Introduction to Economics

Economics is the social science that analyzes the production, distribution and consumption of goods and services, and deals with decision making related to allocation of limited resources among competing uses. The economics focusses on scarcity forces in societies to address following critical issues:

1. What to produce? Whether consumption goods or investment goods? Whether civilian or military goods? What quantities of various goods (& services) should be produced? The answers  should satisfy a large part of the population. 
2.  How to produce? Who, with what resources, using what techniques or methods will the goods (& services) should be produced? 
3.  For whom to produce? Who get benefits? People must be rewarded for their production and at the same time, there need to be justice for people who cannot produce an adequate.

Microeconomics V/s Macroeconomics

Microeconomics concerns individual decision making and its collective effect on allocation of society’s resources. Macroeconomics deals with the aggregate phenomena.

Institutions for allocation of resources

• Capitalist economy: In capitalist economy, the means of productions owned and controlled by and for the benefits of private individuals. In such an economy, the resources are allocated for voluntary trading among producers and consumers. The consumers attempt to maximize satisfaction whereas producers attempt to maximize profits, and base their plans on prices of goods they exchanges.  The price system informs both producers and consumers about underlying changes in the economy and motivates them to adjust in response to those changes.  For example, increase in demand of a good will increase the price of the good. This increase in profit of the producer will motivate them to produce more quantity. However, the higher price of a good, in turn, encourages consumers to buy less. These changes by both consumers and producers will make the price of good to reduce or stabilize at certain level. Such an economy is also referred as a Market Economy. 
• Communist economy: In a communist economy, economic decisions are highly centralized and the government/state owns and controls the means of production and distribution. Therefore, the price system does not provide producers and consumers with accurate and timely information about underlying changes in the market. In such an economy, because of both the political and monetary cost, price changes are infrequent and so there is no signal for producers and consumers to adjust their behavior to absorb the excess supply or demand. Furthermore, in such an economy, producers do not get the profits or incur losses associated with changing prices and so this would not motivate them much to adjust production quantity. This economy is also referred as a Command Economy. 
•  Mixed economy: Many economy are combination of both capitalist and communist economy.

Market

Markets are economic institutions that provide people with opportunities and procedures for buying and selling goods and services. Markets are the most common form of economic decentralization. In microeconomics, a market is associated with a single group of closely related products and Offered for sale within particular geographic boundaries.  Following are essential features of any market system:

• Buyer and seller: A market system needs the buyers and sellers to exchanges their goods. 
• Governed by prices: In a market system, the exchange of goods is governed by exchange value of goods. Relative price measures what must be given up to purchase an item and provide information about the exchange value to the consumers. In a market, the prices are allowed to fluctuate in response to changes in demand and supply. The changes in price acts as a signal and as a motivator for consumers and producers. 
•  Private Property rights: For proper functioning of a market system, private or transferable property rights must be defined, established and enforced by the law. This allow individual to base their decisions on their own self-interest.

Demand

The law of demand states that consumers will purchase more of a good at lower prices and less of a good at higher prices. The graphical representation, called demand curve, is typically used to analyze the variation in demand against the price. It depicts the price that consumers are willing to pay and the amount of good that consumer will able to purchase a good at the given price. 

Other Demand Factors: There are also factors, other than price of the good, changes in which will result in a change in demand. An increase in demand due to change in demand factor is depicted as a rightward shift of the demand curve.  An increase in demand means that consumers plan to purchase more of the good at each possible price.  Similarly, a decrease in demand due to change in demand factor is depicted as a leftward shift of the demand curve. A decrease in demand means that consumers plan to purchase less of the good at each possible price.

• Change in own price (say due to taxes): There is no shift in the demand curve and the movement of demand schedule will happen along the same demand curve itself.
• Income is a factor that can affect demand. 

1. If increase in income will result in an increase in demand while decreases in income will decrease demand, the good is referred as a normal good,

2. If increase in income will result in a decrease in demand while decreases in income will increase demand, the good is referred as an inferior good

• The price of related goods is another factor affecting demand. The related goods are typically classified into following two category:

1.   Substitutesare goods that satisfy a similar need or desire. For example, tea and coffee can substitute each other. An increase in the price of coffee will increase demand for tea.

2.   Complements are goods that are used jointly. For example, tea and sugar. An increase in the price of sugar will decrease demand for tea.  

Supply

The law of supply states that producers will sell less of a good at lower prices and more of a good at higher price. The relationship between price and quantity supplied, keeping all other factors constant, graphically analyzed by supply curve. The changes in other supply factors will result in a change in supply. An increase in supply is depicted as a rightward shift of the supply curve. An increase in supply means that producers plan to sell more of the good at each possible price. Similarly, a decrease in supply is depicted as a leftward shift of the supply curve. A decrease in supply means that producers plan to sell less of the good at each possible price. 

Other Supply Factors: The other factors affecting supply could include technology, the prices of raw materials or input, and the prices of alternative goods that could be produced.

• An advance in technology, a decrease in the prices of inputs, or a decrease in the prices of alternative goods that could be produced will result in an increase in supply.

• A deterioration of technology, an increase in the prices of inputs, or an increase in the prices of alternative goods that could be produced will result in a decrease in supply.

Equilibrium

Equilibrium exits when there is no reason for a situation to change. When equilibrium exits, the quantity people plan to buy is equal to the quantity that producers plan to sell. The laws of demand and supply cause the market to move to equilibrium.

1.       Change in Demand: A change in demand will cause equilibrium price and production level to change in the same direction. A decrease in demand will cause a reduction in the equilibrium price and quantity of a good. An increase in demand will cause an increase in the equilibrium price and quantity of a good.

2.       Change in Supply: A change in supply will cause equilibrium price and output to change in opposite directions. An increase in supply will cause a reduction in the equilibrium price and increase in the equilibrium quantity of a good. A decrease in supply will cause an increase in the equilibrium price and a decrease in the equilibrium quantity of a good.

3.       Changes in Demand and Supply

a.       If demand and supply change in opposite directions, then the change in the equilibrium price can be determined, but the change in the equilibrium output cannot.

·   A decrease in demand and an increase in supply will cause a fall in equilibrium price, but the effect on equilibrium quantity cannot be determined.

·   For any quantity, consumers now place a lower value on the good, and producers are willing to accept a lower price; therefore, price will fall. The effect on output will depend on the relative size of the two changes.

·   An increase in demand and a decrease in supply will cause an increase in equilibrium price, but the effect on equilibrium quantity cannot be determined.

·   For any quantity, consumers now place a higher value on the good, and producers must have a higher price in order to supply the good; therefore, price will increase. The effect on output will depend on the relative size of the two changes.

b.      If demand and supply change in the same direction, the change in the equilibrium output can be determined, but the change in the equilibrium price cannot.

·   If both demand and supply increase, there will be an increase in the equilibrium output, but the effect on price cannot be determined.

·   If both demand and supply increase, consumers wish to buy more and firms wish to supply more so output will increase. However, since consumers place a higher value on each unit, but producers are willing to supply each unit at a lower price, the effect on price will depend on the relative size of the two changes.

·   If both demand and supply decrease, there will be a decrease in the equilibrium output, but the effect on price cannot be determined.

·   If both demand and supply decrease, consumers wish to buy less and firms wish to supply less, so output will fall. However, since consumers place a lower value on each unit, but producers are willing to supply each unit only at higher prices, the effect on price will depend on the relative size of the two changes.