IBDP HL Microeconomics Lecture Slides

ABHISHEK MAITY
2012
MICROECONOMICS
Abhishek Maity, KIS, 2012
1

 Unit 1: Introduction to Economics
 Unit 2A: Demand
 Unit 2B: Supply
 Unit 3: Market Equilibrium
 Unit 4: Elasticity
 Unit 5: Taxes, Subsidy, and Price Control
 Unit 6: Market Failure
 Unit 7: Theory of Firms: Costs, Revenues, and Profits
 Unit 8A: Theory of Firms: Perfect Competition and Monopoly
 Unit 8B: Theory of Firms: Price Discrimination
 Unit 9: Theory of Firms: Monopolistic Competition and Oligopolies
2

ABHISHEK MAITY
SEMESTER 1, 2012
INTRODUCTION
3

 Economics Course Companion Second Edition (Blink and
Dorton, Oxford)
 Economics for the IB Diploma (Welker and Maley, Pearson)
 The Good, the Bad, and the Economist (McGee, Cambridge)
 Economics from the Global Perspective (Glanville, Glanville)
 The IB Study Guide
 Handouts and Lecture Slides (Go through the notes at the bottom
please)
 The internet!
4

 Please:
 Bring your text book, note book, pen, pencil, and eraser to class
 Refrain from using your cell phone in class
 Be on time and don’t miss classes
 Hand in your homework, essays, and assignments on time (your
internal assessment depends on this)
 Late submissions will not be entertained
 Respect the classroom space, the subject, your fellow students, and
yourself
 ASK QUESTIONS!
 Think, question, argue
5

Four Major Units:
 Microeconomics (Grade 11 – Semester 1 and 2)
 Macroeconomics
 International Trade and Finance
 Development Economics (Grade 11 – Semester 2)
6

 Differences between HL and SL
 Two Papers in the SL and Three Papers in the HL
 Paper 1 – Microeconomics and Macroeconomics (40% for SL and
30% for HL)
 Paper 2 – International Economics and Development (40% for SL
and 30% for HL)
 Paper 3 – HL extension topics like Theory of Firm (20%)
 Calculators allowed in Paper 3 of HL only
 Internal Assessment (A portfolio of 3 article analysis of 750 words
each over the two years)
7

 Internal Assessment and Formative Tests (20% for KIS Diploma)
 Unit Quiz
 Concept Test
 Team Presentation
 Homework Assignment
 Article Analysis
 Commentary
 DRQ Analysis
 Data Assignment
 Internal Assessment Portfolio (IA) – 20% for IBDP specifically
8

 IB Internal Assessment (20% of your grade)
 Three article analyses
 Three different sources
 Three different units
 750 words
 A demonstration of application of economic tools
9

 Introduction to Microeconomics
 Scarcity, Choice, Opportunity Cost, PPF
 Demand and Supply and Market Equilibrium
 Price Mechanism and Market efficiency
 Elasticity
 Government Intervention and Price Controls
 Market Failure
 Theory of the Firm and Market Structures (HL Only)
 Production
 Pricing Mechanism
 Law of Diminishing Returns
10

 Continuation of Theory of Firms from Semester 1 (HL only)
 Monopolistic Competition
 Oligopoly
 Cost, Revenue and Profit
 Economic Development (Unit 4)
 Consequence of Growth and Barriers to Development
 International Trade and Growth
 Foreign Aid and National Debt
 Free Markets and Government Intervention
 Introduction to Keynesian and Austrian Economic Models.
11

 Any Questions?
 If you’re having any difficulty please feel free to find me after class
hours.
 Email or find me in the Social Science Department Office to set-up an
appointment.
12

A Science or an Art?
13

 Economics – Greek, meaning “Rules of the Household”
 Move from Feudalism to Capitalism in the 17th Century
 Creation of money and capital from the Barter System
 Creation of Banking Systems
 In the late 18th Century, Adam Smith (The Wealth of Nations)
postulated the foundations of modern economic thought.
 “The Invisible Hand” – Liberty and self interest leads to the optimal
allocation of society's scarce resources
14

 EconStories
 John Papola – Director
 Russ Roberts – Professor of Economics at George Mason University
 Created in the aftermath of the $700bn bailout of major US financial
institution by the US Government
 John Keynes – “Father of Modern Macro” – The General Theory
 Regulated markets and central planning
 F. A. Hayek – “Father of Austrian Economics” – The Road to Serfdom
 Laissez-faire economy (“Let it be” – AS 1776)
 Free market Libertarianism Abhishek Maity, KIS, 2012
15

 Economists develop rudimentary models to represent the real world
 Models abstract from irrelevant details and use simplifying
assumptions to facilitate analysis
 Models are not perfect – they exist to help us directionally
understand changes to complex systems
 Y = C + I + G + NX
 Assumption of cetris parabis
 Allows economists to analyze the effects of one part of the
economy (even though in reality many parts of the economy are
changing simultaneously)
 Assumption of rational* behavior and optimization
16

 Two kinds of economic analysis
 Positive Economics – The part of economics that studies how the
world actually works (the study of what *IS*) Descriptive
 Normative Economics – The part of economics that studies how the
world *SHOULD* be. Prescriptive
17

 Lowering income taxes may increase the amount people save
 Positive Statement
 Taxes on middle income people should be lowered
 Normative Statement
 The best way to lower the budget deficit is to raise taxes
 Mixed Statement
18

 Economics is Social Science:
 A study of interaction between humans, our institutions and the
natural and social environment we inhabit
 It is a HUMAN Science encompassing
Psychology, Mathematics, Environmental Science, History and
Finance.
 Economics is the science of allocating scarce goods and services
 ALLOCATION – Production (Supply) and Consumption (Demand)
 SCARCE – Implies trade-offs (Opportunity Cost)
19

 Our resources are finite – our need and want is infinite
 Includes natural and man-made goods and services
 Examples?
 LAND, LABOR, CAPITAL (Factors of Production)
 Land resources – natural raw materials
 Labor resources – human capital
 Capital resources – tools, technology, and money
 Allocation and distribution of these three resources led to
development of different schools of economic thought and systems
 Abundant resources?
 Creativity and entrepreneurship
 Solar and wind power?
20

 The Basic Economic Questions:
 What should be produced?
 Food, toys, clothes, tools, financial services, entertainment, call
centers and BPOs (Business Process Outsourcing)
 How should it be produced?
 Labor intensive or capital intensive?
 For whom should it be produced?
 For domestic consumption or export?
 For the affluent or for the common man?
The MARKET determines the answers to these questions.
There are FREE MARKETS and CENTRALLY PLANNED MARKETS
21

 A market is a place where buyers and sellers come together to engage
in exchanges with one another
 Circular Flow of the Market
22
Households
Firms
Labor MarketGoods Market
w
w
LS
LD
P
P
QS
QD

 QUESTIONS – EE/IA/TOK:
 Do we need central planning for teachers, farmers, police, military?
 How does a free market ensure that “indispensable” jobs get done?
 Is privatization more efficient?
 How are wages determined in centrally planned economies?
 What is better a FREE MARKET, or a CENTRALLY PLANNED MARKET?
23

 As a result of scarcity, choices have to be made.
 When a choice is made, an alternative is foregone.
 Definition: The opportunity cost of any action is the value of best
forgone alternative.
 The TOTAL COST of any action is the DIRECT COST *plus* the
OPPORTUNITY COST
 TC = DC + OC
24

 What is the cost of your KIS Education?
 Direct Cost = Rs. 8.5L + Rs. 1.5L + Rs. 1L + Rs. 1L = Rs. 12L/year
 Opportunity Cost?
 Work at McDonalds – Earn a salary – Rs. 2L
 Put the money in the bank and earn interest – Rs. 1L
 Delivering pizzas for Dominoes – Rs. 1L
 Total Cost?
 Total Cost = Direct Cost + Opportunity Cost
 TC = 12L + 3L = 15L/year
 NOTHING IS FREE
25

 Does Bill Gates have Opportunity Cost?
26

 Consider a simple economy
 A fixed level of Technology (A)
 2 Goods
 Guns (G)
 Butter (B)
 2 Factors of Production
 Labor (L)
 Capital (K) – Let’s assume this is fixed
27

Scenario Guns (#) Butter (Kg)
A 200 0
B 175 75
C 100 100
D 50 115
E 0 125
28

 Production Possibilities Frontier (PPF): Is the locus of all possible
efficient production points of an economy
29
Butter
Guns
Specialized in
Gun Production
A200
175
75
B
100
100
C
125
D
Specialized in Butter
Production
PPF

30
Guns
Butter
“RECESSION”
“GROWTH”
“FULL EMPLOYMENT”
A
B
C
D

 The extent to which governments should intervene in the allocation of
resources.
 The threat to sustainability as a result of current patterns of resource
allocation
 Sustainable development meets the needs of the present without
compromising the ability of future generations to meet their own
needs.
 The distinction between economic growth and economic development
 GDP vs HDI
31

 Positive/Normative statements (AO2)
 Definitions: Competitive Market, Economics, Opportunity Cost (AO1)
 Differences: Economic/Free Goods; Free Market/Centrally Planned
Market (AO3)
 Describe: Factors of Production, The Three Fundamental Economic
Questions (AO1)
 Drawing a Production Possibility Curve based on data. (AO4)
 Describing points on a PPC (Feasible, inefficient, non-feasible, growth)
(AO1)
 Calculate: Total Cost based on data.(AO4)
32

ABHISHEK MAITY
SEMESTER 1, 2012
DEMAND
33

 A market is an institution which permits the interaction between
buyers and sellers.
 In a FREE MARKET – the market also determines which goods to
produce and how scarce resources will be allocated.
 Types of Markets?
 Labor Market (Factors are traded in Factor Market)
 Financial Markets
 Stock Market
 Bond Market
 Foreign Exchange Market
 Product/Goods Market
 Consumers and Producers determine price of products – DEMAND
and SUPPLY
34

 Demand is the behavior of Consumers
 Suppose you get an allowance for food every week:
 Suppose you can only buy:
 Burgers
 As price increases, the quantity demanded decreases.
 People have different earning levels and preferences.
 SUBSTITUTION EFFECT: If the price of Good X increases then all other
goods automatically become relatively cheaper so consumers will tend
to substitute other goods for X.
 INCOME EFFECT: If the price of Good X increases then purchasing power
of consumers decrease and they will be able to afford less of X
35

The demand for good summarizes the behavior of buyers
in a market.
Various possible prices and quantity a buyer is willing
and able to purchase per time period, cetris parabis.
The relationship between price per unit and quantity
demanded per period of time is inverse (negative)
LAW OF DEMAND:
As P the Qd AND as P the Qd
There are very rare exceptions!
36

37
Scenario Price
Quantity of Books
Demanded
A $2 60,000
B $4 40,000
C $6 30,000
D $8 25,000
E $10 23,000

 If INCOME changes?
 If income increases, demand for most goods will increase.
 The demand curve will “shift” to the right.
 Only for NORMAL goods.
 For an INFERIOR good, an increase in income will lower the
demand for said product.
39

 A good is NORMAL if:
 An increase in income leads to an increase in the demand or, more
generally, if income and demand change in the same direction.
 A good is INFERIOR if:
 An increase in income leads to a decrease in its demand or, more
generally, if income and demand change in the opposite directions.
40

41
D1
D2
Quantity demanded per period
Priceperunit
Normal good: An increase in
income will increase demand
– the curve shifts right from
D1 to D2
D1
D2
Priceperunit
Inferior good: An increase in
income will decrease
demand – the curve shifts
left from D1 to D2
Quantity demanded per period

 Two goods are considered COMPLEMENTS if they are often consumed
together.
 Example – Coffee and Sugar
 If the price of a product increases then then the demand for its
complement decreases.
 If the price of coffee ↑ then the demand for sugar ↓ (the demand
curve shifts to the left)
 Similarly if the price of coffee ↓ then the demand for sugar ↑
(demand curve shifts to the right)
42

 Two goods are considered SUBSTITUTES if they are in competitive
consumption – consumer buys one or the other.
 Example – Coke and Pepsi
 If the price of a product increases then then the demand for its
substitute will increase.
 If the price of Pepsi ↑ then the demand for Coke ↑ (the demand
curve shifts to the right)
 Similarly, if the price of Pepsi ↓ then the demand for Coke ↓ (the
demand curve shifts to the left)
43

 Changes in taste
 Tastes are affected by advertising, by fashion, by observing others,
health considerations…
 Changes in the size of the market
 Increase in the population will increase demand for most goods
 Changes in demographics
 Ageing population of the baby boomers – demand for false teeth
increases and chewing gum drops…
 Seasonal change
 Government Policy - taxation
 EXPECTATIONS!
 An expected change in income and or price of a good.
 People buy more of a good before prices go up
44

 BIRD FLU!
 Price of chicken collapses. What happens to the demand of its
SUBSTITUTES – fish and mutton?
 The demand for SUBSTITUTES go up!
 TIP: Avoid saying demand curve shifts ‘up’ or ‘down’ – use ‘shift to the
right’ or ‘shifts to the left’
45

 Movement along demand curve  if the price of the good changes.
 Movement of the demand curve  if any of the other factors affecting
demand changes (income, price of substitutes, price of complements,
and taste)
 Please NOTE: Neither of these change the slope of the demand curve!
46

 Typical demand function:
 Qd = a – bP
 Qd is the quantity demanded
 A is the natural demand or autonomous demand if price was 0
 B is the relationship between price and quantity demanded – it is
always negative! When the price increases by $1 (or 1 unit) then the
quantity demanded decreases by the value of B.
 P is the price of a single item
47

 Qd = 600 – 50P
 @ P = 0, Qd = 600
 -50 is the slope of the demand curve (from the form y = mx + c)
 @ P = 10, Qd = 100
 @ P = 5, Qd = 350
48

 Change in the autonomous level of demand
 How does the demand curve move when A changes?
 What can a change in A represent?
 Any of the factors that causes a shift in the demand curve!
49

 Change in the slope of the demand curve
 How does the demand curve move when B changes?
 What can a change in B represent?
 People are changing their responsiveness to a change in prices!
 Examples?
 Petrol, cigarettes
 X-box
50

 Consider the function: Qd = 300 – 30P
 1. Create a demand schedule with P = $0, 3, 5, 7, and 9
 2. Create a demand curve
 Decrease a by 30 units and illustrate
 Change the PRICE CO-EFFICIENT (b) to -10. Illustrate the new results
51

ABHISHEK MAITY
SEMESTER 1, 2012
SUPPLY
52

 Supply is the behavior of Producers
 Law of Supply:
 If the price of a product increases then quantity supplied per period is
expected to increase.
 The relationship between price per unit and quantity supplied is
directly proportional.
 The supply curve will hence be positively sloped!
53

 Supply curve is the summation of the individual firms supply
schedules.
 At each price, we add the quantities supplied by each firm.
 NOTE: The firms have to make identical products to be included in the
supply curve.
54

 Why do we expect the LAW OF SUPPLY to hold?
 Simple answer:
 … because at a higher price, a firm’s profit margin is
greater, inducing it to offer more units per period.
 A more theoretically sound answer:
 … because if it becomes costlier for the firm to produce more and
more units per period of time using existing capacity, then it will
be willing to do so only at a higher per unit price.
55

 Changes in the cost of FACTORS of PRODUCTION
 Wages; LABOR ↑
 Price of Raw Materials; LAND ↑
 SUPPLY ↓ Or the SUPPLY CURVE “Shifts” LEFT
56

 Improvement in TECHNOLOGY – Cost of Production ↓
 Increase in Productivity
 Training, experience, healthier
 SUPPLY ↑ or SUPPLY CURVE “Shifts” RIGHT
57

 Effect of Indirect Taxation?
 Increase production cost hence supply “shifts” LEFT
 Effect of Subsidy?
 Decrease in production cost hence the supply “shifts” RIGHT
58

 Change in the price of JOINTLY SUPPLIED GOODS
 If the price goes up, the supply of the JSG will also go up.
 Change in the price of COMPETING SUPPLIED GOODS
 If the price goes up, the supply of the CSG will go down.
 Size of the MARKET – the number of FIRMS
 Number of firms increase, then supply increases.
 Natural conditions and disasters (SUPPLY SHOCKS)
 Expectations
 If you expect the price of a product to go up in the future, in the
short run, supply might decrease, i.e. shift to the left.
59

 If the Price of the good changes  Movement along the supply curve
 If any other factors affecting supply changes (Production factors,
technology, productivity, Price of jointly produced goods, competitive
supply, Indirect Taxes, subsidies, weather, disaster, market size etc) 
Shift of the Supply Curve
60

 Standard form of the Supply Curve: Qs = C + dP
 Qs represents the quantity supplied
 C is the Natural or Autonomous Supply; it is the quantity supplied at P
=0; typically C will be a negative value.
 D represents the rate at which a change in price will cause the
quantity supplied to increase in a supply function, d is always
POSITIVE, keeping with the LAW of SUPPLY. So when the price
increases by $1 (or 1 unit), then the quantity supplied increases by the
value of D.
61

 Qs = -200 + 150P
 Make P = 0 to get the value of C
 Note that the P-intercept is at 1.33 (Qs = -200 when P =0)
 Suppliers won’t sell you something for free!
 Make the Supply Schedule/Table
 Choose P = $0, 3, 5, 8, 10
 Plot the curve!
62

63
$0
$1
$2
$3
$4
$5
$6
0 100 250 400 550
Price($)
Quantity Supplied(#)
Supply Curve

 A change in C will mean that the natural supply or the autonomous
supply is changing.
 It will cause a shift to the right if C increases and a shift to the left if it
decreases.
64

 A change in D will cause a change in the slope of the supply curve.
 The slope can not be negative!
65

 Qs = -100 + 10P
 Create a Supply schedule with prices of $10, 20, 30, 40, 50
 Create a Supply Curve from the schedule
 Increase the autonomous supply by 50 units – illustrate
 Change the value of the price co-efficient to +30. Illustrate the new
supply curve.
66

ABHISHEK MAITY
SEMESTER 1, 2012
MARKET
EQUILIBRIUM
67

ABHISHEK MAITY
SEMESTER 1, 2012
ELASTICITY
68

ABHISHEK MAITY
SEMESTER 1, 2012
TAXES, SUBSIDY, PRICE
CONTROL
69

ABHISHEK MAITY
SEMESTER 1, 2012
MARKET FAILURE
70

ABHISHEK MAITY
SEMESTER 1, 2012
THEORY OF FIRMS:
COSTS, REVENUES, AND
PROFITS
71

ABHISHEK MAITY
SEMESTER 2, 2012
THEORY OF FIRMS:
PERFECT COMPETITION
72

Traditionally markets are split into FOUR types:
Perfect Competition
Monopoly
Monopolistic Competition
Oligopoly
73

Characteristics:
Very many small firms
Altering their output won’t influence the market
Price Takers
Homogenous product
No entry (or exit) barriers
All participants have perfect information
Perfect mobility of factors of production
74

Economies of Scale are common
Product differentiation
Information is not perfect
There is no perfect mobility of factors of production
particularly Labor
Creation of barriers to entry
Apple v. Samsung
So why study perfectly competitive markets?
Most efficient of the four market structures.
75

ABHISHEK MAITY
SEMESTER 2, 2012
THEORY OF FIRMS:
MONOPOLY
77

 Definition:
 “A monopoly is a market where one firm dominates the market for a
good that has no substitutes and where significant barriers to entry
exist”
78

 Standard Oil – 1940s
 J.D. Rockefeller – 80% of all global oil production and refining.
 Richest man in the world.
 Microsoft – 1990s
 Bill Gates – 90% of all operating system sales worldwide.
 Richest man in the world.
 TelMex – 2000s
 Carlos “Slim” Helu – 90% of all telecom in Mexico, Central and South
America
 Richest man in the world
79

 Single seller
 One firm controls the market – dominance.
 No close substitutes
 Sells something with no substitutes – unique product
 Price-makers
 Power to set prices
 Constrained by the demand curve
 Barriers to entry
 Anything to avoid competition
80

 Economies of Scale (EOS)
 Small firms can’t compete with lower costs via EOS
 Legal Barriers
 Copyrights, patents, licenses
 Ownership of Essential Resources
 Control of vital inputs
 Aggressive Tactics
 Buy out a rival firm/hostile takeover
 “Predatory Pricing” and Anti-Competitive Behaviour
 Choking supply of raw materials
 Advertising/brand image building – BRAND LOYALTY
 Diversify product range: Kelloggs
81

 Market Demand = Monopoly’s Demand
 The monopoly controls the market so the market demand curve is
the same curve the firm sees.
82
Price ($) Quantity TR ($) AR ($) MR ($)
- 0 - - -
10 1 10 10 10
9 2 18 9 8
8 3 24 8 6
7 4 28 7 4
6 5 30 6 2
5 6 30 5 0
4 7 28 4 -2
3 8 24 3 -4
2 9 18 2 -6
1 10 10 1 -8

 As P↑ then Qd ; Law of Demand
 Price = Average Revenue = DEMAND CURVE
 Total Revenue increases then decreases – “diminishing returns”
 Total Revenue starts to drop after MR = 0
 MR↓ by 2x the Price or the demand curve.
 The MR has twice the slope of the demand curve!
83

ABHISHEK MAITY
SEMESTER 2, 2012
THEORY OF FIRMS:
PRICE DISCRIMINATION
84

ABHISHEK MAITY
SEMESTER 2, 2012
THEORY OF FIRMS:
MONOPOLISITC COMPETITION
AND OLIGOPOLIES
85

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