Concepts of Microeconomics

1.Competition and Market Structures:

"Competition," wrote Samuel Johnson, "is the act of endeavoring to gain what another endeavors to gain at the same time." We are all familiar with competitionfrom childhood games, from sporting contests, from trying to get ahead in our jobs. But our firsthand familiarity does not tell us how vitally important competition is to the study of economic life. Economic competition takes place in markets--meeting grounds of intending suppliers and buyers. Typically, a few sellers compete to attract favorable offers from prospective buyers. Similarly, intending buyers compete to obtain good offers from suppliers. When a contract is concluded, the buyer and seller exchange property rights in a good, service, or asset. Everyone interacts voluntarily, motivated by selfinterest. In the process of such interactions, much information is signaled through prices. Keen sellers cut prices to attract buyers, and buyers reveal their preferences by raising their offers to outcompete other buyers. When a deal is done, no one may be entirely happy with the agreed price, but both contract partners feel better off. If prices exceed costs, sellers make a profit, an inducement to supply more. When other competitors learn what actions lead to profits, they may emulate the original supplier. Conversely, losses tell suppliers what to abandon or modify. 2.Consumers: One who consumes, especially one who acquires goods or services for direct use or ownership rather than for resale or use in production and manufacturing. When you buy a good or service, you rarely have perfect knowledge of its quality and safety. You are justifiably concerned about getting "ripped off." Thus the need for consumer protection. Economic activity flourishes when consumers can trust producers, but the consumer must have grounds for trust. Consumers value, then, not only quality and safety, but also the assurance of quality and safety. Trust depends on assurance. 3.Demand : One of the most important building blocks of economic analysis is the concept of demand. When economists refer to demand, they usually have in mind not just a single quantity demanded, but what is

called a demand curve. A demand curve traces the quantity of a good or service that is demanded at successively different prices. The most famous law in economics, and the one that economists are most sure of, is the law of demand. On this law is built almost the whole edifice of economics. The law of demand states that when the price of a good rises, the amount demanded falls, and when the price falls, the amount demanded rises. The strength of microeconomics comes from the simplicity of its underlying structure and its close touch with the real world. In a nutshell, microeconomics has to do with supply and demand, and with the way they interact in various markets. 4.Elasticity of Demand: Price elasticity of demand is the quantitative measure of consumer behavior that indicates the quantity of demand of a product or service depending on its increase or decrease in price. Price elasticity of demand can be calculated by the percent change in the quantity demanded by the percent change in price. 5.Entrepreneurs: An entrepreneur is someone who organizes, manages, and assumes the risks of a business or enterprise. An entrepreneur is an agent of change. Entrepreneurship is the process of discovering new ways of combining resources. Entrepreneurs introduce new products and technologies with an eye toward making themselves better off--the profit motive. New goods and services, new firms, and new industries compete with existing ones in the marketplace, taking customers by offering lower prices, better performance, new features, catchier styling, faster service, more convenient locations, higher status, more aggressive marketing, or more attractive packaging. In another seemingly contradictory aspect of creative destruction, the pursuit of self-interest ignites the progress that makes others better off. 6.Government Failures and Public Choice Analysis: Public choice theory is a branch of economics that developed from the study of taxation and public spending. It emerged in the fifties and received widespread public attention in 1986, when James Buchanan, one of its two leading architects (the other was his colleague Gordon Tullock), was awarded the Nobel Prize in economics. 7.Income Distribution: The distribution of income is central to one of the most enduring issues in political economics. On one extreme are those who argue that all incomes should be the same, or as nearly so as possible, and that a

principal function of government should be to redistribute income from the haves to the have-nots. On the other extreme are those who argue that any income redistribution by government is bad. 8.Market Failures: 'Market Failures' is an economic term that encompasses a situation where, in any given market, the quantity of a product demanded by consumers does not equate to the quantity supplied by suppliers. This is a direct result of a lack of certain economically ideal factors, which prevents equilibrium. Most economic arguments for government intervention are based on the idea that the marketplace cannot provide public goods or handle externalities. Public health and welfare programs, education, roads, research and development, national and domestic security, and a clean environment all have been labeled public goods. Externalities occur when one person's actions affect another person's well-being and the relevant costs and benefits are not reflected in market prices. A positive externality arises when my neighbors benefit from my cleaning up my yard. If I cannot charge them for these benefits, I will not clean the yard as often as they would like. (Note that the free-rider problem and positive externalities are two sides of the same coin.) A negative externality arises when one person's actions harm another. When polluting, factory owners may not consider the costs that pollution imposes on others. 9.Markets and Prices: So we have supply, which is how much of something you have, and demand, which is how much of something people want. Put the two together, and you have supply and demand. Now, how do you show the relationship between the two? One way is to use the price of something. Generally speaking, the price of something will go up if the demand goes up. Why? Because the seller thinks he or she can get more money for whatever he or she is selling. At the root of everything is supply and demand. It is not at all farfetched to think of these as basically human characteristics. If human beings are not going to be totally self-sufficient, they will end up producing certain things that they trade in order to fulfill their demands for other things. The specialization of production and the institutions of trade, commerce, and markets long antedated the science of economics. Indeed, one can fairly say that from the very outset the science of economics entailed the study of the market forms that arose quite naturally (and without any help from economists) out of human behavior. People specialize in what they think they can do best--or more existentially, in what heredity, environment, fate, and

their own volition have brought them to do. They trade their services and/or the products of their specialization for those produced by others. Markets evolve to organize this sort of trading, and money evolves to act as a generalized unit of account and to make barter unnecessary. 10.Price Ceilings and Floors: Governments have been trying to set maximum or minimum prices since ancient times. The appeal of price controls is understandable. Even though they fail to protect many consumers and hurt others, controls hold out the promise of protecting groups that are particularly hard-pressed to meet price increases. Thus, the prohibition against usury--charging high interest on loans--was intended to protect someone forced to borrow out of desperation; the maximum price for bread was supposed to protect the poor, who depended on bread to survive; and rent controls were supposed to protect those who were renting when the demand for apartments exceeded the supply, and landlords were preparing to "gouge" their tenants. The reason most economists are skeptical about price controls is that they distort the allocation of resources. To paraphrase a remark by Milton Friedman, economists may not know much, but they do know how to produce a shortage or surplus. Price ceilings, which prevent prices from exceeding a certain maximum, cause shortages. Price floors, which prohibit prices below a certain minimum, cause surpluses, at least for a time. Suppose that the supply and demand for wheat flour are balanced at the current price, and that the government then fixes a lower maximum price. The supply of flour will decrease, but the demand for it will increase. The result will be excess demand and empty shelves. Although some consumers will be lucky enough to purchase flour at the lower price, others will be forced to do without. 11.Producers: A producer is someone who creates and supplies goods or services. Producers combine labor and capitalcalled factor inputs or factors of productionto createthat is, to outputsomething else. Businessescalled "firms"are the main examples of producers and are usually what economists have in mind when talking about producers. However, governments are producers of some kinds of servicessuch as police services, defense, public schools, and mail deliveryand sometimes goods, such as when a government owns the oil fields and oil production. Households and individuals are producers of non-market goods and services such as cleaning, child-rearing, cooked food, etc.

Producers pay wages to workers. Wages include salaries, bonuses, and benefits such as health insurance. What producers pay for capital is called economic rent. Economic rents include interest pyaments. Anything left over for the owner of the business is called economic profit. 12.Profit: Capitalists earn a return on their efforts by providing three productive inputs. First, they are willing to delay their own personal gratification. Instead of consuming all of their resources today, they save some of today's income and invest those savings in activities (plant and equipment) that will yield goods and services in the future. Second, some profits are a return to those who take risks. Some investments make a profit and return what was invested plus a profit, but others don't. Third, some profits are a return to organizational ability, enterprise, and entrepreneurial energy. 13.Roles of Government: Most economic arguments for government intervention are based on the idea that the marketplace cannot provide public goods or handle externalities. Public health and welfare programs, education, roads, research and development, national and domestic security, and a clean environment all have been labeled public goods. Public goods have two distinct aspects"nonexcludability" and "nonrivalrous consumption." Nonexcludability means that nonpayers cannot be excluded from the benefits of the good or service. If an entrepreneur stages a fireworks show, for example, people can watch the show from their windows or backyards. Because the entrepreneur cannot charge a fee for consumption, the fireworks show may go unproduced, even if demand for the show is strong. The distribution of income is central to one of the most enduring issues in political economics. On one extreme are those who argue that all incomes should be the same, or as nearly so as possible, and that a principal function of government should be to redistribute income from the haves to the have-nots. On the other extreme are those who argue that any income redistribution by government is bad. 14.Supply: The most basic laws in economics are the law of supply and the law of demand. Indeed, almost every economic event or phenomenon is the product of the interaction of these two laws. The law of supply states that the quantity of a good supplied (i.e., the amount owners or producers offer for sale) rises as the market price rises, and falls as the price falls. Conversely, the law of demand (see Demand) says that the

quantity of a good demanded falls as the price rises, and vice versa. One function of markets is to find "equilibrium" prices that balance the supplies of and demands for goods and services. Economists often talk of "demand curves" and "supply curves." A demand curve traces the quantity of a good that consumers will buy at various prices. As the price rises, the number of units demanded declines. That is because everyone's resources are finite; as the price of one good rises, consumers buy less of that and, sometimes, more of other goods that now are relatively cheaper. Similarly, a supply curve traces the quantity of a good that sellers will produce at various prices. As the price falls, so does the number of units supplied. Equilibrium is the point at which the demand and supply curves intersect--the single price at which the quantity demanded and the quantity supplied are the same. Why does the quantity supplied rise as the price rises and fall as the price falls? The reasons really are quite logical. First, consider the case of a company that makes a consumer product. Acting rationally, the company will buy the cheapest materials (not the lowest quality, but the lowest cost for any given level of quality). As production (supply) increases, the company has to buy progressively more expensive (i.e., less efficient) materials or labor, and its costs increase. It charges a higher price to offset its rising unit costs.