Microeconomics

Markets

• A market is where buyers (consumers) and sellers (producers) come together to establish an equilibrium price and quantity for a good or service. It does not need to be an actual place.
• Ceteris paribus is a Latin expression that means “let all other things remain equal.” It is an assumption made by economists in order to construct economic models.
• Demandis the willingness and ability to purchase a quantity of a good or service at a certain price over a given time of period.
  • The law of demand states that as the price of a good or service rises, the quantity demanded decreases, ceteris paribus. example
  • The demand curve is a graphical representation of the law of demand. It is (usually) a downward-sloping curve (or line) illustrating the inverse relationship between price and quantity demanded.
• Supply is the willingness and ability pf a producer to produce a quantity og a good or service at a certain price over a given period of time. example
  • The law of supply states that as the price of a good rises, the quantity supplied increases, ceteris paribus.
  • The supply curve is a graphical representation of the law of supply. It is a upward-sloping curve (or line) illustrating the direct relationship between price and quantity supplied.
• Equilibrium price is the market clearing price. It occurs where demand is equal to supply.
• A maximum price is also known as a ceiling price. It is a price set by the government, above which the market price is not allowed to rise. It may be set to protect consumers from high prices, and it may be used in markets for essential goods, such as rice or house rentals.
• A minimum price is also known as a floor price. It is a price set by the government, below which the market price is not allowed to fall. It may be set to protect producers producing essential products from facing prices that are felt to be too low, such as many agricultural products in the European Union. example
• A buffer stock scheme sets a maximum and a minimum price in a market to stabilize prices. example

Elasticities example

• Price elasticity of demand (PED)is a measure of the responsiveness of the quantity demanded of a good or service to a change in its price.
  • Elastic demand means that a change in the price of a good or service will cause a proportionately larger change in quantity demanded.
  • Inelastic demand means that a change in the price of a good or service will cause a proportionately smaller change in quantity demanded.
• Cross elasticity of demand (XED)is a measure of the responsiveness of he demand for a good or service to a change in the price of a related good.
  • Substitute goods are goods hat can be used instead of each other, such as butter and margarine. Substitute goods have positive cross elasticity of demand.
  • Complement goods are goods which are used together, such as DVD players and DVD discs. Complement goods have negative cross elasticity of demand.
• Income elasticity of demand (YED)is a measure of the responsiveness of demand for a good to a change in income.
  • A normal good has a positive income elasticity of demand. As income rises, demand increases.
  • Inferior goods have a negative income elasticity of demand. As income rises, demand decreases.
• Price elasticity of supply (PES) is a measure of he responsiveness of the quantity supplied of a good or service to a change in its price.
• Taxis a compulsory contribution to state revenue, levied by the government on the suppliers and consumers, raising the cost of goods or services.
  • An indirect tax is an expenditure tax on a good or service. An indirect tax is shown on a supply  and demand diagram as an upward shift in the supply curve, where the vertical distance between the two supply curves represents the amount of the tax. A specific tax is shown as a parallel shift. An ad valorem tax is shown as a divergent shift.
  • The incidence (or burden) of tax refers to the amount of tax paid by the producer or the consumer. If the demand for a good is inelastic the greater incidence of the tax falls on the consumer. If the demand for a good  is elastic, the greater incidence of the tax falls on the producer. example
• Subsidy is a sum of money granted by the government or a public body to assist an industry or business so that the price of a commodity or service may remain low or competitive

Theory of the firm

• Fixed costsare costs of production that do not change with the level of output. They will be the same for the one or any other number of units.
  • Variable costs are costs are costs of production that vary with the level of output.
  • Total costs are the total costs of producing a certain level of output–fixed costs plus variable costs.
  • Average cost is the average (total) cost of production per unit. It is calculated by dividing the total cost by the quantity produced.
  • Marginal cost is the additional cost of producing an additional unit of output.
• The short runis the period of time in which at least one factor of production is fixed–the production stage.
  • The law of diminishing average returns states that as extra units of a variable factor are applied to a fixed factor, the output per unit of the variable factor will eventually diminish.
  • The law of diminishing marginal returns states that as extra units of a variable factor are applied to a fixed factor, the output from each additional unit of the variable factor will eventually diminish.
• The long runis the period of time in which all factors of production are variable.
  • Economies of scale are any fall in long-run unit (average) costs that come about as a result of a firm increasing its scale of production (output). example
  • Diseconomies of scale are any increase in long-run unit (average) costs that come about as a result of a firm increasing its scale of production (output).
• Total revenueis the aggregate revenue gained by a firm from the scale of a particular quantity of output (equal to price times quantity sold).
  • Average revenue is total revenue received divided by the number of units sold. Usually, price is equal to average revenue.
  • Marginal revenue is the extra revenue gained from selling an additional unit of a good or service.
• Normal profitsare the amount of revenue needed to cover the total costs of production, including the opportunity costs.
  • Abnormal profits are any level of profit that is greater than the required to ensure that a firm will continue to supply its existing good or service. (It is an amount of revenue greater than the total costs of production, including opportunity costs.)
  • The profit-maximizing level of output is the level of output where marginal revenue is equal to marginal cost.
• The shut-down price is the price where average revenue is equal to average variable cost. Below this price, the firm will shut down in the short run.
• The break-even price is the price where average revenue is equal to average total cost. Below this price, the firm will shut down in the long run.
• Allocative efficiencyis the level of output where marginal cost is equal to average revenue, or price. The firm sells the last unit it produces at the amount that it cost it to make it.
  • Productive efficiency exists when production is achieved at the lowest cost per unit of output. This is achieved at the point where average total cost is at its lowest value.
• Perfect competition is a market structure where there is a very large number of small firms, producing identical products. No individual firm is capable of affecting the market supply curve and thus cannot affect the market price. Because of this, the firms are price takers. There are no barriers to entry or exit and all the firms have perfect knowledge of the market.
• Monopolistic competitionis a market structure where there are many buyers and sellers producing differentiated products, with no barriers to entry or exit.
  • Oligopoly is a market structure where there is a small number of large firms that dominate the market. For example, 90% of petrol sold in a country is accounted for by four large chains of petrol stations.
  • Monopoly is a market form where there is only one firm in the industry; the firm is the industry.
  • Barriers to entry are obstacles that may be in the way of potential newcomers to a market, such as economies of scale, product differentiation, and legal protection.
• Price discrimination occurs when a producer charges a different price to different customers for an identical good or service.

Market Failure

• Market failureis the failure of markets to produce at the socially efficient level of output.
  • Positive externalities are beneficial effects that are enjoyed by a third party when a good or service is produced or consumed.
  • Negative externalities are the bad effects that are suffered by a third party when a good or service is produced or consumed. example, example2
• Public goods are goods or services that would not be provided at all by the market.
  • Merit goods are goods or services considered as beneficial for people and that would be under-provided by the market and so under-consumed.
  • Demerit goods are goods or services considered to be harmful to people and that would be over-produced by the market and so over-consumed.
• Marginal private benefit (MPB)is the increase in private benefit resulting from the consumption of one more unit or the production of one more unit.
  • Marginal private cost (MPC) is the cost incurred by just the firm or the consumer in producing or consuming each extra unit of a good.
  • Marginal social benefit (MSB) is the increase in social benefit resulting from the consumption of one more unit or the production of one more unit.
  • Marginal social cost (MSC) is the cost incurred by just the firm or the consumer  and society in producing or consuming each extra unit of a good.
• A welfare loss occurs the optimum outcome for society is not achieved. This will happen where marginal social benefit is not equal to marginal social cost and therefore there is a loss to society.