Microeconomics Notes Utility Utility: Satisfaction from consuming a product. Total Utility: Satisfaction from all units consumed. Marginal Utility: Satisfaction from one more unit consumed; tends to fall as consumption increases. Purchase condition: P ≤ M U P≤MU P ≤ M U Law of Diminishing Marginal Utility: Marginal utility falls as consumption rises. Equi-Marginal Principle: Utility maximized when marginal valuation for each product is the same: M U ∗ A P ∗ A = M U ∗ B P ∗ B = M U ∗ C P ∗ C = ⋯ MU∗AP∗A=MU∗BP∗B=MU∗CP∗C=⋯ M U ∗ A P ∗ A = M U ∗ B P ∗ B = M U ∗ C P ∗ C = ⋯ Demand curve derivation: Price rises for A, marginal utility decreases, reducing consumption compared to other goods. Budget Line, Substitution, and Income Effect Budget Line: Combinations of two products obtainable with given income and prices. Substitution Effect: Consumers replace more expensive products with cheaper alternatives after a price change. Income Effect: Change in demand due to changes in purchasing power.Normal goods: Positive relationship; increased income leads to more purchases. Inferior goods: Inverse relationship; increased income leads to fewer purchases. Budget line shifts:Rightward for normal goods. Leftward for inferior goods. Indifference Curve Indifference Curve: Combinations of two goods providing equal satisfaction. Marginal Rate of Substitution: Rate at which a consumer is willing to substitute one product for another, affecting the curve's slope. Consumers are indifferent to points on the same curve. Higher indifference curves indicate higher utility. Optimal choice: Budget line tangent to the highest indifference curve. Price Change Effects Price decrease for Normal Good B increases purchasing power. Substitution effect: Shift from E1 to E2, movement along the indifference curve. Income effect: Shift from E2 to E3, shift to a new indifference curve. Price Effect = Substitution Effect + Income Effect. Giffen Goods Subcategory of inferior goods where consumption increases as price increases due to a strong income effect. Efficiency and Market Failure Economic Efficiency: Efficient use of scarce resources to maximize output.Productive Efficiency: Production at the lowest possible cost. Achieved when producing on the border of a PPC curve. Allocative Efficiency: Price equals marginal cost; firms produce goods consumers want. Achieved when any point on a PPC curve where the marginal cost and selling price are the same. Pareto Optimality: Impossible to make someone better off without making someone else worse off. Dynamic Efficiency: Productive efficiency that benefits a firm over time. Market Failure: Free market fails to make optimum use of scarce resources without government intervention. Costs and Benefits Social Costs = Private Costs + External Costs Marginal Social Costs = Private Marginal Costs + External Marginal Costs Social Benefits = Private Benefits + External Benefits Marginal Social Benefits = Marginal Private Benefits + Marginal External Benefits Externalities Externalities: Side effects on third parties from producers' or consumers' actions. Negative Externalities: Impose costs on third parties. Positive Externalities: Benefit third parties. Overproduction of goods with negative externalities occurs due to failure to account for social costs. Asymmetric Information: One party has more knowledge than the other. Moral Hazard: Increased risk-taking due to insurance or protection, arising from asymmetric information. Adverse Selection: Hiding information during a policy sale. Cost-Benefit Analysis (CBA) Method for assessing project desirability by considering costs and benefits.
Stages:Identification of all relevant costs and benefits. Putting a monetary value on all relevant costs and benefits. Forecasting future costs and benefits (where appropriate). Decision-making - the interpretation of the results from CBA. Short-Run Production Function Relationship between one variable factor and output, with others fixed. Formula: Q = A F ( K , L ) Q=AF(K, L) Q = A F ( K , L ) Short Run Cost Function Fixed Costs: Independent of output in the short run. Variable Costs: Vary directly with output. Total cost = total fixed cost + total variable cost. It starts at the fixed cost line and follows the variable cost line, since it combines both. Average Fixed Cost= t o t a l f i x e d c o s t o u t p u t =\frac{total \ fixed \ cost}{output} = o u tp u t t o t a l f i x e d cos t Average variable cost= t o t a l v a r i a b l e c o s t o u t p u t =\frac{total \ variable \ cost}{output} = o u tp u t t o t a l v a r iab l e cos t Average total cost= t o t a l c o s t o u t p u t =\frac{total \ cost}{output} = o u tp u t t o t a l cos t Marginal cost= c h a n g e i n c o s t c h a n g e i n q u a n t i t y =\frac{change \ in \ cost}{change \ in \ quantity} = c han g e in q u an t i t y c han g e in cos t Isoquant: Curve showing a particular output level over a combination of inputs. Optimum Output: Most efficient output at the lowest unit cost. Long-Run Production Function All factors of production are variable. Increasing returns to scale: Output increases faster than factor inputs. Decreasing returns to scale: Factor inputs increase faster than output. Long Run Cost Function Minimum Efficient Scale: Lowest output level at which costs are minimized. Low MES: Fragmented market. High MES: Natural monopoly. Long-run average cost cure-envelope curve LRAC is also known as the envelope curve, consisting of the short-run average costs over time. Economies and Diseconomies of Scale Economies of Scale: Benefits from falling long-run average costs as output increases.Internal Economies of Scale External economies of scale External diseconomies of scale. Diseconomies of Scale: Long-run average cost increases as output increases.Internal Diseconomies of Scale. External diseconomies of scale. Revenue and Profit Total Revenue (TR) = price x quantity Average Revenue (AR) =total revenueOutput Marginal Revenue (MR) =change in total revenuechange in total output Normal Profit: Cost of production just sufficient for the firm to keep running Subnormal Profit: Less than normal profit. P<AC, price less than average cost. Supernormal Profit: More than normal profit. TR>TC, the total revenue is greater than the total costs. Market Structure Industry: A group of productive enterprises or organizations that produce or supply goods, services, or sources of income. MNC: A multinational corporation (MNC) has business operations in two or more countries. Market Structure: The way a market is organized in terms of the number of firms and barriers to the entry of new firms. Spectrum Structure:Perfect Competition Imperfect CompetitionMonopolistic Competition Oligopoly Monopoly Concentration Ratio Barriers to Entry Perfect Competition Theoretical Extreme Firms are price takers. Demand = Average revenue = Marginal revenue. Profit maximisation point MC = MR (price) The Shutdown price is when P=AR=AVC Long-run equilibrium leaves only productive and allocative efficient firms due to normal profit. Contestable Market Any market structure with a threat that potential entrants are free and able to enter this market. Imperfect Competition Monopolistic Competition Oligopoly Monopoly Monopolistic Competition Numerous buyers and sellers Few barriers to entry Wide choice of differentiated products Firms have some influence on market price Oligopoly Dominated market by a few firms Decisions are interdependent on rival strategies/reactions. High or substantial barriers to entry The uncertainty and risk associated with price competition may lead to price rigidity. Cartel: a formal agreement between firms to limit competition by limiting output or fixing prices. Main Theories to Attempt to Explain Oligopolistic BehaviourThe Kinked Demand Curve Game Theory Prisoners’ Dilemma Monopoly Single seller No close substitutes High barriers to entry The monopolist is the price maker Local monopolies can exist because it could be too costly for the others to set up, even tho it could be a small firm. Natural Monopoly Growth and Survival of Firms Existence of Small firms GrowthInternal Growth External Growth Cartels Cartel: formal agreement between firms to limit competition by limiting output or fixing prices. Differing Objectives and Policies of Firms Government Microeconomic Intervention Measures to Tackle Different Forms of Market Failure Negative Production Externalities Negative Consumption Externalities Positive Production Externalities Positive Consumption Externalities Knowt Play Call Kai