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MICROECONOMICS
AP EXAM
REVIEW
Define Economics
A Social Science
which studies how people respond to the
Unlimited Wants – Limited Resource
Dilemma
DefineOpportunity
Cost
The amount of other products
forgone in order to produce
a given product
This is referred to by them as
Economists make the assumption that we
act in a way that maximizes
our utility.
“____________ Self Interest”
RationalSelf
Interest
Define
Marginal Analysis
ComparingMarginal Benefit
to
Marginal Cost
Remember This Formula:
MB = MC
Why might your Marginal Analysisyield a completely
different resultthan my
Marginal Analysis?
Because the utility you receive
will not necessarily matchthe utility I receive
from the very same good or service
Define this term:
MARGINAL
EXTRA
ADDITIONAL
CHANGE IN
Ceteris Paribus refers to an assumption
Economists must make to study their
theories. What does it mean?
All
Other
Things
Being
Equal
Statements which are
Facts
and Have No Value Judgment
DescriptiveCause and Effect
are referred to as “___ ___”
POSITIVE
ECONOMICS
The use of
ALL
AVAILABLE
RESOURCES
is the definition of “___ ___”
FULL
EMPLOYMENT
Define Productive Efficiency
The production of
a mix of goods and servicesat the lowest possible
cost
What Formula indicates Productive Efficiency?
P = Minimum ATC
Explain what this is and what the given curve and points
stand for.
A
B
This is a PPF Curve
A
B
The curve represents the full employment of resources and the
various possible combinations of two goods or types of goods.
Point A is Inefficient Use Of Resources and Point B is
Unobtainable At This Time
Capital Goods
Consumer Goods
Production Possibilities Frontier
Look at the Opportunity Cost Of Producing Y. What is the cost of
changing the number of Y produced from C to D?Y
X
D
E F G H I
C
B
A
F to E
Y
X
D
E F G H I
C
B
A
The Production of X falls from
Name The Law
The Opportunity Cost of Each Additional Unit is
Greater than the Cost of the Preceding One
The Law OfIncreasing
Opportunity Cost
Why does the cost of producing “the
next good” increase with
additional production of that
good?
Because the resources used
are more suited for that goodthan those used on
subsequent goods
first
Name 4 things that make thePPF Curve shift
INor
OUT
Δ in TECHNOLOGY
Δ in resource QUANTITY
Δ in resource QUALITY
Δ in the INFRASTRUCTURE
Statements Which Contain Words Like
Should
Ought To
or that support specific policies
are referred to as “___ ___”
or
NORMATIVE
ECONOMICS
What is
AllocativeEfficiency?
Allocative Efficiency is
the least costly productionof the particular mix
of goods and servicesmost wanted by society
So what is the Economic TermThat means that you are
producing
with both Productiveand Allocative
Efficiency?
FULL
PRODUCTION
Using a PPF, demonstrate how a society can use its resources in a way that
results in economic growth!
By using more of their resources for Capital on PPF1
Capital Goods
Consumer Goods
they can move out to PPF2
PPF1
PPF2
How do economists measure
the satisfaction we derive
from the consumption of a
good or service?
UTILS
Draw a basic
“four box”
Circular Flow Chart
Consumpti
on
Expenditur
es
WRIPCost
s
Revenue
Resourc
esLand, Labor, Capital,
and Entrepreneurial
Ability
Goods and
Services
Goods and
Services
Resource
Market
Product
Market
Businesses
Households
And
The
Answer
Is…
U.S.A.
Mexico
Avocados
90
60
15 30 Soybeans
Who should grow what?
U.S.A.
Mexico
Avocados
90
60
15 30 Soybeans
Avocados : Mexico Soybeans : U.S.A.
U.S.A.
Mexico
Avocados
90
60
15 30 Soybeans
Fair Terms of Trade?
U.S.A.
Mexico
Avocados
90
60
15 30 Soybeans
1 Soybean : 3.5 Avocados
If they ask what shape the PPF Curve is…
what should you answer?
Convex or Concave ?
Convex or
Concave
What will happen to price and quantity if
there is an increase in demand?
Price
Quantity
S
D
Pe
Qe
D2
D1
Q1
P1
Title
What will happen to price and quantity if
there is an increase in
supply?
Price
Quantity
S
D
Pe
Qe
S2
S1
Q1
P1
Title
What will happen in the corn industry if the farmers greatly expand their corn
production for alternative fuel yet
production of vehicles that run on ethanol has only increased
slightly?
Price
Quantity
S1
Pe
Qe
S2
D1
D2
Q2
P2
Title
What will happen if widgett production increases slightly at the same time that scientists discover
that people who own widgetts live longer,
healthier lives?
Price
Quantity
S1
Pe
Qe
S2
D1
D2
Q2
P2
Title
How would you graph the concept
that the demand for labor is a DERIVED
DEMAND
Demand for Wazits Demand for Wazit Makers
P r i c e
Quantity of Wazits
Quantity of Labor
W a g e s
P1
W1
P2
W2
QL1 QL2Q1 Q2
D1
D2 DL2
DL1
S S
The Demand For Labor Is DERIVED from the Demand
for the Product They Make
What is this and what does it cause? S
D
?
It’s a Price Ceiling…S
D
Pc
Causing A Shortage!QS QD
Explain A and B
S
D
Pe
Qe
A
B
Consumer Surplus – those who were willing and able to spend more than they had to for this
product – and did not have to
S
D
Pe
Qe
CS
PS
Producer Surplus – those who were willing and able to accept a lower price for their product – and did
not have to
Draw and explain the differences between a
Market Day, Short Run, and
Long Run Supply Curve.
Market Day – all variables are fixed
Short Run – some variables are fixedLong Run – NO variables are
fixedSMD SSR
SLR
P
Q
ELASTICITY
State the formula for the
of
DEMAND
Ed = % Δ in QD of X % Δ in P of X
What Do These Mean?
ED = ∞ED = 0
What Do These Mean?
ED = ∞ Perfectly Elastic (%ΔQ/0 = ∞)
ED = 0 Perfectly Inelastic (0/% Δ P = 0)
What Do These Mean?
ED > 1ED < 1
ED > 1 Elastic Demand The % Δ in Q is more than the % Δ in P
ED < 1 Inelastic DemandThe % Δ in P is more than the % Δ
in Q
Draw a typical demand curve and
label the areas of: 1 unit
elasticity 2 inelasticity 3 elasticity
10
9
8
7
6
5
4
3
2
1
0
1 2 3 4 5 6 7 8 9 10 Quantity
Price
D
Elastic
Inelastic
Unit Elastic
Four Things Help To Determine That The Demand For A Good Will Be
Highly Elastic
If there are many good ___________.
It uses a high % of your ___________.
If it is a ____ rather than a ___ good.
You have plenty of ______ to acquire the good.
Four Things Help To Determine That The Demand For A Good Will Be
Highly Elastic
There are many good
A high % of your
It is a
There’s plenty of
will be usedINCOME
SUBSTITUTES
LUXURY GOOD
TIME to acquire the good
State the formula for the
Cross Elasticityof
Demand
% Δ Qx % Δ Py
and it is used to determine if two goods
are
COMPLEMENTS or SUBSTITUTES
Exy
=
So what is the cross elasticity of demand
coefficient for a…SUBSTITUTE GOODand a
COMPLEMENTand why ??????
SUBSTITUTE GOOD EXY > 0
COMPLEMENT EXY < 0
because as the price of Y goes up - the quantity demanded of X goes up - so Exy is a
positive #
because as the price of Y goes up - the quantity demanded of X goes down - so Exy
is a negative #
How can you tell the strength of the
relationship of two goods?
(The answer is the same for both complements and
substitutes.)
ZERO
The Further The Coefficient is from
State the Formula For
INCOME ELASTICITY
Income Elasticity Formula
Ei =
% Δ Qx
% Δ I
What does it mean if Ei
> 0What does it
mean if Ei < 0
Ei > 0 If Income and Quantity it is a NORMAL
GOOD
Ei < 0 If Income and Quantity it is a INFERIOR
GOOD
What if Exy = 0
Exy = 0
There is no relationship
between the two goods – they are INDEPENDENT
GOODS
What is this and what does it cause?
S
D
?
It’s a Price Floor…S
D
Pf
Causing A Surplus!QD QS
Draw a double-decker graph with Total Utility in the
top graph and Marginal Utility in the bottom graph.
TUUtils
Quantity
QuantityMU
Utils
Other things being equal…if marginal utility falls sharply
the demand for that good is…
Elastic or Inelastic? Explain Why
INELASTIC
If my marginal utility for the second unit is only slightly less, I am very likely to buy the second
good with just a small decrease in price.
That would be ELASTIC demand.
A decline in price will elicit only a small increase in quantity demanded because the second unit really does not give much additional utility – even on sale
I do not want more.
That is INELASTIC demand.
Explain how raising prices on an elastic good
will have a different result
than raising prices on an inelastic
good.
A small price increase for an elastic good will cause
MANY consumers to flee. Therefore…
your profits
will FALL Go To Next Slide For The Results Of A Price Increase On An
Inelastic Good
But a small price increase for an inelastic
good will cause VERY FEW consumers to flee. Most will still buy the product at the new higher price.Therefore…
your profits will INCREAS
E
Draw a graph that shows the impact on
CS, PS, and DWL when the
government institutes a Price
Ceiling
S
D
Pc
QC Qe
Pe
P1
CS
PS
DWL
What formula is used to show how we make choices
that maximize our utility?
MUA MUB
PA PB=
The monetary payments a firm makes to those who supply labor, materials, fuel, transportation, etc.
are called _____ costs.The opportunity costs of
using its self-owned, self-employed resources
that could have been put to an alternative use are
called _____ costs.
The monetary payments a firm makes to those who supply labor, materials, fuel, transportation, etc. are called Explicit CostsThe opportunity costs of
using its self-owned, self-employed resources
that could have been put to an alternative use are
called Implicit Costs
____________ PROFIT
Total Revenue – Explicit Costs =
The Above – Implicit Costs =____________ PROFIT
ACCOUNTING PROFIT
Total Revenue – Explicit Costs =
Accounting Profit – Implicit Costs =
ECONOMIC PROFIT
The minimum payment made by a firm to obtain
and keep the entrepreneur is
called…
NORMALPROFIT
When a firm has a normal profit it is covering all of its costs…
including the amount it takes for the entrepreneur to make this product rather than something
else
Given: fixed technology and all resources of equal qualityThen: as successive units of a variable resource are added to a fixed resource, beyond some point the
marginal product that can be attributed to each additional unit of variable resource will declineNAME THE LAW
The Law of
Diminishing
Returns
Explain:
Total Product
Marginal Product
Average Product
Total Product is how many total units all of the resource (labor)
was able to produce.
Marginal Product is how many units the last worker hired added
to the Total Product.
Average Product is output per labor unit
Firms use MARGINAL PRODUCT to decide if it is worth hiring the NEXT
employee.
(LABOR is usually the “resource” used in the examples!)
Marginal Product is the
____________
Of the Total
Product Curve
Marginal Product is the
SLOPEOf the
Total Product Curve
Graph the relationship
between:Total Product
Marginal Product
and
Watch your TP slope from start to finish and the relationship between TP
and MP at MP = 0
TP MP
MPUnits
of Labor
Graph the relationship
between:Marginal Product
Average Product
and
Show the relationship such that when MP is greater than AP, AP is increasing and when
MP is less than AP, AP is decreasing. AP
MP
MP Units of Labor
AP
Explain:
Total Fixed Costs
Total Costs
Total Variable Costs
TFC = costs that don’t vary with output
TC = The sum of fixed and variable costs
TVC = costs that change with the level of output
You knew it was next
Graph the relationship
between TFC, TVC, and TC.
Costs
Output
TFC
TVC
TC
TFC
TVC
Write the Formula
ATC AFC
AVC
ATC = TC / Q
AFC = TFC / Q
AVC = TVC / Q
or AVC + AFC
Graph
AFC
AVC
ATC
MC
Costs
Output
MC
ATC
AVC
AFC
MC crosses ATC and AVC at their minimums. AFC approaches
the X axis as the Fixed Costs are spread across more and more
output. ATC and AVC draw closer as AFC fall.
Costs
Output
MC
ATC
AVC
AFC
What will happen to each of these curves
if property taxes increase?
Costs
Output
MC
ATC
AVC
AFC
Taxes are Fixed Costs so AFC and ATC shift up and MC
and AVC do not.
Costs
Output
MC
ATC
AVC
AFC
What will happen to each of these curves
if variable costs increase?
Costs
Output
MC
ATC
AVC
AFC
When Variable Costs Increase… MC and AVC and ATC shift up. AFC
does not.
Explain:
Total Revenue
Marginal Revenue
Average Revenue
TR = Price x Total Sold
MR = The additional revenue from the sale of the next unit
AR = TR ÷ Total Sold (Same as Price in PURE COMPETITION)
Graph the relationship
between the Total
Cost Curve and
Total Revenue Curve
for the Purely Competitive Firm
TR
TCTR TC
Quantity
Demand
ed
Break Even Point
Break Even Point
Maximum Economic
Profit
Profit Maximization
P = ___
In Pure Competition
because every additional unit is sold
for the same price
P = MRIn Pure
Competition
because every additional unit is sold
for the same price
What Formula Uses
Marginal Revenue To Define The Profit
Maximization
Point?
MR = MC
Practice the Graph Which Shows How a Perfectly
Competitive Firm Can Use Marginal Revenue To Determine Everything From When They Will
Maximize Profits To When They Should Shut Down
AVC
ATC
MR1
MC
MR2
MR3
MR4
MR5
quantity
price
Pure Competition - The Firm At “A” Represents…?
E
D
C
B
A
“A” Represents Where The Firm Is Shut Down - losses would be greater if they produce because they would owe Fixed
AND Variable Costs
AVC
ATC
MR1
MC
MR2
MR3
MR4
MR5
quantity
price
Pure Competition - The Firm At “B” Represents…?
E
D
C
B
A
“B” Represents Where The Firm Is At SHUT DOWN POINT
AVC
ATC
MR1
MC
MR2
MR3
MR4
MR5
quantity
price
Pure Competition - The Firm At “C” Represents…?
E
D
C
B
A
“C” Represents Where The Firm Is losing $ but remains open because at least some of the FIXED
COSTS are covered
AVC
ATC
MR1
MC
MR2
MR3
MR4
MR5
quantity
price
Pure Competition - The Firm At “D” Represents…?
E
D
C
B
A
“D” Represents Where The Firm Is Earning a Normal Profit
AVC
ATC
MR1
MC
MR2
MR3
MR4
MR5
quantity
price
Pure Competition - The Firm At “E” Represents…?
E
D
C
B
A
“E” Represents Where The Firm Is Earning an ECONOMIC PROFIT
AVC
ATC
MR1
MC
MR2
MR3
MR4
MR5
quantity
price
So where is the Supply Curve For Pure Competition?
E
D
C
B
A
AVC
ATC
MR1
MC
MR2
MR3
MR4
MR5
quantity
price
It is the MC Curve ABOVE the Shut Down Point
E
D
C
B
A
Draw a graph that shows the
relationship between
productivity and cost curves.
AP
AC MC
AP MP
MP
MC
AC
Quantity of Product
Quantity of Labor
Long Run ATC Curves are U-Shaped. That is NOT because of the Law of Diminishing
Return because that law assumes a _______ Plant
(that one resource is fixed in supply)
Fixed Plant
So what does explain the reason that Long Run ATC
Curves are U-Shaped?“________ of ________”
Long Run Cost Curves are shaped by…
ECONOMIES
of
SCALE
LRAC
Planes, Inc.
Costs
Output
What should you label the area between Q1 and
Q2 ?
Q1 Q2
LRAC
Planes, Inc.
Costs
Output
MES = Minimum
Efficient Scale
Q1 Q2
MES
LRAC
Costs
Output
MES can also be referred to as…
Q1
Q2
Tarmart
MES
LRAC
Costs
Output
MES = Constant Return
To Scale
Q1
Q2
Tarmart
MES
LRAC
LRAC
Tarmart
Planes, Inc.
Costs
Costs
Output
Output
Why is the MES so much further to the
right for Planes, Inc.
than for Tarmart?
MES
MES
LRAC
LRAC
Tarmart
Planes, Inc.
Costs
Costs
Output
Output
Because it takes a large
plant with high output
to reach MES for airplanes.
MES
MES
LRACStarJoes
Costs
Output
This part of
the LRAC curve
for StarJoes is
where “__ _ __”
occur.
MES
Q1 Q2
LRACStarJoes
Costs
Output
Economies of Scale
MES
Q1 Q2
LRACStarJoes
Costs
Output
This part of
the LRAC curve
for StarJoes is
where “__ _ __”
occur.
MES
Q1 Q2
LRACStarJoes
Costs
Output
Diseconomies of Scale
MES
Q1 Q2
LRACStarJoes
Costs
Output
Economies of Scale means that a 10% increase of inputs will result in a
“_____ _____” 10% increase
in output.
MES
Q1 Q2
LRACStarJoes
Costs
Output
Economies of Scale means that a 10% increase of inputs will result in a
greater than
10% INCREASE
in output.
MES
Q1 Q2
LRACStarJoes
Costs
Output
So what does
Diseconomies of Scale
Mean?
MES
Q1 Q2
LRACStarJoes
Costs
Output
Diseconomies of Scale
means a 10% increase
of inputs results
in a less than 10%
increase in output.
MES
Q1 Q2
And what happens if you increase resources by 10% in the constant
returns to scale section of the graph?
Q2Q1
MES
Costs
Quantity
A 10% increase of the inputs within the
constant returns to scale section of the
graph results in exactly a 10% increase in the
output of the good.
Characteristics of the Four Basic
Market Models
Can You Name The 4 Models?
The Four Basic Market Models
Pure Competition
Monopolistic Competition
Oligopoly
Monopoly
Number Of Firms
Type Of Product
Control Over Price
Conditions of Entry
Non-price Competition
Example
The Characteristics of: PURE COMPETITIONClick To Reveal One Answer At A Time
A Very Large Number
Standardized
None – Price Takers
No Barriers To Entry
None (nothing different about your product to tell people about)
Agriculture
Number Of Firms
Type Of Product
Control Over Price
Conditions of Entry
Non-price Competition
Example
The Characteristics of: MONOPOLYClick To Reveal One Answer At A Time
One
Unique (no substitutes)
Price Makers
Blocked
Few (public relations ads)
Local Utilities
Number Of Firms
Type Of Product
Control Over Price
Conditions of Entry
Non-price Competition
Example
The Characteristics of: MONOPOLISTIC COMPETITIONClick To Reveal One Answer At A Time
Many
Differentiated
Some (within narrow limits)
Relatively Easy
Major Emphasis
Jeans Companies
Number Of Firms
Type Of Product
Control Over Price
Conditions of Entry
Non-price Competition
Example
The Characteristics of: OligopolyClick To Reveal One Answer At A Time
Few
Standardized or Differentiated
Limited by Mutual Interdependence but Considerable With Collusion
Significant Obstacles
Much – But Only When Product is Differentiated
Standardized Product – Oil Differentiated Product - Appliances
Use a graph to show how the
perfectly competitive
firm is a price taker.
P=MR
D
S MC
ATC
Qe q
Pe
Q
Industry
Firm
The perfectly competitive firm takes its price from the
industry equilibrium price.
P
Q
Now show how much an industry-wide increase in
demand will impact the perfectly
competitive firm.
P=MR1
D2
S MC
ATC
Qe1q1
Pe
1
Q
Industry
Firm
D1
Pe
2
Qe2
P=MR2
q2
The Firm is making an Economic Profit in the Short Run
Economic Profit
Q
P
D2
S1MC
ATC
Qe1q1,3
Pe
1
Q
Industry Firm
D1
Pe
2
Qe2
P=MR2
q2
But in the Long Run, new firms will be attracted by that Economic Profit, industry-wide supply will increase, and the firm will return to earning a
Normal Profit
S2
P=MR1,3
Qe3 Q
P
Now show how much an industry-wide decrease in
demand will impact the perfectly
competitive firm.
P=MR1
D1
S MC
ATC
Qe1q1
Pe
1
Q
Industry
Firm
D2
P=MR2
Qe2
Pe
2
q2
Loss
The Firm is At A Loss in the Short Run (an AVC curve would be needed
to tell if they should shut down)
P
Q
P=MR1
D1
S MCATC
Qe1q1
Pe
1
Q
Industry
Firm
D2
P=MR2
Qe2
Pe
2
q2
Loss
Now you have the AVC Curve! What should this firm do in
the SHORT RUN?
AVC
Q
P
P=MR1
D1
S MCATC
Qe1q1
Pe
1
Q
Industry
Firm
D2
P=MR2
Qe2
Pe
2
q2
It’s Time To Stop Producing Those 8-Track Tapes! not only can’t you pay your fixed costs ( see ) if you produce
anything you will also have these variable costs ( see ) you cannot pay!
AVC
Loss
Q
P
Sometimes the decrease in demand creates a situation where a firm should continue to operate at a loss in the short
run.Draw That Graph
P=MR1
D1
S MCATC
Qe1q1
Pe
1
Q
Industry
Firm
D2
P=MR2
Qe2
Pe
2
q2
Loss
This firm should continue to produce in the SHORT RUN because they are at LEAST covering almost
half ( see )of their fixed costs
AVC
Q
P
Are firms in Perfectly
Competitive Industries efficient?
Productively?
YES! P = min. ATCAllocatively?
YES! P = MCIt is only in Pure Competition that
you have Productive and Allocative Efficiency All
other models have Excess Capacity
Industries change based on the demand for their
products.
Given: A Constant Costs Perfectly Competitive
Industry
Draw the graph which shows the Long Run Supply Curve for this
industry.
Price
Quantity
SL
D1
S2 S3 S4
D2
D3
D4
S1
Perfect Competition With Constant Costs
Let’s move on to a different type of industry structure…
Graph A
PURE MONOPOLY
Price
Quantity
MR
D
ATC
MC
Economic Profit
PM
MONOPOLY
PC
QM
Price
QuantityMR
D
ATC
MC
Economic Profit
PM
MONOPOLY
PC
QM
How do you know they produce at QM with price PM and Costs PC resulting in
an economic profit?
Price
QuantityMR
D
ATC
MC
Economic Profit
PM
MONOPOLY
PC
QM
Because you always maximize profits where MR = MC
Fall Faster Than The Demand
Curve?
MR
curve
Why does the
So to sell the next higher quantity of goods you must
charge a lower price.
The Law Of Demand explains that to sell more of something you
must lower the price .
As you sell more, your TOTAL REVENUE
increases by smaller and smaller increments.
Therefore: MR falls faster than D
D
MR
Price
Quantity
Why is a Monopoly Price always in the ELASTIC SECTION
of the Demand Curve?
Because it is only in the elastic region that lowering the price…
will result in an INCREASE in
Revenue
How can you tell from the graph that a Monopoly
does not have
orProductive
Allocative
Efficiency
Price
QuantityMR
D
ATC
MC
Economic Profit
PM
MONOPOLY
PC
QM
Because P ≠ Min ATC and P ≠ MC(no productive or allocative efficiency)
Do Monopolies
Under Allocate Or
Over Allocate Resources?
Price
QuantityMR
D
ATC
MC
Economic Profit
PM
MONOPOLY
PC
QM
UNDER ALLOCATE ( P > MC ) we value the product more than the resources used to make the good We wish
they would make more!
So what is
PriceDiscriminat
ion?
When a Monopolistknowing who will pay at each
price level and having a product that cannot be re-sold
charges each customer the price they are willing
and able to pay.For example: the airline that
charges more for a seat reserved today than for the seat reserved 4
weeks ago
So how does the graph differ for a Price
Discriminating
Monopolist?
Price
Quantity
MR
D
ATC
MC
Economic Profit
PM
MONOPOLY
PC
QM
D = MR
Price Discriminating Monopoly
Economic Profits Increase Because MR = D For The P.D.M.
If a natural monopoly is going to be regulated, what options do
governments consider?
Price
QuantityMR
D
ATC
MC
PM
REGULATING MONOPOLIES
PF
QM
PS
QSQF
PM and QM represent what the Monopoly wants (profits are maximized where
MR = MC)
PS and QS represent the Socially Optimal Price (Allocative Efficiency P=MC)
PF and QF represents the Fair Return Price (monopoly earns a normal profit because
Price = Average Total Cost)
They Use The Fair Return Price As The Best Compromise Increased Output, Lower Price
and the Monopoly Earns a Normal Profit
Regulation often occurs when economies of scale prevent more than one
industry from producing a good or service.
What do we call that type of
market model?
A
NaturalMonopo
ly
Graph
Monopolistic Competition.show the firm making an economic profit
Price
Quantity
MR
D
ATC
MC
Economic Profit
PMC
PC
QMC
MONOPOLISTIC COMPETITION
The monopolistic competitor earns an economic profit in the short run….which
attracts others to enter the industry.
Graph what
happens as more firms enter this industry.
Price
Quantity
MR
D
ATC
MC
Economic LossPMC
PC
QMC
MONOPOLISTIC COMPETITION
As firms enter the industry, the increased competition takes consumers away from the firm,
to the point some firms suffer losses that force them to shut down.
So what does the graph look like
for Monopolistic
Competition in the
Long Run?
Price
Quantity
MR
D
ATC
MC
As firms drop out…the monopolistic competitor earns a normal profit…in
the long run.
PMC
MONOPOLISTIC COMPETITION
QMC
Why are the Demand and Marginal Revenue Curves so much more
elastic on the Monopolistic
Competition graph than on the Pure Monopoly graph?
Because the barriers to entry are present…but
not that great…so competitors can
come and go fairly easily.
Sometimes Oligopoly firms decide that rather than be
stuck with a price of Po they will meet in a dark room and come to an agreement to set output such that they can get
a higher price and more profits for their goods.
What are these evil-doers practicing?
Collusion
Sometimes it isn’t that they have come to an illegal
agreement. Sometimes there is just one dominant, efficient firm that is the
first to react to cost or demand changes, changes that will also
impact all of the firms in the Oligopoly. So the other firms tend to
follow what that dominant firm does. What do economists call
this Oligopoly Model?
PRICE
LEADERSHIP
So what does the Oligopoly Graph look
like if the firms are practicing COLLUSION or
PRICE LEADERSHIP?
Price
Quantity
MR
D
ATC
MC
Economic Profit
PM
MONOPOLY
PC
QM
OLIGOPOLY (COLLUSION or PRICE LEADERSHIP)
It is time to practice some Game Theory!
High Low
ABC Gum Profits
Bu
bb
le G
um
P
rofi
ts Hig
hLow
Copy this chart and use squares to show the ABC Gum strategy and circles to show the
Bubble Gum strategy.
Click when you are ready to check your answer
36
4536
18
The Numbers Represent the Price for a Crate of Gum
18 24
45 24
Game Theory!
High Low
ABC Gum Profits
Bu
bb
le G
um
P
rofi
ts Hig
hLow
Squares show the ABC Gum strategy. Circles show the Bubble Gum strategy.
36
4536
18
The Numbers Represent the Price for a Crate of Gum
18 24
45 24
Is there a dominant strategy here? Is there Nash Equilibrium here?
Let’s see if you’ve got
game!
Game Theory!
High LowABC Gum
Profits
Bu
bb
le G
um
P
rofi
ts Hig
hLow
36
4536
18
18 24
45 24
Is there equilibrium dominant strategy here?
Is there Nash Equilibrium here? YES - low, low
YES – no player can benefit from moving from the low, low strategy if the other player does not move with her
The price and amount of
resources used is determined in the _______ _______
FACTOR
MARKET
What determines how many
resources an industry will
demand and what is this called?
The Demand For The
Product Determines The Demand For The
Resourcethis is a DERIVED
DEMAND
So to maximize profits, a firm needs to
determine how much a resource will cost vs. how much it will add
to its revenue. Write This Formula
MRP = MRC Marginal Revenue
Product
=
Marginal Resource Cost (WAgE)
Given: a perfectly competitive labor market
How many workers should this firm hire if the market wage is
$10.00 per hour? Firm’s MRP Firm’s MRC Units of Labor --- $10 0 $20 $10 1 $18 $10
2 $15 $10 3
$12 $10 4 $ 9 $10
5 $ 6 $10 6
Given: a perfectly competitive labor marketHow many workers should this
firm hire if the market wage is $10.00 per hour?
Firm’s MRP Firm’s MRC Units of Labor --- $10 0 $20 $10 1 $18 $10
2 $15 $10 3 $12
$10 4 $ 9 $10 5
$ 6 $10 6
The MRP curve
represents the firm’s demand for…..
LABOR
If a perfectly competitive firm operates where
there is a perfectly competitive labor
market…what does the graph for the
supply and demand for labor look like?
Perfect Competition Seller and Perfect Competition Employer
Quantity of Resource Demanded
MRC
D = MRP
Price and Wag
e Rate
PW
QL
note the demand curve is fairly elastic because they do not have to lower their price to sell more goods so MRP
only falls because of the Law of Diminishing Returns
But what if the employer is not selling a good in a perfectly competitive market?She must lower the price to sell the additional units.Draw her
demand for labor graph.
Imperfect Competition Seller and Perfect Competition Employer
Quantity of Resource Demanded
MRC
D = MRP
Price and Wag
e Rate
PW
QL
The demand curve is LESS elastic because the price must be lowered to sell more units… so MRP falls
QUICKLY due to the Law of
Diminishing Returns and because the Price is being lowered to sell
additional units
What if a firm is using both labor and capital to produce
its product.What formula do
they use to determine how much to use of each in order to
produce at the least
cost ?
MPL = MPC
PL PCMarginal Product of Labor
divided by the Cost of Labor must equal the Marginal
Product of Capital divided by the Cost of Capital to produce at the lowest
possible cost.
Given: MPL = MPC PL PC
MPL = 500 MPC =
250 ..PL $10 PC $25
What should this firm do?
Wanted: MPL = MPC PL
PC
500 ≠ 250 $10 $25
The Firm Should Use More Labor because they are
getting 50 units of product for $1 of labor and just 10 units of product from $1 of
capital
50 > 10 ..$1 $1
What is the
PROFITMAXIMIZING
RULE
MRPL= MRPC = 1 PL PC
Is this firm UNDEREMPLOYING or OVEREMPLOYING
its Resources?
MRPL = $30 PL = $15
MPRC = $10 PC = $5
$30 $10 1 $15 $5
Given: MRPL = $30 PL = $15 MPRC = $10 PC = $5
Profit Maximizing Rule Is
MRPL = MRPC = 1 PL PC
≠=This firm is UNDER-EMPLOYING both resources because the ratios do not equal one. They should keep using
both until they have $15/$15 = $5/$5 = 1
For example – a coal mine town
Sometimes…a firm is the only place in town for
people to work.
What Is This Called And What Does Its
Labor Market Graph Look Like?
MONOPSONYMRC
S
DL = MRP
Wc
Wm
Qm Qc
The Monopsonist hires at Qm and pays wages at
Wm. If there were other options for employment in this town, this firm would hire at Qc and pay at Wc.
Wages
Quantity of Labor
MRP =MRC
QM people will work for this wage
Draw the Graph that is
used to explain a Negative
Externality
MSB
MSC
MPC
Qsociet
y wants
Quantity
Cost to Society is > Cost to the Producer so this is inefficient – it is an overallocation of resources and it is creating a NEGATIVE EXTERNALITY
Price Cost
Qbeing
produced
Firm Creating Pollution
So what does the
government do in a negative externality situation?
Tax the producer so his costs
increase, driving the quantity
produced down to a socially
acceptable level.
Draw the Graph that is
used to explain a Positive
Externality
MPB
MSB
MPC
Qsociet
y wants
Quantity
Benefit to Society > Benefit to the Producer so this is inefficient – it is an underallocation of resources and it is creating a POSTITIVE EXTERNALITY
Price Cost
Qbeing
produced
Flu Shots
So what does the
government do in a positive externality situation?
The government subsidizes the
activity so production will increase to a
socially acceptable level.
What formula is used to
demonstrate that there are
no externalities.
∑ MBi = MSCthe sum of all of the
individual benefits in society must equal the
cost to society
Draw a Lorenz Curve
and explain what it shows
Income
Percent of Households
Lorenz Curve
A
B
this graph shows the distribution of income among households
The Lorenz Curve is the actual distribution of income.
The 45° line represents perfect income distribution equality.
Area “A” reflects the degree of income inequality.
What mathematical approach is
taken to explain this concept?Name and
write the formula.
Income
Households
Lorenz Curve
A
B
What would the coefficient be if income was equally distributed among the households of this economy? (click for the answer)
The Gini
Coefficient
A A+B
(A / A+B) = (0 / 0+B) = 0 (Perfect Equality)
Income
Households
Lorenz Curve
A
B
What would the coefficient be if one family had all of the income in the
society? (click for the answer)
The Gini
Coefficient
A A+B
(A / A+B) = (1 / 1+0) = 1 (Perfect Inequality)
THE END