Microeconomics

Chapter 1: Introduction to
Economics
Learning Objectives
At the end of this chapter, the students should be able
to:

1. Differentiate between economics as a social science and

as an applied science;
2. Apply the concept of opportunity cost when evaluating
options and making economic decisions;
3. Make decisions based on how man can satisfy most of
his wants given limited resources;
4. Differentiate macroeconomics and microeconomics;
5. Describe and state the importance of economic
resources;
6. Differentiate positive and normative
economics;
7. Differentiate gross national product and gross
domestic product;
8. Identify the basic problems of the Philippine
economy;
9. Analyze basic economic problems and propose
solutions to the problem using the principles of
applied economics; and
10. Describe the various economic systems.
Introduction to Economics
People always complain about not having enough---not
enough food on table, not enough money to pay one’s
debts, or not enough income to meet all the family’s
needs.

• Scarcity is the condition where there are insufficient

resources to satisfy all the needs and wants of a
population.
Scarcity is the reason why people have to practice economics.

• Economics as a study, is the social science that

involves the use of scarce resources to satisfy unlimited
wants.
Scarcity: Relative or Absolute

• Relative scarcity
▫ Is when a good is scarce compared to its demand.
▫ Occurs because of the circumstances that
surround the availability of the good.
• Absolute scarcity
▫ is when a supply is limited.
Choice and Decision-Making
• Opportunity cost refers to the value of the best forgone
alternative.

Example:
The opportunity cost of watching a movie in cinema is the
value of other things that you could have bought with
that money such as a pint of ice cream , a combo meal in
a fast food o a simple t-shirt to be used in a PE class.

A manager who quits his job in order to take up master’s

degree, gives up his salary as a manager. That salary is
his opportunity cost.
Economic resources, also known as factors of
production, are the resources used to produce
goods and services.

• 1. Land – soil and natural resources that are

found in nature and are not man-made.
• 2. Labor – physical and human effort exerted in
production.
• 3. Capital - man-made resources used in the
production of goods and services, which include
machineries an equipment.
Economics as a Social Science

• It studies human behaviour just like psychology

and sociology.
• The study of society and how people behave and
influence the world around them.
• It studies how individuals make choices in
allocating scarce resources to satisfy their
unlimited wants.
Branches of Economics

• Macroeconomics
• Microeconomics
• Macroeconomics is a division of economics
that is concerned with the overall performance
of the entire economy. Macroeconomics is about
the nature of the economic growth, expansion of
productive capacity and growth of national
income.
• Microeconomics is concerned with the
behaviour of the individual entities such as
consumer, the producer, and the resource
owner. It is more concerned on how goods flow
and move from the business firm to the
consumer.
Microeconomics is also concerned with the
process of setting prices of goods that is also
known as Price Theory.
Basic Economic Problems of Society

• 1. What to produce and how much

• 2. How to produce
• 3. For whom to produce
Economic Systems
Economic system is the means through which
society determines the answers to the basic
economic problem mentioned.
Types of Economic System
• 1. Traditional economy. Decisions are based
on tradition and practices upheld over the years.
• 2. Command economy. Authoritative system
wherein decision-making is centralized in
government or a planning committee.
• 3. Market economy. Most democratic form of
economic system. Decisions are based on the
workings of demand and supply, and on what
goods and services to produce.
Why economics is important?
• Understand why there is a need for everybody, including
the government, to budget and properly allocate the use
of whatever resources are available.

• Understand how to make more rational decisions in

spending money, saving part of it, and even investing
some of it.

• Enable us to take a look on how economy operates and

decide for ourselves if the government officials and
leaders are effective in shaping up the economy.
Scientific Approach in the Empirical
Testing of an Economic Theory
Economics is a study that attempts how an
economy operates and how the consumer
attempts to maximize his/her wants within
limited means.
Scientific approaches:
1. State the propositions or conditions that are
taken as given and do not need further
investigation, as basic starting point of
investigation. These proposition will serve as the
premises upon which the theory is established.
2. Observe facts in connection with the activity
that we want to theorize.
3. Apply the rules of logic to the observed facts to
determine causal relationships between observed
factors and to eliminate facts that are unnecessary
and irrelevant.
4. Establish a set of principles such that
formulated hypotheses may be tested as to
whether they are valid or not.
5. Use statistics and econometrics as empirical
proof in the testing the hyphotheses.
Positive economics vs. Normative
economics
• Positive economics
▫ deals with what is – things that are actually
happening that is possibly far from what is ideal
Example: current inflation rate, number of employed labor, level of gross
national product
• Normative
▫ Refers to what should be – that which embodies
the ideal and focuses on policy formulation that
will help attain the ideal situation.
Example: Ideal rate of the population or effective tax system
Gross National Product (GNP)
▫ Is the market value of final products, both
sold and unsold, produced by the resources
of the economy in a given period.
GNP/GDP: Expenditure Approach
GNP = C + I + G+ (X-M)

where;
C = household and individual consumption
G = government expenditure on goods and services including labour
X = export
I = investments
M = import components
Gross Domestic Product (GDP)
▫ Is the market value of final products produced
within the country.

Net Inflow = Inflow – Outflow

To
–Net Inflow = -Inflow + Outflow
GNP/GDP: Income Approach
• Another way to account GNP and classify its
components is by resource uses and
contributions that make up the production
stages.
• In conclusion, all products and their values are
the contributions of these essential factors of
production.
Economics as an Applied Science
• Applied economics is the application of
economic theory and econometrics in specific
settings with the goal of analyzing potential
outcomes.
Applying economic theory in our lives means
trying to address actual economic issues and be
able to do something about it.
Applied Economics in Relation to
Philippine Economic Problems

• A solid understanding of economic principles

and how they are applied in real life situation
can serve as significant tools to help address the
country’s economic problem.

Example: Understanding the existence of scarcity

can help everyone analyze how to maximize the
use of available resources in order to overcome
scarcity.
Economic Problems of the Philippines

• Unemployment
• Poverty
• Booming Population growth
Booming population

Source: Philippine Statistics Office

Chapter 2: Application of Demand and
Supply
Learning Objectives
At the end of this chapter, the students should be able to:

• 1. Explain the law of supply and demand and illustrate

how equilibrium price and quantity are determined;
• 2. Discuss and explain the factors that affect demand and
supply;
• 3. Reason effectively how a change in demand or supply
or in both can affect equilibrium price and equilibrium
quantity;
• 4. Apply the principles of demand and supply to
illustrate how prices o commodities are determined;
• 5. Distinguish between elastic and inelastic demand and
supply.
• 6. Describe the characteristics and distinguish the features of the
market structures (perfect competition, monopoly, monopolistic
competition, and oligopoly);
• 7. Relate population growth with the country’s labor supply and
apply the law of demand and supply in the determination of wages
of labor;
• 8. Deduce how the excess supply of labor has led to the
phenomenon of the Overseas Filipino Worker;
• 9. Analyze how demand and supply forces can affect the value of the
Philippine peso in relation to foreign currencies;
• 10. Apply the law of demand and supply to Philippine housing
shortage and show how this has led to the real estate boom in the
country;
• 11. Understand how savings channeled into investments can affect
economy;
• 12. Explain the concept of minimum wage; and
• 13. Discuss why it is necessary for the government to impose taxes.
Basic Principles of Demand and Supply
• Marketing is an interaction between buyers and
sellers of trading or exchange.

• Good market
 Most common type of market
 Where we buy consumer goods
• Labor market
 Where workers offer services and look for jobs
 Where employers look for workers to hire
• Financial market
 Includes stock market where securities of
corporations are traded.
Significance

• The tools of demand and supply can be

applied to a range of important topics such as:
▫ evaluating how global weather conditions will affect
agricultural production and market prices of
agricultural commodities;
▫ assessing the impact of government rent control on
dormitory space;
▫ understanding how taxes, subsidies, and other
government policies affect both consumers and
producers.
The Concept of DEMAND
• Demand - refers to the various quantities of a
good or service that consumers are willing to
purchase at alternative prices, ceteris paribus.

▫ Conveys both the elements of desire for the

commodity and capacity to pay (must be willing and
able).
▫ Emphasizes the relationship between quantity bought
and its price, although there may be other factors that
determine how much a consumer wants to purchase.
The Law of Demand

• Asserts that the quantity demanded of a good or

service is negatively or inversely related to its
own price.
▫ When the price increases, less of the good or
service will be bought
▫ When the price decreases, more of the commodity
will be purchased.

WHY SO?
Two Reasons for the Inverse
Relationship
• Substitution effect
▫ Is felt when a price of a good changes demand due
to alternative consumption of substitute goods.
▫ When price of a demand decreases, the consumer
substitutes good increases.
• Income effect
▫ When price decreases, the consumer’s real income
(or purchasing power) increases, so he tends to
buy more.

P Q
3 Ways of presenting
the demand relationship
The relationship between quantity purchased
and alternative prices may be presented in 3
ways:
• Demand schedule –in tabular form.
• Demand curve – in graphical form
• Demand function – in equation form
Demand Schedule
TABLE 3.1. Demand Schedule for Denim Pants

Price of Denim Pants Quantity Demanded per month

(in pesos) (No. of pairs)
0 8
50 7
100 6
150 5
200 4
250 3
300 2
350 1
400 0
Demand Curve
P

400
Price (in pesos)

300

200

100
D

0 2 4 6 8
Q

Quantity

Figure 3.1. Demand Curve. The negative slope of the

demand curve depicts the inverse relationship between
price and quantity demanded.
Demand Function
• Quantity demanded (Q) is expressed as a
mathematical function of price (P). The demand
function may thus be written as:

Qd = a - bP
where
▫ a is the horizontal intercept of the equation or the
quantity demanded when price is zero
▫ (-b) is the slope of the function.
• Example: Qd = 8 – 0.02P
Factors Affecting Demand
1. Price of the commodity
2. Prices of related commodities (substitutes and
complements)
3. Consumer incomes
4. Tastes and preferences
5. Number of consumers
6. Price expectations
Change in Quantity Demanded vs.
Change in Demand
• Change in quantity demanded – is a movement
along the same demand curve, due solely to a
change in price, i.e., all other factors held
constant.
• Change in demand – is a shift in the entire
demand curve (either to the left or to the right)
as a result of changes in other factors affecting
demand.
Change in quantity demanded
Price
•A decrease in price from p1
p3 to p2 brings about an
p1 increase in quantity
demanded from q1 to q2
•It is shown as a movement
along the same demand
p2 curve

Quantity
q3 q1 q2
 Change in demand
•An increase in demand
Price means that at the same price
such as p1 more will be
brought, due to other factors
such as increased incomes,
p1 increase in number of
consumers, etc.
•It is shown as a shift in the
entire demand curve

This is a
decrease in
demand D1

D0
D2
Quantity
q1 q2
 Change in Demand
P P

D’ D
D’
D

Q Q

Increase in Demand Decrease in Demand

Other factors affecting demand
• Income: as income changes, demand a
commodity usually changes
▫ Normal goods – are goods whose demand respond
positively to changes in income.
 Most goods are normal goods. As income increases,
more of shoes, TVs, clothes, are bought.
▫ Inferior goods – are goods whose demand respond
negatively to change in income
 Few but existent. Examples are firewood, “tuyo”,
“adidas or chicken feet”, bicycles, etc.
Other factors affecting demand
• Prices of related commodities in
consumption:
▫ Substitutes – are goods that are substitutable with
each other (not necessarily perfect).
 Examples are coffee and tea, Coke and Pepsi, beer and ginebra.
 When the price of a good increases, the demand for that good
will decrease while the demand for its substitute will increase. -
-- Py Qx (inverse relationship)
▫ Complements – are goods that are used or consumed
together.
 Examples are coffee and sugar, bread and butter, tennis rackets
and tennis balls.
 When the price of a complement increases, quantity bought of
a good decreases. --- Py Qx  (direct relationship)
Other factors affecting demand
• Consumer tastes and preferences:
▫ When consumer tastes shift towards a particular good,
greater amounts of a good are demanded at each price.
 Example: consumers preference for drinking mineral water
increases so its demand curve will shift rightward.
▫ If consumer preferences change away from a good, its
demand will decrease; at every possible price, less of
the good is demanded than before.
 Example: the demand for VCDs and VHS tapes decreases due
to preference for DVDs.
Other factors affecting demand
• Consumer expectations: Expectations about
future prices and income affect our current
demand for many goods and services.
▫ If we expect prices of dried fish to increase with
coming of the rainy season, we might stock up on the
good to avoid the expected price increase. Thus,
current demand for dried fish might increase
▫ those who expect to lose their jobs due to bad
economic conditions, will reduce their demand for a
variety of goods in the current period.
Other factors affecting demand
• Number of Consumers: affects the total
demand for a good.
▫ Total demand is also known as market demand. It is
the summation of the individual demand of all
consumers
• An increase in the number of consumers shifts
the market demand curve to the right
▫ Example: demand for housing and transportation
increases with an increase in population.
• On the other hand, less consumers will cause the
market demand to decrease, resulting in a shift
to the left of the entire demand curve.
The Concept of SUPPLY
• Supply - refers to the various quantities of a
good or service that producers are willing to sell
at alternative prices, ceteris paribus.

▫ Obviously, firms are motivated to produce and sell

more at higher prices.

▫ Emphasizes the relationship between quantity sold of

a commodity and its price. However, there are other
factors that determine how much a producer would
like to produce and sell.
The Law of Supply

• States that the quantity sold of a good or service

is positively or directly related to its own price.
▫ When the price increases, more of the good or
service will be sold
▫ When the price decreases, less of the commodity
will be purchased.
3 Ways of presenting
the supply relationship
The relationship between quantity supplied and
alternative prices may be presented in 3 ways:
• Supply schedule –in tabular form.
• Supply curve – in graphical form
• Supply function – in equation form
Supply Schedule
TABLE 3.2. Supply Schedule for Denim Pants

Price of Denim Pants Quantity Supplied per month

(in pesos) (No. of pairs)
0 0
50 1
100 2
150 3
200 4
250 5
300 6
350 7
400 8
Supply PCurve
400
S
Price (in pesos)

300

200

100

0 2 4 6 8
Q

Quantity

Figure 3.2. Supply Curve. The positive slope of the supply

curve depicts the direct relationship between price and
quantity supplied.
Supply Function
• Quantity supplied (Qs) is expressed as a
mathematical function of price (P). The supply
function may thus be written as:

Qs = c + dP
where
▫ c is the horizontal intercept of the equation or the
quantity supplied when price is zero
▫ d is the slope of the function.
• Example: Qs = 0 + 0.02P
Change in Quantity Supplied vs.
Change in Supply
• Change in quantity supplied – is a movement
along the same supply curve, due solely to a
change in price, i.e., all other factors held
constant.
• Change in supply – is a shift in the entire supply
curve (either to the left or to the right) as a result
of changes in other factors affecting supply.
Change
Price
in quantity supplied
S

•An increase in price from p1

to p2 results in an increase in
quantity supplied from q1 to
p2
q2
•It is shown as a movement
along the same supply curve
p1

Quantity
q1 q2
 S2 S0

Change
Price
in supply S1

•An increase in supply

p1 means that at the same price
such as p1 more will be sold,
due to other factors such as
improvement in technology,
increase in number of
producers, etc.
This is a
decrease in •It is shown as a shift in the
supply entire supply curve

Quantity
q1 q2
 Change in Supply S’
P S P
S
S’

D’ D

Q Q

Increase in Supply Decrease in Supply

Other factors affecting supply
• There are other factors aside from price that
affect the supply schedule. These are
1. resource prices
2. prices of related goods in production
3. technology
4. expectations
5. number of sellers.
Other factors affecting supply
• Resource prices:
▫ When prices of inputs to production increase,
the supply of the firm's product decreases.
▫ Decreases in resource prices, however, translate
to an increase in supply. The entire supply curve
shifts to the right.
Other factors affecting supply
• Prices of related goods in production:
▫ Resources can be employed to produce several
alternative goods and services.
▫ Examples from agriculture:
 a piece of farmland can be used to grow rice, corn, or
sugarcane. An increase in price of sugarcane may result in
decreased supply of rice and corn.
 farmers can use their land and labor to produce
ornamental flowers instead of vegetables. If vegetable
prices decrease, the supply of ornamental flowers may
increase.
Other factors affecting supply
• Technology: A change in production
techniques can lower or raise production costs
and affect supply.
• Improvements in technology shift the supply
curve to the right.
▫ A cost-saving invention will enable firms to produce
and sell more goods than before at any given price.
▫ New high yielding crop varieties will increase
production on the same amount of land.
Other factors affecting supply
• Producer expectations:
▫ When producers expect the price of their product to
increase in the future, they may hoard their output
for later sale, thus reducing supply in the present
period. Thus the supply curve shifts to the left.
▫ If firms expect that the price of their product will fall
in the near future, supply may increase in the
current period as firms try to increase production as
well as to dispose of their inventory.
Other factors affecting supply
• Number of sellers: As the number of sellers
increases, so will total supply.
▫ The market supply is the horizontal summation of
the supply schedules of individual producers.
▫ As more firms enter the market, more will offered
for sale at each possible price, thus shifting the
supply curve to the right.
▫ Similarly, the supply curve shifts to the left when
firms exit the market.
Market Equilibrium
• Market equilibrium is that state in which the
quantity that firms want to supply equals the
quantity that consumers want to buy.
▫ The price that clears the market is called the
equilibrium price and the quantity (sold and
bought) is called the equilibrium quantity.
▫ The market is said to be "at rest" since the equilibrium
price and equilibrium quantity will stay at those levels
until either demand or supply changes.
 Market Equilibrium
TABLE 3.3. Market for Denim Pants
Quantity Demanded Quantity Supplied
Price of Denim Pants per month per month
(in pesos) (No. of pairs) (No. of pairs)
0 8 0
Equilibrium 50 7 1
Price=200 100 6 2
150 5 3
200 4 4
250 3 5
300 2 6
350 1 7
400 0 8

Equilibrium
Quantity=4
Market Equilibrium
• At prices above the equilibrium price, quantity supplied
is greater than quantity demanded, resulting in a
temporary surplus.
▫ In a surplus situation, producers will try to reduce price to entice
consumers to buy more denim pants. Actions by both producers
and the public will wipe out the temporary surplus
• At prices below the equilibrium price, consumers desire
to buy more denim pants than are available, creating a
temporary shortage.
▫ Consumers will try to outbid each other, thus pushing up the
price. As price rises, firms increase their production while some
consumers reduce their purchases.
Market Equilibrium
P

400
S

Surplus
Price (in pesos)

300

200

100
Shortage

0 2 4 6 8
Q

Quantity
Market Equilibrium
• Algebraic solution: equate the demand and
supply equations (Qd=Qs).
Qd = 8 - 0.02P
Qs = 0 + 0.02 P
▫ Step by step solution:
 8 - 0.02P = 0 + 0.02 P
 0.04P = 8
 P* = 8/0.04 = 200
 Qd = 8 – 0.02(200) = 8 – 4 = 4
• P* =200 per unit, Q* = 4 per month