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Welcome!
Dr Siang Ng (lectures 1 & 2)
Office: room 708
Email: [email protected]
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Objectives
• Understand the behaviour of consumers
and producers, and the determination of
price and output in various market
environments;
• Demonstrate knowledge of the principles
and tools of economic analysis used in
specific business decisions;
• Understand the role of government policy in
shaping the business environment.
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MICROECONOMICS
Robert Pindyck and Daniel Rubinfeld
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Lecture 1. Introduction to Economics
A. Basic Principles
• What are the key themes of microeconomics?
• What is a market?
• Why study microeconomics?
B. The basics of supply and demand
Readings: chapters 1 & 2
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A. Basic Principles
Themes of Microeconomics
• Microeconomics deals with limits
– Limited budgets
– Limited time
– Limited ability to produce
• How do we make the most of limits?
• How do we allocate scarce resources?
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Themes of Microeconomics
• Workers, firms and consumers must make
trade-offs
– Do I work or go on vacation?
– Do I purchase a new car or save my money?
– Do we hire more workers or buy new
machinery?
• How are these trade-offs best made?
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• Consumers
– Limited incomes
– Consumer theory – describes how consumers maximize their wellbeing, using their preferences, to make decisions about trade-offs
• Workers
– Individuals decide when and if to enter the workforce
• Trade-offs of working now or obtaining more education/training
– What choices do individuals make in terms of jobs or workplaces?
– How many hours do individuals choose to work?
• Trade-off of labor and leisure
• Firms
– What types of products do firms produce?
• Constraints on production capacity and financial resources create
needs for trade-offs
– Theory of the Firm – describes how these trade-offs are best made
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– Trade-offs are often based on prices faced by consumers and producers
– Workers make decisions based on prices for labor – wages
– Firms make decisions based on wages and prices for inputs and on prices
for the goods they produce
How are prices determined?
• Centrally planned economies – governments control prices
• Market economies – prices determined by interaction of market
participants
Market: collection of buyers and sellers whose interaction determines the
price of good
– Buyers: consumers purchase goods;
companies purchase labor and inputs
– Sellers: consumers sell labor, resource owners sell inputs;
firms sell goods
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Types of Markets
• Perfectly competitive markets
– Because of the large number of buyers and sellers,
no individual buyer or seller can influence the price
• Example: Most agricultural markets
– Fierce competition among firms can create a
competitive market
• Noncompetitive Markets
– Markets where individual producers can influence the
price
• Cartels – groups of producers who act collectively
• Example: OPEC dominates with world oil market
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Market Definition
• Market Definition
– Which buyers and sellers should be included
in a given market?
– This depends on the extent of the market –
boundaries, geographical and by range of
products, to be included in it
• Market for housing in Guangzhou or Guangdong
• Market for all cameras or digital cameras
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Theories and Models
• Economics is concerned with explanation of observed
phenomena
– Theories are used to explain observed phenomena in terms of a
set of basic rules and assumptions:
• The Theory of the Firm
• The Theory of Consumer Behavior
• Theories are used to make predictions
– Economic models are created from theories
– Models are mathematical representations used to make
quantitative predictions
• Validating a Theory
– The validity of a theory is determined by the quality of its
prediction, given the assumptions
– Theories must be tested and refined
– Theories are invariably imperfect – but gives much insight into
observed phenomena
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• Positive Analysis – statements that describe the
relationship of cause and effect
– Questions that deal with explanation and prediction
• What will be the impact of an import quota on foreign cars?
• What will be the impact of an increase in the gasoline excise
tax?
• Normative Analysis – analysis examining
questions of what ought to be
– Often supplemented by value judgments
• Should the government impose a larger gasoline tax?
• Should the government decrease the tariffs on imported cars?
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Why Study Microeconomics?
• Microeconomic concepts are used by
everyone to assist them in making choices
as consumers and producers
• Examples show the numerous levels of
microeconomic questions necessary in
many decisions
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Built Ford Explorer in 1991, Ford Expedition in 1997 and Ford Excursion in 1999. In
each of these cases, Ford had to consider many aspects of the economy to
ensure their introduction was a sound investment:
• How strong is demand and how quickly will it grow?
• Must understand consumer preferences and trade-offs
– What are the costs of manufacturing?
• Given all costs of production, how many should be produced each year?
– Ford had to develop pricing strategy and determine competitors’ reactions
– Risk analysis
• Uncertainty of future prices: gas, wages
– Organizational decisions
– Government regulation
• Emissions standards
• Clean Air Act imposed emissions standards and have become increasingly
stringent:
• What are the impacts on consumers?
• What are the impacts on producers?
• How should the standards be enforced?
• What are the benefits and costs?
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B. The Basics of Supply and Demand
• What are supply and demand?
• What is the market mechanism?
• What are the effects of changes in market
equilibrium?
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Supply and Demand
• Supply and demand analysis can:
1. Help us understand and predict how real
world economic conditions affect market
price and production
2. Analyze the impact of government price
controls, minimum wages, price supports,
and production incentives on the economy
3. Determine how taxes, subsidies, tariffs and
import quotas affect consumers and
producers
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Supply
• In markets where sellers are price-takers, sellers’
intentions are summarised in supply.
• Quantity supplied is the amount of a good that sellers
are willing and able to sell.
• A supply function (curve, table) relates quantity
supplied to the price of a good at a given place and
time period.
• As prices rise, a larger quantity of goods is supplied,
ceteris paribus (or everything else equal).
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Example: supply table (schedule)
Price
$1.00
$1.50
$2.00
$2.50
$3.00
$3.50
$4.00
Quantity
4
6
8
10
12
14
16
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Alternative representation: supply curve
• The Supply Curve
– The relationship between the quantity of a
good that producers are willing to sell and the
price of the good
– Measures quantity on the x-axis and price on
the y-axis
Q S  Q S (P)
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Price
($ per slice)
Supply
4
3
2
8
12
16
Quantity
(1000s of slices
per day)
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Price
($ per slice)
Supply
4
3
2
8
12
16
Quantity
(1000s of slices
per day)
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Movement along the supply curve
P = Price
of wine ($)
When the price falls from $25
to $23, the quantity supplied
decreases from 160 to 100.
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It is a movement along the
given supply curve.
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It is a decrease in the
quantity supplied.
100
160
Q = # bottles
supplied per day
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Shifts in supply
P = Price
of wine
When factors other than
price change, the whole
supply curve shifts.
In the example, the supply
curve shifted to the left
(or up, or north-west) –
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It is a decrease in supply.
when would this happen?
140
250
Q = # bottles
supplied per day
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What causes shifts in supply?
• Input prices
• Technology (by changing the costs of
production)
• Expectations about output prices in the
future
• Number of sellers
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Demand
• In markets where buyers are price-takers, buyers’
intentions are summarised in demand.
• Quantity demanded is the amount of a good that
buyers are willing and able to purchase.
• A demand function (curve, table) relates buyers’
quantity demanded to the price of a good at a given
place and time period.
• As price increases, buyers demand less of that good,
hence a downward sloping demand curve, ceteris
paribus (or everything else equal).
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Example: demand table (schedule)
Price
$1.00
$1.50
$2.00
$2.50
$3.00
$3.50
$4.00
Quantity
20
18
16
14
12
10
8
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Alternative representation: demand curve
• The Demand Curve
– The relationship between the quantity of a
good that consumers are willing to buy and
the price of the good
– Measures quantity on the x-axis and price on
the y-axis
QD  QD(P)
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Price
($ per slice)
4
3
2
Demand
8
12
16
Quantity
(1000s of slices
per day)
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Price
($ per slice)
4
3
2
Demand
8
12
16
Quantity
(1000s of slices
per day)
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Movement along the demand curve
P = Price of
wine ($)
When price falls from $25 to
$23, the quantity demanded
increases from 100 to 140.
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It is a movement along the
given demand curve.
It is an increase in the
quantity demanded.
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100
140
Q = # bottles
demanded per year
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Shifts in demand
When factors other than
price change, the whole
demand curve shifts.
In the example, the demand
curve shifted to the right (or
up, or north-east) –
P = Price of
wine ($)
It is an increase in demand.
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when would this happen?
140
250
Q = # bottles
demanded per year
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What causes shifts in demand?
•
•
•
•
•
•
Income: normal vs inferior goods
Changes in tastes, preferences
Changes in the price of complements
Changes in the price of substitutes
Expectations about future price
Number of potential buyers
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Demand and supply together:
market equilibrium
• Equilibrium is a situation in which supply and demand
are in balance.
• When the market is in equilibrium, the price is called an
equilibrium price and the quantity, an equilibrium
quantity.
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Equilibrium
Price of
wine
equilibrium
Supply
Equil.
price
= 20
Demand
Equil. quantity = 250
# bottles of wine
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The Market Mechanism
• The market mechanism is the tendency in a free
market for price to change until the market
clears
• Markets clear when quantity demanded equals
quantity supplied at the prevailing price
• In equilibrium
–
–
–
–
There is no shortage or excess demand
There is no surplus or excess supply
Quantity supplied equals quantity demanded
Anyone who wants to buy at the current price can and
all producers who want to sell at that price can
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The Market Mechanism
• Supply and demand interact to determine the
market-clearing price
• When not in equilibrium, the market will adjust to
alleviate a shortage or surplus and return the
market to equilibrium
• Markets must be competitive for the mechanism
to be efficient
• Competitive markets allocate goods and
services where demand and supply are in
balance.
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Markets not in equilibrium
• Excess Supply (or surplus)
• Price is above the equilibrium price.
• Sellers are unable to sell all they want to sell at the
going price.
• Quantity supplied exceeds quantity demanded.
• Sellers respond to excess supply by cutting prices until
the equilibrium is recovered.
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Excess supply
When the price is
$23, there is excess
supply of 6.
Price of
wine
excess supply
Supply
23
20
As the price falls
towards $20,
quantity demanded
increases and
quantity supplied
falls.
This continues till
excess supply
disappears, and
Demand the equilibrium is
recovered.
247
250
253
# bottles of wine
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Markets not in equilibrium
• Excess Demand (or shortage)
• Price is below the equilibrium price.
• Buyers are unable to buy all they want at the going
price.
• Quantity demanded exceeds quantity supplied.
• Producers respond to excess demand by charging
more until the equilibrium is recovered.
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Excess demand
Price of
wine
When the price is $17, there
is excess demand of 6.
Supply
20
17
excess demand Demand
247
250
253
As the price rises
towards $20,
quantity demanded
falls and quantity
supplied increases.
This continues till
excess demand
disappears, and
the equilibrium is
recovered.
# bottles of wine
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Changes in equilibrium
• Decide whether the event shifts the supply or demand
curve (or both).
• Decide whether the curve(s) shift(s) to the left or right.
• Determine how the shift affects equilibrium price and
quantity.
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A change in demand
How does a medical report,
“A bottle a day keeps the
doctor away” change the
equilibrium?
Price of
wine
Demand
At the new
equilibrium,
P2
the price is higher
and the quantity
is larger.
P1
New demand
Supply
Q1
Q2
# bottles of wine
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A change in supply
Price of
wine
New supply
Demand
P2
A bad weather led to an
increase in the price of
grapes. How does it
affect the wine market?
At the new
equilibrium,
P1
the price is higher
and the quantity
is smaller.
Supply
Q2
Q1
# bottles of wine
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Change in demand and supply
• When both curves shift, the final effect on price and
quantity depends on the relative shift in demand and
supply.
• Increase (decrease) in demand has potential to
increase (decrease) price and quantity.
• Increase (decrease) in supply has potential to
decrease (increase) price but increase (decrease)
quantity.
• Combined effect – Draw demand-supply diagrams.
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