Microeconomics: Chapter 1 The Market Economy

Chapter 1 The Market Economy
1.1 Scarcity and Economics
Economics is the study of how people and societies deal with scarcity. Microeconomics focuses on the economic behavior of individual decision-making units, such as households and firms, and how these individual decisions fit together.

The Three Questions
Because of scarcity, every society has to answer three questions.
1. What Is to Be Produced? Resources can be used to produce a variety of products. The value of the most highly valued forgone alternative is the opportunity cost.
2. How Is It to Be Produced? Society must decide which resources to allocate to the production of various commodities.
3. Who Gets the Output? Everyone can’t have everything that they want. The allocation of resources is how society’s resources are divided among the various outputs, among the different organizations that produce these outputs, and among the members of society. This is done by using the market system, a mode of organization in which resource allocation is determined by the independent decisions and actions of individual consumers and producers

1.2 Models
A model is a simplified description of some aspect of the economy, often containing equations and graphs.

1.3 The Workings of a Price System: A Preview
The Circular Flow Model illustrates that economic activity is circular. The inner circle shows the flows of physical goods and services and of inputs through the system. Firms supply goods and services that are demanded by households; households supply inputs that are demanded by businesses. The outer model shows the flows of money. Households spend money on goods and services that flow to businesses as revenues; these revenues flow to households as payments for supplying their inputs. [Image pg. 9]

The Supply and Demand Model
Demand: The demand schedule (or demand curve) is the relation between the market price of a good and the quantity demanded of that good during a given time period, other things (such as income, tastes, and other prices) being the same.

A change in a good’s own price induces a movement along the demand curve, causing a change in quantity demanded. A change in demand refers to a shift of the entire demand schedule (this is caused by changes in income, prices of related goods, or tastes).

Price: The Law of Demand states that price and quantity demanded are inversely related. (The demand curve slopes down.) This means as the price goes up, the quantity demanded goes down.

Income: If an increase in income increases demand, the good is called a normal good. If an increase in income decreases demand, the good is called an inferior good.

Prices of Related Goods: If two goods are substitutes, then as the price of one goes up, the demand for the other goes up (it is substituted for the more-expensive good).  If two goods are complements than as the price of one goes up, the demand for the other goes down (people don’t want to buy the good if they can’t buy its complement).

Tastes: Demand is also affected by the extent to which people “like” a good.

Supply
The supply schedule is the relation between the market price and the amount of a good that producers are willing to supply during a given period of time, all else equal. Supply depends on price, price of inputs, and conditions of production.

A change in supply refers to a shift of the entire supply curve (due to a change in price of inputs or in technology available). A change in quantity supplied refers to a movement along a given supply curve (due to a change in the good’s own price).

Price: In general, the higher the price per item, the greater the quantity that firms are willing to supply.

Price of Inputs: If the cost of inputs goes up, the amount produced goes down.

Conditions of Production: If there is a technological improvement in bread production, the supply increases.

Equilibrium
Equilirium is a state of affairs that will persist because no one has any incentive to change his or her behavior. In the supply and demand model, equilibrium is characterized by the equality of quantity supplied and quantity demanded at a particular price.

Supply and Demand for Inputs
Supply and demand can be used to look at the flow of goods from firms to households, but it can also be used to look at the flow of inputs from households to firms. This can be done by looking at the supply and demand for employees at particular wages.

The Roles of Prices
1. Prices convey information. Prices signify what is relatively scarce and relatively abundant, so prices can efficiently channel production and consumption
2. Prices ration scarce resources. The market rations goods based on a willingness to pay.
3. Prices determine incomes. Your money income depends on the prices of the inputs that you supply to the market. This is determined by supplies and demands of the various inputs.