Microeconomics Revision Notes

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2.1 Markets

·

Definition of markets with relevant local, national and

international examples

A market is any

place, physical or virtual, where the buyers and sells of goods and services

meet.

Local

market: weekend farmers market, dairy shop

National

market: participants are from the market country- healthcare, education, labour

markets.

International

market: exchange of commodities, e.g. steel, oil, coffee, cotton

·

Brief descriptions of perfect competition, monopoly and

oligopoly as different types of market structures, and monopolistic

competition, using the characteristics of the number of buyers and sellers,

type of product and barriers to entry.

Market structure

Number of firms

Level of differentiation

Market power

Barriers to entry and exit

Example

Competition

Perfect

competition

Very many

Homogenous

products with same production cost. Perfect substitutes of each other.

No power.

Price TAKER.

None

Agricultural

commodities, bonds, stocks, currencies

Intense

Monopolistic

competition

Many firms

Differentiated/

heterogeneous

Generally little

power.

Price TAKER

Relatively

insignificant

Restaurants, jewelers,

clothing stores

Heavy

Oligopoly

A few dominating

Heterogeneous or

homogeneous

Significant power.

Price MAKER.

Significant

Airlines,

breakfast cereals, cell phone networks

Interdependent

Monopoly

One dominating

None; no close

substitutes

Significant power.

Price MAKER

Major

Power, water,

local utilities

None

·

Importance of price as a signal and as an incentive in terms of

resource allocation

Price rationing- free market mechanism-

reflects the true demand and supply of a good.

Demand

·

Definition of demand: the quantity of a good that consumers are

willing and able to buy at a given price during a specific time period.

·

Law of demand with diagrammatic analysis- shows the inverse

relationship between P and Qd; negative slope- Qd decreases as P increases,

ceteris paribus. Law of DIMINISHING RETURNS. (MB decreases as Qd increases). Demand

curve reflects the MB we receive from consuming additional units of a good.

·

Determinants of demand: income, price of substitute and

complementary goods, consumer taste and preferences, expectations of future

prices and income, number of potential buyers

-

Income: normal (D increases as income increases) versus inferior

goods (D decreases as income increases).

-

Price of related goods:

Substitutes (to be

used in place of)- D increases as the price of substitutes increases.

Complements

(consumed together)- D decreases as the price of complementary increases.

-

Role of expectations

Of future prices: D

increases if consumers believe future price will rise rather quickly.

Of future income: D

increases if consumers conclude their income will rise- high economic growth,

steadily rising wages, surging business investment, relatively low unemployment

-

Higher demand when there is a larger number of potential buyer,

e.g. in China when the markets first became open.

·

Fundamental distinction between a movement along a demand curve

and a shift of the demand curve

-

Movement- change in price (law of demand)- change in Qd

-

Shift of the curve-change in determinants – change in D

(leftwards or rightwards)

·

Exceptions to the law of demand (the upward-sloping demand

curve)

o Ostentatious (Veblen)

goods- display of social status, so Qd increases as P increases.

o Giffen goods

Supply

·

Definition of supply- the quantity of a good or service that

producers are willing to offer for sale at a given price during a specific time

period.

·

Law of supply with diagrammatic analysis- positive relationship

between Qs and P; positive slope-Qs increases as P increases, ceteris paribus.

PROFIT incentive

·

Determinants of supply: production costs, productivity,

government intervention, price of related goods, supply shocks.

-

Costs of production- higher costs = increased difficulty to make

profits (profit = revenue-cost), ceteris paribus. S decreases if costs

increase.

-

Productivity= amount of output per unit of input- aiming to

minimize the amount of FOPs to keep costs down. Increased productivity- methods

of production /technical improvements. Higher productivity increases supply.

-

Government intervention:

Introduction of

indirect taxes (collected at the point of sale then passed onto the

government)- part of production costs-decreases supply. Shifts supply curve

leftwards by the amount of the tax.

Introduction of

subsidies (payments made to firms to increase supply), Per-unit subsidy- made for each unit produced-

reduces costs- shifts supply curve rightwards- encouraging more supply at each

and every price.

-

Price of supply substitute- S decreases if price increases (uses

similar inputs and production methods)- more profitable.

-

Supply shocks-natural disaster, strikes,

·

Fundamental distinction between a movement along a supply curve

and a shift of the supply curve

-

Movement- change in price (law of supply)- change in Qs

-

Shift of the curve-change in determinants – change in S

(leftwards or rightwards)

Interaction of demand and supply

·

Equilibrium = market-clearing price and quantity (Qd = Qs), no

shortage nor surplus.

·

Diagrammatic analysis of changes in demand and supply to show

the adjustment to a new equilibrium (mechanism of free market to re-establish

equilibrium status).

market inefficiency- electricity shortage in southern China due to supply shock

(coals and drought) + the failing central planned coal price vs free-market

price- government regulations to ensure supply of coals- lower quality. *mainly

due to the central planned electricity price.

·

Price controls

·

Maximum price: causes (protecting consumers from paying

unaffordable prices and consequences (must be set below equilibrium, so

shortage Qs

Eg. Rent controls,

oil price controls, Chinese electricity shortage.

·

Minimum price: causes (protect producers from receiving absurdly

low prices) and consequences( surpluses Qs>Qd, resource inefficiency, firms

trying to sell illegally below the price floor, e.g. labour market

·

Price support/buffer stock schemes

·

Commodity agreements

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