INTRODUCTION OF MICROECONOMICS MODULE

TEACHING ASSISTANTS OF MICROECONOMICS AND MACROECONOMICS

ECONOMICS AND DEVELOPMENT STUDIES
FACULTY OF ECONOMICS AND BUSINESS
PADJADJARAN UNIVERSITY
2012
 CHAPTER 1 AND 2
ECONOMICS METHOD AND ECONOMICS PROBLEM
 The key word of definition in economics is choose. Economics is the study of how individuals and
societies choose to use the scarce resources that nature and previous generations have provided.
 Four main idea to learn economics :
1. Learn way of thinking has important reasons for studying economics. There are three
fundamentals concepts to approach the economics.
a. Oppurtunity cost is the best alternative that we forgo, or give up, when we make a choice
or a decision.
b. Marginalism is in weighting the costs and benefit that arise from the decision.
c. Efficient market is a market in which profit opportunities are eliminated almost
instantaneously. The way to reveal concept efficient market is “ there’s no free lunch” .
2. To Understand Society
3. To Understand Global Affairs
4. To Be An Informed Citizen
 Microeconomics is the branch of economics that examines the functioning of individual
industries and the behavior of individual decision-making units-that is, business firms and
households.
 Macroeconomics is the branch of economics that examines economic behavior of aggregates.
 Positive economics : an approach to economics that seeks to understand behavior and the
operation of systems without making judgements. It describes what exists and how it works.
 Normative economics : an approach to economics that analyzes outcomes of economic behavior,
evaluates them as good or bad, and may prescribe courses of action. This method is also called
policy economics.
 Every society has some system or mechanism that transforms that society’s scarce resources into
useful goods and services. Production is the process by which resources are transformed into
useful forms.
 Three basic questions all societies must decide to understand economics system:
a. What will be produced?
b. How will it be produced?
c. Who will get what is produced?
 The production possibility frontier (ppf) is a graph that shows all of the combinations of goods
and services that can be produced if all of society’s resources are used efficiently. The PPF
ilustrates an important economic concepts such as scarcity, unemployment, inefficiency, and
incerasing the opportunity cost of economic growth.

CHAPTER 3, 4, AND 5
DEMAND, SUPPLY, MARKET EQUILIBRIUM, AND
ITS ELASTICITY

 The law of demand implies as a price rises, quantity demanded decreases, and vice versa. So, the
relationship between price and quantity demanded is negative and graphed as a downward
sloping curve.
 Change in price of a goods or services leads to change in quantity demanded (movement along
the demand curve), but change in income, preferences, or prices of other goods or services leads
to change in demand (shift to the demand curve).
 The law of supply states producers will offer more of a product at a high price than at a low price.
Thus, the relationship between price and quantity supplied is positive, and supply is graphed as
an upward sloping curve.
 Change in price of a good or service leads to change in the quantity supplied (movement along
the supply curve), but change in costs, input prices, technology, or prices of related goods and
services leads to change in supply ( shift of a supply curve.
 The equilibrium price and quantity are established at the intersection of the supply and demand
curves. The interaction of market demand and market supply adjusts the price to the point at
which the quantities demanded and supplied are equal. This is the equilibrium price. The
corresponding quantity is the equilibrium quantity.
 When quantity demanded exceeds quantity supplied at the current price, there will be excess
demand or a shortage exist and the price tends to rise.
 The market system, performs two important and closely related functions:
Resource allocation: the market system determines the allocation of resources among produces
and the final mix of outputs.

Price rationing: the market system distributes goods and services on the basis of willingness and
ability to pay.

 A price ceiling is a maximum price that sellers may charge for a good, that results in a shortage.
 A price floor is a minimum price below which exchange is not permitted. The result of setting a
price floor will be excess supply, or higher quantity supplied than quantity demanded.
 Consumer surplus is the difference between the maximum amount a person is willing to pay for a
good and its current market price, but producer surplus is the difference between the current
market price and the full cost of production for the firm.
 The dead weight loss is the net loss of producer and consumer surplus from underproduction.
 Elasticity is a general concept that can be used to quantify the response in one variable when
another variable changes.
 Price elasticity of demand measures how responsive consumers are to changes in the price of a
product.

% change in quantity demanded

Price elasticity of demand =
% change in price

 When demand does not respond at all to a change in price, demand is perfectly inelastic, but
when quantity demanded changes infinitely with any change in price, demand is perfectly elastic.

CHAPTER 6
HOUSEHOLD BEHAVIOR AND CONSUMER CHOICE

• A key assumption in the study of household and firm behavior is that all input and output
markets are perfectly competitive.
• Perfect competition is
the industry, producing virtually identical (or homogeneous)
products and in which no firm is large enough to have any control
over price.
• Perfect knowledge
prices of everything available in the market, and that firms have all
available information concerning wage rates, capital costs, and
output prices.

• Every household must make three basic decisions:

 - How much of each product, or output, to demand.

- How much labor to supply.

- How much to spend today and how much to save for the future.

• Consumer surplus is the difference between the maximum amount a person is willing to pay for a
good and its current market price.
• The budget constraint refers to the limits imposed on household choices by income, wealth, and
product prices.
• In general, the budget constraint can be written: PXX + PYY = I
• A choice set or opportunity set is the set of options that is defined by a budget constraint.
• Utility is the satisfaction, or reward, a product yields relative to its alternatives. Marginal utility is
the additional satisfaction gained by the consumption or use of one more unit of something.
• Total utility is the total amount of satisfaction obtained from consumption of a good or service.
• The law of diminishing marginal utility:
The more of one good consumed in a given period, the less satisfaction (utility) generated by
consuming each additional (marginal) unit of the same good.

• The labor supply curve is a diagram that shows the quantity of labor supplied at different wage
rates. Its shape depends on how households react to changes in the wage rate.

CHAPTER 7
THE PRODUCTION PROCESS

 Production is the process by which inputs are combined, transformed, and turned into outputs.
 All firms must make several basic decisions to achieve maximum profits: (1) How much output to
supply, (2) Which production technology to use, (3) How much of input to demand.
 Profit (economic profit) is the difference between total revenue and total cost. Profit = total
revenue - total cost
 Total revenue is the amount received from the sale of the product (q x P).
 Total cost (total economic cost) is the total of (1) out-of-pocket costs, (2) normal rate of return
on capital, and (3) opportunity cost of each factor of production.
 Normal rate of return is a rate of return on capital that is just sufficient to keep owners and
investors satisfied. For relatively risk-free firms, it should be nearly the same as the interest rate
on risk-free government bonds.
 Short run: period of time for which two conditions hold: The firm is operating under a fixed scale
(fixed factor) of production, and firms can neither enter nor exit an industry.
 Long run: period of time for which there are no fixed factors of production: Firms can increase or
decrease the scale of operation, and new firms can enter and existing firms can exit the industry.
 The Bases of Decisions: (1) The market price of output which determines potential revenues, (2)
The techniques of production that are available, and (3) The prices of inputs.
 Production function or total product function is a numerical or mathematical expression of a
relationship between inputs and outputs.
 Marginal product is the additional output that can be produced by adding one more unit of a
specific input, ceteris paribus.
∆TP TP2 - TP1
 MP = = , where X is input.
∆X X2- X1

 Law of diminishing returns occurs when additional units of a variable input are added to fixed
inputs after a certain point, the marginal product of the variable input declines.
 Average product is the average amount produced by each unit of a variable factor of production.
 Two things determine the cost of production:
- Technologies that are available and

- Input prices.

CHAPTER 8
SHORT RUN COSTS AND OUTPUT DECISIONS
 There are three decisions facing firms:
a. The quantity of output to supply
b. How to produce that output (which technique to use)
c. The quantity of each input to demand
 The short run is a period of time for which two conditions hold:
1. The firm is operating under a fixed scale (fixed factor) of production,
2. Firms can neither enter nor exit an industry.
 Costs in the short run :
Fixed cost is any cost that does not depend on the firm’s level of output. These costs are incurred
even if the firm is producing nothing.
Variable cost is a cost that depends on the level of production chosen.
TC TFC  TVC
Where, TC : Total Costs
TFC : Total Fixed Cost
TVC : Total Variable Cost
Average Fixed Cost (AFC), is the total fixed cost (TFC) divided by the number of units of output
(q).

Average Variable Cost (AVC), is the total variable cost (TVC) divided by the number of units of
output (q).

Marginal Cost (MC), is the increase in total cost that result from producing one more unit of
output. Marginal cost reflects changes in variable costs.

 Causes marginal cost is the cost of one additional unit. Average variable cost is the average
variable cost per unit of all units being produced. So, average variable cost follows marginal cost,
but lags behind.
 Sunk costs occurs when firms have no control over fixed costs in the short run.
 The fact, in the short run the firm faces diminishing returns to variable inputs and the firm has
limited capacity to produce output.
 The relationship between marginal cost and average variable cost :
a. When marginal cost is below average cost, AC is declining.
b. When marginal cost is above average cost, AC is increasing.
 Total Revenue is the total amount that a firm takes in from the sale of its output.
TR = P x q

 Marginal Revenue is the additional revenue that a firm takes in when it increases output by one
additional unit.
In perfect compeetition, MR = P, therefore, the profit-maximizing perfectly competitive firm will
produce up to the point where the price of its output is just equal to short run marginal cost. The key
idea is that firms will produce as long as marginal revenue exceeds marginal cost
 CHAPTER 9

LONG-RUN COSTS AND OUTPUT DECISIONS

 For any firm, one of the three conditions holds at any given moment, there are:
(1) The firm is earning positive profits
(2) The firm is suffering losses, or
(3) The firm is just breaking even – that is, earning a normal rate of return and thus zero profits.
 In the short run, firms have to decide how much to produce in the current scale of plant.
 In the long run, firms have to choose among many potential scales of plant.
 There are three kind of Long-Run Costs:
(1) Increasing returns to scale or economies of scale, refers to an increase in a firm’s scale of
production, which leads to lower average costs per unit produced.

(2) Constant returns to scale, refers to an increase in a firm’s scale of production which has no
effect on average costs per unit produced.

(3) Decreasing returns to scale or diseconomies of scale, refers to an increase in a firm’s scale of
production, which leads to higher average costs per unit produced.

 The long-run average cost curve (LRAC) is a graph that shows the different scales on which a firm
can choose to operate in the long-run. Each scale of operation defines a different short-run.
 In the long run, equilibrium price (P*) is equal to long-run average cost, short-run marginal cost,
and short-run average cost. Profit are driven to zero.

 Economies of scale that are found within the individual firm are called internal economies of
scale.
 External economies of scale describe economies or diseconomies of scale on an industry-wide
basis.

CHAPTER 10 AND 11
INPUT MARKET

 Input market are households supply inputs to all resource market; firms demand in all resource
market.
 Three important inputs are labor, land and capital. Labor gets wage, land gets rent and capital
gets interest.
 The value of any input depends on society’s valuation of the output produced by that input. Input
will be hired as long as their contribution to the value of production is greater than their cost.
 Marginal Productivity of Labor (MPL) is the addition output that can be produced by labor. The
demand of labor is a demand derived from the demand for the output.
 Marginal Revenue Product (MRP) is the addition to total revenue attributable to the hiring of the
addition input. It can be defined as the extra units of output (marginal product) times the price of
the product.
MRP = MPL x PX
 To maximize profits, the employer should hire each input up to the point at which MRP equals
the cost of hiring that input. For labor, wage will equal MRP.
 Capital goods are those goods that can be used as input into the production process now and in
the future. Capital can be tangible (machines, all construction, and inventories) or intangible
(human capital, goodwill, brand loyalty).
 Stock are variables that are measured at a point in time (capital stock) while flows are measured
over a period of time. Investment is the creation of capital. It is not financial purchase.
 Depreciation is the decline in the economics value of an asset over time. A unit of capital might
depreciate simply because of wear and tear or because new technology renders it obsolete.

CHAPTER 12
MONOPOLY MARKET

 While a competitive firm is a price taker, a monopoly firm is a price maker.

 A firm is considered a monopoly if it is the sole seller of its product and its product doesn’t have
close substitute.
 Barriers to entry have three sources:
- Ownership of a key resource.

- The government gives a single firm the exclusive right to produce some good.

- Costs of production make a single producer more efficient than a large number of producers.

 Monopolist’s revenue :
- Total Revenue

P ´ Q = TR

- Average Revenue

TR/Q = AR = P

- Marginal Revenue

DTR/DQ = MR

 A monopoly maximizes profit by producing the quantity at which marginal revenue equals
marginal cost.
 Government responds to the problem of monopoly with antitrust law
 Two Important Antitrust Laws :
- Sherman Antitrust Act (1890)

- Clayton Act (1914)

 Price discrimination is the business practice of selling the same good at different prices to
different customers, even though the costs for producing for the two customers are the same.
 Two important effects of price discrimination:
- It can increase the monopolist’s profits.

- It can reduce deadweight loss.

 CHAPTER 13
OLIGOPOLY MARKET, GAME THEORY,
AND MONOPOLISTIC MARKET

 Monopolistic market is characterized by a large number of firms, none of which can control
market price, but which produce differentiated products. There are no barriers to entry, example:
restaurant. Firms in monopolistic market are price taker.
 Advertising can be an important aid in making the firm’s demand curve less elastic. Supporters of
advertising must make consumers aware of their products and differentiate its product from
those of its competitors.
 Profit maximization occurs at the production level where marginal revenue is equal to marginal
cost.
П = MR= MC

 Because price is greater than MR, price is greater than marginal cost at the profit maximizing
output level. This is inefficient because society wants production to occur up the point where P =
MC. In the long run, because demand is downward sloping, average cost is not minimized,
resources are not used to their maximum efficiency.
 Oligopoly is the market structure with a “few” interdependent firms, each having market power
and exerting barrier to entry. The behavior of one firm in an oligopolistic industry depends on the
reactions of the others.
 There are collusion, cartel, and cournot model in oligopoly market.
 Game theory is used for analysis strategic behavior and reaction from the competitors. In this
game theory, assume the firm can anticipate reaction from the competitors.

CHAPTER 14
GENERAL EQUILIBRIUM AND MARKET EFFICIENCY

 General equilibrium is the condition that exists when all markets (input market and output
market) in an economy are in simultaneous equilibrium.
 In judging the performance of an economic system, two criterias used are:
1. Efficiency
 Is the condition in which the economy is producing what people want at the least
possible cost. Pareto Efficiency is a condition in which no change is possible that will
make some members of society better off without making some other members of
society worse off.
2. Equity (Fairness)
 Dividing scarce resources in balance distribution for all society.
 Each perfectly competitive firm uses inputs such that MRPL = PL, when
MRPL = The marginal value of each input to each firm
PL = Market price
 The key of efficiency condition in competitive firm is when the price equals to marginal cost, but
when the price ≠ marginal cost, then:
a. If Px > MCx, society gains value by producing more X
b. If Px < MCx, society gains value by producing less X
 Market failure occurs when resources are misallocated or allocated inefficiently. The result is
waste or lost value. The evidence of market failure is revealed by the existence of:
 1. Imperfect Competition, is an industry in which single firms have some control over price and
competition that make inefficient allocation of resources.
2. Public Goods, or social goods are goods and services that bestow collective benefits on
members of society.
3. Externalities, is a cost or benefit resulting from some activity or transaction that is imposed
or bestowed on parties outside the activity or transaction.
4. Imperfect Information, is the absence of full knowledge concerning product characteristics,
available price, and so forth.
 Public goods characteristics are:
1. Nonrival in consumption, when one person’s consumption of the good does not interfere
another person’s consumption to consume the good.
2. Nonexcludable in their benefits, no one can be excluded from enjoying its benefits. The good
cannot be withheld from those that don’t pay for it.