Today we will.. Begin our review of the entire MICRO economics course – any notes you take from the power point (in your own handwriting) may be used on the test to be given next week. Wednesday – Multiple choice portion (60 questions) – counts as 2/3rds of the score Friday – Free Response portion (3 questions – one long and two short) – counts as 1/3 of the score Begin watching the videos assigned (partner quiz on January 21st or 22nd) and studying our vocabulary terminology (quiz on January 19th or 20th)

Microeconomics Review Fall 2015

Circular Flow

Basic Economic Concepts to Know: Production Possibilities Curve- law of increasing costs (not perfect substitutes, show opportunity costs Production Possibilities Curve – Constant Cost – perfect substitutes for each other

PPC Shifters and Points of Interest Technology (usually outward) Resources (could be either direction) Remember the whole curve does NOT always shift (capital v. consumer goods Outward shift is economic growth Trade allows consumption outside the PPC

Opportunity Costs, Trade Offs and scarcity Demands that choices be made Too many wants and not enough resources Basic economic problem Trade offs All that is given up Opportunity Costs Next best alternative On the PPC

Comparative Advantage In table format OOO (output question) – think about “units” of goods IOU (input question) – how much time is used to produce? In graph format

Comparative v. absolute advantage Comparative Advantage Lower opportunity cost of the item Math involved Only one comparative advantage per country Absolute Advantage More efficient use of resources Produce more using same amount of resources

Utility Marginal Utility Total Utility Extra satisfaction earned from purchasing or consuming one more good Law of Diminishing Marginal Utility MU/$ of good A= MU/$ of good B Total Utility Increases until MR equals 0

Economic Systems Market System Command System Traditional System Private ownership of property Contract rights Price as an incentive Command System Government makes decisions Traditional System Habits and customs Mixed System Market and Command Regulations, etc.

Right is INCREASE; Left is DECREASE Supply and Demand Demand shifters “T” – tastes and preferences “R” – related goods (think about substitutes and complements) “I” – income (normal and inferior goods) “B” – number of buyers “E” – expectations for the future Supply Shifters “R” – resource costs “O” – opportunity costs (could I produce something else) “T” – technology “T” – taxes and subsidies (taxes-left; subsidies – right) “E” – expectations for future “N” – number of sellers Right is INCREASE; Left is DECREASE

Change in Quantity – due price and only PRICE Change in…… due to factors other than price

Shortages and Surpluses Price charged is below equilibrium price Fix by raising the price Price charged is above the equilibrium price Fix by lowering the price

Government interference Price floors Price Ceilings

Consumer Surplus, Producer Surplus and Deadweight Loss

Elasticity of Demand and Supply Determinants of Demand Availability of substitutes Market structure (how much competition) Proportion of income spent on the good Time to adjust to changes in price Necessity or luxury item Determinants of Supply Product type Timing Production Capacity Input substitution Flexibility and mobility

Price Elasticity of Supply Inelastic Supply PES< 1 Increase in price leads to a small change in supply Elastic Supply PES>1 Increase in price leads to a bigger % increase in supply If the price of a coffee increases 10%, and the supply increases 20%, the PES is 2 If the price of bananas decreases 12% and the quantity supplied falls 2%, then PES =.16

Graphs to know Elastic Supply Inelastic Supply

Elasticity of Demand Graphs Relatively Inelastic Perfect Elastic Perfectly Inelastic Perfectly Elastic

Elasticity and Total Revenue Test

Types of elasticity Cross Price Elasticity Income Elasticity <0 (complements); >0 (substitutes) <0 (inferior); >0 (normal)

Costs of Production Variable Cost Fixed Cost Total Cost Average Changes with the amount of output Increase, then decrease production Fixed Cost Does not change with the amount of output Total Cost Fixed plus variable Average Divide cost by quantity

Things to remember about cost curves Marginal Cost (MC) crosses the AVC and ATC at the minimum points MC>MR – decrease the level of production MR=MC Shut down rule – price below AVC Economies of Scale Long run ATC made up several short run ATC Remember this is part of all the structures – your ATC curve is your LRATC Increasing Returns to Scale= downward sloping LRATC

Perfect Competition Three Outcomes – things to think about – usually side by side graphs Where is the ATC curve in relation to Price? Go in a straight line from price to ATC for profit or loss Short Run Supply curve is MC from AVC and long run is from ATC

Perfect competition Mr. DARP = MC (Marginal Revenue=Demand=Average Revenue= Price=Marginal Cost) Demand increases quantity in short run will increase but Long run return Characteristics of: Free entry and/or exit from (loss firms leave; profit firms enter) Know the side by side graphs (industry is basic supply and demand) Price Takers Identical products Cannot change price ever (this is important) Perfect Information for all involved (buyers and sellers) Long Run: P=AR=MR=ATC (tangent)

Role of taxes and subsidies

Monopolistic competition Things to remember: Excess Capacity Price >MC P=ATC AR= Price Long run: MR=MC

MC v. PC NOTICE: (1) both ATC curves are tangent to the price but (2) Monopolistic Competition price is greater than MC In PC, MC equals the Price BIG difference – please remember this part.

Oligopoly Cartel – monopoly prices created Game Theory Mergers – reduce the ATC for both firms

Monopoly Monopoly Price Fair Return Price Socially Optimal Price MR=MC and up to demand More than PC Fair Return Price Minimum ATC cross Demand Break Even Point Socially Optimal Price MC=Demand Subsidies required to break even

Monopolies Revenue Maximization Profit Maximization Power of the firm MR = 0 If MR is negative, decrease production to increase profits Profit Maximization Elastic portion of the demand curve Power of the firm Barriers to entry Price Discrimination Reason for MR below D Consumer Surplus will help define it Charge different prices in order to make more money Know demand elasticities Characteristics Under allocation of resources Higher prices than Perfect Competition MR< Price Per unit tax shared by both consumers and producers Under produces and charges higher price

Factor Economics Demand for inputs If MRP > MRC If MRP = MRC Labor Resources Derived Demand drives the resource demand curve MRP = Marginal Revenue Product MR for factor markets = ΔTR / ΔQ Additional revenue a firm earns with a new unit of resource (usually worker) MRC = Marginal Revenue Cost MC for factor markets = ΔTC / ΔQ If MRP > MRC Increase Production If MRP = MRC Max profits Stop (ideal) Production If MRP < MRC Decrease production

Factor Economics Marginal Productivity / Least Cost Derived Demand MPA / PA = MPB / PB Firms produce at a level where all costs are minimized This is the part where math is involved – you need to determine the “per unit cost” with division Derived Demand Demand for products creates or affects the demand for resources such as labor

Resource Market Place Derived Demand – resource market for labor that produces the good or service

Resource Market The cost of a resource should be less than the marginal product Hire labor until the Marginal Product of Labor is less than the price Diminishing Marginal Product Increase Price in PC, MRP will increase

Market Failures and Government Involvement Public Goods Non rivals Non excludable Lighthouses Externalities Positive – bird feeders, vaccinations Negative – pollution, MSC>MSB; increase optimal quantity of the good

Negative Externalities Externality Cost Supply Failure Suppliers do not have to pay the full value Will supply more b/c costs paid by others Costs affect supply Taxes raise price to public equilibrium Social Cost P Private Cost P2 P1 Private Value Q2 Q1 Q

Positive Externalities Demand Failure Public not willing to pay full value Benefits or subsidies needed to induce suppliers to supply at lower price levels Benefits affect demand Subsidies absorb costs creating public equilibrium External Benefit Private Cost P Public Cost P1 P2 Private Value Q1 Q2 Q

Market Failures Lorenz curve – shows inequalities in income distribution Taxes Progressive – as income increases, proportional of tax increases – reduces inequalities Regressive – as income increases, amount of tax decreases (sales tax) Proportional – flat tax (same percentage for all income brackets)

Market Failures Per unit tax v. Lump Sum tax (who pays depends on elasticity) Next slide shows the difference with relation to elasticity

Taxes and the government Tax Incidence – who pays the tax burden

Can you? Draw and explain the cost curves and relationships for perfect competition and monopolistic competition Draw and explain the cost curves and relationships for a monopolistic producer (only one)? Game Theory – determine and read the matrix Marginal Utility, Total Utility and Marginal Utility per dollar Determine the costs for a firm in perfect competition

Test time Next class – the multiple choice section of the test – 60 questions to be answered within the class period – this part will count as 2/3rds of the total grade Second class – the free response portion of the test – you will have the entire class to do the questions, but bring something to keep you quiet just in case you finish early. This will count as 1/3 of the grade Grades: 74-90 points will receive a 5 or 95 (two times)-no retake 60-73 points will receive a 4 or 85 (two times)- no retake 48-59 points will receive a 3 or 75 (two times) – no retake 37-47 points will receive a 2 or 65 (two times) – may do retest by January 28 – two review sessions required 0-36 points will receive a 1 or 55 (two times) –may do retest by January 28 – two review sessions required