Microeconomics Study Notes: Foundations, Demand & Supply, Equilibrium, and Elasticity

Economic Issues and Concepts

What is Economics?

Economics is the study of how scarce resources are allocated to satisfy unlimited human wants. It addresses fundamental questions about production, consumption, and distribution in society.

• Scarcity: Limited resources versus unlimited wants.

• Factors of Production: Land (natural resources), Labour (human effort), Capital (machinery, buildings), Entrepreneurship (organization and risk-taking).

• Goods: Tangible products (e.g., food, clothing).

• Services: Intangible activities (e.g., teaching, healthcare).

• Production: The process of making goods and services.

• Consumption: The use of goods and services.

Opportunity Cost: The value of the next best alternative forgone when making a choice.

Production Possibility Frontier (PPF): Shows the maximum combinations of goods/services that can be produced with available resources. Points on the curve represent efficient use of resources.

• Economic growth shifts the PPF outward.

• Movement along the PPF involves opportunity cost.

Types of Economic Systems

• Market Economy: Resources allocated by market forces (supply and demand).

• Command Economy: Central authority allocates resources.

• Traditional Economy: Allocation based on customs and traditions.

• Mixed Economy: Combines elements of market and command systems.

Economic Theories, Data, and Graphs

Positive vs. Normative Statements

• Positive Statement: Describes what is, can be tested (e.g., "Higher income taxes reduce spending").

• Normative Statement: Prescribes what ought to be, involves value judgments (e.g., "Government should raise taxes").

Building and Testing Economic Theories

• Variables: Quantities that can take different values.

• Endogenous Variables: Determined within the model.

• Exogenous Variables: Determined outside the model.

• Correlation vs. Causation: Correlation is a relationship; causation means one variable directly affects another.

• Scientific Approach: Formulate hypotheses, test with data, refine theories.

Economic Data and Graphs

• Index Numbers: Used to compare data across time periods.

• Formula for % Change:

$\text{\% change} = \frac{\text{New Value} - \text{Old Value}}{\text{Old Value}} \times 100$

• Scatter Diagrams: Used to visualize relationships between two variables.

Demand, Supply, and Price

Demand

Demand refers to the amount of a good or service that consumers are willing and able to purchase at various prices over a period of time.

• Quantity Demanded: Specific amount consumers will buy at a given price.

• Law of Demand: As price increases, quantity demanded decreases (inverse relationship).

• Demand Curve: Downward sloping, showing the relationship between price and quantity demanded.

• Shifts in Demand: Caused by changes in income, tastes, prices of related goods, expectations, and population.

• Movement Along the Curve: Caused by a change in the price of the good itself.

Supply

Supply refers to the amount of a good or service that producers are willing and able to sell at various prices over a period of time.

• Quantity Supplied: Specific amount producers will sell at a given price.

• Law of Supply: As price increases, quantity supplied increases (direct relationship).

• Supply Curve: Upward sloping, showing the relationship between price and quantity supplied.

• Shifts in Supply: Caused by changes in input prices, technology, taxes/subsidies, expectations, and number of sellers.

• Movement Along the Curve: Caused by a change in the price of the good itself.

Market Equilibrium

Market equilibrium occurs where quantity demanded equals quantity supplied. The equilibrium price is the price at which this balance is achieved.

• Excess Demand (Shortage): Quantity demanded exceeds quantity supplied; price tends to rise.

• Excess Supply (Surplus): Quantity supplied exceeds quantity demanded; price tends to fall.

Calculating Equilibrium:

• Set demand and supply equations equal to each other and solve for price ($P$).

• Substitute $P$ back into either equation to find equilibrium quantity ($Q$).

$Q_D = Q_S$ Solve for $P$ Substitute $P$ into $Q_D$ or $Q_S$ to find $Q$

Market Interactions

Regional and input-output linkages can affect market equilibrium. For example, changes in supply or demand in one region or for one product can influence related markets.

• Mobile Supply/Demand: Supply or demand can shift between regions, affecting equilibrium price and quantity.

• Input-Output Linkages: Changes in supply of one input (e.g., anchovies for cattle feed) affect related products.

• Joint Production: When one product is a by-product of another, changes in demand/supply for one affect the other.

Elasticity

Price Elasticity of Demand

Elasticity measures how much quantity demanded responds to changes in price.

• Elastic Demand: Quantity demanded changes significantly when price changes.

• Inelastic Demand: Quantity demanded changes little when price changes.

Formula for Price Elasticity of Demand:

$E_d = \frac{\%\ \text{change in quantity demanded}}{\%\ \text{change in price}}$

Alternatively, using averages:

$E_d = \frac{\Delta Q / (Q_1 + Q_2)/2}{\Delta P / (P_1 + P_2)/2}$

• Determinants of Elasticity: Availability of substitutes, necessity vs. luxury, proportion of income spent, time horizon.

• Applications: Elasticity affects total revenue, tax incidence, and market efficiency.

Other Elasticities

• Income Elasticity of Demand: Measures response of quantity demanded to changes in income.

• Cross Elasticity of Demand: Measures response of quantity demanded of one good to changes in price of another good.

• Price Elasticity of Supply: Measures response of quantity supplied to changes in price.

Tax Incidence and Surplus

• Tax Incidence: The division of a tax burden between buyers and sellers depends on relative elasticities.

• Consumer and Producer Surplus: Measures the benefit to consumers and producers from market transactions.

Utility Maximization

• Consumers maximize utility by equating the marginal utility per dollar spent across goods:

$\frac{MU_x}{P_x} = \frac{MU_y}{P_y}$

Tables

Example: Price Reductions (Cheese)

This table compares absolute and relative changes in price and quantity for cheese, illustrating elasticity calculations.

Price	Quantity	Absolute Change	Relative Change (%)
$5.00	100	-	-
$4.50	120	+20	+20%
$4.00	140	+20	+16.7%
$3.50	160	+20	+14.3%

Additional info:

• Notes include graphical analysis, calculation steps, and real-world examples for each concept.

• Coverage aligns with Chapters 1-4 of a standard Microeconomics curriculum.