Diploma in Accounting/Banking & Finance/International Business

ECO0006 Economics for Managers

Lecture 1
Introduction to Economics

Tan Khay Boon, Economics for Managers Module Book, SIM

Global Education, 2014
Session 1
 Learning Objectives
At the end of the lesson, students will be able to:

1. Comprehend the meaning of ‘scarcity’ and link

micro and macro issues to the problem of scarcity.
2. Comprehend the model and the main concepts that
the production possibility curve is trying to
illustrate.
3. Derive demand and supply curves and comprehend
their properties.
Introducing Economics
What do Economists Study?
 WHAT DO ECONOMISTS STUDY?
• Microeconomics
– Study of individual parts of the economy
– Consumer behaviour in making choices
– Firm behaviour in price and output decisions
– Market behaviour
• Macroeconomics
– Study of economy as a whole
– Objectives of economic growth, unemployment
and income equality issues
 WHAT DO ECONOMISTS STUDY?
Scarcity: the central economic problem
• defining scarcity, choices and opportunity costs.
• use of resources (factors of production)
Labour
Land
Capital
Entrepreneurs
 Basic Economic concepts
• Scarcity – arises when wants are more than
what available resources can produce.
• Choice – pick among the alternative uses of
limited resources.
• Opportunity Cost - value of the next best
alternative foregone (i.e. given up)
https://www.youtube.com/watch?v=yw6wB7ha
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 Basic Economic concepts
• Rational Choice and Marginal Analysis

–Weigh marginal costs against marginal

benefit
–Optimum level of activity when
marginal cost equal to marginal benefit
 Economic Systems
• Command economy:
–All resources belong to the government
–All decisions made by government
–Advantage include decisions being made
for the good of the society as a whole
–E.g. North Korea
 Economic Systems
• Free market economy
– All decisions made by individuals and firms based
on self interest
– No government intervention
– Price mechanism allocate resources
– Price is the indicator used to clear shortages and
surpluses
– Advantages include a efficient economy that
functions automatically
 Economic Systems
• Mixed economy:
–Price mechanism is in operation with
government intervention
–Government provides taxes and
subsidies where the market fails (income
inequality, merit good, demerit good)
–Most economies are mixed economies
 WHAT DO ECONOMISTS STUDY?
• The production possibility curve
– A curve showing the different combination of two
goods that an economy can produce when all the
resources are fully utilised.
– For example, R0 shows that the maximum amount
of rice the economy can produce when all the
resources are fully used.
– S0 shows that the maximum number of shirts the
economy can produced when all the resources are
fully used.
A production possibility curve
Rice

R0
R1 A

R2 B

Shirt
S1 S 2 S0
 A production possibility curve
– choices
• Represented by all the different points on the PPC.
– increasing opportunity cost
• Represented by concave shape of PPC.
• As economy moves from point R0 to point A, it loses small amount
of rice to gain shirts.
• As economy moves from point A to point B, it loses more rice to
gain same increase in shirt production.
• This shows the concept of increasing opportunity cost whereby
the equal gain in units of shirts comes at the cost of increasing
amounts of rice.
 A production possibility curve
• Points on the PPC: Efficient
– More of one product can be produced only by
producing less of the other product (Point A to D
or B)
• Points within the PPC: Inefficient
– Possible to increase both shirts and rice at the
same time (Point C to A, D or B)
– Idle resources
• Points outside PPC: Unattainable (Point E)
A production possibility curve
Rice

R0 D (Efficient)
R1 A (Efficient)
E (Unattainable)

R2 B (Efficient)
C
(Inefficient)

Shirt
S1 S 2 S0
 A production possibility curve

• Shifts in the curve

– A parallel shift of the PPC outwards shows the economy is
increasing its potential output i.e. enjoying economic
growth.
 This can come about through factors such as having
more resources or improvements in productivity
– A parallel shift of the PPC inwards shows decrease in
quantity or quality of resources, negative technology shock
Changes may only affect one product
A production possibility curve
Rice

R1

R0

Shirt
S0 S1
Supply and Demand

Demand
 DEMAND
• Relationship between demand and price
– the law of demand
• It states that as the price of a good increases, the quantity
demanded (bought) will fall, ceteris paribus.
• (Note: ceteris paribus – a term meaning all other factors
remaining constant)
– Why does the demand curve slopes down-wards?
• the income effect
– As price rises, the purchasing power (or real income) of the
consumer falls. Hence he can buy less goods with his income.
• the substitution effect
– As price rises, he will buy less of the more expensive goods and more
of the cheaper alternatives.
 DEMAND
• The demand curve
– individual's and market demand curves
• When you add up all the individual demand schedule,
you get the market demand schedule.
• The curve is downward sloping (or negatively sloped) to
show the inverse relationship between price and quantity
demanded.
 Demand Schedule
Price of Bread Quantity Demanded of Bread
$0.80 140
$1.00 130
$1.20 120
$1.40 110
$1.60 100
$1.80 90
 DEMAND
• Other determinants of demand
– Price of related goods
– Income or wealth
– Tastes and Preferences
 Demand
• Demand vs Quantity demanded

– Demand refers to entire price range

– Quantity demanded refers to only at a particular
point
– Changes in price are represented by movements
along the demand curve
 Demand – Movement
Price

A
P1
B
P2 Demand curve

Q1 Q2 Quantity demanded
 Demand - Shift
Price

D2
D1
Quantity
Q1 Q2 demanded
 Other Determinants of Demand:

Income and Wealth

 Income: The total of all earnings received by a
household in a given period of time
 Wealth: The total value of what a household
owns less what it owes.
 Other Determinants of Demand: Income
and Wealth

Normal Good
• Goods for which demand goes up when income
is higher and for which demand goes down
when income is lower.
• For example, overseas travel
 Other Determinants of Demand: Income
and Wealth
Inferior Goods
• Goods for which demand falls when
income rises.
• For example, instant noodles vs restaurant
food; black & white TV vs colour TV; Video-
tapes vs DVD
 Other Determinants of Demand: Prices of
Related Goods
Substitutes
• Goods that can serve as replacements for
one another.
• When the price of one increases, demand
for the other goes up.
• Examples: Buns vs Cakes, Butter vs
Margarine
 Other Determinants of Demand: Prices of
related Goods

Complements
• Goods that are used together.
• When the price of one increases, demand
for the other goes down.
• Examples: car & petrol; bread & butter
 Other determinants: Expectation of Future
Price
• If consumers expect that prices will increase in
the future, they will make their purchase now
and current demand will rise. Demand curve
shifts right;
• If consumers expect prices to decrease in the
future, they will postpone their purchase and
current demand will fall. Demand curve shifts
left.
 Other determinants: Consumers
Population

• Increase in population results in an

increase in consumers
• Demand increases at any given price
• Demand curve shifts to the right
Other Determinants of Demand: Tastes and
Preferences

• These are quite subjective and tend to

change over time.

• Can be influenced by advertising.

Supply and Demand

Supply
 SUPPLY
• Relationship between supply and price
– the law of supply
• It states that as the price of a good increases, the quantity
supplied (sold) will rise, ceteris paribus.
• (Note: ceteris paribus – a term meaning all other factors
remaining constant)
– Why does the supply curve slopes upwards?
• the profit effect
– As price rises, the profit margin per unit of good sold
rises. Hence the firm has an incentive to sell more units
of the good.
 SUPPLY
• The supply curve
– individual's and market supply curves
• When you add up all the individual supply
schedule, you get the market supply
schedule.
• The curve is upward sloping (or positively
sloped) to show the direct relationship
between price and quantity supplied.
 Supply Schedule
Price of Bread Quantity Supplied of Bread
$0.80 100
$1.00 110
$1.20 120
$1.40 130
$1.60 140
$1.80 150
 Supply – Movement
Price

Supply curve
B
P2

P1 A

Q1 Q2 Quantity supplied
 Supply - Shift
Price
S1

S2
A
P B

Quantity
Q1 Q2 supplied
 SUPPLY
• Other determinants of supply
– Technology
– Resource prices
– Prices of related goods in production
– Expectation of future prices
– Number of sellers
– Government policy: Taxes and Subsidies
 Determinants of Supply: Technology

Technology
• New and efficient technology enables firms
to produce units of output with fewer
resources.
• Using fewer resources lowers production
costs and increases supply
• Rightward shift of supply curve
 Determinants of Supply: Resource Prices

Resource Prices
• An increase (decrease) in the resource
prices.
• Increase (decrease) in the costs of
production.
• Leftward (rightward) shift of supply curve
 Determinants of Supply: Number of Sellers

Number of Sellers
• An increase (decrease) number of sellers.
• Increase (decrease) in supply.
• Rightward (leftward) shift of supply curve
 Determinants of Supply: Prices of Related
Goods
• Substitutes in production
– Land can be used to grow either fruits or
vegetables
– If price of vegetables fall, supply of fruits will
increase
• Complements in production
– Leather and beef
– If price of leather increases, supply of beef will
increase too
 Determinants of Supply: Expectation of
future price
• If price of a product is expected to increase,
suppliers may defer production and current
supply will fall
• If price of a product is expected to fall,
suppliers may choose to supply more to earn
current profits and supply rises
• Applies particularly for durables
 Determinants of Supply: Taxes and
Subsidies
Taxes and Subsidies

• Imposition of tax on good.

– Increases the cost of production.
– Decreases the supply.
– The supply curve shifts leftward.

• Payment by government (subsidy)

– Decreases the costs of production.
– Increases the supply.
– The supply curve shifts rightward.
 Supply and Demand
Market Equilibrium - Price and
Output determination
 Market Equilibrium
Price

Supply curve

Pe E

Demand curve

Quantity
Qe
 Market Equilibrium: Surplus
Price

Supply curve
Surplus
P1

Pe E

Demand curve

Quantity
Q1 Q2
 Market Equilibrium: Shortage
Price

Supply curve

Pe E

P1
Shortage
Demand curve

Quantity
Q1 Q2
 PRICE AND OUTPUT DETERMINATION

• Effects of shifts in the demand curve

–movement along the supply curve and

the new demand curve
 Impact of Change in Demand
Price

Supply curve

P2 E2
P1 E1

D2
D1

Quantity
Q1 Q2
 Impact of Change in Demand
Price

Supply curve

P1 E1
P2 E2

D1
D2

Quantity
Q2 Q1
 Impact of Change in Supply
Price
S2
S1

E2
P2
P1 E1

Demand curve
Quantity
Q2 Q1
 Impact of Change in Supply
Price
S1

S2
P1 E1
P2 E2

Demand curve
Quantity
Q1 Q2
 Discussion Question 1
Sean applied to three faculties in the State University. If
offered a place by all faculties, he would opt for
Engineering as his first choice, Computer Science as his
second choice and Business Studies as his third choice.
Eventually he enrolled in the faculty of Engineering and
the opportunity cost of this decision is,
A. studying Computer Science.
B. studying Business Studies.
C. studying Computer Science and Business Studies.
D. studying all other courses offered by the State
University.
 Discussion Question 2
Which of the following will not cause a shift in the
demand curve for apple?

A. An increase in income of consumers.

B. The price of pear increases and pear is a
substitute for apple.
C. A decrease in the price of apple.
D. A research report concluding that eating apple
is beneficial to health.
E.
 Discussion Question 3
Which of the following would cause the equilibrium price
of bread to decrease and the equilibrium quantity of bread
to increase?

A. An increase in the price of butter, a complement for

bread.
B. A decrease in the price of flour.
C. An increase in the price of cake, a substitute for bread.
D. An increase in the price of flour.
 Discussion Question 4
When an economist talks of scarcity, the economist
is referring to the _______.

A. ability of society to employ all of its resources.

B. ability of society to consume all that it produces.
C. inability of society to satisfy all human wants because of
limited resources.
D. ability of society to continually make technological
breakthroughs and increase production.
 Discussion Question 5
Which of the following does NOT shift the demand curve for
avocados?

A. An increase in the cost of fertiliser used to grow avocados.

B. The Federal Food and Drug Administration releases a report that
consumption of avocados reduces cholesterol level.
C. An increase in the price of chick peas, a substitute for avocados,
because rodents gobbled up much of this year's chick peas crop.
D. A decrease in the price of chick peas, a substitute for avocados,
because of a bumper crop of chick peas this year.
 Discussion Question 6
Consider Country Tee producing two types of goods: rice and
cars; using three types of resources: land, labour and machines.
Assume land and labour are used to produce rice, while labour
and machines are used to produce cars. Analyse the effects on
the production possibility frontier of Country Tee when the
following incidents occur independently.

A. The government allows more workers to migrate to Country

Tee.
B. A major earthquake destroys land and kills half the labour
force in Country Tee.
 Discussion Question 7
What are the effects on the mobile phone market when
the following incidents occur? Analyse each case
independently and support your analysis with a market
diagram.

A. The price of tablets increases. Major components in

the production of both mobile phones and tablets can
be shared.

B. Consumers are increasingly concerned about reports

on mobile phones causing brain tumours.
End of Session 1