Microeconomics for Policy

Muhammad Yudha Pratama

1 March 2023

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 The Basics of Supply and Demand

Section 1

The Basics of Supply and Demand

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 The Basics of Supply and Demand

Themes of Microeconomics

Microeconomics deals with the behavior of individual economic

units—consumers, firms, workers, and investors—as well as the
markets that these units comprise.
Trade-offs and Choices–Consumers, Firms, and Workers.
Prices and Market–One good or service market
Competitive versus noncompetitive market

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 The Basics of Supply and Demand

Supply
The higher the price, the more that firms are able and willing to produce
and sell. Other variables affecting the supply will shift the supply curve.

QS = QS (P)

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 The Basics of Supply and Demand

Demand
The lower the price, the more consumers that are willing to buy. Other
variables affecting the demand will shift the demand curve.

QD = QD (P)

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 The Basics of Supply and Demand

The Market Mechanism

The market will clear (Adam Smith called this “invisible hand”) the surplus
or the shortage of the goods such that quantity supplied equals quantity
demanded.

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 The Basics of Supply and Demand

Elasticities of Supply and Demand

Price elasticity of demand and supply

∆Q/Q ∆Q P
Ep = (%∆Q)/(%∆P) = =
∆P/P ∆P Q

Completely inelastic supply or demand has a vertical curve, while infinitely

elastic supply or demand has a horizontal curve.

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 The Basics of Supply and Demand

Short-run versus Long-run Elasticities

Short-run and long-run differ in the time frame. Durable goods has a more
flatter (more elastic) short-run demand curve compared to the long-run
demand curve. Non-durable goods has a more elastic long-run curve than
short-run curve.

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 Consumer Behaviour and Individual Demand Curve

Section 2

Consumer Behaviour and Individual Demand Curve

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 Consumer Behaviour and Individual Demand Curve

Consumer Preferences–Indifference curve

The indifference curve represents the combination of market baskets that
provide a consumer the same level of satisfaction.

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 Consumer Behaviour and Individual Demand Curve

Marginal Rate of Substitution

The amount of one good that a consumer will give up to obtain more of
another where the consumer is indifferent.

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 Consumer Behaviour and Individual Demand Curve

Budget Constraint
A budget line describes the combinations of goods that can be purchased
given the consumer’s income and the prices of the goods.

PF F + PC C = I

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 Consumer Behaviour and Individual Demand Curve

Consumer Choice
The satisfaction is maximized when

MRS = PF /Pc

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 Consumer Behaviour and Individual Demand Curve

Derivation of Consumer’s Demand

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 Exercises

Section 3

Exercises

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 Exercises

Question 1

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 Exercises

Answer 1

a. price elasticity of demand when the price is $80:

∆Q P −2 80 −2 100
∆P Q = 20 20 = −0.4. When the price is $ 100 is: 20 18 = −0.56
∆Q P 2 80
b. price elasticity of demand when the price is $80: ∆P Q = 20 16 = 0.5.
2 100
When the price is $ 100 is: 20 18 = 0.56
c. Equilibrium price and quantity are $100 and 18 million units,
respectively.
d. The Ceiling price will cause a shortage of 4 million units

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 Exercises

Question 2

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 Exercises

Answer 2
a. The demand and supply functions are QD = a + bP and QS = c + dP.
From the elasticities, we could get the slopes:
∆QD P
ϵD =
∆P QD
5
b = −0.4
15.75
,
b = −1.26
Using the same way for the supply curve, we have d = 1.575. For the
constant a and c, we could plug in to the linear function:
15.75 = a − 1.26(5), so a = 22.05, and the equation for demand is
QD = 22.05 − 1.26P 15.75 = c + 1.575(5), so c = 7.875, and the
equation for supply is QS = 7.875 + 1.575P

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 Exercises

Answer 2

b. We could use the average price and quantity instead of point elasticity:

∆Q P̄ −7.75 3.5
ϵD = = = −0.46
∆P Q̄ 3 19.625

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 Exercises

Question 3

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 Exercises

Answer 3
a and b The budget line is 100D + 400F = 4000 or D + 4F = 40

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 Exercises

Answer 3

c. Jane can afford the utility of 800 but she cannot afford utility of 1200.
d. The utility maximizing choice:
PF
MRS =
PD
MUF 10D D
MRS = = =
MUD 10F F
D
=4
F

Substituting D = 4F into the budget function D + 4F = 40 yields F = 5

and D = 20.

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