Microeconomics Notes Class

Fundamentals of Microeconomics
ECON521
Vikas Gupta
Key References : Principles of Microeconomics – N Gregory Mankiw – 6th edition Modern Microeconomics – H L Ahuja – 18th edition 1
Professional
Vikas Gupta, CFA • Seasoned Executive with 28 years in global financial services, built in
the USA, UK & APAC; passionate to leverage experience for teaching,
advising, mentoring leaders, and businesses
• Held senior executive positions with Wells Fargo (Chief Risk Officer),
Credit Suisse (Chief Compliance Officer), Royal Bank of Scotland (Head
of Risk), Bank of America, and Wellington Management
Academic
• MBA Finance from Duke University, Durham, North Carolina, USA
• Electronics Engineering from MANIT, Bhopal India
• Chartered Financial Analyst (CFA)
• IICA Certified Independent Board Director
Expertise
• Finance and Banking
Vikas Gupta, CFA • Corporate Governance and Board Engagements
• Risk Management and Regulatory Compliance
• Teaching and Mentoring
• Talent development and management
Personal
[email protected] • US Citizen with Overseas Citizen of India status
+91 7838368526 • Board member at Sarv Samarthan Foundation (NGO)
LinkedIn: Vikas Gupta • Avid Traveler (35 countries), passionate foodie, Nature & Wildlife
explorer
Learning Outcomes
• Fundamental principles of Microeconomics and their application
• Supply and Demand Analysis and Equilibrium
• Elasticity and it’s relevance in market decision-making
• Government Policies to correct market failures – Taxes, Subsidies, Regulations
• Welfare Economics – Consumer, Producer and Total Surplus
• Taxation and Deadweight Loss
• Externalities and policies to address them
• Market Structures and their impact
• Production Function and profit maximization
Course Outline
WEEK TOPICS DETAILS
Week 1 (Aug 22/23) Introduction to Microeconomics • Definition and scope of Microeconomics
• Principles of Microeconomics
• Economic models and their importance in understanding microeconomic phenomena
• Supply and demand analysis and Equilibrium
Week 2 (Aug 29/30) Market Failures and Government • The concept of elasticity and its relevance in consumer decision-making
Intervention • Government policies to correct market failures: taxes, subsidies, and regulations
• Welfare Economics - Consumer surplus, producer surplus
• Taxation and deadweight loss
Week 3 (Sep 5/6) Welfare Economics and Tax systems • Externalities and their impact on efficiencies
& QUIZ 1 • Public policies to address externalities
• Public goods and the free-rider problem
• Design of effective tax system
Week 4 (Sep 12/13) Production and Profit Maximization • The production function and input-output relationships
• Short-run versus long-run production decisions
• Cost concepts: fixed costs, variable costs, and total costs
• Profit maximization and long-run equilibrium in Perfectly Competitive Markets
Week 5 (Sep 20) Market Structures & QUIZ 2 • Monopoly: sources of market power and pricing strategies
• Monopolistic competition: product differentiation and long-run
Week 6 (Sep 26/27) Market Structures and Economics • Oligopoly: behaviour of interdependent firms and game theory
of Labor markets • Factors of Production and Marginal productivity theory
• Economics of Discrimination, Income inequality and poverty
Week 7 (Oct 3/4) Theory of Consumer Choice and • Consumer Preference and Utility
Frontiers of Microeconomics • Asymmetric Information, Political Economy and Behavioral Economics
• Key Topics Review
Evaluation Criteria
Component Weightage
QUIZ 1 20%
QUIZ 2 20%
Final Exam 60%
Total 100% 4
Expectations from the class
• Arrive ON TIME and remain focused during each class
• Do not disrupt the class
• Keep phones on silent, and social media on pause
• Speak respectfully towards peers and professor
• Do not cheat on assignments: this is a strict violation of class rules
• Focus on learning, not on grades
• Absorb the concepts, don’t get bog down by graphs and numbers
Resources
Primary books
• Principles of Microeconomics – N Gregory Mankiw – 6th edition
• Modern Microeconomics – H L Ahuja – 18th edition
Enjoyable Reading – Freakonomics by Steven D. Levitt and Stephen J. Dubner
Movies
Best resource for understanding
- A Beautiful Mind Economics is
- The Wolf of Wallstreet The World around you!!
- The Informant!
- Margin Call
- Inside Job
Source: app.Hedgeye.com 7
Source: Mysay.in 8
9
If we may ask?
Why do companies Why is there only one

offer a discount How can Starbucks sell electricity provider in How does a company
Why does government
coffee at Rs 250 while decide how many cars
coupon of 10% instead charge such high tax town when you have
of a flat 10% discount you can get coffee multiple mobile to make each month?
~50% on Petrol?
outside at Rs 40?
in store? companies?
Why does a restaurant

Why do you see
How is the price of a Why do airlines sell the remain open on a Why are 75 people in
multiple fruit vendors
cake in a bakery same air ticket at very weekday even if they this class pursuing an
selling same things
determined? different prices? do 90% of business on MBA degree?
next to each other?
weekends?
Economics
• “Economics is a study of mankind in the ordinary business of life.” - Alfred Marshall

• The word economy comes from the Greek word oikonomos, which means “one who manages a
household.”
• Economics is the study of how society manages its scarce resources

• Scarcity means that society has limited resources and therefore cannot produce all the goods
and services people wish to have.
• Micro(Economists) study how people make decisions, how much they work, what they buy,
how much they save, how they invest, and how they interact with each other as buyers/sellers
• Macro(Economists) study forces affecting economy as a whole, how countries progress, how
they trade, at what rate the prices rise
“If all economists were laid end to end, they would not reach
a conclusion.” - George Bernard Shaw
Ten Principles of Economics
Principles 1-4 -Individual Decision making
Principle 1: People Face Trade-offs
• To get something you like you have to give up have to give something else you like
• Study vs. sports, job vs. vacation, public vs. private school, health vs. enjoyment
• Societies face larger trade-offs – clean environment vs. development, guns vs. butter
• Efficiency (maximization of benefits) vs. Equality (fair distribution of benefits)
Principle 2: The Cost of Something Is What You Give Up to Get It

• Decision making requires comparing of cost and benefits of alternate courses of action
• Opportunity Cost of an item is what you give up to get that item
Principle 3: Rational People Think at the Margin

• Rational people systemically and purposefully do their best to achieve objectives given available opportunities
• Decisions are made by thinking of Marginal benefits and Marginal costs
• A rational decision maker only takes an action when marginal benefit of action exceeds marginal cost
Principle 4: People Respond to Incentives

• An incentive is something that induces a person to act, in form of reward or punishment
• Higher price of a good is incentive for buyers to buy less and seller to sell more
• Public policies could change the incentives and thus alter behaviours of buyers and sellers
12
Key References : Principles of Microeconomics – N Gregory Mankiw – 6th edition Modern Microeconomics – H L Ahuja – 18th edition
Principles 5-7 –How people interact with each other
Principle 5: Trade Can Make Everyone Better Off
• Trade allows each person to specialize in activities they are good at
• By trading with others, people can buy greater variety of goods and services at lower cost
• Countries trade to maximize the potential of what they could produce and enjoy benefits of what others do
Principle 6: Markets Are Usually a Good Way to Organize Economic Activity

• Market economy - an economy that allocates resources through the decentralized decisions of many firms and
households as they interact in markets for goods and service.
• Each participant in market does what’s best or them which led to organizing economic activity that promotes overall
economic wellbeing (Adam Smith’s Invisible Hand observation)
Principle 7: Governments Can Sometimes Improve Market Outcomes

• Government policies enforce rules and maintains institutions key to the market like property rights, promote
equality and reduce inefficiencies
• Market economy rewards people per their ability to produce and willingness to buy, but does not ensure equal
distribution of wellbeing, so government policies are expected to help. Do they always help?
The Invisible Hand
Principles 8-10 –How Economy works as a whole
Principle 8: A Country’s Standard of Living Depends on Its Ability to Produce Goods and Services
• Majority of variations in standards of living between countries is attributable to the country’s productivity
• Productivity – amount of goods and services produced from each unit of labour
• Growth rate of a country’s productivity determines the growth rate of its average income
• Relationship between productivity and standards of living have profound influence over public policies
Principle 9: Prices Rise When the Government Prints Too Much Money
• Inflation is an increase in the overall level of prices in the economy.
• When a government creates large quantities of the nation’s money, the value of the money falls.
Principle 10: Society Faces a Short-Run Trade-off between Inflation and Unemployment
• In a short run, increase in money supply stimulates spending and increases demand, leads to higher prices, but
firms increase supply so hire more workers and this reduces unemployment
• Policymakers exploit these trade-offs using policy instruments like money supply, tax rates, government spending
to influence the demand and supply and to control the economy, but should they?
Applications of the Principles
1. You win $100 in a basketball pool. You have a choice between spending the money now or putting it
away for a year in a bank account that pays 5 percent interest. What is the opportunity cost of spending
the $100 now?
2. Your roommate is a better cook than you are, but you can clean more quickly than your roommate can.
If your roommate did all the cooking and you did all the cleaning, would your chores take you more or
less time than if you divided each task evenly? Give a similar example of how specialization and trade can
make two countries both better off.
3. Water is necessary for life, and Diamond is not. Is the marginal benefit of a glass of water large or
small? What about the marginal benefit of Diamond? Why is Diamond so much more expensive than
water?
Economic Models
Circular Flow Model - model that explains, in general terms, how the economy is organized and how
participants in the economy interact with one another.
Factors of Production – Labor, land and

capital
Households own the factors of

production and consume all the goods
and services that the firms produce.
In the markets for goods and services,

households are buyers, and firms are
sellers.
In the markets for the factors of

production, households are sellers, and
firms are buyers.
17
Economic Models
Production Possibilities Frontier (or Production Possibilities Curve)- a graph that shows the various
combinations of output—in this case, cars and computers—that the economy can possibly produce given the
available factors of production and the available production technology that firms use to turn these factors into
output
Points on (rather than inside) the
production possibilities frontier
represent efficient levels of
production.
With available resources, the

economy can produce at any point
on or inside the production
possibilities frontier, but it cannot
produce at points outside the
frontier.
Shift in Production Possibilities Frontier
Micro and Macro Economics
• Microeconomics - the study of how households and firms make decisions

and how they interact in markets
• Macroeconomics - the study of economywide phenomena, including
inflation, unemployment, and economic growth
• Microeconomics and macroeconomics are closely intertwined. Because
changes in the overall economy arise from the decisions of millions of
individuals, it is impossible to understand macroeconomic developments
without considering the associated microeconomic decisions.
Thinking Like an Economist
• The Economist as Scientist - the study of observations, theory and more

observations. Uses data (and assumptions) to analyse and make observations
• The Economist as a Policy Advisor - Uses the observations to recommend
policies and actions to improve the world
• Positive statements - Claims that attempt to describe the world as it is. They are
descriptive – “Taxation causes deadweight loss”
• Normative statements - Claims that attempt to prescribe how the world should
be. They are prescriptive – “Government should reduce taxes”
Key is to remember that these are both intertwined and need to be understood
together to know what’s happening (and why), and suggest how to improve it
Exercise
An economy consists of three workers: Larry, Moe, and Curly. Each works ten hours a day and can
produce two services: mowing lawns and washing cars.
In an hour,
• Larry can either mow one lawn or wash one car
• Moe can either mow one lawn or wash two cars
• Curly can either mow two lawns or wash one car.
Calculate how much of each service is produced under the following circumstances, which we label
A, B, C, and D:
• •All three spend all their time mowing lawns. (A)
• All three spend all their time washing cars. (B)
• All three spend half their time on each activity. (C)
• Larry spends half his time on each activity, while Moe only washes cars and Curly only mows lawns.
(D)
Market Forces of Demand and Supply
• Supply and demand are the forces that make market economies work. They determine
the quantity of each good produced and the price at which it is sold.
• A market is a group of buyers and sellers of a particular good or service. The buyers as a
group determine the demand for the product, and the sellers as a group determine the
supply of the product.
• Competitive market describes a market in which there are so many buyers and so many
sellers that each has a negligible impact on the market price. (Basic assumption)
• A competitive market assumes that all goods and services offered for sale are exactly the
same
• Buyers and sellers in perfectly competitive markets must accept the price the market
determines, they are said to be price takers. At the market price, buyers can buy all they
want, and sellers can sell all they want.
Demand Curve
a graph of the relationship between the price of a good and the quantity demanded
Market Demand
Key References : Principles of Microeconomics – N Gregory

Mankiw – 6th edition Modern Microeconomics – H L Ahuja – 25
18th edition
Shift in Demand Curve
Because the market demand curve holds other things constant, it need not be stable over time. If something
alters the quantity demanded at any given price, the demand curve shifts. Any change that increases the quantity
demanded at every price, shifts the demand curve to the right and is called an increase in demand. Any change
that reduces the quantity demanded at every price shifts the demand curve to the left and is called a decrease in
demand.
26
Variables that cause Demand curve to shift
• Income – most likely demand falls when income falls (Normal goods) but for some goods
(like public transport or fast food) demand increases when income falls (Inferior goods)
• Price of related goods – demand can decrease if the price of another product falls (called
substitutes). For some products, the demand may increase when the price of another
product falls (complements)
• Tastes – tastes could change over period of time or due to season affecting the demand
• Expectations –Expectations of future may affect demand for today – expecting higher
income, demand for dining out may increase, expecting price of tomato to increase may
reduce demand for it now, stock market works this way
• Number of Buyers – more buyers means higher demand at the same price
Note: Change in price is a movement along the Demand curve, not a shift of the curve
Related Goods
• Normal Goods – a good for which, other things equal, an increase in

income leads to an increase in demand
• Inferior Goods – a good for which, other things equal, an increase in
income leads to a decrease in demand
• Substitutes –two goods for which an increase in the price of one leads to
an increase in the demand for the other
• Complements – two goods for which an increase in the price of one leads
to a decrease in the demand for the other
Demand Curve - Shift vs Movement
Variables that influence Buyers
Supply Curve
a graph of the relationship between the price of a good and the quantity supplied
Market Supply
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Shift in Supply Curve
Because the market supply curve holds other things constant, the curve shifts when one of the factors changes.
Any change that raises quantity supplied at every price, such as a fall in the price of sugar, shifts the supply curve
to the right and is called an increase in supply. Similarly, any change that reduces the quantity supplied at every
price shifts the supply curve to the left and is called a decrease in supply
33
Variables that cause Supply curve to shift
• Input Prices: the supply of a good is negatively related to the price of the inputs used to make the
good. At certain input prices, the supplier may even shut down and stop supplying.
• Technology – Advancement in technology could help firm reduce price of production, so could
increase the supply at the same price.
• Expectations- Suppliers may tailor their supply based on expectations of future. If they expect the
price of their product to rise in future, they may want to store the product to supply later and thus
reduce the current supply.
• Number of Sellers – more sellers mean more supply of the product.
Note: Change in price is a movement along the Supply curve, not a shift of the curve
Variables that influence Sellers
Demand and Supply make the market
Equilibrium
Equilibrium - a situation in which the market price has reached the level at which quantity supplied
equals quantity demanded. The price at this intersection is called the equilibrium price, and the
quantity is called the equilibrium quantity.
Equilibrium Explained
• At the equilibrium price, the quantity of the good that buyers are willing and able to buy exactly
balances the quantity that sellers are willing and able to sell.
• The equilibrium price is called the market-clearing price because, at this price, everyone in the market is
satisfied: Buyers have bought all they want to buy, and sellers have sold all they want to sell.
• If the market price is above the equilibrium price, then there is excess supply (called Surplus) – the
sellers can’t sell entire quantity so they cut the prices. There is movement along both D and S curves
until the equilibrium is reached.
• If the market price is below the equilibrium price, then there is excess demand (called Shortage) – the
sellers can increase the prices due to excess demand, so they increase the prices. There is movement
along both D and S curves until the equilibrium is reached.
• Thus, regardless of whether the price starts off too high or too low, the activities of the many buyers and
sellers automatically push the market price toward the equilibrium price.
• Once the market reaches its equilibrium, all buyers and sellers are satisfied, and there is no upward or
downward pressure on the price.
• Law of supply and demand: The price of any good adjusts to bring the quantity supplied and quantity
demanded for that good into balance.
Markets Not in Equilibrium
Analyzing Changes in Equilibrium
Three Steps to Analyzing Changes in Equilibrium
1. Whether the event shifts the supply curve, the demand curve, or, in some
cases, both curves.
2. We decide whether the curve shifts to the right or to the left.
3. We use the supply-and-demand diagram to compare the initial and the
new equilibrium, which shows how the shift affects the equilibrium price
and quantity of any good adjusts to bring the quantity supplied and
quantity demanded for that good into balance.
Change in Equilibrium due to Change in Demand
Supply stay same, demand increases (so shifts the curve right). End result in the new equilibrium is the increase in
price and quantity both. Here the Demand curve shifts right, Supply curve does not, and there is movement along
Supply curve.
Change in Equilibrium due to Change in Supply
Demand stays same, supply decreases (shifts curve left). So end result in new equilibrium is the increase in price
and decrease in quantity. Here Supply curve shifts left, Demand does not and there is movement along Demand
curve.
Change in Equilibrium due to Change in Demand and Supply
Both curves shift (Demand increases so D right shift, and Supply decreases so S left shift). End result could be one of the
two: 1) if shift in D is substantially more than shift in S, then new equilibrium has higher price and higher quantity (though
Q is less than if only D had shifted). And Vice versa 2) if shift in S is substantially more than shift in D, then new
equilibrium has higher price and lower quantity (though Q is higher than if only S had shifted).
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Analyzing Changes in Equilibrium

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Fundamentals of Microeconomics

Enjoyable Reading – Freakonomics by Steven D. Levitt and Stephen J. Dubner

Why do companies Why is there only one

Why does a restaurant

• “Economics is a study of mankind in the ordinary business of life.” - Alfred Marshall

• Economics is the study of how society manages its scarce resources

Principle 2: The Cost of Something Is What You Give Up to Get It

Principle 3: Rational People Think at the Margin

Principle 4: People Respond to Incentives

Principle 6: Markets Are Usually a Good Way to Organize Economic Activity

Principle 7: Governments Can Sometimes Improve Market Outcomes

Factors of Production – Labor, land and

Households own the factors of

In the markets for goods and services,

In the markets for the factors of

With available resources, the

• Microeconomics - the study of how households and firms make decisions

• The Economist as Scientist - the study of observations, theory and more

Key References : Principles of Microeconomics – N Gregory

• Normal Goods – a good for which, other things equal, an increase in

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