noun The social science that analyses the production, distribution and consumption of goods and services given unlimited wants and scarce resources.
ORIGIN late 16th cent. (denoting the science of household management): from ta oikonomika, the name of a treatise by Aristotle (or his student Theophrastus).
Definition: Microeconomics /ˌmʌɪkrəәʊ-/
noun That part of economics concerned with the choices made by individual economic agents (such as households and firms, or buyers and sellers) and the interactions of these choices in markets.
eg. In order to undertake a microeconomic analysis it is first necessary to understand the objectives of the individual economic agents.
If you do not understand economics you do not understand business!
Microeconomics shows us how prices affect the number of sales, revenue and profits that a firm can realise.
Microeconomics also helps us understand the role of product variety (differentiation), reputation (brands), contracts (HR & outsourcing) and government (taxes & regulations).
Microeconomic theory is the foundation for most fields of business study.
Microeconomics in Business
The Language of Economics
Clear communication requires a common understanding of language.
It is important to be precise and succinct when discussing economic phenomena.
In economics we use a number of special terms to convey specific economic meanings; these meanings are not always the same as the common usage of the words.
You are expected to become fluent in the use of the language of economics.
Definition: Market /ˈmɑːkɪt/
noun A collective term for the buyers and sellers of a good or service, and the institutions and arrangements by which they come together to trade.
eg. As a result of the large number of farmers producing wheat, the market for grain is very competitive.
ORIGIN Middle English, via Anglo-Norman French from Latin mercatus, from mercari ‘buy’.
Definition: Consumer /kəәnˈsjuːməә/
noun A person who purchases a good or service for personal use (as opposed to purchasing the good or service to assist in the production of another good or service). plural Consumers.
Synonyms Buyer, customer, end user, client.
eg. The buying habits of consumers depend upon their personal preferences.
Definition: Firm /fəәːm/
noun A business or enterprise that produces one or more goods or services for sale to consumers, government or other firms.
eg. Government often seeks to limit the market power of firms.
ORIGIN late 16th cent.: from Latin firmare ‘fix, settle’ (in late Latin ‘confirm by signature’). The word originally denoted one's autograph or signature; later the name under which the business of a firm was transacted, hence the firm itself (late 18th cent).
• Reduce the behaviour of consumers to the number of units (quantity) of the good or service that they wish to purchase.
• Reduce the behaviour of firms to the number of units of the good or service that they wish to sell.
• Consider each factor that can influence the behaviour of consumers and firms in isolation.
Three Tricks for Simplifying a Market
Definition: Demand /dɪˈmɑːnd/
noun The number of units of a particular good or service that the consumers in a market are willing to purchase during a specified period and under a given set of conditions.
eg. The demand for large vehicles is adversely affected by high fuel prices.
ORIGIN Middle English (as a noun): from Latin demandare ‘hand over, entrust’ (in medieval Latin ‘demand’), from de- ‘formally’ + mandare ‘to order’.
Determinants of Demand
• The price of the good or service
• The price of competing goods and services
• The price of complementary goods and services
• Consumer income
• Expectations of a price change
• Tastes and preferences
• Advertising expenditure
Jack’s Demand for Bananas
Price($)
Quantity(kg/week)
$3.00 4
$6.00 3
$9.00 2
$12.00 1
Definition: Demand Schedule /dɪˈmɑːnd ˈʃɛdjuːl/
noun A table listing the quantity of a good or service that is demand at each of a range of prices. Within a demand schedule all factors that influence demand are held constant except for the price of the good or service.
eg. Jake was able to construct his demand schedule by recording the quantity of bananas he purchased as prices fluctuated over the course of a year.
0
Pric
e ($
)
Quantity (kg/week)
12
9
6
3
1 32 4
Price Quantity
$3.00 4
$6.00 3
$9.00 2
$12.00 1
Jack’s Demand Curve
Definition: Demand Curve /dɪˈmɑːnd kəәːv/
noun A curve on a price-quantity graph that illustrates the relationship between the price of a product and the quantity of the product demanded. Along a demand curve all factors that influence demand are held constant except for price.
eg. An increase in consumer income over the last 12 months meant that Brian had to recalculate the demand curve for his business.
QD = a – bP
Linear Demand Curves
ExampleQD = 100 – 2P
Price (Vertical) Intercept
At the price intercept QD = 0
QD = 100� 2P
0 = 100� 2P
0 + 2P = 100� 2P + 2P
2P = 100
2P
2=
100
2
Add 2P to both sides
Divide both sides by 2
P = 50
QD = 100� 2P
0 = 100� 2P
0 + 2P = 100� 2P + 2P
2P = 100
2P
2=
100
2
P = 50
Quantity (Horizontal) Intercept
At the quantity intercept P = 0
QD = 100� 2P
QD = 100� 2⇥ 0
QD = 100
QD = 100� 2P
QD = 100� 2⇥ 0
QD = 100
0
Pric
e
Quantity
Demand
100
50
Definition: Law of Demand /lɔː ɒv dɪˈmɑːnd/
noun The law of economics that states that holding everything else constant, when the price of a product falls, the quantity demanded of the product will increase, and when the price of a product rises, the quantity demanded of the product will decrease.
eg. From the law of demand Julia knew that she could increase her firm’s sales by lowering its prices.
The total market demand for a good or service can be found by adding together the demands of each individual consumer in the market.
Holding all else equal as a market grows so too does the demand for a good or service.
Market Demand
0
Pric
e
Quantity 0
Pric
e
Quantity
30
10
3 4 9 13 7 22
Market Demand
Joe’s Demand
Sam’s Demand
Definition: Ceteris Paribus /ˌkeɪtəәrɪs ˈparɪbʊs/
adverb With other conditions remaining the same.
eg. Increasing the number of firms in a market will, ceteris paribus, reduce the market price.
ORIGIN early 17th cent.: modern Latin.
0
Pric
e
Quantity
D
P1
P2
Q1Q2
Movement along the demand curve
Change in thequantity demanded
0
Pric
e
Quantity
D1
P1
Q1 Q2
Shift of the demand curve
D2
Change in demand
Definition: Substitute /ˈsʌbstɪtjuːt/
noun A good or service that can be consumed in place of another. Typically a product with a similar function.
eg. As the price of bananas increased many consumers switched to consuming apples, a relatively cheaper substitute.
ORIGIN late Middle English (denoting a deputy or delegate): from Latin substitutus ‘put in place of’, past participle of substituere, based on statuere ‘set up’.
0
Pric
e
Quantity
D1
Price of a substitute good
D2
An increase in the price of a substitute good causes consumers to switch to the relatively cheaper alternative.
Definition: Complement /ˈkɒmplɪm(əә)nt/
noun A good or service that is improved when consumed with another. Includes goods and services that must be consumed together in order to create a benefit for consumers.
eg. Aaron was annoyed when his parents bought him an X-Box but failed to provide the complementary product, games.
ORIGIN late Middle English (in the sense ‘completion’): from Latin complementum, from complere ‘fill up’.
0
Pric
e
Quantity
D1
Price of a complementary good
D2
An increase in the price of a complementary good makes it more expensive to consume the two goods bundled together, decreasing demand.
Definition: Normal Good /ˈnɔːm(əә)l gʊd/
noun A product of which consumers demand more as their incomes increase. Goods that are very sensitive to increases in income are sometimes referred to as luxury goods.
eg. After her promotion Alison went skiing every year indicating that for Alison skiing is a normal good.
D1 D2
0
Pric
e
Quantity
Income (Normal Good)
An increase in income increases the quantity of the normal good that consumers demand at each and every price.
Definition: Inferior Good /ɪnˈfɪəәrɪəә gʊd/
noun A product of which consumers demand less as their incomes increase. Typically an inferior substitute for a more expensive normal good.
eg. Once Charlie joined the workforce he could afford steak and no longer ate the inferior good, instant noodles.
D1D2
0
Pric
e
Quantity
Income (Inferior Good)
An increase in income causes consumers to substitute away from an inferior good causing the quantity demanded to decrease at each and every price.
D1 D2
0
Pric
e
Quantity
Taste for the good
As consumers’ taste (desire) for a good increases they demand more of the good at each and every price.
D1 D2
0
Pric
e
Quantity
Population
An increase in population means that more individual demand curves are added together to form market demand.
D1 D2
0
Pric
e
Quantity
Expected price in the future
If consumers expect the price to rise in the future they will purchase (demand) more today so that they can store some of the good for tomorrow.
Special Cases
Some economic phenomena do not fit neatly into the standard market setup that we analyse in this course.
We refer to these as special cases.
Some results and rules must be amended when dealing with special cases.
0
Pric
e
Quantity
DP = 20
Perfectly Elastic Demand
0
Pric
e
Quantity
D
QD = 20
Perfectly Inelastic Demand
Suppose that market demand is given by QD = 100 - 2P. If the market price is $27 the quantity demanded is,
Feedback Question
(a) QD = 46.
(b) QD = 54.
(c) QD = 73.
(d) QD = 127.
Definition: Supply /səәˈplʌɪ/
noun The number of units of a good or a service that the firms in a market are willing to supply in a given period and under a given set of conditions.
eg. An increase in labour costs reduces the supply of plumbing services.
ORIGIN late Middle English: from Old French soupleer, from Latin supplere ‘fill up’, from sub- ‘from below’ + plere ‘fill’.
Determinants of Supply
• The price of the good or service
• The prices of raw materials used as inputs in the production process (eg. labour and capital)
• Expectations of the future
• Technology
0
Pric
e ($
)
Quantity (kg/week)
12
9
6
3
10 3020 40
Price Quantity
$3.00 10
$6.00 20
$9.00 30
$12.00 40
Supply Curve
Describing Supply
The supply schedule is a table listing the quantity of a good or service that is supplied at each of a range of prices.
The supply curve is a curve on a price-quantity graph that illustrates the relationship between the price of a product and the quantity of the product supplied.
Within a supply schedule and along a supply curve all factors that influence supply are held constant except for price.
Linear Supply Curves
Example
QS = a+ bP
QS = �20 + 2P
QS = a+ bP
QS = �20 + 2P
Price & Quantity Intercepts
QS = �20 + 2P
At the price intercept QS = 0
Add 20 to both sides
Divide both sides by 2
0 = �20 + 2P
20 = 2P
10 = P
At the quantity intercept P = 0 QS = �20 + 2⇥ 0
QS = �20
QS = �20 + 2P
0 = �20 + 2P
20 = 2P
10 = P
QS = �20 + 2⇥ 0
QS = �20
0
Pric
e
Quantity-20
10
Supply
Definition: Law of Supply /lɔː ɒv səәˈplʌɪ/
noun The law of economics that states that holding everything else constant, an increase in the price of a product causes an increase in the quantity supplied, and a decrease in price causes a decrease in the quantity supplied.
eg. In accordance with the law of supply farmers increase their production of bananas when the price of bananas rises.
0
Pric
e
Quantity 0
Pric
e
Quantity
30
10
20120 180 50 300
Market SupplyAsus’ Supply
Dell’s Supply
30
0
Pric
e
Quantity
S
P1
P2
Q1 Q2
Movement along the supply curve
Change in thequantity supplied
0
Pric
e
Quantity
P1
Q1 Q2
Shift of the supply curve
Change in supply
S1 S2
Causes of Shifts in Supply
If the price of inputs to the production process increase firms are less willing to supply the good or service at each and every price.
If firms expect the price of a product to increase in the future they will supply less of the product today, storing some for sale tomorrow.
Improvements in technology reduce the cost (increase the efficiency) of production and increase the willingness of firms to supply at each and every price.
0
Pric
e
Quantity
P = 10
Perfectly Elastic Supply
S
0
Pric
e
QuantityQS = 100
Perfectly Inelastic Supply
S
Which of the following influences does NOT cause the supply curve to shift?
(a) A rise in the wages paid to workers.
(b) Development of new technology.
(c) People deciding that they want to buy more of the product.
(d) A decrease in the number of suppliers.
Feedback Question
Definition: Equilibrium /ˌiːkwɪˈlɪbrɪəәm, ˌɛkwɪ-/
noun A state within a market in which supply is equal to demand and the market price is stable.
eg. A market equilibrium is characterised by the absence of excess demand or supply.
ORIGIN early 17th cent. (in the sense ‘well-balanced state of mind’): from Latin aequilibrium, from aequi- ‘equal’+ libra ‘balance’.
0
Pric
e
Quantity-20
10Demand
100
50Supply
P*
Q*
Equilibrium Price
Equilibrium
Equilibrium Quantity
Calculating Equilibrium
QS = �20 + 2PQD = 100� 2P
In equilibrium QD = QS 100� 2P = �20 + 2P
Add 20 to both sides
Add 2P to both sides
Divide both sides by 4
Substitute P = 30 into QD
120� 2P = 2P
120 = 4P
30 = P
QD = 100� 2⇥ 30
QD = 40
QD = 100� 2P QS = �20 + 2P
100� 2P = �20 + 2P
120� 2P = 2P
120 = 4P
30 = P
QD = 100� 2⇥ 30
QD = 40
0
Pric
e
Quantity-20
10Demand
100
50Supply
30
40
40
20 60
Excess Supply of40 units
Quantity Demanded
Quantity Supplied
0
Pric
e
Quantity-20
10Demand
100
50Supply
30
40
15
7010
Excess Demand of60 units
QuantityDemanded
QuantitySupplied
The price adjustment process
If the price in a market is not equal to the equilibrium price then the market must be experiencing either excess demand or supply.
In the case of a excess supply firms reduce their prices in order to eliminate excess stock.
This both increases the quantity that consumers demand and reduces the firm’s desire to produce.
In the case of excess demand firms raise their prices as consumers are willing to pay more for the product than the current price.
This both reduces the quantity that consumers demand and increases the incentive for firms to produce.
P ⇤1
P ⇤2
Q⇤2Q⇤
10
Pric
e
Quantity
D1
S
Shift of the demand curve
Movement along the
supply curve
D2
P ⇤1
P ⇤2
Q⇤2Q⇤
1
P ⇤1
P ⇤2
Q⇤2Q⇤
1
P ⇤1
P ⇤2
Q⇤2Q⇤
10
Pric
e
Quantity
D
S1
Shift of the supply curve
Movement along the
demand curve
S2
0
Pric
e
Quantity
D1
S1
Perfectly Inelastic Supply
D2
0
Pric
e
Quantity
D1
S1
Perfectly Elastic Demand
S2
(a) Demand curve for wheat shifting rightward.
(b) Demand curve for wheat shifting leftward.
(c) Supply curve for wheat shifting rightward.
(d) Supply curve for wheat shifting leftward.
Assume that both the price and quantity traded of wheat increase. This can be the result of the,
