Micro-Economics Review

Course Summary

• Tax on buyers shifts D-curve, Tax on sellers shifts S-Curve

• Taxes always produce deadweight loss!– You produce less at a higher cost

• Tax Incidence does not depend on who pays the tax!– Buyers & Sellers share the burden

– Elasticity determines who bears the most!

• The majority of the tax burden falls on more inelastic curve– Steeper curve pays more of tax

Tax Summary

Tax on Sellers

2.80

Quantity ofIce-Cream Cones

0

Price ofIce-Cream

Cone

Pricewithout

tax

Pricesellersreceive

Equilibriumwith tax

Equilibrium without tax

Tax ($0.50)

Pricebuyers

payS1

S2

Demand, D1

A tax on sellersshifts the supplycurve upwardby the amount ofthe tax ($0.50).

3.00

100

$3.30

90

Deadweight loss!

EXTERNALITIES• An externality is the uncompensated impact of one person’s

actions on another person– Both positive & negative externalities exist

• Externalities cause markets to be inefficient– That is, markets do not maximize total surplus (welfare)

Negative Externality: Pollution

Equilibrium MC = MB

Quantity ofAluminum

0

Price ofAluminum

Demand = MBP

(private value)

Supply = MCP

(private cost)

MSC = (MCP + MCS)

QOPTIMUM

Optimum

QMARKET

SpilloverCost

External social Cost

Correct a NegativeExternality with a

Tax

Cost Curves

Quantity of Output

Costs

$3.00

2.50

2.00

1.50

1.00

0.50

0 42 6 8 141210

MC

ATCAVC

AFC

Marginal Cost declines at first and then increases due to diminishing marginal product.

Note how MC hits both ATC and AVC at their minimum points.

AFC, a short-run concept, declines throughout.

PerfectCompetition

4 Market Structures

EquilibriumPrice vs. MC P = MC

Maximize Profit When: MR = MC

Long RunEconomic Profit

No

Demand& MarginalRevenue Curve

Quantity of Output

DemandDemand

0

Price

MonopolisticCompetition

P > MC

MR = MC

No

Quantity of Output0

Price

DDMR

Oligopoly

P > MC

MR = MC

Yes

Quantity of Output0

Price

DDMR

Monopoly

P > MC

MR = MC

Yes

Quantity of Output0

Price

DDMR

MC MC MCMC

Perfect Competition

Market Firm(b) Short-Run Response

Quantity (firm)0

Price

P1

Quantity (market)

Long-runsupply

Price

0

D1

D2

P1

S1

P2

Q1

A

Q2

P2

BATCMC

An increase in market demand…

…raises price and output.

This can not be a long term equilibrium!P > ATC encourages entry into the marketWill return to zero econ profit in long run

profit

Quantity0

Costs andRevenue

DemandDemand

MCMC

Marginal revenueMarginal revenue

ATCATC

Example: Monopoly Equilibrium

To Find Equilibrium:• Set MC = MR• Line up to Demand Curve

Opportunity Costs:Lower QTYHigher PriceDeadweight Loss

---------------

----

----

----

----

----

----

---

---------------

profit

Quantity0

Price

DemandDemand

MRMR

ATCATC

MCMC

Quantity0

Price

DemandDemand

MCMCATCATC

MRMR

EfficientscaleEfficientscale

P

Quantityproduced

P

QuantityproducedQuantity

produced

SHORT RUN: Monopolistic Competition LONG RUN: Monopolistic Competition

Profit Exists! Zero Profit, but not atEfficient scale

Liz

Bob HIGH 400, 300 -800, 500

LOW 600, -800 -500, -500

HIGH LOW

Every Dominant Strategy is a Nash EquilibriumBUT: Every Nash Equilibrium is not a dominant strategy

Easy way to find dominant strategy:

First, Circle each players preferred boxes Second, if 2 circles in same row you have a Dominant StrategyBoth Liz and Bob would choose Low!It is an enforceable equilibrium because there is no incentive to cheat

Oligopoly: Game Theory

Product & Factor Markets

Quantity0

Price

DemandDemand

MCMCATCATC

MRMR

EfficientscaleEfficientscale

P

Quantityproduced

P

QuantityproducedQuantity

produced

MR = MC

0 Quantity of

Workers0

Wage Rate

Marginal Revenue Product(demand curve for labor)Marginal Revenue Product(demand curve for labor)

Marketwage

Marketwage

Profit-maximizing quantityProfit-maximizing quantity

MRP = MFC

Competitive Input Markets

Price

Qty

Low Skilled Workers

DL= MRPL

SL

---------------------------

$10

Q1

E1

Price

Qty

Small firms can hire all their workers at Market wage

Entire Factory Industry Individual Firm

$10SL = MFC

Q1

-------------------

DL= MRPL

LABOR MARKET

Low Skilled Workers

Competitive vs Market Power

MRPCMRPM

Therefore: MRPC > MRPM

MRPC = MPL * MR

MRPM = MPL * MR

MR = P for a competitive firm

MR < P for a firm with market power

MRP = [MPL * Price] only forcompetitive firms in output market!

Qty

P

Wage Rate

Firms with market power will hire less workers!

(Monopoly, Oligopoly, Monopolistic Competition

QM QC

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P1