micro & macro economics

MICRO & MACRO

ECONOMICS

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Learners & Trainers Macro/Micro Economics

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Content

SEGMENT l MICRO ECONOMICS

• Micro and Macro Economics

• Economics Problem - Scarcity & Choice

• Factors of Production

• Cost analysis

• Market structure

• Demand Analysis

• Supply Analysis

• Market Price Determination

SEGMENT ll MACROECONOMICS

➔ Economic Cycle and Loan Behaviour

➔ Monetary Policy

➔ Theory of interest Rate

➔ International Economics

➔ Economics of Foreign Exchange



MICRO ECONOMICS VS MACRO ECONOMICS

Micro Economics (Small):

- The study of the economy with focus on economic behaviour of the unit/individual /

households

- The decision making and allocation of scarce resources by the economic units.

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Macro Economics (Large):

- The study of the economy as a whole with interest in stability of output, employment,

and price levels.

Exercise:

Identify some economic issues at the micro level

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Identify some economic issues at the macro-Level

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BASIC CONCEPTS

• Barter

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• Consumption

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• Distribution,

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• Goods

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• Production

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• Scarce goods

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• Free goods

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• Rival Goods

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• Capital

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• Supply

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• Labour

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• Economic Cycle,

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• Market

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• Free Market

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• Price

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• Mixed economy

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• Inflation

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• Unemployment

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• Multiplier

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• Creation of Credit

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• Demand

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• Choice

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• Short Run

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• Long Run

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• Every Thing Being Equal

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SCARCITY & CHOICE

►Available resources are usually always insufficient in relation to the needs/and wants.

►This economic problem is further complicated by the fact that these scarce resources

many times also have alternative uses;

►The individual/unit faces the problem of

acquiring/ sourcing scarce resources

applying the scarce resources.

limited resources unlimited wants

►Prioritizing

Individuals, organisations and governments manage this problem by assigning priorities to

the needs, making a choice, and then allocating the resources to the chosen needs.

The needs that are not chosen are either suspended or-permanently discarded. Such a

choice between competing needs in day-to-day life, in business and indeed in all human

endeavours is part of living.

Examples include

At the Micro level

Spending Saturday morning in bed or at work, (Time)

Buying a car or taking an accommodation (Money)

Marrying Mr. A or B (Affection, time etc)

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At the Macro Level

Construction, Education or national security?

Inflation and Liquidity

Employment and Taxation

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► Rival and non-Rival Goods

Rival goods or resources are goods that the consumption by one entity precludes the

consumption of the same good/resource by another entity. Think of housing in a densely

populated neighbourhood. Air may qualify as non-rival resource because one person

breathing in does not prevent another person from breathing in.

Exercise

Think of a situation where air may be a rival resource.

Name 2 rival, and 2 non-rival resources

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►Opportunity Cost

The ultimate effect of scarcity of resources is that the individuals or economic unit cannot

gain maximum advantage of all opportunities available. The economic unit can only

maximize the benefits from the chosen opportunity. Some opportunities are always lost or

forgone.

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FACTORS OF PRODUCTION

“Unfortunately manna does not rain form heaven anymore; everything society consumes

has to be produced”. Edward T. Nevin

This is similar to the cliché that” there is nothing like a free lunch”. It may be free to you,

but someone is certainly paying for it, or someone has paid for it

The resources employed to produce the goods and services are referred to as factors of

production. They include

• Land

• Labour,

• Capital and

• Enterprise.

Land - includes the plot of land on which our office stands. It also includes other

natural blessings not commonly referred to. Namely, wind, rain, river, mineral

resources and other natural endowments that contribute to productivity

The reward paid by the employer of this factor is rent.

Capital – broadly refers to stock of wealth which contributes to production now or

which is desired for purpose of future production. Capital comprises equity, loan,

customer’s deposit, inter-bank takings, inventory etc.

Interest is the price paid for the use of this factor.



Labour - refers to the contribution of human physical or mental powers to

produce goods and services e. g. physical contribution of drivers in the bank, the

labour of the farm or construction workers. Mental power the includes the

knowledge workers,

Wages and salaries are the price paid for labour. Usually, the greater the

mental contribution to productivity, the higher the reward paid for labour.

Enterprise – is a special factor of production. It is so unique that some modern-

day economists refuse to classify it along with others factors.

Enterprise co-ordinates, controls and organises the other factors in such a way as

to achieve maximum effectiveness and wealth creation. The success of a business

depends largely on enterprise.

In practice, enterprise operates between the manager and the owner of the business;

the manager employs the factors while the owners run the business risk vis-à-vis the

money invested (equity). But owner-managers combine both the control and risk

Profit, which is often largest reward, goes to this factor (enterprise) but the

reward can also be a loss if the business fails.

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COST ANALYSIS

Fixed and Variable Cost

The total cost of doing business can be separated into fixed and variable elements

total cost = fixed costs + variable costs

The separation is important for business decision-making as each element have different

implications for viability, performance and continued existence of a business.

In practice,

it might be difficult to separate these elements of total cost.

Some costs may be both variable and fixed. These costs are referred to as semi-

variable or semi-fixed. Examples will include costs on utility e.g. electricity charges.

Variable Cost – varies directly with output. It increases when outputs increases and

vice-versa. Variable cost will include inputs that are direct to the output. For

example, the cost of Raw Materials, Wages expenses are direct cost of production

and vary with the level of production.

Every business that will survive in the short-run must cover all its variable costs

Fixed Cost – are incurred no matter the level of operations. They are also referred

to as the fixed overheads of the business. For example, the rent on a factory remains

the same irrespective of the level of production. The fixed assets are acquired and

it may or may not be used to full capacity.

Sunk Costs

Major expansion in operations requires increase in fixed costs; however, with

normal increase in operational level, fixed costs remain fixed and would not alter. In

incremental decision-making such as opening a new branch, fixed costs are

regarded as ‘sunk’ and irrelevant to present or future outputs.



Semi variable Cost

This group of costs shows some relationships with output but is also fixed. Some

elements of labour may be semi variable. For example, the salary of the factory

manager is an overhead irrespective of the level of production of the factory. We will

however need more managers to run more factory locations.

The company that will survive perpetually must cover all costs in the long run.

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Short-run and Long-run

Whether a cost is variable or fixed depends on the time period under consideration. In

economics, it is believed that all costs are variable in the long run. The concept of short-

run/ long run applies to several economics issues.

Short-run refers to all situations where there is a constraint in production, plant

capacity, staff strength, office space, number of official cars, available funds etc.

These constraints can prevent an organisation from gaining maximum benefits

arising from changing market conditions such as increasing market demand.

Long run refers to the time period when all constraints are overcome. When all costs

are variable, when there is sufficient liquidity, sufficient plant capacity, adequate

staff strength, sufficient market demand etc.

Short-run /Long run do not imply a specific time period. For example, short-run could be

one day or one year or more for a particular organisation regarding particular constraint

whereas long run could be tomorrow if the constraint is overcome tomorrow.

Marginal Costs

Marginal cost is the cost of producing an additional unit of output. Usually it reduces

to a minimum after which it begins to rise again. Marginal cost is useful for decision-

making on minimizing cost and maximizing profit in relations to the level of output.

According to economic theory, profit is maximized at the point where marginal cost

(cost of producing one additional unit) and marginal revenue (revenue from one

additional unit) are equal

i.e. Marginal Cost = Marginal Revenue



Break-even Analysis

Sales

Variable Costs

P

r

I Pi

c

e

Fixed Costs

Volume

Vi

A business that will exist in perpetuity must cover all costs associated with its revenue.

The output level Vi (above) at which revenue of a firm covers all its costs is referred to as

break-even point (BEP).

Below the BEP the operations make a loss as all costs are not covered. Above the BEP

the operations record a profit.

Arithmetically, the BEP is determined as

BEP = Fixed Costs

Contribution per unit

= Fixed Costs

Selling Price- Variable cost



Illustration:

Stellar Corporation sells its products for $30 per unit.

The variable cost per unit is $10 and the total fixed cost $40, 000.

Determine the break-even of output.

BEP = FC

SP-VC

= (40,000)

(30-10)

= 2000 Units

Check:

Total Revenue = 2000 units x $30

= $60, 000

Total Cost = FC + VC

= $40, 000+ $ 10x 2000 units

= $60, 000

Total Revenue = Total Cost

If Stellar produces less than 2000 units, it will operate at a loss.

Additional output above 2000 units would translate to profit.



MARKET STRUCTURE

Market structures may be classified into 3 main types

* Perfect Competition

* Imperfect Competition

* Monopoly

The knowledge of the conditions and characteristics of these market structures is

imperative. Business people should identify the structure of the market (industry) in which

they play, they should understand the conditions required for success in the market.

➔ Perfect Competition

Features:

◆ Large number of players (buyers and sellers)

◆ Each player (seller) is a price taker and cannot significantly influence the market.

◆ All resources must be perfectly mobile.

◆ There is perfect information and complete knowledge.

◆ There is free entry and exit from the market.

◆ In the short run firms maximize profit by operating at a point where price equals the

marginal cost and marginal revenue.

◆ In the long run, equilibrium occurs at the point where price equals minimum long run

average cost.

◆ Homogeneity of products

This type of market does not exist in real life, as not all the requisite conditions are

attainable at the same time. However, a few markets exhibit many of these

characteristics



➔ Monopoly

Features

◆ A single seller (player)

◆ Entry to the market is difficult

◆ The monopolist can earn supernormal profit both is short-run and long run

since it can control either the output or price.

◆ The monopolist can also segment the market and then charge different prices

for the same produce and same quality.

✓ Monopolies are few in real life.

✓ Natural monopolies are systems made by the nature of the goods and services: e.g.

utilities such as Electricity, Water, postal services etc, which are government

monopolies in Nigeria. Privatization should break these monopolies

✓ Patents on invention create some monopolies for a while; IBM monopolised the

computer market for a long time before the invasion of Xerox and others.

➔Imperfect Competition

Features

This is broad group comprising all forms of competition, which exist between the two

extremes of perfect competition and monopoly e.g. oligopoly, and monopolistic

competition.

The two major structures under imperfect competition are

oligopoly and

monopolistic competition,



Oligopoly

Features

Few players (usually between 2 and 25)

Firm are usually large

Because they are few the action of one firm can have serious repercussion

for others in the market

Players at times collude to form cartels, setting common standards and

religion (on pricing, output level etc) for themselves i.e. competition by

cooperation.

This market is rare in real life. Example includes the computer market with Microsoft.In

Nigeria the soft drinks market is a good example. Nigerian Bottling Company and Seven

Up Bottling Company simply dictate the market.

Some commodities markets exhibit the features of an oligopoly e.g. paper, sugar.

Think of examples of oligopolistic markets/industries

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Monopolistic Competition

Features

Many players, but not as many as in perfect competition

Products are basically similar but can be differentiated

No complete freedom to enter or exit the market

Super normal profit can be enjoyed in the short-run by players, who have

differentiated their products successfully.

Products differentiation, initiative and innovation are key success factors in

this market, one or few players can gain significant influence and market

share with differentiation e.g. of location of service, quality etc.



➔ Other Market Types

Duopoly –2 players (sellers)

Only 1 buyer (opposite of monopoly)



DEMAND ANALYSIS

Demand is the “want or desire” for a commodity that is backed by capacity.

For demand to be effective it must be backed up by purchasing power (Ability to Pay)

otherwise it remains a “desire”

What are the difference between demand and desire?

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Utility

Utility can be defined as the satisfaction or pleasure derived by a person from the

consumption of a good or service; Total utility by extension equal total satisfaction.

The problem with utility is measurement; it cannot be objectively measured or proved.

Whereas Bala might desire great enjoyment from wearing a tie, Uwaifor may have a

disdain for tie. One man’s food is another man’s poison.

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Utility affects the demand for goods and services directly and significantly. A consumer

would not demand for a commodity if he does not derive satisfaction from consuming it.

Marginal Utility

The relationship between utility and consumption is explained by the law of diminishing

marginal utility.

Marginal utility refers to the utility derived from the consumption of one more unit of a

commodity. According to the law, the extra satisfaction derived from the consumption of a

good or service tends to decline as the quantity rises. For example to the thirsty, man the

first bottle of water is highly appreciated. However, the utility of the glasses of cold water



declines the more glasses he drinks. In other words, marginal utility gets smaller and

smaller with increasing consumption.

It should be noted however that the law of diminishing returns holds certain factors (taste,

income etc) constant- ceteris paribus

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Demand Function

Several factors determine the demand for a good or service. In other words, demand is a

function of many factors namely price, income of substitutes, price of complementary

goods, taste, level of advertising, population, Government policy etc.

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Demand Consumer Behaviour

The demand curve shows the relationship between quantity demanded and price for all

possible prices.

Generic Demand Curve

P R I C E

Quantity



Consumer’ behaviour to a good or service is usually depicted by the relationship between

price and quantity demanded. The effect of changes in price on consumer demand for a

good, while holding other factors constant, is demonstrated by demand curve. There is

inverse relationship between quantity demanded and price; other things being equal the

lower the price of a good, the larger the quantity demanded. The slope of the graph is

typically downward sloping.

The above graph shows a hypothetical demand curve where all other things are held

constant. This is termed ceteris paribus by economists.

Exercise

Think of some products (food, beer education etc) and draw their demand curves.

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The demand curves for many products are downward sloping.

If however there is a change in any other factor, then there will be a shift in the demand

curve e.g. if income increase, the consumer might increase his consumption of a good

even at the same – the demand curve then shift right wards.

Elasticity of Demand

The reaction of consumers to price changes depends largely on the good. Cooking gas is

a necessity; the demand or the consumption will not be significantly affected by changes

in the price. We may expect that the quantity demanded of basic staple foods like gari,

will not be sensitive to price movements

Demand for luxury items are usually more price sensitive. We may expect more people to

buy air travels if the airfare drops.



Price elasticity of demand – this measures the degree of responsiveness of quantity

demanded to changes in price.

Illustration l

When price is $9, quantity demanded is 12,000 units and when price is decreased to $8,

quantity demanded increase to 14,000 units.

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Illustration ll

When price is $15, quantity demanded is 2000 units and when price decreased to $10,

quantity increase to 4,000 units.

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Demand is inelastic if the amount spent on a good drops when the price goes down.

Demand is elastic if the amount spent on a good rises when its prices goes down.

Demand is unit elastic if the amount spent on the good stays the same when the price

goes down.



Interpretation For Decision – Making Elasticity of Demand Increase Price Reduce Unit

Greater than 1 (>1) Elastic Revenue falls Revenue rises

Equal to 1 (=1) Unitary No change No change

Less than 1 (<1) Inelastic Revenue rises Revenue falls

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SUPPLY ANALYSIS

Supply refers to the quantity of a needed commodity that a producer or a seller is willing

to bring to the market. It looks at the situation where the supplier has a choice over what

he produces.

Unlike demand, supply has a positive relationship with price: the higher the price the

more profitable production becomes and the greater the output that each producer will

find it worthwhile to produce and vice-versa. This is the reason for the upward-sloping

nature of the SS curve.

Price

Quantity

Supply Function

The supply of goods and services is affected by many factors including.

▪ the goals of the firm.

▪ price of other commodities,

▪ price of factors of production,

▪ the state of technology



Mathematically, it can be presented as,

Qsx = F(Gf + Pc +Pf + T+ etc)

Where Qsx = Supply of goods x

Gf = Goals of the firm

P = Price of the commodity

Pc = Price of other commodities

Pf = Price of factors production



Elasticity of Supply

P2

P1

Q1 Q2

Price Elasticity of Supply measures the degree of responsiveness of quantity supplied

to changes in price

Its measurement is analogous (similar) to that of demand as follows,

Ep = ΔQ P - Point Elasticity

ΔP Q

The only difference is the sign; whereas elasticity of demand is negative, elasticity of

supply is positive due to its relationship with price.

Illustration:

When price is $8, quantity supplied is 2400 units, and when price is increased to $12,

quantity supplied increases to 3100.



PRICE MECHANISM

In market economies, price is determined through the interplay of forces of demand and

supply, often referred to as the invisible hands.

Supply

Pi

Price

Po

P2 Demand

Quantity

Q3 Q1 Q0 Q2 Q4

Earlier on, we considered the behaviour of both the demand and supply curves. The

market is only in equilibrium when these two curves meet. The price at the point of the

equilibrium is referred to as the market price. (Po above), while the quantity at that point

Q0 is the equilibrium quantity supplied and demanded.

At P1, there is and excess SS (Q2 - Q1); given the law of dismissing marginal utility,

consumers will derive smaller marginal utility from a commodity as its total supply

increases such that they are only willing to buy if the price falls.

The price then declines to Po, the point of equilibrium, similarly, at P2 there is excess

demand (Q4 - Q3), such that there is pressure on the available supply, which then pushes

the price to Po, the point of equilibrium where supply equals to demand.



The above analysis of price mechanism applies to all prices; price of good and services,

price of money (interest rates), price of local currency (exchange rates) and price of

labour (salaries and wages), It applies in all markets including the money and capital

markets.

Poser

Apply the above concept to the following

i. Production of cassava

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ii. Telecoms services

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iii. Banking services

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micro & macro economics

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