ECON 102 Microeconomics
sunk costs
a cost that is not recoverable at the moment a decision is made. Should be ignored when making economic decisions.
Giffen good
a low income, non-luxury product for which demand increases as the price increases and vice versa. has an upward-sloping demand curve Examples: wheat, bread
the equilibrium principle
a market in equilibrium leaves no unexploited opportunities for individuals but may not exploit all gains achievable through collective action
Price ceiling/ price cap
a maximum allowable price specified by law If the price ceiling is lower than equilibrium price, there will be excess demand (will cause shortage) If it is higher than the equilibrium price, there is no pressure for the equilibrium price to increase to that price ceiling --> will not influence the market equilibrium
price floor
a minimum allowable price specified by law (prevents price from being too low) If it above the equilibrium price, will cause excess supply (surplus), as the price is too high and not many buyers will buy
Labor Demand
- Marginal Product of labor: additional output a firm gets by employing 1 more unit of labor - multiply MPL by output price to get MVPL (marginal value) - in perfect competition: (wage is marginal cost of labor) firm will employ where w = MVPL --> mvpl also demand curve - MVPL: money value of additional output a firm gets when employing 1 more unit
Downward slope in demand curve
- Substitution Effect: the change in demand of a good that results because buyers switch to or from substitutes when the price of the good changes. - Income Effect: change in demand that results because a change in price changes the buyer's purchasing power. (When the price of a good rises, consumers cannot afford to buy as much. As a result, they purchase less of the curve.) - Buyer's Reservation Price: largest amount a consumer is willing to pay for a good (Equal to the benefit the consumer receives from the good)
Total expenditure and revenue
- amount consumers spend on a product (PxQ) is the same as seller revenue Total Revenue: P x Q - when price elasticity of demand > 1 (elastic), changes in price and total expenditure will move in opposite directions - when price elasticity of demand < 1 (inelastic), changes in price and total expenditure will always move in the same direction.
Applying optimal choice with price variation
- as long as the consumer derives utility from both goods, a price increase will lower the utility. - substitution effect is always negative - for giffen goods: income effect of an inferior good swamp substitution effect (occurs in extreme low income places for very low quality products)
Games with more than 1 Nash Equilibrium
- can't use dominance, need to use response analysis - take one player's perspective -> e.g., if my partner chooses red, what is my best response. - sometimes game theory only tells you stable outcomes, not how to play the game.
Cartel Instability
- cartel: group of independent market participants who collude with each other to improve their profits (usually illegal) - with 2 firms, it seems that the strategy would be collude, but the effectiveness is greatly weakened when there are more firms (which one to imitate)
Isoquants (special cases)
- complements: 2 right angles (L) - if 2 inputs are substitutes: 1 downward sloping line
Repeated Games
- finitely repeated games: solve using backward induction --> start analysis from the last game (e.g., in Prisoner's Dilemma you will always play d as it is the dominating strat) - infinitely repeated: can't use backward induction Grim trigger: i will first cooperate, but if you defect, I will defect for the remainder of the game tit for tat: i will first cooperate and then replicate your previous action
Short Run Production Decision
- fixed capital, need to decide how many workers to hire - look at marginal product of labor (diminishing) - MPL = dq/dL (differentiate)
long-run competitive equilibrium (perf comp)
- free entry: all factors of production are variable - equilibrium: 0 economic profit + firms stop entering/leaving market - firms produce output at minimum AC --> allocative efficiency to find: - price = minimum ATC make MC=ATC and then Price=ATC
labor supply
- graph that looks like budget constraint, but it's on time not money. - utility as a function of leisure and income - point of tangency between budget line and highest attainable indifference curve determines hours of leisure demanded and labor supplied. - substitution effect is always positively related to income change/wage (e.g., rise in the wage tends to increase labor supply) - substitution effect of a fall in the wage tends to reduce labor supply - income effect of a wage change on labor supply may be positive or negative (uncertain) - at high wages, income effect dominates the substitution effect and leads to a backward bending supply of labor (will work less because they'd rather enjoy their time than work) - to decrease labor supply: income tax (discourages workers from working beyond the kink in the line) - to increase supply: offer different wages in the weekend for ex.
Imperfectly competitive firm (price setter)
- has some control over the market price of its product - will only increase output if the MB > MC - firm should shut down in the short run if PxQ is less than VC (variable cost) for all levels of Q OR if price falls bellow min of AVC - firm is profitable if its revenue (PxQ) exceeds total cost (ATC xQ)
Minimum Wages
- in a standard model, minimum wage can generate excess supply of labor and unemployment. - in monopsony, it raises employment. --> MCL becomes the min wage up to the point where ACL passes it
Perfect Competition
- long-run cost: sum of cost of capital and labor - firms cannot determine prices + sell identical products = are price takers - in short run: amount of capital employed + number of firms is fixed - shut down in the short run when revenue from 1 unit is not enough to cover fixed costs - profit maximization: when MC= MR //// price = MC total revenue: (p*q)-total cost (c*q) average revenue: total revenue/quantity sold (price) --> TR/q = p (same as demand curve) Marginal Revenue (same as price in perf comp): rate of change of total revenue with respect to quantity sold ---> derivative of TR/dq
Form Representations
- normal form (table with different choices) --> does not tell you structure of the story - extensive form game (tree diagram) solve using backward induction
Games with no (pure strategy) Nash Equilibrium
- sum of payoff is 0, what someone wins is what the other loses - use best response analysis to solve game - no nash equilibrium, it has mixed strategy.
Choice under risk and uncertainty
- uncertainty: prob. of certain occurrences is unknown (if it can be quantified, it's called risk) - expected value: probability weighted average of each possible outcome (fair if = 0) attitudes to risk: - risk averse: will refuse fair gamble - risk neutral: only interested if the odds yield a profit on average - risk loving: bets even with unfavorable odds certainty equivalent: if it's lower than expected value you are risk averse. If it's higher = risk loving. If it's the same = risk neutral
Long Run Production Decisions
- use of isoquants (similar to indifference curves) --> show combinations of inputs (labor and capital) that can be used to produce a given level of output - Cobb-Douglas: output(q) depends on capital (K) and labor (L) according to relationship
Decision Pitfalls to Avoid (when applying cost-benefit pitfalls)
1. Measuring costs and benefits as proportions rather than absolute money amounts 2. Ignoring Implicit Costs ---> one must consider the value of activities that fail to happen (opportunity costs) 3. Failing to think at the margin: only relevant costs/benefits are those that would occur as a result of taking the action --> costs we can avoid by not taking the action + benefits we wouldn't get (ignore sunk costs)
Oligopoly
A market structure in which a few large firms dominate a market - characterized by strategic interaction --> firms' returns depends on the reactions of their rivals 2 models: - Cournot Model: firm decides level of output, allowing market to determine price - Bertrand Model: firm decides price and allow market to determine volume of sales
Absolute and Comparative Advantages
Absolute - 1 person has an absolute advantage over another if an hour spent doing a task earns more than the other person in the same amount of time. Comparative - 1 person has comparative advantage if his/her opportunity cost is lower than the other person's. Need to find OC: Zoe: 8 bread = 6 beer 1 bread = 0.75 beer Ian: 5 bread = 4 beer 1 bread = 0.8 beer Zoe has lower OC = comparative advantage
Monopoly Profit Maximization
Algebraic example: Suppose that total revenue is given by pq and total costs are given by cq^2 . Suppose further that the inverse demand function is given by p = p0 - αq MC =2cq MR = p0-2 αq Equal to each other to find output Other method --> find where the slope of the profit function is zero
Indifference Curves
All bundles that lead to the same utility lie on the same indifference curve There is one indifference curve for each utility level - they are always downward sloping and cannot cross (due to transitivity, would make 2 baskets indifferent even though one is preferred to the other) - for perfect substitutes, will be a straight line - for perfect complements, utility is always constricted by the lower amount you have
Factors that shift supply
Any change that affects the cost of production will shift supply For ex, an increase in the price of labour will decrease the supply of strawberries. --> less people working, less supply (shift to the left) (more expensive to produce) An improvement in technology that reduces the cost of producing the good/service Weather - e.g., flooding/drought in an area (especially for agricultural products) Change in expectations - if farmers expect the price of a crop to increase in the near future, they will hold on to their stock and wait for the price to increase in order to sell. Change in the number of sellers ---- - A decrease in supply will lead to an increase in equilibrium price and a decrease in equilibrium quantity - An increase in supply will lead to a decrease in equilibrium price and an increase in equilibrium quantity
Determinants of ε
Availability of close substitutes: Unlike novels, no close substitutes for the textbook Therefore the demand for the textbook is likely to be much more inelastic than the demand for any particular novel. Budget share: the larger the share of your budget an item accounts for, the greater your incentive to look for substitutes when the price rises. Time: price elasticity of demand for any good will be higher in the long run than in the short run, where consumers have more time to adjust to a change in price. Addiction/habitual: goods that are addictive tend to be more inelastic
Factors that Shift Demand
Change in prices of related goods: Substitute goods are goods that are consumed in place of one another (e.g., pizza and burgers) --> if the price of a substitute good increases, then demand increases (shifts right) Complementary goods are goods that are consumed together (e.g., bread and butter, pizza and chips, etc) --> if the price of a complementary good decreases, then demand increase (shifts right) Change in income: For a normal good an increase in income leads to an increase in demand For an inferior good an increase in income leads to a decrease in demand (shifts to the left) (e.g., ramen noodles, apartments in unsafe neighborhoods, and other goods for which there are attractive substitutes) Change in preferences: when it became clear that smoking had severe negative health consequences there was a decrease in demand for tobacco Change in population: more buyers lead to an increase in demand Change in expectation of future prices: if I believe the price of iPads will increase dramatically next year, I may rush out and buy one now. - An increase in demand will lead to an increase in equilibrium price and quantity - A decrease in demand will lead to a decrease in equilibrium price and quantity
Assumptions about individual preferences
Completeness: for any pair of available consumption bundles X and Y, individual needs to be able to rank any 2 consumption bundles (either X ≥Y or Y ≥ X, but not 'i don't know') Transitivity: for any three consumption bundles X, Y, and Z; X ≥Y and Y ≥ Z imply X ≥ Z Reflexivity: for identical consumption bundles, there is no strong preference for either of them: X~X Non-satiation: more is better than less (at least more is no worse than less) - Diminishing Marginal Utility --> the happiness you get from an extra item will slowly diminish but it is still positive --> better to have more
Profit Maximization in Perfect Competition
Example: In a perfectly competitive market: A firm operates in a perfectly competitive market. Suppose the firm's total cost curve is TC= 5 +2q^2. Calculate the profit maximizing quantity when price is 16. Price ---- 16 MC (derivative of TC) --> 4q Max profit --> 16 = 4q Q= 4 Trying to find intersection between marginal cost line and price.
Asymmetric Info in Imperfectly Competitive Markets
Example: a flight company does direct route; MC of adding passengers = $120 2 passengers: businessman willing to pay 500 for flight but wants to stay 1 day; if more than a day, he is willing to pay $250 OR holidaymaker is willing to pay at most $200 but doesn't care about the trip length. Situation 1 - symmetric info + no price discrimination: Flight will charge $500 per ticket as there are more earnings Situation 2 - symmetric info + price discrimination: Company can price discriminate --> company charges businessman 500 and holidaymaker 200. The company will earn more as both can buy. How to price discriminate (ASYMMETRIC) without seeing people: Company creates a self-selection device --> offers fares with different prices/ restrictions e.g., (1) A $449 ticket that has no restrictions on when it can be used or (2) a special '$200' holiday ticket that can only be used if the traveler goes on a trip of at least two weeks. real life examples - flight companies charge more if you fly back the next day vs a month
Asymmetric Info in Competitive Markets
Example: Low ability workers have marginal revenue products of $200 per week High ability workers have marginal revenue products of $400 per week When information is asymmetric (workers know their abilities, but the firm doesn't. Firm knows only there is a half chance that an individual is a low ability worker and half that they are high ability): EV: 0.5(200) +0.5(400) = $300 High ability workers will be hurt by the lack of information, they would like to reveal themselves as high ability workers Adverse Selection: sellers have info that buyers do not have (or vice versa) about product quality - asymmetric info tends to reduce the average quality of goods offered for sale example: - people with below average cars are more likely to sell them - buyers know that below average cars are more likely to be in the market = lower their reservation prices - because used car prices are low, people with good cars keep them = average quality of used cars drop Moral Hazard: people take fewer precautions because they know they're insured (e.g., driver with insurance may drive with less care + gov. that promise to bail out loss making banks encourage risk behavior) with insurance: MB decreases as well as total surplus excess/deductible in the insurance policy: provision in insurance where person has to pay initial damages until a set limit
Public Goods/Excludability
Excludable - you have means to prevent somebody to use your private goods (e.g., phone) rivalrous - if you use it, it impacts/affects someone else's use of it Common goods are rival but non-excludable (e.g., fish in ocean) --> cause tragedy of the commons Public good - non-excludable + non-rivalrous (e.g., national defense)
Determinants of Supply Elasticity
Flexibility of inputs --> how easy it is to move inputs around (if they want to produce more in one specific location) --> e.g., a job that requires labor of minimal skills means workers could shift from other activities to that job if a profitable opportunity arose Mobility of inputs --> if inputs can be easily transported from one site to another Ability to produce substitute inputs-->how easy it is for them to use substitutes in periods of shortage - if its easy and supply can increase a lot --> price will be elastic - if it's not easy, supply will be inelastic even with big price increases (supply can't meet the increase in price, and can't produce more) Time --> given time, companies can affect their production --> switch from one activity to another, build new machines, train workers, etc.
Measuring distribution of income/wealth
GINI Coefficient: measure of equality of distribution of income by percentages of households/individuals from poorest to richest (measures the distance between the lorenz curve and line of perfect equality) Gini index coefficient: A/(A+B) - section A: total area between lorenz curve and perf equality line - section B: area outside curve - number ranges from 0-1: where 0 = perfect equality (there is no area, only perf equality line) ; 1= perfect inequality (1 person has all the income, there is no section b) Lorenz curve: graph of the cumulative distribution of income/wealth by percentages of households/individuals - perfect equality: 45 degree line - the farthest the line is from the 45 degree line, the greater the income inequality in a country
Differences in Earnings
Human capital explanation: worker's wage is proportional to his stock of human capital (education, training, experience, etc.) which affect their marginal product trade unions: 2 workers with same human capital can earn diff. if one is part of a labor union compensating wage differentials: wage differences associated with diff. working conditions (good conditions = less wage) discrimination by employers: arbitrary preference of employer for some workers discrimination by others: customer discrimination; willingness to pay more for a product produced by a certain group over others winner takes all market: e.g., best player takes 'all' in a sport
Economies of Scale
If doubling output causes cost to less than double, a firm has economies of scale (total cost rises at slower rate than output rises) (due to fixed costs, specialization, quality of machinery, etc) If doubling output cases cost to more than double, a firm has diseconomies of scale (total cost rises at faster rate than output rises) (due to managerial diseconomies/bureaucracy; geographical diseconomies) If doubling output causes cost to double, a firm has constant economies of scale (total cost rises at same time as output rises)
Perfect vs Imperfect Competition
Perfect - firms face perfectly elastic demand curve -- can't change market price imperfect - down-ward sloping demand curve -- have latitudes to change price - pure monopoly: polar opposite to perf comp - oligopoly: few firms - monopolistic comp: large number of firms selling same product with slight differences
Game Theory Strategic/Non-Strategic
Non strategic: choosing based on utility (won't affect other people's choices) strategic: rock/paper/scissors --> utility doesn't only depend on your choice, but your opponents - everything between monopoly and perf com is 'strategic'
Cournot Model
Oligopoly model in which firms produce a homogeneous good, each firm treats the output of its competitors as fixed, and all firms decide simultaneously how much to produce. - firms face same input costs + have same tech, etc. --> straight line market demand curve - reaction function: firm outputs on 2 axes best output for Firm 1 given any output produced by firm 2 is given by Firm 1's reaction curve. - outputs will continue to change as firms respond to each other until reaching Cournot Equilibrium at equilibrium: MC = (residual) MR --> firms are producing to the left of the point in which AC reaches a minimum + output is below perf comp. but above monopoly would produce - firms earn supernormal profit - Numerical Treatment of Nash Equilibrium: to maximize profit, differentiate with respect to q1 and set answer to 0.
Supply Curve
Shows relationship between how much of a good/service sellers wish to sell, and the price. Upward sloping - as the price of a good increases, sellers wish to sell more.
Simultaneous/Sequential Games
Simultaneous: - outcome: turnout of specific strategy from each player (multiply # of strategies to find outcome number) Sequential: - make decision knowing the other person's
Short Run Market Equilibrium (perfect competition)
Suppose there are 8 identical firms in the perfectly competitive market of cardboard boxes. The firm's total cost function is given by TC=5+2q^2 Suppose the market demand is given by QD= 10-3p Find the short run market equilibrium MC = 4q P = 4q Q = P/4 Qs = 8 x (p/4) = 2p Market equilibrium: QS = QD ---> 2p = 10-3p --> p=2, Qd=4 (you plug in the equilibrium price on the equation to find equilibrium demand) How many units would each individual firm produce?: Q= 2/4 = ½ QS = 8 (½) (there's 8 firms) QS= 4 QD= QS
Marginal Rate of Substitution (MRS)
The marginal rate of substitution between any two goods 1 and 2 (MRS1,2) measures how many units of good 2 the individual is willing to give up (substitute) for 1 additional unit of good 1, such that utility remains constant: MRS 1,2 = MU1/MU2 Trade offs: holding utility constant, how much of one good is a consumer willing to give to get more of another. example: ted consumes only pizza and coke. Suppose that the additional utility Ted gains from an additional slice is 4. The marginal utility of coke is 3. How many cokes is he willing to give up to get an additional slice of pizza? He is willing to give 4/3 cokes for 1 pizza slice. The MRS between pizza and coke is MRS p,c = MUp/MUc = 4/3 MRS IS THE ABSOLUTE VALUE OF THE SLOPE OF AN INDIFFERENCE CURVE (find slope of the tangent line to find MRS)
Utility
The utility function U(X) assigns to each consumption bundle an index number of happiness (= total utility) If U(X) > U(Y), then the individual strictly prefers bundle X to Y. If U(X) = U(Y), then the individual is indifferent between consumption bundles X and Y.
Marginal Cost & Average Cost
When average cost is declining as output increases, marginal cost is < than average cost. When average cost is rising, marginal cost is > than average cost. When average cost is neither rising nor falling (at a minimum or maximum), marginal cost = average cost. Seller maximizes profit at the quantity for which price = marginal cost
Consumption Bundles
a complete list of quantities for all available goods e.g., X= (XB, XC, XF) (bananas, coconuts, and fish) Preferences: If bundle A is strictly preferred to bundle B, then: A>B If bundle A is weakly preferred to bundle B, then: A≥B If the individual is indifferent between A and B, then A~B
Cost-Benefit Principle
a rational decision maker/economic agent should take an action if the benefit outweighs the cost
Asymmetric information
a situation in which one side of the market has more information than the other side 2 types of information: - hidden characteristics: things 1 side of the transaction know about itself that the other doesn't (e.g., sellers better informed) - hidden actions: actions taken by 1 side that the other cannot observe (e.g., firms vs employees)
perfectly inelastic demand
consumers cannot switch to substitutes or stop buying when the price increases (vertical line) e.g., crude oil, lifesaving medicine
excess demand (shortage)
amount by which quantity demanded exceed quantity supplied when the price of a good lies below the equilibrium price. Some buyers want to buy but cannot and so are frustrated--> buyers offer a higher price --> upward pressure on prices
excess supply (surplus)
amount by which quantity supplied exceeds demand when the price of the good exceeds the equilibrium price. Some sellers want to sell but cannot --> frustrated sellers offer a lower price --> downward pressure on prices
economic surplus
benefit of an action - cost of the action (example - willing to buy a book for 100, but bought it for 80 --> surplus is 20
budget line
consists of all of the bundles that exhaust the consumer's income M = p1•x1+p2•x2 effect of a change in income is like the effect on an equal proportional change in all prices -> cut income by half = both horizontal and vertical intercepts fall by half
normative economics
consists of statements in economics that reflect or are based on the ethical value system of the economist, implicitly, explicitly or by omission. ---> what things should be
Returns to Scale
change in the amount of output in response to a proportional increase of the inputs - constant: changing amount of capital/labor by a multiple changes the output by the same - increasing: changing amount of L,K by a multiple changes quantity of output more than proportionally - decreasing: changing L,K by a multiple changes the output by less than proportionally with use of technology --> more output obtained with same inputs: Q = Af (k,L)
Price Discrimination
conditions: - firm must be price maker - firm has to identify diff consumers - consumers not able to arbitrage 1st degree (perfect price discrimination): - monopolist sells output equal to the buyer's max willingness to pay (no consumer surplus) - does not exist in real world - marginal revenue would = demand curve, each unit sold at exact reservation price 2nd degree: - same price offered to all buyers but they sort themselves out through self-selection - e.g., online shopping (student discounts) 3rd degree: - monopolist doesn't know consumer's willingness to pay but observe demographics/characteristics (e.g., younger people get discounted rail cards)
Total economic surplus/welfare
consumer surplus + producer surplus
Costs Functions
costs - the shape of total costs is determined by the law of diminishing marginal product in the short run total cost: fixed costs (capital) + variable cost (labor) --> ATCxQ fixed cost - capital in the short run Average cost: total costs/output example: TC= 50 +30q - 10q^2 + 3q^3 AC = TC/q AC= 50/q+30-10q+3q^2 Marginal Cost: cost of producing 1 more unit of output MC = dTC/dq (derivative of TC) MC=30-20q+9q^2 - marginal cost always crosses average cost at the minimum + also crosses AVC at its minimum average variable cost(AVC): VC/Q Average Fixed Cost: Total Fixed Cost/Output Average Total Cost (ATC): TC/Q firm's profit is difference between total cost and total revenue
perfectly elastic demand
even the slightest increase in price leads to consumers to switch to substitutes (horizontal line) e.g., a brand of milk/water
How to solve a game
find dominance: what option dominates another iterated dominance: things occur step by step
Bertrand Model
firms compete on price and assume the others will change their prices. undercutting: price below their rivals and steal the whole market (any firm can do this as long as their price isnt below MC) Bertrand paradox - for 2 firms producing a highly substitutable output, the nash equilibrium prices is P=MC why paradox will not hold: - firms have capacity constraints --> output can't increase enough for price to be driven down to cost - product differentiation means firms' products aren't highly substitutable - firms understand that short term gain from undercutting = falling long term profits
Behavioral games
games based on idea that players are rational --> not always self-interested, sometimes make decisions based on social preferences (E.g., kindness reciprocity, guilt aversion, etc)
Production possibilities curve
graph describing the max amount of one good that can be produced for every possible level of production of the other good (e.g., all combinations of bread and beer than can be produced with Zoe's labor) inefficient point: a combination of goods for which resources available allow an increase in the production of 1 good without reducing production in another attainable point: a combination of goods that can be produced with available resources efficient point: combination of goods for which resources do not allow an increase in one without decreasing another unattainable good: combination that can't be produced with resources available
Scarcity Principle
having more of one thing means having less of something else --> always a cost
Monopoly and Monopsony Power
if firm has MONOPOLY power in the market: MPL should be multiplied by MR (not price) to get the MRP (same as MVP) if firm has MONOPSONY power (mirror of monopoly - 1 buyer and may sellers, e.g., NHS) --> MCL will be upward sloping (more steep than ACL, as increasing the wages doesn't only affect the 1 additional worker employed, but all those before that). profit maximization: MCL = MRP (will determine output) but wage is determined by average cost of labor (ACL same as labor supply) - MCL pulls up ACL
Efficiency
if price and quantity take anything other than the equilibrium, a transaction that will make at least some people better off without harming others can always be found. Market equilibrium is the total economic surplus maximizing point --> Pareto Efficient - no change is possible that will help some people without harming others Market is not in equilibrium when there are price ceilings/controls
Positive economics
independent of the ethical value system of the economist -> what things are
Free-Riding
individual optimal thing is not contribute towards a public good and reaping its benefits from everyone else paying - if everyone did this --> would lead to market failure (good would not be provided) - prevents private markets from supplying public goods (only gov.)
Monopolistic Competition
many buyers and sellers + sellers can differentiate their products - downward slope on each firm's demand curve - firms will produce where MC=MR (like monopoly) - in the long run, where more firms access the market, demand curve will lower until average revenue = average costs, and profit is 0. - no producer surplus, but consumer surplus (still smaller than in perfect competition)
Marginal cost/benefit
marginal cost - cost of an additional unit of activity marginal benefit - the benefit of an additional unit Will stop an activity when MC=MB
Monopoly
maximize profit: MC=MR profit: total revenue-total cost average revenue: AR= a-bq (same as product price) total revenue: AR*quantity sold --> TR = aq - bq^2 - also price*quantity marginal revenue: differentiate TR --> always less than market price for monopolist - has same intercept as average revenue, but 2x as steep (E.g., AR=8-q --> MR=8-2q) Average Cost: total cost/output marginal cost: differentiate TC - always crosses AC at minimum Inefficient --> lose overall consumer surplus - for a natural monopoly, average cost declines as the number of units produced increases --> AC = TC/q
Elasticity // Price elasticity of demand
measure of the extent to which quantity demanded and supplied respond to variations in price, income, and other factors. -- Price Elasticity of Demand: the percentage change in quantity demanded of a good that results from a 1% change in price. - The price elasticity of demand (ε)is a measure of the responsiveness of quantity demanded to changes in price When ε > 1, we say that demand is elastic - consumers fairly responsive to price change (sensitive) When ε <1, we say that the demand is inelastic - consumers fairly unresponsive to a price change When ε=1, we say that demand is unit elastic ARC elasticity - price elasticity between 2 points on the demand curve
Price elasticity of supply
measures seller's sensitivity to changes in price will always be a positive number
Externalities
negative - the cost of an activity that falls on people other than those who pursue the activity (e.g., air polLution) an activity will be undertaken at a level greater than what is socially optimal In production: - MSC > MPC - welfare loss: triangle pointing to the MSC (line upwards from MPC equilibrium) When production of a good has an external cost, the market equilibrium changes: the socially optimal level of some good: marginal social benefit = marginal social cost. In consumption: problem with negative externalities - self interested person will only consume until their MC = MB, not until the socially optimal level (deadweight loss) - MSB < MPB - E.G., smoking (more consumption that socially optimum) positive - benefit of an activity received by people other than those who pursue it (e.g., vaccination) an activity will be taken at a level less than what is socially optimal In consumption (e.g., vaccines): - MSB > MPB - underconsumption -> welfare loss + misallocation of resources - consumers only consider MPB due to self interest in production: (e.g., in work training schemes --> other firms benefit as workers will have those skills) - MSC < MPC - less production that would be socially optimum as firms only care about their private costs
Market Equilibrium
occurs when all buyers and sellers in a market are satisfied with their respective quantities at the market price. Found by finding the intersection between supply and demand curves (Solve demand function and supply function simultaneously)
Ordinal Utility
only the ranking of utility levels has meaning - the difference between utility levels is meaningless U(A) = 20 and U(B)=40 does not mean the individual prefers bundle B twice as much as A.
Point Price Elasticity
provides a measure of elasticity of demand at a particular point on the demand curve Point price elasticity at point A is: | 1/slope | * P/Q slope - term in front of coefficient (disregard negative values) When Price and Quantity are the same, price elasticity of demand is always greater for the less steep of the 2 demand curves. Elasticity decreases as we move down a straight-line demand curve Price elasticity of demand must be greater than 1 for any point above the midpoint Should be less than 1 at any point below the midpoint
demand curve
quantity of a good that buyers wish to buy at each price
socially optimal quantity
quantity that maximizes the total economic surplus that results from producing and consuming the good. Market equilibrium is not the greatest gain for all in cases where others besides the buyers benefit from the goods (e.g., a neighbor after you get a vaccine) or someone besides the sellers bears costs because of the good (e.g., creates pollution). Equilibrium is socially optimal is markets are perfectly competitive and if the costs/benefits to individual participants are the same as those to society as a whole.
Isocost Lines
shows combinations of the 2 inputs that can be employed for a given cost - slope of isocost line is price of labor/price of capital - need to shift isocost line (without changing its slope) to the lowest place possible to minimize cost and still produce same output - cost minimizing point: tangent of the isoquant and the lowest attainable isocost line // MRTS = price ratio of capital and labor (w/r) - only possible in long run; restricted in short run
Rational Spending Rule
spending should be allocated across goods so that the marginal utility per dollar is the same for each good (due to law of diminishing marginal utility) If consumption bundle maximizes utility given a budget set then: MRS1,2 = p1/p2 if MRS is > , consume more of good 1 and less of 2 if MRS is < , then buy more of 2 and less of 1.
Nash Equilibrum
stable outcome --> nobody has an incentive to move from this outcome e.g., Choice to defect in Prisoner's Dilemma
Welfare Effects of Tariffs
tariffs (Taxes on imports) --> lead to welfare loss with UK in common market: EU product price is lower than market price (higher demand than supply) - local consumers can't compete and UK needs to import - consumer surplus is very big with int trade - producer surplus very small since local firms need to compete with EU that have comp. adv UK out of common market: - UK imposes tariffs on EU products = price increases - consumer surplus shrinks and producer increase a bit (local more competitive) - new government income from tariff + new new loss of surplus (See notes for graphs)
Marginal Utility
the additional utility generated by an additional unit of the good, holding the quantities of all other goods constant. - diminishing marginal utility
Consumer surplus
the difference between a buyer's reservation price and the price actually paid More elastic demand curve reduces consumer surplus --> many substitutes, so for 1 product they are getting smaller amount of benefit
Producer Surplus
the difference between the the seller's reservation price (lowest amount they'd sell) and the price received in graph - below price (straight line down) and on top of supply curve
optimal consumption bundle
the feasible/affordable consumption bundle that maximizes the consumer's utility you draw the indifference curve and budget line in the same graph - optimal bundle will be when the slope at the point is the same for both lines (line tangent to indifference curve) - find MRS: slope of indifference curve at any point - price ratio is the slope of the budget line
seller's reservation price
the minimum price required by a seller to sell an additional unit of a good (opportunity cost) Generally, MC=MR
income elasticity of demand
the percentage change in quantity demanded associated with a 1% change in consumer income - how responsive is demand to income changes - POSITIVE for normal goods - NEGATIVE for inferior goods
Cross-Price Elasticity of Demand
the percentage change in quantity demanded of a good in response to a 1% change in price of another good e.g., if the price of coffee increases by 1% and demand for tea increases by 2%, the cross price elasticity of demand for tea with respect to coffee is 2. POSITIVE if subsitutes NEGATIVE is complements
Coase Theorem
the proposition that if private parties can bargain without cost over the allocation of resources, they can solve the problem of externalities on their own Coase Theorem has a practical problem - requires that negotiations are costless; not always the case in practice. - when negotiation is costly, legal remedies can be used to correct for externalities (e.g., subsidy for vaccines/tax on carbon emissions)
Marginal Rate of Technical Substitution
the rate at which a firm can substitute capital for labor, holding output constant - TO FIND: negative of the slope of the isoquant = MRTS - to CALCULATE: marginal product of labor/marginal product of capital MRTS l,k = MPl / MPk
Death Weight Loss (DWL)
the reduction in total economic surplus due to government intervention (price ceiling/cap)
perfectly inelastic supply
the same amount available in the market no matter whether the price is high or low (e.g., quantity of land in Manhattan) vertical line, elasticity is 0
budget set
the set of all feasible bundles under the budget constraint e.g., m ≥ E(X)
Tragedy of the Commons
the tendency of a shared, limited resource to become depleted because people act from self-interest for short-term gain common goods tend to get used more than is socially desirable marginal private benefit goes to 1 user but disutility (marginal social cost) is shared among everyone (e.g., adding 1 more animal to graze a field vs overgrazing the field for other users) - marginal private cost of adding a cow is lower than the marginal social cost
Opportunity Cost
the value of the next best alternative that is forgone by taking a particular action/// the value of what must be forgone to undertake an activity.
Benefits of International Trade
trade on the basis of comparative advantage improves global output. Example: Suppose a trade price (of bread) is determined so that 1 bread = 0.78 beer (1 beer = 1.282 bread) If no trade: Zoe has 4 bread + 3 beer Ian has 2.5 bread+ 2 beer If trade: before - Zoe has 8 bread; she sells 3.9 bread to ian and gets: 0.78*3.9 = 3.042 of beer Ian has 4 beer; sells 1.22 beer to Zoe and gets: 1.282*1.99 = 2.55 bread After - Zoe has 4.1 bread + 3.042 beer Ian has 2.55 bread + 2.01 beer BOTH BETTER OFF
perfectly elastic supply
when additional units of a good can be produced by using the same combination of inputs, purchased at the same prices horizontal line, elasticity of supply is infinite.
Economic efficiency
when all goods/services of the economy are produced and consumed at their respective socially optimal levels. cost to the seller of producing an additional unit is the same as the benefit to the buyer of having an additional unit --> maximizes total economic surplus
