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Microeconomics
James B. Wilcox
Resources provided by:
The University of Southern Mississippi
Center for Economic and Entrepreneurship Education,
Mississippi State University, & Virtual Economics
Economics…
is the study of how individuals and society
choose, with or without the use of money, to
employ scarce productive resources to
produce various commodities over time and
distribute them for consumption, now and in
the future, among various people and
groups in a society.
The Economic Way
of Thinking:
Three Activities to
Demonstrate
Marginal Analysis
2
2
5
3
9
4
12
3
14
2
15
1
15
0
14
-1
MTE Microeconomics
© 2009 South-Western/Cengage Learning
Production and Costs
• Producers: Maximize profit
• Opportunity cost
– All resources have an opportunity cost
• Explicit costs
– Payments for resources
• Implicit costs
– Opportunity cost of resources owned by
the firm / firm owners
– No cash payment
9
Alternative Measures of Profit
• Accounting profit
– Total revenue minus explicit costs
• Economic profit
– Total revenue minus all costs (implicit and
explicit)
• Opportunity cost of all resources
• Normal profit
– “Accounting profit in excess of normal profit”
• Accounting profit = Economic + Normal profit
10
Production in the Short Run
• Variable resources
– Can be varied quickly
• Fixed resources
– Cannot be altered easily
• Short run
– At least one resource is fixed
• Long run
– No resource is fixed
11
Law of Diminishing Marginal Returns
• Total product: total output produced
• Production function
– Relationship between amount of
resources employed and total product
• Marginal product: the change in total
product resulting from a one-unit
increase in a resource employed by the
firm
12
Law of Diminishing Marginal Returns
• Increasing marginal returns: the MP of
a variable resource increases as each
additional unit of the resource is put into
action
• Diminishing marginal returns
– Marginal product decreases
• Law of diminishing marginal returns:
as more of a variable resource is added
to a given amount of a fixed resource,
13
MP eventually begins to decline
Exhibit 3
Total product
(tons/day)
The total and marginal product of labor
(a) Total product
15
Total
product
10
5
Marginal product
(tons/day)
0
5
4
3
2
1
0
5
Increasing
marginal
returns
10
Diminishing but
positive
marginal returns
Workers per day
(b) Marginal product
Negative
marginal
returns
Marginal product
14
5
10
Workers per day
Costs in the Short Run
• Fixed cost (TFC): any production costs
that a firm incurs even when it is not
producing output; Ex: overhead—rent,
insurance, property taxes
• Variable cost (TVC) any production
costs that change as output changes;
TVC = 0 when the firm is not producing
any output; Ex.: labor costs
15
Costs in the Short Run
• Total cost TC = TFC + TVC
• Marginal cost MC = ∆TC/∆q
• Change in TC to produce one more unit of
output
– Changes in MC reflect changes in
marginal productivity
– Increasing marginal returns
• MC falls
– Diminishing marginal returns
• MC increases
16
Exhibit 4
Short-run TC and MC data for Smoother Mover
(1)
Tons moved
per day
(q)
(2)
Fixed
cost
(FC)
(3)
Workers
per day
0
2
5
9
12
14
15
$200
200
200
200
200
200
200
0
1
2
3
4
5
6
(4)
Variable
cost
(VC)
(5)
Total cost
(6)
Marginal cost
(TC=FC+VC)
MC=∆TC/∆q
$0
100
200
300
400
500
600
17
•SR TC and MC data for Smoother Mover
(1)
Tons moved
per day
(q)
(2)
Fixed
cost
(FC)
(3)
Workers
per day
0
2
5
9
12
14
15
$200
200
200
200
200
200
200
0
1
2
3
4
5
6
(4)
Variable
cost
(VC)
(5)
Total cost
(6)
Marginal cost
(TC=FC+VC)
MC=∆TC/∆q
$0
100
200
300
400
500
600
$200
300
400
500
600
700
800
$50.00
33.33
25.00
33.33
50.55
100.00
18
Exhibit 5
TC and MC curves for Smoother Mover
Total cost
Total dollars
TC is the vertical sum of FC and VC
Variable cost
Fixed
cost
VC starts from origin; increases slowly at first;
with diminishing returns, VC increases rapidly
$500
200
Fixed cost
FC = $200 at all levels of output
Cost per ton
0
3
6
9
12
15
Tons per day
Marginal cost
$50
MC first declines: increasing marginal returns;
then increases: diminishing marginal returns
25
0
3
6
9
12
15
Tons per day
19
Average Cost in the Short Run
• Average variable cost AVC = VC/q
• Average total cost ATC = TC/q
• When MC < average cost
– The marginal pulls down the average
• When MC > average cost
– The marginal pulls up the average
• U-shape of average cost curves
– Law of diminishing marginal returns
20
Exhibit 7
Average and marginal cost curves; Smoother Movers
MC
When MC is above AVC (ATC),
AVC (ATC) is increasing.
Cost per ton
$150
ATC and AVC: decline,
reach low points, then rise.
125
100
ATC
75
AVC
50
When MC is below AVC (ATC),
AVC (ATC) is falling
25
0
5
10
15
Tons per day
When MC = AVC (ATC), AVC (ATC) is at its minimum.
21
Perfect Competition
© 2009 South-Western/ Cengage Learning
What is Market Structure?
• Market structure
– Number of suppliers
– Product’s degree of uniformity
– Ease of entry into the market
– Forms of competition among forms
• Industry
– All firms supplying output to a market
23
Types of Market Structure
• Perfect Competition: many sellers;
horizontal demand curve
• Monopoly: one seller
• Monopolistic Competition: many
sellers; downward-sloping demand curve
• Oligopoly: few sellers
24
Perfectly Competitive Market Structure
•
•
•
•
•
Many buyers and sellers
Commodity; standardized product
Fully informed buyers and sellers
No barriers to entry
Individual buyer or seller
– No control over priceprice-taker
25
Demand Under Perfect Competition
• Market price
– Determined by market demand and
supply. All firms must use this price on
their products.
• Demand curve facing one supplier
– Horizontal line at the market price
– Perfectly elastic
26
Short Run Profit Maximization
• Maximize economic profit
– Choose the quantity at which total
revenue (TR) exceeds total cost (TC) by
the greatest amount
– TR = PxQ
• Profit = TR – TC
27
Golden Rule of Profit Maximization
• Marginal revenue: the change in TR
from selling an additional unit
– ∆TR/∆q
• MR = P = AR (perfect competition)
• Golden rule: produce where MR = MC
– Expand output: MR>MC
– Stop before MC>MR
28
Exhibit 2
(1)
(2)
(3)
(4)
(5)
(6)
(7)
• Short-run
cost
and
revenue;
perfectly
Bushels
Marginal
Total
Total
Marginal
Average
Economic
of wheat
Revenue
Revenue
Cost
Cost
Total cost Profit or Loss
competitive
firm
per day;(q) (Price); (p) (TR=q×p)
(TC)
MC=∆TC/∆q ATC=TC/q
TR-TC
0
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
$5
5
5
5
5
5
5
5
5
5
5
5
5
5
5
5
$0
5
10
15
20
25
30
35
40
45
50
55
60
65
70
75
80
$15.00
19.75
23.50
26.50
29.00
31.00
32.50
33.75
35.25
37.25
40.00
43.25
48.00
54.50
64.00
77.50
96.00
$4.75
3.75
3.00
2.50
2.00
1.50
1.25
1.50
2.00
2.75
3.25
4.75
6.50
9.50
13.50
18.50
$19.75
11.75
8.83
7.25
6.20
5.42
4.82
4.41
4.14
4.00
3.93
4.00
4.19
4.57
5.17
6.00
-$15.00
-14.75
-13.50
-11.50
-9.00
-6.00
-2.50
1.25
4.75
7.75
10.00
11.75
12.00
10.50
6.00
-2.50
29
-16.00
Monopoly
© 2009 South-Western/ Cengage Learning
Barriers to Entry
• Monopoly
– Sole supplier of a product with no close
substitutes
• Barriers to entry
1. Legal restrictions such as a patent
2. Economies of scale – natural monopoly
with a downward sloping LRAC
3. Control of essential resources – EX:
DeBeers Consolidated Mines
31
(diamonds)
Firm’s Costs and Profit Maximization
• Monopolist
– Choose the price
– OR the quantity
– ‘Price maker’
• Profit maximization
– TR minus TC
– Supply quantity where TR exceeds
TC by the greatest amount
– MR equals MC
32
Exhibit 5
(1)
(2)
(3)
(4)
(5)
(6)
(7)
•Diamonds
Short-run
costs
and
revenue
for
a
Price
Total
Marginal
Total
Marginal
Average
per day
(AR)
Revenue
Revenue
Cost
Cost
Total cost
monopolist
(Q)
(p)
TR=p×Q MR=∆TR/∆Q
(TC)
(MC)
ATC=TC/q
0
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
$7,750
7,500
7,250
7,000
6,750
6,500
6,250
6,000
5,750
5,500
5,250
5,000
4,750
4,500
4,250
4,000
3,750
3,500
0
$7,500
14,500
21,000
27,000
32,500
37,500
42,000
46,000
49,500
52,500
55,000
57,000
58,500
59,500
60,000
60,000
59,500
$7,500
7,000
6,500
6,000
5,500
5,000
4,500
4,000
3,500
3,000
2,500
2,000
1,500
1,000
500
0
-500
$15,000
19,750
23,500
26,500
29,000
31,000
32,500
33,750
35,250
37,250
40,000
43,250
48,000
54,500
64,000
77,500
96,000
121,000
$4,750
3,750
3,000
2,500
2,000
1,500
1,250
1,500
2,000
2,750
3,250
4,750
6,500
9,500
13,500
18,500
25,000
$19,750
11,750
8,833
7,750
6,200
5,420
4,820
4,410
4,140
4,000
3,930
4,000
4,190
4,570
5,170
6,000
7,120
(8)
Total profit
or loss
(=TR-TC)
-$15,000
-12,250
-9,000
-5,500
-2,000
1,500
5,000
8,250
10,750
12,250
12,500
11,750
9,000
4,000
-4,500
-17,500
-36,000
33
-61,500
Monopolistic Competition
and Oligopoly
Monopolistic Competition
• Characteristics
– Many producers
– Low barriers to entry
– Slightly different products
• A firm that raises prices: lose some
customers to rivals
– Some control over price ‘Price makers’
• Downward sloping D curve
– Act independently
35
Monopolistic Competition
• Product differentiation
– Physical differences
• Appearance; quality
– Location
• Spatial differentiation
– Services
– Product image
• Promotion; advertising
36
Oligopoly
• Few sellers
• Barriers to entry
– Economies of scale
– Legal restrictions
– Brand names
– Control over an essential resource
– High cost of entry
• Start-up costs; advertising
• Crowding out the competition
37
Collusion and Cartels
• Collusion
– Agreement among firms to
• Divide the market
• Fix the price
• Cartel
– Group of firms that agree to collude
• Act as monopoly
• Increase economic profit
• Illegal in U.S.
38
Comparisons Across Market Structures
Perfect
Monopolistic
Characteristics Competition Competition
Oligopoly
Monopoly
Sellers
Many
Many
Few
One
Products
Identical
Close
substitutes,
but not
identical
Identical (ex:
oil) OR
Different (ex:
cereal)
No close
substitutes
Prices
Price-taker
Price-maker
Price-maker
Price-maker
Entry and Exit
No barriers
No barriers
Barriers
Barriers
Demand
horizontal
Downwardsloping
Downwardsloping
Downwardsloping
Profits
MR=MC
MR=MC
MR=MC
MR=MC
Long-Run
Economic
Profits
Zero
Zero
Greater than
zero
Greater than
zero
39
Public Goods
and Public Choice
© 2009 South-Western/ Cengage Learning
Characteristics of Pure Public Goods
• Nonrival: more than one person can
consume the good or service at the
same timeMC of an additional user is
zero
• Nonexcludable: difficult or impossible to
exclude others from deriving the benefits
of the public good
41
Private, Public Goods, and in Between
1. Private goods
– Rival in consumption
– Exclusive
– Provided by private sector
2. Public goods
– Nonrival in consumption
– Nonexclusive
– Provided by government
42
Private, Public Goods, and in Between
3. Natural monopoly
– Nonrival but exclusive
– With congestion: private goods
– Provided by private sector or government
4. Open-access good
– Rival but nonexclusive
– Regulated by government
43
Exhibit 1
• Categories of goods
44
Paying for Public Goods
• Tax = marginal valuation
– Free-rider problem
• People try to benefit from the public goods
without paying for them
– Ability to pay
45
Externalities
and the Environment
© 2009 South-Western/ Cengage Learning
Externality
• Externality—costs or benefits from the
production process that are not reflected
in the market price and affect the welfare
of others not necessarily using the
product or service.
• Externalities can be positive (reflecting
a benefit) or negative (reflecting a cost.)
47
Negative versus Positive
• Person smoking in a crowded room
• Firm producing honey located next to an
apple orchard
• Person talking loudly on their cell phone
at the table next to yours
• Colorful English country garden in your
next door neighbor’s yard
• Pollution from a coal-burning utility plant
48
Negative Externality
• Marginal Private Cost (MPC): private
costs of production such as wages, costs
of materials, rent, insurance, taxes, etc.
• Marginal External Cost (MEC):
valuation of marginal damage caused by
negative externality
• Marginal Social Cost (MSC):
= MPC + MEC
49
Exhibit 1
Dollars per kilowatt-hour
Total social gain
$0.14
c
b
Marginal
social cost
a
0.10
D
0
35
Marginal social cost
curve includes marginal
private cost and marginal
external cost.
Marginal private cost; 50
Marginal
million kilowatt-hours of
private cost electricity are produced
per month.
The marginal external
cost of production is
imposed on society.
50 Millions of kilowatt-hours
of electricity per month
Marginal social cost; only 35 millions kilowatts-hour are produced,
which is the optimal output.
50
Public Responses to Negative Externalities
• Tax the polluter: levy a tax on each
level of output produced by the polluter
in an amount equal to the MEC inflicted
at the socially efficient level of output.
• Subsidize the polluter: pay the polluter
not to pollute
• Environmental regulation: Government
tells the polluter to reduce pollution or
face sanctions (1990 Clean Air Act)
51
Public Responses to Negative Externalities
• Economic efficiency approach:
marketable permits—government sells
producers permits to pollute (pollution
rights)
52
Positive Externality
• Marginal Private Benefit (MPB): private
benefits of production or consumption
• Marginal External Benefit (MEB):
valuation of marginal benefit created by
positive externality
• Marginal social benefit = MPB + MEB
53
Positive Externalities
• Beneficial externalities
• Education
– Personal benefits
– Benefits to society
• Positive externality
• Public policy
– To increase quantity beyond private
optimum
54
Exhibit 7
• Education and Marginal
positive externalities
S
Dollars per unit
cost
e’
e
Marginal
social benefit
D’
Marginal
private benefit
0
E
E’
D
No government intervention:
equilibrium quantity of
education (E); marginal private
benefit of education equals the
marginal cost as reflected by
the supply curve.
Education also confers a
positive externality on the rest
of society, so the social benefit
exceeds the private benefits.
Quantity of
education per period
At E, the marginal social benefit exceeds the marginal cost, so more education
increases social welfare.
In this situation, government tries to increase education to E’, where the
55
marginal social benefit equals the marginal cost.
Income Distribution
and Poverty
© 2009 South-Western/ Cengage Learning
Income Distribution by Quintiles
• Distribution of income
– U.S. households
– Ranked by income
– Five groups of equal size (quintiles)
• Percentage of income received in 1970
– Poorest 20% of population
• 4.1% of income
– Richest 20% of population
• 43.3% of income
57
Exhibit 1
• Share of aggregate household income
by quintile: 1970, 1980, 1990, and 2005
58
Income Distribution by Quintiles
• Richest 20% of population
– Increased share of income
– Two-earner households
• Poorest 20% of population
– Decreased share of income
– Single-parent household
59
The Lorenz Curve
• Lorenz curve: graphical representation
of the size of the income distribution
• The diagonal line represents equal
distribution or perfect income equality.
Each 20 percent of the population
receives 20 percent of total income.
60
Income (cumulative percent)
Exhibit 2: Lorenz Curve
a
1970
b
2005
Point a: in 1970, the bottom
80% of households
received 56.7% of all
income.
Point b: in 2005, the share
of all income going to the
bottom 80% of households
was lower than in 1970.
If income were evenly
distributed across
households, the Lorenz
curve would be a straight
line.
Households (cumulative percent)
Lorenz curve: convenient way of showing the % of total income received by any
given % of households when households are arrayed from smallest to largest. 61
Why Incomes Differ
•
•
•
•
Number of household members working
Education, ability, job experience
Productivity
High-income household
• Well-educated couple; both spouses employed
• Low-income household
• One person living alone
• Single-parent, female
• Poorly educated
62
A College Education Pays More
• Median wage, past 20 years
– Only high-school diploma: decreased 6%
• Industry deregulation; declining unionization
• Information technology
– College degree: increased 12%
• Information technology
• Higher rewards for education
63
Redistribution Programs
• Official U.S. poverty level
– Family of four: $19,971 in 2005
– $13.70 per person per day
– Pretax money income
– Includes cash transfers
– Excludes value of non-cash transfers
» Food stamps; Medicaid; Subsidized housing
» Employer-provided health insurance
– Recessions: Increase in poverty
• International poverty line:
• $1 per person per day
64
Exhibit 3 (1959-2005)
• Number and percentage of US
population in poverty
65
Social Insurance
1.
2.
3.
4.
•
Social security
Medicare
Unemployment insurance
Workers’ compensation
Deducted from workers’ pay
– Aimed at people with work history
• Income redistribution
• From rich to poor
• From young to old
66
Income Assistance
• Welfare programs
• Means-tested program: only individuals
with incomes below a certain level qualify
1.Cash transfers programs
– Temporary assistance for needy families:
TANF replaced AFDC
– Supplemental security income
– General assistance aid
– Earned-income tax credit
67
Income Assistance
2. In-kind transfer programs
– Medicaid: basic medical care for the poor
– Food stamps
– Housing assistance
– Support for day care, school lunches
– Energy assistance
– Education and training
68
Percent of population living in poverty by state
69
Welfare Reform
• Welfare-to-work programs
• 1997: Temporary assistance for needy
families
– States: more control
• Maximum time to receive benefits: 5 years
• Work participation rates: must work after 2
years of receiving benefits
• Benefit levels are reduced less than dollar
for dollar when one obtains a job
70
Welfare-to-work is working?
• Welfare recipients
– Declined 71% below the peak
• Increased employment among mothers
– Higher income
• Increased welfare spending per recipient
• Earned-income tax credit
• Higher price of going on welfare
71
Statistics from U.S. GAO
QuickTime™ and a
TIFF (Uncompressed) decompressor
are needed to see this picture.
Andrea’s Software
Business
73
$60
$60
-$49 (loss)
$145
$56
$112
$56
-$33 (loss)
$180
$35
$56
$168
$60
$210
$30
$56
$224
$56
$14 (profit)
$60
$245
$35
$280
$56
$35 (profit)
$285
$40
$56
$336
$56
$60
$330
$45
$56
$392
$60
$385
$55
$65
$60
$60
$525
$448
$56
$56
$560
$62 (profit)
$56
$63 (profit)
$56
$54 (profit)
$56
$35 (profit)
74
Microeconomics
James B. Wilcox
Resources provided by:
The University of Southern Mississippi
Center for Economic and Entrepreneurship Education,
Mississippi State University, & Virtual Economics