Objectives:

Objectives: Economics for Business Studies I

1. Basics of Microeconomics 

Demand, Supply and Markets

2. Principles and Theories of Microeconomics  

Firm Behaviour & Market Structure The Public Sector

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Investment Ratings Standard & Poor’s  Very

High Performance

 S&P

 High

AAA – capacity is extremely strong

Performance

 S&P

BBB – capacity is adequate, adverse conditions will have more impact on the outcome

 Low

Performance

 S&P

 Very

C – no interest being paid

Low Performance

 S&P

D – principal and interest in default 2

Textbook Principles of Economics, 4th Edition (2006) 

Thomson South-Western: Mankiw, N.G.

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H

o w

th e

w

o r l

E c o n P o s m y ci c hS s o o l c o i go myl o o g r y e

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Ch.1 10 PRINCIPLES OF ECONOMICS

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Introduction  Definition

of scarcity: the limited nature of society’s resources.  Definition of economics: the study of how society manages its scarce resources. faces Society

Wants > Resources to resolve

adopts

Economics System (e.g. Market Economy) 6

The 10 Principles 

Principle #1: When individuals make decisions, they face



tradeoffs among alternative goals. Principle #2: The cost of any action is measured in terms of foregone opportunities. Definition of opportunity cost: whatever must be given up to obtain some item.



Principle #3: Rational people make decisions by



comparing marginal costs and marginal benefits. Principle #4: People change their behavior in response to the costs and benefits they face.

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The 10 Principles 

Principle #5: Trade can be mutually beneficial.



Principle #6: Markets are usually a good way of

coordinating trade among people.  Principle #7: Government can potentially improve market outcomes if there is some market failure or if the market outcome is inequitable.

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The 10 Principles 

Principle #8: Productivity is the ultimate source

of living standards.  Principle #9: Money growth is the ultimate source of inflation.  Principle #10: Society faces a short-run tradeoff between inflation and unemployment.

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Ch 4 THE MARKET FORCES OF SUPPLY AND DEMAND

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Markets and Competition  Definition

of market: a group of buyers and sellers of a particular good or service.  Definition of competitive market: a market in which there are many buyers and many sellers so that each has a negligible impact on the market price.

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Markets and Competition 

Competition: Perfect and Otherwise 

 



Characteristics of a perfectly competitive market:  The goods being offered for sale are all the same.  The buyers and sellers are so numerous that none can influence the market price. Because buyers and sellers must accept the market price as given, they are often called "price takers." Not all goods are sold in a perfectly competitive market.  A market with only one seller is called a monopoly market.  A market with only a few sellers is called an oligopoly.  A market with a large number of sellers, each selling a product that is slightly different from its competitors’ products, is called monopolistic competition. We will start by studying perfect competition. 12

Demand  The

Demand Curve: The Relationship between Price and Quantity Demanded 



Definition of quantity demanded: the amount of a good that buyers are willing and able to purchase. One important determinant of quantity demanded is the price of the product.  

Quantity demanded is negatively related to price. This implies that the demand curve is downward sloping. Definition of law of demand: the claim that, other things equal, the quantity demanded of a good falls when the price of the good rises. 13

Demand 

The Demand Curve: The Relationship between Price and Quantity Demanded 

Definition of demand schedule: a table that shows the relationship between the price of a good and the quantity demanded.

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Demand  The

Demand Curve: The Relationship between Price and Quantity Demanded 

Definition of demand curve: a graph of the relationship between the price of a good and the quantity demanded.  

Price is generally drawn on the vertical axis. Quantity demanded is represented on the horizontal axis.

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Figure 1 Catherine’s Demand Schedule and Demand Curve Price of Ice-Cream Cone $3.00 2.50 1. A decrease in price ...

2.00 1.50 1.00 0.50 0 1 2 3 4 5 6 7 8 9 10 11 12 Quantity of Ice-Cream Cones 2. ... increases quantity of cones demanded.

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Demand  Market 





Demand Versus Individual Demand

The market demand is the sum of all of the individual demands for a particular good or service. The demand curves are summed horizontally— meaning that the quantities demanded are added up for each level of price. The market demand curve shows how the total quantity demanded of a good varies with the price of the good, holding constant all other factors that affect how much consumers want to buy. 17

Changes in Quantity Demanded Price of IceCream Cones

B

$2.0 0

A tax that raises the price of ice-cream cones results in a movement along the demand curve. A

1.00

D 0

4

18 8Quantity of Ice-Cream Cones

Demand  Shifts 



in the Demand Curve

The demand curve shows how much consumers want to buy at any price, holding constant the many other factors that influence buying decisions. If any of these other factors change, the demand curve will shift.  

An increase in demand can be represented by a shift of the demand curve to the right. A decrease in demand can be represented by a shift of the demand curve to the left. 19

Figure 3 Shifts in the Demand Curve Price of Ice-Cream Cone Increase in demand

Decrease in demand

Demand curve, D3 0

Demand curve, D1

Demand curve, D2

Quantity of20 Ice-Cream Cones Copyright©2003 Southwestern/Thomson Learning

Demand  Shifts 

in the Demand Curve

Income 





The relationship between income and quantity demanded depends on what type of good the product is. Definition of normal good: a good for which, other things equal, an increase in income leads to an increase in demand. Definition of inferior good: a good for which, other things equal, an increase in income leads to a decrease in demand. 21

Consumer Income Normal Good Price of IceCream Cone

$3.0 0 2.5 0 2.0 0 1.5 0 1.0 0 0.5 0

An increase in income... Increase in demand

D1 0 1

2 3 4 5 6 7 8 9 10 11 12

D2

Quantity of Ice22 Cream Cones

Consumer Income Inferior Good Price of IceCream Cone

$3.0 0 2.5 0 2.0 0 1.5 0 1.0 0 0.5 0

An increase in income... Decrease in demand

D2 0 1

D1

2 3 4 5 6 7 8 9 10 11 12

Quantity of Ice-Cream 23 Cones

Demand  Shifts 

in the Demand Curve

Prices of Related Goods 



Definition of substitutes: two goods for which an increase in the price of one good leads to an increase in the demand for the other. Definition of complements: two goods for which an increase in the price of one good leads to a decrease in the demand for the other.

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Demand  Shifts  

Tastes Expectations  



in the Demand Curve

Future Income Future Prices

Number of Buyers

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Demand  Variables

That Influence Buyers

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Question Time!

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Supply  The

Supply Curve: The Relationship between Price and Quantity Supplied 

Definition of quantity supplied: the amount of a good that sellers are willing and able to sell.  

Quantity supplied is positively related to price. Definition of law of supply: the claim that, other things equal, the quantity supplied of a good rises when the price of the good rises.

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Supply 

The Supply Curve: The Relationship between Price and Quantity Supplied 

Definition of supply schedule: a table that shows the relationship between the price of a good and the quantity supplied.

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Figure 5 Ben’s Supply Schedule and Supply Curve Price of Ice-Cream Cone $3.00 1. An increase in price ...

2.50 2.00 1.50 1.00 0.50

0

1 2

3

4

5

6

7

8

9 10 11 12 Quantity of Ice-Cream Cones

2. ... increases quantity of cones supplied.

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Copyright©2003 Southwestern/Thomson Learning

Supply  The

Supply Curve: The Relationship between Price and Quantity Supplied 

Definition of supply curve: a graph of the relationship between the price of a good and the quantity supplied.  

Price is generally drawn on the vertical axis. Quantity demanded is represented on the horizontal axis.

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Supply  Market 





Supply Versus Individual Supply

The market supply curve can be found by summing individual supply curves. Individual supply curves are summed horizontally at every price. The market supply curve shows how the total quantity supplied varies as the price of the good varies.

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Change in Quantity Supplied Price of IceCream Cone

S C

$3.0 0

1.00

0

A rise in the price of ice cream cones results in a movement along the supply curve.

A

1

5

Quantity of Ice-Cream 33 Cones

Supply  Shifts 



in the Supply Curve

The supply curve shows how much producers offer for sale at any given price, holding constant all other factors that may influence producers’ decisions about how much to sell. When any of these other factors change, the supply curve will shift.  

An increase in supply can be represented by a shift of the supply curve to the right. A decrease in supply can be represented by a shift of the supply curve to the left. 34

Figure 7 Shifts in the Supply Curve Price of Ice-Cream Cone

Supply curve, S3

Decrease in supply

Supply curve, S1

Supply curve, S2

Increase in supply

0

Quantity of 35 Ice-Cream Cones Copyright©2003 Southwestern/Thomson Learning

Supply  Shifts    

in the Supply Curve

Input Prices Technology Expectations Number of Sellers

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Supply  Variables

That Influence Sellers

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Supply and Demand Together  Equilibrium 



The point where the supply and demand curves intersect is called the market’s equilibrium. Definition of equilibrium: a situation in which the price has reached the level where quantity supplied equals quantity demanded.

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Supply and Demand Together Demand Schedule

Supply Schedule

At $2.00, the quantity demanded is equal to the quantity supplied! 39

Supply and Demand Together  Equilibrium 





Definition of equilibrium price: the price that balances quantity supplied and quantity demanded. The equilibrium price is often called the "marketclearing" price because both buyers and sellers are satisfied at this price. Definition of equilibrium quantity: the quantity supplied and the quantity demanded at the equilibrium price.

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Figure 8 The Equilibrium of Supply and Demand Price of Ice-Cream Cone

Supply

$2.00

Equilibrium

Equilibrium price

Equilibrium quantity 0

1

2

3

4

5

6

7

8

Demand

9 10 11 12 13 Quantity of Ice-Cream Cones41 Copyright©2003 Southwestern/Thomson Learning

Supply and Demand Together  Equilibrium 

If the actual market price is higher than the equilibrium price, there will be a surplus of the good. 



Definition of surplus: a situation in which quantity supplied is greater than quantity demanded. To eliminate the surplus, producers will lower the price until the market reaches equilibrium.

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Figure 9 Markets Not in Equilibrium

(a) Excess Supply Price of Ice-Cream Cone

Supply Surplus

$2.50 2.00

Demand

0

4 Quantity demanded

7

10 Quantity supplied

Quantity of Ice-Cream Cones

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Copyright©2003 Southwestern/Thomson Learning

Supply and Demand Together  Equilibrium 

If the actual price is lower than the equilibrium price, there will be a shortage of the good. 



Definition of shortage: a situation in which quantity demanded is greater than quantity supplied. Sellers will respond to the shortage by raising the price of the good until the market reaches equilibrium.

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Figure 9 Markets Not in Equilibrium

(b) Excess Demand Price of Ice-Cream Cone

Supply

$2.00 1.50 Shortage Demand

0

4 Quantity supplied

7

10 Quantity of Quantity Ice-Cream demanded Cones

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Supply and Demand Together  Equilibrium 

Definition of the law of supply and demand: the claim that the price of any good adjusts to bring the supply and demand for that good into balance.

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Supply and Demand Together  Three

Steps to Analyzing Changes in Equilibrium 

 

Decide whether the event shifts the supply or demand curve (or perhaps both). Decide in which direction the curve shifts. Use the supply-and-demand diagram to see how the shift changes the equilibrium price and quantity.

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Supply and Demand Together 

Example: A Change in Demand — the effect of hot weather on the market for ice cream.

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Figure 10 How an Increase in Demand Affects the Equilibrium Price of Ice-Cream Cone

1. Hot weather increases the demand for ice cream . . .

Supply New equilibrium

$2.50 2.00 2. . . . resulting in a higher price . . .

Initial equilibrium D D 0

7 3. . . . and a higher quantity sold.

10

Quantity of Ice-Cream Cones

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Supply and Demand Together  Shifts

in Curves versus Movements Along Curves 



A shift in the demand curve is called a "change in demand." A shift in the supply curve is called a "change in supply.“ A movement along a fixed demand curve is called a "change in quantity demanded." A movement along a fixed supply curve is called a "change in quantity supplied." 50

Supply and Demand Together 

Example: A Change in Supply — the effect of a hurricane that destroys part of the sugar-cane crop and drives up the price of sugar.

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Figure 11 How a Decrease in Supply Affects the Equilibrium Price of Ice-Cream Cone S2

1. An increase in the price of sugar reduces the supply of ice cream. . . S1

New equilibrium

$2.50

Initial equilibrium

2.00 2. . . . resulting in a higher price of ice cream . . .

Demand

0

4

7 3. . . . and a lower quantity sold.

Quantity of Ice-Cream Cones

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Supply and Demand Together 

Example: A Change in Both Supply and Demand—the effect of both hot weather and an earthquake which destroys several ice cream factories on the market for ice cream.

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Supply and Demand Together  How 



Prices Allocate Resources

The model of supply and demand is a powerful tool for analyzing markets. Supply and demand together determine the price of the economy’s goods and services. 



These prices serve as signals that guide the allocation of scarce resources in the economy. Prices determine who produces each good and how much of each good is produced.

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Summary  Economists

use the model of supply and demand to analyze competitive markets.  In a competitive market, there are many buyers and sellers, each of whom has little or no influence on the market price.

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Summary  The

demand curve shows how the quantity of a good depends upon the price. 





According to the law of demand, as the price of a good falls, the quantity demanded rises. Therefore, the demand curve slopes downward. In addition to price, other determinants of how much consumers want to buy include income, the prices of complements and substitutes, tastes, expectations, and the number of buyers. If one of these factors changes, the demand curve shifts. 56

Summary  The

supply curve shows how the quantity of a good supplied depends upon the price. 





According to the law of supply, as the price of a good rises, the quantity supplied rises. Therefore, the supply curve slopes upward. In addition to price, other determinants of how much producers want to sell include input prices, technology, expectations, and the number of sellers. If one of these factors changes, the supply curve shifts.

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Summary  Market

equilibrium is determined by the intersection of the supply and demand curves.  At the equilibrium price, the quantity demanded equals the quantity supplied.  The behavior of buyers and sellers naturally drives markets toward their equilibrium.

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Summary  To

analyze how any event influences a market, we use the supply-and-demand diagram to examine how the even affects the equilibrium price and quantity.  In market economies, prices are the signals that guide economic decisions and thereby allocate resources.

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Franko’s Viewpoint

Stock Repurchase

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Stock Repurchase  Company

buys back its own shares of

stock  Open market – buys stock in the open market  Tender offer – company privately states a purchase price and a desired number of shares 61

Information Content of Stock Repurchases  



Stock repurchases sends a positive signal that management believes that the current price is low Tender offers send a more positive signal than open market repurchases because the company is stating a specific price The stock price often increases when repurchases are announced

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