BASIC CONCEPT OF ECONOMICS
resources.
What is ECONOMICS?
It is the study of how humans make decisions in the
face of scarcity. These can be individual decisions,
family decisions, business decisions or societal
decisions.
Microeconomics focuses on the actions of
individual agents within the economy, like
households, workers, and businesses.
Macroeconomics looks at the economy as a whole.
It focuses on broad issues such as growth of
production, the number of unemployed people, the
inflationary increase in prices,government deficits,
and levels of exports and imports.
Concept of Macroeconomics
Macroeconomics is a branch of economics that
focuses on the behavior and decision-making of an
economy as a whole. The study of the entire
economy in terms of the total amount of goods and
services produced, total income earned, the level of
employment of productive resources, and the
general behavior of prices.
There are three central topics for macroeconomic
study on the national level: output, unemployment,
and inflation.
Problem of Scarcity
Scarcity means that human wants for goods,
services and resources exceed what is available.
Resources, such as labor, tools, land, and raw
materials are necessary to produce the goods and
services we want but they exist in limited supply.
Every society, at every level, must make choices
about how to use its resources.
Concept of Opportunity Cost
● Economists use the term opportunity cost to
indicate what one must give up to obtain
what he or she desires.
● The idea behind opportunity cost is that the
cost of one item is the lost opportunity to do
or consume something else.
● Opportunity cost is the value of the next
best alternative.
● Since people must choose, they inevitably
face tradeoffs in which they have to give up
things they desire to obtain other things they
desire more.
What is PPF?
Product Possibilities Frontier is a graph that shows
all the different combinations of output of two
goods that can be produced using available
The said model captures the key concepts of
scarcity, choice, and tradeoffs.
Economic Systems
Traditional economy, which is the oldest
economic system and is used in parts of Asia,
Africa, and South America. Traditional economies
organize their economic affairs the way they have
always done.
In a command economy, economic effort is
devoted to goals passed down from a ruler or ruling
class.
In a market economy, decision-making is
decentralized. Market economies are based on
private enterprise: the private individuals or groups
of private individuals own and operate the means of
production.
Demands for Goods and Services
● Demand refers 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 or want for
something, you won't buy it.
● Demand is also based on ability to pay. If
you cannot pay for it, you have no effective
demand.
Law of Demand
What a buyer pays for a unit of the specific good or
service is called price. The total number of units
that consumers would purchase at that price is
called the quantity demanded.
A rise in price of a good or service almost always
decreases the quantity demanded of that good or
service. Conversely, a fall in price will increase the
quantity demanded.
Demand Schedule and Demand Curve
A demand schedule is a table that shows the
quantity demanded at each price.
A demand curve is a graph that shows the quantity
demanded at each price.
Sometimes the demand curve is also called a
demand schedule because it is a graphical
representation of the demand schedule.
Demand Function
➤ A demand function describes the mathematical
relationship between the quantity demanded and
one or more determinants of the demand, as the
price of the good or service, the price of
complementary and substitute goods.
A demand function could be shown through: Qd=a-
bP
Qa quantity demanded
a = the quantity demanded when the price = 0
(because b x 0 = 0)
P = price
b = Tells us how steep the demand curve will be. It
is the coefficient that determines the slope of the
demand curve (from steep to flat), and measures
how responsive the change in quantity demanded is
to changes in the price. b is always negative
because, as we have seen, there is an inverse
relationship between price and the quantity
demanded.
Factors Affecting the Demand Curve
1. Income
Normal Goods: As mentioned earlier, for normal
goods, an increase in consumer income generally
leads to an increase in demand, shifting the demand
curve to the right. Conversely, a decrease in income
may lead to a decrease in demand, shifting the
curve to the left.
Inferior Goods: The relationship is opposite for
inferior goods. An increase in income may lead to
a decrease in demand for inferior goods, shifting
the demand curve to the left.
2. Tastes and Preferences
Changes in consumer preferences, fads, trends, or
cultural shifts can significantly impact demand. If a
product becomes more popular or is perceived as
desirable, the demand curve may shift to the right.
3. Prices of Related Goods
Substitutes: An increase in the price of a substitute
good can lead to an increase in demand for the
original good and vice versa. The demand curve for
a good may shift to the right if the price of its
substitutes rises.
Complements: The demand for a good may also be
influenced by the price of complementary goods.
For example, if the price of smartphones
(complement) decreases, the demand for mobile
apps (related good) may increase, shifting the
demand curve to the right.
4. Number of Buyers
An increase in the number of buyers in the market
can lead to an increase in demand, shifting the
curve to the right. Conversely, a decrease in the
number of buyers may lead to a decrease in
demand, shifting the curve to the left.
5. Expectations
Expectations about future price changes or
economic conditions can influence current demand.
For example, if consumers expect prices to rise in
the future, they may increase their current demand,
shifting the curve to the right.
6. Government Policies
Policies such as taxes, subsidies, or regulations can
impact the demand for certain goods. For instance,
a subsidy on electric vehicles might increase the
demand for such vehicles, shifting the demand
curve to the right.
Supply of Goods and Services
Supply means the amount of some good or service
a producer is willing to supply at each price.
Price is what the producer receives for selling one
unit of a good or service. A rise in price almost
always leads to an increase in the quantity supplied
of that good or service, while a fall in price will
decrease the quantity supplied.
Law of Supply
The law of supply states that a higher price leads to
a higher quantity supplied and that a lower price
leads to a lower quantity supplied.
Supply Schedule and Supply Curve
● A supply schedule is a table that shows the
quantity supplied at each price.
● A supply curve is a graph that shows the
quantity supplied at each price. Sometimes
the supply curve is called a supply schedule
because it is a graphical representation of
the supply schedule.
● Supply curves and supply schedules are
tools used to summarize the relationship
between supply and price.
Supply Function
➤ A supply function in economics is a
mathematical formula that depicts the relationship
between quantity supplied, price of the commodity,
and other related variables. Here, the quantity
supplied is expressed as a function of the price. It
helps businesses and governments to study and
monitor an economy's demand-supply situation.
A supply function could be shown through: Q{s}=
-a+bP
Q{s}=quantity supplied
-a= the quantity demanded when the price = 0
(because b\times0=0^{\prime}
p= price
b= Tells us how steep the supply curve will be. It is
the coefficient that determines the slope of the
supply curve (from steep to flat), and measures how
responsive the change in quantity supplied is to
changes in the price. b is always positive because,
as we have seen, there is a direct relationship
between price and the quantity demanded.
Factors Affecting the Supply Curve
1. Input Prices
The cost of inputs, such as raw materials, labor, and
energy, can significantly impact production costs.
An increase in input prices generally decreases the
profitability of production, leading to a decrease in
the quantity supplied and shifting the supply curve
to the left. Conversely, a decrease in input prices
can increase profitability and shift the supply curve
to the right.
2. Technological Changes
Advances in technology can lead to more efficient
and cost-effective production methods.
Technological improvements often reduce
production costs, increase productivity, and
contribute to an increase in the quantity supplied.
This shifts the supply curve to the right.
3. Number of Sellers
An increase in the number of sellers or producers
entering the market can lead to an increase in the
overall quantity supplied. This shift to the right is
often associated with increased competition.
4. Expectations
Producer expectations about future prices or market
conditions can influence current supply. If
producers anticipate higher future prices, they may
decrease current supply, holding back some of their
goods to sell later at the expected higher prices,
shifting the supply curve to the left.
5. Government Policies
Government interventions, such as taxes, subsidies,
and regulations, can impact the cost of production
and influence the quantity supplied. For example,
subsidies to agricultural producers may encourage
increased production, shifting the supply curve to
the right.
6. Natural Disasters and Environmental Factors
Events like natural disasters, extreme weather
conditions, or other environmental factors can
disrupt production processes and affect the quantity
supplied. For instance, a drought can reduce
agricultural output, shifting the supply curve to the
left.
7. Changes in the Prices of Related Goods
The prices of goods that are jointly produced (joint
products) can influence the supply of a particular
good. For example, if a firm produces both beef and
leather, an increase in the price of leather may
encourage more production of beef, shifting the
supply curve to the right.
8. Changes in Production Costs
Factors such as changes in wages, energy costs, and
transportation costs can impact production costs.
An increase in production costs may lead to a
decrease in the quantity supplied and a leftward
shift in the supply curve.
MARKET EQUILIBRIUM
It refers to the state in a market where the quantity
of a good or service demanded by consumers
equals the quantity supplied by producers, resulting
in a stable market price.
Supply and demand curves intersect at the
equilibrium price. This is the price at which we
would predict the market will operate.
The equilibrium price is the only price where the
plans of consumers and the plans of producers
agree-that is, where the amount consumers want to
buy of the product, quantity demanded, is equal to
the amount producers want to sell, quantity
supplied.
This common quantity is called the equilibrium
quantity. At any other price, the quantity
demanded does not equal the quantity supplied, so
the market is not in equilibrium at that price.
WHAT IS NATIONAL INCOME?
National income is the sum of all the income made
in the economy on an aggregate level. It is an
essential measure of economic performance.
It is a key indicator of a nation's economic health
and is often used to assess the overall economic
performance of a country.
WHAT IS GDP?
Gross Domestic Product (GDP) is the market value
of all final goods and services produced within a
country's borders in a given period of time.
It represents the total value of all goods and
services produced within a country's borders,
regardless of whether the production is carried out
by domestic or foreign entities.
HOW CAN WE VIEW GDP?
● GDP is as the total income of everyone in
the economy.
● GDP is the total income from the
production of bread, which equals the sum
of wages and profit-the top half of the
circular flow of money.
● GDP is as the total expenditure on the
economy's output of goods and services.
● GDP is also the total expenditure on
purchases of bread-the bottom half of the
circular flow of money.
RULES FOR COMPUTING GDP
ADDING TWO DIFFERENT PRODUCTS
The diversity of products in the economy
complicates the calculation of GDP because
different products have different values.
USED GOODS
● GDP measures the value of currently
produced goods and services.
● Reflects the transfer of an asset, not an
addition to the economy's income
● Thus, the sale of used goods is not included
as part of GDP.
TREATMEN T OF INVENTORI ES
● Imagine that a bakery hires workers to
produce more bread, pays their wages, and
then fails to sell the additional bread. How
does this transaction affect GDP?
● The general rule is that when a firm
increases its inventory of goods, this
investment in inventory is counted as an
expenditure by the firm owners.
INTERMEDIAT E GOODS AND VALUE
ADDED
● Many goods are produced in stages: raw
materials are processed into intermediate
goods by one firm and then sold to another
firm for final processing.
● We should not double count. GDP measures
the final good.
● One way to compute the value of all final
goods and services is to sum the value
added at each stage of production.
● The value added of a firm equals the value
of the firm's output less the value of the
intermediate goods that the firm purchases.
HOUSING SERVICES AND OTHER
IMPUTATION S
● Some goods are not sold in the marketplace
and therefore do not have market prices.
● If GDP is to include the value of these
goods and services, we must use an estimate
of their value. (Imputed Value)
● Example: Housing, Government
employees, underground economy
REAL GDP VS. NOMINAL GDP
● Nominal GDP - referred to as the final value
of goods and services based on the existing
prices on the period of production
● Real GDP - the value of goods and services
measured using a constant set of prices.
● GDP Deflator - measures the price of
output relative to its price in the base year.
MEASURING GDP
➤ Expenditure Approach. GDP can be calculated
by summing up all the expenditures made in the
economy, including consumption, investment,
government spending, and net exports.
GDP = C + I + G + NX
➤ Income Approach: GDP can also be calculated
by summing up all the incomes earned in the
production of goods and services.
GDP = Compensation of Employees + Gross
Profits + Gross Mixed Income + Taxes on
Production and Imports - Subsidies

THE COMPONENTS OF EXPENDITURE

GDP = C + I + G + NX
CONSUMPTION - consists of the goods and
services bought by households. It is divided into
three subcategories: nondurable goods, durable
goods, and services.

INVESTMENT - consists of goods bought for

future use. Investment is also divided into three
subcategories: business fixed investment,
residential fixed investment, and inventory
investment.
GOVERNMENT PURCHASES - are the goods
and services bought by the state, and local
governments. Transfer payments not included
NET EXPORTS - The value of goods and
services sold to other countries (exports) minus the
value of goods and services that foreigners sell us
(imports).