ECON 1101 Microeconomics Notes Table of Contents Comparative Advantage and the Reason for Trade... 2 Perfectly Competitive Markets... 3 Demand... 6 Special Lecture... Error! Bookmark not defined. Demand Continued... Error! Bookmark not defined. Demand and Supply... Error! Bookmark not defined. Government Intervention: The Cost of Interfering with Market Forces... Error! Bookmark not defined. International Trade... Error! Bookmark not defined. Imperfectly Competitive Markets- Monopolies... Error! Bookmark not defined. Oligopoly... Error! Bookmark not defined. Extra Last Week Material... Error! Bookmark not defined.
Comparative Advantage and the Reason for Trade Model: simplified representation of reality David Ricardo 1817: "4 magic numbers" o Assumptions: There are only 2 possible activities There are only 2 individuals No transaction costs (negotiation/transportation costs) No other barriers (import quotas, tariffs) Performing an activity involves use of resources Amount of resources used to perform a productive activity determines productivity Resources are scarce -> we often operate in a constrained environment (financial constraints, time constraints) Production Possibility Curve: all maximum output possibilities for two (or more) goods, given a set of inputs (or resources) if inputs are used efficiently o Label graphs: Units of measure (incl. timeframe) An efficient production point: combination of goods for which currently available resources do not allow an increase in the production of one good without a reduction in the production of another Attainable: any combination of goods that can be produced with currently available resources Unattainable production point: cannot be produced with currently available resources Absolute Advantage: an agent can carry on a productive activity with less resources than another agent Opportunity Cost of a given action is the value of the next best alternative to that particular action o OC = slope of the PPC o OC bananas = (loss in rabbits/ gain in bananas) Cost-Benefit Principle Economists choose among competing interests by using cost-benefit analysis Cost-benefit principle: an individual (or firm/society) should take an action if, and only if, the extra benefits from taking the action are at least as great as the extra costs o One of the core principles of economics Economic Surplus The benefit of taking any action minus its cost o i.e. how much does Alberto like rabbits and bananas? o E.g. the benefit of a mining super profits tax versus the cost (e.g. in jobs) Goal of economic decision makers is to maximise their economic surplus
Oc bananas = loss in rabbit/ gain in bananas PPC gets shifted right if: Increase in infrastructures such as factories, equipment Increase in population/ labour force Advancements in technology and knowledge Principle of increasing opportunity cost (low hanging fruit): First employ resources with the lowest opportunity cost and only once these are exhausted turn to resources with higher cost CPC (Consumption Possibility Curve) Economic welfare of an economy depends on what it consumes, not what it produces If economy is closed, the PPC and the CPC are the same If a country is open, CPC usually greater than PPC because part of production can be traded -> trade increases standard of living Depends on international (world) prices Opportunity costs tend to rise o Why sellers tend to increase price as they sell more Market: the set of all the consumers and suppliers willing to buy and sell a given good or service at a specific price Market equilibrium: price and quantity sold of a given good is stable; quantity consumers want is the same as the quantity suppliers want to sell Perfectly Competitive Markets Perfectly Competitive Market Characteristics: Consumers and suppliers are price-takers Homogenous goods o No matter the producer, the products are exactly the same No externality o External benefit or cost that involves someone who has nothing to do with the production or consumption of the good o E.g. pollution Goods are excludable and rival Full information o Everyone has same information and everyone knows everything Free entry and exit Supply in a Perfectly Competitive Market Think at the margin o Take one action then ask what the next action is If marginal benefit marginal cost take the action! o If marginal benefit < marginal cost, don't take the action o Convention is if you are indifferent, you do it Marginal benefit of producing a certain unit of a given good: the extra benefit accrued by producing that unit Marginal cost of producing a certain unit of a given good: the extra cost of producing that unit (the relevant cost is the "opportunity cost" and not just the "absolute cost" of producing the good")
o Really means marginal opportunity cost Cost-benefit principle: an action should be taker if the marginal benefit is greater than the marginal cost Economic surplus: the difference between the marginal benefit and the marginal cost of taking a specific action Supply Curve for an Individual Quantity supplied by a supplier: quantity of a given good or service that maximises the profit of the supplier Supply curve represents relationship between price and quantity supplied Law of supply: tendency for a producer to offer more of a certain good or service when the price of that good or service increases Interpretation Horizontally: start from a certain price and then use the supply curve to derive the quantity of goods that will be supplied at that price Vertically: start from a given quantity, find the associated price on the supply curve -> the minimum amount of money the producer is willing to accept to supply the marginal unit of the good == Producer Reservation Price For a firm Everything so far applies, but: Suppliers (entrepreneurs) -> Factors of production -> Sunk Cost (cost that once paid cannot be recovered) If factor of production fixed, its cost does not vary with the quantity produced o Fixed cost is cost associated with a fixed factor of production o Every sunk cost is also fixed cost If factor of production is variable, its cost tends to vary with the quantity produced o Variable cost is cost associated with variable factor of production Short run: period of time where at least one factor of production is fixed Long run: period of time during which all factors of production are variable Profit (π)=tr-tc AVC = VC/Q ATC = TC/Q Shut down condition (short run): Πshutdown= -FC Shut down production when: o o Applies even when running a loss AKA covering variable costs, trying to minimise the loss Shut down condition (long run) Exit the industry when π production <0 Exiting the industry brings 0 profit (assuming exit is free) Continuous model If you want 'half a worker', can hire them part time
o In continuous model can hire for as long as you want o When quantity decreases, goes towards infinity ATC and AVC intersect MC at their minimum o At the intersection of AVC and MC, π= -FC point of indifference. If price goes any lower, shut down MC is initially decreasing, but after a certain point, starts increasing Optimal quantity when the Marginal Benefit intersects with MC o Shows you quantity supplied at every price TC= ATC x Q (can use to find the area of TC) TR= P x Q (another area) Profit/loss = TR -TC SR supply curve: part of the MC curve above the AVC curve LR supply curve: part of the MC curve above the ATC curve (in the long run, no distinction between fixed and variable, so ATC really is the AVC) Change in price leads to change in quantity -> move along the curve Shifts to the right: (FIND EXAMPLES) o Drop in the price of (variable) inputs o Advancements in tech (via its impact on productivity) o Expectations on future prices/ demand o Drop in the price/demand of other products o Increase in number of suppliers Price elasticity of supply: Percentage change in q from a v small percentage change in price; Responsiveness of supply to changes in price Elastic supply: price elasticity > 1 Unit elastic supply: price elasticity = 1 Inelastic supply: price elasticity < 1
Factors affecting elasticity of supply: Availability of raw materials Factors mobility Inventories/ excess capacity Time horizon (supply is more elastic towards the long run) Deriving Profit Maximisation Π=TR-TC Dπ/dQ = dtr/dq - dtc/dq = MR -MC Profit maximised or minimised when MR=MC Marginal Cost intersects AVC at the minimum of AVC MC and AVC should start at the same point MC intersects ATC at the minimum Demand Utility represents the satisfaction that an individual derives from consuming a given good or taking a certain action. It is measured in utils per unit of time Decreasing marginal utility: utility from consuming an extra unit of a given good decreases with the number of units that have been previously consumed Marginal benefit Marginal Cost: take the action Marginal benefit < Marginal Cost Don't take the action Cost-benefit principle In the table, Other Goods doesn't have decreasing marginal utility because it is all other goods, much variety Quantity Demanded by a consumer represents the quantity of a given good or service that maximises the utility experienced by the individual consuming it Demand Curve represents relationship between price and quantity demanded Law of demand: tendency to demand more of certain good/service increases the more the price decreases Why did the demand for soda decrease when price increased? o Other goods became cheaper (relative to soda) so she consumes more of them -> substitution effect Captures the change in q demanded following a change in its relative price
o Increase in the price soda makes her poorer in terms of her purchasing effect -> income effect Captures change in quantity following the reduction in the consumer's purchasing power More unclear effect Vertical interpretation of curve tells you willingness to pay aka consumer reservation price Shifts in demand: o Successful marketing campaign o Decrease in price of complements