Notesale: Turn your study into money

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Microeconomics
Economic problem
How to allocate scarce resources (capital (e
...
machinery), enterprise, land, labour [CELL] = factors of
production) given unlimited wants
...
What to produce?
a
...
g
...
If manufactured goods
are in high demand, then that should be produced
2
...
Are there more efficient ways to produce
3
...
Who to produce for
b
...
g
...

c
...


Manufactured
goods

C
B
A

D
PPC

Services
Economic goods: e
...
cars, toys etc…
Free goods: e
...
air, sunlight etc…
Curve tells us maximum of each good that can be produced and how we can combine them to get
different amounts of each
...

e
...
moving from point B to point C, people that consume more services are better off, people that
consume goods are worse off
...
This is the opportunity cost of
producing 15 units of services
...

This is because the PPC tells as, that as we
specialise more and more, the factors of
production used are better suited to the
production of goods than services

Convex: Increasing Cost: This is the standard convex production possibilities curve with increasing
opportunity cost
...
In this case the economy foregoes increasing amounts of one good when
producing more of the other
...
In this case, opportunity cost does not change with production
...
Here the economy
foregoes the same amount of one good when producing more of the other
...
In this case, opportunity cost actually decreases with greater production
...
To do so
would contradict the assumption of technical efficiency and it is contrary to real world observations
...

Manufactured
goods

An outward shift of the curve can be due to:
B
A
PPC

Services






Change in quantity of resources
Change in quality of resources
Change in technology
Trade and specialisation

Specialisation
The concentration of a worker, firm, region, or country to produce a narrow range of goods and services
(depending on what they are best at doing)
...
g
...
Large range of goods and services available
2
...
Trade and growth – exports etc…
Disadvantages
1
...

3
...

5
...
If other countries become better at specialising, sector can slump – unemployed
resources and higher unemployment
Division of labour

Occurs when specialisation has taken place where the production process is broken down into separate
tasks – making labour as efficient and productive as can be
Advantages:
1
...

3
...


Workers get good at their job – improve – feel valued
Production increase  productivity increases
Time saved  production lines – reduces costs
Cost-effective capital for workers – giving machinery to workers who are already good at doing
their tasks will massively increase efficiency and productivity
5
...
Boredom – workers feel de-valued in long run  quality suffers
2
...
Too much reliance on other countries – e
...
reliant on labour force of a specific country because
of cheap wages/ if one country relies on another as its major customer – if relations break down
business will suffer

The demand curve










Always effective
Inverse relationship between price and
quantity
Downward sloping
Drawn linear
Demand – quantity of a good or service that
consumers are willing and able to buy at a
given price in a given time period
P1 to P2 – contraction of demand
P1 to P3 – extension of demand
Change in price = movement along the curve,
assuming ceteris paribus (all other things
being equal)

Shifters of demand:








Population
Advertising
Substitutes
=
Income
Fashion/tastes
Interest rates
Complements










Price
P2
P1
P3
D1
Q2

Price
Population
Income
o Normal goods
o Inferior goods
P1
Related goods
o Substitutes
o Complements
Advertising/ Consumer information
Tastes and preferences
Expectations of future prices

Q1

Q3

Quantity

D2

D1

D3
Q3

Q1

Q2

Quantity

The supply curve














Always effective
Positive relationship between price and
quantity supplied
Upward sloping
Drawn linear
Supply – quantity of a good or service that
suppliers are willing and able to supply at a
given price in a given time period
Higher price – profit motive – more is supplied
(because selling more at a higher price)
Higher price – cost of producing more needs
to be covered
...
of firms
=

Technology
Subsidies

Weather
Costs of production 




Price
Intervention
o Taxes
o Subsidies
o Regulations
P1
Number of suppliers in the
market
Supply shocks
Expectations of future prices
Costs of factors of production
Technology
Supply goods
o Joint
o Competitive

S1

Q3

Q1

Q2

S2

Quantity

Consumer and Producer surplus

Producer surplus – the difference between
the price producers are willing and able to
supply a good or service at and the price
they actually receive
...


Changes in market equilibrium
Invisible hand – as long as consumers are maximising marginal utility and producers are minimising
marginal cost, the market will adjust itself
...
At price P1, there is excess demand (Q1 to Q3)
...
Thus they raise prices as there is an incentive to
make more profits, thus price goes up to P2, and we are
back to equilibrium
...

𝑃𝐸𝐷 =

%∆𝑄𝑑
%∆𝑃

𝑃𝐸𝐷 < 1: 𝐼𝑛𝑒𝑙𝑎𝑠𝑡𝑖𝑐
𝑃𝐸𝐷 > 1: 𝐸𝑙𝑎𝑠𝑡𝑖𝑐
𝑃𝐸𝐷 = 1: 𝑈𝑛𝑖𝑡 𝑒𝑙𝑎𝑠𝑡𝑖𝑐
𝑃𝐸𝐷 = 0: 𝑃𝑒𝑟𝑓𝑒𝑐𝑡𝑙𝑦 𝑖𝑛𝑒𝑙𝑎𝑠𝑡𝑖𝑐
𝑃𝐸𝐷 = ∞: 𝑃𝑒𝑟𝑓𝑒𝑐𝑡𝑙𝑦 𝑒𝑙𝑎𝑠𝑡𝑖𝑐

Price of bus ticket
100p
60p
50p

Quantity demanded
1000
1300
2275

1300 − 1000
× 100
1000
𝐹𝑟𝑜𝑚 100𝑝 𝑡𝑜 60𝑝: 𝑃𝐸𝐷 = |
| = 0
...

𝑃𝐸𝑆 =

%∆𝑄𝑠
%∆𝑃

𝑃𝐸𝑆 < 1: 𝐼𝑛𝑒𝑙𝑎𝑠𝑡𝑖𝑐
𝑃𝐸𝑆 > 1: 𝐸𝑙𝑎𝑠𝑡𝑖𝑐
𝑃𝐸𝑆 = 1: 𝑈𝑛𝑖𝑡 𝑒𝑙𝑎𝑠𝑡𝑖𝑐
𝑃𝐸𝑆 = 0: 𝑃𝑒𝑟𝑓𝑒𝑐𝑡𝑙𝑦 𝑖𝑛𝑒𝑙𝑎𝑠𝑡𝑖𝑐
𝑃𝐸𝑆 = ∞: 𝑃𝑒𝑟𝑓𝑒𝑐𝑡𝑙𝑦 𝑒𝑙𝑎𝑠𝑡𝑖𝑐
Determinants of price elasticity of supply:






Production lag – larger production lag = more inelastic
Substitutability of factors of production – if factors of production are very substitutable, more
elastic and if not very substitutable, inelastic
Stock – more stock = more elastic
Spare capacity – more spare capacity = more elastic
Time period – in short run, factors of production tend to be fixed so inelastic, whereas in long
run it is elastic
Income elasticity of demand (YED)

YED measures the responsiveness of quantity demanded given a change in income
...

𝑋𝐸𝐷 =
-

Complements

%∆𝑄𝑑 𝐴
%∆𝑃 𝐵
0

Substitutes

+

Substitutes:


Price of coke goes up, quantity demanded of pepsi goes up + ÷ + = +

Complements:


Price of cereal goes up, quantity demanded of milk goes down – ÷ + = –

Elasticity:




XED > 1 = closely related
XED < 1 = weakly related
XED = 0 = no relationship
Negative externalities

Market failure – when the free market fails to allocate resources at the socially optimum level – this
leads to a net loss in social welfare
...


Negative externalities – detrimental third party effects as a result of the actions from a separate agent –
i
...
when someone consumes or produces something (engages in an economic transaction), the effect of
doing that harms a third party – somebody else not involved in that transaction is harmed
1
...
Production  Firms  Costs
b
...
Which way does it move
a
...
Negative – left
3
...

5
...


Curve that moved is the social one
Market equilibrium takes private effects into account
Social equilibrium considers full social effect
Welfare loss  Consider MSC, MSB at private equilibrium

More produced than social optimum –
marginal private costs less than
marginal social costs
...


Positive externality
Positive externality – Third party benefits that accrue as a result of actions from a separate agent
...
g
...
E
...
getting a good job = pays higher taxes = other people benefit from improvements from
tax revenues
...
What curve moves:
a
...
Consumption  Consumers  Benefits
2
...
Positive – right
b
...
Curve that moved is the social one
4
...
Social equilibrium considers full social effect

6
...
Social optimum
output (Q2) is higher than private optimum output
(Q1)
...


E
...
– if a firm adopts a very good training regime,
other firms can also adopt that regime, and in
turn, these firms will have lower costs
...
g
...

If the market ignores positive externalities – the
good or service will be underprovided
...
g
...
g
...
E
...
– producers
having more information than consumers
...
g
...
Because of that,
consumers will over consume de-merit goods and under consume merit goods
...
g
...
Non-excludable – benefits cannot be confined to the people that have paid for the good
2
...
g
...

Externalities
1
...
Polluter pays
3
...
Output falls towards social optimum
2
...
Revenues generated by government
BUT



What if demand is inelastic – Qd of de-merit goods won’t fall very much – bad + adverse effect
on consumer welfare
Taxes tend to be regressive





Potential rise in
black market
activity – especially
if tax is severe
Difficult to know if
government is
setting the right
amount of tax –
will tax be
effective?

Subsidies and market failure
Money grants given to firms to reduce cost of production – shifts supply to the right
Good
1
...
Prices fall – extension of demand – if a merit good then hopefully subsidy can solve its under
consumption
Bad
1
...
Not all of it is passed on to consumer
3
...
Resource allocation should improve
2
...
All social benefits are likely to be considered
Bad

P

S

Excess demand
because price of
public good is 0 at the
moment of
consumption
...
Huge opportunity costs
2
...
Ignores private sector (private sector can be very useful in lowering costs, providing greater
quality etc…)

Regulation and market failure
Acts in 2 ways:
1
...
Rules for consumers to abide by, which shifts demand to the left
Good
1
...
Sets a clear standard with incentives for firms to comply
3
...
Introducing rules and laws means they need to be enforced – expensive – government failure if
costs are higher than benefits
2
...
of
permits)

Q
Units of pollution after
regulation

1

20

P

18

2

1

Firm x

20

P

18

2

16

Firm y

=

40

20

36
36
If firm y wants to keep producing at 20 units
of pollution, they need to buy 2 permits
from firm x who has 2 extra
...
Level of information – government needs to know optimum level of pollution etc…
2
...
of firms who are able to reduce pollution – if high number can reduce, policy more likely to
work
Government failure
When cost of implementing a policy overcomes the benefits that come about from implementing the
policy in itself – Makes situation worse – greater loss of social welfare
Occurs when
1
...
Information problems – no guarantee government has more information than free market agent
(e
...
what’s the right level of tax or right amount to subsidise etc… )
3
...


Features
Ownership
Motive

Market economy
Private
Maximise profits

Freedom of choice

High – market decides
how and what to
produce
High

Competition
Role of Gov
Variety and quality of
goods and services
Response to Demand

Efficiency

Public – no
Private – yes
Limited role – intervene when necessary
Public – low & low
Private – high & high
Public – slow
Private – quick

Quick – firms want to
be the first to make the
move in case of higher
demand for example
Allocative efficiency
but some inefficiency

Slow – no such
incentive

Merit goods
De-merit goods
Public goods

Under-provided
Over-provided
May be missing
markets for public
goods
Unequal – no way to
redistribute income
(govt intervention
needed)
Over-production (of
goods which generate
N
...
intervention
Gov
...
intervention

Equal

Progressive tax and welfare state

Social optimum

Gov
...
intervention
Majority of economies

Market economy (= capitalism, laissez-faire) – private sector is left to run freely – owns all the
resources and allocates goods and services through market mechanisms
Command economies (= centrally planned economy, socialism) – public sector (state) – controls and
distributes the resources, hires workers, gives incomes etc…
Indirect taxation
Price

1
...
Price increase, quantity decrease
3
...
Producer burden – rectangle P1DCe
5
...
Producer revenue
a
...
New – rectangle 0Q2Ce
c
...
Dead weight loss
a
...


Subsidy
Price

S1
D

E

Subsidy

S1 + subsidy

A
P1
P2

B

C
P3

Government needs to determine whether cost of
subsidy is surpassed by benefits
...
Supply curve shifts downwards – decrease
in cost of production
2
...
Government cost – rectangle P2BDE
4
...
Pay extra – rectangle Q1Q2BC
5
...
Old – rectangle P1AQ10
b
...
DWL
a
...
g
...
(In truth normally 2 are fixed: land and capital)
...

In short run – it’s hard to build new factories etc… but it is possible in the long run
Marginal – next additional unit
Law of diminishing marginal returns – when we add variable factors of production to a stock of fixed
variables of production, marginal product (output) will initially rise then start to fall
Initially, factors of production are underutilised, so hiring more workers increases total output, however
after that, they are over utilised and total output starts to fall
Increasing marginal product – Total product increasing at an increasing rate – Specialisation
Decreasing marginal product – Total product increasing at a decreasing rate – Fixed resources
Negative marginal product – Total product falling – too many workers – in the way of each other etc…
...
25
5
4
...
6
2
...
g
...
g
...
As marginal product increases, variable
costs are spread over more and more units, thus AVC
decreases
...


Short run cost curves
𝑇𝑜𝑡𝑎𝑙 𝑐𝑜𝑠𝑡𝑠 = 𝑇𝑜𝑡𝑎𝑙 𝑓𝑖𝑥𝑒𝑑 𝑐𝑜𝑠𝑡𝑠 + 𝑇𝑜𝑡𝑎𝑙 𝑣𝑎𝑟𝑖𝑎𝑏𝑙𝑒 𝑐𝑜𝑠𝑡𝑠
𝑀𝑎𝑟𝑔𝑖𝑛𝑎𝑙 𝑐𝑜𝑠𝑡 =

Labour

0
1
2
3
4
5
6

∆ 𝑡𝑜𝑡𝑎𝑙 𝑐𝑜𝑠𝑡
∆ 𝑡𝑜𝑡𝑎𝑙 𝑜𝑢𝑡𝑝𝑢𝑡

Total
Marginal Average Total Marginal
Product Product product costs
costs
(output) (output)
0
0
0
10
4
4
4
20
2
...
25
30
2
15
6
5
40
1
...
25
50
5
18
1
3
...
5
70
-

Long run costs
In the long run, a firm can expand the scale of its production by increasing the number of factors of
production
...


𝐼𝑛𝑐𝑟𝑒𝑎𝑠𝑖𝑛𝑔 𝑟𝑒𝑡𝑢𝑟𝑛𝑠 (𝐸𝑐𝑜𝑛𝑜𝑚𝑖𝑒𝑠) 𝑜𝑓 𝑠𝑐𝑎𝑙𝑒: %∆ 𝑂𝑢𝑡𝑝𝑢𝑡 > %∆ 𝐼𝑛𝑝𝑢𝑡𝑠
𝐶𝑜𝑛𝑠𝑡𝑎𝑛𝑡 𝑟𝑒𝑡𝑢𝑟𝑛𝑠 𝑡𝑜 𝑠𝑐𝑎𝑙𝑒: %∆ 𝑂𝑢𝑡𝑝𝑢𝑡 = %∆ 𝐼𝑛𝑝𝑢𝑡𝑠
𝐷𝑒𝑐𝑟𝑒𝑎𝑠𝑖𝑛𝑔 𝑟𝑒𝑡𝑢𝑟𝑛𝑠 (𝐷𝑖𝑠𝑒𝑐𝑜𝑛𝑜𝑚𝑖𝑒𝑠) 𝑜𝑓 𝑠𝑐𝑎𝑙𝑒: %∆ 𝑂𝑢𝑡𝑝𝑢𝑡 < %∆ 𝐼𝑛𝑝𝑢𝑡𝑠
Economies and diseconomies of scale
Economies of scale – reduction in long run average costs as output increases






Internal economies of scale – when an individual firm benefits from economies of scale
o Risk Bearing – if a firm has a diverse product range, if there is a crisis in the market for
one good, other goods can compensate for it
o Financial economies – the larger the firm, the more output produced – banks will be
willing to give them loans & with lower interest rates – because lower risk
o Marketing economies – the bigger the firm, the more it can spread its marketing budget
& the bigger the firm, it can negotiate lower prices for its marketing
o Technical economies – where technology is a key element in the business, buying
specialist machinery to do a more efficient job/ specialisation and division of labour –
more produced in same time period
o Managerial economies – instead of one person in the firm managing many different
departments, if a firm employs specialist managers, those can increase the productivity
of the departments and make sure that those departments can run at the most efficient
level
o Purchasing economies – bulk buying – lower prices & can negotiate lower prices as
bigger the firm, the more trusted it is
External economies of scale – when entire industry grows – all firms benefit from economies of
scale
o Clustering of firms – lower transportation costs
o Firms can learn ways to train workers from other firms around
o Etc…
Internal diseconomies of scale
o Control – as a firm gets really big, it gets harder to control from the top – principle
worker problem: owners at the top find it very hard to control workers at the bottom –
long chain of command
o Co-ordination – certain workers may have great ideas, but having to co-ordinate with
lots of different people in the firm makes it difficult, time consuming and costly for the
idea to come to fruition
o Communication – how can managers in a department communicate with workers in a
different department efficiently
o Worker motivation – when a worker is one of many doing the same job, de-motivates
the worker as doesn’t feel valued

Cost ($)

LRAC

MES

Output

Q1



On the left of MES (E
...
starting up) – not experiencing diseconomies of scale
For firms with huge LRACs (very high point on left of MES), it will take them a long time to reach
MES, thus it will need to reach enormous levels of output to reach diseconomies of scale
Revenue curves

Perfect competition





Homogenous goods
Perfect information
Many buyers and sellers – firms are price takers
No barriers to entry/exit

𝑇𝑜𝑡𝑎𝑙 𝑅𝑒𝑣𝑒𝑛𝑢𝑒 = 𝑃 × 𝑄

𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝑅𝑒𝑣𝑒𝑛𝑢𝑒 =

𝑇𝑅
𝑄

Imperfect competition




AR = Demand = Price
𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝑅𝑒𝑣𝑒𝑛𝑢𝑒 =

𝑇𝑅
𝑄

=

𝑃𝑄
𝑄

= 𝑃

MR is twice as steep as AR – when a firm reduces its price, it not
only reduces it on one unit, it reduces it on all previous units as
well



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