ECONOMICS NOTES

Factors of production
- Capital refers to man-made resources
- Enterprise is the skill of organizing the other 3 factors of production
- Land refers to natural resources
- Labor refers to human resources

Circular flow of income

- Leakage- when money does not go into circular flow e.g. taxes, savings, imports
- Injection- money added into circular flow e.g. govt. spending, investments, exports

Factor incomes

Factors of production

Firms
Households

Goods and services

Consumer expenditure

Central Pillars of Economy

- Scarcity
- Choice
- Efficiency
- Equity
- Economic well-being
- Sustainability
- Change
- Interdependence
- Intervention

3 Basic Economic Questions

- What to produce?
- How to produce?
- For whom to produce?

Economic systems
- Free market- allocation of resources determined by market forces
- Mixed- allocation determined by market and government
- Planned- allocation determined by the government
 - Opportunity cost- refers to the value of the next best alternative forgone when a choice is
made
- Free goods- naturally abundant, do not incur any opportunity costs

Production-Possibilities Curve

- It shows efficiency, opportunity cost, scarcity, economic growth and recession

- An economy’s PPC can shift outwards if there is
 An increase in quantity of resources
 An improvement in the quality of resources
 An improvement in technology

Economic Methodology
- Positive economics
 Scientific, testable, factual statements
 Uses logic, theories, empirical evidence
- Normative economics
 Subjective judgements
 Uses theories, models, hypotheses, assumptions

Demand
- Demand- the quantity of goods and services that consumers are willing and able to purchase
at a given time, ceteris paribus
- Ceteris paribus- means that all other variables remain the same
- Income effect- the effect of a change in the price of a good or service on real incomes. As the
price of the good or service falls, then the real income levels of consumers rise. This means
that consumers will be able to purchase more goods and services than they were before and
quantity demanded for the product will rise.
- Substitution effect- the effect of change in the price of a good or service on the relative price
of the product. As a product falls in price then the good will be relatively cheap, compared to
its substitutes, and so some consumers will switch their demand to the good.
- Non-price determinants of demand are factors that may influence the willingness and ability
of consumers to purchase a good and/or service. This includes-
 Income
  Number of consumers
 Price of related goods
 Future price expectations
 Taste and preferences
- Income
 Normal goods see and increase in demand as consumer incomes rise, and vice versa.
Examples include necessary items such as food & clothing, and luxury products like
cars and designer wear
 Inferior goods see a decrease in demand as consumer incomes rise, and vice versa.
For example, consumers may switch their secondhand clothes and canned food for
new clothes and fresh food
- Taste and preferences
 Change in consumer tastes and preferences may be affected by social changes
 If taste is good, demand increases
 If taste is not acceptable, demand decreases
- Future price expectations
 If consumers expect the price of a good to rise in the future, some may purchase the
good at the current time period at a comparatively lower price resulting in an increase
in current demand
 Alternatively, if consumers expect the price of a product to fall in the future, some
may delay their purchases, lowering the demand.
- Price of related goods
 Related goods experience a change in demand from a change in the price of an
associated product
 Substitutes are goods that can replace each other to some degree. When price of a
substitute rises, demand for original good increases, and vice versa
  Complements are goods that are used in conjunction with another good. When price
of a good increases, demand of the complementary good decreases, and vice versa

Supply
- Supply is concerned with the behavior of firms and refers to the quantities of a good or
service that producers are willing and able to supply at different prices in a given time period
- Law of diminishing returns states that when additional variable factors of production are
employed to fixed factors, the marginal returns will eventually decrease. This occurs in the
short run, as at least one factor of production is fixed, usually capital.
- Short run- period when there is at least one fixed factor of production
- Long run- period when there are no fixed factors of production
- Marginal cost is the cost of producing an additional unit of output
- Marginal cost increases as output rises, due to diminishing marginal returns

- Non-price determinants of supply

 Subsidies and taxes
 Technology
 Other related goods’ price
 Resource costs
 Expectations of producers
 Size of market
- Subsidies are financial aids provided by the government to producers to encourage output
 Lower cost pf production, higher supply
- Indirect taxes are government charges on producers to discourage output
 Higher cost of production, lower supply
- Advances in technology increase efficiency and productivity, thereby lowering average costs.
Supply of goods and services increase at every price level, shifting the supply curve to the
right
 Lower cost of production, higher supply
 - When two goods are in competitive supply, the output of one good is limited by the
production of another good due to competing resources. As producers have scarce resources,
they cannot produce more of one good without producing less of another.
- When two products are in joint supply, the increase in production of one good increases the
supply of another good. As the supply of the main product changes, the supply of its by-
product changes in the same day
- Cost of production including wages, fent, interest, and profit, are negatively correlated with
supply
- Price has a signaling effect in allocating resources to produce goods. There is a positive
correlation between future price expectations and the supply of the good.
- There is a positive correlation between the number of firms in a market and the market supply
of a product

Market Equilibrium
- Market equilibrium occurs at the price where quantity demanded equals to quantity supplied.
At this point, there is no shortage or surplus
- Equilibrium price- price at which quantity demanded equals quantity supplied
- Equilibrium quantity- quantity at which quantity demanded equals quantity supplied
- Surplus- quantity supplied > quantity demanded
- Shortage- quantity demanded > quantity supplied
- Signalling function- price conveys market information to producers and consumers for
making production and consumption decisions in order to allocate resources
- Incentive function- price provides incentives for producers and consumers to change their
behaviours to maximize their own benefits, in order to allocate resources.
- The rationing function serves to allocate scarce resources by increasing the market price to
deter some consumers from buying the good. An increase in price by the price mechanism
helps to reduce quantity demanded, which is useful to eliminate shortages.
- Producer surplus is the positive difference between the price that a producer receives from
selling the good and the minimum amount they prepare to sell the good at. It is identified as
the area below the selling price and above the supply curve for the quantities sold.
- Consumer surplus is the positive difference between the amount that a consumer is willing
and able to pay for a good and the amount they actually pay. It is identified as the area above
the buying price and below the demand curve for the quantities purchased.
- Social surplus is the sum of consumer surplus and producer surplus at a particular price and
quantity. It is maximised at market equilibrium.
- Allocative efficiency is the socially optimum outcome where resources are allocated such that
the sum of the consumer and producer surplus are maximised. No one can be better-off
without making someone else worse-off. This is attained at the competitive market
equilibrium.
- Demand curve is aka marginal benefit curve
- Supply curve is aka marginal cost curve
- Law of diminishing marginal utility effect- as more of a quantity is consumed the satisfaction
derived from each additional unit consumed falls. Hence, to encourage consumers to buy
more, the price must fall.
Elasticity
- Elasticity in economics refers to the responsiveness of a variable as a result of a change in
another variable
- Elasticity of Demand measures the responsiveness of the quantity demanded in a market as a
result of factors such as price or income.
- Price elasticity of demand (PED) measures the responsiveness of quantity demanded to a
change in price and is calculated using the formula

- PED quantifies the law of demand; hence it is always negative. The negative sign may be
omitted as the value is always negative
- The percentage change in quantity demanded is greater at higher price levels, despite the
gradient of the demand curve being the same

- As price approaches 0 (point B), the percentage change in price (denominator of PED
formula) approaches infinity. Overall, the PED value approaches zero.
 - As quantity demanded approaches zero (point A), the percentage change in quantity
demanded (numerator of PED formula) approaches infinity. Hence, PED value approaches
infinity.
- At the midpoint of the demand curve, point M, the percentage change in quantity demanded
(numerator) is equal to the percentage change in price (denominator). Hence, PED is equals 1.
- At points above the midpoint, price is elastic
- At points below the midpoint, price is inelastic
- The marginal revenue curve is the gradient function of the total revenue curve and represents
the revenue gained for every additional unit sold. The MR curve is always 2x as steep as the
linear demand curve.
- Total revenue is maximised where PED=1 and MR=0

- If PED<1 i.e. price inelastic, firms can increase prices to increase total revenue
- If PED>1 i.e. price elastic, firms can reduce prices to increase total revenue
- Firms can adjust price to the point where PED=1 to maximize total revenue

Impact of PED on the decision making of firms

- Price discrimination
 Firms face different market segments with differing PED
 Students have generally lower incomes in comparison to adults
 Firms can charge higher prices for price inelastic segments i.e. adults and lower
prices for price elastic segments i.e. students to try and maximise revenue
- Dynamic pricing
 Many families with children looking to travel may be restricted to the school
holidays. These consumers have few alternative periods where they can travel so are
less sensitive to higher prices
 Airlines can increase prices during these holiday periods where consumers are less
price sensitive while reducing prices during off-seasons where consumers are more
price sensitive
- Taxation policies
 When demand is price elastic, an increase in price will lead to a proportionally greater
fall in quantity demanded. Governments can tax products with price elastic demand to
effectively discourage its consumption without a significant tax burden on consumers
  When demand is price inelastic, an increase in price will lead to as proportionally
lesser fall in quantity demanded. Hence, governments can tax price inelastic products,
such as cigarettes and alcohol, as a source of government revenue.

Impact of business sector on the PED of a good or service

- Primary commodities are agricultural products produced in the primary sector of the economy
- The PED for primary commodities is relatively low
 Primary commodities are essential for manufacturing]
 They account for a small proportion of national income
 There are fewer substitutes for primary commodities
- Manufactured goods are goods produced in the secondary sector of the economy
- Their PED is relatively high
 Lower degree of necessity
 Secondary goods account for a higher proportion of national income
 Many more substitutes

Income Elasticity of Demand

- Income elasticity of demand (YED) measures the responsiveness of quantity demanded to a
change in real income of consumers. It is calculated using the formula

- The value of YED can either be positive or negative depending on the good, therefore the sign
of the YED value is significant and must be indicated
- Normal goods refer to goods with a postie YED value, where demand increase as consumer
income increases. Normal goods can be separated into necessities and luxury goods.
- Necessities are goods and services used to satisfy basic needs where consumer demand does
not increase or decrease significantly with changes in income. Hence, 0<YED<1
- Luxury goods are goods and services used to satisfy wants and indulgences, where demand
changes proportionally greater to changes in income. Hence, YED>1
- Inferior goods are goods and services with more expensive and higher quality substitutes. As
incomes rise, demand for inferior goods fall as consumers are more willing and able to
purchase better alternatives. Hence, YED<0.
- Engel curve shows relationship between quantity demanded and income
Impact of YED on decision-making of economic agents
- Necessities are less affected by business cycle fluctuations; demand stays relatively constant
- Luxury goods are subject to the highest volatility in demand- strong demand during boom,
weak demand during recession
- Inferior goods are counter-cyclical- as income falls, demand increases and vice versa
- YED can be used to understand sectoral changes in markets at higher incomes. As incomes
rise
 The primary sector providing primary commodities (0<YED<=1) gros at a slower
rate
 Secondary sector providing manufactured goods (YED>!) grows at a faster rate
 Tertiary sector providing services (YED>!) likely grows at even faster rates

Price elasticity of supply

- Price elasticity of supply measures the responsiveness of quantity supplied in a market as a

result of change in price

- Due to law of supply, the mathematical value of PES is always greater than or equal to 0
- When a change in price leads to a proportionally lesser change in quantity supplied, supply is
relatively price inelastic. A relatively price inelastic curve will intersect the Q-axis.

- When a change in price leads to a proportionally greater change in quantity supplied, supply
is relatively price elastic. A relatively price elastic curve will intersect the P-axis
 - A supply curve passing through the origin will always have a PES of 1 i.e. unitary elastic
- As price and quantity supplied are directly proportional, the percentage change in quantity
supplied will always equal the percentage change in demand
- A horizontal curve is perfectly price elastic, a vertical curve is perfectly price inelastic
- Determinants of PES
 Time
 Rate at which costs increase
 Inventory
 Capacity
 Substitute factors of production
- Time
 Required to produce products
 Required to obtain more factors of production
 Needed to distribute goods to consumers
- Rate at which costs increase
 If MC rises slowly, supply is more price elastic
 If MC rises quickly, supply is less price elastic
- Inventory
 Inventory refers to the stocks of unused raw materials, work-in-progress goods, and
finished goods.
 Firms that are able to hold inventory can respond quickly to an increase in price and
can hold more inventory when price falls.
- Unused capacity
 Refers to the spare available resources a firm has but does not utilise
 Firms that choose to have spare capacity can increase production following an
increase in price, or decrease production following a fall in price
- Factor mobility
 Refers to a firm’s ability to substitute factors of production in the production process
 When it is easier to substitute factors of production, producers are more able to adjust
supply following a change in price
 Primary goods- immobile (land and labour intensive)
 Secondary goods- mobile (constituents have many substitutes)

The situation in the semiconductor industry is complex, with expectations that some sectors may see
improvement within six months, though the ripple effects of the current shortage could extend well
into 2022. The rise in prices of integrated circuits (ICs) is not driven by significantly increasing
marginal costs, as IC production relies on mass or flow production, which tends to stabilize costs as
production scales. However, the shortage has been added upon by a failure to stockpile components
with low mobility, leading to supply chain bottlenecks. Additionally, the industry's lack of spare
capacity has contributed to the shortage, though efforts are underway to expand production capacity.
This, however, takes time. It's important to note that the shortage is not due to a lack of fundamental
resources like raw silicon, but rather a mismatch between supply and demand. Restoring equilibrium
in the market will require both time and an expansion of production capacity.

- Veblen goods are goods that have a high snob value

-