Basic Microeconomics PDF First Semester Prelims Reviewer

BASIC MICROECONOMICS FIRST SEMESTER PRELIMS REVIEWER ________________________________________________________ MODULE 1 Services are intangible items. INTRODUCTION TO APPLIED ECONOMICS Microec...

BASIC MICROECONOMICS FIRST SEMESTER PRELIMS REVIEWER ________________________________________________________ MODULE 1 Services are intangible items. INTRODUCTION TO APPLIED ECONOMICS Microeconomics is the study of small economic units, how individuals, Lesson 1 households, and firms make decisions Economic as Social Science and allocate resources, such as individuals, firms, and industries Social science is one field of study that (competitive markets, labor markets, relates to human behaviour and society. personal decision making, etc.) Economics as social science is concerned with varied issues pertaining Macroeconomics is the study of the to the production of goods and services, large economy as a whole or in its basic money, banking and finance, subdivisions (National Economic forecasting business conditions and Growth, Government Spending, other similar business and household Inflation, Unemployment, etc.), the management. branch of economics that studies the behavior and performance of the entire Economics was derived from the Greek economy instead of just its small parts. word "Oikonomos" which means the management of household affairs. Scarcity is the condition in which our wants for goods are greater than the Economics is a social science limited resources available to satisfy concerned with the efficient use of those wants. limited resources to achieve maximum satisfaction of economic wants. Effects of scarcity: ⁃ Choices Economics is the study of scarcity and ⁃ Needs for rationing device- if you are choice Scarcity means that there is a able and willing to pay the price the finite amount of a good or service good is yours (Basically they are limited). Because ⁃ Competition something is limited, we need to make decisions regarding how we use and Lesson 2 allocate our resources. So studying Different economic activities economics helps us to better make decisions regarding how to deal with 1. Production. Production is the the condition of scarcity. process of creating goods and services, and the conversion of Goods are tangible items, or products.  BASIC MICROECONOMICS FIRST SEMESTER PRELIMS REVIEWER ________________________________________________________ raw materials into finished or computers and buildings where a good consumable goods. is produced, or the tools utilized to 2. Distribution. Distribution is the create a good or provide a service. process to allocate or to 4) Entrepreneur. "The talent that some apportion the different fruits of people have for organizing the production to the owners of the resources of land, labor, and capital to different factors of production. produce goods, seek new business opportunities, and develop new ways of The Factors of Production doing things". Entrepreneurship is the are classifications of what goes into the putting together of land labor and making of a good or service. capital to create a good or provide a They include: service. This is basically the ideas that 1) Land or Natural Resources which are go into the process of creating a good products used in the production of or providing a service. goods and services, come from the earth. Examples could include lumber The fruits of production or oil. refers to those benefits received by the Natural resources can be characterized owners of the different factors of as either: production every time these factors of a) Renewable resources are resources production are used to create goods that can be replenished, such as trees and services, or the production process, that can be replanted. for consumption. b) Non-renewable resources are 3. Exchange. Exchange is the resources that cannot be replaced such delivery of the finished goods as coal. from the producer to the end 2) Labor or Human Resources is the user. physical and mental talents people 4. Consumption. Consumption contribute to the production process, it refers to the utilization of goods is the work that goes into the purchased by the buyer to satisfy production of a good or service. When his demand. looking at this factor, we usually look at 5. Public finance. Public finance is the number of workers and the the management of the nation's workers' skills. monetary or financial resources 3) Capital is the term used for the items by the government. that are used to create a good or service, the produced goods that can be Lesson 3 used as inputs for further production, Basic economic problems such as factories, machinery,  BASIC MICROECONOMICS FIRST SEMESTER PRELIMS REVIEWER ________________________________________________________ Basic economic problems refer to a when changes in technology or person's inability to satisfy the basic international competition needs - food, clothing, shelter and change the skills needed to education - of man in order to live a perform jobs or change the normal life. The limited resources as locations of jobs well as the improper management of 4) Cyclical unemployment. The the economy's resources, often result higher than normal to economic problems. unemployment at a business cycle trough and the lower than The following are the basic economic normal unemployment at a problems common in developing business cycle peak. economies: 3. Population high growth rate. The 1. Poverty. A situation where the rate of growth in population is higher people encounter difficulty in than the set rate by the government. satisfying their basic needs on a High growth rate in population with no regular basis. corresponding increases in economic 2. Unemployment. Unemployment growth and productivity would result to is a condition where people, unemployment. physically and mentally 4. High cost of education. It is related qualified, and are willing to to the total expenses incurred in work, cannot find a job aligned earning a degree wherein the cost is with their educational beyond the income level capacity of the attainment. family. Four sources or causes of 5. High cost of health care services. It unemployment: pertains to the high cost of medication 1) Frictional unemployment - is and consultation that deprives the unemployment that arises someone of the proper treatment of a from normal labor diseases. turnover-from people entering 6. High dependence on remittances. and leaving the labor force and Families of OFWs are solely dependent from the ongoing creation and on their remittances that, in most destruction of jobs. cases, has developed among OFWs 2) Seasonal unemployment. This is family members the attitude of due to the seasonal changes in laziness, dependency and extravagant the demand for certain kinds of lifestyles. labor. 7. Graft and corruption. Graft is the 3) Structural unemployment - is acquisition of money and wealth in the unemployment that arises dishonest or illegal ways. It is an illegal  BASIC MICROECONOMICS FIRST SEMESTER PRELIMS REVIEWER ________________________________________________________ transaction mostly committed or uses in such a way that the involving government officials. resources are put to their best Corruption or illegal behaviour leads to possible use. mismanagement of resources resulting to inefficient delivery of public services. To make the best use of economic resources, the following questions need Society must also make choices under to be answered: conditions of scarcity. Scarcity is a 1. What to produce? condition when unlimited demands of Goods were grouped according to: man exceeds the available supply of a) Consumption goods and services production resources needed in b) Capital goods producing goods. It is the fundamental c) Government goods and services problem of every society. It is not d) Export goods and services possible for any economy to produce 2. How do we produce? every type of good in an unlimited 3. How much to produce? quantity. Every economy has to take the 4. For whom to produce? basic decision of making the best use of its available resources in producing What is the scientific method in goods and services. economics? The scientific method involves Reasons why economic problems identifying a problem, gathering data, arise: forming a hypothesis, testing the 1. Unlimited wants hypothesis, and analyzing the results. Multiply over time Cause and effect relationships are used Many want are recurring to establish economic theories and Wants differ in their principles. urgency 2. Limited resources Lesson 4 Productive resources - Demand and Supply Concepts scarce Labor - by size of Demand Concepts population Land - by area If you demand something, then you of country 1. Want it, Capital and technology - 2. Can afford it, and scarcity of various inputs 3. Plan to buy it. 3. Alternative uses of resources The available resources should Wants are the unlimited desires or be allocated among different wishes that people have for goods and  BASIC MICROECONOMICS FIRST SEMESTER PRELIMS REVIEWER ________________________________________________________ services. Scarcity guarantees that economize on its use and switch many-perhaps most-of our wants will to a substitute becomes stronger. never be satisfied. 2. Income Effect. When a price rises, other things remaining the Demand reflects a decision about which same, the price rises relative to one wants to satisfy. income. Faced with a higher price and an unchanged income, The quantity demanded of a good or people cannot afford to buy all service is the amount that consumers the things they previously plan to buy during a given time period bought. They must decrease the at a particular price. The quantity quantities demanded of at least demanded is not necessarily the same some goods and services. as the quantity actually bought. Normally, the goods whose price Sometimes the quantity demanded has increased will be one of the exceeds the amount of goods available, goods that people buy less of. so the quantity bought is less than the quantity demanded. A change in Demand The Law of Demand When any factor that influences buying plans changes, other than the price of The law of demand states that "Other the good, there is a change in demand. things remaining the same, the higher the When demand increases, the demand price of a good, the smaller is the quantity curve shifts rightward and the quantity demanded; and the lower the price of a demanded at each price is greater. good, the greater is the quantity demanded". Six main factors bring changes in demand: Reasons why higher price reduce the The prices of related goods. The quantity demanded: quantity of goods that 1. Substitution Effect. When the consumers plan to buy depends price of a good rises, other in part on the prices of things remaining the same, its substitutes for these goods. relative price - its opportunity Substitute is a good that can be cost -rises. Although each good used in place of another good. is unique, it has substitutes - The quantity of goods that other goods that can be used in people plan to buy also depends its place. As the opportunity cost on the prices of complements of a good rises, the incentive to with the goods. A complement is  BASIC MICROECONOMICS FIRST SEMESTER PRELIMS REVIEWER ________________________________________________________ a good that is used in becomes easier to get, demand conjunction with another good. for the good might increase now. Expected future prices. If the Population. Demand also expected future price of a good depends on the size and the age rises and if the good can be structure of the population. The stored, the opportunity cost of larger the population, the obtaining the good for future use greater is the demand for all is lower today than it will be in goods and services; the smaller the future when people expect the population, the smaller is the the price to be higher. So people demand for all goods and retime their purchases-they services. substitute over time. They buy Preferences. Preferences more of the good now before its determine the value that people price is expected to rise (and less place on each good and service. afterward), so the demand for Preferences depend on such the good increases today. If the things as the weather, expected future price of a good information, and fashion. for falls, the opportunity cost of example, greater health and buying the good today is high fitness awareness has shifted relative to what it is expected to preferences in favor of energy be in the future. So again, people bars, so the demand for energy retime their purchases. They buy bars has increased. less of the good now before its price is expected to fall, so the Supply Concepts demand for the good decreases If a firm supplies a good or service, the today and increases in the future. firm Income. when income increases, 1. Has the resources and technology to consumers buy more of most produce it, goods; and when income 2. Can profit from producing it, and decreases, consumers buy less of 3. Plans to produce it and sell it. most goods. A normal good is one for which demand increases A supply is more than just having the as income increases. An inferior resources and the technology to good is one for which demand produce something. Resources and decreases as income increases. technology are the constraints that Expected future income and limit what is possible. credit. When expected future income increases or credit  BASIC MICROECONOMICS FIRST SEMESTER PRELIMS REVIEWER ________________________________________________________ Many useful things can be produced, think about the supply curve as a but they are not produced unless it is minimum-supply-price curve. if profitable to do so. Supply reflects a the price of a factor of decision about which technologically production rises, the lowest feasible items to produce. price that a producer is willing to accept for that good rises, so The quantity supplied of a good or supply decreases. service is the amount that producers Prices of Related Goods plan to sell during a given time period Produced. The prices of related at a particular price. The quantity goods that firms produce supplied is not necessarily the same influence supply. For example, if amount as the quantity actually sold. the price of energy gel rises, Sometimes the quantity supplied is fums switch production from greater than the quantity demanded, so bars to gel. The supply of energy the quantity sold is less than the bars decreases. Energy bars and quantity supplied. energy gel are substitutes in production- goods that can be The Law of Supply produced by using the same resources. if the price of beef The law of supply states: "Other things rises, the supply of cowhide remaining the same, the higher the price increases. Beef and cowhide are of a good, the greater is the quantity complements in production- supplied; and the lower the price of a goods that must be produced good, the smaller is the quantity together. supplied". Expected Future Prices. If the expected future price of a good Change in Supply rises, the return from selling the When any factor that influences selling good in the future increases and plans other than the price of the good is higher than it is today. So changes, there is a change in supply. supply decreases today and increases in the future. Six main factors bring changes in The Number of Suppliers. The supply: larger the number of firms that The prices of factors of produce a good, the greater is production. The prices of the the supply of the good. As new factors of production used to firms enter an industry, the produce a good influence on its supply in that industry increases. supply. To see this influence, As firms leave an industry, the  BASIC MICROECONOMICS FIRST SEMESTER PRELIMS REVIEWER ________________________________________________________ supply in that industry characteristics of market structure decreases. The commodity or item that's Technology. The term sold and the extent of production "technology" is used broadly to differentiation. mean the way that factors of The ease or difficulty of entering production are used to produce a and exiting the market. good. A technology change The distribution of market share occurs when a new method is for the largest firms. The discovered that lowers the cost number of companies in the of producing a good. market. The State of Nature. The state of The number of buyers and how nature includes all the natural they work with or against the forces that influence production. sellers to dictate price and It includes the state of the quantity. weather and, more broadly, the The relationship between sellers. natural environment. Good weather can increase the supply Competition among the Many include: of many agricultural products 1. Perfect Competition. Perfect and bad weather can decrease competition describes a market their supply. Extreme natural structure, where a large number events such as earthquakes, of small firms compete against tornadoes, and hurricanes can each other. In this scenario, a also influence supply. single firm does not have any significant market power. As a MODULE 2 result, the industry as a whole MARKET STRUCTURE produces the socially optimal level of output, because none of Lesson 1 the firms can influence market Competition among the Many prices. 2. Monopolistic Competition. also What Are Market Structures? refers to a market structure, "Market structures" refer to the where a large number of small different market characteristics that firms compete against each determine relations between sellers to other. However, unlike in perfect each another, of sellers to buyers and competition, the firms in more. monopolistic competition sell similar, but slightly differentiated products. That  BASIC MICROECONOMICS FIRST SEMESTER PRELIMS REVIEWER ________________________________________________________ gives them a certain degree of sellers to dictate price and market power, which allows quantity. them to charge higher prices The relationship between sellers. within a certain range. Competition among the Few include: Lesson 2 1. Monopoly Competition Among the Few A monopoly refers to a market structure where a single firm Introduction controls the entire market. In Market structures provide a starting this scenario, the firm has the point for assessing economic highest level of market power, as environments in business. An consumers do not have any understanding of how companies and alternatives. As a result, markets work allows business monopolies often reduce output professionals and leaders to accurately to increase prices and earn more judge industry and market news, policy profit. changes and legislation and how the 2. Oligopoly economy shapes important decisions. An oligopoly describes a market structure that is dominated by What Are Market Structures? only a small number of firms. "Market structures" refer to the That results in a state of limited different market characteristics that competition. The firms can determine relations between sellers to either compete against each each another, of sellers to buyers and other or collaborate. By doing so, more. There are several basic defining they can use their collective characteristics of a market structure, market power to drive up prices such as the following: and earn more profit. The commodity or item that's sold and the extent of production differentiation. The ease or difficulty of entering A GUIDE TO MARKET STRUCTURE and exiting the market. The distribution of market share Market structures provide a starting for the largest firms. point for assessing economic The number of companies in the environments in business. An market. understanding of how companies and The number of buyers and how markets work allows business they work with or against the professionals and leaders to accurately  BASIC MICROECONOMICS FIRST SEMESTER PRELIMS REVIEWER ________________________________________________________ judge industry and market news, policy 2. Monopolistic Competition changes and legislation and how the Like pure competition, monopolistic economy shapes important decisions. competition is a market structure referring to a large number of small Types of Market Structures firms competing against each other. There are four basic types of market However, firms in monopolistic structures. competition sell similar but highly differentiated products. Lowest 1. Pure Competition possible cost production, which leads Pure or perfect competition is a market to optimal output in a pure competition structure defined by a large number of market structure, is not assumed. small firms competing against each other. A single firm doesn't have These factors give firms in a significant marketing power, and as a monopolistic competition market result, the industry produces an power to charge higher prices within a optimal level of output because firms certain range. The products are don't have the ability to influence remarkably similar, but small market prices. Supply and demand differences become the basis for firms' determine the amount of goods and marketing and advertising. services produced, along with the Differentiation can include style, brand market prices set by the companies in name, location, packaging, the market. Products are identical to advertisement, pricing strategies and competitors' products, and there are no more. significant barriers to entering and exiting the market. Examples include fast food restaurants, clothing stores, breakfast cereal The pure competition market structure companies, service and repair markets, is rare in the real world. This is a tutoring companies and beauty salons theoretical model that is helpful when and spas. Products and services at a looking at industries with similar beauty salon are quite similar, but characteristics. In other words, it's a these companies will use certain value good reference point for other market propositions, such as quality of services structures. The best examples of pure and appealing pricing, to draw more competition market structures are customers. They may even advertise stock, agricultural and craft markets. brand-name beauty products that are themselves in monopolistic competition — there is little that separates makeup and hair products, as  BASIC MICROECONOMICS FIRST SEMESTER PRELIMS REVIEWER ________________________________________________________ far as what constitutes these products Pricing, profits and production levels and their change as the dynamic relationship use. between sellers and buyers changes. Producers freely enter the market when 4. Pure Monopoly profits are attractive. There is easy A monopoly exists when there's a entry and exit in monopolistic single firm that controls the entire competition. market. The firm and industry are synonymous. This firm is the sole 3. Oligopoly producer of a product, and there are no An oligopoly is dominated by a few close substitutes. Because there are no firms, resulting in limited competition. alternatives, the firm has the highest They can collaborate with or compete level of market power. against each other to use their collective market power to drive up Hence, monopolists often reduce prices and earn more profit. output, increase prices and earn more profit. Entry or exit is blocked in a pure Entering into an oligopoly is difficult. monopoly. This can occur for more The most powerful companies have than one reason, as seen in two of the control over raw materials, patents and best examples for pure monopolies: financial and physical resources that public utilities and professional sports create barriers for potential entries. leagues. This is what helps set high prices. However, if prices are too high, buyers Public utilities are considered natural will head to product substitutes in the monopolies because they have market. economies of scale — a firm receives certain cost advantages due to its size - Products may be homogeneous or in an extreme way. New firms cannot differentiated. Typically, there are start up because it would be incredibly three to five dominant firms, but this expensive to reach scale in a short number can vary depending on the amount of time. Building a maze of market. For instance, video gaming pipes and wires to be able to compete consoles are an oligopoly with three with the firm would require a lot of companies - Microsoft, Sony and capital, and there would be legal Nintendo - dominating the market. barriers to entry. That's why there are Other examples of oligopolies are the typically government monopolies (or automobile and gasoline industries. government regulations) for natural monopolies.  BASIC MICROECONOMICS FIRST SEMESTER PRELIMS REVIEWER ________________________________________________________ some of them are just theoretical Professional sports leagues control constructs. Nevertheless, they are player contracts and have leases on critical because they help us major city stadiums and arenas. It understand how competing firms make would take a substantial amount of decisions. With that said, let's look at capital to lure away top talent and the four market structures in more secure a large enough place to detail. showcase that talent, if someone wanted to start a professional sports 1. Perfect Competition league. Plus, there are broadcasting Perfect competition describes a market rights and more at play. For example, structure, where a large number of for the 2017-2018 season, 37 players in small firms compete against each the NBA will earn $20 million or more other. In this scenario, a single firm in salary alone. New arenas in the does not have any significant market league cost in the neighborhood of power. As a result, the industry as a $500 million. Television rights for the whole produces the socially optimal NBA were extended in February 2016 level of output, because none of the with ESPN and TNT for a value of about firms can influence market prices. $2.66 billion per year. The idea of perfect competition builds The Four Types of Market Structures on several assumptions: (1) all firms There are quite a few different market maximize profits (2) there is free entry structures that can characterize an and exit to the market, (3) all firms sell economy. entirely identical (i.e., homogenous) goods, (4) there are no consumer However, if you are just getting started preferences. By looking at those with this topic, you may want to look at assumptions, it becomes obvious that the four basic types of market we will hardly ever find perfect structures first: perfect competition, competition in reality. That is an monopolistic competition, oligopoly, essential aspect because it is the only and monopoly. Each of them has its market structure that can own set of characteristics and (theoretically) result in a socially assumptions, which in turn affect the optimal level of output. decision making of firms and the profits they can make. Probably the best example of a market with an almost perfect competition we It is important to note that not all of can find in reality is the stock market. If these market structures exist in reality; you are looking for more information  BASIC MICROECONOMICS FIRST SEMESTER PRELIMS REVIEWER ________________________________________________________ on perfect competition, you can also different, but at the end of the day, they check our post on perfect competition are all breakfast cereals. vs. imperfect competition. 3. Oligopoly 2. Monopolistic Competition An oligopoly describes a market Monopolistic competition also refers to structure that is dominated by only a a market structure, where a large small number of firms. That results in a number of small firms compete against state of limited competition. The firms each other. However, unlike in perfect can either compete against each other competition, the firms in monopolistic or collaborate (see also Cournot vs. competition sell similar but slightly Bertrand Competition). By doing so, differentiated products. That gives they can use their collective market them a certain degree of market power, power to drive up prices and earn more which allows them to charge higher profit. prices within a specific range. The oligopolistic market structure Monopolistic competition builds on the builds on the following assumptions: following assumptions: (1) all firms (1) all firms maximize profits, (2) maximize profits (2) there is free entry, oligopolies can set prices, (3) barriers and exit to the market, (3) firms sell to entry and exit exist in the market, differentiated products (4) consumers (4) products may be homogeneous or may prefer one product over the other. differentiated, and (5) only a few firms Now, those assumptions are a bit closer dominate the market. Unfortunately, it to reality than the ones we looked at in is not clearly defined what a "few perfect competition. However, this firms" means precisely. As a rule of market structure no longer results in a thumb, we say that an oligopoly socially optimal level of output because typically consists of about 3-5 the firms have more power and can dominant firms. influence market prices to a certain degree. To give an example of an oligopoly, let's look at the market for gaming An example of monopolistic consoles. This market is dominated by competition is the market for cereals. three powerful companies: Microsoft, There is a vast number of different Sony, and Nintendo. That leaves all of brands (e.g., Cap'n Crunch, Lucky them with a significant amount of Charms, Froot Loops, Apple Jacks). market power. Most of them probably taste slightly  BASIC MICROECONOMICS FIRST SEMESTER PRELIMS REVIEWER ________________________________________________________ 4. Monopoly large number of small firms compete A monopoly refers to a market against each other with homogenous structure where a single firm controls products. Meanwhile, monopolistic the entire market. In this scenario, the competition refers to a market firm has the highest level of market structure, where a large number of power, as consumers do not have any small firms compete against each other alternatives. As a result, monopolies with differentiated products. An often reduce output to increase prices Oligopoly describes a market structure and earn more profit. where a small number of firms compete against each other. And last but not The following assumptions are made least, a monopoly refers to a market when we talk about monopolies: (1) the structure where a single firm controls monopolist maximizes profit, (2) it can the entire market. set the price, (3) there are high barriers to entry and exit, (4) there is only one firm that dominates the entire market. From the perspective of society, most monopolies are not desirable because they result in lower outputs and higher prices compared to competitive markets. Therefore, they are often regulated by the government. An example of a real-life monopoly could be Monsanto. This company trademarks about 80% of all corn harvested in the US, which gives it a high level of market power. You can find additional information about monopolies in our post on monopoly power. Summary There are four basic types of market structures: perfect competition, imperfect competition, oligopoly, and monopoly. Perfect competition describes a market structure, where a