Microeconomics

EC 101 Term I 2017

Indian Institute of Management
Calcutta
 EC 101 Logistics
Six sections
Three faculty members, each teaching two
sections

Prof. Anindya Sen (D & E)

Prof. Arijit Sen (A & C)
Prof. Runa Sarkar (B & F)
 Microeconomics ECON 101
Classes for B & F:
B F
Tuesday 2.30 4.00 10.15 1145
(L-22) (N-32)
Thursday 10.15 1145 2.30 4.00
(L-22) (N-32)

Your course web will have the slides uploaded

from each class and will be our medium of
communication
 Microeconomics ECON 101
Separate exams to be given by each
faculty
Grading will be done on uniform basis
across sections
Two exams one midterm and one end-
term
Midterm scores will be raw scores, not
converted into grades
 Reference
B.D. Bernheim and M.D. Whinston
Microeconomics (McGraw Hill)
 COMMON MINIMUM AGREED COURSE CONTENT

Chapter Sections
1 1.1, 1.3, 1.4
2 All
4 All
5 5.1- 5.5
6 6.1- 6.3
7 7.1-7.4
8 All
9 9.1-9.5
11 11.1 11.2
12 12.1-12.4
Contd
Chapter Sections
14 All
15 15.2
17 17.1-17.3, 17.6
18 18.1-18.4
19 19.1 19.6
20 All
21 All

Lets begin
 What is Economics?
the study of how various societies use scarce resources
to produce commodities that are valued by people, and
design mechanisms to allocate them among different
people
Concerned with two central truths
1. Resources are scarce
2. One mechanism of producing and distributing commodities
may be more efficient and/or more equitable than another
mechanism
Scarcity of resources necessitates making choices, and
different ways of organizing an economy will provide different
incentives to agents in making their choices
Economics is all about recognizing trade-offs in decision-
making, and resolving such trade-offs in intelligent ways
Economics is a study of mankind in the ordinary
business of life Alfred Marshall
 The Progression of Economic Analysis

Microeconomics: Studies economic decision-making of buyers and sellers, and how

these decisions gel to generate market outcomes
Macroeconomics: Studies levels and fluctuations of aggregate economic variables:
GNP, employment, inflation, interest rates
International Economics: Studies trading relations between nations and the
interactions among national macro-economies
In all of this, we have two kinds of queries: how things are (positive economics), and
how things ought to be (normative economics)
 Why study Economics?
In your professional life, you will play in a playground called
the global economy. It is important for you to understand:
(a) the rules of the game,
(b) how other players play the game, and
(c) what are the best ways for you to play.

1. Economics helps us to better understand the environment

that we live and work in
- Is the topography of the global economy becoming flatter ?
2. Economics helps us to be more astute participants in the
economy by making us better decision-makers
- Should a firm revise its prices when its overheads change?
3. Economics gives us a better understanding of the pros and
cons of policy making
- Should futures market be banned to control commodity price rise?
 EC 101
Objectives
1. Understand the principles of
intelligent decision-making in
different economic
environments
2. Analyze workings of an
industry/market and of
market participants
3. Study interplay between
individual decisions and
market environment
-individual decisions are affected
by the market environment,
while the environment is itself
shaped by aggregation of
individual decisions
The Production Possibilities Frontier
In Figure 1-1, the boundary
presented in the graph represents
the different possibilities that
society has in the allocation of
D resources.
C The frontier boundary and its
interior represent what is
achievable given the currently
available resources, and assuming
no trade. In this context, this is
also the consumption
A possibilities frontier
B
In contrast, points outside the
frontier are not attainable given
the resources and technology
present.
The PPF can shift because of
growth, trade, etc
 Inside the Market EconomyI
Three pillars: markets, prices, firms
1. Markets
a triadic relation between firms, their customers, and their suppliers
boundary depends mainly on (a) the range of products related in
consumption and/or production, and (b) geography [depends greatly
on the eye of the beholder]
Market Structure composed of (i) demand structure, (ii) structure of
input supply, and (iii) industry structure size distribution of firms in
the industry
these three determine market power (e.g., power to affect prices vis-
-vis costs)
Some markets are non-existent or incomplete
The essence of entrepreneurship is to identify such gaps and
devise economically/socially profitable ways of filling them
 Inside the Market EconomyII
Three pillars: markets, prices, firms
2. Prices:
convey information, affect resource allocation, and determine
incomes and profits
new technological and institutional innovations (the internet,
electronic marketplaces in the rural economy, etc.) highlight the
benefits of information conveyed by prices
to compare prices over time and across space:
Absolute vs. relative prices: comparing affordability of a product
relative to other goods, and across space (e.g., across
currencies). When two products are expressed in same
currency, we have only to take the ratio of their nominal prices;
but when they are not, we have to use the real exchange rate
(the purchasing power parity)
Nominal vs. real prices: comparing affordability of a good over
time (controlling for inflation) - we have to deflate nominal
price by appropriate inflation index
 Inside the Market EconomyIII
Three pillars: markets, prices, firms
The Value Net Diagram (Brandenberger Nalebuff) places a firm in relation to
its important strategic partners and rivals in the processes of value creation
and value capture

Customers

The Firm

Suppliers

A firms engages with customers, existing and potential competitors, and input
suppliers in the process of value capture
The value net emphasizes that business is war and peace (i.e., concurrent
cooperation and competition, i.e., Co-opetition)
In most of Microeconomics, we will study firm behaviour under the profit
maximization hypothesis owners / managers take purposive decisions to
maximize long-term profits of a firm
 Key Concepts so far
Resources Defining a Market
Markets are usually defined in
Scarcity terms of therapeutic classes of
Trade-Offs drugs.

Markets For example, there is a market

for antiulcer drugs that is very
Prices clearly defined.

Theories and Models Sometimes

pharmaceutical
market
boundaries are
more ambiguous,
like painkillers.
 The Demand- Supply Framework
The Circular Flow
Model of a
Market Economy

Four kinds of demand and supply functions in a market economy:

(i) households demand functions for final goods
(ii) firms supply functions of final goods
(iii) households input supply functions
(iv) firms input demand functions
(i) and (iii) are jointly determined by households, while (ii) and (iv)
are jointly determined by firms

The demand supply framework studies outcomes in individual

markets, and then attempts to analyze interrelationships
 Application
The demand-supply framework is strictly applicable only to
perfectly competitive markets where there are
numerous buyers and sellers who are price takers (no
control over setting prices)
Various commodity markets are close to being perfectly
competitive (commoditization = products losing their
differential attributes in the eyes of consumers)
Even when an industry is not perfectly competitive, understanding
demand and supply behaviour of market participants is useful.
Applied in
the world oil market
foreign exchange markets etc.
Furthermore, firms with market power on the consumer side will
be interested in determining consumer demand structure, and
firms with market power on the supplier side will be interested in
determining input supply structure
 On a dismal note
Thomas Carlyle believed work was morally good and that if a
black man would not voluntarily work for prevailing wages then
he should be compelled to work
He attacked John Stuart Mill who argued that supply and demand
should regulate the labour market
Carlyle wrote:
The social science which finds the secret of this Universe in
supply and demand and reduces the duty of human governors to
that of allowing men to be free to choose is a dreary, desolate,
and distressing discipline, one that we might call the dismal
science. It is unwise to have a situation where supply and
demand is the all-sufficient substitute for command and
obedience among two-legged animals of the unfeathered class.
Thomas Carlyle thus gave economics the name the dismal science
in his 1849 article Occasional Discourse on the Negro Question
which dealt with the post-slavery labour market in the West
Indies
Next Class: Demand and Supply