©2005 Pearson Education, Inc.Chapter 11 ECN 3101 : MIKROEKONOMI Dr Normaz Wana Ismail Bilik E231 Jabatan Ekonomi Fakulti Ekonomi & Pengurusan UPM, 43400

©2005 Pearson Education, Inc. Chapter 1 1

ECN 3101 : MIKROEKONOMI

Dr Normaz Wana IsmailBilik E231

Jabatan EkonomiFakulti Ekonomi & Pengurusan

UPM, 43400 Serdang

Email:[email protected]:-03-89467708


Virtual class

FEP’s website

http://www.econ.upm.edu.my/2007/wmv/click ‘Kelas maya’

http://www.econ.upm.edu.my/2007/wmv/


TOPICS

Introduction: demand and SupplyConsumer BehaviorIndividual demand and MarketProduction and CostPerfect CompetitionMonopolyMonopolistic CompetitionOlogopoly


Chapter 1

Preliminaries


Themes of Microeconomics

Microeconomics deals with limitsLimited budgetsLimited timeLimited ability to produce

How do we make the most of limits?How do we allocate scarce resources?



Workers, firms and consumers must make trade-offsDo 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?



ConsumersLimited incomesConsumer theory – describes how

consumers maximize their well-being, using their preferences, to make decisions about trade-offs.

How do consumers make decisions about consumption and savings?



WorkersIndividuals decide when and if to enter the

work-forceTrade-offs of working now or obtaining more

education/trainingWhat choices do individuals make in terms of

jobs or work places?How many hours do individuals choose to

work?Trade-off of labor and leisure



FirmsWhat types of products do firms produce?

Constraints on production capacity & financial resources create needs for trade-offs.

Theory of the Firm – describes how these trade-offs are best made



PricesTrade-offs are often based on prices faced

by consumers and producersWorkers made decisions based on prices for

labor – wagesFirms make decisions based on wages and

prices for inputs and on prices for the goods they produce-firm decide to hire more workers or purchase more machines



PricesHow are prices determined?

Centrally planned economies -governments control prices

Market economies – prices determined by interaction of market participants

Markets – collection of buyers and sellers whose interaction determines the prices of goods.


Theories and Models

Economics is concerned with explanation of observed phenomenaTheories are used to explain observed

phenomena in terms of a set of basic rules and assumptions.

The Theory of the Firm – firms max profits

( the theory that explains how firm chooses the amounts of L,K,E that they use for production and the amount of output they produce)

The Theory of Consumer Behavior


Theories and Models

Theories are used to make predictionsEconomic models are created from theoriesModels are mathematical representations

used to make quantitative predictions


Theories and Models

Validating a TheoryThe validity of a theory is determined by the

quality of its prediction, given the assumptions.

Theories must be tested and refinedTheories are invariably imperfect – but gives

much insight into observed phenomena


Positive & Normative Analysis

Positive Analysis – statements that describe the relationship of cause and effectQuestions that deal with explanation and

predictionWhat will be the impact of an import quota on

foreign cars?What will be the impact of an increase in the

gasoline excise tax?


Positive & Normative Analysis

Normative Analysis – analysis examining questions of what ought to beOften supplemented by value judgments

Should the government impose a larger gasoline tax?

Should the government decrease the tariffs on imported cars?


Market

What is MarketsType of MarketMarket PriceWhy Market is important

Collection of buyers and sellers, through their actual or potential interaction, determine the prices of products

SUPPLY AND DEMAND

What are supply and demand?What is the market mechanism?What are the effects of changes in

market equilibrium?What are elasticity of supply and

demand?


SupplyIf a firm supplies a good or service, then the firm1. Has the resources and the technology to produce

it,2. Can profit from producing it, and3. Has made a definite plan to produce and sell it.Resources and technology determine what it is

possible to produce. Supply reflects a decision about which technologically feasible items to produce.

The quantity supplied of a good or service is the amount that producers plan to sell during a given time period at a particular price.


The Supply Curve

S

The supply curve slopesupward demonstrating that

at higher prices firmswill increase output

The SupplyCurve Graphically

Quantity

Price($ per unit)

P1

Q1

P2

Q2


Change in Supply

The cost of raw materials fallsProduced Q1 at P1

and Q0 at P2Now produce Q2 at

P1 and Q1 at P2Supply curve shifts

right to S’

P S

Q

P1

P2

Q1Q0

S’

Q2


The Supply Curve-summary

Change in Quantity SuppliedMovement along the curve caused by a

change in price

Change in SupplyShift of the curve caused by a change in

something other than priceChange in costs of production

DemandIf you demand something, then you1. Want it,2. Can afford it, and3. Have made a definite plan to buy it.Wants are the unlimited desires or wishes people

have for goods and services. Demand reflects a decision about which wants to satisfy.

The quantity demanded of a good or service is the amount that consumers plan to buy during a particular time period, and at a particular price.


The Demand Curve

D

The demand curve slopesdownward demonstrating that consumers are willing

to buy more at a lower priceas the product becomes

relatively cheaper.

Quantity

Price($ per unit)

P2

Q1

P1

Q2

Demand

A Shift of the Demand CurveIf the price remains the same but one of the other influences on buyers’ plans changes, demand changes and the demand curve shifts.

DemandSix main factors that change demand are The prices of related goods Expected future prices Income Expected future income Population Preferences


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

Market Clearing price – price at which markets clear


The Market Mechanism

D

S

The curves intersect atequilibrium, or market-

clearing, price. Quantity demanded

equals quantity supplied at P0

P0

Q0Quantity

Price($ per unit)

ELASTICITY OF DEMAND AND SUPPLY

Chapter 2 31

Price Elasticity of Demand

Measures the sensitivity of quantity demanded to price changes.It measures the percentage change in the

quantity demanded of a good that results from a one percent change in price.

P

QE

DDP

%

%

Elasticities for Linear Demand Curves

For linear demand curves re-write the price elasticity of demand formula as:

Notice that the first term is related to the slope of the demand curve

The second term is the initial price divided by the initial quantity

Q

P

P

QE d

2-32


Other Demand Elasticities

Income Elasticity of DemandMeasures how much quantity demanded

changes with a change in income.

I

Q

Q

I

I/I

Q/Q EI


Other Demand Elasticities

Cross-Price Elasticity of DemandMeasures the percentage change in the

quantity demanded of one good that results from a one percent change in the price of another good.

m

b

b

m

mm

bbPQ P

Q

Q

P

PP

QQE

mb

Chapter 3

Consumer Behavior

Chapter 3 36©2005 Pearson Education, Inc.

Introduction

How are consumer preferences used to determine demand?

How do consumers allocate income to the purchase of different goods?

How do consumers with limited income decide what to buy?


Consumer Behavior

There are three steps involved in the study of consumer behavior

1. Consumer Preferences To describe how and why people prefer

one good to another

2. Budget Constraints People have limited incomes


Consumer Behavior

3. Given preference sand limited incomes, what amount and type of goods will be purchased?

What combination of goods will consumers buy to maximize their satisfaction?


• Indifferent between B, A, & D

• E is preferred to U1

• U1 is preferred to H & G

Indifference Curves: An Example

Food

10

20

30

40

10 20 30 40

Clothing

50

U1

G

D

A

EH

B


Indifference Curves

We measure how a person trades one good for another using the marginal rate of substitution (MRS)It quantifies the amount of one good a

consumer will give up to obtain more of another good.

It is measured by the slope of the indifference curve.


Marginal Rate of Substitution

Food2 3 4 51

Clothing

2

4

6

8

10

12

14

16 A

B

D

EG

-6

1

1

11

-4

-2-1

MRS = 6

MRS = 2

FCMRS


Budget Constraints

Preferences do not explain all of consumer behavior.

Budget constraints also limit an individual’s ability to consume in light of the prices they must pay for various goods and services.


Budget Constraints

The Budget LineIndicates all combinations of two

commodities for which total money spent equals total income.

We assume only 2 goods are consumed, so we do not consider savings


C

F

P

P

F

C Slope -

2

1-

The Budget Line

10

20

A

B

D

E

G

(I/PC) = 40

Food40 60 80 = (I/PF)20

10

20

30

0

Clothing


The Budget Line - Changes

(PF = 1)

L1

An increase in theprice of food to$2.00 changes

the slope of thebudget line and

rotates it inward.L3

(PF = 2)(PF = 1/2)

L2

A decrease in theprice of food to$.50 changes

the slope of thebudget line and

rotates it outward.

40Food(units per week)

Clothing(units

per week)

80 120 160

40


Consumer Choice

A corner solution exists if a consumer buys in extremes, and buys all of one category of good and none of another. MRS is not necessarily equal to PA/PB


A Corner Solution

Ice Cream (cup/month)

FrozenYogurt(cups

monthly)

B

A

U2 U3U1

A corner solutionexists at point B.


A Corner Solution

Ice Cream (cup/month)

FrozenYogurt(cups

monthly)

B

A

U2 U3U1

if the consumer could give up more frozen yogurt for ice cream he would do so.

However, there is no more frozen yogurt to give up

At point B, the MRS of ice cream for frozen yogurt is greater than the slope of the budget line.

Chapter 4

Individual and Market Demand

Chapter 4 50

Individual Demand

Price Changes Using the figures developed in the previous

chapter, the impact of a change in the price of food can be illustrated using indifference curves.

For each price change, we can determine how much of the good the individual would purchase given their budget lines and indifference curves

Chapter 4 51

Effect of a Price Change

Each price leads to different amounts of

food purchased5

U3

D

4

U2

B

12 20

Assume: • I = $20• PC = $2• PF = $2, $1, $0.50

Food (units per month)

Clothing

6 A

U1

4

10

Chapter 4 52

Individual demand – income changes

Income ChangesChanging income, with prices fixed, causes

consumer to change their market baskets.An increase in income; (P of all gods fixed) –

causes consumers to alter their choice of market baskets

Chapter 4 53

Effects of Income Changes

Food (units per month)

Clothing(units per

month)

An increase in income,with the prices fixed,

causes consumers to altertheir choice ofmarket basket.

3

4

A U1

5

10

B

U2

D7

16

U3

Assume: Pf = $1, Pc = $2 I = $10, $20, $30

ICC

Chapter 4 54

Income and Substitution Effects

A change in the price of a good has two effects: Substitution Effect -consumer will tend to buy

more of the good that has become cheaper and less of those goods that are now relatively more expensive

Income Effect –because one of the goods is now cheaper, consumers enjoy an increase in real purchasing power. they better off because they can buy the same amount of good for les money- and thus have money left over for additional purchases

Chapter 4 55

Market Demand

Market Demand CurvesA curve that relates the quantity of a good

that all consumers in a market buy to the price of that good.

The sum of all the individual demand curves in the market

Chapter 4 56

Consumer Surplus

Consumer Surplus The difference between the maximum

amount a consumer is willing to pay for a good and the amount actually paid.

Can calculate consumer surplus from the demand curve

Chapter 4 57

Consumer Surplus - Example

Student wants to buy concert ticketsDemand curve tells us willingness to pay for

each concert ticket1st ticket worth $20 but (cost) price is $14 so student

generates $6 worth of surplus It worth to buy because generates $6 surplus of value

( beyond the cost)Can measure this for each ticketThe second also worth (surplus $5)Total surplus is addition of surplus for each ticket

purchased

Chapter 4 58

The consumer surplusof purchasing 6 concerttickets is the sum of the

surplus derived from each one individually.

Consumer Surplus 6 + 5 + 4 + 3 + 2 + 1 = 21

Consumer Surplus - Example

Rock Concert Tickets

Price ($ perticket)

2 3 4 5 6

13

0 1

14

15

16

17

18

19

20

Market Price

Will not buy more than 7 because surplus is negative

Chapter 4 59

Aggregate Consumer Surplus

The stepladder demand curve can be converted into a straight-line demand curve by making the units of the good smaller.

Consumer surplus is area under the demand curve and above the price

Chapter 4 60

Demand Curve

ConsumerSurplus

Consumer Surplusfor the Market Demand

Consumer Surplus

Rock Concert Tickets

Price ($ perticket)

2 3 4 5 6

13

0 1

ActualExpenditure

14

15

16

17

18

19

20

Market Price

CS = ½ ($20 - $14)*(6500) = $19,500

Chapter 6

Production

Chapter 6 62

Production Decisions of a Firm

1. Production Technology Describe how inputs can be transformed

into outputs Inputs: land, labor, capital & raw materials Outputs: cars, desks, books, etc.

Firms can produce different amounts of outputs using different combinations of inputs

Chapter 6 63


2. Cost Constraints Firms must consider prices of labor, capital

and other inputs Firms want to minimize total production

costs partly determined by input prices As consumers must consider budget

constraints, firms must be concerned about costs of production

Chapter 6 64


3. Input Choices Given input prices and production

technology, the firm must choose how much of each input to use in producing output

Given prices of different inputs, the firm may choose different combinations of inputs to minimize costs If labor is cheap, may choose to produce with

more labor and less capital

Chapter 6 65

The Technology of Production

The production function for two inputs:

q = F(K,L)Output (q) is a function of capital (K) and

Labor (L)The production function is true for a given

technologyIf technology increases, more output can be

produced for a given level of inputs

Chapter 6 66

The Technology of Production

Short RunPeriod of time in which quantities of one or

more production factors cannot be changed.These inputs are called fixed inputs.

Long-runAmount of time needed to make all

production inputs variable.Short run and long run are not time

specific

Chapter 6 67

At point D, output is maximized.

Labor per Month

Outputper

Month

0 2 3 4 5 6 7 8 9 101

Total Product

60

112

A

B

C

D

Production: One Variable Input

Chapter 6 68

Average Product


10

20

Output

per Worker

30

80 2 3 4 5 6 7 9 101 Labor per Month

E

Marginal Product

• Left of E: MP > AP & AP is increasing• Right of E: MP < AP & AP is decreasing• At E: MP = AP & AP is at its maximum• At 8 units, MP is zero and output (TP) is at max

Chapter 6 69


From the previous example, we can see that as we increase labor the additional output produced declines

Law of Diminishing Marginal Returns: As the use of an input increases with other inputs fixed, the resulting additions to output will eventually decrease.

Chapter 6 70

The Effect ofTechnological Improvement

Output

50

100

Labor pertime period0 2 3 4 5 6 7 8 9 101

A

O1

C

O3

O2

B

As move from A to B to C labor productivity is increasing over time

Chapter 7

The Cost of Production

Chapter 7 72

Topics to be Discussed

Measuring Cost: Which Costs Matter?

Cost in the Short Run

Cost in the Long Run

Long-Run Versus Short-Run Cost Curves

Chapter 7 73

Fixed and Variable Costs

Total output is a function of variable inputs and fixed inputs.

Therefore, the total cost of production equals the fixed cost (the cost of the fixed inputs) plus the variable cost (the cost of the variable inputs), or…

VC FC TC

Chapter 7 74

Fixed and Variable Costs

Which costs are variable and which are fixed depends on the time horizon

Short time horizon (SR) – most costs are fixed

Long time horizon (LR) – many costs become variable

In determining how changes in production will affect costs, must consider if affects fixed or variable costs

Chapter 7 75

Fixed Cost Versus Sunk Cost

Fixed cost and sunk cost are often confusedFixed Cost

Cost paid by a firm that is in business regardless of the level of output

Paid by firm that is operatingSunk Cost

Cost that have been incurred and cannot be recovered

Eg. Cost of factory with specialized equipment that is no use in another industry

The cost of the factory is not fixed because it cannot be recovered if a firm shut down

Chapter 7 76

Cost Curves for a Firm

Output

Cost($ peryear)

100

200

300

400

0 1 2 3 4 5 6 7 8 9 10 11 12 13

VC

Variable costincreases with production and

the rate varies withincreasing &

decreasing returns.

TC

Total costis the vertical

sum of FC and VC.

FC50

Fixed cost does notvary with output

VC is 0 when input is 0

Chapter 7 77

Cost Curves

0

20

40

60

80

100

120

0 2 4 6 8 10 12

Output (units/yr)

Co

st (

$/u

nit

) MC

ATC

AVC

AFC

Chapter 7 78

Long-Run Average and Marginal Cost

Output

Cost($ per unitof output

LAC

LMC

A

Chapter 7 79

Economies and Diseconomies of Scale

Economies of Scale Increase in output is greater than the increase in

inputs. Includes increasing return to scale as a special caseBut it reflect input proportion to change

Diseconomies of Scale Increase in output is less than the increase in inputs.

U-shaped LAC shows economies of scale for relatively low output levels and diseconomies of scale for higher levels

Documents

©2005 Pearson Education, Inc.Chapter 11 ECN 3101 : MIKROEKONOMI Dr Normaz Wana Ismail Bilik E231 Jabatan Ekonomi Fakulti Ekonomi & Pengurusan UPM, 43400