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 Demand
Change in Demand vs. Change in
Quantity Demanded
• Change in Demand
• Change in Quantity demanded
Change in Demand versus
Change in Quantity Demanded
Pric e
Pric e
A c hang e in
quantity demande d
(a mo ve me nt alo ng
the de mand c urve , D )
A c hang e in de mand
(a s hift in the
de mand c urve )
B
A
D
D
0
Quantity De mande d
(a)
D
0
Quantity De mande d
(b)
Change in Demand
• SHIFT LEFT??
• SHIFT RIGHT??
Shifts in the Demand Curve
Part (a)
Pric e (do llars )
Rig htward s hift
in de mand c urve
(inc re as e in de mand)
30
A
B
D
D
0
500
700
Quantity De mande d o f Blue Je ans
Shifts in the Demand Curve
Part (b)
Pric e (do llars )
Le ftward s hift
in de mand c urve
(de c re as e in de mand)
30
B
A
D
D
0
450
650
Quantity Demande d of Blue Je ans
Change in price of related
goods
• Substitutes
• Compliments
Substitutes
Part (a)
S UBS TITUTES
Pric e
Pric e
P2
P1
B
If Co c a-Co la and
Pe ps i-Co la are
s ubs titute s , a
hig he r pric e fo r
Co c a-Co la le ads to . . .
A
. . . a rig htward
s hift in the de mand
c urve fo r Pe ps i-Co la.
DCC
0
Qd 2 Qd1
Quantity De manded o f Co c a-Cola
DPC 2
DPC 1
0
Quantity De mande d o f Pe ps i-Cola
Complements
Part (b)
COMPLEMENTS
Pric e
P2
If te nnis rac ke ts and
te nnis balls are
c o mple me nts , a hig he r
pric e fo r te nnis
rac ke ts le ads to . . .
Pric e
B
A
P1
. . . a le ftward
s hift in the de mand
c urve fo r te nnis balls .
DTB 1
DTR
0
Qd 2
Qd1
Quantity De mande d o f Te nnis Rac ke ts
DTB 2
0
Quantity De mande d o f Te nnis Balls
Examples
• 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 Supply
Change in Supply vs. Change in
Quantity Supplied
• Change in Supply
• Change in Quantity Supplied
Change in Supply versus
Change in Quantity Supplied
Pric e
Pric e
S
S
S
B
A
A c hang e in s upply
(a s hift in the
s upply c urve )
0
Quantity S upplie d
(a)
0
A c hang e in
quantity
(a mo ve me nt alo ng
the s upply c urve ,S )
Quantity S upplie d
(b)
Change in Supply
• SHIFT LEFT??
• SHIFT RIGHT??
Shifts in the Supply Curve
Part (a)
Pric e (do llars )
Rig htward s hift
in s upply c urve
(inc re as e in s upply)
5
0
A
200
S
S
B
300
Quantity S upplie d o f Go o d X
Shifts in the Supply Curve
Pa rt (b)
Pric e (do llars )
S2
5
B
S1
A
Le ftward s hift
in s upply c urv e
(de c re as e in s upply)
0
50
150
Qu antity S upp lie d o f Go o d X
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???
• 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
Qd  8  2 P
Qs  1  5P
What is equilibriu m price and quantity
Can check results graphically
• Q = 8 – 2P
d
– ____ is the intercept
– ____ is the slope
• Qs = 1+ 5P
– ____ is the intercept
– ____ is the slope
Elasticity
© South-Western College Publishing 1998
Elasticity
Elasticity of ONE point
%Q
Ed 
%P
Elasticity between two points
Qd
Qd 1  Qd 2
 Qd 1  Qd 2 
 Qd 1  Qd 2 




2
2




Ed 

P
P1  P2
 P1  P2 
 P1  P2 




 2 
 2 
So…
• What if Ed = 3?
• Shouldn’t it be negative?
Elasticity of demand can yield 5 basic results
1.
2.
3.
4.
5.
•
Numerator > Denominator
Numerator < Denominator
Numerator = Denominator
Numerator = 0
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
A
B
C
D
E
F
G
P
8
7
6
5
4
3
2
Qd
3
4
5
6
7
8
9
Determinates of price elasticity of demand
Price Elasticity of Supply
Qs
Qs1  Qs 2
 Qs1  Qs 2 
 Qs1  Qs 2 




2
2




Es 

P
P1  P2
 P1  P2 
 P1  P2 




 2 
 2 
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
A
Food
Clothing
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…
I Pf
C 
F
Pc Pc
• Prices double
How about if…
• Income and Prices double
I Pf
C 
F
Pc Pc
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
The Result is Three Points
• 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 ________________
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
1
6
10
16
2
4
8
13
3
2
6
10
4
0
4
7
5
0
2
4
MARKET
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 tickets
One 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
Probability
Lazy
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
Probability
Lazy
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
Probability
Lazy
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)
10,000
10
15,000
18
16,000
24
20,000
28
30,000
30
MU(x)
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
5,000
Sales of
100
5,000
Expected
Profits
5,000
Buy 50
suits
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
0
1
2
3
4
5
6
7
8
9
10
10
10
10
10
10
10
10
10
10
10
10
Total
Output
0
10
30
60
80
95
108
112
112
108
100
APL
MPL
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
What is the MRTSKL between each point?
K
L
1
7
1
2
4
2
3
3
3
4
2.5
4
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
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…
•
•
•
•
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 _______________
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)
Part (b)
Ave rag e Co s t (do llars )
S RATC7
S RATC1
S RATC6
S RATC2
S RATC5
S RATC3 S RATC
4
Ec o no mie s
o f S c ale
A
Co ns tant
Re turns
to S c ale
0
B
Dis e c o no mie s
o f S c ale
Quantity o f Output
Minimum
e ffic ie nt s c ale
LRATC
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
INDUS TRY
Re frig e rato rs
Cig are tte s
Be e r bre wing
Petro le um refining
Paints
S ho e s
MES AS A
PERCENTAGE
OF U.S .
CONS UMPTION
14.1 %
6.6
3.4
1.9
1.4
0.2
S OURCE: F. M. S c he re r, Alan
Be c he ns te in, Eric h Kaufe r, and R. D.
Murphy, The Ec o no mic s o f Multiplant
Ope ratio n (Cambridg e , Mas s .: Harvard
Unive rs ity Pre s 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 8
Profit Maximization and
Competitive Supply
Profit Maximization and Competitive
Supply
• Extremes
– Perfect Competition
– Monopoly
Perfect 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
Revenue
Cost
C(q)
R(q)
A
Profit
B
C
Quantity
Profit
Quantity
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?
Yes
Continue to
produce
Is it above
ATC?
No
Price
Yes
Continue to
produce
No
Shut down
Is it above
AVC?
Perfectly Competitive Firm's
Short-Run Supply Curve
Co s t
MC
Firm’s
S ho rt-run
S upply Curve
0
Quantity
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.
2.
3.
4.
5.
6.
7.
8.
Industry in LR equilibrium
Demand increases (both firm and market)
Equilibrium price increases
Firms gain profits from increase
New firms enter to get profits
New firms cause supply to increase
Equilibrium price decreases
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 __________
Example
Price
10
Quantity
Demand
1
9
2
8
3
7
4
TR
MR
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 Competition
Four 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
Oligopoly
Four 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
Nathan’s Choices
Confess
Not Confess
2
1
Not
Confess
Nathan pays $500
Nathan pays $2,000
Bob pays $5,000
Bob pays $2,000
Bob’s
Choices
Confess
4
3
Nathan pays $5,000
Bob pays $500
Nathan pays $3,000
Bob pays $3,000
Cartels and Prisoner's Dilemma
Hold to
Agreement
Firm A’s Choices
Break
Agreement
1
Hold to
Agreement
A earns $50,000 profits
B earns $50,000 profits
Firm B’s
Choices
Break
Agreement
2
A earns $100,000 profits
B earns $5,000 profits
3
A earns $5,000 profits
B earns $100,000 profits
4
A earns $10,000 profits
B earns $10,000 profits
Characteristics & Consequences
of Market Structures