Welcome to Day 20
Principles of
Microeconomics
Chapter 10
Monopoly
3 Properties of Monopoly
1) One Seller
2) No Close Substitutes
3) Extremely High Barriers to Entry
What are the barriers to entry?
1) Government Restrictions –
Patents
2) Economies of Scale – Natural
Monopoly
3) Restricted Ownership of Raw
Material - ALCOA
Monopoly and Microsoft
Computers in the early 1980’s
1) Apple II
2) Commodore PC
3) Atari 400 (48k)
4) TRS-80
5) IBM PC
All had incompatible
operating systems
Next Generation – Mid 1980’s
1) Early Macs
2) Commodore Amiga
3) Atari ST
4) --5) IBM 386’s, 486’s
The Amiga and Atari ST are dying
of software suffocation.
By the late 1990’s, only the IBM
and its clones, and the Mac are
left.
IBM doesn’t have near monopoly
because of the clones, but
Microsoft does for Windows
Microsoft starts to use this
monopoly of Windows to take over
word processing and web browsing
Government Antitrust Suit Against
Microsoft (1999)
Bush wins the election of 2000 and
the Republican lawyers drop the
case in return for Microsoft’s
promise not to do it again.
This is a variation of the economies
of scale. How can you make a
computer/operating system to
compete with Microsoft when the
software industry is designed to
work with Windows? You would
have to provide your own
software, which would mean
starting on a huge scale.
If this is the market demand curve
for the monopoly’s product, what is
the monopoly firm’s demand curve?
P
P1
Market
P
P2
D
Q1 Q2
Q
Firm
?
Q
The firm’s demand curve is the same
as the market’s because the firm is
the market.
P
P1
Market
P2
D
Q1 Q2
Q
=
P
P1
P2
Firm
Q1 Q2
Q
What’s the relationship between price
and marginal revenue for a monopoly?
Q
0
1
2
3
4
5
P
$10
$8
$6
$4
$2
$0
TR
$0
$8
$12
$12
$8
$0
MR
-$8
$4
$0
-$4
-$8
What’s the relationship between price
and marginal revenue for a monopoly?
Q
0
1
2
3
4
5
P
$10
$8
$6
$4
$2
$0
TR
$0
$8
$12
$12
$8
$0
MR
-$8
$4
$0
-$4
-$8
Marginal revenue is
below price because
each additional unit
you sell causes the
price of the other
units to drop also.
Suppose McDonalds is currently
selling 100 hamburgers at 50 cents
each. TR = $50
They lower their price to 40 cents
and now sell 150. Will their total
revenue rise by 50 hamburgers
times 40 cents = $20?
No. Total revenue rises by 50
hamburgers times 40 cents minus 100
hamburgers times 10 cents = $10.
Let’s double-check.
Q x P = TR
100 hamburgers x 50 cents = $50
150 hamburgers x 40 cents = $60
Yep, it checks.
How to graph the demand and
marginal revenue curve for a
monopoly. For straight
P
0
MR
0
D
Q
lines, the MR
curve hits the
horizontal axis
halfway
between where
the demand
curve does and
the origin.
So how much will the monopolist
produce, and what price will he charge?
Q
0
1
2
3
4
5
P
$10
$8
$6
$4
$2
$0
TR TC
π
$0 $0 -$10
$8 $3 $5
$12 $6 $6
$12 $9 $3
$8 $12 -$4
$0 $15 -$15
MR
--$8
$4
$0
-$4
-$8
MC
--$3
$3
$3
$3
$3
The Marginal Decision Rule Again
Produce the Quantity Where
MR=MC
Then up to
the demand
curve to
determine
the price.
Profit or Loss? Same rule as before.
P>ATC Profit
P<ATC Loss
What we learned today.
1. The 3 properties of Monopoly.
2. How the monopolist’s demand
curve is the market demand curve.
3. That the monopolist’s marginal
revenue is below his price.
4. How to graph the monopoly firm’s
price and quantity.
Welcome to Day 21
Principles of
Microeconomics
What we learned yesterday.
1. The 3 properties of Monopoly.
2. How the monopolist’s demand
curve is the market demand curve.
3. That the monopolist’s marginal
revenue is below his price.
4. How to graph the monopoly firm’s
price and quantity.
P
Price and quantity of donuts in a
market with perfect competition.
Perfect
Competition
P=ATC
MC=ATC
Pc=0.4
D
0
0
Qc=600
Q
Price and quantity of donuts
in a monopoly.
P
Pm=0.7
Pc=0.4
0
m for
monopoly
c for
competitive
Monopoly
MR=MC
MC=ATC
MR
0 Qm=300 Qc=600
D
Q
With perfect competition, the price of
donuts is 40 cents and 600 are made.
With monopoly, the price of the donuts is
70 cents and 300 are made.
The monopolist makes less of the
product to create a scarcity and raise the
price up.
Price discrimination is charging
different prices to different
customers.
You would like to charge a higher price
to the customers at the higher end of
the demand curve.
P
D
0
0
Q
Who are these people?
Sometimes they are richer people.
What traits are associated with
being poor?
What traits are associated with
being poor?
Traditionally, retired seniors have
been poor, and students.
It costs $6 to make dinners at your
restaurant. When you charge $12, you get
one customer, when you charge $10, you
get two. Would you rather charge $12 or
$10?
Can you do better with price discrimination?
What if you have noticed the additional
customers when it is cheaper are mostly
seniors?
Charge straight $12
Profit = $12 - $6 = $6
Charge straight $10
Profit = $20 - $12 = $8
Charge one customer $12 and the
other (senior) $10.
Profit = $22 - $12 = $10
This could also explain student
discounts at the movie theater.
What else could distinguish people
from the high price end of the
demand curve and the lower end?
Think about men and women if this
was demand for baseball tickets.
P
And what if it
was demand
at the hair
salon?
D
0
0
Q
There’s a reason the
Washington
Nationals have
ladies night and not
mens night. There’s
a reason California
hair salons were
sued for charging
women higher
prices.
What about quantity discounts? There’s
a reason bakers give a free donut if you
buy a dozen. Donuts price = $1. Cost of
making donuts = 50 cents.
Sell 8 and charge for them all.
Profit = $8 - $4 = $4
Sell 13 and charge for 12.
Profit = $12 - $6.50 = $5.50
NEW YORK
NYC Human Rights Commission Drops
Charges Against Chinese Restaurant
By Meg Marco May 2, 2007
The case of the Wisconsin man who
filed a complaint with the NYC Human
Rights Commission has come to a close
with the commission dropping charges
against the restaurant.
… “We saw other customers getting
a different menu. We were told we
could order from it if we spoke
Chinese.” The Chinese menu had
prices that were, on average, $1
cheaper per dish.
Soon after the dust-up, Mayor
Bloomberg urged a boycott of the
shady Chinese restaurant. “It’s
unconscionable to use race on any of
these things, in terms of what kind of
service, or how you charge, or
whatever,” Bloomberg told the Daily
News.
The Human Rights Commission
dropped the charges after the guy
from Wisconsin settled with the
restaurant for an undisclosed sum
and, “a promise to change its menu
– by “listing identical prices in
English and Chinese for the same
dishes,”
Chapter 11
Monopolistic Competition and
Oligopoly
Monopolistic Competition
1) Many Sellers
2) Similar Products or
Differentiated Products
3) Easy Entry/Exit
Restaurants are the “typical”
example of monopolistic
competition that we are usually
going to use. Other examples are
barbers and hair salons, and autorepair shops.
So what does the demand curve
look like for a firm in monopolistic
competition?
P
Perfect
Competition
D
P
Monopoly
D
Q
Q
If McDonalds raises the price of the
Big Mac by 10 cents, do they lose
all of their customers?
Do they have to lower their price
to sell more?
So McDonalds demand curve slopes down
like a monopoly. It does probably lose
more customers with a price increase
than a monopoly, so it will be flatter.
P
Monopolistic
Competition
P
Monopoly
D
D
Q
Q
You don’t have to worry about
drawing it flatter. We’ll assume the
units on the axis take card of that.
P
Monopolistic
Competition
P
Monopoly
D
D
Q
Q
What we learned today.
1. The monopolist produces less and
charges more than competition.
2. What price discrimination is.
3. The 3 properties of monopolistic
competition.
4. What the demand curve looks like
for monopolistic competition.
Welcome to Day 22
Principles of
Microeconomics
What we learned yesterday.
1. The monopolist produces less and
charges more than competition.
2. What price discrimination is.
3. The 3 properties of monopolistic
competition.
4. What the demand curve looks like
for monopolistic competition.
Since the demand curve slopes down
showing that Rosa has to lower the price
of all her spaghetti dinners to sell more,
her marginal revenue is below price.
P
Monopolistic
Competition
MC
D
MR
Q
Now it is simply adding the MC and
setting MR=MC as before.
P
Monopolistic
Competition
MC
P1
D
Q1
MR
Q
And guess what? The rule about
showing a profit and loss is the same
too. P> ATC then profit. P<ATC then
loss.
MC
P
ATC
P1
D
Q1
MR
Q
What about profits in the longrun?
What happens when you have
both easy entry and differentiated
goods?
Imagine restaurants in Bakersfield are
making positive economic profits.
What will happen to the number of
restaurants?
These new restaurants will keep
opening until profits for the typical
restaurant are driven to $0. Does
this mean all restaurants are
making $0 profit like the wheat
farms in perfect competition?
Some places, probably only a few, will
be able to differentiate themselves
enough from the their competitors to
keep their profits.
So the result will be that profits
usually go to zero in the long-run,
but not always.
Though even if you have a better
restaurant in some way and can
make profits even in the long-run,
it will be hard to maintain that
advantage.
Oligopoly
1) Few Sellers
2) Identical or Differentiated
Products
3) High Barriers to Entry
Most of the famous brand name
competition you know falls in this category:
1) Ford, GM, Chrysler
2) Coca-Cola and Pepsi
3) Nike and
Adidas
The high barrier to entry is often
that the factories have economies
of scale, so there is a high fixed
cost to enter.
There might also be strong brand
loyalty and its associated high
advertising cost.
For once we don’t have a demand
curve and the rule to set MC=MR.
Why not?
Ford currently has price P1 and is
selling Q1 cars. What happens if
they have a 20% off sale?
D1 – GM doesn’t
change price
D2 – GM cuts
price 10%
D3 – GM cuts
price 20%
P1
P2
Q1 ?
?
?
Unless Ford knows how GM is
going to respond, they don’t know
many additional sales they are
going to get with a price cut.
The key word for oligopoly is
interdependence.
Why haven’t we worried about
how competitors respond to our
price changes before?
1) Monopolies don’t have
competitors.
2) In Perfect Competition, we don’t
lower our price. If we did, our
competitors would laugh at us and
keep charging the equilibrium
price.
3) What about Monopolistic
Competition?
400 restaurants in Bakersfield.
Rosa’s Italian Restaurant serves
200 dinners in a typical night.
Rosa cuts her price by 20% and
gains 20% more customers. BTW,
what is her elasticity of demand if
this happens?
Rosa’s gets 40 more customers a night.
How many customers do most of the
400 other restaurants in Bakersfield
lose?
So how do they respond?
Rosa's Italian Restaurant
Open everyday! (661) 872-1606
This is Rosa’s demand curve for
her spaghetti dinners. What am I
assuming the other
P
restaurants are doing as
she lowers her price
P1
from P1 to P2?
P2
D
0
0
Q1 Q2
Q
Can I make the same assumption
between Ford and GM?
So what are we going to do?
What we learned today.
1. How to graph price and quantity
for monopolistic competition.
2. The long-run equilibrium for
monopolistic competition.
3. The 3 properties of oligopoly.
4. Why there is no demand curve for
oligopoly.
Welcome to Day 23
Principles of
Microeconomics
What we learned yesterday.
1. How to graph price and quantity
for monopolistic competition.
2. The long-run equilibrium for
monopolistic competition.
3. The 3 properties of oligopoly.
4. Why there is no demand curve for
oligopoly.
East U.S. Steel and West U.S. Steel are
the two competing steel companies in
the country. Steel costs $10 a ton to
P
make. Currently they are
competing and have a price
of $11 a ton.
MC
$11
$10
D
0
0
Qa
MR
Q
If they cooperate in setting a
price that will make the most
money
for
them
jointly,
how
P
would you find that price?
MC
$11
$10
D
0
0
Qa
MR
Q
Act like a monopoly, reduce output
and raise price until MR = MC. Now
the price is $13 and they are
P
jointly producing Qm.
$13
$11
$10
MC
D
0
0
Qm Qa
MR
Q
These two firms are price fixing.
Price fixing is when firms agree to
jointly produce less output and
raise the price.
A cartel is a group of businesses
that are price fixing or in collusion.
This is in many cases illegal. But it
is like everything else, it is only
illegal if you get caught.
You don’t announce it or admit it …
unless you get caught.
So, is that it? Big firms will always
successfully collude unless the
government stops them?
No, there is something else,
something called the
Prisoner’s Dilemma.
Suppose the police pick up 2 men they
suspect of bank robbery. They have
enough evidence to convict them for
illegal possession of a gun, but need a
confession to get them for bank robbery.
Prisoner 2
Hold Out
Confess
Hold
Out
Prisoner 1
Pris 1: 1 Year
Pris 2: 1 Year
Pris 1: 20 Years
Pris 2: 0 Years
Pris 1: 0 Years Pris 1: 10 Years
Confess
Pris 2: 20 Years Pris 2: 10 Years
Cooperation in holding out is the
best joint outcome, but it is hard to
get their because, given what the
other person has done, confessing
is always the best choice for each
individual to make.
The Dark Knight Film Clip
So what does this all have to do
with cartels?
Keep
Agreement
Firm 2
Keep
Firm 1: $60
Agreement Firm 2: $60
Firm 1
Firm 1: $90
Cheat
Firm 2: $10
Cheat
Firm 1: $10
Firm 2: $90
Firm 1: $30
Firm 2: $30
So we have two forces acting on
the firms at the same time.
1) The awareness that they make
more money if they cooperate than
if they both don’t.
2) The awareness each has that he
makes the most money if he says he
will cooperate, but then doesn’t.
So it is not certain in this model
what will happen, but that fits real
life, where many different
outcomes have occurred.
What makes a cartel more likely to
work?
1) Less Firms
2) More Personal Trust
3) Easier to Watch the Other Guy
4) A Way to Punish the Other Guy
5) Stable Demand For the Product
6) Repeated Opportunities
Suppose it costs $100 to fly someone
from LAX to SFO. The airlines could
agree on a price of $200 but would be
vulnerable to the prisoner’s dilemma
What if they can get the
government to set them a price of
$160? Are they safe from the
prisoner’s dilemma?
How else to airlines compete
besides price?
This quality of service competition raises
the cost of flying a passenger up close to
$160. So are the airlines making high
profits from their guaranteed high price of
$160?
The same story explains why banks
famously used to give something
away when you opened a bank
account.
What happened to the free toasters?
What we learned today.
1. Why firms in Oligopoly may use
price fixing.
2. How the prisoner’s dilemma
works.
3. What happened in the airline and
bank oligopolies.
Welcome to Day 24
Principles of
Microeconomics
What we learned yesterday.
1. Why firms in Oligopoly may use
price fixing.
2. How the prisoner’s dilemma
works.
3. What happened in the airline and
bank oligopolies.
Chapter 12
Wages and Employment
in Perfect Competition
What does economics have to say
about the wages workers make and
how many are hired?
N
3
4
5
6
7
Q MPPL N=Number Workers
150 -- Q=Quantity Cookies
200 50 MPPL=Marginal
240 40
Physical
270 30
Product of
290 20
Labor
New Term – Marginal Revenue Product
of Labor = Increase in Total Revenue
Achieved by Adding One More Worker
N
3
4
5
6
7
Q MPPL MRPL
150 -200 50
240 40
270 30
290 20
If the price of a box of cookies is 3
dollars each, then:
N
3
4
5
6
7
Q MPPL MRPL
150 -200 50
$150
240 40
$120
270 30
$90
290 20
$60
Marginal Factor Cost = MFC =
Increase in total cost caused by
buying one more input.
If MFC = $135, how many workers
would you hire? What if MFC = $75?
N
3
4
5
6
7
Q MPPL MRPL
150 -200 50
$150
240 40
$120
270 30
$90
290 20
$60
So the rule is buy workers up to the
point where MRP = MFC.
Graph of MRP for this business.
$
$150
$120
$90
$60
MRP
0
0
4
5
6
7
Q
The MRP curve is the demand
curve for labor
$
$150
$120
$90
$60
MFC1
MFC2
MRP
0
0
4 N1 5
6 N2 7
Q
Now that we have the individual
firm’s demand curve for labor, we
can add all the firm’s individual
demand curves to get the market
demand for that kind of labor.
Here is the total demand curve.
Now we add in the supply curve.
$
$150
$120
$90
$60
Firm
demand
curves
DL
0
0
40
50
60
70 Q
Equilibrium wage is $90 and 55
workers are hired.
$
$150
$120
$90
$60
SL
DL
0
0
40
50
60
70 Q
What if technological progress
increases MRP and thus Demand?
$
$150
$120
$90
$60
DL2
DL1
0
0
40
50
60
70 Q
Increase in equilibrium wage from
$90 to $120 and number of
workers hired from 55 to 60.
The name for the theory of wages
we are using here is the Marginal
Productivity Theory of Factor Input
Prices. It state that under
competition, factor inputs are paid
the marginal revenue produce.
Imagine a bag of fertilizer that has a
MRP of $90. In other words, one bag
used on farm land will cause $90 more
wheat to grow. What will its price in
the farm supply store be? Could it be
$60?
At $60, there will be a rush to buy
it. Buying it is like buying a box
that you can put $60 in one end
and $90 comes out the other. This
will cause a shortage that will drive
up the price. The rush will last till
the price reaches $90.
If the price starts at $120, then no
one will want to buy it until the
price falls to $90. The equilibrium
price will adjust to its MRP of $90.
Same for pop singers.
Suppose Shakira
makes $5 million
revenue for her
record company.
Further suppose they
are currently paying
her $1 million. Do
they like that deal?
Of course they do. But how can the
record company across the street
see a way to make money for
themselves out
of this situation
when her
contract with the
original company
expires?
With many firms “bidding” for her
services, her price should end up at
$5 million.
If there was only the one firm, they
could stand firm at $1 million.
As for pop singers, so for
accountants. If accountants make
an MRP of $80,000 for their
businesses, their wage should be
$80,000. Can you explain why?
What we learned today.
1. What marginal revenue product
and marginal factor cost are.
2. The MRP curve is the firm’s
demand curve for labor.
3. The marginal productivity theory
of factor input prices.
Welcome to Day 25
Principles of
Microeconomics
What we learned yesterday.
1. What marginal revenue product
and marginal factor cost are.
2. The MRP curve is the firm’s
demand curve for labor.
3. The marginal productivity theory
of factor input prices.
Let’s clear up a couple of loose
ends.
1) When we say workers are paid
their MRP, do we mean they all get
the same wage or different wages.
2) If a business pays all its workers
all they produce, how can they stay
in business? Will there be anything
left over for profit?
Let’s attach names to our workers.
Remember, price = $3.
N
3
Amy 4
Bart
5
Carla 6
David 7
Q MPPL MRPL
150 -200 50
$150
240 40
$120
270 30
$90
290 20
$60
What is the most the company is
willing to pay David to show up?
N
3
Amy 4
Bart
5
Carla 6
David 7
Q MPPL MRPL
150 -200 50
$150
240 40
$120
270 30
$90
290 20
$60
If the workers are interchangeable,
what is the most they are willing to
pay Amy to show up?
N
3
Amy 4
Bart
5
Carla 6
David 7
Q MPPL MRPL
150 -200 50
$150
240 40
$120
270 30
$90
290 20
$60
So long as the workers are
interchangeable, all of them end
up getting paid $60, not just David.
The MRP of a person is not
necessarily the same as the MRP of
the job they are doing.
If Amy is not interchangeable with
the others, then she can get $150
while they get $60 each.
What is total revenue to the
company from 290 cookies. What
is the labor bill?
N
3
Amy 4
Bart
5
Carla 6
David 7
Q MPPL MRPL
150 -200 50
$150
240 40
$120
270 30
$90
290 20
$60
Total Revenue P x Q = $870.
Wage Bill = $60 x 7 = $420.
This does not guarantee a profit as
there are other costs, but there is a
chance for one.
What if the market wage is $90
and government raises it to $120?
N
3
Amy 4
Bart
5
Carla 6
David 7
Q MPPL MRPL
150 -200 50
$150
240 40
$120
270 30
$90
290 20
$60
Raising the minimum wage
from $90 to $120.
$
$150
$120
$90
$60
MRP
0
0
4
5
6
7
Q
Minimum wage of $120.
$
$150
$120
$90
$60
Surplus
Labor
SL
DL
0
0
40 N2 50 N1 60 70 Q
Let’s tell a long-term story of men,
women, technology, and MRP
In the old days (say 1014), we
know that men and women had
different rights and responsibilities.
By our standards, it was an
unequal society. Why?
What percentage of the jobs
depending at least partly on
physical strength to do the job
well?
(Almost) everyone is poor, what is
your retirement plan?
Given your retirement plan, and
given that half your kids are going
to die before adulthood, how many
kids do you want to have?
How many jobs depend heavily on
physical strength now?
Why?
What caused this?
In the terminology of this chapter,
technology has made the MRP of
men and women equal. And this
has had great social consequences.
What matters
know is what
you know, not
how big a rock
you can lift.
This same thing has increased the
inequality between the educated
and the uneducated.
Who knows what the future will
bring … but I do know one thing.
You want training that will work
with the machines and not against
them.
What we learned today.
1. The wage interchangeable
workers will earn.
2. How technology has changed the
MRP of men and women and the
educated and uneducated and what
this has done to equality/inequality.
Welcome to Day 26
Principles of
Microeconomics
What we learned yesterday.
1. The wage interchangeable
workers will earn.
2. How technology has changed the
MRP of men and women and the
educated and uneducated and what
this has done to equality/inequality.
Chapter 7
The Analysis of
Consumer Choice
So you go to the store and buy a
bag of groceries. I stop you
outside the store and ask why you
bought that combination of goods
and not a different combination.
You answer something like, “These
are the things I like the best for the
money.”
Economists call the benefit or
satisfaction you get from
something its utility.
You make your choices on what to
buy or do to get the most utility
possible. Utility is an all things
considered measure of benefit, not
just how pleasurable something is.
1st Donut 2nd
3rd
4th
Marginal 10 utils 8 utils 3 utils -1 utils
Utility
1st Donut 2nd
3rd
4th
Marginal 10 utils 8 utils 3 utils -1 utils
Utility
Total
Utility
10 utils 18 utils 21 utils 20 utils
If the donuts are free, how many donuts
would you take?
Law of Diminishing Marginal Utility
– As you get more of a good or
activity, the increase in total utility
decreases with each additional
unit.
Are there are any goods or
activities that do not have
diminishing marginal utility?
Does money have diminishing
marginal utility?
Since goods have diminishing
marginal utility and money is used
to buy goods, money should also.
The dollar you get that you use to
buy donut number 3 is less
beneficial to you than the dollar
you get to buy donut number 1.
Do people get utility from things
that happen after they are dead?
Do people get utility from things
that happen after they are dead?
If they don’t, how do you
explain buying life insurance?
So how does all this explain how
much of everything we buy at the
store?
You want to get as much benefit as
you can for the money you have.
This means you want to get as
many utils per dollar as you can.
Shopping is trying to get the most
bang for the buck.
Imagine everything in the store costs
$1 and how much of each would you
buy if you had $1 … $2 … $3 … $4?
1st
2nd
3rd
Candy
14
10
7
Milk
8
4
2
Eggs
6
5
3
Now what if you had $4 and candy
cost $2 while the rest cost $1?
Assume you can buy fractions of
candy.
1st
2nd
3rd
Candy
14
10
7
Milk
8
4
2
Eggs
6
5
3
The benefit you get from buying
something is determined by
comparing how much you like it to
its price. Of course we call how
much you like it the marginal
utility. So the benefit of spending a
dollar on good X is MUx/Px
MUx/Px for our 3 goods when price
of candy is $2 so this is the return
in utils per dollar spent.
st
1
2nd
3rd
Candy Milk
7
8
5
4
3.5
2
Eggs
6
5
3
So our decision rule in choosing
between 2 goods is to buy the one
for which MU/P is higher.
You are going to buy either an apple
or orange. The MU of the apple is
12 and the orange is 4. The price of
the apple is $4 and the orange is $2,
which do you buy?
The apple, because you like it three
times as much and it is only twice as
expensive.
12 utils > 4 utils
$4
$2
To the economist, shopping is always
and only about comparing how much
you like the thing to its price.
What we learned today.
1. What utility, marginal utility, and
total utility are.
2. The law of diminishing marginal
utility.
3. Shopping is all about comparing
marginal utility to price or MU/P.
Welcome to Day 27
Principles of
Microeconomics
What we learned yesterday.
1. What utility, marginal utility, and
total utility are.
2. The law of diminishing marginal
utility.
3. Shopping is all about comparing
marginal utility to price or MU/P.
But what if you are going to buy
more than one apple or one
orange? You start out buying the
one with the higher MU/P, but as
you buy more of it, its MU drops,
and eventually its MU/P becomes
lower than for the other good, then
you switch over to buying the other
good.
That’s exactly what happened in our
candy, milk, and eggs example.
When you are done with shopping, it
should be the case that how much
you like the last unit of each item you
buy compared to its price should be
close to how much you like the last
unit of every other item purchased
compared to its price.
If that’s not true, then you should
put back the item which has an
MU/P less than the other things
and buy more of the item which
has the higher MU/P.
Carried to its logical conclusion,
this means buy your items so that
all your money is spent and for
everything you buy
MUA = MUB = MUC = … = MUZ
PA
PB
PC
PZ
What about things in the store you
don’t buy at all? For those items,
MU/P for even the first item you
would buy would be below MU/P
for the last item of everything you
do buy.
Another way to look at it is to
realize MU/P is the return in utils
for $1 more spent on the good.
Given a choice, you will always
spend so that you get the most
utils per dollar (the most bang for
the buck).
MU is the benefit from getting one
more unit, and 1/P is how many
units you get for one dollar. So the
benefit from one more dollars
worth is MU x 1/P = MU/P.
When you head to the check-out
stand, the return to spending one
dollar more on anything in your
card should be the same as
spending one dollar more on
anything else in your cart. The
equation is just the mathematical
way of saying this.
Question 1:
The utility of an orange is higher
than the utility of an apple. Can
we be sure the shopper will buy
the orange over the apple?
Question 2:
The price of a donut and the price
of an apple are the same, and the
utility of the donut is higher, but
the person is on a diet. Can we be
sure the person will buy a donut
over buying an apple?
Question 3:
1st Donut 2nd
3rd
4th
Marginal 10 utils 8 utils 3 utils -1 utils
Utility
Total
Utility
10 utils 18 utils 21 utils 20 utils
Would you necessarily buy 3 donuts?
Last topic – Yay!!!!
So how does all this create the
demand curve? We’ve actually
done it already.
Imagine everything in the store costs
$1 and how much of each would you
buy if you had $1 … $2 … $3 … $4?
1st
2nd
3rd
Candy
14
10
7
Milk
8
4
2
Eggs
6
5
3
Now what if you had $4 and candy
cost $2 while the rest cost $1?
Assume you can buy fractions of
candy.
1st
2nd
3rd
Candy
14
10
7
Milk
8
4
2
Eggs
6
5
3
Here is the demand curve
for candy.
P
$2
$1
D
0
0
1
2
Q
At a dollar a piece, you buy candy
until the return to another dollars
worth of candy is below whatever
else you could spend that money
on.
Now the price doubles to $2. You
only get half as much candy for a
dollar, so you are getting half the
return in utils for that dollar spent
on candy. Better to spend that
money on other things (more bang
for the buck.
But as you buy less candy, the MU
of the candy rises till finally a
dollars worth of candy is equal in
utils to everything else again, and
that is the new smaller amount of
candy you buy.
MUA = MUB = MUC = … = MUZ
PA
PB
PC
PZ
MUA = MUB = MUC = … = MUZ
PA
PB
PC
PZ
P
$2
$1
D
0
0
1
2
Q
And now … 40 hours of
microeconomics summed
up in 5 minutes.
https://www.youtube.com/watch?v=
W_WU-q9wQ8I&list=RDW_WUq9wQ8I
What we learned today.
1. Consumers will switch between
buying goods until MU/P is equal for
everything they buy.
2. People buy goods that give them the
most utils for the dollar.
3. They will switch their buying dollars
between goods until the last dollar spent
on each good gives them the same utils.
Welcome to Day 28
Principles of
Microeconomics
What we learned yesterday.
1. Consumers will switch between
buying goods until MU/P is equal for
everything they buy.
2. People buy goods that give them the
most utils for the dollar.
3. They will switch their buying dollars
between goods until the last dollar spent
on each good gives them the same utils.
Test Prep Day
Welcome to Day 29
Principles of
Microeconomics
Test Day