Microeconomics

Updated: Oct 24, 2019


Market

It is the place where sellers and buyers come together to carry economic transactions.

Product market They may be physical were money and products are exchanged for money or on-line markets where products are exchanged for credit.

Factors of production There are other types of market such are factors of production (labor for example).

Financial markets

Financial markets like the foreign exchange market where international currencies are traded and stock markets where companies shares are bought and sold.


Demand

Is the quantity of a product that consumers are able and willing to purchase given a certain price and period of time. Law of demand as the price of a product rises, the quantity demanded of that product will decrease, ceteris paribus. The increase in demand (when the price is lowered) is due to two factors:


Income effect. People will have an increase in their real income which reflects the amount their income is able to purchase


Substitution effect. The change in price makes the product more attractive over other products that have their price unchanged. This two produce a movement along the existing curve whereas the following produce a shift in the curve.

Non-price determinants

Income

  • Normal goods

  • Inferior goods

The price of other goods

  • Substitutes

  • Complements

  • Unrelated goods

Taste and preference

Other factors
  • Size of the population

  • Changes in age structure

  • Changes in income distribution

  • Government changes

  • Seasonal changes

Supply


Is the willingness and ability of producers to produce a quantity of product at a given price in given period of time. Law of demand, as the price of a product rises, the quantity supplied of the product will usually increase, ceteris paribus. This occurs because at higher prices there will be more potential profits to be made and so the producer will increase output and indeed other producers may also be attracted to enter the market. Change in price produces a change in the existing curve whereas the following produce a shift in the curve.


Non-price determinants
  • Cost of factors of production.

  • The price of other products which the producer could produce instead of the existing product.

  • The state of technology.

  • Expectations of the producers.

  • Government intervention.

Equilibrium

Is where supply and demand curves meet.

A change in the determinants of either supply or demand (or both) produces a shift of the equilibrium price/quantity.


Role of price mechanism The producer can raise or lower the price of the product and see how the market react and better position their product; nothing is certain.

Market efficiency


The consumer surplus is defined as the extra satisfaction(utility) gained by a consumer from paying the price which is lower than that which they expected to pay.






The producer surplus is defined as the excess of actual earnings that a producer makes from a given quantity of output, over and above the quantity the producer would be willing to accept for that output. The total benefit to society is illustrated by the community surplus which is maximized at the equilibrium point.


Elasticities


Price elasticity of Demand (PED)

Elasticity

Measure of responsiveness: how much something changes when there is a change in one of the factors that determines it.

  • How much the quantity demanded changes due to a change in price.

Price elasticity of demand=Percentage change in quantity demanded/percentage change in price

  • Negative values are normally ignored.

  • As a businessman, you’ll need to know how customers will respond if you change the price of a product.

  • As a student, this formula will come back e.g. when we´re studying taxes and monopoly. Make sure to memorize the formulas as well.

  • PED=0 Perfectly inelastic demand

  • The change in price will have no effect at all on the quantity demanded.

  • PED=infinity Perfectly elastic demand

  • The change in price will have a great effect in quantity demanded.

Inelastic demand PED<1

The change is price is less than the change in quantity. The revenue will increase if price does so.


Elastic Demand PED>1

The price change is not as big as the change in quantity. The total revenue falls if the price is increased.


Unit elastic demand PED=1

Price change will be equal to quantity demanded change. Revenue will remain the same.

What causes a product to be elastic or inelastic?

  1. Substitute and its closeness.

  2. The necessity of the product.

  3. The time period.

Cross elasticity of demand(XED)

The change in demand of a product due to a change in price of another product.

Cross-price elasticity of demand=%change quantity demanded product1/%change price demanded product2. If XED has a positive or negative value is of a great importance. It defines the relation between the two products.

Positive value

The two goods compared are substitutes.

Close substitutes have a higher positive value.


Negative value

The two goods are complements.

Close complements have a lower negative value.

  • As a businessman, you´ll need to know what might have a impact on the demand for your products

  • If your company makes complementary products, you´ll need to know how a change in one price affects your other products.

  • As a student, we will come back to this formula.

Income elasticity of demand(YED)

The change in quantity demanded caused by a change in the consumer´s income

Income elasticity of demand= %change quantity demanded/ %change in income

If YED has a negative or positive sign is of importance.

Normally done by year.


Positive value

The product is a normal good=The more the money the more the quantity.

0 less than YED less than 1 income-inelastic demand.

1 less than YED income-elastic demand.


Negative value

The product is an inferior good=The more the money the less the quantity.

People can now afford to buy alternatives.

Price elasticity of supply(PES)

  • How much the quantity supplied changes due to a change in price.

Price elasticity of demand=%change in quantity demanded/%change in price

  • Usually a positive value. Also, extreme values are more common.

Perfectly inelastic supply PES=0

The quantity supplied will not get affected at all if the price change (it happens in the short run as an example)


Inelastic supply 0 less than PES less than 1

The change in quantity supplied is less then the change in price.

Unit elastic supply PES=1

The change in quantity supplied is just as big as the change in price.

Elastic supply 1 less than PES less than Infinity

The change in quantity supplied is bigger than the change in price.

Perfectly inelastic supply PES=infinity

The quantity supplied will change even in the change in price is small.

What causes a product to be elastic or elastic when it comes to supply?

  1. The price must rise more than the cost of producing a good.

  • Is the company using its resources well?

  • Are the factors of production mobile?

  1. The time period.

  2. The ability to store the products.

Taxes

What are they?

Direct taxes-salary, etc.

Indirect taxes-on products.

  • Excice taxes-reduce consumption-lower revenues for the company.

  • Specific taxes: the tax is fixed; if it is 1$ it will always be so no matter if the price of the product changes.

  • Ad valorem taxes: tax is a percentage.

  • Taxes on spending.

Who?

The Government receives it.

Consumers and Companies pays for it.

Why?

To discourage consumers to buy certain goods.

Pay for the services the Gov´t provides.

Income redistribution.

Consequences

  • Consumers.

  • Prices rise, real income decreases so they afford less

  • Producers.

  • Revenue decreases because they receive less money and the quantity supplied goes down

  • The Gov´t.

  • Has more money to put in to services provided

  • Workers.

  • Unemployment

  • Society.

  • Lowers consumption, generates services and wellbeing, underallocation of resources (people want to buy more and producers want to sell more), jobs are lost.

Assuming an inelastic supply.

If the PED>PES then they will buy much less because the product is very reactive to price change so the producer will pay much of the tax.

If the PED<PES the consumer will buy more or less the same amount and so the tax burden will affect the consumer the most.

Subsidies

What?

Assistance from the Gov´t(direct cash-payments, low-interest7free interest loans, tax relief, etc.)

Why?

  • Increase revenue/support.

  • Growth of particular industries in an economy.

  • Make necessities affordable for low-incomers.

  • Encourage production and consumption of certain goods and services.

  • Encourage exports.

Consequences?

  • Consumers:

  • increased real income, more consumption.

  • Producers:

  • increase revenues (produce more and receive more money).

  • Gov´t:

  • Gives away money.

  • Workers:

  • employment increases.

  • Society:

  • Over-allocation of resources Q-sb>Q-initial

Market failure


Public Goods

  • Everyone has access to it, normally provided by the Gov´t

  • Same as merit services

Private Goods

  • Only those who pay have access to it

  • Apples, bread, etc.

Common access goods

  • Fish, haunting animals, air, see water

Merit goods

  • The Gov´t thinks it will have a positive outcome to society, give subsidies

  • School, Hospitals, Sports facilities

De-merit goods

  • The Gov´t thinks it will have a bad effect on society, taxes on them

  • Drugs, high fat or sugar, violent videogames, weapons

These just describe the rules of how we treat non-human things, Ownership Laws

Excludability-how hard it is to get a good

If you have to pay for it


Non-excludable

You don’t pay such as a nice view

Rivalry-how easy it is to supply and if several people can use them at the same time

If you are using it no one else because is yours


Non-rival

Are such as highways or radio station but to a point it does become rival when too much people have it

Threats of sustainability

  1. Common access goods-risk of overexploitation

  2. The use of fossil fuels-Environmental threat

  3. Poverty-inequality in society

  4. The pursuit to economic growth-overexploitation

Negative externalities

MPC-Marginal Private Cost

MPB-Marginal Private Benefit

MSC-Marginal Social Cost

MSB-Marginal Social Benefit

An externality occurs when the actions of consumers or producers give rise or negative or positive side-effects on other people who are not part of these actions, and whose interests are not taken into consideration. (a third party gets involved)


Positive vs. Negative externalities

Arises from consumption or production


MPB AND MSB

The demand curve=MSB=MPB

MSB: refer tobenefits to society from consuming one more unit of a good.


MPC and MSC

The supply curve shows the marginal cost for the company=MPC

MSC: refers to costs to society of producing one more unit of a good

Negative externalities of production


  • An external cost created by the producer

  • The intersection of MPB and MPC will be the free market outcome

  • The intersection of MSB and MSC will be the social optimum

  • Too much is produced due to over allocation of resources

Wellfare loss

The social benefit lowes due ot misallocation

The society would be better if less is produced


GOVERNMENT REGULATIONS

  • Laws and regulations.

  • Simple and easily implemented. Everybody has to work towards better resources.

  • No distinction between different companies. Lack of information, cost money to follow. A higher over-all cost since it does not work as an incentive.

MARKET BASED POLICIES


  • Taxes.

  • Tradable permits (cap and trade schemes)

  • Previous external cost will now be paid for and by producers and consumers. Might lead to a better use of resources.

  • Different production methods and pollutants>difficulties. How do we measure the harm? Where should we put the cap and bow do we make it fair?

Normally the government has little knowledge of the consequences and so it might have side-effect.


Negative Externalities of Consumption

  • An external cost caused by a consumer. Examples: alcohol, smoking, etc.

  • The social optimum is where the MSC and the MSB intersect with each other. The free market creates an equilibrium where MSC/MPC/S and MPB meets.

  • Too much is consumed and produced compared to the social optimum. An over allocation of resources to the production of that particular good arises.

Avoiding negative consumption externalities

GOVERNMENT REGULATIONS

Laws and regulations

Can be very effective


ADVERTISING

A try to make consumers buy less of harmful goods and thereby decrease the demand

Easier than market based policies

Costs for the campaign will it be effective enough?


MARKET BASED

Negative externalities from production

An external benefit created by the producers.

MPC-MSC=external benefits.

Under-allocation of resources.

What can the government do to correct it

Direct Government provision

  • The Government shows a direct interest in developing the industry by payment(taxes)

  • The MPC curve will move towards the MSC curve

+Increased supply, lower price

-Comes from taxes, difficult to measure the positive external benefit and be fair.

Subsidies

  • Correcting a market failure>more efficient allocation.

  • The MPC will decrease>shift to the right.

+increased supply, lower price.

-comes from taxes, difficult to measure the positive externalities.

Positive externalities of consumption

  • An external benefit created by the consumer.

  • SB-MPB=external benefit.

  • Under-allocation of resources.

What can the Government do to correct the externalities of cosumption

Legislation

  • In order to promote a higher consumption

  • The demand will increase and shift to the right

+Very effective under certain circumstances

-difficult to measure the positive external benefits


Advertising

  • Persuade the consumers to buy more of certain good

  • Increased demand and shift to the right

+Very effective under certain circumstances

-Difficult to measure the positive external benefits. Higher price.


Direct Government Provision

  • Of such great importance that the Government cannot provide them

  • Increase the supply the new supply must intersect the MPB curve at Qopt

Subsidies

  • Increase the supply

Cost, revenues and profit

Law of dimishing returns

Extra units of variable factors added to a fixed factor

output from each variable unit of variable factor will decrease. E.g. adding 323 workers to a 12m2 restaurant

average output will diminish.


Economic Cost

Explicit costs -Factors that are purchased from others. E.g. hur mycket faar jag men dessa pengar.

Implicit costs –Factors that are owned by the company. E.g. jag kunde uthyra det

  • Marginal

  • Average

  • Total

  • Fixed

  • Variable

Short run

Period of time in which at least one factor of production is fixed. All production takes place in the short run.

The length of the short run depends on how much time it takes the firm to increase the quantity of the fixed factor.


Long run

Period of time in which all factors of production are variable, but the state of technology is fixed. All planning occurs in the long run.

As soon as the factors are changed the firm is once again in the short run.

#microeconomics #market #marketfailure #demand #priceelasticityofdemand #PED #Incomeelasticityofdemand #YED #Daniel #DanielMoreraTrettin


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