TIØ4118: Industrial Economic Analysis
This compendium aims to explain the core concepts of the course in a simple manner. Please note that the compendium is written by fellow students like yourself so there are bound to be errors throughout the text. If any such errors are discovered, feel free to correct them.
The compendium is mostly based on the book: Microeconomics by Robert S. Pindyck and Daniel L. Rubinfeld (Ninth edition).
Markets and Prices
The Themes of Microeconomics
Microeconomics is concerned with the decisions made by individual economic units--consumers, workers, investors, owners of resources, and business firms. It is also concerned with the interaction of consumers and firms to form markets and industries.
- Branch of economics that deals with the behavior of individual economic units--consumers, firms, workers, and investors--as well as the markets that these units comprise.
- Branch of economics that deals with aggregate economic variables, such as the level and growth rate of national output, interest rates, unemployment, and inflation.
It relies heavily on the use of theory, which can (by simplification) help to explain how economic units behave and to predict what behavior will occur in the future. Models are mathematical representations of theories that can help in this explanation and prediction process.
Microeconomics is concerned with positive questions that have to do with the explanation and prediction of phenomena. But microeconomics is also important for normative analysis, in which we ask what choices are best--for a firm or for society as a whole. Normative analysis must often be combined with individual value judgements because issues of equity and fairness as well as of economic efficiency may be involved.
- Positive analysis
- Analysis describing relationships of cause and effect.
- Normative analysis
- Analysis examining qustions of what ought to be.
What is a market?
A market refers to a collection of buyers and sellers who interact, and to the possibility for sales and purchases that result from that interaction. Microeconomics involves the study of both perfectly competitive markets, in which individual entities can affect the price.
- Collection of buyers and sellers that, through their actual or potential interactions, determine the price of a product or set of products.
- Market definition
- Determination of the buyers, sellers and range of products that should be included in a particular market.
- Practice of buying at a low price at one location and selling at a higher price in another.
- Perfectly competitive market
- Market with many buyers and sellers, so that no single buyer or seller has a significant impact on price.
The market price is established by the interaction of buyers and sellers. In a perfectly competitive market, a single price will usually prevail. In markets that are not perfectly competitive, different sellers might charge different prices. In this case, the market price refers to the average prevailing price.
- Market price
- Price prevailing in a competitive market.
When discussing a market, we must be clear about its extent in terms of both its geographic boundaries and the range of products to be included in it. Some markets (e.g., housing) are highly localized, whereas others (e.g., gold) are global in nature.
- Extent of a market
- Boundaries of a market, both geographical and in terms of range of products produced and sold within it.
Real versus Nominal Prices
To account for the effects of inflation, we measure real (or constant-dollar) prices, rather than nominal (or current-dollar) prices. Real prices use an aggregate price index, such as the CPI, to correct for inflation.
- Nominal price
- Absolute price of a good, unadjusted for inflation.
- Real price
- Price of a good relative to an aggregate measure of prices; price adjusted for inflation.
- Consumer Price Index
- Measure of the aggregate price level.
- Producer Price Index
- Measure of the aggregate price level for intermediate products and wholesale goods.
Supply and demand
Supply-demand analysis is a basic tool of microeconomics. In competitive markets, supply and demand curves tell us how much will be produced by firms and how much will be demanded by consumers as a function of price.
- Supply curve
- Relationship between the quantity of a good that producers are willing to sell and the price of the good.
- Demand curve
- Relationshipbetween the quantity of a good that consumers are willing to buy and the price of the good.
- Two goods for which an increase in the price of one leads to an increase in the quantity demanded of the other.
- Two goods for which an increase in the price of one leads to a decrease in the quantity demanded of the other.
- Equilibirium (or market clearing) price
- Price that equates the quantity supplied to the quantity demanded.
- Market Mechanism
- Tendency in a free market for price to change until the market clears.
- Situation in which the quantity supplied exceeds the quantity demanaded.
- Situation in which the quantity demanded exceeds the quantity supplied.
- Percentage change in one variabe resulting from a 1-percent increase in another.
- Price elasticity of demand
- Percentage change in quantity demanded of a good resulting from a 1-percent increase in its price.
- Linear demand curve
- Demand curve that is a straight line.