principles of microeconomics - irfan lalirfanlal.yolasite.com/resources/principle of micro 1st...

Principles of Microeconomics

Definition

• Economics is the study of how people and societies

use their scares resources to produce valuable

goods and services and distribute them among

different section of society.

Economics

Economics is the social science that studies the choices

that individuals, businesses, governments, and entire

societies make as they cope with scarcity and the

incentives that influence and reconcile those choices.

Scarcity

• means that society has limited resources and

therefore cannot produce all the goods and services

people wish to have. Just as a household cannot

give every member everything he or she wants, a

society cannot give every individual the highest

standard of living to which he or she might aspire.

•

Scarcity

• Scarcity is situation in which goods are limited

relative to desire.

• Goods are offered is less than its required

• Shortage – Demand greater than supply

Microeconomics

Microeconomics is the study of choices

that individuals and businesses make,

the way those choices interact in

markets, and the influence of

governments.

Macroeconomics

Macroeconomics is the study of the

performance of the national and global

economies.

Production Possibility Frontier-PPF

• Production Possibility Frontier shows the maximum

amounts of production that can be obtain by an

economy, given its technological knowledge and

quantity of inputs available.

Production Possibilities and Opportunity

Cost

The production possibilities frontier (PPF) is the

boundary between those combinations of goods and

services that can be produced and those that cannot.

To illustrate the PPF, we focus on two goods at a time

and hold the quantities of all other goods and services

constant.

That is, we look at a model economy in which

everything remains the same (ceteris paribus) except the

two goods we’re considering.5

Production Possibilities and Opportunity

Cost

• Production

Possibilities Frontier

Figure 2.1 shows the

PPF for two goods: CDs

and pizza.

Any point on the frontier

such as E and any point

inside the PPF such as Z

are attainable.

Points outside the PPF

are unattainable.

Economic system

• Market Economy

• In market economy individuals and firms make major

decisions about production and consumption. In

market economy a system of price mechanism

prevails. Firm adopt low cost of production

techniques and fix prices in order to maximize their

profit. In market economy price Mechanism plays an

important role. In market economy what, how and for

whom are three important elements.

Command Economy

• In Command economy Govt. makes decisions about

what to produce and how to distribute goods and

services. All economic resources, such as land;

capital and are owned by Govt. All workers are Govt.

employees and are paid by Govt. for their services.

All lands and factories controlled and managed by

the Govt.

Mixed Economy

• In mixed economy some sectors of economy are

operated by Govt. while others are being managed

by private sector. Govt. has an important role in

proper functioning of market economy; Govt.

enforces certain rules and regulations. Govt. focuses

more attention on peace and order through police,

better education and health services for the masses.

Two Big Economic Questions

Two big questions summarize the scope of economics:

How do choices end up determining what, how, and for

whom goods and services get produced?

When do choices made in the pursuit of self-interest

also promote the social interest?


What, How, and For Whom?

Goods and services are the objects that people value and produce to satisfy human wants.

What?

What we produce changes over time.

Seventy years ago, almost 25 percent of Americans worked on farms. Today that number is 3 percent.

Seventy years ago, 45 percent of Americans produced services. Today, almost 80 percent of Americans have service jobs.


Figure 1.1 shows the

trends in what the U.S.

economy has produced

over the past 70 years.

It shows the decline of

employment in agriculture

and in mining,

construction, and

manufacturing, and the

expansion in services.

Economics explains these

trends.


How?

Goods and services are produced by using productive

resources that economists call factors of production.

Factors of production are grouped into four categories:

Land

Labor

Capital

Entrepreneurship


The “gifts of nature” that we use to produce goods and services are land.

The work time and work effort that people devote to producing goods and services is labor.

The quality of labor depends on human capital, which is the knowledge and skill that people obtain from education, on-the-job training, and work experience.

The tools, instruments, machines, buildings, and other constructions that are used to produce goods and services are capital.

The human resource that organizes land, labor, and capital is entrepreneurship.


For Whom?

Who gets the goods and services depends on the incomes

that people earn.

Land earns rent.

Labor earns wages.

Capital earns interest.

Entrepreneurship earns profit.

To make coordination work, four complimentary social

institutions have evolved over the centuries:

Firms

Markets

Property rights

Money

Economic Coordination


A firm is an economic unit that hires factors of production and organizes those factors to produce and sell goods and services.

A market is any arrangement that enables buyers and sellers to get information and do business with each other.

Property rights are the social arrangements that govern ownership, use, and disposal of resources, goods or services.

Money is any commodity or token that is generally acceptable as a means of payment.


• Circular Flows Through Markets

A circular flow diagram, like Figure 2.8 on the next

slide, illustrates how households and firms interact in the

market economy.


• Coordinating

Decisions

Markets

coordinate

individual

decisions through

price adjustments.

Demand

If you demand something, then you

1. Want it,

2. Can afford it, and

3. Have made a definite plan to buy it.

Wants are the unlimited desires or wishes people have for

goods and services. Demand reflects a decision about

which wants to satisfy.

The quantity demanded of a good or service is the

amount that consumers plan to buy during a particular

time period, and at a particular price.

Demand

The Law of Demand

The law of demand states:

Other things remaining the same, the higher the price of a

good, the smaller is the quantity demanded; and

the lower the price of a good, the larger is the quantity

demanded.

The law of demand results from

Substitution effect

Income effect

Demand

Substitution effect

When the relative price (opportunity cost) of a good or

service rises, people seek substitutes for it, so the

quantity demanded of the good or service decreases.

Income effect

When the price of a good or service rises relative to

income, people cannot afford all the things they

previously bought, so the quantity demanded of the

good or service decreases.

Demand

Demand Curve and Demand Schedule

The term demand refers to the entire relationship between

the price of the good and quantity demanded of the good.

A demand curve shows the relationship between the

quantity demanded of a good and its price when all other

influences on consumers’ planned purchases remain the

same.

Demand

Figure 3.1 shows a

demand curve for energy

bars.

A rise in the price, other

things remaining the same,

brings a decrease in the

quantity demanded and a

movement along the

demand curve.

Demand

Willingness and

Ability to Pay

A demand curve is also a

willingness-and-ability-to-

pay curve.

The smaller the quantity

available, the higher is the

price that someone is

willing to pay for another

unit.

Willingness to pay

measures marginal benefit.

Demand

A Change in Demand

When any factor that influences buying plans other than

the price of the good changes, there is a change in

demand for that good.

The quantity of the good that people plan to buy changes

at each and every price, so there is a new demand curve.

When demand increases, the demand curve shifts

rightward.

When demand decreases, the demand curve shifts

leftward.

Demand

Six main factors that change demand are

The prices of related goods

Expected future prices

Income

Expected future income

Population

Preferences

Demand

Prices of Related Goods

A substitute is a good that can be used in place of

another good.

A complement is a good that is used in conjunction with

another good.

When the price of substitute for an energy bar rises or

when the price of a complement of an energy bar falls, the

demand for energy bars increases.

Demand

Expected Future Prices

If the price of a good is expected to rise in the future,

current demand fore the good increases and the demand

curve shifts rightward.

Income

When income increases, consumers buy more of most

goods and the demand curve shifts rightward. A normal

good is one for which demand increases as income

increases. An inferior good is a good for which demand

decreases as income increases.

Demand

Expected Future Income

When income is expected to increase in the future, the

demand might increase now.

Population

The larger the population, the greater is the demand for all

goods.

Preferences

People with the same income have different demands if

they have different preferences.

Demand

Figure 3.2 shows an

increase in demand.

Because an energy bar

is a normal good, an

increase in income

increases the demand

for energy bars.

Demand

A Change in the Quantity

Demanded Versus a

Change in Demand

Figure 3.3 illustrates the

distinction between a

change in demand and a

change in the quantity

demanded.

Demand

A Movement along the

Demand Curve

When the price of the good

changes and everything

else remains the same, the

quantity demanded

changes and there is a

movement along the

demand curve.

Demand

A Shift of the Demand

Curve

If the price remains the

same but one of the other

influences on buyers’

plans changes, demand

changes and the demand

curve shifts.

Supply

If a firm supplies a good or service, then the firm

1. Has the resources and the technology to produce it,

2. Can profit from producing it, and

3. Has made a definite plan to produce and sell it.

Resources and technology determine what it is possible

to produce. Supply reflects a decision about which

technologically feasible items to produce.

The quantity supplied of a good or service is the amount

that producers plan to sell during a given time period at a

particular price.

Supply

The Law of Supply

The law of supply states:

Other things remaining the same, the higher the price of a

good, the greater is the quantity supplied; and

the lower the price of a good, the smaller is the quantity

supplied.

The law of supply results from the general tendency for the

marginal cost of producing a good or service to increase

as the quantity produced increases (Chapter 2, page 37).

Producers are willing to supply a good only if they can at

least cover their marginal cost of production.

Supply

Supply Curve and Supply Schedule

The term supply refers to the entire relationship between

the quantity supplied and the price of a good.

The supply curve shows the relationship between the

quantity supplied of a good and its price when all other

influences on producers’ planned sales remain the same.

Supply

Figure 3.4 shows a supply

curve of energy bars.

A rise in the price of an

energy bar, other things

remaining the same,

brings an increase in the

quantity supplied.

Supply

Minimum Supply Price

A supply curve is also a minimum-supply-price curve.

As the quantity produced increases, marginal cost increases.

The lowest price at which someone is willing to sell an additional unit rises.

This lowest price is marginal cost.

Supply

A Change in Supply

When any factor that influences selling plans other than

the price of the good changes, there is a change in

supply of that good.

The quantity of the good that producers plan to sell

changes at each and every price, so there is a new supply

curve.

When supply increases, the supply curve shifts rightward.

When supply decreases, the supply curve shifts leftward.

Supply

The five main factors that change supply of a good are

The prices of productive resources

The prices of related goods produced

Expected future prices

The number of suppliers

Technology

Supply

Prices of Productive Resources

If the price of resource used to produce a good rises, the

minimum price that a supplier is willing to accept for

producing each quantity of that good rises.

So a rise in the price of productive resources decreases

supply and shifts the supply curve leftward.

Supply

Prices of Related Goods Produced

A substitute in production for a good is another good that

can be produced using the same resources.

The supply of a good increases if the price of a substitute

in production falls.

Goods are complements in production if they must be

produced together.

The supply of a good increases if the price of a

complement in production rises.

Supply

Expected Future Prices

If the price of a good is expected to rise in the future,

supply of the good today decreases and the supply curve

shifts leftward.

The Number of Suppliers

The larger the number of suppliers of a good, the greater

is the supply of the good. An increase in the number of

suppliers shifts the supply curve rightward.

Supply

Technology

Advances in technology create new products and lower

the cost of producing existing products, so advances in

technology increase supply and shift the supply curve

rightward.

A natural disaster is a negative technology change, which

decreases supply and shifts the supply curve leftward.

Supply

Figure 3.5 shows an

increase in supply.

An advance in the

technology for producing

energy bars increases the

supply of energy bars and

shifts the supply curve

rightward.

Supply

A Change in the Quantity

Supplied Versus a

Change in Supply


distinction between a

change in supply and a

change in the quantity

supplied.

Supply

A Movement Along the

Supply Curve

When the price of the good

changes and other

influences on sellers’ plans

remain the same, the

quantity supplied changes

and there is a movement

along the supply curve.

Supply

A Shift of the Supply

Curve

If the price remains the

same but some other

influence sellers’ plans

changes, supply changes

and the supply curve

shifts.

Market Equilibrium

Equilibrium is a situation in which opposing forces balance

each other. Equilibrium in a market occurs when the price

balances the plans of buyers and sellers.

The equilibrium price 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.

Price regulates buying and selling plans.

Price adjusts when plans don’t match.

Market Equilibrium

Price as a Regulator


equilibrium price and

equilibrium quantity.

If the price is $2.00 a bar,

the quantity supplied

exceeds the quantity

demanded.

There is a surplus of 6

million energy bars.

Market Equilibrium

If the price is $1.00 a bar, the quantity demanded exceeds the quantity supplied.

There is a shortage of 9 million energy bars.

If the price is $1.50 a bar, the quantity demanded equals the quantity supplied.

There is neither a shortage nor a surplus of energy bars.

Market Equilibrium

Price Adjustments

At prices above the equilibrium price, a surplus forces the price down.

At prices below the equilibrium price, a shortage forces the price up.

At the equilibrium price, buyers’ plans and sellers’ plans agree and the price doesn’t change until some event changes either demand or supply.

Predicting Changes in Price and Quantity

An Increase in Demand

Figure 3.8 shows that

when demand increases

the demand curve shifts

rightward.

At the original price, there

is now a shortage.

The price rises, and the

quantity supplied increases

along the supply curve.


An Increase in Supply

Figure 3.9 shows that

when supply increases

the supply curve shifts

rightward.

At the original price, there

is now a surplus.

The price falls, and the

quantity demanded

increases along the

demand curve.


All Possible Changes in

Demand and Supply

A change demand or

supply or both demand

and supply changes the

equilibrium price and the



Change in Demand with

No Change in Supply

When demand increases,

equilibrium price rises and

the equilibrium quantity

increases.


Change in Demand with

No Change in Supply

When demand decreases,

the equilibrium price falls

and the equilibrium

quantity decreases.


Change in Supply with No

Change in Demand

When supply increases,

the equilibrium price falls

and the equilibrium

quantity increases.


Change in Supply with No

Change in Demand

When supply decreases,

the equilibrium price rises

and the equilibrium

quantity decreases.


Increase in Both Demand

and Supply

An increase in demand and

an increase in supply

increase the equilibrium

quantity.

the increase in demand

raises the equilibrium price

and the increase in supply

lowers it.


Decrease in Both Demand

and Supply

A decrease in both demand

and supply decreases the


the decrease in demand

lowers the equilibrium price

and the decrease in supply

raises it.


Decrease in Demand and

Increase in Supply

A decrease in demand and

an increase in supply lowers

the equilibrium price.

the decrease in demand

decreases the equilibrium

quantity and the increase in

supply increases it.


Increase in Demand and

Decrease in Supply

An increase in demand and a

decrease in supply raises the

equilibrium price.

the increase in demand

increases the equilibrium

quantity and the decrease in

supply decreases it.

Producer surplus is the difference between what the producer

receives for the good and the amount he/she must receive to be

willing to provide the good.

S

D

P

Q

P*

Q*

It is the area above the supply curve & below the price.

Consumer surplus is the difference between what the consumer has to pay for

a good and the amount he/she is willing to pay.

S

D

P

Q

P*

Q*

It is the area under the demand curve & above the price.

Original Consumer

Surplus

Change in Consumer Surplus: Price

Increase

Quantity

New Consumer Surplus

Loss in Surplus: Consumers paying more

Loss in Surplus: Consumers

buying less

Price

D

Po

Qo

P1

Q1

Minimum Amount Needed to

Supply Qo

Producer Surplus

Price

Quantity

Po

Qo

What is paid

Producer Surplus

S

Consumer and Producer Surplus

Price

Quantity

Po

Qo

S

Producer Surplus

Consumer

Surplus

D

Loss in Efficiency

Too High of Price (Price Floor)

Price

Quantity

Po

Qo

S

D

QL

New Consumer

Surplus

PH

New Producer

Surplus

Lost

Consumer

Surplus

Lost Producer Surplus

Deadweight Loss

New Producer

Surplus

New Consumer

Surplus

Loss in Efficiency

Too Low of Price (Price Ceiling)

Price

Quantity

Po

Qo

S

D

QL

PL

Lost

Consumer

Surplus


Deadweight Loss

New Producer

Surplus

Tax

Revenues

New Consumer

Surplus

Loss in Efficiency

Taxation

Price

Quantity

Po

Qo

S

D

QL

PS


PD

STax

Lost Consumer

Surplus Deadweight Loss

Tax

Size of Deadweight Loss

• The deadweight loss of the tax will depend upon two factors:

The size of the tax

The reduction in the quantity sold

• The reduction in the quantity sold will depend upon the elasticity of demand and supply

The more elastic demand or supply is the larger the deadweight loss will be

If either demand or supply is price inelastic then the deadweight loss will small and could be zero if perfectly inelastic (no change in the quantity sold and consumed)

Loss in Efficiency

Subsidy

Po

Qo

S

D

QH

PD

Subsidy Cost

PS SSub Subsidy

New Producer

Surplus

Gain in Producer Surplus

New

Consumer

Surplus

Gain in Consumer

Surplus

Price

Quantity

Deadweight Loss

principles of microeconomics - irfan lalirfanlal.yolasite.com/resources/principle of micro 1st...

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