Economics Unit 2 Microeconomics

8 UNIT 2: Microeconomics WHAT IT IS ➔ The behaviour of resource owners, firms, and consumers, where they make economic decisions in a market Competitive Markets Market: A term referring to the relationship between sellers and buyers in terms of the exchange of good and services,. (Exists in all industries.) The meaning of a competitive market: - Where rivals compete to be able to reach a certain goal - Example: Two firms may compete to see who can produce more output in a given amount if time. Supply and Demand DEMAND: Law of Demand: the negative relationship between price and quantity demand -As the price of goods increases, the quantity demanded decreases. Non-price determinants of market demand: - Income with normal goods -- Refers to most goods, demand increases as a result of an increase in consumer income 9 - Example: shoes Income with inferior goods -- Demand falls as consumer income increases, consumers turn to more expensive alternatives - - Example: used cars, second-hand clothing Preferences and tastes -- the good becomes more trendy or popular, demand increases - Demographic changes -- increaser in the number of buyers causes demand to increase, proves that market demand is the sum of all individual demands - Price of substitute goods -- two goods that satisfy a similar need, a decrease in the price of one substitute results in a decrease in demand of the other substitutes (rightward shift) - Price of complementary goods -- two goods that tend to be used together, a decrease in the price of one results in an increase in the demand of the other - Number of consumers in the market REMEMBER: *A change in price = change in the quantity demand = movement of demand curve, & *A change in a non-price determinant = change in demand = shift of entire demand curve 10 3 SUPPLY: The Law of Supply: Explains the positive/direct causal relationship between price and quantity supplied. (As the price of the supplied good increases, the quantity also increases.) 11 4 *Higher prices = profit increase = incentive to produce more output *Lower prices = lower profitability = incentive to produce less output Non-price determinants of market supply: - Costs of factors of productions - Input prices -- land, labour, capital - Technology -- better technology = lower costs of production = higher profitability - Taxes (government intervention) -- imposes new tax or increases an existing tax = increase in production costs = decreased supply - Subsidies (government intervention) -- payment made to a firm by the government, opposite of tax, given to firms to increase production - Prices of related goods (competitive supply) -- goods competing for the use of the same resources, each firm will end up producing more of one and less of the other - Number of firms -- increases in number of firms producing the good = increased supply - Unpredicted events/shocks -- includes unexpected events such as weather or war 12 Market Equilibrium - The point at which the quantity of both demand and supply are equal. Equilibrium: when quantity supplied is equal to quantity demanded - Here there is no tendency for the price to change - Determined at the point where demand curve intersects supply curve - At this point -- consumers are satisfied and won’t make changes Disequilibrium: excess demand (shortage) or excess supply (surplus) - At any price other than the equilibrium price, there is a market disequilibrium Changes in Equilibrium: when the non-price determinants of supply and demand change (There is a shift in the curve and the equilibrium price adjusts.) 5 13 6 * { Shortage -- when quantity demanded is greater than quantity supplied } { Surpluses -- when quantity supplied is greater than quantity demanded } * Elasticities PED - Price Elasticity of Demand - Measures how responsive the demand of a good is to changes in its price 7 14 - The PED is a negative price because quantity demanded is negatively/indirectly related. THOUGH to avoid confusion, the minus sign is dropped. - The PED creates several possible values and ranges for it. PED Values, Characteristics, and What They Means 8 Determinants of PED: 1. Number of substitutes - the more there are, the higher the elasticity 2. Necessities vs. luxuries - demand for necessities is less elastic than that of luxuries, *necessities are not as responsive to changes in price since we need and can’t live without them 3. Length of time - the longer it takes for purchasing decision to be made, the higher the elasticity 4. Amount of income spent on a good - the more spent from one’s income on a good, the higher the elasticity 15 XED - Cross-price elasticity demand - Measures how responsive the demand of one good is to the change in price of another good 9 PES - Price Elasticity of Supply - Measures the responsiveness of quantity supplied of a good to a change in price of the good. (along the supply curve) 10 PED Values, Characteristics, and What They Means 16 11 Determinants of PES 1. Length of time - responds to changes in price, adjusts their resources and quantity supplied 2. Mobility of factors of production - with how much ease and the pace at which companies adjust their resources and production 3. Extra capacity of firms - capacity not being used, makes it easier to increase output as a response to price increase of a good 4. Ability to store stocks - will likely have a higher PES than those that can’t Role of Government in Microeconomics Indirect Taxes - Imposed on spending of goods and services - Paid by consumers to producers, and then from producers to governments - Differs from direct taxes, which are paid by consumer directly to the government Excise taxes: on particular goods and services (like gas and alcohol) Why they are imposed: 17 1. Source of revenue for the government 2. Discourage consumption of goods that harm individuals (such a cigarettes) 3. Used to redistribute income 4. Improves inefficient resource allocation by improving negative externalities Effects on Stakeholders Consumers - price increases Producers - fall in price and quantity output of good sold Government - positive, only stakeholder that gains from this tax Workers - less output if fewer workers are needed for production, unemployment Subsidies - A way for the government to assist firms and consumers - Through direct cash payments, loans, and more - Usually a fixed amount - Allocation of resources due to how they affect relative price, leading to higher production and consumption Why they are imposed: - Supports growth of industries - Encourages exports of certain goods - To encourage production and consumption Effects on Stakeholders Consumers - decrease in price and increase in quantity purchased 18 Producers - positive, high price and larger quantity leading to higher revenue Government - negative, they take on the burden paying the subsidy Workers - more workers hired, employment Market Failure WHAT IT IS - Failure of the market to achieve allocative efficiency - leading to overallocation or underallocation Externalities: happen when the producers and consumers give rise to negative and positive side effects who are not part of it (third-parties), come from either consumption or production activities *Positive - external benefits *Negative - external costs MPC, Marginal Private Costs: costs to producers of producing one more unit of a good MSC, Marginal Social Costs: costs to society of producing one more unit of a good MPB, Marginal Private Benefits: benefits to consumers of consuming one more unit of a good MSB, Marginal Social Benefits: benefits to society of consuming one more unit of a good 19 *Negative Externalities Fixing it: Market-based policies to manage negative externalities - Tax - tax on output (per unit), tax on pollutants emitted (per unit) such as carbon tax - Tradable permits - policy where polluting is permitted to firms by government Advantages: these policies work to internalize the externality Disadvantages: technical difficulties with designing the tax and risk of the effectiveness of the policy *Positive Externalities Positive production externalities - Underallocation of resources going towards a good with a positive production externality leads to welfare loss. - These losses to society are a result of a scarcity of the good being produced. - Merit goods: desired by consumers but are underallocated and underprovided by the producers Ways of correcting positive production externalities - Government provisions - Subsidies Positive consumption externalities - Benefits created by consumers, externally and socially - Welfare loss from this is seen in difference between MSB and MSC 20 Ways of correcting positive consumption externalities - Government provision - Legislation - Advertising - Subsidies *Sustainability with resources - Sustainable resources are able to reproduce and don’t become depleted, because they are used correctly and at the right pace. - Combines the economy and environment - Problem with sustainability - conflict between economic and environmental goals