Economics Lecture 1– Class Notes
Determinants of Supply
1. Cost of
production – if it increases, supply decreases
Shifts in the Supply Curve
If cost of production
increases, quantity supplied will reduce
Supply curve will shift
leftwards
If cost of production
decreases, quantity supplied will increase
Supply curve will shift
rightwards
2. Taxes
If taxes increase, supply will
reduce, and the supply curve will shift leftwards
Impact of increase in
cost of production and increase in taxes will be the same
After the global financial
crisis of 2008, government reduced taxes to boost supply
This shifted the supply
curve rightwards
3. Goals of Firms
Profit is not always the only
goal of the firm
Goal may be sales
maximization or social welfare
o In this case, the supply
increases, and the supply curve shifts rightwards
Supply may also increase
due to good rainfall leading to increase in agri suppl
4. Elasticity of Supply
“Responsiveness of the quantity
supplied to the change in price”
If the change is steep =>
high elasticity
Elasticity (Es) = (% change in
quantity supplied) / (% change in price)
If Es>1
=> supply is elastic
If Es<1 => supply
is inelastic
Determinants of elasticity of
supply
• Overall determinant is choice – more the choice with the
firm, higher the elasticity e.g. Perishable quantities – firm has no
option/choice to store; has to sell at any price
Similarly for agricultural
commodities – inelastic supply
MARKET EQUILIBRIUM
• Quantity
demanded = quantity supply
Equilibrium point = point of
intersection of demand and supply curves
• Ideal situation – both buyers and sellers derive maximum
utility and satisfaction from this point
• Markets comprise
of two groups – buyers and sellers
o Buyers want lower prices to
maximize their satisfaction
o Sellers want higher profits
• Reducing the
price below the equilibrium will lead to shortage
Price will automatically
go up, in the interest of both the groups
• Increasing the
price about the equilibrium will lead to over-supply
Suppliers will reduce
the price in order to sell all the stock
Consumer’s
equilibrium is the situation where a
consumer spends his income on various commodities
in such a manner that he gets maximum satisfaction
Producer’s
equilibrium is the situation where a
firm produces that level of output which
provides it maximum profits
Who fixes the price in the
market – buyers, sellers, government or nobody?
It happens automatically
through ‘market mechanism’!
Also called Price
Mechanism or the ‘invisible hand’ (Adam Smith)
Adam Smith is called the
father of Economics (Book – An inquiry into the nature and the causes of the
wealth of nations, 1776)
Wealth of nations is the
first book on Economics, separating it from Philosophy
Though Kautilya’s
Arthshashtra dealt with Economics, it was primarily about statecraf
Impact of change in Demand & Supply
When supply
increases, price decreases (e.g. More supply of agricultural produce in the
mandis)
When demand
increases, price increases (e.g. Price of fruits during Navratra) Why are the
prices of agricultural commodities volatile?
Because of inelasticity
of demand & supply
o You don’t start eating more
just because price is less
o Producers anyway have to sell
of their agri products at any price (perishable goods) Paradox of poverty of
farmers
• If crops fail,
farmers have nothing to sell and the farmers lose incom
• But even when
there are bumper crops, their income reduces!
o Farmers lose in both the
cases
Why do producers prefer to burn
or sink the bumper crops, rather than sell?
Because if they export
all, the supply will increase, price will come down, bringing down overall
income
Justification of Minimum
Support Price by the government
• If the govt.
doesn’t intervene, both farmers and consumers will lose
• With govt
willing to buy ALL quantity at an attractive price (MSP), the farmers won’t be
incurring losses
o It will reduce the
fluctuation in prices, even in the case of overproduction
However, MSP is announced only
for important crops (24 in number)
If govt will announce
MSP for all (even potato, tomato etc), it will have to buy unlimited quantity
of all these
Not enough storage for
all the crops
Only those crops which
are crucial to food security are supported by MSP Difference between MSP &
Procurement Price
MSP = Guarantee to buy
unlimited quantity at this price for selected crops
Procurement Price = Guarantee
to buy only limited quantity for distribution in PDS & buffer storage
MSP = Usually below the
market price (though not much below) Procurement Price = At or above the market
pric
MSP Objective = Protect
the interest of farmers in case of overproduction
Procurement Price Objective =
Protect the interest of both, the consumers (through PDS)& farmers
MSP announced before sowing
Procurement Price announced
after harvest
Central Govt
announces both these prices on the recommendation
by Commission of
Agricultural Costs & Prices
(CACP); state govts also consulted
Pricing of Shares
Share market is a form of
Capital Markets, which comprises of Primary & Secondary Markets
Security is the general
term for all kinds of financial assets; share is also a security
Primary Market – First
time selling of shares - Initial Public Offer (IPO)
o Sold by firms to investors
Secondary Market –
Existing shares are sold again
o Sold by one investor to
another
Shareholders are owners
to the extent of the total value of their shares
o They get proportion of the
profits (called dividends) in return
o They can’t sell it back to the company (usually) – can only
transfer it to other investors
Primary Market – price
determined by the company
Secondary Market – price
determined by Demand & Supply equation
o The place where the transactions between buyers & sellers
happen is called stock exchange
o Money given to the company in
order to invest in long term growth
oEnables people to convert the
shares into cash (provides liquidity to the existing securities)
SEBI regulates both,
primary and secondary markets
In a stock market,
shares are auctioned
o Buyers created demand,
sellers create supply
Demand curves are constructed
on the basis of bids placed by interested buyers
Supply curves are constructed
on the basis of the willingness of the sellers to sell at a particular price
Impact of positive news on
share price
Buyers will become
optimistic about the company’s prospects
Demand will increase,
shifting the demand curve rightwards
This increases the price
But fewer sellers will
be there because they will hold on to the shares (good future prospects)
Supply curve will shift
leftwards
Therefore price will go
up
Indices of Stock Exchanges
Shows
performance of the companies
listed on that stock
exchange through a representative group of
companies (BSE – Sensex, comprising of 30 stocks; NSE – Nifty, comprising of 50
stocks)
Market Capitalization =
Number of shares x Share Price
Demand & Supply
depends on the perception of the investors regarding future performance of the compan
o Perception of the
future depends on –
1) Past &
current performance of the company,
2) Govt Policy (liberal policy
will help the company’s performance),
3) Foreign Investment (if its
high, the share price will go up),
4) Global factors (e.g. 2008
Financial Crisis caused a global crash of stock markets),
5) Macro EconomicFactors (GDP,
Inflation) and 6) Political Factors
If the Sensex goes up, can we
say with certainty that the economic performance of the country will be good in
the future?
We cannot be SURE, but
chances are high that the overall performance will be good
Stock markets are based on
perception and sentiments – they are right most of the time, but not all the
time!
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