ECO402 Handouts by VUBuddy

LESSON 1 MARKETS AND PRICES

Economics is the study of how societies use scarce resources to produce valuable commodities and distribute them among different people.

MICROECONOMICS VS. MACROECONOMICS

Microeconomics deals with behavior of individual units. When Consuming; How we choose what to buy When Producing; How we choose what to produce Markets: The interaction of consumers and producers.

Macroeconomics deals with analysis of aggregate issues: y Economic growth y Inflation y Unemployment

Microeconomics is the foundation of macroeconomic analysis.

THEMES OF MICROECONOMICS

According to Mick Jagger & the Rolling Stones, “You can’t always get what you want”. Why Not?

Š Limited Resources Š Unlimited Wants Allocation of Scarce Resources and Trade-offs Š In a planned economy Š In a market economy Microeconomics and Optimal Trade-offs 1. Consumer Theory 2. Workers 3. Theory of the Firm Microeconomics and Prices The role of prices in a market economy How prices are determined

THEORIES AND MODELS

Microeconomic Analysis Theories are used to explain observed phenomena in terms of a set of basic rules and assumptions. For example, the theory of the firm or the theory of consumer behavior.

Models: A mathematical representation of a theory used to make a prediction.

Validating a Theory The validity of a theory is determined by the quality of its prediction, given the assumptions.

Evolving the Theory Testing and refining theories is central to the development of the science of economics.

POSITIVE VERSUS NORMATIVE ECONOMICS

Positive economics deals with the observations or predictions of the facts of economic life. For example: What will be the impact of an increase in wages on the price of a product? Normative Economics is the value judgments about how economics should operate, based on certain moral principles or preferences?” For example: What wage rate should be paid to the auto workers to make them an active member of the society?

WHAT IS A MARKET?

Š Markets vs. Industries Market is a geographically defined area where buyers and sellers interact to determine the price of a product or a set of products. Industries are the supply side of the market. Š Defining the Market The market parameters must be set before an analysis of the market can take place. Š Arbitrage Buying a product at a low price in one location and selling at a high price in another. Š Competitive vs. Noncompetitive Markets In competitive Markets,because of the large number of buyers and sellers, no individual buyer or seller can influence the price. Š Example: Most agricultural markets Noncompetitive Markets are the markets where individual producers can influence the price. Š Example: OPEC Š Market Price Competitive markets establish one price. Noncompetitive markets may set many prices for the same product. Š Market Definition - The Extent of a Market Market Definition Which buyers and sellers should be included in a given market? Market Extent Defines the boundaries of the market Š Geographic Š Range of products Examples Geographic boundaries Š Gold: Lahore vs. Karachi Š Housing: Islamabad vs. Rawalpindi Range of Products Š Gasoline: regular, super, & diesel Š Cameras: Polaroid, point & shoot, digital Markets for Prescription Drugs Š Well-defined markets - therapeutic drugs Š Ambiguous markets – painkillers d

LESSON 2 MARKETS AND PRICES (Continued)

ECONOMICS; ANOTHER PERSPECTIVE

Economics is the study of the choices made by people who are faced with scarcity. Scarcity is a situation in which resources are limited but can be used in different ways; so one good or service must be sacrificed for another.

SOCIETY’S CHOICES

The decisions of producers, consumers and government determine how an economic system answers three fundamental questions:

Q1. What products do we produce?

Q2. How do we produce these products?

Q3. Who consumes the products?

FACTORS OF PRODUCTION

Factors of production are the resources that are used to produce goods and services:

1. Natural resources: The things created by acts of nature such as land, water, mineral, oil and gas deposits, renewable and nonrenewable resources.
2. Labor: The human effort, physical and mental, used by workers in the production of goods and services.
3. Physical capital. All the machines, buildings, equipment, roads and other objects made by human beings to produce goods and services.
4. Human capital: The knowledge and skills acquired by a worker through education and experience.
5. Entrepreneurship: The effort to coordinate the production and sale of goods and services. Entrepreneurs take risk and commit time and money to a business without any guarantee of profit.

THE PRODUCTION POSSIBILITIES FRONTIER

(PPF)

The PPF curve shows the possible combinations of goods and services available to an economy, given that all productive resources are fully and efficiently employed. When the economy is at point i, resources are not fully employed and/or they are not used efficiently. Point g is desirable because it yields more of both goods, but not attainable given the amount of resources available. Point d is one of the possible combinations of goods produced when resources are fully and efficiently employed. g

Tons of farm goods per day Tons of factory goods per

i