Economics is defined as the study of how society allocates limited resources and goods (Encyclopedia Britannica, 2009). Resources include inputs such as labor, capital, and land and are used to produce goods. Goods include products such as food and clothing, as well as services such as those of barbers, doctors, and firefighters. Often goods and resources are deemed scarce because of society's demand for them vs. their availability (Stapleford, 2012). Economics, then, becomes the study of how goods and resources are allocated when scarce. It also allows us to anticipate the outcomes of changes in governmental policies, company practices, or population shifts, and so forth.
The market system is one avenue economists use to allocate scarce resources. A market is defined as any system or arrangement where trade takes place (Encyclopedia Britannica, 2009). In the U.S. there are several markets trading at all times. The study of the market system falls into two branches - macroeconomics and microeconomics.
Microeconomics is the study of the economic behavior of individual firms, consumers and industries and the distribution of total production and income between them (Encyclopedia Britannica, 2009). Microeconomics allows economists to analyze the market to establish the average price point for goods and services. This analysis also aids in the allocation of society's resources among all potential uses (Funderburk, 2012).
This branch of economics first emerged when economists began analyzing consumer decision-making processes and outcomes in the early 18th century (Stapleford, 2012). The first in-depth explanation of the discipline came from a Swiss mathematician named Nicholas Bernoulli, who laid the groundwork for microeconomic theory by suggesting that consumer choices are always rational. In the late 19th century, London economist Alfred Marshall proposed examining individual markets and firms as a way to understand the broader economy. It was then that microeconomics became formally established as a field of study.
In the mid-20th century, the concept of market failure led to the modern definition of microeconomics (Funderburk, 2012). Market failure refers to situations in which market operations prevent the efficient allocation of resources. Today, microeconomists are primarily concerned with analyzing market failure and suggesting ways to prevent or mitigate it (Stapleford, 2012). This is typically accomplished through public policy and/or government intervention.
Once such example of market failure is the monopoly. Monopolies occur when businesses lower the cost of products and/or services to such an extent that it forces the competition out of business (Encyclopedia Britannica, 2009). Similarly, businesses that enjoy a strong market share can monopolize industry resources and deny access to competitors in an attempt to control the means of production. In certain industries government intervenes to prevent such market conditions.
Microeconomists see monopolies and other market failures as an inefficient allocation of resources (Funderburk, 2012). For instance, monopolies may also occur when there is a lack of market competition and one company charges higher-than-market-value prices for products. The unfair pricing impacts consumers - the product may be unaffordable, and if it is a necessity such as gasoline, etc., consumer spending may become strained, therefore negatively impacting economic conditions. Furthermore, a business that has a monopoly on a limited resource may misuse or deplete it, damaging the economy or even the enviroment. Other types of market failure include information asymmetry, missing markets and externalities (Encyclopedia Britannica, 2009). Microeconomists argue that supply and demand is best balanced through perfect competition. No one organization should possess enough power to influence the overall pricing of a particular good or service.
In microeconomics, consumer behavior is typically analyzed by the concept of utility (Stapleford, 2012). In short, consumers purchase products to increase their satisfaction, and businesses produce to maximize their profits. Utility ultimately drives demand and keeps prices reasonable through market competition. The theory is simplistic and applicable to most industries, making microeconomics a foundation for nearly all economic theory (Funderburk, 2012).
Define the law of supply
Supply characteristics relate to the behavior of firms in producing and selling a product or service. The law of supply states that all things being equal (often referred to in its Latin translation ceteris paribus), as the price of a good or service increases, the quantity of that good or service increases and vice versa (Funderburk, 2012). At higher prices, producers are willing to offer more products than when prices are low. Producers of goods and services will make every attempt to increase production as a way of increasing profits. The incentive of profit must be greater than the total cost of producing the good, which includes the resources and value of the other goods that could have been produced instead (Encyclopedia Britannica, 2009). Supplier's profits are dependent on consumer demands and values. When suppliers do not earn enough revenue to cover the cost of production of the good, they incur a loss. Losses occur whenever consumers value a good less than the other goods that could have been produced with the same resources (Stapleford, 2012).
Define the law of demand.
The law of demand states that there is a direct relationship between the price of a good and the demand for it (Funderburk, 2012). In particular, people generally buy more of a good when the price is low and less of it when the price is high. As prices rise, people may buy less of a good if they have the ability to switch to cheaper alternatives. For instance, if the price of orange juice increases (due to poor crops in a given year), consumers may purchase more apple juice as a substitute.
As a general rule, the demand for a product varies inversely with its price (Funderburk, 2012). In other words, lower prices stimulate demand and higher prices reduce it. This is true except in the case of "Giffen goods" or commodities that are so essential to consumer that people will devote more income and resources towards them if prices increase (Encyclopedia Britannica, 2009). There are typically no cheap substitutes for Giffen goods. One modern example is the price of fuel in the Western world. No matter the price, consumers will find a way to purchase it. Gasoline is essential to the livelihood of most Americans. When prices increase, consumers endure higher gas bills, higher airline tickets, and higher prices at the gas pump. Fuel is a necessity.
Identify the factors that lead to a change in supply and demand.
Given ceteris paribus, there are many external factors that affect the demand for goods and services. Changes in the price of a good or service, or the raw materials used to produce it, can precede changes in supply and demand. Changes in the economy, high unemployment and recessions can impact the percentage of income consumers can and will spend on goods and services. At times, consumers' tastes and preferences simply shift. People's preferences can be influenced by advertising and marketing which can influence demand. Further, governmental fiscal policies involving spending and taxation change over time and often result in market changes.
Natural disasters such as storms, earthquakes, and floods, as well as man-made disasters such as oil spills can lead to changes in supply and demand. An example of this was the BP Deepwater Horizon Oil Spill of 2010. This impacted Gulf wildlife habitats and fishing practices -- fish supply was damaged, prices increased and overall demand dropped.
Prices for substitute or complimentary goods or scientific news and developments can cause demand to change. For instance, if a major study reveals that drinking high levels of a certain type of tea can cause cancer, demand for that product will undoubtedly decrease. Similarly, on the supply side of the equation, if the availability of resources used to make a good increases and that good becomes less expensive for end-users, prices may decrease and demand may increase. An example of this is when the cost to manufacture high-tech devices goes down due to advances in technology -- products become smaller, faster, and more efficient without being unaffordable. Demand, in turn, increases.
Is economics a science; why economists use models?
Generally, economics is defined as a social science (Stapleford, 2012). Economists are interested in making statements and answering questions about how changes in policies and incentives affect behavior, inferring something about causation (Encyclopedia Britannica, 2009). For example, if the price of grapefruit changes, what would happen to the quantity of oranges consumed? If tax rates drop, what happens to the labor supply? These questions appear simple, but can be difficult to answer. Because a social science does not lend itself easily to inferences of causation as experimental science does, economists are unable to run traditional experiments to test theories. Models become the tools used to understand how theories play out in the real world.
A model is a simplified and abstract description of reality (Encyclopedia Britannica, 2009). It often takes the form of a set of mathematical relationships that represent the behavior of economic actors. Generically, a model takes inputs and attempts to produce outputs. In economics, inputs are often referred to as exogenous variables…