Microeconomics: deals with the behavior of individual economic units. (any individual
or entity that plays a role in the functioning of our economy)
- allocation of scarce resources
- optimal trade
- role of prices
- theory of firm; firms try to maximize their profit
methodological individualism: Economics tries to explain phenomena on a collective
level, for methodological reasons we descend to the level of the relevant individual
actor. We try to explain the behaviour of this individual actor. Eventually, we aggregate,
because the problem we try to explain is on the collective level.
Market: A market is a collection of buyers and sellers that, through their actual or
potential interactions, determine the price of a product or of products.
Industry: a collection of firms that sell the same or closely related products
Rational choice theory = Goals (what you want), Restrictions (limited resources),
Behaviour (end of our choice process)
Demand curve: curve answering the question “what will be the amount demanded at
different price levels” (quantity demanded is a function of price)
Demand is derived from:
- preferences (needs)
- income (→ effective demand (“koopkrachtige vraag”))
- other factors (incl. the prices of other goods)
Supply curve: curve answering the question “what will be the amount supplied at
different price levels”
Supply is derived from:
- technology
- input costs
- government regulation
ceteris paribus: assuming all other factors stay constant
Arbitrage: practice of buying at a low price and selling at a high price
Chapter 2 – The basics of Supply and Demand
Market mechanism: without government intervention, supply and demand will come
into equilibrium to determine the market price and the total quantity produced.
Tendency in a free market for price to change until the market is in equilibrium.
,Supply curve: quantity of a good that producers are willing to sell at a given price.
(relationship between the quantity supplied and the price)
Depends on price and production costs (wages, interest, inputs, tax).
- Movements along the supply curve = response of quantity supplied to changes in
price.
- Shift of the curve itself = response of supply to changes in other variables.
Demand curve: how much of a good consumers are willing to buy at a given price.
(relationship between quantity demanded and price)
- Change in the demand = shift of the demand curve due to changes in other
variables
- Change in the quantity demanded = movement along the curve, due to change in
price
Subsitutes: goods for which an increase in the price of one leads to an increase in the
quantity demanded of the other. (vervangbaar) (highly price elastic)
Compliments: goods for which an increase in the price of one leads to a decrease in the
quantity demanded of the other. (vullen elkaar aan) (price inelastic)
Equilibrium price = market-clearing price: Evenwichtsprijs tussen vraag en aanbod.
If:
Supply curve shifts to the right > total quantity produced increases > market price drops
Demand curve shifts to the right > total demand increases > market price increases
Both curves shift to the right > new equilibrium price
Elasticity: sensitivity of one variable to another
Price elasticity of demand: (%ΔQ)/(%ΔP) (of nieuw-oud/oudx100)
Must be measured at a particular point on the demand curve. (point vs. arc elasticities)
- the steeper the slope, the less elastic is demand
-1/1 = Elastic
0 = Inelastic
Elastic demand: the quantity demanded is relatively responsive to changes is price
-> total expenditure on the product decreases as the price goes up
Inelastic demand: the quantity demanded is relatively unresponsive to changes is price
-> total expenditure on the product increases when the price increases
Isoelastic demand: when the price elasticity of demand is constant all along the demand
curve.
Ep = price elasticity of demand = % Δ QD
%ΔP
, a. Ep = 0 / (-1) = 0 → inelastic demand (P↓ → R↓)
b. Ep = +1 / (-1) = -1 (P↓ → R equal)
c. Ep = 2 / (-1) = -2 → elastic demand (P↓ → R↑)
NB Always use the value of an elasticity including the sign.
Infinitely elastic demand: consumers will buy as much as they can at only one price.
(horizontal demand curve)
Completely inelastic demand: consumers will buy a fixed quantity, no matter what the
price is. (vertical demand curve)
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 for a
good that results from a 1 percent increase in the price of another good.
- positive = substitutes
- negative = complements
Price elasticity of supply: percentage change in the quantity supplied resulting from a 1
percent increase in price.
Arc elasticity of demand: the elasticity calculated over a range of prices. (use the average
price and average quantity)
Income and price elasticity of demand is much higher in the long run than in the short
run, it takes time for people to change their consumption habits.
opposite is true for durable goods (higher in the short run)
cyclical industries: durable goods industries, fluctuate sharply in response to short-run
income changes.
Elasticity of supply is higher in de long-run than in the short-run supply. Firms face
capacity constraints in the short-run and need time to expand their capacity.
(Most firms can find ways to increase output in the short-run, but for some goods and
services, short-run supply is completely inelastic)
durable goods (and recyclable goods) are more elastic in the short-run
Chapter 3 – Consumer behavior
Theory of consumer behavior: explanation of how consumers allocate incomes to the
purchase of different goods and services
- consumer preferences
- budget constraints
- consumer choices
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