Download Micro Review Day 1

Micro Review Day 1—
Comprehensive
Homework: Micro Review Quiz #2 Due Tomorrow
*AP Test Dates/Locations can be found on my Teacher Page
Topics Covered:
•
Substitutes/compliments & Normal/inferior
•
Monopolistic—SR and LR & Excess Capacity
•
Elasticity (TR Test, Price, Income, Cross-Price) • Oligopoly
• Resource/Factor Market (Firm vs. Market)
Taxes & Tax Incidence
•
Utility Maximization
•
Monopsony
•
Law of Diminishing Marginal Return
•
Minimum Wage
•
Cost Curves (ATC, AVC, AFC, MC) & Shit-down • Derived demand
Rule
• Positive and Negative Externalities
• Perfect Competition
•
•
Monopoly & Notable Points & Taxes/Subsidies
Sample Problem: World Trade
(c) Identify the net gain in total surplus from the trade.
Sample Problem: World Trade
(a)
i. P2
ii. Q2
(b) Q3—Q1
(c) JGH
Substitutes/Compliments & Normal/Inferior Goods

Substitutes: If price for butter increases, demand for margarine increases


Compliments: If price of cereal increases, demand for milk decreases


Something purchased together
Normal good: Steak, North Face, Uggs


Something purchased as a comparable alternative
Goods for which demand increases as income increases
Inferior goods: SPAM

Goods for which demand increases as income decreases
Elasticity: TR Test, Price ED, Income,
Cross-Price
Absolute
Formula %Δ:
New − Old
Old
Value!!!

Price Elasticity of Demand: Sensitivity of the Law of Demand
%Δ Quantity Demanded
 General Formula:
×100 = PED Coefficient
%Δ Price
Coefficient Values:
1
0


Midpoint/Arc Formula:
Q2−Q1
(Q1+Q2)⁄2
P2−P1
(P1+P2)⁄2
Inelastic
Elastic
= PED Coefficient
Cross-Price Elasticity of Demand: How a change in price of one good effects the
QD of another good  substitutes and compliments
%Δ QDGood A
 CPED Formula:
%Δ PriceGood B = CPED Coefficient
 Income Elasticity of Demand: How a change in income effects the QD of
a good

IED Formula:
%Δ Quantity Demanded
= IED Coefficient
%Δ Income
Coefficient Values:
+
−
Compliments
−
0
Substitutes
Coefficient Values:
Inferior
0
Normal
+
Elasticity Demand and Tax Incidence

Tax Incidence: who bears the cost of a tax on a good is related entirely to the
elasticity of demand for the good being taxed

Perfectly inelastic: burden is entirely on consumer

Relatively inelastic: burden is mostly on consumers

Unit elastic: burden is shared by producers/consumers equally

Relatively elastic: burden is mostly on producers

Perfectly elastic: burden is entirely on producers
TR Test
Sample Problem:
(a)
What is the value of revenue for the
producer?
$240
(a)
What is the value of government revenue?
$120
(a)
Between the prices of $5 and $4 is
demand perfectly elastic, relatively
elastic, unit elastic, relatively inelastic,
or perfectly inelastic?
Inelastic: TR test  TR decreases
from $450 to $240 when price falls
Or
Elasticity coefficient = .8
Excise Tax
A Few Things:

Use the wedge! It tells you everything…

Price consumers pay (new EQP)

Price received by producers (Vertical distance down
from new EQP)

Producer Revenue

Tax Revenue

Consumer/Producer Surplus before and after tax

DO NOT FORGET DEADWEIGTH LOSS
Utility Maximization—Broad Rule!!!
MUGood A = MUGood B
PriceGood A PriceGood

B
Not only is this law followed by consumers making
purchases, it’s derived from all marginal analysis:

MC = MR (profit maximizing quantity of output)

MRC = MRP (profit maximizing quantity of workers)

Cost minimizing rule
Sample Problem: Utility Maximization
(a)
Fudge: MU/$=6 Coffee: MU/$=5  More fudge, less coffee. Greater utility per $
(b)
0: perfectly inelastic
None. Can pass all the tax burden onto consumers.
Law of Diminishing Marginal Returns
Law applies to everything
from labor to utility…
Law of Diminishing Marginal Returns: as variable resources (labor) are added to fixed
resources (capital) the marginal product decreases at an increasing rate
This law shapes the MC curve!
Cost Curves and Shut-Down Rule
Please Note:
• ALL MARKET STRUCTURES
HAVE ATC AND MC!!!
• MC intersects ATC & AVC at
their minimum points
• MC guides ATC & AVC
• The difference between ATC
& AVC is AFC
• AFC decreases as Q
increases
Shut Down Rule:
If firm can cover their total variable
costs, in the short-run they will stay
in operation.
In the long-run they will exit the
industry
Perfect Competition: SR and LR
How will this market be affected in the long-run?
Since the firm is profitable, firms will enter in the LR, increasing supply in the market, lowering price. Arrive
at a zero-profit equilibrium.
Monopoly: Notable Points, Changes in Costs
Price
MC
ATC
Important Points:
• Socially Optimal & Allocatively
Efficient Q/P: MC = D
• Fair Return Q/P: ATC = D
• Productively Efficient Q/P: ATC = MC
D=AR=P
Q
MR
Monopoly Key Concepts:
• MR deviated from demand b/c in order to sell more units, monopoly must lower price for
next unit and all previous units
• Not entry and exit due to large market barriers so profit possible in LR
• Profit maximizing quantity rule: MC = MR
• Price monopoly charges indicated by demand curve @ profit max. quanity
Monopoly and Taxes/Subsidies
Price
MC
ATC

Lump-Sum Tax  Increase TOTAL costs (ATC)

Lump-Sum Subsidy  Decrease TOTAL costs (ATC)

Lump-Sum Tax/Subsidy has NO EFFECT on profit
maximizing quantity or price!!!!

Per-unit Tax  Increases MARGINAL costs (MC)

Per-unit Subsidy  Decreases MARGINAL costs (MC)

Per-unit tax/subsidy will CHANGE profit maximizing
quantity and price!

Per-unit Tax: MC = Decrease Q & Increase in Price

BAD FOR CONSUMERS! NEVER IMPOSE
TAX ON A MONOPOLIST
D=AR=P
Q
MR
PER-UNIT
Monopoly Sample Problem:
Q2 P5 (MC=MR)
Q4 P3 (MR=0)
Q3 P4 (MC=D) Socially Optimal
Q5 P2 (ATC=D) Fair Return
Monopolistic: SR, LR, and Excess Capacity

Behaves just like monopoly in SR

LR Adjustment from entry/exit of
competitors—effects D of firms good


Entry (profit): D

Exit (losses): D
Market @ zero-profit equilibrium—LREQ


PAY ATTENTION: Price (D) must be
tangent to ATC


TR = TC @ profit max. output
By far the most common mistake
When graphing LR:

Draw D/MR curves

Draw MC

Determine P/Q (MR=MC)

Draw ATC to touch P in it’s downward
sloping segment
QPE
Excess Capacity: Difference between productively efficient
(cost minimizing quantity) and profit maximizing quantity
• Productively efficient Q: MC = ATC
Oligopoly: Game Theory Matrix
BOX-OUT Values and
use Check-mark Rule
Oligopoly. Consider each others
actions
Early.
Early.
No. Better off to go late if
Roadway is late.
$900. Both choose early
(Nash equilibrium)
Resource/Factor Market: FIRM vs. MARKET

Wage
The biggest concept we struggled with last unit was distinguishing between the
actions relating to the firm and actions relating to the market.
Labor Market
Firm
SL
WE
WE
DL
QE
S = MRC
D = MRP
QL
QH
Need to read the question to see what market to analyze. If firm’s new technology make
workers more productive, what happens to: (a) quantity of workers hired? (b) wage rate firm
pays? (a) Increase  MRP  as MPL  = D (b) No change!!! MRC constant; hiring from PC labor market
L
Monopsony
MRC
SL
Rules:
1. Firm always hires the quantity
of labor: MRC = MRP
Q2
2. Wage = SL @ Q2
W2
Just like a monopoly:
Hire less and pay lower wages
than perfectly competitive!
What are W1 and Q1?
D = MRP

MRC is greater than SL due to the fact that in order for a monopsonist
to hire an additional worker, they must pay that worker a higher
wage (SL) and all previously hired worker that higher wage.
Minimum Wage Floor in PC and Monopsony
Labor Market
Wag
e
Firm
S
MRC
L
WMin
WMin
S = MRC
WE
WE
SL
WMin
D = MRP
DL
QLD
QE
QLS
Q
QH2
D = MRP
QH
L
In PC facing Minimum Wage Floor:
• Surplus of workers in the factor market
• Firm will hire less workers as MRC increases
QHMIN
Monopsonist facing Minimum Wage Floor:
• Hire Q of workers where Min. Wage Floor
intersects supply—if they are going to pay that
wage, might as well hire Q willing to work for
it
• MRC = Min. Wage Floor until it intersects SL
Derived Demand of Labor: MPL, MRP, MRC

Demand for labor is directly tied to 2 factors: labor productivity and price of the
output labor produces
MRP = MPL × Poutput
• Additional output produced
from additional worker
• Increase with
technology/training
• If MPL  = MRP (DF) 
• Price of the good firm is producing—
determined in the product market
• Increase with an increase demand for
the good
• If PO  = MRP (DF) 
MRC: cost of hiring an additional worker
• In perfectly competitive labor market MRC is constant (horizontal SL curve)
• For monopsonist MRC is greater than SL, MRC increases as QL increases
Derived Demand for Labor Sample Problem:
(a) Perfectly competitive. Price
of good constant.
(b) Perfectly competitive.
Hire infinite QL for market
wage rate.
(c) $400 = MPL × P (20 × $20)
(d) 6 workers. MRP≥MRC.
$160≥$120
How should government overcome this
market failure?
Per-unit tax! Increase MC, S, DWL
Positive/Negative Externalities
Market With Negative Externality
Market Without Externality
S=MPC=MSC
P
MSC
P
DWL
S=MPC
Value of
Externality
PSO
PFM
P
QFM
D=MPB=MSB
Q
@EQFM only the private transaction in
accounted for. S/D intersect = QFM
• MSB/MPB/D & MSC/MPC/S all together
D=MPB=MSB
Q
QSO QFM
• Account for externality: cost to society > MPC
• Wedge represents value of externality
• DWL ABOVE QFM EQ