Transcript Document

Fundamentals of Economic Theory
Introductory notes
Yevgeniy M. Orel, C.Sc.(Econ.), Docent,
Faculty of Economic Science, NaUKMA
Course outline [1]
• Part 1 (micro):
– Nature and method
– Demand and supply
– Marginal utility and
marginal product
– Costs of production
– Market models
– Productive resources
– Market equilibrium
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– Efficiency and equity
– Market failures
– Public and private
choice
– Government and
market
– Management
– Marketing
– Politico-economic
context
2
Course outline [2]
• Part 2 (macro):
– GDP and other macroindicators
– Aggregate
expenditures
– AD/AS model
– Fiscal policy
– Budget deficit and
national debt
– Money and banking
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– Monetary policy
– Business cycles
– Unemployment and
inflation
– Economic growth
– International
economics
– Economic
globalization and
Ukraine
3
What we do:
• Trimester (108 hrs.):
–
–
–
–
–
–
–
Lectures – 26 hrs
Seminars – 12 hrs
2 interim tests
Self-study – 68 hrs
Consultations – 2 hrs
Office hours – ~ (see  special slide)
Final test 
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What we get:
• Trimester 4:
– Number of credits 2 
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What else we get, if anything at all:
•
•
•
•
•
Thinking like an economist? (likely)
A recipe how to get rich? (hardly)
Pleasure? (hope, yes)
Frustration? (hope, not)
Anything else? Qui vivra verra
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My contact info:
Yevgeniy M. Orel, C.Sc.(Econ.), Docent,
Faculty of Economic Science, NaUKMA
Office: 6/207
Tel.: (380-44) 425-6042, intercom. 432
Cell-phone: +38 050 551 6797
E-mail: [email protected]
Alt. E-mail: [email protected]
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Office hours:
• Tuesday – 14:00-17:00
• Thursday – 14:00-17:00
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Fundamentals of Economic Theory
Lecture 1.
The economizing problem.
Market mechanism versus
command economy.
Demand and supply.
Yevgeniy M. Orel, C.Sc.(Econ.), Docent,
Faculty of Economic Science, NaUKMA
Outline of the presentation:
• The nature, methods and methodology of
economic theory
• Positive and normative economics
• Micro- and macro-economics
• The goals of economic policy
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What economics IS about:
• Production of goods (material goods, services)
– WHAT TO PRODUCE?
• Use of resources – HOW TO PRODUCE?
• Distribution of goods – FOR WHOM TO
PRODUCE?
• Consumption of goods – consumer’s decision
• Behavior, decision-making – broader context
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What economics IS NOT about:
• Mathematics (see  D.Hand’s article)
• Housekeeping (!?),
• Law (!?),
• Music (!?),
• Family planning (!?),
• Marriage and divorce (!?),
• Many other things (!?),
HOWEVER…
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Applications of economics:
•
•
•
•
Businessmen’s decisions
Consumers’ decisions
Policy-makers’ decisions
Voters’ decisions
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Genesis of economics
• Xenophon ca 431-ca 352 Greek historian,
coined the term “economy”
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Genesis of economics [2]
• Aristotle – 384-322 BC – per him, economy
means organization of slave-owner’s
business.
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Schools of economics:
• Pre-modern: Ancient schools of economics
(Kautilya, Xenophon, Aristotle);
• Early Modern: Scholasticism, Mercantilism,
Physiocrats;
• Modern: Classical Economics, English historical
school; German historical school, Socialist
Economics, Neoclassical economics, Lausanne
school, Institutional economics;
• 20th century: Stockholm school, Keynesian
economics, Austrian school, Chicago school.
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Mercantilism
• Mercantilism – the first more-or-less clearcut economic theory. The key principles:
– The money and commodity circulation
(especially foreign trade) is the key contributor
to creation of added value or surplus product;
– Wealth of nations is determined by availability
of the precious metals.
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Antoine de Montcretiens, 1576–1621
• “Treatise on Political Economy” (1615)
• Thus he coined the term “political
economy”.
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Political economy approach
• In the course of production, people enter
into economic (production) relations
• Each level of production relations fits
respective socioeconomic superstructure
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Economic (production) relations [1]
• Production of goods – labor – is a deliberate
and expedient action of human beings.
• Objects of labor:
– Primary objects of labor given by nature;
– Raw materials, i.e. objects earlier processed by
human beings
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Economic (production) relations [2]
• Means of labor consist of the tools and
instruments a human being applies to the
objects of labor. They include:
– Mechanical and non-mechanical means of labor
(machines, equipment, etc.)
– Material conditions of labor (buildings, canals,
pipelines, etc.)
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Economic (production) relations [3]
• Means of production include:
– Objects of labor;
– Means of labor.
• Means of production and labor power (work
force) comprise productive forces of the
society.
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Economic (production) relations [4]
• In the course of production, distribution,
exchange and consumption, human beings
enter into production (economic) relations.
• Production relations comprise a nature
(subject-matter) of political economy.
• Unity and contradiction of productive forces
and production relations.
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Karl Marx, 1818-1883
His main work: Das Kapital
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Socioeconomic superstructure
• Comprises sociopolitical relations,
establishments, political system, judicial
bodies, etc.
• Economic relations (economic basis) and
socioeconomic infrastructure influence
upon one another.
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What are we dealing with?
• Political economy versus analytical economy.
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Subject-matter of economics
(analytical economy)
“Economics is the science which studies
human behavior as a relationship between
ends and scarce means which have
alternative uses.”
Lionel Robbins
“An Essay on the Nature
and Significance of
Economic Science”,
1932
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Basic provisions
•
•
•
•
Human needs are infinite
Resources to satisfy human needs are finite
Alternative use of resources
Human behavior is a factor
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Two levels of science:
• What is?
 Positive science
• What should be?  Normative science
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Positive economics
• Positive economics studies “WHAT IS”,
“how the economy actually works”.
• “The aim of positive economics is to
explain how decisions are made about
production, consumption and the exchange
of goods and to aid predictions about
responses to changes in economic
circumstances” (F.Livesey / Dictionary of
Economics)
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Positive economics [2]
• Examples of statements and questions related to
positive economics:
–
–
–
–
There is a market for CDs
The price control tells on market forces
In July 2005, unemployment rate amounted to 3%
Will inflation reach 20% next year?
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Normative economics [1]
• Normative economics studies “WHAT
SHOULD BE”.
• The aim of normative economics is to
“propose courses of action based on
personal value judgments”.
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Normative economics [2]
• Examples of statements and questions related to
normative economics:
–
–
–
–
There should be a free market for CDs
The central government ought to interfere in pricing
Unemployment rate is not to exceed 3%
How the national income should be distributed?
(equally or fairly?  )
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More on the positive versus the normative
• Period of time is not a criterion
• Positive statements are value-free (?!)
• Normative statements are value-based (!?)
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Distinction: clear or vague?
• Positive economics is not always value-free,
since…
• …economists can apply some procedures and
reject others.
• E.g.: Breaking down a set of elements into a
certain number of categories or groups
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From facts to policy
• Empirical (descriptive) economics  Economic
Theory  Economic Policies (prescriptive
economics)
• The above is not a one-lane street:
– Facts (empirical data) “feed” theory;
– Theory explains facts;
• Economic policies related to as “policy economics”
or “applied economics” (C.McConnell, S.Brue)
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Systems of values result from
theories in ethics (a review?):
• Utilitarianism
• Liberalism
• Communitarianism
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Perspectives:
• Utilitarianism – outcomes
• Liberalism – starting points
• Communitarianism – character
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Utilitarianism (John Bentham)
“the greatest good of the greatest number”:
• Subjective: Individuals decide on their own
well-being;
• Objective: experts create and apply an index
of well-being.
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Utilitarianism – cont.:
problems
• Utility may not even exist as a
measurable thing;
(“utilometer” has never been invented)
• There is no 100%-correct way to
measure utility;
• Is it fair to sacrifice some for others?
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A checking slide:
x
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• Utilitarianism
• Liberalism
• Communitarianism
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Liberalism:
people have the right to choose their own life plan
• Libertarianism (libertarian liberalism): Negative rights, i.e. the
rights to be left alone (laissez-faire?);
• Egalitarianism (egalitarian liberalism): Positive rights as a
prerequisite for effective choice (universal public health
and public education; abortions, euthanasia, etc.).
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Liberalism – cont.:
problems
• Difficult to know who is entitled to what rights;
• Uncertain extent of possible redistribution;
• If the rights conflict, what do we do?
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A checking slide:
x
x
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• Utilitarianism
• Liberalism
• Communitarianism
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Communitarianism:
Good character of individuals to result in good society
• Relativism (relativist communitarianism): Each society to
define good character for itself;
• Universalism (universal communitarianism): One and the
only true good character exists. (Does it?)
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Communitarianism – cont.:
problems
• Boundaries of the community are hardly
(if at all) definable;
• Communities suppress dissent? How far
do they go towards it?
• Conflicting visions of different
universalists: How to handle those
conflicts?
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A checking slide:
x
x
x
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• Utilitarianism
• Liberalism
• Communitarianism
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Economists: what are they?
“Economists tend to be subjective
utilitarians, whether they know it or not”.
Marc J. Roberts
Professor
Harvard School of Public Health
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Two levels of science:
• Positive science

• Normative science 
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based on data
based on values
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Similarly:
Two levels of economics:
• What, how, and for whom
IS produced? 
 Positive economics
• What, how, and for whom
SHOULD BE produced? 
 Normative economics
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Relatively easy to figure out:
• What is
and (separately)
• What should be
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Usually difficult to figure out:
Transition between the two:
“what is”
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?
“what
should be”
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In god we trust,
from others we
request data.
Alan Maynard
Professor
University of York
UK
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Art of economics [1]
• The art of economics forms relation of
positive economics to normative economics
• The art of economics means applying the
knowledge gained from positive economics
to achieving the goals set by normative
economics
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Art of economics [2]
• Examples of statements and questions
related to art of economics:
– Market ensures efficiency, but does not provide
for equity, so the government is to intervene.
– Given the way the economy works, how can we
achieve a higher labor productivity resulting in
better living standards?
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Micro & Macro [1]
• MICROECONOMICS is the study of
markets and that of their participants’
behavior.
• MACROECONOMICS is the study of the
entire economic system at the level of
aggregated units.
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Micro & Macro [2]
• Trees versus forest
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The goals of economic policy
• EFFICIENCY
• EQUITY
• STABILITY
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The goals of economic policy:
EFFICIENCY
• Economic (allocative) efficiency:
– Full employment of labor force
– Full utilization of available adequate resources
• Economic (technical) efficiency
• Economic (distributive) efficiency
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The goals of economic policy:
EQUITY
• Economic freedom
• Fair distribution of income
• Economic security
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The goals of economic policy:
STABILITY
• Macroeconomic stability:
– Stable price level
– Stable national currency unit
– Maintaining foreign trade balance
• Economic growth
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Goals and means
• GOALS are set by policy-makers
• MEANS to achieve them are developed by
economists
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Lecture 1, cont-d:
Sub-Topic
Essence of the economizing
problem
Outline of the presentation
(Sub-Topic Essence of the economizing problem)
•
•
•
•
•
•
•
•
Wants and their classifications
Maslow’s hierarchy
Economic resources
Allocative and technical efficiency
The production possibilities curve/frontier
Opportunity costs
Factors of economic growth
Economic models
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Wants/needs and their
classifications
• By urgency and significance:
– Elementary needs,
– Exquisite needs
• By nature:
– Biological
– Cultural
– Social
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Maslow’s hierarchy
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Abraham Maslow
1908-1970
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What is economics concerned
about?
• What to produce
• How to produce
• For whom to produce
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Economic resources
• Property resources :
– Land
– Capital
• Human resources:
– Work force (labor force)
– Entrepreneurial ability
• [others]
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Money capital and financial capital
• Money IS NOT an economic resource
because it produces nothing
• Financial capital IS NOT an economic
resource because it produces nothing
• Real capital IS an economic resource
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Economic efficiency [1]
• Economic efficiency is “the state of an
economy in which no one can be made
better off without someone being made
worse off” (Bannock’s Dict-ry of Ec-cs)
• Pareto-optimality = economic efficiency
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Vilfredo Pareto
1848-1923
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Economic efficiency [2]
• Economic efficiency requires allocative,
technical and (as mentioned in some
sources) distributive efficiency
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Allocative and technical
efficiency
• Allocative efficiency means that resources
are used for production of goods and
services desired by society.
• Technical/productive efficiency means that
the goods are produced at the lowest cost.
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Allocative efficiency
• When inputs/outputs “are put top their best
uses in the economy so that no further gains
in output of welfare are possible”. (S.Witter &
T.Ensor)
• Nobody can be better-off without somebody
getting worse-off.
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Technical (productive) efficiency
• “When the firm produces the maximum
possible sustained output from a given set
of inputs. (S.Witter & T.Ensor)
• Any given output produced employs
minimal possible resources.
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Three main elements of efficiency
(Pauly, 1970; Culyer, 1985):
• 1. Do not waste resources
• 2. Produce each output at least
cost (Tech.-Effic.)
• 3. Produce the types and amounts
of output which people value most
(Alloc-Effic.)
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Allocative and technical efficiency:
a “rule-of-thumb” distinction
• Allocative efficiency means producing
“right” things
• Productive (technical) efficiency means
producing them in the “right” way
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The production possibilities
curve/frontier
Initial assumptions:
• Full employment and maximal productive
efficiency
• Resources available are constant both in
quantity and in quality
• Technology is not subject to change
• Only two products can be made from the
available resources
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Production possibilities of salo and computers with full employment and
production efficiency in a hypothetic country U
Alternative
opportunities
Computers, thous.
units
Salo, thous. tons
A
0
30
B
1
28
C
2
24
D
3
18
E
4
10
F
5
0
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Example of a production
possibilities frontier (PPF)
35
30
30
Salo (thous. tons)
28
26
25
24
20
18
16
15
10
10
5
0
0
0
1
2
3
4
5
6
Computers (thous. units)
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Opportunity costs
• OPPORTUNITY COST (альтернативна
вартість, вартість найкращої з
втрачених можливостей) – the largest
quantity of the most desirable good we have
to forgo in order to obtain a unit of a
particular good. An opportunity cost of any
option is the best of forgone opportunities.
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ECONOMIC GROWTH
• ECONOMIC GROWTH : Ability of an
economy to produce more and more
products due to the technical progress and
increase in the amount of resources.
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Factors of economic growth
• Factors conducive to economic growth:
§
Increase in the quantity and quality of
resources (natural, investment, human)
§
Technical progress
§
Expanding foreign trade
• Factors hampering economic growth:
§
Wars
§
Discrimination
§
Expanding foreign trade (!?)
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Economic models
•
•
•
•
Traditional
Command economy
Free-market economy
Social market economy
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Different economic models
differently resolve the problems of:
• What to produce
• How to produce
• To whom the produce is distributed
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Command economy model:
• Huge resources are allocated inefficiently by a
privileged bureaucracy, which negatively tells
on individual consumption;
• Due to poor distribution of resources, the
system usually lacks incentives to work hard;
• Bureaucracy develops into a self-serving elite
that allocates resources to its followers, i.e. not
necessarily on merit.
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MARKET, definitions:
• A group of buyers and sellers of a certain
good (commodity or service);
• A place where they – buyers and sellers –
get together;
• A system, network, infrastructure, etc.
conducive to market transactions;
• Other definitions…
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Markets, more
• Types of markets:
– Product market
– Resource market
– Labor market
• Participants in the markets: consumers, producers,
entrepreneurs, sellers, buyers, etc.
***************
*******
***
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Sub-Topic 1c
Demand and supply
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A saying:
Teach a parrot to say,
“Demand and supply!”,
and you have an economist!
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Outline of the presentation
(Sub-Topic 1-c Demand and Supply)
•
•
•
•
•
•
•
•
Market, definition
The law of demand. Demand shifters
Demand and the quantity demanded
The law of supply. Supply shifters
Supply and the quantity supplied
Market equilibrium
Rationing function of prices
Outcomes of changes in demand and supply
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Market, a repeat definition slide:
• MARKET – a group of sellers and buyers
of a good (commodity) or service.
• MARKET – a mechanism, institution, or a
structure that brings together buyers and
sellers of a certain good or service.
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Demand, definitions of
• DEMAND (попит) – a quantity of a
product that buyers are able and willing to
buy at different prices within a certain
period of time, ceteris paribus.
• DEMAND – “The desire for a particular
good or service supported by the possession
of the necessary means of exchange to
effect ownership.” (Bannock’s DoE)
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Conditions of demand
• Willingness to buy
• Ability to pay (availability of means or
resources)
• Certain (limited) period of time
• Other conditions being constant, other
things being equal, ceteris paribus
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Demand schedule
(example of individual demand)
Price per unit, hr.
Quantity demanded per
period of time
1
10
2
8
3
6
4
4
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Demand curve, example
Quantity demanded (units)
25
20
15
10
5
0
0
1
2
3
4
5
6
Price (hr./unit)
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Quantity demanded versus
demand
• QUANTITY DEMANDED (величина
попиту) is determined by the price for a
good.
• DEMAND is determined by the demand
shifters.
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Demand shifters
•
•
•
•
•
•
•
Demand shifters (determinants of demand[1]):
1.) Buyers’ tastes and preferences
2.) Number of buyers
3.) Buyers’ income
4.) Prices for related goods
5.) Buyers’ expectations
[1] Укр.: детермінанти попиту, визначники
попиту, фактори попиту.
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Related goods
• Related goods (Товари за ознакою
спорідненості):
• 1.) substitute goods (beef-pork, butter-oleo)
• 2.) complementary goods (cars-gas,
camcorders-chips)
• 3.) independent goods (beef-gas, oleocamcorders)
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SUPPLY
• SUPPLY (пропозиція) – a quantity of a
product that suppliers are able and willing
to supply at different prices within a certain
period of time, ceteris paribus.
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Conditions of supply:
§
Willingness to sell (produce)
§
Ability to sell (produce)
§
Certain (limited) period of time
§
Other conditions not changed, other
things equal, ceteris paribus
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Supply schedule
(example of individual supply)
Price per unit, hr.
Quantity supplied per
period of time
1
2
2
5
3
9
4
14
5
20
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Example of an individual
supply curve
6
Price (hr.)
5
4
3
2
1
0
0
1
2
3
4
5
6
7
8
9
10
11
12
Quantity supplied (units)
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Quantity supplied versus supply
• QUANTITY SUPPLIED (величина
пропозиції) is determined by the price for a
good.
•
• SUPPLY (пропозиція) is determined by
supply shifters.
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Supply shifters
•
•
•
•
•
•
•
•
Supply shifters (determinants of supply[1]):
1.) Prices for resources
2.) Changes in technology
3.) Taxes and subsidies
4.) Prices for other goods
5.) Suppliers’ expectations
6.) Number of suppliers
[1] Укр.: детермінанти пропозиції, визначники
пропозиції, фактори пропозиції.
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LAW OF DEMAND
The lower the price of a good, the more of it
will be demanded, other things held
constant.
The higher the price of a good, the less of it
will be demanded, other things held
constant.
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INCOME EFFECT*
• The change in the demanded quantity of a product
as a result of a change in its price, i.e. the impact
of a change in price on the spending power of
consumers. The change in price of a product
results in a change in the real income of individual
consumers, who can either afford to buy more
units of the product, or have to buy less of it.
*Ukr.: Ефект доходу
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SUBSTITUTION EFFECT*
• The change in a consumer’s preferences
resulting from changes in relative prices of
goods, given the same real income and the
same total utility.
*Ukr.: Ефект заміщення
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Demand and Supply Curves
6
Price (hr.)
5
4
3
2
1
39
36
33
30
27
24
21
18
15
12
9
6
3
0
0
Quantity demanded/supplied (units)
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EQUILIBRIA
• EQUILIBRIUM PRICE (рівноважна ціна,
ціна рівноваги) – the price at which the market
equilibrium is reached.
– EQUILIBRIUM PRICE – “the price toward which
the invisible hand drives the market.” (D.Collander)
• EQUILIBRIUM QUANTITY (рівноважна
кількість) – “the amount bought and sold at the
equilibrium price.” (D.Collander)
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Topic 1d
Elasticity of demand and supply
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Outline of the presentation
(Topic 1b)
•
•
•
•
•
•
•
•
Price elasticity of demand and supply
Determinants of price elasticity of demand
Cross elasticity of demand
Interdependent (substitute and complementary)
and independent goods
Cross elasticity of supply
Normal goods
Inferior goods
Giffen goods
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Price elasticity formula (repeat)
%-change in Q
________________ = price elasticity
% change in P
Types of price elasticity of demand
•
•
•
•
1.)
2.)
3.)
4.)
5.)
|Ed| > 1 – elastic demand
|Ed| < 1 – inelastic demand
|Ed| = 1 – unit-elastic demand
|Ed| = 0 – perfectly inelastic demand
|Ed| =  – perfectly elastic demand
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Determinants of the price
elasticity of demand:
1.) Substitute products availability,
substitutability
• 2.) Price’s proportion in the consumer’s
income
• 3.) Luxury or necessity? Significance of
the good for consumers
• 4.) Time elapsed since the price change
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PRICE ELASTICITY OF SUPPLY
• Price elasticity of supply: “the percentage
change in quantity supplied divided by the
percentage change in price”
• Es = %Qs / %P
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Types of price elasticity of supply:
•
•
•
•
•
1.)
2.)
3.)
4.)
5.)
Es > 1 – elastic supply
Es < 1 – inelastic supply
Es = 1 – unit-elastic suuply
Es = 0 – perfectly inelastic supply
Es =  – perfectly elastic supply
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Determinants of the price
elasticity of supply:
• 1.) Time elapsed since the price change
• 2.) Cost of the output
expansion/contraction
• 3.) Substitutability of resources
• 4.) Shelf life and the cost of storage of the
good
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Cross-elasticity of supply
• Cross-elasticity of supply is the percentage
change in the quantity demanded of one
product divided by the percentage change in
the price of another product.
• ECross-D = %Qd,X / %PY
• Substitutable goods – positive elasticity
• Complementary goods – negative elasticity
• Independent goods – [nearly] zero-elasticity
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Income elasticity of demand
• Income elasticity of demand:
• EIncome-D = %Q / %I
• Normal goods (“Нормальні” товари) –
Income elasticity of demand is positive
• Inferior goods (Товари нижчої якості) –
Income elasticity of demand is negative
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Дякую за увагу!
Thank you for attention!
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