Micro Economics

Definition
Microeconomics attempts to examine how supply and demand
decisions made by consumers, firms and industries affect the selling
prices of goods and services within an industry or market.
Concepts of Demand and Supply
• Definition: Demand for a product or service can be defined as the
quantity that the consumers desire to buy at a particular point of time
and a particular price, backed by their ability to buy and willingness to
spend.
There are several factors that affect demand of
a good or service.
• Price of the good
• Income of the consumer
• Taste and preferences
• Fashion/ whether
• Substitute goods
• Complementary goods
• Advertisement
• Expected rise in the price of good
Note
• A Complementary good is a product or service that adds value to
another. In other words, they are two goods that the consumer uses
together. For example, cereal and milk, or a DVD and a DVD player. On
occasion, the complementary good is absolutely necessary, as is the
case with petrol and a car.
• Substitute goods is a product or service a consumer sees as the same
or similar to another product. Put simply, a substitute is a good that
can be used in place of another. They provide more choices for
consumers, who are then better able to satisfy their needs. Coca-cola
and Pepsi. Car, motorbike, bike and public transport. Butter and
margarine. Tea and coffee. Bananas and Apples. Cigarettes and e-
cigarettes.
Law of Demand
Definition of law of demand.
• Law of demand is price and demand have an inverse relationship
“when other factors remain constant”
The graph below illustrates how demand of a
certain product can be plotted on a graph.
• The slope in the graph shows that the demand curve has a negative
slope(downward slope), meaning that quantity demanded has an
inverse relationship with price. The higher the price of a product, the
lower the quantity demanded
Supply
• Definition: The concept of supply refers to the quantity of a good that
existing suppliers or would want to produce for the market at a given
price.
There are several factors that affect supply of
a product, these include:
• Cost of production(factors of production)
• Government subsidies(example of a subsidy. When the government gives
money to a farmer to plant a specific farm crop, this is an example of a
subsidy. When you are given a partial scholarship to college, this is an
example of a subsidy.)
• Price of substitutes and complementary.
• Expectations of price changes
• Changes in technology
• Other factors like changes in weather, natural disasters and fashion
• Tax policy
• Price of the good.
Law of Supply
• Law of supply is price and supply have a direct relationship “when
other factors remain constant”
The graph below illustrates how supply of a
certain product can be plotted on a graph
• In the graph, it is shown that the supply curve has a positive
slope(upward slope) meaning that the movement from point A to
point B suggests that every time the price increases, the quantity
supplies also increases.
Equilibrium
`
price demand supply market situation

5 1 5 surplus
4 2 4 surplus
3 3 3 equillibrium
2 4 2 shortage
1 5 1 shortage
SHIFT IN DEMAND CURVE & SUPPLY CURVE
• A Movement refers to a change along a curve. On the demand curve
and supply curve, a movement denotes a change in both price and
quantity demanded and supply from one point to another on the
curve.
• Meanwhile, a Shift in a demand or supply curve occurs when a good's
quantity demanded or supplied changes even though price remains
the same.
SHIFT IN DEMAND CURVE
When there is a change in the conditions of demand the quantity
demanded will change even if a price remains constant. The shift could
be caused by any of the following conditions of demand:
A rise in income
A rise in the price of substitute
A fall in the price of complement
A change in taste
An increase in population etc
Graph
SHIFT IN SUPPLY CURVE
A shift occurs when supply conditions other than the price of the good
itself change. Factors which influence the supply curve.
• A fall in the factor of production
• A fall in the price of other goods
• Technology progress
• A decrease in the taxes. etc
Graph
Practice
Which one of the following would cause the supply curve for a good to
shift to the right (outwards from the origin)?
a) A fall in the price of the good (movement)
b) An increase in the demand for the good
c) A fall in production costs of the good
Practice
Which one of the following would not lead directly to a shift in the
demand curve for overseas holidays?
a) An advertising campaign by holiday tour operators (rightward shift)
b) A fall in the disposable incomes of consumers (leftward shift)
c) A rise in the price of domestic holidays (rightward shift)
d) A rise in the price of overseas holidays (because this is the reason of
movement)
Practice
The demand curve for a product will shift to the left when there is:
a) A rise in household income (rightward)
b) An increase in the product's desirability from the point of view of
fashion (rightward)
c) A fall in the price of a substitute (leftward)
d) A fall in the price of a complement (rightward)
Elasticity of Demand
Definition: Demand elasticity is a term used to describe the degree of
responsiveness of quantity demanded of a good / service to changes in
any of the determinants of demand.
Elasticity of demand can be measured using
three determining factors
Price Elasticity of Demand
Definition: is a measure of the extent of change in the market demand
for a good in response to a change in its price.
Price elasticity of demand (PED) can be measured as:
calculation
• %∆ in Qd = Percentage Change in Quantity Demanded. The
Percentage Change in Quantity Demanded is the New Quantity
Demanded minus the Old Quantity Demanded divided by the Old
Quantity Demanded.
• %∆ in P = Percentage Change in Price. This is the New Price minus the
Old Price divided by the Old Price.
Question. Price elasticity of demand
Consider we are selling a product at a price of 20 Rs with a resulting
demand of 500000 units. A marketing manager has suggested dropping
the price to 19 Rs and claim that demand will rise to 550000 units . So
what is price elasticity of demand.
solution
Percentage change in quantity demanded=0.1
Percentage change in price= -0.05
Price elasticity = -2
Ignore the minus sign in price elasticity of demand
so the price elasticity in this scenario is 2
In a price elasticity of demand after calculate the formula we have to
point out that good is either
Elastic good >1
Inelastic good < 1
Unit elastic good = 1
Elastic good
• Elastic goods are those goods where there is a minor change in price
leads towards a major change in demand.
Goods which are elastic tend to have some or all
of the following characteristics.
• They are luxury goods, e.g. sports cars
• They are expensive and a big % of income e.g. sports cars and
holidays
• Goods with many substitutes and a very competitive market. E.g. if
Sainsbury’s put up the price of its bread there are many alternatives,
so people would be price sensitive.
• Bought frequently
• Perfectly Elastic Demand. When the percentage change in quantity
demanded is infinite even if the percentage change in price is
zero(there is no change in price), the demand is said to be perfectly
elastic.
• Perfectly Elastic Demand. If demand is perfectly elastic, it means that
at a certain price demand is infinite (A good with a very high elasticity
of demand). In other words, if a firm increased the price by 1%, it
would see all its demand evaporate. If demand is perfectly elastic,
then demand will be horizontal
• Example of perfectly elastic is good with too many substitutes in the
market is perfectly elastic good.
Inelastic good
In elastic goods are those goods where there is a major change in price
leads towards a minor change in demand.
Goods which are inelastic tend to have some
or all of the following features:
• They have few or no close substitutes, e.g. petrol, cigarettes.
• They are necessities, e.g. if you have a car, you need to keep buying
petrol, even if price of petrol increases
• They are addictive, e.g. cigarettes.
• They cost a small % of income or are bought frequently
In the short term demand is usually more inelastic because it takes
time to find alternatives
If the price of chocolate increased demand would be inelastic because
there are no alternatives, however if the price of Mars increased there
are close substitutes in the form of other chocolate therefore demand
will be more elastic.
Perfectly Inelastic Demand
• Perfectly Inelastic Demand. When the percentage change in quantity
demanded is zero no matter how price is changed, the demand is said
to be perfectly inelastic.
• An example of perfectly inelastic demand would be a lifesaving drug
that people will pay any price to obtain. Even if the price of the drug
were to increase dramatically, the quantity demanded would remain
the same.
Unit elastic good
Unit elastic demand is referred to as a demand in which any change in
the price of a good leads to an equally proportional change in quantity
demanded. In other words, the unit elastic demand implies that the
percentage change in quantity demanded is exactly the same as the
percentage change in price.
Income elasticity of demand
Definition: The income elasticity of demand for a good indicates the
responsiveness of demand to changes in household incomes. When
household income rises people will not only increase their demand for
existing goods but also start to demand new goods which they could
not previously afford.
Income elasticity of demand (IED) can be measured as:
• After calculate the income elastic formula we have to point out that
good is either
Normal good (+ve positive answer)
Inferior good (-ve negative answer)
Inferior good definition
• An inferior good is an economic term that describes a good whose
demand drops when people's incomes rise.
• Other examples of an inferior good are no-name grocery store
products such as cereal or peanut butter. Consumers may use the
cheaper store brand products when their incomes are lower, and
make the switch to name brand products when their incomes
increase.
Normal good definition
• A normal good is a good that experiences an increase in its demand
due to a rise in consumers' income.
• normal good is a good that experiences an increase in its demand
due to a rise in consumers' income. Normal goods has a positive
correlation between income and demand. Examples of normal goods
include food staples, clothing, and household appliances
Cross Elasticity of Demand
Definition: Cross elasticity of demand is a term used to describe the
degree of responsiveness of quantity demanded of a good/service to
changes in the price of any of its related (substitutes or
complementary) goods.
Cross elasticity of demand (CED) can be measured as:
Factors influencing CED
Factor Influence
Substitute Substitutes are products that can be used interchangeably for
example cars from different companies are considered
substitutes. If price of one car increases, customers will shift to
cars from different companies. This will lead to a positive cross
elasticity of demand.
Complement Complements are products that are used with each other for
example cars and gasoline. If price of gasoline was to increase,
demand for gasoline would fall along with the demand for cars
as people would prefer shifting to public transport. Hence cross
elasticity of demand for complements would be negative, as
demand for product would decrease if price of complements
was to increase.
Cross-elasticity Value Example
Perfect complements -1
Complements -ve Bread and butter
Unrelated products 0 Bread and cars
Substitutes +ve White bread and brown bread
Perfect substitutes +1
Types of competition
• Read From word document
Economic Behavior of Costs
Economic behavior of costs tends to vary overtime.
Short term Cost Behavior:
Costs in the short term can be classified into variable and fixed costs.
• Total fixed cost (TFC): these costs are independent of the level of
production of a firm. Regardless of the business’s activity, these costs tend
to be constant.e.g leases office space for $10000 per month, rents
machinery for $5000 per month etc
• Average fixed cost (AFC): determined by dividing TFC by number of units
produced. The average fixed cost decreases with increase in production
activity as denominator increases reducing the average costs.
Example of average fixed cost
Assume a firm produces clothing. When the quantity of the output
varies from 5 shirts to 10 shirts, fixed cost would be 30 dollars. In this
case, average fixed cost of producing 5 shirts would be 30 dollars
divided by 5 shirts, which is 6 dollars.
• Total variable cost (TVC): these costs increase with increase in
production activity. They are directly proportional to the units
produced. The higher the units produced, the higher the variable
costs. Examples of variable costs are sales commissions, direct labor
costs, cost of raw materials used in production, and utility costs. The
total variable cost is simply the quantity of output multiplied by the
variable cost per unit of output
• Average variable cost (AVC): determined by dividing TVC by number
of units produced.
• Total cost (TC): this can be calculated as TFC + TVC
Marginal cost (MC): this refers to the additional cost incurred by a firm
in an attempt to produce an additional unit of product / service
marginal cost includes all of the costs that vary with the level of
production. For example, if a company needs to build a new factory in
order to produce more goods, the cost of building the factory is a
marginal cost. The amount of marginal cost varies according to the
volume of the good being produced.
In the short term, micro economists believe that costs follow the law of
diminishing returns. As equal quantities of one variable factor of input
such as labor are added to a fixed factor, output initially increases by a
greater proportion, increasing returns and causing the average cost per
unit to fall. However, beyond a certain point, the addition to output will
begin to decrease and the average cost per unit will start to rise again.
Increasing the number of workers in a factory could initially increase
production and may lead to an increased output but as workers keep
increasing, they are more likely to cause an overall decrease in output.
This decrease would occur due to various reasons like conflicts, getting
in each other’s way leading to an overall fall in productivity.
Law of diminishing return
used to refer to a point at which the level of profits or benefits gained is
less than the amount of money or energy invested.
Long Term Cost Behavior
In the long term, all costs tend to be variable in nature. This is because
it is now possible to vary the quantities of any factors that were fixed in
the short term. Many costs that cannot be managed and reduced in
short term are all variable in the long run.
Eventually, however, as the business expands, it will tend to become
less efficient at controlling costs due to poor management and pressure
on supplies. This effect is sometimes referred to as diseconomies of
scale and results in the average cost of production increasing.