Basic Economics Study Guide
Basic Economics Concepts
Definition of Economics
Economics is defined as:
The study of how people make choices to satisfy their wants.
The study of the wealth of nations as articulated by Adam Smith.
A science that studies human behavior as a relationship between ends and scarce means with alternative uses, as defined by Lionel Robbins.
Science and Scarcity
Economics is considered a social science because:
It utilizes methods from physical sciences.
It employs scientific methodologies to build models and theories.
It follows scientific procedures such as hypothesis formulation, data collection, and testing hypotheses through efficient methodologies.
Scarcity
Scarcity is defined by the following points:
Resources are limited, leading to the need for choices among them.
It's the basis for all economic decision-making.
Distinction: Scarcity differs from shortages and poverty.
Microeconomics vs Macroeconomics
Microeconomics:
Study of decision-making by individuals and firms.
Analyzes specific markets and industries.
Macroeconomics:
Analyzes the economy as a whole.
Deals with broad issues like unemployment, national income, and inflation.
Positive vs Normative Economics
Positive Economics:
Analysis that is purely descriptive or makes predictions.
Example: "If call charges of TIGO decrease, demand increases."
Normative Economics:
Involves value judgments about economic policies.
Example: "Ghana should have lower oil prices than Togo since it produces oil."
Resources
Definition of resources:
Inputs utilized for producing goods and services, consisting of:
Land: Natural resources such as water, minerals, and timber; rewarded with rent.
Labour: Human mental and physical efforts involved in production; rewarded with wages.
Capital: Manufactured resources, including machinery and buildings; rewarded with interest.
Entrepreneurship: Individuals who organize the other factors and are rewarded with profit.
Opportunity Cost
Definition: The highest valued alternative sacrificed to attain something.
Examples:
Losing an hour of sleep due to studying late.
Time spent with a partner versus time that could be spent working.
Scale of Preference: A table ranking individuals' wants in order of priority.
Production Possibility Curve (PPC)
Definition: A curve showing all possible combinations of outputs that can be produced using given resources.
Assumptions:
Only two commodities are produced.
Resources are fully employed.
Production time period is fixed.
Capital and technology remain unchanged.
Opportunity Cost and PPC
As more of one commodity is produced, the opportunity cost of producing that commodity increases due to:
The law of diminishing marginal returns.
Decision-making influenced by comparisons of marginal benefit and cost.
Adam Smith and the Invisible Hand
Invisible Hand Concept:
Prices signal the relative value of goods.
It directs resources to their most valued uses.
Enables efficient choices by consumers and producers.
Price Mechanism
Definition: A process where demand and supply interact to determine prices, restoring equilibrium in response to changes.
Demand: The quantity of goods consumers are willing and able to buy at various prices.
Law of Demand: Higher prices lead to lower quantities demanded and vice versa.
Market Demand: Summing individual demands horizontally at each price.
Demand Function
Factors affecting demand:
Price (P), Consumer Income (Y), Advertising (A), Taste and Preferences (T), Availability of Credit (C).
Mathematically represented as: D = eta1P + eta2Y + eta3A + eta4T + eta_5C
Changes in Demand vs Changes in Quantity Demanded
Change in Quantity Demanded: Movement along the demand curve due to price changes; a rise in price decreases quantity demanded.
Change in Demand: A shift in the demand curve due to changes in other factors (not pricing).
Exceptional Demand Curves
Curves that do not slope from left to right:
Giffen Goods: Upward sloping.
Prestige Goods: Backward bending.
Perfectly Elastic/Inelastic: Example goods with perfectly elastic demand.
Supply
Definition: Quantity of goods sellers are willing to offer for sale at different prices.
Supply curve represents the relationship between price and quantity supplied.
Law of Supply: Higher prices lead to higher quantities supplied and vice versa.
Determinants of Supply
Price of the commodity.
Production costs.
Price of related products.
Other factors (climate, market conditions).
Supply Function
Factors affecting supply are similar to those affecting demand.
Mathematically represented in a similar linear format as demand.
Changes in Supply vs Changes in Quantity Supplied
Change in Quantity Supplied: Movement along the supply curve due to price change.
Change in Supply: Shift of the supply curve due to changes in determinants other than price.
Equilibrium
Definition: A state where supply equals demand at a specific price and quantity, with no tendency for change.
Equilibrium Price: Identified at the intersection of demand and supply curves.
Mathematical Example of Equilibrium
Given demand 30P + 5q = 800 and supply 50P − 10q = 600, you can derive equilibrium conditions.
Price Control
Price Control: Legal constraints on prices, can be maximum (price ceiling) or minimum (price floor).
Advantages/Disadvantages of Price Mechanism
Advantages: Consumer sovereignty, efficient resource allocation, variety, lower prices.
Disadvantages: Neglect of low-income needs, income inequality, public goods deficiency, price instability.
Price Elasticity of Demand
Definition: Responsiveness of quantity demanded to price changes; mathematically defined as:
E_p = rac{ ext{Percentage Change in Quantity Demanded}}{ ext{Percentage Change in Price}}
Calculating Price Elasticity of Demand
An elastic demand scenario includes calculations varying prices and observing change in quantity.
Price Elasticity Ranges
Elastic Demand: E_p > 1 (demand is sensitive to price changes).
Unit Elastic Demand: E_p = 1 (proportional change).
Inelastic Demand: E_p < 1 (demand is not sensitive).
Importance of Price Elasticity
Crucial for businesses in pricing strategies, governments in taxation policies, and trade agreements.
Cross Price Elasticity of Demand
Definition: Responsiveness of quantity demanded of one good based on the price changes of another.
Mathematically expressed as:
E_{xy} = rac{ ext{Percentage Change in Quantity Demanded of good X}}{ ext{Percentage Change in Price of good Y}}
Income Elasticity of Demand
Definition: Responsiveness of demand to changes in consumer income, mathematically defined as:
E_y = rac{ ext{Percentage Change in Quantity Demanded}}{ ext{Percentage Change in Income}}
Long-run Production Function
In the long-run, all factors of production are variable.
Isoquants depict various combinations of inputs to yield the same output.
Cost Theory
Definition: Total expenditure incurred for production categorized into explicit and implicit costs.
Short-run Costs: Total costs, fixed, variable costs.
Long-run Cost Curves
Defined by economies of scale leading to U-shaped long-run average costs due to factors such as technology efficiency and scale production adjustments.
Monopoly and Monopolistic Competition
Explanation of market structures characterized by single sellers or differentiated products.
Oligopoly
A market structure defined by few large firms and interdependence in pricing and output decision-making.
Managerial Objectives and Theories of the Firm
Discussion of various firm objectives beyond profit maximization, including growth and managerial utility.
Final Notes
Behavioral theories suggest firms opt for satisfactory rather than maximum levels of performance based on various constraints.