Microeconomics encompasses a wide range of topics that focus on the behavior of

individual economic agents such as households, firms, and markets. Lectures in

microeconomics cover various aspects of how individuals and businesses make
decisions, interact in markets, and allocate resources. Here are some common lecture
topics under microeconomics:
1. Introduction to Microeconomics:
 Overview of microeconomic principles.
 Basic concepts, including scarcity, choice, and opportunity cost.
2. Supply and Demand:
 Law of demand and law of supply.
 Equilibrium price and quantity.
 Factors influencing demand and supply.
3. Consumer Behavior:
 Utility theory and preferences.
 Indifference curves and budget constraints.
 Consumer choice and the concept of elasticity.
4. Production and Costs:
 Production functions and the short-run vs. long-run distinction.
 Different types of costs (fixed, variable, total, marginal).
 Cost minimization and profit maximization.
5. Market Structures:
 Perfect competition, monopoly, monopolistic competition, and oligopoly.
 Characteristics, behavior, and outcomes of firms in each market structure.
6. Factor Markets:
 Analysis of markets for factors of production (land, labor, capital).
 Determination of wages, rent, and interest rates.
7. Market Failures:
 Externalities and public goods.
 Government interventions to address market failures.
 Information asymmetry and moral hazard.
8. Game Theory:
 Basic concepts of strategic interaction.
 Nash equilibrium and its applications.
 Oligopolistic behavior and collusion.
9. Welfare Economics:
 Social welfare functions and Pareto efficiency.
 Analysis of market outcomes and societal well-being.
10. Labor Economics:
 Wage determination and human capital.
 Labor market policies and interventions.
11. Utility Maximization and Consumer Choice:
 Budget constraints and consumer equilibrium.
 Income and substitution effects.
12. Uncertainty and Information:
 Decision-making under uncertainty.
 Adverse selection and moral hazard.
13. Public Economics:
 Analysis of government expenditure and taxation.
 Public goods and common-pool resources.
14. Health Economics:
 Economic analysis of healthcare markets.
 Health insurance and healthcare policy.
15. Environmental Economics:
 Economic analysis of environmental issues.
 Policies to address environmental problems.
MICRO ECONOMICS:

CHAPTER 1: ECONOMICS
Lesson 1: INTRODUCTION TO ECONOMICS

What is economics?
Economics is a vast subject. So it is not easy to give a precise definition or
meaning of economics as its scope and the area it covers are very large. Ever since, it
emerged as a separate branch of study in social science, various scholars and authors
have tried to give its meaning and objectives. It should be noted that with development
of time and civilization the definition of economics has undergone modification and
change.
Many scholars and authors in the late eighteenth and early nineteenth century
believed that economics is the science of wealth. These scholars are called the classical
thinkers. They viewed that economics deals with the phenomenon of wealth which
includes nature and causes of wealth, creation of wealth by individuals and nations etc.
In our day to day life we use a lot of economic concepts such as goods, market,
demand, supply, price, inflation, banking, tax, lending, borrowing, rate of interest etc.
Similarly, we take economic decisions related to the distribution of our income to
purchase various goods, making a budget to do some work, taking up a job to earn,
withdrawing money from bank etc.
Economics is the study of scarcity and its implications for the use of resources,
production of goods and services, growth of production and welfare over time, and a
great variety of other complex issues of vital concern to society.

Some well-known economists and their significant contributions to the field:

a. Adam Smith (1723-1790):

Often regarded as the "father of economics," Smith's most significant
contribution was in "The Wealth of Nations" (1776), where he introduced the
concept of the invisible hand, arguing that individual self-interest in a free-
market system could unintentionally lead to collective economic well-being.
He also posited the division of labor as the chief factor in economic growth.

b. John Maynard Keynes (1883-1946):

Keynes revolutionized macroeconomic thought with "The General Theory of
Employment, Interest, and Money" (1936). British economist, known for his revolutionary
theories on the causes of prolonged unemployment. He advocated for government
intervention during economic downturns to manage unemployment and stabilize
economies through fiscal and monetary policies.

c. Milton Friedman (1912-2006):

A key figure in monetarism, Friedman's work emphasized the role of the money
supply in influencing economic outcomes. His contributions to free-market economics
and skepticism toward government intervention are outlined in works like "Capitalism
and Freedom" (1962).

d. Friedrich Hayek (1899-1992):

Hayek was a leading figure in the Austrian School of Economics. His "The Road to
Serfdom" (1944) warned against the dangers of centralized planning and
advocated for the importance of individual liberty and free markets.

e. Karl Marx (1818-1883):

 Co-author of "The Communist Manifesto" (1848) and author of "Das Kapital,"
Marx's contributions lay in his critique of capitalism, outlining concepts such as historical
materialism and the labor theory of value, which influenced socialist and communist
movements.

f. John Stuart Mill (1806-1873):

Contribution: Mill's "Principles of Political Economy" (1848)
significantly contributed to classical economics. He emphasized the
importance of utility, individual freedoms, and the role of the state in
regulating economic activities to ensure social welfare. He is the leading
expositor of “utilitarianism”…insistent that “utility” include the pleasures
of the imagination and the gratification of the higher emotions

g. Joseph Stiglitz (b. 1943):

Contribution: Stiglitz, a Nobel laureate, has made notable contributions to
information economics, development economics, and globalization. His work on
information asymmetry and his book "Globalization and Its Discontents" (2002) are
widely recognized.

h. Amartya Sen (b. 1933):

Contribution: Sen, a Nobel laureate, introduced the capability approach to welfare
economics, emphasizing the importance of individuals' capabilities and opportunities. His
work has significantly influenced the study of poverty and development.

i. Paul Krugman (b. 1953):

Known for his contributions to international trade theory and economic geography.
His work on trade patterns and economic geography has had a lasting impact.

J. David Ricardo.
He was a major figure in the development of classical economics
and is credited as the first person to systematize economics.

Economic Goals
 Economic Growth
 Full employment
 Economic efficiency
 Price level stability
 Economic freedom
 Equitable distribution
 Economic security
 Balance of trade

Branches of Economics:

a. Microeconomics: Focuses on the behavior and decisions of individual economic agents,

such as households, firms, and markets. It examines how these entities make choices,
allocate resources, and interact in specific markets.

b. Macroeconomics: Examines the overall performance and behavior of an entire

economy. It deals with aggregate such as national income, unemployment, inflation, and
economic growth.

Aspects of Economic Analysis

a. Positive Economics:- ‘what is’ or ‘what would happen if’. Positive economics is
concerned with describing and explaining economic phenomena as they are,
 without making value judgments. It aims to provide an objective analysis based on
observable facts, data, and empirical evidence.
- focuses on absolute facts
- cause & effect relationship
- concerned with ‘what is’
b. Normative – “What should be”. Normative economics involves making value
judgments and expressing opinions about what ought to be or what is desirable in
economic policy.
-incorporates value judgment
-recommends policy prescriptions

Lesson 2. Introduction to Agricultural Economics?

Agricultural economics is a branch of economics that focuses on the application of economic

principles to the production, distribution, and consumption of agricultural goods and services. It
involves the study of how resources such as land, labor, and capital are allocated and utilized
within the agricultural sector.

Key aspects of agricultural economics include:

1. Production Economics: This area examines the decision-making process of
farmers and agricultural producers. It involves analyzing factors such as crop
selection, input use, technology adoption, and production efficiency.
2. Resource Allocation: Agricultural economics studies how limited resources, such
as land, water, and labor, are allocated among various competing uses in
agriculture. This includes understanding the impact of factors like climate, soil
quality, and government policies on resource allocation.
3. Market Analysis: Agricultural economists analyze markets for agricultural
products, including supply and demand dynamics, price determination, and market
structures. This knowledge is essential for understanding how farmers and
consumers interact within the marketplace.
4. Policy Analysis: Agricultural policies, such as subsidies, trade regulations, and
support programs, play a significant role in shaping the agricultural sector.
Agricultural economists evaluate the effects of these policies on farm incomes,
food prices, and overall economic welfare.
5. Rural Development: The field of agricultural economics also considers the
broader implications of agricultural activities on rural economies. This involves
examining the linkages between agriculture and rural development, including
issues like infrastructure, employment, and community well-being.
6. Environmental Economics: With the growing concern for sustainable agriculture
and environmental conservation, agricultural economists study the economic
aspects of environmental issues related to farming practices, land use, and natural
resource management.

Changes in the Agricultural Economics.

The article titled "Public Policy for Agriculture After Commodity Programs" by
Luther Tweeten and Carl Zulauf, published in the "Review of Agricultural Economics" in
1997. discusses several key points related to changes in agriculture and public policy.
Here's an overview of the points mentioned:

1. "80-20 Rule": The reference to the "80-20 Rule" suggests that a small percentage of
farmers (20%) are responsible for a significant majority (80%) of the agricultural output.
This highlights a concentration of production in the hands of a relatively small number of
large-scale or highly productive farms.

2. Shift from Family-Farm Way of Life to Big Business: the traditional family-farm model in
agriculture is being replaced by a more industrialized and business-oriented approach.
This shift may be characterized by larger, more mechanized farms that operate with a
focus on efficiency and economies of scale.
3. Fragmentation of Agricultural Establishment: The united agricultural establishment is
being replaced by fragmented interest groups. This could refer to a diversification of
interests and priorities within the agricultural sector, with different groups advocating for
specific policies or representing various segments of the industry.- FCA’s, R&D groups,
Environmental advocate Groups etc.

6. Importance of Off-Farm Income:

Off-farm income is crucial for many farm households, providing financial stability
and mitigating the risks associated with fluctuations in agricultural income. It serves as a
supplementary source of revenue, helping farmers cope with uncertainties such as
weather conditions and market fluctuations.
Destiny of Agriculture Rests with Service as well as Production Activities:

7. Diversification: This statement emphasizes the broader role of agriculture, suggesting

that the future of agriculture is not solely dependent on production activities but also on
providing services related to agriculture. This may include agri-tourism, consulting, and
other value-added services.

8. Computer Literacy Importance:

Technological Advancements: In modern agriculture, computer literacy is crucial.
Farmers need to access information, manage data, and utilize technology for precision
farming, resource optimization, and market information. Computer literacy enhances
efficiency and competitiveness in agriculture.

9. Education and Other Support Systems are Essential:

Knowledge and Skill Enhancement: Education is vital for farmers to adapt to
changing technologies, market dynamics, and sustainable practices. Support systems,
including extension services, financial assistance, and research, contribute to the overall
development of the agricultural sector.

10. Reduced Government Profile in Agriculture is a Reality:

Shift in Policies: This statement suggests a shift away from heavy government
involvement in agriculture. Policies might be moving towards more market-oriented
approaches, emphasizing private sector participation, and reducing direct government
interventions in farming operations.

11. International Competitiveness:

Global Perspective: The competitiveness of agriculture on the international stage is
crucial for economic sustainability. This involves adopting efficient production methods,
complying with international standards, and being responsive to global market demands.

What does an Agricultural Economist Do?

At the microeconomic level, economists play a vital role in understanding and

optimizing individual decisions within specific economic units, such as households, firms,
and markets. They employ economic theories and models to analyze behavior, inform
decision-making, and provide insights into the functioning of various economic agents.

a. Production Economists: focus on the microeconomic aspects of firms and

industries. They analyze how businesses make decisions about what and how much to
produce, considering factors like technology, input costs, and production efficiency.
Production economists aim to optimize the production process to maximize output and
minimize costs, often using models like the production function.
b. Market Economists: study the microeconomic dynamics of markets, including
supply and demand, price determination, and market structures. They analyze how
individual buyers and sellers interact in various market conditions. Market economists
help understand the factors influencing market outcomes, such as competition,
monopolies, and the effects of government interventions.
c. Financial Economists: focus on the microeconomic aspects of finance, including
individual and corporate financial decision-making. They analyze how individuals and
firms allocate resources among different investment options, manage risk, and make
financial decisions. Financial economists contribute to understanding topics like portfolio
management, capital budgeting, and financial markets.
d. Resource Economists: concentrate on the allocation and utilization of resources,
such as land, labor, and capital. They study how these resources are managed in various
sectors, examining issues related to sustainability, environmental economics, and
natural resource management. Resource economists often contribute to policies
addressing resource conservation and efficient utilization.

The application of economic principles at the microeconomic level is essential for

addressing issues related to efficiency, resource allocation, and the well-being of
individuals and businesses within a given economic system.

CHAPTER 2: MICROECONOMICS
The purpose of this chapter is to introduce you to several basic economic
principles that will be useful in understanding the costs, markets, and the materials to
follow in subsequent chapters. This chapter will examine scarcity, factors of production,
economic efficiency, opportunity costs, and economic systems. In this chapter the first
economic model will also be developed and the production possibilities frontier (or
curve).

Micro Economics The word “micro” means very small. So micro economics implies
study of economics at a very small level. In a society comprising of many individuals
collectively every single individual makes just a small part. So the economic decisions
taken by a single individual become the subject matter of micro economics.

What are the economic decisions an individual takes? (examples)

(a) In order to satisfy various wants an individual buys good and services. To buy
goods and services the individual has to pay some price from his limited
amount of income. So the individual has to make a decision with regard to
quantity of the good to be purchased at given price. He/she has to also decide
the combination of different goods to buy given his/her income so that he/she
can get maximum satisfaction as a buyer.
(b) An individual also sells goods and services as a seller. Here he has to take
decision regarding the quantity of good to be supplied at a given price so that
he/she can earn some profit.

(c) All of us pay price to buy a good? How does this price get determined in the
market? Micro economics provides answer to this question.

(d) In order to produce a good an individual producer has to take decision as to

how to combine the various factors of production so that maximum output can
be produced at minimum cost

Lesson 1: Concepts of Microeconomics

The Economizing Problem: Scars Resources, Unlimited Wants

Economics is concerned with decision-making. An economic decision is one that

allocates resources, time, money, or something else of use or value. The fundamental
question in economics is called the economizing problem. The economizing problem
follows directly from the definition of economics offered in Chapter 1.
 a. The economizing problem involves the allocation of resources among competing
wants.
b. The economizing problem exists because there is scarcity. Scarcity arises because
of two facts; (1) there are unlimited human wants, but (2) there are limited
resources available to meet those wants. In other words, scarcity exists because
we do not have sufficient resources to produce everything we want. Perhaps at
some date in the future, a utopian world may be obtained where everyone's
desires can be fully satisfied -- most economists probably hope that will not happen
in their lifetimes because of their own self-interest.

Because there is scarcity there is always the question of how resources are
allocated and the effects of allocations on various economic agents. Each decision
allocating resources to one use or economic agent is also, by necessity, a decision not
to allocate resources to an alternative use. To fully understand the idea of scarcity, each
of its components must be mastered. The following section of this chapter examines
resources. The next sections will examine economic efficiency, opportunity costs and
allocations, before proceeding to the production possibilities model and economic
systems.

Resources and factor payments

The resources used to produce economic goods and services (also called
commodities) are called factors of production. These resources are the physical assets
needed to produce commodities. The way that these resources are combined to produce
is called technology. For example, a technology that can produce the same commodity
as a man with a shovel is a backhoe and an operator -the former is more labor intensive,
and the latter is more capital intensive.

Land: Rent. Land is a factor of production. Land includes space, natural resources,
and what is commonly thought of as land. A building lot, farm land, or a parking space is
what people normally think of when they think of land. However, iron ore, water
resources, oil, and other natural resources obtained from land are also one dimension of
this factor of production. Another, perhaps equally important dimension, is space. The
location of a building site for a business is an important consideration. For example, a
retail establishment may succeed or fail because of location, therefore location is
another important aspect of the resource called land. The factor payment that accrues to
land for producing is rent.

Capital: Interest. Capital includes the physical assets (i.e., plant and equipment)
used in the production of commodities. Often accountants refer to capital as money
balances that are earmarked for the purchase of plant or equipment. Capital receives
interest for its contributions to production.

There is one important variation on capital. Economists also called the skills,
abilities, and knowledge of human beings as human capital. Human capital is a
characteristic of labor. Human capital can be acquired (i.e., education) or may be
something inherent in a specific individual (i.e., size, beauty, etc.).

Labor: Wages. Labor includes the broad range of services (and their
characteristics) exerted in the production process. Labor is a rather unique factor of
production because it cannot be separated from the human being who provides it.
Human beings also play other roles in the economic system, such as consumer that
complicates the analysis of labor as a productive factor. The amount of human capital
possessed by labor varies widely from the totally unskilled to highly trained professionals
and highly skilled journeymen. Labor also includes hired management, and the lowest
paid janitor. Labor is paid wages for its contribution to the production of commodities.

Entrepreneurial: Talent. Entrepreneur (risk taker) is the economic agent who

creates the enterprise. Entrepreneurial talent not only assumes the risk of starting a
business, but is generally responsible for innovations in products and production
processes. This factor of production receives profits for its contribution to output.

Economic Efficiency

Economic efficiency consists of three components; these are: (1) allocative

efficiency, (2) technical or productive efficiency, and (3) full employment. For an
economy to be economically efficient all three conditions must be fulfilled.

Allocative efficiency is concerned with how resources are allocated. In a

perfectly competitive economy, without institutional impediments, monopoly, or cartels
the markets will allocate resources in an allocatively efficient manner. Allocative
efficiency is measured using a concept known as Pareto Optimality (or Superiority in an
imperfect world).

Pareto Optimality is that allocation where no person could be made better off
without inflicting harm on another. A Pareto Optimal allocation of resources can exist,
theoretically, only in the case of a purely competitive economy (which has never existed
in reality). What is of practical significance is a Pareto Superior allocation of resources. A
Pareto Superior allocation is that allocation where the benefit received by one person is
more than the harm inflicted on another. [cost - benefit approach]

Technical or productive efficiency is a somewhat easier concept. Technical

efficiency is defined as the minimization of cost for a given level of output or
(alternatively) for a given level of cost you maximize output. Most profit-maximizing
firms (as well as government agencies and non-profit organizations) will at least have
technical efficiency as one of its operational goals.

For an economic system to be economically efficient then full employment is also

required. Due primarily to the business cycles, no economic system can consistently
achieve full employment. The U.S. economy typically has one (during recoveries) to four
percent (during recessions) unemployment above that associated with the natural rate of
unemployment.

To obtain the maximum amount of output from the available productive resources
an economic system should have full employment. Full employment is the utilization of
all resources that is consistent with normal job search and maintenance of productive
capacity. However, full production, 100% capacity utilization involves greater than full
employment and cannot be maintained for a prolonged period without labor and capital
breaking-down. Underemployment has been a persistent problem in most developed
economies. Underemployment arises when a resource is not fully utilized in line with
achieving full employment. This situation can manifest in two main ways. Firstly,
individuals may work full-time but fail to utilize their full human capital. Secondly,
underemployment can occur when someone is involuntarily working part-time instead of
securing full-time employment in a suitable position.

Pigou states the basic proposition of Pareto Superiority in the real world; an
application of income re-distribution. The “transference of income from a relatively rich
man to a relatively poor man of similar temperament” making one less poor, and the
other less rich, results in an application of the principle of diminishing marginal utility
and, hence, allocative efficiency. In other words, the cost-benefit approach on the
margin. We take the last dollar from those with less value for that dollar and add that to
those more desperate for an additional dollar of income. Not only is this allocatively
efficient, but there are those who would argue that this is also fair.
Economic Cost

Economic cost consists of two distinct types of costs: (1) explicit (accounting)
costs, and (2) opportunity (implicit) costs. Explicit costs are direct expenditures in the
production process. These are the items of cost with which accountants are concerned.

An opportunity cost is the next best alternative that must be foregone as

a result of a particular decision. Rather than a direct expenditure, an opportunity
cost is the implicit loss of an alternative because of a decision. For example, reading this
chapter is costly, you have implicitly decided not to watch T.V. or spend time doing
something else by deciding to read this chapter. Every choice is costly; that is, there is
an opportunity cost.

Lesson 2: Production Possibilities

The production possibilities frontier (or curve) is a simple model that can be used
to illustrate what a very simple economic system can produce under some restrictive
assumptions. The production possibilities model is used to illustrate the concepts of
opportunity cost, productive factors and their scarcity, economic efficiency
(unemployment etc.) and the economic choices an economy must make with respect to
what will be produced.

There are four assumptions necessary to represent the production possibilities in a

simple economic system. The assumption which underpins the production possibilities
curve model are: (1) the economy is economically efficient, (2) there are a fixed number
of productive resources, (3) the technology available to this economy is fixed, and (4) in
this economy we are going to produce only two commodities. With these four
assumption we can represent all the combinations of two commodities that can be
produced given the technology and resources available are efficiently used.

Consider the following diagram:

Along the vertical axis we measure the number of units of beer we can produce
and along the horizontal axis we measure the number of units of pizza we can produce.
Where the solid line intersects the beer axis shows the amount of beer we can produce if
all of our resources are allocated to beer production. Where the solid line intersects the
pizza axis indicates the amount of pizza we can produce if all of our resources are
allocated to pizza production. Along the solid line between the beer axis and the pizza
axis are the intermediate solutions where we have both beer and pizza being produced.

The reason the line is curved, rather than straight, is that the resources used to
produce beer are not perfectly useful in producing pizza and vice versa. The dashed line
represents a second production possibilities curve that is possible with additional
resources or an advancement in available technology.

Increasing Opportunity Costs is illustrated in the above production possibilities

curve. Notice as we obtain more food (move to the right along the food axis) we have to
give up large amounts of machine (downward move along beer axis). In other words, the
slope of the production possibilities curve is the marginal opportunity cost of the
production of one additional unit of one commodity, in terms of the other commodity.
 Inefficiency, unemployment, and underemployment are illustrated by a point inside
the production possibilities curve, as shown below. A point consistent with inefficiency,
unemployment, or underemployment is identified by the symbol to the inside of the
curve.

Economic growth can also be illustrated with a production possibilities curve. The
line in the model below shows a shift to the right of the curve. The only way this can
happen is for there to be more resources or better technology and this is called economic
growth. It is also possible that the curve could shift to the left (back toward the origin --
the intersection of the machine axis with the food axis), this could result from being
forced to use less efficient technology (pollution controls) or the loss of resources.

Economic Growth is the ability to produce a larger total output – a rightward shift of the
production possibilities curve is caused by
Lesson 3: Economic Systems

Production and the allocation of resources occur within economic systems.

Economic systems rarely exist in a pure form and the pure forms are assumed simply for
ease of illustration. The following classification of systems is based on the dominant
characteristics of those systems.

Pure capitalism is characterized by private ownership of productive capacity,

very limited government, and motivated by self-interest. Laissez faire means that
government keeps their hands-off and markets perform the allocative functions within
the economy. This type of system has the benefit of producing allocative efficiency if
there is no monopoly power, but this type of system tends towards heavy market
concentration left unregulated. Economic decisions are primarily driven by market forces,
with prices determined by supply and demand. Competition is a key driver of efficiency
and innovation. Economic decisions are primarily driven by market forces, with prices
determined by supply and demand. Competition is a key driver of efficiency and
innovation. The United States, Canada, and many Western European countries operate
under capitalist systems.
In command economies the government makes the allocative decisions. These
decisions are backed with the force of law (and sometimes martial force). In a command
or planned economy, a central authority (usually the government) makes all economic
decisions, including what to produce, how much to produce, and how resources should
be allocated. Examples, of these types of systems abound, Nazi Germany, Chile, the
former Soviet Union are but a few examples.

Traditional economies base allocations on social mores or ethics or other

nonmarket, non-legislative bases. For example, Iran is an Islamic Republic and the
allocation of resources is heavily influenced by religious precepts. The purest forms of
traditional economies are typically observed in tribal societies. In the South Pacific and
traditions, only some of which are based in their religion. Many of these traditions
developed because of economic constraints. For example, the tradition that some native
tribes in the Arctic had of putting their elderly out of the community to starve or freeze
may seem barbaric, but because of the difficulty in obtaining the basic requirements of
life, those that could not contribute, could not be supported. Hence a tradition that arose
from economic constraints. Technological advancements and changes occur slowly, and
there is often a focus on subsistence farming and traditional artisanal activities.

Socialism generally focuses on maximizing individual welfare for all persons

based on perceived needs, not necessarily on contributions. Socialist systems are
generally concerned more with perceived equity rather than efficiency. In socialism,
there is a mix of public and private ownership. Key industries and resources may be
owned or controlled by the state, while some private ownership is allowed. While
markets may exist, there is often a degree of economic planning to address social
inequality and ensure a more equitable distribution of wealth. Sweden, Denmark, Norway
and Iceland have systems that have large elements of socialism. Each of these three
countries have been reasonably successful in maintaining relatively high levels of
productivity and standards of living.
 Communism is a system where everyone shares equally in the output of society
(according to their needs), at least theoretically. Generally, there is no private holdings of
productive resources, and government is a trustee until such time as what is called
"Socialist Man" fully develops (where the individual is more concerned with aggregate
welfare than individual gain). The ultimate goal of communism is to create a classless
society with no social or economic hierarchies. The former Soviet Union was not a
communist society as perceived by Karl Marx in Das Kapital. However, examples of
communist societies exist on small community levels. Both New Harmony, Indiana and
Amana, Iowa were utopian communist systems that were probably more in keeping with
Marxist ideals, but without the political implications and in very limited scope.

Virtually all economic systems are mixed systems. A mixed system is one that
contains elements of more than one of the above pure systems. The U.S. economy is a
mixed system, with significant amounts of capitalism, command, and socialism. The U.S.
economy also has some very limited amounts of communism and tradition that have
helped shape our system. Much of the political controversies concerning the budget
deficit, social security, and the environment focuses on the what the appropriate
mix of systems should exist in our economic system.

Most developed economies are mixed systems. As a society grows and becomes
more complex, simple pure examples of economic systems are incapable of handling the
demands placed on them. Complexity generally requires elements of command,
socialism and capitalism to properly allocate resources and produce commodities. This is
no more evident in the troubles being experienced in the former Soviet Union and in
China. As these economies attempt to modernize and develop, the policy makers have
discovered the utility of market systems for many economic decisions.

Developed economies are generally high income economies, because the

production processes tend be capital intensive, and focused on high value-added
products. An economy that has a per capita GDP of $8000 or more is a high income
economy. Less developed economies fall into two categories, middle income $8000 to
$800, and low income economies or those below $800. Low income economies are
concentrated in South Asia, and Africa South of the Sahara. Middle income economies
are in the Middle East, Eastern Europe and Latin America. The majority of the world’s

Perhaps the greatest economic issue facing the current generation is what can be
done to bring the low income economies into meaningful participation in the global
economy. The poverty of the low income economies is a serious matter without any other
issue. AIDS, malaria, and a host of other health problems are associated with the poverty
in these nations. Perhaps more importantly, with rising incomes in these parts of the
world come several benefits globally. As income rise in low income countries, cheap labor
is no longer a cause for outsourcing from the high income, industrialized parts of the
world. Further, as income rise, so too does the demand for goods and services. The often
used cliché “a rise tide makes all boats float higher” is exactly the case in these nations
emergence into full participation in the global economy. More
concerning these issues will be offered later in this book.

Lesson 4: The Circular Flow Diagram

The circular flow diagram is a visual representation of the flow of goods, services,
and money in an economy. It illustrates the interdependence between households,
businesses, government, and the foreign sector. The diagram illustrates that there are
several collections of similar economic agents, called sectors. Households provide
resources to government and business and consume the outputs of these other sectors.
The markets in which land, labor, capital, and entrepreneurial talent are sold are called
resource markets.

The markets in which the output of business and in some cases government is sold
are called product markets. To this point, the circular flow diagram is relatively simple.
However, when a foreign sector or substantial governmental sector is added it becomes
more complicated. It is not unusual for a modern economy to have substantial
participation in both the product and resource markets from both foreigners and
governments (sometimes even foreign governments).

Consider a relatively simple open-economy, trade and foreign investment occurs.

The following diagram illustrates this relatively simple economic system. The
interdependence in the sectors is represented by the flows in both the resource and
factor markets. Resources flow from household to both the government and businesses.
Private goods and services flow from the businesses to households and government, and
public goods and services flow from the government to both households and businesses.

Resource Market Product Market

Nature of In the resource market, the In the product market, transactions
Transaction transactions involve the buying revolve around the buying and selling of
and selling of factors of final goods and services.
production, such as labor, land,
capital, and entrepreneurship.
Businesses or firms are the Consumers are the buyers in the product
buyers in the resource market as market as they purchase goods and
they seek to acquire the services for personal consumption.
necessary inputs for production.
Individuals or households are the Businesses or firms are the sellers in the
sellers in the resource market, product market, offering their finished
supplying their labor, land, or products and services to consumers.
capital in exchange for income.

Goods and Factors of production are Final goods and services are exchanged
Services exchanged in the resource in the product market. These are the
Exchanged market. This includes services goods and services that have undergone
such as labor (workforce), rent the production process and are ready for
(for the use of land), interest (for consumption.
the use of capital), and profits
(for entrepreneurship).
ayments in the resource market Payments in the product market are
are made in the form of wages, made by consumers to acquire the final
rent, interest, and profits. products and services.
Participants in Participants in the resource Participants in the product market
Transactions market include businesses or include consumers looking to purchase
firms seeking factors of goods and services and businesses or
 production and individuals or firms selling those final products.
households supplying those
factors.
The primary goal for individuals The primary goal for businesses in the
in the resource market is to earn product market is to generate revenue
income through the sale of their by selling goods and services to
labor, land, or capital. consumers.
Focus of Transactions in the resource Transactions in the product market focus
Transactions market focus on acquiring the on the exchange of finished goods and
necessary inputs for production. services between producers and
Firms aim to obtain labor, land, consumers. Consumers seek to satisfy
and capital to produce goods and their wants and needs through the
services. acquisition of final products.

CHAPTER 3: THE MARKET SYSTEM

We usually think of a market as a place where some sort of exchange occurs;

however, a market is not really a place at all. A market is the process of exchanging
goods and service between buyers and seller. Ruffin & Gregory (1997) defines market as
an established management that brings buyers and sellers together to exchange
particular goods and services. A market, therefore, exists when these three elements are
present: a buyer, a seller and a facility for exchange.

Lesson 1: Structure

In an economy where there are numerous goods and services offered for
exchange, several market structure prevail. The structure of a market is defined by the
concentration of firms in an industry that produce a specific product, either with similar
or with differentiated characteristics. Whether the industry has less or more
concentration of firms determine how producers or sellers develop their products market
power in terms of their control over supply and pricing strategies. Consumers also adjust
their buying decisions with varied pricing structures and supply levels due to the nature
of the market where such goods and services are being sold.

There are generally four market structure, namely; perfect competition,

monopolistic competition, oligopoly and monopoly. The latter three structures are also
considered as imperfect competition. The type of market structure can be describe by
the number of sellers or firms, the nature of product, entry and exit barriers, and degree
of control over price, among other factors.

Perfect / Pure Competition.

A perfectly competitive market exists where there are many sellers of homogenous
products in the market. These sellers are usually small in size with relatively low of level
of capital which makes it attractive for many to enter the market easily. There is a high
degree of competition among the sellers which give them almost no control over price,
hence, they are most often considered as price takers. Since, entry into the market is
easy, there is also no difficulty in exiting the market because little investment cost is
incurred by the firm. Examples of products under this market structure are agricultural
commodities (in unprocessed form) and street foods.
It is a theoretical market structure characterized by a large number of small firms
producing identical products

Monopolistic Competition
A Monopolistic competitive market is characterized by many sellers of
differentiated products. Product differentiation may be done thru branding, advertising or
creating differences in quality and or service. Because of the certain uniqueness or
variation in the product, the seller enjoys a certain degree of control in terms of the
availability and price of the product. Similar to perfect competition, monopolistic sellers
can easily enter and exit from the market as they may gain profits or incur economic
losses. Franchised food businesses are good examples of this market structure.
In monopolistic competition, firms engage in non-price competition by
differentiating their products and creating brand loyalty. While the products may share
similarities, each brand attempts to establish a unique identity in the minds of
consumers.

Oligopoly
Oligopoly markets are characterized by very few sellers with homogeneous or
unique products. Oftentimes, products offered in this market structure entail huge
amount of loss to develop and to sell. Barriers to enter the market usually come in the
form of technological barrier or huge capital investment requirement. Because the sellers
are considerably few, they have significant market power to control product supply and
even control the price, either thru collusive or non collusive strategies. In the Philippines
big gasoline companies such as shell, petron and Caltex are considered to play in an
oligopolistic market. Although, there are also several small payers in the gasoline
industry but whose market power are less significant than these big companies.

Monopoly
A monopoly is basically one-firm industry. There is only one producer of a unique
product that has no available substitutes in the market. Being an only seller a
monopolistic has the total market power in terms of controlling supply as well as the
price of the product. In most cases, monopolies are create or controlled by the
government, although there are very few private entities that put up monopoly business.
Knowledge and ownership of technology, territorial jurisdictions or legal rights are
usually the sources of power that provide monopolies the shields or barriers from entry
by other firms. Ex. Beneco, patent, copyright trademark

Characteristi Pure Monopolistic Oligopoly Pure

cs Competition Competition Monopoly
Number of Very Large Many Few One
firms Number
Type of Product Standardized Differentiated Standardized Unique; no
for Raw close
materials; substitutes
Differentiated
for finished
consumer
goods
Control over None Some, but Limited by Considerable
Price within rather mutual
narrow limits interdependenc
e; considerable
with collusion
Condition of Very Easy, No Relatively Easy Significant Blocked
entry obstacle obstacle
Non-Price None Considerable Typically a great Mostly public
Competition emphasis on deal particularly relations
advertising, with product advertising
brand names. differentiation
Trademarks
Examples Agriculture- Retail trade, Steel, Local Utilities-
crops and fishes dresses, shoes, automobile, Electricity,
fast food chains, many water, natura
Smartphones, household gas,
Coffee Shops, appliances pharmaceutical
Toothpaste companies,
brands. Yogurt airline, Natura
brand resources.
Lesson 2: Demand Supply And Market Equilibrium

Objective:

After finishing this unit students are expected to:

- Understand how market works
- Know how goods and services are valued based on their prices.
- Understand demand, supply and market equilibrium.

This unit deals with understanding the market and how it works especially on how
goods and services are valued based on their prices. It should be clear by now that
market is more than its basic meaning of a place but involves mechanism on how the
forces of demand and supply interact with each other in order to undergo exchange. In
any economic and non-economic activity, it involves mechanism on how the forces of
demand and supply interact with each other in order to undergo exchange. In any
economic and non-economic activity, it involves the law of demand and supply, thus the
need to understand their individua functions and interactions in order to be guided and
arrived at good (or excellent) decisions.

The Concept of Price Theory.

It is concerned with understanding how prices are set for goods and services and
how these prices, in turn, allocate resources efficiently in a market economy. Price theory
primarily operates at the microeconomic level, analyzing individual markets, firms, and
consumers.

Key concepts within price theory include:

a. Supply and Demand: The cornerstone of price theory is the interaction between supply
and demand. Supply represents the quantity of a good or service that producers are
willing to offer at various prices, while demand represents the quantity that consumers
are willing to purchase at different prices. The equilibrium price is where the two curves
intersect.

b. Consumer Behavior: Price theory delves into consumer decision-making, exploring

how individuals allocate their limited budgets among various goods and services.
Concepts such as marginal utility, indifference curves, and budget constraints are often
used to explain consumer choices.

c. Firm Behavior: Price theory also analyzes the behavior of firms in response to changing
market conditions. It examines how firms decide on the quantity of output to produce
and at what price, considering factors such as production costs, technology, and market
competition.

d. Market Structures: Different market structures, such as perfect competition,

monopolistic competition, oligopoly, and monopoly, are studied within price theory. Each
structure influences how prices are determined and how resources are allocated in the
market.

e. Market Efficiency: Price theory assesses the efficiency of markets in allocating

resources. It argues that, under certain conditions, markets tend to allocate resources
efficiently, maximizing overall welfare and satisfaction.

f. Price Elasticity of Demand and Supply: Price theory considers the responsiveness of
quantity demanded and supplied to changes in price. Elasticity measures how much
quantity changes in response to changes in price, influencing the behavior of consumers
and producers.

g. Market Failures: Price theory also explores situations where markets may fail to
achieve efficiency. Market failures, such as externalities, public goods, and asymmetric
information, are analyzed to understand instances where intervention may be necessary.
 In summary, price theory provides a framework for understanding the forces that
shape prices in markets, the interactions between consumers and producers, and the
resulting allocation of resources. It serves as a fundamental tool in microeconomic
analysis and decision-making.

Demand.
It I the amount of goods and services consumers are willing and able to buy from
the market at various prices, all other factors remaining constant. Demand is
quantifiable, meaning it ca be counted. For demand to become actual, the consumer
should have both the willingness ad the ability to buy the good or avail of a service.
Effective demand requires both the desire for the product and the ability to pay for it.

Law of Demand. As the price of the good increases, quantity demanded decreases; and
as the price decreases, quantity demanded increases. There is an inverse (negative)
relationship between price and quantity demanded. Thus, the slope (m=Δy/Δx) of a
demand curve is negative.

Demand Schedule. It shows the list of prices with the corresponding quantities
demanded.

Change in quantity demanded. It the movement of points within the same demand
curve, the changes in the quantities demanded is brought about by the change in prices.
Change in demand is a shift of the entire demand curve to the right (increase in demand)
or to the left (decrease in demand) and is caused by change in the non-price
determinants of demand without necessarily affecting the price.

Change in Demand is the shifting of the demand curve either to the right (increase in
quantity demanded D to D1) or the left (Decrease in quantity demanded, D to D2) of the
original demand curve. The change in the quantity demanded is brought about by any of
the non-price determinants of demand and not by price (Which is constant).
The Non-Price Determinants of Demand (TIPPS)
A decrease of demand by non-price shift the graph.
Aside from price as a major factor affecting the quantity demanded by the
consumers, the following are important to consider in order to understand why demand
curves shift either to the right or to the left of the original demand curve.

1. Taste and preference. Every individual has his/her own preference or standard with
regards to choosing a particular good. Basically, if a person feels that he/she will be
maximizing satisfaction from a good or a service then most probably the demand for
such good / service will increase.

2. Income. Aside form the price, income is a major factor affecting the decision of the
consumer on how much to demand for a good or a service. Income is neither consumed
or saved. The consumption component is where quantity demanded for goods and
services may be derived. Basically, with higher income, the more the tendency for a
consumer to demand for more goods and services, and that the lesser the income, the
lesser is the demand. However, the income effect could be depended on the type of
good or service demanded. For normal goods, a higher income will cause consumer to
demand more of the good or service. In contrast, with higher income, consumers will
tend to consume less of inferior goods and service.

3. Size of the population. The number of buyers in the market affects the quantity
demanded for a particular good or service. The more rapid is the increase in the
population, the greater is the demand for goods especially the basic commodities, and a
reverse situation occurs with less population. (yet it depends on the kind of population).

4. Prices of Related Goods. (Two) Goods may be complements or substitutes.

Complementary goods are commodities where one cannot function in the absence of the
other. In the case of gasoline and vehicle, the increase in the price of gasoline will result
to the decrease in the demand for vehicle. In the case of substitute goods, one good can
function even in the absence of the other good. The increase in the price of rice resulted
to the increase in the demand for bread as a substitute to rice.

5. Price and income Expectations. When consumers expect that the price of a certain
good will increase in the future, their current demand for the good will increase. With
income expected to increase in the future, current consumption level tend to increase
that results to increase in the demand for goods and services.

Determinant: Factors that Shift the Demand Curve

Change in buyer tastes Physical fitness rises in popularity- increasing demand for
jogging shoes, bicycles, badminton, rackets.
Change in number of A decline in birthrate reduces the demand for milk
buyers
Change in income A rise in incomes increases demand for norma goods while
reducing the demand for inferior goods.
Change in the price of Substitute goods- a reduction in the price of air conditioning
related goods units reduces the demand for electric fan.
Complementary goods- a decline in the price of CD players
increases the demand for CDs
Change in expectations Increasing price of gasoline creates an expectation of
higher future prices of prime commodities thereby
increasing today’s demand for prime commodities.

Foundations of the Law of Demand

1. Common sense and simple observation- Common sense will tell us to buy more of
the goods if the price is low

2. Law of diminishing marginal utility- States that successive units of a given

product yields less and less extra satisfaction to the customer. In simpler terms, as you
consume more of a good or service, the extra enjoyment or utility you get from each
additional unit tends to decrease.

3. Income effect and substitution effect.

With income effect- at a lower price, one can afford more of the good without
giving up any alternative good.
Substitute effect- indicates that at a lower price, one has the incentive to
substitute a cheaper good to another good which is now relatively more expensive.

Supply

It is the amount of goods and services producers are willing and able to sell in the
market at various prices, all other factors remaining constant.

Law of supply. It states that as the price of good increases, the quantity supplied for
the good also increases; and as the price declines, the quantity supplied also declines.
There is a direct positive relationship between price and quantity supplied. Thus, the
slope (m=Δy/Δx) of a demand curve is positive.

Supply Schedule. It shows the lit of prices with the corresponding quantities supplied.

Supply Function. It shows the relationship between the quantity supplied and the price
of the good (and other factors). In simple terms, quantity supplied is a function of price.
Change in Quantity Supplied is the movement of points within the same supply
curve, the changes in the quantities supplied is brought about by the changes in prices.

Change in Supply is the shifting of the demand curve either to the right (increase in
quantity supplied, S to S1) or to the left (decrease in quantity supplied, S to S2) of the
original supply curve. The change in the quantity supplied is brought about by ay of the
non-price determinants of supply and not by price (which is constant).

The Non-Price Determinants of Supply

Aside form price as a major factor affecting the quantity supplied of the producer,
the following factors are important to consider to understand why supply curves shift
either to the right or to the left of the original supply curve.

a. Number of sellers. The number of sellers in the market will indicate the
quantity available for sale. Thus, the greater is their number, the more is the
quantity supplied for a particular good or service.

b. Technology. A modern or advance technology will result to mass production,

while traditional method brings about inadequate output.

c. Cost of production. The higher the cost of producing a particular good, the
lesser is the amount of goods available for sale.

d. Taxes and subsidies. Taxes are negative income to people especially to the
producers. Instead of using the amount to production activities, it will be used to
pay what the government requires from an organization. The higher the tax, the
lesser will be the amount available for re-investment by the firm, thereby creating
less outputs. On the other hand, subsidies are grants or aids extended by the
government (could be in monetary or in kind) to help ease the production activities
of producers. Therefore, the more subsidies given by the government, the more
outputs will be produced.
The Demand Function.

a. Creating a demand function from the demand schedule.

Qd = a - bP

Where: Qa= is dependent as it is dependent to the change in price.

a= represents the price of quantity demanded when price is zero.
b=it is the quantity if there is a 1 unit change in price.

P (y-axis) Qd (x-axis)
1 10
2 8
3 6
4 4

Step 1. Look for the value of b. Then choose from the table any of the points.
Label which among the points is the Qd1-Qd2 up to P2- P4.
In this example, we chose P1= 2, P2= 3 Qd1= 8, Qd2=6
b= ΔQ = Qd2-Qd1 = 6-8 = -2
ΔP P2-P1 3-2

Step2. Look for the value of a. Choose any of the points from the demand
schedule then substitute to the demand function: Qd = a + bP
For instance we choose (P=3, and Qd=6)
Qd = a + bP
6 = a + (-2)(3)
6 =a–6
6+6=a
12= a

Thus the demand equation will be Qd= 12 -2P.

b. Creating a demand schedule from a demand function. Using the demand

function
Qd = 100 – bP , we can create the demand schedule by simple substitution.

P (y-axis) Qd = 100 – 10P Qd (x-axis)

0 Qd = 100 – (10x0)= 100 100
1 Qd = 100 – (10x1)= 90 90
2 Qd = 100 – (10x2)= 80 80
3 Qd = 100 – (10x3)= 70 70
 4 Qd = 100 – (10x4)= 60 60
5 Qd = 100 – (10x5)= 50 50
6 Qd = 100 – (10x6)= 40 40

If the “b” is higher, the quantity demanded would be twice less responsive to
changes in price. The slope will be flatter.

P (y-axis) Qd = 100 – 20P Qd (x-axis)

0 Qd = 100 – (20x0)= 100 100
1 Qd = 100 – (20x1)= 100 80
2 Qd = 100 – (20x2)= 100 60
3 Qd = 100 – (20x3)= 100 40
4 Qd = 100 – (20x4)= 100 20
5 Qd = 100 – (20x5)= 100 0
6 Qd = 100 – (20x6)= 100 -20

c. Plotting a demand curve given a demand function.

The Supply Function.

a. Creating a supply function from the supply schedule.

Qs = c + dP

Where: Qs= is dependent as it is dependent to the change in price.

c= represents the price of quantity supplied when price is zero.
d=it is the quantity supplied if there is a 1 unit increase in price.

P (y-axis) Qs (x-axis)
1 10
2 15
3 20
4 25

Step 1. Look for the value of b. Then choose from the table any of the points.
Label which among the points is the Qs1-Qs2 up to P2- P4.
In this example, we chose P1= 2, P2= 3 Qs1= 10, Qs2=15
d= ΔQs = Qs2-Qs1 = 15-10 = 5
ΔP P2-P1 2-1

Step2. Look for the value of c. Choose any of the points from the supply
schedule then substitute to the supply function: Qs = c + dP
For instance we choose (P=3, and Qs=20)
Qs = c + dP
6 = c + (5)(3)
6 = d+8
6 -8 = d
-2= d

Thus the supply equation will be Qs= -2 + 5P.

b. Creating a supply schedule from a supply function. Using the supply function
Qs = -2+5P, we can create the supply schedule by simple substitution.
 P (y-axis) Qs = -2+5P Qs (x-axis)
0 Qd = -2 + (5x0)=-2 -2
1 Qd = -2 + (5x1)=3 3
2 Qd = -2 + (5x2)=7 7
3 Qd = -2 + (5x3)=13 13
4 Qd = -2 + (5x4)=18 18
5 Qd = -2 + (5x5)=23 23
6 Qd = -2 + (5x6)=27 27

If the ‘d’ variable is higher, the more responsive producers are to price change will
be flatter

P (y-axis) Qs = -2+6P Qs (x-axis)

0 Qd = -2 + (6x0)=-2 -2
1 Qd = -2 + (6x1)=4 4
2 Qd = -2 + (6x2)=10 10
3 Qd = -2 + (6x3)=16 16
4 Qd = -2 + (6x4)=22 22
5 Qd = -2 + (6x5)=28 28
6 Qd = -2 + (6x6)=34 34

0
-5 0 5 10 15 20 25 30

QD2 QD1

c. Plotting a supply curve given the supply function.

Given a supply function, Qs = -2+6P

1. Set Qs=0 thus
0= -2 + 6P
2=6P
P=0.33 (0.33,0)

2. Plug in any price from the equation, for this, we use P=5
Qs=-2+6(5)
Qs=28 (28,5)
 6

0
0 5 10 15 20 25 30
-1

-2

-3

Market Equilibrium

It is a concept in economics that is very idea for certain economy. It is a condition

where the market demand curve and the market supply curve intersect with each other
forming an equilibrium point in which the market price and the equilibrium quantity are
derived. The interplay between demand and supply becomes significant with the
derivation of the equilibrium point where the market clears, that is there is neither
surplus nor shortage of supply.

“Market clearing price”. The price at which the market is in the equilibrium.

Mathematically, the equilibrium point can be derived by solving the demand and
supply equations simultaneously.

Given the demand and supply equations, x=15-3y and x=2y-3 respectively, the
resulting values of x=.2 and y=3.6. This is the equilibrium point (4.2, 3.6) given the x the
quantity (quantity demanded and quantity supplied are equal) and y as the price, it
means to say that at the price of 3.6, both the buyers and the sellers agree to have an
exchange of a good or a service in which the quantity demanded is equal to the quantity
supplied.

Graphically, the demand and the supply curves are presented below with the point
of intersection / equilibrium.
 Though in reality, equilibrium rarely or do not happen. There are disruptions in the
equilibrium point. When the price is higher than the market price, surplus of
supply occurs (quantity supplied exceeds the quantity demanded)

When the price is lower than the market price, shortage of supply happen
in which the quantity demanded exceed the quantity supplied.

Thus supply and demand will adjust to one another so as to solve the problems,
and maintain the idea situation of equality between the amount demanded and supplied.

When either demand or supply curves shift to the right or left, changes in the
market price and equilibrium quantity occur. A shift to the right of the supply curve,
which implies an increase in supply; and a shift of the demand curve to the left
implying a decrease in demand, will both lower the market price, while the
impact on the change in equilibrium quantity varies. A shift to the left of the
supply curve (decrease in supply) and a shift to the right of the demand curve
(increase in demand) will both increase the market price, and different result
will occur to the equilibrium quantity.

When both demand and supply curves shift, consider the directions (increase /
decrease) and magnitudes (more / less) of the change.
 References: https://www.ibdeconomics.com/demand.html

Activity.

Chapter 4: Elasticity Concepts

Similar to a rubber band, a customer’s demand for a particular product may be flexible at varying degrees.
Quantity demanded may increase or decrease depending on his/her purchasing power or income, the price of the
product and the price of available related products.

For example, quantity demanded by the consumer for banana may increase or decreasing depending on its own
price and the price of its substitutes such as lanzones. As we can see, a change in quantity demanded cannot explain the
relative responsiveness of the consumer to a change in price. One kilo of banana is equal to one kilo of lanzones.
However, it is more likely that the price of a kilo of banana is equal to one kilo of lanzones.
 That is why more consumers buy banana in greater quantities than lanzones. In this example, it is easy to identify
which is more preferred by the consumers because unit of measurement is both in kilo and the price is valued in
Philippine peso for both products. But what if we are going to compare two commodities with different units of
measurement? Let us take as an example a consumer who is faced with only two products to buy, plantain banana (saba)
and rice, given his limited budget. How would we compare the consumer’s preference for saba with his preference for
rice if saba is sold by the piece and rice is sold by the kilo? In this case, it is difficult to compare consumer’s preference or
responsiveness to different products with varied units of measurement even if the changes in the prices are measured in
the same currency.

A very good tool in comparing demand for products subject to price changes is the percentage (%). An evaluative
tool that is presented in percentage has no unit of measurement. The compared values are simply expressed in (%).
Therefore, we can compare the percentage change in quantity in demanded for rice per percent change in its price.
Hence, consumes’ responsiveness to changes in price or changes in income are measured in terms of percentage using
the elasticity concept. In this chapter, three types of elasticity of demand are discussed, namely; price elasticity, income
elasticity and cross price elasticity.

Price elasticity is a concept in economics that measures how sensitive the quantity demanded or supplied of a
good or service is to a change in its price. It helps to quantify the responsiveness of consumer demand or producer
supply to changes in the price of a product.

Price Elasticity Of Demand

The Price Elasticity of Demand measures how much the quantity demanded will change in response to a change
in price. The price elasticity of demanded is the responsiveness of the quantity demanded of a good to changes in the
good’s price other things held equal. Price elasticity is defined as the percentage change in quantify demanded for a
product by the consumer for every percent change in the price.

ep = % change in QD
% change in P

ep = Qd2 – Qd1
(Qd2 + Qd1) / 2
________________
P2 – P1
(P2 + P1) / 2

A consumer’s demand for a product is elastic if the computed absolute value of elasticity is greater than 1, | e p |
> 1. If the price elasticity of demand is less than 1, |e p | < 1, the demand is inelastic, however if the | e p | = 0, the
demand is perfectly inelastic. An elasticity equal to 1, |e p | = 1, means that the demand for the product is unitary. The
price elasticity of demand also tells us the kind of product that is being bought by the consumer. A product that has an
elastic demand is called a luxury good while a product that has an inelastic demand is considered a necessity good.
Elastic: | ep | > 1 to ∞, luxury good
Unitary: |ep | = 1, Unitary
Inelastic: | ep | <1 to 0, necessity good
Qd for banana decreased by 2.6% as a result of 1% increase in its price. The cosumer faces an elastic demand for this
luxury good.

Income Elasticity
Income Elasticity of demand (ey) is a measure of responsive of the consumers to a change in income (Y). It
measures how much change in quantity demanded occurs when the buyer’s income changes. It is the percentage change
in Qd for a percent change in income.

If the ey is positive but less than 1 (0 < e y, <1), the product is considered a normal good. However, if the e y, is
positive and greater than 1 (0 < ey >1), the product is called a luxury good because the consumer tends to buy the
product in greater proportion than the proportional increase in income. If e y is negative or is < 0, then product is
considered an inferior good as the buyer tends to buy less of the product when income increases.
 Quantity demanded for banana increased by 1.8% as a result of a 1% increase in income. Bananas are a luxury
good because the computed income elasticity has a positive value.

Cross Price Elasticity (Cross Price Elasticity)

The cross price elasticity measure the consumer’s responsiveness to a change in the price of related goods. It
determines the change in the quantity demanded for a good when the price of the other related goods. Two goods may
be related substitutes or compliments. For example, chicken meat may be a substitute for pork when the price of pork
becomes higher than chicken. Gasoline is needed to run an automobile, hence, the two goods are complements. Given
two goods X and Y, the cross price elasticity is computed as follows:

Supply Elasticity
The price elasticity of supply measures the percentage change in quantity supplied in response to a one percent
change in the goods price. Most Agricultural products have inelastic supply because crop and livestock growers cannot
easily adjust their supply when prevailing prices suddenly change. Standing crops or currently raised livestock cannot be
forced to produce more or less yields during the production season at the time the price increases or decreases.
Processors, on the other hand, usually face elastic supply for their products because they can adjust their volume of
production when price changes in the market.