BASIC ECONOMIC CONCEPTS AND TERMINOLOGY

Supply and demand is an economic model of price determination in a market economy. It

concludes that in a perfect competition model the unit price for a particular product will vary
until it settles at a point where the quantity demanded by consumers (at current price) will equal
the quantity supplied by producers (at current price), resulting in an economic equilibrium for
price and quantity.
The four basic laws of supply economics and demand are::37
1. If demand increases (demand curve shifts to the right) and supply remains unchanged, a
shortage occurs, leading to a higher equilibrium price.
2. If demand decreases (demand curve shifts to the left) and supply remains unchanged, a
surplus occurs, leading to a lower equilibrium price.
3. If demand remains unchanged and supply increases (supply curve shifts to the right), a
surplus occurs, leading to a lower equilibrium price.
4. If demand remains unchanged and supply decreases (supply curve shifts to the left), a
shortage occurs, leading to a higher equilibrium price.
Although it is normal to regard the quantity demanded and the quantity supplied as a
mathematical function of the of the price of the goods, the standard graphical representation,
usually attributed to Alfred Marshall has price on the vertical axis and quantity on the horizontal
axis, the opposite of the standard convention for the representation of a mathematical function.
Since determinants of supply and demand other than the price of the goods in question are not
explicitly represented in the supply-demand diagram, changes in the values of these variables are
represented by moving the supply and demand curves (often described as "shifts" in the curves).
By contrast, responses to changes in the price of the good are represented as movements along
unchanged supply and demand curves.
A supply schedule is a table that shows the relationship between the price of a good and the
quantity supplied. Under the assumption of perfect competition, supply is determined by
marginal cost. That is, firms will produce additional output while the cost of producing an extra
unit of output is less than the price they would receive.
A hike in the cost of raw goods would decrease supply, shifting costs up, while a discount would
increase supply, shifting costs down and hurting producers as producer surplus decreases.

By its very nature, conceptualizing a supply curve requires the firm to be a perfect competitor
(i.e. to have no influence over the market price). This is true because each point on the supply
curve is the answer to the question "If this firm is faced with this potential price, how much
output will it be able to and willing to sell?" If a firm has market power, its decision of how
much output to provide to the market influences the market price, therefor the firm is not "faced
with" any price, and the question becomes less relevant.
Economists distinguish between the supply curve of an individual firm and between the market
supply curve. The market supply curve is obtained by summing the quantities supplied by all
suppliers at each potential price. Thus, in the graph of the supply curve, individual firms' supply
curves are added horizontally to obtain the market supply curve.
Economists also distinguish the short-run market supply curve from the long-run market supply
curve. In this context, two things are assumed constant by definition of the short run: the
availability of one or more fixed inputs (typically physical capital), and the number of firms in
the industry. In the long run, firms have a chance to adjust their holdings of physical capital,
enabling them to better adjust their quantity supplied at any given price. Furthermore, in the long
run potential competitors can enter or exit the industry in response to market conditions. For both
of these reasons, long-run market supply curves are generally flatter than their short-run
counterparts.
The determinants of supply are:
1. Production costs: how much a goods costs to be produced. Production costs are the cost
of the inputs; primarily labor, capital, energy and materials. They depend on the
technology used in production, and/or technological advances. See productivity:
2. Firms' expectations about future prices
3. Number of suppliers
A demand schedule, depicted graphically as the demand curve represents the amount of some
goods that buyers are willing and able to purchase at various prices, assuming all determinants of
demand other than the price of the good in question, such as income, tastes and preferences, the
price of the substitute good and the price of the complementary good, remain the same.
Following the law of demand, the demand curve is almost always represented as downwardsloping, meaning that as price decreases, consumers will buy more of the good.
Just like the supply curves reflect marginal cost, demand curves are determined by marginal
utility curves. Consumers will be willing to buy a given quantity of a good, at a given price, if
the marginal utility of additional consumption is equal to the opportunity cost determined by the
price, that is, the marginal utility of alternative consumption choices. The demand schedule is

defined as the willingness and ability of a consumer to purchase a given product in a given frame
of time.
By its very nature, conceptualizing a demand curve requires that the purchaser be a perfect
competitorthat is, that the purchaser has no influence over the market price. This is true
because each point on the demand curve is the answer to the question "If this buyer is faced with
this potential price, how much of the product will it purchase?" If a buyer has market power, so
its decision of how much to buy influences the market price, then the buyer is not "faced with"
any price, and the question is meaningless.
Like with supply curves, economists distinguish between the demand curve of an individual and
the market demand curve. The market demand curve is obtained by summing the quantities
demanded by all consumers at each potential price. Thus, in the graph of the demand curve,
individuals' demand curves are added horizontally to obtain the market demand curve.
The determinants of demand are:
1. Income.
2. Tastes & preferences.
3. Prices of related goods and services.
4. Consumers' expectations about future prices and incomes that can be checked.
5. Number of potential consumers

Generally speaking, an equilibrium is defined to be the price-quantity pair where the quantity
demanded is equal to the quantity supplied. It is represented by the intersection of the demand
and supply curves. The analysis of various equilibria is a fundamental aspect of microeconomics.
Market Equilibrium: A situation in a market when the price is such that the quantity demanded
by consumers is correctly balanced by the quantity that firms wish to supply. In this situation, the
market clears.

Demand curve shifts:

When consumers increase the quantity demanded at a given price, it is referred to as an increase
in demand. Increased demand can be represented on the graph as the curve being shifted to the
right. At each price point, a greater quantity is demanded, as from the initial curve D1 to the new
curve D2. In the diagram, this raises the equilibrium price from P1 to the higher P2. This raises
the equilibrium quantity from Q1 to the higher Q2. A movement along the curve is described as a
"change in the quantity demanded" to distinguish it from a "change in demand," that is, a shift of
the curve. there has been an increase in demand which has caused an increase in (equilibrium)
quantity. The increase in demand could also come from changing tastes and fashions, incomes,
price changes in complementary and substitute goods, market expectations, and number of
buyers. This would cause the entire demand curve to shift changing the equilibrium price and
quantity. Note in the diagram that the shift of the demand curve, by causing a new equilibrium
price to emerge, resulted in movement along the supply curve from the point (Q1, P1) to the point
(Q2, P2).
If the demand decreases, then the opposite happens: a shift of the curve to the left. If the demand
starts at D2, and decreases to D1, the equilibrium price will decrease, and the equilibrium
quantity will also decrease. The quantity supplied at each price is the same as before the demand
shift, reflecting the fact that the supply curve has not shifted; but the equilibrium quantity and
price are different as a result of the change (shift) in demand.
Supply curve shifts:
When technological progress occurs, the supply curve shifts. For example, assume that someone
invents a better way of growing wheat so that the cost of growing a given quantity of wheat
decreases. Otherwise stated, producers will be willing to supply more wheat at every price and
this shifts the supply curve S1 outward, to S2an increase in supply. This increase in supply
causes the equilibrium price to decrease from P1 to P2. The equilibrium quantity increases from
Q1 to Q2 as consumers move along the demand curve to the new lower price. As a result of a
supply curve shift, the price and the quantity move in opposite directions. If the quantity supplied
decreases, the opposite happens. If the supply curve starts at S2, and shifts leftward to S1, the
equilibrium price will increase and the equilibrium quantity will decrease as consumers move
along the demand curve to the new higher price and associated lower quantity demanded. The
quantity demanded at each price is the same as before the supply shift, reflecting the fact that the
demand curve has not shifted. But due to the change (shift) in supply, the equilibrium quantity
and price have changed.
The movement of the supply curve in response to a change in a non-price determinant of supply
is caused by a change in the y-intercept, the constant term of the supply equation. The supply
curve shifts up and down the y axis as non-price determinants of demand change.

In both Classical economics and Keynesian economics the money market is analyzed as a
supply-and-demand system with interest rates being the price of money. The money supply may
be a vertical supply curve, if the central bank of a country chooses to use monetary policy to fix
its value regardless of the interest rate; in this case the money supply is totally inelastic (i.e.
demand does not shift in response to price changes). On the other hand, the money supply curve
is a horizontal line if the central bank is targeting a fixed interest rate and ignoring the value of
the money supply; in this case the money supply curve is perfectly elastic (i.e., demand does
shift in response to price changes). The demand for money intersects with the money supply to
determine the interest rate.
According to Hamid S. Hosseini, the power of supply and demand was understood to some
extent by several early Muslim scholars, such as fourteenth-century Mamluk scholar Ibn
Taymiyyah who wrote: "If desire for goods increases while its availability decreases, its price
rises. On the other hand, if availability of the good increases and the desire for it decreases, the
price comes down.
If desire for goods
increases while its
availability decreases, its
price rises. On the other
hand, if availability of
the good increases and
the desire for it
decreases, the price
comes down.

Adam Smith
The phrase "supply and demand" was used by Adam Smith in his 1776 book The Wealth of
Nations and David Ricardo titled one chapter of his 1817 work Principles of Political Economy
and Taxation "On the Influence of Demand and Supply on Price". The model was further
developed and popularized by Alfred Marshall in the 1890 textbook Principles of Economics.

International trade is the exchange of capital goods and services across international borders or
territories. In most countries, such trade represents a significant share of gross domestic product
(GDP). While international trade has been present throughout much of history, its economic,
social, and political importance has been on the rise in recent centuries. It is the presupposition of
international trade that a sufficient level of geopolitical peace and stability are prevailing in order
to allow for the peaceful exchange of trade and commerce to take place between nations.
Trading globally gives consumers and countries the opportunity to be exposed to goods and
services not available in their own countries. Almost every kind of product can be found on the
international market: food, clothes, spare parts, oil, jewelry, wine, stocks, currencies and water.
Services are also traded: tourism, banking, consulting and transportation. A product that is sold to
the global market is an export, and a product that is bought from the global market is an import.
Imports and exports are accounted for in a country's current account in the balance of payments.
Industrialization, advanced technology, transport, globalization, multinational corporations, and
outsourcing are all having a major impact on the international trade system. Increasing
international trade is crucial to the continuance of globalization. Without international trade,
nations would be limited to the goods and services produced within their own borders.
International trade is, in principle, no different from domestic trade as the motivation and the
behavior of parties involved in a trade do not change fundamentally regardless of whether trade
is across a border or not. The main difference is that international trade is typically more costly
than domestic trade. The reason is that a border typically imposes additional costs such as tariffs,
time costs due to border delays and costs associated with country differences such as language,
the legal system or culture.

Another difference between domestic and international trade is that factors of production such as
capital and labor are typically more mobile within a country than across countries. Thus
international trade is mostly restricted to trade in goods and services, and only to a lesser extent
to trade in capital, labor or other factors of production. Trade in goods and services can serve as a
substitute for trade in factors of production. Instead of importing a factor of production, a
country can import goods that make intensive use of that factor of production and thus embody
it. An example is the import of labor-intensive goods by the United States from China. Instead of
importing Chinese labor, the United States imports goods that were produced with Chinese labor.
One report in 2010 suggested that international trade was increased when a country hosted a
network of immigrants, but the trade effect was weakened when the immigrants became
assimilated into their new country.
In the era before the rise of the nation state, the term 'international' trade cannot be literally
applied, but simply means trade over long distances; the sort of movement in goods which would
represent international trade in the modern world.
Adam Smith displays trade taking place on the basis of countries exercising absolute advantage
over one another.
The law of comparative advantage was first proposed by David Ricardo by focusing on
comparative advantage, which arises due to differences in technology or natural resources. The
Ricardian model does not directly consider factor endowments, such as the relative amounts of
labor and capital within a country.
The Ricardian model is based on the following assumptions:

Labor is the only primary input to production

The relative ratios of labor at which the production of one good can be traded off for
another differ between countries and governments

In the early 1900s a theory of international trade was developed by two Swedish economists
known as the Heckscher-Olin model. The results of the HO model are that countries will

produce and export goods that require resources (factors) which are relatively abundant, such as
capital, and import goods that require resources which are in relative short supply, such as labor.
The HO model makes the following core assumptions:

Labor and capital flow freely between sectors

The amount of labor and capital in two countries differ (difference in endowments)

Technology is the same among countries (a long-term assumption)

Tastes are the same.

Largest countries by total international trade:]

Rank
-World Total
European
Union
1.China
2.U.S,
3.Germany
4.Japan
5.Nethlds
6..France
7.U.K

Country

International Trade of
Date of
Goods
information
(Billions of)
37,706.0
2013 est.

% GDP
(nominal)
50.5%

4,485.0

2013 est.

25.6%

4,150.0
3,908.7
2,600.6
1,548.3

2013 est.
2013 est.
2013 est.
2013 est.

43.8%
23.3%
71.5%
31.6%

1,261.6

2013 est.

147.8%

1,260.7

2013 est.

44.9%

1,196.9

2013 est.

47.4%

8.H.Kong
9.S.Korea
10. Italy

1157.8
1,075.2
995.1

2013 est.
2013 est.
2013 est.

422.3%
81.1%
48.0%

FUTURES AND FUTURES MARKETS: OUTLINE

Futures as bet on future price of any commodity (like gold or oil or corn) and now since 1972,
currencies which are in effect no different from other commodities. Unlike typical stock market
where you only win if value of stock goes up, here you can win even if price of commodity
drops (see below) depending on your bet.
In simple terms, futures depend on contracts (for us it will be to the end of the semester) between
two parties, one a holder of a commodity (you) and the other a buyer who wants to hedge their
risk by contracting for a future purchase of the commodity from you.
If you go long on a contract (that is you do a call), you are betting that the price of the
commodity will rise over the period of the contract. So, lets say, you buy 20,000 barrels of oil at
todays price of $80 a barrel betting that by the end of the contract the price will rise to $100 a
barrel giving you a profit of $20 a barrel x 20,000 barrels = $400,000 x multiple of 10 which
figures in any futures contract = $4 million. Of course, if the price of oil drops to say $60 a
barrel, you then take a loss of $20 a barrel and ultimately a $4 million loss (which by the way,
you all dont have as your total capitalization is only $1 million so bet conservatively).
If you go short on a commodity (that is a put), you are betting that the price will drop over the
period of the contract. So as in the above example you promise to sell oil at the current price of
$80 to a customer who wants to hedge against possible future price rises above that figure in
the commodity, while you, by contrast, believe the price will drop again in this case to $60 a
barrel. So on the day of the contracts delivery, you go out and buy the oil, and if it has indeed
dropped to $60 (while you sell it to the contracting party at the agreed price of $80) then you
clear a profit of $20 and make the $4 million profit. Of course, if, contrary to your expectations,
the price rises on the day of the contract, you take a bath!
Your bet either way is dependent on research by recent hotshot graduates like yourself who are
willing to work 80 hours a week to provide the traders with the necessary informationpolitical,
economic, meteorological, you name itthat affect price changes. If you are right, you get a
raise. If you are wrong, well you just lost your firm $4 million, so forget the raise and hope you
still have a job.

Futures markets affect price levels worldwide and so West African cotton growers and Zambian
copper for example see the price of their crop and metals set by markets over which they have
absolutely no control. Futures markets are regulated so you have to have the capital to back up
your bets (unlike credit default swaps in 2008 which is why the world economy almost tanked)
but governments, even Chinas, dont try to affect the price that much. Prices are ultimately up to
the market. Go on youtube and watch video from Chicago exchangelooks chaotic because it is.