Lecture 1: Chap 1 & 3 of Textbook (Block 1 & 2 of Subject Guide)

Block 1: Economics, the Economy & Tools of Economic Analysis

Scarcity:
• Limited resources to produce all goods & services that we would like to have.
→ i.e. can’t get everything we want
→ to have more of something, we must have less of something else.
→ e.g. choosing to spend more resources to build a new military ship means having fewer
resources to build new schools/hospitals.
→ requires us to make a choice (i.e. to choose)
→ opportunity costs incurred when choices are made

Cost (in Economics):

• Two components:
o 1) Explicit cost: amount of money we need to pay for a choice
▪ E.g. price of a movie ticket
o 2) Opportunity cost: value of next best alternative forgone
▪ E.g. benefit from the time spent sleeping instead of catching the movie

Practice (Subject Guide Sample Exam MCQ)

Every summer, New York City puts on free performances of Shakespeare in Central Park. Tickets
are distributed on a first-come first-served basis at 13.00 on the day of the show, but people begin
lining up before dawn. Most of the people in the lines appear to be young students, but at the
performances most of the audience appears to be made up of older working adults (tickets can be
transferred, so the person picking up the tickets does not have to be the person watching the
performance). Which of the following concepts best explains this fact?

(a) Ceteris paribus.

✓
(b) Opportunity cost.
(c) Marginal analysis.
(d) Absolute advantage.

Practice (2018 Zone A MCQ Q1)

Matthew needs to decide whether to go to work today or call in sick. If he goes to work, he will get
his daily wage of £73. It costs £20 to get to work. If he calls in sick, he will stay at home and invite
his friends over to watch a movie, which he values at £80. The cost of renting a movie and getting
snacks is £30. What is the best thing for Matthew to do given this information?

(a) Go to work as his opportunity cost of working is £30.

(b) Call in sick as his opportunity cost of staying at home is £53.
✓
(c) Go to work as his opportunity cost of working is £50. [Value of next best alternative forgone (i.e. “call in sick”) is 50]
(d) Call in sick as his opportunity cost of staying at home is £73.

Working:
Choices Benefits Costs Net Gain
Go Work 73 20 53
Call in Sick 80 30 50

By Mr William Tan, using UOL EC1002 Subject Guide & David Begg’s Economics 11e
1|Page
 Lecture 1: Chap 1 & 3 of Textbook (Block 1 & 2 of Subject Guide)
Production Possibility Frontier (PPF)
• An economic framework to explain scarcity, choice, opportunity cost & efficiency.
• Shows all the maximum combinations of goods that can be produced if the all resources
are fully employed.
• For simplicity, assume a two-good economy.
Combinations Fish Fish Coconuts Coconuts
workers workers
A 4 10 0 0
B 3 9 1 1
C 2 7 2 2
D 1 4 3 3
E 0 0 4 4

Fish All points outside PPF (e.g. Point S):

• Unattainable with existing resource
A (reflects max fish) quantity, quality & level of technology.
10 • Reflects scarcity
S
B
9 (Scarcity) All points inside PPF (e.g. Point I & U):
• Reflects productive inefficiency (Pt. I)
• Or reflects unemployed resources (Pt. U)
7 C
All points on PPF:
U I • Reflects productive efficiency
(0C, 6F) PPF o A productive efficient allocation of
(1C, 6F)
(Unemployed (Inefficient) resources is one which yields a
) combination of outputs where it is
D not possible to  the output of one
4
good without ing the output of the
other good
• All resources are employed
• Only 1 point on PPF is allocative efficient
such that welfare is maximised

E (reflects max. coconuts)

0 Coconuts
0 1 2 3 4
• Negative slope of PPF reflects opportunity cost – the amount of one good that must be
sacrificed to get more of the other good
o Concave to the origin (i.e. increasingly steep curve): increasing opportunity cost
▪ Due to diminishing marginal returns – each additional unit of input produces
less and less additional units of output.
▪ E.g. 1st worker sent to produce fish produces 4 units, 2nd worker, 3 units, 3rd
worker 2 units & 4th worker 1 unit
▪ Due to heterogenous inputs – inputs (e.g. manpower) are not equally suited
to the production of both goods
o Linear (i.e. straight line; constant gradient): constant opportunity cost
Good Y
-2 20 ∆𝒀 −𝟐
18 𝑷𝑷𝑭 𝒔𝒍𝒐𝒑𝒆 = = = −𝟐 = O.C. of 1 unit of Good X
-2 ∆𝑿 +𝟏
16
𝟏
= 𝒐𝒑𝒑𝒐𝒓𝒕𝒖𝒏𝒊𝒕𝒚 𝒄𝒐𝒔𝒕 𝒐𝒇 𝟏 𝒖𝒏𝒊𝒕 𝒐𝒇 𝑮𝒐𝒐𝒅 𝒀
𝑷𝑷𝑭𝒔𝒍𝒐𝒑𝒆
PPF

–2
Good X
0 +11 +1 2 10
By Mr William Tan, using UOL EC1002 Subject Guide & David Begg’s Economics 11e
2|Page
Lecture 1: Chap 1 & 3 of Textbook (Block 1 & 2 of Subject Guide)
*Absolute Advantage (AA) & Comparative Advantage (CA)
• An individual has an absolute advantage in producing a good if s/he is more efficient at
producing that good compared to someone else.
• An individual has a comparative advantage in producing a good if s/he incurs a lower
opportunity cost in producing that good compared to someone else.
• Differences in CA makes it possible to have mutually beneficial trades between two
persons even if one of them has AA in producing all goods over the other person.

Practice (Subject Guide Sample Exam Question)

1. The output produced by Samuel & Roberto in 20 labour hours is given below for wine &
cheese. Choose the option with the correct statement below.

Wine Cheese
Samuel 6 OR 4
Roberto 2 OR 3
Working: Compare output/input

For AA Wine (output/input) Cheese (output/input)

Samuel 6 wine / 20hr → 0.3 wine / hr 4 cheese / 20hr → 0.2 cheese / hr
>

>
Roberto 2 wine / 20hr → 0.1 wine / hr 3 cheese / 20hr → 0.15 cheese / hr
Samuel’s CA ∵ his O.C. is lower (0.67C < 1.5C) Roberto’s CA ∵ his O.C.
For CA Wine Cheese is lower (0.67W < 1.5W)
Compare alternative good
1W 0.67 C
forgone; sacrificed Samuel 6 OR
6
6W 4C
(output in 20 hrs) 4 4
1.5 W 1C
1W 1.5 C
Roberto 2 2
2W OR 3C
(output in 20 hrs) 3 3
0.67 W 1C

✓
a. Samuel has an absolute advantage in both products & a comparative advantage in cheese. X
X
b. Roberto has an absolute advantage in both products & a comparative advantage in cheese.
X
c. Roberto has an absolute advantage in cheese & a comparative advantage in wine, while
the opposite is true for Samuel.
✓ ✓ ✓
d. Samuel has an absolute advantage in both products & a comparative advantage in wine.
X
e. Roberto has an absolute advantage in both products & a comparative advantage in wine.
✓
Practice (Subject Guide Activity 1.4)
Suppose there are two countries (M & W) & two goods (shoes & hats).
The table gives the labour requirements to produce a unit of each output in each country.

Country M (input/output) Country W (input/output)

Shoes 5 labour hrs (for each shoe) < 10 labour hrs (for each shoe)
Hats 2 labour hrs (for each hat) < 5 labour hrs (for each hat)

Working:
For AA Country M (output/input) Country W (output/input)
Shoes 0.2 shoe / hr > 0.1 shoe / hr
Hats 0.5 hat / hr > 0.2 hat /hr
CA in hat ∵ lower O.C. (0.4S < 0.5S) CA in shoe ∵ lower O.C. (2h < 2.5H)
For CA Country M (output in 10hr) Country W (output in 10hr)
1S  2 2 S  5 0.4 S 1S  1 1 S  2 0.5 S
OR OR
2.5 H  2 5 H  5 1H 2H 12H2 1H

a. Which country has an absolute advantage in shoes? In hats?

Country M has AA in both shoes & hats.

b. Which country has a comparative advantage in shoes? In hats?

Country W has CA in shoes while Country M has CA in hats.

By Mr William Tan, using UOL EC1002 Subject Guide & David Begg’s Economics 11e
3|Page
Lecture 1: Chap 1 & 3 of Textbook (Block 1 & 2 of Subject Guide)
*Constructing a PPF
Example:
• Two individuals, Mary & John, making the two goods, shirts (S) & cakes (C).
• Number of shirts produced by each person = Shirts produced per hour x Labour hours
spent on shirt production:
S = (Shirts produced per hour) x LS
𝑆
→ 𝐿𝑆 =
𝑆ℎ𝑖𝑟𝑡𝑠 𝑝𝑟𝑜𝑑𝑢𝑐𝑒𝑑 𝑝𝑒𝑟 ℎ𝑜𝑢𝑟

• Number of cakes produced by each person = Cakes produced per hour x Labour hours
spent on cakes production:
C = (Cakes produced per hour) x LC
𝐶
→ 𝐿𝐶 =
𝐶𝑎𝑘𝑒𝑠 𝑝𝑟𝑜𝑑𝑢𝑐𝑒𝑑 𝑝𝑒𝑟 ℎ𝑜𝑢𝑟

• Let LT be the total number of labour hours a person spends on producing shirts & cakes:

LS + LC = LT
𝑆 𝐶
→ + = 𝐿𝑇
𝑆ℎ𝑖𝑟𝑡𝑠 𝑝𝑟𝑜𝑑𝑢𝑐𝑒𝑑 𝑝𝑒𝑟 ℎ𝑜𝑢𝑟 𝐶𝑎𝑘𝑒𝑠 𝑝𝑟𝑜𝑑𝑢𝑐𝑒𝑑 𝑝𝑒𝑟 ℎ𝑜𝑢𝑟

(i.e. this is the PPF equation of each person)

• Assume Mary can produce 4 shirts per hour (i.e. need only ¼ hr per shirt) & 2 cakes per
hour (i.e. need only ½ hr per cake) & she can work up to a total of 10 hours. Hence her PPF
is:
𝑺 𝑪 Working
PPFMary: + = 𝟏𝟎 1 hr (Mary)
𝟒 𝟐
1S OR ½C
• Mary can produce 4 shirts/hr & 2 cakes/hr 4 4
→ Mary’s opportunity cost of (each) cake = 2 shirts (per cake)
4S OR 2C
2 2
→ Mary’s opportunity cost of (each) shirt = ½ cake (per shirt). 2S OR 1C

Practice (My Activity)

If equation of PPFJohn is 2S + C = 10, where 10 is the total number of working hours

a) What is the maximum number of shirts John can produce (i.e. C = 0)? 2S + 0 = 10 → S = 5
b) What is the maximum number of cakes John can produce (i.e. S = 0)? 2(0) + C = 10 → C = 10

c) What is the number of hours John needs to produce 1 shirt? 2 hours per shirt
d) What is the number of hours John needs to produce 1 cake? 1 hour per cake

e) What is the number of shirts John can produce in an hour? ½ shirt per hour
f) What is the number of cakes John can produce in an hour? 1 cake per hour

g) What is John’s opportunity cost of cakes in terms of shirts (i.e. how many shirts does he give
up for each cake he chooses to produce)? ½ shirt forgone per cake

h) What is John’s opportunity cost of shirts in terms of cakes? (i.e. how many cakes does he give
up for each shirt he chooses to produce)? 2 cakes forgone per shirt

i) Compared with Mary, who has the AA in producing shirts? Mary

j) Compared with Mary, who has the AA in producing cakes? Mary
k) Compared with Mary, who has the CA in producing shirts? Mary
l) Compared with Mary, who has the CA in producing cakes? John

By Mr William Tan, using UOL EC1002 Subject Guide & David Begg’s Economics 11e
4|Page
Lecture 1: Chap 1 & 3 of Textbook (Block 1 & 2 of Subject Guide)
Practice (Subject Guide Activity 1.3)
i. Putting cakes on the horizontal axis & shirts on the vertical axis draw Mary & John’s PPF
for a 10-hour working day.

Shirts
40 TIP! : The best way to draw a linear
PPF is to simply find the maximum
number of the each good one can
produce and connect these 2
intercepts on the 2 axis.

PPF Mary : ¼S + ½C = 10
PPF John : 2S + C = 10
PPF Mary

5
PPF John

–½ –2
Cakes
10 20

ii. In what way do these PPFs differ from the (concave) PPF shown earlier? Why?
These PPFs are linear instead because opportunity cost is constant instead of
increasing here.

iii. Write down the equations of these production possibility frontiers, making S (shirts) a function
of C (cakes).
PPF Mary: ¼S + ½C = 10 PPF John : 2S + C = 10
S + 2C = 40 2S = 10 – C
S = 40 – 2C S = 5 – ½C

iv. What is the interpretation of the slope of these PPFs?

PPF slope = opportunity cost of cakes (i.e. the good on the x-axis) in terms of shirts
forgone. E.g. slope of Mary’s PPF = – 2 → i.e. she produces 2 less shirts for each
additional cake produced.

v. In your diagram what represents Mary’s absolute advantage in producing both goods?
Mary’s PPF is always higher than John’s PPF.
(lower opportunity cost)
vi. In your diagram what represents John’s comparative advantage in making cakes?
John’s PPF is less steep; flatter (i.e. lower O.C. of cakes) than Mary’s PPF.

Consolidation Questions
Good Y Q. Who has AA in Good X? Person B
PPFA Q. Who has AA in Good Y? Person A
Q. Who has CA in Good X? Person B
PPFB
Q. Who has CA in Good Y? Person A
Good X

By Mr William Tan, using UOL EC1002 Subject Guide & David Begg’s Economics 11e
5|Page
Lecture 1: Chap 1 & 3 of Textbook (Block 1 & 2 of Subject Guide)
Block 2: Demand, Supply & the Market

Demand & Supply (i.e. Holding all else constant)

• Demand is the quantity of a product that buyers are willing & able to buy at any given
price, ceteris paribus.
o Note the distinction between demand & quantity demanded.
o The term ‘quantity demanded’ makes sense only in relation to a particular price.
• Law of demand states there is negative relationship between the price & the quantity
demanded of a good or service → demand curve is downward sloping.
• Direct demand function: QD = a – bP
𝑎 1
• Inverse demand function: 𝑷 = − 𝑄𝐷 (intercept on price axis is a/b & gradient is –1/b)
𝑏 𝑏

Supply
• Supply is the quantity of a product that sellers are willing & able to sell at any given price,
ceteris paribus.
o Note the distinction between supply & quantity supplied.
o The term ‘quantity supplied’ makes sense only in relation to a particular price.
• Law of supply states there is positive relationship between the price & the quantity
supplied of a good or service → supply curve is upward sloping.
• Direct supply function: QS = c + dP
𝑐 1
• Inverse supply function: 𝑷 = − + 𝑄 𝑆 (intercept on price axis is – c/d & gradient is 1/d)
𝑑 𝑑

Practice (Subject Guide Activity 2.3)

Find the inverse demand & supply functions using the direct demand & supply functions below.
Direct Demand/Supply Function Inverse Demand/Supply Function
Demand QD = 30 – ¾ P ¾ P = 30 – QD → 3P = 120 – 4QD → P = 40 – 4/3 QD
Supply QS = 5 + ½ P ½ P = QS – 5 → P = 2QS – 10 → P = – 10 + 2QS

& graph these in the following box:

Finding 2 points on the demand curve (Q = 0)

P
On Q axis (i.e. when P = 0):
QD = 30 – ¾(0) S
QD = 30 40
On P axis (i.e. when Q = 0):
0 = 30 – ¾P
¾P = 30
3P = 120
P = 40

D
Finding 2 points on the supply curve

On Q axis (i.e. when P = 0): 4

QS = 5 + ½(0) 2 −
3
QS = 5 Q (P = 0)
5 30
On P axis (i.e. when Q = 0):
0 = 5 + ½P – 10
½P = – 5
P = – 10

By Mr William Tan, using UOL EC1002 Subject Guide & David Begg’s Economics 11e
6|Page
Lecture 1: Chap 1 & 3 of Textbook (Block 1 & 2 of Subject Guide)
Market Equilibrium Price & Quantity
Market for Rice
Price
surplus
S1
$15
A B

E
$10

C D
$5

shortage D1

0 100 Quantity
50 150
• The market clears, or is in equilibrium, at the price that makes quantity demanded &
quantity supplied equal.
o Graphically, it is where supply & demand curves intersect.
o In a free market, deviations from the equilibrium price will be self-correcting.

• At prices above market equilibrium:

o E.g. at price =$15, QD = 50 < 150 = QS → excess supply (surplus)
→ sellers  P → QD  & QS  till QD = QS = equilibrium.

• At prices below market equilibrium:

o E.g. at price = $5, QD = 150 > 50 = QS → excess demand (shortage)
→ buyers  P → QD  & QS  till QD = QS = equilibrium.

• At equilibrium price = $10, QD = QS & there is no incentive for any further price changes.

Practice (Subject Guide Activity 2.2)

The direct demand & direct supply function can be used to find the equilibrium quantity & price.

QD = 30 – ¾ P
QS = 5 + ½ P
Working:
At equilibrium, QD = QS 30 – 5 = ½ P + ¾ Using supply function, (Check)Using demand function,
30 – ¾ P = 5 + ½ P 25 = 54 P QS = 5 + ½ (20) QD = 30 – ¾ (20)
e
P = $20 e
Q = 15 Qe = 15

Practice (2018 Zone A MCQ Q2)

The figure shows a supply and demand diagram. Find the equations of the supply and demand
curves. Which of the following statements about the equilibrium price p and quantity Q is correct?
𝟏𝟐 𝟑
:𝑷= 𝑸+ 𝟎= 𝑸
𝟖 𝟐 (a) p = 6, Q = 4
(b) p = 6, Q = 5
✓(c) p = 9, Q = 6
(d) p = 10, Q = 7
12
12 𝟏𝟐 At equilibrium, D = S
:𝑷= − 𝑸 + 𝟏𝟐 𝟏 𝟑
𝟐𝟒 − 𝑸 + 𝟏𝟐 = 𝑸 Using the supply equation,
𝟏 𝟐 𝟐
= − 𝑸 + 𝟏𝟐 𝟑 𝟏 𝟑
𝟐 𝟏𝟐 = 𝑸 + 𝑸 𝑷 = ሺ𝟔ሻ
𝟐 𝟐 𝟐
24 12 = 2Q Pe = $9
8
Qe = 6

By Mr William Tan, using UOL EC1002 Subject Guide & David Begg’s Economics 11e
7|Page
 Lecture 1: Chap 1 & 3 of Textbook (Block 1 & 2 of Subject Guide)
(Non-price) Factors shifting demand & supply curves (i.e. factors other than price of the good)
• When demand or supply , they shift RIGHT (i.e. at every price level, QD or QS )
• When demand or supply , they shift LEFT (i.e. at every price level, QD or QS )

Price Price
S2 S0 S1

C A B C A B
P0 P0
S S
D D

D2 D0 D1
Quantity Quantity
0 Q2 Q0 Q1 0 Q2 Q0 Q1

Demand Supply
1) Price of Related Goods 1) Input Costs
a. Substitutes • Lower input costs
• E.g. price of oranges  → cost of production 
P Grapefruit → QD of oranges  as people switch to → makes production more lucrative
E2
S substitutes such as grapefruit → firms supply more output at each price
P2 → demand for grapefruit  & shift right; QD → supply 
P1
E1 of grapefruit  at each possible price.
Porange (substitute)
D2 → equilibrium price & qty. of grapefruit  • Higher input costs
D1
Q → cost of production 
Q1 Q2
b. Complements → makes production less lucrative
• E.g. price of cars  → firms supply less output at each price
P Petrol → QD of cars  as people switch to → supply 
S substitutes such as public transport
E1
P1 → demand for complements such as • Taxes → cost of production  → S 
P2
E2 petrol  & shift left; QD of petrol  at each
Pcar (complement) • Subsidies → cost of production  → S 
D1
possible price.
Q → equilibrium price & qty. of petrol 
D2
Q2 Q1
2) Consumer Incomes 2) Technology
a. Normal goods • Technological advance allows more
• Income  → demand  output from the same inputs as before
→ supply 
b. Inferior goods (e.g. unbranded, 2nd hand)
• Income  → demand 

3) Tastes & Preferences 3) Government Regulation

• Shaped by convenience, custom & social • Whenever regulations prevent producers
attitudes from selecting the production methods they
• E.g. greater social emphasis on health & would otherwise have chosen, the
fitness regulations will  supply & shift it left.
→  demand for gyms &  demand for cakes o E.g. more stringent safety regulations
prevent chocolate producers using the most
productive process because it is quite
dangerous for workers.
o E.g. anti-pollution devices may raise the cost
of making cars

4) Expectations 4) Expectations
• Expect future price to  • Expects future price to 
→ start buying now →  supply today
→ demand 

By Mr William Tan, using UOL EC1002 Subject Guide & David Begg’s Economics 11e
8|Page
Lecture 1: Chap 1 & 3 of Textbook (Block 1 & 2 of Subject Guide)
Practice (Subject Guide Activity 2.4)
The Market for Sushi

Event Supply or Direction? Effect on Effect on Movement

Demand equilibrium equilibrium along
shifts? price? quantity? the other
curve –
which
direction?
Price of Supply Left   Demand, left
(input)
salmon  Price S1 S0
→ COPsushi  P1
→S P0
D0
Q 1 Q0 Quantity

New sushi Supply Right   Demand, right

machines
make
production Price S0 S1
more
efficient P0
→ tech. P1
improve; D0
productivity Q0 Q1 Quantity
→S

Sushi Demand Right   Supply, right

becomes
more
popular
Price S0
→ tastes ∆ P1
towards P0
favouring D1
sushi D0
→D Q0 Q1 Quantity

New Demand Left   Supply, left

evidence
reveals sushi
is not as Price S0
healthy as
people had P0
thought P1
→ tastes ∆ D1 D0
→D Q 1 Q0 Quantity

Price of Demand Right   Supply, right

substitutes
(e.g. Korean Price
food)  S0
P1
→ some
P0
consumers
switch to D1
D0
sushi Quantity
→D Q0 Q1

By Mr William Tan, using UOL EC1002 Subject Guide & David Begg’s Economics 11e
9|Page
 Lecture 1: Chap 1 & 3 of Textbook (Block 1 & 2 of Subject Guide)
Practice (Subject Guide Sample Exam Question)
An increase in consumer incomes would result in:
a. a decreaseX in demand for bread --- Normal Good
X
b. a decrease in demand for diamonds --- Normal Good
✓c. a decrease in demand for low-quality cars --- Inferior Good
X
d. an increase in demand for inter-city bus travel (compared to flying or taking the train).--- Inferior Good

----------------------------------------------------------------------------------------------------------------------------- ----------
An increase in the price of (input) chilli would lead to: → Cost of production (of Mexican food) 
Normal Good
a. an increase in demand for Mexican food
✓b.
c.
decrease in supply of Mexican food
an increase in the supply of Mexican food
d.  X
a decrease in demand for other spices.
(Substitute input)
(DD Upward Sloping)
----------------------------------------------------------------------------------------------------------------------------- ----------
P Scenario 1
D Suppose that the price of Porto wine was £20 per litre in 2010 & £25 per litre in 2011. Ingrid
2011 observes that Margaret’s consumption of wine rose from 1 litre per month in 2010 to 1.2 litres per
25
month in 2011.
20 2010 (i.e. MUST be)
Ingrid concludes that Margaret’s demand for Porto wine has to be upward sloping:
Q
1 1.2 a. Ingrid is wrong: given the above information Margaret’s demand for Porto wine has to be
(DD Downward Sloping) downward sloping.
P Scenario 2 b. Ingrid is right: given the above information Margaret’s demand for Porto wine has to be upward
S sloping.
E2
25

20
E1 ✓
c. Ingrid is wrong: the above information is not enough to conclude that Margaret’s demand for
Porto is necessarily upward sloping.
D2011
D2010 ---------------------------------------------------------------------------------------------------------------------------------------
Q
1 1.2
The demand curve for good A is given by:
QDA = a – bPA + cPB
(Substitute)
where PA is the price of good A, PB is the price of good B, & a, b, c are positive constants. The supply
curve for good A is also linear & is upward sloping. When the price of good B increases:
PA PB 
a. The quantity of A purchased falls X
 & the price of A falls. E2
S

✓
b. The quantity of A purchased increases & the price of A increases.
c. The quantity of A purchased increases & the price of A falls.
PA2
E1
PA1
d. The quantity of A purchased increases & the price of A stays the same.
D1 D2
QA
a + cPB1 a + cPB2
Reservation Prices QA1 QA2

• maximum price a buyer is willing to pay for a given amount of a good or service.
• minimum price a seller is willing to accept for a given amount of a good or service.

Consumer & Producer Surplus

Price
S0

CS
P0
PS

D0
Quantity
0 Q0

By Mr William Tan, using UOL EC1002 Subject Guide & David Begg’s Economics 11e
10 | P a g e
 Lecture 1: Chap 1 & 3 of Textbook (Block 1 & 2 of Subject Guide)
Consumer Surplus (CS) Producer Surplus (PS) Economic Surplus
o difference between the o difference between the o sum of consumer &
maximum price (reservation minimum price (reservation producer surplus
price) that a buyer is willing to price) that a seller is willing to
pay for a given amount of a accept for a given amount of a
good or service & the price the good or service & the price the
buyer actually pays. seller actually receives.

o area below the market o area above the market supply o is highest at the
demand but above the & below the equilibrium price. equilibrium price –
equilibrium price. i.e. at any other price,
economic surplus will
be lower.

Practice (Subject Guide Activity 2.5)

The only four consumers in a market have the following willingness to pay for a good:

Buyer Willingness to Pay

Sally £15
Simon £25 Reservation price (of buyers); Max. price
Susan £35
Shaun £45

If there is only one unit of the good & if the buyers bid against each other for the right to purchase
it, then the consumer surplus will be:
a. £0 or slightly less Consumer surplus = Reservation price (of Shaun) – actual price (Shaun) paid
= £45 – £35.10
✓ b.
c.
£10 or slightly less
£30 or slightly less
= £9.90

d. £45 or slightly less.

----------------------------------------------------------------------------------------------------------------------------- ----------
At the equilibrium price, the producer
surplus is equal to:

✓a.b.£2,000
£4,000
c. £6,000
100
d. £10,000

Producer surplus
= Area between Supply Curve & Transacted price, up till the transacted quantity
PS
= ½ (60 – 20)(100 – 0)
40 = ½(40)(100)
= ½(4000)
= 2000

----------------------------------------------------------------------------------------------------------------------------- ----------

By Mr William Tan, using UOL EC1002 Subject Guide & David Begg’s Economics 11e
11 | P a g e
Lecture 1: Chap 1 & 3 of Textbook (Block 1 & 2 of Subject Guide)

When the price per match falls from £8 to £6,

his welfare:
(consumer surplus)

✓a.b.Rises by £16
Falls by £16
CS
A c. Rises by £12
d. Falls by £12
+ CS
+ CS  in consumer surplus
B
= Area of green trapezium
Demand = ½ x (sum of the two parallel sides)(distance between these two sides)
= ½(6 + 10)(8 – 6)
= ½(16)(2)
= 16

Price controls
• Markets will not be free when effective price controls exist.
• Price controls results in deadweight loss, as economic surplus (CS + PS) 

• Price ceiling:
o legally established maximum price below the market equilibrium price
o  price →  QD but  QS → QD > QS → results in excess demand (shortages)

Price
Deadweight Welfare Loss
(DWL) Supply

CS

Pe
X
CS
PSX X
PS
Pmax → +CS
Price Ceiling (e.g. rent control)
PS
Shortage
Demand
Quantity
QS Qe Qd
• Price floor:
o legally established minimum price above the market equilibrium price
o  price →  QD but  QS → QD < QS → results in excess supply (surpluses)

Price
Surplus Supply
Pmin CS
Price Floor (e.g. minimum wage)
X
CS
→ +PS X
CS
Pe
X
PS
PS
Deadweight Welfare Loss
(DWL)
Demand
Quantity
Qd Qe QS

By Mr William Tan, using UOL EC1002 Subject Guide & David Begg’s Economics 11e
12 | P a g e
Lecture 1: Chap 1 & 3 of Textbook (Block 1 & 2 of Subject Guide)
Practice (Subject Guide Activity 2.6)
Price floors & ceilings result in a loss of consumer & producer surplus, this is called a deadweight
loss. Can you calculate how much consumer & producer surplus is lost due to the price ceiling
in the diagram below? Has there also been a transfer of surplus between consumers & producers?

DWL
= ½ x (80 – 40)(100 – 50) Initial = ½ (100)(100 – 60) CS with = ½ [(100 – 40) + (80 – 40) X 50]
= ½(40)(50) CS = 2,000 price = 2,500
= ½(2000) celling
= 1000 Initial = ½ (100)(60 – 20) PS with = ½ (50)(40 – 20)
PS = 2,000 price = 500
DWL
ceiling
CS
Initial = Initial CS + Initial PS ES with = new CS + new PS
ES = 2,000 + 2,000 price = 2,500 + 500
CS X
CS = 4,000 ceiling = 3,000

PS X X
PS
→ + CS
(max. price)
PS

Deadweight Loss = Initial ES – New ES = 4,000 – 3000 = 1,000

Transfer of surplus from producers to consumers = (60 – 40)(50) = 1,000

Practice (Subject Guide Sample MCQ)

From the diagram below, the loss in consumer surplus due to the price floor is:

a. £50
b. £100
✓ c.
d.
£150
£200

CS
(min. price)
CSX
→ + PS X
CS Loss in consumer surplus
= Area of green trapezium
PS = ½ x (sum of the two parallel sides)(distance between these two sides)
= ½(10 + 20)(40 – 30)
PS
= ½(30)(10)
= 150

----------------------------------------------------------------------------------------------------------------------------- ----------

By Mr William Tan, using UOL EC1002 Subject Guide & David Begg’s Economics 11e
13 | P a g e
 Lecture 1: Chap 1 & 3 of Textbook (Block 1 & 2 of Subject Guide)
Given the following inverse demand & supply curves:

Demand: P = 8 – QD/2
Supply: P = 2 + QS
(max. price)
& assuming that price is fixed below the equilibrium price at £5,
the loss in producer surplus due to the price ceiling is:
At Equilibrium, D = S Using the supply equation,
8 – ½Q = 2 + Q When Q = 4,
Working: 8 – 2 = Q + ½Q P=2+4
3
6= Q Pe = $6
Price 2
12 = 3Q
8 Supply Qe = 4

CS Using the supply equation,

Pe = 6 CS
X X
PS PS
Pmax = 5 → + CS Price Ceiling
When P = $5,
5 = 2 + QS
5 – 2 = QS
PS QS = 3

Loss in producer surplus = ½ (4 + 3)(6 – 5)

= ½ (7)(1)
2 = 3.5
–½ Demand
Quantity
QS Qe Qd
=3
=4

✓a.b.£3.50
£4.50
c. £8
d. £9

Practice (Subject Guide Sample Exam Long Question)

Suppose that the inverse demand & supply schedules for rental apartments in the city of Auckland
are as given by the following equations:

Demand: P = 2700 – 0.12QD

Supply: P = –300 + 0.12QS

a. What is the market equilibrium rental price per month & the market equilibrium number of
apartments demanded & supplied? ($1,200; 12,500 apartments)

b. If the local authority can enforce a rent-control law that sets the maximum monthly rent at
$900, will there be a surplus or a shortage? Of how many units will this be? & how many
units will actually be rented each month? (shortage 5,000 apartments; 10,000 units)

c. Suppose that the government decides to implement a policy to keep out the poor. It declares
that the minimum rent that can be charged is $1,500 per month. If the government can enforce
that price floor, will there be a surplus or a shortage? Of how many units will this be? & how
many units will actually be rented each month? (surplus 5,000 apartments; 10,000 units)

d. Suppose that the government wishes to decrease the market equilibrium monthly rent to
$900 by increasing the supply of housing. Assuming that demand remains unchanged,
find the new equilibrium quantity & the new inverse supply curve. (15,000 apartments; P
= – 900 + 0.12QS)

Acknowledgements & References

Economics 11e by David Begg, Gianluigi Vernasca, Stanley Fischer, Rudiger Dornbusch
ISBN: 0077154517. Publisher: Mc Graw Hill

Subject Guide 2016 for EC 1002 Introduction to Economics by O. Birchall assisted by D. Verry
University of London International Programmes

By Mr William Tan, using UOL EC1002 Subject Guide & David Begg’s Economics 11e
14 | P a g e