ACF 265: Microeconomics for Business Lecture Notes

ACF 265: Microeconomics for Business Lecture Notes

Institution Information

• University: Kwame Nkrumah University of Science & Technology, Kumasi, Ghana
• Department: Department of Accounting and Finance
• Instructors: Dr. Daniel Domeher

Basic Concepts

Learning Objectives

By the end of the lecture, students should be able to:

• Illustrate the concept of scarcity in decision-making for economic units.
• Explain how rational consumers make their economic choices.
• Examine trade-offs faced by consumers, firms, and governments.
• Distinguish between scarcity and poverty.
• Discuss how incentives affect people’s behavior.
• Discuss the efficiency of markets in resource allocation.
• Draw the production possibilities frontier (PPF) and explain scarcity and opportunity cost.

Introduction

• The term economy originates from the Greek word oikonomos, which translates to "one who manages a household".
• Businesses must allocate scarce resources among competing uses—considering diverse stakeholder needs.
• Economics is fundamentally the study of how society manages its limited resources that can serve various ends to fulfill unlimited human desires.
  • Resources in societies are usually allocated through the interactions of countless households and firms rather than a singular planner.

Resources

• Definitions:
  • Resources: Inputs used for the production of goods and services to satisfy human wants.
  • Scarcity: Refers to resources being limited in supply; insufficient to satisfy all human wants.
  • Types of Resources:
  • Natural Resources: E.g., rain, crude oil, mineral deposits.
  • Human Resources: Labor services.
  • Man-made Resources: E.g., machines, equipment used in production.
  • Entrepreneurship: A fourth resource contributing to production.

Scarcity

• Scarcity Definition: The limited nature of society’s resources, indicating that it cannot produce all desired goods and services.
  • Scarcity is relative—society's demand often exceeds its ability to supply.
  • It constitutes the central problem of economics.
• Economists study decision-making processes and interactions among individuals and businesses because economics is effectively the "science of decision-making".

Decision-Making Involves Trade-Offs

• The principle of "no free lunch" implies that to gain something, one must sacrifice something else:
  • Choices involve weighing benefits against alternatives and associated costs.

Opportunity Cost

• The cost of something is essentially what you give up to obtain it. This encompasses more than monetary costs.
• Opportunity Cost: When making decisions, it's crucial to recognize the opportunity costs tied to each action. Decisions entail costs exceeding mere money, including forgone alternatives.

Rational Choices

Marginal Thinking

• Economists refer to marginal changes as small incremental adjustments to existing plans.
  • Rational decision-makers consider actions beneficial when the marginal benefit exceeds the marginal cost.
  • Businesses use marginal thinking extensively to justify operational decisions.

Response to Incentives

• Individuals and firms compare costs and benefits to make decisions: this is termed responsiveness to incentives.
  • Policies altering costs or benefits can induce behavioral changes: both direct and indirect effects should be assessed when analyzing policies.

Market Efficiency

• Market Economics: Resources are allocated through decentralized decisions made by numerous firms and households as they interact in markets for goods/services.
  • Individual decisions replace those made by central planners, leading to interactions where prices and self-interest guide outcomes.

Role of Government

• Despite market efficiencies, government interventions are sometimes necessary to protect property rights and promote market efficiency and equity.
• Market Failure: Instances wherein markets fail to yield an efficient allocation of resources justifying government intervention.

Production Possibilities Frontier (PPF)

Assumptions Underlying the PPF

1. Time Period: Production is evaluated over a specified timeframe, typically one year.
2. Fixed Resources: Resources remain constant within the timeframe, meaning all inputs must achieve maximum potential.
3. Efficient Resource Use: Resources are utilized in such a way that no additional output can be produced without increasing inputs elsewhere.

The Law of Increasing Opportunity Cost

• The PPF is typically concave due to the law of increasing opportunity cost, which indicates that producing more of one good requires giving up increasingly larger quantities of another.

Discussion Questions

1. Explain circumstances where the PPF may shift inwards/outwards or pivot.
2. Distinguish between scarcity and poverty.
3. Why is economics classified as a science/social science?
4. Contrast free goods with economic goods; provide examples of both.
5. Offer brief explanations of: microeconomics vs. macroeconomics; positive vs. normative economics; hypotheses vs. theories vs. laws; deductive vs. inductive approaches; economic activities and classifications.

Demand and Supply: How Markets Work

Learning Objectives

By the end of this discussion, students should be able to:

• Understand competitive markets and factors determining supply and demand.
• Distinguish between movements along and shifts of curves.
• Analyze how supply and demand establish prices and quantities sold.
• Recognize the role of prices in resource allocation in market economies.

Market Dynamics

• A market consists of buyers (demand) and sellers (supply). Supply and demand drives market economies.
• Market forces can change prices, which corresponds to changes in demand and supply quantities.

Price vs. Cost

• Price: The monetary amount required by buyers to acquire a product.
• Cost: Refers to payments made for factor inputs used in production.

Market Structure and Competition

• A competitive market features numerous buyers and sellers, making individual impact on market prices negligible.
  • This leads to what’s termed perfectly competitive markets where:
  • The goods sold are homogeneous, meaning no buyer prefers one seller over another.
  • The number of sellers/buyers is sufficient that none can influence price.
• Monopoly exists when a single seller sets prices; oligopolies comprise few sellers who may not compete aggressively.

Demand Definition

• Demand: Represents the quantity consumers are willing to buy at a given price during a specified timeframe (ceteris paribus).
  • Effective demand indicates desire backed by financial ability.

Demand Curve and Law of Demand

• Demand Curve: Graphical representation of the relationship between price and quantity demanded.
• Law of Demand: In simplifying terms—when prices rise, quantity demanded falls; conversely, when prices fall, quantity demanded increases. This negative relationship necessitates holding other factors constant (ceteris paribus).

Demand Curve Shifts vs. Movements

• A shift in the demand curve occurs due to other factors affecting demand outside of price changes, referred to as an increase or decrease in demand.
• A movement along the demand curve is due to price changes only, showing a change in quantity demanded.

Supply

Supply Curve

• Supply: The amount producers are willing and able to sell:
  • Quantity supplied increases as price rises and decreases as the price falls; characterized by the law of supply.

Movement vs. Shift in Supply Curve

• A shift indicates a change in supply due to factors other than price (i.e., increase or decrease in supply).
• Movements along the curve are caused by price changes only.

Variables Affecting Supply Curve

1. Input Prices: Changes in input costs affect supply negatively.
2. Technology: Advances increase productivity, leading to increased supply at lower costs.
3. Expectations: Producers' future price expectations can influence current supply.
4. Number of Sellers: More firms typically increase the market supply.
5. Natural or Social Factors: External circumstances affecting production (e.g., climate change, societal trends, etc.).

Market Equilibrium

Definition and Dynamics

• Equilibrium: A state where supply equals demand, resulting in no market pressure for price fluctuations.
  • Equilibrium price is the price point where the quantity demanded equals the quantity supplied, often termed the market-clearing price.

Surplus & Shortage

• Surplus: Occurs when market price exceeds equilibrium price, leading to excess supply. Price adjustments lead to movements towards equilibrium.
• Shortage: Occurs when market price is below equilibrium, leading to excess demand. Price increases lead to movement toward equilibrium.

Finding Equilibrium Using Equations

1. Set demand
   $Q_d = 2100 - 2.5p$
   and supply
   $Q_s = -10 + 6p$
   - Solve for equilibrium price and quantity.

Example: Finding Equilibrium

1. Given:
   $Q_d = 32 - 3p$
   $Q_s = 20 + 4p$
2. Set equal for equilibrium: $32 - 3p = 20 + 4p$
   • Result: $p = £1.71$
3. Calculate quantity supplied/demand at this price.

Elasticities in Economics

Elasticity: General Concept

• Elasticity measures how responsive one variable is to changes in another (e.g., demand adjusting due to price fluctuations).
• Types of Elasticity:
  • Price Elasticity of Demand (PED)
  • Income Elasticity of Demand (Ey)
  • Cross Elasticity of Demand (Ety)

Price Elasticity of Demand (PED)

• Definition: Measures how demand varies in response to price changes.
  • Formula:
    PED = rac{ ext{% Change in Quantity Demanded}}{ ext{% Change in Price}}
• Results classified as elastic (>1), inelastic (<1), or unit elastic (=1).
• Total Revenue Relationship: The impact of elasticity on profit can guide pricing strategies—understanding how changes affect total revenues is crucial.

Income Elasticity of Demand (Ey)

• Definition: Responsiveness of demand when consumer income changes.
  • Normal Goods: Ey > 0 (demand rises as income increases).
  • Inferior Goods: Ey < 0 (demand decreases as income rises).

Cross Price Elasticity of Demand (Ety)

• Definition: Responsiveness of demand for one good when another’s price changes.
  • Ety > 0 indicates goods are substitutes, while Ety < 0 indicates they are complements.

Price Elasticity of Supply (Es)

• Similar to PED but measures the response of supply to price changes with calculations similar to those used for demand.

Production Theory

Key Concepts

• Defining essential terms and understanding firm behavior in producing goods and services is vital.
  • Fixed vs. Variable Costs: Knowledge of varying costs helps firms assess production economics and decisions.
  • Average vs. Marginal Costs: Understanding how these impact decision-making is critical for pricing strategy and output levels.

Economies and Diseconomies of Scale

• Economies of Scale: Costs decline as output rises.
• Diseconomies of Scale: Costs increase as the firm grows large.

Decision-Making in Production

• Producers analyze marginal product vs. average product to maximize efficiency in production—identifying optimal output levels.

Summary

After covering these foundational elements, students should grasp how economic principles apply to decision-making, cost structures, and market behaviors.