Introduction to microeconomics (2016)Apunte Inglés
Basic concepts of microeconomics
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INTRODUCTION TO MICROECONOMICS
PART I: COMPETITIVE MARKETS
TOPIC I: Supply and demand
A model of competitive markets
A market is a group of buyers and sellers of a particular good or service. The buyers as a group
determine the demand for the product, and the sellers as a group determine the supply of a
Economists use the term competitive market to describe a market in which there are so many buyers and sellers that each has a negligible impact on the market price.
For a market to be perfectly competitive, the goods offered for sale are all exactly the same, and the buyers and sellers are so numerous that no single buyer or seller has any influence over the market price.
The supply curve The quantity supplied of any good or service is the amount that sellers are willing and able to sell.
Law of supply: the quantity supplied of a good rises when the price of the good rises.
The supply curve is a graph of the relationship between the price of a good and the quantity supplied.
The demand curve The quantity demanded of any good or service is the amount that buyers are willing and able to purchase.
Law of demand: the quantity demanded of a good falls when the price of the good raises.
The demand curve is a graph of the relationship between the price of a good and the quantity demanded.
1 The price quantity equilibrium Equilibrium: a situation in which the market price has reached the level at which quantity supplied equals quantity demanded.
Equilibrium price: the price that balances quantity supplied and quantity demanded.
Who trades in equilibrium? Not everyone trades.
The demanders: only when the price of the good is less or equal to their reservation price.
The suppliers: only when the price of the good is over their reservation price.
Reserve price, profit of sellers and consumers’ surplus Reservation price: The maximum price that the demander is willing to pay for a good.
The minimum price at which the seller is willing to sell the good.
The producer surplus is the amount a seller is paid for a good minus the seller’s cost of providing it.
The consumer surplus is the amount a buyer is willing to pay for a good minus the amount the buyer actually pays for it.
The efficiency of competitive equilibrium Is the property of a resource allocation of maximizing the total surplus received by all members of society.
Comparative statics 2 Smooth demand and supply curves In a large population, the gaps between one demander’s buyer value and the next higher and lower buyer value are likely to be very small, and the demand curve will consist of many small steps. We can therefore “smooth out” the small steps and approximate the demand curve by a smooth curve. Likewise, if the gaps between adjacent seller costs are small, we can draw a smooth supply curve.
Vocabulary Substitutes: two goods for which an increase in the price of one leads to an increase in the demand for the other.
Complements: two goods for which an increase in the price of one leads to a decrease in the demand for the other.
Surplus: a situation in which quantity supplied is greater than quantity demanded.
Shortage: a situation in which quantity demanded is greater than quantity supplied.
Fixed costs: the costs that have already been incurred and cannot be reduced by altering the production.
Variable costs: the costs vary when the number of units sold do so.
Comparative statistics: a procedure to predict how shifts in supply/demand curves will affect the economic variables (p*, q*, surplus…).
3 TOPIC II: Slope and price elasticity The slope The sensitivity of demand/supply to price changes depends on the slope of the demand/supply curve OR the change in quantity when price increases by one unit.
In general: Supply curve: (positive slope), when the price increases by one unit the quantity supplied increases.
Demand curve: (negative slope), when the price increases by one unit the quantity demanded decreases.
The shallower (horizontal) the curve, the greater the change in quantity.
The steeper (vertical) the curve, the lesser the change in quantity.
The calculation of the slope: 𝑠𝑙𝑜𝑝𝑒 = ∆𝑃 𝑑𝑃 = ∆𝑄 𝑑𝑄 Price elasticity The price elasticity of demand is a measure of how much the quantity demanded of a good responds to a change in the price of that good, computed as a percentage change in quantity demanded divided by the percentage change in price.
% 𝑐ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑄𝑑 𝑝𝑟𝑖𝑐𝑒 𝑒𝑙𝑎𝑠𝑡𝑖𝑐𝑖𝑡𝑦 𝑜𝑓 𝑑𝑒𝑚𝑎𝑛𝑑 = % 𝑐ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑃 𝑚𝑖𝑑𝑝𝑜𝑖𝑛𝑡 𝑚𝑒𝑡ℎ𝑜𝑑 = (𝑄2 − 𝑄1 )/[(𝑄2 + 𝑄1 )/2] (𝑃2 − 𝑃1 )/[(𝑃2 + 𝑃1 )/2] Demand for a good is said to be elastic if the quantity demanded responds substantially to changes in the price. It is said to be inelastic if the quantity demanded responds only slightly to changes in the price.
The price elasticity of demand for any good measures how willing consumers are to buy less of the good as the price rises.
What determines price elasticity? Availability of close substitutes: goods with close substitutes tend to have more elastic demand because it is easier for consumers to switch from one good to others.
4 Necessities vs. luxuries: necessities tend to have inelastic demands, whereas luxuries have elastic demands.
Definition of the market: narrowly defined markets tend to have more elastic demand than broadly defined markets because it’s easier to find close substitutes for narrowly defined markets.
Time horizon: goods tend to have more elastic demand over longer time horizons.
Other demand elasticities Income elasticity of demand: a measure of how much the quantity demanded of a good responds to a change in consumers’ income, computed as the percentage change in quantity demanded divided by the percentage change in income.
Cross-price elasticity of demand: a measure of how much the quantity demanded of one good responds to a change in the price of another good, computed as the percentage change in quantity demanded of the first good divided by the percentage change in the price of the second good.
The price elasticity of supply is a measure of how much the quantity supplied of one good responds to a change in the price of that good, computed as the percentage change in quantity supplied divided by the percentage change in price.
Relationship between the slope and elasticity 𝐸= 𝑃 ∆𝑄 𝑃 1 𝑃 1 = = 𝑄 ∆𝑃 𝑄 ( ∆𝑃 ) 𝑄 (𝑠𝑙𝑜𝑝𝑒) ∆𝑄 Properties of the price elasticity If E > 1, elastic If E < 1, inelastic If E = 1, unit elasticity If E = 0, perfectly inelastic If E = ∞, perfectly elastic 5 Price elasticity and total revenue The total revenue is the amount paid by buyers and received by sellers of a good, computed as the price of the good times the quantity sold.
6 PART II: INTERVENTION IN THE MARKET AND ECONOMIC POLICY TOPIC III: Taxes and welfare, the case of a sale tax Tax on sale for sellers The supply curve will move upwards by the same units as the amount of tax. Then Q* will decrease and P* will rise.
Sales tax for buyers Demand curve will move downwards by the same units as the amount of tax. Then Q* will decrease as will do the P*.
Who bares the tax? The real effects of a per-unit tax do not depend on whether the tax is paid by buyers of sellers.
The incidence of the tax is not equal among buyers and sellers. The division depends on elasticity.
Taxes and welfare Without taxes, the competitive market is 100% efficient but when the government introduces fiscal policies (taxes, subsidies) DWL (Deadweight loss) normally appears. We have taxes because efficiency doesn’t mean justice.
7 TOPIC IV: The labour market, minimum wage and measurement of productivity Introduction The labour market is a market in which units of labour are bought and sold at a determinate price (salary). Firms demand labour in order to produce goods and workers offer their labour if what they are paid compensates what they could do with their time if not working.
The demand for labour Rule of marginal product value If a company must produce a positive amount, it will maximize its profits by hiring workers as long as the value of marginal product of hiring one more employee is bigger than the salary of this employee.
Marginal product and average product The marginal product of labour is the increase in the amount of output from an additional unit of labour (value of production with n+1 employees – value of production with n employees).
The average product value is the value of the units produced by each employee (value of production/number of workers).
Labour-demand curve of a company The labour-demand or value-of-marginal-product curve reflects the value of the marginal product of labour.
Labour-demand curve of the market The market labour-demand curve is the total quantity of labour demanded by each level of wage.
8 Labour supply The workers will be willing to work provided the wage compensates them for what they might otherwise do with their time.
The monetary value of devoting working time to other uses is called reservation wage (an example of opportunity cost).
The labour-supply curve is the total amount of labour supplied at any wage level or the number of employees whose reservation wage is equal or less than said wage level.
Not all the workers will be employed.
Voluntary unemployment: the number of people who are unemployed because they are not willing to work at the average market wage. They do not work because their reservation wage is higher than the market wage.
Involuntary unemployment: the number of people who are unemployed and would be willing to work at the average market wage but can’t find jobs. Their reservation wage is lower than the market wage but they can’t find a job.
Competitive equilibrium in the labour market Effects of a minimum wage If wmin < w*, nothing happens, but if wmin > w* The minimum wage generates involuntary unemployment and employment falls.
9 Losers: o Companies must pay higher salaries without having raised the income for their production.
o Workers who have lost their jobs that now receive their reservation wage which is below the wages they received before.
Winners: o Employed workers. If they are working, they receive a wage increase. If they were not working, they receive a higher wage than their reservation wage.
Minimum and maximum prices The minimum price for a good is the lowest price at which the law allows the good to be bought or sold.
If pmin < p*, it has no effect, but if pmin > p* the quantity supplied is bigger than the quantity demanded (excess supply).
For sellers, a minimum price means selling at a higher price, but a lower amount.