MICROECONOMICS

INTRODUCTION

BY: Aklilu A. (MSc.)

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 Course Objectives
Understand the basic concept of economics, its scope and the

circular flow of goods and services;

Illustrate and explain price determination using demand and

supply ;
Understand the concepts utility maximization and indifference

curves to explain the nature of consumer demand;

Familiarize with the basic concepts of production and costs and the

interrelationships between them and describe firm behavior under

various market structures; and also understand the causes of market
failure.
 Understanding Economics and Scarcity
There are two fundamental facts that provide the foundation for
the field of economics.
i. Human (society‘s) material wants are unlimited.
ii. Economic resources are limited (scarce).

Scarcity means that there are never enough resources to satisfy

all human wants. It is a fundamental economic problem that any
human society faces is the problem of scarcity.

Thus, every society, at every level, must make choices about

how to use its resources.
 Understanding Economics & Scarcity Cont’d …
Hence, Economics is defined as the study of how societies choose
to use their scarce productive resources that have alternative
uses, to produce valuable commodities and distribute them among
its different groups for consumption to satisfy the unlimited
human wants.

In simple words, Economics is a discipline which studies about

efficient allocation of scarce resources so as to attain the
maximum fulfillment of unlimited human needs.
 Productive Resources
Four productive resources also called factors of production include:
 Land: any natural resource, including actual land, but also trees,
plants, livestock, wind, sun, water, etc.
 Capital: anything that’s manufactured in order to be used in the
production of goods and services.
 Labor: any human service—physical or intellectual. Also
referred to as human capital.
Entrepreneurship: the ability of someone (an entrepreneur)
to recognize a profit opportunity, organize the other factors of
production, and accept risk.
Microeconomics and Macroeconomics
Modern economics is formed by its two major branches:
Macroeconomics: is a branch of economics that deals with
the aggregate behavior of the economy. It looks at the
economy as a whole and focuses on broad issues such as
growth, unemployment, inflation, and trade balance.

Microeconomics is concerned with the economic behavior of

individual decision making units such as households, firms,
markets and industries. In other words, it deals with how
households and firms make decisions and how they interact in
specific markets. Hence, in Microeconomics, we learn about
the theory of consumer behavior and the theory of the firm.
 Decision making units and the circular flow
model
 There are three decision making units in a closed economy.
 Household: can be one person or more who live under one roof and
make joint financial decisions. Households make two decisions.
 Selling of their resources, and
 Buying of goods and services.

 Firm: is a production unit that uses economic resources to produce

goods and services. Firms also make two decisions:
 Buying of economic resources
 Selling of their products.

 Government: is an organization that has legal and political power to

control or influence households, firms and markets. Government also
provides some types of goods and services known as public goods and
services for the society.
Decision making units and the circular flow model
Cont’d …
 Those economic agents interact in two markets:
 Product market: it is a market where goods and services are
transacted/ exchanged. That is, a market where households and
governments buy goods and services from business firms.
 Factor market (input market): it is a market where economic units
transact/exchange factors of production (inputs). In this market, owners
of resources (households) sell their resources to business firms and
governments.
 The circular-flow diagram is a visual model of the economy that
shows how money, economic resources and goods and services flows
through markets among the decision making units.
 CHAPTER ONE
THE BASICS OF DEMAND & SUPPLY

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 1.1 THEORY OF DEMAND
In our day-to-day life we use the word “demand” and
“desire/want” interchangeably. But in economics they are
different.
Demand refers to the consumers willingness and ability to
purchase the commodity, which he/she desires. Thus, demand
implies more than a mere desire to purchase a commodity.
A poor person is willing to buy a car; it has no significance, since
he/she has no ability to pay for it. On the other hand, if his/her
desire to buy the car is backed by the purchasing power then this
constitutes demand.
Demand, thus, means the desire of the consumer for a commodity
backed by purchasing power.

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 THEORY OF DEMAND CONT’D …
More specifically, Demand refers to various quantities of a
commodity or service that a consumer would purchase at a given
time in a market at various prices, given other things unchanged
(ceteris paribus).
The quantity demanded of a particular commodity depends on the
price of that commodity.
Law of demand: states that , price of a commodity and its
quantity demanded are inversely related i.e., as price of a
commodity increases quantity demanded for that commodity
decreases and vice versa, ceteris paribus.

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 Demand schedule (table), demand curve and
demand function
 The relationship that exists between price and the amount of a
commodity purchased can be represented by a table (schedule) or a
curve or an equation.
 Demand schedule- states the relationship between price and quantity
demanded in a table form.
 Consider the individual household demand for orange per week

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 Demand schedule (table), demand curve and
demand function Cont’d …
 Demand curve is a graphical representation of the
relationship between different quantities of a
commodity demanded by an individual at different
prices per time period.

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 Demand schedule (table), demand curve and
demand function Cont’d …
Demand function is a mathematical relationship
between price and quantity demanded, all other
things remaining the same. A typical demand
function is given by:
Qd=f(P)
where Qd is quantity demanded and P is price of the
commodity, in our case price of orange.
Example: Let the demand function be Q = a + bP
b = (Negative value) , slope of demand curve
Therefore, Q=15-2P is the demand function for orange in the
above numerical example.
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 Market Demand
 Market Demand: The market demand schedule or
curve is derived by horizontally adding the quantity
demanded for the product by all buyers at each price.

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 Market Demand Function
Market demand function = individual demand function times
number of identical buyers.
Numerical Example: Suppose the individual demand function of
a product is given by: Q= 20 - 2P and there are about 100
identical buyers in the market. Find the market demand function.
Solution:
The individual demand function is given: Q= 20 - 2P
Number of identical buyers: 100
The market demand function can be obtained by multiplying the
individual demand function by the number of buyers.
Qm = (20 – 2P) 100 = 2000-200P

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 Determinants of Demand
The demand for a product is influenced by the many factors. Some of
them are as follows:
 Price of the product (-)
 Taste or preference of consumers (+)
 Income of the consumers
 Normal good (+)
 Inferior goods (-)
 Price of related goods
 Substitute Goods (+)
 Complementary Goods (-)
 Consumers expectation of price (+)
 Number of buyers in the market (+)
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 Now let us examine how each factor affect
demand.
I. Taste or preference
 When the taste of a consumer changes in favour of a
good, her/his demand will increase and the opposite is
true.
II. Income of the consumer
 Normal Goods – the higher the income the more people
consume
That is: ↑Income => consume more =>↑D
Examples: Cars, LCD TV, Smart phones, Meat/ Kitfo
 Inferior Goods – as income rises people consume less
That is: ↑Income => consume other products => ↓ D
Examples: Shiro wot, Second hand clothes
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 Cont’d…
III. Price of related goods
Substitute goods - goods which satisfy same desire of the consumer.
 If the price of a commodity increases, demand for its substitute rises.
Example: tea and coffee or Pepsi and Coca-Cola
↑Price of Pepsi => drink less Pepsi => purchase more Coca (↑D)
Complimentary goods- goods which are jointly consumed. For
example, car and fuel or tea and sugar
 If good x and y are complements, ↑price of X => ↓Demand of Y
IV. Expectations
 ↑Price tomorrow => buy today instead of tomorrow => ↑D
V. Number of buyers
 ↑number of buyers => More of the good is consumed => ↑D

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 Changes in Quantity Demanded vs. Changes in
Demand
Changes in Quantity Demand – is represented by a
movement a long a given demand curve
=>This is caused by the change in the price of the good
 Changes in Demand – is represented by a shift of the demand
curve from its original location.
=>This is caused by the change in the determinants of demand
other than price of the product.
For this reason those factors listed above other than price are
called demand shifters.

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 Changes in Demand
 Changes in demand: a change in any determinant of
demand except for the good‘s price- which causes the
demand curve to shift.

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 1.2 THEORY OF SUPPLY
Supply indicates various quantities of a product
that sellers (producers) are willing and able to
provide at different prices in a given period of
time, other things remaining unchanged.
The law of supply: states that, ceteris paribus,
as price of a product increase, quantity supplied
of the product increases, and vice versa. It tells
us there is a positive relationship between price
and quantity supplied.

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 Supply schedule, supply curve and supply
function
A supply schedule is a tabular statement that states the different
quantities of a commodity offered for sale at different prices.
Table 2.3: An individual seller’s supply schedule for butter
Price ( birr per kg) 30 25 20 15 10

Quantity supplied 100 90 80 70 60

kg/week

The supply of a commodity can be briefly expressed in the

following functional relationship:
S = f(P),
where S is quantity supplied and P is price of the commodity.
In Linear equation form: Qss= a+ bP
In our case, b = ∆Q/∆p= 2. Thus, Q = 40+2P
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 Supply Curve
A supply curve conveys the same information as a supply
schedule. But it shows the information graphically rather than in a
tabular form.

Figure 2.5 supply curve

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 Market supply
It is derived by horizontally adding the quantity supplied of the
product by all sellers at each price.
Table 2.4: Derivation of the market supply of good X

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 Determinants of supply
Apart from the change in price which causes a change in quantity
demanded, the supply of a particular product is determined by:
 Price of the product itself (+)
 Price/cost of inputs (-)
↑Price of labor =>hire less people =>produce less at current P =>↓S
 Technology (+)
New technology => produce output more => higher profit on output
=> produce more at current P => ↑S
 Prices of related goods (-)
Examples: leather Jacket Vs leather shoe
↑Price of leather Jacket => produce less leather shoe => Produce
more leather Jacket => ↓S of leather shoe
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 Determinants of supply Cont’d …
 Sellers’ expectation of price of the product (-)
↑Price tomorrow => Sell tomorrow instead of today => ↓S
 Taxes (-) & subsidies (+)
↑ tax => Less of the good is produced=> ↓S
↑subsidy => more of the good is produced => ↑S
 number of sellers in the market (+)
↑number of sellers => More of the good is produced => ↑S
 Weather condition (Agricultural Products) (+)
Good Weather condition => ↑ production of the goods => ↑S

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 1.3 Market Equilibrium: Putting the Demand
and Supply Together
Market equilibrium occurs when market demand equals market
supply.

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 Shortage vs Surplus
Any price greater than the market clearing price will lead to
market surplus (Excess supply).
 As the price of the commodity increases, consumers demand less
of the product, while producers supply more of the good resulting
in surplus.
If the price decreases below the market clearing price buyers
demand to buy more and suppliers prefer to decrease their supply
leading to shortage (Excess demand) in the market.
In other words, a shortage (excess demand) occurs when the
quantity demanded is greater than the quantity supplied at a
particular price, where as surplus (excess supply) occurs when the
quantity demanded is less than the quantity supplied at a
particular price.
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 Figure: Surplus vs Shortage

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 Numerical Example:
Given the market demand: Qd = 100 - 2P, and the market supply:
Qs= 2P - 20
a) Calculate the market equilibrium price and quantity
b) Determine, whether there is surplus or shortage at P=25 and P=35.
Solution:
a) At equilibrium, Qd= Qs
100 – 2P = 2P – 20
4P =120
= 30, and =40
b) Qd(at P = 25) = 100-2(25) =50 and Qs(at P = 25 ) = 2(25) -20 =30
Therefore, there is a shortage of: 50 -30 =20 units
Qd( at P=35) = 100-2(35) = 30 and Qs (at p = 35) = 2(35)-20 = 50
Therefore, there is a surplus of 20 units

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 THANK YOU!

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