Basic Microeconomics

Demand, Supply and Market Equilibrium

Firms and Households: Basic Decision-Making Units

Firm: primary producing unit in an economy Exists when a person or group of people decide to produce a good or service by transforming inputs into outputs Households: consuming unit in an economy Is a large, heterogeneous group whose tastes find expression in the marketplace A common constraint among consumers is that they ultimately have limited income. Income levels are constrained by availability of jobs, current wages, capability and wealth.

Firms and Households: Basic Decision-Making Units

Input Markets and Output Markets: Circular Flow

Households and firms interact in both the product and factor markets Circular flow of economic activity Goods and services flow from firms to households through the output market Labor services flow from households to firms through input markets. Payment for goods and services flow in the opposite direction.

Demand in Product/Output Markets

Households demand for a product depends on the ff: Price of product Income available to household Amount of accumulated wealth Price of other products Households taste or preferences Expectation about future income, wealth and prices.

Demand in Product/Output Markets

Demand in Product/Output Markets

Law of Demand

A demand schedule shows the quantities of a good that a household would be willing to buy at different price levels. These price and quantity coordinates can be plotted to form a demand curve. The Law of Demand states an inverse relationship between quantity demanded and the price Characteristics of the shape of a demand curve:

Negative slope Intersects quantity axis as a result of time limitation Intersects price axis as a result of limited income and wealth

Other Determinants of Household Demand

Income and Wealth

Income sum of all wages, salaries and profits, interest payments, rents and other forms of earnings received by a household within a given period of time Wealth total value of what a household owns minus what it owes (also known as net worth). It is a stock measure (at a given point in time).

Other Determinants of Household Demand

Prices of Other Goods or Services

Households must apportion their income over so many different goods and services that the price of any one good will affect the demand for other goods. Substitutes and Complements:

Substitutes related goods wherein the increase in the price of one good leads to the increase in quantity demanded of another good

Other Determinants of Household Demand

Substitutes and Complements: Complements related goods wherein the increase in the price of one good leads to the decrease in the quantity demanded of another good Taste and Preferences These are volatile and idiosyncratic Expectations Expectations about the change in price, income and wealth affect present and future demand

Demand in Product/Output Markets

Changes in Quantity Demanded vs. Changes in Demand

Changes in the price of a product affect quantity demanded per period. Changes in any other factor, such an income or preferences, affect demand or essentially a shift in the demand curve.

Demand in Product/Output Markets

Shift of Demand versus Movement Along a Demand Curve

Change in price leads to a change in quantity demanded or a movement along the same demand curve Change in all other factors affecting demand leads to a change in demand or a shift of the entire demand curve

From Household Demand to market Demand

Market demand is the sum of all the quantities of a good or service demanded per period by all households buying the good in the market Graphically the market demand is a horizontal summation of all individual demand curves.

From Household Demand to market Demand

Supply in Product/Output Markets

Supply decisions depend on profit potential. It reacts to changes in revenues and costs Costs, in turn, depends on other factors which include the following:

Type of inputs necessary to produce the product Amount of each input required Prices of these inputs

Firms choose the production technique most appropriate for product and the level of production. The method of production chosen is one that minimizes cost within reasonable bounds.

Supply in Product/Output Markets

Law of Supply

Quantity supplied is the amount of a particular product that firms would be willing and able to offer for sale at a particular price at a particular period of time. A supply schedule shows how much of a product a firm will sell at different levels of prices. There is a positive relationship between the quantity of a good supplied and the price. Determinants of Supply

Cost of Production Prices of Related Products

Law of Supply

Shifts in Supply versus Movement Along a Supply Curve

A supply curve is derived holding everything constant except the price. When the price of a product changes, ceteris paribus, a change in quantity supplied follows and a movement along the same supply curve takes place. When factors other than the price changes , the supply curve shifts resulting in a change in supply.

Shifts in Supply versus Movement Along a Supply Curve

From Individual Supply to Market Supply

Market supply is the sum of all that is supplied each period by all producers of a product. The market supply curve also depends on the number of firms that produce in the market. Profits attract other firms to enter the same line of business as other firms that have done so previously.

From Individual Supply to Market Supply

Market Equilibrium

The operation of a market depends on the interaction between demand and supply. Conditions that could prevail in the market:

Quantity demanded exceeds quantity supplied or a situation of excess demand Quantity supplied exceeds quantity demanded or a situation of excess supply Quantity demanded just equals quantity supplied or a situation of equilibrium in the market

Market Equilibrium

Market Equilibrium

Changes in equilibrium occur every time either the demand or supply curves shift. Changes in quantity demand, quantity supplied and price will all depend on how and by how much these curves shift.