Summary book microeconomics pindyck and rubinfeld summary of the book chapter 1 to 7 PDF

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Summary microeconomicsChapter 1: PreliminariesMicroeconomics is the branch of economics that deals with the behavior of individual economic units ranging from consumers, to firms, to workers and as well investors. Microeconomics describes and analyses the trade-offs that are faced by these different...

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Summary microeconomics Chapter 1: Preliminaries Microeconomics is the branch of economics that deals with the behavior of individual economic units ranging from consumers, to firms, to workers and as well investors. Microeconomics describes and analyses the trade-offs that are faced by these different entities and investigates the role of prices as well as how they are determined. Microeconomics analysis instruments: -

Theories: Used to explain observed phenomena in terms of a group of basic rules and assumptions. Models: Mathematical representations of economic theories that are used to make predictions.

Positive analysis is aalsis that desies ause ad effet elatioships.  What will happen to the price, the production and to the sales of cars if the US government imposes an importing quota on foreign cars. (no opinion) Normative analysis is an analysis that examines questions of what ought to be.  What is the best mix of different sized cars that should be produced to maximize profits when the tax on gasoline is imposed. (opinion) A market is the collection of different buyers and sellers that determine the price as well as the allocation of a product or set of products through actual/potential interactions. -

On the markets for goods/products, firms and industries are considered to form the supply side whereas consumers are considered to form the demand side.

Market definition refers to the determination of which buyers and sellers are to be included within a particular market. Furthermore, it also refers to which products should be included in a particular market. The extent of a market refers to the geographical boundaries as well as boundaries in terms of product range that are to be produced or sold within the market. Market definition is important for the following three reasons: -

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A company must define whom its actual and/or possible customers are in order to know which products and/or potential products to sell in the future. A company must know the product boundaries as well as geographical boundaries of its market so that it can set a price, determine budgets for advertising, and make investment decisions. Market definition is important for public policy decisions as it impacts various policies on future competition and prices.

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Arbitrage is the practice of buying something at a low price in one location and then selling it at a much higher price in a different location. Perfect competitive markets are markets with many buyers and sellers, thus no single buyer or seller can have a significant impact on price. In other words, in a competitive market a single price (market price) will prevail. Noncompetitive markets are markets where many firms exist each affecting the price of a product. Chapter 2: The basics of supply and demand Supply curves show the relationship between the quantity of a good that producers are willing to sell at a certain price. The relationship can be expressed in the following format: Qs = Cs(p) -

Upward sloping, therefore the higher the price, the more the firms are able to and willing to produce and sell.

Change in price and other variables: impact on supply curve: -

A change in price, and therefore Qs i.e. quantity supplied, is represented by a movement along the supply curve. A change in any other supply determining variable, such as lower material costs, result in a shift of the supply curve itself.

Importance of supply and demand analysis: -

Supply and demand analysis enables us to understand and predict the effects of changing market conditions. It allows us to analyze the effects of economic policy. It allows us to carry out an equilibrium analysis, i.e. to find out when the supply and demand are in balance, and to find out how exogenous changes in the economic conditions affect the equilibrium.

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The demand curve is a curve that represents the relationship between the quantity of a good that consumers are happy to buy as price per unit changes. The relationship is presented by the following equation: Qd=Qd(p)

Change in price and other variables: impact on demand curve -

An increase in price, as well as income levels, causes a shift on the demand curve to the right. This is referred to as a change in demand. A change in any other demand-determining variable causes a change in the quantity demanded. This is referred to as a movement along the demand curve.

Substitute goods: An increase in the price of good 1 causes an increase in the quantity demanded for good 2. Complementary goods: An increase in the price of good 1 causes a decrease in the quantity demanded for good 2. The market mechanism is the tendency, in a free market, for the price to change until the market clears. The term market clears refers to the price that equates the quantity supplied to the quantity demanded. This is known as the equilibrium price or the market-clearing price. A condition where the quantity supplied exceeds the quantity demanded is referred to as a surplus. A condition where the opposite happens, i.e. the quantity demanded exceeds the quantity supplied, is referred to as a shortage.

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Supply-demand model assumptions -

At any given price, a given quantity will be produced as well as sold. A market must be at least roughly competitive.

A shift in the supply curve will induce a price drop which will cause an increase in quantity produces and an increase in sales (due to the price drop). A shift in the demand curve will increase price, which will cause an increase in quantity produced. Price elasticity of demand and supply

Ep= P/Q  ∆Q/∆P -

The price elasticity of demand: use Qd The price elasticity of supply: use Qs Price elasticity shows the percent change that will occur in supply (or demand) in response to a percentage increase in price.

Price elasticity of supply is usually positive: -

As price increases, the suppliers have an incentive to increase output

Price elasticity of demand is usually negative: -

As price increases, quantity demanded decreases.

Infinitely elastic demand means that consumers will buy as much as they can at one particular price. Completely inelastic demand means that consumers will buy a fixed quantity, regardless of the price.  In the presence of close substitutes: a price increase causes consumers to buy more of the substitute instead, hence demand is highly price elastic (Epd > 1).  In the absence of close substitutes: a price increase would not result in consumers buying different goods, hence demand will be price inelastic (Epd < 1) Price elasticity of demand changes as we move along a curve.  Epd is measured at a particular point on the demand cure, ad ee though ∆Q/∆P ight e constant, the ratio P/Q would change as we move along the curve, which is what causes the change in Epd as we move along the curve. Income elasticity of demand refers to the percentage change in quantity demanded resulting from a percentage increase in income. -

Eid = I/Q  ∆Q/∆I

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Cross price elasticity of demand refers to the percentage change in quantity demanded for a good that results from a one-percent price increase in another good. -

Elasticity of demand of good A with respect to price of good B: P/Qa  ∆Qa/∆P

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It is positive when the goods are substitutes (a rise in price of good 1 will make good 2 cheaper relative to good 1 so customers will demand more of good 2). It is negative when goods are complements (the two goods tend to be used together).

Arc elasticity of demand is price elasticity of demand, but it is over a range of prices rather than a particular point on the demand curve. - Ep = P./Q.  ∆Q/∆P  Where, P. is the average of the initial and final prices in the range and Q. is the average of the corresponding quantity. Difference between short-run and long-run elasticities -

Short-run: allowing only a year or less to pass by before measuring changes in quantity demanded of supplied. Long-run: allowing enough time for consumers/producers to fully adjust to the price change before measuring the changes in quantity demanded or supplied.

Elastic demand refers to the increase in demand for a certain good that results from a price change. -

The change in quantity demaded is igge tha the hage i pie, ∆Qd > ∆P, hih esults in EpD having a magnitude greater than 1, i.e. the demand is elastic.

Inelastic demand refers to the decrease in demand for a certain good that results from a price change. -

The change in quatit deaded is salle tha the hage i pie, ∆Qd < ∆P, hih results in EpD having a magnitude less than 1 i.e. the demand is inelastic.

Short-run demand -

Demand, e.g. for coffee, is less price elastic because habits change gradually Demand for durable goods is more price elastic

Long-run demand -

Demand, e.g. for coffee, is more price elastic because consumers have had enough time to change their habits Demand for durable goods is less price elastic

Short-run supply -

Supply is less price elastic because firms face capacity constraints Supply of durable goods is more price elastic (because goods can be recycled as part of supply if price increases)

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Long-run supply -

Supply is much more price elastic Supply of durable goods is less price elastic (due to the contraction of secondary supply i.e. the supply from recycling).

Chapter 3: Producers, consumers, and competitive markets The three basic preferences assumptions -

Completeness: consumers can compare and rank all baskets. Transitivity: if a consumer prefers A to B and B to C, then we can conclude that the consumer prefers A to C. More is better than less: more is always better, even if it is only a little better.

Market basket refers to a list of quantities of one or more goods. Also referred to as a bundle. An indifference curve is a graphical illustration of all market basket combinations that provide a consumer with the same level of utility (satisfaction). -

Indifference curves are always downward sloping (convex) because of the assumption more is better.

An indifference map graphically presents a set of indifference curves among which a consumer is indifferent. Indifference curves cannot intersect on the map due to the transitivity and more is better assumptions. In a case like this, you would focus on the utility curve that is the highest and the basket on that utility curve would be the basket that generates the highest utility level.

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Marginal rate of substitution refers to the maximum amount of a good that a consumer is willing to give up in order to obtain one additional unit of another good. -

MRS = - ∆A etial ais / ∆B hoizotal ais ∆A is negative, so the negative sign in from of the equation ensures that MRS is positive.

Bads are goods for which having less is preferred to having more. Examples include air pollution, where less of it is preferred to more. Utility is a number that represents the level of satisfaction/happiness that a consumer gets from a certain market basket. Utility function is a formula that assigns a level of utility to individual market baskets. It is a way of ranking different baskets. -

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Ordinal utility functions rank different market baskets from most to least preferred, but the magnitude does not say much because we do not know by how much one casket is preferred over another. Cardinal utility functions tell by how much one market basket is preferred to another, but it is ignored because we cannot make such measurements.

Budget constraints are the second element of consumer theory. They refer to constraints that consumers face due to having a limited income. A budget line is a line that indicates all combinations of goods for which the total amount of money spent is equal to income. Effect of changing income on the budget line: -

Slope remains the same I increases: budget line moves outward I decreases: budget line moves inward

Effect of price changes on the budget line: -

Price of one good (on y axis) decreases, budget line rotates outward Price of one good (on y axis) increases, budget line rotates inward.

Goods are chosen to maximize satisfaction given the limited budget that is available.

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The necessary conditions to maximize a basket: -

The basket must be located on the budget line (more specifically, it must be located on the highest indifference curve that touches the budget line, i.e. that it is tangent to it). The basket must give consumers the most preferred combination of goods.

When is satisfaction maximized? When: -

Marginal Rate of Substitution = Ratio of the prices In other words: Marginal benefit = marginal cost

Where marginal benefit is the benefit associated with consuming one additional unit of the good and marginal cost is the cost of the additional unit of the good. The satisfaction maximizing equation indicates: -

It tells the value of each osue’s MRS It does not inform us of the quantity of goods that a consumer buys: This depends on individual preferences, so quantity purchased by two customers can differ even though their MRS is the same.

A corner solution aises he a ustoe’s aginal rate of substitution does not equal the price ratio for all levels of consumption. The customer, therefore, maximizes their satisfaction by only buying one of the numerous goods available for purchase.

The revealed preferences approach -

The revealed preferences approach checks whether individual choices are consistent with the consumer theory assumptions.

Marginal utility measures the additional satisfaction that is obtained from consuming one additional unit of a particular good. Marginal utility that yields less and less satisfaction as more and more of a good is consumed is referred to as diminishing marginal utility. The equal marginal principle states that utilit is aiized he a osue’s agial utilit pe dollar of expenditure across all goods is equalized. -

MRS= MUa/Mub We also know that utility is maximized when: MRS = Pa/Pb  We can conclude that MUa/MUb=Pa/Pb, equivalently, MUa/Pa=MUb/Pb

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The cost of living index is a ratio of the present cost of a typical bundle of goods compared to the cost of an identical bundle during a base period.  The ideal cost-of-living index is the cost of attaining a given level of utility at current prices relative to the cost of attaining the same utility at base-year prices. - It requires information about prices, expenditures, as well as preferences (which differ between individuals). The two cost-of-living indexes: -

Laspeyres price index: is the amount of money (at current prices) that a customer needs to purchase a bundle chosen in the base year divided by the cost of purchasing the same bundle at base year prices. PA current price x Abase year quantity + PB current price x B base year quantity PA base year price x A base year quantity + PB base year price x B base year quantity

 Laspeyres price index is greater than the ideal cost-of-living index  Laspeyres price index always overstates the true cost-of-living index  The Laspeyres price index assumes that consumption patterns are not altered as prices change. -

Paasche index: is the amount of money (at current prices) that a customer needs to purchase a bundle chosen in the current year divided by the cost of purchasing the same bundle at base year prices. PA current price x A current quantity + PB current price x B current quantity PA base year price x A current quantity + PB base year price x B current quantity

 Paasche index is lower than the ideal cost-of-living index  Paasche index always understates the true cost-of-living index  This is due to the assumption that customers will buy the current year bundle in the base period.

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Chapter 4: Individual and market demand A price-consumption curve is a curve that traces all utility maximizing combinations of two goods as the price of one of the goods changes. An individual demand curve is a curve that relates the quantity of a good that a single consumer will buy to its price. -

Individual demand can be derived using the price-consumption.

The properties of an individual demand curve are: -

The level of utility that can be attained changes along the curve. At every point on the curve the consumer maximizes their utility (because at every point on the ue, MRS= the eatio of the pies of the goods’ oditio is satisfied.

An income-consumption curve traces all combinations of goods that maximize utility as the income of a consumer changes. As income changes, demand curve shifts to the left or the right. Normal goods are goods that consumers want to buy more of as their income increases. Inferior goods are goods that consumers want to buy less of as their income increases. Engel curves are curves that relate the quantity of a good consumed to income. -

Upward sloping Engle curve applied to normal goods.

The effects of a price decrease: -

Consumers buy more of the good that has become cheaper, and less of the good that is now relatively more expensive. Consumers enjoy greater real purchasing power due to one of the goods becoming cheaper.

A situation where a change in consumption of a good results from a change in its price, while utility remains constant, is referred to as the substitution effect. A situation where relative prices are constant, and a change in consumption of a good is a result of an increase in purchasing power is referred to as the income effect.  When added together they make up the total effect. The market demand curve represents the relationship between the quantity of a good that all customers in a market will buy related to its price.  The market demand curve can be derived by adding up the individual curves of all of the customers in the market Dead ure’s reatio he ore osuers eter the arket - The market demand curve shifts further to the right as more customers enter the market  Factors that influence the consumer demand will also affect market demand.

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The building blocks of market demand Consumer Preferences

Budget Constraints

Consumer Choice

Individual Demand

Market Demand An isoelastic demand curve is a demand curve that has a price elasticity that is constant. Consumer surplus is a measure of how much better off individuals are in the market. It is the difference between how much consumers are willing to pay for a good and how much they actually pay. Network externalities ae situatios i hih a osue’s dead depeds o the puhases of others. These externalities can be negative, if the externality leads to a decrease in demand in response to growth in purchases by ot...