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Micro-Economics Review Course Summary Tax Summary • Tax on buyers shifts D-curve, Tax on sellers shifts S-Curve • Taxes always produce deadweight loss! – You produce less at a higher cost • Tax Incidence does not depend on who pays the tax! – Buyers & Sellers share the burden – Elasticity determines who bears the most! • The majority of the tax burden falls on more inelastic curve – Steeper curve pays more of tax Tax on Sellers Price of Ice-Cream Price Cone buyers pay $3.30 3.00 Price 2.80 without tax S2 Equilibrium with tax S1 Tax ($0.50) A tax on sellers shifts the supply curve upward by the amount of the tax ($0.50). Equilibrium without tax Price sellers receive Deadweight loss! Demand, D1 0 90 100 Quantity of Ice-Cream Cones EXTERNALITIES • An externality is the uncompensated impact of one person’s actions on another person – Both positive & negative externalities exist • Externalities cause markets to be inefficient – That is, markets do not maximize total surplus (welfare) Negative Externality: Pollution MSC = (MCP + MCS) Price of Aluminum External social Cost Supply = MCP (private cost) Correct a Negative Externality with a Tax Spillover Cost Optimum Equilibrium MC = MB Demand = MBP (private value) 0 QOPTIMUM QMARKET Quantity of Aluminum Cost Curves Marginal Cost declines at first and then increases due to diminishing marginal product. Costs AFC, a short-run concept, declines throughout. $3.00 Note how MC hits both ATC and AVC at their minimum points. MC 2.50 2.00 1.50 ATC AVC 1.00 0.50 AFC 0 2 4 6 8 10 12 14 Quantity of Output 4 Market Structures Maximize Profit When: MR = MC Equilibrium Price vs. MC P = MC Perfect Competition Long Run Economic Profit MR = MC MR = MC MR = MC P > MC P > MC P > MC Monopolistic Competition No No Price Price Demand & Marginal Revenue Curve MC MC Oligopoly Monopoly Yes Yes Price MC MC Price Demand MR 0 Quantity of Output 0 D Quantity of Output MR 0 D Quantity of Output MR 0 D Quantity of Output Perfect Competition An increase in market demand… …raises price and output. (b) Short-Run Response Price Price B P2 P1 profit Firm Market MC S1 ATC P2 A Long-run supply P1 Quantity (market) 0 D2 D1 0 Q1 Q2 This can not be a long term equilibrium! P > ATC encourages entry into the market Will return to zero econ profit in long run Quantity (firm) Example: Monopoly Equilibrium profit Costs and Revenue To Find Equilibrium: • Set MC = MR • Line up to Demand Curve MC --------------------------- ----------------------------- Opportunity Costs: Lower QTY Higher Price Deadweight Loss 0 ATC Demand Marginal revenue Quantity SHORT RUN: Monopolistic Competition Price Profit Exists! LONG RUN: Monopolistic Competition Price Zero Profit, but not at Efficient scale MC MC ATC ATC P Demand MR Demand MR 0 Quantity 0 Quantity produced Efficient scale Quantity Oligopoly: Game Theory Every Dominant Strategy is a Nash Equilibrium BUT: Every Nash Equilibrium is not a dominant strategy Liz HIGH HIGH Bob LOW 400, 300 LOW -800, 500 600, -800 -500, -500 Easy way to find dominant strategy: First, Circle each players preferred boxes Second, if 2 circles in same row you have a Dominant Strategy Both Liz and Bob would choose Low! It is an enforceable equilibrium because there is no incentive to cheat Product & Factor Markets Wage Rate Price MC ATC P Market wage MR 0 Quantity produced Efficient scale Demand Quantity MR = MC Marginal Revenue Product (demand curve for labor) 0 Profit-maximizing quantity MRP = MFC Quantity of Workers Competitive Input Markets LABOR MARKET Entire Factory Industry Individual Firm Low Skilled Workers Price Low Skilled Workers SL Q1 E1 $10 DL= MRPL Qty Small firms can hire all their workers at Market wage ------------------- ------------- $10 -------------- Price Q1 SL = MFC DL= MRPL Qty Competitive vs Market Power MR = P for a competitive firm MR < P for a firm with market power MRP = [MPL * Price] only for competitive firms in output market! Therefore: MRPC > MRPM MRPC = MPL * MR MRPM = MPL * MR P Wage Rate QM --------------- --------------- P1 MRPM QC Qty MRPC Firms with market power will hire less workers! (Monopoly, Oligopoly, Monopolistic Competition