Summary Microeconomics Jeffrey M. Perloff, complete PDF

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M I C R O E C O N O M I C SC H A P T E R Microeconomics – study of how individuals and =irms make themselves as well off as possible in a world of scarcity and the consequences of those individual decisions for markets and entire economy -­‐often call price theory to emphasize important role of pric...

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M"I"C"R"O"E"C"O"N"O"M"I"C"S C"H"A"P"T"E"R"""1 Microeconomics*–*study"of"how"individuals"and"=irms"make" themselves"as"well"off"as"possible" in"a"world"of"scarcity"and"the"consequences"of"those"individual"decisions"for"markets"and"entire" economy" F often"call"price&theory"to"emphasize"important"role" of"prices"–"it"explains"how"actions"of"all" buyers"and"sellers"determine"prices"and"how"prices"in=luence" the"decisions"and"actions"of" individual"buyers"and"sellers F Microeconomics"is"the"study"of"the"allocation"of"scarce"resources Three"possible"tradeFoffs: 1. Which"goods/services"to"produce 2. How"to"produce 3. Who"gets"the"goods"and"services Markets*–*an"exchange"mechanism"that"allows"buyers"to"trade"with"sellers Model* –* description" of" the" relationships" between" two" or"more" economic" variables"–"used" to" predict"how"a"change"in"one"variable"will"affect"another Economic*theory*–*development" and"use" of" a"model"to"test"hypothesis," which"are" predictions" about"cause"and"effect Positive*statement*–*a" testable"hypothesis"about"cause" and"effect"–"what"somebody"know"that" will"happen Normative*statement*–*a"conclusion"as"to"whether"something"is"good"or"bad"–"what"somebody" believes"should"happen C"H"A"P"T"E"R"""2 Factors"affecting"demand: • Consumer’s&tastes"determine"what"to"buy • Information"about"the"uses"of"a"good"affects"consumers’"decision • Prices&of&other&goods a) Substitute"–"product"that"you"view"similar"or"identical"to"one"you" considering" to" purchase b) Complement"–"good"that"you"like"to"consume"at"the"same"time"as"the"product"you" are"considering"to"buy • Income"determines"how"much"consumer"will"purchase • Government&rules&and®ulations&affecting"purchase"decisions Quantity*demanded*–*the" amount"of"a"good" that"consumers"are" willing" to"buy"at"given"price," holding"other"factors"that"can"in=luence"the"decision"constant Demand*curve*–*relation"between" prices"and"quantity"demanded;*quantity"demanded"at"each" possible" price," holding" constant" other" factors" (QFquantity" demanded" is" usually" expressed" as" some"physical"measure"per"time"period) Law*of*Demand*–*consumers"demand"more"of"a"good"the"lower"its"price"holding"constant"other" factors"F"demand"curve"slope"downward Change"in"price"–"movement"along"the"demand"curve Change"in"any"other"factor"–"shift"of"the"curve

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Demand*function:"Q"="D(p,q,r,s,Y)"F"how"the" quantity"of"a"demanded"good"is"dependable"on"the" price"of"other"goods"and"on"your"disposable"income." Slope"of"the"demand"function:

(negative"slope"is"consistent"with"the"Law"of"Demand) Total"demand:"sum"of"all"individual"demand"curves(only"possible"when"everyone" face"the" same" price) Factors"affecting"the"supply: • Costs"of"production"F"the"less"is"the"cost"of"producing,"the"more"a"=irm"wants"to"supply • Government"rules"and"regulations"F"taxes," costs"of" covering" pollutions," health" insurance" for"workers"F""altering"costs"of"production Quantity*supplied*–*amount"of"a"good"that"=irms"want"to"sell"at"a"given"price,"holding" constant" other"factors Supply*curve* –*a" quantity "supplied" at"each" possible" price," holding" constant"the" other" factors" that"in=luence"=irm’s"supply"decisions Change"in"price"–"movement"along"the"supply"curve"F"the"higher"the"price" of"a"product,"the" more" the"=irm"wants"to"sell,"the"more"it"supplies Change"in"any"other"factor"–"shift"of"the"supply"curve Supply*function:*Q" ="S(p,pb)" F"how"the"quantity"of" supplied"good"is"dependable" on" the" price"of" this"good,"on"the"price"of"other"goods Total"supply:"total"quantity"produced"by"all"suppliers"at"each"possible"price Effects*of*government*import*policies*on*supply*curves: Quota* –*limit"that"a" government"sets"on"the" quantity"of" foreignF produced"goods"that"may"be"imported Without"any"ban"on"the"supply,"the"supply"of"the"product"is"equal" to"the" domestic" and" foreign" supply.(=latter"supply"curve)" When" there" is" a" ban," the" overall" supply" is" just" the" domestic" supply. (steeper"curve)" The& supply&of& the&foreign&;irms& is& vertical&at& the"a& value&(no& matter& what& the& price& is,& they& can& not& supply& more& than& the& established"a&value) Market*equilibrium: Equilibrium*–*situation"in"which"no"one" wants"to"change" his"or"her"behavior"–"point"where"the" supply"and"demand"curve"meets Equilibrium*price*–"price"at"which"consumers"can"buy"as"much"as"they"want"and"sellers"can"sell" as"much"as"they"want"F"called" also" the" market&clearing&price& as"it"removes"from" the"market"all" unsatis=ied"buyers"and"sellers Equilibrium*quantity*–"quantity"that"is"bought"and"sold"at"the"equilibrium"price Determining"the"equilibrium"point:"Q(d)"="Q(s) Disequilibrium:"quantity"demanded"is"not"equal"to"the"quantity"supplied Excess* demand*–* amount" by" which" the" quantity" demanded" exceeds" the" quantity" supplied" at" speci=ied"price" Excess*supply*–*amount"by"which"the"quantity"supplied"is"greater"than"the"quantity"demanded" at"a"speci=ied"price

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Equilibrium" changes"only" if" shock" occurs"that" shifts" the" demand"curve" or"the" supply"curve" –" those"shifts"occurs"only"if"one"of"the"variables"that"were"hold"constant"change Shocking*the*equilibrium Equilibrium"of"supply"and"demand"can"only"change"if"the"shock"(change"in"the"price"of"substitute" or"the"input)"occurs,"which"shifts"the"demand" curve"or"the"supply"curve. " Shift" of" the" demand" curve" causes" a" movement" along" the" supply" curve," until" the" new" equilibrium"is"achieved. " Shift" of" the" supply" curve" " causes" a" movement" along" the" demand" curve," until"the" new" equilibrium"is"reached. Effects*of*Government*interventions" Policies"which"shifts"the"supply"curve: E Licensing*laws:*limiting"the" number"of" =irms"that"can"sell"goods"in"a"market(e.g."Limit"on" the"number"of"taxicabs) E Quotas:*limiting"the"amount"of"a"good"that"can"be"sold(common"in"limiting"imports) Policies*that*cause*the*demand*to*differ*from*supply: F some" governmental" actions" can" cause" excess" supply/demand" if" e.g"there"is"direct"control"of"a"prices,"which"are"not"established"at" its"equilibrium"value E Price*ceiling*E*price"controlling" stating"that"the"price" can"not"be" higher"than"given"value"of"price"ceiling;enforced"price"ceiling"can" cause" a" shortage," which" is" the" persistent" excess" demand" (excessive"demand"(QdFQs))" if"the"price"ceiling"is"above" the"equilibrium"value"it"does"not"affect"the" price;"non"binding"price"ceiling EPrice* Floor*E*price" at" which" goods"is" sold" can" not" fall" below" established" value"(e.g"minimum"wage)" (LsFLd"F"unemployment"(permanent"excessive"supply)) When*to*use*the*supplyEandEdemand*model? A)everyone"is"a"price"taker"(no"one"can"affect"the"market"price) B)Firms"sell"identical"products C)Everyone" has" full" information" about"the" price" and" quality"of" goods D)Costs"of"trading"are"low* (all"features"of"perfectly"competitive"markets) *Transaction* costs* E*the" expenses"of" =inding" a" trading" partner" and"making"a" trade"for"a"good"or"service" beyond"the" price" paid" for"the"good"or"service

C*H*A*P*T*E*R***3*E*Applying*the*SupplyEandEDemand*Model How" much" the" equilibrium" quantity" falls" and" how" much" the" equilibrium" price" of" its" e.g." ingredient"rises"depend"on"the"shape"of"the"demand"curve. Sensitivity* of*quantity*demanded* to* price" F" how" much" quantity" demanded" changes" as" the" price"changes Elasticity* E* the" percentage" change" in" a" variable" in" response" to" a" given" percentage" change" in" another"variable." Most" commonly" used" measure" of" the" sensitivity" of" one" variable" to" another" variable.

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Price*elasticity*of*demand: Price*elasticity*of*demand*(elasticity*of*demand)* E*percentage"change" in"quantity"demanded" Q"in"response"to"change"in" price" p"at"a"particular"point"on"the"demand"curve."Elasticity"is"given" as"pure"number"(without"any"unit)."(according&to&the&Law&of& Demand(less&quantity&is&demanded& as&the&price&rises),&elasticity&is&a&negative&number,&the&negative&sign&is&usually&omitted) Assuming"that"

,"then"

Elasticity*along*the*demand*curve Elasticity" of" the" demand" often" varies" along" the" demand" curve;" elasticities" are" constant" only" along" horizontal" and" vertical" linear" demand" curves." (describes" movement" along" the" demand" curve) DownwardEsloping*linear*demand*curve F elasticity"is"more"negative"as"higher"the"price"is F 1%" increase" in"price" causes"a" larger"percentage" fall" in" quantity" near" the" top" of" the" curve," than" near"the"bottom"of"the"curve F At" the" point" where" the" elasticity" of" demand" is" zero" (price" is" zero)" the" elasticity" is" said" to" be" perfectly&inelastic F Unitary" elasticity" F" 1%" increase" in" price" causes" 1%"fall"in"quantity F When"the" demand" curve" hits" the" price" axis" it"is" perfectly& elastic& and" elasticity" approaches" negative"in=inity Constant&elasticity&curves: 1.*Horizontal*demand*curve F small" increase" in" price" causes" an" in=inite" drop" in" quantity" F" demand" curve" is" perfectly& elastic,&ε&=&H∞ F Horizontal"demand"curve"occurs"for"instance"in"case"of"perfect"substitutes 2.*Vertical*demand*curve F if"the"price"goes"up"the"quantity"demanded"remain"the"same"F"the"demand"curve"is"perfectly& inelastic&everywhere,"ε&=&0 F Vertical"demand"curve"occurs"in"case"of"essential"goods"F"e.g"medicines Demand"elasticities"over"time:" Two"factors"determine"whether"the" short"run"demand"elasticities"are"larger"or"smaller"than"the" long"run"elasticities. F Ease"of"substitution"F"in"the"long"run,"one"often"can"substitute"between"the"products,"so"the" change"in"demand"in"response"to"change"in"price"would"be"smaller"than"in"the"shortFrun F Storage"opportunities"F"if"is"easy"to"store"given"good,"shortFrun"demand"curve"may"be"more" elastic" than" long" run" curve(in" the" long" run" we" are" not"that" much" sensitive" to" the" price" change,"as"we"have"given"good"stored) Income* elasticity* of* demand* (income* elasticity)" F" percentage" change" in" the" quantity" demanded"Q"in"response"to"a"given"percentage"change"in"incomeY.

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If"quantity"demanded"increases"as"the" income"rises,"the" income"elasticity"of" demand"is"positive." If"the"quantity"does"not"change"as"income"rises,"the"income"elasticity"is"zero." If"the"quantity"demanded"falls"as"income"rises,"the"elasticity"is"negative. Goods"that"are"viewed"as"necessities(food)"have"elastics"near"zero. Goods"that"are"considered"to"be"luxuries,"generally"have"elasticity"greater"than"one. CrossEprice*elasticity*of*demand*(crossEprice*elasticity)* E*percentage" change"in"the" quantity" demanded"in"response"to"a"given"percentage"change"in"the"price"of"another"good

If"the"crossFprice" elasticity"is"negative" F"goods"are"complements"F"people" buy"less"of"the" good"a" the"price"increase. If"the"crossFprice" elasticity"is"positive" F"goods"are"substitutes"F"people"will"buy"more" of"another" good"if"price"of"this"one"increase. Sensitivity*of*quantity*supplied*to*price Price* elasticity* of*the* supply*(elasticity*of*supply)" is"the" percentage" change" in" the" quantity" supplied" in" response" to"a"given"percentage" change"in"the" price.(describes"movement"along" the" supply"curve)

If"the"supply"curve"is"upward"sloping,"the"supply"elasticity"is"positive. If"the"supply"curve"slopes"downward,"the"supply"elasticity"is"negative. If"ŋ"="0,"the"supply"curve"is"perfectly"inelastic"F"the"supply"does"not"change"as"the"price"is"raising. If"ŋ"="1,"the"supply"curve"has"unitary&elasticity. If&ŋ">"1,"the"supply"curve"is"elastic." Elasticity*along*the*supply*curve: * UpwardEsloping*supply*curve:** " " " " " " " " " " " " " " " " " " " " " " " "

η"="0"F"supply"curve"is"perfectly"inelastic 0"D(p),"Dr(p)"=0. Residual" demand" curve" at" any" price" is" the" horizontal" difference" between" the" market" demand"curve"and"the"supply"curve"of"other"=irms." If"there"are"n"identical"=irms,"then"the"elasticity"of"demand"facing"=irm"i,"is: ," where"ε" is"the"market"elasticity"of"demand,"η0" is"the"elasticity" of"supply"of"each"of"the"other"=irm"and"nF1"is"the"number"of"other"=irms." Why"do"we"study"perfect"competition? 1. Many"markets"can"be"reasonably"described"as"competitive. 2. Competitive"markets"has"many"desirable"properties. ProFit*maximization: Pro=it:"*π*=*R*E*C Economic*cost*E*including"both"explicit"and"implicit"costs;"it"is"the"opportunity&cost&H&the"value"of" the"best"alternative"use"of"any"assets"the"=irm"employs Economic*proFit*=*revenue*E*economic*cost Business*proFit*is"based"only"on"the"explicit"costs"(often"larger"than"economic"pro=it) Two"steps"to"maximize"pro=it: 8 Output"decision"F"what"output"of"level"q*"maximizes"pro=it"or"minimizes"loss? 8 Shutdown"decision"F"is"it"more"pro=itable"to"produce"q*"or"shut"dow?

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Firms"pro=it"function:"""

π(q)*=*R(q)*E*C(q)

Output*rules:* 1. The*Firm*sets*its*output*where*its*proFit*is*maximized*(at*∏*) Firm" can" experimentally" determine" the" slope" of" its" pro=it" curve" by" slightly"increasing"its"output. Slope"of"the"pro=it"curve"F"=irm’s"marginal*proFit. * Marginal*proFit*E*change"in"pro=it"a"=irm"gets"from"selling"one" more"unit"of"output" 2. The*Firm*sets*its*output*where*its*marginal*proFit*is*zero. MC"=*ΔC/Δq,"MR"="ΔR/Δq,"

MP(q)*=*MR(q)*E*MC(q)** 3. The*Firm*sets*its*output*where*its* marginal*revenue*equals* its* marginal*cost * Marginal* revenue* E* the" change" in" revenue" a" =irm" gets" from" selling" one" more" unit" of" " output Marginal"pro=it"F"Marginal"revenue"F"Marginal"Cost * MP*(q)*=*MR*(q)*E*MC*(q) * MR*(q)*=*MC*(q) Shutdown*rule: 1. The*Firm*shuts*down*only*if*it*can*reduce*loss*by*doing*so. (short" run)" F" =irm" should" compare" it"variable" cost"with" its"revenues." The" =ixed" cost"are" sunk" F" they"will"be"present"whether"the"=irm"operates"or"not,"so"they"are"irrelevant"to"this"decision. If"Revenues""Variable"costs,"=irm"should"not"shut"down 2. The*Firm*shuts*down*only*if*its*revenue*is*less*than*its*avoidable*costs. (long" run)" F"all"costs"are" avoidable" in" the"long" run," because" the" =irm"can"eliminate" them" all" by" shutting"down."In"such"situation"it"is"pro=itable"to"shut"down"if"the"=irm"faces"any"loss. BOTH" EXPRESSIONS" FOR" THE" SHUTDOWN" RULE" HOLDS" FOR" ALL" TYPES" OF" FIRMS" IN" THE" SHORT"AND"LONG"RUN. Competition*in*the*short*run: ShortHrun&output&decision: Because" a"competitive"=irm’s"marginal"revenue" equals"the" market" price" F" proFit* maximizing* competitive* Firm" produces"the"amount"of" output"at"which" its"marginal"cost" equals"the"market"price. MC"(q)"="p"="MR(q) The"pro=it"area"is"therefore:"

Π*=*(pEAC)*Q*(!!!!) ShortHrun&shutdown&decision: A" competitive" =irm" shuts"down" if" the" market"price" is"less" than" the" minimum" of" its" shortFrun" average" variable" cost" curve." The" =irm" can" gain" by" shitting" down" only" if" its" revenue"is"less"than"its"shortFrun"variable"cost: """pq"...