Principles of Microeconomic
Principles of Microeconomic
Principles of Microeconomic
BBEK1103
PRINCIPLES OF MICROECONOMICS
Market is a situation where potential buyers (consumers) and potential sellers (producers) of a
goods or service come together for the purpose of exchange. Activities of both producers and
consumers determine the level of demand and supply. The concept of demand and supply is the
basic concept in market economy. The price system will determine how resources, goods and
services are distributed. It is depends on anyone who has wants and willing to pay will obtain
what is required.
Demand is refer to total quantity of goods required and able to be purchased by consumers at
various price levels in a particular period of time. Market demand refers to the total quantities of
a product that all households would want to buy at each price level. Price elasticity of demand is
a measurement on responsiveness of demand quantity towards a price change. Generally,
elasticity can be pictured in the shape of demand curve. The range of price elasticity at different
point on a downward sloping straight line demand curve is illustrated in Figure 1.
Price
P
0.5P
0.5Q
Quantity
Nowadays fuel is one of the main materials (input) in many sectors. It is almost become a
necessity of our life. In general, demand for fuel is inelastic since there are almost no other
substitute goods can be replaced it. When demand is inelastic, an increase in price will still result
1
in a fall in quantity demanded, but in total expenditure will rise. Figure 2 illustrate area X
(expenditure gained) is greater than area Y (expenditure lost). Therefore, price change gives a
more significant effect compared to quantity change.
Price
Expenditure rises
when price rises
PB
PA
B
X
A
Y
Quantity
QB QA
Price (RM)
10
20
30
40
50
60
Price
D
60
50
40
30
20
10
Quantity
100 200 300 400 500 600
A supply curve is show quantity of a goods that existing supplier (existing producers) are willing
to produce for the market at a given price. It is upward sloping curve from left to right, the
greater the quantities will be supplied at higher price. Figure 4 is the supply curve derived from
Table 2. Table 2 shows the quantity of goods that willing to produce by the producer at different
price level.
Table 2: Supply Table
Price (RM)
10
20
30
40
50
60
Price
S
60
50
40
30
20
10
100 200 300 400
500 600
Quantity
Market supply
Pe
Shortage
Qe
Market demand
Quantity
When change in the price of goods relates to a commodity will shift the position of demand
curve. A change in the price of one goods will not necessarily change the demand for another
goods. For example we would not expect an increase in the price of bread to affect the demand
4
for car. However, if both of the goods in the market demand are inter-connected and there are no
other substitute goods, then the demand sensitivity of cars towards the price change of fuel is
high.
Substitute goods are goods that are alternative to each other. Meaning to say an increase in the
demand for one is likely to cause a decrease in the demand for another. Consumers may switch
demand from one goods to another rival goods. Example of substitute goods and services are:i)
ii)
iii)
Complementary goods are goods that can be consume together, so that an increase in the demand
for one is likely to cause an increase in the demand for the other and vice versa. Examples of
complements are:i)
ii)
iii)
For instance, an example of complementary goods likes fuel and car. The fuel price increase in
the market due to supply disruption in the world. Lets say the price of fuel increase from P1 to
P2. This will cause quantity demand for petrol decrease. Refer demand curve for fuel which
illustrated in Figure 6(a).
Consequences after the increase of fuel price, it will have direct impact towards car market.
Consumers will reduce demand for cars; see Figure 6 (b) illustrated below. In other words, the
change in fuel price will cause consumers make changes to the fuel consumption they willing to
be purchased. Demand for cars decrease as consumers have a mindset that fuel price too high,
given that fuel and car are complementary goods.
In car market demand will shift left due to reason expensive fuel price discourage people from
buying car (Figure 6b). Therefore demand quantity for car market will decrease. When increase
fuel prices, it is not only will affect car market. It will also cause other sectors increase in cost of
production. Hence, costs of living such as foods and clothing also rise due to increase fuel price.
This will then push inflation upwards, and later is interest rate rise!
Price
Price
D1
D
P2
P1
Do
B
A
P1
A
Do
5
D
D1
Q2
Quantity
Q1
Q2
Q1
Quantity
On the other hand, demand for public transport and bikes market will increase as there is not
much other alternative to substitute fuel.
The effect of one form of government intervention in market is indirect tax imposed on certain
goods. When government tax imposed on cars, this will increase cost to seller, hence the tax will
shift the supply curve to the left. Consumer has to pay the price includes the tax. For example in
Figure 7:
(a) S0 is the supply curve before impose tax
(b) S1 is the supply curve including the cost of tax
(c) Q0 is the demand quantity before impose tax
(d) Q1 is the demand quantity after impose tax
Price
S1
S0
P2
P0
P1
B
C
Q1
D
Q0
Quantity
From graph above (Figure 7) we can see when supply curve from S0 to S1, the market
equilibrium from A move to B. Quantity demand has fall from Q0 to Q1 and price pay by
consumer has increase from P0 to P2. The amount of tax collected by government is depicted by
area P1P2BE and amount borne by consumer is the area P0P2BC. The amount of tax borne by the
seller is P1P0CE.
In general, the greater the elasticity of the demand and supply, the greater will be the effect of a
tax in reducing the quantity sold in and the produced for the market. It can be appreciated from
Figures 8 that the consumer bears greater proportion of the tax burden when the demand curve be
more elastic.
Price
Price
D
S1
B
Tax
S1
S0
D
B
S0
Tax
Q1 Q2
(a) Inelasticity demand
Quantity
F
Q1
Q2
Quantity
Point A in both diagrams is the initial equilibrium point and point B is the market equilibrium
after tax is imposed. From Figure 8(a) we can see when the demand is inelasticity, the bigger the
tax burden that has to be borne by consumers in area CHBE.
Refer to Figure 8 (b) where the elasticity demand for car is elastic, the seller has to bear more
taxes imposed (area EFGH) as we compare with consumer (area CHBE).
In summary, when elasticity of demand or supply becomes lesser, the quantity will get decrease
from Q2 to Q1. This may lead to significant rises in the unit costs of production when companies
reduce quantities in production after government imposed tax.
In view of fuel is an important resources to many sectors, government should not impose tax to
burden both supplier and consumers. The impacts of increase price in fuel and follow by adverse
consequences on the car market; this will make the country produce goods and services in an
uncompetitive situation when compete with oversea market with foreign firm which are not
subject to the same tax.
Reference
Munzarina Ahmad Samidi, Norehan Abdullah, Jamal Ali and Zalina Mohd Mohaideen (2009).
Principles of Microeconomics. Meteor Doc. Sdn Bhd.