Micro-Economics Review Course Summary

Tax on buyers shifts D-curve, Tax on sellers shifts S-Curve Taxes always produce deadweight loss! –You produce less at a higher cost Tax Incidence does not depend on who pays the tax! –Buyers & Sellers share the burden –Elasticity determines who bears the most! The majority of the tax burden falls on more inelastic curve –Steeper curve pays more of tax Tax Summary

Tax on Sellers 2.80 Quantity of Ice-Cream Cones 0 Price of Ice-Cream Cone Price without tax Price sellers receive Equilibrium with tax Equilibrium without tax Tax ($0.50) Price buyers pay S1S1 S2S2 Demand,D1D1 A tax on sellers shifts the supply curve upward by the amount of the tax ($0.50) $ Deadweight loss!

EXTERNALITIES An externality is the uncompensated impact of one person’s actions on another person –Both positive & negative externalities exist Externalities cause markets to be inefficient –That is, markets do not maximize total surplus (welfare)

Negative Externality: Pollution Equilibrium MC = MB Quantity of Aluminum 0 Price of Aluminum Demand = MB P ( private value ) Supply = MC P ( private cost ) MSC = ( MC P + MC S) Q OPTIMUM Optimum Q MARKET Spillover Cost External social Cost Correct a Negative Externality with a Tax

Cost Curves Quantity of Output Costs $ MC ATC AVC AFC Marginal Cost declines at first and then increases due to diminishing marginal product. Note how MC hits both ATC and AVC at their minimum points. AFC, a short-run concept, declines throughout.

Perfect Competition 4 Market Structures Equilibrium Price vs. MC P = MC Maximize Profit When: MR = MC Long Run Economic Profit No Demand & Marginal Revenue Curve Monopolistic Competition P > MC MR = MC No Oligopoly P > MC MR = MC Yes Monopoly P > MC MR = MC Yes MC

Perfect Competition Market Firm (b) Short-Run Response Quantity (firm) 0 Price P 1 Quantity (market) Long-run supply Price 0 D 1 D 2 P1P1 S 1 P 2 Q 1 A Q 2 P 2 B ATC MC An increase in market demand… …raises price and output. This can not be a long term equilibrium! P > ATC encourages entry into the market Will return to zero econ profit in long run profit

Example: Monopoly Equilibrium To Find Equilibrium: Set MC = MR Line up to Demand Curve Opportunity Costs: Lower QTY Higher Price Deadweight Loss profit

SHORT RUN: Monopolistic Competition LONG RUN: Monopolistic Competition Profit Exists! Zero Profit, but not at Efficient scale

Liz Bob HIGH 400, , 500 LOW 600, , -500 HIGH LOW Every Dominant Strategy is a Nash Equilibrium BUT: Every Nash Equilibrium is not a dominant strategy Easy way to find dominant strategy: First, Circle each players preferred boxes Second, if 2 circles in same row you have a Dominant Strategy Both Liz and Bob would choose Low! It is an enforceable equilibrium because there is no incentive to cheat Oligopoly: Game Theory

Product & Factor Markets MR = MC MRP = MFC

Competitive Input Markets Price Qty Low Skilled Workers D L = MRP L SLSL $10 Q1Q1 E1E1 Price Qty Small firms can hire all their workers at Market wage Entire Factory IndustryIndividual Firm $10 S L = MFC Q1Q D L = MRP L LABOR MARKET Low Skilled Workers

Competitive vs Market Power MRP C MRP M Therefore: MRP C > MRP M MRP C = MP L * MR MRP M = MP L * MR MR = P for a competitive firm MR < P for a firm with market power MRP = [MP L * Price] only for competitive firms in output market! Qty P Wage Rate Firms with market power will hire less workers! (Monopoly, Oligopoly, Monopolistic Competition Q M Q C P1P1