MICROECONOMICS

Microeconomics focuses on the study on how entrepreneurs make wise decisions based on
the allocation of limited resources. It examines how these decisions and behaviours affect the
supply and demand for goods and services, which determine the prices we pay. These prices, in
turn, determine the quantity of goods supplied by businesses and the quantity of goods demanded
by consumers. Microeconomics explores issues such as how families reach decisions about what
to buy and how much to save. It also affects how firms, such as Nike, determine how many shoes
to make and at what price to sell, as well as how competitive different industries are and how that
affects consumers. Microeconomics should not be confused with macroeconomics, which is the
study of economy-wide things such as growth, inflation and unemployment.

TOPICS IN MICROECONOMICS

 Supply and Demand – these are the most fundamental tools for economic analysis, it is the
relationship between the supply of goods and the demand for them.
o As an example, in the winter, the cold causes you to heat your house for more hours
than you would in other months. This is likely true not just for you, but for all of
your neighbours as well. As a result, demand for heat is higher. Because demand is
higher, gas companies can charge more for gas. Similarly, an oil spill from a tanker,
bad weather, or war in the Middle East may often create a short-term gas shortage,
which is a reduction in supply and can affect the price you pay, also.
o Two (2) goals:
- How much of a product do we have?
- Is the demand for product strong?

LAW OF SUPPLY

“How much of a good or service is a company willing to produce at **** price?” – If

nothing changes, a company will produce a greater quantity of products when the price for that
good is high

Factors that determine supply (PIGTOES)

– P roductivity (workers, machines, and/or assembly)

– I nputs (Change in the price of materials needed to make the good)

– G overnment Actions (Subsidies, Taxes, and Regulations)

– T echnology (Improvements in machines and production)

– O utputs (Price changes in other products)

– E xpectations (outlook of the future)

– S ize of Industry (Number of companies in the industry)

Supply Curve Movement – a supply curve shifts whenever a factor that affects the supply of good
(other than price) changes.

- RIGHT: increase in supply (at all price)

- LEFT: decrease in supply (at all price)

Factors that causes a shift in a Supply Curve

Two (2) Reasons:

o A change in cost of production

– Increase/decrease in a cost of producing a product = increase/decrease in the
supply of that product
o The role of technology in production
– Increase/decrease in technology to make a product = increase/decrease in
ability to supply it

LAW OF DEMAND

“What is the willingness of consumers to buy a product at **** price?” – If nothing else
changes, the demand of a good is greatest for consumers when the price is low.

Factors that determine the demand (POINT)

– P oint of other goods (substitute or complementary)

– O utlook (consumer expectation of the future)

– I ncome (normal goods versus inferior goods)

– N umber of potential customers (pop of market)

– T aste (fads and trends)

Demand Curve Movement – a demand curve shifts whenever a factor that affects the demand of
the good (other than price)

– RIGHT: increase in demand (at all prices)

– LEFT: decrease in demand (at all prices)

Factors that causes a shift in a Demand Curve

o Three (3) reasons:
 Change in consumer’s income
– Increase/decrease in a worker’s income = increase/decrease in a
demand for a product
 Change in the demand for a “substitute” / rival goods vs. your product
– Increase/ Decrease in the price of a “sub” good = increase/decrease in
the demand of your product
 Change in consumer tastes
– Increase/decrease in popular taste = increase/decrease in a demand for
that product
 Market Equilibrium – this occurs when the pressure for higher prices is evenly balanced
by the pressure for lower prices so that the current state of exchange between buyers and
sellers can be expected to persist. This is often not the case, however. Many times surpluses
and shortages exist for products that cause prices to go up and down. It is when quantity
supplied and quantity demanded are equal. Many companies strive to reach economic
equilibrium.
Excess Supply: “Having too much”

 Excess supply is when the supplied exceeds quantity demanded at a

given price.
– Also known as a “surplus”
 When this happens, prices tend to fall until equilibrium is restored
– Little re-sale value
– Lack of consumer interest
– Worthlessness

* Price floor is a situation when the price charged is more than or less than the equilibrium price
determined by market forces of demand and supply.

Excess Demand: “Not Enough”

 Excess demand is when the quantity demanded exceeds the quantity
supplied at a given price
– Also known as a “shortage”
 When this happens, price tends to rise until equilibrium is restored
– Black markets
– Rationing
– Violence
* Price ceiling is a situation when the price charged is more than or less than the
equilibrium price determined by market forces of demand and supply.

 Elasticity – is defined as how much the demand for the good or service is affected by a
change in price. It is used to help determine the change in consumer demand (how much
do you want of something) as a result of change in the good’s price. When a good or service
is elastic, this suggests that the demand for the good or service is affected by a change in
price, whereas something that is inelastic is insensitive to price.
o An example of an elastic good may be an apple. If the price of apples goes up, you
most likely will think about switching to a different fruit that is cheaper. The
demand for the fruit will go down.
o An examples of inelastic goods are baby formula and electricity. Even if the price
goes up, you will most likely keep buying them. Businesses also often strive to sell
products or services that are, or seem, inelastic in demand because doing so can
mean that few customers will be lost if they raise prices.

%ChangeInQuantityDemanded
%ChangeInPrice
Graphical Presentation
Perfectly inelastic (A) Perfectly elastic (B) Unitary elastic (C)

o Perfectly inelastic – An economic situation in which the price of a product will have
no effect on the supply. In a perfectly inelastic situation regardless of the amount
of a product on the market, the price of the product remains the same.
o Perfectly elastic – A perfectly elastic demand is a demand where any price increase
would cause the quantity demanded to fall to zero, and reducing the price of a good
or service will not increase sales.
o Unitary elastic – is when percentage change in price of a commodity is equal to the
percentage change in quantity demanded of that good.

 Opportunity Cost – is defined as the value of the best foregone alternative. It dives on how
individuals and businesses weigh different options. Based on this definition, it captures the
idea that the cost of something is not just its monetary cost but also the value of what you
didn’t get.
 o For example, the opportunity cost of spending $50 on a pair of shoes is what you
would have done with the $50 instead, and perhaps the value of the time spent
shopping.
o The opportunity cost of purchasing a pet includes not just the purchase price of the
pet but also the food, carpet cleaning, veterinary bills, and so on. So the pet that
initially costs $100, may really have an opportunity cost of $800. What could you
purchase for $800 instead?

 Forms of Competition
o Perfect Competition – means that there are many businesses with identical
products, no barriers to entry (such as political barriers or large up front
investments), and good pricing information. This usually results in good prices for
consumers.
o Oligopoly – refers to a situation in which particular market is controlled by a small
group of firms, such as the gasoline industry.
o Monopoly – is a market structure characterized by a single seller, selling a unique
product in the market. In a monopoly market, the seller faces no competition, as he
is the sole seller of goods with no close substitute. An example of this may be a
company in your area that provides electricity or water.

 Profit Maximization – is the process by which a company determines the price and output
level that returns the greatest profit.

Summary:

Microeconomics is a key area of economics that studies the behaviour of individuals and
businesses and how decisions are made based on the allocation of limited resources, such as time
and money. Common topics are supply and demand, elasticity, opportunity cost, market
equilibrium, forms of competition, and profit maximization.
Assessment:

True/False

1. Increase in demand shifts the demand curve left wards.

2. A price ceiling imposed above the market equilibrium price will result in a shortage of the product.
3. If both, the supply and the demand increase at the same time, the equilibrium price will definitely
increase.
4. An upward slopped supply curve is consistent with the law of supply.
5. The equilibrium price is the price level at which there is no surplus or shortage in the market.
6. The ceteris paribus assumption means that all other relevant factors remain unchanged.
7. A given supply curve assumes that input prices, production technology, and any other relevant
factors except the price of the product, are held constant.
8. Car manufactures use many commodities in their production process. If prices of those
commodities increase, then we should expect the supply curve to shift downwards (to the right).
9. The law of supply arises from the fact that the marginal costs are rising with the level of output.
10. A decline in input prices will cause the quantity demanded in the output market to increase.
11. If buyers and sellers of homes start to expect inflation in housing values, then both, the current
demand and the supply functions will increase.
12. When the demand decreases while the supply increases, the market equilibrium price declines.
13. Labor is demanded by firms in a factor market.
14. A fall in the price of iPads would shift the demand curve for iPads to the right.
15. As the price of a product falls, the quantity demanded of that product will increase, other things
equal.
16. According to the law of demand, there is a positive relation between price and the quantity
demanded.
17. If the demand for potatoes increases as income decreases, economists would consider potatoes as
an inferior good.
18. If the demand for eggs decreases as the price of bacon increases, economists would consider eggs
and bacon as compliments.
19. An increase in income will increase the demand for all goods.
20. An increase in income will increase the demand for all goods.
21. The supply curve will shift upwards on a graph if the prices of inputs into production go up.
22. The concept of the circular flow of economic activity illustrates the point that all economic
activities are interdependent.
23. Third degree price discrimination occurs when the market demand consists of different groups with
varying price elasticities. Monopolist sells output to these groups while the cost structure of the
monopolist remains as what it is.
24. . First degree price discrimination is the kind of discrimination that brings the most profits, because
the monopolist takes all the consumer surplus by selling the good to each consumer at their
reservation price.
25. When demand is inelastic, an increase in price will not cause a sharp decrease in quantity
demanded, therefore firm’s revenue will increase.
 26. Monopolistically competitive firms are very sensitive to any increase in marginal costs.
27. Total output may continue to rise even though marginal physical product is negative.
28. When firms enter a monopolistically competitive industry, the market supply curve shifts to the
left.
29. A sunk cost is a cost that has occurred but can be recovered.
30. In a perfectly competitive market, firms will earn economic profits in the long run.

Multiple Choice

1. Scarcity is a situation in which ________.

A) Something is being wasted
B) Long lines form at gas stations
C) Some people are poor and others are rich
D) We are unable to satisfy all our wants
2. Microeconomics is the study of ________.
A) The global economy
B) The choices that individuals and businesses make
C) The national economy
D) All aspects of scarcity
3. Most economists agree that
A) Rent ceilings cut the availability of housing.
B) Tariffs and import restrictions make most people worse off.
C) A minimum wage increases unemployment among young workers and low-skilled workers.
D) All of the above
4. "Hunting limits on deer help ensure a constant population. Therefore, if I only hunt to my limit,
there will be sufficient deer for all." This statement is an example of a possible
A) Ceteris paribus fallacy.
B) Post hoc fallacy.
C) Fallacy of composition.
D) Normative statement.
5. To better see a football game, one spectator stands. Assuming that everyone trying to get a good
view of the game can also stand represents an example of the
A) Opportunity cost fallacy.
B) Fallacy of truth.
C) Post hoc fallacy.
D) Fallacy of composition.
6. The post hoc fallacy is the error of reasoning
A) From models to predictions.
B) From predictions to theories.
C) From timing to cause and effect.
D) From cause and effect to models.
7. You are not surprised that it has started to rain. After all, an hour ago you just finished washing
your car. Your reasoning is an example of
A) The ceteris paribus assumption.
B) The distinction between positive and normative statements.
C) The post hoc fallacy.
D) The fallacy of composition.
8. The post hoc, ergo propter hoc fallacy is
A) A statement about the way the economic world ought to be.
B) The error of reasoning that a first event causes a second event because the first event occurred
before the second event.
C) An expression that means "other things being equal."
D) The (false) statement that what is true of the parts is true of the whole or what is true of the
whole is true of the parts.
9. Microeconomics focuses on all of the following EXCEPT
A) The effect of increasing the money supply on inflation.
B) The purchasing decisions that an individual consumer makes.
C) The effect of an increase in the tax on cigarettes on cigarette sales.
D) The hiring decisions that a business makes.
10. In broad terms the difference between microeconomics and macroeconomics is that
A) Microeconomics studies the effects of government taxes on the national unemployment rate.
B) Macroeconomics studies the effects of government regulation and taxes on the price of
individual goods and services whereas microeconomics does not.
C) They use different sets of tools and ideas.
D) Microeconomics studies decisions of individual people and firms and macroeconomics studies
the entire national economy.
11. Studying the determination of prices in individual markets is primarily a concern of
A) Negative economics.
B) Microeconomics.
C) Positive economics.
D) Macroeconomics.
12. The analysis of the behaviour of individual decision-making units is the definition of
A) Microeconomics.
B) Macroeconomics.
C) Positive economics.
D) Normative economics.
13. The most fundamental economic problem is
A) Security
B) The fact the United States buys more goods from foreigners than we sell to foreigners.
C) Health
D) Scarcity
14. Economics is best defined as the study of how people, businesses, governments, and societies
A) Make choices to cope with scarcity.
 B) Attain wealth.
C) Choose abundance over scarcity.
D) Use their infinite resources.
15. Economists point out that scarcity confronts
A) The rich but not the poor.
B) The poor but not the rich.
C) Both the poor and the rich.
D) Neither the poor nor the rich.
16. Scarcity requires that people must
A) Trade.
B) Compete.
C) Cooperate.
D) Make choices.
17. As an economic concept, scarcity applies to
A) Neither time nor money.
B) Both money and time.
C) Time but not money.
D) Money but not time.
18. Which is the most accurate definition of the study of economics? Economics is the study of
A) The distribution of surplus goods to those in need.
B) Affluence in a morally bankrupt world.
C) Ways to reduce wants to eliminate the problem of scarcity.
D) The choices we make because of scarcity.
19. Which of the following statements about opportunity cost is TRUE?

I. Opportunity cost is equal to implicit costs plus explicit costs.

II. Opportunity cost only measures direct monetary costs.
III. Opportunity cost accounts for alternative uses of resources such as time and money.

a) I, II and III.
b) I
c) III only.
d) I and III only.
20. Suppose that you deciding between seeing a move and going to a concert on a particular Saturday
evening. You are willing to pay $20 to see the movie and the movie ticket costs $5. You are willing
to pay $80 for the concert and the concert ticket costs $50. The opportunity cost of going to the
movie is:
A. $5.
B. $30.
C. $35.
D. $65.
21. I am considering loaning my brother $10,000 for one year. He has agreed to pay 10% interest on
the loan. If I don’t loan my brother the $10,000, it will stay in my bank account for the year, where
it will earn 2% interest. What is the opportunity cost to me of the loan to my brother?
E) $200.
F) $800.
G) $1,000.
H) $1,200.
22. In January, in an attempt to commit to getting fit, I signed a year-long, binding contract at a local
gym, agreeing to pay $40 per month in membership fees. I also spent $300 on extremely stylish
gym clothes. This morning, I was trying to decide whether or not to actually go to the gym. Which
of the following was relevant to this decision?
a) The $40 that I paid the gym this month.
b) The $300 I spent on gym clothes.
c) The fact that I also had to write a 103 midterm exam today.
d) All of the above were relevant.
23. Suppose you have bought and paid for a ticket to see Kanye in concert. You were willing to pay up
to $350 for this ticket, but it only cost you $100. On the day of the concert, a friend offers you a
free ticket to Lady Gaga instead. You can resell your Kanye ticket for $80. What do your sunk costs
equal?
a) $0.
b) $20.
c) $80.
d) $100.
24. If the demand for widgets is inelastic, then when the price of widgets increases, revenues will:
a) Decrease
b) Remain the same
c) Increase
d) Increase, unless there are substitutes for widgets
e) Decrease because of the law of demand holds for widgets.
25. Which of the following shifts the supply curve leftward?
a) An improvement in technology that decreases the cost of production.
b) An increase in the number of suppliers.
c) An anticipated drought that will make inputs more expensive.
d) A decrease in the wage rate.
26. Diminishing marginal rate of substitution necessarily implies that the marginal rate of substitution
A) Falls as one travels down (eastward) along an indifference curve.
B) Falls as one travels up (westward) along an indifference curve.
C) Stays the same as one travels up (westward) along an indifference curve.
D) Decreases as the quantities of both goods increase.
E) We get less utility when we have higher incomes.
27. Perfect complements will have indifference curves that are
A) Concave to the origin.
 B) Vertical.
C) Straight lines.
D) L-shaped.
E) Horizontal.
28. In which of the following market structures do firms recognize their mutual interdependence?
b) Oligopoly
c) Monopoly
d) Perfect Competition
e) Unregulated Natural Monopoly
f) Monopsony
29. Promoters of a rock group know that if they charged $8 a ticket, 400 people would buy tickets for
a concert, and if they charged $4 a ticket, 800 people would buy tickets. Over this price range, the
demand for the concert tickets for the rock group is
a) Elastic
b) Inelastic
c) Unit Elastic
d) Perfectly Elastic
e) Perfectly Inelastic
30. A farmer grows wheat using two inputs: labor and land whose price are constant. If she doubles
her inputs, she finds that quantity of wheat produced more than doubles. Therefore, it must be true
that in this output range her long-run average total cost curve is
a) Upward sloping
b) Downward sloping
c) Horizontal
d) Vertical
e) U-shaped

Long problems

Problem 1. The following table gives the daily supply and demand for hot dogs at a sporting event:

Price, $ Quantity demanded Quantity supplied

2.10 800 7,200

1.80 1,600 4,800

1.60 2,400 2,400

1.40 3,200 800

1.20 4,100 200

 a. What is the equilibrium price of hot dogs? What makes you think so?

b. If the organizers of the sporting event decide to set the price at 1.80, how many hot dogs
will be sold?

Problem 2. The total demand for wheat and the total supply of wheat per month in the Kansas City
grain
Thousands of bushels Price per bushel, Thousands of bushels Surplus (+)
demanded $ supplied or shortage (--)

85 3.40 72
80 3.70 73
75 4.00 75
70 4.30 77
65 4.60 79
60 4.90 81
market are as follows:

a. Fill in the surplus/shortage column. Use the information in that column to state the
equilibrium price and equilibrium quantity in this market.

b. Why is $3.40 not the equilibrium price in this market? How about $4.90?

c. "Surpluses drive prices up; shortages drive them down." Do you agree?

d. Now suppose that the government establishes a ceiling (maximum legal) price for wheat
at $3.70. Carefully explain the effects of such a ceiling and demonstrate your answer
graphically.

Problem 3. Initially Hans Johnson was the only consumer in the market for "Casa de Econ" beer,
produced by a small local brewery. As the price of "Casa de Econ" six-pack varies between $10
and $20, the price elasticity of his individual demand is equal to negative 1. Now imagine that
Hans has been cloned 4 times, and now we have 5 identical consumers in the market for "Casa de
Econ". What will happen to the price elasticity of market demand in the price range given above?
Will the demand become more price elastic, less price elastic, or will elasticity stay the same?
Explain your answer.
Answer Keys.
True/False Multiple Choice

1. False 1. D
2. False 2. C
3. False 3. D
4. True 4. C
5. True 5. D
6. True 6. C
7. True 7. C
8. False 8. B
9. True 9. A
10. True 10. D
11. False 11. B
12. True 12. A
13. True 13. D
14. False 14. A
15. True 15. C
16. False 16. D
17. True 17. C
18. True 18. D
19. False 19. D
20. True 20. C
21. True 21. A
22. True 22. C
23. True 23. B
24. False 24. C
25. True 25. C
26. True 26. A
27. False 27. D
28. False 28. A
29. False 29. C
30. False 30. B

Problems

Problem 1

a) According to the definition, the equilibrium price is the price at which quantity
supplied equals quantity demanded. From the table we can see that at $1.60, Qs = Qd =
2,400. Therefore $1.60 is the equilibrium price.
 b) At $1.80, 4,800 hot dogs will be offered for sale, but only 1,600 will be demanded.
Therefore, only 1,600 hot dogs will be sold.

Problem 2

a) Market equilibrium occurs at the point where market clears, that is, where quantity
supplied is equal to quantity demanded. In other words, equilibrium price is the price at
which there exists neither surplus nor shortage. Looking at the entries in the last column
(in bold), we can see the equilibrium price is $4. Therefore, the equilibrium quantity is
75,000 bushels.

b) At $3.40, there would be a 13,000 bushels shortage of wheat. The price will not stay at
that level since it will be in the sellers' best interest to raise their prices.
At $4.90, sellers will supply 21,000 bushels more than buyers would demand, thus
creating a surplus. In order to get rid of the surplus, sellers would have to decrease their
price.

c) The statement is false. A surplus means that at a given price, quantity supplied is
greater than quantity demanded. Trying to get rid of the surplus, sellers will decrease
their prices. Therefore, surpluses drive prices down, not up. Shortages, on the other hand,
give sellers the opportunity to raise prices, hence "shortages drive prices up".

d) A ceiling at $3.70 established by the government (which probably tries to prevent the
price from being what it perceives as "too high") would not allow the price to move
towards the equilibrium. As a result, a permanent shortage of wheat will emerge. Buyers
will demand 7000 more bushels of wheat than there is available.

Problem 3

Since elasticity deals with relative changes, it doesn't matter how many consumers we
have in the market as long as all of them are same. (If the quantity demanded for each of
them changes by 50% that would mean the quantity demanded in the entire market will
change by 50%, too.) So the price elasticity of demand will stay the same.