The world of economics is overwhelming and complex, but we thought it might be helpful for you to know a few things that your competition already knows. In the knowledge economy, you can’t afford to be ignorant of economics when it comes to business.A \$2.00 tax levied on the sellers of birdhouses will shift the supply curve. A 3% tax on the sales of pharmaceuticals will lead to higher prices and lower sales. Taxes on imports/exports will cause inflation in your domestic economy, which means less purchasing power for your customers.

## WHAT IS ECONOMICS?

Economics describes the way things work in the real world. It is a social science that tries to explain why things happen. Economics also helps us to think about what we want as a society. Economists generally agree that people have only two goals in life—to get as much money as possible from the least amount of work and to give away as much money as possible.

## 1. The Law of Demand and Supply

The law of demand states that if the price (P) of something increases, demand (Q) will fall, ceteris paribus (all other things remaining the same). Conversely, if the price of something falls, demand will rise. The equation for this is:

### Q=∂P / ∂P > 0.

Note that ∂ is the Greek letter delta which stands for ‘derivative’. The law of supply states that if the price (P) of something increases, then the quantity supplied (Q) will increase, ceteris paribus. If the price decreases, then quantity supplied will decrease. The equation for this is:

## 2. Elasticity of Demand and Supply

Along with the laws of demand and supply, economists also have formulas to explain how much demand or supply will vary as a function of a change in price or income. These formulas are known as the elasticity of demand and elasticity of supply. The formula for elasticity of demand is:

### ∂Q / ∂P = -η where η stands for “elasticity”.

The formula for elasticity of supply is:

### ∂Q/ ∂P = γ where γ stands for “elasticity”.

Elasticity is a measure of the relationship between a price change and change in quantity. When the elasticity is greater than zero, demand or supply is considered to be elastic. When the elasticity is less than zero, demand or supply is considered to be inelastic. If the elasticity is equal to zero, then the demand or supply has unitary elasticity (or it does not change at all).

## 3. The Law of Diminishing Marginal Utility

The law of diminishing marginal utility states that the more you consume of something, the less each additional unit is worth to you. The basic formula for this is:

### U = ∫ C × Q = ∫ U(C) × Q > 0.

In words: Utility (U) equals the integral of consumption (C) times quantity (Q). In other words, it is the amount of utility gained as a function of consumption and quantity. It is a declining function of consumption and quantity.

## 4. The Law of Diminishing Marginal Utility, Continued

The law of diminishing marginal utility has many implications for firms and consumers. For instance, it tells why there is an inverse relationship between price and quantity demanded—as the price decreases, each additional unit becomes relatively more expensive. This leads to the law of demand: if the price decreases, demand increases while if the price increases, demand decreases.

## 5. Quantity and Supply Curves

Firms will have supply schedules or curves, which tell them how much of a good they are going to produce in different combinations. When the demand schedule or curve is vertical at a certain level of price, quantity demanded (Q) will be zero. This law is known as the law of fixed proportions—that is, if Q is given by some function of price. Thus, the law of fixed proportions says that a firm will set its output at a certain level for every price established by the market.

## 6. Perfect Competition and Monopoly

In the case of perfect competition there is a level of product differentiation and freedom of entry that results in a horizontal demand curve. This means that if any firm can produce a good or service at the same price, people will not care which one they buy. Thus, firms will create identical goods or services in order to compete.

Firms will sell their products at the same price. The price will be driven by the market, not by the firm itself. This is why we see a horizontal demand curve with perfect competition—there is no reason for firms to differentiate their product further than this, since everyone can obtain it for the same price.

## 7. Monopolies and Oligopolies

In the case of monopoly, a firm has control over the price of the good. This is usually due to a barrier to entry (such as brand loyalty or technological know-how), which allows it to set its own price. The demand curve for a monopoly will be upward-sloping because even though buyers will be willing to pay less for a good if the price increases, still they have no choice but to pay more because there is a good outside their market with higher prices.

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