INSTRUCTOR’S INFORMATION

Adams SorekuongYakubu Adama

School of Economics
University of Cape Coast
adams.adama@ucc.edu.gh
+233244368026
 The Role and Method of Economics

• Economics:A Brief Introduction

• Economic Behaviour
• Economic Theory
• Pitfalls to Avoid in Scientific Thinking
• Positive Analysis and Normative Analysis
 Economics: A Brief Introduction
 You’re thinking about cutting class
and going to the beach?
 Is the expected marginal benefit greater than the expected marginal cost?
 What if it is expected to be windy and rainy?
 What if you have a final next class period, and today is the review?
 Do these scenarios affect your decision?
 Many issues in our lives are at least partly economic in character:
 Why do 10 AM classes fill up faster than 6:30 AM classes during Lectures?
 Economics: A Brief Introduction
 Why is teenage unemployment higher than adult unemployment?
 How does inflation impact you and your family?
 Why do professional athletes make so much money?
 The study of economics improves your understanding of these and many other
concerns.
 The economic approach sheds light on many social issues such as discrimination,
education, crime and divorce.
Economics: A Brief Introduction
 Newspapers and websites are filled with
articles related to economics—either
directly or indirectly. News headlines
may cover topics such as
unemployment, deficits, financial
markets, health care, Social Security,
energy issues, war, global warming, and
so on.
 Economics: A Brief Introduction
 Economics is the study of the choices we make among our many wants, and
desires given our limited resources.
 Resources are inputs (land, human effort, and skills, and machines and factories)
that are used to produce goods and services.
 The problem is that our unlimited wants for goods and services exceed our limited
resources, a fact that we call scarcity.
 The economic problem: Scarcity forces us to choose, and choices are costly
because we must give up other opportunities that we value.
 Consumers must make choices on what to buy, how much to save, and how much
to invest of their limited incomes.
 Economics: A Brief Introduction
 Workers must decide what types of jobs they want, when to enter the workforce,
where they will work, and number of hours they wish to work.
 Firms must decide what kinds of goods and services to produce, how much to
produce, and how to produce those goods and services at the lowest cost.
 Consumers, workers, and firms all face choices because of scarcity, which is why
economics is sometimes called the study of choice.
 Economics: A Brief Introduction
 Living in a world of scarcity involves trade-offs.
 When you choose to do something, you are giving up other things you value:
shopping, spending time on Facebook, text messaging with friends, going to the
movies, sleeping, or working out. Choices are costly.
 Economic Behaviour
 Economists assume that most individuals act as if they are motivated by self-
interest and respond in predictable ways to changing circumstances.
 To a worker, self-interest means pursuing a higher paying job and/or better
working conditions.
 To a consumer, self-interest means gaining a greater level of satisfaction from their
limited income and time.
 In short, a great deal of human behavior can be explained and predicted by
assuming that most people act as if they are motivated by their own self-interest in
an effort to increase their expected personal satisfaction
 Economic Behaviour
 When people make choices, they often do not know with certainty which choice is
best. But they expect the best outcome from that decision—the one that will yield
the greatest satisfaction.
 Critics will say people don’t think that way, and the critics might be right. But
economists are arguing that people act that way.
 Economists are observing and studying what people do—their actions. We largely
leave what people think to psychologists and sociologists.
 There is no question that self-interest is a powerful force that motivates people to
produce goods and services. But self-interest can include benevolence.
 Economic Behaviour
 Think of the late Mother Teresa, who spent her life caring for others. One could say
that her work was in her self-interest, but who would consider her actions selfish?
 Similarly, workers may be pursuing self-interest when they choose to work harder
and longer to increase their charitable giving or saving for their children’s
education.
Economic Behaviour (What is Rational Behaviour?)
 Economists assume that people, for the most part, engage in rational, or
purposeful, behavior.
 To an economist, rational behavior merely means that people do the best they can,
based on their values and information, under current and anticipated future
circumstances.
 That is, people may not know with complete certainty which decisions will yield
the most satisfaction and happiness, but they select the one that they expect to give
them the best results among the alternatives.
 It is important to note that it is only the person making the choice that determines
its rationality.
Economic Behaviour (What is Rational Behaviour?)
 You might like red sports cars while your friend might like black sports cars
 So, it would be rational for you to choose a red sports car and your friend to
choose a black sports car.
 Economists assume that people do not intentionally make decisions that will make
them worse off. Most people act purposefully.
 They make decisions with some expected outcome in mind. Their actions are
rational and purposeful, not random and chaotic.
Economic Behaviour (What is Rational Behaviour?)
 Individuals all take purposeful actions when they decide what to buy and produce.
 They make mistakes and are impacted by emotion, but the point is that they make
their decisions with some expected results in mind.
 In short, rational self-interest means that individuals try to weigh the expected
benefits and costs of their decisions.
 Economic Theories and Models
Theories: Is shorthand way of telling or explaining a
story and making predictions.
Here we use logic, reason and inductions to arrive at
conclusions.
Because of the complexity of human behaviour,
economists must abstract to focus on the most
important components of a particular problem.
 Economic Theories and Models
This is similar to maps that highlight the important information
(and assume away many of the minor details) to help people get
from here to there.
How is economic theory like a map? Much like a road map,
economic theory is more useful when it ignores details that are
not relevant to the questions that are being investigated.
Economic Theories and Models
 Economic Theories and Models
Models: A model is a formal statement of a theory. It is usually a
mathematical or graphical statement of a presumed relationship
between two or more variables.
We use models to simplify reality in order to improve our
understanding of the world.
 Economic Theories and Models
An economic model is abstract because it doesn’t attempt to
capture all of the relevant influences on behaviour.
Building an economic model often follows these steps:
Decide on the assumptions to use in developing the model.
Formulate a testable hypothesis.
Use economic data to test the hypothesis.
Revise the model if it fails to explain the economic data well.
Retain the revised model to help answer similar economic questions
in the future.
 Economic Theories and Models
Example of economic model:
𝑸 = 𝒇(𝑷𝒙 , 𝑴, 𝑷𝒚 ) 𝒐𝒓 𝑸 = 𝒂 + 𝒃𝟏 𝑷𝒙 + 𝒃𝟐 𝑴 + 𝒃𝟑 𝑷𝒚
Variables: A measure that can change from time to time or from
observation to observation
Economic variables could be Endogenous or Exogenous
variable.
Economic Theories and Models(Assumptions & simplifications)
Assumptions Simplifies the economic problem that is being
analyzed
Every economic model makes two types of assumptions:
Simplifying assumption and critical assumption.
Simplifying assumption is a way of making a model simpler
without affecting any of its important conclusions
Economic Theories and Models(Assumptions & simplifications)
A roadmap, for example, makes the simplifying assumption,
“There are no trees.”
Such assumptions wouldn’t change the important insight we get
from the phenomenon under study
Critical assumption is that assumption that affects conclusions
of a model in important ways
Examples of such assumption are those associated with firm
behaviour.
 Assumptions and simplifications
➢A common assumption in economics is expressed
using a ceteris paribus.
➢“holding everything else constant”
➢For example, if the price of tomatoes falls, we would
expect to see more people buy tomatoes.
➢What if all other things are not equal
 The Ten Principles of Economics
➢ Markets are usually a good way to organize economic activity.
➢ A country’s standard of living depends on its ability to produce goods and service.
➢ Prices rise when the government prints too much money
➢ Government can sometimes improve market outcomes
➢ Society faces a short-run trade-off between inflation and unemployment
 Why study Economics?
➢To learn a way of thinking.
➢Opportunity Cost
➢Efficient market - No free lunch
➢Marginalism - cost & benefit analysis
➢ To understand how society works.
➢To be an informed citizen and gain self-confidence.
➢To Help Prepare for Other Careers.
➢To Become an Economist
 Microeconomics & Macroeconomics
➢Microeconomics examines the functioning of
individual industries and the behaviour of individual
decision making units business firms and households.
➢It is concerned with the choices of firms on:
➢What to produce
➢How to produce
➢When to produce
➢How much to charge for what has been produced
 Microeconomics & Macroeconomics
➢It is also concerned with how households make
choices about:
➢What to buy
➢How much to buy
➢When to buy etc.
➢Thus microeconomics is based on how decisions are
made by individuals and firms and the consequences
of those decisions
 Microeconomics & Macroeconomics
➢Macroeconomics is the study of economy-wide
phenomena, including inflation, unemployment and
economic growth.
➢Macroeconomics looks at the economy as a whole.
➢That how the actions of all the individuals and firms in the
economy interact to produce a particular level of economic
performance as a whole
➢It examines the factors that determine national output, or
national product.
 Microeconomics Vs. Macroeconomics
➢Microeconomics looks at the individual unit - the
household, firm and industry.
➢Macroeconomics looks at the whole, the aggregate.
➢Microeconomics is concerned with household
income;
➢Macroeconomics deals with national income.
 Microeconomics Questions
➢Go to business school or take a job?
➢What determines the salary offered by GCB to Kofi
Mensah?
➢What government policies should be adopted to
make it easier for low-income students to attend
colleges of education?
➢How much money do you have on you?
 Macroeconomics Questions
➢How many people are employed in the economy as a whole?
➢What determines the overall salary levels paid to workers in a
given year?
➢What determines the overall level of prices in the economy as a
whole?
➢What government policies should be adopted to promote full
employment and growth in the economy as a whole?
➢What determines the overall trade in goods, services and
financial assets between the Ghana and the rest of the world?
 Fields of Economics

➢ Behavioural Economics, ➢ Health Economics,

➢ Comparative economic ➢ International Economics,
systems, ➢ Labour Economics,
➢ Econometrics, ➢ Public Economics,
➢ Development Economics, ➢ Monetary Economics,
➢ Economic History, ➢ Mathematical Economics,
➢ Environmental Economics, ➢ Urban and Regional Economics,
➢ Financial Economics, ➢ Economics of Sports
Nature Of Economics
 Positive and Normative Economics
➢Economists like Scientists usually seek the truth
about how individuals behave
➢Economists also make predictions about economic
behaviour and assess the validity of those predictions
based on experiences
➢Economists also observe patterns of behaviour
objectively with value judgement
 Positive Economics

➢Positive economics emphasizes how people do

behave, rather than how people should behave.
➢Economist attempt to observe patterns of behaviour
objectively, without reference to the appropriateness
or inappropriateness of that behaviour.
➢This objective, value-free approach, based on the
scientific method, is called positive analysis.
 Positive Statements
➢Positive economic statements are statements that
attempt to describe the world as it is.
➢That is, descriptive analysis. It describes what exists
and how it works.
➢It is the use of objective, value-free approach based
on scientific methods.
➢A positive statement does not have to be a true
statement, but it does have to be a testable statement
 Positive Statements
➢Examples include:
➢An increase in the minimum wage will cause a decrease
in employment among the least-skilled.
➢Higher federal budget deficits will cause interest rates to
increase.
➢If carbon emissions were cut by 25%, air quality would
improve and the number of people diagnosed with
asthma would decrease significantly
 Normative Statements
➢Normative statements are statements about how the
world should be or how the world ought to be.
➢It looks at the outcomes of economic behaviour and asks
whether they are good or bad and whether they can be
made better.
➢They are subjective non-testable item about what should
be or what ought to happen.
➢They can be seen prescriptive analysis - policy
economics.
 Normative Statements
➢Examples include:
➢ The income gains from a higher minimum wage are worth more than any slight
reductions in employment.
➢Governments should collect from tobacco companies the costs of treating
smoking-related illnesses among the poor.
➢Should the government subsidize or regulate the cost of higher education?
Should medical benefits to the elderly under Medicare be available only
to those with incomes below some threshold?
➢To clean up air quality and cut down carbon emissions by 25%, 4x4
vehicles should only be sold to farmers and those living in rough
terrain areas
 Methods of Studying Economics
➢Historical or Inductive methods: based on
happenings in the past.
➢Deductive or Observation methods: observing the
fact to make future predictions.
 Tools of Economic Analysis
➢These are economic methods and process for
economic analysis.
➢These tools are mostly used to analyse relationships
that are captured by economic variables.
➢E.g: when the price of sugar rises, people buy fewer
sugar.
➢This mean there is a relationship between the price
of sugar and amount of sugar bought.
 Theories in Economics
 Theories are shorthand way of telling or explaining a story and making predictions
 It involves the use of logic, reasoning and induction to arrive at conclusions
 Because of the complexity of human behaviour, economist abstract to focus on the
most important components of a particular problem.
 Models in Economics
 Models are formal statements of a theory. It is usually a mathematical or graphical
statement of a presumed relationship between two or more variables
 Models are used to simplify reality in order to improve our understanding of the
world
 An economic model is abstract because it doesn’t attempt to capture all the
relevant influences on behaviour
 Steps in building an Economic Model
Building an economic model often follows these steps
 Decide on the assumptions to use in developing the model.
 Formulate a testable hypothesis
 Use economic data to test the hypothesis
 Revise the model if it fails to explain the economic data well
 Retain the revised model to help answer similar economic questions in the future.
 Assumptions and Simplifications
 Assumption simplify the economic problem that is being analysed
 Every economics model makes two types of assumption
 Simplifying assumption
 Critical assumption
Simplifying assumption is a way of making a model simpler without affecting any of
its important conclusions
Examples of a simplifying assumption
A roadmap, for example, making the simplifying assumption. “There are no trees”
Assumptions and Simplifications
 Such assumption would not change the important insight we get from the
phenomenon under study
 Critical assumption on the other hand is that assumption that affects conclusions of
a model in important ways
 Examples of such assumption are those associated with firms behaviour

 All Else Equal

 Ceteris paribus or all else equal is a device used to analyze the relationship between two
variables while the values of other variables are held unchanged
 Using the device of ceteris paribus is one part of the process of abstractions
 Theories and Model Economics
 Cautions and Pitfalls
Economists are interested in cause and effect, but sorting out causality from
correlation is not always easy
Post Hoc, Ergo Propter Hoc: Literally, “after this (in time), therefore because of this.”
This is a common error made in thinking about causation:
If Event A happens before Event B, it is not necessarily true that A caused B
Empirical Economics refers to the collection and use of data to test economic
theories
 Tools of Economic Analysis
➢Economists use tools to represent such relationships.
➢Does this mean that there is a relationship between
the variable, price and the variable, demand?
➢Economists will use maths to represent such
relationships and also through graphs.
 Tools of Economic Analysis

➢Words
➢Functions 𝐐𝐃 = 𝐟 𝐏 𝐨𝐫 𝐐𝐒 = 𝐟 𝐏 𝐐𝐃 = 𝐟(𝐏, 𝐘, 𝐏𝐘 , 𝐇)
➢Linear Equations 𝐐𝐃 = 𝛂 + 𝛃𝐏
➢Tables
➢Graphs
➢Graph of two variables
➢Graphs of a Single Variable
Q P
0 10
5 9
7 8
9 7
11 6
13 5
15 4
17 3
19 2
21 1
Tools of Economic Analysis
 Tools of Economic Analysis
Economic Growth Rate (Ghana only)
16
14 14.04600263
12
10
9.149799094 9.292511869
8 7.899740293
7.312525021
6 6.399912419
5.900003953
5.59999999
5.199999984 4.845756132
4 4 4.499999699 4.346819153 3.985865624
3.882704469
2
0
2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015
 Economic Behaviour-(Self Interest)
➢Why did you come to lecture today?
➢Why do people go to work?
➢Economists assume that most individuals act as if
they are motivated by self-interest and respond in
predictable ways to changing circumstances.
➢Self-interested simply means that you seek your own
personal gain.
 Economic Behaviour-(Self Interest)

➢Acc. to Adam Smith: ”It is not from the benevolence

(kindness) of the butcher, the brewer, or the baker
that we expect our dinner, but from their regard to
their own interest.”
➢To a worker, self-interest means pursuing a higher
paying job and/or better working conditions.
➢To a consumer, self-interest means gaining a greater
level of satisfaction from their limited income and
time.
 Economic Behaviour-(Self Interest)

➢Human behaviour can be explained and predicted by

assuming that most people act as if they are motivated by
their own self-interest in an effort to increase their
expected personal satisfaction.
➢There is no question that self-interest is a powerful force
that motivates people to produce goods and services.
➢Similarly, workers may be pursuing self-interest when
they choose to work harder and longer to increase their
saving for their family.
➢Question: Is being self-interested greedy? Is it immoral?
 Economic Behaviour-(Rational Behaviour)

➢Have you ever been accused of being irrational?

➢Economists assume that people, for the most part,
engage in rational, or purposeful, behaviour.
➢Rational behaviour is when our actions are
predictable, sensible and logical.
➢It is when individual or economic agent exercises
sensible choice making, which provides them with
the optimum amount of benefit.
 Economic Behaviour-(Rational Behaviour)

➢Economic theories typically assume that individuals

are rational beings, working to obtain that which is
most beneficial to themselves.
➢That is, people may not know with complete
certainty which decisions will yield the most
satisfaction and happiness. But they select the
one that they expect to give them the best results
among the alternatives.
 Economic Behaviour-(Rational Behaviour)

➢NOTE: it is only the person making the choice that

determines its rationality.
➢You might like red sports cars while your friend
might like black sports cars.
➢So it would be rational for you to choose a red sports
car and your friend to choose a black sports car.
 The Economic Problem
➢Now we examine some ideas that serve as the basic
foundation of economics.
➢These basic ideas will occur repeatedly throughout our
study of economics.
➢Economic agents face scarcity, costly trade-offs and
opportunity cost.
➢People are rational decision makers and engage in
marginal thinking; and people respond predictably to
incentives.
 The Economic Problem

What Will You Do?

Suppose you are offered a part-time job which will pay you GH 2000.00 every month.
However, the nature of the job is such that you will not be able to learn or do your
assignments over the weekend.
Will you choose the part-time job over making good grades in school?
 The Economic Problem
➢People Face Scarcity and Costly Trade-offs
➢Individual wants are practically unlimited.
 The Economic Problem
➢On the other hand resources available to satisfy this
wants are very limited.
➢This gives rise to the problem of scarcity.
➢Economics is concerned primarily with scarcity —
how well we satisfy our unlimited wants in a world of
limited resources.
➢As long as human wants exceed available resources,
scarcity will exist.
 The Economic Problem

➢Resources refers to inputs or factors of production,

used to produce goods and services.
➢Inputs and Resources: Anything provided by nature
or previous generations that can be used directly or
indirectly to satisfy human wants.
➢Categories of inputs: Land, Labour, Capital and
Entrepreneurial ability.
 The Economic Problem
➢Land: is a gift of nature and it include all water bodies,
trees, Oil reserve, air etc.
➢Labour: Includes human efforts both physical and mental.
➢Capital: Human creations used in producing goods and
services. Physical capital like: Factories, tools, machines,
airports, highways etc. Human capital: consist of
knowledge and skills that enhance labour productivity.
➢Entrepreneurial Ability: special human skills, talent
required to bring new products.
 Economics in Practice

What Will You Do?

Suppose you are offered a part-time job which will pay you GH 2000.00 every
month. However, the nature of the job is such that you will not be able to learn or do
your assignments over the weekend.
Will you choose the part-time job over making good grades in school?
 What are Goods and Services
➢Goods are tangible & intangible things for which more is
preferred to less of it. Thus, they are items we value or
desire to have more of it.
➢Services on the other hand are intangible acts for which
people are willing to pay for.
➢Can we equate the desire of people to have more of a good
to selfishness?
➢Does everyone face scarcity in life?
➢Can we ever eliminate scarcity?
 The Three Basic Questions
 Every society has some system or process that transforms its scarce resources into useful goods
and services.
 In doing so, it must decide what gets produced, how it is produced, and to whom it is distributed.
 The primary resources that must be allocated are land, labor, and capital.
 Choice and Opportunity Cost

➢Due to the unlimited nature of our wants, we are always

forced to choose from our numerous wants, things our
available resources can satisfy.
➢This implies that we always forced to trade off some items
for the other.
➢Trade-off implies the exchange of one thing to get the
another.
➢The choices sacrificed. It represents what is given up to
get what is wanted?
 Choice and Opportunity Cost

➢Economic Choice: is deciding between different uses

of scarce resources.
➢Once you are compelled to make choices, you would
be compelled to leave out some of your wants.
➢Opportunity Cost: this is the value of the next best
alternative forgone.
➢Thus , what you give up when you make a choice
Summary of the Economic Problem

Resources

Scarcity
Economic Goods
 Is there any such thing as free Lunch?
➢The expression “there’s no such thing as a free lunch”
clarifies the relationship between scarcity and
opportunity cost.
 Marginal Thinking
➢Individual decisions are rarely straight-forward and usually
involve weighing of costs and benefits to achieve maximum
results.
➢Economist emphasize marginal thinking when the focus is on
additional or marginal choices.
➢Marginal choices involve the effects of adding or subtracting
from the current situation.
➢Marginal Change: describe small incremental adjustments to an
existing plan of action.
➢Thinking at the margin can be seen as the basic rule of rational
behaviour.
 Incentives Matter

➢Individuals always wish to be better off today than

they were yesterday.
➢As such they respond to changes in incentives.
➢Economics can therefore be reduced to incentive
Marginal Benefit vs. Marginal Cost.
➢Both consumers and producers are driven by
incentives that affects their expected cost or benefits.
 Economic System
➢Because of scarcity, certain economic questions must
be answered regardless of the level of affluence of the
society or its political structure.
Economic System

Scarcity
Command Economics/Socialism
 Command Economies

➢They rely on central planning.

➢Decisions about what is produced is largely
determined by a government official or a committee
associated with the central planning organization.
➢E.g. Cuba, Russia, N. Korea, and China
 Command Economies

➢Features:
➢Economic resources are owned by a centrally planned authority
or state ownership.
➢Central planners guide economic activities and answer the three
key questions of the economic problem.
➢Adv.
➢May improve efficiency and fairness in allocation of resources.
➢Disadv.
➢a poorly functioning government can destroy incentives, lead to
corruption, and result in the waste of a society’s resources.
 Market economies

➢It largely rely on a decentralized decision-making

process.
➢Literally millions of individual producers and
consumers of goods and services determine what
goods will be produced.
➢E.g. U.S., Canada, Germany, U.K., Japan
 Market economies

➢Features:
➢Private ownership of economic resources or factor of
production.
➢Minimal government intervention.
➢Economic decisions are based on market conditions or
prices.
➢Production is operated primarily for profit gains.
 Market economies

➢Adv.
➢Raises the standard of living of people by allowing individuals to
earn income and enjoy life.
➢Profit motives provides an incentive for entrepreneurs to take risks
to organize factor of production.
➢Profit motives leads to innovations in knowledge and information
which further lead to economic development.
➢Disadv.
➢it favours those whose have acquired factors of production are able
to exploit workers.
➢it leads to social and economic inequalities.
 Mixed Economies

➢Most countries, including the Ghana, have mixed

economies in which the government and private
sector together determine the allocation of resources.
➢Combines the features of the two types
 Mixed Economies

➢Both price mechanism and government intervention in

the market might still lead to inefficiencies.
➢Market failures: is a situation where the market fails to allocate
the scarce resources to their most efficient use. Possible
causes: Externalities and market power.
➢Externalities: cost and benefit of one person’s actions on the
well-being of a third party which the decision maker
does not take into account in making the decision.
➢Market power: is the ability of a single economic agent to have a
substantial influence on market prices or output.
 The Circular Flow Model

➢A simple economic model illustrating the flow of goods and

services though the economy.
➢In the model, producers are termed as "firms" while consumers
are referred to as "households."
➢Firms supply goods and services while households consume
these goods and services.
➢Factors of production (land, labour, capital) are supplied by the
household to firms and the firms convert these into finished
products for household consumption.
➢Product markets are the markets for goods and services
➢Factor or input markets
 Consumption Product Market
Expenditure Household buy
Firms Sell Revenue
Goods and Services
purchased Goods and Services
Supplied
Households
Buy Goods & Services Firms
Supply inputs Supply Goods & Services
Buy inputs
Factors of
Factors of
production Supplied
production
Factor Market purchased
Household Sell
Firms Buy Wages, rent,
Money Income
interest profit
 Efficiency

➢An efficient economy is one that produces what

people want at the least possible cost. If the system
allocates resources to the production of goods and
services that nobody wants, it is inefficient.
➢E.g: If all members of a particular society were vegetarians
and somehow half of all that society’s resources were
used to produce meat, the result would be
inefficient.
 Efficiency

➢Inefficiencies: can arise in numerous ways. Sometimes

they are caused by government regulations or tax laws
that distort otherwise sound economic decisions.
➢A firms that cause environmental damage are not held
accountable for their actions, the incentive to
minimize those damages is lost and the result is
inefficient.
 Equity

➢Equity: has to do with Fairness or equal distribution.

➢equity (fairness) lies in the eye of the beholder. To
many, fairness implies a more equal distribution of
income and wealth.
➢Fairness may imply alleviating poverty, but the extent
to which the poor should receive cash benefits from
the government is the subject of enormous
disagreement.
 The Production Possibilities Frontier/Curve
➢Scarcity & opportunity cost are unavoidable
➢A PPF is used to illustrate opportunity cost that an
economy may face in the production of goods and
services
➢Hence, it can be seen as a model of scarcity, choice, &
opportunity cost.
➢The PPF shows the trade-offs among choices we make.
 The Production Possibilities Frontier/Curve

➢The PPF is a curve showing different combinations of

goods and services that can be produced in a full
employment, where the available supplies of resources and
technology are fixed.
➢Thus, the PPF represents all the different combinations of
goods and services an economy can produce at maximum
efficiency.
➢It’s called the PPF because the graph shows the POSSIBLE
outcomes of PRODUCTS, When all productive resources
are fully employed.
 The Production Possibilities Frontier/Curve
➢Only two goods are produced in the economy
➢There is full employment of resources
➢Resources are fixed-(scarcity)
➢Technology is fixed
➢There exist efficiency (technical efficiency)
 Production Possibility Schedule

➢A production possibility Schedule lists a choice's

opportunity costs by summarizing what alternative
outputs you can achieve with your inputs.
 Production Possibility Schedule

RICE (TONNES) COCOA (TONNES)

A 0 15
B 1 14
C 2 12
D 3 9
E 4 5
F 5 0
Cocoa

15 A
B
14

12 C

D
J
9
Q E
5

F
0 1 2 3 4 5 Rice
Cocoa

15 A
B
14

12 C

D
9
Q E
5

F
0 1 2 3 4 5 Rice
 The Production Possibilities Frontier/Curve
➢The PPC indicates that the opportunity cost that an
economy faces increases along the PPC.
➢This is because some resources are better suited for the
production of some goods than to the production of other
goods.
➢Why is the PPC not a straight line?
➢This is because the PPC curve tells us about the increasing
opportunity cost that the an economy is faced with.
➢Thus the Principle of Increasing Opportunity Cost applies
with the PPC
 The principle of increasing opportunity cost
➢It states that opportunity costs increase the more you
concentrate on an activity. In order to get more of
something, one must give up ever increasing quantities of
something else.
➢Negative Slope and Opportunity Cost: The slope of the PPF
is negative. Because a society’s choices are limited by
available resources and existing technology, when those
resources are fully and efficiently employed, it can
produce more capital goods only by reducing production
of consumer goods.
 Marginal Rate of Transformation (MRT)

➢The slope of the PPC at any given point is called

the MRT. It describes numerically the rate at
which one good can be transformed into the other.
➢It is also called the “marginal opportunity cost” of
i.e. the opportunity cost of rice in terms of cocoa at
the margin.
𝚫𝐢𝐧 𝐠𝐨𝐨𝐝 .𝐢.𝐞.𝐛𝐞𝐢𝐧𝐠 𝐫𝐞𝐝𝐮𝐜𝐞𝐝
➢𝐎𝐏𝐏𝐂𝐎𝐒𝐓 =
𝚫𝐢𝐧 𝐠𝐨𝐨𝐝 .𝐢.𝐞.𝐛𝐞𝐢𝐧𝐠 𝐢𝐧𝐜𝐫𝐞𝐚𝐬𝐞𝐝
 Economic Growth
➢An economy can only grow with qualitative or quantitative
changes in the factors of production–land, labour, capital
and entrepreneurship.
➢Advancements in technology, improvements in labour
productivity or new natural resource finds could all lead to
outward shifts of the production possibilities curve.
➢Economic growth means an outward shift in the possible
combinations of goods and services produced illustrated
by the production possibilities curve.
➢With growth comes the possibility to have more of both
goods than were previously available.
 Economic Growth
➢To generate economic growth, a society must produce
fewer consumption goods and more capital goods in
the present.
➢They must sacrifice some consumption of consumer
goods in the present in order to experience growth in
the future.
➢Investing in capital goods will increase the future
production capacity of the economy.
➢So an economy that invests more and consumes less
now will be able to produce and consume more in the
future.
 CHINA GHANA

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

Kg

0 Cg
Cocoa
A’

B’
15 A
B C’
14

12 C
D
D ’
9
Q E E’
5

F F’
0 1 2 3 4 5 Rice
 Technological Change & Growth

➢Technological advance does not have to impact all

sectors of the economy equally.
➢There is a technological advance in food
production but not in housing production.
➢The technological advance in agriculture causes
the production possibilities curve to extend out
further on the horizontal axis which measures
food production
housing

A
15
B’
14
B
C’
12 C
D D’
9
Q E E’
5

F F’
Rice
0 1 2 3 4 5
 Growth, Scarcity, Efficiency and Equity.

➢Does economic growth imply the absence of

scarcity?
➢What is meant by equity
➢What is meant by efficiency
Trade-Offs among the Rich and Poor
 In all societies, for all people, resources are limited relative to people’s demands.
 In 1990, the World Bank defined the extremely poor people of the world as those
earning less than $1 a day.
 Even for the poorest consumers, biological need is not all determining. So even in
extremely poor societies, household choice plays a role.
CRITICAL THINKING
Why might we see a greater demand for festivals in poor countries than in rich ones?
How might this be affected by choices available?
Theory of Demand and Supply
 What is Demand?

➢Demand is the amount of a product that people

are willing and able to purchase at each possible
price during a given period of time.
➢Willing: you want to buy the product
➢Able: you can afford the buy the product
➢The quantity demand is the amount of a product
that people are willing and able to purchase at
one specific price.
 Demand Schedule & Curve

➢Demand curve: Price of Quantity

Good Demanded
➢a curve showing the relation
between the price of a good GH₵2 210
and quantity demanded
during a given period, other GH₵4 180
things constant. GH₵7 130
➢Suppose we are making GH₵10 100
pizza. GH₵12 45
 Law of Demand

➢States that a quantity of a good demanded during

a given period relates inversely to its price, other
things constant.
➢Price increases ➔ Quantity Demanded decreases
➢Price decreases ➔ Quantity demanded increases
➢Creates a downward sloping demand curve
 Why the Law of Demand?

➢Substitution Effect
➢Unlimited wants/scarce resources
➢When the price of a good falls, consumers substitute that good for
other goods, which become relatively more expensive.
➢Reverse also holds true
➢Income Effect
➢Money income: is simply the number of Cedis received per period
➢Real income: your income measured in terms of what it can buy.
➢A fall in the price of a good increases consumers’ real income making
consumers more able to purchase goods; for a normal good, the
quantity demanded increases.
 Demand Curve

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

GH₵2

0 180 Q
45 100 130 200
 Shifts In Demand Versus Movements Along A Demand Curve

➢Demand refers to a schedule of quantities of a

good that will be bought per unit of time at
various prices, other things constant.
➢Graphically, it refers to the entire demand curve.
➢Quantity demanded refers to a specific amount
that will be demand per unit of time at a specific
price.
➢Graphically, it refers to a specific point on the
demand curve.
 Shifts in Demand vs. Movement Along the Demand Curve

➢A movement along a demand curve is the

graphical representation of the effect of a change
in price on the quantity demanded.
➢A shift in demand is the graphical representation
of the effect of anything other than price on
demand.
Movement along the Demand Curve
Price

B
₵6

₵5 A

Demand

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

 Neutral goods refers to goods whose demand do not change as income change.
Example salt.
 Giffen goods refer to goods whose quantity demanded increases as price increases
and vice-versa. Giffen goods have an upward sloping demand curve.
 Number of Price of Related
Buyers Goods

Income

Supply?
Shifts in Demand vs. Movement Along the Demand Curve

₵1
D1 D2

75 100
 Market vs Individual Demand

➢It is the sum of the individual demand for a product from

buyers in the market.
➢ If more buyers enter the market and they have the ability to
pay for items on sale, then market demand at each price level
will rise

15
+
15
= 15
10 10 10
D2
D1 D1
4 5 2 8 6 13
 Demand Function
➢The function describes how much of a good will be
purchased at different prices taking into
consideration other determinants of demand.
➢𝐐𝐝𝐱 = 𝐟(𝐏𝐱 , 𝐏𝐲 , 𝐌, 𝐓, 𝐇)
➢𝐐𝐝𝐱 = 𝛂𝟎 + 𝛂𝟏 𝐏𝐱 , +𝛂𝟐 𝐏𝐲 , +𝛂𝟑 𝐌, +𝛂𝟒 𝐓, +𝛂𝟓 𝐇
➢ An economic consultant for Microsoft Corporation
recently provided the firm’s marketing manager with
this estimate of the demand function for the firm’s
product:
➢𝐐𝐝𝐱 = 𝟏𝟐𝟎𝟎 − 𝟑𝐏𝐱 + 𝟒𝐏𝐲 − 𝐌 + 𝟐𝐀 𝐱
 Demand Function

➢Where 𝐝
𝐐𝐱 represents the amount consumed of good
X, 𝐏𝐱 is the price of good X, 𝐏𝐲 is the price of good Y, M
is income and 𝐀 𝐱 represents the amount of
advertising spent on good X.
➢Suppose good X sells for GH¢20 per unit, good Y sells
for GH¢15 per unit, the company utilizes 2,000 units
of advertising, and consumer income is GH¢10,000.
How much of good X do consumers purchase? Are
goods X and Y substitutes or complements? Is good X
a normal or inferior good?
Derived demand Competitive
demand

Composite Demand
Derived demand Competitive
demand

Composite Demand
Demand Function
Try Work
Suppose the price of commodity X is GH¢35.00 per unit, the price of good Y is
GH¢25.00 per unit, and the income of the consumer is GH¢8,000.00. How much of
good X will this consumers purchase?
Are goods X and Y substitutes or complements goods?
Is good X a normal or inferior good?
What will be the new quantity demanded if price falls to GH¢35.00
 Supply

➢Supply is the amount of goods and services which

is actually offered for sale at a given price during
given period of time.
 The Law of Supply

➢The quantity of a good supplied during a given

period is usually directly related to the price of
the good, all other things been equal.
➢Increase in price leads to increase in quantity
supplied
➢Decrease in price leads to decrease in quantity
supplied.
➢Creates upward sloping supply curve
Reasons Behind Upward Sloping Supply Curve
➢Law of variable proportions.
➢Hence, more quantity is supplied only at higher price so as
to cover the increase in production cost.
➢Goal of profit maximisation.
 Supply Curve & Schedule

Price of Supply Price

Good
₵3 50 6 Supply
₵4 75
₵5 100 5
₵6 150
₵7 200
Quantity
 Individual Supply Curve

➢A curve which shows the various quantities of a

given commodity which an individual producer is
willing to supply at different
Price
prices at given
period of time. 6 Supply

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

period of time.
Supply Supply
Price Supply

6 6
6

5 5
5

16 25 Quantity 36 55 Quantity
20 30 Quantity
 Change in Quantity Supplied
➢Movement along the supply curve is
caused by changes in the price of
the commodity when all other
factors are held constant. ₵6 B
➢It is also known as change in
quantity supplied. ₵4 A
➢That change in quantity supplied
occurs as a result of change in price
holding all other factors constant. 100 150
 Change in Supplied
➢What happens when to supply all other factors
are not constant?
➢Thus, changes in other determinants of supply
other than price would cause the supply curve to
shift.
➢What are these determinants
 Change in Supplied
➢What happens when to supply all other factors
are not constant?
➢Thus, changes in other determinants of supply
other than price would cause the supply curve to
shift.
➢What are these determinants
 STATE OF
PRICE OF
TECHNOLOG
RELATED GOODS
Y

SUPPLY PRODUCER
COST OF INPUTS DETERMINANTS EXPECTATIONS

NUMBER OF GOVERNMENT
PRODUCERS POLICY
 The supply Function

➢The supply function of a good describes how much of the good

will be produced at alternative prices of the good, alternative
prices of inputs, and alternative values of other variables that
affect supply.
➢The supply function of a good say X can be written as:
➢𝐐𝐬𝐱 = 𝐟 𝐏𝐱 , 𝐏𝐫 , 𝐖, 𝐇
➢Where 𝐏𝐱 is the price of the good, 𝐏𝐫 is the price of
technologically related goods, W is the price of an input and H is
the value of some other variable that affects supply (such as
existing technology, the number of firms in the market, taxes, or
producer expectations).
 Equilibrium
➢Equilibrium is a condition or state in which
economic forces are balanced.
➢These economic variables remain unchanged from
their equilibrium values in the absence of external
influences.
➢Economic equilibrium may also be defined as the
point at which supply equals demand for a product,
with the equilibrium price existing where the
hypothetical supply and demand curves intersect.
 Equilibrium
➢At specific price where:
➢Quantity demanded = Quantity supplied
➢Equilibrium price –
➢market clearing price
➢Equilibrium quantity –
➢D = S
➢The price in a competitive market is determined by
the interactions of all buyers and sellers in the
market.
 Market Equilibrium
P
 At specific price
S
where:
Quantity demanded ₵5 Equilibrium

Equals
Quantity Supplied D

Q
150
(The Walrasian Price Adjustment)

D S
Surplus

PH
Pe
PL

Shortage
S D
Q0 Qe Q2 Q
 (The Marshallian Quantity Adjustment)

➢Under the Marshallian adjustment, a difference

between what consumers are willing to pay
➢and what producers require to cover at least their
cost of production
➢sets up incentives for economic agents to alter output
levels
 P

D S
P1
PS1

Pe
P2
Ps2
S D

Q1 Qe Q2 Q
 (IS there a Unique Equilibrium)

➢A unique equilibrium exist when there is just one

single equilibrium position.
➢Such equilibrium is said to be stable when it can
only at one point.
➢i.e. when in disequilibrium, forces tend to move
price and quantity back towards equilibrium
Veblen effect – this implies that the high price is the reason for
buying it for the status it confers on the purchaser
W S
D PRICE
We2
P2 D
E2

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

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

P0 P0
P1

D1 D1
S D S D
Q0 Q1 Q Q0 Q1 Q
Simultaneous Increase In Both Demand And Supply
D1 S
P
D
P1

P0
D1

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

P0 P0

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

P1

P0

D1
S D
Q0 Q1 Q
ELASTICITIES
 Elasticities
➢If a rock band increases the price it charges for
concert tickets, what impact will that have on
ticket sales?
➢More precisely, will ticket sales fall a little or a
lot?
➢Will the band make more money by lowering the
price or by raising the price?
 Elasticities
➢The law of demand establishes that quantity
demanded changes inversely with changes in
price, ceteris paribus.
➢But how much does quantity demanded change?
➢This is very important to understand for many
economic issues.
➢This is what the price elasticity of demand is
designed to answer.
Elasticities
➢Think of price elasticity like an elastic rubber
band.
➢When small price changes greatly affect, or
“stretch,” quantity demanded, the demand is
elastic, much like a very stretchy rubber band.
➢When large price changes can’t “stretch”
demand, however, then demand is inelastic, more
like a very stiff rubber band.
 Elasticities
➢The price elasticity of demand measures how responsive
quantity demanded is to a price change.
➢The price elasticity of demand is defined as the
percentage change in quantity demanded divided by the
percentage change in price.
𝐏𝐞𝐫𝐜𝐞𝐧𝐭𝐚𝐠𝐞 𝐜𝐡𝐚𝐧𝐠𝐞 𝐢𝐧 𝐪𝐮𝐚𝐧𝐭𝐢𝐭𝐲 𝐝𝐞𝐦𝐚𝐧𝐝𝐞𝐝
𝐏𝐄𝐃 =
𝐏𝐞𝐫𝐜𝐞𝐧𝐭𝐚𝐠𝐞 𝐜𝐡𝐚𝐧𝐠𝐞 𝐢𝐧 𝐩𝐫𝐢𝐜𝐞
𝚫𝐐 𝐏
𝐨𝐫 𝐏𝐄𝐃 = ×
𝚫𝐏 𝐐
 Elasticities
Good A Original New % Change Elasticity

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

Price 1 1.10 -10%

Good B

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

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

A
P1
𝜟𝑷
P2 B
C
𝜟𝑸

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

𝚫𝐐 𝐏
𝐛𝐮𝐭 𝐞𝐩 = ×
𝚫𝐏 𝐐
𝐂𝐁 𝐐𝟏 𝐀
⇒ 𝐞𝐩 = ×
𝐂𝐀 𝟎𝐐𝟏
𝐂𝐁
➢The first term in the equation = reciprocal of the
𝐂𝐀
slope of the straight line –DD’
➢Straight line has a constant slope, hence the value of
𝐂𝐁
is the same at any point on the demand curve
𝐂𝐀
 𝐐𝟏 𝐀
The second term - thus the price-quantity ratio- are
𝟎𝐐𝟏
𝟎
coordinates of poi (l intercept (D’)- =𝟎
𝟎𝐃′
➢Thus the numerical value of the price-quantity ratios
varies from infinity to zero. The value of 𝐞𝐩 thus depends
on the point on the demand curve
P 𝒆𝒑 = ∞

𝒆𝒑 > 𝟏

𝒆𝒑 = 𝟏

𝒆𝒑 < 𝟏

𝒆𝒑 =0
0 Q
 ARC Elasticity
➢Used when price changes are relatively high.
𝐏𝟏 + 𝐏𝟐ൗ
𝚫𝐐 𝟐
𝐞𝐩(𝐚𝐫𝐜) = ×
𝚫𝐏 𝐐𝟏 + 𝐐𝟐ൗ
𝟐
𝚫𝐐 𝐏𝟏 +𝐏𝟐 𝟐
 𝐞𝐩(𝐚𝐫𝐜) = × ×
𝚫𝐏 𝟐 𝐐𝟏 +𝐐𝟐
𝚫𝐐 𝐏𝟏 +𝐏𝟐
 𝐞𝐩(𝐚𝐫𝐜) = ×
𝚫𝐏 𝐐𝟏 +𝐐𝟐
 The arc elasticity measures the average price
elasticity
 Demand And Total Revenue
➢Once the market demand for various goods and services
are known, it becomes quite easy to estimate the revenue
that firms are likely to obtain.
➢This is because total consumer spending is equivalent to
total business receipts or revenue from sales.
➢Total consumer spending TCS:
➢𝐓𝐂𝐒 = 𝐏 × 𝐐 = 𝐓𝐑
➢If the market demand is linear the total-revenue curve
will be a curve which initially slopes upwards, reaches a
maximum and then starts declining.
 Price Elasticity and Revenue
➢The total revenue can be computed by multiplying
price by the corresponding quantity. E.g 𝐓𝐑𝟏 = 𝐏𝟏 ∗
𝟎𝐐𝟏
➢The Marginal revenue is of particular interest in this
analysis.
➢Marginal Revenue is the change in TR that occurs as a
result of selling an additional unit of the commodity.
➢The slope of the TR curve gives us the MR
TR

𝑻𝑹
P
D 𝒆𝒑 = ∞

P2 A 𝒆𝒑 > 𝟏
P1 B 𝒆𝒑 = 𝟏
P3 C 𝒆𝒑 < 𝟏
D’ 𝒆𝒑 =0
Q2 Q1 Q3 Q
𝑴𝑹
 Marginal Revenue
𝐓𝐑 And
= 𝐏𝐐 Price Elasticity
𝐛𝐮𝐭 𝐏 = 𝐟 𝐐
hence 𝐓𝐑 = 𝐏𝐐 = 𝐟 𝐐 𝐐
To get the MR, we differentiate TR using the Product Rule

𝐝𝐓𝐑 𝐝𝐐 𝐝𝐏
=𝐏 +𝐐
𝐝𝐐 𝐝𝐐 𝐝𝐐

𝐝𝐏
𝐌𝐑 = 𝐏 + 𝐐
𝐝𝐐
𝐝𝐐 𝐏
𝐛𝐮𝐭 𝐞𝐩 = − ×
𝐝𝐏 𝐐
 𝐐
Multiply both sides by −
𝐏
𝐐 𝐝𝐐 𝐏 𝐐
− 𝐞𝐩 = − × ×−
𝐏 𝐝𝐏 𝐐 𝐏
𝐐 𝐝𝐐
− 𝐞𝐩 =
𝐏 𝐝𝐏
𝐏 𝐝𝐏
Rearranging − =
𝐞𝐩 𝐐 𝐝𝐐

𝐝𝐏
Substituting into MR
𝐝𝐐
 𝐝𝐏
𝐌𝐑 = 𝐏 + 𝐐
𝐝𝐐
𝐏
=𝐏−𝐐
𝐞𝐩 𝐐
The two Qs will cancel out
𝐏
𝐌𝐑 = 𝐏 −
𝐞𝐩

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

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

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

LUXURY GOODS NECESSITY

Long Term Short Term

Substitutes No Substitutes

Possibility of Postponement of
Purchase

Income Levels
 CROSS ELASTICITY
➢Measures the extent to which Changes in the price of
one commodity is affects the quantity demanded of
another commodity
𝚫𝐐𝐱 𝐏𝐘
➢𝐄𝐱𝐲 = ×
𝚫𝐏𝐘 𝐐𝐗
➢The co-efficient of 𝐄𝐱𝐲 could either be positive or
negative depending on the type of commodity
➢If the two commodities in question are substitute it
would be positive
➢If the two commodities in question are complements
it would be negative
 INCOME ELASTICITY
➢The income elasticity of demand is a measure of the
relationship between a relative change in income and
the consequent relative change in quantity
demanded, ceteris paribus.
➢Thus, measures the responsiveness of quantity
demanded to changes in income
𝚫𝐐 𝐌
𝛄= ×
𝚫𝐌 𝐐
 INCOME ELASTICITY
 If the income elasticity is positive, then the good in
question is a normal good because the change in
income and the change in quantity demanded move
in the same direction.
 If the income elasticity is negative, then the good in
question in an inferior good because the change in
income and the change in quantity demanded move
in opposite directions.
 Consumer surplus
 What is it?
 Willingness to pay: the maximum amount that a
buyer will pay for a good.
 It measures how much the buyer values the good or
service.
 The difference between what you paid, and what you
were willing and able to pay.
 Consumer surplus
Buyer Willingness to Pay
James GH₵100
Jerry GH₵80
Winifred GH₵70
Gifty GH₵50
Buyers Price Quantity
Demande
Consumer surplus d
More than GH₵100 More than None
GH₵100
James GH₵81 to GH₵100 1
Jerry GH₵71 to GH₵80 2
Winifred GH₵51 to GH₵70 3
James , Jerry , GH₵50 to less 4
Winifred, Gifty
Price of
Album

100 James’ willingness to pay

Jerry’s willingness to pay

80
70 Winifred‘’s willingness to pay

50 Gifty’s willingness to pay

Demand

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

80

70

50

Demand

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

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

Demand

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

Seller Cost
Akpors GH₵900
Akpordoos GH₵800
Kakporgbo GH₵600
Gbokataa GH₵500
Using Supply Curve to Measure Producer Surplus
➢Just as consumer surplus
is related to the demand
curve, producer surplus is
closely related to the
supply curve.
 P
Supply

900

800

600

500

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

800

600

500

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

D E
P2 F

P1 B
Initial surplus C
Producer surplus
to new producers

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

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

𝐏𝐒 = 𝐏 ∗ 𝐐∗ − න 𝐟 𝐐 𝐝𝐐
𝟎
 THE INFLUENCE OF GOVERNMENT POLICIES ON
MARKET OUTCOMES

➢Price controls are legal restrictions on how high

or low a market price may go.
➢2 kinds of price controls:
➢Price Ceilings: a maximum price sellers are
allowed to charge for a good. It’s an upper limit
for the price.
➢Price Floors: a minimum price buyers are
required to pay for a good. Its a lower limit for
the price.
 THE INFLUENCE OF GOVERNMENT POLICIES ON
MARKET OUTCOMES
➢Why Price controls?
➢During crisis times, emergencies or wars the
government wants to protect the consumers
from rapidly increasing prices.
➢If the equilibrium wage given by supply and
demand for low skilled workers is below
poverty level, the government can set a
minimum wage
THE INFLUENCE OF GOVERNMENT POLICIES ON MARKET
OUTCOMES
▪ Equilibrium ▪ Price ceiling

S Price D S
Price D

4 4

3 3
Price
2 Ceiling
2
Shortage

200 Quantity 200 800 Quantity

100 of of
100
icecreams icecreams
 THE INFLUENCE OF GOVERNMENT POLICIES ON
MARKET OUTCOMES

➢Because of these ceilings, we are faced

with a shortage.
➢The shortage will lead to inefficiencies:
➢ A market or an economy is inefficient if
there are missed opportunities: some
people could be made better off without
making other people worse off.
 THE INFLUENCE OF GOVERNMENT POLICIES ON
MARKET OUTCOMES

➢Inefficient Allocation to Consumers

➢Wasted Resources
➢Inefficiently Low Quality
➢Black Markets
 Price Controls: Price Ceilings
Inefficient Allocation to Consumers
 People who really want the good and are willing
to pay a high price don’t get it, and those who
are not so interested in the good and are only
willing to pay a low price do get it.
 Example: rent control. In such case people get
the apartment usually through luck or personal
connections.
 Lost Producer and Consumer Surplus due to
Price
a price ceiling
S

PF

Pe

PC Ceiling
Shortage
D
0 Qs Qe Quantity
Qd
 Price controls: Price ceilings
Wasted Resources
 People spend money, time and expend effort in
order to deal with the shortages caused by the
price ceiling.
 You waste a lot of time looking for a good in case
of shortage, the time has it’s value! You can work
or just rest, do something better than look for a
good you’ can’t find.
 Price controls: Price ceilings
 Inefficiently Low Quality
 Price ceilings often lead to inefficiency in that the
goods being offered are of inefficiently low quality
 In case of rent controls, the landlords will not
improve the conditions of the apartments, there is
no incentive since the rental fee is low but the main
reason is that since there is a shortage, people are
willing to rent the apartment as it is, even in bad
condition!
 Price controls: price ceilings
 Black Markets
 A black market is a market in which goods or
services are bought and sold illegally—either
because it is illegal to sell them at all or because
the prices charged are legally prohibited by a
price ceiling.
 If someone for example bribes (gives extra
money) to the apartment owners he will get the
apartment, but the honest people that don’t
break the law will never find one this way!
 Price Controls: Price Floor
 Price Floors: a minimum price buyers are
required to pay for a good. Its a lower limit for
the price.

 The minimum wage is a legal floor on the wage

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

S Surplus S
Price D Price D

4 4

3 3
Price
2 2 Ceiling

200 Quantity Quantity

100 200 600
of of
100
icecreams icecreams
 Price controls: Price floors
Why a Price Floor Causes Inefficiency
 Inefficient Allocation of Sales Among Sellers

Price floors lead to inefficient allocation of sales

among sellers: those who would be willing to sell the
good at the lowest price are not always those who
actually manage to sell it.
 Wasted Resources
Like a price ceiling, a price floor generates
inefficiency by wasting resources.
The Welfare Effects of Taxes & Subsidies

When economists use the term welfare effects

of a government policy, they are referring to
the gains and losses associated with
government intervention.
 Using Consumer and Producer Surplus
to Find the Welfare Effects of a Tax

The tax is illustrated by the vertical distance

between the supply and demand curve at the
new after-tax output—shown as the bold
vertical line in the Figure below
 Using Consumer and Producer Surplus
to Find the Welfare Effects of a Tax

P ST

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

S
PT

P1

PS

Q
QT Q1
P
ST
S

PT

P1

PS
D

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

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

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

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

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

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

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

 There are basically two approaches to measuring consumers’ utility

 The Cardinalist’ approach

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

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

𝒅𝑻𝑼 𝑻𝑼𝒙 −𝑻𝑼𝒙−𝟏

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

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

Quantity Total Utility Average Utility Marginal Utility

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

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

P,MU

E
𝜆𝑃𝑥

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

P,MU

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

P,MU

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

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

 If, as the quantity consumed of a good increase, marginal utility decreases quickly,
the demand for the good is inelastic.
 If, as the quantity consumed of a good increases, MU decreases slowly, the demand
for that good is elastic.
Quantity
Example Px=4 and Py=4.5, Income =GHS34.00
1 22 27 5.5 6
2 20 24 5 5.33
3 18 21 4.5 4.6
4 16 18 4 4
5 14 15 3.5 3.33
6 12 12 3 2.67
7 10 9 2.5 2
 THE FIRM

THEORY OF PRODUCTION AND COSTS

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

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

𝒅𝑻𝑷 𝑻𝑷𝑿 −𝑻𝑷𝒙−𝟏

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

Units of Labour Total Product Average Product Marginal Product

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

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

6 100 16.67 160 26.67 260 43.33 30

7 100 14.28 200 28.57 300 42.86 40

8 100 12.50 250 31.25 350 43.75 50

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

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

𝑻𝑹
𝑨𝑹 =
𝑸
𝑷∗𝑸
𝑨𝑹 =
𝑸

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

𝒅𝑻𝑹
M𝑹 =
𝒅𝑸

𝒅𝑷𝑸
𝑴𝑹 =
𝒅𝑸

M𝑹 = 𝑷 This proves that MR=P=AR

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

P=MR=AR

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

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

 Short Run Profit and Loss

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

 Long Run Profit Analyses

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

AR=DD
0
MR
 Monopoly: The Price Maker
 Profit Maximization of the Monopolist

AR/P/MR
MC

B
P

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