Session 2 - Production, Supply and Demand

Factors of Factors of production are the inputs used in producing goods and
Production services.
Output is the production the firm creates.
Inputs are the things a firm needs to make its output.
Four Factors of Land consists of the geographic location and natural resources used in
Production production
Capital consists of all the man-made resources that workers use to create
the final product. This category includes machinery, tools, and other
man-made goods.
Labor generally consists of workers and the skills those workers bring to
a job.
Entrepreneurs are the people who conceive and start a business.
Labor Labor is the human effort that can be applied to production.
In the modern economy, human capital, the improvement in labor which
is the knowledge and skills that people use to help them produce output.
Human Capital
Skills a worker has as a result of education, training, or experience that
can be used in production are called Human Capital.
The amount of labor available to an economy can be increased in two
ways:
• Increase the total quantity of labor, either by increasing the
Amount of Labor
number of people available to work or by increasing the average
number of hours of work per time period.
• Increase the amount of human capital possessed by workers.
Human-made machines, tools, and structures that aren’t directly
Capital (or
consumed but are used to produce other things that people do directly
Capital Goods)
consume.
Capital does not consist solely of physical objects. Capital may thus
include physical goods and intellectual discoveries.
Any resource is capital if it satisfies two criteria:
1. The resource must have been produced.
2. The resource can be used to produce other goods and services.
Money is not considered capital. A firm cannot use money directly to
produce other goods, so money does not satisfy the second criterion for
capital. Firms can, however, use money to acquire capital.
Land / Natural Land isn’t just real estate but all naturally occurring resources that can be
Resources used to produce things people want to consume.
 Land includes the weather, plant and animal life, geothermal energy, and
the electromagnetic spectrum.
Any resource is Land if it satisfies two criteria:
1. They are found in nature—that no human effort has been used to
make or alter them.
2. They can be used for the production of goods and services. That
requires knowledge; we must know how to use the things we find
in nature before they become resources.
The natural resources available to us can be expanded in three ways:
1. Discovery of new natural resources
2. Discovery of new uses for resources
3. Discovery of new ways to extract natural resources in order to use
them
An entrepreneur is a person who, operating within the context of a
market economy, seeks to earn profits by finding new ways to organize
factors of production.
Entrepreneur Entrepreneurship is the human resource, distinct from labor, that
combines the other three factors of production (land, labor, and capital)
to produce new products or make innovations in the production of
existing products.
Industry Industry is a group of firms that sell similar products or services.
1. A place (physical or virtual) where there is a reasonable
expectation of finding both buyers and sellers for the same
product or service
Market 2. The interaction of buyers and sellers defined within the bounds of
broad product categories
3. An economic system (a “market economy”) that relies on markets
to conduct many economic activities
Households:
• Owns the factors of production
• To consume all final goods and services
• Their income consists of wages, rent, interest and profits
Participants in a
Business or Firms:
Market
• Acquires factors of production from households
• Produce and sell goods and services goods to the households
• Receives profits from sale of goods and service
Buyer and Sellers are roles.
Circular Flow of The Circular Flow of Economy is a visual model of the economy
Economy
Households and firms interact in two types of markets.
• Markets for goods and services (Product Markets)
• Markets for the factors of production (Factor Markets)
The inner loop represents the flows of inputs and outputs.
The outer loop of the diagram represents the corresponding flow of
money.
In the Factor Markets, households are sellers, and firms are buyers.
Factor Markets In these markets, households provide the inputs that firms use to produce
goods and services.
In the Product Markets, households are buyers, and firms are sellers.
Product Markets In particular, households buy the output of goods and services that firms
produce.
Involves the government in the circular flow.
Three Sector
Just like households and firms the government also earns incomes and
Model
makes expenses.
Three kinds of monetary flows between the government and the rest of
the economy i.e.
• Taxes on both households and firms
• Purchase goods and services
• Transfer payments and subsidies
Four Sector Involves Financial Intermediaries and Foreign markets.
Model`
Financial Institution consists of banks and non-bank intermediaries who
Financial
engage in the borrowing (savings from households) and lending of
Institution
money.
Foreign Market consists of two kinds of international economic
Foreign Market transactions i.e. export and import of goods and services and inflow and
outflow of capital.
Leakages are money that exits the circular flow model. It is not a saving
Leakages
rather it reduces the volume of the circular flow.
Injections are money that enters the circular flow model. It increases the
Injections
size of the flow of money in the circulation
Market A market is a group of buyers and sellers of a particular good or service.
The buyers as a group determine the demand for the product, and the
sellers as a group determine the supply of the product.
 The terms supply and demand refer to the behavior of people as they
interact with one another in markets.
Economists use the term competitive market to describe a market in
which there are so many buyers and so many sellers that each has a
negligible impact on the market price.
Competitive
Each seller has limited control over the price because other sellers are
Market
offering similar products.
Similarly, no single buyer can influence the price because each buyer
purchases only a small amount.
When a market is competitive, its behavior is well described by the
supply and demand model.
Supply and When a market is competitive, its behavior is well described by the
Demand Model supply and demand model.
There are five key elements in this model:
1. The demand curve
2. The supply curve
3. The set of factors that cause the demand curve to shift and the set
of factors that cause the supply curve to shift
4. The market equilibrium, which includes the equilibrium price and
equilibrium quantity
5. The way the market equilibrium changes when the supply curve
or demand curve shifts
Demand exists when an individual or a group wants something badly
Demand
enough to pay or trade for it.
The law of demand states that, other things being equal, quantity
Law of Demand
demanded falls when prices rise, and rises when prices fall.
Quantity Quantity Demand is the different quantities of goods that consumers are
Demanded willing and able to buy at different prices
The sum of all the individual quantities demanded by each buyer in the
Market Demand
market at each price.
Demand curve is usually graphed with price on the vertical axis and
quantity on the horizontal axis.
Demand curve refers to the entire curve, while quantity demanded is a
Demand Curve
point on the curve.
Note that the demand curve shown in Figure slopes downward. It is
representing an inverse relationship
Demand A table showing the different quantities of a good that a person is willing
schedule and able to buy at various prices over a given period of time.
Market demand A table showing the different total quantities of a good that consumers
schedule are willing and able to buy at various prices over a given period of time.
Ceteris paribus is a Latin phrase economists use meaning “all other
things held constant.”
Ceteris paribus
Demand curve or Supply curve is accurate only as long as the ceteris
paribus assumption is true.
Shifts in the A shift in the demand curve, either to the left or right.
Demand Curve Caused by any change that alters the quantity demanded at every price.
Five principal factors that shift the demand curve for a good or service:
1. Changes in the prices of related goods or services
2. Changes in income
3. Changes in tastes and preference
4. Changes in (future) expectations
5. Changes in the number of consumers
When economists refer to supply, they mean the amounts that firms are
Supply
willing and able to produce (or sell) at particular prices.
Law of supply claims that, other things being equal, the quantity supplied
Law of Supply
of a good rises when the price of the good rises
Quantity Quantity supplied is the amount of a good or service that producers are
Demanded willing and able to sell at the current price
The market supply is the sum of the quantities supplied by each seller in
Market Supply
the market at each price.
Supply curve is usually graphed with price on the vertical axis and
quantity on the horizontal axis.
Supply curve refers to the entire curve, while quantity supply is a point on
the curve.
Supply Curve
Keep in mind that the points on the supply curve don’t represent the
prices that the seller wants to receive for any given amount.
Supply curve is accurate only as long as the ceteris paribus assumption is
true.
A table showing the different quantities of a good that producers are
Supply schedule
willing and able to supply at various prices over a given time period.
Market Supply A supply schedule can be for an individual producer or group of
Schedule producers, or for all producers (the market supply schedule).
Change in Supply
Shifts in the
• A shift in the supply curve, either to the left or right.
Supply Curve
• Caused by a change in a determinant other than price.
Five principal factors that shift the supply curve for a good or service:
 1. Changes in prices/availability of inputs
2. Changes in Gov’t actions
3. Changes in technology
4. Changes in expectations of future profit
5. Changes in the number of producers or sellers
In the context of supply and demand, equilibrium occurs when the
Equilibrium pressure for higher prices is balanced by the pressure for lower prices,
and so that rate of exchange between buyers and sellers persists.
Equilibrium is the point where conflicting interests are balanced.
Equilibrium is where the two curves intersect.
Only at this point is the amount that demanders are willing to purchase
the same as the amount that suppliers are willing to supply.
It is a point which will be automatically reached in a free market through
the operation of the price mechanism.
The price that balances quantity supplied and quantity demanded.
Equilibrium Price On a graph, it is the price at which the supply and demand curves
intersect.
The quantity supplied and the quantity demanded at the equilibrium
Equilibrium price.
Quantity On a graph it is the quantity at which the supply and demand curves
intersect.
Defined as the condition in which the quantity willingly offered for sale
by sellers at a given price is just equal to the quantity willingly demanded
Market by buyers at that same price. When that condition is met, we say that the
Equilibrium market has discovered its equilibrium price.
The equilibrium of supply and demand balances the quantity demanded
and the quantity supplied so that there is no surplus or shortage of either.
When the current price is above the equilibrium price, the quantity
supplied exceeds the quantity demanded, and some suppliers are unable
Surplus to sell their goods because fewer units are purchased than are supplied.
This condition, where the quantity supplied exceeds the quantity
demanded, is called a surplus.
When the current price is lower than the equilibrium price, the quantity
demanded exceeds the quantity supplied, and a shortage exists.
Shortage
This condition, where the quantity demanded exceeds the quantity
supplied, is called a surplus.
Shifts in A shift in the supply curve is called a change in supply.
Equilibrium
A movement along a fixed supply curve is called a change in quantity
supplied.
A shift in the demand curve is called a change in demand.
A movement along a fixed demand curve is called a change in quantity
demanded.