Review

Microeonomics
PRINCIPLES OF

N. Gregory Mankiw

This lecture is brought to you by Dr. Doan Le

CHAPTER 1 SUMMARY

The principles of decision making are:

 People face tradeoffs.
 The cost of any action is measured in terms of
foregone opportunities.
 Rational people make decisions by comparing
marginal costs and marginal benefits.
 People respond to incentives.

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CHAPTER 1 SUMMARY

The principles of decision making are:

 People face tradeoffs.
 The cost of any action is measured in terms of
foregone opportunities.
 Rational people make decisions by comparing
marginal costs and marginal benefits.
 People respond to incentives.

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CHAPTER 1 SUMMARY

The principles of interactions among people are:

 Trade can be mutually beneficial.
 Markets are usually a good way of coordinating
trade.
 Govt can potentially improve market outcomes if
there is a market failure or if the market outcome
is inequitable.

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CHAPTER 1 SUMMARY

The principles of the economy as a whole are:

 Productivity is the ultimate source of living
standards.
 Money growth is the ultimate source of inflation.
 Society faces a short-run tradeoff between
inflation and unemployment.

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 CHAPTER
2

Thinking Like An Economist

Microeonomics
PRINCIPLES OF

N. Gregory Mankiw

This lecture is brought to you by Dr. Doan Le

 Factors of Production
 Factors of production: the resources the
economy uses to produce goods & services,
including
 labor
 land
 capital (buildings & machines used in
production)

THINKING LIKE AN ECONOMIST 6

FIGURE 1: The Circular-Flow Diagram

Households:
 Own the factors of production,
sell/rent them to firms for income
 Buy and consume goods & services

Firms Households

Firms:
 Buy/hire factors of production,
use them to produce goods
and services
 Sell goods & services
THINKING LIKE AN ECONOMIST 7
FIGURE 1: The Circular-Flow Diagram

Revenue Spending
Markets for
G&S Goods &
G&S
sold Services bought

Firms Households

Factors of Labor, land,

production Markets for capital
Factors of
Wages, rent, Production Income
profit
THINKING LIKE AN ECONOMIST 8
CHAPTER
3
The Market Forces of
Supply and Demand
Economics
PRINCIPLES OF

N. Gregory Mankiw

This lecture is brought to you by Dr. Doan Le

 Summary: Variables That Influence Buyers
Variable A change in this variable…

Price …causes a movement

along the D curve
# of buyers …shifts the D curve
Income …shifts the D curve
Price of
related goods …shifts the D curve
Tastes …shifts the D curve
Expectations …shifts the D curve
THE MARKET FORCES OF SUPPLY AND DEMAND 10
Summary: Variables that Influence Sellers
Variable A change in this variable…
Price …causes a movement
along the S curve
Input Prices …shifts the S curve
Technology …shifts the S curve
# of Sellers …shifts the S curve
Expectations …shifts the S curve

THE MARKET FORCES OF SUPPLY AND DEMAND 11

Three Steps to Analyzing Changes in Eq’m

To determine the effects of any event,

1. Decide whether event shifts S curve,

D curve, or both.
2. Decide in which direction curve shifts.

3. Use supply-demand diagram to see

how the shift changes eq’m P and Q.

THE MARKET FORCES OF SUPPLY AND DEMAND 12

Terms for Shift vs. Movement Along Curve
 Change in supply: a shift in the S curve
occurs when a non-price determinant of supply
changes (like technology or costs)
 Change in the quantity supplied:
a movement along a fixed S curve
occurs when P changes
 Change in demand: a shift in the D curve
occurs when a non-price determinant of demand
changes (like income or # of buyers)
 Change in the quantity demanded:
a movement along a fixed D curve
occurs when P changes
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 CONCLUSION:
How Prices Allocate Resources
 One of the Ten Principles from Chapter 1:
Markets are usually a good way
to organize economic activity.
 In market economies, prices adjust to balance
supply and demand. These equilibrium prices
are the signals that guide economic decisions
and thereby allocate scarce resources.

THE MARKET FORCES OF SUPPLY AND DEMAND 14

CHAPTER SUMMARY

 A competitive market has many buyers and sellers,

each of whom has little or no influence
on the market price.
 Economists use the supply and demand model to
analyze competitive markets.
 The downward-sloping demand curve reflects the
Law of Demand, which states that the quantity
buyers demand of a good depends negatively on
the good’s price.
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CHAPTER SUMMARY

 Besides price, demand depends on buyers’ incomes,

tastes, expectations, the prices of substitutes and
complements, and number of buyers.
If one of these factors changes, the D curve shifts.
 The upward-sloping supply curve reflects the Law of
Supply, which states that the quantity sellers supply
depends positively on the good’s price.
 Other determinants of supply include input prices,
technology, expectations, and the # of sellers.
Changes in these factors shift the S curve.
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CHAPTER SUMMARY

 The intersection of S and D curves determines the

market equilibrium. At the equilibrium price,
quantity supplied equals quantity demanded.
 If the market price is above equilibrium,
a surplus results, which causes the price to fall.
If the market price is below equilibrium,
a shortage results, causing the price to rise.

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CHAPTER SUMMARY

 We can use the supply-demand diagram to

analyze the effects of any event on a market:
First, determine whether the event shifts one or
both curves. Second, determine the direction of
the shifts. Third, compare the new equilibrium to
the initial one.
 In market economies, prices are the signals that
guide economic decisions and allocate scarce
resources.
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CHAPTER 5 SUMMARY

 Elasticity measures the responsiveness of

Qd or Qs to one of its determinants.
 Price elasticity of demand equals percentage
change in Qd divided by percentage change in P.
When it’s less than one, demand is “inelastic.”
When greater than one, demand is “elastic.”
 When demand is inelastic, total revenue rises
when price rises. When demand is elastic, total
revenue falls when price rises.
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CHAPTER 5 SUMMARY

 Demand is less elastic in the short run,

for necessities, for broadly defined goods,
or for goods with few close substitutes.
 Price elasticity of supply equals percentage
change in Qs divided by percentage change in P.
When it’s less than one, supply is “inelastic.”
When greater than one, supply is “elastic.”
 Price elasticity of supply is greater in the long run
than in the short run.
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CHAPTER 6 SUMMARY

 Implicit costs do not involve a cash outlay,

yet are just as important as explicit costs
to firms’ decisions.
 Accounting profit is revenue minus explicit costs.
Economic profit is revenue minus total (explicit +
implicit) costs.
 The production function shows the relationship
between output and inputs.

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CHAPTER 6 SUMMARY

 The marginal product of labor is the increase in

output from a one-unit increase in labor, holding
other inputs constant. The marginal products of
other inputs are defined similarly.
 Marginal product usually diminishes as the input
increases. Thus, as output rises, the production
function becomes flatter, and the total cost curve
becomes steeper.
 Variable costs vary with output; fixed costs do not.
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CHAPTER 6 SUMMARY

 Marginal cost is the increase in total cost from an

extra unit of production. The MC curve is usually
upward-sloping.
 Average variable cost is variable cost divided by
output.
 Average fixed cost is fixed cost divided by output.
AFC always falls as output increases.
 Average total cost (sometimes called “cost per
unit”) is total cost divided by the quantity of output.
The ATC curve is usually U-shaped.
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CHAPTER 6 SUMMARY

 The MC curve intersects the ATC curve

at minimum average total cost.
When MC < ATC, ATC falls as Q rises.
When MC > ATC, ATC rises as Q rises.
 In the long run, all costs are variable.
 Economies of scale: ATC falls as Q rises.
Diseconomies of scale: ATC rises as Q rises.
Constant returns to scale: ATC remains constant
as Q rises.
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 Chapter 7 CONCLUSION:
The Efficiency of a Competitive Market
 Profit-maximization: MC = MR
 Perfect competition: P = MR
 So, in the competitive eq’m: P = MC
 Recall, MC is cost of producing the marginal unit.
P is value to buyers of the marginal unit.
 So, the competitive eq’m is efficient, maximizes
total surplus.
 In the next chapter, monopoly: pricing &
production decisions, deadweight loss, regulation.

FIRMS IN COMPETITIVE MARKETS 25

CHAPTER 7 SUMMARY

 For a firm in a perfectly competitive market,

price = marginal revenue = average revenue.
 If P > AVC, a firm maximizes profit by producing
the quantity where MR = MC. If P < AVC, a firm
will shut down in the short run.
 If P < ATC, a firm will exit in the long run.
 In the short run, entry is not possible, and an
increase in demand increases firms’ profits.
 With free entry and exit, profits = 0 in the long run,
and P = minimum ATC.
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 Chapter 8 CONCLUSION:
The Prevalence of Monopoly
 In the real world, pure monopoly is rare.
 Yet, many firms have market power, due to:
 selling a unique variety of a product
 having a large market share and few significant
competitors
 In many such cases, most of the results from this
chapter apply, including:
 markup of price over marginal cost
 deadweight loss

MONOPOLY 27
CHAPTER 8 SUMMARY

 A monopoly firm is the sole seller in its market.

Monopolies arise due to barriers to entry, including:
government-granted monopolies, the control of a
key resource, or economies of scale over the entire
range of output.
 A monopoly firm faces a downward-sloping
demand curve for its product. As a result, it must
reduce price to sell a larger quantity, which causes
marginal revenue to fall below price.

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CHAPTER 8 SUMMARY

 Monopoly firms maximize profits by producing the

quantity where marginal revenue equals marginal
cost. But since marginal revenue is less than
price, the monopoly price will be greater than
marginal cost, leading to a deadweight loss.
 Monopoly firms (and others with market power)
try to raise their profits by charging higher prices
to consumers with higher willingness to pay.
This practice is called price discrimination.

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CHAPTER 8 SUMMARY

 Policymakers may respond by regulating

monopolies, using antitrust laws to promote
competition, or by taking over the monopoly and
running it. Due to problems with each of these
options, the best option may be to take no action.

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CHAPTER 9 SUMMARY

 A monopolistically competitive market has

many firms, differentiated products, and free entry.
 Each firm in a monopolistically competitive market
has excess capacity – produces less than the
quantity that minimizes ATC. Each firm charges a
price above marginal cost.

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CHAPTER 9 SUMMARY

 Monopolistic competition does not have all of the

desirable welfare properties of perfect competition.
There is a deadweight loss caused by the markup
of price over marginal cost. Also, the number of
firms (and thus varieties) can be too large or too
small. There is no clear way for policymakers to
improve the market outcome.

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CHAPTER 9 SUMMARY

 Product differentiation and markup pricing lead to

the use of advertising and brand names. Critics of
advertising and brand names argue that firms use
them to reduce competition and take advantage of
consumer irrationality. Defenders argue that firms
use them to inform consumers and to compete
more vigorously on price and product quality.

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 Key points

ESSENTIAL KNOWLEDGE

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