PRINCIPLES OF MICROECONOMICS

RAYMOND ELIKPLIM KOFINTI (PHD)

SCHOOL OF ECONOMICS
 The Role and Method of
Economics
• Economics: A Brief Introduction
• Economic Behaviour
• Economic Theory
• Pitfalls to Avoid in Scientific Thinking
• Positive Analysis and Normative Analysis
 Economics: A Brief Introduction
You’re thinking about cutting class and going to the beach?
Is the expected marginal benefit greater than the expected marginal
cost?
What if it is expected to be windy and rainy?
What if you have a final next class period, and today is the review?
Do these scenarios affect your decision?
Many issues in our lives are at least partly economic in character:
Why do 10 AM classes fill up faster than 6:30 AM classes during
Lectures?
 Economics: A Brief Introduction
Why is teenage unemployment higher than adult unemployment?
How does inflation impact you and your family?
Why do professional athletes make so much money?
The study of economics improves your understanding of these and
many other concerns.
The economic approach sheds light on many social issues such as
discrimination, education, crime and divorce.
Economics: A Brief Introduction
Newspapers and websites are
filled with articles related to
economics—either directly or
indirectly. News headlines may
cover topics such as
unemployment, deficits, financial
markets, health care, Social
Security, energy issues, war, global
warming, and so on.
 Economics: A Brief Introduction
What is Economics?
The study of the choices we make among our many wants, and
desires given our limited resources.
The study of choices when there is scarcity
The science that is concerned with the efficient use of scarce
resources to achieve the maximum satisfaction of economic
wants.
The study of how humans make decisions in the face of
scarcity. These can be individual decisions, family decisions,
business decisions or societal decisions.
 Economics: A Brief Introduction
What is Economics?
The key word in the definition is choose.
Economics is thus a behavioural, or social, science.
Economics is the study of how people make choices.
 Economic Behaviour-(Self Interest)
Why did you come to lecture today?
Why do people go to work?
Economists assume that most individuals act as if they are
motivated by self-interest and respond in predictable ways
to changing circumstances.
Self-interested simply means that you seek your own
personal gain.
 Economic Behaviour-(Self Interest)
Acc. to Adam Smith: ”It is not from the benevolence
(kindness) of the butcher, the brewer, or the baker that we
expect our dinner, but from their regard to their own
interest.”
To a worker, self-interest means pursuing a higher paying
job and/or better working conditions.
To a consumer, self-interest means gaining a greater level
of satisfaction from their limited income and time.
 Economic Behaviour-(Self Interest)
Human behaviour can be explained and predicted by
assuming that most people act as if they are motivated by
their own self-interest in an effort to increase their expected
personal satisfaction.
There is no question that self-interest is a powerful force
that motivates people to produce goods and services.
Similarly, workers may be pursuing self-interest when they
choose to work harder and longer to increase their saving
for their family.
Question: Is being self-interested greedy? Is it immoral?
 Economic Behaviour-(Rational Behaviour)
Have you ever been accused of being irrational?
Economists assume that people, for the most part, engage
in rational, or purposeful, behaviour.
Rational behaviour is when our actions are predictable,
sensible and logical.
It is when individual or economic agent exercises sensible
choice making, which provides them with the optimum
amount of benefit.
 Economic Behaviour-(Rational Behaviour)
Economic theories typically assume that individuals are
rational beings, working to obtain that which is most
beneficial to themselves.
That is, people may not know with complete certainty
which decisions will yield the most satisfaction and
happiness. But they select the one that they expect to give
them the best results among the alternatives.
 Economic Behaviour-(Rational Behaviour)
NOTE: it is only the person making the choice that
determines its rationality.
You might like red sports cars while your friend might like
black sports cars.
So it would be rational for you to choose a red sports car and
your friend to choose a black sports car.
 Scope of Economics
Microeconomics. The study of the choices made by
households, firms, and governments, and how these choices
affect the markets for goods and services.
It is concerned with the choices of firms on:
What to produce
How to produce
When to produce
How much to charge for what has been produced
 Scope of Economics
Microeconomics is also concerned with how households
make choices about:
What to buy
How much to buy
When to buy etc.
Thus microeconomics is based on how decisions are made
by individuals and firms and the consequences of those
decisions
 Using Microeconomics to Understand Markets and
Predict Changes
One reason for studying microeconomics is to better
understand how markets work and to predict how
various events affect the prices and quantities of
products in markets.

For example, how would a tax on beer affect:

1. The price of beer?
2. How many people buy beer?
3. How many people are likely to drink and drive?
Using Microeconomics to Make Personal and Managerial
Decisions
On the personal level, we use economic analysis to decide
how to spend our time, what career to pursue, and how to
spend and save the money we earn.

Managers use economic analysis to decide how to produce

goods and services, how much to produce, and how much
to charge for them.
 Using Microeconomics to Evaluate Public Policies
We can use economic analysis to determine how well the
government performs its roles in the market economy.
For example, prescription drugs are protected from being
copied because of government patents.
If we shortened patent lengths, we may get cheaper generic
drugs sooner; but fewer drugs may get developed because
of the decreased profitability of drug development.
Microeconomics can help evaluate the best policy here.
 Scope of Economics
Macroeconomics. The branch of economics that examines
the economic behavior of aggregates-income, employment,
output, and so on-on a national scale.
Macroeconomics looks at the economy as a whole.
That how the actions of all the individuals and firms in
the economy interact to produce a particular level of
economic performance as a whole
It examines the factors that determine national output, or
national product.
 Microeconomics Vs. Macroeconomics
Microeconomics looks at the individual unit - the
household, firm and industry.
Macroeconomics looks at the whole, the aggregate.
Microeconomics is concerned with household
income;
Macroeconomics deals with national income.
 Microeconomics Questions
Go to business school or take a job?
What determines the salary offered by GCB to Kofi
Mensah?
What government policies should be adopted to
make it easier for low-income students to attend
colleges of education?
How much money do you have on you?
 Macroeconomics Questions
How many people are employed in the economy as a whole?
What determines the overall salary levels paid to workers in a
given year?
What determines the overall level of prices in the economy as a
whole?
What government policies should be adopted to promote full
employment and growth in the economy as a whole?
What determines the overall trade in goods, services and
financial assets between the Ghana and the rest of the world?
Table 1.1 Examples of Microeconomic and Macroeconomic
Concerns
Division of Production Prices Income Employment
Economics
Microeconomics Production/output in Prices of Distribution of income Employment by individual
individual industries individual goods and wealth businesses and industries
and businesses and services Wages in the auto Jobs in the steel industry
How much steel How Price of medical industry Number of employees in
much office space care Minimum wage a firm
How many cars Price of gasoline Executive salaries Number of accountants
Food prices Poverty
Apartment rents

Macroeconomics National Aggregate price National income Employment and

production/output level Consumer Total wages and unemployment in the
Total industrial output prices Producer salaries economy
Gross domestic product prices Total corporate Total number of jobs
Growth of output Rate of inflation profits Unemployment rate
Q.Which one of the ff is a microeconomic issue?
A.The government spends more
than it receives in tax revenue.

B.House prices rise more rapidly.

C.Unemployment rises.

D.The Bank of England raises

interest rates.

E.Imports exceed exports.

 Why study Economics?
To learn a way of thinking.
Opportunity Cost
Efficient market - No free lunch
Marginalism - cost & benefit analysis
To understand how society works.
To be an informed citizen and gain self-confidence.
To Help Prepare for Other Careers.
To Become an Economist
 Fields of Economics
Behavioural Economics, Health Economics,
Comparative economic systems, International Economics,
Econometrics, Labour Economics,
Development Economics, Public Economics,
Economic History, Monetary Economics,
Environmental Economics, Mathematical Economics,
Financial Economics, Urban and Regional
Natural Resource Economics Economics,
Economics of Sports
 The Principles and Practice of Economics
Economic Agent = Any
group or individual that
makes choices, such as:
consumers,
households
firms,
Governments, etc.
 Method of Economics
Economics deals with two kinds of questions: positive and
normative.
Positive economics. An approach to economics that seeks to
understand behaviour and the operation of systems without
making judgments. It describes what exists and how it works.
Normative economics. An approach to economics that analyzes
outcomes of economic behaviour, evaluates them as good or bad,
and may prescribe courses of action. Also called policy economics.
 Positive and Normative Economics
Economists like Scientists usually seek the truth about how
individuals behave
Economists also make predictions about economic
behaviour and assess the validity of those predictions based
on experiences
Economists also observe patterns of behaviour objectively
with value judgement
 Positive Economics
Positive economics emphasizes how people do behave,
rather than how people should behave.
Economist attempt to observe patterns of behaviour
objectively, without reference to the appropriateness or
inappropriateness of that behaviour.
This objective, value-free approach, based on the scientific
method, is called positive analysis.
 Positive Statements
Positive economic statements are statements that attempt to
describe the world as it is.
That is, descriptive analysis. It describes what exists and
how it works.
It is the use of objective, value-free approach based on
scientific methods.
A positive statement does not have to be a true statement,
but it does have to be a testable statement
 Positive Statements
Examples include:
An increase in the minimum wage will cause a decrease
in employment among the least-skilled.
Higher budget deficits will cause interest rates to
increase.
If carbon emissions were cut by 25%, air quality would
improve and the number of people diagnosed with
asthma would decrease significantly
 Normative Statements
Normative statements are statements about how the world
should be or how the world ought to be.
It looks at the outcomes of economic behaviour and asks
whether they are good or bad and whether they can be made
better.
They are subjective non-testable item about what should be
or what ought to happen.
They can be seen prescriptive analysis - policy economics.
 Normative Statements
Examples include:
The income gains from a higher minimum wage are worth more than
any slight reductions in employment.
Governments should collect from tobacco companies the costs of
treating smoking-related illnesses among the poor.
Should the government subsidize or regulate the cost of higher
education? Should medical benefits to the elderly under Medicare be
available only to those with incomes below some threshold?
To clean up air quality and cut down carbon emissions by 25%, 4x4
vehicles should only be sold to farmers and those living in
rough terrain areas
 Economic Theories and Models
Theories: It is a shorthand way of telling or
explaining a story and making predictions.
Here we use logic, reason and inductions to arrive at
conclusions.
Because of the complexity of human behaviour,
economists must abstract to focus on the most
important components of a particular problem.
 Economic Theories and Models
This is similar to maps that highlight the important
information (and assume away many of the minor
details) to help people get from here to there.
How is economic theory like a map? Much like a road
map, economic theory is more useful when it ignores
details that are not relevant to the questions that are
being investigated.
Economic Theories and Models
 Economic Theories and Models
Models: A model is a formal statement of a theory. It
is usually a mathematical or graphical statement of a
presumed relationship between two or more variables.
We use models to simplify reality in order to improve
our understanding of the world.
Ockham’s razor. The principle that irrelevant detail
should be cut away.
 Economic Theories and Models
An economic model is abstract because it doesn’t attempt
to capture all of the relevant influences on behaviour.
Example of economic model:
𝑸 = 𝒇(𝑷𝒙 , 𝑴, 𝑷𝒚 ) 𝒐𝒓 𝑸 = 𝒂 + 𝒃𝟏 𝑷𝒙 + 𝒃𝟐 𝑴 + 𝒃𝟑 𝑷𝒚
Variables: A measure that can change from time to
time or from observation to observation
Economic variables could be Endogenous or
Exogenous variable.
 Steps in building an Economic Model
Decide on the assumptions to use in developing the model.
Formulate a testable hypothesis
Use economic data to test the hypothesis
Revise the model if it fails to explain the economic data well
Retain the revised model to help answer similar economic
questions in the future.
Economic Theories and Models(Assumptions & simplifications)
Economists use assumptions to make things simpler and focus attention
on what really matters
It simplifies the economic problem that is being analyzed
Every economic model makes two types of assumptions: Simplifying
assumption and critical assumption.
Simplifying assumption is a way of making a model simpler without
affecting any of its important conclusions
A roadmap, for example, makes the simplifying assumption, “There are
no trees.”
Such assumption would not change the important insight we get from
the phenomenon under study
Assumptions and Simplifications
Critical assumption on the other hand is that assumption that
affects conclusions of a model in important ways
Examples of such assumption are those associated with firms’
behaviour
All Else Equal
Ceteris paribus or all else equal is a device used to analyze the
relationship between two variables while the values of other
variables are held unchanged
Using the device of ceteris paribus is one part of the process of
abstractions
 Assumptions and simplifications
All Else Equal cont’d
For example, if the price of tomatoes falls, we would expect
to see more people buy tomatoes.
What if all other things are not equal?
We have to be careful to make the right assumptions and
simplifications.
 Theories and Model Economics
Cautions and Pitfalls
Economists are interested in cause and effect, but sorting out
causality from correlation is not always easy
Post Hoc, Ergo Propter Hoc: Literally, “after this (in time), therefore
because of this.” This is a common error made in thinking about
causation:
If Event A happens before Event B, it is not necessarily true
that A caused B
Empirical Economics refers to the collection and use of data to
test economic theories
 Methods of Studying Economics
Inductive methods: The inductive method which is also
called empirical method derives economic generalisations
on the basis of experience and observations.
In this method detailed data are collected with regard to a
certain economic phenomenon and effort is then made to
arrive at certain generalisations which follow from the
observations collected.
 Methods of Studying Economics
Deductive Method: The deductive method is also called
abstract, analytical and apriori method and represents an
abstract approach to the derivation of economic
generalisations and theories.
The principal steps in the process of deriving economic
generalisations through deductive logic are:
(a) perception of the problem to be enquired into;
 Methods of Studying Economics
(b) defining precisely the technical terms and making
appropriate assumptions, often called postulates or premises;
(c) deducing hypotheses, that is, deriving conclusions from
the premises through the process of logical reasoning; and
(d) testing of hypothesis deduced.
 Theories and Model in Economics
Testing Theories and Models: Empirical Economics
empirical economics: The collection and use of data to test
economic theories.
 Economics in Practice
Does Your Roommate Matter for Your
Grades?
Several studies of the effect of roommates on
university grades help to sort out causality in peer
effects.
One study looked at randomly assigned freshman
roommates in one university to test the peer
effects from different types of roommates.
The author found strong roommate effects on
grade point average, effort in school, and fraternity
membership.
CRITICAL THINKING
1. Would you expect university seniors who choose their own roommates to have more or less
similar grades than college freshmen who are assigned as roommates? Why or why not?
 The Ten Principles of Economics
Principle 1: People face Trade-offs
Principle 2:The Cost of something is what you give-up to
get it
Principle 3: Rational people think at the Margin
Principle 4: People respond to Incentives
Principle 5: Trade can make everyone Better-off
Principle 6: Markets are usually a good way to organize
economic activity
 The Ten Principles of Economics cont’d
Principle 7: Governments can sometimes improve market
outcomes
Principle 8: A country’s standard of living depends on its
ability to produce goods and service
Principle 9: Prices rise when the government prints too
much money
Principle 10: Society faces a short-run trade-off between
inflation and unemployment
52

Categorising the 10 Principles of Economics

How People Make Decisions
1: People Face Trade-offs
2: The Cost of Something Is What You Give Up to Get It
3: Rational People Think at the Margin
4: People Respond to Incentives
53

Categorising the 10 Principles of Economics

How People Interact
5: Trade Can Make Everyone Better Off
6: Markets Are Usually a Good Way to Organize
Economic Activity
7: Governments Can Sometimes Improve Market
Outcomes
54

Categorising the 10 Principles of Economics

How the Economy as a Whole Works

8: A Country’s Standard of Living Depends on Its
Ability to Produce Goods and Services
9: Prices Rise When the Government Prints Too Much
Money
10: Society Faces a Short-Run Trade-off between
Inflation and Unemployment
 Tools of Economic Analysis
These are economic methods and process for economic
analysis.
These tools are mostly used to analyse relationships that are
captured by economic variables.
E.g: when the price of sugar rises, people buy fewer sugar.
This mean there is a relationship between the price of sugar
and amount of sugar bought.
 Tools of Economic Analysis
Economists use tools to represent such relationships.
Does this mean that there is a relationship between the
variable, price and the variable, demand?
Economists will use maths to represent such relationships
and also through graphs.
 Tools of Economic Analysis
Words
Functions 𝐐𝐃 = 𝐟 𝐏 𝐨𝐫 𝐐𝐒 = 𝐟 𝐏 𝐐𝐃 = 𝐟 𝐏, 𝐘, 𝐏𝐘 , 𝐇
𝒇𝟏 < 𝟎
Linear Equations 𝐐𝐃 = 𝛂 + 𝛃𝐏; 𝛃 < 𝟎
Tables
Graphs
Graph of two variables
Graphs of a Single Variable
Tools of Economic Analysis
Q P
0 10
5 9
7 8
9 7
11 6
13 5
15 4
17 3
19 2
21 1
Tools of Economic Analysis
 Tools of Economic Analysis
Economic Growth Rate (Ghana only)
16
14 14.04600263
12
10
9.149799094 9.292511869
8 7.899740293
7.312525021
6 6.399912419
5.900003953
5.59999999
5.199999984
4.499999699 4.346819153 4.845756132
4 4 3.985865624
3.882704469
2
0
2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015
 The Economic Problem
Now we examine some ideas that serve as the basic
foundation of economics.
These basic ideas will occur repeatedly throughout our
study of economics.
Economic agents face scarcity, costly trade-offs and
opportunity cost.
People are rational decision makers and engage in marginal
thinking; and people respond predictably to incentives.
 The Economic Problem
What Will You Do?
Suppose you are offered a part-time job which will pay you GH¢2000.00
every month. However, the nature of the job is such that you will not
be able to learn or do your assignments over the weekend.
Will you choose the part-time job over making good grades in school?
 The Economic Problem
People Face Scarcity and Costly Trade-offs
Individual wants are practically unlimited.
 The Economic Problem
On the other hand resources available to satisfy this wants
are very limited.
This gives rise to the problem of scarcity.
Economics is concerned primarily with scarcity — how well
we satisfy our unlimited wants in a world of limited
resources.
As long as human wants exceed available resources, scarcity
will exist.
 The Economic Problem
Resources refers to inputs or factors of production, used to
produce goods and services.
Inputs and Resources: Anything provided by nature or
previous generations that can be used directly or indirectly
to satisfy human wants.
Categories of inputs: Natural resources, Labour, Physical
capital, Human capital and Entrepreneurial ability.
 The Economic Problem
Resources
Natural Resources: Resources provided by nature and used to
produce goods and services.
Labour: Human effort, including both physical and mental,
used to produce goods and services.
Physical Capital: The stock of equipment, machines,
structures, and infrastructure that is used to produce goods and
services.
 The Economic Problem
Resources Cont’d?
Human Capital: The knowledge and skills acquired by a
worker through education and experience and used to
produce goods and services.
Entrepreneurship: The effort used to coordinate the factors
of production—natural resources, labor, physical capital,
and human capital—to produce and sell products.
 What are Goods and Services?
Goods are tangible & intangible things for which more is preferred
to less of it. Thus, they are items we value or desire to have more of
it.
Services on the other hand are intangible acts for which people are
willing to pay for.
Can we equate the desire of people to have more of a good to
selfishness?
Does everyone face scarcity in life?
Can we ever eliminate scarcity?
 The Three Basic Questions
Every society has some system or process that transforms its scarce
resources into useful goods and services.
In doing so, it must decide what gets produced, how it is produced,
and to whom it is distributed.
The primary resources that must be allocated are land, labor, and
capital.
 Choice and Opportunity Cost
Due to the unlimited nature of our wants, we are always forced to
choose from our numerous wants, things our available resources
can satisfy.
This implies that we always forced to trade off some items for the
other.
Trade-off implies the exchange of one thing to get the another.
The choices sacrificed. It represents what is given up to get what is
wanted?
 Choice and Opportunity Cost
Economic Choice: is deciding between different uses of
scarce resources.
Once you are compelled to make choices, you would be
compelled to leave out some of your wants.
Opportunity Cost: this is the value of the next best
alternative forgone.
Thus , what you give up when you make a choice
Summary of the Economic Problem
Wants Resources

Scarcity
Economic Goods
Choices

Opportunity Cost
 Is there any such thing as free Lunch?
The expression “there’s no such thing as a free lunch”
clarifies the relationship between scarcity and
opportunity cost.
 Application: The Cost of Military Spending
The war in Iraq cost the United States an estimated $1
trillion. Each $100 billion could:
Enroll 13 million preschool children in the Head Start program
for one year.
Hire 1.8 million additional teachers for one year.
Immunize all the children in less-developed countries for the
next 33 years.
The true cost of the war was its opportunity cost: what the United
States sacrificed for it.
 Marginal Thinking
Individual decisions are rarely straight-forward and usually involve
weighing of costs and benefits to achieve maximum results.
Economist emphasize marginal thinking when the focus is on
additional or marginal choices.
Marginal choices involve the effects of adding or subtracting from
the current situation.
Marginal Change: describe small incremental adjustments to an
existing plan of action.
Thinking at the margin can be seen as the basic rule of rational
behaviour.
 Incentives Matter
Individuals always wish to be better off today than they
were yesterday.
As such they respond to changes in incentives.
Economics can therefore be reduced to incentive Marginal
Benefit vs. Marginal Cost.
Both consumers and producers are driven by incentives that
affects their expected cost or benefits.
 Economic System
Because of scarcity, certain economic questions must
be answered regardless of the level of affluence of
the society or its political structure.
The way resources are allocated has a lot to do with
the economic system being operated
 Economic System
Limited Resources Unlimited Wants and Needs
Scarcity

What goods and services will be produced?

How will the goods and services be produced?
Who will get the goods and services produced?

The Choices We Make Will Determine

Command Economy Mixed Economy Market Economy

Command Economics/Socialism
 Command Economies
They rely on central planning.
Decisions about what is produced is largely determined by
a government official or a committee associated with the
central planning organization.
E.g. Cuba, Russia, N. Korea, and China
 Command Economies
Features:
Economic resources are owned by a centrally planned authority or
state ownership.
Central planners guide economic activities and answer the
three key questions of the economic problem.
Adv.
May improve efficiency and fairness in allocation of resources.
Disadv.
a poorly functioning government can destroy incentives, lead to
corruption, and result in the waste of a society’s resources.
 Market economies
It largely relies on a decentralized decision-making
process.
Literally millions of individual producers and
consumers of goods and services determine what
goods will be produced.
E.g. U.S., Canada, Germany, U.K., Japan
 Market economies
Features:
Private ownership of economic resources or factor of
production.
Minimal government intervention.
Economic decisions are based on market conditions or
prices.
Production is operated primarily for profit gains.
 Market economies
It largely rely on a decentralized decision-making process.
Adv.
Raises the standard of living of people by allowing individuals to earn
income and enjoy life.
Profit motives provides an incentive for entrepreneurs to take risks
to organize factor of production.
Profit motives leads to innovations in knowledge and information
which further lead to economic development.
Disadv.
it favours those whose have acquired factors of production and are able to
exploit workers.
it leads to social and economic inequalities.
 Mixed Economies
Most countries, including Ghana, have mixed
economies in which the government and private
sector together determine the allocation of resources.
Combines the features of the two types
 Mixed Economies
Both price mechanism and government intervention in the
market might still lead to inefficiencies.
Market failures: is a situation where the market fails to
allocate the scarce resources to their most efficient use.
Possible causes: Externalities and market power.
Externalities: cost and benefit of one person’s actions on
the well-being of a third party which the decision maker
does not take into account in making the decision.
Market power: is the ability of a single economic agent to
have a substantial influence on market prices or output.
 The Circular Flow Model
A simple economic model illustrating the flow of goods and services
though the economy.
In the model, producers are termed as "firms" while consumers are
referred to as "households."
Firms supply goods and services while households consume these
goods and services.
Factors of production (land, labour, capital) are supplied by the
household to firms and the firms convert these into finished products
for household consumption.
Product markets are the markets for goods and services
Factor or input markets
 Consumption Product Market
Expenditure Household buy
Firms Sell Revenue
Goods and Services
purchased Goods and Services
Supplied
Households
Buy Goods & Services Firms
Supply inputs Supply Goods & Services
Buy inputs
Factors of
Factors of
production Supplied
production
Factor Market purchased
Household Sell
Firms Buy Wages, rent,
Money Income
interest profit
 Efficiency
An efficient economy is one that produces what
people want at the least possible cost. If the system
allocates resources to the production of goods and
services that nobody wants, it is inefficient.
E.g: If all members of a particular society were vegetarians and
somehow half of all that society’s resources were used to
produce meat, the result would be inefficient.
 Efficiency
Inefficiencies: can arise in numerous ways. Sometimes they
are caused by government regulations or tax laws that
distort otherwise sound economic decisions.
A firms that cause environmental damage are not held accountable
for their actions, the incentive to minimize those damages is lost
and the result is inefficient.
 Equity
Equity: has to do with Fairness or equal distribution.
equity (fairness) lies in the eye of the beholder. To many,
fairness implies a more equal distribution of income and
wealth.
Fairness may imply alleviating poverty, but the extent to
which the poor should receive cash benefits from the
government is the subject of enormous disagreement.
The Production Possibilities Frontier/Curve
Scarcity & opportunity cost are unavoidable
A PPF is used to illustrate opportunity cost that an economy
may face in the production of goods and services
Hence, it can be seen as a model of scarcity, choice, &
opportunity cost.
The PPF shows the trade-offs among choices we make.
The Production Possibilities Frontier/Curve
The PPF is a curve showing different combinations of
goods and services that can be produced in a full
employment, where the available supplies of resources and
technology are fixed.
Thus, the PPF represents all the different combinations of
goods and services an economy can produce at maximum
efficiency.
It’s called the PPF because the graph shows the POSSIBLE
outcomes of PRODUCTS, When all productive resources
are fully employed.
The Production Possibilities Frontier/Curve
Only two goods are produced in the economy
There is full employment of resources
Resources are fixed-(scarcity)
Technology is fixed
There exist efficiency (technical efficiency)
 Production Possibility Schedule
A production possibility Schedule lists a choice's
opportunity costs by summarizing what alternative
outputs you can achieve with your inputs.
 Production Possibility Schedule
RICE (TONNES) COCOA (TONNES)
A 0 15
B 1 14
C 2 12
D 3 9
E 4 5
F 5 0
Cocoa Any point
Tradeoff Alongon
thethe
PPF frontier is Productively
Every choice along the PPF involves a tradeoff. On this
A
Efficient.
15 PPF, we must give up some Cocoa to get more rice or
B
It may or may not be Allocatively
give up some rice to get more cocoa.
Efficient
14
C
Any point within the frontier is
12 productively inefficient
D
J By reallocating resources output
9
can be increased without reducing
Q E the production of any of the
5
commodities.
F
0 1 2 3 4 5 Rice
This point is unatainable
Hence the Moving along the PPC indicates how much of one
PPC gives us
an idea of
good must be given up to obtain more of the other.
the Cocoa E.g. from A to B from B to C etc.
opportunity
This occurs because resources in the economy are
cost that
economies 15 A fully utilised and before the production of one good
are faced B can be increased, resources has to be moved from
with when 14 the production of one to the other.
making C
economic 12 OPPORTUNITY COST
decisions As we move down along the PPF, we
D
9 produce more rice, but the quantity of
cocoa we can produce decreases.
Q E The opportunity cost of a bag of rice is
5
the cocoa forgone
F
0 1 2 3 4 5 Rice
 The Production Possibilities Frontier/Curve
The PPC indicates that the opportunity cost that an economy
faces increases along the PPC.
This is because some resources are better suited for the
production of some goods than to the production of other goods.
Why is the PPC not a straight line?
This is because the PPC curve tells us about the increasing
opportunity cost that the an economy is faced with.
Thus the Principle of Increasing Opportunity Cost applies with
the PPC
The principle of increasing opportunity cost
It states that opportunity costs increase the more you
concentrate on an activity. In order to get more of something,
one must give up ever increasing quantities of something
else.
Negative Slope and Opportunity Cost: The slope of the PPF
is negative. Because a society’s choices are limited by
available resources and existing technology, when those
resources are fully and efficiently employed, it can produce
more capital goods only by reducing production of consumer
goods.
 Marginal Rate of Transformation (MRT)
The slope of the PPC at any given point is called the
MRT. It describes numerically the rate at which one
good can be transformed into the other.
It is also called the “marginal opportunity cost” of i.e.
the opportunity cost of rice in terms of cocoa at the
margin.

𝚫𝐢𝐧 𝐠𝐨𝐨𝐝 𝐭𝐡𝐚𝐭 𝐢𝐬 𝐛𝐞𝐢𝐧𝐠 𝐫𝐞𝐝𝐮𝐜𝐞𝐝

𝐎𝐩𝐩𝐨𝐫𝐭𝐮𝐧𝐢𝐭𝐲 𝐂𝐨𝐬𝐭 =
𝚫𝐢𝐧 𝐠𝐨𝐨𝐝 𝐭𝐡𝐚𝐭 𝐢𝐬 𝐛𝐞𝐢𝐧𝐠 𝐢𝐧𝐜𝐫𝐞𝐚𝐬𝐞𝐝
 Economic Growth
An economy can only grow with qualitative or quantitative
changes in the factors of production–land, labour, capital and
entrepreneurship.
Advancements in technology, improvements in labour
productivity or new natural resource finds could all lead to
outward shifts of the production possibilities curve.
Economic growth means an outward shift in the possible
combinations of goods and services produced illustrated by
the production possibilities curve.
With growth comes the possibility to have more of both goods
than were previously available.
 Economic Growth
To generate economic growth, a society must produce
fewer consumption goods and more capital goods in the
present.
They must sacrifice some consumption of consumer goods
in the present in order to experience growth in the future.
Investing in capital goods will increase the future
production capacity of the economy.
So an economy that invests more and consumes less now
will be able to produce and consume more in the future.
 CHINA GHANA

Higher Investment,
Greater Economic Lower Investment, less
Growth Economic Growth

Kg

0 Cg
 It is important to remember that increases in a
Cocoa society's output do not make scarcity disappear.
A’

B’
15 A
B C’
14

12 C
D
D ’
9
Q E E’
5

F F’
0 1 2 3 4 5 Rice
Application 1: Don’t Forget the Costs of Time and Invested
Suppose you go into the
application development
business. It takes you 1,000
hours to develop the
application and requires
using a GH¢30,000 computer
setup for half a year.
What is the true cost of
developing the app?
Application 1: Don’t Forget the Costs of Time and Invested Funds
Value the 1,000 hours at your
hourly wage; perhaps GH¢84 per
hour, hence GH¢84,000.
For the computer setup, you must
devote GH¢30,000 in funds for six
months; at 6 percent interest per
year, this costs GHS¢1,800.
 Technological Change & Growth
Technological advance does not have to impact all
sectors of the economy equally.
There is a technological advance in food production but
not in housing production.
The technological advance in agriculture causes the
production possibilities curve to extend out further on
the horizontal axis which measures food production
Cocoa

A
15
B’
14
B
C’
12 C
D D’
9
Q E E’
5

F F’
Rice
0 1 2 3 4 5
 Growth, Scarcity, Efficiency and Equity.
Does economic growth imply the absence of
scarcity?
What is meant by equity?
What is meant by efficiency?
Q.Which of the ff would shift the PPF outwards?
A. An increase in the population of
working age
B. A reduction in unemployment
C. A reduction in VAT
D. An increase in the general level of
prices
E. A reduction in expenditure on
education
 Economics in Practice
Trade-Offs among the Rich and Poor
In all societies, for all people, resources are
limited relative to people’s demands.
In 1990, the World Bank defined the extremely
poor people of the world as those earning less
than $1 a day.
Even for the poorest consumers, biological need
is not all determining. So even in extremely poor
societies, household choice plays a role.

CRITICAL THINKING
1. Why might we see a greater demand for festivals in poor countries than in rich ones?
How might this be affected by choices available?
Economics and Global Issues
 Economics and global issues
COVID-19 and the global health emergency
effects on individuals
changes in buying patterns
the issue of choice of whether to be vaccinated and effects
on other people
effects on firms
costs, revenues and profit: many made a loss
move to online
 Economics and global issues
COVID-19 and the global health emergency
effects on employment and wages
some were laid-off; others working online
effects on economic growth: a fall in GDP
support by government and effects on borrowing
support by central banks: creating money
 Economics and global issues
The environment and the global climate
emergency
people’s actions affect others: spillover effects
many firms emit CO2 in production
consumers emit CO2 when they use fossil fuels
importance of prices and incentives
use of green taxes and subsidies
carbon trading
 Economics and global issues
The environment and the global climate emergency
the issue of fairness: winners and losers
fairness between individuals, generations and nations
international action to curb emissions and destruction
of carbon sinks
getting international agreements: problem of ‘game playing’
does free trade benefit the environment?
Theory of Demand and Supply
 What is Demand?
Demand is the amount of a good/service that
individuals/consumers are willing and able to
purchase at each possible price during a given period of
time.
The quantity demanded is the amount of a product that
people are willing and able to purchase at one specific
price.
 Components of the Definition
1. Price/quantity relationship-price is the most important
determinant of quantity
2. Ready, Willing and Able-this defines the market
Ready-in the market; Willing-desires the good; Able-has the wherewithal/ability
3. Per unit of time-Time must be specified as it reflects diminishing
marginal utility
4. Other things Constant-A number of things aside from price
effect
5. Downward-Sloping due to diminishing MU (fullness)-This is the
reason why there is an inverse relationship between price and
quantity.
 Demand Schedule
Demand curve:
a curve showing the relation
between the price of a good
and quantity demanded
during a given period, other
things constant.
Suppose we are making pizza.
 Law of Demand
States that a quantity of a good demanded during a
given period relates inversely to its price, other things
constant.
Price increases ➔ Quantity Demanded decreases
Price decreases ➔ Quantity demanded increases
Creates a downward sloping demand curve
 Why the Law of Demand?
Substitution Effect
Unlimited wants/scarce resources
When the price of a good falls, consumers substitute that good
for other goods, which become relatively more expensive.
Reverse also holds true
Income Effect
Money income: is simply the amount of Cedis received per
period
Real income: your income measured in terms of what it can buy.
A fall in the price of a good increases consumers’ real income
making consumers more able to purchase goods; for a normal
good, the quantity demanded increases.
Application 1: Young Smokers and the Law of Demand
As price decreases, the quantity
of cigarettes demanded
increases for two reasons:
People who already smoke, choose
to smoke more; and
Some (mostly young) people
start smoking.
Keeping cigarette prices high,
or increasing them with taxes, is
one way that governments try to
discourage young people from
starting smoking.
 Demand Curve
P

GH₵12
A curve showing the relation
GH₵10
between the price of a good
GH₵7 and the quantity demanded.
GH₵4

GH₵2

0 Q
45 100 130 180 200
Shifts in Demand versus Movements Along a Demand Curve
Demand refers to a schedule of quantities of a good that
will be bought per unit of time at various prices, other
things constant.
Graphically, it refers to the entire demand curve.
Quantity demanded refers to a specific amount that will
be demand per unit of time at a specific price.
Graphically, it refers to a specific point on the demand
curve.
Shifts in Demand versus Movements Along a Demand Curve
A movement along a demand curve is the graphical
representation of the effect of a change in price on the
quantity demanded.
A shift in demand is the graphical representation of the
effect of anything other than price on demand.
Movement along the Demand Curve
Price

B
GH₵6

GH₵5 A

Demand

0
75 100 Quantity
A shift (change) in the demand curve
A graphical representation of the effect of changes in other
determinants of demand rather than changes in a commodity’s
own price. And these factors are
Consumer’s income
Price of other related commodities
Taste and preference of the consumer
Consumers’ expectation of future prices
Season and weather
 Types of Goods Demanded
Complementary goods: Two goods are known as complements
when they are jointly consumed or demanded. With complementary
goods as quantity demand for one increases, quantity demanded for
the other increases as well. A change in the price of one good
affect not only the quantity demanded of that good but also the
quantity demanded of its complement. For example, Car and petrol
are jointly demanded. Also tennis and racket are jointly demanded.
Usually in a demand equation, the coefficient of the prices of
complementary goods carry the same signs.
 Types of Goods Demanded
Substitute goods: Two goods are known as substitute goods if the
two goods satisfy the same or similar needs or desires. With
substitutes goods, as the quantity demanded for one increases,
demand for the other decreases. A rise in the price of one goods
increases quantity demanded of the other because it becomes
relatively cheaper to buy than the other. These goods could be close
substitutes or perfect substitutes. Example, Coca Cola and Pepsi
are substitute goods.
Usually in a demand equation, the coefficient of the prices of
substitutes goods carry different signs.
 Types of Goods Demanded
Normal good refers to any good whose quantity demanded changes
in the same direction with a given change in income. That is, as
income rises, quantity demanded rises and vice versa. Example of a
normal good is ‘good food’. Usually in a demand equation, the
coefficient of the income variable is positive.
Inferior goods refers to goods for which less is demanded as
income rises. They are inversely related to income. Usually in a
demand equation, the coefficient of the income variable is negative
 Types of Goods Demanded
Neutral goods refers to goods whose demand do not change as
income change. Example salt.
Giffen goods refer to goods whose quantity demanded increases as
price increases and vice-versa. Giffen goods have an upward
sloping demand curve.
 Number of Price of Related
Buyers Goods

Determinants of Quality
Income Demand

Expectations about Taste Supply?

the Future
Shifts in Demand vs. Movement Along the Demand Curve

Price

GH₵1

D2
D1
Quantity
75 100
 Market vs Individual Demand
It is the sum of the individual demand for a product from
buyers in the market.
If more buyers enter the market and they have the ability to pay
for items on sale, then market demand at each price level will
rise

15 15 15

10
+ 10
= 10

D2
D1 DM

4 5 2 8 6 13
 Demand Function
The function describes how much of a good will be purchased
at different prices taking into consideration other
determinants of demand.
𝐐𝐝𝐱 = 𝐟(𝐏𝐱 , 𝐏𝐲 , 𝐌, 𝐓, 𝐇)
𝐐𝐝𝐱 = 𝛂𝟎 + 𝛂𝟏 𝐏𝐱 , +𝛂𝟐 𝐏𝐲 , +𝛂𝟑 𝐌, +𝛂𝟒 𝐓, +𝛂𝟓 𝐇
 Demand Function
Example
An economic consultant for Microsoft Corporation recently
provided the firm’s marketing manager with this estimate of
the demand function for the firm’s product:
𝐐𝐝𝐱 = 𝟏𝟐𝟎𝟎 − 𝟑𝐏𝐱 + 𝟒𝐏𝐲 + 𝐌 + 𝟐𝐀 𝐱
Where 𝐐𝐝𝐱 represents the amount consumed of good X, 𝐏𝐱 is the
price of good X, 𝐏𝐲 is the price of good Y, M is income and 𝐀 𝐱
represents the amount of advertising spent on good X.
 Demand Function cont’d
Example cont’d
Suppose good X sells for GH¢20 per unit, good Y sells for GH¢15
per unit, the company utilizes 2,000 units of advertising, and
consumer income is GH¢10,000.
a. How much of good X do consumers purchase?
b. Are goods X and Y substitutes or complements?
c. Is good X a normal or inferior good?
Derived demand Competitive
demand

Types of
Demand

Joint demand Composite Demand

Derived demand Competitive
demand

Types of
Demand

Joint demand Composite Demand

 ECONOMICS IN PRACTICE
Have You Bought This Textbook?
One might think that the total number of textbooks, used plus new,
should match class enrollment. After all, the text is required!
Economists found that the higher the textbook price, the more text sales
fell below class enrollments.
Students found substitutes when textbook prices were high.
CRITICAL THINKING
1. If you were to construct a demand curve for a required text in a course, where would that
demand curve intersect the horizontal axis?
2. In the year before a new edition of a text is published, many college bookstores will not
buy the older edition. Given this fact, what do you think happens to the gap between
enrollments and new plus used book sales in the year before a new edition of a text is
expected?
 ECONOMICS IN PRACTICE
On Sunny Days People Buy Convertibles!
Cars are durable goods that last for a number of years.
But some economists recently found that car purchasers’ choices were heavily
influenced by temporary weather changes at the time of purchase.
An increase of 10 degrees on a fall or spring day over the norm increased
purchase of convertibles by almost 3%.

CRITICAL THINKING
1. Economists predict that my interest in purchasing a convertible also depends
on how much I think other people like convertibles. How is this prediction
related to the durability of cars?
 Supply

Supply is the amount of a good or service which a

seller/supplier is willing to offer for sale at possible
prices during a given period of time holding other
factors constant.
 The Law of Supply
All other things remaining the same, the higher the price of
the good or service, the larger the quantity supplied; the
lower the price of the good or service, the smaller the
quantity supplied.
Price influences the willingness to offer for sale
Increase in price leads to increase in quantity supplied
Decrease in price leads to decrease in quantity supplied.
Creates upward sloping supply curve
 The Law of Supply
Example: Assuming input costs are constant, how
many cups of coffee would you offer to sell per week
if the price is GH¢1? If the price is GH¢4?
 Why Is the Individual Supply Curve Positively Sloped?
A higher price encourages the firm to increase its output by
purchasing more materials and hiring more workers.
Even if the new materials are more expensive, or the new workers are
more costly or less productive, the firm is willing to incur those higher
marginal costs to sell at higher prices.
This is consistent with the marginal principle: increase the level of an
activity as long as its marginal benefit exceeds its marginal cost.
Choose the level at which the marginal benefit equals the marginal
cost.
The price is the marginal benefit; the supply curve shows the firm’s
marginal cost of production.
 Supply Curve & Schedule
Price
Price of Quantity
Good Supply Supply

GH₵3 50 6
GH₵4 75
GH₵5 100 5
GH₵6 150
GH₵7 200 Quantity
 Individual Supply Curve
A curve which shows the Price Supply
various quantities of a
given commodity which an 6
individual producer is
willing to supply at
different prices at given 5
period of time.

Quantity
 Market Supply Curve
It is curve which shows the various quantities of a
commodity which all producers are willing to produce
and sell at different prices at a given period of time.
Price Supply Price Price
Supply Supply

6
6 6

5
5 5

16 25 Quantity 36 55 Quantity
20 30 Quantity
Why Is the Market Supply Curve Positively Sloped?
There are two reasons why the market supply curve is positively
sloped. As the market price increases,
1. Individual firms increase output by purchasing more materials
and hiring more workers; and
2. New firms enter the market, encouraged by the higher price.
As with the individual supply curve, the market supply curve shows
the marginal cost of production, this time for the market as a whole.
 Change in Quantity Supplied
Movement along the supply Price
Supply
curve is caused by changes in
the price of the commodity
when all other factors are held
constant. GH₵6
B

It is also known as change in

quantity supplied. A
GH₵4
That change in quantity
supplied occurs as a result of
change in price holding all other
factors constant. 100 150 Quantity
 Change in Supply
What happens to supply when all other factors are not
constant?
Thus, changes in other determinants of supply other than
price would cause the supply curve to shift.
What are these determinants
Increases in Supply Shift the Supply Curve
What could cause the supply curve to increase (shift to the right)?
Anything other than a price increase that makes firms want to provide
more of the good. Some examples:
A decrease in input costs: If wages or the cost of materials go down, production
becomes more profitable, so firms expand.
Technological advance: New technologies can make production
more profitable and hence encourage expansion.
Government subsidy: A payment from the government will also make
production more profitable also.
Expected future prices falling: A firm that learns prices will fall next
month will try to sell more at current higher prices.
Number of producers: More firms mean more production.
Changes in Supply Shift the Supply Curve Downward and to the Right
 STATE OF PRICE OF
TECHNOLOGY RELATED GOODS

SUPPLY PRODUCER
COST OF INPUTS DETERMINANTS EXPECTATIONS

NUMBER OF GOVERNMENT
PRODUCERS POLICY
 The supply Function
The supply function of a good describes how much of the good
will be produced at alternative prices of the good, alternative
prices of inputs, and alternative values of other variables that
affect supply.
The supply function of a good say X can be written as:
𝐐𝐬𝐱 = 𝐟 𝐏𝐱 , 𝐏𝐫 , 𝐖, 𝐇
Where 𝐏𝐱 is the price of the good, 𝐏𝐫 is the price of
technologically related goods, W is the price of an input and H
is the value of some other variable that affects supply (such as
existing technology, the number of firms in the market, taxes,
or producer expectations).
Market Equilibrium: Bringing Demand and Supply Together
A market is an arrangement that brings buyers and sellers
together. These buyers and sellers jointly determine prices
and quantities traded.
Market equilibrium: A situation in which the quantity
demanded equals the quantity supplied at the prevailing
market price.
When a market is in equilibrium, there is no pressure on
the price to change.
 Market Equilibrium
At specific price where:
Quantity demanded = Quantity supplied
Equilibrium price –
market clearing price
Equilibrium quantity –
𝑸𝑫 = 𝑸𝑺
The price in a competitive market is determined by the
interactions of all buyers and sellers in the market.
 Market Equilibrium
At specific price where: P

Quantity demanded S

Equals
Quantity Supplied GH₵5 Equilibrium

Q
150
(The Walrasian Price Adjustment)
P

D S
Surplus

PH
Pe
PL

Shortage
S D
Q0 Qe Q2 Q
 (The Marshallian Quantity Adjustment)
Under the Marshallian adjustment, a difference between what
consumers are willing to pay and what producers require to cover
at least their cost of production sets up incentives for economic
agents to alter output levels
 Since P1 (what the consumer is willing to
pay) exceeds their MC, they are willing to
supply more, hence supply increases
P
D S
P1
PS 1

Pe Since P2 (what the consumer is willing to

pay) is less than their MC, they would not
P2 be willing to supply more, hence supply
reduces
Ps2
S D

Q1 Qe Q2 Q
 (Is there a Unique Equilibrium)
A unique equilibrium exist when there is just one single
equilibrium position.
Such equilibrium is said to be stable when it can only at one
point.
i.e. when in disequilibrium, forces tend to move price and
quantity back towards equilibrium
Veblen effect – this implies that the high price is the reason for
buying it for the status it confers on the purchaser
W S
D PRICE
We2
P2 D
E2

We1
P1 E1
S
D
D 0
Q1 Q2 QUANTITY
Le2 Le1 L
EFFECTS OF CHANGES IN DEMAND AND SUPPLY ON EQUILIBRIUM
Shift in Demand Curve Shift in Supply Curve
P D1 S
P S1
D S
D

P1
P0
P0
P1
D1
S D S D
Q0 Q1 Q2 Q S1
Q0 Q1 Q2 Q
 SIMULTANEOUS INCREASE IN BOTH DEMAND AND SUPPLY

P D1 P S
D1 S1
D S D
S1

P0 P0
P1

D1 D1
S D S D
Q0 Q1 Q Q0 Q1 Q
SIMULTANEOUS INCREASE IN BOTH DEMAND
AND SUPPLY
D1
P S
S1
D

P1
P0

D1

S S1 D
Q0 Q1 Q
Increase In Demand But A Decrease In Supply
S1
S1 S
P P D1
D1
D S D
P1
P1

P0 P0

D1 D1
S D S D
Q0 Q Q1 Q0 Q
Increase In Demand But A Decrease In Supply
D1 S1
P
D S

P1

P0

D1
S D
Q0 Q 1 Q
 Equilibrium using Algebra
𝑮𝒊𝒗𝒆𝒏 𝒕𝒉𝒆 𝒅𝒆𝒎𝒂𝒏𝒅 𝒇𝒖𝒏𝒄𝒕𝒊𝒐𝒏 𝒐𝒇 𝒕𝒉𝒆 𝒇𝒐𝒓𝒎
𝑸𝒅 = 𝒂 − 𝒃𝑷
And the supply function given as
𝑸𝒔 = −𝒄 + 𝒅𝑷
Determine equilibrium price and quantity
Solution
Set the equilibrium condition
In equilibrium 𝑸𝒅 = 𝑸𝒔 = 𝑸
𝒂 − 𝒃𝑷 = −𝒄 + 𝒅𝑷
Grouping like terms
Equilibrium using Algebra
Solution cont’d
Grouping like terms 𝒂 + 𝒄 = 𝒃𝑷 + 𝒅𝑷
Factor out the P so that we obtain
𝒂 + 𝒄 = (𝒃 + 𝒅)𝑷 and then divide both sides by b + d
Which leads us to
𝒂+𝒄
𝑷= − 𝑬𝒒𝒖𝒊𝒍𝒊𝒃𝒓𝒊𝒖𝒎 𝒑𝒓𝒊𝒄𝒆
𝒃+𝒅
To determine the equilibrium quantity, put the equilibrium price
into either the demand or supply function
 Equilibrium using Algebra
Solution cont’d
Substituting the equilibrium price into the demand function, we obtain;
𝒂+𝒄
𝑸=𝒂−𝒃
𝒃+𝒅
𝒂𝒃 − 𝒃𝒄 𝒂 𝒃 + 𝒅 − 𝒂𝒃 − 𝒃𝒄 𝒂𝒃 + 𝒂𝒅 − 𝒂𝒃 − 𝒃𝒄 𝒂𝒅 − 𝒃𝒄
=𝒂− = = =
𝒃+𝒅 𝒃+𝒅 𝒃+𝒅 𝒃+𝒅
Therefore, the equilibrium quantity is given by

𝒂𝒅 − 𝒃𝒄
𝑸= − −𝑬𝒒𝒖𝒊𝒍𝒊𝒃𝒓𝒊𝒖𝒎 𝒒𝒖𝒂𝒏𝒕𝒊𝒕𝒚
𝒃+𝒅
 Market Equilibrium
Using Algebra to Find the Equilibrium
D and S Curves: 𝑸𝒅 = 𝟏𝟔𝟎– 𝟒𝟎𝒑 and 𝑸𝒔 = 𝟓𝟎 + 𝟏𝟓𝒑
We want to find the p at which Qd = Qs = Q, the
equilibrium quantity.
In equilibrium, it must be that Qs = Qd.
In Equilibrium, 𝟏𝟔𝟎 – 𝟒𝟎𝒑 = 𝟓𝟎 + 𝟏𝟓𝒑
We can obtain the same result if we use the D curve.
 Market Equilibrium
Using Algebra to Find the Equilibrium
We use algebra to find the equilibrium price:
𝟓𝟓𝒑 = 𝟏𝟏𝟎, so 𝒑 ∗ = 𝑮𝑯𝑺𝟐
We can determine the equilibrium q by substituting this
p into either Qd or Qs.
Using the S Curve: 𝑸 ∗= 𝟓𝟎 + (𝟏𝟓 × 𝟐) = 𝟖𝟎
We find that the equilibrium quantity is 80 million lbs per
month.
ELASTICITIES
 Elasticities
If a rock band increases the price it charges for
concert tickets, what impact will that have on
ticket sales?
More precisely, will ticket sales fall a little or a
lot?
Will the band make more money by lowering the
price or by raising the price?
 Elasticities
The law of demand establishes that quantity
demanded changes inversely with changes in price,
ceteris paribus.
But how much does quantity demanded change?
This is very important to understand for many
economic issues.
This is what the price elasticity of demand is
designed to answer.
 Elasticities
Think of price elasticity like an elastic rubber band.
When small price changes greatly affect, or “stretch,”
quantity demanded, the demand is elastic, much like
a very stretchy rubber band.
When large price changes can’t “stretch” demand,
however, then demand is inelastic, more like a very
stiff rubber band.
 Elasticities
The price elasticity of demand measures how responsive quantity
demanded is to a price change.
The price elasticity of demand is defined as the percentage change
in quantity demanded divided by the percentage change in price.
∆𝑸
𝐏𝐞𝐫𝐜𝐞𝐧𝐭𝐚𝐠𝐞 𝐜𝐡𝐚𝐧𝐠𝐞 𝐢𝐧 𝐪𝐮𝐚𝐧𝐭𝐢𝐭𝐲 𝐝𝐞𝐦𝐚𝐧𝐝𝐞𝐝 𝑸
𝐏𝐄𝐃 = =
𝐏𝐞𝐫𝐜𝐞𝐧𝐭𝐚𝐠𝐞 𝐜𝐡𝐚𝐧𝐠𝐞 𝐢𝐧 𝐩𝐫𝐢𝐜𝐞 ∆𝑷
∆𝑸 ∆𝑷 ∆𝑸 𝑷 𝚫𝐐 𝐏 𝑷
= ÷ = × 𝐨𝐫 𝐏𝐄𝐃 = ×
𝑸 𝑷 𝑸 ∆𝑷 𝚫𝐏 𝐐
 Elasticities
Good A Original New % Change Elasticity

Quantity 100 95 -5% -5%/10% = -0.5%

Price 1 1.10 -10%

Good B

Quantity 200 140 -30% -30%/20%=-1.5%

Price 5 6 20%
 Elasticities
Inelastic demand when 𝐞𝐩 <
𝟏
Fairly elastic when 𝐞𝐩 > 𝟏
Unitary elastic demand when
𝐞𝐩 = 𝟏
Perfectly inelastic demand
when 𝐞𝐩 = 𝟎
Infinitely elastic demand
when 𝐞𝐩 = ∞
Graphical Illustration of Point Elasticity of Demand

A
P1
𝜟𝑷
P2 B
C
𝜟𝑸

0 Q1 Q2 D’ Q
 𝚫𝐏 = 𝐂𝐀; 𝚫𝐐 = 𝐂𝐁, ; 𝐏 = 𝐐𝟏 𝐀; 𝐐 = 𝟎𝐐𝟏

𝚫𝐐 𝐏
𝐛𝐮𝐭 𝐞𝐩 = ×
𝚫𝐏 𝐐
𝐂𝐁 𝐐𝟏 𝐀
⇒ 𝐞𝐩 = ×
𝐂𝐀 𝟎𝐐𝟏
𝐂𝐁
The first term in the equation = reciprocal of the
𝐂𝐀
slope of the straight line –DD’
𝐂𝐁
Straight line has a constant slope, hence the value of is
𝐂𝐀
the same at any point on the demand curve
Graphical Illustration of Point Elasticity of Demand

𝐐𝟏 𝐀
The second term - thus the price-quantity ratio-are
𝟎𝐐𝟏
𝟎
coordinates of poi (l intercept (D’)- =𝟎
𝟎𝐃′
Thus the numerical value of the price-quantity ratios varies
from infinity to zero. The value of 𝐞𝐩 thus depends on the
point on the demand curve
P 𝒆𝒑 = ∞

𝒆𝒑 > 𝟏

𝒆𝒑 = 𝟏

𝒆𝒑 < 𝟏

𝒆𝒑 =0
0 Q
 𝐏
Illustration

1. Compute the price elasticity of

𝑨 demand from point A to B
𝟏𝟎𝟎 2. Compute the price elasticity of
∆𝐏
demand from point B to A

𝟕𝟎 𝑩
∆𝑸
𝑫

𝟎 𝟏, 𝟓𝟎𝟎 𝟐, 𝟏𝟎𝟎 𝑸
 Illustration
Solution
1. Price elasticity of demand from point A to B
∆𝑸 𝑷 𝟐, 𝟏𝟎𝟎 − 𝟏, 𝟓𝟎𝟎 𝟏𝟎𝟎 𝟔𝟎𝟎 𝟏 𝟔𝟎𝟎
𝜺𝑨→𝑩 = × = × = × =
∆𝑷 𝑸 𝟕𝟎 − 𝟏𝟎𝟎 𝟏. 𝟓𝟎𝟎 −𝟑𝟎 𝟏𝟓 −𝟒𝟓𝟎
= −𝟏. 𝟑𝟑
2. Price elasticity of demand from point B to A
∆𝑸 𝑷 𝟏, 𝟓𝟎𝟎 − 𝟐, 𝟏𝟎𝟎 𝟕𝟎
𝜺𝑩→𝑨 = × = × = −𝟎. 𝟔𝟕
∆𝑷 𝑸 𝟏𝟎𝟎 − 𝟕𝟎 𝟐, 𝟏𝟎𝟎
 ARC Elasticity
Used when price changes are relatively high.
𝐏𝟏 + 𝐏𝟐 ൗ
𝚫𝐐 𝟐
𝐞𝐩(𝐚𝐫𝐜) = ×
𝚫𝐏 𝐐𝟏 + 𝐐𝟐 ൗ
𝟐
𝚫𝐐 𝐏𝟏 +𝐏𝟐 𝟐
𝐞𝐩(𝐚𝐫𝐜) = × ×
𝚫𝐏 𝟐 𝐐𝟏 +𝐐𝟐
𝚫𝐐 𝐏𝟏 +𝐏𝟐
𝐞𝐩(𝐚𝐫𝐜) = ×
𝚫𝐏 𝐐𝟏 +𝐐𝟐
The arc elasticity measures the average price elasticity
 Further Illustration
𝟏
1. Suppose the 𝜺 = 𝒂𝒏𝒅 𝑸 = 𝟐𝟓 𝒖𝒏𝒊𝒕𝒔. What will be the change
𝟒
in quantity as a result of 20% fall in price of the commodity?
2. Suppose 𝜺 = 𝟒, what is the change in price that will cause a 10%
fall in quantity demanded?
 Further Illustration
𝟏
1. Suppose the 𝜺 = 𝒂𝒏𝒅 𝑸 = 𝟐𝟓 𝒖𝒏𝒊𝒕𝒔. What will be the change
𝟒
in quantity as a result of 20% fall in price of the commodity?
Solution
𝑿 𝟏
1. Let X = % change in Q, then by definition =
𝟐𝟎% 𝟒
Multiplying both sides by 20%, we obtain
𝟏
𝑿 = 𝟐𝟎% = 𝟓%
𝟒
Thus approximately, the change in Q is 5% of 25 = 1.25units
 Further Illustration
2. Suppose 𝜺 = 𝟒, what is the change in price that will cause a 10%
fall in quantity demanded?
Solution
𝟏𝟎%
2. Let X = % change in P, then by definition =𝟒
𝑿
Multiplying both sides by X, we obtain
𝟏𝟎% = 𝟒𝑿
𝟏𝟎%
Thus 𝑿 = = 𝟐. 𝟓%
𝟒
The price must rise by 2.5% in order to induce a 10% fall in Q.
 Demand And Total Revenue
Once the market demand for various goods and services are known,
it becomes quite easy to estimate the revenue that firms are likely to
obtain.
This is because total consumer spending is equivalent to total
business receipts or revenue from sales.
Total consumer spending TCS:
𝐓𝐂𝐒 = 𝐏 × 𝐐 = 𝐓𝐑
If the market demand is linear the total-revenue curve will be a
curve which initially slopes upwards, reaches a maximum and then
starts declining.
 Price Elasticity and Total Revenue
The total revenue can be computed by multiplying price by
the corresponding quantity.
E.g 𝐓𝐑𝟏 = 𝐏𝟏 ∗ 𝟎𝐐𝟏 The Marginal revenue is of particular
interest in this analysis.
Marginal Revenue is the change in TR that occurs as a
result of selling an additional unit of the commodity.
The slope of the TR curve gives us the MR
TR

𝑻𝑹
P 𝒆𝒑 = ∞
D

P2 A 𝒆𝒑 > 𝟏
P1 B 𝒆𝒑 = 𝟏
P3 C 𝒆𝒑 < 𝟏
D’ 𝒆𝒑 =0
Q2 Q1 Q3 Q
𝑴𝑹
 Price Elasticity and Total Revenue
Elastic Demand: E d > 1.0
If price … Total revenue Because the percentage change in quantity is …
…
  Larger than the percentage change in price.
  Larger than the percentage change in price.

Inelastic Demand: E d < 1.0

If price … Total revenue Because the percentage change in quantity is …
…
  Smaller than the percentage change in price.
  Smaller than the percentage change in price.
Using Elasticity to Predict the Revenue Effects of Price Changes
1. Market versus Brand Elasticity:
The demand for a specific brand of a product is more elastic than the
demand for the product.
Raising the price of all coffees would increase coffee revenue; but raising
the price of one brand would decrease revenue for that brand.

2. Bus Fares and Deficits:

Public bus systems almost always run a deficit.
But demand is typically inelastic.
If fares were raised, the “good news” (more revenue per rider) would
dominate the “bad news” (fewer riders), so total fare revenue would
increase, potentially eliminating the deficit.
Using Elasticity to Predict the Revenue Effects of Price Changes
3. A Bumper Crop is Bad News for Farmers:
An unusually large crop of soy beans increases the number of bushels of soy beans for
sale (good news).
But the price decreases, because of the increased supply (bad news).
But demand is inelastic, so the bad news dominates the good news: a bumper crop
results in lower overall revenues.

4. Antidrug Policies and Property Crime:

Antidrug policies raise the price of drugs. But demand for drugs is inelastic, so total
spending on drugs increases.
This increases property crime, as drug addicts commit crime to obtain money for drugs.
 Marginal Revenue and Price Elasticity
𝐓𝐑 = 𝐏𝐐
𝐛𝐮𝐭 𝐏 = 𝐟 𝐐
hence 𝐓𝐑 = 𝐏𝐐 = 𝐟 𝐐 𝐐
To get the MR, we differentiate TR using the Product Rule
𝐝𝐓𝐑 𝐝𝐐 𝐝𝐏
=𝐏 +𝐐
𝐝𝐐 𝐝𝐐 𝐝𝐐
𝐝𝐏
𝐌𝐑 = 𝐏 + 𝐐
𝐝𝐐
𝐝𝐐 𝐏
𝐛𝐮𝐭 𝐞𝐩 = − ×
𝐝𝐏 𝐐
 Marginal Revenue and Price Elasticity
𝐐
Multiply both sides by −
𝐏
𝐐 𝐝𝐐 𝐏 𝐐
− 𝐞𝐩 = − × ×−
𝐏 𝐝𝐏 𝐐 𝐏
𝐐 𝐝𝐐
− 𝐞𝐩 =
𝐏 𝐝𝐏
𝐏 𝐝𝐏
Rearranging − =
𝐞𝐩 𝐐 𝐝𝐐
𝐝𝐏
Substituting into MR
𝐝𝐐
 Marginal Revenue and Price Elasticity
𝐝𝐏
𝐌𝐑 = 𝐏 + 𝐐
𝐝𝐐
𝐏
=𝐏−𝐐
𝐞𝐩 𝐐
The two Qs will cancel out
𝐏
𝐌𝐑 = 𝐏 −
𝐞𝐩

𝟏
𝐌𝐑 = 𝐏 𝟏 −
𝐞𝐩
 Marginal Revenue and Price Elasticity
We noted that when the demand curve is falling the TR
curve initially rises, reaches a maximum and then starts
declining.
Thus
If 𝐞𝐩 > 𝟏 ⇒ the total revenue curve has a positive slope-
thus is still increasing and has not reached maximum point
𝟏
𝑷 > 𝟎 𝒂𝒏𝒅 𝟏 − > 𝟎 ⇒ 𝑴𝑹 > 𝟎
𝒆𝒑
 Marginal Revenue and Price Elasticity

If 𝐞𝐩 = 𝟏 ⇒ the TR curve reaches maximum level,

because at this point the slope of MR=0
𝟏
𝑷 > 𝟎 𝐚𝐧𝐝 𝟏 − = 𝟎 ⇒ 𝐌𝐑 = 𝟎
𝐞𝐩

If 𝐞𝐩 < 𝟏 ⇒ the TR curve has a negative slope

𝟏
𝐏 > 𝟎 𝐚𝐧𝐝 𝟏 − < 𝟎 ⇒ 𝐌𝐑 < 𝟎
𝐞𝐩
 Determinants of Elasticity
Elastic Inelastic

LUXURY GOODS NECESSITY

Long Term Short Term

Substitutes No Substitutes

Possibility of Postponement
of Purchase

Income Levels
Application : Drones and the Lower Half of a Linear Demand Curve
Suppose a firm that produces
hobby drones (for civilian use)
has a linear demand curve for its
product, with a vertical intercept
of GH¢800. The firm currently
charges a price of GH¢300.
Should the firm raise its price?
Application : Drones and the Lower Half of a Linear Demand Curve
Solution
Should the firm raise its price?
Yes!
1. The price is below the
midpoint of the linear demand
curve, so raising price would
increase revenue.
2. It would need to make fewer
drones, so its costs would fall.
 CROSS ELASTICITY
Measures the extent to which Changes in the price of one
commodity is affects the quantity demanded of another commodity
𝚫𝐐𝐱 𝐏𝐘
𝐄𝐱𝐲 = ×
𝚫𝐏𝐘 𝐐𝐗
The co-efficient of 𝐄𝐱𝐲 could either be positive or negative
depending on the type of commodity
If the two commodities in question are substitute it would be
positive
If the two commodities in question are complements it would be
negative
 CROSS ELASTICITY
The co-efficient of Exy could either be positive or
negative or zero depending on the nature of the
relationship between the goods
Substitute goods: Exy > 0.
Complementary goods: Exy < 0.
No relationship Exy = 0.
 Practice What You Know
Economists have studied that when the price of chicken increases,
people purchase less rice. With these two goods, which of the
following is true?
A. EC < 0, chicken and rice are complements.
B. EC > 0, chicken and rice are complements.
C. EC < 0, chicken and rice are substitutes.
D. EC > 0, chicken and rice are substitutes.
 INCOME ELASTICITY
The income elasticity of demand is a measure of the relationship
between a relative change in income and the consequent relative
change in quantity demanded, ceteris paribus.
Thus, measures the responsiveness of quantity demanded to
changes in income
𝚫𝐐 𝐌
𝛄= ×
𝚫𝐌 𝐐
 INCOME ELASTICITY
If the income elasticity is positive, then the good in
question is a normal good because the change in
income and the change in quantity demanded move
in the same direction.
If the income elasticity is negative, then the good in
question in an inferior good because the change in
income and the change in quantity demanded move
in opposite directions.
 Practice What You Know
State whether you think the following goods are inferior, necessity,
or luxury goods:
•steak •laptop computers
•toothpaste •lawn-care service
•fast food •milk
•pedicures •gasoline
•new vehicles •cigarettes
•used vehicles •lottery tickets
 Practice What You Know
Suppose that Kofi receives a pay increase at work, and his income
increases by 20 percent. As a result, Kofi decides to buy 12 percent
less ground beef. For Kofi, ground beef is a(n) ________________.
A. luxury good
B. necessity good
C. normal good
D. inferior good
 Price Elasticity of Supply
Producers also respond to changes in price.

Price elasticity of supply:

Measures the responsiveness of the quantity
supplied to a change in price.
Determinants of the Price Elasticity of Supply
Flexibility of producers:
More production flexibility implies firms are more able to
respond to changes in price.

A firm will have more production flexibility if it is able to:

have spare capacity
maintain inventory
relocate easily.
Determinants of the Price Elasticity of Supply
Time and adjustment process:
Immediate run:
Suppliers are stuck with what they
have on hand; no adjustment.

Short run, long run:

Over time, the firm is able to adjust to
market conditions.
Supply becomes more elastic.
Supply Elasticity over Time
 Calculating the Price Elasticity of Supply
This ratio will be positive.
Law of supply:
Positive relationship between price and quantity supplied.

% change in quantity supplied

price elasticity of supply = ES =
% change in price

%QS
ES =
%P
 Combining Supply and Demand
We’ve previously drawn shifts in demand and supply, and
studied the changes in equilibrium price and quantity.
How will the magnitude of the price and quantity changes
be affected if we alter the demand or supply elasticity?
Increase in Demand for Oil from China
 Consumer surplus
What is it?
Willingness to pay: the maximum amount that a
buyer will pay for a good.
It measures how much the buyer values the good or
service.
The difference between what you paid, and what you
were willing and able to pay.
 Consumer surplus
Buyer Willingness to Pay
James GH₵100
Jerry GH₵80
Winifred GH₵70
Gifty GH₵50
 Consumer surplus
Buyers Price Quantity
Demanded
More than GH₵100 More than GH₵100 None

James GH₵81 to GH₵100 1

Jerry GH₵71 to GH₵80 2

Winifred GH₵51 to GH₵70 3
James , Jerry , Winifred, Gifty GH₵50 to less 4
Price of
Album

100 James’ willingness to pay

Jerry’s willingness to pay

80
70 Winifred‘’s willingness to pay

50 Gifty’s willingness to pay

Demand

0 1 2 3 4 Quantity of
Albums
Price of
Album
(a) Price = GH₵80
100
James’ consumer surplus (20)

80

70

50

Demand

0 1 2 3 4 Quantity of
Albums
 (b) Price = 70
Price of
Album
100
James’ consumer surplus (20)

80
Jerry’s consumer
70 surplus (10)
Total
50 consumer
surplus ($40)

Demand

0 1 2 3 4 Quantity of
Albums
Using Demand Curve to Measure Consumer Surplus
The market demand curve depicts the various
quantities that buyers would be willing and able to
purchase at different prices.
The area below the demand curve and above the
price measures the consumer surplus in the market
 The formula for consumer surplus is given by:
P
P A
0
𝟏
𝐂𝐒 = × 𝐛𝐚𝐬𝐞 × 𝐡𝐞𝐢𝐠𝐡𝐭
𝟐
First In this case
Surplu 𝟏
P1
s
Surplus for B 𝐂𝐒 = × (𝟎 − 𝐐𝟐 ) × (𝐏𝟎 − 𝐏𝟐 )
new 𝟐∗
Additional
ConsumersSurplus 𝐐
P2
𝐂𝐒 = න 𝐟 𝐐 𝐝𝐐 − 𝐏 ∗ 𝐐∗
D 𝟎
0 Q1 Q2 Q
 Producer Surplus
What is it?
The amount a seller is paid, minus the seller’s cost.
It measures the benefit to sellers participating in a market.
Cost: the value of everything a seller must give up to
produce a good.
 The Cost of Four Possible Sellers?

Seller Cost
Akpors GH₵900
Akpordoos GH₵800
Kakporgbo GH₵600
Gbokataa GH₵500
Using Supply Curve to Measure Producer Surplus
Just as consumer surplus is related to the demand curve,
producer surplus is closely related to the supply curve.
Sellers Price Quantity
Supplied
Akpors, Akpordoos, GH₵900 or More 4
Gbokataa, Gbokataa
Akpordoos GH₵800 to GH₵900 3
Kakporgbo GH₵600 to GH₵800 2
Gbokataa GH₵500 to GH₵600 1
None GH₵500 to less 0
 P
Supply

Akpors’ cost
900

Akpordoos’ cost
800

600 Kakporgbo’s cost

500 Gbokataa’s cost

Q
1 2 3 4
Using Supply Curve to Measure Producer Surplus
The area below the price and above the supply curve
measures the producer surplus in a market.
900 Total Producer surplus

800

600 Kakporgbo’s producer surplus

500 Gbokataa’s producer surplus

1 2 3 4
 How a Higher Price Raises Producer Surplus
As price rises, producer surplus increases for two reasons:
Those already selling the product will receive additional
producer surplus because they are receiving more for the
product than before
Since the price is now higher, some new sellers will enter the
market and receive producer surplus on these additional units
of output sold
 (b) Producer Surplus at Price P
Price
Additional producer Supply
surplus to initial
producers

D E
P2 F

P1 B
Initial surplus C
Producer surplus
to new producers

A
0 Q1 Q2 Quantity
The formula for Producer surplus is given by:

𝟏
= × 𝐛𝐚𝐬𝐞 × 𝐡𝐞𝐢𝐠𝐡𝐭
𝟐
In this case
𝟏
P𝐒 = × (𝟎 − 𝐐𝟐 ) × (𝐏𝟎 − 𝐏𝟐 )
𝟐
∗
𝐐

𝐏𝐒 = 𝐏 ∗ 𝐐∗ − න 𝐟 𝐐 𝐝𝐐
𝟎
THE INFLUENCE OF GOVERNMENT
POLICIES ON MARKET OUTCOMES
 Big Questions
1. When do price ceilings matter?
2. What effects do price ceilings have on economic
activity?
3. When do price floors matter?
4. What effects do price floors have on economic
activity?
 Price Controls
Price Ceiling Price Floor
Legally set maximum price Legally set minimum price
Rent control apartment, Minimum wage
price gouging
Three situations:
Three situations: Nonbinding
Nonbinding Binding
Binding Long-run effects
Long-run effects
The Influence of Government Policies on Market Outcomes
Price controls are legal restrictions on how high or low a
market price may go.
Attempt to set, or manipulate, prices through government
regulations in the market.
2 kinds of price controls:
Price Ceilings: a maximum price sellers are allowed to
charge for a good. It’s an upper limit for the price.
Price Floors: a minimum price buyers are required to pay
for a good. Its a lower limit for the price.
THE INFLUENCE OF GOVERNMENT POLICIES ON MARKET
OUTCOMES
Why Price controls?
During crisis times, emergencies or wars the government
wants to protect the consumers from rapidly increasing
prices.
If the equilibrium wage given by supply and demand for
low skilled workers is below poverty level, the government
can set a minimum wage
THE INFLUENCE OF GOVERNMENT POLICIES ON
MARKET OUTCOMES
▪ Equilibrium ▪ Price ceiling
Price Price
S
S
D D

4 4

3 3
Price
2 Ceiling
2
Shortage

100 200 Quantity 100 200 800 Quantity

of of
icecreams icecreams
THE INFLUENCE OF GOVERNMENT POLICIES ON MARKET
OUTCOMES
Because of these ceilings, we are faced with a shortage.
The shortage will lead to inefficiencies:
A market or an economy is inefficient if there are missed
opportunities:
some people could be made better off without making
other people worse off.
THE INFLUENCE OF GOVERNMENT POLICIES ON MARKET
OUTCOMES
Inefficient Allocation to Consumers
Wasted Resources
Inefficiently Low Quality
Black Markets
 Price Controls: Price Ceilings
Inefficient Allocation to Consumers
People who really want the good and are willing
to pay a high price don’t get it, and those who
are not so interested in the good and are only
willing to pay a low price do get it.
Example: rent control. In such case people get
the apartment usually through luck or personal
connections.
Lost Producer and Consumer Surplus due to a price ceiling
Price
S
PF

Pe

PC Ceiling
Shortage
D
0 Qs Qe Quantity
Qd
 Price controls: Price ceilings
Wasted Resources
People spend money, time and expend effort in
order to deal with the shortages caused by the
price ceiling.
You waste a lot of time looking for a good in case
of shortage, the time has it’s value! You can work
or just rest, do something better than look for a
good you’ can’t find.
 Price controls: Price ceilings
Inefficiently Low Quality
Price ceilings often lead to inefficiency in that
the goods being offered are of inefficiently low
quality
In case of rent controls, the landlords will not
improve the conditions of the apartments, there
is no incentive since the rental fee is low but the
main reason is that since there is a shortage,
people are willing to rent the apartment as it is,
even in bad condition!
 Price controls: price ceilings
Black Markets
A black market is a market in which goods or
services are bought and sold illegally—either
because it is illegal to sell them at all or because
the prices charged are legally prohibited by a
price ceiling.
If someone for example bribes (gives extra
money) to the apartment owners he will get the
apartment, but the honest people that don’t
break the law will never find one this way!
Demonstration on the Computation of Full Economic Price
Ghana recently accelerated its plan to privatize tens of thousands
of state-owned firms. The estimates of the market demand and
supply for the goods are given by
𝑸𝒅 = 𝟏𝟎 − 𝟐𝑷
𝑸𝒔 = −𝟐 + 𝟐𝑷
Determine the equilibrium price and quantity.
The government raises a concern that the free market price might
be too high for the consumers and is planning to set a price ceiling
of GH¢1.5.
Demonstration on the Computation of Full Economic Price

Determine
(a) the quantity demanded,
(b) the quantity supplied,
(c) the amount of shortage and
(d) the full economic price paid by the consumers if a price
ceiling of GH¢1.50 is imposed in the market
Solution
𝑸𝒅 = 𝟏𝟎 − 𝟐𝑷, 𝑸𝒔 = −𝟐 + 𝟐𝑷
𝑰𝒏 𝒆𝒒𝒖𝒊𝒍𝒊𝒃𝒓𝒊𝒖𝒎, 𝑸𝒅 = 𝑸𝒔 = 𝑸
𝟏𝟎 − 𝟐𝑷 = −𝟐 + 𝟐𝑷
𝟏𝟎 + 𝟐 = 𝟐𝑷 + 𝟐𝒑
𝟏𝟐 = 𝟒𝑷
Therefore, 𝑷 = 𝟑
To determine the equilibrium quantity, we substitute the value of P
into either the demand or supply function, either way the solution
will be the same.
Therefore, 𝑸 = 𝟏𝟎 − 𝟐 𝟑 = 𝟒
Solution
𝑸𝒅 = 𝟏𝟎 − 𝟐𝑷, 𝑸𝒔 = −𝟐 + 𝟐𝑷
a. Placing the ceiling price into both the demand and supply
functions, we obtain
𝑸𝒅 = 𝟏𝟎 − 𝟐 𝟏. 𝟓 = 𝟕
b.
𝑸𝒔 = −𝟐 + 𝟐 𝟏. 𝟓 = 𝟏
c. The amount of shortage will be given by
𝑺𝒉𝒐𝒓𝒕𝒂𝒈𝒆 = 𝑸𝒅 − 𝑸𝒔 ⟹ 𝟕 − 𝟏 = 𝟔
𝑭 𝑭 𝑭 𝟗
d. 𝟏 = 𝟏𝟎 − 𝟐𝑷 ⟹ 𝟐𝑷 = 𝟏𝟎 − 𝟏 ⟹ 𝑷 = = 𝑮𝑯𝑺𝟒. 𝟓𝟎
𝟐
 Practice What You Know
Supply and demand generally become more elastic in the long run.
This means that shortages caused by price ceilings
_________________ in the long run.
A. disappear completely
B. become smaller
C. become larger
D. become infinitely large
 Price Controls: Price Floor

Price Floors: a minimum price buyers are required

to pay for a good. Its a lower limit for the price.

The minimum wage is a legal floor on the wage rate,

which is the market price of labor.
 Price controls: Price floors
Equilibrium Price floor

S S
D Surplus
Price Price D
Price floor
4 4
3
3

2 2

100 200 Quantity 600

100 200 Quantity
of of
icecreams icecreams
 Impact of a Price Floor
Price Surplus S
PF Price Floor
The shaded area is the
cost of purchasing the
P*
surplus to the
government

Qd Q* QS Quantity
Demonstration of Cost of Purchasing the Surplus
Based on the analysis in problem above, the government worries
that the free market price might be too high for the producers to
earn a fair rate of return and is planning to set a price floor of
GH¢4.
Determine (a) the quantity demanded, (b) the quantity supplied,
and (c) the amount of surplus if a price floor of GH¢4 is imposed
in the market. (d) What is the cost to the Ghanaian government of
buying the surplus under the price floor?
Solution
𝑸𝒅 = 𝟏𝟎 − 𝟐𝑷, 𝑸𝒔 = −𝟐 + 𝟐𝑷
With the price floor, we substitute the floor value into both the
demand and supply functions, so that
a. 𝑸𝒅 = 𝟏𝟎 − 𝟐 𝟒 = 𝟐
b. 𝑸𝒔 = −𝟐 + 𝟐 𝟒 = 𝟔
c. 𝑺𝒖𝒓𝒑𝒍𝒖𝒔 = 𝑸𝒔 − 𝑸𝒅 ⟹ 𝟔 − 𝟐 = 𝟒
d. Cost of purchasing the surplus= 𝑷𝒓𝒊𝒄𝒆 𝒇𝒍𝒐𝒐𝒓 × 𝑺𝒖𝒓𝒑𝒍𝒖𝒔 ⟹
𝑮𝑯𝑺𝟒 × 𝟒 = 𝑮𝑯𝑺𝟏𝟔
 Price controls: Price floors
Why a Price Floor Causes Inefficiency
Inefficient Allocation of Sales Among Sellers
Price floors lead to inefficient allocation of sales among
sellers: those who would be willing to sell the good at the
lowest price are not always those who actually manage to
sell it.
Wasted Resources
Like a price ceiling, a price floor generates inefficiency by
wasting resources.
 Minimum Wage
Minimum wage:
The lowest hourly wage rate that firms may legally pay
their workers

Rationale for minimum wage:

Provide a “living wage.”
Help the working poor who are often unskilled.
Provides skills, experience.
The Taxation System and The
Costs of Taxation
The Welfare Impacts of Tax
The Welfare Effects of Taxes & Subsidies
When economists use the term welfare effects
of a government policy, they are referring to
the gains and losses associated with
government intervention.
 Using Consumer and Producer Surplus
to Find the Welfare Effects of a Tax
The tax is illustrated by the vertical distance
between the supply and demand curve at the
new after-tax output—shown as the bold
vertical line in the Figure below
 Using Consumer and Producer Surplus
to Find the Welfare Effects of a Tax
P ST

PT
A
B E
P1
C F
PS
D
D
Q
QT Q1
 Before Tax After Change
Tax
Consumer 𝐀+𝐁+𝐄 𝐀 𝐀 − (𝐀 + 𝐁 + 𝐄)
Surplus = −𝐁 − 𝐄
Producer 𝐂+𝐃+𝐅 𝐃 𝐃 − (𝐂 + 𝐃 + 𝐅)
Surplus = −𝐃 − 𝐅
Tax 0 𝐁+𝐂 B+C
Revenue
Total 𝐀+𝐁+𝐄+𝐂+𝐃+𝐅 𝐀+𝐁 (𝐀 + 𝐁 + 𝐂 + 𝐃)
Welfare + 𝐂 + 𝐃 − (𝐀 + 𝐁 + 𝐄 + 𝐂
+ 𝐃 + 𝐅) = − −𝐄 − 𝐅
Elasticity and the Size of the Deadweight Loss
The size of the deadweight loss from a tax, as
well as how the burdens are shared between
buyers and sellers, depends on the price
elasticities of supply and demand.
The less elastic the curves are, the smaller the
deadweight loss.
P ST

S
PT

P1

PS

Q
QT Q1
P
ST
S

PT

P1

PS
D

Q
QT Q1
Elasticity and the Size of the Deadweight Loss
Elasticity differences can help us understand tax
policy.
Those goods that are heavily taxed often have a
relatively inelastic demand curve in the short run.
This means that the burden falls mainly on the
buyer.
It also means that the deadweight loss to society is
smaller than if the demand curve was more
elastic.
 The Welfare Effects of Subsidies
If taxes cause deadweight or welfare losses, do
subsidies create welfare gains?
Think of a subsidy as a negative tax.
 The Welfare Effects of Subsidies
If taxes cause deadweight or welfare losses, do
subsidies create welfare gains?
Think of a subsidy as a negative tax.
We see that the subsidy lowers the price to the
buyer and increases the quantity exchanged.
P

S
A S1
Ps
B H
Pe G
Pd C E F
D

D
Qe Q1 Q
 With No Subsidy With Subsidy Impact of
Subsidy

Consumer A+B A+B+C+E+F C+E+F

Surplus
Producer C+D B+H+C+D B+H
Surplus
Impact on gov’t Zero -B-H-C-E-F-G -B-H-C-E-F-G
Budget

Net Benefits A+B+C+D A+B+C+D-G -G

Deadweight Loss Zero J

CONSUMER CHOICE THEORY
 Consumer Behaviour
The theory of consumer choice examines how consumers make
decisions when they face trade trade-offs and also how they
respond to changes in their environment.
Consumers are surrounded by a great variety of goods they may
want but their ability to have whatever bundle of these goods is
dependent on their financial resources.
With the limited financial resources, consumers would have to
choose the kind of good among the many alternatives that will
bring them the most satisfaction.
 Consumer Behaviour
Utility is an abstract and a fundamental measure used in studying
consumer behaviour and consumers’ preferences among a wide
variety of goods and services.
It refers to the satisfaction derived from the consumption of a
certain quantity of a product.
The utility a consumer derives from consuming a good determines
their willingness to pay for that good.
 Consumer Behaviour
Utility is introspective and subjective. It may differ from consumer
to consumer
Utility is quite distinct from ‘satisfaction’
Utility implies the potentiality of a good to satisfy the consumer whereas
satisfaction is actual realization.
Utility induces the consumer to purchase a good whereas satisfaction is
the end result from consuming a good.
Satisfaction, sometimes, may be more or less than the expected
satisfaction (utility) a consumer may perceive to derive from consuming a
good.
 Consumer Behaviour
Measurement of Utility

There are basically two approaches to measuring consumers’ utility

The Cardinalist’ approach

The Ordinalist’s approach
 Consumer Behaviour
The Cardinalist's Approach

The cardinal measurement of utility was propounded by Alfred Marshall

and his followers, known as the cardinalists.
According to the cardinalists, the utility of a commodity can be quantified
and thus measured numerically.
For example, the utility derived from consuming a ball of Kenkey can be
measured, say 50 utils.
Assumption of the Cardinal Utility Theory
Rationality of consumers: The cardinalists assume that consumers
aim at maximizing their utility subject to the constraint imposed by
their income
Cardinal utility: The cardinalists believe that utility can be
measured. The unit of measurement is utils. Also, they assume that
the amount a consumer is willing to pay for a good reflects the
utility the consumer derives.
Assumption of the Cardinal Utility Theory
Constant marginal utility of money: This implies that the
satisfaction obtained from spending more money (income ) is
constant. Therefore marginal utility obtained from spending an
additional cedi is constant.
Diminishing marginal utility: This assumption implies that the
utility derived from consuming successive units of a commodity
diminishes as the consumer consumes larger quantity of the
commodity.
The total utility a consumer derives depends on the quantity of
goods he/she consumers
Cardinal Utility Concepts
Total Utility (TU): It is the total satisfaction enjoyed from
consuming any given quantity of a good
Mathematically, it can be expressed as the summation of the
marginal utility derived from consuming each unit of the good to
the last quantity consumed
TU= σ 𝑴𝑼 or 𝐓𝐔 = ‫ 𝒙𝒅𝑼𝑴 ׬‬or 𝐓𝐔 = 𝑨𝑼 ∗ 𝑸
Cardinal Utility Concepts
Marginal Utility (MU): Refers to the extra satisfaction derived from
consuming additional units of a good
Mathematically, it is the change in the utility

𝒅𝑻𝑼 𝑻𝑼𝒙 −𝑻𝑼𝒙−𝟏

𝑴𝑼 = OR 𝑴𝑿 =
𝒅𝑸 𝑸𝒙 −𝑸𝒙−𝟏
 Cardinal Utility Concepts
Average Utiltiy (AU): It refers to utility a consumer derives per unit
of the good consumed
Mathematically, It is measured as

𝑻𝑼
𝐴𝑼 =
𝑸
The relationship between TU,AU and MU (Utility Schedule )

Quantity Total Utility Average Utility Marginal Utility

1 80 80 80
2 120 60 40
3 150 50 30
4 170 42.5 20
5 180 36 10
6 180 30 0
7 170 24.29 -10
8 150 18.75 -20
Relationship between TU, AU and MU
From the table, the following can be observed.
At the first unit, the TU, MU, and AU derived from consuming the
good are equal.
After the first unit, TU increases but at a decreasing rate up to the
5th quantity. Within the same range of quantity consumed, MU and
AU also decrease but both are still positive (greater than zero)
Form the 5th to the 6th quantity consumed TU remains constant at
180 utils and the MU obtained from consuming the additional unit
is zero.
 Relationship between TU, AU and MU
The point where TU is constant and MU is zero is known as the
point of satiety.
At the point of satiety, utility is maximized, marginal utility is zero
and any further consumption will yield a negative marginal utility.
Beyond the point of Satiety (after the 6th unit consumed), TU
declines and MU is negative. The negative MU implies negative
satisfaction or disutility to the consumer. AU keeps decreasing but
does not become zero.
Relationship between TU, AU and MU
The Law of Diminishing Marginal Utility
The law states that all else equal, as an individual consumes more
and more of a good the additional satisfaction derived falls.
Assumptions
Homogeneity of the good
Continuity
Reasonability
Constancy
Rationality
The Law of Diminishing Marginal Utility
Criticisms of the Law
The numerical measurement of utility does not hold
The law is based on unrealistic assumptions. The assumption of
constancy, homogeneity, continuity, and rationality are very difficult to
come to paly in everyday living.
The law is not applicable to bulky or indivisible goods like electronic
appliances whose purchases are a one time thing.
Marginal utility of money is not constant
The Law of Diminishing Marginal Utility
Exception to the Law
Alcoholics
Reading
Music and poetry
 Importance of the Law of Diminishing Marginal Utility
Theoretically, the law is important for the following reasons:
It helps explain the behaviour and equilibrium condition of rational
consumers.
It forms the basis or foundation for many various laws of
consumption in economics including the law of demand.
It helps to explain the paradox of value
Helps in justifying progressive taxation as means to redistribute
income
 Equilibrium Condition Under the Cardinalist’s Approach
Single Commodity Case (Good X)
At equilibrium
𝑴𝑼𝒙 = 𝝀𝑷𝒙
Where 𝑴𝑼𝒙 is the marginal Utility, 𝝀 is the marginal utility of
income 𝑷𝒙 is the price of good X. This implies that a consumer
consumes more of a good to the point where the marginal utility
derived from consuming the good is equal to the utility he/she
derives from spending the last cedi on the last unit of the good
Equilibrium Condition Under the Cardinalist’s Approach
Single commodity Case (Good X)

𝑴𝑼𝒙
𝛌= , Thus the utility derived from spending the last cedi should
𝑷𝒙
be equal to the proportion of the MU obtained from the price of the
good.
 Equilibrium Condition under the behavior
Single Commodity Case (Good X)
Graphical representation
P,MU

E
𝜆𝑃𝑥

𝑀𝑈𝑥
0 Qty
Xe
 Equilibrium Condition Under the cardinalist’s Approach

Single Commodity Case (Good X)

The consumer will be in equilibrium at the point where
𝑴𝑼𝒙 = 𝝀𝑷𝑿 .
The corresponding quantity consumed is Xe
 Equilibrium Condition Under the cardinalist’s Approach
Single Commodity Case (Good X)
Effect of a price a change on the equilibrium
P,MU

𝑒1
𝜆𝑃3
𝑒0
𝜆𝑃𝑥
𝑒2
𝜆𝑃2
𝑀𝑈𝑥
0 X1 X X2
 Equilibrium Condition Under the cardinalist’s Approach
Single Commodity Case (Good X)
Effect of a price a change on the equilibrium
From the diagram the consumer is in equilibrium at point e where
𝑴𝑼𝒙 = 𝝀𝑷𝒙
Assuming price of good X increases from 𝑷𝒙 to 𝑷𝒙𝟏 , then the
consumer can no longer be in a state of equilibrium at point e
because 𝑴𝑼𝒙 < 𝝀𝑷𝒙 . To restore equilibrium, the consumer has to
consume less of good X (Less than X units which is X1).
 Equilibrium Condition Under the cardinalist’s Approach
Single Commodity Case (Good X)
Effect of a price a change on the equilibrium.
Per the law of diminishing marginal utility, the more units
consumed, the lesser the MU and the less units consumed, then
higher the MU. Therefore the consumer will derive a higher MU
from consuming less units. Equilibrium will be restored at point e1.
Assuming price falls to P2
There will be disequilibrium (𝑴𝑼𝒙 < 𝝀𝑷𝒙 ). For equilibrium to be
restored, the consumer has to consume more units of good X
 Equilibrium Condition under the Cardinalist's Approach
Single Commodity Case (Good X)
Effect of a price a change on the equilibrium
Quantity consumed increases to X2. As more unit good X is being
consumed, the MU derived falls (per the law of diminishing
marginal utility) and equilibrium is restored at point e2.
 Derivation of the Demand Curve under the Cardinalist's
Approach
The analysis used to explain the effect of a price change on the
equilibrium condition is used to derive the demand curve.
P,MU

𝑒1
𝜆𝑃3
𝑒0
𝜆𝑃𝑥
𝑒2
𝜆𝑃2
𝑀𝑈𝑥
0 X1 X X2
 Equi-marginal Utility
In reality, household consume multiple goods concomitantly.
𝑴𝑼𝒙
The equilibrium condition for the single commodity case (𝛌 = )
𝑷𝒙
does not hold
The principles of equi-marginal utility is then adopted to explain
how consumers maximize the utility they derive from consuming
each good given their income constraints and prices of the
commodities in question.
 Equi-marginal Utility
The principles or law of equi-marginal utility states that consumers
will distribute their income among the goods in such a way that the
marginal utility derived from the last cedi spent on each good is
equal
Mathematically
𝑴𝑼𝒙 𝑴𝑼𝒚 𝑴𝑼𝒛
= =……. , Where X to Z are different commodities
𝑷𝒙 𝑷𝒚 𝑷𝒛
consumed. For the sake of easy analysis the principle will be
restricted to two goods X and Y
 Example, Px=4 Py=3, Income = GHS 34
Quantity

1 22 27 5.5 9
2 20 24 5 8
3 18 21 4.5 7
4 16 18 4 6
5 14 15 3.5 5
6 12 12 3 4
7 10 9 2.5 3
 Given the equilibrium condition as
𝑴𝑼𝒙 𝑴𝑼𝒚
= , the consumer has three alternative bundles to choose
𝑷𝒙 𝑷𝒚
from two goods. Nonetheless, the consumer is constrained by
his/her income and the price of the two of goods. The consumer
can only consume less or equal to his/her budget
The budget constraint of the consumer is given by
PxX+PyY=Income
Cont’
Alternative 1
The consumer can consume 2 units of good X and 5 units of good Y.
The total expenditure will be 4(2)+3(5)=GHS23.00
GHS23.00<GHS34.00
The consumer’s expenditure is lesser than his/her income
Alternative 2
The consumer can consume 4 units of good X and 6 units of good Y.
The total expenditure will 4(4)+3(6)=GHS34
GHS=34.00=34.00, consumer’s expenditure equal to his/her income
Cont’
Alternative 3
The consumer can consume 6 units of good x and 7 units of good
y. The total expenditure will be 4(6)+3(7)=GHS45
GHS45>GHS34.00
Hence expenditure larger than income
Conclusion
Given the equilibrium condition and the budget constraints of the
consumer, this consumer will choose alternative 3. Thus s/he wull
consume 4 units of good x and 6 units of good y. This bundle gives
the consumer the maximum utility give his/her budget constraint
Cont’
Why not Option 1 or 3
The consumer does not choose alternative 1 although it meets the
two conditions because the consumer is rational. S/he has the
objective of maximizing his/her utility. The surplus (money left)
can be used to buy more of each good which will give the
consumer a higher utility than what s/he derives from consuming
the bundles in alternative 1.
The consumer does not choose alternative 3 although it give the
consumer the highest level of satisfaction. This is because the
consumer is constrained by their income and so cannot buy the
bundle of goods offered in alternative 3
 Marginal Utility and the Elasticity of Demand
If, as the quantity consumed of a good increase, marginal utility
decreases quickly, the demand for the good is inelastic.
If, as the quantity consumed of a good increases, MU decreases
slowly, the demand for that good is elastic.
Example Px=4 and Py=4.5, Income =GHS34.00
Quantity

1 22 27 5.5 6
2 20 24 5 5.33
3 18 21 4.5 4.6
4 16 18 4 4
5 14 15 3.5 3.33
6 12 12 3 2.67
7 10 9 2.5 2
 THE FIRM

THEORY OF PRODUCTION AND COSTS

 Firms and Profits
Explicit costs refers to the cost incurred when an actual (monetary)
payment is made. Explicit costs require an outlay of money by the firm.
Example include money spent on raw materials and wages paid to
labour.
Implicit cost represent the value of resources used in for which no
actual (monetary) payment is made. They do not require the outlay of
money by the firm. Example include transport cost, money spent on
airtime for calls, use of owner’s residence as administrative office,
opportunity cost of using one’s skills in the running of the firm.
There are two types of profits, accounting profits and economic profits.
 Firms and Profits
Accounting profit refers to the difference between total revenue and
total explicit cost.
Economic profit refers to the difference between a firm’s total revenue
and their total cost (both implicit and explicit costs).
A firm’s accounting profit will always be higher than or equal to (never
lower than) its economic profit.
Economists emphasize economic profit in calculating the profits of
firms
Economic profit is an important concept because it motivates the firms
that supply goods and services to keep producing.
It is the main determining factor affecting firms’ decision to stay or
leave services or leave the market.
 Firms and Profits
Economists emphasize economic profit in calculating the profits of
firms.
This is because, it is the main determining factor affecting firms’
decision to stay or leave the market.
A firm making a positive economic profit will stay in business. It is
covering all its opportunity costs and has some revenue.
A firm making a zero economic profit will stay in the market. The
firm may be earning a positive accounting profit or the firm is able
to cover all its opportunity cost given its revenue.
A firm making a negative economic profit will either exit the
market or change its production processes.
 Firms and Profits
Production refers to the transformation of resources or resources
into final goods and services.
The theory of production describes the relationship between inputs
and outputs.
Output refers to the quantity or amount of goods or services a firm
is able to produce using available inputs or factors of production
over a period of time.
Inputs (factors of production) encompass land, labour, capital,
technology and raw materials used in the production process.
 Firms and Profits
These inputs are broadly grouped into two categories
Fixed Inputs are inputs or factors of production which cannot
be increased or decreased in the short-run. They cannot be
manipulated easily in attempt to increase or decrease output. Eg
Land
Variable inputs are resources or factors of production which
can be changed in the short-run by firms as they seek to change the
quantity of output produced. Eg Labor
The relationship between inputs and outputs can using a production
function 𝑸 = 𝒇(𝑳, 𝑵, 𝑻)
 Theory of Production
Economists often distinguish between two time periods – the short
run and the long run.
These are not fixed time periods instead, they are defined in terms
of a firms’ ability to vary the various factors of production.
The short run period refers to the period of time when it is possible
to vary the inputs of some factors of production but impossible to
vary the input of at least one of the factors. Thus it exists when
there is at least one fixed factor of production. Any of the factors of
production can be fixed in the short run.
 Theory of Production
Long run Period(LRP) refers to the time period where firms are
required to bring about a change in input of all the factors of
production. Thus no fixed factors of production exist in the long
run
Definition of concepts- Single Variable Case Model
Total Product(TP) refers to total output resulting from the
employment of all factors of production. Mathematically, it can be
𝑻𝑷 = σ 𝑴𝑷 or 𝑻𝑷𝒙 = ‫ 𝒙𝒅 𝑷𝑴 ׬‬or 𝑻𝑷 = 𝑨𝑷 ∗ 𝑸
 Theory of Production
Average Product refers to the output per unit of factor input
employed. Mathematically represented as

𝑻𝑷
𝑨𝑷 = ,
𝑳
Marginal Product refers to the change in output that arises from an
additional unit of input employed

𝒅𝑻𝑷 𝑻𝑷𝑿 −𝑻𝑷𝒙−𝟏

M𝑷 = , or 𝑴𝑷𝑿 =
𝒅𝑳 𝑳𝒙 −𝑳𝒙−𝟏
 Production In The Short Run
Table : Relationship between TP, AP and MP

Units of Labour Total Product Average Product Marginal Product

0 0 - -
1 80 80 80
2 170 85 90
3 270 90 100
4 368 92 98
5 430 86 62
6 480 80 50
7 504 72 24
8 504 63 0
9 495 55 -9
10 480 48 -15
Production In The Short Run
 Production In The Short Run
Stages in Production (Returns to Scale)
A few of the assumptions include
The firm is in the short run
At least there is a fixed output (land)
Technique of production does not change
Stage 1: Increasing Returns to Scale
This evident in the early stages of production.
Production increases at an increasing rate
As successive units of a variable factor are combined with a fixed factor both
marginal product and average product will rise.
However total product will rise more in proportion than an increase in inputs.
 Production In The Short Run
From the table or graph, increasing returns to scale occurs from the first unit of
labour employed to the third labour employed. In this region, marginal product
increases and peaks at 100 units, average products also increases.
The firm does not stop employing more units of variable inputs . Rather, the
firm is encouraged to continue employing more units of
Stage 2:
After stage 1, any additional input employed adds little to production.
At this stage of production, output increases at a diminishing rate till it reaches
maximum
Marginal product and average product starts to fall at this stage. This is as a result of
the law of diminishing marginal returns to scale.
Stage 3:
At this stage output begins to decline rapidly.
 Production In The Short Run
The law of diminishing marginal returns to scale states that as ever
larger amounts of variable inputs are employed or combined with
fixed inputs (land) eventually the marginal physical product of the
variable input(s) decline.
From the table or graph, this stage occurs from the fourth units of
labour employed to the eighth labour employed.
This is the best and rational stage of production.
Although marginal production is decreasing, total production is still
increasing
 Production In The Short Run
Negative Returns to Scale
At this stage, marginal product is negative and average product is
decreasing but not zero. Total product at this stage is reducing so it
is not rational for any firm to continue to employ more units of
variable factor with the intention of increasing production.
This occurs from the ninth unit of labour employed.
 Production In The Short Run
Fixed Cost (TFC) refers to cost that do not vary with the quantity
of output produced. These costs are incurred on fixes inputs. Eg
rent
Variable Cost (TVC) refer to the cost that vary with the quantity of
output produced. These costs are incurred on variable input Eg
wages paid to labour, cost incurred on the purchases of raw
materials
Total Cost (TC) refers to the sum of fixed costs and variables costs
𝑻𝑪 = σ 𝑴𝑪 or 𝑻𝑪𝒙 = ‫ 𝒙𝒅 𝑪𝑴 ׬‬or 𝑻𝑪 = 𝑨𝑪 ∗ 𝑸
𝑻𝑪 = 𝑻𝑭𝑪 + 𝑻𝑽𝑪
 Costs In The Short Run
Marginal cost(MC) refers to the additional cost incurred by
increasing production by one unit. Simply put, it refers to a change
in the total cost that results from a change in output
𝚫𝑻𝑪
𝑴𝑪 = ,
𝚫𝑸
Average Fixed Cost(AFC) refers to the total fixed cost divided by
the quantity produced
𝑻𝑭𝑪
𝑨𝑭𝑪 = ,
𝑸
 Costs In The Short Run
Average Variable Cost (AVC) refers to the total variable cost divided
by the quantity of output produced
𝑻𝑽𝑪
𝑨𝑽𝑪 = ,
𝑸
Average Total Cost(ATC) refers to the total cost divided by the
quantity of output produced
𝑻𝑽𝑪
𝑨𝑻𝑪 = ,
𝑸
 Costs In The Short Run
Quantity of Total Fixed Average Fixed Total Variable Average Total Cost Average Total Marginal Cost
Output cost cost Cost Variable Cost Cost

0 100 - 0 - 100 - -
1 100 100 50 50 150 150 50
2 100 50 80 40 180 90 30
3 100 33.33 100 33.33 200 66.67 20
4 100 25 110 27.50 210 52.50 10
5 100 20 130 26 230 46 20

6 100 16.67 160 26.67 260 43.33 30

7 100 14.28 200 28.57 300 42.86 40

8 100 12.50 250 31.25 350 43.75 50

9 100 11.11 310 34.44 410 45.56 60
10 100 10 380 38 480 48 70
Costs In The Short Run
Costs In The Short Run
Costs In The Short Run
Costs In The Short Run
Costs In The Short Run
Costs In The Short Run
Costs In The Short Run
Costs In The Short Run
 Costs In The Short Run
Relationship between MC and ATC
Whenever marginal cost is less than average total cost, average total
cost is falling.
Whenever marginal cost is greater than average total cost, average
total cost is rising.
The marginal-cost curve crosses the average-total-cost curve at its
minimum.
At low levels of output, marginal cost is below average total cost, so
average total cost is falling.
 Costs In The Short Run
Relationship between MC and ATC
However, after the two curves cross, marginal cost rises above
average total cost.
From that point henceforth, average cost also rises with output.

Sunk Cost refers to cost incurred in the past that cannot be changed
by current decisions and therefore cannot be recovered.
 Costs In The Short Run
Long Run Total Cost : In the long run, all factors of production are
varied. There is no fixed input so no fixed costs are incurred. Unlike
the short run where total cost is the summation of the total fixed
cost and the total variable cost, the long run total cost is equal to
the long run total variable cost.
The long run average total cost curve shows the lowest unit cost at
which the firm can produce any given level of output.
 Costs In The Short Run
The long run average total cost curve
 Economies and Diseconomies of Scale
Economies of scale are cost advantages firms experience or enjoy
in the long run in the form of lower average cost as production
increases in the long run.
Production becomes efficient because the cost of production can
be spread over a larger amount of goods.
The factors giving rise to economies of scale are be broadly
grouped
internal factors
external factors
 Economies and Diseconomies of Scale
Internal Economies of Scale are factors resulting from the firms’
decisions and actions. They include:
Technical or technological economies of scale
Managerial economies of scale
Monopsony power
Network economies of scale
Bulk purchasing
External economies of scale are factors that are external to a firm
but within the same industry that bring cost benefit to a firm.
They usually are industry-wide decision and activities external to the firm.
 Economies and Diseconomies of Scale
Examples of external economies of scale include
Infrastructure economies of scale
Specialization and division of labour
Tax incentives
Innovation and research
Access to raw materials from different firms for free or at lesser costs
 Economies and Diseconomies of Scale
Diseconomies of Scale are costs disadvantages that firms
experience in the form of higher average cost as they increase
production in the long run.
That is, as production rises, the average cost of production also
rises.
Firms become worse off than they were in the short run.
The sources of diseconomies of scale are also group into internal
diseconomies of scale and external diseconomies of scale.
 Economies and Diseconomies of Scale
Internal and External sources of Diseconomies of Scale
Managerial diseconomies
Higher input prices
Marketing diseconomies
Low morale
 MARKETS
A market refers to the interaction between firms and buyers to
facilitate the transaction or exchange of goods and services.
Perfectly Competitive Markets
 Perfectly Competitive Markets
Perfectly Competitive Market also known as Competitive Market or
PCM refers to a market with many buyers and sellers trading
identical products so that each buyer and seller is a price taker.
Features
There are many sellers and many buyers
Homogenous and identical goods
No barriers to entry into or exit from the market
Perfect information between buyers and sellers
Both sellers and buyers are price takers
 Perfectly Competitive Markets
Nature of Curves
Because producers are price takers, a firms revenue is proportional
to the units of goods it produces.
Under the PCM, the price of the good is equal to the average
revenue as well as the marginal revenue.
P=AR=MR is a horizontal curve because price is constant
A firm in the PCM maximizes profit by producing the quantity at
which its marginal cost is equal to its marginal revenue.
 Perfectly Competitive Markets
Nature of Curves
Mathematically,
𝑻𝑹 = 𝑷 ∗ 𝑸

𝑻𝑹
𝑨𝑹 =
𝑸
𝑷∗𝑸
𝑨𝑹 =
𝑸

𝑨𝑹 = 𝑷
 Perfectly Competitive Markets
Nature of Curves
Mathematically,
𝑻𝑹 = 𝑷 ∗ 𝑸

𝒅𝑻𝑹
M𝑹 =
𝒅𝑸

𝒅𝑷𝑸
𝑴𝑹 =
𝒅𝑸

M𝑹 = 𝑷 This proves that MR=P=AR

 Perfectly Competitive Markets
Demand Curve
Because firms are price takers, demand is perfectly elastic for a
single firm thus horizontal in shape.

P=MR=AR

0 Qnty
 Perfectly Competitive Markets
Demand Curve
However, the market demand is downward sloping.

P=MR=AR
0 Qnty
 Perfectly Competitive Markets
Profit Maximization
 Perfectly Competitive Markets
Profit Maximizing Condition
Profit is maximized at the point where the MR curve in equal to the
MC curve, that is a necessary condition.
From the Curve, although MR=MC at point D, the firm is
encouraged to increase the output produced. This is because, with
the additional goods produced, the firm’s marginal revenue exceeds
its marginal cost until the point E.
Beyond point E, the firm incurs a higher cost more than the
revenue it earn from producing the good. The firm is therefore
encouraged to reduce the units of its output.
 Perfectly Competitive Markets
Profit maximizing Condition
This is because when the firm reduces its output, the marginal cost
saved will be higher than the marginal revenue lost
Point E is the profit maximizing point. The firm is encouraged to
produce Q units at point E because that will give it the maximum
profit. The firm’s MR=MC.
The profit maximizing output level is produced at the point where
the MC=MR but the MC cuts the MR curve from below
 Perfectly Competitive Markets

Short Run Profit and Loss

In the short run profit analysis, a firm’s average total cost or average
cost ATC (AC) determines if it is making a profit or a loss
If the firm’s AC curves lies below the price level, then the firm is
making a supernormal profit or an abnormal profit (Figure…)
If the firm’s AC curves lies directly on the price level, the firm makes a
normal profit. (Figure ….)
If the firm’s AC curves lies above the price level, then the firm is
making a loss (Figure…)
Perfectly Competitive Markets
Short Run Profit and Loss
Abnormal or Supernormal Profit
Perfectly Competitive Markets
Short Run Profit and Loss
Normal Profit
Perfectly Competitive Markets
Short Run Profit and Loss
Loss
 Perfectly Competitive Markets
Firms’ Decision to Shutdown
In the short run profit analysis, if a firm is making a loss, its
decision to shutdown depends whether it is able to cover its average
variable cost or not
If a firm is able to cover its average variable cost thus the AC curve
lies above the price level but the AVC lies below the price level, it is
advisable for the firm to continue production although it is making
loss. In this case, the firm is able to cover its variable cost but not its
fixed cost.
On the other hand if both the ATC and the AVC lie above the price
level of the good, the firm is encouraged to shutdown
Perfectly Competitive Markets
Loss no Shutdown
Perfectly Competitive Markets
Loss (Shutdown Point)
ATC/AVC/MR/P/MC
Perfectly Competitive Markets

Long Run Profit Analyses

In the long run, all firms make normal profits
This is because of the free entry into and exit from the market
All firms making a loss exit the market and new firms enter the
market
In the Long run the profit maximizing output level is at the point
where P=ATC=MR
 Perfectly Competitive Markets
Long Run Equilibrium and Profit Analyses
 MARKETS
Monopoly: The Price Maker
 Monopoly: The Price Maker
Whereas a firm in the PCM is a price taker, the monopolist is a
price maker.
A firm is a monopoly if it is the sole seller of its product and if its
product does not have any close substitutes.
Factors giving rise to monopoly are
No close substitutes: if the good produced by a particular firm has
no substitute then the firm producing enjoys the privilege of being
the sole producer of that good and faces no competition from other
firms
 Monopoly: The Price Maker
Factors giving rise to monopoly are
Monopoly may also result mainly because of barrier to entry in the
market. Here, only one firm exists in the market with no
competitors. The barrier to entry may be as a result of
Government regulation: the government may grant a single firm the sole
right to produce a particular good while disallowing other firms to
produce same or similar good. This is known as patent right.
The cost of production: the production process of producing a good may
be very costly that only one firm may be able to produce the good at a
lower cost to the entire market than a great number of firms.
 Monopoly: The Price Maker
Factors giving rise to monopoly are
Monopoly in resources: If the key resources used in the production of a
certain good are owned by a single firm then that may hinder other firms
from producing the same good.
Demand and Marginal Revenue of the Monopolist
The monopolist faces a downward sloping demand curve.
The monopolist would have to either produce more and accept a lower
price or produce less and accept a higher price.
The monopolist cannot choose any point outside the demand curve
The demand curve or price is equal to the Average revenue of the
monopolist.
 Monopoly: The Price Maker
Demand and Marginal Revenue of the Monopolist
Unlike the PCM where P=AR=MR, the marginal revenue of the
monopolist is lesser than the average revenue or the price of the good.
This is because price and quantity produced move in different direction
having dual effect on the Total revenue earned. For example, a fall in
the price of the good will have two effects on total revenue
• The output effect: More output is sold, so Q is higher, which tends to increase
total revenue.
• The price effect: The price falls, so P is lower, which tends to decrease total
revenue.
 Monopoly: The Price Maker
Demand and Marginal Revenue of the Monopolist
AR/P/MR

AR=DD
0
MR
 Monopoly: The Price Maker
Profit Maximization of the Monopolist
AR/P/MR
MC

B
P

0 AR=DD
MR
Q
 Monopoly: The Price Maker
Profit Maximization of the Monopolist
A monopolist maximizes profits by choosing the quantity at which
MR equal MC at point A
It then uses the demand curve to find the price that will induce
consumers to buy that quantity Point B
The profit of a monopolist is equal the its total revenue minus the
total cost
𝝅 = 𝑻𝑹 − 𝑻𝑪
 Monopoly: The Price Maker
The Monopolist and Welfare
The monopolist charges a higher price than the price in the perfect
competitive market
The monopolist produces lesser units of a good than the output
level in the perfect competitive market.
The monopolist enjoys a greater producer surplus than producers
in the perfect competitive market
Consumers in the perfect competitive market enjoy greater
consumer surplus than consumers in the monopoly market.
 Monopoly: The Price Maker
The Monopolist and Welfare
There is inefficiency in the monopoly market.
Resources are not allocated efficiently.
Consumers are worse off because of the higher price which has
been set by the monopolist and/or the limited units of output
produced.
Welfare loss
The surplus of consumers is transferred to the producer
The market welfare loss is indicated by the deadweight loss
 Monopoly: The Price Maker
The Monopolist and Welfare
 THANK YOU

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