Microeconomics - Schemi

Microeconomics

Two branches

Macroeconomics: deals with aggregate economics variable.

The study of how national economy perform.

Microeconomics: deal with behavior of individual economic units as well as the market that these units comprise.

Explain how best allocate the limited resources.

Is the science of constrained choice.

Planned economy: Those decision are made by the government, price is set by government.

Agentsà single subject that make decision and affect other bigger ripple effect.

Microeconomics has a strong connection with macroeconomics because they are the singles effects that compose macroeconomics.

Trade off and choices

• Consumeràlimited incomesà have a budget that is very limitedàmaximize utility.
• Workersàfirst take decision of life, second on job, third on satisfactionàutility.

Wage: workers trade off that they can get for their labour.

• Firmsàdecision on which production, where, the offer, the investment: how much, borrow or use company’s capital (borrowàcosts, time, control).
• Governmentàset rules: price, quality, quantity (Trump duties), competition (usually denied monopolism), subsidies (amount of money given to consumer, producer, worker(es.110%).

Those actors determine price (=amount of money consumer have to pay for goods).

Price is set by the interception of offer and demand curves.

Equilibrium priceàdemand=supply.

Is variableà can change a lot or not: depends.

Depend on number of producer and consumeràfew produceràmore power of impose price. More produceràless power of impose price.

Theories and models

Explanation and prediction are based on theoriesà developed observing phenomena in term of setting basic economic rules.

Theory of the firm: businesses always try to maximize utility (=profits).

Model: mathematic representation of a firm or an entity.

Variablesà exogenous: take as given (es. Preferences or income levels).

Endogenous: exogenous variables according to models (es type of goods or quantity bought by consumers.

Analytical tools

• Constrain optimizationà have a constrain(budget) and have objective function to maximize it.
• Equilibrium analysisà a state or condition that will continue as long as exogenous variables continue (es. Chooses of consumers).
• Comparative statics of themà how a change in exogenous affect endogenous variablesàchange and see the outcome for testing new theories.

The analysis

Positive: describe relation cause-affectàhow an economic system work and predict What happen if…?

Normative: examining question of what ought to beà how the market should work to maximize?

Value judgment (not tell what the best)à what is best: set rules in order to benefit actors.

Markets

Market: collection of buyer and sellers that determine the price of goods.

Have a central role in economy.

Market definition: description of buyers, sellers and range of product that should be included in a particular marketàALSO geographical.

Industry: collection of firms that sell the same or closely related products.

Arbitrage: practice to buy at a low price in a specific location et sell at an higher in another location.

Perfectly competitive: may buyers and sellersà single buyer or seller has no impact on price.

Non-competitive(monopolism): individual firms can affect the price.

Average of them: not perfectly competitive but not as large power of prices as non-competitive ones.

Market price: price prevailing in a competitive marketà may fluctuate a lot (stocks).

Extent of market: boundaries of a market, geographical and in term of product produced and sold within it.

Is very important the knowledge of the market definition because:

• Understand competitors (also future).
• Understand product to produce.
• Public policy decision (es. Vertical acquisition.

Prices

Nominal price (current euro price): absolute price of goods, unadjusted for inflation.

Real price (constant euro price): price of goods related to the aggregate measure of prices, price adjuster for inflation.

PPI (producer price index): aggregate price level for intermediate and wholesale goods.

CPI (consumers price index): measure of the aggregate price levelàcost of living. Difficult to calculate because of variables and the product to bring inside.

Delta CPIàmeasure of inflation rate.

Inflation: increase of the overall price level over timeàincrease CPI over time.

Inflation rate: (CPI final-CPI initial)/CPI initial.

If a single good inflation rate is lowerà the price of good decrease in time (in real terms).

Real vs nominal value technique.

• Px :CPIx=Py :CPIy Py∗CPIx Px= CPIy.
• Nominal price of goods compared delta CPI (Py-Px)/Px >or< (CPIy-CPIx)/CPIx.

If it is > good in more expensive, if it is < good in cheaper.

Indexes

F=units of food.

C=units of clothing.

Pf=price of a units of clothing.

Pc= price of a units of food.

b=base year: year fixed in order to analyse change (STARTING POINT).

t=current year: year we analyse.

LASPEYRES price index 100*(current year)/(base year).

100∗PFtF b+ PCtC b.

Fix quantity of base year= PFbF b+ PCbC b.

Monetary changeà same quantity in different yearàamount spent in base year for same quantity.

PAASCHE index 100*(current year)/(base year)+100∗PFtF t PCtC t.

Fix current quantity of current year= PFbF t+ PCbC t.

Good changeàsame quantity in different year.

Supply and demand

Without government supply and demand will reach the equilibrium and will determinate the selling price and the quantity to produce (quality and quantity).

Supply curve: positive relationship between the price and the quantity of goods the producers will sell.

Qs=f(P) à direct supply function (Qs=a+bP).

Ps=f(Q) à indirect supply function (Ps=A+BQ).

In graphical representation we use indirect supply function.

WTI: wiliness to pay, the quantity of goods exchanged for a quantity of (hight costàshift left/low moneyàcan change and make the curve shift costsàshift right) (change market condition).

Change in supply: apply a curve shift (not change).

Change in the quantity supplied: apply movement on the curve the market condition.

Demand curve: negative relationship between price and quantity of goods consumers will buy.

Demand: mathematical function describing choices of consumers.

QD=f(P) àdirect demand function.

PD=f(Q) àindirect demand function.

In graphical representation we use indirect demand function.

Slide left if income level is lower and right if the income After shock WTI will level is higher (more income for consumersàhigher WTI).

Substitutes: two goods which an increase in the price of one leads an increase in the quantity demanded for the other (copper and aluminium).

Complements: two goods which an increase in the price of one lead to a decrease in the quantity demanded for the other (coca cola and chips).

Market mechanism

Vertical axis: Price.

Horizontal axis: Quantity.

Equilibrium price: price that equates quantity supplied and quantity demanded.

Market mechanism: tendency in a free market for price to change until the market clears (Until Q=S).

Effects:

• Demand upà right.
• Demand lowàleft.
• Supply upà right.
• Supply lowàleft.

Surplus: situation in which the quantity supplied exceeds the quantity demanded.

Shortage: situation in which the quantity demanded exceeds the quantity supplied.

The price will automatically convert to equilibrium price (simultaneal).

Effect of shortage and surplice: reach the equilibriumà government have not to do anything.

Important: at any given price a given quantity will be produce and sold, BUT ITS TRUE ONLY IF WE HAVE A PERFECT COMPETITIVE MARKET.

Price floor: minimum price set by the government in order to protect a marketà business can set only higher price (or at least equal).

Price floor affect the market if and only if is higher of the equilibrium price.

Price seeling: maximum price set by the government in order to protect the consumer.

It affects the market if and only if the price is lower than the equilibriumàcreate inefficiently= impossible to create an equilibrium price.

Elasticity

Elasticityà index of sensitivity.

Percentage change in one variable resulting from a 1-percent increase in other.

Demand depends onà prices if goods, consumers income and price of other goods with relation.

Supply depends onà price and variables that affect production costs.

Price elasticity of demand

PRICE ELASTICITY OF DEMANDà linear demand curve is a straight line percentage changed in quantity demanded of a good from a 1-percent increase in price.

% ∆∗Q Ep= % ∆∗P.

Same as ∆ Q∗P Ep= ∆ P∗Q.

Are usually negative numberà price increase, demand falls.

Magnitude: absolute size of change in price elasticity.

Near the topà elasticity near infinite.

Downà elasticity is (near) 0.

Elasticity >1à price elastic.

Elasticity <1à price inelastic.

Linear demand curve

LINEAR DEMAND CURV Q=a-bP ¿

Elasticity: constant along the demandedà( ∆ Q/∆ P.

Infinity elastic demand(horizontal): at a set priceà demand is unlimited.

At a higher priceàdemand is zero.

At a lower priceàdemand is infinite.

∆Q =infinite.

Elasticity is infiniteà ∆P.

Completely inelastic demand(vertical): consumer will buy a fix quantity regardless the price.

∆Q =0.

Elasticity is zeroà ∆P.

Always use average P and Qàbetter approximation.

Income elasticity of demand

INCOME ELASTITY OF DEMAND.

Percentage changed in quantity demanded resulting from a 1-percent increase in income.

∆ Q∗I Ei= ∗Q ∆ I.

Cross price of elasticity of demand

CROSS PRICE OF ELASTICITY OF DEMAND.

Pm∗∆ Qb( )=E QbPm Qb∗∆ Pm.

Change in one good priceà other goods effect:

• If elasticity has a positive valueà substitutesà increase quantity demanded.
• If the value is negativeà complementsàdecrease quantity demanded.

Price elasticity of supply

PRICE ELASTICITY OF SUPPLYàhigher price gives producers an incentive to increase output à elasticity is positive.

Point elasticity of demand

POINT ELASTICITY OF DEMANDà price elasticity in a particular point of the curve à usually the most used.

Q∗∆ P.

Equation= )àusually took in consideration original P e Q(P∗∆ Q)/¿

Can vary depending on what point of the demand curve me took in consideration.

Arc elasticity of demand

ARC ELASTICITY OF DEMANDà price elasticity calculated over a range of prices à initial and final price.

❑∆Q ∆ P❑

Equation= E p= ❑av . P av .Q❑

How much time will pass before we measure a change in quantity demanded and supplied?

DEMAND long runàmore short run.

Non-durable goodsà price elastic thatàshort runàmore long run.

Durable goodsà price elastic thatàINCOME àlong runàmore short run.

Income elasticity price elastic thatàCYCLICAL àindustries in which sales tends to magnify cyclical changes in gross domestic product and national income.

Only durable goods magnify high increases in growth periods.

SUPPLY long runàmore short run.

Supply of goodsà price elastic thatà.

In short run firms face capacity constrains – can increase outputs using existent facilities.

Increases in production are hardly in short runà need investments.

For some goodsà short run supply completely inelastic – es houses short runàmore long run recyclable goodsà price elastic thatà.

Government intervention

Market are rarely free from government.

3types:

• Fiscal(taxes).
• Fix quantity.
• Fix price ceiling price=government decides P0 is too highà fix Pmax LOWER that P0àshortage reduce offer and reduce priceà producer lossà not all the consumers have a gainà someone will not been able to buy the goods.

Consumers behavior

Theory of consumers behavior: how consumers allocate incomes among different goods and services to maximize their well-being.

Consumers have a limited budgetàmust chooseà suppose consumers rational and informed.

Consumers behavior:

• Consumer Preferences.
• Budget Constraints.
• Consumer Choices.

Market basket: list of specific quantity of one or more goods.

Basic assumption of preferences:

• Completeness: consumers are informed of all baskets and don’t take on account costs.
• Transitivity: normally regarded as necessary for consumer consistency; A>B, B>C, A>C.
• More is better than less: more goods=more satisfactionà even if just a little better.
• Diminishing MRS: consumers prefer balance market instead of extreme ones.

Bad: goods for which less is preferred rather than moreà es. Air pollution.

Indifferent curve: Curve representing all combinations of a market baskets that provide a consumer with the same level of satisfaction.

Indifference maps: Graph containing a set of indifference curves showing the never cross together market baskets among which a consumer is indifferentà.

MRS marginal rate of substitution.

Maximum amount of a good that a consumer is willing to give up in order to obtain one additional unit of another good (fixed the utility level)à if MRS decrease along the indifference curve: the curve is convexà slope of indifferent curve increase (fall in magnitude).

Measure the value that an individual place 1extra unit of a good in term of (less vertical axis, more horizontal axis) another.

If MRS is less or greater than the price ratioà not maximized the consumer satisfaction.

Perfect substitutes: Two goods for which the marginal rate of substitution of one for the other is a constant.

Increase in price of Aà increase in demand of B.

Perfect complements: Two goods for which the MRS is zero or infinite; the indifference curves are shaped as right angles.

Increase in price of Aà decrease in demand of B.

Independent: if a change in price of A have no effect on quantity demanded B.

Utility: Numerical score representing the satisfaction that a consumer gets from a given market basket.

Utility function: Formula that assigns a level of utility to individual market baskets. U(X,Y)=X+xY.

Level of satisfaction obtained prom consuming X and Y.

Ordinal utility function: function that generate a ranking between all the market basket.

Cardinal utility function: function of how much a market basket A is preferred to B.

Budget

Budget constrains: constrain consumer face as results of a limited income.

Budget line: All combinations of goods for which the total amount of money spent is equal to income.

Made by two functionsà one preferences of consumersà utility function (goods that individual can buy in the market) measure level of satisfaction (base on the quantity of goods holds in time).

Function of budget constraintsà function based on price of goods and income.

( ) ( )I Pf ∗F PfF+ PcC=I C= –Pc Pc.

Considering only 2goodsà price of money spent for F and C=income.

∆Y Slope: àCalculated in units △ x.

Magnitude tell us the rate which the 2 goods can be exchange each other whiteout changing the total amount spent à vertical intercept (I/Pc), horizontal intercept à (I/Pf).

Change income and price

Budget line depend from income and price.

Change in income: budget line shift parallel to the origin.

Change in price: use the equation of budget line to estimate new quantity.

Purchasing power: ability to generate utility thought the purchase of goods and services.

Consumer choice

How much of each goods to buyà maximize satisfaction with a limited budget.

Maximized market basket have to:

• Must be located on the budget line.
• Must give the consumer the most preferred combination of goods and services.

Marginal utility (MU): Additional satisfaction obtained from consuming one additional unit of a good.

Diminishing marginal utility: Principle that as more of a good is consumed, the consumption of additional amounts will yield smaller additions to utility.

Marginal Rate of Substitution: slope of the indifference curve (∆U=0), that is quantity of F that the consumer is willing to give up against 1 additional unit of C in order to have the same level of satisfaction (utility)à more goods=less level of satisfaction.

MRS=Pf/Pc.

MUf MUc= àmaximization Pf Pc.

Marginal benefit: Benefit from the consumption of one additional unit of a good.

Marginal cost: Cost of one additional unit of a good.

Equal marginal principle: utility is maximized when the consumer has equalized the marginal utility per dollar of expenditure across all goods.

Corner solution: Situation in which the marginal rate of substitution is not equal to the slope of the budget lineà consumer maximize satisfaction consuming only one of the two goods Px≅MRS corner solutionà MRS not necessarily equal to price ratioà Ry.

Reveled preferences: if consumer chose market basket A an