Microeconomics Midterm Reviewer.pdf

TOPIC 1 - INTRODUCTION TO ECONOMICS What is Economics? Assuming humans have unlimited wants within a world of limited means, economists analyze how resources are allocated for production, distribution, and consumption. The study of microeconomics focuses on the choices of individuals and businesses...

TOPIC 1 - INTRODUCTION TO ECONOMICS What is Economics? Assuming humans have unlimited wants within a world of limited means, economists analyze how resources are allocated for production, distribution, and consumption. The study of microeconomics focuses on the choices of individuals and businesses, and macroeconomics concentrates on the behavior of the economy on an aggregate level. One of the earliest recorded economists was the 8th-century B.C. Greek farmer and poet Hesiod who wrote that labor, materials, and time needed to be allocated efficiently to overcome scarcity. Maslows Hierarchy Of Needs Theory Maslow's Hierarchy of Needs is a psychological theory proposed by Abraham Maslow in 1943. It outlines a five-tier model of human needs, often depicted as a pyramid. According to Maslow, individuals are motivated to fulfill these needs in a hierarchical order, starting from the most basic and moving towards higher-level needs. Here’s a breakdown of the levels: 1. Physiological Needs: These are the most basic and essential needs for human survival, including food, water, warmth, and rest. Until these needs are met, individuals are unlikely to focus on higher levels of the hierarchy. 2. Safety Needs: Once physiological needs are satisfied, people seek safety and security. This includes physical safety, financial stability, health, and protection from accidents and harm. 3. Love and Belongingness Needs: After securing safety, individuals strive for social connections. This encompasses relationships, love, friendship, and a sense of belonging within a community or group. 4. Esteem Needs: Once people have established relationships and a sense of belonging, they seek esteem. This involves self-esteem, confidence, respect from others, and recognition of achievements. 5. Self-Actualization Needs: At the top of the hierarchy is self-actualization, where individuals pursue personal growth, creativity, and realizing their full potential. This is about becoming the best version of oneself and achieving personal goals and aspirations. Maslow believed that higher-level needs become prominent only after lower-level needs have been reasonably satisfied. However, people can fluctuate between levels, and not everyone follows this exact progression. The theory suggests that fulfillment of each level is crucial for achieving overall well-being and personal development. Understanding Microeconomics Microeconomics is the study of what's likely to happen when individuals make choices in response to changes in incentives, prices, resources, or methods of production. These scenarios are also known as tendencies. It can be applied in a positive or normative sense. Positive microeconomics describes economic behavior and explains what to expect if certain conditions change. It theorizes that consumers will tend to buy fewer cars than before if a manufacturer raises the prices of cars. The price of copper will tend to increase if a major copper mine collapses because supply is restricted. Understanding Macroeconomics Macroeconomics is a branch of economics that studies the behavior of an overall economy, which encompasses markets, businesses, consumers, and governments. Macroeconomics examines economy-wide phenomena such as inflation, price levels, rate of economic growth, national income, gross domestic product (GDP), and changes in unemployment. What causes unemployment? What causes inflation? What stimulates economic growth? Macroeconomics attempts to measure how well an economy is performing, understand what forces drive it, and project how performance can improve. Sectors In The Economy What Is a Sector? A sector is an area of the economy in which businesses share the same or related business activity, product, or service. Sectors represent a large grouping of companies with similar business activities, such as the extraction of natural resources and agriculture. Primary Sector The primary sector involves companies that participate in the extraction and harvesting of natural products from the Earth. Primary sector companies are typically engaged in economic activity that utilizes the Earth's natural resources, which are sold to consumers or commercial businesses. Companies involved in the processing and packaging of raw materials are also categorized within the primary sector. Primary sector business activities include the following: Mining and quarrying Fishing Agriculture Forestry Hunting Emerging economies tend to have a higher amount of economic activity and employment concentrated within the primary sector versus more advanced economies. On the other hand, developed nations tend to utilize machinery and technology in their primary sector activities, meaning the primary sector doesn't represent a large portion of the population's employment. Secondary Sector The secondary sector consists of processing, manufacturing, and construction companies. The secondary sector produces goods from the natural products within the primary sector. The secondary sector includes the following business activities: Automobile production Textile Chemical engineering Aerospace space Shipbuilding Energy utilities Tertiary Sector The tertiary sector is comprised of companies that provide services, such as retailers, entertainment firms, and financial organizations. The tertiary sector provides services to businesses and consumers by selling the goods that are manufactured by companies in the secondary sector. The types of services provided by the tertiary sector include: Retail sales Transportation and distribution Restaurants Tourism Insurance and banking Healthcare services Legal services Quaternary Sector The quaternary sector includes companies engaged in intellectual activities and pursuits. The quaternary sector typically includes intellectual services such as technological advancement and innovation. Research and development that leads to improvements to processes, such as manufacturing, would fall under this sector. The companies and firms within the quaternary sector had been traditionally part of the tertiary sector. However, with the growth of the knowledge-based economy and technological advancements, a separate sector was created. Firms within the quaternary sector use information and technology to innovate and improve processes and services, leading to enhancements in economic development. Firms within the quaternary sector might be engaged in the following business activities: Research and development Information technology (IT) Education Consulting services TOPIC 2 - BASIC ECONOMIC CONCEPTS AND THE CONCEPT OF SCARCITY What is Economics? 1. Studies Demand and Supply – The law of supply and demand combines two fundamental economic principles that describe how changes in the price of a resource, commodity, or product affect its supply and demand. Supply rises while demand declines as the price increases. Supply constricts while demand grows as the price drops. 2. Studies Consumption, Production and Distribution of our Scarce Resources – The study of economics is primarily concerned with analyzing the choices that individuals, businesses, governments, and nations make to allocate limited resources. Economics has ramifications on a wide range of other fields, including politics, psychology, business, and law. 3. Etymologically, “OIKONOMIA” - The word "economics" is derived from a Greek word "oikonomia" which means "household management" or "management of house affairs" i.e., how people earn income and resources and how they spend them on their necessities, comforts and luxuries. 4. Studies of How Society Manages its Scarce Resources (Mankiw, 2018) - In most societies, resources are allocated not by an all-powerful dictator but through the combined choices of millions of households and firms. Economists, therefore, study how people make decisions: how much they work, what they buy, how much they save, and how they invest their savings. 5. Efficient Allocation of the Society’s Scarce Resources in Meeting the Unlimited Demands – Scarcity is an economic concept where individuals must allocate limited resources to satisfy their needs. Scarcity occurs when demand for a good or service is greater than availability. Scarcity affects the monetary value individuals place on goods and services. Trade-Off In economics, a very basic trade-off can be understood as the idea that if you choose one thing, you are going to lose another. The trade-off is taking the opportunity to have something, but in order to get that thing, you have to give up, or sacrifice, something else. Opportunity Cost Money, time, and energy are such valuable resources, it is important to understand what the opportunity costs are when making a decision so that you can make the most beneficial trade-off for each particular situation. Factors of Production Land – Land has a broad definition as a factor of production and can take on various forms, from agricultural land to commercial real estate to the resources available from a particular piece of land. Natural resources, such as oil and gold, can be extracted and refined for human consumption from the land. Labor - Labor refers to the effort expended by an individual to bring a product or service to the market. Again, it can take on various forms. For example, the construction worker at a hotel site is part of the labor, as is the waiter who serves guests or the receptionist who enrolls them into the hotel. Capital - In economics, capital typically refers to money. However, money is not considered part of the capital factor of production because it is not directly involved in producing a good or service. Instead, it facilitates the acquisition of things that are considered capital such as capital goods. Entrepreneurship - Entrepreneurship is the secret sauce that combines all the other factors of production. Entrepreneurs use land, labor, and capital in order to produce a good or service for consumers. Entrepreneurship is involved with establishing innovative ideas and putting that into action by planning and organizing production. GDP Gross domestic product (GDP) is the total monetary or market value of all the finished goods and services produced within a country’s borders in a specific time period. As a broad measure of overall domestic production, it functions as a comprehensive scorecard of a given country’s economic health. The calculation of a country’s GDP encompasses all private and public consumption, government outlays, investments, additions to private inventories, paid-in construction costs, and the foreign balance of trade. Exports are added to the value and imports are subtracted. GNP GNP is commonly calculated by taking the sum of personal consumption expenditures, private domestic investment, government expenditure, net exports, and any income earned by residents from overseas investments, then subtracting income earned by foreign residents. GNP measures the total monetary value of the output produced by a country's residents. Therefore, any output produced by foreign residents within the country's borders must be excluded in calculations of GNP, while any output produced by the country's residents outside of its borders must be counted. TOPIC 3 - THE CIRCULAR FLOW OF MONEY IN AN ECONOMY CHAPTER 4: MARKET STRUCTURE What is Market Structure? In economics, market structure describes the classification and differentiation of industries according to their level and type of competition for goods and services. It focuses on the features that affect the behavior and results of firms operating within a particular market. 1. The Industry’s Buyer Structure This feature examines the composition and distribution of buyers within the market. It considers whether the market is dominated by a few large buyers or many smaller ones. In markets with a concentrated buyer structure, a few major buyers may have significant bargaining power over sellers, potentially influencing prices and market conditions. Conversely, a market with a dispersed buyer structure often exhibits more competitive pricing and less buyer power. 2. The Turnover of Customers This refers to how frequently customers switch between different suppliers or brands. High customer turnover indicates that consumers frequently change their purchasing preferences, which can signal high competition and low brand loyalty. In contrast, low turnover suggests that customers tend to stick with certain brands or suppliers, possibly due to brand loyalty, satisfaction, or high switching costs. 3. The Extent of Product Differentiation This feature assesses how distinct the products or services offered by different firms in the market are from one another. High product differentiation means that products have unique attributes or features that distinguish them from competitors, which can reduce direct competition and give firms more pricing power. Low differentiation implies that products are more homogeneous, leading to greater competition primarily based on price. 4. The Nature of Costs of Inputs This aspect evaluates the cost structure related to the inputs required for production. It includes examining whether inputs are expensive or cheap and whether they are readily available or scarce. Markets with high input costs may experience higher barriers to entry, while those with lower input costs might have more entrants and competitive dynamics. Additionally, the nature of input costs can impact the pricing and profitability of firms in the market. 5. The Number of Players in the Market The number of firms or players operating within a market is a fundamental feature that affects competition. Markets with a large number of players typically exhibit more competition, which can lead to lower prices and increased innovation. Conversely, markets with few players may experience less competition, potentially resulting in higher prices and less consumer choice. This feature helps categorize markets into types such as perfect competition, oligopoly, or monopoly.  6. Vertical Integration Extent in the Same Industry This feature looks at the degree to which firms in the market control multiple stages of the production or supply chain within the same industry. High vertical integration means that a firm is involved in several stages of production, from raw materials to final products. This can lead to efficiencies and cost savings but might also reduce competition if a few firms dominate multiple stages of the supply chain. Low vertical integration indicates that firms focus on specific stages of production and rely on other firms for different stages. 7. The Largest Player’s Market Share The market share of the largest player provides insight into the level of market concentration and competition. A high market share held by the largest firm often indicates a concentrated market where one firm has significant control over prices and market dynamics. In contrast, a market where the largest player has a small market share suggests a more competitive environment with multiple firms sharing the market space more evenly. MONOPOLY What Is a Monopoly? A monopoly is a market structure where one seller or producer dominates an entire industry or sector. In free-market economies, monopolies are generally discouraged because they hinder competition, reduce the availability of alternative options for consumers, and restrict consumer choice. 1. A Natural Monopoly is a type of monopoly that occurs when a single firm can supply a product or service to an entire market at a lower cost than any potential competitor. This could be due to the high set-up costs or ongoing fixed costs which make it unviable for multiple firms to operate within the industry. 2. A Government Monopoly, as the term suggests, is a monopoly created and owned by the government. This is usually seen in industries deemed essential or strategic for national security or where competition is considered undesirable. 3. A Technological Monopoly is one that is held by a company which owns a method or process necessary to produce a specific good or service. Usually, this involves owning a patent. 4. A Geographic Monopoly is a monopoly in a specific geographic area. Often, these occur in regions or localities where certain resources or services are scarce or not easily accessible. What Is Vertical Integration? Vertical integration is a strategy that companies use to streamline their operations. It involves taking ownership of various stages of its production process. Companies achieve vertical integration through mergers or acquisitions or establishing suppliers, manufacturers, distributors, or retail locations rather than outsourcing them. Vertical integration often requires significant initial capital investment. What Is Horizontal Integration? Horizontal integration is the acquisition of a business operating at the same level of the value chain in the same industry—that is, they make or offer similar goods or services. This is in contrast to vertical integration, where firms expand into upstream or downstream activities, which are at different stages of production. OLIGOPOLY What Is an Oligopoly? An oligopoly is a market structure where a few firms have significant control over the market. In such a setup, these companies can either directly or indirectly limit production or set prices to increase their profits. A defining feature of an oligopoly is that no single firm can prevent the others from having a major impact on the market. This contrasts with a monopoly, where a single firm dominates the entire market. Special Considerations Governments often address oligopolies by enacting laws to prevent price-fixing and collusion. However, cartels can still engage in price-fixing if they operate outside of government jurisdiction or with government approval. In mixed economies, oligopolies frequently seek to influence and advocate for favorable government policies, sometimes working under government regulation or direct oversight. Advantages One of the main benefits of having an oligopoly is that competition is very limited. That's because there are very few players in the market. Since there are few competitors, an oligopoly allows those who participate to net a higher number of profits. Disadvantages Oligopolies come with higher barriers to entry for new participants. This means that it can be difficult to enter the market because of the high costs associated with doing business, the regulatory environment, and the problems that arise when it comes to accessing supply and distribution channels. PERFECT COMPETITION What Is Perfect Competition? Perfect competition, or pure competition, represents an ideal market scenario where numerous sellers vie to offer the best prices, and no single seller, regardless of size, holds any advantage over others. While true perfect competition is rare in actual markets, it serves as a valuable model for understanding how supply and demand influence prices and market behavior. Characteristics In a perfectly competitive market, all firms offer identical products and are price takers, meaning they cannot affect market prices. Market share doesn’t impact prices, and buyers have complete information about products and prices. Resources and labor are fully mobile, and firms can enter or exit the market without incurring costs. MONOPOLISTIC COMPETITION What Is Monopolistic Competition? Monopolistic competition occurs when numerous companies provide similar, but not identical, products or services. In such markets, entry barriers are low, and the actions of one firm do not directly impact its rivals. Characteristics of a Monopolistic Competition Low Barriers to Entry: Multiple firms can enter and compete in the market without fearing significant impacts from competitors, as no single firm dominates. Product Differentiation: Companies distinguish their similar products through unique marketing, brand names, and varying quality levels. Pricing: Firms set their own prices and can adjust them without triggering intense price wars, unlike in oligopolies. Demand Elasticity: Demand is highly responsive to price changes, with consumers easily switching brands based on price fluctuations. CHAPTER 5: LAW OF DEMAND AND LAW OF SUPPLY Law of Demand Demand - refers to the goods and services buyers (1) desire; (2) are willing; and (3) has the ability to purchase at a given price within a given period. Law of Demand – states that when price (P) rises, the quantity demanded (Qd) falls, vice versa, ceteris paribus. Demand Function: Qd = f(P) Law of Supply Supply - refers to the goods and services sellers (1) desire; (2) are willing; and (3) has the ability to sell at a given price within a given period. Law of Supply – states that when price (P) rises, the quantity supplied (Qs) also increases, vice versa, ceteris paribus. Supply Function: Qs = f(P) Market Equilibrium When Qs and Qd meet, the so-called market equilibrium is reached. Disequilibrium Surplus – quantity demanded is less than quantity supplied. (Qd < Qs) Shortage – quantity demanded is greater than quantity supplied. (Qd > Qs) Government Intervention: Price Controls PRICE FLOOR SURPLUS Supports the suppliers Qd < Qs PRICE CEILING SHORTAGE supports the demanders Qd > Qs