4. Elasticity of Demand and Supply, Price elasticity of Demand, Elasticity and Revenue, Price elasticity of supply.

Elasticity of Demand and Supply
o In order to turn supply and demand into truly useful tool, we need to know how much supply and demand response to changes in price
o That's why the concept of elasticity is applied. That is, How the consumer respond to their demands due to the changes in price can be measured through elasticity of demand and supply.

Price elasticity of Demand
o Goods vary enormously in their price elasticity or sensitivity to their price changes.
o When the price elasticity of a good is high, we say that the good has elastic demand, which means that its quantity demanded responds greatly to price changes. Substitute goods like luxurious item can be termed as elastic as due to their change in price changes the demand as a whole. Example: automobile.
o When the price elasticity of a good is low, we say that the good has inelastic demand, which means that its quantity demanded responds little to price changes. Example: food which is a necessity item for which demand tends to be inelastic.


o Economic factors that define the size of price elasticity for individual goods:
n Elasticities tend to be higher for
i. Luxuries goods
ii. Substitute products
iii. The length of time

Luxuries goods- For necessities like food, fuel and prescription drugs demand tend to be inelastic. Such items are the stuff of the life and cannot easily be foregone when the prices rise. By contrast, one can easily substitute other goods when luxurious item like Italian designer clothing rise in price.
Substitute products- Goods that have ready substitute products tend to have more elastic demand than those that have no substitutes. For example –if the prices of food items increase people hardly stop eating. So, food item is price-inelastic.
On the other hand, if mad–cow diseases drives up the price of British beef , people can turn to beef from other countries or to lamb or poultry for their meet needs. So, British beef shows a high price –elasticity.
The length of time-In the long run people adjust their behavior to the changes in higher prices of goods rather than in the short-run.
For example-If the price of gasoline suddenly increases the people do not sell their car or abandon their vacation. So, in the short-run the demand for gasoline may be very in-elastic. But in the long run the people can adjust their behavior to the higher price of gasoline.

Elasticity and Revenue

q Whether raising price will raise or lower the revenues can be analyzed through developing relationship between price and elasticity.
o Total revenue=Total revenue is equal to price and quantity( Or Price x quantity).
o Suppose, if consumers buy 5 units at $3 each , total revenue would be $15.



Price elasticity of supply
o Measures how much the quantity supplied of a good changes when its price changes.
o Price elasticity of supply: It is the percentage change in quantity supplied divided by the percentage change in price.
o We can calculate the coefficient of price elasticity numerically according to the following formula.
Price elasticity of supplied (ES) = (Percentage change in quantity supplied / Percentage change in price)
o When the price elasticity of a good is high, we say that the good has elastic supply, which means that its quantity supplied responds greatly to price changes.

o When the price elasticity of a good is low, we say that the good has inelastic supply, which means that its quantity supplied responds little to price changes.

3.Demand Schedule, Curve n Forces behind it,Market Dmnd, Shift Dmnd Curve, Supply schedule n Forces behind curve, Equilibrium of supply & dmnd, effect

The Demand Schedule

+A demand schedule shows the relationship between the quantity demanded and the price of a commodity, other things held constant. Such a demand schedule, depicted graphically by a demand curve, holds constant other things like family incomes, tastes, and the prices of other goods. Almost all commodities obey the law of downward-sloping demand, which holds that quantity demanded falls as a good's price rises. This law is represented by a downward-sloping demand curve.

+Many influences lie behind the demand schedule for the market as a whole: average family incomes, population, the prices of related goods, tastes, and special influences. When these influences change, the demand curve will shift.

The Supply Schedule.

+The supply schedule (or supply curve) gives the relationship between the quantity of a good that producers desire to sell - other things constant - and that good's price. Quantity supplied generally responds positively to price, so the supply curve is upward-sloping.

+ Elements other than the good's price affect its supply. The most important influence is the commodity's production cost, determined by the state of technology and by input prices. Other elements in supply include the prices of related goods, government policies, and special influences.

The Demand Curve
o The graphical representation of the demand schedule is the “demand curve”.
o In the demand curve , the quantity demanded is put on to the horizontal axis and the price (P) on the vertical axis.
o In the curve the price and the quantity are inversely related. That is, Q goes up when P goes down.
o The curve slopes downward, going from northeast to southwest. This important property is called “The law of down warding–slopping demand”.

Forces behind the Demand curve:
There are some factors that determines or influences the demand at a given price.
i. The average income of the consumers
ii. The size of the market
iii. The prices and the availability of then related goods
iv. Consumer’s tastes or preferences
v. Specials influences


Market Demand
o The fundamental building block for demand is individual preferences.
o Market demand represents the sum of all individual demands.
q Market demand curve can be found by adding together the quantities demanded by all individuals at each price in a given period of time.

q Market demand also follows the law of downward sloping demand. For example, lower prices attract new customers through the substitution effect. In addition, a price reduction will induce extra purchase of goods by existing consumers through both the income and the substitution effects. Conversely, a rise in the price of a good will cause some of the consumers to buy less.

Forces behind Demand curve/Reasons of shift of Demand curve:
o Average income of consumer increases(+)= increase in demand, buy more
o Size of market increases(+)=increase in demand, buy more
o Prices of related / substitutes increases (+) = increase in demand, buy more
o Tastes improves= if favorable change in tastes occurs, increase in demand, buy more
o Special influences = seasons, taxes, etc

Shift of Demand Curve
o When one of the other determinants changes, a whole new demand curve is constructed, that is the curve shifts.
o A shift in demand curve is referred to as change in demand curve.
o If a change in one of the other determinants causes demand to rise-say, income rises, the whole curve will shift to the right. At each price, more will be demanded than before.

The Supply schedule
o Supply: The amount of a particular economic good or service that a producer or group of producers will want to produce and supply at a given price over a given period of time.
o Supply schedule: The relationship between price and quantity supplied is called supply schedule.


Forces behind the supply curve:
o The fundamental point to grasps that producers supply commodities for profit and not for fun or charity. There are some major elements that forces the supply curve to determine.
i. Cost of production
ii. Prices of inputs
iii. Prices of related goods
iv. Technological advances
v. Government policies
vi. Special influences
i. Cost of production-
When production costs for a good are low relative to the market price, it is profitable for the producers to supply in a great deal.
When production cost are high relative to price ,firms produce little, switch to the production of other products and may simply go out of the business.
ii. Prices of inputs-
If the prices of the inputs such as- labor, energy or machinery has increased that will have an influence on the cost of producing the given level of output, thus increases their production cost and lowered their supply.
iii. Prices of related goods-
If the prices of one production substitute rises, the supply of another substitute will decrease. If there is more demand for one particular product, and its prices rises, the producers will switch more of making that product, and the supply of other product will fall.
iii. 4. Technological advances-
It consist of changes that lower the quantity of inputs needed to produce the same quantity of output. Such advances include everything from scientific breakthrough to better applicant existing technology.
iv. 5. Government policies-
Environmental and health considerations determine what technologies can be used while taxes and minimum-wage laws can significantly raise the input prices. Government's trade policies will also have a positive impact on the free-trade economy.
v. 6. Special influences- It will also has an effect on the supply curve.
Ø The weather
Ø Market structure
Ø Expectations about future market price etc.

Equilibrium of supply and demand:
q The market equilibrium comes that price and quantity where the forces of supply and demand are balanced.
o At the equilibrium price, amount that buyers want to buy is just equal to the amount that sellers want to sell.
o When the forces of supply and demand are in balance, there is no reason for price to rise or fall as long as other things remain unchanged.
o Market clearing price: price at which quantity demanded = quantity supplied. This denotes that all supply and demand orders are filled, the books are “cleared” of orders , and demanders and suppliers are satisfied.
n Surplus- When quantity supplied has exceeds the quantity demanded.
n Shortage-When the market quantity demanded has exceeds the quantity supplied.
n Equilibrium point- The equilibrium price and quantity come when the amount willingly supplied equals the amount willingly demanded. In a competitive market, this equilibrium is found at the intersection of supply and demand curves. There are no shortages and surpluses at the equilibrium price.

Effect of a shift in supply or demand:
o Supply an demand can also be used to predict the impact of changes in economic conditions on prices and quantities.
o Case:
n Input price increases
n Supply curve shifts to the left as supply will decline
n The result is a shortage of goods as compared to demand
n Price increase and quantity demanded declines
n A new equilibrium point will be identified
n Net effect: shift of supply curve and movement along the demand curve.

1. Eco, Micro vs macro, Logic of eco, Functions of eco system, Different Forms eco System, input & output, Society’s technological possibilities & PPF

Economics: The study of how societies use scarce resources to produce valuable goods and services and distribute those among people with the view to satisfying human needs.

Microeconomics vs macroeconomics :
o Microeconomics: The study of economic behavior of individual decision making units, such as: individual consumers, resource owners and business firms and the operation of individual markets in a free economic system (an economic system where economic decisions are made by individuals and firms).
o It attempts to explain some of the most important economic and social problems.
o It focuses on two economic units: households and business units .
o It examines two types of markets: the market for goods and services and market for economic resources.
o Macroeconomics: Deals with the overall performance of the economy.
o Studies the aggregate level of output, national income, national employment, consumption, investment and prices for the economy as a whole.


Logic of economics: how it works
Economic life is an enormously complicated hive of activity, with people buying, selling, bargaining, investing, persuading, and threatening. The ultimate purpose of economic science and of this text is to
understand this complex undertaking. How do economists go about their task?

o Scientific Approach: Economics apply scientific approaches to understand economic life. Ex: observing economic affairs, drawing upon statistics.
o Theoretical Approach: Economics apply theoretical approaches to develop broad generalizations. Ex: theories of international trades.
o Econometrics: Economics apply econometrics that apply the tools of statistics to solve economic problems.


Functions of economic system/problems of economic organization.
o When society rise, three questions comes first, they are called the “fundamentals of Economic Organization”.
o The mechanics of decision making in a larger economy are more complex, but the type of decisions that must be made are nearly identical.
o All societies must decide:
o What to produce and in what quantities: All societies must decide how much of each of the many possible goods and services it will make and when they will be produced.
Ø Rice or pulse?
Ø How much goods or inputs will be used to make the outputs and when?
Ø What quality it is ensuring? (High, medium or low)
o How to produce: A society must determine who will do the production, with what resources and what production techniques they will use that is to produce at lowest costs
Ø Who will do the entire process of production?
Ø With what kinds of resources?
Ø With what production techniques? (Labor-intensive or Capital-intensive technique)
Ø Who sells, who serves and who teaches?
Ø How the resources will be used with the minimum possible costs like-coal, oil,gas etc.

o For whom to produce: A society also decide for whom are goods be produced that means who gets to at the fruit of the economic activity to distribute properly for whom they are produced.
Ø How the ‘ national products” divided among different households?
Ø How income will be divided?

o Positive economics: Describes the facts of an economy that is, it studies what it is.
o Normative economies: It involves value judgments that is, it studies what it should be.

Different Forms economic System:
o Market economy: An economic system where economic decisions are made by individuals and firms.
o Command economy: Government makes the decision of production and distribution.
o Mixed economy: Combinations of market and command economy. That is, economy with element of market and command economy.


o Inputs: Commodities or services used to produce goods and services. An economy uses its existing technology to combine inputs to produce outputs.
o Another term for inputs is “Factors of Production”. These can be classified into three broad categories.
Ø Land
Ø Labor
Ø Capital Resources

Ø Outputs: Goods and services result from the production process. Outputs are the various useful goods or services that result from the production process either consumed or employed in further production.



Society’s technological possibilities:
o Opportunity costs: The cost of forgoing the alternatives.
In a world of scarcity, choosing one thing means giving up something else
o Efficiency: efficiency ensures scarce resources are being used as effectively as possible to satisfy people’s needs and desires
o Productive efficiency: occurs when an economy cannot produce more of one goods without producing less of another goods
o Technological progress: Development of new and better production technology to make a given, improved or an entirely new product



THE PRODUCTION-POSSIBILITY
FRONTIER
The production-possibility frontier (or PPF )
shows the maximum amounts of production that
can be obtained by an economy, given its technological
knowledge and quantity of inputs available.

Societies cannot have everything they want. They are
limited by the resources and the technology available
to them. Take defense spending as an example.
Countries must decide how much of their limited resources
goes to their military and how much goes
into other activities (such as new factories or education).
Some countries, like Japan, allocate only 1 percent
of their national output to their military. The
United States spends 4 percent of its national output
on defense, while a fortress economy like North Korea
spends up to 20 percent of its national output on
the military. The more output that goes for defense,
the less there is available for consumption and investment.
Let us dramatize this choice by considering an
economy which produces only two economic goods,
guns and butter. The guns, of course, represent military
spending, and the butter stands for civilian
spending. Suppose that our economy decides to
throw all its energy into producing the civilian good,
butter. There is a maximum amount of butter that
can be produced per year. The maximal amount of
butter depends on the quantity and quality of the
economy’s resources and the productive efficiency

Alternative Production Possibilities
Butter Guns
Possibilities (millions of pounds) (thousands)
A 0 15
B 1 14
C 2 12
D 3 9
E 4 5
F 5 0