Basic Microeconomics PDF

BASIC MICROECONOMICS **SCARCITY** -Scarcity means that society has limited resources and therefore cannot produce all the goods and services people wish to have. **ECONOMIC** -is the study of how society manages its scarce resources. In most societies, resources are allocated not by an all-power...

BASIC MICROECONOMICS **SCARCITY** -Scarcity means that society has limited resources and therefore cannot produce all the goods and services people wish to have. **ECONOMIC** -is the study of how society manages its scarce resources. In most societies, resources are allocated not by an all-powerful dictator but through the combined choices of millions of households and firms. -A professional who studies economics and statistical data, as well as the production and distribution of resources, goods and services is called ECONOMIST **WHAT DOES AN ECONOMIST DO?** -study how people make decisions: how much they work, what they buy, how much they save, and how they invest their savings. -Economists also study how people interact with one another. \*EXAMPLE : they examine how the multitude of buyers and sellers of a good together determine the price at which the good is sold and the quantity that is sold. -Finally, economists analyze the forces and trends that affect the economy as a whole, including the growth in average income, the fraction of the population that cannot find work, and the rate at which prices are rising. **Ten Principles of Economics How People Make Decisions** **1-1a Principle 1: People Face Trade-offs** "To get something that we like, we usually have to give up something else that we also like." REMEMBER - Making decisions requires trading off one goal against another. - Efficiency and Equality - Efficiency means that society is getting the maximum benefits from its scarce resources - Equality means that those benefits are distributed uniformly among society's members **1-1b Principle 2: The Cost of Something Is What You Give Up to Get It** -The **OPPORTUNITY COST** of an item is what you give up to get that item. -When making any decision, decision makers should be aware of the opportunity costs that accompany each possible action. **1-1c Principle 3: Rational People Think at the Margin** -Rational people systematically and purposefully do the best they can to achieve their objectives, given the available opportunities. -As you study economics, you will encounter firms that decide how many workers to hire and how much of their product to manufacture and sell to maximize profits. You will also encounter individuals who decide how much time to spend working and what goods and services to buy with the resulting income to achieve the highest possible level of satisfaction **1-2c Principle 7: Governments Can Sometimes Improve Market Outcomes** -property rights the ability of an individual to own and exercise control over scarce resources -EXAMPLE : A farmer won't grow food if she expects her crop to be stolen; a restaurant won't serve meals unless it is assured that customers will pay before they leave; and a film company won't produce movies if too many potential customers avoid paying by making illegal copies. - **market failure** a situation in which a market left on its own fails to allocate resources efficiently - **externality** the impact of one person's actions on the well-being of a bystander - **market power** the ability of a single economic actor (or small group of actors) to have a substantial influence on market prices INTRODUCTION **Supply** and **demand** are fundamental concepts in economics that describe how prices and quantities of goods and services are determined in a market. -These concepts are crucial because they form the basis of how markets operate. The interaction between supply and demand determines the market price and quantity of goods and services. When supply matches demand, the market is said to be in equilibrium. Any imbalance leads to changes in prices, influencing both consumer behavior and production decisions. The **Law of Demand** is a fundamental principle in economics that describes the inverse relationship between the price of a good or service and the quantity demanded by consumers. Understanding this concept is crucial for analyzing market behavior and predicting how changes in prices can influence consumer decisions. **Demand** refers to the quantity of a good or service that consumers are willing and able to purchase at various price. **FACTORS AFFECTING DEMAND** **-Economic Conditions**: General economic conditions, such as recessions or booms, can influence overall demand. In a recession, demand for luxury goods may decrease, while demand for essential goods might remain steady or even increase **-Advertising and Marketing**: Effective advertising and marketing campaigns can increase consumer awareness and preference for a product, thereby boosting demand. **-Government Policies and Regulations**: Taxes, subsidies, and regulations can affect demand. For example, subsidies might lower the effective price of a good, increasing demand, while taxes might have the opposite effect. "Understanding these factors can help businesses and policymakers predict changes in demand and make informed decisions." The **law of supply** is a fundamental concept in economics that describes the relationship between the price of a good and the quantity supplied by producers. It states that, all else being equal, an increase in the price of a good will increase the quantity supplied, and a decrease in the price will decrease the quantity supplied. **Supply** refers to the quantity of a good or service that producers are willing and able to offer for sale at various prices **FACTORS AFFECTING SUPPLY** **-Production Costs:** Changes in the costs of inputs (e.g., raw materials, labor) can impact supply. Lower production costs can increase supply, while higher costs can decrease it. **-Technology:** Improvements in technology can make production more efficient and increase supply. **-Number of Producers:** An increase in the number of suppliers in the market generally leads to an increase in the total supply of a good **-Government Policies:** Taxes, subsidies, and regulations can influence supply. For instance, subsidies might encourage higher production, while taxes might discourage it **-Expectations:** If producers expect prices to rise in the future, they might reduce current supply to sell more later at higher prices. Conversely, if prices are expected to fall, they might increase current supply **-Natural Conditions:** For agricultural and natural resource-based products, weather conditions and other environmental factors can significantly affect supply "Understanding supply helps explain how markets function and how changes in economic conditions, policies, and other factors can influence the availability and price of goods and services." **Market equilibrium and efficiency** are central concepts in economics that describe how markets function and how resources are allocated. Market equilibrium represents the point where supply and demand balance, while efficiency refers to how well the market maximizes total welfare. **MARKET EQUILIBRIUM** -Market equilibrium occurs when the quantity demanded by consumers equals the quantity supplied by producers at a given price. At this point, there is no tendency for the price or quantity to change unless influenced by external factors. - **Equilibrium Price (Pₑ)**: The price at which the amount of goods consumers want to buy is equal to the amount producers want to sell. - **Equilibrium Quantity (Qₑ)**: The quantity of goods that are bought and sold at the equilibrium price. **ADJUSMENT TO EQUILIBRIUM**  **-Surplus**: Occurs when the price is above the equilibrium price, leading to a situation where quantity supplied exceeds quantity demanded. Sellers will reduce prices to clear the surplus. **-Shortage**: Occurs when the price is below the equilibrium price, leading to a situation where quantity demanded exceeds quantity supplied. Sellers will raise prices to eliminate the shortage. **Introduction to elastricity** **Elasticity** measures how much the quantity demanded or supplied of a good changes in response to changes in price, income, or the prices of related goods. **TYPE OF ELASTICITY** - Price Elasticity of Demand (PED) - Income Elasticity of Demand (YED) - Cross Elasticity of Demand (XED) TYPES **Income Elasticity of Demand (YED)** **1. Normal Goods (YED \> 0):** Goods for which demand increases as consumer income rises. They have a positive income elasticity of demand. - Demand increases as income rises. **TYPES OF NORMAL GOODS:** - **Necessities (0 \< YED \< 1):** Demand for necessities increases with income but at a slower rate. They are essential items that people need regardless of their income level. **Example:** Basic food items, utilities, and household essentials. If income rises by 10%, the demand for these goods might rise by less than 10%. - **Luxuries (YED \> 1):** Demand for luxury goods increases more than proportionately as income rises. Consumers buy more of these goods as they feel more financially comfortable. **Example:** High-end electronics, luxury cars, and designer clothing. If income increases by 10%, the demand for these goods might increase by more than 10%. 2\. Inferior Goods (YED \< 0) **Definition:** Goods for which demand decreases as consumer income rises. They have a negative income elasticity of demand. **Example:** Generic brand products, public transportation, and instant noodles. As people's income increases, they tend to buy fewer of these goods and opt for higher-quality alternatives. For instance, if income rises, consumers might buy less instant noodles and more fresh produce. TYPES OF **CROSS ELASTICITY DEMAND (XED)** - **Substitute Goods (XED \> 0)** **Definition:** Substitute goods are products that can be used in place of each other. When the price of one good increases, the demand for its substitute also increases because consumers switch to the cheaper alternative. **Example:** Butter and margarine. If the price of butter increases, the demand for margarine (a substitute) is likely to rise, resulting in a positive cross elasticity of demand. - **Complementary Goods (XED \< 0)** **Definition:** Complementary goods are products that are used together. An increase in the price of one good leads to a decrease in the demand for its complement, as they are typically consumed together. **Example:** Coffee and sugar. If the price of coffee increases, the demand for sugar (a complement) may decrease because people are less likely to buy coffee, thus reducing the need for sugar. - **Unrelated Goods (XED = 0)** **Definition:** Unrelated goods have no significant relationship with each other. Changes in the price of one good do not affect the demand for another. **Example:** Shoes and apples. If the price of shoes changes, it generally has no impact on the demand for apples, resulting in a cross elasticity of demand close to zero. **CONSUMERS BEHAVIOR** refers to the decision-making processes individuals use when selecting, purchasing, and using goods and services. Assumption of Consumers Behavior - **Rationality**: Consumers aim to maximize satisfaction (utility) given their income. - **Utility**: A measure of satisfaction or pleasure derived from consuming goods or services. - **Preferences**: Consumers have ranked preferences for goods and services. **TYPE OF UTILITY** **1. Total Utility (TU)** **Definition**: The overall satisfaction a consumer derives from consuming a certain quantity of goods or services. **Example**: If consuming 3 apples provides a total satisfaction of 50 units of utility, then 50 is the total utility from those apples. **Concept**: Total utility typically increases as consumption increases, but at a decreasing rate. **2. Marginal Utility (MU)** **Definition**: The additional satisfaction a consumer gets from consuming one more unit of a good or service. **Example**: If consuming a fourth apple increases total satisfaction from 50 to 60, the marginal utility of the fourth apple is 10. **Law of Diminishing Marginal Utility**: As a consumer consumes more of a good, the marginal utility of each additional unit tends to decrease. For example, the first slice of pizza may bring more satisfaction than the fourth or fifth slice. **3. Average Utility** **Definition**: The total utility divided by the number of units consumed, representing the average satisfaction per unit. **Example**: If consuming 4 apples provides 60 units of total utility, the average utility per apple is 15 units. **4. Cardinal Utility** **Definition**: Assumes that utility can be measured quantitatively (e.g., in \"utils\") and compared numerically. **Example**: A consumer might get 20 utils of satisfaction from a cup of coffee and 10 utils from a glass of juice, allowing for comparison. **Limitation**: This approach assumes that utility can be measured precisely, which is not always practical. **5. Ordinal Utility** **Definition**: Assumes that consumers cannot measure utility in exact numbers, but they can rank preferences. It's based on the idea that consumers can say they prefer one good over another without assigning a numerical value. **Example**: A consumer might prefer coffee to juice and juice to water but cannot say by how much more they prefer coffee. **Summary:** I. Consumers aim to maximize utility under budget constraints. II. Optimal consumption occurs when marginal utility per dollar is equal across all goods. "Understanding consumer behavior helps predict market demand and consumption patterns." Theory of production - \- Production refers to the process of transforming inputs into outputs. **Main Concept**: -The Law of Diminishing Returns describes how increasing the quantity of one input, while keeping others constant, will eventually result in smaller increases in output. -As additional units of a variable input are added to fixed inputs, the marginal product eventually declines. **Example**: Adding more workers to a factory with a fixed amount of machinery may initially increase production, but over time, each new worker contributes less additional output because of the limited amount of machinery available. **Factors of production:** 1. Land 2. Labor, 3. Capital, and 4. Entrepreneurship. **1. Land** **Definition**: -Land refers to all natural resources used in the production process. It includes not just the ground, but all resources that come from the earth. **Examples**: -Oil, minerals, forests, rivers, and agricultural land. **Key Points**: -Land is a passive factor, meaning it does not change through use. -Income derived from land is called **rent**. -Natural resources can be renewable (like forests) or non-renewable (like oil). **2. Labor** **Definition:** Labor is the human effort -- both physical and mental -- used in the production of goods and services. **Examples:** Factory workers, teachers, engineers, and doctors. **Key Points:** **-** Labor can be skilled or unskilled, and the value of labor depends on the skill level. \- The reward for labor is **wages** or **salaries**. \- Human capital (the skills, education, and training of workers) plays a crucial role in productivity. **3. Capital** **Definition**: Capital refers to the tools, equipment, machinery, and buildings used in the production of goods and services. **Examples**: Factories, computers, transportation vehicles, and machinery. **Key Points**: -Capital is a man-made resource that increases the productivity of labor. -The reward for the use of capital is **interest**. -There are two types of capital: - **Physical Capital**: Tangible assets like machinery and buildings. - **Human Capital**: Skills and knowledge acquired by workers. **Types of production:** 1. Short run and 2. Long run production. **1. Short Run Production** **Definition**: The short run is a period during which at least one input is fixed, typically capital (machinery, buildings), while other inputs like labor can be varied. **Key Points**: **Fixed Inputs**: These are resources that cannot be changed quickly (e.g., factory size, machinery). **Variable Inputs**: These are inputs that can be adjusted in the short run (e.g., labor, raw materials). The **Law of Diminishing Marginal Returns** often applies in the short run: as more units of a variable input (like labor) are added to a fixed input, the additional output produced by each new unit will eventually decrease. **Examples**: -A restaurant hires more waitstaff to meet increasing customer demand but cannot expand the kitchen immediately. -A manufacturer increases worker shifts but cannot buy additional machines in the short term. **Costs in the Short Run** **Points to Discuss**: **Fixed Costs (FC)**: Costs that do not change with the level of output (e.g., rent, salaries of permanent staff). **Variable Costs (VC)**: Costs that vary with output (e.g., wages for temporary workers, raw materials). **Total Cost (TC)**: The sum of fixed and variable costs. **Marginal Cost (MC)**: The additional cost of producing one more unit. **Graphical Representation**: Short-run cost curves, including Average Total Cost (ATC), Average Variable Cost (AVC), and Marginal Cost (MC), can be used to show how costs behave as output changes. **Costs in the Long Run** **Points to Discuss**: -In the long run, there are **no fixed costs**; all costs become variable as firms can adjust all inputs. **-Long-run Average Cost (LRAC)** curve shows the lowest possible cost at which any output level can be produced when all inputs are variable. **-Economies of Scale**: As production increases, average costs per unit fall due to factors like bulk purchasing, specialization, and technological efficiency. **-Diseconomies of Scale**: After a certain point, increasing production can lead to inefficiencies, such as coordination difficulties or overburdened resources, resulting in higher average costs. -The LRAC curve is typically U-shaped, representing economies of scale at lower production levels and diseconomies of scale at higher levels.