MICROECONOMICS

WEEK 1: TEN PRINCIPLES OF ECONOMICS

I. KEY TERMS
- Economy: “one who manages a household”. A household faces many decisions
(allocate sacre resources) and a society also faces many decisions (allocate resources,
allocate output)
- Resources are scarce => cannot produce all the goods and services people wish to
have
o Scarity: limited nature of society’s resources
- Economics: Study of how society manages its scarce resources
- Economist: Study how people make decisions, how people interact with one another,
analyse force and trends that affect the economy as a whole

II. TEN PRINCIPLES OF ECONOMICS

How people make decisions

1. People face Tradeoffs (chấp nhận bất lợi để có được một điều gì đó tốt đẹp hơn)
- Making decisions requires trading off one goal against another
Ex: Protecting the environment requires resources that could otherwise be used to
produce consumer goods

2. The cost of something is what you give up to get it

- The Opportunity cost ( the potential benefits that a business, an investor, or an
individual consumer misses out on when choosing one alternative over another)
- Making decisions requires comparing the costs and benefits of alternative
courses of action
Ex: The opportunity cost of studying at university for 3 years is the 3 years of pay
that you do not earn during that time

3. Rational people think at the margin

 - Rational people: people who systematically and purposefully do the best they
can do to achieve their objectives, given the available opportunities
- Margin change: a small incremental adjustment to a plan of action
- Rational people make decisions by evaluating the cost and benefits of marginal
changes

4. People respond to incentives

- Incentive: sth that induces a person to act
- Because rational people make decisions by comparing costs and benefits, they
respond to incentives
Ex: When cigarette taxes increase, teen smoking falls

APPLYING THE PRINCIPLES

 Trade-off: You’re deciding between

repairing the transmission or selling
the car “as is”. The repair cost $600
 The opportunities cost: if you don’t
repair the car, you give up the
potential $800 increase in value (from $5700 to $6500)
 The marginal benefit of repairing the transmission is the increase in the car’s
value, which is $6500- $5700 = $800. The marginal cost of repair is $600
 The incentive here is an $800 increase in value if the car is repaired,
compared to a $600 repair cost
 Repair the transmission because the benefit outweighs the cost

How people interact

5. Trade can make everyone better off
- Rather than being self-sufficient, people can specialise in producing one good or
service and exchange it for other goods
- Countries also benefit from trade & specialisation:
 o Get a better price abroad for goods they produce
o Buy other goods more cheaply from aboard than could be produced at home

6. Markets are usually a good way to organize economic activity

- Market: a group of buyers and sellers
- Market economy: an economy that allocates resources through the decentralized
decisions of many firms and households as they interact in markets for goods and
services
- Organize economic activity:
o What goods to produce
o How to produce them
o How much of each to produce
o Who gets them

7. Government can sometimes improve market outcomes

- The role of institutions: enforce property rights so individuals can own and
control scarce resources
o Property rights: quyền sở hữu tài sản
- Market failure: when the market fails to allocate society’s resources efficiently
- Externalities: the production or consumption of a good affects bystanders (ex:
pollution)
- Market power: a single buyer or seller has substantial influence on the market
price

How the economy as a whole works

8. A country’s standard of living depends on its ability to produce goods & service
- Huge variation in living standards across countries and over time
- The most important determinant of living standard: productivity (the amount of
goods and services produced per unit of labour)
9. Prices rise when the government prints too much money
- Inflation (an increased level in the overall level of prices in the economy) caused
by the increase in the quantity of money.
- Large quantity of money => The value of money will fall

10. Society faces a short-run trade-off between inflation and unemployment

- In the short- run (1-2 years), many economic policies push inflation and
unemployment in opposite directions. The tradeoff is always present
- Analysis of the business cycle (fluctuation in economic activity, such as
employment and production)

III. THE CIRCULAR-FLOW DIAGRAM

First Model:
 - Household
o Own the factor of production, sell/ rent them to firms for income
o Buy and consume goods & services
- Firms
o Buy/ hire factors of production, use them to produce goods and services
o Sell goods & services

Second Models:

- The production possibilities

frontier (bow-shaped: hình cánh
cung)
- The combinations of output (cars
and computers) that the economy
can possibly produce => F, A, B,
E
- Points outside the frontier C are
not feasible given the economy’s
resources
- Opportunity cost of a car-
highest- many cars >< fewer computers
 - Opportunity cost of a car- lower- fewer cars >< many computers

- A technological advance in the computer

industry enables the economy to produce
more computers for any given number of
cars. As a result, the production
possibilities frontier shifts outward. If the
economy moves from point A to point G,
then the production of both cars and computers increases.

 Why the PPF might be bowed- shaped (đường giới hạn khả năng sản xuất)?

- Depends on what happens to opportunity cost as economy shifts resources from

one industry to the other

o If the opportunity cost remains constant, the PPF will be a straight line.
This means that as more of one product is produced, the economy only
needs to give up a fixed amount of the other product without any change in
opportunity cost.
o If the opportunity cost increases as more of a product is produced, the
PPF will be bow-shaped. This happens when the economy has to give up
increasingly larger amounts of the other product to produce an additional
unit of the first product, as specialized and more efficient resources in one
industry are reallocated to the other.

IV. MICROECONOMICS AND MACROECONOMICS

- Microeconomics is the study of how households and firms make decisions and
how they interact in markets.
- Macroeconomics is the study of economy-wide phenomena, including inflation,
unemployment, and economic growth.
 These two branches of economics are closely intertwined, yet distinct – they address
different questions.

V. POSITIVE STATEMENT & NORMATIVE STATEMENTS

- As scientists have different scientific judgments → positive statements → to
describe the world as it is.
- As policy advisors have different values → normative statements → to
prescribe how the world should be.
 Positive statements can be confirmed or refuted, normative statements cannot.
 WEEK 2: THE MARKET FORCES OF SUPPLY AND DEMAND
I. MARKET AND COMPETITION
- A market is a group of buyers and sellers of a particular product.
- A competitive market is one with many buyers and sellers, each has a negligible
effect on price.
- In a perfectly competitive market:
o All goods exactly the same
o Buyers & sellers so numerous that no one can affect market price – each is
a “price taker”
II. DEMAND
1. Definition
- If you demand something, then you: Want it, can afford it, and have made a
definite plan to buy it.
- The quantity demanded of any good is the amount of the good that buyers are
willing and able to purchase
- Law of demand: the claim that the quantity demanded of a good falls when the
price of the good rises, other things equal
- The demand schedule: a table shows the relationship between the price of a good
and the quantity demanded
- The demand curve: a graph of the relationship between the price of good and the
quantity demanded
 - Market demand versus individual demand

2. Demand curve shifters

- The demand curve shows how price affects quantity demanded, other things
being equal.
 - These “other things” are non-price determinants of demand (i.e., things that
determine buyers’ demand for a good, other than the good’s price).
- Changes in them shift the D curve…
 Variables that can shift the demand curve
- Income
o Normal good: a good for which, other things equal, an increase in income
leads to an increase in demand => beer.. => D curve shift to the right
o Inferior good: a good for which, other things equal, an increase in income
leads to a decrease in demand => car…=> D curve shift to the left
- Prices of related goods
o Substitutes: two goods for which an increase in the price of one leads to an
increase in the demand for the other => beef oodles and chicken noodles
=> D curve shift to the right
o Complements: two goods for which an increase in the price of one leads to
a decrease in the demand for the other => computer and software,… => D
curve shift to the left
- Tastes:
o Anything that causes a shift in tastes toward a good will increase demand
for that good and shift its D curve to the right
- Expectations
o Expectations affect consumers’ buying decisions (If people expect their
incomes to rise, their demand for meals at expensive restaurants may
increase now)
- Number of buyers
3. Example
- Public policymakers often want to reduce the amount that people smoke because
of smoking’s adverse health effects. There are two ways to slove this:
o 1st: Reduce smoking is to shift the demand curve for cigarettes and other
tobacco products => panel a
o 2nd: raise the price of cigarettes to move the demand curve to a point with a
higher price and lower quantity => panel b
III. SUPPLY
1. Definition
 Supply comes from the behavior of sellers.
- If a firm supplies a good or service, then the firm:
o Has the resources and the technology to produce it
o Can profit from producing it, and
o Has made a definite plan to produce and sell it.
 The quantity supplied of any good is the amount that sellers are willing and able to
sell.
 Law of supply: the claim that the quantity supplied of a good rises when the price of
the good rises, other things equal
 Supply schedule: a table that shows the quantity supplied at each price
 Supply curve: a graph that shows the quantity supplied at each price
 Market supply versus individual supply

2. Shifts in the supply curve

 - The supply curve shows how price affects quantity supplied, other things being
equal.
- These “other things” are non-price determinants of supply.
- Changes in them shift the S curve…

 Variables that can shift the supply curve

- Input prices
o A fall in input prices makes production more profitable at each output
price, so firms supply a larger quantity at each price, and the S curve shifts
to the right. => wages, prices of raw materials
- Technology
o Technology determines how much inputs are required to produce a unit of
output.
o A cost-saving technological improvement has same effect as a fall in input
prices, shifts the S curve to the right.
- Expectations
o Suppose a firm expects the price of the good it sells to rise in the future.
o The firm may reduce supply now, to save some of its inventory to sell later
at the higher price.
o This would shift the S curve leftward
- Number of sellers
o An increase in the number of sellers increases the quantity supplied at each
price, shifts the S curve to the right.
 IV. SUPPLY AND DEMAND TOGETHER
1. Equilibrium
- Equilibrium: A situation in which the market price has reached the level at which
quantity supplied equals quantity demanded

Equilibrium price: The price that equates Equilibrium quantity: The quantity
quantity supplied with quantity demanded supplied and quantity demanded at the
equilibrium price
Surplus: when the quantity supplied is Shortages: when quantity demanded is
greater than the quantity demanded greater than quantity supplied

2. Three steps to analyzing changes in equilibrium

 To determine the effects of any event
- Decide whether event shifts S curve, D curve, or both.
- Decide in which direction curve shifts (left or right).
- Use supply-demand diagram to see how the shift changes eq’m P and Q

3. A chage in market equilibrium due to a shift in demand

 - One summer - very hot weather
- Effect on the market for ice cream?
o Hot weather - demand curve (tastes )
o Demand curve shifts to the right
o Higher equilibrium price; higher equilibrium quantity

4. A change in market equilibrium due to a shift in supply

- One summer - a hurricane destroys part of the sugarcane crop
- Price of sugar - increases
- Effect on the market for ice cream?
o Change in price of sugar - supply curve
o Supply curve - shifts to the left
o Higher equilibrium price; lower equilibrium quantity
5. Shifts in both supply and demand
- One summer: hurricane and heat wave
o Heat wave – shift demand curve; hurricane – shift supply curve
o Demand curve shifts to the right; Supply curve shifts to the left
o Equilibrium price raises
+ If demand increases substantially while supply falls just a little:
equilibrium quantity –rises
+ If supply falls substantially while demand rises just a little: equilibrium
quantity falls
6. What happens to price and quantity when supply or demand shifts?
 WEEK 3: ELASTICITY AND ITS APPLICATION

I. Price elasticity
 Definition: Elasticity is a numerical measure of the responsiveness of Qd or Qs to
one of its determinants
 Calculating percentage change: (end value – start value/ start value) x 100%

- Going from A to B, the % change in P

equals
($250-$200)/$200= 25%
- Going from A to B, the % change in P
equals
($200-$250)/$250= 33%

 Midpoint method: The midpoint is the number halfway between the start & end
values, also the average of those values

- The % change in P equals: $250 – $200/ $225 x 100% = 22.2%

- The % change in Q equals 12 – 8/ 10 x 100% = 40.0%
- The price elasticity of demand equals 40/22.2 = 1.8

Price elasticity of demand Price elasticity of supply

Measures how much Qd responds to a change in P Mmeasures how much Qs responds to a change in
P
Ex: 15%/ 10%= 1.5

Along a D curve, P and Q move in opposite

directions, which would make price elasticity
negative. We will drop the minus sign and report all
price elasticities as positive numbers.

Determinants

- The extent to which close substitutes are - The more easily sellers can change the
available quantity they produce, the greater the
- Whether the good is a necessity or a price elasticity of supply.
luxury - For many goods, price elasticity of
- How broadly or narrowly the good is supply is greater in the long run than in
defined the short run, because firms can build
- The time horizon: elasticity is higher in new factories, or new firms may be able
the long run than the short run. to enter the market.

 Perfect inelastic demand (one extreme  Perfect inelastic supply => Elasticity = 0
case)  Inelastic supply Elasticity <1
 Unite elastic supply => Elasticity =1
 Elastic supply => Elasticity > 1
 Perfectly elastic supply => Elasticity euals
 Inelastic demand (demand (% change in Q infinity
< % change in P)
 Unit elastic demand

 Elastic demand (% change in Q > % change

in P)

 Perfectly elastic demand (the other extreme)

Total revenue of demand

 Elastic demand (Pe > 1)

 Inelastic demand
II. Income and cross- price elasticity
 The income elasticity of demand measures the response of Qd to a change in
consumer income

- For normal goods, income elasticity > 0

- For inferior goods, income elasticity < 0.
 The cross-price elasticity of demand measures the response of demand for one good
to changes in the price of another good

- For substitutes, cross-price elasticity > 0

o E.g: an increase in price of beef causes an increase in demand for chicken
- For complements, cross-price elasticity < 0
o E.g: an increase in price of computers causes decrease in demand for
software.
 WEEK 4: SUPPLY, DEMAND AND GOVERNMENT POLICIES

1. Controls on Price

Price ceiling Price floor

Definition a legal maximum on the price at which a legal minimum on a price at which a
a good can be sold (rent control….) good can be sold (minimum wage….)

How it the government decide to protect when the government decided to protect
happens consumers sellers

Outcome 1: not biding ( > equilibrium Outcome 1: not biding ( < Pe) => no
price) => no effect on the price or effect on the price or quantity sold
quantity sold Outcome 2: biding (> Pe) => Surplus
Outcome 2: biding ( < equilibrium occurs.
Outcomes
price) => Shortage occurs. In response
to this shortage, some mechanisms for
rationing ice cream will naturally
develop.

The price ceiling was motivated by a Some sellers are unabe to sell all they
desire to help buyers of ice cream, but want at the market price.
not all the buyers benefit from the
policy
Evaluating
- Waste buyers’ time in long
runs
- Some people can’t buy ice
cream because of shortage
- Seller bias consumers =>
inefficient and potentially
unfair
 Price celling

Price floor

 Evaluating price control

 - Governments use Price Controls because they think that the market outcome is
unfair
- Aimed at helping the poor
- Often hurt those they are trying to help
- Other ways of helping those in need
o Rent subsidies
o Wage subsidies

2. Taxes and effect on market outcomes

- Tax incidence: the manner in which the burden of a tax is shared among
participants in a market

Tax on Sellers affect the market outcomes Taxes on Buyers affect demand outcomes

Tax burden on sellers Tax burden on buyers

  Taxes levid on sellers and teaxes leives on buyers are equilibrium

3. Elasticity and Tax incidence

- How exactly is the tax burden divided?

Elastic Supply, Inelastic Demand Inelastic Supply, Elastic Demand

 The tax incidence falls more

 The tax incidence of he tax falls more
heavily on producers
heavily on consumers
4. Tax and deadweight loss

Tax revenue Deadweight loss

- T: the size of tax The fall in total surplus that result from a

- Q: the quantity of the goods market distortion, such as a tax

sold
- T x Q: Tax revenue

Taxes cause deadweight losses because they

prevent buyers and sellers from realizing
some of the gains from trade

5. Determinants of Deadweight Loss

- Tax Distortions and Elasticities
- The greater the elasticities of demand and supply
o The larger will be the decline in equilibrium quantity
o The greater the deadweight loss of a tax
- Tax size and Tax Revenue
WEEK 5: CONSUMERS, PRODUCERS AND THE EFFICIENCY OF MARKETS

- Welfare economics: the study of how the allocation of resources affects economic
well-being
I. Consumer Surplus

Willingness to pay: the maximum

amount that a buyer will pay for a
good. It measures how much the
buyer values the good.

- If the price is higher than WTP,

consumers would not have to pay.

Demand Schedule: Derived from the

willingness to pay of the possible
buyers

At
any

price quantity, the price given by the demand

curve shows the willingess to pay of the
marginal buyer.
 The area below the demand curve and above
the price is the consumer surplus in a market.
Consumer surplus: the amount a Price = 80 => CS = WTP- P = 100- 80= 20.
buyer is willing to pay for a good
A
minus the amount the buyer actually
pays for it.

 CS measures the benefits that

buyers receive from a good as
the buyers themselves perceive
it.
lower price raises consumer surplus.

Price = 70 => The sum of CS = (20 + 10) + 10

= 40

How the price affect consumer surplus

 II. Producer Surplus

Cost: (should be interpreted as

Opportunity Cost) : the value of
everything a seller must give up to
produce a good

Willing to Sell: the lowest price at which

suppliers are willing to sell their goods or
services
Supply schedule + supply curve

- The height of the supply curve

reflects sellers’ costs
Producer surplus: The amount a seller - PS: the area below price and
is paid for a good minus the seller’ cost above the sipply curve
of providing it - Price = 600 => CS= P – Cost to
seller = 600- 500= 100
 PS measures the benefits sellers
receive from participating in a
market
 - A higher price raise producer
surplus

- Price = 800 => CS= (800- 500) +

(800- 600) = 500.

How a higher price raise producer surplus

 III. Market efficiency & equilibrium
1. Total surplus
 Total surplus: the total gains from trade in a market

 Efficiency: the property of a resource allocation of maximising the total surplus

received by all members of society
 Get the most output from the least input
 Equality (whether the various buyers and sellers in the market have a similar level of
economic well- being) : the property of distributing economic prosperity uniformly
among the members of society

2. Evaluating the Market Equilibrium

- Free market allocatee the
supply of goods to the buyers
who value them most highly, as
measured by their willingness to
pay.
- Free markets allocate the
deamand for goods to the
sellers who can produce them at
the lowest cost.
- Free market produces the quantity of goods that maximizes the sum of
consumer and producer surplus.
 WEEK 3: INTERDEPENDENCE AND GAINS FROM TRADE
1. Production Possibilities
- The amount of time each person requires to produce 1 ounce of each good