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Basics of Economics

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CHAPTER

BASICS OF ECONOMICS 11 CHAPTER

INTRODUCTION

Macro Economics

Economics, often referred to as the “dismal science”, is a study of certain aspects of society. Adam Smith, the “father of modern economics” and author of the famous book “An Inquiry into the Nature and causes of the wealth of Nations”, spawned the discipline of economics by trying to understand why some nations prospered while others lagged behind in poverty. Alfred Marshall, author of “The Principles of Economics”, reflects the complexity underlying economics: “Thus it is on one side the study of wealth; and on the other, and more important side, a part of the study of man.”

• It looks at the total output of a nation and the way the nation allocates its limited resources of land, labor and capital in an attempt to maximize production levels and promote trade and growth for future generations.

Meaning of economics • The term ‘economics’ comes from the Greek term oikonomia, which is composed of oikos (house) and nomos (law), meaning rules of the household. • Economics is concerned with the factors that determine the production, distribution, and consumption of goods and services.

BRANCHES OF ECONOMICS Micro Economics • It examines the behaviour of basic elements in the economy, including individual agents and markets, their interactions, and the outcomes of interactions. • It shows us how individuals and firms respond to changes in price and why they demand what they do at particular price levels.

• It analyses the entire economy and issues affecting it, including unemployment of resources (labour, capital and land), inflation, economic growth, and the public policies that address these issues (monetary, fiscal, and other policies).

ECONOMICS BASICS: DEMAND AND SUPPLY • Demand refers to how much (quantity) of a product or service is needed by buyers at various prices. The relationship between price and quantity demanded is known as the demand relationship. • Supply represents how much the market can offer. It is the producer’s willingness and ability to supply a given good at various price points. The correlation between price and how much of a good or service is supplied to the market is known as the supply relationship. Price, is a reflection of supply and demand

A. The Law of Demand • The law of demand states that, if all others factors remain equal, the higher the price

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Basics of Economics

of a good, the less people will demand that good. Demand curve illustrates • Negative relationship between price and quantity demanded.

D. Disequilibrium

B. The Law of Supply • The law of supply demonstrates the quantities that will be sold at a certain price.

• Disequilibrium occurs whenever the price or quantity is not equal to P* or Q*. • If price is set to high, excess supply will be created within the economy. • Excess demand is created when price is set below the equilibrium price. • A movement along the supply curve will occur when the price of the good changes and the quantity supplied changes in accordance to the original supply relationship. • A shift in a demand or supply curve occurs when a good’s quantity demanded or supplied changes even though price remains the same.

E. Elasticity • The degree to which a demand or supply curve reacts to a change in price is the curve’s elasticity. Elasticity of the supply or demand curves • Supply curve shows an upward slope. This means that the higher the price, the higher the quantity supplied.

C. Equilibrium • When demand and supply are equal the economy is said to be at equilibrium. • At this point, the amount of goods being supplied is exactly the same as the amount of goods being demaned.

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equation:  E=

F. Utility

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% change in quantity   %change in price 

• Utility explains how individuals and economies aim to gain optimal satisfaction in dealing with scarcity. • Total Utility is the aggregate sum of satisfaction that an individual gains from consuming a given amount of goods or services.

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Basics of Economics • Marginal Utility is the additional satisfaction, or amount of utility gained from each extra unit of consumption.

G. Monopolies, Oligopolies and Perfect Competition • A monopoly is a market structure in which there is only one producer/seller for a product. For example, in Saudi Arabia the government has sole control over the oil industry. • In an oligopoly, there are only a few firms that make up an industry. This group of firms has control over the price. • Perfect competition is characterized by many buyers and sellers, many products that are similar in nature and, as a result many substitutes. In a perfectly competitive market prices are determined by supply and demand.

Meaning of an Economy • An economy is a man-made organization for the satisfaction of human wants. • It is a framework where all economic activities are carried out.

TYPES OF ECONOMIES • Typically, economies are divided into different types based on the extent of government involvement in econmic decision-making. Based on above criteria, the following are the major types of economies.

Traditional Economy • There is very little government involvement in this type of economy. Allocation of resources here relies on customs, rituals and time-honored belief. • There is very little individual choice in this system and people work together for the common good. • This type exists in tribes in Amazon, Aborigines in Australia, etc.

Command Economy • A command economy is a system where the government determines what goods should be produced, how much should be produced and the price at which the goods are offered for sale. • Cuba, North Korea and the former Soviet Union are examples of countries that have command economies.

Free Market Economy • It refers to an economy where the government imposes few or no restrictions and regulations on buyers and sellers. • More, participants determine what products are produced, how, when and where they are made, to whom they are offered, and at what price - all based on supply and demand.

Capitalistic Economy • In this system capital goods are owned by private individuals or business partners. • Individuals are free to determine where to invest, what to produce or sell, and at which prices to exchange goods and services.

Socialist Economy • In the socialist or centrally planned economies all the productive resources are owned and controlled by the government. • Countries such as Russia, China and many eastern European countries are said to be socialist countries.

Mixed Economy • A mixed economy combines the best features of capitalism and socialism. • This system protects private property and allows a level of economic freedom in the use of capital, but also allows for governments to interfere in economic activities in order to achieve social aims.

Open Economy • It is an economy in which there are economic activities between the domestic community and outside.