2. Lecture Outline
• Introductions & ice-
breakers
• Course Outline &
Assessments
• Class Rules & Contact
Details
• Introduction to Principles
of Economics
3. Course Outline
• Understanding Individual
Markets (The Price System)
• Consumer Behaviour and Utility
Theory
• Public Goods, public expenditures
& Common Resources
• The Costs of Production
• Price and Output Determination /
Profit Maximizing Decision in
Different Market Structures
• Macroeconomic Goals and
Measures
• Fiscal Policy and Macroeconomic
Issues
• Monetary Policy and
Macroeconomic Issues
5. What is Economics?
• “Economics is a
study of mankind in
the ordinary
business of life”
Alfred Marshal
6. The Basic Economic Problem
• Society’s resources are
limited or scarce
• The scarcity of society’s
resources means that it
cannot produce all the
goods and services people
wish to have
• How can we solve this
problem?
7. What is Economics?
• Economics is the study of how
society manages its scarce
resources.
• Two implicit assumptions:
1. People have unlimited
wants, but limited resources
2. Everything has a cost
Scarcity
Decision
making
Efficient
allocation of
resources
8. Thinking Like an Economist
• Economists apply a set of concepts and
principles to understand everyday life
around them
How the Economy
Works as a Whole
How People
Interact
How People
Make
Decisions
9. Principle 1: People Face Trade-Offs
• Making decisions requires trading-
off one goal against another
Ø To get one thing, we have to give up another
thing in return
• Examples of Trade-offs:
Ø How a students decides to allocate her time:
Studying vs. Watching something on Netflix
ØHow a family decides to spend their income:
Food vs. clothing vs. schooling
ØHow a government decides to spends it
budget: Healthcare vs. Defence
10. Principle 2: The Cost of Something is
What you Give Up to Get It
• Because people face trade-offs, making a
decision requires comparing the costs
and benefits between alternative
courses of action
The opportunity cost of an item is
what must be given up to obtain it
• The opportunity cost of something can
be monetary (e.g. forgone money) or
non-monetary (e.g. time)
11. Exercise: Would you rather….?
Trade-Offs & Opportunity Cost
• Which of the following would you rather choose?
What is the true cost of making your choice?
1. Going to the cinema with friends next Thursday night
or studying for an exam
2. Earning a university degree or getting a job
3. Depositing $100 in an interest-bearing savings account
or spending it on a new pair of shoes
When making a choice, the opportunity cost
is given by the next-best alternative.
12. Principle 3: Rational People Think
at the Margin
• For Economists, rational people are those that systematically
and purposefully do the best they can to achieve their objectives,
given available opportunities.
• Economists use marginal change to describe a small,
incremental adjustment to an existing plan of action.
ØE.g. An extra hour of studying instead of watching Netflix
Rational people often make
decisions by comparing marginal
benefits vs. marginal costs.
Marginal
Benefit
Marginal
Cost
13. Exercise: Marginal Decision
Making
• Suppose that the company you manage invested SR 5
Million in developing a new product, but the development
is not quite finished. At a recent meeting, your sales
executive reported that the expected sales of your new
product has been reduced to SR 3 Million as your
competitors have introduced a similar product. At the
same time, it would cost your company another SR 1
Million to finish the development of your product.
• Based on your understanding of marginal decision
making, discuss whether you should complete the
development of this product. If so, what is the most
you should be willing to pay to complete the
development? Explain your reasoning.
14. Letting Go of Sunk Costs..
• Sunk cost: A cost that has already been
committed and cannot be recovered
• Sunk costs should be irrelevant to decisions;
you must pay them regardless of your choice.
15. Principle 4: People Respond to
Incentives
• An incentive is something that induces a
person to act
ØAn incentive can be positive (i.e. reward) or
negative (i.e. punishment)
• Incentives are crucial to analysing how
markets work
ØI.e. Price incentives influence the behaviour of
consumers and producers and the outcomes of
markets
• Incentives are important to consider when
designing new policies
17. Thinking Like an Economist
• Economists try to address problems
with a scientist’s objectivity
• Economists make assumptions to
simplify complex real-world events
–Beware of over-simplifying
assumptions!
18. The Tools of Economics
Economic Analysis
Mathematics
Words
Diagrams
19. Microeconomics vs. Macroeconomics
Microeconomics
• The study of how
individual households
and firms make decisions
and how they interact with
another in markets
Macroeconomics
• The study of the economy
as a whole i.e. how
economic changes affect
many households, firms and
markets simultaneously
20. Positive vs. Normative
Positive
• What is?
• Not based on value
judgements
Normative
• What should to be?
• Based on value
judgements
21. MBEC
6001
Pre-‐Economics
L2:
Understanding
Individual
Markets
&
The
Price
Mechanism
The
Market
Forces
of
Supply
and
Demand
22. What
is
a
Market?
• In
a
market,
buyers as
a
group
determine
the
demand for
the
product
&
sellers as
a
group
determine
the
supply of
the
product
• When
buyers
and
sellers
interact
in
a
market
place,
the
price
and
quantity of
goods
and
services
are
determined
• Markets
can
be
highly
organized
or
less
organized
A
market is
a
group
of
buyers
and
sellers
of
a
particular
good
or
service
24. Demand
• The
QUANTITY
DEMANDED
of
a
good
is
the
amount
of
the
good
that
buyers
are
willing
and
able
to
purchase.
• The
quantity
demanded
of
a
good
will
be
influenced
by
many
factors,
but
the
most
important
factor
is
its
price
THE
LAW
OF
DEMAND:
Other
things
equal,
when
the
price
of
a
good
rises,
the
quantity
demanded
of
the
good
falls
and
when
the
price
falls,
the
quantity
demanded
rises.
The
quantity
demanded
is
negatively
related to
the
price.
25. The
Demand
Schedule
• A
DEMAND
SCHEDULE
is
a
table
that
shows
the
relationship
between
the
price
of
a
good
and
the
quantity
demanded.
• E.g.
Coffeeholic’s demand
for
lattes
• Holding
constant
everything
else
that
may
influence
how
many
lattes
Coffeeholic wants
to
buy,
the
demand
schedule
shows
that
his/her
preferences
OBEY
THE
LAW
OF
DEMAND
Price
of
lattes
Quantity
of
lattes
demanded
$0.00 16
1.00 14
2.00 12
3.00 10
4.00 8
5.00 6
6.00 4
26. $0.00
$1.00
$2.00
$3.00
$4.00
$5.00
$6.00
0 5 10 15
Price
of
Lattes
Quantity
of
Lattes
The
Individual
Demand
Curve
Price
of
lattes
Quantity
of
lattes
demanded
$0.00 16
1.00 14
2.00 12
3.00 10
4.00 8
5.00 6
6.00 4
The
DEMAND
CURVE
is
a
graph
of
the
relationship
between
the
price
of
a
good
and
the
quantity
demanded.
A
demand
curve
is
always
downward
sloping.
27. Market
Demand
Vs.
Individual
Demand
4
6
8
10
12
14
16
Coffeeholic’s Qd
2
3
4
5
6
7
8
Latteholic’s
Qd
+
+
+
+
=
=
=
=
6
9
12
15
+ = 18
+ = 21
+ = 24
Market
Qd
$0.00
6.00
5.00
4.00
3.00
2.00
1.00
Price
• The
MARKET
DEMAND
CURVE
shows
how
the
total
quantity
demanded
of
a
good
varies
as
the
price
of
the
good
varies,
while
all
other
factors
are
held
constant.
• The
market
demand
curve
is
the
SUM of
all
individual
demands
for
a
particular
good.
Assuming
Coffeeholic &
Latteholic are
the
only
buyers
in
the
market,
the
market
demand
is
the
sum
of
the
quantities
demanded
(Qd)
by
them
at
each
price.
28. $0.00
$1.00
$2.00
$3.00
$4.00
$5.00
$6.00
0 5 10 15 20 25
P
Q
The
Market
Demand
Curve
for
Lattes
P
Qd
(Market)
$0.00 24
1.00 21
2.00 18
3.00 15
4.00 12
5.00 9
6.00 6
A
Change
in
the
price
of
lattes
causes
movements
along
the
demand
curve
(e.g.
a
decrease
in
the
price
from
$3
-‐ $2
will
cause
an
increase
in
demand
from
15-‐18).
29. Shifts
in
the
Demand
Curve
• The
demand
curve
shows
the
quantity
demanded
at
any
given
price,
other
things
being
equal
(ceteris
paribus).
• These
“other
things”
are
non-‐price
determinants that
may
alter
demand
(e.g.
income,
tastes,
expectations)
• A
change
in
any
of
these
determinant
will
cause
SHIFTS in
the
demand
curve
Ø Changes
that
lead
to
an
INCREASE
in
demand
à Shift
the
D-‐curve
RIGHTWARDS
Ø Changes
that
lead
to
a
DECREASE
in
demand
à Shift
the
D-‐curve
LEFTWARDS
30. $0.00
$1.00
$2.00
$3.00
$4.00
$5.00
$6.00
0 5 10 15 20 25 30
P
Q
Suppose
the
number
of
buyers
increases.
Then,
at
each
P,
Qd will
increase
(by
5
in
this
example).
Demand
Curve
Shifters:
#
of
Buyers
An
increase
in
the
number
of
buyers,
increases
the
quantity
demanded
at
each
price.
This
leads
the
D-‐curve
to
shift
to
the
right.
31. Demand
Curve
Shifters:
Income
• The
effect
of
change
in
income
on
demand
depends
on
the
type
of
good:
Normal
Good
• Demand
for
a
normal
good
is
positively
related
to
income.
• An
increase
in
income
increases
the
quantity
demanded
at
each
price.
This
leads
the
D-‐curve
to
shift
to
the
right.
Inferior
Good
• Demand
for
an
inferior
good
is
negatively
related to
income.
• An
increase
in
income
decrease
the
quantity
demanded
at
each
price.
This
leads
the
D-‐curve
to
shift
to
the
left.
32. Demand
Curve
Shifters:
Prices
of
Related
Goods
• The
relationship
between
two
goods
can
be
described
as
being
substitutes
or
complements:
• Two
goods
are
substitutes
if
an
increase
in
the
price
of
one
causes
an
increase
in
the
demand for
the
other.
Substitutes
• Two
goods
are
compliments
if
an
increase
in
the
price
of
one
causes
a
fall
in
the
demand for
the
other.
Complements
33. Exercise:
Relationships
between
Goods
• EXERCISE:
If
an
increase
in
the
price
of
mangoes
leads
to
an
increase
in
the
demand
for
pineapples,
then
mangoes
&
pineapples
are:
A. Complements
B. Substitutes
C. Normal
Goods
D. Inferior
Goods
34. Demand
Curve
Shifters:
Tastes
• Anything
that
causes
a
shift
in
tastes
toward
a
good
will
increase
demand
for
that
good
and
shift
its
D-‐curve
to
the
right.
• Examples:
ØAs
kale
becomes
more
popular
for
healthier
eating
habits,
this
causes
an
increase
in
demand
for
kale,
which
shifts
the
kale
demand
curve
to
the
right.
35. Demand
Curve
Shifters:
Expectations
• Expectations
affect
consumers’
buying
decisions
and
therefore,
their
demand
for
goods
and
services.
• Examples:
ØIf
people
expect
their
incomes
to
rise,
their
demand
for
meals
at
expensive
restaurants
may
increase
now.
ØIf
the
economy
is
in
a
downturn
and
people
worry
about
their
future
job
security,
demand
for
new
cars
may
fall
now.
36. Summary:
Variables
That
Influence
Buyers
Variable A
change
in
this
variable…
Price …causes
a
movement
along the
D curve
#
of
buyers …shifts the
D curve
Income …shifts the
D curve
Price
of
related
goods …shifts the
D curve
Tastes …shifts the
D curve
Expectations …shifts the
D curve
37. Exercise:
Demand
Curve
Shifters
• EXERCISE:
Which
of
the
following
would
cause
a
decrease
in
the
demand
for
Shahid
subscriptions?
A. An
increase
in
the
popularity
of Shahid-‐produced
shows.
B. An
increase
in
the
number
of
smart-‐device
users.
C. A
decrease
in
household
disposable
incomes
(if
Shahid
is
a
normal
good).
D. An
increase
in
the
price
of Netflix
subscriptions (if
Shahid
&
Netflix
are
substitutes).
39. Supply
• The
QUANTITY
SUPPLIED
of
a
good
is
the
amount
of
the
good
that
sellers
are
willing
and
able
to
sell.
• The
quantity
supplied
of
a
good
will
be
influenced
by
many
factors,
but
the
most
important
factor
is
its
price
THE
LAW
OF
SUPPLY:
Other
things
equal,
when
the
price
of
a
good
rises,
the
quantity
supplied
of
the
good rises
and
when
the
price
falls,
the
quantity
supplied
falls.
The
quantity
supplied
is
positively
related to
the
price.
40. The
Supply
Schedule
Price
of
lattes
Quantity
of
lattes
supplied
$0.00 0
1.00 3
2.00 6
3.00 9
4.00 12
5.00 15
6.00 18
• A
SUPPLY
SCHEDULE
is
a
table
that
shows
the
relationship
between
the
price
of
a
good
and
the
quantity
supply.
• E.g.
Coffee
Bean’s
supply
of
lattes
• Holding
constant
everything
else
(ceteris
paribus)
that
may
influence
how
many
lattes
Coffee
Bean
wants
to
sell,
the
supply
schedule
OBEYS
THE
LAW
OF
SUPPLY
41. $0.00
$1.00
$2.00
$3.00
$4.00
$5.00
$6.00
0 5 10 15
The
Individual
Supply
Curve
Price
of
lattes
Quantity
of lattes
supplied
$0.00 0
1.00 3
2.00 6
3.00 9
4.00 12
5.00 15
6.00 18
P
Q
The
SUPPLY
CURVE
is
a
graph
of
the
relationship
between
the
price
of
a
good
and
the
quantity
supplied.
A
supply
curve
is
always
upward
sloping.
42. Market
Supply
Vs.
Individual
Supply
• The
MARKET
SUPPLY
CURVE
shows
how
the
total
quantity
supplied
of
a
good
varies
as
the
price
of
the
good
varies,
while
all
other
factors
are
held
constant.
• The
market
supply
curve
the
SUM of
the
quantities
supplied
by
all
sellers at
each
price.
18
15
12
9
6
3
0
Coffee
Bean’s
Qs
12
10
8
6
4
2
0
Costa’s
Qs
+
+
+
+
=
=
=
=
30
25
20
15
+ = 10
+ = 5
+ = 0
Market
Qs
$0.00
6.00
5.00
4.00
3.00
2.00
1.00
Price
Assuming
Coffee
Bean
&
Costa
are
the
only
sellers
in
the
market,
the
market
supply
is
the
sum
of
the
quantities
supplied
by
them
at
each
price.
44. Shifts
in
the
Supply
Curve
• The
demand
curve
shows
the
quantity
supplied
at
any
given
price,
other
things
being
equal
(ceteris
paribus).
• These
“other
things”
are
non-‐price
determinantsthat
may
change
supply
(e.g.
technology,
expectations)
• A
change
in
any
of
these
determinant
will
causes
SHIFTS in
the
supply
curve:
ØChanges
that
lead
to
an
INCREASE
in
supply
à Shift
the
S-‐curve
RIGHTWARDS
ØChanges
that
lead
to
an
DECREASE
in
supply
à Shift
the
S-‐curve
LEFTWARDS
45. Supply
Curve
Shifters:
Input
Prices
• Examples
of
input
prices:
wages,
prices
of
raw
materials.
• 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.
46. $0.00
$1.00
$2.00
$3.00
$4.00
$5.00
$6.00
0 5 10 15 20 25 30 35
P
Q
Supply Curve Shifters: Input Prices
Suppose
the
price
of
milk
falls.
Then,
at
each
P,
Qs of
lattes
will
increase
(by
5
in
this
example).
An
fall
in
input
prices,
increases
the
quantity
supplied
at
each
price.
This
leads
the
S-‐curve
to
shift
to
the
right.
47. Supply
Curve
Shifters:
Technology
• Technology
determines
how
much
inputs
are
required
to
produce
a
unit
of
output.
• A
cost-‐saving
technological
improvement
has
the
same
effect
as
a
fall
in
input
prices,
which
leads
the
S-‐curve
to
shift
to
the
right.
48. Supply
Curve
Shifters:
#
of
Sellers
• An
increase
in
the
number
of
sellers
increases
the
quantity
supplied
at
each
price,
shifts
the
S-‐ curve
to
the
right.
49. Supply
Curve
Shifters:
Expectations
• In
general,
sellers
may
adjust
supplywhen
their
expectations
of
future
prices
change.
Examples:
• If
sellers
expect
the
price
of
coffee
beans
to
rise
in
the
future,
they
will
put
some
of
their
current
production
into
storage
and
supply
less
to
the
market
today,
which
shifts
the
S-‐curve
to
the
left.
50. Summary:
Variables
that
Influence
Sellers
Variable A
change
in
this
variable…
Price …causes
a
movement
along the
S curve
Input
Prices …shifts the
S curve
Technology …shifts the
S curve
#
of
Sellers …shifts the
S curve
Expectations …shifts the
S curve
51. Exercise:
Supply
Curve
Shifters
• EXERCISE:
Which
of
the
following
would
cause
the
supply
of
manufactured
clothing
to
increase?
A. An
increase
in
the
cost
of
raw
materials.
B. An
improvement
in
manufacturing
technology.
C. A
decrease
in
the
number
of
clothing
manufacturers.
D. An
increase
in
the
wages
of
workers
employed
in
clothing
factories.
53. The
Law
of
Demand
vs.
Supply
THE
LAW
OF
DEMAND:
Other
things
equal,
when
the
price
of
a
good
rises,
the
quantity
demanded
of
the
good falls
and
when
the
price
falls,
the
quantity
demanded
rises.
THE
LAW
OF
SUPPLY:
Other
things
equal,
when
the
price
of
a
good
rises,
the
quantity
supplied
of
the
good rises
and
when
the
price
falls,
the
quantity
supplied
falls.
55. Terms
for
Shifts
vs.
Movements
Along
Curves
• Change
in
supply: A
shift in
the
S curve
occurs
when
a
non-‐price
determinant
of
supply
changes
(like
technology
or
costs).
• Change
in
the
quantity
supplied: A
movement along
a
fixed
S
curve
occurs
when
P changes.
• Change
in
demand: A
shift in
the
D curve
occurs
when
a
non-‐
price
determinant
of
demand
changes
(like
income
or
#
of
buyers).
• Change
in
the
quantity
demanded:A
movement along
a
fixed
D curve
occurs
when
P changes.
56. $0.00
$1.00
$2.00
$3.00
$4.00
$5.00
$6.00
0 5 10 15 20 25 30 35
P
Q
Putting
Supply
and
Demand
Together
D S Equilibrium:
P has
reached
the
level
where
quantity
supplied
equals
quantity
demanded
57. D S
$0.00
$1.00
$2.00
$3.00
$4.00
$5.00
$6.00
0 5 10 15 20 25 30 35
P
Q
Equilibrium
P QD QS
$0 24 0
1 21 5
2 18 10
3 15 15
4 12 20
5 9 25
6 6 30
The
equilibrium
price
is
the
price
that
equates
quantity
supplied
with
quantity
demanded
58. D S
$0.00
$1.00
$2.00
$3.00
$4.00
$5.00
$6.00
0 5 10 15 20 25 30 35
P
Q
P QD QS
$0 24 0
1 21 5
2 18 10
3 15 15
4 12 20
5 9 25
6 6 30
The
equilibrium
quantity
is
the
quantity
supplied
and
quantity
demanded
at
the
equilibrium
price
Equilibrium
59. $0.00
$1.00
$2.00
$3.00
$4.00
$5.00
$6.00
0 5 10 15 20 25 30 35
P
Q
D S
Surplus
(A.K.A.
Excess
supply):
A
surplus occurs
when
the
quantity
supplied is
greater
than
quantity
demanded
Surplus
Example:
If P = $5,
then
QD = 9 lattes
and
QS = 25 lattes
resulting in a
surplus of 16 lattes
60. $0.00
$1.00
$2.00
$3.00
$4.00
$5.00
$6.00
0 5 10 15 20 25 30 35
P
Q
D S Facing a surplus,
sellers try to increase
sales by cutting price.
This causes
QD to rise
Surplus
…which reduces the
surplus.
and QS to fall…
Surplus (A.K.A.
Excess
supply):
A
surplus occurs
when
the
quantity
supplied
is
greater
than
quantity
demanded
61. $0.00
$1.00
$2.00
$3.00
$4.00
$5.00
$6.00
0 5 10 15 20 25 30 35
P
Q
D S Facing a surplus,
sellers try to increase
sales by cutting price.
This causes
QD to rise and QS to fall.
Surplus
Prices continue to fall
until market reaches
equilibrium.
Surplus
(A.K.A.
Excess
supply):
A
surplus occurs
when
the
quantity
supplied
is
greater
than
quantity
demanded
62. $0.00
$1.00
$2.00
$3.00
$4.00
$5.00
$6.00
0 5 10 15 20 25 30 35
P
Q
D S Example:
If P = $1,
then
QD = 21 lattes
and
QS = 5 lattes
resulting in a
shortage of 16 lattes
Shortage
Shortage (A.K.A.
Excess
Demand):
A
shortage occurs
when
the
quantity
demanded is
greater
than
quantity
supplied
63. $0.00
$1.00
$2.00
$3.00
$4.00
$5.00
$6.00
0 5 10 15 20 25 30 35
P
Q
D S Facing a shortage,
sellers raise the price,
causing QD to fall
…which reduces the
shortage.
and QS to rise,
Shortage
Shortage (A.K.A.
Excess
Demand):
A
shortage occurs
when
the
quantity
demanded is
greater
than
quantity
supplied
64. $0.00
$1.00
$2.00
$3.00
$4.00
$5.00
$6.00
0 5 10 15 20 25 30 35
P
Q
D S Facing a shortage,
sellers raise the price,
causing QD to fall
and QS to rise.
Shortage
Prices continue to rise
until market reaches
equilibrium.
Shortage (A.K.A.
Excess
Demand):
A
shortage occurs
when
the
quantity
demanded is
greater
than
quantity
supplied
65. Exercise:
Surpluses
vs.
Shortages
• EXERCISE:
Are
the
following
statements
TRUE or
FALSE?
• If
the
price
of
a
good
is
less
than
the
equilibrium
price,
there
is
surplus
and
the
price
will
fall.
• If
the
price
of
a
good
is
greater
than
the
equilibrium
price,
there
is
shortage
and
the
price
will
increase
66. Three
Steps
to
Analyzing
Changes
in
Equilibrium
To
determine
the
effects
of
any
event:
1. Decide
whether
event
shifts
S curve,
D curve,
or
both.
2. Decide
in
which
direction curve
shifts.
3. Use
supply-‐demand
diagram
to
see
how
the
shift
changes
eq’m P and
Q.
67. The
Market
for
Lattes
P
Q
D1
S1
P1
Q1
Price of
Lattes
Quantity of
Lattes
In
equilibrium,
the
quantity
demanded
for
Lattes
equals
the
quantity
supplied
of
Lattes
and
the
market
price
and
quantity
of
Lattes
is
determined.
68. STEP
1:
• D curve
shifts
because
price
of
tea
affects
the
demand
for
lattes.
• S curve
does
not
shift,
because
price
of
tea
does
not
affect
cost
of
producing
lattes.
STEP
2:
• D shifts
right because
a
higher
price
of
tea
makes
lattes
more
attractive
to
consumers.
EXAMPLE
1:
A
Shift
in
Demand
EVENT:
An
increase
in
price
of
tea.
P
Q
D1
S1
P1
Q1
D2
P2
Q2
STEP
3:
• The
shift
causes
an
increase
in
price
and
quantity
of
Lattes
in
the
market.
69. P
Q
D1
S1
P1
Q1
D2
P2
Q2
Notice
that:
When
P rises,
producers
supply
a
larger
quantity
of
Lattes,
even
though
the
S
curve
has
not
shifted.
Always
be
careful
to
distinguish
between
a
shift
in
a
curve
and
a
movement
along
the
curve.
Always
be
careful
to
distinguish
between
a
shift
in
a
curve
and
a
movement
along
the
curve.
EXAMPLE
1:
A
Shift
in
Demand
70. STEP
1:
• S curve
shifts
because
the
event
affects
cost
of
production.
• D curve
does
not
shift,
because
input
costs
is
not
one
of
the
factors
that
affect
demand.
STEP
2:
• S shifts
right
because
event
reduces
cost,
making
production
more
profitable
at
any
given
price.
P
Q
D1
S1
P1
Q1
S2
P2
Q2
STEP
3:
• The
shift
causes
price
to
fall
and
quantity
to
rise.
EVENT:
An
decrease
in
the
price
of
coffee
beans.
EXAMPLE
2:
A
Shift
in
Supply
71. P
Q
D1
S1
P1
Q1
S2
D2
P2
Q2
STEP
1:
Both
curves
shift.
STEP
2:
Both
shift
to
the
right.
STEP
3:
Q rises,
but
effect
on
P is
ambiguous:
If
demand
increases
more
than
supply,
P rises.
EXAMPLE
3:
A
Shift
in
BOTH
Demand
and
Supply
EVENT:
An
increase
in
the
price
of
tea
AND
a
decrease
in
the
price
of
coffee
beans.
72. P
Q
D1
S1
P1
Q1
S2
D2
P2
Q2
EXAMPLE
3:
A
Shift
in
BOTH
Demand
and
Supply
STEP
3
Continued:
But
if
supply
increases
more
than
demand,
P falls.
EVENT:
An
increase
in
the
price
of
tea
AND
a
decrease
in
the
price
of
coffee
machines.
73.
74. Exercise:
Demand
&
Supply
• EXERCISE:
All
other
things
equal,
an
increase
in
the
supply
of
desert
safari
tours
will
tend
to
cause:
A. An
increase
in
the
equilibrium
price
and
quantity
of
desert
safari
tours.
B. An
increase
in
the
equilibrium
price
and
a
decrease
in
the
equilibrium
quantity
of
desert
safari
tours.
C. A
decrease
in
the
equilibrium
price
and
an
increase
in
the
equilibrium
quantity
of
desert
safari
tours.
D. A
decrease
in
the
equilibrium
price
and
quantity
of
desert
safari
tours.
75. Takeaways
• In
market
economies,
prices
adjust
to
balance
supply
and
demand.
• Equilibrium
prices
are
the
signals
that
guide
economic
decisions
and
thereby
allocate
scarce
resources.
Markets
are
usually
a
good
way
to
organize
economic
activity
77. Thought Experiment
• Imagine that after graduating you decided to
run your own business.
• You must decide how much to produce, what
price to charge, how many workers to hire, etc.
• What factors should affect these decisions?
Your costs
How much competition you face
• The level of competition will be
determined by the type of market
structure.
79. Market Structures
• Markets may be characterized by different degrees of competition:
High Competition Low Competition
Perfect
Competition
Monopoly
Oligopoly
Monopolistic
Competition
Perfect
Competition
Monopolistic
Competition
Oligopoly Monopoly
Number of
Sellers
Many Many Few One
Products Sold
by Firms
Identical Differentiated
(similar, but not
identical)
Differentiated or
identical
Unique
Market Power
Held by Firms
No market
power (Price
Takers)
Some market
power
Some market
power
Complete
market power
(Price Maker)
Barriers to
Entry
Low to no
barriers
Low to no
barriers
Some barriers High barriers
82. 7
Characteristics of Perfect
Competition
1. Many buyers and many sellers.
2. The goods offered for sale are largely the same.
3. Firms can freely enter or exit the market.
Because of 1 & 2, each buyer and seller is a
“price taker” – takes the price as given.
83. Decisions Faced by Perfectly
Competitive Firm
• Profit maximizing decision: How
does a competitive firm determine
the quantity that maximizes profits?
• Shut down decision: When might
a competitive firm shut down in the
short run?
• Exit decision: When might a
competitive firm exit the market in
the long run?
85. The Costs of a Competitive Firm
• The total costs faced by different can be categorized into
two types:
Total Costs (TC)
TC = FC +VC
Fixed Costs (FC)
Costs that do not vary
with the quantity of
output produced.
Variable Costs (VC)
Costs that vary with the
quantity produced.
E.g.
Wages,
costs of
materials,
etc.
E.g. Rent,
cost of
equipment,
loan
payments
86. Fixed vs. Variable Costs
7
6
5
4
3
2
1
620
480
380
310
260
220
170
$100
520
380
280
210
160
120
70
$0
100
100
100
100
100
100
100
$100
0
TC
VC
FC
Q
$0
$100
$200
$300
$400
$500
$600
$700
$800
0 1 2 3 4 5 6 7
Q
Costs
FC
VC
TC
Notice
that the
TC curve
is parallel
to the VC
curve but
is higher
by the
amount
FC.
87. The Costs of a Competitive Firm
• The per unit costs of
production are given by:
Average total cost (ATC)
Average variable cost
(AVC)
Average fixed cost (AFC)
∆TC
∆Q
MC =
TC
Q
ATC =
VC
Q
AVC =
FC
Q
AFC =
• Marginal cost (MC) of
production is given by the
change in TC that arises from
producing one more unit.
88. Initially when
a firm
increases its
output, TC &
VC start to
increase at a
diminishing
rate. This is
why marginal
cost falls until
it reaches a
minimum.
Then, as
output rises,
the marginal
cost increases.
Marginal Cost
620
7
480
6
380
5
310
4
260
3
220
2
170
1
$100
0
MC
TC
Q
140
100
70
50
40
50
$70
$0
$25
$50
$75
$100
$125
$150
$175
$200
0 1 2 3 4 5 6 7
Q
Costs
92. Economies of Scale
Economies of Scale:
• Occur when an increase in a firm’s level of
output lowers the average costs of
production.
• Results from:
• Specialization of labour
• Spreading of fixed costs
• Bulk purchase of factor inputs
Diseconomies of Scale:
• Occur when an increase in a firm’s level of
output raises the average costs of
production.
• Results from:
• Bureaucracy
• Higher labour costs
• Spreading specialized resources too thin
93. The Various Cost
Curves Together
AFC
AVC
ATC
MC
$0
$25
$50
$75
$100
$125
$150
$175
$200
0 1 2 3 4 5 6 7
Q
Costs
94. Use AFC =
FC/Q
Use AVC =
VC/Q
Use MC = Δ
TC/ Δ Q
Use ATC =
TC/Q
First, deduce
FC = $50 and
use TC = FC
+ VC
380
280
210
120
70
VC
80
63.33
16.67
480
6
56
5
77.50
25
310
4
86.67
53.33
33.33
260
3
220
2
$170
$70
1
n/a
n/a
n/a
$100
0
MC
ATC
AVC
AFC
TC
Q
100
40
$70
Exercise: The Costs of a Competitive Firm
Fill in the below cost structure for a perfectly
competitive firm:
95. Use AFC =
FC/Q
Use AVC =
VC/Q
Use MC = Δ
TC/ Δ Q
Use ATC =
TC/Q
First, deduce
FC = $50 and
use TC = FC
+ VC
380
280
210
160
120
70
$0
VC
80
63.33
16.67
480
6
76
56
20
380
5
77.50
52.50
25
310
4
86.67
53.33
33.33
260
3
110
60
50
220
2
$170
$70
$100
170
1
n/a
n/a
n/a
$100
0
MC
ATC
AVC
AFC
TC
Q
100
70
50
40
50
$70
Exercise: The Costs of a Competitive Firm
Fill in the below cost structure for a perfectly
competitive firm:
96. The Revenues of a Competitive
Firm
• Total revenue (TR)
• Average revenue (AR)
• Marginal revenue (MR)
The change in TR from
selling one more unit.
∆TR
∆Q
MR =
TR = P x Q
TR
Q
AR = = P
97. Exercise: The Revenues of a
Competitive Firm
$50
$10
5
$40
$10
4
$10
3
$10
2
$10
$10
1
n/a
$10
0
TR
P
Q MR
AR
$10
99. MR = P for a Competitive Firm
• A competitive firm can keep increasing its output
without affecting the market price.
• So, each one-unit increase in Q causes revenue to
rise by P, i.e., MR = P.
MR = P is only true for
firms in competitive markets.
100. Profit Maximization
• What Q maximizes the firm’s profit?
• To find the answer, “think at the margin”.
➢If increase Q by one unit, revenue rises by MR,
cost rises by MC.
• If MR > MC, then increase Q to raise profit.
• If MR < MC, then reduce Q to raise profit.
101. Profit Maximization
Rule: The profit-maximizing Q occurs when:
MR = MC
If this is not satisfied, choose Q where:
MR ≈ MC but MR > MC
104. Shutdown vs. Exit
• Shutdown:
A short-run (SR) decision not to produce anything
because of market conditions.
• Exit:
A long-run (LR) decision to leave the market.
• A key difference:
If firms shut down in the SR, they must still pay
FC (Fixed costs).
If firms exit in the LR, they incur zero costs.
105. A Firm’s Short-run Decision to
Shut Down
• Cost of shutting down: Revenue loss = TR
• Benefit of shutting down: Cost savings = VC
(Variable Cost) (firms must still pay FC)
• So, shut down if TR < VC
• Divide both sides by Q: TR/Q < VC/Q
• So, firm’s decision rule is:
Shut down if P < AVC
106. The Irrelevance of Sunk Costs
• Sunk cost: A cost that has already been
committed and cannot be recovered
• Sunk costs should be irrelevant to decisions;
you must pay them regardless of your choice.
• FC is a sunk cost: The firm must pay its fixed
costs whether it produces or shuts down.
• So, FC should not matter in the decision to
shut down.
107. A Firm’s Long-Run Decision to
Exit the Market
• Cost of exiting the market: Revenue loss = TR
• Benefit of exiting the market: Cost savings =
TC (zero FC in the long run)
• So, firm exits if TR < TC
• Divide both sides by Q to write the firm’s decision
rule as:
Exit if P < ATC
108. A New Firm’s Decision to Enter
the Market
• In the long run, a new firm will enter the market if
it is profitable to do so: if TR > TC.
• Divide both sides by Q to express the firm’s entry
decision as:
Enter if P > ATC
109. Case Study:
Near-empty Restaurants
• To decide whether to stay open for lunch, the restaurant should
rationally compare the benefits vs. the costs of closing for lunch
(i.e. a temporary shut-down):
• Cost of shutting down: Revenue lost = TR
• Benefit of shutting down: Cost savings = VC (Only VC is
relevant, FC is sunk)
Shut down if revenues from lunch < variable cost
Stay open if revenues from lunch > variable cost
There are many restaurants that remain open during lunch hour even though
the majority of their business occurs during the evening.
What determines their decision to stay open for lunch?
111. • Determine
this firm’s
total profit.
• Identify the area on
the graph that
represents
the firm’s profit.
Q
Costs, P
MC
ATC
P = $10 MR
50
$6
A competitive firm
Determining a Firm’s Profits
112. profit
Q
Costs, P
MC
ATC
P = $10 MR
50
$6
A competitive firm
Profit per unit
= P – ATC
= $10 – 6
= $4
Total profit
= (P – ATC) x Q
= $4 x 50
= $200
Determining a Firm’s Profits
113. • Determine
this firm’s
total loss,
assuming AVC <
$3.
• Identify the area
on the graph that
represents
the firm’s loss.
Q
Costs, P
MC
ATC
A competitive firm
$5
P = $3 MR
30
Determining a Firm’s Loss
114. loss
MR
P = $3
Q
Costs, P
MC
ATC
A competitive firm
loss per unit = $2
Total loss
= (ATC – P) x Q
= $2 x 30
= $60
$5
30
Determining a Firm’s Loss
115. Exercise: Determining a Firm’s
Loss
A. What is the firm’s
profit maximizing
quantity?
B. What is the total
profits at this profit
maximizing quantity?
116. Conclusion: The Efficiency of
a Competitive Market
• Profit-maximization: MC = MR
• Perfect competition: P = MR
• So, in the competitive eq’m: P = MC
• Recall, MC is cost of producing the marginal unit.
P is value to buyers of the marginal unit.
• Therefore, the competitive equilibrium is
efficient.
118. Introduction
• A monopoly is a firm that is the
sole seller of a product without
close substitutes.
• The key difference between perfect
competition and monopoly:
A monopoly firm has market power, the ability to
influence the market price of the product it sells. In
contrast, a competitive firm has no market power.
119. Characteristics of a Monopoly
Only one
supplier
Unique
good
High
barriers
to entry
Market
Power
121. Why Monopolies Arise
The main cause of monopolies is barriers to entry
– other firms cannot enter the market.
Three sources of barriers to entry:
1. A single firm owns a key resource.
E.g., DeBeers owns most of the world’s
diamond mines.
2. The govt gives a single firm the exclusive right to
produce the good.
E.g., patents, copyright laws
122. Case Study: The History of De
Beers & Diamonds
• The Incredible Story of How De Beers Created
and Lost the Most Powerful Monopoly Ever
123. Why Monopolies Arise
3. Natural monopoly: a single firm can produce the
entire market Q at lower cost than could several firms.
Q
Cost
ATC
1000
$50
Example: 1000 homes
need electricity
Electricity
ATC slopes
downward due
to huge FC
and small MC.
ATC is lower if
one firm services
all 1000 homes
than if two firms
each service
500 homes. 500
$80
This is the power of economies of scale!
124. Exercise: Types of Monopoly
• EXERCISE: Which of the following results in a
natural monopoly?
A. When the government grants a firm the exclusive right
to supply a good or service.
B. When a single firm is able to produce at a lower
average cost than two or more firms.
C. When there is a government license is required before
a firm can sell a good or service.
D. When a firm own a key resource.
126. Monopoly vs. Competition:
Demand Curves
• In a competitive market,
the market demand curve
slopes downward.
• But the individual
demand curve for any
firm’s product is horizontal
at the market price.
• The firm can increase Q
without lowering P, so for
the competitive firm,
MR = P
D
P
Q
A competitive firm’s
demand curve
127. Monopoly vs. Competition:
Demand Curves
• A monopolist is the
only seller, so it faces
the market demand
curve.
• To sell a larger Q,
the firm must reduce
P.
• Thus, for the
monopoly, MR ≠ P.
D
P
Q
A monopolist’s
demand curve
128. Q P TR AR MR
0 $4.50
1 4.00
2 3.50
3 3.00
4 2.50
5 2.00
6 1.50
n.a.
• Suppose that Coffee Bean
is the only seller of
cappuccinos in DAH.
• The table shows the
market demand for
cappuccinos.
• Fill in the missing spaces
of the table.
• What is the relation
between P and AR?
Between P and MR?
Example: A Monopolist’s Revenues
129. • Here, P = AR,
same as for a
competitive firm.
• However, MR < P,
whereas MR = P
for a competitive
firm.
1.50
6
2.00
5
2.50
4
3.00
3
3.50
2
1.50
2.00
2.50
3.00
3.50
$4.00
4.00
1
n.a.
9
10
10
9
7
4
$ 0
$4.50
0
MR
AR
TR
P
Q
–1
0
1
2
3
$4
Example: A Monopolist’s Revenues
130. Example: A Monopolist’s Revenues
-3
-2
-1
0
1
2
3
4
5
0 1 2 3 4 5 6 7 Q
P, MR
MR
$
Demand curve (P)
1.50
6
2.00
5
2.50
4
3.00
3
3.50
2
4.00
1
$4.50
0
MR
P
Q
–1
0
1
2
3
$4
At any Q, the MR < P.
131. Understanding the Monopolist’s
MR
• Increasing Q has two effects on revenue:
Output effect: higher output raises revenue
Price effect: lower price reduces revenue
• To sell a larger Q, the monopolist must reduce
the price on all the units it sells.
Hence, MR < P for a monopolist.
133. Profit-Maximization
• Like a competitive firm, a monopolist
maximizes profit by producing the
quantity where MR = MC.
• Once the monopolist identifies this
quantity, it sets the highest price
consumers are willing to pay for
that quantity.
• It finds this price from the D-curve.
135. The Monopolist’s Profit
As with a competitive firm,
the monopolist’s profit equals:
(P – ATC) x Q Quantity
Costs and
Revenue
ATC
D
MR
MC
Q
P
ATC
markup
Notice that the
monopolist charges
a markup of price
over marginal cost:
P > MC = MR
MC
136. The Monopolist’s Profit
The monopolist’s
profit equals:
(P – ATC) x Q =
(40 – 30) x 50 =
$500
Quantity
Costs and
Revenue
ATC
D
MR
MC
50
40
30
137. Exercise: The Monopolist’s Profit
• Identify each of the following:
A.The level of output
B.The price
C.The total revenue
D.The total costs
E.The profit or loss
138. Price Discrimination
• Price discrimination: selling the same good
at different prices to different buyers.
• The characteristic used in price discrimination
is willingness to pay (WTP):
A firm can increase profit by charging a higher
price to buyers with higher WTP.
• In the real world, firms divide customers into groups
based on some observable trait related to WTP
e.g. age, occupation, gender, etc.
139. Examples of Price Discrimination
Movie tickets
Discounts for seniors, students, and people
who can attend during weekday afternoons.
They are all more likely to have lower WTP
than people who pay full price on weekend nights.
Airline prices
Discounts for weekend stayovers help distinguish
business travelers, who usually have higher WTP,
from more price-sensitive leisure travelers.
141. Introduction
Two extremes market structures:
Perfect competition: many firms, identical products
Monopoly: one firm, unique product
In between these extremes, lies imperfect competition:
Oligopoly: only a few sellers offer similar or identical
products.
Monopolistic competition: many firms sell similar but
not identical products.
143. profit
ATC
P
A Monopolistically Competitive Firm
Earning Profits in the Short Run
• This firm faces a downward-
sloping D curve.
• At each Q, MR < P (The MR cure
is below the D-curve).
• To maximize profit, firm
produces Q where MR = MC and
chooses P using the D curve.
• For this firm, P > ATC
at the output where MR = MC.
• Therefore, it is making profits in
the short-term.
Quantity
Price
ATC
D
MR
MC
Q
The D-curve is flatter than for a
monopoly.
144. losses
A Monopolistically Competitive Firm
with Losses in the Short Run
• For this firm,
P < ATC
at the output where
MR = MC.
• The best this firm
can do is to
minimize its losses.
Quantity
Price
ATC
Q
P
ATC
MC
D
MR
145. Advertising & Branding
• In monopolistically competitive
markets, product differentiation &
mark-up pricing lead naturally to
the use of advertising.
• In general, the more differentiated
the products, the more advertising
firms use.
• Firms with brand names usually
spend more on advertising & charge
higher prices.
146. Case Study: Advertising in
Monopolistic Competition
• Samsung Galaxy: Join
the Flip Side
• Samsung Galaxy:
Growing Up
147. Exercise: Monopolistic Competition
• EXERCISE: Which of the following statements
about monopolistic competition is FALSE?
A. Products are similar, but differentiated.
B. Firms charge a markup of price over marginal
cost.
C. Firms face a downwards sloping D-curve.
D. Firms face high barriers to entry.
149. Comparison of Market Structures
Perfect
Competition
Monopolistic
Competition
Monopoly
Number of
Sellers
Many Many One
Free entry/exit Yes Yes No
Long-run
economic profits
Zero Zero Profit
The products
firm sell
Identical Differentiated One unique
product
Firms have
market power
No (Price-takers) Yes Yes (Price-maker)
Firm’s D-curve Horizontal Downward sloping Downward sloping
150. Determining Profits or Losses
• In all three markets, four main curves used in the
analysis:
1. MC curve (upward-sloping);
2. ATC curve (u-shape);
3. MR curve;
4. Firm’s D-curve.
• To determine a firm’s profit or losses:
1. First, identify the profit maximizing quantity (Q)
where MR=MC
2. Next, identify the price (P) set by the firm given Q
3. Finally, compare the vertical distance between P and
where the Q hits the ATC curve
➢If P>ATC → PROFITS
➢If P<ATC → LOSSES
151. profit
Q
Costs, P
MC
ATC
P MR
50
ATC
A competitive firm
Perfect Competition
Total profit = height * width
=Profit per unit * No. of units
=(P-ATC) *Q
Profit Max: MR= MC
Perfect Comp.:
P=MR
(Shown by horizontal D-
curve being the same as
the MR curve)
155. Introduction
• We consume many goods without paying:
parks, national defense, clean air & water.
• When goods have no prices, the market forces
that normally allocate resources are absent.
• The private market may fail to provide the
socially efficient quantity of such goods.
• In this case, governments can sometimes
improve market outcomes.
157. Important Characteristics of
Goods
• A good is excludable if a person can be prevented
from using it.
Excludable: Cinema tickets, airplane tickets
Not excludable: Street lighting, national defense
• A good is rival in consumption if one person’s
use of it diminishes others’ use.
Rival: Fuel, food
Not rival: Museums, paintings
158. The Different Types of Goods
• Using these two characteristics, most goods can be
classified into four categories:
Rival in Consumption?
Yes No
Excludable?
Yes Private Goods
Clothing
Club Goods
Cable TV
No Common Resources
The environment
Public Goods
Clean air
159. The Different Types of Goods
Private
Goods
Jeans
Hamburgers
Contact lenses
Public
Goods
Fire works
Mosquito
protection
Traffic control
Club
Goods
Private parks
Wifi
Computer
software
Common
Goods
Public roads
Fish in the
Ocean
Public
schooling
Excludable &
Rival in
consumption
Non-excludable
& non-rival in
consumption
Excludable, but
non-rival in
consumption
Non-excludable,
but rival in
consumption
161. Public Goods
• Public goods are difficult for private markets to
provide because of the free-rider problem.
Free-rider: A person who receives the benefit of a good
but avoids paying for it.
• If a good is not excludable, people have incentive to be
free riders, because firms cannot prevent non-payers
from consuming the good.
• Result: The good is not produced, even if buyers
collectively value the good higher than the cost of
providing it.
• There is a need for government to provide
the good.
163. Common Resources
• Like public goods, common resources are not
excludable:
Cannot prevent free-riders from using
Little incentive for firms to provide
There is a need for government to provide the
good.
• An additional problem with common resources is that
they are rival in consumption:
Each person’s use reduces others’ ability to use it
There is a need for government to ensure that
the good is not overused.
164. Tragedy of the Commons
• https://www.youtube.com/watch?v=CxC161GvMPc
165. Public Goods and Common
Resources
• For both public goods & common resources,
externalities arise because something of
value has no price attached to it.
• In this case, private decisions about
consumption and production in the market
can lead to an inefficient outcome. In
other words, there is a market failure.
• Therefore, there is a role for
governments to step in to potentially
raise economic well-being.
An externality is the
economic impact of
consuming or
producing a good on a
third party who isn’t
connected to the good
(E.g. positive externality
(clean air), negative
externality (pollution)).
