MGEB02

Chapter 1: Preliminaries

- Microeconomics deals with the behavior of individual economic units

- macroeconomics deals with aggregate economic quantities, such as the
level and growth rate of national output, interest rates, unemployment,
and inflation
- A model is a mathematical representation, based on economic theory, of a
firm, a market, or some other entity
- Positive questions deal with explanation and prediction, normative
questions with what ought to be
- positive analysis: statements that describe relationships of cause and effect
- normative analysis, which is important for both managers of firms and
those making public policy
- A market is the collection of buyers and sellers that, through their actual or
potential interactions, determine the price of a product or set of products
- An industry is a collection of firms that sell the same or closely related products
- market definition—with determining which buyers and sellers should be
included in a particular market
- arbitrage: buying at a low price in one location and selling at a higher
price somewhere else
- A perfectly competitive market has many buyers and sellers, so that no
single buyer or seller has any impact on price
- In a perfectly competitive market, a single price—the market price—will
usually prevail
- extent of a market—its boundaries, both geographically and in terms of the
range of products to be included in it
- The nominal price of a good (sometimes called its “current-dollar” price)
is its absolute price
- The real price of a good (sometimes called its “constant-dollar” price) is
the price relative to an aggregate measure of prices
- For consumer goods, the aggregate measure of prices most often used is
the Consumer Price Index (CPI)
- the prices of raw materials and other intermediate products bought by
firms, as well as in finished products sold at wholesale to retail stores. In
this case, the aggregate measure of prices often used is the Producer Price
 Index (PPI)

Chapter 2: The Basics of Supply and Demand

- The supply curve shows the quantity of a good that producers are willing
to sell at a given price, holding constant any other factors that might affect
the quantity supplied
- QS = QS(P)
- the higher the price, the more that firms are able and willing to produce and sell
- the quantity that producers are willing to sell depends not only on the
price they receive but also on their production costs, including wages,
interest charges, and the costs of raw materials
- economists often use the phrase change in supply to refer to shifts in the
supply curve, while reserving the phrase change in the quantity supplied to
apply to movements along the supply curve
- The demand curve shows how much of a good consumers are willing to
buy as the price per unit changes
- QD = QD(P)
- change in demand to refer to shifts in the demand curve, and reserve the
phrase change in the quantity demanded to apply to movements along the
demand curve
- Goods are substitutes when an increase in the price of one leads to an
increase in the quantity demanded of the other
- Goods are complements when an increase in the price of one leads to a
decrease in the quantity demanded of the other
- The two curves intersect at the equilibrium, or market-clearing, price and
quantity
- The market mechanism is the tendency in a free market for the price to
change until the market clears— i.e., until the quantity supplied and the
quantity demanded are equal
- A surplus—a situation in which the quantity supplied exceeds the
quantity demanded
- A shortage—a situation in which the quantity demanded exceeds the
quantity supplied
- An elasticity measures the sensitivity of one variable to another.
Specifically, it is a number that tells us the percentage change that will occur
in one variable in response to a 1-percent increase in another variable
 - We write the price elasticity of demand, Ep, as Ep = (% change in Q)/(%
change in P)
- The percentage change in a variable is just the absolute change in the variable
divided by the original level of the variable
- linear demand curve—that is, a demand curve of the form, Q = a - bP
- infinitely elastic demand: Consumers will buy as much as they can at a
single price P*
- completely inelastic demand: Consumers will buy a fixed quantity Q*, no
matter what the price.
- Income elasticity of demand is the percentage change in the quantity
demanded, Q, resulting from a 1-percent increase in income I
- A cross-price elasticity of demand refers to the percentage change in the
quantity demanded for a good that results from a 1-percent increase in the
price of another good
- The price elasticity of supply is the percentage change in the quantity
supplied resulting from a 1-percent increase in price
- The point elasticity of demand, for example, is the price elasticity of demand
at a particular point on the demand curve
- the arc elasticity of demand: the elasticity calculated over a range of prices
- Arc elasticity: Ep = (change in Q/change in P)(P/Q)
- For many goods, demand is much more price elastic in the long run than
in the short run
- the income elasticity of demand is larger in the long run than in the short
run
- cyclical industries—their sales patterns tend to magnify cyclical changes
in gross domestic product (GDP) and national income
- Firms face capacity constraints in the short run and need time to expand
capacity by building new production facilities and hiring workers to staff
them
- Demand: Q = a - bP
- Supply: Q = c + dP
- Q = a - bP + fI where I is an index of the aggregate income or GDP

Chapter 3: Consumer Behaviour

- theory of consumer behavior: the explanation of how consumers allocate

incomes to the purchase of different goods and services
- market basket is a list with specific quantities of one or more goods
- An indifference curve represents all combinations of market baskets that
provide a consumer with the same level of satisfaction
- any market basket lying above and to the right of indifference curve U1 is
preferred to any market basket on U1
- To describe a person’s preferences for all combinations of food and
clothing, we can graph a set of indifference curves called an indifference
map
- To quantify the amount of one good that a consumer will give up to obtain
more of another, we use a measure called the marginal rate of
substitution (MRS)
- MRS measures the value that the individual places on 1 extra unit of a good in
terms of another
- MRS is the amount of the good on the vertical axis that the consumer is willing to
give up in order to obtain 1 extra unit of the good on the horizontal axis
- an indifference curve is convex if the MRS diminishes along the curve
- two goods are perfect substitutes when the marginal rate of substitution
of one for the other is a constant
- Two goods are perfect complements when the indifference curves for both
are shaped as right angles
- bads: Less of them is preferred to more
- utility refers to the numerical score representing the satisfaction that a consumer
gets from a market basket
- A utility function is a formula that assigns a level of util- ity to each
market basket
- a utility function that generates a ranking of market baskets is called an
ordinal utility function
- The ranking associated with the ordinal utility function places market
baskets in the order of most to least preferred
- A utility function that describes by how much one market basket is
preferred to another is called a cardinal utility function
- the budget constraints that consumers face as a result of their limited
incomes
- The budget line indicates all combinations of F and C for which the total
amount of money spent is equal to income
- purchasing power—her ability to generate utility through the purchase of
 goods and services
- We assume that consumers make this choice in a rational way—that they
choose goods to maximize the satisfaction they can achieve, given the limited
budget available to them
- Satisfaction is maximized when the marginal rate of substitution is equal to the
ratio of the prices
- satisfaction is maximized when the marginal benefit—the benefit
associated with the consumption of one additional unit of food—is equal
to the marginal cost—the cost of the additional unit of food
- corner solution, when one of the goods is not consumed, the consumption
bundle appears at the corner of the graph
- When a corner solution arises, the consumer’s MRS does not necessarily equal the
price ratio
- Marginal utility (MU) measures the additional satisfaction obtained from
consuming one additional unit of a good
- diminishing marginal utility: As more and more of a good is consumed,
consuming additional amounts will yield smaller and smaller additions to
utility
- utility maximization is achieved when the budget is allocated so that the
marginal utility per dollar of expenditure is the same for each good
- equal marginal principle—i.e., has equalized the marginal utility per dollar of
expenditure across all goods
- ideal cost-of-living index represents the cost of attaining a given level of
utility at current prices relative to the cost of attaining the same utility at base
prices
- A price index that uses a fixed consumption bundle in the base period is called
a Laspeyres price index
- The Laspeyres price index answers the question: What is the amount of
money at current-year prices that an individual requires to purchase the bundle of
goods and services that was chosen in the base year divided by the cost of
purchasing the same bundle at base-year prices?
- the Laspeyres price index assumes that consumers do not alter their consumption
patterns as prices change
- the Paasche index focuses on the cost of buying the current year’s bundle
- the Paasche index answers another question: What is the amount of money at
current-year prices that an individual requires to purchase the current bundle of
 goods and services divided by the cost of purchasing the same bundle in the base
year?
- the Laspeyres (LI) and Paasche (PI) indexes are fixed-weight indexes: The
quantities of the various goods and services in each index remain
unchanged

Chapter 4: Individual and Market Demand

- price-consumption curve is the curve tracing the utility-maximizing

combinations of two goods as the price of one changes.
- An individual demand curve relates the quantity of a good that a single
consumer will buy to the price of that good
- income-consumption curve is the curve tracing the utility-maximizing
combinations of two goods as a consumer’s income changes
- a change in the price of a good corresponds to a movement along a demand
curve
- any change in income must lead to a shift in the demand curve itself
- Engel curves, which relate the quantity of a good consumed to an
individual’s income
- The substitution effect is the change in food consumption associated with a
change in the price of food, with the level of utility held constant
- the income effect: the change in food consumption brought about by the increase
in purchasing power, with relative prices held constant
- Total Effect(F1F2) = Substitution Effect(F1E) + Income Effect(EF2)
- A good is inferior when the income effect is negative: As income rises,
consumption falls
- the income effect may be large enough to cause the demand curve for a
good to slope upward. We call such a good a Giffen good
- market demand curves can be derived as the sum of the individual
demand curves of all consumers in a particular market
- When the price elasticity of demand is constant all along the demand
curve, we say that the curve is isoelastic
- speculative demand is demand driven not by the direct benefits one
obtains from owning or consuming a good but instead by an expectation
that the price of the good will increase
- Consumer surplus measures how much better off individuals are, in the
aggregate, because they can buy goods in the market.
- Individual consumer surplus is the difference between the maximum amount that
a consumer is willing to pay for a good and the amount that the consumer
actually pays
- consumer surplus is found by adding the excess values or surpluses for all
units purchased
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