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micro1.pptx0
Microeconomics: The Introduction
Trade-Offs
Consumers
Workers
Firms
Have limited incomes,
- Must decide to save or to spend
- Must decide on variety of goods and services,
Face constraints and make trade-offs.
Must decide whether and when to enter the workforce.
Face trade-offs in their choice of employment.
Must sometimes decide how many hours per week they wish to work,
=> Trading off between labor & leisure.
Must decide:
What products to produce,
How to use the resources available to produce them.
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Microeconomics: The Definitions?
● Market Collection of buyers and sellers that, through their actual or potential interactions, determine the price of a product or set of products.
● Arbitrage Practice of buying at a low price at one location and selling at a higher price in another.
● Perfectly competitive market Market with many buyers and sellers, so that no single buyer or seller has a significant impact on price.
● Market price Price prevailing in a competitive market.
● Extent of a market Boundaries of a market, both geographical and in terms of range of products produced and sold within it.
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Why Study Microeconomics?
Important for the a private firm, because it must decide:
- How the people would react to a new products.
- The cost of the new product.
- Its relationship to the government and the effects of regulatory policies.
Important for the government because the government:
- Must evaluate the monetary impact of new regulatory programs on consumers.
- Must determine how new standards will affect the production cost.
- Must ask whether the market forces are sufficient or regulations are required.
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The Basics of Supply and Demand
How changing world economic conditions affect market price and production
The impact of government price controls, minimum wages, price supports, and production incentives
How taxes, subsidies, tariffs, and import quotas affect consumers and producers
Demand and Supply functions will be developed in the remainder of the course. In this lecture we focus on their implication:
S/D analysis: powerful tool can be applied to the analysis of:
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Supply Curve
● Supply Curve: Relationship between the quantity of a good that producers are willing to sell and the price of the good.
Shows how the quantity of a good offered for sale changes as the price of the good changes.
- It is upward sloping: The higher the price, the more firms produce and sell.
Note: If production costs fall, firms can produce the same quantity at a lower price or a larger quantity at the same price. => S shifts to S’.
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Supply Curve
The supply curve: a relationship between the quantity supplied and the price or =>
Supply Function: QS = QS(P)
Inverse Supply: P = PS(QS)
Other Variables That Affect Supply
- Production costs (wages, interest charges, the costs of raw materials.)
- Example: Production costs decrease => output increases for every given price => Shifts to the right.
Change in supply: shifts in the supply curve,
Change in the quantity supplied: movements along the supply curve.
=> more generally the supply curve can be written as:
QS = QS(P,Raw Material, W, Interest rate, etc )
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Demand curve: The quantity of a good demanded as a function of its price.
- Downward sloping;
=> holding other things equal, will want to purchase more of a good as its price goes down.
Demand Function: QD = QD(P)
Inverse demand: P = PD(QD)
Other variables: Income, the weather, and the prices of other goods.
For most products, a higher income level shifts the demand curve to the right (from D to D’).
QD = QD(P, I, Pj, etc)
Demand Curve
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Supply & Demand
Shifting the Demand Curve
● Substitutes Two goods for which an increase in the price of one leads to an increase in the quantity demanded of the other.
● Complements Two goods for which an increase in the price of one leads to a decrease in the quantity demanded of the other.
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The Market Mechanism
● Equilibrium (or market clearing) price Price that equates the quantity supplied to the quantity demanded.
(P0 )
- Market mechanism Price changes until the market clears
- Surplus Quantity supplied > quantity demanded.
(P1 )
Shortage Quantity demanded > quantity supplied.
(P2 )
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Changes in Market Equilibrium
Supply and demand curves shift over time as market conditions change.
- Rightward shifts of the supply and demand curves => a bit higher price and a much larger quantity.
=> Changes in price and quantity depend on the shift in the curves and the shape of each curve.
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Changes in Market Equilibrium Example-1
Supply curve for eggs shifted rightward (production costs fell);
Demand curve shifted to the left (consumer preferences changed)
=> The real price of eggs down sharply while consumption is up.
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Changes in Market Equilibrium Example-2
Supply curve for a college education shifted to the left (Why?).
Demand curve shifted to the right (Why?)
both price and enrollments rose sharply.
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Elasticities of Demand & Supply
Elasticity Percentage change in one variable resulting from a 1-percent increase in another.
Percentage change in quantity demanded of a good resulting from a 1-percent increase in its price.
Price Elasticity of Demand
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Elasticities of Demand & Supply
Linear demand curve Demand curve that is a straight line.
The price elasticity of demand depends on:
the slope of the demand curve
the price and quantity.
=> varies along the curve as price and quantity change.
Near the top: elasticity is large.
Near the bottom: elasticity is small.
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Elasticities of Demand & Supply
Infinitely Elastic Demand (Horizontal Demand)
Horizontal demand curve: ΔQ/ΔP is infinite.
- A tiny change in price leads to an enormous change in demand.
- An individual buys as much of a good as they can get at a single price, but for any higher price the quantity demanded drops to zero, while for any lower price the quantity demanded increases without limit.
Completely Inelastic Demand (Vertical Demand)
Vertical demand curve: ΔQ/ΔP is zero.
- The quantity demanded is the same no matter what the price, the elasticity of demand is zero.
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Elasticities of Demand & Supply
Income elasticity of demand Percentage change in the quantity demanded resulting from a 1-percent increase in income.
Other Demand Elasticities
Cross-price elasticity of demand Percentage change in the quantity demanded of one good resulting from a 1-percent increase in the price of another.
Price elasticity of supply Percentage change in quantity supplied resulting from a 1-percent increase in price.
Elasticities of Supply
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Elasticities of Supply & Demand
Point elasticity of demand Price elasticity at a particular point on the demand curve.
Arc elasticity of demand Price elasticity calculated over a range of prices.
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Elasticities of Supply & Demand Numerical Example
The following supply & demand curves are provided.
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Elasticities Short term vs. Long Term
The short term and the long term demand curves are not identical
=> The short term and long term elasticities of demand will not be identical.
For some goods, in the short term demand curve is steep:
- Demand in the short run does not adjust if the price changes.
=> Short term elasticity of demand will be lower than the long run.
For some goods, in the short term demand curve is flat:
- Demand in the short run does adjust quickly if the price changes.
=> Short term elasticity of demand will be higher than the long run.
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Elasticities Short term vs. Long Term
Gasoline: Short-Run and Long-Run Demand Curves
Short run: increase in price has small effect on the demand.
=> Elasticity small
Long run: car owners shift to other sources of transportation, to more fuel-efficient cars, etc..
=> Elasticity large
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Demand
Elasticities Short term vs. Long Term
Automobiles: Short-Run and Long-Run Demand Curves
Short run: increase in price large effect demand. (Why?)
=> Elasticity large
Long run: owners have to buy cars.
=> Elasticity smaller
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Income Elasticity of Demand
Income elasticity of Demand is:
- For most good is positive. (Normal Goods)
- For some goods it is negative (Inferior Goods)
For most goods and services: Larger in the long run than in the short run.
- For a durable goods (car, refrigerator, etc), the opposite is true. The short-run income elasticity of demand will be much larger than the long-run elasticity.
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Supply Elasticities Short term vs. Long Term
The short term and the long term supply curves are not identical either.
=> The short term and long term elasticities of supply will not be identical.
For some goods, in the short term, supply curve is more steep
=> The supply in the short run does not adjust if the price changes.
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Supply Elasticities Short term vs. Long Term
Copper: Short-Run and Long-Run Supply Curves
The supply of primary copper, shown in part is more elastic in the long run.
When price increases, firms would like to produce more but are limited by capacity constraints in the short run.
In the longer run, they can add to capacity and produce more.
These goods can be recycled.
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Elasticities Short term vs. Long Term
Supply and Demand for Coffee
A freeze or drought in Brazil causes the supply curve to shift to the left.
Short run:
supply is completely inelastic.
Demand is relatively inelastic.
=> Sharp increase in price, from P0 to P1.
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Elasticities Short term vs. Long Term
Supply and Demand for Coffee
Intermediate run:
Supply and demand are both more elastic
=> Price falls part of the way back, to P2.
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Elasticities Short term vs. Long Term
Supply and Demand for Coffee
Long run:
Supply is extremely elastic:
=> Price returns to P0.
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UNDERSTANDING AND PREDICTING THE EFFECTS OF CHANGING MARKET CONDITIONS
Fitting Linear Supply and Demand Curves to Data
Given:
a) P* and Q*,
b) ED and ES,
Calculate c and d for the supply curve and a and b for the demand curve.
Use the curves to analyze the behavior of the market quantitatively.
Follow the numerical example
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Example
In 1998, Americans smoked 470 billion cigarettes, or 23.5 billion packs of cigarettes. The average retail price was $2 per pack. Statistical studies have shown that the price elasticity of demand is –0.4, and the price elasticity of supply is 0.5.
Find the supply and the demand assuming both are linear.
Suppose a new government policy results in a 20% reduction in demand (the quantity demanded is 80% of what it was for every value of price). What would be the equilibrium price?
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Math Review
Basic calculus: Slope of a line is the “rise over the run”.
- While for a straight line this slope is a constant number, for curves it is not.
- Calculus provides tools to find the slope for a variety of functions.
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Math Review
One variable framework:
Rules:
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Math Review
Common Derivatives:
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Math Review
Two Variable Function:
Partial Derivatives:
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Math Review
Two Variable Function (Examples)
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Math Review
Example:
The equation denoted by MRS which quantifies the slope of y with respect to x is used extensively in the Microeconomics.
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Math Review
Optimization (Max or Min):
- One variable function:
This is a Max because?
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Math Review
Optimization (Max or Min):
- Two variable function:
This is a Max because?
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Math Review
Constrained Maximization:
Define a Lagrange multiplier ( )?
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Math Review
Constrained Maximization:
Solve
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Math Review
Constrained Maximization (Example)
Construct the Lagrangian:
Solve:
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