Table of Contents
Week 1 – Choice & Resource Allocation Under Scarcity ...................................................... 3
1.1. Constrained Optimisation .............................................................................................. 3
1.2. The Budget Constraint ................................................................................................... 3
1.3. Opportunity Cost & Indifference Curve .......................................................................... 4
1.4. Optimising Consumption ............................................................................................... 6
1.5. Normal & Inferior Goods ............................................................................................... 6
1.6. Income & Substitution Effects........................................................................................ 8
Week 2 – Determinants of Demand & Demand Elasticities ................................................ 9
2.1. The Determinants of Demand ............................................................................................. 9
Week 3 – Supply & the Theory of the Firm ....................................................................... 15
3.1. The Efficient Out of a Firm ..................................................................................................15
3.2. Firm Efficiency – Minimising Production Costs ....................................................................15
3.3. Optimal Production and the Supply Curve ..........................................................................17
3.4. The Elasticity of Supply.......................................................................................................23
Week 4 – Equilibrium, Consumer & Producer Surplus, Taxes & Subsidies .......................... 24
4.1. Equilibrium in Supply & Demand ........................................................................................24
4.2. Changes in Equilibrium .......................................................................................................26
4.3. Consumer & Producer Surplus ............................................................................................28
4.4. Market Efficiency – Competitive Markets ...........................................................................29
4.5. Taxes & Subsidies ...............................................................................................................31
Week 5 – Firm Costs, Revenue & Profit ............................................................................ 36
5.1. Firms’ Objective – Maximising Profits .................................................................................36
5.2. The Production Function & the Marginal Product ...............................................................36
5.3. A Firm’s Cost Curves ...........................................................................................................37
5.4. Profit Maximisation by Firms..............................................................................................41
Week 6 – Firms in Competitive Markets ........................................................................... 42
6.1. Perfect Competition ...........................................................................................................42
6.2. The Marginal Firm ..............................................................................................................42
6.3. Temporary Shut Down and Industry Exit ............................................................................43
6.4. Impact of Industry Entry & Exit ...........................................................................................45
6.5. Changing Market Conditions in a Competitive Industry ......................................................47
Week 7 – Monopoly ......................................................................................................... 48
7.1. Relaxing the Assumptions of Competitive Markets.............................................................48
, 7.2. The Characteristics of Monopoly, Profit Maximisation by a Monopolist, Inefficiency of
Monopolies ..............................................................................................................................48
7.3. Price Discrimination by Monopolies ...................................................................................50
7.4. The Case for Regulating Monopolies ..................................................................................52
Week 8 – Oligopoly & Imperfectly Competitive Markets .................................................. 53
8.1. Oligopoly............................................................................................................................53
8.2. Co-operations in Oligopoly .................................................................................................54
8.3. Non-co-operation in Oligopoly – Game Theory ...................................................................54
8.4. Oligopoly: Policy Issues ......................................................................................................55
8.5. Assumptions & Characteristics of Imperfect Competition ...................................................55
8.6. Equilibrium in Imperfect Competition ................................................................................56
8.7. Differentiation in Imperfect Competition ...........................................................................57
Week 9 – Market Failure, Externalities & Public Goods .................................................... 58
9.1. Market Failure ...................................................................................................................58
9.2. Externalities in Production .................................................................................................58
9.3. Externalities in Consumption..............................................................................................59
9.4. Externalities & Government Policy .....................................................................................60
9.5. Private Solutions to Externalities ........................................................................................60
9.6. What are Public Goods? .....................................................................................................61
9.7. Issues in the Supply of Public Goods ...................................................................................61
9.8. Common Resources ............................................................................................................62
9.9. The “Tragedy of the Commons”..........................................................................................62
Week 10 – The Market for Labour.................................................................................... 62
10.1. The Supply & Demand for Labour .....................................................................................62
10.2. Equilibrium in the Labour Market .....................................................................................66
10.3. Labour Productivity & Technology ....................................................................................67
10.4. Compensating Wage Differentials ....................................................................................68
10.5. Efficiency Wages & Superstars..........................................................................................69
10.6. Discrimination in the Labour Market ................................................................................69
10.7. The Minimum Wage .........................................................................................................69
,Week 1 – Choice & Resource Allocation Under Scarcity
1.1. Constrained Optimisation
• Consumers want to maximise their satisfaction, referred to as utility.
• Firms want to maximise their profits and minimise their costs and, therefore, be efficient.
• Markets determine the level of competition between firms and, therefore, output and prices.
• Governments might want to maximise social benefit (welfare) or taxation while minimising
waste and damage to the environment.
o However, these maximisations are subject to constraints since these is scarcity of
goods. Therefore, economics focuses on optimisation given the constraints.
1.2. The Budget Constraint
• Most consumers have limited money, which requires choices to be made under scarcity.
Therefore, it is not possible to increase consumption of one good without reducing the
consumption of at least one other. For example, students might have to opt between buying
new clothes or going to a restaurant. Hence, the total consumption is limited by the resources
available. That is, the income available, which creates a budget constraint. The budget
constraint indicate what consumers can afford to spend and, therefore, the greater the
expected consumption of most goods and services, and vice versa.
The budget constraint can be analysed through the analysis of the choice between two goods
or services – x and y – where x is the one that we are interested in and y can be other good or
service, or all other goods or services. Using the relationship of x and y, it is possible to draw
a Budget Line that shows all possible combinations of x and y in terms of either quantity (q)
or price (p), as shown in the following diagram. The decision of what combination of the two
goods to consume is then based on the consumer’s preferences. Lastly, the slope of the
Budget Line is the relative price of the two goods and, therefore, is calculated as following: -
px / py.
Diagram - Budget Line
, 1.3. Opportunity Cost & Indifference Curve
• Opportunity cost is the cost of choosing one option relative to another, when choice is
constrained. That is, when choosing what to consume, consumers must sacrifice one good to
consume another. For instance, if we consider two goods – chocolate and apple – the cost of
choosing chocolate is not consuming the apple. Therefore, opportunity cost is the benefit
foregone by not choosing to consume the apple. Hence, individuals, firms, and governments
aim to minimise the total opportunity cost of their choices.
• Consumers have different tastes and preferences, and therefore each consumer their own
valuation of opportunity cost for any choice. These preferences of any individual consumer
and their opportunity cost valuations can be illustrated using Indifference Curves (diagram),
which represent the trade-off that any consumer is willing to make, when choosing between
two goods x and y.
Diagram – Indifference Curve
The Indifference curve represent equal utility in every combination of x and y, and its slope is
determined by the willingness (opportunity cost) of a consumer to give up units of x, in order
to consume more units of y, and vice versa. This is referred to as the Marginal Rate of
Substitution between x and y (MRSxy). That is, the rate at which a consumer is willing to
sacrifice consumption of one good for its alternative. While utility is the same along the
Indifference Curve, the MRSxy does change along the curve, due to the Diminishing Marginal
Utility. Diminishing Marginal Utility means that increased consumption of good x increases
the opportunity cost of not consuming good y. Therefore, however much a consumer likes
good x, at some point, if the individual keeps consuming x, he will start to vale y more than
consuming additional units of x.
• Not all Indifference Curves have curved slopes. Perfect substitutes, for instance, have equal
utility. For example, Coca-Cola versus Pepsi. Therefore, the Indifference Curves must be
straight lines since the rate of exchange remains constant, as shown is the following diagram.
Week 1 – Choice & Resource Allocation Under Scarcity ...................................................... 3
1.1. Constrained Optimisation .............................................................................................. 3
1.2. The Budget Constraint ................................................................................................... 3
1.3. Opportunity Cost & Indifference Curve .......................................................................... 4
1.4. Optimising Consumption ............................................................................................... 6
1.5. Normal & Inferior Goods ............................................................................................... 6
1.6. Income & Substitution Effects........................................................................................ 8
Week 2 – Determinants of Demand & Demand Elasticities ................................................ 9
2.1. The Determinants of Demand ............................................................................................. 9
Week 3 – Supply & the Theory of the Firm ....................................................................... 15
3.1. The Efficient Out of a Firm ..................................................................................................15
3.2. Firm Efficiency – Minimising Production Costs ....................................................................15
3.3. Optimal Production and the Supply Curve ..........................................................................17
3.4. The Elasticity of Supply.......................................................................................................23
Week 4 – Equilibrium, Consumer & Producer Surplus, Taxes & Subsidies .......................... 24
4.1. Equilibrium in Supply & Demand ........................................................................................24
4.2. Changes in Equilibrium .......................................................................................................26
4.3. Consumer & Producer Surplus ............................................................................................28
4.4. Market Efficiency – Competitive Markets ...........................................................................29
4.5. Taxes & Subsidies ...............................................................................................................31
Week 5 – Firm Costs, Revenue & Profit ............................................................................ 36
5.1. Firms’ Objective – Maximising Profits .................................................................................36
5.2. The Production Function & the Marginal Product ...............................................................36
5.3. A Firm’s Cost Curves ...........................................................................................................37
5.4. Profit Maximisation by Firms..............................................................................................41
Week 6 – Firms in Competitive Markets ........................................................................... 42
6.1. Perfect Competition ...........................................................................................................42
6.2. The Marginal Firm ..............................................................................................................42
6.3. Temporary Shut Down and Industry Exit ............................................................................43
6.4. Impact of Industry Entry & Exit ...........................................................................................45
6.5. Changing Market Conditions in a Competitive Industry ......................................................47
Week 7 – Monopoly ......................................................................................................... 48
7.1. Relaxing the Assumptions of Competitive Markets.............................................................48
, 7.2. The Characteristics of Monopoly, Profit Maximisation by a Monopolist, Inefficiency of
Monopolies ..............................................................................................................................48
7.3. Price Discrimination by Monopolies ...................................................................................50
7.4. The Case for Regulating Monopolies ..................................................................................52
Week 8 – Oligopoly & Imperfectly Competitive Markets .................................................. 53
8.1. Oligopoly............................................................................................................................53
8.2. Co-operations in Oligopoly .................................................................................................54
8.3. Non-co-operation in Oligopoly – Game Theory ...................................................................54
8.4. Oligopoly: Policy Issues ......................................................................................................55
8.5. Assumptions & Characteristics of Imperfect Competition ...................................................55
8.6. Equilibrium in Imperfect Competition ................................................................................56
8.7. Differentiation in Imperfect Competition ...........................................................................57
Week 9 – Market Failure, Externalities & Public Goods .................................................... 58
9.1. Market Failure ...................................................................................................................58
9.2. Externalities in Production .................................................................................................58
9.3. Externalities in Consumption..............................................................................................59
9.4. Externalities & Government Policy .....................................................................................60
9.5. Private Solutions to Externalities ........................................................................................60
9.6. What are Public Goods? .....................................................................................................61
9.7. Issues in the Supply of Public Goods ...................................................................................61
9.8. Common Resources ............................................................................................................62
9.9. The “Tragedy of the Commons”..........................................................................................62
Week 10 – The Market for Labour.................................................................................... 62
10.1. The Supply & Demand for Labour .....................................................................................62
10.2. Equilibrium in the Labour Market .....................................................................................66
10.3. Labour Productivity & Technology ....................................................................................67
10.4. Compensating Wage Differentials ....................................................................................68
10.5. Efficiency Wages & Superstars..........................................................................................69
10.6. Discrimination in the Labour Market ................................................................................69
10.7. The Minimum Wage .........................................................................................................69
,Week 1 – Choice & Resource Allocation Under Scarcity
1.1. Constrained Optimisation
• Consumers want to maximise their satisfaction, referred to as utility.
• Firms want to maximise their profits and minimise their costs and, therefore, be efficient.
• Markets determine the level of competition between firms and, therefore, output and prices.
• Governments might want to maximise social benefit (welfare) or taxation while minimising
waste and damage to the environment.
o However, these maximisations are subject to constraints since these is scarcity of
goods. Therefore, economics focuses on optimisation given the constraints.
1.2. The Budget Constraint
• Most consumers have limited money, which requires choices to be made under scarcity.
Therefore, it is not possible to increase consumption of one good without reducing the
consumption of at least one other. For example, students might have to opt between buying
new clothes or going to a restaurant. Hence, the total consumption is limited by the resources
available. That is, the income available, which creates a budget constraint. The budget
constraint indicate what consumers can afford to spend and, therefore, the greater the
expected consumption of most goods and services, and vice versa.
The budget constraint can be analysed through the analysis of the choice between two goods
or services – x and y – where x is the one that we are interested in and y can be other good or
service, or all other goods or services. Using the relationship of x and y, it is possible to draw
a Budget Line that shows all possible combinations of x and y in terms of either quantity (q)
or price (p), as shown in the following diagram. The decision of what combination of the two
goods to consume is then based on the consumer’s preferences. Lastly, the slope of the
Budget Line is the relative price of the two goods and, therefore, is calculated as following: -
px / py.
Diagram - Budget Line
, 1.3. Opportunity Cost & Indifference Curve
• Opportunity cost is the cost of choosing one option relative to another, when choice is
constrained. That is, when choosing what to consume, consumers must sacrifice one good to
consume another. For instance, if we consider two goods – chocolate and apple – the cost of
choosing chocolate is not consuming the apple. Therefore, opportunity cost is the benefit
foregone by not choosing to consume the apple. Hence, individuals, firms, and governments
aim to minimise the total opportunity cost of their choices.
• Consumers have different tastes and preferences, and therefore each consumer their own
valuation of opportunity cost for any choice. These preferences of any individual consumer
and their opportunity cost valuations can be illustrated using Indifference Curves (diagram),
which represent the trade-off that any consumer is willing to make, when choosing between
two goods x and y.
Diagram – Indifference Curve
The Indifference curve represent equal utility in every combination of x and y, and its slope is
determined by the willingness (opportunity cost) of a consumer to give up units of x, in order
to consume more units of y, and vice versa. This is referred to as the Marginal Rate of
Substitution between x and y (MRSxy). That is, the rate at which a consumer is willing to
sacrifice consumption of one good for its alternative. While utility is the same along the
Indifference Curve, the MRSxy does change along the curve, due to the Diminishing Marginal
Utility. Diminishing Marginal Utility means that increased consumption of good x increases
the opportunity cost of not consuming good y. Therefore, however much a consumer likes
good x, at some point, if the individual keeps consuming x, he will start to vale y more than
consuming additional units of x.
• Not all Indifference Curves have curved slopes. Perfect substitutes, for instance, have equal
utility. For example, Coca-Cola versus Pepsi. Therefore, the Indifference Curves must be
straight lines since the rate of exchange remains constant, as shown is the following diagram.
