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What is Microeconomics?
Objectives
•
•
•
•
•
Role of prices
Supply and Demand
Competitive market
Differing market Characteristics
Analyze real-life situations
Chapter 1
What is Economics
About
Definition of Economics
Scarcity
Normative vs. Positive Economics
• Normative
• Positive
Examples: Positive or Normative?
• The government fought inflation during the early
1980s because it felt the inflation was damaging
potential long-term economic growth.
• The government should cut taxes in order to
stimulate consumption.
• Increases in consumer spending improved the
Japanese economy last year.
• Balancing the federal budget would be good for the
economy.
Micro vs. Macro
• Microeconomics
• Macroeconomics
Economic Way of Thinking
Why Study Economics?
• Social Problems
• Understand why things happen
• Understand the Political Process
Beginning to Think Like an Economist
…is this a good thing?
Defining Economic Goods
• Utility
• Tangibility
• Resources or factors of production used
Remember Scarcity Runs the Show…
Opportunity Cost
•
•
•
•
Pizza vs CD
Revolutionary War
Big Macs
Highway System
Summary Statement of Scarcity and Related
Concepts
The “wants” in the definition
of scarcity are for goods.
Scarcity
is the condition
where wants
are greater than
resources.
We get utility from
Because of scarcity, a
rationing device is needed.
Whatever the rationing device
is, people will compete for it.
Scarcity and competition are
linked.
Because of scarcity, people
must make choices.
When choices are made,
opportunity costs are incurred.
Goods are produced with
resources: land, labor, capital,
and entrepreneurship.
Changes in opportunity cost
affect behavior.
Costs and Benefits at the Margin
• Marginal Cost
• Marginal Benefits
• Unintended effects
Efficiency
• What is the “right amount” of time to study?
Economic way of thinking includes…
Economic Thinking Errors
• Association vs. Causation
• Fallacy of Composition
• Ceteris Paribus
Parts of a Theory
Scientific Approach
• What do you want to predict/explain?
• What variables are important?
Building and Testing a Theory
Evidence supports the
theory. No further action is
necessary, although it is a
good idea to continue to
examine the theory closely.
Decide on what
it is you want to
explain or
predict.
Identify the
variables that
you believe are
important to
what you want
to explain or
predict.
State the
assumptions of
the theory.
State the
hypothesis.
Test the theory
by comparing
its predictions
against realworld events.
Either
Or
Return
Evidence rejects the theory, so
either formulate a new theory,
or amend the old theory in terms
of its variables, assumptions,
and hypotheses.
How do we judge theories?
•
Appendix A
Working with Diagrams
Two-Variable Diagram Representing an
Inverse Relationship
The variables price
and quantity
demanded are
inversely related.
Price of CDs ($)
20
18
16
A
B
C
D
14
12
0
E
Demand for CDs
100 120 140 160 180
Quantity Demanded of CDs
Two-Variable Diagram Representing a
Direct Relationship
Consumption ($)
360
F
300
E
240
D
180
C
120
60
0
B
The variables
income and
consumption are
directly related.
A
100 200 300 400 500
Income ($)
Two Diagrams Representing Independence between
Two Variables
Y
Variables X and Y are
independent (neither variable
is related to the other).
Variables X and Y
are independent.
Y
40
40
D
30
30
C
20
20
B
10
10
A
A
0
10
B
20
(a)
C
30
D
40
X
0
10
20
30
40
(b)
X
Calculating Slopes
The 45 Line
45 Line
Y
20
0
A
45
20
X
Chapter 2
Economic
Activities: Producing
and Trading
Efficiency
Production Possibility Frontier
PPF
Production Possibilities Frontier
for Grades
GRADE IN
S OCIOLOGY
HOURS S PENT
S TUDYING
ECONOMICS
GRADE IN
ECONOMICS
POINT IN
PART (b)
6
90
0
60
A
5
85
1
65
B
4
80
2
70
C
3
75
3
75
D
2
70
4
80
E
1
65
5
85
F
0
60
6
90
G
HOURS S PENT
S TUDYING
S OCIOLOGY
(a)
Two types of Production Possibility Frontiers
Production Possibilities Frontier
(Constant Opportunity Costs)
COMBINATION
COMPUTERS AND
TELEVIS ION S ETS
(numbe r o f units pe r ye ar)
POINT IN
PANEL (b)
A
50,000
and
0
A
B
40,000
and
10,000
B
C
30,000
and
20,000
C
D
20,000
and
30,000
D
E
10,000
and
40,000
E
F
0
and
50,000
F
Part (a)
Production Possibilities Frontier
(Constant Opportunity Costs)
Second Type of PPF
Production Possibilities Frontier
(Changing Opportunity Costs)
Pa rt (a)
COMBINATION
COMPUTERS
AND TELEVIS ION S ETS
(nu mbe r o f un its pe r ye a r)
POINT IN
PANEL (b)
A
50,000
and
0
A
B
40,000
and
20,000
B
C
25,000
and
40,000
C
D
0
and
60,000
D
Production Possibilities Frontier (Changing
Opportunity Costs)
Law of Increasing Opportunity Costs
• Goes along with _____________________
• As ________ of a good is produced the opportunity
cost to produce that good _____________
Economic Concepts illustrated by PPF
Examples of Law of Increasing Opportunity
Costs
• Armed Services
• Home Improvements
Economic Growth
Economic Growth within
a PPF Framework
Exhibit 6
Military Go o ds
Ec o nomic g ro wth s hifts
the PPF o utward.
PPF
2
PPF
1
0
Civilian Go o ds
How would each of the following affect the
United States PPF?
• A rise in the unemployment rate
• The invention of the computer
• An increase in the number of birth in the United
States
• An increase in the number of births in Russia
More Hours of Study Shifts the Production Possibilities
Frontier
Efficiency…Again
• ON PPF –
• UNDER PPF –
• OVER PPF –
Unemployment
• Efficient?
• On, over, or under PPF?
Efficiency Criterion
• Will alternate arrangements of resources or goods
make at least one person better off without hurting
someone else?
• Yes?
• No?
Efficiency, Inefficiency, and Unemployment Resources, within a
PPF Framework
Te le vis io n S e ts
A
55
B
50
Effic ie nt po ints lie o n
the pro duc tio n po s s ibilitie s
fro ntie r; ine ffic ie nt po ints
lie be lo w the fro ntie r.
C
35
D
28
E
15
F
0
5
15
35
45
Cars (tho us ands )
52
Trade or exchange
• Why would you trade?
• Example: a leather jacket is $100…what does this
show??
Periods relevant to trade
• Before the trade takes place
• At the point of the trade
• After the trade
Benefits of Trade
• Compare the__________ and _________ point of
views
– Consumer Surplus
– Producer Surplus
Which makes you better off?
• Increases in Consumer or Producer Surplus?
• Why?
Terms of Trade
• Which part does buyers remorse fit into?
Costs of Trade
• Transaction costs
• Third-party effects
Producing and trading
• Two people: Elizabeth and
Brian
• Each produce two goods:
Bread and Apples
• Elizabeth  10 loaves of
bread and 10 apples
• Brian  5 loaves of bread
and 15 apples
Elizabeth
Apples
Elizabeth Bread
Brian Apples
Brian Bread
Comparative Advantage
• Should both produce apples and bread or should
they specialize?
• What does specialize mean?
What are the opportunity costs?
• Elizabeth
– If give up 10 apples how
much more bread can she
produce?
– If give up 10 loaves of
bread how many more
apples can she produce?
• Opportunity Costs
Elizabeth
Apples
Elizabeth Bread
20
0
10
10
0
20
What are the opportunity costs?
• Brian
– If give up 15 apples how
much more bread can he
produce?
– If give up 5 loaves of bread
how many more apples can
he produce?
• Opportunity Costs
Brian
Apples
Brian
Bread
0
10
15
5
30
0
Should we specialize?
• Elizabeth
• Brian
• Who produces apples cheaper?
• What does cheaper mean?
• Who produces bread cheaper?
Here is the deal
•
•
•
•
___________ produces only bread (___ loaves)
___________ produces only apples (___ apples)
Trade 8 loaves of bread for 12 apples
Breakdown of end result
– Elizabeth Bread?
– Elizabeth Apples?
• Brian Bread
• Brian Apples
• Are they better off??
Are they better off??
No
Specialization
or Trade
Elizabeth
Bread
Elizabeth
Apples
Brian Bread
Brian Apples
Specialization
and Trade
Gains from
trade
Economic System
• The way in which a society decides to answer key
economic questions
–
–
–
–
–
–
What goods will be produced?
How will the goods be produced?
For whom will the goods be produced?
Where on the PPF will the economy operate?
What is the nature of trade?
What function do prices serve?
Two major economic systems
• Capitalism
• Socialism
How do they differ
• PPF
– Capitalist:
– Socialist:
• What good to produce?
– Capitalist:
– Socialist:
• How goods will be produced?
– Capitalist:
– Socialist:
• For whom to produce?
– Capitalist:
– Socialist:
• Trade
– Capitalist view:
– Socialist view:
• Prices
– Capitalism views
– Socialism views
Chapter 3
Supply and Demand:
Theory
Market
• Two sides
Starting with the Buyer Side
• Quantity demanded
Important parts of definition
Demand
So….
Who does what in the Market?
• Consumers
• Firms
Circular Flow
Law of Demand
Demand Schedule
Price
4
3
2
1
Quantity
10
20
30
40
Demand Curve
• Used to represent the relationship between price
and quantity
• Why type of relationship do you expect price and
quantity to have?
Demand Schedule and Demand Curve
DEMAND S CHEDULE FOR GOOD X
Pric e (do llars )
PRICE
(do llars )
QUANTITY
DEMANDED
POINT IN
PANEL (b)
4
10
A
3
3
20
B
2
2
30
C
1
40
D
4
A
De mand Curve
B
C
D
1
0
10
20
30
40
Quantity De mande d o f Go o dX
(a)
(b)
Market Demand Curves
• Previous demand curve was for an individual
• How can we get the market curve from individual
demand curves?
Therefore….
Deriving a Market Demand Schedule & Curve
Part (a)
QUANTITY DEMANDED
PRICE
JONES
S MITH
OTHER BUYERS ALL BUYERS
$15
1
2
20
23
14
2
3
45
50
13
3
4
70
77
12
4
5
100
109
11
5
6
130
141
10
6
7
160
173
Determinants of Demand
Change in Demand vs. Change in
Quantity Demanded
• Change in Demand
• Change in Quantity demanded
Change in Demand
• SHIFT LEFT??
• SHIFT RIGHT??
Shifts in the Demand Curve
Part (a)
Pric e (do llars )
Rig htward s hift
in de mand c urve
(inc re as e in de mand)
30
A
B
D
D
0
500
700
Quantity De mande d o f Blue Je ans
Shifts in the Demand Curve
Part (b)
Pric e (do llars )
Le ftward s hift
in de mand c urve
(de c re as e in de mand)
30
B
A
D
D
0
450
650
Quantity Demande d of Blue Je ans
Change in price of related goods
• Substitutes
• Compliments
Substitutes and Complements
Part (a)
S UBS TITUTES
Pric e
Pric e
P2
B
If Co c a-Co la and
Pe ps i-Co la are
s ubs titute s , a
hig he r pric e fo r
Co c a-Co la le ads to . . .
A
P1
. . . a rig htward
s hift in the de mand
c urve fo r Pe ps i-Co la.
DCC
0
Qd 2
Qd1
Quantity De manded o f Co c a-Cola
DPC 2
DPC 1
0
Quantity De mande d o f Pe ps i-Cola
Substitutes and Complements
Part (b)
COMPLEMENTS
Pric e
P2
P1
If te nnis rac ke ts and
te nnis balls are
c o mple me nts , a hig he r
pric e fo r te nnis
rac ke ts le ads to . . .
B
A
Pric e
. . . a le ftward
s hift in the de mand
c urve fo r te nnis balls .
DTB 1
DTR
0
Qd 2 Qd1
Quantity De mande d o f Te nnis Rac ke ts
DTB 2
0
Quantity De mande d o f Te nnis Balls
Examples
• The housing market: Consumer’s income
increases
• The sugar market: Saccharine is found to lead
to cancer
• The jelly market: The price of peanut butter
increases
• The beer market: The price of beer decreases
Does the Law of Demand Hold?
• The price of eating out increases from $10 to $15
and the quantity demanded of restaurants increases
from 10 to 14 meals.
The other side…supply
• Quantity supplied
Important Parts
Supply
Law of Supply
Supply Schedule
Price
4
3
2
1
Quantity
40
30
20
10
Supply Curve
• Supply Curve
• What type of relationship do we have between
price and quantity supplied?
Supply Curve
Pric e (do llars )
S upply Curve
4
D
3
C
2
1
0
B
A
20
40
10
30
Quantity S upplie d of Go o dX
Stuff continued…
• Change in supply
• Change in quantity supplied
• Increase in supply --• Decrease in supply ---
Change in Supply versus
Change in Quantity Supplied
Pric e
Pric e
S
S
S
B
A
A c hang e in s upply
(a s hift in the
s upply c urve )
0
Quantity S upplie d
(a)
0
A c hang e in
quantity
(a mo ve me nt alo ng
the s upply c urve ,S )
Quantity S upplie d
(b)
Shifts in the Supply Curve
Part (a)
Pric e (do llars )
Rig htward s hift
in s upply c urve
(inc re as e in s upply)
5
0
A
200
S
S
B
300
Quantity S upplie d o f Go o d X
Shifts in the Supply Curve
Pa rt (b)
Pric e (do llars )
S2
5
B
S1
A
Le ftward s hift
in s upply c urv e
(de c re as e in s upply)
0
50
150
Qu antity S upp lie d o f Go o d X
Question???
• Can the supply curve ever be vertical?
• First…what does a vertical curve indicate about the
relationship between price and quantity supplied?
Determinants of Supply
Examples
• The computer market: The price of computer chips
decreases
• The fast food market: McDonalds opens three new
stores in Bakersfield
• The pencil market: The price of pencils increases
• The gasoline market: A tax is imposed on gas
station owners for each gallon of gas pumped out of
their station
Market Supply Curves
• Previous supply curve was for an individual
• How can we get the market curve from individual
supply curves?
Therefore….
Deriving a Market Supply Schedule & Curve
Part (a)
QUANTITY S UPPLIED
PRICE
BROWN
ALBERTS
OTHER S UPPLIERS ALL S UPPLIERS
$10
1
2
96
99
11
2
3
98
103
12
3
4
102
109
13
4
5
106
115
14
5
6
108
119
15
6
7
110
123
Auction Model
But…
• There is only one price where ___________
• This is called the _________________
Scissors and economics?
• Alfred Marshall compared Supply and demand to a
pair of scissors
– “It is impossible to say which blade is actually doing the
cutting just like it is impossible to say whether demand
or supply is responsible for the price
What determines the price?
Equilibrium
• Also called the _______________
At Disequilibrium can have…
• Shortage
• Surplus
Moving to Equilibrium
Pric e (do llars )
Exhibit 13
S
15
S urplus
10
PRICE
Qs
Qd
$15
150
50
S urplus
10
100
100
Equilibrium
5
50
150
S ho rtag e
E
S ho rtag e
5
D
0
CONDITION
50
100
Quantity
150
Moving to Equilibrium
• If we have a surplus, price must _______ to get to
equilibrium.
• If we have a shortage, price must _______ to get to
equilibrium.
Do Shortage and Scarcity refer to the same
thing???
Applications of Supply and Demand
Change in Supply and Demand but no change in
equilibrium price
What Happens???
•
•
•
•
•
•
•
•
Increase D and S constant?
Decrease D and S constant?
D constant and increase S?
D constant and decrease S?
D increase and S decreases by equal amounts?
D decrease and S increases by equal amounts?
D increases more than S decreases?
D increases less than S decreases?
A Summary Exhibit of a Market
MARKET
PRICE,
QUANTITY
DEMAND
Prefe renc e s
Inc o me
Numbe r
o f Buyers
Expe c tatio ns
o f Future Pric e
Pric e s o f
Re late d Go o ds
(S ubs titute s
and
Co mple me nts )
S UPPLY
Pric e s o f
Re le vant
Re s ouc e s
Numbe r
of
S e lle rs
Taxe s
and
S us idie s
Go ve rnme nt
Re s tric tio ns
Te c hno lo g y
Expe ctatio ns
of
Future Pric e
Price Controls
• Produces a barrier to which the economy can no
longer operate freely
• Two types
Price Ceiling
Impacts of Price Ceilings
Price Floor
Impacts of Price Floors
Minimum Wage
• In California the minimum wage is __________ per
hour
• Government mandated minimum wage is
____________
Impacts of Minimum Wage
Chapter 4
Applications of Supply and Demand
**You are responsible for reading
this chapter***
Chapter 5
Elasticity
What have we done?
• Chapter 3 & 4 gave us downward sloping demand
curves
• Now want to see how Qd changes when price
changes
Elasticity
So…
• What if Ed = 3?
• Shouldn’t it be negative?
Point elasticity
•
example
•
•
•
•
•
P1 = 10
P2 = 12
Q1 = 100
Q2 = 50
Elasticity??
Problem
Arc Elasticity
Differences
Price elasticity of demand can yield 5 basic
results
•
•
•
•
•
•
Numerator > Denominator
Numerator < Denominator
Numerator = Denominator
Numerator = 0
Denominator = 0
Each has a specific name and result
Elastic Demand
Inelastic Demand
Unit Elastic Demand
Perfectly Elastic Demand
Perfectly inelastic demand
Aren’t demand curve downward sloping?
How does a change in price affect Total Revenue of a
Firm?
• Revenue depends on _______________
• Michael Jordan and Nike shoes
– Substitutes – elastic demand
What is total revenue??
examples
• Elastic demand
– Price increase
– Price decrease
• Inelastic demand
– Price increase
– Price decrease
• Unit elastic demand
– Price increase
– Price decrease
Important to look at because…
• Elasticity of the demand determines if with a price
increase…
When would a half packed auditorium be better than a
packed one?
• If sell 10,000 tickets for $25
• Or 20,000 tickets for $10
Price elasticity of demand and a straight line
Point
A
B
C
D
E
F
G
P
8
7
6
5
4
3
2
Qd
3
4
5
6
7
8
9
Summary
• Upper end of Demand Curve
• Lower end of Demand Curve
So…
Determinants of price elasticity of demand
Cross Elasticity of Demand
When would you use Cross Price Elasticity?
• Ec>0
• Ec<0
• Ec=0
Income elasticity of demand
Why use income elasticity of demand?
• Ey>0
• Ey<0
Can also say…
• If |Ey| > 1
• If |Ey| < 1
• If |Ey| = 1
Can we use income elasticity in the real world??
• If invest in the stock market do you want to invest
in a normal or inferior good?
• Why??
Example
• Can a good be normal and income inelastic?
• Normality is determined by?
• Income inelastic would be denoted by?
Price Elasticity of Supply
Classification is like demand
• Es > 1
• Es < 1
• Es = 1
Any extreme elasticities???
• Es = 
• Es = 0
Does time play a role in elasticity of supply?
Elasticity and taxes
• If government levies a tax on a product who pays
the tax??
• Producers?? Consumers?? Share??
How find??
Who pays more of the tax??
•
•
•
•
Perfectly inelastic demand
Perfectly elastic demand
Perfectly elastic supply
Perfectly inelastic supply
Summary
• Ed > Es
• Ed < Es
• Ed = Es
Chapter 6
Consumer Choice: Maximizing Utility
and Behavioral Economics
Diamond-Water Paradox
• Why is water (necessary to life) so cheep while a
diamond (not necessary to life) is so expensive?
Two types of value for a good
How do you measure utility?
• Construct an artificial measure called a _________
Total Utility
Marginal Utility
Thus…
Law of Diminishing Marginal Utility
(1) UNITS OF
GOOD X
(2) TOTAL
(3) MARGINAL
UTILITY (utils) UTILITY (utils)
0
1
2
3
4
5
—
10
9
8
7
6
0
10
19
27
34
40
Total Utility (utils)
Marginal Utility (utils)
TU
40
10
9
34
8
7
27
6
MU
19
10
0
1
2
3
4
5 Good X
0
1
2
3
4
5
Good X
Does the “law” always hold?
Soften the Law
Examples…
• Car rides
• Fads
• eating
Thus…the law says
•
• What about to someone else or the interpersonal
utility?
–
Example
• Who would value a dollar more: a poor person or a
millionaire?
Diamond-Water Paradox revisited
•
• Water
– TU?
– MU?
Diamond-Water Paradox continued
• Diamonds
– TU??
– MU??
Solution to Diamond-Water Paradox
•
• Prices (value of exchange) are most often
determined by…
Is gambling worth it?
• If only want to win???
• If gain pleasure from the gambling process???
How do we compare MU of different units?
• Example: What is the MU of an apple vs. an
orange?
Decision Making Process
• If the MU of good A relative to its price is greater
than the MU of good B relative to its price we
should buy ________________
• Compare ____________ of each good
•
•
•
•
Example
MUorange = 30
MUapple = 20
Income = $20
Buy 10 oranges for $1 each and 10 apples for $1 each
• Good??
Is it good????
• Buy one more orange and one less apple
_____________
• When do we stop?
Consumer Equilibrium
• Therefore:
Example
P =$2; P =$1; Income=$60
M
c
# muffins
MUM
# cookies
MUc
5
11
44
6
6
8
46
5
7
6
48
4
8
3
50
3
What if the price of a good changes?
• Must recalculate
Pa=$1;Pb=$1? Pa=$0.50;Pb=$1?
Income = $7.00
#a
1
2
3
4
5
6
7
MUa
12
11.5
11
10
9
8
7
#b
1
2
3
4
5
6
7
MUB
22
20
18
16
14
12
10
Consumer Equilibrium and a Fall in Price
GOOD A
Orig inal
Purc has e
Ne w
Purc has e
Units of Go od A
1
2
3
4
5
6
7
12
11.5
11
10
9
8
7
Marg inal Utility
Ne w
Purc has e
GOOD B
Units o f Go o d B
Orig inal
Purc has e
1
2
3
4
5
6
7
22
20
18
16
14
12
10
Marg inal Utility
Orig inal
Purc has e
Go o d A
Go o d B
Ne w
Purc has e
Go o d A
Go o d B
12 utils
12 utils
=
$1.00
$1.00
8 utils
16 utils
=
$.50
$1.00
So…
Do RATS understand the inverse relationship between price and
quantity?
• Choice between two liquids
– Root beer
– Collins mix
• Given 300 pushes (each liquid had a different number of
pushes to get it – price)
• Found ????
Why isn’t education and medical care free?
• If cost = 0 when do we stop using it?
Consumer Surplus
Changes in Supply affect Consumer Surplus
Sales schemes
• Consumer is willing to buy
– One pair of shorts for $40
– Second pair of shorts for $30
• Store has a choice
– Sell shorts for $30
– Have sale where buy first for $40 get $10 off second
pair?
Chapter 7
The Firm
\
Business Firm
• Employs ___________
• Produces ___________________
• Sells to _____________________
Market
• Two sides
– Buyers
– Sellers
How do the two sides come together?
• Market Coordination
How does the firm decide what to produce?
• Managerial Coordination
Why follow this invisible hand?
• Armen Alchian and Harold Demsetz say…
Problem with teamwork
• Shirking
Can shirking increase or decrease?
How can we decrease shirking?
Who monitors the monitor?
Another way to ward off shirking?
Why do people submit to being monitored??
Objective of the firm
• _____________________
• Why not Sales or power maximization??
Chapter
8
Production
and Costs
Cost Side
• Explicit Cost
• Implicit Cost
Sacrifice
Profit
• Two types
– Accounting
– Economic
Which do you think is lower??
Zero Economic Profit
Sunk versus Fixed Costs
• Sunk
• Fixed
Production
Two types of time
• Short Run
• Long Run
Short Run
• Fixed input
• Variable input
• Fixed Cost (FC)
Costs
• Variable Costs (VC)
(1)
QUANTITY
OF
OUTPUT, Q
(units )
(2)
TOTAL
FIXED
COS T
(TFC)
0
$100
1
100
2
100
3
100
4
100
5
100
6
100
7
100
8
100
9
100
10
100
Total
Fixed
Cost
TFC (do llars )
TFC
100
0
1 2 3 4 5 6 7 8 9 10
Q
(1)
QUANTITY
OF
OUTPUT, Q
(units )
(4)
TOTAL
VARIABLE
COS T (TVC)
Total
Variable
Cost
TVC (do llars )
500
0
$ 0
1
50
2
3
80
100
4
110
5
130
6
160
200
7
8
9
10
250
310
380
400
TVC
300
200
100
0
1 2 3 4 5 6 7 8 9 10
Q
Total Costs
(1)
QUANTITY
OF
OUTPUT, Q
(units )
(6)
TOTAL COS T
(TC)
TC = TFC + TVC
= (2) + (4)
0
1
150.00
180.00
4
5
6
7
8
9
10
TC (do llars )
500
$100.00
2
3
Total
Cost
200.00
210.00
TC
400
300
200
100
230.00
260.00
300.00
350.00
410.00
480.00
0
1 2 3 4 5 6 7 8 9 10
Q
Other costs of importance…
• Average Variable Cost
• Average Fixed Cost
• Average Total Cost
(1)
QUANTITY
OF
OUTPUT, Q
(units )
(5)
AVERAGE
VARIABLE
COS T (AVC)
AVC = TVC/Q
= (4)/(1)
Average
Variable
Cost
AVC (do llars )
0
1
2
$50.00
3
4
33.33
5
26.00
6
26.67
7
28.57
31.25
8
9
10
40.00
27.50
34.44
38.00
100
50
0
AVC
1 2 3 4 5 6 7 8 9 10
Q
(1)
QUANTITY
OF
OUTPUT, Q
(units )
(3)
AVERAGE
FIXED COS T
(AFC)
AFC = TFC/Q
= (2)/(1)
Average
Fixed
Cost
AFC (do llars )
0
1
2
$100.00
50.00
100
3
4
33.33
25.00
50
5
20.00
6
7
16.67
14.28
8
9
12.50
11.11
10
10.00
AF
0
1 2 3 4 5 6 7 8 9 10
Q
(1)
QUANTITY
OF
OUTPUT, Q
(un its )
(7)
AVERAGE
TOTAL COS T
(ATC)
ATC = TC/Q
= (6)/(1)
Average Total
Cost
ATC (dollars)
150
0
1
2
3
4
$15 0.00
90.00
66.67
46.00
43.33
7
42.86
43.75
10
50
ATC
52.50
5
6
8
9
100
45.56
48.00
0
1 2 3 4 5 6 7 8 9 10
Q
Marginal Cost
Why Change in Total Cost or Total Variable
Cost????
(1)
(8)
QUANTITY MARGINAL COS T (MC)
OF
MC = TC/Q
OUTPUT, Q
= (6)/(1), o r
(un its )
= TVC/Q
= (4)/(1)
Marginal
Costs
MC (dollars)
0
1
$50 .00
2
30.00
3
20.00
4
10.00
5
20.00
6
30.00
7
40.00
8
50.00
9
60.00
10
70.00
100
MC
50
0
1 2 3 4 5 6 7 8 9 10
Q
Example
Shapes of Curves
Marginal Physical Product (MPP)
• What is the variable input?
• What is the variable cost?
So…
Marginal Physical Product
Part (a)
(1)
VARIABLE
INPUT,
LABOR
(wo rke rs )
(2)
FIXED
INPUT,
CAPITAL
(units )
(3)
QUANTITY OF
OUTPUT, Q
(units )
0
1
0
1
2
1
1
18
37
3
4
1
1
57
76
5
1
94
6
7
1
1
111
127
(4)
MARGINAL
PHYS ICAL
Marg inal Phys ic al Pro duc t
PRODUCT OF 20
VARIABLE
INPUT (units ) 19
(3)(1)
18
18
19
17
16
MP
20
19
18
17
16
0
1
2 3 4 5 6 7
Numbe r o f Wo rke rs
Crowding Problem
Average Physical Productivity
So find that…
• MC and MPP are related
• What is the relationship?
Marginal Cost
Part (b)
(5)
TOTAL
FIXED
COS T
(dollars )
(6)
TOTAL
VARIABLE
COS T
(do llars )
(7)
TOTAL
COS T
(do llars )
(5) + (6)
$40
$0
$40
40
20
60
40
40
80
40
60
100
40
80
120
40
100
140
40
120
160
40
140
180
(8)
Marg inal Co s t (do llars )
MARGINAL
COS T
(do llars )
1.25
(7)(3)
or
1.17
(6)(3)
1.11
$1.11
$1.05
MC
1.05
1.00
$1.00
$1.05
$1.11
$1.17
$1.25
0
18 37 57 76 94 111 127
Quantity o f Output
Does this relationship make sense?
• If productivity increases what would happen to
costs??
• Productivity decreases??
MPP determines shape of MC
• MPP must have a declining part because of
__________________
• Can also define MC as:
Average-Marginal Rule
• Can use to see what the ATC and AVC curve look
like
• Tells us what happens when ___________ is above
or below the “average” curves
• If MC is above AVC and ATC
• If MC is below AVC and ATC
From Average-Marginal Rule can infer…
So…
• MC gains it shape from???
• MC below ATC: What is ATC curve doing?
• MC above ATC: What is ATC curve doing?
Now switching to the Long Run
• When does Long Run start?
• Important curves
Short Run vs. Long Run
• Short Run assumes ________________plant size
• Each plant size has a unique ATC curve associated
with it
• LRATC combines all the SRATC curves
• Which points of the SRATC???
Why minimum?
Long-Run Average Total Cost Curve (LRATC)
Part (a)
Ave rag e Co s t (do llars )
S RATC2
S RATC1
B
6
5
A
S RATC3
D
C
LRATC
(blue
c urve )
0
Q1
Q2
Quantity o f Output
Isn’t the LRATC curve smooth??
Shape of LRATC
Economies of Scale
Constant Returns to Scale
Diseconomies of Scale
Are economies, diseconomies, and constant returns to scale in SR,
LR, or both???
Is this the same as diminishing returns?
Review
• Economies of Scale
• Constant Returns to Scale
• Diseconomies of Scale
Why does economies of scale exist?
Why does diseconomies of scale exist?
Why is minimum efficient scale important?
Minimum Efficient Scale for Six Industries
INDUS TRY
Re frig e rato rs
Cig are tte s
Be e r bre wing
Petro le um refining
Paints
S ho e s
MES AS A
PERCENTAGE
OF U.S .
CONS UMPTION
14.1 %
6.6
3.4
1.9
1.4
0.2
S OURCE: F. M. S c he re r, Alan
Be c he ns te in, Eric h Kaufe r, and R. D.
Murphy, The Ec o no mic s o f Multiplant
Ope ratio n (Cambridg e , Mas s .: Harvard
Unive rs ity Pre s s , 1975), p. 80.
Where would you expect to find less firms?
(using MES)
Efficient Number of Firms
• __________ divided by _____________
• 100% of goods are wanted by consumers
• Cigarette firm’s MES = 6.6
• Petroleum firm’s MES = 1.9
What cause SRTC, LRTC, and MC to shift?
Chapter 9
Perfect
Competition
Assumptions
Price Takers
Examples
Demand Curve
• Individual Market
• Industry Market
Why???
Would a firm sell at price lower than market
price?
Why horizontal though??
• What happens to elasticity as increase the
number of substitutes for the good?
• How many substitutes exist for a homogenous
good?
• What type of elasticity does this demand have?
Does this go against the Law of Demand?
• What is the Law of Demand??
• Go against??
Total Revenue
Marginal Revenue Continued
• For a perfectly competitive firm
• Why???
• Why???
So…
• For perfectly competitive the MR curve is
the same as the ______________
• Since price taker –
Example
Price
Quantity
5
1
5
2
5
3
TR
MR
So…
What if assumptions don’t hold?
When will firm produce??
Profit Maximization Rule
Since…
Why not produce where distance between MR
and MC is largest?
Four Cases: Produce or not?
• Price equals ATC
• Price above ATC
• Price below AVC
• Price below ATC but above AVC
Price equals ATC
Price above ATC
Price below AVC
Shut Down Rule
Price below ATC but above AVC
What Should a Firm Do in the Short Run?
Yes
Continue to
produce
Is it above
ATC?
No
Price
Yes
Continue to
produce
No
Shut down
Is it above
AVC?
What is the shut down rule??
• Shut down if _________
• So…produce if ________________
How find the market supply curve?
• What is the individual firm’s supply curve?
• Why are market supply curves upward sloping??
Job Security and fixed costs?
• Is this the Short Run or Long Run?
Which firm has more job security?
Firm X
Firm Y
TC
600
600
TVC
400
500
TFC
200
100
Will there be the same number of firms in the
short and long runs?
Long Run Competitive Equilibrium
Summary of Incentives present at Long Run
Equilibrium
Perfect Competition
• Resource Allocative Efficiency
• Productive Efficiency
Summary for Perfect Competition
• Objective
• Constraints
• Choice
MONOPOLY
Assumptions
Government can “grant” monopoly power in
three ways…
Monopolies exist because:
Two types of Monopolies
• Government monopolies
• Market monopolies
Price maker
Demand Curve
• Remember the individual firm is _____________
• What does the demand curve look like??
Example
Price
Quantity
10
2
9.75
3
TR
MR
What differs here from Perfect Competition??
Example
Price
10
Quantity
Demand
1
9
2
8
3
7
4
TR
MR
Goal
Three cases
• P > ATC
• P < ATC
• P=ATC
Differences between monopoly and perfect
competition
Similarities
Long Run Profits
Capitalization of Profits
Economic Rent
• Know…
• May bring about Rent Seekers
Monopolies are inefficient compared to Perfect
Competition
Monopoly inefficiencies
X-inefficiency
Does monopolist have to charge same price to
everyone?
• Called _______________________
• Three types
Perfect Price discrimination
Bulk Pricing
Group Pricing
Why Price Discriminate?
Why doesn’t everyone price discriminate?
Does a monopolist exhibit resource allocative
efficiency?
So does one person paying high prices mean that
another can pay low prices??
Would firms rather be a monopoly?
Finally Chapter 11
Monopolistic
Competition,
Oligopoly, and Game
Theory
Monopolistic Competition
Four Assumptions
Examples
Monopolistic is combination of Perfect
Competition and Monopoly
Why most likely????
Still have three cases
• P = ATC
• P > ATC
• P < ATC
Differs from perfect competition…
The more we
differentiate our product
the closer we get to
___________. If we
can’t differentiate our
product we are closer to
____________________
Oligopoly
Oligopoly
Four assumptions
How find???
So…
• High concentration ratio?
• Small concentration ratio?
Question…
How do firms react to
actions of other firms???
Three theories
• Kinked Demand Curve Theory
• Price Leadership Theory
• Cartel Theory
Kinked Demand Theory
Demand Curve
Why kinked
So…
Criticisms
Price Leadership Theory
So…
• Dominate firm
• Fringe Firm
Dominate Firm does not
have to be the largest!!! It
could be the one with the
______________!!
How derive demand curve?
From Demand Curve
Cartel Theory
Problems for a cartel
Why Cheat???
The Government tries to keep some cartels
together
• Farmers
• Airlines
Game Theory
Prisoner’s dilemma
Prisoner's Dilemma
Nathan’s Choices
Confess
Not Confess
2
1
Not
Confess
Nathan pays $500
Nathan pays $2,000
Bob pays $5,000
Bob pays $2,000
Bob’s
Choices
Confess
4
3
Nathan pays $5,000
Bob pays $500
Nathan pays $3,000
Bob pays $3,000
Cartels and Prisoner's Dilemma
Hold to
Agreement
Firm A’s Choices
Break
Agreement
1
Hold to
Agreement
A earns $50,000 profits
B earns $50,000 profits
Firm B’s
Choices
Break
Agreement
2
A earns $100,000 profits
B earns $5,000 profits
3
A earns $5,000 profits
B earns $100,000 profits
4
A earns $10,000 profits
B earns $10,000 profits