Welcome back! In the last blog, we analysis the relationship between income &substitutional effect and the demand of products. Moreover, we illustrate how to analysis the income effect and substitutional effect through graph. In today’s blog we will firstly introduce the cost, revenue, profit, and shout-run& long-run production function.

There are few concept that we need to be familiar with.

Firstly, Revenue. The revenue of a firm means receipts of money from the sale of goods and services over a given time period. Some people also refer to the revenue as turnover.

Secondly. Total revenue (TR), which is calculated by multiplying the quantity sold by the price at which the goods were sold, TR = Price × Quantity.

Thirdly, Average revenue (AR), which is the amount of money received, on average for each good sold. AR = TR/Quantity = Price.

The last one, Marginal revenue (MR), which is the revenue received from selling one more unit of output. It is the extra revenue at the margin (i.e. by selling marginal unit of output).

This graph below successfully summarize the relationship between total revenue, average revenue, and margins revenue.

In the top diagram, the downward sloping demand curve is average revenue and marginal revenue curve, which is falling twice as fast as average revenue curve. When marginal revenue falls, the extra revenue gained from the sale of the last unit is falling with every unit sold, but it is still positive. This is why the total revenue curve keeps rising,  but at a declining rate (decreasing slop).

The total revenue curve is at a maximum when the marginal revenue curve cuts the x-axis (MR = 0). The last unit sold added no revenue to the total, so the total revenue curve remains unchanged (it is momentarily flat). As successive marginal revenues are negative, the total does finally fall.

If the demand curve is perfectly elastic, the situation will be like this:

The perfectly elastic average revenue curve is flat, because any change in price will lead to zero in quantity, The marginal revenue must be the same value as the average revenue. So the two curves are the same.

As marginal revenue is constant, the extra revenue added to the total every time a unit is sold is the same for every unit. Hence, total revenue is continually rising and at a constant rate.

That’s all for today’s blog, In the next blog, we all talk about different cost curve.

Welcome back to my blog! In today’s blog, I will introduce you the relationship between income &substitutional effect and the demand of products.

Generally speaking, Substitution effect moves quantity demanded in the opposite direction to the price change: when price decreases (increases), substitution effect works to increase (decrease) quantity demanded; Income effect can work to either increase or decrease the quantity of a good demanded, depending on whether the good is normal or inferior.

It is possible to illustrate the substitution and income effects of the fall in the price of a good diagrammatically.  We begin by identifying the substitution effect. In order to do this we need to remove the income effect which is achieved by drawing in a new budget line, SV, parallel to the new budget line (RT), but tangential to the original indifference curve (I1). This leaves the individual on the original indifference curve and shows how much of good B would have been purchased had their real income not been increased. The movement from X to Z represents the substitution effect. The rest of the movement from X to Y is, therefore, the income effect.

It can be seen that when the price of good B is reduced the change in the quantity demanded resulting from the substitution effect is the movement from B1 to B3 and that resulting from the income effect by the movement from B3 to B2. In the case of a normal good ,the income and substitution effects of the price fall have worked in the same direction in order to bring about an increase in the quantity of B demanded.

This graph illustrates the situation for an inferior good.

An inferior good is one for which the quantity demand will fall as consumers’ income rises. In this case the substitution and income effects move in opposite directions. The substitution effect increases the demand from B1 to B3, but the negative income effect moderates the increase to some extent and will reduce the consumption of B from B3 to B2.

The final graph illustrated a Giffen good.

Giffen goods are generally regarded as goods of low quality which are important elements in the expenditure of those on low incomes. A good example is a basic food such as rice, which forms a significant part of the diet of the poor in many countries. The argument, not accepted by all economists, is that when the price of rice falls sufficiently individuals’ real income will rise to an extent that they will be able to afford more attractive substitutes such as fresh fruit or vegetables to make up their diet and as a result they will actually purchase less rice even though its price has fallen. In this case, the negative income effect (B3 to B2) completely outweighs the substitution effect (B1 to B3).

That’s all for today’s blog! For the next time, we will talk about different market structures.

Welcome back to my blog! Last time, we cover some concept about utility, which can be defined as a want-satisfying power, the satisfying or pleasure one gets from consuming a product. In today’s blog, I will introduce the Indifference curve and Budget line.

Indifference curve shows the different combinations of two goods that give a consumer equal satisfaction (utility).Here are some features of indifference curve:

• Higher indifference curve represents higher levels of utility
• Downward sloping
• Cannot cross
• Concave

Budget lines shows the combination of two products obtainable with given income and prices. The emerge of budget is due to the fact that all individuals must face two facts of economic life: have to pay prices for the Good&Services they buy, and have limited funds to spend. Budget Iine is somehow similar to the production possibility curve that we covered in the last semester. Both of them show the limits, but the main difference is that the production possibility curve is showing the production with limited resource, and the budget is showing the consumption with limited funds. All the points on the budget line and below the budget is affordable, but all the points above the budget line is not affordable, and they does not exist.

Budget can be changed by two reasons. Firstly, the change in income. Increase in income will shift the budget line upward (and rightward), and decrease in income will shift the budget line downward (and leftward). Keep it in mind that all shifts are parallel, which means that the changes in income do not affect the budget line’s slop. Secondly, Changes in price. In each case, one of the budget line’s intercepts will change, as well as its slope. When the price of a good changes, the budget line rotates, and both its slope and one of its intercepts will change.

While a rational consumer is making decision. He or she will buy one product on the exact point where the budget line is intersect with the indifference curve. At that point, the consumer’s utility is maximized, because he or she is spending all the money that he have on the two product, and gaining the equal satisfaction from these two product. Remember what we said in the last blog? “while the utility that the consumer gain from each product is same, the consumer will have the maximum utility”.

After the discussion of Indifference curve and Budget line, I will introduce the Substitution effects and Income Effect.

Substitution effects (change of relative price) means that as the price of a good falls, the consumer substitutes that good in place of other goods whose prices have not changed. Income effect shows that the increase in income will shift the budget line outward.

What is the relationship between these two effect and the demand of products? I will solve this problem in the next blog.

Welcome!

In the last semester, I introduced several topics about Microeconomics including efficiency, supply&demand, price elasticity, externality, market failure… For this semester, I decided to continue the introduction for Economics. If you are interested in economics, Please follow my blogs!

The first topic for this semester is Utility.

Utility can be defined as a want-satisfying power, the satisfying or pleasure one gets from consuming a product. However, utility and usefulness are not synonymous. For example, A painting by Picasso may offer great utility to an art connoisseur, but the painting itself is useless functionally. Utility is a subjective concept, since the utility of a specific product may vary widely from person to person. Moreover, Utility is difficult to quantify. Anything that makes the consumer better off is assumed to raise his utility, and anything that makes the consumer worse off will decrease his utility.

What economist mainly focus on is the Marginal utility, which is the additional utility derived from the consumption of one more unit of a particular good. Economist found that every decision maker(consumers) are always trying to make the best out of any situation, thus marginal utility theory treats consumers as striving to maximize their utility. However, economist also found an interesting phenomenon, that marginal utility falls as the consumption increases.

Here is a graph which describes the marginal utility and total utility.

If successive units of a good yield smaller and smaller amounts of marginal utility, then the consumer will buy additional units of a product only if its price falls. Diminishing marginal utility supports the idea that price must decrease in order to increase the quantity demanded, and it also confirm the idea that I mentioned in my third blog— “demand curve normally have a downward trend”.

In considering the consumer’s equilibrium, consumers have limited incomes, behave in a rational manner and seek to maximize their total utility. So here is the question: How do they maximize their total utility while making choices?

From an economic perspective, the answer is “Equi-marginal principle”. Consumers maximize their utility when their marginal valuation for each product consumed is the same, thus it is not possible to increase total utility by switching any expenditure from product A to product B. We normally use an equation to explain this.

That’s all about utility. For the next blog, I will introduce the Indifference curve and Budget line, as well as the income effect and substitution effect. See you next time!