MICRO AP Review

Demand Elasticity Elastic -- %ΔQ > %ΔP; %ΔQ / %ΔP > 1 (luxuries, cruises, restaurant meals) – flat D curve Unit Elastic -- %ΔQ = %ΔP; %ΔQ / %ΔP = 1 Inelastic -- %ΔQ < %ΔP; %ΔQ / %ΔP < 1 (electricity, newspapers, salt) – vertical D curve

More Demand Elasticity Cross-price elasticity – change in the price of 1 good affects demand for another; if it’s positive, they are substitutes; if it’s negative, they are complements Income elasticity – change in income affects demand for another good; if it’s positive, it’s a normal good; if it’s negative, it’s an inferior good

Maximizing Utility Utility of 2 goods is maximized when: –Marginal utility of 1 good divided by its price equals marginal utility of 2 nd good divided by price –See pp

Market Structures Pure Comp. Mono. Comp. OligopolyMonopoly # of firms, product Many, same Many, different Few, different one Control over P Price taker Not much SomePrice seeker Entry or exit FreeRel. easyDifficultVery difficult Non-P comp. NoneSomeLotsPR ads Ex:Tomatoe s, pork Toothpa ste, soap Cars, cokes Local phone

Costs TC = FC + VC; ATC = AFC + AVC MC curve crosses AVC and ATC curves at their minimums Businesses produce at output level where MR = MC If MR < AVC, business will shut down If MR > AVC but less than ATC, business will stay in business but will lose money on each item produced.

Pure Competition Industry (Market)Firm P P Q Q P1 P1=MR D S ATC MC MR = MC intersects ATC at its. min. Q1Qf

Pure Competition Industry (Market)Firm P P Q Q P1 P2=MR D1 S ATC MC Shaded area Represents area of loss to firm Q1Qf1 D2 P2 New P = P2 but costs are still at ATC Q2 Qf2 If P > AVC, they will stay in business. If not, they’ll shut down AVC

Pure Competition Industry (Market)Firm P P Q Q P1 P2=MR D1 S ATC MC Shaded area Represents area of economic profit to firm Q1Qf1 D2 P2 New P = P2 but costs are still at ATC Q2 Qf2 New firms enter industry and reduce the price of the good. AVC

Pure Monopoly Industry graph Is firm graph! D MR MR < D b/c a lower P reduces revenue for all sold! MC $10 P Q ATC $8 P=$10 ATC=$8 so $2 x 20 = $40 is economic profit! 20 All businesses produce where MR = MC!

Monopolistic Competition D MR MR < D b/c a lower P reduces revenue for all sold! MC $9 P Q ATC $8 P=$9 ATC=$8 so $1 x 20 = $20 is economic profit! New firms enter industry! 20 All businesses produce where MR = MC!

PQTR = PxQMR

Monopolistic Competition D MR MC $13 P Q ATC $11 P=$11 ATC=$13 so $2 x 20 = $40 is loss to firms! Firms will leave industry! 20 All businesses produce where MR = MC!

Monopolistic Competition D MR MC $12 P Q ATC P=$12 ATC=$12 so in long-run, there are no economic profits! 20 All businesses produce where MR = MC!

Labor Market Marginal Product of Labor (MPL) = additional output produced by adding 1 more worker Marginal Revenue Product (MRP) = MP x product price OR Δ total revenue / Δ output Demand for labor = MRP Firms will hire workers until MRP = MRC OR until value of output produced by add’l worker = cost of hiring that worker

Product of Labor Total product – total output produced Marginal product – extra output produced by adding 1 more worker It makes sense to add the additional worker if the value of the output produced is greater than or equal to that worker’s wage. Ex: worker earns $20/hour and produces 4 items per hour; item’s price is $5 – makes sense to hire the worker.

Least-Cost rule Costs are minimized when: Marginal product of laborcapital = Price of labor price of capital

Game Theory Pepsi Coke Super Bowl Ad No Ad Super Bowl Ad $10000, $8000$12000, $6000 $8000, $10000$9000, $7000 For Coke, running an ad is a dominant strategy b/c it is always better than not running an ad! Does Pepsi have a dominant strategy? What is it?

Consumer Surplus CS = all the benefit that consumers receive from consuming the good S D CS P P1 Q P Q D1 S If P changes, CS will change! CS before Δ in D = A+B; CS after Δ in D = B + C. A B C D D2

Producer Surplus PS = all the benefit that producers receive from selling the good at P1 S D PS = B P P1 Q P Q D1 S If P changes, PS will change! PS before Δ in D = C+D+E; PS after Δ in D = E. A B C D D2 A B E

Deadweight Loss Also called efficiency loss is the efficiency the economy loses from a tax or from monopoly D S St P Q Q1 P1 Pt Qt E F G H I J K Before tax: CS=E+F+G+H; PS=I+J+K; After tax: CS=E; PS=F+K; DWL=H+I

Deadweight Loss and Monopoly D MR MC $10 P Q ATC $8 20 P = $10 ATC = $8 DWL caused by monopoly

Positive Externalities (Spillover Benefits) P Q P Q Dm Do S Dm = market demand Do = optimal demand Qo Qm Qo – Qm represents an underallocation of that good Govt. may correct for underallocation by: D1 Dt S Can ↑ D by Giving subsidies To consumers (tax credits, coupons) Q1Qt Qt=Qo

Positive Externalities (Spillover Benefits) P Q P Q Dm Do S Dm = market demand Do = optimal demand Qo Qm Qo – Qm represents an underallocation of that good Govt. may correct for underallocation by: D1 St S Can ↑ S by giving subsidies to producers Q1Qt Qt=Qo

Negative Externalities (Spillover Costs) P Q P Q D Do Sm Sm = market supply So = optimal supply QoQm Qm – Qo represents an overallocation of that good Govt. may correct for overallocation by: D1 So S Can ↓S by taxing producers Q1Qt St Qt=Qo