorable change lead to a decrease.
3. Number of Buyers: the more buyers lead to an increase in demand; fewer
buyers lead to decrease.
4. Price of related goods:
a. Substitute goods (those that can be used to replace each other): price of
substitute and demand for the other good are directly related.
Example: If the price of coffee rises, the demand for tea should increase.
b. Complement goods (those that can be used together): price of
complement and demand for the other good are inversely related.
Example: if the price of ice cream rises, the demand for ice-cream toppings
will decrease.
5. Expectation of future:
a. Future price: consumers current demand will increase if they expect
higher future prices; their demand will decrease if they expect lower future
prices.
b. Future income: consumers current demand will increase if they expect
higher future income; their demand will decrease if they expect lower future
income.
Determinants of Suppply
When price changes, quantity supplied will change. That is a
movement along the same supply curve. When factors other than price
changes, supply curve will shift. Here are some determinants of the supply
curve.
1. Production cost: Since most private companies goal is profit
maximization. Higher production cost will lower profit, thus hinder supply.
Factors affecting production cost are: input prices, wage rate, government
regulation and taxes, etc.
2. Technology: Technological improvements help reduce production cost and
increase profit, thus stimulate higher supply.
3. Number of sellers: More sellers in the market increase the market supply.
4. Expectation for future prices: If producers expect future price to be
higher, they will try to hold on to their inventories and offer the products to
the buyers in the future, thus they can capture the higher price.
Econimic Significance:
A finding in economics may be said to be of economic significance (or
substantive significance) if it shows a theory to be useful or not useful, or if
has implications for scientific interpretation or policy practice (McCloskey and
Ziliak, 1996).
Elasticity of Supply:
Price elasticity of supply
The price elasticity of supply measures how the amount of a good that
a supplier wishes to supply changes in response to a change in price. In a
manner analogous to the price elasticity of demand, it captures the extent of
horizontal movement along the supply curve relative to the extent of vertical
movement. If the price elasticity of supply is zero the supply of a good
supplied is "totally inelastic" and the quantity supplied is fixed.
Elasticities of scale
Elasticity of scale or output elasticity measures the percentage change
in output induced by a collective percent change in the usages of all
inputs. A production function or process is said to exhibit constant returns to
scale if a percentage change in inputs results in an equal percentage in
outputs (an elasticity equal to 1). It exhibits increasing returns to scale if a
percentage change in inputs results in greater percentage change in output
(an elasticity greater than 1). The definition of decreasing returns to scale is
analogous.
Budget Line:
The Budget Line, also called as Budget Constraint shows all the
combinations of two commodities that a consumer can afford at given
market prices and within the particular income level.
We know that the higher the indifference curve, the higher is the
utility, and thus, utility maximizing consumer will strive to reach the highest
possible Indifference curve. But, he has two strong constraints: limited
income and given the market price of goods and services. The income in
hand is the main constraint (budgetary) that decides how high a consumer
can go on the indifference map. In a two commodity model, the budgetary
constraint can be expressed in the form of the budget equation:
Px . Qx + Py . Qy =M
Where,
Px and Py are the prices of commodity X and Y and Qx, and Qy is their
respective quantities.
M= consumers money income
The Budget equation states that the consumers expenditure on
commodity X and Y cannot exceed his money income (M). Thus, the
quantities of commodities X and Y that a consumer can buy from his income
(M) at given prices Px and Py can be calculated through the budget equation
given below:
The values of Qx
and Qy are plotted
on the X and Y
axis, and a line
with a negative
slope is drawn
connecting the
points so obtained.
This line is called
the budget line or price line.
The first factor of production is land, but this includes any natural resource
used to produce goods and services. This includes not just land, but anything
that comes from the land. Some common land or natural resources are
water, oil, copper, natural gas, coal, and forests. Land resources are the raw
materials in the production process. These resources can be renewable, such
as forests, or nonrenewable such as oil or natural gas. The income that
resource owners earn in return for land resources is called rent.
The second factor of production is labor. Labor is the effort that people
contribute to the production of goods and services. Labor resources include
the work done by the waiter who brings your food at a local restaurant as
well as the engineer who designed the bus that transports you to school. It
includes an artist's creation of a painting as well as the work of the pilot
flying the airplane overhead. If you have ever been paid for a job, you have
contributed labor resources to the production of goods or services. The
income earned by labor resources is called wages and is the largest source of
income for most people.
You will notice that I did not include money as a factor of production. You
might ask, isn't money a type of capital? Money is not capital as economists
define capital because it is not a productive resource. While money can be
used to buy capital, it is the capital good (things such as machinery and
tools) that is used to produce goods and services. When was the last time
you saw a carpenter pounding a nail with a five dollar bill or a warehouse
foreman lifting a pallet with a 20 dollar bill? Money merely facilitates trade,
but it is not in itself a productive resource.
Remember, goods and services are scarce because the factors of production
used to produce them are scarce. In case you have forgotten, scarcity is
described as limited quantities of resources to meet unlimited wants.
Consider a pair of denim blue jeans. The denim is made of cotton, grown on
the land. The land and water used to grow the cotton is limited and could
have been used to grow a variety of different crops. The workers who cut and
sewed the denim in the factory are limited labor resources who could have
been producing other goods or services in the economy. The machines and
the factory used to produce the jeans are limited capital resources that could
have been used to produce other goods. This scarcity of resources means
that producing some goods and services leaves other goods and services
unproduced.
It's time to test your knowledge with a little game I like to call, Name That
Resource. I will say the name of an item and you will identify it as one of the
four possible resources that form the factors of production: land, labor,
capital, or entrepreneurship.
Coal... land
Forklift... capital
Factory... capital
Oil... land
Production of function:
In economics, a production function relates physical output of a
production process to physical inputs or factors of production. The production
function is one of the key concepts of mainstream neoclassical theories, used
to define marginal product and to distinguish allocative efficiency, the
defining focus of economics.The primary purpose of the production function
is to address allocative efficiency in the use of factor inputs in production and
the resulting distribution of income to those factors, while abstracting away
from the technological problems of achieving technical efficiency, as an
engineer or professional manager might understand it. Production function
denotes an efficient combination of inputs and outputs.
In macroeconomics, aggregate production functions are estimated to
create a framework in which to distinguish how much of economic growth to
attribute to changes in factor allocation (e.g. the accumulation of capital)
and how much to attribute to advancing technology. Some non-mainstream
economists, however, reject the very concept of an aggregate production
function
Land
Land not only consists of mere surface of land but also includes all the
natural sources such as oceans, mountains, forests etc. Marshall defines land
as " By land is meant materials and forces which nature gives freely for
man's aid, in land, water, in air, light and heat." Thus land is a significant
part of production which facilitates in the production of goods and services in
one way or the other.
Labour
Labour refers to the act of working for some monetary benefits against
physical and mental activity. It does not comprise of any leisure activity. It
includes the services of a factory worker, any professional workers such as
engineers, doctors, teachers, lawyer etc. If a person paints or sings in order
to please someone or himself without any target or for monetary benefits he
won't be called a labour. But if he intends to sell the painting or sing against
any monetary reward then it involves labour. Thus labour forms an essential
aspect of production.
Capital
Capital means all human-made materials such as tools, equipments,
infrastructure, machinery, seeds, plants, modes of transportation such as
rail, road and air etc. In general it encompasses all affluences eliminating
land as land is utilised for supplementary production of affluence. Now-a-
days, capital not only includes physical capital but also involves human
capital which is defined as "process of increasing knowledge, the skills and
capacities of all people of the country." Human capital is more vital than the
physical capital since without human's interference the materialistic capital
cannot be utilised effectively. Prof. Galbraith defines as "We now get the
larger part of our industrial growth not from more capital investment but
from investment in men and improvements brought about by improved
men."
Organisation
The prime aspects of production such as land, labour and capital are
correspondingly nature, man and material modes of production. Without
these factors it is unfeasible to produce and making use of these factors
effectively there has to some source. This source is nothing but the
organisation which hires them from their owners by paying rent, salary and
interest and makes a decision upon the amount of each required for
production. Organisation refers to the services of an entrepreneur who
controls, organises and manages the policy of a firm, innovates and
undertakes all risks.
Criticisms
o Several economists have criticisms for the above factors of production
economist Benham has objected to a broader meaning of land as a
factor of production. As per him, it is convenient to consider only land
as factor of production, rather than such elements as sunshine, climate
etc. which does not enter directly into costs. Likewise, it is incorrect to
group together the services of an untalented worker with that of
professionals. Yet again, there is tiny tip in syndicating mutually as
capital, as assorted as canals, diesel, seeds and machinery. It would
consequently, be more appropriate to chunk collectively all
standardized units, whether hectares of land, workers or capital goods
and to regard each group as an individual factor of production. This
method gives us a hefty integer of factors of production and each
group is regarded as a separate factor.
o Over and again, the distinction amidst land, labour and capital are not
apparent. To take land and capital, it is said that land is a gift of nature
whose supply cannot be amplified while capital is human made whose
supply is amendable. This is not correct for the reason that the supply
of land can also be greater than before by cleaning it, draining and
irrigating it and fertilising it by the pains of human and capital. The
supply of land does not consign to its area alone, but to its productivity.
o Moreover, we find that land, labour and capital frequently get mingled
into one another and it is tricky to specify the involvement of each
individually. For example, when land is vacant canals are dug and
fences are erected, the efficiency of land enhances. But all these
development on land are feasible by making capital investments and
through labour. In such a condition, it is feasible to stipulate the
involvement of land, labour and capital escalating efficiency. Likewise,
the sum of money spent on cultivating and exercising workers is
integrated under capital. So when such workers produce articles by
functioning machines in a factory, they put in their labour as well as
ability by using raw materials which are also the product of labour and
machines used on land. Thus it is hard to unravel the contribution of
land, labour and capital in such cases.
o Fixed factors are those whose costs do not vary with the variation in
output, such as machinery, tube well etc. Variable factors are those
whose quantities and costs vary with the variation in output. Larger
outputs entail larger quantities of labour, raw materials power etc. So
long as a firm covers the costs of production of the variable factors it
employs, it will persist to produce even if it fails to cover the costs of
production of the hired factors and sustains loss. But this is only
feasible in the short-run; in the long-run it must cover the costs of
production of both the fixed and variable factors. Thus the distinction
amidst fixed and variable factors is of much value for the theory of the
firm.
Cost of Production:
Production cost refers to the cost incurred by a business when
manufacturing a good or providing a service. Production costs include a
variety of expenses including, but not limited to, labor, raw materials,
consumable manufacturing supplies and general overhead. Additionally, any
taxes levied by the government or royalties owed by natural resource
extracting companies are also considered production costs.
Economic Cost:
Economic cost is the combination of gains and losses of any goods that
have a value attached to them by any one individual. Economic cost is used
mainly by economists as means to compare the prudence of one course of
action with that of another. The goods to be taken into consideration are e.g.
money, time and resources.
The comparison includes the gains and losses precluded by taking a
course of action, as those of the course taken itself. Economic cost differs
from accounting cost because it includes opportunity cost.
Aspects of economic costs:
Variable cost: Variable costs are the costs paid to the variable input.
Inputs include labour, capital, materials, power and land and buildings.
Variable inputs are inputs whose use vary with output. Conventionally
the variable input is assumed to be labor.
Total variable cost (TVC) total variable costs is the same as
variable costs.
Fixed cost (TFC) fixed costs are the costs of the fixed assets those
that do not vary with production.
Total fixed cost (TFC)
Average cost (AC) average cost are total costs divided by output. AC
= TFC/q + TVC/q
Cost curves
Economics of Scale:
In microeconomics, economies of scale are the cost advantages that
enterprises obtain due to size, output, or scale of operation, with cost per
unit of output generally decreasing with increasing scale as fixed costs are
spread out over more units of output.
Often operational efficiency is also greater with increasing scale,
leading to lower variable cost as well.
Economies of scale apply to a variety of organizational and business
situations and at various levels, such as a business or manufacturing unit,
plant or an entire enterprise. For example, a large manufacturing facility
would be expected to have a lower cost per unit of output than a smaller
facility, all other factors being equal, while a company with many facilities
should have a cost advantage over a competitor with fewer.
Some economies of scale, such as capital cost of manufacturing
facilities and friction loss of transportation and industrial equipment, have a
physical or engineering basis.
The economic concept dates back to Adam Smith and the idea of
obtaining larger production returns through the use of division of labor.
Diseconomies of scale are the opposite.
Economies of scale often have limits, such as passing the optimum
design point where costs per additional unit begin to increase. Common
limits include exceeding the nearby raw material supply, such as wood in the
lumber, pulp and paper industry. A common limit for low cost per unit weight
commodities is saturating the regional market, thus having to ship product
uneconomical distances. Other limits include using energy less efficiently or
having a higher defect rate.
Large producers are usually efficient at long runs of a product grade (a
commodity) and find it costly to switch grades frequently. They will therefore
avoid specialty grades even though they have higher margins. Often smaller
(usually older) manufacturing facilities remain viable by changing from
commodity grade production to specialty products.
Some of the economies of scale recognized in engineering have a
physical basis, such as the square-cube law, by which the surface of a vessel
increases by the square of the dimensions while the volume increases by the
cube. This law has a direct effect on the capital cost of such things as
buildings, factories, pipelines, ships and airplanes.
In structural engineering, the strength of beams increases with the
cube of the thickness.
Drag loss of vehicles like aircraft or ships generally increases less than
proportional with increasing cargo volume, although the physical details can
be quite complicated. Therefore, making them larger usually results in less
fuel consumption per ton of cargo at a given speed.
Heat losses from industrial processes vary per unit of volume for pipes,
tanks and other vessels in a relationship somewhat similar to the square-
cube law.
Figure of Maximation:
A business can produce as many goods as its labor, equipment and
other resources will allow, but running at full production isnt always the best
approach. The optimum level of output is the one that generates the highest
profit, which is called the profit-maximizing output. A companys profit
begins to diminish beyond this level. You can figure your business profit-
maximizing output level by determining the profit your business makes at
each level of output you can produce.
Determine the different levels of output your business can
produce in a certain time period, such as one day or one week. Write the
output levels in ascending order in the first column of a sheet of paper. For
example, assume your business can produce zero, one, two, three, four or
five hats daily. Write "0" through "5" in ascending order in the first column on
a sheet of paper.
Determine the total revenue your business would generate at
each output level. Write each revenue amount next to its corresponding
output level in the second column. In this example, assume that your selling
price per hat decreases as you make more hats. Assume you generate $0,
$50, $100, $150, $160 and $175 in total revenue if you make zero, one, two,
three, four and five hats, respectively. Write each amount in the second
column.
Determine the total economic costs you incur at each output
level, and write them in the third column. Economic costs include explicit
costs and opportunity costs. Explicit costs are those for which you actually
pay money, such as supplies. An opportunity cost is something you give up,
but for which you dont actually pay money. This might be a salary you forgo
by choosing to run your small business instead of working a job. In this
example, assume you incur $20, $30, $40, $52, $67 and $85 in total
economic costs when you make zero, one, two, three, four and five hats,
respectively. Write the costs in the third column.
Subtract each amount of total economic costs in the third
column from each corresponding amount of total revenue in the
second column to determine the total profit for each output level. Write each
amount of profit in the fourth column. Continuing with the example, subtract
$20 from $0 to get negative $20, or a $20 loss, at an output of zero. Subtract
$30 from $50 to get $20 in profit at an output of one. Calculate the
remaining profit levels to get $60, $98, $93 and $90 in profit when you make
two, three, four and five hats respectively. Write these amounts in the fourth
column.
Find the greatest amount of profit in the fourth column and
identify the corresponding output level in the first column to
determine your profit-maximizing output. Concluding the example, the
highest profit in the fourth column is $98, which corresponds to an output of
three in the first column. Therefore, your small businesss profit-maximizing
output would be three hats daily.