Chapter 2
Microeconomics is the branch of economics that studies the specific choices made
by consumers and producers
• How do consumers respond to price changes?
• How many units will a firm supply at a given price?
• How is the price determined in a market?
We look at models; simplified representations of reality that focus
on the aspects of reality that are important for the problem at
hand.
Supply the combined amount of a good that all producers in a market are
willing to sell
Demand the combined amount of a good that all consumers in a market
are willing to buy
A market* is characterized by a specific
- Product or service being bought and sold
- Location
- Point in time
*Markets facilitate exchange
Four key assumptions in the Supply and Demand model:
1. Focus on supply and demand in a single market
2. All goods sold in the market are identical
3. All goods sold in the market sell for the same price, and everyone has the same
information
4. There are many producers and consumers
Commodities goods traded in markets where consumers view different varieties
of the good as essentially interchangeable
Factors that influence demand:
- Price
- Number of consumers
- Consumer wealth
- Consumer tastes
- Prices of other, related goods (complements/substitutes)
Substitutes a good that can be used in place of another
Complement a good that is often purchased and used in combination with
another good
,Demand curve the relationship between the quantity of a good that consumers
demand and the good’s price, holding all other factors constant
Demand choke price the price at which quantity demanded in zero
Inverse demand curve a demand curve written in the form of price as a function of
quantity demanded
For example,
A demand curve QD = 2,400 – 400P
Inverse demand curve P = 6 – 0.0025QD
What about the other factors that influence demand?
- The demand curve is graphed in two dimensions; all other factors are assumed constant
- If another factor changes, the demand curve will shift
Change in quantity demanded a movement along the demand curve in response to a
price change, with everything else held constant
Change in demand a shift of the entire demand curve caused by a change in a
non-price factor that affects demand
Factors that influence supply:
- Price
- Number of sellers
- Production costs
- Sellers’ outside options
Production technology the processes used to make, distribute, and sell a good
Supply curve the relationship between the quantity supplied of a good and the
good’s price, holding all other factors constant
Supply choke price the price at which no firm is willing to produce a good and
quantity supplied is zero
Inverse supply curve a supply curve written in the form of price as a function of
quantity supplied
For example,
A supply curve QS = 400P – 800
An inverse supply curve P = 2 + 0.0025Q
,Change in quantity supplied a movement along the supply curve in response to a price
change, with everything else held constant
Change in supply a shift of the entire supply curve caused by a change in a
non-price factor that affects supply
Market equilibrium occurs when the price of a good results in the quantity
demanded equal to the quantity supplied
Equilibrium price is the only price at which the quantity demanded equals
the quantity supplied
For example,
QD = 2,400 – 400P QS = 400P – 800
At equilibrium, Qe = QD = QS (Qe is equilibrium quantity); we solve for equilibrium price, Pe, by
setting supply equal to demand
2,400 – 400Pe = Qe = 400Pe – 800
Combining terms containing Pe yields;
800Pe = 3200 Pe = 4
To find Qe, substitute Pe = 4 into either equation, yielding Qe = 800
S
Price of oranges
(dollars/pound)
6
5
4
3
2
1
D
Quantity of
0 oranges (pounds)
400 800 1,20 1,60 2,00 2,40
0 0 0 0
, Two parameters that determine the magnitude of the change in equilibrium price and quantity;
1. Size of the shift
2. Slope of the curves
Steep curves : large changes in price, small changes in quantity
Shallow curves: small changes in price, large changes in quanity
Elasticity is the ratio of the percentage change in one value to the
percentage change in another and describes the sensitivity of
quantity demanded or supplied
Elasticity is high when relatively small increases in price result in
relatively large drops in quantity.
Elasticity is low when relatively large increases in price result in
relatively small drops in quantity
Price elasticity of demand percentage change in quantity demanded divided by percent
change in price
% DQ D
E D =
% DP
Price elasticity of supply percentage change in quantity supplied divided by percent change
in price
% DQ S
E S =
% DP
Microeconomics is the branch of economics that studies the specific choices made
by consumers and producers
• How do consumers respond to price changes?
• How many units will a firm supply at a given price?
• How is the price determined in a market?
We look at models; simplified representations of reality that focus
on the aspects of reality that are important for the problem at
hand.
Supply the combined amount of a good that all producers in a market are
willing to sell
Demand the combined amount of a good that all consumers in a market
are willing to buy
A market* is characterized by a specific
- Product or service being bought and sold
- Location
- Point in time
*Markets facilitate exchange
Four key assumptions in the Supply and Demand model:
1. Focus on supply and demand in a single market
2. All goods sold in the market are identical
3. All goods sold in the market sell for the same price, and everyone has the same
information
4. There are many producers and consumers
Commodities goods traded in markets where consumers view different varieties
of the good as essentially interchangeable
Factors that influence demand:
- Price
- Number of consumers
- Consumer wealth
- Consumer tastes
- Prices of other, related goods (complements/substitutes)
Substitutes a good that can be used in place of another
Complement a good that is often purchased and used in combination with
another good
,Demand curve the relationship between the quantity of a good that consumers
demand and the good’s price, holding all other factors constant
Demand choke price the price at which quantity demanded in zero
Inverse demand curve a demand curve written in the form of price as a function of
quantity demanded
For example,
A demand curve QD = 2,400 – 400P
Inverse demand curve P = 6 – 0.0025QD
What about the other factors that influence demand?
- The demand curve is graphed in two dimensions; all other factors are assumed constant
- If another factor changes, the demand curve will shift
Change in quantity demanded a movement along the demand curve in response to a
price change, with everything else held constant
Change in demand a shift of the entire demand curve caused by a change in a
non-price factor that affects demand
Factors that influence supply:
- Price
- Number of sellers
- Production costs
- Sellers’ outside options
Production technology the processes used to make, distribute, and sell a good
Supply curve the relationship between the quantity supplied of a good and the
good’s price, holding all other factors constant
Supply choke price the price at which no firm is willing to produce a good and
quantity supplied is zero
Inverse supply curve a supply curve written in the form of price as a function of
quantity supplied
For example,
A supply curve QS = 400P – 800
An inverse supply curve P = 2 + 0.0025Q
,Change in quantity supplied a movement along the supply curve in response to a price
change, with everything else held constant
Change in supply a shift of the entire supply curve caused by a change in a
non-price factor that affects supply
Market equilibrium occurs when the price of a good results in the quantity
demanded equal to the quantity supplied
Equilibrium price is the only price at which the quantity demanded equals
the quantity supplied
For example,
QD = 2,400 – 400P QS = 400P – 800
At equilibrium, Qe = QD = QS (Qe is equilibrium quantity); we solve for equilibrium price, Pe, by
setting supply equal to demand
2,400 – 400Pe = Qe = 400Pe – 800
Combining terms containing Pe yields;
800Pe = 3200 Pe = 4
To find Qe, substitute Pe = 4 into either equation, yielding Qe = 800
S
Price of oranges
(dollars/pound)
6
5
4
3
2
1
D
Quantity of
0 oranges (pounds)
400 800 1,20 1,60 2,00 2,40
0 0 0 0
, Two parameters that determine the magnitude of the change in equilibrium price and quantity;
1. Size of the shift
2. Slope of the curves
Steep curves : large changes in price, small changes in quantity
Shallow curves: small changes in price, large changes in quanity
Elasticity is the ratio of the percentage change in one value to the
percentage change in another and describes the sensitivity of
quantity demanded or supplied
Elasticity is high when relatively small increases in price result in
relatively large drops in quantity.
Elasticity is low when relatively large increases in price result in
relatively small drops in quantity
Price elasticity of demand percentage change in quantity demanded divided by percent
change in price
% DQ D
E D =
% DP
Price elasticity of supply percentage change in quantity supplied divided by percent change
in price
% DQ S
E S =
% DP
