Topic 2.1 - 2.8 (Microeconomics)

Market

a place where people come together to buy and sell goods

Types of markets and what they are

• product = goods and services

• factor = labour market

• financial = foreign + stock exchange

Law of Demand

• price goes down = demand goes up

• price goes up = demand goes down

what is demand?

quantity of a good or service that consumers are willing and able to buy (at a given time and price, ceteris paribus)

Individual Demand

the demand for a good or a service by a single consumer at a particular cost and at a specific point in time

Market demand

sum of all individual demands for a good or service

Demand curve relationship

negative

Determinants of demand (and what they cause)

• price determinants = cause a movement along the curve

• non - price determinants = cause a shift of the curve

Non-price determinants of demand

• income (normal goods, inferior goods)

• preferences and tastes

• price of other products (substitute goods, complementary goods)

• number of consumers

demand for normal goods (what type of shift they cause)

• income goes up = demand goes up

• shift to the right

demand for inferior goods (what type of shift they cause)

• income goes up = demand goes down

• shift to the left

demand for substitute goods

• P1 goes up = D2 goes up

demand for complementary goods

• P1 goes down = D2 goes up

Assumption for law of demand

• Law of diminishing marginal utility

• The substitution effect

• The income effect

Law of diminishing marginal utility

consumption of additional units of a product, the satisfaction (utility) for each additional unit (marginal unit) grows smaller (diminishes) 

The substitution effect

price of a good increases, consumers switch from other similar products to this good, for lower price

The income effect

price of a good decreases, the quantity demanded increases (consumers have more real income to spend) With more purchasing power, consumers are more likely to buy more of the same product

Supply

quantity of a good or service that producers are willing to offer for sale (at a given price during specific time period, ceteris paribus)

Law of supply

• price increases = supply increases

• price decreases = supply decreases

Determinants of supply (and what they cause)

• price determinants = cause a movement along the curve

• non - price determinants = cause a shift of the curve

Non-price determinants of supply

• Costs of factors of production

• Price of other products

• State of technology

• Expectations

• Government intervention

• Number of firms

• Unpredictable events

Assumption of law of supply

• Law of diminishing marginal utility

• Increasing marginal costs and the firms supply curve

Increasing marginal costs and the firms supply curve

the cost of producing one additional unit of a good or service for a firm is higher at each level of production than it was previously

Market equilibrium

state in which the quantity supplied is equal to the quantity demanded

equilibrium price

price at which quantity supplied and demanded are equal

equilibrium price term

P(e)

equilibrium quantity term

Q(e)

market equilibrium term

M(e)

Market disequilibrium

any price at which demand and supply quantities are not equal

Surplus (Market disequilibrium)

when the quantity of a good supplied is larger than quantity demanded (excess supply)

Shortage (Market disequilibrium)

when the quantity of a good demanded is larger than the quantity supplied (shortage of supply)

Price mechanism

the forces of demand or supply make markets move to an equilibrium

Allocative efficiency

when economy allocates its resources according to consumer preferences

MC

supply

MB

demand

MB > MC

shortage

MC > MB

excess

MB = MC

allocative efficiency

consumer surplus

when the price that consumers pay for a product or service is less than the price they're willing to pay

Consumer surplus formula (+graph)

willing to pay - market price (A = bxhx0.5)

Producer surplus formula (+graph)

market price - supply price (A = bxhx0.5)

Community surplus

consumer surplus + producer surplus

Rational consumer choice

• Consumer rationality

• Perfect information

• Utility maximization

Limitation of rational consumer choice

• rule of thumps

• anchoring

• framing

• availiability

Bounded rationality

the idea that customers are rational only within limits

Elasticity

Measures responsiveness of a variable to changes in price of the variables determinants (ceteris paribus)

Types of elasticities

• Elasticities of demand

• Elasticities of supply

Price elasticity of demand (PED)

A measure of how much the quantity demanded of a product changes when there is a change in price

PED

Price elasticity of demand

formula PED

(percentage change in quantity demanded) / (percentage change in price)

percentage change formula

(new - old) / (old)

Why is PED important? (To a business)

• how consumers respond to changes in the price of a product

• aware of effect that changes in price will have on market demand

Why is PED important? (To a governments)

• deciding which goods to place taxes on

PED < 1

inelastic demand (quantity demanded is relatively unresponsive to price)

PED > 1

elastic demand (quantity demanded is responsive to price)

PED = 1

unit elastic demand (percentage change in quantity demanded equals to percentage change in price)

PED = 0

perfectly inelastic demand (quantity demanded is completely unresponsive to price)

PED = infinity

perfectly elastic demand (quantity demanded is infinitely responsive to price)

Determinants of PED

• Substitution

• Income

• Necessity

• Habits, Addictions, Fashion, Taste

• Advertising and Brand Loyalty

• Time

• Durability

• Cost of switching

Total revenue (TR) (PED) formula

P x Q

PED elastic + indirect taxes

• taxes = price goes up

• price goes up = big change in demand

• low tax revenue for government

PED inelastic + indirect taxes

• taxes = price goes up

• price goes up = small change in demand

• high tax revenue for government

Income Elasticity of Demand (YED)

measure of the responsiveness of demand to changes in income

YED

Income Elasticity of Demand

Formula YED

(change in quantity demanded) / (change in income)

YED > 0 (positive YED)

• income increases, demand increases

• normal good

YED < 0 (negative YED)

• demand for the good does not respond significantly to a change in income

• inferior good

YED < 1

• income inelastic demand

• percentage increase in income = smaller percentage increase in demand

• goods are necessities

YED > 1

• income elastic demand

• percentage increase in income = bigger percentage increase in demand

• luxury goods

if income increases and good has YED > 1, the demand …

increases on a large scale

if income decreases and good has YED > 1, the demand …

decreases on a large scale

goods with YED > 1 can afford …

large falls in sales

what are the 3 sectors of economy?

• primary

• secondary

• tertiary

Engel curve

accurate way to illustrate YED

Price elasticity of supply (PES)

A measure of the responsiveness of the quantity of a good supplied to change in price

PES

price elasticity of supply

Formula PES

(percentage change in quantity supplied) / (change in price)

PES < 1

supply price is inelastic (quantity supplied is relatively unresponsive to price)

PES > 1

supply price is elastic (quantity supplied is responsive to price)

PES = 1

percentage change in quantity supplied is equal to percentage change in price

PES = 0

quantity supplied is completely unresponsive to price

PES = infinity

quantity supplied is infinitely responsive to price

Determinants of PES

• Time period

• Ease and cost of factor substitution

• Degree of spare productive capacity

• The level of stock

primary comodities

raw, unprocessed materials

primary commodities have … (PES) than manufactured goods

lower

Indirect taxes

• are imposed on spending to buy goods and services

• are partly paid by consumers but are paid to the government by producers

why do governments impose taxes?

• as a source of government revenue (on inelastic PED goods)

• a method to discourage consumption of demerit goods

• redistribute income (taxes on luxury goods)

• improve the allocation of resources

specific taxes

a fixed amount of tax per unit of the good or service

Ad valorem taxes

a fixed percentage of the price of the good or service

The specific tax causes a … (what type of shift/movement)

parallel shift in the supply curve

The specific tax causes an … in the costs of production

increases

what do specific taxes do to the market equilibrium (price and quantity demanded)

• the market equilibrium is increased

• price is increased

• quantity demanded is decreased

The ad valorem causes a … (what type of shift/movement)

pivotal shift in the supply curve

what do ad valorem taxes do to the market equilibrium (price and quantity demanded)

• equilibrium reduced (with higher price)

• higher price

• quantity demanded is lower

Stakeholders

Individuals that have an interest in something and are affected by it

Consumer consequence after taxes

price goes up = demand goes down

Producer consequence after taxes

price goes up = demand goes down

Government consequence after taxes

revenue goes up

Workers consequence after taxes

demand goes down = unemployment goes up

Society consequence after taxes

demand goes down = under-allocation