Microeconomics = the branch of economics that studies the specific choices made by consumers and
producers. It relies on theories and models to study the choices made by individuals and firms.
Goal of models is to predict or explain changes.
➢ Microeconomics can be divided into two areas:
1. Analyzing the behavior of individuals and firms: “How to allocate scarce resources”.
2. Explaining market structures and price setting (monopoly, complete competition, oligopoly,
cartel).
➢ Microeconomics uses models based on ‘rationality’.
➢ Models are expressed by mathematical formulas.
Advantage: unambiguous (ondubbelzinnig, niet open voor meerdere interpretaties).
Disadvantage: limited, complex.
➢ Model is "locally" valid.
What is an economic model?
- Model is a simplified representation of real life
- Trade-off between applicability and manageability (afweging tussen toepasbaarheid en
beheersbaarheid)
Example 1: Minister of Social Affairs wants to know the effect of increasing the
minimum wage of unemployment.
- A minimum wage increase increases wages, which causes that more people want to
work.
- For firm’s labor costs increase, which causes that they hire fewer people.
- The unemployment rate increases.
- But employed people have more income which they can use to consume (demand
for products of firms).
- Unemployed workers are more active in job search when gap between wages and
benefits increases.
Example 2: Firms have the impression that sickness absenteeism of workers is sometimes longer than necessary.
- Sick workers continue to receive salary.
- Expensive for firms.
- No incentive to start working soon.
- Firms require a certificate from doctors confirming their sickness.
Model prediction is that requirement of doctor’s certificate reduces the length of sickness absenteeism.
Swedish experiment (see graph in pp):
Born on even day: doctor’s certificate on 15e day (treatment group).
Born of odd day: doctor’s certificate on 8e day (control group).
, Chapter 2 - Supply & Demand
Market equilibrium = demand equals supply
Supply depends on:
- Production technology
- Costs of inputs
- Market price
Supply curves shift when suppliers are willing to sell more of less of their product for any price. For
example, a farmer can harvest quicker with his new machine and is willing to sell 10kg of tomatoes
for $1 instead of 8kg for $1 → producers supply more tomatoes at any price. Similarly, if there is a
drought, it will cost more to irrigate the fields and producers want to supply less tomatoes at any
given price.
Demand depends on:
- Preferences of consumers
- Income of consumers
- Market price
- Price of other goods
Demand curves shift when consumers want to buy less or more of a product at any price. For
example, tomatoes cure cancer → people buy more tomatoes, even at a higher price. Or when
tomatoes are a source of salmonella → people buy less tomatoes even at a lower price.
The concept of elasticity expresses the responsiveness of one value to change in another. An
elasticity relates the percentage in one value to the percentage change in another. For example, we
refer to the price elasticity of demand: the percentage change in quantity demanded resulting from a
given percentage change in price.
Elasticity sounds a lot like the slope of a demand curve, what’s different? Elasticity is better because:
- Slopes depend on the units of measurement, not percentages.
- You can’t compare slopes across different products.
Price elasticity (demanded or supplied) = (% change in quantity) / (% change in price)
Elasticity = 0 → Perfectly inelastic, there is no change in quantity for any change in price.
Elasticity < 1 → Inelastic, large changes in price produce only modest changes in the quantity.
Elasticity = 1 → Unit elastic, a change in price will cause an equal proportional change in quantity.
Elasticity > 1 → Elastic, small changes in price product big changes in quantity (Coca Cola/Pepsi).
Elasticity = infinite → Perfectly elastic, any change of price leads to an infinite change in quantity.
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