Introduction to Economics

Why Should Engineers Care?

Abid Nahiyan Alam

September 11, 2023

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Content
1. Overview
2. Microeconomics
3. Macroeconomics
4. Demand
5. Production
6. Supply
7. Market
8. Interesting Cases
9. Looking Ahead

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Beginnings

• ’Economics is a science of wealth’ - Adam Smith, 1776

• Smith is often referred to as the father of economics

• However, tradition can be traced back to Aristotle.

• Economic thinking dates back to the beginning of humankind. How?

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Definition

• Economics is a social science. It is fundamentally a study of how humankind provides for

its material well being.

• It is the science of making (optimal) choices. It helps us understand, or predict choices.

• The resources available to us are finite, but our wants are unlimited. This is the
fundamental problem of economics. This is called “scarcity“.

• So how do we solve the problem of scarcity? - Our best bet is to make optimal choices
i.e., the best possible choice given our objective, our constraints, and the information
available to us at time of decision making.

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Important Questions

• Economics deals with three fundamental questions:

• Which goods and services to produce?

• How to produce them?
• How do we distribute the output?

• Economics is about how individuals, firms, and governments make choices and how these
choices interact in the market.

• Economics is divided into two broad categories: Microeconomics, and Macroeconomics.

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The Economic Way of Thinking

• Economic analysis, and the “economic way of thinking“ is fundamentally different from
other forms of analysis and thinking.

• For starters, all decisions are made at the margin. i.e., an rational individual is assumed to
engage in an activity if the additional benefit derived from that activity exceeds the
additional cost.

• Economic costs are different from accounting costs, as economic cost also accounts for
opportunity costs. So what is opportunity cost?

• Opportunity cost is the cost of the next best alternative forgone. i.e., the benefit you lose
from choosing to engage in an activity by forgoing the next best alternative.

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Microeconomics
• The origin of the prefix micro is a Greek work which meant “small”.

• Microeconomics deals with individuals, and firms, their choices, and how their choices
respond to changes in prices, incentives, and information.

• Such individual agents are often grouped into subgroups such as buyers, sellers, and
markets based on their particular types.

• In a nutshell, microeconomics provides the foundation up on which macroeconomics is

built.

• As such, it fundamentally deals with consumer theory - how consumers make choices, and
producer theory - how producers make choices.

• It deals with demand, supply, and markets at the fundamental level.

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A bit more of the small

• So What is demand? supply? prices? and markets?

• Moreover, why should we care?

For the time being, here is a quick glimpse:

• As engineers, some of you may want to understand if there is a demand for what you are
enthusiastic about creating.
• As entrepreneurs who hire engineers, you may want to understand what it takes to
actually produce and supply the product your team produces.
• And as a visionary who aims to solve a problem, you may want to understand the market
you wish to enter.

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Okay, I’ll stop with the small talk

• For this you need to understand consumer theory - how consumers make choices - i.e., to
understand demand.
• Next you need to understand producer theory - how firms make choices - i.e., to
understand supply.
• Then you need to understand markets - how producers and consumers interact.
• Moreover, you need to not only be able to understand, but predict the choices made by
all parties, and that is where use of economic data comes in. More on that later..
• But most importantly, you need to be able to perform economic analysis for yourselves!

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Macroeconomics

• The origins of the word macro relates to something large, mega, or long.
• Macroeconomics deals with the aggregate economy.
• In other words, how an aggregate of consumers, producers, or firms behave. Also, how
governments, and entire economies (countries) interact with each other.
• It probably has to deal with every bit of economics news, or discussion you have heard in
the recent past.
• In other words, inflation, economic growth, recession, budget and other terms you keep
hearing in conversation or the news every other day.
• It is the study of countries (economies), and the world as a whole - in general terms!

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More on the big!

• We will be learning about terms that you hear everyday! Its time we all get up to speed!
• What is inflation and why should we care?
• What is a budget deficit?
• What should the government do? What does the central bank do?
• What was the 2008 crisis all about?
• What is money? What is crypto? Why do we keep hearing about this?
• What does the World Bank do? What is the IMF?
• I’m an engineer, what does this have to do with me?

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Is Micro and Macro It?

• Other than this broad categorization, economics is subdivided into other fields!
• These include:
• Behavioral Economics
• Financial Economics
• Labor economic and economics of education
• international trade, public economics and health economics
• econometrics, machine learning and use of economic data
• Industrial organization, growth, and search theory
• Disruptive Technology, and how they affect both sides of the market (Thank you Professor
Andrew Maxwell)
• And many more!

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Demand

• Demand is the willingness and ability to purchase a commodity/product at a given price,

in a particular point in time.

• Willingness alone without the ability to purchase is therefore just a want, and is different
from demand.

• There is a negative relationship between price, and quantity demanded. This means that
the price per unit has to decrease in order for quantity demanded to increase - The law of
demand.

• Thus, (conventionally) we plot price on the vertical axis, against quantity demanded on
the horizontal axis in a graph, and we get a downward sloping demand curve.

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The Demand Curve

• The demand curve shows the relationship between price and quantity demanded, when all
other factors other than the price of the good remains unchanged.

• With respect to the demand curve, there are two movements that we care about.

• A movement along the demand curve occurs when there is a change in the product’s own
price. i.e., we move along the demand curve for oil, if the price of oil changes.

• A shift in the demand curve occurs when factors other than the product’s own price
changes, such as the change in price of a related good, among others.

• An outward shift (right) indicates an increase in demand, and inward shift (left) indicates
a decrease in demand.

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Demand Schedule and Demand Curve

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Shifts in Demand - Increase

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Shifts in Demand - Decrease

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Factors that Shift the Demand Curve

• The five factors that cause a shift in the demand curve are:

• Preferences
• Price of a related good - complements/substitutes
• Number of consumers
• Income
• Expected future prices

• A change in any of these factors will change demand, and thus shift the demand curve
outwards or inwards.

• So how do these factors affect demand?

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Elasticity
• The slope of the demand curve, is an indicator of its price “elasticity”

• Price elasticity of demand is the responsiveness of quantity demanded, due to changes in

the price of a good. It is always negative because of the negative relationship between
price and quantity demanded.

• A higher value means that quantity demanded changes a lot due when price changes, thus
demand is referred to as “elastic” (flatter demand curve).

• Similarly a lower value indicates that demand is “inelastic”, a steeper demand curve,

%∆Qd
ηQd p =
%∆Price

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Elasticity Example

• Suppose that the the price of product A changes from P1 = 10 to P2 = 8, resulting in a

change in quantity demanded from Q1 = 30 to Q2 = 50.
• The price elasticity of demand can then be calculated as:

(Q2 −Q1 ) (50−30)

(Q1 +Q2 ) (50+30) 9
ηQd P = (P2 −P1 )
= (8−10)
= − = −2.25
4
(P1 +P2 ) (10+8)

• As we can see, the demand is elastic in this case. How can we interpret this number?
• What does the negative sign indicate?

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Elasticity and Magnitude

• Price elasticity of demand is always negative.

• We consider the absolute value of price elasticity when making interpretations:
• |ηQd P |> 1: Demand is elastic.
• |ηQd P |< 1: Demand is inelastic.
• |ηQd P |= 1: Demand is unit elastic.
• |ηQd P |= 0: Demand is perfectly inelastic.
• |ηQd P |= ∞: Demand is perfectly elastic.
• For example, when demand is elastic, a %∆Qd > %∆P. When demand is inelastic,
%∆Qd < %∆P. When demand is unit elastic, %∆Qd = %∆P

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Elasticity

• Now suppose that P1 = 12, P2 = 6, Q1 = 40 and Q2 = 50. What is the price elasticity of
demand? Is it elastic or inelastic?
• How about P1 = 100, P2 = 110, Q1 = 100, and Q2 = 90
• Note that the formula is:

(Q2 −Q1 )
(Q1 +Q2 )
ηQd P = (P2 −P1 )
(P1 +P2 )

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More on Elasticity

• Income elasticity of demand is the responsiveness of quantity demanded to changes in

income. It can either have a positive or negative value.
• When income elasticity of demand is positive, it means that the consumer buys more of
the particular good when income increases. Such goods are called normal goods.
• When income elasticity of demand is negative, it means that the consumer buys less of
the particular good with income increases. Such goods are called inferior goods.
• Another elasticity that we care about is cross elasticity of demand. It is the responsiveness
of quantity demanded of a particular good, due to changes in the price of another.
• A positive cross elasticity tells us that the two goods are substitutes, whereas a negative
cross elasticity tells us that the two goods are complements.

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Factors of Production
• Factors that go into the production of a good are broadly categorized as land, labor,
capital and entrepreneur.

• Land not only refers to its namesake, but also all other natural resources which are used
in production. Land earns rent.

• Labor is the human component or effort that goes into production. Labor earns wages.

• Capital is any product of land and labour which can be used to further aid in production.
Capital, generally earns interest rates.

• An entrepreneur is an individual who organizes production, and undertakes the risk

associated with it. As such, entrepreneurs make profits.

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Costs

• Costs associated with production are important as they dictate many important decisions.

• There are a few terms associated with cost that you should all be familiar with.
Total Cost = Variable Cost + Fixed Cost (+ Sunk Cost)
Total Cost
Average Cost =
Output

• Variable costs are costs that change with output, fixed costs remain unchanged, and sunk
costs are costs that cannot be recovered.
• Marginal cost is the cost of producing the last unit. If producing the tenth unit changes
total cost from 100, to 115, then the marginal cost of the tenth unit produced is 15.

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Supply

• Supply is the willingness and ability of individuals or firms to sell a product at a given
price in a particular point in time.
• There is a positive relationship between quantity supplied and price. As the price
increases, quantity supplied increases as well.
• Thus, unlike demand, the supply curve is upward sloping. A movement along the supply
curve occurs whenever there is a change in the products own price.
• Changes in the following factors can change supply, and therefore cause a shift in the
supply curve: Technology, Environment, Price of Inputs, Price of Related Goods/Services,
Expected Future Prices and Number of Firms.
• An increase in supply is indicated by a rightward shift, and a decrease in supply is
indicated by a leftward shift.

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Supply Curve

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Market

• A market is a place, physical or virtual, where buyers and sellers go to interact/trade.

• The market demand for a good, is the sum of all individual demands from all the
potential buyers.
• The market supply of a good, is the sum of all individual supplies from all the potential
sellers.
• The interaction between market demand, and market supply determines the market price.
Graphically it is determined by the intersection of the demand, and the supply curves.
• Note that I am referring to demand and supply as being curves, instead of the straight
lines that I have used to demonstrate them. This is just for simplicity at this point. These
in reality are almost never perfectly linear.

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Market Equilibrium

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Interesting Cases

• Now that we have some basic knowledge of demand, and supply, and the factors that can
affect them, lets look at some interesting cases of how these interact in the market.

• Nvidia, AMD and the market for graphics cards

• China the global supplier of ALMOST ANYTHING!
• Right to Repair - a good idea?
• Many more to come

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Market For GPUs

• All throughout the pandemic, the prices of dedicated graphics cards increased drastically.
• From the demand side of things, what do you think caused it?
• How about the supply side?
• Can you demonstrate this using a demand and supply diagram?

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Looking Ahead

• We will be looking at interesting case studies in the tutorials.

• The goal is not to know definitions, but to use the underlying knowledge and apply it to
the real world.
• I am open to suggestions if there is a particular economic phenomenon or situation you
would like to talk about.
• Think: how can we relate the things we have discussed today to disruptive technologies?

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