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1.

0 INTRODUCTION

The strength of microeconomics comes from the simplicity of its underlying structure
and its close touch with the real world. In a nutshell, microeconomics has to do with supply
and demand, and with the way they interact in various markets. Microeconomic analysis moves
easily and painlessly from one topic to another and lies at the centre of most of the recognized
subfields of economics. Labour economics, for example, is built largely on the analysis of the
supply and demand for labour of different types. The field of industrial organization deals with
the different mechanisms (monopoly, cartels, different types of competitive behaviour) by
which goods and services are sold. International economics worries about the demand and
supply of individual traded commodities, as well as of a country’s exports and imports taken
as a whole, and the consequent demand for and supply of foreign exchange. Public finance
looks at how the government enters the scene.

Traditionally, its focus was on taxes, which automatically introduce “wedges”


(differences between the price the buyer pays and the price the seller receives) and cause
inefficiency. More recently, public finance has reached into the expenditure side as well,
attempting to analyse (and sometimes actually to measure) the costs and benefits of various
government outlays and programs. It deals with the costs and benefits of just about anything
government projects, taxes on commodities, taxes on factors of production (corporation income
taxes, payroll taxes), agricultural programs (like price supports and acreage controls), tariffs
on imports, foreign exchange controls, various forms of industrial organization (like monopoly
and oligopoly), and various aspects of labour market behaviour (like minimum wages, the
monopoly power of labour unions, and so on).

It is hard to imagine a basic course in microeconomics failing to include numerous cases


and examples drawn from all the fields listed above. This is because microeconomics is so
basic. It represents the trunk of the tree from which all the listed subfields have branched. At
the root of everything is supply and demand. It is not at all farfetched to think of these as
basically human characteristics. If human beings are not going to be totally self-sufficient, they
will end up producing certain things that they trade to fulfil their demands for other things.

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The specialization of production and the institutions of trade, commerce, and markets
long antedated the science of economics. Indeed, one can fairly say that from the very outset
the science of economics entailed the study of the market forms that arose quite naturally (and
without any help from economists) out of human behaviour. People specialize in what they
think they can do best or more existentially, in what heredity, environment, fate, and their own
volition have brought them to do. They trade their services and/or the products of their
specialization for those produced by others. Markets evolve to organize this sort of trading, and
money evolves to act as a generalized unit of account and to make barter unnecessary.

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2.0 QUESTION ONE

Does a change in consumers’ tastes lead to a movement along the demand curve or a shift in
the demand curve? Does a change in price lead to a movement along the demand curve or a
shift in the demand curve? Explain your answers.

In economic the demand curve is the graph depicting the relationship between the price
of a certain commodity and the amount of it that consumers are willing and able to purchase at
any given price. It is a graphic representation of a market demand schedule. Change in taste
creates a shift in the demand curve. The number of people willing to buy the project at a given
price point has changed. A shift in the demand curve then causes a movement of the location
of where the supply and demand curves cross which is the equilibrium point for that market.
So, we can also say that a the equilibrium point has moved along the demand curve as a result.
But if the supply curve doesn’t change, and the demand curve does change, it’s more accurate
to say the equilibrium point has moved along the supply curve due to a shift in the demand
curve.

The demand curve for all consumers together follows from the demand curve of every
individual consumer: the individual demands at each price are added together, assuming
independent decision-making. A demand schedule and the corresponding curve represent a set
of coordinated points between price and quantity demanded. We infer from observation some
functional form between these points that creates a best fit line known as the demand curve.
The demand curve is the relationship between changes in price and changes in quantity
demanded, assumed to be a negative relationship except with respect to certain theoretical
exceptions (Giffen good, Veblen good). A demand curve explicitly requires that no other
variables which are theoretically related can change except price of that good itself (for clarity
"own price"). When any other factor changes other than its own price (e.g. prices of "related
goods" known are substitutes or compliments, income, preferences or tastes, expectations about
future changes to demand, changes in policy like taxes and subsides, or some other theoretically
related variable) demand is referred to as shifting.

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A "shift" means that the price remains the same and the quantity demanded changes. In other
words, the old coordinated set of points between price and quantity are no longer valid because
some other relevant factor has changed. The demand curve is always shifting because other
variables are always changing. An introductory economics course posits the static nature of
demand in order to build intuition. At the intermediate level where multivariate calculus is
used, the use of partial derivatives also captures this temporary static nature of demand. More
advanced analysis of economic interactions take some general relationships observed
empirically and uses them to talk about general tendencies in the economy.

Economics is as a useful insight is limited by the sophistication of the person using the
tools. The distinction between quantity demanded (own price elasticity of demand) and changes
in other relevant factors (shifts) is part of learning to become sophisticated as a user of
economic analysis. Technology improvements that allow for more efficient processes in the oil
industry will shift the oil supply curve out to the right. Suppliers will be willing and able to
supply more at any given price point, Ceteris Paribus.

If we look at supply and demand graph below, what are the axis? It probably looks something
like this only a change in an axis variable will cause a change along the curve. A movement up
or down the curve. This will be a change in price. A relevant change in non axis variables, will
shift a curve. Technology improvements that allow for more efficient processes in the oil
industry will shift the oil supply curve out to the right. Suppliers will be willing and able to
supply more at any given price point, Ceteris Paribus.

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3.0 QUESTION TWO

Does a change in producers’ technology lead to a movement along the supply curve or a shift in
the sup- ply curve? Does a change in price lead to a movement along the supply curve or a shift in
the supply curve?

A technological change would lead to a shift in supply curve. Only when quantity supplied gets
affected by a change in price of that commodity, movement would happen along the supply
curve. And that’s because by definition supply curve is a graphical representation of quantity
supplied at different price levels of a commodity. As regards to change in supply caused by
factor other than price of the commodity, that would lead to a shift in supply curve.

Like the case that has been mentioned in the question. Technological change. Intuitively, I
would assume a better technology use with time. And this would mean increase in production
and hence increased willingness to supply at each price level by producers which would shift
supply curve to the right. An inferior technology on the other hand would shift the supply curve
leftwards indicating producers are willing to supply less at each price. If production costs
increase, the supplier will face increasing costs for each quantity level. Holding all else the
same, the supply curve would shift inward (to the left), reflecting the increased cost of
production. The supplier will supply less at each quantity level.

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If production costs declined, the opposite would be true. Lower costs would result in an increase in
output, shifting the supply curve outward (to the right) and the supplier will be willing sell a larger
quantity at each price level. The supply curve will shift in relation to technological improvements and
expectations of market behaviour in very much the same way described for production costs.

Technological improvements that result in an increase in production for a set amount of inputs
would result in an outward shift in supply. Supply will shift outward in response to indications
of heightened consumer enthusiasm or preference and will respond by shifting inward if there
is an assessment of a negative impact to production costs or demand.

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4.0 QUESTION THREE

Describe the role of prices in market economies.

Price has the most central roles in a market economy. It is the determinant demand,
supply, and inflation. Let’s just say that price is the heart of market economy. if the price goes
up fast, inflation happens (just like someone's blood pressure shooting through the roof) and if
prices go down, well that’s when there is little certainty in the market and bad things happen
again. If prices are stable with little inflation, then everyone lives happy. In any market, buyers
look at the price when determining how much to demand, and sellers look at the price when
deciding how much to supply. As a result of the decisions that buyers and sellers make, market
prices reflect both the value of a good to society and the cost to society of making the good.
Smith’s great insight was that prices adjust to guide these individual buyers and sellers to reach
outcomes that, in many cases, maximize the well-being of society as a whole In the current
competitive economy, any entities from non-profit to multinational organizations that are
considered as cash cow are in high demand for economic knowledge to survive.

Price acts as a signal for shortages and surpluses which help firms and consumers
respond to changing market conditions. If a good is in shortage price will tend to rise. Rising
prices discourage demand and encourage firms to try and increase supply. If a good is in surplus
price will tend to fall. Falling price encourage people to buy, and cause firms to try and cut
back on supply. Prices help to redistribute resources from goods with little demand to goods
and services which people value more. Below is an Example of how price influences a market.
As the supply of oil falls, the price rises. Price acts as a signalling mechanism to producers
trying to gauge how much product to create, investment to undertake, and inventory to sell and
to consumers trying to determine which products to purchase. When prices are high relative to
costs, profit-seeking suppliers are incentivized to increase production. Consumers on the other
hand are incentivized to find cheaper alternatives. When prices are low relative to costs, profit-
seeking suppliers are then incentivized to decrease production while consumers are
incentivized to increase consumption.

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Together the opposing desires of consumers to buy at low prices and suppliers to sell
at high prices results in a remarkably efficient allocation and utilization of resources. As the
USSR and Communist China witnessed, a market without freely determined prices is sure to
produce only one thing: gross inefficiency. Imagine you buy 10 pens at the cost of 5 each with
the purpose of selling them further. You walk into a room of 50 people, each having different
amount of money with them, who need a pen for some purpose. When you price the pen at 10,
everyone is able and willing to buy it. Since you want to maximise your profit and see the
opportunity, you increase the price to 12, now only 30 people are able to buy it. You decide to
increase your price further to 15. At this price, 20 people are ready to buy the pens. When you
increase your price to 17, 10 people are able to buy it. Now if you go on increasing your price
and take it to 20, only say 6 people will buy your pens. Therefore, you will sell it at 17, where
demand for the pens is equal to supply.

In a similar scenario, where people don’t see as much utility in buying the pen as the
one above, you as a seller will have to reduce the price instead of increasing it to induce them
to buy your pens. As a buyer, no one will spend more than the utility they find from
consumption of the commodity. Similarly, a seller will never sell below the cost price. This
marginal utility and cost price command the price range of the product. And the price at which
quantity demanded is same as quantity supplied, is the equilibrium price, which is also the
market price

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5.0 QUESTION FOUR

Consider the following events: Scientists reveal that eating oranges decreases the risk of
diabetes, and at the same time, farmers use a new fertilizer that makes orange trees produce
more oranges. Illustrate and explain what effect these changes have on the equilibrium price
and quantity of oranges

There will be shifts of both demand and supply. If oranges decrease the risk of diabetes we will
see more people consume oranges. The demand line will shift to the right, independently this
would cause price and quantity to increase. If at the same time, a new fertilizer makes orange
trees more productive this will increase the supply, farmers will be willing to supply more
oranges at all prices. Independently the increase in supply would cause price to fall and quantity
to increase. Taken together, we know with certainty that quantity will increase but we don’t
know what will happen to price.

Demand ↑⇒ P rice ↑ Quantity ↑

Supply ↑⇒ P rice ↓ Quantity ↑

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6.0 CONCLUSION

As a market expands, a natural monopoly can evolve into a competitive market. For
example, when a population is small in a town, the bridge may be a natural monopoly. A single
bridge a satisfy the entire demand for trips across the river at the lowest cost. Yet, as the
population grows, and the bridge becomes more congested, satisfying the entire demand may
require more bridges across the same river. For a monopoly, marginal revenue is lower than
price because a monopoly faces a downward-sloping demand curve. When a monopoly
increases production by one unit, it must reduce the price it charges for every unit it sells, and
this cut in price reduces revenue on the units it was already selling.

The economics of supply and demand has a sort of moral or normative overtone, at least
when it comes to dealing with a wide range of market distortions. In an undistorted market,
buyers pay the market price up to the point where they judge further units not to be worth that
price, while competitive sellers supply added units as long as they can make money on each
increment. At the point where supply just equals demand in an undistorted market, the price
measures both the worth of the product to buyers and the worth of the product to sellers.

That is not so when an artificial distortion intervenes. With a 50 percent tax based on
selling price, an item that costs $1.50 to the buyer is worth only $1.00 to the seller. The tax
creates a wedge, mentioned earlier, between the value to the buyer and the return to the seller.
The anomaly thus created could be eliminated if the distortion were removed; then the market
would find its equilibrium at some price in between (say, $1.20) where the product’s worth
would be the same to buyers and to sellers. Whenever we start with a distortion, we can usually
assert that society as a whole can benefit from its removal. This is epitomized by the fact that

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buyers gain as they get extra units at less than $1.50, while sellers gain as they get to sell extra
units at more than $1.00.

Many different distortions can create similar anomalies. If cotton is subsidized, the
price farmers get will exceed, by the amount of the subsidy, the value to consumers. Society
thus stands to gain by eliminating the subsidy and moving to a price that is the same for both
buyers and sellers. If price controls keep bread (or anything else) artificially cheap, the
predictable result is that less will be supplied than is demanded. Nine times out of ten, the
excess demand will end up being reflected in a gray or black market, whose existence is
probably the clearest evidence that the official price is artificially low. In turn, economists are
nearly always right when they predict that pushing prices down via price controls will end up
reducing the amount supplied and generating black-market prices not only well above the
official price, but also above the market price that would prevail in the absence of controls.

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7.0 REFERENCES

1. Alchian, Armen, and William R. Allen. Exchange and Production. 3d ed. Belmont, Calif.:
Wadsworth, 1983.
2. Colander, David C. Microeconomics. 5th ed. Boston: McGraw-Hill/Irwin, 2004.

3. Friedman, David D. Price Theory: An Intermediate Text. 2d ed. Cincinnati: South-Western,


1990.

4. Hirshleifer, Jack, and David Hirshleifer. Price Theory and Applications.6th ed. Upper
Saddle River, N.J.: Prentice Hall, 1998.

5. Mankiw, N. Gregory. Principles of Microeconomics. 3d ed. Mason, Ohio: Thomson/South-


Western, 2004.

6. Nicholson, Walter. Intermediate Microeconomics and Its Applications. 9th ed. Mason,
Ohio: Thomson/South-Western, 2004.

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