An assignment on

WEST BENGAL UNIVERSITY OF ANIMAL AND FISHERY SCIENCES

Submitted To:

Miss Arundhoti Sanyal Dept. of FES

CONTENTS

Micro Economics, theory of Demand, Supply and Market Equilibrium

FES-213

SUBMITTED BY:

ASIK IKBALFS-06/13

1) Introduction.2) What is Microeconomics?3) Assumptions and definitions.4) Microeconomics topics.5) What is applied microeconomics?6) What is Behavioral economics?7) What is Demand and Supply?8) Demand - Definition, Factor affecting

demand, Law of demand, Market demand, Exception to the law of demand, Elasticity of demand, Measurement of elasticity of demand, Special cases.

9) Supply- Definition, Quantity Supply, Law of Supply, Measurement of elasticity of supply.

10) Market Equilibrium.11) Conclusion.12) References.

Introduction: Economics is the study of the ALLOCATION of SCARCE Resources to meet UNLIMITED human wants. In the year 1976 Sir Adam Smith used the term ‘economic’ in his book ‘The Wealth of Nation’. He called ‘Father of economics’. Microeconomics is concerned with decision-making by individualeconomic agents such as firms and consumers. (Subject matter of thiscourse). Macroeconomics is concerned with the aggregate performance of the entire economic system. (Subject matter of the following course). Empirical economics relies upon facts to present a description of economic activity. Economic theory relies upon principles to analyse

behaviour of economic agents. Inductive logic creates principles from observation. Deductive logic hypothesis is formulated and tested.

Usefulness of economics -Economics provides an objective mode of analysis, with rigorous models that are predictive of human behaviour.a. Scientific approachb. Rational choiceAssumptions in Economics -Economic models of human behaviour are built upon assumptions; or simplifications that permit rigorous analysis of real world events, without irrelevant complications.a. model building b. simplifications:1. ceteris paribus - means all other things equal.2. There are problems with abstractions, based on assumptions.Too often, the models built are inconsistent with observed reality - therefore they are faulty and require modification. When a model is so complex that it cannot be easily communicated or its implications easily understood - it is less useful.a. POSITIVE economics is concerned with description of facts, circumstances, relationship with economy etc.b. NORMATIVE economics is concerned with what should be.

MicroeconomicsMicroeconomics (from Greek prefix mikro- meaning "small") is a branch of economics that studies the behavior of individuals and small impacting organizations in making decisions on the allocation of limited resources (see scarcity).Typically, it applies to markets where goods or services are bought and sold. Microeconomics examines how these decisions and behaviors affect the supply and demand for goods and services, which determines prices, and how prices, in turn, determine the quantity supplied and quantity demanded of goods and services. Mainly microeconomics deals with the analysis of individual economic units

such as consumers, firms, groups of individual units such as industries and markets.

This is in contrast to macroeconomics, which involves the "sum total of economic activity, dealing with the issues of growth, inflation, and unemployment." Microeconomics also deals with the effects of national economic policies (such as changing taxation levels) on the aforementioned aspects of the economy. Particularly in the wake of the Lucas critique, much of modern macroeconomic theory has been built upon 'micro foundations'—i.e. based upon basic assumptions about micro-level behavior.

Assumptions and definitionsThe fundamentals of Microeconomics lies in the analysis of the preference relations. Preference relations are defined simply to be a set of different choices that an actor can choose (a k-cell metric space) that actors can also compare between any two bundles of choices (completeness of the relationship.) In order to analyze the problem further, the assumption of transitivity is added to the mix. These two assumptions of completeness and transitivity that are imposed upon the preference relations are what is termed rationality. Microeconomic analysis are conducted mainly through imposition of additional constraints on the preference relations or even relaxation of the above stated assumptions (most often transitivity) although such relaxation makes the problem much harder to analyze.

Microeconomic topicsThe study of microeconomics involves several "key" areas:

Demand, supply, and equilibrium

Supply and demand is an economic model of price determination in a market. It concludes that in a competitive market, the unit price for a particular good will vary until it settles at a point where the quantity demanded by consumers will equal the quantity supplied by producers resulting in an economic equilibrium for price and quantity.

Measurement of elasticities

Elasticity is the measurement of how responsive an economic variable is to a change in another variable. Elasticity can be quantified as the ratio of the percentage change in one variable to the percentage change in another variable, when the latter variable has a causal influence on the former. It is a tool for measuring the responsiveness of a variable, or of the function that determines it, to changes in causative variables in a unit less way. Frequently used elasticities include price elasticity of demand, price elasticity of supply, income elasticity of demand, elasticity of substitution between factors of production and elasticity of intertemporal substitution.

Consumer demand theory

Consumer demand theory relates preferences for the consumption of both goods and services to the consumption expenditures; ultimately, this relationship between preferences and consumption expenditures is used to relate preferences to consumer demand curves. The link between personal preferences, consumption and the demand curve is one of the most closely studied relations in economics. It is a way of analyzing how consumers may achieve equilibrium between preferences and expenditures by maximizing utility subject to consumer budget constraints.

Theory of production

Production theory is the study of production, or the economic process of converting inputs into outputs. Production uses resources to create a good or service that is suitable for use, gift-giving in a gift economy, or exchange in a market economy. This can include manufacturing, storing, shipping, and packaging. Some economists define production broadly as all economic activity other than consumption. They see every commercial activity other than the final purchase as some form of production.

Costs of production

The cost-of-production theory of value is the price of an object or condition is determined by the sum of the cost of the resources that went into making it. The cost can comprise any of the factors of production: labor, capital, land. Technology can be viewed either as a form of fixed capital (ex: plant) or circulating capital (ex: intermediate goods).

Perfect competition

Perfect competition describes markets such that no participants are large enough to have the market power to set the price of a homogeneous product. An example is EBay.

Perfect monopoly

A monopoly (from Greek monos μόνος (alone or single) + polein πωλεῖν (to sell)) exists when a single company is the only supplier of a particular commodity.

Oligopoly

An oligopoly is a market form in which a market or industry is dominated by a small number of sellers (oligopolists). Oligopolies can result from various forms of collusion which reduce competition and lead to higher costs for consumers.

Market structure

The market structure can have several types of interacting market systems. Different forms of markets is a feature of capitalism and advocates of socialism often criticize markets and aim to substitute markets with economic planning to varying degrees. Competition is the regulatory mechanism of the market system.

Monopolistic competition, also called competitive market, where there is a large number of firms, each having a small proportion of the market share and slightly differentiated products.

Oligopoly, in which a market is run by a small number of firms that together control the majority of the market share.

Duopoly, a special case of an oligopoly with two firms.

Monopsony, when there is only one buyer in a market.

Oligopsony, a market where many sellers can be present but meet only a few buyers.

Monopoly, where there is only one provider of a product or service.

Natural monopoly, a monopoly in which economies of scale cause efficiency to increase continuously with the size of the firm. A firm is a natural monopoly if it is able to serve the entire market demand at a lower cost than any combination of two or more smaller, more specialized firms.

Perfect competition, a theoretical market structure that features no barriers to entry, an unlimited number of producers and consumers, and a perfectly elastic demand curve.

Examples of markets include but are not limited to: commodity markets, insurance markets, bond markets, energy markets, flea

markets, debt markets, stock markets, online auctions, media exchange markets, real estate market.

Game theory

Game theory is a major method used in mathematical economics and business for modeling competing behaviors of interacting agents. Applications include a wide array of economic phenomena and approaches, such as auctions, bargaining, mergers & acquisitions pricing, fair division, duopolies, oligopolies, social network formation, agent-based computational economics, general equilibrium, design, and voting systems, and across such broad areas as experimental, behavioral economics, information economics, industrial organization, and political economy.

Labor economics

Labor economics seeks to understand the functioning and dynamics of the markets for wage labor. Labor markets function through the interaction of workers and employers. Labor economics looks at the suppliers of labor services (workers), the demands of labor services (employers), and attempts to understand the resulting pattern of wages, employment, and income. In economics, labor is a measure of the work done by human beings. It is conventionally contrasted with such other factors of production as land and capital. There are theories which have developed a concept called human capital (referring to the skills that workers possess, not necessarily their actual work), although there are also counter posing macro-economic system theories that think human capital is a contradiction in terms.

Welfare economics

Welfare economics is a branch of economics that uses microeconomic techniques to evaluate well-being from allocation of productive factors as to desirability and economic efficiency within an economy, often relative to competitive general equilibrium. It analyzes social welfare, however measured, in terms of economic activities of the individuals that compose the theoretical society considered.

Accordingly, individuals, with associated economic activities, are the basic units for aggregating to social welfare, whether of a group, a community, or a society, and there is no "social welfare" apart from the "welfare" associated with its individual units.

Economics of information

Information economics or the economics of information is a branch of microeconomic theory that studies how information and information

systems affect an economy and economic decisions. Information has special characteristics. It is easy to create but hard to trust. It is easy to spread but hard to control. It influences many decisions. These special characteristics (as compared with other types of goods) complicate many standard economic theories.

Applied microeconomicsApplied microeconomics includes a range of specialized areas of study, many of which draw on methods from other fields. Industrial organization examines topics such as the entry and exit of firms, innovation, and the role of trademarks. Labour examines wages, employment, and labor market dynamics. Financial economics examines topics such as the structure of optimal portfolios, the rate of return to capital, econometric analysis of security returns, and corporate financial behavior. Public economics examines the design of government tax and expenditure policies and economic effects of these policies (e.g., social insurance programs). Political economy examines the role of political institutions in determining policy outcomes. Health economics examines the organization of health care systems, including the role of the health care workforce and health insurance programs. Urban economics, which examines the challenges faced by cities, such as sprawl, air and water pollution, traffic congestion, and poverty, draws on the fields of urban geography and sociology. Law and economics applies microeconomic principles to the selection and enforcement of competing legal regimes and their relative efficiencies. Economic history examines the evolution of the economy and economic institutions, using methods and techniques from the fields of economics, history, geography, sociology, psychology, and political science.

Supply and demandIn microeconomics, supply and demand is an economic model of price determination in a market. It concludes that in a competitive market, the unit price for a particular good will vary until it settles at a point where the quantity demanded by consumers (at current price) will equal the

quantity supplied by producers (at current price), resulting in an economic equilibrium for price and quantity.

The price P of a product is determined by a balance between

production at each price (supply S) and the desires of those

with purchasing power at each price (demand D). The diagram

shows a positive shift in demand from D1 to D2, resulting in an

increase in price (P) and quantity sold (Q) of the product.

The four basic laws of supply and demand are:

1. If demand increases (demand curve shifts to the right) and supply remains unchanged, a shortage occurs, leading to a higher equilibrium price.

2. If demand decreases (demand curve shifts to the left) supply remains unchanged, a surplus occurs, leading to a lower equilibrium price.

3. If demand remains unchanged and supply increases (supply curve shifts to the right), a surplus occurs, leading to a lower equilibrium price.

4. If demand remains unchanged and supply decreases (supply curve shifts to the left), a shortage occurs, leading to a higher equilibrium price.

DemandThe quantity demanded of a good is the amount that consumers plan to buy during a time period at a particular price. Higher prices decrease the quantity demanded for two reasons:

Substitution effect — a higher relative price raises the opportunity cost of buying a good and so people buy less of it.

Income effect — a higher relative price reduces the amount of goods people can buy. Usually this effect decreases the amount people buy of the product that rose in price.

Demand is the entire relationship between the price of a good and the quantity demanded. A demand curve shows the inverse relationship between the quantity demanded and price, everything else remaining the same. For each quantity, a demand curve shows the highest price someone is willing to pay for that unit.

Shift of demand curveThis highest price is the marginal benefit a consumer receives for that unit of output.

A change in the price of the product leads to a change in the quantity demanded and a movement along the demand curve. The higher the price of a good, the lower is the quantity demanded. This relationship is shown in Figure: 1 with the movement along __ from 4,000 to 2,000 street hockey balls demanded per week in response to a rise in price from $2 to $4 for a street hockey ball.

A change in demand and a shift in the demand curve, occur when any factor that affects buying plans, other than the price of the product changes. An increase in demand means that the demand curve shifts rightward, such as the shift from to in Figure crease in demand refers to a shift leftward.

The demand Curve shifts from changes in the following: Prices of related goods — a rise in the price of a substitute

increases demand and the demand curve shifts rightward; a rise in the price of a complement decreases demand and the demand curve shifts leftward.

Expected future prices — if a product’s price is expected to rise in the future, the current demand for it increases and the demand curve shifts rightward.

Income — for a normal good, an increase in income increases demand and the demand curve shifts rightward; for an inferior good an increase in income decreases demand and the demand curve shifts leftward.

Population — an increase in population increases demand and the demand curve shifts rightward.

Preferences — if people decide they like a good more, its demand increases and the demand curve shifts rightward.

Factor affecting demand: Price (price is inversely related to demand). Price of other commodities. Household income. Household’s taste and preference.

If we assume that among all these determinants the price of the commodities only changes while other factors remain unaffected. Then we say that quantity demand of any commodity by a household depend on the price of same commodity only. This depend of quantity demanded of any commodity on its price can be represented in terms of a function which is called the demand function. If ‘q’ represents quality and ‘p’ represents price then demand function would be: qd =f (p)

Law of demand: The law of demand states that other things remaining the same if the price of any commodities decreases its quantity demand increases and vice-versa.

Market demand: The market demand refers to the sum of quantity demand by all household at different prices .We can get different individual demand curves for individual household. Each individual demand curves show the quantity demand by a household at a particular price. By summing all the quantities demanded by all the household at a particular price we can get the market demand at that price. Market demand curves are

also sloping. Market demand curve is drawn on the basis of the assumption that all other prices, total household income and its distribution among household and taste of household are held constant. If any of this factor change the market demand curve will shift from its position.

Exception to the law of demand:

1. If the commodity is the giffen commodity to an individual then that individual the demand curve for that commodity will be upward rising. This happens when the commodity will be inferior and the the income effect of a fall in price is stronger than the substitution effect. Such commodity is called ‘GIFFEN COMMODITY’.

2. When the price of any commodity increases the consumer may expect the price of the commodity to rise further in future in that case consumer may purchase more units of the commodity even when its price rises. So in this case the demand curve will be upward rising.

3. Sometimes the consumers judge the quantity of any commodity by its price that is when the price of any commodity increases. Some consumer may think that a qualitative improvement has taken place. The consumer may purchase more units of this commodity even when its price increase. This effect is known as ‘VEBLEN EFFECT’.

4. In the share market it is found that as the price of any share increase its demand also increases; the law of demand is therefore not applicable on the share market.

Elasticity of demand: The elasticity of demand is defined as the % change in quantity demand due to 1% change in price.Thus elasticity of demand =% Change in quantity demanded / % change in price.Here, % change in quantity demanded= (changing quantity demand/total quantity demand) x 100And % change in price = (changing price demand / total price demand) x 100.

Elastic demand-If the absolute value elasticity of demand is greater than 1.0(unit), is known as elastic demand.Inelastic demand-If the absolute value of elasticity of demand is less than 1.0, is known as inelastic demand.Unit elastic demand-If the absolute value of elasticity of demand is equal to 1.0; that is unity; is known as unit elastic demand.

Measurement of elasticity:

Here, AB is linear demand curve. Now two points P and Q are considered on AB. Then two perpendiculars are drawn on oq axis PN and QS. Also MP and RQ are drawn. PN and QR intersect each other in T point.

Now MR=PT, QR=OS, TQ=NS. Between point P and Q the change in price demanded is PT (MR), change in quantity demanded is NS.So Change in quantity demand= (NS/ON) x 100. Change in price demand= (MR/OM) x 100.

Elasticity of demand at point ‘P’ = (NS/ON) x (OM/OR) = (OM/ON) x (NS/MR) [as triangle PTQ & PNB almost equal ] = (OM/ON) x (TQ/PT) = (OM/ON) x (NB/PN) = (PN/ON) x (NB/PN) = NB/ON = Lower segment/Upper segment

Special Cases:

All straight line demand curve having the intercept from the price axis will have the same elasticity of demand at each price even if they have different slope. In the figure, from a two demand curve AB and AC are drawn.

Linear demand curve

For AB demand curve, elasticity of demand = PB/PA. For AC demand curve, elasticity of demand =QC/QA. So PB/PA=QC/QA.

If two straight line demand curves intersect each other and if we have to compare their elasticity and demand at their intersection point then it can see that the stepper demand curve have lower absolute value of the elasticity of the demand and vice-versa. Linear demand curveIn the figure both AB & CD intersect on the point ‘P’. For AB demand curve, elasticity of demand= PB/PA. For CD demand curve, elasticity of demand=PD/PC. So PD/PC>PB/PA.

If the demand curve is vertical it has the highest steepness and it’s elasticity of demand is zero at all points on it. Figure-1

On the other hand if the straight line demand curve is parallel to the horizontal axis it is perfectly flat and its elasticity is infinite at all. Figure-2

Figure-1 Figure-2

SupplyIf supply any commodity, we mean that the amount of that commodity offered for sell at any price. The supply of any commodity may be consider from two stand point.

First, we may consider the supply from the stand point of a single seller or a single firm. This is known as ‘individual supply’.

Second, we may consider the supply from the stand point of the market. This is known as market supply.

Quantity supply:

Whatever amount of commodity a firm/seller willing to supply. It depends on several factors, such as:

a) The quantity supply is influence the price of the commodity. As the price of the commodity increases the quantity supplied of the commodity also increases. This is known as the law of supply.

Law of supply: It states that other things remaining the same as the prices of any commodity increases the quantity supplies also increases that their exist a direct relation between prices and quantity supplies.

b) Quantity supplies is also influence by the prices of factors of production. Other things remaining the same the higher price of any factor of production used in the production of a commodity, used in the less profitable will it be to produce the commodity. That means the higher the price of the factor of the production the lower will be the quantity supplied.

c) The quantity supplied is also influenced by the goals of the producing firms. If the goals of firms is to get maximum sells even at the cost of some profit then the quantity supply will be higher than if it wants to make maximum profit. Similarly if a firm reluctant to take risk we would expect a lower quantity supplied by that firm.

d) The quantity supply is also influenced by state of technology. As a result of improvement in that technique of production it is possible to produce more output even with the employment of the same factors of production. In that case the quantity supplied will increase even if other things remain the same.

The quantity supplied will be a function of price of that commodity only denoting the quantity supplied of the commodity by quantity supply and the price of the commodity by we can

express this supply function by the notion : qs = f(p) . That is called function of supply.

The supply curve in the above figure is an individual supplies of all seller at any price we can get the market supply at that price plotting the market supply on the horizontal axis and price of the commodity on the vertical axis we can get the supply curve.

Distinction between the movement along the supply curve and a shift along the supply curve:

A movement of supply curve takes place when there is a change in price of the commodity (other things remaining the same) the change in quantity supplied therefore means movement along the same supply curve from one to another point.

Shift of supply curve

Measurement of Elasticity of Supply:

We take points ‘A’ & ‘C’ on SS’ supply curve. Considering point ‘C’,

Perpendicular CD and AE are drawn. So, % change in quantity supply = (BD/OB) x 100. And % change in price = (CE/AB) x 100. Elasticity of supply at point ‘C’ = (BD/OB) x (AB/CE) [as triangle ASB and AEC are almost equal, so (SB/AB) = (AC/CE) and BD=AE] = (AE/CE) x (AB/OB) = (SB/AB) x (AB/OB) = SB/OB.

Similarly as demand, elastic supply>1.0; inelastic supply<1.0; unit elastic supply=1.0

Linear supply curve

Market EquilibriumThe equilibrium price is determined by the intersection of the demand and supply curves. It is the price at which the quantity demanded equals the quantity supplied. The equilibrium quantity is the quantity bought and sold at the equilibrium price.

Now equilibrium price is that price at which total demand for any commodity in market is equal to total supply of that commodity in the market. We assume that there exists perfect competition in the commodity market. This means that there are large number of buyers & sellers in the market. Each buyer takes the price as given and decides to demand certain unit of the commodity at that price. In this way each buyer has an individual demand curve. Market equilibrium curveBy summing all the individual demand curves, we can get the market demand curve. In the same way, each seller takes the price as given and decide to offer a certain quantity for sell in the market Thus each seller has an individual supply curve and by summing these, we can get market supply curves.

Equilibrium: Equilibrium is defined to be the price-quantity pair where the quantity demanded is equal to the quantity supplied, represented by the intersection of the demand and supply curves.

Market Equilibrium: A situation in a market when the price is such that the quantity that consumers demand is correctly balanced by the quantity that firms wish to supply.

Comparative static analysis: Examines the likely effect on the equilibrium of a change in the external conditions affecting the market.

Changes in market equilibrium: Practical uses of supply and demand analysis often center on the different variables that change equilibrium price and quantity, represented as shifts in the respective curves. Comparative statics of such a shift traces the effects from the initial equilibrium to the new equilibrium.

Conclusion: Micro economics is concerned with the determination of prices of various commodities and factors of production and allocation of resources among competing uses. On the other hand, macroeconomics

focuses on the level of utilisation of resources, particularly the level of employment and the general level of prices.

Economics is also the mother-discipline for the academic areas, roughly referred to as business administration. A solid foundation microeconomics is going to make marketing, production management, and finance far easier to master and apply. Price elasticity of demand (and other elasticities) is much of the subject matter in marketing, marginal analysis will again become central in the methods we use in production management, and finance is concerned primarily with capital markets. Therefore, microeconomics will follow throughout academic career if we are a business major and throughout our real world career if we make decisions.

References: Introduction to microeconomics- Dr. David A. Dilts www.google.com /wikipedia Class notes

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