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Summary of the book 'microeconomics' by Pindyck & Rubinfeld
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A complete summary of the book Microeconomics for the current course microeconomics.
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Exam (elaborations) BEC 3101 Microeconomics
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Summary Principles of Microeconomics
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MicroeconomicsChapter 1 Preliminaries
Microeconomics deals with the behaviour of individual economic units. Microeconomics is about
limits and ways to make the most of these limits, it´s about the allocation of scarce resources.
Microeconomics describe the trade-offs that consumers, workers and firms face and shows how
these trade-offs are best made. Consumer have limited incomes, which can be spent on a variety of
goods or saved for the future. Workers must decide where and when to enter the workforce, they
face trade-offs in their choice of employment and workers must sometimes decide how many hours
per week they wish to work, thereby trading off labour for leisure. Firms face trade limits in the
production. Microeconomics is also about prices. A market is a collection of buyers and sellers that
together determine the price of a good. In (micro)economics, explanation and prediction are based
on theories. Microeconomics is concerned with both positive and normative questions.
Positive analysis = Analysis describing relationships of cause and effect.
Normative analysis = Analysis examining questions of what ought to be. It’s often supplemented by
value judgments.
Market = Collection of buyers and sellers that through their actual or potential interactions,
determine the price of a product or set of products.
An industry is not the same as a market, an industry is the supply side of a market. Potential
interactions are just important as the actual ones, they can both influence the price.
Market definition = Determination of the buyers, sellers and range of products that should be
included in a particular market.
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 significant impact on the price. It’s uniform product, there are no
entry or exit barriers and the information is clear.
Market price = Price prevailing in a competitive market.
Market definition identifies which buyers and sellers should be included in a given market, to
determine which buyers and sellers to include, we must determine the extent of a market,
boundaries of a market, both geographical and in terms of range of products produced and sold
within it. Market definition is important for two reasons:
A company must understand who its competitors are for the various products (in the future) and
what the boundaries are.
Market definition can be important for public policy decisions.
Chapter 2 The Basics of Supply and Demand
The supply-demand model combines the supply curve and a demand curve. The supply curve is the
relationship between the quantity of a good that producers are willing to sell and the price of the
good. The equation is: Qs = Qs(P).The curve is slope upward, the higher the price, the more that firms
are able and willing to produce and sell. The quantity that producers are willing to sell also depends
on production costs, wages, interest chargers and more. Economics use often the phrase change in
supply to refer to shifts in the supply curve, while reserving the phrase change in the quantity
supplied to apply to movements along the supply curve. The demand curve is a relationship between
the quantity of a good that consumers are willing to buy and the price of the good. The equation is:
Qd = Qd(P). The demand curve slopes downward. Incomes affect the quantity that consumers are
willing to buy. We will use the phrase change in demand to refer to shifts in the demand curve and
reserve the phrase change in the quantity demand to apply to movements along 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 of the other.
The two curves intersect at the equilibrium/market-clearing price. The market mechanism is the
tendency in a free market for price to change until the market clears.
Surplus = situation in which the quantity supplied exceeds the quantity demanded.
Shortage = situation in which the quantity demanded exceeds the quantity supplied.
An elasticity, percentage change in one variable resulting from a 1-percent increase in another,
measures the sensitivity of one variable to another. The price elasticity of demand is:
or
If the elasticity is greater than 1 in magnitude (EP > |1|), the demand is price elastic, if the price
elasticity is less than 1 in magnitude (EP < |1|), the demand is price inelastic. The price elasticity must
be measured at a particular point on the demand curve and will generally change as we move along
the curve (point elasticity of demand). The infinitely elastic demand is the principle that consumers
will buy 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.
The completely inelastic demand is the principle that consumers will buy a fixed quantity of a good
regardless of its price. Other demand elasticity’s are:
Income elasticity of demand = percentage change in the quantity demanded resulting from a 1-
percent increase in income: .
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: . If this elasticity
is positive, the two goods are substitutes and when the elasticity is negative, the goods are
complements. _
Arc elasticity of demand = price elasticity calculated over a range of prices:
The price elasticity of supply is the percentage change in quantity supplied resulting from a 1-percent
increase in price.
It‘s important to be clear about how much time is allowed to pass before we measure the changers
in the quantity demanded or supplied. Demand is much more price elastic in the long run than in the
short run. But not all products, automobiles, televisions and refrigerators for example are durable,
the total stock of each good owned by consumers is large relative to annual production.
Cyclical industries = industries in which sales tend to magnify cyclical changes in gross domestic
product (GDP) and national income.
Elasticity’s of supply also differ from the long run to the short run. For most products, long-run is
much more price elastic than short-run supply: firms face capacity constraints in the short run and
need time to expand capacity by building new production facilities and hiring workers to staff them.
For some goods, supply is more elastic in the short run than in the long run, such goods are durable
and can be recycled as part of supply if price goes up. An example is the secondary supply of metals.
Chapter 3 Consumer Behaviour
Consumer behaviour is best understood in three steps: consumer preferences, budget constraints
and consumer choices. Consumers do not always make purchasing decisions rationally. Behavioural
economics is a model of consumer behaviour that is more realistic about rationality and decision
making.
, Consumer preferences:
A market basket/bundle is a list with specific quantities of one or more goods. The theory of
consumer behaviour is about with basket a consumer prefer. Three basic assumptions about
people’s preferences are:
Completeness: preferences are assumed to be complete. A consumer prefer basket A to B, will
be prefer B to A or will be indifferent between the two.
Transitivity: if a consumer prefers A to B and B to C, then the consumer also prefers A to C.
More is better than less.
An indifference curve represents all combinations of market baskets that provide a consumer with
the same level of satisfaction. Any market basket lying above and to the right of an indifference curve
is preferred to any market basket on that indifference curve. To describe a person’s preferences for
all combinations of, for example food and clothing, we can graph a set of indifference curves called
an indifference map. Each indifference curve shows the market basket among with the person is
indifferent. Indifference curves can’t intersect and there are an infinite number of curves. The fact
that indifference curves slope downward follows directly from the assumption that more of a good is
better than less. The Marginal Rate of Substitution (MRS) is the maximum amount of a good that a
consumer is willing to give up in order to obtain one additional unit of another good. The MRS
measures the value that the individual places on one extra unit of a good in terms of another. The
MRS falls as we move down the indifference curve, this reflects an important characteristic of
consumer preferences. An possible fourth assumption is:
Diminishing MRS: an indifference curve is convex if the MRS diminishes along the curve.
Consumers prefer balanced market baskets.
Two extreme cases are perfect substitutes and perfect complements. Perfect substitutes are two
goods for which the MRS of one for the other is constant. Perfect complements are two goods for
which the MRS is zero or infinite: the indifference curves are shaped as right angles. A bad is a good
for which less is preferred rather than more, for example trash. In this case: we redefine the product
under study so that consumer tastes are represented as a preference for less of the bad. It is often
useful to assign numerical values to individual baskets, the concept is known as utility. Utility is the
numerical score representing the satisfaction that a consumer gets from a given basket. A utility
function is a formula that assigns a level of utility to each market basket. The utility function is
simply a way of ranking different market baskets: the magnitude of the utility difference between
any two baskets does not really tell us anything. It’s an alternative of indifference curves. If a utility
function is u(F,C) = FC, we can draw a graph where every utility is the same, for example F = 5 and C =
5, F = 10 and C = 2,5 and F = 2,5 and C = 10. An ordinal utility function is a function utility function
that generates a ranking of market baskets in order of most to least preferred. It does not indicate
how much one if preferred to another and interpersonal comparisons of utility are impossible. A
cardinal utility function is a utility function describing by how much one market basket is preferred to
another. Unfortunately, we can’t measure satisfaction.
Budget constraints:
Budget constraints are constraints that consumers face as a result of limited incomes. The budget
line indicates all combinations of, for example, food and clothing for which the total amount of
money spent is equal to income, so PfF + PcC = I. A budget line is linear line. The slope of the budget
line, -(Pf/Pc), is the negative ratio of the prices of the two goods. A change in income alters the
vertical intercept of the budget line, but does not change the slope, because the price of neither
good changed. If income rises, the budget line shifts outward. If a price of one good changes, the
slope of the line changes as well. A consumer can buy more or less. A consumer’s purchasing power
is her ability to generate utility through the purchase of goods and services.
Consumer choice:
With given preferences and budget constraints, we can determine how individual consumers choose
how much of each good to buy, we assume that consumers make this choice in a rational way. They
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