What are the determinants of demand? Or: What are the factors that affect demand? Or: What cause shift in demand curve? Or: What cause change in demand?

 The price is the most important influence on the amount of any product purchased. But economists know that other factors can and do affect purchases. These factors, called determinants of demand are assumed to be constant when demand law is discussed. When any of these determinants changes, the demand curve will shift to right or left.

 For this reason, determinants of demand are sometimes referred to as demand shifters. The basic determinants are briefly discussed below.

a) Tastes: A favourable change in consumer tastes for a product or a change that makes the product more desirable means that more of it will be demanded at each price. Demand will increase; the demand curve will shift rightward. An unfavourable change in consumer preferences will decrease demand, shifting the demand curve to the left.

b) Number of buyers: An increase in the number of buyers in a market increases demand. A decrease in the number of buyers in a market decreases demand.

c) Income: If consumers’ income rises, demand for commodities will also rise and if income decreases, demand will also decrease. Products whose demand varies directly with money income are called superior goods or normal goods. Goods whose demand varies inversely with money income are called inferior goods.

d) Prices of related goods: When two products are substitutes, the price of one and the demand for the other move in the same direction. When two products are complements, the price of one good and the demand for the other good move in opposite direction. When two products are independent, price change of one may have very little or no change in demand for the other.

e) Expectations: An expectation of higher future prices may cause consumers to buy now in order to beat the anticipated price rises, thus increasing current demand. Again, a change in expectations concerning future income may prompt consumers to change their current spending.

Why demand curve slopes downward

 Why is the inverse relationship between price and quantity demanded?

The reasons for why there is an inverse relationship between price and quantity demanded or for demand curve being downward sloping are as follows.

a) Consistency with common sense: Price is an obstacle that deters consumers from buying. The higher that obstacle, the less of a product they will buy; the lower the price obstacle, the more they will buy.

b) Diminishing marginal utility: Consumption is subject to diminishing marginal utility. And because successive units of a particular product yield less and less marginal utility, consumers will buy additional units only if the price of those units is progressively reduced.

c) Income effect: The income effect indicates that a lower price increases the purchasing power of a buyer’s money income, enabling the buyer to purchase more of the product than she or he could buy before. A higher price has the opposite effect.

d) Substitution effect: The substitution effect suggests that at a lower price buyers have the incentive to substitute what is now a less expensive product for similar products are now relatively more expensive.

What are the exceptions to the law of demand

 The law of demand shows the negative relationship between price and quantity demanded of a commodity if other things remain constant. The exceptions to the law of demand are as follows.

a) Inconsistency of ceteris paribus assumption: Law of demand has an assumption those other things (include the number of consumers in the market, consumer tastes or preferences, prices of substitute goods, consumer price expectations, and personal income) than price will remain constant. If any of those factors changes, demand law will not work.

b) Giffen goods: The lowest quality category of a necessary commodity is classified as Giffen goods according to the name of Sir Robert Giffen. When price of a commodity rises, quantity demanded of Giffen goods increases.

c) Veblen goods: According to economist Thorstein Veblen, some consumers measure the utility of a commodity entirely by its price. The greater the price will be, the greater the utility. Diamond as prestigious goods is an example of this category.

d) Inferior goods: The commodities that have a very low price and use a very small portion of income do not follow the law of demand.

e) Change in product quality: If there is a change in product quality, the demand for that will be affected irrespective of price change.

Explain the law of demand. Or: The law of downward sloping demand curve.

 A fundamental characteristic of demand is this: Ceteris paribus (All else equal), as price falls, the quantity demanded rises, and as price rises, the quantity demanded falls. In short, there is a negative or inverse relationship between price and quantity demanded. Economists call this inverse relationship the law of demand. The other-things-equal assumption means that anything that affects demand other than price like income or taste of consumer will not change.

Law of demand is illustrated below with the help of schedule and figure.

Let,       Q_D = 22 - 2P      where, Q_D is quantity of demand and P is price.

 

Demand schedule
Price (P)	Demand (QD)
4	14
5	12
6	10

 

 

In the schedule we can see the inverse relationship between price and quantity of demand which is shown in figure by negative sloped demand curve.

What is demand

 Demand is human wants backed by buying power. So, three features are essential to be demand in the view point of economics. These are as follows.

a) Want or desire to consume, b) Ability to purchase and c) Willingness to spend.

Therefore, demand is a set of various amounts of a product that consumers are willing and able to purchase at each of a series of possible prices during a specified period of time.

Demand depends on the price of the commodity, the person’s money income, the prices of other commodities, and individual tastes

Discuss circular flow of income

The circular flow model implies a complex, interrelated web of decision making and economic activity. In monetary economy, there are two decision makers; households and businesses. Government is added as a third decision maker in open economy.

Households and businesses participate in both basic markets, resource and product market, but on different sides of each. Businesses are on the buying or demand side of resource markets and households, as resource owners, are on the selling or supply side. In the product market, these positions are reversed. Households, as consumers, are on the demand side, and businesses are on the supply side.

 

The interaction of firms and households in product and factor markets generates a flow of expenditure and income. Factor services are sold by households through factor markets. This leads to a flow of income from firms to households. Commodities are sold by firms through product markets. This leads to a flow of payments from households to firms.

Government makes purchases in both product and resource markets and pays for this. It provides public goods and services to both businesses and households. Government collects taxes from businesses and subsidies. It also collects taxes from households and makes available transfer payments.

Households do not spend all their income. Some of their income is saved and it is invested to businesses through financial market. If government has a surplus budget, the surplus amount also goes to businesses through financial market. If the opposite happens, government collects the deficit amount from the same.

Intrahousehold and intrabusiness economic activities are avoided for simplicity.

Write notes on production possibility curve/frontier (PPC/PPF)

 A production possibility curve shows the different combinations of various commodities that producers can turn out, given the available resources and existing technology.

 

All combinations of commodities on the curve (a, b) represent maximum quantities attainable only as the result of the most efficient use of all available resources. Points lying inside the curve (u) are also attainable, but are not desirable as points on the curve. These points imply a failure to achieve full employment and full production. Points lying outside the production possibilities curve (w) would be superior to many points on the curve; but such points are unattainable, given the current supplies of resources and technology. The barrier of limited resources prohibits production of capital and consumer goods lying outside the production possibilities curve.

Since resources are scarce, a full employment, full production economy cannot have an unlimited output of goods and services. As a result, choices must be made on which goods and services to produce and which to forgo. Production possibility curve helps us to solve this basic problem.

Assumptions:

a) The economy is operating at full employment and achieving full production.

b) The available supplies of the factors are fixed in both quantity and quality.

c) The state of the technological arts is constant.

d) Economy produces two commodities.

Properties/Features:

a) Downward slope: The downward slope of the curve implies the notion of opportunity cost.

b) Concavity: The concavity of the curve reveals increasing opportunity cost.

Expanding resources supplies, improvements in resource quality, and technological progress cause economic growth, that is, an outward shift of the production possibility curve.

Positive economics, Normative economics, Distinguish between positive and normative economics

 There are different views regarding the scope of economics such as positive, normative etc. It is very important to know the difference between positive and normative economics. Some differences of the two views are appended below.

Positive economics

The study of economics based on objective analysis. Most economists today focus on positive economic analysis, which uses what is and what has been occurring in an economy as the basis for any statements about the future. Positive economics stands in contrast to normative economics, which uses value judgments.

For example, a positive economic statement would be: "Increasing the interest rate will encourage people to save." This is considered a positive economic statement because it does not contain value judgments and its accuracy can be tested.

 

Normative economics

A perspective on economics that incorporates subjectivity within its analyses. It is the study or presentation of "what ought to be" rather than what actually is. Normative economics deals heavily in value judgments and theoretical scenarios. It is the opposite of positive economics. Normative statements are often heard in the media because they tend to represent a theory or opinion rather than objective analysis. Normative economics is a valuable way to establish goals and generate new ideas, but it should not be used as a basis for policy decisions.

An example of a normative economic statement would be, "We should cut taxes in half to increase disposable income levels"

There are different views regarding the scope of economics such as positive, normative etc. It is very important to know the difference between positive and normative economics. Some differences of the two views are appended below.

Positive economics	Normative economics
Positive economics is concerned with explaining what it is? That is it describes theories and laws to explain observed economic phenomena.	Normative economics is concerned with what should be or what ought to be the things.
According to J.N. Keynes, “A positive science may be defined as a body of systematized knowledge concerning what it is.”	According to J.N. Keynes, “Normative science is a body of systematized knowledge relating to criteria of what ought to be and concerned with the ideal as distinguished from the actual.”
Positive economics are broadly concerned with explaining the determination of relative prices and the allocation of resources between different commodities.	Normative economics is concerned with describing what should be the things, what price for a product should be fixed, what wages rate should be paid etc.
Positive economics states that monopolist will fix a price, which will equate marginal cost with marginal revenue.	The normative economics states the value judgments. It meant the conception of the people about what is good or bad.
The laws of positive economics are derives from set of axioms or propositions.	The normative economics is concerned with welfare propositions.

What are the branches of economics

 In modern economics the subject matter of economics has been divided into two parts. The two branches are microeconomics and macroeconomics. These terms were first introduced by Ragnar Frisch and have now been adopted by the economist all the world over.

Microeconomics deals with specific economic units and a detailed consideration of these individual units. At this level of analysis, the economist figuratively puts an economic unit under the microscope to observe details of its operation. It talks in terms of an individual firm, or household, and concentrate upon such magnitudes as the output or price of a specific product, the workers employed by a single firm etc. Microeconomics is useful in achieving a worm’s-eye view of some very specific component of our economic system.

Macroeconomics deals either with the economy as a whole or with the basic subdivisions or aggregates such as government, household and business sectors which make up the economy. It is concerned with obtaining a general outline of the structure of the economy and the relationships among the major aggregates. It speaks of such magnitudes as total output, total level of employment, total income, aggregate expenditures, the general level of price and so forth. Macroeconomics gives a bird’s-eye view of the economy.

 

What are the solutions to the economic problems? (Isms, market systems)

 There are different ways that a society can answer the basic questions. By the three kinds of economics we can get the solution of the problems. These are briefly discussed below.

Market economy: A market economy is one in which individuals and private firms make the major decisions about production and consumption. A system of process of markets of profits and losses, of incentives and rewards determines what, how and whom. In United States most economic questions are solved by this market economy. The extreme case of a market economy in which government keeps it hands off economic decisions is called a laissez-faire economy.

Command economy: A command economy is one is which the government makes all important decisions about production and distribution. It is operated in China. In short in a command economy, the government answers the major economic questions through its ownership of resources and its power to enforce decisions.

Mixed economy: In a mixed economy there exist both the market and command economy. A mixed economy is widely known as one, which has both private and public sector. The private has the features of free enterprise of market economy and public sector has the features of command or socialist economy.

The economic system depends on the environment and acceptability. As a developing country mixed economy is the unique solution for Bangladesh.

What are the basic problems of economics

 The scarcity of resources gives rise to various economic problems which have to be solved by economic system if it is to fulfill its purpose. The basic problems are:

a) What to produce?                  b) How to produce?

c) For whom to produce?           d) What provision should be made for economic growth?

What to produce: The problem ‘what to produce’ is the problem of choice between commodities. Scarcity of resources does not permit production of all goods and service that people would like to consume. Besides, all the goods and service are not equally valued in terms of their utility by the consumers. This is why the problem of choice between the commodities arises. Production possibility curve helps to analyze the problem.

How to produce: This means what combination of resources society decides to produce goods. Economy aims at using the available resources in the most efficient method. Isoquant curve helps to take the decision.

For whom to produce: This implies how the national product is to be distributed among the members of the society. Economic problem solutions depend on distribution process.

What provision should be made for economic growth: Both an individual and a society would not like to use all its scarce resources for current consumption only. This is because if all resources are used for producing consumer goods only and no provision in terms of allocating some resources for investment, that is, for production of capital goods is made, the future resources or productive capacity would not increase.

What are the goals of economics

 A number of economic goals or value judgments are accepted in the society. These goals may be briefly listed as follows.

a) Economic growth: The production of more and better goods and services, or more simply stated a higher standard of living, is desired.

b) Full employment: Suitable jobs should be available for willing and able to work.

c). Economic efficiency: All want maximum benefits at minimum, cost form the limited productive resources available.

d) Price level stability: Sizable upswings or downswings in the general price level, that is, inflation and deflation, should be avoided.

e) Economic freedom: Business executives, workers, and consumers should enjoy a high degree of freedom in their economic activities.

f) An equitable distribution of income: No group of citizens should face stark poverty while others enjoy extreme luxury.

g) Economic security: Provision should be made for those who are chronically ill, disabled, handicapped, laid off, aged, or otherwise unable to earn minimal levels of income.

h) Balance of trade: Economists seek a reasonable balance in international trade and financial transactions.

What is economics

 Economics is a social science. The word ‘Economics’ came from the Greek word ‘Oikonomioa’ which refers the ‘household management’. Many economists defined economics in different ways. Some definitions are given below.

Adam Smith defined, “Economics is a science which enquires the nature and causes of wealth of nations.”

L. Robins defined, “Economics is a science which studies human behaviour as a relationship between ends and scarce means which have alternative uses.”

According to Paul A. Samuelson, “Economics is the study of how societies use scarce resources to produce valuable commodities and distribute them among different people.”

Thus, we can conclude that, Economics is the science concerned with the problem of using or administering scarce resources to attain the greatest or maximum fulfilment of society’s unlimited wants.

What are the facts that provide the foundation of economics?

 Economics is the science concerned with the problem of using or administering scarce resources to attain the greatest or maximum fulfilment of society’s unlimited wants.

Two fundamental facts provide a foundation for the field of economics. These are shortly discussed below.

Unlimited wants: Society’s material wants are unlimited and insatiable. Material wants include the desires of consumers to obtain and use various goods and services which provide utility such as automobiles, sweaters, pizzas, legal advice and the like. It also includes those which businesses and units of government seek to satisfy such as machinery, communications systems, hospitals and the like.

Material wants cannot be satisfied completely. Over a short period of time, wants for a particular product can be satisfied. But, over a period of time wants multiply. When some of those are fulfilled, new wants are added. Overall objective of all economic activity is the attempt to satisfy these diverse material wants.

Scarce Resources: Economic resources are limited or scarce. Economic resource means all natural, human and manufactured resources that go into the production of goods and services. Economists broadly classify such resources as either (1) property resources— land or raw materials and capital; or (2) human resources— labour and entrepreneurial ability.

Gresham's law

 Gresham's law is an economic principle that states: "When a government overvalues one type of money and undervalues another, the undervalued money will leave the country or disappear from circulation into hoards, while the overvalued money will flood into circulation."   It is commonly stated as: "Bad money drives out good".

This law applies specifically when there are two forms of commodity money in circulation which are required by legal-tender laws to be accepted as having similar face values for economic transactions. The artificially overvalued money tends to drive an artificially undervalued money out of circulation and is a consequence of price control. 

 In economics, Gresham's law is a monetary principle stating that "bad money drives out good". For example, if there are two forms of commodity money in circulation, which are accepted by law as having similar face value, the more valuable commodity will disappear from circulation.

The law was named in 1858 by Henry Dunning Macleod, after Sir Thomas Gresham (1519–1579), who was an English financier during the Tudor dynasty.Gresham’s law, observation in economics that “bad money drives out good.” More exactly, if coins containing metal of different value have the same value as legal tender, the coins composed of the cheaper metal will be used for payment, while those made of more expensive metal will be hoarded or exported and thus tend to disappear from circulation. Sir Thomas Gresham, financial agent of Queen Elizabeth I, was not the first to recognize this monetary principle, but his elucidation of it in 1558 prompted the economist H.D. Macleod to suggest the term Gresham’s law in the 19th century.

Excess liquidity

 Excess liquidity is the liquidity that banks hold in excess of the aggregate needs arising from minimum reserve requirements and autonomous factors amount.

 Excess liquidity is defined as deposits at the deposit facility net of the recourse to the marginal lending facility, plus current account holdings in excess of those contributing to the minimum reserve requirements.

In normal times, when the interbank market functions properly, banks would channel liquidity to each other across the system and excess liquidity would have little or no reason to exist, because the cost opportunity of holding it would be just too high.

Producer Surplus

 Producer surplus is an economic measure of the difference between the amount that a producer of a good receives and the minimum amount that he or she would be willing to accept for the good. The difference, or surplus amount, is the benefit that the producer receives for selling the good in the market.

Consumer surplus/buyer’s surplus

 Consumer surplus, also known as buyer’s surplus, is the economic measure of a customer’s excess benefit. It is calculated by analyzing the difference between the consumer’s willingness to pay for a product and the actual price they pay, also known as the equilibrium price. A surplus occurs when the consumer’s willingness to pay for a product is greater than its market price.  

Basel II

 Basel II is the second of the Basel Accords, which are recommendations on banking laws and regulations issued by the Basel Committee on Banking Supervision.

 Basel II, initially published in June 2004, was intended to amend international standards that controlled how much capital banks need to hold to guard against the financial and operational risks banks face. These rules sought to ensure that the greater the risk to which a bank is exposed, the greater the amount of capital the bank needs to hold to safeguard its solvency and economic stability. Basel II attempted to accomplish this by establishing risk and capital management requirements to ensure that a bank has adequate capital for the risk the bank exposes itself to through its lending, investment and trading activities. One focus was to maintain sufficient consistency of regulations so to limit competitive inequality amongst internationally active banks.

Basel II uses a "three pillars" concept – (1) minimum capital requirements (addressing risk), (2) supervisory review and (3) market discipline.

Objective

The final version aims at:

1. Ensuring that capital allocation is more risk sensitive;
2. Enhance disclosure requirements which would allow market participants to assess the capital adequacy of an institution;
3. Ensuring that credit risk, operational risk and market risk are quantified based on data and formal techniques;
4. Attempting to align economic and regulatory capital more closely to reduce the scope for regulatory arbitrage.

While the final accord has at large addressed the regulatory arbitrage issue, there are still areas where regulatory capital requirements will diverge from the economic capital

 The Basel I accord dealt with only parts of each of these pillars. For example: with respect to the first Basel II pillar, only one risk, credit risk, was dealt with in a simple manner while market risk was an afterthought; operational risk was not dealt with at all.

 Minimum capital requirements: The first pillar deals with maintenance of regulatory capital calculated for three major components of risk that a bank faces: credit risk, operational risk, and market risk.

 Supervisory review: This is a regulatory response to the first pillar, giving regulators better 'tools' over those previously available. It also provides a framework for dealing with systemic risk, pension risk, concentration risk, strategic risk, reputational risk, liquidity risk and legal risk, which the accord combines under the title of residual risk. Banks can review their risk management system.

 The Market Discipline: This pillar aims to complement the minimum capital requirements and supervisory review process by developing a set of disclosure requirements which will allow the market participants to gauge the capital adequacy of an institution.

 Basel III, The third installment of the Basel Accords,was developed in response to the deficiencies in financial regulation revealed by the financial crisis of 2007–08. Basel III is intended to strengthen bank capital requirements by increasing bank liquidity and decreasing bank leverage.