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Principles of Economics

There are 10 principles of Economics which are briefly discussed with their examples
below.

Principle # 1: People face Trade offs


To gain something we like, we have to give up another thing we like as there is
nothing as a Free Lunch.

Example # 1:
A student has a five hour job opportunity for Rs.5000 (1000/hr). He also has 3 hours
to study a subject. He decides to do 3 hour job and earns Rs.3000 and spends 2 more
hours on that particular subject, so there is a trade off between job and studying a
subject of 2 hours.

Example # 2:
Suppose a student has 500 rupees to spend. He wants to purchase a piece of pant-shirt
but he also needs some books for his studies. Both books and pant-shirt cost Rs. 500
each. Ultimately he decides to purchase books and does not buy pant-shirt and hence
there is a trade off between books and pant-shirt.

Principle # 2: The cost of something is what you give up to get it

Opportunity cost: whatever must be given to obtain some item.

Example # 1:
Government plans to build a hospital and also make a motorway but it has the budget
to make only one thing. Government decides to build a hospital and hence forgo the
making of motorway; hence motorway is the opportunity cost of hospital here.

Example # 2:
A person has a choice between his job and a holiday in Murree. He prefers his job on
going to Murree, as he sees benefit to do a job rather going to Murree, so in this case
forgoing of holiday in Murree is the opportunity cost of his job.

Principle # 3: Rational people think at the margin

In this clause, margin means benefit and this whole clause means that sensible people
always seek for maximum benefits while buying or selling something.

Example # 1:
It is more beneficial for a student to buy his study books instead of spending that
money in getting amusement.

Example # 2:
A producer produces a certain good and wants to sell it for 100 rupees where cost of
production of that good was 60 rupees. Now for any reason, no one is ready to
purchase that good for 100 rupees but they want to purchase it for 80 rupees. Now
producer will also be ready to sell it for 80 rupees because he knows that it is better to
sell it for 80 rupees instead of waiting for it to be sold at Rs.100.

Principle # 4: People respond to Incentives

As we know that benefits of a product encourage people to buy that product.

Example # 1:
Take an example of companies that provide cellular services. A person while
purchasing a sim card for his mobile phone would purchase the sim of that company
which gives better and more services to its customers.

Example # 2:
A shampoo producing company is offering a conditioner bottle along with shampoo in
same price, so the people are going to buy shampoo of that company more as
compared to that of other companies.

Principle # 5: Trade can make every one better off

A single person cannot fulfill all its needs by himself. It is better for him and the
others to do trade with each other.

Example # 1:
Pakistan import machinery from Japan and Japan import cotton from Pakistan to
fulfill each other’s needs.

Example # 2:
It would not be better for a farmer to grow wheat and just eat himself. He better sell it
and get money in reward so that he can fulfill his other needs and other people also
get wheat from him according to their need.

Principle # 6: Markets are usually a good way to make economic activity

Example # 1:
The decentralize decision making by the thousands of firms and millions of house
holds decide what to produce and how to produce when they interact in a market for
goods and services.

Example # 2:
A person needs a certain chip for computer. He goes to computer market and
examines different kinds of chips at different prices, so he can easily find and buy a
chip which can complete his task and suits his pocket as well.

Principle # 7: Government can sometimes improve market outcomes

Example # 1:
Suppose a Leather manufacturing company is running into loss and hence plans to
close the factory, here government can help that company by giving subsidy and other
reasonable support to carry out the production of leather products.
Example # 2:
To eradicate the monopolistic competition, government of Pakistan had imposed some
sanctions on Mobilink (a cellular company), so that new companies could come and
invest in the market.

Principle # 8: A country’s standard of living depends upon its ability to


produce goods and services

Greater is the production of goods and services in a country, higher is the standard of
living there.

Example # 1:
An American earns $34100 per year while a Pakistani earns $650 per year. It is
because America almost produces every goods and services which they need, on the
other hand Pakistan mostly import goods and services from other countries.

Example # 2:

Principle # 9: Inflation rises when government prints too much money

Example # 1:
As the credit cards is plastic money. A person having credit card is able to buy a
costly product, so he faces high prices. Therefore as the supply of money increases,
prices of products increase and inflation prevails.

Example # 2:
There came news in a magazine that in Zimbabwe, a person gave $200,000 to buy an
ice-cream while in America you can buy an ice-cream with in $5. We can see the
major difference here and it is because government in Zimbabwe prints too much
money due to which inflation rises and hence prices of products are very high but in
America, government prints a reasonable amount of money and hence inflation rate is
under control there.

Principle # 10: There is a short term Trade off between inflation and
unemployment
Degrees of Elasticity of Demand
There are five degrees of elasticity of demand and these are given with examples
below.

1- Elastic Demand
When a small change in price causes relatively a big change in quantity demanded, it
is known as elastic demand. In this case elasticity is greater than 1 and it has a flatter
curve.

Examples:
1- If price of 7up falls then people who were drinking Team before this fall in price
would start drinking 7up and hence demand of 7up increases.

price Q.d

2- If Versace increases price of its garments then people who wear Versace will shift
towards any other brand like Armani or Levis. Hence the demand of garments
Versace decreases.

price Q.d

2- Perfectly Elastic Demand


When the quantity demanded at the ruling price is infinite then this is called perfectly
elastic demand. In this case Ed = ∞ and it has a curve parallel to x-axis.

Examples:
1-

price Q.d
2-

price Q.d

3- Unit Elasticity
When the %age change in price and the %age change in quantity demanded is in same
ratio then elasticity is a unit. In this case elasticity equals 1.

Examples:
1- Suppose that a 10 percent drop in the price of chocolate causes a 10 percent
increase in the quantity demanded of chocolate.

price Q.d

2-

price Q.d

4- Inelastic Demand
When a large %age change in price causes relatively a less %age change in quantity
demanded then the demand is said to be inelastic. In this case elasticity is than 1 and it
has a steeper curve.

Examples:
1- Suppose that a 10 percent decline in the price of coffee leads to only a 5 percent
increase in its quantity demanded.

price Q.d
2-

price Q.d

5- Perfectly Inelastic Demand


When there is a change in the price but there is no change in quantity demanded then
the demand is said to be perfectly inelastic. In this case elasticity equals zero and it
has a curve parallel to y-axis.

Examples:
1- Cement is a perfectly inelastic commodity as to construct a building or a home we
must need it, whether its price is high or not.

price Q.d

2- Giffen goods are also perfectly inelastic as they have no effect of change in price
e.g. Diamond is considered as Giffen good as mostly rich people buy diamonds and
they are not concerned about the price of diamond, they just buy it.

price Q.d
Subject: Micro Economics

Assignment: -Principles of Economics with Examples


-Degrees of Elasticity of Demand with examples

Group Members
Name Roll No.

Ambreen Malik 008


Sadia 060
Muhammad Faris 040
Sufyan 068
Zain-ul-Abdain 084

Submitted to: Miss Zainab

Dated: 27/09/2007