The Framework

of
Financial Management
Application of MICROECONOMIC THEORY

Prepared by: Maria Christina L. Candelario

Topics:
• Introduction to MICROECONOMICS
• Demand
 Nature
 Demand Curve Shift
 Factors affecting the Demand of a
product other than its Price
 The elasticity of Demand
• Supply
 Nature
 Supply Curve Shift
 Factors affecting the Supply of a
Product Other than its Price
 Elasticity of Supply
• Market Equilibrium and Pricing
 Impact on Equilibrium of Shifts in
the Supply and Demand Schedule
 Short-run total costs
 Long-run total costs
 Profits
 Production
 Marginal Product
• Money
 The Role of Money in the Economy
 The supply and Demand for Money
< Money supply
< The Demand for money
 The Impact of Money
 The Quantity Theory of Money
• Interest Rates
 How Interest Rates are
Determined
 Money Market Equilibrium
 The Nominal or Money Rate Versus
the Real Rate of Interest
 Interest Rates Risk
 Effect of Change in Interest
Rates
Microeconomics
- Deals with the behaviours of individual and firms
in making decisions regarding the allocation of scarce
resources.

Demand
- defined as, the amount of a commodity people are
willing and able to buy at all possible prices and in a
given time.

The Law of Demand

- an increase in a goods price causes a decrease in
the quantity demanded and a decrease in price causes an
increase in the quantity demanded.
Price – Up Quantity Demanded –Down
Price –Down Quantity Demanded –Up
Demand Curve
- A graph that plots all the possible
combinations of prices and quantities
demanded.

P
5

4
D
3

Q
1 2 3 4 5
Reasons for Downward Slope

 Income Effect
- any increase or decrease in consumers
purchasing power caused by a change in price.
I have $30 to spend on video games:
Ex. Video game prices increase from $50 to $60

 Substitution Effect
- The tendency of consumers to substitute a
similar, lower priced product for another product
with a higher price.

Ex. Laundry detergent

Diminishing Marginal Utility

• Utility
Usefulness of a product or the amount of
satisfaction an individual receives from a
product.

• Diminishing Marginal Utility

- The more of a product that is consumed, the
satisfaction from each additional unit declines.

• Marginal: Means one additional unit

At some point consumers cannot use any more of a
product.
 Demand Schedule
A way to show the relationship between the
price of a good and the quantity that consumers
demand.

Price $ Quantity
Demanded

$5.00 1
$4.00 2
$3.00 3
$2.00 4
$1.00 5
 FACTORS THAT INFLUENCE QUANTITY
DEMANDED

• Price of the commodity itself

• Price of other commodities which are
related to the good in question (be they
substitute
or complementary)
• Consumer income
• Consumer taste and preference for the good
• Advertisement
• Consumer expectation about future prices
• Size of population and its composition
Price Elasticity of Demand
- is how economists measure the responsiveness of
quantities demanded to changes in prices.

Price elasticity of demand = % change in qty. demanded

% change in price

Ex:

500 kilos – 450 kilos = -10 %

P1 – P1.20 = 20%

10%/20% = - 0.5 Inelastic

Elastic demand
- means that the quantities demanded respond more than
proportionately to changes in price; >1

Inelastic demand
- means that the quantities demanded respond less than
proportionately to changes in price; <1
 Two extreme cases of Price Elasticity of Demand

 Perfectly Inelastic
 Perfectly elastic
Demand is:

 Unit-elastic if the price elasticity of demand is exactly 1.

 Elastic if the price elasticity of demand is greater than 1.
 Inelastic if the price elasticity of demand is less than 1
Elasticity and Total Revenue
Supply
- as a commodity is defined as the quantity of
that commodity sellers are willing to
put in the market at a given price and at a given
time.

Law of Supply
- more goods and services are supplied when
they can be sold at higher prices, and fewer
goods and services are supplied when they must be
sold at lower prices.

P Q
 Supply Schedule
The quantity of a product that a producer is
willing to supply at a various prices.

Price Quantity
Supplied
1.00 4,000

2.00 9,500

3.00 14,500
Supply curve
Price 5 Supply

1
1 2 3 4 5
Quantity
Factors that influence supply

• The price of the commodity

• Objectives of the firm
• The technology used
• The cost of production incurred by
producers
• Taxation policies of the government
• Weather condition
• Price of competing products
• Peace and stability
• Infrastructure
Price Elasticity of Supply
- measure the responsiveness of quantity of a good
supplied to the price of the good.

Price elasticity of supply = % change in qty. supplied

% change in price
Equilibrium
- state of rest. It is a situation whereby quantity
demanded (Qd) is equal to quantity supplied (Qs) or Qd
= Qs
Effects of shifts of demand/supply curve on equilibrium

1. Increase in Demand, Increase in Supply

2. Increase in Demand, Decrease in Supply
3. Decrease in Demand, Increase in Supply
4. Decrease in Demand, Decrease in Supply
1. Increase in Demand, Increase in Supply
1. Increase in Demand, Increase in Supply
2. Increase in Demand, Decrease in Supply
2. Increase in Demand, Decrease in Supply
3. Decrease in Demand, Increase in Supply
3. Decrease in Demand, Increase in Supply
4. Decrease in Demand, Decrease in Supply
4. Decrease in Demand, Decrease in Supply
Short-run total costs Long-run total costs
= VC + FC
Profit- Total revenue – total cost

Production- this is the creation of goods and services

through the transformation of inputs into outputs

Marginal Product- is the additional output that is

generated by an additional worker.
The role of money in the economy

• By serving as a medium of exchange

• Unit of account
• By acting as a store of value

Demand for money –the desired

holding of financial assets in the
form of money.

Money supply – total amount of

monetary assets available in an
economy at a specific time.
Quantity theory of money
- states that money supply and
price level in an economy are in
direct proportion to one another.
M x V = P x Y

Interest rates
- it is the rate a bank or other
lender charges to borrow its money,
or the rate a bank pay its savers for SM
Int.
keeping money in an account. rate

Money market equilibrium

IR e ------------------
- the quantity of money demanded
equals the quantity of money DM
supplied.

Quantity of money
 Nominal rate vs. Real rate

Nominal interest rate

- refers to the interest rate before taking
inflation into account.

Real interest rate

- is an interest rate that has been
adjusted to remove the effects of inflation
and gives the real rate of bond or loan.

P100 Principal
8% interest rate
5% inflation rate
Interest rate risk
- is the potential that a change in
overall interest rates will reduce the value
of a bond or other fixed-rate investment.

Example: An investor buys a five year $500

bond with a 3% coupon. Then interest rate
rises to 4%.
Resources:
• (1) (PDF) Introductory Microeconomics
www.academia.edu
• ECON 150: Microeconomics
courses.byui.edu
• THE ROLE OF MONEY AND INTEREST RATE
www.jstor.org
• Elasticity of demand
www.slideshare.net
• 3.1. Nature of demand
www.slideshare.net
• Introduction to monetary policy
courses.lumelearning.com