Micro

Question 1

Market/Marketplace

Answer 1

Where buyers and sellers meet to exchange goods and services: buyers demand goods from the market whilst sellers supply goods to the market.

There are many forms of market (product markets [eg. food market], factor markets [e.g. labour market], stock markets [Ftse 100], international financial market [FOREX], etc.).

At the core of standard market theory are the concepts of demand and supply.

Question 2

Assumptions about our market

Answer 2

1. Competition (among firms to sell the most, among buyers to get scarce commodities, workers for jobs with best salaries, etc.: trying to meet wants/desires of buyers, compete for access to FOPs).
2. Many buyers and sellers, all of whom act independently (hindered when work together [may workers to choose from, many could be working for…]).
3. No individual or group can control the price on their own.

*Assume full competition
*Assumptions not too bad (tend not to be)

Question 3

Demand (+ effective demand) and supply (+ effective supply)

Answer 3

Demand is the quantity of goods or services that will be bought at any given price over a period of time. Supply is the quantity of a good or service that producers are willing and able to produce and sell at different prices.

Must be willing AND able to supply/pay for a good/service for it to be effective (will be implied/assumed realistically [ex. 100 units per month = 100 people willing and able to buy per month]).

Question 4

Demand schedules and supply schedules

Answer 4

Demand schedules show the quantity of a good people will demand at varying prices. Supply schedules show the quantity of a good firms will supply at varying prices.

Question 5

Demand/Supply curve

Answer 5

Shows what the quantity demanded/supplied of a good will be at a given price.

Demand curve is downward sloping from left to right; supply curve is upward sloping from left to right.

*Origin of supply curve not at zero

Question 6

Drawing individual and market demand/supply curves

Answer 6

• Draw an x- and y-axis
• Label the y-axis ‘Price’
• Label the x-axis ‘Quantity [demanded/supplied]’
• Include the prices to cover your range
• Include the appropriate quantities out to the highest total demand/supply from your market
• Don’t forget your units
• Give your graph a title (ex. ‘Market for Chocolate Bars’)
• Plot the total quantities demanded/supplied at the various prices
• Once you have plotted the different quantities from your schedule, connect the dots, and you have the demand/supply curve

Question 7

Market demand/supply

Answer 7

Sum of the quantities demanded/supplied by each person/producer in the market at a given price (can be achieved by “horizontal summing”).

Question 8

Law of demand and law of supply

Answer 8

There is an inverse relationship between price and quantity demanded (the greater the price, the lower the quantity demanded, ceteris paribus [all other things being equal]).

There is a direct relationship between price and quantity supplied (the greater the price the higher the quantity supplied, ceteris paribus).

Question 9

Movements along the demand/supply curve

Answer 9

A ‘change in quantity demanded’ comes about due to a movement along the demand curve, caused by a change in price. A change in price causes a ‘change in quantity supplied’, shown by movement along the supply curve.

• Expansion of quantity demanded along the demand curve (fall in price)
• An increase in price causes movement forward along the supply curve (expansion in supply)
• Contraction of quantity demanded along the demand curve (rise in price)
• A fall in price causes movement back along the supply curve (contraction in supply)

Question 10

Shifts of the demand/supply curve

Answer 10

A ‘change in demand’ means a ‘shift’ of the demand curve: non-price determinants of demand (demand shifters) will lead to a ‘shift’ in demand at every given price level (incomes, other related goods’ prices, tastes, expectations, size of the market, special circumstances).

A ‘change in supply’ means a ‘shift’ of the supply curve. Non-price determinants of supply will lead to a ‘shift’ in supply at every given price level (costs of FOPs, other related goods’ prices, government intervention [subsidies and taxes], future expectations, technology, special circumstances).

*Remember to use “ceteris paribus”

Question 11

Income (demand) and costs of FOPs (supply)

Answer 11

D:
Normal Goods: As income rises, the demand for the product will also rise, e.g., designer clothes.

Inferior Goods: As income rises, the demand for the product will fall, e.g., own brand butter (anything where you’re going from the low-end brand to something fancier).

S:
If there is an increase in the cost of a factor of production, such as wages for a firm that relies heavily on workers, then this will increase the firm’s costs and they will therefore be able to supply less of their consumer good (finished product) at all prices.

A fall in the costs of production will enable firms to increase their supply, shifting the supply curve to the right.

Question 12

Price of related goods (s, d)

Answer 12

D:
Substitute good - A good that can be used in place of another.

A change in the price of one will lead to a change in demand for the other.

Complementary good - A good that is used in conjunction with another

A change in the price of one will lead to a change in demand for the other.

Unrelated goods - A change in price of one product will have no effect upon the demand for the other product.

S:
Competitive supply - Often, producers have a choice as to what they are going to produce, because the factors of production that they control are capable of producing more than one product (e.g a producer of roller skates may be able to easily switch production to skateboards). Competing for the same resources (opportunity cost).

Joint supply - When a good is produced at the same time as another, often as a “byproduct” (e.g. when sugar is refined, molasses, a black treacle, is produced).

Question 13

Tastes and preferences

Answer 13

If tastes change in favor of a particular product, then more will be demanded at every price. Similarly, if tastes change so that a product become unpopular, less will be demanded at every price.

Special case: Veblen goods (price up, demand up [ex. luxury goods]).

Question 14

Future price expectations (s, d)

Answer 14

D:
If consumers think the price of a product will increase in the future, they may demand more of that product in the present in order to purchase it before the price increases. This would lead to an increase in demand (shift of the demand curve to the right).

S:
If producers think the demand for a product and subsequent price of a product might increase in the future then they may hold back supplies until the price increases (shift leftwards of the supply curve), then increase supply once the price is higher (shift rightwards of the supply curve). However if they think prices may fall then they may reduce supply and consider switching to the production of an alternative product.

Question 15

Number of consumers

Answer 15

If there is an increase in the number of consumers of a product, then there will be a shift of the demand curve to the right. This can come about due to an increase in population or an increase in the population of a certain demographic.

Question 16

Special circumstances (s, d)

Answer 16

D:
Events such as natural disasters may lead to an increase in demand for certain products or services.

S:
In markets vulnerable to weather conditions, such as agriculture, the weather can have both positive and negative effects on supply. Extremely favorable weather could lead to a “bumper harvest”, whereas a drought or a flood could lead to a poor harvest and fall in supply.

Question 17

Govt intervention

Answer 17

In many countries, governments intervene in markets in ways that alter supply. The two most common ways are through indirect taxes and subsidies.

Indirect taxes - Taxes on a goods or services that are added to a price of the product.

The producers are the ones that have to pay the taxes to the government, so the taxes effectively increase the costs of production to firms. This shifts the supply curve upwards by the amount of the indirect tax (a shift to the left). Less of the product will be supplied at every price.

Throughout the world, Value Added Taxes (VAT) are common, applied at every step of the supply chain, and collected and remitted by the seller. The VAT is almost always included in the price.

The US uses a sales tax system, where the final customer pays sales tax on a good, and the marketplace is responsible for collecting and remitting the tax.

Despite this difference, US sales tax is still considered an indirect tax that shifts the supply curve.

Subsidy - Payment by the government to firms.

Subsidies effectively reduce costs of production. This shifts the supply curve downwards by the amount of the subsidy (shift to the right). Thus, more will be supplied at every price.

Question 18

Changes in tech

Answer 18

Improvements in technology in a firm or industry should lead to more being supplied at all prices (shift to the right of the supply curve). Although unlikely, a fall in technology will lead to a shift back in supply, this may occur when there is a natural disaster.

Question 19

NOTE

Answer 19

• Different producers have different costs of production.
• Some firms are more efficient than other thus can produce their products at a lower marginal cost.
• Firms with lower costs are willing to sell their products at a lower price.
• However, as the price of a good rises, more firms are willing and able to produce and sell their good in the market, as it becomes easier to cover higher production costs (this helps to explain the law of supply).

Question 20

Market equilibrium and disequilibrium

Answer 20

A market is in equilibrium when the price and quantity are at a level at which supply equals demand. When a market is at equilibrium, resources are efficiently allocated. The market is allocatively efficient.

• Consumer demand = producer supply
• No shortages or surpluses
• Every unit produced is also consumed

Equilibrium price (Pe) - The price of a good at which the quantity demanded is equal to the quantity supplied.

Equilibrium quantity (Qe) - The quantity of output at which supply equals demand.

ex.
*See slides…
Demand and Supply for bread intersect at a price of $2 per loaf and a quantity of 10 loaves, the intersection of the supply and demand curves. At supply higher than 10, there is a surplus, less than 10 there is a shortage. Price will adjust to clear the shortage.

Question 21

Demand and marginal social benefit (MSB)

Answer 21

Demand = MSB

Demand represents the benefits that society derived from consuming that good. MSB decreases at higher output because additional units of a good bring benefits to fewer people.

Question 22

Supply and marginal social cost (MSC)

Answer 22

Supply = MSC

Supply represents the cost to society of producing the good. For most goods, the greater the amount produced, the more an additional unit will cost. MSC represents the cost to society of producing the good. As an example, as the world produces more oil, it becomes increasingly more difficult (and costly to produce each additional unit).

Question 23

Allocative efficiency when MSB = MSC

Answer 23

Allocative efficiency is achieved when the the quantity being produced results in the benefit society derives from the last unit is equal to the cost imposed on society to produce the last unit.

Consumer surplus - The benefit enjoyed by consumers who were willing to pay a higher price than they had to (Pe): graphically, the area below the demand curve and above the price equilibrium line (Pe). Consumers gain by paying a price, Pe, below what they were willing to pay. Calculation: area of a triangle.

Producer surplus - The benefit enjoyed by producers who were willing to sell at a lower price than they had to (Pe). graphically, the area above the supply curve and below the Pe line. Consumers gain by paying a price, Pe, below what they were willing to pay. Calculation: area of a triangle.

Total welfare is maximized when a market is at equilibrium: it is the sum of consumer and producer surplus. Any other combination of price and quantity will lead to a loss of total welfare. The total welfare is consumer + producer surplus.

Question 24

Functions of the price mechanism

Answer 24

The price mechanism is simply the price determined by s and d in a competitive market.

Signalling function - Prices communicate important information to consumers and producers.

Incentive function - Prices motivate decision makers to respond to this information.