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Summary Introduction to Microeconomics
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Summary Introduction to Microeconomics. Prof: Bruno Heydels, Stijn van Puyvelde
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Business Economics Bachelor 1: Introduction to microeconomicsIntroduction to microeconomics
1. Definition
Economics is the science which studies human behaviour as a relationship between ends and scarce means
that have alternative uses.
Economic activity -> how much buying and selling goes on in economy over period of time.
Land -> natural resources of earth, labour -> human effort (mental/physical) that goes in production. Capital
-> equipment/structure to produce goods/services.
Conflict -> Scarce resources = limited nature society’s resources (Labour, kapital, land) <-> unlimited wants.
Make choices!
Microeconomics -> How people make decisions, how they interact. Studies the way in which
households/firms make decisions, how they interact in markets. Macroeconomics -> How economy as a
whole works, economic reality (inflation, economic growth, unemployment).
2. M & T principles
1. People face trade-offs -> make choices, you can’t do 2 things at the same time -> compare marginal benefits
(= additional satisfaction costumer receives when good/service is purchases) <-> marginal costs (= change in
production cost when making extra unit). The loss of benefits from a decision <-> benefits occurred from
choice made.
Equity -> property of distributing economic prosperity fairly among members society.
2. The cost of something is what you give up to get it
- Opportunity cost -> what you have to give up ( explicit + implicit cost)
- Explicit cost -> amount of money that you pay if you choose x
- Implicit cost -> value of best alternative that you forgo.
3. Rational people think at the margin -> you decide at the moment ex. You attend this class, but don’t know if
you’re gonna attend the next one.
4. People respond to incentives -> Rational actors change their behaviour if costs and/or benefits change.
5. Trade can make everyone better off -> every country can specialize in what they are best at and with that
income they can trade with other country’s who specialize -> improve standard of living as a result.
6. Markets are usually a good way to organize economic activity -> market economy = economy addresses the
3 key questions of economic problem are addressed through decisions of many firms. Planned economic
systems = economic activity organised by central planners who decided answers to economic questions.
7. Governments can sometimes improve market outcomes -> for the promotion of efficiency and equality. They
can improve market outcomes. Most useful when there’s a market failure.
3. Market & market structure
Market -> group of buyers (demand )/sellers (supply ) of a particular good/service.
Competitive market -> many buyers/sellers -> each negligible impact on market price.
Monopoly -> 1 firm, price setter. Model does not exist -> Most “monopolies” don’t dominate entire global
industry but major assents in 1 country.
Oligopoly -> few firms, homogeneous (= exactly the same with every supplier)/heterogeneous (= differs with
every supplier ) products.
Monopolistic competition -> many firms/ heterogeneous products
Perfection competition -> many buyers & sellers, perfect information, homogeneous goods, price takers
(price set by market), buyers & sellers act independently, buyers & sellers consider all costs & benefits.
Model does not exist -> products are never fully identical, theoretical model.
4. Demand
Individual demand = how much a consumer is willing (and able) to buy at different prices <-> Inverse
Demand = how much consumer is willing to pay (per unit) for different qD. Demand equation -> p = a – b.
qD.
- Higher p -> 2 effects Income effect: purchasing power falls -> qD falls. Substitution effect: Good
becomes less attractive compared to alternatives -> qD falls. Law of demand: qD falls as price increases.
Market demand = how much all consumers are willing (and able) to buy at different prices. qD = f ( p ) ->
how many goods (qD) consumers are willing to buy at given p <-> inverse market demand: p = f (qD ) -> what
price are consumers willing to pay for given qD
- Market Demand is obtained through horizontal summation of individual Demand curves.
, - Market demand curve: Gives the quantity demanded at different prices assuming that other factors that
affect Demand are constant -> ceteris paribus.
- Market demand -> (qD)n = f (Pn , P1 , P2 , …, Pn-1 , Y, T, PLS, A, E) -> P1,P2 = prices of other goods, Y =
income, T= tastes/preferences (if you like milk -> you buy more of it) , PLS= level/structure population,
A= advertising, E= expectations <-> inverse market demand -> (qD)n = f (Pn , given [P1 , P2 , …, Pn-1 , Y,
T, PLS, A, E])
Change in Pn change in quantity demanded qD-> movement along demand curve
Change in other determent of D -> change in demand -> movement of demand curve
- Changes in prices of other goods: ex. P of coffee -> (qD)n sugar = complements/ (qD)n thee =
substitutes
- Consumers income: ex. Y -> (qD)n appels = normal goods/ (qD)n spaghetti = inferior goods.
- Expectations costumers -> expectations affect demand for good/service ex. If price milk will rise next
month -> costumers will buy more milk at todays price.
- Size/structure population -> higher the population -> higher the demand
5. Supply
Individual supply = how much units a producer is willing to sell at different prices. Supply equation: p = a +
b.qS
Market supply = how much all producers are willing to sell at different prices -> qS = f ( p ) = how much qS is
supplies as a function of p. <-> inverse supply function p= f( qS)
- Market supply is obtained by horizontal summation of the individual supply curves
- Law of supply: quantity supplied increases as p
- Market supply curve: Considers the quantity supplied at different prices … assuming that other factors
that affect supply are constant -> ceteris paribus.
- Market supply -> (qS )n = f (Pn , P1 , ..,Pn-1 , H, N/S, F1 ,F2 , ..,Fm ,E , Sq ) -> P1, P2: profitability other
goods, H: technology, N/S= natural shocks, social events, Fi: Cost factors of production, Sq= number of
suppliers, E= expectations <-> inverse market supply -> (qS )n = f (Pn , given [P1 , ..,Pn-1 , H, N/S,
F1 ,F2 , ..,Fm ,E , Sq ])
Change in Pn -> change in quantity supplied qS -> movement along supply curve
Change in other determent of qS -> movement of supply curve
- change in profitability other goods ex. P wooden toys -> (qS)n wooden chairs or P lamb ->
(qS)n wool = goods in joint supply
- Advances in Technology increase productivity -> more produced with fewer factor inputs. Ex.
Fertilizers/milking parlours -> increase milk yield/cow.
- Social/natural facors -> weather affecting crops, natural disasters
- Input prices: prices of factor of production -> ex. When the price of fertilizer, feed, farm building ->
producing milk less profitable for farmers.
6. Market equilibrium
Point where consumers/producers are happy. q* = qD = qS
Situation where price is such that quantity demanded equals quantity supplied -> how many good will be on
the market and at what price? Demand gives what consumers want/ supply what producers want.
Law of demand and supply: Price adjusts until quantity demanded and quantity supplied are equal.
Disequilibrium = equilibrium disturbed if demand/supply curves move. Quantity supplied not equal to
quantity demanded -> Surplus & Shortage
Prices as signal: allocate resources -> buyers: Price tells them how much they have to give up to obtain a
good or service. Sellers: Price tells them what they can obtain if they produce a good or service
Rising prices in a competitive market -> for sellers -> shortage, signal to expand production because they
know that they will be able to sell what they produce, For buyers -> trade-off , they decide the value of the
benefits.
Introduction to micro economics: Elasticity and its applications
1. Elasticity of demand: definition and size
Elasticity measures how “sensitive” one variable is to changes in another variable.
Price-elasticity of demand: How much quantity demanded q changes following a change in p.
Almost always a negative number.
, Size -> from 0 to - ∞ -1 = unit elasticity, -1 -> - ∞ = elastic( qD changes more than proportionally when its
price increases, - 1 -> 0 = inelastic (qD changes very little when price fluctuates)
TR = p * q
Business decisions making and price elasticity for business that aren’t price takers -> understanding of
price elastic of demand -> important in decision making. Inverse reaction between price and demand. Ex. ->
if demand is price inelastic -> increase in price -> increase in total expenditure -> quantity falls -> fall in Q is
smaller than rise in P. or if demand is price elastic -> increase in price -> decrease in total expenditure -
>quantity falls -> fall in Q is greater than rise in P.
2. General rule
When demand is price inelastic, price and total expenditure move in same direction.
When demand is price elastic, price and total expenditure move in opposite directions
If demand is unit price elastic, total expenditure remains constant when price changes.
3. Price-elasticity of demand: determinants
- Reasons why the prices of products change.
Availability of substitutes goods with close substitutes have more elastic demand -> easier for
consumers to switch from that good to others. ex. Eggs don’t have good substitutes, demand inelastic/
butter has a good substitute -> elastic.
Time horizon Goods have more price elastic demand over longer time horizons
Necessities vs. Luxury goods Necessities have price inelastic demands, luxuries have price elastic
demands. Ex. -> When the price of gas/electricity rises -> people will reduce demand a little but still need
warm houses or When the price of boats rises -> the quantity demanded falls substantially.
Definition market elasticity market depends on how we draw boundaries of the market. Narrowly defined
markets -> more price elastic demand than broadly defined markets -> easier to find substitutes to Narrowly
defined markets. Ex. -> Food -> price inelastic -> no good substitutes or Vanilla ice cream -> price elastic ->
very close substitutes.
Share of income The higher the proportion of income devoted to the product the greater the price
elasticity is likely to be.
4. Price-elasticity: calculate and Arc elasticity – midpoint method
Calculate price-elasticity of demand would differ depending on the “starting point”. Need for
method/convention to avoid this
Arc Elasticity elasticity midpoint method ->
5. Price-elasticity: point elasticity
Δ 𝑄 = 𝑄2 − 𝑄1 / Δ 𝑃 = 𝑃2 − 𝑃1.
In point -> -> ->
6. Price-elasticity: shapes of the demand curve
, Rule of Thumb -> Flatter demand curve -> more price elastic demand (absolute value of price elasticity is
larger) for given p & q.
The rule of thumb only applies if both the scales of the graph and prices are identical. An identical slope ->
different elasticity if scale and or price differ!
Different scale: midpoint method/ Different price: Point elasticity -> For a linear D function elasticity ranges
between 0 en -∞
7. Price-elasticity: Linear demand
Linear demand -> relation between elasticity and total revenue (TR) -> TR = p . q
Midpoint method. An increase in price leads to an increase in TR if demand is p-inelastic; it leads to a
decrease in TR if demand is p-elastic. An increase in q leads to an increase in TR if demand is p-elastic; it leads
to a decrease in TR if demand is p-inelastic
Graphics ppt p8
8. Income-elasticity and Cross-price- elasticity of demand
Income- elasticity definition -> How much quantity demanded q changes following a change in Y.
- q,y < 0 = inferior goods ( higher income -> lowers quantity demanded) -> negative income elasticities or q,y ≥
0 = Normal goods( higher income -> raises quantity demanded) -> positive income elasticities -> 0 ≤ .. < 1 =
necessary goods and ≥ 1 = luxury goods;
Cross-price-elasticity definition -> How much quantity demanded q1 changes following a change in price p2
(price of a different good):
- q,p2 > 0 = Substitutes ( cross-price elasticity is positive) or q,p2 < 0 = complements ( cross-price elasticity is
negative).
9. Price-elasticity of supply: Definition/magnitude
How much quantity supplied q changes following a change in p
TR = P X Q. If supply is price inelastic -> increase in p -> increase in TR. If supply is price elastic -> increase in p
-> larger than proportionate increase in supply -> large increase in TR.
10. Price-elasticity of supply: determinants
- Price elasticity of supply depends on flexibility of sellers to change the amount of the good they produce in
response to changes in price. Ex. Seafront property -> price inelastic supply -> difficult to produce more
quickly -> supply is not sensitive to changes in price or books have high price elasticity -> easy to produce
more quickly -> Supply is sensitive to changes in price.
Time supply is more price elastic in the long run ( over longer periods, firms can build new factories,
employ new staff, buy more capital and equipment ) than in the short run ( firms cannot easily change the
size of factories or productive capacity to make more or less of a good.
Production capacity utilization if firms operate near full capacity -> supply price inelastic but if firm
operate below full capacity -> supply price elastic. How they use capacity depends on state of economy.
Size Firm/industry supply more price elastic in smaller firms and supply more price inelastic in larger
firms. Ex. A small furniture man -> when demand rises -> able to but raw materials to meet increase in
demand -> unit cost material won’t increase substantially or a steel manufacturer -> when demand rises ->
increases purchase of raw materials -> buying large quantities drive up unit price.
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