AP MICRO REVIEW FINAL EXAM

 Ed = Ed = Or equivalently… PRICE ELASTICITY OF DEMAND The Price-Elasticity Coefficient and Formula Ed = Percentage change in quantity demanded of product X Percentage change in price of product X Or equivalently… Ed = change in quantity demanded of X Original quantity demanded of X Change in price of X  Original price of X

Extreme Cases PRICE ELASTICITY OF DEMAND Perfectly Inelastic Demand Ed = 0 Q Perfectly Elastic Demand P D2 Ed =  Q

P D Q PRICE ELASTICITY & TOTAL REVENUE When prices are low, So is total revenue P TR D Q Quantity Demanded

P D Q PRICE ELASTICITY & TOTAL REVENUE Total revenue rises with price to a point... P TR D Q Quantity Demanded

P D Q PRICE ELASTICITY & TOTAL REVENUE Total revenue rises with price to a point... then declines P TR D Q Quantity Demanded

P D Q PRICE ELASTICITY & TOTAL REVENUE Total revenue rises with price to a point... then declines P TR D Q Quantity Demanded

Total Revenue Test P D Q PRICE ELASTICITY & TOTAL REVENUE Total revenue rises with price to a point... then declines P TR D Q Quantity Demanded

P D Q PRICE ELASTICITY & TOTAL REVENUE Total revenue rises with price to a point... then declines P TR Inelastic Demand D Inelastic Demand Q Quantity Demanded

P D Q PRICE ELASTICITY & TOTAL REVENUE Total revenue rises with price to a point... then declines P TR Elastic Demand Inelastic Demand D Elastic Demand Inelastic Demand Q Quantity Demanded

P D Q PRICE ELASTICITY & TOTAL REVENUE Total revenue rises with price to a point... then declines P TR Elastic Demand Unit Elastic Inelastic Demand D Elastic Demand Inelastic Demand Q Quantity Demanded

ECONOMIC COSTS Profits to an Economist Profits to an Accountant L R E V N U Economic Profit Accounting Profit Implicit costs (including a normal profit) Economic (opportunity) Costs Explicit Costs Accounting costs (explicit costs only)

Law of Diminishing Returns SHORT-RUN PRODUCTION RELATIONSHIPS Law of Diminishing Returns Total Product Total Product, TP Increasing Marginal Returns Quantity of Labor Average Product, AP, and Marginal Product, MP Average Product Marginal Product Quantity of Labor

Law of Diminishing Returns SHORT-RUN PRODUCTION RELATIONSHIPS Law of Diminishing Returns Total Product Total Product, TP Diminishing Marginal Returns Quantity of Labor Average Product, AP, and Marginal Product, MP Average Product Marginal Product Quantity of Labor

Law of Diminishing Returns SHORT-RUN PRODUCTION RELATIONSHIPS Law of Diminishing Returns Total Product Total Product, TP Negative Marginal Returns Quantity of Labor Average Product, AP, and Marginal Product, MP Average Product Marginal Product Quantity of Labor

Algebraic Restatement of the Utility Maximization Rule UTILITY MAXIMIZING COMBINATION Algebraic Restatement of the Utility Maximization Rule MU of product A Price of A MU of product B Price of B = 8 Utils $1 16 Utils $2 =

PRODUCTIVITY AND COST CURVES Costs (dollars) Average product and marginal product AP MP Quantity of labor Quantity of output MC AVC

LONG-RUN PRODUCTION COSTS Unit Costs Output

LONG-RUN PRODUCTION COSTS Unit Costs Output

LONG-RUN PRODUCTION COSTS The long-run ATC just “envelopes” all of the short-run ATC curves. Unit Costs Output

LONG-RUN PRODUCTION COSTS Unit Costs long-run ATC Output

Managerial Specialization Efficient Capital Other Factors ECONOMIES AND DISECONOMIES OF SCALE Labor Specialization Managerial Specialization Efficient Capital Other Factors Diseconomies of Scale Constant Returns to Scale graphically presented...

ECONOMIES AND DISECONOMIES OF SCALE Unit Costs long-run ATC Output

long-run ATC Unit Costs Output Economies Constant returns of scale ATC decreases as Output increases ATC is constant as Output increases Economies of scale Constant returns to scale Unit Costs long-run ATC Output

long-run ATC Unit Costs Output Economies of scale Constant returns ATC decreases as Output increases ATC is constant as Output increases ATC increases as Output increases Economies of scale Constant returns to scale Diseconomies of scale Unit Costs long-run ATC Output

Profit Maximization Position MARGINAL REVENUE-MARGINAL COST APPROACH Profit Maximization Position $200 150 100 50 Economic Profit MC $131.00 MR ATC Cost and Revenue AVC $97.78 1 2 3 4 5 6 7 8 9 10

MR = MC Optimum Solution MARGINAL REVENUE-MARGINAL COST APPROACH Profit Maximization Position $200 150 100 50 Economic Profit MC MR = MC Optimum Solution $131.00 MR ATC Cost and Revenue AVC $97.78 1 2 3 4 5 6 7 8 9 10

Short-Run Shut Down Point MARGINAL REVENUE-MARGINAL COST APPROACH Short-Run Shut Down Point $200 150 100 50 MC ATC Cost and Revenue AVC MR $71.00 Minimum AVC is the Shut-Down Point 1 2 3 4 5 6 7 8 9 10

The Competitive Firm “Takes” its Price from the Industry Equilibrium SHORT-RUN COMPETITIVE EQUILIBRIUM The Competitive Firm “Takes” its Price from the Industry Equilibrium S= MCs P P Economic Profit ATC S=MC D $111 $111 AVC D 8 Q Q 8000 Firm (price taker) Industry

How about the long-run? The Competitive Firm “Takes” its SHORT-RUN COMPETITIVE EQUILIBRIUM The Competitive Firm “Takes” its Price from the Industry Equilibrium S= MCs How about the long-run? P P Economic Profit ATC S=MC D $111 $111 AVC D 8 Q Q 8000 Firm (price taker) Industry

Firm Industry Temporary profits and the reestablishment PROFIT MAXIMIZATION IN THE LONG RUN Temporary profits and the reestablishment of long-run equilibrium S1 P Q 100 100,000 Industry Firm (price taker) $60 50 40 MC ATC MR D1

Firm Industry An increase in demand increases profits… Economic PROFIT MAXIMIZATION IN THE LONG RUN An increase in demand increases profits… Economic Profits S1 P Q 100 100,000 Industry Firm (price taker) $60 50 40 MC ATC MR D2 D1

Firm Industry New competitors increase supply, and lower PROFIT MAXIMIZATION IN THE LONG RUN New competitors increase supply, and lower prices decrease economic profits. Zero Economic Profits S1 P Q 100 100,000 Industry Firm (price taker) $60 50 40 S2 MC ATC MR D2 D1

Firm Industry Decreases in demand, losses, and the PROFIT MAXIMIZATION IN THE LONG RUN Decreases in demand, losses, and the reestablishment of long-run equilibrium S1 P Q 100 100,000 Industry Firm (price taker) $60 50 40 MC ATC MR D1

Firm Industry A decrease in demand creates losses… Economic Losses P Q PROFIT MAXIMIZATION IN THE LONG RUN A decrease in demand creates losses… Economic Losses S1 P Q 100 100,000 Industry Firm (price taker) $60 50 40 MC ATC MR D1 D2

Firm Industry Competitors with losses decrease supply, and PROFIT MAXIMIZATION IN THE LONG RUN Competitors with losses decrease supply, and prices return to zero economic profits. S3 Return to Zero Economic Profits S1 P Q 100 100,000 Industry Firm (price taker) $60 50 40 MC ATC MR D1 D2

Loss Minimization Position MARGINAL REVENUE-MARGINAL COST APPROACH Loss Minimization Position $200 150 100 50 Economic Loss MC ATC Cost and Revenue AVC $91.67 MR $81.00 1 2 3 4 5 6 7 8 9 10

MONOPOLY REVENUES & COSTS Elastic $200 150 200 50 Dollars MR D Q 0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 $750 500 250 Dollars TR Q 0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18

MONOPOLY REVENUES & COSTS Elastic Inelastic $200 150 200 50 Inelastic Portion MR is Negative Dollars A Monopolist will always operate on the Elastic Portion of the Demand Curve MR D Q 0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 $750 500 250 Dollars TR Q 0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18

Remember the MR=MC Rule? OUTPUT AND PRICE DETERMINATION Profit Maximization Under Monopoly Remember the MR=MC Rule? Q 200 175 150 125 100 75 50 25 0 1 2 3 4 5 6 7 8 9 10 Price, costs, and revenue Profit Per Unit MC $122 Profit ATC $94 D MR = MC MR

What About Loss Minimization? Profit OUTPUT AND PRICE DETERMINATION Profit Maximization Under Monopoly What About Loss Minimization? Q 200 175 150 125 100 75 50 25 0 1 2 3 4 5 6 7 8 9 10 Price, costs, and revenue Profit Per Unit MC $122 Profit ATC $94 D MR = MC MR

Loss Minimization Under Monopoly OUTPUT AND PRICE DETERMINATION Loss Minimization Under Monopoly Q 200 175 150 125 100 75 50 25 0 1 2 3 4 5 6 7 8 9 10 Price, costs, and revenue Since Pm exceeds AVC, the firm will produce Loss Per Unit MC ATC A Loss AVC Pm V D MR = MC MR Qm

What are the Economic Effects of Monopoly? OUTPUT AND PRICE DETERMINATION Loss Minimization Under Monopoly Q 200 175 150 125 100 75 50 25 0 1 2 3 4 5 6 7 8 9 10 Price, costs, and revenue Loss Per Unit What are the Economic Effects of Monopoly? MC ATC A Loss AVC Pm V D MR = MC MR Qm

INEFFICIENCY OF PURE MONOPOLY An industry in pure competition sells where supply and demand are equal P S = MC At MR=MC A monopolist will sell less units at a higher price than in competition Pm Pc D MR Q Qm Qc

Monopoly pricing effectively creates an income transfer from INEFFICIENCY OF PURE MONOPOLY P S = MC At MR=MC A monopolist will sell less units at a higher price than in competition Pm Pc Monopoly pricing effectively creates an income transfer from buyers to the seller! D MR Q Qm Qc

REGULATED MONOPOLY Dilemma of Regulation Which Price? P MR = MC Fair-Return Price Pm Socially-Optimum Price Price and Costs ATC Pf MC Pr D MR Q Qm Qf Qr

MONOPOLISTIC COMPETITION AND EFFICIENCY MC Long-Run Equilibrium Price is Not = Minimum ATC ATC P3 = A3 Price  MC Price and Costs D MR Q3 Quantity

MONOPOLISTIC COMPETITION AND EFFICIENCY Not Productively Efficient  Minimum ATC Not Allocatively Efficient Price  MC Excess Capacity Graphically…

OLIGOPOLY BEHAVIOR B A D C A Game-Theory Overview $12 $15 $6 $8 RareAir’s Price Strategy High Low B A D C $12 $15 $6 $8 High Low Uptown’s Price Strategy

OLIGOPOLY BEHAVIOR B A D C A Game-Theory Overview $12 $15 $6 $8 RareAir’s Price Strategy High Low B A D C $12 $15 $6 $8 Greatest Combined Profit High Low Uptown’s Price Strategy

OLIGOPOLY BEHAVIOR A B C D A Game-Theory Overview $12 $15 $6 $8 RareAir’s Price Strategy High Low B A D C $12 $15 $6 $8 Independent Actions Stimulate Response High Low Uptown’s Price Strategy

OLIGOPOLY BEHAVIOR A B C D A Game-Theory Overview $12 $15 $6 $8 RareAir’s Price Strategy High Low B A D C $12 $15 $6 $8 Independent Actions Stimulate Response High Low Uptown’s Price Strategy Gravitating to the Worst Case

OLIGOPOLY BEHAVIOR B A D C A Game-Theory Overview $12 $15 $6 $8 RareAir’s Price Strategy High Low B A D C Collusion Invites a Different Solution. $12 $15 $6 $8 High Low Uptown’s Price Strategy

OLIGOPOLY BEHAVIOR B A D C A Game-Theory Overview $12 $15 $6 $8 RareAir’s Price Strategy High Low B A D C Collusion Invites a Different Solution. $12 $15 $6 $8 High Low Uptown’s Price Strategy

OLIGOPOLY BEHAVIOR A B C D A Game-Theory Overview $12 $15 $6 $8 RareAir’s Price Strategy High Low B A D C Collusion Invites a Different Solution. $12 $15 $6 $8 High Low But, the incentive to cheat is very real. Uptown’s Price Strategy

PURELY COMPETITIVE LABOR MARKET EQUILIBRIUM S Quantity of Labor Wage Rate (dollars) Includes Normal Profit Non- Labor Costs S = MRC Wc $10 $10 $10 $10 $10 $10 Wc ($10) Labor Costs D = MRP ( mrp’s) d = mrp (1000) (5) Labor Market Individual Firm

PURELY COMPETITIVE LABOR MARKET EQUILIBRIUM Marginal Resource Cost (MRC) will be constant and equal to resource price (the wage rate) S Quantity of Labor Wage Rate (dollars) Includes Normal Profit Non- Labor Costs S = MRC Wc $10 $10 $10 $10 $10 $10 Wc ($10) Labor Costs D = MRP ( mrp’s) d = mrp (1000) (5) Labor Market Individual Firm

MONOPSONISTIC LABOR MARKET In monopsony MRC lies above the supply curve. Wage Rate (dollars) Quantity of Labor

MONOPSONISTIC LABOR MARKET MRC S MRP = MRC Wage Rate (dollars) Wm MRP Qm units of labor hired Qm Quantity of Labor

MONOPSONISTIC LABOR MARKET MRC S The competitive solution would result in a higher wage and greater employment. Wage Rate (dollars) Wc Wm MRP Qm Qc Quantity of Labor

OPTIMAL AMOUNT OF A PUBLIC GOOD $ 9 7 5 3 1 S Yields the optimum amount of the public good MB = MC DC Q 0 1 2 3 4 5

THE LORENZ CURVE Lorenz Curve (actual distribution) Perfect Equality 100 80 60 40 20 Lorenz Curve (actual distribution) Perfect Equality Percent of Income Lorenz curve after taxes and transfers Area between the lines shows the degree of income inequality Complete Inequality 20 40 60 80 100 Percent of Families