Comprehensive Notes – Demand, Supply, Utility, Elasticity & Firm Theory

Firms and Households: Basic Decision-Making Units

• Firm – organization that transforms inputs into outputs to earn profit.
• Entrepreneur – organizes, manages, bears risk, turns new idea into business.
• Households – primary consuming units; supply factors, demand products.

Input & Output Markets: The Circular Flow

• Product/output markets – goods & services traded.
• Input/factor markets – resources (land, labor, capital) traded.
• Labor market – households supply work for wages.
• Capital market – households supply savings for interest/profits; firms borrow to buy capital.
• Land market – households rent land/real property for rent.
• Circular flow diagram:
– Clockwise real flow: household labor → firms; goods/services → households.
– Counter-clockwise money flow: households pay firms for goods; firms pay households for labor.

Demand in Product/Output Markets

Quantity Demanded & Law of Demand

• Quantity demanded (Qᵈ) – amount household would buy per period at given price.
• Demand schedule – table of Qᵈ at various prices.
• Demand curve – graphical inverse relation $P \to Q^d$; negative slope.
• Law of demand – $P\uparrow \Rightarrow Q^d\downarrow$ and vice-versa, ceteris paribus.
• Properties: intersects price axis (income/wealth limits) & quantity axis (time limits, diminishing MU).

Other Determinants of Demand (Shift Variables)

• Income (flow) and Wealth (stock)
– Normal goods: $Y\uparrow \Rightarrow D\uparrow$
– Inferior goods: $Y\uparrow \Rightarrow D\downarrow$
• Prices of related goods
– Substitutes ($P<em>A\uparrow \Rightarrow D</em>B\uparrow$); perfect substitutes identical.
– Complements ($P<em>A\downarrow \Rightarrow D</em>B\uparrow$).
• Tastes/preferences – volatile & idiosyncratic.
• Expectations – about future prices, income, wealth.

Shift vs Movement Along Demand Curve

• Price change ⇒ movement along curve (∆Qᵈ).
• Non-price determinant change ⇒ shift of curve (∆D).
• Illustration (Chloe’s calls): income rise shifts $D<em>0 \to D</em>1$ rightward.

From Household to Market Demand

• Market demand = horizontal sum of all household Qᵈ at each price.

Supply in Product/Output Markets

Quantity Supplied & Law of Supply

• Quantity supplied (Qˢ) – amount firm willing & able to sell at given price/time.
• Supply schedule & curve – positive slope graph.
• Law of supply – $P\uparrow \Rightarrow Q^s\uparrow$ (direct relationship).

Determinants of Supply (Shift Variables)

1. Product price → movement along curve.

2. Cost of production
   – Input prices (labor, land, capital, energy)
   – Technology

3. Prices of related products (substitutable outputs or joint products)

Shift vs Movement Along Supply Curve

• Price change ⇒ movement (∆Qˢ).
• Other factors ⇒ shift (∆S). Example: new disease-resistant soybean seed shifts $S<em>0 \to S</em>1$ right.

From Individual to Market Supply

• Market supply = horizontal sum of individual firm Qˢ at each price.

Market Equilibrium

• Equilibrium – $Q^d = Q^s$; no pressure on price.
• Excess demand (shortage) – Q^d>Q^s → price rises.
• Excess supply (surplus) – Q^s>Q^d → price falls.
• Shifts of D or S change equilibrium $P^<em>$ and $Q^</em>$ (e.g., coffee freeze shifts S left, doubling price).

Review: Mechanics of Supply & Demand

• Demand depends on $P, Y, W, P<em>{related}, tastes, expectations.$ • Supply depends on $P, C</em>{inputs}, tech, P_{related}.$
• Distinguish movements vs shifts.

Markets & Allocation of Resources

• Demand signals willingness/ability to pay; supply reflects profit motive & technology.
• Price rations scarce goods: shortages raise price, allocating to those willing/able to pay.

Utility Theory

Definition & Subjectivity

• Utility – power of good/service to satisfy want; subjective & varies across persons.

Law of Diminishing Marginal Utility (Marshall)

• Statement: additional benefit from extra unit falls as stock increases.
• Example table of rasgullas shows $MU\downarrow$; $MU=0$ at saturation, negative beyond.

Classifications

• Initial, Total, Marginal, Zero & Negative utility.

Characteristics

1. No moral content; 2. Psychological; 3. Individual & relative; 4. ≠ usefulness; 5. Not objectively measurable; 6. Depends on want intensity; 7. Differs from pleasure; 8. Distinct from satisfaction.

Types of Utility

• Form, Place, Time, Service utilities – created by production, transport, storage, personal services.

Cardinal vs Ordinal Utility

• Cardinal approach (utils): measurable; basis for laws:
– Law of Diminishing MU
– Law of Equi-Marginal Utility: allocate income s.t. $\frac{MU<em>x}{P</em>x}=\frac{MU<em>y}{P</em>y}=\dots$
• Ordinal approach (Hicks, Allen): utility ranks only; basis for indifference curves.

Indifference Curve Analysis

• Indifference curve = combinations of two goods yielding equal satisfaction.
• Properties depicted via indifference map (IC₁, IC₂…).

Managerial Economics Context

• Course applies economic principles to business problems: optimize resources, maximize profit, adapt to change.
• Micro topics: demand/supply analysis, elasticity, consumer behavior, production, cost, market structures.
• Macro topics: national income, cycles, policy, etc.

Positive vs Normative Economics

• Positive: fact-based, testable (e.g., “Gov’t healthcare raises expenditures”).
• Normative: value-based (e.g., “Gov’t should provide healthcare”).
• Classroom activities classify statements accordingly.

Divisions of Economic Activity

• Production – create goods/services using inputs.
• Distribution – allocate outputs/income.
• Consumption – use of goods/services.
• Exchange – transfer via markets; money as medium.

Ten Principles of Economics (Mankiw)

1. People face trade-offs (no free lunch).

2. Cost = what you give up (opportunity cost).

3. Rational people think at the margin.

4. People respond to incentives.
   … (Principles 5-9 omitted in transcript) …

5. Society faces short-run trade-off between inflation & unemployment (Phillips curve).

Factors of Production

• Land/Natural resources – fixed supply (oil, water, forests).
• Labor – human effort (mental & physical).
• Capital goods – manufactured aids (machines, buildings) – not money.
• Entrepreneurship – risk-taking, organizes other factors.

Economic Systems

• Key Qs: What, How, For whom to produce?

1. Traditional – customs, bartering; e.g., rural tribes.

2. Command – gov’t owns property, sets prices; e.g., Cuba, N. Korea.

3. Market – decisions via prices & private property; no pure form, US closest.

4. Mixed – blend; most democracies (Canada, UK, Brazil).
   • Market system excels in growth, freedom, efficiency; command/traditional offer security.

Elasticity Concepts

General Definition

• Elasticity = responsiveness of $Q$ to changes in price/income/other variable.

Price Elasticity of Demand (Eₚ)

• Formula: $E<em>p=\frac{\%\,\Delta Q^{d}}{\%\,\Delta P}$. • Classifications: – Ep>1 elastic; $E<em>p=1$ unit; Ep<1 inelastic; $E<em>p\to \infty$ perfectly elastic; $E</em>p\to0$ perfectly inelastic.
• Determinants: availability of substitutes, luxury vs necessity, price/income share, time.
• Total-Revenue Test: $P \uparrow$ ⇒ $TR$ falls if elastic, rises if inelastic.
• Examples: demand for apparel elastic; farm products inelastic (bumper crop lowers $TR$).

Cross Elasticity (Eₓᵧ)

• $E<em>{xy}=\frac{\%\,\Delta Q</em>x}{\%\,\Delta P<em>y}$. • E{xy}>0 substitutes, E{xy}<0 complements, $E</em>{xy}=0$ unrelated.

Income Elasticity (Eᵧ)

• $E<em>{Y}=\frac{\%\,\Delta Q}{\%\,\Delta Y}$. • EY>1 luxury (income-elastic normal good); 0<EY<1 necessity; EY<0 inferior good.

Price Elasticity of Supply (Eₛ)

• $E_s=\frac{\%\,\Delta Q^{s}}{\%\,\Delta P}$; always ≥0.
• Determinants: time to adjust, storage possibilities.
• Classifications mirror demand (elastic, inelastic, perfectly elastic/inelastic).

Theory of the Firm: Production & Cost

Types of Business Firms

• Sole proprietorship – single owner; unlimited liability.
• Partnership – several owners; unlimited liability.
• Corporation – shareholders; limited liability; may issue stock; dominant in sales.

Production Function & Technology

• Mapping from input combinations to maximum output.
• Short run – at least one fixed input; Long run – all inputs variable.

Short-Run Production & Diminishing Returns

• Total Product (TP), Marginal Product of Labor (MPL) = $\Delta Q / \Delta L$.
• Increasing then diminishing marginal returns as labor added to fixed capital.

Cost Concepts

• Fixed cost (FC) – independent of Q.
• Variable cost (VC) – varies with Q.
• Total cost (TC) = $FC+VC$.
• Average costs: $AFC=FC/Q$, $AVC=VC/Q$, $ATC=TC/Q$.
• Marginal cost (MC) = $\Delta TC/\Delta Q$; U-shaped, intersects minima of AVC & ATC.
• Sunk cost – already incurred; irrelevant for decisions.

Long-Run Costs & Scale

• Long-run total cost (LRTC) minimal cost with all inputs variable.
• Long-run average total cost (LRATC) obtains envelope of SR ATC curves.
• Economies of scale: LRATC ↓ as Q ↑ (specialization, lumpy inputs).
• Constant returns to scale: LRATC flat.
• Diseconomies of scale: LRATC ↑ (management complexity).
• Minimum Efficient Scale (MES) – smallest Q at minimum LRATC; relation between MES and market demand shapes market structure (many small firms vs natural monopoly).

Profit Concept

• $\text{Profit}=\text{Revenue} - \text{Cost}$; goal is maximization subject to technology & costs.

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