The Principles of Micro Economics
Summary & Review
Chapter 1 Introduction
Chapter is the general introduction to this subject. It states the intrinsic of economics. The unlimited desire of people cannot be satisfied by the limited resources, so people need to forgo at least something in order to perform other activities. This is called the scarcity principle, and that is why economics is important. It determine the people’s reaction under the scarcity principle and the impact of these action towards society.The fundamental rule of economics is the cost-benefit principle, therefore as a rational person we should take an action only if the benefit for taking that action is at least great as the extra cost.This is a normative principle that tells how people should behave and there are positive principles that predicts how people would behave. For example, the incentive principle( incentive for people taking activities related to the change in benefit/cost). According to the cost-benefit principle, the goal for economic decisions is to maximize economic surplus. There are four major pitfalls preventing people to do that, hence if people want to perform rational decisions, they need to:account benefits and costs in absolute dollar value not proportions; measure all opportunity cost; ignore the sunk cost because not all cost and benefit matter equally; understand the difference between average cost/benefit and marginal cost/benefit.
Chapter 2 Comparative advantage
The opportunity cost is the trade-off for the next-best alternative people must perform in order to take an activity. When a firm or person has a lower opportunity cost at a specific task ,it is said to have the comparative advantage. When a firm/personal can provide more output with same/less input, it said to have the absolute advantage. The maximum output change be produced when everyone concentrates on the activities for which their opportunity cost is lowest. It is called production specialization, and the gains will grow as the difference in OC increases. There is the production possibility curve to describe the opportunity cost of one good at the maximum production of the other good. To define the production with current resources is whether possible, the points’ attainability determined it. Those attainable points are classified as efficient and inefficient point based on the feasibility to increase in production of one good without reduction in the other. The chapter also interpreted the reason of the up-ward sloping trend of opportunity cost by the low-hanging-fruit principle. It explains that the resources with the lowest opportunity cost will be adopted first, for the sake of expanding production.
Chapter 3 Supply and demand
The demand and supply in a market can be addressed with the demand and supply curve. The market combines all buyers and sellers for a good/service and the demand curve defines the quantity consumer wants to buy at a specific price. It is downward sloping since lower the price better the sale. The quantity changed because customers switch to substitutes once price changed.If the customer’s reservation price(benefit) is at least great as the market price(cost), they will purchase. And the difference between the reservation price and the actual amount paid is the consumer surplus. On the other hand, the supply curse shows the quantity of the good sellers wish to sell at the corresponding price. The seller’s reservation price is the smallest dollar amount for which a seller willing to sell an additional unit, which general equal to the marginal cost. The markets reach equilibrium once customers and sellers are satisfied with their respective quantities at the market price. When the price beyond the equilibrium price, there will be an excess supply/surplus. If below, there will be excess demand/shortage. The change in quality demanded/supplied is the movement along the curve, and the change in demand/supply will shift the curve. There are some factors that will shift the demand curve. The price change in complement and substitutes goods, change in income whereas normal good demanded will increase with the income and inferior good is in contrast. There are also exterior factors such as seasonal variation that affect demand and supply. At the last, the chapter introduces the cash on table metaphor when people have failed to take advantage of all mutually beneficial exchange, therefore, there are unexploited gains. An economic reached efficiency when the good and service are produced and consumed at their socially optimal level. The socially optimal quantity is defined when marginal benefit equals to the marginal cost, therefore, the maximum economic surplus can be reached. The market in equilibrium is efficient only if there are no external costs/benefits
Chapter 4 Elasticity
The price elastic of demand is the measure in economics that defines the percentage of quantities change in demand corresponding to the percentage change in price. The price elasticity is always negative since the demand curve is down-ward sloping. The time, proportion of budget and availability of substitutes defines a product’s demand is inelastic or elastic. We use (P/Q)/slope to define the elasticity at a specific point, and use the mid-point formula to identify the elasticity between two points. The price elasticity is one at the middle point of the straight-ling demand curve. Because total expenditure equals to the total revenue equals to the price times quantity, the change in price and change in total expenditure will move opposite direction when price elastic is larger than 1. When the price elastic is smaller than one, the movement is in the contrary. In addition, the cross-price elasticity of demand measures the proportion change in quantity demand related to the proportion change in price of another good. When these two goods are complement, the cross-price of demand is negative since the price increase will decrease the quantity demand. If these two goods are substitutes, the cross-price elasticity of demand is positive. Furthermore, the income elasticity of demand is positive with normal goods, and negative with inferior goods. The price elasticity of supply is pretty much the same structure, except the supply curve that passes through the origin will always have an elasticity of one.
Chapter 5 Demand: the benefit side of market
The law of demand states that the when the cost exceeds the buyer’s reservation price, the quantity demanded will decline and vice versa. The customer’s needs/wants are translated to the utility which is the satisfaction people derives from the consumption. The marginal utility people obtained by purchasing an additional unit of goods defines how do they allocate their income. The marginal utility will drop beyond some point of consumption, and this phenomenon is called the law of diminishing marginal utility. To distribute income rationally, we allocate our spending across goods where the marginal utilities per dollar are the same. That allows people to achieve the optimal combination of goods, which is the affordable combination yields highest possible utility. Other factors will influence the distributions of income are the nominal compare to the real price and the income difference. The demand curves are generally the summarization of individual diminishing marginal utility curve corresponding to the price. To define a market demand curve, we can simply integrate the quantity horizontally, and with large markets, we multiplied the quantity by the number of people.
Chapter 6 Perfectly competitive supply: the cost side of market
In a perfectly competitive market, all the suppliers are the price-taker that has no control over their own price nor the market power. In the short-run, at least one of the firm’s production factor is fixed, which means the quantity of this input can not be varied in this period. On the opposite, the variable factor’s input quantity can be altered such as labor, and the cost associated to these two factors are called fixed and variable cost. The total cost is the aggregate of these costs, and the marginal cost is the extra cost incurred for each additional unit of production. The law of diminishing returns states that in the short term where there is at least one fixed factor, the output yielded from the increase of variable factors will decline. Thus, the marginal cost will rise for greater quantity outputs. The firm needs to be shut down when the total revenue(P*Q) is less than the variable cost at all levels of quantity. It can be restated as the firm needs to have the price larger than the average total cost to be profitable. If the firm wants to maximize the profit, the price is necessarily to be at least great as the marginal cost. The marginal curve meets the average total cost and average variable curve at their minimum point. In the perfectly competitive firm, the supply curve is the marginal cost curve, and at every point along the curve , price measures the cost to expand production by one unit. The supply measures the cost side of the market.
Chapter 7 Efficiency and exchange
When there is no opportunity for exchange or trade that will make at least someone better off without harming others, we can claim that situation is efficient. It identifies the optimal and a market equilibrium is efficient because it leaves no cash on the table. Only the equilibrium will maximize economic surplus. Efficiency is the first goal on decision making, because it allows an economist to pursue other goals. The price ceiling will create a dead-weight loss on economic surplus, and the the function of rational pricing is not met since the goods are not distributed to the customer values it the most. In order to be served, customer will take costly actions. Same to the price ceiling, the subsidy also creates a dead-weight loss because the cost for providing the subsidy is greater than the increase on consumer’s surplus. Airline firms tend to use fist-come, first-served method to eliminate exceeds of demand, but compensation is way better Because it creates to less complain plus smaller loss in economic surplus. Furthermore, the public service should be charged at the marginal cost to reach equilibrium. And the marginal cost is the least efficient source for producing the goods. Government implies tax on supplies, it can be treated as an increase in marginal cost, which shift the supply curve vertically up-wards. The change in total economic surplus results from tax collection need to take the beneficial tax collection into account, which is the new equilibrium quantity times tax per item. Subtract this amount from the total loss in economic surplus will remain the dead-weight loss.By the way, the greater elasticity of demand/supply, the larger the dead-weight loss form a tax.Plus when the supply is perfectly inelastic, the burden of tax falls entirely on consumers.
Chapter 8 The invisible hand and quest for profit
The normal profit is the accounting profit less the economic profit. Whereas the economic profit is what firms pursue, it is the total revenue subtract all explict(actual payments) and implicit(opportunity cost of the resource) costs of the product. The invisible hand theory states the two functions of the price: to distribute goods or service to the customer with the highest reservation price( rational function), and to direct resources leave the market produce economic loss to enter the markets can provide economic profit(allocative function). These functions allows to distributed the supplies in a market efficiently and the most efficient combination to mix goods and service can be reached. As a consequence, when a market is generating economic profit, new competitor will enter the market, which drags the supply curve to the right. The market equilibrium price will decrease, until it reaches the point where marginal cost equals to average total cost. Then the remaining economic profit will be zero. In contrast, if the market is in deficit, the current resources is going to leave the market. That will increase the equilibrium price to the balance point. The no-cash-on table theory declare when people confront an opportunity for gain, they are always quick to exploit it. To apply the invisible hand theory, it is very important for the market to have no barriers to exit or entry. In the long run, the economic profit is pushed toward zero by the allocative function. In a perfectly competitive markt, the economic rent is the part that the payment received is larger than the reservation price. To understand the practical influence of the invisible hand theory over the stock market, we need to be able to calculate the present value of the share. Which equation is PV=M/(1+r)^t, and M stands for maturity value According to the efficient market hypothesis, the current price of stock will reflect all the relevant information about its current and future earnings prospects.
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