MICROECONOMICSAP EXAMREVIEW

Define Economics

A Social Science

which studies how people respond to the

Unlimited Wants – Limited Resource

Dilemma

DefineOpportunity

Cost

The amount of other products

forgone in order to produce

a given product

This is referred to by them as

Economists make the assumption that we

act in a way that maximizes

our utility.

“____________ Self Interest”

RationalSelf

Interest

Define

Marginal Analysis

ComparingMarginal Benefit

toMarginal Cost

Remember This Formula:

MB = MC

Why might your Marginal Analysisyield a completely

different resultthan my Marginal Analysis?

Because the utility you receive

will not necessarily matchthe utility I receive

from the very same good or service

Define this term:

MARGINAL

EXTRA

ADDITIONAL

CHANGE IN

Ceteris Paribus refers to an assumption

Economists must make to study their

theories. What does it mean?

AllOther

ThingsBeing Equal

Statements which are Facts

and Have No Value Judgment

DescriptiveCause and Effect

are referred to as “___ ___”

POSITIVEECONOMICS

The use ofALL

AVAILABLERESOURCES

is the definition of “___ ___”

FULLEMPLOYMENT

Define Productive Efficiency

The production ofa mix of goods and

servicesat the lowest possible cost

What Formula indicates Productive Efficiency?

P = Minimum ATC

Explain what this is and what the given curve and points

stand for.

A

B

This is a PPF Curve

A

B

The curve represents the full employment of resources and the

various possible combinations of two goods or types of goods.

Point A is Inefficient Use Of Resources and Point B is

Unobtainable At This Time

Capital Goods

Consumer Goods

Production Possibilities Frontier

Look at the Opportunity Cost Of Producing Y. What is the cost of

changing the number of Y produced from C to D?Y

X

D

E F G H I

C

B

A

F to EY

X

D

E F G H I

C

B

A

The Production of X falls from

Name The Law

The Opportunity Cost of Each Additional Unit is

Greater than the Cost of the Preceding One

The Law OfIncreasing

Opportunity Cost

Why does the cost of producing “the

next good” increase with

additional production of that

good?

Because the resources used

are more suited for that goodthan those used on

subsequent goods

first

Name 4 things that make thePPF Curve shift

INor

OUT

Δ in TECHNOLOGY

Δ in resource QUANTITY

Δ in resource QUALITY

Δ in the INFRASTRUCTURE

Statements Which Contain Words Like

Should

Ought Toor that support specific

policiesare referred to as “___ ___”

or

NORMATIVEECONOMICS

What isAllocativeEfficiency?

Allocative Efficiency is

the least costly productionof the particular mix

of goods and servicesmost wanted by society

So what is the Economic TermThat means that you are

producingwith both Productive

and AllocativeEfficiency?

FULLPRODUCTION

Using a PPF, demonstrate how a society can use its resources in a way that

results in economic growth!

By using more of their resources for Capital on PPF1

Capital Goods

Consumer Goods

they can move out to PPF2

PPF1

PPF2

How do economists measure

the satisfaction we derive

from the consumption of agood or service?

UTILS

Draw a basic“four box”

Circular Flow Chart

Consumpti

on

Expenditur

es

WRIPCosts

Revenue

Resources

Land, Labor, Capital,

and Entrepreneurial

Ability

Goods and

ServicesGoods and Services

Resource

Market

Product

Market

Businesses

Households

AndThe

AnswerIs…

U.S.A.Mexico

Avocados

90

60

15 30 Soybeans

Who should grow what?

U.S.A.Mexico

Avocados

90

60

15 30 Soybeans

Avocados : Mexico Soybeans : U.S.A.

U.S.A.Mexico

Avocados

90

60

15 30 Soybeans

Fair Terms of Trade?

U.S.A.Mexico

Avocados

90

60

15 30 Soybeans

1 Soybean : 3.5 Avocados

If they ask what shape the PPF Curve is…

what should you answer?

Convex or Concave ?

Convex or

Concave

What will happen to price and quantity if

there is an increase in demand?

Price

Quantity

S

D

Pe

Qe

D2

D1

Q1

P1

Title

What will happen to price and quantity if

there is an increase in

supply?

Price

Quantity

S

D

Pe

Qe

S2

S1

Q1

P1

Title

What will happen in the corn industry if the farmers greatly expand their corn

production for alternative fuel yet

production of vehicles that run on ethanol has only increased

slightly?

Price

Quantity

S1

Pe

Qe

S2

D1

D2

Q2

P2

Title

What will happen if widgett production increases slightly at the same time that scientists discover

that people who own widgetts live longer,

healthier lives?

Price

Quantity

S1

Pe

Qe

S2

D1

D2

Q2

P2

Title

How would you graph the concept

that the demand for labor is a DERIVED

DEMAND

Demand for Wazits Demand for Wazit MakersP

r i c e

Quantity of Wazits

Quantity of Labor

W a g e s

P1

W1

P2

W2

QL1 QL2Q1 Q2

D1

D2 DL2DL1

S S

The Demand For Labor Is DERIVED from the Demand

for the Product They Make

What is this and what does it cause? S

D

?

It’s a Price Ceiling…S

D

Pc

Causing A Shortage!QS QD

Explain A and B

S

D

Pe

Qe

A

B

Consumer Surplus – those who were willing and able to spend more than they had to for this

product – and did not have to

S

D

Pe

Qe

CSPS

Producer Surplus – those who were willing and able to accept a lower price for their product – and did

not have to

Draw and explain the differences between a

Market Day, Short Run, and

Long Run Supply Curve.

Market Day – all variables are fixedShort Run – some variables are fixedLong Run – NO variables are

fixedSMD SSR

SLR

P

Q

ELASTICITY

State the formula for the

ofDEMAND

Ed = % Δ in QD of X % Δ in P of X

What Do These Mean?

ED = ∞ED = 0

What Do These Mean?

ED = ∞ Perfectly Elastic (%ΔQ/0 = ∞)ED = 0 Perfectly Inelastic (0/% Δ P = 0)

What Do These Mean?

ED > 1ED < 1

ED > 1 Elastic Demand The % Δ in Q is more than the % Δ in P

ED < 1 Inelastic DemandThe % Δ in P is more than the % Δ

in Q

Draw a typical demand curve and

label the areas of: 1 unit elasticity 2 inelasticity 3 elasticity

109876543210

1 2 3 4 5 6 7 8 9 10 Quantity

Price

D

Elastic

Inelastic

Unit Elastic

Four Things Help To Determine That The Demand For A Good Will Be

Highly Elastic

If there are many good ___________.

It uses a high % of your ___________.

If it is a ____ rather than a ___ good.

You have plenty of ______ to acquire the good.

Four Things Help To Determine That The Demand For A Good Will Be

Highly Elastic

There are many good

A high % of your

It is a

There’s plenty of

will be usedINCOME

SUBSTITUTES

LUXURY GOOD

TIME to acquire the good

State the formula for the

Cross Elasticityof

Demand

% Δ Qx % Δ Py

and it is used to determine if two goods

areCOMPLEMENTS or SUBSTITUTES

Exy=

So what is the cross elasticity of demand

coefficient for a…SUBSTITUTE GOODand a

COMPLEMENTand why ??????

SUBSTITUTE GOOD EXY > 0

COMPLEMENT EXY < 0

because as the price of Y goes up - the quantity demanded of X goes up - so Exy is a

positive #

because as the price of Y goes up - the quantity demanded of X goes down - so Exy

is a negative #

How can you tell the strength of the

relationship of two goods?

(The answer is the same for both complements and

substitutes.)

ZERO The Further The

Coefficient is from

State the Formula For

INCOME ELASTICITY

Income Elasticity Formula

Ei =

% Δ Qx

% Δ I

What does it mean if Ei

> 0What does it

mean if Ei < 0

Ei > 0 If Income and Quantity it is a NORMAL

GOODEi < 0 If Income and Quantity it is a INFERIOR

GOOD

What if Exy = 0

Exy = 0There is no relationship

between the two goods – they are INDEPENDENT

GOODS

What is this and what does it cause?

S

D

?

It’s a Price Floor…S

D

Pf

Causing A Surplus!QD QS

Draw a double-decker graph with Total Utility in the

top graph and Marginal Utility in the bottom graph.

TUUtils

Quantity

QuantityMU

Utils

Other things being equal…if marginal utility falls sharply

the demand for that good is…

Elastic or Inelastic? Explain Why

INELASTIC

If my marginal utility for the second unit is only slightly less, I am very likely to buy the second

good with just a small decrease in price. That would be ELASTIC demand.

A decline in price will elicit only a small increase in quantity demanded because the second unit really does not give much additional utility – even on sale

I do not want more. That is INELASTIC demand.

Explain how raising prices on an elastic good

will have a different result

than raising prices on an inelastic

good.

A small price increase for an elastic good will cause

MANY consumers to flee. Therefore…

your profits

will FALL Go To Next Slide For The Results Of A Price Increase On An

Inelastic Good

But a small price increase for an inelastic

good will cause VERY FEW consumers to flee. Most will still buy the product at the new higher price.Therefore…

your profits will INCREAS

E

Draw a graph that shows the impact on

CS, PS, and DWL when the

government institutes a Price

Ceiling

S

D

Pc

QC Qe

Pe

P1

CS

PS

DWL

What formula is used to show how we make choices

that maximize our utility?

MUA MUB

PA PB=

The monetary payments a firm makes to those who supply labor, materials, fuel, transportation, etc.

are called _____ costs.The opportunity costs of using its self-owned, self-employed resources

that could have been put to an alternative use are

called _____ costs.

The monetary payments a firm makes to those who supply labor, materials, fuel, transportation, etc. are called Explicit CostsThe opportunity costs of

using its self-owned, self-employed resources

that could have been put to an alternative use are

called Implicit Costs

____________ PROFITTotal Revenue – Explicit Costs =

The Above – Implicit Costs =____________ PROFIT

ACCOUNTING PROFIT

Total Revenue – Explicit Costs =

Accounting Profit – Implicit Costs =ECONOMIC PROFIT

The minimum payment made by a firm to obtain

and keep the entrepreneur is

called…

NORMALPROFIT

When a firm has a normal profit it is covering all of its costs…

including the amount it takes for the entrepreneur to make this product rather than something

else

Given: fixed technology and all resources of equal qualityThen: as successive units of a variable resource are added to a fixed resource, beyond some point the

marginal product that can be attributed to each additional unit of variable resource will declineNAME THE LAW

The Law of

Diminishing

Returns

Explain:Total Product

Marginal ProductAverage Product

Total Product is how many total units all of the resource (labor)

was able to produce.

Marginal Product is how many units the last worker hired added

to the Total Product.

Average Product is output per labor unit

Firms use MARGINAL PRODUCT to decide if it is worth hiring the NEXT

employee.

(LABOR is usually the “resource” used in the examples!)

Marginal Product is the

____________

Of the Total

Product Curve

Marginal Product is the SLOPE

Of the Total

Product Curve

Graph the relationship

between:Total Product

Marginal Productand

Watch your TP slope from start to finish and the relationship between TP

and MP at MP = 0

TP MP

MPUnits

of Labor

Graph the relationship

between:Marginal Product

Average Productand

Show the relationship such that when MP is greater than AP, AP is increasing and when

MP is less than AP, AP is decreasing. AP

MP

MP Units of Labor

AP

Explain:Total Fixed Costs

Total CostsTotal Variable

Costs

TFC = costs that don’t vary with output

TC = The sum of fixed and variable costs

TVC = costs that change with the level of output

You knew it was next

Graph the relationship

between TFC, TVC, and TC.

Costs

Output

TFC

TVCTC

TFC

TVC

Write the Formula

ATC AFC

AVC

ATC = TC / Q

AFC = TFC / QAVC = TVC / Q

or AVC + AFC

Graph

AFCAVCATCMC

Costs

Output

MC

ATC

AVC

AFC

MC crosses ATC and AVC at their minimums. AFC approaches

the X axis as the Fixed Costs are spread across more and more

output. ATC and AVC draw closer as AFC fall.

Costs

Output

MCATC

AVC

AFC

What will happen to each of these curves

if property taxes increase?

Costs

Output

MCATC

AVC

AFC

Taxes are Fixed Costs so AFC and ATC shift up and MC

and AVC do not.

Costs

Output

MCATC

AVC

AFC

What will happen to each of these curves

if variable costs increase?

Costs

Output

MCATC

AVC

AFC

When Variable Costs Increase… MC and AVC and ATC shift up. AFC

does not.

Explain:Total Revenue

Marginal RevenueAverage Revenue

TR = Price x Total Sold

MR = The additional revenue from the sale of the next unit

AR = TR ÷ Total Sold (Same as Price in PURE COMPETITION)

Graph the relationship

between the Total

Cost Curve and

Total Revenue Curve

for the Purely Competitive Firm

TR

TCTR TC

Quantity

Demand

ed

Break Even Point

Break Even Point

Maximum Economic

Profit

Profit Maximization

P = ___

In Pure Competition

because every additional unit is sold

for the same price

P = MRIn Pure

Competition

because every additional unit is sold

for the same price

What Formula Uses

Marginal Revenue To Define The Profit

Maximization

Point?

MR = MC

Practice the Graph Which Shows How a Perfectly

Competitive Firm Can Use Marginal Revenue To Determine Everything From When They Will

Maximize Profits To When They Should Shut Down

AVC

ATC

MR1

MC

MR2

MR3

MR4

MR5

quantity

price

Pure Competition - The Firm At “A” Represents…?

E

D

C

B

A

“A” Represents Where The Firm Is Shut Down - losses would be greater if they produce because they would owe Fixed

AND Variable Costs

AVC

ATC

MR1

MC

MR2

MR3

MR4

MR5

quantity

price

Pure Competition - The Firm At “B” Represents…?

E

D

C

B

A

“B” Represents Where The Firm Is At SHUT DOWN POINT

AVC

ATC

MR1

MC

MR2

MR3

MR4

MR5

quantity

price

Pure Competition - The Firm At “C” Represents…?

E

D

C

B

A

“C” Represents Where The Firm Is losing $ but remains open because at least some of the FIXED

COSTS are covered

AVC

ATC

MR1

MC

MR2

MR3

MR4

MR5

quantity

price

Pure Competition - The Firm At “D” Represents…?

E

D

C

B

A

“D” Represents Where The Firm Is Earning a Normal Profit

AVC

ATC

MR1

MC

MR2

MR3

MR4

MR5

quantity

price

Pure Competition - The Firm At “E” Represents…?

E

D

C

B

A

“E” Represents Where The Firm Is Earning an ECONOMIC PROFIT

AVC

ATC

MR1

MC

MR2

MR3

MR4

MR5

quantity

price

So where is the Supply Curve For Pure Competition?

E

D

C

B

A

AVC

ATC

MR1

MC

MR2

MR3

MR4

MR5

quantity

price

It is the MC Curve ABOVE the Shut Down Point

E

D

C

B

A

Draw a graph that shows the

relationship between

productivity and cost curves.

AP

AC MC

AP MP

MPMC

AC

Quantity of Product

Quantity of Labor

Long Run ATC Curves are U-Shaped. That is NOT because of the Law of Diminishing

Return because that law assumes a _______ Plant

(that one resource is fixed in supply)

Fixed Plant

So what does explain the reason that Long Run ATC

Curves are U-Shaped?“________ of ________”

Long Run Cost Curves are shaped by…

ECONOMIES of

SCALE

LRAC

Planes, Inc.

Costs

Output

What should you label the area between Q1 and

Q2 ?

Q1 Q2

LRAC

Planes, Inc.

Costs

Output

MES = Minimum

Efficient Scale

Q1 Q2

MES

LRAC

Costs

Output

MES can also be referred to as…

Q1

Q2

Tarmart

MES

LRAC

Costs

Output

MES = Constant Return

To Scale

Q1

Q2

Tarmart

MES

LRAC

LRAC

Tarmart

Planes, Inc.

Costs

Costs

Output

Output

Why is the MES so much further to the

right for Planes, Inc.

than for Tarmart?

MES

MES

LRAC

LRAC

Tarmart

Planes, Inc.

Costs

Costs

Output

Output

Because it takes a large

plant with high output

to reach MES for airplanes. MES

MES

LRACStarJoes

Costs

Output

This part of

the LRAC curve

for StarJoes is

where “__ _ __”

occur.

MES

Q1 Q2

LRACStarJoes

Costs

Output

Economies of Scale

MES

Q1 Q2

LRACStarJoes

Costs

Output

This part of

the LRAC curve

for StarJoes is

where “__ _ __”

occur.

MES

Q1 Q2

LRACStarJoes

Costs

Output

Diseconomies of Scale

MES

Q1 Q2

LRACStarJoes

Costs

Output

Economies of Scale means that a 10% increase of inputs will result in a

“_____ _____” 10% increase

in output.

MES

Q1 Q2

LRACStarJoes

Costs

Output

Economies of Scale means that a 10% increase of inputs will result in a

greater than

10% INCREASE

in output.

MES

Q1 Q2

LRACStarJoes

Costs

Output

So what does

Diseconomies of Scale

Mean?

MES

Q1 Q2

LRACStarJoes

Costs

Output

Diseconomies of Scale

means a 10% increase

of inputs results

in a less than 10%

increase in output.

MES

Q1 Q2

And what happens if you increase resources by 10% in the constant

returns to scale section of the graph?

Q2Q1

MES

Costs

Quantity

A 10% increase of the inputs within the

constant returns to scale section of the

graph results in exactly a 10% increase in the

output of the good.

Characteristics of the Four Basic

Market Models

Can You Name The 4 Models?

The Four Basic Market Models

Pure CompetitionMonopolistic Competition

OligopolyMonopoly

Number Of Firms

Type Of Product

Control Over Price

Conditions of Entry

Non-price Competition

Example

The Characteristics of: PURE COMPETITIONClick To Reveal One Answer At A Time

A Very Large Number

Standardized

None – Price Takers

No Barriers To Entry

None (nothing different about your product to tell people about)

Agriculture

Number Of Firms

Type Of Product

Control Over Price

Conditions of Entry

Non-price Competition

Example

The Characteristics of: MONOPOLYClick To Reveal One Answer At A Time

One

Unique (no substitutes)

Price Makers

Blocked

Few (public relations ads)

Local Utilities

Number Of Firms

Type Of Product

Control Over Price

Conditions of Entry

Non-price Competition

Example

The Characteristics of: MONOPOLISTIC COMPETITIONClick To Reveal One Answer At A Time

Many

Differentiated

Some (within narrow limits)

Relatively Easy

Major Emphasis

Jeans Companies

Number Of Firms

Type Of Product

Control Over Price

Conditions of Entry

Non-price Competition

Example

The Characteristics of: OligopolyClick To Reveal One Answer At A Time

Few

Standardized or Differentiated

Limited by Mutual Interdependence but Considerable With Collusion

Significant Obstacles

Much – But Only When Product is Differentiated

Standardized Product – Oil Differentiated Product - Appliances

Use a graph to show how the

perfectly competitive

firm is a price taker.

P=MR

D

S MCATC

Qe q

Pe

Q

Industry

Firm

The perfectly competitive firm takes its price from the

industry equilibrium price.

P

Q

Now show how much an industry-wide increase in

demand will impact the perfectly

competitive firm.

P=MR1

D2

S MCATC

Qe1q1

Pe

1

Q

Industry

Firm

D1

Pe

2

Qe2

P=MR2

q2

The Firm is making an Economic Profit in the Short Run

Economic Profit

Q

P

D2

S1MC

ATC

Qe1q1,3

Pe

1

Q

Industry Firm

D1

Pe

2

Qe2

P=MR2

q2

But in the Long Run, new firms will be attracted by that Economic Profit, industry-wide supply will increase, and the firm will return to earning a

Normal Profit

S2

P=MR1,3

Qe3 Q

P

Now show how much an industry-wide decrease in

demand will impact the perfectly

competitive firm.

P=MR1

D1

S MCATC

Qe1q1

Pe

1

Q

Industry

Firm

D2

P=MR2

Qe2

Pe

2

q2

Loss

The Firm is At A Loss in the Short Run (an AVC curve would be needed

to tell if they should shut down)

P

Q

P=MR1

D1

S MCATC

Qe1q1

Pe

1

Q

Industry

Firm

D2

P=MR2

Qe2

Pe

2

q2

Loss

Now you have the AVC Curve! What should this firm do in

the SHORT RUN?

AVC

Q

P

P=MR1

D1

S MCATC

Qe1q1

Pe

1

Q

Industry

Firm

D2

P=MR2

Qe2

Pe

2

q2

It’s Time To Stop Producing Those 8-Track Tapes! not only can’t you pay your fixed costs ( see ) if you produce

anything you will also have these variable costs ( see ) you cannot pay!

AVC

Loss

Q

P

Sometimes the decrease in demand creates a situation where a firm should continue to operate at a loss in the short

run.Draw That Graph

P=MR1

D1

S MCATC

Qe1q1

Pe

1

Q

Industry

Firm

D2

P=MR2

Qe2

Pe

2

q2

Loss

This firm should continue to produce in the SHORT RUN because they are at LEAST covering almost

half ( see )of their fixed costs

AVC

Q

P

Are firms in Perfectly

Competitive Industries efficient?

Productively?

YES! P = min. ATCAllocatively?

YES! P = MCIt is only in Pure Competition that

you have Productive and Allocative Efficiency All

other models have Excess Capacity

Industries change based on the demand for their

products. Given: A Constant Costs

Perfectly Competitive Industry

Draw the graph which shows the Long Run Supply Curve for this

industry.

Price

Quantity

SL

D1

S2 S3 S4

D2

D3

D4

S1

Perfect Competition With Constant Costs

Let’s move on to a different type of industry structure…

Graph A

PURE MONOPOLY

Price

Quantity

MR

D

ATC

MC

Economic Profit

PM

MONOPOLY

PC

QM

Price

QuantityMR

D

ATC

MC

Economic Profit

PM

MONOPOLY

PC

QM

How do you know they produce at QM with price PM and Costs PC resulting in

an economic profit?

Price

QuantityMR

D

ATC

MC

Economic Profit

PM

MONOPOLY

PC

QM

Because you always maximize profits where MR = MC

Fall Faster Than The Demand

Curve?

MR

curve

Why does the

So to sell the next higher quantity of goods you must

charge a lower price.

The Law Of Demand explains that to sell more of something you

must lower the price .

As you sell more, your TOTAL REVENUE

increases by smaller and smaller increments.

Therefore: MR falls faster than D

D

MR

Price

Quantity

Why is a Monopoly Price always in the ELASTIC SECTION

of the Demand Curve?

Because it is only in the elastic region that lowering the price…

will result in an INCREASE in

Revenue

How can you tell from the graph that a Monopoly

does not have

orProductive

AllocativeEfficiency

Price

QuantityMR

D

ATC

MC

Economic Profit

PM

MONOPOLY

PC

QM

Because P ≠ Min ATC and P ≠ MC(no productive or allocative efficiency)

Do Monopolies

Under Allocate Or

Over Allocate Resources?

Price

QuantityMR

D

ATC

MC

Economic Profit

PM

MONOPOLY

PC

QM

UNDER ALLOCATE ( P > MC ) we value the product more than the resources used to make the good We wish

they would make more!

So what is

PriceDiscriminat

ion?

When a Monopolistknowing who will pay at each

price level and having a product that cannot be re-soldcharges each customer

the price they are willing and able to pay.

For example: the airline that charges more for a seat reserved today than for the seat reserved 4

weeks ago

So how does the graph differ for a Price

Discriminating

Monopolist?

Price

QuantityMR

D

ATC

MC

Economic Profit

PM

MONOPOLY

PC

QM

D = MR

Price Discriminating Monopoly

Economic Profits Increase Because MR = D For The P.D.M.

If a natural monopoly is going to be regulated, what options do

governments consider?

Price

QuantityMR

D

ATC

MCPM

REGULATING MONOPOLIES

PF

QM

PS

QSQF

PM and QM represent what the Monopoly wants (profits are maximized where

MR = MC)

PS and QS represent the Socially Optimal Price (Allocative Efficiency P=MC)

PF and QF represents the Fair Return Price (monopoly earns a normal profit because

Price = Average Total Cost)

They Use The Fair Return Price As The Best Compromise Increased Output, Lower Price

and the Monopoly Earns a Normal Profit

Regulation often occurs when economies of scale prevent more than one

industry from producing a good or service.

What do we call that type of

market model?

A

NaturalMonopo

ly

Graph

Monopolistic Competition.show the firm making an economic profit

Price

Quantity

MR

D

ATCMC

Economic Profit

PMC

PC

QMC

MONOPOLISTIC COMPETITION

The monopolistic competitor earns an economic profit in the short run….which

attracts others to enter the industry.

Graph what

happens as more firms enter this industry.

Price

Quantity

MR

D

ATC

MC

Economic LossPMC

PC

QMC

MONOPOLISTIC COMPETITION

As firms enter the industry, the increased competition takes consumers away from the firm,

to the point some firms suffer losses that force them to shut down.

So what does the graph look like

for Monopolistic

Competition in the

Long Run?

Price

Quantity

MR

D

ATC

MC

As firms drop out…the monopolistic competitor earns a normal profit…in

the long run.

PMC

MONOPOLISTIC COMPETITION

QMC

Why are the Demand and Marginal Revenue Curves so much more

elastic on the Monopolistic

Competition graph than on the Pure Monopoly graph?

Because the barriers to entry are present…but

not that great…so competitors can

come and go fairly easily.

Sometimes Oligopoly firms decide that rather than be

stuck with a price of Po they will meet in a dark room and come to an agreement to set output such that they can get

a higher price and more profits for their goods.

What are these evil-doers practicing?

Collusion

Sometimes it isn’t that they have come to an illegal

agreement. Sometimes there is just one dominant, efficient firm that is the

first to react to cost or demand changes, changes that will also

impact all of the firms in the Oligopoly. So the other firms tend to

follow what that dominant firm does. What do economists call

this Oligopoly Model?

PRICELEADERSHI

P

So what does the Oligopoly Graph look

like if the firms are practicing COLLUSION or

PRICE LEADERSHIP?

Price

Quantity

MR

D

ATC

MC

Economic Profit

PM

MONOPOLY

PC

QM

OLIGOPOLY (COLLUSION or PRICE LEADERSHIP)

It is time to practice some Game Theory!

High LowABC Gum

Profits

Bubb

le G

um

Profi

ts Hig

hLo

w

Copy this chart and use squares to show the ABC Gum strategy and circles to show the

Bubble Gum strategy.

Click when you are ready to check your answer

364536

18

The Numbers Represent the Price for a Crate of Gum

18 2445 24

Game Theory!

High LowABC Gum

Profits

Bubb

le G

um

Profi

ts Hig

hLo

w

Squares show the ABC Gum strategy. Circles show the Bubble Gum strategy.

364536

18

The Numbers Represent the Price for a Crate of Gum

18 2445 24

Is there a dominant strategy here? Is there Nash Equilibrium here?

Let’s see if you’ve got

game!

Game Theory!

High LowABC Gum

Profits

Bubb

le G

um

Profi

ts Hig

hLo

w

364536

18

18 2445 24

Is there equilibrium dominant strategy here?

Is there Nash Equilibrium here? YES - low, low

YES – no player can benefit from moving from the low, low strategy if the other player does not move with her

The price and amount of

resources used is determined in the _______ _______

FACTORMARKE

T

What determines how many

resources an industry will

demand and what is this called?

The Demand For The

Product Determines The Demand For The

Resourcethis is a DERIVED

DEMAND

So to maximize profits, a firm needs to

determine how much a resource will cost vs. how much it will add

to its revenue. Write This Formula

MRP = MRC Marginal Revenue

Product=

Marginal Resource Cost (WAgE)

Given: a perfectly competitive labor market

How many workers should this firm hire if the market wage is

$10.00 per hour? Firm’s MRP Firm’s MRC Units of Labor --- $10 0 $20 $10 1 $18 $10

2 $15 $10 3

$12 $10 4 $ 9 $10

5 $ 6 $10 6

Given: a perfectly competitive labor marketHow many workers should this

firm hire if the market wage is $10.00 per hour?

Firm’s MRP Firm’s MRC Units of Labor --- $10 0 $20 $10 1 $18 $10

2 $15 $10 3 $12

$10 4 $ 9 $10 5

$ 6 $10 6

The MRP curve

represents the firm’s demand for…..

LABOR

If a perfectly competitive firm operates where

there is a perfectly competitive labor

market…what does the graph for the

supply and demand for labor look like?

Perfect Competition Seller and Perfect Competition Employer

Quantity of Resource Demanded

MRC

D = MRP

Price and Wag

e Rate

PW

QLnote the demand curve is fairly elastic because they do not have to lower their price to sell more goods so MRP

only falls because of the Law of Diminishing Returns

But what if the employer is not selling a good in a perfectly competitive market?She must lower the price to sell the additional units.Draw her

demand for labor graph.

Imperfect Competition Seller and Perfect Competition Employer

Quantity of Resource Demanded

MRC

D = MRP

Price and Wag

e RatePW

QL

The demand curve is LESS elastic because the price must be lowered to sell more units… so MRP falls

QUICKLY due to the Law of

Diminishing Returns and because the Price is being lowered to sell

additional units

What if a firm is using both labor and capital to produce

its product.What formula do

they use to determine how much to use of each in order to

produce at the least

cost ?

MPL = MPC

PL PCMarginal Product of Labor divided by the Cost of Labor

must equal the Marginal Product of Capital divided by the Cost of Capital to produce at the lowest

possible cost.

Given: MPL = MPC PL PC

MPL = 500 MPC = 250 ..PL $10 PC $25

What should this firm do?

Wanted: MPL = MPC PL PC

500 ≠ 250 $10 $25

The Firm Should Use More Labor because they are

getting 50 units of product for $1 of labor and just 10 units of product from $1 of

capital

50 > 10 ..$1 $1

What is the

PROFITMAXIMIZING

RULE

MRPL= MRPC = 1 PL PC

Is this firm UNDEREMPLOYING or OVEREMPLOYING

its Resources?

MRPL = $30 PL = $15

MPRC = $10 PC = $5

$30 $10 1 $15 $5

Given: MRPL = $30 PL = $15 MPRC = $10 PC = $5

Profit Maximizing Rule Is MRPL = MRPC = 1

PL PC

≠=This firm is UNDER-EMPLOYING both resources because the ratios do not equal one. They should keep using

both until they have $15/$15 = $5/$5 = 1

For example – a coal mine town

Sometimes…a firm is the only place in town for

people to work.

What Is This Called And What Does Its

Labor Market Graph Look Like?

MONOPSONYMRC S

DL = MRP

Wc

Wm

Qm Qc

The Monopsonist hires at Qm and pays wages at

Wm. If there were other options for employment in this town, this firm would hire at Qc and pay at Wc.

Wages

Quantity of Labor

MRP =MRC

QM people will work for this wage

Draw the Graph that is

used to explain a Negative

Externality

MSB

MSCMPC

Qsociet

y wants

Quantity

Cost to Society is > Cost to the Producer so this is inefficient – it is an overallocation of resources and it is creating a NEGATIVE EXTERNALITY

Price Cost

Qbeing

produced

Firm Creating Pollution

So what does the

government do in a negative externality situation?

Tax the producer so his costs

increase, driving the quantity

produced down to a socially

acceptable level.

Draw the Graph that is

used to explain a Positive

Externality

MPBMSB

MPC

Qsociet

y wants

Quantity

Benefit to Society > Benefit to the Producer so this is inefficient – it is an underallocation of resources and it is creating a POSTITIVE EXTERNALITY

Price Cost

Qbeing

produced

Flu Shots

So what does the

government do in a positive externality situation?

The government subsidizes the

activity so production will increase to a

socially acceptable level.

What formula is used to

demonstrate that there are

no externalities.

∑ MBi = MSCthe sum of all of the

individual benefits in society must equal the

cost to society

Draw a Lorenz Curve

and explain what it shows

Income

Percent of Households

Lorenz Curve

A

B

this graph shows the distribution of income among households

The Lorenz Curve is the actual distribution of income.

The 45° line represents perfect income distribution equality.

Area “A” reflects the degree of income inequality.

What mathematical approach is

taken to explain this concept?Name and

write the formula.

Income

Households

Lorenz Curve

A

B

What would the coefficient be if income was equally distributed among the households of this economy? (click for the answer)

The Gini

Coefficient

A A+B

(A / A+B) = (0 / 0+B) = 0 (Perfect Equality)

Income

Households

Lorenz Curve

A

B

What would the coefficient be if one family had all of the income in the

society? (click for the answer)

The Gini

Coefficient

A A+B

(A / A+B) = (1 / 1+0) = 1 (Perfect Inequality)

THE END