# Introduction to Economics

Lecturer: Dr. A. Beyza Celep
Course Code: ECON2003
Credit: 4 ECTS


### Week 2

• Specialisation leads to more productivity.
• John can produce 1 cake per hour and 3 t-shirt per hour, then if John choose to produce cake, the opportunity cost for the cake will be 3 t-shirt per hour.
• Comparative Advantage is the advantage of lower opportunity cost. Consider two person which one of them produces a cake and its opportunity cost is a half t-shirt and other one produces a cake too but its opportunity cost is 3 t-shirts. So that, the one that has a half t-shirt opportunity cost has comparative advantage in making cakes.

### Week 3

• Data-types of economic models are time-series, cross-section and panel data. Panel data is a mix-type of both time and cross data.
• Index number is used for expressing data relative to a given base point with no dimensions.
• Consumer Price Index is used to measure changes in the cost of living: that is, the money that must be spent to purchase the typical bundle of goods consumed by a representative household. Index numbers are calculated for each category of commodity purchased by households. Then by taking a weighted average of the different commodity groupings.
• Retail Price Index has a addition of mortgagee payments to CPI and used by America mostly.
• Nominal Price of a something is the price of the thing in that year. For example, maybe a house in 1934 cost you $7. Then the nominal price of that house is 7 dollar. It does not give any information about inflation. • Real Price is the price which counts the retail price index in that year.$Real P. = (NominalP. / R.P.I) \cdot 100$. Real Prices indicates the economic scarcity. • The Purchasing Power of the Money is an index of the quantity of goods that can be bought for 1 unit of money. ### Week 4 • Demand and supply determinate the quantity and price of the good. • Even if the product is free, the demand will be a certain value which is not infinite. After a certain level of price, the demand will be zero. • The Law of Demand states that as the price of good or service increases, the quantity demanded of that good or service decreases (of course if the other things are equal). • There is a negative relation between the demand and the price but there is a positive relation between the supply and the price. • The equilibrium price is the price which demand equals to supply. • Excess Demand is a situation that the quantity demanded exceeds the quantity supplied at that price. Excess Supply is the vice-versa. • If quantity demanded is greater than quantity supplied, then there is a shortage. • Substitute goods are the alternatives to each other. Like Coca Cola and Pepsi. • Complement goods are the relative goods which is dependent to each other. Like fuel and cars. • Inferior goods are the products that is very cheap and when the consumer will be able to afford more, they will stop buying that goods. Demands fall when income increases. • Normal goods are the products that demands are increasing when the income of the consumers increases. • What happens to the chocolates if ice cream price is rise? • The demand for the chocolate will be shifted to the right and it means that more demand will occur for same price. • It will create a excess demand situation, hence a shortage. • The shortage binds up the prices of chocolate and therefore the demand will go down. ### Week 5 • Surplus means "fazlalık". Consumer surplus is the surplus underline the demand graph and above the equilibrium price. On the other hand, produces surplus is the surplus above-line the supply graph and under the equilibrium price. • The price elasticity of demand can be given with these formula:$\text{PED} = \frac{\text{% change in quantity}}{\text{% change in price}}$. The demand elasticity is negative. • The high or low demand elasticity can be considered with its absolute value instead of minus sign. If the demand elasticity is high, we can say that the$Q_d$is sensitive to price. If the demand elasticity is low, we can say that the$Q_d$is insensitive to price. • Consider sensitivity to price as if the market can be changed easily with the change of price. Let me give an example. If the sensitivity of the price for a product is low, we can conclude that whenever price can be even increased, the people, consumers will still want the nearly the same demand. • Demand elasticity falls down from higher prices to lower prices. • Demand is elastic when the price elasticity is more negative then -1. Demand is inelastic when the price elasticity lies between -1 and 0. • A price cut in the market results two situations: • Price Effect: Each unit of the good sold for lower price, hence a decreasing in total spending will be happened. • Quantity Effect: There will be more units sold, hence a increasing in total spending will be happened. • For elastic demand, 1 unit price cut leads to more than 1 unit demand. For inelastic demand, 1 unit price cut leads to less than 1 unit demand. ### Week 6 • Short Run: The period after P change but before Q adjustment occur. • Long Run: The period needed for complete adjustment to a P change. • Cross-price Elasticity is the elasticity which in between related goods.$\text{CPE} = \frac{\text{%Quantity change in good A}}{\text{% Price change in good B}}$. Good A is the one we're looking its CPE and good B is the one its related. The price of the good A must be constant.. • CPE is positive when relation is substitute. CPE is negative when relation is complement. If CPE is close to zero, that means the two good A and B is independent. • The quantity demanded is more sensitive to its own price changes instead of related product's price change. • Income elasticity of demand for a good is the percentage change in quantity demanded divided by the corresponding percentage change in consumer income.$\text{IED} = \frac{\text{% change in Quantity demanded}}{\text{% change in Income}}$. • Consumer Choice Theory shows us how a consumer choose how much to consume of different goods. These parameters are important to understand the theory: the consumer's tastes and utility, consumers are rational, consumers' income, and prices. • Tastes are the driving forces behind what a consumer chooses to consume. • Utilities are the satisfaction consumers get from consuming goods. • A rational consumer chooses the bundle that maximises his/her satisfaction. • Consumption bundle is what a consumer would like to consume different quantities of various goods. If there are two goods Films and Meals, we can say that there are -for example- 3 bundles like (6F, 5M); (4F, 2M); (2F, 1M). • Transitivity: If bundle a is preferred to bundle b and if bundle b is preferred to bundle c, we can say that bundle a is preferred to bundle c. That's called Transitivity. • Consumer prefers "more" to "less". • Marginal Rate of Substitution: How many films the consumer is willing to exchange for an additional meal without changing total utility. MRS between two goods: measures quantity of a good, the consumer must sacrifice to rise the quantity of the other good by 1 unit without changing total utility. ### Week 7 • Budget constraint describes the different bundles that the customer can afford. If one has 50₺ and the films are ₺5 and bread ₺1, then$50 = 5f+1b$. The maximum quantity of one good given the quantity of the other good purchased. • If prices wouldn't changed and our income is raised, end-points will be changed. • Consumption bundle which consumer prefers is the point that budget line and utility curve crosses. • A normal good has positive income elasticity demand. While our income is rising, the demand for normal good is also rising. • An inferior good has negative income elasticity demand. While our income is rising, the demand for normal good is decreasing. • A luxury good has income elasticity above unity. • A necessity good has income elasticity below unity. ### Week 8 • Production function is the relationship between the Q of inputs and the Q of outputs. In these inputs, we're going to restrict them to only capital (machinery) and labour (number of workers or worked hours). • Shot run is a period of time in which the quantity of at least one input of production is fixed. Long run is a period of time sufficiently long such that all inputs can be varied. • Marginal product of a variable factor is the extra output from an extra unit of that input, while holding constant all other inputs. It won't always rises whenever a variable factor rises. It has a maximum point, then it is decreases. • The Law of Diminishing Marginal Returns means that beyond some level of the variable input, further increases in the variable input to a steadily decreasing marginal product of that input. • Shot run marginal cost is the extra cost of making an extra unit of output in the short-run while some inputs remain fixed. • Short run average total cost is increasing when short run marginal cost is greater then short run average total cost. The crossing point of short run marginal cost and short run average total cost is the minimum point of short run average total cost. • Short run average variable cost is growing when short run marginal cost is greater then short run average variable cost. It means that after the crossing point of these graphs. • Average cost is falling when marginal cost$<$average cost; is minimum when marginal cost$=$average cost; is rising when marginal cost$>$average cost. ### Week 10 • Marginal cost is the rise in total cost when output rises by 1 unit. • Marginal revenue is the rise in total revenue when output rises by 1 unit. • Firm's optimal output is at which marginal revenue is equal to marginal cost. If the price is above SATC, firm is making profit; if it is between SATC and SAVC, the firm partly covers its fixed costs but loosing money; if the price is below SAVC, the firm produce zero, in this region the firm even does not cover its variables costs. • The firm's output decision in the short run: Choose the output at which marginal return = short run marginal cost. Produce this output if$p > SAVC$. Otherwise, produce zero. • Capital intensity technique: A technique using a lot of capital (machines) and little labour. Labour intensity technique: A technique using a lot of labour and little capital. • Long run total cost is the eventual cost after all adjustments have been made. • Long run marginal cost is the rise in long-run total cost if output rises permanently by one unit. It can be simply explained as "how much total cost is involved in making the last unit of output". • Long run average cost is the ratio of long run total cost by level of output Q. • If long-run marginal cost is below long-run average cost, then long-run average cost decreases. • If long-run marginal cost is above long-run average cost, then long-run average cost increases. • If long-run marginal cost is equal to long-run average cost, long-run average cost reaches minimum. • Scale is the output of the firm when in long-run. Returns to scale is the relationship between the long-run average cost and output produced by a firm when in long-run. • Economies of scale means increasing returns to scale, dis-economies of scale means decreasing returns to scale. ### Week 11 • What do firms think? • Maximise the profit! • The least cost way of making output! • The cheapest available technique! • If capital is expensive, switch from capital intensive to labour intensive! • Higher wage of labour leads to higher marginal cost but unchanged demand and marginal revenue. As a result, the firm chooses to make less output. • The marginal product of labour (MPL) is the extra total output when an extra worker is added. • The marginal value of product of labour (MVPL) is the extra revenue from selling the output made by an extra worker. • The firm hires more workers if the MVPL is greater than the wage cost. • If MVPL > wage-rate, it is profitable to increase worker count. Else, it is profitable to reduce. • A rise in the wage leads to lower employment to raise the MVPL in line with its higher MC. • If outputs are selling for a higher price, output and employment needed to expand until diminishing marginal product drives MVPL back down to the wage 0. • If firm had begun with a higher capital stock (like more machines), each workers has more machinery which means that they will create more product. If worker wage and price won't change, MPL will rise; therefore MVPL ($MVPL = (MPL) \cdot (Price)$) also rises. It ends up with expanding in employment and output. • A profit maximizing competitive firm demands labour up to the point at which the MPL equals its real wage (the nominal wage is divided by the output price). • How many hours will a person wish to work depends on the real wage:$W/P = \frac{\text{nominal wage}}{\text{price of goods}}$. • An individual will want to work until the marginal utility derived from the goods that an extra hour of work will provide is just equal to the marginal utility from the last hour of leisure. • Substitution effect: A higher real wage increases the quantity of good an extra hour of work will purchase. • Income effect: People are working to get a target bundle of goods (to eat, to pay rent, ...). A higher real wage leads to need to work fewer hours to get the same bundle of goods. • The participation rate: the fraction of the working age population who join the labour force. If labour force participation is higher: 1. The more people’s tastes favour the benefits of working (goods or job status) relative to the benefits of leisure. 2. The lower their income from non-work sources 3. The lower the fixed cost of working 4. The higher real wage rate • Non-labour income is a income that is not earned with working. Like rentals or welfare payments... • Reservation wage is the lowest wage a worker is willing to accept to work in a given occupation. ### Week 12 • Macroeconomics is the study of the economy as a system. • Gross domestic product (tr. Gayri safi yurt içi hasıla) is the output of goods and services produced by an economy. • Economic growth is a rise in real gross domestic product. • The labour force is the number of people at work or looking for work. The unemployment rate is the fraction of the labour force without a job. • The inflation rate is the percentage annual increase in the average price of goods and services. • Gross debt (tr. Brüt borç) is the total liabilities owed to creditors. Net debt is the total liabilities (total assets) that could be sold in order to raise money to pay creditors. • There are only two economic units in the economy: Households and Firms. The Circular Flow is the flow between firms and household. • Three equivalent ways to measure total economic activity: 1. The value of all goods and services produced (the value of production), 2. The total value of earnings arising from the factor services supplied (the level of factor incomes), 3. The total value of spending on goods (total expenditure on goods and services). •$\text{Profit} = \text{The value of sale}-\text{The rental of inputs}$• Total output, total earnings, total spending is the way of the level of economic activity can be measured. • Gross National Product or Gross National Income is the total income of a country. Total worldwide income of citizens of a country. • Gross Domestic Product is the output produced within a country -- no matter which citizenship produce it. • Final good is purchased by the ultimate user, either households buying consumer goods or firms buying capital goods such as machinary. • Intermediate goods is made one firm but then used as an input by another firm like steel. • Investment is the purchase of new capital goods by firms. Saving is the part of income not spent buying goods and services. • A leakage from the circular flow is money not recycled from households to firms (leakage: saving) • An injection is money that flows to firms without being recycled through households (injection: investment saving). • Saving and investment are always equal in the absence of government and foreign sectors. • Government raise revenues both through direct taxes on income or indirect taxes on expenditure. • Closed economy is the economy that covers firms household and government. Open economy additionally includes foreign countries. • Nominal GDP measures GDP at the prices prevailing when output was produced. • Real GPD, GDP at constant prices, adjust for inflation, measuring GDP in different years at the prices prevailing at a particular date, known as the base year. • Output is demand –determined if there is excess supply. • Output is supply–determined if there is excess demand. • If there is no government and no foreign sector, there are two types of demand sources: Consumption demand by households (C) and Investment demand by firms (I). • Aggregate demand is the sum of consumption demand and investment demand.$AD = C+I$• Personal disposable income = income households receive from firms + transfers received from government – taxes paid to government. Also, it means net income households can spend or save. For non-governmental economic models, it only equals to the income received from firms. • If aggregate personal income rises, then households' consumption demand rises. • Consumption Function is$C = A + cy$. A is the autonomous consumption that means the demand which is not dependent on income (must-have demand) because households wish to consume even if income Y is zero. So, autonomous consumption demand is not based on current income. • Different people have different marginal propensity to consume (c). For poor people, they likely to spend immediately any extra income that they receive. So that marginal propensity to consume (c) is close to 1. Billionaires, on the other hand, marginal propensity to consume is close to 0. • Saving function is$S = -A + (1-c)Y$. • Investment demand is firms’ desired or planned additions to physical capital (factors & machines). Desired investment$I$is constant, independent of current output & income. ### Week 13 • Aggregate Demand is the amount firms and households plan to spend at each income level. In a simple model it is$AD = C + I$. We assume that investment$I$is constant. The slope of both consumption function and aggregate demand is,$c$, marginal propensity to consume. • Each extra unit of income adds to consumption but not to investment. • If aggregate demand falls below potential output, involuntary excess capacity (firms cannot sell as much as they would like), involuntary unemployment (workers cannot work as much as they would like). • The cross-section of$45^\circ$line and aggregate demand line is the equilibrium point which$AD = \text{income}$. Means that, desired spending and output (or income) is same. For any other output, output is not equal to aggregate demand. • If aggregate demand$>$actual output, it'll cause excess demand. Firms have to raise outputs. • If aggregate demand$<$actual output, it'll cause excess supply. Firms have to reduce outputs. • In equilibrium, planned investment (not based on income) is equal to planned saving (based on income). Investment demand = 30 Saving function = -10 + 0.4*Y Equilibrium output = Y = 100 # Solving: -10 + 0.4Y = 30 0.4Y = 40 -> Y = 100 S = -10 + 0.4(100) S = 30 # Result: Planned saving = Planned investment  • If$S = -10 + 0.4Y$then$C=10+0.6Y$. • Multiplier is the ratio of the change in equilibrium output tot the change in autonomous spending. For example, if a fall of 10 in investment demand caused a fall of 25 in equilibrium output, the multiplier is$\frac{25}{10} = 2.5$. ### Week 14 • Fiscal Policy (tr. Maliye Politikası): Government policy on spending and taxes affects the size of government deficits and government debts. • Stabilisation policy (tr. İstikrar Politikası): Government action to keep AD and actual output close to potential output. • Budget deficit (tr. Bütçe Açığı): the excess of gov. spending over governmental receipts during a particular period. • National debt (tr. Ulusal Borç): the stock of government debt outstanding. • Governmental spending (G) on goods and services is added directly to aggregate demand. • With an assumption that there is no indirect taxes and ignoring foreign trades,$AD = C + I + G$. Note that, transfer payments are affecting AD only by$C$or$I$. • Disposable (spending/saving amount available) Income:$YD = (1-t)\cdot Y$•$Y$: national income •$t$: net tax rate • If national income rises by 1€, net tax revenue rises by 0.20€ and household disposable income rises by 0.80€. • An increase in the income tax rate leads to increasing the net tax rate$t$. As a result, aggregate demand equals actual output at lower output level than before. Raising the net tax rate reduces equilibrium output. • If AD and equilibrium output$<$potential output, lower tax rates or higher transfer benefits will raise aggregate demand, hence, and equilibrium output. • The Balanced Budget Multiplier$=$A rise in government spending$+$equal rises in taxes$=\$ leads to a higher output. BBM a tool for government to rise AD without adding to the deficit & debt.
• Budget Deficit or Budget Surplus is determined by 3 things = the tax rate (t), the level of government spending G, the level of output Y