Microeconomics Revision Notes

2.1 Markets ·         Definition of markets with relevant local, national and international examples A market is any place, physical or virtual, where the buyers and sells of goods and services meet. Local market: weekend farmers market, dairy shop National market: participants are from the market country- healthcare, education, labour markets. International market: exchange of commodities, e.g. steel, oil, coffee, cotton   ·         Brief descriptions of perfect competition, monopoly and oligopoly as different types of market structures, and monopolistic competition, using the characteristics of the number of buyers and sellers, type of product and barriers to entry. Market structure Number of firms Level of differentiation Market power Barriers to entry and exit Example Competition Perfect competition Very many Homogenous products with same production cost. Perfect substitutes of each other. No power. Price TAKER. None Agricultural commodities, bonds, stocks, currencies Intense Monopolistic competition Many firms Differentiated/ heterogeneous Generally little power. Price TAKER Relatively insignificant Restaurants, jewelers, clothing stores Heavy Oligopoly A few dominating Heterogeneous or homogeneous Significant power. Price MAKER. Significant Airlines, breakfast cereals, cell phone networks Interdependent Monopoly One dominating None; no close substitutes Significant power. Price MAKER Major Power, water, local utilities None   ·         Importance of price as a signal and as an incentive in terms of resource allocation Price rationing- free market mechanism- reflects the true demand and supply of a good. Demand ·         Definition of demand: the quantity of a good that consumers are willing and able to buy at a given price during a specific time period. ·         Law of demand with diagrammatic analysis- shows the inverse relationship between P and Qd; negative slope- Qd decreases as P increases, ceteris paribus. Law of DIMINISHING RETURNS. (MB decreases as Qd increases). Demand curve reflects the MB we receive from consuming additional units of a good. ·         Determinants of demand: income, price of substitute and complementary goods, consumer taste and preferences, expectations of future prices and income, number of potential buyers -          Income: normal (D increases as income increases) versus inferior goods (D decreases as income increases). -          Price of related goods: Substitutes (to be used in place of)- D increases as the price of substitutes increases. Complements (consumed together)- D decreases as the price of complementary increases. -          Role of expectations Of future prices: D increases if consumers believe future price will rise rather quickly. Of future income: D increases if consumers conclude their income will rise- high economic growth, steadily rising wages, surging business investment, relatively low unemployment -          Higher demand when there is a larger number of potential buyer, e.g. in China when the markets first became open. ·         Fundamental distinction between a movement along a demand curve and a shift of the demand curve -          Movement- change in price (law of demand)- change in Qd -          Shift of the curve-change in determinants – change in D (leftwards or rightwards) ·         Exceptions to the law of demand (the upward-sloping demand curve) o    Ostentatious (Veblen) goods- display of social status, so Qd increases as P increases. o    Giffen goods Supply ·         Definition of supply- the quantity of a good or service that producers are willing to offer for sale at a given price during a specific time period. ·         Law of supply with diagrammatic analysis- positive relationship between Qs and P; positive slope-Qs increases as P increases, ceteris paribus. PROFIT incentive ·         Determinants of supply: production costs, productivity, government intervention, price of related goods, supply shocks. -          Costs of production- higher costs = increased difficulty to make profits (profit = revenue-cost), ceteris paribus. S decreases if costs increase. -          Productivity= amount of output per unit of input- aiming to minimize the amount of FOPs to keep costs down. Increased productivity- methods of production /technical improvements. Higher productivity increases supply. -          Government intervention: Introduction of indirect taxes (collected at the point of sale then passed onto the government)- part of production costs-decreases supply. Shifts supply curve leftwards by the amount of the tax. Introduction of subsidies (payments made to firms to increase supply),  Per-unit subsidy- made for each unit produced- reduces costs- shifts supply curve rightwards- encouraging more supply at each and every price. -          Price of supply substitute- S decreases if price increases (uses similar inputs and production methods)- more profitable. -          Supply shocks-natural disaster, strikes, ·         Fundamental distinction between a movement along a supply curve and a shift of the supply curve -          Movement- change in price (law of supply)- change in Qs -          Shift of the curve-change in determinants – change in S (leftwards or rightwards) Interaction of demand and supply ·         Equilibrium = market-clearing price and quantity (Qd = Qs), no shortage nor surplus. ·         Diagrammatic analysis of changes in demand and supply to show the adjustment to a new equilibrium (mechanism of free market to re-establish equilibrium status). market inefficiency- electricity shortage in southern China due to supply shock (coals and drought) + the failing central planned coal price vs free-market price- government regulations to ensure supply of coals- lower quality. *mainly due to the central planned electricity price. ·         Price controls ·         Maximum price: causes (protecting consumers from paying unaffordable prices and consequences (must be set below equilibrium, so shortage QsEg. Rent controls, oil price controls, Chinese electricity shortage. ·         Minimum price: causes (protect producers from receiving absurdly low prices) and consequences( surpluses Qs>Qd, resource inefficiency, firms trying to sell illegally below the price floor, e.g. labour market ·         Price support/buffer stock schemes ·         Commodity agreements

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