Summary Microeconomics
Chapter 1 Preliminaries
Real vs Nominal Prices
The nominal price of a good (current-dollar) is its absolute price, which you can see in the
supermarket.
The real price of a good (constant-dollar) is the price relative to an aggregate (total) measure of
prices. It is the price adjusted for inflation.
For consumer goods, the aggregate measure of prices most often used is the Consumer Price Index
(CPI). Percentage changes in the CPI measure the rate of inflation in the economy.
CPI 1970
Real price of a good in 1980 in terms of 1970 dollars = --------------- x nominal price in 1980
CPI 1980
Percentage change = new – old / old x 100%
Chapter 2 The Basics of Supply and Demand
Supply and demand
The supply curve shows the quantity of a good that producers are willing to sell at a given price.
Qs = Qs(P) inverse supply function P = P(Qs). The supply curve is upward sloping.
When production costs decrease, the supply curve shifts to the right.
The demand curve shows how much consumers are willing to buy as the price per unit changes.
Qd = Qd(P) inverse demand curve P = P(Qd). The demand curve is downward sloping.
When income increases, the demand curve shifts to the right. When the price of a substitute good
increases, the demand curve of the other good shifts to the right. When the price of a
complementary good decreases, the demand curve of the other good shifts to the right.
Equilibrium = market-clearing price. Point where supply and demand curves cross. The tendency for
markets is to clear.
Surplus = supply is greater than demand producers begin to lower prices demand will increase
quantity supplied decreases until the equilibrium is reached.
Shortage = demand is greater than supply producers increase price demand will decrease
until the equilibrium is reached.
Elasticities
We use elasticities to measure how much the quantity supplied or demanded will rise or fall.
Price elasticity of demand = Ep
Percentage change in quantity demanded of a good resulting from a 1-percent increase in its price.
Q / Q Nieuw – oud / oud x 100% in Q
Ep = ----------------- = ---------------------------------------------
P / P Nieuw – oud / oud x 100% in P
Ep = P / Q x Q / P
,The price elasticity of demand is usually a negative number. When the price increases, the quantity
demanded falls.
Inelastic demand = Ep ligt tussen -1 en 1
The quantity demanded reageert nauwelijks op een price change. Bijv. sigaretten, medicijnen
Elastic demand = Ep is groter dan 1 en lager dan -1
The quantity demanded reageert veel op een price change.
Unit elasticity = Ep = -1
If EP is elastic, a decrease in the price leads to rising revenue.
If EP is inelastic, a decrease in the price leads to declining revenue.
Q
----- = slope of the demand curve (not inverse demand curve) = afgeleide van de demand curve.
P
With a linear demand curve in the exact middle of the curve the Ep is -1 = unit elasticity. The upper
part is elastic. Ep is - when the curve intersects with the y-axis. The part below the middle is
inelastic. Ep is 0 when the curve intersects with the x-axis. This is when P = 0.
The steeper the demand curve the more inelastic is demand.
• Infinitely elastic demand is a horizontal line. Consumers will buy as much as they can at a
single price. Demand is infinitely elastic at the intercept on the y-axis. To calculate the price
at a infinitely elastic demand, fill in Q = 0.
• Completely inelastic demand is a vertical line. Consumers will buy a fixed quantity, no matter
what the price. Demand is completely inelastic at the intercept on the x-axis.
Income elasticity of demand = E(I)
Percentage change in the quantity demanded, resulting from a 1-percent increase in income (I).
Q / Q I Q
E(I) = --------------- , or ----- x -----
I / I Q I
Cross-price elasticity of demand = E,Q,P
Percentage change in the quantity demanded for a good, resulting from a 1-percent increase in price
of another good.
So the elasticity of demand for product A with respect to the price of product B would be:
Qa / Qa Pb Qa
E, Qa,Pb = ------------- or ------ x ----------
Pb / Pb Qa Pb
When the goods are substitutes the cross-price elasticity is positive.
When the goods are complements the cross-price elasticity is negative.
, Chapter 3 Consumer behavior
1. Preferences
Market basket: a list with specific quantities of one or more goods.
Preference for one market basket vs another relies on three assumption:
1) Completeness: Consumers can compare and rank all possible baskets.
2) Transitivity: If a consumer prefers basket A to B and basket B to C, then the consumer also
prefers A to C. If this applies to today, it should also be true tomorrow.
3) More is always better: you will always prefer more of the goods. You will never be satisfied.
Indifference curve: represents all the combinations of market baskets that provide a consumer with
the same level of satisfaction. The consumer is indifferent among the market baskets represented
on the curve. Convex downwards sloping curve!!
Any market basket to the right and above of the indifference curve is preferred to any market basket
on the curve.
Indifference curves cannot intersect!!
Marginal Rate of Substitution (MRS)
MRS = amount of the good on the Y-axis that the consumer is willing to give up to obtain 1 extra unit
of the good on the X-axis.
Y
MRS = - ------
X
MRS is the slope of the indifference curve.
Diminishing marginal rate of substitution: When the indifference curve is convex downwards sloping
the MRS always falls as we move down the indifference curve.
Perfect substitutes: the indifference curve is a straight-linear line. The MRS is a constant number.
Perfect complements: the indifference curve is L-shaped (rechte hoek). The MRS is 0 (horizontal part)
or infinite (vertical part).
Utility = numerical score representing the satisfaction that a consumer gets from a market basket.
U = f(x,y)
Marginal utility = the additional satisfaction from consuming one more unit of a good.
The market baskets on the same indifference curve must have the same utility level. The highest
indifference curve has the highest utility level.
2. Budget line
The budget line indicates all combinations of X and Y for which the total amount of money spent is
equal to income.
I = Price of good X times amount of X + Price of good Y times amount of Y.
The slope of the budget line Y/X = the price ratio of Px/Py
Chapter 1 Preliminaries
Real vs Nominal Prices
The nominal price of a good (current-dollar) is its absolute price, which you can see in the
supermarket.
The real price of a good (constant-dollar) is the price relative to an aggregate (total) measure of
prices. It is the price adjusted for inflation.
For consumer goods, the aggregate measure of prices most often used is the Consumer Price Index
(CPI). Percentage changes in the CPI measure the rate of inflation in the economy.
CPI 1970
Real price of a good in 1980 in terms of 1970 dollars = --------------- x nominal price in 1980
CPI 1980
Percentage change = new – old / old x 100%
Chapter 2 The Basics of Supply and Demand
Supply and demand
The supply curve shows the quantity of a good that producers are willing to sell at a given price.
Qs = Qs(P) inverse supply function P = P(Qs). The supply curve is upward sloping.
When production costs decrease, the supply curve shifts to the right.
The demand curve shows how much consumers are willing to buy as the price per unit changes.
Qd = Qd(P) inverse demand curve P = P(Qd). The demand curve is downward sloping.
When income increases, the demand curve shifts to the right. When the price of a substitute good
increases, the demand curve of the other good shifts to the right. When the price of a
complementary good decreases, the demand curve of the other good shifts to the right.
Equilibrium = market-clearing price. Point where supply and demand curves cross. The tendency for
markets is to clear.
Surplus = supply is greater than demand producers begin to lower prices demand will increase
quantity supplied decreases until the equilibrium is reached.
Shortage = demand is greater than supply producers increase price demand will decrease
until the equilibrium is reached.
Elasticities
We use elasticities to measure how much the quantity supplied or demanded will rise or fall.
Price elasticity of demand = Ep
Percentage change in quantity demanded of a good resulting from a 1-percent increase in its price.
Q / Q Nieuw – oud / oud x 100% in Q
Ep = ----------------- = ---------------------------------------------
P / P Nieuw – oud / oud x 100% in P
Ep = P / Q x Q / P
,The price elasticity of demand is usually a negative number. When the price increases, the quantity
demanded falls.
Inelastic demand = Ep ligt tussen -1 en 1
The quantity demanded reageert nauwelijks op een price change. Bijv. sigaretten, medicijnen
Elastic demand = Ep is groter dan 1 en lager dan -1
The quantity demanded reageert veel op een price change.
Unit elasticity = Ep = -1
If EP is elastic, a decrease in the price leads to rising revenue.
If EP is inelastic, a decrease in the price leads to declining revenue.
Q
----- = slope of the demand curve (not inverse demand curve) = afgeleide van de demand curve.
P
With a linear demand curve in the exact middle of the curve the Ep is -1 = unit elasticity. The upper
part is elastic. Ep is - when the curve intersects with the y-axis. The part below the middle is
inelastic. Ep is 0 when the curve intersects with the x-axis. This is when P = 0.
The steeper the demand curve the more inelastic is demand.
• Infinitely elastic demand is a horizontal line. Consumers will buy as much as they can at a
single price. Demand is infinitely elastic at the intercept on the y-axis. To calculate the price
at a infinitely elastic demand, fill in Q = 0.
• Completely inelastic demand is a vertical line. Consumers will buy a fixed quantity, no matter
what the price. Demand is completely inelastic at the intercept on the x-axis.
Income elasticity of demand = E(I)
Percentage change in the quantity demanded, resulting from a 1-percent increase in income (I).
Q / Q I Q
E(I) = --------------- , or ----- x -----
I / I Q I
Cross-price elasticity of demand = E,Q,P
Percentage change in the quantity demanded for a good, resulting from a 1-percent increase in price
of another good.
So the elasticity of demand for product A with respect to the price of product B would be:
Qa / Qa Pb Qa
E, Qa,Pb = ------------- or ------ x ----------
Pb / Pb Qa Pb
When the goods are substitutes the cross-price elasticity is positive.
When the goods are complements the cross-price elasticity is negative.
, Chapter 3 Consumer behavior
1. Preferences
Market basket: a list with specific quantities of one or more goods.
Preference for one market basket vs another relies on three assumption:
1) Completeness: Consumers can compare and rank all possible baskets.
2) Transitivity: If a consumer prefers basket A to B and basket B to C, then the consumer also
prefers A to C. If this applies to today, it should also be true tomorrow.
3) More is always better: you will always prefer more of the goods. You will never be satisfied.
Indifference curve: represents all the combinations of market baskets that provide a consumer with
the same level of satisfaction. The consumer is indifferent among the market baskets represented
on the curve. Convex downwards sloping curve!!
Any market basket to the right and above of the indifference curve is preferred to any market basket
on the curve.
Indifference curves cannot intersect!!
Marginal Rate of Substitution (MRS)
MRS = amount of the good on the Y-axis that the consumer is willing to give up to obtain 1 extra unit
of the good on the X-axis.
Y
MRS = - ------
X
MRS is the slope of the indifference curve.
Diminishing marginal rate of substitution: When the indifference curve is convex downwards sloping
the MRS always falls as we move down the indifference curve.
Perfect substitutes: the indifference curve is a straight-linear line. The MRS is a constant number.
Perfect complements: the indifference curve is L-shaped (rechte hoek). The MRS is 0 (horizontal part)
or infinite (vertical part).
Utility = numerical score representing the satisfaction that a consumer gets from a market basket.
U = f(x,y)
Marginal utility = the additional satisfaction from consuming one more unit of a good.
The market baskets on the same indifference curve must have the same utility level. The highest
indifference curve has the highest utility level.
2. Budget line
The budget line indicates all combinations of X and Y for which the total amount of money spent is
equal to income.
I = Price of good X times amount of X + Price of good Y times amount of Y.
The slope of the budget line Y/X = the price ratio of Px/Py
