Engineering Economics Course Description: Engineering Economics course introduces students to economics principles and practices which will

enable them to understand the socio-economic environments in the course of engineering practice. Detailed Course Content Introduction to Economics. History and definition of economics of economics. Macro and Micro economic. Economics laws and applications. Assumptions and methods of economics. Economic planning and development. Economic assessment; Economic Comparisons, Profitability measures, Cost benefit Analysis, prices, wages, rent, interest and profits, Inflation, accuracy of future estimates, Financial modelling.

Introduction Economics is concerned with the efficient allocation of scarce factors/resources to try to satisfy human needs to the best advantage. What is meant by scarce resources? These are such things that command price even though they may be in abundance. Then factors are those that are more usually known as factors of production, inputs or production factors and are necessary whether one is producing potatoes, architects drawings, or office blocks. Economics can also be defined as the study of the manner in which the forces of supply and demand allocate resources. Others say it is the science that analyses the production, distribution, and consumption of goods and services. Economics aims to explain how economies work and how economic agents interact. Economic analysis is applied throughout society, in business, finance and government, but also in crime, education, the family, health, law, politics, religion, social institutions, war, and science. Common distinctions are drawn between various dimensions of economics. The primary distinction is between microeconomics, which examines the behaviour of basic elements in the economy, including individual markets and agents (such as consumers and firms, buyers and
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sellers), and macroeconomics, which addresses issues affecting an entire economy1, including unemployment, inflation, economic growth, and monetary and fiscal policy. Other distinctions include: between positive economics (describing "what is") and normative economics (advocating "what ought to be"); between economic theory and applied economics; Positive economics deals with issues that can be observed or scientific explanations of the working of the economy. It looks at the world as it is and different from what it should be. It aims at explaining how society makes decisions about say production, consumption, and exchange of goods and services. It holds that if certain conditions remain constant then things can be expected to happen since things are arrived at through economic research. For example statement such as income inequality can be reduced through a system of income taxes. Normative economics refers to recommendations based on personal judgement. It tries to explain how the world should be. It does not involve scientific proof or research .for instance a statement like income tax system is good, is a normative statement. Because its goodness depends on the perceptions of the individuals who say so most likely it is good to those who do not pay for it. Economics deals with the laws and principles which govern the functioning of an economy and its various parts. An economy exists because of two basic facts. Firstly, human wants for goods and services are unlimited and secondly, productive resources with which to produce goods and services are scarce. Therefore, an economy has to decide how to use its scarce resources to obtain the maximum possible satisfaction of the members of the society. It is this basic problem of scarcity which gives rise to many of the economic problems. There has been a lot of controversy among economist about the true content of economic theory or its subjects matter. The subject matter and scope of economics has been variously defined. Each definition is incomplete inadequate and because of various conflicting definition, some confusion has been created about the nature and scope of economics. Objective The main objective of engineering economics course is to enable engineering graduates acquire the fundamental economic principles that can help them to produce the products and services within the cost limitations through making realistic economic decisions. Cost limitation is an important factor which differentiates the work of an engineer from that of scientist. While working on something engineers must have consideration of cost in his mind. Application of economic knowledge Today all over the world people have become highly economic minded. They have realized that the study of economics can provide them a solution to their economic and social problems. This
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The intentional saving of money, commonly the saving of time, energy etc or the system of trade and industry by which the wealth of a country is made and used

has made economics more useful than any other branch of knowledge because it makes human welfare its direct and primary concern. We make economic decisions every day. Everything that involves weighing choices and sacrificing one benefit for another greater benefit require economic decision. Everyone is a part of economy and everyone uses the rules of economy too. From the time we are born, we become consumers of various products and services (say, medical services, baby foods, and so on). We grow and diversify to attain various different roles as producers, traders, mediators and agents. Todays world is that of economic imperialism, where economical factors, most importantly, money dictates all the elements of the society, not to forget close family relations. With recession wreaking havoc, economics is something which even ignorant households are learning. Economics is a science which deals with production, distribution and consumption of goods and services. Therefore, we can conclude that whatever involves transfer of money includes economics. There are two schools of economics, namely, microeconomics and macroeconomics. The combined results of these two determine the actual effect of economics on people. To list all the important functions of economics would be literary impossible as newer issues keep creeping up. In the following lines, we have described some broad and basic functions of economics as below:

Optimizes Resource Usage In todays world, the amount of resources available to us is reducing each day. This condition will only worsen, if we keep using our resources with low efficiency and effectiveness. Economics provides a mechanism for looking at possible ways to optimize resource utilization and reduce wastages. Utilizes the Opportunity Cost This is another principle used for resources in which the scarce resources are utilized efficiently, after calculating and checking the opportunity cost. A simple theory of exclusion is put into play. If you choose something over another thing, then what loss you sustain is the opportunity cost. If we minimize the opportunity cost, we get maximum profits. For example, a person who invests $10,000 in a stock denies himself the interest that could have been accrued, by leaving the $10,000 in the bank account instead. The opportunity cost of the decision to invest in stock, is the value of the interest. When this principle is used in budget allocations by government, it results in better growth rates. Gains Social Efficiency If a society keeps on putting money into its economy with no profits or loss, then the economy becomes inefficient and so does the society, as it gets dependent on the economy. If the input into an economy is larger than the output, then the society starts disintegrating and falls prey to destructive social evils, like unemployment and poverty. The same is the case if the economy is
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stagnant. Understanding of economics leads to better planned economy. Also, profitable economic steps introduced largely aid in the societys overall prosperity. Stabilizes the Overall Economy The stability of an economy is inevitable to any country or society. Only through economically sound practices can we ensure that the economy is stable and growing at the same time. In recent times, when the worlds economy fell, only a few countries were able to sustain their growth rate and prevent severe monetary impacts on their citizens. Understands Individual Economics This is important for the growth of individuals economically. A person needs to understand the economic situations and stipulations present in his own life. He may not need the hardcore subjective understanding of economics, but he definitely needs to understand the economic practices that he must follow to eradicate chances of going broke or bankrupt. Also, understanding of economics helps in using the resources in the best possible way and gaining maximum profit. Following are the main micro economic advantages of the study of economics. Provide Guides to Producers:Economics is very useful for the producer. It guides him on how he should combine the four factors of production and minimize the cost of production. Useful to the consumer:The consumer can adjust his expenditure of various goods in a better way if he knows the principles of economics. He will spend his income according to the law of Equi-Marginal utility in order to get maximum satisfaction. Reduces Poverty and Leads to Development:It helps in reducing or removing the poverty from a country. Under developed countries are facing many problems like unemployment, over population, low per capita income and low production. Economics is very useful in solving these problems. It is helpful leaders:Its study is helpful for the leaders to understand the economic problems. Useful for the Finance Department/Ministries:Finance managers prepare the yearly budget of the departments/countries. Economics guides him that how he should frame the tax policy and monetary policy.

Useful for the Distribution of National Income:From the study of economics one can easily judge how the income should be distributed equitably to everybody. Cultural Value:A person's education cannot be considered complete unless he has some knowledge of economics. The things which happen daily around us have an important economic bearing. So there is also the cultural value of the study of economics. Importance for a Common Man:The study of economics is very useful for every citizen. It enables him to understand and criticize the economic policies of the government. He can also guide the government. Economic Planning:In the modern age the importance of economic planning can not be ignored. Through planning we can utilize our natural resources in better way and can improve our economic condition. Importance For Labour:It guides the workers that how they can get maximum wages from the employer. It enables them to get the right of trade union , collective bargaining and fixation of working hours. Provides Solution For Economic Crises :It guides the nations that how they can save themselves from the economic crises. The advanced countries desire is that there should be economic stability and full employment without inflation to achieve these objectives, economics is very useful for them. Inspiration for Development:The study of advanced countries economy inspires the less development countries that they can also improve their economics conditions. Intellectual Value :Economics has great intellectual value, because it broadens our out-look, sharpens our intellect and inculcate in us that habit of balanced thinking economically. Optimum Use of Resources:5

In the third world countries there is a lot of wastage of resources which is the main cause of their poverty. The study of economic development will enable them to make the optimum use of their resources.

Creates the Sense of Responsibility:Economics develop the sense of responsibility among the citizens by explaining the various problems and their solutions. Useful For International Trade :It helps the importers and exporters to earn maximum profit. A businessman can easily understand the trade policies of various countries History of economics: The history of economic thought deals with different thinkers and theories in the subject that became political economy and economics from the ancient world to the present day. It encompasses many disparate schools of economic thought. Greek writers such as the philosopher Aristotle examined ideas about the "art" of wealth acquisition and questioned whether property is best left in private or public hands. In medieval times, scholars such as Thomas Aquinas argued that it was a moral obligation of businesses to sell goods at a just price. British philosopher Adam Smith is often cited as the father of modern economics for his treatise The Wealth of Nations (1776). His ideas built upon a considerable body of work from predecessors in the eighteenth century particularly the Physiocrats. His book appeared on the eve of the Industrial Revolution with associated major changes in the economy. Smith's successors included such classical economists as the Rev. Thomas Malthus, Jean-Baptist Say, David Ricardo, and John Stuart Mill. They examined ways the landed, capitalist and labouring classes produced and distributed national output and modelled the effects of population and international trade. In London, Karl Marx castigated the capitalist system, which he described as exploitative and alienating. From about 1870, neoclassical economics attempted to erect a positive, mathematical and scientifically grounded field above normative politics. After the wars of the early twentieth century, John Maynard Keynes led a reaction against what has been described as governmental abstention from economic affairs, advocating interventionist fiscal policy to stimulate economic demand and growth. With a world divided between the capitalist first world, the communist second world, and the poor of the third world, the post-war consensus broke down. Others like Milton Friedman and Friedrich von Hayek warned of The Road to Serfdom and socialism, focusing their theories on what could be achieved through better monetary policy and
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deregulation. As Keynesian policies seemed to falter in the 1970s there emerged the so called New Classical school, with prominent theorists such as Robert Lucas and Edward Prescott. Governmental economic policies from the 1980s were challenged, and development economists like Amartya Sen and information economists like Joseph Stiglitz introduced new ideas to economic thought in the twenty-first century. Early economic thoughts The earliest discussions of economics date back to ancient times (e.g. Chanakya's Arthashastra or Xenophon's Oeconomicus). Back then, and until the industrial revolution, economics was not a separate discipline but part of philosophy. In Ancient Athens, a slave based society but also one developing an embryonic model of democracy, Plato's book The Republic contained references to specialization of labour and production. But it was his pupil Aristotle that made some of the most familiar arguments, still in economic discourse today. Aristotle's Politics (c.a. 350 BC) was mainly concerned to analyse different forms of a state (monarchy, aristocracy, constitutional government, tyranny, oligarchy, democracy) as a critique of Plato's advocacy of a ruling class of "philosopher-kings". In particular for economists, Plato had drawn a blueprint of society on the basis of common ownership of resources. Aristotle viewed this model as an oligarchical anathema. In Politics, Book II, Part V, he argued that, "Property should be in a certain sense common, but, as a general rule, private; for, when everyone has a distinct interest, men will not complain of one another, and they will make more progress, because everyone will be attending to his own business... And further, there is the greatest pleasure in doing a kindness or service to friends or guests or companions, which can only be rendered when a man has private property. These advantages are lost by excessive unification of the state." Though Aristotle certainly advocated there be many things held in common, he argued that not everything could be, simply because of the "wickedness of human nature".[5] "It is clearly better that property should be private," wrote Aristotle, "but the use of it common; and the special business of the legislator is to create in men this benevolent disposition." In Politics Book I, Aristotle discusses the general nature of households and market exchanges. For him there is a certain "art of acquisition" or "wealth-getting". Money itself has the sole purpose of being a medium of exchange, which means on its own "it is worthless... not useful as a means to any of the necessities of life".[6] Nevertheless, points out Aristotle, because the "instrument" of money is the same many people are obsessed with the simple accumulation of money. "Wealth-getting" for one's household is "necessary and honourable", while exchange on the retail trade for simple accumulation is "justly censured, for it is dishonourable".[7] Aristotle disapproved highly of usury and also cast scorn on making money through monopoly.[8] Middle Ages
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Thomas Aquinas (12251274) was an Italian theologian and writer on economic issues. He taught in both Cologne and Paris, and was part of a group of Catholic scholars known as the Schoolmen, who moved their enquiries beyond theology to philosophical and scientific debates. In the treatise Summa Theologica Aquinas dealt with the concept of a just price, which he considered necessary for the reproduction of the social order. Bearing many similarities with the modern concept of long run equilibrium a just price was supposed to be one just sufficient to cover the costs of production, including the maintenance of a worker and his family. He argued it was immoral for sellers to raise their prices simply because buyers were in pressing need for a product. Aquinas discusses a number of topics in the format of questions and replies, substantial tracts dealing with Aristotle's theory. Questions 77 and 78 concern economic issues, mainly relate to what a just price is, and to the fairness of a seller dispensing faulty goods. Aquinas argued against any form of cheating and recommended compensation always be paid in lieu of good service. Whilst human laws might not impose sanctions for unfair dealing, divine law did, in his opinion. One of Aquinas' main critics[9] was Duns Scotus (12651308) in his work Sententiae (1295). Originally from Duns Scotland, he taught in Oxford, Cologne and Paris. Scotus thought it possible to be more precise than Aquinas in calculating a just price, emphasising the costs of labour and expenses - though he recognised that the latter might be inflated by exaggeration, because buyer and seller usually have different ideas of what a just price comprises. If people did not benefit from a transaction, in Scotus' view, they would not trade. Scotus defended merchants as performing a necessary and useful social role, transporting goods and making them available to the public. From the localism of the Middle Ages, the waning feudal lords, new national economic frameworks began to be strengthened. From 1492 and explorations like Christopher Columbus' voyages, new opportunities for trade with the New World and Asia were opening. New powerful monarchies wanted a powerful state to boost their status. Mercantilism was a political movement and an economic theory that advocated the use of the state's military power to ensure local markets and supply sources were protected. Mercantile theorists thought international trade could not benefit all countries at the same time. Because money and gold were the only source of riches, there was a limited quantity of resources to be shared between countries. Therefore, tariffs could be used to encourage exports (meaning more money comes into the country) and discourage imports (sending wealth abroad). In other words a positive balance of trade ought to be maintained, with a surplus of exports. The term mercantilism was not in fact coined until the late 1763 by Victor de Riqueti, marquis de Mirabeau and popularised by Adam Smith, who vigorously opposed its ideas. Thomas Mun An English businessman Thomas Mun (15711641) represents early mercantile policy in his book England's Treasure by Foraign Trade . Although it was not published until 1664 it was widely circulated as a manuscript before then. He was a member of the East India Company and also wrote about his experiences there in A Discourse of Trade from England unto the East Indies
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(1621). According to Mun, trade was the only way to increase England's treasure (i.e., national wealth) and in pursuit of this end he suggested several courses of action. Important were frugal consumption to increase the amount of goods available for export, increased utilisation of land and other domestic natural resources to reduce import requirements, lowering of export duties on goods produced domestically from foreign materials, and the export of goods with inelastic demand because more money could be made from higher prices. Philipp von Hrnigk (16401712, sometimes spelt Hornick or Horneck) was born in Frankfurt am Main and became an Austrian civil servant writing in a time when his country was constantly threatened by Ottoman invasion. In sterreich ber Alles, Wenn Sie Nur Will (1684, Austria Over All, If She Only Will) he laid out one of the clearest statements of mercantile policy. He listed nine principal rules of national economy. "To inspect the country's soil with the greatest care, and not to leave the agricultural possibilities of a single corner or clod of earth unconsidered. All commodities found in a country, which cannot be used in their natural state, should be worked up within the country. Attention should be given to the population, that it may be as large as the country can support. Gold and silver once in the country are under no circumstances to be taken out for any purpose. The inhabitants should make every effort to get along with their domestic products. [Foreign commodities] should be obtained not for gold or silver, but in exchange for other domestic wares... and should be imported in unfinished form, and worked up within the country... Opportunities should be sought night and day for selling the country's superfluous goods to these foreigners in manufactured form... No importation should be allowed under any circumstances of which there is a sufficient supply of suitable quality at home." Fundamental Economic Problems The fundamental economic problems are scarcity, choice and opportunity cost. 1. Scarcity means that all resources are relatively less compared to mans desire for them. 2. Choice means the taking of the right decision at the right time 3. Opportunity cost is the alternative foregone when choice is made.

Relationship between the fundamental economic problems Since resources are scarce relative to human desire for them, consumers and producers have to make choice. In making a choice, they forego the next best alternative thus opportunity cost. In other words, the scarcity of resources necessitates a choice among the alternatives. The choice gives rise to opportunity cost.
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Importance of opportunity cost.

It helps consumers to plan their consumption It helps in pricing of commodities and factors of production. It guides investment and production decisions. It facilitates government planning It facilitates international specialisation based on the law of comparative advantage.

THE MAJOR ECONOMIC QUESTIONS

a) What to produce (Product). This addresses the type of the commodity, whether it is the

consumer durables or non durables. Societies are always faced with the problem of deciding on what to produce. If resources were in abundance this problem would never arise but since resources are scarce, society has to choose between producing: cars, Tvsets, tractors (consumer durables and producing rice and beer, (non-durable) or to mix the two to maximise utility.
b) How to produce (methodology or technology). This is concerned about the production

technique and it tries to identify those cost minimising, hence efficient technique of production. By efficiency we mean optimal resource utilisation. During production, firms use factors of production; firms use factors of production such as labour, capital, entrepreneurial skills and land. But these factors are in limited supply hence scarce. Accordingly, there is need to choose that input mix that will minimise cost so as to achieve the major objective or interest of firms which is profit maximising.
c) When to produce? (The timing). Society is always faced with the problem of choosing

between producing now for consumption or delaying production and having it later.
d) For whom to produce? (Market). This addresses the targeted market, whether

production is for the low income or high income groups, for the young or old people. The aim here is to produce for those who need the good most since they obtain more satisfaction and are willing to demand more hence pay a higher price for the goods which in turn maximises the producers profits.
e) Where to produce (Place). This question is concerned with the location of the firm.ie. Is

it near to the source of raw material or near the source of energy, near transport system or near the market? Terminologies

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a) Free goods: goods provided in abundance by nature and can be obtained at zero price e.g

air, sunshine, rainfall etc.

b) Economic goods: goods that are relatively scarce and are paid for c) Public goods: goods whose consumption by one individual does not exclude the

consumption by others. They are provided collectively by the state because of their indivisible benefits and are paid for indirectly through taxes. Public goods possess characteristics of non-divisibility, non-excludability, and non-rivalry in use. Examples are roads, security, bridges etc.
d) Merit goods: goods that are considered intrinsically desirable and consumers are

encouraged to use them. Their public benefits exceed the private benefits. Examples include U.S.E, U.P.E, and public health.
e) Intermediate goods: goods which have not yet reached their final stage of production e.g

lint for clothes, bricks and cement for construction.

f) Final goods: goods ready for use e.g houses for rents, computers etc. g) Inferior goods: goods whose consumption reduces with the increase in consumers

income. They have got negative income elasticity of demand. Iron sheets and tiles.
h) Normal goods: goods whose consumption increases with increase in consumers income.

They have positive income elasticity of demand e.g use of private transport vs public transport.
i) Giffen goods: cheap products consumed by low income earners and the consumption

increases with the increase in their prices.

j) Capital goods: goods which are used to produce other goods e.g equipment etc

Other terms

Economic resources: things that are used in the production of goods and services are scarce and carry a price. They are also called factors or agents of production. Business wealth: is the one possessed for the sake of producing further wealth e.g factories, buildings etc Social wealth: is the publicly owned wealth e.g schools, hospitals, roads etc Want: the human desires (material or immaterial) Needs: things that man cannot do without i.e necessities e.g food, water, shelter etc

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Consumer sovereignty: the freedom of the consumer in influencing what to produce and how resources should be allocated through casting vote i.e demanding what is produced. Ceteris paribus: Latin word meaning other factors being constant. It is a tool of economic analysis used in economic theory to study the effect of a particular aspect or problem by assuming other influencing factors to be constant. Scale of preference: a list of human wants in order of priority i.e beginning with the most pressing wants and ending with the least pressing ones. Command economy: a system of economic organisation where there is public ownership of the means of production and resources are allocated by the central authority (state). It is called a planned economy or socialism Mixed economy: the one where both the state and private sector participate in resource allocation with neither sector being dominant of the other. Dual economy: an economy with contrasting features i.e one being desirable and another undesirable e.g subsistence sector and monetary sector Open economy: an economy that participates in an international trade Closed economy: the one that does not participate in international trade or has no dealings with outside economies.

Microeconomics Microeconomics is the study of the economic actions of individuals and small groups of economic agents such as consumers, producers and resource owners. It looks at the functioning of small economic units such as resource owners and business firms. One fundamental assumption is that economic agents maximize their interests, for instance consumers maximize satisfaction/utility, and producers maximize profits, so economic agents are assumed to be rational. It therefore examines these rational economic agents by providing conditions under which those interests are maximized. Microeconomics is about: 1. Buying decisions of the individual 2. Buying and selling decisions of the firm 3. The determination of prices in the markets 4. The quantity, quality and variety of products 5. Profits 6. Consumers satisfaction There are two sides in a market for consumption goods: DEMAND SUPPLY
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Created by Consumers Each consumer maximizes satisfaction (utility) ------------------------------ CONSUMPTION THEORY

Created by firms Each firm maximizes its profits ----------------------------- PRODUCTION THEORY

We will first study consumption and later production. In the third part of the course we will take the demand schedule from the consumption analysis and the supply schedule from the production analysis and put them together in a market. The price, and the quantity exchanged will be determined in the market. We will also discuss the performance and efficiency of markets. Economists study: production, trade and consumption decisions, such as those that occur in a traditional marketplace. METHODOLOGY, MODELS AND ASSUMPTIONS IN ECONOMICS. In economics, when making conclusion, previous events are essential. All economic questions can be analysed by examining the decisions of individuals and the outcome of the decisions. For instance positive statements can be subjected to empirical analysis. What we mean is that such statements can be proved scientifically. The scientific proof is based on theory. For example we can state that currency depreciation/devaluation leads to increased exports: A model is built basing on the underlying theory, data is collected on these variables over a period of time together with that of exports, then we have exports as the dependent variable and the rest as independent variables, and we use statistical packages (Computer softwares) e.g SPSS or Microsoft excel to analyse the data. The methodology for the analysis of data involves the use of statistical methods and econometrics. The basic framework for the analysis involves an economic model. As economic model is simplified, small scale version of some aspect of the economy. Economic models can be expressed in different forms such as: 1. Equations; For instance; Qdx = Q(Px,Py,T,Y,Yd,Pn,A) The equation is a demand function and it states that the quantity of a commodity x i.e Qdx demanded depend on factors such as; Px= Price of the commodity x. Py= Price of related commodities that may either be substitutes or completements T= Taste and preferences of the consumers Y = Income of the consumers. Yd = Income distribution of the population Pn = The size of the population and A = Other factors 2. Graphs An econometric model could as well be expressed in a graphical form, for instance, a demand function could be simplified for graphical purposes to assume that quantity demanded depends
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only on the price of the commodity. This would then give rise to a graphical demand model or curve. This form however, reduces the economic model to only two variables; the dependent variable and the independent variable because of the graph having only two axes. 3. In words An economic model can as well be expressed in words for instance when the price of a commodity increases, its demand falls such a statement implies that quantity demanded and prices of the commodity are related, specifically they are inversely or negatively related. Stages in model Building Generally there are two stages in model building: i. Identifying the factors that are likely to affect the variable in question; For instance suppose the task is to find out how the quantity of bricks demanded, responds to changes in its price. We would therefore need to build a model of quantity demanded. We however note that the quantity of bricks demanded at any particular time period is affected by several factors other than its price such as price of its related commodities which include both compliments (commodities that have to be consumed together rather than simultaneously at any one time such as cement and aggregates) and substitute goods that can be consumed in place of another due to the income constrains such as common bricks, concrete blocks and engineering bricks. Another factor that affects the quantity demanded in the market is taste and preference of the consumers. Other factors include consumers incomes, religion of the consumers. Time period is another factor of demand ( for instance, around Christmas, people tend to purchase more beef, population, past quantities of goods purchased and many other factors. The above analysis can be summarised by the following equation. Qdb = Q(Pb,Py,T,PT,A) Where Qdb = quantity demanded of a commodity Pb = Price of the commodity Py = Price of related commodity T = Taste and preference PT = Time period A = Other factors ii. The second stage involves data collection on the identified variables: Data on the variables that can be measured (quantifiable) e.g price of commodity, income, price of related goods etc is collected and it is then subjected to economic analysis using either statistical or econometrics techniques, so as to estimate the actual strength of each independent variable postulated in the module. The idea is to determine how each independent variable affects the dependent variable. For instance suppose the price of cement changes by 10% from 25,000/ per 50kg bag, by what percentage will the quantity demanded of cement change? What if the consumers income changes
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by 10%. The economic model also helps to tell whether a commodity is a substitute good or a complement. Assumptions in economics Economics use assumption so that they can easily explain a phenomenon particular that may be explained by a number of factors. In which case if all variables or factors were allowed to change, we could hardly be in position to tell the impact and direction of the factor on the given phenomenon or variable. These assumptions are used so as so to try to reflect the most important aspects of behaviour of an aspect and hence draw conclusions or predictions whenever there is a change in one variable. Time and again economists use a statement ceteris paribus. This is a key assumption in economics. It simply means all other factors constant. The researcher assumes that other factors that affect the aspect under investigation (dependent Variable) do not change, instead only one factor (independent variable) changes. This enables the researcher to draw conclusions, which we would otherwise not have done if other variables or factors changed as well. Assumptions and models are used in economics to simplify the examination of a problem under discussion. However two problems are likely to occur during construction of a model and these are:
i.

Over simplification:

This may remove an important aspect of the situation under discussion. For example consider a demand function Qd = Q(P) which assumes that price is the only determinant of quantity demanded. This statement is over simplified and may lead to false results. ii. Under simplification:

When a model is under simplified, it leaves the important aspects obscured by too much details, for example; Qd=f(P,PY,Y,T,S,Pt+1,Rc,Sx,E,M,A,Nc,L) where

P = Price of the commodity PY= Price of other related goods Y= Income of consumers T = Taste and preference of consumer S = Season of the year Pt+1 = The expected price of the commodity Rc = Religion and other cultural factors Sx = Sex, E = Level of education M = Marital status,
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A = Age, Nc= Number of consumers, L = Location of consumers

We note that some factors like age, sex, education, marital status etc may not change the demand for a commodity so much Markets Microeconomics, like macroeconomics, is a fundamental method for analyzing the economy as a system. It treats households and firms interacting through individual markets as irreducible elements of the economy, given scarcity and government regulation. A market might be for a product, say building cements, or the services of a factor of production, say bricklaying. The theory considers aggregates of quantity demanded by buyers and quantity supplied by sellers at each possible price per unit. It weaves these together to describe how the market may reach equilibrium as to price and quantity or respond to market changes over time. Such analysis includes the theory of supply and demand. It also examines market structures, such as perfect competition and monopoly for implications as to behaviour and economic efficiency. Analysis of change in a single market often precedes from the simplifying assumption that relations in other markets remain unchanged, that is, partial-equilibrium analysis. General-equilibrium theory allows for changes in different markets and aggregates across all markets, including their movements and interactions toward equilibrium. Production, cost, and efficiency In microeconomics, production is the conversion of inputs into outputs. It is an economic process that uses inputs to create a commodity for exchange or direct use. Production is a flow and thus a rate of output per period of time. Distinctions include such production alternatives as for consumption (food, haircuts, etc.) vs. investment goods (new tractors, buildings, roads, etc.), public goods (national defense, small-pox vaccinations, etc.) or private goods (new computers, bananas, houses.), and "guns" vs. "butter". Cost Cost refers to the price/fee/worth or charge in monetary value of a commodity. Opportunity cost refers to the economic cost of production infact the value of the next best opportunity foregone. Choices must be made between desirable yet mutually exclusive actions. It has been described as expressing "the basic relationship between scarcity and choice. The opportunity cost of an activity is an element in ensuring that scarce resources are used efficiently, such that the cost is weighed against the value of that activity in deciding on more or less of it. Opportunity costs are not

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restricted to monetary or financial costs but could be measured by the real cost of output forgone, leisure, or anything else that provides the alternative benefit (utility). Inputs used in the production process include such primary factors of production as labour services, capital (durable produced goods used in production, such as an existing factory), and land (including natural resources). Other inputs may include intermediate goods used in production of final goods, such as the steel used in the construction of buildings, bridges, or in a new car. Economic efficiency describes how well a system generates desired output with a given set of inputs and available technology. Efficiency is improved if more output is generated without changing inputs, or in other words, the amount of "waste" is reduced. A widely-accepted general standard is Pareto efficiency, which is reached when no further change can make someone better off without making someone else worse off.

An example PPF with illustrative points marked The production-possibility frontier (PPF) is an expository figure for representing scarcity, cost, and efficiency. In the simplest case an economy can produce just two goods (say "guns" and "butter"). The PPF is a table or graph (as above) showing the different quantity combinations of the two goods producible with a given technology and total factor inputs, which limit feasible total output. Each point on the curve shows potential total output for the economy, which is the maximum feasible output of one good, given a feasible output quantity of the other good. Scarcity is represented in the figure by people being willing but unable in the aggregate to consume beyond the PPF (such as at X) and by the negative slope of the curve. If production of one good increases along the curve, production of the other good decreases, an inverse relationship. This is because increasing output of one good requires transferring inputs to it from production of the other good, decreasing the latter. The slope of the curve at a point on it gives the trade-off between the two goods. It measures what an additional unit of one good costs in units forgone of the other good, an example of a real opportunity cost. Thus, if one more Gun costs 100
17

units of butter, the opportunity cost of one Gun is 100 Butter. Along the PPF, scarcity implies that choosing more of one good in the aggregate entails doing with less of the other good. Still, in a market economy, movement along the curve may indicate that the choice of the increased output is anticipated to be worth the cost to the agents. By construction, each point on the curve shows productive efficiency in maximizing output for given total inputs. A point inside the curve (as at A), is feasible but represents production inefficiency (wasteful use of inputs), in that output of one or both goods could increase by moving in a northeast direction to a point on the curve. Examples cited of such inefficiency include high unemployment during a business-cycle recession or economic organization of a country that discourages full use of resources. Being on the curve might still not fully satisfy allocative efficiency (also called Pareto efficiency) if it does not produce a mix of goods that consumers prefer over other points. Much applied economics in public policy is concerned with determining how the efficiency of an economy can be improved. Recognizing the reality of scarcity and then figuring out how to organize society for the most efficient use of resources has been described as the "essence of economics," where the subject "makes its unique contribution." Specialization Specialization is considered key to economic efficiency based on theoretical and empirical considerations. Different individuals or nations may have different real opportunity costs of production, say from differences in stocks of human capital per worker or capital/labour ratios. According to theory, this may give a comparative advantage in production of goods that make more intensive use of the relatively more abundant, thus relatively cheaper, input. Even if one region has an absolute advantage as to the ratio of its outputs to inputs in every type of output, it may still specialize in the output in which it has a comparative advantage and thereby gain from trading with a region that lacks any absolute advantage but has a comparative advantage in producing something else. It has been observed that a high volume of trade occurs among regions even with access to a similar technology and mix of factor inputs, including high-income countries. This has led to investigation of economies of scale and agglomeration to explain specialization in similar but differentiated product lines, to the overall benefit of respective trading parties or regions.[15] The general theory of specialization applies to trade among individuals, farms, manufacturers, service providers, and economies. Among each of these production systems, there may be a corresponding division of labour with different work groups specializing, or correspondingly different types of capital equipment and differentiated land uses.[16]

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An example that combines features above is a country that specializes in the production of hightech knowledge products, as developed countries do, and trades with developing nations for goods produced in factories where labor is relatively cheap and plentiful, resulting in different in opportunity costs of production. More total output and utility thereby results from specializing in production and trading than if each country produced its own high-tech and low-tech products. Theory and observation set out the conditions such that market prices of outputs and productive inputs select an allocation of factor inputs by comparative advantage, so that (relatively) low-cost inputs go to producing low-cost outputs. In the process, aggregate output may increase as a byproduct or by design.[17] Such specialization of production creates opportunities for gains from trade whereby resource owners benefit from trade in the sale of one type of output for other, more highly valued goods. A measure of gains from trade is the increased income levels that trade may facilitate.[18] Supply and demand

The supply and demand model describes how prices vary as a result of a balance between product availability and demand. The graph depicts an increase (that is, right-shift) in demand from D1 to D2 along with the consequent increase in price and quantity required to reach a new equilibrium point on the supply curve (S). Prices and quantities have been described as the most directly observable attributes of goods produced and exchanged in a market economy.[19] The theory of supply and demand is an organizing principle for explaining how prices coordinate the amounts produced and consumed. In microeconomics, it applies to price and output determination for a market with perfect competition, which includes the condition of no buyers or sellers large enough to have price-setting power. For a given market of a commodity, demand is the relation of the quantity that all buyers would be prepared to purchase at each unit price of the good. Demand is often represented by a table or a
19

graph showing price and quantity demanded (as in the figure). Demand theory describes individual consumers as rationally choosing the most preferred quantity of each good, given income, prices, tastes, etc. A term for this is 'constrained utility maximization' (with income and wealth as the constraints on demand). Here, utility refers to the hypothesized relation of each individual consumer for ranking different commodity bundles as more or less preferred. The law of demand states that, in general, price and quantity demanded in a given market are inversely related. That is, the higher the price of a product, the less of it people would be prepared to buy of it (other things unchanged). As the price of a commodity falls, consumers move toward it from relatively more expensive goods (the substitution effect). In addition, purchasing power from the price decline increases ability to buy (the income effect). Other factors can change demand; for example an increase in income will shift the demand curve for a normal good outward relative to the origin, as in the figure. Supply is the relation between the price of a good and the quantity available for sale at that price. It may be represented as a table or graph relating price and quantity supplied. Producers, for example business firms, are hypothesized to be profit-maximizers, meaning that they attempt to produce and supply the amount of goods that will bring them the highest profit. Supply is typically represented as a directly-proportional relation between price and quantity supplied (other things unchanged). That is, the higher the price at which the good can be sold, the more of it producers will supply, as in the figure. The higher price makes it profitable to increase production. Just as on the demand side, the position of the supply can shift, say from a change in the price of a productive input or a technical improvement. Market equilibrium occurs where quantity supplied equals quantity demanded, the intersection of the supply and demand curves in the figure above. At a price below equilibrium, there is a shortage of quantity supplied compared to quantity demanded. This is posited to bid the price up. At a price above equilibrium, there is a surplus of quantity supplied compared to quantity demanded. This pushes the price down. The model of supply and demand predicts that for given supply and demand curves, price and quantity will stabilize at the price that makes quantity supplied equal to quantity demanded. Similarly, demand-and-supply theory predicts a new price-quantity combination from a shift in demand (as to the figure), or in supply. For a given quantity of a consumer good, the point on the demand curve indicates the value, or marginal utility, to consumers for that unit. It measures what the consumer would be prepared to pay for that unit.[20] The corresponding point on the supply curve measures marginal cost, the increase in total cost to the supplier for the corresponding unit of the good. The price in equilibrium is determined by supply and demand. In a perfectly competitive market, supply and demand equate marginal cost and marginal utility at equilibrium.[21]

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On the supply side of the market, some factors of production are described as (relatively) variable in the short run, which affects the cost of changing output levels. Their usage rates can be changed easily, such as electrical power, raw-material inputs, and over-time and temp work. Other inputs are relatively fixed, such as plant and equipment and key personnel. In the long run, all inputs may be adjusted by management. These distinctions translate to differences in the elasticity (responsiveness) of the supply curve in the short and long runs and corresponding differences in the price-quantity change from a shift on the supply or demand side of the market. Marginalist theory, such as above, describes the consumers as attempting to reach most-preferred positions, subject to income and wealth constraints while producers attempt to maximize profits subject to their own constraints, including demand for goods produced, technology, and the price of inputs. For the consumer, that point comes where marginal utility of a good, net of price, reaches zero, leaving no net gain from further consumption increases. Analogously, the producer compares marginal revenue (identical to price for the perfect competitor) against the marginal cost of a good, with marginal profit the difference. At the point where marginal profit reaches zero, further increases in production of the good stop. For movement to market equilibrium and for changes in equilibrium, price and quantity also change "at the margin": more-or-less of something, rather than necessarily all-or-nothing. Other applications of demand and supply include the distribution of income among the factors of production, including labour and capital, through factor markets. In a competitive labour market for example the quantity of labour employed and the price of labour (the wage rate) depends on the demand for labour (from employers for production) and supply of labour (from potential workers). Labour economics examines the interaction of workers and employers through such markets to explain patterns and changes of wages and other labour income, labour mobility, and (un)employment, productivity through human capital, and related public-policy issues.[22] Demand-and-supply analysis is used to explain the behavior of perfectly competitive markets, but as a standard of comparison it can be extended to any type of market. It can also be generalized to explain variables across the economy, for example, total output (estimated as real GDP) and the general price level, as studied in macroeconomics.[23] Tracing the qualitative and quantitative effects of variables that change supply and demand, whether in the short or long run, is a standard exercise in applied economics. Economic theory may also specify conditions such that supply and demand through the market is an efficient mechanism for allocating resources.[24] Firms Theory of the firm, Industrial organization, Financial economics, Business economics, and Managerial economics

21

One of the assumptions of perfectly competitive markets is that there are many producers, none of which can influence prices or act independently of market forces. In reality, however, people do not simply trade on markets, they work and produce through firms. The most obvious kinds of firms are corporations, partnerships and trusts. According to Ronald Coase people begin to organise their production in firms when the costs of doing business becomes lower than doing it on the market.[25] Firms combine labour and capital, and can achieve far greater economies of scale (when producing two or more things is cheaper than one thing) than individual market trading. Industrial organization studies the strategic behavior of firms, the structure of markets and their interactions. The common market structures studied include perfect competition, monopolistic competition, various forms of oligopoly, and monopoly.[26] Financial economics, often simply referred to as finance, is concerned with the allocation of financial resources in an uncertain (or risky) environment. Thus, its focus is on the operation of financial markets, the pricing of financial instruments, and the financial structure of companies.[27] Managerial economics applies microeconomic analysis to specific decisions in business firms or other management units. It draws heavily from quantitative methods such as operations research and programming and from statistical methods such as regression analysis in the absence of certainty and perfect knowledge. A unifying theme is the attempt to optimize business decisions, including unit-cost minimization and profit maximization, given the firm's objectives and constraints imposed by technology and market conditions.[28] Market failure Market failure, Government failure, Information economics, Environmental economics, and Agricultural economics Pollution can be a simple example of market failure. If costs of production are not borne by producers but are by the environment, accident victims or others, then prices are distorted. The term "market failure" encompasses several problems which may undermine standard economic assumptions. Although economists categorise market failures differently, the following categories emerge in the main texts.[29] Natural monopoly, or the overlapping concepts of "practical" and "technical" monopoly, is an extreme case of failure of competition as a restraint on producers. The problem is described as one where the more of a product is made, the greater the unit costs are. This means it only makes economic sense to have one producer. Information asymmetries arise where one party has more or better information than the other. The existence of information asymmetry gives rise to problems such as moral hazard, and adverse
22

selection, studied in contract theory. The economics of information has relevance in many fields, including finance, insurance, contract law, and decision-making under risk and uncertainty.[30] Incomplete markets is a term used for a situation where buyers and sellers do not know enough about each other's positions to price goods and services properly. Based on George Akerlof's Market for Lemons article, the paradigm example is of a dodgy second hand car market. Customers without the possibility to know for certain whether they are buying a "lemon" will push the average price down below what a good quality second hand car would be. In this way, prices may not reflect true values. Public goods are goods which are undersupplied in a typical market. The defining features are that people can consume public goods without having to pay for them and that more than one person can consume the good at the same time. Externalities occur where there are significant social costs or benefits from production or consumption that are not reflected in market prices. For example, air pollution may generate a negative externality, and education may generate a positive externality (less crime, etc.). Governments often tax and otherwise restrict the sale of goods that have negative externalities and subsidize or otherwise promote the purchase of goods that have positive externalities in an effort to correct the price distortions caused by these externalities.[31] Elementary demand-and-supply theory predicts equilibrium but not the speed of adjustment for changes of equilibrium due to a shift in demand or supply.[32] In many areas, some form of price stickiness is postulated to account for quantities, rather than prices, adjusting in the short run to changes on the demand side or the supply side. This includes standard analysis of the business cycle in macroeconomics. Analysis often revolves around causes of such price stickiness and their implications for reaching a hypothesized long-run equilibrium. Examples of such price stickiness in particular markets include wage rates in labour markets and posted prices in markets deviating from perfect competition. Macroeconomic instability, addressed below, is a prime source of market failure, whereby a general loss of business confidence or external shock can grind production and distribution to a halt, undermining ordinary markets that are otherwise sound.

Some specialised fields of economics deal in market failure more than others. The economics of the public sector is one example, since where markets fail, some kind of regulatory or government programme is the remedy. Much environmental economics concerns externalities or "public bads".

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Policy options include regulations that reflect cost-benefit analysis or market solutions that change incentives, such as emission fees or redefinition of property rights.[33] Public sector Main articles: Economics of the public sector and Public finance See also: Welfare economics Public finance is the field of economics that deals with budgeting the revenues and expenditures of a public sector entity, usually government. The subject addresses such matters as tax incidence (who really pays a particular tax), cost-benefit analysis of government programs, effects on economic efficiency and income distribution of different kinds of spending and taxes, and fiscal politics. The latter, an aspect of public choice theory, models public-sector behavior analogously to microeconomics, involving interactions of self-interested voters, politicians, and bureaucrats.[34] Much of economics is positive, seeking to describe and predict economic phenomena. Normative economics seeks to identify what economies ought to be like. Welfare economics is a normative branch of economics that uses microeconomic techniques to simultaneously determine the allocative efficiency within an economy and the income distribution associated with it. It attempts to measure social welfare by examining the economic activities of the individuals that comprise society.[35] Macroeconomics

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A depiction of the circular flow of income Macroeconomics Macroeconomics examines the economy as a whole to explain broad aggregates and their interactions "top down," that is, using a simplified form of general-equilibrium theory.[36] Such aggregates include national income and output, the unemployment rate, and price inflation and subaggregates like total consumption and investment spending and their components. It also studies effects of monetary policy and fiscal policy. Since at least the 1960s, macroeconomics has been characterized by further integration as to microbased modeling of sectors, including rationality of players, efficient use of market information, and imperfect competition.[37] This has addressed a long-standing concern about inconsistent developments of the same subject.[38] Macroeconomic analysis also considers factors affecting the long-term level and growth of national income. Such factors include capital accumulation, technological change and labor force growth.[39] Growth

World map showing GDP real growth rates Main articles: Economic growth and General equilibrium Growth economics studies factors that explain economic growth the increase in output per capita of a country over a long period of time. The same factors are used to explain differences in the level of output per capita between countries, in particular why some countries grow faster than others, and whether countries converge at the same rates of growth. Much-studied factors include the rate of investment, population growth, and technological change. These are represented in theoretical and empirical forms (as in the neoclassical and endogenous growth models) and in growth accounting.[40]
25

Business cycle Main article: Business cycle See also: Circular flow of income, Aggregate supply, Aggregate demand, Unemployment, and Great Depression The economics of a depression were the spur for the creation of "macroeconomics" as a separate discipline field of study. During the Great Depression of the 1930s, John Maynard Keynes authored a book entitled The General Theory of Employment, Interest and Money outlining the key theories of Keynesian economics. Keynes contended that aggregate demand for goods might be insufficient during economic downturns, leading to unnecessarily high unemployment and losses of potential output. He therefore advocated active policy responses by the public sector, including monetary policy actions by the central bank and fiscal policy actions by the government to stabilize output over the business cycle[41] Thus, a central conclusion of Keynesian economics is that, in some situations, no strong automatic mechanism moves output and employment towards full employment levels. John Hicks' IS/LM model has been the most influential interpretation of The General Theory. Over the years, the understanding of the business cycle has branched into various schools, related to or opposed to Keynesianism. The neoclassical synthesis refers to the reconciliation of Keynesian economics with neoclassical economics, stating that Keynesianism is correct in the short run, with the economy following neoclassical theory in the long run. The New classical school critiques the Keynesian view of the business cycle. It includes Friedman's permanent income hypothesis view on consumption, the "rational expectations revolution"[42] spearheaded by Robert Lucas, and real business cycle theory. In contrast, the New Keynesian school retains the rational expectations assumption, however it assumes a variety of market failures. In particular, New Keynesians assume prices and wages are "sticky", which means they do not adjust instantaneously to changes in economic conditions. Thus, the new classicals assume that prices and wages adjust automatically to attain full employment, whereas the new Keynesians see full employment as being automatically achieved only in the long run, and hence government and central-bank policies are needed because the "long run" may be very long. Inflation and monetary policy

26

The Federal Reserve sets monetary policy as the central bank of the United States. Main articles: Inflation and Monetary policy See also: Money, Quantity theory of money, Monetary policy, History of money, and Milton Friedman Money is a means of final payment for goods in most price system economies and the unit of account in which prices are typically stated. It includes currency held by the nonbank public and checkable deposits. It has been described as a social convention, like language, useful to one largely because it is useful to others. As a medium of exchange, money facilitates trade. Its economic function can be contrasted with barter (non-monetary exchange). Given a diverse array of produced goods and specialized producers, barter may entail a hard-to-locate double coincidence of wants as to what is exchanged, say apples and a book. Money can reduce the transaction cost of exchange because of its ready acceptability. Then it is less costly for the seller to accept money in exchange, rather than what the buyer produces.[43] At the level of an economy, theory and evidence are consistent with a positive relationship running from the total money supply to the nominal value of total output and to the general price level. For this reason, management of the money supply is a key aspect of monetary policy.[44] Fiscal policy and regulation Main articles: Fiscal policy, Government spending, Regulation, and National accounts National accounting is a method for summarizing aggregate economic activity of a nation. The national accounts are double-entry accounting systems that provide detailed underlying measures of such information. These include the national income and product accounts (NIPA), which provide estimates for the money value of output and income per year or quarter. NIPA allows for tracking the performance of an economy and its components through business cycles or over longer periods. Price data may permit distinguishing nominal from real amounts, that is, correcting money totals for price changes over time.[45] The national accounts also include measurement of the capital stock, wealth of a nation, and international capital flows.[46]
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International economics Main articles: International economics and Economic system International trade studies determinants of goods-and-services flows across international boundaries. It also concerns the size and distribution of gains from trade. Policy applications include estimating the effects of changing tariff rates and trade quotas. International finance is a macroeconomic field which examines the flow of capital across international borders, and the effects of these movements on exchange rates. Increased trade in goods, services and capital between countries is a major effect of contemporary globalization.[47]

World map showing GDP (PPP) per capita. The distinct field of development economics examines economic aspects of the development process in relatively low-income countries focusing on structural change, poverty, and economic growth. Approaches in development economics frequently incorporate social and political factors.
[48]

Economic systems is the branch of economics that studies the methods and institutions by which societies determine the ownership, direction, and allocation of economic resources. An economic system of a society is the unit of analysis. Among contemporary systems at different ends of the organizational spectrum are socialist systems and capitalist systems, in which most production occurs in respectively state-run and private enterprises. In between are mixed economies. A common element is the interaction of economic and political influences, broadly described as political economy. Comparative economic systems studies the relative performance and behavior of different economies or systems.[49] Practice Main articles: Mathematical economics, Economic methodology, and Schools of economics Contemporary mainstream economics, as a formal mathematical modeling field, could also be called mathematical economics.[50] It draws on the tools of calculus, linear algebra, statistics, game
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theory, and computer science.[51] Professional economists are expected to be familiar with these tools, although all economists specialize, and some specialize in econometrics and mathematical methods while others specialize in less quantitative areas. Heterodox economists place less emphasis upon mathematics, and several important historical economists, including Adam Smith and Joseph Schumpeter, have not been mathematicians. Economic reasoning involves intuition regarding economic concepts, and economists attempt to analyze to the point of discovering unintended consequences. Theory Mainstream economic theory relies upon a priori quantitative economic models, which employ a variety of concepts. Theory typically proceeds with an assumption of ceteris paribus, which means holding constant explanatory variables other than the one under consideration. When creating theories, the objective is to find ones which are at least as simple in information requirements, more precise in predictions, and more fruitful in generating additional research than prior theories.
[52]

In microeconomics, principal concepts include supply and demand, marginalism, rational choice theory, opportunity cost, budget constraints, utility, and the theory of the firm.[53][54] Early macroeconomic models focused on modeling the relationships between aggregate variables, but as the relationships appeared to change over time macroeconomists were pressured to base their models in microfoundations. The aforementioned microeconomic concepts play a major part in macroeconomic models for instance, in monetary theory, the quantity theory of money predicts that increases in the money supply increase inflation, and inflation is assumed to be influenced by rational expectations. In development economics, slower growth in developed nations has been sometimes predicted because of the declining marginal returns of investment and capital, and this has been observed in the Four Asian Tigers. Sometimes an economic hypothesis is only qualitative, not quantitative.[55] Expositions of economic reasoning often use two-dimensional graphs to illustrate theoretical relationships. At a higher level of generality, Paul Samuelson's treatise Foundations of Economic Analysis (1947) used mathematical methods to represent the theory, particularly as to maximizing behavioral relations of agents reaching equilibrium. The book focused on examining the class of statements called operationally meaningful theorems in economics, which are theorems that can conceivably be refuted by empirical data.[56] Empirical investigation Main articles: Econometrics and Experimental economics
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Economic theories are frequently tested empirically, largely through the use of econometrics using economic data.[57] The controlled experiments common to the physical sciences are difficult and uncommon in economics,[58] and instead broad data is observationally studied; this type of testing is typically regarded as less rigorous than controlled experimentation, and the conclusions typically more tentative. The number of laws discovered by the discipline of economics is relatively very low compared to the physical sciences.[citation needed] Statistical methods such as regression analysis are common. Practitioners use such methods to estimate the size, economic significance, and statistical significance ("signal strength") of the hypothesized relation(s) and to adjust for noise from other variables. By such means, a hypothesis may gain acceptance, although in a probabilistic, rather than certain, sense. Acceptance is dependent upon the falsifiable hypothesis surviving tests. Use of commonly accepted methods need not produce a final conclusion or even a consensus on a particular question, given different tests, data sets, and prior beliefs. Criticism based on professional standards and non-replicability of results serve as further checks against bias, errors, and over-generalization,[54][59] although much economic research has been accused of being non-replicable, and prestigious journals have been accused of not facilitating replication through the provision of the code and data.[60] Like theories, uses of test statistics are themselves open to critical analysis,[61] although critical commentary on papers in economics in prestigious journals such as the American Economic Review has declined precipitously in the past 40 years. This has been attributed to journals' incentives to maximize citations in order to rank higher on the Social Science Citation Index (SSCI).[62] In applied economics, input-output models employing linear programming methods are quite common. Large amounts of data are run through computer programs to analyze the impact of certain policies; IMPLAN is one well-known example. Experimental economics has promoted the use of scientifically controlled experiments. This has reduced long-noted distinction of economics from natural sciences allowed direct tests of what were previously taken as axioms.[63] In some cases these have found that the axioms are not entirely correct; for example, the ultimatum game has revealed that people reject unequal offers. In behavioral economics, psychologists Daniel Kahneman and Amos Tversky have won Nobel Prizes in economics for their empirical discovery of several cognitive biases and heuristics. Similar empirical testing occurs in neuroeconomics. Another example is the assumption of narrowly selfish preferences versus a model that tests for selfish, altruistic, and cooperative preferences. [64] These techniques have led some to argue that economics is a "genuine science."[8] Game theory

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Main article: Game theory Game theory is a branch of applied mathematics that studies strategic interactions between agents. In strategic games, agents choose strategies that will maximize their payoff, given the strategies the other agents choose. It provides a formal modeling approach to social situations in which decision makers interact with other agents. Game theory generalizes maximization approaches developed to analyze markets such as the supply and demand model. The field dates from the 1944 classic Theory of Games and Economic Behavior by John von Neumann and Oskar Morgenstern. It has found significant applications in many areas outside economics as usually construed, including formulation of nuclear strategies, ethics, political science, and evolutionary theory.[65] Profession Main article: Economist The professionalization of economics, reflected in the growth of graduate programs on the subject, has been described as "the main change in economics since around 1900". [66] Most major universities and many colleges have a major, school, or department in which academic degrees are awarded in the subject, whether in the liberal arts, business, or for professional study; see Master of Economics. The Nobel Memorial Prize in Economic Sciences (commonly known as the Nobel Prize in Economics) is a prize awarded to economists each year for outstanding intellectual contributions in the field. In the private sector, professional economists are employed as consultants and in industry, including banking and finance. Economists also work for various government departments and agencies, for example, the national Treasury, Central Bank or Bureau of Statistics. Related subjects Main articles: Philosophy of economics, Law and Economics, Political economy, and Natural resource economics Economics is one social science among several and has fields bordering on other areas, including economic geography, economic history, public choice, energy economics, cultural economics, and institutional economics. Law and economics, or economic analysis of law, is an approach to legal theory that applies methods of economics to law. It includes the use of economic concepts to explain the effects of legal rules, to assess which legal rules are economically efficient, and to predict what the legal
31

rules will be.[67] A seminal article by Ronald Coase published in 1961 suggested that well-defined property rights could overcome the problems of externalities.[68] Political economy is the interdisciplinary study that combines economics, law, and political science in explaining how political institutions, the political environment, and the economic system (capitalist, socialist, mixed) influence each other. It studies questions such as how monopoly, rentseeking behavior, and externalities should impact government policy.[69] Historians have employed political economy to explore the ways in the past that persons and groups with common economic interests have used politics to effect changes beneficial to their interests.[70] Energy economics is a broad scientific subject area which includes topics related to energy supply and energy demand. Georgescu-Roegen reintroduced the concept of entropy in relation to economics and energy from thermodynamics, as distinguished from what he viewed as the mechanistic foundation of neoclassical economics drawn from Newtonian physics. His work contributed significantly to thermoeconomics and to ecological economics. He also did foundational work which later developed into evolutionary economics.[71] The sociological subfield of economic sociology arose, primarily through the work of mile Durkheim, Max Weber and Georg Simmel, as an approach to analysing the effects of economic phenomena in relation to the overarching social paradigm (i.e. modernity).[72] Classic works include Max Weber's The Protestant Ethic and the Spirit of Capitalism (1905) and Georg Simmel's The Philosophy of Money (1900). More recently, the works of Mark Granovetter, Peter Hedstrom and Richard Swedberg have been influential in this field. History Main article: History of economic thought Economic writings date from earlier Mesopotamian, Greek, Roman, Indian, Chinese, Persian, and Arab civilizations. Notable writers from antiquity through to the 14th century include Aristotle, Xenophon, Chanakya (also known as Kautilya), Qin Shi Huang, Thomas Aquinas, and Ibn Khaldun. The works of Aristotle had a profound influence on Aquinas, who in turn influenced the late scholastics of the 14th to 17th centuries.[73] Joseph Schumpeter described the latter as "coming nearer than any other group to being the 'founders' of scientific economics" as to monetary, interest, and value theory within a natural-law perspective.[74]

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1638 painting of a French seaport during the heyday of mercantilism Two groups, later called 'mercantilists' and 'physiocrats', more directly influenced the subsequent development of the subject. Both groups were associated with the rise of economic nationalism and modern capitalism in Europe. Mercantilism was an economic doctrine that flourished from the 16th to 18th century in a prolific pamphlet literature, whether of merchants or statesmen. It held that a nation's wealth depended on its accumulation of gold and silver. Nations without access to mines could obtain gold and silver from trade only by selling goods abroad and restricting imports other than of gold and silver. The doctrine called for importing cheap raw materials to be used in manufacturing goods, which could be exported, and for state regulation to impose protective tariffs on foreign manufactured goods and prohibit manufacturing in the colonies.[75] Physiocrats, a group of 18th century French thinkers and writers, developed the idea of the economy as a circular flow of income and output. Physiocrats believed that only agricultural production generated a clear surplus over cost, so that agriculture was the basis of all wealth. Thus, they opposed the mercantilist policy of promoting manufacturing and trade at the expense of agriculture, including import tariffs. Physiocrats advocated replacing administratively costly tax collections with a single tax on income of land owners. In reaction against copious mercantilist trade regulations, the physiocrats advocated a policy of laissez-faire, which called for minimal government intervention in the economy.[76] Modern economic analysis is customarily said to have begun with Adam Smith (17231790).[77] Smith was harshly critical of the mercantilists but described the physiocratic system "with all its imperfections" as "perhaps the purest approximation to the truth that has yet been published" on the subject.[78] Classical political economy Main article: Classical economics Publication of Adam Smith's The Wealth of Nations in 1776, has been described as "the effective birth of economics as a separate discipline."[79] The book identified land, labor, and capital as the three factors of production and the major contributors to a nation's wealth.
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Adam Smith wrote The Wealth of Nations Smith discusses the benefits of the specialization by division of labour. His "theorem" that "the division of labor is limited by the extent of the market" has been described as the "core of a theory of the functions of firm and industry" and a "fundamental principle of economic organization."[80] To Smith has also been ascribed "the most important substantive proposition in all of economics" and foundation of resource-allocation theory that, under competition, owners of resources (labor, land, and capital) will use them most profitably, resulting in an equal rate of return in equilibrium for all uses (adjusted for apparent differences arising from such factors as training and unemployment).[81] In Smith's view, the ideal economy is a self-regulating market system that automatically satisfies the economic needs of the populace. He described the market mechanism as an "invisible hand" that leads all individuals, in pursuit of their own self-interests, to produce the greatest benefit for society as a whole. Smith incorporated some of the Physiocrats' ideas, including laissez-faire, into his own economic theories, but rejected the idea that only agriculture was productive. In his famous invisible-hand analogy, Smith argued for the seemingly paradoxical notion that competitive markets tended to advance broader social interests, although driven by narrower selfinterest. The general approach that Smith helped initiate was called political economy and later classical economics. It included such notables as Thomas Malthus, David Ricardo, and John Stuart Mill writing from about 1770 to 1870.[82] The period from 1815 to 1845 was one of the richest in the history of economic thought.[83] While Adam Smith emphasized the production of income, David Ricardo focused on the distribution of income among landowners, workers, and capitalists. Ricardo saw an inherent conflict between landowners on the one hand and labor and capital on the other. He posited that the

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growth of population and capital, pressing against a fixed supply of land, pushes up rents and holds down wages and profits.

Malthus cautioned law makers on the effects of poverty reduction policies Thomas Robert Malthus used the idea of diminishing returns to explain low living standards. Human population, he argued, tended to increase geometrically, outstripping the production of food, which increased arithmetically. The force of a rapidly growing population against a limited amount of land meant diminishing returns to labor. The result, he claimed, was chronically low wages, which prevented the standard of living for most of the population from rising above the subsistence level. Malthus also questioned the automatic tendency of a market economy to produce full employment. He blamed unemployment upon the economy's tendency to limit its spending by saving too much, a theme that lay forgotten until John Maynard Keynes revived it in the 1930s. Coming at the end of the Classical tradition, John Stuart Mill parted company with the earlier classical economists on the inevitability of the distribution of income produced by the market system. Mill pointed to a distinct difference between the market's two roles: allocation of resources and distribution of income. The market might be efficient in allocating resources but not in distributing income, he wrote, making it necessary for society to intervene. Value theory was important in classical theory. Smith wrote that the "real price of every thing ... is the toil and trouble of acquiring it" as influenced by its scarcity. Smith maintained that, with rent and profit, other costs besides wages also enter the price of a commodity.[84] Other classical economists presented variations on Smith, termed the 'labour theory of value'. Classical economics focused on the tendency of markets to move to long-run equilibrium. Marxism

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Main article: Marxian economics

The Marxist school of economic thought comes from the work of German economist Karl Marx. Marxist (later, Marxian) economics descends from classical economics. It derives from the work of Karl Marx. The first volume of Marx's major work, Das Kapital, was published in German in 1867. In it, Marx focused on the labour theory of value and what he considered to be the exploitation of labour by capital.[85] The labour theory of value held that the value of an exchanged commodity was determined by the labor that went into its production. Neoclassical economics Main article: Neoclassical economics A body of theory later termed 'neoclassical economics' or 'marginalism' formed from about 1870 to 1910. The term 'economics' was popularized by such neoclassical economists as Alfred Marshall as a concise synonym for 'economic science' and a substitute for the earlier, broader term 'political economy'.[86] This corresponded to the influence on the subject of mathematical methods used in the natural sciences.[2] Neoclassical economics systematized supply and demand as joint determinants of price and quantity in market equilibrium, affecting both the allocation of output and the distribution of income. It dispensed with the labour theory of value inherited from classical economics in favor of a marginal utility theory of value on the demand side and a more general theory of costs on the supply side.[87] In the 20th century, neoclassical theorists moved away from an earlier notion suggesting that total utility for a society could be measured in favor of ordinal utility, which hypothesizes merely behavior-based relations across persons.[21][88]
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In microeconomics, neoclassical economics represents incentives and costs as playing a pervasive role in shaping decision making. An immediate example of this is the consumer theory of individual demand, which isolates how prices (as costs) and income affect quantity demanded. [21] In macroeconomics it is reflected in an early and lasting neoclassical synthesis with Keynesian macroeconomics.[89] Neoclassical economics is occasionally referred as orthodox economics whether by its critics or sympathizers. Modern mainstream economics builds on neoclassical economics but with many refinements that either supplement or generalize earlier analysis, such as econometrics, game theory, analysis of market failure and imperfect competition, and the neoclassical model of economic growth for analyzing long-run variables affecting national income. Keynesian economics Main articles: Keynesian economics and Post-Keynesian economics

John Maynard Keynes (right), was a key theorist in economics. Keynesian economics derives from John Maynard Keynes, in particular his book The General Theory of Employment, Interest and Money (1936), which ushered in contemporary macroeconomics as a distinct field.[90] The book focused on determinants of national income in the short run when prices are relatively inflexible. Keynes attempted to explain in broad theoretical detail why high labour-market unemployment might not be self-correcting due to low "effective demand" and why even price flexibility and monetary policy might be unavailing. Such terms as "revolutionary" have been applied to the book in its impact on economic analysis.[91] Keynesian economics has two successors. Post-Keynesian economics also concentrates on macroeconomic rigidities and adjustment processes. Research on micro foundations for their
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models is represented as based on real-life practices rather than simple optimizing models. It is generally associated with the University of Cambridge and the work of Joan Robinson.[92] New-Keynesian economics is also associated with developments in the Keynesian fashion. Within this group researchers tend to share with other economists the emphasis on models employing micro foundations and optimizing behavior but with a narrower focus on standard Keynesian themes such as price and wage rigidity. These are usually made to be endogenous features of the models, rather than simply assumed as in older Keynesian-style ones. Chicago School of economics Main article: Chicago school (economics) The Chicago School of economics is best known for its free market advocacy and monetarist ideas. According to Milton Friedman and monetarists, market economies are inherently stable if left to themselves and depressions result only from government intervention.[93] Friedman, for example, argued that the Great Depression was result of a contraction of the money supply, controlled by the Federal Reserve, and not by the lack of investment as Keynes had argued. Ben Bernanke, current Chairman of the Federal Reserve, is among the economists today generally accepting Friedman's analysis of the causes of the Great Depression.[94] Milton Friedman effectively took many of the basic principles set forth by Adam Smith and the classical economists and modernized them. One example of this is his article in the September 1970 issue of The New York Times Magazine, where he claims that the social responsibility of business should be to use its resources and engage in activities designed to increase its profits... (through) open and free competition without deception or fraud. [95] Other schools and approaches Main article: Schools of economics Other well-known schools or trends of thought referring to a particular style of economics practiced at and disseminated from well-defined groups of academicians that have become known worldwide, include the Austrian School, the Freiburg School, the School of Lausanne, postKeynesian economics and the Stockholm school. Contemporary mainstream economics is sometimes separated into the Saltwater approach of those universities along the Eastern and Western coasts of the US, and the Freshwater, or Chicago-school approach. Within macroeconomics there is, in general order of their appearance in the literature; classical economics, Keynesian economics, the neoclassical synthesis, post-Keynesian economics, monetarism, new classical economics, and supply-side economics. Alternative developments include ecological economics, institutional economics, evolutionary economics, dependency
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theory, structuralist economics, world systems theory, econophysics, and biophysical economics.
[96]

Criticism "The dismal science" is a derogatory alternative name for economics devised by the Victorian historian Thomas Carlyle in the 19th century. It is often stated that Carlyle gave economics the nickname "the dismal science" as a response to the late 18th century writings of The Reverend Thomas Robert Malthus, who grimly predicted that starvation would result, as projected population growth exceeded the rate of increase in the food supply. The teachings of Malthus eventually became known under the umbrella phrase "Malthus' Dismal Theorem". His predictions were forestalled by unanticipated dramatic improvements in the efficiency of food production in the 20th century; yet the bleak end he proposed remains as a disputed future possibility, assuming human innovation fails to keep up with population growth.[97] Some economists, like John Stuart Mill or Leon Walras, have maintained that the production of wealth should not be tied to its distribution. The former is in the field of "applied economics" while the latter belongs to "social economics" and is largely a matter of power and politics.[98] In The Wealth of Nations, Adam Smith addressed many issues that are currently also the subject of debate and dispute. Smith repeatedly attacks groups of politically aligned individuals who attempt to use their collective influence to manipulate a government into doing their bidding. In Smith's day, these were referred to as factions, but are now more commonly called special interests, a term which can comprise international bankers, corporate conglomerations, outright oligopolies, monopolies, trade unions and other groups.[99] Economics per se, as a social science, is independent of the political acts of any government or other decision-making organization, however, many policymakers or individuals holding highly ranked positions that can influence other people's lives are known for arbitrarily using a plethora of economic concepts and rhetoric as vehicles to legitimize agendas and value systems, and do not limit their remarks to matters relevant to their responsibilities.[citation needed] The close relation of economic theory and practice with politics[100] is a focus of contention that may shade or distort the most unpretentious original tenets of economics, and is often confused with specific social agendas and value systems.[101] Notwithstanding, economics legitimately has a role in informing government policy. It is, indeed, in some ways an outgrowth of the older field of political economy. Some academic economic journals are currently focusing increased efforts on gauging the consensus of economists regarding certain policy issues in hopes of effecting a more informed political environment. Currently, there exists a low approval rate from professional economists regarding many public policies. Policy issues featured in a recent survey of AEA economists include trade restrictions, social insurance for those put out of work by international competition, genetically modified foods, curbside recycling, health insurance (several questions), medical
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malpractice, barriers to entering the medical profession, organ donations, unhealthy foods, mortgage deductions, taxing internet sales, Wal-Mart, casinos, ethanol subsidies, and inflation targeting.[102] In Steady State Economics 1977, Herman Daly argues that there exist logical inconsistencies between the emphasis placed on economic growth and the limited availability of natural resources.
[103]

Issues like central bank independence, central bank policies and rhetoric in central bank governors discourse or the premises of macroeconomic policies[104] (monetary and fiscal policy) of the state, are focus of contention and criticism.[105] Deirdre McCloskey has argued that many empirical economic studies are poorly reported, and while her critique has been well-received, she and Stephen Ziliak argue that practice has not improved.[106] This latter contention is controversial.[107] A 2002 International Monetary Fund study looked at consensus forecasts (the forecasts of large groups of economists) that were made in advance of 60 different national recessions in the 90s: in 97% of the cases the economists did not predict the contraction a year in advance. On those rare occasions when economists did successfully predict recessions, they significantly underestimated their severity.[108] Criticism of assumptions Economics has been subject to criticism that it relies on unrealistic, unverifiable, or highly simplified assumptions, in some cases because these assumptions lend themselves to elegant mathematics. Examples include perfect information, profit maximization and rational choices.[109] [110] Some contemporary economic theory has focused on addressing these problems through the emerging subdisciplines of information economics, behavioral economics, and complexity economics, with Geoffrey Hodgson forecasting a major shift in the mainstream approach to economics.[111] Nevertheless, prominent mainstream economists such as Keynes[112] and Joskow, along with heterodox economists, have observed that much of economics is conceptual rather than quantitative, and difficult to model and formalize quantitatively. In a discussion on oligopoly research, Paul Joskow pointed out in 1975 that in practice, serious students of actual economies tended to use "informal models" based upon qualitative factors specific to particular industries. Joskow had a strong feeling that the important work in oligopoly was done through informal observations while formal models were "trotted out ex post". He argued that formal models were largely not important in the empirical work, either, and that the fundamental factor behind the theory of the firm, behavior, was neglected.[113]

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Despite these concerns, mainstream graduate programs have become increasingly technical and mathematical.[114] Although much of the most groundbreaking economic research in history involved concepts rather than math, today it is nearly impossible to publish a non-mathematical paper in top economic journals.[115] Disillusionment on the part of some students with the abstract and technical focus of economics led to the post-autistic economics movement, which began in France in 2000. David Colander, an advocate of complexity economics, has also commented critically on the mathematical methods of economics, which he associates with the MIT approach to economics, as opposed to the Chicago approach (although he also states that the Chicago school can no longer be called intuitive). He believes that the policy recommendations following from Chicago's intuitive approach had something to do with the decline of intuitive economics. He notes that he has encountered colleagues who have outright refused to discuss interesting economics without a formal model, and he believes that the models can sometimes restrict intuition.[116] More recently, however, he has written that heterodox economics, which generally takes a more intuitive approach, needs to ally with mathematicians and become more mathematical.[50] "Mainstream economics is a formal modeling field", he writes, and what is needed is not less math but higher levels of math. He notes that some of the topics highlighted by heterodox economists, such as the importance of institutions or uncertainty, are now being studied in the mainstream through mathematical models without mention of the work done by the heterodox economists. New institutional economics, for example, examines institutions mathematically without much relation to the largely heterodox field of institutional economics. In his 1974 Nobel Prize lecture, Friedrich Hayek, known for his close association to the heterodox school of Austrian economics, attributed policy failures in economic advising to an uncritical and unscientific propensity to imitate mathematical procedures used in the physical sciences. He argued that even much-studied economic phenomena, such as labor-market unemployment, are inherently more complex than their counterparts in the physical sciences where such methods were earlier formed. Similarly, theory and data are often very imprecise and lend themselves only to the direction of a change needed, not its size.[117] In part because of criticism, economics has undergone a thorough cumulative formalization and elaboration of concepts and methods since the 1940s, some of which have been toward application of the hypothetico-deductive method to explain realworld phenomena Supply and demand

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The price P of a product is determined by a balance between production at each price (supply S) and the desires of those with purchasing power at each price (demand D). The diagram shows a positive shift in demand from D1 to D2, resulting in an increase in price (P) and quantity sold (Q) of the product. Supply and demand is an economic model of price determination in a market. It concludes that in a competitive market, the unit price for a particular good will vary until it settles at a point where the quantity demanded by consumers (at current price) will equal the quantity supplied by producers (at current price), resulting in an economic equilibrium of price and quantity. The four basic laws of supply and demand are [1] 1. If demand increases and supply remains unchanged then higher equilibrium price and quantity. 2. If demand decreases and supply remains the same then lower equilibrium price and quantity. 3. If supply increases and demand remains unchanged then lower equilibrium price and higher quantity. 4. If supply decreases and demand remains the same then higher price and lower quantity. The graphical representation of supply and demand The supply-demand model is a partial equilibrium model representing the determination of the price of a particular good and the quantity of that good which is traded. Although it is normal to regard the quantity demanded and the quantity supplied as functions of the price of the good, the standard graphical representation, usually attributed to Alfred Marshall, has price on the vertical axis and quantity on the horizontal axis, the opposite of the standard convention for the representation of a mathematical function.
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Determinants of supply and demand other than the price of the good in question, such as consumers' income, input prices and so on, are not explicitly represented in the supply-demand diagram. Changes in the values of these variables are represented by shifts in the supply and demand curves. By contrast, responses to changes in the price of the good are represented as movements along unchanged supply and demand curves. Supply schedule The supply schedule, depicted graphically as the supply curve, represents the amount of some good that producers are willing and able to sell at various prices, assuming ceteris paribus, that is, assuming all determinants of supply other than the price of the good in question, such as technology and the prices of factors of production, remain the same. Under the assumption of perfect competition, supply is determined by marginal cost. Firms will produce additional output as long as the cost of producing an extra unit of output is less than the price they will receive. By its very nature, conceptualizing a supply curve requires that the firm be a perfect competitor that is, that the firm has no influence over the market price. This is because each point on the supply curve is the answer to the question "If this firm is faced with this potential price, how much output will it be able to and willing to sell?" If a firm has market power, so its decision of how much output to provide to the market influences the market price, then the firm is not "faced with" any price, and the question is meaningless. Economists distinguish between the supply curve of an individual firm and the market supply curve. The market supply curve is obtained by summing the quantities supplied by all suppliers at each potential price. Thus in the graph of the supply curve, individual firms' supply curves are added horizontally to obtain the market supply curve. Economists also distinguish the short-run market supply curve from the long-run market supply curve. In this context, two things are assumed constant by definition of the short run: the availability of one or more fixed inputs (typically physical capital), and the number of firms in the industry. In the long run, firms have a chance to adjust their holdings of physical capital, enabling them to better adjust their quantity supplied at any given price. Furthermore, in the long run potential competitors can enter or exit the industry in response to market conditions. For both of these reasons, long-run market supply curves are flatter than their short-run counterparts. The determinants of supply follow: 1. Production costs 2. The technology of production
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3. The price of related goods 4. Firm's expectations about future prices 5. Number of suppliers Demand schedule The demand schedule, depicted graphically as the demand curve, represents the amount of some good that buyers are willing and able to purchase at various prices, assuming all determinants of demand other than the price of the good in question, such as income, tastes and preferences, the price of substitute goods, and the price of complementary goods, remain the same. Following the law of demand, the demand curve is almost always represented as downward-sloping, meaning that as price decreases, consumers will buy more of the good.[2] Just as the supply curves reflect marginal cost curves, demand curves are determined by marginal utility curves.[3] Consumers will be willing to buy a given quantity of a good, at a given price, if the marginal utility of additional consumption is equal to the opportunity cost determined by the price, that is, the marginal utility of alternative consumption choices. The demand schedule is defined as the willingness and ability of a consumer to purchase a given product in a given frame of time. As described above, the demand curve is generally downward-sloping. There may be rare examples of goods that have upward-sloping demand curves. Two different hypothetical types of goods with upward-sloping demand curves are Giffen goods (an inferior but staple good) and Veblen goods (goods made more fashionable by a higher price). By its very nature, conceptualizing a demand curve requires that the purchaser be a perfect competitorthat is, that the purchaser has no influence over the market price. This is because each point on the demand curve is the answer to the question "If this buyer is faced with this potential price, how much of the product will it purchase?" If a buyer has market power, so its decision of how much to buy influences the market price, then the buyer is not "faced with" any price, and the question is meaningless. As with supply curves, economists distinguish between the demand curve of an individual and the market demand curve. The market demand curve is obtained by summing the quantities demanded by all consumers at each potential price. Thus in the graph of the demand curve, individuals' demand curves are added horizontally to obtain the market demand curve. The determinants of demand follow: 1. Income
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2. Tastes and preferences 3. Prices of related goods and services 4. Expectations 5. Number of Buyers Microeconomics Equilibrium Equilibrium is defined to the price-quantity pair where the quantity demanded is equal to the quantity supplied, represented by the intersection of the demand and supply curves. Market Equilibrium: A situation in a market when the price is such that the quantity that consumers wish to demand is correctly balanced by the quantity that firms wish to supply. Comparative static analysis: Examines the likely effect on the equilibrium of a change in the external conditions affecting the market. Changes in market equilibrium Practical uses of supply and demand analysis often center on the different variables that change equilibrium price and quantity, represented as shifts in the respective curves. Comparative statics of such a shift traces the effects from the initial equilibrium to the new equilibrium. Demand curve shifts

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An outward (rightward) shift in demand increases both equilibrium price and quantity When consumers increase the quantity demanded at a given price, it is referred to as an increase in demand. Increased demand can be represented on the graph as the curve being shifted to the right. At each price point, a greater quantity is demanded, as from the initial curve D1 to the new curve D2. In the diagram, this raises the equilibrium price from P1 to the higher P2. This raises the equilibrium quantity from Q1 to the higher Q2. A movement along the curve is described as a "change in the quantity demanded" to distinguish it from a "change in demand," that is, a shift of the curve. In the example above, there has been an increase in demand which has caused an increase in (equilibrium) quantity. The increase in demand could also come from changing tastes and fashions, incomes, price changes in complementary and substitute goods, market expectations, and number of buyers. This would cause the entire demand curve to shift changing the equilibrium price and quantity. Note in the diagram that the shift of the demand curve, by causing a new equilibrium price to emerge, resulted in movement along the supply curve from the point (Q1, P1) to the point Q2, P2). If the demand decreases, then the opposite happens: a shift of the curve to the left. If the demand starts at D2, and decreases to D1, the equilibrium price will decrease, and the equilibrium quantity will also decrease. The quantity supplied at each price is the same as before the demand shift, reflecting the fact that the supply curve has not shifted; but the equilibrium quantity and price are different as a result of the change (shift) in demand.

The movement of the demand curve in response to a change in a non-price determinant of demand is caused by a change in the x-intercept, the constant term of the demand equation. Supply curve shifts

An outward (rightward) shift in supply reduces the equilibrium price but increases the equilibrium quantity
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When the suppliers' unit input costs change, or when technological progress occurs, the supply curve shifts. For example, assume that someone invents a better way of growing wheat so that the cost of growing a given quantity of wheat decreases. Otherwise stated, producers will be willing to supply more wheat at every price and this shifts the supply curve S1 outward, to S2an increase in supply. This increase in supply causes the equilibrium price to decrease from P1 to P2. The equilibrium quantity increases from Q1 to Q2 as consumers move along the demand curve to the new lower price. As a result of a supply curve shift, the price and the quantity move in opposite directions. If the quantity supplied decreases, the opposite happens. If the supply curve starts at S2, and shifts leftward to S1, the equilibrium price will increase and the equilibrium quantity will decrease as consumers move along the demand curve to the new higher price and associated lower quantity demanded. The quantity demanded at each price is the same as before the supply shift, reflecting the fact that the demand curve has not shifted. But due to the change (shift) in supply, the equilibrium quantity and price have changed. The movement of the supply curve in response to a change in a non-price determinant of supply is caused by a change in the y-intercept, the constant term of the supply equation. The supply curve shifts up and down the y axis as non-price determinants of demand change. Elasticity Elasticity is a central concept in the theory of supply and demand. In this context, elasticity refers to how strongly the quantities supplied and demanded respond to various factors, including price and other determinants. One way to define elasticity is the percentage change in one variable (the quantity supplied or demanded) divided by the percentage change in the causative variable. For discrete changes this is known as arc elasticity, which calculates the elasticity over a range of values. In contrast, point elasticity uses differential calculus to determine the elasticity at a specific point. Elasticity is a measure of relative changes. Often, it is useful to know how strongly the quantity demanded or supplied will change when the price changes. This is known as the price elasticity of demand or the price elasticity of supply, respectively. If a monopolist decides to increase the price of its product, how will this affect the amount of their good that customers purchase? This knowledge helps the firm determine whether the increased unit price will offset the decrease in sales volume. Likewise, if a government imposes a tax on a good, thereby increasing the effective price, knowledge of the price elasticity will help us to predict the size of the resulting effect on the quantity demanded. Elasticity is calculated as the percentage change in quantity divided by the associated percentage change in price. For example, if the price moves from $1.00 to $1.05, and as a result the quantity

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supplied goes from 100 pens to 102 pens, the quantity of pens increased by 2%, and the price increased by 5%, so the price elasticity of supply is 2%/5% or 0.4. Since the changes are in percentages, changing the unit of measurement or the currency will not affect the elasticity. If the quantity demanded or supplied changes by a greater percentage than the price did, then demand or supply is said to be elastic. If the quantity changes by a lesser percentage than the price did, demand or supply is said to be inelastic. If supply is perfectly inelastic;that is, has zero elasticity, then there is a vertical supply curve. Short-run supply curves are not as elastic as long-run supply curves, because in the long run firms can respond to market conditions by varying their holdings of physical capital, and because in the long run new firms can enter or old firms can exit the market. Elasticity in relation to variables other than price can also be considered. One of the most common to consider is income. How strongly would the demand for a good change if income increased or decreased? The relative percentage change is known as the income elasticity of demand. Another elasticity sometimes considered is the cross elasticity of demand, which measures the responsiveness of the quantity demanded of a good to a change in the price of another good. This is often considered when looking at the relative changes in demand when studying complements and substitute goods. Complements are goods that are typically utilized together, where if one is consumed, usually the other is also. Substitute goods are those where one can be substituted for the other, and if the price of one good rises, one may purchase less of it and instead purchase its substitute. Cross elasticity of demand is measured as the percentage change in demand for the first good divided by the causative percentage change in the price of the other good. For an example with a complement good, if, in response to a 10% increase in the price of fuel, the quantity of new cars demanded decreased by 20%, the cross elasticity of demand would be -2.0. In a frictionless economy, the price and quantity in any market would be able to move to a new equilibrium position instantly, without spending any time away from equilibrium. Any change in market conditions would cause a jump from one equilibrium position to another at once. In real economic systems, markets don't always behave in this way, and markets take some time before they reach a new equilibrium position. This is due to asymmetric, or at least imperfect, information, where no one economic agent could ever be expected to know every relevant condition in every market. Ultimately both producers and consumers must rely on trial and error as well as prediction and calculation to find the true equilibrium of a market. Vertical supply curve (perfectly inelastic supply)

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When demand D1 is in effect, the price will be P1. When D2 is occurring, the price will be P2. The equilibrium quantity is always Q, and any shifts in demand will only affect price. If the quantity supplied is fixed in the very short run no matter what the price, the supply curve is a vertical line, and supply is called perfectly inelastic. Other markets The model of supply and demand also applies to various specialty markets. The model is commonly applied to wages, in the market for labor. The typical roles of supplier and demander are reversed. The suppliers are individuals, who try to sell their labor for the highest price. The demanders of labor are businesses, which try to buy the type of labor they need at the lowest price. The equilibrium price for a certain type of labor is the wage rate.[4] A number of economists (for example Pierangelo Garegnani[5], Robert L. Vienneau[6], and Arrigo Opocher & Ian Steedman[7]), building on the work of Piero Sraffa, argue that that this model of the labor market, even given all its assumptions, is logically incoherent. Michael Anyadike-Danes and Wyne Godley [8] argue, based on simulation results, that little of the empirical work done with the textbook model constitutes a potentially falsifying test, and, consequently, empirical evidence hardly exists for that model. Graham White [9] argues, partially on the basis of Sraffianism, that the policy of increased labor market flexibility, including the reduction of minimum wages, does not have an "intellectually coherent" argument in economic theory. This criticism of the application of the model of supply and demand generalizes, particularly to all markets for factors of production. It also has implications for monetary theory[10] not drawn out here.

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In both classical and Keynesian economics, the money market is analyzed as a supply-and-demand system with interest rates being the price. The money supply may be a vertical supply curve, if the central bank of a country chooses to use monetary policy to fix its value regardless of the interest rate; in this case the money supply is totally inelastic. On the other hand,[11] the money supply curve is a horizontal line if the central bank is targeting a fixed interest rate and ignoring the value of the money supply; in this case the money supply curve is perfectly elastic. The demand for money intersects with the money supply to determine the interest rate.[12] Empirical estimation Demand and supply relations in a market can be statistically estimated from price, quantity, and other data with sufficient information in the model. This can be done with simultaneous-equation methods of estimation in econometrics. Such methods allow solving for the model-relevant "structural coefficients," the estimated algebraic counterparts of the theory. The Parameter identification problem is a common issue in "structural estimation." Typically, data on exogenous variables (that is, variables other than price and quantity, both of which are endogenous variables) are needed to perform such an estimation. An alternative to "structural estimation" is reduced-form estimation, which regresses each of the endogenous variables on the respective exogenous variables. Macroeconomic uses of demand and supply Demand and supply have also been generalized to explain macroeconomic variables in a market economy, including the quantity of total output and the general price level. The Aggregate Demand-Aggregate Supply model may be the most direct application of supply and demand to macroeconomics, but other macroeconomic models also use supply and demand. Compared to microeconomic uses of demand and supply, different (and more controversial) theoretical considerations apply to such macroeconomic counterparts as aggregate demand and aggregate supply. Demand and supply are also used in macroeconomic theory to relate money supply and money demand to interest rates, and to relate labor supply and labor demand to wage rates. History The power of supply and demand was understood to some extent by several early Muslim economists, such as Ibn Taymiyyah who illustrates:[verification needed] "If desire for goods increases while its availability decreases, its price rises. On the other hand, if availability of the good increases and the desire for it decreases, the price comes down."[13] John Locke's 1691 work Some Considerations on the Consequences of the Lowering of Interest and the Raising of the Value of Money.[14] includes an early and clear description of supply and
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demand and their relationship. In this description demand is rent: The price of any commodity rises or falls by the proportion of the number of buyer and sellers and that which regulates the price... [of goods] is nothing else but their quantity in proportion to their rent. The phrase "supply and demand" was first used by James Denham-Steuart in his Inquiry into the Principles of Political Oeconomy, published in 1767. Adam Smith used the phrase in his 1776 book The Wealth of Nations, and David Ricardo titled one chapter of his 1817 work Principles of Political Economy and Taxation "On the Influence of Demand and Supply on Price".[15] In The Wealth of Nations, Smith generally assumed that the supply price was fixed but that its "merit" (value) would decrease as its "scarcity" increased, in effect what was later called the law of demand. Ricardo, in Principles of Political Economy and Taxation, more rigorously laid down the idea of the assumptions that were used to build his ideas of supply and demand. Antoine Augustin Cournot first developed a mathematical model of supply and demand in his 1838 Researches into the Mathematical Principles of Wealth, including diagrams. During the late 19th century the marginalist school of thought emerged. This field mainly was started by Stanley Jevons, Carl Menger, and Lon Walras. The key idea was that the price was set by the most expensive price, that is, the price at the margin. This was a substantial change from Adam Smith's thoughts on determining the supply price. In his 1870 essay "On the Graphical Representation of Supply and Demand", Fleeming Jenkin in the course of "introduc[ing] the diagrammatic method into the English economic literature" published the first drawing of supply and demand curves therein,[16] including comparative statics from a shift of supply or demand and application to the labor market. [17] The model was further developed and popularized by Alfred Marshall in the 1890 textbook Principles of Economics.[15] Criticism At least two assumptions are necessary for the validity of the standard model: first, that supply and demand are independent; and second, that supply is "constrained by a fixed resource"; If these conditions do not hold, then the Marshallian model cannot be sustained. Sraffa's critique focused on the inconsistency (except in implausible circumstances) of partial equilibrium analysis and the rationale for the upward-slope of the supply curve in a market for a produced consumption good[18]. The notability of Sraffa's critique is also demonstrated by Paul A. Samuelson's comments and engagements with it over many years, for example: "What a cleaned-up version of Sraffa (1926) establishes is how nearly empty are all of Marshall's partial equilibrium boxes. To a logical purist of Wittgenstein and Sraffa class, the Marshallian partial equilibrium box of constant cost is even more empty than the box of increasing cost."[19].
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Aggregate excess demand in a market is the difference between the quantity demanded and the quantity supplied as a function of price. In the model with an upward-sloping supply curve and downward-sloping demand curve, the aggregate excess demand function only intersects the axis at one point, namely, at the point where the supply and demand curves intersect. The SonnenscheinMantel-Debreu theorem shows that the standard model cannot be rigorously derived in general from general equilibrium theory[20]. The model of prices being determined by supply and demand assumes perfect competition. But: "economists have no adequate model of how individuals and firms adjust prices in a competitive model. If all participants are price-takers by definition, then the actor who adjusts prices to eliminate excess demand is not specified"[21].

Goodwin, Nelson, Ackerman, and Weissskopf write: "If we mistakenly confuse precision with accuracy, then we might be misled into thinking that an explanation expressed in precise mathematical or graphical terms is somehow more rigorous or useful than one that takes into account particulars of history, institutions or business strategy. This is not the case. Therefore, it is important not to put too much confidence in the apparent precision of supply and demand graphs. Supply and demand analysis is a useful precisely formulated conceptual tool that clever people have devised to help us gain an abstract understanding of a complex world. It does not - nor should it be expected to - give us in addition an accurate and complete description of any particular real world market." [22] Economies of scale: Mass production The intent of mass production is to produce in extremely large quantities at the lowest possible cost so as to drive down price and create demand. There is also a learning curve with the production of most new products that exhibits a similar phenomenon of lowering costs, which in turn drives demand. In the case of mass production, both the assumptions of supply and demand being independent and constraints on supply are not applicable. The price response to the change in supply curve is valid, but the price response to the change in demand curve is not. The lowered price in response to increased demand is because the incremental cost of production is less than the average cost, assuming that there is excess capacity, which is the condition of most manufactured goods today. In typical business cycles, prices do increase as maximum capacity is approached; however, this usually results in an expansion of capacity using more efficient processes, leading to even lower prices in the next cycle.

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The economic analysis of law (also known as law and economics) is an analysis of law applying methods of economics. Economic concepts are used to explain the effects of laws, to assess which legal rules are economically efficient, and to predict which legal rules will be promulgated.[1] Contents [hide]

1 Relationship to other disciplines and approaches 2 Origin and history 3 Positive and normative law and economics o 3.1 Positive law and economics o 3.2 Normative law and economics 4 Important scholars 5 Influence 6 Critique o 6.1 Rational choice theory o 6.2 Pareto efficiency o 6.3 Responses 7 Contemporary developments 8 Universities with law and economics programs 9 See also 10 Journals 11 Regional and international associations 12 Bibliography 13 Notes

[edit] Relationship to other disciplines and approaches As used by lawyers and legal scholars, the phrase "law and economics" refers to the application of the methods of economics to legal problems. Because of the overlap between legal systems and political systems, some of the issues in law and economics are also raised in political economy, constitutional economics and political science. Most formal academic work done in law and economics is broadly within the Neoclassical tradition.[citation needed] Approaches to the same issues from Marxist and critical theory/Frankfurt School perspectives usually do not identify themselves as "law and economics". For example, research by members of the critical legal studies movement and the sociology of law considers many of the same fundamental issues as does work labeled "law and economics".

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The one wing that represents a non-neoclassical approach to "law and economics" is the Continental (mainly German) tradition that sees the concept starting out of the Staatswissenschaften approach and the German Historical School of Economics; this view is represented in the Elgar Companion to Law and Economics (2nd ed. 2005) andthough not exclusivelyin the European Journal of Law and Economics. Here, consciously non-neoclassical approaches to economics are used for the analysis of legal (and administrative/governance) problems. Origin and history As early as in the 18th century, Adam Smith discussed the economic effect of mercantilist legislation. However, to apply economics to analyze the law regulating nonmarket activities is relatively new. In 1961, Ronald Coase and Guido Calabresi independently from each other published two groundbreaking articles: "The Problem of Social Cost" [2] and "Some Thoughts on Risk Distribution and the Law of Torts".[3] This can be seen as the starting point for the modern school of law and economics.[4] In the early 1970s, Henry Manne (a former student of Coase) set out to build a Center for Law and Economics at a major law school. He began at Rochester, worked at Miami, but was soon made unwelcome, moved to Emory, and ended at George Mason. The latter soon became a center for the education of judgesmany long out of law school and never exposed to numbers and economics. Manne also attracted the support of the John M. Olin Foundation, whose support accelerated the movement. Today, Olin centers (or programs) for Law and Economics exist at many universities. Positive and normative law and economics Economic analysis of law is usually divided into two subfields, positive and normative. Positive law and economics Positive law and economics uses economic analysis to predict the effects of various legal rules. So, for example, a positive economic analysis of tort law would predict the effects of a strict liability rule as opposed to the effects of a negligence rule. Positive law and economics has also at times purported to explain the development of legal rules, for example the common law of torts, in terms of their economic efficiency. Normative law and economics Normative law and economics goes one step further and makes policy recommendations based on the economic consequences of various policies. The key concept for normative economic analysis is efficiency, in particular, allocative efficiency.
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A common concept of efficiency used by law and economics scholars is Pareto efficiency. A legal rule is Pareto efficient if it could not be changed so as to make one person better off without making another person worse off. A weaker conception of efficiency is Kaldor-Hicks efficiency. A legal rule is Kaldor-Hicks efficient if it could be made Pareto efficient by some parties compensating others as to offset their loss. Important scholars Important figures include the Nobel Prize winning economists Ronald Coase and Gary Becker, U.S. Court of Appeals for the Seventh Circuit judges Frank Easterbrook and Richard Posner, Andrei Shleifer and other distinguished scholars such as Robert Cooter, Henry Manne, William Landes, A. Mitchell Polinsky, and Ugyen Rangdol from Rangsit University. Guido Calabresi, judge for the U.S. Court of Appeals for the Second Circuit, author of the 1970 book, The Costs of Accidents: A Legal and Economic Analysis, wrote in depth on this subject, with Costs of Accidents being cited as influential in its extensive treatment of the proper incentives and compensation required in accident situations.[5] Calabresi took a different approach in his 1985 book, Ideals, Beliefs, Attitudes, and the Law, where he argued , "who is the cheapest avoider of a cost, depends on the valuations put on acts, activities and beliefs by the whole of our law and not on some objective or scientific notion (69)." Influence In the United States, economic analysis of law has been extremely influential. Judicial opinions utilize economic analysis and the theories of law and economics with some regularity. The influence of law and economics has also been felt in legal education. Many law schools in North America, Europe, and Asia have faculty members with a graduate degree in economics. In addition, many professional economists now study and write on the relationship between economics and legal doctrines. Anthony Kronman, former dean of Yale Law School, has written that "the intellectual movement that has had the greatest influence on American academic law in the past quarter-century [of the 20th Century]" is law-and-economics.[6] Critique Despite its influence, the law and economics movement has been criticized from a number of directions. This is especially true of normative law and economics. Because most law and economics scholarship operates within a neoclassical framework, fundamental criticisms of neoclassical economics have been applied to work in law and economics. Rational choice theory

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Within the legal academy, law and economics has been criticized on the ground that rational choice theory in economics makes unrealistic simplifying assumptions about human nature (see rational choice theory (criminology)); Posner's application of law and economic reasoning to rape and sex [7] may be an example of this. Critics of the law and economics movements have argued that normative economic analysis does not capture the importance of human rights and concerns for distributive justice. Some of the heaviest criticisms of the "classical" law and economics come from the critical legal studies movement, in particular Duncan Kennedy[1] and Mark Kelman. A classic criticism of Posner's Economic Analysis of the Law, and more generally of similar approaches, was written by Arthur Allen Leff, who criticized Posner on formal grounds, namely that Posner's reasoning depends upon the arbitrary assumption that economically rational behavior is desirable. Pareto efficiency Relatedly, additional critique has been directed toward the assumed benefits of law and policy designed to increase allocative efficiency when such assumptions are modeled on "first-best" (Pareto optimal) general-equilibrium conditions. Under the theory of the second best, for example, if the fulfillment of a subset of optimal conditions cannot be met under any circumstances, it is incorrect to conclude that the fulfillment of any subset of optimal conditions will necessarily result in an increase in allocative efficiency.[8] Consequently, any expression of public policy whose purported purpose is an unambiguous increase in allocative efficiency (for example, consolidation of research and development costs through increased mergers and acquisitions resulting from a systematic relaxation of anti-trust laws) is, according to critics, fundamentally incorrect, as there is no general reason to conclude that an increase in allocative efficiency is more likely than a decrease. Essentially, the "first-best" neoclassical analysis fails to properly account for various kinds of general-equilibrium feedback relationships that result from intrinsic Pareto imperfections.[8] Another critique comes from the fact that there is no unique optimal result. Warren Samuels in his 2007 book, The Legal-Economic Nexus, argues, "efficiency in the Pareto sense cannot dispositively be applied to the definition and assignment of rights themselves, because efficiency requires an antecedent determination of the rights (23-4)." Responses Law and economics has adapted to some of these criticisms (see "contemporary developments," below). One critic, Jon D. Hanson of Harvard Law School, argues that our legal, economic, political, and social systems are unduly influenced by an individualistic model that assumes "dispositionism" -- the idea that outcomes are the result of our "dispositions" (economists would
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say "preferences"). Instead, Hanson argues, we should look to the "situation", both inside of us (including cognitive biases) and outside of us (family, community, social norms, and other environmental factors) that have a much larger impact on our actions than mere "choice." Hanson has written many law review articles on the subject and has books forthcoming. Contemporary developments Law and economics has developed in a variety of directions. One important trend has been the application of game theory to legal problems. Other developments have been the incorporation of behavioral economics into economic analysis of law, and the increasing use of statistical and econometrics techniques. Within the legal academy, the term socio-economics has been applied to economic approaches that are self-consciously broader than the neoclassical tradition. Universities with law and economics programs Almost every major American law school, and most leading economics departments, offer courses in law and economics and has faculty working in the field. Two of the leading law schools focusing on Law and Economics are the University of Chicago Law School, whose faculty includes Judge Richard A. Posner, Ronald Coase and Gary Becker, and the George Mason University School of Law, whose faculty used to include Nobel laureate Vernon Smith (though Smith and his team have since moved to Chapman University), and perennial Nobel finalist Gordon Tullock. In the spring of 2006, Vanderbilt University Law School announced the creation of a new program to award a Ph.D. in Law & Economics. A ranking of law and economics Ph.D. programs was published in the Southern Economics Journal in 2008, and also includes among the top 10 programs (based on publications in the field) the economics departments at UC Berkeley, Harvard University, University of Connecticut, UC San Diego, Princeton University, MIT, University of Wisconsin - Madison, Florida State University, Central Michigan University, and the University of Michigan. The University of Toronto's Faculty of Law offers a combined J.D. / M.A. Economics, as well as a J.D. / Ph.D. Economics. In Europe, a consortium of universities from ten different countries is running the European Master Program in Law and Economics, also known as EMLE which is the leading European program in the field since 1990. A newer European Doctorate in Law and Economics program is operated by three leading European centers in Law and Economics. In 2009 the University of Copenhagen and the Copenhagen Business School established an interdisciplinary elite master program in International Law, Economics and Management (ILECMA) that is jointly offered by both institutions. The program is not only a Copenhagen
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Master of Excellence (COME) but also one of only twelve elite programs in Denmark and attracting students from all over Europe. Since 2009 there has been created a new PhD program in Law and Economics of Finance and Money from Goethe University in Frankfurt am Main/Germany. The program is entirely created for the purpose of research in fields such as regulation of Financial Institutions and Market Regulation. The program is thought to be finished within four years and is entirely taught in English. The Collegio Carlo Alberto in Turin, Italy hosts an International Ph.D. Program in Institutions, Economics and Law within the CLEI Centre. Members of the teaching staff come from various academic institutes in Europe and the United States. A separate Doctoral Program in Law and Economics is currently run by the School of Economics at the University of Siena. Also in Italy, the International University College of Turin [2], with students and faculty from worldwide, runs a biennial Master of Sciences in Comparative Law, Economics and Finance which challenges mainstream views on the subject. Switzerland's University of St. Gallen has a Law and Economics Program on both the undergraduate (Bachelor of Arts in Law and Economics) and graduate levels (Master of Arts in Law and Economics). The graduate program was initiated in October 2005 at the first international scientific conference on Law and Economics by the President of the University, Ernst Mohr and the St. Gallen Professor and leading business lawyer Peter Nobel. The Law and Economics Program is supported by an International Academic Council lead by leading experts in the field of law and economics, such as Richard A. Posner, Ronald J. Gilson, Victor Goldberg or Geoffrey P. Miller. Operating outside this particular framework, the Utrecht University offers students the possibility to major in law and economics as part of their undergraduate studies, or to specialize in law and economics in a one-year post-graduate programme. University of Economics, Prague, namely Department of Institutional Economics at the Faculty of Economics and Public Administration, offers Law and Economics as a possible specialization for graduate students, while complete graduate program is being prepared. The University of Leicester runs a degree program called Economics and Law, with various modules taught in the specific area.The University of Cambridge also has a specific course called 'Land Economy', who combines law, economy and the environment into one discipline.[3] The University of Manchester Law School, Nottingham University Business School and City University Law School, London have undergraduate courses in Law and Economics. University College London offers undergraduate courses in Law and Economics in its Economics Faculty and post-graduate courses in its Law Faculty.
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The Centre for Economic Studies and Planning, [4] Jawaharlal Nehru University was the first to introduce a Post-graduate Optional course in Law and Economics in India. In the past few years Law and economics has also become one of the major research areas at the centre. The Delhi School of Economics [5] also offers law and economics courses at the post graduate level. The National University of Juridical Sciences (NUJS) offers two courses in Law and Economics to its undergraduate students. [6], so does NALSAR University of Law, Hyderabad, India. In the National University of Singapore, a highly selective Double Honours Programme in Law and Economics was launched in 2005, whereby students complete two Bachelors' degrees in five years. The University of Bonn has recently founded a Center for the Advanced Studies of Law and Economics (CASTLE). Supply and demand From Wikipedia, the free encyclopedia Jump to: navigation, search For other uses, see Supply and demand (disambiguation).

The price P of a product is determined by a balance between production at each price (supply S) and the desires of those with purchasing power at each price (demand D). The diagram shows a positive shift in demand from D1 to D2, resulting in an increase in price (P) and quantity sold (Q) of the product. Supply and demand is an economic model of price determination in a market. It concludes that in a competitive market, the unit price for a particular good will vary until it settles at a point where the quantity demanded by consumers (at current price) will equal the quantity supplied by producers (at current price), resulting in an economic equilibrium of price and quantity.
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The four basic laws of supply and demand are [1] 1. If demand increases and supply remains unchanged then higher equilibrium price and quantity. 2. If demand decreases and supply remains unchanged then lower equilibrium price and quantity. 3. If supply increases and demand remains unchanged then lower equilibrium price and higher quantity. 4. If supply decreases and demand remains unchanged then higher price and lower quantity. Contents [hide]

1 The graphical representation of supply and demand o 1.1 Supply schedule o 1.2 Demand schedule 2 Microeconomics o 2.1 Equilibrium 3 Changes in market equilibrium o 3.1 Demand curve shifts o 3.2 Supply curve shifts 4 Elasticity o 4.1 Vertical supply curve (perfectly inelastic supply) 5 Other markets 6 Empirical estimation 7 Macroeconomic uses of demand and supply 8 History 9 Criticism o 9.1 Economies of scale: Mass production 10 See also 11 References 12 External links

The graphical representation of supply and demand The supply-demand model is a partial equilibrium model representing the determination of the price of a particular good and the quantity of that good which is traded. Although it is normal to regard the quantity demanded and the quantity supplied as functions of the price of the good, the
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standard graphical representation, usually attributed to Alfred Marshall, has price on the vertical axis and quantity on the horizontal axis, the opposite of the standard convention for the representation of a mathematical function. Determinants of supply and demand other than the price of the good in question, such as consumers' income, input prices and so on, are not explicitly represented in the supply-demand diagram. Changes in the values of these variables are represented by shifts in the supply and demand curves. By contrast, responses to changes in the price of the good are represented as movements along unchanged supply and demand curves. Supply schedule The supply schedule, depicted graphically as the supply curve, represents the amount of some good that producers are willing and able to sell at various prices, assuming ceteris paribus, that is, assuming all determinants of supply other than the price of the good in question, such as technology and the prices of factors of production, remain the same. Under the assumption of perfect competition, supply is determined by marginal cost. Firms will produce additional output as long as the cost of producing an extra unit of output is less than the price they will receive. By its very nature, conceptualizing a supply curve requires that the firm be a perfect competitor that is, that the firm has no influence over the market price. This is because each point on the supply curve is the answer to the question "If this firm is faced with this potential price, how much output will it be able to and willing to sell?" If a firm has market power, so its decision of how much output to provide to the market influences the market price, then the firm is not "faced with" any price, and the question is meaningless. Economists distinguish between the supply curve of an individual firm and the market supply curve. The market supply curve is obtained by summing the quantities supplied by all suppliers at each potential price. Thus in the graph of the supply curve, individual firms' supply curves are added horizontally to obtain the market supply curve. Economists also distinguish the short-run market supply curve from the long-run market supply curve. In this context, two things are assumed constant by definition of the short run: the availability of one or more fixed inputs (typically physical capital), and the number of firms in the industry. In the long run, firms have a chance to adjust their holdings of physical capital, enabling them to better adjust their quantity supplied at any given price. Furthermore, in the long run potential competitors can enter or exit the industry in response to market conditions. For both of these reasons, long-run market supply curves are flatter than their short-run counterparts.

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The determinants of supply follow: 1. 2. 3. 4. 5. Production costs The technology of production The price of related goods Firm's expectations about future prices Number of suppliers

Demand schedule The demand schedule, depicted graphically as the demand curve, represents the amount of some good that buyers are willing and able to purchase at various prices, assuming all determinants of demand other than the price of the good in question, such as income, tastes and preferences, the price of substitute goods, and the price of complementary goods, remain the same. Following the law of demand, the demand curve is almost always represented as downward-sloping, meaning that as price decreases, consumers will buy more of the good.[2] Just as the supply curves reflect marginal cost curves, demand curves are determined by marginal utility curves.[3] Consumers will be willing to buy a given quantity of a good, at a given price, if the marginal utility of additional consumption is equal to the opportunity cost determined by the price, that is, the marginal utility of alternative consumption choices. The demand schedule is defined as the willingness and ability of a consumer to purchase a given product in a given frame of time. As described above, the demand curve is generally downward-sloping. There may be rare examples of goods that have upward-sloping demand curves. Two different hypothetical types of goods with upward-sloping demand curves are Giffen goods (an inferior but staple good) and Veblen goods (goods made more fashionable by a higher price). By its very nature, conceptualizing a demand curve requires that the purchaser be a perfect competitorthat is, that the purchaser has no influence over the market price. This is because each point on the demand curve is the answer to the question "If this buyer is faced with this potential price, how much of the product will it purchase?" If a buyer has market power, so its decision of how much to buy influences the market price, then the buyer is not "faced with" any price, and the question is meaningless. As with supply curves, economists distinguish between the demand curve of an individual and the market demand curve. The market demand curve is obtained by summing the quantities demanded by all consumers at each potential price. Thus in the graph of the demand curve, individuals' demand curves are added horizontally to obtain the market demand curve. The determinants of demand follow:
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1. Income 2. Tastes and preferences 3. Prices of related goods and services 4. Expectations 5. Number of Buyers Microeconomics Equilibrium Equilibrium is defined to the price-quantity pair where the quantity demanded is equal to the quantity supplied, represented by the intersection of the demand and supply curves. Market Equilibrium: A situation in a market when the price is such that the quantity that consumers wish to demand is correctly balanced by the quantity that firms wish to supply. Comparative static analysis: Examines the likely effect on the equilibrium of a change in the external conditions affecting the market. Changes in market equilibrium Practical uses of supply and demand analysis often center on the different variables that change equilibrium price and quantity, represented as shifts in the respective curves. Comparative statics of such a shift traces the effects from the initial equilibrium to the new equilibrium. Demand curve shifts Main article: Demand curve

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An outward (rightward) shift in demand increases both equilibrium price and quantity When consumers increase the quantity demanded at a given price, it is referred to as an increase in demand. Increased demand can be represented on the graph as the curve being shifted to the right. At each price point, a greater quantity is demanded, as from the initial curve D1 to the new curve D2. In the diagram, this raises the equilibrium price from P1 to the higher P2. This raises the equilibrium quantity from Q1 to the higher Q2. A movement along the curve is described as a "change in the quantity demanded" to distinguish it from a "change in demand," that is, a shift of the curve. In the example above, there has been an increase in demand which has caused an increase in (equilibrium) quantity. The increase in demand could also come from changing tastes and fashions, incomes, price changes in complementary and substitute goods, market expectations, and number of buyers. This would cause the entire demand curve to shift changing the equilibrium price and quantity. Note in the diagram that the shift of the demand curve, by causing a new equilibrium price to emerge, resulted in movement along the supply curve from the point (Q1, P1) to the point Q2, P2). If the demand decreases, then the opposite happens: a shift of the curve to the left. If the demand starts at D2, and decreases to D1, the equilibrium price will decrease, and the equilibrium quantity will also decrease. The quantity supplied at each price is the same as before the demand shift, reflecting the fact that the supply curve has not shifted; but the equilibrium quantity and price are different as a result of the change (shift) in demand.

The movement of the demand curve in response to a change in a non-price determinant of demand is caused by a change in the x-intercept, the constant term of the demand equation. Supply curve shifts Main article: Supply (economics)

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An outward (rightward) shift in supply reduces the equilibrium price but increases the equilibrium quantity When the suppliers' unit input costs change, or when technological progress occurs, the supply curve shifts. For example, assume that someone invents a better way of growing wheat so that the cost of growing a given quantity of wheat decreases. Otherwise stated, producers will be willing to supply more wheat at every price and this shifts the supply curve S1 outward, to S2an increase in supply. This increase in supply causes the equilibrium price to decrease from P1 to P2. The equilibrium quantity increases from Q1 to Q2 as consumers move along the demand curve to the new lower price. As a result of a supply curve shift, the price and the quantity move in opposite directions. If the quantity supplied decreases, the opposite happens. If the supply curve starts at S2, and shifts leftward to S1, the equilibrium price will increase and the equilibrium quantity will decrease as consumers move along the demand curve to the new higher price and associated lower quantity demanded. The quantity demanded at each price is the same as before the supply shift, reflecting the fact that the demand curve has not shifted. But due to the change (shift) in supply, the equilibrium quantity and price have changed. The movement of the supply curve in response to a change in a non-price determinant of supply is caused by a change in the y-intercept, the constant term of the supply equation. The supply curve shifts up and down the y axis as non-price determinants of demand change. Elasticity Main article: Elasticity (economics) Elasticity is a central concept in the theory of supply and demand. In this context, elasticity refers to how strongly the quantities supplied and demanded respond to various factors, including price and other determinants. One way to define elasticity is the percentage change in one variable (the quantity supplied or demanded) divided by the percentage change in the causative variable. For
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discrete changes this is known as arc elasticity, which calculates the elasticity over a range of values. In contrast, point elasticity uses differential calculus to determine the elasticity at a specific point. Elasticity is a measure of relative changes. Often, it is useful to know how strongly the quantity demanded or supplied will change when the price changes. This is known as the price elasticity of demand or the price elasticity of supply, respectively. If a monopolist decides to increase the price of its product, how will this affect the amount of their good that customers purchase? This knowledge helps the firm determine whether the increased unit price will offset the decrease in sales volume. Likewise, if a government imposes a tax on a good, thereby increasing the effective price, knowledge of the price elasticity will help us to predict the size of the resulting effect on the quantity demanded. Elasticity is calculated as the percentage change in quantity divided by the associated percentage change in price. For example, if the price moves from $1.00 to $1.05, and as a result the quantity supplied goes from 100 pens to 102 pens, the quantity of pens increased by 2%, and the price increased by 5%, so the price elasticity of supply is 2%/5% or 0.4. Since the changes are in percentages, changing the unit of measurement or the currency will not affect the elasticity. If the quantity demanded or supplied changes by a greater percentage than the price did, then demand or supply is said to be elastic. If the quantity changes by a lesser percentage than the price did, demand or supply is said to be inelastic. If supply is perfectly inelastic;that is, has zero elasticity, then there is a vertical supply curve. Short-run supply curves are not as elastic as long-run supply curves, because in the long run firms can respond to market conditions by varying their holdings of physical capital, and because in the long run new firms can enter or old firms can exit the market. Elasticity in relation to variables other than price can also be considered. One of the most common to consider is income. How strongly would the demand for a good change if income increased or decreased? The relative percentage change is known as the income elasticity of demand. Another elasticity sometimes considered is the cross elasticity of demand, which measures the responsiveness of the quantity demanded of a good to a change in the price of another good. This is often considered when looking at the relative changes in demand when studying complements and substitute goods. Complements are goods that are typically utilized together, where if one is consumed, usually the other is also. Substitute goods are those where one can be substituted for the other, and if the price of one good rises, one may purchase less of it and instead purchase its substitute. Cross elasticity of demand is measured as the percentage change in demand for the first good divided by the causative percentage change in the price of the other good. For an example with a
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complement good, if, in response to a 10% increase in the price of fuel, the quantity of new cars demanded decreased by 20%, the cross elasticity of demand would be -2.0. In a frictionless economy, the price and quantity in any market would be able to move to a new equilibrium position instantly, without spending any time away from equilibrium. Any change in market conditions would cause a jump from one equilibrium position to another at once. In real economic systems, markets don't always behave in this way, and markets take some time before they reach a new equilibrium position. This is due to asymmetric, or at least imperfect, information, where no one economic agent could ever be expected to know every relevant condition in every market. Ultimately both producers and consumers must rely on trial and error as well as prediction and calculation to find the true equilibrium of a market. Vertical supply curve (perfectly inelastic supply)

When demand D1 is in effect, the price will be P1. When D2 is occurring, the price will be P2. The equilibrium quantity is always Q, and any shifts in demand will only affect price. If the quantity supplied is fixed in the very short run no matter what the price, the supply curve is a vertical line, and supply is called perfectly inelastic. Other markets The model of supply and demand also applies to various specialty markets. The model is commonly applied to wages, in the market for labor. The typical roles of supplier and demander are reversed. The suppliers are individuals, who try to sell their labor for the highest price. The demanders of labor are businesses, which try to buy the type of labor they need at the lowest price. The equilibrium price for a certain type of labor is the wage rate.[4]

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A number of economists (for example Pierangelo Garegnani[5], Robert L. Vienneau[6], and Arrigo Opocher & Ian Steedman[7]), building on the work of Piero Sraffa, argue that that this model of the labor market, even given all its assumptions, is logically incoherent. Michael Anyadike-Danes and Wyne Godley [8] argue, based on simulation results, that little of the empirical work done with the textbook model constitutes a potentially falsifying test, and, consequently, empirical evidence hardly exists for that model. Graham White [9] argues, partially on the basis of Sraffianism, that the policy of increased labor market flexibility, including the reduction of minimum wages, does not have an "intellectually coherent" argument in economic theory. This criticism of the application of the model of supply and demand generalizes, particularly to all markets for factors of production. It also has implications for monetary theory[10] not drawn out here. In both classical and Keynesian economics, the money market is analyzed as a supply-and-demand system with interest rates being the price. The money supply may be a vertical supply curve, if the central bank of a country chooses to use monetary policy to fix its value regardless of the interest rate; in this case the money supply is totally inelastic. On the other hand,[11] the money supply curve is a horizontal line if the central bank is targeting a fixed interest rate and ignoring the value of the money supply; in this case the money supply curve is perfectly elastic. The demand for money intersects with the money supply to determine the interest rate.[12] Empirical estimation Demand and supply relations in a market can be statistically estimated from price, quantity, and other data with sufficient information in the model. This can be done with simultaneous-equation methods of estimation in econometrics. Such methods allow solving for the model-relevant "structural coefficients," the estimated algebraic counterparts of the theory. The Parameter identification problem is a common issue in "structural estimation." Typically, data on exogenous variables (that is, variables other than price and quantity, both of which are endogenous variables) are needed to perform such an estimation. An alternative to "structural estimation" is reduced-form estimation, which regresses each of the endogenous variables on the respective exogenous variables. Macroeconomic uses of demand and supply Demand and supply have also been generalized to explain macroeconomic variables in a market economy, including the quantity of total output and the general price level. The Aggregate Demand-Aggregate Supply model may be the most direct application of supply and demand to macroeconomics, but other macroeconomic models also use supply and demand. Compared to microeconomic uses of demand and supply, different (and more controversial) theoretical considerations apply to such macroeconomic counterparts as aggregate demand and aggregate
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supply. Demand and supply are also used in macroeconomic theory to relate money supply and money demand to interest rates, and to relate labor supply and labor demand to wage rates. History The power of supply and demand was understood to some extent by several early Muslim economists, such as Ibn Taymiyyah who illustrates:[verification needed] "If desire for goods increases while its availability decreases, its price rises. On the other hand, if availability of the good increases and the desire for it decreases, the price comes down."[13] John Locke's 1691 work Some Considerations on the Consequences of the Lowering of Interest and the Raising of the Value of Money.[14] includes an early and clear description of supply and demand and their relationship. In this description demand is rent: The price of any commodity rises or falls by the proportion of the number of buyer and sellers and that which regulates the price... [of goods] is nothing else but their quantity in proportion to their rent. The phrase "supply and demand" was first used by James Denham-Steuart in his Inquiry into the Principles of Political Oeconomy, published in 1767. Adam Smith used the phrase in his 1776 book The Wealth of Nations, and David Ricardo titled one chapter of his 1817 work Principles of Political Economy and Taxation "On the Influence of Demand and Supply on Price".[15] In The Wealth of Nations, Smith generally assumed that the supply price was fixed but that its "merit" (value) would decrease as its "scarcity" increased, in effect what was later called the law of demand. Ricardo, in Principles of Political Economy and Taxation, more rigorously laid down the idea of the assumptions that were used to build his ideas of supply and demand. Antoine Augustin Cournot first developed a mathematical model of supply and demand in his 1838 Researches into the Mathematical Principles of Wealth, including diagrams. During the late 19th century the marginalist school of thought emerged. This field mainly was started by Stanley Jevons, Carl Menger, and Lon Walras. The key idea was that the price was set by the most expensive price, that is, the price at the margin. This was a substantial change from Adam Smith's thoughts on determining the supply price. In his 1870 essay "On the Graphical Representation of Supply and Demand", Fleeming Jenkin in the course of "introduc[ing] the diagrammatic method into the English economic literature" published the first drawing of supply and demand curves therein,[16] including comparative statics from a shift of supply or demand and application to the labor market.[17] The model was further developed and popularized by Alfred Marshall in the 1890 textbook Principles of Economics.[15] Criticism
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At least two assumptions are necessary for the validity of the standard model: first, that supply and demand are independent; and second, that supply is "constrained by a fixed resource"; If these conditions do not hold, then the Marshallian model cannot be sustained. Sraffa's critique focused on the inconsistency (except in implausible circumstances) of partial equilibrium analysis and the rationale for the upward-slope of the supply curve in a market for a produced consumption good[18]. The notability of Sraffa's critique is also demonstrated by Paul A. Samuelson's comments and engagements with it over many years, for example: "What a cleaned-up version of Sraffa (1926) establishes is how nearly empty are all of Marshall's partial equilibrium boxes. To a logical purist of Wittgenstein and Sraffa class, the Marshallian partial equilibrium box of constant cost is even more empty than the box of increasing cost."[19]. Aggregate excess demand in a market is the difference between the quantity demanded and the quantity supplied as a function of price. In the model with an upward-sloping supply curve and downward-sloping demand curve, the aggregate excess demand function only intersects the axis at one point, namely, at the point where the supply and demand curves intersect. The SonnenscheinMantel-Debreu theorem shows that the standard model cannot be rigorously derived in general from general equilibrium theory[20]. The model of prices being determined by supply and demand assumes perfect competition. But: "economists have no adequate model of how individuals and firms adjust prices in a competitive model. If all participants are price-takers by definition, then the actor who adjusts prices to eliminate excess demand is not specified"[21].

Goodwin, Nelson, Ackerman, and Weissskopf write: "If we mistakenly confuse precision with accuracy, then we might be misled into thinking that an explanation expressed in precise mathematical or graphical terms is somehow more rigorous or useful than one that takes into account particulars of history, institutions or business strategy. This is not the case. Therefore, it is important not to put too much confidence in the apparent precision of supply and demand graphs. Supply and demand analysis is a useful precisely formulated conceptual tool that clever people have devised to help us gain an abstract understanding of a complex world. It does not - nor should it be expected to - give us in addition an accurate and complete description of any particular real world market." [22] Economies of scale: Mass production The intent of mass production is to produce in extremely large quantities at the lowest possible cost so as to drive down price and create demand. There is also a learning curve with the production of
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most new products that exhibits a similar phenomenon of lowering costs, which in turn drives demand. In the case of mass production, both the assumptions of supply and demand being independent and constraints on supply are not applicable. The price response to the change in supply curve is valid, but the price response to the change in demand curve is not. The lowered price in response to increased demand is because the incremental cost of production is less than the average cost, assuming that there is excess capacity, which is the condition of most manufactured goods today. In typical business cycles, prices do increase as maximum capacity is approached; however, this usually results in an expansion of capacity using more efficient processes, leading to even lower prices in the next cycle. Economics Basics: Demand and Supply

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Supply and demand is perhaps one of the most fundamental concepts of economics and it is the backbone of a market economy. Demand refers to how much (quantity) of a product or service is desired by buyers. The quantity demanded is the amount of a product people are willing to buy at a certain price; the relationship between price and quantity demanded is known as the demand relationship. Supply represents how much the market can offer. The quantity supplied refers to the amount of a certain good producers are willing to supply when receiving a certain price. The correlation between price and how much of a good or service is supplied to the market is known as the supply relationship. Price, therefore, is a reflection of supply and demand.

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The relationship between demand and supply underlie the forces behind the allocation of resources. In market economy theories, demand and supply theory will allocate resources in the most efficient way possible. How? Let us take a closer look at the law of demand and the law of supply. A. The Law of Demand The law of demand states that, if all other factors remain equal, the higher the price of a good, the less people will demand that good. In other words, the higher the price, the lower the quantity demanded. The amount of a good that buyers purchase at a higher price is less because as the price of a good goes up, so does the opportunity cost of buying that good. As a result, people will naturally avoid buying a product that will force them to forgo the consumption of something else they value more. The chart below shows that the curve is a downward slope.

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A, B and C are points on the demand curve. Each point on the curve reflects a direct correlation between quantity demanded (Q) and price (P). So, at point A, the quantity demanded will be Q1 and the price will be P1, and so on. The demand relationship curve illustrates the negative relationship between price and quantity demanded. The higher the price of a good the lower the quantity demanded (A), and the lower the price, the more the good will be in demand (C). B. The Law of Supply Like the law of demand, the law of supply demonstrates the quantities that will be sold at a certain price. But unlike the law of demand, the supply relationship shows an upward slope. This means that the higher the price, the higher the quantity supplied. Producers supply more at a higher price because selling a higher quantity at a higher price increases revenue.

A, B and C are points on the supply curve. Each point on the curve reflects a direct correlation between quantity supplied (Q) and price (P). At point B, the quantity supplied will be Q2 and the price will be P2, and so on. (To learn how economic factors are used in currency trading, read Forex Walkthrough: Economics.) Time and Supply Unlike the demand relationship, however, the supply relationship is a factor of time. Time is important to supply because suppliers must, but cannot always, react quickly to a change in demand or price. So it is important to try and determine whether a price change that is caused by demand will be temporary or permanent.

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Let's say there's a sudden increase in the demand and price for umbrellas in an unexpected rainy season; suppliers may simply accommodate demand by using their production equipment more intensively. If, however, there is a climate change, and the population will need umbrellas yearround, the change in demand and price will be expected to be long term; suppliers will have to change their equipment and production facilities in order to meet the long-term levels of demand. C. Supply and Demand Relationship Now that we know the laws of supply and demand, let's turn to an example to show how supply and demand affect price. Imagine that a special edition CD of your favorite band is released for $20. Because the record company's previous analysis showed that consumers will not demand CDs at a price higher than $20, only ten CDs were released because the opportunity cost is too high for suppliers to produce more. If, however, the ten CDs are demanded by 20 people, the price will subsequently rise because, according to the demand relationship, as demand increases, so does the price. Consequently, the rise in price should prompt more CDs to be supplied as the supply relationship shows that the higher the price, the higher the quantity supplied. If, however, there are 30 CDs produced and demand is still at 20, the price will not be pushed up because the supply more than accommodates demand. In fact after the 20 consumers have been satisfied with their CD purchases, the price of the leftover CDs may drop as CD producers attempt to sell the remaining ten CDs. The lower price will then make the CD more available to people who had previously decided that the opportunity cost of buying the CD at $20 was too high. D. Equilibrium When supply and demand are equal (i.e. when the supply function and demand function intersect) the economy is said to be at equilibrium. At this point, the allocation of goods is at its most efficient because the amount of goods being supplied is exactly the same as the amount of goods being demanded. Thus, everyone (individuals, firms, or countries) is satisfied with the current economic condition. At the given price, suppliers are selling all the goods that they have produced and consumers are getting all the goods that they are demanding.

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As you can see on the chart, equilibrium occurs at the intersection of the demand and supply curve, which indicates no allocative inefficiency. At this point, the price of the goods will be P* and the quantity will be Q*. These figures are referred to as equilibrium price and quantity. In the real market place equilibrium can only ever be reached in theory, so the prices of goods and services are constantly changing in relation to fluctuations in demand and supply. E. Disequilibrium Disequilibrium occurs whenever the price or quantity is not equal to P* or Q*. 1. Excess Supply If the price is set too high, excess supply will be created within the economy and there will be allocative inefficiency.

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At price P1 the quantity of goods that the producers wish to supply is indicated by Q2. At P1, however, the quantity that the consumers want to consume is at Q1, a quantity much less than Q2. Because Q2 is greater than Q1, too much is being produced and too little is being consumed. The suppliers are trying to produce more goods, which they hope to sell to increase profits, but those consuming the goods will find the product less attractive and purchase less because the price is too high. 2. Excess Demand Excess demand is created when price is set below the equilibrium price. Because the price is so low, too many consumers want the good while producers are not making enough of it.

In this situation, at price P1, the quantity of goods demanded by consumers at this price is Q2. Conversely, the quantity of goods that producers are willing to produce at this price is Q1. Thus, there are too few goods being produced to satisfy the wants (demand) of the consumers. However, as consumers have to compete with one other to buy the good at this price, the demand will push the price up, making suppliers want to supply more and bringing the price closer to its equilibrium.

F. Shifts vs. Movement

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For economics, the movements and shifts in relation to the supply and demand curves represent very different market phenomena: 1. Movements A movement refers to a change along a curve. On the demand curve, a movement denotes a change in both price and quantity demanded from one point to another on the curve. The movement implies that the demand relationship remains consistent. Therefore, a movement along the demand curve will occur when the price of the good changes and the quantity demanded changes in accordance to the original demand relationship. In other words, a movement occurs when a change in the quantity demanded is caused only by a change in price, and vice versa.

Like a movement along the demand curve, a movement along the supply curve means that the supply relationship remains consistent. Therefore, a movement along the supply curve will occur when the price of the good changes and the quantity supplied changes in accordance to the original supply relationship. In other words, a movement occurs when a change in quantity supplied is caused only by a change in price, and vice versa.

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2. Shifts A shift in a demand or supply curve occurs when a good's quantity demanded or supplied changes even though price remains the same. For instance, if the price for a bottle of beer was $2 and the quantity of beer demanded increased from Q1 to Q2, then there would be a shift in the demand for beer. Shifts in the demand curve imply that the original demand relationship has changed, meaning that quantity demand is affected by a factor other than price. A shift in the demand relationship would occur if, for instance, beer suddenly became the only type of alcohol available for consumption.

Conversely, if the price for a bottle of beer was $2 and the quantity supplied decreased from Q1 to Q2, then there would be a shift in the supply of beer. Like a shift in the demand curve, a shift in the
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supply curve implies that the original supply curve has changed, meaning that the quantity supplied is effected by a factor other than price. A shift in the supply curve would occur if, for instance, a natural disaster caused a mass shortage of hops; beer manufacturers would be forced to supply less beer for the same price.

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