Economics for Engineers (UNIT-1)

V SEMESTER HS-301

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Economics for Engineers �Course Objectives

• To explain the basic micro and macro economics concepts.
• To analyze the theories of production, cost, profit and break even analysis.
• To evaluate the different market structures and their implication for the behavior of the firm.
• To apply the basics of rational income accounting and business cycles

to Indian economy.

Department of ECE, BVCOE, New Delhi

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Economics for Engineers �Course Outcomes (CO)

• CO1: Analyze the theories of demand, supply, elasticity and consumer choice in the market.
• CO2: Analyze the theories of production, cost, profit and break even analysis.
• CO3: Evaluate the different market structures and their implication for the

behavior of the firm.

• CO4: apply the basics of rational income accounting and business cycles to Indian economy.

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Economics for Engineers �Course Outcomes (CO)

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Economic Understandings

Use the basic concepts of trade, opportunity cost, specialization, voluntary exchange, productivity, and price incentives to illustrate historical events.

• Hi! My name is Mrs. Econ and today I am going to teach you about economics.

​

• Economics is the study of the making, buying, and selling of goods or services.

Barter-Trade

• When the 13 colonies were founded, some people were good hunters, some were craftsmen, and some were farmers.

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• In order to get things that a person needed to survive, one person might have traded one item for another item.

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• This is known as voluntary exchange.

I have 5 rabbits to trade. Want to trade with me?

What is voluntary exchange?

• People will trade if they both get something from it.
• The lady trades a jug of milk and 3 eggs for 5 rabbits.
• She needs the rabbits to make rabbit stew.
• She’ll use the rabbits’ skin to make a fur cap.
• The man’s family needs milk and eggs.

Yes. I will trade my milk and eggs for your rabbits.

Let’s review voluntary exchange.

• Voluntary exchange helps both buyers and sellers.
• Voluntary exchange was used in the system of colonial trade. (barter)
• The colonists swapped goods that they had for things they needed.

I’ll make your farming tools for 4 crates of apples.

I’ll give you 4 crates of apples for farming tools.

Both parties must benefit from the trade.

Trade was very important after the Revolutionary War ended.

Under the Articles of Confederation, Congress had no power to make laws about trade.

This turned out to be a big problem among the thirteen states.

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How was this a problem?

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• Each state wanted to control their own trade. They tried to make big profits.

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• Each state made their own money. Sometimes they would not accept another state’s money.

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• Most foreign countries would not trade with the United States because the 13 states could not get along with each other.

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How did they solve these economic problems?

• Thanks goodness they wrote the U.S. Constitution!
• The Constitution says that the federal government controls trade between the states and with foreign countries.
• The state government controls trade within its own state.

1. Who is the United States’ Number 1 trading partner?

• Canada

• Automobiles

2. Can you name one of the most important industries trading between Canada and the U.S.A.?

(It’s big in Japan and Korea, too.

Your family probably uses this every day!)

Choices

PRODUCTIVITY

Opportunity

Cost

Basic Economics

Specialization

Price Incentives

Voluntary

Exchange

Choices Cost You!

• We have to make economic choices every day.
• Some choices are easy because they’re not very expensive.
• Some choices are hard because they cost a lot of money.

$

$

$

$

$

$

Examples of Daily Choices

(Cost a small amount of money)

Examples of Hard Choices

(Involves a lot of money)

Opportunity Cost

• Opportunity cost is the value of what is given up when a choice is made.
• Every time you make a choice, you give up something else.
• You might decide to watch TV instead of washing a neighbor’s car to make some money.
• Your opportunity cost is the money you could have made washing the car!

Making Choices�All choices require giving up something

• A farmer decides to grow corn instead of tomatoes.

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• His opportunity cost is the tomatoes he could have grown.

Making Choices�All choices require giving up something

• A dad decides to watch his son’s soccer game instead of earning some extra money fixing the neighbor’s computer.

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• His opportunity cost is the money he could have earned fixing the computer.

Leaders throughout history have had to make choices that involved opportunity cost.

• The kings and queens decided to spend money to search for a short cut to Asia. They paid for ships, supplies, and manpower.

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• Their opportunity cost was the money that could have be used for important things at home or to trade with other countries closer to home.

How do price incentives affect people’s behavior and choices?

• A price incentive is used to affect people’s buying behavior.
• Incentives can motivate people to take action!
• An offer for “Buy one pizza, get one free,” is a price incentive.
• A sale where items are ½ price is a price incentive.

BASIC ECONOMIC PROBLEM

Department of Electrical and Electronics Engineering, BVCOE New Delhi

Subject: Economics for Engineers , Instructor: SANDEEP SHARMA

33

BASIC ECONOMIC PROBLEM

Department of Electrical and Electronics Engineering, BVCOE New Delhi

Subject: Economics for Engineers , Instructor: SANDEEP SHARMA

34

Physical Environment:

Engineers produce products and services depending on physical laws. Physical efficiency takes the form:

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System Output

Physical (efficiency)=

System Input

BASIC ECONOMIC PROBLEM

Department of Electrical and Electronics Engineering, BVCOE New Delhi

Subject: Economics for Engineers , Instructor: SANDEEP SHARMA

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Economic Environment:

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Much less of a quantitative nature is known about economic environments– this is due to economics being involved with the actions of people, and the structure of organization.

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System worth

Economic (efficiency) =

System Cost

BASIC ECONOMIC PROBLEM

Department of Electrical and Electronics Engineering, BVCOE New Delhi

Subject: Economics for Engineers , Instructor: SANDEEP SHARMA

36

BASIC ECONOMIC PROBLEM

Department of Electrical and Electronics Engineering, BVCOE New Delhi

Subject: Economics for Engineers , Instructor: SANDEEP SHARMA

37

ECONOMIC PROBLEM SOLUTION

Department of Electrical and Electronics Engineering, BVCOE New Delhi

Subject: Economics for Engineers , Instructor: SANDEEP SHARMA

38

ECONOMIC PROBLEM SOLUTION

Department of Electrical and Electronics Engineering, BVCOE New Delhi

Subject: Economics for Engineers , Instructor: SANDEEP SHARMA

39

Micro and Macro Economics

Introduction

Economics is the study of choice. It makes a choice between unlimited wants and limited means. Men and society have to make choices to fulfil their wants. Men have to choose to satisfy their wants and society has to choose as to what to produce and in what quantity and how to distribute it among the different individuals. This problem of choice for the men and society lead us to study economics in 2 parts: Micro and Macro Economics.

Micro Economics

The term micro economics is derived from the Greek word ‘Mikros’ meaning small. Micro economics studies an individual or a firm. It studies the smallest unit of the economy.

According to K.E.Boulding, “Microeconomics is the study of particular firms, particular households, individual prices, wages, incomes, individual industries, particular commodities”.

Subject Matter of Micro Economics

Commodity Pricing

The basic concept behind micro economics is the commodity pricing. It looks into the demand and supply from individual perspective and tries to reach the equilibrium position with the interaction between the two. On the demand side we study the law of demand which is the one of the basic concepts of economics. We also study about the law of supply and with the interaction of the two the consumer reaches the equilibrium. Elasticity of demand and supply is also one of the basic concept of economics.

Factor Pricing

The factors engaged in production process need to be paid remuneration and economics find out how. There are basically four factors of production: land, labour, capital and entrepreneur. Land is paid rent, labour is paid wages, capital is paid interest and entrepreneurs are paid profits. Factor pricing helps the firm to decide how a piece of land or a worker is paid for his participation in the work.

Theory of Economic Welfare

Economic welfare guides the government in taking key policy decisions. It decides as to whether a policy should be implemented or not by weighing it under the parameters of economic welfare. If a policy decision benefit someone but harm others then should that policy decision be taken or not is decided by the economic welfare concept.

Macroeconomics

The word is derived from the Greek word ‘Makros’ which means large. It studies the economy as a whole. It studies in aggregates. It seeks to solve problem for the whole of the economy.

K.E.Boulding, “Macroeconomics deals not with individual quantities as such but with aggregates of these quantities; not with individual incomes but with national income; not with individual prices but with price levels; not with individual outputs but with the national output.”

Theory of Income and Employment

The theory of income and employment determines the optimum level in the economy taking into consideration aggregate demand and aggregate supply function. It depends upong consumption function and investment function. Any divergence between the two leads to fluctuations in the business cycle.

Theory of Price Level and Inflation

The general level of price level at which economy will function smoothly is determined by the theory of price level. How much is the inflation rate and how is it affecting the economy

is all decided by the macro economics. Too much inflation or deflation is harmful for the economy. The theory suggests measure to control them.

Theory of Economic Growth

The theory of economic growth explains the growth rate which is optimum for the economy of any country. Any divergence from the optimum growth rate leads to problems of inflation or deflation and can also lead to deep economic problems of poverty and unemployment. The theory suggests ways in which it can be checked.

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Macro Theory of Distribution

Macro economics deals with the overall distribution of wages and profits for a nation as a whole. It seeks to find out ways in which overall distribution is affected so that balance is maintained in the economy.

Differences Between Micro and Macro Economics

TABLE 1.1 – PRODUCTION POSSIBILITIES

Copyright © 2001 by Houghton Mifflin Company. All rights reserved.

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Simplifying Assumptions:

1. Economy is operating efficiently
2. Available supply of resources is fixed in quantity and quality at this point of time
3. No new development in technology during analysis
4. Economy produces only 2 types of products
5. Choices will be necessary because resources and technology are fixed

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A production possibilities table indicates some of the possible choices, PPC is a graphical presentation of choices

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 Production Possibility Curve

Figure 1.1�The Production Possibilities Curve

Copyright © 2001 by Houghton Mifflin Company. All rights reserved.

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• Points on the curve represent maximum possible combinations
• Points inside the curve represent underemployment or unemployment
• Points outside the curve are unattainable at present
• Optimal or best product will some point on the curve. The exact point depends on society ; this is a normative decision.

Law of increasing opportunity costs�

• The slope of PPC becomes steeper, showing increasing opportunity cost. That is, the amount of other goods and services that must be foregone to obtain more of any given product increases
• Economic rationale: economic resources are not completely adaptable to alternative uses

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Copyright © 2001 by Houghton Mifflin Company. All rights reserved.

59

Key question

How does a society decide its optimal point on the PPC?

Society receives marginal benefits (MB) from each additional product consumed

But the law of increasing opportunity costs reminds us that marginal costs (MC) also rise as more of a product is produced and consumed

Selection Criterion: Produce and consume so long as MB exceeds MC

3. Unemployment, economic growth and the future�

• Unemployment and productive inefficiency occur when the economy is producing less than full production or inside the PPC
• Economic growth occurs when PPC shifts outward. This happens when:
• Resource supplies expand in quality or quantity
• Technological advances are occurring
• Our present choices affect our future possibilities

Copyright © 2001 by Houghton Mifflin Company. All rights reserved.

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Figure 1.2�Shifts in the Production Possibilities Curve

Figure 1.3 �Shifts in the Production Possibilities Curve Depend on Choices

Copyright © 2001 by Houghton Mifflin Company. All rights reserved.

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THE CIRCULAR FLOW OF ECONOMIC ACTIVITY

Households – suppliers of the factors of production

& demanders of goods and services

Government – providers of public goods and services & demanders of both private goods and services and the factors of production

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Businesses / Firms – suppliers of goods and services

& demanders of the factors of production

Factor Market – where the factors of production

are exchanged

Product Market – where goods and services are exchanged

• The circular-flow diagram is a model that represents the transactions in an economy by flows around a circle.

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• Two sectors models

a.) savings economy

b.) non-savings economy

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• Three sectors models
• Four sectors models

Two sectors model (no savings economy)

(savings economy)

Factors of Production

(land, labor, capital, entrepreneur)

Factors of payment

(rent, wages, interest, profit)

Consumption of G/S

Household Sector

Business Firm

Output of G/S

Household savings

Expansion of business

• Three sectors models

It includes household sector, producing sector and government sector. It will study a circular flow income in these sectors excluding rest of the world

i.e. closed economy income. Here flows from household sector and producing sector to government sector are in the form of taxes. The income received from the government sector flows to producing and household sector in the form of payments for government purchases of goods and services as well as payment of subsides and transfer payments. Every payment has a receipt in response of it by which aggregate expenditure of an economy becomes identical to aggregate income and makes this circular flow unending.

• Four sectors models
• A modern monetary economy comprises a network of four sector economy these are-
• 1.Household sector 2. Firms or Producing sector

3. Government sector 4. Rest of the world sector. Each of the above sectors receives some payments from the other in lieu of goods and services which makes a regular flow of goods and physical services. Money facilitates such an exchange smoothly. A residual of each market comes in capital market as saving which in turn is invested in firms and government sector. Technically speaking, so long as lending is equal to the borrowing i.e. leakage is equal to injections, the circular flow will continue indefinitely. However this job is done by financial institutions in the economy.

Types of cost

• Fixed Costs
• Variable Costs

• Nessicity –luxury
• Producer-Consumer
• Complementary – Substitute
• Inferior –Normal

Classification of Goods

Types of Markets

• Perfectly competitive markets have

the following two

characteristics:

• Goods being sold are all the same
• Both Buyers and sellers are price takers

Monopoly is characterized by:

• One seller and many buyers
• Seller sets the price

Oligopoly is characterized by

• Few sellers without rigorous competition
• The sellers get together to set a price

Monopolistic competition is characterized by

• Many sellers, each selling a differentiated product
• Sellers have some ability to set the price for their own

product

Types of Demand

• Elastic and Non-elastic

The Concept of Demand, Supply, and Market Equilibrium

The Basic Decision-Making Units

• A firm is an organization that transforms resources (inputs) into products (outputs). Firms are the primary producing units in a market economy.
• An entrepreneur is a person who organizes, manages, and assumes the risks of a firm, taking a new idea or a new product and turning it into a successful business.
• Households are the consuming units in an economy.

The Circular Flow of Economic Activity

• The circular flow of economic activity shows the connections between

firms and households in input and output markets.

Input Markets and Output Markets

• Output, or product, markets are the markets in which goods and services are exchanged.
• Input markets are the markets in which resources—labor, capital, and land— used to produce products, are exchanged.

• Payments flow in the opposite direction as the physical flow of resources, goods, and services (counterclockwise).

Input Markets

Input markets include:

• The labor market, in which households supply work for wages to firms that demand labor.
• The capital market, in which households supply their savings, for interest or for claims to future profits, to firms that demand funds to buy capital goods.
• The land market, in which households supply land or other real property in exchange for rent.

Determinants of Household Demand

A household’s decision about the quantity of a particular output to demand depends on:

• The price of the product in question.
• The income available to the household.
• The household’s amount of accumulated wealth.
• The prices of related products available to the household.
• The household’s tastes and preferences.
• The household’s expectations about future income, wealth, and prices.

SUPPLY

• Quantity supplied of any good is the amount that sellers are willing to sell in the market
• Determinants of supply:
• Price
• Input prices
• Technology
• Expectations
• Number of sellers (Market supply curve)

Law of supply

• Other things equal, the quantity supplied of a good rises when the price of the good rises.
• Quantity supplied is positively related to the price of the good
• Supply schedule is a table that shows the relationship between the price of a good and the quantity supplied
• Supply curve graphs the supply schedule. It is upward sloping

SUPPLY AND DEMAND

• How do supply and demand combined together determine the quantity and price of a good sold in the market?
• Supply and demand curves intersect. At this equilibrium price quantity supplied equals quantity demanded
• Equilibrium is a situation in which supply equals demand
• Equilibrium price is also called as the market clearing price as quantity supplied equals quantity demanded

• What happens when market price is not equal to the equilibrium price?
• Excess supply- surplus in the market
• Excess demand- shortage in the market
• Free markets reach equilibrium through the interaction of buyers and sellers and price is the tool through which the market is cleared

Demand in Output Markets

• A demand schedule is a table showing how much of a given product a household would be willing to buy at different prices.
• Demand curves are usually

derived from demand schedules.

Law of Demand

• Other things equal, the quantity demanded of a good falls when the price of the good rises.
• Price and quantity demanded are negatively related
• Quantity demanded is the amount of the good that buyers are willing to purchase

• Determinants of quantity demanded:
• Income (normal, inferior)
• Prices of related goods (substitutes, complements)
• Tastes
• Expectations
• Number of buyers (Market demand curve)
• Demand schedule and Demand curve
• Demand schedule is a table that shows the relationship between the price of a good and the quantity demanded
• Demand curve graphs the demand schedule. The demand curve slopes downward

The Demand Curve

• The demand curve is a graph illustrating how much of a given product a household would be willing to buy at different prices.

PRICE (PER CALL)

QUANTITY DEMANDED (CALLS PER MONTH)

$

0

0.50

3.50

7.00

10.00

15.00

30

25

7

3

1

0

ANNA'S DEMAND SCHEDULE FOR

TELEPHONE CALLS

The Law of Demand

• The law of demand states that there is a negative, or inverse, relationship between price and the quantity of a good demanded and its price.

• This means that demand curves slope downward.

Other Properties of Demand Curves

• Demand curves intersect the quantity (X)- axis, as a result of time limitations and diminishing marginal utility.
• Demand curves intersect the (Y)-axis, as a

result of limited incomes and wealth.

Income and Wealth

• Income is the sum of all households wages, salaries, profits, interest payments, rents, and other forms of earnings in a given period of time. It is a flow measure.
• Wealth, or net worth, is the total value of what a household owns minus what it owes. It is a stock measure.

Related Goods and Services

• Normal Goods are goods for which demand goes up when income is higher and for which demand goes down when income is lower.
• Inferior Goods are goods for which demand falls when income rises.

Related Goods and Services

• Substitutes are goods that can serve as replacements for one another; when the price of one increases, demand for the other goes up. Perfect substitutes are identical products.
• Complements are goods that “go together”; a decrease in the price of one results in an increase in demand for the other, and vice versa.

Shift of Demand Versus Movement Along a Demand Curve

• A change in demand is not the same as a change in quantity demanded.
• In this example, a higher price causes lower quantity demanded.
• Changes in determinants of demand, other than price, cause a change in demand, or a shift of the entire demand curve, from D_A to D_B.

A Change in Demand Versus a Change in Quantity Demanded

• When demand shifts to the right, demand increases. This causes quantity demanded to be greater than it was prior to the shift, for each and every price level.

A Change in Demand Versus a Change in Quantity Demanded

• Change in price of a good or service leads to

​

• Change in quantity demanded
• (Movement along the curve).

To summarize:

Change in income, preferences, or prices of other goods or services

leads to

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Change in demand (Shift of curve).

The Impact of a Change in Income

• Higher income decreases the demand for an inferior good

• Higher income increases the demand for a normal good

The Impact of a Change in the Price of Related Goods

• Demand for complement good

(ketchup) shifts left

• Demand for substitute good (chicken) shifts right

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• Price of hamburger rises
• Quantity of hamburger demanded falls

From Household to Market Demand

• Demand for a good or service can be defined for an individual household, or for a group of households that make up a market.
• Market demand is the sum of all the quantities of a good or service demanded per period by all the households buying in the market for that good or service.

• Assuming there are only two households in the market, market demand

is derived as follows:

Supply in Output Markets

• A supply schedule is a table showing how much of a product firms will supply at different prices.
• Quantity supplied represents the number of units of a product that a firm would be willing and able to offer for sale at a particular price during a given time period.

The Law of Supply

• The law of supply states that there is a positive relationship between price and quantity of a good supplied.
• This means that supply curves

typically have a positive slope.

Determinants of Supply

• The price of the good or service.
• The cost of producing the good, which in turn depends on:
• The price of required inputs (labor, capital, and land),
• The technologies that can be used to produce the product,
• The prices of related products.

A Change in Supply Versus

a Change in Quantity Supplied

• A change in supply is not the same as a change in quantity supplied.
• In this example, a higher price causes higher quantity supplied, and a move along the demand curve.
• In this example, changes in determinants of supply, other than price, cause an increase in supply, or a shift of the entire supply curve, from S_A to S_B.

A Change in Supply Versus

a Change in Quantity Supplied

• When supply shifts to the right, supply increases. This causes quantity supplied to be greater than it was prior to the shift, for each and every price level.

A Change in Supply Versus

a Change in Quantity Supplied

• Change in price of a good or service leads to

​

• Change in quantity supplied
• (Movement along the curve).

To summarize:

Change in costs, input prices, technology, or prices of related goods and services

leads to

​

Change in supply (Shift of curve).

From Individual Supply to Market Supply

• The supply of a good or service can be defined for an individual firm, or

for a group of firms that make up a market or an industry.

• Market supply is the sum of all the quantities of a good or service supplied per period by all the firms selling in the market for that good or service.

• As with market demand, market supply is the horizontal summation of

individual firms’ supply curves.

• Excess supply, or surplus, is the condition that exists when quantity supplied exceeds quantity demanded at the current price.

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• When quantity supplied exceeds quantity demanded, price tends to fall until equilibrium is restored.

Increases in Demand and Supply

• Higher demand leads to higher equilibrium price and higher equilibrium quantity.

• Higher supply leads to lower equilibrium price and higher equilibrium quantity.

Decreases in Demand and Supply

• Lower demand leads to lower price and lower quantity exchanged.

• Lower supply leads to higher price and lower quantity exchanged.

Relative Magnitudes of Change

• The relative magnitudes of change in supply and demand determine the outcome of market equilibrium.

Relative Magnitudes of Change

• When supply and demand both increase, quantity will increase, but price may go up or down.

Analyzing Changes in Equilibrium: Summary

Law of Diminishing Returns

• The law of diminishing returns states that in all productive processes, adding more of one factor of production, while holding all others constant, will at some point yield lower incremental per-unit returns.

​

• The law of diminishing returns does not imply that adding more of a factor will decrease the total production, a condition known as negative returns, though in fact this is common.

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A common sort of example is adding more workers to a job, such as assembling a car on a factory floor. At some point, adding more workers causes problems such as workers getting in each other's way or frequently finding themselves waiting for access to a part. In all of these processes, producing one more unit of output per unit of time will eventually cost increasingly more, due to inputs being used less and less effectively.

Income elasticity

Market Equilibrium

• The operation of the market depends on the

interaction between buyers and sellers.

• An equilibrium is the condition that exists when quantity supplied and quantity demanded are equal.
• At equilibrium, there is no tendency for the market

price to change.

Market Equilibrium

• Only in equilibrium is quantity supplied equal to quantity demanded.

• At any price level other than P₀, the wishes of buyers and sellers do not coincide.

Market Disequilibria

• Excess demand, or shortage, is the condition that exists when quantity demanded exceeds quantity supplied at the current price.

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• When quantity demanded exceeds quantity supplied, price tends to rise until equilibrium is restored.