Introduction to microeconomics

Basic Terms and Definitions

• Economics?

• Oikos – a household, nomos – a rule

• Economics = rules how to manage a household ☺

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Resources are limited; wants are unlimited

Scarcity = not enough resources to produce the goods to satisfy

our wants.

Resources: Adam Smith in his Wealth of Nations (1776)

divided resources into land, labour and capital.

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Opportunity Costs

The cost of the next best use of your time or money

when you choose to do one thing rather than another.
Trade Offs

• Decisions involve tradeoffs. When you make a choice, you give up an opportunity to do
something else.

• The highest-valued alternative you give up is the opportunity cost of your decision.
Diminishing Marginal Utility
Utility describes the usefulness of a product, or amount of satisfaction that
an individual receives from consuming a product.

A product’s overall utility usually increases as more of the product is

consumed. However, as more units of product are consumed, the
satisfaction received from consuming each additional unit declines.

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Industry structure

• Pure competition
• Monopoly
• Duopoly
• Oligopoly
• Monopolistic competition
• Monopsony
Law of Demand
The Law of Demand is an inverse relationship between price and quantity
demanded.

The Law of Demand states that an increase in price causes a decrease in the
quantity demanded. Consumers will buy more at lower prices and buy less at
higher prices. A decrease in price causes an increase in demand. Ceteris paribus.

PJATK 2017/18
Substitution Effect
The substitution effect says that when the price of a good or service rises,
people will buy less of that good in favor of a cheaper substitute.

Consumers have the tendency to substitute a similar, lower priced

product for another product that is relatively more expensive.

Example: the price of steak increases, so many consumers will switch to

chicken, a lower priced substitute.
Law of Supply
The Law of Supply is a direct relationship between price and quantity supplied.

The Law of Supply states that producers will offer more of a product at higher prices
and less of a product at lower prices. Producers supply more goods and services when
they can sell them at higher prices. They will supply fewer goods and services when
they must sell them at lower prices. Ceteris paribus.
Equilibrium
The goal of supply and demand is to reach equilibrium between the two. By
reaching the equilibrium there are exactly enough goods to be sold, at a price the
producers are willing to supply at. All items will be sold, and there will be nothing
left over, nor anyone still demanding the product.

Watch this video for more information: Market Equilibrium

Demand and Supply
Key factors impacting consumers’ demand:
• Wants.
• Income.
• Prices.

Key factors impacting supply:

• Costs of production.
• More firms.
• Investment in capacity.
• The profitability of alternative products.
• Weather.
Price (P) and Demand (D)

•P D ceteris paribus

• Paradoxes:
- Giffen’s paradox
- Veblen’s paradox
Price and demand – Giffen’s paradox
Giffen good – a Giffen good is typically an inferior product
that does not have easily available substitutes, as a result of
which the income effect dominates the substitution effect.
Price increase does not reduce demand.
Price and demad –Veblen’s goods

Veblen good – A veblen good is a good for which demand increases

as the price increases, because of its exclusive nature and appeal
as a status symbol.

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Price Elasticity of Demand Edp

Edp Measures the responsiveness of quantity

demanded to changes in price.

Edp – in most cases NEGATIVE

% change in quantity demanded

price elasticity of demand =
% change in price

The Big Idea: A small increase in price may actually cut profit. For
example, a pizza shop sells 500 pizzas at $10 each. But when they
increase the price to $12.50 they only sell 300.

(500x10=$5000 or 300x12.50= $3750)

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 Characteristics:
Edp approaches infinity, demand is perfectly elastic. Consumers are very sensitive
to price change (pure competition).

Edp > 1, demand is elastic. Consumers are relatively responsive to price changes.

Edp = 1, demand is unit elastic. Consumers’ response and price change are in
same proportion.

Edp < 1, demand is inelastic. Consumers are relatively unresponsive to price

changes.

Edp approaches 0, demand is perfectly inelastic. Consumers are very insensitive

to price change e.g. lack of substitutes (rare, life saving medicine).
Cross-price elasticity of demand Edx(py)

A measure of the response of the quantity of one good demanded to

a change in the price of another good.

% change in quantity of Y demanded

cross - price elasticity of demand =
% change in price of X
Cross-price elasticity of demand

1. Complementary goods (compulsory insurance and car)

Edx(py) – negative
Insurance price ceteris paribus
Demand for cars
Cross-price elasticity of demand

2. Substitutes (butter and margarine)

Edx(py) – positive
Butter price ,ceteris paribus
Demad for margarine
Income Elasticity of Demand Edi
Edi A measure of the responsiveness of demand to changes in
income.

% change in quantity demanded

income elasticity of demand =
% change in income
 Income Elasticity of Demand

An example of a product with positive income elasticity could be Ferraris. Let's say
the economy is booming and everyone's income rises by 400%. Because people
have extra money, the quantity of Ferraris demanded increases by 15%.

We can use the formula to figure out the income elasticity for this Italian sports car:

Edi = 15% / 400% = 0.0375

Income Elasticity of Demand

Normal goods (positive value):

Edi > 0 These are goods whose consumption increases with an increase in income.

Necessitiy goods: These are goods whose consumption increases an amount smaller than an
increase in income.
0 < Edi < 1

Luxury goods: These are goods whose consumption increases an amount larger than an increase
in income.
Edi > 1
 Income Elasticity of Demand

Inferior goods (negative value): These are goods which consumption

decreases with an increase in income.

Edi < 0
Control
Control - definition

• Control: regulation of organizational activities in such a way as to facilitate goal

attainment.

• Regulating organizational activities so that targeted elements of performance

remain within acceptable limits.
 Control – basic definitions

Control – the last basic management function

Control = a means
Control = goal in itself
Control – an important element of the managerial feedback.

The aim of control: to find out if and to what extent there have appeared
deviations from the desired state
Levels of Control

Strategic control
Levels of control
Operations control – focuses on the process that the organization uses to transform resources
into products or services (e.g. quality control)

Financial control – concerned with the organization’s financial resources

Structural control – concerned with how the elements of the organization’s structure are
serving their intended purpose (administrative staff vs. core staff)

Strategic control – focuses on how effectively the organization’s strategies are succeeding in
the helping the organization meet its goals
Balanced Scorecard (Kaplan and Norton)

Source: (Kaplan and Norton, 1996)

The Balanced Scorecard - Example