Chapter 1

Introduction…Do we remember Economics 201??

What was Microeconomics?

• Two parts:

• What type of Behavior?

What are some major changes in the economy

that have happened in the last six months?

Objectives met in Econ 201

• Role of prices– Why do we have prices?– How are prices determined?– Who determines prices?

• Supply and Demand– How do we draw them?– What changes each?

• Competitive markets

– What makes us competitive?– Sports…football vs. tennis

• Differing market Characteristics– Control over prices– Number of firms/customers

• Analyze real-life situations– Why did the minimum wage change?– Why are gas prices so high?– Why do businesses have sales?– Why do doctor visits cost so much?

Definition of Economics

Scarcity

Remember…

• Microeconomics deals with individual units

• Science of Choices

• Cost vs. Benefits

Macroeconomics

• Aggregated economic quantities

• Extension of Microeconomics

What groups are we interested in?

• Consumers

• Firms

• Workers

Positive vs. Normative Economics

• Positive

• Normative

Positive or normative??? If a statement is normative, change it to a positive

statement.

• The government should provide free tuition to all college students.

• An effective way to increase the skills of the workforce is to provide education to all potential workers.

• The government must provide job training if we are to compete with other countries.

Overview

• Positive

• Normative

Market

• Two sides

Who is who??

• Buyers_____________ in the consumer market_____________ in the labor market

• Sellers_____________ in the consumer market_____________ in the labor market

So…

• ________________ interaction of buyers and sellers determine the price

Competitive Markets

Noncompetitive Markets

• Oligopoly

• Monopolies

• Monopsonistic

Real vs. Nominal Prices

• Real

• Nominal

How convert??

Example

• 1970 CPI = 38.8

• 1999 CPI = 167

• Was there a little or much inflation??

• Milk prices were $1.05 in 1999 and $0.65 in 1970

Market can be explained in two ways…

• Geographic

• Range of products

Why important to look at??

Chapter 2

You can’t escape….

Supply and Demand

Before we can do Micro we must know how the market works

• Buyers

• Sellers

Individual vs. Market

• Individual

• Market

Determinates of DemandDeterminates of Demand

Change in Demand vs. Change in Quantity Demanded

Change in Demand vs. Change in Quantity Demanded

• Change in Demand

• Change in Quantity demanded

Change in Demand versus Change in Quantity Demanded

Change in Demand versus Change in Quantity Demanded

a

Price

0 Quantity Demanded

A change in demand(a s hift in the

demand curve)

Price

0 Quantity Demanded

B

A

A change inquantity demanded(a movement along

the demand curve , D )

DD

D

(b)(a)

Change in DemandChange in Demand

• SHIFT LEFT??

• SHIFT RIGHT??

Shifts in the Demand Curve Shifts in the Demand Curve

a

Price (dollars )

30

0 500 700

Rightward s hiftin demand curve

(increas e in demand)

Quantity Demanded of Blue Jeans

Part (a)

DD

A B

Shifts in the Demand Curve Shifts in the Demand Curve

a

Price (dollars )

30

0 450 650

Leftward s hiftin demand curve

(decreas e in demand)

Quantity Demanded of Blue Jeans

Part (b)

DD

B A

Change in price of related goods

Change in price of related goods

• Substitutes

• Compliments

Substitutes Substitutes

a

Part (a)SUBSTITUTES

Price

Quantity Demanded of Coca-Cola

Price

Quantity Demanded of Peps i-Cola

00

If Coca-Cola andPeps i-Cola ares ubs titutes , ahigher price forCoca-Cola leads to . . .

DPC1

DPC2

Qd1Qd 2

P1

P2

DCC

A

B

. . . a rightwards hift in the demandcurve for Peps i-Cola.

Complements Complements

a

COMPLEMENTSPart (b)

Price

Quantity Demanded of Tennis Rackets

Price

Quantity Demanded of Tennis Balls

00

If tennis rackets andtennis balls arecomplements , a higherprice for tennisrackets leads to . . .

DTB 2

DTB1

DTR

Qd1Qd2

P1

P2

A

B

. . . a le ftwards hift in the demandcurve for tennis balls .

ExamplesExamples• The housing market: Consumer’s income

increases

• The sugar market: Saccharine is found to lead to cancer

• The jelly market: The price of peanut butter increases

• The beer market: The price of beer decreases

Determinates of SupplyDeterminates of Supply

Change in Supply vs. Change in Quantity Supplied

Change in Supply vs. Change in Quantity Supplied

• Change in Supply

• Change in Quantity Supplied

Change in Supply versus Change in Quantity Supplied

Change in Supply versus Change in Quantity Supplied

a

Price

0 Quantity Supplied

A change in s upply(a s hift in thes upply curve)

Price

(b)(a)

0 Quantity Supplied

A

B

SS S

A change inquantity

(a movement alongthe s upply curve ,S )

Change in SupplyChange in Supply

• SHIFT LEFT??

• SHIFT RIGHT??

Shifts in the Supply Curve Shifts in the Supply Curve

aa

Price (dollars )

0

Quantity Supplied of Good X

Rightward s hiftin s upply curve

(increas e in s upply)

Part (a)

S

S

200 300

5A B

Shifts in the Supply Curve Shifts in the Supply Curve

a

Part (b)

0

Quantity Supplied of Go od X

Price (do llars )

15050

S1S2

Leftward s hiftin s upply curve

(de creas e in s upply)

5B A

Examples

• The computer printer market: Ink cartridges become less expensive

• The car market: Robots are taken away from production lines

• The taco market: Six more Taco Bell stores open

• The jellybean market: The price of jellybeans decreases

Question???Question???• Can the supply curve ever be vertical?

• First…what does a vertical curve indicate about the relationship between price and quantity supplied?

Equilibrium• Also called the ______________

• Disequilibrium

At Disequilibrium can have…• Shortage

• Surplus

Market Mechanism

• The ability for price to increase or decrease until hit equilibrium or where the market clears

• What causes this?

Do Shortage and Scarcity refer to the same thing???

Remember..• Equilibrium price and quantity are

determined by the_____________ of supply and demand

What happens to equilibrium price and quantity???

• Increase D and S constant?• Decrease D and S constant?• D constant and increase S?• D constant and decrease S?• D increase and S decreases by equal amounts?• D decrease and S increases by equal amounts?• D increases more than S decreases?• D increases less than S decreases?

Empirically

quantityandpricemequilibriuisWhat

PQ

PQ

s

d

51

28

Can check results graphically

• Qd = 8 – 2P

– ____ is the intercept– ____ is the slope

• Qs = 1+ 5P– ____ is the intercept– ____ is the slope

ElasticityElasticity

© South-Western College Publishing 1998

Elasticity

P

QEd

%

%

Elasticity of ONE point

Elasticity between two points

2

2

2

2

21

21

21

21

21

21

PPPP

QQQQ

PPP

QQQ

E

dd

dd

dd

d

d

So…

• What if Ed = 3?

• Shouldn’t it be negative?

Elasticity of demand can yield 5 basic results

1. Numerator > Denominator

2. Numerator < Denominator

3. Numerator = Denominator

4. Numerator = 0

5. Denominator = 0• Each has a specific name and result

Elastic

• Ed > ________

• ___________ CURVE

• What are some examples of an elastic good???

Inelastic

• Ed < ________

• ____________CURVE

• What are some examples of an inelastic good?

Unit Elastic

• Ed = ______________

• Change in price brings a ____________ change in quantity demanded

Perfectly Elastic

• Ed =

• Price increases and quantity demanded goes to __

• Extreme• Examples???

Perfectly inelastic• Ed = _____________

• % change in quantity demanded __________ in response to a change in price

• Extreme

• Examples???

Aren’t demand curve downward sloping?

How does a change in price affect Total Revenue of a Firm?

• Revenue depends on _________

• Michael Jordan and Nike shoes

What is total revenue??

• Total revenue =

• Firm uses to decide if to produce more or less

examples

• Elastic demand

– Price increase

– Price decrease

• Inelastic demand

– Price increase

– Price decrease

• Unit elastic demand

– Price increase

– Price decrease

Price elasticity of demand and a straight line

• Demand is _________

• Along the line elasticity ___________

• But…remember SLOPE is ____________

Point P Qd

A 8 3

B 7 4

C 6 5

D 5 6

E 4 7

F 3 8

G 2 9

Determinates of price elasticity of demand

Price Elasticity of Supply

2

2

2

2

21

21

21

21

21

21

PPPP

QQQQ

PPP

QQQ

E

ss

ss

ss

s

s

Classification is like demand• Es > 1

• Es < 1

• Es = 1

Any extreme elasticities???

• Es =

• Es =

Elasticity and taxes

• If government levies a tax on a product who pays the tax??

• Producers?? Consumers?? Share??

Two types of taxes

• Proportional

• Percentage

How find??

• Find equilibrium price

• Supply shifts left in the amount of the tax

• Find new equilibrium

• Find point of second equilibrium on ORGINAL supply curve

Who pays more of the tax??

• Perfectly inelastic demand

• Perfectly elastic demand

• Demand more elastic than supply

• Supply more elastic than demand

Summary

• Ed > Es

• Ed < Es

• Ed = Es

Chapter 3

Consumer

Preference

Consumer Behavior

• How individuals choose a good at a given price and income level

• What makes demand for some goods more sensitive than others?

How do we analyze this behavior?

• Examine Indifference Curves

• Look at Budget constraint

• Trace out individual demand using previous

• Aggregate individual demand to get market demand

Market Basket

Assumptions

How measure preferences?

• Indifference Curves

• Indifference Curve Map

• Downward sloped– What if positively sloped?

Market Basket

Food Clothing

A 20 30

B 10 50

D 40 20

E 30 40

G 10 20

H 10 40

Indifference Curves cannot cross

Marginal Rate of Substitution

What happens to the slope?Market Basket Clothing Food

A 16 1

B 10 2

C 6 3

D 4 4

G 3 5

Diminishing Marginal Utility

• Convex

• Why?

Polar Cases

What is the MRS?

• Horizontal portion– MRS =

• Vertical portion– MRS =

IC can show which good you prefer

Now…

Utility and Budget Constraints

Two types of value for a good

How do you measure utility?

• Construct an artificial measure called a ___________

• REMEMBER:

• Sum of the utility gained by consuming a market basket = ______________

Marginal Utility

Thus…

Remember…

• Along an IC utility is _______

• The additional utility from consuming an additional unit of one of the goods is called??

• So…we can used ________ to re-define the slope of the Indifference Curve

How do we compare MU of different units?

• Example: What is the MU of an apple vs. an orange?

Decision Making Process

• If the ___________ relative to its _______ is greater than the ____________ relative to its __________ we should buy more of A and less of B

• Compare ___________ of each good

Example• MUorange = 30

• MUapple = 20

• Income = $20

• Buy 10 oranges for $1 each and 10 apples for $1 each

• Good??

Consumer Equilibrium

What was the consumer equilibrium condition?

• Also called _________________

Utility Function

• U(F,C) = F + 2C

• What is the utility of a market basket with 5 units of food and 3 units of clothing?

• What is the marginal utility if the market basket changes to 4 units of clothing?

Important

• U1=50 and U2=100

Why?• Ordinal Utility

• Cardinal Utility

• ________ is preferred but hard to get data on

• Do you prefer an apple or a banana??

• By how much do you prefer it???

Budget Constraint

So..• Thus a ___________ shows all possible

combinations of those goods that may be purchased given a certain amount of _______________ of the goods

Example

• Price of y = 80

• Price of x = 100

• Income = 1200

• Draw the budget constraint

Slope of the Budget Constraint

• Slope =

• But wasn’t slope ???

The Budget Constraint

What changes the Budget Constraint?

How do they change the budget constraint?

• Income?

• Price?

Examples

• Consumer’s income increases

• Price of y increases

• Consumer’s income decreases

• Price of X decreases

Empirically• Income = PcC + PfF

– Income = 45– Price of Clothing = 2– Price of Food = 3– What is the slope of the budget constraint?– How does the budget constraint change if the

income changes to 120?– How does slope change if the price of Clothing

changes to 5 with an income of 45?

What happens if…

• Prices double

FP

P

P

IC

c

f

c

How about if…

• Income and Prices double

FP

P

P

IC

c

f

c

Combining IC and BC

At Tangency Slopes are Equal

• What is the slope of the BC?? IC??

• So equilibrium is at …

Maximization of Utility must have two conditions met

Corner Solution

Chapter 4: Individual and Market

Demand

Goal• Investigate individual consumer demand

• What information do we have?

• Use individual information to find the market demand curve

• Measure Consumer Surplus

IC, BC and Demand Curve?

• Can use the IC/BC relationship to derive the demand curve for good x, good y, or both

–

Starting with IC and BC• Pc=2• Pf=1• I=20• Draw the Budget Constraint and optimal

bundle with food on the x-axis• Pf changes to 2• Draw the new Budget Constraint and

optimal bundle

Properties of the Individual Demand Curve

Drawing the good x demand curve• Vary the price of x

• Find optimal quantity of x

• Take quantity and price information down to plot the demand curve

Examples

• Demand curve for Y with price increase

• Demand curve for X with price decrease

Remember…this is a change in price so

only a movement along the demand

curve

Price-Consumption Curve

How can goods be related?

• Substitute:

• Compliments:

• Independent:

How know??

• Downward sloped portion

• Upward sloped portion

Change in Income

• Causes two things:

• Pf=1, Pc=2, Income=20 draw BC and optimal bundle with food on the x-axis

• Income changes to 10

• Income changes to 40

Example

• Demand curve for Y with an increase in income

Income Consumption Curve

Normal and Inferior Goods• Normal

• Inferior

When price of a good decreases

• Two things happen

Substitution Effect

• When the price of a good decreases relative to the prices of other goods people buy _______ of it

• Portion of the change in Qd is attributed to the change in price

Income Effect

• If a person’s real income increases due to a price decrease he/she can buy ________ of that product or other products given _____________

• The portion of the change in Qd that is attributed to the change in income due to the change in the price

To graphically break up the effects

• Price decrease causes a rotation on the BC

• Look at what would we have bought with this new income level (new BC) at our old Utility level

• Old optimal bundle to new optimal bundle is the ______________

•

• Old optimal bundle to new tangency on original IC is __________________

• New tangency on original IC to new optimal bundle is ________________

The Result is Three Points

So…• Two effects of price decrease of food

Effects• Total Effect

• Substitution Effect

• Income Effect

Types of good (for a price decrease)• Normal Good

• Inferior Good

• Giffen Good

Normal Good Continued• Initial price =

• Final price =

• Initial slope =

• Final slope =

So…

• Need to get to original utility level to split out _________________

• Can’t change price because ______________

• Parallel shift of the BC allows ___________________________________

Breakdown

• Income effect

• Substitution effect

Inferior Good

Giffen Good

Market Demand

Demand

Price A B C MARKET

1 6 10 16

2 4 8 13

3 2 6 10

4 0 4 7

5 0 2 4

So…• Demand is not always _____________

• Does demand become more or less elastic when a new firm enters?

• Why?

Consumer Surplus• The difference between

______________________________________________________________

Concert Tickets: Everyone wants to by 2 ticketsOne for self and one for their date. Market sets

Price at $14

What does the demand curve look like??

What is everyone’s Consumer Surplus?

• Need area of the respective rectangles

• Andy is willing to pay $20

• Barbara is willing to pay $19

• Eugine is willing to pay $14

Why look at consumer surplus?

Changes in Supply affect Consumer Surplus

• Decrease in the number of sellers

• Increase in the price of relevant resources

• Advance in technology

• A per-unit tax placed on producers/seller

Network Externalities• Usually assume demand is determined by

price, preferences, price of other goods….but all of the individual

• Two types

Bandwagon Effect

Why is market demand more elastic?

Snob Effect

Chapter 5

Choice Under Uncertainty

Adding in Reality

• So far assumed prices, incomes and other variables are know with certainty

• Why do we use credit cards?

Objectives• Quantify risk

• Examine peoples preferences towards risk

• Examine how we can reduce risk

• How people choose the amount of risk to undertake

Risk is about Choices

• After graduate you are offered two jobs– Salary– Commission

• Your choice of the job will show your ________

• Consumer Behavior defines _______________

Probability helps quantify risk• Probability is the _____________ a

situation will happen

• Objective Probability

• Subjective Probability

• So…. Two events

– Success with a probability of .25

– Failure with a probability of .75

– Buy shares before exploration starts for $25

• What do you do??? Buy or pass up???

Expected Value• Also called ________________

What is the expected value?

• P(success) = .25

• P(failure) = .75

• Value of success = $40

• Value of failure = $20

Do we buy the stock??• Buy shares for $25

• Indifferent between buying it or not

• If buy for $20

• If buy for $30

Example

• 100% certainty the previous company will be successful what is EV?

Another example

• Two part time jobs – Job A = commission based– Job B = Salary based

• Two ways to work– Hard– Lazy

• Need to determine which job to take

Work hard Lazy

Probability income Probability income

A .50 2000 .50 1000

B .99 1510 .01 510

Mean-Variance

• Looks at variability in payoffs

• X = ACTUAL VALUE

• EXP = EXPECTED VALUE

• Higher variation _______________

Work hard Lazy

Probability income Probability income

A .50 2000 .50 1000

B .99 1510 .01 510

Can also measure with variance

Now add $100 to each payoff in Job A

Work hard Lazy

Probability income Probability income

A .50 2100 .50 1100

B .99 1510 .01 510

• EV(A)?

• Variance (A)

• Std deviation (A)

• EV(B)=

• Variance =

• Std deviation =

• Which job do you chose?

Decision

Consumer Preference Toward Risk

• Assume consumer knows all probabilities for one good

• Need _________________

• What was the shape of the IC??

• Utility functions are ________________

Earn U(x)

10,000 10

15,000 18

16,000 24

20,000 28

30,000 30

Earn U(x) MU(x)

10,000 10

15,000 18

16,000 24

20,000 28

30,000 30

Which Job is better?

• Option 1– Income = $15000– U(x) = 18 from Curve

• Option 2– $30,000 with Probability =.5– $10,000 with Probability =.5

Can find EV and EU

Expected Utility

• U(x) from curve is _________________

• U(x) from formula is _____________-

• What is expected utility?

• Which job do you take???

Risk Averse

Two options• Job 1

• Income=$20000

• Assured Utility = 16

• Where do you get assured utility?

• Job 2

• Income = $10000; Pr=.5

• Income = $30000; Pr=.5

Find EV and EU

• EV =

• EU =

Risk Averse

Risk lovers

• EV =

• EU =

Risk Neutral

• EV =

• EU =

Risk Premium

Risk Aversion and IC

• IC are _________________– Why?

Reducing Risk

Diversification• “Don’t put all you eggs in one basket”

Insurance

Value of Information

• How much will you pay?

How many suits will we sell for this season??

• If Q=100 then P=$180 per suit• If Q=50 then P=$200 per suit• Sell each suit in store for $300• Can return unsold suits to warehouse for ½ Price• Pr(sell 100) = .5; Pr(sell 50) = .5

Profits Sales of 50 Sales of 100

Expected Profits

Buy 50 suits

5,000 5,000 5,000

Buy 100 suits

1,500 12,000 6,750

If buy 100 suits

• EV with complete information

• EV with incomplete information (buy 100 suits)

• Value of complete information

Chapter 6

Moving from the Consumer Side to the Seller Side and

….Production

Production• Want to look at production behavior

• What are the questions to address?– How much capital to employ?– How much labor to employ?– Should we build a new plant or hire new

workers to increase production?

Look at physical relationship between inputs and outputs

• Production Technology

• Inputs

• Outputs

Inputs vs. Outputs

• What are the inputs/outputs of a– Bakery?

– College?

Production Function

• Indicates ___________ produced for very specified combination of ______________

• Also called ________________

Q = F (K, L)

• ___________________

How differ from IC??

Short Run vs. Long Run

• SR

• LR

One variable input

• Average Product of Labor

Marginal Product of Labor

L K Total Output

APL MPL

0 10 0

1 10 10

2 10 30

3 10 60

4 10 80

5 10 95

6 10 108

7 10 112

8 10 112

9 10 108

10 10 100

To find APL and MPL from graph

• APL

• MPL

Important Points of Graphs

• When APL is upward sloping

• When APL is downward sloping

• Called the _____________________

• Point of intersection between APL and MPL _________________________________

Intersection of APL and MPL

Law of Diminishing Returns doesn’t mean lower quality of

worker

What if technology increases?

Labor Productivity• Found through __________ because fairly easy

to find

• Why need??

Change over the the LR

• K and L are __________

• Use __________to analyze combinations of K and L that will produce the same level of output

Diminishing Returns in both L & K

How see???

How see?

• Hold K constant

• Hold L constant

• Diminishing returns to labor in _______

• Diminishing returns to capital in __________-

• Why???

What else??

• How do we substitute the goods for each other?

MRTSKL

K L

1 7 1

2 4 2

3 3 3

4 2.5 4

What is the MRTSKL between each point?

So…

• MRTS becomes __________

• Labor becomes ___________ as gain more

• Give up _________ to maintain constant output level

Diminishing MRTS

• Shows isoquants are ___________

• Shows any input _____________

MRTS and MR are related

• Additional output from increases in labor is:

• Reduction in output from decreases in capital is:

• To keep output constant the sum must be equal to

0

• Rearrange to:

• So increase labor causes MPL and MPK which causes the isoquant __________________

Special Case Production Functions

• Perfect Substitutes

Perfect Compliments

Returns to Scale

• Why are some firms small and some large?

Increasing Returns to Scale

Decreasing Returns to Scale

Another way to see…• Q = (K/L) + L multiply by 2 and resolve

Constant Returns to Scale

Knowing Q=2K+3L

• What is the MPL?

Remember…

• MRTS is the ______________

• Now we want to bring into the graph the price of inputs to determine optimal cost

Chapter 7

The Cost of Production

So far…• Bring in Cost of Production to find…

How differ from Consumer Theory?

• Consumer theory wanted highest IC could reach given their BC

• Production theory wants highest isoquant can reach with isocost

Two types of Cost• Economic

• Accounting

Other costs to consider• Opportunity Costs

• Sunk Costs

Short Run

• K is _______ and L ____________-

Other costs of importance…Other costs of importance…

• Average Variable Cost (AVC)

• Average Fixed Cost (AFC)

• Average Total Cost (ATC)

• Marginal Cost (MC)

Example…

• Remember the rate at which costs increase depend on the nature of

the production process

Another Example

• With diminishing returns in labor, what happens to labor as increase output???

• So…MC for labor would be

• The MPL is

• The inverse of this is

• So…MC for labor can be re-written as

So…

Can also see diminishing return by looking at MC

MC

---

50

28

20

14

18

20

25

29

38

58

85

Law of diminishing returns also links AVC and APL

• What is the TVC of labor?

• What is the AVC of labor?

• What was APL?

• So…

• Since wages are seen as fixed there is an

_________________ between AVC and APL

• APL=5 and W=30 per hour– Each hour output increases by _______ on average– How much will each unit cost?

– Each unit will take _________ to make

• Direct link between ___________________ and the _______________

What do the curves

look like??

Why does the space between the AVC and ATC decrease??

Average-Marginal Rule

• If MC is above AVC and ATC

• If MC is below AVC and ATC

From Average-Marginal Rule can infer…

How do we find these curves from the Total curves?

• AVC?? ATC??

• MC??

Cost Minimization Input Choice

• Two input variables

• Both can be rented or bought in the market– What are their prices?

Isocost Line

• Includes all possible combinations of _________ that can be purchased given ___________

• Or…as a straight line

What is the slope???

• Ratio of

• Says give up a unit of labor and get ____ units of capital so that TC stays the same

• w=10 and r=5 what is the slope?

How choose inputs???• If want output level of Q1 how can we produce at

minimum cost?

Changes of isocost line

Increase price of labor

What are the slopes???• Isoquant?

• Isocost?

• At tangency the slopes are ___________

example

• w = $10

• r = $2

• Firm chooses inputs so that MP of labor and capital both labor and capital equal 10

• Are we at minimum cost?

Only minimize cost when production of

additional units ____________________________________

_____

Switching to the Long Run

• Now…K and L are both _______________

• Can plot out optimal choices for K and L

In SR constrained by capacity…

• Why??

Short Run vs. Long Run

• Short Run assumes _________________

• Each plant size has a unique ______________ associated with it

• LRATC combines all the _____________

• Which points???

Why?

Isn’t the LRATC curve smooth??

Shape of LRATC

Economies of Scale

Constant Returns to Scale

Diseconomies of Scale

Long-Run Average Total Cost Curve (LRATC) Long-Run Average Total Cost Curve (LRATC)

a

Average Cos t (dollars )

Quantity of Output

Dis economiesof Scale

Cons tantReturnsto Scale

SRATC1

SRATC2

SRATC3 SRATC4

SRATC5

SRATC6

SRATC7

Economiesof Scale

A B

LRATC

Minimumeffic ient s cale

Part (b)

0

How can we measure economies of scale?

3 cases

• MC > AC

• MC < AC

• MC = AC

Are economies, diseconomies, and constant returns to scale in SR, LR, or both???

Is this the same as diminishing returns?

Minimum Efficient Scale for Six Industries Minimum Efficient Scale for Six Industries

a

14.16.63.41.91.40.2

%RefrigeratorsCigarettesBeer brewingPetroleum refiningPaintsShoes

INDUSTRY

MES AS APERCENTAGEOF U.S.CONSUMPTION

SOURCE: F. M. Scherer, AlanBechens te in, Erich Kaufer, and R. D.Murphy, The Economics of MultiplantOperation (Cambridge , Mas s .: HarvardUnivers ity Pres s , 1975), p. 80.

Where would you expect to find less firms? (using MES)

• Why??

• _______ SHOE companies (MES = .2)

• __________ REFRIGERATOR companies (MES = 14)

Efficient Number of Firms

• Cigarette firm’s MES = 6.6

• Petroleum firm’s MES = 1.9

Chapter 8Profit Maximization and

Competitive Supply

Profit Maximization and Competitive Supply

• Extremes– Perfect Competition

– Monopoly

Perfect CompetitionPerfect Competition• Assumptions

Questions to address

• What output level does the firm use?

• How does the choice of output determine the market supply?

MR, MC and Profit Maximization

• _______________ and ______________ are the same thing

R(q)

C(q)RevenueCost

Quantity

Quantity

Profit

A B C

Profit

Revenue Curve

• What is the revenue when output = 0?

• Curve increases at an increasing rate, then decreasing rate, then negative rate

Price Taker

• What is R(q) of producing q units?

• What is AR?

• What is MR? Units revenue

1 P

2 2P

Demand Curve• Industry

• Individual Market

• Demand Curve is also __________ curves

• Why?

Why horizontal??• What happens to elasticity as increase the

number of substitutes for the good?

• How many substitutes exist for a homogenous good?

• What type of elasticity does this demand have?

What if assumptions don’t hold?

• Difference small?

• Difference big?

When will firm produce??

• Produce as long as ________

• Do not produce if ______________

• Maximize profit where ____________

Profit Maximization Rule

Since…

Four Cases: Produce or not?• Price equals ATC

• Price above ATC

• Price below AVC

• Price below ATC but above AVC

• Each case must start with _____________

• What was that rule???

Price equals ATC

Price above ATC

Price below AVC

Shut Down Rule

• If ____________-- should shut down

• Why?

Price below ATC but above AVC

What Should a Firm Do in the Short Run?

What Should a Firm Do in the Short Run?

a

Pric e

Co ntinue topro duce

Shut downNo

Ye s

Is it aboveAVC?

Co ntinue topro duce

Ye s

No

Is it aboveATC?

Perfectly Competitive Firm's Short-Run Supply Curve

Perfectly Competitive Firm's Short-Run Supply Curve

a

Cos t

Quantity0

Firm’sShort-run

Supply Curve

MC

AVC

How find the market supply curve?

• What is the individual firm’s supply curve?

• _______________- all individual supply curves to get the market supply curve

• Why are market supply curves upward sloping??

Job Security and fixed costs?

• Is this the Short Run or Long Run?

• Increases in __________________ means more job security

• Why?

Which firm has more job security?

Firm X Firm Y

TC 600 600

TVC 400 500

TFC 200 100

Firm ______ has more job security!!

• Unions know this so usually negotiate more benefits for workers before wages

• Why??

Will there be the same number of firms in the short and long runs?

• If there is a profit

• If there is a loss

• If there is normal profit

Long Run Competitive Equilibrium

Summary of Incentives present at Long Run Equilibrium

What if increase demand at LR competitive equilibrium??

• Equilibrium price will ________

• What caused this increase in price?

• Existing firms ____________ Quantity

• Why?

• Why?

• Do you think this would lead to profits or

losses?

• What would this do to the number of firms in the industry?

• What does this increase in firms do to supply?

• What happens to equilibrium price?

Wow…1. Industry in LR equilibrium2. Demand increases (both firm and market)3. Equilibrium price increases4. Firms gain profits from increase5. New firms enter to get profits6. New firms cause supply to increase7. Equilibrium price decreases8. Firm demand curve decreases to reflect

new market price

Is ending equilibrium price higher or lower than original???

• Three types of industries

Constant Cost Industry

How can profits be reduced?

Connecting equilibrium points on market graph gives you…

Increasing Cost Industry

Decreasing Cost Industry

What if demand decreases??

• Demand Shift _______

• Equilibrium Price ___________

• Firms suffer ___________

• Supply shifts ___________

• Equilibrium Price _________-

Perfect Competition

• Resource Allocative Efficiency

• Productive Efficiency

Chapter 10

MONOPOLY

Assumptions

Two types of Monopolies

• Government monopolies

• Market monopolies

Price maker

Demand Curve

• What does the demand curve look like??

What differs here from Perfect Competition??

• Price doesn’t equal ________!!!

• Monopolist’s demand curve and marginal revenue curves are __________

ExamplePrice Quantity

DemandTR MR

10 1

9 2

8 3

7 4

Goal

• Profit Maximization

• What is the profit maximization rule?

Three cases

• P > ATC

• P < ATC

• P=ATC

• Where is AVC??

Differences between monopoly and perfect competition

Similarities

Long Run Profits

Monopolies are inefficient compared to Perfect Competition

Chapter 11

Pricing with Market Power

Does monopolist have to charge same price to everyone?

• Called _________________________

• Three types– First degree– Second degree – Third degree

Perfect Price discrimination

Bulk Pricing

Group Pricing

Why Price Discriminate?

Why doesn’t everyone price discriminate?

Does a monopolist exhibit resource allocative efficiency?

So does one person paying high prices mean that another can pay low prices??

Would firms rather be a monopoly?

Chapter 12

Monopolistic Competition and

Oligopolies

Monopolistic CompetitionFour Assumptions

Examples

• What about cereals??

Monopolistic is combination of Perfect Competition and Monopoly

Why most likely????

Still have three cases

• P = ATC

• P > ATC

• P < ATC

Differs from perfect competition…

The more we differentiate our

product the closer we get to _______.

If we can’t differentiate our product we are

closer to ________.

Oligopoly

OligopolyFour assumptions

How find???

So…

• High concentration ratio?

• Small concentration ratio?

Question…

How do firms react to actions of other firms??? Important since they are

interdependent!

Three theories

• Kinked Demand Curve Theory

• Price Leadership Theory

• Cartel Theory

Kinked Demand Theory

Demand Curve

• Flatter above kink

• Steeper below kink

Why kinked

So…

Criticisms

Price Leadership Theory

So…

• Dominate firm

• Fringe Firm

Dominate Firm does not have to be the

________!!! It could be the one with the _____________!!

How derive demand curve?

From Demand Curve

Cartel Theory

Problems for a cartel

Why Cheat???

The Government tries to keep some cartels together

• Farmers

• Airlines

• Each tends to increase _______________

Game Theory

Prisoner’s dilemma

Prisoner's Dilemma Prisoner's Dilemma

a

Bob’sChoices

Nathan’s Choices

NotConfess

Confess

Confess

Not Confess

Nathan pays $2,000

Bob pays $2,000

Nathan pays $5,000

Bob pays $500

Nathan pays $500

Bob pays $5,000

Nathan pays $3,000

Bob pays $3,000

1 2

3 4

Cartels and Prisoner's Dilemma Cartels and Prisoner's Dilemma

a

Firm B’sChoices

Firm A’s Choices

Hold toAgreement

BreakAgreement

BreakAgreement

Hold toAgreement

A earns $50,000 profits

B earns $50,000 profits

A earns $5,000 profits

B earns $100,000 profits

A earns $100,000 profits

B earns $5,000 profits

A earns $10,000 profits

B earns $10,000 profits

1 2

3 4

Characteristics & Consequences of Market Structures

Characteristics & Consequences of Market Structures