Economics notes 2

1. Distinguish between Microeconomics and Macroeconomics?

2. Distinguish between Positive Economics and Normative Economics?
3. “Rational people think at the margin’ – explain.
4. What is demand? What are the determinants of demand?
5. Explain the “law of demand” and “law of supply”.
6. What is the difference between” change in quantity demanded” and “shift
in demand”?
7. What is supply? What are the determinants of supply?
8. Why does the supply curve shift? When does the quantity supplied change?
9. A demand equation: Qd= 800 – 2p, A supply equation: Qs = 600+4p.
determine the equilibrium price and quantity. Find the price and quantity
when there is a 20% increase in price. Explain graphically.
10.What is market equilibrium? When does market equilibrium changes?
What happens to price and quantity if:
a) there is an increase in demand, with no change in supply
b) there is an increase in demand and decrease in supply
c) there is a decrease in demand and increase in supply.
d) there is an increase in demand and increase in supply.
e) There is increase in supply, with no change in demand.
11.What is price elasticity of demand? What are the determinants of price
elasticity of demand?
12.What is cross elasticity of demand? What is income elasticity of demand?
13.What are the variations in price elasticity of demand? Explain graphically.
14.What is price elasticity of supply? What are the determinants of price
elasticity of supply?
15.When price of dominos pizza is 5$ per unit , the quanity demanded of Pizza
hut’s pizza is 20 units. If the price of dominos pizza rises to 10%, the
demand for pizza hut’s pizza increases to 30 units. Find the cross elasticity
of demand.
16. Explain a) what is PCM and monopoly, b) distinguish between PCM and Monopoly c) PCM
profit and loss d) features of PCM
11.What is price elasticity of demand? What are the determinants of price elasticity of
demand? price elasticity of demand a measure of how much the quantity demanded of a good
responds to a change in the price of that good, computed as the percentage change in quantity
demanded divided by the percentage change in price
Availability of Close Substitutes A good with close substitutes tends to have more elastic
demand because it is easier for consumers to switch from that good others. For example, butter
and margarine are easily substitutable. A small increase in the price of butter, assuming the
price of margarine is held fixed, causes the quantity of butter sold to fall by a large amount. By
contrast, because eggs are a food without a close substitute, the demand for eggs is less elastic
than the demand for butter. A small increase in the price of eggs does not cause a sizable drop
in the quantity of eggs sold
The more substitutes a good has, the higher the price elasticity of demand will be.
The fewer substitutes a good has, the lower the price elasticity of demand
The more broadly defined the good is, the fewer the substitutes it will have.
The more narrowly defined the good, the more the substitutes.
Necessities versus Luxuries Necessities tend to have inelastic demands, whereas luxuries have
elastic demands. When the price of a doctor’s visit rises, people do not dramatically reduce the
number of times they go to the doctor, although they might go somewhat less often. By
contrast, when the price of sailboats rises, the quantity of sailboats demanded falls
substantially. The reason is that most people 89CHaptEr 5 elasticity and its application view
doctor visits as a necessity and sailboats as a luxury. Whether a good is a necessity or a luxury
depends not on the good’s intrinsic properties but on the buyer’s preferences. For avid sailors
with little concern about their health, sailboats might be a necessity with inelastic demand and
doctor visits a luxury with elastic demand. Definition of the Market The elasticity of demand in
any market depends on how we draw the boundaries of the market. Narrowly defined markets
tend to have more elastic demand than broadly defined markets because it is easier to find
close substitutes for narrowly defined goods. For example, food, a broad category, has a fairly
inelastic demand because there are no good substitutes for food. Ice cream, a narrow category,
has a more elastic demand because it is easy to substitute other desserts for ice cream. Vanilla
ice cream, an even narrower category, has a very elastic demand because other flavors of ice
cream are almost perfect substitutes for vanilla
Time As time passes, buyers have greater opportunities to be responsive to a price change.
If the price of electricity went up today and you knew about it, you probably would not
change your consumption of electricity today as much as you would three months from
today. As time passes, you have more chances to change your consumption by finding
substitutes (natural gas), changing your lifestyle (buying more blankets and turning down
the thermostat at night), and so on. ● The more time that passes (since the price change), the
higher the price elasticity of demand for the good will be.● The less time that passes, the lower
the price elasticity of demand for the good will be. In other words, the price elasticity of
demand for a good is higher in the long run than in the short run.
Percentage of one’s Budget spent on the good Claire Rossi has a
monthly budget of $3,000. Of this monthly budget, she spends $3 per month on pens
and $400 per month on dinners at restaurants. In terms of percentages, she spends
0.1 percent of her monthly budget on pens and 13 percent of her monthly budget
on dinners at restaurants. Suppose both the price of pens and the price of dinners at
restaurants double. Claire is likely to be more responsive to the change in the price
of restaurant dinners than to the change in the price of pens. Claire feels the pinch
of a doubling in the price of a good on which she spends 0.1 percent of her budget a
lot less than a doubling in price of a good on which she spends 13 percent. Claire is
more likely to ignore the increased price of pens than she is to ignore the heightened
price of restaurant dinners. Buyers are (and thus the quantity demanded is) more
responsive to price as the percentage of their budget that goes for the purchase of the
good increases.
● The greater the percentage of one’s budget that goes to purchase a good, the higher
the price elasticity of demand will be.
● The smaller the percentage of one’s budget that goes to purchase a good, the lower
the price elasticity of demand will be.
12.What is cross elasticity of demand? What is income elasticity of demand?
The Income Elasticity of Demand The income elasticity of demand measures
how the quantity demanded changes as consumer income changes. It is calculated
as the percentage change in quantity demanded divided by the percentage change
in income. That is,
Income elasticity of demand Percentage change in quantity demanded
Percentage change in income .5[shutro]
As we discussed in Chapter 4, most goods are normal goods: Higher income raises
the quantity demanded. Because quantity demanded and income move in the same
direction, normal goods have positive income elasticities. A few goods, such as bus
rides, are inferior goods: Higher income lowers the quantity demanded. Because
quantity demanded and income move in opposite directions, inferior goods have
negative income elasticities.
Even among normal goods, income elasticities vary substantially in size.
Necessities such as food tend to have small income elasticities because consumers
choose to buy some of these goods even when their incomes are low. Indeed, a long-
established empirical regularity is Engel’s Law (named after the statistician who
discovered it): As a family’s income rises, the percent of its income spent on food
declines, indicating an income elasticity less than one. By contrast, luxuries such
as jewelry and recreational goods tend to have large income elasticities because
consumers feel that they can do without these goods altogether if their incomes
are too low.
Ey is a positive number; so good X is a normal good. Also:
● Because Ey . 1, demand for good X is said to be income elastic. In other words,
the percentage change in quantity demanded of the good is greater than the
percentage change in income.
● If Ey , 1, the demand for the good is said to be income inelastic.
● If Ey 5 1, then the demand for the good is income unit elastic.
The Cross-Price Elasticity of Demand The cross-price elasticity of demand
measures how the quantity demanded of one good responds to a change in the price
of another good. It is calculated as the percentage change in quantity demanded
of good one divided by the percentage change in the price of good two. That is,
5Cross-price elasticity of demand Percentage change in quantity demanded of good one
Percentage change in the price of good two
Whether the cross-price elasticity is positive or negative depends on whether the
two goods are substitutes or complements. As we discussed in Chapter 4, substitutes are goods
that are typically used in place of one another, such as ham-
burgers and hot dogs. An increase in hot dog prices induces people to grill more
hamburgers instead. Because the price of hot dogs and the quantity of hamburgers demanded
move in the same direction, the cross-price elasticity is positive.
Conversely, complements are goods that are typically used together, such as computers and
software. In this case, the cross-price elasticity is negative, indicating that an increase in the
price of computers reduces the quantity of software
demanded.
14.What is price elasticity of supply? What are the determinants of price elasticity of supply?
price elasticity of supply a measure of how much the quantity supplied
of a good responds to a change in the price of that good, computed as the percentage change
in quantity supplied divided by the percentage change in price The law of supply states that
higher prices raise the quantity supplied. The price elasticity of supply measures how much the
quantity supplied responds to
changes in the price. Supply of a good is said to be elastic if the quantity supplied
responds substantially to changes in the price. Supply is said to be inelastic if the
quantity supplied responds only slightly to changes in the price.
The price elasticity of supply depends on the flexibility of sellers to change
the amount of the good they produce. For example, beachfront land has
an inelastic supply because it is almost impossible to produce more of it.
Manufactured goods, such as books, cars, and televisions, have elastic supplies
because firms that produce them can run their factories longer in response to
higher prices.
In most markets, a key determinant of the price elasticity of supply is the time
period being considered. Supply is usually more elastic in the long run than in the
short run. Over short periods of time, firms cannot easily change the size of their
factories to make more or less of a good. Thus, in the short run, the quantity sup-
plied is not very responsive to changes in the price. Over longer periods of time,
firms can build new factories or close old ones. In addition, new firms can enter
a market, and old firms can exit. Thus, in the long run, the quantity supplied can
respond substantially to price changes.
6.What is the difference between” change in quantity demanded” and “shift in demand”?
Change in Quantity Demanded Definition: A change in quantity demanded refers to a
movement along the demand curve due to a change in the price of the good or service. The
quantity demanded of any good is the amount of the good that buyers are willing and able to
purchase. As we will see, many things determine the quantity demanded of a good, but in our
analysis of how markets work, one determinant plays a central role: the good’s price. If the
price of ice cream rose to $20 per scoop,
you would buy less ice cream. You might buy frozen yogurt instead. If the price of
ice cream fell to $0.50 per scoop, you would buy more. This relationship between
price and quantity demanded is true for most goods in the economy and, in fact, is
so pervasive that economists call it the law of demand: Other things being equal,
when the price of a good rises, the quantity demanded of the good falls, and when
the price falls, the quantity demanded rises. The table in Figure 1 shows how many ice cream
cones Catherine would buy each month at different prices. If ice-cream cones are free,
Catherine buys 12 cones
per month. At $1 per cone, Catherine buys 10 cones each month. As the price rises
further, she buys fewer and fewer cones. When the price reaches $6, Catherine
doesn’t buy any cones at all. This table is a demand schedule, a table that shows
the relationship between the price of a good and the quantity demanded, holding constant
everything else that influences how much of the good consumers want to buy.
The graph in Figure 1 uses the numbers from the table to illustrate the law of
demand. By convention, the price of ice cream is on the vertical axis, and the quantity of ice
cream demanded is on the horizontal axis. The line relating price and
quantity demanded is called the demand curve. The demand curve slopes down-
ward because, other things being equal, a lower price means a greater quantity
demanded.
Shift in Demand Definition: A shift in demand refers to a change in the entire demand curve,
either to the right (increase in demand) or to the left (decrease in demand), indicating that at
every price level, consumers are willing to buy more or less of the good.
Causes: Several factors can cause a shift in demand, including changes in consumer income,
tastes and preferences, prices of related goods (substitutes and complements), expectations
about future prices, and demographic factors.
Because the market demand curve holds other things constant, it need not be stable
over time. If something happens to alter the quantity demanded at any given price,
the demand curve shifts. For example, suppose the American Medical Association
discovers that people who regularly eat ice cream live longer, healthier lives. The
discovery would raise the demand for ice cream. At any given price, buyers would
now want to purchase a larger quantity of ice cream, and the demand curve for ice
cream would shift Figure 3 illustrates shifts in demand. Any change that increases the quantity
demanded at every price, such as our imaginary discovery by the American
Medical Association, shifts the demand curve to the right and is called an increase
in demand. Any change that reduces the quantity demanded at every price shifts
the demand curve to the left and is called a decrease in demand.
8. Why does the supply curve shift? When does the quantity supplied change?
The quantity supplied of any good or service is the amount that sellers are willing
and able to sell. There are many determinants of quantity supplied, but once again,
price plays a special role in our analysis. When the price of ice cream is high, sell-ing ice cream
is quite profitable, and so the quantity supplied is large. Sellers of ice
cream work long hours, buy many ice-cream machines, and hire many workers.
By contrast, when the price of ice cream is low, the business is less profitable, so
sellers produce less ice cream. At a low price, some sellers may even shut down,
reducing their quantity supplied to zero. This relationship between price and
quantity supplied is called the law of supply: Other things being equal, when the
price of a good rises, the quantity supplied of the good also rises, and when
the price falls, the quantity supplied falls as well.
The table in Figure 5 shows the quantity of ice-cream cones supplied each
month by Ben, an ice-cream seller, at various prices of ice cream. At a price
below $2, Ben does not supply any ice cream at all. As the price rises, he supplies
a greater and greater quantity. This is the supply schedule, a table that shows
the relationship between the price of a good and the quantity supplied, holding
constant everything else that influences how much of the good producers want
to sell.
The graph in Figure 5 uses the numbers from the table to illustrate the law of
supply. The curve relating price and quantity supplied is called the supply curve.
The supply curve slopes upward because, other things being equal, a higher price
means a greater quantity supplied.
the supply curve shift
the supply curve for ice cream shows how much ice cream producers offer for sale at any given
price Holding constant all other factors beyond price that influence producers decisions about
how much to sell. this relationship can change over time which is represented by shift in the
supply curve. For example, suppose
the price of sugar falls. Sugar is an input in the production of ice cream, so the lower
price of sugar makes selling ice cream more profitable. This raises the supply of ice
cream: At any given price, sellers are now willing to produce a larger quantity. As
a result, the supply curve for ice cream shifts to the right.
Figure 7 illustrates shifts in supply. Any change that raises quantity supplied at
every price, such as a fall in the price of sugar, shifts the supply curve to the right
and is called an increase in supply. Any change that reduces the quantity supplied
at every price shifts the supply curve to the left and is called a decrease in supply.
There are many variables that can shift the supply curve. Let’s consider the most
important ones.
13.What are the variations in price elasticity of demand? Explain graphically.
Price elasticity of demand (PED) measures how sensitive the quantity demanded of a good is to
a change in its price. It can vary significantly based on several factors, leading to different types
of elasticity. Here are the main variations, along with a graphical explanation:
1. Perfectly Inelastic Demand (PED = 0)
Definition: Quantity demanded does not change regardless of price changes.
Example: Essential medicines.
Graph: The demand curve is a vertical line. No matter how high or low the price goes, the
quantity demanded remains constant.
2. Inelastic Demand (0 < PED < 1)
Definition: Quantity demanded changes less proportionally than the price change.
Example: Necessities like bread or fuel.
Graph: The demand curve is relatively steep. A large price increase results in a small decrease in
quantity demanded.
3. Unitary Elastic Demand (PED = 1)
Definition: Quantity demanded changes proportionally to price changes.
Example: Some goods that consumers are balanced about in their demand.
Graph: The demand curve has a rectangular hyperbola shape. A price change results in an equal
percentage change in quantity demanded.
4. Elastic Demand (1 < PED < ∞)
Definition: Quantity demanded changes more than proportionately to a price change.
Example: Luxury goods or non-essential items.
Graph: The demand curve is flatter. A small decrease in price results in a large increase in
quantity demanded.
5. Perfectly Elastic Demand (PED = ∞)
Definition: Quantity demanded changes infinitely with any price change.
Example: Perfect substitutes.
Graph: The demand curve is a horizontal line. Consumers will only buy at one price; any
increase in price causes the quantity demanded to drop to zero.
Summary of Key Points
Perfectly Inelastic: No change in quantity; graph is vertical.
Inelastic: Small change in quantity; graph is steep.
Unitary Elastic: Equal percentage change; graph is rectangular hyperbola.
Elastic: Large change in quantity; graph is flatter.
Perfectly Elastic: Infinite change in quantity; graph is horizontal.
Elastic Demand The demand when the percentage change in quantity demanded is greater
than the percentage change in price.The quantity demanded changes proportionately more
than price changes. Inelastic Demand The demand when the percentage change in quantity
demanded is less than the percentage change in price. The quantity demanded changes
proportionately less than price changes. unit Elastic Demand The demand when the percentage
change in quantity demanded is equal to the percentage change in price. The quantity
demanded changes proportionately to price changes. Perfectly Elastic Demand The demand
when a small percentage change in price causes an extremely large percentage change in the
quantity demanded (from buying all to buying nothing). Perfectly Inelastic Demand The
demand when the quantity demanded does not change as price changes.
16.Explain a) what is PCM and monopoly, b) distinguish between PCM and Monopoly c) PCM
profit and loss d) features of PCM
The theory of perfect competition is built on four assumptions:
1. There are many sellers and many buyers, none of which is large in relation to total sales or
purchases. This assumption speaks to both demand (the number of buyers) and supply
(the number of sellers). Given many buyers and sellers, each buyer and each seller may
act independently of other buyers and sellers, respectively, and each is such a small a
part of the market as to have no influence on price.
2. Each firm produces and sells a homogeneous product. Each firm sells a product that is
indistinguishable from all other firms’ products in a given industry. (For example,
a buyer of wheat cannot distinguish between Farmer Stone’s wheat and Farmer Gray’s
wheat.) As a consequence, buyers are indifferent to the sellers.
3. Buyers and sellers have all relevant information about prices, product quality, sources
of supply, and so forth. Buyers and sellers know who is selling what, at what prices, at
what quality, and on what terms. In short, they know everything that relates to buying,
producing, and selling the product. CHAPTER 23 Perfect Competition 527
4. Firms have easy entry and exit. New firms can enter the market easily, and existing firms
can exit the market easily. There are no barriers to entry or exit.
Features of pcm
1. Large Number of Buyers and Sellers There are many buyers and sellers in the market, none of whom can
influence the market price on their own. Each participant acts as a price taker.
2. Homogeneous Products The products offered by all sellers are identical or perfectly substitutable. This
means consumers have no preference for one seller over another based on product differences.
3. Free Entry and Exit Firms can enter or exit the market freely without significant barriers. This feature
allows for the adjustment of supply in response to profit opportunities, ensuring that profits in the long run
tend to zero.
4. Perfect Information All buyers and sellers have complete and accurate information about prices, products,
and production techniques. This transparency allows for informed decision-making and competitive pricing.
5. Price Taker Behavior Individual firms cannot influence the market price and must accept the prevailing
market price. Any attempt to raise prices above the market level will result in zero sales, while lower prices
will lead to losses.
6. No Government Intervention In a perfectly competitive market, there are no government regulations,
taxes, or subsidies affecting prices. The market operates on the principles of supply and demand.
7. Perfect Mobility of Resources Factors of production (labor, capital, etc.) can move freely in and out of
industries without restrictions, allowing resources to be allocated efficiently where they are most needed.
8. Short-Run and Long-Run Equilibrium In the short run, firms can earn supernormal profits or incur losses.
However, in the long run, the entry and exit of firms lead to a situation where firms earn normal profits (zero
economic profit).
9. Non-price Competition While firms compete primarily on price, they may also engage in non-price
competition through advertising, branding, or customer service, although this is less prominent than in other
market structures.
10. Market Efficiency Perfect competition leads to allocative and productive efficiency. Resources are
allocated in a way that maximizes consumer and producer surplus, and firms produce at the lowest possible
cost
Distinguish between PCM and Monopoly
1. Number of Sellers
• PCM: Many buyers and sellers exist. No single seller can influence the market price.
• Monopoly: A single seller dominates the market. This seller controls the entire supply of a product or
service.
2. Product Differentiation
• PCM: Products are homogeneous or identical across sellers. Consumers view them as perfect
substitutes.
• Monopoly: The monopolist offers a unique product with no close substitutes, giving them significant
pricing power.
3. Price Setting
• PCM: Firms are price takers; they accept the market price determined by supply and demand.
Individual firms cannot set prices.
• Monopoly: The monopolist is a price maker. They can influence the price by adjusting the quantity
supplied to the market.
4. Market Entry and Exit
• PCM: There are no barriers to entry or exit, allowing firms to enter or leave the market freely based
on profitability.
• Monopoly: High barriers to entry exist (e.g., legal restrictions, high startup costs, control of
resources), preventing other firms from entering the market.
5. Profit Maximization
• PCM: Firms maximize profits where marginal cost (MC) equals marginal revenue (MR), leading to
normal profits in the long run.
• Monopoly: A monopolist maximizes profits by producing where MC equals MR, often leading to
supernormal profits in both the short and long run due to restricted output.
6. Consumer Choice
• PCM: Consumers have a wide range of choices due to the presence of many firms. The market
responds quickly to changes in consumer preferences.
• Monopoly: Consumer choice is limited, as there is only one provider. Consumers may have to accept
the price and quantity set by the monopolist.
7. Efficiency
 • PCM: Achieves allocative and productive efficiency, as resources are allocated according to
consumer preferences and firms operate at minimum average cost.
• Monopoly: Typically leads to allocative inefficiency, as the monopolist restricts output to raise prices,
resulting in a deadweight loss in consumer surplus and overall welfare.
8. Examples
• PCM: Agricultural markets (e.g., wheat, corn), where many farmers sell identical products.
• Monopoly: Utilities (e.g., water, electricity) or a patented drug, where one company controls the
supply.
Features of monopoly
1. Single Seller In a monopoly, there is only one firm that dominates the entire market. This
single seller controls the supply of the product or service, giving them significant market power.
2. Unique Product The monopolist offers a product or service that has no close substitutes. This
uniqueness allows the monopolist to set prices without the threat of competition, as
consumers cannot easily switch to alternative products.
3. Price Maker Unlike firms in a perfectly competitive market, a monopolist is a price maker.
They have the ability to influence the market price by adjusting the quantity of the product
supplied. This control allows them to maximize profits by setting prices above marginal costs.
4. High Barriers to Entry Monopolies are characterized by significant barriers to entry that
prevent other firms from entering the market. These barriers can be legal (patents, licenses),
economic (high startup costs), or technological (control of essential resources), ensuring that
the monopolist maintains its market position.
5. Limited Consumer Choice Since there is only one provider, consumer choice is restricted.
Consumers must either accept the monopolist's pricing and product offerings or do without the
good or service.
6. Economic Profits Monopolists can earn supernormal profits in the long run because of their
market power and the barriers preventing new entrants. These profits arise from the ability to
set prices above average total costs.
7. Inefficiency Monopolies often lead to allocative and productive inefficiencies. Allocative
inefficiency occurs because the monopolist restricts output to raise prices, resulting in a
deadweight loss to society. Productive inefficiency arises when the monopolist does not
produce at the lowest point on the average cost curve.
8. Price Discrimination Monopolists may engage in price discrimination, charging different
prices to different consumers for the same product based on their willingness to pay. This
practice allows monopolists to increase their profits by capturing more consumer surplus.
9. Demand Curve The demand curve faced by a monopolist is downward sloping, reflecting that
to sell more units, the monopolist must lower the price. This is unlike perfectly competitive
firms, which face a perfectly elastic demand curve.
10. Long-Run Stability A monopoly can maintain its market position over the long term due to
the barriers to entry. Unlike competitive markets where firms may enter or exit freely,
monopolies tend to be more stable in their market presence.