Microeconomics Textbook Notes

Chapter 1 Economics and Life

 Economics is the study of how people manage resources. Decisions about how to
allocate resources can be made by individuals but also by groups of people in families,
firms, governments and other organizations.
 Microeconomics The study of how individuals and firms manage resources
 When people make choices to achieve their goals in the most effective way possible,
they are exhibiting rational behaviour

Scarcity
 Scarcity The condition of wanting more than we can get with available resources
 Firstly, you ask What are the wants and constraint of those involved?
o Given both rational behaviour and scarcity People can expect to work to get
what they want but to be constrained in their choices by limited resources
available to them
o Example You want to spend as much time as possible this summer taking road
trips, but you are constrained by the four months of summer, behaving rationally
you might work double shifts for two months and travel for two months

Opportunity Cost and Marginal Decision Making

 Opportunity Cost The value of what you have to give up in order to get something, or
the opportunity you have to pass up in order to take your first choice
 Example You have a 15$ gift card for a restaurant to either get spaghetti or pizza.
Without the gift card you are willing to spend 15$ on pizza and 10$ on spaghetti.
o If you chose pizza Opportunity cost would be the 10$ you are missing out for
spaghetti.
o If you chose spaghetti Opportunity cost would be 15$ since you are missing
out on the pizza.
o Meaning you would choose pizza since it has the lowest opportunity cost.
 Marginal Decision Making Describes the idea that rational people compare the
additional benefits of a choice against the additional cost with considering related
benefits and costs of past choices
 Example Canada’s Wonderland has a 20$ admission price and charges 2$ per ride.
o If you are standing outside the park, the cost of the first ride is 22$ because you
will have to pay the admission price and buy a ticket to go on the ride.
o Once you are inside the park , the marginal cost for each additional ride is 2$
 When looking at opportunity cost, you measure the enjoyment/pleasure
you get vs. the cost of the additional ride
  Sunk costs Costs that have already been incurred and cannot be recovered
o Example the 20$ admission fee or any other money you spent, therefore they
should not have any bearing on your marginal decision

Incentives
 Incentive Something that causes people to behave in a certain way by changing the
trade-offs they face.
o Positive Incentive Makes people more likely to do something
o Negative Incentive Makes people less likely to do something
Efficiency
 Describes a situation in which resources are used in the most productive way possible to
produce the goods and services that have greatest total economic value to society
o How do we determine value?
The ways which circumstances might not be normal
 Innovation Yet to be discovered innovations/ideas increase efficiency
 Market Failure People and firms may be prevented capturing the benefits of the
opportunity or incur additional costs
 Intervention Interventions in the economy cause transactions to not take place
o Most often government policies
 Goals other than profit Individuals and governments have goals other than profits

Correlation and Causation

 Correlation Consistent relationship between two events or variables, we say there is a
correlation between them
 Causation Means one event brings out another. Causation and correlation often go
together

Correlation without Causation

 Two events may be extremely correlated making it appear that a relationship ebwteen
the two exist
 Omitted Variables Two events may be extremely correlated due to a third event
causing the two
 Reverse Causation Sometimes it is unclear whether event A causes Event B or Event B
causes Event A
Models
 Model simplified representation of a complicated situation.

 Circular flow Model

o Households Vitals in two ways, they supply land and labour to firms and invest
capitals in firms. Second, they buy the goods and services that firms produce
o Firms Buy or rent land, labour and capital supplied by households, and they
produce and sell goods and services.
o Market for goods Reflects activity involved in the buying and selling of goods
and services. In this market- households spend their wages from labour and
income from land and capital and firms then earn revenue
o Market for factors of production Households supply land, labour, and capital
and firms hire and purchase or rent these inputs

Statements
 Positive Statement Makes factual declaration about how the world actually works is
called a positive statement
o Ex. Canadian residential school system abused 30,000 First Nations Children
 Normative Statement Makes a claim how the world should be
o Ex. Canadian government should apologize to those children and compensate
them
Chapter 2 Specialization and Exchange
 Production Possibilities Frontier(PPF) Line or curve that shoes all the possible
combinations of outputs that can be produced using all available resources
o Answers following questions
 What are the wants and constraints of those involved?

 Points that lie on the frontier (the line) are called efficient since they
squeeze most output
 Absolute Advantage If a producer can generate more output than others with a given
amount of resources that producer has an absolute advantage
 Comparative Advantage When a producer can make a good at a lower opportunity
cost then other producer
 Specialization When a country focuses on producing the good for which it has a
comparative advantage, total production increases
 Suppose China and Canada trade 2 billion bushels of wheat for 0.75 billion, resulting in a
surplus of 0.5 billion more shirts, this is called the gains from trade.
Chapter 3 Markets
 Market Refers to the buyers and sellers who trade who trade a particular good and
service
 Competitive market A market in which fully-informed buyers and sellers can easily
trade a standardized good or service
o Four Characteristics
 Standardized Good Any two units or goods have the same features
and are interchangeable
 Full Information Market participants know everything about the price
and features of the good
 No Transaction Costs there is no cost to participate of exchange in the
market
 Participants are price takers Buyers and sellers do not have the power
to affect the price of the market

Demand Describes how much of something people are willing and able to buy under certain
circumstances
o The amount of a particular good that buyers in a market will purchase at a given
price during a specified period is called the quantity demanded
o The inverse relationship between price and quantity demanded is so important
that economists refer to it as the law of demand
 Law of demand When all is held equal, quantity demanded rises as
prices fall
 Demand Curve Graph that shows the quantity of a particular good or service that
consumers will demand at various prices
 Determinant of Demand If one of the non-price factors that determines demand
changes the curve will shift
o Demand curve shows the trade-offs people face between
 The benefit they expect to receive from a good
 Opportunity cost they face from buying it
 Non-Price Determinants
o Consumer Preferences
 Buy Canadian products, increases demand while E. coli in romaine lettuce
decrease demand due to consumer preference
o Price of Related Goods
 Decrease price of hot dogs increases the demand for relish
(complementary good)
 Decrease in taxi fares, decreases the demand for subway stations
o Incomes
 Economic downturn lowers incomes, increased demand for ground beef
an inferior good
 Economic downturn lowers incomes, decreasing the demand of steak a
normal good
 o Expectations
 Hurricane destroys part of wheat crops, causing expectations that prices
will and increasing current demand of wheat crops
 Announcement that a new smartphone is coming decreases demand of
current model
o Number of Buyers
 Increase in life expectancy increases demand of nursing homes
 Falling birthrate decreases demand of diapers
 Substitutes When products/ services serve similar purposes that a consumer might
purchase one in place of another
 Complements Goods that are consumed together, purchasing one good will make
you more likely to purchase another (if the price of one increase demand for other will
decrease)
 Normal Goods Increase in income causes increase in demand will decrease in income
decreases income
 Inferior Goods As income increases, demand decreases, people replace inferior goods
with more expensive ones when incomes rise (replacing android with iPhone)
 Shits in the Demand Curve
o Non-price Determinants Causes the ENTIRE demand curve to change, as a
result of external factors notes as “change in demand”
o Price Change Movement along the demand curve, but the curve itself remain
constant (i.e. the curve does NOT move) notes as “change in quantity
demanded”

Supply
 Law of supply Quantity supplied increases as price increases and vice versa
 Determinants of Supply
o Price Of Related goods It affects the opportunity cost of production
o Technology Improved technology, lowers production costs, increasing
quantity supplied
o Price of Inputs When it increases, quantity supplied decreases
o Expectations
o Number of Sellers
 A change in the non-price determinants of supply shift the supply curve and a price
change decreases the quantity supplied

Market Equilibrium
 Equilibrium When demand and supply curves meet
o The price at this point is called the equilibrium price
o Price at this point is called the equilibrium quantity
 Surplus When quantity supplied is higher than the quantity demanded
 Shortage(excess quantity demanded) When quantity demanded is higher than
quantity supplied
 Shifts in Demand
o Shift to the right, equilibrium price and quantity increases
o Shift to the les, equilibrium price and quantity decrease
 Shifts in Supply
o Shift to the right, equilibrium price decreases and quantity increases
o Shift to the left, equilibrium price increases, quantity decreases
 Shifts in Both Curves
Chapter 4 Elasticity
 Elasticity describes how much a change price will affect consumers

What is Elasticity?
 Elasticity Measure of how much consumers and producers will respond to a change in
market conditions
 Cross-Price/Demand Elasticity Describes how much quantity demanded and quantity
supplied change when the price of goods change
 Cross-Price Elasticity of Demand Describes what happens to the quantity of one good
when the price of another good changed
 Income Elasticity of Demand Measures how much the quantity demand reacts to
changes in consumers incomes

Elasticity of Demand
 Price Elasticity of Demand Describes the size of the change in quantity demanded of
a good or service when its price changes
o When consumers are influenced by price, the demand curve is more elastic
o When consumers are not sensitive to price, the demand curve is less elastic

o Price Elasticity of Demand will always be negative

Midpoint Method
 Price of elasticity changes depending on which direction you go, the midpoint method
measures the percentage change relative to a point midway between the two points
Determinants of Price Elasticity of Demand
 Consumers are more sensitive to price changes for some goods and service than for
others
o Availability of Substitutes
 When the price of a good with a substitute increases, consumers buy
substitute instead, meaning the demand curve is more elastic
o Degree Of Necessity
 When a good is a basic necessity, people will buy it even if the price
rises, making any luxuries people afford much more elastic
o Cost Relative to Income
 If consumers spend very small amount of their income for a good, the
demand is less elastic
o Adjustment Time
 Goods have a much more elastic demand in the long run than in the
short term
o Scope of the Market
 How we define the market, i.e. the price elasticity of demand for
bananas might be high, but the price elasticity of fruit can still be low

Using Price Elasticity of Demand

 Perfectly Elastic Demand curve is horizontal, indicating that consumers are very
sensitive to price, because demand drops to zero when price increases
 Perfectly Inelastic The demand curve is vertical, indicating the quantity demanded is
the same no matter the price
 Between these two extremes elasticity is divided into three categories
o Elastic When the absolute value of price elasticity is greater than 1
o Inelastic When the absolute value of price elasticity is less than 1
o Unit-Elastic When the absolute value of price elasticity is equal to 1
 Knowing whether the demand for a good is elastic or inelastic allows managers to
determine if the total revue will fall or ride
o Increase in Price causes two things
 Quantity Effect Decreases in revenue from less units sold
 Price Effect Increase in revenue that results from receiving a higher
price for each unit sold
o When demand is elastic quantity effect>price effect
o When demand is inelastic quantity effect<Price effect
Price Elasticity of Supply
 Price Elasticity of Supply Size of change in the quantity supplied of a good or service
when its price changes

Determinants of Supply
 Availability of inputs
o If producing more of a good will cost more than the initial quantity did, since
extra inputs will be harder to find then the producer will be reluctant to
increases the quantity supplied
 Flexibility of Production Process
o Draw production capacity away from other good or serives when the price of
another good rises
 I.e. farmers will produce more corn if corn is more expensive
 Adjustment Time

Other Elasticities
 Cross Price Elasticity of Demand Describes how the quantity demanded of one good
changes when the price of a different good changes
 Income Elasticity of Demand Describes how much quantity demanded changes in
response to a change in consumer’s incomes
Chapter 5 Efficiency

 Willingness to Pay Buyer’s Maximum price they are willing to pay

 Willingness to Sell The lowest price a seller is willing to sell their product at

Willingness to Pay and Demand Curve

 The willingness to pay is the point at which the benefit of a good or service is equal to
spending money on another alternative In other words the opportunity costs

Willingness to Sell and the Supply Curve

 Sellers willingness to pay is determined by the trade-offs they face and the opportunity
cost for the sale

Surplus
 Surplus Way of measuring who benefits by transactions and by how much
o Difference between the price a buyer or seller would be willing to trade and the
actual price
 Ex. If you buy something on sale, the “bonus money” you saved is called
the surplus
 Consumer Surplus The difference between the willingness to pay and the actual price
for the service or good
o Ex. Price willing to pay is 500, actual price is 160 therefore the consumer surplus
is 340$
o Ex. Price willing to pay is 150, actual price is 160 therefore consumer surplus is
zero
o When price falls, consumer surplus rises
 Producer SurplusNet benefit the producer receives from the sale of a good or service,
measured by willingness to sell and the actual price they sell it for
o When price falls, sellers are less willing to sell so their producer surplus
decreases
 Total SurplusProducer surplus and Consumer Surplus added together
 Zero-Sum GameSituation where one person gains and another loses
o Ex. Poker, one person ones a certain amount another person loses making the
net benefit zero

Market Equilibrium and Efficiency

 At market equilibrium, buyers are matched to sellers and the point where the total
surplus is maximized
 When the price rises above equilibrium (Moves to the left), fewer transactions take
place, consumer surplus lowers and producer surplus rises, however the total surplus
decreases
 When price lowers from equilibrium (moves to the right), more transactions take place,
consumer surplus rises, producer surplus decreases, and total surplus decreases
 Therefore, only at equilibrium are total surplus is maximized
 Efficient A market is efficient when it is at equilibrium, there is no exchange that can
make someone better off without making another worse off
 Deadweight Loss Loss of total surplus that results when quantity of a good that is
bought and sold is below the market equilibrium quantity
 Missing Market We say a market is missing, there is no place for potential buyers and
sellers to exchange a good or service