Summary MicroEconomics - ECON221

ECON221 MICROECONOMICS ECON 221
STUVIA.CO.ZA




GeekyS – Stuvia.co.za

2013




[MICROECONOMICS]
[Notes for ECON221. Chapters:1-4 , 6-11 & 13. Summarized for exam purposes by using the
prescribed textbook Microeconomics (International Edition) 8thEd. Robert S. Pindyck & Daniel L.
Rubinfeld & class notes ]

, MICROECONOMICS ECON 221
STUVIA.CO.ZA


CHAPTER 1 INTRODUCTION


ECONOMICS
MICRO ECONOMICS MACROECONOMICS




Deals with the behaviour of individual economic Deals with Aggregate economic variables, such
units - Firms, Consumers, Workers & Investors- as Inflation, Economic growth, Total Production,
as well as the markets that these units comprise. Total Income, Unemployment
 The extension of microeconomic analysis.

Microeconomic Themes

Microeconomics = about limits Limitations: Limited Time, Limited Resources & Limited Income/
Budget and the choices 1. Ways to make the most of the limitations and 2. How the scarce
resources are allocated.

Microeconomics describes the trade-offs that the role players face and how these trade-offs are best
made.

Consumer, Worker & Firms “Trade-Offs”
Consumer: Workers: Firms:
 Limited Income  When and where to  Limitations in terms of
 Spent Income (G&S) vs. enter the workforce? the product
Save  Choice of work  Limited resources
 Labour vs. Leisure

Prices and Markets
 Prices determine the “Trade-offs”:  Example: Chicken vs. Beef
 Firms:  Prices are influenced by:
 Input prices (cost), output prices  Government – Centrally planned
 Wages economies.
 Consumers:  Other market participants – Market
 Price of goods and services economies.

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Theories, Models & Analyses
 Theory: Different theories explain the economy.
 Consumers Theory:
Describes how consumers maximize their well-being, using their preferences, to make decisions
about trade-offs
 Firm Theory:
Describes how trade-offs are best made
 Test against observations
 Models: Mathematical presentations based on economic theories.
 Positive vs. Normative Analysis:
 Positive Analysis: Questions that deal with explanation and prediction.
Analysis describing relationships of cause and effect.
 What will be the impact of an import quota on foreign cars?
 What will be the impact of an increase in the gasoline excise tax?
 Normative Analysis: Analysis examining questions of what ought to be.
Often supplemented by value judgements.
 Should the Government impose a larger gasoline tax?
 Should the G decrease the tariffs on imported cars?
Market

Market  Collection of buyers and sellers, through their actual or potential interaction, determine
the prices of products
Buyers: Consumers purchase goods, companies purchase labour inputs.
Sellers: Consumers sell labour, resource owners sell inputs, and firms sell goods.

Market Definition  Determination of buyers, Sellers and a range of products that should be
included in a particular market.
Extent of a market  Boundaries of a market, both geographical and in terms of range of products
produced and sold within it.

Importance of the Market definition:
 Determine the actual and potential competitors.
 Price determination & budgeting.
 Determine the product boundaries and product characteristics of the market.
 Determine the economic policy

Arbitrage  Practice of buying at a low price at one location and selling at a higher price in another.
Some markets have on price: price of gold while others have more than one price: laundry
detergent.

Type of Markets:
Perfectly Competitive Market  Market with many buyers and sellers, so that no single buyer or
seller has a significant impact on price.
Non-competitive Market: individual firms that jointly affect the price  oil.

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Market Price:Price prevailing in a competitive market.

Real vs. Nominal prices

Nominal Price: Real Price:
 Nominal = Now  Real=Price of a good Relative to a specific
 Absolute price of a good (includes base year
inflation)  Adjusted for inflation.

Measures of Prices:
 Consumer Price Index (CPI): Measure of aggregate price level.
 Inflation1932 = (CPI1932 – CPI1931) / CPI1931 x 100

 Producer Price Index (PPI): Measure of aggregate price level for intermediate products and
wholesale goods.

Recap of Chapter 1

 Positive and normative analysis;- go beyond explanation to ask such questions as "what is best"?
 Markets
 Extent of market
 Arbitration
 Competitive versus non-competitive markets
 Real versus nominal prices

CHAPTER 2 DEMAND & SUPPLY




Supply & Demand Analysis

Fundamental & a power tool that can be applied
to a variety of interesting and important
problems, for example:
 Understand/ predict how changing world
economic conditions affect market price &
production;
 Evaluate impact of policy changers, i.e.
minimum wage
 Impact of taxes, tariffs, import quotas on
consumers and producers

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Supply and Demand

Supply Curve:
 Def Relationship between the quantities (Q) of a good /service that producers plan to sell, at each
possible price (P) during a certain period.
 Positive slope.




a b
 Movement:
 On the curve (a)  a change in Price
 Of the curve (b) other variables than P for example
 Lower production cost – supply curve move to the right S' irrespective of P
 Quantity stay fixed at Q1- price firms would except to produce




 Remember 
 Determinants:

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Demand Curve:

 Def Relationship between the quantity (Q) of a product/service that potential buyers can afford – the
price (P) and are willing to purchase.
 Negative slope.




 a b
 Movement:
 On the curve (b)  a change in Price (ΔP)
 ONE DEMAND curve
 Change in QUANTITY demanded (ΔQd)
 NOT a change in DEMAND (Not from Beer  Brandy)
 Of the curve (a) Change in demand
 Determinants: (5)




Substitutes: Two goods for which an increase in the price of one leads to an increase in the quantity demanded
of the other.

Complements: Two goods for which an increase in the price of one, leads to a decrease in the quantity
demanded of the other.

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The Market Mechanism

Equilibrium (or Market-clearing) price: Price that equates the quantity supplied to the quantity demanded 
Qs=Qd

Market Mechanism = Tendency in a free market for price to change until the market clears  Equilibrium




Surplus – Excess Supply Shortage – Excess Demand
 Market price above equilibrium  Market prices below equilibrium
 Quantity supplied (Qs) > Quantity demanded (Qd)  Quantity supplied (Qs) < Quantity demanded (Qd)
 Downward pressure on the price  Upward pressure on the P
 Quantity demanded increases and quantity  Quantity demanded decreases and Q supplied
supplied decreases. Increases
 Until Qs=Qd  Until Qs=Qd

Changes in Market Equilibrium

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Conclusion  If both the D & S curves shift, the P and Q will depend on:
 The relative size and direction of change.
 The slope of the curves
 Elasticity
Elasticities of Supply & Demand

Elasticity: % change in one variable as a result of a 1% change in another  Change in Q resulting from a
change in P.

Price Elasticity of Demand (EPD): % change in quantity demanded of a good resulting from a 1% increase in its
price.  E p  (%Q) /(%P)

 E  Q / Q  PQ
P / P QP
p

Price Elasticity of Demand:
 The % change in a variable is the absolute change in the variable divided by the original level of the variable
 Ratio of P/Q at a point on the curve. (Point Elasticity)
 Usually a negative number  - relationship : if ↑P → ↓Q
 Interpretation  absolute values
Example: EPD = -2 is 2 in magnitude
 EP> -1  EP< -1
 Absolute value:  Absolute value:
 EP> 1→price elastic.  EP< 1 → inelastic.
 |%Q| > |%P|  |%Q| < |% P|
 Elasticity depends on the availability of substitutes.
 Substitutes:
 Product with substitutes will be elastic.
 ↑P will ↓Q and consumer will buy more of the substitute.
 The price elasticity of demand depends not only on the slope of the demand curve but also on the P & Q.
 The elasticity, therefore, varies along the curve as price and quantity change. Slope is constant for this
linear demand curve.
 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.
 The steeper the slope of D, the more inelastic the demand is for the goods.
 The flatter the slope of D, the more elastic the demand for the product.