Summary Chapter 1 - 3

CHAPTER 1 : INTRODUCTION OF ECONOMY

CHAPTER 2 : PRICING THEORIES

CHAPTER 3 : PRODUCTION  THEORIES

PRODUCTION & COST

DEFINITION OF PRODUCTION

-Production means the transformation of inputs into outputs

INPUT is things that a firm buy for use in production process . 

Ex : land , labour, capital , entrepreneur

OUTPUT is what we get at the end of the production process

SHORT RUN & LONG RUN PRODUCTION

Short-run period

Time frame in which at least one of the inputs is fixed but the other inputs are varied . Ex : building, equipment, tools

Long-run period

Time frame in which all inputs are variable

Fixed input

An input which the quantity does not change according to output . Ex : Machinery , land , building

Variable input

An input which the quantity changes according to output . Ex : raw materials , transportation

TYPES OF PRODUCTION

a. primary production

Industries that involved in the first stage on the production process . It included the extractive industries such as coal mining , iron , agricultural , etc . These industries provide the raw material which are made into finished goods .

b. secondary production

Industries involved in manufacturing he finished goods from he raw materials . It included textile manufacturers , motorcar industries , etc

c. Tertiary production

Provide services which enable the production of goods by primary and secondary producers to take place for effective . Consists of two parts : commercial services and direct services

i.  Commercial services

These include all those industries engaged in the movement of commodities so that they reach the final consumer on time , in good condition and in the correct quantity . Ex : Maybank , Tesco , Mas Cargo etc

ii.  Direct services

Direct to consumer by example , Doctors and teachers . They are important to the production process because they increase efficiency . Ex : Hospitals , College , etc

LAW OF DIMINISHING MARGINAL RETURNS

The situation when producer increase , the input to output will be increase at decreasing rates .

Total product (TP) is the amount of output produced when a given amount of that input used together with fixed inputs .

Average product (AP) can be obtained by dividing the total product by the amount of that input used , In this case , labour is used .

Marginal Product (MP) is the additional to total product when one more unit of labour is employed .

If capital is used as a variable input ,

The table below shows the relationship between output and labour when the capital is fixed .

Fixed inputs Capital  (K)	Variable inputs Labours (L)	Total Product  (TP)	Average product (AP)	Marginal Product (MP)
1	0	0	0	0
1	1	5	5	5
1	2	12	6	7
1	3	35	11.7	23
1	4	53	13.3	18
1	5	65	13	12
1	6	72	12	7
1	7	72	10.3	0
1	8	70	8.8	-2

The diagram above show the relationship between AP, MP, and TP

Relationship between Total Product (TP) and Marginal Product (MP)

• ·         When MP is increasing , TP will increase at an increasing rate
• ·         When MP is decreasing , TP will increase at a decreasing rate
• ·         When MP is zero , TP is at its maximum
• ·         When MP is negative , TP declines

Relationship between Marginal Product (MP) and Average Product (AP)

• ·         When MP is above AP , AP is increasing
• ·         When MP is below AP , AP is decreasing
• ·         When MP is equals to AP , AP is at maximum
• 
  

COST OF PRODUCTION

 Ø  Cost of production refers to the expenses incurred by the producer in producing a particular quantity of output.

There are 7 types of short-run costs :

                     i.        Total fixed cost

                   ii.        Total variable cost

                 iii.        Total cost

                 iv.        Average fixed cost

                   v.        Average variable cost

                 vi.        Average cost

               vii.        Marginal cost

Total fixed cost (TFC) , Total variable cost (TVC) , Total cost (TC)

Consider the following hypothetical example of a boat building firm. The total fixed costs, TFC, include premises, machinery and equipment needed to construct boats, and are £100,000, irrespective of how many boats are produced. Total variable costs (TVC) will increase as output increases.

Plotting this gives us Total Cost, Total Variable Cost, and Total Fixed Cost.

Total fixed costs

Given that total fixed costs (TFC) are constant as output increases, the curve is a horizontal line on the cost graph.

Total variable costs

The total variable cost (TVC) curve slopes up at an accelerating rate, reflecting the law of diminishing marginal returns

Total costs

The total cost (TC) curve is found by adding total fixed and total variable costs. Its position reflects the amount of fixed costs, and its gradient reflects variable costs.

Average total cost (ATC) can be found by adding average fixed costs (AFC) and average variable costs (AVC). The ATC curve is also ‘U’ shaped because it takes its shape from the AVC curve, with the upturn reflecting the onset of diminishing returns to the variable factor.

Average fixed costs ( AFC )

Average fixed costs are found by dividing total fixed costs by output. As fixed cost is divided by an increasing output, average fixed costs will continue to fall.

Average variable costs ( AVC )

Average variable costs are found by dividing total fixed variable costs by output.

Average cost ( AC )

Average costs are a key cost in the theory of the firm because they indicate how efficiently scarce resources are being used. Average variable costs are found by dividing total fixed variable costs by output. Total Fixed costs and Total Variable costs are the respective areas under the Average Fixed and Average Variable cost curves

Marginal cost (MC)

Refers to the change in the total cost (or TVC ) those results from producing another unit of output. MC is the change in TC or TVC divided by the change in output. 

Relationship between Marginal Cost (MC) and Average Cost (AC)

Exercise

In a firm , fixed costs are RM 600 , average costs are RM 4.00 , and average variable costs RM2.00. Total output of the firm is

A.100 units

B.150 units

C.200 units

D.300 units

PRICING THEORIES

Assalamualaikum w.b.t.

This time we are going to discuss about chapter 2 which is Pricing theories. We are going to share some note and briefly explain about this topics  based on our understanding. 

 DEMAND

• What is demand ?

The ability and willingness to buy specific quantities of goods in a given 

period of time at a particular price.

 

• Law of demand 

 Negative relationship between price of the product and quantity demand.

        -There is negative relationship between price of the product and quantity demanded

               When the price fall , we can see the increase of demand

               When the price rises , there will be decrease in demand 

•  Demand schedule and demand curve
 

Table 2.1 shows the quantity of coffee demanded at each price level

Combination	Price (RM)	Quantity (units)
A	3	12
B	2	16

 

 Figure 2.1 Demand curve for coffee

The demand curve shows the law of demand . The demand curve must 

negative slope because the inverse relationship between price and demand .

Individual demand and market demand

Individual demand  : The relationship between the quantity of a 

                                   product demanded by a single and its price .

Market demand : Relationship between the total quantity of a product 

                            demanded by all consumers in the market and its price.

•  Determinants of demand

       -The price is not only the factor that influenced demand either 

        increase/decrease . Demand is also affected by the following : 

1. price of related goods

   -  Substitute goods  are goods or services that can be used in place another 

     product or services

When the price of chicken meat increase , the quantity demand will decrease and the people will look for another alternative . So , the demand for red meat will increase. 

                  

Example :

-  Complementary goods are goods that are used in conjunction with another 

product . For example :

2. consumer’s Income

When the income increase , consumer’s demand will increase 

Normal goods : income increase , demand increase . 

Ex: cars, shirts, books

Inferior goods : income increase , demand decrease . 

Ex: used cars, low-grade price

3. Taste and fashions

If a product becomes more fashionable , the demand for it will increase and

 if the same product becomes outdated , the demand for it will decrease . 

For example : change in music , apparel of recreation .

4. population

Demand depends on the size of the total population in the market . A large 

number of population will creates a greater demand for goods or services . 

Increasing population will shift the supply curve to the right .

5. Festive seasons and climatic condition

During festive seasons, different products will be in high demand . 

For example : during Chinese New Year , the demand for mandarin oranges 

will be greater .

6. Price expected

If the people think that prices are going to rise in the future , they are likely 

to buy more now before the price goes up . So , if the price expected increase , 

 demand curve for today will shift to the right ( increase )

• Movement along and shifts in the demand curve

Change in Quantity Demanded (movement)

I )  Situation 

         -movement along the demand curve

II) Factor

         -Occurs when the price of a product changes (own for the price)

III) Evidence

          -Upward movement

           Decrease in quantity demanded ( from b to a )

          -Downward movement

           Increase in quantity demanded ( from a to b )

Change in Demand (shift)

I)  Situation 

-Shift in demand curve whether increase or decrease

II) Factor

-Occurs when there are changes in factor such as population ,

 income , price of related goods .

III) Evidence

Increase or decrease in demand curve

-Demand curve shift to right ( increase ) if :

1. Price of substitutes goods increase

2. Price of complement goods decrease

3. Income increases (normal goods)

4. Expected future price increases

5. Number of buyers increases

-Demand curve shift to left ( decrease ) if :

1. Price of substitute goods decreases

2. Price of complement goods increases

3. Income decreases (normal goods)

4. expected future price decreases

5. Number of buyers decrease

SUPPLY

• Definition of supply

   The ability and willingness to sell or produce a specific quantities of goods 

   in a given period of time at a particular price.

Supply = willingness to sell + ability to sell

• Law of supply 
  
  
  Positive relationship between price of the product and quantity supplied
  
  

• Supply schedule and Supply curve 

The supply schedule for a product is a list of the quantity that a producer is 

willing to sell at different prices at one particular time.

Combination	Price (RM)	Quantity (units)
A	120	5
B	90	4
C	60	3
D	30	2

Example of supply schedule

The supply curve relationship shows an upward slope between price & 

quantity.Means that, the higher the price, the higher the quantity supplied.

Producers supply more at higher price to increase revenue.

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 & the 

price will be P2.

Individual supply & market supply

Individual supply : Relationship between the quantity of a product supplied 

by an individual seller & its price.

Market supply : Combination of individual supply.

Individual supply 1 + Individual supply 2 = MARKET SUPPLY

Combination	Price (RM)	Market Supply	Firm A (units)	Firm B (units)
A	15	6	4	2
B	20	9	6	3

• Determinant of Supply

Price of related goods

# Substitute goods

When the price of Maxis increase, the quantity supplied will increase 

(law of supply) and the quantity supply of Celcom will be decrease. So, if 

price of substitute goods increase, supply curve for current goods will shift 

to the left.

# Complementary goods

When the price of Car increases, the quantity of car supplied will increase 

and the supply on petrol will also increase since both are complementary 

goods. So, if the price of complementary goods increases, supply curve will 

shift to the right.

    

# Cost of production

  Increase in wages of labor and price of capital equipment in production 

process will increase the cost of production and thus reduce the supply curve.

So, cost of production increase, will shift the supply curve to the left.

# Expected future price

  When the government announces an increase in the price of sugar, the 

current supply will decrease because the supplier wants to gain a higher 

profit with a new price.

# Technological advance

  When new technology was introduced in paddy harvesting, the supply of 

  rice will be increase.So, the technology advance will shift the supply curve 

  to the right.

# Number of seller

  If there is an increase in the number of cafeterias in a FPMBP, the supply 

 of food & drink will increase.If the number seller increase supply curve will 

 shift to the right and vice versa.

Change in quantity supply (movement) and change in supply (shift).

Change in Quantity Supply  (movement)	Change in Supplied  (shift)
i. Situation Movement along the supply  curve (move point to point) ii. Factor Occurs when price of a  product changes (own price of the product) Others factors remain constant iii. Evidence - Upward movement increase in quantity supply Price of the product rises, the  quantity supplied increases. Example; from point b to point a - Downward movement Decrease in quantity supply Price of the product falls, the  quantity supplied decreases.              Example; from b to c	i. Situation Shift in the supply curve  (new curve) ii. Factor Occurs when there are changes  in other factors such as technology,  government policy, price of related  goods, etc. Price of the product remains  constant iii. Evidence Increase or decrease in supply  curve - Supply curve shift to right  (increase) if;  S1 → S2 1. Price of substitutes goods  decreases 2. Price of complement goods  increases 3. Price of input decreases 4. Expected future price      decreases 5. Increases the number of     sellers - Supply curve shift to left  (decrease) if; S1 → S3 1. Price of substitutes goods     increases 2. Price of complement goods     decrease 3. Price of input increases 4. Expected future price increases 5. Decreases in number of sellers

• Definition of Market Equilibrium

Situation when quantity demanded and quantity supplied are equal and 

there is no tendency for price or quantity to change. Market equilibrium is  determined by the intersection of both the demand and supply curve.

      Quantity Demanded (Qd) = Quantity Supply (Qs)

# Shortage (below equilibrium price)

Situation where the quantity demanded is greater than the quantity 

supplied. At the price RM10 , buyers are willing to buy 30 units but sellers 

only sell 16 units. There is occurring the excess demand. The amount of 

excess demand (shortage) is 10 units (Qd – Qs). If the shortage happened, the 

rational customer or producer will accept that price and sell back at the 

market price.

# Surplus (above equilibrium price)

Surplus is the situation of the quantity supplied is greater than the quantity 

demanded. At the price RM P1 , sellers are produce Q3 units but buyers only 

buy Q1 units. There is occurring the excess supply. The amount of excess 

supply (surplus) is 10 units (Qs – Qd).

• Supply, demand and government policy
  
  
  # Maximum Price or Ceiling Price
  
  
     A price ceiling is imposed by the government below the equilibrium 
     price ( market price). That price is not allowed to rise above this level 
    but it is allowed to fall below it.
  
  
  Problem : emergence of black market
  
  
  Black market is where people ignore the government’s price and 
  quantity controls & sell illegally at whatever price.
  
  
  
  
  

# Minimum Price or Floor Price

  A price floor is imposed by the government above the equilibrium price 

  (Market Price). That price is not allowed to fall below this level but is 

  allowed to rise above it.

• Elasticity

Price elasticity of demand (PED) shows the relationship between price and 

quantity demanded and provides a precise calculation of the effect of a 

change in price on quantity demanded.  

Four types of elasticity :

# Price elasticity of demand (Ep)

Price elasticity of demand measures the responsiveness of the quantity 

demanded due to a change in its price.

Example :

Price increase from RM2.00 TO RM4.00 and quantity demanded falls from 

60 units to 40 units.Find the value of elasticity demand

Answer: Q0 = 60,  Q1 = 40,  P0 = RM2,  P1 = RM4

                                            =  Q1 – Q0  X  P0

                                                 P1  -- P0  X  Q0

                                             = 40 – 60  x   2

                                                   4  -  2   x  60

                                             = - 0.33

# Price Elasticity of Demand

Income elasticity of demand ( Ey)

Income elasticity of demand measures the relationship between a change in 

quantity demanded for good X and a change in real income.   

Formula                 

Example : 

If income increases from RM2500 to RM3500 and the quantity demanded for

the product increases by 40 to 60 units, calculate the income elasticity of 

demand.

Answer: Q1 = 60, Q0 = 40, Y1 = RM3500, Y0 = RM2500

                                           

                                           =   60     –    40    x  2500

                                              3500  -  2500  x     40

                                           = 1.25

#Normal Goods

Normal goods have a positive income elasticity of demand so as consumers’ 

income rises more is demanded at each price i.e. there is an outward shift of 

the demand curve

Normal necessities have an income elasticity of demand of  

between 0 and +1 for example, if income increases by 10% and the demand 

for fresh fruit increases by 4% then the income elasticity is +0.4. Demand is 

rising less than proportionately to income.

Luxury goods and services have an income elasticity of demand > +1 i.e. 

demand rises more than proportionate to a change in income – for example 

a 8% increase in income might lead to a 10% rise in the demand for new 

kitchens. The income elasticity of demand in this example is +1.25.

#Inferior Goods

Giffen / inferior goods have a negative income elasticity of demand 

meaning that demand falls as income rises. Typically inferior goods or 

services exist where superior goods are available if the consumer has the 

money to be able to buy it. Examples include the demand for cigarettes, 

low-priced own label foods in supermarkets and the demand for 

council-owned properties.

#Cross price elasticity of demand ( Eab )

The cross-price elasticity of demand measures the responsiveness of the  

quantity demanded of one good when compared with a change in the price 

of another good. Cross elasticity used to determine relationship of the goods 

either substitute’s goods, complements goods or independents goods.

Example :

If the quantities demand for chicken increases from 120 to 160 units when 

the price of beef increase from RM15 to RM18, calculate the cross elasticity 

of demand between chicken and beef. 

Answer: Q1A = 160, Q0A = 120, P1B = 18, P0B = 15

                                       = 160 – 120  x   15

                                            18  -  15    x  120 

                                       = 1.67

Characterizing Cross-Price Elasticity


Substitutes (E>0). Are goods that can be used in exchange for one another. 

For instance, if the price of Pepsi were to increase, the demand for Coca Cola 

would increase because people generally see these two goods as substitutes for 

one another.

Compliments (E<0). Are goods that people tend to consume hand in  hand. 

For example, if the price of hamburger meat increases, the demand for 

American Cheese will decrease. This is because people commonly use 

American Cheese to make cheeseburgers.

Independent (E=0). These are goods that show no relationship. An example 

of independant goods is Halloween costumes and marble flooring.