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Understanding Demand Elasticity, Market Structures, and Externalities in Economics

This review delves into various concepts of demand elasticity, distinguishing between elastic, unit elastic, and inelastic goods with practical examples such as luxuries and necessities. It further examines market structures, focusing on pure competition and monopolistic competition, illustrating how firms determine pricing and output to achieve economic profit or losses. Additionally, it covers consumer and producer surplus, deadweight loss, and how positive and negative externalities impact market efficiency, along with government interventions aimed at correcting market failures.

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Understanding Demand Elasticity, Market Structures, and Externalities in Economics

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  1. MICRO AP Review

  2. Demand Elasticity • Elastic -- %ΔQ > %ΔP; %ΔQ / %ΔP > 1 (luxuries, cruises, restaurant meals) • Unit Elastic -- %ΔQ = %ΔP; %ΔQ / %ΔP = 1 • Inelastic -- %ΔQ < %ΔP; %ΔQ / %ΔP < 1 (electricity, newspapers, salt)

  3. Market Structures

  4. 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

  5. Pure CompetitionIndustry (Market) Firm MC Shaded area Represents area of loss to firm P P S ATC P1 P1 P2 P2=MR P2 New P = P2 but costs are still at ATC D1 D2 Q2 Q1 Qf1 Q Qf2 Q

  6. 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

  7. 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

  8. 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

  9. 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

  10. Labor Market • Marginal Product of Labor (MP) = 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

  11. 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

  12. 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

  13. 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

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

  15. 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

  16. 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

  17. 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 Qo – Qm represents an overallocation of that good Qt=Qo Do D1 D Q Qt Q1 Qo Qm Q

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