Microeconomics

1. Institute of Economic Theories - University of Miskolc Microeconomics University of Miskolc Faculty of Economics Institute of Economic Theory and Methodology 2018/19

2. Microeconomics IntroductionDemand, supply, market equilibrium Institute of Economic Theories - University of Miskolc

3. Four main reasons to study economics: • to learn a way of thinking, • to understand society, • to understand global affairs, and • to be an informed voter. The nature and scope of economics Economics is a social science which seeks to explain the economic basis of human societies. Economics deals with the decision alternatives of economic actors and with the social consequences of each decision.

4. Cause of decision: necessity ≠ possibility Necessity:need for the consumption and use of goods and services, which appears as a lack. Need:Needand necessity are not the same concepts. Needs may include desires as well, which cannot be satisfied under existing economic conditions. Possibilities:are resources, which are available for satisfying needs. Possibilities in economics are determined byeconomicresources. NECESSITY > POSSIBILITY almost limited unlimited scarce

5. Economics=science of choices and decisions Economics is the study of howscarce resources are allocated among competing uses. Basic questions: What to produce How we produce it For whom to produce

6. To learn a way of thinking • Opportunity cost: The best alternative that we forgo, or give up, when we make a choice or a decision. • Marginalism: The process of analyzing the additional or incremental costs or benefits arising from a choice or decision.

7. Place of economics in the system of sciences Main aspects for the classifications of sciences: According to verification logical, empirical (e.g. economics). According to topic nature, society (e.g. economics). According to function theoretical (e.g. microeconomics, macroeconomics and international economics), applied: - functional (e.g. finance), - sectorial (e.g. industrial economics). According to relationship with politics normative positive economics

8. Levels: Microeconomics analyses the individual decision alternatives of the economic actors (consumers, firms, workers, and investors) Macroeconomics analyses the economy as an aggregate, on national economy level. (the level and growth rate of national output, interestrates, unemployment, and inflation.) International economics analyses causes and effects of real and financial relationships between national economies.

9. Most important methods of economics Measurement:Itmeansthe description of processes, drawing conclusions, generally aimed at quantification. Modelling: Models show the most typical features and working mechanisms of economic processes using an analogy in a different medium.Simplified representations of the real world.Economic models attempt to focus on what is relevant to the problem at hand and omit what is not. Assumptions:The set of circumstances in which a model is applicable. Every model, or theory, must be based on a set of assumptions. Ceteris paribusassumption(all else equal)A device used to analyze the relationship between two variables while the values of other variables are held unchanged. Analysis, testing and evaluation.

10. The market System of exchange relationships between potentialbuyers and sellers. The area where buyers and sellers meet, where the exchange happens. Market actors: Buyers Sellers Features of the market A democratic institute, Measurement by equal standards, Competition, concurrence, Participants depend on each other.

11. According to market characters market of goods, market of labour, money and capital market. According to market area local, national , international or world market. According to market formations free trade where norms are established norm-follower market, which is not a perfectly competitive market

12. Modelling the market D= demand function: shows the quantities demanded by the buyers belonging to different prices and a given income. Formula: D = f / P / S= supply function: shows the quantities offered by producers for selling at different prices. Formula: S = f / P /

13. Deducting the market demand curve Conditions of the model Income is given and will not change at the beginning, Market price influences the demanded quantities; price and quantity are in inverse relationship, We examine the demand of one product and of one /ordinary/ consumer, We assume that the consumer will raise his purchases by one unit as the price falls. Price, P Quantity, Q P1 P2 D Q2 Q1

14. Deducting the market supply curve Conditions the quantity to be sold is given, the owners are not willing to sell their products at any price, we analyse the market supply of one product at first. Price, P S Quantity, Q P2 P1 Q1 Q2

15. Conclusions Market supply can be modelled in the dimension of the quantity of one product and the price. Supply function can be used to model the aggregate market supply as well. Between the market price and the quantity to be sold there is a direct proportionality as far as normal goods are concerned. An individual’s demand for a product and the market demand for a group of products and their relationship with the price can be modelled by the demand function. We assume a continuous change of the price, and that a demanded quantity belongs to every price, which results in a continuous demand curve, The function shows an inverse proportionality between the changing of the price and the demanded quantities as far as normal goods are concerned. If the consumer’s income changes, we will arrive at another demand function.

16. Market equilibriumModel of the market’s working mechanism In a market in the state of oversupply the equilibrium will be established by a fall in the market price. In a market in the state of excess demand the equilibrium will be established by an increase in the market price. Price, P Excess supply S P* P2 D Excess demand Q* Quantity, Q P1

17. The price’srole in the market’s working mechanism orientation of market actors, provides buyers with information about the price ratios of substituting products, inspires market actors to rational decision-making, keeps the market moving.

18. A variety of other factors may change the entire price–quantity relationship: Consumers’ income Prices of related goods (Substitutes and complements) Tastes and preferences Expectations about future prices The number of consumers in the market Factors that affect the supply of a good: Prices of inputs (such as wages) Technology Natural disruptions (such as bad weather) The number of firms in the market Expectations Government policies Shifts of the demand and supply curves

19. Changes in the market resulting from an increase (decrease) of demandby an unchanged supply function the equilibrium price will rise (fall), producers’ income will rise (fall), buyers’ expense will rise (fall) considering the product. By an increase in supply and an unchanged demand the new market equilibrium price will be established at a lower price, by a decrease in supply and an unchanged demand the new market equilibrium price will be established at a higher price.

20. Price, P a b D Q1 Q2 Quantity, Q Geometry of Consumer Surplus • It measures the amount a consumer gains from apurchase by the difference between the price he actually pays and the price he would have been willing to pay. • It can be derived from the market demand curve. P1 P2

21. Institute Of Economic Theories - University Of Miskolc - Hungary Microeconomics Consumers’ behaviour (utility, elasticity)

22. The analyses of consumers’ behaviour • Behaviour of households is a synonym to consumers’ behaviour • Household: A collective of cohabiting people, who make own decisions according to some order and tolerate the consequences together. • The decisionsareinfluencedby: • Preferences • Income • Price

23. Consumers’ decisions • The goal: To maximize the satisfaction of needsmaximisation of utility. • Utility: the satisfaction derived from a consumption of a good. • The cardinalutilityanalysis: • The consumer is able to measure the utility in cardinal numbers. • Goods are comparable. • The utility of some goods is not a function of another good’s utility.

24. Total Utility (TU) Total utility (TU): The whole utility feeling gained by consuming a given amount of goods. U Fullness point X 1 2 3 4 5

25. Marginal utility (MU) Marginal utility (MU): The change in the utility resulting from the consumption of a subsequent piece of goods.

26. Caracteristics of Utility • The more consumed quantity is, the more total utility is • The contribution of all the pieces of goods to the total utility shows diminishing tendency in the order of consumption.  Hypothesis of diminishing marginal utility = Gossen’s First Rule • At a point fullness occurs, after consuming a number of products, the total utility is not growing, but decreasing • At the Fullness Point TU is at the maximum and MU=0

27. The optimum of consumption • In case of one good: until the fullness point • In case of 2 goods Theory of Equalization of Utilities Optimal consumption: MUx = MUy

28. Analysis of consumers’ preferencesAxioms of preference ordering • Completeness: any 2 consumption bundles can be compared with each other • Reflexivity: the consumer can identify the consumption bundles and their utility • Transitivity : if utilityA>utilityB and utilityB>utilityC then utilityA >utilityC

29. Indifference curves • An indifference curve represents the points of those consumption bundles in the system of coordinates of two goods, which have the same utilities and they ensure the same consumption/utility level. • The indifference/preference map shows all the indifference curves in this system of coordinates. It represents the consumer’s preference ordering system.

30. Illustration of indifference curves

31. Characteristics of indifference curves • One can not intersect the other, • Drawing away from the origin the indifference curves represent higher utility levels, • The slope is always negative, • The normal indifference curves are convex to the origin.

32. Irregular indifference curves Perfect substitutes Neutral goods Goods with fullness point or harmful goods Perfect complements

33. Rate of Substitution • Rate of Substitution (RS): Represents the ratio of changing quantities of “x” for “y”, or the slope of the chord between two points (“A” and “B”) of the indifference curve. It means:

34. Marginal Rate of Substitution (MRS) • Marginal Rate of Substitution (MRS): Shows the rate atwhichtheconsumer is justwillingtosubstituteonegood(x) foranother (y), notchanginghis Total Utility It is the slope of the curve in a tangential point (“A” or “B”). Y A B C U RS MRS X

35. The budget constraint • Consumption bundles: a combination of goods or services that a consumer typically buys together • The budgetconstraintmeans the points that represent those goods combinations, which are still purchasable in the coordination system of – ordinary two – goods and the money runs out fully.

36. The budget line • Recomposing: • The slope of the curve: Y I/Py I (budget line) I/Px X

37. Change in the income of consumersThe line moves parallel, the slope will not change. Y I : original income I1: increasing income I2: decreasing income I1/Py I/Py I2/Py I1 I2 I I2/Px I1/Px X I/Px

38. Change in the prices of thegoodsTherewill be achange in the slope of the budget line Y I : original price I1: decreased price of good x (Px1) I2: increased price of good x (Px2) I/Py I1 I2 I I/Px2 I/Px I/Px1 X

39. The consumer’s optimal choice Gossen’s Second Rule Point B is the optimal combination of the two goods Y max=I/Py A B U2 C U1 I X max=I/Px

40. The changes of income and the optimal consumption • Conditions of examination: • Unchanged preference systems • Unchanged prices • Changing income

42. Income consumption curve (ICC) and the Engel curve • ICC curve: represents the points which show the connection between the changing income and the optimal consumption in a two-goods coordination system. • Engel curve:shows the connection between the consumer’s income and the consumption of a good x.

43. Increasing income optimal consumption is on those indifference curves that represent higher and higher utility level. • Normal goods: slope of both ICC and Engel curve is positive

44. The relation among the consumption of inferior good and the changing income

45. Inferior goods • Inferior good: the consumption of which is decreasing as the income raises. • The consumer gets on higher utility level, but the inferior good’s consumption becomes less and less. • The steepness of ICC and of Engel curve is negative

46. The relation among changing prices and demand • The conditions of examination: • Unchanged preference system • Unchanged income • Only one good’s price is changing, the others are not.

48. Price Consumption Curve (PCC) • PCC : represents the points of changing consumption in the case of changing price in the two goods coordination system • Normalgoods: increasingprice of x, decreasingconsumed amount of x. • Influence of changingprice (Px)ontheotherproduct decreasingPx, the consumed amount of good y: • can be increasing if the goods are substitutes. • can be decreasing if the goods are complements. • If a price raises, the consumption gets on an indifference curve which represents lower utility level.

49. Individual demand curve • Individual demand curve: points which show the connection between the changing price and consumption of the good x. • The slope of the demand curve is negative in the case of normal goods so if the price is increasing, demand is decreasing • BUT!! If the slope of the demand curve is positive PARADOX PRICE EFFECT

50. Paradox price-effect • Quality-effect: higher quality=higher price. • Speculative-effect: If the prices are increasing, we count on a further increase, so we will buy more. • Veblen-effect: the prestige goods • Giffen-effect: The demand of good x will be higher in spite of increasing price, if the price of the substitute product is increasing more.