Summary Microeconomics
Chapter 1 – Preliminaries
Microeconomics deals with the behaviour of individual economic units. These
units include any individual or entity that plays a role in the functioning of our
economy. Microeconomics explains how and why these units make economic
decisions.
Another concern of microeconomics is how economic units interact to form larger
units – markets and industries. Microeconomics reveals how industries and
markets operate and evolve, why they differ from one another, and how they are
affected by government policies and global economic conditions.
Macroeconomics deals with aggregate economic quantities, such as the level
and growth rate of national output, interest rates, unemployment, and inflation.
1.1 Themes of microeconomics
Microeconomics is much about limits – the limited incomes that consumers can
spend on goods and services, the limited budgets and technical knowledge of
firms, limited number of hours in a week that workers can allocate to labour or
leisure. Microeconomics is about ways to make the most of these limits, the
allocation of scarce resources.
Trade-offs
Consumers have limited incomes consumer theory: how consumers,
based on their preferences, maximize their well-being by trading off the
purchase of more of some goods for the purchase of less of others.
Workers must decide whether and when to enter the workforce. One must
trade off working now (and earning immediate income) for continued
education (and hope of earning higher future income). Also, workers face
trade-offs in their choice of employment large corporations that offer job
security but limited potential for advancement, small companies where
there is more opportunity for advancement but less security. Lastly,
workers must sometimes decide how many hours per week they wish to
work, trading off labour for leisure.
Firms face limits in the kinds of products they can produce, and the
resources available to produce them. it is also constrained in terms of
financial resources and the current production capacity of its factories.
Theory of the firm: describes how trade-offs can best be made, begins
with the assumption that firms try to maximise their profits.
Prices and markets
All of the trade-offs described above are based on the prices faced by consumers,
workers and firms. In a centrally planned economy, prices are set by the
government. In a market economy, prices are determined by interactions on
markets.
Theories and models
Theory: developed to explain observed phenomena in terms of a set of basic
rules and assumptions. Economic theories are also the basis for making
predictions. Thus the theory of the firm tells us whether a firm’s output level will
increase of decrease in response to an increase in wage rates or a decrease in
material prices.
,Model: mathematical representation, based on economic theory of a firm,
market of other entity.
Quantifying the accuracy of a prediction can be as important as the prediction
itself. No theory is perfectly correct. The usefulness of and validity depend on
whether it succeeds in explaining and predicting the set of phenomena that it is
intended to explain and predict.
Positive vs Normative analysis
Positive analysis: analysis describing relationships of cause and effect.
Explanation and prediction.
Normative analysis: analysis examining questions of what ought to be. Is often
supplemented by value judgements society must make a value judgement
weighing equity against economic efficiency. When value judgements are
involved, microeconomics cannot tell us what the best policy is. However it can
clarify the trade-offs and thereby help to illuminate the issues and sharpen the
debate. Ex: a comparison between a gasoline tax and an oil import tariff might
conclude that the gasoline tax will be easier to administer but will have a greater
impact on lower-income consumers.
1.2 What is a market?
Market: collection of buyers and sellers that, through their actual or potential
interactions, determine the price of a product or set of products.
Market definition: determination of the buyers, sellers, and a range of products
that should be included in a particular market.
Arbitrage: practice of buying at a low price at one location and selling at a
higher price in another.
Competitive vs noncompetitive markets
Perfectly competitive market: market with many buyers and sellers, so that
no single buyer or seller has a significant impact on price.
Some markets contain many producers but are noncompetitive; that is,
individuals can jointly affect the price. The world oil market is one example. Since
the early 1970s, that market has been dominated by the OPEC cartel (group of
producers that acts collectively).
Market price: price prevailing in a competitive market.
In markets that are not perfectly competitive, different firms might charge
different prices for the same product. This might happen because one firm is
trying to win customers from its competitors, or because customers have brand
loyalties that allow some firms to charge higher prices than others.
The market prices of most goods will fluctuate over time, and for many goods the
fluctuations can be rapid. This is particularly true for goods sold in competitive
markets.
Market definition – The extent of a market
Extent of a market: boundaries of a market, both geographical and in terms of
range of products produced and sold within it.
For some goods, it makes sense to talk about a market only in terms of very
restrictive geographic boundaries housing (specific per area, people want
house in city A, not in B). retail gasoline markets, though less limited
geographically, are still regional because of the expense of shipping gasoline
over long distances. But gold is bought and sold in a world market, the possibility
of arbitrage prevents the price from differing significantly from one location to
another.
,Market definition is important for 2 reasons:
A company must understand who its actual and potential competitors are
for the various products that it sells or might sell in the future. It must also
know the product boundaries and geographical boundaries of its market in
order to set price, determine advertising budgets, and make capital
investment decisions.
Market definition can be important for public policy decisions. Should the
government allow a merger or acquisition involving companies that
produce similar products, or should it challenge it? Answer depends on
impact of the merger on future competition and prices can be evaluated
by defining a market.
1.3 Real vs Nominal prices
Nominal price: absolute price of a good, unadjusted for inflation.
Real price: price of a good relative to an aggregate measure of prices; price
adjusted for inflation.
Consumer price index: measure of the aggregate price level.
Producer price index: measure of the aggregate price level for intermediate
products and wholesale goods.
Chapter 2 – The basics of supply and demand
Without government intervention, supply and demand will come into equilibrium
to determine both the market price of a good and the total quantity produced.
Variation of price and quantity over time depend on the ways in which supply and
demand respond to other economic variables.
2.1 Supply and demand
The supply-demand model combines the supply curve (relation between quantity
willing to sell and price) and a demand curve (relation between quantity
consumers want and price).
Supply curve
The higher the price, the more that firms are able and willing to produce
and sell. A higher price may enable current firms to expand production by
hiring extra workers or by having existing workers work overtime. A higher
price may also attract new forms to the market. These newcomers face
higher costs because of their inexperience in the market and would
therefore have found entry uneconomical at a lower price.
Quantity supplied can depend on other variables besides price: wages,
interest charges, costs of raw materials (make production more profitable).
When production costs decrease, output increases supply curve shifts to
the right.
Change in quantity movement along the supply curve.
Demand curve
Slopes downward consumers are usually ready to buy more if the price
is lower. The quantity of a good that consumers are willing to buy can
depend on other besides its price. Income is especially important.
Change in demand shifts in the demand curve.
Change in the quantity demanded movement along the demand curve.
Substitutes: 2 goods for which an increase in the price of one leas to an
increase in the quantity of the other. (beef and chicken)
Complements: 2 goods for which an increase in the price of one leads to
a decrease in the quantity demanded of the other. (gas and automobiles)
, 2.2 The market mechanism
Equilibrium price: price that equates the quantity supplied to the quantity
demanded
Market mechanism: tendency in a free market for price to change until the
market clears.
Surplus: situation in which the quantity supplied exceeds the quantity
demanded.
To sell surplus, producers would begin to lower prices. Eventually as price fell,
quantity demanded would increase, and quantity supplied would decrease until
the equilibrium was reached.
Shortage: situation in which the quantity demanded exceeds the quantity
supplied.
Shortage leads to upwards pressure on price as consumers tried to outbid one
another for existing supplies and producers react by increasing price and
expanding output price reaches equilibrium.
2.3 Changes in market equilibrium
Lower costs result in lower prices and increased sales. In general, price and
quantity will change depending both on how much the supply and demand
curves shift and on the shapes of those curves.
2.4 Elasticities of supply and demand
Supply depends both on price and on variables that affect production cost.
The price elasticity of demand measures the sensitivity of quantity demanded to
price changes.
Elasticity: percentage change in one variable resulting from a 1-percent
increase in another.
Price elasticity of demand: percentage change in quantity demanded of a good
resulting from a 1-percent increase in its price Ep = (%∆Q)/(%∆P) or
(usually negative number)
When price elasticity is greater than 1 demand is price elastic
When price elasticity is less than 1 demand is price inelastic
When there are close substitutes, a price increase will cause the consumer to buy
less of the good and more of the substitute. Demand will then be highly price
elastic. When there are no close substitutes, demand will tend to be price
inelastic.
Near the top, because price is high and quantity is small, the elasticity is large in
magnitude. The elasticity becomes smaller as we move down the curve.
∆Q/∆P = (1/slope of curve). As a result, for any price and quantity combination,
the steeper the slope of the curve, the less elastic is demand.
Chapter 1 – Preliminaries
Microeconomics deals with the behaviour of individual economic units. These
units include any individual or entity that plays a role in the functioning of our
economy. Microeconomics explains how and why these units make economic
decisions.
Another concern of microeconomics is how economic units interact to form larger
units – markets and industries. Microeconomics reveals how industries and
markets operate and evolve, why they differ from one another, and how they are
affected by government policies and global economic conditions.
Macroeconomics deals with aggregate economic quantities, such as the level
and growth rate of national output, interest rates, unemployment, and inflation.
1.1 Themes of microeconomics
Microeconomics is much about limits – the limited incomes that consumers can
spend on goods and services, the limited budgets and technical knowledge of
firms, limited number of hours in a week that workers can allocate to labour or
leisure. Microeconomics is about ways to make the most of these limits, the
allocation of scarce resources.
Trade-offs
Consumers have limited incomes consumer theory: how consumers,
based on their preferences, maximize their well-being by trading off the
purchase of more of some goods for the purchase of less of others.
Workers must decide whether and when to enter the workforce. One must
trade off working now (and earning immediate income) for continued
education (and hope of earning higher future income). Also, workers face
trade-offs in their choice of employment large corporations that offer job
security but limited potential for advancement, small companies where
there is more opportunity for advancement but less security. Lastly,
workers must sometimes decide how many hours per week they wish to
work, trading off labour for leisure.
Firms face limits in the kinds of products they can produce, and the
resources available to produce them. it is also constrained in terms of
financial resources and the current production capacity of its factories.
Theory of the firm: describes how trade-offs can best be made, begins
with the assumption that firms try to maximise their profits.
Prices and markets
All of the trade-offs described above are based on the prices faced by consumers,
workers and firms. In a centrally planned economy, prices are set by the
government. In a market economy, prices are determined by interactions on
markets.
Theories and models
Theory: developed to explain observed phenomena in terms of a set of basic
rules and assumptions. Economic theories are also the basis for making
predictions. Thus the theory of the firm tells us whether a firm’s output level will
increase of decrease in response to an increase in wage rates or a decrease in
material prices.
,Model: mathematical representation, based on economic theory of a firm,
market of other entity.
Quantifying the accuracy of a prediction can be as important as the prediction
itself. No theory is perfectly correct. The usefulness of and validity depend on
whether it succeeds in explaining and predicting the set of phenomena that it is
intended to explain and predict.
Positive vs Normative analysis
Positive analysis: analysis describing relationships of cause and effect.
Explanation and prediction.
Normative analysis: analysis examining questions of what ought to be. Is often
supplemented by value judgements society must make a value judgement
weighing equity against economic efficiency. When value judgements are
involved, microeconomics cannot tell us what the best policy is. However it can
clarify the trade-offs and thereby help to illuminate the issues and sharpen the
debate. Ex: a comparison between a gasoline tax and an oil import tariff might
conclude that the gasoline tax will be easier to administer but will have a greater
impact on lower-income consumers.
1.2 What is a market?
Market: collection of buyers and sellers that, through their actual or potential
interactions, determine the price of a product or set of products.
Market definition: determination of the buyers, sellers, and a range of products
that should be included in a particular market.
Arbitrage: practice of buying at a low price at one location and selling at a
higher price in another.
Competitive vs noncompetitive markets
Perfectly competitive market: market with many buyers and sellers, so that
no single buyer or seller has a significant impact on price.
Some markets contain many producers but are noncompetitive; that is,
individuals can jointly affect the price. The world oil market is one example. Since
the early 1970s, that market has been dominated by the OPEC cartel (group of
producers that acts collectively).
Market price: price prevailing in a competitive market.
In markets that are not perfectly competitive, different firms might charge
different prices for the same product. This might happen because one firm is
trying to win customers from its competitors, or because customers have brand
loyalties that allow some firms to charge higher prices than others.
The market prices of most goods will fluctuate over time, and for many goods the
fluctuations can be rapid. This is particularly true for goods sold in competitive
markets.
Market definition – The extent of a market
Extent of a market: boundaries of a market, both geographical and in terms of
range of products produced and sold within it.
For some goods, it makes sense to talk about a market only in terms of very
restrictive geographic boundaries housing (specific per area, people want
house in city A, not in B). retail gasoline markets, though less limited
geographically, are still regional because of the expense of shipping gasoline
over long distances. But gold is bought and sold in a world market, the possibility
of arbitrage prevents the price from differing significantly from one location to
another.
,Market definition is important for 2 reasons:
A company must understand who its actual and potential competitors are
for the various products that it sells or might sell in the future. It must also
know the product boundaries and geographical boundaries of its market in
order to set price, determine advertising budgets, and make capital
investment decisions.
Market definition can be important for public policy decisions. Should the
government allow a merger or acquisition involving companies that
produce similar products, or should it challenge it? Answer depends on
impact of the merger on future competition and prices can be evaluated
by defining a market.
1.3 Real vs Nominal prices
Nominal price: absolute price of a good, unadjusted for inflation.
Real price: price of a good relative to an aggregate measure of prices; price
adjusted for inflation.
Consumer price index: measure of the aggregate price level.
Producer price index: measure of the aggregate price level for intermediate
products and wholesale goods.
Chapter 2 – The basics of supply and demand
Without government intervention, supply and demand will come into equilibrium
to determine both the market price of a good and the total quantity produced.
Variation of price and quantity over time depend on the ways in which supply and
demand respond to other economic variables.
2.1 Supply and demand
The supply-demand model combines the supply curve (relation between quantity
willing to sell and price) and a demand curve (relation between quantity
consumers want and price).
Supply curve
The higher the price, the more that firms are able and willing to produce
and sell. A higher price may enable current firms to expand production by
hiring extra workers or by having existing workers work overtime. A higher
price may also attract new forms to the market. These newcomers face
higher costs because of their inexperience in the market and would
therefore have found entry uneconomical at a lower price.
Quantity supplied can depend on other variables besides price: wages,
interest charges, costs of raw materials (make production more profitable).
When production costs decrease, output increases supply curve shifts to
the right.
Change in quantity movement along the supply curve.
Demand curve
Slopes downward consumers are usually ready to buy more if the price
is lower. The quantity of a good that consumers are willing to buy can
depend on other besides its price. Income is especially important.
Change in demand shifts in the demand curve.
Change in the quantity demanded movement along the demand curve.
Substitutes: 2 goods for which an increase in the price of one leas to an
increase in the quantity of the other. (beef and chicken)
Complements: 2 goods for which an increase in the price of one leads to
a decrease in the quantity demanded of the other. (gas and automobiles)
, 2.2 The market mechanism
Equilibrium price: price that equates the quantity supplied to the quantity
demanded
Market mechanism: tendency in a free market for price to change until the
market clears.
Surplus: situation in which the quantity supplied exceeds the quantity
demanded.
To sell surplus, producers would begin to lower prices. Eventually as price fell,
quantity demanded would increase, and quantity supplied would decrease until
the equilibrium was reached.
Shortage: situation in which the quantity demanded exceeds the quantity
supplied.
Shortage leads to upwards pressure on price as consumers tried to outbid one
another for existing supplies and producers react by increasing price and
expanding output price reaches equilibrium.
2.3 Changes in market equilibrium
Lower costs result in lower prices and increased sales. In general, price and
quantity will change depending both on how much the supply and demand
curves shift and on the shapes of those curves.
2.4 Elasticities of supply and demand
Supply depends both on price and on variables that affect production cost.
The price elasticity of demand measures the sensitivity of quantity demanded to
price changes.
Elasticity: percentage change in one variable resulting from a 1-percent
increase in another.
Price elasticity of demand: percentage change in quantity demanded of a good
resulting from a 1-percent increase in its price Ep = (%∆Q)/(%∆P) or
(usually negative number)
When price elasticity is greater than 1 demand is price elastic
When price elasticity is less than 1 demand is price inelastic
When there are close substitutes, a price increase will cause the consumer to buy
less of the good and more of the substitute. Demand will then be highly price
elastic. When there are no close substitutes, demand will tend to be price
inelastic.
Near the top, because price is high and quantity is small, the elasticity is large in
magnitude. The elasticity becomes smaller as we move down the curve.
∆Q/∆P = (1/slope of curve). As a result, for any price and quantity combination,
the steeper the slope of the curve, the less elastic is demand.
