Microeconomics

Final Exam
by Daniel Mata

∆ 4 1
 
Introduction ∆ 8 2
ECONOMICS is the study of how society decides or in order to produce another unit of film, two
what, for whom and how to produce. Taking units of food must be sacrificed.
into account that resources are scarce
Positive and Normative
INCOME DISTRIBUTION in a nation or in the world is
Positive = how it IS and how it WILL be, answers
how total income is distributed between
the question of why is something happening?
different groups or individuals.
And to predict.
OPPORTUNITY COST is a crucial concept in
Normative = how it SHOULD be, answers the
economic analysis and can be defined as the
question, should X do Y?
quantity of a good that must be sacrifices to
obtain another unit of another good. This
concept is associated with the production
possibility frontier. Microeconomics and
macroeconomics
In Fig1: for each level of output of one good, the Microeconomics focuses on one aspect of
production possibility frontier shows the economic behavior and ignores interactions
maximum amount of the other good that can with the rest of economic players in order to
be produced keep simplicity.

Macroeconomics emphasizes on the

interactions of the economy as a whole,
simplifying the approach to the individual
building blocks.

• Gross Domestic Product: total output of

an economy in a given period
• Aggregate price level: average price of
good and services
• Unemployment rate: fraction of the
labor force without a job

Fig1: Production possibility frontier

In this case the opportunity cost is

Tools of economic analysis produce (Adam Smith “The wealth of Nations”
A MODEL makes assumptions from which it 1776).
deduces how people will behave. It’s a
Since nothing in life is black and white, there is
simplification of reality.
a different mix of both in every country. This is
CROSS SECTION DATA record at a point in time the called a Mixed Economy.
way an economic variable differs across
DEMAND: quantity buyers want at the given
different individuals or group of individuals
price
AN INDEX NUMBER expresses data relative to a
• Excess demand when quantity
given base value and inflation rate is the annual
demanded exceeds the quantity
rate of of change of the retail price index
supplied at the ruling price
NOMINAL VALUES are measured in the prices
SUPPLY: quantity sellers want to sell at a given
ruling at the time of measurement
price
Change
• Excess supply when quantity supplied
PERCENTAGE CHANGE is the absolute change
exceeds the quantity demanded at the
divided by the original number x100
ruling price
GROWTH CHANGE is the percentage change per
Equilibrium price is when quantity demanded
period
equals the quantity supplied

Market
Market is a process of reconciliation of DEMAND CURVE AND SUPPLY CURVE: relation
decisions. Each actor, consumers, between quantities demanded/supplied and
manufacturers or produces, workers, etc. make price other things equal.
a decision about consumption, production or
labor, and all those decisions are reconciled in Shift in demand curve:
the price.
• Price of related goods
Resource allocation Price of a good goes up, raises demand of
You must make a decision on how should
substitute, reduces demand of complements
society allocate its resources, how do you do
it?. According to economics there are two • Consumer income
alternatives, a free market economy and a
command economy. Normal good: demand increases when income
increases
In a free market economy the government does
not interfere and the self-interest of individuals Inferior good: demand falls when income
will efficiently allocate society’s resources. In a increases
command economy is the government’s job to
• Tastes
plan what, how and for whom society will
Shift in supply curve: Elastic and inelastic demand

• Technology
• Input costs Elastic Inelastic
• Government regulation

PRICE CONTROL is government rules or laws

setting either maximum or minimum prices. As -1 0
seen in Fig1 when there is a maximum price the Unit elastic
market equilibrium is above it and then there is
a disequilibrium, less is produced and more is
demanded (black market), the opposite is when
there is a minimum price, the equilibrium is PED 1
below it and (minimum wage) so this means
more people wants to work but companies will
reduce the hours of work or decrease the rate
of hiring.

S
Pmin

Pmax
PED 2
D

0
If you can easily substitute then demand is
Fig1: maximum et minimum elastic, if not then demand is inelastic

Price Elasticity of Demand PED

ଵ  ଴ 
%∆ 100% ଴
  
%∆   ଴ 
100% ଵ
଴
In the short run consumers may not be ready
Q: quantity for changes so demand may be inelastic
(insensitive to price) in the long run consumer
P: price
may adapt so demand may turn elastic
(sensitive to price).
Cross-price elasticity tells us what happens
when the price of the good of interest is
constant and changes happen with the price of
related goods. Consumer choice and demand
decisions
The effect of income on demand depends on
In order to describe the consumer and the
the nature of the good:
market the model uses
Normal, inferior and luxury goods
Budget constraint, different bundles that a
consumer can afford

Inferior
Normal goods
goods
Neccesities Luxuries

0 1

Types of goods

The figure above represents the effect of

income in demand, so if income increases,
demand for inferior goods decreases, and
demand for normal good increases, this also
means a shift in the demand curve.
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Slope:   
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Elasticity of supply THE CONCEPT OF TASTE is associated with 1. The

ଵ  ଴ 
%∆௦ 100% ଴ assumption that consumers want maximum
   utility and 2. More is preferred to less
%∆
௦ 

଴
100% ଵ

଴
MARGINAL RATE OF SUBSTITUTION of X for Y is the
Taxes incidence will describe who will be paying quantity of Y the consumer must sacrifice to
it, consumers or suppliers. If supply is flat, he increase the quantity of X by one unit without
consumer has the burden of the tax and vice changing total utility.
versa
DIMINISHING MARGINAL RATE OF SUBSTITUTION is
exhibited by taste, when holding utility
constant, diminishing quantities of one good
must be sacrificed to obtain successive equal
increases in the quantity of other good.
These assumptions give the indifference curve,
where utility is constant.
An indifference curve
• Every point in the curve yields the same
utility
• The slope gets flatter as we move to the
right because of diminishing marginal
rate of substitution
Income changes
When including the budget line, the choice of
the consumer will be the point where one curve
of the family of IC will be tangent with the
budget line, hence utility maximation. As shown
below
Choice
When incomes change there are two effects
depending on the nature of the goods.
1. When the goods are normal, then
demand will increase
2. When the goods are inferior, demand
will decrease
Normal goods
Inferior goods
Another kind of change is changes in price, two
issues happen at the same time, substitution of
one good for the other (since the first one got
expensive) and income effect (now you afford
less)
Price changes
A change in prices shifts the budget line
according to the new number of goods that can
be acquired
 Budget line changes

Change in price effects

In the figure above, the substitution effect is

going from point C to point D and the income
effect is going from D to E

When there are inferior goods then the income

Change in quantity of meals
The price change response has two effects: the
substitution effect and the income effect
effects behaves in the opposite direction,
increasing the number of products demanded
given the rise of price.
Supply decisions
The aim is to make as much profit as possible

• The substitution effect is the A company has legal existence distinct from its
adjustment of demand due to the owners
change in price, therefore changing the
bundle of products. Reduces the
quantity of products demanded
• The income effect is the adjustment of
demand to the change in real income so
since the price of a product is higher the
budget affords less (normal goods).