1. 1 Microeconomics Jan Fábry University of Economics Prague http://nb.vse.cz/~fabry ___________________________________________________________________________ ___________________________________________________________________________ This project is co-financed by the European Union

2. 2 Literature ___________________________________________________________________________ ___________________________________________________________________________ This project is co-financed by the European Union Samuelson, P., Nordhaus, W.D. Economics. Samuelson, P., Nordhaus, W.D. Economics. Mankiw, N.G. Principles of Microeconomics. www.swlearning.com/economics/mankiw/ mankiw3e/powerpoint_micro.html Mankiw, N.G. Principles of Microeconomics. www.swlearning.com/economics/mankiw/ mankiw3e/powerpoint_micro.html Collander, D. Microeconomics. Collander, D. Microeconomics.

3. 3 Course Information ___________________________________________________________________________ ___________________________________________________________________________ This project is co-financed by the European Union Test in the middle of the course – at least 50% Test in the middle of the course – at least 50% Final Test – at least 50% Final Test – at least 50% Presence – at least 60% Presence – at least 60%

4. 4 Part 1 ___________________________________________________________________________ ___________________________________________________________________________ This project is co-financed by the European Union Introduction into Economics Introduction into Economics Macroeconomics & Microeconomics Macroeconomics & Microeconomics Firm, Consumer, Market Firm, Consumer, Market Optimization & Equilibrium Optimization & Equilibrium Consumer Preferences Consumer Preferences Utility, Consumer Surplus Utility, Consumer Surplus Indifference Curves, Marginal Rate of Substitution Indifference Curves, Marginal Rate of Substitution Budget Constraint Budget Constraint Consumer Optimum Consumer Optimum Individual Demand Individual Demand Market Demand Market Demand

5. 5 Economics ___________________________________________________________________________ ___________________________________________________________________________ This project is co-financed by the European Union Economics is the study of how people use their limited resources to satisfy unlimited wants Scarcity is a lack of available resources to satisfy all their desired uses

6. 6 Economics ___________________________________________________________________________ ___________________________________________________________________________ This project is co-financed by the European Union Positive economics is the study of “what is” in economic matters Normative economics is the study of “what should be” in economic matters objective subjective descriptive analysis prescriptive analysis

7. 7 Economics ___________________________________________________________________________ ___________________________________________________________________________ This project is co-financed by the European Union Macroeconomics is the branch of economics that examines and explains the economy as a whole, i.e. in aggregate values Microeconomics is the part of economics that examines individual decisions and particular markets

8. 8 Microeconomics ___________________________________________________________________________ ___________________________________________________________________________ This project is co-financed by the European Union Firm Production Supply of Goods and Services Demand for Inputs Consumer Consumption Preferences Demand for Goods and Services Supply of Labour MarketProduct Supply Demand Price

9. 9 Market ___________________________________________________________________________ ___________________________________________________________________________ This project is co-financed by the European Union Competitive Market Large number of buyers or sellers Large number of buyers or sellers No individual subject can influence the price Noncompetitive Market Small number of sellers Individual subject can influence the price

10. 10 Opportunity Cost ___________________________________________________________________________ ___________________________________________________________________________ This project is co-financed by the European Union The cost of a choice stated in terms of the value of other goods or services that must be given up

11. 11 Microeconomic Analysis ___________________________________________________________________________ ___________________________________________________________________________ This project is co-financed by the European Union Mathematical tools and models Best decision of the subject Optimum Equilibrium Simplification of the reality Interaction of subjects at the markets

12. 12 Optimization ___________________________________________________________________________ ___________________________________________________________________________ This project is co-financed by the European Union Producer Consumer Maximization of the profit, revenue Income Limited resources & demand Technology Budget Minimization of the cost Maximization of the utility Preferences

13. 13 Equilibrium ___________________________________________________________________________ ___________________________________________________________________________ This project is co-financed by the European Union Interaction of sellers & buyers Supply & demand Particular market Equilibrium price & quantity

14. 14 Equilibrium - computing ___________________________________________________________________________ ___________________________________________________________________________ This project is co-financed by the European Union Example Q P a b a -b d c E P E Q dQcplyP S  )(sup bQademandP D  )( Q E – Equilibrium Quantity P E – Equilibrium Price

15. 15 Equilibrium, surplus and shortage ___________________________________________________________________________ ___________________________________________________________________________ This project is co-financed by the European Union Example demandP D )( Q P E P E Q plyP S )(sup Q D =Q S equilibrium Q S <Q D shortage surplus Q D <Q S

16. 16 Equilibrium - computing ___________________________________________________________________________ ___________________________________________________________________________ This project is co-financed by the European Union Example: P S = 10 + Q P D = 20 – 4Q Calculate 1)the equilibrium price 2)the equilibrium quantity 3)the surplus, if the price floor fixed by government is 14 CZK. The price floor – the minimum of the price fixed by government The price ceiling – the maximum a seller may charge for a product

17. 17 Equilibrium - computing ___________________________________________________________________________ ___________________________________________________________________________ This project is co-financed by the European Union Solution P S = 10 + Q P D = 20 – 4Q Eguilibrium: P S = P D 10 + Q = 20 – 4Q 10 + Q = 20 – 4Q P = 12 CZK Q = 2 units P = 12 CZK Q = 2 units Q P 12  E P 2  E Q QP S  10 QP D 420  1) and 2)

18. 18 Equilibrium - computing ___________________________________________________________________________ ___________________________________________________________________________ This project is co-financed by the European Union 3) the surplus, if the price floor fixed by government is 14 Czech crowns P S = 10 + Q S P D = 20 – 4Q D P S =P D = 14 CZK P S = P D = 14 CZK S  S 14 = 10 + Q S  Q S = 4 D  D 14 = 20 – 4Q D  Q D = 3/2 SD Surplus: Q S -Q D = 4- 3/2= 5/2 Q P 12  E P 2  E Q QP S  10 QP D 420  P f =14

19. 19 Consumer Theory ___________________________________________________________________________ ___________________________________________________________________________ This project is co-financed by the European Union 3. Consumer Optimum 2. Budget Constraints 4. Individual and Market Demand 1. Consumer Preferences

20. 20 Consumer Preferences ___________________________________________________________________________ ___________________________________________________________________________ This project is co-financed by the European Union Utility Consumption of a normal good brings utility Cardinal theory Utility can be measured Ordinal theory Utility cannot be measured but compared

21. 21 Consumer Preferences - cardinal theory ___________________________________________________________________________ ___________________________________________________________________________ This project is co-financed by the European Union Example – beer consumption Marginal Utility measures the additional satisfaction obtained from consuming one additional unit of a good

22. 22 Consumer Preferences - cardinal theory ___________________________________________________________________________ ___________________________________________________________________________ This project is co-financed by the European Union Example – beer consumption Marginal Utility is diminishing MU 90 70 50 30 10 -10 -30 -50 -70

23. 23 Consumer Preferences - cardinal theory ___________________________________________________________________________ ___________________________________________________________________________ This project is co-financed by the European Union Example – beer consumption

24. 24 Consumer Preferences - cardinal theory ___________________________________________________________________________ ___________________________________________________________________________ This project is co-financed by the European Union Maximization of Total Utility MU=0 Consumer Optimum MU=P Consumer does not want to pay more or less for additional unit of good than such unit brings him in utility.

25. 25 Consumer Preferences - cardinal theory ___________________________________________________________________________ ___________________________________________________________________________ This project is co-financed by the European Union Example: beer consumption What quantity of beer does indicate the consumer optimum, if the price of beer is 30 CZK? See the previous table of beer consumption. consumer optimum Q=4 MU=P=30 Q=4 MU=P=30 MU 90 70 50 30 10 -10 -30 -50 -70

26. 26 Consumer Preferences - cardinal theory ___________________________________________________________________________ ___________________________________________________________________________ This project is co-financed by the European Union Consumer Surplus Difference between what consumer was willing to pay and really paid (difference between utility and costs).

27. 27 Consumer Preferences - cardinal theory ___________________________________________________________________________ ___________________________________________________________________________ This project is co-financed by the European Union Consumer Surplus MU 1 =90 MU 2 =70 MU 3 =50 MU 4 =30 P=30 Consumer Surplus MU 1 +MU 2 +MU 3 +MU 4 – (X * P X ) 90+70+50+30-4 * 30 =120 Consumer surplus Beer (0,5 l) d MU (P of beer) P*=30 X*=4 P=90 P=70 P=50 4 * 30

28. 28 Consumer Preferences - ordinal theory ___________________________________________________________________________ ___________________________________________________________________________ This project is co-financed by the European Union Market Basket Collection of one or more commodities One market basket can be preferred over another market basket containing a different combination of goods

29. 29 Consumer Preferences - ordinal theory ___________________________________________________________________________ ___________________________________________________________________________ This project is co-financed by the European Union Assumptions 1. Completeness of preferences - A is preferred to B - B is preferred to A - A and B are indifferent 2. Transitiveness (preferences are consistent) - if A is preferred to B and B is preferred to C then A is preferred to C then A is preferred to C 3. Non-satiation - consumer always prefers more of any goods to less

30. 30 Consumer Preferences - ordinal theory ___________________________________________________________________________ ___________________________________________________________________________ This project is co-financed by the European Union Market Basket - Example Food/week Beer/week

31. 31 Consumer Preferences - ordinal theory ___________________________________________________________________________ ___________________________________________________________________________ This project is co-financed by the European Union Market Basket - Example

32. 32 Consumer Preferences - ordinal theory ___________________________________________________________________________ ___________________________________________________________________________ This project is co-financed by the European Union Market Basket - Example Indifference Curve

33. 33 Consumer Preferences - ordinal theory ___________________________________________________________________________ ___________________________________________________________________________ This project is co-financed by the European Union Indifference Curves Indifference curves represent all combinations of market baskets that provide to consumer the same level of satisfaction (utility) Indifference curve is a graph showing combinations of two goods to which a consumer is indifferent Indifference curve is a graph showing combinations of two goods to which a consumer is indifferent

34. 34 Consumer Preferences - ordinal theory ___________________________________________________________________________ ___________________________________________________________________________ This project is co-financed by the European Union Indifference Curves - features 1. An indifference curve slopes downward from left to right (negative slope) - goods – exceptions are bads and neuters U1U1 U3U3 U2U2 X Y X Y X Y U1U1 U2U2 U3U3 U1U1 U2U2 U3U3

35. 35 Consumer Preferences - ordinal theory ___________________________________________________________________________ ___________________________________________________________________________ This project is co-financed by the European Union Indifference Curves - features 2. Indifference curves do not intersect U1U1 U2U2 X Y A B C A and B are indifferent A and C are indifferent NO ! C and B should be indifferent but C is preferred to B

36. 36 Consumer Preferences - ordinal theory ___________________________________________________________________________ ___________________________________________________________________________ This project is co-financed by the European Union Indifference Curves - features 4. The curves are convex When consumers have less and less of one good, they require more of the other good to compensate (corresponding to the law of diminishing marginal utility) 3. There exists an indifference curve through any given point on an indifference map

37. 37 Consumer Preferences - ordinal theory ___________________________________________________________________________ ___________________________________________________________________________ This project is co-financed by the European Union Marginal Rate of Substitution (MRS) MRS quantifies the amount of one commodity a consumer will give up to obtain more of another commodity. MRS is measured by the slope of the indifference curve

38. 38 Consumer Preferences - ordinal theory ___________________________________________________________________________ ___________________________________________________________________________ This project is co-financed by the European Union Marginal Rate of Substitution (MRS) Beer (units per week) MRS is diminishing

39. 39 Consumer Preferences - ordinal theory ___________________________________________________________________________ ___________________________________________________________________________ This project is co-financed by the European Union Beer (units per week) Example: How much of beer is the consumer willing to give up to obtain the second, the third, the fourth and the fifth unit of food?

40. 40 Consumer Preferences - ordinal theory ___________________________________________________________________________ ___________________________________________________________________________ This project is co-financed by the European Union Substitutes and Complements Two commodities are substitutes in case that consumer can use one instead of another (rolls and pigs) Two commodities are complements if consumer consumes one commodity along with another (left and right shoes)

41. 41 Consumer Preferences - ordinal theory ___________________________________________________________________________ ___________________________________________________________________________ This project is co-financed by the European Union Marginal Rate of Substitution (MRS) MRS is constant MRS is 0 or infinity

42. 42 Consumer Preferences - ordinal theory ___________________________________________________________________________ ___________________________________________________________________________ This project is co-financed by the European Union Budget Constraint Budget Constraint limits a consumer's ability to buy unlimited amount of goods and services Budget Line indicates all combinations of two commodities for which total money spent equals total income. Budget Line

43. 43 Consumer Preferences - ordinal theory ___________________________________________________________________________ ___________________________________________________________________________ This project is co-financed by the European Union Budget Constraint The consumer divides his income between the commodities X and Y I … income P X …price of X P Y …price of Y x … amount of X y … amount of Y I = P X. x + P Y. y

44. 44 Consumer Preferences - ordinal theory ___________________________________________________________________________ ___________________________________________________________________________ This project is co-financed by the European Union Budget Constraint - example x = # units of food y = # cans of beer I = 100 USD P beer = 5 USD/can P food = 10 USD/unit 100 = 10x + 5y Beer Food X 20 10 16 26 8

45. 45 Consumer Preferences - ordinal theory ___________________________________________________________________________ ___________________________________________________________________________ This project is co-financed by the European Union Budget Constraint – slope of budget line 100 = 10x + 5y If we sacrifice 2 cans of beer we can buy additional unit of food

46. 46 Consumer Preferences - ordinal theory ___________________________________________________________________________ ___________________________________________________________________________ This project is co-financed by the European Union Budget Constraint – change of income and price 120 = 10x + 5y 100 = 8x + 5y Income increases The price of the good decreases

47. 47 Consumer Preferences - ordinal theory ___________________________________________________________________________ ___________________________________________________________________________ This project is co-financed by the European Union Budget Constraint – change of income and price Example a) Assume there are two goods – T-shirts and skirts. The price of the T-shirt is $4 and the price of the skirt is $10. The income is I= $200. -determine the budget constraint. -determine the slope and the intercepts of the budget line. -graph the budget area. b) Assume that income increases to I= $300. At the same time the price of the T-shirt increases to $10. -determine the equation of the new budget line. -determine the slope and the intercepts of the new budget line. -graph the new budget area.

48. 48 Consumer Preferences - ordinal theory ___________________________________________________________________________ ___________________________________________________________________________ This project is co-financed by the European Union Budget Constraint – change of income and price Solution a) The budget constraint is given by 4x+10y<=200. Thus, the budget line is given by 4x+10y=200. The intercepts are [50,0] and [0,20]. The slope is -Px/Py= - 4/10= -0.4 b) The new budget line is 10x+10y=300. The intercepts are [30,0] and [0,30]. The slope is - Px/Py =-1 T-shirts skirts

49. 49 Consumer Preferences - ordinal theory ___________________________________________________________________________ ___________________________________________________________________________ This project is co-financed by the European Union Consumer Optimum Consumers choose a combination of goods that will maximize the satisfaction they can achieve, given the limited budget available to them The maximizing market basket must satisfy two conditions: 1) It must be located on the budget line 2) It must maximize the utility

50. 50 Consumer Preferences - ordinal theory ___________________________________________________________________________ ___________________________________________________________________________ This project is co-financed by the European Union Consumer Optimum Slope of indifference curve equals slope of budget line.

51. 51 Consumer Preferences - ordinal theory ___________________________________________________________________________ ___________________________________________________________________________ This project is co-financed by the European Union Consumer Optimum Marginal rate of substitution in consumption Marginal rate of substitution in exchange

52. 52 Consumer Preferences - ordinal theory Consumer Optimum Example See the graph with the indifference curve and the budget line. The price of the good X is Px = 20 CZK. Determine a) Income of the consumer. b) Py. c) MRS in the consumer optimum. d) The the equation of the budget line. Y 50 UCUC * X * Y X 40 a)I= Px * X= 20 * 50= 1000 CZK b)Py= I/40=25 CZK c)MRS=Px/Py=20/25=0.8 d)20X+25Y=1000

53. 53 Individual Demand ___________________________________________________________________________ ___________________________________________________________________________ This project is co-financed by the European Union Demand is the amount of a good, which buyers wish to purchase at each conceivable price Individual demand is a demand of one consumer for one good The curve of individual demand is derived from indifference analysis

54. 54 Individual Demand ___________________________________________________________________________ ___________________________________________________________________________ This project is co-financed by the European Union Change of the price of good X  P of food   x of food Assumptions Constant incomeConstant income Constant price of a good YConstant price of a good Y Change of the relevant quantity of good X

55. 55 Individual Demand ___________________________________________________________________________ ___________________________________________________________________________ This project is co-financed by the European Union Change the price of good X P 0  P 1  P 2 Changethe quantity of good X Change the quantity of good X x 0  x 1  x 2 Change of consumer optimum PCC Price – Consumption Curve

56. 56 Individual Demand ___________________________________________________________________________ ___________________________________________________________________________ This project is co-financed by the European Union Individual demand curve (d) graphs the relationship between demanded quantityof a good X and its price P Individual demand curve (d) graphs the relationship between demanded quantity of a good X and its price P X 0 X 0 P 1 X 2 X 2 P 1 P d P

57. 57 Individual Demand ___________________________________________________________________________ ___________________________________________________________________________ This project is co-financed by the European Union The law of demand The more of a good is demanded the lower its price Negative slope of demand curve Q 0 X 0 P 1 X 2 X 2 P 1 P d P

58. 58 Individual Demand ___________________________________________________________________________ ___________________________________________________________________________ This project is co-financed by the European Union Income Effect The price of a good X rises Decrease in real income (real purchasing power) Decrease in demanded quantity of X Substitution Effect The price of a good X rises Increase in relative price of X Decrease in demanded quantity of X Increase in demanded quantity of cheaper good Nominal income is constant !!!!!

59. 59 Individual Demand ___________________________________________________________________________ ___________________________________________________________________________ This project is co-financed by the European Union Increase in nominal income I 1 > I Change of nominal income I d d1d1 Q P d2d2 d  d 1 Decrease in nominal income I 2 < I d  d 2

60. 60 Individual Demand ___________________________________________________________________________ ___________________________________________________________________________ This project is co-financed by the European Union Normal Good A good whose consumption increases with an increase of income Inferior Good A good whose consumption decreases with an increase of income (cheap salami) Necessary good – low sensitivity of demand to changes of nominal income (bread, salt) Luxury good – high sensitivity of demand to changes of nominal income (gold)

61. 61 Individual Demand ___________________________________________________________________________ ___________________________________________________________________________ This project is co-financed by the European Union Independent Goods No significant sensitivity of demand for X when price of Y changes Substitutes Increase in demand for X when price of Y rises Complements Decrease in demand for X when price of Y rises

62. 62 Individual Demand ___________________________________________________________________________ ___________________________________________________________________________ This project is co-financed by the European Union Price elasticity of demand is the percentage change in quantity demanded divided by the percentage change in price The more elastic demand, the more sensitive is the reaction of a consumer to the change in price e PD < 0

63. 63 Individual Demand ___________________________________________________________________________ ___________________________________________________________________________ This project is co-financed by the European Union Q P e PD =-1 d Elastic demand Unit elastic demand Inelastic demand d Q P -1<e PD <0 Q P d e PD <-1 Necessary good How can the consumer react to the change in price ? Luxury good

64. 64 Individual Demand Example: Price elasticity of demand Price Quantity demanded 11 50 50 9100 7200 5300 3400 Specify the range of the demand schedule in which the demand priceis inelastic? Specify the range of the demand schedule in which the demand price is inelastic?

65. 65 Individual Demand Example: Price elasticity of demand Price Quantity demanded Price elasticity of demand 11 50 50 9100-1/0,19=-5,26 7200-1/0,22=-4,55 5300-0,5/0,29=-1,72 3400-0,3/0,4=-0,75 Specify the range of the demand schedule in which the demand priceis inelastic? Specify the range of the demand schedule in which the demand price is inelastic?

66. 66 Individual Demand Example: Price elasticity of demand If a 5% increase in the price of one good results in a decrease of 2% in the quantity demanded of another good, then it can be concluded that the two goods are a)complements b)substitutes c)independent d)normal

67. 67 Individual Demand ___________________________________________________________________________ ___________________________________________________________________________ This project is co-financed by the European Union Perfect elastic demand Perfect inelastic demand Drugs, insulin How can the consumer react to the change in price ? d Q P Q P d ? your homework Goods without substitutes

68. 68 Market Demand ___________________________________________________________________________ ___________________________________________________________________________ This project is co-financed by the European Union Market demand is a sum of all individual demands for one good P X1X1 X2X2 X 1 +X 2 PMPM PMPM P XX D=d 1 +d 2 d1d1 d2d2 Market demand can be derived graphically as horizontal summation of individual demand curves.