Essential of Economics: Market Equilibrium, Limitations of GDP and Complementary Measures

This article discusses market equilibrium, limitations of GDP and complementary measures in Essential of Economics. It explains the impact of income, supply and demand on market equilibrium. It also highlights the shortcomings of GDP as a measure of living standard and explores complementary measures like Genuine Progress Indicator and Human Development Index.

Running head: ESSENTIAL OF ECONOMICS
Essential of Economics
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1ESSENTIAL OF ECONOMICS
Table of Contents
Answer 1..........................................................................................................................................2
Answer a......................................................................................................................................2
Answer b......................................................................................................................................3
Answer c......................................................................................................................................5
Answer 2..........................................................................................................................................6
Answer a......................................................................................................................................6
Limitation of GDP as a measure of standard of living................................................................6
Answer b......................................................................................................................................7
Complementary measures of GDP..............................................................................................7
References list..................................................................................................................................9

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Answer 1
Answer a
Following the standard theory of microeconomics, equilibrium in a market is defined as a
balanced state of demand and supply. At this point, the interest of buyers and sellers coincides.
The self-interest of buyers and sellers help the market to attain a stable free market equilibrium.
The change in either demand or supply or both lead a change in equilibrium position altering
market price and traded quantity. An important determinant of demand is income. Consumers’
income determines the purchasing power (Baumol and Blinder 2015). An increase in income
indicates an increase in purchasing power, which in turn increases demand. The resulted increase
in demand shifts the demand the rightward. The market then approaches to a new equilibrium
raising both price and quantity traded. The figure below explains the impact of an increase in
consumers’ income on equilibrium of car market.
Figure 1: Increase in income and effect on car market
(Source: as created by Author)

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The initial demand curve in the car market is shown as DD. The initial market supply
curve is SS. With interaction of forces of demand and supply, the car market attains equilibrium
at the point E. At this point, the equilibrium price of car is P*. The equilibrium quantity traded in
the market is Q*. Now, an increase in income of consumers increase affordability of cars among
buyers. The demand for car thus increases. The increased demand for car is captured by the new
demand curve D1D1. As the demand curve shifts, the new equilibrium is attained corresponding
to the intersection point of new demand and existing supply curve (Sloman and Jones 2017). The
new equilibrium is achieved at point E1. Under the new equilibrium price of car increases from
P* to P1. The quantity traded in the market increases to Q1.
Answer b
The joint forces of demand and supply attain equilibrium under free market condition.
External factors causing change in demand and supply leads to a change in market equilibrium
and associated market outcome. Under the given scenario, the market of mobile phone is initially
in equilibrium. The entry of new suppliers in the market increase availability of mobile phones in
the market. The increasing availability of mobile phones increase supply (McKenzie and Lee
2016). The expansion of market supply shift the market supply curve outward. The demand
however cannot adjust immediately. Given the demand, increase in supply causes a change in
market equilibrium of mobile phone altering price and number of mobile phones under initial
equilibrium. The figure below portraits scenario of mobile market following the change in
supply.

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Figure 2: The market of mobile phones
(Source: as created by Author)
In the above figure, the downward sloping curve D1D1 indicates the initial demand curve
for mobile phone. The upward sloping curve S1S1 shows initial supply curve of mobile phones.
With the initial demand and supply curve, the initial equilibrium in the market is attained at the
point E. The initial equilibrium yields a market price of P1 and equilibrium number of mobile
phones as Q1. Now, consider the effect of entry of new mobile phone producers in the market. As
more producers are now supplying mobile phones, there is an increase in supply of mobile
phones. The expansion in market supply is shown by the outward shift of the supply curve to
S1S1 (Friedman 2017). Given the demand, the new supply curve shifts the equilibrium from E1 to
E2. The excess supply in the market lowers the equilibrium price from P1 to P2. Because of the
increased supply, the equilibrium quantity in the market for mobile phone increases from Q1 to
Q2.

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Answer c
Initial equilibrium in a market is determined from the demand and supply condition in the
market. Several exogenous factors influence demand and supply of a good. Apart from own
price, price of related goods affect the demand of a particular good. Related goods include
substitute and complementary goods. An increase in price of substitute goods make the good
relatively cheaper. People then tend to substitute their demand toward the cheaper alternative.
This increases demand for the concerned good. The reverse is the case for a decline in price of
substitute good. A decline in price of substitute good, make the good relatively expensive (Hill
and Schiller 2015). This lowers the demand of the particular product. Pepsi is a close substitute
of Coca Cola. When price of Pepsi falls, Coca-Cola seems to be relatively expensive to the
buyers. They then tend to increase their demand for Pepsi substituting the demand for Coca-
Cola. The lower demand in the Coca-Cola market affect the market equilibrium, which is
illustrated in the following figure.
Figure 3: Fall in price of substitute and effect on Coca-Cola market

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(Source: as created by Author)
Figure above portraits the market of Coca-Cola. The initial equilibrium in the market is
E0. The equilibrium is obtained from the interaction of initial market demand and market supply
curve of Coca- Cola. The equilibrium price and quantity in the market is given as P0 and Q0
respectively. Following a decline in price of Pepsi, the demand for Coca-Cola declines as people
prefers the cheaper alternatives (Cowell 2018). The decline in demand of Coca-Cola causes the
market demand curve to shift inward to D2D2. The new equilibrium is at E1. At the new
equilibrium, a lower quantity (Q1) of Coca-Cola is traded. The equilibrium price also falls to P1
under the new equilibrium.
Answer 2
Answer a
Gross Domestic Product of a nation captures the national income of a country. GDP is
used as the simplest measure of tracing living standard. GDP however is only a quantitative
measure computing monetary values of produced goods and services in a nation (Decancq and
Schokkaert 2016). GDP though is a simple measure but it has several shortcomings that prevents
GDP to be a complete measure of living standard.
Limitation of GDP as a measure of standard of living
GDP computes the value of goods and services that are exchanged in the market. This
creates a problem of measurement. In a society, there are different activities that are not
exchanged in the market such as housework, volunteer work, home care and community service.
These are the virtual aspects of economic well-being (Robert et al. 2014). No components of
GDP that can captures the non-marketed activities. A society where children drive recklessly in

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the road, older citizens do not receive proper care and dominance of drug dealers in the society
cannot be considered as enjoying a good quality of life. The increase in per capita GDP thus does
not always mean an increase in living standard.
GDP is a quantitative measure and hence is unable to capture qualitative change in living
standard. GDP though measures the value of produced goods and services, it does not deduct the
cost of bad activities such as pollution and over exploitation of natural resources. When tobacco
or a soap pollute water and air, the market value of soap and tobacco are included in the GDP. It
however does not exclude the cost of pollution (Jones and Klenow 2016). A higher per capita
GDP with poor quality of environment cannot ensure a good living standard. The more industrial
production takes place in a country, the more is environmental pollution hampering quality of
life.
In order to evaluate true living standard, focus should also be given on enjoyment of
leisure time and happiness. It is difficult to measure these things through GDP. The working
hours are included in GDP but leisure time is not captured in GDP. With increase in working
hours, GDP increases. In contrast, an increase in work hours means a lesser time for leisure
(Feldstein 2017). The lesser time for enjoyment hampers the quality of life. GDP does not
include the economic inequality. A nation with higher GDP but high inequality in income
distribution does not have a high living standard.
Answer b
Complementary measures of GDP

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Following the shortcomings of GDP as a measure of well-being complementary measures
of GDP for capturing living standard needs to be used. Two alternative measures of living
standard are Genuine Progress Indicator (GPI) and Human Development Index (HDI).
Genuine Progress Indicator (GPI)
Genuine Progress Indicator (GPI) is a well-known indicator of sustainability. This in
addition to GDP captures a variety of indicators. This include commuting cost, transport
accidents, cost of pollution, crime water pollution, land degradation, industrial action, use of
irrigation water, land degradation, loss of forest, climate change, depletion of natural resources,
depletion of ozone layers and many others (Andrade and Garcia 2015). As GPI includes many
other indicators, which GDP does not, it a better measure of well-being.
Human Development Index (HDI)
HDI is measure for capturing human development. It has three main components – life
expectancy at birth, adult literacy and combined ratio of primary, secondary and tertiary gross
enrollment and per capita GDP adjusted in purchasing power parity also called Gross National
Income (GNI) (Çilingirturk and Kocak 2018). The measure ranged between 1 and 0. Value
closer to 1 means better quality of human development while value closer to 0 means lower
quality of living.

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References list
Andrade, D.C. and Garcia, J.R., 2015. Estimating the genuine progress indicator (GPI) for Brazil
from 1970 to 2010. Ecological Economics, 118, pp.49-56.
Baumol, W.J. and Blinder, A.S., 2015. Microeconomics: Principles and policy. Nelson
Education.
Çilingirturk, A.M. and Kocak, H., 2018. Human Development Index (HDI) Rank-Order
Variability. Social Indicators Research, pp.1-24.
Cowell, F., 2018. Microeconomics: principles and analysis. Oxford University Press.
Decancq, K. and Schokkaert, E., 2016. Beyond GDP: Using equivalent incomes to measure well-
being in Europe. Social indicators research, 126(1), pp.21-55.
Feldstein, M., 2017. Underestimating the real growth of GDP, personal income, and
productivity. Journal of Economic Perspectives, 31(2), pp.145-64.
Friedman, L.S., 2017. The microeconomics of public policy analysis. Princeton University Press.
Hill, C. and Schiller, B., 2015. The Micro Economy Today. McGraw-Hill Higher Education.
Jones, C.I. and Klenow, P.J., 2016. Beyond GDP? Welfare across countries and time. American
Economic Review, 106(9), pp.2426-57.
McKenzie, R.B. and Lee, D.R., 2016. Microeconomics for MBAs: The economic way of thinking
for managers. Cambridge University Press.

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Robert, C., Kubiszewski, I., Giovannini, E., Lovins, H., McGlade, J., Pickett, K.E., Vala
Ragnarsdóttir, K., Roberts, D., De Vogli, R. and Wilkinson, R., 2014. Time to leave GDP
behind. Nature, 505(7483).
Sloman, J. and Jones, E., 2017. Essential Economics for Business. Pearson.