Title: Principles of Microeconomics
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Microeconomics deals with the decision making and market results of consumers and firms. Microeconomics is a branch of economics that studies how individuals, households, and firms make decisions to allocate limited resources, typically in markets where goods or services are being bought and sold.
Microeconomics examines how these decisions and behaviors affect the supply and demand for goods and services, which determines prices, and how prices, in turn, determine the supply and demand of goods and services.
In recent years, economic theory has been broadly separated into two major fields: macroeconomics, which studies entire economic systems; and microeconomics, which observes the workings of the market on an individual or group within an economic system. In the later twentieth century such ideas as supply side economics which states that a healthy econonomy is very necessary for the health of the nation and Milton Friedman's ideas that the money supply is the most important influence on the economy. In this paper I will discuss Capital- with its narrow and broad uses – and Elasticity, in relation to microeconomics.
Capital in narrow and broad uses
In classical economics, capital is one of three factors of production. The others are land and labor. Goods with the following features are capital:
▪ It can be used in the production of other goods (this is what makes it a factor of production).
▪ It was produced, in contrast to "land," which refers to naturally occurring resources such as geographical locations and minerals.
▪ It is not used up immediately in the process of production unlike raw materials or intermediate goods. (The significant exception to this is depreciation allowance, which like intermediate goods, is treated as a business expense.)
These distinctions of convenience carried over to neoclassical economics with little change in formal analysis for an extended period. There was the further clarification that capital is a stock. As such, its value can be estimated at a point in time, say December 31. By contrast, investment, as production to be added to the capital stock, is described as taking place over time ("per year"), thus a flow.
Earlier illustrations often described capital as physical items, such as tools, buildings, and vehicles that are used in the production process. Since at least the 1960s economists have increasingly focused on broader forms of capital. For example, investment in skills and education can be viewed as building up human capital or knowledge capital, and investments in intellectual property can be viewed as building up intellectual capital. These terms lead to certain questions and controversies discussed in those articles. Human development theory describes human capital as being composed of distinct social, imitative and creative elements:
▪ Social capital is the value of network trusting relationships between individuals in an economy.
▪ Individual capital which is inherent in persons, protected by societies, and trades labor for trust or money. Close parallel concepts are 'talent', 'ingenuity', 'leadership', 'trained bodies', or 'innate skills' that cannot reliably be reproduced by using any combination of any of the others above. In traditional economic analysis individual capital is more usually called labor.
Further classifications of capital that have been used in various theoretical or applied uses include:
▪ Financial capital which represents obligations, and is liquidated as money for trade, and owned by legal entities. It is in the form of capital assets, traded in financial markets. Its market value is not based on the historical accumulation of money invested but on the perception by the market of its expected revenues and of the risk entailed.
▪ Natural capital which is inherent in ecologies and protected by communities to support life, e.g. a river which provides farms with water.
▪ Infrastructural capital is non-natural support systems (e.g. clothing, shelter, roads, personal computers) that minimize need for new social trust, instruction, and natural resources. (Almost all of this is manufactured, leading to the older term manufactured capital, but some arises from interactions with natural capital, and so it makes more sense to describe it in terms of its appreciation/depreciation process, rather than its origin: much of natural capital grows back, infrastructural capital must be built and installed.)
In part as a result, separate literatures have developed to describe both natural capital and social capital. Such terms reflect a wide consensus that nature and society both function in such a similar manner as traditional industrial infrastructural capital, that it is entirely appropriate to refer to them as different types of capital in themselves. In particular, they can be used in the production of other goods, are not used up immediately in the process of production, and can be enhanced (if not created) by human effort.
There is also a literature of intellectual capital and intellectual property law. However, this increasingly distinguishes means of capital investment, and collection of potential rewards for patent, copyright (creative or individual capital), and trademark (social trust or social capital) instruments.
In economics, elasticity is the ratio of the proportional change in one variable with respect to proportional change in another variable. In other words, it is the sensitivity of quantity demanded or supplied to changes in prices. Elasticity is usually expressed as a negative number but shown as a positive percent value.
One typical application of the concept of elasticity is to consider what happens to consumer demand for a good (for example, a product) when prices increase. As the price of a good rises, consumers will usually demand a lower quantity of that good, perhaps by consuming less, substituting other goods, and so on. The greater the extent to which demand falls as price rises, the greater the price elasticity of demand. However, there may be some goods that consumers require, cannot consume less of, and cannot find substitutes for even if prices rise (for example, certain prescription drugs). Another example is oil and its derivatives such as gasoline. For such goods, the price elasticity of demand might be considered inelastic.
Further, elasticity will normally be different in the short term and the long term. For example, for many goods the supply can be increased over time by locating alternative sources, investing in an expansion of production capacity, or developing competitive products which can substitute. One might therefore expect that the price elasticity of supply will be greater in the long term than the short term for such a good, that is, that supply can adjust to price changes to a greater degree over a longer time.
This applies to the demand side as well. For example, if the price of gasoline rises, consumers will find ways to conserve their use of the resource. However, some of these ways, like finding a more fuel-efficient car, take time. So consumers as well may be less able to adapt to price shocks in the short term than in the long term.
The concept of elasticity has an extraordinarily wide range of applications in economics. In particular, an understanding of elasticity is useful to understand the dynamic response of supply and demand in a market, in order to achieve an intended result or avoid unintended results. For example, a business considering a price increase might find that doing so lowers profits if demand is highly elastic, as sales would fall sharply. Similarly, a business considering a price cut might find that it does not increase sales, if demand for the product is price inelastic.
An example of how elasticity can be useful in business situations can be shown by the equation MR = P * (1+E)/E, where MR is marginal revenue, P is price of the good, and E is the own price elasticity of demand for the good. Notice that when E is less than negative one, demand is elastic. When E is between negative one and zero, demand is inelastic. And at E=-1, demand is unit elastic (or unitary elastic), and thus MC=MB and MB=0.
In economics, the definition of elasticity is based on the mathematical notion of point elasticity. For example, it applies to price elasticity of demand and price elasticity of supply, in which case the functions of the interest are Qd(P) and Qs(P). When working with graphs, it is common to put Quantity on x-axis and Price on y-axis, thus the function of the interest is x(y) rather than commonly used in mathematics y(x).
In general, the "y-elasticity of x" is:
or, in terms of percentage change
The "y-elasticity of x" is also called "the elasticity of x with respect to y".
It is typical to represent elasticity as 'E', 'e' or lowercase epsilon.
Unit elasticity for a supply line passing through the origin.
A common mistake for students of economics is to confuse elasticity with slope. (Case & Fair, 1999: 108, 109). Elasticity is the slope of a curve on a loglog graph only, not on a regular graph (taking into account whether the independent variable is on the horizontal or the vertical axis). Consider the information in the figure. This is a special case which illustrates that slope and elasticity are different. In the above example the slope of S1 is clearly different from the slope of S2, but since the rate of change of P relative to Q is always proportionate, both S1 and S2 are unit elastic (i.e. E = 1).
(Keeping in mind the example of price elasticity of demand, these figures show x = Q horizontal and y = P vertical).
Illustrations of perfect elasticity and perfect inelasticity.
The demand curve (D1) is perfectly ("infinitely") elastic.
The demand curve (D2) is perfectly inelastic.
Elasticity is an important concept in understanding the incidence of indirect taxation, marginal concepts as they relate to the theory of the firm, distribution of wealth and different types of goods as they relate to the theory of consumer choice and the Lagrange multiplier. Elasticity is also crucially important in any discussion of welfare distribution, in particular consumer surplus, producer surplus, or government surplus. The concept of elasticity was also an important component of the Singer-Prebisch thesis which is a central argument in dependency theory as it relates to development economics.
An elasticity, defined as a ratio of proportional or percent changes, is necessarily dimensionless -- meaning that it is independent of units of measurement. For example, the value of the price elasticity of demand for gasoline would be the same whether prices were measured in dollars or francs, or quantities in tones or gallons. This unit-independence is the main reason why elasticity is so popular a measure of the responsiveness of economic behavior.
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