Allocation of resources
Microeconomics and Macroeconomics
● Microeconomics
○ The study of the behavior and decisions of households and firms, and the performance of
individual markets
○ Small scale
● Macroeconomics
○ The study of the whole economy
○ Large scale
● Market
○ An arrangement which brings buyers into contact with sellers
● Those who undertake economic activities and make economic decisions are called economic agents
● These economic agents are → households, firms and governments
● Household
○ They are buyers or consumers, savers or workers
○ They seek lower prices and good quality products/ good conditions and high pay
● Firms
○ They are business concerns that produce goods and services, employ workers and other
factors of production
○ They seek to make as much profit as possible
● Government
○ It is the system which rules a country or region. A government produces and provides some
products, provides financial benefits and taxes and regulates the private sector
○ Government seeks for strong economy (full employment of labour) and improve performance of
individual markets by taxing sale of cigarettes
Role of markets in allocating resources
● What to produce
○ This question is necessary because resources are limited but wants are unlimited. Society
wants a lot of goods and services but everything cannot be produced.
○ Society must choose among the wide assortment of alternatives when selecting which goods to
produce
● How to produce it
○ Society must decide which limited resources to use for which good. Every good cannot be made
using the same resources
● For whom to produce it
○ With limited resources, the production of goods is also limited. With limited goods, everyone
cannot have everything
● Economic system
○ The institutions, organisations and mechanisms that influence economic behaviour and
determine how resources are allocated
Different economic systems
● Planned economic system
○ An economic system where the government makes the crucial decisions, land and capital are
state owned and resources are allocated by directives.
○ It is an economy where the government makes all the decisions about what to produce, how
and who. The state owns all or most of the land and capital and employs workers
○ Government gives directives to state-owned enterprises(SOE’s) on what to produce and how to
produce it
○ It usually is made for basic necessities and important products like housing, transport and
education, free of cost or at a low price
● Mixed economy system
○ An economy in which both the private and public sectors play an important role
● Market economy system
○ An economic system where consumers determine what is produced, resources are allocated by
price mechanism and land and capital are privately owned.
○ In the market economic system, government intervention is minimum. Land and capital are
privately owned. Private sector firms decide how to produce the products
● Free enterprise economy
○ An economy which operates a market economic system is known as a market economy or a
free enterprise economy
○ It is one in which buyers/consumers determine what is produced. They signal their preferences
to sellers through price mechanism
● Price mechanism → the way the decisions made by households and firms interact to decide the
allocation of resources
● Some firms use large amounts of capital relative to labour. These are capital-intensive(use of high
proportion of capital to labour)
● Others for e.g. hotels require more labour, therefore they are labour intensive(the use of high proportion
of labour relative to capital)
● Demand → the willingness and ability to buy a product
● Supply → the willingness and ability to sell a product
● Market equilibrium → a situation where demand and supply are equal at the current price
● Market disequilibrium → a situation where demand and supply are not equal at the current market price
● Price increases if demand increases or supply decreases
Demand
● Demand
○ The willingness and ability to buy a product
○ Demand and price are inversely proportional
○ If the price rises, the willingness and ability to buy that product falls
● Market demand → total demand for a product
● Aggregation → addition of individual components to arrive to a total amount
● Extension in demand
○ A rise in the quantity demanded caused by a fall in price of the product itself
○ Price is inversely proportional to demand, which means a higher rise in demand causes a
steeper fall in price which is harmful if it gets too low.
● Contraction in demand
○ A fall in the quantity demanded caused by a rise in the price of the product itself
● Conditions of demand
○ Changes in demand → shifts the demand curve either left or right
○ Increase in demand
■ A rise in demand at any given price, causing the demand curve to shift to the right
○ Decrease in demand
■ A fall in demand causing the demand curve to shift to the left
● Increase in demand (moves to the right)
● Decrease in demand ( moves to the left)
Causes of change in demand (PIRATES)
● Population
○ The larger the population, the higher the demand. Changing the structure of the population also
affects demand such as distribution of different age groups
● Income
○ If consumers have more disposable income, they are able to afford more goods so demand
increase
● Related goods
○ They are substitutes and complements.
○ A substitute can replace another good. If the price of substitute falls, the quantity demanded of
the original good will also fall because consumers will switch to the cheaper option.
○ A complement goes with another good. For e.g. cream is complementary good for strawberries.
If the price of strawberries increases, the demand for cream will fall as fewer people will be
buying strawberries. And if demand for strawberries increases, the demand for cream increases
with it.
● Advertising
○ This will increase consumer loyalty to the good and increase demand
● Tastes and fashions
○ Demand curve will also shift if consumers' tastes change. For e.g. demand of physical books will
fall if consumers start preferring to read e-books
● Expectations
○ If spectators expect the price of shares in a company to increase in the future, demand is likely
to increase in present
● Seasons
○ Demand changes according to the season. For eg. in the summer, the demand for ice cream
and sun lotion increases
● Normal goods
○ A product whose demand increases when income increases and decreases when income falls
● Inferior goods
○ A product whose demand decreases when income increases when increase when income falls
● Substitute
○ A product that can be used in place of another
● Complement
○ A product that is used together with another product
Supply
● Supply
○ The willingness and ability to sell a product
● Market supply
○ Total supply of a product
● Supply and price are directly proportional
● Extension in supply
○ A rise in quantity supplied is caused by a rise in the price of the product itself
● Contraction in supply
○ A fall in the quantity supplied caused by a fall in the price of the product itself
● Increase in supply
○ A rise in supply at any given price, causing the supply curve to shift to the right
● Decrease in supply
○ A fall in supply at any given price, causing the supply curve to shift to the left
Causes of changes in supply
● Productivity
○ Higher productivity causes an outward shift in the supply because the average costs for the firm
fall
○ 2 reasons of a change in costs of production
■ Change in the price of any of the factors
■ Change in their productivity
○ A rise in productivity of a factor of production will reduce unit cost
○ An increase in wages paid to workers by itself would raise the costs of production and therefore
cause a decrease in supply
○ If increase in wages in accompanied by an equal rise in productivity then unit costs and supply
remain unchanged
○ Unit cost → the average cost of production. It is found by dividing total cost by output
● Taxes
○ Direct taxes → taxes on the income and wealth of individuals and firms
○ Indirect taxes → taxes on goods and services
○ A rise in the rate of an existing tax or the imposition of a new tax, it will make it more expensive
to supply a product and hence will reduce supply
○ More taxes, lesser supply, it causes an inward shift in the the supply curve
○ Taxes and supply are inversely related
● Technology
○ More advanced the technology, more the supply, causes an outward shift in the supply curve
○ Improvement in technology → advances in the quality of capital goods and method of
production (directly proportional)
● Subsidies
○ A subsidy is payment by government to encourage the production or consumption of a product
○ Thus granting a subsidy will cause an increase in supply and an outward shift in supply
○ Directly proportional
● Weather and livestock
○ It is for agricultural produce. Favourable weather conditions will increase supply
○ More healthy the livestock, the more supply. While a disease outbreak would reduce supply
● Cost of production
○ If the cost of production falls, more firms can afford to supply more and curve shifts outwards
○ Depreciation in exchange rate will increase cost of imports which will cause an inward shift in
supply
● Prices of other products
○ Firms produce varieties of products. If one product becomes more popular, its price will rise and
supply will extend
○ But in order to produce this product, the resources from other products get diverted to this
product. So the firm will supply less of the other products
○ For eg. if a farmer keeps cattle and sheep, a rise in the price and profitability will likely result in
the farmer keeping fewer cows
● Disasters and wars
○ Natural disasters such as hurricanes, floods and wars. These effects reduce the supply of a
range of products
● Discoveries and depletion
○ The supply of commodities like coal, gold and oil is affected by discoveries of new sources
○ Discovery of a new oilfield increases supply of oil while if coal is all used up in present, supply of
coal will be reduced in the future
Price determination
● Equilibrium price
○ The price where demand and supply are equal
● Disequilibrium
○ A situation where demand and supply are not equal
● If firm sets the price above the equilibrium level, it will not sell all products offered for sale, there will be
a surplus (excess supply)
● To ensure the firm sells all of the products, it will lower the price until market clears, with the quantity
demanded equalling the quantity supplied
Price changes
● Changes in demand will cause a change in price and a
movement along the supply curve
● A increase in demand will cause a rise in price and a
expansion in supply
● A decrease in demand will cause fall in price and a
contraction in supply
● With lower demand, there will be a surplus of unsold products
at initial price of P. THe surplus pushes down the price and therefore the supply contracts until new
equilibrium of price and quantity is reached
● Changes in supply will have the opposite effect.
● A rise in price causes a contraction in demand
● Decrease in supply will have the opposite effect. It will cause a rise in price, which in turn causes a
contraction in demand
● Increase in demand being greater than increase in supply will cause the price to rise
● Supply being greater than demand causes price to fall
