1 Microeconomics
VISUAL 1-1
The Economic Way of Thinking
■■ Everything has a cost.
■■ People choose for good reasons.
■■ Incentives matter.
■■ P
eople create economic systems to influence
choices and incentives.
■■ People gain from voluntary trade.
■■ Economic thinking is marginal thinking.
■■ T
he value of a good or service is affected by
people’s choices.
■■ Economic actions create secondary effects.
■■ T
he test of a theory is its ability to predict
correctly.
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1 Microeconomics
VISUAL 1-2
Production Possibilities Curve
12
A
B
ARMY TRUCKS
10
E
8
C
6
4
F
2
D
0
2
1
3
CARS
(1) What trade-offs are involved?
(2) Why is the PPC concave, or bowed out, from the origin?
(3) What does a point inside the PPC illustrate?
(4) What is a historical example of a point inside the PPC?
(5) What is the significance of a point outside the PPC?
(6)Under what conditions can a point outside the PPC be reached?
(7) What would a country’s PPC look like if it did not have a
scarcity of resources?
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1 Microeconomics
VISUAL 1-3
Determining Comparative Advantage
(output method)
Japan
Mexico
CDs
20
30
Output per hour
Pounds of beef
5
15
(1)Which country has an absolute advantage
in producing CDs?
(2)Which country has an absolute advantage
in producing beef?
(3)Which country has a comparative advantage
in producing CDs?
(4)Which country has a comparative advantage
in producing beef?
(5)Which country should specialize in CD
production?
(6)Which country should specialize in beef
production?
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1 Microeconomics
VISUAL 1-4
Determining Comparative Advantage
(input method)
Japan
Mexico
Time required for one unit
1 CD
1 pound of beef
3 minutes
12 minutes
2 minutes
4 minutes
(1)Which country has an absolute advantage in
producing CDs?
(2)Which country has an absolute advantage
in producing beef?
(3)Which country has a comparative advantage in
producing CDs?
(4)Which country has a comparative advantage
in producing beef?
(5)Which country should specialize in CD
production?
(6)Which country should specialize in beef
production?
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1 Microeconomics
VISUAL 1-5
Illustrating the Difference between a
Change in Demand and a Change in
Quantity Demanded
$8
$7
PRICE PER GREEBE
$6
$5
$4
A
$3
D1
B
$2
D
$1
0
D2
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
QUANTITY
(hundreds of Greebes per week)
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1 Microeconomics
VISUAL 1-6
Determinants of Demand
Factors that shift
the demand curve
■■ Change in consumer tastes
■■ Change in the number of buyers
■■ Change in consumer incomes
■■ C
hange in the prices of complementary
and substitute goods
■■ Change in consumer expectations
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1 Microeconomics
VISUAL 1-7
Illustrating the Difference between a
Change in Supply and a Change in
Quantity Supplied
$8
$7
S2
PRICE PER GREEBE
$6
S
$5
B
$4
S1
A
$3
$2
$1
0
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
QUANTITY
(hundreds of Greebes per week)
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1 Microeconomics
VISUAL 1-8
Determinants of Supply
Factors that shift
the SUPPLY curve
■■ Change in resource prices or input prices
■■ Change in technology
■■ Change in taxes and subsidies
■■ Change in the prices of other goods
■■ Change in producer expectations
■■ Change in the number of suppliers
Any factor that increases the cost of
production decreases supply.
Any factor that decreases the cost of
production increases supply.
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1 Microeconomics
VISUAL 1-9
Equilibrium and Disequilibrium
$6
S
$5
800 Greebe surplus
PRICE PER GREEBE
$4
$3
$2
800 Greebe shortage
$1
0
D
1
2
3
4
5
6
7
8
9
10 11
12 13 14 15 16 17 18 19 20
QUANTITY
(hundreds of Greebes per week)
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1 Microeconomics
VISUAL 1-10
The Effects of Shifts in Demand or Supply
S
PRICE
PRICE
S
P1
P
P1
P
D
D1
D
D1
Q
Q1
QUANTITY
Q1
Q
QUANTITY
A. INCREASE IN DEMAND
B. DECREASE IN DEMAND
D
D
P
P
Q
Q
S1
S1
P
PRICE
PRICE
S
S
P1
P
P1
D
Q
Q1
QUANTITY
D
Q1
Q
QUANTITY
C. INCREASE IN SUPPLY
D. DECREASE IN SUPPLY
S
S
P
P
Q
Q
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2 Microeconomics
VISUAL 2-1
Price Elasticity of Demand
(1) dd =
percentage change in quantity demanded of Good X %ΔQd .
=
percentage change in price of Good X
%ΔP
(2) The Midpoint or Arc Method:
 (Q2 − Q1 ) 


 (Q2 + Q1 ) 2 
.
εd =
 ( P2 − P1 ) 


 ( P2 + P1 ) 2 
Example: When price increases from $9 to $10, the quantity demanded
decreases from 12 units to 10 units.
 (10 − 12) 
 −2 
 (10 + 12 ) 2 
 
−18.2%


= −17
εd =
..
= 11 =
 ($10 − $9)   +$1  +10.5%

 ($10 + $9) 2   $950
. 


As a result of the price rising by 10.5 percent, the quantity demanded fell by
18.2 percent. Since the absolute value of dd is greater than 1.0, the demand for
the good is elastic over this price range.
(3)When price increased, total revenue decreased from $108 to $100. This
means demand is elastic over this price range.
(4) Interpretation of the absolute value of the price elasticity of demand:
Absolute value of dd
Meaning
Greater than 1.0
Demand is elastic over this price range.
Equal to 1.0
Demand is unit elastic over this price range.
Less than 1.0
Demand is inelastic over this price range.
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2 Microeconomics
VISUAL 2-2
Summarizing Price Elasticity of Demand
Impact on total revenue of
Elasticity
coefficient
Term
Description
Price increase Price decrease
Greater than 1 Elastic
|εd| > 1
Quantity demanded
changes by a larger
percentage than
does price.
Total revenue
decreases.
Total revenue
increases.
Equal to 1
|εd| = 1
Unit
elastic
Quantity demanded
changes by the
same percentage
as does price.
Total revenue
is unchanged.
Total revenue
is unchanged.
Less than 1
|εd| < 1
Inelastic Quantity demanded
changes by a
smaller percentage
than does price.
Total revenue
increases.
Total revenue
decreases.
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2 Microeconomics
VISUAL 2-3
Tax Incidence and Elasticity of Demand
S2
S1
PRICE
P2
P1
The more inelastic the
demand for a good, the
more the incidence of an
excise tax can be shifted
to the consumer.
D1
Q2
Q1
QUANTITY
S2
S1
PRICE
P2
P1
D2
Q2
Q1
QUANTITY
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2 Microeconomics
VISUAL 2-4
A Price Ceiling
$6
S
$5
PRICE PER GREEBE
$4
$3
$2
Equilibrium price
Price ceiling
$1
0
D
1
2
3
4
5
6
7
8
9 10 11 12 13 14 15 16 17 18 19 20
QUANTITY
(hundreds of Greebes)
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2 Microeconomics
VISUAL 2-5
A Price Floor
$6
$5
Price floor
S
PRICE PER GREEBE
$4
$3
Equilibrium price
$2
$1
0
D
1
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2
3
4
5
6
7
8
9 10 11 12 13 14 15 16 17 18 19 20
QUANTITY
(hundreds of Greebes)
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2 Microeconomics
VISUAL 2-6
The Effect of Pollution
The Market for Paper
MSC
PRICE
P2
S = MPC
P1
D = MPB = MSB
0
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Q1 Q2
QUANTITY OF PAPER
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2 Microeconomics
VISUAL 2-7
Deadweight Loss of a Price Ceiling
The Market for Gasoline
$6.00
S
$5.50
PRICE
$5.00
$4.50
$4.00
D
$3.50
$3.00
0
200 400 600
QUANTITY OF GASOLINE
(millions of gallons)
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4 Microeconomics
VISUAL 4-1
Big Ideas about Factor (or Resource) Markets
1. The economic concepts are similar to those for product
markets.
2. The demand for a factor of production is derived from
the demand for the good or service produced from this
resource.
3. A firm tries to hire additional units of a resource up to
the point where the resource’s marginal revenue product
(MRP) is equal to its marginal resource cost (MRC).
4. In hiring labor, a perfectly competitive firm will do best if
it hires up to the point where MRP = the wage rate. Wages
are the marginal resource cost of labor if the labor market
is perfectly competitive.
5. If you want a high wage:
(A) Make something people will pay a lot for.
(B) Work for a highly productive firm.
(C) Be in relatively short supply.
(D) Invest in your human capital.
6. Real wages depend on productivity.
7. Productivity depends on real or physical capital, human
capital, labor quality, and technology.
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4 Microeconomics
VISUAL 4-2
The Demand for a Resource When the
Product Market and Resource Market
Are Perfectly Competitive
(3)
(6)
Units of
resource
Total
product
(Q)
Marginal
physical
product
(MPP) =
∆(2)/∆(1)
0
0
—
$5.00
$0.00
—
1
12
+12
$5.00
$60.00
+$60.00
2
26
+14
$5.00
$130.00
+$70.00
3
38
+12
$5.00
$190.00
+$60.00
4
48
+10
$5.00
$240.00
+$50.00
5
56
+8
$5.00
$280.00
+$40.00
6
62
+6
$5.00
$310.00
+$30.00
7
66
+4
$5.00
$330.00
+$20.00
8
68
+2
$5.00
$340.00
+$10.00
(2)
(1)
(4)
(5)
Product
Total
price
revenue
(P)
(TR) = (2)x(4)
Marginal
revenue
product
(MRP) =
∆(5)/∆(1)
1. How many units of the resource would be hired at each of
these perfectly competitive resource prices: $45, $35, and
$25?
2. Why does the value of MRP decrease as more units of the
resource are added by the firm?
3. Is the MRP curve the firm’s demand curve for the resource?
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4 Microeconomics
VISUAL 4-3
The Demand for a Resource When the Product
Market Is Imperfectly Competitive and the
Resource Market Is Perfectly Competitive
(3)
(6)
Units of
resource
Total
product
(Q)
Marginal
physical
product
(MPP) =
∆(2)/∆(1)
0
0
—
$5.80
$0.00
—
1
12
+12
$5.60
$67.20
+$67.20
2
26
+14
$5.40
$140.40
+$73.20
3
38
+12
$5.20
$197.60
+$57.20
4
48
+10
$5.00
$240.00
+$42.40
5
56
+8
$4.80
$268.80
+$28.80
6
62
+6
$4.60
$285.20
+$16.40
7
66
+4
$4.40
$290.40
+$5.20
8
68
+2
$4.20
$285.60
–$4.80
(2)
(1)
(4)
(5)
Product
Total
price
revenue
(P)
(TR) = (2)x(4)
Marginal
revenue
product
(MRP) =
∆(5)/∆(1)
1. How many units of the resource would be hired at each
of these perfectly competitive resource prices: $45, $35,
and $25?
2. Why does the value of MRP decrease as more units of the
resource are added by the firm?
3. Is the MRP curve the firm’s demand curve for the resource?
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4 Microeconomics
VISUAL 4-4
The Supply of and Demand for Labor
in a Competitive Labor Market
Market
A Firm
WAGE RATE
S
Wage
S = MRC
D = MRP
(∑ of firms' MRPs)
QUANTITY OF LABOR
D = MRP
L1
QUANTITY OF LABOR
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4 Microeconomics
VISUAL 4-5
A Monopsonistic Labor Market
WAGE RATE
MRC
S
W1
MRP
L1
UNITS OF LABOR
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4 Microeconomics
VISUAL 4-6
Economic Rent
S
RENT
R3
R2
D3
R1
D2
D1
0
1,000
UNITS OF LAND (acres)
Economic rent is the amount by which the price of a
resource exceeds the minimum level required to keep
that resource in its current use. This graph assumes the
quantity of land is fixed at 1,000 acres. The greater the
demand for the land, the higher is the economic rent.
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5 Microeconomics
VISUAL 5-1
The Economic Functions of Government
1. Enforce laws and contracts.
2. Maintain competition.
3. Redistribute income. Provide an economic safety net.
4. Provide public goods:
■■ Nonexclusion
■■ Shared consumption
5. Correct market failures:
■■ Provide market information.
■■ Correct negative externalities.
■■ Subsidize goods with positive externalities.
6. Stabilize the economy:
■■ Fight unemployment.
■■ Encourage price stability.
■■ Promote economic growth.
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5 Microeconomics
VISUAL 5-2
Illustrating a Negative Externality
S1 = MSC = MPC + MEC
PRICE
S2 = MPC
D = MSB = MPB
Q1 Q 2
QUANTITY
MSC = marginal social cost
MPC = marginal private cost
MEC = marginal external cost
MSB = marginal social benefit
MPB = marginal private benefit
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5 Microeconomics
VISUAL 5-3
Illustrating a Positive Externality
PRICE
S = MSC = MPC
D1 = MSB = MPB + MEB
D2 = MPB
Q1
Q2
QUANTITY
MSB = marginal social benefit
MPB = marginal private benefit
MEB = marginal external benefit
MSC = marginal social cost
MPC = marginal private cost
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