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UGBS

2024

Dr. Stephen Antwi and Dr. Ophelia Amo

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microeconomics economics economic theory business

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This document is lecture notes on microeconomics, covering topics such as scarcity, opportunity cost, and production possibilities. It details the components of microeconomics and macroeconomics, how they differ, and economic models.

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UGBS 201 Micro Economics Session 0 – Introduction to Economics INSTRUCTORS: DR. STEPHEN ANTWI AND DR. OPHELIA AMO EMAIL: [email protected] and [email protected] Business School 2023/2024 [email protected] ...

UGBS 201 Micro Economics Session 0 – Introduction to Economics INSTRUCTORS: DR. STEPHEN ANTWI AND DR. OPHELIA AMO EMAIL: [email protected] and [email protected] Business School 2023/2024 [email protected] Session Overview We often do not get everything that we want. More often than not, our wants are unlimited but the resources we have to satisfy these unlimited wants are scarce. This is the problem of scarcity. All economic questions arise because scarcity exists. As economics is a social science, this section also discusses the tools for analyzing economic problems Dr. Stephen Antwi and Dr. Ophelia Amo Slide 2 Learning Objectives At the end of the session, the student will – Understand why we study Economics – Understand the Nature of Economics. – Distinguish between Microeconomics and Macroeconomics Dr. Stephen Antwi and Dr. Ophelia Amo Slide 3 Reading List Read Chapter 1 of Recommended Text – Bade and Parkin (2013) and the 5th Edition of Begg, Dornbusch and Fischer Session Slides Other Economics text books available to students Dr. Stephen Antwi and Dr. Ophelia Amo Slide 4 DEFINITION AND QUESTIONS The fundamental problem in economics is scarcity. Scarcity Scarcity is when your resources are not able to meet your needs. Scarcity requires that we make choices among available options. This will mean that we will have to arrange all our wants in order of preference. This is what we call scale of preference. Dr. Stephen Antwi and Dr. Ophelia Amo Slide 5 DEFINITION AND QUESTIONS All economic questions and problems arise because human wants exceed the resources available to satisfy them. Scale of preference Scale of preference is the list that contains all available wants in order of importance. Because you cannot have everything you want, you would have to make a choice in your attempt to pursue one goal. In making a choice to pursue one goal you would have to forgo another. Opportunity cost is the cost of forgoing all the other alternatives. Dr. Stephen Antwi and Dr. Ophelia Amo Slide 6 DEFINITION AND QUESTIONS Opportunity cost divides into explicit and implicit cost Economics divides into two parts: Microeconomics: The study of the choices that individuals and businesses make and the way these choices interact and are influenced by governments. Macroeconomics: The study of the aggregate (or total) effects on the national economy and the global economy of the choices that individuals, businesses, and governments make. Dr. Stephen Antwi and Dr. Ophelia Amo Slide 7 DEFINITION AND QUESTIONS Two big economic questions summarise the scope of economics: How do choices determine what, how, and for whom goods and services get produced? When do choices made in self-interest also promote the social interest? Dr. Stephen Antwi and Dr. Ophelia Amo Slide 8 DEFINITION AND QUESTIONS What, How, and For Whom? Goods and services are the objects (goods) and actions (services) that people value and produce to satisfy human wants. What goods and services get produced and in what quantities? How are goods and services produced? For Whom are the various goods and services produced? Dr. Stephen Antwi and Dr. Ophelia Amo Slide 9 DEFINITION AND QUESTIONS Can the Pursuit of Self-Interest Be in the Social Interest? The choices that are best for the individual who makes them are choices made in the pursuit of self-interest. The choices that are best for society as a whole are choices made in the social interest. Dr. Stephen Antwi and Dr. Ophelia Amo Slide 10 DEFINITION AND QUESTIONS Can choices made in self-interest also serve the social interest? Let’s illustrate with four topics: 1 Globalization Globalization—the expansion of international trade and the production of components and services by firms in other countries—has been going on for centuries. Dr. Stephen Antwi and Dr. Ophelia Amo Slide 11 THE ECONOMIC WAY OF THINKING Economic Ideas: Six ideas define the economic way of thinking: Choice is a tradeoff Cost is what you must give up to get something Benefit is what you gain from something People make rational choices by comparing benefits and costs Most choices are “how much” choices made at the margin Choices respond to incentives Dr. Stephen Antwi and Dr. Ophelia Amo Slide 12 THE ECONOMIC WAY OF THINKING A Choice Is a Tradeoff Because we face scarcity we must make choices. To make a choice we select from alternatives. Whatever choice you make, you could have chosen something else. You can think about your choices as tradeoffs. A tradeoff is an exchange—giving up one thing to get something else. Dr. Stephen Antwi and Dr. Ophelia Amo Slide 13 THE ECONOMIC WAY OF THINKING Cost: What You Must Give Up Opportunity cost is the best thing that you must give up to get something—the highest-valued alternative forgone. Benefit: What You Gain Benefit is the gain or pleasure that something brings. Benefit is measured by what you are willing to give up. Dr. Stephen Antwi and Dr. Ophelia Amo Slide 14 THE ECONOMIC WAY OF THINKING Rational Choice A rational choice is a choice that uses the available resources to best achieve the objective of the person making the choice. We make rational choices by comparing costs and benefits. Dr. Stephen Antwi and Dr. Ophelia Amo Slide 15 THE ECONOMIC WAY OF THINKING How Much? Choosing at the Margin A choice made at the margin is a choice made by comparing all the relevant alternatives systematically and incrementally. Dr. Stephen Antwi and Dr. Ophelia Amo Slide 16 THE ECONOMIC WAY OF THINKING Marginal Cost Marginal cost is the opportunity cost of a one-unit increase in an activity. The marginal cost of something is what you must give up to get one additional unit of it. Marginal Benefit Marginal benefit is what you gain when you get one more unit of something. The marginal benefit of something is measured by what you are willing to give up to get one additional unit of it. Dr. Stephen Antwi and Dr. Ophelia Amo Slide 17 ECONOMIC WAY OF THINKING Making a Rational Choice You make a rational choice when you take those actions for which marginal benefit exceeds or equals marginal cost. Choices Respond to Incentives An incentive is a reward or a penalty that encourages or discourages an action. Dr. Stephen Antwi and Dr. Ophelia Amo Slide 18 ECONOMIC WAY OF THINKING Economics as Social Science Economists use scientific methods which were initially developed by scientists to understand and predict the effects of economic forces. The scientific method is a common sense way of systematically checking what works and what does not work. An economist observes some facts about the cause and effect of a puzzle and question. This is the first step an economist uses in its approach. Dr. Stephen Antwi and Dr. Ophelia Amo Slide 19 ECONOMIC WAY OF THINKING Economic Models The second step for an economist is to use a model to show the potential answer to a question. An economic model :description of some feature of the economic world that includes only those features assumed necessary to explain the observed facts. Check Models Against Facts Step 3 for an economist is to compare the proposed model to the facts. Dr. Stephen Antwi and Dr. Ophelia Amo Slide 20 ECONOMIC WAY OF THINKING To check an economic model against the facts, economists use Natural experiments Statistical investigations Economic experiments Dr. Stephen Antwi and Dr. Ophelia Amo Slide 21 ECONOMIC WAY OF THINKING Disagreement: Normative versus Positive Economists sometimes do not agree on all models. Some disagreements can be settled by appealing to further facts, but others cannot. This leads us to a distinction between normative and positive statements normative statements—statements about what ought to be. usually occurs when you disagree about facts positive statements—statements about what is. No disagreement about facts Dr. Stephen Antwi and Dr. Ophelia Amo Slide 22 ECONOMIC WAY OF THINKING Economics as Policy Tool Economics is not just important for the government. Its importance can also be seen in our personal lives and businesses. Dr. Stephen Antwi and Dr. Ophelia Amo Slide 23 The Economic Problem When you have completed your study of this session, you will be abClHeECtoK 1. Use the production possibilities frontier to show and explain the concepts of scarcity, production efficiency, opportunity cost. 2. Calculate opportunity cost. 3. Explain what makes production possibilities expand. Dr. Stephen Antwi and Dr. Ophelia Amo Slide 24 PRODUCTION POSSIBILITIES Production Possibilities Frontier (PPF) Production possibilities frontier The maximum combinations of goods and services that can be produced, with the factors of production and technology available. The PPF is an important tool for showing the concept of scarcity and opportunity cost. Dr. Stephen Antwi and Dr. Ophelia Amo Slide 25 PRODUCTION POSSIBILITIES Figure 1 shows the PPF for cell phones and DVDs. The figures in the each column have been plotted to give the points on the PPF. The boundary created by the points represent the PPF. Dr. Stephen Antwi and Dr. Ophelia Amo Slide 26 Dr. Stephen Antwi and Dr. Ophelia Amo Slide 27 PRODUCTION POSSIBILITIES The PPF puts three features of production possibilities into perspective: Attainable Combinations Efficiency Opportunity Cost Dr. Stephen Antwi and Dr. Ophelia Amo Slide 28 PRODUCTION POSSIBILITIES Attainable and Unattainable Combinations Because the PPF shows the maximum amount of goods that can be produced, it illustrates the limits of production. Figure 2 on the next slide illustrates the attainable and unattainable combinations. Dr. Stephen Antwi and Dr. Ophelia Amo Slide 29 PRODUCTION POSSIBILITIES Any point inside the PPF is attainable. Points such as G are unattainable. Dr. Stephen Antwi and Dr. Ophelia Amo Slide 30 PRODUCTION POSSIBILITIES Efficient and Inefficient Production Production efficiency occurs when we cannot produce more of one good without sacrificing some of the other goods. Figure 3 on the next slide illustrates the distinction between efficient and inefficient production. Dr. Stephen Antwi and Dr. Ophelia Amo Slide 32 PRODUCTION POSSIBILITIES 1. When production is on the PPF, such as at point E or D, production is efficient. 2. If production were inside the PPF, such as at point H, more could be produced of both goods without forgoing either good. Production is inefficient. Dr. Stephen Antwi and Dr. Ophelia Amo Slide 33 PRODUCTION POSSIBILITIES Tradeoffs and Free Lunches A tradeoff is an exchange—giving up one thing to get something else. A free lunch is a gift—getting something without giving up something else. Figure 3.3 on the next slide illustrates the distinction between a tradeoff and a free lunch. Dr. Stephen Antwi and Dr. Ophelia Amo Slide 35 PRODUCTION POSSIBILITIES 3. When production is on the PPF, we face a tradeoff. 4. If production were inside the PPF, there would be a free lunch. Moving from point H to point D does not involve a tradeoff. Dr. Stephen Antwi and Dr. Ophelia Amo Slide 36 PRODUCTION POSSIBILITIES The slope of the PPF gets steeper as you move down indicating increasing opportunity cost. In other words, as you move down the PPF, you need to sacrifice more of one good to get a little more of the other. Dr. Stephen Antwi and Dr. Ophelia Amo Slide 37 OPPORTUNITY COST The Opportunity Cost of a Cell Phone The opportunity cost of a cell phone is the decrease in the quantity of DVDs divided by the increase in the number of cell phones as we move along the PPF. Figure 4 illustrates the calculation of the opportunity cost of a cell phone. Dr. Stephen Antwi and Dr. Ophelia Amo Slide 38 OPPORTUNITY COST Moving from A to B, 1 cell phone costs 1 DVD. Dr. Stephen Antwi and Dr. Ophelia Amo Slide 39 OPPORTUNITY COST Moving from B to C, 1 cell phone costs 2 DVDs. Dr. Stephen Antwi and Dr. Ophelia Amo Slide 41 OPPORTUNITY COST Moving from C to D, 1 cell phone costs 3 DVDs. Dr. Stephen Antwi and Dr. Ophelia Amo Slide 42 OPPORTUNITY COST Moving from D to E, 1 cell phone costs 4 DVDs. Dr. Stephen Antwi and Dr. Ophelia Amo Slide 43 OPPORTUNITY COST Moving from E to F, 1 cell phone costs 5 DVDs. Dr. Stephen Antwi and Dr. Ophelia Amo Slide 44 OPPORTUNITY COST Increasing Opportunity Cost The opportunity cost of a cell phone increases as more cell phones are produced. Dr. Stephen Antwi and Dr. Ophelia Amo Slide 45 OPPORTUNITY COST Opportunity Cost and the Slope of the PPF The slope of the PPF tells the opportunity cost. The slope of the PPF in Figure 4 measures the opportunity cost of a cell phone. The PPF is concave (bowed outward). As you increase the production of a cell phone, you give up more DVDs and therefore the opportunity cost of producing cell phones increases. Dr. Stephen Antwi and Dr. Ophelia Amo Slide 47 OPPORTUNITY COST Opportunity Cost Is a Ratio The opportunity cost of a cell phone is the ratio of quantities of DVDs forgone divided to the quantity of cell phones gained. The opportunity cost of a DVD is the ratio of the quantity of cell phones forgone to the quantity of DVDs gained. Dr. Stephen Antwi and Dr. Ophelia Amo Slide 48 OPPORTUNITY COST  Increasing Opportunity Costs Are Everywhere Just about every activity has an increasing opportunity cost. Dr. Stephen Antwi and Dr. Ophelia Amo Slide 49 Learning Objectives The main objective of this study is to: – Understand what demand is – Identify the factors that influence consumers to purchase products – Understand how these factors influence demand – Understand what supply is – Identify the factors that influence producers decision to put goods on the market for sale – Understand market equilibrium and how price and quantity change Dr. Stephen Antwi and Dr. Ophelia Amo Slide 50 Learning Outcomes At the end of the session, the student will be able to – Understand how to develop their own competitive strategies and to respond to the actions of their competitors – Understand how public policy will impact the operations of firms Dr. Stephen Antwi and Dr. Ophelia Amo Slide 51 Reading List Read Chapter 2 of Recommended Text – Bade and Parkin (2013) and the 5th Edition of Begg, Dornbusch and Fischer Session Slides Other Economics text books available to students Dr. Stephen Antwi and Dr. Ophelia Amo Slide 52 DEMAND Demand: Quantities of goods and services that consumers are willing and able to buy at various prices at a given period of time. Demand refers to a specific period of time. For example, the amount per day or per month. This means that price is a factor that influences demand for a product. We discuss the other factors that influence demand later Dr. Stephen Antwi and Dr. Ophelia Amo Slide 53 DEMAND The Law of Demand All other things equal, The higher the price of a product, the fewer the quantity that people buy The lower the price of a product, the greater the quantity that people buy. Dr. Stephen Antwi and Dr. Ophelia Amo Slide 54 DEMAND Demand Schedule, Demand Curve and Demand Function These show the relationship between the different quantities of a good and their respective prices when we do not allow all the other factors to change. Dr. Stephen Antwi and Dr. Ophelia Amo Slide 55 DEMAND Demand schedule is a tabular relationship between the different prices and their respective quantities holding all other factors constant. Demand curve is a graphical representation showing the relationship between the prices and their respective quantities holding all other factors constant. Demand function is a mathematical relationship between prices and their respective quantities holding all other factors constant. Dr. Stephen Antwi and Dr. Ophelia Amo Slide 56 DEMAND Dr. Stephen Antwi and Dr. Ophelia Amo Slide 57 DEMAND Individual Demand and Market Demand Market demand is the horizontal summation of the individual demand curves Dr. Stephen Antwi and Dr. Ophelia Amo Slide 59 DEMAND Dr. Stephen Antwi and Dr. Ophelia Amo Slide 60 DEMAND Other factors that change demand are: Income Prices of related goods Expected future prices Expected future income and credit Number of buyers Preferences Changes in all of these factors apart from the price of a product is what causes a change in demand Dr. Stephen Antwi and Dr. Ophelia Amo Slide 62 DEMAND Income The type of good one will be dealing with determines how demand will change Two types of goods: Normal and Inferior For normal goods if income increases people buy more increases and if income decreases people buy less. For inferior goods if income increases people buy less and if income decreases people buy more. Dr. Stephen Antwi and Dr. Ophelia Amo Slide 63 DEMAND Prices of Related Goods Also depends on whether you are dealing with substitutes or complements A substitute is a good that serves the same purpose as other goods. For example, milo and bournvita. If the price of a substitute increases, the demand for a good increases. If the price of a substitute decreases, the demand for a good decreases. Thus, for substitutes, there is a positive relationship between the price of a product and the demand for the other product Dr. Stephen Antwi and Dr. Ophelia Amo Slide 64 DEMAND Complements are goods that are consumed together. For example, torchlights and batteries are complements. If the price of a complement falls, the demand for a good rises. If the price of a complement rises, the demand for a good falls. Dr. Stephen Antwi and Dr. Ophelia Amo Slide 65 DEMAND Expected Future Prices If prices are expected to rise in the future, current demand increases. If prices are expected to fall in the future, current demand falls. For example, if the price of a phone is expected to rise next week, the demand for phones today will fall. Dr. Stephen Antwi and Dr. Ophelia Amo Slide 66 DEMAND Number of Buyers The demand for a good will increase if there are a large number of buyers for that particular good. Taste and Preferences When preferences change, it shifts the demand of one product to the product that consumers now prefer. Taste and preferences are influenced by: increased information more options available culture religion Dr. Stephen Antwi and Dr. Ophelia Amo Slide 67 Changes in Quantity Demand This is caused directly by a change in the price of the product only It causes a movement along the same demand curve and not a shift of the demand curve Dr. Stephen Antwi and Dr. Ophelia Amo Slide 68 DEMAND Changes in Demand Change in demand is the resultant change in quantity arising from the factors that affect demand other than the price of the good. A change in demand shifts the demand curve either to the left or right. Dr. Stephen Antwi and Dr. Ophelia Amo Slide 69 DEMAND Figure shows changes in demand. 1. The demand curve shifts to the left from D0 to D1when any of the factors apart from price causes demand to decrease, 2. The demand curve shifts to the right from D0 to D2 when any of the factors other than Slide 70 SUPPLY Supply is the quantities of a good or service that producers are willing and able to put on the market for sale at various prices per period of time. Price – a major factor that influences supply.  The Law of Supply All other things equal, The higher the price of a product, the greater the amount that is put on the market for sale. The lower the price of a product, the smaller the quantity that is put on the market for sale. Dr. Stephen Antwi and Dr. Ophelia Amo Slide 72 SUPPLY Supply Schedule and Supply Curve Supply which shows a relationship between the quantities of a good put on the market at various prices can be illustrated by a supply schedule, supply function and a supply curve. Dr. Stephen Antwi and Dr. Ophelia Amo Slide 73 SUPPLY A supply schedule shows a list of different quantities supplied at their respective prices when all other influences on selling plans remain the same. A supply curve illustrates the relationship between the quantities supplied and their respective prices on a graph holding all other factors constant. A supply function depicts the relationship between the quantities supplied and their respective prices in the form of an equation holding all other factors constant. Dr. Stephen Antwi and Dr. Ophelia Amo Slide 74 SUPPLY Dr. Stephen Antwi and Dr. Ophelia Amo Slide 75 SUPPLY Individual Supply and Market Supply Market supply is the horizontal summation of individual supply curves. Dr. Stephen Antwi and Dr. Ophelia Amo Slide 77 SUPPLY Dr. Stephen Antwi and Dr. Ophelia Amo Slide 78 Other Factors Influencing Supply of a Product Apart from the price of a product, other factors influence supply of a product 1. Cost of production 2. Price of related products 3. Technology 4. Changes in weather conditions etc Dr. Stephen Antwi and Dr. Ophelia Amo Slide 80 SUPPLY Prices of Related Goods When the price of one good changes, the supply of another good can change. substitutes in production under supply compete for the use of the same resource. For example, wheat and maize If the price of one good falls, the supply of its substitute increases. If the price of one good rises, the supply of its substitute falls. Dr. Stephen Antwi and Dr. Ophelia Amo Slide 81 SUPPLY complements in production are produced together. For example, saw dust and plywood. If the price of one good increases, the production of the other good increases. If the price of one good falls, the production of the other good falls. Dr. Stephen Antwi and Dr. Ophelia Amo Slide 82 SUPPLY Cost of Production If the cost of production is high, supply reduces vice versa. Technology An improvement in technology increases supply. Obsolete technology reduces supply. Dr. Stephen Antwi and Dr. Ophelia Amo Slide 83 SUPPLY Changes in Supply Changes in the factors listed in the previous slide illustrate a change in supply. In other words, a change in supply results from changes in the factors other than the price of the product A change in supply causes a shift of the supply curve. Dr. Stephen Antwi and Dr. Ophelia Amo Slide 84 SUPPLY Figure shows changes in supply. 1. When supply decreases, the supply curve shifts leftward from S0 to S1. 2. When supply increases, the supply curve shifts rightward from S0 to S2. Dr. Stephen Antwi and Dr. Ophelia Amo Slide 85 SUPPLY Change in Quantity Supplied Versus Change in Supply A change in quantity supplied is caused by a change in the own price of the product. It causes a movement along the same supply. A change in supply is caused by other factors apart from the price of the product. It causes a bodily shift of the supply curve. Dr. Stephen Antwi and Dr. Ophelia Amo Slide 87 MARKET EQUILIBRIUM When buyers and sellers come together, there is only one price at which how much consumers wish to buy is just equal to how much sellers wish to produce. This is the equilibrium price. The corresponding quantity is the equilibrium quantity. In Equilibrium quantity demanded equals the quantity supplied. Dr. Stephen Antwi and Dr. Ophelia Amo Slide 88 MARKET EQUILIBRIUM Figure shows the equilibrium price and equilibrium quantity. 1. the demand curve and the supply curve intersect at equilibrium. 2. The equilibrium price is $1 a bottle. 3. The equilibrium quantity is 10 million bottles a day. Dr. Stephen Antwi and Dr. Ophelia Amo MARKET EQUILIBRIUM Dr. Stephen Antwi and Dr. Ophelia Amo Slide 90 MARKET EQUILIBRIUM Figure achieves market equilibrium. At GHC1.50 a bottle: 1. Quantity supplied is 11 million bottles. 2. Quantity demanded is 9 million bottles. 3. There is a surplus of 2 million bottles. 4. Price falls until the surplus is eliminated and the market is in equilibrium. Dr. Stephen Antwi and Dr. Ophelia Amo 8/15/2019 Slide 92 MARKET EQUILIBRIUM Figure achieves market equilibrium. At 75 pesewas a bottle: 1. Quantity demanded is 11 million bottles. 2. Quantity supplied is 9 million bottles. 3. There is a shortage of 2 million bottles. 4. Price rises until the shortage is eliminated and the market is in equilibrium. Slide 94 Dr. Stephen Antwi and Dr. Ophelia Amo MARKET EQUILIBRIUM What causes price to change : Three Things 1. When any of the factors that influence supply changes apart from the own price 2. When any of the factors that influence demand changes apart from the own price 3. When any of the factors that influence demand and supply change apart from the own price Dr. Stephen Antwi and Dr. Ophelia Amo Slide 96 MARKET EQUILIBRIUM  Effects of Changes in Demand Event: study shows that tap water is unsafe. In the market for bottled water: 1. With tap water unsafe, demand for bottled water changes. 2. The demand for bottled water increases, the demand curve shifts rightward. 3. What are the new equilibrium price and equilibrium quantity and how have they changed? Dr. Stephen Antwi and Dr. Ophelia Amo Slide 97 MARKET EQUILIBRIUM Figure illustrates the outcome. 1. An increase in demand shifts the demand curve rightward. 2. At GHC1.00 a bottle, there is a shortage, so the price rises. 3. The quantity supplied increases along the supply curve. 4. Equilibrium quantity increases. Dr. Stephen Antwi and Dr. Ophelia Amo Slide 98 MARKET EQUILIBRIUM Event: A new zero-calorie sports drink is invented. In the market for bottled water: 1. The new drink is a substitute for bottled water, so the demand for bottled water changes 2. The demand for bottled water decreases and the demand curve shifts leftward. 3. What are the new equilibrium price and equilibrium quantity and how have they changed? Dr. Stephen Antwi and Dr. Ophelia Amo Slide 100 MARKET EQUILIBRIUM Figure shows the outcome. 1. A decrease in demand shifts the demand curve leftward. 2. At GHC1.00 a bottle, there i s a surplus, so the price falls. 3. Quantity supplied decreases along the supply curve. 4. Equilibrium quantity decreases. Dr. Stephen Antwi and Dr. Ophelia Amo Slide 101 MARKET EQUILIBRIUM  Effects of Changes in Supply Event: European water bottlers buy springs and open plants in Ghana. In the market for bottled water: 1. With more suppliers of bottled water, supply changes. 2. The supply of bottled water increases and the supply curve shifts rightward. 3. What are the new equilibrium price and equilibrium quantity and how have they changed? Dr. Stephen Antwi and Dr. Ophelia Amo Slide 103 MARKET EQUILIBRIUM Figure shows the outcome. 1. An increase in supply shifts the supply curve rightward. 2. At GHC1 a bottle, there is a surplus, so the price falls. 3. Quantity demanded increases along the demand curve. 4. Equilibrium quantity increases. MARKET EQUILIBRIUM Event: Drought dries up some springs in Ghana. In the market for bottled water: 1. Drought changes the supply of bottled water. 2. The supply of bottled water decreases and the supply curve shifts leftward. 3. What are the new equilibrium price and equilibrium quantity and how have they changed? Dr. Stephen Antwi and Dr. Ophelia Amo Slide 106 MARKET EQUILIBRIUM Figure shows the outcome. 1. A decrease in supply shifts the supply curve leftward. 2. At GHC1.00 a bottle, there is a shortage, so the price rises. 3. Quantity demanded decreases along the demand curve. 4. Equilibrium quantity decreases. Dr. Stephen Antwi and Dr. Ophelia Amo MARKET EQUILIBRIUM  Effects of Changes in Both Demand and Supply Both Demand and Supply can change at the same time: How does this action change equilibrium price and quantity? Dr. Stephen Antwi and Dr. Ophelia Amo Slide 109 MARKET EQUILIBRIUM Figure shows the effects of an increase in both demand and supply. 1.The demand curve shifts to the right when there is an increase in demand. The demand curve shifts to the left when there is a decrease in demand. 2. The effect on equilibrium price is unknown. 3. There is a definite increase in Equilibrium quantity. 8/15/2019 Slide 110 Dr. Stephen Antwi and Dr. Ophelia Amo MARKET EQUILIBRIUM Figure shows the effects of a decrease in both demand and supply. 1.The demand curve shifts to the left when there is a decrease. 2.The supply curve also shifts to the left when there is a decrease in demand. 3. Equilibrium quantity decreases. Slide 112 MARKET EQUILIBRIUM Figure shows the effects of a decrease in demand and an increase in supply. 1. The demand curve shifts to the left with a decrease in demand. The supply curve shifts to the right with an increase in supply. 2. Equilibrium price definitely falls. 3. Change in equilibrium quantity is uncertain. Dr. Stephen Antwi and Dr. Ophelia Amo Slide 114 MARKET EQUILIBRIUM Figure shows the effects of an increase in demand and a decrease in supply. 1.Demand curve shifts to the right with an increase in demand. Supply curve shifts to the left with a decrease in supply. 2. Equilibrium price rises. 3. Change in equilibrium quantity is uncertain. Dr. Stephen Antwi and Dr. Ophelia Amo Slide 116 Price Control Sometimes, governments directly intervene in the market to set prices. They may set the price below or above the market price When the government imposes a price above the market equilibrium price, we have a minimum price (price floor) a common example is a minimum wage. When the government-imposed price is below the market price, we have a maximum price (price ceiling). Dr. Stephen Antwi and Dr. Ophelia Amo 118 Minimum Price A minimum price is a government imposed price that producers are allowed to charge. It is usually set above the market price. It is illegal to pay below the minimum but buyers are allowed to pay higher than minimum price. They are designed to protect the suppliers in the market. A minimum price policy always leads to excess supply and will not be sustainable until additional measures are taken to remove the excess supply. Dr. Stephen Antwi and Dr. Ophelia Amo 119 UGBS 201 Microeconomics Session 4 – Elasticity of demand and supply Business School 2020/2021 Dr. Stephen Antwi and Dr. Ophelia Amo Learning Objectives At the end of the session, the student will Understand how to measure how consumers demand will respond to changes in the factors that influence demand Understand how to measure how producers will respond to changes in the factors that influence supply Dr. Stephen Antwi and Dr. Ophelia Amo Slide 121 Reading List Read Chapter 4 of Recommended Text – Bade and Parkin (2013) Session Slides Other Economics text books available to students Dr. Stephen Antwi and Dr. Ophelia Amo Slide 122 The Concept of Elasticity Elasticity refers to “responsiveness” or “stretchiness”. Elasticity of demand (supply) is the measure of the responsiveness of quantity demanded (supplied) to changes in price. That is, the extent to which a change in the price of a good will cause a change in quantity demanded (supplied), other things held constant. Dr. Stephen Antwi and Dr. Ophelia Amo Slide 123 THE PRICE ELASTICITY OF DEMAND Note three types of elasticity of demand Price elasticity of demand Cross price elasticity of demand Income elasticity of demand Dr. Stephen Antwi and Dr. Ophelia Amo 124 PRICE ELASTICITY OF DEMAND Price elasticity of demand is the degree of responsiveness of quantity demanded to changes in the price of the same good. To explain the price elasticity of demand, we find the percentage change in the quantity demanded divided by the percentage change in price. %∆Q Price elasticity of demand (Ep) = %∆P Dr. Stephen Antwi and Dr. Ophelia Amo PRICE ELASTICITY OF DEMAND The law of demand states that the quantity demanded and price are inversely related. Therefore, the price elasticity of demand is always negative, because an increase in price will lead to a decrease in quantity demanded and a decrease in price will lead to an increase in quantity demanded For own price elasticity of demand, we use the absolute values (after computation) to interpret and arrive at the extent responsiveness of quantity changes to price changes. By convention, we ignore the negative sign Dr. Stephen Antwi and Dr. Ophelia Amo Calculating Elasticity Two approaches are point and arc or mid-point elasticity Point elasticity of demand. That is calculating elasticity at a point  Q d p E p    p Q d Where the Greek letter stands for “change in  Calculating Elasticity  Arc elasticity When we use arc Elasticities we do not need to worry about which point is the starting point and which point is the ending point. (Average of initial and new price, hence midpoint) This benefit comes at the cost of a more difficult calculation. Q P Ep   (Q 1  Q 2 ) / 2 ( P1  P2 ) / 2 Dr. Stephen Antwi and Dr. Ophelia Amo Example Consider an example in which a 10% rise in the price of oil leads to a reduction in quantity demanded of only 1%. The price of Kenwood blender increased from ȼ150 to ȼ250. Following the increase in price, quantity demanded of the blender dropped from 500 to 400.  Compute the point and arc elasticity of demand Dr. Stephen Antwi and Dr. Ophelia Amo Price Elasticity Ranges Elastic Demand Unit Elasticity of Demand Inelastic Demand Extreme Elasticities Perfect elasticity Perfect inelasticity Dr. Stephen Antwi and Dr. Ophelia Amo PRICE ELASTICITY OF DEMAND Demand is elastic if a percentage change in price leads to a more than proportionate percentage change in quantity demanded. In this case price elasticity of demand is greater than 1 Demand is inelastic if quantity demanded changes by lesser percentage as compared to percentage change in price. Price elasticity of demand is less than 1. Demand is unit elastic if the percentage change in price leads to the same percentage change in the quantity demanded. Price elasticity of demand equals 1. Dr. Stephen Antwi and Dr. Ophelia Amo THE PRICE ELASTICITY OF DEMAND Extreme cases: Demand is perfectly elastic when the quantity demanded changes by a very large proportion as there is no change in price. Price elasticity of demand infinite. Demand is perfectly inelastic if a percentage change in price leads to no change in quantity demanded. Price elasticity of demand is zero. Dr. Stephen Antwi and Dr. Ophelia Amo CROSS PRICE ELASTICITY Cross Price elasticity of demand refers to the effect of a change in price of one good on the quantity demanded of a related good (substitute/complement) other things being equal. Percentage change in quantity demanded of a Cross Price good X elasticity of = demand Percentage change in the price of good Y  Q d x Py E    Py xy Q d x Note: Here the sign (+/-) is very important Dr. Stephen Antwi and Dr. Ophelia Amo 133 Cross price elasticity of demand When two goods are substitutes, the cross price elasticity of demand is positive.  For example, when the price of margarine goes up, the demand for butter will rise too as consumers shift away from the now relatively more expensive margarine to butter. When two related goods are complements, the cross price elasticity of demand is negative. If goods are completely unrelated, their cross price elasticity of demand will be zero. Dr. Stephen Antwi and Dr. Ophelia Amo CROSS PRICE ELASTICITY - EXAMPLE 1. Suppose that when the price of milo falls by 10 percent, the quantity of bournvita demanded decreases by 5 percent. Cross – 5 percent elasticity of = = 0.5 demand – 10 percent 2. Suppose that the price of torch lights increased from $20 to $30 and the quantity of batteries falls from 100 units to 70 units a day. Calculate the cross price elasticity. Dr. Stephen Antwi and Dr. Ophelia Amo INCOME ELASTICITY Income elasticity of demand measures the degree of responsiveness of a change in quantity demanded when income changes, other things remaining the same. Income Percentage change in quantity demanded elasticity of = demand Percentage change in income  Q d Y E    y y Q d Dr. Stephen Antwi and Dr. Ophelia Amo Income elasticity of demand A normal good has a positive income elasticity of demand A inferior good has a negative income elasticity of demand A luxury good has an income elasticity larger than one A necessity has an income elasticity less than one Dr. Stephen Antwi and Dr. Ophelia Amo Income elasticity of demand Period Number of CDs Income per Month (demanded per month) 1 6 400 2 8 600 Hence measured income elasticity of demand for CDs is 0.667 Dr. Stephen Antwi and Dr. Ophelia Amo DETERMINANTS OF ELASTICITY OF DEMAND The existence, number, and quality of substitutes.  If it is easy to find a substitute for a good, we say the good is elastic.  The demand for a good is inelastic if a substitute for it is hard to find. Three main factors influence the ability to find a substitute for a good: Luxury Versus Necessity A good is said to be a necessity when it has poor substitutes, which means that the demand for a necessity is inelastic. Example is food. A good that has many substitutes is said to be luxury, so the demand for a luxury is elastic. Dell laptops are luxuries. Dr. Stephen Antwi and Dr. Ophelia Amo DETERMINANTS OF ELASTICITY OF DEMAND The percentage of consumer’s total income devoted to purchase of that commodity.  The greater percentage of a total budget/income spent on the commodity, the greater the price elasticity of demand. The length of time allowed for adjustment to changes in the prices of the commodity  Elasticity of demand is greater in the long run than in the short run. (long run is the period of time necessary for consumers to make full adjustment to a given price change) Dr. Stephen Antwi and Dr. Ophelia Amo THE PRICE ELASTICITY OF SUPPLY Price elasticity of supply is a degree of responsiveness of quantity supplied of a good to a change in the price of the good. Elasticity of supply (Es)= percentage change in quantity supplied/percentage change in price  Q s P E    p s Q s Dr. Stephen Antwi and Dr. Ophelia Amo THE PRICE ELASTICITY OF SUPPLY Elastic and Inelastic Supply Supply is perfectly elastic if a small percentage change in price leads to a very large percentage change in the quantity supplied. Supply is elastic if the percentage change in the quantity supplied is more than the percentage change in price. Dr. Stephen Antwi and Dr. Ophelia Amo THE PRICE ELASTICITY OF SUPPLY If the percentage change in the quantity supplied is the same as the percentage change in price then Supply is unit elastic. Supply is inelastic if the percentage change in the quantity supplied is more than the percentage change in price. Supply is perfectly inelastic when there is no percentage change in quantity supplied when price changes. Dr. Stephen Antwi and Dr. Ophelia Amo THE PRICE ELASTICITY OF SUPPLY Computing the Price Elasticity of Supply Price elasticity Percentage change in quantity supplied of supply = Percentage change in price Supply is elastic if the price elasticity of supply is greater than 1. If the price elasticity of supply equals 1, supply is unit elastic. supply is inelastic if the price elasticity of supply is less than 1. Dr. Stephen Antwi and Dr. Ophelia Amo UGBS 201 Microeconomics Session 5 – Theory of Consumer Behaviour Business School 2020/2021 Dr. Stephen Antwi and Dr. Ophelia Amo Learning Objectives At the end of the session, the student will able to explain important concepts like the law of diminishing marginal utility, the budget constraint, indifference curves, marginal rate of substitution. understand how consumers maximize utility, how indifference curves can be used to represent a consumer’s preferences and how a budget constraint represents the choices a consumer can afford. Dr. Stephen Antwi and Dr. Ophelia Amo Slide 146 Reading List Read Chapter 13 of Recommended Text – Bade and Parkin (2013) Session Slides Other Economics text books available to students Dr. Stephen Antwi and Dr. Ophelia Amo Slide 147 Introduction to Theory of Consumer Choice Consumers are confronted with thousands of goods to buy everyday. Because of limited financial resources, you cannot buy everything that you want. Consumers, therefore, consider the prices of various goods being offered for sale and buy a bundle of goods, given their resources, that is that which best suits their needs and desires. The theory of consumer choice examines the tradeoffs that people face in their role as consumers. Hence, when a consumer buys more of one good, he can afford less of other goods. Dr. Stephen Antwi and Dr. Ophelia Amo Slide 148 Utility Theory Consumers buy goods because of the satisfaction they expect to receive from having and using that good. Utility can be defined as the satisfaction a consumer derives from consuming various units of a commodity. With respect to the utility of the consumer there are two schools of thought These are the Cardinalist and Ordinalist Approach Dr. Stephen Antwi and Dr. Ophelia Amo Slide 149 The Cardinal Approach Utility can be measured in units called utils. Individuals can quantify or value in monetary terms the satisfaction they derive from consuming a particular commodity. Thus consumers can measure total utility (TU), average utility (AU) and marginal utility (MU). Dr. Stephen Antwi and Dr. Ophelia Amo Slide 150 The Cardinal Approach Total utility is the total of the satisfaction derived from consuming units of a commodity. Eg. Suppose an individual consumes ‘n’ number of commodities, then the total utility Total Utility (TU)= U1+U2+U3+……………..+Un  Average Utility can be defined as the satisfaction per number of commodities consumed. Average Utility (AU)= 𝑇𝑈ൗ 𝑄, where Q denotes the number of commodities consumed.  Marginal Utility refers to the extra satisfaction a consumer derived from consuming an extra unit of a given commodity.  Algebraically expressed as the ratio of the change in total utility to the change in quantity consumed. Marginal Utility (MU) =∆𝑇𝑈ൗ ∆𝑄 Dr. Stephen Antwi and Dr. Ophelia Amo Slide 151 Example Dr. Stephen Antwi and Dr. Ophelia Amo Slide 152 Relationship between Total Utility and Dr. Stephen Antwi and Dr. Ophelia Amo Slide 153 The Cardinal Approach Diminishing Marginal Utility: this refers to the scenario when extra satisfaction from consuming several units of a commodity diminishes.  Hence, the law of diminishing marginal utility states that all things being equal, as several units of a commodity is consumed the extra satisfaction derived from each additional unit diminishes over time. This is depicted by the marginal utility curve, in which its seen that marginal utility is continuously declining.  From the table and graph, MU becomes negative after consuming the 5th bottle of water.  When marginal utility is negative, an additional unit consumed actually lowers total utility.  Thus a rational consumer will stop consuming at the point at which marginal utility becomes negative, even if the good is free. Dr. Stephen Antwi and Dr. Ophelia Amo Slide 154 CONSUMER EQUILIBRIUM – Single good A consumer is in equilibrium when how much he pays for a commodity (say x) is equal to the extra satisfaction he derives from that commodity (MU x). i.e. MU x = P x When MU x > P x there is a disequilibrium and the consumer will react. In this case, the consumer will buy more of commodity x because the extra satisfaction derived from commodity x is more than the price. However over time marginal utility begins to fall till it equals price. The reverse is true when Mu x < P x. Dr. Stephen Antwi and Dr. Ophelia Amo Slide 155 CONSUMER EQUILIBRIUM – Multiple goods The rule is that a consumer maximizes personal satisfaction when allocating money income in such a way that the last cedi spent on good A, good B and good C and so on yield equal amounts of marginal utility. M U of good A M U of good B  M U of good Z  becom es... PA r ilg ceeobfragioca o ldlyA , this P r i ce o f g o od B Pr i ceof good Z Dr. Stephen Antwi and Dr. Ophelia Amo Slide 156 Example Dr. Stephen Antwi and Dr. Ophelia Amo Slide 157 Derivation of the Demand Curve Use the equilibrium concept to do the derivation. Dr. Stephen Antwi and Dr. Ophelia Amo Slide 158 ORDINAL APPROACH Utility cannot be measured in utils. It is impossible for consumers to quantify the level of satisfaction derived from consuming a particular commodity. However individuals could show their preference for one good over the other. For example if a consumer is presented with three goods namely A, B and C the individual can say he/she prefers A over B and B over C. (A>B>C) By so doing the individual can tell which commodity is worth more to him or her. Dr. Stephen Antwi and Dr. Ophelia Amo Slide 159 The Budget Constraint Most people will like to increase the quantity or quality of the goods they consume, but they are constrained by their income. The budget constraint shows the various bundles of goods that the consumer can afford for a given income. Suppose that the consumer has an income of ȼ1000 per month and that he spends the entire income each month on food and clothes. The price for a unit of food ¢10 and that of clothes is ¢2. Observe: The more food he buys, the fewer clothes he can afford. It also shows the limit on the consumption bundles that a consumer can afford. Hence Budget line can be expressed as: I = Px(X) + Py(Y), Dr. Stephen Antwi and Dr. Ophelia Amo Slide 160 Dr. Stephen Antwi and Dr. Ophelia Amo Slide 161 Slope of the Budget line The slope of the budget constraint measures the rate at which the consumer can trade one good for the other (vertical over horizontal or rise over run). From point A to B the vertical distance is 100 units and the horizontal distance is 500. Thus the slope is (100/500) (actually because the budget constraint slopes downward, the slope is a negative number. But for the purposes we ignore the minus sign. Notice that the slope of the budge constraint equals the relative price of the two goods. That is, the price of one good compared to the other. A unit of food costs (1/5) times as much as clothes, so the opportunity cost of food is 1/5 units of clothes. Alternatively, Slope of the budget line, I = Px(X) + Py (Y) ,→ I – PxX= PyY 𝑃𝑥𝑋 𝐼 − =𝑌 𝑃𝑦 𝑃𝑦 ൗ −𝑑𝑦 𝑃𝑥 = 𝑑𝑥 𝑃𝑦 Dr. Stephen Antwi and Dr. Ophelia Amo Slide 162 Changes in the Budget Line There are two reasons why budget line can change. That is; Relative changes in price: As price of the good represented on the horizontal axis changes the budget line rotates. If the prices increase the BL rotates inwards and when they decrease it rotates outwards. Income changes: The budget constraint shifts outward or inward in parallel lines if income changes but relative prices do not change. Dr. Stephen Antwi and Dr. Ophelia Amo Slide 163 Relative changes in price Versus Income changes Dr. Stephen Antwi and Dr. Ophelia Amo Slide 164 INDIFFERENCE CURVE The consumer’s preferences allow him to choose among different bundles of goods. The consumer’s preferences are represented with indifference curves. An indifference curve is a locus of combination of goods and services that yield the same level of satisfaction to the consumer and therefore he/she is indifferent as to which combination to choose. PROPERTIES OF THE INDIFFERENCE CURVE  Negatively sloped: this means that to get more of good x the consumer has to reduce the amount of good y consumed  Higher indifference curves represent higher levels of satisfaction  Indifference curves do not intersect: if they do, they violate the law of transitivity. Dr. Stephen Antwi and Dr. Ophelia Amo Slide 165 PROPERTIES OF THE INDIFFERENCE CURVE They are convex to the origin: this is due to the law of diminishing marginal rate of technical substitution. Every point on an indifference curve denotes the same level of satisfaction Dr. Stephen Antwi and Dr. Ophelia Amo Slide 166 SLOPE OF THE INDIFFERENCE CURVE The slope at any point on an indifference curve equals the rate at which the consumer is willing to substitute one good for the other. This rate is called Marginal Rate of Substitution (MRS). The marginal rate of substitution is equal to the change in the quantity of one good that just offsets a one- unit change in the consumption of another good, such that total satisfaction remains constant. Because Indifference curves are not straight lines the marginal rate of substitution is not the same at all points on a given indifference curve. Suppose the utility function of a consumer is given as U=f(X,Y) then the slope of the indifference curve is given as 𝑑𝑦ൗ 𝑑𝑥= 𝑀𝑈𝑥𝑑𝑥 + 𝑀𝑈𝑦𝑑𝑦 = 0 -MUydy= Muxdx − 𝑑𝑦ൗ 𝑀𝑈𝑥ൗ 𝑑𝑥 = 𝑀𝑈𝑦= MRSxy Dr. Stephen Antwi and Dr. Ophelia Amo Slide 167 CONSUMER EQUILIBRIUM The consumer can maximize total utility only subject to budget constraint. The consumer is in equilibrium when the indifference curve is tangent to the budget line. Thus consumer optimum is achieved when the marginal rate of substitution is equal to the slope of the budget line or the relative prices of the goods consumed. They must have the same slope 𝑀𝑈𝑥ൗ = 𝑃𝑥ൗ 𝑀𝑈 𝑃 𝑦 𝑦 Dr. Stephen Antwi and Dr. Ophelia Amo 8/15/2019 Slide 168 CONSUMER EQUILIBRIUM Here, the relative price at which the market is willing to trade one good for the other is equal to the marginal rate of substitution which is the rate at which the consumer is willing to trade one good for the other. Dr. Stephen Antwi and Dr. Ophelia Amo Slide 169 PRICE CONSUMPTION CURVE (PCC) Definition: The price consumption curve is the curve that results from connecting tangents of indifference curves and budget lines (optimal bundles) when income and the price of good y are fixed, and the price of x changes. When good x and good y are complements, as real income increases, you buy more of both goods, making the PCC positively sloping. When good x and good y are substitutes, as real income increases, you buy more of one good (in this case good x) and less of the substitute (good y), making the PCC negatively sloping. Dr. Stephen Antwi and Dr. Ophelia Amo Slide 170 PRICE CONSUMPTION CURVE Dr. Stephen Antwi and Dr. Ophelia Amo Slide 171 INCOME CONSUMPTION CURVE (ICC) The Income Consumption Curve is the set of optimal bundles when income changes, while preferences and prices of goods are kept constant. Pictured below is the curve for a normal good. The ICC for an inferior good bends backwards. The Engel Curve graphs the relationship between purchasing good x and a consumer’s income. For a normal good, the curve is upward sloping. For an inferior good, the curve is downward sloping. Dr. Stephen Antwi and Dr. Ophelia Amo Slide 172 INCOME CONSUMPTION CURVE (ICC) FOR NORMAL GOOD Dr. Stephen Antwi and Dr. Ophelia Amo Slide 173 INCOME CONSUMPTION CURVE (ICC) FOR INFERIOR GOOD Dr. Stephen Antwi and Dr. Ophelia Amo Slide 174 Income & substitution effect for PRICE CHANGE SUBST. EFFECT INCOME EFFECT TOTAL EFFECT NORMAL Price increase Qty Qty Qty Price decrease Qty Qty Qty INFERIOR Price increase Qty Qty Qty Price decrease Qty Qty Qty GIFFEN Price increase Qty Qty Qty Price decrease Qty Qty Qty Dr. Stephen Antwi and Dr. Ophelia Amo Slide 175 Maximum Price Unlike minimum price, maximum price is set below the equilibrium price. It is called a maximum price because it is the maximum that suppliers are allowed to charge for the good or service. A maximum price leads to excess demand for the good. Until the excess demand is eliminated from the market, the controlled price will collapse and/or a black market will emerge. Dr. Stephen Antwi and Dr. Ophelia Amo 176 UGBS 201 Microeconomics And Business Session 6 – Production and Cost Business School 2020/2021 Dr. Stephen Antwi and Dr. Ophelia Amo Learning Objectives Students should know about; What production is and the production function The main factors of production and the role of the firm The economic view of the difference between long and short run The relationship between total, average and marginal physical products The law of diminishing marginal returns and returns to scale Economies and diseconomies of scale Isoquants and marginal rate of technical substitution Dr. Stephen Antwi and Dr. Ophelia Amo Slide 178 Reading List Read Chapter 14 of Recommended Text – Bade and Parkin (2013) Session Slides Other Economics text books available to students Dr. Stephen Antwi and Dr. Ophelia Amo Slide 179 Theory of Production In economics, production means any economic activity which is directed at the satisfaction of the wants of the people. Production may be any process by which resources are transformed into goods and services or output. Production also includes transporting, retailing, repackaging, and so on. Firms produce and sell in order to maximize Profit = TR- TC. Implies production is done using inputs/resources/factors of production. Inputs can be classified broadly or narrowly. The firm is the entity that brings together the factors of production/inputs – labour, land, physical capital, human capital, and entrepreneurial skill Dr. Stephen Antwi and Dr. Ophelia Amo Slide 180 Fixed and Variable Inputs A fixed input is an input A variable input is an that does not change as input that changes as output is changing during output is changing during a given period of time. a given period of time. The quantity of the fixed A variable factor is one factor cannot readily be whose usage rate can be changed within a short changed easily. Eg. labour time. Eg. Land, factory and raw materials space, plant and equipment. Dr. Stephen Antwi and Dr. Ophelia Amo Production Function A production function Q = f(L, K, M, …) describes the relationship where between a flow of inputs Q = quantity of output and the resulting flow of L = quantity of labor input outputs in a production K = quantity of capital input process during a given M = quantity of materials period of time. input Dr. Stephen Antwi and Dr. Ophelia Amo Short-run vrs Long run The short-run is a period of production during which at least one input is fixed. During the short run, a firm makes do with whatever machines and factory size it already has, no matter how much more it wants to produce because of increased demand for its products. It can, however, alter its variable inputs. The long-run is a period of production during which all inputs are variable. The long-run is also the time period when all adjustments to production can be made. Let us assume there are only 2 factors of production: Capital and Labour Dr. Stephen Antwi and Dr. Ophelia Amo SHORT-RUN PRODUCTION Also assume that capital is fixed but labour is variable To increase output in the short run, a firm must increase the quantity of labor it uses. How does output vary with inputs? We look at 3 measures of productivity: Total product Marginal product Average product Dr. Stephen Antwi and Dr. Ophelia Amo Total Product The total amount of TP or Q = f(L, K ), where output produced with TP or Q = total product or given quantities of fixed total quantity produced and variable inputs. L = quantity of labor input (variable) K = quantity of capital Total product rises as (fixed) more and more units of variable input is employed. Dr. Stephen Antwi and Dr. Ophelia Amo Short Run Production: Average Product The amount of AP = Total Product output per unit of Units of Variable Factor variable input. APL = TP÷L or Q÷L, where APL = average product of labor Dr. Stephen Antwi and Dr. Ophelia Amo Short Run Production: Marginal Product This is the change in total product per unit TP MP  change in the quantity  U n it o f In p u t of variable factor. MPL = ΔTP÷ΔL or ΔQ÷ΔL where MPL = marginal product of labor Dr. Stephen Antwi and Dr. Ophelia Amo Example Input of capital Input of Labour Total Product Average Product Marginal (K) (L) (TP) (AP) Product (MP) 10 0 0 10 1 30 10 2 70 10 3 120 10 4 140 10 5 150 10 6 150 10 7 140 Short Run Production:Total Product Curve Dr. Stephen Antwi and Dr. Ophelia Amo Short Run Production: Average and Marginal Product Curves Dr. Stephen Antwi and Dr. Ophelia Amo Relationship among TP, AP and MP Stage I: increasing marginal returns, TP is is increasing at an increasing rate. Stage II: MP is falling but Stage I Stage II Stage AP is rising, TP is III increasing at a decreasing rate. Stage III: both MP and AP are falling, but AP>MP. Beyond stage III, there is negative marginal returns Relationship among TP, AP and MP Dr. Stephen Antwi and Dr. Ophelia Amo Slide 192 Summary of the Relationship between AP and MP MP > AP, when AP rises as a result of an increase in quantity of variable input MP = AP when AP is maximum that is MP curve cuts the AP curve at its maximum MP < AP, when AP falls as a result of a decrease in Quantity of variable input Dr. Stephen Antwi and Dr. Ophelia Amo Slide 193 Diminishing Returns Also known as the law of variable proportions: refers to the input-output relationship, when the output is increased by varying the quantity of one input. Short-run phenomenon. These can be divided into three categories Diminishing Total Returns – implies the reduction in the total product with every additional unit of input Diminishing Average Returns – refers to the portion of the APP curve after its intersection with the MPP curve Diminishing Marginal Returns – refers to the point where MPP curve starts to slope down and travels all the way down to the x-axis and beyond First the diminishing marginal returns sets in, then average returns, followed by the total returns. Dr. Stephen Antwi and Dr. Ophelia Amo Slide 194 Which stage of operation will a rational producer choose and why? Stages of Operation A Rational producer will not produce in Stage 3 as MP of variable factor is negative Stage 1 as factors of production are underutilised A rational producer will always produce in Stage 2 where both the marginal product and average product of the variable factors are diminishing. At which particular point in this stage, a producer will decide to produce depends on the prices of factors Dr. Stephen Antwi and Dr. Ophelia Amo Slide 195 Guiding the Production Process Producing on the Production Function Employing the right level of inputs When capital or labour vary in the short run, to maximise profit a manager will hire – Capital until the value of marginal product of capital equals the rental rate: VMPK = r – Labour until the value of marginal product of labour equals the wage rate: VMPL = w Dr. Stephen Antwi and Dr. Ophelia Amo Slide 196 Long run production function. If all inputs are allowed to be varied, then the diagram would express outputs relative to total inputs, and the function would be a long run production function. In this case we examine the Law of Returns to Scale. That is, behaviour of output in response to change in scale, that is when all factors are increased or decreased in some proportion. Dr. Stephen Antwi and Dr. Ophelia Amo Slide 197 Law of returns to Scale Dr. Stephen Antwi and Dr. Ophelia Amo Slide 198 Economies of Scale of Production According to Stigler, Economies of scale is synonymous to Returns to Scale When the scale of production is increased up to a point, one gets economies of scale, thereafter diseconomies of scale. Increasing returns to scale is the result of these economies. These may arise from both internal and external economies. These include marketing economies, transport and storage economies, labour economies, technical economies among others. Dr. Stephen Antwi and Dr. Ophelia Amo Slide 199 Diseconomies of Scale When a given percentage increase in all the factors causes less than proportionate increase in output after a point it results in what is known as diseconomies of scale. That is increase in scale beyond the optimum level, results in diseconomies of scale. These may arise from unwieldy management and technical difficulties. Dr. Stephen Antwi and Dr. Ophelia Amo Slide 200 Other ways of expressing the Production Relationship It is also possible to assess the mix of inputs employed in production. Example, an Isoquant An Isoquant relates the quantities of one input to the quantities of another input. It indicates all possible combinations of inputs that are capable of producing a given level of output. The producer would be indifferent between them. Isoquants are thus contour lines which trace the loci of equal outputs. As the production remains the same on any point of this line, it is also called equal product curve. Dr. Stephen Antwi and Dr. Ophelia Amo Slide 201 Marginal Rate of Technical Substitution Isoquants are typically convex to the origin reflecting the fact that the two factors are substitutable for each other at varying rates. The rate of substitutability is called the marginal rate of technical substitution (MRTS). Q This measures the reduction in one input per unit increase in the other input that is sufficient to maintain the constant level of production. Z The marginal rate of technical substitution of labour for capital is equivalent to the absolute Labour slope of the Isoquant at that point (change in capital divided by change in labour) Dr. Stephen Antwi and Dr. Ophelia Amo Slide 202 Theory of Cost As part of the learning objectives, Students will be able to; Explain the concept of Total cost, marginal and average cost, the role of opportunity cost in economic cost Analyze the link between a firm’s production process and its total costs Examine the relationship between short-run and long-run costs Theory of Cost Firms incur several cost in their business operations. When economists talk about cost, they talk about opportunity cost/economic cost. This concept of cost is different from that of the accountant. An economic measure of cost. The value of the next best alternative forgone Dr. Stephen Antwi and Dr. Ophelia Amo Slide 204 Accounting/Economic Cost and Profit The Firm’s Goal is to maximize profit Accounting Cost and Profit An accountant measures cost and profit to ensure that the firm pays the correct amount of income tax and to show the bank how the firm has used its bank loan. Economists predict the decisions that a firm makes to maximize its profit. These decisions respond to opportunity cost and economic profit. Explicit Costs and Implicit Costs An explicit cost is a direct cost/out of pocket cost. An implicit cost is an indirect cost. Dr. Stephen Antwi and Dr. Ophelia Amo 205 Cost Function A mathematical expression showing the relationship between the cost of production and the level of output, all other factors held constant. Dr. Stephen Antwi and Dr. Ophelia Amo SHORT-RUN COST 207 Short Run Costs COST FUNCTION DEFINITION Total fixed cost TFC = (PK) x (K) Total variable cost TVC = (PL) x (L) Total cost TC = TFC + TVC Average fixed cost AFC = TFC ÷ Q Average variable cost AVC = TVC ÷ Q Average total cost ATC = TC ÷ Q = AFC + AVC Marginal cost MC = ΔTC ÷ ΔQ = ΔTVC ÷ ΔQ Example PK = 50 and PL = 100 K L TP = Q TFC TVC TC AFC AVC ATC MC 10 0 0 10 1 14 10 2 35 10 3 62 10 4 91 10 5 121 10 6 150 10 7 175 10 8 197 10 9 212 10 10 217 Dr. Stephen Antwi and Dr. Ophelia Amo Total Cost Curves Dr. Stephen Antwi and Dr. Ophelia Amo Average and Marginal Cost Curves 8/15/2019 Dr. Stephen Antwi and Dr. Ophelia Amo Relationship Between Short Run Production and Cost TC  PL  L TVC PL  L TC TVC AVC   MC   Q Q Q Q PL  PL  L L APL   PL Q Q PL PL   Q MPL L Dr. Stephen Antwi and Dr. Ophelia Amo SHORT-RUN COST Why the Average Total Cost Curve Is U-Shaped Remember ATC=AFC+AVC shape of the ATC curve will come from its components Implying, the U shape of the average total cost curve arises from the influence of two opposing forces: Spreading total fixed cost over a larger output Decreasing marginal returns Dr. Stephen Antwi and Dr. Ophelia Amo 213 SHORT-RUN COST Relationship between Cost Curves and Product Curves The technology that a firm uses determines its costs. When employment and output are low, increasing employment increases marginal product and average product, and decreases marginal cost and average variable cost. Then, when marginal product is at its maximum, marginal cost is at its minimum. As the firm increases its employment of labour, marginal product decreases and marginal cost increases. Dr. Stephen Antwi and Dr. Ophelia Amo 214 SHORT-RUN COST Figure on the right illustrates the relationship between the product curves and cost curves. A firm’s marginal cost curve is linked to its marginal product curve. If marginal product rises, marginal cost falls. If marginal product is a maximum, marginal cost is a minimum. 215 Dr. Stephen Antwi and Dr. Ophelia Amo SHORT-RUN COST A firm’s average variable cost curve is linked to its average product curve. If average product rises, average variable cost falls. If average product is a maximum, average variable cost is a minimum. Dr. Stephen Antwi and Dr. Ophelia Amo 217 SHORT-RUN COST At small outputs, MP and AP rise and MC and AVC fall. At intermediate outputs, MP falls and MC rises and AP rises and AVC falls. At large outputs, MP and AP fall and MC and AVC rise. 8/15/2019 218 SHORT-RUN COST What causes the cost curves to shift 1. Technology When technology changes, the TP, AP and MP curves shift upwards. For instance, with an improved technology, output can be produced using the same inputs. This lowers the average and marginal costs. Dr. Stephen Antwi and Dr. Ophelia Amo 219 SHORT-RUN COST 2. Prices of inputs When prices of inputs increase, they become expensive and shifts some of the cost curves. Which of the curves will shift then? It depends on which input experiences the price change. If the price of a fixed input increases; Both TFC and AFC shift upward. TC shift upward. AVC, TVC and MC do not change. Dr. Stephen Antwi and Dr. Ophelia Amo 220 SHORT-RUN COST An increase in the price of a variable input Shifts the TVC and AVC upward. Shifts the marginal cost curve MC upward. AFC and TFC do not change Dr. Stephen Antwi and Dr. Ophelia Amo 221 UGBS 201 Microeconomics and Business Session 9 – Market Structures (Part I) Business School 2020/2021 Dr. Stephen Antwi and Dr. Ophelia Amo Learning Objectives At the end of this session, Students will - Be able to identify the different market structures based on some characteristics - Understand what a Perfectly Competitive Industry is - Be able to select the price and output that will maximize profit in the short run. - Be able to select the price and output that will maximize profit in the long run. Dr. Stephen Antwi and Dr. Ophelia Amo Slide 223 Reading List Read Chapter 11 & 12 of Recommended Text – Bade and Parkin (2013) Session Slides Other Economics text books available to students Dr. Stephen Antwi and Dr. Ophelia Amo Slide 224 Market types The four market types are Perfect competition Monopoly Monopolistic competition Oligopoly The differences in pricing and production decisions shapes the types of market structures that exist. A market is competitive if each buyer and seller is small compared to the total size of the market and therefore, has little ability to influence market prices. By contrast, if a firm can influence the market price of the good it sells, it is said to have market power. Dr. Stephen Antwi and Dr. Ophelia Amo Slide 225 Market Structure Perfect Monopolistic Characteristic Competition Competition Oligopoly Monopoly Number of firms Large number Large number Small number Single firm competing Nature of the Undifferentiated No close Homogenous Differentiated product or differentiated substitutes Entry No restrictions Few barriers Many barriers Blocked Information Complete Relatively good Asymmetric Asymmetric availability Substantial Firm’s control None Firm is price Some Some maker over price Firm is price taker Dr. Stephen Antwi and Dr. Ophelia Amo 226 Market type 1: Perfect Competition Perfect competition exists when Undifferentiated products are sold to many buyers by many sellers. There are no barriers to entry into (or exit from) the market. Existing firms have no advantage over new firms. Information in the market is perfect. That is sellers and buyers are well informed about prices. A price taker is a firm that has no control over the price of the good or service that it produces. The firm in perfect competition is a price taker. Dr. Stephen Antwi and Dr. Ophelia Amo Slide 227 Revenue of a competitive firm A firm in a competitive market, like most firms in the economy, tries to maximize profit, which equals total revenue minus total cost (Profit = TR–TC). Consider a firm that produces bottled water. Because the firm is small compared to the market for bottled water, it takes the price as set by market. Even if the firm increases the output it produces, the price of water remains the same. Thus, total revenue is proportional to the amount of output and not the price. Dr. Stephen Antwi and Dr. Ophelia Amo Slide 228 Revenue Function Depicts the relationship between revenue and output. Total revenue (TR) is price times the quantity/output. TR = (P x Q). Average revenue (AR) is total revenue divided by output. AR = TR/Q = (P x Q)/Q = P For all firms, average revenue equals the price of the good It refers to the revenue a firm receives for a typical unit sold. Dr. Stephen Antwi and Dr. Ophelia Amo Slide 229 Revenue Function Marginal Revenue (MR) is the change in total revenue from the sale of each additional unit of output. MR = ΔTR/ ΔQ For competitive firms, marginal revenue equals the price of the good. Total revenue is P x Q, and P is fixed by the market for a competitive firm. Therefore, when Q rises by 1 unit, total revenue rises by P cedis. Dr. Stephen Antwi and Dr. Ophelia Amo Slide 230 Example Dr. Stephen Antwi and Dr. Ophelia Amo Slide 231 Solution Slide 232 Dr. Stephen Antwi and Dr. Ophelia Amo A FIRM’S PROFIT-MAXIMIZING CHOICES The goal of a competitive firm is to maximize profit, which equals total revenue minus total cost. In the Short Run, firms under Perfectly competitive markets can 1. Make profits 2. Break-even 3. Make losses 4. Shut down Dr. Stephen Antwi and Dr. Ophelia Amo Slide 233 A FIRM’S PROFIT-MAXIMIZING CHOICES  Marginal Analysis and the Supply Decision Marginal analysis compares marginal revenue, MR, with marginal cost, MC. As output increases, marginal revenue remains the same but marginal cost increases. If marginal revenue is above marginal cost (if MR > MC), the extra revenue from selling one more unit exceeds the extra cost incurred to produce it. Economic profit/ abnormal profit increases if output increases. The opposite is true if MR < MC Profit-maximizing quantity is the quantity at which MR = MC. Dr. Stephen Antwi and Dr. Ophelia Amo Slide 234 Profit Maximization and the Competitive Firm. Marginal analysis Dr. Stephen Antwi and Dr. Ophelia Amo Slide 235 Profit Maximization and the Competitive Firm. Marginal analysis Dr. Stephen Antwi and Dr. Ophelia Amo Slide 236 Shut down Decision of the Firm  Temporary Shutdown Decisions Temporary shutdown decision is made when a firm is incurring an economic loss that it believes is not permanent, that will make it remain in the market, and produce some output or temporarily shut down. Note the distinction between a temporary shutdown of a firm and the permanent exit of a firm from the market. The short run and long run decisions differ because most firms cannot avoid their fixed costs in the short run but can do so in the long run. A firm that shuts down temporarily still has to pay its fixed costs (but saves the variable cost), whereas a firm that exits the market saves both its fixed and its variable costs. Economic loss is equal to total fixed cost when the firm shuts down temporarily. Dr. Stephen Antwi and Dr. Ophelia Amo Slide 237 A FIRM’S PROFIT-MAXIMIZING CHOICES  If total revenue were less than total variable cost, the firm’s economic loss would exceed total fixed cost. So the firm would shut down temporarily. Mathematically, Shut down if TR < VC Dividing both sides by Q we have TR/Q < VC/Q TR/Q is average revenue while VC/Q average variable cost. Recall that Average Revenue = Price Therefore, Shut down if P < AVC when choosing to produce, the firm compares the price it receives for the typical unit to the average variable cost that it must incur to produce the unit. If the price does not cover the AVC, the firm is better off stopping production altogether. Dr. Stephen Antwi and Dr. Ophelia Amo Slide 238 A FIRM’S PROFIT-MAXIMIZING CHOICES The firm’s economic loss will be equal total fixed cost when price equals average variable cost. If total revenue exceeds total variable cost, the firm’s economic loss is less than total fixed cost. So it pays for the firm to produce and incur an economic loss. – The firm’s shutdown point is the output and price at which price equals minimum average variable cost. – Figure 4 on the next slide illustrates a firm’s shutdown point. Dr. Stephen Antwi and Dr. Ophelia Amo Slide 239 A FIRM’S PROFIT-MAXIMIZING CHOICES Marginal revenue curve is MR. The firm’s cost curves are MC, ATC, and AVC. Slide 240 Dr. Stephen Antwi and Dr. Ophelia Amo A FIRM’S PROFIT-MAXIMIZING CHOICES Dr. Stephen Antwi and Dr. Ophelia Amo Slide 241 A FIRM’S PROFIT-MAXIMIZING CHOICES 1. With a market price (and MR) of GHC 24 a TV, the firm minimizes its loss by producing 8 TVs a day. The firm is at its shutdown point. Dr. Stephen Antwi and Dr. Ophelia Amo Slide 242 A FIRM’S PROFIT-MAXIMIZING CHOICES 2. At the shutdown point, the firms incurs an economic loss equal to total fixed cost. Dr. Stephen Antwi and Dr. Ophelia Amo Slide 243 A FIRM’S PROFIT-MAXIMIZING CHOICES The Firm’s Short-Run Supply Curve – A perfectly competitive firm’s short-run supply curve shows how the firm’s profit-maximizing output changes as the price varies, other things remaining the constant. – Figure 5 on the next slide illustrates a firm’s supply curve and its relationship to the firm’s cost curves. Dr. Stephen Antwi and Dr. Ophelia Amo Slide 244

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