Unit 1 Basic Economic Problems. Our wants are UNLIMITED but resources are LIMITED……… So there is SCARCITY Hence we have to make CHOICES.

Unit 1

Basic Economic Problems

Our wants are UNLIMITED but resources are LIMITED………

So there is SCARCITY

Hence we have to make CHOICES

3 major economic questions:

•What to produce•How to produce•Whom to produce

• WHAT TO PRODUCE

• Food or Clothes• Cars or hospitals• ipods or Cosmetics or military strength

Basic Economic Problem- 3 decisions

techniques used. least cost method of production labour intensive or capital intensive

Basic Economic Problem- 3 decisions

HOW TO PRODUCE

• Production: Creating goods and services

• Consumption: Using the goods and services to satisfy want

Labor

The Enterprise:- Organizes the 3 factors and production process- Takes the risk (Profit and Loss)

Opportunity Cost

If I ask you, what will you choose??

DEMAND DEFINEDWhat is Demand?

Demand is the different quantities of goods that consumers are willing and able to buy at different prices.

What is the Law of Demand? The law of demand states There is an

INVERSE relationship between P and QD.

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Income

2. Inferior Goods – As income increases, demand falls– As income falls, demand increases– Ex: instant noodles, used cars, used clothes,

1. Normal Goods – As income increases, demand increases– As income falls, demand falls– Ex: cars, jewelry, homes, TV’s

The incomes of consumer change the demand, but how depends on the type of good.

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Prices of Related Goods

2. Complements are two goods that are bought and used together. – If the price of one increase, the demand for the

other will fall. (or vice versa)– Ex: If price of skis falls, demand for ski boots will...

1. Substitutes are goods used in place of one another. – If the price of one increases, the demand for the

other will increase (or vice versa)– Ex: If price of Pepsi falls, demand for coke will…

The demand curve for one good can be affected by a change in the price of ANOTHER related good.

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What Causes a Shift in Demand?

5 Determinates (SHIFTERS) of Demand:

1.Market size2.Expectations of future price3.Related goods price4.Income5.Tastes and preferances

Changes in PRICE don’t shift the curve. It only causes movement along the curve.

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6 Determinants (SHIFTERS) of Supply1. Prices/Availability of inputs (resources)2. Number of Sellers3. Technology4. Government Action: Taxes & Subsidies

5. Expectations of Future Profit

6. Other – War, weather

Changes in PRICE don’t shift the curve. It only causes movement along the curve.

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Qo

$5

4

3

2

1

PDemand Schedule

10 20 30 40 50 60 70 80

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P Qd

$5 10

$4 20

$3 30

$2 50

$1 80

Supply Schedule

P Qs

$5 50

$4 40

$3 30

$2 20

$1 10

Supply and Demand are put together to determine equilibrium price and equilibrium quantity

Equilibrium Price = $3 (Qd=Qs)

Equilibrium Quantity is 30

D

S

Qo

$5

4

3

2

1

PDemand Schedule

10 20 30 40 50 60 70 80

18

P Qd

$5 10

$4 20

$3 30

$2 50

$1 80

Supply Schedule

P Qs

$5 50

$4 40

$3 30

$2 20

$1 10

Supply and Demand are put together to determine equilibrium price and equilibrium quantity

D

S

What if the price increases to $4?

Qo

$5

4

3

2

1

PDemand Schedule

10 20 30 40 50 60 70 80

19

P Qd

$5 10

$4 20

$3 30

$2 50

$1 80

Supply Schedule

P Qs

$5 50

$4 40

$3 30

$2 20

$1 10

D

S

At $4, there is disequilibrium. The quantity demanded is less than quantity supplied.

Surplus (Qd<Qs)

How much is the surplus at $4?

Answer: 20

Qo

$5

4

3

2

1

PDemand Schedule

10 20 30 40 50 60 70 80

20

P Qd

$5 10

$4 20

$3 30

$2 50

$1 80

Supply Schedule

P Qs

$5 50

$4 40

$3 30

$2 20

$1 10

D

S

How much is the surplus if the price is $5?

Answer: 40What if the price decreases to $2?

Qo

$5

4

3

2

1

PDemand Schedule

10 20 30 40 50 60 70 80

21

P Qd

$5 10

$4 20

$3 30

$2 50

$1 80

Supply Schedule

P Qs

$5 50

$4 40

$3 30

$2 20

$1 10

D

S

At $2, there is disequilibrium. The quantity demanded is greater than quantity supplied.

Shortage(Qd>Qs)

How much is the shortage at $2?

Answer: 30

Qo

$5

4

3

2

1

PDemand Schedule

10 20 30 40 50 60 70 80

22

P Qd

$5 10

$4 20

$3 30

$2 50

$1 80

Supply Schedule

P Qs

$5 50

$4 40

$3 30

$2 20

$1 10

D

S

Answer: 70

How much is the shortage if the price is $1?

Qo

$5

4

3

2

1

PDemand Schedule

10 20 30 40 50 60 70 80

23

P Qd

$5 10

$4 20

$3 30

$2 50

$1 80

Supply Schedule

P Qs

$5 50

$4 40

$3 30

$2 20

$1 10

D

SWhen there is a

surplus, producers lower prices

The FREE MARKET system automatically pushes the price toward equilibrium.

When there is a shortage, producers

raise prices

Where do you get the Market Demand?

Q

Frank Price Q Demd

$5 1

$4 2

$3 3

$2 5

$1 7

Yao Ming Other Individuals Price Q Demd

$5 0

$4 1

$3 2

$2 3

$1 5

Price Q Demd

$5 9

$4 17

$3 25

$2 42

$1 68

Price Q Demd

$5 10

$4 20

$3 30

$2 50

$1 80

Market

3

P

Q2

P

Q25

P

Q30

P

$3 $3 $3 $3

D DDD

• What you DO NOT CHOOSE is your

Opportunity Cost

• Opportunity Cost is the 2’nd best option

Production Possibility Curve (PPC)

• Every decision/choice we make has an Opportunity Cost

• This idea of Opportunity Cost can be illustrated using a PPC

A Typical PPF ………….Unattainable

Inefficient

Opportunity cost of is increasing…

PPC is also tells you:

• What you can and cannot produce

• What is the cost of producing the other good

Bik

es

Computers

14

12

10

8

6

4

2

0

0 2 4 6 8 10

A

B

C

D

E

G

Inefficient= Unemployment

Impossible (given current resources)

Efficient

Production PossibilitiesHow does the PPC graphically shows trade-offs, opportunity

costs, and efficiency?

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2 Bikes

2.The opportunity cost of moving from b to d is…

4.The opportunity cost of moving from f to c is…

3.The opportunity cost of moving from d to b is…

7 Bikes

4 Computer

0 Computers

5.What can you say about point G?

Unattainable

1. The opportunity cost of moving from a to b is…

Example:

Opportunity Cost

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