Micro Review Day 1— Comprehensive Topics Covered: Substitutes/compliments & Normal/inferior Elasticity (TR Test, Price, Income, Cross-Price) Taxes & Tax Incidence Utility Maximization Law of Diminishing Marginal Return Cost Curves (ATC, AVC, AFC, MC) & Shit-down Rule Perfect Competition Monopoly & Notable Points & Taxes/Subsidies Monopolistic—SR and LR & Excess Capacity Oligopoly Resource/Factor Market (Firm vs. Market) Monopsony Minimum Wage Derived demand Positive and Negative Externalities Homework: Micro Review Quiz #2 Due Tomorrow *AP Test Dates/Locations can be found on my Teacher Page

Sample Problem: World Trade (c) Identify the net gain in total surplus from the trade.

Sample Problem: World Trade (a) i. P 2 ii. Q 2 (b) Q 3 —Q 1 (c) JGH

Substitutes/Compliments & Normal/Inferior Goods  Substitutes: If price for butter increases, demand for margarine increases  Something purchased as a comparable alternative  Compliments: If price of cereal increases, demand for milk decreases  Something purchased together  Normal good: Steak, North Face, Uggs  Goods for which demand increases as income increases  Inferior goods: SPAM  Goods for which demand increases as income decreases

Elasticity: TR Test, Price ED, Income, Cross-Price  Price Elasticity of Demand: Sensitivity of the Law of Demand  General Formula:  Midpoint/Arc Formula:  Cross-Price Elasticity of Demand: How a change in price of one good effects the QD of another good  substitutes and compliments  CP ED Formula:  Income Elasticity of Demand: How a change in income effects the QD of a good  I ED Formula: %Δ Quantity Demanded %Δ Price ×100 Formula %Δ: New − Old Old = P ED Coefficient Absolute Value!!! Q 2 −Q 1 (Q 1 +Q 2 )⁄2 P 2 −P 1 (P 1 +P 2 )⁄2 = P ED Coefficient Coefficient Values: 0 Inelastic Elastic 1 %Δ QD Good A %Δ Price Good B = CP ED Coefficient Coefficient Values: Compliments Substitutes 0 − + %Δ Quantity Demanded %Δ Income = I ED Coefficient Coefficient Values: Inferior Normal 0 − +

Elasticity Demand and Tax Incidence TR Test  Tax Incidence: who bears the cost of a tax on a good is related entirely to the elasticity of demand for the good being taxed  Perfectly inelastic: burden is entirely on consumer  Relatively inelastic: burden is mostly on consumers  Unit elastic: burden is shared by producers/consumers equally  Relatively elastic: burden is mostly on producers  Perfectly elastic: burden is entirely on producers

Sample Problem: (a) What is the value of revenue for the producer? (a) What is the value of government revenue? (a) Between the prices of $5 and $4 is demand perfectly elastic, relatively elastic, unit elastic, relatively inelastic, or perfectly inelastic? $240 $120 Inelastic: TR test  TR decreases from $450 to $240 when price falls Or Elasticity coefficient =.8

Excise Tax A Few Things:  Use the wedge! It tells you everything…  Price consumers pay (new EQ P )  Price received by producers (Vertical distance down from new EQ P )  Producer Revenue  Tax Revenue  Consumer/Producer Surplus before and after tax  DO NOT FORGET DEADWEIGTH LOSS

Utility Maximization—Broad Rule!!!  Not only is this law followed by consumers making purchases, it’s derived from all marginal analysis:  MC = MR (profit maximizing quantity of output)  MRC = MRP (profit maximizing quantity of workers)  Cost minimizing rule MU Good A MU Good B Price Good A Price Good B =

Sample Problem: Utility Maximization (b) (a) Fudge: MU/$=6 Coffee: MU/$=5  More fudge, less coffee. Greater utility per $ 0: perfectly inelastic None. Can pass all the tax burden onto consumers.

Law of Diminishing Marginal Returns Law of Diminishing Marginal Returns: as variable resources (labor) are added to fixed resources (capital) the marginal product decreases at an increasing rate This law shapes the MC curve! Law applies to everything from labor to utility…

Cost Curves and Shut-Down Rule Please Note: ALL MARKET STRUCTURES HAVE ATC AND MC!!! MC intersects ATC & AVC at their minimum points MC guides ATC & AVC The difference between ATC & AVC is AFC AFC decreases as Q increases Shut Down Rule: If firm can cover their total variable costs, in the short-run they will stay in operation. In the long-run they will exit the industry

Perfect Competition: SR and LR How will this market be affected in the long-run? Since the firm is profitable, firms will enter in the LR, increasing supply in the market, lowering price. Arrive at a zero-profit equilibrium.

Monopoly: Notable Points, Changes in Costs Price Q MC ATC D=AR=P MR Monopoly Key Concepts: MR deviated from demand b/c in order to sell more units, monopoly must lower price for next unit and all previous units Not entry and exit due to large market barriers so profit possible in LR Profit maximizing quantity rule: MC = MR Price monopoly charges indicated by demand profit max. quanity Important Points: Socially Optimal & Allocatively Efficient Q/P: MC = D Fair Return Q/P: ATC = D Productively Efficient Q/P: ATC = MC

Monopoly and Taxes/Subsidies  Lump-Sum Tax  Increase TOTAL costs (ATC)  Lump-Sum Subsidy  Decrease TOTAL costs (ATC)  Lump-Sum Tax/Subsidy has NO EFFECT on profit maximizing quantity or price!!!!  Per-unit Tax  Increases MARGINAL costs (MC)  Per-unit Subsidy  Decreases MARGINAL costs (MC)  Per-unit tax/subsidy will CHANGE profit maximizing quantity and price!  Per-unit Tax: MC  = Decrease Q & Increase in Price  BAD FOR CONSUMERS! NEVER IMPOSE PER-UNIT TAX ON A MONOPOLIST Price Q MC ATC D=AR=P MR

Monopoly Sample Problem: Q 2 P 5 (MC=MR) Q 4 P 3 (MR=0) Q 3 P 4 (MC=D) Socially Optimal Q 5 P 2 (ATC=D) Fair Return

Monopolistic: SR, LR, and Excess Capacity  Behaves just like monopoly in SR  LR Adjustment from entry/exit of competitors—effects D of firms good  Entry (profit):  D  Exit (losses):  D  zero-profit equilibrium—LREQ  TR = profit max. output  PAY ATTENTION: Price (D) must be tangent to ATC  By far the most common mistake  When graphing LR:  Draw D/MR curves  Draw MC  Determine P/Q (MR=MC)  Draw ATC to touch P in it’s downward sloping segment Excess Capacity: Difference between productively efficient (cost minimizing quantity) and profit maximizing quantity Productively efficient Q: MC = ATC Q PE

Oligopoly: Game Theory Matrix BOX-OUT Values and use Check-mark Rule Oligopoly. Consider each others actions Early. No. Better off to go late if Roadway is late. $900. Both choose early (Nash equilibrium)

Resource/Factor Market: FIRM vs. MARKET  The biggest concept we struggled with last unit was distinguishing between the actions relating to the firm and actions relating to the market. Labor Market Firm SLSL DLDL Wage QLQL WEWE QEQE S = MRC D = MRP WEWE QHQH Need to read the question to see what market to analyze. If firm’s new technology make workers more productive, what happens to: (a) quantity of workers hired? (b) wage rate firm pays? (a) Increase  MRP  as MPL  =  D L (b) No change!!! MRC constant; hiring from PC labor market

Monopsony  MRC is greater than S L due to the fact that in order for a monopsonist to hire an additional worker, they must pay that worker a higher wage (S L ) and all previously hired worker that higher wage. SLSL MRC D = MRP Rules: 1.Firm always hires the quantity of labor: MRC = MRP Q 2 2.Wage = S Q 2 W 2 Just like a monopoly: Hire less and pay lower wages than perfectly competitive! What are W 1 and Q 1 ?

Minimum Wage Floor in PC and Monopsony Labor Market Firm SLSL DLDL Wag e QLQL WEWE QEQE S = MRC D = MRP WEWE QHQH SLSL MRC D = MRP W Min QL D QL S QH 2 W Min In PC facing Minimum Wage Floor: Surplus of workers in the factor market Firm will hire less workers as MRC increases Monopsonist facing Minimum Wage Floor: Hire Q of workers where Min. Wage Floor intersects supply—if they are going to pay that wage, might as well hire Q willing to work for it MRC = Min. Wage Floor until it intersects S L QH MIN

Derived Demand of Labor: MPL, MRP, MRC  Demand for labor is directly tied to 2 factors: labor productivity and price of the output labor produces MRP = MPL × P output Additional output produced from additional worker Increase with technology/training If MPL  = MRP (D F )  Price of the good firm is producing— determined in the product market Increase with an increase demand for the good If P O  = MRP (D F )  MRC: cost of hiring an additional worker In perfectly competitive labor market MRC is constant (horizontal S L curve) For monopsonist MRC is greater than S L, MRC increases as Q L increases

Derived Demand for Labor Sample Problem: (a) Perfectly competitive. Price of good constant. (b) Perfectly competitive. Hire infinite Q L for market wage rate. (c) $400 = MPL × P (20 × $20) (d) 6 workers. MRP≥MRC. $160≥$120

Positive/Negative Externalities P P Q Q S=MPC=MSC D=MPB=MSB P Q FM Market Without Externality S=MPC MSC Market With Negative Externality D=MPB=MSB Value of Externality Q FM P FM P SO Q SO FM only the private transaction in accounted for. S/D intersect = Q FM MSB/MPB/D & MSC/MPC/S all together Account for externality: cost to society > MPC Wedge represents value of externality DWL ABOVE Q FM EQ How should government overcome this market failure? Per-unit tax! Increase MC,  S, DWL