IBDP HL Microeconomics Lecture Slides


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International Baccalaureate Diploma lecture slides for Microeconomics Unit.

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  • Sample IAs and for those interested Extended Essays will be shared. We will also have one mock IA submission to prepare you for the IB IAs.
  • Choice – Veg or Non. Veg for lunchElastic – luxury goods like X-box; Inelastic – necessary goods like food and petrolPrice discrimination – Nike example of shoes (Branding and luxury items)Different types of markets have different weaknesses. Different types of governments have different types of economic practices. Fidel Castro had banned Monopoly in Cuba as he considered it a monopolistic game.
  • Microsoft and Standard Oil – Apple and Exxon anti-trust casesOPEC – Oligopoly; Organization of Petroleum Producing CountriesColonialism – Exploitation; Curse of natural resources – barriers to developWorld Bank, the IMF – lend money; US National debt - http://www.usdebtclock.org/(15.8 Trillion since I last checked! That’s about $50K per person)
  • Levitt verses Krugman (see “Freakanomics”)A combination of art and scienceScientific MethodObservation  AssertionMore observation  Warranted AssertionMore observation  Theory
  • Other early economic stalwarts include John S. Mill, Karl Marx, Friedrich Engels, Malthus, Ricardo.Are social workers bad people?
  • There are several opposing schools of Economic thought, each with their own champions – Chicago, Neo-Classical, Liberal, Libertarian, Conservative, Socialist – and they are all deeply inter-linked with national political systems. The two can not be divorced from each other. Thus there is no real right answer in economics (in social science in general) only practiced norms. The video: http://www.youtube.com/watch?v=d0nERTFo-SkFor more videos: http://econstories.tv
  • *There is a new school of economic thought dealing with irrational expectations and behavior. https://www.coursera.org/course/behavioraleconY = C + I + G + NX is known as the aggregate demand model in macroeconomics, primarily developed by Keynes and his disciples.Cetris-Parabis (L)– “All else equal” – Any other field of knowledge use cetris parabis?Comes from “etcetra” = other things; “Para” = equal
  • Positive Statements – How the world is, so the statement can be proven as true or false, at least in principle. It can be tested against real data. An example: “A minimum wage policy will increase unemployment among unskilled labor”. Phrases to look out for: “may be”, “can”, “might”, “will”.Normative Statements – Opinions, value judgments, instructive – more examples: “Inflation is rising too fast”, “Income distribution is not fair”, “Key phrases to watch out for include “ought to be”, “should be”, “too much”, “too little”, “is fair”, “is unfair”…
  • Think of other positive and normative statements
  • The goal of economics is to improve efficiency in the use of and allocation of the world’s scarce resources.
  • Scarce natural goods – oil, coal, iron, food, landScarce man-made goods – steel, money (capital), power, food, man-powerScarce services – customer service, checkout counter
  • Free Market means no/minimal government intervention in determining the answer to the BASIC ECONOMIC QUESTIONS.In a Centrally Planned Economy, the government decides the answers to the three questions. Example: Communist states – Pre-1990 Bucharest, Romania had only one central dairy store!In a Communist regime (also known as command economies) all these questions are answered by the ruling party – Mao, Castro, Stalin, Kim Jong-Il. China, though a “Communist” state has embraced market reforms since Mao’s death in 1976. Similarly after the fall of the U.S.S.R. in 1991, Russia embraced market economics and after Castro stepped down as the leader of Cuba in 2007, Cuba too has shifted to a market based system. Only North Korea remains a true totalitarian regime.Economic Goods – Goods and services that require scarce material in order to be producedFree Goods – Zero Opportunity Cost – sea water, air; goods available at zero price are not free in an economic sense if scarce resources have been used to make them.
  • CIRCULAR FLOW OF INCOME MODEL:Goods and services flow clockwise (outer loop) and money flows anti-clockwise (inner loop)Households provide land and labor (Factors of Production or LS) to the Labor/Resource Market; Firms demand Factors of Production (LD) from the Labor/Resource Market.The Labor/Resource Market gets money (w) from firms and pays the households in terms of wages, rent, or interest (w).Once Firms have the necessary inputs, they sell their finished products to the households through the Goods Market (QS). Money earned from the Resource/Labor Market goes to paying for goods and services Household’s demand (P).This expenditure becomes revenue for the firms (P).This completes the circular flow of the market – inputs turn into outputs; income turns into revenue.Adam Smith – “Give me that which you want, and you shall have this which you want” ~ In a perfect world with no collusion and oppression.Competitive Market – A market where there are many small firms, the good is homogenous (identical across firms), and there are no barriers to entry or exit the market.
  • Think about these questions, research these questions
  • Constant Opportunity Cost – When the value of the best forgone alternative is always constant. The graph is a straight line since the slope (ratio of the trade-off is always constant for each subsequent sacrifice).Increasing Opportunity Cost – When the value of the best forgone alternative is increasing. The graph is a convex curve since the slope is constantly changing as the ratio of the trade-off increases with each sacrifice.
  • The opportunity cost is 3L (2L + 1L) because it the BEST foregone option.Putting the money in the bank and working at McDonald’s is NOT mutually exclusive so you can do both, hence the opportunity cost is the sum of the two.However, you can’t deliver pizzas AND work at McDonald’s so that 1L is not counted. Also, 1L + 1L < 2L + 1L, hence, the opportunity cost is 3L
  • Yes, he does.
  • (EXTRA) Production Function: QB = A f(K,L) where QB is the quantity of butter produced; A is the level of technology; K is the Capital and L is the labor.An algebraic example would be: QB = 3K +2L. So if K =10; L = 20, then QB = 70 kgs
  • The Law of Increasing Opportunity cost states that as you move towards one spectrum or the other, you have to give up more of the other. Every extra hour you study, you become less productive.
  • This is a non-linear PPF. We can also have a linear PPF where the trade-off is one to one, i.e. constant opportunity cost. The non-linear PPF is based on the Law of Increasing Opportunity Cost. When drawing the PPF, ensure that the PP curve is touching the two axes and that it is curved outward (increasing opportunity cost) or straight line (constant opportunity cost).
  • Any point outside the PPF is a non-feasible production region (D) – unless there is growth, in which case the entire PPF shifts outward.Any point inside the PPF is an inefficient production point (C) – can be due to recession or bad governanceAny point on the PPF (B) and (A) are optimal production points, no waste of resources.What all does the PPC tell us?Scarcity (if there was no scarcity, all points would be feasible); Choice; Efficiency; Inefficiency; Opportunity Cost (Constant Opportunity Cost, Increasing Opportunity Cost); GrowthNote, when there is a recession the PPC itself does not SHIFT INWARDS! The PPC shifts inwards when the economy shrinks – maybe when there is a war and half the population dies…
  • All Free Market – too much pollution, not enough libraries or art, high rates of unemployment, inadequate health care for the poor, risky behavior, scientific enterprise (holding back of tech. most research comes from Military and government funds), care for profit only at the cost of the environment (Fracking)All Government – lack of competition and hence motivation, deteriorating product, inefficiency, loss of freedom of choiceGovernment intervention can’t guarantee success, what is the cost of intervening – loss of freedom and enterprise, creation of loopholes, corruption.How can growth be bad? Using up natural resources, polluting, global warming, any others?The extent to which the goal of economic efficiency may conflict with the goal of equity?
  • (Code in Brackets) – Category of command terms – please refer to the student IB Course Guide. This is available on KISNet using this link: http://net.kis.in/kis_departments/social-studies/economics/subject-guide.htmlPlease read through Chapter 1 of your Course Companion as well.
  • Interaction between consumers and producers (firms) in the Product/Goods Market determines the market price of each product. Changes in market conditions therefore result in changes in market prices. These set off a chain of events which leads to more or less of the good being produced and so to a new allocation of scarce resources.Competitive Market – is the market for a good with a large number of buyers and sellers, where every single seller has little or no market power…Milton Friedman – “The great virtue… enable people who hate one another to deal with one another”…True?
  • It’s not enough for consumers to be willing to buy, they have to be able to afford it as well.
  • “Demand” and “Quantity Demanded” are different! “Demand” is the sum of all the individual quantity demanded at each pricing point.Suppose there are only Joey and Ross as consumers in a marketJoey’s quantity demand of coffee @ $2 is 5 coffees/weekRoss’s quantity demand of coffee @ $2 is 7 coffees/weekMarket DEMAND @ $2 is 12 coffees/week (the market demand is the sum of all individual demand curves)The LAW OF DEMAND states that if the price of a good rises then quantity demanded per period will fall, cetrisparabis.
  • Goals of a typical consumer:Consumer’s will try to maximize utility/happiness. They will do this by choosing a bundle of goods which maximizes their satisfaction and which they can afford, given their income and the prices in the market. Consumers are happiest when they get more goods at the lowest possible price.Given a limited amount of income, what and how many goods should be purchased to maximize utility/happiness.
  • DEMAND or the DEMAND CURVE is the schedule of *ALL* price and quantity demanded combinations. [Think of it as a PPC for quantity demanded]The demand curve may or may not touch the axes. It can be a straight line or slightly curved. What matters is that the curve is negatively sloped.
  • The same good may be a NORMAL good in one market and an INFERIOR good in another market.For example: Used Cars, in a low income population, if Income ↑ then Demand for used cars ↑, however, in a wealthy country, if Income ↑ then demand for used cars ↓. Singapore only allows cars less than ten years old…Rice and Steak (Vietnam and USA)Examples of inferior goods?Instant noodles, Maruti 800, Public transport
  • Other complements?
  • Things you should learn from this section:Explain the demand function of the form: Q = a – bPPlot the demand functionIdentify the slope and it’s meaning in a demand contextIdentify how a change in the equation will affect the curve
  • Form the demand schedule from the equation; plot the demand curve
  • Introduction to elastcityExamples of elastic and inelastic products?
  • Supply is the relationship between various possible prices and the corresponding quantities that the firms are willing to produce per period, ceteris paribus.
  • If a market consists of 100 identical firms and each is willing to offer 200 units per month at the price of $5, then the market supply will be 20,000 units per month at the price of $5 per unit.We assume perfect competition. This is implies the existence of many small, identical firms producing undifferentiated products whose prices are known to all consumers. Under perfect competition, market price is determined by the markets, not individual firms.
  • Like in the case of the Demand Curve – Shift LEFT means DECREASE and Shift RIGHT means INCREASE.
  • Like in the case of the Demand Curve – Shift LEFT means DECREASE and Shift RIGHT means INCREASE.
  • Direct Taxes verses Indirect TaxesLater we will see how firms can shift the burden of taxation to the consumer
  • Changes to the slope of the Supply curve will be dealt with when we cover elasticity in Unit 3.
  • If you are showing the supply curve crossing the Y-axis, please use dotted lines as the concept of negative quantity is absurd.
  • Resource allocation and efficiency considerations are greatly affected by market structure.Market structures are distinguished on the basis of the number of firms in the market (many, few, or one), type of product (homogenous or differentiated), and whether barriers to entry exist.
  • Examples of Perfectly Competitive Markets? - Commodities - Agricultural products - Watermelons in Shanghai in October
  • Despite being rare, PCMs are worth studying for what they teach us about resource allocation and the efficiency resulting from high levels of competition.Assuming no externalities, PCMs result in the most optimal social output and price of the four market structures. - No shortage or excess - MSC =MSB - Most efficient -> Efficiency decreases as markets become less competitive.
  • Despite being rare, PCMs are worth studying for what they teach us about resource allocation and the efficiency resulting from high levels of competition.Assuming no externalities, PCMs result in the most optimal social output and price of the four market structures. - No shortage or excess - MSC =MSB - Most efficient -> Efficiency decreases as markets become less competitive.
  • Anti-trust cases:Standard Oil was broken down into 34 smaller companies, the largest of which is Exxon and Chevron – with revenue streams larger than the economies or Portugal and Austria.
  • EOS: Ship building, aircraft manufacturing; NATURAL MONOPOLY - utilitiesLegal Barriers: Apple v. Samsung, “Bittersweet Symphony”; pharmaceuticals; nationalized companiesOwnership of vital resources: Real Madrid, Man CityAggressive tactics: Products known by their brand name – Hoover, Poloroid, Xerox, MobilAnyone who has lost that status - Bisleri
  • IBDP HL Microeconomics Lecture Slides

    1. 1. ABHISHEK MAITY 2012 MICROECONOMICS Abhishek Maity, KIS, 2012 1
    2. 2.  Unit 1: Introduction to Economics  Unit 2A: Demand  Unit 2B: Supply  Unit 3: Market Equilibrium  Unit 4: Elasticity  Unit 5: Taxes, Subsidy, and Price Control  Unit 6: Market Failure  Unit 7: Theory of Firms: Costs, Revenues, and Profits  Unit 8A: Theory of Firms: Perfect Competition and Monopoly  Unit 8B: Theory of Firms: Price Discrimination  Unit 9: Theory of Firms: Monopolistic Competition and Oligopolies Abhishek Maity, KIS, 2012 2
    3. 3. ABHISHEK MAITY SEMESTER 1, 2012 INTRODUCTION Abhishek Maity, KIS, 2012 3
    4. 4.  Economics Course Companion Second Edition (Blink and Dorton, Oxford)  Economics for the IB Diploma (Welker and Maley, Pearson)  The Good, the Bad, and the Economist (McGee, Cambridge)  Economics from the Global Perspective (Glanville, Glanville)  The IB Study Guide  Handouts and Lecture Slides (Go through the notes at the bottom please)  The internet! Abhishek Maity, KIS, 2012 4
    5. 5.  Please:  Bring your text book, note book, pen, pencil, and eraser to class  Refrain from using your cell phone in class  Be on time and don’t miss classes  Hand in your homework, essays, and assignments on time (your internal assessment depends on this)  Late submissions will not be entertained  Respect the classroom space, the subject, your fellow students, and yourself  ASK QUESTIONS!  Think, question, argue Abhishek Maity, KIS, 2012 5
    6. 6. Four Major Units:  Microeconomics (Grade 11 – Semester 1 and 2)  Macroeconomics  International Trade and Finance  Development Economics (Grade 11 – Semester 2) Abhishek Maity, KIS, 2012 6
    7. 7.  Differences between HL and SL  Two Papers in the SL and Three Papers in the HL  Paper 1 – Microeconomics and Macroeconomics (40% for SL and 30% for HL)  Paper 2 – International Economics and Development (40% for SL and 30% for HL)  Paper 3 – HL extension topics like Theory of Firm (20%)  Calculators allowed in Paper 3 of HL only  Internal Assessment (A portfolio of 3 article analysis of 750 words each over the two years) Abhishek Maity, KIS, 2012 7
    8. 8.  Internal Assessment and Formative Tests (20% for KIS Diploma)  Unit Quiz  Concept Test  Team Presentation  Homework Assignment  Article Analysis  Commentary  DRQ Analysis  Data Assignment  Internal Assessment Portfolio (IA) – 20% for IBDP specifically Abhishek Maity, KIS, 2012 8
    9. 9.  IB Internal Assessment (20% of your grade)  Three article analyses  Three different sources  Three different units  750 words  A demonstration of application of economic tools Abhishek Maity, KIS, 2012 9
    10. 10.  Introduction to Microeconomics  Scarcity, Choice, Opportunity Cost, PPF  Demand and Supply and Market Equilibrium  Price Mechanism and Market efficiency  Elasticity  Government Intervention and Price Controls  Market Failure  Theory of the Firm and Market Structures (HL Only)  Production  Pricing Mechanism  Law of Diminishing Returns Abhishek Maity, KIS, 2012 10
    11. 11.  Continuation of Theory of Firms from Semester 1 (HL only)  Monopolistic Competition  Oligopoly  Cost, Revenue and Profit  Economic Development (Unit 4)  Consequence of Growth and Barriers to Development  International Trade and Growth  Foreign Aid and National Debt  Free Markets and Government Intervention  Introduction to Keynesian and Austrian Economic Models. Abhishek Maity, KIS, 2012 11
    12. 12.  Any Questions?  If you’re having any difficulty please feel free to find me after class hours.  Email or find me in the Social Science Department Office to set-up an appointment. Abhishek Maity, KIS, 2012 12
    13. 13. A Science or an Art? Abhishek Maity, KIS, 2012 13
    14. 14.  Economics – Greek, meaning “Rules of the Household”  Move from Feudalism to Capitalism in the 17th Century  Creation of money and capital from the Barter System  Creation of Banking Systems  In the late 18th Century, Adam Smith (The Wealth of Nations) postulated the foundations of modern economic thought.  “The Invisible Hand” – Liberty and self interest leads to the optimal allocation of society's scarce resources Abhishek Maity, KIS, 2012 14
    15. 15.  EconStories  John Papola – Director  Russ Roberts – Professor of Economics at George Mason University  Created in the aftermath of the $700bn bailout of major US financial institution by the US Government  John Keynes – “Father of Modern Macro” – The General Theory  Regulated markets and central planning  F. A. Hayek – “Father of Austrian Economics” – The Road to Serfdom  Laissez-faire economy (“Let it be” – AS 1776)  Free market Libertarianism Abhishek Maity, KIS, 2012 15
    16. 16.  Economists develop rudimentary models to represent the real world  Models abstract from irrelevant details and use simplifying assumptions to facilitate analysis  Models are not perfect – they exist to help us directionally understand changes to complex systems  Y = C + I + G + NX  Assumption of cetris parabis  Allows economists to analyze the effects of one part of the economy (even though in reality many parts of the economy are changing simultaneously)  Assumption of rational* behavior and optimization Abhishek Maity, KIS, 2012 16
    17. 17.  Two kinds of economic analysis  Positive Economics – The part of economics that studies how the world actually works (the study of what *IS*) Descriptive  Normative Economics – The part of economics that studies how the world *SHOULD* be. Prescriptive Abhishek Maity, KIS, 2012 17
    18. 18.  Lowering income taxes may increase the amount people save  Positive Statement  Taxes on middle income people should be lowered  Normative Statement  The best way to lower the budget deficit is to raise taxes  Mixed Statement Abhishek Maity, KIS, 2012 18
    19. 19.  Economics is Social Science:  A study of interaction between humans, our institutions and the natural and social environment we inhabit  It is a HUMAN Science encompassing Psychology, Mathematics, Environmental Science, History and Finance.  Economics is the science of allocating scarce goods and services  ALLOCATION – Production (Supply) and Consumption (Demand)  SCARCE – Implies trade-offs (Opportunity Cost) Abhishek Maity, KIS, 2012 19
    20. 20.  Our resources are finite – our need and want is infinite  Includes natural and man-made goods and services  Examples?  LAND, LABOR, CAPITAL (Factors of Production)  Land resources – natural raw materials  Labor resources – human capital  Capital resources – tools, technology, and money  Allocation and distribution of these three resources led to development of different schools of economic thought and systems  Abundant resources?  Creativity and entrepreneurship  Solar and wind power? Abhishek Maity, KIS, 2012 20
    21. 21.  The Basic Economic Questions:  What should be produced?  Food, toys, clothes, tools, financial services, entertainment, call centers and BPOs (Business Process Outsourcing)  How should it be produced?  Labor intensive or capital intensive?  For whom should it be produced?  For domestic consumption or export?  For the affluent or for the common man? The MARKET determines the answers to these questions. There are FREE MARKETS and CENTRALLY PLANNED MARKETS Abhishek Maity, KIS, 2012 21
    22. 22.  A market is a place where buyers and sellers come together to engage in exchanges with one another  Circular Flow of the Market Abhishek Maity, KIS, 2012 22 Households Firms Labor MarketGoods Market w w LS LD P P QS QD
    23. 23.  QUESTIONS – EE/IA/TOK:  Do we need central planning for teachers, farmers, police, military?  How does a free market ensure that “indispensable” jobs get done?  Is privatization more efficient?  How are wages determined in centrally planned economies?  What is better a FREE MARKET, or a CENTRALLY PLANNED MARKET? Abhishek Maity, KIS, 2012 23
    24. 24.  As a result of scarcity, choices have to be made.  When a choice is made, an alternative is foregone.  Definition: The opportunity cost of any action is the value of best forgone alternative.  The TOTAL COST of any action is the DIRECT COST *plus* the OPPORTUNITY COST  TC = DC + OC Abhishek Maity, KIS, 2012 24
    25. 25.  What is the cost of your KIS Education?  Direct Cost = Rs. 8.5L + Rs. 1.5L + Rs. 1L + Rs. 1L = Rs. 12L/year  Opportunity Cost?  Work at McDonalds – Earn a salary – Rs. 2L  Put the money in the bank and earn interest – Rs. 1L  Delivering pizzas for Dominoes – Rs. 1L  Total Cost?  Total Cost = Direct Cost + Opportunity Cost  TC = 12L + 3L = 15L/year  NOTHING IS FREE Abhishek Maity, KIS, 2012 25
    26. 26.  Does Bill Gates have Opportunity Cost? Abhishek Maity, KIS, 2012 26
    27. 27.  Consider a simple economy  A fixed level of Technology (A)  2 Goods  Guns (G)  Butter (B)  2 Factors of Production  Labor (L)  Capital (K) – Let’s assume this is fixed Abhishek Maity, KIS, 2012 27
    28. 28. Scenario Guns (#) Butter (Kg) A 200 0 B 175 75 C 100 100 D 50 115 E 0 125 Abhishek Maity, KIS, 2012 28
    29. 29.  Production Possibilities Frontier (PPF): Is the locus of all possible efficient production points of an economy Abhishek Maity, KIS, 2012 29 Butter Guns Specialized in Gun Production A200 175 75 B 100 100 C 125 D Specialized in Butter Production PPF
    30. 30. Abhishek Maity, KIS, 2012 30 Guns Butter “RECESSION” “GROWTH” “FULL EMPLOYMENT” A B C D
    31. 31.  The extent to which governments should intervene in the allocation of resources.  The threat to sustainability as a result of current patterns of resource allocation  Sustainable development meets the needs of the present without compromising the ability of future generations to meet their own needs.  The distinction between economic growth and economic development  GDP vs HDI Abhishek Maity, KIS, 2012 31
    32. 32.  Positive/Normative statements (AO2)  Definitions: Competitive Market, Economics, Opportunity Cost (AO1)  Differences: Economic/Free Goods; Free Market/Centrally Planned Market (AO3)  Describe: Factors of Production, The Three Fundamental Economic Questions (AO1)  Drawing a Production Possibility Curve based on data. (AO4)  Describing points on a PPC (Feasible, inefficient, non-feasible, growth) (AO1)  Calculate: Total Cost based on data.(AO4) Abhishek Maity, KIS, 2012 32
    33. 33. ABHISHEK MAITY SEMESTER 1, 2012 DEMAND Abhishek Maity, KIS, 2012 33
    34. 34.  A market is an institution which permits the interaction between buyers and sellers.  In a FREE MARKET – the market also determines which goods to produce and how scarce resources will be allocated.  Types of Markets?  Labor Market (Factors are traded in Factor Market)  Financial Markets  Stock Market  Bond Market  Foreign Exchange Market  Product/Goods Market  Consumers and Producers determine price of products – DEMAND and SUPPLY Abhishek Maity, KIS, 2012 34
    35. 35.  Demand is the behavior of Consumers  Suppose you get an allowance for food every week:  Suppose you can only buy:  Burgers  As price increases, the quantity demanded decreases.  People have different earning levels and preferences.  SUBSTITUTION EFFECT: If the price of Good X increases then all other goods automatically become relatively cheaper so consumers will tend to substitute other goods for X.  INCOME EFFECT: If the price of Good X increases then purchasing power of consumers decrease and they will be able to afford less of X Abhishek Maity, KIS, 2012 35
    36. 36. The demand for good summarizes the behavior of buyers in a market. Various possible prices and quantity a buyer is willing and able to purchase per time period, cetris parabis. The relationship between price per unit and quantity demanded per period of time is inverse (negative) LAW OF DEMAND: As P the Qd AND as P the Qd There are very rare exceptions! Abhishek Maity, KIS, 2012 36
    37. 37. Abhishek Maity, KIS, 2012 37 Scenario Price Quantity of Books Demanded A $2 60,000 B $4 40,000 C $6 30,000 D $8 25,000 E $10 23,000
    38. 38. Abhishek Maity, KIS, 2012 38
    39. 39.  If INCOME changes?  If income increases, demand for most goods will increase.  The demand curve will “shift” to the right.  Only for NORMAL goods.  For an INFERIOR good, an increase in income will lower the demand for said product. Abhishek Maity, KIS, 2012 39
    40. 40.  A good is NORMAL if:  An increase in income leads to an increase in the demand or, more generally, if income and demand change in the same direction.  A good is INFERIOR if:  An increase in income leads to a decrease in its demand or, more generally, if income and demand change in the opposite directions. Abhishek Maity, KIS, 2012 40
    41. 41. Abhishek Maity, KIS, 2012 41 D1 D2 Quantity demanded per period Priceperunit Normal good: An increase in income will increase demand – the curve shifts right from D1 to D2 D1 D2 Priceperunit Inferior good: An increase in income will decrease demand – the curve shifts left from D1 to D2 Quantity demanded per period
    42. 42.  Two goods are considered COMPLEMENTS if they are often consumed together.  Example – Coffee and Sugar  If the price of a product increases then then the demand for its complement decreases.  If the price of coffee ↑ then the demand for sugar ↓ (the demand curve shifts to the left)  Similarly if the price of coffee ↓ then the demand for sugar ↑ (demand curve shifts to the right) Abhishek Maity, KIS, 2012 42
    43. 43.  Two goods are considered SUBSTITUTES if they are in competitive consumption – consumer buys one or the other.  Example – Coke and Pepsi  If the price of a product increases then then the demand for its substitute will increase.  If the price of Pepsi ↑ then the demand for Coke ↑ (the demand curve shifts to the right)  Similarly, if the price of Pepsi ↓ then the demand for Coke ↓ (the demand curve shifts to the left) Abhishek Maity, KIS, 2012 43
    44. 44.  Changes in taste  Tastes are affected by advertising, by fashion, by observing others, health considerations…  Changes in the size of the market  Increase in the population will increase demand for most goods  Changes in demographics  Ageing population of the baby boomers – demand for false teeth increases and chewing gum drops…  Seasonal change  Government Policy - taxation  EXPECTATIONS!  An expected change in income and or price of a good.  People buy more of a good before prices go up Abhishek Maity, KIS, 2012 44
    45. 45.  BIRD FLU!  Price of chicken collapses. What happens to the demand of its SUBSTITUTES – fish and mutton?  The demand for SUBSTITUTES go up!  TIP: Avoid saying demand curve shifts ‘up’ or ‘down’ – use ‘shift to the right’ or ‘shifts to the left’ Abhishek Maity, KIS, 2012 45
    46. 46.  Movement along demand curve  if the price of the good changes.  Movement of the demand curve  if any of the other factors affecting demand changes (income, price of substitutes, price of complements, and taste)  Please NOTE: Neither of these change the slope of the demand curve! Abhishek Maity, KIS, 2012 46
    47. 47.  Typical demand function:  Qd = a – bP  Qd is the quantity demanded  A is the natural demand or autonomous demand if price was 0  B is the relationship between price and quantity demanded – it is always negative! When the price increases by $1 (or 1 unit) then the quantity demanded decreases by the value of B.  P is the price of a single item Abhishek Maity, KIS, 2012 47
    48. 48.  Qd = 600 – 50P  @ P = 0, Qd = 600  -50 is the slope of the demand curve (from the form y = mx + c)  @ P = 10, Qd = 100  @ P = 5, Qd = 350 Abhishek Maity, KIS, 2012 48
    49. 49.  Change in the autonomous level of demand  How does the demand curve move when A changes?  What can a change in A represent?  Any of the factors that causes a shift in the demand curve! Abhishek Maity, KIS, 2012 49
    50. 50.  Change in the slope of the demand curve  How does the demand curve move when B changes?  What can a change in B represent?  People are changing their responsiveness to a change in prices!  Examples?  Petrol, cigarettes  X-box Abhishek Maity, KIS, 2012 50
    51. 51.  Consider the function: Qd = 300 – 30P  1. Create a demand schedule with P = $0, 3, 5, 7, and 9  2. Create a demand curve  Decrease a by 30 units and illustrate  Change the PRICE CO-EFFICIENT (b) to -10. Illustrate the new results Abhishek Maity, KIS, 2012 51
    52. 52. ABHISHEK MAITY SEMESTER 1, 2012 SUPPLY Abhishek Maity, KIS, 2012 52
    53. 53.  Supply is the behavior of Producers  Law of Supply:  If the price of a product increases then quantity supplied per period is expected to increase.  The relationship between price per unit and quantity supplied is directly proportional.  The supply curve will hence be positively sloped! Abhishek Maity, KIS, 2012 53
    54. 54.  Supply curve is the summation of the individual firms supply schedules.  At each price, we add the quantities supplied by each firm.  NOTE: The firms have to make identical products to be included in the supply curve. Abhishek Maity, KIS, 2012 54
    55. 55.  Why do we expect the LAW OF SUPPLY to hold?  Simple answer:  … because at a higher price, a firm’s profit margin is greater, inducing it to offer more units per period.  A more theoretically sound answer:  … because if it becomes costlier for the firm to produce more and more units per period of time using existing capacity, then it will be willing to do so only at a higher per unit price. Abhishek Maity, KIS, 2012 55
    56. 56.  Changes in the cost of FACTORS of PRODUCTION  Wages; LABOR ↑  Price of Raw Materials; LAND ↑  SUPPLY ↓ Or the SUPPLY CURVE “Shifts” LEFT Abhishek Maity, KIS, 2012 56
    57. 57.  Improvement in TECHNOLOGY – Cost of Production ↓  Increase in Productivity  Training, experience, healthier  SUPPLY ↑ or SUPPLY CURVE “Shifts” RIGHT Abhishek Maity, KIS, 2012 57
    58. 58.  Effect of Indirect Taxation?  Increase production cost hence supply “shifts” LEFT  Effect of Subsidy?  Decrease in production cost hence the supply “shifts” RIGHT Abhishek Maity, KIS, 2012 58
    59. 59.  Change in the price of JOINTLY SUPPLIED GOODS  If the price goes up, the supply of the JSG will also go up.  Change in the price of COMPETING SUPPLIED GOODS  If the price goes up, the supply of the CSG will go down.  Size of the MARKET – the number of FIRMS  Number of firms increase, then supply increases.  Natural conditions and disasters (SUPPLY SHOCKS)  Expectations  If you expect the price of a product to go up in the future, in the short run, supply might decrease, i.e. shift to the left. Abhishek Maity, KIS, 2012 59
    60. 60.  If the Price of the good changes  Movement along the supply curve  If any other factors affecting supply changes (Production factors, technology, productivity, Price of jointly produced goods, competitive supply, Indirect Taxes, subsidies, weather, disaster, market size etc)  Shift of the Supply Curve Abhishek Maity, KIS, 2012 60
    61. 61.  Standard form of the Supply Curve: Qs = C + dP  Qs represents the quantity supplied  C is the Natural or Autonomous Supply; it is the quantity supplied at P =0; typically C will be a negative value.  D represents the rate at which a change in price will cause the quantity supplied to increase in a supply function, d is always POSITIVE, keeping with the LAW of SUPPLY. So when the price increases by $1 (or 1 unit), then the quantity supplied increases by the value of D. Abhishek Maity, KIS, 2012 61
    62. 62.  Qs = -200 + 150P  Make P = 0 to get the value of C  Note that the P-intercept is at 1.33 (Qs = -200 when P =0)  Suppliers won’t sell you something for free!  Make the Supply Schedule/Table  Choose P = $0, 3, 5, 8, 10  Plot the curve! Abhishek Maity, KIS, 2012 62
    63. 63. Abhishek Maity, KIS, 2012 63 $0 $1 $2 $3 $4 $5 $6 0 100 250 400 550 Price($) Quantity Supplied(#) Supply Curve
    64. 64.  A change in C will mean that the natural supply or the autonomous supply is changing.  It will cause a shift to the right if C increases and a shift to the left if it decreases. Abhishek Maity, KIS, 2012 64
    65. 65.  A change in D will cause a change in the slope of the supply curve.  The slope can not be negative! Abhishek Maity, KIS, 2012 65
    66. 66.  Qs = -100 + 10P  Create a Supply schedule with prices of $10, 20, 30, 40, 50  Create a Supply Curve from the schedule  Increase the autonomous supply by 50 units – illustrate  Change the value of the price co-efficient to +30. Illustrate the new supply curve. Abhishek Maity, KIS, 2012 66
    67. 67. ABHISHEK MAITY SEMESTER 1, 2012 MARKET EQUILIBRIUM Abhishek Maity, KIS, 2012 67
    68. 68. ABHISHEK MAITY SEMESTER 1, 2012 ELASTICITY Abhishek Maity, KIS, 2012 68
    69. 69. ABHISHEK MAITY SEMESTER 1, 2012 TAXES, SUBSIDY, PRICE CONTROL Abhishek Maity, KIS, 2012 69
    70. 70. ABHISHEK MAITY SEMESTER 1, 2012 MARKET FAILURE Abhishek Maity, KIS, 2012 70
    73. 73. Traditionally markets are split into FOUR types: Perfect Competition Monopoly Monopolistic Competition Oligopoly Abhishek Maity, KIS, 2012 73
    74. 74. Characteristics: Very many small firms Altering their output won’t influence the market Price Takers Homogenous product No entry (or exit) barriers All participants have perfect information Perfect mobility of factors of production Abhishek Maity, KIS, 2012 74
    75. 75. Economies of Scale are common Product differentiation Information is not perfect There is no perfect mobility of factors of production particularly Labor Creation of barriers to entry Apple v. Samsung So why study perfectly competitive markets? Most efficient of the four market structures. Abhishek Maity, KIS, 2012 75
    76. 76. Abhishek Maity, KIS, 2012 76
    77. 77. ABHISHEK MAITY SEMESTER 2, 2012 THEORY OF FIRMS: MONOPOLY Abhishek Maity, KIS, 2012 77
    78. 78.  Definition:  “A monopoly is a market where one firm dominates the market for a good that has no substitutes and where significant barriers to entry exist” Abhishek Maity, KIS, 2012 78
    79. 79.  Standard Oil – 1940s  J.D. Rockefeller – 80% of all global oil production and refining.  Richest man in the world.  Microsoft – 1990s  Bill Gates – 90% of all operating system sales worldwide.  Richest man in the world.  TelMex – 2000s  Carlos “Slim” Helu – 90% of all telecom in Mexico, Central and South America  Richest man in the world Abhishek Maity, KIS, 2012 79
    80. 80.  Single seller  One firm controls the market – dominance.  No close substitutes  Sells something with no substitutes – unique product  Price-makers  Power to set prices  Constrained by the demand curve  Barriers to entry  Anything to avoid competition Abhishek Maity, KIS, 2012 80
    81. 81.  Economies of Scale (EOS)  Small firms can’t compete with lower costs via EOS  Legal Barriers  Copyrights, patents, licenses  Ownership of Essential Resources  Control of vital inputs  Aggressive Tactics  Buy out a rival firm/hostile takeover  “Predatory Pricing” and Anti-Competitive Behaviour  Choking supply of raw materials  Advertising/brand image building – BRAND LOYALTY  Diversify product range: Kelloggs Abhishek Maity, KIS, 2012 81
    82. 82.  Market Demand = Monopoly’s Demand  The monopoly controls the market so the market demand curve is the same curve the firm sees. Abhishek Maity, KIS, 2012 82 Price ($) Quantity TR ($) AR ($) MR ($) - 0 - - - 10 1 10 10 10 9 2 18 9 8 8 3 24 8 6 7 4 28 7 4 6 5 30 6 2 5 6 30 5 0 4 7 28 4 -2 3 8 24 3 -4 2 9 18 2 -6 1 10 10 1 -8
    83. 83.  As P↑ then Qd ; Law of Demand  Price = Average Revenue = DEMAND CURVE  Total Revenue increases then decreases – “diminishing returns”  Total Revenue starts to drop after MR = 0  MR↓ by 2x the Price or the demand curve.  The MR has twice the slope of the demand curve! Abhishek Maity, KIS, 2012 83