01 Ec101 Section 1 Slides 14 S2

8/10/2019 01 Ec101 Section 1 Slides 14 S2

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Welcome to ECON 101:Microeconomics

Department of Economics

University of Auckland

Semester 2


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Lecturer

Gamini Jayasuriya Room 260-692 ; Phone 923-3900

Email [email protected]

Office hours_____________
mailto:[email protected]:[email protected]


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Instructions The course book is essentialif you have not

already purchased a copy, please do so after thislecture. You can buy the course book from theBusiness School Bookshop, Level 0 of OGGB.

Homework for tonight is to read the front section ofyour course book, especially theAdditional CourseInformation section. This contains very important

information about the course, including the date ofyour TEST, and instructions regarding thisassessment.

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Preliminary Remarks (1) Before starting we would like to point out the

following:

We are making all the lecture slides availablein the Course Book

They will also be available on CECIL underLecture Slides

That does not mean that everything wesay in class will appear on the slides


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Preliminary Remarks (2) While lecturing we will often talk about

examples or issues that may or may not

appear on the slides

As a result it is very important thatas you follow along with our

lectures you also take notes


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Preliminary Remarks (3) Learning how to take notes is one

of the most valuable skills that you

should be picking up

It would be a good idea to startNOW!


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Preliminary Remarks (4) We expect this to be a semester-long

dialogue between you and us (the

teaching team) Please feel free to ask questions

Please feel free to stay back after class

if you want to discuss something Please feel free to utilize the office

hours of the lecturer and the tutor


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How Should You Study for this

Class? Read the slides in the course book!

The course material is defined by what

is covered in lectures Do the tutorial problems and attend

tutorials

Clarify anything you dont understand

by reading the text-book


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What you need to do this week Familiarise yourself with CECIL

(www.cecil.auckland.ac.nz); there is apamphlet available in Business andEconomics Student Centre

Make sure you check your University ofAuckland email account (your email address

will have the [email protected]) All Cecil announcements are automatically sent to your

University of Auckland email address
mailto:[email protected]:[email protected]


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What you need to do this week Make at least one friend in the class!

They can tell you what happened in a

particular lecture in case you miss one. Forming a study group is a good idea.

For that also you need to make some

friends.


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Section 1

1. Preliminary Concepts

2. Demand, Supply and MarketEquilibrium


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Thinking Like an Economist:Some preliminary concepts

Stiglitz and Walsh (Third Edition):

Chapter 2, pages 35 - 39 and 41 - 45

Stiglitz and Walsh (Fourth Edition):Chapter 2, pages 38 - 42 and 47 - 50.


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The Study of Economics

Economicsis the study of how

individuals and societies choose touse the scarce resources thatnature and previous generationshave provided.


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Why Study Economics? Probably the most important reason

for studying economics is to learn away of thinking.

Three fundamental concepts:

Opportunity cost Marginalism

Efficient markets


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Trade-offs When there is scarcity, not all needs

can be satisfied

Firms, households and individuals haveto make trade-offs between competingobjectives

Choices involve opportunity costs


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Opportunity Cost

Opportunity costis the bestalternative that we forgo, or give up,

when we make a choice or a decision. Opportunity costs arise because time

and resources are scarce. Nearly alldecisions involve trade-offs.

Opportunity cost does not necessarilyhave to be measured in dollars. Itcould be measured in terms of time aswell.


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Graph the following Production

Possibility FrontierPossibilities

Clothing

(Units per year)

Food

(Units per year)

A 4000 0

B 3600 400

C 3000 600

D 2000 800

E 0 950


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Production Possibility Frontier

Unattainable

Inefficient

Figure 3.3, p34


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Crunchies and Kit Kats

You have enough resources to produce thefollowing combinations:

Crunchies Kit Kats

10 0

8 4

6 7

4 8

0 10


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Kit Kats and Crunchies

What is needed to make these bars?

1. Chocolate (Both)

2. Hokey Pokey (C only)

3. Wafers (KK only)

4. Creamy stuff between wafers (KK only)

5. Foil to wrap (Both)

6. All of the above


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Questions

If you only make Crunchies how many can youmake?

If you only make Kit Kats how many can you

make?

If you make a combination of the two, what isthe greatest number of total bars that you canmake?

Why?

Which resources are fully mobile?

Which resources are more specialised?

What happens to the specialised resources for KKs ifyou choose to only make crunchies?


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Shape of PPF

As the production of a good expands,the opportunity cost of producing

additional units generally increases. This is because resources used fall into

two categories

Those that can be used in any process

Those that have more limited use.

What are some implications of this?


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Shifts in PPF What were the assumptions?

What if these change?

How does the curve change?


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Changes in Technology

St John and Stewart, 2000, p22


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Other Applications

Instead of two goods, as we have been using,we can rename the goods to show other things.

For example if we use capital goods and

consumer goods we can use the same model toillustrate efficiency in the economy and growth.

NOTE:

Capital goods are used to produce other goods Consumer goods are used to satisfy wants and

needs directly.


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Changes in Capital Goods

Figure 3.4, p35


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Marginalism

In weighing the costs and benefits of adecision, it is important to weigh only

the costs and benefits that arise fromthe decision.


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Marginalism

For example, when deciding whether toproduce additional output, a firm

considers only the additional(ormarginal) cost, not any sunk cost.

Sunk costsare costs that cannot be

avoided, regardless of what is done inthe future, because they have alreadybeen incurred.


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Sunk Costs

Are expenditures to which you havealready committed.

Example: The cost of the clothes in yourdrawers is sunk (why?)

Economists ignore sunk costs when

making decisionsBecause, by definition, sunk costs are notaffected by decisions we are making now.


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Efficient Markets

An efficient marketis one in whichprofit opportunities are eliminated

almost instantaneously. There is no free lunch! Profit

opportunities are rare because, at

any one time, there are many peoplesearching for them.


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The Scope of Economics

Microeconomicsis the branch of

economics that examines the functioningof individual industries and the behaviourof individual decision-making unitsthatis, business firms and households.


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The Scope of Economics

Macroeconomicsis the branch of

economics that examines the economicbehaviour of aggregatesincome,output, employment, and so onon anational scale.


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Market Forces of Supply andDemand

Third Edition: Chapter 4, Demand, Supplyand Price

Fourth Edition: Chapter 3, Demand Supplyand Price


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The Market Forces ofSupply and Demand

Supplyand demandare the twowords economists use most often.

Supplyand demandare the forcesthat make market economies work.

Much of modern microeconomics isabout supply, demand, and marketequilibrium.


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Markets

A marketis a group of buyers and

sellers of a particular good or service. The market could have a real

(shopping mall) or virtual form (e.g.,on-line auction)

The terms supply and demand refer tothe behaviour of people . . . as theyinteract with one another in markets.


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Markets

Buyersdetermine demand.

Sellersdeterminesupply.


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Demand Schedule

Thedemand scheduleis a tablethat shows the relationshipbetween thepriceof the goodand the quantitydemanded.

To illustrate this, we asked Jim abouthis preferences for ice cream


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Jims Demand Schedule for Icecream

Price Quantity$0.00 12

0.50 101.00 81.50 6

2.00 42.50 23.00 0


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Jims Demand Curve

$3.00

2.50

2.00

1.50

1.00

0.50

21 3 4 5 6 7 8 9 10 1211

Price ofIce-CreamCone

Quantity of

Ice-CreamCones0


0.50 101.00 8

1.50 62.00 42.50 23.00 0


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Demand Curve

Thedemand curveisthe downward

sloping line relating price toquantity demanded.


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Law of Demand

Thelaw of demandstates that there is

an inverse relationshipbetweenprice and quantity demanded.

So, as price , quantity demanded


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Doing the math

Everything else held constant (ceterisparibus) the quantity demanded can beexpressed as a function of its own price,Q = f(P).

We will find it easier to work with the

Inverse Demand Function.

So, we write P = F(Q).

So P is the dependent variable


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Form of the equation

Jims demand curve is Downward sloping; and

Linear, i.e., a straight line

So it has the form y = c - mx, where m is the slope, and

c is the intercept

Substitute PRICE for y and QUANTITY for x toget: P = c - mQ


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Finding m and c

Slope (m) = rise/run

= (change in price)/(change in

quantity)= 0.50/2 = 1/4

So we can now write P = c - (1/4)Q


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Finding m and c

What is c?

Pick any corresponding P and Q pair from thedemand schedule (e.g. P = 1.00, Q = 8) andplug them into the above equation to solvefor c

Given P = c - (1/4)Q, if P = 1 and Q = 8,

then: 1 = c - (1/4)8 = c - 2

c = 3


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Demand curve equation

Now we can write the demand equation

P = 3 - (1/4)Q

Implications: If P = $3.00 then Q = 0

For $0.25 change in P, Q changes by1 ice cream

If Price goes down by 25 cents, Jim buys1 more ice cream


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Jims Demand Curve

$3.00

2.50

2.00

1.50

1.00

0.50

21 3 4 5 6 7 8 9 10 1211


Quantity of

Ice-CreamCones0


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Graphing the Demand Curve

Price

Quantity

AWe have already found that whenQ = 0, P = 3. So the intercept ofthe demand curve on the Y-axis is $3.

The point A then corresponds to P = $3and Q = 0

B

P = $3Q = 0


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Price

Quantity

AHow about the point B? At B, theprice is equal to 0. How aboutquantity?

How do we find what this quantity isat the point B?

B


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Graphing the demand curve

Recall that we already found that the demandcurve is P = 3 - (1/4)Q

What we want to find is the value of Q whenP = 0

Set P = 0 in the above demand equation

We get 0 = 3 - (1/4)Q

Or (1/4)Q = 3

Or Q = 12


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Price

Quantity

A

B

P = $0Q = 12


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Price

Quantity

A

B

Thus we find that the point A correspondsto P = $3 and Q = 0 while the point Bcorresponds to P = $0, Q = 12

P = $3Q = 0

P = $0Q = 12

Slope = 1/4 (absolute value)

A Li A i ti f


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A Linear Approximation ofDemand

Is the demand curve always linear?

That isis it necessarilya straight

line? No, not necessarily

It is possible (and quite likely) that the

demand curve is non-lineartherelationship between price and quantityis more complex

A Li A i ti f


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The demand curve might actually looklike this

Q

P

A Li A i ti f


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However it is possible to approximatethis non-linear relationship by a straight

line

Q

P

A Li A i ti f


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A straight line makes calculations easier

Q

P Very often we APPROXIMATE therelationship between the price andquantity by a straight line.This is easier and in mostcircumstances any loss in accuracy

is minimal.


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Market Demand

Market demandrefers to the sum of allindividual demands for a particular good orservice.

Graphically, individual demand curves aresummed horizontallyto obtain the marketdemand curve.

Horizontal, because we want to add allquantities for a given price


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Market DemandIce-creamprice

Jimsdemand

Katesdemand

Marketdemand

$0.00 12 7 19

$0.50 10 6 16

$1.00 8 5 13

$1.50 6 4 10

$2.00 4 3 7

$2.50 2 2 4

$3.00 0 1 1


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Demand

Aggregating Demand graphically

Q1 Q2 Q1+Q2

P1

Q3 Q4

P2

Q3+Q4

Jims Demand Kates Demand Market Demand


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Ceteris Paribus

Ceteris paribusis a Latin phrase thatmeans all variables other than the ones

being studied are assumed to beconstant. Literally, ceteris paribusmeans other things being equal.

The demand curve slopes downwardbecause, ceteris paribus, lower prices

imply a greater quantity demanded!


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Determinants of Demand

Price of the good itself is NOT a determinantof demand. It is only a determinant of theQUANTITY demanded.

Tastes and Fashion

Income

Price of related goods (complements &substitutes)

Size and Nature of population


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Shifts of the demand curve

Changes in the following factors shiftthe demand curve: Taste

Income

Price of related goods

Size of population

Changes in price cause movement alongthe demand curve - NOT a shift of thecurve


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Change in Quantity Demanded

versus Change in Demand

Change in Quantity Demanded Movement along the demand curve.

Caused by a change in thepriceof

the product.


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Change in Quantity Demanded

versus Change in Demand

Change in Demand

A shift in the demand curve, either tothe left or right.

Caused by a change in a determinant

other than the price.


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Changes in Income

If demand for a good is positivelyrelated to income, it is called a normal

good demand increases when income

increases

demand decreases when income falls Examples: cars, wine, holidays?


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Changes in Income

If demand for a good is inverselyrelated to income it is called an

inferior good. demand decreases when income

increases

demand increases when incomedecreases

Example: beer, public transport?


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Substitutes and Complements

Two goods are substitutes if a rise in theprice of one increases demand for the other(e.g. Xbox and PlayStation; butter and

margarine) Two goods are complements if a rise in the

price of one decreases demand for the other

(e.g. Computers and software; DVD playersand DVDs)


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PlayStation and XBox aresubstitutes

Price ofPlayStation

Quantity

D after fall in

Xbox price

Demand beforechange in Xbox

priceD after rise inXbox price

D D D

Demand for PlayStations

DVD l d DVD


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DVD players and DVDs arecomplements

Price of

DVD Discs

Quantity

D after rise in

price of DVDplayers

Demand beforechange in DVD

priceD after fall inprice of DVDplayers

D D D

Demand for DVD Discs


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Supply

Quantity suppliedis the amount of a

good that sellers are willing andable to sell at every price.


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Supply Schedule

Thesupply scheduleisa table that

shows the relationship between theprice of the good and the quantity

supplied.


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Supply Schedule


0.50 01.00 11.50 22.00 32.50 43.00 5


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Supply Curve

Thesupply curveis the upward-sloping line relating price to

quantity supplied.


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Law of Supply

The law of supplystates that

there is a direct (positive)relationshipbetween price andquantitysupplied.


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Market Supply

Market supplyrefers to the sum ofall individual supplies for all sellers

of a particular good or service.Graphically, individual supply

curves are summed horizontallytoobtain the market supply curve.

Ch i Q tit S li d


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Change in Quantity Suppliedversus Change in Supply

Change in Quantity Supplied Movement along the supply curve.

Caused by a change in the market price

of the product.


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Change in Quantity Supplied

1 5


Quantity ofIce-CreamCones

0

S

1.00A

C$3.00 A rise in the price

of ice cream cones

results in a

movement along

the supply curve.


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Determinants of Supply

Price of the good itself is NOT a determinantof supply. It is only a determinant of the

QUANTITY supplied.

Costs of Production

Environment

Number of suppliers

Technology

Change in Quantity Supplied


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Change in Quantity Suppliedversus Change in Supply

Change in Supply

A shift in the supply curve, either tothe left or right.

Caused by a change in a determinant

other than price.


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Shifts of the supply curve

Changes in the following factors inducea shift of the supply curve:

Costs of production Environment

Number of suppliers

Technology used to produce the good

Change in technology:


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Change in technology:example

Price ofgrain ($)

Quantity of grain(bushels)

Supply beforeGeneticallyEngineeredgrain

S after GEgrainintroduced

S S

Geneticengineeringallows more

grain to beproducedfrom thesame area of

land


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Supply and Demand Together

Equilibrium Price The price that balances supply and demand.

On a graph, it is the price at which thesupply and demand curves intersect.

Equilibrium Quantity

The quantity that balances supply anddemand. On a graph it is the quantity atwhich the supply and demand curvesintersect.



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Price Quantity4 05 16 2

7 38 49 5

10 6

Price Quantity16 014 1

12 210 38 46 5

4 6

Demand Schedule Supply Schedule

At $8.00, the quantity demanded isequal to the quantity supplied!


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Market Equilibrium

Demand

Supply

Q = 4

P=$8

Price ($)

Quantity


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Disequilibrium

A well functioning market will tend tosettle at the equilibrium price

For various reasons, this might nothappen

There are two other possibilities: Shortage of goods = Excess demand

Surplus of goods = Excess supply


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Surplus

Quantity ofgrain (bushels)

SD

Price ofgrain ($)

Q Q

P*

Q*

Surplus

P1is higher than theequilibrium price (P*)

At P1, suppliers are willingto sell Q but buyers only

want Q

A surplus of grain equal to(Q - Q) will exist

Suppliers will have a lot ofstock lying around

Suppliers have an incentiveto lower their price to get ridof the surplus until P* isreached

P1


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Numerical Example

ANSWER: At the market clearing price, demand = supply,

so we must have16 - 2Q = 4 + QSo: 12 = 3Q Q* = 4Now, plug in Q=4 into Demand (or Supply) to

get P* = $8


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Graph of previous problem

Market Equilibrium$16

8

Demand$4

Supply

4

$8

Price

Quantity

Documents

01 Ec101 Section 1 Slides 14 S2