Chapter 1: Introduction

Economic and Scarcity

Resources (land, labor, factory buildings, timber, minerals, machinery and the like) are the basis
for producing the food, shelter, medical care, and luxury goods that we want. Some of these are
natural resources (land and timber), some are capital goods resources (factories and machinery)
and some are human resources (labor). These resources are scarce in the sense that there are not
enough of them to produce everything we need and desire. Even when using all resources as
efficiently and completely as possible, and using all modern technology to its fullest extent, there
is some limit to the amount we can currently produce.

Production possibilities shows the maximum amounts of two different goods that can possibly be
produced during any particular time period using society's scarce resources. Because reality is
complex, economists try to simplify it by making assumptions about the basic elements involved
in analyzing an issue. In examining production possibilities, we must make these simplifying
assumptions about our economy

1. All available resources are used fully

2. All available resources are used efficiently
3. The quantity and quality of available resources are not changing during our period of analysis.
4. Technology is not changing during our period of analysis.
5. We can produce only two goods with our available resources and technology

Efficiency means that we use our knowledge and technology to produce the maximum amount of
output with these resources. These first two assumptions mean that our economy is doing the
best that it can it is operating fully and efficiently. Third, the quantity and quality of our
resources are not changing. This means that over the current time period, workers do not begin
new training programs to make them more productive, new natural resources are not discovered,
and so on. We make these last two assumptions to deal with the world as it is right now, and not
how it might become in the future. And finally, to simplify our analysis (and because here we
graph in only two dimensions), we assume that we can produce only two goods with our
resources.

Opportunity cost is the best alternative that is forgone to produce or consume something else.
The opportunity cost of producing roses is not measured in dollars but in the bread that we give
up when we produce these roses. And the opportunity cost of producing bread is the roses we
give up when we produce this bread.

The second economic concept that is illustrated by production possibilities is that of

unemployment. Realize that our alternative combinations of the two products represent possible
quantities. In reality, some resources may go unused: factories are idle and workers are laid off.
Nor do we always use resources in the most efficient manner.
Finally, it is evident that our country need not be restricted to a single production possibilities
curve forever. Economic growth may occur if the quality or quantity of society's resources
increases, or if new technologies are developed so that we can produce more output with our
available resources.

Of course, our country and world are capable of producing more than just two goods. We
produce trucks, spaghetti, gasoline, smart phones, swimming suits, and a bewildering array of
merchandise that fills our shopping centers. We also produce services such as health care,
education, road repair, and cellular phone service. We can easily imagine infinite combinations
of all the goods and services that an economy can potentially produce. We might redefine the
horizontal axis as staple goods and the vertical axis as luxury goods. Or we could divide our
economy's output into agricultural goods and manufactured goods, or consumer goods (goods
that are purchased by consumers) and capital goods (goods such as factory buildings and
machinery that are used to produce other goods). We may examine the choice between military
goods and civilian goods. Or we may look at the production possibilities for private goods (such
as cell phones and hamburgers, which are provided by businesses) and public goods (such as
police and fire protection, which are provided by government).

Economics and Distribution

Although production choices are important, they really tell us only half of the story. At least as
important are choices relating to the distribution of goods and services. The reason there is
hunger in a world of plenty is not a problem of production but of distribution, Poor people and
poor governments lack the income to purchase the food that is produced.

Demand and Supply

1. Demand
 Alternative prices and the quantities that people are willing and able to purchase
at these prices. This is called a demand schedule.
 This simple common-sense idea that people will be willing and able to buy more
of a good or service at low prices than at high prices is a fundamental economic
principle, the law of demand, which is usually stated as follows: price and
quantity demanded are negatively related, all other things equal.
 This means that when price goes up, quantity demanded goes down, and vice
versa.
 A graph of demand is referred to as a demand curve (even though demand curves
are often drawn as straight lines). Connecting points gives us the demand curve.
 The demand curve (labeled D for demand) indicates all possible combinations of
alternative prices and quantity demanded, assuming that all factors except price
that could affect quantity demanded are held constant. The demand curve is
downward sloping, reflecting the law of demand.
2. Supply
  The law of supply, which is usually stated as follows price and quantity supplied
are positively related, all other things equal. This simply means that price and
quantity supplied (the amount offered for sale) change in the same direction.
 If price goes up, so does quantity supplied; price goes down, so does quantity
supplied.
 The supply curve indicates all possible combinations of quantity supplied and
alternative prices with the assumption that all other factors affecting supply are
held constant.
 If the supply curve is upward sloping, reflecting the law of supply price and
quantity supplied increase together. Changes in the costs of producing or
supplying a product are among the most important factors causing a shift in the
supply curve.
3. Putting Demand and Supply Together
 Economists usually refer to this phenomenon as the rationing function of price.
This means that the movement of the price has ultimately rationed away the
shortage. Without the ability of prices to adjust by moving upward, the shortage
would have persisted indefinitely. Socialist countries have often done just that
they have prohibited prices from adjusting upward. As a result, shortages have
been common place.
4. Shifts in the Demand and Supply
 A market for services will remain in equilibrium unless some other factor
affecting the market changes. Because things rarely remain unchanged, it is
important to consider what might happen if the variables affecting either the
demand for or the supply of a services were to change.
 An increase in incomes caused an increase in the demand for a services. The only
thing that we are doing differently now is considering this shift in demand in the
context of demand, supply, and equilibrium.
 Because demand has increased, the market price has increased, and suppliers have
moved up their supply curve and increased the amount that they are willing to
offer for sale (the quantity supplied). The increased demand curve and the
unchanged supply curve have thus caused an increase in both equilibrium price
and equilibrium quantity.
 The opposite phenomenon would have occurred if there had been a decrease in
demand. If incomes had decreased, causing a decrease in demand, the demand
curve would have shifted backward. The new equilibrium point would show that
both price and quantity would have decreased.
5. The Real World.
 All markets have a demand (buyer's) side and a supply (seller's) side. And the
things that affect supply and demand are the commonsense sorts of things.
 Demand curves shift if the number of buyers changes, if consumers taste change
or if the prices of other goods that the consumers regard as substitutes or
complements change.
 Substitute relationships occur when the consumer substitutes one good for the
other good. A classic example of substitutes is butter and margarine.
 Complements are the opposite of substitutes. If the consumer uses more of one
good, he or she will also use more of the other.
 A good example of complementary goods is digital cameras and memory cards. If
the price of digital cameras goes down, all other things constant, more digital
cameras will be purchased. With more digital cameras in the hands of consumers,
there will be a greater demand for memory cards.
 Another example of a situation causing a shift in demand would be an increase in
consumer incomes. While we normally expect an increase in income to cause an
increase in demand, this is not always the case Consider flat screen televisions,
for example.
 A rise in consumer income will most likely cause a decrease in demand for flat
screen televisions (whose price is now fairly low), but an increase in the demand
for three-dimensional TV sets (still quite expensive).
 A final example of a circumstance causing a shift in demand might be an
expectation of the future So if you read in the newspapers that a large increase in
the price of toilet paper is expected next month, you and others may run out to
buy toilet paper today, with the increased current demand actually causing a rise
in its price (a self-fulfilling prophesy that is not uncommon in economics).
 Supply curves shift if the number of sellers changes or if the factors that affect the
producers (sellers) costs change. So, a rise in the energy costs of a manufacturer
will decrease the supply of manufactured goods. If businesses must pay higher
wage rates to produce the same amount of output. the supply of output will
decrease.
 On the other hand, if the price of raw materials goes down, the supply of the
product for which the materials are used will increase. If technology improves,
such that it becomes cheaper and easier to produce a product, supply of the
product will increase.
 If the government taxes the production of a good or service or imposes costly
regulations on the supplier, the supply of output will decrease, if the government
provides subsidies (which lowers costs), however, the supply of the product will
increase.
 Because these examples involve costs of production, we can think of higher costs
of production as squeezing a supplier's profit margin, and thereby reducing
incentives to supply the product. This would ultimately increase the price of the
final product. Lower costs of production would do the opposite.
6. Which comes First
 Which comes first, the price or the quantity? We know that price determines both,
quantity demanded and quantity supplied. Yet demand and supply together
determine the market price of the product. In a market economy, it is the
simultaneous interaction of all prices, quantities, demands, and supplies that
ultimately determines the final market price and the market quantity exchanged.
 And, of course, in the real world, demand and supply may both continually shift
backward and forward, causing prices to continually change as well. Often,
 however, one curve will have a dominant shift in one direction, and this can
explain much of the fluctuation that we see in real-world prices.

Factors that Cause Real World Demand Curves to Shift

1. Changes in the number of consumers who wish to purchase the product.
2. Changes in the Taste of the consumers in the Market.
3. Changes in the prices of complements or substitutes.
4. Changes in consumer’s income
5. Changes in consumer’s expectations about the product’s future price or
availability

Factors that Cause Real World Suppl Curves to Shift

1. Changes in the number of sellers in the Market.
2. Changes in the price of resources used to produce the product.
3. Changes in the Technology used to produce the product.
4. Changes in the prices of other products that could be produces with the same
resources.
5. Changes in government taxes and subsidies.
6. Changes in sellers’ expectations about the product’s future price.

Efficiency and Equity

 Consumer surplus and producer surplus are the basic tools that economists use to study
the welfare of buyers and sellers in a market. These tools can help us address a
fundamental economic question: Is the allocation of resources determined by free
markets desirable?
 Efficiency is the property of a resource allocation of maximizing the total surplus
received by all members of society.
 Equity is a value-laden concept, and the economist cannot say whether a particular
distribution of goods and is fair. But certain results of market activity may not see fair to
some of us.
 The market place is often efficient, but not necessarily equitable.

Market Failures and a glimpse of the Future

1. Public Goods and Services
 Public goods and service have unique characteristics that make it unlikely that the
market will provide enough for them.
 Public goods and services include national defense, public libraries, highway
construction, prime prevention, public education and others.
 Public goods and services are unlikely provided by the market place because they
cannot divide into small segments and offered for sale.
2. Spillovers
  Neither economic efficiency nor equity occurs when spillovers exist.
 Economic spillovers occurs when some cost (or benefits) related to production or
consumption “spillover” onto people not involved in the production or
consumption of goods.
3. Inequity
 Market place is not necessarily equitable.
 Aside from discrimination, poverty and inequality of income distribution are also
uses of equity.
 The inability of low-income people meets their basic needs is unfair. Housing,
health care and social security also raise issues of equity.
4. Market Power
 Competition protects us from unreasonable prices.
 A single supplier and or the price- fixing group possesses market power, which is
the ability of a supplier to influence the market price of the product.
 Many industries consist of just a few dominant producers (examples are the
automobile, steel, and breakfast cereal industries), competition is reduced and
society’s well-being suffers
 Market power arises when a small number of suppliers, whether these are
domestic or foreign producers, will serve to reduce market power. Many people
are unaware of the important contribution of international trade in enhancing
competition and reducing market power.
5. Instability
 The factors that determine whether our nation will be on the production
possibilities curve (Operating full at employment) or below the production
possibilities curve (with unemployed resources) are very volatile.
 At times we may have a very low employment, and at other times we may have
high employment.
 When the average price level rises, we have inflation. Because prices and
employment tend to fluctuate, many say that our market economy is inherently
unstable.

Chapter 2: Overview of Economic Development

How is Development Economist Distinct from other aspects of economics?

 Economic Development concentrates on economies that have low per capita incomes.
 These economies are set apart, for argument’s sake, from the industrial economies of
Europe, North America, Japan and Australia/New Zealand.
 Economic Development considers the experience of the industrial countries as relevant
for analyzing the process of economic growth.
 In asia, there are many poor countries, as well as some that have recently joined the group
of industrialized countries, such as Singapore, Hongkong, Korea and Taiwan.

Measuring Growth and Development

  Economic Development was considered to be synonymous with economic growth-either
total economic growth or economic growth per capita terms. The two concepts of
economic growth and economic development are however not necessarily the same.
 Using a measure of the amount of goods and services produced in an economy in a year,
we can get an idea about the standard living in that economy. When the value of the
goods increases over time, there is economic growth.
 Gross Domestic Product (the total values of production in an economy) or gross national
product (GNP-which is GDP plus net factor income from abroad) is used to deflate it to
per capita terms.
 An improvement in the living standards of the population is a natural consequence idea
about living standards and how they change over time. Comparisons of these figures also
allow is to relate the performances of countries or regions in terms of their growth.

New Approaches to Measuring Economic Development

1. The Human Development Index (HDI)
 The United Nations Development Program (UNDP) developed the HDI in the
late 1980s and has been publishing it since 1990.
 This index has three components: per capita income and two additional
measures-life expectancies at birth and level of educational attainment that
combines adult literacy and educational enrolment rates.
 These are added to per capita income, which is adjusted to reflect the diminishing
marginal use of money, to obtain HDI.
 The HDI developed as a ratio of a particular country to the most developed
country. It varies between zero and one. Both of these indicators are somewhat
related to per capita income.
 However, the HDI can be useful in recognizing that some countries may have
rather low-income levels, but still have achieved a lot of satisfying human needs.
2. Health Life Expectancy
 A measure used by the World Health Organization (WHO) summarizes the
expected number of years to be lived in “full health”. The years of ill-health are
weighted according to severity bd subtracted from overall life expectancy rate to
give the equivalent years of healthy life.
3. Green NP
 One of the more recent approaches developed to address the inherent
shortcomings of GDP and GNP as growth and development measures is based on
what is known as the "green" system of national accounting.
 Green GNP is the informal name given to national income measures that are
adjusted to take into account the depletion of natural resources (both renewable
and non-renewable) and environmental degradation. The types of adjustments
made to standard GNP would include the cost of exploiting a natural resource and
valuing the social cost of pollution emissions.
 Damages to the global environment, such as global warming and depletion of the
ozone layer, should also be deducted, but these damages are hard to estimate.
Others suggest that "defensive" expenditures, those for environ- mental protection
 and compensation for environmental damage, including medical expenses, should
also be deducted. The argument here is that these costs would not have been
incurred if the environment had not been damaged.

Making Comparisons Between Countries

 There are two different methods currently in use for comparing income between countries
using the GDP measure the exchange rate method and the purchasing power parity (PPP)
method.

Exchange Rate Method

 The exchange rate method uses the exchange rate between the local currency and the US
dollar to convert the currency into its U.S. dollar equivalent. A country's GDP and GDP
per capita would then be valued accordingly, in US. dollars.

PPP Method

 The purchasing power parity method develops a cost index for comparable baskets of
consumption goods in the local currency and then compares this with prices in the United
States for the same set of buy the same amount of goods and services that a dollar would
buy in the United States. Because the PPP method uses a basket of many goods and
calculates the relative price of these goods, many economists view this as a better
measure of the relative standards of living than the conventional exchange rate method.
 These two different methods can give widely varying estimates of GDP. In general, the
PPP method gives higher estimates of living standards for developing countries compared
with the exchange rate method.
 The reason is that calculations of GDP based on exchange rate values depend only on the
relative prices of traded goods, whereas the PPP method considers a basket of goods that
include both traded and nontraded goods.
 Nontraded goods are generally much cheaper in developing countries and this helps to lift
the estimate of GDP for these economies. A further advantage of the PPP method is that
it is unaffected by exchange rate changes. As a result of these advantages, the PPP
method has become the preferred measure of GDP for country comparisons. One
difficulty with the PPP method, however, is that it is costly to maintain since price
movements need to be updated on a regular basis.