1. 1. S G D P G Q Opportunity Cost : the value of Costs : expenses a firm Mct=s pt Q in the next best alternative incurs from engaging in its McT=s Pt QtAbsolute Advantage : fewer resources business activities D P T Q 4 D P 1 Q 1 are used in production Profit : total revenue ( TR ) minus * Comparative Advantage : lower opp . total cost ( TC ) Determinants Of cost of production Marginal Revenue :( MR ) addi - Demand : population , Terms of Trade : ratio of goods at tional revenue a firm receives income , prices of subs Which countries agree to trade at from selling one more unit 4 complements , tastes 1 Production Possibilities Frontier : Marginal Cost : ( MC ) the preferences , expectations ( PPF ) a graphical representation of the additional Cost a firm incurs Determinants of Supply : goods a country can produce given When they sell I more Unit MC shifters , expect a - their productivity E constraints Market Power : the ability Of a tons , # of sellers Consumption Possibilities Frontier : firm to set its own price p ( C PF ) : graphical depiction of what Producer surplus : ( Ps ) differ . ' E price to Max - profit : a country can consume given its end between price received - $66- productivity , constraints , da trading da the cost of production - I . - opportunities Law of Demand : The price - : Mc- Spontaneous ( emergent ) order : of a good or service is - , iii.MR D 0 4 5 10 a phenomenon in Society that is inversely related to the individual Firm in Perfect Competition the result Of human action but quantity demanded ( PT Qtr ) c individual firm 's supply ) B = 5 p 1 1 1 1 1 1 1 H 1 1 1 1 not human design Law of Supply : Prices Galan - . . =3 , ;; .ly#..y.EIiYb?3IFr? Demand : the relationship between titles supplied are directly QHOO " = ' a. . a EEM" the price of a good or services related ( PTQT ) bk ( Pqmerwagrgtoattsqwmweasitintion the quantity demanded Perfectly Competitive Equili - 100 S = MC Inferior Goods : as income increases , brium : occurs at a price where sellers . demand decreases QD is equal to Qs a p 100 SOO 900 Normal Good : as income increases , Dead weight Loss : LDWL ) the 20 s=Mc = demand increases reduction in total surplus from I = Ims Substitute Goods : an increase Market inefficiencies 12=11111 %;y Iii ( ill PE - - nrr( decrease ) in the price Of One 8=1111 iii.111111 good causes an increase ( decrease ) Winners from Int ' l Trade : = shortage Consumers / producers from I I I D In the price of the other good i i 1 i i 1 1 1 11 Q increased variety 4001^600 Complimentary Goods : an increase QD=Qs ( decrease ) in the price of one firms 1 Workers in export p mc=s good causes a decrease ( increase ) intensive industries in the demand for the other good lower prices Ts " SI" ' ' . Consumer Surplus : ( CS ) differ . Losers from Int ' 1 Trade : a end between consumers ' firms 1 workers in import willingness to pay ( wtp ){ the intensive industries s s s price ( p ) of the good or service increased expenditures D P Q Pf QP PTQt Revenue : income a firm On displaced Workers D pp QT p ? Qp Pga ? receives for engaging in its CPSGIPWIPMEP ts= ( s + Ps D Pt QtPTQ ? P ?Qt business activities
2. 2. Own price elasticity of demand : If Demand increases . . . S a measure of the responsiveness Income elasticity of demand : Of consumers to a change in a Measure Of Consumers ' S p . P , the price of a good or service responsiveness TO Changes in Dz Dz E D= !j?aQp " income . a D ' a. a . D ' IE D= %4Q 's t.IQ > tap tap ) t.IQ E , , ( Oas long as the law of ' 1. II when supply is more elastic When supply is more inelastic demand holds IED ( 0 inferior good If Supply decreases . . . IE , , 71 elastic E , , =1 unit elastic IED=O no relationship p . sz s . E , ( I inelastic IED 7 0 normal good p , i s , pp s , Percent change from x. toxz : Cross Price elasticity of Demand D D 2 - ' 100.1 . ( Good At Good B) ' . a measure Of QQ ' on a X , t.AM/.LlQ t.IQ > tap consumers ' responsiveness for when demand is more inelastic when demand is more elastic* The more horizontal a demand Good A when the price of B Curve is , themoreelasticitis s s p Changes . * Ifa profit - Maxim 't , IT E"f .EE#ggq2in9firmiscurrehHyxqD=yaQD( Good A) " %ttEp ( s on floor = 1111 " pricing in an inelastic 31111 11 11 Ceiling = = . ' 1.41 > ( GOODB ) binding ps shore . = region of demand , ceiling 3000 p D . = ii. iii. ii. a they should KED )0 substitutes 489070 38,0,6%0 increase price K If a profit - maximizing firm is KE D=0 Unrelated prefloor s postfloors currently pricing in an elastic KEDCO Complements bo%Moo|cs 120451 , 11111 floor region of demand , it is Unclear 1111 , new '= DWL whether they should change KASIKEDI increases , the - aa - nonbinding Ps = Ps - price relationship blwthezgoods floor = is . is * Revenue is maximized ata P soo 300 s , price where demand is increases unit elastic Price Floor :a government mandated a sz HIE ,> 1 I { PT minimum price g- Cs S B D) subsidy Revenue Costs ( QH RevenueCoststprice ceiling :a government Ernie DWL , F Wedge Profitytproatpyofitt Profitytprof.tl?Ygfittmandated maximum price 3- " ' " ' " ' " " I B,PIsefTIDeterminants of More Tax Burden : the amount by which stooyjo Q D Elasticity of Demand Elastic if ... a tax causes prices to increase need less necessary ( decrease ) for consumers ( producers ) Presubsidy Post Subsidy availability of more available * More inelastic side is more CS A + B A + B+F+E close substitutes substitutes affected by taxes subsidies PS F + G Ft G + Btc market definition more narrow time horizon longer Externalities : an action COST - ( B+C+D+EtF ) percentage of larger TS At B+F+G At B+F+G - D consumer 's budget percentage Causesa positive Negative * D= DWL effect On a third party Negative Externality Own Price Elasticity Of egiadhY+ social cost = private # + external cost supply :a measure of the Social Costs -- private quantity &Wm}efFfiFe Sprivate cost responsiveness Of producers outcome I competitive outcome costs + external Costs ==TO Changes in prices = = D= private benefit - social benefit Social Benefits - private Asean { s=%} benefits + external benefits Positive E+emE.li?adYnys=priva+ecos+=sociaicos+ quantity DWL from Es ) Oiflawof supply holds Cease Theorem : The women 've { s ) I elastic competitive outcome ; = social Benefit = private benefit + external Es =/ unit elastic Socially Efficient = , = , Dprivate benefit benefit Esc1 inelastic Outcome to an ex - Qpcose Determinants of More Elasticity# supply Elastic if ... lethality Will be teach - K Transaction costs can be time horizon iongertimehori . Ed Privately if trans - prohibitively high in some cases zonslwlingoods ) action costs are low , so the initial assignment of property production shorter Production regardless Of the rights is important for efficiencytime time ( across goods ) . perishability less perishable Initial Property rights K The initial assignment of property capital lower capital Total Surplus : Consumer surplus 't rights affects payments blw parties requirements requirements Producer Surplus + 1- externality
3. 3. Intro Economics : the study of how goods Er services are produced { allocated Macroeconomics : economy wide factors - Unemployment , interest rates , GPP , etc . Microeconomics : the study of how agents make choices tradeoffs
4. 4. Absolute G Comparative Advantage Specialization When can trade make people better off ? Model of International Trade Elements includes : Could also include - Countries CZ ) transportation costs - goods (2) preferences - number of Workers cost of production - labor productivity Model : Average Worker Productivity TVs T-shirts Uxemburg 101 hour 501 hour Burdini I 1 hour 401 hour Luxemburg : 100 Worker hours Burdini : 200 worker hours Opportunity Cost : the value of the next best alternative i. e. Opp . cost of attending ND is the salary of a full - time job Absolute Advantage L in producing a good or service ) : fewer resources are Used in production comparative advantage : lower opportunity cost of production David Ricardo ( 1772 - 1823 ) Theory of Comparative Advantage AH Countries Can benefit from trade by specializing in their comparative advantages regardless of absolute advantages
5. 5. LUX has the absolute advantage in producing TVs E T-shirts Opportunity Cost of 1 TV : LUX - 10 TVs : 50 T-shirts Lux has 1 TV : 5 T - shirts a comparative - advantage in opp . cost of ITV producing TVs bk of lower But - Opp . cost 1 TV : Llotshirtsopp. cost of 1 TV Opportunity Cost of 1 T-Shirt Lux - 50 T-shirts : IOTVS Bur has a 1 T - shirt : ' 15 TV - comparative But - 40 T-shirts : | Tv advantage in 1 T-shirt : 1,40 + v / Producing T-Shirts * In a 2 good , 2 country economy , a country Can't have a comparative advantage in both If split Labor Hours * specialize 4 ( wlih a country ) Don't Trade TVs T-shirts TVs T-shirts Lux : 50.10=500 50-50=2500 100.10=1000 0 Bur : 100 . I = 100 100.40=4000 0 200.40=8000 600 tvs { 6,500t-shirts vs . 1000 tvs { 8000 shirts
6. 6. . Lux gives up 25 = SOOTVS if they T produce ZSOO Stopp . cost of producing 1 TV + - Shirts Most # of tvs LUX Would be Willing to give up for 2. SOO + - shirts : 500 Min . # of TVs that BUR needs to be willing to give up ZSOO t-shirts : 2500 -40 = 62 . S q 40 = Opp . cost of producing 1 TV ( Burundi gives up 2500/40=62 . S tvs if they produce 2500 t - shirts ) Terms of Trade : ratio of goods at which countries agree to trade at Suppose Luxembourg 4 Burundi trade 2. soot - shirts for 250 tvs TVs T . shirts Luxembourg 1000 - 250=750 0+2500=2500 Burundi 0 + 250 = ZSO 8000-2500=500 Production Possibilities Frontier LPPF ) : A graphical depiction of the goods a country can produce given their productivity 4 constraints
7. 7. PPFS and CPFS ; pros { Cons of Trade Burundi 's PPF Quantity * straight of Line because TVs opportunity slope : - ' 140 cost is 200 Constant (1200) = This Could 8000 Change L guns (40200) G butter example luantity of T-shirts better resources would be Used first ) butter Consumption Possibilities Frontier LCPF ) : graphical depiction of what a country can Consume given its productivity , constraints { trading opportunities World Terms for Trade : 10 t-shirts for Itv consumption with specialization { * held another country trade all + - shirts to trade with blc for TVs On Burundi can only g s 1000 . produce 8000 t-shirts 800. 3 g- TVs slope = - ' 110 8 ( PF production s if complete X S specialization S A J 200 800 50%0 10800 T-shirts
8. 8. Winners da Losers from International Trade Winners Losers Consumers da producers firms G workers in import from an increased variety intensive industries of goods da services . reduced government revenue firms G workers in export from tariffs ( taxes on imports ) intensive industries MAYBE lower prices increased expenditures on displaced workers Trade has essentially the same impact , but Viewed politically different - cheaper - displaced workers
9. 9. Markets da Demand Unregulated markets can give the best outcome Spontaneous ( or emergent order ) : a phenomenon in Society that is the result of human action but not human design- prices companies must set prices in an attempt to find the perfect price based on economic activity - ex : language How are prices determined ? Why do they change ? How do they affect market activity ? * When the price of a good goes up , people want to buy less of it Law of Demand : The price of a good or service is inversely related to the quantity demanded Demand : the relationship between the price of a good or service 4 the quantity demanded Quantity Demanded Price price ( P ) 200 - Tickets 42 200 iso - 42 150 52 100 ioo - 77 50 Dencaurnvde 86 0 so - If a demand curve is o , Quantity downward sloping , it 412 154 717 86 ( Q ) satisfies the law of demand
10. 10. * When the price of a good increases , the demand for that good stays the same If the price of a good increases , demand does not change , so instead the quantity demanded decreases ( movement along the curve ) p Apples A shift to the right in the demand Curve is associated with an increase in demand D , Dz p Q Bananas As population increases , demand increases 3- - - - - , - . . , pop 9 1 1 D ! b , ! Dz W p 200 700 Q demand increases , Overalls If income goes up , demanddecreases if inferior good ,ex : Would rather buy nicer clothes,, possible,Inferior Goods : as income DaD , i possible a increases , demand decreases Ormal Good : as income increases , demand increases
11. 11. P Jelly p Peanut Price of jelly 4 Butter Quantity Demanded of Peanut Butter ii.=:: : !a ! ! Q Dz D , Q 140 200 Increase in price of labor increase in demand for physical capital p Physical capital Price of labor T Demand of Capital - increasing D , DZ Q * Determinants of Demand - population- income - prices of substitutes E complements - expectations- tastes 4 preferences . substitute Goods : an increase ( decrease ) in the price of one good causes an increase ( decrease in demand for the other good . Complimentary Goods : an increase ( decrease ) in the price of one good causes a decrease C increase ) in the demand for the other good
12. 12. Demand ; Market Power P Doritos If Cost of Production T Then Demand stays the same But price T Q P TVs today ) If expectations 1 ( expect price of TV to decrease in future ) thlh 1) today of tvs Dz D ' Q Consumer Surplus ( CS ) : difference between Consumers ' willingness to pay LWTP ) G the Price CP ) of the good or service Cs = WTP - P p P Total CS= 125 10 - 10 - WTP = 7 p = 5 P = SO ( S = I bh WTP - 3O+h Unit = 'z( SO ) ( S ) p= s . (S{ . Pts - = 125 D D 310 Q 0 2's go Q
13. 13. Supplier Behavior w/ Market Theory of the Firm Power Revenue : income a firm receives for engaging in its business activities Costs : expenses a firm incurs from engaging in its business activities profit : total revenue LTR ) minus total cost CTC ) TR - TC P Coffee io . Total Revenue : Price Quantity = TR when Q =3 is 73=5121 > - a TR when Q=4 is 64 = $246 = MR =TRy - TR 3=24-21 = $3 = B c 4 T 4 = D Btc A + B C - A 0 1 1 }4 1 1 11 i. to Q Marginal Revenue CMR ) : additional revenue a firm receives from selling 1 more Unit i. e. derivative of total revenue function P p Q TR MR i. 10 0 0 q = 9 1 9 7 i 8 2 16 = 7 3 21 5 i D 3 1 1 1 1 1 1 1 1 1 1 Q 6 4 24 , 5 5 25 - i * MR is twice as Steep as 4 6 24 - 3 demand { has same Vertical 3 7 21 - s intercept as demand 2 8 16 - > * is linear { firm can set , q 9 prices 0 10 0 - 9
14. 14. Marginal Cost ( MC ) : the additional cost a firm incurs when they sell 1 more unit of output $ $ $ $ 5 - 5 - 4 - MC MC 3- 3 - a capacity constraint MC | I Q ' - 1 1 Q Q Q 100 900 100 900 1100 00 I no capacity constraint, stable cost structure
15. 15. Market Outcomes P MAXTR :S P . For Q > 4 price tomax- profit : MR< MC I $6 produce less - = . For Q< 4 . - o GMRhp Q : F.mc MR > MC - - - : .mr D produce more TRTQT TRIVQT 0 ' 1 its To : 1. Find Q* where MR=MC P*= 70 p . a , MCsoi : 2. Trace " up " to the demand s *= curve for P* i.It's !noB'' ' E Q * = best . Market Power : the ability for a firm to set its Own price . Cost : whatafirmmustpayto produce something . Price : what a firm charges for what it produces CS= WTP - p Producer Surplus ( PS ) =P - MC Difference between price received 's the Cost Of production
16. 16. P woo - What is the CSG PS from the transaction of the wY*Eb88I . ;:is , zothtv ? = I mc CS= 700-600=100 Ii MR D Q T T ' ' zfto ' ' ' ' ' go WTP p* PS = 600-200=400 T T p* MC P Cs = 1 1 11 - = PS = - MC:MR D Q P P, Pz mc , MCT Pt QT Mcz MR D Q Q , Qz P D Pz PT QT P , D , MC Dz MR , MRZ Q Q , Qz
17. 17. P Income T p , * Bananas are inferior good D Pz Pt Qtr MC D ,MRZ Dz MR ' Q Qz Qi P Us Autos If Ds+ee| :' Mcz then Pstealn MC , Mcauto T MR DQ Panto T Qz Qi Qauto t Types of Shifts Changes in PEQ D pp QT D Pt Qt MCT PT Qt Mct Pt QT ) Pcorn T Mcchips T Pchipstn Qcnipst 2) Psalsat Dchips Pchipstn Qchipst SO Pcnipstn Qcnips ?
18. 18. Market Outcomes Between 2006 E 2008 , PinsuranceTQ= Changes in Predictions supply - side problem MC or D about PGQ D Pt QT ex : problems occurred when D Pt Qt insurance incorporated MCT PT Qt how health information Mct Pt QT systems ( MCT ) Characteristics of Perfect Competition : - homogeneous goods - free entry E free exit ( no barriers to enter 1 exit market ) - large number of firms - large number of customers - full information * In perfect competition , firms take market price as given ( price takers ) P Individual Firm in perfect . At a price of $5 , firm can competition sell as many units as possible market firms have no incentive to price = 5 D= MR set lower price because they can sell unlimited units at $5 Q . every firm is small , and there p vs . are so many firms that if a Firm w/ firm raised their price , no Market Power One would buy MR D Q
19. 19. = y individual firm 's supply curve - MC =s If P =3 , Q = 60 - If P= 6 , Q = 90 Pz = 6 ; Dz = MRZ p , =3 't .#D. = MR , * would not want to produce = l 1 i I l l 1 1 11 USS than 10 bk unprofitable 10 60 90 Q , Qz . MR , > MC , Law of Supply : Prices E quantities supplied are directly related As PTQT Or Pt Qtr * s= Market supply P Individual Firm in P Perfect Competition Market Level in Perfect Competition ( individual firm 's supply ) ( w/ 100 sellers ) MC = S s = MC B = 5 1 1 1 1 1 1 1 1 1/1 11 D3= MR } P , =3 1 1 1 1 1 - 1 1 1=1 1 1 D , = MR , Pz = 1 1 - i 1 1 1 1=1 1 1 1 [1 1 11 Dz = MRZ . 1 Q Q tz , 0,93 100 SOO 900 9 00 ( because 100 sellers ) * When the price of a good goes up , supply stays the same C i. e. an increase in the price of a good does not change supply but instead Changes the quantity supplied )
20. 20. P * s ' = Mc ' shift to the right in - sz = ME Supply or demand is 4 t ii iii. i 1 1 1 1 i , 1 associated With increase in Supply or demand i 1 1 1 s ' Q Determinants of Supply : - marginal cost shifter - change in input prices - technological productivity change- weather - expectations about future prices - number of sellers P Individual Firm p in Perfect Competition Market Level MC S = MC myriad . =D= Mr 43 !"!."." ;. . - D = Q Q Q*
21. 21. Perfect Competition E supply P 20 S = MC = = At P= 12 - surplus Qs = 600 Q D= 400 = ~ 12=1 1 I 11 I 1 1 1 ( (11 QS ) Q D PE " ' " Surplus Of 600-400=8Ill11 itT.FI 1 1 11 ( 200 units - . At P= 8 = shortage Qs = 400 Q D= 600 = = = D Qs < QD = - . 1 I I 1 I I I I 1 1 Q Shortage Of 600 - 400=400p 600 200 Units QD = QS A perfectly competitive equilibrium occurs at a price where the quantity demanded is equal to the quantity supplied P MC=S Cs PS =p - MC " ( ' b's" " .io#surpfusEsYIEIps D Q
22. 22. P p S S = MC p= 7001-45 . , soap # e- DWL 500 - pig- DWL P = 300 D Ps D I 1 Q 1 Q 30 50 30 50 At P= 700 At P= 300 Q D= 30 Qs = 30 Dead Weight Loss ( DWL ) : the reduction in total surplus from market inefficiencies p S = MC Mf negative surplus generated D= WTP Q * total surplus tells nothing about who benefits A perfectly competitive equilibrium is both stable 4 efficient L i. e. maximizes total surplus )
23. 23. Expectations C for seller ) T s PT Qt p p S , 52 S , B c- A 52 S Pz S P , Pf Q T P , A PT Qf pz B . Q Q Q , Qz Qz Q , Shifts in S } D Changes in PdQ Mct =s Pt QT MCT =S PT Qt1) PT QT D Pt Qt
24. 24. Elasticity Own Price Elasticity of Demand : a measure of the responsiveness of consumers to a change in the price of a good or service E. = gallop ' ( percent change in quantity demanded ) p ( percent change in price ) own price elasticity of demand 1 1 or T 1 EDCO as long as the law of demand holds If IE ,, 1 > 1 Demand is elastic it Q' ' 1 > 1%4 PI ( big response ) If LED 1=1 Demand is Unit elastic 1%4 QDI = ltllpl If 19>1 ( 1 Demand is inelastic HIQDI ( It . API ( little response ) If the absolute value of ED = 2 and P increases 10.1 . the QP = - 20% a , / 10.1 . |=2 Q D= - 2( 10%1=-201 . If P increases from $2 to $34 QD decreases from 2000 to 1600 , is E ,> elastic luhitelasticl inelastic ? 1600 - 2000 - 400 2000 2000 = -20%3- 2 = 1 go , inelastic 2 2
25. 25. Percent Change from X. Xz : Xz - Xi 100% X , Qz - Qi Qi = Qz - Q , P , ED = pz - p , Q , Pz - P , Pi P a . If P 89 , What is ED ?P ,=8= I I -2 - 1 - 2 2 - = = - 4 = 9-8 1 - 8 8 elastic1 1 , lz1 1 1 1 1 1 1 Q QZQ , : = If P 21 , what is Ep ? = 9-8 1 = 8 8 1 . - - 1 - 2 - 1 4 FEE2 2 inelastic1 1 1 1 1 1 1 1 lqlqQ Q , Qz : %6% . see Feeney- 11 1 11 1 . . - = - - 1 1 1 1 1 1 1 Q
26. 26. p * The more horizontal a demand P, l ' ' ' ' 1 ' 111 curve is , the more elastic it is Pz 1 1 1 1 1 1 1 1 1 1 D , Dz For D , , there's a large t.IQ 's Q in comparison to % QP , so D , is more elastic than Dz P Remember : Mastic If I EDI L I inelastic yunit elastic IEDI = I Unit elastic tgneiastic IEDI > 1 elastic a * If a profit maximizing firm is currently pricing in an inelastic region of demand , they should increase price * If a profit maximizing firm is currently pricing in an elastic region of demand , it is unclear whether they should change price If IEDI ( I { PT If IEDI > I E. PT Revenue T Costst ( Qd ) Revenue t Costst ( Qtr ) profit T Profitt Profitt Profitt profitTd profit ? 4 Revenue is maximized at a price where demand is unit elastic If demand is inelastic , an increase in price increases revenue If demand is elastic , a decrease in price increases revenue
27. 27. Determinants Of Elasticity of Demand More Elastic If ... need . less necessary . availability of close substitutes . more available substitutes market definition . more narrow definition time horizon . longer time horizon percentage of consumer 's budget smaller percentage Own Price Elasticity of Supply a measure of the responsiveness of producers to changes in prices { 5 = % QQ s % 4 P If the law Of Supply holds , Es > 0 If Es > 1 supply is elastic Es = 1 supply is Unit elastic Es < 1 supply is inelastic P 52 S , is more elastic than Sz P, 11 11 11 1 ' ' ' 5 ' The more horizontal a Supply Be in i , curve is , the more elastic it is Q Jeterminants of Elasticity of Supply More Elastic If ... . time horizon . longer time horizons L within goods ) production time shorter production time ( across goods ) . perishability . less perishable . capital requirements lower capital requirements
28. 28. If Demand increases . . . S Be S Pz P , P , Dz Dz D , D , 1 Qz Q I Qz t.IQ > tap tap ) t.IQ when supply is more elastic when supply is more inelastic If Supply decreases . . . pz 52 Sz . S , PZ S , P , P , D D Qz Q ) QZ Qi t.AM/.LlQ t.IQ > ' tap When demand is more inelastic when demand is more elastic
29. 29. A B C s s inelastic Pz 1 1 1 1 1 1 1 Pz 1 1 1 1 1 1 R S P, 1 11 1 1 11 = = Dz p , . 11 1 11 1 1 ' . elastic = - p , 1 1 | , , - - - - Dz - D Di == = = 2 == elastic = =D, inelastic - = D , - = Q , Qz Q , Qz Qi QZ * perfectly competitive market , firms don't have market power A : an academic hospital with excess capacity ( elastic supply ) treating high severity patients ( inelastic demand ) B : a non - academic hospital with moderate capacity L relatively neutral supply ) with a moderately severe case load ( relatively neutral demand ) C : A capacity constrained group of rural practitioners C inelastic supply ) treating low severity patients L elastic demand ) If there is an equivalent increase in demand , which market would expect the largest increases in price ? Market C
30. 30. A B C S , S , S , P, I I I I I I 1 P, I I 1 1 11 I s P ' l ' = s s Pz I I I 1 I i 1 1 - 2 % I I 1 - I I I 1 1 - DZ % I I I 1 I [ 1 1 - 2 I D inelastic = = elastic = = D Qi Qz Q , Qz Q , Qz A : Gas stations close to car rental agencies at airports L inelastic demand because of renters needing gas before returning cars ) B : Gas stations operating in large suburban shopping areas ( elastic demand because large amount of Competition ) C : Gas stations clustered off of interstate exits ( relatively neutral demand because competing With other gas stations at exit { other surrounding exits ) Income Elasticity of Demand : A measure of Consumers ' responsiveness to changes in income I E D= %aQ ' ' If IEDCO then inferior good %dI IED = 0 tbheonaunsorghgtteogshib between DEI IE 's > 0 then normal good Cross price elasticity of Demand ( Good At Good B ) : A measure of consumers ' responsiveness for Good A When the price of Good B changes KEDAB = %4QD( Good A) If KED > 0 substitutes % Llp C Good B) KED =O Unrelated KED ( 0 Complements * As 1) ( EDI increases , the relationship blwthez goods increases
31. 31. Government RegulationPrice Ceiling : A government mandated maximum price Examples : interest usury laws ( maximum interest rates ) , necessities ( utilities in US ) , rent control , price gouging laws often leads to shortages because suppliers lose incentive S nnmgbkEEF.ly a on 3 1 1 11 ItI 1 Ceilingbinding ps shortage Ceiling 3000 D 4000 7000 QS QD Price Floor : A government mandated minimum price Examples : minimum wage , agricultural support , alcohol } tobacco S 7 Y floor D 3000 6000 QD QS prefloor postfloor S S CSbthodoirn ,9o .gs, , , 120 twlpsl=L 1 bwld floor - Old - nonbinding Ps = Ps - floor = D - D 500 300
32. 32. wage wage households S 7 5 floor 7 floor 6 1 1 1 1 - 6 11 - 1 1 1 - . - - - D - = - - . - firms - D a = = a 17500 200 500 490 10 people unemployed 300 people unemployed The success of raising Minimum wage depends on how elastic the demand curve is . P Mcz 3- in $2 MC , $2 per Unit tax On producers I - Q p D Individual Market Level - Firm - MC post tax 7- Sposttax- ( + $2 ) - wpYff=5 - s - S pretax- MC pretax - - 3 - - - - 1 - I I I I I I I 1 Q I I I I I I I I I Q 5 100 SOO 900 A per unit tax on producers shifts the market supply Curve " Up " by the amount of tax ( S ) P sposttax Consumers pay $5 consumers pay = 5.11iii. s pretax After - tax price for Sellers = $3 sellers receive =3i Iii - - D = Q
33. 33. P s post tax Consumers pay $5 5.tax wedge { t $2 s pretax After - tax price for sellers = $3 3- is Total tax revenue :$ 2500=511000 ' Q 500 Tax Wedge: The difference between the price consumers pay G sellers receive due to tax Tax Burden ( Or Tax Incidence ) : The amount by which a tax causes prices to increase L decrease ) for Consumers ( producers ) Tax Burden Consumers : 5 - 4 = $1 per unit Producers : 4 - 3 = $1 per unit * The more inelastic side Will bear a majority of the tax burden p Tax Revenue # of units solid per unit tax S post tax 500 2 buyers pay = 5 i 1 l l I i 5 Pretax $ 1000 severs receive =3%sFn*Et " E. D DWL= (2200)=200 500 700 Q
34. 34. Sposttax - S pretax 8- Original price = $6 buyers pay > > - ' = $6 + $2 tax = $8 6- - sellers receive > s - - = If p= 8 Qs= 40 - = I D Q D= 20 2040 surplus = 40-20=20 Units producers don't pass full Tax onto consumers P A per unit tax on consumers t . $2 Shifts demand " down " by D pretax the amount of tax D post tax Q p Producersurplus tax revenue CS s - tax - S $500 Revenue DWL , 3h's " ' " ' " ' ' E ' I ispjoesttatxax consumer surplus tax revenue 5007100 Q $500 In perfect competition , market outcomes ( P ,Q , surplus ) don't depend on which side of the market pays the tax P s Tax Burden buyers Consumers : 110 - 100=51101 unit pay = 110 4 Producers : 100-60=15401 unit 100 - srLIFE 60 - D pretax 40 so QDPost tax
35. 35. Subsidies s , $2 subsidy to producers - $2 52 t s , $40 subsidy to producers 120 . iii iii. Buyers pay $80 no - 52 producers receive $120 80 1 1 1 1 1 1 it= D Producer price = Cost to consumers + subsidy , T 120 = 80 + 40 50 70 Total Cost of subsidy = per unit subsidy # of units sold 2800 = 40 70 Pre - subsidy Post - Subsidy CS 1250 2450 PS I 250 2450 Cost - 2800 TS 2500 ) 2100 Total Surplus for 7Oth Unit : CS 80-80 = 0 ps 120 - 120 = 0 Cost - 40 TS - 40
36. 36. 5 , Presubsidy Post Subsidy CS A+B A + B+F+E A 52 ps F + G F+G + B + C B D) subsidy Cost - ( B+C+D+EtF ) F Wedge TS A+B+F+G At B+F+G - D G * D= DWL D Total Surplus always decreases * $2 Subsidy to Consumers $2 Dz :$40 subsidy to Consumers Dz After - sub price for consumers : D , $120 - $40 = $80 Producers receive : $120 $70 Subsidy to consumers % . . , ...,% . , s NOSUB price for Consumers :$ 100 = aftersubpricefor Consumers : $40 == Dz Consumer benefit ' . $60 I I D , * More inelastic side gets more benefits
37. 37. Externalities Externalities : an action causes a positive or negative effect on a third party ( a market inefficiency ) - ex : secondhand smoke Social Efficiency : the outcome maximizes total surplus Private Costs : the value of costs only incurred by the firm External Costs : the value of costs imposed by negative externalities Social Costs : private costs + external costs Ex : What is the socially efficient number of transactions if there is a per unit external cost of $20 associated with the production of the good ? 4,000 units Sz = S , + social cost 70 - I I I 1 S , so l ' ' - HOW many units Will be sold in a perfectly competitive market ? = = D 1 1 5000 units 4000 5000 52 $20 per unit externality 70 iii. ' . s , Sale Of 4000 th Unit : so ill ' E ' . ( S = 65 - 50 = $15 - PS = 50 - 45 = $5 ) External Cost = $20 40005000 Total Surplus = 0
38. 38. social Cost = after tax supply curve private cost 45 - zs - What per unit tax should the , D government impose ? $20 5000 Pigouvian Tax : a tax designed to correct negative externalities Absent government intervention , a competitive market production level in the market for a negative ( positive ) externality will result in more ( less ) units being produced Private benefit : value of benefit only to consumers External Benefits : Value of benefits imposed by positive externalities Social Benefit : private benefit + social benefit Pigouvian Subsidy : a subsidy designed to account for positive externalities
39. 39. Negative Externality socially efficient Social Cost = private Cost + external cost quantity 8Wm}efFfiFe Sprivate cost outcome = competitive outcome- . - D= private benefit = social benefit QSELQPC Positive Externality socially efficient S= Private cost social cost quantity DWL from Competitive = outcome competitive outcome _ = social Benefit = private benefit + external - benefit = = D private benefitI 1 Qpc QSE
40. 40. Coase Theorem Your roommate shores . You value peace E quiet at $100 Roommate values not having to wear nasal strips at $50 socially Efficient Rules Protect Peace Rules Protect the Outcome : E Quiet Right to Make Noise Roommate wears Outcome : Roommate Outcome : Roommate nasal strips wears the nasal Wears nasal strips strips You pay between $50 G $100 to roommate Cease Theorem : The socially efficient Outcome to an externality program will be reached privately if transaction costs are low , regardless of the initial assignment of property rights Transaction Costs : the costs incurred in making an economic exchange ( e. g. time , contracting , litigation Costs ) Property Rights : Entitlements which holders Cannot be forced to give up Liable : legally responsible to compensate another party for damages Socially efficient outcome ( Coasian Framework ) : Final assignment of property rights that maximizes net benefits ( benefits - costs )
41. 41. Example : Factory { Farmer # 1 - cost of pollution reducing technology = $95,000 - 1,000 farmers - average Cost of pollution = $1001 farmer Socially efficient outcome : factory adopts technology 95,000 70,000 ) large small If Farmer A keeps a large herd , Farmer B Will keep a large herd . ( 40,000 > 20,000 ) large small Both farmers have a dominant strategy of always Choosing a large herd Solutions to Tragedy of the Commons - private solution through negotiation - social norms - use restrictions - licenses - establish property rights - sanctions 1 punishments - littering fine - WTO - taxes 1. generate revenue 2. Curb Use
42. 45. Free Rider Problem : individuals can benefit from public goods without paying a share of the cost Spending on public goods can generate a social multiplier ( i. e. the total benefits exceed the benefit received by the individual ) Solutions to DWL from market power : - price ceiling at $5 problem : How does the regulatorknow E Update this price ? - subsidy to consumers 1 producers problem : rewarding the firm for charging too high of a price S post subsidy price ceiling
43. 46. Theory of the Firm Industrial Organization ( 10 ) Building Blocks Explicit Costs : physical transfers of money for business activities Implicit Costs : foregone profits from engaging in business activities ( Opportunity costs ) ( I . e. foregone interest ) Accounting profit = Total Revenue - Explicit Costs Economic Profit = Total Revenue - Explicit Costs - Implicit Costs If economic profit = 0 , then the firm is making exactly as much accounting profit as they would be in their next best alternative Note : we will assume " costs " include explicit E implicit costs Sunk Costs : a cost that has already been paid E cannot be recovered Sunk Cost Fallacy : incorporating sunk costs into decision making
44. 47. Suppose a firm has made a $10,000 lease payment at the beginning of a month . If it pays $5000 in labor , material , G implicit costs , it will generate $6000 in revenue . Broad96000 - sooo - oooo = -9000 }pwritdauceDon't Produce profit = - 10000 Fixed Costs : Costs that remain constant as output Changes Variable Costs : Costs that change as output changes Total Costs ( TC ) = Total Fixed Costs CTFC ) + Total Variable Costs CTVC ) Short Run : a period of time in which some costs are fixed Long Run : a period of time in which all costs are Variable Exit Rule : exit the industry in the long run if current E future projected economic profit is negative TC > TR Total Cost ( TC ) = AFC + AVC. Average Total Cost ( ATC ) = Quantity of Output ( Q ) Average Fixed Cost ( Afc ) = Total Fixed Cost CTFC ) Q Average Variable Cost ( AVC ) = Total Variable Cost ( TVC ) Q Marginal cost = TC Q
45. 48. ;offing, =PF.tatIFE.t8 70 ( 300 ) - 60 ( 300 ) = 3000 MR DQ 3 Ways to Write Out Profit 1. Total Revenue - Total Cost 2 . P . Q - ATC . Q 3 . Q ( P-A_TC) profit per unit
46. 49. Game Theory Game Theory : the formal study of strategic decision making pioneered by Jon von Neumann ( 1903 - 1957 ) Nash Equilibrium : a set of strategies such that no player has incentive to unilaterally deviate i. e. Conditional on what everyone else does , no one Wants to change their decision irm B High Low High 8 , 8 0 , IQ Firm A - Nash Equilibrium Low 1-0,0, payoff to pay off to row player column player Dominant Strategy : a strategy that leads to at least as high of a payoff as any other strategy regardless of other players ' strategies Prisoner 's Dilemma : the Category of games in which players have a dominant strategy to " cheat ' ; preventing beneficial cooperation from Occurring Builders Metric Us Metric 5 , LO 0,0 Toolmakers us 0 , O, 2- , 4- 2 Nash Eauilibria
47. 50. Coordination Game : the category of game in which multiple Nash Equilibria exist , each corresponding to the players coordinating on their actions Player B ROCK Paper Scissors ROCK 0,0 - 1,11 , -1 Rafter paper 1 , - I 0,0 - 1 itScissors - 1,11 , - I 0,0 Nash Equilibrium : being as random as possible Mixed Strategy Nash Equilibrium : a Nash Equilibrium in which players randomize over a set of actions [ enter I fight C- S , s ) don't fight ( 10 , 10 ) don't enter ( 0,20 ) payoff to first moveI tfay Off to second mover ( Eehters , I doesn't fight ) is a Nash Equilibrium E a Subgame Perfect Nash Equilibrium LE doesn't enter , I fights if entry ) is a Nash Equilibrium Sequential Rationality : players must behave optimally at every stage of the game
48. 51. Sub game Perfect Nash Equilibrium : A Nash Equilibrium that satifies sequential rationality Ci. e. it rules out non - credible strategies ) Backwards Induction : the process of working backwards to ensure that sequential rationality is satisfied product L - 10 , -10 ) B product don't produce ( SO , l ) A product ( I , 50 ) don't produce B ( 10 , 10 )don't produce ( A produces ; B doesn't produce if A produces , B produces if A doesn ' t ) is a Subgame Perfect Nash Equilibrium doesn't satisfy sequential rationality ( A doesn't produce ; B produces if A produces ,d B produces is A doesn ' t ) is a Nash Equilibrium product ( -10 , 2) B $12 Subsidy product don't produce ( SO , l ) to B if They A product ( 1 , 62 ) choose to don't produce B produce don't produce ( 10 , 10 ) SPNE : ( A doesn't produce ; B produces no matter What )
49. 52. Industrial Organization Industrial Organization ( 10 ) : the study of the strategic behavior of firms , regulatory and antitrust policy , and market Competition Oligopoly : a market Structure dominated by a few firms Monopoly : a single entity producing a good or service with no close substitutes Sources of Monopoly ( Market ) Power : patents , copyrights , trademarks access to rare resource ( e. g . DeBeers ' diamonds ) production process - high fixed costs ( utilities ) innovation ( e.g. iPod ) tastes government ownership ( e. g . USPS ) Natural Monopoly : a monopoly with decreasing average total cost over the entire relevant range of output :( AMTE Q
50. 53. How much profit does this natural monopolist make if they are not regulated ? : . Profit = Total Revenue - Total Costs = = P . Q - ATC Q 50 8000 = 60 ( 400 ) - 40 ( 400 ) I- ATC - MC - MR D 1 1 I I I I I I I Q 500 What price ceiling would the government set to ensure that the monopolist makes zero economic profit ? P profit = P . Q - ATC . Q = Q ( P - ATC ) : If P= ATC , profit = 0 : para Price ceiling to ensure monopolist makes so : zero economic profit = $30 . Mc pricing - Atc If P= 30 , ATC = 30 Profit = 0- MC- D 1 1 1 1 1 1 1 1 1 Q sooniwdpffiocinng Average Cost Pricing : Regulating a monopolist To price at average cost In long run , monopolist probably Will not exit market because still making accounting profit E making as much as in 2nd best alternative K Can't know accounting profit from graph accounting profit will always be greater than economic profit ; so if economic profit =O , then accounting profit is positive
51. 54. : Socially efficient quantity = 800 Isocially efficient price = $20 50 I- ATC - MC - MR D I 1 I I I I I I I Q 500 Marginal Cost ( Plus ) Pricing : regulating a monopolist to price at marginal cost , which requires a subsidy to the firm in Order to Cover fixed costs If P = 20 , ATC = 28 profit = 20 . 80 - 28 . 80 = - $6400 If the monopolist is regulated to price at marginal cost ( Without subsidy ) , the firm Will exit in The long run because it is making negative economic profit Cons of ATC Pricing : - low quality products - firm doesn't have incentive to cut Costs If entry occurs : . Competitive effect : entry increases price competition which leads to a greater overall quantity C total surplus increases ) cost effect : firms individually Will produce less which increases average costs reduces surplus
52. 55. Characteristics of Monopolistic Competition - large amount of buyers sellers } same as perfect - low barriers to entry 's exit Competition - differentiated products In the long run in monopolistic competition , If short run economic profits are positive increased entry reduced demand for individual firms reduced profits If short run economic profits are negative increased exit increased demand for remaining individual firms increased profits In long run , in monopolistic competition E perfect Competition , economic profits are zero
53. 56. Health Economics Health Economics : a branch of economics that analyzes both micro - E macroeconomic health G medical Care related issues in an environment with scarce resources Premium : the payment made to an insurer solely to Obtain Coverage Premiums T P T QT Moral Hazard : changes in behavior due to risk protection Adverse Selection : when an individual knows more about their true risk level than an insurer and is thus more likely to purchase ( select into ) insurance - i. e. history of breast cancer Principal - Agent Problem : occurs when an entity L " the agent " ) is able to make decisions on behalf of another entity ( " the principal " ) , E their incentives are not necessarily aligned St. Joseph Purchase Don't Purchase Memorial Purchase 30 , 40 70 , 30 Don't Purchase To, 850 , 60