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Principles of Economics

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GROUP MEMBERS:

  • Lai Kah Mun
  • Lee Jin Yuan
  • Lim Qin Wei
  • Loh Wen Yan

 

  1. Introduction

Economics has contributed greatly to every aspect of human life especially to the development of civilization. It is one of the oldest social sciences that study the economic activity of people for the purpose of satisfying their needs and demands which are basically the reason why economic activity exists.

(Vengedasalam, 2013, p. 4)

Human beings are complex with undying desires and need to fulfill their survival as well as self-satisfaction in life. However, with such unlimited demands, there is only a limited amount of resources that we must wisely allocate in order to keep up and sustain order with these never ending wants. Economics is an important tool in solving the economic issues faced by individuals, firms and countries as well as helping in achieving gain which is valued in terms of money.

(Vengedasalam, 2013, p. 4)

  1. The Law of Demand

Demand, in economic terms, is defined as the ability and willingness of a consumer to purchase a particular product or service at a certain price in a given period of time, provided that all other factors are held constant. The term often used to describe these unchanged factors is known as ceteris paribus, a phrase originating from Latin.

(Vengedasalam, 2013, p. 28)

Such as sciences like physics, economics is equipped with a number of laws as well. The very first law that will be introduced in microeconomics is known as the law of demand. The law of demand states that when the price of a good or service increases, consumer demand for the good or service will decrease, and vice versa, ceteris paribus. This is so because the opportunity cost of a consumer will increase when purchasing a more expensive good or service as they will have to make more trade-offs to acquire it. As for the inverse situation, when the price decreases, there will be an increase in demand as consumers will have more purchasing power for more affordable and cheaper goods or services. From the statement of the law of demand, it is concluded that the relationship between price and the demand or the quantity demanded is inverse.

(Vengedasalam, 2013, p. 28 & 29)

In economics, diagrams and graphs are utilized to provide a better understanding as well as to make drawing out conclusions more convenient visually and mathematically. To understand the law of demand via this method, data may be tabulated in a demand schedule to organize information. With the given information that has been tabulated, a graph showing the demand curve may be plotted. In this way, the information may be viewed clearly and the relationship between the two data obtained may be easily concluded and understood. An example of a demand schedule and demand curve may be viewed in Diagram 1.

http://www.webzeest.com/articleimages/8f14e45fce_1385361066843Demand.png

Diagram 1

Diagram 1 is actually portraying the law of demand. Based on the diagram, the demand curve is sloping downwards. The direction of where the curve is sloping is proof that the relationship between the price and quantity demanded is inversed. If the relationship were to be direct, the curve will slope upwards.

(Vengedasalam, 2013, p. 29)

Diagram 2

Diagram 2 explains the law of demand in more detail via the demand curve. According to the demand curve in the diagram, it is displaying the relationship between the price of a can and the quantity demanded in one week, with all factors influencing demand kept equal. The purpose of points A and B are to provide a connection between the price and quantity demanded. For instance as based in the diagram, at point A, when the price of the can is 80, the quantity demanded is 300 units. However, when point A moves along the curve to point B, it shows that when the price is reduced to 60, the quantity demanded is increased to 500 units. To simplify this, the demand curve in Diagram 2 is obeying the law of demand because it shows that when price of can reduces, the quantity demanded for it increases and vice versa. In this scenario, it is assumed that all factors influencing the demand are constant.

The condition of demand can be analyzed via the demand curve as well. However, this will require a separate set of data that will be needed to compare between the initial demand curve and new demand curve. A graph has been prepared in diagram 3 to provide a visual understanding.

(Vengedasalam, 2013, p. 28)

http://www.economicsonline.co.uk/How%20markets%20work%20graphs/Housing-demand-shifts.png

Diagram 3

Following Diagram 3, the demand curve shows the relationship between house prices and quantity demanded, provided that all factors influencing demand is kept constant with ‘D’ as the initial demand curve.

In scenario 1, the income of a certain population has increased thus more people will obtain more money from salary. In this scenario, the demand will increase as more people will be able to afford to buy houses. The demand curve will shift to the right thus the new demand curve becomes ‘D1’. With this, we can say that the demand has increased.

In scenario 2, house prices are expected to drop in the future. This will result in a decrease in demand as people will wait to purchase houses when the price has decreased. The demand curve will then shift to the left thus the new demand curve becomes ‘D2’. From this, it is said that the demand has decreased.

To simplify this, the condition of demand is shown when there is a change in the position of the demand curve. When it shifts to the right, there is an increase in demand whereas when it shifts to the left, there is a decrease in demand. All conditions related to the law of demand as well as demand can be analyzed via the demand curve, a very suitable method to provide a good visual understanding.

(Vengedasalam, 2013, p. 28)

The law of demand is indeed one of the most basic concepts of economics that states the inverse relationship between price and demand, assuming that all conditions affecting demand is unchanged. It becomes a guideline for many units, mainly of corporate background, to ensure a healthy growth in economy. It is extremely essential as it studies the human behavior towards change in prices in order to safeguard the satisfaction and benefit of both consumers and suppliers.

  1. The Market Supply Curve

In economics, not only do we focus on the consumer’s perspective but as well as the supplier or producer’s point of view. Supply is defined as the willingness and ability of a retailer to produce and sell certain quantities of a good at manipulated prices in a given period of time, ceteris paribus.

(Vengedasalam, 2013, p. 49)

The law of supply states that as the price of the good increases, the quantity supplied will also increase and vice versa, given that all factors influencing supply is kept constant. In other words, the law of supply exists in a direct or positive relationship. For example, the price of MP3 players are high in the market, thus suppliers will produce more MP3 players. This is so because the suppliers will want to achieve more profit as MP3 players are selling at a higher price.

(Vengedasalam, 2013, p. 49)

Such as consumer demand, the law of supply can be portrayed via diagrams and graphs for the convenience of suppliers to analyze their data and keep organized records. An example of a supply curve with a tabulated data (supply schedule) is as given in Diagram 4.

http://www.harpercollege.edu/mhealy/ecogif/s%26d/sdsline.gif

Diagram 4

The supply schedule tabulates and displays the data for the quantity supplied of a certain product at different prices, assuming that all factors influencing it remain constant. From the schedule, we can analyze the relationship between the quantity supplied and the changes in price while assuming ceteris paribus. The supply curve, which is the graphical representation of how much the supplier is willing to produce at a certain price, portrays a more detailed relationship between the quantity supplied and the changes in price visually, concluding that the relationship for the law of supply is direct. The supply curve is also analyzed similarly as the demand curve by viewing the position of the points which bind the information on both axis together.

(Vengedasalam, 2013, p. 51)

The relationship between the quantity of a certain good supplied by a single producer and its price can be displayed in a graph known as an individual supply curve. When two or more individual supply curves are combined together, the summation of the data will equal to the market supply curve, which is the horizontal summation of individual supply curves. An example of two individual supply curves with its tabulated data combining into a market supply curve is shown in Diagram 5.

(Vengedasalam, 2013, p. 51)

Price ($)

Firm 1

(Quantity

Supplied)

Firm 2

(Quantity Supplied)

Market Supply

1

10

10

10 +10 = 20

3

15

15

15+15= 30

Diagram 5

Based on Diagram 5, we can see that two individual supply curves of Firm 1 and Firm 2 are plotted according to the data provided by the table. Let’s say Firm 1 and Firm 2 produce water bottles. When both of the firms set the price of one bottle of water at $ 1, they both supply 10 units. However, when the price of one bottle of water has increased to $ 3, they supply another 5 units so that they are able to obtain more profit from the sales.

When calculating the market supply of water bottles from these two firms, the total quantity of water bottles supplied at $ 1 and $ 3 are calculated respectively, as follows below:

So once the market supply has been totaled up, the market supply curve can be plotted.

In conclusion, the market supply curve is the horizontal summation of individual supply curves.

  1. Determinants of Demand

The factors that can cause a change in the demand curve are price of related goods, income, and expectation of future price of goods.

  1. Price Of Related Goods

One of the factors that changes the demand curve is the price of related goods. There are two types of related goods which are substitute goods and complement goods.

i) Substitute Goods

https://fbcdn-sphotos-h-a.akamaihd.net/hphotos-ak-xpf1/v/t34.0-12/10994642_10153061357035280_7610209585710283154_n.jpg?oh=0c978fc377f3b6c410281da8b61a778f&oe=54F3466E&__gda__=1425217473_56a37f250470f5fac2ea5594f3952a80

Substitute goods are two goods that have a similar usage and can be easily replaced by the other related good. For example, if the price of product X increases, the demand for product Y increase, and likewise, if the price of product X decreases, the demand of product Y decreases. It is concluded that product X and product Y are substitute goods. Example of substitude goods are Massimo and Gardenia. If Massimo gets subsidies from the government, the price of massimo will decrease. Therefore, the demand for Massimo will increase causing the demand of Gardenia to decrease as consumers will prefer to buy at a cheaper price from Massimo. Vice, versa, if taxes is implemented on Massimo, the price of Massimo will then increase causing the demand to decrease. This causes the demand for Gardenia to increase since the price will be lower compared to Massimo. The two goods have a positive relationship.

(Vengedasalam, 2013, p. 31)

ii) Complement Goods

https://fbcdn-sphotos-h-a.akamaihd.net/hphotos-ak-xpf1/v/t35.0-12/1900797_10153061356460280_921971315683359734_o.jpg?oh=a49dabbc55c160d8aa325afce5541b79&oe=54F33391&__gda__=1425243950_63362f1cfc3f9dc108c2e9f7ee502290

Complement goods are two goods that are consumed together. They may be either consumed separately or used alongside. If the demand of product A falls as the price for product B rises, and likewise, the demand of product A rises as the price for product B falls, A and B are complement. For example, badminton racket and shuttlecock are complement goods as they are both used at the same time to play badminton. The demand for badminton rackets will increase because of the price of shuttlecock has decreased, and likewise, when the price of badminton racket increases, the demand for shuttlecock will decrease. This is because if the price of badminton racket is high, the demand will fall causing the demand of the shuttlecock to decrease as there will be lesser rackets to use to play badminton.

(Vengedasalam, 2013, p. 31)

  1. Income

A change in income of an individual may cause a change in the demand for a certain good or service. As the income changes, the demand might increase, decrease or remain constant according to the willingness and abilities of consumers to consume the goods and depending on what type of goods is being consumed. When the demand for a certain good increases, its demand curve would shift to the right (outward shift), ceteris paribus.

(Vengedasalam, 2013, p. 31)

Demand-Curve-Shift-to-Right.png

Vice versa, when the demand for a particular good decreases, its demand curve shifts to the left (inward shift), ceteris paribus.

http://h3laboratories.com/wp-content/uploads/2013/09/Demand-Curve-Shift-to-Left.png

The Three Types of Goods that are influenced by change in income:

  • Natural Goods

Natural goods are goods that experience a rise in demand when the income increases. When the income of an individual increases, the demand for natural goods will increase, ceteris paribus. When the demand increases, the demand curve will shift to the right (outward shift).Vice versa, when the income of an individual decreases, the demand for natural goods would decrease, ceteris paribus. When the demand decreases, the demand curve would shift to the left (inward shift). It is said that the relationship between the income of an individual and the demand for natural goods is positive or direct.

(Vengedasalam, 2013, p. 31)

It is undeniable that when we make more money, we do spend a little more and the money that we spend is mostly on natural goods. For example, when we have extra money in our pocket, we tend to want to spend more such as on clothing or electronic goods. In general, natural goods are goods that we consume or demand more when our income has increased. Examples of natural goods are clothing, gadgets (namely smartphones and computers) and cars.

  • Inferior Goods

Inferior goods are the opposite of natural goods. Unlike natural goods, when the income of consumer increases, the demand for inferior goods would decrease, ceteris paribus. When the demand decreases, the demand curve will shift to the left (inward shift). Vice versa, when the income of consumers decreases, the demand for these goods will increase, ceteris paribus. When the demand increases, the demand curve would shift to the right (outward shift). Thus, the relationship between the income of consumers and the demand for inferior goods is negative or inversely related.

(Vengedasalam, 2013, p. 31)

Examples of inferior goods are second-hand phones, used cars, and low-grade rice. When we make more money, we do not demand for more second-hand phones, as we will have a tendency to purchase a more advanced or highly branded phone such as Samsung, HTC and Apple. On the contrary, when our income has decreased, we consume more of low-grade rice compared to those imported ones from Thailand because of the price difference.

(Vengedasalam, 2013, p. 31)

  • Neutral Goods

For neutral goods, when the income of an individual increases or decreases, the demand for these goods will not change, ceteris paribus. When there is a change in income, the demand for neutral goods will remain constant and therefore, the demand curve will not shift. This is because these goods are necessary goods to us, and as our income changes, it will not affect the quantity of these goods consumed.

(Vengedasalam, 2013, p. 31)

For example, when our income increases, do we consume more rice? Certainly not, we have an unlimited need or want to consume additional amounts of these goods. Another example is when our income decreases, do we buy lesser toothpaste? Do we not demand for toilet papers? We still consume these goods to meet our needs even when our income has decreased. Examples of neutral goods are rice, toothpaste, sugar and flour. In conclusion, neutral goods are goods that are necessary and needed to be consumed consistently when the income of an individual changes.

(Vengedasalam, 2013, p. 31)

4.3 Expectations of Future Price of Good

The next factor that causes a change in demand is expectations of future price. Expectations of future price is for buyers to determine the future price, so that they can determine when would be the best time to buy the good. Before expecting the future price, buyers should collect all the information from relevant sources, such as from the news, newspaper, professional proposal as well as government projects. After buyers have obtained all the information or plan from all these sources, buyers should conduct a research about the authenticity of the information. If that information is authentic, then buyers will determine the amount of the goods that the buyers should buy so that they can be prevented from buying too many goods to cause wastage.

If the buyers expect the price of the good to increase next month, then buyers will purchase the good this month, it will cause an increase in demand and the demand curve will shift to the right. For the example, if the price of biscuits increases next month, then buyers will buy the biscuits this month, causing the demand of biscuits to increase within this period. If the buyers expect the price of the biscuits to decrease next month, then buyers will wait to buy it next month, causing a decrease in demand and the demand curve will shift to the left. For example, if the price of biscuits decreases next month, then buyers will wait to buy the biscuits next month, causing the demand to decrease within this period. Thus, it shows the inverse relationship between price and quantity demanded. (Vengedasalam, 2013, p. 32)

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