CHAPTER 1.

1: Introduction to Economic Theory

TERMINOLOGIES:
● Economics - a social science concerned with man’s problem of issuing scarce
resources to satisfy unlimited wants.
● Goods - anything that yields satisfaction to someone.
● Basic needs/ Essentials - man’s needs required for his survival
● Luxury goods - goods that man can do without
● Economic resources - inputs used in the production of goods and services.
● Land - natural resources, not man-made, covering anything found on or under
land, including water, forests, minerals, and animals.
● Labor - human effort expended in production.
● Entrepreneur - organized all other factors of production to be used in the
creation of goods and services.
● Capital - materials used in the production of goods and services including
money.
● Variable - a factor that is subject to change or variations.
● Macroeconomics - the branch of Economics that studies the economy as a
whole, also known as National Income Analysis.
● Microeconomics - the branch of Economics that deals with parts of the
economy such as the household and the business firm. It is also known as Price
Theory.
● Normative Economics - an analysis of economics which deals with what
should be.
● Positive Economics - an analysis of economics which deals with what actually
is.
● Empirical Validation - the use of statistical evidence to prove the validity of the
hypothesis.
● Economic system - the means by which an economy reaches decisions. The
framework in which a society decides on its economic problems.
● Free enterprise system - a system in which all economic resources are
privately owned. Individuals are free to engage in a business of their choice.
● Right to private property - the right of private individuals and enterprises to
own things of value.
● Market - the context in which buyers and sellers buy and sell, goods, services,
and resources.
● Wants - the various desires and needs of consumers that have to be satisfied
through the use of goods and services.
● Outputs - refer to valuable goods and services resulting from the production
process.
BASIC TERMS IN ECONOMICS

Goods can be tangible (material goods or commodities) and intangible (services).

Goods can be classified into:

● Consumer and capital goods:

1. Consumer goods are goods that yield immediate satisfaction (food,

drinks, etc.)
2. Capital goods are used in the production of other goods and services
(buildings, machinery, and equipment)

● Essentials/ Necessity and luxury goods:

1. Essentials satisfy basic needs (food, shelter, medicine)

2. Luxury used to contribute to comfort and well being

● Economic or free goods:

1. Economic goods are both useful and scarce.

2. Free goods are so abundant that there is enough of it to satisfy
everyone’s needs without anybody paying for it. It is free, but air from the
electric fan is an economic good.

ECONOMIC RESOURCES

Land - refers to all natural resources. It is scarce and a parice has to be paid for it.
Income in the form of rent is offered when being used by others.
Labor - any form of human effort exerted in the production of goods and services.
Labor supply is highly dependent on the people’s social and cultural practices as well
as age distribution, migratory tendencies, etc. Wages include salaries, commissions,
tops, and other forms of remuneration.
Capital - man-made goods used in the production of goods and services. A nation’s
capital is dependent on its level of savings. Capital is an economic good and the owner
earns income called interest.
Entrepreneur - decides on the combination of land, labor, and capital in production.
The income earned by an entrepreneur is called profit which is what’s left behind after
all allocations of the other economic resources have been made.

SCARCITY
- Scarcity refers to the limitations that exist in obtaining all the goods and services
that people want and is the reason why people economize. Because of this,
society must confront 3 fundamental and interdependent economic problems:
1. What to produce and how much?
2. How shall goods be produced?
3. For whom shall goods be produced?
“Consumption”
The household is the basic consuming unit in the economy. Opportunity cost is
the value of a forgone alternative to a specific resource. The business firm serves as
the economy’s producing unit to satisfy human wants with goods and services.

GOALS OF ECONOMIC ACTIVITY

Problems that can be solved by restructuring the economic system of the government:

1. Unemployment of labor or other resources;

2. Economic instability that causes high and lows in production and investment
levels;
3. Low levels of growth and development, which make it more difficult for
underdeveloped and developing nations to rise from their low levels of income
and employment;
4. Inequality in income distribution resulting in the concentration of the nation’s
wealth in the hands of the few;
5. Determination of the type of economic system to adopt to fit the country’s
peculiar conditions and needs.

Unemployment leads to the existence of idle resources. Income is foregone. Economic

instability makes it difficult for producers to make accurate forecasts on demand and
consumption levels causing fluctuations in production and supplies resulting in
surpluses and shortages. Low levels of economic growth and development affects
poor countries the most. They get caught in a cycle of poverty which doesn’t allow
them to channel funds to investments to propel economic growth. Unequal distribution
of wealth causes a pyramidal structure in the economy with the majority on the low
income base only able to afford basic needs while the few (one-percenters) have a
huge purchasing power. Choosing the type of economic system for a country will vary
based on a nation’s needs and capacity.

ECONOMIC ANALYSIS AND ECONOMIC POLICY

Economic analysis is the process of directing economic relationships by

examining economic behavior and events, and determining the causal relationships
among the data and activities observed. Economics is a positive science which means
it deals with what it is.

One must learn to draw conclusions using inductive reasoning (particular to

general) or deductive reasoning (general to particular). This calls for the use of the first
tool of Economics which is logic.
Statistics is the second tool in Economics and is used by economic analysts to
quantitatively describe economic behavior which is used as a basis for hypothesis
testing. A hypothesis becomes a theory or principle once empirically validated.

The third tool of economics is mathematics which enables analysts to conceptualize

and quantify a hypothesis for empirical validation.

This scientific manner can be outlined in the following stage:

1. Observation - recognize conditions, behaviors, and events in the environment.

2. Definitions and Assumptions - describe the specific uses of the study and the
peripheral conditions.
3. Deductions - temporary conclusions made, based on observations and are
subject to evidence.
4. Empirical Testing - deductions have to be tested for validity. This will be the
basis of accepting or rejecting a hypothesis. The evidence consists of statistics
gathered.

Purposes of Economic Analysis:

1. It is an aid in understanding how an economy operates since it explains how

economic variables relate to one another.
2. It permits the prediction of the results of changes in economic variables.
3. It serves as the basis for policy formulation.

TYPES OF ECONOMIC SYSTEMS:

1. The Traditional Economy - subsistence economy. Produces everything that it

consumes. Production is carried on in the methods used by the forefathers and
therefore, primitive. It is very backward since it does not allow change.
2. The Command Economy - means of production are owned by the government.
3. The Market Economy - resources are privately owned and decisions are made
by the people themselves. It is coordinated through an interlocking network of
markets and prices. It depends on the demand and supply, competition is
supreme, there is consumer sovereignty, and the price is a guiding factor for
supply production.
4. The Mixed Economy - It is seldom that an economic system exists in pure
form. The Philippines is a mixed economy since it applies a mixture of the three
forms of decision-making. However, it is more market-oriented rather than
command or traditional.
In the resource market, the price of the resources: the rent, salaries, and interest, will
depend on the amount made available by the resource owners as well as the amount
of these resources that the producers will be willing to hire.

OPPORTUNITY COST
When one makes a choice, there is always an alternative that has to be given
up. The values of these alternatives given up are called opportunity costs.

PRODUCTION POSSIBILITIES FRONTIER

Because of scarcity, decisions have to be made on the combination of goods
that are to be produced using a given amount of input.
Everything that falls on the curve (point F) is possible and results in productive
efficiency. On the other hand, anything under point U will result in wasted resources. A
rightward shift in the PPC is caused by an increase in capital.

MACROECONOMICS AND MICROECONOMICS

Microeconomics is the division in Economics that studies the economy in

parts. It is a study of the price system, the individual consumer, and the individual firm.
Concerned with the flow of goods and services from firms to consumers, and resource
owners to business firms.

Macroeconomics is the division of Economics that deals with aggregates. It

presents pictures of totals: income, output, employment, spending, and price level.
Studies economics as a whole.

PRICE THEORY AND ECONOMIC THEORY

The principal functions of economic theory fall into two categories: (1) to
explain the nature of economic activity and (2) to predict what will happen to the
economy as facts change.

Positive economics is supposed to be completely objective, limited to the

cause-and-effect relationship of economic activity. Normative economics is
concerned with what ought to be. Economic policymaking is essentially normative in
character but if economic policymaking is to be effective in improving economic
well-being, it must be rooted in sound positive economic analysis.

Price theory (also called microeconomics) is abstract because it does not and
cannot encompass all the economic data of the real world. The function of theory is to
single out what appears to be the most relevant data and to build an overall conceptual
framework of the price system.

Characteristics of Microeconomics:
1. Microeconomics looks at the decisions of individual units.
2. Microeconomics looks at how prices are determined.
3. Microeconomics is concerned with social welfare.
4. Microeconomics has a limited focus.
5. Microeconomics develops skills:
a. Develops logical reasoning
b. Help you develop skill in the construction and use of models.
c. Employs optimizing techniques
d. Concept studies are applicable to personal resource allocation decisions.
 CHAPTER 1.2: The Circular Flow of Economic Activity

TERMINOLOGIES:
● Production - the use of economic resources in the creation of goods and
services for the satisfaction of human wants.
● Employment - the use of economic resources in production
● Consumption - the use of economic resources
● Flow - a quantity measured over a particular period of time
● Stock - a quantity measured as of a given point in time
● Wealth - anything of value owned
● Rent - payments for the use of land
● Wages - payment for the use of labor
● Interest - payment for the use of capital or money
● Monetary policy - that which affects savings, investment, and money supply
● Fiscal supply - that which controls taxes and government expenditures.
● Trade policy - that which affects a country’s exports and imports
● Inflows - incomes that go inside the economy like investment, government
expenditures, and exports which expand the flow of goods and services
● Outflows - incomes that go out of the economy like savings, taxes, and imports,
which constrict the flow of goods and services
● Multiplier - the number of times income is generated by an original inflow

ECONOMIC MODEL OF PRODUCTION

The flow of goods and services moves in a clockwise direction as seen in the
figure below:

We see the households delivering economic resources to the business firms because
households are the resource owners who can own land, labor, and capital which they
provide the firms. Once these goods are in their final form, they are now delivered to
households for consumption.
There are 3 types of firms: Raw materials are unprocessed goods like logs,
wheat, and iron ore. Intermediate goods are also called goods in process because
they are partially processed. Final goods consist of the final goods delivered for
consumption.
The figure below shows the existing interrelationship between these 3 types of firms:

ECONOMIC MODEL OF INCOME AND CONSUMPTION

The flow of physical goods is normally accompanied by a flow of income. In Figure 9,

we can see that in return for resources delivered by the households to the firms, they
get a money payment which becomes income for them.
The circular flow of income is in a counterclockwise direction illustrated in Figure 10.

When economic resources are delivered by the households to the business firms,
income is generated in the form of wages, rents, and interests earned. This income is
now the source of funds for households needed for them to buy goods and services for
consumption.

Combining the circular flow of physical and financial transactions, we arrive at Figure
11. The final output of goods within the flow consists of:

First: goods used in consumption, called consumer goods;

Secondly: goods used in the production of other goods, called capital,
producers, or investment goods.

The value of this final output of goods is equal to the value of the expenditures on
these goods.

THE CIRCULAR FLOW OF OUTPUT AND INCOME

The 2 flows of output and income are exactly equal. Thus, the value of all goods
and services produced in the economy during a year is equal to the money which
business firms spent, and which households as resource owners received. The
measure of output and income always result in the same value because for every peso
output produced, an income of one peso is created.
Figure 12 is a simplified model showing only the household and the firm:

Figure 13 shows what happens when we add two other important elements: the
government and foreign countries:

The government makes 2 types of purchases:

1. It hires labor from the household sector, rents its land for offices and factories,
and borrows capital by selling securities.
2. Buys goods from the business firms.

A country maintains trade relations with other countries. First, it sells to these countries
in the form of exports. For these, foreign countries make payments to the business
firms which sell to them. In turn, a country also buys from other countries’ goods and
services called imports.
INFLOWS AND OUTFLOWS

Consumption is the mainstream of the circular flow. If the total demand for
goods equals the amount of output, businesses would be able to sell all that they
produce. However, households do not usually spend all their income.

OUTFLOWS:

Savings have the effect of decreasing the level of economic activity in the flow.
This constitutes the first outflow from the stream.
Taxes decrease the level of economic activity which constitute our second
outflow since it lessens the disposable incomes of households.
Imports constitute our third outflow since the expenditures are not siphoned
back to our economy but instead, flow into foreign countries.

With these outflows in our economy, we are bound to experience a continuous

recession of economic activity. This could be offset by siphoning funds back into the
economic flow.

INFLOWS:

Investment is our first inflow because when households save, they bring the
money into the banks which the banks use to invest or lend to people who are planning
to invest. If investments are equal to savings, it offsets the outflow caused by
households.
Government Spending is our second inflow. The taxes collected by the
government are used to defray expenses for infrastructure, social services, education,
etc.
Exports are our third inflow because when we purchase goods from other
countries, we expect them to reciprocate by buying from us.
Outflows are difficult to control because they are dependent on income. Inflows
however are easier to manipulate with the proper use of policy to encourage exports
and investments to increase their expenditures. 3 sets of policies may be adopted:

1. Monetary policy affects savings and investment

2. Fiscal policy controls taxes and government expenditures
3. Trade policy affects a country’s exports and imports
 CHAPTER 2: DEMAND AND SUPPLY
DEMAND FOR GOODS AND SERVICES

Economists use the term demand to refer to the amount of some good or service
consumers are willing and able to purchase at each price.

Demand is fundamentally based on needs and wants—if you have no need for
something, you won’t buy it. Demand is also based on the ability to pay. If you cannot
pay then you have no effective demand.

Price is what a buyer pays for a unit of a specific good or service.

The quantity demanded (Qd) is the total number of units that consumers would
purchase at any price. A rise in the price of a good or service, decreases the quantity
demanded of that good. This is the reason why economists call the law of demand an
inverse relationship between price and quantity demanded.

DEMAND SCHEDULE AND DEMAND CURVE

There are two ways to describe the relationship between price and quantity demanded.
It is the Demand Schedule and Demand Curve.

Demand Schedule shows that as price rises, quantity demanded decreases and vice
versa. As we graph these points and the line connecting them is the demand curve.

Demand curves will appear somewhat different for each product. They may
appear relatively steep or flat or they may be straight or curved. But demand is mostly
slope down from left to right. This illustrates the law of demand—the inverse
relationship between price and quantity supplied.

Demand is not the same as quantity demanded. Demand refers to the curve and
quantity demanded refers to the specific point on the curve.
SUPPLY OF GOODS AND SERVICES

Supply means the amount of some good or service a producer is willing to supply at
each price.

A rise in price always leads to an increase in the quantity supplied of that good
or service, while a fall in price will decrease the quantity supplied.

The economists call the law of supply, a positive relationship between price and
quantity supplied—that a higher price leads to a higher quantity supplied and
vice-versa.

SUPPLY SCHEDULE AND SUPPLY CURVE

The Supply Schedule is the table that shows the quantity supplied of gasoline at each
price. As the price rises, the quantity supplied also increases, and vice-versa. The
Supply Curve is created by graphing the points from the supply schedule and then
connecting them. The upward slope of the supply curve illustrates the law of
supply—that a higher price leads to a higher quantity supplied, and vice-versa.

EQUILIBRIUM—WHERE DEMAND AND SUPPLY INTERSECT

The word equilibrium means balance. It is called the equilibrium, when two lines—the
supply curve and demand curve intersect with each other.

Equilibrium Price is the only price where the plans of consumers and the plans of
producers agree—that is, where the amount of the product consumers want to buy
(quantity demanded) is equal to the amount producers want to sell (quantity supplied).
They call this the equilibrium quantity.

If the quantity demanded does not equal the quantity supplied, then the market
is not in equilibrium at any price.

An excess supply or surplus occurs when a producer’s supply exceeds the

consumer’s demand. Example is Christmas decorations, especially when we are not in
the Christmas season. The supply of Christmas decorations is high but the people’s
demand is low.
 If a surplus remains unsold, those firms involved in making the productions of
supply will affect the worker’s minimum wage and productions of supply because of
the cost of producing new products.

An excess demand or shortage occurs when a consumer’s demand exceeds

the producer’s supply. Example is the issue last month about the sugar supply, sugar is
essential to our daily life especially for the bakers. The demand for sugar increases but
the supply of sugar is low.

CETERIS PARIBUS ASSUMPTION

A demand curve or a supply curve is a relationship between two, and only two,
variables when all other variables are held constant.

The assumption behind a demand or supply curve is that no relevant economic factors
are changing.

Ceteris Paribus means “other things being equal”.

We typically apply ceteris paribus when we observe how changes in price affect
demand and supply. Demand and supply depend on more factors than just price. For
instance, a consumer’s demand depends on income and a producer’s supply depends
on the cost of producing the product.

We examine the changes one at a time, assuming the other factors are held constant
or equal.

Example of Ceteris Paribus: an increase in the price reduces the amount consumers
will buy (assuming income, and other factors that affect demand is held constant). The
amount consumers buy falls for two reasons: because of the high price and the low
income of a consumer.

SHIFT IN DEMAND

A shift in demand means that at any price, the quantity demanded will be different than
it was before.

Summarizes 6 factors that can shift demand curves. The direction of the arrows
indicates whether the demand curve shifts represent an increase or a decrease in
demand.

A change in the price of a good or service causes a movement along a specific

demand curve, and it leads to some change in the quantity demanded, but it does not
shift the demand curve.

A rightward shift means an increase while a leftward shift means a decrease in

demand.
FACTORS THAT AFFECT DEMAND:

● Income of a Consumer

Income affects demand, when the income of a consumer decreases, the

demand of the consumer also decreases. Because the consumer does not have
the ability to purchase more products as his income is lacking and vice-versa.

For some—luxury cars and fine jewelry—the effect of a rise in income can
be especially pronounced. A product whose demand rises when income rises,
and vice-versa, is called normal goods.

As income rises, many people are less likely to buy second hand cars and
more likely to buy brand new cars. A product whose demand falls when income
rises, and vice-versa, is called inferior goods.

● Changing Tastes or Preferences

For example, traditional news sources like newspapers and digital

sources. Changing your preferences would cause a change in demand.

● Changes in the Composition of the Population

For example, new born babies, the demand for baby products is most
likely to rise if many mothers give birth. Similarly, changes in the size of the
population can affect demand for housing and many other goods.

● Changes in the Prices of related Goods such as Substitutes or

Complements

A substitute is a good or service that we can use in place of another good

or service. As electronic books become more available, you would expect to see
a decrease in demand for traditional printed books. A lower price for a substitute
decreases demand for the other product and a higher price for a substitute good
has the reverse effect.

Other goods are complements for each other, meaning we often use the
goods together, because consumption of one good tends to enhance
consumption of the other. Example if the price of golf clubs rises, since the
quantity demanded of golf clubs falls, demand for a complement good like golf
balls decreases, too.

● Changes in expectations about Future Prices

For example, if a consumer predicts that the price of the fish will most
likely increase in the future, she will try to buy a fish today or as soon as possible
and vice-versa.

Therefore, a shift in demand happens when a change in some economic

factor causes a different quantity to be demanded at every price.
SHIFT IN SUPPLY

Means a change in the quantity supplied at every price.

A shift in supply happens when a certain factor that affects supply will cause a change
in quantity supplied. A shift to the right is an increase in supply curve and shift to the
left is a decrease in supply curve.

FACTORS THAT AFFECT SUPPLY

● Production Cost

A firm produces goods and services using combinations of labor,

materials, and machinery, or what we call inputs or factors of production.

Example, if a firm faces lower costs of production, while the prices for the
goods or services the firm produces remain unchanged, a firm’s profits go up.
When a firm’s profits increase, it is more motivated to produce output, since the
more it produces the more profit it will earn. When costs of production fall, a firm
will tend to supply a larger quantity at any given price for its output.

● Changes in Weather

This factor will affect the cost of production for many agricultural
products. For instance, in 2014 the Manchurian Plain in Northeastern China,
which produces most of the country’s wheat, corn, and soybeans, experienced
its most severe drought in 50 years. A drought decreases the supply of
agricultural products, which means that at any given price, a lower quantity will
be supplied. Conversely, especially good weather would bring positive results.

● New Technologies for Production

When a firm discovers a new technology that allows the firm to produce
at lower cost, a positive result is expected. A technological improvement that
reduces costs of production will shift supply to the right, so that a greater
quantity will be produced at any given price.

● Government Policies

This factor can affect the supply curve through taxes, regulations, and
subsidies. Businesses treat taxes as costs. The higher the taxes are, the lower a
supply will be produced.

Other examples of policy are the wide array of government regulations

that require firms to spend money to provide a cleaner environment. Complying
with regulations increases costs.

Government subsidy, on the other hand, is the opposite of a tax. A

subsidy occurs when the government pays a firm directly or reduces the firm’s
 taxes if the firm carries out certain actions. Subsidies reduce the cost and
increase supply at every given price.

CHANGES IN EQUILIBRIUM PRICE AND QUANTITY: THE FOUR-STEP

PROCESS

1. Draw a demand and supply model before the economic change took place.
2. Decide whether the economic change you are analyzing affects demand or
supply.
3. Decide whether the effect on demand or supply causes the curve to shift to the
right (increase) or to the left (decrease), and sketch the new demand or supply
curve on the diagram.
4. Identify the new equilibrium and then compare the original equilibrium price and
quantity to the new equilibrium price and quantity.

PRICE CEILINGS AND PRICE FLOORS

Government does intervene in a market either to prevent the price of some goods or
services from rising ”too high” or from falling “too low”. Government like the
Department of Trade and Industry (DTI).

Price controls is a law that the government enact to regulate prices. Price controls
come in two flavors. A price ceiling keeps a price from rising above a certain level,
while a price floor keeps a price from falling below a given level.

PRICE CEILING

Price Ceiling is a legal maximum price that one pays for some goods and services.

A government imposes price ceilings in order to keep the price of some necessary
goods or services affordable.

Price ceilings are enacted in an attempt to keep prices low for those who need the
product. However, when the market price is not allowed to rise to the equilibrium level,
a shortage occurs.

PRICE FLOORS

Price Floor is the lowest price that you can legally pay for some good or service.

Minimum wage is a known example of price floor, which is based on the view that
someone working full time should be able to afford a basic standard of living.

Price floor is sometimes called “price supports,” because they support a price by
preventing it from falling below a certain level. The most common way price supports
work is that the government enters the market and buys up the product, adding to
demand to keep prices higher than they otherwise would be.

DEMAND, SUPPLY, AND EFFICIENCY

Consumer Surplus

The amount that individuals would have been willing to pay, minus the amount that
they actually paid.

For instance, you bought an airplane ticket for a flight to Disney World during school
vacation week for $100, but you were willing to pay $300 for one ticket. The $200
represents your consumer surplus.

Producer Surplus

The amount that a seller is paid for a good minus the seller’s actual cost.

For instance, each firm produces coffee at a slightly different cost. For some, it costs
$2 to produce, whilst it costs others $3 and a few pays $5. At the equilibrium point, the
coffee is sold at $5. The producer surplus refers to all those who produce at a cost
lower than $5.

Social Surplus

Also known as “Total Surplus” or “Economic Surplus”.

It is the sum of consumer surplus and producer surplus.

Social surplus is larger at the equilibrium quantity and price than it will be at any other
quantity and price. Deadweight loss is loss in total surplus that occurs when the
economy produces at an inefficient quantity.
 CHAPTER 3: ELASTICITY OF DEMAND AND SUPPLY

WHAT IS ELASTICITY?

Elasticity is an economics concept that measures responsiveness or sensitivity of one

variable to changes in another variable. Those with elasticities higher than 1 (like 1.2 or
1.5) are elastic or are more sensitive to let’s say change in demand when price
changes. Examples of elastic goods are clothing, food, basically luxury goods. While
basic goods are inelastic or are less sensitive to change since they are essentials.

PRICE ELASTICITY

This is the ratio between the percentage change in the Quantity Demanded (Qd) or
Quantity Supplied (Qs) and the corresponding percent in change.

Price Elasticity of Demand

Measure of how sensitive the quantity demanded is to its price.

Percentage change in the quantity demanded of a good or service

Percentage change in price

Price Elasticity of Supply

Measures the degree of responsiveness of quantity supplied to a change in own price

of the commodity.

Percentage change in the quantity demanded of a good or service

Percentage change in price

We can usefully divide elasticities into three broad strategies:

What is the Midpoint Method for Elasticity?

This is used to calculate elasticity along a demand or supply curve. Economists use the
average percent change in both quantity and price.

It is represented in the following equations:

2 Extreme Cases of Elasticity

1. Infinite Elasticity or Perfect Elasticity - refers to the extreme case where either
the quantity demanded (Qd) or supplied (Qs) changes by an infinite amount in
response to any change in price at all.

2. Zero Elasticity or Perfect Inelasticity - refers to the extreme case in which a

percentage change in price, no matter how large, results in zero changes in
quantity.

3. Constant Unitary Elasticity - in either a supply or demand curve, occurs when

a price change of one percent results in a quantity change of one percent. (left is
demand curve which right is supply curve)
Why is the demand curve with constant unitary elasticity concave?

Because at high prices, a one percent decrease in price results in more than a one
percent increase in quantity. As we move down the demand curve, price drops and the
one percent decrease in price causes less than one percent increase in quantity.

What is the supply curve with a constant unitary elasticity a straight line?

Because the curve slopes upward and both price and quantity are increasing
proportionally.

How Price Elasticities impact Revenue

Studying elasticities is useful for a number of reasons, pricing being most important.

Demand for necessities such as housing and electricity is inelastic, while items that are
not necessities such as restaurant meals are more price-sensitive.

Elasticity and Tax Incidence

The analysis, or manner, of how a tax burden is divided between consumers and
producers. The figure below shows how an excise tax introduces a wedge between the
price paid by consumers (Pc) and the price received by the producers (Pp).
Long Run vs Short Run Impact

Elasticities are often lower in the short run than in the long run. The underlying
reason for this pattern is that supply and demand are often inelastic in the short run, so
that shifts in either demand or supply can cause a relatively greater change in prices.
However, since supply and demand are more elastic in the long run, the long-run
movements in prices are more muted, while quantity adjusts more easily in the long
run.

Income Elasticity of Demand

The income elasticity of demand is the percentage change in quantity

demanded divided by the percentage change in income.

% change in quantity demanded

Income elasticity of demand =
% change in income

Cross-Price Elasticity of Demand

This is the percentage change in the quantity of good A that is demanded as a

result of a percentage change in the price of good B.

The term “cross-price” refers to the idea that the price of one good is affecting
the quantity demanded of a different good

% change in Qd of good A
Cross- price elasticity of demand =
% change in price of good B
Quiz:

1. It measures responsiveness of one variable to changes in another variable.

- Elasticity

2. This case is when a demand does not change or affect the quantity, when the price
changes.

- Perfect Inelasticity

3. This case is the same or equal to the change of quantity demand and change of
price.

- Constant Unitary Elasticity

4. The analysis, or manner, of how a tax burden is divided between consumer and
producers.

- Tax Incidence

5. Period time in which the quantities of all inputs can be varied.

- Short-run

For more information, refer to the Principles of Microeconomics pdf file that Ma’am
Macel sent.
 CHAPTER 4: THEORY OF CONSUMPTION

Budget Constraint Line

The budget constraint line shows various combinations of 2 goods given to the
consumer’s limited income. The quantity of one good is on the horizontal axis and the
quantity of the other good is on the vertical axis.

Based on your budget, you can afford to buy a specific amount of good A but
sacrificing how much of good B you can purchase. The example below shows that at
point S, you can afford 6 movies and 1 t-shirt. If you want to purchase 2 shirts, you can
only afford 4 movies as shown in point R.

Total Utility and Law of Diminishing Marginal Utility

Utility - satisfaction or happiness a person gets from consuming a good or service.

Total Utility - overall level of satisfaction derived from consumer choices. It is the
aggregate (formed by adding together several amounts of things) amount of
satisfaction or fulfillment that a consumer receives through the consumption of a
specific good or service.

Marginal Utility - the additional utility provided by one additional unit of consumption.
Used to determine how much of an item consumers are willing to purchase the
equation for marginal utility.

Law of Diminishing Marginal Utility - the common pattern that each marginal unit of
a good consumed provides less of an addition to utility to the previous unit. As
consumption increases, the marginal utility that a consumer gets from each additional
unit declines or decreases.

How Changes in Income Affect Consumer Choices

When income rises, the most common reaction is to purchase more of both goods,
conversely, when income falls, the most typical reaction is to purchase less of both
goods.
Normal Goods - This is what we call goods and services when a rise in income leads
to a rise in the quantity consumed of that good and a fall in income leads to a fall in the
quantity consumed.

Inferior Goods - These are goods where its demand declines as income rises
(conversely, where demand rises as income falls). This occurs when people trim back
on a good as income rises, because they can now afford the more expensive choices
they prefer.

How Price Changes Affect Consumer Choices

The typical response to higher prices is that a person chooses to consume less of the
product with the higher price. This occurs for 2 reasons:

Substitution Effect - occurs when a price changes and consumers have an incentive
to consume less of the food with a higher price and more of a good with a lower price.

Income Effect - Higher prices means that the buying power of income has been
reduced, which leads to buying less of the good.

An example of this is the situation today. Higher prices while income or minimum
wages remain unchanged causes people to purchase less of a good with higher prices
and more of a good with lower prices.

The Foundations of Demand Curves

Changes in the price of a good lead the budget constraint to shift. A shirt in the budget
constraint means that when individuals are seeking their highest utility, the quantity
that is demanded of that good will change.
Traditional and Behavioral Economics

Traditional Economics assumes rationality, which means that people take all available
information and make consistent and informed decisions that are in their best interest.

How does a consumer make decisions in Traditional Economics?

1. Gather all information

2. Weigh up all information
3. Take time and make a utility maximizing decision

Behavioral Economics seeks to enrich our understanding of decision-making by

integrating the insights of psychology into economics. Traditional economists argue
that these are “irrational behaviors” but they omit something important: people’s state
of mind.

Traditional economists assume that human beings have complete self control and
would make consistent economic decisions everyday, free from temptations, but we all
know that we don’t. Behavioral economists are at least trying to explain behavior that
perhaps, these “irrational behaviors” have deeper underlying reasons in the first place.

Irrational Behavior Economics happens when people make choices and decisions
that go against the assumption of rational utility-maximizing behavior.

Quiz:

1. As the quantity rises the marginal utility decreases

- Law of Diminishing Marginal Utility

2. Shows the various combinations of two goods that are affordable given consumer
income

- Budget Constraint line

3. It is the term economists use to describe the satisfaction or happiness a person gets
from consuming a goods or services.

- Utility
4. It is the aggregate amount of satisfaction or fulfillment that a consumer receives
through the consumption of specific goods or services.

- Total Utility

5. Goods where demand declines as income rises or conversely, where the demand
rises as income falls.

- Inferior Goods

6. It occurs when a price changes and consumers have an incentive to consume less
of the good with a relatively higher price and more of the good with a relatively lower
price.

- Substitution Effect

7. seeks to enrich our understanding of decision-making by integrating the insights of

psychology into economics.

- Behavioral economics

8. consumers in behavioral economics are

- irrational

9-10 Define Consumer choice based on your own understanding.