Movement Along The Demand Curve & Shift of The Demand Curve

Movement Along The Demand Curve &Shift of The Demand Curve

Economists usually mean something different when they talk about a 'change in the quantity demanded' than when they talk about 'change in demand'. In economics we tend to draw a distinction between these two terms. We should keep this distinction clearly in mind so as to avoid any possibility of confusion.

Change in Quality Demanded - Movement along the Demand curve 

When the amount demanded of a commodity changes (rises or falls) as a result of change in its own price, while other determinants of demand (like income, tastes and prices of related goods) remain constant, it is known as change in quantity demanded.
Change in Quantity demanded may be of two types:  (i) extension of demand,  (ii) contraction of demand

  (i) Extension of demand: When the quantity demanded of a commodity rises due to fall in its price, other things remaining the same, it is called 'rise in quantity demanded' or 'extension of demand'.
For example, when the price of apples falls from ₹60 to ₹50 per kg, a consumer's purchase

  (ii) Contraction of demand: 'Contraction of demand' or 'fall in the quantity demanded' refers to a decrease in the quantity demanded of a commodity as a result in its rise of its price, other things remaining the same.
For example, when the price of apples rises from ₹30 a kg to ₹40 a kg, a consumer buys less apples, 4 kg instead of 6 kg, in this case there is contraction in demand or decrease in quantity demanded.

Any point on a demand curve represents a particular quantity being bought at a specified price. Different points on a demand curve represents different quantities demanded at different prices. A movement down the demand curve is called a 'rise in the quantity demanded' or 'extension of demand'. On the other hand, a movement up the demand curve is called a 'fall in quantity demanded' or 'contraction 
demand'.

                
                                                   Movement along the demand curve

Change in demand - Shift in demand curve

When the amount purchased of a commodity rises or falls because of change in factors other than the own price of the commodity, it is called change in demand.
Change in demand may be of two types:  (1) Increase in Demand,  (2) Decrease in Demand.


(i) Increase in Demand: Increase in demand refers to a situation when the consumers buy larger amount of commodity at the same price because of change in factors other than the own price of the commodity. Increase in demand may take place due to rise in income, a change in taste in favour of the commodity, rise in prices of substitutes, fall in prices of complimentary goods, increase in population, redistribution of  income, etc.

(ii) Decrease in Demand: Decrease in Demand refers to a situation when the consumers buy a smaller quantity of commodity at the same price. Decrease in demand takes place as a result in change of factors other than the own price of the commodity under question.

Change in demand is illustrated below:

Shift in Demand

Exceptions to the Law of Demand

Exceptions of Law of Demand

The Law of demand is a common statement stating that prices and quantities of a commodity are inversely correlated. There are certain peculiar situations in which the law of demand will not hold well. In those situations, more will be demanded at higher price and less will be demanded at a lower price. The demand curves in those situations slope upwards exhibiting a positive relationship among price and quantity demanded as shown in figure below:

A Positively sloping Demand Curve

(1) Articles of Snob Appeal:

   Veblen has indicated that there are some goods demanded by very wealthy people for their social prestige. Whenever price of these goods increase, their use becomes more attractive and they are purchased in bigger amounts.

Demand for diamonds from wealthier class will go up when there is raise in price. When such goods were cheaper, the rich would not even buy.

(2) Giffen Paradox:

  Sir Robert Giffen introduced that the poor people will demand more of low-grade goods when their prices increase and demand less when their prices fall. Inferior goods are those goods that people purchase in large quantities when they are poor and in small quantities when they become rich. For illustration, poor people expend the major portion of their income on coarse grains and only a small portion on rice. Whenever the price of coarse grains increases, they will purchase less rice. To fill up the resultant gap, more of coarse grains have to be purchased. Therefore, raise in the price of coarse grains outcomes in the raise in quantity of coarse grains bought. This is termed as ‘Giffen Paradox’. In such situations, the law of demand has an exemption.


(3) Exceptions Regarding Future prices: If price of a commodity is rising today and it is likely to rise more in the future, people will buy more even at the existing higher price and store it up.They will do this in order to avoid the pinch of higher price in future. Similarly, when the consumers anticipate a large fall in the price of a commodity in future, they will postpone their purchase even if price falls today so as to purchase this commodity at still lower price in future.

(4) Emergencies: Law of demand may not hold good during emergencies like war, famines, etc. At such times, consumers behave in an abnormal way. If they expect shortage of goods, they would buy and hoard goods even at high prices during such periods. On the other hand, during depression they will buy less even at low prices.

(5) Quality-Price Relationship: Sometimes consumers assume that high priced goods are of higher quality than the low priced goods. They take price as an index of quality. In such cases, more of the goods are demanded at a higher price.

(6) Change in Fashion:  When a commodity goes out of fashion, consumers will not purchase a larger quantity of this commodity even when its price is reduced.

More About Demand Curve

Why Does Demand Curve Slopes Downward to the Right?

It has been explained in an earlier post that the Demand curves slopes downward from left to the right. The negative sloping curve is based on the law of demand. Now the question arises, why does the demand curve slopes downwards to the right? In other words, what is the explanation of the law of demand? These can be explained  in terms of the following factors:

    (1) Law of Diminishing Marginal Utility: This law states that with an increase in the units of a commodity consumed, every additional unit of the commodity gives lesser satisfaction to the consumer. A consumer will maximize his satisfaction when he equalizes the marginal utility of the commodity with its price, i.e.,
                          Marginal utility of a commodity = Price of the quantity.

From this equilibrium condition, it  follows that a consumer would purchase a larger amount of commodity only when its price falls because the marginal utility from additional utility falls.

  (2) Income Effect: A change in demand on account of change in real income resulting from change in the price of a commodity is known as income effect.

Suppose a consumer is spending ₹120 on purchase of apples , and he is able to purchase 2 kg of apples when the price of apples is ₹60 per kg.Now suppose the price of apple falls  to ₹50 per kg. If the consumer continues to buy 2 kg of apples as before, he has to spend only ₹100. He is, therefore able to save ₹20. It means his real income(in terms of apples) has increased. The consumer may use this increased real income(i.e., ₹20 saved in purchasing the original quantity of apples at a lower price) in purchasing more apples. Thus, a fall in price of a commodity causes increase in real income and thereby increase in the quantity of commodity demanded.

  (3) Substitution Effect: The substitution effect is the effect that a change in relative prices of substitute goods has on the quantity demanded.
For instance if the price of coffee falls, the price of tea remaining the same, coffee will become relatively cheaper. Coffee becomes more attractive to people in comparison with tea. This increase in demand on account of a commodity  becoming relatively cheaper is known as substitution effect.
The sum total of income effect and substitution effect is called the price effect.

                                  Price effect = Income effect + Substitution effect

(4) Increase in number of consumers: A fall in the price of a commodity leads to an increase in quantity demanded  by the existing customers due to income and substitution effect. At the same time, at high prices only a few rich people can afford to buy that commodity. When the price of that commodity falls a little, people with moderate income will also be able to purchase that commodity. At still lower prices, even the poor persons will be able to afford it and, therefore the demand for the commodity will rise.

(5) Several uses of a commodity: There are some goods that can be put to number of uses.Some of them are more important , while others are less important. Steel, aluminium, coal, electricity, milk are examples of such commodities.When the price of such commodities are very high, they can be used for more important puposes only and, therefore, a small quantity will be in demand. But when the price falls, the commodity will be put to less omportant uses also, leading to an increase in demand. For example, when the price of electricity is very high, it will be used mainly for lighting puposes. When the price falls, it will be used for cooking as well.

Commercial Papers

Commercial Papers

1. What is Commercial Paper (CP)?

Commercial Paper (CP) is an unsecured money market instrument issued in the form of a promissory note.

2. When it was introduced?

Commercial credit, in the form of promissory notes issued by corporations, has existed since at least the 19th century. For instance,Marcus Goldman, founder of Goldman Sachs got his start trading commercial paper in New York in 1869.It was introduced in India in 1990.

3. Why it was introduced?

It was introduced in India in 1990 with a view to enabling highly rated corporate borrowers to diversify their sources of short-term borrowings and to provide an additional instrument to investors. Subsequently, primary dealers and all-India financial institutions were also permitted to issue CP to enable them to meet their short-term funding requirements for their operations.

4. Who can issue CP?

Corporates, primary dealers (PDs) and the All-India Financial Institutions (FIs) are eligible to issue CP.

5. Whether all the corporates would automatically be eligible to issue CP?

No. A corporate would be eligible to issue CP provided –

a. the tangible net worth of the company, as per the latest audited balance sheet, is not less than Rs. 4 crore

b. company has been sanctioned working capital limit by bank/s or all-India financial institution/s; and

c. the borrowal account of the company is classified as a Standard Asset by the financing bank/s/ institution/s.

6. Is there any rating requirement for issuance of CP? And if so, what is the rating requirement?

Yes. All eligible participants shall obtain the credit rating for issuance of Commercial Paper either from Credit Rating Information Services of India Ltd. (CRISIL) or the Investment Information and Credit Rating Agency of India Ltd. (ICRA) or the Credit Analysis and Research Ltd. (CARE) or the FITCH Ratings India Pvt. Ltd. or such other credit rating agency (CRA) as may be specified by the Reserve Bank of India from time to time, for the purpose.

The minimum credit rating shall be A-2 [As per rating symbol and definition prescribed by Securities and Exchange Board of India (SEBI)].

The issuers shall ensure at the time of issuance of CP that the rating so obtained is current and has not fallen due for review.

7. What is the minimum and maximum period of maturity prescribed for CP?

CP can be issued for maturities between a minimum of 7 days and a maximum of up to one year from the date of issue.However, the maturity date of the CP should not go beyond the date up to which the credit rating of the issuer is valid.

8. What is the limit up to which a CP can be issued?

The aggregate amount of CP from an issuer shall be within the limit as approved by its Board of Directors or the quantum indicated by the Credit Rating Agency for the specified rating, whichever is lower.

As regards FIs, they can issue CP within the overall umbrella limit prescribed in the Master Circular on Resource Raising Norms for FIs, issued by DBOD and updated from time-to-time.

9. In what denominations a CP that can be issued?

CP can be issued in denominations of Rs.5 lakh or multiples thereof.

10. How long can the CP issue remain open?

The total amount of CP proposed to be issued should be raised within a period of two weeks from the date on which the issuer opens the issue for subscription.

11. Whether CP can be issued on different dates by the same issuer?

Yes. CP may be issued on a single date or in parts on different dates provided that in the latter case, each CP shall have the same maturity date. Further, every issue of CP, including renewal, shall be treated as a fresh issue.

12. Who can act as Issuing and Paying Agent (IPA)?

Only a scheduled bank can act as an IPA for issuance of CP.

13. Who can invest in CP?

Individuals, banking companies, other corporate bodies (registered or incorporated in India) and unincorporated bodies, Non-Resident Indians (NRIs) and Foreign Institutional Investors (FIIs) etc. can invest in CPs. However, investment by FIIs would be within the limits set for them by Securities and Exchange Board of India (SEBI) from time-to-time.

14. Whether CP can be held in dematerilaised form?

Yes. CP can be issued either in the form of a promissory note (Schedule I given in the Master Circular-Guidelines for Issue of Commercial Paper dated July 1, 2011 and updated from time –to-time) or in a dematerialised form through any of the depositories approved by and registered with SEBI. Banks, FIs and PDs can hold CP only in dematerialised form.

15. Whether CP is always issued at a discount?

Yes. CP will be issued at a discount to face value as may be determined by the issuer.

16. Whether CP can be underwritten?

No issuer shall have the issue of Commercial Paper underwritten or co-accepted.

17. Whether CPs are traded in the secondary market?

Yes. CPs are actively traded in the OTC market. Such transactions, however, are to be reported on the FIMMDA reporting platform within 15 minutes of the trade for dissemination of trade information to market participation thereby ensuring market transparency.

18. What is the mode of redemption?

Initially the investor in CP is required to pay only the discounted value of the CP by means of a crossed account payee cheque to the account of the issuer through IPA. On maturity of CP,

(a) when the CP is held in physical form, the holder of the CP shall present the instrument for payment to the issuer through the IPA.

(b) when the CP is held in demat form, the holder of the CP will have to get it redeemed through the depository and receive payment from the IPA.

19. Whether Stand by facility is required to be provided by the bankers/FIs for CP issue?

CP being a `stand alone’ product, it would not be obligatory in any manner on the part of banks and FIs to provide stand-by facility to the issuers of CP.

However, Banks and FIs have the flexibility to provide for a CP issue, credit enhancement by way of stand-by assistance/credit backstop facility, etc., based on their commercial judgement and as per terms prescribed by them. This will be subjected to prudential norms as applicable and subject to specific approval of the Board.

20. Whether non-bank entities/corporates can provide guarantee for credit enhancement of the CP issue?

Yes. Non-bank entities including corporates can provide unconditional and irrevocable guarantee for credit enhancement for CP issue provided :

a. the issuer fulfils the eligibility criteria prescribed for issuance of CP;

b. the guarantor has a credit rating at least one notch higher than the issuer by an approved credit rating agency and

c. the offer document for CP properly discloses: the networth of the guarantor company, the names of the companies to which the guarantor has issued similar guarantees, the extent of the guarantees offered by the guarantor company, and the conditions under which the guarantee will be invoked.

21. Role and responsibilities of the Issuer/Issuing and Paying Agent and Credit Rating Agency.

Issuer:

a. Every issuer must appoint an IPA for issuance of CP.

b. The issuer should disclose to the potential investors its financial position as per the standard market practice.

c. After the exchange of deal confirmation between the investor and the issuer, issuing company shall issue physical certificates to the investor or arrange for crediting the CP to the investor's account with a depository.

Investors shall be given a copy of IPA certificate to the effect that the issuer has a valid agreement with the IPA and documents are in order (Schedule II given in the Master Circular-Guidelines for Issue of Commercial Paper dated July 1, 2011 and updated from time –to-time).

Issuing and Paying Agent

a. IPA would ensure that issuer has the minimum credit rating as stipulated by the RBI and amount mobilised through issuance of CP is within the quantum indicated by CRA for the specified rating or as approved by its Board of Directors, whichever is lower.

b. IPA has to verify all the documents submitted by the issuer viz., copy of board resolution, signatures of authorised executants (when CP in physical form) and issue a certificate that documents are in order. It should also certify that it has a valid agreement with the issuer (Schedule II given in the Master Circular-Guidelines for Issue of Commercial Paper dated July 1, 2011 and updated from time –to-time).

c. Certified copies of original documents verified by the IPA should be held in the custody of IPA.

Credit Rating Agency

a. Code of Conduct prescribed by the SEBI for CRAs for undertaking rating of capital market instruments shall be applicable to them (CRAs) for rating CP.

b. Further, the credit rating agencies have the discretion to determine the validity period of the rating depending upon its perception about the strength of the issuer. Accordingly, CRA shall at the time of rating, clearly indicate the date when the rating is due for review.

c. While the CRAs can decide the validity period of credit rating, CRAs would have to closely monitor the rating assigned to issuers vis-a-vis their track record at regular intervals and would be required to make its revision in the ratings public through its publications and website

22. Is there any other formalities and reporting requirement with regard to CP issue?

Fixed Income Money Market and Derivatives Association of India (FIMMDA), may prescribe, in consultation with the RBI, any standardised procedure and documentation for operational flexibility and smooth functioning of CP market. Issuers / IPAs may refer to the detailed guidelines issued by FIMMDA on July 5, 2001 in this regard, and updated from time-to-time.

Every CP issue should be reported to the Chief General Manager, Reserve Bank of India, Financial Markets Department, Central Office, Fort, Mumbai through the Issuing and Paying Agent (IPA) within three days from the date of completion of the issue, incorporating details as per Schedule III given in the Master Circular-Guidelines for Issue of Commercial Paper dated July 1, 2011 and updated from time-to-time.

The Law Of Demand

Law of Demand

Statement of law:

  The law of demand states that the other things remaining equal, the quantity demanded of a commodity increases when its price falls and decreases when its price rises.

Thus the law of demand indicates an inverse relationship between the price and quantity demanded of a commodity. That is  with a rise in price demand will fall and with a fall in price demand will rise.

Assumptions of law of demand:

The law of demand is based on following assumptions:

1. There should be no change in the income of consumer.
2. There should be no change in the tastes and preferences of the consumer.
3. Prices of related commodities should remain unchanged.
4. Size of population should not change.
5. The distribution of income should not change.
6. The commodity should be a normal commodity.

The law of demand can be illustrated numerically through a 'Demand Schedule' and graphically through a 'Demand Curve'.

Demand Schedule:

It is tabular statement that shows different quantities of a commodity that would be demanded at different prices.
Demand schedule is of two types, viz. (1) Individual demand schedule, and (2) Market demand schedule.

  (1) Individual Demand Schedule:  Individual demand schedule is the table which shows various quantities of a commodity that would be purchased at different prices by a household.
For Example:

Individual demand for a product

  (2) Market Demand Schedule: Market demand schedule is a table which shows various quantities of a commodity that all the buyers (consumers) will purchase at different prices during a given period.

Market Demand Schedule for oranges

Demand Curve and its Derivation:

Demand curve is a graphic presentation of the law of demand.

We can convert the demand schedule into a demand curve by plotting the various price-quantity combinations graphically.

The picturization of the demand schedule is called the 'Demand curve'. It is the curve showing different quantities demanded at various alternative  prices during a given period.

Demand curves are of two types, viz.  (1) Individual Demand curve,  (2) Market Demand curve.

  (1) Individual Demand curve: Individual Demand curve for a good  is the curve that shows different quantities of the good which a consumer is willing to buy at different prices during a given period of time.

                                                             Individual demand Curve

  (2) Market Demand curve: Market Demand curve is a graphic representation of graphic schedule. It is a curve that represents different quantities of goods which all consumers in the market are willing to buy at different prices during a specified period.
It is the horizontal summation of the demand curves of all households.

                                                              Market Demand Curve

Demand

Meaning of Demand

Definition:
         Demand for any commodity refers to the amount of that commodity that will be purchased, i.e., the amount which consumers are willing and able to purchase at a particular period of time.

In economics, demand is the utility for a good or service of an economic agent, relative to a budget constraint. (Note: This distinguishes "demand" from "quantity demanded", where demand is a listing or graphing of quantity demanded at each possible price. In contrast to demand, quantity demanded is the exact quantity demanded at a certain price. Changing the actual price will change the quantity demanded, but it will not change the demand, because demand is a listing of quantities that would be bought at various prices, not just the actual price.)

Demand is a buyer's willingness and ability to pay a price for a specific quantity of a good or service. Demand refers to how much (quantity) of a product or service is desired by buyers at various prices. The quantity demanded is the amount of a product people are willing to buy at a certain price; the relationship between price and quantity demanded is known as the demand. The term demand signifies the ability or the willingness to buy a particular commodity at a given point of time.

Types of Demand:

• Individual Demand and Market Demand: The quantity of a commodity that an individual consumer is willing to purchase at a given price during a given period of time is known as individual demand. Market demand refers to the total quantity of a commodity that all the households are willing to buy at a given price during a given period of time.

   Individual & market demand curve

• Ex ante and Ex post Demand: Ex ante Demand refers to the amount of goods that consumers want to or willing to buy during a particular time period. Ex post Demand on the other hand refers to the amount of goods that the consumers actually purchase during a specific period.
• Joint Demand: Joint Demand refers to the demand for two or more goods which are used jointly or demanded together. For example, cars & petrol, butter & bread, milk & sugar, etc are the goods which are used together.In this type of demand, the rise in price of one good leads to the fall in demand for the other and vice versa.
• Derived Demand: The demand for a commodity that arises because of the demand for another commodity is called Derived demand. For instance, demand for steel, bricks ,cement, stones, wood, etc.is a derived demand-- derived from the demand for houses and other buildings.
• Composite Demand: Demand for goods that have multiple uses is called composite demand. For example, the demand for steel arises from various uses of steel, such as use of steel in making utensils, bus bodies, room coolers, cars and so on.Thus a commodity is said to have composite demand when it can be put to several alternative uses.

Factors affecting Demand:

Price of the commodity: The most important determinant of the demand of a commodity is the price of the commodity itself. Normally there is an inverse relationship between the price of a commodity and the quantity demanded. It implies that lower the price of goods, higher is the quantity demanded and vice versa. This type of demand is known as price demand. 

Income levels of consumer:  Generally there is direct relationship between income of a consumer and his demand for a product. When an individual’s income goes up, their ability to purchase goods and services increases, and this causes demand to increase. When incomes fall there will be a decrease in the demand for most goods. However this may not always be the case.      

    We may distinguish three types of commodities: i) Normal Goods   ii) Inferior Goods   iii) Inexpensive necessities of life.

     (i) Normal Goods: Normal goods are those goods the demand for which increases with increase in income of consumers and decreases with fall in income.

    (ii) Inferior goods: Inferior goods are those goods the demand for which falls with increase in income of consumer.
   (iii) Inexpensive goods of necessities: In case of inexpensive necessities of life such as salt and matchbox, quantity purchased increases with increase in income upto certain level and thereafter it remains constant irrespective of the level of income.
  The functional relationship between the demand for a commodity and the level of income is known as income demand.

Relation between Income & Demand

Consumer tastes and preferences: Changing tastes and preferences can have a significant effect on demand for different products. Persuasive advertising is designed to cause a change in tastes and preferences and thereby create an increase in demand. 

Prices of related Goods: The demand for a commodity is also affected by the prices of related goods. related goods can be classified into two categories, viz  (i)Substitute or competitive goods,                                                                                                           (ii) Complementary goods
     

      (i) Substitute or competitive goods:Substitute goods are those which satisfy the same type of demand and hence can be used in place of one another. For example, if the price of coffee rises, many consumers will shift from consumption of coffee to consumption of tea because tea has now become relatively cheaper.

Substitute goods

     (ii) Complementary goods: Complementary goods are those goods which are complementary to one another in the sense that they are used jointly or consumed together to satisfy a given want.

                                                          Complementary goods

The way demand for one particular product is affected by a change in price in another product is known as cross demand or cross price effect. the cross demand shows the functional relation between the price of a commodity and demand for some other related commodity
       

Competition: Competitors are always looking to take a bigger share of the market, perhaps by cutting their prices or by introducing a new or better version of a product

Fashions: When a product becomes unfashionable, demand can quickly fall away.

Differences in Macroeconomics & Microeconomics

Macroeconomics vs. Microeconomics

We live in a world of scarcity. There is a limited amount of money, resources, time, etc. Economics is the study of how individuals and societies choose to use these scarce resources. Most people tend to think of economics as something related to the stock market, or inflation, or unemployment. In truth, it includes those subjects and a whole lot more. Given the breath of the areas covered by economics, the discipline is divided into two major subgroups which are (1) Microeconomics and (2) Macroeconomics.

 

Economics is defined as the study of how individuals and society choose to use scarce resources.  In essence, economics is a study on how individuals make choices.   There are two branches of economics: (1) Microeconomics and (2) Macroeconomics 

Microeconomics looks at the decision making behavior of individual decision making units: Households, firms, industries, etc…

Macroeconomics looks at the entire (aggregate) economy.  Table 1 illustrates the difference between the type of questions addressed by microeconomics vs. macroeconomics.

Table 1

	PRODUCTION	PRICES	INCOME	EMPLOYMENT
Microeconomics	How many hamburgers does In N’ Out produce?	What is the price of an In N’ Out hamburger?	What are the wages of the workers at In N’ Out?	How many workers are employed at In N’ Out?
Macroeconomics	How much goods and services does the United States produce each year?	What is the price of all consumer goods in the economy?	What are the total wages and salaries of workers in the economy?	What are the total number of workers in an economy?

II.  Some Key Principles of Economics

The book provides several themes that you will see over and over again in this course.  Two of these principles that we should pay particular attention is the idea of opportunity cost and the idea of margin.

1.                  Opportunity Cost:  All decisions involve trade-offs.  Opportunity cost measures the cost of the next best alternative that we give up when making a choice.

For  example, when calculating the cost of college, economists think not only about the direct costs such as tuition, textbooks, living expenses, etc…, but also the opportunity cost.  What is the opportunity cost for going to college?  This varies from individual to individual as people have different alternatives to going to college.  Presumely for many individuals, they could have worked instead of going to college.  The wages one could have earned is the opportunity cost of going to college.

See if you determine what would be the potential opportunity cost of the following:

Ex)  The opportunity cost of going to class this morning

Ex)  The opportunity cost of the war in Afghanistan

2.                  Marginalism:  When making a decision, one should only consider the additional (not total) cost or benefits that will arise from that decision.  We’ll introduce two terms here, which we will discuss more fully later on in the course.

Marginal Cost: Additional cost of producing one more unit of a good

Marginal Benefit:  Additional benefit of producing one more unit of a good

Example:  Suppose Tiger Woods is flying to Honolulu to participate in a charity golf event (He has to pay for his own ticket to Hawaii).  Suppose that after the charity event, he wants to spend a week in Maui with one of his cocktail waitress mistresses.    When making a decision whether or not to spend a week in Maui, what are the costs that Tiger should consider?  In this example, Tiger should only consider the additional cost of flying from Honolulu to Maui.

Example: To drive home the point of marginalism, consider an example where you are taking a class that has 2 midterms and a final.  After taking the two midterms your average was a 90.  Suppose you wanted an A in the course.  That would mean on the final exam you would need to score a 90 or above.  At the end of the semester, what really matters for your grade is not the two midterms, but rather the marginal grade (the grade on the final exam).

III.      Positive vs. ormative Economics

Economists try to answer to type of questions: positive and normative.  It’s straightforward to differentiate between the two.  In this course we’ll usually limit our discussion to positive economics, although at times we might tackle normative questions as well. 

(1)   Positive economics is an approach to economics that seeks to understand behavior of the economic system without making judgments. It describes what exists and how it works.

(2)   ormative economics is an approach to economics that analyzes outcomes of economic behavior, evaluates them as good or bad, and may include recommendations on how to improve outcomes.  It is also called policy economics. When economists disagree, the points they disagree  about are often normative points (differences of opinion and values).

For example: Raising the minimum wage will lower employment of high school age workers is a positive statement.   Raising the minimum wage is the best way to get families out of poverty is a normative statement.

IV.       The Production Possibility Frontier (PPF)

The production possibility frontier shows all the combinations of two goods that can be produced if all of society’s resources are used efficiently.

Figure 1 shows the production possibility frontier for consumption and capital goods.

Point A represents a point where all the resources in the economy are being used to produce capital goods.  In this case only capital goods are produced and no consumption goods are produced.  

Point B represents the opposite case where all the resources in the economy are being used to produced consumption goods.  In this case only consumption goods are being produced and no capital goods are produced.

There are any number of combinations in between these two extremes, and any point on the curve in Figure 1 are possible production points for the economy.  Points E and F are points along the PPF, which means that an economy utilizing all its resources efficiently can produce at those points.  

Point C is another point that is obtainable in this economy.  In fact any point inside the production possibility frontier is obtainable.  However, Point C is not desirable since it implies that the economy is not using its resources efficiently.  We can see that, because the economy can go to another point which would be able to produce more capital goods and more consumption good.  Thus the economy doesn’t want to remain at a point inside its PPF.  How does an economy get to be at a point inside its PPF?  There are two possibilities:

(1)   Resources such as labor are not being fully utilized.  If there is unemployment, then the economy is not producing at its full potential.  As workers get hired, the economy will be able to produce more.

(2)   Resources are wasted or mismanaged.  Even if workers and capital are fully employed, there can be ways in which the economy produces below full potential.  Suppose a new law was put into effect saying that all college educated individuals could only work as janitors, while those only with a high school education would be allowed to run corporations and factories.  Although labor might be fully utilized, it is clear that it is being mismanaged as jobs are not matched with the skill sets.  As a result production will be less.

Point D represents a point that is unattainable.  Given the level of technology in the economy, there is no method which will allow the economy to reach that level of consumption and capital goods.

A. Properties of the Production Possibility Frontier  

PPFs are not just useful in examining the tradeoffs between consumption and capital goods, they can be used to examine the tradeoffs between any two goods.  For example the table below shows an economy with fixed resources is able to produce the following combinations of grapes and apples.

POINT	GRAPES	APPLES
A	75	0
B	60	12
C	45	22
D	30	30
E	15	36
F	0	40

Figure 2 uses the data in the table to graph the PPF between apples and grapes.

Using Figure 2 we can illustrate several properties of PPF.

Property #1:  To be efficient and economy must also produce what consumers want.  This is called output efficiency.  We talked earlier about how an economy is efficient if it uses all of its resources (production inefficiencies).  Any of the Points A-F uses its resources efficiently.  However, if the economy is producing at Point F, but everyone in the economy hates apples then the result is a waste of resources (we have output inefficiency).  The point of output efficiency is determined by consumer preferences. 

Property #2:  PPF have negative slope.  The slope of the PPF is called the marginal rate of transformation (MRT).  Note that throughout the curve, the slope is negative.  For example as we move from Point C to Point D, the number of grapes decreases by 15 while the number of apples increases by 8.  The slope from C to D is -15/8.   The reason for the negative slope is quite straightforward.  Because resources are limited, in order to produce more apples, the other product (grapes) must be sacrificed.  Thus between C and D, in order to produce 8 more apples, the economy has to sacrifice 15 grapes.

Property #3:  The Law of Increasing Opportunity Costs implies that PPF is bowed.  Notice in Figure 2 that opportunity cost is increasing as we shift production from grapes to apples.  For example, as we move from A to B, in order to get 12 apples we have to sacrifice 15 bushels of grapes.  The opportunity cost per apple is 15/12 = 1.25 grapes.  Now as we move from E to F, if we sacrifice 15 bushels of grapes we only get 4 more apples.  The opportunity cost per apple is 15/4 = 3.75 grapes.  Why does the opportunity cost increase?  It’s reasonable to assume that apples and grapes require different land to grow best.  As we shift production more and more away from grapes, we are increasingly taking away land that is best suited towards grape production and shifting it to apple production.  As a result we are sacrificing more grapes to get less apples.  This idea of increasing opportunity cost explains why the PPF curve is bowed.  If the opportunity cost was constant (like in our island example) then the PPF would simply be a straight line.

Property #4:  Economic growth is characterized by the PPF shifting outwards to the right.

Economic growth can occur if:

(1)   There are more resources such as more labor or more capital or

(2)   There is new technology that allows producers to produce more output with the same level of inputs.

Figure 3 shows how economic growth can be represented by our PPF.  Suppose that the economy was fully utilizing its resources at Point D.  With new technology, with the same amount of capital and labor it can produce both more apples and more grapes and will move to a higher point such as Point G.  This will be true at every other old combination and thus the curve will shift to the right. Figure 3:  Economic Growth

 IN A NUTSHELL

Difference between Microeconomics & Macroeconomics

1. Macroeconomics deals with the functioning of the entire economy, while microeconomics is concerned with parts of economy.
2. Macroeconomics deals with broad economic aggregates like national income and employment, while microeconomics deals with individual income,employment in a particular industry, individual prices, etc.
3. Different parameters - prices in microeconomics and National income in macroeconomics.
4. Macroeconomics is the top-down view of the economy, while microeconomics is the bottom-up view, i.e., Microeconomics and macroeconomics look at economic issues from different perspectives.
5. Microeconomics and macroeconomics differ from each other on the basis of nature of assumptions. In microeconomics, it is assumed that the total output, income and employment, general price level, etc(i.e.,economic variables of macroeconomics) are given. On the basis of these assumptions, microeconomics explains how allocation of resources takes place and how prices of different commodities are determined. Macroeconomics on the other hand assumes allocation of resources, distribution of output, spending among particular goods and services, relative prices etc(i.e.,economic variables of microeconomics) are given. On the basis of these assumptions, macroeconomics explains how aggregate output, income, employment and price level, etc are determined in the economy as a whole.