microeconomics
Kwame Nkrumah University of Science & Technology, Kumasi, Ghana
ACF 265: Microeconomics For Business
DEPT. OF ACCOUNTING AND FINANCE
KNUST School of Business
Dr. Daniel Domeher
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Kwame Nkrumah University of Science & Technology, Kumasi, Ghana.
ACF 265: Microeconomics For Business.
Department of Accounting and Finance.
KNUST School of Business.
Dr. Daniel Domeher.
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BASIC CONCEPTS
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LEARNING OBJECTIVES
At the end of this lecture, students should be able to:
Illustrate the concept of scarcity in the decision making of economic units.
Explain how rational consumers make their economic choices.
Examine some of the trade-offs that consumers, firms, and governments face.
Distinguish between scarcity and poverty.
Discuss how incentives affect people’s behavior.
Discuss why markets are a good, but not perfect, way to allocate resources.
Draw the production possibilities frontier (PPF) and use it to explain the concepts of scarcity and opportunity cost.
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INTRODUCTION
The term ‘economy’ is derived from the Greek word oikonomos, meaning ‘one who manages a household’.
Businesses allocate scarce resources among competing uses, considering various stakeholder wants and needs.
Economics studies how society manages limited resources with alternative uses to satisfy unlimited desires.
Resource allocation is often decentralized, achieved through the actions of households and firms rather than a single central planner.
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RESOURCES
Resources refer to things used to produce goods and services that satisfy human wants:
Limited in supply: Scarcity arises as quantities are insufficient to meet all human wants.
Natural resources: Examples include rain, crude oil, and mineral deposits.
Human resources: Encompasses labor services.
Man-made resources: Such as machines and equipment that aid further production.
Entrepreneurship serves as a fourth resource, driving innovation and efficiency.
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SCARCITY
Scarcity is defined as the limited nature of society’s resources.
It signifies that society cannot produce all the desired goods and services due to limited resources.
Relative concept: Society desires more than is available.
Central problem of economics.
Economists analyze decision making and interactions among people and businesses, making economics a science of decision making.
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DECISION MAKING AND TRADE-OFFS
The maxim “there is no such thing as a free lunch” emphasizes the essence of trade-offs.
To obtain benefits from one choice, one often incurs costs from another choice, highlighting the necessity of comparison.
Decision making typically involves trading off one goal against another, integrating costs and benefits.
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OPPORTUNITY COST
The cost associated with any action is defined as what one gives up to obtain it.
Decisions encompass both obvious and less recognizable costs.
Opportunity cost: Defined as what is relinquished to obtain a certain item.
Recognizing opportunity costs is crucial in decision-making processes, as costs can extend beyond mere monetary values.
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MARGINAL THINKING
Economists refer to marginal changes as small incremental adjustments to an existing plan.
Rational decision-makers act if the marginal benefit of an action exceeds its marginal cost.
Significance in business is heightened due to the tendency for businesses to rationalize decision-making more than individuals do.
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INCENTIVES
People's and businesses’ decisions hinge upon a comparison of costs and benefits, influenced by incentives.
Policies impacting costs or benefits can result in alterations in behavior.
When evaluating policies, it's essential to account for both direct and indirect effects arising from shifting incentives.
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MARKET ECONOMY
A market economy allocates resources through decentralized decisions made by numerous firms and households (often referred to as the invisible hand).
Central planning is replaced by the decentralized decisions of millions:
Firms decide on hiring and production.
Households choose employment and spending.
Interactions in the marketplace, fueled by prices and self-interest, guide decision-making processes.
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GOVERNMENT INTERVENTION
Market failure is a term economists use to describe scenarios where the market fails to achieve an efficient resource allocation.
Questions arise regarding government necessity despite the effectiveness of the invisible hand, with the response asserting that government is needed:
To enforce property rights.
To promote efficiency and equity.
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THE PRODUCTION POSSIBILITIES FRONTIER (PPF)
Assumptions Underlying PPF:
Production is assessed over a specified time frame, typically a year.
Resources are fixed during this time period and are employed maximally.
Resources must be utilized efficiently.
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GRAPHIC REPRESENTATION OF PPF
Quantity of guns produced is represented on one axis.
Quantity of butter produced is represented on the other.
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THE LAW OF INCREASING OPPORTUNITY COST
The concave shape of the PPF reflects the law stating:
As production of one good increases, the opportunity cost of producing the alternative good also rises.
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EXPLANATION FOR THE BOWED OUTWARD PPF
Law of increasing relative cost:
This law indicates that some economic resources are better suited for certain goods than others; hence they adapt differently to alternate uses.
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DISCUSSION QUESTIONS
Explain the conditions under which the PPF may shift (inward/outward) or pivot.
Distinguish between the concepts of scarcity and poverty.
Discuss why economics is considered a science (or social science).
Differentiate between free goods and economic goods, providing three examples of each.
Generate brief notes on:
Microeconomics and macroeconomics
Positive and normative economics
Hypothesis, theory, and law
Deductive and inductive approaches to economic study
Economic activities and classifications
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QUESTIONS
- For inquiries, contact ddomeher.cass@knust.edu.gh
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MICROECONOMICS FOR BUSINESS
LECTURE 3
Department of Accounting and Finance, KNUST School of Business, College of Humanities and Social Sciences.
Dr. Daniel Domeher
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DEMAND AND SUPPLY: HOW MARKETS WORK
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LEARNING OBJECTIVES
By the end of this discussion, students will be able to:
Identify what constitutes a competitive market.
Analyze the determinants of supply and demand for a good in a competitive market.
Differentiate between movements along a curve and shifts of a curve.
Understand how supply and demand dictate prices and quantities sold.
Assess the critical role of prices in resource allocation within market economies.
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MARKET FORCES OF DEMAND AND SUPPLY
A market involves two main entities: buyers (demand) and sellers (supply).
Together, demand and supply are the forces that drive market economies, affecting prices and quantities produced.
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PRICE VS. COST
Price: The monetary value a buyer must pay to acquire a good.
Cost: Payments made for factor inputs during production.
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MARKETS AND COMPETITION
A market represents an arrangement through which buyers and sellers of a specific good interact, determining prices and quantities.
Not restricted to a physical location.
Collectively, sellers define supply, while buyers dictate demand.
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COMPETITIVE MARKETS
Competition exists when multiple firms vie for the same customer base.
In a competitive market, many buyers and sellers ensure that no single entity significantly influences market prices.
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CHARACTERISTICS OF PERFECTLY COMPETITIVE MARKETS
Goods are identical (homogenous), leading to no buyer preference.
The number of buyers and sellers is extensive; no singular buyer or seller can influence prices.
Buyers and sellers must accept market-determined prices, defining them as price takers.
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TYPES OF COMPETITION
Not all goods exist within perfectly competitive markets:
Monopoly: A market with only one seller who sets the price.
Oligopoly: A market with few sellers, often not competing aggressively.
Imperfectly competitive market: Multiple sellers offer slightly different products, allowing some price-setting ability for each.
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DEMAND DEFINED
Demand signifies the quantity of a good consumers are willing to buy at a specific price, during a designated time frame, with the assumption that other factors remain constant (ceteris paribus).
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DEMAND CURVE
Various determinants influence the quantity demanded, with price playing a central role.
The quantity demanded is inversely related to price changes; as price rises, demand typically falls and vice versa.
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LAW OF DEMAND
When other factors remain uniform, an increase in a good's price correlates with a decrease in quantity demanded, and a price decrease correlates with an increase in quantity demanded.
Ceteris paribus is crucial as price isn’t the sole influencing factor on purchases.
To isolate price influence, other factors (e.g. income) must be held constant.
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DEMAND SCHEDULE AND CURVE
A demand schedule: A table displaying the relationship between price and quantity demanded, assuming all other influencing factors are constant.
A demand curve graphs this relationship illustrating how demand shifts with price variations.
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MARKET DEMAND VS INDIVIDUAL DEMAND
The demand curve visually represents how the quantity demanded changes with price, typically sloping downward.
Market demand: The sum of all individual demands for a product, aggregating individual demands at each price level.
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SHIFT VERSUS MOVEMENT ALONG THE DEMAND CURVE
A shift in the demand curve occurs due to factors other than price changes.
This represents an overall increase or decrease in demand.
A movement along the curve indicates a change in quantity demanded resulting strictly from price changes—with all other factors assumed constant.
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SHIFTS IN DEMAND CURVE
An increase in quantity demanded at a given price shifts the demand curve rightward.
A decrease results in a leftward shift.
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VARIABLES THAT SHIFT THE DEMAND CURVE
Income:
Lower income results in reduced overall spending, impacting demand negatively.
Normal goods: Demand increases as income rises.
Inferior goods: Demand rises when income decreases.
Prices of related goods:
Substitutes: Price decrease in one good reduces the demand for its substitute.
Complements: Price decreases in one good raise the demand for its complement.
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FURTHER VARIABLES AFFECTING DEMAND
Tastes: Consumer preferences directly impact demand levels.
Expectations: Anticipated future prices can alter current demand behavior.
Population: A larger population typically correlates with heightened demand for goods and services, influenced by structural changes within the population.
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SUPPLY DEFINED
Supply indicates the quantity sellers are willing and able to offer at various price points.
Quantity supplied typically rises with price increases, thus exhibiting a positive relationship between both variables.
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LAW OF SUPPLY
Law of Supply: Holding other factors constant, an increase in the price of a good directly correlates with an increase in quantities suppliers are willing to offer.
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MARKET SUPPLY VS INDIVIDUAL SUPPLY
A supply schedule: A table that aligns price levels with quantities suppliers are willing to offer.
The graphical supply curve slopes upward, demonstrating that higher prices equate with increased supply.
Market supply sums the individual supplies of all sellers in the market, derived horizontally by compiling individual supply curves.
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SHIFT VERSUS MOVEMENT ALONG THE SUPPLY CURVE
A shift occurs due to supply-affecting factors other than price changes, resulting in altered supply quantities independently of current price levels.
A movement along the supply curve indicates supply variation inferring from price changes, all else held constant.
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VARIABLES THAT SHIFT THE SUPPLY CURVE
Input Prices: Rising input prices typically result in reduced supply due to decreased profitability. Conversely, falling input prices stimulate increased supply.
Technology: Technological advancements can increase productivity, thereby elevating supply.
Expectations: Anticipated future prices may influence current supply decisions.
Number of Sellers: An increase in the number of firms in an industry heightens potential supply levels.
Natural/Social Factors: External factors like weather patterns and social attitudes may impact supply.
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EQUILIBRIUM ANALYSIS
MARKETS NOT IN EQUILIBRIUM: SURPLUS
Occurs when market prices exceed equilibrium price, leading to excess supply.
Resultant surplus: Sellers cannot liquidate excess stock, prompting price reductions.
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MARKETS NOT IN EQUILIBRIUM: SHORTAGE
Occurs when market prices fall below equilibrium price, resulting in excess demand.
Buyers face constraints in acquiring products, leading suppliers to respond by raising prices.
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EQUILIBRIUM DEFINED
Equilibrium: A balanced state where market forces are in alignment, with no external forces prompting price changes.
The intersection of supply and demand curves indicates equilibrium.
At equilibrium price and quantity, the market achieves a state of rest.
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FINDING MARKET EQUILIBRIUM USING EQUATIONS
The relationship between price and demand/supply can be expressed through equations:
Example Demand Equation: Q_d = 2100 - 2.5p
Example Supply Equation: Q_s = -10 + 6p
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FINDING PRICE AND QUANTITY
In equilibrium, set the demand and supply equations equal to each other:
Qd = Qs
Solve simultaneously for equilibrium price (P) and quantity (Q) based on pre-defined equations.
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INCREASE IN DEMAND AND ITS IMPACT ON EQUILIBRIUM
An event raising quantity demanded at any given price shifts the demand curve rightward, raising both equilibrium price and quantity accordingly.
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DECREASE IN SUPPLY AND ITS IMPACT ON EQUILIBRIUM
A reduction in supply at any given price shifts the supply curve leftward, leading to increased equilibrium prices and decreased equilibrium quantities.
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SIMULTANEOUS SHIFTS IN SUPPLY AND DEMAND
Dual shifts may lead to varied results:
An increase in demand plus a decrease in supply can elevate prices while impacting quantity sold unevenly.
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MEASUREMENT OF ELASTICITIES
PRICE, INCOME, AND CROSS ELASTICITY
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ELASTICITY CONCEPT
Elasticity measures responsiveness of one variable in relation to changes in another.
The core metrics revolve around defining how demand alters with pricing and income changes.
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ELASTICITY TYPES
Price Elasticity of Demand (PED): Reflects responsiveness of demand to price changes.
Income Elasticity of Demand: Indicates change in demand responsiveness to income alterations.
Cross Elasticity of Demand: Relates to responsiveness of demand for one good in relation to changes in a related good’s price.
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PRICE ELASTICITY OF DEMAND (PED)
Measures the degree of responsiveness of demand concerning price centers:
If PED > 1, demand is elastic;
If PED < 1, demand is inelastic;
If PED = 1, demand is unitary elastic.
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PED FORMULA
PED is calculated using the formula:
PED = rac{ ext{% Change in Quantity Demanded}}{ ext{% Change in Price}}Notably, price elasticity of demand remains negative, reflecting inverse relationships between price and demand.
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PED AND TOTAL REVENUE
The intersection of PED with total revenue is pivotal, as it indicates financial impacts of price alterations.
Total Revenue (TR): Defined as TR = ext{Price} imes ext{Quantity Sold}.
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DETERMINANTS OF PED
Various factors influence price elasticity of demand, including:
Necessity degree of commodities
Proximity and availability of substitutes
Consumer income levels
Proportion of income spent on goods
Brand loyalty and habit formation
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APPLICATIONS OF PRICE ELASTICITY
Applications extend into various realms:
Pricing strategies for commodities
Implications of taxation (burden & incidence)
Strategic firm expansions and decision-making
Analyzing responses to currency shifts
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INCOME ELASTICITY OF DEMAND (2)
The responsiveness of demand concerning income changes.
Normal Good: Demand escalates as income rises; Positive e_y
Inferior Good: Demand contracts as income increases; Negative e_y.
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CROSS ELASTICITY OF DEMAND
Measures demand responsiveness for one good in reaction to price shifts of related products.
Positive e_{ty} indicates substitutive relationship (goods consumed in place of one another)
Negative e_{ty} indicates complementary relationship (goods consumed together).
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PRICE ELASTICITY OF SUPPLY (E_S)
Measures responsiveness of supply to price fluctuations:
Inelastic if e_s < 1;
Elastic if e_s > 1;
Unitary if e_s = 1.
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DETERMINANTS OF ELASTICITY OF SUPPLY
Influencing factors include:
Input availability for production
Pre-existing production capacity
Duration for adjustment
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APPLICATIONS OF PRICE ELASTICITY OF SUPPLY
Consumer perspective: Price inelasticity impacts potential cost increases.
Producer perspective: An understanding of supply elasticity can drive pricing strategies during demand hikes.
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COSTS OF PRODUCTION
DISTINCTION OF ECONOMIC VS ACCOUNTING PROFIT
Total Revenue: The income generated from sales.
Total Cost: Market value of inputs utilized during production.
Profit: Defined as total revenue less total costs.
Economic profit incorporates both explicit and implicit costs of running a business.
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FIXED AND VARIABLE COSTS
Fixed Costs: Do not fluctuate with production levels, incurred even when output is zero (e.g., rent).
Variable Costs: Change corresponding with production output.
Total Costs = Fixed Costs + Variable Costs.
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AVERAGE AND MARGINAL COST
Average Total Cost (ATC): Total Cost divided by quantity of output.
ATC = rac{TC}{Q}
Marginal Cost (MC): Demonstrates the change in total cost when output increases, serving as a critical determinant in production decisions.
MC = rac{ ext{Change in Total Cost}}{ ext{Change in Quantity}}