19. Microeconomics

Question 1

What is microeconomics?

Answer 1

Deals with price and cost of manufacturing goods, and the reactions of suppliers and customers.

Question 2

What affects the position and slope of the price against quantity demand curve?

Answer 2

• Price of goods
• Consumers income
• Substitutes and complements
• Fashion and taste
• Essential vs luxury (price doesn’t affect demand as much for essential goods compared to luxury goods)
• Expectation of future price changes (consumers thinking price will rise soon causes higher demand)

Question 3

What does elastic demand mean?

Answer 3

When small prices changes cause large change in demand.

Question 4

What does inelastic demand mean?

Answer 4

When change in price has relatively little effect on demand.

Question 5

What is the price elasticity of demand defined as?

Answer 5

The proportional (or percentage) change in demand ÷ The proportional (or percentage) change in price

Question 6

What does a price elasticity of demand greater than 1 indicate?

Answer 6

That a relatively small change in price will cause a relatively large change in demand (elastic)

Question 7

What does a price elasticity of demand less than 1 indicate?

Answer 7

That a relatively small change in price will cause a relatively small change in demand (inelastic)

Question 8

What does a price elasticity of demand equal to 1 indicate?

Answer 8

That revenue will be constant if price is changed slightly.

Question 9

What are the two approaches to calculate elasticity?

Answer 9

• Arc elasticity
• Point elasticity

Question 10

How do you calculate elasticity using point elasticity?

Answer 10

This uses the starting price as our basis point.

For this example, price starts at P1 and moves to P2, while quantity starts at Q1 and ends at Q2:
- Find absolute change in price P2-P1
- Use this to find proportionate change in price absolute change ÷ P1
- Do the above steps for quantity (Q2-Q1) ÷ Q1
- Convert both decimals to positive if they are negative
- Divide proportionate change in quantity by proportionate change in price ((Q2-Q1)÷Q1)÷((P2-P1)÷P1)
- The result is the price elasticity of demand

Question 11

How do you calculate elasticity using arc elasticity?

Answer 11

This uses the mid point between two quantities as our basis point.

For this example, price starts at P1 and moves to P2, while quantity starts at Q1 and ends at Q2:
- Find mid point of price change (P1+P2)÷2
- Use this to find proportionate change in price (P2-P1)÷((P1+P2)÷2)
- Do the above steps for quantity (Q2-Q1)÷((Q1+Q2)÷2)
- Convert both decimals to positive if they are negative
- Divide proportionate change in quantity by proportionate change in price ((Q2-Q1)÷((Q1+Q2)÷2))÷((P2-P1)÷((P1+P2)÷2))
- The result is the price elasticity of demand

Question 12

What is income elasticity of demand?

Answer 12

Measures how demand varies with income

Question 13

What is income elasticity of demand defined as?

Answer 13

Proportional change in demand ÷ Proportional change in income

Question 14

What is a product called if it’s income elasticity of demand is negative?

Answer 14

Inferior goods

Question 15

What are inferior goods?

Answer 15

• Where the income elasticity of demand is negative
• Means people switch to different brands as their income increases

Question 16

What does an inelastic (0 to 1) income elasticity of demand represent?

Answer 16

Necessities

Goods bought when income is low or high

Question 17

What does an elastic (greater than 1) income elasticity of demand represent?

Answer 17

Luxuries

More purchased when income increases

Question 18

What is the relationship of price and quantity (supplied/demanded) in a supply curve compared to demand curve?

Answer 18

Supply curve
- As price increases, supply increases
- Production is ramped up as there are more opportunities for profit when price is high
Demand curve
- As price increases, demand decreases

Profits are only made if the goods produced actually sell, so an equilibrium is reached where demand is matched by supply

Question 19

What is the market price of a product?

Answer 19

The equilibrium point where demand is matched by supply

Question 20

What causes a rightward shift in the demand curve?

Answer 20

• Rise in income
• Rise in price of substitutes
• Rise in expected price of the product
• Reduction in price of complements
• Change in tastes/fashion
• Population increase

Question 21

What does a rightward shift in demand curve represent?

Answer 21

More demand for a product at any given price point

Question 22

What does a rightward shift in supply curve represent?

Answer 22

More products supplied at any given price point

Question 23

What causes a rightward shift in supply curve?

Answer 23

• Fall in production costs
• Fall in price of other goods
• Technology changes
• Subsidies
• Lower tax

Question 24

What are the two types of cost?

Answer 24

• Fixed costs
• Variable costs

Question 25

What are fixed costs?

Answer 25

Costs that don’t vary in short term as production increases

Eg factory rent

Question 26

What are variable costs?

Answer 26

Costs that increase with production volume

Eg labour costs

Question 27

What happens to the average fixed cost (fixed cost per unit) as production costs increase?

Answer 27

Average fixed cost decreases

• Constant fixed costs are spread over more units

Question 28

What happens to average variable cost (variable cost per unit) as production increases?

Answer 28

Goes down initially as it’s more efficient, but goes back up again due to diminishing returns.

Eg machines become more expensive to run at the highest output

Question 29

What is the average total cost?

Answer 29

Sum of averaged fixed cost and average variable cost

Question 30

What is the marginal cost?

Answer 30

The cost of producing one more unit

Always crosses over the minimum point of the average variable cost curve and the average total cost curve

Question 31

What are the types of competition?

Answer 31

Perfect competition
&
**Imperfect competition*”
- Monopolist
- Oligopoly
- Monopolistic competition

Question 32

What is perfect competition?

Answer 32

• Where there are many small buyers and seller
• No buyer or seller is large enough to affect the market
• Free entry and exit from the market

Question 33

What is Monopoly?

Answer 33

• Only one supplier
• They can set price at any level but volume demanded will change

Question 34

What is Oligopoly?

Answer 34

• Small number of suppliers
• If supplier raises price, the others will win market share by sticking to old price
• If supplier lowers price, others have to follow to maintain market share

Question 35

What is Monopolistic competition?

Answer 35

• Firms increase demand using methods other than price
• eg brand and reputation