Microeconomics Unit 1 - Supply & Demand - MIT

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Microeconomics: Unit 1 – Supply

& Demand | MIT
Patricia Galves Derolle
5-6 minutos
Principles
Economics is the study of choice. Because choices range

over every imaginable aspect of human experience, so
does economics.
Scarcity
Scarcity implies decisions, constrained optimization and

trade-offs.
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Consumers & producers
Models of how both consumers and producers behave,

they’re never precise;
Regarding consumers, the key word for them is wealth, as

they’re constrained by their budget. Consumers tend to
maximize their Utility, but the Utility is subject to a Budget
Constraint (µ), this is called Consumer’s Utility
Maximization.
Concerning Firms, they tend to maximize their profits,

although their profits are subject to consumer’s demand
and also input costs (π), this is called the Firm’s Profit
Maximization.
Fundamental questions of microeconomics
1. What goods and services should be produced?
2. How to produce those goods and services?
3. Who gets the goods and services?
The key word to understand the above questions is PRICE.

Because only after defining the price of goods one can
answer the questions appropriately.
Economics
Theoretical and Empirical Economics: the first build

models to explains the world and the latter are testing
models.
Positive and Normative Economics: the first is how things

really are and the latter is how things should be.
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Supply & Demand
// Demand is how much someone wants something: ↑D↑P
// Supply is how much of it there is to have
Water-diamond paradox (Adam Smith): We can’t live

without water, but it’s OK not to have a diamond. So why’s
the difference in price? You’ve considered only demand
and not supply. In this case, the demand is high, but the
supply is even higher, so the price ends up lower;
As-if principle (Milton Friedman): When you’re playing pool,

you could compute the optimal angles of which to shoot
the ball in order to get appropriate bounce and get the
balls in. Pool players act like they solved the optimization
problems.
Applying Supply & Demand
The study of microeconomics can be understood in three

different levels: intuitively, graphically and mathematically.
. Demand curve:
Intuitively is the willingness of consumers to pay for the

good. Graphically is a downward sloping because as the
price goes up, consumers are willing to buy less of a good.
. Supply curve:
Intuitively is the willingness of producers to supply the

good, how much they are going to charge for a given
quantity of the good. Graphically is a upward sloping
because as the price rises, they’re willing to supply more.
“As the prices rise, consumers demand less. As the prices
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rise, consumers produce more.”
Equilibrium
Equilibrium = happiness. It’s a point where consumers

want a certain amount at a certain price. At that’s price,
producers say “I’m happy” to produce at that price.
Substitute goods
Example: substitute for pork has become more expensive;

consequently, the demand for pork will increase.
Costs
1. Efficiency loss: producers would be happy to produce

more at a high price, but that’s not happening.
2. Allocation inefficiency: somebody who wants that good for

that price gets it, who doesn’t want won’t get it. In
equilibrium, this problem is fixed; however the same things
doesn’t happen in disequilibrium (Secondary market can
evade – i.e. Kyoto Protocol)
Elasticity
How much do supply & demand respond? Do the

quantities supplied and demanded respond when the price
changes? How sensitive id the quantity demanded? The
slope of the demand curve will be the sensitivity of quantity
demanded to the price consumers face, and that will
determine the market responsiveness.
// Perfectly inelastic demand: it’s all about substitutes.

When there’s no substitutes, when there’s nowhere to go, it
doesn’t matter what the price is. Supply shock: price goes
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up.
// Perfectly elastic demand: you’re indifferent between a

good and a substitute.
Empirical economics: Estimating the elasticities
Causation x Correlation (Frank Fisher): the case of the

cholera outbreak. Peasants observed that where there
were more people dying of cholera, there were more
doctors, so the peasants killed the doctors, once they
thought the doctors were spreading the disease. They
confused causation with correlation.
How to measure the elasticity of demand?
By shifting the demand curve along its slope so to reach

the new price and the new supply curve.
Ed = variation of Q / variation of P (demand curve) –> it’s

something that shifts supply
How to measure the elasticity of supply?
By shifting the supply curve along.
Es = variation of Q / Q / variation of P / P (supply curve) –>

it’s something that shifts the demand
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Microeconomics: Unit 1 – Supply & Demand | MIT about:reader?url=https://pgderolle.wordpress....

Microeconomics: Unit 1 – Supply

Economics is the study of choice. Because choices range

Scarcity implies decisions, constrained optimization and

Consumers & producers

Models of how both consumers and producers behave,

Regarding consumers, the key word for them is wealth, as

Concerning Firms, they tend to maximize their proﬁts,

Fundamental questions of microeconomics

1. What goods and services should be produced?

2. How to produce those goods and services?

3. Who gets the goods and services?

The key word to understand the above questions is PRICE.

Theoretical and Empirical Economics: the ﬁrst build

Positive and Normative Economics: the ﬁrst is how things

Supply & Demand

// Demand is how much someone wants something: ↑D↑P

// Supply is how much of it there is to have

Water-diamond paradox (Adam Smith): We can’t live

As-if principle (Milton Friedman): When you’re playing pool,

Applying Supply & Demand

The study of microeconomics can be understood in three

Intuitively is the willingness of consumers to pay for the

Intuitively is the willingness of producers to supply the

“As the prices rise, consumers demand less. As the prices

rise, consumers produce more.”

Equilibrium = happiness. It’s a point where consumers

Example: substitute for pork has become more expensive;

1. Eﬃciency loss: producers would be happy to produce

2. Allocation ineﬃciency: somebody who wants that good for

How much do supply & demand respond? Do the

// Perfectly inelastic demand: it’s all about substitutes.

// Perfectly elastic demand: you’re indiﬀerent between a

Empirical economics: Estimating the elasticities

Causation x Correlation (Frank Fisher): the case of the

How to measure the elasticity of demand?

By shifting the demand curve along its slope so to reach

Ed = variation of Q / variation of P (demand curve) –> it’s

How to measure the elasticity of supply?

By shifting the supply curve along.

Es = variation of Q / Q / variation of P / P (supply curve) –>

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