AP ECONOMICS Topic : Changes in demand | extension, contraction, fall , rise

Movement along the demand Curve

Extension of demand

Extension of demand is the increase in demand due to the fall in price, all other factors remaining constant.

Contraction of demand

Contraction of demand is the fall in demand due to the rise in price, all other factors remaining constant.

Shift in the demand curve

Usually demand curves are drawn based on the assumption except for price all other factors remain the same. But there might be instances when demand may be affected by factors other than price. This will result in the change in demand although the price will remain the same. This change in demand may cause the demand curve to SHIFT inwards or outwards.

• Shift of demand curve OUTWARDS shows an increase in demand at the same price level. It is known as INCREASE IN DEMAND.
• Shift of demand curve INWARDS shows that less is demanded at the same price level. It is known as a FALL IN DEMAND.

AP ECONOMICS Topic : Straight line demand curve

Straight line (linear) demand curve

A straight line demand curve will have a different elasticity at each point on it.
The price elasticity of demand can also be measured at any point on the demand curve.
If the demand curve is linear (straight line), it has a unitary elasticity at the midpoint. The total revenue is maximum at this point. Any point above the midpoint has elasticity greater than 1, (Ed > 1).
Here, price reduction leads to an increase in the total revenue (expenditure). Below the midpoint elasticity is less than 1. (Ed < 1). Price reduction leads to reduction in the total revenue of the firm. Now the question arises, why does a straight line demand curve have different elasticity at each point? The value of PED falls as price falls.
The reason is that low priced products have a more inelastic demand than high priced products, because consumers are not that price sensitive when the product is inexpensive, Similarly the value of PED is higher when the prices increase because consumers are more sensitive to price change when the good is expensive. A mathematical explanation can be given as follows. As we seen in diagram below

AP ECONOMICS Topic : What is demand

What is demand?

Demand is defined as want or willingness of consumers to buy goods and services.

In economics willingness to buy goods and services should be accompanied by the ability to buy (purchasing power) and is referred to as effective demand.

Law of demand

The law of demand is an economic law that states that 

 consumers buy more of a good when its price decreases and less when its price increases, ceteris paribus.

It states that when price increases, the amount demanded will fall and when prices fall, the amount demanded will rise.

Rationale of the law of demand

There are two reasons for a fall in demand when the prices increase.
Income effect: People feel poorer. As the price of a good rises the purchasing power of people to buy that good will fall. This is known as income effect.
Substitution effect: Some people might shift to cheaper alternatives/substitutes once the price of a good rise, thus leading to a fall in demand for that good.

AP ECONOMICS Topic : What is Market

What is Market

Market is a place where buyers and sellers meet. In economics, the concept of a market is any structure that allows buyers and sellers to exchange any type of goods, services and information. The exchange of goods or services for money is a transaction.

Features of a market

• Market participants consist of all the buyers and sellers of a good who influence its price.
• There are two roles in markets, buyers and sellers.
• The market facilitates trade and enables the distribution and allocation of resources in a society.
• Markets allow any tradable item to be evaluated and priced.
• A market emerges spontaneously or is constructed deliberately by human interaction in order to facilitate the exchange of goods and services

AP ECONOMICS Topic : Transition Economies

Transition Economies

A transition economy is an economy which is changing from a centrally planned economy to a free market. Transition economies undergo economic liberalization, where market forces set prices rather than a central planning organization and trade barriers are removed, privatization of government-owned enterprises and resources, and the creation of a financial sector to facilitate the movement of private capital.

The Ingredients of the Transition Process include

• Liberalization: the process of allowing most prices to be determined in free markets and lowering trade barriers that had shut off contact with the price structure of the world's market economies.
• Macroeconomic stabilization: primarily the process through which inflation is brought under control and lowered over time, after the initial burst of high inflation that follows from liberalization and the release of pent-up demand. This process requires discipline over the government budget and the growth of money and credit (that is, discipline in fiscal and monetary policy) and progress toward sustainable balance of payments.
• Restructuring and privatization: the processes of creating a viable financial sector and reforming the enterprises in these economies to render them capable of producing goods that could be sold in free markets and of transferring their ownership into private hands.
• Legal and institutional reforms: These are needed to redefine the role of the state in these economies, establish the rule of law, and introduce appropriate competition policies.

Examples of Transition economies
 Transition economies in Europe and the former Soviet Union
 CEE
Albania, Bulgaria, Croatia, Czech Republic, FYR Macedonia, Hungary, Poland, Romania, Slovak Republic, Slovenia
Baltics   
Estonia, Latvia, Lithuania
CIS
Armenia, Azerbaijan, Belarus, Georgia, Kazakhstan, Kyrgyz Republic, Moldova, Russia, Tajikistan, Turkmenistan, Ukraine, Uzbekistan
 Transition economies in Asia
 Cambodia, China, Laos, Vietnam

AP ECONOMICS Topic : Market economic system | features, advantages and disadvantages

Market Economic System

The central thought of this system is that it should be the producers and consumers who decide how to utilise the resources. Thus, the market forces decide what to produce, how much to produce and for whom to produce.

Features

• All resources are privately owned by people and firms.
• Profit is the main motive of all businesses.
• There is no government interference in the business activities.
• Producers are free to produce what they want, how much they want and for whom they want to produce.
• Consumers are free to choose.
• Prices are decided by the Price mechanism i.e. the demand and supply of the good/service.

Advantages

• Free market responds quickly to the people’s wants: Thus, firms will produce what people want because it is more profitable whereas anything which is not demanded will be taken out of production.
• Wide Variety of goods and services: There will be wide variety of goods and services available in the market to suit everybody’s taste.
• Efficient use of resources encouraged: Profit being the sole motive, will drive the firms to produce goods and services at lower cost and more efficiently. This will lead to firms using latest technology to produce at lower costs.

Disadvantages

• Unemployment: Businesses in the market economy will only employ those factors of production which will be profitable and thus we may find a lot of unemployment as more machines and less labour will be used to cut cost.
• Certain goods and services may not be provided: There may be certain goods which might not be provided for by the Market economy. Those which people might want to use but don’t want to pay may not be available because the firms may not find it profitable to produce. For example, Public goods, such as, street lighting.
• Consumption of harmful goods may be encouraged: Free market economy might find it profitable to provide goods which are in demand and ignore the fact that they might be harmful for the society.
• Ignore Social cost: In the desire to maximise profits businesses might not consider the social effects of their actions.

AP ECONOMICS Topic : Planned economy | features, advantages and disadvantages

Planned Economy

In a planned economy, the factors of production are owned and managed by the government. Thus the Government decides what to produce, how much to produce and for whom to produce.

Features:

• All resources are owned and managed by the government.
• There is no Consumer or producer sovereignty.
• The market forces are not allowed to set the price of the goods and services.
• Profit in not the main objective, instead the government aims to provide goods and services to everybody.
• Government decides what to produce, how much to produce and for whom to produce.

Advantages

• Prices are kept under control and thus everybody can afford to consume goods and services.
• There is less inequality of wealth.
• There is no duplication as the allocation of resources is centrally planned.
• Low level of unemployment as the government aims to provide employment to everybody.
• Elimination of waste resulting from competition between firms.

Disadvantages

• Consumers cannot choose and only those goods and services are produced which are decided by the government.
• Lack of profit motive may lead to firms being inefficient.
• Lot of time and money is wasted in communicating instructions from the government to the firms.

Examples of Planned economies

• North Korea
• Cuba
• Turkmenistan
• Myanmar
• Belarus
• Laos
• Libya
• Iran
• Iraq (until 2003)

AP ECONOMICS Topic : Mixed economy | features, advantages and disadvantages

Mixed Economy

A mixed economy is an economic system that incorporates aspects of more than one economic system. This usually means an economy that contains both privately-owned and state-owned enterprises or that combines elements of capitalism and socialism, or a mix of market economy and planned economy characteristics. This system overcomes the disadvantages of both the market and planned economic systems.

Features

• Resources are owned both by the government as well as private individuals. i.e. co-existence of both public sector and private sector.
• Market forces prevail but are closely monitored by the government.

Advantages

• Producers and consumer have sovereignty to choose what to produce and what to consume but production and consumption of harmful goods and services may be stopped by the government.
• Social cost of business activities may be reduced by carrying out cost-benefit analysis by the government.
• As compared to Market economy, a mixed economy may have less income inequality due to the role played by the government.
• Monopolies may be existing but under close supervision of the government.

AP ECONOMIC Topic : What is an economic system

What is an Economic System?

Because of the fact that there is scarcity of resources and unlimited wants, it is always a problem to allocate resources in an efficient manner. We are constantly facing three basic questions. These are:

• What to produce?
• How to produce?
• For whom do we produce?

Every community or country must choose and develop its own way of solving these problems. The way a country decides what to produce, how to produce and for whom to produce is called it Economic System.
The three Economic Systems existing are:

• Market Economic system
• Planned Economic System
• Mixed Economic System

Note:

• There are no PURE command economies
• There are no PURE market economies
• Instead there is a continuum of different characteristics

What happens when countries move from command economy to market economy?

CHARACTERISTIC		COMMAND ECONOMY		MARKET ECONOMY
Ownership of resources:	From:	government ownership	To:	private ownership
Decision making:	From:	centrally planned	To:	by the market
Motivation:	From:	"the social good"	To:	self interest and profit
Prices and Wages:	From:	set by the government often distorted	To:	set by the market change with market
Result:	From:	inefficiency full employment low inflation low standard of living shortages more equal distrib	To:	economic efficiency periods of unemploy. periods of inflation high standard of living wide range available less equal distrib.
Problems:	From:	corruption=self interest lack of incentives (the incentive problem) distorted prices (the coordination problem) inefficiency	To:	monopoly= inefficiency inequality changing prices instability (UE, IN) pollution
OVERALL:	From:	LESS FOR MORE (INEFFICIENT) and a lower standard of living	To:	MORE FOR LESS (EFFICIENT) and a higher standard of living

AP ECONOMICS Topic : Budget Line

The Budget Line

Consumer’s choices are limited by the budget available. Total spending for goods and services can fall short of the budget constraint but may not exceed it.
Suppose a college student, Rocky, wants to go in for Music classes and Karate classes. A day spent pursuing either activity costs $50. Suppose she has $250 available to spend on these two activities each semester.

The budget line shows combinations of the Music classes and Karate classes Rocky could consume if the price of each activity is $50 and she has $250 available for them each semester. The slope of this budget line is -1, the negative of the price of Music classes divided by the price of Karate classes
For a consumer who buys only two goods, the budget constraint can be shown with a budget line. A budget line shows graphically the combinations of two goods a consumer can buy with a given budget.
As the Price of karate classes will fall relative to Music classes, Rocky will substitute Karate classes for Music Classes. This is known as the substitution effect of a price change.

 

AP ECONOMICS Topic : Equi-marginal Principle

Equi-Marginal Principle

The Law of Equi-Marginal Utility is an extension to the law of diminishing marginal utility. The principle of equi-marginal utility explains the behavior of a consumer in distributing his limited income among various goods and services.
This law states that how a consumer allocates his money income between various goods so as to obtain maximum satisfaction.
Let us assume there are only three commodities available in the market, A, B and C. Also assume that Tom has a daily income of only $15 to spend and that he can exactly order his utility preference for each of the three products. Product A costs $1 per unit, Product B costs $3 per unit and Product C costs $5. Note that diminishing marginal utility sets in immediately for each of the three products. Marginal utility information is described on per $ basis, because a consumers choice are influenced not only by the amount of additional utility that successive units give him but also how many dollars he give up to get them.
Let us consider each dollar spent. Marginal utility per dollar shows that one dollar spend on Product A provides the highest satisfaction of 20 utils as opposed to only 12 and 8 utils from products B and C, respectively.
Second dollar spends again buys the highest utility of 15 utils. However, when Tom spends the third dollar, a switch to Product B promises 15 utils of added satisfaction as opposed to 11 utils from Product A. Following the principle, the best combination Tom can purchase with $15 would be 4 units of A, 2 units of B and 1 unit of C. The total utility generated would be 154 utils. $4 spent on A give 54 utils of satisfaction; $6 spent on Product B gives 60 utils and $5 spent on C gives 40 utils. This gives a total of 154 utils. No other combination will result in as high utility as this with an expenditure of $15.

The results from the table above can be generalised to n commodities and the following condition should hold in equilibrium:

AP ECONOMICS Topic : Ceteris paribus

C?ter?s paribus is a Latin phrase, literally translated as "with other things the same." It is commonly rendered in English as "all other things being equal."

In economics, theoretical models are build on the basis of ceteris paribus in order to test and illlustrate various theories.

When using ceteris paribus in economics, assume all other variables except those under immediate consideration are held constant. For example, it can be predicted that if the price of beef decreases—ceteris paribus—the quantity of beef demanded by buyers will increase. In this example, the clause is used to operationally describe everything surrounding the relationship between both the price and the quantity demanded of an ordinary good.

AP ECONOMICS Topic : Production Possibility Curve

Production Possibility Curve/Production Possibility Boundary/Production Possibility Frontier

From the point of view of an Economy, there is an opportunity cost of using its resources. Production Possibility curve (PPC) shows the maximum combinations of goods and services that can be produced by an economy in a given time period with its limited resources.

In the graph, if all the resources are used to produce Schools then there will be no Hospitals. If you move to the other end then all the resources would be used to produce Hospitals and not Schools will be there in the economy. Government has to move along this curve and decide the best possible combination of goods to produce. For example Z, shows the possible combinations of School buildings and Hospitals. Thus, it is impossible to build more Schools without also building fewer Hospitals.

Resources have to be switched from building more Hosipitals to building more Schools. This is known as rellocation of resources. Before the rellocation of resources we will have to consider the costs of rellocating these resources between uses. This costs will include retraining cost of our workforce and the time consumed in this rellocation.

Any point outside the curve is unattainable unless there is an outward shift of the PPC. This can only be possible if there is an improvement in the quantity and/or quality of factors of production. This is known as economic growth. It is a process of increasing the economy’s ability to produce goods and services.

AP ECONOMICS Topic : Law of diminishing marginal utility

What is Utility?

Why do you buy the goods and services you do? It must be because they provide you with satisfaction—you feel better off because you have purchased them. Economists call this satisfaction utility. The concept of utility is an elusive one. A person who consumes a good such as peaches gains utility from eating the peaches. But we cannot measure this utility the same way we can measure a peach’s weight or calorie content. There is no scale we can use to determine the quantity of utility a peach generates.

Total Utility

If we could measure utility, total utility would be the number of units of utility that a consumer gains from consuming a given quantity of a good, service, or activity during a particular time period. The higher a consumer’s total utility, the greater that consumer’s level of satisfaction.

Marginal Utility

The amount by which total utility rises with consumption of an additional unit of a good, service, or activity, all other things unchanged, is marginal utility.

Law of diminishing Marginal Utility

Suppose that you are really thirsty and you decide to consume a soft drink. Consuming the drink increases your utility, probably by a lot. Suppose now you have another. That second drink probably increases your utility by less than the first. A third would increase your utility by still less. This tendency of marginal utility to decline beyond some level of consumption during a period is called the law of diminishing marginal utility . Failure of marginal utility to diminish would lead to extraordinary levels of consumption of a single good to the exclusion of all others. Since we do not observe that happening, it seems reasonable to assume that marginal utility falls beyond some level of consumption.

AP ECONOMICS Topic : Factors of production

What are factors of Production?

Resources available on earth to make goods and services to satisfy our needs and want are limited.

In economics, factors of production (or productive inputs) are the resources employed to produce goods and services. These can be categorised as

• Land (natural resource) - natural resources used in the creation of products, paid in economic rent, because they are simply irreproducible.
• Labor - human efforts provided in the creation of products, paid in wage.
• Capital goods - human-made goods or means of production (including machinery, building and so forth) used in the production of other goods, paid in interest.
• Enterprise – is the organising and risk-taking factor of production. An entrepreneur brings together land, labour and capital to produce goods and services and is paid in profit.

Detailed notes on factors of production

AP ECONOMICS Topic : Scarcity, Choice and resource allocation

Unlimited Wants

Human beings, in order to survive need a lot of things. Some of these things are very important for our existence. For example, food, clothing, water, shelter and air. These things can be classified as Needs. Apart from this there are things which are needed by us but they are not important for our survival and we can live without them also. For example, going on an expensive holiday, owning a 57 inches Plasma TV. These are known as Wants. This list is never ending and is continuously increasing.

Limited Resources

On the other hand, we have limited resources to produce these goods and services we want. There are not enough car factories to provide cars to everybody on earth. Everything on this planet has some limits except for our Wants.
When unlimited wants meet limited resources, it is known as Scarcity.

Alternative Uses

All the resources we have on this planet can be utilised in a number of way. They have alternative uses. For example, a piece of land can be used for making a factory, or doing farming or constructing a school and so on. Therefore, we have to choose what is best for us. If we talk from an economist point of view it means ‘making the optimum use of resource available’.

Opportunity Cost

Though we have alternative uses, we have to select the best way to use these resources. When we choose best alternative, the next best alternative which is left out is known as the Opportunity cost of making a choice. In other words, the benefits we lost and could have achieved from the next best alternative.

Examples of Opportunity Cost

A person who invests $10,000 in a stock denies themselves the interest they could have earned by leaving the $10,000 dollars in a bank account instead. The opportunity cost of the decision to invest in stock is the value of the interest.
If a city decides to build a hospital on vacant land it owns, the opportunity cost is the value of the benefits forgone of the next best thing which might have been done with the land and construction funds instead. In building the hospital, the city has forgone the opportunity to build a sports centre on that land, or a parking lot.

Economic Problem

The problem then becomes how to determine what is to be produced and how the factors of production (such as capital and labour) are to be allocated. Economics revolves around methods and possibilities of solving the economic problem.

AP ECONOMICS Topic : Normative and Positive Statements

Normative and Positive Statements

Two kinds of assertions in economics can be subjected to testing. One of it is a statement of fact, such as “It is raining outside” or “India has an unemployment rate of 9%.” Like hypotheses, such assertions can be demonstrated to be false. Unlike hypotheses, they can also be shown to be correct. A statement of fact or a hypothesis is a positive statement.Although people often disagree about positive statements, such disagreements can ultimately be resolved through investigation.

There is another category of assertions, however, for which investigation can never resolve differences. A normative statement is one that makes a value judgment. Such a judgment is the opinion of the speaker; no one can “prove” that the statement is or is not correct. Here are some examples of normative statements in economics: “We ought to do more to help the poor.” “People in the United States should save more.” “Corporate profits are too high.” The statements are based on the values of the person who makes them. They cannot be proven false.

Because people have different values, normative statements often provoke disagreement. An economist whose values lead him or her to conclude that we should provide more help for the poor will disagree with one whose values lead to a conclusion that we should not. Because no test exists for these values, these two economists will continue to disagree, unless one persuades the other to adopt a different set of values. Many of the disagreements among economists are based on such differences in values and therefore are unlikely to be resolved.

AP ECONOMICS Topic : Economics Definitions

Definitions

Social Science and Economics

Social Science is defined as a branch of science that studies the society and human behavior in it, including anthropology, communication studies, criminology, economics, geography, history, political science, psychology, social studies, and sociology.
Economics is the branch of social science that deals with the production and distribution and consumption of goods and services and their management.
It is the study of how scarce resources are allocated to fulfil unlimited wants.

Microeconomics and Macroeconomics

Economics is usually divided into two main branches:
Microeconomics, which examines the economic behaviour of individual actors such as businesses, households, and individuals, with a view to understand decision making in the face of scarcity and the allocation consequences of these decisions.
Macroeconomics, which examines an economy as a whole with a view to understanding the interaction between economic aggregates such as national income, employment and inflation.
Economic growth is the increase of per capita gross domestic product (GDP) or other measure of aggregate income. It is often measured as the rate of change in GDP. Economic growth refers only to the quantity of goods and services produced.
Economic development typically involves improvements in a variety of indicators such as literacy rates, life expectancy, and poverty rates. It is a measure of welfare in the economy. Human Development Index (HDI) is one of the most commonly used development measure.
Sustainable development is a pattern of resource use that aims to meet human needs while preserving the environment so that these needs can be met not only in the present, but also for future generations. Economic development that meets the needs of the present without compromising the ability of future generations to meet their own needs.

Free goods and Economics goods

Free goods are what is needed by the society and is available without limits. The free good is a term used in economics to describe a good that is not scarce. A free good is available in as great a quantity as desired with zero opportunity cost to society.
Economics goods are consumable item that is useful to people but scarce in relation to its demand, so that human effort is required to obtain it.