Microeconomics

National economics
university
VUKIMDUNG2001@YAHOO.COM
Microeconomics
Ass.Prof. Dr. VŨ KIM DŨNG
Microeconomic Concepts 1
TOPICS
I Introduction
II What to Produce?
How to Produce?
III
 Production & Business Organization
 Theory of the Firm
 Market structure
 Factors of Production
For Whom to Produce?
IV
WHAT IS ECONOMICS ? I
Economics is the science which studies

human behavior as the relationship
between unlimited wants and limited
resources which have alternative uses.
 Science: avoids “value judgement”

 Limited resources: most goods are “economic
goods” that have “opportunity costs”
THE ECONOMIC PROBLEM I
WHAT TO PRODUCE?
HOW TO PRODUCE?
FOR WHOM TO PRODUCE?
ECONOMIC SYSTEMS I
 Central planning
 Market economy
 Mixed economy
PRODUCTION IN DIFFERENT
I
ECONOMIC SYSTEMS
PLANNED MARKET
WHAT State Money vote

HOW State Profits
FOR WHOM State Income
Role of Prices !
CIRCULAR FLOW IN A
I
MARKET ECONOMY
Consumer demand Industry supply
PRODUCT
MARKET
HOUSEHOLDS BUSINESSES
FACTOR
MARKET
Supply of factors Derived demand
CHARACTERISTICS OF A
I
MARKET ECONOMY
 Private property
 Freedom of
enterprise & choice
 Role of self-interest
 Competition
MARKET ECONOMY - I
ADVANTAGES & DISADVANTAGES
DISADVANTAGES ADVANTAGES
 Insufficient  “Invisible hand”
competition possible  Competition
 Externalities  Production Efficiency
 Public goods  Allocative efficiency
 Other market failure  Innovation
 Cannot deal with  Decentralization of
inequality economic power
DEMAND, SUPPLY &
II
MARKET EQUILIBRIUM
 Demand: quantity a consumer is
prepared to purchase at a given price
 Supply: quantity a producer is prepared
to supply at a given price
 Market equilibrium: when total
quantity demanded equals total
quantity supplied
DEMAND II
Price
6 Quantity Price
5 Demanded
4 1 6
3
2 5
3 4
2
4 3
1
5 2
0
6 1
1 2 3 4 5 6
Quantity
MARKET DEMAND II
Price
Market demand is the sum of all
individual demands.
D1 D2 D1+D2
Quantity
FACTORS AFFECTING
II
DEMAND
 Price
Prices of other goods
Population
Income
Taste
Expectation
TYPES OF GOODS II
 Related vs. unrelated

 Unrelated
 Related
– Complements
– Substitute
 Essential vs. luxury
SUPPLY II
Price
6 Quantity Price
5 Supplied
4 1 1
3
2 2
3 3
2
4 4
1
5 5
0
6 6
1 2 3 4 5 6
Quantity
MARKET SUPPLY II
Price Market supply is the sum of all

individual supplies.
S1 S2 S1+S2
Quantity
FACTORS AFFECTING
II
SUPPLY
 Price
 Prices of other products
 Resource (factor) prices
 Taxes & subsidies
 Technology
 Expectations
 Number of sellers
MARKET EQUILIBRIUM II
Market equilibrium is achieved when

Price the quantity demanded equals the
quantity supplied.
Surplus
S
Pe e
Shortage
D
Qe Quantity
DEMAND & SUPPLY
II
SHIFTS
 ‘ Demand Supply
Shift Shift
S
S’
S
e
e’
e e’
D’ D
D
II
CONSUMER BEHAVIOR
 Consumer preferences derived from
satisfaction (“utility”)
 Law of Diminishing Marginal Utility:
As a person consumes more & more of
a good, assuming that consumption of
other goods is unchanged, the marginal
utility of that good declines.
 Law explains inverse relations between
price & quantity demanded.
II
CONSUMER SURPLUS
 Excess of what a
consumer is willing
to pay over what
Consumer
Surplus he/she actually
pays
 Hence, consumer
Demand receives more
(willingness
to pay) satisfaction than
what he/she paid
CONSUMER SURPLUS
II
EXAMPLE
Supply without Consumer surplus
project
Supply with benefits
project
Net project financial
returns
Project cost
Price
Cost
Demand
Estimating Project Benefits

PRODUCER SURPLUS II
Price  Excess of market

price over minimum
Supply
(willingness price producer
to sell) would accept for his
product
 Hence, producer
Producer
Surplus receives more than
his minimum price
Quantity
DEMAND PRICE ELASTICITY II
The price elasticity of demand (Ed) is the

proportionate change in quantity demanded
resulting from a proportionate change in price.
 Price elastic if Ed < -1

 Price with unit elasticity if Ed = -1
 Price inelastic if Ed > -1
ESTIMATING PRICE
II
ELASTICITY
Price Quantity Elasticity

Demanded
12 3
10 9 [(9-3)/3]/[(10-12)/12]=-12
8 15 [(15-9)/9]/[(8-10)/10]=-3.3
6 20 [(20-15)/15]/[(6-8)/8]=-1.3
GRAPHING PRICE
II
ELASTICITY OF DEMAND
Elastic
Infinitely Elastic
D D
Infinitely
Inelastic Inelastic
D D
PRICE ELASTICITY
II
DETERMINANTS
Determinant Elasticity Higher if:
Ease of substitution Greater ease

% of income spent % larger
on the good
Period of time Period longer
No. of new buyers More buyers
OTHER DEMAND
II
ELASTICITIES
 Income elasticity:
% change in quantity demanded resulting
from a 1% change in income.
Ey = [dQ/Q]/[dY/Y]
 Cross elasticity:
% change in quantity demanded resulting
from a 1% change in price of another good.
Ec = [dQ/Q]/[dPz/Pz]
SUPPLY PRICE ELASTICITY II
The price elasticity of supply (Es) is the

proportionate change in quantity supplied
resulting from a proportionate change in price.
 Price elastic if Es > 1

 Price with unit elasticity if Es = 1
 Price inelastic if Es < 1
PRICE ELASTICITY
II
EXAMPLE
 Tree crops like
rubber have low
supply elasticity
 But the introduction

of synthetic rubber
increased demand
elasticity for natural
rubber
DEMAND -SUPPLY
II
ANALYSIS - IMPLICATIONS
 Price controls usually lead to surpluses
or shortages...
 And to consumers’ welfare losses
 Elasticities have major implications for
consumers, producers, & policy makers
BUSINESS ORGANIZATION IIIA
 Sole proprietorship
 Partnership
 Corporation
 Cooperative
 State enterprise
ORGANIZATION FORMS - IIIA
SOLE PROPRIETOR CORPORATION
 Small, quick  Large, slow decision-
decision-making making
 Low overhead cost  High overhead cost
 Owner is manager  Owner(s) not manager
 Limited capital  More capital
 Unlimited liability  Limited liability
 Suitable for small  Suitable for large
markets markets
WHERE TO PRODUCE ? IIIA
Weight-loss in Perishable, fragile, bulky

production finished product
RAW
MARKET
MATERIALS
Non-economic
Government
factors, e.g., chance
Directors’, workers’
Nearness to
preferences
similar firms
HOW TO ORGANIZE
IIIA
PRODUCTION
 Specialization
One worker performs
only one or a few
tasks
 No specialization
One worker performs
all tasks
SCALE OF PRODUCTION IIIA
 Large:
 Technical advantages
 Commercial advantages
 Managerial advantages
 Cheaper finance
 Risks spread out
 Small:
 Adaptability
 Independence
 But limitations
OUTPUT CONCEPTS IIIB
 Total Product
The total output produced by a particular
type of input (factor of production).
 Marginal Product
The change in total output resulting from
an extra unit of variable input.
 Average Product
The level of output per unit input, or (total
output)/(Units of input).
OUTPUT CONCEPTS
IIIB
ILLUSTRATED
LABOR TOTAL MARGINAL AVERAGE
INPUT PRODUCT PRODUCT PRODUCT
0 0
1 3 3 3
2 7 4 3.5
3 12 5 4
4 16 4 4
5 19 3 3.8
6 21 2 3.5
7 22 1 3.1
LAND INPUT = 10
LAW OF DIMINISHING
IIIB
RETURNS
As successive units of a Total P
25
variable resource are Marginal P
added to a fixed 20 Average P
resource, beyond a
15
certain point the
marginal product will 10
decline.
5
Beyond a certain point,
total product will 0
decline 1 2 3 4 5 6 7
TYPES OF COSTS IIIB
 Fixed & variable
 Marginal, average &

total
 Short-run & long-

run
TYPES OF COSTS
IIIB
ILLUSTRATED
Qty Fixed Variable Total Marginal Average Av. Fixed
0 10 0 10
1 10 6 16 6 16 10
2 10 11 21 5 10.5 5
3 10 15 25 4 8.3 3.3
4 10 21 31 6 7.7 2.5
5 10 31 41 10 8.2 2
6 10 45 55 14 9.2 1.7
7 10 63 73 18 10.4 1.4
COST CONCEPTS
IIIB
GRAPHED
Total Marginal
60 Fixed
16
Average
Variable 14 Av Fixed
50
12
40
10
30 8
6
20
4
10
2
0 0
0 1 2 3 4 5 6 1 2 3 4 5 6
SHORT- VS. LONG-RUN
IIIB
AVERAGE COST
Cost Short-run average
cost curves
Long-run average
cost curve
Output
RETURNS TO SCALE IIIB
Increasing (Economies)
 Labor specialization
 Managerial specialization Minimum AC
cost
 Capital efficiency
3
Decreasing (Diseconomies)
 Managerial problems 1 2
 Factors overcrowding
Constant
BREAK-EVEN POINT IIIB
Value
Total revenue
Total cost
TR=
TC E=Break-even
point
Q Quantity
IIIC
MARKET STRUCTURE
Depends on number of
sellers, buyers
 Perfect competition
 Imperfect competition
 Monopolistic
competition
 Oligopoly
 Monopoly
IIIC
MARKET STRUCTURE
PERFECT MARKET IMPERFECT MARKET
 Many buyers, sellers  Few buyers, sellers
 Homogenous product  Differentiated product
 Free entry, exit  Restricted entry, exit
 Perfect knowledge  Imperfect knowledge
 Perfect mobility of  Immobility of factors
factors  May be a price-setter
 Price-taker
IIIC
PERFECT COMPETITION
 Firm produces at
lowest average cost Marginal cost
Av cost
 “Supernormal” SR Price
profit in short-run LR Price
 “Normal” profit in
Profit
long-run
Qe(LR) Qe(SR)
PERFECT COMPETITION - IIIC
 Income distribution  Production
problem (demand efficiency (min. av.
reflects specific cost)
income distribution)  Allocative efficiency
 Market failure (resources efficiently
allocated)
IIIC
MONOPOLY
 One seller
 No good substitute
 Price-setter
 Restricted entry, exit
Examples: national
airline, public utilities
BASIS OF MONOPOLY
IIIC
POWER
 Control of factors of
production
 Legal privilege or
protection
 Advantage of large scale
production
 Government policy
 Natural advantages
MONOPOLY PROFIT
IIIC
MAXIMIZATION
 Firm produces at lower Marginal cost

output than perfectly
Av cost
competitive firm
 “Supernormal” profit
Price=
in short-run & long- Av rev
Marginal
run Profit Revenue
Qe
MONOPOLY - ADVANTAGES &
DISADVANTAGES IIIC
 High price,  Economies of scale
excessive profit  Natural advantages
 Less than optimum  Avoids duplication
output
DEALING WITH MONOPOLY IIIC
 Antitrust laws
 Monopolies
Commissions
MONOPOLISTIC
IIIC
COMPETITION
 Many sellers
 Differentiated products,
but close substitutes
 Non-price competition,
use of advertising
 Easy entry & exit
PRODUCT
IIIC
DIFFERENTIATION
 Product quality
 Services
 Location advantage
 Promotion &
packaging
ADVERTISING - ADVANTAGES
& DISADVANTAGES IIIC
 Persuade, not inform  Provides information
 Unproductive  Stimulates product
expenditure development
 Self-cancelling  Supports national
 Promotes monopoly communications
 Brings about scale
economies
MONOPOLISTIC IIIC
COMPETITION - SHORT-RUN
SHORT-RUN EQUILIBRIUM
 Firms produce at
Marginal cost
higher than minimum
Av cost
average cost ...
 Charge higher price, Price=
Av rev
and earn Marginal
 “Supernormal” profit Profit Revenue
Qe
MONOPOLISTIC IIIC
COMPETITION - LONG-RUN
LONG-RUN EQUILIBRIUM
 Firms produce at
higher than Marginal cost
Av cost
minimum average
cost ...
 Charge higher price,
Price=
and earn Av rev
Marginal Revenue
 “Normal” profit
Qe
IIIC
OLIGOPOLY
 Few sellers
 High output for most efficient scale of
plant
 Barriers to competition (legal, tariffs,
scale economies)
 Product differentiated or standardized
 Interdependence among sellers
COLLUSION &
IIIC
COMPETITION
 Competitive strategies
 Price war & non-price competition
 Collusion & cartel
 Obstacles to collusion
 Antitrust laws
 Cheating
 Common objective difficult (e.g.
OPEC)
IIID
FACTORS OF PRODUCTION
 Land
 Labor
 Capital
 Entrepreneurship
IIID
FACTOR DEMAND
 Demand & supply analysis applicable
to both inputs & outputs.
 Input demand depends on:
 Derived demand
 Factor productivity
 Prices of other factors (substitutes,
complements)
MARGINAL PRODUCTIVITY
IIID
THEORY
 A factor will be demanded according to
its marginal productivity and will be paid
a price equal to the value of its net
contribution to the product.
 Assumes competitive markets
 Criticisms:
 Unequal income distribution
 Market failure, e.g., monopoly
MARGINAL PRODUCTIVITY
IIID
ILLUSTRATED
No. of Marg. Physical Price Marg. Revenue
Workers Product (MPP) Product (MRP)
1 1 20 20
2 7 20 140
3 19 20 380
4 13 20 260
5 7.5 20 150
6 6.5 20 130
7 6 20 120
FACTOR DEMAND ELASTICITY
DETERMINANTS IIID
DETERMINANT
 Demand elasticity
of product higher
 Fall of MRP faster
 Substitution by ELASTICITY IS
other factors easier HIGHER
 Factor cost as % of
total cost larger
 Longer-run
FACTOR MARKET
IIID
EQUILIBRIUM
Factor
 Equilibrium when
price Factor demand = supply
supply
 Demand curve is
MRP curve
Pe E  Supply curve for
firm is vertical,
Factor
demand industry is upward
sloping
Qe Factor quantity
Market structure does not affact
equilibrium !
IIID
LABOR
 Unemployment
problems
 Immobility
 Geographical
 Institutional (e.g., TUs)
 Sociological
 Effort may not be
directly related to
reward, e.g., time rate
IIID
LAND
 A free gift of nature
 Fixed in total supply
 Rent is payment for
land
Rent
Note:
R’
R
Economic rent: payment
D’ to a factor in excess of
S D its supply price.
Quantity of land
IIID
CAPITAL
 Manufactured goods used to produce
other goods
 Investment: process of producing &
accumulating capital
 Rate of return on capital: Annual net
return per unit of investment
expenditure
 Present value: value, at today’s prices,
of future income stream from a capital
good
PRESENT VALUE &
DISCOUNTING
Present Value of $1 at a Future Date
n
PV = 1/(1+i)
Period 1 PV of $1 Per Period
0 $1.0000
1 0.9090
2 0.8264
3 0.7513
4 0.6830
IIID
INTEREST RATE
Interest
 Interest rate is the
Capital
rate
supply price of capital,
determined by
i2 equation of demand
i1
& supply
 Demand depends on
Capital
productivity
capital productivity
 Supply from savings
K2 K1 Capital stock
INTEREST RATE
IIID
DETERMINANTS
Degree of risk reflected in:

 Amount of capital
required
 Maturity
 Market imperfections
 Creditworthiness of firm
IIID
ENTREPRENEURSHIP
Plays a vital role in:
 Bringing factors of
production together
 Risk-taking under
uncertainty
 Inducing innovation &
invention
Profit is return to enterpreneurship
IIID
PROFIT
 Different from other returns to factors:
 May be negative
 Fluctuates
 A residue
 Normal & abnormal profit
 Depends on:
 Market structure
 Short- or long-run
INCOME DISTRIBUTION IV
 Theory of distribution describes how

income is distributed to factors of
production.
 But income distribution to individuals,
households more important for policy
 Efficient allocation of resources does not
guarantee equitable distribution of
income.
INCOME DISTRIBUTION IN
IV
THE UNITED STATES 1985
Income % Income Cumulative Cumulative % of Income
Quintile Share % of People Actual Absolute Absolute
Equal’y Ineq’lity
Lowest 4.6 20 4.6 20 0
Second 10.9 40 15.5 40 0
Third 16.9 60 32.4 60 0
Fourth 24.2 80 56.4 80 0
Highest 43.4 100 100 100 100
MEASURING INCOME
IV
DISTRIBUTION
 Lorenz curve graphs 100
relation between Cumulative
cumulative %s of %
income and population of
Income
 Deviation of curve
from diagonal is
measure of inequality
of distribution
0 100
Cumulative % of Population
INCOME INEQUALITY
IV
MEASURES
 Variance
 Relative mean deviation
 Gini Coefficient
 Theil Index
 Atkinson Index
All measures have implicit or
explicit “social welfare weights”.
CHARACTERISTICS OF
IV
INCOME INEQUALITY
 Kuznets’ Hypothesis
 Early development: little inequality
 Rapid growth: high inequality
 Mature economy: inequality declines
 Wealth distribution more unequal than
income distribution!
SOURCES OF INCOME
IV
INEQUALITY
 Abilities & skills
 Intensity of work
 Occupational differences
 Education
 Inheritance / ownership of wealth
 Saving & risk-taking
INEQUALITY - FOR &
IV
AGAINST
AGAINST: FOR:
 Perpetuates “vicious  Provides incentive
circle of poverty” to work
 Social & political  Higher saving
instability  Supports
innovation, quality
improvement
Efficiency & equity: Is there a tradeoff?
INEQUALITY & POVERTY IV
 Inequality usually
associated with poverty.
 Government policy
targets poverty &
inequality
INEQUALITY IN EAST ASIA IV
East Asian countries

have reduced income
inequality & poverty
substantially during
the 1980s.
MICROECONOMIC CONCEPTS
THE END
... OF THE BEGINNING

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Microeconomics

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National economics

Economics is the science which studies

 Science: avoids “value judgement”

FOR WHOM TO PRODUCE?

WHAT State Money vote

 Related vs. unrelated

Price Market supply is the sum of all

Market equilibrium is achieved when

Estimating Project Benefits

Price  Excess of market

The price elasticity of demand (Ed) is the

 Price elastic if Ed < -1

Price Quantity Elasticity

Determinant Elasticity Higher if:

Ease of substitution Greater ease

The price elasticity of supply (Es) is the

 Price elastic if Es > 1

 But the introduction

Weight-loss in Perishable, fragile, bulky

added to a fixed 20 Average P

 Fixed & variable

 Marginal, average &

 Short-run & long-

 Firm produces at lower Marginal cost

Degree of risk reflected in:

 Theory of distribution describes how

Efficiency & equity: Is there a tradeoff?

East Asian countries

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