Enomics as a Social Science B.

Key Concepts

The discipline of Economics is social science as it - Scarcity: The fundamental economic problem
seeks to explain the relationships between that resources are limited while wants and needs
people and societies. As a matter of fact, it is the are unlimited. This forces individuals and
“queen of the social sciences,” as cited by Paul societies to make choices about how to allocate
Samuelson. Like other social sciences such as their resources.
sociology, psychology, and political science,
economics is also concerned about human - Opportunity Cost: The value of the next best
behavior. Although economics has similarities alternative forgone when making a choice. It
with other fields, it is viewed from a different represents the cost of choosing one option over
perspective. Economics is unique in analyzing another. For example, the opportunity cost of
various areas of human behavior. Economists attending college is the income you could have
answer different questions and solve problems earned if you had worked instead.
using tools and methodologies, which are far-
reaching that other social scientists find - Rationality: The assumption that individuals
overwhelming. make decisions that maximize their own self-
interest. This doesn't necessarily mean they are
always selfish, but rather that they act in a way
that they believe will lead to the best outcome
Economics Defined Etymologically, the word for themselves.
economics comes from the ancient Greek word
‘‘oikonomia”—which literally means the - Marginal Analysis: The process of comparing the
management of a family or a household. A additional benefits and costs of making a
household has inadequate resources and decision. This involves considering the
managing these resources will require certain incremental changes in benefits and costs
decision-making skills. associated with a small change in an activity. For
example, a firm might use marginal analysis to
decide whether to produce one more unit of
output.
The word ‘Economics’ originates from a Greek
word ‘Oikonomikos’

This Greek word has two parts: C. Importance of Microeconomics

‘Oikos’ meaning ‘Home’ - Understanding Individual Behavior:

Microeconomics provides insights into how
‘Nomos’ meaning ‘Management’ individuals make decisions about consumption,
saving, and investment. This knowledge is
Hence, Economics means ‘Home Management’ essential for understanding consumer behavior
and developing effective marketing strategies.
Greek word 'Oikonomos’ means to ‘manage the
house’ or management of household -especially - Analyzing Market Dynamics: Microeconomics
in those matters which are relating to the income helps us understand how markets work, how
and expenses of the Family. prices are determined, and how changes in
supply and demand affect market outcomes. This
knowledge is crucial for businesses,
policymakers, and consumers.
I. Introduction to Microeconomics
- Evaluating Government Policies:
Microeconomics provides tools for evaluating the
A. Definition and Scope impact of government policies on the economy.
For example, we can use microeconomic models
- Microeconomics: The branch of economics that to assess the effects of taxes, subsidies, and
studies the behavior of individual economic units, regulations on market outcomes.
such as consumers, firms, and markets. It
focuses on how these units make decisions in the
face of scarcity and how their interactions shape
II. Demand and Supply
the allocation of resources.

- Scope: Microeconomics encompasses a wide

range of topics, including: A. Demand
- Consumer behavior: How individuals make - Definition: Demand refers to the relationship
choices about what to buy and how much to between the price of a good and the quantity
consume. that consumers are willing and able to buy at
that price, holding all other factors constant. It is
- Producer behavior: How firms make decisions
represented by a demand curve, which slopes
about production, pricing, and hiring.
downward from left to right.
- Market structure: The different types of market
- Law of Demand: The law of demand states that
organizations, such as perfect competition,
as the price of a good increases, the quantity
monopoly, and oligopoly.
demanded decreases, holding all other factors
- Resource allocation: How scarce resources are constant. This inverse relationship is due to:
distributed among competing uses.
- Substitution effect: As the price of a good rises,
- Welfare economics: The study of how economic consumers may switch to cheaper substitutes.
decisions affect the well-being of individuals and
- Income effect: As the price of a good rises,
society.
consumers have less purchasing power, leading
to a decrease in demand.
- Factors Affecting Demand: - Expectations: Expectations about future prices
and input costs can influence current supply. For
- Income: An increase in income leads to an example, if producers expect the price of their
increase in demand for normal goods (goods product to rise in the future, they may decrease
whose demand increases as income rises) and a their supply today to take advantage of the
decrease in demand for inferior goods (goods higher future price.
whose demand decreases as income rises).

- Prices of Related Goods: The demand for

substitutes (goods that can be used in place of C. Market Equilibrium
each other) increases when the price of the
original good increases, while the demand for - Definition: Market equilibrium is the point where
complements (goods that are used together) the quantity demanded equals the quantity
decreases. supplied. At this point, the market clears and
there is no excess demand or supply.
- Tastes and Preferences: Changes in consumer
preferences can affect demand. For example, the - Determination of Equilibrium Price and
demand for organic food has increased in recent Quantity: The equilibrium price and quantity are
years due to growing consumer awareness of determined by the intersection of the demand
health and environmental issues. and supply curves.

- Expectations: Expectations about future prices - Changes in Equilibrium: Changes in the factors
and income can influence current demand. For affecting demand or supply will shift the
example, if consumers expect the price of respective curves, leading to a new equilibrium
gasoline to rise in the future, they may increase price and quantity.
their demand for gasoline today.

- Population: An increase in population leads to

an increase in demand for most goods and III. Consumer Choice
services.

- Demographics: Changes in the age, gender, and

other demographic characteristics of the A. Utility
population can affect demand.
- Definition: Utility is the satisfaction or pleasure
that consumers derive from consuming goods
and services. It is a subjective concept, meaning
B. Supply that different individuals may derive different
levels of utility from the same good.
- Definition: Supply refers to the relationship
between the price of a good and the quantity - Total Utility: The total satisfaction a consumer
that producers are willing and able to sell at that derives from consuming a given quantity of a
price, holding all other factors constant. It is good.
represented by a supply curve, which slopes
upward from left to right. - Marginal Utility: The additional utility gained
from consuming one more unit of a good.
- Law of Supply: The law of supply states that as
the price of a good increases, the quantity
supplied increases, holding all other factors
B. Law of Diminishing Marginal Utility
constant. This positive relationship is due to:
- Statement: The law of diminishing marginal
- Profit motive: Producers are more willing to
utility states that as consumption of a good
produce and sell a good at a higher price
increases, the marginal utility derived from each
because they can earn higher profits.
additional unit decreases. This means that the
- Increased production: Higher prices may first unit of a good provides the most satisfaction,
encourage producers to expand production by and each subsequent unit provides less
hiring more workers or using more capital. satisfaction than the previous one.

- Factors Affecting Supply: - Example: Imagine you are eating pizza. The first
slice of pizza might provide you with a lot of
- Input Prices: An increase in input prices (such as satisfaction, but each subsequent slice will
wages, raw materials, or energy) leads to a provide less satisfaction than the previous one.
decrease in supply. This is because higher input Eventually, you may reach a point where you are
costs reduce the profitability of production. no longer willing to eat another slice, even if it is
free.
- Technology: Technological advancements can
increase supply. For example, the development
of new farming techniques has increased the
supply of agricultural products. C. Budget Constraint

- Government Regulations: Regulations can affect - Definition: The budget constraint represents the
supply by imposing costs or restrictions on limit on the amount of goods and services that a
production. For example, environmental consumer can afford, given their income and
regulations can increase the cost of production prices. It is a straight line that shows the various
for certain industries, leading to a decrease in combinations of goods that a consumer can buy
supply. with their limited income.

- Number of Sellers: An increase in the number of - Slope of Budget Constraint: The slope of the
sellers leads to an increase in supply. This is budget constraint is equal to the negative of the
because there are more producers willing to offer ratio of the prices of the two goods.
the good at each price.
D. Consumer Equilibrium firm can only change its output by varying its
variable inputs.
- Definition: Consumer equilibrium is the point
where the consumer maximizes their utility, - Long-Run Costs: In the long run, all factors of
subject to their budget constraint. This occurs production are variable. This means that the firm
where the marginal utility per dollar spent on can adjust its scale of production to minimize its
each good is equal. costs.

- Graphical Representation: Consumer

equilibrium is represented by the point where the
indifference curve (a curve that shows all V. Perfect Competition
combinations of goods that provide the consumer
with the same level of utility) is tangent to the
budget constraint.
A. Characteristics

- Many Buyers and Sellers: There are many

IV. Production and Costs buyers and sellers in the market, each of whom is
too small to influence the market price.

- Homogeneous Products: All firms produce

A. Production Function identical products, so consumers are indifferent
about which firm they buy from.
- Definition: The production function shows the
relationship between the quantity of inputs used - Free Entry and Exit: Firms can easily enter or
and the quantity of output produced. It is a exit the market in the long run.
mathematical expression that describes how
inputs are transformed into outputs. - Perfect Information: All buyers and sellers have
perfect information about prices, products, and
- Inputs: Factors of production used in the production costs.
production process, such as labor, capital, land,
and raw materials.

- Outputs: Goods or services produced by the B. Price Taker

firm.
- Definition: Firms in perfect competition are
price takers, meaning they must accept the
market price for their product. They cannot
B. Marginal Product influence the price by changing their output.

- Definition: The marginal product of an input is - Reason: Because there are many sellers, each
the additional output produced by using one firm's output is a small fraction of the total
more unit of that input, holding all other inputs market supply. Therefore, if a firm tries to raise
constant. its price above the market price, it will lose all its
customers to other firms.
- Law of Diminishing Marginal Returns: The law of
diminishing marginal returns states that as more
and more units of an input are added to a fixed
amount of other inputs, the marginal product of C. Profit Maximization
the variable input eventually declines. This
means that the first few units of an input may - Rule: Firms in perfect competition maximize
lead to significant increases in output, but as profits by producing the quantity of output where
more units are added, the increases in output marginal cost equals price.
become smaller and smaller.
- Reason: If marginal cost is less than price, the
firm can increase profits by producing more
output. If marginal cost is greater than price, the
C. Costs of Production firm can increase profits by producing less
output.
- Fixed Costs: Costs that do not vary with the
level of output. These costs are incurred even if
the firm produces nothing. Examples include
rent, insurance, and salaries of fixed personnel. D. Long-Run Equilibrium

- Variable Costs: Costs that vary with the level of - Zero Economic Profits: In the long run, firms in
output. These costs increase as the firm produces perfect competition earn zero economic profits.
more output. Examples include raw materials, This means that they earn just enough revenue
labor, and utilities. to cover their explicit costs (such as wages,
materials, and rent) and their implicit costs (such
- Total Cost: The sum of fixed and variable costs. as the opportunity cost of the owner's time and
capital).
- Average Cost: Total cost divided by the quantity
of output. - Entry and Exit: If firms are earning positive
economic profits, new firms will enter the market,
- Marginal Cost: The additional cost incurred by increasing supply and driving down prices. If
producing one more unit of output. firms are earning negative economic profits,
firms will exit the market, decreasing supply and
driving up prices.

D. Relationship Between Costs and Production

- Short-Run Costs: In the short run, at least one VI. Monopoly

factor of production is fixed. This means that the
 products are not perfect substitutes for each
other.
A. Characteristics
- Barriers to Entry: There are significant barriers
- Single Seller: There is only one seller in the to entry that prevent new firms from entering the
market. market.

- No Close Substitutes: There are no close

substitutes for the monopolist's product.
B. Types of Imperfect Competition
- Barriers to Entry: There are significant barriers
to entry that prevent other firms from entering - Monopolistic Competition: Many sellers,
the market. These barriers can include: differentiated products, and easy entry and exit.
Examples include restaurants, clothing stores,
- Natural monopoly: A situation where it is more and hair salons.
efficient for one firm to produce the entire output
of the market. - Oligopoly: Few sellers, interdependent decision-
making, and significant barriers to entry.
- Legal monopoly: A situation where the Examples include car manufacturers, airlines,
government grants a firm exclusive rights to and oil companies.
produce a good or service.

- Technological monopoly: A situation where a

firm has a patent or copyright that gives it C. Strategic Interactions
exclusive rights to produce a good or service.
- Definition: Firms in imperfect competition must
consider the actions of their rivals when making
decisions. This is because their profits depend
B. Price Maker not only on their own actions but also on the
actions of their competitors.
- Definition: Monopolies have the power to set
the price of their product. They are not price - Game Theory: Game theory is a branch of
takers like firms in perfect competition. mathematics that studies strategic interactions.
It provides tools for analyzing how firms make
- Reason: Because there are no close substitutes, decisions in imperfect competition.
consumers have no other options but to buy from
the monopolist. Therefore, the monopolist can
charge a higher price than it could if there were
competitors in the market. VIII. Market Failures

C. Profit Maximization A. Definition

- Rule: Monopolies maximize profits by producing - Market Failure: A situation where the market
the quantity of output where marginal cost fails to allocate resources efficiently. This can
equals marginal revenue. happen when:

- Difference from Perfect Competition: In perfect - Externalities: Costs or benefits that are not
competition, marginal revenue equals price. In reflected in the market price.
monopoly, marginal revenue is less than price
because the monopolist must lower its price to - Public Goods: Goods that are non-rivalrous (one
sell more output. person's consumption does not prevent another
person from consuming the good) and non-
excludable (it is impossible to prevent people
from consuming the good).
D. Deadweight Loss
- Information Asymmetry: One party in a
- Definition: Deadweight loss is a reduction in transaction has more information than the other.
social welfare due to the higher price and lower
quantity produced by a monopoly. It represents
the value of output that is not produced because
of the monopoly. B. Externalities

- Reason: The monopolist restricts output to - Definition: An externality is a cost or benefit

maximize its profits, which leads to a higher price that affects a third party who is not directly
and a lower quantity demanded than would be involved in the transaction.
the case in a perfectly competitive market.
- Types of Externalities:

- Negative externalities: Costs imposed on third

VII. Imperfect Competition parties. Examples include pollution, noise, and
traffic congestion.

- Positive externalities: Benefits conferred on

A. Characteristics third parties. Examples include education,
vaccination, and research and development.
- Few Sellers: There are a few sellers in the
market, each of whom has a significant market - Market Failure: Externalities lead to market
share. failure because the market price does not reflect
the full social cost or benefit of the good.
- Differentiated Products: Firms produce
differentiated products, meaning that their
C. Public Goods - Perfect competition: In a perfectly competitive
market, the price is equal to the marginal cost of
- Definition: A public good is a good that is non- production. This ensures that all units of output
rivalrous and non-excludable. that are worth producing are produced and
consumed.
- Examples: National defense, street lighting, and
clean air. - No externalities: When there are no
externalities, the market price reflects the full
- Market Failure: Public goods are often under- social cost or benefit of the good.
provided by the market because it is difficult to
charge people for their consumption. - Full information: When all buyers and sellers
have full information, they can make informed
decisions that maximize their own well-being.
D. Information Asymmetry

- Definition: Information asymmetry occurs when X. International Trade

one party in a transaction has more information
than the other.

- Examples: Used car sales, insurance markets, A. Comparative Advantage

and healthcare markets.
- Definition: A country has a comparative
- Market Failure: Information asymmetry can lead advantage in producing a good if it can produce
to market failure because the party with less it at a lower opportunity cost than other
information may make decisions that are not in countries.
their best interest.
- Basis for Trade: Countries specialize in the
production of goods in which they have a
comparative advantage and trade with other
IX. Welfare Economics countries. This allows each country to consume a
wider variety of goods and services than it could
produce on its own.
A. Consumer Surplus

- Definition: Consumer surplus is the difference B. Gains from Trade

between the maximum price a consumer is
willing to pay for a good and the actual price they - Definition: The gains from trade refer to the
pay. increase in welfare that results from
specialization.
- Graphical Representation: Consumer surplus is
represented by the area below the demand curve
and above the market price.

B. Producer Surplus

- Definition: Producer surplus is the difference

between the minimum price a producer is willing
to accept for a good and the actual price they
receive.

- Graphical Representation: Producer surplus is

represented by the area above the supply curve
and below the market price.

C. Social Welfare

- Definition: Social welfare is the sum of

consumer surplus and producer surplus. It
represents the total benefit to society from the
production and consumption of a good.

- Maximizing Social Welfare: The goal of welfare

economics is to maximize social welfare. This is
achieved when the market is efficient, meaning
that resources are allocated in a way that
maximizes the total benefit to society.

D. Efficiency

- Definition: A market is efficient when it

maximizes social welfare. This occurs when the
marginal cost of production equals the marginal
benefit of consumption.

- Conditions for Efficiency: