IK 335 Business English IAutumn SemesterDr.Dilek Seymen

Course I

I. What is Economics?II.What is the differences between Economics and the Economy?III.Main economic terms to understand Economics: Scarcity, Resource &Commodities, Choice, Opportunity Cost.IV. Possitive & Normative EconomicsV. Microeconomics & Macroeconomics.

Economics and the Economy

Every group of people must solve three basic problems of daily living;- what goods and services to produce- how to produce these goods and services- for whom to produce these goods and services.Society must answer all three questions. By emphasizing the role of society, economics is a social science that stuy and explain human behaviour. The subject matter of economics is human behavior in the production, exchange and use of goods and services. The central economic problem for society is how to reconcile the conflict between people's virtualy limitless desires for goods and services and the scarcity of resources (labour, machinery and raw materials) with which these goods and services can be produced. In aswering the questions, what, how, and whom to produce, economics explains how scarce resources are allocated between competing claims on their use. Economics is the study of the use of scarce resources to satisfy unlimited human wants. Economics is the social science that deals with problems such as what, how, and for whom to produce.

An Economy, is defined as a set of interrelated production and consumption activities. It may refer to this activity in a region of one country (for example the Economy of New England ) in a country (the American economy) or in a group of countries (the economy of Western Europe). In any economies the allocation of resources is determined by the production, sales and purchase decision made by firms, house holds and government.

ScarcityScarce good is a commodity for which the quantity demanded exceeds the quantity supplied at a price of zero; and therefore a good that commands a positive price in a market economy.Scarcity is inevitable and is central to economics problems. In relation to desires,(for more and better foods,clothing, housing, schooling, entertainment etc.) existing resources are woefully inadequate; there are enough to produce only a small fraction of the goods and services that are wanted.

Resources&CommoditiesA society’s resources consist of natural gifts such as land, forests and minerals; human resources, both mental and physical, and manufactured aids to production such as tool, machinery and buildings. Economists call such resources factors of production, because they are used to produce those thing that people desire. The thing produced are called commodities. Commodities may be divided in to goods and services. Goods are tangible and services are intangible.

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What are goods? Goods are physical commodities such as steel, pencil and book etc. What are services? Services intangible commodities such as hair cut or medical care. People use goods and services to satisfy many of their wants The act of making goods and services is called production, and the act of using them to satisfy wants is called consumption.

ChoiceBecause resource are scarce, all societies face the problem of deciding what to produce, and how to divide the product among their members. Societies differ in who makes the choices and how they are made, but the need to choose is commen to all. Just as scarcity ipmlies the need for choice, so choice implies the existence of cost.

Opportunity CostThe opportuniy cost is the cost of using resources for a certain purpose, measured by the benefit given up by not using them in an alternative way; that is, measured in terms of other commodities that could have been optained instead. Every time scarcity forces one to make a choice. These cost are measured in terms of forgone alternatives.

Positive &Normative EconomicsThe success of modern science rest partly on the ability of scientists to separate their views on what does happen from their views on what they would like to happen.Positive statements concern what is, was or will be. Normative statements concern what one bleives ought to be. Positive statements or theories may be simple or complex, but they are basically about matters of fact. Normative statements, because they concern what ought to be, are bound up with philosophical, cultural, and religious systems. A normative statement is one that makes or is based on a value judgement -a judgement about what is good what is bad. In studying economics, its important to distinguish two branches of the subject, "positive" and "normative" economics.Positive economics deals with objective or scientific explanations of the economy. The aim of the positive economics is to explain how society makes decisions about consumption, production and exchange of goods. Normative economics offers recomendations based on value judgements. Normative economics is based on subjective value judgements, not on the research for any objective truth. The following statements combines positive and normative economics:"The elderly have very high medical expenses, and the government should subsidize their health bills."The first part of the proposition- the claim that the aged have relatively high medical bills- is a statement in positive economics. It is a statement about how the world works, and we can imagine a research programme that could determine whether or not it is correct. Broadly speaking this assertion happens to be correct. The second part of the proposition- the recommendation about what the government should do- could never be proved to be correct or false by any scientific research investigation. It is simply a subjective value judgement based on the feelings of the person making the statement. Many people might share this subjective judgement. But other people might reasonably disagree. You might belive that it is more important to devote society’s scarce resource to improve the environment. There is no way that economics can be used to show that one of these normative judgements is correct and the other wrong. It all depends on the preferences or priorities of the individual or the society that has to make this choice.

Microeconomics&MacroeconomicsWe can classify branches of economics according to the approach that is used.

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Microeconomics analysis offers a detailed treatment of individual decisions about particular commodities.Microeconomics is the study of the allocation of resources and the distribution of income as they are affected by the working of the price system and by government policies. Microeconomics deal with the determination of prices and quantities in individual markets and with the relations among these market. Thus it looks at the details of the economy. In contrast, Macroeconomics focuses on much broader aggregates.It looks at such thing as the total number of people employed and unemployed., the average level of price and how it changes over time, national output, and aggregate consumption. Macroeconomics emphasizes the interactions in the economy as a whole. Macroeconomics is the study of the determination of economic aggregates and averages such as total output, total employment, the price level and rate of economic growth.Whereas microeconomics looks at demand and supply with regard to particular commodities, macroeconomics looks at aggregate demand and aggregate supply.

Course II

I Graphical Explanation of Scarcity, Choice and Opportunity CostII. Alternative Economic Systems: Command Economy, Free Market Economy, Mixed Economy.IV. The Decision Makers; Households, Firms, Government.

I.Graphical Explanation of Scarcity, Choice and Opportunity CostA decision to have more of one thing requires a decision to have less of something else. It is this fact that makes the first decision costly. The opportuniy cost is the cost of using resources for a certain purpose, measured in terms of the benefit given up by not using them in an alternative way; that is, measured in terms of other commodities that could have been obtained instead.

Industrial Goodsd

Production Possibilityb Boundary

c a

Industrial Goodsd

Production Possibilityb Boundary

c a

Agricultural Products

Consider for example the important social choice between agricultural products and industrial products.It is not possible to produce an unlimited quantity of both agricultural and industrial products. If resources are fully employed and the government wishes to produce more industrial goods, then less agricultural goods must be produced. The opportunity cost of increased industrial goods production is forgone production of agricultural goods.The choice is illustrated in Figure above. The downward-sloping boundary shows the combinations that are just attainable when all of the society's resources are efficiently employed. The quantity of agricultural goods produced is measured along the horizontal axis, the quantity of industrial goods produced along the vertical axis. Thus, any point on the diagram indicates some amount of each kind of good produced. The production possibility boundary separates the attainable combinations such as a,b,and

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c from unattainable combinations such as d. It slopes downwards because resources are scarce. More of one good can be produced only if resources are freed by producing less of the other goods. Points a and b represents either efficient use of society's resources. Point c represents either inefficient use of resources or failure to use all the available resources. A production possibility boundary illustrates three concepts; scarcity, choice, and opportunity cost. Scarcity is indicated by the unattainable combination above the boundary, choice by the need to choose among the alternative attainable points along the boundary and opportunity cost by downward slope of the boundary.The allocation of scarce resources among alternative uses called resource allocation, determines the quantities of various goods that are produced. Choosing to produce a particular combination of goods means choosing a particular allocation of resources among the industries or regions producing the goods because, for example, producing a lot of one good requires that a lot of resources be allocated to its production. Further, because resources are scarce it is desirable that they be used efficiently. Hence it matters which of the available methods of production is used to produce each of the goods that is to be produced.The capacity to produce commodities to satisfy human wants grows rapitly in some countries, slowly in others and actually declines in still others. Growth in productive capacity can be represented by a pushing outward of the production possibility boundary as shown in Figure above. If an economy’s capacity to produce goods and services is growing, combination that are unattainable today will become attainable tomorrow. Growth makes it possible to have more of all goods.

II.Alternative Economic SystemsThe role of the market in allocating resources differs vastly between countries. In the command economy resources are allocated by central government planning. In the free market economy there is virtually no government regulation of the consumption, production and exchange of goods, ın between lies the mixed economy, where market forces play a large role but the government intervenes extensively. All economies face scarcity, and all must decide how to allocate scarce resources and distribute goods and services; all may face problem of inflation, unemployment, and unsatisfactory rates of growth.Because all economies faces many common problems, economic analysis can contribute valuable insights even where familiar instutitions are modified or absent. Economies can differ from one another in many ways and such classification as "capitalism" "socialism" or "mixed economy", represent simplification of complex matters.

The Command Economy (centrally planned economy-socialism)A command economy is a society where the government makes all decisions about production and consumption. A government planning office decides what will be produced, how it will be produced, and for whom it will be produced. Detailed instructions are then issued to household, firms, workers.Such planing is very complicated task, and there is no complete command economy where all allocation decisions are undertaken in this way. However in many countries, for example those in Chine, Cuba, and those formerly in the Soviet Bloc, there was large measure of central direction and planning. The state owned factories and land made the most important decisions about what people should consume, how goods should be produced, and how much people should work.

Free Market Economy: The Invisible Hand (market oriented system-capitalism)Markets in which government do not intervene are called free markets. Individual in free markets pursue their own interests trying to do as well for themselves as they can without any government direction or interference. Smith argued that individuals pursuing their self-interest would be led 'as by an invisible hand' to do things that are in

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the interest of society as a whole. The idea that such a system could solve the what, how, and for whom to produce problem.

The Mixed EconomyThe free market allows individuals to pursue their self interest without any government restrictions. The command economy allows little scope for individual economic freedom since most decisions are taken centrally by the government. Between these two extremes lies the mixed economy.In a mixed economy the government and private sector interact in solving economic problems. The government controls a significant share of output through taxation, transfer payments, and the provision of goods and services such as defence and the police force. It also regulates the extend to which individuals may pursue their own self-interest.

III. The Decision MakersEconomics is about the behavior of people. There are millions of individual in most economies. To make a systematic study of their behaviour more manageable, we categorize them into three important groups: households, firms, government.A household is defined as all the people who live under one roof and who make or are subject to others making for them, joint financial decisions. The members of household are often referred to as concumers. A firm, is defined as the unit that employes factors of production to produce commodities that it sells to other firms, to households, or to government. For obvious reasons a firm is often called a producer. The term government is used in economics in a broad sense to include all public officials, agencies, government bodies and other organization belonging to or under the direct control of state.

Course III.

I. The MarketII. Demand&Supply III. The Market and Equilibrium Price

I. The MarketA market is a set of arrangements by which buyers and sellers are in contact to exchange goods or services. Some markets physically bring together the buyer and seller. Other markets (the stock exchange) operate through intermediaries (stock brokers) who transact business on behalf of clients. To understand this process more fully, we require a model of a typical market. The essential features are demand , the behhaviour of buyers, and supply, the behaviour of sellers. We can study the interaction of these forces to see how a market works in practice.

II. Demand& Supply Demand is the quantity of a good buyers wish to purchase at each conceivable price. The first column of Table below, shows a range of prices for bars of chocolate. The second column shows the quantities that might be demanded at these prices. Even when chocolate is free, only a finite amount will be wanted. People get sick from eating too much chocolate. As the price of chocolate rises, the quantity demanded falls, other things equal. We have assumed that nobady will buy any chocolate when the price is more than 1000 TL.per bar. Taken together, columns (1) and (2) describe the demand for chocolate as a function of its price.

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Table: The Demand for and supply of chocolate

16001000.000

12040600.000

8080400.000

40120250.000

0160150.000

02000

(3)Supply(million

bars/year)

(2)Demand(million

bars/year)

(1)Price

(TL/ bar)

16001000.000

12040600.000

8080400.000

40120250.000

0160150.000

02000

(3)Supply(million

bars/year)

(2)Demand(million

bars/year)

(1)Price

(TL/ bar)

Supply is the quantity of a good seller wish to sell at each conceivable price. The third column of the Table shows how much seller wish to sell at each price. Chocolate can not be produced for nothing. Nobody would wish to supply if they receive a zero price. In our example, It takes a price of 250.000 TL. before there is any incentive to supply chocolate. At a higher prices it becomes increasingly lucrative to supply chocolate bars and there is a corresponding increase in the quantity of bars supplied.Taken together columns (1) and (3) describe the supply of chocolate bars as a function of their price.The demand schedule relating price and quantity demanded and the supply schedule relating price and quantity supplied are each constructed on the assumption of "other things equal"(ceteris paribus). Other things equal, the lower the price of chocolate, the higher the quantity demanded. Other things equal, the higher the price of chocolate the higher the quantity supplied. A campaign by dentist warning of the effect of chocolate on tooth decay, or a fall in household incomes, whould change the "other things" relevant to the demand for chocolate. Either of these changes would reduce the demand for chocolate, reducing the quantities demanded at each price. Cheaper cocoa beans, technical advances in packaging chocolate bars, would change the "other things" relevant to the supply of chocolate bars. They would tend to increase the supply of chocolate bars, increasing the quantity supplied at each possible price.

III. The Market and Equilibrium PriceFor the moment, we assume that all these other things remain constant. We combine the behavior of buyers and sellers described in the Table to model how the market for chocolate bars would actually work. At low prices, the quantity demanded exceeds the quantity supplied but the reverse is true at high price. At some intermadiate price, which we call the "equilibrium price" the quantity demanded just equal the quantity supplied. The equilibrium price clears the market for chocolate It is the price at which the quantity supplied equals the quantity demanded. Table shows that the equilibrium price is 400.000TL=80 million bars per year is the quantity buyers wish to buy and sellers wish to sell at this price. We call 80 million bars per year the equilibrium quantity. At prices below 400.000 TL. the quantity demanded exceeds the quantity supplied, and some buyers will be frustrated.There is a shortage: what we call excess demand. You will realize that when economists say there is excess demand they are using a convenient shorthand for the more complicated expression: the quantity demanded exceeds the quantity supplied at this price. Conversely, at any price above 400.000TL. the quantity supplied exceeds the quantity demanded. Sellers will be left with unsold stock. To describe this surplus, economists use the sorthand excess supply, it being understood that this means excess in the quantity supplied at this price. Is the market for chocolate bars automatically in equilibrium? If so, what bring this about ? Suppose the price of chocolate is initially 1000.000TL, higher than the equilibrium price, Producers wish to sell 160 million bars per year but nobody wishes to buy at this price. To recoup the money spent in producing chocolate, seller have to cut the price to clear their stock. Cutting the price to 600.000 TL. has two effects: It increases the quantity demanded to 40 million bars per year and it reduces the

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quantity producers wish to supply to 120 million bars per year. Both effects reduce the excess supply. The process of price cutting will continue until the equilibrium price of 400.000 TL. is reached and excess supply has been eliminated. At this price the market clears.When the price lies below the equilibrium price the process works in reverse. In this sense, market are self correcting.

IV.Demand and Supply CurveTable shows demand and supply conditions in the chocolate market and allows us to find the equilibrium price and quantity. It is convinient to approach the same problem diagrammatically using demand and supply curve.The demand curve shows the relation between prices and quantity demanded, holding other things constant. In Figure I, we measure on the vertical axis prices of chocolate bars. Corresponding quantities demanded in millions of bars per year are measured on the horizontal axis. The demand curve plots the data in the first two column of the Table. The points A shows that 160 million bars per year are demanded at a price of 150.000 TL. The point B shows that 120 million bars per year are demanded at a price of 250.000 TL. plotting all the point and joining them up, we obtain the demand curve. In our example this curve happens to be a straight line. As expected, it has a negative slope showing that larger quantities are demanded at lower prices.

Price (000. TL) Price (000.TL)

Figure I Figure II

Quantity Demanded Quantity Supplied(million bars/year) (million bars/year)

Price (000. TL) Price (000.TL)

Figure I Figure II

Quantity Demanded Quantity Supplied(million bars/year) (million bars/year)

The supply curve shows the relation between price and quantity holding other things constant. In FigureII. We plot columns (1) and (3) of the Table. Again we join up the different data points. In FigureIII, we show the demand curve labelled DD, and the supply curve labelled SS, in the same diagram. We can now re-examine our analysis of excess supply, excess demand, and equilibrium. Consider a particular prices as represented by a height on the vertical axis. At a price below the equilibrium price the horizontal distance between the supply curve and the demand curve at this height shows the excess demand at this price. For example, at 250.000 TL. the quantity supplied is 40 million bars per year the quantity demanded 120 million bars per year and the distance AB represents the excess demand of 80 million bars per year. Conversely, at a price above the equilibrium price there is excess supply. At 600.000 TL. 40 million bars per year are demanded, 120 million bars Per year are supplied and the horizontal distance FG measures the excess supply of 80 million bars per year at this price.Price(000 TL)

Quantity (million bars/year)Market equilibrium is shown by the intersaction of the demand curve DD and the supply curve SS, at a price of 400.000 TL , at which 80 million bars per year are transacted. At any other price the quantity traded is the smaller of the quantity demanded and the quantity supplied. We can now reconsider price determination in the

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Figure III

chocolate market. Figure III, implies that there is excess supply at all prices above the equilibrium price of 400.000 TL. Seller react to unsold stocks by cutting prices. Only when prices have been reduced to the equilibrium price will excess supply be eliminated. The equilibrium position is shown by the point E. Conversely at prices below 400.000 TL. there is excess demand, which bids up the price of chocolate, gradually eliminating excess demand until the equilibrium point E is reached. In equilibrium buyers and sellers can trade as much as they wish at the equilibrium price and there is no incentive for any further price change.

Course IV

I. Movements Along the Demand Curve Versus Shifts of the Whole CurveII. Movements Along the Supply Curve Versus Shifts of the Whole Curve III. The Laws of Demand and SupplyIV. Demand and Supply: What Really HappensV. Prices in Inflation

I. Movements Along the Demand Curve Versus Shifts of the Whole CurveSuppose you read in today’s newspaper that a soaring price of carrots has been caused by a greatly increased demand for that commodity. Then tomorrow you read that the rising price of carrots is greatly reducing the typical household’s purchases of carrots as shoppers switch to potatoes, yams and peas. The two statements appear to contradict each other.The first associates a rising price with a rising demand; the second associates a rising price with a declining demand. Can both statements be true? The answer is that they can be because they refer to different things. The fist describes a shift in the demand curve; the second describes a movement along a demand curve in response to a change in price.Consider first the statement that the increase in the price of carrots has been caused by an increased demand for carrots. This statement refers to a shift in the demand curve for carrots. In this case the demand curve must have shifted to the right, indicating more carrots demanded at each price. This shift will increase the price of carrots.Now consider the statement that fewer carrots are being bought because carrots have become more expensive. This refers to a movement along a given demand curve and reflects a change between two specific quantities being bought, one before the price rose and one afterward. So what lay behind the two stories might have been something like the following;1) A rise in the population is shifting the demand curve for carrots to the right as more

and more demanded at each price. This in turn is raising the price of carrot. This was the fist newspaper story.

2) The rising price of carrots is causing each individual household to cut back on its purchase of carrots. This causes a movement upward to the left along any particular demand curve for carrots. This was the second newspaper story.

To prevent the typ of confusion caused by our two news paper stories economist have developed a specialized vacabulary to distinguish shift of curves from movements along curve. Economist reserve the term change in demand to describe a shift in the whole curve, that is a change in the amount that will be bought at every price. Any one point on a demand curve represent a spesific amount being bought at a specified price. It represents, therefore a particular quantity demanded. A movement along a demand curve is refered to as a change in the quantity demanded.

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II. Movements Along the Supply Curve Versus Shifts of the Whole Curve As with demand, it is important to distinguish movements along the supply curves from shifts of the whole curve. The term change in supply is reserved for a shift of the whole supply curve. This means a change in the quantity supplied at each price of the commodity. A movement along the supply curve indicates a change in the quantity supplied in response to a change in the price of the commodity. Thus an increase in supply means that the whole supply curve has shifted to the right; an increase in the quantity supplied means a movements upward to the right along a given supply curve.

III. The Law of Demand and SupplyChange in any of the variables other than price that influence quantity demanded or supplied will cause a shift in the supply curve or the demand curve or both. There are four possible shifts: 1) a rise in demand (a rightward shift in the demand curve). 2) a fall in demand (a leftward shift in the demand curve) 3) a rise in supply 4) a fall in supply.Each of these shifts causes changes that are described by one of the four "laws" of demand and supply. Each of the laws summarizes what happens when an initial position of equilibrium is upset by some shift in either the demand or the supply curve and a new equilibrium position is then established. To discover the effects of each of the curve shifts that we wish to study, we use the method known comparative statics. We start from a position of equilibrium and then introduce the change to be studied. The new equilibrium position is determined and compared with the original one. The four laws of demand and supply are derived in the Figures below, which generalizes our specific discussion (about carrots.)

The laws of supply and demand are: 1) A rise in demand causes an increase in both the equilibrium price and the equilibrium quantity exchanged.2) A fall in demand causes a decrease in both the equilibrium price and the equilibrium quantity exchanged.3) A rise in supply causes a decrease in the equilibrium prices and an increase in the equilibrium quantity exchanged.4)A fall in supply causes an increase in the equilibrium price and a decrease in the equilibrium quantity exchanged.

We have studied many forces that can cause demand and supply curves to shift. By combining this analysis with the four laws, we link many real world events that cause demand or supply curves to shift with changes in market prices and quantities.The usefulness of this theory in interpreting what we see in the world around us is further discussed.

IV.Demand and Supply: What Really HappensWhat Really Happens"The theory of supply and demand is neat enough", said the skeptic, "but tell me what really happens.""What really happens," said the economists "is that fist, demand curves slope downward; second, supply curve slope upword; third, prices rise in response to excess demand, and fourth, prices fall in response to excess supply.""But that's theory", insisted the skeptic. "What about reality?""That is reality as well", said the economist."Show me" said the skeptic.The economist produced, the fallowing passages from articles in the New York Times.

***

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Increased demand for macademia nuts causes price to rise above competing nuts. Major producer now plans to double the size of its orchards during the next five years.

***OPEC countries once again fail to agree on output quotas. Output soars and price plummet.

***Last summer, Rhode Island officials reopened the northern side of Narragansett Bay, a 9500-acre fishing ground that had been closed since 1978 because of pollution. Suddenly clam prices dropped, thanks to an underwater population explosion that had transformed the Narragansett area in to a clam harvester's dream.

***Increasing third world agricultural production threatens the stability of American agriculture, In the 1970's American farm prosperity was built on rising demand due to world prosperity and on falling output in Eastern Europe. Farm experts now, worry that the prosperity will prove fragile in the face of major increases in world output.

***The effects of (the fist year of) deregulation of the nation's airlines were spectacular: cuts in air fares of up to 70 percent in some cases, record passanger jam-ups at the airports, and spectacular increase in the average load factor (the proportion of occupied seats on average commercial flight.)

***The skeptic's response is not recorded, but you will have no trouble telling which of the economist's four statements about "what really happens."

V. Prices in InflationUp to now, we have developed the theory of the prices of individual commodities under the assumption that all other prices remained constant. Does this mean that the theory is in applicable to an inflationary world when almost all prices are rising? Fortunately the answer is no.The key lies in what are called relative prices. We have mentioned several times that what metters for demand and supply is the price of the commodity in question relative to the prices of other commodities. This is called a relative price.In an inflationary world we are often interested in the price of a given commodity as it relates to the average price of all other commodities. If during a period when the general price level rose by 40 percent, the price of carrots rose by 60 percent, then the price of carrots rose relative to the price level as a whole. Carrots became relatively expensive. However, if carrots had risen in price by only 30 percent, when the general price level rose by 40 percent then the relative price of carrots would have fallen. Although the money price of carrots rose substantially, carrots became relatively cheap. In price theory, whenever we talk of a change in the price of one commodity, we mean a change relative to other price. If the price level is constant, this change, requires only that the money price of the commodity in question should rise If the price level is itself rising, this change requires that the money price of the commodity in question should rise faster than the price level.We have been analyze a change in a particular price in the context of a constant price level. The analysis easily extended to an iflationary peirod. By remembering that any force that raises the price of one commodity when other price remain constant will, given general inflation raise the price that commodity faster than the price level is rising. For example a change in tastes in favor of carrots that would raise their price by 20 percent when other price were constant, would raise their price by 32 percent if at the same time the general price level goes up by 10 percent . In each case the price of carrots rises 20 percent relative to the average of all price.

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Course V

I. Price Elasticity of DemandII. Price Elasticity and Changes in Total ExpenditureIII. What Determines Elasticity of Demand?IV. Cross Elasticity of DemandV. Income Elasticity of DemandVI. What Determines Income Elasticity?VII.Elasticity of Supply

I. Price Elasticity of DemandElasticity of demand is the measure of responsiveness of quantity demanded to price changes.

This measure is frequently called demand elasticity. When it is necessary to distinguish it from other related concepts, it may however be called price elasticity of demand, since the variable causing the change in quantity demanded is the commodity's own price. Because demand curve slope downward, an increase in price is associated with a decrease in quantity demanded and vice versa. Since the percentage changes in price and quantity have opposite signs, demand elasticity is a negative number.The numerical value of elasticity can vary from zero to infinity. Elasticity is zero, when quantity demanded does not respond at all to a price change. As long as the percentage change in quantity is less than the percentage change in price the elasticity of demand has a value of less than unity (less than one). When the elasticity is less than one, the demand is said to be inelastic. When the two percentage changes are equal to each other, elasticity is equal to unity. When the percentage change in quantity exceeds the percentage change in price, the value for the elasticity of demand is greater than unity. If the elasticity is more than unity, the demand is said to be elastic. If purchasers (sellers) are prepared to buy (sell) all they can at some price and none at all at an even slightly higher (lower) price, the demand is said to be infinitely elastic.

Table: EstimatedPrice Elasticities of Demand in the US

2.1Automobiles

1.2Furniture

0.9Beef

0.6Gasoline

0.4All foods

0.4Public Transportation

0.3Sugar

0.3Potatoes

ElasticitiesCommodities

2.1Automobiles

1.2Furniture

0.9Beef

0.6Gasoline

0.4All foods

0.4Public Transportation

0.3Sugar

0.3Potatoes

ElasticitiesCommodities

II.Price Elasticity and Changes in Total ExpenditureThe total amount spent by purchasers is also the total revenue received by the sellers. How does this revenue or expenditure react when the price of a product is changed? What happens to total revenue or expenditure depends on the price elasticity of demand. If elasticity is less than unity, the percentage change in price exceeds the percentage change in quantity. The price change will then dominate so that total revenue will change in the same direction as the price changes. If, however, elasticity exceeds unity the percentage change in quantity exceeds the percentage change in

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price.The quantity change will then dominate so that total revenue will change in the same direction as quantity changes ( that is , in the opposite direction to the change in price.)The general relations between elasticity and change in price can be summarized as follows:1.If demand is elastic, a fall in price increases total revenue and a rise in price reduces it.2.If deman is inelastic a fall in price reduces total revenue and a rise in price increases it.3. If elasticity of demand is unity a rise or a fall in price leaves total revenue unaffacted.

III.What Determines Elasticity of Demand?The Table above, shows some measured elasticities of demand. Evidently, they can vary considerably. The main determanent of elasticity is the availability of substitutes. Some commodities, such as margarine, cabbage, lamb have quite close substitutes- butter, other green vegetables, beef. A change in the price of these commodities, the price of substitutes remaining constant, can be expected to cause much substitution. A fall in price leads consumers to buy more of the commodity and less of the substitutes, and a rise in price leads consumers to buy less of the commodities and more of the substitutes.A commodity with close substitutes tend to have an elastic demand, one with no close substitutes an inelastic demand.The degree of response to a price change, and thus the measured price elasticity of demand, will tend to be greater the longer the time span considered, as well.

IV.Cross Elasticity of DemandThe responsiveness of demand to changes in the prices of other commodities is called cross elasticity of demand. Complementary goods such as cars and gasoline have negative cross elasticities. A large rise in the price of gasoline will lead to a decline in the demand for cars as some people decided to do without a car and others decided not to buy a second car. Substitute commodities such as car and public transport, have positive cross elasticities. A large rise in the price of cars (relative to public transport) would lead to a rise in the demand for public transport as some people shifted from cars to public transport.

V.Income Elasticity of Demand One of the most determinants of the demand is the income of the potantial customers. The responsiveness of demand to changes in income is termed income elasticity of demand.

For most goods increases in income lead to increases in demand and income elasticity will be positive. These are called normal goods. Goods for which consumption decreases in response to a rise in income have negative income elastisities and are called inferior goods.The income elasticity of normal goods may be greater than unity (elastic) or less than unity (inelastic), depending on whether the percentage change in the quantity demanded is greater or less than the percentage change in income. It is also common to use the terms income-elastic and income inelastic to refer to income elasticities of greater or less than unity.

Table: Estimated Income Elasticities of Demand in the US

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2.4Restaurant Meals

1.1Gasoline

0.5Beef

0.4Cheese

0.3Poultry

0.3Starchy roots

-0.2Pig Products

-0.5Whole Milk

ElasticitiesCommodities

2.4Restaurant Meals

1.1Gasoline

0.5Beef

0.4Cheese

0.3Poultry

0.3Starchy roots

-0.2Pig Products

-0.5Whole Milk

ElasticitiesCommodities

VI.What Determines Income Elasticity?Does the distinction between luxuries and necessities explain differences in income elasticities? The Table above suggests that it does. The more basic an item in the consumption pattern of households, the lower its income elasticity. Income elasticities for any one commodity also vary with the level of a households's income. When incomes are low, households may eat almost no meat and consume lots of starchy foods such as bread and potatoes; at a higher income levels they may eat the cheaper cuts of meat and more green vegatables along with their bread and potatoes; at yet higher levels they are likely to eat more (and more expensive) meat to substitute frozen for canned vergetables and to eat greater variety of foods.

VIII. The Elasticity of SupplyThe elasticity of supply measures the responsiveness the quantity supplied to a change in the price of that commodity.

Because supply curves slope upwards, the elasticity of supply is positive. As we move along a supply curve, positive price changes are associated with positive output changes. An increase in price causes an increase in quantity sold. The more elastic is supply the larger the percentage increase in quantity supplied in response to a given percentage change in price. Thus elastic supply curves are relatively flat and inelastic supply curves relatively steep.There are important special cases. If the supply curve is vertical, -the quantity suplied does not change as prices changes- elasticity of supply is zero. A horizontal supply curve has an infinitely high elasticity of supply: A small drop in price would reduce the quantity producers are willing to supply from an indefinetely large amount to zero.

Course VI

I. The Theory of Consumer ChoiceII. Total Utility& Marginal UtilityIII Diminishing Marginal UtilityIV. Maximizing UtilityV.Consumers’ Surplus, Diminishing Marginal Utility and Demand Curve

I. The Theory of Consumer ChoiceEarly economists, struggling with the problem of what determines the relative prices of commodities, encountered what they came to call the paradox of value: Necessary commodities, such as water have prices that are low compared with prices of luxury commodities, such as diamonds. Water is necessary to our existence, while diamons used as ornaments are frivolous and could disappear from the face of the earth

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tomorrow without causing any great loss. Does it not seem odd then, these economists argued, that water is so cheap and diamonds are so expensive? It took along time to resolve this apperent paradox, so it is not suprising that even today the confusion persist and in different forms clouds many current policy discussions. The key to resolving the apparent paradox lies in the important distinction between marginal and total utulity.

II.Total Utility& Marginal UtilityThe satisfaction someone receives from consuming commodities is called utulity.Total utility refers to the total satisfaction from consuming some commodity. For example, the total utility of consuming 10 units of any commodity is the total satisfaction those 10 units provide. Marginal utility refers to the change in satisfaction resulting from consuming a little more or a little less of the commodity. The marginal utulity of the tenth unit consumed is the additional satisfaction provided by the consumption of that unit, or in other words, the difference in total utility gained by consuming 9 units and by consuming 10 units. The significance of this distinction can be seen by considering two questions: (1) If you had to give up consuming one of the following commodities completely, which would you choose: water or the movies? (2) If you had to pick one of the following, which would you choose: increasing your water consumption by 35 gallons a month (the amount required for an average bath) or attending one more movie a month?In (1) you are comparing the value you place on your total consumption of water with the value you place on all your attendance at the movies. You are compering the total utility of your water consumption with the total utility of your movie attendance. There is little doubt that everyone would answer (1) in the same way revealing that the total utility derived from consuming water exceeds the total utility derived from attending the movies.In (2) you are compering the value you place on a small addition to your water consumption with the value you place on a small addition to your movie attendances. You are compering your marginal utility of water with your marginal utility of movies. In responding to (2), some might select the extra movie; others might select the extra water. Furthermore, their choice would depend on whether it was made at a time when water was plentiful so that they placed a low value on obtaining a little additional water. (low marginal utility of water) or when water was scarce, so that they might put quite high value on obtaining a little more water. (high marginal utility of water)Choices of type (1) are encountered much less commonly than are choices of type (2). If our income rises a little, we have to decide to have some more of one thing or another. If we find that we are overspending or if our income falls, we have to decide what to cut down on. Do we have a little less of this or a little less of that?Real choices are rarely conditioned by total utilities; it is marginal utilities that are relevant to choices concerning a little more or a little less.Now cosidering marginal utility approach, to understand the case of water and diamonds, remember that water is cheap because there is enough of it that people consume it to the point at which its marginal utility is low, they are not prepared to pay a high price to obtain a little more of it. Diamond are expensive because they are scarce (the owners of diamond mines keep diamonds scarce by limiting output) and those who buy them have to stop at a point where marginal utility is still high; they are prepared to pay a high price for an additional diamond.

III. Diminishing Marginal UtilityThe basic hypothesis of utility theory, sometimes called the law of of diminishing marginal utulity, is:The utility any household derives from successive units of a particular commodity diminishes as total consumption of the commodity increases while the consumption of all other commodities remains constant.

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Consider water once again some minimum quantity is essential to sustain life, and a person would , if necessary, give up all his or her income to obtain that quantity of water. Thus the marginal utility of that much water is extremely high. More than this bare minimum will be drunk, but the marginal utility of successive glasses of water drunk over a period will decline steadily.How much money would induce you to cut your consumption of water by one glass per week? The answer is very little. How much would induce you to cut it by a second glass? By a third glass? To only one glass consumed per week? The aswer to the last quaestion is quite bit. The fewer glasses you are consuming already, the higher the marginal utility of one more or less glass of water.

IV. Maximizing UtilityA basic assumption of the economic theory of household behaviour is that household try to make themselves as well off as they possibly can in the circumtances in which they find themselves. In other words, the members of a household seek to maximize their total utility. How can household adjust its expenditure so as to maximize the total utility of its members? The household maximizing its utility will allocate its expenditure among commodities so that the utility of the last lira spent on each is equal.

This says that the household will allocate its expenditure so that the utility gained from the last lira spent on each commodity is equal.

IV.Consumers' Surplus, Diminishing Marginal Utility and Demand CurveAssume that you would be willing to pay as much as 100TL. a month for the amount of a commodity for 60TL. instaed of 100TL. What a bargain! You have paid 40TL. less than the top figure you were willing to pay. Yet this sort of bargain is not rare; it occurs every day in any economy where prices do the rationing. Indeed it is so common that the 40TL.saved in this example has been given a name: consumers' surplus. Consumers' surplus is a direct consequence of diminising marginal utility. We can explain it with an example: If you were getting no milk at all, how much would you be willing to pay for one glass per week? With no hasitation you might answer 300TL. We than ask: If you had already consumed that one galss how much would you pay for a second glass per week? After a bit of thought you might answer 150TL. Adding one glass per week with each question, we discover that you would be willing to pay 100TL to get a third glass per week and 80TL., 60TL, 50TL, 40TL, 30TL, 25 TL, and 20TL. for successive glasses per week. The progressively lower valuation on each additional glass of milk illustrates the general concept of diminising marginal utility. But you dont have to pay a different price for each glass of milk you consume each week. You can buy all the milk you want at the prevailing market price. Suppose the price is 30 TL. You will buy eight glass per week, because you value the eight glass just at the market price, while valuing all earlier glasses at higher amounts. Because you value the fist glass at 300 TL, but get it for 30, you make a "profit" of 270TL. on that glass Between your 150TL valuation of second glass and what you have to pay for it you clear a "profit" of 120TL. You clear 70 TL on the third glass, and so on. These profit amounts are called your consumers' surpluses on each glass. (The total suplus is 570TL. per week.) The data in columns 1 and 2 of the Table below give your deman curve for milk It is your demand curve because, you will go on buying glasses of milk as long as you value each glass at least as much as the market price you must pay for it. When the market price is 300 TL. per glass you will buy only one glass when it is 150 TL., you will

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buy two glasses and so on. The total valuation is the area below your demand curve and consumers' surplus is that part of the area that lies above the price

Table: Consumers' Surplus on Milk Consumption by One Consumer

270 TL120 TL70 TL50 TL30 TL20 TL10 TL00 TL

--

300 TL150 TL100 TL80 TL60 TL50 TL40 TL30 TL

25 TL20 TL

FirstSecondThirdFourthFifthSixthSeventhEightNinthTenth

Consumers' Surplus on each glass if milk costs 30 TL per glass (3)

Amount the consumerwould pay to get thisglass (2)

Glass of milkconsumed (1)

270 TL120 TL70 TL50 TL30 TL20 TL10 TL00 TL

--

300 TL150 TL100 TL80 TL60 TL50 TL40 TL30 TL

25 TL20 TL

FirstSecondThirdFourthFifthSixthSeventhEightNinthTenth

Consumers' Surplus on each glass if milk costs 30 TL per glass (3)

Amount the consumerwould pay to get thisglass (2)

Glass of milkconsumed (1)

Course VII

I. Indifference Curve Analysis of Consumer ChoiceII.The Budget ConstraintIII. Indifference CurveIV.Utility Maximization and The Equilibrium of the ConsumerV.The Analysis of the Firm’s Input DecisionVI.A Single IsoquantVII..Isocost LineVIII..Conditions for Cost Minimization

Indifference Curve Analysis of Consumer ChoiceThe model’s fourth elements describe both the consumer and the market environment: The consumer’s income The prices at wich goods can be bought The consumer’s preferences, wich rank different bundles of goods by the

satisfaction they yield. The behavioural assumption that consumers do the best they can for themselves.

The Budget ConstraintThe bugget constraint describes the different bundles that the consumer can afford.Which bundles are feasible, or can be afforded, depends on two factors: The consumer's income and the prices of different goods.

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The budget constraint shows the maximum affordable quantity of one good given the quantity of the other good being purchased. ( we assume that all income is spent on goods. There is no saving.)Budget line; Graghic representation of all combinations of commodities that a household may obtain if it spends a given amount of money at fixed prices of the commodities. Also called isocost line. The slope of the budget line depends only on the ratio of the price of two goods. A change in the price of one commodity changes relative prices and thus changes the slope of the budget line. Variations in the household’s money income, with prices constant, shift the budget line parallel to itself

Y Y Y

x x xo o o

B/Py

B/Px

Y Y Y

x x xo o o

B/Py

B/Px

Indifference Curve.An indifference curve, shows all the consumption bundles which yield the same utility.Along each same indifference curve, consumer utility is constant. Since more is preferred to less any point on a higher indifference curve is preferred to any point on a lower indifference curve. Indifference curve slope downwards. Otherwise the consumer would have more of both goods and be better off. The marginal rate of substitution of one good for another good, is the quantity of one good the consumer must sacrifice to increase the quantity of other good by one unit without changing total utility.Consumer tastes exhibit a diminising marginal rate of substitution when, to hold utility constant, diminishing quantities of one good must be sacrificed to obtain successive equal increases in the quantity of the other good.A set of indifference curves is called an indifferences map. It specifies the household’s preferences by showing its rate of substitution between the two commodities for every level of current consumption of these commodities.

Y Y

x xo o

B/Py

X1 X2

Y1

Y2

A

B I3I2

I1

Y Y

x xo o

B/Py

X1 X2

Y1

Y2

A

B I3I2

I1

Utility Maximization and The Equilibrium of the HouseholdThe budget line shows affordable bundles given the consumer's market environment (the budget for spending and the price of different goods). The indifference map describe the preferences of consumers. To predict what households will actually do, both sets of information must be put together.To complete the model, we assume that consumers chooses the affordable bundle that maximizes their utility. The household’s satisfaction is maximized at the point where an indiference curve is tangent to the budget line. At such a tangency position the slope of the indifference curve (the

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consumers marginal rate of substitution of the goods) is the same as the slope of the budget line (the relative prices of the goods in market) The consumer cannot afford (unaffordable points) points that lie above the budget line, and will

Y

xo X1 A

I3I2

I1

Y1

B

Y

xo X1 A

I3I2

I1

Y1

B

never choose points that lie below the budget line where it is possible to purchase more of one good without sacrificing any of the other good.

The Analysis of the Firm’s Input DecisionThe production function, gives the relation between the factor inputs that the firm uses and the output that it obtains. In the long run, the firm can choose among many different combinations of inputs that will yield the same output. The production function and the choices open to the firm can be represented graphically using the concept of an isoquant.

A Single IsoquantIsoquant shows the whole set of technologically efficient possibilities for producing a given level of output. In other words, an isoquant describes the firm’s alternative methods for producing a given output.(It is analogous to an indifference curve that sows all combinations of commodities that yield an equal utility)

K K

L Lo oL1 L2

K1

K2

A

B O3O2

O1

K K

L Lo oL1 L2

K1

K2

A

B O3O2

O1

As we move from one point on an isoquant to another, we are substituting one factor for another while holding output constant. The marginal rate of substitution measures the rate at which one factor is substituted for another with output held constant. Graphically, the marginal rate of substitution is measured by the slope of the isoquant at a particular point.Isoquant are downword-sloping and convex. The downword slope reflects the requirement of technological efficiency. A method that uses more of one factor must use less of the other factor if it is to be technologically efficient. The marginal rate of substitution has a negative value. Decreases in one factor must be balanced by increases in the other factor if output is to be held constant. The isoquant is convex

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viewed from the origin. The convex shape of the isoquant reflects a diminishing marginal rate of substitution.Each isoquant refers to a specific output and connects combination of factors that are technologically efficient methods of achieving that output. If we plot, a representative set of these isoquants on a single graph, we get an isoquant map. The higher the level of output along a particular isoquant, the farther the isoquant is from the origin.

Isocost lineIsocost line is used to show alternative combinations of factors a firm can buy for a given outlay. The slope of isocost reflects, relative factor prices, just as the slope of the budget line represented relative product prices (in the theory of consumer choice). For the given factor prices a series of parallel isocost lines will reflect the alternative level of expenditure on factor purchases that are open to the firm. The higher the level of expenditure, the farther the isocost line is from the origin.

K

Lo

C/PK

C/PL

K

Lo

C/PK

C/PL

Conditions for Cost MinimizationFinding the efficient way of producing any output requires finding the least-cost factor combination. To find this combination when both factors are variable, factor prices need to be known. The economically most efficient method of production position (the least cost position) is given graphhically by the tangency point between the isoquant and isocost lines. The slope of the isocost line is given by the ratio of the prices of the two factors of production. The slope of the isoquant is given by the ratio of their marginal products. When the firm reaches its least-cost position, it has equated the price ratio (which is given to it by the market prices) with the ratio of the marginal products (which it can adjust by varying the proportion in which it hires the factors)

K

Lo L1 C

Q3Q2

Q1

K1

C

E

K

Lo L1 C

Q3Q2

Q1

K1

C

E

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Course VIII.

I. Costs: Total, Average, Marginal Costs, Variable&Fixed Cost.II. RevenueIII. Profit, Profit Maximization

How do firms decide how much to produce and offer for sale? For each possible output level, a firm needs to answer two questions: how much will it cost to produce this output and how much revenue will be earned by selling it. For each output level, production costs depend on technology that determines how many inputs are needed to produce this output, and on input prices that the firms have to pay for these inputs. The revenue obtained from selling output depends on the demand curve faced by the firm. The demand curve determines the price for wich any given output quantity can be sold and hence the revenue that the firm will earn. Profits are the excess of revenues over cost. The key to the theory of supply is the assumption that all firms have the same objective: to make as much profit as with possible. By examining how revenues and costs change with the level of output produced and sold, the firm can select the output level which maximizes its profits. To understand how firms make output decisions we must therefore analyse the determination of revenues and costs.

Revenues, costs, and profits.A firms revenue, is the amount it earns by selling goods or services in a given period such as a year. The firms costs are the expenses incurred in producing goods or services durind the period.

Profits are the excess of revenues over costs.

Cost, to the producing firm, is the value of inputs used in producing its outputs.Total cost (TC), is the total cost of producing any given level of output. Total cost is diveded into two parts; total fixed cost (TFC), total variable cost (TVC). A fixed cost is one that does not vary with output; it will be the same if output is 1 unit or one million units. Such a cost is also refered as an overhead costs or unavoidable cost. A cost that varies directly with output, rising as more is produced and falling as less is produced, is called a variable costs (also a direct or avoidable cost).

Avarega total cost (ATC), also called averega cost is the total cost of producing any given output divided by that output. Average total cost may be divided into average fixed cost (AFC) and average variable cost (AVC) in the same way that total costs were.Although average variable costs may rise or fall as production is increased (depending on whether output rises more rapidly or more slowly than total variable costs), it is clear that average fixed costs decline continuously as output increases. A doubling of output always leads to a halving of fixed costs per unit of output. This is a process popularly known as spreading one's overhead.

Marginal cost (MC), is the increase in total cost resulting from raising the rate of production by one unit. Because fixed cost don't vary with otput marginal fixed costs are always zero. Therefore marginal cost are necessarily marginal variable costs, and a change in fixed costs will leave marginal costs unaffected. For example, the marginal cost of producing a few more potatoes by farming a given amount of land more intensively is the same, whatever the rent paid for the land.

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Marginal cost is the increase in total cost when output is increased by 1 unit. Marginal revenue is the increase in total revenue when output is increased by 1 unit (when an additional unit of output is sold).

Firms have costs even when no output is produced. This cost includes the expenses of being in bussiness at all runing an office, renting a telephone and so on. Thereafter, cost rise with the level of production. Total cost of production is higher the more is produced. At the begining costs rise quite slowly as output rises. At high levels of output, costs rise sharply as output increases.

Profit Maximization&Cost MinimizationEconomist assume that firms make supply and output decisions so as to make as much money as possible, in other words to maximize profits.Any firm maximizing profits certainly wants to produce its chosen output level at the minimum possible costs. Otherwise, by producing the same output at lower cost it could increase profits. Thus a profit maximizing firm must produce its output at minimum cost.

Economies and Diseconomies of ScaleThere are economies of scale (or increasing return to scale), when long run average costs decrease as output rises. There are diseconomies of scale (or decreasing return to scale) when long run average costs increase as output rises. In these definitions, scale refers to the size of the firm as measured by its output.There are some reasons for economies of scale. The first is indivisibilities in the production process, some minimum quantity of inputs required by the firm to be in business at allwhether or not output is produced. These are called fixed costs, because they don’t vary with the output level. To be in business a firm requires a manager, a telephone, an accountant, a market research survey. The firm can not have half a manager and half a telephone merely because it wishes to operate at low output levels. Begining from small output levels, these cost don’t initially increase with output. The manager can organize three workers as easly as two. As yet there is no need for a second telephone. There economies of scale because these fixed cost can be spread over more units of output as output is increased, reducing average cost per unit of output.

Sophisticated but expensive machinery also has an element of indivisibilty. No matter how productive a robot assembly line is, it is pointless to install one to make five cars a week. However at high output levels the machinery cost spread over a large number of units of output and this production technique may produce so many cars that average costs are low.

The second reason for economies of scale is specialisation. A sole trader must be undertake all the different tasks of business. As the firm expands and takes on more workers, each worker can concentrate on a single task and handle it more efficiently.

The main reason for diseconomies of scale is that management becomes more difficult as the firm become larger: there are managerial diseconomies of scale. The company becomes bureaucratic, coordination problems arise, and average cost may begin to rise.

Geography may also explain diseconomies of scale. If the first factory is located in the best side, to minimize the cost of transporting goods to the market, the site of a second factory must be less advantageus. To take a different example in extracting coal from a mine, a firm will extract the easiest coal first. To increase output deeper coal seams have to be worked and these will be more expensive.

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Course IX

I. Market StructureII. Perfect Competitive MarketIII. MonoplyIV. Monopolistic CompetitionV. Oligopoly

Market StructureThe term market structure refers to all aspects of a market, such as the number of firms and the type of product sold, that may affect the behavior and performance of the firms in that market. The structure of a market is a description of the behavior of buyers and sellers in that market.First it is useful to establish two benchmark cases, the opposite extremes between which all other types of market structure must lie. These limiting cases are perfect competition on the one hand, monopoly on the other hand.A perfectly competitive market is one which both buyers and sellers believe that their own buying or selling decision have no effect on the market price. A monopolist is the only seller or potential seller of the good in that industry.

Perfect Competitive Market, The extreme of competitiveness occurs when each firm has zero power.In such a case there are so many firms that each must accept the price set by the forces of market demand and supply. This extreme is called the perfectly competitive market structure. In it there is no need for individual firms to compete actively with one another since none has any power over the market. One firm's ability to sell its product does not depend on the behavior of any other firm.Assumptions of Perfect Competition, The theory of perfect competition is built on two critical assumptions, one about the behavior of individual firm and one about the nature of the industry in which it operates. (An industry is the set of all firms making the same product.)The firm is assumed to be a price taker; A firm operating in a perfectly competitive market has no power to influence that market trough its own individual actions. It must passively accept whatever price happens to be ruling.The industry is assumed to be characterized by freedom of entry and exit; that is, any new firm is free to set up production if it so wishes, and any existing firm is free to cease production and leave the industry. Existing firms can not bar the entry of new firms, and there are no legal prohibitions on entry or exit.In a perfectly competitive economy there are many firms and many households. Each is a price taker. No single firm and no single consumer has any power over the market. Individual consumers and producers are quantity adjusters who respond to market signals. The perfectly competitive model is almost too good to be true.Because the market mechanism works, it is not necessary for the government to intervene. Market reaction, not public policies, will eliminate shortages or surpluses. There is no need for regulatory agencies or bureaucrats to make arbitrary decisions about who may produce what, how to produce it, or how much it is permissible to charge for the product. If there are no government officials to make such decisions, there will be no one to bribe to make one decision rather than another.In the impersonal decision-making world of perfect competition, neither private firms nor public officials wield economic power. The market mechanism, like an invisible hand determines the allocation of resources among competing uses.

Monoply, The word monopoly comes from the Greek words, monos polein, which mean "alone to sell". It is convenient for now to think of monopoly, as the situation in which the output of an entire industry is controlled by a single seller. This seller will be called the monopolist. Because the monopoly firm is the only producer of a particular

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product, its demand curve is identical with the demand curve for that product. The market demand curve, which shows the aggregate quantity that the monopolist will purchase at every price, also shows the quantity that the monopolist will be able to sell at any price it sets. The importance of this is that the monopoly, unlike the firm in perfect competition, faces a downward-sloping demand curve. The firm therefore faces a trade-off between price and quantity: Sales can be increased only if price is reduced, while price can be increased only if sales are reduced. A monopolists is the sole supplier and the potantial supplier of the industry's product. The firm and the industry coincide. A monopoly will persist only if entry of new firms does not occur. Impediments that prevent entry are called entry barriers; they may be either natural or created. Natural barriers most commonly arise as a result of economies of scale. If the long run average cost declines over a large range of output big firms will have significantly lower average total cost than small firms. The cost to the new firm of entering the market, developing its product, and establising such things as its brand image and its dealer network may be such that entry is rendered unprofitable.Barriers to entry may be created by the conscious action of participants in some markets. Some are created by the government and are therefore condoned by it. Patent laws, for instance, may prevent entry by conferring on the patent holder the sole right to produce a particular commodity.

Cartels As Monopolies, A second way in which a monopoly can arise is for the firms in an industry to agree to cooperate with one another, to behave as if they were a single firm, and thus to eliminate competitive behavior among themselves. Such a group of firm is called a cartel. A cartel that includes all of the firms in the industry can behave in just the same way as would a single firm monopoly that owned all of these firms. The firms can agree among themselves to restrict their total output to the level that maximize their joint profits.

Monopolistic Competition ; The theory of monopolistic competition was developed in two famous books of the early 1930's one by the British economist Joan Robinson, the other by the American economist Edward Chamberlin.The market envisaged in this theory is similar to perfect competition in that there are many firms with relatively easy entry and exit. But it defers in one important respects; Each firm has some power over price because each sells a product that is differentiated significantly from those of its competitors. One firm's soap might be similar to another firms soap, but it differs in chemical composition, color, smell, softness, reputation, and a host of other characteristics that matter to customers. This is the phenomenon of product differentiation.It implies that each firm has a certain degree of local monopoly power ower its own product. It could raise its price, even its competitors did not, and not lose all of its sales. This is the monopolistic part of the theory. The monopoly power is severely restricted, however by the precense of similar products sold by many competing firms and by easy entry and exit. As a result the monopolistically competitive firm's demand curve is very much flatter than the industry demand curve.The demand curve highly elastic because, similar products sold by other firms provide many close substitutes. This the competition part of the theory. Firm in monopolistic competition, sell a differantiated products, which means a group of commodities similar enough to be called the same product, but dissimilar enough that the producer of each has some power over its own price. This dissimilarity leads to, and is enhanced by, establisment of brand names and advertasing.Monopolistic competition produces a wider range of products, but at somewhat higher cost per unit, than perfect competition.(because of advertising cost and product differentiation cost).

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OligopolySuch industries have three major characteristics; (1) there are more competing firms- thus the industry is not a monopoly. (2) Each firm faces a downward-sloping demand curve for its own product –thus the industry is not perfectly competitive. (3) There is at least one large firm that is aware that its competitors will react to any move it makes- thus the industry is not monopolistically competitive.Collusion is an explicit or implicit aggreement between existing firms to avoid competition with one another.Under perfect competition or monopolistic competition, there are so many firms in the industry that no single firm need worry about the effect of its own actions on rival firms. However, the very essence of an oligopolistic industry is the need for each firm to consider how its own actions will affect decision of its relatively few competitors.

OPEC: A Real World OligopolyThe Organization of Petroleum Exporting Countries (OPEC) is an example of the attempted cartelization of a formerly competitive industry. It illustrates many of the problems of oligopolistic industries.The oil industry in the years before 1973 was not perfectly competitive. However, there were many oil producing countries, so many, indeed that no one of them could significantly influence the price of oil by witholding its own output from the market. They were price takers in the market in which they sold their oil. OPEC did not become a cartel nor attract world attention until 1973. In that year, however members of OPEC placed a temporary embargo on the export of Middle Eastern oil.(The embargo was in retaliation for support, particularly by the US, for Israel in the Arab-Israeli was that broke out in that year.)After the embargo ended, the OPEC members voluntarily restricted their outputs by negotiating quotas among themselves. At the time OPEC countries accounted for about 70 percent of the world’s supply of crude oil and 87 percent of world oil exports. So although it was not quite a complete monopoly, the cartel had substantial monopoly power. The world oil market contained one large oligopolistic producers’ organization surrounded by a competitive fringe of many smaller producing countries.

Course X

I.What do governments do?II.What should governments do?

Most resources in market economies are allocated through markets in which individuals and private firms trade with other individuals or firms. However governments play a major role. They set the legal rules, they buy goods and services, they produce goods and services, and they make payments such as pensions. Through taxation and borrowing, governments exert a major influence on prices, interest rates, and production.

This course, adresses some basic questions about the government’s role in economic life. What do governments actually do? How can governments in principle improve the allocation of resources in the economy ? How do governments decide what to do?

I.What do governments do?

Create Laws, Rules and Regulations

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Goverments determine the legal frame work that sets the basic rules for ownership of property and the operation of markets. Even in the most capitalist economies, there are limits to the rights of ownership. Not everyone can own a gun. It is usually illegal to build a factory in a residental area. In addition, governments at all levels regulate economic behaviour, setting detailed rules for the operation of businesses. Regulations include, planing permission (how land can be used and where businesses can locate), health and safety regulations, and attempts to prevent some types of business, such as the sale of heroin. Buy and sell goods and servicesGovernments buy and produce many goods and services, such as defence, education, parks and roads which they provide to firms and households. Most of these goods, such as defence and education are provided to users free of direct charge. Some, such as local bus rides and government publications are paid for directly by the user.

Governments also produce and sell goods. In some countries, the phone company is government-owned; in most countries, the government owns and operates urban transport such as buses and the undergraund.

Make transfer paymentsGovernments also make transfer payments such as social security, and unemployment benefits to individuals.

Transfer payments are payments for which no current direct economic service is provided in return.

A firemans’s salary is not a transfer payment; a social security cheque is, as are unemployment benefits and interest payments on government borrowing.

Impose taxesGovernments pay for the goods they buy and for the transfer payments they make by levying taxes or by borrowing. Taxes raised at national level such as income tax or VAT, are usually supplemented by local taxes assessed on property values or household size.

Try to stabilize the economy Every market economy suffers from business cycles.The business cycle consists of fluctuations of total production, or GDP, accompanied by fluctuations in the level of unemployment and the rate of inflation.

Governments often attempt to modify fluctuations in the business cycle. The government may reduce taxes in a recession in the hope that people will increase spending and thus raise the GDP. When inflation is high, the central bank may reduce the rate of money growth with the aim of reducing inflation. These are macroeconomic policies through which the government attemps to stabilize the economy. Keeping it close to full employment but with low inflation.

Affect the allocation of resourcesBy spending and taxing, the government plays a major part in allocating resources in the economy. In terms of what, how, and for whom, governments chooses much of what gets produced, from defence expenditures to education to its support for the arts. It affects how goods are produced through regulation and through the legal system. It affects for whom goods are produced through its taxes and transfers, which take income away from some people and give it to others.

II. What should governments do?

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Why should government intervene in a market economy? There are some theoretical justifications for government intervention;

The general argument for government intervantion is market failure. Sometimes markets do not allocate resources efficiently, and government intervention may improve economic performance. Government could, in theory, improve the allocation of resources. Economic theory, identifies the types of market failures;

The business cycleThe business cycle has many external causes, from wars or oil price changes to bursts of new inventions. Government policies also affect it. Increases in taxes and reductions in government spending generally reduce GNP, increases in the money stock increase GNP and prices. Government policy can make the business cycle worse, lenthening recessions and creating inflations, or it can reduce economic fluctuations. Since the government does control a large share of total spending and the quantity of money, it must make its decisions with their effect on the business cycle in mind. And it does: taxes may be cut when the economy is in a recession, and the growth rate of money may be reduced when the inflation rate is too high or be increased when the economy is in a recession.

Public goodsThere are goods we can all consume simultaneously. These are called public goods.A public good is a good that, even if it is consumed by one person, is stil available for consumption by others. A private good, if consumed by one person, can not be consumed by another.

Clean air is a public good. So is national defence, or public safety. It is no coincidence that most public goods are not provided in private markets. Because of the free rider problem, private market have trouble ensuring that the right amount of a public good will be produced. A free-rider is some one who gets the consume a good that is costly to produce without paying for it. The free-rider problem applies particularly to public goods because if everyone were to buy the good, it would then be available for everyone else to consume.

ExternalitiesMarkets work well when the price of a good equals society’s cost of producing that good and when the value of the good to the buyer is equal to the benefit of the good to society, However the cost and benefits are sometimes not fully reflected in market prices. An externalities exist when the production or consumption of a good directly affects businesses or consumers not involved in buying and selling it and when those spillover effects are not fully reflected in market prices.Externalities might be negative or positive; Such as pollution or views of newly painted houses. When externelities are present, market prices do not reflect all the social costs and benefits of the production of a good. Government intervention may improve the functioning of the economy, for example by requiring firms to treat their waste products in certain ways before dumping them.

Monopoly and market powersCompetitive markets generally work well, but markets where either buyers and sellers can manipulate prices generally do not. In particular to little will be produced and price will be to high in a market where a single seller controls supply.Some monopolies are almost unavoidable. Most public utilities (gas for exaple) are potantial monopolies. The government can regulate such companies by controlling the prices they are allowed to charge, or it may elect to supply the products itself. Other monopolies may be artificial, brougth about through manupilation by firms. Here

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governments intervene with competition laws, seeking to make competition more vigorous and to prevent monopolies or other attemps to control supply.

Income redistribution and merit goodsIn practice modern governments engage in large scale redistribution of income. Government spending on transfer payments represents government redistribution of income- towards the elderly (through social security), the unemployed (through unemployment benefits), farmers (through price supports) and other beneficiaries.

There is difference between government intervention to effect the distribution of income and intervention to ensure the right level of production of public goods or to make market prices reflect externalities. In the later cases the government is taking actions that at least in principle can make every one in society beter off. But when the government intervenes to affect the income distribution, it make some people better off by making others worse off. Governments are concerned not just with the distribution of income, but also with the consumption of particular goods and services. Merit goods are goods that society thinks people should consume or receive, no matter what their incomes are.Merit goods typically include health, education shelter, and food.

Course XI

I. Factors Market: Some terms on factors of production.II.The Functional Income Distribution

The demand for factors of production is derived demand because it is derived from the demand for the output that the factors are used to produce.

Labour

Lobour, a factor of production consisting of all physical and mental contributions provided by people.

Labour supply, the number of workers (or more generally the number of labour-hours) available to an aconomy. The principle determinants of labour supply are population, real wages, and social traditions.

The labour force, is all individuals in work or seeking employment.

Minimum wages, legally specified minimum rate of pay for labour in covered occupations

Unemployment, the number of persons who are not employed and are actively searching for a job.

Trade Unions are worker organizations designed to affect pay and working conditions.

Lobour boycott, an organized attempt to pursuade customers to refrain from purchasig the products of a firm or industry whose employees are on strike.

Strike, the concerted refusal of the members of a union to work.

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Bread and butter unionism, is a union movement whose major objectives are better wages and conditions of employment rather than political and social ends.

Capital

Capital, A factor of production consisting of all manufactured aids to further production.

Physical capital is the stock of produced goods that contribute to the production of other goods and services. Physical capital consists of durable produced goods that are in turn used in production. The major components of capital are equipment, structures, and inventory. When signifiying capital goods reference is also made to real capital.

Portfolio capital or financial capital, means the total amount of money subscribed by the shareholder-owners of a corporation, in return for which they receive shares of the company’s stock.

Capital deepining; adding capital to the production process in such a way as to increase the ratio of capital to labour and other factors of production. In economic growht theory, an increase in the capital labour ratio (contrast with capital widening)

Capital widening, A rate of growth in real capital stock just equal to the growth of the labour force, so that the ratio between total capital and total labour remains unchanged. (contrast with capital deepining)

Capital gains, the rise in value of a capital asset, such as land or common stocks, the gain being the difference between the sale price and the purchase price of the asset.

Capital consumption allowance; depreciation of an asset: A decline in the value of an asset in both business and national accounts, depreciation is the money estimate of the extend to wich capital has been used up or worn out over the period in question.

Capital markets, markets in which financial resources (money bonds, stocks) are traded, These along with financial intermediaries, are institution through which savings in the economy are transfered to investors.

Capitalist; one who owns capital goods.

Capitalist economy; an economy in which capital is predominantly owned by privately rather than by the state.

Capital-labour ratio, a measure of the amount of capital per worker in an economy.

Capital-output ratio, The ratio of the value of capital to the annual value of output produced by it. In economic growth theory, the ratio of the total capital stock to annual GDP.

Capital stock, The aggregate quantity of a society’s capital goods or the total of a firm’s capital goods.

Human Capital, is the stock of expertise accumulated by a worker. It is valued for its income earning potential in the future.

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Nature, Land

Land is the factor of production that nature supplies. Land is a factor of production consisting of all gifts of nature, including raw materials and “land” as conventionally defined.

Land is one of the three basic factors of production in clasical and neoclasical economies; More generally land is taken to iclude land used for agricultural or industrial purposes as well as natural resources taken from above or below the soil.

Rent is the price of using a piece of land for a period of time.

The functional income distribution, tells us how an economies total income is divided between factors of production. For example it tells the share going to labour through wages and salaries, the share going to landowners through property rents, the share going to capital owners through the interest earning.

REFERENCES

Begg, D., S.Fischer, R.Dornbush, Economics, Mc Graw Hill, 1994.

Lipsey, R.G., P.O. Steiner, Economics, Harper International Edition, 1987.

Samuelson, P.A., W. Nordhaus, Economics, Mc Graw Hill, 1995.

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