Lecture 2. Introduction to Economics

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Reference: Economics Parkin & King (1937 Reading Room)

Definition: Economics is a study of scarcity & choice

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Economic Actors

• 1. Individuals/Households
• 2. Firms
• 3. Governments

Economic Models:

• Individuals/Households maximize happiness (utility) subject to income constraint
• Firms maximize profit (revenue - cost)
• Governments maximize ?

Demand

Quantity Demanded (Q) F(P, P{sub}, P{com}, Y, T,....)

Demand curve

Market demand = Total demand for the product

Demand Curve

Simply plots quantity against price

Downward sloping i.e. Lower the price, the higher the quantity of sales

Supply

Quantity Supplied = F(P, P{other}, w, r, Tech,....)

Supply curve

Market supply = Total supply of all firms in the market.

Supply Curve

Upward sloping, i.e. the higher the price, the greater the quantity produced

Price Determination

Supply meet demand

Price determined when Quantity demanded = Quantity supplied

Elasticity

• Price elasticity of demand. Measures response of demand to change in price dq/dp
• Income elasticity of demand. Measures reponse of demand to change in income.
• Cross price elasticity of demand. Measures change in demand of one product i as a result of the change in price of a second product j
• Elasticity of supply. Measures responsiveness of supply to a change in price.

Firms

• Short Run: At least one input/factor of production is fixed
• Total product (TP)
• Average product (AP)
• Marginal product (MP)
• Diminishing Marginal Product

Definitions of Cost

• Total costs (TC) = Total cost of production.
• Distinguish between costs that are fixed and those that are variable in short-run. Normally labour and materials costs thought of as variable, cost of plant and machinery a fixed cost.
• Total fixed costs (FC)
• Total variable costs (TVC)
• Average costs (AC) = TC/q where q is the level of output
• Average fixed costs (AFC) = TFC/q
• Average variable costs (AVC) = TVC/q
• Marginal costs (MC) Cost of producing one additional unit of output.

Long Run

• Long Run: All Inputs Are Variable
• Returns to scale
• Increasing returns to scale
• Constant returns to scale
• Decreasing returns to scale

Market Structures

1. Perfect Competition
2. Monopoly
3. Oligopoly

Perfect Competition

• Large number of buyers and sellers
• Identical (homogeneous) product
• Free entry and exit
• Full information
• Firms are price takers

• Total revenue (TR) = Income of firm from sale of goods = Price x Quantity
• Average revenue (AR) = TR/q
• Marginal revenue (MR) = Extra revenue earned from selling one additional unit of output
• Short Run
• Firm produces up to point where
• MC = MR = P

Normally think of competition as a process of rivalry.

Such rivalry absent in perfect competition.

Schumpeter: Perfect competition denotes a state in which competition is completely absent.

Perfect Competition – A Mythical State

'First-year students are still puzzled when they are faced with models of atomistic perfect competition and wonder which real world industries this actually describes.'

J. Kay, (1996): The Business of Economics, Oxford University Press, p.8.

• A theoretical concept.

• Provides yardstick against which cost of restrictions on competition can be measured.

Concepts of Efficiency

• Technical or Productive Efficiency;

• Allocative efficiency; and

• Dynamic efficiency.

• Competition maximises efficiency

2. Monopoly

• Large number of buyers but one seller
• Identical (homogeneous) product
• Barriers to entry
• Full information
• Monopolist will also produce up to point where MC = MR but MR < P

Monopoly Seen as Harmful

'They forget that whatever competition is not, monopoly is; and that monopoly in all its forms, is the taxation of the industrious for the support of indolence, if not of plunder'. John Stuart Mill (1848)Principles of Political Economy: Books IV and V, p.141.

• The Harmful Effects of Monopoly

  • Prices higher and output lower than under competition

  • X – inefficiency

  • 'The best of all monopoly profits is a quiet life.'

  • John Hicks, (1935): Annual Survey of Economic Theory: The Theory of Monopoly, Econometrica, 3 (January): 1-20.

  • Rent Seeking

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