CHAPTER 1

What is Economics?
What is Economics?

 Economics is a board- ranging discipline, both in the question it asks and the methods
it use to seek answer. Many of the worlds most pressing problems are economic in
nature. The first part of this chapter gives you some idea of sort of issues that economic
analysis helps to clarify and the kind of solution that economic principles suggest. The
second part briefly introduces some tools the economist use. you are likely to fined
some of these tools useful in your career, personal life, and role as an informed citizen,
long after this course is over.

1-1 IDEAS FOR BEYOND THE FINAL EXAM.

 Elephants may never forget, but people do. To help you identify some of the most
crucial concepts, we have selected 10 from the many in this book. Some offer key
insights into the workings of the economy, and several bear on important policy issues
that appear in media; others point out common misunderstandings that occur among
even thoughtful observers. many politicians who failed to understand basic economic
principles could have made wiser decisions. The same holds for judges, university
administrators, and even business executives
1-1a idea1: HOW MUCH DOES IT REALLY COST?

 Opportunity cost of any decision is the value of the next best alternative that the
decision forces the decision maker to forgo.. These are called opportunity cost
because they represent the opportunities the individual, firm, or government must
forgo to make the desired expenditure taking opportunity cost into account in your
personal planning will help you to make more rational decisions.

1-2a idea2 ATTEMPTS TO REPEAT THE LAWS OF SUPPLY AND

DEMAND: THE MARKET STRIKES BACK
The concept of supply and demand forms the cornerstone of modern economics,
influencing prices, production, and consumption in markets around the world. It
explores the phenomenon where attempts to manipulate or circumvent these
fundamental economic laws often lead to unintended consequences, demonstrating the
resilience and power of the market to "strike back."
Supply and demand are interconnected forces that shape the allocation of goods and
services in any economy. When governments, businesses, or individuals attempt to
intervene in these market forces, the outcome can be surprising and counterproductive.
1-1c Idea 3: The Surprising Principle of Comparative
Advantage.
 A remarkable result, called the principle of comparative advantage, shows that,
even in this extreme case, the two nations could still benefit by trading and that
each could gain as a result! We will explain this principle in Chapter 2. For now, a
simple parable.

1-1d idea4: TRADE IS A WIN-WIN SITUATION.

 One of the most fundamental ideas of economics is that both parties must expect to
gain something in a voluntary exchange. Otherwise, why would they have agreed to
the deal ? The principle seems self-evident, yet it is amazing how often it is ignored
in practice. In every one of these case well- intentioned but misguided reasoning
blocks the possible mutual gains that arise from voluntary exchange and thereby
interferes with one of the most basic function of an economic system.
1-1e idea 5 THE IMPORTANCE OF THINKING AT THE
MARGIN
 Thinking at the margin is a fundamental concept in economics and
decision-making, and its importance extends to various aspects of life.

 In other explanation, thinking at the margin is a versatile and essential

concept that facilitates rational decision-making, efficient resource
allocation, and the pursuit of optimal outcomes in economics and many
other aspects of life. It encourages individuals and organizations to make
informed choices that consider the incremental benefits and costs of their
decisions.
1f Idea 6: Externalities-A Shortcoming of the Market
Cured by Market Methods.

 Markets are adept at producing the goods that consumers want and in just the
quantities they desire. However, some transactions affect third parties who are not
involved in the decision. Such social costs are called externalities because they
affect parties external to the economic transactions that cause them. The
government use market mechanism to control undesirable externalities.
1-1g idea7: THE TRADE-OFF BETWEEN EFFICIENCY AND
EQUAL.
 Wages and income have grown more unequal in the United state si8nce the late
1970s.Highly skilled workers have pulled away from low-skilled workers. The rich
have grown richer while the poor have become poorer. In many European
countries however, inequality has not grown nearly as much. Yet, over the same
time period, U.S unemployment has generally been much lower than European
unemployment. Many economists see these phenomena as related. Europe and
the United state have made different choices regarding how best to balance the
conflicting claims of greater economic efficiency (more output and jobs)versus
greater equality. The American solution is to let markets work to promote
efficiency, something they are very good at doing with only minimal government
interference to reduce economic inequalities. They find it scandalous that many
Americans work for$7.25 per hour or less, with virtually no fringe benefits and no
job security. European laws mandate not only relatively high minimum wages but
also substantial fringe benefits and employment protection. of course European
taxes must be much higher to pay for these programs.
1-1h EPILOGUE IN BUSINESS

 In a business context, an "epilogue" typically doesn't refer to a formal literary

device as it does in literature. However, the term can be used metaphorically to
describe certain events, actions, or phases that occur after a significant
business transaction, project, or period has concluded. Here are a few ways the
term "epilogue" might be used in a business context:
 In each of these cases, "epilogue" is used figuratively to describe a phase or
series of activities that come after a significant event or decision in the business
world. It emphasizes the idea that the story or process doesn't end abruptly but
continues with a series of actions, adjustments, and adaptations.
1-2 INSIDE ECONOMIST'S TOOL KIT.

 We turn now from the kinds of issues economists deal with to some of the tools they
use to grapple with them.

1-2a ECONOMICS AS A DISCIPLINE.

 Although economics is clearly the most rigorous of the social sciences, it
nevertheless looks decidedly more" social" than "scientific" when compared with,
say, physics. An economist must be a jack-of-several-trades, borrowing modes
analysis from numerous field. Mathematical reasoning is used prominently in
economics, but so is historical study. And neither looks quite the same as when
practiced by a mathematician or a historian. Statistics play a major role in modern
economic inquiry, although economist have had to modify standard statistical to fit
their kinds of data.
1-2a THE NEED FOR ABSTRACTION, ECONOMICS

 In economics, abstraction is a crucial concept and tool that helps

economists and policymakers analyze and understand complex economic
systems.
 In summary, abstraction is a fundamental tool in economics that allows
economists to simplify, analyze, and understand the complexities of
economic systems. It underpins economic modeling, policy analysis, and
the development of economic theories. Abstraction is essential for
making sense of the economic world and making informed decisions
about economic policy and resource allocation.
1-2c The Role of Economic Theory.

 The word theory means used to explain how those something different from what it
means in common speech. theory is not an untested assertion of alleged fact.
People who have never studied economics often draw a false distinction between
theory and practical policy. It is precisely the concern for policy that makes
economic theory so necessary and important. To analyze policy options,
economists must deal with possibilities that have not actually occurred.

1-2d WHAT IS AN ECONOMIC MODEL?

 An economic model is a representation of a theory part of a theory, often used to
gain insight into cause and effect. The notion of a "model" is familiar enough to
children, and economists like other researchers use the term the same way children
do. Economists use models for similar purposes. The late A.W.PHILIPS, an engineer
turned economist, was talented enough to construct a working model of the
determination of national income in a simple economy by using colored water
flowing through pipes. For years this contraption graced the basement of the
London School of Economics.
REASONS FOR DISAGREEMENTS: IMPERFECT
INFORMATION AND VALUE JUDGEMENTS

 Disagreements in various domains, whether in economics, politics,

ethics, or everyday life, often stem from a combination of imperfect
information and value judgments.
 In summary, disagreements are a natural part of human interaction and
discourse. Imperfect information and value judgments are two primary
reasons for these disagreements. Recognizing these factors can help
individuals engage in more constructive and empathetic discussions,
acknowledge differing viewpoints, and work towards common ground or
compromise when possible.
 CHAPTER 2
The Fundamental Economic Problem: Scarcity and
Choice
THE FUNDAMENTAL ECONOMIC PROBLEM: SCARCITY AND
CHOICE
 Our necessities are few but our wants are endless INSCRIPTION ON A FURTUNE
COOKIE Understanding what the market.
 What do economists expect the market to accomplish? The most common answer is
that the market resolves what is often called the fundamental economic problem:
how best to manage the resources of society, doing as well as possible with them,
despite their scarcity. All decisions are constrained by the scarcity of available
resources. A dreamer may envision a world free of want, in which everyone, even in
Africa and Central America drives a BMW, and eats caviar, but the earth lacks of
resources needed to make that dream come true.
 This chapter shows how economists analyze choices like these. The same basic
principles, founded on the concept of opportunity costs, apply to the decisions
made by the individuals, business firms, governments and society as a whole. Many
of the basic ideas of economics, such as efficiency, division of labor, comparative
advantage, exchange, and the role of markets appear here for the first time.
2-1 SCARCITY, CHOICE, AND OPPORTUNITY COST
 One of the basic themes of economics is scarcity- the facet the resources are
limited, so there are never enough to do all the things we might want to do with
them. Even Philip II, of Spanish Armada fame and ruler of one of the greatest
empire in history, had to cope with frequent rebellions with his armies when he
could not meet his payrolls or even got them basic provisions.He is reported to
undergone bankruptcy astonishing eight times during his reign. In more recent
years the US government has been agonizing the difficult budget decisions even
though it spends more than $4 trillion annually.But the scarcity of physical
resources is more fundamental, than the scarcity of funds. Fuel supplies, for
example, are not limitless, and some environmentalists claim that we should now
be making hard choices- such as keeping our homes cooler in winter and warmer
in summer and saving gas by living closer to our jobs.Goods produced by
human effort are in limited supply because they require fuel, labor, and other
scares that inputs.The Following Fundamental Principle of Economics that we
will encounter again and again.‘virtually all resources are scarce, meaning that
people have less of them than they would like. Therefore, choices must be made
among a limited set of possibilities, I full recognition of the inescapable fact that
the decision to have more of one thing means that people may have less of
something else.’
2-1a OPPORTUNITY COST AND MONY COST

 Because we live in an economy where (almost) everything has its price, students often
wonder about the connection and difference between an item’s opportunity and its
market prior. This statement seems to divorce the two concepts: the true opportunity
cost of a car is not its market price but the value its potential purchaser of the other
things (like refrigerators) that could have been made or purchased instead.
2-1b OPTIMAL CHOICE:
 Not just any choice
How do people and firms make decisions? There are many ways, some of them
based on hunches with little forethought, some are even based on superstition or
the advice of a fortune teller.
Often, when the required information is the scarce and the necessary research
and calculations are costly and difficult, the decision maker will settle on the first
responsibility that he can ‘live with’ a choice that promises to yield results that are
not too bad and that seem fairly safe. The decision maker may be willing to
choose this course even though he recognizes that there might be other options
that are better but are unknown to him. This way of deciding is called satisficing.
An optimal decision for an individual x is one that is selected after implicit or
explicit comparison of the consequences of each of the possible choices and that
is shown by analysis to be the one that most effectively promotes the goal of a
person x.
2-2 SCARSITY OF CHOICE OF A SINGLE FIRM

 The nature of opportunity costs is perhaps clearest in the case of a single

business firms from produces two outputs from the fixed supplies of
inputs.Given current technology and the limited resources at its disposal,
the more of one good the firm produces, the less of the other it will be
able to make. Unless managers explicitly the desirability of the product
against the other, they are unlikely make rational production
decisions.the outputs of the firm or an economy are the goods and
services it produces. The inputs used by a firm or economy are the labor,
raw materials, electricity and other resources used to protect outputs.
2-2a THE PRODUCTION POSSIBILITIES FRONTIER
 The production possibilities frontier is a curve
that shows the maximum quantities of outputs it
is possible to produce with the available
resources quantities and the current state of
technological knowledge.The production
possibilities curve (PPC) or production
possibility frontier (PPF) is a graphical
representation showing all the possible options
of output for two goods that can be produced
using all factors of production. The PPF
demonstrates that the production of one
commodity may increase only if the production
of the other commodity decreases.* . The
production possibility curve portrays the cost of
society's choice between two different goods.
An economy that operates at the production
possibility frontier has the highest standard of
living it can achieve, as it is producing as much
as it can using its resources.
2-2b THE PRINCIPLE OF INCRESING COSTS

 The principle of increasing costs is an

economic principle that states that when
production increases, so do costs. This
happens when all the factors of
production are at maximum output.
Therefore, if your production rises from,
for example, 100 to 200 units a day, costs
will increase. The law of increasing costs
is also known as the law of increasing
opportunity cost. It is a principle that
describes how opportunity costs
increase as resources are applied.
2-3 SCARCITY AND CHOICE FOR ENTIRE SOCIETY

 Like an individual firm the entire economy is also constrained by its limited resources
and technology.If the public wants more aircraft and tanks it will have to give up some
boats and automobiles. If it wants to build more factors and stores it will have to build
fewer homes and sports in general.

2-3a SCARCITY AND CHOICE ELSEWHERE IN THE ECONOMY

 We have emphasized that limited resources hard choices on business manager and
society as a whole but the some types of choices arises elsewhere in household
universities and other nonprofit organizations as well as the government.

HARD CHOICES IN THE REAL WORLD

 This except from a recent newspaper story brings home the realities of scarcity and
choice even in a wealthy society like the United States. Insured Americans with serious
medical conditions say the financial stress of rising out of pocket health care cost is
forcing them to juggle household budgets delay or skimb on care even run up credit
cards or dogde debt collectors a new study reveals
2-4 THE THREE COORDINATION TASK OF ANY ECONOMY

 First it must figure out how to utilize it's resources

 Second It must decide which of the possible combination
 Third It must decide how much of the total output of each good to distribute to
each person.
2-5 THE CONCEPT OF EFFICIENCY

 Economists evaluate the market system's ability to address economic

questions, aiming to determine if there are alternative solutions that
would improve people's lives. They assume that firms or economies
operate efficiently on their production possibilities frontier.
2-6 TASK 1. HOW THE MARKET FOSTERS EFFICIENT
RESOURCE ALLOCATION

 Productive efficiency is a fundamental task in the economy, with specialization

being a key source of significant productivity gains.Smith emphasized the
importance of specialization and division of labor in the Industrial Revolution,
enabling workers to specialize and increase productivity, thereby reducing poverty
and enabling greater efficiency.

2-6b The Amazing Principle of Comparative Advantage

 The principle of comparative advantage, discovered by David Ricardo 200 years
ago, states that a producer has a comparative advantage over another producer in
the production of a good if they have a lower opportunity cost of producing that
good than the other producer. This principle applies to nations, as trade between
two countries can improve the welfare of citizens of both countries. For example, a
country that is proficient in producing certain items can specialize in those
activities, allowing it to take the money earned from exports and purchase from
other nations.
2-6c The Arithmetic of Comparative Advantage and
Trade
 In this text, the arithmetic of comparative advantage and trade is used to
illustrate the benefits of specializing and trading. Two people, Matt and Kim, are
stranded on a remote island with only two sources of food: gathering coconuts
and catching fish. Kim is more productive at both activities, able to gather 32
pounds of coconuts and catch 16 pounds of fish per week. This comparative
advantage suggests that it makes sense to specialize in producing coconuts
and trade with Matt to obtain fish. However, Matt still has a comparative
advantage in catching fish. To calculate the opportunity costs of producing
each good, it is evident that the lower the opportunity cost, the better the
comparative advantage. In this case, Kim's opportunity cost of a pound of
coconuts is a half-pound of fish, while Matt's opportunity cost of a pound of
coconuts is a pound of fish.
2-7 TASK 2 MARKET EXCHANGE AND DECIDING HOW MUCH OF EACH GOOD TO
PRODUCE

 As we noted, the gains from specialization are welcome, but they create a problem.
With specialization, people no longer produce only what they want to consume
themselves.

 without a system of exchange, the productivity miracle achieved by comparative

advantage and the decision of labor would do society little good.

 although people can and do trade goods, a system of exchange works better when
everyone agrees to use some common item.

 is carried out by means of exchange between money and goods or services.

2-8 TASK 3 HOW TO DISTRIBUTE THE ECONOMY'S OUTPUTS AMONG CONSUMERS

 Two phenomena
specialization
exchange
 Working in tandem led to vast increases in the abundance that the more prosperous
economies of the world were able to supply.
 Third basic issue
• what forces allow those outputs to be distributed among the population in reasonable
ways?
• what forces establish a smoothly functioning system of exchange so that people can
first exploit their comparative advantages and then acquire what they want to
consume?
• One alternative is to have a central authority telling people what to do .

 A Market system is a form of economic organization in which resource allocation

decisions are Left to individual producers and consumers acting in their own best
2-9 LOOKING AHEAD

 In very broad terms, how a market economy solves their basic problems
facing Any society.

 Their are three basics.

• How to produce any given combination of goods efficiently
• How to select an appropriate combination of goods to produce
• How to distribute these goods sensibly among people.
 CHAPTER 3
Supply and Demand: An Initial Look
What is Invisible Hand?

is a phrase used by Adam Smith to describe how, pursuing their own self - interest. people in a
market system led by an invisible hand" to promote the walk - being of the community.

3-2 Demand and Quantity Demanded

The quantity demanded of any product normally depends on its price. Quantity demanded also
depends on a number of other determinants, including population size consumer incomes,
taste, and the prices of other products.

3-2 a The Demand Schedule

A demand schedule is a table showing how the quantity demanded of some product during a
specified period of time changes as the prices of the product changes holding all other
determinants of quantity demanded constant.
3-2b The Demand Curve

A demand curve is a graphical depiction of a demand schedule. It shows how the quantity
demanded of some product will change as the price of that product changes during a
specified period of time, holding all the determinants of quantity demanded constant.

3-2 c Shifts of the Demand Curve

A shift in demanded curve occurs when any relevant variable other than price changes. If
consumers want to buy more at any and all given prices than they wanted previously, the
demand curve shifts to the right (or outward). If they desire less any given price, the
demand curve shifts to the left ( or inward).
Manipulation of Electricity
Free market pieces always determined by supply and demand? Although the wholesale
price of electricity was set by the Federal Government for many years, starting in the early
1990s the government deregulated the industry and allowed market forces to determine
the wholesale price of electricity. The Federal Energy Regulatory Commission contented
that allowing competition among producers should guarantee the lowest possible price,
but electricity prices have generally not fallen, in many cases, have risen sharply.

3-3 Supply and Quantity Supplied

Like quantity demanded, the quantity of beef that supplied by business firms such as
farms is not a fixed number, it also depends on many things. Obviously, we except more
beef to be supplied if there are more farms or more cows per farm. Cows may provide less
meat if bad weather deprives them of their feed. As before, however, lets turn our attention
first to the relationship between the price and quantity of beef supplied.
3-3 a The Supply Schedule and the Supply Curve
Table 2 shows the relationship between the price of beef and its quantity supplied.
Tables such as this one are called supply schedules, they show how much sellers are
willing to provide during a specified period at alternative possible prices. This
particular supply schedule tells us that a low price like 7.00 per pound will induce
suppliers to provide only 40 million pounds, whereas a higher price like 7.30 will as you
might have guessed, when such information is plotted on a graph, it is called a supply
curve. Figure 4 is the supply curve corresponding to the supply schedule in Table 2,
showing the relationship between the price of beef and the quantity supplied. It slopes
upward-it has positive slope.

3-3 b Shifts of the Supply Curve

The quantity supplied in a market typically responds influences other than price. The
weather, cost of feed, the number and size of and a variety of other factors all influence
how much beef will be brought to market. the supply curve depicts only the
relationship between the price of beef and the quality of beef supplied, holding all other
influences constant, a change in any these determinants of quantity supplied will cause
the entire supply curve to shift.
3-4 Supply and Demand Equilibrium

The state in which market supply and demand balance each other, and as a
result prices become stable. Generally, an over-supply of goods or services
causes prices to godown, which result in higher demand-while an under-
supply or shortage causes prices to go up resulting in less demand.
3-4a The Law of Supply and Demand
The law of supply and demand is a fundamental economic principle. It states that in a
competitive market, the price of a product or service will adjust until it reaches a point
where the quantity demanded by consumers equals the quantity supplied by
producers. In simpler terms, when demand for a product is high and supply is low,
prices tend to rise. Conversely, when demand is low and supply is high, prices tend to
fall. This law helps explain how prices are determined in markets and how they change
in response to shifts in supply and demand conditions.
3 – 5. EFFECTS OF DEMAND SHIFTS ON SUPPLY – DEMAND
EQUILIBRIUM

 The quantity demanded at the old equilibrium price of $7.20 increases from 60
million pounds to 75 million pounds per year. Because the price quantity demand
exceeds quantity supplies. It cause to a shortage of 15 million pounds. In this case
$7.20 is no longer the equilibrium price.
 The new equilibrium is where the price is $7.30 per pound both quantities
demand and supplies 70 million pounds per year. The higher price causes both an
increase in quantity supplied (producers) and decrease in quantity demand
(consumers) along the new demand curve.
3 – 6a. APPLICATION: WHO REALLY PAYS THAT TAX?

 The buyer pays per gallon minus the tax paid to the government on each gallon.
The price that the buyer and the price that the seller received must always differ by
the exactly the amounts of the tax.

 3 – 6b. SPECULATION
Is a process where the speculations accumulate and store goods in periods of
abundance and make goods available in periods of scarcity. For example the high
pricing of rice here in the Philippines. Many entrepreneurs do hoarding of rice
production because the more the higher demand of supply in the market the higher
profit they can get. So, that is why they used hoarding of goods.
3-7 BATTLING THE INVISIBLE HAND: THE MARKKET FIGHTS BACK

His is talk about lawmakers and rulers have often been dissatisfied with the outcomes
of free markets sometimes rather than trying to adjust the working of the market
governments have tried to raise or lower the price of specific commodities by decree.
3-7a RESTRAINING THE MARKET MECHANISM: PRICE CELLING

PRICE CELLING are maximum that the prices charged for a commodity cannot legally
exceed.
Five imposed virtually the same series of consequences ensues.
 1.A persistent shortage develops because quantity demanded exceeds quantity supplied.
 2.An illegal or “Black” market often arises to supply the commodity.
 3.The prices is an illegal markets are almost certainly higher than those that would prevail
in free markets.
 4.A substantial portion of the price falls into the hands of the illicit supplies instead of
going to those who produce the good or perform the service.
 5.Investment in the industry generally dries up.
3-7b CASE STUDY: RENT CONTROLS IN NEW YORK CITY
 Base on study New York is the only major city in the United States that has
continuously legislated rent controls in much of its rental housing and has done
to since World War II.

3-7c RESTRAINING THE MARKET MECHANISM: PRICE

FLOORS
 PRICE FLOORS are legal minimum below which the prices charged for a
commodity are not permitted to fall.
Four standard series consequences of price floors

 1.A surplus develop because sellers cannot find enough buyer.

 2.Where goods rather than services are involved the surplus creates a problem of
disposal.
 3.To get around the regulation, Sellers may offer discount in disguised and often
unwanted forms.
 4.Regulation that keep prices artificially high encourage over investment in the
industry.
3-7d CASE STUDY: FORM PRICE SUPPORTS AND THE CASE
OF SUGAR PRICES

 In this case America extensive program of farm price support began in 1993 as a
temporary method of dealing with an emergency in the years of the great
depression farmers were going broke in droves.
3-7e A CAN OF WORMS

 Here is a partial list of others problems that may arise when prices are
controlled
 1.Favouritism and corruption
 2.Unenforceability
 3.Auxiliary Restriction
 4.Limitation of volume of transaction
 5.Misallocation of Resources

3-8 A SIMPLE BUT POWERFUL LESSON

Astonishing as it may seem, many people in authority do not understand the
law of supply and demand or they act as if does not exist.
 CHAPTER 4
Consumer Choice: Individual and Market Demand
SCARCITY AND DEMAND
 DEMAND refers to the amount of some good or service consumers are willing
to pay and able to purchase at each price or based on needs and wants.
SCARCITY refers to a limited supply of goods. That scarcity can then lead to high
demand from consumers.
 Question: What is the effect of scarcity in economy?

UTILITY: A TOOL TO ANALYZE PURCHASE DECISIONS

 The word purchase decision, the purchasing decision stage of buying decision
process is when customers make a final decision about which product or service
to buy.
 Question: What is the purpose of utility analysis?
 MARGINAL UTILTY a consumer
(measured in money terms) is the
maximum amount of money that she or
he is willing to pay for one more unit.

 MARGINAL ANALYSIS is a
method for calculating optimal choices
-the choices that best promote the
decision maker’s objective. It works by
testing whether, and by how much, a
small change in a decision will move
things toward or away from the goal.
CONSUMER'S SURPLUS

 Consumer surplus, also known as buyer’s surplus, is the economic measure of a

customer’s excess benefit. It is calculated by analyzing the difference between the
consumer’s willingness to pay for a product and the actual price they pay, also
known as the equilibrium price. A surplus occurs when the consumer’s willingness
to pay for a product is greater than its market price.

 Consumer's Surplus = willingness to pay - actual price

 Actual price of product = 300
 Amy is willing to pay 500 for the product
 Amy's consumer surplus is 200
INDIVIDUAL DEMAND CURVES TO MARKET DEMAND CURVES

 An individual demand curve is one that examines the price-quantity relationship

for an individual consumer, or how much of a product an individual will buy
given a particular price.
 A market demand curve shows how the total quantity of some product
demanded by all consumers in the market during a specified period of time
changes as the price of that product changes , holding all other things constant .

THE LAW OF DEMAND

 The " law " of demand states that a lower price generally increases the amount of
a commodity that people in a market are willing to buy and also tends to increase
the number of buyers . Therefore , for most goods , market demand curves have
negative slopes.
EXCEPTIONS TO THE LAW OF DEMAND

 Some exceptions to the " law " of demand have been noted . One common
exception occurs when people judge quality on the basis of price - they perceive a
more expensive commodity as offering better quality . For example , many people
buy name - brand aspirin , even if right next to it on the drugstore shelf they see an
unbranded , generic aspirin with an identical chemical formula selling at half the
price . The consumers who do buy the name - brand aspirin may well use
comparative price to judge the relative qualities of different brands . They may
prefer Brand X to Brand Y because X is slightly more expensive . If Brand X were
to reduce its price below that of Brand Y , consumers might assume that it was no
longer superior and actually reduce their purchases of X.
Geometry of Available choices : The budget Line

 What is budget line ?

A budget line shows the combinations of two products that a consumer can afford to
buy with a given income – using all of their available budget.
Example:
If an apple costs £1 and a banana £2, the above budget line shows all the
combinations of the goods which can be bought with £40. For example :
.20 apples @ £1 and 10 bananas @£2
.10 apples @£1 and 15 bananas @£2
Properties of the Budget Line

 1. Budget Line slopes Downward: The slope of a budget line is

negative. It means that as more of one good is bought by
reducing some units of the other good, the slope of the budget
line goes downwards.

 2. Budget Line is a Straight Line: We know that the slope of the

Budget Line is represented by the Price Ratio, which is constant
throughout; therefore, the Budget Line is a straight line.
 Changes in the budget line

Position of the budget line depends on two factors namely, income of the consumer
and prices of the two goods.

 What consumer prefers : properties of indifference curve

An indifference curve connects all combinations of the commodities that are equally
desirable to the consumer.
The slopes of indifference curves and budget lines

 The marginal rate of substitution (MRS) between the commodities, represents the
maximum amount of one commodity that the consumer is willing to give up exchange for
one more unit of other commodity.
 The slope of a budget line is the amount of one commodity that the market requires an
individual to give up to obtain one additional unit of another commodity without any
change in the amount of money spent.
 The slopes of the two types of curves, then , are perfectly analogous In their meaning.
The slope of the indifference curve indicates the terms on which the consumer is willing
to trade one commodity for another, whereas the slope of the budget line reports the
terms on which the market allows the consumer to trade one good for another. It is useful
to cary our interpretation of the slope of the budget line one step further.
 The slope of the budget line is equal to the ratio of the price of the two commodities.
 At the point of tangency, where the consumer benefits from purchasing cheese, and
rubber bands are maximized, the slope of the budget line equals the slope of the
indifference curve.
Consequences of income changes: Inferior Goods.

 A rise of income may or may nit increase the demand for a commodity. The rise of
income does lead the consumer to buy more cheese and more rubber bands but
indifference curves needs not always be positioned in a way that yields this sort of
result. The slope of indifference curves means that the slope decrease with
movement from left to right.

Tangency Conditions
 According to the first of the properties of indifference curves, the consumer prefers
higher curve to lower ones, he will go to the point on the budget line that lies on the
highest indifference curve attainable. He can afford no other point that he likes as
well, and every other point he can afford he likes less.
 Consumer will select the most desired combination of goods obtainable for their
money. The choice will be that point on the budget line at which the budget line is
tangent to an indifference curve.
Consequences of the price changes: Deriving the Demand Curve.

 Finally, we come to the main question underlying demand curves: How does a consumer
choice change if the price of one good changes?