CHAPTER ONE

1
CHAPTER ONE

• The Economic Problem

2
What Is Economics ?

• Definition Economics is defined as The study
  of the use of scarce resources to satisfy
  unlimited human wants .
• Another definition of Economics
• It is the science of choice . Therefore, it is
  the science that explains the choices we make .

3
The Aim of Economics

• To help the people obtain the greatest possible
  satisfaction out of the resources at their
  disposal, which means to do the best they can
  with what they have .

4
What are the Societys Resources ?

• 1. Natural Resources such as Land, Forests, and
  Minerals .
• 2. Human Resources both mental and Physical .
• 3. Manufactured aids to production such as tools,
  machinery, and buildings .

5
What is Scarcity ?

• Scarcity means that we do not have enough of
  everything , including time, to satisfy our every
  desire .
• Scarcity exists because human wants always
  exceeds what can be produced with the limited
  resources available .
• Scarcity implies that we must make choices .

6
Choice

• Choice is a trade off , which means that we give
  up something to get something else .
• Every choice involve a cost .

7
The Opportunity Cost

• It is the best alternative given up or forgone.
• It is the action that you choose not to do .

8
Example

• What is the opportunity cost of attending a 3
  hours lecture in economics ?
• For a Jogger is the forgone 3 hours of exercise .
• For early sleeper is the forgone 3 hours in bed .
  
• And so on .

9
Example 2

• Consider the choice that must be made by your
  little brother who has SR 5 to spend and who is
  determined to spend it all on candy.
• Assume there are only two kinds of candy that he
  can buy ( Bubble Gum which sells for SR 0.50 each
  ) and ( Chocolates which sells for SR 1.00 each )
  .
• What are the attainable combinations ?

10
Attainable Combinations

• Bubble Gums Chocolates
  Total cost
• 10 0
  SR 5
• 8 1
  SR 5
• 6 2
  SR 5
• 4 3
  SR 5
• 2 4
  SR 5
• 0 5
  SR 5

11
Example 2 - continue

• After careful thought , your brother has almost
  decided to buy 6 bubble gums and 2 chocolate,
• But at the last moment he decided that he must
  have 3 chocolates .
• What will it cost to get this extra chocolate ?
• The answer is two bubble gums, so he has to give
  up 2 bubble gums to get one more chocolate .
  The 2 bubble gums is called by economists as the
  opportunity cost of the third chocolate.

12
Graphically
10 9 8 7 6 5 4 3 2 1 0
unattainable
attainable
1 2 3 4 5
6 7 8 9 10
13
Production Possibilities

• Production Is the conversion of Natural, Human
  , and Capital resources into goods and services .
  
• Production Possibility Boundary
• Makes the boundary between production level
  that can and can not be attained .

14
Example

• Assume the following
• 1. There is only one producer ( Ahmed )
• 2. There are only two goods to be produced
• ( Corn and Cloth )
• 3. Ahmed can work 12 hours each day .
• So, the amount of Corn and Cloth that Ahmed can
  produce depends on how many hours he devotes to
  producing them .

15
In addition you are given the following Table 1

• Hours worked Corn Grown Cloth
  produced
• per day pound per month Yards
  per month
• 0 0
  0
• 3 either 9
  or 4
• 6 either 15
  or 7
• 9 either 20
  or 9
• 12 either 25 or
  10
• Calculate Ahmeds Production boundary ?

16
Ahmeds Production Possibility Boundary

• Possibility Corn
  Cloth
• (pound per month)
  (Yard per month)
• a 25
  and 0
• b 20
  and 4
• c 15
  and 7
• d 9
  and 9
• e 0
  and 10

17
Note

• Points on the boundary is always better than
  points inside the boundary .
• Points on the boundary ( a,b,c,d, and e )
  represent full and efficient use of societys
  resources .
• While points inside the boundary represent either
  inefficient use of resources or failure to use
  all the available resources .

18
Four Key Economic Problems

• Whatever the economic system, most problems
  studied by economists can be grouped under 4 main
  headings
• 1. What is Produced and How ?
• 2. What is consumed and by whom ?
• 3. Why are Resources sometimes idle ?
• 4. Is production capacity growing ?

19
I. What is Produced and How ?

• The allocation of scarce resources among
  alternative uses determines the quantity of
  various goods that are produced.
• Because resources are scarce, it is desirable
  that they be used efficiently .
• If resources are used efficiently, than at which
  point on the boundary will production take place
  ? .

20
What is Consumed and by Whom ?

• Will the economy consume exactly the same goods
  as it produces ?
• Or , will the countrys ability to trade with
  other countries permit the economy to consume a
  different combination of goods ?
• Who consume the goods and services produced
  depends on the income that people earns .

21
III. Why are Resources sometimes idle ?

• When an economy is in a recession some resources
  such as labor, factories and equipment, and raw
  materials are idle.
• Why are resources sometimes idle ? And should
  government worry about such idle resources ?

22
IV. Is productive capacity growing ?

• Growth in production capacity can be represented
  by an outward shift of the production possibility
  boundary .
• If an economys capacity to produce goods and
  services is growing, combinations that are
  unattainable today will become attainable
  tomorrow .
• Growth makes it possible to have more of all
  goods .

23
Alternative Economic Systems

• There are 3 types of economic systems . These are
  
• 1. Traditional Systems .
• 2. Command Systems .
• 3. Market Systems .

24
I. Traditional Systems

• A traditional economy is one in which behavior is
  based primarily on Traditions, Customs , and
  Habits . Example
• Young men follow their fathers occupations .
• Women do what their mother did .
• So , there is little change in the patterns of
  goods produced from year to year .

25
II. Command Systems

• Economic behavior id determined by some central
  authority ( Government ) which make most of the
  necessary decisions on
• What to prodce ?
• How to produce it ?
• Who will gets it ?
• Such economies are characterized by the
  Centralization of Decision Making . Example
  China and Cuba .

26
III. Market Systems ( Free-Market economy )

• In such an economy, decisions relating to the
  basic economic issues are decentralized .
• Decisions are made by individual producers and
  consumers .

27
Mixed Systems

• Economies that are fully traditional or fully
  centrally planned or wholly free-market are pure
  types that are useful for studying basic
  principles.
• But in practice, every economy is a mixed economy
  in the sense that it combine significant elements
  of all three systems in determining the economic
  behavior .

28
Ownership of Resources

• Economies differ as to who own their productive
  resources. Example
• Who owns a nations farms and factories
• Who owns a nations coal,mines, forests ?
• Who owns a nations railways,airline, hotels,
  etc. ?

29
Private-Ownership Economy

• The basic raw materials, the productive assets of
  the society, and the goods produced in the
  economy are pre-dominantly privately owned.
• Example the U.S.A. System .

30
Public-Ownership Economy

• Is one in which the productive assets are
  predominantly publicly owned . Example
• China and Former Soviet Union

31
CHAPTER 4

• Demand and Supply

32
In this Chapter

• 1. We need to understand what determines the
  demand for a particular product ?
• 2. We will also study what determine the supply
  of a particular product ?
• 3. We will see how demand and supply together
  determine the price of a product and the quantity
  that are exchanged in the market ?

33
The Demand

• What determine the demand for a product ?
• To answer this question , we have first to
  distinguish between two terms
• 1. Quantity Demanded
• 2. Demand

34
Quantity Demanded

• Is the total amount of any particular good or
  service that the consumer wish to purchase in
  some time period for a given price .

35
The Term Demand

• Refers to the entire relationship between the
  quantity demanded of a product and the price of
  that product . Therefore
• The quantity demanded represent a single point on
  the demand curve .

36
The Law of Demand

• A basic economic assumption is that
• The price of any good and the quantity demanded
  of that good are negatively related, other things
  being equal . Therefore
• The lower the price of a good, the higher the
  quantity demanded of that good . And
• The higher the price, the lower the quantity
  demanded .

37
The Law of Demand-continue

• This negative relationship between the price and
  the quantity demanded is called The Law of
  Demand . This relationship can be shown by 1.
  Demand Schedule or
• 2. Demand Curve .

38
The Demand Schedule

• The Demand Schedule is a table that shows the
  quantity demanded of a product at different
  prices .
• The Demand curve is a graphical representation of
  the demand Schedule .

39
Example

• Price of Carrots Quantity demanded
• ( per ton ) ( in thousands of
  tons)
• 120 50
• 100 60
  
• 80
  70
• 60
  80
• 40
  90
• 20
  110

40
Factors that influence the Quantity Demanded

• 1. The products own price .
• 2. The prices of related products .
• 3. The Income .
• 4. The Population .
• 5. The Preferences or Tastes .
• 6. The expected future prices .

41
Quantity Demanded and the price

• How the quantity demanded of a product changes as
  its price change ?

42
Change in Quantity Demanded

• If we assume that the price of a product may
  change, while other factors that influence the
  quantity demanded remain constant, then that
  causes a movement along the demand curve .
• Therefore, a movement along the demand curve
  shows a change in quantity demanded.

43
Change in Demand

• If the price of the product is held constant, and
  other factors changes such as Income ,
  population, preferences, etc. , that will cause a
  shift in the demand curve .
• Therefore, a shift in demand curve to the right
  or to the left shows a change in demand.

44
Determinants of Demand

• The determinants of demand are what cause
  consumers to change their view of how much they
  will buy of a given good or service at all
  possible prices that could be charged for it.
• These determinants depends on the good in
  question .

45
Some Determinants of Demand

• 1. Consumer Income
• 2. Population ( of consumers in the market)
• 3. Prices o related products
• 4. Preferences or Tastes .
• 5. Expected Future Prices .

46
Consumer Income

• Normally as consumers income increases, they
  tend to purchase more goods and services .
  Therefore,
• If an individual consumer purchase more of a good
  when his income increases , that good is said to
  be Normal good.
• And if the consumer purchase less of a good when
  his income increases, that good is said to be an
  inferior good .

47
Consumer Income-continue

• For a Normal good an increase in income will
  shift the demand curve to the right. And a
  decrease in income will shift the demand curve to
  the left .
• For an inferior good an increase in income will
  shift the demand curve to the left . And a
  decrease in income will shift the demand curve to
  the right .

48
Prices of related Products

• The relation between the quantity demanded of a
  good and the price of related good depends on
  whether the two goods are substitutes or
  complements .

49
Substitute Goods

• Substitute goods are goods that can be used in
  place of other goods .
• Example Tea and Coffee or Pepsi and Coke
• A good will be substituted in place of other good
  if it become relatively cheaper than other good.

50
Substitute goods - continue

• For substitute goods , there is a positive
  relation between quantity demanded of one product
  and the price of other product . Example
• As price of coffee rises, the quantity demanded
  of tea rises . And
• As price of coffee falls, the quantity demanded
  of of tea falls .

51
Complements

• Are products that are tend to be used jointly or
  together .
• Example Car and Gasoline
• Computer and Printer
• Tea and Sugar
  
• A fall in price of complementary product will
  shift a product demand curve to the right which
  means more will be purchases at each price .

52
Complements - continues

• A rise in price of complementary product will
  shift the demand curve of the product to the
  left.
• Therefore, there is a negative relationship
  between the price of complementary product and
  the quantity demanded of the product .

53
Population

• Demand also depends on the size of the population
  or of consumers in the market
• The larger the population, the greater is the
  demand for all goods and services , and that
  shift the demand curve to the right .
• And the smaller the population, the smaller is
  the demand for all goods and services, so the
  demand curve will shifts to the left .

54
Preferences or Tastes

• A change in taste in favor of a product will
  increase the demand for that product, and shift
  the demand curve to the right .
• And a change in taste against the product will
  decrease the demand for that product and shift
  the demand curve to the left .

55
Expected Future Prices

• If the consumers expect that prices of the
  product will rise in the future, they will
  increase their demand for the product today. This
  will shift the demand curve of that product to
  the right .
• And if the consumers expect that prices of the
  product will fall in the near future they will
  decrease their demand today. This will shift the
  demand curve of that product to the left .

56
Supply

• Here, we need to distinguish between Quantity
  Supplied and Supply .
• Quantity supplied of a product is
• The amount that the producer plan to produce and
  sell during a given time period at a particular
  price .

57
Supply

• Refers to the entire relationship between the
  quantity supplied and the price of the product .

58
Determinants of the Quantity Supplied

• 1. The price of the product
• 2. Prices of resources used to produce the
• product . ( input prices )
• 3. Technology
• 4. The number of suppliers
• 5. Prices of related goods produced
• 6. Expected future prices

59
1. The quantity supplied the price

• The Law of Supply
• A basic economic assumption states that
• For any product, the price of the product and the
  quantity supplied are positively related . Which
  means
• The higher the price, the greater is the quantity
  supplied .

60
Note

• This positive relationship between the price and
  the quantity supplied can be shown by
• 1. Supply Schedule , or by
• 2. Supply Curve

61
Supply Schedule

• It is a table that shows the positive
  relationship between quantity supplied and the
  price of the product , other things being equal .

62
Example

• Supply Schedule of X
• Price of X Quantity Supplied of X
• SR 20 5,000
• 40 10,000
• 60 15,000
• 80 20,000
• And so on .

63
Supply Curve

• Is a graphical representation of the supply
  schedule .

64
Change in Quantity Supplied

• A change in the price of the product, holding
  other factors constant, will cause a change in
  quantity supplied in the same direction as the
  change in the price .
• The change in quantity supplied as a result of
  change in price will cause upward or downward
  movement along the supply curve

65
Change in Supply

• Holding the price of the product constant, a
  change in any of the following factors will
  change the supply and cause a shift in the supply
  curve
• 1. Number of suppliers
• 2. Prices of related goods produced
• 3. Expected future prices .
• 4. Prices of resources used in production

66
The Determination of Price

• How the two forces of the market (the Demand
  Supply ) interact to determine the price of the
  product in the market ?
• To answer the above question let us look at the
  following schedule

67
Demand Supply Schedule

• Price of X Quantity Demanded Quantity Supply
• SR 20 1000
  600
• 40 900
  700
• 60 800
  800
• 80 700
  900
• 100 600
  1000

68
Note

• When actual price is above the equilibrium
  price, then Quantity supplied gt Quantity
  demanded , and that will create excess supply ,
  which put pressure on prices to go down .
• When actual price is below the equilibrium price,
  then Quantity demanded gt Quantity supplied, and
  that create excess demand , which put pressure
  on prices to go up .

69
Note

• The price at which quantity demanded exactly
  equals to quantity supplied is called
  Equilibrium price or Market Clsearing Price and
  and price where Quantity demanded does not equal
  Quantity supplied is called Disequilibrium Price
  .

70
Laws of Demand Supply

• 1. A rise in demand
• 2. A fall in demand
• 3. A rise in supply
• 4. A fall in Supply

71
1. A rise in demand

• If there is an increase in demand, that will
  shift the demand curve to the right, and increase
  both the equilibrium price and the equilibrium
  quantity exchanged.

72
2. A Fall in Demand

• If there is a fall in demand then that will shift
  the demand curve to the left, and decrease both
  the equilibrium price and equilibrium quantity
  exchanged.

73
3. A rise in Supply

• A rise in supply will shift the supply curve to
  the right and that will decrease the equilibrium
  price and increase the equilibrium quantity
  exchanged .

74
4. A Fall in Supply

• A fall in supply causes a shift in the supply
  curve to the left and that will increase the
  equilibrium price and decrease the equilibrium
  quantity exchanged .

75
CHAPTER 5

• Elasticity

76
Price Elasticity of Demand

• It measures the responsiveness of quantity
  demanded of a product to the change in the market
  price . Therefore
• PE change in quantity demanded
• change in the price

77
Arc Elasticity

• Measures the average responsiveness of quantity
  demanded to the change in the price over an
  interval of demand curve .
• Therefore , PE
• PE Q2 Q1 / P2 P1___
• (Q1 Q2) /2 (P1 P2) / 2
• PE Q2 Q1 . X (P1P2)/2 .
• (Q1Q2)/2 P2 P1

78
Example

• Given the following demand schedule , Calculate
  the Arc price Elasticity of demand . Price
  Quantity demanded
• 20 100
• 40 20
• PE 20 100 X (2040)/2 2
• 40 20 (100 20)/2

79
Point Elasticity

• It measures the responsiveness of Quantity
  demanded to the change in price of a particular
  product at a particular point on the demand curve
  .

80
Example

• Given the following demand schedule, Calculate
  the Point Elasticity of demand.
• Price of X Quantity demanded of x
• 20 100
• 40 20
• PE 20 100 X 20 0.80
• 40 20 100

81
The Numerical Value of Elasticity

• The numerical value of elasticity vary from Zero
  to infinity . Therefore
• 1. PE 0 Perfectly inelastic demand
• 2. 0 lt PE lt 1 inelastic demand
• 3. PE 1 unit elastic demand
• 4. PE gt 1 elastic demand
• 5. PE infinity Perfectly elastic demand

82
Perfectly inelastic demand when PE 0

• When PE 0 it means that quantity demanded
  does not respond at all to the change in the
  price of the product .
• Example Price Quantity demanded
• 20 100
• 40 100
• PE 100 100 X (2040)/2 0 X 30
  0
• 40 - 20 (100100)/2 20
  100

83
Inelastic Demand 0ltPElt1

• When 0 lt PE lt 1 inelastic demand
• This means that
• change in quantity lt change in the price
• Example Price of x Quantity demanded of
  x
• 20
  100
• 40
  80
• PE 80 100 X ( 20 40 )/2 0.33
• 40 20 ( 100 80 )/2

84
Unit elastic demand , PE 1

• When PE 1 , we have unit elastic demand
• This means that
• change in quantity change in price
• Example Price Quantity demanded
• 20 100
• 40 50
• PE 50 100 X ( 20 40)/2 1
• 40 - 20 ( 100 50)/2

85
Elastic Demand , PE gt 1

• When PE gt 1 , we have elastic demand
• This means that
• change in quantity gt change in the price
• Example Price of x Quantity demanded
• 20 100
  
• 40
  20
• PE 20 100 X ( 20 40 )/2 2
• 40 20 ( 100 20)/2

86
Price elasticity and change in Total Revenue ( or
total expenditure )

• How does total revenue react to a change in the
  price of a product ?
• The response of total revenue depends on the
  price elasticity of demand which means it depends
  on whether the
• demand is elastic, inelastic , or unit elastic ?

87
If the Demand is elastic, PEgt1

• In this case , the price and total revenue are
  negatively related . Therefore
• A fall in the price , will increase total revenue
  
• A rise in the price, will decrease total revenue
• Example Price Quantity Total
• 20 100
  2000
• 40 20
  800
• PE 2

88
If the Demand is inelastic , PE lt1

• If the demand is inelastic , PE lt 1 , then
• Price and total revenue are positively related,
  which means
• A fall in price , will decrease total revenue ,
  and
• A rise in price, will increase total revenue
• Example Price Quantity Total revenue
• 20 100
  2000
• 40 80
  3200
• PE 0.33

89
If the Demand is Unit elastic , PE1

• When the demand is unit elastic, PE 1 ,then
• Total revenue will not be changed ( constant )
  which means
• As price rises or falls , total revenue remain
  unchanged . Example P Q TR
• 20
  100 2000
• 40
  50 2000
• PE 1

90
Determinants of The Price Elasticity of Demand

• The main determinant of elasticity of demand is
  the availability of substitute
• A product with close substitute tend to have
  elastic demand .
• While a product with no close substitute tend to
  have inelastic demand .

91
Other Demand Elasticity

• 1. Income Elasticity of Demand
• 2. Cross Elasticity of Demand

92
Income Elasticity of Demand,Ei

• This elasticity measures the responsiveness of
  demand to a change in income .
• EI change in Quantity Demanded
• change in Income
• Where EI Income elasticity
• The income elasticity could be positive or
  negative.

93
Positive Income Elasticity , EIgt0

• Goods with positive income elasticity are called
  Normal Goods . Therefore , for Normal Good
• As income rises , consumption rises . And
• As income falls , consumption falls .
• Example Income Quantity Demanded
• 1000 100
• 3000 500
  
• EI 400 X 2000 400 1.3
• 2000 300 300

94
Example 2

• Income Quantity Demanded
• 1000 100
• 3000 200
• EI 100 X 2000 100 0.67
• 2000 150 150

95
Negative Income Elasticity, EIlt0

• Goods with negative income elasticity are called
  Inferior Goods . Therefore for Inferior goods
  
• As income rises , consumption will falls and
• As income falls , consumption will rise .

96
Example

• Income Quantity Demanded
• 1000 100
• 3000 60
• EI - 40 X 2000 - 1 .
• 2000 80 2
• Since EI - 0.5 lt 0 negative EI , therefore
  X an inferior good .

97
Cross Elasticity of Demand

• This elasticity measures the responsiveness of
  demand to the change in the price of another
  product. It is defined as
• E x y change in quantity demanded of X
• change in the price of Y
• E x y Q2 Q1 X ( P y2 Py1) /2
• P2 P1 (Q x2 Q x1) /2
• The Cross elasticity could be positive or negative

98
Positive Cross elasticity, Exy gt 0

• If the Cross elasticity is positive , then
• Both goods ( X and Y ) are Substitutes
• If the Cross elasticity is negative , then
• Both goods ( X and Y ) are Complements

99
Example

• Price of Coal Quantity demanded of Oil
• 10 100
• 20 300
• E xy 200 X 15 15 1.5
• 10 200 10
• Since E xy 1.5 gt 0 Positive Cross elasticity
• Therefore, X and Y are Substitutes .

100
Example 2

• Price of Car Quantity demanded of
• Gasoline
• SR 50,000 100,000
• 30,000 200,000
• Exy 100,000 X 40,000 - 1.33
• - 20,000 150,000
• Since Exy - 1.33 lt 0 , therefore,
• Car and Gasoline are complements .

101
Elasticity of Supply, Es

• This elasticity measures the responsiveness of
  the quantity supplied to a change in the
  products price and it is defined as
• Es percentage change in quantity supplied
• percentage change in the price
• The elasticity of supply range between zero and
  infinity , so 0 lt Es lt infinity

102
What Determines the Elasticity of Supply ?

• 1. The ability of the firm to shift the resources
  from the production of other commodities to the
  one whose price has risen .
• 2. Cost behavior
• If cost of production rises rapidly as output
  rises, then there is no incentive to expand the
  production , so supply will be less elastic ) .
  But if cost rises only slowly as production
  increases, then a rise in price will stimulate a
  large increase in quantity supply, so the supply
  will be more elastic .

103
Short-run and Long-run market adjustment

• Shift in demand or supply have different effects
  on equilibrium price and quantity depending on
  the degree of price elasticity .
• Shift in Supply In the short-run , when demand
  is relatively inelastic, a shift in supply leads
  to sharp change in equilibrium price, but to only
  a small change in equilibrium quantity . But, in
  long-run , demand is more elastic , so shift in
  supply curve results in small change in
  equilibrium price and large change in quantity.

104
Shift in Demand

• In the short-run, when supply is relatively
  inelastic, a shift in demand leads to sharp
  change in equilibrium price , but only to a small
  change in equilibrium quantity .
• However, in the long-run, when supply is more
  elastic than short-run, a shift in demand leads
  to a small change in equilibrium price , but to a
  large change in equilibrium quantity .

105
CHAPTER 6

• Demand and Supply in Action

106
Government Controlled Prices

• In some cases , government fix the prices of some
  products in the market .
• Government price controls are policies that
  attempt to hold the prices at some disequilibrium
  value .
• Some controls , hold the market price below its
  equilibrium value. This create a shortages .
• Other controls, hold price above equilibrium.
  This create a surplus at the control price .

107
Quantity Exhanged

• At any disequilibrium price, we know that the
  quantity exchanged is determined by the lesser
  of quantity demanded or supplied. Therefore
• For price below equilibrium price , quantity
  exchanged will be determined by the supply curve.
  
• For the prices above the equilibrium price, the
  quantity exchanged is determined by the demand
  curve .

108
Floor Price

• It is the minimum price that can be charged for a
  product .
• The floor price that is set at or below the
  equilibrium price has no effect because the
  equilibrium price remain attainable.
• But, if the floor price is set above the
  equilibrium price , it is said to be binding or
  effective .

109
Note

• The effective floor price leads to excess supply.
  
• Either unsold surplus will exist or some one must
  enter the market and buy the excess supply .

110
Ceiling Price

• Is the Maximum price at which certain good or
  service may be sold .
• If the ceiling price is set above the equilibrium
  price , it has no effect because the equilibrium
  price is attainable .
• But , if ceiling price is set below the
  equilibrium price , it is said to be effective or
  binding .

111
Note

• The effective ceiling price will create excess
  demand or shortages and this invite what is
  called Black Market where goods are sold
  at illegal price
• ( the price is higher or lower than the
  controlled price ) .

112
Rent Control A case study of price ceiling

• Rent controls are just special case of price
  ceiling .
• Here, we need to distinguish between short-run
  and long-run supply or rental accommodation .

113
Short-run Supply

• The short-run supply for Housing is quite
  inelastic because it takes years to plan and
  build new apartments .
• Therefore, the supply curve in short-run is
  perfectly inelastic , which means
• An increase or decrease in demand will cause rent
  to change in short-run , but there is no change
  in quantity supplied.

114
Long-run Supply

• The Long-run supply curve of rental housing is
  highly elastic because
• If the return on investment in new housing rises
  significantly above the return on comparative
  investment , there will be flow of investment
  funds into the industry of new rental housing.
• And if the return on investment in new housing
  fall below what can be earned on comparative
  investment , the fund will go elsewhere.

115
The effect of rent control in short and long run

• Rent Quantity Quantity Surplus
  
• demanded supply or
  shortage -
• 60 100 500
  400
• 50 200 400
  200
• 40 300 300
  0
• 30 400 200
  - 200
• 20 500 100
  - 400
• Assume we have ceiling price at 30

116
Note

• If the ceiling rent is set below the equilibrium
  rent that will cause shortages in both the
  Short-run as well as in the Long-run, but the
  shortages in the Long-run will be greater because
  the supply curve in the long-run is more elastic.

117
Who gain and Who loss from rent control ?

• Tenants in rent control accommodations are the
  gainers .
• While Landlords and potential future tenants are
  the losers .
• Note Chapter 6 up to page 121 only
• Up to ( Agriculture Farm problem)

118
CHPTER 7

• Consumer Behavior

119
Main Points

• In this chapter, we will discuss
• Marginal Utility consumer choice
• Utility Schedules Graphs
• Maximizing Utility
• Marginal Total Utility
• Derivation of consumer Demand curve
• Consumer Surplus
• Income Substitution Effects .

120
Marginal Utility Consumer Choice

• Consumer choice is fundamental to market
  economies .
• Consumers make all kinds of decisions
• Economists assume that consumers are motivated to
  maximize their utility .
• How the consumer make decision based on utility
  maximization ?

121
Definition of Utility

• Utility is defined as follows
• It is the satisfaction that the consumers drive
  from the goods and services that they consume .

122
Total Utility

• Is the full satisfaction resulting from the
  consumption of that product by the consumer .

123
Marginal Utility

• It is the change in satisfaction resulting from
  consuming one more unit of the product . Or
• It is the additional utility derived from
  consuming one more unit of the product.
• MU Change in total utility
• Change in number of unit consumed

124
Example

• Pizza Total utility Marginal utility
• 0 0
  0
• 1 30 30
• 2 50 20
• 3 65 15
• 4 75 10
• 5 83 8
  
• 6 89 6
  
• 7 93 4
  
• 8 96
  3
• 9 98
  2
• 10 99 1

125
Diminishing Marginal Utility

• The basic hypothesis of utility theory is called
  Law of diminishing Marginal utility which
  means that
• The utility that may any consumer drives from
  successive units of particular product diminishes
  as total consumption of that product increase,
  holding consumption of all other products constant

126
Maximizing Utility equilibrium

• How can a household adjust its expenditure so as
  to maximize its utility ?
• The condition for utility maximization is
• M U x M U y
• P x P y
• Where M U x marginal utility per dollar
• P x spent on X

127
Equilibrium Condition

• Alternatively, we can write the equilibrium
  condition as follows
• M U x P x .
• M U y P y
• MU x Relative marginal utility of both
• MU y goods X and Y
• P x Relative prices of both goods
• P y X and Y

128
Example

• Assume an individual who spend his income on two
  goods ( X and Y ) has an income of 360 . Assume
  also that the price of X 60 and the price of
  Y 30 . In addition you are given the
  following data
• Q x TU x Q y TU y
• 0 0 0 0
  Required
• 1 50 2 56
  How many units of
• 2 88 4 100
  X and Y this
• 3 121 6 138
  consumer should
• 4 150 8 172
  consume to maximize
• 5 175 10 202
  his utility ?

129
The Answer

• Q x TU x MU x MU x Q y TU y MU y
  MU y
• P x
  P y
• 0 0 0 0 10
  202 15 0.5
• 1 50 50 0.83 8
  172 17 0.57
• 2 88 38 0.63 6
  138 19 0.63
• 3 121 33 0.55 4
  100 22 0.73
• 4 150 29 0.48 2
  56 28 0.93
• 5 175 25 0.42 0
  0 0 0
• He should consume 2 x and 6 y to maximize his
  utility

130
Income and Substitution Effects

• How does the household react to a change in the
  price of one good ?
• A fall in the price of one good affects the
  consumer in two ways
• 1. Relative price change
• This provide an incentive to buy more of
• the good which its price has fallen .
• 2. The household real income increases .

131
Example

• Assume the following
• Income 360
• Price of X 12
• Price of Y 6
• Relative price of X to Y 12 2
• 
  6
• What will happen if price of X fall to 6?

132
Substitution Effect

• Is the change in quantity demanded as a result of
  a change in relative prices with real income held
  constant .

133
Income Effect

• Is the change in quantity demanded as a result of
  a change in real income .

134
Note

• 1. The substitution effect is always
• negative .
• 2. Income effect could be positive or
• negative .
• 3. Goods with positive income effect are
• called Normal goods
• 4. Goods with negative income effect are
• called Inferior goods

135
Note

• 5. Normal goods always have downward
• demand curve .
• 6. Inferior goods may have downward or
• upward demand curve .
• 7. Inferior goods with downward demand
• curve is called Non-Giffen goods
• 8. Inferior goods with upward demand
• curve is called Giffen goods

136
Note

• If substitution effect gt negative income effect
• Then that good is called Non-Giffen goods .
• If substitution effect lt negative income effect
  then that good is called Giffen good .

137
Chapter 8

• Production and Cost in the Short-run

138
Note

• In this chapter we will talk about
• - production of goods services
• by the firms .
• - How we determine or measure
• the cost as well as the profit of
• the firms .

139
Short-run

• Is a period of time where at least one or more of
  the input factors used in production can not be
  changed ( Fixed).
• Therefore, in short-run, we have
• 1. Fixed inputs factors .
• 2. Variable inputs factors .

140
Long-run

• Is a period of time where all factors of
  production used by the firm can be changed (
  Variable )

141
Profit Maximization

• Economists usually assume that firms try to make
  their profit as large as possible which means to
  maximize their profit.
• Firms seek profit by producing and selling
  commodities .
• All production can be accounted for by the
  service of 3 kinds of inputs called Factors of
  production .

142
Factors of Production

• 1. Land
• 2. Labor
• 3. Capital
• The value of these inputs is called Cost

143
Measurement of Cost

• There are two ways of measuring the cost
• 1. Historical cost cost of purchased and
• hired factors
• 2. Opportunity cost which is the cost of
• all inputs used in production whether it is
  purchased, hired, or imputed cost .

144
Historical Cost

• It is the value of resources at prices actually
  paid for them .
• It is the value of all purchased and hired input
  factors .

145
Opportunity Cost

• It is the cost of the best alternative given up .
• It is the cost of each input used in production
  whether it is purchased, hired , or imputed cost.
• Opportunity cost of purchased imputed cost
• cost and hired factors
• ( Explicit cost ) (
  Implicit cost)

146
Imputed cost ( Implicit cost )

• It is the cost of inputs used in production which
  is neither purchased nor hired .
• It is the cost of inputs which its uses does not
  require payment to anyone outside the firm.
• Example
• The owners services to the firm (time and effort
  ) .
• The owners investment in the firm .

147
The meaning of Economic Profits

• Profit Revenue Cost
• Since we have different measurement of cost , we
  also have different measurement of profit each
  based on different measurement of cost .
• Accounting Revenue Historical cost
• profit
• Economic Revenue opportunity
• profit cost

148
Note

• When Revenue opportunity cost , then
• Economic profit is 0 this is called Normal
  profit .
• When Economic profit gt 0 the firm is earning
  more than the normal profit .
• When economic profit lt 0 the firm is earning
  less than the normal profit .

149
Example

• Assume you are given the following data for a
  firm .
• Revenue from sale SR 300,000
• Cost of goods sold SR 150,000
• Utilities other services SR 20,000
• Wages ( hired ) SR 50,000
• Depreciation SR 22,000 Bank interest 12000
• In addition you know that the owner of the firm
  invested SR 115,000 of his own money in the firm
  and worked 1000 hours during the year in his firm
  where the rate per hour is SR 40 and rate of
  interest is 10 . Calculate the Accounting
  profit and the Economic Profit ?

150
Accounting Profit Revenue Historical
cost

• Revenue
  SR 300,000
• Less Historical cost
• cost of goods sold SR 150,000
• Utilities other services 20,000
• Wages ( hired ) 50,000
• Depreciation 22,000
• Bank interest 12,000
  254,000
• Accounting Profit
  SR 46,000

151
Economic Profit Revenue Opportunity cost

• Revenue
  SR 300,000
• Less Opportunity cost
• Cost of goods sold SR 150,000
• Utilities services 20,000
• Wages ( hired ) 50,000
• Bank interest 12,000
• Fall in value of assets 10,000
• Owners salary 40,000
• Interest on owners money 11,500 293,500
• Economic Profit
  SR 6,500

152
Short-run Production Function

• Production Function
• Give us the relationship between the inputs
  used in production and the output produced.
• The short-run production can be described by
  three ways
• 1. Total product curve
• 2. Average product curve
• 3 . Marginal product curve

153
Example

• Assuming a firm using only 2 inputs
• ( Labor capital ) where Labor is the variable
  factor and capital is a fixed factor . In
  addition you are given the following data
• Labor Capital Output
• 0 2 0
• 1 2 4
• 2 2 10
• 3 2 13
• 4 2 15
• 5 2 16

154
Total Product , TP

• Is the total amount that is produced during a
  given period of time .
• Total product will change as more or less of the
  variable input factor is used with the given
  amount of the fixed factor

155
The Average Product , AP

• Is the total product divided by of units of the
  variable input used in production.
• AP TP Q
• L L
• Where AP Average product
• TP Total product
• L Labor

156
Example

• Labor Capital Total product Average product
  
• 0 2 0
  0
• 1 2 4
  4
• 2 2 10
  5
• 3 2 13
  4.3
• 4 2 15
  3.75
• 5 2 16
  3.20

157
Marginal Product , MP

• Is the change in total product (output )
  resulting from the use of one more unit of the
  variable input factor .
• MP of L change in total product
• change in Labor

158
Example

• Labor Capital Output Marginal product
• 0 2 0 -
  
• 1 2 4 4
  
• 2 2 10 6
• 3 2 13 3
• 4 2 15 2
• 5 2 16 1

159
Relationship between AP and MP

• When MP gt AP . AP is rising
• When MP lt AP . AP is falling
• When MP AP . AP is at its Maximum
• The point at which AP is at its maximum is also
  called point of diminishing AP

160
Short-run Variation in Cost

• How the firms cost vary as its varies its output
  ?
• First let us have a brief definition of several
  cost concept such as
• Total cost Total fixed cost
• Total variable cost Average total cost
• Average fixed cost Average variable cost and
  Marginal cost .

161
Total Cost , TC

• Is the sum of the cost of all input used in
  production .
• Total cost is divided into two parts Total fixed
  cost and total variable cost . Therefore
• TC TFC TVC

162
Total Fixed Cost , TFC

• This cost does not change as output changes .
• It is independent of the level of output .
• It is also called overhead cost or
  unavoidable cost

163
Total Variable Cost , TVC

• This cost vary with the level of output .
• It is the cost of all variable input used in the
  production .
• It is also called Direct cost or avoidable
  cost .

164
Average Total Cost , ATC

• It is the total cost per unit of output .
• ATC TC
• Q
• Or ATC AFC AVC

165
Marginal Cost MC

• Is the increase in total cost resulting from a
  unit increase in output .
• It is also called incremental cost .
• MC change in total cost
• change in output

166
Example

• Assume that TFC 25 per day , and a worker
  cost 25 per day . Assume Labor is variable
  input. In addition you are given the following
  data Labor Output
• 0 0 Required
  
• 1 4 Calculate
  TFC TVC TC
• 2 10
  AFC AVC ATC
• 3 13
  and MC
• 4 15
• 5 16

167
The Answer

• L Q TFC TVC TC AFC AVC ATC MC
• 0 0 25 0 25 - -
  - -
• 1 4 25 25 50 6.25 6.25
  12.5 6.25
• 2 10 25 50 75 2.50 5.00
  7.5 4.17
• 3 13 25 75 100 1.92 5.77
  7.7 8.33
• 4 15 25 100 125 1.67 6.67
  8.33 12.5
• 5 16 25 125 150 1.56 7.81
  9.38 25.0

168
Notes

• 1. TFC is constant at 25 regardless of the
  level
• of output , so it has a horizontal cost
  curve .
• 2. TVC and TC both increase as output rises .
• 3. The vertical distance between TC and TVC
• curves is equal to TFC .
• 4. AFC decreases as output rises .
• 5. AVC and ATC both take the U-shape which means
  they first decrease , reach a minimum and then
  rises .

169
Chapter 9

• Production and Cost in the Long-Run

170
In the Long-Run

• All input factors are variables.
• No Fixed factors .
• There are different ways to produce the given
  output .

171
Capital Intensive Method

• Using more capital and less labor

172
Labor Intensive Method

• Using more labor and less capital

173
Profit Maximization Cost Minimization

• To maximize the profit in the long-run
• The firm should select the method that produces
  its output at the lowest cost possible .
• This implication is called Cost
  Minimization

174
What can the firm do in the long-run to make its
cost as low as possible?

• Choice of Factor Mix
• The firm should substitute one factor (ex.
  capital)
• For another factor ( ex. Labor) as long as the
  Marginal product of one factor per dollar is
  greater than the marginal product of the other
  factor per dollar expended on it .

175
Condition for Cost Minimization

• MP K MP L
• P K P L
• Where
• MP K marginal product of capital per dollar
• P K spent on capital
• MP L marginal product of labor per dollar
  spent
• P L on labor

176
Note

• Whenever the two sides of the equation are not
  equal, there are possibilities to Substitute one
  factor for another to minimize the cost of
  production .

177
Example

• If MP K 10 last dollar spent on K
• P K added 10 units
  to the
• output .
• And If MP L 4 last dollar spent on
• P L Labor added 4
  units
• to the output
  .
• Therefore, the firm should use more capital and
  less labor .

178
The cost minimization condition

• Can be rearranged as follows
• MP K P K
• MP L P L

179
Example

• Assume that
• MP K 4 so one unit of capital added
  4
• MP L times as much as one
  unit of
• labor would add
  to the output.
• PK 2 so one unit of capital
  is twice as
• PL expensive as one
  unit of labor .
• So, the firm should use more capital and less
  labor .

180
Long-Run Cost Curves

• When all factors of inputs can be changed , then
  
• There is a Least Cost Method of producing each
  possible level of output.
• LRATC curve shows the minimum achievable cost for
  each level of output .

181
The Shape of LRATC curve

• The LRATC curve
• First fall , reach a minimum , and then rises as
  output rises .
• Therefore, The LRATC curve take a U-Shape .
• It separate the attainable cost from those
  unattainable cost .
• Any point on the curve or above is attainable
  cost
• Any point below the curve is unattainable cost.

182
Decreasing cost

• When the LRATC curve fall , we have Decreasing
  cost. In this case
• An expansion of output permits a reduction in
  cost . This is called Economies of Scale , so
  over this range the firm enjoy Increasing return
  to Scale .

183
Constant Cost

• Over the Flat portion of LRATC curve
• The firm would have a constant cost.
• So, the firm will have constant return to scale

184
Increasing Cost

• Over the range of output gt qc
• The firm has rising cost , so an expansion in the
  production will cause increase in LRATC , so the
  firm will have Decreasing Return to Scale.

185
Substituting between Labor and Capital to produce
a given output

• Example
• Method Capital
  Labor
• a 4
  1
• b 2
  2
• c 1
  4
• The different combinations of capital labor
  required to produce a given level of output give
  us The ISO Quant (equal quantity) curve.

186
ISO-Cost Line

• This curve shows different combinations of
  capital labor that can be bought for a given
  total cost .

187
Example

• Assume a firm decided to spend 100 a day to
  produce certain output.
• Also, assume that a machine operator (L) can be
  hire