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Economics as a 



It is a systematic study that focuses in the activities of man in relation to his environment. It
studies the society͛s allocation of scarce resources to meet unlimited needs and wants. Scarcity is a
general characteristic of resources, basically due to a resource͛s alternative uses.

Economics as the 

 



From the households͛ choice to purchase goods to the firms͛ choice of production, everything in
our world now is a result of the many decisions individuals made in the past. Economics
studies these choices and how and why these choices are made.

The concept of Opportunity Cost

In economics, the 

 of making a certain choice includes the value of what we give up by
not choosing the alternative choice. For example, the opportunity cost of studying in college is the
time you could have used to do other things or the money you could have earned if you decided to
work as a high school graduate.

Ceteris Paribus
Translated to English, this means 
 This concept allows one variable to change as
other variables are held constant.

Three basic questions in economics:

 Ôhat to produce?
 ow is it produced?
 For whom is it produced?

Microeconomics
The branch of economics that examines the behaviour of individual decision-making units, e.g.
the household and the firms.

Macroeconomics
The branch of economics that deals with the behaviour of aggregates (income, employment,
output etc.) on a national level.

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c

  

  
 
 
 

In a market economy, individual consumers make plans of consumption and individual firms make plans
of production based on the changes in market prices.

 

Ñ The Law of Demand

 It shows the negative relationship between 
 and 
   As price of a
commodity increases, demand for it decreases and vice-versa.

 
  

  
 

Ñ A demand schedule is a table showing the quantities of a good that a consumer would buy at all
different prices. Below is an example of a demand schedule.

Table 1.1 £


  

Price Quantity Demanded
0 20
1 15
2 10
3 5
4 0

Ñ In mathematics, price & quantity demanded have a functional relationship. (In a demand
function, price is called the independent variable and quantity demanded the dependent
variable). A 

 shows the above relationship in a graph.

Figure 1.1 £

  



4.00

3.00

2.00

1.00

0
5 10 15 20 

Ñ Demand curves are downward-sloping due to the negative relationship of price and demand,
thus the Law of Demand applies.



Ñ Factors affecting a change in demand: A Shift of Demand Curve

Ñ Prices of Related Goods

Ôhen the price of a good (X) rises, it does not only affect its Qd, but also the Qd of another
related good (Y).
If a rise in price of good X leads to a in demand of good Y, these 2 goods are called
 substitutes in economics. (There involves a movement along the demand curve of X and
a shift of the demand curve of Y.)
If a rise in price of good X leads to a fall in demand of good Y, these 2 goods are called
complements or complementary goods. They are in joint demand.

Ñ Income
A rise in income leads to a higher purchasing power or ability to buy of the consumers.
( If nominal income and prices increase by the same percentage, the real income is unchanged.)
If a rise in income leads to a rise in demand of a good by a consumer, the good is called a
normal good or superior good.
If a rise in income leads to a fall in demand of a good, the good is called an inferior
good. ͞Inferior͟ does not refer to the quality of the good.




3

3! "

   
Normal Increases Increases
Decreases Decreases
Inferior Increases Decreases
 Decreases Increases

3 

3!  
#   #
Substitute Increases Increases
Decreases Decreases
 Complement Increases Decreases
 Decreases Increases


Movement along a demand curve:

Changes in price of a commodity Change in 


Shift of a demand curve

Changes in income, tastes & preferences, prices of   goods Change in  

Ñ The Law of Supply

It shows the positive relationship between 
 and 
 
. An increase in market
price would increase quantity supplied, and vice-versa.

Ñ A supply schedule is a table showing the quantities of a good that a firm or producer would
produce (sell) at all different prices within a time period, ceteris paribus.
 Table 2.1 


 


Price Quantity Supplied

2 0
4 1
6 2
8 3
10 4

Ñ A supply curve shows the relationship of price and quantity supplied in graph, in a similar
manner with the demand curve.

Figure 2.1 

  


   
   10

0 1 2 3 4

Ñ Movement along a supply curve

Ôhenever the market price changes, a firm or supplier will change its quantity supplied
accordingly.

Change in price of a good Change in 




Ñ Shift of a supply curve

Change in costs, input prices, technology,
weather, or prices if related goods Change in 


 $c%  

Ñ c

 is achieved when Quantity Demanded = Quantity Supplied. (Qd = Qs)

Ñ   c
is a condition wherein Qd > Qs at the current price.
Ñ 

 c

a condition wherein Qs > Qd at the current price.




Figure 3.1       Figure 3.2 



      
       
3.5
3    
2.5 
2

20 25 40   10 30 35 

Ñ (Fig. 3.1) The equilibrium point is when P = 3. Ôhen P= 2, a   
of 20 units is present.
Ñ (Fig. 3.2) The equilibrium point is when P = 2.5. Ôhen P=3.5, a 

 

 of 25 units is present.

# c



c




Demand function: Qd = 100 ʹ 2P Supply Function: Qs = 20 + 2P


   
100 ʹ 2P = 20 + 2P 20 + 2(20) = 60
= 20 100 ʹ 2(20) = 60


  is based on utility

&is the satisfaction a product yields.
 #&is the additional utility gained from additional consumption.

Ñ Law of Diminishing Marginal Utility
As the consumer increases consumption, overall utility increases while marginal or
additional utility obtained from every consumption decreases.

Ñ Indifference Curves
A set of points that shows 
  

  of commodities that
gives the consumer the  
 

Fig. 4.1 


  !

   Fig. 4.2 
 



Chips Good 1
CA       
A D

CB B B
C
E U1
CC C U2

JA JB JC Juice Good 2
Ñ (Fig. 4.1) In this indifference curves, the combinations A(CA amount and JA), B and C will give the same level of total
utility. The curve has a   implying that in order for the individual to have the same total utility, he has to
reduce consumption of chips to increase consumption of juice. The curve is
 because of the  '#
 # . This means that the rate at which Chips is being replaced by Juice is 


Ñ (Fig. 4.2) U1 and U2 intersect at point B. Points A, B and C are indifferent along U1 while points D, B and C are
indifferent along U2. If B is indifferent to both U1 and U2, then applying the assumption of transitivity in
consumption, then A is indifferent to D and so on. This does not hold however because U2 has a higher level of Total
Utility. Therefore, indifference curves should not intersect.

Ñ The Budget Line

The various combinations of the amount of goods an individual can consume given his
budget and the price of commodities.

   c%   ( Ôhen the slope of the indifference curve and the budget line are
equal, then the marginal utility per amount of money derived from good1 is equal to the
marginal utility per amount of money derived from good2.

Ñ Substitution Effect & Income Effect

Table 3 Income & Substitution Effect

*This summarizes the effect of price increases and decreases for each type of good.

3!  
 c
 "
 c

Normal Increases - (buy less) - (buy less)
Decreases + (buy more) + (buy more)
Inferior Increases - (buy less) + (buy more)
Decreases + (buy more) - (buy less)

Ñ Consumer Surplus
The 

 derived by an individual when consuming a good or service. It is the
difference between the amounts he/she is    from the 

 amount he/she paid
for the good or service.

Fig. 4.3 




Ñ (Fig. 4.3) If market price is set at P1

Price
A and quantity demanded is at Q1,
there are still consumers willing to
but at   Q1 and pay a  
P1 B 
 than P1. These consumers
therefore gain a consumer surplus
equal to triangle AP1B when they
buy at price P1 and get quantity Q1 .

D
Q1 Quantity
 Ñ Price elasticity of demand
- Responsiveness of demand for a good due to a change in its price.

"
 )  *Demand that responds slightly to a change in price.
* Absolute value < 1
* Producers will benefit from an increase in price because it
will increase revenue, as the % decline in demand is 
  the increase in price.

 
"
 ) *Qd does not respond at all to a change in price.

c
 ) - % change in Qd > % change in price
* Absolute value is > 1
* Producers will benefit from a decrease in price because it
will increase demand and revenue.

 
c
 ) - Qd drops to zero at an increase in the change in price.

Ñ Cross elasticity of demand

- Responsiveness of demand for a good due to changes in the price of other goods.

Ôhen cross elasticity is:

*

  (e.g. an increase in the price of beef will increase the
demand for pork.)

#*
 (e.g. price increase in sugar would decrease the demand
for coffee.)

Ñ Income elasticity of demand

- The change in quantity demanded brought due to a percentage change in the income of the
consumer.

Ôhen income elasticity is:

*   
   
  

 #*   

Ñ The Production Function

This shows the relationship the quantities of inputs and the maximum quantities of outputs
produced. Below illustrates the concept in a table.
 
Table 4.1 TP, AP and MP in production of a good

Machine (Capital) Labor Total Product Average Product Marginal Product

]   Π
1 1 15 15 15
1 2 40 20 25
1 3 75 25 35
1 4 90 22.5 15
1 5 85 17 5
1 6 85 14.17 0
1 7 77 11 -8

+") Machine K  # 

,Total Product / Variable Input
- ") Labor L  # 
,TP2 ʹ TP1 / L2 ʹ L1


# 
) K is underutilized so MP is increasing up to the 3rd labourer being added.
# 
) K is fully utilized so MP is decreasing (  

"
until it reaches 0.
# 
) K is over-utilized so MP is negative meaning additional labourers
decrease production.

Ñ Costs of Production

Table 4.2 Costs and Average Costs exhibit

Total Product Total Fixed Total Variable Total Cost Average Fixed Average Average Total
 Cost Cost  Cost Variable Cost Cost
    Œ Œ Œ
0 100 0 100 - - -
20 100 50 150 5.00 2.50 7.50
30 100 75 175 3.33 2.43 5.83
40 100 115 215 2.50 2.88 5.38
50 100 170 270 2.00 3.40 5.40
60 100 210 310 1.67 3.50 5.17
70 100 240 340 1.43 3.43 4.86

3 ,TFC + TVC - ,TVC/TP

 ,TFC/TP 3 ,TC/TP

Ñ Isoquants
A curve showing different combinations of  
 that will give the   of
production.

 #3
'
)Rate at which capital is being substituted for labor.

Ñ Isocosts
A locus of points showing combinations of variable inputs that will result in the same total cost
for the firm.
  
 
)

Fig. 5 c
 

 

 Capital ] 


  A


u
]  E

      
      
    B  
   
   èu    Labor è

Ñ (Fig. 5) At point E, the isoquant line Q1 is  to the isocost line. This is the condition for efficient production. It
means that the marginal productivity of capital per amount spent and marginal productivity of labor per amount
spent will give the same marginal productivity. The firm should therefore produce at Ku and Lu. Production at
isoquant Q2 will not be efficient because at point A nor at point B where it meets the isocost line. 





 $ 
 

Ñ Perfectly competitive market
 *No single firm has # . Firms are 
# 
- Many buyers and sellers.
- omogenous products are being sold in the market.
- There is a free entry/exit in the market.

 + .is attained when $

 
In a perfectly competitive market, it is attained when MR=Price=MC

The 

of a perfectly competitive firm is perfectly elastic.

The 


 in a perfectly competitive market is its MC curve from the point where it is
 equal to the AVC curve. The firm should not produce below this point.

Ñ Monopoly
*Single producer of a product or service in the market.
* Product sold is differentiated/unique.
* Barriers to entry in the market are present.


 The # 

 is the AR curve, and since there is only one producer, it is also the
%

 

 + . in a monopoly is when MR=MC.
The monopolist will produce where MR=MC. There is an incentive to gain profit if it produces at
MC<MR while losses will be incurred if it produces at MC>MR.


 #  is a firm that gives the same output or service at different price
levels, by dividing its market to maximize profit.
Consumers with an 
 

 will be charged a higher price while those with an



 will be charged a lower price.

Ñ Oligopoly
- Price and output of one firm is based on the actions of competitors in the market.
- Few sellers present in the market.


   /$   

Fig. 6.1 #$
 


      Fig. 6.2 ]#£


Qty. 

B
XA1 D P1 C

XA2 E J
E
XAC

RFA

RFB D
XB1 XB2 XBC Qty. Q1 

MR
Ñ (Fig. 6.1) If firm A produces at quantity XA1 firm B reacts to this and produces at XB1 to maximize its profit based on its
reaction function. In turn, firm A adjusts to production level XA2, and firm B produces at XB2. The intersection of RFA and
RFB is the equilibrium amount to be supplied by each firm in the market, XAE and XBE.

Ñ (Fig. 6.2) The kinked demand curve ‰ £ is broken at point  At this point, market price is at P1. If prices are set above
P1, the portion of the demand curve is more elastic, thus if one firm increases price others will not follow, and that
firm will lose consumers. If one firm decreases price it is on the portion wherein the demand curve is more inelastic,
meaning that % increase in demand < % decrease in price.

Ñ Monopolistic Competition
- Numerous sellers present in the market.
- Products are differentiated through advertising, packaging, etc.
The most efficient production level cannot be achieved because of the firm͛s ability to influence
price through product differentiation. Price is set where it is higher than the MC of the firm. It
cannot operate on the lowest AC because its demand curve has an negative inclination.

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