Trade, Money and Capital

Advanced Economies have three features:-Trade Specialisation: trade between individuals and

countries depends on specialisation - Division of Labour.

-Money: It measures the economic value of things and is used for financing trade.

-Capital: It leverages labour power into a much more efficient factor of production and increases production.

Trade Specialisation and Division of Labour

Today’s World: - Countries depends on specialisation of individuals and firms. -Connected by an extensive network of trade.

Specialisation occurs when people concentrate on a particular set of tasks.

Capital and land are highly specialised.

Contd..

Specialisation gives greater productivity.

Individuals and countries voluntarily trade goods in which they specialise for others’ products – vastly increasing the range and quantity of consumption.

Have potential to raise living standards.

Money

It is the means of payment.

Due to the acceptance of money as payment or goods and debts, trade is facilitated.

Governments control the money supply through their central banks.

Like other factors, money can spoil the economy or can overheat the economic engine.

Capital

Capital has to be produced before it is used.

More capital formation => consumption cut and more savings=> increase future productivity and future consumption.

In market economy, capital is privately owned- income from the capital goes to individuals =>capitalism.

Economic Role of Government

Three functions of Govt. :--Increase efficiency by promoting competition, curbing externalities like pollution and providing public goods.

-Promote equity by using tax and expenditure programs to redistribute income towards particular group.

-Foster macroeconomic stability and growth – reducing unemployment and inflation.

Efficiency

Smith (1776):Perfectly competitive markets will produce an efficient allocation of resources- economy is always on PPF.

Why does an Economy fall short of efficient perfect competition?

- Imperfect Competition- Externalities- Public Goods.

Imperfect Competition

It happens when a buyer or a seller affects the price level.

Consequences of Imperfect Competition:-When it happens society moves inside the PPF.-Too high price and too low output is the hallmark of the inefficiencies associated with imperfect competition.

Steps taken by the Government to curb The IE: -Regulate the price and profits of monopolies such as local water, electricity etc.

Externalities

Involve involuntary imposition of costs or benefits. Examples:

-Airport creates noise but do not compensate people living around the airport.-Companies spend lot of money on R and D which have positive impact on the society

Govt.s are more concerned about the negative externalities rather than positive ones.

Govt. regulations are designed to control externalities like air and water pollution, damage from strip mining, hazardous wastes etc.

Public Goods

These are commodities which are enjoyed by everyone in the Society. No one can be excluded.

Example:- Defense, Roads etc.

Private provision of Public Goods is insufficient. Govt. has to step into encourage the production of public goods.

Govt has to find the revenues to pay for its public goods and for its income redistribution programs.

Sources of revenues: -Taxes levied on Personal and Corporate incomes.-Taxes on wages and sales of the consumer goods etc.

Equity

Markets do not produce a fair distribution of income which is not acceptable from the social point of view.

If income inequality exists, Gove can take the following steps:

-can engage progressive taxation,-taxing large income at a higher rate than small

incomes.-impose heavy taxes on wealth.

- Can make transfer payments like aid for elderly , blind and disabled people

-can subsidize the consumption of low-income group

Macroeconomic Growth and Stability

Economic growth denotes the growth in Nation’s output.

Macroeconomic policies for stabilization and economic growth include fiscal policies along with Monetary Policies.

Fiscal policies- change in taxes and change in govt. spending.

Monetary policies- change in money supply and money demand – affect interest rates and credit conditions.

Contd..

Since 1930s Govt.s are succeeded to curb the inflation. In most of the industrialised countries, we findsome variant of a mixed economy.

-the market determines output and prices in most individual sectors.

-government steers the overall economy with programs of taxation, spending, and monetary regulation.

Introduction to Demand and Supply

Demand and Demand Curves (a)

There exists a definite relationship between themarket price of a good and the quantity

demanded of that good, other things held constant. This relationship between price and quantity bought is called the demand schedule, or the demand curve.

Law of Demand

Law of downward-sloping demand: When theprice of a commodity is raised (and other things

are held constant), buyers tend to buy less of the commodity.

Similarly, when the price is lowered, other things being constant, quantity demanded increases.

Demand and Demand Curves (b)

• The individual demand curve shows the quantity demanded at each price by one consumer.

Demand and Demand Curves (c)

• Demand curves are downward sloping.• As price falls, consumers buy more of the

good.• The position of an individual’s demand curve

also depends on:– Income – Social trends – The price of related goods – Expectations about the future

Market Demand Curve (d)– The market demand curve is the horizontal sum of the

demand curves of all individuals.

Factors behind the demand curves

• Average Income

• Size of the Market

• Related Goods

• Taste and Preferences

• Special Influences – umbrella in Rainy Season.

Shifts in a Demand Curve versus Movements along a Demand Curve

• A change in price is represented by a movement along the demand curve.

• All other changes that affect demand will shift the demand curve.

Sources of Shifts in the Demand Curves (a)

• Tastes• Prices of related goods• Income• Demographics• Information• Availability of credit• Changes in expectations

Sources of Shifts in Demand Curves (b)

• Tastes: If one day everyone in the United States woke up and liked Britney Spears CDs, the demand curve for Britney Spears CDs would shift to the right.

Sources of Shifts in Demand Curves (c)

• Prices of related goods• Complementary goods: Peanut butter and jelly

– When the price of peanut butter rises, there is movement along the demand curve for peanut butter.

– When the demand for jelly falls, the demand curve for jelly shifts to the left.

Sources of Shifts in Demand Curves (d)

• Price of related goods• Substitute goods

– When the price of coffee rises, there is movement along the demand curve for coffee.

– When the demand for tea increases, the demand curve for tea shifts to the right.

Sources of Shifts in Demand Curves (e)

• An increase in income increases the demand for most goods.

• The demand curve shifts to the right.

Sources of Shift in Demand Curves (f)

• Availability of credit– If banks reduce the number of automobile loans they

approve, the demand for cars decreases and the demand curve shifts to the left.

Sources of Shift in Demand Curves (f) (cont.)

• A change in expectations– If consumers believe the price will increase in the future,

demand increases today (when the good is cheaper); this shifts the demand curve to the right.

– A change in expectations about the future affects current variables.

– A change in expectations may be self-fulfilling.

Supply and Supply Curves

The supply schedule (or supply curve) for a commodity shows the relationship between its market price and the amount of that commodity that producers are willing to produce and sell other things held constant.

The Slope of the Supply Curve

• The supply curve is upward sloping.• When the price of a good or service rises, the

quantity supplied to the market rises.– Suppliers find it more profitable to produce more goods

or services when prices are higher.– A higher price allows firms to cover the higher costs of

producing more goods.

Market Supply

• The market supply curve is the horizontal sum of the supply curves of all the suppliers.

• Just as individual supply curves have a positive slope, so do market supply curves.

Forces behind the Supply Curves

• Cost of Production

• Technological Advances

• Price of related goods

• Govt. Policies

• Special Influences

Shifts in a Supply Curve versus Movements along a Supply Curve

• A change in price is represented by a movement along the supply curve.

• All other changes that affect supply shift the supply curve.

Sources of Shifts in Supply Curves (a)

• A change in the price of inputs• A change in technology• A change in the natural environment• A change in the availability of credit• A change in expectations

Sources of Shifts in Supply Curves (b)

• A rise in the price of coffee increases the costs of making espresso.

• The supply of coffee decreases and the supply curve for coffee shifts left or up.

Sources of Shifts in Supply Curves (c)

• If a new technology improves coffee bean harvesting, the costs of producing coffee fall.

• This increases the suppliers’ desire to sell at each price.

• The supply increases and the supply curve shifts right.

A market equilibrium comes at the price at which quantity demanded equals quantity supplied.

-At that equilibrium, there is no tendency for the price to rise or fall. The equilibrium price is also called the market-clearing price.

-This denotes that all supply and demand orders are filled, the books are “cleared” of orders, and demanders and suppliers are satisfied.

Equilibrium of Supply and Demand

Law of Supply and Demand (b)

• The equilibrium price is the market clearing price that equates quantity demanded with quantity supplied.

• Equilibrium occurs where the demand curve intersects the supply curve—Qd = Qs.

Excess Supply• The law of supply and demand predicts that

prices will move to equilibrium values.• Excess supply causes prices to fall.• Suppliers cannot sell all they wish, so they cut

price.– Quantity demanded increases along the demand curve

to point E0.– Quantity supplied decreases along the supply curve to

point E0.

Excess Demand

• Excess demand causes prices to rise.• Consumers cannot buy as much of the item as they

want.• They bid up the price.

– As the price rises, the quantity supplied increases along the supply curve.

– As the price rises, the quantity demanded decreases along the demand curve.

Using Demand and Supply Curves (a)

Using Demand and Supply Curves (b)

Price and Cost (b)

• In the basic competitive model, the price equals the marginal cost.

• An example of the difference between price and marginal cost is land.– The supply of land is fixed (ignore reclamation from the

sea).– So marginal cost is infinite or at least very high.– But the price of land is finite.