1.INTRODUCTION AND MICROECONOMICS

PART 1 - CHAPTER 1INTRODUCTION AND MICROECONOMICSI. INTRODUCTION ............................................................................................................................................A.Adam Smith Resource Allocations ........................................................................................ ..................................B.Basic Economic Systems and Decisions .......................................................................................... .....................C.Free Market Decisions ........................................................................................................................ .....................D.Production Possibilities Curve ............................................................................................................ ...................Il. DEMAND CURVE ANALYSIS………………………………………………………………………………A. Utility and Consumers Demand .......................................................................................................... ..................B. Marginal Utility Theory ...................................................................................................................... ..................C. Indifference Curve Analysis ..................................................................................................................................D. Basic Demand Curve Features ............................................................................................................ ..................E. Elasticity of Demand ........................................................................................................................... ..................III. SUPPL Y CURVE ANAL YSIS .................................................................................................................A.Basic Supply Curve Features .............................................................................................................. ..................B. Elasticity of Supply ............................................................................................................................. ..................IV. INTERACTION OF DEMAND AND SUPPLY ..............................................................................................A. Equilibrium ......................................................................................................................................... ..................B. Government Price Support Programs ................................................................................................. ..................C. Government Price Ceiling Programs ................................................................................................. ...................V. PRODUCTION FUNCTION AND FACTORS OF COST ......................................................................................A. Efficiency of Production ..................................................................................................................... .................B.Family of Costs ................................................................................................................................... ......................C.Short-Term Marginal Costs ................................................................................................................ .......................D.Marginal Revenue Analysis ................................................................................................................ ......................E.MR- MC Relationship ....................................................................................................................... ........................F.Long-Term Cost Analysis ..........................................................................................................................................G.Profit Measurement ............................................................................................................................. ......................VI. RESOURCE PRICING AND EMPLOYMENT ..............................................................................................A. Resource Returns........................................................................................................................... ..............B. Input Demand Factors ......................................................................................................................... ....................C. Optimum Usage Quantity ................................................................................................................... .....................D. Resource Imperfections ....................................................................................................................... ....................VII. MARKET STRUCTURE .........................................................................................................................A. Perfect or Pure Competition ................................................................................................................ ...................PART 1 -CHAPTER 1INTRODUCTION AND MICROECONOMICSA. Adam Smith Resource AllocationsThe Scottish economist, Adam Smith, in his 1776 masterpiece, The Wealth of Nations, founded the modem economic theory known as economic liberalism. Smith's basic assumptions of economic analysis included that there are unlimited economic needs and wants among consumers, as well as limited resources (land, labor and capital) available. Aggregate economy wide demand exceeds resource supply. The most efficient allocation of scarce resources to achieve the largest amount of goods and services becomes the ultimate goal. Smith's analysis concludes that a system of competitive free markets ("the invisible guiding hand") best achieves this result. Individuals pursuing their own selfish best interests facilitate efficiency through the division of labor; this specialization creates national and individual wealth and maximizes efficiency in resource allocation.B. Basic Economic Systems and DecisionsConventional economic study recognizes three elementary economic systems.1.Conventional System: Historically, economics was built upon land and agriculture. It was common to adopt Barter economy, but was limited to transactions between people who wanted the same item. To overcome this restriction, rare metals started serving as an exchange medium. Medium examples include the European Middle Ages' feudal systems and some nowadays underdeveloped countries.mand System: The economic system is centrally manipulated/planned and resources are often publicly owned. This includes a variety of democratic, socialist, or communist political systems with centrally-controlled resources. Such centralized systems lack the efficiency of the free-market and are losing favor as a means for organizing economic activity. Many countries are privatizing businesses previously owned by the Government. Russia plans to privatize 3/4 of the Soviet State businesses before the year 2005. But the exchange to a free-market economy has proven difficult in Eastern Europe; in order to cover deficits, the government has printed money. Yet, it has produced high inflation and a fall of real incomes by 40% since 1992. There is political uncertainty following.3. Capitalism: Individuals and firms seek for their personal private interests in the free market system of' private ownership. More is determined by the market and less by the government. Consumer demands are contented by free-enterprise firms running for profit.a. Consumer Votes: Consumers show their preferences in the global marketplace on a basis of one vote, one dollar. They seek to get the best-quality product at the cheapest price. This price mechanism determines resource allocation.b. Production Costs: Businesses fight for consumers' money in an egocentric search for profits. Competition compulses producers to innovate and specialize. This promotes efficiency and costs reduction per unit. Costs of production, mixture of inputs and control are equally important as revenue.c. Efficiency and GDP: The free market economy is more efficient than a command system. This efficiency creates a maximum Gross Domestic Product (GDP) for the economy given a pre-existing income level. Therefore, the highest standard of living for the people is created.4. Mixed Systems: Nowadays, most systems are mixed; partially capitalistic and partially command. Japan is an instance where resources are privately owned, but the government organizes the economic climate through an industrial policy.C. Free Market DecisionsThe five basic free-market economic decisions include:1. What to Produce? Consumers vote for their preferences with dollars in the marketplace and hence, determine the production of demanded goods. Suppliers produce to meet the market demand.2. How to Produce It? The production procedure is to be accomplished by the most efficient, leastcost per unit, method possible.3. How Much to Produce? The market determines the quantity demanded. An individual firm can sell all the quantity it wants at the market price in a truly competitive environment.4. What Price to Charge?This decision as to the exchange price may not be available in a truly competitive environment. In other economic contexts, the firm may enjoy price elasticity.5. Ownership Structure: This decision determines who shall receive tile profit or bear tile loss caused by the sale of the goods or services. In the free market economy private individuals own the business entities and resources.D. Production Possibilities CurveThe production possibilities curve is illustrated by Figure 1-1 below.1. Purpose: This curve indicates all possible combinations of two goods that a society can produce, employing its available level of resources at greatest efficiency. The gradient of the curve represents the rising opportunity cost of producing each successive unit of one good in terms of units of the other good for which production is foregone.2. Variable Points: Due to scarcity of resources, points to the right of the curve are not obtainable. Points to the inside of the curve represent underemployment of resources are available. Growth in productive resource capacity or the productivity of workers (output per labor hour) causes the curve to shift outward. This allows the society to produce more of both goods. In 1990s and early 2000 decade, U.S. productivity increased about 3% per year.II. DEMAND CURVE ANALYSISA. Utility and Consumer Demand1. Dollar Votes: Dollar votes in the marketplace indicate the perception of consumers towards a good's utility. Utility measures the satisfaction or benefit derived from consuming a unit of the good. Total utility (TU) is the cumulative satisfaction or benefit derived from all units consumed. Marginal utility (MU) shows the satisfaction or benefit derived from the last unit consumed.2. Savings Utility: Utility is provided through earning the security and interest from savings.B. Marginal Utility TheoryMarginal utility theory is one approach used to explain how the consumer with a given level of income behaves to maximize the utility provided by various goods. This theory assumes that the quantification of utility.1. The Law of Diminishing Marginal Utility: Each successive unit of the same good consumed provides declining additional, or marginal, satisfaction. The more you buy an item, the less you want the next unit. This results in a downward-sloping demand curve. Graphically, it can be shown that as increased quantities of a good are consumed, the total utility curve rises at a decreasing rate, and the marginal utility curve declines.2. Utility Maximization: Maximization of utility for a given consumer's level of income is where the marginal consumption utility (MU) per dollar price of all goods equals savings. If a, b, and c are different goods available to the consumer and s equals savings, the formula to maximize utility for a given consumer's income is: MUa = MUb = MUc = MUsPa Pb Pc PsC. Indifference Curve AnalysisIndifference curve analysis is an another approach to explain consumption behavior. This approach does not measure utility quantitatively. An indifference curve shows all combinations of two goods which yield the same level of satisfaction to the consumer, who is indifferent between combinations represented by points on the curve.1. The Marginal Rate of Substitution:The slope of an indifference curve is the Marginal Rate of Substitution (MRS), or the amount of one commodity that the consumer is willing to forego to obtain an extra unit of the other goods. The MRS diminishes along the curve due to the consumer's increasing unwillingness to give up successive units of a commodity to continue to increasingly more of the other. A set of indifference curves is referred to as an indifference map. Convex curves further from the origin represent higher levels of consumption successively and satisfaction correspondingly.2. The Budget Line: The linear budget line indicates all possible matchings of the two commodities that the consumer can buy given the prices of the commodities and the level of income available to buy them. A change in money income results in a parallel shift of the budget line -outward if income is increased, toward the origin if decreased. Whenever there is a change in the relative prices, the slope of the budget line changes correspondingly.3. Maximization of Consumer Satisfaction: When the budget line is superimposed upon the indifference map, at the point of tangency of the budget line to an indifference curve, the consumer's satisfaction is maximized. Figure 1-2 is an illustration.D. Basic Demand Curve Features1. General Considerations: A demand schedule indicates the quantity consumers will purchase at a given price. The law of demand states that as unit price decreases, consumers will purchase an increasing number of goods. As unit price rises, quantity demanded will fall. This produces a demand curve that is downward sloping to the right and normally convex to the origin.2.Demand Curve Shift: A shift of the demand curve (a change in demand - see below) is different from a movement on the same demand schedule. The above movement from P2/Q2 to P1/Q1 is an example which indicates a change in quantity demanded.a.Cause of Change in Quantity Demanded: A change in quantity demanded results from a change in price, with all other factors remaining the same. This is a movement along the demand curve from one price-quantity combination to another.b.Causes of Change in Demand: Changes in consumers' tastes, prices of complementary or substitute items, money income, expectations as to price or income changes, the range of available products, and the number of buyers may all result in a change in demand.c.Direction of Shift: An increase in income or the elimination of a substitute good can result in a shift of the curve to the right, an increase in demand. While a decrease in income or an increase in substitute goods can result in a shift to the left, a decrease in demand.E. Demand ElasticityDemand Elasticity measures the responsiveness of quantity to a change in the product's price. For most goods, the basic determinant of the demand elasticity is the amount of substitutes available. The more close substitutes a good has, the greater its elasticity of demand. A longer period of time or when a larger portion of the consumer's income is required to purchase the commodity may also facilitate greater elasticity. The impact of the change on total revenue becomes the eventual question.1. Elastic Demand: Total Revenue rises from a fall in price if the percentage change in quantity (Q) is larger than the percentage change in price (P). This occurs in tile lower right section of a traditional concave demand schedule and the coefficient of elasticity is greater than one. If the elasticity of demand is 1.3, a 5% decrease in price will increase quantity demanded by 6.5%. In this portion, the demand curve is more horizontal (remember the elastic or rubber band). Luxury and expensive goods usually enjoy more elastic demand than necessary products. If the demand curve is horizontal at a given price, demand is perfectly elastic (the coefficient is infinite).2. Inelastic Demand: Total Revenue decreases from a decrease in price if the percentage change in Q is less than the percentage change in P. This is in the upper left section of a traditional concave demand schedule and the coefficient of elasticity is less than one. In this portion, the curve is more vertical. Inelasticity in the demandcurve allows a seller to more easily pass supplementary costs, new taxes, etc. through to the buyer. The demand will be more inelastic in case there are fewer substitutes for a good. If the demand curve is vertical at a given quantity, such as a diabetic's requirement for insulin, demand is perfectly inelastic (the coefficient is zero).3. Unitary Demand: This is the point on the demand curve where a decrease in price is exactly eliminated by an increase in quantity. The coefficient is exactly one. At this point, total revenue remains static.4. Price Elasticity of Demand: This is a measure to evaluate and quantify the elasticity relationship of elasticity. The formula for the coefficient of elasticity indicates the impact on quantity purchased caused by a price change. To get a positive number, the result is negative multiplied by (-1).Example:The unit price of a good fell from $15 to $12 and the unit quantity increased from 22 to 28. What was the elasticity principle of the demand curve and calculate the elasticity coefficient?Answer: The demand curve was in the elastic portion of the schedule. A total revenue increase caused by the change. ($12 x 28 = $336 > $15 x 22 = $330). The Coefficient is calculated as:28-22 = 6 12-15 28+22 25 12+152 2 -3 (For simplify, offset the decimal, the13.5 price change fraction can be changedto-6/27)5. Income Elasticity of Demand: A measurement of the impact on quantity purchased from income change.Formula = % change in Quantity %change in Incomea. Normal Good: A normal good indicates a positive elasticity coefficient. Quantity demanded rises with an increase in income, such as lobster.b. Inferior Good:An inferior good indicates a negative elasticity coefficient. As income rises, quantity demanded falls, such as beans.6. Cross Elasticity of Demand: Measures the relationships of changes in two products. A typical exam question includes a manufacturer adding a product line or changing the unit price. The question is whether such an action will retard orarouse the purchase of the other product.Formula = % change in Quantity of Y% change in Price of Xa. Substitute Goods: Substitutes bears a positive coefficient index. They are alternatives. Consumers purchase one good or the other, such as Coke - Pepsi or butter - margarine. The greater number of substitute products, more elastic the demand schedule for any one. If substitute goods increase their prices, the demand curve for a firm's product will shift to the right.b. Complementary Goods: Complements indicates a negative coefficient. One facilitates the other. The purchase of one good stimulates the purchase of another, such as beer -pizza or baseballs - baseball bats. A decline in the price of a complementary good will shift the demand curve of the joint commodity to the right.7. Increase in Price or Income: An increase in price or income would have the counter effect. For instance, if the demand curve is inelastic, a rise in price (say from a sales tax increase) will be more easily shifted ahead to consumers. Similarly, an inelastic demand is required for a crop reduction program to increase farmers' incomes.III. AN ANALYSIS OF SUPPLY CURVEA. Basic Supply Curve Characteristics1. General Considerations: The supply schedule shows the various quantities producers will bring to market at various prices. The law of supply states that sellers will provide more quantity at a higher price and less quantity at a lower price. The supply curve schedule is, therefore, downward sloping to the left.2. Supply Curve Shift:A shift in the supply curve (a change in supply) should be compared with a movement on the same schedule (a change in quantity supplied).a. Cause of Change in Quantity Supplied:A change in quantity supplied is originated from a change in price, with other factors remaining static.b.Causes of Change in Supply: A change in supply (a shift to the right of the supply curve) results from a change in one of the following: input prices, technology, prices of other commodities, the amount of suppliers, and suppliers' expectations.c. Shift Direction:1.) Right: A fall in the cost of the required inputs or a technological improvement are examples of changes that will shift the supply curve to the right; this will increase the quantity provided by a supplier at all price levels. The price would be reduced if there was no quantity change.2.) Left: A fall in the amount of suppliers or increase in input prices will shift the supply curve to the left, causing from a decrease in supply.B. Elasticity of SupplyElasticity of supply indicates the measurement of the responsiveness of quantity supplied to a change in the price of the product.Formula -- % change in Quantity% change in Price1. Elasticity Measurement:When the coefficient is greater than one; supply is elastic (percentage change in quantity exceeds percentage change in price). When the coefficient is less than one, supply becomes inelastic. A positive number signifies the elasticity of supply. There are two exceptional cases: the coefficient is zero with a vertical supply curve and infinite with a horizontal supply curve.2. Determinants: T he ease of input substitution, length of time, and behavior of costs as output levels change are all basic elasticity determinants. Supply is more elastic for a given commodity when it is relatively easy to shift the production factors to another commodity, if the buyer can provide a variety of input usage, when a longer time frame is involved, and when production costs show no tendency to rise sharply as output increases.IV. INTERACTION OF DEMAND AND SUPPLYWith no government interventions, the consumers demand and producers supply for a good proceed the transactions in the free market.A. EquilibriumThe equilibrium market price and quantity, as shown by Figure 1-8 below is produced under the circumstance that there is an intersection of the supply and demand curve. An equal increase in both supply and demand will rise market-clearing quantity.B. Government Price Support ProgramsThe political process may think that some industries or resource input cannot receive an equitable income allocation under the free market system operation. To remedy, government price support programs dictate a certain price which is usually above the market equilibrium price. At this support price, the quantity supplied will be greater than the quantity demanded. Minimum wage is an instance. The government purchased he surplus in quantity supplied. Milk and wheat surplus programs are instances of these free market restrictions (and may result in milk lakes and wheat gifts to foreign countries). Since consumers payhigher prices, the affected producers of the surplus enjoy the benefit.C. Government Price Ceiling ProgramsThe government may impose a maximum or ceiling price on a good that is lower than the market equilibrium price. Rent control is a typical instance. The quantity demanded exceeds the quantity supplied at the governed price. The government may need to ration the product. Such a free market restriction, the long-term result is that the quality of good subject to price ceiling will fall.V. PRODUCTION FUNCTION AND FACTORS OF COSTA. Production EfficiencyThe production function requires figuring out the quantity demanded by the market. This includes combining resource variable inputs (labor and raw materials) and fixed inputs (managerial capability, equipment and space). The objective is the most efficient utilization and combination of inputs. The state of technological efficiency (technical and engineering know-how) eventually determines the maximum quantity of physical output a firm can produce with a specific combination of resource inputs. The following is the graphical representation of the production function:1. Increasing Returns to Scale: The short-run marginal output transcends the marginal input. This is often called economies of scale and the short-run average cost of production is declining.a. Marginal Product Increasing: In segment AB, the marginal product curve is rising and is above the average product curve resulting in the rise of both the average product and the total product to rise. The increased quantity produced has resulted in labor specialization. Specialization facilitates efficiency, as well as marketing advantages, by-product utilization. Volume purchase discounts may lead to additional economic efficiency.b. Marginal Product Declining: In segment BC, marginal product starts declining per additional unit of input. Average product continues to rise since marginal product curve is above the average product curve. Total product continues to rise but at a diminishing rate.2. Constant Returns to Scale: This condition assumes all resource inputs are variable. The additional output is constant to the input. No economies or diseconomies of scale can be observed. This is at point C. This refers to the quantity location of maximum average productivity.3. Decreasing Returns to Scale: The Law of Diminishing Returns states that the marginal output (increase in total units) decreases eventually as more variable inputs are added to a given number of fixed inputs. Inefficiency has set in. This may also be named diseconomies of scale.a. Positive Marginal Product: In segment CD, marginal product continues to decline but remains positive. Because the marginal product curve is below the average product curve, average product will decline in this range. Total product continues to increase, at a declining rate.b. Maximum Output: At point D, output is at a maximum. The ideal output range is Segment BD since the marginal product for a unit of input resource is greater than zero and total product is still rising.c. Negative Marginal Output: Beyond D, the marginal output of product from a unit of variable resource input is negative; total product is ,hence, decreasing. Because the marginal product curve is below the average product curve, average product is falling as well. Bottlenecks, transportation problems as well as the management difficulties that result from coordinating large enterprises may cause diseconomies.4. Management's Decision: In making management decisions, priority will be given to produce in some location within segment BD. The optimal point is at C where average productivity is maximized. Management would regard production unacceptable in the segments of AB and DE. In segment AB the firm's capital is not being utilized efficiently. In segment DE marginal output is negative and extra units of variable resource inputs will result in decrease in total output.B. Family of CostsTotal Costs -- Total Fixed Costs + Total Variable Costs1.Fixed Costs: These costs remain fixed in total over the relevant production range.2.Variable Costs: Variable costs vary directly with the production level.C. Short-Term Marginal CostsMarginal costs (MC) are the change in Total Variable Costs in the short-run as a supplementary unit is produced. Fixed or sunk costs are not paid attention. Increasing returns to scale usually mean the cost curve will decrease at first. But ultimately diminishing returns and/or increasing costs will result from each variable input unit in the short-term. Therefore marginal costs tend to increase as production expands. The entrepreneur should be sensitive to the relationship. The short-term marginal cost curve is upward sloping to the right.。