Microeconomics 11^th Edition

Chapter 1

Microeconomics

Introduction

What is economics?

1. Study of how scarce resources are allocated among alternative uses

2. Study of economic behavior of individual units and decision makers: consumers, firms and owners to name a few

Tasks Performed by an Economic System

Economics deals with the functioning of an economic system by allocating scarce resources to competitive users to produce goods and services for consumption.

1. Certain limited resources should be used in a certain way to make best use of them.

2. Who should get what and how should it be distributed

3. Time brings about economic growth

Building and Using an Economic Model

Much like scientist in other disciplines, economist use models to understand how the system works. Models simplify things so that they can be better understood, but remember that a model should not be made so simple that it is useless.

Evaluating a Model

• Accuracy of prediction – a model should be as accurate as the finances will allow

• Logical consistency – any findings based on the model should be done in a logical fashion

• Range of applicability – the more general a model, the less accuracy will be obtained; the more specific a model, the more accuracy will be obtained

• Use the best available – given a choice, the best model should be used, even if it is not the one that does what you want

Keep it simple. Get it right. Make it credible. Robert Solow

Positive Analysis versus Normative Analysis

Positive analysis describes what will happen if a particular system were to change. Normative analysis describes what should be done in response to a change. While it is possible that both types could result in similar answers to a problem, they also have a good chance of not giving the same answer. They should, however be compared.

Modeling the Price System – Demand Supply and Equilibrium

Economist deal with markets. Markets can be defined as a group of firms and individuals who are in touch with one another for the purpose of buying or selling some good.

The Demand Side of the Market

A market demand schedule is a table that shows how much of a good would be purchased at each possible price. A market demand curve is plot on a graph of that information, price on the y axis and amount on the x axis. In general the slope will be downward from left to right as consumers will demand more when the price goes down. This information is for a particular time frame.

Demand curves depend on the taste of the consumers for how they are formed. If a consumer likes a product the curve will shift to the right. Less popularity means that the curve will shift to the left. The income of a consumer will affect the curve as well, in general, more income and the curve shifts right, less income and the curve shifts left. Lastly, the cost of other products, called substitutes, can cause the demand curve to shift as well.

The Supply Side of the Market

Like wise, the sellers have the supply side of the market. A market supply schedule is a list of how many goods a supplier would be willing to supply at each price range. From that table, we could make a market supply curve like the demand curves. Like the demand curve, this curve is for a specific point in time.

A change in technology that causes products to be produced cheaper will cause the supply curve to shift to the right. Conversely, rising costs of labor, energy and raw material can cause the cost to go up and the supply curve to shift to the left.

Market Equilibrium

Equilibrium is a situation where there is no tendency to change. An equilibrium price is would be a price that would not change for a long period of time. By nature, the market should find this point automatically. To see why it is necessary to take the demand curve and overlay it with the supply curve. We can see that at a lower price there would be more demand and less supplied creating a shortage. Eventually this would cause prices to go up. Like wise, at a higher price there would be a large supply but less demand causing a surplus causing the price to go down. It both cases the prices will change repeatedly until the point where the two lines cross. At that point, the supply and demand will equal and there will be no shortage or surplus.

Actual Price

Though a company may set a price not equal to the equilibrium price, eventually the price will works it way to the equilibrium price. It can not be said how long this will take though.

The Effects on Price of Shifts in the Demand Curve

If consumers developed a higher demand for a product, the demand curve would shift to the right. If there is no price change there will be a shortage and the supplier would have to raise price to meet demand to get to equilibrium. On the other hand, if the demand goes lower, then the curve shifts to the left and we see a surplus causing the suppliers to drop price to get rid of the surplus. This would eventually lead to a new equilibrium point.

The Effects on Price of Shifts in the Supply Curve

If we assume that technology improvements will eventually mean that more can be produced for the same price we effectively lower the price of the item. What does this do to equilibrium point? A lower supply price would create a higher demand. If the price were to rise, then the demand would decrease. In either case, the equilibrium point would set itself accordingly.

The Effects on Price and Quantity of Simultaneous Shifts in Supply and Demand

If moves are made in changes of demand and price, there can be many different results.

Price effects:

	Increase Demand	Reduce Demand
Increase Supply	?	-
Reduce Supply	+	?

Quantity Change

	Increase Demand	Reduce Demand
Increase Supply	+	?
Reduce Supply	?	-