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What is Economics? Economics = the study of how people use
their scarce resources to satisfy their
unlimited wants.
How to allocate scarce resources among
competing needs.
The study of the production, distribution and
consumption of goods and services.
Types of economicsNormative - The economics of what
is. This is descriptive of fact andtheory without opinion.
Positive - The economics of whatshould be. This is economics whereones opinion is offered.
Micro Economics examines the factors thatinfluence individual economic choices.
Examines how markets coordinate the choicesof various decision-makers
Looks at specific economic unit
e.g. Price of specific product, employment ofspecific firm, etc
Macro Economics studies the performance ofthe economy as a whole
Focuses on the big picture
e.g. government, household, firms in thenation, etc.
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Need,WantandDemand
Demand, Wants, and Needs
Consumer demand and wants are not the same thing
Wants ignore the importance of ability to buy as
expressed by a persons budget
E.g. wanting expensive cars, designers clothing, long
holidays, want a CAT certificate (but do not want to
attend lectures or study at home), ...
Nor is demand the same as need
Need focuses on the willingness and again ignores the
ability to purchase
E.g. Need in-campus accommodation, need medical
treatment, need a car, ...
Needs - A needis something you have to
have, something you can't do without
i.e. I am hungry, I need food.
Wants - A wantis something you would
like to have. It is not absolutely
necessary, but it would be a good thing
to have. i.e. I want a hamburger, French
fries, and a soft drink.
Demands - Human wants backed by
buying power and willingness. i.e. I have
money to buy this meal.
Scarcity There is not enough of everything that
people want (and need) to go around.
Some people will get things and others will
not. That is a fact. The question is then, how
do we determine who gets what.
Scarcity is at the heart of economics. If there
were no scarcity, there would be no need for
economics.
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Scarcity refers to the fact that there is a
limited quantity of almost all things that
people want.
These things are called goods. Goods
are any items that are desired by
people. Most goods are available in
scarce quantities.
Economists assume that people act to
maximize their own happiness
This does not mean people are greedy -
some people get happiness from others
happiness
This happiness that economists assume
people maximize is called utility
We also assume all people act rationally
The reason that there is scarcity of
goods (and services) is that there is
scarcity of resources that are used to
make goods.
Resources are all the raw elements that
go into the production of a good orservice.
Workforce and their skills
Stock of capital assets
Limited natural resources
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Opportunity cost Scarcity forces us to make choices
Whenever you make a choice, you must passup another opportunity
Opportunity Cost is the next best alternativeforgone when using a resource
So your opportunity cost of seeing a moviemight be studying or going on a date or maybereading a book. But not all 3 -- only the oneyou value next best.
Utility Analysis Utilityis the sense of pleasure, or satisfaction, that comes
from consumption
The utility that a person derives from consuming a
particular good depends on persons tastes or preferences
for different goods and services likes and dislikes
Total Utility (TU) the total satisfaction that
people derive from spending their income and
consuming goods.
Marginal Utility (MU) - the change in total
utility when consumption of a good changes
by one unit.
Law of Diminishing Marginal Utility -
eventually, a point is reached where
the marginal utility obtained by
consuming additional units of a good
starts to decline, ceteris paribus.
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Example
If Im really hungry, I get a lot of satisfaction
from first slice of pizza.
If I keep eating pizza, the satisfaction from the
8th slice would be much less than that of the
first slice.
Utility Maximisation Suppose that we have the following bits of information
The price of pizza is $8
The rental price of a movie video is $4
After tax income equals $40 per week
To see you income is allocated between two goods soas to maximize utility, suppose we start with somecombination of pizzas and videos
If we can increase utility by reallocating ourexpenditures we will do so, and we will continue tomake adjustments as long as utility can beincreasedwhen no further utility-increasingmoves are possible, we have arrived at the
equilibrium combination
Pizza & Video Rentals
Marginal Marginal
Utility Utility
of Pizza of Videos
Pizza Total Marginal per Dollar Video Total Marginal per Dollar
Consumed Utility Utility Expended Rentals Utility of Utility of ExpendedPer Week of Pizza of Pizza (price=$8) per Week Videos Videos (price=$4)
(1) (2) (3) (4) (5) (6) (7) (8)
0 0 - - 0 0 - -1 56 1 402 88 2 683 112 3 884 130 4 1005 142 5 108
6 150 6 114
Pizza & Video Rentals
Marginal Marginal
Utility Utility
of Pizza of Videos
Pizza Total Marginal per Dollar Video Total Marginal per Dollar
Consumed Utility Utility Expended Rentals Utility of Utility of ExpendedPer Week of Pizza of Pizza (price=$8) per Week Videos Videos (price=$4)
(1) (2) (3) (4) (5) (6) (7) (8)
0 0 - - 0 0 - -1 56 56 7 1 40 40 102 88 32 4 2 68 28 73 112 24 3 3 88 20 54 130 18 2 4 100 12 35 142 12 1 5 108 8 2
6 150 8 1 6 114 6 1
Suppose you start off spending your entire budget of $40 on pizza at a total utility of 142.
If you give up one pizza, you free up enough money to rent 2 videos and total utility
increases from 142 to 198.
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Marginal Marginal
Utility Utility
of Pizza of Videos
Pizza Total Marginal per Dollar Video Total Marginal per Dollar
Consumed Utility Utility Expended Rentals Utility of Utility of Expended
Per Week of Pizza of Pizza (price=$8) per Week Videos Videos (price=$4)(1) (2) (3) (4) (5) (6) (7) (8)
0 0 - - 0 0 - -1 56 56 7 1 40 40 102 88 32 4 2 68 28 73 112 24 3 3 88 20 54 130 18 2 4 100 12 35 142 12 1 5 108 8 26 150 8 1 6 114 6 1
Reduce consumption of pizza to 3 units, you give up 18 units of utility from the 4th unit of
pizza but gain a total of 32 units of utility from the 3rd and 4th videos, another utility-
increasing move
Thus, by trial and error, we find that the utility-maximizing equilibrium condition is 3 pizzas
and 4 videos per week, for a total utility of 212 and an outlay of $24 on pizza and $16 onvideos
Pizza & Video Rentals Utility-Maximising Condition
Consumer equilibrium is achieved when the
budget is completely spent and the last dollar
spent on each good yields the same utility
Where MUp is the marginal utility of pizza,pp is
the price of pizza, MUv is the marginal utility of
videos, andpv the price of videos
v
v
p
p
PMU
P
MU
DEMANDANDSUPPY
Demand
Demandindicates how much of a good consumers are both
willing and able to buy at each possible price during a given
time period, other things constant
A person who wants something he/she cannot afford does
not demand the good in an economic sense; nomatter how badly he/she wants it.
E.g. DD for Pepsi, DD for Nissan cars, DD for child care
services, DD for residential apartments, ...
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Law of Demand says that quantity demanded
varies inversely with price, other things
constant
The higher the P, the smaller the quantity
demanded
The lower the P, the larger the quantity
demanded
E.g. the higher the fees of child care
services, the lower the quantity demanded
for child care services.
Demand Schedule & Demand Curve for Pizza
(b) Demand Curve
e
d
c
b
$0
$3
$6
$9
$12
$15
$18
8 14 20 26 32Millions of Pizzas per week
PriceperPizza
a
(a) Demand Schedule
Price per Quantity Demanded
Pizza per Week (millions)
a) $15 8
b) 12 14
c) 9 20
d) 6 26
e) 3 32
Demand and Quantity Demanded
Price
perquart
8 14 20 26 32
$15.00
12.00
9.00
6.00
3.00
0
a
b
c
d
eD
Millions of pizzas per week
Demand for pizza is not a specific
quantity, but rather the entire
relation between price and quantity
demanded, and is represented by
the entire demand curve
An individual point on the demand
curve shows the quantity demanded
at a particular price
Changes in demand
Change in Demand - a change in the desire ormeans to purchase the good, thus there is achange in quantity demanded at EVERY price.
Change in Demand - a shift of the demandcurve
A demand curve is drawn under theassumption of ceteris paribus.
When this assumption is relaxed, the entiredemand curves shifts
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Change in Demand vs. Change inQuantity Demanded
This is a very important distinction. In short - a
change in demand is a shift in the WHOLE
demand curve. People are willing to buy more
(or less) at every price.
Change in Quantity Demanded (DQd) -
movement along a demand curve
A change in quantity demanded can onlybe
caused by a change in the price of the good.
Changes in Quantity Demanded
Increase in Qd - a movement to the right along
a demand curve
Decrease in Qd - a movement to the left along
a demand curve
Increase in Demand
P
QdD
D
Increase in Quantity demanded
P
QdD
AB
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Increase in demand - demand curve
shifts to the right
Decrease in demand - demand curve
shifts to the left
1 Changes in Consumer IncomeGoods can be classified into 2 broad categories depending on how
the demand for the good responds to changes in money income
Normal goods: demand increases when income increases &
decreases when income decreases
E.g. Income increase, demand for fried chicken from KFC increases.
Inferior goods: demand decreases when income increases &
increases when income decreases
As income increases, consumers tend to switch from consuming
these goods to consuming normal goods
E.g. 2nd hand car, 2nd hand clothes, re-threaded tyre
2 Changes in the Prices of Related Goods
The Price of other goods & other factors are assumed constantalong a given demand curve
If 2 goods are substitutes, an increase in the Price of one shiftsthe demand for the other rightward
Conversely, if a decrease in the Price of one shifts the demandfor the other good leftward
E.g. Price of margarine increase, quantity demanded formargarine will fall, demand for butter will increase.
If 2 goods are complements, an increase in the Price of one
shifts the demand for the other leftward A decrease in the price of one shifts the demand for the other
rightward
E.g. Price of PCs increase, quantity demanded for PCs will fall,demand for printers will fall.
3 Changes in Consumer Expectations
If individuals expect income to increase in the future, currentdemand increases and vice versa
Eg If government servants expect a salary increment of 10% nextyear, their Demand for goods and services will increase.
If individuals expect prices to increase in the future, currentdemand increases and decreases if future prices areexpected to decrease
E.g. If consumers expect the price of Proton cars will fall in 3
months time, demand for proton cars now will fall.
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4 Changes in Consumer Tastes
Tastes are a persons likes and dislikes as a consumer Difficult to say what determines tastes but clearly they are important
And whatever factors change taste will clearly change
demand
E.g. More people prefers local fruits, then the demand for local
fruits will rise.
5 Availability of credit
If it is easier to borrow money (credit cards have lower
interest rates or are easier to obtain, etc.), do you think
people will buy more or less of a good at a given price?
Probably more. Since people can buy things that
couldnt buy before, their means have (in a sense)
increased. So an increase in the availability of credit will
increase demand.
Supply
Supplyindicates how much of a good producers are willingand able to offer for sale per period at each possible price,other things constant
Law of supplystates that the quantity supplied is usuallydirectly related to its price, other things constant
The lower the price, the smaller the quantity supplied
The higher the price, the greater the quantity supplied
Supply Schedule and Curve for Pizzas
12 16 20 24 28
$15
12
9
6
3
0
S
Millions of pizzas per week
Price
Producers offer more for sale at higherprices than at lower prices the supplycurve slopes upward.
Supply Schedule
Price per Quantity Supplied
Pizza per Week (millions)
$15 28
12 24
9 20
6 16
3 12
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$15.00
12.00
9.00
6.00
3.00
0
12 16 20 24 28
Millions of pizzas per week
Price
perquart
S
g
S'
h
Suppose a new high-tech
oven bakes pizza in half
the time, and this cause
the supply curve shifts
from S to S'.
1 Changes in Technology 2 Changes in the Prices of Relevant Resources
If the price of some relevant resource increases
supply decreases
shifts to the left
For example, if the price of mozzarella cheese falls, the costof pizza production declines supply increases shiftsto the right
3 Uncontrollable factors
Certain industries are particularly susceptible touncontrollable factors, such as changes in the weather
A good example is agriculture where bad whether candiminish or obliterate supply.
4 Changes in Producer Expectations
If suppliers expect higher prices in the future, they may beginto expand today
current SS shifts rightward
SS increases
Eg If a firm expects the chicken will rise in a few monthstime due to Eid celebration, the firm will start to raremore chicken now.
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5 Changes in the Number of Producers
If that number increases, supply increases
shifts to the right
If the number of producers decreases, supply will decrease
shift to the left
Eg As the number of pirated VCD producers fall, the
Supply of pirated VCD will fall.
6 Taxes and subsidies
Increase in tax on the good decreases
supply
Raises the cost of production
Decrease in tax on the good increases
supply
Lowers the cost of production
A subsidy is an amount the paid to the
producer for each unit of a good produced
Increase in Subsidy on the Good Increases
Supply
Lowers the costs of production
Decrease in Subsidy on the Good Decreases
Supply
Raises the costs of production
7 Availability of credit
If it is easier for the firm to borrow money, the
firm will be able to produce more
Thus Supply increases
If it is more difficult for the firm to borrow
money, the firm will have to produce less
Thus Supply decreases
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Equilibrium price Consumers want to pay as little as possible, but suppliers
want to charge as much as possible. The two sides of themarket have to compromise at some price betweenthese two extremes.
When the quantity that consumers are willing and ableto pay equals the quantity that producers are willing andable to sell, the market reaches equilibrium
Also called market price or market clearing price
The Market for Pizzas
Millions of pizzas per week
$15.00
12.00
9.00
6.00
3.00
0
c
S
D
Surplus
Suppose the initial
price is $12, producers
supply 24 million pizzas
per week as shown by
the supply curve while
consumers demand
only 14 millionexcess quantity
supplied (or surplus) of
10 million pizzas per
week
14 20 24
Price
Millions of pizzas per week
$15.00
12.00
9.00
6.00
3.00
0
c
S
D
Shortage
Alternatively, suppose
the price is initially $6
per pizza. At this price
consumers demand 26
million pizzas but
producers supply only 16
million an excessquantity demanded (or a
shortage) of 10 million
pizzas per week.
16 20 26
Price
The Market for Pizzas Disequilibrium Prices
Markets do not always reach equilibrium quickly.
Disequilibrium is usually temporary as the market gropes for
equilibrium
However, as a result of government intervention in markets,
disequilibrium can sometimes last a long time
To have an impact, a price floor must be set above theequilibrium price and a price ceiling must be set below theequilibrium price
Effective price floors and ceilings distort markets in that theycreate a surplus and a shortage, respectively
In these situations, various nonprice allocation devices emergeto cope with the disequilibrium resulting from the intervention
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Effects of a Price Floor
$2.50
14 19 24
S
D
Millions of gallons per month
Surplus
0
The federal government often regulates the prices
of agricultural commodities in an attempt to
ensure farmers a higher and more stable income
than they would otherwise earn.
To achieve higher prices, the federal
government sets aprice floor a minimumselling price that is above the equilibrium price
This surplus milk will spoil if it sets on store shelves. As
a result of this price support program, the government
spends billions of dollars buying and storing surplus
agricultural products.
$1.90
Effects of a Price Ceiling
$1000
$600
40 50 60
D
S
Thousands of rental units per month
0
Shortage
Sometimes public officials try to keep
prices below the equilibrium levels by
establishing aprice ceiling, or a maximum
selling price
A common example is rent control in
some cities. The market-clearing rent
is $1,000 per month with 50,000
apartments being rented.
Now suppose the government decides to
set a maximum rent of $600. At this
ceiling price, 60,000 rental units are
demanded, but only 40,000 are supplied
(a shortage).
CONSUMER
SURPLUS AND
PRODUCERSURPLUS
Consumer surplus measures the welfare that consumers
derive from their consumption of goods and services, or
the benefits they derive from the exchange of goods.
Consumer surplus is the difference between what
consumers are willing to pay for a good or service
(indicated by the position of the demand curve) and what
they actually pay (the market price). The level of consumer
surplus is shown by the area under the demand curve and
above the ruling market price
Producer surplus is a measure of producer welfare. It ismeasured as the difference between what producers are
willing and able to supply a good for and the price they
actually receive. The level of producer surplus is shown by
the area above the supply curve and below the market
price
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CO
NSUMERSURPLUSAND
PR
ODUCERSURPLUS
Elasticity 4 basic types used:
Price elasticity of demand
Price elasticity of supply
Income elasticity of demand
Cross elasticity of demand
We know, from the Law of Demand, that price
and quantity demanded are inversely related.
Now, we are going to get more specific in
defining that relationship
We want to know just how much will quantity
demanded change when price changes? That
is what elasticity of demand measures.
Price elasticity of demand (PED)
Elasticity of Demand (Ed) measures theresponsiveness of Qd of a good to a change inits P.
Ed = %D in Qd%D in P
Note that Dmeans change Also note that the law of demand implies Ed is
negative. We will ignore the negative sign onlywhen discussing elasticity of demand.
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Demand Curve for N
Take for example the calculation of
the price elasticity of demand for
N when the price ofN increase
from $1.40 to $1.60 each.
Arc elasticity
Price elasticity between a and b =
9.52 / 13.33 = 0.71
1.40
0
b
Thousands per day
D
$1.60 a
200220
Price
perN
Point elasticity
Price elasticity between a and b =
9.09 / 14.29 = 0.64
2/)pp(
p
2/)qq(
q
DE
D
D
Categories
The price elasticity of demand can be divided into three generalcategories
If the percent change in quantity demanded is smaller than thepercent change in price, demand is inelastic quantitydemanded is relatively unresponsive to a change in P
If the percent change in quantity demanded just equals thepercent change in price unit-elastic demand
If the percent change in quantity demanded exceeds the percent
change in price, demand is said to be elastic quantity is
responsive to changes in price
Inelastic absolute value between 0 and 1.0 unresponsive
Unit elastic absolute value equal to 1.0
Elastic absolute value greater than 1.0 responsive
P
0 Qd
Relatively
Inelastic
Relatively
Elastic
Constant Elasticity Demand Curves
Price
perunit
Price
perunit
Price
perunit
p
0 Quantityper period
Quantityper period
Quantityper period
E =D
(a) Perfectly elastic
$10
6
0 60 100
E =D 1
(c) Unit elastic
D
0
E =D 0
(b) Perfectly inelastic
D'
Q
D"
a
b
Demand curve in (a)
indicates consumers willdemand all that is offered
at the given price, p. If the
price rises above p,
quantity demanded drops
to zeroperfectly elasticdemand curve.
Demand curve in (b) is
vertical, quantity demandeddoes not vary when the price
changes no matter howhigh the price, consumers will
purchase the same quantity
perfectly inelastic demandcurve.
(c) shows a unit-elastic
demand curve where
any percent change in
price results in an
identical offsetting
percent change in
quantity demanded.
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Elasticity
If demand is priceelastic:
Increasing price wouldreduceTR (% Qd > % P)
Reducing price wouldincrease TR
(% Qd > % P)
If demand is priceinelastic:
Increasing price wouldincrease TR
(% Qd < % P)
Reducing price wouldreduceTR (% Qd < % P)
(a) Demand and Price Elasticity$100908070605040302010
ed
c
b
a
D
Inelastic ED < 1
Unit elastic ED = 1
Elastic ED > 1
0Quality per period
100 200 500 800 900 1,000
$25,000
Tota
lrevenue
0
Totalrevenue
(b) Total Revenue
TR = p x q
Price
perunit
Quantity per period 1,000500
Where demand is elastic, a
decrease in price will increase
total revenue because the gain in
revenue from selling more units
exceeds the loss in revenue from
selling at the lower price.
Where demand is inelastic, a price
decrease reduces total revenue
because the gain in revenue from
selling more units is less than the loss
in revenue at the lower price.
Demand, Price Elasticity and Total Revenue
1 Availability of Substitutes
The greater the availability of substitutes for a good and the closer the
substitutes, the greater the goods price elasticity of demand
E.g. sports shoes : Nike and Adidas
Tooth paste : Colgate and close-up, etc
Insulin has no substitutes if diabetic and demand is very
inelastic.
Habit forming goods such as cigarettes and drugs
Determinants of Price Elasticity of Demand 2 Proportion of Consumers Budget The less expensive a good is as a fraction of our
total budget, the more inelastic the demand forthe good is (and vice versa).
Example:
Price of cars go up 10% (from $20,000 to$22,000)
Price of box of matches goes up 10% (from $0.50
to $0.55) Demand is more effected by the price of cars
increasing. Matches are bought infrequently andthe price is only a very small part of totalspending few people will notice the rise.
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3. Necessities vs. Luxuries
The more necessary a good is, the more
inelastic the demand for the good (and vice
versa).
Example: Insulin
4. The importance of the good
Goods, which take a small part of consumers
total budget often, yield inelastic demand
schedule.
If the price of table salt falls by 2% per kilo,
few consumers would increase their rate of
consumption of salt.
5. The time period
the longer the time period the buyer can wait
before effecting a repeat purchase of the
good, the more elastic is the buyers demand
for that good.
The reason for this is that the longer time
period gives the buyer more time to find and
hence switch to substitute goods.
Demand is more elastic in the long run than in
the short run.
Other Elasticity Measures
1 Income Elasticity of Demand
The income elasticity of demandmeasures how responsive
demand is to a change in income
Measures the percent change in demand divided by the percent
change in income
Goods with income elasticities less than zero (-ve) are called inferior
goods demand declines when income increases
E.g. used clothing, recycled plastic containers, etc.
Normalgoods have income elasticities > zero demandincreases when income increases. (necessities vs luxuries)
E.g. furniture, clothing, electrical appliances, etc
Elastici ty Value Type of goods Example
Negative -ve Inferior Inter-city bus
Inelastic 0 - 1 Necessity Basic food stuffs
Elastic 1 Luxury Yatchs, sports cars
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2 Cross Elasticity of Demand
Cross elasticity of demand is defined as the percent change in the
demand of one good divided by the percent change in the price
of another good.
If an increase in the price of one good leads to an increase in the
demand for another good, their cross-price elasticity is positive
the two goods are substitutes. Eg Tea and coffee.
If an increase in the price of one good leads to a decrease in the
demand for another, their cross-price elasticity is negative the
two goods are complements.
Eg PCs and printers.
Perfect complements -1
Complements -ve
Unrelated goods 0
Substitutes +ve
Perfect substitutes +1
E1,2 = % D in Qd of Good 1
% D in P of Good 2
Note that the sign DOES matter for this
elasticity also!
Theprice elasticity of supplymeasures how responsive
producers are to a price change
Theprice elasticity of supplyequals the percent change in quantity
supplied divided by the percent change in price
Since the higher price usually results in an increasedquantity supplied, the percent change in price and thepercent change in quantity supplied move in the same
direction
the price elasticity of supply is usually a positivenumber
Price Elasticity of Supply Price Elasticity of Supply
p'
p
0 Quantity per period
S
q q'
If the price increases
fromp top', the
quantity supplied
increases from q to q'
The price elasticity of Es, is
WhereD q is the change inquantity supplied and D p is thechange in price.
Pricep
erunit
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The terminology for supply elasticity is the same as for
demand elasticity
If supply elasticity is less than 1.0, supply is inelastic
If it equals 1.0, supply is unit elastic
If it exceeds 1.0, supply is elastic
The next exhibit illustrates some special cases of supply
elasticity to consider
Categories of Supply ElasticityConstant-Elasticity Supply Curves
Price
peruni
Price
perunit
Price
perunit
p
0
E =S
(a) Perfectly elastic
$10
5
0 10 20
E =S 1
(c) Unit elastic
S
0
E =S 0
(b) Perfectly inelastic
S'
Q
S"
Quantity per periodQuantity per periodQuantity per period
At one extreme is the
horizontal supply curve.
Here producers will supply
none of the good at a price
below p, but will supply
any amount at a price of p,
as in (a).
The most unresponsive
relationship is where there
is no change in the quantity
supplied regardless of the
price, as shown in (b) where
the supply curve is perfectly
vertical.
Any supply curve that is
a straight line from the
origin such as shown in
(c) is a
unit-elastic supply
curve.
Determinants of Price Elasticity ofSupply
1. The existence of surplus capacity
If surplus capacity exists suppliers can more
easily react to price rises and supply will be
more elastic.
It is possible to produce more with the same
quantities of labor and capital, by extending
overtime, by keeping old machinery in use a
little longer, or by using or making a better use
of spare factory space.
2. Ease of entry into the market
elasticity may be influenced by the ease with
which firms can enter and leave the market.
Natural barriers: There may be limited
amount of land and skills so that it is difficult
to increase supply. Production may be very
expensive, as in the case of oil drilling for gas,
so that it is possible for relatively few firms
only.
Artificial barriers: Large monopolies
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Importance of Elasticity
Relationship between changes in price and
total revenue
Importance in determining what goods to tax
(tax revenue)
Influences the behaviour of a firm
COST Sunk Cost - A cost, once paid, that can never
be recovered.
For instance, you buy a license to sell food.Whether you sell the food or not - you havepaid for this cost and can not sell it or get yourmoney back in any way.
we are always concerned with future costsand benefits since the past cannot bechanged.
For instance, if you are in line at BML ATM and
the other line is going faster - should you
switch lines?
Yes. It doesnt matter how long you have
committed to one lane - your goal is to get
out fastest and you pick the lane thatfrom
that moment on, will suit you best in meeting
that goal. What is done - is done.
Total Fixed Cost (TFC) - costs which do not vary
with output.
the costs of fixed inputs (capital)
Total Variable Costs (TVC) - any cost that varies
with the quantity of output produced.
the costs of variable inputs (labor)
Total Cost (TC) - sum of all costs of production
TC = total fixed costs + total variable costs
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A Firms Short Run Costs
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 withproduction and
the rate varies withincreasing &
decreasing returns.
TC
Total costis the vertical
sum of FCand VC.
FC50
Fixed cost does notvary with output
Marginal Cost (MC) - the additional cost of
producing one more unit of output.
Average Variable Cost (AVC) = TVC / Q
Average Fixed Cost (AFC) = TFC / Q
Average Total Cost (ATC) = TC / Q
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Cost Curves
0
20
40
60
80
100
120
0 12
Output (units/yr)
Cost($/unit)
MC
ATC
AVC
AFC
SummaryIn the short run, the total cost of any level of output is the sum of fixed
and variable costs: TC=FC+VC
Profit maximization point is when MC= MR
A firm may continue to produce as long as the MR exceeds its AVC, as in
doing so it will be making a contribution towards covering its fixed costs.
AFC is decreasing
AVC and ATC are U-shaped, reflecting increasing and then diminishing
returns.
Marginal cost curve (MC) falls and then rises, intersecting both AVC
and ATC at their minimum points.
Short-run and long-run production
decisions
In the short-run if:
TR > TVC continue production.
TR = TVC normal production.
TR < TVC cease production.
AR = Price =VC continue production.
In the short-run AR = AVC.
In the long-run AR = ATC.
In the long run, a firm will only continue inproduction if the price at which their product issold at least equals the average total cost ofproduction.
MARKET STRUCTURES
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Imperfect Competition
Market Structure Continuum
Pure
Competition
Pure
MonopolyMonopolistic
Competition Oligopoly
Fundamentally, there are two extremes to
the market structures. At one end, is the
perfect competition and the other is the
monopoly.
Characteristics of Perfect Competition
Large number of buyers and sellers.
Firms sell identical (homogenous) product.
No barriers to entry or exit.
Buyers and sellers have perfect information
Firms have no say in stating prices (Price Taker)
Perfect Comp. is our "Benchmark" Modelmeaning it is not very realistic, but will be used tocompare with more realistic models
DEMAND CURVE OF THE INDIVIDUAL
FIRM
Under perfect competition the firm is a price taker.
The demand curve for the firm is horizontal so that theprice equals AR which is the same as MR.
Imperfect Market
Imperfect competition is a market situationwhere individual firms have a measure ofcontrol over the price of the commodity in anindustry. a firm that can affect the market price of its
output can be classified as an imperfectcompetitor.
Normally, imperfect competition arises when anindustry's output is supplied only by one, or arelatively small number of f irms.
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Imperfect Market
An imperfect market is a situation where individual firms havesome measure of control or discretion over the price of thecommodity in an industry
This imperfect competition does not necessarily mean that afirm can arbitrarily put any price on its commodity
an imperfect competitor does not have absolute power overprice
Aside from discretion over price, imperfect competitors mayor may not have product differentiation/variation
Forms of imperfect competition
Monopoly
Oligopoly
Duopoly
Monopolistic competition
MONOPOLY
Monopoly exists when one producer suppliesthe entire market.
One large seller and many potential buyers.
No close substitutes exist.
High barriers to entry such as economies of
scale, legal protection etc The firm is a price setter(and thus quantity
taker) or a quantity setter (and price taker)
Long-run supernormal profits (due to thebarriers to entry) and subjected to regulationsby government and NGOs
Pure monopoly industry is thefirm!
Actual monopoly where firm has>25% market share
Natural Monopoly high fixed
costs gas, electricity, water,telecommunications, rail
Types of Monopoly
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1 Relatively Large Numbers: Small market share, Nocollusion & Independent actions2 Product Differentiation: Product Attributes, Services,Location, Brand Names and Pa ckaging3 Easy Entry and Exit: Firms are free to set up
business.4 Non-price Competition Advertising: Eachmonopolistic firm differentiates its products throughadvertisements
Monopolistic Competition
Oligopoly
Few large firms dominate the market.
They may produce homogeneous product (oil).
Cartels often form. (OPEC)
Complex use of product differentiation, barriersto entry and high level of influence on prices inthe market
Interdependence of firms i.e. how their rivals willreact.
2 to 6
Duopoly
Two usually large firms dominate.
Each producer has some control over price
and output, but most consider the possible
reactions of the competitor firm. Duopolists,
like oligopolist, can act competitively or
collusively.
Extensive non-price competition exists
Features of the four market structures
Type ofmarket
Numberof firms
Freedom ofentry
Nature of product Examples Implications fordemand curvefaced by firm
Perfectcompetition
Verymany Unrestricted
Homogeneous(undifferentiated)
Cabbages, carrots(approximately)
Horizontal:firm is a price taker
Monopolisticcompetition
Many /several
Unrestricted Differentiated Plumbers,restaurants
Downward sloping,but relatively elastic
Oligopoly Few RestrictedUndifferentiated
or differentiated
Cement
cars, electricalappliances
Downward sloping.Relatively inelastic
(shape depends onreactions of rivals)
Monopoly One Restricted orcompletely
blocked
UniqueLocal water
company, gas andelectricity in many
countries
Downward sloping:more inelastic thanoligopoly. Firm has
considerablecontrol over price