URP 1157: Principal of Economics: Fatema Tuj Johora

Department Of Urban Planning: Khulna University Bangladesh

August 14, 2015

Political economy (Mode of production)

In the writings of Karl Marx and the Marxist theory of historical materialism, a mode of

production (in German: Produktionsweise, meaning 'the way of producing') is a specific

combination of:

Productive forces: these include human labour power and means of production (e.g. tools,

equipment, buildings, technologies, knowledge, materials, and improved land).

Social and technical relations of production: these include the property, power, and control

relations governing society's productive assets (often codified in law), cooperative work

relations and forms of association, relations between people and the objects of their work,

and the relations between social classes.

Marx regarded productive ability and participation in social relations as two essential

characteristics of human beings and that the particular modality of these relations

in capitalist production are inherently in conflict with the increasing development of human

productive capacities

Means of Production:

In economics and sociology, the means of production are physical, non-human inputs used in

production, such as machinery, tools and factories, infrastructural capital and natural capital.

The means of production has two broad categories of objects: instruments of labour (tools,

factories, infrastructure, etc.) and subjects of labor (natural resources and raw materials). If

creating a good, people operate on the subjects of labor, using the instruments of labor, to create

a product; or, stated another way, labour acting on the means of production creates a good.

In an agrarian society the means of production is the soil and the shovel. In an industrial

society it is the mines and the factories, and in a knowledge economy the offices and computers.

In the broad sense, the "means of production" includes the "means of distribution" such as stores,

the internet and railroads.

Ownership of the means of production and control over the surplus product generated by their

operation is a key factor in categorizing different economic systems. In classical economics the

means of production is the "factors of production" minus financial capital and minus human

capital.

Different method of calculating National Income:

There are mainly Three Approaches to measure GNP.

2.1 Output or value added approach: The total value of all final goods and services (i.e.

outputs) can be found out by adding up the total values of outputs produced at different stages of

production .This method it to avoid the so called double-counting or an over-estimation of GNP.

URP 1157: Principal of Economics: Fatema Tuj Johora

Department Of Urban Planning: Khulna University Bangladesh

August 14, 2015

However, there are difficulties in the collection and calculation of data obtained; caution should

be taken to take Final Goods not Intermediate goods as it will result in Double Counting.

2.2. Expenditure approach: Amount of Expenditure refers to all spending on currently-

produced final goods and services only in an economy. In an economy, there are three main

agencies which buy goods and services. These are: Households, Firms and the Government. In

Economics, we use the following Terms:

C = Private Consumption Expenditure (of all Households)

I = Investment Expenditure (of all firms)

G = Government Consumption Expenditure (of the local government).

In an economy the entire output which is produced in a year is not fully consumed by that

economy as some goods are exported and in the similar way the domestic consumption

(expenditure) may also include imports. Hence under the expenditure approach to measure the

GNP, the value of exports must be added to C, I and G whereas the values of imports must be

deducted from the above amount.

Finally, we have: GNP at market prices = C+I+G+X-M (Where X-M = Exports –Imports)

For example in a Cycle Manufacturing Unit, computing the

total value of cycles produced in a year the final value of the

cycle (Multiplied by total no of units produced) which is

ready to be marketed for sale will be taken not the cost of

intermediate goods which are used in the process of

manufacture as it will result in double counting. I.e. The

market price of a cycle is suppose Tk.2000 which includes

say profit margin of Tk.200 besides the cost of

manufacturing of Tk.1800. This 1800 includes all costs

including components and parts etc. (these are intermediate

goods which are used in the process of production.)If the

costs of parts etc. are also taken while computing final value

of total units produced, it will give inflated figure and hence

result in double counting error. Same way at macro level,

while computing the National Income under Value Added

Method the value of final goods and services should be

taken up to avoid the double counting error as the cost of

Intermediate Goods are already counted in the final value of

the product.

URP 1157: Principal of Economics: Fatema Tuj Johora

Department Of Urban Planning: Khulna University Bangladesh

August 14, 2015

Gross Domestic Product (GDP):

We can only find the amount of outputs which are produced within the domestic boundary of an

economy in a specific period, say a year. To arrive at the value of GNP, Net Factor Income

Earned from Abroad (NFIA) has to be added to the GDP.

Income from abroad = income earned by local citizens form the provision of factors services

abroad.

Income to abroad = income earned by foreign citizens form the provision of factors services

locally

Net Factor Income from abroad – Income earned from abroad – Income sent to abroad

GNP = GDP + Net Factor Income Earned from Abroad

2.3 Income approach: The Income approach tries to measure the total flows of income earned

by the factor-owners in the provision of final goods and services in a current period. There are

four types of factors of production and four types of factors incomes accordingly i.e. Land,

Labour, Capital, and Organization as Factors of Production and Rent, Wages, Interest and Profit

as Factor Incomes correspondingly.

National Income = Wages+ Interest Income + Rental Income +*Profit

The term* Profit can be further sub-divided into; profit tax; dividend to all those shareholders;

and retained profit (or retained earnings).

3. Relevant concepts of National Income

3.1 Net National Product (NNP) The investment expenditure of the firms is made up of two

parts. One part is to buy new capital goods and machinery for production. It is called net

investment because the production capacity of the firms can be expanded. Another part-

consumption allowance or depreciation- is spent on replacing the used-up capital goods or the

maintenance of existing capital goods will face wear and tear out over time. Depreciation refers

to all non-cash provision charged against profit each year to replace the fixed assets due to wear

and tear, obsolescence, destruction and accidental loss etc. The sum of these two amounts is

called Gross Investment in economics.

Gross Investment= Net investment + Depreciation

Net investment will increase the production capacity and output of a nation, but not by

depreciation expenditure. So we have, NNP = GNP-Depreciation

3.2 GNP at Factor Cost: The amount of National Income calculated under the Income

Approach will not be the same as the amount of GNP at market prices found by the expenditure

approach. In the expenditure approach, the value of GNP included some types of expenses which

are not factor incomes earned by the citizens. They include depreciation, indirect business taxes,

and government subsidies.

URP 1157: Principal of Economics: Fatema Tuj Johora

Department Of Urban Planning: Khulna University Bangladesh

August 14, 2015

GNP at factor Cost = GNP at market price = Indirect Business Taxes + Subsidies = GNP at

market price = Indirect Business Taxes less Subsidies

GNP at factor cost carries the meaning that we are measuring the total output by their costs of

production. As output generates income to the factor-owners, it is also related with the value of

national income.

GNP at factor Cost = National Income + Depreciation.

Depreciation is also a type of costs of production but will not become a source of income

directly. So it is included in the factor cost but excluded in the value of national income.

3.3 GNP (GNP at Current Market Prices) GNP is a measure based on market prices which are

expressed in terms of money. In reality, market prices changes all the time. The same amount of

outputs may different total market values provided that price change. In order to isolate the effect

of prices change on the value of GNP, economists have developed the concept and techniques of

constant market prices.

GNP at the base year (1990) = 1X 6 + 2 x 4 +2 x 2m. = 18 million

GNP at current market prices in 1995 = 1x 6 +2 x6 +3 x 4m. = 30 Million.

The 2 value of GNP at current market prices in 1995 & 2000 are calculated by using the money

prices in that year, eg. The nominal growth rate is 66.67 % between 1990 to 2000.

GNP at constant market prices of 1995 = 1 x 6 + 2 x 6 +2 x 4m. = 26 million

The real output changes from 18 to 26 million from 1990 to 1995. GNP at constant marker prices

is called real GNP. The growth rate of real GNP is called real growth rate of GNP.

Difficulties of calculating National Income:

All the countries face some special difficulties in estimating national income. Some of these

difficulties are given below:

(1) Problems of Definition: What should we include in the National Income?

Ideally we should include all goods and services produced in the course of the year, but there are

some services which are not calculated in terms of money, e.g., services of housewives.

(2) Lack of Adequate Data:

The lack of adequate statistical data makes the task of estimation of national income more acute

and difficult.

(3) Non-availability of Reliable Information:

The reason of illiteracy, most producers has no idea of the quantity and value of their output and

do not follow the practice of keeping regular accounts.

(4) Choice of Method:

URP 1157: Principal of Economics: Fatema Tuj Johora

Department Of Urban Planning: Khulna University Bangladesh

August 14, 2015

The selection of method while calculating National Income is also an important task. The wrong

method leads to poor results.

(5) Lack of Differentiation in Economic Functioning:

In all the countries the occupational specialization is still incomplete so that there is a lack of

differentiation in economic functioning. An individual may receive income partly from farm

ownership and partly from manual work in industry in the slack season.

(6) Double Counting:

Double counting is also an important problem while calculating national income. If the value of

all goods and services totaled, the total will overtake the national output, because some goods are

currently consumed being used in the making of others. The best way to avoid this error is to

calculate only the value of those goods and services that enter into final consumption.

(7) Transfer Payments

Individual get pension, unemployment allowance and interest on public loans, but these

payments creates difficulty in the measurement of national income. These earnings are a part of

individual income and they are also a part of government expenditures.

(8) Capital Gains or Loss

when the market prices of capital assets change the owners make capital gains or loss such gains

or losses are not included in national income.

(9) Price Changes

National income is the money value of goods and services. Money value depends on market

price, which often changes. The problem of changing prices is one of the major problems of

national income accounting. Due to price rises the value of national income for particular year

appends to increase even when the production is decreasing.

(10) Wages and Salaries paid in Kind

Additional payments made in kind may not be included in national income. But, the facilities

given in kind are calculated as the supplements of wages and salaries on the income side.

(11) Petty Production

there are large numbers of petty producers and it is difficult to include their production in

national income because they do not maintain any account.

(12) Public Services

Another problem is whether the public services like general administration, police, army

services, should be included in national income or not. It is very difficult to evaluate such

services.

URP 1157: Principal of Economics: Fatema Tuj Johora

Department Of Urban Planning: Khulna University Bangladesh

August 14, 2015

(13) Non-Monetary Transactions

The first problem in National Income accounting relates to the treatment of non-monetary

transactions such as the services of housewives to the members of the families. For example, if a

man employees a maid servant for household work, payment to her will appear as a positive item

in the national income. But, if the man were to marry to the maid servant, she would performing

the same job as before but without any extra payments. In this case, the national income will

decrease as her services performed remains the same as before.

Factors determining countries standard of living:

The standard of living is defined as the level of wealth experienced by a county which is

indicated by the average disposable income of the population, ownership of capital equipment,

the level of research and access to modern technology and the quality and quantity goods and

services enjoyed by citizens.

Level of goods and services available: goods and services are needed to satisfy the needs and

wants of a society.

Average disposable income: per capita GNP reveals the average amount of earnings of each

person in an economy.

Ownership of capital equipment: Capital goods/investment goods are used to create consumer

goods and services locally and for export.

Research and technology leads to innovation and increases production.

Whereas the standard of living is measured by physical quantity, a country’s quality of life is

determined by the quality of goods and services enjoyed by citizens. These include: safety (low

crime rates), good diet and nutrition, environmental quality, quality of health and educational

facilities, life expectancy, rate of infant mortality and the access to public utilities such as water.

Functions of Money:

Money is any good that is widely accepted in exchange of goods and services, as well as

payment of debts. Most people will confuse the definition of money with other things, like

income, wealth, and credit. Three functions of money are:

1. Medium of exchange: Money can be used for buying and selling goods and services. If there

were no money, goods would have to be exchanged through the process of barter (goods would

be traded for other goods in transactions arranged on the basis of mutual need). For example: If I

raise chickens and want to buy cows, I would have to find a person who is willing to sell his

cows for my chickens. Such arrangements are often difficult. But Money eliminates the need of

the double coincidence of wants.

2. Unit of account: Money is the common standard for measuring relative worth of goods and

service.

URP 1157: Principal of Economics: Fatema Tuj Johora

Department Of Urban Planning: Khulna University Bangladesh

August 14, 2015

3. Store of value: Money is the most liquid asset (Liquidity measures how easily assets can be

spent to buy goods and services). Money’s value can be retained over time. It is a convenient

way to store wealth.

Relations between inflation and unemployment:

The relationship between inflation rates and unemployment rates is inverse. Graphically, this

means the short-run Phillips curve which is L-shaped.

The Phillips curve relates the rate of inflation with the rate of unemployment. The Phillips curve

argues that unemployment and inflation are inversely related: as levels of unemployment

decrease, inflation increases. The relationship, however, is not linear. Graphically, the short-run

Phillips curve traces an L-shape when the unemployment rate is on the x-axis and the inflation

rate is on the y-axis.

The Phillips Curve is a graph that illustrates the observed relationship between the inflation rate

and the unemployment rate. It is a downward sloping curve, indicating that a trade-off exists

between inflation and unemployment. This has important implications for government policies

that attempt to achieve economic stability. Expansionary policies may reduce unemployment at

the expense of higher inflation. Contractionary policies may reduce inflation at the cost of

higher unemployment. Activist government policies, then, require that the costs and benefits

associated with such policies be considered.

Perfect competition versus imperfect competition:

Perfect competition is a microeconomics concept that describes a market structure controlled

entirely by market forces. In a perfectly competitive market, all firms sell identical products and

services, firms cannot control prevailing market prices, market share per firm is small, firms and

customers have perfect knowledge about the industry, and no barriers to entry or exit exist. If any

of these conditions are not met, a market is not perfectly competitive.

URP 1157: Principal of Economics: Fatema Tuj Johora

Department Of Urban Planning: Khulna University Bangladesh

August 14, 2015

Describe the Assumptions of a Competitive Market.

To measure how competitive a market is, we need to define what an ideal or perfectly

competitive market looks like. There are four main characteristics of a competitive market:

1. Many Buyers and Sellers There is a very large number of firms and consumers in the market.

No single firm or consumer having extra influence on the market, and consequently all firms are

very small compared to the overall market.

2. No Barriers to Entry and Exit (Full Mobility of Resources) Any firm can enter and leave

the market if it wants to. There is nothing stopping a new firm from entering a market, or an

existing firm leaving a market if it wants to. Put another way, firms are free to move their

resources in or out of a market. Barriers such as high setup costs, consumer loyalty schemes,

legal barriers (e.g. patents) do not exist in a perfectly competitive market. Only one factor - time

- affects firms’ ability to move in or out of a market, and all firms are affected exactly the same.

We will look at this idea (short run vs long run) later in this standard.

3. Identical Product All firms produce exactly the same product. Every firms’ product look the

same, has the same design and features, is the same quality, has the same guarantees, etc. For

consumers, the product of one firm is a perfect substitute for the product of any other firm.

4. Perfect Knowledge All firms and consumers in the market know everything about the

product, consumers and other producers. Firms know each other’s’ costs of production and

design features. If one firm were to improve its design, all other firms would immediately find

out about this and be able to copy it. Consumers also know about all firms’ costs of production,

selling prices, and the features of their products. If one firm tries to sell its (identical) product at a

higher price, consumers will immediately know that this price is higher than all other firms ...

and not buy from that firm.

URP 1157: Principal of Economics: Fatema Tuj Johora

Department Of Urban Planning: Khulna University Bangladesh

August 14, 2015

Imperfect competition, in which a competitive market does not meet the above conditions, is

very common. Examples of imperfect competition include oligopoly, monopolistic competition,

monopsony and oligopsony.

In an oligopoly, there are many buyers for a product or service but only a few sellers. The cable

television industry in most areas of the United States is a prototypical oligopoly. While an

oligopolistic market is competitive - the few active firms within an industry compete with one

another - it falls well short of perfect competition in several key areas. The firms involved

usually sell similar products, but they are not identical. Because of the small number of firms, a

singular firm has the power to influence market prices; in fact, collusion, an underhanded tactic

in which competing firms join forces to manipulate market prices, has historically been rampant

in oligopolies. By its very nature, an oligopoly provides large market share to each firm. Perfect

knowledge does not exist, and the barriers to entry are typically high, ensuring the number of

players remains small.

Monopolistic competition describes a market that has a lot of buyers and sellers, but whose firms

sell vastly different products. Therefore, the condition of perfect competition that products must

be identical from firm to firm is not met. The restaurant, clothing and shoe industries all exhibit

monopolistic competition; firms within those industries attempt to carve out their own

subindustries by offering products or services not duplicated by their competitors. In many ways,

monopolistic competition is closer than oligopoly to perfect competition. Barriers to entry and

exit are lower, individual firms have less control over market prices and consumers, for the most

part, are knowledgeable about the differences between firms' products.

Monopsony and oligopsony are counterpoints to monopoly and oligopoly. Instead of being made

up of many buyers and few sellers, these unique markets have many sellers but few buyers. The

defense industry in the U.S. constitutes a monopsony; many firms create products and services

and attempt to sell them to a singular buyer, the U.S. military. An example of an oligopsony is

the tobacco industry. Almost all of the tobacco grown in the world is purchased by less than five

companies, which use it to produce cigarettes and smokeless tobacco products. In a monopsony

or an oligopsony, it is the buyer, not the seller, who has the ability to manipulate market prices

by playing firms against one another.

URP 1157: Principal of Economics: Fatema Tuj Johora

Department Of Urban Planning: Khulna University Bangladesh

August 14, 2015

Law of diminishing marginal returns:

The law of diminishing marginal returns means that the productivity of a variable input declines

as more is used in short-run production, holding one or more inputs fixed. This law has a direct

bearing on market supply, the supply price, and the law of supply. If the productivity of a

variable input declines, then more is needed to produce a given quantity of output, which means

the cost of production increases, and a higher supply price is needed. The direct relation between

price and quantity produced is the essence of the law of supply.

Example:

To illustrate this important law, consider the production of Super

Deluxe TexMex Gargantuan Tacos (with sour cream and jalapeno

peppers). The table to the right presents the hourly production of

Gargantuan Tacos as Waldo's TexMex Taco World employs different

quantities of labor, the key variable input for short-run taco

production. The first column is the number of workers, the second is

the total hourly production of Gargantuan Tacos and the third column

is the marginal product generated by each additional worker.

For the first two workers marginal product actually increases. This

reflects increasing marginal returns and commonly results when the

variable input is able to make increasingly effective use of a

given fixed input.

For the third worker on, however, marginal product decreases. This

reflects decreasing marginal returns and the law of diminishing

marginal returns. The marginal product of the third worker is 25

tacos, compared to 30 tacos for the second worker. The marginal

product of the fourth worker then declines to 20 tacos. For the fifth

worker, the marginal product falls to 15. For each subsequent

worker, the marginal product declines. Marginal product eventually

reaches zero for the eighth worker and even declines for the ninth

and tenth workers.

The decreasing values of marginal product exhibited for taco

production by Waldo's TexMex Taco World reflect the law of

diminishing marginal returns.

Making Tacos

URP 1157: Principal of Economics: Fatema Tuj Johora

Department Of Urban Planning: Khulna University Bangladesh

August 14, 2015

Financial Institutions:

A financial institution is an establishment that conducts financial transactions such as

investments, loans and deposits. Almost everyone deals with financial institutions on a regular

basis. Everything from depositing money to taking out loans and exchanging currencies must be

done through financial institutions.

Major categories of financial institutions and their roles in the financial system.

Commercial Banks

Commercial banks accept deposits and provide security and convenience to their customers. Part

of the original purpose of banks was to offer customers safe keeping for their money. By keeping

physical cash at home or in a wallet, there are risks of loss due to theft and accidents, not to

mention the loss of possible income from interest. With banks, consumers no longer need to keep

large amounts of currency on hand; transactions can be handled with checks, debit cards or credit

cards, instead.

Commercial banks also make loans that individuals and businesses use to buy goods or expand

business operations, which in turn leads to more deposited funds that make their way to banks. If

banks can lend money at a higher interest rate than they have to pay for funds and operating

costs, they make money.

Investment Banks

Investment banks may be called "banks," their operations are far different than deposit-gathering

commercial banks. An investment bank is a financial intermediary that performs a variety of

services for businesses and some governments. These services include underwriting debt and

equity offerings, acting as an intermediary between an issuer of securities and the investing

public, making markets, facilitating mergers and other corporate reorganizations, and acting as a

broker for institutional clients.

Insurance Companies

Insurance companies pool risk by collecting premiums from a large group of people who want to

protect themselves and/or their loved ones against a particular loss, such as a fire, car accident,

illness, lawsuit, disability or death.

Brokerages

A brokerage acts as an intermediary between buyers and sellers to facilitate securities

transactions. Brokerage companies are compensated via commission after the transaction has

been successfully completed.

Investment Companies

An investment company is a corporation or a trust through which individuals invest in

diversified, professionally managed portfolios of securities by pooling their funds with those of

URP 1157: Principal of Economics: Fatema Tuj Johora

Department Of Urban Planning: Khulna University Bangladesh

August 14, 2015

other investors. Rather than purchasing combinations of individual stocks and bonds for a

portfolio, an investor can purchase securities indirectly through a package product like a mutual

fund.

Nonbank Financial Institutions

The following institutions are not technically banks but provide some of the same services as

banks.

Savings and Loans

Savings and loan associations, also known as S&Ls or thrifts, resemble banks in many respects.

Most consumers don't know the differences between commercial banks and S&Ls. By law,

savings and loan companies must have 65% or more of their lending in residential mortgages,

though other types of lending is allowed.

Credit Unions

Credit unions are another alternative to regular commercial banks. Credit unions are almost

always organized as not-for-profit cooperatives. Like banks and S&Ls, credit unions can be

chartered at the federal or state level. Like S&Ls, credit unions typically offer higher rates on

deposits and charge lower rates on loans in comparison to commercial banks.

Law of supply and demand:

Law of Demand: The law of demand states that, if all other factors remain equal, the higher the

price of a good, the less people will demand that good. In other words, the higher the price, the

lower the quantity demanded. The amount of a good that buyers purchase at a higher price is less

because as the price of a good goes up, so does the opportunity cost of buying that good. As a

result, people will naturally avoid buying a product that will force them to forgo the consumption

of something else they value more. The chart below shows that the curve is a downward slope.

URP 1157: Principal of Economics: Fatema Tuj Johora

Department Of Urban Planning: Khulna University Bangladesh

August 14, 2015

A, B and C are points on the demand curve. Each point on the curve reflects a direct correlation

between quantity demanded (Q) and price (P). So, at point A, the quantity demanded will be Q1

and the price will be P1, and so on. The demand relationship curve illustrates the negative

relationship between price and quantity demanded. The higher the price of a good the lower the

quantity demanded (A), and the lower the price, the more the good will be in demand (C).

Law of Supply:

Like the law of demand, the law of supply demonstrates the quantities that will be sold at a

certain price. But unlike the law of demand, the supply relationship shows an upward slope. This

means that the higher the price, the higher the quantity supplied. Producers supply more at a

higher price because selling a higher quantity at a higher price increases revenue.

A, B and C are points on the supply curve. Each point on the curve reflects a direct correlation

between quantities supplied (Q) and price (P). At point B, the quantity supplied will be Q2 and

the price will be P2, and so on.

Utility:

Utility refers to want satisfying power of a commodity. It is the satisfaction, actual or expected,

derived from the consumption of a commodity. Utility differs from person- to-person, place-to-

place and time-to-time. In the words of Prof. Hobson, “Utility is the ability of a good to satisfy a

want”. In short, when a commodity is capable of satisfying human wants, we can conclude that

the commodity has utility.

URP 1157: Principal of Economics: Fatema Tuj Johora

Department Of Urban Planning: Khulna University Bangladesh

August 14, 2015

Measurement of Utility:

Cardinal Utility is the idea that economic welfare can be directly observable. For example,

people may be able to express the utility that consumption gives for certain goods. This is

important for welfare economics which tries to put values on consumption. For example,

allocative efficiency is said to occur when MC = Marginal Utility.

One way to try and put values on goods utility is to offer choices for consumers. This is a rough

guide to the utility given to a good.

Ordinal Utility. In ordinal utility the utility derived from a good is not observable

Total Utility (TU):

Total utility refers to the total satisfaction obtained from the consumption of all possible units of

a commodity. It measures the total satisfaction obtained from consumption of all the units of that

good. For example, if the 1st ice-cream gives you a satisfaction of 20 utils and 2nd one gives 16

utils, then TU from 2 ice-creams is 20 + 16 = 36 utils. If the 3rd ice-cream generates satisfaction

of 10 utils, then TU from 3 ice-creams will be 20+ 16 + 10 = 46 utils.

TU can be calculated as:

TUn = U1 + U2 + U3 +……………………. + Un

Where:

TUn = Total utility from n units of a given commodity

U1, U2, U3,……………. Un = Utility from the 1st, 2nd, 3rd nth unit

n = Number of units consumed

Marginal Utility (MU):

Marginal utility is the additional utility derived from the consumption of one more unit of the

given commodity. It is the utility derived from the last unit of a commodity purchased. As per

given example, when 3rd ice-cream is consumed, TU increases from 36 utils to 46 utils. The

additional 10 utils from the 3rd ice-cream is the MU.

MU = Change in Total Utility/ Change in number of units = ∆TU/∆Q

URP 1157: Principal of Economics: Fatema Tuj Johora

Department Of Urban Planning: Khulna University Bangladesh

August 14, 2015

Ice-creams

Consumed

Marginal Utility

(MU) Total Utility (TU)

1 20 20

2 16 36

3 10 46

4 4 50

5 0 50

6 -6 44

In Fig. 2.1, units of ice-cream, are shown along the X-axis and TU and MU are measured along

the Y-axis. MU is positive and TU is increasing till the 4th ice-cream. After consuming the

5th ice-cream, MU is zero and TU is maximum.

Elasticity:

Elasticity is a measure of how much the quantity demanded of a service/good changes in relation

to its price, income or supply.

If the quantity demanded changes a lot when prices change a little, a product is said to be elastic.

This often is the case for products or services for which there are many alternatives, or for which

consumers are relatively price sensitive. For example, if the price of Cola A doubles, the quantity

demanded for Cola A will fall when consumers switch to less-expensive Cola B.

When there is a small change in demand when prices change a lot, the product is said to

be inelastic. The most famous example of relatively inelastic demand is that for gasoline. As the

URP 1157: Principal of Economics: Fatema Tuj Johora

Department Of Urban Planning: Khulna University Bangladesh

August 14, 2015

price of gasoline increases, the quantity demanded doesn't decrease all that much. This is because

there are very few good substitutes for gasoline and consumers are still willing to buy it even at

relatively high prices.

Income Elasticity of Demand: the responsiveness of quantity demanded to a change in income.

Price Elasticity of Demand (PED): the responsiveness of quantity demanded to a change in price.

Elasticity of Supply: the responsiveness of the quantity supplied to a change in price.

Price Elasticity of demand is the degree of responsiveness of demand to a change in its price. In

technical terms it is the ratio of the percentage change in demand to the percentage change in

price. Thus,

Ep = Percentage change in quantity demanded/Percentage change in price

in mathematical terms it can be represented as: Ep = (∆q/∆p) (p/q)

From the definition it follows that

1. When percentage change in quantity demanded is greater than the percentage change in

price then, price elasticity will be greater than one and in this case demand is said to be

elastic.

2. When percentage change in quantity demanded is less than the percentage change in

price then, price elasticity will be less than one and in this case demand is said to be

inelastic.

3. When percentage change in quantity demanded is equal to the percentage change in price

then price elasticity will be equal to one and in this case demand is said to be unit elastic.

Numerical example to calculate price elasticity of demand:

Let us consider a situation where Price of tea has increased from Rs.7 to Rs 8and as a result of

this demand for tea has declined from 50 cups to 48 cups.

URP 1157: Principal of Economics: Fatema Tuj Johora

Department Of Urban Planning: Khulna University Bangladesh

August 14, 2015

The price elasticity in this case can be calculated as follows:

Percentage change in demand = ( New demand – Old demand)/Old demand

= (48-50)/50

= -0.04

Percentage change in price = (New price –Old Price)/ Old price

= ( 8- 7)/ 7

= o.14

Price elasticity of demand = (percentage change in demand)/(Percentage change in price)

= - 0.04 /0.14

= -0.28

Since the Elasticity of Demand is less than one Demand is inelastic . In other words we can say

that for a 14% increase in price, demand has declined only by 4%. The negative sign indicates

the inverse relationship between demand and price.

Diagrammatic representation Of Price Elasticity of Demand

URP 1157: Principal of Economics: Fatema Tuj Johora

Department Of Urban Planning: Khulna University Bangladesh

August 14, 2015

Income elasticity of demand is a measure of how much demand for a good/service changes

relative to a change in income, with all other factors remaining the same.

The formula for income elasticity is:

Income Elasticity = (% change in quantity demanded) / (% change in income)

An example of a product with positive income elasticity could be Ferraris. Let's say

the economy is booming and everyone's income rises by 400%. Because people have

extra money, the quantity of Ferraris demanded increases by 15%.

We can use the formula to figure out the income elasticity for this Italian sports car:

Income Elasticity = 15% / 400% = 0.0375

An example of a good with negative income elasticity could be cheap shoes. Let's again assume

the economy is doing well and everyone's income rises by 30%. Because people have extra

money and can afford nicer shoes, the quantity of cheap shoes demanded decreases by 10%.

The income elasticity of cheap shoes is:

Income Elasticity = -10% / 30% = -0.33

The elasticity of supply measures the responsiveness of the quantity supplied to a change in the

price of a good, with all other factors remaining the same.

The formula for elasticity of supply is:

Elasticity of Supply = (% change in quantity supplied) / (% change in price)

As demand for a good or product increases, the price will rise and the quantity supplied will

increase in response. How fast it increases depends on the elasticity of supply. Let's look at an

example. Assume when pizza prices rise 40%, the quantity of pizzas supplied rises by 26%.

Using the formula above, we can calculate the elasticity of supply.

Elasticity of

Supply =

(26%) /

(40%) =

0.65

URP 1157: Principal of Economics: Fatema Tuj Johora

Department Of Urban Planning: Khulna University Bangladesh

August 14, 2015

Factors of production:

In economics, factors of production, resources, or inputs are what is used in the production

process in order to produce output—that is, finished goods. The amounts of the various inputs

used determine the quantity of output according to a relationship called the production function.

There are three basic resources or factors of production: land, labour, and capital. Some modern

economists also consider entrepreneurship or time a factor of production.

Difference between classical and neo classical economics:

"Classical" and "neoclassical" are the names for two philosophical approaches to economics. As

the names suggest, classical economics was a predecessor of neoclassical economics. The

differences between the two, however, aren't merely a matter of one coming before the other.

Each had a distinctive approach to analyzing the economy.

1) Attitude of Analysis

Classical economics focuses on what makes an economy expand and contract. As such, the

classical school emphasizes production of goods and services as the key focus of economic

analysis. Neoclassical economics focuses on how individuals operate within an economy. As

such, the neoclassical school emphasizes the exchange of goods and services as the key focus of

economic analysis.

2) Methods of Analysis

Because the classical school aims at explaining how economic systems grow and contract,

economists from this school take a holistic view of such systems. All their analyses and

predictions are based on this wide perspective on the economy as a whole system. The

neoclassical school, on the other hand, explains the behaviors of individual people or companies

within a whole system. The neoclassical method takes a focused view of one small part of an

entire system.

3) Importance of History

Classical economics grounds its analysis in history, specifically the history of the nation or

culture of which a certain economic system is a part. History provides a notion of how this

economy expanded and contracted in the past, which can then be used to try to predict how it

might expand and contract in the future. Neoclassical economics, on the other hand, grounds its

analysis in mathematical models that are not grounded in history. These models provide a notion

of how an individual economic actor might behave in response to certain events.

4) Value in Analysis

Because classical economics focuses so heavily on economic systems and on the production of

those systems, the school emphasizes the inherent value of goods and services. These goods and

services are thought to be worth something regardless of who produces them and who uses them.

URP 1157: Principal of Economics: Fatema Tuj Johora

Department Of Urban Planning: Khulna University Bangladesh

August 14, 2015

Neoclassical economics, with its focus on individuals within systems, emphasizes the variable

value of goods and services. These goods and services are only thought to be worth something

depending upon who produces them, who uses them and how they are used.

How market force determine the price:

Market forces generally is taken to mean the determinants of supply and demand. Generally

where supply and demand meet is the equilibrium price ie optimum price for a given product. If

either the supply or demand changes then the price will be affected.

Thus, market price is derived by the interaction of supply and demand. The resultant market

price is dependent upon both of these fundamental components of a market. An exchange of

goods or services will occur whenever buyers and sellers can agree on a price. When an

exchange occurs, the agreed upon price is called the "equilibrium price", or a "market clearing

price”. This can be graphically illustrated as follows: (Figure 3)

In figure 3, both buyers and sellers are willing to

exchange the quantity "Q" at the price "P". At this

point supply and demand are in balance or

"equilibrium". At any price below P, the quantity

demanded is greater than the quantity supplied. In this

situation consumers would be anxious to acquire

product the producer is unwilling to supply resulting

in a product shortage. In order to ration the shortage

consumers would have to pay a higher price in order

to get the product they want; while producers would

demand a higher price in order to bring more product

on to the market. The end result is a rise in prices to

the point P, where supply and demand are once again

in balance. Conversely, if prices were to rise above P,

the market would be in surplus - too much supply

relative to the demand. Producers would have to lower their prices in order to clear the market of

excess supplies. Consumers would be induced by the lower prices to increase their purchases.

Prices will fall until supply and demand are again in equilibrium at point P.

What is stock?

Stock is a share of a company held by an individual or group. Corporations raise capital by

issuing stocks and entitle the stock owners (shareholders) to partial ownership of the corporation.

Stocks are bought and sold on what is called an exchange. There are several types of stocks and

the two most typical forms are preferred stock and common stock.

Total Revenue and Marginal Revenue:

URP 1157: Principal of Economics: Fatema Tuj Johora

Department Of Urban Planning: Khulna University Bangladesh

August 14, 2015

Revenue

Revenue is the income a firm retains from selling its products once it has paid indirect tax, such

as VAT. Revenue provides the income which a firm needs to enable it to cover its costs of

production, and from which it can derive a profit. Profit can be distributed to the owners, or

shareholders, or retained in the business to purchase new capital assets or upgrade the firm’s

technology.

Revenue is measured in three ways:

Total revenue

Total revenue (TR), is the total flow of income to a firm from selling a given quantity of output

at a given price, less tax going to the government. The value of TR is found by multiplying price

of the product by the quantity sold.

Average revenue

Average revenue (AR), is revenue per unit, and is found by dividing TR by the quantity sold, Q.

AR is equivalent to the price of the product, where P x Q/Q = P, hence AR is also price.

Marginal revenue

Marginal revenue (MR) is the revenue generated from selling one extra unit of a good or service.

It can be found by finding the change in TR following an increase in output of one unit. MR can

be both positive and negative.

Revenue schedule

A revenue schedule shows the amount of revenue generated by a firm at different prices.

PRICE

(£) (000)

QUANTITY

DEMANDED

TOTAL

REVENUE

(000)

MARGINAL

REVENUE

(000)

10 1 10

9 2 18 8

8 3 24 6

7 4 28 4

URP 1157: Principal of Economics: Fatema Tuj Johora

Department Of Urban Planning: Khulna University Bangladesh

August 14, 2015

6 5 30 2

5 6 30 0

4 7 28 -2

3 8 24 -4

2 9 18 -6

1 10 10 -8

Revenue curves

Total revenue

Initially, as output increases total revenue (TR) also increases, but at a decreasing rate. It

eventually reaches a maximum and then decreases with further output.

Less competition in a given market is likely to lead to higher prices and the possibility of higher

super-normal profits.

Average revenue

However, as output increases the average

revenue (AR) curve slopes downwards. The

AR curve is also the firm’s demand curve.

Marginal revenue

The marginal revenue (MR) curve also slopes

downwards, but at twice the rate of AR. This

means that when MR is 0, TR will be at its

maximum. Increases in output beyond the

point where MR = 0 will lead to a negative

MR.

Elasticity of demand: exam problem

Price elasticity of demand: The ratio of the percentage of change in quantity demanded to the

percentage of change in price; measures the responsiveness of demand to changes in price.

URP 1157: Principal of Economics: Fatema Tuj Johora

Department Of Urban Planning: Khulna University Bangladesh

August 14, 2015

pricein change %

demandedquantity in change % demand of elasticity price

Value of Marginal product of labor:

The Production Function and the Marginal Product of Labor

� Production Function is the relationship between quantity of inputs used to make a good and

the quantity of output of that good.

� Marginal Product of Labor the increase in the amount of output from an additional unit of

labor.

� Note: In general, MPL = dQ /dL ;

� Diminishing Marginal Product is the property whereby the marginal product of an input

declines as the quantity of the input increases.

Diminishing Marginal Product is the property whereby the marginal product of an input declines

as the quantity of the input increases.

Value of the Marginal Product the marginal product of an input times the price of the output:

VMPL = P MPL:

Opportunity Cost:

An opportunity cost is defined as the value of a forgone activity or alternative when another item

or activity is chosen. Opportunity cost comes into play in any decision that involves a trade-off

between two or more options. It is expressed as the relative cost of one alternative in terms of the

next-best alternative. Opportunity cost is an important economic concept that finds application in

a wide range of business decisions.

Human capital and theory

Human capital is the stock of knowledge, habits, social and personality attributes,

including creativity, embodied in the ability to perform labor so as to produce economic value.

Alternatively, Human capital is a collection of resources—all the knowledge, talents, skills,

abilities, experience, intelligence, training, judgment, and wisdom possessed individually and

collectively by individuals in a population. These resources are the total capacity of the people

that represents a form of wealth which can be directed to accomplish the goals of the nation or

state or a portion thereof.

Human-capital theory this is a modern extension of Adam Smith's explanation of wage

differentials by the so-called net (dis)advantages between different employments. The costs of

learning the job are a very important component of net advantage and have led economists such

as Gary S. Becker and Jacob Mincer to claim that, other things being equal, personal incomes

vary according to the amount of investment in human capital; that is, the education and training

undertaken by individuals or groups of workers. A further expectation is that widespread

URP 1157: Principal of Economics: Fatema Tuj Johora

Department Of Urban Planning: Khulna University Bangladesh

August 14, 2015

investment in human capital creates in the labour-force the skill-base indispensable for economic

growth.

What is CPI and what are the different methods is of adjust inflation

A consumer price index (CPI) measures changes in the price level of a market basket of

consumer goods and services purchased by households.

Inflation:

The inflation rate is widely calculated by calculating the movement or change in a price index,

usually the consumer price index. The inflation rate is the percentage rate of change of a price

index over time. The Retail Prices Index is also a measure of inflation that is commonly used in

the United Kingdom. It is broader than the CPI and contains a larger basket of goods and

services.

To illustrate the method of calculation, in January 2007, the U.S. Consumer Price Index was

202.416, and in January 2008 it was 211.080. The formula for calculating the annual percentage

rate inflation in the CPI over the course of the year

is: The resulting inflation rate for the CPI in

this one-year period is 4.28%, meaning the general level of prices for typical U.S. consumers

rose by approximately four percent in 2007.

How can we calculate the optimal quantity of public good?

The government is providing an efficient quantity of a public good when its marginal benefit

equals its marginal cost. To determine the optimal quantity of a public good, it is necessary to

first determine the demand for it. Demand for public goods is represented through price-quantity

schedules, which show the price someone is willing

to pay for the extra unit of each possible quantity.

Unlike the market demand curve for private goods,

where individual demand curves are summed

horizontally, individual demand curves for public

goods are summed vertically to get the market

demand curve. As a result, the market demand curve

for public goods gives the price society is willing to

pay for a given quantity. It is equal to the marginal

benefit curve. Due to the law of diminishing

marginal utility, the demand curve is downward

sloping.

Often, the government supplies the public good. The supply curve for a public good is equal to

its marginal cost curve. Because of the law of diminishing returns, the marginal cost increases as

the quantity of the good produced increases. The supply curve therefore has an upward slope.

URP 1157: Principal of Economics: Fatema Tuj Johora

Department Of Urban Planning: Khulna University Bangladesh

August 14, 2015

As already noted, the demand curve is equal to the marginal benefit curve, while the supply

curve is equal to the marginal cost curve. The optimal quantity of the public good occurs where

MB (society's marginal benefit) equals MC (provider's marginal cost), or where the two curves

intersect. When MB = MC, resources have been allocated efficiently.

Define Economics?

Economics is the science that deals with production, exchange and consumption of various

commodities in economic systems. It shows how scarce resources can be used to increase wealth

and human welfare. The central focus of economics is on scarcity of resources and choices

among their alternative uses. The resources or inputs available to produce goods are limited or

scarce. This scarcity induces people to make choices among alternatives, and the knowledge of

economics is used to compare the alternatives for choosing the best among them.

According to Adam Smith (Early Definition: As the Science of Wealth; 1776)

“Economics is concerned with the enquiry into the nature and Cause of wealth of nation.”

According to Alfred Marshall (Marshallian Definition: As the Science of Material Welfare;

1890):

“Economics is the science of mankind in the ordinary business of life; it examines that part of

individual and social action which is most closely connect with the attainment and with the use

of the material requisites of wellbeing “

According to Lionel Robinson (Robinson’s Definition: As the Science of Choice; 1931):

“Economics is the science which studies the human behavior as a relationship between ends and

scarce means which have alternative uses.”

According Paul Samuelson (Modern Definition: On the basis of the concept of growth criteria):

“Economics is a study of how men and society ‘choose’ with of without the use of money, to

employ scarce productive uses resources which could have alternative uses, to produce various

commodities over time and distribute them for consumption, now and in the future among the

various people and groups of society. “

Economics is the study of how men and society choose, with or without the use of money, to

employ scarce productive resources which could have alternative uses, to produce various

commodities over time and distribute them for consumption now and in the future amongst

various people and groups of society (P.A Samuelson).

Thus we can conclude the definition of Economics as;

Economics is a social science concerned with the way the society chooses to employ its limited

resources, which have alternative uses to produce goods and services for present and future

purposes or consumption.

Economics is not only science but also arts, discuss?

URP 1157: Principal of Economics: Fatema Tuj Johora

Department Of Urban Planning: Khulna University Bangladesh

August 14, 2015

I agree with the statement that economics is a combination of both science and art. In order for

economists to theorize mathematical models explaining any type of economic behavior, whether

it’s a supply and demand chart or a production possibilities frontier chart, economists must base

their theories on the future behavior of consumers. This economical behavior is assumed to be

rational by economics, creating an error in their theories when human behavior turns out to be

irrational. Therefore, no economist is able to precisely calculate how humans will respond to

future decisions in the economy. For that reason, this element of uncertainty makes economics an

art. So yes, economics does include various amounts of mathematics, laws, and principles, which

is why most people often are fooled into thinking it’s a science, but you cannot run controlled

experiments in a lab on future consumer behavior.

Economics - A Science and an Art

a) Economics is a science: Science is a systematized body of knowledge that traces the relationship

between cause and effect. Another attribute of science is that its phenomena should be amenable to

measurement. Applying these characteristics, we find that economics is a branch of knowledge

where the various facts relevant to it have been systematically collected, classified and analyzed.

Economics investigates the possibility of deducing generalizations as regards the economic motives

of human beings. The motives of individuals and business firms can be very easily measured in terms

of money. Thus, economics is a science.

b) Economics - A Social Science: In order to understand the social aspect of economics, we should bear

in mind that labourers are working on materials drawn from all over the world and producing

commodities to be sold all over the world in order to exchange goods from all parts of the world to

satisfy their wants. There is, thus, a close inter-dependence of millions of people living in distant

lands unknown to one another. In this way, the process of satisfying wants is not only an individual

process, but also a social process. In economics, one has, thus, to study social behaviour i.e.,

behaviour of men in-groups.

c) b) Economics is also an art. An art is a system of rules for the attainment of a given end. A science

teaches us to know; an art teaches us to do. Applying this definition, we find that economics offers us

practical guidance in the solution of economic problems. Science and art are complementary to each

other and economics is both a science and an art.

The economist has to study both micro and macro-economic problems, two studies are

complementary each other than being alternative matters of the study, discuss?

The study of economics is divided into parts which is both necessary to understand the economy as a

whole. I agree with the statement that both subjects are complementary rather than alternative

1. Microeconomics analyses the economic behaviour of any particular decision making unit such as a

household or a firm. Microeconomics studies the flow of economic resources or factors of production

from the households or resource owners to business firms and flow of goods and services from

business firms to households. It studies the behaviour of individual decision making unit with regard

to fixation of price and output and its reactions to the changes in demand and supply conditions.

Hence, microeconomics is also called price theory.

2. Macroeconomics studies the behaviour of the economic system as a whole or all the decision-

making units put together. Macroeconomics deals with the behaviour of aggregates like total

employment, gross national product (GNP), national income, general price level, etc. So,

macroeconomics is also known as income theory.

URP 1157: Principal of Economics: Fatema Tuj Johora

Department Of Urban Planning: Khulna University Bangladesh

August 14, 2015

Microeconomics cannot give an idea of the functioning of the economy as a whole. Similarly,

macroeconomics ignores the individual’s preference and welfare. What is true of a part or individual

may not be true of the whole and what is true of the whole may not apply to the parts or individual

decision making units. By studying about a single small-farmer, generalization cannot be made about

all small farmers, say in Tamil Nadu state. Similarly, the general nature of all small farmers in the

state need not be true in case of a particular small farmer. Hence, the study of both micro and

macroeconomics is essential to understand the whole system of economic activities.

Three main differences separate micro-and macroeconomics?

First, microeconomics studies individual components, whereas macroeconomics studies the economy as a

whole. Microeconomics treats the economy as so many separate components, whereas macroeconomics

treats the components of the economy as one unit, as one aggregate, that is looks for relationships

between the various components.

Second, controversy aside, government involvement in microeconomics is relatively small, and relegated

to public goods, regulation, and welfare. But, controversy notwithstanding, government involvement in

macroeconomics is rather substantial, nearly total; it is only government that makes and enforces

monetary and fiscal policy.

Third, whereas microeconomics has been around since the mid eighteenth century, macroeconomics

began only as a reaction to the Great Depression of the 1930s.

Discuss significance of opportunity cost?

The opportunity cost of anything is the alternative that has been foregone. This implies that one

commodity can be produced only at the cost of foregoing the production of another commodity. In the

words of Prof. Byrns and Stone “opportunity cost is the value of the best alternative surrendered when a

choice is made.” In the words of John A. Perrow “opportunity cost is the amount of the next best produce

that must be given up (using the same resources) in order to produce a commodity.”

As Adam Smith observed, if a hunter can bag a deer or a beaver in the course of a single day, the cost of a

deer is a beaver and the cost of a beaver is a deer. A man who marries a girl is foregoing the opportunity

of marrying another girl. A film actor can either act in films or do modeling work. She cannot do both the

jobs at the same time. Her acting in film results in the loss of an opportunity of doing modeling work.

Importance of the Concept of Opportunity Cost

1. Determination of Relative Prices of goods

The concept is useful in the determination of the relative prices of different goods. For example, if a given

amount of factors can produce one table or three chairs, then the price of one table will tend to be three

times equal to that one chair.

2. Fixation of Remuneration to a Factor

The concept is also useful in fixing the price of a factor. For example, let us assume that the alternative

employment of a college professor is work as an officer in an insurance company at a salary of $4,000 per

month. In such a case, he has to be paid at least $4,000 to continue to retain him in the college.

URP 1157: Principal of Economics: Fatema Tuj Johora

Department Of Urban Planning: Khulna University Bangladesh

August 14, 2015

3. Efficient Allocation of Resources

The concept is also useful in allocating the resources efficiently. Suppose, opportunity cost of 1 table is 3

chairs and the price of a chair is $100, while the price of a table is $400. Under such circumstances, it is

beneficial to produce one table rather than 3 chairs. Because, if he produces 3 chairs, he will get only

$300, whereas a table fetches him $400, that is, $100 more.

Describe the use of production possibility curve?

Production possibility frontier is a curve on a graph that depicts combination of quantities of different

goods that can be produced by an economy with the fixed quantities of factors of production available

with it. A point on the curve represents situations when the combination of goods produced will utilize

full available quantity of at least one of the factors of production completely. In this situation production

of any good cannot be increased without increasing the quantity of this factor of production, or reducing

production of some other good. A point inside the curve indicates combination quantities of goods

produced will underutilized at all the factors of production to some extent. This represents a situation that

is inefficient. A point outside the production possibility frontier represents a combination of quantities of

different goods that cannot be achieved practically with the existing quantities of factors of production

available.

The production possibility frontier is useful in taking meaningful decisions on allocating the resources of

economy to different sectors of development, and on different types of goods. It enable to identify what is

possible, compare it with what is desirable, and identify resource gaps for achievement of the desirable.

What is substitute goods and complementary goods?

In economics, a complementary good or complement is a good with a negative cross elasticity of demand,

in contrast to a substitute good. This means a good's demand is increased when the price of another good

is decreased. Conversely, the demand for a good is decreased when the price of another good is increased.

If goods A and B are complements, an increase in the price of A will result in a leftward movement along

the demand curve of A and cause the demand curve for B to shift in; less of each good will be demanded.

A decrease in price of A will result in a rightward movement along the demand curve of A and cause the

demand curve B to shift outward; more of each good will be demanded.

Complementary goods exhibit a negative cross elasticity of demand: as

the price of good Y rises, the demand for good X falls.

In consumer theory, substitute goods or substitutes are products that a consumer perceives as similar or

comparable, so that having more of one product makes them desire less of the other product. Formally, X

and Y are substitutes if, when the price of X rises, the demand for Y rises. Potatoes from different farms

URP 1157: Principal of Economics: Fatema Tuj Johora

Department Of Urban Planning: Khulna University Bangladesh

August 14, 2015

are an example: if the price of one farm's potatoes goes up, then it can be presumed that fewer people will

buy potatoes from that farm and source them from another farm instead. A substitute good, in contrast to

a complementary good, is a good with a positive cross elasticity of demand. This means a good's demand

is increased when the price of another good is increased. Conversely, the demand for a good is decreased

when the price of another good is decreased. If goods A and B are substitutes, an increase in the price of

A will result in a leftward movement along the demand curve of A and cause the demand curve for B to

shift out. A decrease in the price of A will result in a rightward movement along the demand curve of A

and cause the demand curve for B to shift in.

Discuss the

different types of demand?

The different types of demands have been explained below as follows:

Individual demand:

It is the quantity of a commodity demanded by an individual consumer at a particular price during a given

period of time. Market demand: It is the total quantity of a commodity demanded by all the consumers

in the market during a given period of time. Joint demand: When two or more commodities are jointly

needed to satisfy a single want, then the demand for such goods are said to be joint demand. Composite

demand: When a commodity is demanded for a number of uses, then the demand for that commodity is

said to composite in nature. Competitive demand: When two goods are close substitutes of one another,

then the demand for such goods is said to be competitive in nature. Derived demand: When demand for

a commodity gives rise to demand for another commodity, then it is said to be as a derived demand.

Variation in demand: It refers to extension or contraction in demand which is exclusively due to change

in the price of a product. Changes in demand: Change in demand refers to increase or decrease in

demand which is due to change factors other than price of the commodity. Giffen goods: It refers to

some inferior goods which are demanded in smaller quantities when their price falls. Direct demand:

Goods which yield direct satisfaction to a customer can be termed as the direct demand.

What is price elasticity of demand? Suppose price increase from 10 taka to 12 taka and

demand falls from 96 unit to 80 unit. Find the price elasticity of demand? Suppose you are

the seller of the product what will be your strategy?

Price elasticity of demand (PED or Ed) is a measure used in economics to show the responsiveness, or

elasticity, of the quantity demanded of a good or service to a change in its price, ceteris paribus. More

precisely, it gives the percentage change in quantity demanded in response to a one percent change in

price (ceteris paribus, i.e. holding constant all the other determinants of demand, such as income).

URP 1157: Principal of Economics: Fatema Tuj Johora

Department Of Urban Planning: Khulna University Bangladesh

August 14, 2015

% change in Q.D = (-16/96)*100 = – 16.67%

% change in price (2/10)*100= 20%

Therefore PED = – 16.67/20 = -0.8335

The negative sign indicates that P and Q are inversely related. Now as a seller the decision will depends

on the revenue and the degree of response of quantity demanded to a change in price.

Revenue: Before 10*96= 960

After: 12*80= 960. So the total revenue is same in both cases, thus change in TR=0. As a seller best

strategy would be to set the price at the point whether elasticity will be less and revenue would be

positive.

Explain the law of supply?

The law of supply is a fundamental principle of economic theory which states that, all else equal, an

increase in price results in an increase in quantity supplied. In other words, there is a direct relationship

between price and quantity: quantities respond in the same direction as price changes. This means that

producers are willing to offer more products for sale on the market at higher prices by increasing

production as a way of increasing profits. In short, Law of Supply is a positive relationship between

quantity supplied and price and is the reason for the upward slope of the supply curve.

Draw the elasticity of supply and define how it can be measured the various point of

supply curve?

The elasticity of supply measures the percentage change in the quantity of supply compared to the

percentage change in a supply determinant. The price elasticity of supply measures the percentage

change in supply quantity compared to the percentage change in the price, which, in turn,

determines the change in total revenue.

Price Elasticity of Supply =

Quantity Change Percentage

Price Change Percentage

If supply is elastic, producers can increase output without a rise in cost or a time delay

If supply is inelastic, firms find it hard to change production in a given time period.

The formula for price elasticity of supply is:

Percentage change in quantity supplied divided by the percentage change in price

URP 1157: Principal of Economics: Fatema Tuj Johora

Department Of Urban Planning: Khulna University Bangladesh

August 14, 2015

When Pes > 1, then supply is price elastic

When Pes < 1, then supply is price inelastic

When Pes = 0, supply is perfectly inelastic

When Pes = infinity, supply is perfectly elastic following a change in demand

What is supply function? What are the determinant of supply?

The supply function is the mathematical expression of the relationship between supply and those

factors that affect the willingness and ability of a supplier to offer goods for sale. An example

would be the curve implied by where is the price of the good and is

the price of a related good. The semicolon means that the variables to the right are held constant

when quantity supplied is plotted against the good's own price. The supply equation is the

explicit mathematical expression of the functional relationship. A linear example is

. Here is the repository of all non-specified factors that affect

supply for the product. The coefficient of is positive following the general rule that price and

quantity supplied are directly related. is the price of a related good. Typically its coefficient

is negative because the related good is an input or a source of inputs.

Determinants of the supply curve.

1. Production cost:

Since most private companies’ goal is profit maximization. Higher production cost will lower profit, thus

hinder supply. Factors affecting production cost are: input prices, wage rate, government regulation and

taxes, etc.

2. Technology:

Technological improvements help reduce production cost and increase profit, thus stimulate higher

supply.

URP 1157: Principal of Economics: Fatema Tuj Johora

Department Of Urban Planning: Khulna University Bangladesh

August 14, 2015

3. Number of sellers:

More sellers in the market increase the market supply.

4. Expectation for future prices:

If producers expect future price to be higher, they will try to hold on to their inventories and offer the

products to the buyers in the future, thus they can capture the higher price.

Discuss the factors of production in brief?

In economics, factors of production, resources, or inputs are what is used in the production process in

order to produce output—that is, finished goods. The amounts of the various inputs used determine the

quantity of output according to a relationship called the production function. There are three basic

resources or factors of production: land, labour, and capital. Some modern economists also consider

entrepreneurship or time a factor of production. These factors are also frequently labeled "producer

goods" in order to distinguish them from the goods or services purchased by consumers, which are

frequently labeled "consumer goods." All three of these are required in combination at a time to produce a

commodity. Factors of production may also refer specifically to the primary factors, which are land, labor

(the ability to work), and capital goods applied to production. Materials and energy are considered

secondary factors in classical economics because they are obtained from land, labour and capital. The

primary factors facilitate production but neither become part of the product (as with raw materials) nor

become significantly transformed by the production process (as with fuel used to power machinery). Land

includes not only the site of production but natural resources above or below the soil. Recent usage has

distinguished human capital (the stock of knowledge in the labor force) from labor. Entrepreneurship is

also sometimes considered a factor of production. Sometimes the overall state of technology is described

as a factor of production.

Why division of labor is advantageous?

The various advantages of division of labour are gives below:

1. Right person in the right Job: Every worker is assigned the task for which he is best suited. This helps

to provide, opportunities for the best utilisation of natural talents as a person performs the job which he

likes he gets pleasure in work. Right man in the right job leads to higher output. Secondly, due to division

of labour, a worker continuously repeats his work. He becomes an expert in performing the job Repetition

of the same work improves his dexterity and skills.

2. Greater Efficiency: Division of labour helps to increase the efficiency of workers due to two reasons.

First, every worker is assigned a job that suits his skills, experience, training and aptitude.

3. Better Quality of Work: Division of labour not only increases the quantity of work it also improves the

quality of production. Better and modern machines and equipment are used. Better quality products help

to increase the goodwill and profits of business.

4. Saving of time: Division of labour helps to avoid waste of time and effort caused by changes from one

type of work to another. The worker does not have to shift from one process to another.

5. Economies of large scale production: Division of labour facilitates mass production. Large scale

production provides economies in the use of resources, such as raw materials, labour, tools etc. Optimum

use of means of production helps to reduce cost of production.

URP 1157: Principal of Economics: Fatema Tuj Johora

Department Of Urban Planning: Khulna University Bangladesh

August 14, 2015

6. Less learning period: Under division of labour a worker needs to learn only a part of the whole task.

Therefore, lesser time and expenditure is involved in training workers.

7. Inventions and Innovations: A worker doing the same task again and again tries to find new and better

ways of doing the job. Small and simple parts of a task can easily be done by machines. Thus, division of

labour increases scope for inventions and innovations.

8. Less Strain: Division of labour makes tasks small and simple Workers can perform them without much

strain and physical tiredness is reduced. Less skilled labour is required to perform the divided and sub-

divided tasks.

9. Wider Market: Division of labour makes available cheaper goods of a wide variety. As a result demand

for goods and services increases.

10. Benefits to society: Society is benefited due to (a) reduced cost on account of large scale production

(b) higher productivity which leads to economic growth (c) employment of unskilled workers and (d)

better quality of goods and services for consumers.

Capital formation tends to be low in under develop countries? Describe

The lack of real capital is so characteristic a feature of all under-developed economies that they are often

called “capital-poor economies”. Low productivity, in under-developed countries, is mainly due to the

small amount of capital per head of population. Low capital for underdeveloped countries can be describe

by the vicious circle whether less productivity generates less per capita income, les savings, less

investment, finally low capital formation.

However, not only is the existing stock of capital very small in the underdeveloped countries, but also the

current rate of capital formation is also very low. In most under-developed countries, investment is only

5% to 8% of the national income, whereas in the United States, Western European countries and in Japan,

it generally varies from 15% to 20% of the national income and even higher.

The low rate of capital formation in under-developed countries is due to the following reasons:

(a) Domestic savings are very small.

(b) There is a dearth of daring, honest and dynamic entrepreneurs who should perform the task of making

investment and bearing risks.

(c) Inducement to invest is very weak.

(d) Weak financial system.

Why should planner need to have a clear understanding about the macroeconomic

variables?

Planners should have a clear idea how the macroeconomic variables such as total income, output,

employment and general price level works to analyze the effects of the functioning of the economy. It

helps to explain them how and why the economy grows and fluctuates over time based on the decisions

made, in the aggregate, by consumers, businesses, and governments. By studying macro variables

planners can develop simple models that can generate useful and realistic explanations about the behavior

of important macroeconomic variables and apply these models to analyze historical and current

macroeconomic developments and to make predictions about future events. It is essential for the

formulation and evaluation of good economic policy.

URP 1157: Principal of Economics: Fatema Tuj Johora

Department Of Urban Planning: Khulna University Bangladesh

August 14, 2015

What do you mean gross domestic products?

The gross domestic product (GDP) is one the primary indicators used to gauge the health of a country's

economy. It represents the total dollar value of all goods and services produced over a specific time

period - we can think of it as the size of the economy.

Difference between nominal and real GDP?

The main difference between nominal and real values is that real values are adjusted for inflation, while

nominal values are not. As a result, nominal GDP will often appear higher than real GDP. Nominal values

of GDP (or other income measures) from different time periods can differ due to changes in quantities of

goods and services and/or changes in general price levels. As a result, taking price levels (or inflation)

into account is necessary when determining if we are really better or worse off when making comparisons

between different time periods. Values for real GDP are adjusted for differences in prices levels, while

figures for nominal GDP are not.

Describe the expenditure method of measuring GDP?

A method for calculating GDP that totals consumption, investment, government spending and net exports.

Although GDP can be calculated through other methods, the expenditure method is the most common.

The formula for its calculation is often expressed as.

GDP = C + G + I + NX

This calculation gives us nominal GDP, which must then be adjusted for inflation to give us the real GDP.

Discuss the divergence between individual and social welfare?

Under the welfare economics individual welfare maximization depends on individual utility function

whether utility derives from their preference and choice, whereas social welfare function uses

microeconomic techniques to evaluate well-being (welfare) at the aggregate (economy-wide) level by

summing all the individual utility functions. Social welfare function treat all individual equally. In using

welfare measures of persons in the society as inputs, the social welfare function is individualistic in form.

One use of a social welfare function is to represent prospective patterns of collective choice as to

alternative social states. The social welfare function is analogous to the consumer theory of indifference-

curve/budget constraint equilibrium for an individual, except that the social welfare function is a mapping

of individual preferences or judgments of everyone in the society as to collective choices, which apply to

all, whatever individual preferences are for (variable) constraints on factors of production. One point of a

social welfare function is to determine how close the analogy is to an ordinal utility function for an

individual with at least minimal restrictions suggested by welfare economics, including constraints on the

amount of factors of production.

What are the obstacles to welfare maximization?

If maximum welfare is to be attained optimum allocation of factors of production is essential. This

allocation must he in keeping with the consumer’s preferences. For this purpose there must prevail

perfect competition. But in the real world perfect competition docs not prevail instead there is imperfect

competition. This constitutes a big obstacle in the way of the attainment of maximum welfare.

Imperfect competition may take the form of monopoly or monopolistic competition or oligopoly. We see

how these market forms stand in the way of welfare maximization.