Micro Economics

Course Notes - Principles of Microeconomics

Table of Contents

• Topic 1: Introduction to Economics

  • The Scope and Method of Economics Studies

  • Scarcity, Choice and Opportunity Cost

  • Production Limitations

  • Basic Economic Questions and Economic Systems

  • Circular Flow of Income and Expenditure

• Topic 2: Demand and Supply

  • Demand

  • Law of Demand

  • Supply

• Topic 3: Market Equilibrium

  • Market Equilibrium

  • Elasticity and Sensitivity

• Topic 4: Utility Analysis

• Topic 5: Theory of Production

  • Production Process

  • Production in Short-run

  • Production in Long-run

• Topic 6: Cost Theory

  • Concept of Cost

  • Short-run Production Costs

  • Long-run Production Costs

• Topic 7: Perfectly Competitive Market

  • Economic Profit and Accounting Profit

  • Characteristics of a Perfectly Competitive Market

  • Profit Maximisation in the Short-run

  • Long-run Equilibrium of the Firm

• Topic 8: Monopoly Market

  • Characteristics of a Monopoly

  • Price Discrimination

  • Social Costs of Monopoly

• Topic 9: Monopolistic Market

  • Characteristics of a Monopolistic Market

• Topic 10: Oligopoly Market

  • Characteristics of an Oligopoly Market

  • Cournot Model and Sweezy Model

Topic 1: Introduction to Economics

• Economics Definition: Study of the allocation of scarce resources to meet unlimited wants.

• Microeconomics vs. Macroeconomics:

  • Microeconomics: Focuses on individual units (households, firms).

  • Macroeconomics: Deals with aggregates (national income, inflation).

Scarcity, Choice and Opportunity Cost

• Scarcity arises due to limited resources and unlimited wants.

• Opportunity Cost: The cost of the next best alternative foregone.

Production Limitations

• Utilization of resources develops limitations like the production possibility curve (PPC).

• PPC: Represents maximum feasible output combinations.

Topic 2: Demand and Supply

Demand

• Law of Demand: As price falls, quantity demanded rises.

• Determinants of Demand: Income, preferences, price of related goods.

Supply

• Law of Supply: As price rises, quantity supplied rises.

• Determinants of supply: Input prices, technology, expectations.

Topic 3: Market Equilibrium

• Market Equilibrium: Quantity demanded equals quantity supplied.

• Elasticity: Measures responsiveness of quantity demanded/supplied to price changes.

Topic 4: Utility Analysis

• Studies consumer behavior based on satisfaction from goods.

• Total Utility: Total satisfaction from consumption.

• Marginal Utility: Satisfaction from an additional unit consumed.

Topic 5: Theory of Production

Production Process

• Comprises inputs (land, labor, capital) transformed into outputs (goods/services).

Short-run and Long-run Production

• Short-run: At least one input is fixed.

• Long-run: All inputs are variable, allowing for better decision-making in production.

Topic 6: Cost Theory

Economic Costs

• Total costs comprised of fixed and variable costs.

• Fixed Costs: Do not vary with output.

• Variable Costs: Vary directly with output.

Topic 7: Perfectly Competitive Market

Characteristics

• Many firms and buyers, homogeneous products, free entry/exit.

Profit Maximisation

• Condition for profit maximization in short-run: MR = MC.

• Long-run Equilibrium: Firms only earn normal profit.

Topic 8: Monopoly Market

Characteristics

• Single seller, barriers to entry, price maker.

Price Discrimination

• Charging different prices to different consumers.

• Deadweight Loss: Loss in total welfare due to monopolistic pricing.

Topic 9: Monopolistic Market

Characteristics

• Large number of firms, differentiated goods.

• Firms have some price control, facing a downward sloping demand curve.

Topic 10: Oligopoly Market

Characteristics

• Few firms, interdependence in pricing and output decisions.

Cournot and Sweezy Models

• Models that describe firm behavior in oligopoly through reaction curves and price strategies.

Key Terms

• Microeconomics

• Macroeconomics

• Opportunity Cost

• Market Equilibrium

• Total Utility

• Marginal Utility

• Fixed Costs

• Variable Costs

• Price Elasticity

• Demand Curve

• Supply Curve

• Perfect Competition

• Monopoly

• Monopolistic Competition

• Oligopoly

Detailed Explanations in Principles of Microeconomics

1. Introduction to Economics

Economic Definition: Economics is the study of how individuals and societies allocate scarce resources to satisfy unlimited wants. Microeconomics vs. Macroeconomics:

• Microeconomics deals with individual units such as households and firms, analyzing their behavior and decision-making processes.

• Macroeconomics looks at the aggregates in the economy, assessing overall performance indicators like national income, inflation rates, and employment levels.

2. Scarcity, Choice, and Opportunity Cost

Scarcity: Scarcity arises when limited resources cannot meet the limitless wants of consumers. Opportunity Cost: This is defined as the value of the next best alternative that is given up when a choice is made, highlighting the trade-offs inherent in every economic decision.

3. Production Limitations

Production Possibility Curve (PPC): The PPC illustrates the maximum feasible output combinations of two goods, given fixed resources, underscoring trade-offs and opportunity costs when choosing between different products.

4. Demand and Supply

Demand Law: Indicates that as prices decrease, the quantity demanded by consumers increases, leading to a downward-sloping demand curve. Supply Law: Shows that with rising prices, the quantity supplied increases, resulting in an upward-sloping supply curve.

5. Market Equilibrium

Market Equilibrium: Achieved when quantity demanded equals quantity supplied, creating a stable market price. Elasticity: This concept measures how responsive the quantity demanded or supplied is to changes in price, reflecting consumer sensitivity and market dynamics.

6. Utility Analysis

Consumer Behavior: Examines how individuals derive satisfaction (utility) from consuming goods and services.

• Total Utility: Total satisfaction obtained from consumption.

• Marginal Utility: Additional satisfaction gained from consuming one more unit of a good, demonstrating diminishing returns with increased consumption.

7. Theory of Production

Production Inputs: The transformation of inputs (land, labor, capital) into outputs (goods/services) is fundamental in production theory.

• Short-run Production: At least one input is fixed, limiting flexibility.

• Long-run Production: All inputs are variable, allowing for optimal production adjustments.

8. Cost Theory

Economic Costs: Comprising both fixed and variable costs, important for determining profitability.

• Fixed Costs: Costs that remain constant regardless of output level.

• Variable Costs: Costs that fluctuate directly with output levels.

9. Perfectly Competitive Market

Market Characteristics: Features many firms and buyers, homogeneous products, and barriers to entry that are low or non-existent. Profit Maximization: In the short run, firms maximize profit where marginal revenue (MR) equals marginal cost (MC).

10. Monopoly Market

Market Characteristics: A single seller dominates, establishing significant barriers to entry and acting as a price maker. Price Discrimination: The practice of charging different prices to different consumers, which can lead to deadweight loss in total welfare due to disparity in consumer surplus.

11. Monopolistic Competition

Market Characteristics: A large number of firms offer differentiated goods which allow for some degree of pricing power, resulting in a downward-sloping demand curve.

12. Oligopoly Market

Market Characteristics: Characterized by a small number of firms whose pricing and output decisions are interdependent. The behavior of firms is commonly analyzed using models like Cournot and Sweezy, which describe how firms react to changes in market conditions and competitor actions.

Principles of Microeconomics

1. Introduction to Economics

Economic Definition: Economics studies the allocation of scarce resources to satisfy unlimited wants.Micro vs. Macro Economics:

• Microeconomics: Focuses on individual units like households and firms.

• Macroeconomics: Analyzes aggregates, such as national income and inflation rates.

2. Scarcity, Choice, and Opportunity Cost

Scarcity: Limited resources vs. limitless wants.Opportunity Cost: The value of the next best alternative given up when making choices.

3. Production Limitations

Production Possibility Curve (PPC): Illustrates maximum output combinations of two goods, demonstrating trade-offs and opportunity costs.

4. Demand and Supply

Demand Law: As prices decrease, quantity demanded increases, leading to a downward slope.Supply Law: As prices rise, quantity supplied increases, leading to an upward slope.

5. Market Equilibrium

Equilibrium: Quantity demanded equals quantity supplied, establishing a stable price.Elasticity: Measures responsiveness of demand or supply to price changes.

6. Utility Analysis

Total Utility: Overall satisfaction from consumption.Marginal Utility: Additional satisfaction from consuming one more unit, usually diminishing with increased consumption.

7. Theory of Production

Production Inputs: Involve transforming land, labor, and capital into goods/services.

• Short-run: At least one input is fixed.

• Long-run: All inputs can vary for optimal output adjustments.

8. Cost Theory

Economic Costs: Comprise fixed and variable costs.

• Fixed Costs: Constant regardless of output.

• Variable Costs: Change with the level of output.

9. Perfectly Competitive Market

Characteristics: Many firms, homogeneous products, low barriers to entry.Profit Maximization: Firms earn profits where marginal revenue equals marginal cost (MR = MC).

10. Monopoly Market

Characteristics: Single seller, high barriers to entry, price maker.Price Discrimination: Charging different prices to different consumers can lead to deadweight loss.

11. Monopolistic Competition

Characteristics: Many firms offer differentiated products, allowing some pricing power.

12. Oligopoly Market

Characteristics: Few firms whose decisions affect each other.Model Examples: Cournot and Sweezy models describe strategic interactions in pricing and output decisions.