PPT 1

1. The Economic Problem:

● Human wants and desires are unlimited, meaning we always desire more
goods and services than we can obtain with our available resources. However,
resources to produce these goods and services are limited or scarce.
● Economics is the study of how individuals, businesses, and societies allocate
scarce resources to satisfy unlimited wants.

2. Resources:

● Resources, also known as factors of production, are the inputs used to

produce goods and services. There are four primary types:
● Labor: Refers to the physical and mental efforts of individuals involved
in production. It includes both physical labor and mental labor, such as
managerial skills and creativity. Labor is compensated with wages.
● Capital: Encompasses the physical tools, machinery, equipment, and
infrastructure used in production. It also includes human capital, which
refers to the skills, knowledge, and expertise of individuals. Capital is
compensated with interest.
● Natural Resources: These are the gifts of nature used in production,
such as land, water, minerals, and forests. Natural resources can be
renewable or exhaustible and are compensated with rent.
● Entrepreneurial Ability: This refers to the talent, innovation, and
risk-taking ability of individuals who organize and manage the other
factors of production. Entrepreneurs bear the risk of business ventures
and are compensated with profits.

3. Goods and Services:

● Goods are tangible products that can be seen, touched, or felt, such as cars,
clothes, and food items.
● Services are intangible products that provide benefits but cannot be physically
touched, such as healthcare, education, and transportation.
● Scarce goods and services are those for which the demand exceeds the
available quantity at a zero price. This scarcity necessitates choices and
trade-offs.

4. Economic Decision Makers:

● Economic decisions are made by various entities:

● Households: These are individuals or groups of people who consume
goods and services and supply resources such as labor and capital to
the economy.
● Firms: Also known as businesses, firms demand resources to produce
goods and services, and they supply finished products to consumers.
● Governments: Governments play a significant role in economic
decision-making through policies, regulations, and the provision of
public goods and services.
● Rest of the World: Refers to foreign entities involved in international
trade and investment, influencing the allocation of resources globally.

5. Markets:

● Markets are institutions where buyers and sellers interact to exchange goods,
services, and resources. They play a crucial role in determining prices and
quantities in an economy.
● Product markets facilitate the exchange of goods and services between
households and firms.
● Resource markets involve the exchange of resources, such as labor, capital,
and natural resources, between households and firms.

6. Circular-Flow Model:

● The circular-flow model illustrates the flow of resources, products, income,

and revenue among economic decision-makers, primarily households and
firms. It demonstrates how households supply resources to firms in exchange
for income, which is then used to purchase goods and services produced by
firms.

7. Rational Self-Interest:

● Rational self-interest refers to the behavior of individuals and firms making

decisions to maximize their own benefits or utility given their limited
resources.
● Individuals and firms weigh the expected benefits against the costs of their
actions and choose the option that provides the highest net benefit.
● This concept underlies much of economic theory and decision-making.

8. Microeconomics vs. Macroeconomics:

● Microeconomics focuses on the individual units of an economy, such as

households, firms, and markets. It examines how individual decision-makers
allocate resources and interact in markets to determine prices and quantities.
● Macroeconomics, on the other hand, studies the economy as a whole,
including aggregate variables such as national income, unemployment,
inflation, and economic growth. It analyzes the overall performance and
behavior of the economy.

9. Economic Analysis:

● Economic analysis involves the application of economic theory and models to

understand and predict real-world economic phenomena.
● Economic theories and models are simplifications of reality that highlight
important aspects of economic problems and relationships.
● Good economic theories help guide decision-making by sorting, saving, and
understanding information.

10. Pitfalls of Faulty Economic Analysis:

● Economic analysis can be prone to fallacies if not conducted rigorously:

● Mistaking association for causation: Assuming that because two
events occur together, one causes the other.
● Fallacy of composition: Assuming that what is true for one individual or
part of the economy is true for the economy as a whole.
● Ignoring secondary effects: Failing to consider the unintended
consequences of an economic action or policy.

11. Opportunity Costs:

● Opportunity cost is the value of the next best alternative forgone when a
decision is made.
● It represents the benefits that could have been gained by choosing the next
best alternative.
● All economic decisions involve trade-offs, as choosing one option necessarily
means giving up the benefits of other options.

12. Economic Systems:

● Economic systems are the institutional arrangements and mechanisms

through which societies allocate resources and make decisions about
production, distribution, and consumption.
● Pure capitalism and pure command systems represent extreme forms of
economic systems, with mixed economies combining elements of both.
● Capitalism emphasizes private property rights, competitive markets, and
individual decision-making, while command systems rely on central planning
and government control.
PPT 2
1. Demand:

● Definition: Demand refers to the quantity of a good or service that consumers

are willing and able to purchase at various prices during a specific period. It
represents the consumer side of the market.
● Law of Demand: This law states that there is an inverse relationship between
the price of a good and the quantity demanded, assuming all other factors
remain constant. In simpler terms, when the price of a good increases, the
quantity demanded decreases, and vice versa.
● Substitution Effect: When the price of a good decreases relative to
other goods, consumers tend to substitute the cheaper good for more
expensive ones, leading to an increase in demand for the cheaper
good.
● Income Effect: A decrease in the price of a good increases consumers'
real income, allowing them to purchase more of it. Conversely, an
increase in price reduces real income, leading to a decrease in demand.

2. Supply:

● Definition: Supply refers to the quantity of a good or service that producers are
willing and able to offer for sale at various prices during a specific period. It
represents the producer side of the market.
● Law of Supply: This law states that there is a direct relationship between the
price of a good and the quantity supplied, assuming all other factors remain
constant. In simpler terms, when the price of a good increases, the quantity
supplied increases, and vice versa.

3. Market Equilibrium:

● Market equilibrium occurs when the quantity demanded equals the quantity
supplied, resulting in a balance between buyers and sellers. At this point, there
is neither a shortage nor a surplus of the good or service. The equilibrium
price and quantity are determined by the intersection of the demand and
supply curves.

4. Shifts in Demand and Supply:

● Various factors can cause shifts in demand and supply curves, leading to
changes in equilibrium price and quantity.
● Factors affecting demand include changes in consumer income, prices of
substitutes or complements, consumer expectations, number of consumers,
and consumer tastes.
● Factors affecting supply include technological changes, prices of relevant
resources, prices of alternative goods, producer expectations, and the number
of producers in the market.

5. Disequilibrium:

● Disequilibrium occurs when the quantity demanded does not equal the
quantity supplied, resulting in either a shortage or a surplus. This situation
leads to price adjustments until equilibrium is reached.
● Government interventions such as price floors (minimum prices) and price
ceilings (maximum prices) can lead to disequilibrium in markets, causing
either shortages or surpluses.

Case Study: Rent Ceilings in New York City:

● Rent ceilings in New York City have led to housing shortages, decreased
construction, and lower-quality housing. This has caused increased demand
in the free-market sector, resulting in higher rents.
PPT 7
Production and Cost in the Firm

1. Cost and Profit:

● Producers aim to maximize profit by making production decisions that

optimize their costs and revenues.
● Opportunity Cost: Refers to the value of the next best alternative foregone
when a decision is made. All resources have an opportunity cost, which is the
value of the alternative uses of those resources.
● Explicit Costs: These are the actual monetary payments a firm makes
to purchase resources such as labor, materials, and equipment.
● Implicit Costs: Also known as economic costs, these represent the
opportunity cost of using resources owned by the firm or its owners.
These costs do not involve a direct monetary payment but represent
the value of the resources in their next best alternative use.

2. Production in the Short Run:

● Variable Resources: These are resources that can be adjusted or varied

quickly by the firm in response to changes in output levels. Examples include
labor and raw materials.
● Fixed Resources: These are resources that cannot be easily adjusted in the
short run, typically due to contractual or technological constraints. Examples
include factory space and specialized machinery.
● Law of Diminishing Marginal Returns: This law states that as a firm increases
the use of one input (e.g., labor) while keeping other inputs constant, the
marginal product of that input will eventually decrease. This occurs because
as more of a variable input is added to a fixed input, the marginal productivity
of the variable input will decline.

3. Costs in the Short Run:

● Fixed Cost (FC): These are costs that do not vary with the level of output in the
short run. Fixed costs include expenses such as rent for factory space and
insurance premiums.
● Variable Cost (VC): These are costs that vary with the level of output.
Examples of variable costs include wages for labor and the cost of raw
materials.
● Total Cost (TC): This is the sum of fixed and variable costs and represents the
total expenses incurred by the firm in producing a given level of output.
● Marginal Cost (MC): This is the additional cost incurred by the firm for
producing one more unit of output. It is calculated by dividing the change in
total cost (∆TC) by the change in quantity (∆q) of output produced.

4. Average Cost in the Short Run:

● Average Variable Cost (AVC): This is the variable cost per unit of output and is
calculated by dividing total variable cost by the quantity of output produced.
● Average Total Cost (ATC): This is the total cost per unit of output and is
calculated by dividing total cost (fixed plus variable) by the quantity of output
produced.
● Relationship between MC and AC: The relationship between marginal cost
and average cost is crucial. When marginal cost is less than average cost,
average cost decreases. Conversely, when marginal cost is greater than
average cost, average cost increases. This relationship results in the U-shaped
average cost curves commonly observed in the short run.

5. Costs in the Long Run:

● In the long run, all resources are variable, allowing firms to adjust their inputs
more flexibly than in the short run.
● The long-run average cost curve (LRAC) depicts the lowest possible average
cost for producing each level of output when all inputs are variable.
● Economies of scale: These occur when a firm experiences decreasing average
costs as it increases its scale of production. This can result from factors such
as specialization, bulk purchasing discounts, and more efficient use of
production facilities.
● Diseconomies of scale: These occur when a firm experiences increasing
average costs as it increases its scale of production. Factors contributing to
diseconomies of scale include communication difficulties, coordination
problems, and decreased employee morale.
● Constant returns to scale: This occurs when a firm's average cost remains
constant as its scale of production increases. It implies that the firm's
production process is efficient and well-suited to the scale of operation.

Appendix: A Closer Look at Production and Cost:

● The production function describes the relationship between inputs and

outputs in the production process. It indicates the maximum quantity of
output that can be produced with a given set of inputs.
● Isoquants represent different combinations of inputs that result in the same
level of output. They are typically downward sloping and convex to the origin.
● The marginal rate of technical substitution (MRTS) measures the rate at which
one input can be substituted for another while keeping output constant. It is
equal to the ratio of the marginal product of one input to the marginal product
of the other input.
● Isocost lines represent all combinations of inputs that can be purchased for a
given total cost. They are typically linear and have a negative slope.
● Profit maximization occurs when the firm chooses the combination of inputs
that minimizes the cost of producing a given level of output. This is achieved
when the isocost line is tangent to the isoquant, indicating that the marginal
rate of technical substitution equals the ratio of input prices.
● The expansion path shows how the optimal combination of inputs changes as
output expands. It typically slopes upward and to the right, indicating that
more of both inputs is required to produce higher levels of output.
PPT 8
Introduction to Perfect Competition:

● Market Structure:
● Market structure refers to the characteristics of a market that
determine the behavior of firms within it. These characteristics include
the number of firms in the market, the degree of product differentiation,
the ease of entry into the market, and the forms of competition among
firms.
● Number of Suppliers: Perfect competition involves a large number of
small firms, none of which have a significant market share.
● Product’s Degree of Uniformity: In perfect competition, products are
homogeneous, meaning they are identical across different suppliers.
● Ease of Entry into the Market: Perfectly competitive markets allow new
firms to enter and exit easily without facing significant barriers.
● Forms of Competition among Firms: Competition in perfect
competition is purely based on price and quality, with no room for
product differentiation.
● Industry:
● The industry encompasses all firms that supply output to a particular
market. It includes both existing firms and potential entrants.

Perfectly Competitive Market Structure:

● Characteristics:
● Many Buyers and Sellers: Perfect competition involves numerous
buyers and sellers, none of whom individually influence market prices.
● Commodity; Standardized Product: Products in perfect competition are
considered commodities because they are identical across all
suppliers, allowing consumers to make decisions solely based on
price.
● Fully Informed Buyers and Sellers: In perfect competition, both buyers
and sellers have complete information about market conditions, prices,
and product quality.
● No Barriers to Entry: Perfectly competitive markets have low barriers to
entry, meaning new firms can easily enter the market and existing firms
can exit without significant obstacles.
● Individual Buyer or Seller: Each individual buyer or seller has no control
over market prices and must accept the prevailing market price. They
are price takers rather than price makers.
Demand Under Perfect Competition:

● Market Price Determination: Market price in perfect competition is determined

by the intersection of market demand and supply. It represents the equilibrium
price at which quantity demanded equals quantity supplied.
● Firm's Demand Curve: In perfect competition, the demand curve facing an
individual firm is perfectly elastic, represented by a horizontal line at the
market price. This means the firm can sell any quantity of output at the
prevailing market price.

Market Equilibrium and a Firm’s Demand Curve:

● Market Equilibrium: Market equilibrium occurs when the quantity demanded

equals the quantity supplied, resulting in a stable price and quantity in the
market. It is determined by the intersection of the market demand and supply
curves.
● Firm's Demand: The demand curve facing a perfectly competitive firm is
horizontal at the market price. This means the firm can sell any quantity of
output at the prevailing market price, as it has no influence over the price.

Short-Run Profit Maximization:

● Objective: In the short run, firms aim to maximize economic profit, which is
the difference between total revenue and total cost.
● Maximizing Economic Profit: Firms determine the quantity of output at which
total revenue exceeds total cost by the greatest amount. This is achieved by
producing where marginal revenue equals marginal cost.
● Marginal Revenue and Marginal Cost: In perfect competition, marginal
revenue is equal to price, as each additional unit sold adds the same amount
to total revenue. Firms continue to increase production as long as marginal
revenue exceeds marginal cost.

Minimizing Short-Run Losses:

● Shut Down Decision: In the short run, firms may choose to shut down if total
revenue does not cover variable costs. This decision is based on whether total
revenue is greater than variable costs, which determines whether the firm
incurs an economic loss.
● Minimizing Losses: Firms continue to produce in the short run if total revenue
covers variable costs and a portion of fixed costs. They shut down only if total
revenue fails to cover variable costs.

Firm and Industry Short-Run S Curves:

● Short-Run Supply Curve: The short-run supply curve for an individual firm is
the upward-sloping portion of its marginal cost curve above the minimum
average variable cost. It represents the quantity of output the firm is willing to
supply at different prices in the short run.
● Industry Short-Run Supply Curve: The industry short-run supply curve is
derived by horizontally summing the short-run supply curves of all firms in the
market. It represents the total quantity of output supplied by all firms at each
price level in the short run.

Firm Supply and Market Equilibrium:

● In the short run, the market converges to equilibrium price and quantity, with
each firm maximizing profit or minimizing loss based on its individual supply
curve.

Perfect Competition in the Long Run:

● In the long run, firms enter or exit the market until economic profit disappears,
resulting in zero economic profit. This occurs as new firms enter the market in
response to economic profit, increasing supply and driving prices down.

Long-Run Adjustment to Changes in Demand:

● Changes in demand in the long run lead to adjustments in market supply as

firms enter or exit the market until equilibrium is restored.

The Long-Run Industry Supply Curve:

● In constant-cost industries, the long-run industry supply curve is a horizontal

line, indicating that firms can adjust their scale of operations without affecting
input prices or average costs.

Perfect Competition and Efficiency:

● Perfect competition leads to both productive and allocative efficiency.

Productive efficiency occurs when firms produce at the lowest possible cost,
while allocative efficiency occurs when resources are allocated to produce the
goods and services most desired by consumers.

Conclusion:
● Perfect competition ensures efficiency and maximum welfare through
competitive pricing and the allocation of resources according to consumer
preferences.
●
PPT 9
1. Barriers to Entry:

● Definition: Monopoly arises when a single firm dominates the market,

controlling the supply of a particular product or service with no close
substitutes.
● Barriers to entry prevent new competitors from entering the market and
challenging the monopoly. These barriers include:
1. Legal restrictions: Patents, copyrights, and licenses grant exclusive
rights to produce or sell a product for a specified period. For example,
patents provide inventors with a monopoly on their invention for a set
duration, typically 20 years.
2. Economies of scale: Monopolies often benefit from economies of
scale, where the average cost of production decreases as output
increases. This can create a natural monopoly scenario where one firm
can produce at a lower average cost than multiple firms.
3. Control of essential resources: Some monopolies arise from controlling
vital resources necessary for production. For instance, DeBeers
Consolidated Mines controls a significant portion of the diamond
market due to its dominance in diamond mining and distribution.

2. Revenue for the Monopolist:

● Revenue Maximization: Monopolists aim to maximize their revenue, which is

determined by the interplay between price, quantity, and demand elasticity.
● Total revenue (TR): This is the total income received from selling a
certain quantity of goods or services at a given price. TR equals price
(p) multiplied by quantity (Q).
● Average revenue (AR): AR is the revenue per unit sold and equals total
revenue divided by quantity (AR=TR/Q). In monopoly, AR equals the
demand curve (D) because the firm sets the price.
● Marginal revenue (MR): MR is the additional revenue earned from
selling one more unit of a product. It's crucial for profit maximization. In
monopoly, MR is typically less than price (MR<p) because the
monopolist must lower the price to sell more units.

3. Profit Maximization for the Monopolist:

● Price Determination: Monopolists have the power to set prices and quantities
in the market, making them "price makers."
● Profit maximization: Monopolists seek to maximize profit, achieved
when marginal revenue (MR) equals marginal cost (MC). This
equilibrium point determines the optimal quantity to produce and the
corresponding price.
● Choosing Price or Quantity: Monopolists can either set the price and let
the market determine the quantity demanded or set the quantity and let
the market determine the price. This flexibility is unique to monopolies.

4. Short-Run and Long-Run Considerations:

● Short-Run Analysis: In the short run, monopolists may continue operating if

they can cover their variable costs, even if they're incurring losses. However, if
they can't cover their variable costs, they may choose to shut down
temporarily.
● Long-Run Profitability: Monopolies may sustain economic profits in the long
run due to high barriers to entry that prevent new firms from entering the
market. However, if these barriers weaken or if costs rise, the monopoly's
profitability may decline.

5. Monopoly and Resource Allocation:

● Perfect Competition Comparison: Monopolies contrast with perfectly

competitive markets, where resources are allocated efficiently and social
welfare is maximized.
● In perfect competition, price equals marginal cost (p=MC), resulting in
an optimal allocation of resources and maximum social welfare.
● Monopolies, however, restrict output below the level that maximizes
social welfare, leading to a smaller consumer surplus, economic profit
for the monopolist, and deadweight loss to society.

6. Price Discrimination:

● Definition: Price discrimination involves charging different prices to different

groups of consumers based on their willingness to pay.
● Conditions: Price discrimination requires firms to have market power,
downward-sloping demand curves, and the ability to segment
consumers based on price elasticity of demand.
● Examples: Airlines often offer different prices for the same flight,
targeting business travelers with higher fares and leisure travelers with
discounted rates. Similarly, companies like IBM may offer different
prices for their products based on features or intended use