Introduction to Microeconomics - Part 2 (Demand, supply and the market)

Describe the demand and supply model

Most basic model in economics. Used to analyse determinants of price and quantity of individual goods and services.

Define endogenous variables

Value determined from within the model - price and quantity of the good or service.

Define exogenous variables

Value determined from outside the model - are factors that cause shift in the demand/supply curve

Draw the demand curve and explain what it shows.

Price on y-axis, quantity on x-axis, demand curve sloping downwards.

What does the demand curve mean?

Shows consumers' planned purchases at each possible price. Alternatively, it is the quantity of each good or service that the consumer is planning to purchase at each possible price. Only shows planned purchases, and not what actually happens. A key assumption is that consumers are price takers - cannot influence price, but this is not true in the example of the government being the sole purchaser of defence equipment. Consumers can only choose the quantity, and take the price as a given. All other influences on demand are deemed to be constant.

Describe the supply curve

Price on y-axis, quantity on x-axis, supply curve facing upwards.

What does the supply curve show?

Quantity supplier is willing to supply at each possible price. Again, not what actually happens and a key assumption is that the seller is the price taker and cannot influence market price, although this does not hold true for oligopolies.

Describe elasticities

The shift in demand or supply depends on slopes. Economists refer to elasticity rather than slopes.

What is the own price elasticity of demand (include formula). Give examples of inelastic and elastic demand.

Responsiveness of the quantity demanded of a good to a change in its own price. %change(proportionate) in quanitty demanded/%change (proportionate) in price. Holds other factors, such as income and prices, constant. Necessities like wheat have inelastic demand (<1) and luxury good like holidays have an elastic demand (>1). Demand is elastic in the long run when consumers have gotten adjusted to the price change and have adjusted expenditures accordingly.

Elasticity and demand curve - what does the demand curve show? (Draw and reveiew this curve from graphs section)

The price consumers are willing to pay at each possible quantity.

Elasticity and demand curve - what does the marginal revenue curve show?

Extra revenue firm gets by selling each additional unit

Why is the marginal revenue curve lower than the demand curve for a firm with a market power (monopolistic)?

When firm lowers price to sell an extra unit it must lower price on all previous units too, reducing revenue on earlier sales.

If a firm decides to reduce its prices, what happens to total revenue if the demand is (a) elastic (b) inelastic or (c) unit elastic?

(a) Total revenue increases (revenue from new sales is greater than fall from existing sales) (b) Total revenue decreases, since the revenue from new sales is lwoer than the fall in existing sales (c) The revenue from new sales exactly offsets the fall in existing sales.

What is cross price elasticity of demand? Give the formula. When is it positive vs negative.

Measures responsiveness in change in demand to change in price. Hold other factors, such as income or prices constant.

% change in quantity demanded of good/ % change in the price of good.

If it is a substitute good, then the sign is positive and if it is complimentary then the sign is negative.

What is the income elasticity of demand. Give formula and changes in sign.

The income elasticity of demand measures the responsiveness of quantity demanded to a change in income:

% change in quantity demanded of a good/% change in consumer income

Holding other factors, such as prices of the good in question and other prices, constant.

Normal goods have elasticity greater than 0.

Inferior goods have elasticity less than 0.

Luxury goods have elasticity greater than 1.

Describe the application of income elasticity for developing countries.

Used to identify goods or services for export market. Face lower income elasticities than industrialised countries for their exports. Less exposure to downturns but also not able to take full advantage of booms in the market. This is a serious impediment to becoming a developed country.