Microeconomics core concepts

Markets: Physical or non-physical (online) setup which brings consumers (buyers) & producers (sellers) together to carry out an economic transaction. 

Factor Market: Market for resources like land, labour and capital.

Product Market: Market for goods and services. 

Consumers: The role is to create a demand for goods & services in a market

Demand: The ability and willingness to purchase a quantity of a good or service at a certain price over a period of time.

Ineffective demand: There is either willingness or ability but not both. 

Individual demand - Demand of one person for a product

Market demand - Sum of all the individual demands for a product at every price

Law of demand: An inverse relationship between price and quantity demanded. As the price of goods rises, the quantity demanded will usually fall, ceteris paribus (everything else is constant). (& vice versa). 

Factors which result in rise/fall of demand: Income, Price of related goods, Tastes and preferences and future expectations.

Normal Goods: As income increases, Demand increases

Inferior Goods: As income decreases, Demand increases. These tend to be lower quality, less expensive goods. 

How does Price of Related Goods affect demand?: Goods can be substitutes for each other, complementary to each other or not related at all. When they are related in some way, a change in the price of one will result in a change in the demand of the other.

Complements: Two goods that are typically purchased or used together. When the price of a complement increases demand of the other good will decrease

Substitutes: Two goods that are similar. When the price of a substitute increases, demand of the other good will increase

How do Tastes and Preferences affect demand?: When goods become more or less popular because of fashion, current events or promotion campaigns, demand is affected and the demand curve may shift to the right or to the left. 

How do Future expectations affect demand for goods and services?: If people expect prices of goods and services to increase in the near future, they may decide to purchase more of the goods now. If consumers expect the economy to do well meaning consumers expect to keep their jobs and increase their incomes in the near future they may increase their consumption of goods and services vice versa. 

Supply: The quantity of a good or service that producers are willing and able to offer at various prices during a specific time period, ceteris paribus. 

Individual Supply: Supply of one product from one firm at every price. 

Market: The marked supply is the sum of all the individual supplies of a product at every price.

Effective: The quantity of goods or services that producers are actually selling at various prices, supported by their ability to produce.

Law of Supply: There is a direct relationship between price and quantity supplied. As the price of a good rises, the quantity supplied will usually rise, ceteris paribus (& vice versa).

6 shifters of supply: Cost of production, Technology, Number of firms, future expectations, price of related goods, government intervention

How does the change in cost of production shift supply?: Increase the cost of production leads to supply curve shifting left (supply reduces) and vice versa

How does Technology shift supply?: Improvements in a firm or industry's technology can increase the supply of a good or service by increasing productivity

How do Number of Firms/Sellers shift supply?: As the market supply is the sum of all the individual supplies of a product, when the number of firms that offer the same good increases the market supply also increases shifting the supply curve of that good outwards (to the right). 

How can Future Expectations affect supply?: If firms expect prices of the products they sell to increase in the near future, they might withhold part of their current production from the market (by not offering it for sale and storing it, also called hoarding) in the hope of being able to sell more at a higher price in the future. In addition, If producers expect the economy to do well, they will expect that people will have more money to spend and that the consumption of goods and services will increase thus increasing their price and supply (extension along the supply curve)

Joint Supply: When two or more goods are derived from the same product, so that it is not possible to produce more of one without producing more of the other. The second good is often called a by-product.

Competitive supply: When the production of two goods uses similar resources and processes. When a supplier produces more of one good, it means producing less of the other. 

Government Intervention: Includes Indirect taxes, subsidies and price control/ regulations affect the firm’s supply curve

Indirect Tax: Tax paid by the producers to the government for production/selling of goods & services. When indirect taxes are imposed or increased the costs of production for firms increase, causing supply to decline

Direct Tax: Tax dependent on your income/ salary

Subsidy: Subsidy is a monetary benefit from government to producers to encourage production & increase supply. Subsidies have the opposite effect of a tax. When the government gives a subsidy to a firm it reduces the firm's costs of production, increasing the supply. 

Regulations: To reduce/ manage the side effects or drawbacks from the production process. These rules and requirements usually increase the costs of production for firms which will decrease the supply. Examples:- Pollution, Demerit Goods (Alcohol, cigarette, drugs)

Non price determinants of supply/demand: All factors affecting supply/demand other than price; they cause the entire supply/demand curve to shift.

Allocative efficiency: Producing the optimal combination of goods from a society's point of view; achieved when the economy is allocating resources so that no one can be better off without making somebody else worse off (quantity supplied = quantity demanded)

Consumer Surplus: The difference between the price that consumers pay and the price that they are willing to pay.

Producer Surplus: The difference between the price producers are willing and able to sell it and the price earned from selling the good at the market price.

Commodity: A type of good which is an important input to production. Oil, iron ore and timber are all examples of commodities.  

Price Elasticity of demand (PED): A measure of responsiveness of quantity demanded of a good or service due to a change in the price of that good/service, cetris paribus. It measures the ratio of % change in quantity demanded to % change in price. 

Price Elastic demand: A situation where the percentage change in the quantity of a good or service is greater than the percentage change in its price.

Price Inelastic demand: A situation where the percentage change in the quantity of a good or service is less than the percentage change in its price.

Unitary elastic demand: The situation in which the percentage change in the quantity of a good or service is equal to the percentage change in its price.

Inelastic demand

Determinants of price elasticity of demand: Substitutes, Addictiveness, Time period, Income, Nature of product (essential/luxury) - Acronym (SATIN)

PED of high number of substitutes - Elastic

PED of low number of substitutes - Inelastic

PED of addictive goods - Inelastic

PED of non-addictive goods - Elastic

PED of essential goods - Inelastic

PED of luxury goods - Elastic

How Addictiveness affects PED - Non addictive (PED elastic), Addictive (PED inelastic)

How does Time period affect PED?: Consumers have little/no time before purchase such as Medicines (PED inelastic). Consumers have a lot of time such as a house or property then it is elastic.

How does Income affect PED - proportion of income spend on the good is low (PED inelastic), proportion of income spent on the good is high (PED elastic)

Income elasticity of Demand (YED): A measure of how much quantity demanded of a good or service changes in response to an income change.

Normal goods: Goods whose demand increases as people's incomes increase.

Inferior goods: Goods whose demand decreases as people’s incomes increase.

Superior goods: Goods with a high price that tend to make up a larger share of a consumer’s income as income rises

Primary Sector of industries: The sector of an economy that involves extraction of natural resources; agriculture and mining are examples.

Secondary Sector of industries: The sector of an economy where raw materials are combined or changed through manufacturing to make physical products.

Tertiary Sector of industries: The sector of the economy where goods and services are provided to consumers.

Sectoral change: The change in the structure of the economy to increase or decrease production in one sector or another.

Price elasticity of Supply (PES): A measure of how much the quantity supplied of a good changes when there is a change in its own price.

Determinants of Price elasticity of Supply: Time period considered, unused capacity, ability to store stock, Mobility (flexibility) and cost of factors of production

How does Time period affect PES?: When there is a change in the price of a good, in the very immediate moment after the change, firms are unable to vary the level of supply very much. Hence, The longer the time period considered, the more elastic the supply will be.

How does mobility(flexibility) and cost of factors of production affect PES?: The more mobile (flexible) its factors of production are, the more responsive a firm can be to changes in price by increasing or reducing the quantity supplied to the market, and therefore the greater the PES.

How does unused capacity affect PES?: When firms are not using their production resources at their maximum capacity – for example, their workers are not working full-time or there is unused space in their factories – they can easily increase the production output of their product without increasing their costs significantly.

How does Ability to store stock affect PES?: If a firm has the capacity to store stock, which means keeping inventories of a good in a warehouse, the supply can be more responsive to a change in price. (more elastic)

PES of primary commodities compared to manufactured products: Have low PES (inelastic supply) compared to manufactured products because of the long time period or high levels of investment needed to increase production, which affects the ability of producers to react to price changes.

Value added tax (VAT): Is an indirect tax on goods and services at every point or stage in the production process where value is added. Also known as Goods and Services Tax (GST).

Demerit goods: Goods that have negative effects when consumed and cause negative externalities of consumption.

Price ceiling: Maximum price set by the government that is set below the equilibrium price.

Consequences of imposing maximum price: It produces shortages. It generates a rationing problem. It promotes the creation of parallel (black) markets. It eliminates allocative efficiency and generates welfare loss. Loss in producer surplus and revenue.

Non-price rationing methods: When shortages result from price ceilings, the good or service will need to be allocated in a different way than by using the price, such as by queuing, or on a first-come-first-served basis.

Parallel market: A market where buying and selling transactions are unrecorded, and are usually illegal.

Price floor: Minimum prices set by the government that are set above the equilibrium price.

Consequences of implementing price floor: It produces surpluses. It promotes the creation of black markets. The government needs to dispose of the surplus. It might create firm inefficiency. It eliminates allocative efficiency and generates welfare loss. There are consequences for market stakeholders, consumer surplus decreases.

Ways the government dispose their surplus: Store the good (which generate additional costs), export the goods but should be careful not doing too much as it will be seen as dumping especially with demerit goods or burning the excess goods

What is the correct way to avoid surplus?: To avoid the problem of what to do with the surplus goods and still protect producers by guaranteeing them a higher price for their total production, many countries decide to pay producers not to produce the excess. The unused resources, such as land, are then used to produce something else.

Specific tax: An indirect tax that is a flat value, rather than a percentage, added to the sale of a good.

Percentage/ ad-valorem tax: An indirect tax that adds a percentage of the price to the sale of the good, such as 5%.

Subsidy: An amount of money granted by the government to a firm or industry; it reduces the firm’s costs of production, increasing the supply of the good or service. Usually a per-unit payment by the government to firms in order to lower production costs and increase production.

Regulation: When governments monitor firms and industries to confirm that they are abiding by relevant legislation.

Legislation: Laws enacted by governments to limit, prohibit, or require certain behaviours. These include, age restrictions, advertising bans and permanent bans.

Consumer nudges: Gentle reinforcements and suggestions to influence market participants towards the desired behaviour. Example: traffic light symbols on food packaging that tell consumers what the nutritional content of the food is (calories, fat, sugar and salt content) might persuade them to make healthier choices. 

Conditions for consumer nudges: They must be easy, attractive, social, and timely.

Advantages of consumer nudges: Consumer nudges use relatively inexpensive methods to gently nudge consumers towards the more ideal behaviours.

Disadvantages of consumer nudges: Some critics of consumer nudges argue that these methods are manipulative and belittling. Not allowing people to make decisions fully on their own takes away their chance to be intelligent adults. x