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MICRO AP Review

MICRO AP Review. Demand Elasticity. Elastic -- % Δ Q > % Δ P; % Δ Q / % Δ P > 1 (luxuries, cruises, restaurant meals) – flat D curve Unit Elastic -- % Δ Q = % Δ P; % Δ Q / % Δ P = 1 Inelastic -- % Δ Q < % Δ P; % Δ Q / % Δ P < 1 (electricity, newspapers, salt) – vertical D curve.

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MICRO AP Review

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  1. MICRO AP Review

  2. 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

  3. 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

  4. Maximizing Utility • Utility of 2 goods is maximized when: • Marginal utility of 1 good divided by its price equals marginal utility of 2nd good divided by price • See pp. 398 - 399

  5. 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.

  6. Pure CompetitionIndustry (Market) Firm MC P P MR = MC intersects ATC at its. min. S ATC P1 P1 P1=MR D Q1 Qf Q Q

  7. Pure CompetitionIndustry (Market) Firm MC Shaded area Represents area of loss to firm P P S ATC AVC P1 P1 P2 P2=MR P2 New P = P2 but costs are still at ATC D1 D2 Q2 Q1 Qf1 Q Qf2 Q If P > AVC, they will stay in business. If not, they’ll shut down

  8. Pure CompetitionIndustry (Market) Firm P2=MR MC Shaded area Represents area of economic profit to firm P P S ATC P2 P2 P1 P1 AVC New P = P2 but costs are still at ATC D1 D2 Q2 Q1 Qf1 Q Qf2 Q New firms enter industry and reduce the price of the good.

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

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

  11. P Q TR = PxQ MR 10 1 10 10 9 2 18 8 8 3 24 6 7 4 28 4 6 5 30 2

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

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

  14. 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

  15. 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.

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

  17. 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? Game Theory Pepsi No Ad Super Bowl Ad Super Bowl Ad $10000, $8000 $12000, $6000 Coke $8000, $10000 $9000, $7000 No Ad

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

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

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

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

  22. Positive Externalities (Spillover Benefits) Govt. may correct for underallocation by: Dm = market demand Do = optimal demand P P S S Qo – Qm represents an underallocation of that good Qt=Qo Dt Do Can ↑ D by Giving subsidies To consumers (tax credits, coupons) D1 Dm Q Q1 Qt Qo Qm Q

  23. Positive Externalities (Spillover Benefits) Govt. may correct for underallocation by: Dm = market demand Do = optimal demand P P Can ↑ S by giving subsidies to producers S S St Qo – Qm represents an underallocation of that good Qt=Qo Do D1 Dm Q Q1 Qt Qo Qm Q

  24. Negative Externalities (Spillover Costs) Govt. may correct for overallocation by: Sm = market supply So = optimal supply P P Can ↓S by taxing producers St So S Sm Qm – Qo represents an overallocation of that good Qt=Qo Do D1 D Q Qt Q1 Qo Qm Q

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