Unit 1

Scope of Economics
Mechanism of Supply and Demand

Archana.H
M.Arch, 1st Sem
CSIIT, Hyd

Definition of Economics
Economics has various definitions, such as;

The art of handling scarce resources

The study of choice

How society chooses to allocate its scarce

resources among competing demands to best
satisfy human wants

Micro Vs. Macroeconomics

Microeconomics: is generally the study of
individuals and business decisions regarding
the allocation of resources, and prices of
goods
and
services.

Macroeconomics: looks at a higher level

(country and government decisions), studies
the behavior of the economy as a whole and
not just on specific companies, but entire
industries
and
economies.

The Economic Problem

The Economic problem is summed up in 4 points;
Unlimited Wants
Scarce Resources Land, Labour, Capital
Resource Use
Choices

Unlimited Wants
It simply means that people are never totally
satisfied with the quantity and variety of goods and
services they consume.
It means that people never get enough, that there's
always something else that they would want or
need.

SCARCE RESOURCES
It states that society has insufficient productive
resources to fulfill all human wants and needs.
Alternatively, scarcity implies that not all of society's
goals can be pursued at the same time;
tradeoffs are made of one good against others.

Resource Use
Since we established already that resources are
scarce, so the use of these scarce resources
becomes the most important aspect of all.
Proper and efficient management of these
scarce resources is the key to success and
prosperity.

CHOICES
Choices are inevitable because human wants and needs
are unlimited but the resources available to meet them
are finite.
Examples:

What is to be produced?
How is it to be produced?
For whom will it be produced?

The concept of efficiency

Economists define Efficiency as the
absence of Waste. An efficient
economy utilizes all of its available
resources and produces the
maximum amount of output that its
technology permits.

But why are resources wasted in

real life?
oFor many reasons, such as;

Unemployment: which is the most important

waste of all, waste of human resources.
Assigning inputs to the wrong task: Like using a
dry land to grow rice and a rainy land to grow
sesame!
Poor Management: Failure in managing the
decision making process leading to waste in
resources.

Opportunity cost
Opportunity cost is what a person sacrifices
when they choose an option over another,
the cost of an alternative that must be forgone in
order to pursue a certain action. Put another
way, the benefits you could have received by
taking
an
alternative
action.
oExample: The opportunity cost of going to
college is the money you would have earned if
you worked instead. On the one hand, you lose
four years of salary while getting your degree; on
the other hand, you hope to earn more during
your career, thanks to your education, to offset
the lost wages.

Opportunity COST
In all cases, a choice between two
options must be made. It would be
an easy decision if you knew the
end outcome; however, the risk that
you could achieve greater "benefits"
(be they monetary or otherwise) with
another option is the opportunity
cost.

What is market?
Literal meaning-Place where goods and services are
brought and sold
In economicsIt is used in abstract sense.
According to SAMUELSON & NORDHAUS
A market is a mechanism by which buyers & sellers
interact to determine the price & quantity of a good or service.
Sellers & buyers- individuals, firms, factories, dealers & agents

Features of market concept

A market need not be situated in a particular locality or
area
Buyers & sellers need not come into personal contact
with each other
Word market may refer to a commodity / service or to a
geographical area
Economists distinguish market on the basis of
Nature of goods & services (input market, output market)
No. of firms & degree of competition. (competitive mkt.,
monopolistic market)

What is market mechanism?

The market for a product works on certain market
principles i.e. the laws that govern the working of the
market system, also called market mechanism
Working of the market system is governed by certain
fundamental laws of market called Law of Demand
and Supply.
Clear understanding of this is required for chalking
out an appropriate market strategy.

Supply side of the market

Some important terms in this:Supply- It is the quantity of a commodity that its producers/
sellers offer for sale at a given price, per unit of time.
Market supply- Sum of suppliers of a commodity made by all
the individual firms or their supply agencies. Market supply of
product is governed by the law of supply.
Supply of a commodity depends on:1.Its price
2.Cost of production.

Law of supplySupply of a product

Increase in price

And vice versa all the other factors remaining constant.

Other things technology, price of related goods, weather
& climatic conditions in case of agricultural goods.

Supply schedule- A supply schedule is a tabular

presentation of the law of supply.
Supply curve- Graphical representation of supply
schedule.

Price

Quantity supplied per unit of time

Supply function- It is a mathematical statement which

states the relationship between the quantity supplied of a
commodity and its price.

Qx = 10Px
Qx = quantity supplied of commodity X
per unit of time
Px = Its Price

How determinants of supply

causes shift in supply curve?
1. Change in Input pricesInput prices

Use of inputs

As a result, Product Supply

Supply curve SS shifts to the right to SS
When input Price increases, product supply curve shifts to
SS

Supply Curve

Price

Quantity

2. Technological ProgressTechnological changes that -----reduce cost of production or

increase efficiency in production

Product Supply

3.Price of product substitutesFall in the price of

--------Supply of other
one of the product s
substitutes

4.Nature & Size of the industryDepend on whether an industry is monopolized or

competitive.
Under monopoly -------- Supply is fixed
If monopolized industry ------- Total supply
is made competitive

If size of an industry ------- Total supply

due to new firms
joining the industry
5. Government policyWhen govt. imposes

--------- Production tends to fall

restrictions on production

Supply
6.Non economic factors
Labor, strikes, lockouts, communal riots, epidemics, affect
supply

Market equilibriumequilibrium of demand & supply

Determination of price in a Free market
Free market is one in which the market forces of demand
& supply are free to take their own course & no outside
control on price, demand & supply
Market equilibrium Refers to a state of market in which
Quantity demanded
=
Quantity supplied
of a commodity
of
the commodity
Equality of demand and supply produces equilibrium Price
It is also called Market Clearing Price because market is
cleared in the sense that there is no unsold stock and no
unsupplied demand.

Determination of market price

In a free market, disequilibrium itself creates the condition
for equilibrium.
When there is excess supply, it forces downward
adjustment in the price & quantity supplied.
When there is excess of demand it forces upward
adjustment in the price & quantity demanded.
Process of downward & upward adjustment in price
determines till price reaches equilibrium and the quantities
supplied and demanded are in balance
This process is automatic.

Market mechanism: How

market brings balance?
Market mechanism: Process of interaction between the
market forces of demand & supply to determine
equilibrium price.
1) If
Supply

with

demand

Then it gives sellers an opportunity to raise its price & it

prepares buyers to accept & pay higher price. As result
price goes up.
So we conclude that :If Supply

with

demand ------Prices

2) If
Supply

with

demand

Excess supply forces the competing sellers to cut down

the price in order to clear their unsold stock.
Some firms find low price unprofitable & go out of the
market.
Some cut down their productivity, supply goes down
Thus we conclude that :If Supply

with

demand

------- Prices

Demand, Supply, and

Market Price

Price

Demand

Supply

Quantity

Surplus
The equilibrium condition is not fulfilled at any other point on the
demand and supply curves. Therefore, there would be either
excess supply or shortage.

Demand

Supply

Price

Surplus
E

Quantity

Shortage

Su
pp
ly

nd
ma
De

Price

The equilibrium condition is not fulfilled at any other point on the demand
and supply curves. Therefore, there would be either excess supply or
shortage.

Shortage

Quantity

Shift in Demand and Supply curves and

equilibrium
D

Shift in demand
curve and
equilibrium

D
M
P
Price

D
S

Quantity

S
P
M

Price
S

D
S
Q

Quantity

Shift in Supply
curve and
equilibrium

Simultaneous Shift in
Demand and
Supply curves
D
S1
D

S3
S3
E1

P1
P0

E2
E3

Price
D2
S

D1
S

S
Q1

Q2 Q3

Quantity Parallel

shift in Demand Supply

curve and its effect on equilibrium
price and output

Parallel shift in Demand Supply

curve and its effect on equilibrium
price and output

S1

S2

E2

P2

E1

P1
Price

D2
S

D1
S
Q1

Quantity

Q2