The
study of economics is broken down into 2 major parts that is microeconomics and
macroeconomics. In this blog post, I will only be discussing about microeconomics.
Investopedia defines microeconomics as ‘the branch of economics that analyses
the market behaviour of individual consumers and firms in an attempt to
understand the decision-making process of firms and households’ (2013). In
simple terms, microeconomics focuses more on things such as basic laws of
supply and demand of individual firms in contrast to macroeconomics which looks
at the “bigger picture”. Under microeconomics, I am going discuss on scarcity, opportunity
cost, demand and supply, and elasticity.
First
of all, the study of economics revolves around scarcity. Given the unlimited
wants of humans and the limited resources, scarcity arises. Economists study
how to allocate these scarce resources in order to obtain maximum benefit from
them. A common example to illustrate scarcity is using natural resources such
as water. According to this article by Martin Khor, limited water supply is
quickly becoming a global crisis (2010).
“While climate change has captured the headlines, many
countries are running out of freshwater supplies, threatening human health and
causing conflicts between nations” (Khor, 2010).
Although 75% of our planet is water, 97% of that water is
salt water in the ocean. The population needs fresh water to sustain then and
the supply of fresh water is limited only to sources such as underground water,
rivers, streams, rainwater, and other similar source. Given the volatile
climate change, the supply of fresh water is becoming lesser and lesser. This
means that the supply of fresh water is scarce and cannot sustain the growing population
much longer if the trend of the consumption doesn’t change. Awareness has to be
increased and wastes have to be decreased or this scarcity will evolve into a
global crisis.
Next, as
a result of scarcity, opportunity cost arises. Opportunity cost is the ‘cost of
an alternative forgone to pursue a certain action’ (Investopedia, 2013). It
simply means what you have to sacrifice to get something else.
To further illustrate this
concept, let’s take the opportunity cost of a college degree in the United
States. According to Greenstone and Looney, the ‘total investment for a 4 year
college degree is about $102 000’ (2011). When pursuing a college degree, one
does not only invest in money but also in time. The amount of money spent in
pursuing the degree can be used for various other things such as investments in
stocks or bonds. The time spent on pursuing the degree can also be used for
other things such as getting a job and making more money. So, in this case, the
opportunity cost to gain a degree is not only the time and money for other
things, but also the returns you gain. Think of the college degree as an
investment. With the same amount of money, you can invest in stock market,
bonds, properties and many other investments. The returns gained from each of
investments will be the opportunity cost of a college degree. Besides the fact
that college graduates earn almost 3 times more than high school graduates
(Shah, 2013), is it worth it to invest in a college degree? We can apply the
concept of opportunity cost in decision making to guide us on the right track.
(Greenstone
and Looney, 2011)
The chart above shows the returns
on each of the alternative investments compared to a college degree. We can see
that the returns on a college degree are much higher than any other
alternatives. Therefore, the opportunity cost of a college degree is not that
high and it is worth it to invest in a college degree as it will give a higher
benefit in the long run.
Next,
our daily lives are governed by the laws of demand and supply. The law of
demand states that the higher the price of a good, the lower the quantity
demanded with ceteris paribus applied. When prices are higher, people are less
willing to pay for the good and will look for alternatives or they will just
make do without the good. Generally, the demand curve is downward sloping
because of the law of demand. The law of
demand is largely affected by the substitution effect and income effect. Other determinants that affects the demand of
a good are the price of related goods, expected future prices, income, expected
future income and credit, population, and preferences.
To further illustrate the laws of
demand in action, let’s take the demand for cars in Malaysia. In 2011, the
Prime Minister has announced a full exemption of excise and import duty for
hybrid cars (Ng, 2011). The duty exemption has brought down the prices of
hybrid cars. While it is still higher than the price of average cars, people
are more willing to buy hybrid cars because of the added benefits and the
lowered price.
More recently, vehicle sales has
become more stagnant resulting from the manifesto drawn out by BN before the
general elections (Mahalingam, 2013). The manifesto includes a revision of the
National Automotive Policy to bring down the price of cars. With the expectation of lower future prices
of cars, the demand for cars has slowed down because people are waiting for the
price to be lowered before buying a car. If they were to buy a car now, they
would be paying a higher price.
Opposite
from the law of demand, is the law of supply. With ceteris paribus considered,
the law of supply states that the higher the price of a good, the higher the
quantity supplied and vice versa. When the market price of a good is higher,
firms are more willing to supply more of the good because they stand to make
more profit. The positive relationship between price and quantity supplied
shows in the upwards sloping supply curve.
The second microeconomics concept is elasticity. Price elasticity
of demand is the measure of responsiveness of the quantity demanded of a good
towards a change in the price, with ceteris paribus taken into consideration.
Price elasticity of demand can either be elastic or inelastic. Elastic demand
is when the quantity demanded is heavily influenced by the change in price.
Inelastic demand is when the quantity demanded is not much affected by the
change in price.
For example, let’s look at the quantity demanded for concert
tickets.
“Are Rolling Stones
fans balking at their high ticket prices? With hours to go before the band kick
off their 2013 tour, hundreds of tickets seem to be languishing at the box
office of Los Angeles's Staples Centre.” (Michaels, 2013).
This shows that the demand for a Rolling Stones concert
ticket is elastic. Even though they are well-established legends in the music
industry, fans are not willing to pay the high price for a concert ticket. A
lot of tickets are left unsold and only the tickets with the lower prices are
sold out. Concert tickets are generally expensive and can be considered as a
luxury good. The demand for luxury goods is very sensitive to price change therefore;
people are less inclined to buy a concert ticket if the price is too high.
On the other hand, inelastic demand is quite the opposite.
For example;
“What do milk and gasoline have in common? With milk, as
with gasoline, consumers have a hard time turning away even when prices soar”
(Doherty, 2007)
Although milk can be considered as a normal good, it is also
a necessity. For some people, it is essential in their daily diet. Therefore,
even though the price has increased, consumers have no other choice than to
still keep buying them because of those reasons. This makes the demand for milk
to be inelastic because people have no other alternatives and they cannot just make
do without milk.
Firms use price elasticity of demand to determine at what
price they should sell their product at. They will determine the price that
will give them the maximum level of profit when compared to the cost to produce
those good
(1473 words)
List of References
List of References
Doherty, R (2007) Reuters.
Available at : http://www.reuters.com/article/2007/06/20/us-milk-prices-idUSN2024940220070620 [Accessed 5 June 2013]
Greenstone, M. and Looney, A. (2011) Brookings. Available at : http://www.brookings.edu/research/papers/2011/06/25-education-greenstone-looney [Accessed 30 May 2013]
Helbling, T. (2013) International
Monetary Fund. Available at : http://www.imf.org/external/pubs/ft/fandd/2013/03/helbling.htm [Accessed 3 June 2013]
Investopedia (2013) Micoreconmics.
Available at: http://www.investopedia.com/terms/m/microeconomics.asp [Accessed 30 May 2013]
Investopedia (2013) Opportunity
Cost. Available at: http://www.investopedia.com/terms/o/opportunitycost.asp [Accessed 30 May 2013]
Khor, M. (2010) The
Star Online. Available at : http://thestar.com.my/news/story.asp?file=/2010/3/1/focus/5767412&sec=focus [Accessed 30 May 2013]
Khor, M. (2010) The
Star Online. Available at : http://thestar.com.my/news/story.asp?file=/2010/3/1/focus/5767412&sec=focus [Accessed 30 May 2013]
Mahalingam, E. (2013) The
Star Online. Available at : http://biz.thestar.com.my/news/story.asp?file=/2013/5/2/business/13053314 [Accessed 3 June 2013]
Mahalingam, E. and Huong, T. (2011) The Star Online. Available at : http://biz.thestar.com.my/news/story.asp?file=/2011/10/6/business/9637466&sec=business [Accessed 2 June 2013]
Michaels, S. (2013) the
guardian. Available at : http://www.guardian.co.uk/music/2013/may/03/rolling-stones-tickets-us-tour [Accessed 3 June 2013]
Ng, T. (2011) NBC
Blog. Available at : http://www.nbc.com.my/blog/hybrid-electric-cars-continued-to-be-cheaper/ [Accessed 2 June 2013]
Shah, N. (2013) The
Wall Street Journal. Available at : http://blogs.wsj.com/economics/2013/04/02/college-grads-earn-nearly-three-times-more-than-high-school-dropouts/ [Accessed 30 May 2013]
