Article -3: Basic economy concepts

Article – 2: National Income, Growth, Development and other concepts
December 2, 2018
Article – 4: Budgeting
December 4, 2018

Article 3: Basic Economy Concepts

Current Affairs for Engineering Service Exam

Video Lectures and Test Series for ESE 2019

Contents

  1. Supply
  2. Demand
  3. Elasticity
  4. Sensitivity
  5. Expenditure
  6. Different Curves
  7. Price Determination
  8. Savings and Investment
  9. Factors of Production
  10. Quiz

Basic economy concepts

Supply

  • Supply is a fundamental economic concept that describes the total amount of a specific good or service that is available to consumers.
  • Supply can relate to the amount available at a specific price or the amount available across a range of prices if displayed on a graph.
  • This relates closely to the demand for a good or service at a specific price; all else being equal, the supply provided by producers will rise if the price rises because all firms look to maximize profits
  • The Law Of Supply: The law of supply says that as the price of an item goes up, suppliers will attempt to maximize their profits by increasing the quantity offered for sale.
  • The chart below depicts the law of supply using a supply curve, which is always upward sloping. A, B and C are points on the supply curve. Each point on the curve reflects a direct correlation between quantity supplied (Q) and price (P). So, at point A, the quantity supplied will be Q1 and the price will be P1, and so on.

Examples:

  • When consumers start paying more for cupcakes than for donuts, bakeries will increase their output of cupcakes and reduce their output of donuts in order to increase their profits.
  • When college students learn computer engineering jobs pay more than English professor jobs, the supply of students with majors in computer engineering will increase.

The concept of Demand

  • Demand is an economic principle referring to a consumer’s desire and willingness to pay a price for a specific good or service.
  • Holding all other factors constant, an increase in the price of a good or service will decrease demand, and vice versa.

Aggregate Demand vs. Individual Demand

Aggregate demand refers to the overall or average demand of many market participants. Individual demand refers to the demand of a particular consumer. For example, a particular consumer’s demand for a product is strongly influenced by her personal income.

Demand Curve:

  • The demand curve is a graphical representation of the relationship between the price of a good or service and the quantity demanded for a given period of time.
  • In a typical representation, the price will appear on the left vertical axis, the quantity demanded on the horizontal axis.

Example:

If the price of corn rises, consumers will have an incentive to buy less corn and substitute it for other foods, so the total quantity of corn consumers demand will fall.

Elasticity:

  • The degree to which demand or supply reacts to a change in price is called elasticity.
  • Elasticity varies from product to product because some products may be more essential to the consumer than others.

Demand elasticity:

  • The demand elasticity (elasticity of demand) refers to how sensitive the demand for a good is to changes in other economic variables, such as prices and consumer income.
  • Demand elasticity is calculated as the percent change in the quantity demanded divided by a percent change in another economic variable.
  • A higher demand elasticity for an economic variable means that consumers are more responsive to changes in this variable.

Price Elasticity of Demand:

  • Price elasticity of demand is an economic measure of the change in the quantity demanded or purchased of a product in relation to its price change.
  • Expressed mathematically, it is:

Price Elasticity of Demand = % Change in Quantity Demanded / % Change in Price

Sensitivity:

  • Sensitivity is the magnitude of a financial instrument/factor’s reaction to changes in underlying factors.
  • For example, financial instruments, such as stocks and bonds, are constantly impacted by many factors.
  • Sensitivity accounts for all factors that impact a given quantity in a negative or positive way.
  • The objective is to learn how much a certain factor impacts the value of a particular quantity.

Expenditure:

Expenditure is the spending of money on something, or the money that is spent on something.

Types of Expenditure:

  1. Capital Expenditure: Capital expenditure, or CapEx, are funds used by a company to acquire, upgrade, and maintain physical assets such as property, industrial buildings, or equipment. CapEx is often used to undertake new projects or investments by the firm.
  2. Revenue Expenditure: The expenditure incurred in one accounting year and the benefits from which is also enjoyed in the same period only. This expenditure does not increase the earning capacity of the business but maintains the existing earning capacity of the business.
  3. Operating Expenditure(OpEx): An operating expense is an expense a business incurs through its normal business operations. Often abbreviated as OPEX, operating expenses include rent, equipment, inventory costs, marketing, payroll, insurance, and funds allocated for research and development.

Curves in Economics:

Laffer Curve:

  • The Laffer Curve is a theory developed by supply-side economist Arthur Laffer to show the relationship between tax rates and the amount of tax revenue collected by governments.
  • The curve is used to illustrate Laffer’s main premise that the more an activity — such as production is taxed, the less of it is generated. Likewise, the less an activity is taxed, the more of it is generated.

The Phillips curve:

  • The Phillips curve is an economic concept developed by A. W. Phillips stating that inflation and unemployment have a stable and inverse relationship.
  • The theory claims that with economic growth comes inflation, which in turn should lead to more jobs and less unemployment.

The Kuznets Curve

  • The theory developed by Simon Kuznets
  • A Kuznets curve graphs the hypothesis that as an economy develops, market forces first increase and then decrease economic inequality.

Environmental Kuznets curve:

The environmental Kuznets curve suggests that economic development initially leads to a deterioration in the environment, but after a certain level of economic growth, a society begins to improve its relationship with the environment and levels of environmental degradation reduces.

Price determination

  • The interaction between the demand and supply in the free market that is used to determine the costs for a goods or service.

Factors Affecting Price Determination:

  • Product Cost
  • The Utility and Demand
  • Extent of Competition in the Market
  • Government and Legal Regulations
  • Pricing Objectives
  • Marketing Methods Used

Price Equilibrium:

  • The equilibrium price is the market price where the quantity of goods supplied is equal to the quantity of goods demanded.
  • This is the point at which the demand and supply curves in the market intersect.

Savings and Investment

Savings:

Savings comprise the amount of money left over after spending.

Investment

  • An investment is an asset or item acquired with the goal of generating income or appreciation.
  • In an economic sense, an investment is the purchase of goods that are not consumed today but are used in the future to create wealth.

Factors of production:

  • Factors of production is an economic term that describes the inputs used in the production of goods or services in order to make an economic profit.
  • The factors of production include land, labor, capital and entrepreneurship. These production factors are also known as management, machines, materials and labor, and knowledge has recently been talked about as a potential new factor of production.
  1. Land: Land has a broad definition as a factor of production and can take on various forms, from agricultural land to commercial real estate to the resources available from a particular piece of land
  2. Labor: Refers to the effort expended by an individual to bring a product or service to the market.
  3. Capital: Refers to the purchase of goods made with money in production.

Capacity utilisation:

  • Capacity utilisation is a measure of the extent to which the productive capacity of a business is being used.
  • It can be defined as: The percentage of total capacity that is actually being achieved in a given period.

Quiz

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