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 supply
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 statecraft
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 income
• 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 price
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 equations
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
o Enables 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 company
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!
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 supply
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 statecraft
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 income
• 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 price
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 equations
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
o Enables 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 company
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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