TASK 1 - Definition of Economics
'Economics is a science that studies human behavior as a relationship between end and scarce means which have alternative uses' says Robbins L,
Economics is the study of how a firm allocates its scares resources such as, land, building, labour, and capital through the forces of supply and demand. This can be further classified in to micro economics where companies, consumers and the government behavior is considered and macro economics where inflation, unemployment, industrial production & the government activities are taken to account. (Investorwords, 2011)
What is Scarcity and Choice?
Resources are limited, but human needs or wants are unlimited, here arises scarcity. In other words human wants are more than what is available in the society. As an individual scarcity is the limited income we get, limited time, limited capabilities, etc. As a company it may be the limited capacity of a machine, limited time, limited work force, and limited raw material available during a period, and limited capital available for expenses.
This in turns triggers the need of a choice. Now it has to be decided which desire or need is going to be satisfied and which desire or need is going to be left un satisfied, when you choose more of one thing scarcity forces you to give up or choose less of another thing.
Opportunity Cost
This is the cost of the best forgone product or activity when making a choice. For example
Option ; Invest in government bonds
Option; Invest in shares of a company
Option; Acquire company A
If you invest in INV (1) the opportunity cost would be the profit or returns you would get by investing in INV (2) the one which brings in the next highest return.
INVEST IN (1)£
INVEST IN (2)£
OPTIONS
5,000
0
A
4,000
1,000
B
2,500
4,500
C
0
5,000
D
PRODUCTION POSSIBILITY CURVE
0
F
E
4,500
1,000
2,500
4,000
C
B
INVESTMENT (2)
INVESTMENT (1)
FIG : 01
According to the above FIG 01 the following can be derived, from a total amount of £ 5,000 available for investment, if
Option B : £ 4,000 is invested in INV(1) then only £ 1,000 can be invested in INV(2) [ opportunity cost would be the forgone interest earned from the INV (2)]
Option C : £ 2,500 is invested in INV(1) then only £ 4.500 can be invested in INV(2) [opportunity cost would be the forgone interest earned from INV(1) ]
Option E : resources under utilized
Option F : un attainable as there is no sufficient resources available.
Microeconomics and Macroeconomics
MICROECONOMICS
MACROECONOMICS
Definition
This depicts how individuals and firms make decisions in a market, i.e
the study of how income is distributed,
what is the consumer behavior,
how is the price of a product decided in a market,
how does taxes and government regulations affect the consumer buying patterns,
how interest, wages, profits and income are decided
This is the study of the total economy and focuses on economic issues such as unemployment, the rate of inflation, national total output, money supply and money demand in the market, government policies such as fiscal policies & monetary policy, the value of money and public finance.
Differences (T.R.Jain, 2010-2011)
1
Studies small units in an economy, such as individuals or firms
Considers the total economy as a whole in to which individuals and firms are included
2
Studies on the principals, problems and policies relating to the optimum allocation of resources.
Studies on the principals, problems and policies relating to employment, growth of the economy etc.
3
Decisions of Consumers, Producers, Factors of production is based on Price
Decisions on aggregate consumption, aggregate saving, aggregate investment is based on Income.
4
Partial Equilibrium Analysis - while studying two factors other factors are assumed to be held constant
Quasi General Equilibrium Analysis - mutual inter dependence of factors can be seen.
5
Assumes full employment, on this basis it sought how optimum allocation of resources takes place and how market equilibrium is achieved.
Assumes optimal allocation of resources, on this basis it is sought to know how full utilization of national resources can be made.
TASK 2
Individual Demand Curve
A curve usually sloping towards the right of the chart, showing the change in price to the quantity demanded. It is assumed that Income level, prices of substitutes and customer preferences remain constant during this period. (Businessdictionary, 2011)
DEMAND SCHEDULE AND DEMAND CURVE
PRICE
QUANTITY DEMANDED
10
1,000
20
500
http://t0.gstatic.com/images?q=tbn:ANd9GcQEsvcvxLQyWh7qjkB2YvPMd_N_ywcOndub0qZOtasAfRcLsOeXwA
FIGURE: 02
When Price is at $ 10 (P1) quantity demanded is 1000 units (M1) and when price is increased to $ 20 (P) quantity demanded decreases to 500 units (M). [it is assumed other factors remain constant ] This shows the inverse relationship between price and quantity demanded.
Market Demand Curve
FIGURE : 03
dsu.nodak.edu (2011)The aggregate demand of all potential customers, during a period of time, in a specific market, for a particular product. (businessdictionary,2011)http://www2.dsu.nodak.edu/users/fernando/PrenticeHall/Hubbard_2e_Web/Images/Ch09/Fig9-3.gif
Firms output decision in the Short-run -[assumption in a monopolistic market.]
MC- Marginal Cost
MR-Marginal Revenue
ATC - Average Total Cost
AR- Average Revenue
D- Demand
http://www.economicsonline.co.uk/Business_graphs/Super%20normal%20profits.png
FIGURE :04
(economicsonline,2011)
SUPER NORMAL PROFITS
There are many firms in competition in this market, in the short run supernormal profits are possible, The demand curve slopes towards the right, as the firm has more demand than its competitor. It is believed that profit is maximized at the point where Marginal Cost equals Marginal Revenue. (MC=MR) the output at this point is Q and the price is P. At the output of Q average total cost is only C x Q. Therefore, supernormal profits would be, PQ-CQ = ABCP
http://t2.gstatic.com/images?q=tbn:ANd9GcQZYffR0C8-TQXCazX_GF3HjZ8MhumUEE7Tx60R3HOkS17qcTyk5w
FIGURE: 05
(tutor2u.net,2011)
SUB-NORMAL PROFITS
Not all the firms are in a position to make supernormal profits, some firms which their average total cost higher than their market price would experience subnormal profits, in other words as their short run costs are high they would be showing an economic loss or subnormal profit as depicted in figure 05.
http://t1.gstatic.com/images?q=tbn:ANd9GcS56CRoiQtUHGB9mVOcBTPoWCvnyOe47Ppc9UyjVm93n_yrgYhX
FIGURE: 06
(wikibooks.org,2011)
NORMAL PROFITS
There are also firms showing normal profits, when their total cost equals total revenue as depicted in figure 06.
A firms output decision in the Long - run
NORMAL PROFITS IN THELONG RUN
FIGURE: 07
(mfu.ac.th,2011)
http://t1.gstatic.com/images?q=tbn:ANd9GcT9z6D9eQrtnZjmrYnc211pJar3Co0_7ToJIuewa3KNj1_4a66Zvw
As all factors are available in the long run firms would adjust their price to the equilibrium price and quantity, new firms which would have got attracted to the supernormal profit trends in the short run and firms which were making sub-normal profits would have exist the market by now as only efficient firms can remain in the long run and earn 'normal profits' as illustrated in figure 07.
TASK 3
Market Equilibrium
This the point at which quantity demanded of a product in the market equals to the quantity supplied at that given price. As reflected in Figure 08 when price is at (Px) quantity demanded & quantity supplied both are at (Qx), this is the point of Equilibrium (E) where the market is at its most efficient.
http://t0.gstatic.com/images?q=tbn:ANd9GcSZaBdinn2tBx0QVwG1q4wes6hyE0XFx2Yi5ctMsSYnW293tsxSQg
PRICE
QTY DEMANDED
QTY SUPPLIED
PX
QX
QX
FIGURE: 08
(Wizznotes, 2011)
Effect on Market Equilibrium when conditions of Demand / Supply changes
Demand changes - (supply constant)
When Demand for the product changes, while supply remains constant, then there would be a shift in the Demand curve either to the right or left, if the Demand is higher curve will shift to the right and if Demand is less curve will shift to the left, as depicted in figure 09 there is an increase in Demand and the curve has shifted towards the right http://t0.gstatic.com/images?q=tbn:ANd9GcS3C6_u0GqpEHtclARmPgsA8PlbpgY7EqsABW0CA15xgBS9CbPeqA
FIGURE:09 (history-society,2011)
increasing quantity demanded from Q1 to Q2 and the price of the product too has increased from P1 to P2
Supply changes - (Demand constant)
FIGURE:10 (history-society,2011)
When Supply for a certain product changes while Demand remains constant the supply curve moves inwards or out wards, as depicted in Figure 10 when Supply for the product has increase from S1 to S2 quantity demanded has increased from Q1 to Q2 and price has decreased by P2 to P1. Government taxes and subsidies make changes in supply, a government tax decreases supply shifting the supply curve inward, and government subsidies increase supply shifting the supply curve outward.If both supply and demand curve change at the same time equilibrium is derived after ascertaining as to whether there was a increase or decrease in supply / demand, the magnitude of the shift and the elasticity (slope) of both supply and demand.Supply curve shifts
Effects of Excess supply on Market Equilibrium - Price Floor
In this scenario the Price of the product is higher than the equilibrium price, here a surplus occurs as the quantity supplied would exceed the quantity demanded, meaning suppliers are willing to sell more of their product but there are no willing consumers (demand), as shown in figure 11 when the price gets fixed at 'Price floor' there is an excess supply in the market, and 'quantity demanded' reduces from the market quantity and 'quantity supplied' has increased. There is a mismatch here, which will make the firms to cut down their prices in order to sell their produce. As the price drops market would shrink, demand would increase moving downward the curve and supply would decrease moving downward the supplier curve.
http://1.bp.blogspot.com/_RJG1019h-bc/S-lDFN4l04I/AAAAAAAAACY/BaPBYS7DFJs/s1600/Effect_of_a_Price_Floor.gif
FIGURE :11
(mynameisnotmuzungu,2011)
A minimum price is set by the government sometimes for a good or service this is to
Discourage uses from certain products
To have a control of price like in the case of minimum wages.
This keeps a permanent surplus in the market as the market does not operate on market equilibrium.
Effects of excess Demand on Market Equilibrium - Price Ceiling
FIGURE:12
(investopedia,2011)
http://i.investopedia.com/inv/articles/site/micro3.6.gif
Quantity demanded exceeds quantity supplied. A supplier is allowed to charge a controlled price only which is below the equilibrium price, then the supplier reduces supplying the product and there arises a shortage of products in the market. As a result,
Black markets may arise as some suppliers would be willing to pay higher price in order to obtain the product.
Consumers may have to be on a waiting list to get their products
Supplier might give priority to family members of the employees, etc
The price ceiling may be set by the government in order to
Encourage buyers to use that certain product
As a sanction to lower income groups
To lower the cost of living
TASK 4
Perfect Competition
DEFINITION: An industry is said to be perfectly competitive if,
There are a large number of small produces
Selling identical products - homogeneous products
Firms can enter or leave the market as required
Can sell any amount of commodity in the market- a price taker
All produces are aware of the market conditions
No transport cost associated
ADVANTAGES:
Resources utilized in the most efficient manner
Goods and services mostly needed by the society are being produced
Consumer pays lowest price
In the long run firm operates at the optimum level with optimum output
The greatest utility being given to consumers
Can be used as a yard stick to measure other markets as it is highly efficient
Affects of a change in Market Demand:
In the short run business would operate with at least one fixed factor, therefore elasticity of the supply curve will depend on the spare capacity or the ability to produce the expanded demand, in figure 12 the short run diagram shows a shift/ increase in the Demand while the supply remains in-elastic, this drives the price higher.
In the long run due to freedom of entry and exist market supply becomes elastic, therefore as depicted in figure 12 when the demand for a product increases, as supply is elastic, market output would increase putting pressure on Price.
FIGURE: 12
(Tutor2u, 2011)Effects of a change in market demand
Profit Maximization in the Short - run /Long- run
When total revenue is greater than total cost it is assumed profit is achieved in the short -run. (TR<TC) in other words Marginal Revenue minus Marginal Cost (MR-MC)
MR = the change in Total Revenue per unit change in quantity sold, as any amount of product can be sold in a Perfect market at the prevailing price MR=P
Therefore short run profits would be maximized where,
MR=P=MC (where MC is rising)
Firms on the short run could make super normal profits, sub-normal profits (economic losses) or normal profits.
Where as in the long-run due to the market becoming more stable with the short term firms having exited and only the efficient firms remaining it's possible to earn normal profits.
Oligopoly
There would be few mutually interdependent sellers in the market, with either standardized or differentiated products. As there are few sellers the action of one seller affects the other drastically, e.g. a price reduction by one seller may result in a drastic drop in sale of the other sellers products, therefore firms in that situation may retaliate with a possible price war, it is strongly recommended not to change prices in a oligopolistic market instead competition could be based on quality, product design, customer service and advertising. Entry to the market is restricted. Examples of oligopolistic markets, electrical appliances, cigarette manufacturers, automobiles, etc. (Dominick Salvadore….2003)
The Kinked Demand Curve
An Oligopolistic firm would not know the shape of its demand curve to their products as this depends on the reaction of its rivals; they would need to predict how their competitors react to a change in price in order to know the shape of their demand curve.
Assume firms are looking at maintaining high level of profit & market share,
A price increase by one firm may not be followed by other firms, therefore demand becomes elastic and the firm which increased the price would find loss of share in the market and thereby reduction in total revenue.
Firm makes a price decrease, which the rivals readily match as they would not want a decrease in market share, this makes the demand in elastic and a fall in price again results in fall in total revenue.
http://tutor2u.net/economics/content/diagrams/kinked_demand1.gif
FIGURE: 13
(tutor2u, 2011)
FIGURE: 14
(tutor2u, 2011)
http://tutor2u.net/economics/content/diagrams/kinked_demand2.gif
In figure 14 it shows a discontinuity in the MR curve. If we assume MR curve is cutting MC curve, then this is the point where profit is being maximized.
http://tutor2u.net/economics/content/diagrams/kingked_demand3.gif
FIGURE:15
(tutor2u,2011)
Figure 15 shows a rise in MC, this does not necessarily mean a rise in Price, the final outcome of all these is, in an oligopolistic market there cannot be a price competition the only way to compete is through, advertising, promotion, and other non-price activities.
TASK 5
Keynesian Economics
Keynes Theory determines the equilibrium level of income through aggregate income & aggregate supply.
Aggregate Supply is given to be 450 http://www.marketoracle.co.uk/images/2010/Jul/keynes-Figure1.png
Line (E)
Aggregate Expense (D) sloping upward
AE = C + I + G + (X-M)
FIGURE: 16
(marketoracle,2011)
Aggregate expense consist of,
Consumption (C')
Investment (I)
Government Expenditure (G)
Net Exports (X-M)
Investment Expenditure:
This can be either Gross investment or Net investment; Investment refers to the increase in real capital stock of an economy.
NET INVESTMENT = GROSS INVESTMENT - REPLACEMENT INVESTMENT
COST OF INVESTMENT = INTEREST RATE
RETURN ON INVESTMENT = RETURN ON CAPITAL EMPLOYED
According to Keynesian theory National Income equals to Aggregate Expenditure.
If a firm is pessimistic low interest rates will not encourage them to borrow, while if they are optimistic high interest rate would not always discourage them from investing. A high level of company profits would make them think more optimistically and invest in business as they have more funds. Government may give tax incentives to encourage investments and reduce interest rates in order to make borrowings cheaper.
How economy can move towards Equilibrium Income and full Employment
This is assessed through the multiplier concept; any increase in income would have a multiplier impact on investment.
Multiplier : the ratio of the change in income to a permanent change in the flow of expenditure. This shows the number of times Income will increase as a given initial increase in Investment.
C = A + c Ywhere,
C = Consumption Demand
A = Autonomous Consumption Demand (consumption not related to Income)
Y = Personal disposable Income
C = Marginal Propensity to Consume
Monetarist Economics
The regularization of money supply and interest rates within the economy, by the Central bank of the country in order to control inflation and stabilize currency. This can be done through qualitative and quantitative methods.
Bank Rate: the minimum rate at which central Bank re-discounts its bills of exchange.
Open Market Operation: the purchase or sale of government securities by the central Bank by which it controls the volume of credit in the market.
Cash reserve Ratio: the amount of assets to be maintained by the commercial banks, this is decided by the Central Bank, by doing so it decides how much of credit is available in the market.
Special Deposits: if the Central Bank feels that there is a requirement to reduce the credit flow in the market they can instruct the commercial banks to maintain a special deposit with Central Bank, this would reduce the liquidity of the commercial banks.
Rationing of Credit: the Central Bank specifying requirements of minimum down payments for loans and the duration of installments.
Moral Suasion: The Central Banks role as an adviser, Persuader to the commercial banks.
LIMITATIONS;
If the bank rate is increased in order to control domestic inflation, it may result in short term foreign funds coming into the country, endangering the banks anti-inflation policy.
If the commercial banks have large cash reserves with them the 'Variable cash reserve ratio' may not work as the commercial banks can continue to create credit.
CONCLUSION
The above topics discussed in Task 1 to 5 is giving an insight as to how a firm would operate in an economy, what would the outcome of its product be, what are the types of profit that can be earned and how it would survive in a market, using which type of economic policy.
