ALLAMA IQBAL OPEN UNIVERSITY, ISLAMABAD

Name: Hamna Mushtaq

Registration Number: 0000580438

Semester: 01 (Autumn 2023)

Course: Principles of Macroeconomics

Course Code: 9301

Assignment No: 01

Department: BS Accounting & Finance

Submitted To:

Date: January 13, 2024

 ASSIGNMENT: 01

Q 1: Differentiate Between Positive and Normative Economics.

Answer:

Positive Economics
Positive economics is a stream of economics that focuses on the description, quantification, and
explanation of economic developments, expectations, and associated phenomena. It relies on
objective data analysis, relevant facts, and associated figures. It attempts to establish any cause-
and-effect relationships or behavioral associations which can help ascertain and test the
development of economic theories.

Positive economics is objective and fact-based where the statements are precise, descriptive,
and clearly measurable. These statements can be measured against tangible evidence or
historical instances. There are no instances of approval-disapproval in positive economics.

Here's an example of a positive economic statement: "Government-provided healthcare

increases public expenditures." This statement is fact-based and has no value judgment attached
to it. Its validity can be proven (or disproven) by studying healthcare spending where
governments provide healthcare.

Normative Economics
Normative economics focuses on value-based judgments aimed at improving economic
development, investment projects, and the distribution of wealth. Its goal is to summarize the
desirability (or lack thereof) of various economic developments, situations, and programs by
asking what should happen or what ought to be.

Normative economics is subjective and value-based, originating from personal perspectives or

opinions involved in the decision-making process. The statements of this type of economics are
rigid and prescriptive in nature. They often sound political, which is why this economic branch
is also called "what should be" or "what ought to be" economics.

An example of a normative economic statement is: "The government should provide basic
healthcare to all citizens." As you can deduce from this statement, it is value-based, rooted in
personal perspective, and satisfies the requirement of what "should" be.

Example:
Any economic agenda that promotes some sort of social or policy agenda could be said to be
normative. For instance, arguing for a higher minimum wage for the benefit of workers would
be an example of a normative argument, in that this argument is based on subjective values.
However, an assertion that higher minimum wages would lead to a higher GDP would be
considered positive economics.
Difference Between Positive and Normative Economics
Positive and Normative Economics do have some underlying differences between them. We will
analyze the differences between them in terms of meaning, perspective, function, area of study,
testing, economical clarification. Now, let us delve into it right away.
Meaning
Positive economics means more focus on data, facts, and figures rather than personal
perspectives. The statements here are to the point and supported by relevant information. On the
other hand, normative economics focuses more on personal perspectives and opinions rather than
facts and figures. Here the statements are based on an individual’s point of view, and ample data
is always available to support such claims.
Perspective
The perspective of these two concepts is a significant point of difference between them. Positive
economics is objective, whereas normative economics is subjective. The focus of positive
economics is on presenting relevant and more focused statements backed by actual data.
Contrarily, normative economics focuses on presenting statements that may or may not be
possible in the future. Moreover, in some cases, such statements do not have any credible data to
back them up.
Function
Their functions can distinguish between positive and normative economics. Positive economics
describes the cause and outcome of the relationship among variables. On the other hand,
normative economics provides value judgment.
Area of Study
Positive economics is the study of ‘what is’; whereas normative economics describes ‘what
should be’. One branch relies on a factual approach supported by data. Contrarily, normative
economics relies more on personal opinions rather than actual data.
Testing
Every statement of positive economics can be tested scientifically and either proven or
disregarded. However, normative economics statements cannot be tested scientifically. It entirely
depends on the belief of an individual.
Economical Clarification
Positive economics provides a more scientific and calculated clarification on an economic issue.
However, normative economics also provides such solutions but ones that are based on personal
values.
Case in Points of Positive Economics, Examples
• Monopolies have proved to be inefficient
• The desired rate of return on gambling stocks are higher compared to others
• The relationship between wealth and demand is inverse in the case of inferior goods
• House prices reduce once the interest rate on loans get higher
• Car scrappage schemes can result in a fall in the prices of second-hand cars
Case in Points of Normatics Economics, Examples
• The government should implement strict wealth tax laws to decrease the uneven
distribution of wealth
• No individuals should be entitled to inheritances as it belongs to society
• Import duties should be increased on goods coming from nations with humble human
rights record
• Investors ought to be more socially responsible and stop investing in vice stocks
• Developing countries should only accept democracy when their entire population is
educated and liberated
Importance of Positive and Normative Type Economics
Even though normative economics is a subjective study, it acts as a base or a platform for out-of-
the-box thinking. These concepts will provide a basic foundation for the innovative ideas that
will ignite to reform an economy.
However, all the decisions cannot rely on them altogether. On the other hand, Positive economics
is needed to provide an objective approach. Positive economics is focused on the facts and
analyses of the effects of such decisions in society and thereby it helps by providing a statement
that comprises the necessary information to make a sound economic decision.
Normative economics is thus useful in creating and generating newer ideas from another or
different perspectives, also note it cannot be the only basis for making decisions on important
economic issues, and here the positive economics come into action thus complementing each
other.
So, Positive economic theory can help the economic policymakers to implement the normative
value judgments. Like - it can describe how the government is in power to impact inflation by
printing more money or restructuring the banking reforms, this economics can support that
statement with strong facts and analysis with relationships between inflation and growth in the
money supply of an economy.

Q 2: Explain In Detail the Law of Marginal Utility.

Answer:
The Law of Marginal Utility
The Law of Marginal Utility is a fundamental concept in economics that explains the relationship
between the consumption of a good or service and the satisfaction or utility derived from
consuming additional units of that good or service. It states that as a consumer consumes more
units of a good or service, the additional satisfaction or utility derived from each additional unit
(marginal utility) decreases, all else being equal.
There are several key components and implications of the Law of Marginal Utility:
Diminishing Marginal Utility
The Law of Marginal Utility is based on the principle of diminishing marginal utility, which
means that the additional satisfaction or utility derived from consuming each additional unit of a
good decreases as the quantity consumed increases. This is because consumers tend to allocate
their limited resources (such as money or time) to satisfy their most urgent needs or desires first.
As they consume more units of a good, the intensity of their desire or need for additional units
diminishes, leading to a decrease in marginal utility.
Utility and Satisfaction
Utility refers to the satisfaction or benefit that individuals derive from consuming goods and
services. It is a subjective concept that varies from person to person and can be difficult to
measure objectively. Marginal utility specifically refers to the change in total utility resulting
from consuming one additional unit of a good. Marginal utility can be positive, negative, or zero,
depending on whether the additional unit increases, decreases, or has no effect on total utility.
Law of Equi-Marginal Utility
The Law of Equi-Marginal Utility is closely related to the Law of Marginal Utility and states that
consumers allocate their limited resources (such as income) among different goods and services
in such a way that the marginal utility per dollar (or per unit of currency) spent is equal for each
good. In other words, consumers maximize their total utility by allocating their budget in a way
that equalizes the marginal utility derived from the last unit of each good consumed.
Consumer Behavior and Demand
The Law of Marginal Utility has significant implications for consumer behavior and demand
theory. It helps explain why demand curves slope downward from left to right, indicating that
consumers are willing to pay less for additional units of a good as they consume more of it. It
also helps explain why consumers may be willing to pay a higher price for the first unit of a good
(which provides the highest marginal utility) compared to subsequent units.
Optimal Consumption
Understanding the Law of Marginal Utility can help consumers and producers make more
informed decisions about consumption and production. For consumers, it implies that they
should allocate their resources in a way that maximizes their total utility by consuming goods
and services up to the point where the marginal utility per dollar spent is equal across all goods.
For producers, it suggests that they should produce goods up to the point where the marginal cost
of production is equal to the marginal revenue generated from selling additional units.
Types of Marginal Utility
Consumer behavior and decisions are the two main things that influence the type of marginal
utility you obtain as a result. Let’s review each type in more detail to see how customer
happiness affects it.
Positive Marginal Utility
You can see this type of marginal utility when an additional item brings happiness to a customer.
Say, there’s a person who loves to eat cakes, so when they eat an extra slice, they would enjoy it
and get some positive emotions.
Zero Marginal Utility
When this type occurs, it indicates that an additional product didn’t manage to bring some more
satisfaction to a consumer. For example, when a person eats two hamburgers and feels full, they
wouldn’t enjoy having a third one.
Negative Marginal Utility
This indicates that if a customer consumes too much of a product, an extra portion might even
harm their health. Say, if a person ate two slices of an apple pie, they could feel sick after the
third one.
Calculation of Marginal Utility
Companies and individuals widely use marginal utility calculations to give a qualifiable worth to
their products and services. With its help, they gauge the success of a particular item and adjust
their production. Although some companies leverage complex estimations to figure out the
measure, you can calculate it by using a simple formula you see below.

Now let’s see the steps in detail to learn how to find the necessary measures.

Find The First Total Utility

To find an average measure, a manager needs to determine the total utility of a customer’s first
visit. Total utility is the level of customer satisfaction from consuming a product or service. You
need to sum up the prices a consumer is willing to pay for the first and each additional product to
obtain the total utility.
Search for the second total utility
Analyze the information you have about the second visit. Pay attention to the sum of money a
customer is ready to pay for your products and use the same approach. Add all the prices
together to obtain the second total utility.
Calculate the difference
Once you figure out the total utilities of the visits, collect them to calculate the difference. The
result you obtain will be the measure you need to use in the formula.
Estimate the difference between the number of goods
After obtaining totals, you need to sum up the purchased goods from the first visit. Do the same
for the second visit. Afterward, subtract the totals from each other to get the second measure —
quantity of goods difference.

Marginal Utility Example

Let’s imagine that there’s a very hungry office worker who decided to go to a cafe with veggie
burgers on its menu. Although one veggie burger costs only $3, this visitor can even pay $6 for
each. Therefore, the utility worth of one burger will be $6.

During their stay in the cafe, the worker is eager to eat two burgers. Since this person already
knows that they will be full after the first veggie burger, they are ready to pay $4 for the second
one. As a result, the utility cost decreases. To find the total utility, we need to sum up the prices
the worker is willing to pay.

Total utility (1) = $6 + $4 = $10.

During the second visit to the cafe a month later, the worker wants to eat four burgers. After
paying $6 for the first veggie burger, they decide that the second burger is only worth $5 because
they don’t feel so hungry anymore. After they eat the second one, they would only pay $2 for
each next burger.

Total utility (2) = $6 + $5 + $2 + $2 + $2 = $17.

Let’s find the total utility difference = $17 - $10 = $7.

Quality of items difference = 5 - 2 = 3.

Now let’s estimate marginal utility:

Marginal utility = 7 / 3 = 2.3.

Hence, the marginal utility shows the level of satisfaction a customer can obtain from consuming
an additional product or service. A consumer stops buying additional products when the price is
higher than their marginal utility.

Q 3: Define the Factors Responsible for Shift in The Demand Curve.

Answer:
The demand curve in economics illustrates the relationship between the price of a good or service
and the quantity demanded by consumers, holding all other factors constant. However, the demand
curve can shift due to changes in various factors other than price. These factors include:

1. Income
Changes in consumer income can lead to shifts in the demand curve. For normal goods, an increase
in income typically leads to an increase in demand, shifting the demand curve to the right.
Conversely, a decrease in income may lead to a decrease in demand for normal goods, shifting the
demand curve to the left. For inferior goods, the relationship is opposite: an increase in income
may lead to a decrease in demand, shifting the demand curve to the left.

2. Price of Related Goods

The prices of related goods can influence the demand for a particular good. Substitutes are goods
that can be used in place of each other, while complements are goods that are consumed together.
An increase in the price of a substitute good leads to an increase in demand for the original good,
shifting its demand curve to the right. Conversely, an increase in the price of a complement good
leads to a decrease in demand for the original good, shifting its demand curve to the left.

3. Consumer Preferences
Changes in consumer preferences, tastes, or preferences for a particular good can cause shifts in
the demand curve. For example, if a new study suggests health risks associated with consuming a
certain product, consumer preferences may shift away from that product, leading to a decrease in
demand and a leftward shift in the demand curve. Conversely, if a new trend or fashion makes a
product more desirable, consumer preferences may shift towards that product, leading to an
increase in demand and a rightward shift in the demand curve.

4. Expectations
Consumer expectations about future changes in price, income, or other factors can also influence
current demand. If consumers expect the price of a good to increase in the future, they may increase
their current demand to stock up before the price hike, leading to a rightward shift in the demand
curve. Conversely, if consumers expect the price of a good to decrease in the future, they may
decrease their current demand, leading to a leftward shift in the demand curve.

5. Population and Demographics

Changes in population size, age distribution, or demographic characteristics can also affect
demand for certain goods and services. For example, an increase in the population of young adults
may lead to an increase in demand for products targeted towards that demographic, shifting the
demand curve to the right.

6. Government Policies and Regulations

Government policies, such as taxes, subsidies, or regulations, can impact the demand for certain
goods and services. For example, a subsidy on electric vehicles may increase demand for such
vehicles, shifting the demand curve to the right. Conversely, a tax on sugary beverages may
decrease demand for these products, shifting the demand curve to the left.

7. Seasonal Factors
Seasonal variations in demand due to factors like weather, holidays, or cultural events can also
cause shifts in the demand curve. For example, demand for winter clothing increases during the
cold months, leading to a rightward shift in the demand curve during that season.

These factors illustrate how changes in variables other than price can influence the quantity
demanded of a good or service, leading to shifts in the demand curve. It's important to note that
these factors operate independently of changes in price and can cause the entire demand curve to
shift either to the right (increase in demand) or to the left (decrease in demand).
Q 4: Define elasticity of supply. discuss with the help diagram the concept of arc elasticity of
supply.
Answer:
Definition
The elasticity of supply definition is based on the law of supply, which states that the number of
goods and services supplied will usually change when prices change.

The law of supply states that;

“When there is an increase in the price of a good or service, the supply for that good will
increase. On the other hand, when there is a decrease in the price of a good or service, the
quantity of that good will decrease.”
But how much will the quantity of a good or service decrease when there is a price decrease?
What about when there is a price increase?

The elasticity of supply measures how much the quantity supplied of a good or service changes when
there is a price change.

The amount by which the quantity supplied increases or decreases with a price change depends
on how elastic the supply of a good is.
The ability of suppliers to alter the quantity of a good they produce directly impacts the degree to
which the quantity supplied can change in response to a change in price.
Although the construction company can't start building a significant number of houses in
response to the price increase in the short run, in the long run, constructing houses is more
flexible. The company can invest in more capital, employ more labor, etc.Time has a strong
influence on the elasticity of supply. In the long run, the supply of a good or service is more
elastic than in the short run.

Formula for Elasticity of Supply

The formula for elasticity of supply is as follows.

%ΔQuantity supplied
Price elasticity of Supply =
%ΔPrice

The elasticity of supply is computed as the percentage change in quantity supplied divided by the
percentage change in price. The formula shows how much a change in price changes the quantity
supplied.
Elasticity of Supply Example
As an example of elasticity of supply, let's assume that the price of a chocolate bar increases
from $1 to $1.30. In response to the price increase of the chocolate bar, firms increased the
number of chocolate bars produced from 100,000 to 160,000.
To calculate the price elasticity of supply for chocolate bars, let's first calculate the percentage
change in price.

1.30 − 1 0.30
%ΔPrice = = = 30%
1 1

Now let's calculate the percentage change in quantity supplied.

𝟏𝟔𝟎, 𝟎𝟎𝟎 − 𝟏𝟎𝟎, 𝟎𝟎𝟎 𝟔𝟎, 𝟎𝟎𝟎

%𝚫Quantity = = = 𝟔𝟎%
𝟏𝟎𝟎, 𝟎𝟎𝟎 𝟏𝟎𝟎, 𝟎𝟎𝟎

Using the formula

%𝚫Quantity supplied
Price elasticity of Supply =
%𝚫Price
the price elasticity of supply for chocolate bars.
60%
Price elasticity of Supply = =2
30%

As the price elasticity of supply equals 2, it means that a change in the price of chocolate bars
changes the quantity supplied for chocolate bars by twice as much.

Types of Supply Elasticity

There are five main types of supply elasticity: perfectly elastic supply, elastic supply, unit elastic
supply, inelastic supply, and perfectly inelastic supply.

Types of Supply Elasticity

• Perfectly Elastic Supply

Definition:
When a good's elasticity of supply equals infinity, the good is said to have perfect elasticity.
This indicates that the supply can accommodate a rise in the price of any magnitude, even if just
slightly. It means that for a price above P, the supply for that good is infinite. On the other hand,
if the price of the good is below P, the quantity supplied for that good is 0.

• Elastic supply

The supply curve for a good or service is elastic when the elasticity of supply is greater than 1. In
such a case, a price change from P1 to P2 leads to a greater percentage change in the number of
goods supplied from Q1 to Q2 compared to the percentage change in price from P1 to P2.

For example, if the price were to increase by 5%, the quantity supplied would increase by 15%.

On the other hand, if the price of a good were to decline, the quantity supplied for that good
would decrease by more than the decrease in price.

A firm has an elastic supply when the quantity supplied changes by more than the change in
price.

•Unit Elastic Supply

Definition:
A unit elastic supply occurs when the elasticity of the supply is 1.
For example, if the price were to increase by 10%, the quantity supplied would also increase by
10%.

•Inelastic Supply

An inelastic supply curve occurs when the elasticity of supply is less than 1.
An inelastic supply means that a change in price leads to a much smaller change in quantity
supplied. Notice in Figure 4 that when the price changes from P1 to P2, the difference in quantity
from Q1 to Q2 is smaller.

•Perfectly Inelastic Supply

A perfectly inelastic supply curve occurs when the elasticity of supply equals 0.
A perfectly inelastic supply means that a change in price leads to no change in quantity. Whether
the price triples or quadruples, the supply remains the same.
An example of a perfectly inelastic supply could be the Mona Lisa painting by Leonardo Da
Vinci.

Q 5: Discuss In Detail the Concept of Consumer Surplus.

Answer:
Consumer surplus is an economic measurement of consumer benefits resulting from market
competition. A consumer surplus happens when the price that consumers pay for a product or
service is less than the price they're willing to pay. It's a measure of the additional benefit that
consumers receive because they're paying less for something than what they were willing to
pay.
Consumer surplus may be compared with producer surplus.

Understanding Consumer Surplus

The concept of consumer surplus was developed in 1844 to measure the social benefits
of public goods such as national highways, canals, and bridges. It has been an important tool in
the field of welfare economics and the formulation of tax policies by governments.

Consumer surplus is based on the economic theory of marginal utility, which is the additional
satisfaction a consumer gains from one more unit of a good or service. The utility a good or
service provides varies from individual to individual based on their personal preference.

Typically, the more of a good or service that consumers have, the less they're willing to spend
for more of it, due to the diminishing marginal utility or additional benefit they receive. A
consumer surplus occurs when the consumer is willing to pay more for a given product than the
current market price.

The Formula for Consumer Surplus

Economists define consumer surplus with the following equation:

Consumer surplus = (½) x Qd x ΔP

where:

• Qd = the quantity at equilibrium where supply and demand are equal

• ΔP = Pmax – Pd, or the price at equilibrium where supply and demand are equal
• Pmax = the price a consumer is willing to pay
Measuring Consumer Surplus

The demand curve is a graphic representation used to calculate consumer surplus. It shows the
relationship between the price of a product and the quantity of the product demanded at that
price, with the price drawn on the y-axis of the graph and the quantity demanded drawn on the
x-axis. Because of the law of diminishing marginal utility, the demand curve is downward
sloping.

Consumer surplus is measured as the area below the downward-sloping demand curve, or the
amount a consumer is willing to spend for given quantities of a good, and above the actual
market price of the good, depicted with a horizontal line drawn between the y-axis and demand
curve. Consumer surplus can be calculated on either an individual or aggregate basis, depending
on if the demand curve is individual or aggregated.

Consumer surplus always increases as the price of a good falls and decreases as the price of a
good rises. For example, suppose consumers are willing to pay $50 for the first unit of product
A and $20 for the 50th unit. If 50 of the units are sold at $20 each, then 49 of the units were sold
at a consumer surplus, assuming the demand curve is constant.

Consumer surplus is zero when the demand for a good is perfectly elastic. But demand is
perfectly inelastic when consumer surplus is infinite.

Consumer surplus is measured as the area below the downward-sloping demand curve, or the
amount a consumer is willing to spend for given quantities of a good, and above the actual
market price of the good, depicted with a horizontal line drawn between the y-axis and demand
curve. Consumer surplus can be calculated on either an individual or aggregate basis, depending
on if the demand curve is individual or aggregated.

Consumer surplus always increases as the price of a good falls and decreases as the price of a
good rises. For example, suppose consumers are willing to pay $50 for the first unit of product
A and $20 for the 50th unit. If 50 of the units are sold at $20 each, then 49 of the units were sold
at a consumer surplus, assuming the demand curve is constant.

Consumer surplus is zero when the demand for a good is perfectly elastic. But demand is
perfectly inelastic when consumer surplus is infinite.
Example of Consumer Surplus

Consumer surplus is the benefit or good feeling of getting a good deal. For example, let's say
that you bought an airline ticket for a flight to Disney World during school vacation week for
$100, but you were expecting and willing to pay $300 for one ticket. The $200 represents your
consumer surplus.

However, businesses know how to turn consumer surplus into producer surplus or for their gain.
In our example, let's say the airline realizes your surplus and as the calendar draws near to
school vacation week raises its ticket prices to $300 each.

The airline knows there will be a spike in demand for travel to Disney World during school
vacation week and that consumers will be willing to pay higher prices. So by raising the ticket
prices, the airlines are taking consumer surplus and turning it into producer surplus or additional
profits.

….

THE END!
Much Obliged!