CATHOLIC UNIVERSITY COLLEGE OF GHANA,

FIAPRE

[Faculty of Economics and Business Administration]

REGULAR AND WEEKEND PROGRAMMES

COURSE OUTLINE:
PRINCIPLES OF ECONOMICS I

1
• Course: EBA 201 Principles of Economics I
• Semester: First Semester, 2016/2017
• Level: Undergraduate, Level 200
• Lecturer: Mr. Isaac A. Amankwa
(020-844-8719, 024-351-9594)
• Email: aamankwah@[Link]:
mrscientific2007@[Link]
• Lecture Day: Saturday, 7:30–10:00am @ C 1;
Thursday, 8:00–10:30am @ LT 2
• Office: First Floor of the Adm. Block, Room 6
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Course objective and description
•The purpose of this course is to introduce
students to microeconomics.
•It provides students with a foundational
study of the concepts and theories underlying
individual choice and economic interactions in
markets.
•In terms of approach, the course combines
economic intuition with a rigorous treatment
of concepts taught in introductory economics.
3
Course objective and description
•Students will learn a set of analytical tools and
be equipped with the basic knowledge to take
advanced courses in microeconomic theory.
•The applicability of theories and concepts to
practical situations, and the linkages to other
economic fields will as well be discussed in the
course.
•This course discusses selected issues in
microeconomics: nature and scope of
4
Course objective and description
•economics; price mechanism; demand and
supply; elasticity of demand and supply; the
consumption decision; time and risk; theory of
the firm; and market structures.
•These key substantive issues in
microeconomics will be analysed critically.

5
Reading Materials
•McConnell, C. R., Brue, S. L. and Flynn, S. M.
(2009). Economics (19th ed), New York: McGraw-
Hill Irwin.
• Mankiw, N. G. (2007). Principles of
Microeconomics (4th ed).
•Bajada, C., Jackson, J, McIver, R. and Wilson, E.
(2012). Economic Principles, New York: McGraw –
Hill.
• Colander, D. C. (1998). Microeconomics, Boston:
McGraw-Hill Irwin.
6
Reading Materials
•Frank, R. H. and Bernanke, B. S. (2009).
Principles of Economics, New York: McGraw-Hill
Irwin
•Harvey, J. (1994). Mastering Economics,
London: Macmillan.
•Lipsey, R.G. (1989). An Introduction to Positive
Economics, London: Weidenfeld and Nicolson.
•Matziorinis, K. N. (2012). Business Economics:
Theory and Practice, Montreal: Canbek
Publications.
7
Reading Materials
•Parkin, M. (2012), Economics, Harlow: Pearson
Education Ltd.
•Salvatore, D. and Diulio, E.A. (1996), Principles
of Economics, New York: McGraw-Hill.
•Samuelson, P. A. and Nordhaus, W. D. (2010),
Economics, New York: McGraw-Hill Irwin.
•Stiglitz, J. (1993), Economics, New York: W. W.
Norton Co. Ltd.

8
Examinations
• This course will be examined by means of a
continuous assessment and an end of semester
examination.
•The Continuous Assessment will constitute 40%
of the total mark to be awarded for this course.
•This will comprise of class attendance and
participation, ten percent (10%); and assessed
class exercises/assignments, thirty percent
(30%).
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Eligibility for Final Examination
•A student will only be allowed to take part in
the final examination provided they have
attended at least 80% of all the core lectures.
•Students are to note that it is in their own
interest to be in class at all material times, as
attendance will be checked in class.

10
Academic Integrity
•Academic integrity consists in adhering to the
five fundamental values of honesty, trust,
fairness, respect, and responsibility (Check the
Academic Integrity Website
[Link]
•From these values flow the principles of
behaviour that will enable the Catholic
University College of Ghana to translate ideals
into action.
•An academic community flourishes and
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Academic Integrity
•advances the frontiers of knowledge when its
members are committed to the five
fundamental values.
•In this direction, therefore, both students and
the course lecturer are expected to behave well
and responsibly for the entire duration of the
course.
•The use of cellular phones in class, for instance,
will not be tolerated under any circumstance.
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Academic Integrity
•Students should also note that plagiarism
(academic dishonesty/stealing) is a very
serious offence in the University.

13
 TEN PRINCIPLES OF ECONOMICS
• The word economy comes from the
Greek word for “one who manages a
household.” Households and economies
have much in common.
• A household faces many decisions. It
must decide:
– Who cooks supper? Who washes the
utensils? Who gets the extra dessert at
supper? Who chooses TV show to watch?
14
 TEN PRINCIPLES OF ECONOMICS
• In short, the household must allocate its
scarce resources among its various
members,
• taking into account each member’s
abilities, efforts, and desires.
• Similarly, a society faces countless decisions.
It must decide what jobs will be done and
who will do them.
• It must decide what jobs are there and who 15
 TEN PRINCIPLES OF ECONOMICS
• will do them, how to allocate the
output of goods and services that they
produce?
• The management of society’s resources
is important because resources are
scarce.
• Scarcity means the limited nature of
society’s resources.
16
 TEN PRINCIPLES OF ECONOMICS
• Economics is the study of how
society manages its scarce resources .
• Economists study how people (i.e. you
and I) make decisions:
– How much we work, what we buy, how
much we save, and how we invest our
savings.
• Economists also study how people
17
 TEN PRINCIPLES OF ECONOMICS
• Interact with one another. Hence,
Alfred Marshall’s definition.
• The study of economics has many
facets, the field is unified by several
central ideas/themes.
• Let’s consider the ‘Ten Principles of
Economics’. These principles run
throughout this course and the next 18
 TEN PRINCIPLES OF ECONOMICS
1st: People face tradeoffs
•The first lesson about making
decisions is summarized in the adage:
– “There is no such thing as a free
lunch.”
• To get one thing means, we usually
have to give up another thing.
19
 TEN PRINCIPLES OF ECONOMICS
1st: People face tradeoffs
• Thus, making decisions requires
trading off one goal against another.
• If you spend your time playing around,
you don’t pass.
• Examples of trade offs: Guns and butter;
efficiency and equity.
• Efficiency: the property of society 20
 TEN PRINCIPLES OF ECONOMICS
1st: People face tradeoffs
•getting the most it can from its scarce
resources.
•Equity: the property of distributing
economic prosperity fairly among the
members of society.
•These two goals conflict. Taxing the
well-to-do more, they work less. 21
 TEN PRINCIPLES OF ECONOMICS
• 2nd: The cost of something is what
you give up to get it
• Making decisions requires comparing
the costs and benefits of alternative
courses of action.
• This is because people face trade
offs. The opportunity cost of an item
is what you give up to get that item.
22
 TEN PRINCIPLES OF ECONOMICS
• Did Gates, Winfrey, and Rodriguez
Make Bad Choices?
• Opportunity costs come into play in
decisions well beyond simple buying
decisions.
• Consider the different choices people
make with regard to college.
• College graduates usually earn 50% 23
 TEN PRINCIPLES OF ECONOMICS
• more during their lifetimes than
persons with just high school
certificate.
• For most capable students, “Go to
college, stay in college, and earn a
degree” is very sound advice.
• Yet Microsoft cofounder Bill Gates
and talk show host Oprah Winfrey. 24
 TEN PRINCIPLES OF ECONOMICS
• both dropped out of college, and
baseball star Alex Rodriguez (“A-
Rod”) never even bothered to start
classes.
• What were they thinking? Unlike
most students, Gates faced huge
opportunity costs for staying in
college. 25
 TEN PRINCIPLES OF ECONOMICS
• He had a vision for his company,
and his starting work young helped
ensure Microsoft’s success.
• Similarly, Winfrey landed a spot in
local television news when she was
a teenager, eventually producing
and starring in the Oprah Winfrey
Show when she was 32 years old. 26
 TEN PRINCIPLES OF ECONOMICS
• Getting a degree in her twenties
might have interrupted the string of
successes that made her famous talk
show possible.
• And Rodriguez knew that
professional athletes have short
careers.
• Therefore, going to college directly
27
 TEN PRINCIPLES OF ECONOMICS
• after high school would have taken
away four years of his peak earning
potential.
• So Gates, Winfrey, and Rodriguez
understood opportunity costs and
made their choices accordingly.
• The size of opportunity costs greatly
matters in making individual decisions.
28
 TEN PRINCIPLES OF ECONOMICS
• 3rd: Rational people think at the
margin
• Economists use the term marginal
changes to describe small
incremental adjustments to an
existing plan of action.
• Keep in mind that “margin” means
“edge,” so marginal changes are 29
 TEN PRINCIPLES OF ECONOMICS
• 3rd: Rational people think at the
margin
• adjustments around the edges of
what you are doing.
• By comparing marginal/additional
benefits and costs, you can evaluate
whether your coming to school is
worthwhile. 30
 TEN PRINCIPLES OF ECONOMICS
• 3rd: Rational people think at the
margin
• A rational decision maker takes an
action if and only if the marginal
benefit of the action exceeds the
marginal cost.

31
 TEN PRINCIPLES OF ECONOMICS
• 4th: People respond to incentives
• Because people make decisions by
comparing costs and benefits, their
behaviour may change when the
costs or benefits change.
• When policymakers fail to consider
how their policies affect incentives,
they can end up with results that 32
 TEN PRINCIPLES OF ECONOMICS
• 4th: People respond to incentives
• they did not intend.
• When analyzing any policy, we must
consider not only the direct effects
but also the indirect effects that work
through incentives.
• If the policy changes incentives, it will
cause people to alter their behaviour. 33
 TEN PRINCIPLES OF ECONOMICS
• The above principles deal with how
people/individuals make decisions.
• The next 3 sections deal with how
people interact since many of our
decisions affect not only ourselves
but other people as well.

34
 TEN PRINCIPLES OF ECONOMICS
• 5th: Trade can make everyone better
off
• Trade allows each person to
specialize in the activities he or she
does best.
• By trading with others, people can
buy a greater variety of goods and
services at lower cost. 35
 TEN PRINCIPLES OF ECONOMICS
• 5th: Trade can make everyone better
off
• Thus, trade is a zero-sum-game
unlike a sports contest where one
side wins and the other losses.
• Trade allows countries to specialize
in what they do best and to enjoy a
greater variety of goods and services.
36
 TEN PRINCIPLES OF ECONOMICS
• 6th: Markets are usually a good way
to organize economic activity
• The collapse of communism in the
Soviet Union and Eastern Europe
may be the most important change
in the world during the past half
century.
• Central planners made key decisions
37
 TEN PRINCIPLES OF ECONOMICS
• 6th: Markets are usually a good way
to organize economic activity
• such as what, how and for whom to
produce.
• The idea behind central planning was
that only the government could
organize economic activity in a way
that promoted economic well-being 38
 TEN PRINCIPLES OF ECONOMICS
• 6th: Markets are usually a good way
to organize economic activity
• for the country as a whole. In a
market economy, the decisions of a
central planner are replaced by the
decisions of millions of firms and
households.
• In his 1776 book An Inquiry into the
39
 TEN PRINCIPLES OF ECONOMICS
• 6th: Markets are usually a good way
to organize economic activity
• Nature and Causes of the Wealth of
Nations, Adam Smith observed that:
– Households and firms interacting in
markets act as if they are guided by
an “invisible hand” that leads them to
desirable market outcomes. 40
 TEN PRINCIPLES OF ECONOMICS
• 6th: Markets are usually a good way
to organize economic activity
• Nature and Causes of the Wealth of
Nations, Adam Smith observed that:
– Households and firms interacting in
markets act as if they are guided by
an “invisible hand” that leads them to
desirable market outcomes. 41
 TEN PRINCIPLES OF ECONOMICS
• 6th: Markets are usually a good way
to organize economic activity
• You’ll understand that prices are the
instrument with which the invisible
hand directs economic activity.
• In communist countries, prices were
not determined in the marketplace
but were dictated by central 42
 TEN PRINCIPLES OF ECONOMICS
• 6th: Markets are usually a good way
to organize economic activity
• planners. These planners lacked the
information that gets reflected in
prices when prices are free to
respond to market forces.
• Central planners failed because they
tried to run the economy with one 43
 TEN PRINCIPLES OF ECONOMICS
• 6th: Markets are usually a good way
to organize economic activity
• hand tied behind their backs—the
invisible hand of the marketplace.

44
 TEN PRINCIPLES OF ECONOMICS
• 7th: Governments can sometimes
improve market outcomes
• Though markets are usually a good
way to organize economic activity.
• But there are some important
exceptions for two broad reasons:
– to promote efficiency and to promote
equity. 45
 TEN PRINCIPLES OF ECONOMICS
• 7th: Governments can sometimes
improve market outcomes
• The invisible hand usually leads
markets to allocate resources
efficiently.
• However, for various reasons, the
invisible hand sometimes does not
work i.e. the market fails. 46
 TEN PRINCIPLES OF ECONOMICS
• 7th: Governments can sometimes
improve market outcomes
• Market failure is a situation in which
the market on its own fails to
allot/allocate resources efficiently.
• Two possible causes include:
– An externality: the impact of one person’s
actions on the well-being of a bystander.
– Market power: Ability of a single person 47
 TEN PRINCIPLES OF ECONOMICS
• 7th: Governments can sometimes
improve market outcomes
– (or small group of people) to unduly
influence market prices i.e. monopoly.
• The invisible hand does not ensure
that everyone has sufficient food,
decent clothing, and adequate
health care. 48
 TEN PRINCIPLES OF ECONOMICS
• 7th: Governments can sometimes
improve market outcomes
• A goal of many public policies, such
as the income tax and the welfare
system, is to achieve a more
equitable distribution of economic
well-being.
• Studying economics will enable you 49
 TEN PRINCIPLES OF ECONOMICS
• 7th: Governments can sometimes
improve market outcomes
• to judge when a government policy
is justifiable to promote efficiency or
equity and when it is not.
• NB: the next 3 sections also deals
with issues regarding how the
economy as a whole works. 50
 TEN PRINCIPLES OF ECONOMICS
• 8th: A country’s standard of living
depends on its ability to produce
goods and services
• The differences in living standards
around the world are shocking.
• In 1997, the average American had
an income of about $29,000; $8,000
by a Mexican and $900 the Nigerian.
51
 TEN PRINCIPLES OF ECONOMICS
• 8th: A country’s standard of living
depends on its ability to produce
goods and services
• It reflects the quality of life as
citizens of high-income countries
have more TV sets, more cars,
better nutrition, better health care,
and longer life expectancy than 52
 TEN PRINCIPLES OF ECONOMICS
• 8th: A country’s standard of living
depends on its ability to produce
goods and services
• citizens of low-income countries. This
is explained by differences in
countries’ productivity.
– the amount of goods and services produced
from each hour of a worker’s time.
53
 TEN PRINCIPLES OF ECONOMICS
• 8th: A country’s standard of living
depends on its ability to produce
goods and services
• To boost living standards, policy
makers need to raise productivity by
ensuring that:
– workers are well educated, have the tools
needed to produce goods and services, and
have access to the best available 54
 TEN PRINCIPLES OF ECONOMICS
• 8th: A country’s standard of living
depends on its ability to produce
goods and services
– technology.
• Budget deficits have adverse effects on
productivity.
• This is because it reduces the quantity of
money available for borrowers.
• Thereby reducing investment. 55
 TEN PRINCIPLES OF ECONOMICS
• 9th: Prices rise when the government
prints too much money
• In Germany in January 1921, a daily
newspaper cost 0.30 marks.
• Less than 2 years later, in November
1922, the same newspaper cost
70,000,000 marks.
• All other prices in the economy rose
56
 TEN PRINCIPLES OF ECONOMICS
• 9th: Prices rise when the government
prints too much money
• by similar amounts. This is called
inflation, an increase in the overall
level of prices in the economy.
• What causes inflation? In almost all
cases of large or persistent inflation,
the culprit turns out to be the same 57
 TEN PRINCIPLES OF ECONOMICS
• 9th: Prices rise when the government
prints too much money
– growth in the quantity of money.
• When a government creates large
quantities of the nation’s money, the
value of the money falls.
• Thus, inflation is always and every
where a monetary phenomenon. 58
 TEN PRINCIPLES OF ECONOMICS
• 10th: Society faces a short-run
tradeoff between inflation and
unemployment
• The curve that illustrates this
tradeoff between inflation and
unemployment is called the Phillips
curve.
• This means that, over a period of a
59
 TEN PRINCIPLES OF ECONOMICS
• 10th: Society faces a short-run tradeoff
between inflation and unemployment
• year or two, many economic policies
push inflation and unemployment in
opposite directions.
• Common explanation says that this
arises because some prices are slow to
adjust.
60
 TEN PRINCIPLES OF ECONOMICS
• 10th: Society faces a short-run
tradeoff between inflation and
unemployment
• Thus, prices are said to be sticky in
the short run.
• And so, various types of government
policy have short-run effects that
differ from their long-run effects.
61
 TEN PRINCIPLES OF ECONOMICS
• 10th: Society faces a short-run
tradeoff between inflation and
unemployment
• When government reduces the
quantity of money,
– it reduces the amount that people
spend reducing the quantity of goods
and services firms sell. Lower sales, in
turn, cause firms to lay off workers. 62
 TEN PRINCIPLES OF ECONOMICS
• 10th: Society faces a short-run
tradeoff between inflation and
unemployment
• Thus, the reduction in the quantity of
money raises unemployment
temporarily until prices have fully
adjusted to the change.
• This tradeoff is only temporary, but it
can last for several years. 63
 TEN PRINCIPLES OF ECONOMICS
• 10th: Society faces a short-run
tradeoff between inflation and
unemployment
• Phillips curve helps us to understand
many developments in the economy
• By changing the amount that the
government spends, the amount it
taxes, and the amount of money it
64
 TEN PRINCIPLES OF ECONOMICS
• 10th: Society faces a short-run
tradeoff between inflation and
unemployment
• prints, policy makers can, in the
short run, influence both inflation
and unemployment that the
economy experiences.
65
Nature and scope of Economics: What is Economics?
• Economics is simply about how people
use their little resources we have to
satisfy our numerous needs/wants.
• It is also concerned with the way in
which a society chooses to employ its
scarce resources which have alternative
uses, for the production of goods for
present and future consumption.
• In defining economics, people relate the 66
 Nature and scope of Economics: Definitions
• subject to our many needs and scarce
resources.
• Among the important definitions of
economics are those by leading
economists like Adam Smith, Alfred
Marshall, Lionel Robbins and Samuelson.
• Adam Smith (1723-90) defined in his
famous book, “Wealth of Nations” (1776),
– “Economics is an inquiry into the nature and
causes of the wealth of nations”. 67
 Nature and scope of Economics: Definitions
• He was interested mainly in studying:
– the problems arising from wealth-getting,
wealth-using activities of people and the
ways by which the wealth of all nations
could be increased.
• In economics, wealth refers to those
goods which satisfy human wants.
• Air and sunlight satisfy human wants and
are essential for us but they are not
regarded as wealth. 68
Nature and scope of Economics: Definitions
• This is because they are abundant and
unlimited in supply.
• It is only those that are relatively scarce
and have money value that we consider.
• Alfred Marshall (1842-1924) wrote in
his book Principles of Economics (1890).
– “A study of mankind in the ordinary
business of life”
• To him, economics on one hand is a 69
 Nature and scope of Economics: Definitions
• study of wealth, and on the other and
more importantly, the study of man.
• Man was the centre of his study and so,
– Thus, how people get their income, how
they use it and how they make best use of
their resources.
• For Marshall, economics is about how
people try to increase the material
means of well-being or welfare.
• Hence, this material welfare definition. 70
 Nature and scope of Economics: Definitions
• In the book, “An Essay on the Nature and
significance of Economic Science” (1932),
Lionel Robbins defined economics as:
– “A science which studies human behaviour
as a relationship between ends and scarce
means which have alternative uses”.
• The definition of Robbins is based on the
following basic assumptions:
– Ends are various. The term “ends” mean
wants. Human wants are unlimited. 71
Nature and scope of Economics: Definitions
– Means are limited. Means like time, money
and resources are limited.
– We can put time and money to alternative
uses. We can use time for earning money or
we may enjoy it as leisure, and
– All wants are not of equal importance.
• The definition of Marshall classified
human behaviour into economic activity
and non-economic activity.
– It considered only those activities which 72
Nature and scope of Economics: Definitions
– promoted material welfare as economic
activity.
• But Robbins’ definition covers the whole
field.
– If there is scarcity of a thing in relation to
the demand for it, it becomes the subject–
matter of economics.
– That way, even the labour of those who
provide services (e.g. lawyers, doctors,
actors) are taken for study in economics. 73
Nature and scope of Economics: Definitions
• Another merit of Robbins’ definition is it
makes economics a scientific study.
– Ethical aspects of economic problems are
not taken into account in discussions.
– It does not try to establish a link between
economics and welfare.
– Some economists have criticized this view
arguing that if economics is a social
science, its aim should be the promotion
of human welfare. 74
Nature and scope of Economics: Definitions
• Paul Samuelson’s definition is known as
a modern definition of economics.
– “Economics is a social science concerned
chiefly with the way society chooses to
employ its resources, which have
alternative uses, to produce goods and
services for present and future
consumption”.
• Some aspects are similar to that of
Robbins. The difference is that: 75
Nature and scope of Economics: Definitions
– He went a step further to discuss how a
society uses limited resources for producing
goods and services for present and future
consumption of various people or groups.
• He also put economics into four main
divisions:
– consumption, production, exchange and
distribution.
• Samuelson also tells us that the society
may or may not make use of money. 76
 The economist as scientist
• Economics is regarded as a science
because it employs scientific approach
in its inquiry.
• The methods/procedures include:
– the observation of real world behaviour
and outcomes;
– Formulating hypothesis;
– Collection of data;
– Analysis of data collected; 77
 The economist as scientist
– Drawing conclusions from the analysis –
accepting rejection or modification of
hypothesis;
– Making generalizations.
• The role of assumptions:
– Like scientists, economists also make use of
assumptions. Can you mention some?
– Assumptions can make the world easier to
understand.
• The use of economic models: 78
 The economist as scientist
– Economists also use models to learn about
the world.
– But instead of being made of plastic, they
are most often composed of diagrams and
equations. E.g. PPF, circular flow diagram.
• So you see why it is said that economics
is a science?
• It is a social or soft science as it deals
with human beings whose behaviour is
erratic and sometimes unpredictable. 79
 The study of human behaviour
• As used by Robbins, human behaviour
refers to the activities of man to earn a
living.
– How man or society manages scarce
resources to satisfy the unlimited wants.
• Ends (Needs and wants) refers to the
many economic goods and services that
we derive satisfaction from.
• Means also are the resources we use to
achieve our ends. These include: 80
Relationship between Ends and Means
– Natural resources: Nature’s free gifts e.g.
land, forest, minerals, wind etc.
– Human resources: skilled and unskilled,
mental and physical. All HR, called labour.
– Man-made resources: Things made by
man for further production. E.g. machines,
tools, factories etc. Also known as capital.
– Entrepreneurship: Entrepreneurship is
human effort again. Entrepreneurs are the
risk takers. They are more than managers,
although they use managerial ability. 81
Relationship between Ends and Means
– Entrepreneurs reap the profits or bear the
losses of their undertakings.
• These resources collectively are called
factors of production or ‘factors’ for short.
– Entrepreneurship is the organizational force
that combines the other factors of production
— land, labour, and capital — and transforms
them into the desired output.
• The output may be capital or consumer
goods, but ultimately consumer goods
82
Relationship between Ends and Means
• are produced to satisfy wants.
• The relationship is that:
– Whereas our ends are unlimited, the
means or resources needed to satisfy
them are limited hence scarcity. goods,
but ultimately consumer goods

83
 Basic Economic Principles: Scarcity
• Scarcity is a relationship between how
much there is of something and how
much of it is wanted.
• Resources are scarce compared to all of
the uses we have for them.
• Scarcity means the limited nature of
society’s resources.
• Note that since our resources in the
world are not enough to satisfy our
needs, we say resources are scarce. 84
 Basic Economic Principles: Scarcity
– If resources were unlimited and we get
whatever we wanted,
– there will be no economic problem and
hence no economics.
– If we want to use more than there is of an
item, it is scarce.
• Every economic agent faces this
problem.

85
 Basic Economic Principles: Choice
• Scarcity forces choice. Choice is the act of
selecting from alternatives.
• Thus, ends we decided to satisfy:
– Because our needs are many and the
means to satisfy them are limited, we are
compelled to make choices.
• As a student, since your money cannot
pay for everything that you need, you
must decide on what should be done.
• The various economic agents face same. 86
 Scale of Preference
• Rank options according to a person’s
preference order.
• It is an orderly arrangement of our
wants with the most pressing appearing
first.
• Option 1 going to school.
• Option 2 going to cinema.
• Option 3 sleeping at home.
87
Basic Economic Principles: Alternative Uses
• As said, society is faces scarcity and thus
choices must be made about how those
resources will be used or allocated.
• Allocate means distribute. Society must
make choices among the alternatives.
• Society must decide: which goods will
be produced, how to allocate resources
to produce goods, and how to allocate
the goods among the population. 88
Basic Economic Principles: Alternative Uses
• The method used to decide how these
allocations will be made depends on the
kind of economic system the society has
chosen.
• It makes no difference whether the
problem is how government will use its
resources or how individuals or business
use theirs.
• In every case, resources are scarce, and
choices must be made. 89
Basic Economic Principles: Opp. Cost
• Because there are always alternative uses
of the resources and for the reason that
scarcity exists,
• society cannot produce all that it wants. It
must therefore choose among the
alternatives.
• Hence cost is imposed on society; economists
call this cost opportunity cost.
• It refers to the value of the forgone
alternative. Thus, what you gave up when 90
Basic Economic Principles: Opp. Cost
• you got something. When we satisfy one
need, we are not able to satisfy other
needs.
• This is where opportunity cost comes in.
Your government chooses more defense
spending and sacrifices human services.
• To get a precise value or measure of
opportunity cost, economists count the
sacrifice as that of the best available
alternative lost or forgone. 91
The Basic Problem of
Economics

92
 Present and Future Consumption
• Choice also imposes opportunity cost
over time.
• The use of resources now means that
those resources will not be available for
future use.
• A decision must be made, an opportunity
cost encountered, as to whether to
allocate for present needs or future needs.
• Thus, today versus tomorrow. Some
goods will be consumed today and 93
 Present and Future Consumption
• some in the future. By reducing consumption
today, future consumption may be
increased.
• Isn’t that one reason you are in school? If
you are not working full time, you are not
consuming all you could.
• You are postponing consumption. Why?
Because you believe you could get a
better job (and one with more pay) if you
have more training and education. 94
 Present and Future Consumption
• So you can consume even more later.
So you postpone current consumption
while building up your skills to increase
• consumption later. Again, a barrel of oil
pumped from the ground now is a
barrel of oil that will not be available for
consumption any day in the future.
• So to use the oil today imposes forgone
opportunities in the future. 95
 Why We Study Economics
General Reasons
• To gain a better understanding of
economic activities in our economy.
• To allocate resources efficiently.
• To decide how much to produce and
how much to charge for it.
• To make choices.
• To understand how markets work. 96
 Why We Study Economics
To The Individual
• To maximise satisfaction
• Manage productive resources
effectively
• Know the wisdom in saving
• Awareness of the interdependent
nature of human prosperity
97
 Why We Study Economics
To The Society
• To maximise satisfaction
• To maximise output
• Make predictions about the future
• For economic planning
• Complement other disciplines

98
 Is Time a Cost?
• Price of a mobile phone = GHC180
• Search = one day
• Income forgone while searching = GHC
4.2
• Opportunity cost of buying the mobile
phone is GHC 184.2

99
 Economic Goods and Free Goods
• An economic good is a good that
commands price.
• It is also a good that is produced from
scarce resources.
• They are desired (useful) but cannot be
obtained from nature to the extent
desired.
• A free good is a good that does not
command price.
• They are not scarce and can be obtained
100
 Economic Goods and Free Goods
• from nature in the quantities desired.
– Free goods mean that you could have all
you want of everything without having to
give up something else you also want.
• Can you think of goods that are not
scarce? There may be some, maybe air.
– Isn’t it free? What do you have to give up to
get air?
– In some locations, it probably is free.
– But, in other locations, it is not, especially if air
means clean air. 101
Production Possibilities Curve (PPC)
• Like individuals, a society as whole has
limited resources. It has to decide what to
produce with the limited resource.
• All such choices can be made with help of
PPC.
– A curve that shows all possible combinations
of the maximum amount of any two goods
or services that can be produced from a
fixed amount of resources.
• It separates outcomes that are possible 102
Production Possibilities Curve (PPC)
• for the society to produce from those
which cannot be produced subject to
the available resources.
• Also called the Production Possibilities
Frontier (PPF), Production Possibilities
boundary (PPB) or transformation curve.
• We arbitrarily represent the economy’s
output of capital goods (i.e. cocoa) on
the vertical axis and that of consumer
103
Production Possibilities Curve (PPC)
• goods (i.e. maize) on the horizontal axis.
Assumptions:
– Production over a specified time period – usually a
year;
– Resources are fixed over the time period. i.e. using
all human, natural, and manufactured resources to
maximum effect.
– Resources are used efficiently and technology is
constant.

• 104
Production Possibilities Curve (PPC)
• The data presented in a production
possibilities table are shown graphically
as a production possibilities curve.

105
 Production Possibilities Curve (PPC)
• Each point on the PPC represents some
maximum combination of two products
that can be produced if resources are fully
employed.
• When an economy is operating on the
curve, more food means fewer clothing,
and vice versa hence the negative slope.
• Limited resources and a fixed technology
make any combination of food and
clothing lying outside the curve (such as
106
 Production Possibilities Curve (PPC)
• at W ) unattainable. Points inside the
curve are attainable, but they indicate
that full employment is not being
realized.
• Points on the frontier are the preferred
ones.
• Now let us explain the concepts of
scarcity, choices as well as opportunity
cost from the PPC.
107
 PPC and the Concepts
• PPC and Scarcity:
– At a given point on the PPC, it is due to
limited resources impossible to increase the
production of both goods at the same time.
– Again point W which is outside the PPC
cannot to attained for resources are not
enough to produce at that level.
• PPC and Choice:
– Choice means selecting from a range. It can
select from U to D based on its needs.
108
 PPC and the Concepts
• PPC and Opportunity Cost:
– Implied by the downward /negative slope
of the PPC meaning that obtaining more
food requires less clothing.
– Remember also that, it defines the best
alternative forgone.
– Hence, producing 8m units of foods means
no clothing. Similarly, producing 7m units of
clothing means no food.
– Again point X the opportunity cost of
producing 4m units of clothing is 2m units109
 PPC and the Concepts
• (8 – 6)of food left unproduced. I guess
you understand the opportunity cost
idea using the PPC.
• With reference to figure 1.1, what is the
opportunity cost in each of the ff.:
– Production of 6m units of clothing?
– Production of 5m units of food?
– Production 7m units of food?
– Production of 3m units of clothing?
– Production of 2m units of food? 110
 Changes in the PPC
• The PPC can expand and it can contract.
Can you guess why?
• Expansion means more resources are
available to produce the two goods.
• We can get more resources for higher
production through various ways like:
– Improvement in technology;
– Discovery of new resources such as oil;
– Improvement in administration that lead to
efficiency. 111
 Changes in the PPC
– Foreign Aid e.g. technical assistance,
material assistance, or provision of capital.
– Better terms of trade;
– Increased regional trade;
– Increase in net investment.
• Contraction comes about due to the ff.:
– Careless exploitation of resources;
– Capital consumption without replacement
– Cut in Foreign Aid;
– Natural disaster and abnormal circumstances.
112
 Microeconomics
• The branch of economics which is
concerned with the study of various
economic units like individual consumers,
individual firms, and individual industries.
• Usually studies whether, why and to what
extent a consumer will alter his purchase
of a product following a price change.
• The goals of microeconomics are the

113
 Microeconomics
• Determination of prices and the
allocation of specific resources to
particular uses. For instance,
– the allocation of total production;
– why more of some things are produced
than others;
– who gets what quantity
• Thus, the overriding goal of
microeconomics is the efficient
allocation of scarce resources. 114
 Macroeconomics
• Studies the economy as a whole. It looks
at the economy from a national point of
view.
• It deals with aggregates, rather than parts.
• Concerns itself with such issues as
national income, inflation, unemployment
levels, government revenue, economic
growth etc.
115
 Macroeconomics
• The goals of macroeconomics are:
– Full employment; price stability; balance
of payments stability; economic growth.
• Whereas full employment, price
stability and balance of payments relate
to stability theory, economic growth
relates to growth theory.
• Though the two are different, they are
strongly connected. Thus, both fields 116
 Macroeconomics
• make use of:
– demand and supply analysis;
– knowledge in macroeconomics principles
helps in understanding the decision
making processes of individual economic
agents or units.
• Take for instance inflation which is
– The rate at which the general level of
prices increase or decrease over time.
• Notice that it is determined by individual
117
 Macroeconomics
• individual prices (under micro), an
understanding of how these prices
behave help understand the behaviour
of general prices (under macro).

118
 Objective Policy Analysis
• Good economic policy analysis is objective.
– It keeps the analyst’s value judgments
separate from the analysis.
– Objective analysis does not say, “This is
the way things should be”, reflecting a
goal established by the analyst.
• To make clear the distinction between
objective and subjective analysis,
economists have divided economics into 119
 Objective Policy Analysis
• two main categories namely:
– positive economics and;
– normative economics.
• Let us consider them in turns in the
slides that follow.

120
 Positive Economics
• Studies “what is”, and how the economy
works.
• It is concerned with “how economic
problems of society are solved”.
• It is devoid of value judgments or
subjective feelings.
– It can be proven to be “true” or “false” based
on observations of real-world behaviour.
• E.g. if the price of books goes up, we will
buy less”. 121
 Normative Economics
• Analysis containing whether explicitly or
implicitly, someone’s values.
• It studies “what ought to be” or “how
the economic problems of society
should be solved.
– Are opinions hardly to prove as “true/false”.
• E.g. If the price of books goes up, we
will buy less and therefore we should
not allow the price of books to go up. 122
Positive or normative economic statement?
a) “The price of oranges is too high”.
b) “Our government spends too much”.
c) “When people buy Ghanaian made products,
that helps preserve Ghanaian jobs”.
d) “Ghanaians should buy more Ghanaian-
made products”.
e) “Large profits in a market will encourage
more business people to enter that market”.
f) “Government involvement in the economy
should be kept to a minimum”. 123
Deductive Approach to the Study of Economics
• This is the traditional method of economic
analysis.
• Under this approach,
– Hypothesis (statement) is made and based
on the hypothesis, conclusions are drawn.
• No actual data is gathered on the issue.
• No actual facts are observed.
– E.g. Producers want to make the highest possible
profit and so if a producer charges a price, it is
assumed that he is making maximum profit.
124
Inductive Approach to the Study of Economics
• This is the empirical approach. Facts
and not logic or reasoning are used to
draw conclusions.
• Data is gathered on the issue and
analysed before predictions are made
about the future.

125
 Economic Activities
• Production: the actual creation of goods
and services.
– The production of a good or service is never
complete until it gets to the final consumer
• Distribution: the act of making produced
goods available to the consumer.
– Distribution is not an independent economic
activity by itself but a part of the production
process.
• Consumption: the act of making use of
what has been produced be it goods 126
 Economic Activities
• or services.
– It is not an economic activity in itself but is
necessary to justify production
Classification of activities
• Primary sector:
– All extractive activities
• Secondary sector:
– Processing activities
• Tertiary sector:
– Services 127
 Classification of activities
• Primary sector – all extractive
activities
• Secondary sector – processing
activities
• Tertiary sector - services

128
 Discussion Questions
1. The main economic problem facing
humankind is how to satisfy
unlimited wants with limited
resources. “ Explain this statement.
2. Why is scarcity the fundamental
problem in economics?

129
 Discussion Questions
3. Consider the production
possibilities for an entire nation.
Within any national economy there
are only two general kinds of
products which can be produced –
consumer products and capital
products. Consumer products (e.g.
food, clothes, medical services,
etc…) satisfy our wants directly130
 Discussion Questions
when we use them and while we
consume them. Capital products (e.g.
machines, and other plant and
equipment) satisfy our wants
indirectly and in the future because
they increase our productivity and
help us produce even more products
over time. Answer the following
questions based on the production131
 Discussion Questions
Possibilities of consumer and capital
products for a national economy
shown in the graph below.

132
 Discussion Questions
a) Which of the points on the graph
illustrates productive efficiency?
b) Which of the points on the graph
illustrates productive inefficiency?
c) Which of the points on the graph
represents a combination of
output which is currently
unobtainable?
133
 Discussion Questions
d) How does this production
possibilities curve show that this
nation is faced with scarcity?
e) Assume there is an increase in the
amount of resources (inputs), or
an increase in technology that this
nation has to work with,
i. what impact would this have on the
nation’s production possibilities
134
 Discussion Questions
i. and its production possibilities
curve?
ii. how is this related to economic
growth?
f) Between the production
possibilities A and B, which would
provide the greatest amount of
current satisfaction? Why?
g) What is the opportunity cost of135
 Discussion Questions
g) moving from point B to A?

136
 Quiz 1
• For each of the following, note whether the
statement is an example of positive
economic analysis or an example of
normative economic analysis:
1)An increase in the minimum wage will lead
to a higher rate of teenage unemployment:
……………………………
2)If the government reduces the tax on
tobacco, more individuals will start smoking:
……………………………………………. 137
 Quiz 1
3) The government should lower taxes
because tax rates are too high for the
average U.S. family: ………………………………
4) Wealthy senior citizens can afford to buy
their own health insurance and therefore
should not be given Medicare coverage:
……………………………………………………………..
5) If the price of apples increases, people will
buy more bananas: ………………………………..
138
 Quiz 1
Use the PPF below to answer the questions
that follow:

6)The opportunity cost of the second unit of

pizza is: ………………………………………………
7)The total opportunity cost of 7 units of
robots is: …………………………………………… 139
 Quiz 1
7) Production possibilities curve ABCDE is
bowed out from the origin because:
a. the marginal benefit of pizzas declines as more pizzas
are consumed.
b. the curve gets steeper as we move from E to A.
c. it reflects the law of increasing opportunity costs.
d. resources are scarce.
8) All points on this production possibilities
curve necessarily represent:
a. society’s optimal choice.
b. less than full use of resources.
c. unattainable levels of output.
d. full employment. 140
 Economic Systems
• Refers to the framework within which
economic activities are organized to solve
the central problems of an economy:
– what, how and for whom to produce.
• The economic system consists of various
individuals and their institutions like:
– banking institutions, educational institutions
and economic institutions.
• The most general economic systems are:
Traditional Economy; Capitalist 141
 Economic Systems
– Economy; Socialist Economy and; Mixed
Economy.
Traditional Economy
•Here the basic problems are solved by
traditions and custom rules every aspect
of behaviour.
•It produces exactly to its consumption
requirements. It is a subsistence
economy. 142
 Economic Systems
• There is not much of sales as there is
only small scale production.
• The same product will be produced by
every generation.
• The production techniques are
traditional.

143
 Capitalist Economy
• A system in which the production and
distribution of commodities take place
through the mechanism of free markets.
• Hence it is also called the market economy
or free trade economy.
– Each individual be it a producer, consumer
or resource owner has considerable
economic freedom.
• The salient features of capitalism are:
– Right to Private Property; Profit-Motive; 144
 Capitalist Economy
– Freedom of Choice; minimal role of
government; and consumer sovereignty.
Merits of Capitalist Economy
•Increase in productivity:
– In a capitalist economy every farmer, trader
or industrialist can hold property and use it
in any way he likes. He increases the
productivity to meet his own self-interest.
• Maximizes Individual Welfare:
– It is claimed that there is efficiency in
145
 Capitalist Economy
– production and resource use. The self-
interest of individual also promotes
society’s welfare.
– “. . . It is not from the benevolence of the
butcher, the brewer, or the baker that we expect
our dinner, but from their regard to their own
interest. . . .” (Smith, 1776).
• Flexible System:
– It operates automatically through the price
mechanism as shortages and surpluses in
the economy are adjusted by the forces of
demand and supply. 146
 Capitalist Economy
• Non-interference of the State:
– The State has a minimum role to play. No
conflict between the individual interest and the
society.
– The economic institutions function
automatically preventing the interference of the
government.
• Technological improvement:
– The element of competition under capitalism
drives the producers to innovate something new
to boost the sales and thereby bring about
progress. 147
 Disadvantages of Capitalist Economy
• Inequalities:
– Capitalism creates extreme inequalities in
income and wealth. Capitalism widens the
gap between the rich and the poor creating
inequality.
• Leads to Monopoly:
– Inequality leads to monopoly. Firms
combine to form cartels, trusts and in this
process bring about reduction in number of
firms engaged in production and often hike
prices. 148
 Disadvantages of Capitalist Economy
• Social Welfare is ignored:
– Private enterprises produce luxury goods
which give higher profits and ignore the
basic goods required which give less profit.
Thus the welfare of public is ignored.
• Exploitation of Labour:
– Stringent labour laws enacted for the
exclusive profit-motive of capitalists help to
exploit the labour by keeping their wage rate
at its lowest minimum. Fire and hire policy
become the order of the day. 149
 Socialist Economy
• The means of production are owned
and operated by the State.
• All decisions regarding production and
distribution are taken by the central
planning authority.
• Hence the socialist economy is also
called planned or command economy.
– The government plays an active role Social
welfare is given importance; hence equal
opportunity is given to all. 150
 Socialist Economy
• Some of the most successful socialist
economies are China, Cuba, Vietnam,
Libya and North Korea.
• The following are the basic features of
socialism.
– Social welfare motive; limited right to
private property; central planning and; no
market forces.
• Merits of Socialist Economy
– Efficient use of resources: The resources are
utilized efficiently to produce socially 151
 Socialist Economy
– useful goods without taking the profit
margin into account.
• Economic Stability:
– There is stability because the production and
consumption of goods and services are well
regulated. Government plans well to avoid
over-production or unemployment.
• Maximization of Social Welfare:
– All citizens work for the welfare of the State.
Everybody receives his or her remuneration.
Basic necessities produced. 152
 Socialist Economy
• Absence of Monopoly:
–The state is a monopoly but produces
quality goods at reasonable price.
• Equitable distribution of resources/
incomes:
– The basis of socialist planning is equity in
welfare. Government provide services
available to the masses.
– People on low incomes benefit from
public housing, and state provide services.
153
 Demerits of Socialism
• Bureaucratic Expansion:
– People here work out of fear of higher
authorities. It does not give any initiative for
the people to work hard.
• No Freedom:
– Consumer’s choice is very limited. There is
no freedom of occupation. Jobs are provided
by the State. Place of work is also provided
by the State.
• Absence of competition: This makes the
154
 Demerits of Socialism
• system inefficient.
• Absence of Technology:
– Work is monotonous and no freedom is given.
– Any change in the production process will
alter the entire plan.
– Hence any innovation cannot be easily
enforced.
– Everything is rigid and technological changes
are limited.
155
 Mixed Economy
• Both public and private institutions
exercise economic control.
• The public sector functions as a
socialistic economy and the private
sector as a free enterprise economy.
• A mixed economy possesses the
freedom to hold private property, to
earn profit, to consume, produce and
distribute and to have any occupation.
156
 Mixed Economy
• But if these freedoms affect public
welfare adversely, they are regulated
and controlled by the State.
• The main features of mixed economic
system are:
– Co-existence of public and private sectors;
consolidation of merits of capitalism and
socialism and; economic planning is
another important feature of the mixed
economy. 157
 Merits of Mixed Economy
• Efficient resource utilisation:
– The resources are utilized efficiently as
good features of both capitalism and
socialism coexist.
–If there is misallocation of resources,
the State controls and regulates it.
–This ensures the efficient utilization of
resources.
158
 Merits of Mixed Economy
• Prices are administered:
– The prices are not fixed always by forces
of demand and supply.
– In the case of goods which are scarce, the
prices are administered by the
government and such goods are also
rationed.

159
 Merits of Mixed Economy
• Social Welfare:
– In a mixed economy, planning is
centralized and there is overall welfare.
– Workers are given incentives and reward
for any innovations.
– There is social security provided to the
workers.
– Inequalities of income and wealth are
reduced.
160
 Demerits of Mixed Economy
• Lack of coordination:
– The coordination between the public and
private sectors is poor in a mixed
economy. Public sector spends huge
public resources for infrastructure.
– The private sector aims at profit
maximization by using the infrastructure
created by the public sector.
– They lack social responsibility and fail to
spend for public courses like health, etc.
161
 Demerits of Mixed Economy
• Red–tapism and delay by Public Sector:
– There is every chance that the public
sector works inefficiently.
– There is too much of red-tapism (strict
adherence to official formalities) and
corruption leading to delays in decision-
making and project implementation.
– They result in inefficiency and also affect
production.
162
 Demerits of Mixed Economy
• Economic Fluctuations:
– The mixed economies experience
economic fluctuations.
– While the private sector does not operate
under very rigid conditions prescribed by
the government,
– The public sector too does not operate
under very rigid conditions enforced by the
planned economy.
– This results in economic fluctuations. 163
The Concept of Price Determination
• Price may be determined under free
market conditions or regulated market
conditions.
• Under free market conditions, the
government does not interfere with the
process of arriving at prices.
• Buyers and sellers meet and depending
on the relative strengths of DD and SS,
prices are arrived at (“invisible hand”).
164
The Concept of Price Determination
• Under regulated market conditions,
prices are fixed for various goods and
services by the state.
• No matter the strengths of DD and SS,
those prices must be complied with and
it is illegal to sell at a higher or lower
price.
• This can be in the form of maximum or
minimum price legislations. 165
 The Price Mechanism
• The price mechanism refers to the free
interplay of forces of demand and supply.
• It is one of the means by which scarce
goods are distributed among consumers.
• It is also a means by which prices for these
goods are determined.
• The price mechanism is thus defined as:
– the process by which the allocation of

166
 The Price Mechanism
– productive resources, distribution of
goods and services, and the
determination of prices are done by the
forces of demand and supply.
• Thus, it is an invisible force that helps to
allocate scarce resources or factors of
production.

167
Advantages of the Price Mechanism
• It is cost effective:
– Prices find their own level without
government setting up bodies to do so
• It is an effective way of distributing
scarce goods and services among
consumers:
– goods are displayed for who ever can buy.
• It also allocates scarce productive
resources among producers:
– consumer purchases are like votes that 168
Advantages of the Price Mechanism
– send signal to producers.
• It decides who should perform
entrepreneurial functions:
– those who can afford factors of production
• Private profits made by efficient
entrepreneurs encourage efficient
allocation and use of resources
• It guarantees consumer sovereignty:
169
Advantages of the Price Mechanism
– the consumer is free to buy whatever
s/he desires to buy in quantities s/he
prefers and whenever s/he desires as
long as s/he has the purchasing power.

170
 Disadvantages of Price
Mechanism
• The system always favours the rich to
the disadvantage of the poor.
• Since it follows demand, some
industries may shrink or collapse due to
a change in demand leading to
structural unemployment.
• Does not favour the production of
public goods.
• Leads to gross inequalities in income 171
 Disadvantages of Price
Mechanism
• distribution.
• Could lead to the production of goods
and services that are not in the interest of
society.
• The system promotes private profits and
not social benefits:
– producers may destroy the environment to
make more profits.
• It is not suitable for making structural
changes that would ensure sustained 172
 Disadvantages of Price
Mechanism
• economic growth:
– producers will only consider activities that
will give them immediate profits and not
think about the long-term benefit to
society.
• It functions well only under perfect
competition where there is a perfect
knowledge of the market by both
producers and consumers and where
there is freedom of exit and entry.
173
 Disadvantages of Price
Mechanism
• The system does not lead to national
income maximisation but individual
profit maximisation.

174
 Functions of the Price System
• The market system, performs two
important and closely related functions:
– Resource allocation: the market system
determines the allocation of resources
among produces and the final mix of
outputs.
– Price rationing: the market system
distributes goods and services on the basis
of willingness and ability to pay.
• It uses the mechanism of prices to effect
changes in resource use. 175
 Functions of the Price System
• It (through the price mechanism) solves
the problem of resource allocation.
• Resource allocation involves answering
the three basic questions of what, how
and for whom goods and services will
be produced.

176
 What is to be produced?
• This question is answered by the price
system through the incentives generated
in the system.
• The foremost incentive in this system is
profit.
• The search for higher profits causes
decision-makers to produce a mix of
goods whose total effective demand is
the greatest relative to the scarce
resources available for the production
177
 What is to be produced?
• of all goods and services.
• Resources are thus moved from lower-
value to high-value uses.
• This movement depends on consumer
sovereignty which means that
– consumers are the ultimate determiners
of how much of what to produce.

178
 What is to be produced?
• One of the advantages of allocating
resources through the price system is
that resources will be put to their most
valued use.
• This efficiency can also be linked to
consumer sovereignty.
• There are two types of efficiency
– Technical Efficiency and;
– Economic Efficiency. 179
 What is to be produced?
• Technical efficiency:
– means that resources will never be
wasted in producing a given output.
• Economic efficiency:
– means that resources will be used in their
highest-valued uses.
– thus, maximizing the total subjective
valuation (Utility).
180
 How will Goods be Produced?
• This relates to the efficient use of scarce
resources. i.e. Organising Production.
• The price system ensures that at all times,
the least-cost combination of factors of
production are used to produce a given
output.
• The price system achieves this through
the competition that exist between firms
or producers in the system. 181
 How will Goods be Produced?
• The assumption here is that technology
and resource prices are held constant.
• Producers must decide on the methods
or technique of production. It can either
be labour intensive or capital intensive.
– Labour intensive: Using a lot of workers
and relatively little capital equipment.
– Capital intensive: the use of few workers
and a great deal of capital equipment.182
 For Whom to Produce?
• This refers to how total output is
distributed among competing claimants.
– the distribution of total output.
• The problem of distribution can be
separated into two parts:
– one relating to the distribution of products
to consumers and;
– the other relating to the distribution of
money income to individuals.
183
 For Whom to Produce?
• The distribution of products to
consumers is based on ability and
willingness to pay the market price.
• Meanwhile, the ability of the consumer
to pay is dependent on their money
income.
• The money income depends on the
quantities, qualities and types of
resources (both human and non-human)
– the person owns and can supply to the 184
 For Whom to Produce?
– market.
• A perfectly performing price-system
may not provide equality in income.

185
 Evaluating the Price System
What it can do What it cannot do
• Promotes Efficiency both • Check externalities
technical and economic
• Produce public goods and
• Guarantees individual does a poor job of
freedom: producing merit goods
• – i.e. people can further • Thrives only on
their self-interest competition
• Ensures growth: • Leads to unequal
• – increase is the productive distribution of income
capacity of a nation • Survives only where there
is factor mobility
186
 Results of the Evaluation
• The price systems seems to be able to
satisfy some social problems but at the
same time, it cannot satisfy numerous
others.
• That not withstanding, it is a system
that can be blended with other systems
to ensure the survival of society
especially in the face of scarce
resources. 187
 Demand, Supply and Price
Demand:
•The willingness and ability to purchase a
particular good or service.
•It can also be defined as:
– the quantity of a good that consumers are
able and willing to buy in a market at a
given price during a specified period of
time, ceteris paribus (other things being
equal).
AD 2014 188
 The Theory of Demand
• The theory of demand holds that other
things equal, as the price of a good or
service rises, its quantity demanded
falls.
– The reverse is also true: as the price of a
good or service falls, its quantity
demanded increases.
• In simple terms, the theory of demand
is that:
– At higher prices, a lower quantity of a
good will be demanded and at lower
189
 The Theory of Demand
– prices, a higher quantity of a good will be
demanded. other things being equal.

AD 2014 190
 Other things being equal
• The ceteris paribus assumption is
stated any time we state the theory of
demand, because we are assuming
that ‘other things are held constant’.
• This is necessary because price is not
the only thing that affects purchases.
• There are many others:
– one for example is income.
AD 2014 191
 Other things being equal
• If, while the price of a good is changing,
income is also changing, then we would
not know the change in the quantity
demanded was due to a change in the
price or to a change in income.
• Therefore we hold income constant, as
well as any other factor that might affect
the quantity of the product demanded.
AD 2014 192
 Relative Prices
• The relative price of any item is its price
compared to the price of other goods,
or relative to a (weighted) average of all
other prices in the economy.
• The prices that we pay in cedis for any
good or service at any point in time are
called absolute, or nominal, prices.

AD 2014 193
 Relative Prices
• Consumer-buying decisions, however,
depend on relative, not absolute prices.
• Making this distinction between
absolute and relative price enables us
to avoid a possible confusion about the
meaning of price (increases) during a
period of generally rising prices.

AD 2014 194
 Reasons for the inverse relationship
between price and quantity demanded
• There are two fundamental reasons that
explain why the quantity demanded of a
good is inversely related to its price,
other things being equal. These are:
– The Substitution Effect
– The Income Effect
• Sometimes, a third reason is added and
that is:
– The Law of Diminishing Marginal Utility
195
 Substitution Effect
• Society has several goods, not exactly
the same, or perhaps even very
different from one another, but all
serving basically the same purpose.
• If the price of one particular good falls,
we most likely will substitute in favour
of the lower-priced good and against
the other similar goods we might have
been purchasing. 196
 Substitution Effect
• Conversely, if the price of that good
rises relative to the price of the other
similar goods, we will substitute in
favour of them and not buy as much of
the high-priced good.

197
 Real Income Effect
• This is the effect of the changes in price
on our purchasing power.
• If the price of something that you buy
goes up while your money income and
other prices stay the same, then your
ability to purchase goods in general
goes down.
• That is to say, your effective purchasing
power is reduced even though your 198
 Real Income Effect
• money income has stayed the same.
• It would be impossible to purchase as
much of the high-priced good (as you
• used to do at the lower price) and still
purchase the same quantity of all other
• goods and services that you were
purchasing.
• You are poorer, and hence you can buy
less of a number of things, including the
good whose price rose and vice-versa. 199
 The Demand Schedule
• A demand schedule is a table relating
prices to the quantity demanded at
each price.
• It is a set of planned purchasing rates
that depends on the price of the
product.
• It provides the co­ordinates of points
needed to plot the demand curve.

200
The Demand Schedule

AD 2014 201
Individual Demand and Market Demand
• The demand curve has a negative slope,
consistent with the theory of demand.
• Individual demand is the demand of an
individual consumer.
• Market demand is the sum of all the
individual demands of consumers in the
market.
• The market demand traces the
relationship between the price of a good
and the quantity that all 202
Individual Demand and Market Demand
• consumers in the market are prepared
to buy.
• In most markets there are many
consumers, sometimes millions.
• Thus, demand for a good or service can
be defined for an individual household,
or for a group of households that make
up a market.
203
 From Household
Demand to Market Demand
• Assuming there are only two households in
the market, market demand is derived as
follows:

204 of 48
 Determinants of Demand
• Demand is generally influenced by
factors that can be grouped into two
broad categories:
– Price determinant; which is the price of
the good or commodity in question, and
• Non-price determinants; which are
factors other than the price of the good
in question.
– Consumer income; the prices of related
goods; consumer tastes and preferences;
changes in expectations of future relative
prices; the number of consumers in the 205
 Determinants of Demand
– in the market (population); season of the
year; culture and religion; cost of
financing the purchase of very expensive
consumer goods.

206
 Change in Quantity Demanded and
Change in Demand
• Change in quantity demand is a
movement along the demand curve
often caused by changes in the price of
the commodity in question.
• Change in demand is a shift in the
demand curve often cause a change in
any of the non-price determinants of
demand. 207
 Change in Quantity Demanded and
Change in Demand
• If demand increases, the demand curve
shifts outward to the right.
• If demand decreases, the demand curve
shifts inward to the left.

208
 Shift of Demand Versus
Movement Along a Demand Curve

• A change in demand is not

the same as a change in
quantity demanded.
• A higher price causes lower
quantity demanded and a
move along the demand
curve DA.
• Changes in determinants of
demand, other than price,
cause a change in demand,
or a shift of the entire
209 of 48
demand curve, from DA to DB.
 A Change in Demand Versus
a Change in Quantity Demanded
To summarize:
Change in price of a good or service
leads to

Change in quantity demanded

(Movement along the curve).

Change in income, preferences, or

prices of other goods or services
leads to

Change in demand
210 of 48
(Shift of curve).
 The Impact of a Change in Income
• Higher income • Higher income
decreases the increases the
demand for an demand for a
inferior good normal good

211 of 48
 The Impact of a Change
in the Price of Related Goods
• Demand for
complement
good
(ketchup)
shifts left

• Demand for
substitute
good
(chicken)
• Price of hamburger rises shifts right
• Quantity of hamburger
demanded per month falls
212 of 48
 The Theory of Supply
• The theory of supply holds that other
things equal, as the price of a good
rises, its quantity supplied will rise,
and vice versa.
• Simply put, “at higher prices, a larger
quantity will generally be supplied
than at lower prices, ceteris paribus”
AD 2014 213
 The Theory of Supply
• Why do producers produce more
output when prices rise?
–They seek higher profits
–They can cover higher marginal
costs of production

AD 2014 214
Why a Direct or Positive Relationship?
• Producers offer more goods for sale
when prices are higher for two
reasons.
• The first has to do with a willingness
to offer more for sale at a higher
price than at a lower price (i.e.
incentives for increasing
production).
AD 2014 215
Why a Direct or Positive Relationship?

• A second reason has to do

with the increased ability to
supply the good at the higher
prices (i.e. the theory of
increasing costs).

AD 2014 216
 The Supply Schedule
• A supply schedule is a table relating
prices to the quantity supplied at each
price.
• It is a set of planned production rates
that depends on the price of the product.
• It provides the co-ordinates of points
needed to plot the supply curve.

AD 2014 217
Supply Curve

AD 2014 218
 Supply Curve
• The supply curve shows the
quantity of a well-defined good
supplied at various prices. It has a
positive slope, consistent with
the theory of supply.

AD 2014 219
 The Determinants of Supply
• The supply curve is drawn under the assumption that no changes
occur in other factors that can change supply. Such factors
include:
• the state of technology
• the price of resources (inputs) used to produce the product
• the prices of related goods
• taxes and subsidies
• price expectations of producers
• the number of producers.
• supply conditions - e.g. weather conditions in the case of
agricultural goods; quota restrictions when a government
imposes production limits.
• These are the non-price determinants of supply. If any of them
changes, there will be a shift in the supply curve.

AD 2014 220
 Changes in Supply
• A change in the price of the good itself will
cause a movement along the supply curve.
Thus if the price of a good changes, its supply
curve will not change and therefore will not
shift.
• It is only when there is a change in the non-
price determinants of supply that the entire
curve will shift.
• Thus a shift in the supply curve can be caused
by any, or combination of changes in the non-
price determinants of supply.

AD 2014 221
 Shift of Supply Versus
Movement Along a Supply Curve
• A higher price causes
higher quantity
supplied, and a
move along the
demand curve.
• A change in determinants
of supply other than price
causes an increase in
supply, or a shift of the
entire supply curve, from
SA to SB.
222 of 48
 Shift of Supply Curve for Soybeans
Following Development of a New Seed Strain

• In this example, since the

factor affecting supply is not
the price of soybeans but a
technological change in
soybean production, there is
a shift of the supply curve
rather than a movement
along the supply curve.

• The technological advance means that

more output can be supplied for at any
given price level.
223 of 48
 Shift of Supply Versus
Movement Along a Supply Curve
To summarize:
Change in price of a good or service
leads to

Change in quantity supplied

(Movement along the curve).
Change in costs, input prices, technology, or prices of
related goods and services
leads to

Change in supply
(Shift of curve).
224 of 48
 From Individual
Supply to Market Supply
• The supply of a good or service can be
defined for an individual firm, or for a
group of firms that make up a market
or an industry.
• Market supply is the sum of all the
quantities of a good or service supplied
per period by all the firms selling in the
market for that good or service.
225 of 48
 From Individual
Supply to Market Supply
• As with market demand, market
supply is the horizontal summation of
individual firms’ supply curves.

226 of 48
 Equilibrium
• In economics, equilibrium is the
condition that exists when quantity
supplied and quantity demanded are
equal.
• At equilibrium, there is no tendency for
the market price to change.
• Any time demand and supply come
together, a market is established.
• Therefore if demand equates supply,
AD 2014 227
 Market Equilibrium
• we say that the market is in equilibrium
and the market just clears.
• Only in equilibrium is
quantity supplied
equal to quantity
demanded.
• At any price level
other than P0, such
as P1, quantity
supplied does not
AD 2014
equal quantity 228
Market Equilibrium

AD 2014 229
 Equilibrium

Equilibrium occurs when

quantity demanded is equal to
quantity supplied and this
occurs at a price of $3 and a
quantity of 30 units.

AD 2014 230
 Excess Demand
• Excess demand, or
shortage, is the
condition that exists
when quantity
demanded exceeds
quantity supplied at the
current price.

• When quantity
demanded exceeds
quantity supplied,
price tends to rise
until equilibrium is
231 of 48
restored.
 Excess Supply
• Excess supply, or surplus,
is the condition that exists
when quantity supplied
exceeds quantity demanded
at the current price.

• When quantity supplied

exceeds quantity
demanded, price tends
to fall until equilibrium
232 of 48
is restored.
 Changes in Equilibrium (Increase):
Equilibrium after DD & SS Shifts

• Higher demand leads to higher • Higher supply leads to lower

equilibrium price and higher equilibrium price and higher
equilibrium quantity. equilibrium quantity.
233 of 48
 Changes in Equilibrium
(Decrease): Equilibrium after DD &
SS Shifts

• Lower demand leads to lower • Lower supply leads to

price and lower quantity higher price and lower
exchanged. quantity exchanged.
234 of 48
 Relative Magnitudes of Change

• The relative magnitudes of change in supply and demand

determine the outcome of market equilibrium.
235 of 48
 Relative Magnitudes of Change

• When supply and demand both increase, quantity

will increase, but price may go up or down.
236 of 48
 Examples 1
• With diagrams and specific examples,
explain the effects of
1)An increase in the price of commodity M
on the quantity demanded and price of
commodity N where M and N are
complements.
2)A decrease in the price of commodity A
on the quantity demanded and price of
commodity B where A and B are
substitutes. AD 2014 237
 Example 2
Using supply and demand analysis (and providing
appropriate diagrams to support your answer),
explain the effect of each of the following on the
equilibrium price and quantity traded in Commodity X.
•The publication of reports in the newspaper that the
consumption of commodity X is harmful to human
health.
•The taste of consumers of commodity X rise.
Consumers expect the price of commodity X to fall

in the future.
•The price of raw materials used to produce
commodity X has been reduced.
•A technological improvement reduces the cost of
producing compact disc players.
 Example 3
• Consider the effects of each of the
events listed in the table below on the
market indicated.
• Indicate by placing a (+), (-), or (0) under
the appropriate heading whether there
will be an increase, decrease, or no
change in demand (D), supply (S),
equilibrium price (P), and quantity traded
(Q):
• Refer to the Table below.
 Market Event D S P Q

Compact Disc A technological improvement reduces the cost

of producing compact disc players
Butter Medical evidence suggests that margarine
causes Migraines
Video rentals Movie theatres halve their admission prices

Newspapers Because of worldwide shortages, the price of

paper increases dramatically
TV Sets A technological improvement reduces the cost
of producing television sets
Road The cost of airline ticket between Sunyani and
Transportation Accra is reduced 50%.
Air The price of an airline ticket decreases 20%.
transportation
Air The income of households in Sunyani and Accra
transportation increases 20%.
 Consumer Surplus
• Consumer surplus is the difference
between the maximum amount a
person is willing to pay for a good and
its current market price.

241 of 42
 Consumer Surplus
• Some consumers
are willing to pay
as much as $5
each for
hamburgers.
• Since the price is
only $2.50, they
receive a
consumer surplus
of $2.50.
242 of 42
 Consumer Surplus
• Others are willing
to pay something
less than $5.00 but
more than $2.50.
• Consumer surplus
is the area below
the demand curve
and above the
price level.
243 of 42
 Producer Surplus
• Producer surplus is the difference
between the maximum amount a
producer is willing to accept to supply
a good and its current market price.

244 of 42
 Producer Surplus
• Some producers
are willing to
accept as little as
75 cents each for
hamburgers.
• Since the price is
$2.50, they receive
a producer surplus
of $1.75 per
hamburger.
245 of 42
 Producer Surplus
• Others producers
are willing to
receive something
less than $5.00 but
higher than 75
cents.
• Producer surplus is
the area above the
supply curve and
below the price
level.
246 of 42
 Markets Maximize the Sum of
Producer and Consumer Surplus
• Total producer and
consumer surplus is
highest where supply
and demand curves
intersect at equilibrium.
• Consumers receive
benefits in excess of
what they pay and
producers receive
compensation in excess
247 of 42 of costs.
 Markets Maximize the Sum of
Producer and Consumer Surplus
• If the market produces
too little, say 4 million
instead of 7 million
hamburgers per
month, total producer
and consumer surplus
is reduced. This
reduction (triangle
ABC) is called a
deadweight loss.
248 of 42
Potential Causes of Deadweight Loss
From Under- and Overproduction
• Deadweight losses can
occur from under- and
overproduction.
• If the market produces
10 million instead of 7
million hamburgers per
month, the cost of
production rises above
the willingness of
consumers to pay,
resulting in a
249 of 42 deadweight loss.
 Price Control and Rationing
• Maximum Price legislation (price
ceiling):
– a price fixed by the government usually
below the equilibrium market price above
which it is illegal to sell or buy the
commodity.
• Minimum Price legislation (price floors):
– a price fixed by the government usually above
the equilibrium price below which it is illegal to
sell or buy the commodity.
250
 Price Control and Rationing
• Reasons for Maximum Price legislation:
– the gov’t may consider to be too high.
– to reduce the supply of certain commodities
and its consumption.
– ensure equal distribution of scarce goods
whose prices are rising at a higher rate.
• Reasons for Minimum Price legislation:
– Ensure a better standard of living, so gov’t
fixes the price for labour for higher wages.
– encourage and increase the production of
certain commodities. 251
A Price Ceiling
 Price Control and Rationing
• Queuing: is a nonprice rationing system
that uses waiting in line as a means of
distributing goods and services.
• Favored customers: are those who
receive special treatment from dealers
during situations when there is excess
demand.
• Ration coupons: are tickets or coupons
that entitle individuals to buy a certain
amount of a given product per month. 253
 Price Control and Rationing
• Attempts to restrict prices often result
in the evolution of a black market.
• A black market is a market in which
illegal trading takes place at market-
determined prices.
• The problem with rationing systems is
that excess demand is created but not
eliminated.
254
Price Floor
 Price Floor
• The result of setting a price floor will be
excess supply, or higher quantity
supplied than quantity demanded.
• The most common example of a price
floor is the minimum wage, which is a
floor set under the price of labour.

256 of 42
 Elasticity
• Elasticity is a general concept that can be
used to quantify the response in one
variable when another variable changes.
• It is the responsiveness of one variable to
changes in another.
• When price rises or income falls, what
happens to demand? Demand falls
• BUT! How much does demand fall?
257 of 42
 Elasticity
• If price rises by 10%, income falls by 5% or
the price of another goods increases by
2% - what happens to demand?
• We know demand will fall if price rises or
if income falls.
• We also know that if the price of another
good (a complement or a substitute)
increases, demand for our good may fall
or increase.
258 of 42
 Elasticity
• The question is, by what percentage?
• By more than 10%? By less than 10%?
• Elasticity measures the extent to which
demand will change or respond to
changes in prices, or income.
• NB: if demand is responding to changes in
price, we talk of “price elasticity of
demand”; if on the other hand, demand is
responding to changes in Income, we talk
of “income
259 of 42
 Elasticity
• elasticity of demand” and if demand is
responding to changes in the price of
other goods, we talk of “cross
elasticity of demand”.
• There are four basic types:
– Price elasticity of demand;
– Income elasticity of demand;
– Cross elasticity;
– Price elasticity of supply.
260 of 42
 Price Elasticity of Demand
• A popular measure of elasticity is price
elasticity of demand measures how
responsive consumers are to changes
in the price of a product.
% c h a n g e in q u a n tity d e m a n d e d
p ric e e la s tic ity o f d e m a n d 
% c h a n g e in p ric e

• The value of demand elasticity is

always negative, but it is stated in
absolute terms.
261 of 42
 Slope and Elasticity
• The value of the slope of the demand
curve and the value of elasticity are not
the same.
• Unlike the value of the slope, the value
of elasticity is a useful measure of
responsiveness.

262 of 42
 Slope and Elasticity

23 1 23 1
slope   slope  
10  5 5 160  80 80

• Changing the units of measure yields a very different value

of the slope, yet the behavior of buyers in both diagrams is
identical.
263 of 42
 Types of Elasticity
Hypothetical Demand Elasticities for Four Products
% CHANGE % CHANGE IN
IN PRICE QUANTITY DEMANDED ELASTICITY
PRODUCT (%P) (%QD) (%QD  %P)
Insulin +10% 0% 0.0 Perfectly inelastic
Basic telephone service +10% -1% -0.1 Inelastic
Beef +10% -10% -1.0 Unitarily elastic
Bananas +10% -30% -3.0 Elastic

Where % change in demand is greater than %

change in price (PED > 1) – demand is elastic
Where % change in demand is less than % change
in price (PED < 1) – demand is inelastic
Where % change in demand is equal to change in
price (PED = 1) – demand is unitary elastic
264 of 42
 Perfectly Elastic and
Perfectly Inelastic Demand Curves

• When demand does not • Demand is perfectly elastic

respond at all to a change when quantity demanded
in price, demand is drops to zero at the slightest
perfectly inelastic. increase in price.
265 of 42
 Calculating Elasticities (Point)
• Calculating percentage changes:

P2  P1
% c h a n g e in p ric e  x 100%
P1

Q2  Q
% c h a n g e in q u a n tity d e m a n d e d  1
x 100%
Q1

266 of 42
 Calculating Elasticities
• Elasticity is a ratio of
percentages.
• Using the values on
the graph to compute
elasticity, using
percentage changes
yields the following
result:
Ped = -50%/+50% = 1
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 Numerical Example 1
1) A manufacturer has found that the
demand for the product is 7100 units
at a price of GH¢6.00 per unit and
6800 units at a price of GH¢7.00 per
unit. Calculate the price elasticity of
demand.
2) The sales price of existing single-
family homes in Sunyani was GH
¢127,100 in March, and at this
268 of 42
 Numerical Example 1
• price 4,890,000 homes were bought.
• One month later, the price of the single-
family homes had increased to GH
¢128,200 and as a result, 4,770,000
homes were bought.
• Calculate the own price elasticity of
demand for single-family homes in
Sunyani using both the point and arc
approaches.
269 of 42
 Numerical Example 2
• For each of the following, calculate and
interpret the coefficient of price elasticity
of demand.
1)Suppose that a 2 percent decline in the
price of cut flowers results in a 4 percent
increase in quantity demanded.
2)Suppose that a 2 percent decline in the
price of coffee leads to only a 1 percent
increase in quantity demanded.
270 of 42
 Numerical Example 2
3) Suppose that a 2 percent drop in the
price of chocolate causes a 2 percent
increase in quantity demanded.
4) Suppose that a 2 percent decline in
the price of coffee leads to only a 1
percent increase in quantity
demanded.

271 of 42
 Calculating Elasticities

Q2  Q1
x 100%
% Qd (Q 1  Q 2 ) / 2

% P P2  P1
x 100%
272 of 42
( P1  P2 ) / 2
 Calculating Elasticities
Here is how to interpret two different
values of elasticity:
• When p = 0.2, a 10% increase in price
leads to a 2% decrease in quantity
demanded.
• When p = 2.0, a 10% increase in price
leads to a 20% decrease in quantity
demanded.
273 of 42
 Elasticity Changes along a
Straight-Line Demand Curve
• Price elasticity of
demand decreases as
we move downward
along a straight line
demand curve.
• Demand is elastic in
the upper range and
inelastic in the lower
range of the line.
274 of 42
 Elasticity Changes along a
Straight-Line Demand Curve
 6.4 • Along the elastic
range, elasticity values
are greater than one.

 .29 • Along the inelastic

range, elasticity
values are less than
one.

275 of 42
 Elasticity and Total Revenue
TR = P ×Q
Effect of an
Change in quantity increase in Effect of a
Type of versus change in price on total decrease in price
demand Value of Ed price revenue on total revenue
Elastic Greater Larger percentage Total revenue Total revenue
than 1.0 change in quantity decreases increases
Inelastic Less than Smaller percentage Total revenue Total revenue
1.0 change in quantity increases decreases
Unitary Equal to 1.0 Same percentage Total revenue Total revenue
elastic change in quantity does not does not change
and price change

• When demand is inelastic, price and total revenues are directly related. Price
increases generate higher revenues.
• When demand is elastic, price and total revenues are indirectly related. Price
increases
276 of 42 generate lower revenues.
 The Determinants of Demand Elasticity
• Availability of substitutes:
– Demand is more elastic when there are more
substitutes for the product.
• Importance of the item in the budget:
– Demand is more elastic when the item is a more
significant portion of the consumer’s budget.
• Luxuries versus Necessities:
– The more a good is considered to be a “luxury”,
the greater is the price elasticity of demand.
• Time dimension:
– Demand becomes more elastic over time.
277 of 42
 Uses (applications) of PED
• To the Consumer:
– Pricing of a commodity
– Charging for labour services
– Effects (incidence) of indirect taxation
• To the Producer:
– Output expansion
– Pricing of a commodity
– Incidence of taxation
– Fixing wages for labour
278 of 42
 Uses (applications) of PED
• To the Government:
– Incidence of taxation
– Ensuring success of price support scheme
– Taxation
– Import restrictions
– Fixing rate of foreign
– Determining terms of trade
– Devaluation or depreciation of a currency
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• Income elasticity of demand
– Measures the responsiveness of demand to
changes in income.
% c h a n g e in q u a n tity d e m a n d e d
in c o m e e la s tic ity o f d e m a n d 
% c h a n g e in in c o m e
• Demand is income-elastic if εy > 1 and
income-inelastic if εy < 1.
• It is used to determine if a good is an
inferior good or a normal good.
• Inferior Good – demand falls as income
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 Other Important Elasticities
• rises and vice versa. Thus, εy < 0 (-ve).
• Normal Good – demand rises as income
rises and vice versa. Thus, εy > 0 (+ve).
• If 0 < εy < 1 = the good is normal and a
necessity.
• If εy > 1 , the good is normal and a luxury.
Examples:
1)εy = - 0.6:
– Good is an inferior good but inelastic.
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 Other Important Elasticities
– This means that a rise in income of 3%
would lead to demand falling by 1.8%.
2) εy = +0.4:
– Good is a normal good but inelastic.
– This means that a rise in incomes of 3%
would lead to demand rising by 1.2%
3) εy = +1.6:
– Good is a normal good and elastic.
– Thus, a rise in incomes of 3% would lead
to demand rising by 4.8%
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 Other Important Elasticities
4) εy = - 2.1:
– Good is an inferior good and elastic.
– Thus, a rise in incomes of 3% would lead
to a fall in demand by 6.3%.
Uses of Income Elasticity of Demand
• Knowledge of income elasticity of
demand is particularly important to
the firm (producer or seller) and the
government.
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 Other Important Elasticities
• To the Firm:
– Enables the firm to decide which goods to
produce or supply more when income
changes.
– When income rises, it would be profitable to
supply more of goods with positive income
elasticity (normal goods).
• To the Government:
– Serves as a guide to the government to
know the kinds of goods whose production
should be emphasized in the
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 Other Important Elasticities
– developmental process.
– Serves as a guide in taxation policies.
– Following an increase in income, higher
taxes may be imposed on goods with high
income elasticity in order to yield higher
revenue.

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 Other Important Elasticities
• Cross-price elasticity of demand:
– A measure of the response of the quantity
of one good demanded to a change in the
price of another good.
% c h a n g e in q u a n tity o f Y d e m a n d e d
c ro s s - p ric e e la s tic ity o f d e m a n d 
% c h a n g e in p ric e o f X

• It helps us to determine whether two

goods are related as a substitute or a
complement.
• If εc is positive (i.e. εc > 0), then the two
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 Other Important Elasticities
• goods are substitutes.
• If εc is negative (i.e. εc < 0), it means the
two goods are related as complements.
• If εc is equal to zero (i.e. εc = 0), then the
two goods are not related. They are
independent of each other.
• Cross elasticity of demand is used (with
difficulty) to define the boundaries of an
industry.
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 Other Important Elasticities
• Elasticity of supply:
– A measure of the response of quantity of a
good supplied to a change in price of that
good.
– Likely to be positive in output markets.
% c h a n g e in q u a n tity s u p p lie d
e la s tic ity o f s u p p ly 
% c h a n g e in p ric e

• If the percentage change in quantity

supplied is less than the percentage
change in price, supply is inelastic
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 Other Important Elasticities
• (i.e. εs<1). This means that it is difficult
for suppliers to react swiftly to changes
in price.
• If on the other hand, the % change in
quantity supplied is greater than the %
change in price, supply is elastic (i.e. εs>
1).
• By implication, suppliers can react
quickly to changes in price.
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 Other Important Elasticities
• If the percentage changes in both
quantity supplied and price is equal, the
supply is unitary elastic (i.e. εs = 1).
• Determinants of Elasticity of Supply
– Nature of the good or service;
– input availability;
– Quantity of commodity in stock;
– Existence of spare capacity;
– Stage of production;
– Factor mobility;
– Effects of the weather;
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 Other Important Elasticities
• Determinants of Elasticity of Supply
– durability of good or availability of storage
facilities;
– Number of markets;
– Number of firms in the industry;
– Time available for adjustment.

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 Other Important Elasticities
• To the Consumer:
– Makes the consumer aware that if price is
supply inelastic, it follows that they would
have to pay more if demand for the
commodity rises.
– NB. The consumer is worse off if supply is
inelastic than if it is elastic.
• To the Producer:
– Makes the producer aware that if supply
was price inelastic and demand increased,
they could gain more profits.
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 Other Important Elasticities
NB. The producer is better off if supply is
inelastic than if it is elastic.
• To the Government:
– Pricing or subsidizing to encourage supply
– Fixing wages to encourage supply of
labour
– Devaluation

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 Assignment 1
• The markets for bananas, muffins, and
coffee are interrelated, and each market
is perfectly competitive.
a)In the market for bananas, the
equilibrium price is GH¢1.00 per pound,
and the equilibrium quantity is 1,000
pounds per week. Suppose the
government imposes a price floor on
bananas at GH¢1.20 per pound, causing the
quantity supplied to increase to 1,500
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 Assignment 1
• pounds per week.
i. Would the price floor result in a
shortage, a surplus, or neither? Explain.
[Link] the price elasticity of supply if
the price increases from GH¢1.00 to GH
¢1.20. show your work.
[Link] GH¢1.00 and GH¢1.20, is
supply elastic, unitary elastic or
inelastic? Explain.
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 Assignment 1
b) Bananas are an input for muffins:
i. Draw a correctly labeled graph of the
market for muffins indicating the
equilibrium price and quantity labeled
P0 and Q0, respectively.
ii. On the graph drawn in part (b)(i), show
the impact of an increase in the price
of bananas on the muffin market,
labeling the new equilibrium price and
quantity P1
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 Assignment 1
b)
ii. and Q1, respectively.
iii. On the same graph, completely shade
the area that represents the change in
the consumer surplus caused by the
increase in the price of bananas.
c) In the market for coffee, the
equilibrium price is GH¢3.00 per cup
and the equilibrium quantity is 100
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 Assignment 1
c) cups per week. The cross-price
elasticity of coffee with respect to
muffins is -2.
i. Are coffee and muffins normal goods,
inferior goods, complementary goods, or
substitute goods?
ii. Assume the supply of coffee is
perfectly elastic. Using the equilibrium
price and quantity given above, draw a
correctly labeled
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 Assignment 1
c)
ii. graph for the coffee market, and
show the impact of an increase in the
price of muffins on the coffee market.
iii. Given the original quantity of 100 cups
of coffee per week, if the increase in the
price of muffins is 10%, calculate the new
equilibrium quantity in the coffee
market. Show your work.
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