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МІНІСТЕРСТВО ОСВІТИ І НАУКИ УКРАЇНИ
СУМСЬКИЙ ДЕРЖАВНИЙ УНІВЕРСИТЕТ
До друку та в світ
дозволяю на підставі
«Єдиних правил», п. 2.6.14
Заступник першого проректора начальник організаційно - методичного
управління
В.Б. Юскаєв
МЕТОДИЧНІ ВКАЗІВКИ
до проведення практичних занять з дисципліни
”Мікроекономіка”
для іноземних студентів факультету економіки та менеджменту
Усі цитати, цифровий та
фактичний матеріал,
бібліографічні
відомості перевірені,
запис одиниць
відповідає стандартам
Укладачі:
Ю.М. Петрушенко,
Н.М. Костюченко,
О.В. Дудкін
Відповідальний за випуск
В.о. декана факультету
економіки та менеджменту
О.В. Прокопенко
Суми
Видавництво СумДУ
2010
О.В. Прокопенко
Ministry of Education and Science of Ukraine
Sumy State University
Methodological Instructions for practical
training on Microeconomics
for foreign students of the Department of
Economics and Management
Sumy
Sumy State University Publishers
2010
1
Методичні вказівки до проведення практичних занять з
дисципліни ”Мікроекономіка” для іноземних студентів
факультету економіки
та менеджменту
/
Укладачі:
Ю.М. Петрушенко, Н.М. Костюченко, О.В. Дудкін. – Суми:
Вид-во СумДУ, 2010. – 37 с.
Кафедра економічної теорії
Methodological
Instructions
for
practical
training
on
Microeconomics for foreign students of the Department of
Economics and Management / Compilers: Y.M. Petrushenko,
N.M. Kostyuchenko, O.V. Dudkin. – Sumy: Sumy State University
Publishers, 2010. − 37 p.
Chair of Economic Theory
2
PART 1. BASIC MICROECONOMIC CONCEPTS
Practical class 1
Subject matter and method of Microeconomics
Structure of the topic:
Thinking like an economist.
An economist as a scientist.
Scientific method: observation, theory, and more observation.
The role of assumptions.
Economic models.
Тhe circular-flow diagram.
The production possibilities frontier.
Microeconomics and macroeconomics.
An economist as policy adviser.
Positive versus normative analysis.
Why economists disagree.
Differences in scientific judgments.
Differences in values.
Perception versus reality.
Summary
Economists try to address their subject with a scientist’s
objectivity. Like all scientists, they make appropriate assumptions
and build simplified models in order to understand the world around
them. Two simple economic models are the circular-flow diagram
and the production possibilities frontier.
The field of economics is divided into two subfields:
microeconomics and macroeconomics. Microeconomists study
decision-making by households and firms and the interaction
between households and firms in the marketplace. Macroeconomists
study the forces and trends that affect the economy as a whole.
A positive statement is an assertion about how the world is. A
normative statement is an assertion about how the world ought to be.
When economists make normative statements, they are acting more
as policy advisers than scientists.
3
Economists who advise policymakers offer conflicting advice
either because of differences in scientific judgments or because of
differences in values. At other times, economists are united in the
advice they offer, but policymakers may choose to ignore it.
Key Concepts
Сircular-flow diagram, production possibilities frontier,
microeconomics, macroeconomics, positive statements, normative
statements.
Questions for Review
1. What is Economics like a science?
2. Why do economists make assumptions?
3. Should an economic model describe reality exactly?
4. Draw and explain a production possibilities frontier for an
economy that produces milk and cookies. What happens to this
frontier if disease kills half of the economy’s cow population?
5. Use a production possibilities frontier to describe the idea of
“efficiency.”
6. What are the two subfields into which economics is divided?
Explain what each subfield studies.
7. What is the difference between a positive and a normative
statement? Give an example of each.
8. What is the Council of Economic Advisers?
9. Why do economists sometimes offer conflicting advice to
policymakers?
Problem sets
1. Two types of goods are being produced in the country –
peaceful goods and military goods. If all the resources are used for
manufacturing peaceful goods, 1 million items can be made. If all the
resources are used to produce military goods 10000 items can be
made. Find the opportunity costs of both goods manufacturing.
2. Five persons on the island with tropical climate are gathering
coconuts and eggs. Each of them gathers either 20 coconuts or 10
eggs per day. How will the production possibilities frontier change if
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new machinery, that enables people to gather 28 coconuts, is brought
here (mind that only 3 persons know how to use it).
3. A consumer earns 10 UAH per hour. It takes him one hour to
stand in a queue to buy the good at 8 UAH per unit. One doesn’t
have to stand in a queue if he/she is ready to pay 12 UAH per unit.
How many units of the goods a consumer should buy so that it would
be rational to buy cheap goods?
Advisable sources: Mankiw N.G., chapter 2; Varian H.R.,
chapter 1; Colander D.C., chapter 1; Kearl J.R., chapters 1, 2.
Practical class 2
Market forces of supply and demand
Structure of the topic:
Markets and competition.
Competitive markets.
Competition: perfect and otherwise.
Demand.
What determines the quantity an individual demands?
The demand schedule and the demand curve.
Market demand versus individual demand.
Shifts in the demand curve.
Supply.
What determines the quantity an individual supplies?
The supply schedule and the supply curve.
Market supply versus individual supply.
Shifts in the supply curve.
Supply and demand together.
Equilibrium.
Three steps to analyzing changes in equilibrium.
How prices allocate resources.
5
Summary
Economists use the model of supply and demand to analyze
competitive markets. In a competitive market, there are many buyers
and sellers, each of whom has little or no influence on the market
price.
The demand curve shows how the quantity of a good demanded
depends on the price. According to the law of demand, as the price of
a good falls, the quantity demanded rises. Therefore, the demand
curve slopes downward.
In addition to price, other determinants of the quantity demanded
include income, tastes, expectations, and the prices of substitutes and
complements. If one of these other determinants changes, the
demand curve shifts.
The supply curve shows how the quantity of a good supplied
depends on the price. According to the law of supply, as the price of
a good arises, the quantity supplied rises. Therefore, the supply curve
slopes upward.
In addition to price, other determinants of the quantity supplied
include input prices, technology, and expectations. If one of these
other determinants changes, the supply curve shifts.
The intersection of the supply and demand curves determines the
market equilibrium. At the equilibrium price, the quantity demanded
equals the quantity supplied.
The behavior of buyers and sellers naturally drives markets
toward their equilibrium. When the market price is above the
equilibrium price, there is a surplus of the good, which causes the
market price to fall. When the market price is below the equilibrium
price, there is a shortage, which causes the market price to rise.
To analyze how any event influences a market, we use the supplyand-demand diagram to examine how the event affects the
equilibrium price and quantity. To do this we follow three steps.
First, we decide whether the event shifts the supply curve, the
demand curve, or both. Second, we decide which direction the curve
shifts. Third, we compare the new equilibrium with the old
equilibrium.
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In market economies, prices are the signals that guide economic
decisions and thereby allocate scarce resources. For every good in
the economy, the price ensures that supply and demand are in
balance. The equilibrium price then determines how much of the
good buyers choose to purchase and how much sellers choose to
produce.
Key Concepts
Мarket, competitive market, quantity demanded, law of demand,
normal goods, inferior goods, substitutes, complements, demand
schedule, demand curve, ceteris paribus, quantity supplied, law of
supply, supply schedule, supply curve, equilibrium, equilibrium
price, equilibrium quantity, surplus, shortage, law of supply and
demand.
Questions for Review
1. What is a competitive market? Briefly describe the types of
markets other than perfectly competitive markets.
2. What determines the quantity of a good that buyers demand?
3. What are the demand schedule and the demand curve, and how
are they related? Why does the demand curve slope downward?
4. Does a change in consumers’ tastes lead to a movement along
the demand curve or a shift in the demand curve? Does a change in
price lead to a movement along the demand curve or a shift in the
demand curve?
5. Popeye’s income declines and, as a result, he buys more
spinach. Does spinach belong to inferior or normal goods? What
happens to Popeye’s demand curve for spinach?
6. What determines the quantity of a good that sellers supply?
7. What are the supply schedule and the supply curve, and how
are they related? Why does the supply curve slope upward?
8. Does a change in producers’ technology lead to a movement
along the supply curve or a shift in the supply curve? Does a change
in price lead to a movement along the supply curve or a shift in the
supply curve?
7
9. Define the equilibrium of a market. Describe the forces that
move a market toward its equilibrium.
10. Beer and pizza are complements because they are often
enjoyed together. When the price of beer rises, what happens to the
supply, demand, quantity supplied, quantity demanded, and the price
in the market for pizza?
11. Describe the role of prices in market economies.
Problem sets
1. The function of demand for a product is Qd  8  P , the
function of supply is QS  7  2 P . Find the consumer surplus.
2. The function of demand for a product is Qd  14  2P , the
function of supply is QS  4  2 P . Find the tax rate when
equilibrium quantity is 2 units.
3. The function of demand for a product is Qd  7  P , the
function of supply is QS  5  2 P . Find the tax rate (in UAH per
unit) when the total amount of tax is maximum.
4. The function of demand for a product is Qd  8  P , the
function of supply is QS  4  2 P . A tax that is paid by a consumer
was provided for goods. The tax rate is 20% of the price of the
goods. Find the consumer’s gain:
a) before the tax was imposed;
b) after the tax was imposed.
Advisable sources: Mankiw N.G., chapter 4; Varian H.R.,
chapters 1, 6, 15, 16, 22, 23; Colander D.C., chapter 34; Kearl J.R.,
chapters 6, 9, 10.
Practical class 3
Elasticity and its application
Structure of the topic:
8
Elasticity of demand.
Price elasticity of demand and its determinants.
Midpoint method: a better way to calculate percentage changes
and elasticities.
The variety of demand curves.
Total revenue and price elasticity of demand.
Elasticity and total revenue along a linear demand curve.
Other demand elasticities.
Elasticity of supply.
Price elasticity of supply and its determinants.
Computing price elasticity of supply.
The variety of supply curves.
Three applications of supply, demand, and elasticity.
Can good news for farming be bad news for farmers?
Why did OPEC fail to keep the oil price high?
Summary
The price elasticity of demand measures how much the quantity
demanded responds to changes in the price. Demand tends to be
more elastic if the goods are luxury rather than necessity, if close
substitutes are available, if the market is narrowly defined, or if
buyers have substantial time to react to a price change.
The price elasticity of demand is calculated as the percentage
change in quantity demanded divided by the percentage change in
price. If the elasticity is less than 1, so that quantity demanded moves
proportionately less than the price, demand is said to be inelastic. If
the elasticity is greater than 1, so that quantity demanded moves
proportionately more than the price, demand is said to be elastic.
Total revenue, the total amount paid for a good, equals the price
of the good times the quantity sold. For inelastic demand curves,
total revenue rises as price rises. For elastic demand curves, total
revenue falls as price rises.
The income elasticity of demand measures how much the quantity
demanded responds to changes in consumers’ income. The crossprice elasticity of demand measures how much the quantity
demanded of one good responds to the price of another good.
9
The price elasticity of supply measures how much the quantity
supplied responds to changes in the price. This elasticity often
depends on the time horizon under consideration. In most markets,
supply is more elastic in the long run than in the short run.
The price elasticity of supply is calculated as the percentage
change in quantity supplied divided by the percentage change in
price. If the elasticity is less than 1, so that quantity supplied moves
proportionately less than the price, supply is said to be inelastic. If
the elasticity is greater than 1, so that quantity supplied moves
proportionately more than the price, supply is said to be elastic.
The tools of supply and demand can be applied in many different
kinds of markets. This lecture uses them to analyze the market for
wheat, the market for oil, and the market for illegal drugs.
Key Concepts
Elasticity, price elasticity of demand, total revenue, income
elasticity of demand, cross-price elasticity of demand, price elasticity
of supply.
Questions for Review
1. Define the price elasticity of demand and the income elasticity
of demand.
2. List and explain some of the determinants of the price elasticity
of demand.
3. If the elasticity is greater than 1, is demand elastic or inelastic?
If the elasticity equals 0, is demand perfectly elastic or perfectly
inelastic?
4. On a supply-and-demand diagram, show equilibrium price,
equilibrium quantity, and total revenue received by producers.
5. If demand is elastic, how will an increase in price change total
revenue? Explain.
6. What do we call a good, income elasticity of which is less than
0?
7. How is the price elasticity of supply calculated? Explain what
this measures.
8. What is the price elasticity of supply of Picasso paintings?
10
9. Is the price elasticity of supply usually larger in the short run or
in the long run? Why?
10. In the 1970s, OPEC caused a dramatic increase in the price of
oil. What prevented it from maintaining this high price through the
1980s?
Problem sets
1. The elasticity of demand in the equilibrium point equals 2, and
the elasticity of supply is 0.5. The equilibrium price is 5, and the
equilibrium quantity is 10. Find functions of supply and demand
curves if the functions are linear.
2. The goods are sold by 3 produces on the market with the
following supply functions: Qs1 = 2P – 6; Qs2 = 3P – 15; Qs3 = 5P.
Find the field price elasticity of supply if the price is 3 UAH.
3. When the price of the commodity X increased from 10 to
15 UAH per unit, the consumption of the commodity Y grew up
from 50 to 75 product units. Find the coefficient of the cross
elasticity of demand and identify if these goods are substitutes or
compliments.
4. The function of the demand for product X is
Qx  14  Px  0.1Py . The price of product X is 6 UAH per unit, and
the price of product Y is 10 UAH per unit. Find the cross elasticity of
demand for X according to Y price.
Advisable sources: Mankiw N.G., chapter 5; Varian H.R.,
chapter 15; Colander D.C., chapter 2; Kearl J.R., chapter 7.
Practical classes 4-5
The theory of consumer choice
Structure of the topic:
The budget constraint: what the consumer can afford.
Preferences: what the consumer wants.
Representing preferences with indifference curves.
11
Four properties of indifference curves.
Two extreme examples of indifference curves.
Optimization: what the consumer chooses.
The consumer’s optimal choices.
How changes in income affect the consumer’s choices.
How changes in prices affect the consumer’s choices.
Income and substitution effects.
Deriving the demand curve.
Summary
A consumer’s budget constraint shows possible combinations of
different goods he can buy (given his income and the prices of the
goods). The slope of the budget constraint equals the relative price of
the goods.
The consumer’s indifference curves represent his preferences. An
indifference curve shows various bundles of goods that make the
consumer equally satisfied. Points on higher indifference curves are
preferred to points on lower indifference curves. The slope of an
indifference curve at any point is the consumer’s marginal rate of
substitution − the rate at which the consumer is willing to trade one
good for the other.
The consumer optimizes by choosing the point on his budget
constraint that lies on the highest indifference curve. At this point,
the slope of the indifference curve (the marginal rate of substitution
between the goods) equals the slope of the budget constraint (the
relative price of the goods).
When the price of a good falls, the impact on the consumer’s
choices can be broken down into an income effect and a substitution
effect. The income effect is the change in consumption that arises
because a lower price makes the consumer better off. The
substitution effect is the change in consumption that arises because a
price change encourages greater consumption of the good that has
become relatively cheaper. The income effect is reflected in the
movement from a lower to a higher indifference curve, whereas the
substitution effect is reflected by a movement along an indifference
curve to a point with a different slope.
12
The theory of consumer choice can be applied in many situations.
It can explain why demand curves can potentially slope upward, why
higher wages could either increase or decrease the quantity of labor
supplied, why higher interest rates could either increase or decrease
saving, and why the poor prefer cash to inkind transfers.
Key Concepts
Budget constraint, indifference curve, marginal rate of
substitution, perfect substitutes, perfect complements, normal goods,
inferior goods, income effect, substitution effect, Giffen goods.
Questions for Review
1. A consumer has an income of $3,000. Wine costs $3 for a glass,
and cheese costs $6 for a pound. Draw the consumer’s budget
constraint. What is the slope of this budget constraint?
2. Draw a consumer’s indifference curves for wine and cheese.
Describe and explain four properties of these indifference curves.
3. Pick a point on an indifference curve for wine and cheese and
show the marginal rate of substitution. What does the marginal rate
of substitution tell us?
4. Show a consumer’s budget constraint and indifference curves
for wine and cheese. Show the optimal consumption choice. If the
price of wine is $3 for a glass and the price of cheese is $6 for a
pound, what is the marginal rate of substitution at this optimum?
5. A person who consumes wine and cheese gets a raise, so his
income increases from $3,000 to $4,000. Show what happens if both
wine and cheese are normal goods. Now show what happens if
cheese belongs to inferior goods.
6. The price of cheese rises from $6 to $10 for a pound, while the
price of wine remains $3 for a glass. Show what happens to
consumption of wine and cheese for a consumer with a constant
income of $3,000. Decompose the change into income and
substitution effects.
7. Can an increase in the price of cheese induce a consumer to buy
more cheese? Explain.
13
8. Suppose that a person who buys only wine and cheese is given
$1,000 in food stamps to supplement his $1,000 income. The food
stamps cannot be used to buy wine. Might the consumer be better off
with $2,000 in income? Explain in words and with a diagram.
Problem sets
1. Utility function is ТU = 2х1х2. Income is 70 UAH per unit.
Find the prices of goods х1 and х2 if optimal set is х1 = 4, х2 = 7.
2. A consumer having an income of 100 UAH buys 4 items of
product X, and 9 units of product Y. Find the prices of products X
and Y if the marginal rate of substitution of X by Y is 4.
3. A consumer likes tea with sugar. He always puts 2 teaspoons of
sugar per cup. If the proportion is changed, he will refuse drinking
tea. A tea-with-sugar day costs are 4 UAH. The price of a sugar
teaspoon is 5 kop. The price of a cup of tea without sugar is 15 kop.
Find graphically the equilibrium point of consumer. What quantity of
tea and sugar is optimal in the constraints of the budget?
Advisable sources: Mankiw N.G., chapter 14; Varian H.R.,
chapters 3, 4, 5; Colander D.C., chapter 6; Kearl J.R., chapter 5.
14
PART 2. MARKET STRUCTURE TYPES
Practical class 6
The costs of production
Structure of the topic:
What are costs?
Total revenue, total cost, and profit.
Costs as opportunity costs.
The cost of capital as an opportunity cost.
Economic profit versus accounting profit.
The production function.
From the production function to the total-cost curve.
The various measures of cost.
Fixed and variable costs.
Average and marginal costs.
Cost curves and their shapes.
Typical cost curves.
Costs in the short run and in the long run.
The relationship between short-run and long-run average total
costs.
Economies and diseconomies of scale.
Summary
The goal of firms is to maximize profit, which equals total
revenue minus total cost.
When analyzing a firm’s behavior, it is important to include all
the opportunity costs of production. Some of the opportunity costs,
such as the wages that are paid to workers by a firm pays its workers,
are explicit. Other opportunity costs, such as the wages the firm
owner gives up by working in the firm rather than taking another job,
are implicit.
A firm’s costs reflect its production process. A typical firm’s
production function gets flatter as the quantity of an input increases,
displaying the property of diminishing marginal product. As a result,
a firm’s total-cost curve gets steeper as the quantity produced rises.
15
A firm’s total costs can be divided between fixed costs and
variable costs. Fixed costs are costs that do not change when the firm
alters the quantity of output produced. Variable costs are costs that
do change when the firm alters the quantity of output produced.
From a firm’s total cost, two related measures of cost are derived.
Average total cost is total cost divided by the quantity of output.
Marginal cost is the amount by which total cost would rise if output
were increased by 1 unit.
When analyzing firm behavior, it is often useful to graph average
total cost and marginal cost. For a typical firm, marginal cost rises
with the quantity of output. Average total cost first falls as output
increases and then rises as output increases further. The marginalcost curve always crosses the average-total-cost curve at the
minimum of average total cost.
A firm’s costs often depend on the time horizon being considered.
In particular, many costs are fixed in the short run but variable in the
long run. As a result, when the firm changes its level of production,
average total cost may rise more in the short run than in the long run.
Key Concepts
Total revenue, total cost, profit, explicit costs, implicit costs,
economic profit, accounting profit, production function, marginal
product, diminishing marginal product, fixed costs, variable costs,
average total cost, average fixed cost, average variable cost, marginal
cost, efficient scale, economies of scale, diseconomies of scale,
constant returns to scale.
Questions for Review
1. What is the relationship between a firm’s total revenue, profit,
and total cost?
2. Give an example of an opportunity cost that an accountant
might not count as a cost. Why would the accountant ignore this
cost?
3. What is marginal product, and what does it mean if it is
diminishing?
16
4. Draw a production function that exhibits diminishing marginal
product of labor. Draw the associated total cost curve (In both cases,
be sure to label the axes). Explain the shapes of the two curves you
have drawn.
5. Define total cost, average total cost, and marginal cost. How are
they related?
6. Draw marginal-cost and average-total-cost curves for a typical
firm. Explain why the curves have the shapes that they do and why
they cross where they do.
7. How and why does a firm’s average-total-cost curve differ in
the short run and in the long run?
8. Define economies of scale and explain why they might arise.
Define diseconomies of scale and explain why they might arise.
Problem sets
1. Put the data into the blanks.
Table 1
Output
Fixed costs
(FC)
Variable costs
(VC)
Total costs
(TC)
0
100
200
300
400
500
600
700
$500
$500
$500
$0
$700
$1,300
$500
$1,200
$500
$500
$2,500
$3,300
$4,300
$5,500
Change in
total costs
(ΔTC)
$700
$600
$500
$2,300
$3,800
$4,800
$6,000
$800
2. Put the data into the blanks. Assume that the fixed costs are
60$, and the total variable costs are illustrated in the table 2.
Table 2
Total
product
1
0
1
FC
VC
TC
MC
AFC
AVC
ATC
2
$60
3
0
$45
4
5
$45
6
$60
7
$45
8
$105
$105
17
Table 2 continuation
1
2
3
4
5
6
7
8
9
10
2
3
$85
$120
$150
$185
$225
$270
$325
$390
$465
4
5
$40
6
$30
7
$42.5
8
$72.5
3. According to the data in problem set 2 draw the curves FC, VC,
and TC. Draw all the curves at one graph. What is the difference
between fixed costs and total costs?
Advisable sources: Mankiw N.G., chapter 21; Varian H.R.,
chapters 20, 21; Colander D.C., chapter 7, 8; Kearl J.R., chapters 1,
9, 10.
Practical class 7
Firms in competitive markets
Structure of the topic:
What is a competitive market?
The meaning of competition.
The revenue of a competitive firm.
Profit maximization and the competitive firm’s supply curve.
The marginal-cost curve and the firm’s supply decision.
The firm’s short-run decision to shut down.
Sunk costs.
The firm’s long-run decision to exit or enter a market.
Measuring profit for the competitive firm.
The supply curve in a competitive market.
The short run: market supply with a fixed number of firms.
18
The long run: market supply with entry and exit.
Why do competitive firms stay in business if they make zero
profit?
A shift in demand in the short run and long run.
Why the long-run supply curve might slope upward.
Summary
Because a competitive firm is a price taker, its revenue is
proportional to the amount of output it produces. The price of the
good equals both the firm’s average revenue and its marginal
revenue.
To maximize profit, a firm chooses a quantity of output such that
marginal revenue equals marginal cost. Because marginal revenue
for a competitive firm equals the market price, the firm chooses
quantity so that price equals marginal cost. Thus, the firm’s marginal
cost curve is its supply curve.
In the short run when a firm cannot recover its fixed costs, the
firm will choose to shut down temporarily if the price of the good is
less than average variable cost. In the long run when the firm can
recover both fixed and variable costs, it will choose to exit if the
price is less than average total cost.
In a market with free entry and exit, profits are driven to zero in
the long run. In this long-run equilibrium, all firms produce at the
efficient scale, price equals the minimum of average total cost, and
the number of firms adjusts to satisfy the quantity demanded at this
price.
Changes in demand have different effects over different time
horizons. In the short run, an increase in demand raises prices and
leads to profits, and a decrease in demand lowers prices and leads to
losses. But if firms can freely enter and exit the market, then in the
long run the number of firms adjusts to drive the market back to the
zero-profit equilibrium.
Key Concepts
Competitive market, average revenue, marginal revenue, sunk
cost.
19
Questions for Review
1. What is meant by a competitive firm?
2. Draw the cost curves for a typical firm. For a given price,
explain how the firm chooses the level of output that maximizes
profit.
3. Under what conditions will a firm shut down temporarily?
Explain.
4. Under what conditions will a firm exit a market? Explain.
5. Does a firm’s price equal marginal cost in the short run, in the
long run, or both? Explain.
6. Does a firm’s price equal the minimum of average total cost in
the short run, in the long run, or both? Explain.
7. Are market supply curves typically more elastic in the short run
or in the long run? Explain.
Problem sets
1. It is known that the firm’s fixed costs are 55 UAH. Marginal
costs’ function is МС = 22 + 3Q3 + 2Q2 − 8Q. Calculate firm’s profit,
if the revenue at the output of 5 units is 1000 UAH.
2. The formula of the average costs of competitive firm is
АС = 40 + 2Q. In what a way the output will change, if the
product’s price declines from 200 to 100 UAH per unit.
3. It is known that the formula of the competitive firm’s costs is
ТС = 16 + Q2. If the market price for the product declines, what
should the output be that the firm will get no economic profit in the
short run?
4. The firm acts under the perfect competition conditions. The
total costs function is TС = 0.1Q2 + 15Q + 200.
a) What output should the firm choose if the price is 25 UAH
per unit?
b) What should the price be that the firm was closed in the short
run?
Advisable sources: Mankiw N.G., chapter 14; Varian H.R.,
chapters 22, 23; Colander D.C., chapter 9; Kearl J.R., chapter 11.
20
Practical classes 8-9
Monopoly
Structure of the topic:
Why monopolies arise.
Monopoly resources.
Government-created monopolies.
Natural monopolies.
Monopoly versus competition.
A monopoly’s revenue.
Profit maximization.
A monopoly’s profit.
The welfare cost of monopoly.
The deadweight loss.
The monopoly’s profit − a social cost?
Public policy towards monopolies.
Increasing competition with antitrust laws.
Regulation.
Public ownership.
Price discrimination.
The analytics of price discrimination.
The prevalence of monopoly.
Summary
Monopoly is a firm that is the sole seller in its market. A
monopoly arises when a single firm owns a key resource, when the
government gives a firm the exclusive right to produce a good, or
when a single firm can supply the entire market at a smaller cost than
many firms could.
Because a monopoly is the sole producer in its market, it faces a
downward-sloping demand curve for its product. When a monopoly
increases production by 1 unit, it causes the price of its good to fall,
which reduces the amount of revenue earned on all units produced.
As a result, a monopoly’s marginal revenue is always below the price
of its good.
21
Like a competitive firm, a monopoly firm maximizes profit by
producing the quantity at which marginal revenue equals marginal
cost. The monopoly then chooses the price at which that quantity is
demanded. Unlike a competitive firm, a monopoly firm’s price
exceeds its marginal revenue, so its price exceeds marginal cost.
A monopolist’s profit-maximizing level of output is below the
level that maximizes the sum of consumer and producer surplus. That
is, when the monopoly charges a price above marginal cost, some
consumers who value the good more than its cost of production do
not buy it. As a result, monopoly causes deadweight losses similar to
the deadweight losses caused by taxes.
Policymakers can respond to the inefficiency of monopoly
behavior in four ways. They can use the antitrust laws to try to make
the industry more competitive. They can regulate the prices that the
monopoly charges. They can turn monopolist into a government-run
enterprise. Or, if the market failure is deemed small compared to the
inevitable imperfections of policies, they can do nothing at all.
Monopolists often can raise their profits by charging different
prices for the same goods based on a buyer’s willingness to pay. This
practice of price discrimination can raise economic welfare by
getting the goods to some consumers who otherwise would not buy
it. In the extreme case of perfect price discrimination, the deadweight
losses of monopoly are completely eliminated. More generally, when
price discrimination is imperfect, it can either raise or lower welfare
compared to the outcome with a single monopoly price.
Key Concepts
Monopoly, natural monopoly, price discrimination.
Questions for Review
1. Give an example of a government-created monopoly. Is
creation of this monopoly necessarily a bad public policy? Explain.
2. Define natural monopoly. What does the size of a market have
to do with whether an industry is a natural monopoly?
3. Why is a monopolist’s marginal revenue less than the price of
its good? Can marginal revenue ever be negative? Explain.
22
4. Draw the demand, marginal-revenue, and marginal-cost curves
for a monopolist. Show the profit-maximizing level of output. Show
the profit-maximizing price.
5. In your diagram from the previous question, show the level of
output that maximizes total surplus. Show the deadweight loss from
the monopoly. Explain your answer.
6. What gives the government the power to regulate mergers
between firms? From the standpoint of the welfare of society, give a
good reason and a bad reason that two firms might want to merge.
7. Describe the two problems that arise when regulators tell a
natural monopoly that it must set a price equal to marginal cost.
8. Give two examples of price discrimination. In each case,
explain why the monopolist chooses to follow this business strategy.
Problem sets
1. The function of demand in monopolized market is Qd = 301− Р,
the function of monopoly’s total costs is ТС = 120 + Q + Q2. What
will the product price be, if the monopoly maximizes: a) profit;
b) revenue?
2. A monopoly practicing no price discrimination owns two
enterprises producing the same goods but with different total costs:
ТС1 = 10Q1, TC2 = 0,25Q22. The demand function is Q = 200 – 2Р.
What quantity of goods will the monopoly produce at different
enterprises?
3. There are 5 firms in the market producing 2%, 3%, 5%, 10%
and 30% of market output. The last part of output is made by small
firms, each producing approximately 1% of market output. Make a
conclusion about the level of monopolization of the market.
4. The demand function of the monopoly is Qd = 100 – Р. The
function of monopoly’s total costs is TС = 10Q + 0.5Q2. Find the
deadweight loss of the society because of monopoly.
Advisable sources: Mankiw N.G., chapter 15; Varian H.R.,
chapter 24; Colander D.C., chapter 10; Kearl J.R., chapter 13.
23
Practical class 10
Oligopoly
Structure of the topic:
Between monopoly and perfect competition.
Markets with only a few sellers.
A duopoly example.
Competition, monopolies, and cartels.
The equilibrium for an oligopoly.
How the size of an oligopoly affects the market outcome?
Game theory and the economics of cooperation.
The prisoners’ dilemma.
Oligopolies as a prisoners’ dilemma.
The prisoners’ dilemma and the welfare of society.
Why people sometimes cooperate?
Public policy towards oligopolies.
Restraint of trade and the antitrust laws.
Controversies over antitrust policy.
Summary
Oligopolists maximize their total profits by forming a cartel and
acting like monopolists. Yet, if oligopolists make decisions about
production levels individually, the result is a greater quantity and a
lower price than under the monopoly outcome. The larger the
number of firms in the oligopoly, the closer the quantity and price
will be to the levels that would prevail under competition.
The prisoners’ dilemma shows that self-interest can prevent
people from maintaining cooperation, even when cooperation is in
their mutual interest. The logic of the prisoners’ dilemma applies in
many situations, including arms races, advertising, common-resource
problems, and oligopolies.
Policymakers use the antitrust laws to prevent oligopolies from
engaging in behavior that reduces competition. The application of
these laws can be controversial, because some behavior that may
seem to reduce competition may in fact have legitimate business
purposes.
24
Key Concepts
Oligopoly, monopolistic competition, collusion, cartel, Nash
equilibrium, game theory, prisoners’ dilemma, dominant strategy.
Questions for Review
1. If a group of sellers could form a cartel, what quantity and price
would they try to set?
2. Compare the quantity and price of an oligopoly to those of a
monopoly.
3. Compare the quantity and price of an oligopoly to those of a
competitive market.
4. How does the number of firms in an oligopoly affect the
outcome in its market?
5. What is the prisoners’ dilemma, and what does it have to do
with oligopoly?
6. Give two examples other than oligopoly to show how the
prisoners’ dilemma helps to explain behavior.
7. What kinds of behavior do the antitrust laws prohibit?
8. What is resale price maintenance, and why is it controversial?
Problem sets
1. The market demand function is Р = 240 – 3Q. There are two
firms in the market competing under Cournot model. Find the
marginal costs of the firm, if the total output of the market is Q = 32.
Draw firms’ reaction curves and find the equilibrium quantity and
equilibrium price.
2. The market demand curve for Bertrand duopoly is described
by the equation Р = 10 – Q. The marginal costs of both firms are
constant МС = 2. Find:
a) equilibrium price and output for each firm;
b) economic profit for each firm;
c) illustrate the solution graphically.
3. Assume that a firm A is trying to break the monopoly of a firm
B in the market of one product. The firm A is deciding whether to
enter the market or not, and the firm B is deciding whether to
25
Firm A
decrease the output or not if the firm A enters the market. The
variants of these decisions are given in the Table 3.
Table 3
Firm B
Not to decrease To decrease
the output
the output
To enter the
-6; -4
8; 8
market
Not to enter
0; 20
0; 20
the market
Find all the types of equilibrium. Analyze the problem that is
characterized by this model.
Advisable sources: Mankiw N.G., chapter 16; Varian H.R.,
chapters 27, 28; Colander D.C., chapter 11; Kearl J.R., chapter 14.
Practical class 11
Monopolistic competition
Structure of the topic:
Competition with differentiated products.
The monopolistically competitive firm in the short run.
The long-run equilibrium.
Monopolistic versus perfect competition.
Monopolistic competition and welfare of society.
The debate over advertising.
Advertising as a signal of quality.
Brand names.
Summary
A monopolistically competitive market is characterized by three
attributes: many firms, differentiated products, and free entry.
The equilibrium in a monopolistically competitive market differs
from that in a perfectly competitive market in two related ways. First,
26
each firm has excess capacity. That is, it operates on the downwardsloping portion of the average-total-cost curve. Second, each firm
charges a price above marginal cost.
Monopolistic competition does not have all the desirable
properties of perfect competition. There is the standard deadweight
loss of monopoly caused by the mark-up of price over marginal cost.
In addition, the number of firms (and thus the variety of products)
can be too large or too small. In practice, the ability of policymakers
to correct these inefficiencies is limited.
The product differentiation inherent in monopolistic competition
leads to the use of advertising and brand names. Critics of
advertising and brand names argue that firms use them to take
advantage of consumer irrationality and to reduce competition.
Defenders of advertising and brand names argue that firms use them
to inform consumers and to compete more vigorously on price and
product quality.
Key Concepts
Monopolistic competition, differentiated products.
Questions for Review
1. Describe the three attributes of monopolistic competition. What
are the common features of monopolistic competition and perfect
competition?
2. Draw a diagram depicting a firm in a monopolistically
competitive market that is making profits. Show what happens to this
firm as new firms enter the industry.
3. Draw a diagram of the long-run equilibrium in a
monopolistically competitive market. How is price related to average
total cost? How is price related to marginal cost?
4. Does a monopolistic competitor produce too much or too little
output compared to the most efficient level? What practical
considerations make it difficult for policymakers to solve this
problem?
5. How might advertising reduce economic well-being? How
might advertising increase economic well-being?
27
6. How might advertising with no apparent informational content
in fact convey information to consumers?
7. Explain two benefits that might arise from the existence of
brand names.
Problem sets
1. The demand function of monopolistic competitor is
Qd = 300 – 5Р, the function of total cost is TС = 200 + 30Q. Find
the optimal quantity and price that will maximize profit.
2. Marginal revenue of monopolistic competitor is MR = 20 – Q,
the function of marginal cost is МС = 3Q – 10. Find the firm’s
overcapacity in product units, if minimal long-term average costs are
11 UAH.
3. The average costs of the firm acting in terms of monopolistic
competition equal 200 UAH when 200 units are produced, 201 UAH
when 201 units are produced, 202 UAH when 202 units are
produced. At the moment the firm is maximizing its profit producing
201 units of the good. The consumer is ready to pay 300 UAH for
only the 202-nd unit. Should the firm accept the offer if the
production and sale of the 202-nd unit don’t affect other firm’s sales.
Advisable sources: Mankiw N.G., chapter 17; Varian H.R.,
chapter 25; Colander D.C., chapter 11; Kearl J.R., chapter 14.
28
PART 3. RESOURCE MARKETS AND INSTITUTIONAL
ASPECTS OF THE MARKET
Practical classes 12-13
Resource markets
Structure of the topic:
The demand for labor.
The competitive profit-maximizing firm.
The production function and the marginal product of labor.
The value of the marginal product and demand for labor.
What causes the labor demand curve to shift?
The supply of labor.
The trade-off between work and leisure.
What causes the labor supply curve to shift?
Shifts in labor supply.
Shifts in labor demand.
The other factors of production: land and capital.
Equilibrium in the markets for land and capital.
Linkages among the factors of production.
Summary
The economy’s income is distributed in the markets for the factors
of production. The three most important factors of production are
labor, land, and capital.
The demand for factors, such as labor, is a derived demand that
comes from firms that use the factors to produce goods and services.
Competitive, profit maximizing firms hire each factor up to the point
at which the value of the marginal product of the factor equals its
price.
The supply of labor arises from individuals’ trade-off between
work and leisure. An upward-sloping labor supply curve means that
people respond to an increase in the wage by enjoying less leisure
and working more hours.
The price paid to each factor allows to balance the supply and
demand for that factor. Because factor demand reflects the value of
29
the marginal product of that factor, in equilibrium each factor is
compensated according to its marginal contribution to the production
of goods and services.
Because factors of production are used together, the marginal
product of any factor depends on the quantities of all factors that are
available. As a result, a change in the supply of one factor alters the
equilibrium earnings of all the factors.
Key Concepts
Factors of production, production function, marginal product of
labor, diminishing marginal product, value of the marginal product,
capital.
Questions for Review
1. Explain how a firm’s production function is related to its
marginal product of labor, how a firm’s marginal product of labor is
related to the value of its marginal product, and how a firm’s value of
marginal product is related to its demand for labor.
2. Give two examples of events that could shift the demand for
labor.
3. Give two examples of events that could shift the supply of
labor.
4. Explain how the wage can adjust to balance the supply and
demand for labor while simultaneously equaling the value of the
marginal product of labor.
5. If the population of the United States suddenly grew because of
a large immigration, what would happen to wages? What would
happen to the rents earned by the owners of land and capital?
Problem sets
1. A firm is a perfect competitor in commodities market and in the
market of factors of production. Its production function
is Q = 200L – 2L2 for a given amount of capital. Find the firm’s
demand function for labor.
2. Production technology is described by the production function:
Q  L0,5  K . The firm has 40 units of capital (K). Wage rate (w) is
30
5 UAH per unit. The price of the product (Р) is 1 UAH per unit.
What quantity of labor will the firm use if it is trying to maximize
profit?
3. Acreage is 120 hectares. Demand for land is Qd = 180 – 3r,
where r – rental rate per 1 hectare. Interest rate is 10% per year. Find
the price of 1 hectare of land?
4. There are to ways to get income. In the variant A income is
2000 UAH which is paid out by equal portions during the year:
1000 UAH today and another 1000 UAH in a year. In the variant B
income is also 2000 UAH which is paid out in several stages:
500 UAH today, 1000 UAH in a year, and 500 UAH in two years.
Interest rate is r = 10%.
a) What variant would you chose?
b) What must the interest rate be to make you change your mind?
Advisable sources: Mankiw N.G., chapter 18; Varian H.R.,
chapter 26; Colander D.C., chapters 19, 20; Kearl J.R., chapters 21,
22.
Practical class 14
Externalities
Structure of the topic:
Externalities and market inefficiency.
Welfare economics: a recap.
Negative externalities in production.
Positive externalities in production.
Externalities in consumption.
Private solutions to externalities.
The types of private solutions.
The Coase theorem.
Why private solutions do not always work?
Public policies toward externalities.
Regulation.
31
Pigovian taxes and subsidies.
Tradable pollution permits.
Objections to the economic analysis of pollution.
Summary
When transaction between a buyer and seller directly affects a
third party, the effect is called externality. Negative externalities,
such as pollution, cause socially optimal quantity in a market to be
less than the equilibrium quantity. Positive externalities, such as
technology spillovers, cause socially optimal quantity to be greater
than the equilibrium quantity.
Those affected by externalities can sometimes solve the problem
privately. For instance, when one business confers an externality on
another business, the two businesses can internalize the externality
by merging. Alternatively, the interested parties can solve the
problem by negotiating a contract. According to the Coase theorem,
if people can bargain without cost, they can always reach an
agreement in which resources are allocated efficiently. In many
cases, however, reaching a bargain among many interested parties is
difficult, so the Coase theorem does not apply.
When private parties cannot adequately deal with external effects,
such as pollution, the government often steps in. Sometimes the
government prevents socially inefficient activity by regulating
behavior. Other times it internalizes an externality using Pigovian
taxes. Another way to protect the environment is for the government
to issue a limited number of pollution permits. The final result of this
policy is largely the same as imposing Pigovian taxes on polluters.
Key Concepts
Externality, internalizing an
transaction costs, Pigovian tax.
externality,
Coase
theorem,
Questions for Review
1. Give examples of negative externality and positive externality.
2. Use a supply-and-demand diagram to explain the effect of
negative externality in production.
32
3. In what way does the patent system help society solve an
externality problem?
4. List some of the ways to solve problems without governmental
intervention that are caused by externalities.
5. Imagine that you are a non-smoker sharing a room with a
smoker. According to the Coase theorem, what determines whether
your room-mate smokes in the room? Is this outcome efficient? How
do you and your room-mate reach this solution?
6. What are Pigovian taxes? Why do economists prefer them over
regulations as a way of environmental protection?
Problem sets
1. A firm that produces pulp also emits smelly pollution. The
more pulp it produces, the more pollution it emits. The pollution
primarily affects the people who live in the area. Suppose the pulp is
solid in a perfectly competitive market and that the firm has linear
marginal cost (MC), which increases with pollution. Suppose also
that the marginal cost of pollution (ME – the marginal cost of
externality) increases proportionally to the quantity produced, and is
approximately 1/3 as large as the firm’s marginal cost.
a) Draw a diagram with quantity of pulp on the X-axis and
cost/revenue on the Y-axis. Indicate the profit maximising choice of
quantity given the assumptions.
b) How should the social cost be represented in the graph?
c) Show in the graph how to find the socially optimal quantity.
Will that quantity be higher or lower than in the answer to a)?
d) Suggest the solution how to motivate the firm to produce the
socially optimal quantity.
Advisable sources: Mankiw N.G., chapter 10; Varian H.R.,
chapter 34; Colander D.C., chapter 17; Kearl J.R., chapter 16.
33
Practical class 15
Public goods and common resources
Structure of the topic:
Kinds of goods.
Public goods.
The free-rider problem.
Some important public goods.
A difficult job of cost-benefit analysis.
Common resources.
The tragedy of the commons.
Some important common resources.
The importance of property rights.
Summary
Goods differ in whether they are excludable and whether they are
rival. Goods are excludable if it is possible to prevent someone from
using them. Goods are rival if one person’s enjoyment of the goods
prevents other people from enjoying the same unit of the goods.
Markets work best for private goods, which are both excludable and
rival. Markets do not work as well for other types of goods.
Public goods are neither rival nor excludable. Examples of public
goods include fireworks displays, national defense, and creation of
fundamental knowledge. Because people are not charged for their
use of the public goods, they have an incentive to free ride when the
goods are provided privately. Therefore, governments provide public
goods, making their decision about the quantity based on cost-benefit
analysis.
Common resources are rival but not excludable. Examples include
common grazing land, clean air, and congested roads. Because
people are not charged for their use of common resources, they tend
to use them excessively. Therefore, governments try to limit the use
of common resources.
Key Concepts
Excludability, rivalry, private goods, public goods, common
resources, free rider, cost-benefit analysis, tragedy of the commons.
34
Questions for Review
1. Explain what is meant by goods being “excludable.” Explain
what is meant by goods being “rival.” Is pizza excludable? Is it rival?
2. Define and give an example of public goods. Can the private
market provide these goods on its own? Explain.
3. What is cost-benefit analysis of public goods? Why is it
important? Why is it hard?
4. Define and give an example of a common resource. Will people
use these goods too much or too little without governmental
intervention? Why?
Problem sets
1. Two individuals, A and B, have decided to arrange a small park
between their respective houses. However, they have very different
opinions how big this park should be. In Figure 1, we see their
different marginal willingness to pay. We have also drawn the
marginal cost (MC) of producing different quantities of park. Show
how A and B can decide on the optimal size of park.
$
MC
DB
DA
q
Figure 1
Advisable sources: Mankiw N.G., chapter 11; Varian H.R.,
chapter 36; Colander D.C., chapters 15, 16; Kearl J.R., chapter 17.
35
REFERENCES
1. Mankiw, Gregory N. Principles of Microeconomics / Gregory
N. Mankiw. – 2nd edition. – Harcourt College Pub, 2000. – 495 р.
2. Varian, Hal R. Intermediate Microeconomics – A Modern
Approach / Hal R. Varian. – 7th edition. – Norton, 2006. – 776 р.
3. Colander, David C. Microeconomics / David C. Colander. –
Homewood, IL : Irwin, 1993. – 531 p.
4. Kearl, James R. Principle of microeconomics / James R. Kearl.
– Lexington : D.C. Heath, 1993. – 637 p.
36
Навчальне видання
Methodological Instructions for practical training on
Microeconomics for foreign students of the Department of
Economics and Management
Відповідальний за випуск
Редактор:
О.В. Прокопенко
М.В. Буката
Комп’ютерне верстання
О.В. Дудкіна,
Н.М. Костюченко
Підписано до друку 1.11.2010, поз.
Формат 60×84/16. Ум. друк. арк. 2,09. Обл..-вид. арк. 2,05. Тираж 30 пр. Зам. №
Собівартість видання
грн.
к.
Видавець і виготовлювач
Сумський державний університет,
вул. Римського-Корсакова, 2, м. Суми, 40007
Свідоцтво суб’єкта видавничої справи ДК № 3062 від 17.12.2007.
37