MICROECONOMICS
Dr. Arun Kumar Bairwa
Assistant Professor – Economics
Indian Institute of Management Ranchi
Microeconomics
Microeconomics
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CHAPTER 1
Preliminaries
CHAPTER OUTLINE
1.1 The Themes of
Microeconomics
1.2 What Is a Market?
1.3 Real versus Nominal
Prices
1.4 Why Study
Microeconomics?
Prepared by:
Fernando Quijano, Illustrator
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● microeconomics Branch of economics that deals with the behavior of
individual economic units—consumers, firms, workers, and investors—as well
as the markets that these units comprise.
● macroeconomics Branch of economics that deals with aggregate
economic variables, such as the level and growth rate of national output,
interest rates, unemployment, and inflation.
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1.1 The Themes of Microeconomics
Trade-Offs
CONSUMERS
Consumers have limited incomes, which can be spent on a wide variety of
goods and services, or saved for the future.
WORKERS
Workers also face constraints and make trade-offs. First, people must decide
whether and when to enter the workforce. Second, workers face trade-offs in
their choice of employment. Finally, workers must sometimes decide how many
hours per week they wish to work, thereby trading off labor for leisure.
FIRMS
Firms also face limits in terms of the kinds of products that they can produce,
and the resources available to produce them.
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Prices and Markets
Microeconomics describes how prices are determined.
In a centrally planned economy, prices are set by the government.
In a market economy, prices are determined by the interactions of consumers,
workers, and firms. These interactions occur in markets—collections of buyers
and sellers that together determine the price of a good.
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Theories and Models
In economics, explanation and prediction are based on theories. Theories are
developed to explain observed phenomena in terms of a set of basic rules and
assumptions.
A model is a mathematical representation, based on economic theory, of a
firm, a market, or some other entity.
Positive versus Normative Analysis
● positive analysis Analysis describing relationships of cause and effect.
● normative analysis Analysis examining questions of what ought to be.
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1.2 What Is a Market?
● market Collection of buyers and sellers that, through their actual or
potential interactions, determine the price of a product or set of products.
● market definition Determination of the buyers, sellers, and range of
products that should be included in a particular market.
● arbitrage Practice of buying at a low price at one location and selling at a
higher price in another.
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Competitive versus Noncompetitive Markets
● perfectly competitive market Market with many buyers and sellers, so
that no single buyer or seller has a significant impact on price.
Many other markets are competitive enough to be treated as if they were
perfectly competitive.
Other markets containing a small number of producers may still be treated as
competitive for purposes of analysis.
Finally, some markets contain many producers but are noncompetitive; that is,
individual firms can jointly affect the price.
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Market Price
● market price Price prevailing in a competitive market.
In markets that are not perfectly competitive, different firms might charge
different prices for the same product. This might happen because one firm is
trying to win customers from its competitors, or because customers have brand
loyalties that allow some firms to charge higher prices than others.
The market prices of most goods will fluctuate over time, and for many goods
the fluctuations can be rapid. This is particularly true for goods sold in
competitive markets.
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Market Definition—The Extent of a Market
● extent of a market Boundaries of a market, both geographical and in terms
of range of products produced and sold within it.
For some goods, it makes sense to talk about a market only in terms of very
restrictive geographic boundaries.
We must also think carefully about the range of products to include in a market.
Market definition is important for two reasons:
• A company must understand who its actual and potential competitors are for
the various products that it sells or might sell in the future.
• Market definition can be important for public policy decisions.
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EXAMPLE 1.1 THE MARKET FOR SWEETENERS
In 1990, the Archer-Daniels-Midland Company (ADM) acquired the Clinton Corn
Processing Company (CCP).
The U.S. Department of Justice (DOJ) challenged the acquisition on the grounds that it
would lead to a dominant producer of corn syrup with the power to push prices above
competitive levels.
ADM fought the DOJ decision, and the case went to court. The basic issue was whether
corn syrup represented a distinct market.
ADM argued that sugar and corn syrup should be considered part of the same market
because they are used interchangeably to sweeten a vast array of food products.
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EXAMPLE 1.2 A BICYCLE IS A BICYCLE. OR IS IT?
There are actually two different markets for bicycles,
markets that can be identified by the type of store in
which the bicycle is sold.
TABLE 1.1 MARKETS FOR BICYCLES
TYPE OF BICYCLE COMPANIES AND PRICES (2011)
Mass Market Bicycles: Huffy: $90—$140
Sold by mass merchandisers Schwinn: $140—$240
such as Target, Wal-Mart, Mantis: $129—$140
Kmart, and Sears. Mongoose: $120—$280
Dealer Bicycles: Sold by Trek: $400—$2500
bicycle dealers – stores that Cannondale: $500—$2000
sell only (or mostly) bicycles Giant: $500—$2500
and bicycle equipment. Gary Fisher: $600—$2000
Mongoose: $700—$2000
Ridley: $1300—$2500
Scott: $1000—$3000
Ibis: $2000 and up
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1.3 Real versus Nominal Prices
● nominal price Absolute price of a good, unadjusted for inflation.
● real price Price of a good relative to an aggregate measure of prices; price
adjusted for inflation.
● Consumer Price Index Measure of the aggregate price level.
● Producer Price Index Measure of the aggregate price level for
intermediate products and wholesale goods.
After correcting for inflation, do we find that the price of butter was more
expensive in 2010 than in 1970? To find out, let’s calculate the 2010 price of
butter in terms of 1970 dollars. The CPI was 38.8 in 1970 and rose to about
218.1 in 2010. (There was considerable inflation in the United States during the
1970s and early 1980s.) In 1970 dollars, the price of butter was
•38.8
× $ 3.42=$ 0.61
218.1
In real terms, therefore, the price of butter was lower in 2010 than it was in 1970.
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EXAMPLE 1.3 THE PRICE OF EGGS AND THE PRICE OF
A COLLEGE EDUCATION
TABLE 1.2 THE REAL PRICES OF EGGS AND OF A COLLEGE EDUCATION
1970 1980 1990 2000 2010
Consumer Price Index 38.8 82.4 130.7 172.2 218.1
Nominal Prices
Grade A Large Eggs $0.61 $0.84 $1.01 $0.91 $1.54
College Education $2,112 $3,502 $7,619 $12,976 $21,550
Real Prices ($1970)
Grade A Large Eggs $0.61 $0.40 $0.30 $0.21 $0.27
College Education $2,112 $1,649 $2,262 $2,924 $3,835
The real prices of eggs in 1970 dollars is calculated as follows:
• CPI1970 38.8
Real price of eggs in 1980= × nominal price in 1980= ×0.84=0.40
CPI1990 82.4
• CPI1970 38.8
Real price of eggs in 1990= × nominal price in 1990= ×1.01=0.30
CPI1990 130.7
While the nominal price of eggs rose during these years, the real price of eggs
actually fell.
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EXAMPLE 1.3 THE PRICE OF EGGS AND THE PRICE OF
A COLLEGE EDUCATION
TABLE 1.2 THE REAL PRICES OF EGGS AND OF A COLLEGE EDUCATION
1970 1980 1990 2000 2010
Consumer Price Index 38.8 82.4 130.7 172.2 218.1
Nominal Prices
Grade A Large Eggs $0.61 $0.84 $1.01 $0.91 $1.54
College Education $2,112 $3,502 $7,619 $12,976 $21,550
Real Prices ($1970)
Grade A Large Eggs $0.61 $0.40 $0.30 $0.21 $0.27
College Education $2,112 $1,649 $2,262 $2,924 $3,835
The real prices of eggs in 1990 dollars is calculated as follows:
• CPI1990 130.7
Real price of eggs in 1970= × nominal price in 1970= ×0.61=2.05
CPI1970 38.8
• CPI1990 130.7
Real price of eggs in 2010= × nominal price in 2010= ×1.54=0.92
CPI2010 218.1
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EXAMPLE 1.3 THE PRICE OF EGGS AND THE PRICE OF
A COLLEGE EDUCATION
TABLE 1.2 THE REAL PRICES OF EGGS AND OF A COLLEGE EDUCATION
1970 1980 1990 2000 2010
Consumer Price Index 38.8 82.4 130.7 172.2 218.1
Nominal Prices
Grade A Large Eggs $0.61 $0.84 $1.01 $0.91 $1.54
College Education $2,112 $3,502 $7,619 $12,976 $21,550
Real Prices ($1970)
Grade A Large Eggs $0.61 $0.40 $0.30 $0.21 $0.27
College Education $2,112 $1,649 $2,262 $2,924 $3,835
The percentage change in real price is calculated as follows:
• real price in 2010− real price in 1970
Percentage change in real price=
real price in 1970
• 0.92 − 2.05
¿ =−0.55
2.05
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EXAMPLE 1.4 THE MINIMUM WAGE
FIGURE 1.1
THE MINIMUM WAGE
In nominal terms, the minimum wage has increased steadily over the past 70 years.
However, in real terms its expected 2010 level is below that of the 1970s.
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1.4 Why Study Microeconomics?
Corporate Decision Making: The Toyota Prius
Hybrid cars are more energy efficient than cars with just a gasoline engine; the
Prius, for example, can get 45 to 55 miles per gallon. The Prius was a big
success, and within a few years other manufacturers began introducing hybrid
versions of some of their cars.
The design and efficient production of the Prius involved not only some
impressive engineering, but a lot of economics as well.
First, Toyota had to think carefully about how the public would react to the
design and performance of this new product.
Next, Toyota had to be concerned with the cost of manufacturing these cars.
Finally, Toyota had to think about its relationship to the government and the
effects of regulatory policies.
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Public Policy Design: Fuel Efficiency Standards for
the Twenty-First Century
In 1975, the U.S. government imposed regulations designed to improve the
average fuel economy of domestically-sold cars and light trucks. The CAFE
(Corporate Average Fuel Economy) standards have become increasingly
stringent over the years.
A number of important decisions have to be made when designing a fuel
efficiency program, and most of those decisions involve economics.
First, the government must evaluate the monetary impact of the program on
consumers.
Before imposing CAFE standards, it is important to estimate the likely impact
those standards will have on the cost of producing cars and light truck.
The government must also ask why problems related to oil consumption are
not solved by our market-oriented economy.
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