Introduction of Economics

Dr Nabila Khurshid
Economics
• Economics is the science that deals with the production and
consumption of goods and services and the distribution and rendering
of these for human welfare.
The following are the economic goals:
• A high level of employment
• Price stability
• Efficiency
• An equitable distribution of income
• Growth
Engineering Economics
• Engineering economy involves formulating, estimating, and
evaluating the expected economic outcomes of alternatives designed
to accomplish a defined purpose. Mathematical techniques simplify
the economic evaluation of alternatives.
• Besides applications to projects in your future jobs, what you learn
from this book and in this course may well offer you an economic
analysis tool for making personal decisions such as car purchases,
house purchases, major purchases on credit, e.g., furniture, appliances,
and electronics.
Engineering Economics
• People make decisions; computers, mathematics, concepts, and guidelines assist people in their
decision-making process. Since most decisions affect what will be done, the time frame of engineering
economy is primarily the future . Therefore, the numbers used in engineering economy are best
estimates of what is expected to occur . The estimates and the decision usually involve four essential
elements:

• Cash flows

• Times of occurrence of cash flows

• Interest rates for time value of money

• Measure of economic worth for selecting an alternative

The Basic Decision-Making Units
• A firm is an organization that transforms resources (inputs)
into products (outputs). Firms are the primary producing
units in a market economy.
• An entrepreneur is a person who organizes, manages, and
assumes the risks of a firm, taking a new idea or a new
product and turning it into a successful business.
• Households are the consuming units in an economy.
The Circular Flow of Economic Activity

• The circular flow of

economic activity
shows the connections
between firms and
households in input and
output markets.
Input Markets and Output Markets
• Output, or product, markets
are the markets in which
goods and services are
exchanged.
• Input markets are the
markets in which resources—
labor, capital, and land—used
to produce products, are
• Payments flow in the opposite
exchanged.
direction as the physical flow of
resources, goods, and services
(counterclockwise).
Circular Flow Diagram
Input Markets
Input markets include:
• The labor market, in which households supply work for
wages to firms that demand labor.
• The capital market, in which households supply their savings,
for interest or for claims to future profits, to firms that demand
funds to buy capital goods.
• The land market, in which households supply land or other
real property in exchange for rent.
Determinants of Household Demand
A household’s decision about the quantity of a particular
output to demand depends on:
• The price of the product in question.
• The income available to the household.
• The household’s amount of accumulated wealth.
• The prices of related products available to the
household.
• The household’s tastes and preferences.
• The household’s expectations about future income,
wealth, and prices.
Quantity Demanded

• Quantity demanded is the amount

(number of units) of a product that a
household would buy in a given time
period if it could buy all it wanted at the
current market price.
Demand in Output Markets
ANNA'S DEMAND
• A demand schedule is a
SCHEDULE FOR table showing how much
TELEPHONE CALLS of a given product a
QUANTITY household would be
PRICE DEMANDED willing to buy at
(PER (CALLS PER
CALL) MONTH)
different prices.
$ 0 30 • Demand curves are
0.50 25
3.50 7
usually derived from
7.00 3 demand schedules.
10.00 1
15.00 0
The Demand Curve
ANNA'S DEMAND
SCHEDULE FOR
• The demand curve is a
TELEPHONE CALLS graph illustrating how
PRICE
QUANTITY
DEMANDED
much of a given product
(PER
CALL)
(CALLS PER
MONTH)
a household would be
$ 0
0.50
30
25
willing to buy at
3.50 7 different prices.
7.00 3
10.00 1
15.00 0
The Law of Demand
• The law of demand states
that there is a negative, or
inverse, relationship
between price and the
quantity of a good
demanded and its price.

• This means that

demand curves slope
downward.
Other Properties of Demand Curves

• Demand curves intersect the quantity (X)-axis, as a

result of time limitations and diminishing marginal
utility.
• Demand curves intersect the (Y)-axis, as a result of
limited incomes and wealth.
Income and Wealth
• Income is the sum of all households' wages, salaries,
profits, interest payments, rents, and other forms of
earnings in a given period of time. It is a flow measure.
• Wealth, or net worth, is the total value of what a
household owns minus what it owes. It is a stock
measure.
Related Goods and Services

• Normal Goods are goods for which demand goes up when income is
higher and for which demand goes down when income is lower.
• Inferior Goods are goods for which demand falls when income rises.
• Substitutes are goods that can serve as replacements for one another;
when the price of one increases, demand for the other goes up. Perfect
substitutes are identical products.
• Complements are goods that “go together”; a decrease in the price of
one results in an increase in demand for the other, and vice versa.
Shift of Demand Versus Movement Along a Demand
Curve
• A change in demand is
not the same as a change
in quantity demanded.
• In this example, a higher
price causes lower
quantity demanded.
• Changes in determinants
of demand, other than
price, cause a change in
demand, or a shift of the
entire demand curve, from
DA to DB.
A Change in Demand Versus a Change in Quantity Demanded

• When demand shifts to

the right, demand
increases. This causes
quantity demanded to be
greater than it was prior to
the shift, for each and
every price level.
A Change in Demand Versus a Change in Quantity Demanded

To summarize:
Change in price of a good or service
leads to

Change in quantity demanded

(Movement along the curve).

Change in income, preferences, or

prices of other goods or services
leads to

Change in demand
(Shift of curve).
The Impact of a Change in Income
• Higher income • Higher income
decreases the demand increases the demand
for an inferior good for a normal good
The Impact of a Change in the Price of
Related Goods
• Demand for complement good
(ketchup) shifts left

• Demand for substitute good (chicken)

shifts right

• Price of hamburger rises

• Quantity of hamburger
demanded falls
 From Household to Market Demand
• Demand for a good or service can be defined for an
individual household, or for a group of households that
make up a market.
• Market demand is the sum of all the quantities of a good
or service demanded per period by all the households
buying in the market for that good or service.
From Household Demand to Market
Demand
• Assuming there are only two households in the market, market
demand is derived as follows:
Supply in Output Markets
CLARENCE BROWN'S • A supply schedule is a table
SUPPLY SCHEDULE showing how much of a product
FOR SOYBEANS
firms will supply at different
QUANTITY
SUPPLIED prices.
PRICE (THOUSANDS
(PER OF BUSHELS • Quantity supplied represents the
BUSHEL) PER YEAR)
$ 2 0 number of units of a product that
1.75 10
2.25 20
a firm would be willing and able to
3.00 30 offer for sale at a particular price
4.00
5.00
45
45
during a given time period.
The Supply Curve and the Supply Schedule

• A supply curve is a graph illustrating how much of a

product a firm will supply at different prices.
CLARENCE BROWN'S 6

Price of soybeans per bushel ($)

SUPPLY SCHEDULE
FOR SOYBEANS 5
QUANTITY
SUPPLIED
4
PRICE (THOUSANDS
(PER OF BUSHELS
3
BUSHEL) PER YEAR) 2
$ 2 0
1.75 10 1
2.25 20
3.00 30 0
4.00 45
5.00 45 0 10 20 30 40 50
Thousands of bushels of soybeans
produced per year
The Law of Supply
Price of soybeans per bushel ($)
6 • The law of supply
5 states that there is a
4 positive relationship
3 between price and
2 quantity of a good
1 supplied.
0
• This means that supply
0 10 20 30 40 50
Thousands of bushels of soybeans curves typically have a
produced per year
positive slope.
 Determinants of Supply
• The price of the good or service.
• The cost of producing the good, which in turn depends on:
• The price of required inputs (labor, capital, and land),
• The technologies that can be used to produce the product,
• The prices of related products.
A Change in Supply Versus a Change in Quantity Supplied

• A change in supply is
not the same as a
change in quantity
supplied.
• In this example, a higher
price causes higher
quantity supplied, and
a move along the
demand curve.
• In this example, changes in determinants of supply, other
than price, cause an increase in supply, or a shift of the
entire supply curve, from SA to SB.
A Change in Supply Versus a Change in Quantity Supplied

• When supply shifts

to the right, supply
increases. This
causes quantity
supplied to be
greater than it was
prior to the shift, for
each and every price
level.
A Change in Supply Versus a Change in Quantity Supplied

To summarize:
Change in price of a good or service
leads to

Change in quantity supplied

(Movement along the curve).

Change in costs, input prices, technology, or prices of

related goods and services
leads to

Change in supply
(Shift of curve).
 From Individual Supply to Market Supply
• The supply of a good or service can be defined for an individual
firm, or for a group of firms that make up a market or an industry.
• Market supply is the sum of all the quantities of a good or service
supplied per period by all the firms selling in the market for that
good or service.
Market Supply
• As with market demand, market supply is the horizontal
summation of individual firms’ supply curves.
Market Equilibrium
• The operation of the market depends on the interaction
between buyers and sellers.
• An equilibrium is the condition that exists when
quantitysupplied, and quantity demanded are equal.
• At equilibrium, there is no tendency for the market price
to change.
Market Equilibrium
• Only in equilibrium is
quantity supplied equal
to quantity demanded.

• At any price level

other than P0, the
wishes of buyers
and sellers do not
coincide.
Market Disequilibria
• Excess demand, or shortage,
is the condition that exists
when quantity demanded
exceeds quantity supplied at
the current price.

• When quantity demanded

exceeds quantity
supplied, price tends to
rise until equilibrium is
restored.
Market Disequilibria
• Excess supply, or surplus, is
the condition that exists
when quantity supplied
exceeds quantity demanded
at the current price.

• When quantity supplied

exceeds quantity
demanded, price tends to
fall until equilibrium is
restored.
Increases in Demand and Supply

• Higher demand leads to higher • Higher supply leads to lower

equilibrium price and higher equilibrium price and higher
equilibrium quantity. equilibrium quantity.
Decreases in Demand and Supply

• Lower demand leads to • Lower supply leads to higher

lower price and lower price and lower quantity
quantity exchanged. exchanged.
Relative Magnitudes of Change

• The relative magnitudes of change in supply and

demand determine the outcome of market equilibrium.
Relative Magnitudes of Change

• When supply and demand both increase, quantity

will increase, but price may go up or down.