Unit – 1Scope of Economics

Mechanism of Supply and Demand

Archana.HM.Arch, 1st SemCSIIT, Hyd

Definition of Economics

Economics has various definitions, such as;

The art of handling scarce resources

The study of choice

How society chooses to allocate its scarce resources among competing demands to best satisfy human wants

Micro Vs. MacroeconomicsMicroeconomics: is generally the study of individuals and business decisions regarding the allocation of resources, and prices of goods and services.

Macroeconomics: looks at a higher level (country and government decisions), studies the behavior of the economy as a whole and not just on specific companies, but entire industries and economies.

The Economic Problem

The Economic problem is summed up in 4 points;

Unlimited Wants

Scarce Resources – Land, Labour, Capital

Resource Use

Choices

Unlimited Wants

It simply means that people are never totally satisfied with the quantity and variety of goods and services they consume.

It means that people never get enough, that there's always something else that they would want or need.

SCARCE RESOURCES

It states that society has insufficient productive resources to fulfill all human wants and needs.

Alternatively, scarcity implies that not all of society's goals can be pursued at the same time; tradeoffs are made of one good against others.

Resource Use

Since we established already that resources are scarce, so the use of these scarce resources becomes the most important aspect of all.

Proper and efficient management of these scarce resources is the key to success and prosperity.

CHOICES

Choices are inevitable because human wants and needs are unlimited but the resources available to meet them are finite.

Examples:

What is to be produced?How is it to be produced?

For whom will it be produced?

The concept of efficiency

Economists define Efficiency as the absence of Waste. An efficient

economy utilizes all of its available resources and produces the

maximum amount of output that its technology permits.

But why are resources wasted in real life?

oFor many reasons, such as;

Unemployment: which is the most important waste of all, waste of human resources.

Assigning inputs to the wrong task: Like using a dry land to grow rice and a rainy land to grow sesame!

Poor Management: Failure in managing the decision making process leading to waste in resources.

Opportunity costOpportunity cost is what a person sacrifices when they choose an option over another, the cost of an alternative that must be forgone in order to pursue a certain action. Put another way, the benefits you could have received by taking an alternative action.

oExample: The opportunity cost of going to college is the money you would have earned if you worked instead. On the one hand, you lose four years of salary while getting your degree; on the other hand, you hope to earn more during your career, thanks to your education, to offset the lost wages. 

Opportunity COST

In all cases, a choice between two options must be made. It would be an easy decision if you knew the end outcome; however, the risk that you could achieve greater "benefits" (be they monetary or otherwise) with another option is the opportunity cost.

What is market?

Literal meaning-Place where goods and services are brought and sold

In economics- It is used in abstract sense.According to SAMUELSON & NORDHAUS A market is a mechanism by which buyers & sellers interact to determine the price & quantity of a good or service.Sellers & buyers- individuals, firms, factories, dealers & agents

Features of market concept

A market need not be situated in a particular locality or area

Buyers & sellers need not come into personal contact with each other

Word market may refer to a commodity / service or to a geographical area

Economists distinguish market on the basis ofNature of goods & services (input market, output market)No. of firms & degree of competition. (competitive mkt.,

monopolistic market)

What is market mechanism?The market for a product works on certain market

principles i.e. the laws that govern the working of the market system, also called market mechanism

Working of the market system is governed by certain fundamental laws of market called Law of Demand and Supply.

Clear understanding of this is required for chalking out an appropriate market strategy.

Supply side of the marketSome important terms in this:- Supply- It is the quantity of a commodity that its producers/

sellers offer for sale at a given price, per unit of time.

Market supply- Sum of suppliers of a commodity made by all the individual firms or their supply agencies. Market supply of product is governed by the law of supply.

Supply of a commodity depends on:-1.Its price2.Cost of production.

Law of supply-

Supply of a product – Increase in price

And vice versa all the other factors remaining constant.

Other things – technology, price of related goods, weather & climatic conditions in case of agricultural goods.

Supply schedule- A supply schedule is a tabular presentation of the law of supply.

Supply curve- Graphical representation of supply schedule.

Pric

e

Quantity supplied per unit of time

Supply function- It is a mathematical statement which states the relationship between the quantity supplied of a commodity and its price.

Qx = 10Px

Qx = quantity supplied of commodity X

per unit of time

Px = Its Price

How determinants of supply causes shift in supply curve?

1. Change in Input prices-

Input prices – Use of inputs

As a result, Product Supply Supply curve SS shifts to the right to SS’ When input Price increases, product supply curve shifts toSS’’

Quantity

Supply CurvePr

ice

SS’ S’’

2. Technological Progress-

Technological changes that ------ Product Supply reduce cost of production or increase efficiency in production

3.Price of product substitutes-

Fall in the price of --------- Supply of other one of the product ’s substitutes

4.Nature & Size of the industry-

Depend on whether an industry is monopolized or competitive.

Under monopoly -------- Supply is fixed

If monopolized industry ------- Total supply is made competitive

If size of an industry ------- Total supply due to new firms joining the industry

5. Government policy-

When govt. imposes --------- Production tends to fall restrictions on production Supply

6.Non economic factors –

Labor, strikes, lockouts, communal riots, epidemics, affect supply

Market equilibrium- equilibrium of demand & supply

Determination of price in a Free marketFree market – is one in which the market forces of

demand & supply are free to take their own course & no outside control on price, demand & supply

Market equilibrium – Refers to a state of market in which Quantity demanded = Quantity supplied

of a commodity of the commodity

Equality of demand and supply produces equilibrium Price

It is also called Market Clearing Price because market is cleared in the sense that there is no unsold stock and no

unsupplied demand.

Determination of market priceIn a free market, disequilibrium itself creates the condition

for equilibrium.

When there is excess supply, it forces downward adjustment in the price & quantity supplied.

When there is excess of demand it forces upward adjustment in the price & quantity demanded.

Process of downward & upward adjustment in price determines till price reaches equilibrium and the quantities supplied and demanded are in balance

This process is automatic.

Market mechanism: How market brings balance?Market mechanism: Process of interaction between the

market forces of demand & supply to determine equilibrium price.

1) If

Supply with demand

Then it gives sellers an opportunity to raise its price & it prepares buyers to accept & pay higher price. As result price goes up.

So we conclude that :-

If Supply with demand ------Prices

2) If

Supply with demand Excess supply forces the competing sellers to cut down the price in order to clear their unsold stock.

Some firms find low price unprofitable & go out of the market.

Some cut down their productivity, supply goes down

Thus we conclude that :-

If Supply with demand ------- Prices

Quantity

Demand, Supply, and Market Price

Pric

e SupplyDemand

EE

Quantity

Surplus

Pric

e

SupplyDemand

E

Surplus

The equilibrium condition is not fulfilled at any other point on the demand and supply curves. Therefore, there would be either excess supply or shortage.

Quantity

Shortage

Pric

e

Supply

Demand

E

Shortage

The equilibrium condition is not fulfilled at any other point on the demand and supply curves. Therefore, there would be either excess supply or shortage.

Shift in Demand and Supply curves and equilibrium

O

Quantity

D

D’’

D’

D

P

M

Q N

S

S Shift in demand curve and equilibrium

Price

Quantity

S

S’’

D

D

P

M

Q N

S

S’

Price

Shift in Supply curve and equilibrium

Quantity

Price

S

S3

D1

D

E1

Q1

S

S1

P1

D2

P0

Q3

E3E2

Q2

D

S

S3

Parallel shift in Demand Supply curve and its effect on equilibrium price and output

Simultaneous Shift in Simultaneous Shift in Demand and Supply curvesDemand and Supply curves

Parallel shift in Demand Supply curve and its effect on equilibrium price and output

Quantity

S

S2

D1

D

E1

Q1

S

S1

Price

P1

D2

P2

Q2

E2

D