Claritas Curriculum Review: Chapter 6 Microeconomics

If you didn’t fall asleep studying quantitative methods in chapter five, microeconomics might just do the trick. I will be the first to admit that the material can be dry at best, and I’m an economist!
As part of module 3, worth 20% of your score, you can’t afford to neglect the material. Thinking of each concept in real-world terms, i.e. how does General Motors decide how many cars to make, can help to make the material more interesting.

Introduction


The broad definition of economics and the difference between micro- and macro-economics are important here. Economics is just how people use limited resources. Macro-economics is the national and international-level details so data like inflation, unemployment and GDP. Micro-economic, think micro = small, is the individual level for people and businesses. This is going to be data like selling prices, production costs and revenue.
The curriculum seems to cover a lot of material but it looks like basic overview stuff and you should probably just focus on the main points within each section. Much of the chapter lends itself well to flash cards for definitions.

Supply and Demand

The respective curves are important and you should remember how each is affected by different changes. Important is the difference between a shift in the curve or movement along the curve. Changes in income, substitute prices, preferences, etc will cause a shift in the demand curve while a change in price will only affect movement on the curve. Similarly; input prices, technology, taxes, etc will cause shifts in the supply curve while only a change in the product price will cause movement along the curve.
Flash cards will help you understand the basic idea for each variable that affects the curves (i.e. technology, taxes, preferences, etc).
The equilibrium quantity and price is just where the two curves meet and people will be willing (and able) to buy a certain amount for a certain price. Be able to tell on a supply-demand chart if there is a surplus/excess supply or a shortage/excess demand.

Elasticities of Demand


This one could be tricky for some so first focus on the idea then try to get the basic formula. Elasticity of demand just says that people will buy less of a product if the price increases (duh!). The formula helps to quantify it by comparing the percentage change in demand against the percentage change in price, up or down.
Edemand = % change quantity / % change in price
Understand the difference between elastic and inelastic demand. Elastic demand is noted by a larger decrease in demand when price increases. Think luxury cars and jewelry, not necessarily needed things so when the price goes up, people buy fewer. In contrast to inelastic demand where demand does not change as much with price changes, think milk.

Profits and Costs of Production


All the cost curves are a pain so getting the ideas first will help make the graphs commonsense. Fixed costs are those that do not depend on quantity produced so things like rent, insurance, and equipment. Variable costs rise and fall with production, items like raw materials. The average fixed and variable costs are just divided by the number of products produced.
Since fixed costs do not change and variable costs increase at high rates of production, average total costs decrease at first but then rise later (a u-shaped curve).
Some other definitional terms are important as well like: operating leverage, marginal cost and marginal revenue.

Pricing


This is a fairly short section and the prior sections really cover the material. Understand the key factors that affect pricing: supply, demand, elasticity of demand and industry structure.

Industry Structure


Understand that Perfect Competition, Monopolistic Competition, Oligopoly, and Pure Monopoly lie on a scale with the key differences in number of firms, barriers to entry and exit, competition between firms, and profits.
In perfect competition, there is high competition and low barriers to entry/exit. This results in firms taking the price that buyers are willing to pay and profits equal to opportunity costs in the long-run.
In pure monopoly, there is just one seller and high barriers to entry so the firm sets the price in the market (profits are high due to pricing power).
In an oligopoly, there are a few sellers and barriers to entry/exit are high. As the next structure from monopoly, there will be a lot of similarities with the key differences being number of firms and limited increased competition.
We’ll cover chapter 7, macro-economics in the next review. The jury is out whether macro-economics is more or less interesting than micro-economics. I enjoy it more because it is broader concepts that seem to matter more on the big picture but many prefer micro- for its relevance to actual company operations. Remember, getting the basic ideas within each section will make it easier to grasp the details and thinking of the material in practical terms might make it more interesting.
‘til next time, happy studyin’
Joseph Hogue, CFA
 

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