MICROECONOMICS - Slides For Student

22/08/2021
 Brief information
 Course outline
 Reading Materials
MICROECONOMICS
CONTENTS  Assessment
Lecturer: TRAN THI THANH HUYEN  Tips for students
Mobile: 098 383 0104
Email: huyenttt0104@gmail.com
Brief information Course outline
 Name: MICROECONOMICS Chapter 1: Introduction

 Description: Provide learners with basic knowledge of economics at
Chapter 2: Supply and demand
micro level.
Chapter 3: Markets and welfare
 The operating mechanism of markets
 Behaviour of consumer Chapter 4: The theory of consumer choice
 Behaviour of enterprise and the organization of industry Chapter 5: Firm behavior and the organization of industry
 The economic role of government in regulating markets
 Duration: 8 weeks
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Reading Materials Assessment
Mid- Case study

a. Textbook: N. Gregory Mankiw (2021). Principles of Class attendance
term test
Final Exam
Economics 9th edition. Cengage Learning. % of the

total 10% 15% 15% 60%
b. Readings: Readings including articles and research papers marks
As schedule
Due date Every session 4th week 7th week
related to each topic will be provided before the lecture. of BAV
-Check attendance
Short
-Doing homework Group Long
Form written
-Give opinions presentation written test
test
-Discussion in groups
5 6
Group presentation Group presentation

 Time allowed:  Activity
You are to produce a report based on your findings for one specific
10 minutes for presentation + 5 minutes for questions each team. commodity market that includes following parts:
 Scenario: 1. An introduction to the issue, which explaining why you choose the
Assume that you are an economist and your work is to study and topic.
2. Describing circumstances and the trend of the supply, demand and
investigate the trend of supply, demand and price of one specific the price of the market.
commodity, then analyse the structure of that market. 3. Analysis of the internal and external factors affecting the market,
supported by theories and concepts.
4. Analysis of the market structure.
5. Conclusions.
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Timeline
Session DATE CHAPTER CONTENTS
Group presentation
1 Monday 23/8 1 Ten principles of economics
2 Friday 27/8 1 Thinking like an economist
 Assessment Criteria: 3 Monday 30/8 2 Demand and supply
4 Friday 3/9 2 Elasticity
• Compelling reasons; Interesting and Urgent issue. 5 Monday 6/9 2 Government policies
6 Friday 10/9 3 Market and welfare
• Circumstances and trends are proved by data.
7 Monday 13/9 4 The budget constraint
• Applying economic theories to critically analyze the market.
8 Friday 17/9 4 Preferences and optimization
• Analyse the market structure clearly and persuasively. 9 Monday 20/9 Mid-term test Google forms, and written test
10 Friday 24/9 5 The costs of production
• Well presented. 11 Monday 27/9 5 Firms in competitive markets
12 Friday 1/10 5 Monopoly
Monopolistic competition and
13 Monday 4/10 5 Oligopoly
14 Friday 8/10 Group presentation
15 Monday 11/10 Group presentation
9 10
16 Friday 15/10 Revision
T O
M S
O
M
T S
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M 1. List keywords/concepts by groups M These below activities are also important

- Meanings
- Pronunciation: 4. Read, prepare lessons before each session
https://www.oxfordlearnersdictionaries.com/
2. Summarize each chapter right after studying 5. Listen and take note carefully
3. Work in groups 6. Do homework

- Doing exercises & discussing problems in https://forms.gle/ZfANhd6BjSy9Yfpt6
each session
- Preparing for the presentation
- Other activities
https://docs.google.com/spreadsheets/d/111AeS_T3QXRS5gBwT611f
mjp3SlZHFTxfOP4Rnvnbb4/edit?usp=sharing
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MICROECONOMICS
CHAPTER
Tran Thi Thanh Huyen (Dr.)
Faculty of Economics
1 Introduction
Banking Academy of Vietnam
Interactive PowerPoint Slides by: Interactive PowerPoint Slides by:
V. Andreea Chiritescu V. Andreea Chiritescu
Eastern Illinois University Eastern Illinois University
1 2
Reading materials Purpose

Lay out ten economic principles that will serve as building
Chapter 1, 2. Mankiw, N.G (2021), Principles of blocks for the rest of the text. The ten principles can be
Economics, 9th Edition, Cengage Learning. grouped into three categories: how people make decisions,
how people interact, and how the economy works as a
whole.
Familiarize students with how economists approach
economic problems.
Students will see how economists employ the scientific
method, the role of assumptions in model building, and the
application of two specific economic models.
 Students will also learn the important distinction between
two roles economists can play: as scientists when we try to
explain the economic world and as policymakers when we try
to improve it.
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Learning objectives Contents

By the end of this chapter, students should
understand:
• Ten principles of economics, about how each individual 1. Ten principles of economics
makes decision, how individuals interact with each other
and how an economy works.
• The role of an economist, as a scientist and as a policy
adviser.
• Some basic concepts: Circular-Flow Diagram,
Production Possibilities Frontier and Opportunity Cost. 2. Thinking like an economist
• The difference between microeconomics and
macroeconomics? Between positive and normative?
5 6
Resources are scarce

• Scarcity: the limited nature of society’s
resources
– Society has limited resources and cannot
produce all the goods and services people wish
to have.
• Economics
Ten Principles of
1.1 Economics
– The study of how society manages its
scarce resources
Interactive PowerPoint Slides by:

V. Andreea Chiritescu
Eastern Illinois University
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Economists study: a. How People Make Decisions

– How people decide how much they work, Principle 1: People face trade-offs
what they buy, how much they save, and Principle 2: The cost of something is what
how they invest their savings you give up to get it
– How firms decide how much to produce
Principle 3: Rational people think at the
and how many workers to hire
margin
– How society decides how to divide its
resources between national defense, Principle 4: People respond to incentives
consumer goods, protecting the
environment, and other needs
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Principle 1: People Face Trade-Offs EXAMPLE 1A: Society faces trade-offs
To get something that we like, we have to give • The more a society spends on weapons to
up something else that we also like. protect from foreign aggressors
– Going to a party the night before an exam – The less it can spend on consumer goods
• Less time for studying • Pollution regulations: cleaner environment
– In order to have more money to buy stuff and improved health
• Working longer hours, less time for leisure – But at the cost of reducing the well-being
of the firms’ owners, workers, and
customers
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EXAMPLE 1B: Society faces trade-offs EXAMPLE 1B: Society faces trade-offs
• Efficiency: Society gets the maximum
benefits from its scarce resources.
• Equality: Prosperity is distributed uniformly
among society’s members.
• Trade-off:
– To achieve greater equality, we could
redistribute income from wealthy to poor.
– But this reduces incentive to work and
produce, which shrinks the size of
economic “pie”.
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Principle 2: The Cost of Something EXAMPLE 2: Opportunity cost

Is What You Give Up to Get It
• Making decisions: • What is the opportunity cost of going to
college for a year?
– Compare costs with benefits of alternatives
– Need to include opportunity costs
• Opportunity cost
– Whatever you have to give up to obtain
some item • What is the opportunity cost of going to the
movies?
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EXAMPLE 2: Opportunity cost HOMEWORK
• What is the opportunity cost of being invited

1. “There’s no such thing as a free lunch”
to go to the movies? Do you agree or disagree with this
statement? Give examples and arguments to
support your idea.
2. Do you know why citizens in a large city are

always in a hurry and impatient, meanwhile
people in country sides seem to be more
friendly and easier to talk to?
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Principle 3: Rational People Think at the Margin Active Learning 1: Thinking at the margin
A. As the manager at the local supermarket, you are
• Rational people thinking of hiring one more cashier that would
– Do the best they can to achieve their objectives increase sales revenues by $400 per week. You
given the available opportunities have to pay the new cashier $300 per week.
– Make decisions by evaluating costs and benefits Should you hire the new cashier? Why?
of marginal changes
B. The average cost of each seat of a flight from New
York to Washington DC is $500.
A plane is about to take off with 10 empty seats
and a standby passenger waiting at the gate is
willing to pay $300 for a seat. Should the airline sell
the ticket?
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Active Learning 1: Answers A Active Learning 1: Answers B

A. Manager at the local supermarket: B. Airline:
How your answers would change

if the marginal cost is $500/week?
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Principle 4: People Respond to Incentives EXAMPLE 3: Incentives

• Incentive • An increase in the price of pizzas:
– Something that induces a person to act – Consumers buy fewer pizzas.
• People respond to incentives – Sellers produce more pizzas.
– Because the incentives change the costs and/or
benefits of their actions
– And rational people make decisions by
comparing the marginal costs and the marginal
benefits
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EXAMPLE 3: Incentives Active Learning 2: Applying the principles

The government increases the gasoline tax by $1 You are selling your old car. At the last minute, the car
per gallon. engine dies. You can pay $1,400 to have it repaired, or
• How do consumers respond? sell the car “as is.”
In each of the following scenarios, should you have the
car engine repaired? Explain.
A. What you could get for the car is $14,500 if the engine
works, $11,200 if it doesn’t.
B. What you could get for the ca is $12,300 if the engine
• How do businesses respond? works, $11,000 if it doesn’t.
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Active Learning 2: Answers b. How People Interact
Principle 5: Trade can make everyone better off.

Principle 6: Markets are usually a good way to
organize economic activity.
Principle 7: Governments can sometimes improve
market outcomes.
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Principle 5: Trade Can Make Everyone Better Off Principle 6: Markets Are Usually a Good Way to
Organize Economic Activity – 1
• People benefit from trade: • Market
– People can buy a greater variety of goods and – A group of buyers and sellers
services at lower cost. • “Organize economic activity” means
• Countries benefit from trade: determining
– Allows countries to specialize in what they do – What goods and services to produce
best – How to produce these goods and services
– Enjoy a greater variety of goods and services – How to allocate them to their final user
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Principle 6: Markets Are Usually a Good Way to Principle 7: Governments Can Sometimes
Organize Economic Activity – 3 Improve Market Outcomes – 1
• Prices: • Government: enforce property rights
– Determined by the interaction of buyers and – Enforce rules and maintain institutions that
sellers are key to a market economy
– Reflect the good’s value to buyers • People are less inclined to work, produce,
– Reflect the cost of producing the good invest, or purchase if there is a large risk of
• Adam Smith’s “invisible hand”: their property being stolen.
• We rely on government-provided police and
– In the process prices guide households and
firms to make decisions to maximize their courts to enforce our rights over the things we
produce.
benefit, it also helps to maximize society’s
economic well-being.
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Principle 7: Governments Can Sometimes Principle 7: Governments Can Sometimes

Improve Market Outcomes – 2 Improve Market Outcomes – 3
• Government: enhance economic efficiency • Government: promote equality
–In the presence of externalities – Many public policies, such as the income tax
E.g.: When the production of a good pollutes the and the welfare system, aim to achieve a more
air and creates health problems for those who live equal distribution of economic well-being.
near the factories, the market on its own may fail to
take this cost into account.
– In the presence of market power
E.g.: The owner of the only gas station in a village
(far away from other villages) will have an incentive
to restrict the output to keep the price high.
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Principle 7: Governments Can Sometimes Active Learning 3: The government

Improve Market Outcomes – 3
• Important here: In each of the following situations, does the
government’s intervention improve the outcome?
– To say that the government can improve market
outcomes does not mean that it always will A. Public schools for school-aged children
B. Workplace safety regulations
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c. How the economy as a whole works ACTIVE LEARNING 4

Banking Academy decides to reduce the price of a
Principle 8: A country’s standard of living depends parking permit on campus from VND250.000 per semester
on its ability to produce goods and services. to VND100.000 per semester.
Principle 9: Prices rise when the government prints A. The number of students desiring to park their
too much money. motorbikes on campus will _________.
Principle 10: Society faces a short-run trade-off B. The amount of time it would take to find a parking place
between inflation and unemployment. will ___________.
C. Will the lower price of a parking permit necessarily
lower the true cost of parking? (Hint: opportunity cost)
D. Would the opportunity cost of parking be the same for
students with no outside employment and students with
jobs earning VND100.000 per hour?
37 © 2021 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a
license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use. 38
1.2. Thinking like an economist

• Economists play two roles:
1. Scientists: try to explain the world
2. Policy advisors: try to improve the
world
Thinking like an
1.2 economist
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a. The Economist as a Scientist a. The Economist as a Scientist

• As scientists, economists employ the • Economists make assumptions.
scientific method. – Simplify the complex world and make it easier
to understand.
– Observation, Theory, and More • For example, to study the relationship between price
Observation. and quantity of rice that consumers buy, we assume
that other factors, including income, unchanged.
– However, for economists, conducting
experiments is often impractical. They • Economists use models to study economic
often have to make do with whatever data issues.
the world gives them – Simplified representation of a more complicated
reality
– Two main models: The circular-flow diagram;
production possibilities frontier.
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The Circular-Flow Diagram The circular flow – 1

• Circular-flow diagram Households:
– Visual model of the economy  Own the factors of production,
– Shows how money flow through markets sell/rent them to firms for income
among households and firms  Buy and consume goods and
• Two decision makers services
Households
– Firms and households Firms
• Interacting in two markets Firms:
– Market for goods and services  Buy/hire factors of production,
use them to produce goods
– Market for factors of production (inputs)
and services
 Sell goods and services
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The circular flow – 2 The circular flow – 3

Revenue Spending
Markets for Markets for
Goods and G&S Goods &
G&S
Services sold Services bought
 Goods and services
are bought and sold.
 Sellers: firms
Firms Households
 Inputs are bought  Buyers: households
and sold.
 Sellers: households Factors of Labor, land,
 Buyers: firms Markets for production Markets for capital
Factors of Factors of
Production Wages, rent, Production Income
profit
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The PPF EXAMPLE 4: The PPF

• Production possibilities frontier (PPF) • Assume the following:
– A graph that shows various combinations of – A country produces only two goods: Cars and
outputs that the economy can possibly rice.
produce, given the available factors of – It has a fixed amount of resources (labor).
production and the available production
– And it has a fixed amount and quality of
technology.
technology.
• Maximum outputs that an economy can produce
• Given: the available inputs and the available – The available resources and technology can be
production technology used to produce:
• Only rice (5,000 tons)
• Only Cars (100 Cars)
• Or a combination of rice and Cars
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EXAMPLE 4: The PPF and output combinations EXAMPLE 4: Drawing the PPF
Cars Tons of rice
A 0 5,000
B 20 4,000
C 40 3,000
D 60 2,000
E 80 1,000
F 100 0
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Active Learning 5: Points off the PPF The PPF: What We Know So Far
Use the graph from the previous example. • Points on the PPF (like A – F): efficient
• Would it be possible for the economy to produce – Efficient: all resources are fully utilized
the following combinations of the two goods? • Points under the PPF (like G): possible
– Point H: 80 Cars and 4,000 tons of rice – Not efficient: some resources are
– Point G: 20 Cars and 2,000 tons of rice underutilized (e.g., workers unemployed,
factories idle)
• Points above the PPF (like H)
– Not possible
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Economic growth and the PPF Moving Along the PPF

Cars
• Moving along a PPF
• The economy can
produce: – Involves shifting resources from the
120 Economic growth • more rice, production of one good to the other
100 shifts the PPF
outward.
• More cars, • Society faces a tradeoff
80 • or any combination in – Getting more of one good requires sacrificing
between.
50 some of the other.
WHEN: …..
40
• The slope of the PPF
20 – The opportunity cost of one good in terms of
the other is the slope of the PPF
0 1,000 2,000 3,000 4,000 5,000 6,000
rice (tons)
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EXAMPLE 5: The PPF and opportunity cost The Shape of the PPF
Cars
To produce the first • Shape of the PPF
100 F
E
1,000 tons of rice: give – Straight line:
80 up 20 Cars
D
60 • Opportunity cost of 1
C
40 ton of rice = _______
B
20
To produce the first 20 – Bowed outward:
A
0 1,000 2,000 3,000 4,000 5,000

cars: give up 1,000
Rice (tons) tons of rice
• Opportunity cost of 1
car = _______
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Why the PPF might be bowed outward – 1 Why the PPF might be bowed outward – 2
• As the economy shifts At A, opportunity cost of • At point A, most workers

Beer
Beer
computers is low. are producing beer, even
resources from beer to
A those who are better
computers: suited to producing
• The opportunity cost of computers.
computers increases.
• PPF becomes steeper • At B, most workers are
At B, opportunity producing computers.
cost of computers
B The few left in beer
is high. production are the best
brewers.
Computers Computers
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Micro - and Macroeconomics Micro - and Macroeconomics

• Microeconomics
– The study of how households
and firms make decisions and
how they interact in markets
– The study of government
interventions in each market
• Macroeconomics
– The study of economy-wide
phenomena, including inflation,
unemployment, and economic
growth
– Studying the economic role of
government at macro level.
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Micro - and Macroeconomics b. The Economist as Policy Adviser

• Positive statements: descriptive
1. High tax on cigarette will limit smoking.
– Attempt to describe the world as it is
2. Unemployment in European countries increased
– Confirm or refute by examining evidence
rapidly in the 1990s.
• “Minimum-wage laws cause unemployment.”
3. An increase in households’ income can lead to an
• Normative statements: prescriptive
increase in the demand for cars.
– Attempt to prescribe how the world should be
4. High interest rates can reduce GDP of a country
• “The government should raise the minimum wage.”
due to low private investment.
5. Workers with higher wages can buy more food.
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Active Learning 6: Positive or normative? ASK THE EXPERTS

Which of these statements are “positive” and which “Due to Covid-19 pandemic, people are isolated from
are “normative”? How can you tell the difference? social activities. Working and studying from home is
A. The government should raise the minimum wage to getting more popular. In this time, people need more
help workers to improve their lives
computers/ laptops for online studying/working than
B. Taxes imposed on a commodity will decrease its
ever before. As a result, the price of computers/laptops
supply
has risen dramatically. According to some experts, to
C. When income rises, demand for instant noodles falls.
stabilize the laptop market, the government should
D. The government should print more money.
impose a price ceiling to protect consumers.”
E. A tax cut is needed to stimulate the economy.
F. An increase in the price of coffee will cause an
Questions:
increase in consumer demand for tea. 1. Which statement is positive?
2. Which statement is normative?
3. Why has the price of computers/laptops increased?
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PREPARATION FOR CHAPTER 2 SUMMARY

A. Related to demand part, your mission is to • Individual decision making:
prepare a presentation to clarify: • People face trade-offs among alternative goals.
(i) quantity demanded, law of demand;
(ii) two ways to illustrate demand (demand
• The cost of any action is measured in terms of
forgone opportunities.
schedule and demand curve);
(iii) how to determine market demand from • Rational people make decisions by comparing
individual demand; marginal costs and marginal benefits.
(iv) Difference between movement along the • People change their behavior in response to the
demand curve and demand curve shifts. incentives they face.
(v) and the most important part of this section:
which factors change demand then shift the
demand curve.
B. The same task is applied to supply part. 65 66
SUMMARY SUMMARY
• Interactions among people: • The economy as a whole:
• Trade and interdependence can be mutually • Productivity is the ultimate source of living
beneficial. standards.
• Markets are usually a good way of coordinating • Growth in the quantity of money is the ultimate
economic activity among people. source of inflation.
• Governments can potentially improve market • Society faces a short-run trade-off between
outcomes by remedying a market failure or by inflation and unemployment.
promoting greater economic equality.
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SUMMARY SUMMARY
• Economists are scientists. • A positive statement is an assertion about how the
– Make appropriate assumptions and build world is.
simplified models • A normative statement is an assertion about how
– Use the circular-flow diagram and the the world ought to be.
production possibilities frontier • As policy advisers, economists make normative
• Microeconomists study decision making by statements.
households and firms and their interactions in the • Economists sometimes offer conflicting advice.
marketplace. – Differences in scientific judgments
• Macroeconomists study the forces and trends that – Differences in values
affect the economy as a whole.
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Reading materials
Chapter 4, 5, 6. Mankiw, N.G (2021), Principles

of Economics, 9th Edition, Cengage Learning.
CHAPTER
Supply and demand

2
2
1
Purpose Contents
Establish the model of supply and demand.
Introduce the concept of elasticity, which allows us to 1. The market forces of supply and demand
make quantitative observations about the impact of
changes in supply and demand on equilibrium prices
and quantities.
Consider two types of government policies (price 2. Elasticity
controls & taxes). Government policies sometimes
produce unintended consequences.
3. Supply, demand, and government policies
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Learning objectives
By the end of this part, students should be
able to understand:
2.1 • What factors affect buyers’ demand for goods?

• What factors affect sellers’ supply of goods?
• How do supply and demand determine the
price of a good and the quantity sold?
The market forces of • How do changes in the factors that affect
demand or supply affect the market price and
supply and demand quantity of a good?
• How do markets allocate resources?
© 2021 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a 5 6
license distributed with a certain product or service or otherwise on a password-proteted website or school-approved learning management system for classroom use.
2.1. The market forces of

a. Markets and Competition
supply and demand
• Market
a. Markets and competition – A group of buyers and sellers of a
particular good or service
b. Demand – Buyers as a group
• Determine the demand for the product
c. Supply – Sellers as a group
• Determine the supply of the product
d. Supply and demand together
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a. Markets and Competition b. Demand

• Competitive market • Quantity demanded
– Many buyers and many sellers, each has a – Amount of a good that buyers are willing
negligible impact on market price and able to purchase
• Perfectly competitive market • Law of demand
– All goods are exactly the same
– Other things equal
– Price takers: so many buyers and sellers that no
one can affect the market price – When the price of a good rises, the
– At the market price, buyers can buy all they quantity demanded of the good falls
want, and sellers can sell all they want – When the price falls, the quantity
demanded rises
9 10
Demand Schedule and Demand Curve EXAMPLE 1A: Sofia’s demand for pizzas
• Demand schedule: Sofia’s demand Price Quantity

of of pizzas
− A table that shows the relationship schedule for pizzas pizzas demanded
between the price of a good and the $0.00 16
quantity demanded
− Notice that Sofia’s 1.00 14
• Demand curve preferences obey the 2.00 12
− A graph of the relationship between the law of demand. 3.00 10
price of a good and the quantity 4.00 8
demanded 5.00 6
6.00 4
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EXAMPLE 1B: Sofia’s demand schedule & demand curve Market Demand
Price of
a pizza Price Quantity
of of pizzas • Market demand
$6.00
pizzas demanded
– Sum of all individual demands for a good
$5.00 $0.00 16
or service
$4.00 1.00 14
2.00 12 – Market demand curve: sum the individual
$3.00 A decrease
in price… 3.00 10 demand curves horizontally
$2.00 4.00 8 • To find the total quantity demanded at any
$1.00 5.00 6 price, we add the individual quantities
6.00 4
$0.00
Quantity of
0 5 10 15 pizzas
… increases the quantity of pizzas demanded.
13 14
EXAMPLE 1C: Market vs. individual demand EXAMPLE 1D: Market demand curve for pizzas
Suppose Sofia and Diego are the only two buyers in P
Qd
the market for pizzas. (Qd = quantity demanded) $6.00 P
(Market)
$5.00 $0.00 24
Price Sofia’s Qd Diego’s Qd Market Qd A movement
$4.00 1.00 21
$0.00 16 8 along the
An demand curve 2.00 18
1.00 14 7 $3.00 increase in
price… 3.00 15
2.00 12 6 $2.00 4.00 12
3.00 10 5 $1.00 5.00 9
4.00 8 4
$0.00 6.00 6
5.00 6 3 Q
0 5 10 15 20 25
6.00 4 2 … decreases the quantity of pizzas demanded.
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Demand Curve Shifters – 1 Demand Curve Shifters – 2

• The demand curve shifts • Shifts in the demand curve are caused by
– When something happens to alter the quantity changes in:
demanded at any given price. – Number of buyers
– Something here includes non-price determinants
– Income
of demand
• Factors shift the D curve – Prices of related goods
– Any change that increases the quantity demanded – Tastes
at any prices shifts the demand curve to the right – Expectations
and is called an increase in demand.
– Any change that decreases the quantity
demanded at any prices shifts the demand curve
to the left and is called an decrease in demand.
17 18
Shift vs. Movement Along the Demand Curve A Movement along the Demand Curve
• Change in demand: P
$6.00
– A shift in the demand curve
– Occurs when a non-price determinant of $5.00
A movement
demand changes (like income or number of $4.00 along the
buyers…) An demand curve
$3.00 increase in
• Change in the quantity demanded: price…
$2.00
– A movement along a fixed demand curve
$1.00
– Occurs when the price changes
$0.00
Q
0 5 10 15 20 25
… decreases the quantity of pizzas demanded.
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A Shift in the Demand Curve Shift vs. Movement Along the Demand Curve
P Suppose the number of
$6.00 buyers increases.
$5.00 • Then, at each P, Qd
will increase
$4.00
• The demand curve
$3.00 shifts to the right
$2.00
$1.00
$0.00
Q
0 5 10 15 20 25 30
21 22
Active Learning 1: The demand curve Active Learning 1A. Price of apple juice increases
Draw the demand curve for orange juice, D1,
and a point A (P1, Q1) on the demand curve.
What happens in each of the following
scenarios? Why?
A. The price of apple juice increases

B. The price of orange juice falls
C. Consumers’ income falls (and orange juice
is a normal good)
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Active Learning 1B. The price of orange juice falls Active Learning 1C. Consumers’ income falls
Price of • Move down along

orange the demand curve
juice to a point with lower
P, higher Q.
A
P1
B • The D curve does
P2
not shift.
D1
Q1 Q2 Quantity of
orange juice
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c. Supply Supply Schedule and Supply Curve

• Quantity supplied • Supply schedule:
– Amount of a good − A table that shows the relationship between the
– Sellers are willing and able to sell price of a good and the quantity supplied
• Law of supply • Supply curve
– Other things equal − A graph of the relationship between the price of
– When the price of a good rises, the quantity a good and the quantity supplied
supplied of the good rises
– When the price falls, the quantity supplied falls
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EXAMPLE 2A: Pizza Hut's supply of pizzas EXAMPLE 2B: Pizza Hut's supply schedule & supply curve
Price Quantity
Pizza Hut's supply of of pizzas P Price Quantity
schedule of pizzas pizzas supplied $6.00
of of pizzas
pizzas supplied
$0.00 0
$5.00 $0.00 0
− Notice that Pizza Hut's 1.00 3
$4.00 1.00 3
2.00 6
supply schedule obeys 2.00 6
3.00 9 $3.00
the law of supply 3.00 9
4.00 12 $2.00
4.00 12
5.00 15
$1.00 5.00 15
6.00 18
$0.00 6.00 18
Q
0 5 10 15
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Market Supply vs. Individual Supply EXAMPLE 2C: Market vs. individual supply
• Market supply Suppose Pizza Hut and Pepperonis are the only
two sellers in the pizza market. (Qs = quantity
– Sum of the supplies of all sellers of a good or
service supplied) Q Q
s s
– Market supply curve: sum of individual supply Price Pizza Hut Pepperonis Market Qs
curves horizontally $0.00 0 0
• To find the total quantity supplied at any price, we 1.00 3 2
add the individual quantities 2.00 6 4
3.00 9 6
4.00 12 8
5.00 15 10
6.00 18 12
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EXAMPLE 2D: Market supply curve of pizzas Supply Curve Shifters – 1

P QS
P • The supply curve shifts
$6.00 (Market) – When something happens to alter the quantity
$5.00 $0.00 0 supplied at any given price.
An
1.00 5 – Something here includes non-price determinants
$4.00 increase in A movement
price… along the 2.00 10 of supply
$3.00 supply curve • Factors shift the S curve
3.00 15
$2.00 4.00 20
– Any change that increases the quantity supplied
at any prices shifts the supply curve to the right
$1.00 5.00 25
and is called an increase in supply.
$0.00 6.00 30
– Any change that decreases the quantity supplied
0 5 10 15 20 25 30 35 Q at any prices shifts the supply curve to the left and
… increases the quantity of pizzas supplied. is called an decrease in supply.
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Supply Curve Shifters – 2 Shift vs. Movement Along the Supply Curve
• Shifts in the supply curve are caused by • Change in supply:
changes in: – A shift in the supply curve
– Input prices – Occurs when a non-price determinant of supply
– Technology changes (like technology or costs)
– Number of sellers • Change in the quantity supplied:
– Expectations about the future – A movement along a fixed supply curve
– Occurs when the price changes
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Summary: variables that influence sellers Active Learning 2: The supply curve
Draw a supply curve for apple juice, S1, and a
point A (P1, Q1) on the supply curve. What
happens to it in each of the following
scenarios? Why?
A. Grocery stores cut the price of apple juice.
B. A technological advance allows apple juice
to be produced at lower cost.
C. Grocery stores cut the price of orange
juice.
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Active Learning 2A. Decrease in price of apple juice Active Learning 2B. Technological advance
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Active Learning 2C. Decrease in price of orange juice d. Supply and demand together – 1
Equilibrium:
P
Price has reached D
$6.00
S
the level where
quantity supplied $5.00
equals quantity $4.00
demanded; where
supply and $3.00
demand curves $2.00
intersect $1.00
$0.00
Q
0 5 10 15 20 25 30 35
41 42
d. Supply and demand together – 2 ASK THE EXPERTS

Do you agree or disagree with this statement?
Equilibrium price: price where QS = QD = equilibrium
“Government should pass its regulation, which states that
Q
P D during a ‘disaster – e g. natural disaster, no person within
S
$6.00 P QD QS the chain of distribution of consumer goods/services shall
$5.00 $0 24 0 sell or offer to sell consumer goods/services for a price
that is unreasonably high’”.
$4.00 1 21 5
2 18 10
$3.00
3 15 15
$2.00
4 12 20
$1.00 5 9 25
$0.00 6 6 30
Q
0 5 10 15 20 25 30 35
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Markets not in equilibrium: shortage – 1 Markets not in equilibrium: shortage – 2

Shortage Facing a shortage,
P (excess demand) P sellers raise the price,
D S D S
$6.00 Quantity demanded is $6.00 - Causing QD to fall
greater than quantity - and QS to rise,
$5.00 $5.00
supplied
$4.00 $4.00
- …which reduces the
If P = $1, shortage.
$3.00 - then QD = 21 pizzas $3.00
– And so on… until
$2.00 - and QS = 5 pizzas $2.00 market reaches
$1.00 - Resulting in a $1.00 equilibrium
shortage of 16 pizzas Shortage
$0.00 Shortage $0.00
Q Q
0 5 10 15 20 25 30 35 0 5 10 15 20 25 30 35
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Markets not in equilibrium: surplus – 1 Markets not in equilibrium: surplus – 2

Surplus (excess supply): Facing a surplus, sellers
P quantity supplied is P try to increase sales by
D S D S cutting the price:
$6.00 Surplus greater than quantity $6.00 Surplus
demanded – This causes QD to rise
$5.00 $5.00
If P = $5, – and QS to fall…
$4.00 $4.00 – …which reduces the
– then QD = 9 pizzas
$3.00 – and QS = 25 pizzas, $3.00 surplus.
$2.00 – Resulting in a $2.00 – And so on… until
surplus of 16 pizzas market reaches
$1.00 $1.00
equilibrium.
$0.00 $0.00
Q Q
0 5 10 15 20 25 30 35 0 5 10 15 20 25 30 35
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Supply and Demand Together EXAMPLE 3: The market for pizzas

P
Three steps to analyzing changes in equilibrium: price of
S1
pizzas
1. Decide whether the event affects the supply,
the demand, or, in some cases, both
Market
2. Decide whether the demand/supply P1 equilibrium
E1
increase/decrease the demand or supply
curve(s) shifts to the right or to the left
3. Use the supply-and-demand diagram D1
Q
• Compare the initial and the new Q1
equilibrium
quantity of
• Effects on equilibrium price and quantity pizzas
49 50
EXAMPLE 3A: A shift in demand EXAMPLE 3B: A shift in supply

EVENT A: Increase in the price of hamburgers. EVENT B: New technology
The market for pizzas of producing pizzas.
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EXAMPLE 3C: A shift in both S and D – 1 EXAMPLE 3C: A Shift in Both S and D – 2
EVENTS: Price of hamburgers rises AND new technology
reduces production costs.
If supply increases more

than demand, P falls.
54
53
EXAMPLE 3C: A Shift in Both S and D – 2 Active Learning 3: Shifts in supply and demand
Use the three-step method to analyze the
effects of each event on the equilibrium price
and quantity of orange juice.
Event A: A fall in the price of apple juice
Event B: The price of oranges declines
If increase of supply because of an abundant orange
equals increase of crop.
demand, P remains Event C: Events A and B both occur
unchanged. simultaneously.
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Active Learning 3A. A fall in price of apple juice Active Learning 3B. Fall in the price of oranges
The market for orange juice The market for orange juice
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Active Learning 3C. Events A and B together THINK-PAIR-SHARE

You are watching a national news broadcast. It
The market for orange juice
is reported that a drought is going to affect the North
of Vietnam and that it will likely destroy much of this
year’s orange crop. Your roommate says, “This is not
going to affect me, I don’t eat oranges, I only drink
pineapple smoothies.”
A. As an eager economics student, what’s your
response going to be? Explain.
B. What other markets will be impacted by the
destroyed orange crop? How?
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SUMMARY SUMMARY
• Economists use the model of supply and demand • The supply curve shows how the quantity of a
to analyze competitive markets. good supplied depends on the price.
– Many buyers and sellers, all are price takers – Law of supply: as the price of a good rises, the
• The demand curve shows how the quantity of a quantity supplied rises; the S curve slopes upward.
good demanded depends on the price. • Other determinants of supply: input prices,
– Law of demand: as the price of a good falls, the technology, expectations, and number of sellers.
quantity demanded rises; the D curve slopes – If one of these factors changes, supply curve shifts.
downward • The intersection of the supply and demand curves
• Other determinants of demand: income, prices of determines the market equilibrium.
substitutes and complements, tastes, expectations, – At the equilibrium price, quantity demanded =
and number of buyers. quantity supplied
– If one of these factors changes, the D curve shifts
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SUMMARY SUMMARY
• The behavior of buyers and sellers naturally drives • To analyze how any event influences a market, we
markets toward their equilibrium. use the supply-and-demand diagram to examine
– When the market price is above the equilibrium how the event affects the equilibrium price and
price, there is a surplus of the good, which quantity.
causes the market price to fall. 1. Decide whether the event affects the supply, the
– When the market price is below the equilibrium demand (or both).
price, there is a shortage, which causes the 2. Decide in which direction the curve shifts.
market price to rise. 3. Compare the new equilibrium with the initial one.
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Learning objectives
By the end of this part, students should be able to
understand:
• What is elasticity?
• What kinds of issues can elasticity help us
understand?
• What is the price elasticity of demand? How is it
2.2 Elasticity related to the demand curve? How is it related to
revenue and expenditure?
• What is the price elasticity of supply? How is it
related to the supply curve?
• What are the income and cross-price elasticity of
demand?
65 66
Our scenario 2.2.1. The Elasticity of Demand

• You maintain the social media accounts for local
businesses • Elasticity
– You charge $2,000 per business, – Measure of the responsiveness of Qd or Qs to a
– The social media accounts per year: 12 change in one of its determinants
businesses • Price elasticity of demand
• Your costs are rising – How much the quantity demanded of a good
 You consider raising the price to $2,500. responds to a change in the price of that good
• The law of demand: if you raise your price, you will • Loosely speaking, it measures the price-sensitivity of
not have as many accounts to maintain. buyers’ demand
– How many fewer accounts? %
– How much will your revenue fall, or might it EDP =
%
increase?
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A. The Price Elasticity of Demand The Variety of Demand Curves

% • Demand is perfectly inelastic:
P EDP =
% – Price elasticity of demand = 0
• Demand is inelastic:
P rises P2 – Price elasticity of demand < 1
by 10% P1
• Demand has unit elasticity:
D – Price elasticity of demand = 1
Q Along a D curve, P and Q • Demand is elastic:
Q2 Q1 move in opposite
– Price elasticity of demand > 1
Q falls directions, which would
by 15% make price elasticity • Demand is perfectly elastic:
negative. – Price elasticity of demand = infinity
We will drop the minus sign and report all price elasticities as
positive numbers (absolute values).
69 70
Perfectly inelastic demand Inelastic demand

% 0% % <10%
EDP = = =0 EDP = = <1
% 10% % 10%
P
• D curve: P
• D curve
D
Vertical relatively steep
P
P1 • Consumers’ P falls 1
P falls by 10% P • Consumers’ price
by 10% P
2
price sensitivity: 2
sensitivity:
D
None relatively low
Q1 Q
• Elasticity: Q1 Q2 Q
• Elasticity:
Q changes 0 Q rises less
<1
by 0% than 10%
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Unit elastic demand Elastic demand

% 10% % >10%
EDP = = =1 EDP = = >1
% 10% % 10%
P • D curve P • D curve
intermediate relatively flat
P1
P falls
P1 slope P falls
• Consumers’ price
by 10% P
by 10% • Consumers’ price D
P2 2 sensitivity:
D
sensitivity: relatively high
intermediate Q1 Q2 Q • Elasticity:
Q1 Q2 Q
Q rises • Elasticity: Q rises more >1
by 10% =1 than 10%
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Perfectly elastic demand The Variety of Demand Curves

% any % • The greater the price elasticity of demand
EDP = = = infinity
% 0%
– The flatter the demand curve
P • D curve
D horizontal
P2 = P1
P changes
• Consumers’
by 0% price sensitivity:
extreme
Q1 Q2 Q • Elasticity:
Q changes infinity
by any %
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Calculating the Price Elasticity of Demand Calculating the Price Elasticity of Demand
• Standard method Standard method of • Midpoint method
computing the percentage (%) – The midpoint is the average of the start and end
P
change: values
B
$2500 end value  start value
$2000
A  100%
start value end value  start value
D percentage change   100%
Going from A to B: midpoint
Q (Q  Q1 ) / [(Q2  Q1 ) / 2 ]
8 12
Price elasticity of demand
(  )/2
Going from B to A: EDP = (P2  P1 ) / [(P2  P1 ) / 2 ]
( )/
77 78
Our scenario Active Learning 4: Calculate an elasticity

Use the following information to calculate the
Using the midpoint method price elasticity of demand for iPhones:
P of computing % changes:
B
• if P = $400, Qd = 10,600
$2500 • if P = $600, Qd = 8,400
A
$2000 A. Use the midpoint method to calculate percentage
D change in price
Q B. Use the midpoint method to calculate percentage
8 12
change in quantity
C. Calculate the price elasticity of demand
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Active Learning 4: Answers Elasticity along a linear demand curve

Using the midpoint method to calculate percentage  The slope of a
changes: P linear demand
A. % change in P = 200% curve is constant,
$30 E = = 5.0
40% but its elasticity
67% is not.
B. % change in Qd = 20 E = = 1.0
67%  Elasticity falls as
40% you move
C. Price elasticity of demand 10 E = = 0.2 downward and
200%
= % change in Qd / % change in P rightward along a
$0 Q linear demand
0 20 40 60 curve.
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Determinants of price elasticity of demand - 1 Determinants of price elasticity of demand - 2

 Prices of both of these goods rise by 20%. Prices of both of these goods rise by 20%.
For which good does Qd drop the most? Why? For which good does Qd drop the most? Why?
• Apple • Viettien shirts
• Traveling by airplanes • Clothing
 Price elasticity is ……. when close substitutes  Price elasticity is ….….. for narrowly defined
are available. goods than for broadly defined ones.
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Determinants of price elasticity of demand - 3 Determinants of price elasticity of demand - 4

Prices of both of these goods rise by 20%. The price of gasoline rises 20%. Does Qd drop
For which good does Qd drop the most? Why? more in the short run or the long run? Why?
• Insulin is a necessity to diabetics. • In the short run,
• In the long run,

• A Rolex watch is a luxury.
 Price elasticity is ……. in the long run.

 Price elasticity is ………. for luxuries than for
necessities.
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Price Elasticity and Total Revenue Our scenario: Elastic demand

If a firm raises its price, would the revenue rise
or fall?
increased P and Q  TR
Total Revenue (TR) = P x Q P revenue due to
higher P When D is elastic,
• A price increase has two effects on revenue: a price increase
lost revenue
– Higher revenue: because of the higher P P2 due to lower Q causes revenue to
……..
– Lower revenue: because of the lower Q P1
D
• Which of these two effects is bigger?
– It depends on the price elasticity of demand
Q
Q2 Q1
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Our scenario: Inelastic demand Price Elasticity and Total Revenue - Summary
For a price increase, if demand is elastic
P and Q  TR  E > 1: % change in Q ….. % change in P
increased
P revenue due to  The fall in revenue from lower Q ….the increase
higher P
in revenue from higher P  TR …..
P2 When D is inelastic,
lost revenue a price increase For a price increase, if demand is inelastic
due to lower Q
causes revenue to  E < 1: % change in Q ….. % change in P
P1
…….  The fall in revenue from lower Q …. the
D
increase in revenue from higher P  TR ……
Q
Q2 Q1
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Active Learning 5: Elasticity and total revenue Active Learning 5: Answers, A

A. Pharmacies raise the price of insulin by 10%. A. Pharmacies raise the price of insulin by 10%.
– Does total expenditure on insulin rises or falls? – Does total expenditure on insulin rises or falls?
B. As a result of a fare war, the price of a luxury
cruise falls 20%.
– Does luxury cruise companies’ total revenue
rises or falls?
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Active Learning 5: Answers, B B. Income Elasticity of Demand

B. As a result of a fare war, the price of a luxury • Income elasticity of demand
cruise falls 20%. – How much the quantity demanded of a good
– Does luxury cruise companies’ total revenue responds to a change in consumers’ income
rises or falls? %
EDI =
%
• Classification
– Normal goods: income elasticity > 0
– Inferior goods: income elasticity < 0
– Luxuries: income elasticity > 1
– Necessities: income elasticity positive but < 1
93 94
C. Cross-Price Elasticity of Demand 2.2.2. The Elasticity of Supply

• Cross-price elasticity of demand • Price elasticity of supply
– How much the Qd of one good responds to a – How much the quantity supplied of a good
change in the price of another good responds to a change in the price of that good
% %
Edx,y = ESP =
% %
– Loosely speaking, it measures sellers’

• Classification
price-sensitivity
– Substitutes: cross-price elasticity > 0
– Complements: cross-price elasticity < 0
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Calculating Price Elasticity of Supply The Variety of Supply Curves
Price elasticity percentage change in Q s 16% • Supply is perfectly inelastic

of supply   2 – Price elasticity of supply = 0
percentage change in P 8%
• Supply is inelastic
P
S – Price elasticity of supply < 1
Again, we use the
midpoint method to P rises P2 • Supply is unit elastic
compute the by 8% P
1 – Price elasticity of supply = 1
percentage
• Supply is elastic
changes.
Q – Price elasticity of supply > 1
Q1 Q2
Q rises • Supply is perfectly elastic
by 16% – Price elasticity of supply = infinity
97 98
Perfectly inelastic supply Inelastic supply

Price elasticity % change in Q 0% Price elasticity % change in Q < 10%
= = =0 = = <1
of supply % change in P 10% of supply % change in P 10%
• S curve: P • S curve: P
S S
vertical relatively steep
P • Sellers’ price P rises P2
• Sellers’ price P rises 2
sensitivity: by 10% P sensitivity: by 10% P1
1
none relatively low

• Elasticity: Q • Elasticity: Q
Q1 Q1 Q2
0 Q changes <1 Q rises less
by 0% than 10%
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Unit elastic supply Elastic supply

Price elasticity % change in Q 10% Price elasticity % change in Q > 10%
= = =1 = = >1
of supply % change in P 10% of supply % change in P 10%
• S curve: P
• S curve: P
intermediate slope S relatively flat S
• Sellers’ price P2 • Sellers’ price P rises P2
sensitivity: sensitivity: by 10%
P1 P1
intermediate P rises relatively high
• Elasticity: by 10% Q • Elasticity: Q
Q1 Q2 Q1 Q2
=1 Q rises
>1 Q rises more
by 10% than 10%
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Perfectly elastic supply The Variety of Supply Curves

Price elasticity % change in Q any % • The greater the price elasticity of supply
= = = infinity
of supply % change in P 0% – The flatter the supply curve
• S curve:
P
horizontal
• Sellers’ price P2 = P1 S
sensitivity: P changes
extreme by 0%
• Elasticity: Q
Q1 Q2
infinity Q changes
by any %
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The Determinants of Supply Elasticity Active Learning 6: Elasticity and changes in equilibrium
• The more easily sellers can change the Assume the supply of parking spots is inelastic
quantity they produce, the greater price and the supply of rice is elastic. Suppose
elasticity of supply population growth causes demand for both goods
to double (at each price, Qd doubles).
• Price elasticity of supply is greater in the
• For which product will P change the most?
long run than in the short run
• For which product will Q change the most?
– In the long run: firms can build new factories,
or new firms may be able to enter the market A. Draw a graph with the new equilibrium in the
market for parking spots
B. Draw a graph with the new equilibrium in the
market for rice
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Active Learning 6A. Parking spots Active Learning 6B. Rice

Parking spots Rice
When supply is (inelastic supply): When supply (elastic supply):
P P
inelastic is elastic
Q Q
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2.2.3. Some applications of elasticity An increase in supply in the market for rice
1. Can Good News for Farming Be Bad News
for Farmers?
– Applying new technological production of rice:
20% increased production per hectare
109 110
2.2.3. Some applications of elasticity Why Did OPEC Fail to Keep the Price of Oil High?
2. Why Did OPEC Fail to Keep the Price of Oil  In the short-run:
High?
• Decrease in oil supply  large increase in price
in short-run (1973-1974)
 In the long run:
• Decrease in supply  small increase in price in
long-run (1971-1981)
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A reduction in supply in the world market for oil THINK-PAIR-SHARE: Another application
(a) The Oil Market in the Short Run (b) The Oil Market in the Long Run In order to reduce teen smoking, the government
places a VND 5,000 per pack tax on cigarettes. After
one month, the quantity demanded of cigarettes has
Price
been reduced only slightly. Discuss the following:
Price
A. What conclusion can you draw about the one-
month demand for cigarettes?
B. Nam suggests that the cigarette industry should
get together and raise the price of cigarettes in
long run to increase total revenue .
C. Lan suggests that only your firm should raise the
price of your cigarettes to increase total revenue.
0 Quantity 0 Quantity
113 114
SUMMARY SUMMARY
• The price elasticity of demand • Demand tends to be more elastic if
– Measures how much the quantity demanded – Close substitutes are available
responds to changes in the price. – The good is a luxury rather than a necessity
– Is the percentage change in quantity demanded – The market is narrowly defined
divided by the percentage change in price. – Buyers have substantial time to react to a price
• The variety of the price elasticity of demand change.
– If < 1, inelastic demand: quantity demanded • Total revenue (PxQ), total amount paid for a good
moves proportionately less than the price – Moves in the same direction as P (inelastic D)
– If > 1, elastic demand: quantity demanded – Moves in the opposite direction as P (elastic D)
moves proportionately more than the price
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SUMMARY SUMMARY
• The cross-price elasticity of demand • The price elasticity of supply
– Measures how much the quantity demanded of – Measures how much the quantity supplied responds
to changes in the price.
one good responds to changes in the price of
– Is the percentage change in quantity supplied
another good
divided by the percentage change in price
• The income elasticity of demand • The variety of the price elasticity of supply
– Measures how much the quantity demanded – If < 1, inelastic supply: quantity supplied moves
responds to changes in consumers’ income proportionately less than the price
– If > 1, elastic supply: quantity supplied moves
proportionately more than the price
• Depends on the time horizon under consideration. In
most markets, supply is more elastic in the long run
than in the short run.
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Learning objectives
understand:
• What are price ceilings and price floors?
What are some examples of each? How do
Supply, Demand, and price ceilings and price floors affect market
2.3 Government Policies
outcomes?
• How do taxes affect market outcomes?
How do the effects depend on whether
the tax is imposed on buyers or sellers? What
is the incidence of a tax? What determines the
Interactive PowerPoint Slides by: incidence?
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Government Policies A. Controls on Prices

• Economists as policy advisers • Price ceiling:
– Use theories to help change the world for the – Legal maximum on the price at which a good
better. can be sold
• Policies – In order to protect buyers
– Use price controls and taxes to alter the private – Example: Rent-control laws
market outcome • Price floor:
– Often have effects that their architects did not – Legal minimum on the price at which a good
intend or anticipate can be sold
– In order to protect sellers
– Example: Minimum wage laws
121 122
PRICE CEILING PRICE CEILING: Not binding price ceiling
Rental P S A price ceiling above The Market for Apartments

price of the equilibrium price P S
apartments is not binding Price
Equilibrium without $1000
ceiling
$800 price controls
$800
D
Q
300 D
Q
Quantity 300
of apartments
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PRICE CEILING: Binding price ceiling PRICE CEILING: Binding price ceiling in long run
The price ceiling below
The Market for Apartments In the long run, supply The Market for Apartments
the equilibrium price
P S and demand of rental
is binding, apartments are more P S
price-elastic.
$800
$800
Price
$500 Price
ceiling $500
ceiling
D
Q D
250 400 Q
150 450
125 126
BIDING PRICE CEILING: Evaluation PRICE FLOOR

• Impacts of biding price ceiling Wage W
paid to S
- Long lines
unskilled
- Discrimination according to sellers’ biases workers
- Are often unfair and inefficient Equilibrium without
$9.00
• Conclusion price controls
- Even though the price ceiling was motivated by
a desire to help buyers, not all buyers benefit
from the policy.
D
- Some buyers pay a lower price, although they L
may have to wait in line to do so. 500
- Other buyers even cannot buy the goods Quantity of
anymore (because the quantity supplied, unskilled workers
available on the market, is too small).
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PRICE FLOOR: Not binding price floor PRICE FLOOR: Binding price floor
A price floor below the The equilibrium wage The Market for Unskilled Labor
The Market for Unskilled Labor
equilibrium price is not ($9) is below the floor
binding W S and therefore illegal.
W S
Price
$10.25
The price floor is floor
$9.00 binding
$9.00
Price
$7.00
floor
D
L D
500 L
400 550
129 130
Minimum Wage Laws: Evaluation Active Learning 7: Price Controls

• Pros: One way to raise the income of The market for P
The market for bicycles
140
working poor bicycles is in 130
S
• Cons: equilibrium as in 120
o Causes unemployment the graph. 110
o Encourages teenagers to drop out of high Determine the 100
school effects of: 90
80 D
o Prevents some unskilled workers from getting
A. $90 price ceiling 70
on-the-job training
B. $90 price floor 60
50
C. $120 price floor 40
0 Q
50 60 70 80 90 100 110 120 130
131 132
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Active Learning 7A: $90 price ceiling Active Learning 7B: $90 price floor
133 134
Active Learning 7C: $120 price floor Evaluating Price Controls

• Economists usually oppose price ceilings
and price floors, because:
– Markets are usually a good way to organize
economic activity
– Prices have the crucial job of balancing supply
and demand
135 136
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Evaluating Price Controls B. Taxes

• Governments can sometimes improve market • Government uses taxes
outcomes by using price controls – To raise revenue for public projects
– Policymakers are motivated to control prices • Roads, schools, and national defense
because they view the market’s outcome as
unfair. Besides, price controls are often aimed • Should the government impose tax on buyers or
at helping the poor. sellers?
– Yet price controls often hurt those they are
trying to help
• Other ways of helping those in need is • The tax can be a percentage of the good’s price,
subsidies, which does not lead to shortage or or a specific amount for each unit sold. For
surplus. However, this policy costs money and simplicity, we analyze per-unit taxes only.
therefore, requires higher taxes.
137 138
Case 1: Tax imposed on sellers Case 1: Tax imposed on sellers

Effects of a $3 per unit A tax on sellers is like Effects of a $3 per unit New equilibrium:
tax on sellers a cost increase, tax on sellers Q = 450
causes their supply to P Buyers pay
P S2
S2 PB =
$13.00 fall S1
Tax S1 $12.00 Sellers receive
Tax
Hence, a tax on $10.00 PS =
$10.00 sellers shifts the S $9.00 Difference between
curve up (left) by the them = …… = tax
amount of the tax. D1
D1
Q 450 500 Q
500
139 140
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Case 1: Tax imposed on sellers Case 2: Tax imposed on buyers

• Tax incidence: how the burden of a tax is Effects of a $3 per unit tax Buyers will have to pay
shared among market participants on buyers more, which causes their
P demand to fall
In our example, S1
Hence, a tax on buyers
• buyers pay ……more,
$10.00 shifts the D curve down
Tax
• sellers get …….less.
by the amount of the tax.
$7
D1
D2
Buyers and sellers share the burden of tax 500 Q

• Sellers get a lower price, are worse off
• Buyers pay a higher price, are worse off
141 142
Case 2: Tax imposed on buyers Case 2: Tax imposed on buyers

Effects of a $3 per unit tax New equilibrium:
on buyers Q = 450 In our example,
P Sellers receive • buyers pay …… more,

$12
S1 PS • sellers get …..less.
Tax
Buyers pay
$10.00 Buyers and sellers share the burden of tax
PB
$9 • Sellers get a lower price, are worse off
• Buyers pay a higher price, are worse off
D1 Difference between
D2 them = PB - PS =
….. = tax
450 500 Q
143 144
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The outcome … Active Learning 8: Effects of a tax

The market for P The market for bicycles
140
bicycles is in S
130
equilibrium as in the 120
P
graph. Suppose the 110
S1 government 100
PB = $12
Tax
imposes a tax on 90
$10
buyers of $30 per 80 D
PS = $9
bicycle. 70
60
D1 • Find the new 50
Q, PB, PS, and 40
450 500 Q incidence of tax. 0 Q
50 60 70 80 90 100 110 120 130
145 146
Active Learning 8: Answers Elasticity and Tax Incidence

• When a good is taxed
– Buyers and sellers of the good share the
burden of the tax
– But how exactly is the tax burden divided?
• Depends on the elasticity of demand and elasticity of
supply
147 148
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Tax Incidence: Elastic supply, inelastic demand Tax Incidence: Inelastic supply, elastic demand
Buyers’ share P • It’s easier for • It’s easier for

of tax burden sellers than buyers than
buyers to leave P
PB S Buyers’ share S sellers to leave
the market. of tax burden the market.
Tax
• So buyers bear PB • Sellers bear
Price if no tax
most of the Price if no tax most of the
PS Tax burden of the
burden of the
Sellers’ share tax. tax.
D
of tax burden Sellers’ share PS
D
Q of tax burden
Q
149 150
Elasticity and Tax Incidence – Conclusion Active Learning 9: Who pays the luxury tax?
Tax burden falls more heavily on the side of • The government intend to adopt a new tax
the market that is less elastic: on luxuries, e.g. jewelry, expensive cars.
• Small elasticity of demand: Buyers do not have Who will pay most for the tax, the sellers or
good alternatives to consuming this good. the buyers?
Buyers bear most of the burden of the tax.
• Small elasticity of supply: Sellers do not have
good alternatives to producing this good.
Sellers bear most of the burden of the tax.
151 152
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Active Learning 9: Who pays the luxury tax? THINK-PAIR-SHARE

The market for expensive cars
In order to raise more tax revenue for the State
budget, the Prime Minister proposes a tax on food.
According to him, everyone must eat and, thus, a food
tax would surely raise a great deal of tax revenue. He
insists the tax should be placed on food sellers to
protect the poor who spend a large proportion of their
income on food.
A. Will the burden of a food tax fall only on the sellers
of food as the Prime Minister said? Explain.
B. Who will bear most of this tax burden? Explain.
153 154
SUMMARY SUMMARY
• A price ceiling is a legal maximum on the price • When the government levies a tax on a good,
of a good or service. Example: rent control. the equilibrium quantity of the good falls.
– Binding if below the equilibrium price: causing – The tax places a wedge between the price
shortage. paid by buyers and the price received by
– Sellers must in some way ration the good or sellers.
service among buyers. – Buyers pay more for the good and sellers
• A price floor is a legal minimum on the price of a receive less for it.
good or service. Example: minimum wage. • Buyers and sellers share the tax burden.
– Binding if above the equilibrium price: causing – The incidence of tax depends on the price
surplus. elasticities of supply and demand.
– Buyers’ demands for the good or service must – Most of the burden falls on the side of the
in some way be rationed among sellers. market that is less elastic.
155 156
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Reading materials
Chapter 7. Mankiw, N.G (2021), Principles of

Economics, 9th Edition, Cengage Learning.
CHAPTER
Consumers, Producers, and
3 the Efficiency of Markets
© 2021 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a 2
1 license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use.
Purpose Learning objectives

Develop welfare economics - the study of how the By the end of this chapter, students should be
allocation of resources affects economic well-being. able to:
Discover that under most circumstances the Understand what consumer surplus is, how it is
equilibrium price and quantity is also the one that related to the demand curve?
maximizes welfare. Understand what producer surplus is, how it is related
to the supply curve?
Explain why the equilibrium quantity in a market
maximizes total surplus in that market.
Explain the difference between efficiency and
equality.
© 2021 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a 3 © 2021 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a 4
license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use. license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use.
22/08/2021
Contents Welfare Economics

• Welfare economics
1. Consumer surplus – Studies how the allocation of resources affects
economic well-being
• Allocation of resources refers to how much of each
good is produced, which producers produce it, and
2. Producer surplus which consumers consume it
• Economic well-being: the benefits that buyers and
sellers receive from engaging in market transactions.
3. Market efficiency – Looks at how society can make these benefits

as large as possible
3.1. Consumer Surplus EXAMPLE 1A: Willingness to pay

• Consumer surplus (CS) You work at the local store that sells iPads. The
– CS reflects benefits buyers receive from store is running a sale on the iPad mini 3. Each of
participating in a market. your roommates wants to buy an iPad mini 3.
However, their willingness to pay is not the same.
– CS = WTP – P
Buyers’ willingness to pay for a good minus Q: If the sale price is $200, who
Name WTP
the actual price. will buy an iPad, and what is the
– WTP (willingness to pay): A $250 quantity demanded?
• Is maximum amount the buyer will pay for B 175
that good. C 300
• Reflects how much the buyer values the good
D 125
© 2021 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a 7 © 2021 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a
8
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EXAMPLE 1B: WTP and the demand schedule EXAMPLE 1C: WTP and the demand curve -1
Derive the P
demand P (price $350
who buys Qd
schedule: of iPad) $300
$301 & up $250
Name WTP
251 – 300 $200
A $250
176 – 250
$150
B 175
$100
C 300 126 – 175
$50
D 125 $0
0 – 125
0 1 2 3 4 Q
© 2021 Cengage Learning . May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a
® © 2021 Cengage Learning . May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a
®
license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use.
10
About the staircase shape… EXAMPLE 1C: WTP and the demand curve - 2
P This D curve looks like P At any Q, the height of
$350 a staircase with 4 $350 the D curve is the
$300 steps – one per buyer. $300 WTP of the marginal
$250 If there were a huge # $250 buyer, the buyer who
of buyers, there would
$200 $200 would leave the
be a huge # of very
$150 tiny steps, and it $150 market if P were any
$100 would look like a $100 higher.
straight curve.
$50 $50
$0 $0
Q
0 1 2 3 4 Q 0 1 2 3 4
© 2021 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a © 2021 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a
12
22/08/2021
EXAMPLE 2A: Calculating consumer surplus EXAMPLE 2B: CS and the demand curve
P
CS = WTP - P Suppose P = $220
$350
Name WTP Suppose P = $220. $300
A $250 $250
B 175 $200
C 300 $150
D 125 $100
CS is the area
$50 below the demand
$0 curve and above
0 1 2 3 4 Q the price.
14
EXAMPLE 2C: Consumer surplus for one buyer EXAMPLE 2D: Total consumer surplus
Price
per unit
P The demand for T-shirts CS is the area P The demand for T-shirts
$ 60 between P and $ 60 P = $30, Qd = 15
At Q = 5, the the D curve,
marginal buyer is 50 from 0 to Q. 50
h
willing to pay $50 for 40 40
a T-shirt.
30 30
20 T-shirts 20
Suppose P = $30.
10 10
D D
Then his consumer 0 Q 0 Q
surplus = $20. 0 5 10 15 20 25 30 0 5 10 15 20 25 30
16
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EXAMPLE 2E: A higher price reduces CS Active Learning 1: Consumer surplus

If P rises to $40, A. Find marginal P
50
P demand curve
buyer’s WTP at $45
60 Q = 10. 40
50
B. Find CS for P = $30 35
40 30
Suppose P falls to $20. 25
30 How much will CS 20
20 increase due to… 15
C. buyers entering 10
10
D the market 5
0 Q D. existing buyers 0
0 5 10 15 20 25 30 paying lower price Q
0 5 10 15 20 25
®
18
Active Learning 1: Answers 3.2. Producer Surplus

• Producer surplus (PS)
– Measures the benefits sellers receive from
participating in a market
– PS = P – cost/WTS
• Amount a seller is paid for a good minus the seller’s
cost of providing it.
• Price received minus willingness to sell
– Cost vs. WTS (Willingness to sell)
• WTS: The lowest price accepted by a seller for one
unit of a good or service
• The cost is a measure of willingness to sell: produce
and sell the good/service only if the price > cost
© 2021 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a
19 © 2021 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a 20
22/08/2021
EXAMPLE 3A: Cost and willingness to sell EXAMPLE 3B: WTS and the supply curve – 1
You want to get your house painted. There are 3
P
sellers of painting services that you can hire. The
$40
table below shows their willingness to selling the
services.
$30
Q: Derive the supply schedule
P Qs
from the cost data.
$20
$0 – 9
Name cost
10 – 19 $10
DULUX $10
NIPPON 20 20 – 34 $0
Q
MY KOLOR 35 35 & up 0 1 2 3
22
EXAMPLE 3B: WTS and the supply curve – 2 EXAMPLE 4A: Calculating producer surplus
P At each Q, the PS = P - cost
height of the S Suppose P = $25.
$40
curve is the cost of Name cost • DULUX’s PS =
$30 the marginal DULUX $10 • NIPPON’s PS =
seller, the seller
who would leave NIPPON 20 • MY KOLOR
$20
the market if the MY KOLOR 35
price were any
$10
lower.
• Total PS =
$0 Q
0 1 2 3
24
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EXAMPLE 4B: Producer surplus & the S curve EXAMPLE 4C: Producer surplus for one seller
P PS = P – cost Price P The supply of T-shirts
$40 Suppose P = $25. per unit
60
Suppose P = $40. 50 S
$30
40
$20 At Q = 15, the 30
marginal seller’s cost
$10 (WTS) is $30, and 20 T-shirts
her producer surplus 10
$0 PS is the area below is $10.
0 Q
0 1 2 3 Q the price and above
0 5 10 15 20 25 30
the supply curve
26
EXAMPLE 4D: Total producer surplus EXAMPLE 4E: A lower price reduces PS
The supply of T-shirts If P falls to $30,

PS is the area P P
between P and 60 60
the S curve, from
50 S 50 S
0 to Q.
40 40
30 30
h
20 20
10 10
0 Q 0 Q
0 5 10 15 20 25 30 0 5 10 15 20 25 30
28
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Active Learning 2: Producer surplus Active Learning 2: Answers

A. Find marginal seller’s P
50
supply curve
cost at Q = 10. 45
B. Find total PS for 40
P = $20. 35
Suppose P rises to $30. 30
Find the increase in PS 25
due to: 20
C. selling 5 additional 15
units 10
5
D. getting a higher price
on the initial 10 units 0
0 5 10 15 20 Q
25
® © 2021 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a
30
3.3. Market Efficiency – 1 Does eq’m Q maximize Total surplus?
• Total surplus = CS + PS Market equilibrium: P

• CS: Buyers’ gains from buying in the market
P = $30 60
• PS: Sellers’ gains from selling in the market
Q = 15
50 S
– CS = Value to buyers – Amount paid by buyers Total surplus
40
– PS = Amount received by sellers – Cost to sellers =
30
Total surplus = Value to buyers – Cost to sellers
20
10
D
0 Q
0 5 10 15 20 25 30
© 2021 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a 31 © 2021 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a
32
22/08/2021
Does eq’m Q maximize Total surplus? Does eq’m Q maximize Total surplus?
At Q = 20: At Q = 10:
P P
Cost of producing the Cost of producing the
60 60
marginal unit is $35; marginal unit is $25;
The value to consumers 50 S 50 S
The value to consumers
of the marginal unit is 40 of the marginal unit is 40 (1)
(1)
only $20 $40
30 (2) 30
Total surplus = Total surplus = (2)
20 20
10 10
D D
0 Q 0 Q
0 5 10 15 20 25 30 0 5 10 15 20 25 30
®
34
Does eq’m Q maximize Total surplus? Efficiency vs. Equality

• Yes. The market equilibrium quantity
maximizes total surplus.
• At any other quantity, total surplus will
increase by moving toward the market
equilibrium quantity.
© 2021 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a
35 © 2021 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a 36
22/08/2021
Efficiency vs. Equality Market Inefficiency & Market Failure – 1

• Efficiency • Market Efficiency exists when resources are
– The allocation of resources maximizes allocated efficiently
total surplus • Two important assumptions:
– Is the pie as big as possible? 1. Markets are perfectly competitive
2. Outcome in a market matters only to the
• Equality
buyers and sellers in that market
– Distribute economic prosperity uniformly
• When these assumptions do not hold
among the members of society
– Q will be over or below eq’m Q
– Every member of society gets an equal – “Market equilibrium is efficient” may no longer
slice of the pie? be true
Market Inefficiency & Market Failure – 2 Market Inefficiency & Market Failure – 3
• Market failures • Market failures
– Market power: a single buyer or seller (small – Externalities: decisions of buyers and sellers
group) control market prices affect people who are not participants in the
• The owner of the only gas station in a village (far market at all
away from other villages) will have an incentive to • When the production of a good pollutes the air and
restrict the output to keep the price high. Q is below creates health problems for those who live near the
eq’m Q  markets are inefficient. factories, the market on its own may fail to take this
cost into account.
• Q is over eq’m Q  market is inefficient.
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SUMMARY SUMMARY
• Consumer surplus: • An allocation of resources that maximizes total
– Measures the benefit buyers get from surplus is said to be efficient
participating in a market – Policymakers are concerned with the efficiency,
– Buyers’ willingness to pay for a good minus the as well as the equality of economic outcomes.
amount they actually pay • Equilibrium of S and D maximizes total surplus
– Area below the D curve and above P
• Producer surplus: – The invisible hand of the marketplace leads
– Measures the benefit sellers get from buyers and sellers to allocate resources
participating in a market efficiently.
– Amount sellers receive for their goods minus • Markets do not allocate resources efficiently in the
their costs of production presence of market failures (market power or
– Area below P and above the S curve externalities)
42
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Reading materials
Chapter 21. Mankiw, N.G (2021), Principles of

Economics, 9th Edition, Cengage Learning.
CHAPTER
The Theory of
4 Consumer Choice
2
1
Purpose Learning objectives

By the end of this chapter, students should be able to
• Develop the theory that describes how consumers understand:
make decisions about what to buy. : • How the budget constraint represents the choices a
• After that, the theory is applied to a number of consumer can afford?
• How indifference curves represent the consumer’s
questions about how the economy works. preferences?
• What determines how a consumer divides her resources
between two goods?
3 4
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Contents 4.1. The Budget Constraint
• Budget constraint:
1. The budget constraint – Shows all combinations (bundles) of the two goods that
the consumer can afford to buy
– The limit on the consumption bundles that a consumer
can afford  It is a “consumption possibility frontier” for
2. Preferences the consumers.
• Trade-offs: Buying more of one good leaves less
income to buy other goods
3. Optimization
5 6
EXAMPLE 1A: Russell’s budget constraint EXAMPLE 1A: Solutions
Russell divides his income of $3,000 between two goods:

pizzas and coffee. Prices are: Pz = $10 per pizza and Pc =
$2.50 per cup of coffee
A. If Russell spends all his income on pizzas, how many
pizzas does he buy?
B. If Russell spends all his income on coffee, how many cups
of coffee does he buy?
C. If Russell buys 200 pizzas, how many cups of coffee can
he buy?
D. Plot each of the bundles from above on a graph (pizzas on
the horizontal axis and cups of coffee on the vertical axis).
7 8
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The slope of the budget constraint - 1 The slope of the budget constraint - 2
The slope of the budget constraint

Cups of coffee More generally, budget constraint Y
1200
= how many coffee (y-axis good) I formula: I/Py
have to give up to get 1 more pizza
1000 X.Px + Y.Py = I
(x-axis good).
D Where:
= the rate at which a consumer can 800
afford to trade one good for X, Y: Quantities of 2 goods

600
another.
C Px, Py: Prices of X, Y
400
I: Income
200
Other way: Y = (- Px/Py)*Y + I/Py
0
0 50 100 150 200 250 300 350 The slope of the budget constraint
I/Px X
equals the relative price of the two
Pizzas
goods (-Px/Py) (*)
9
(*) We can ignore the minus sign 10
EXAMPLE 1B: The slope of Russell’s budget constraint Changes to the budget constraint
Cups of coffee Initial problem:
1200
The slope of the budget X.Px + Y.Py = I

1000
constraint Where: X, Y: Quantities of 2 goods
D
= 800
Px, Py: Prices of X, Y
600
I: Income
C
400 Show what happens to budget constraint if:
200 A. Income falls
0
B. Py rises
0 50 100 150 200 250 300 350
C. Px rises
Pizzas
11 12
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Changes to the budget constraint - income falls Changes to the budget constraint – price rises
13 14
Changes to the budget constraint – price rises EXAMPLE 1C: Change to Russell’s budget constraint
Initial problem: Russell’s income = $3,000 and prices: PP =

$10 per pizza, PC = $2.50 cup of coffee.
Show what happens to Russell’s budget constraint if:
A. His income falls to $2,000.
B. The price of coffee rises to PC = $4 per cup of coffee
(Income doesn’t change)
15 16
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EXAMPLE 1C: Change to Russell’s budget constraint EXAMPLE 1C: Change to Russell’s budget constraint
17 18
4.2. Preferences
A. Assumptions of consumer’s preferences
A. Assumptions of consumer’s preferences  Assumption 2: Transitivity of preferences
 Assumption 1: Preferences can be ranked in order
19 20
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A. Assumptions of consumer’s preferences B. Indifference curve

 Assumption 3: “More is better than less”
* Which bundle do you like most?
7 * Which bundle is preferred at least?

Cups
of coffee 6 D
per week
5
A
4
3
2 B
1 C
0 1 2 3 4 5 6 7
21
Pizzas per week 22
B. Indifference curve B. Indifference curve
How about A and B? Indifference curve (IC): a curve

7 7
that shows different consumption
6 6
Cups Cups bundles that give the consumer
5 5
of coffee of coffee
per week 4 A per week 4 the same level of satisfaction.
A
3 3
2 B 2 B
IC
1 1
0 1 2 3 4 5 6 7 0 1 2 3 4 5 6 7
Pizzas per week 23
Pizzas per week 24
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Property 1: Higher indifference curves

Four properties of indifference curve
are preferred to lower ones - 1
- Points on the same IC

Higher indifference curves are preferred to lower ones
7 represent the same satisfaction.
6 - Points on different ICs reflect
Indifference curves slope downward Cups different satisfaction.
5
of coffee - The farther away of an IC from
per week 4 A E the origin, the higher level of
Indifference curves cannot cross
3
IC satisfaction it represents.
2
2 B
IC1
Indifference curves are bowed inward 1
0 1 2 3 4 5 6 7
25
Pizzas per week 26
 .
Property 1: Higher indifference curves

Property 2: Indifference curves slope downward - 1
are preferred to lower ones - 2
Increasing 7
7 satisfaction
6
6 Cups
- The farther away of an IC from 5
Cups of coffee
5 the origin, the higher level of
of coffee per week 4
per week 4 satisfaction it represents.
A E F IC3 3
3
IC2 2
2 IC1
IC1 1
1
0 1 2 3 4 5 6 7
0 1 2 3 4 5 6 7 Pizzas per week
Pizzas per week 27 28
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Property 4: Indifference curves are bowed inward - 1

Property 3 : Indifference curves cannot cross - 1 10
A
Cups
Suppose they did. of coffee 9 Tradeoff -Marginal rate of substitution
per week 8
7 (MRS) measures the rate at
MRS = 4
7 4
6 which consumers are willing
Cups 6
5 to forgo a number of this
of coffee 1 B
per week 4 C 5
B good in order to get one more
3 4
other good, while keeping
2 A
IC1
3 your satisfaction constant.
1
IC2 2
IC1
0 1 2 3 4 5 6 7 1
Pizzas per week
29
0 1 2 3 4 5 6 7 8 9 10 Pizzas per week 30
Property 4: Indifference curves are bowed inward - 2 Property 4: Indifference curves are bowed inward - 3
10 MRS
A Bundle No of Cups of Increase in Cups of
Cups pizzas coffee per number of coffee (6) =
of coffee 9 (1) per week week pizzas
(4)
forgone
(5)/(4)
(2) (3) (5) MRS = slope of IC
per week 8 A 1 9 - -
MRS =
7 B 2 5 MRS falls when moving
C 3 3 down along the IC
6 D 4 2 People are more willing to
B trade away goods that they
5 have in abundance
4 MRS = Slope of IC tends to decrease
3 C
MRS =
ICs are bowed inward
2 D
IC1
1
0 1 2 3 4 5 6 7 8 9 10 Pizzas per week 31 32

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Active Learning Extreme Cases of Indifference Curves
Do all ICs slope downward

and have bowed inward shape?
33 34
Extreme Cases of Indifference Curves Close substitutes & close complements
• Shape of an indifference curve Hamburgers Shoes
– Reveals the consumer’s willingness to trade one good

for the other
• Perfect substitutes:
– Two goods with straight-line indifference curves
(constant MRS)
• Perfect complements:
– Two goods with right-angle indifference curves Hot dogs Socks
Indifference curves for close Indifference curves for close

substitutes are not very complements are very bowed.
bowed.
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4.3. Optimization A. Optimal bundle
• Consumer optimization Optimum: A Y

– Buying the bundle that makes the consumer happiest, • Russell prefers B to A but
given his income. cannot afford B
• The consumer’s optimal choices/Optimum: • Russell can afford D and B
– Represents the best bundle of the two goods that the C, but A is on a higher
indifference curve. A
consumer can afford
– The point on the budget constraint that touches the • Slope of indifference curve
highest possible indifference curve = Slope of budget C
constraint D
MRS = PX/PY
X
37 38
B. Changes in Income Increase in income: Normal goods
• A change in income initial optimum: A.

– Shifts the budget constraint outward/inward • An increase in income
– Move on a different indifference curve shifts the budget
constraint outward.
• If both goods are normal
goods, Russell buys more
of each.
New optimum: B.
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Increase in income: Inferior vs. normal goods C. Change in price - overall
X is a normal good Initial optimum: A.

Y is an inferior good. PX decreases
• Budget constrains pivots
outward
• Initial optimum: A
• New optimum: C
• New optimum: B
• Russell buys more X and
– More X
fewer Y
– Less Y
41 42
The income and substitution effects – 1 The income and substitution effects – 1
A decrease in the price of a good has two effects: ● Substitution Effect: A change in consumption of a
good that is associated with a change in the price of
1. Consumers tend to buy more cheaper goods and that good. The degree of benefit is constant.
less of more expensive goods - Substitution effect ● Income effect: The change in consumption of a
good that is brought about by an increase in
2. Since one of the goods is cheaper, the consumer purchasing power, with the relative prices of the
enjoys an increase in real purchasing power – goods remaining the same.
Income effect
Total Effect (TE) = Substitution Effect (SE) + Impact Effect (IE)
•43 •44
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The income and substitution effects – 2 The income and substitution effects – X is a normal good
A fall in the price of X has two effects on Russell’s optimal • Initial optimum: A. Y
consumption PX falls.
• Substitution effect I1 I2
• Substitution effect: from A to
– A fall in PX makes X cheaper relative to Y: Russell buys I/PY
B, buy more X
more X and fewer Y • Income effect: from B to C,
• Income effect buy more X A C
– A fall in PX boosts the purchasing power of Russell’s Overall:
income: buy more X and more Y (if X is a normal good, B
When X is a normal good, SE
Y is a normal good)
and IE have the same SE IE
 Russell buys more X direction. Consumers buy XA XB XC I/PX1 I/PX2
The net effect on Y is ambiguous. However, for simplicity, more X X
we skip studying about consumption of Y. Total effect
45 46
The income and substitution effects – 3 The income and substitution effects – X is an inferior good
A fall in the price of X has two effects on Russell’s optimal • Initial optimum: A. Y
consumption PX falls.
• Substitution effect • Substitution effect: from A to I1 I2
– A fall in PX makes X cheaper relative to Y: Russell buys B, buy more X I/PY
more X
• Income effect: buy less X
• Income effect C
• income effect < substitution A
– A fall in PX boosts the purchasing power of Russell’s effect  Overall: buy more X
income: buy less X (if X is inferior good) B
In conclusion:
– SE and IE have reverse direction IE
• In case income effect < substitution effect: Russell buys more X, When X is an inferior good, SE SE
his D curve is downward. and IE have reverse direction. If XA XC XB I/PX1 I/PX2
• In case income effect > substitution effect: Russell buys fewer IE < SE, consumers buy more X X
Total effect
X; X is a Giffen good (his D curve is upward).
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The income and substitution effects – X is a Giffen good D. Deriving the Demand Curve
• Initial optimum: A. Y • The demand curve

PX falls. – Shows the quantity demanded of a good for any given
• Substitution effect: from A to I1 price
B, buy more X and fewer Y I/PY
C
– Reflects the consumption decisions
• Income effect: buy less X – Is a summary of the optimal decisions that arise from the
• income effect > substitution A budget constraint and indifference curves
effect  Overall: buy less X B
In conclusion:
When X is an inferior good, SE IE
SE
and IE have reverse direction. XC XA XB I/PX1 I/PX2
If IE > SE, consumers buy less X
Total effect
X  X is a Giffen good
49 50
D. Deriving the Demand Curve Deriving the Demand Curve – Giffen goods
Y Y
I1 I2
1,200 1,200 C
I2
• When Px = $10, QDX = 100 • When Px = $10, QDX = 100
A C A
• When PX = $6, QDX = 250 I1 • When PX = $6, QDX = 90
100 250 300 500 X 90 100 300 500 X

Y Y
DX
A A
$10 $10
C
$6 $6 C
DX
100 250 X 90 100 X
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SUMMARY SUMMARY
• Consumer’s budget constraint: possible combinations of different • The consumer optimizes by choosing the point on her budget
goods she can buy given her income and the prices of the goods. constraint that lies on the highest indifference curve.
• The slope of the budget constraint equals the relative price of the – At this point, slope of the indifference curve (MRS) = slope of the
goods. budget constraint (relative price of the goods).
• Consumer’s indifference curves represent her preferences. An • The substitution effect of a drop in price is the change in
indifference curve: various bundles of goods that make the consumption that arises because a price change encourages
consumer equally happy. (Higher indifference curves are greater consumption of the good that has become relatively
preferred.) cheaper. Is reflected by a movement along an indifference curve to
a point with a different slope.
• The slope of an indifference curve at any point = marginal rate of
substitution (rate at which the consumer is willing to trade one • The income effect of a drop in price is the change in consumption
good for the other). that arises because a lower price makes the consumer better off. It
is reflected in the movement from a lower to a higher indifference
curve.
• The theory of consumer choice can be applied in many situations.
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Reading materials
Chapter 13, 14, 15, 16, 17. Mankiw, N.G (2021),

Principles of Economics, 9th Edition, Cengage
Learning.
CHAPTER
Firm behavior and the
5 organization of industry
2
1
Purpose Contents
Address the costs of production and develop
the firm’s cost curves, which underlie the firm’s 1. The costs of production
supply curve.
2. Firms in competitive markets
Examine the behavior of firms in different
kinds of markets:
3. Monopoly
• Competitive markets where firms do not have
market power
• Monopoly with sole firm 4. Monopolistic competition
• Monopolistic competition - a market structure in
which many firms sell products that are similar 5. Oligopoly
but not identical
• Oligopoly - a market structure in which only a few
sellers offer similar or identical products
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Learning objectives
By the end of this part, students should be
able to grasp:
• What is a production function? What is
marginal product? How are they
related?
• What are the various costs? How are
5.1 The Costs of Production they related to each other and to output?
• How are costs different in the short run
vs. the long run?
• What are “economies of scale”?
6
5
5.1.1. What are costs? Total Revenue, Total Cost, and Profit
Active Learning 1: Favorite Bakery Shop • Assumption:
Think about your favorite Bakery shop. – The goal of a firm is to maximize profit
A. List three different costs they have. • Total revenue, TR = P × Q
– The amount a firm receives for the sale of
B. List three different business decisions
its output
that are affected by these costs.
• Total cost, TC
– The market value of the inputs a firm uses
in production
• Profit = TR – TC
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EXAMPLE 1A: Mary’s milk tea shop Explicit and Implicit costs
Mary owns a small milk tea shop. She can • “The cost of something is what you give up to
make 15,000 cups of milk tea a year, and sell
get it.”
them at $5 each. If Mary’s total costs are
$65,000 a year, how much profit the shop – Explicit costs
brings in one year? • Input costs that require an outlay of money by the
firm (E.g.: paying wages to workers). Accounts keep
• Total revenue: TR = track of how much money flows into and out of the
firm.
– Implicit costs
• Profit = TR – TC =
• Input costs that do not require an outlay of money by
the firm (E.g.:opportunity cost of the owner’s time)
• Total cost = Explicit + Implicit costs
9 10
EXAMPLE 1B: Costs for Mary’s milk tea shop EXAMPLE 1C: The cost of capital for Mary’s
Mary owns a small milk tea shop on campus. Mary Mary invested $80,000 in the factory and equipment
pays $20,000 a year for raw materials, and $12,000 to start the business last year: $30,000 from savings
in rent. Mary can work at the local coffee shop for and borrowed $50,000 (interest 10% for saving and
$25,000 a year. Identify and calculate the explicit borrowing). Identify and calculate the explicit and
and implicit costs. implicit costs.
• Explicit costs: • Explicit cost:
• Implicit cost:
• Implicit cost:
• Total costs =
The opportunity cost of capital =
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Economic Profit vs. Accounting Profit EXAMPLE 1D: Profit for Mary’s milk tea shop
• Accounting profit Mary owns a small milk tea shop on campus.

She can make 15,000 cups of milk tea a year,
– Total revenue minus total explicit costs
and sell them at $5 each.
• Economic profit Mary pays $20,000 a year for raw materials,
– Total revenue minus total costs (explicit and $12,000 in rent. Mary can work at the local
and implicit costs) coffee shop for $25,000 a year.
• Accounting profit ignores implicit costs, Mary invested $80,000 in the factory and
so it’s higher than economic profit. equipment to start the business last year:
$30,000 from savings and borrowed $50,000
(interest 10% for saving and borrowing).
Q: Calculate accounting and economic profit.
13 14
EXAMPLE 1D: Solutions Active Learning 2: Economic vs. accounting profit
The equilibrium rent on office space has just

increased by $500/month.
Determine the effects on accounting profit and
economic profit if:
A. You rent your office space (you pay
$500/month)
B. You own your office space
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Active Learning 2: Answers 5.1.2. Production and Costs

• Assumption:
– Production in the short run
– Factory size is fixed
– To increase production: hire more workers
17 18
Production function Production function

• Jonhny has a popcorn truck (fixed resource) • Reflects the Q
that he takes to fairs and sporting events. relationship between 100
the quantity of inputs 90

• He can hire as many workers as he wants
Quantity of Output
(workers) and quantity 75
– The quantity of output produced varies of output
with the number of workers L Q 55
workers buckets
– If Jonhny hires only 1 worker, his truck will 0 0 30
produce 30 buckets of popcorn per day 1 30
– If Jonhny hires 5 workers, his truck will 2 55
produce 100 buckets of popcorn per day 3 75
0 1 2 3 4 5 L
Number of workers
4 90
19 20
5 100
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Marginal Product EXAMPLE 2A: Jonhny’s total and marginal product
• Marginal product L Q MPL

workers buckets buckets
– Increase in output that arises from an
0 0
additional unit of input (Other inputs ∆L = 1 ∆Q =
1 30
constant) ∆L = 1 ∆Q =
2 55
– Slope of the production function ∆L = 1 ∆Q =
3 75
• Marginal product of labor, MPL = ∆Q / ∆L ∆L = 1 ∆Q =
4 90
– If Jonhny hires one more worker, his ∆L = 1 ∆Q =
5 100
output rises by the marginal product of
labor.
21 22
Diminishing MPL Active Learning 3: Diminishing MPL
• Diminishing marginal product A. What is the marginal

Number product of the second
– Marginal product of an input declines as the of Output MPL worker?
quantity of the input increases workers
– MPL is the slope of the production function 0 0 B. What is the marginal
product of the fourth
Production function gets flatter as more inputs 1 45 worker?
are being used 2 85
• Why MPL is important? 3 115 C. Does this production
– “Rational people think at the margin” function exhibits
4 135 diminishing marginal
– Decide to hire an extra worker by comparing 5 145 returns?
output rises by MPL and the costs rise by the
wage paid
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Relationship between production & cost EXAMPLE 2B: Jonhny’s production and cost
• Jonhny must pay $200 per day for the truck,
regardless of how much popcorn he L Q Cost of Cost Total
produces workers buckets the truck of labor Cost
• The market wage for popcorn makers is $50 0 0

per day 1 30
2 55
• So, Jonhny’s costs are related to how much
popcorn the truck produces 3 75
4 90
5 100
25 26
Total cost curve 5.1.3. The Various Measures of Cost

Total Cost
$500
• Total cost, TC = FC + VC
450
400 – Total cost of producing a given amount of
350 output
300
250 • Fixed costs, FC
200
– Do not vary with the quantity of output
produced
– Incur even if production is zero
0 30 55 75 90 100 Q
Quantity of Output • Variable costs, VC
Total cost gets steeper as the amount produced rises because of
diminishing marginal product: producing one additional unit of output – Vary with the quantity of output produced
requires more and more additional units of inputs, so the cost increases
27 28
sharply.
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Average and Marginal Cost EXAMPLE 3A: Anna’s knitted scarves business
Q FC VC TC Anna loves to knit
• Average fixed cost, AFC = FC / Q
0 18 0 scarves:
• Average variable cost, AVC = VC / Q 1 18 15
• Anna paid $18 for
• Average total cost, 2 18 25
two pairs of knitting
3 18 30
ATC = TC / Q = AFC + AVC needles
4 18 32
– The cost of the typical unit produced • To produce more
5 18 36
– Total cost divided by the quantity of output scarves, Anna
6 18 44
needs more yarn
• Marginal cost, MC = ΔTC / ΔQ 7 18 58
and more workers
8 18 78
– The increase in total cost that arises from an
9 18 104
extra unit of production
10 18 136
29 30
FC, VC, and TC curves EXAMPLE 3B: Anna’s average and marginal cost
Cost Q FC VC TC AFC AVC ATC MC
$160
0 $18 $0 $18 - - -
TC
120 1 18 15 33
VC 2 18 25 43
80
3 18 30 48
40 4 18 32 50
FC 5 18 36 54
0 6 18 44 62
0 2 4 6 8 10 Q
Quantity of output 7 18 58 76
8 18 78 96
The TC and VC curves are parallel
9 18 104 122
The FC curve is a horizontal line
10 18 136 154
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AFC curve AVC and ATC curves

Costs
$ 35.0 Costs
$ 35.0
Efficient scale:
30.0
30.0 quantity that
25.0 25.0
minimizes ATC
20.0 20.0 ATC

15.0 15.0
10.0 10.0 AVC
5.0 AFC 5.0
0.0
0.0
0 2 4 6 8 10 Q
0 2 4 6 8 10 Q Quantity of output
Quantity of output
33 34
Marginal cost curve Cost curves

Costs
$ 35.0
Costs
$ 35
MC
30.0
30 MC
25.0
25
20.0
20
ATC
15 15.0
10 AVC
10.0
5
5.0
0 AFC
0 2 4 6 8 10 Q 0.0
Quantity of output 0 2 4 6 8 10 Q
Quantity of output
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ATC and MC curves Active Learning 4: Calculating costs

35.0 • When MC < ATC, Fill in the blank spaces of this table.
MC ATC is …...
30.0
Q VC TC AFC AVC ATC MC
25.0 0 $50 n/a n/a n/a
• When MC > ATC, $10
20.0 1 10 $10 $60.00
ATC ATC is …….
15.0 2 30 80
30
10.0 • The MC curve 3 16.67 20 36.67
5.0 crosses the ATC 4 100 150 12.50 37.50

curve at the ATC 5 150 30
0.0 60
0 2 4 6 8 10
curve’s …….
6 210 260 8.33 35 43.33
37 38
Relationship between
5.1.4. Costs in the Short Run & Long Run short run vs. long run average cost
• Short run, SR: • Long run, LR:
– At least one input is fixed (e.g., factories, land)
– The costs of these inputs are FC – Firms have greater flexibility in choosing to use
• Long run, LR: the most efficient mix of inputs to produce the
– All inputs are variable (e.g., firms can expand same quantity as in the short run.
the size of factories, build more factories or sell – ATC at any Q does not exceed that in the short
existing ones)
– FC = 0 run
• How long does it take a firm to get to the
long run?
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Relationship between Economies and diseconomies of scale

short run vs. long run average cost
• All the short-run curves lie on or above the long-run (1) Economies of
curve. In other words, the long-run average cost curve scale: LATC falls ATC
as Q increases.
(LAC) is found to be the “envelope” of the SATCs
(2) Constant returns LRATC
• LTC ≤ STC, LAC ≤ SAC (at each Q) to scale: LATC
SAC1
stays the same as
AC
SAC4 LAC Q increases.
SAC2
SAC3 (3) Diseconomies of
scale: LATC rises
as Q increases. Q
(Q1) (Q2)
Q
42
41
THINK-PAIR-SHARE SUMMARY
Your neighbor has a garden and grows fresh
fruit and vegetables to be sold at a local “farmer’s • The goal of firms is to maximize profit, which
market.” He says, “I hired a college student who equals total revenue minus total cost.
was on summer vacation to help me this summer • When analyzing a firm’s behavior, it is important to
and my production more than doubled. Next include all the opportunity costs of production.
summer, I think I’ll hire three helpers and my – Explicit: wages a firm pays its workers
output should go up more than three or fourfold.” – Implicit: wages the firm owner gives up by
A. What can explain why the production more than working at the firm rather than taking another
doubled when your neighbor hired a helper? job
B. Will production increase three- or fourfold if your • Economic profit takes both explicit and implicit
neighbor hires 3 helpers next summer? costs into account, whereas accounting profit
considers only explicit costs.
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SUMMARY SUMMARY
• A firm’s costs reflect its production process. • Average total cost is total cost divided by the
– Diminishing marginal product: production quantity of output.
function gets flatter as Q of an input increases • Marginal cost is the amount by which total cost
– Total-cost curve gets steeper as the quantity rises if output increases by 1 unit.
produced rises. • Graph average total cost and marginal cost.
• Firm’s total costs = fixed costs + variable costs. – Average total cost first falls as output increases
– Fixed costs: do not change when the firm alters and then rises as output increases further.
the quantity of output produced. – The MC curve always crosses the ATC curve at
– Variable costs: change when the firm alters the the minimum of ATC
quantity of output produced.
45 46
SUMMARY
• A firm’s costs often depend on the time horizon
considered.
– Many costs are fixed in the short run but
variable in the long run.
– In long run:
• Firms have greater flexibility in choosing to use the
most efficient mix of inputs to produce the same
quantity as in the short run.
• Firms may have to face: economies of scale,
constant returns to scale and diseconomies of scales.
5.2 Firms in competitive markets

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Learning objectives 5.2.1. What is a Competitive Market?
By the end of this part, students should be able to Characteristics of perfectly competitive markets:
understand: 1. Market with many buyers and sellers
– Each firm does not need to reduce its price in order to
• What is a perfectly competitive market? sell a larger quantity (*)
• What is marginal revenue? How is it related 2. Trading identical products
to total and average revenue? – If a firm raises its price above the market price, demand
• How does a competitive firm determine the for its product falls to zero (**)
quantity that maximizes profits? A competitive firm is a price-taker, and it can sell as
much as it wants at the market price. It faces a perfectly
• When might a competitive firm shut down in elastic demand
the short run?
3. Firms can freely enter

or exit the market
49
The Revenue of a Competitive Firm EXAMPLE 4: Linda's apple farm: revenue

• Total revenue, TR = P ˣ Q Linda's apple farm can Q P TR AR MR
produce up to 10 0 $20
• Average revenue, AR = TR / Q bushels of apples per 1 20
– How much revenue does the firm receive for year, and the current 2 20
one unit produced market price is $20
3 20
per bushel.
• Marginal revenue, MR = ∆TR / ∆Q 4 20
• Calculate Linda’s
– Change in TR from an additional unit sold apple orchard’s total 5 20
– How much additional revenue does the firm revenue, average 6 20
receive if it increases production by 1 unit revenue, and 7 20
marginal revenue 8 20
• For competitive firms: AR = P = MR
9 20
10 20
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5.2.2. Profit Maximization EXAMPLE 5: Linda’s apple farm: profit

Δ Profit
• Goal of a firm: maximize profit = TR – TC If MR > MC, Q TR TC Profit MR MC = MR - MC
• TR = P × Q and TC = FC + VC increasing Q 0 $0 $6
$20
…… profit. 1 20 14
• What Q maximizes a firm’s profit? 20
2 40 24
– Think at the margin: if Q increases by one unit, 20
MR = MC: 3 60 36
revenue rises by MR and cost rises by MC 20
profit is 4 80 50
20
• Comparing MC with MR …………… 5 100 66
20
– If MR > MC: increasing Q will raise profit 6 120 85
20
7 140 105
– If MR < MC: increasing Q will cause a loss of profit If MR < MC, 20
8 160 126
– MR = MC: Profit is maximized increasing Q 20
9 180 150
………………. 20
10 200 176
profit.
53 54
MC and the firm’s supply decision – 1 MC and the firm’s supply decision – 2
If the market price Rule: MR = MC at the the MC curve is the
If price rises to P2,
is P1 = MR1 profit-maximizing Q. firm’s supply curve.
At Qa, MC < MR. then the profit- Costs
Costs maximizing quantity
So, increase Q MC
to raise profit. MC rises to Q2.
P2 MR2
At Qb, MC > MR. The MC curve
determines the
So, reduce Q
firm’s Q at any price. P1 MR1
to raise profit. P1 MR1
At Q1, MC = MR. Hence, the MC curve
is the firm’s supply
Changing Q Q
would lower profit. Q curve Q1 Q2
Qa Q1 Qb
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Shutdown or Exit? Sunk Costs

• Shutdown: • Sunk cost
– A short-run decision not to produce anything – A cost that has already been committed and
because of market conditions. cannot be recovered
– Q = 0 in the short run – Should be ignored when making decisions
• Exit: – You must pay them regardless of your choice
– A long-run decision to leave the market. – In the short run, FC are sunk costs
• So, FC should not matter in the decision to shut
• A key difference: down
– If shut down in SR, must still pay FC.
– If exit in LR, zero costs.
57 58
Short-run Decision to Shut Down A competitive firm’s short run supply curve
Costs
 Should a firm shut-down in the short run?
MC
• Cost of shutting down
If P > AVC, then the
firm produces Q ATC
• Benefit of shutting down where P = MC.
AVC
If P < AVC, then firm

 Shut down (Produce Q = 0 in the short run) shuts down (produces
Q = 0). Q
• If
The firm’s short run supply curve is the portion of its
MC curve above AVC.
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A firm’s Long-Run Decision Active Learning 5: Your favorite concert

• Should a firm exit or enter in the long run? While attending a rap concert, you paid $35
• Cost of exiting market for a hoodie of your idol. However, it is too
• Benefit of exiting market = cost savings small for you.
– You decide to sell your hoodie to your cousin
• Firm’s long-run decision who lives in a different town.
– Exit the market if: – You’ll have to pay $10 for delivery by mail.
• What is the lowest price you should ask for
– Enter the market if: the hoodie?
61 62
THINK-PAIR-SHARE SUMMARY
Walking into a Vinmart store at 2:00 a.m. to buy • A competitive firm is a price - taker
some cat food, your friend says, “I can’t believe that
these stores stay open all night. There are 10 – Its revenue is proportional to the amount of
shoppers in this store, and only one checkout lane is output it produces.
open. It doesn’t make any sense for this store to be – P = MR = AR
open all night.” – The firm’s marginal-cost curve above AVC is its
A. Why do you think this Vinmart is open all night? supply curve in the short run
B. Are the costs of rent, equipment, fixtures, salaries • Short run: a firm cannot recover its FC
of management, and so on relevant when Walmart – Shut down temporarily if P < AVC
makes the decision whether to stay open all night? • Long run: the firm can recover both FC and VC
C. If Vinmart had 10 customers during its nighttime – Exit if P < ATC
hours, do you think it would continue to operate in
long run?
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Learning objectives
understand:
Why do monopolies arise?
Why is MR < P for a monopolist?
How do monopolies choose their P and Q?
5.3 Monopoly

66
65
5.3.1. Why Monopolies Arise Three Barriers to Entry – 1

• Monopoly 1. Monopoly resources
– A firm that is the sole seller of a product without – A single firm owns a key resource.
close substitutes • e.g.: Single water provider in town; DeBeers - owns
– Has market power most of the world’s diamond mines
• The ability to influence the market price of the product
it sells: “price maker”
– Arise due to barriers to entry
• Other firms cannot enter the market to compete with it
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Three Barriers to Entry – 2 Three Barriers to Entry – 3

2. Government regulation 3. The production process: natural monopoly
– The government gives a single firm the – A single firm can produce the entire market Q
exclusive right to produce the good. at lower cost than could several firms
• Patent and copyright laws – Arises when there are economies of scale over
the relevant range of output
– Distribution of water, electricity, etc.
69 70
EXAMPLE 6: Natural monopoly Monopoly versus Competition

You live in a small town where 1,000 homes • Competitive firm
need electricity. – Price taker
• ATC is lower if one firm services all 1,000 homes – Small, one of many
than if two firms each service 500 homes. – Faces individual demand at P: perfectly elastic
Cost Electricity demand
• Monopoly firm
ATC slopes downward due – Price maker, market power
to huge FC and small MC
$80 – Faces the entire market demand: downward
$50 ATC sloping demand
Q
500 1000
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Demand curves: competitive firm vs. monopoly Active Learning 6: JJ’s hairdo revenue
Jayla and Jaden own Q P TR AR MR
P A competitive firm’s P A monopolist’s
demand curve demand curve the only hair salon in 0 $60
town, “JJ’s hairdo.” 1 55
P = MR The table shows the 2 50
D market demand for 3 45
The market haircuts. 4 40
demand curve D • Fill in the missing 5 35
Q Q spaces of the table. 6 30
The firm can increase To sell a larger Q, the • What is the relation 7 25
Q without lowering P, firm must reduce P. between P and AR? 8 20
so MR = P for the Thus, MR ≠ P. • Between P and MR? 9 15
competitive firm. 10 10
73 74
Active Learning 6: Answers EXAMPLE 7: JJ’s MR and demand curves

Q P TR AR MR P, MR
0 $60
$60 n/a
1 55 50
Demand curve (P)
2 50 40
3 45 30
4 40 20
5 35 10
MR
6 30 0
-10
Q
7 25
8 20 -20
9 15 -30
0 1 2 3 4 5 6 7 8 9 10
10 10
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A Monopolist’s Revenue 5.3.2. Monopoly Profit Maximization

• Increasing Q has two effects on revenue: • Produce Q where MR = MC
– Output effect: higher output raises revenue • Sets the highest price consumers are willing to
– Price effect: lower price reduces revenue pay for that quantity
• Finds this price on the D curve
• Marginal revenue, MR < P
• P > MR = MC
– To sell a larger Q, the monopolist must reduce
the price on all the units it sells • If P > ATC, the monopoly earns a profit
– MR is negative if price effect > output effect
• e.g., when JJ’s increases Q from 6 to 7
77 78
Profit-maximization for a monopoly The monopolist’s profit

Costs and Costs and
Revenue MC Revenue MC
As with a
At this Q, find P on P P
competitive firm, ATC
the demand curve. the monopolist’s ATC
profit equals
The profit-maximizing D D
(P – ATC) x Q
Q is where MR = MC. MR MR
Q Quantity Q Quantity
Profit-maximizing output
79 80
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A Monopoly Does Not Have a Supply Curve CASE STUDY: Monopoly vs. Generic Drugs
The market for
• A competitive firm takes P as given Price
Patents on new a typical drug
– Has a supply curve that shows how its Q
drugs give a temporary
depends on P
monopoly to the seller: PM
• A monopoly firm is a “price-maker” PM, QM.
– Q does not depend on P PC = MC
– Q and P are jointly determined by MC, MR, and D
the demand curve When the patent
MR
– Hence, no supply curve for monopoly. expires, the market
becomes competitive, QM QC
generics appear: PC, QC. Quantity
81 82
The Welfare Cost of Monopolies Competition versus monopoly

Competition Monopoly
• Competitive market equilibrium: Similarities
– At P = MC and maximizes total surplus Goal of firms Maximize profits Maximize profits
Rule for maximizing MR = MC MR = MC
• Monopoly equilibrium: at P > MR = MC
Can earn economic profits in SR? Yes Yes
– The monopoly Q is lower than competitive Differences
market equilibrium Q  Market is not efficient Number of firms Many One
 Monopoly results in a dead weight loss Marginal revenue MR = P MR < P
Price P = MC P > MC
Produces welfare-maximizing Yes No
level of output?
Entry in the LR? Yes No
Can earn economic profits in LR? No Yes
83 84
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SUMMARY SUMMARY
• Monopoly: the sole seller in its market. • Monopoly maximizes profit
• Monopoly arises when: – Produce Q where MR = MC, but Q is not
– A single firm owns a key resource efficient
– The government gives a firm the exclusive – For this Q, the price is on the demand curve.
right to produce a good – So P > MR = MC
– A single firm can supply the entire market at a – A monopoly does not have a supply curve
lower cost than many firms could. – Causes deadweight loss
• Monopoly faces a downward-sloping demand
curve for its product: MR < P
85 86
Learning objectives
understand:
• What market structures lie between perfect
competition and monopoly, and what are their
characteristics?
• How do monopolistically competitive firms
choose price and quantity? Do they earn
5.4 Monopolistic competition economic profit?

88
87
22/08/2021
5.4.1. Between monopoly and perfect competition The four types of market structure
• Two extreme forms of market structures: Number of firms?
• Perfect competition: many firms, identical Many firms
products, price takers, P = MC One
firm Type of products?
• Monopoly: one firm, price maker, P > MC
• Imperfect competition – in between the Differentiated Identical
extremes: Few products products
firms
• Monopolistic competition: many firms sell Monopolistic Perfect
similar but not identical products Monopoly Oligopoly Competition Competition
• Oligopoly: only a few sellers offer similar or
identical products. Tap water Tennis balls Movies Wheat
Cable TV Cigarettes Restaurants Milk
89 90
Monopolistic Competition Comparisons

• Characteristics: Perfect Monopolistic Monopoly
competition competition
– Many sellers: competing over customers
Number of Many Many One
– Product differentiation sellers
• Not price takers; downward sloping D curve Free entry/exit Yes Yes No
• Location is a critical product differentiation LR economic Zero Zero Positive
– Free entry and exit profit
Products firm Identical Differentiated No close
• Zero economic profit in the long run
sells substitute
• Examples: Market power? None Yes Yes
– Books, computer games, restaurants, piano D curve facing Horizontal Downward- Downward-
firm sloping sloping
lessons, cookies, clothing
(market D)
91 92
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5.3.2. Competition with differentiated products EXAMPLE 8: Short-run equilibrium
A. The Short Run Equilibrium The firm faces a

downward-sloping
• Profit maximization in the short-run for the D curve. Price
profit MC
monopolistically competitive firm: At each Q, MR < P.
ATC
P
– Produce the quantity where MR = MC Identify the firm’s profit
– Price: on the demand curve or loss. ATC
D
– If P > ATC: profit To maximize profit, firm
– If P < ATC: loss produces Q where MR
MR = MC.
– Similar to monopoly
The firm uses the Q Quantity
D curve to set P.
93 94
Active Learning 7: Profit or loss in SR? B. The Long-Run Equilibrium
Identify the firm’s • If monopolistically competitive firms are

profit or loss. Price
making profit in short run
MC – New firms: incentive to enter the market
For this firm, • Increase number of products
losses ATC
P < ATC – Reduces demand faced by each firm
at the output where ATC
• Demand curve shifts left; prices fall
MR = MC. P – Each firm’s profit declines to zero
The best this firm can D • If losses in the short run:
do is to minimize its MR – Some firms exit the market, remaining firms
losses. Q Quantity enjoy higher demand and prices
– D curve shifts left, prices rise
– Each firm’s profit increases to zero
95 96
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Long-run equilibrium C. Monopolistic vs. Perfect Competition

Entry and exit • Monopolistic competition
occurs until: Price • Excess capacity: quantity is not at minimum
MC ATC (it is on the downward-sloping portion
P = ATC and
profit = zero. ATC of ATC)
P = ATC • Markup over marginal cost: P > MC
Notice that the firm
charges a markup markup • Perfect competition
of price over D • Quantity: at minimum ATC (efficient scale)
marginal cost and MC MR • P = MC
does not produce at Q Quantity
minimum ATC.
97 98
Monopolistic vs. Perfect Competition SUMMARY

• Monopolistically competitive market: many firms,
differentiated products, and free entry and exit.
• LR equilibrium
– Each firm has excess capacity (Q is on the
downward-sloping portion of the ATC curve)
– Each firm charges a price above marginal cost.
 Inefficiencies
• Product differentiation:
– Through actual physical differences, advertising
(or branding), and location.
Market quantity < Socially efficient quantity
Inefficiency Efficiency – Location is a critical product differentiation
99 100
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Learning objectives
grasp:
• What outcomes are possible under oligopoly?
• Why is it difficult for oligopoly firms to
cooperate?
• How we can use game theory to analyze the
economics of cooperation?
5.5 Oligopoly

102
101
Review: the four types of market structure 5.5.1. Markets with Only a Few Sellers
Number of firms? • Characteristics:
Many firms – Market structure in which only a few sellers
One offer similar or identical products
firm Type of products?
• Strategic behavior in oligopoly:
Differentiated
Identical “Interdependence among firms”
Few products
products – A firm’s decisions about P or Q can affect other
firms firms and cause them to react
Monopolistic Perfect
Monopoly Oligopoly Competition Competition – The firm will consider these reactions when
making decisions
Tap water Tennis balls Movies Wheat
Cable TV Cigarettes Restaurants Milk
103 104
22/08/2021
The Equilibrium for an Oligopoly The Size of an Oligopoly
• When firms in an oligopoly individually • As the number of sellers in an oligopoly

choose production to maximize profit increases:
– Produce Q at which MR = MC: greater than – The oligopoly looks more and more like a
monopoly Q, less than competitive Q competitive market
– The price: is less than the monopoly P, greater – The price approaches marginal cost
than the competitive P = MC – The market quantity approaches the socially
efficient quantity
105 106
5.5.2. The Economics of Cooperation EXAMPLE 9: The prisoners’ dilemma – 1

A. The prisoners’ dilemma The police have caught Bonnie and Clyde, two
– Particular “game” between two captured suspected bank robbers, but only have enough
evidence to imprison each for 1 year.
prisoners
• The police question each in separate rooms, offer
– Illustrates why cooperation is difficult to each the following deal:
maintain even when it is mutually beneficial
– If you confess and implicate your partner,
you go free.
– If you do not confess but your partner implicates
you, you get 20 years in prison.
– If you both confess, each gets 8 years in prison.
107 108
22/08/2021
EXAMPLE 9: The prisoners’ dilemma – 2 EXAMPLE 9: The prisoners’ dilemma – 3

Confessing is the dominant strategy for both players. • Outcome of the game:
Bonnie’s decision
Confess Remain silent
– Both would have been better off if both
remained silent.
Confess – But even if Bonnie and Clyde had agreed
Clyde’s before being caught to remain silent, the logic of
decision self-interest takes over and leads them to
confess.
Remain
silent
109 110
B. Oligopolies as a Prisoners’ Dilemma THINK-PAIR-SHARE

• When oligopolies form a cartel Your friend is amazed that both grocery stores
(the only ones in town) are open 24 hours. He says
– Hoping to reach the monopoly outcome, they
“This is a great idea! Staying open all the time must
become players in a prisoners’ dilemma
mean that both stores make lots of profit!”
– The monopoly outcome is jointly rational, but
A. Since there are only two grocery stores in town, is
each firm has an incentive to cheat: self-interest
it likely they make “lots of profit” by staying open
makes it hard to maintain the cooperative
24 hours?
outcome with low production, high prices, and
monopoly profits B. Can you use prisoners’ dilemma to explain why the
stores are open 24 hours a day?
• Why People Sometimes Cooperate
– When the game is repeated many times,
cooperation may be possible
111 112
22/08/2021
SUMMARY SUMMARY
• Oligopolists maximize their total profits by • The prisoners’ dilemma shows that self-interest
forming a cartel and acting like a monopolist. can prevent people from maintaining
– Yet, if oligopolists make decisions about cooperation, even when cooperation is in their
production levels individually, the result is a mutual interest. However, when the game is
greater quantity and a lower price than under repeated many times, cooperation may be
the monopoly outcome. possible
– The larger the number of firms in the
oligopoly, the closer the quantity and price will
be to the levels that would prevail under
perfect competition.
113 114

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Brief information Course outline

 Name: MICROECONOMICS Chapter 1: Introduction

Reading Materials Assessment

Mid- Case study

Economics 9th edition. Cengage Learning. % of the

Group presentation Group presentation

M 1. List keywords/concepts by groups M These below activities are also important

3. Work in groups 6. Do homework

Reading materials Purpose

Learning objectives Contents

Resources are scarce

Interactive PowerPoint Slides by:

Economists study: a. How People Make Decisions

Principle 1: People Face Trade-Offs EXAMPLE 1A: Society faces trade-offs

Principle 2: The Cost of Something EXAMPLE 2: Opportunity cost

EXAMPLE 2: Opportunity cost HOMEWORK

• What is the opportunity cost of being invited

2. Do you know why citizens in a large city are

Active Learning 1: Answers A Active Learning 1: Answers B

How your answers would change

Principle 4: People Respond to Incentives EXAMPLE 3: Incentives

EXAMPLE 3: Incentives Active Learning 2: Applying the principles

Active Learning 2: Answers b. How People Interact

Principle 5: Trade can make everyone better off.

Principle 7: Governments Can Sometimes Principle 7: Governments Can Sometimes

Principle 7: Governments Can Sometimes Active Learning 3: The government

c. How the economy as a whole works ACTIVE LEARNING 4

1.2. Thinking like an economist

a. The Economist as a Scientist a. The Economist as a Scientist

The Circular-Flow Diagram The circular flow – 1

The circular flow – 2 The circular flow – 3

The PPF EXAMPLE 4: The PPF

Economic growth and the PPF Moving Along the PPF

0 1,000 2,000 3,000 4,000 5,000

• As the economy shifts At A, opportunity cost of • At point A, most workers

Micro - and Macroeconomics Micro - and Macroeconomics

Micro - and Macroeconomics b. The Economist as Policy Adviser

Active Learning 6: Positive or normative? ASK THE EXPERTS

PREPARATION FOR CHAPTER 2 SUMMARY

Chapter 4, 5, 6. Mankiw, N.G (2021), Principles

Supply and demand

3. Supply, demand, and government policies

2.1 • What factors affect buyers’ demand for goods?

2.1. The market forces of

a. Markets and Competition b. Demand

• Demand schedule: Sofia’s demand Price Quantity

Demand Curve Shifters – 1 Demand Curve Shifters – 2

A. The price of apple juice increases

Price of • Move down along

c. Supply Supply Schedule and Supply Curve

EXAMPLE 2D: Market supply curve of pizzas Supply Curve Shifters – 1

d. Supply and demand together – 2 ASK THE EXPERTS

Markets not in equilibrium: shortage – 1 Markets not in equilibrium: shortage – 2

Markets not in equilibrium: surplus – 1 Markets not in equilibrium: surplus – 2

Supply and Demand Together EXAMPLE 3: The market for pizzas

EXAMPLE 3A: A shift in demand EXAMPLE 3B: A shift in supply

If supply increases more

Active Learning 3C. Events A and B together THINK-PAIR-SHARE

Our scenario 2.2.1. The Elasticity of Demand

A. The Price Elasticity of Demand The Variety of Demand Curves

Perfectly inelastic demand Inelastic demand

Unit elastic demand Elastic demand