MICROECONOMICS THERE ARE THREE PREDICATES OF MICROECONOMICS ANALYSIS

1) COMPARATIVE STATISTICS 2) EQUILIBRIUM ANALYSIS 3) CONSTRAINED OPTIMISATION

ECONOMIC MODELS ARE AFFECTED BY:

• ENDOGENOUS VARIABLES WHICH ARE WITHIN THE WORKING OF THE MODEL AND AFFECT THE MODEL

• EXOGENOUS VARIABLES ARE FACTORS OUTSIDE THE MODEL ALSO AFFECTING IT I.E. FACTORS OUT OF THE MODELLER’S WORLD SO TO SPEAK

FOR EXAMPLE IN A MODEL OF THE OIL MARKET, AN ENDOGENOUS VARIABLE WILL BE PRICE (P) AND AN EXOGENOUS VARIABLE IS COULD BE CIVIL WAR. SIMILARLY, THERE ARE DIFFERENT FACTORS IN THE MODEL, BUT ONLY ONE IS THE FOCUSSED ON PER TIME, AND ALL OTHERS ARE ASSUMED CONSTANT.

• POSITIVE ANALYSIS IS SCIENTIFIC • NORMATIVE ANALYSIS INVOLVES ETHICS/CONSCIENCE; PHILOSOPHY AND VALUE

JUDGEMENT HOWEVER, MICROECONOMICS HAS PROVED TOO IDEAOLOGICAL SUCH THAT FAIRLY RECENT DEVELOPMENTS LIKE GAME THEORY STUDIES THE HUMAN BEHAVIOURAL ASPECT OF THE MARKET USING EXPERIMENTAL EVIDENCE; AS UNTIL NOW IT WAS NOT BEING SUFFICIENTLY MODELLED

DEMAND WE ACCEPT FOR NOW THAT THE DEMAND FUNCTION IS 𝑄  =  𝐹(𝑃) WHERE Q IS THE DEPENDENT VARIABLE FOR “QUANTITY OF GOODS” AND P THE INDEPENDENT VARIABLE FOR “PRICE OF GOODS” TWO SPECIAL FORMS FOR THE DEMAND FUNCTION WILL BE LOOKED AT (WHERE a AND b ARE CONSTANTS)

• 𝑄  =  𝑎 – 𝑏 𝑃  LINEAR FORM • 𝑄  =  𝑎 𝑃!! CURVI-LINEAR OR LOG-LINEAR FORM

CALCULATING ELAST IC ITY • POINT ELASTICITY METHOD FOR CONTINUOUS FORM I.E. FUNCTIONS

𝜀!,!  =  %"#$%&' !!! % !"#$%& !"#$% 

=∆!

! ∗ !""%∆!

! ∗ !""%

      

• ARC ELASTICITY METHOD FOR DISCRETE FORM I.E. TABULATED VALUES

𝜀!,!  =  𝑄1 − 𝑄0𝑄0

 ∗ 100𝑃1 − 𝑃0𝑃0

 ∗ 100

TWO DEMAND FUNCTION CASES 1 . 𝑄  =  𝑎 – 𝑏 𝑃    LINEAR FORM

• THE INVERSE DEMAND FUNCTION WHICH IS “PRICE” IS CALCULATED THUS:

𝑄  =  𝑎 – 𝑏 𝑃 𝑄  −  𝑎  =  −𝑏𝑃 𝑏𝑃 =  𝑎 –𝑄     

• THE CHOKE PRICE HERE IS 𝑃  =    𝑎𝑏   WHICH IS THE PRICE AT WHICH WE HAVE ZERO QUANTITY DEMANDED (𝑄 = 0)

• ALSO WE CALCULATE ELASTICITY THUS:

𝜀!,! =   𝜕𝑄𝜕𝑃 ∗

𝑃𝑄 

 !"!" =    !(𝑎 –𝑏 𝑃  )

!" =  −𝑏 

            𝜀!,! =  −𝑏 ∗

!!

𝜀! =  !!"

(!!!")  

𝜀!  =   !"!"∗ !!  

𝜀! =  !!! ! !!!!

!  ! !!!!!!!

!  

𝑃  =  !! – !

! 𝑄      

 

2 . 𝑄 =  𝑎 𝑃!! CURVI-LINEAR OR LOG-LINEAR FORM

• WE CALCULATE ELASTICITY THUS:

𝜀!,! =   𝜕𝑄𝜕𝑃 ∗

𝑃𝑄 

(ALSO NOTE THAT 𝑄 =  𝑎 𝑃!! IMPLIES THAT 𝑙𝑜𝑔 𝑄 =  −𝑏 𝑙𝑜𝑔! 𝑃)

     !"!" =    !(𝑎 𝑃

−𝑏)!"

  

  𝜕(𝑎 𝑃−𝑏)

𝜕𝑃  =  −𝑏 ∗ 𝑎𝑃(−𝑏−1)      𝜀!,! =  −𝑏 ∗ 𝑎𝑃(−𝑏−1) ∗ !!

𝜀!,! =  −𝑏∗𝑎𝑃(−𝑏−1+1)

𝑄  =  −𝑏∗𝑎𝑃(−𝑏)

𝑄  

SUBSTITUTE 𝑄 =  𝑎 𝑃!!

𝜀!,! =  −𝑏∗𝑎𝑃(−𝑏)

𝑎 𝑃−𝑏

TYPES OF PRICE ELAST IC IT IES OF DEMAND VALUES FOR PRICE ELASTICITY OF DEMAND IS ALWAYS NEGATIVE BECAUSE AS PRICE GOES UP QUANTITY DEMANDED DECREASES FOR MOST GOODS (EXCEPT LUXURY GOODS, WHICH IS SHOWN LATER) AND IS RESTRICTED TO BETWEEN −∞ ≤ 𝜀!,!  ≤ 0 (Y=P, X=Q)

1 . INFINITELY ELASTIC IS THE CASE WHERE 𝜀!,!  =  −∞ THIS HAPPENS IF ANY CHANGE IN THE PRICE OF A GOOD BRINGS ABOUT ZERO QUANTITY DEMANDED. SO ONLY IF PRICE IS P* ANY QUANTITY IS DEMANDED.

2 . RELATIVELY ELASTIC IS THE CASE WHERE 𝜀!,!  <  −1 THIS HAPPENS IF A CHANGE IN PRICE OF A GOOD BRINGS ABOUT A MORE THAN PROPORTIONATE CHANGE TO THE QUANTITY DEMANDED. IF A GOOD IS ELASTIC THEN IT BENEFITS FROM A LOW PRICE AS THIS GENERATES MORE REVENUE. THIS USUALLY LEADS TO A PRICE WAR BETWEEN COMPETITORS IN THE FAST MOVING GOODS MARKET

3 . UNITARY ELASTIC IS THE CASE WHERE 𝜀!,!  =  −1 AND % CHANGE IN QUANTITY DEMANDED OF A GOOD IS PROPORTIONATE TO % CHANGE IN PRICE

4 . RELATIVELY INELASTIC IS THE CASE WHERE 0  >  𝜀!,!  >  −1 IF A CHANGE IN PRICE BRINGS ABOUT A LESS THAN PROPORTIONATE CHANGE IN QUANTITY

𝜀!  = −𝑏      

5. PERFECTLY INELASTIC IS THE CASE WHERE 𝜀!,!  =  0 THIS HAPPENS IF ANY CHANGE IN THE PRICE OF A GOOD HAS NONE WHATSOEVER EFFECT ON THE QUANTITY DEMANDED. FOR ANY PRICE P, Q* IS THE QUANTITY DEMANDED.

NOTE, UNLIKE MOST GOODS, LUXURY/SUPERIOR GOODS HAVE THE UNIQUE PROPERTY THAT IF PRICE INCREASES THE QUANTITY DEMANDED ALSO INCREASES E.G. PORSCHE CARS WORKED EXAMPLES 1) GIVEN  𝑄 =  350 – 7𝑃, FIND THE QUANTITY DEMANDED AND THE ELASTICITIES AT 𝑃  =  40, 50

SOLUTION: 𝐼𝐹 𝑃  =  40 𝑄 =  350 – (7  ∗  40) 𝑄 =  350 –  280 𝑄 =  60

𝜀!",!" =   𝜕(350 −7𝑃)

𝜕𝑃 ∗ 4060

            =  −7 ∗ 23

            =  −4.67 WHICH IS RELATIVELY ELASTIC 𝐼𝐹 𝑃  =  50 𝑄 =  350 – (7  ∗  50) 𝑄 =  350 –  350 𝑄 =  0

𝜀!,!" =   𝜕(350 −7𝑃)

𝜕𝑃 ∗ 500             =  −7 ∗∞             =  −∞ WHICH IS INFINITELY ELASTIC 2) GIVEN CASE 1 TABLE BELOW, CALCULATE PRICE ELASTICITY

• SOLUTION: USING ARC ELASTICITY

𝜀!,! =  𝑄1 − 𝑄0𝑄0

∗100𝑃1 − 𝑃0𝑃0

∗100

         =  !" ! !"!"! ! !!

 =  !"!"!!! 

        =  −3.75 WHICH IS RELATIVELY ELASTIC SO WE ACTUALLY MAKE MORE REVENUE IF WE REDUCE THE PRICE 𝑊𝐻𝐸𝑁 𝑃  =  5,    𝑅  = 𝑄 ∗ 𝑃  =  40  ∗  5      =  200 𝑊𝐻𝐸𝑁 𝑃  = 4 𝑅  = 𝑄 ∗ 𝑃  =  70  ∗  4      =  280 ∆R  = 280 –  200         =  80 THIS IS A DISPROPORTIONATE INCREASE IN REVENUE FROM SUCH A SMALL CHANGE IN PRICE, PROVING THAT THE GOOD IS RELATIVELY PRICE ELASTIC 3) GIVEN CASE 2 TABLE, CALCULATE PRICE ELASTICITY

• •

𝜀!,! =  𝑄1 − 𝑄0𝑄0

∗100𝑃1 − 𝑃0𝑃0

∗100

         =  !" ! !"!"! ! !!

 =  !!"!!! 

        =  −0.125 WHICH IS RELATIVELY INELASTIC

PRICE 5 4 Q UNITS 40 70

PRICE 5 4 Q UNITS 40 41

INELASTIC 

ELASTIC 

INFINITELY 

-1 = UNIT  

Q PERFECT 0 

‐∞ 

REPRESENTATION OF ALL ELASTIC IT IES :

 

IN CASE 2, WE ACTUALLY LOSE REVENUE IF WE REDUCE THE PRICE 𝑊𝐻𝐸𝑁 𝑃  =  5,    𝑅  = 𝑄 ∗ 𝑃  =  40  ∗  5      =  200 𝑊𝐻𝐸𝑁 𝑃  = 4 𝑅  = 𝑄 ∗ 𝑃  =  41  ∗  4      =  164 ∆R  = 164 –  200         =  − 38 THIS RESULTS IN A LOSS IN REVENUE FROM THE CHANGE IN PRICE, PROVING RELATIVE INELASTICITY

THEORY OF THE F IRM

THIS IS THE BRANCH OF MICROECONOMICS LOOKING AT THE PRODUCER ASPECT OF THE MARKET. WE ASSUME THESE SEVEN FACTORS IN THE THEORY OF THE FIRM:

1) LARGE NUMBER OF BUYERS AND SELLERS SO NO INDIVIDUAL BUYER/SELLER CAN INFLUENCE THE PRICE OF THE GOOD THUS EACH BUYER/SELLER IS A PRICE TAKER

2) FREE ENTRY AND EXIT 3) PERFECT MOBILITY OF FACTORS OF PRODUCTION 4) PRODUCT HOMEGENEITY SUCH THAT ALL PRODUCTS ARE CLONES 5) EACH FIRM WANTS TO MAKE THE MOST PROFIT: PROFIT MAXIMISATION 6) FREE FLOW OF INFORMATION IN THE MARKET 7) CERIS PARIBUS MEANS HOLDING ALL OTHER FACTORS CONSTANT 8) ALL FIRMS ARE IDENTICAL

TIME PERIOD

• SHORT RUN IS A PRODUCTION PLANNING PERIOD WHERE AT LEAST ONE FACTOR IS HELD FIXED

• LONG RUN ON THE OTHER HAND HAS ALL FACTORS AS VARIABLE MARKET STRUCTURE LAYS OUT THE RULES OF OPERATION FOR CONSUMERS AND SUPPLIERS IN A MARKET:

PRODUCTION IS THE CONVERSION OF INPUT INTO OUTPUT TO SATISFY CUSTOMER WANT/NEEDS. THERE ARE FOUR FACTORS OF PRODUCTION LAND, LABOUR, CAPITAL AND ENTREPRENEUR.

CAPITAL IS THE PRODUCTIVE ASSET USED FOR THE PRODUCTION OF GOODS AND SERVICES THAT LASTS MORE THAN ONE YEAR. HUMAN CAPITAL IS LABOUR, HEALTH AND INTELLECTUAL CAPITAL EG TWO-FACTOR MODEL OF THE FIRM HAS ECONOMIC PROFITS AS

Π = 𝑃𝑄  −  𝑤𝐿 – 𝑟𝐾 wL - WAGE RATE x LABOUR rK - RENTAL PRICE x CAPITAL ACCOUTING COST IS THE CASH OUTFLOW IN THE PRODUCTION PROCESS OPPORTUNITY COST IS FORGONE ALTERNATIVES ECONOMIC COST IS OPPORTUNITY COST FIXED COSTS (TFC) EXAMPLES:

1) SALARIES OF ADMIN STAFF 2) DEPRECIATION (WEAR AND TEAR OF MACHINERY) 3) EXPENSES FOR BUILDING DEPRECIATION AND REPAIRS 4) EXPENSES FOR LAND MAINTENANCE AND DEPRECIATION (THE VALUATION OF THE GOOD

REDUCES AS IT AGES) VARIABLE COSTS (TVC) EXAMPLES:

1) COST OF RAW MATERIALS 2) COST OF DIRECT LABOUR 3) RUNNING EXPENSES OF FIXED CAPITAL SUCH AS FUEL, ORDINARY REPAIRS AND ROUTINE

MAINTENANCE TOTAL REVENUE OR REVENUE

𝑇𝑅  =  𝐴𝑅 ∗  𝑄 𝑇𝑅  =  𝑃 ∗  𝑄

TOTAL COST OR COST

𝑇𝐶  =  𝐴𝐶 ∗  𝑄  𝑇𝐶  =  𝑇𝐹𝐶  +  𝑇𝑉𝐶

AVERAGE COST

𝐴𝐶  =   !"!

 !"!=   !"#

! +  !"#

!

𝐴𝐶  =  𝐴𝐹𝐶  +  𝐴𝑉𝐶

AVERAGE VARIABLE COST

𝐴𝑉𝐶  =   !"#!

AVERAGE FIXED COST

IMPERFECT PERFECT - COMPETITIVE MARKET  - MONOPOLY

- MONOPOLISTIC COMPETITION - MONOPSONY - OLIGOPOLY - OLIGOPSONY 

𝐴𝐹𝐶  =   !"#!

MARGINAL COST

𝑀𝐶  =   ∆!"!!

= !"#!!

MARGINAL REVENUE

𝑀𝑅  =   ∆!"!!

= !"#!!

THERE ARE THREE PROFITS IN ECONOMICS:

• ZERO ECONOMIC PROFITS IS WHEN TOTAL REVENUE = TOTAL COST

• NORMAL ECONOMIC PROFITS IS

REVENUE – ACCOUNTING COST – OPPORTUNITY COST

• SUPERNORMAL PROFITS IS (AR - AC)*QE WE ASSUME THAT A FEW FIRMS START OUT THE INDUSTRY. SO INITIALLY DEMAND OUTDOES SUPPLY AND THERE IS AN INCREASE IN PRICE. THIS EXCESS ENSUES A PROFIT CALLED SUPERNORMAL PROFIT. WHICH INDUCES MORE MARKET ENTRY IN THE LONG RUN SUCH THAT COMPETITION AND MORE OUTPUT IN THE MARKET CAUSES THIS PROFIT TO REDUCE INTO NORMAL PROFITS

PROFIT IS DEFINED AS

𝛱(𝑄)  =  𝑇𝑅(𝑄)  −  𝐶(𝑄)  PROFIT MAXIMISING OUTPUT

𝛥𝛱(𝑄)  =  0                 = ∆𝑅(𝑄)  −  ∆𝐶(𝑄)  =  0                   =  𝑀𝑅 –𝑀𝐶  =  0   ⇒  𝑀𝐶  =  𝑀𝑅

THE PROFIT MAXIMISING OUTPUT LEVEL IS AT THE POINT WHERE MR = MC AND IT ALWAYS HOLDS IN ALL MARKETS, PERFECT AND IMPERFECT SHORT RUN VS LONG RUN, PERFECTLY COMPETIT IVE MARKET (DIFFERENT RULES APPLY FOR A MONPOLY) A PERFECTLY COMPETITIVE MARKET IN THE SHORT RUN MAKES SUPERNORMAL PROFIT, BUT IN THE LONG RUN MAKES NORMAL PROFITS. WE TAKE AS GIVEN THAT EVERY BUISINESS ENTERPISE AT START UP HAS A GESTATION PERIOD. SO IN THE SHORT RUN WE HAVE BOTH FIXED AND VARIABLE COSTS.

THE TOTAL COST FUNCTION- TC(Q), AS WE KNOW IT IS ACTUALLY THE SHORT-RUN COST FUNCTION BECAUSE IN THE LONG RUN THE FIXED COSTS DISAPPEAR AND ALL COSTS BECOME VARIABLE. LAW OF DIMINISHING MARGINAL RETURNS: IN THE SHORT RUN WHEN AT LEAST ONE FACTOR OF PRODUCTION IS HELD FIXED, THERE WILL COME A POINT WHERE ADDITIONAL OUTPUT PRODUCED BY A VARIABLE FACTOR WILL BEGIN TO DIMINISH SHORT RUN GRAPH

• THE MC CURVE PASSES THROUGH THE MINIMUM POINT OF THE AC CURVE (IT’S TAKEN AS A GIVEN THAT THE AVERAGE COST, AC GRAPH IS A U-SHAPED PARABOLA)

• AS A FIRM FIRST OPENS, SUPERNORMAL PROFIT IS MADE BY A PERFECTLY COMPETITIVE MARKET IN THE SHORT RUN AND IT IS THE SHADED RECTANGLE = (AR-AC)QE

• AT THE POINT WHERE QE LINE HITS THE AVERAGE COST CURVE, THEN TRACE IT BACK AND THAT BECOMES THE SUPERNORMAL PROFIT

• MC CUTS THE AC IN THE LOWEST POINT BY THEOREM (PROOF **) IN SHORT RUN • NOTE THAT P = MR = AR = D • AT THE POINT WHERE THE QE LINE TOUCHES THE CURVE IS THE INDUSTRY OUTPUT LEVEL.

SO IF FIRM SELLS AT P ≤ PE, IT MAKES A LOSS. BUT IF P ≥ PE THEN QUANTITY SOLD IS ZERO

• ALSO IN THE SHORT RUN, THE SUPPLY CURVE HAS TO DO WITH FIRMS AND PRODUCERS

**PROOF: MC CUTS THE AC IN THE LOWEST POINT (SEE IMAGE ABOVE)

• THE AVERAGE COST IS THE PRICE OF EACH UNIT FOR THE SOLD OUTPUT, WHILE THE MARGINAL COST IS THE PRICE FOR THE NEXT UNIT

• WHEN THE AVERAGE COST IS ONLY INCREASING, ITS DUE TO THE MARGINAL COST INCREASING, THEN MR > AC . THE LOGIC IS THAT WHEN THE MEAN VALUE INCREASES ITS AS A RESULT OF THE BORDER VALUES INCREASING

AC  

MC  

MR = AR = P = D   P  

qe  

• IF THE MARGINAL COST IS ONLY DECREASING THEN THE AVERAGE COST IS ALSO REDUCING, AS A RESULT AC < MC. THE LOGIC IS THAT WHEN THE MEAN DECREASES ITS AS A RESULT OF THE BORDER VALUES DECREASING

• THUS WHEN THE AVERAGE COST IS AT THE LOWEST POINT MC = AC SATC- SHORT-RUN AVERAGE TOTAL COST SMC- SHORT-RUN MARGINAL COST SVC- SHORT-RUN VARIABLE COST SMC GRAPH (ALSO A GIVEN) MUST CUT THE SATC AND SVC AT THE LOWEST POINT INDUSTRY THE INDUSTRY IS THE TOTAL NUMBER OF FIRMS OPERATING IN A PARTICULAR MARKET OR COMBINATION OF ALL FIRMS PRODUCING SIMILAR GOODS AND SERVICES IMRPORTANT RESULTS:

1. SO IF THERE ARE n FIRMS IN THE INDUSTRY THEN WE HAVE:

2. TOTAL MARKET OUTPUT 𝑄  =  𝑄! +  𝑄!  +  𝑄!  +  …+  𝑄!  =   𝑄!!! ! !

3. EQUILIBRIUM IS THE PRICE (PE) AND QUANTITY (QE) WHERE THE SUPPLY AND DEMAND

CURVES MEET SO THAT 𝑄!(𝑃)  = 𝑄!(𝑃) AND 𝑃!(𝑆)  = 𝑃!(𝑄)

 

(THE PRICE AT WHICH INDUSTRY SELLS IS THE SAME PRICE THAT ALL FIRMS MUST SELL WHICH IS THE PRICE-TAKING PROPERTY. THUS, FIRM PRICE FOR THE n FIRMS IS THE PRICE SET BY THE MARKET AND THE UNDERSTANDING IS THAT DUE TO FREEDOM OF INFORMATION AND THE CONSUMERS EASE OF ACCESS, IF ANY ONE FIRM CHOOSES TO INCREASE PRICE BY ONE UNIT THERE WILL BE ZERO DEMAND) INDUSTRY VS F IRM SUPPLY AND COST CURVES NOTE, WE DO NOT ASSESS THE REVENUE ASPECT OF THE SUPPLY BUT THE COST ASPECT

RESULTS:

• IN A PERFECTLY COMPETITIVE MARKET MR = P BECAUSE THE REVENUE FROM ONE EXTRA UNIT IS THE REVENUE FROM ANY ONE UNIT AND IT IS THE SAME AS PRICE SET BY THE MARKET THUS: 𝐴𝑅  =  𝑃  =  𝐷 I.E. PRICE PER UNIT 𝐴𝑅  =  𝑀𝑅  =  𝑃  =  𝐷

• ALSO PROFIT IS Π  =  𝑃𝑄 − 𝑇𝐶 WITH 𝑇𝐶 =  𝑇𝐹𝐶 + 𝑇𝑉𝐶

THEN Π  =  𝑃𝑄 − 𝑇𝐹𝐶 − 𝑇𝑉𝐶

• THE PROFIT MAXIMISING LEVEL OF OUTPUT OCCURS WHEN 𝑀𝐶  =  𝑀𝑅 BUT WE SAW THAT 𝑀𝐶  =  𝑃 GIVES US THE VALUE Q* FOR PROFIT MAXIMISING LEVEL OUTPUT

FIRMS MAY KEEP PRODUCING AS LONG AS 𝑀𝑅  ≥  𝑀𝐶 THE LOGIC BEING THAT AS LONG AS THE REVENUE EARNED FROM THE NEXT UNIT OF OUTPUT IS EQUAL TO OR GREATER THAN THE COST OF PRODUCING IT. SHUTDOWN POINT IS THE PRICE P, WHERE THE FIRM MUST NOW CEASE PRODUCTION. PROOF: IT IS ASSUMED THAT PROFIT MAXIMISING LEVEL IS WHAT WE ARE WORKING AT, SO 𝑄  =  𝑄⋆ THE PROFIT MAX. QUANTITY THE FIRM IS PRODUCING

PE 

Q E 

D  

S 

INDUSTRY

S 

S 

D 

D FIRM 

P  P  

SVC  SATC   

SMC  

𝑃  < 𝐴𝑉𝐶   

SO Π  =  𝑃𝑄⋆ –𝑇𝐹𝐶  − 𝑇𝑉𝐶 𝑇𝑉𝐶  =  𝐴𝑉𝐶 × 𝑄⋆ Π  =  𝑃𝑄⋆ –𝐴𝑉𝐶 × 𝑄⋆–𝑇𝐹𝐶  Π  =   (𝑃 –𝐴𝑉𝐶)𝑄⋆–𝑇𝐹𝐶 

HERE 𝑇𝐹𝐶  IS NEGLIGIBLE TO (𝑃 –𝐴𝑉𝐶)𝑄⋆ 

• IF 𝑃  > 𝐴𝑉𝐶 , (𝑃 –𝐴𝑉𝐶) IS POSITIVE SO THE FIRM IS MAKING PROFIT, SO Π  > 0 (REMEMBER MC = MR= P)

• IF 𝑃  = 𝐴𝑉𝐶 , (𝑃 –𝐴𝑉𝐶) IS ZERO THEN Π  =  −𝑇𝐹𝐶 , BUT FIRM CAN STILL CONTINUE PRODUCING EVEN THOUGH FIRM NOT MAKING ECONOMIC PROFIT

• BUT WHEN 𝑃  < 𝐴𝑉𝐶 , (𝑃 –𝐴𝑉𝐶) IS NEGATIVE THIS IS THE SHUT DOWN POINT AS Π  <  0. THE PRODUCTION MUST STOP AT THIS POINT

MARKET SUPPLY THE QUANTITY IN EQUILIBRIUM FOR THE INDUSTRY IS THE SUM OF ALL THE QUANTITIES PER FIRM SHOWN PREVIOUSLY, AND WE ASSUME THAT EACH FIRM IS IDENTICAL, SO

𝑄! =   𝑄𝑛

THE COST STRUCTURE FOR EACH FIRM IS SIMILAR AND LINEAR, WITH 𝜇 A CONSTANT 

𝑀𝐶! =   𝜇 𝑄!

TOTAL REVENUE AND TOTAL COST GRAPH FOR EACH FIRM

LONG RUN AN ASSUMPTION IS THERE ARE FEW FIRMS INITIALLY AND THEN THE PROFIT (MARK-UP) ATTRACTS MORE SO THE MARKET SHARE FOR EACH FIRM IS REDUCED IN THE LONG RUN THE AC CURVE GETS FLATTER AND THERE ARE MORE FIRMS IN THE INDUSTRY LEADING TO GREATER TOTAL OUTPUT FOR THE INDUSTRY AND A DECREASE IN OUTPUT PER FIRM AS THE MARKET PRICE REDUCES THE LONG RUN PROFIT POSITION FOR THE PERFECTLY COMPETITIVE MARKET IS

𝑇𝑅(𝑄)  =  𝑇𝐶(𝑄) 𝛱(𝑄) = 𝑇𝑅(𝑄)  −  𝑇𝐶(𝑄)  =  0

IN THE LONG RUN THE AC CURVE IS NOW FLATTER.

MONOPOLY A MONOPOLY IS THE SINGLE SELLER FOR A PRODUCT OR THE ONLY PRODUCER, WHICH HAS NO CLOSE SUBSTITUTES, AND THERE ARE ENTRY BARRIERS TO THE MARKET.

MC  AC  

Pe 

qe  

1ST 2ND 3RD 4TH 

Pe 

qe  

S1 

S2 

P2  

LAC = LMC 

q2

TR  

TC  LOSS 

LOSS 

PROFIT 

P1  

P2  

Q 1,2  

LMC  LAC

P1 = AR1 = D 1  

P2 = AR2 = MR 2 =D 2  

A MONOPOLY CANNOT INFLUENCE BOTH PRICE AND QUANTITY AT THE SAME TIME. THE MONOPOLY CAN CHOOSE TO INCREASE PRICE AND THE CONSUMER WILL REDUCE QUANTITY DEMANDED OR IT CAN REDUCE PRICE AND THE CONSUMER WILL INCREASE THE QUANTITY DEMANDED. THE MONOPOLIST IS THE MARKET. SO THE INDUSTRY = MONOPOLY. THEY ARE NOT PRICE-TAKERS. FACTORS THAT SUSTAIN A MONOPOLY ARE:

• ARTIFICAL BARRIERS EXTERNAL OR CONSTRUCTED BY THE MONOPOLY. FOR EXAMPLE A GOVERNMENT MAY ENSURE AN INVENTOR HAS EXCLUSIVE RIGHTS TO PRODUCE A GOOD BY ALLOCATING PATENTS

• EG. ROCKERFELLER, OWNER OF STANDARD OIL CREATED BARRIERS TO ENTRY BY DELIBERATELY SHUTTING DOWN OTHER COMPETITORS USING PRICING TECHNIQUES. HE HAD THE FINANCING FOR IT AND SUPPORT FROM THE GOVERNMENT

• HETEROGENOUS GOODS FOR EXAMPLE APPLE HAS CLOSED OUT THE TECH MARKET BY THEIR PRODUCT INNOVATION

• ADVERTISING COSTS CAN BE CHEAPER FOR LARGER SCALE PRODUCTION ECONOMIES OF SCALE (WHICH IS NOT ALWAYS TRUE) SAYS THAT FIRMS CAN SPREAD THEIR COST OVER AN INCREASED OUTPUT MONOPOLIST CHOICE VARIABLE IS Q. AS REVENUE IS P*Q. IF THEY CHOOSE Q, THEY WILL ALLOW THE MARKET DEFINES THE PRICE FOR THEM TO SELL ALL THEIR Q (NOTE THAT PRICE AT ANY TIME IS DEPENDENT ON THE QUANTITY IT WILL TURN OUT THAT THEY CAN ALSO CHOOSE P AND THE EFFECT WILL BE IDENTICAL) A MONOPOLIST GIVES THE MARKET THE OPTION FOR DECIDING WHAT THEIR PRICE IS SO THIS MEANS

𝑃  =  𝐷 AS PREVIOUSLY SHOWN, PROFIT MAXIMISING OUTPUT LEVEL: 𝛱(𝑄) = 𝑅(𝑄)  −  𝐶(𝑄) WHERE THE MAX. POINT EXISTS                           𝛥𝛱(𝑄)  =  0  ⟹ ∆𝑅(𝑄)  −  ∆𝐶(𝑄)  =  0    ⟹                 𝑑𝑅𝑑𝑄  −  

𝑑𝐶𝑑𝑄  =  0   

⟹               𝑀𝑅 –𝑀𝐶  =  0   ⇒                           𝑀𝐶  =  𝑀𝑅  THIS CONDITION HOLDS FOR THE DIFFERENT KINDS OF MARKETS FOR THE MONOPOLY, WE USE THE INVERSE DEMAND FUNCTION. WHEREAS FOR A COMPETIVE MARKET:

𝑄  =  𝑎 – 𝑏 𝑃

FOR A MONOPOLY WE HAVE: 𝑃  =  𝑐  +  𝑑𝑄

𝑇𝑅  =  𝑃(𝑄)  ∗  𝑄 𝑇𝑅  =   (𝑐  +  𝑑𝑄) ∗  𝑄                          =  𝑐𝑄  +  𝑑𝑄! TO CALCULATE AR:

𝐴𝑅  = !"! = !" ! !"!

!

𝐴𝑅  = 𝑐  +  𝑑𝑄  =  𝑃 THUS WE HAVE SHOWN, FOR A MONOPOLY:

𝐴𝑅  =  𝑃 TO CALCULATE MR:

!"#!"

 =   !!"

𝑐𝑄  +  𝑑𝑄2

𝑀𝑅  =  𝑐 +  2𝑑𝑄 UNLIKE THE PERFECTLY COMPETITIVE MARKET WHERE AR = MR, FOR THE MONOPOLY WE HAVE:

𝑀𝑅  ≠  𝐴𝑅 𝑐 +  2𝑑𝑄  ≠  𝑐  +  𝑑𝑄

SO THE SLOPE OF THE MARGINAL REVENUE CURVE IS TWICE THE SLOPE OF THE AVERAGE REVENUE CURVE. THIS ALWAYS HOLDS. TO HELP DETERMINE THE PRICE FOR THE MONOPOLY, WE MUST FIND THE RELATIONSHIP BETWEEN PRICE ELASTICITY OF DEMAND, PRICE AND MARGINAL REVENUE ETC FIRST OF ALL: WE DEFINE PRICE ELASTICITY OF DEMAND AS

 𝜀𝑃  =   !"!" ∗  !

!

𝜀! ∗ 𝑄 =    𝜕𝑄𝜕𝑃 ∗  𝑃

!!∗𝑄 !

=    𝜕𝑄𝜕𝑃 

∴   𝜕𝑃𝜕𝑄 =

𝑃 !!∗!

  

MR  AR 

q0  q0 

THIS INVERSE DEMAND DEIVATIVE CAN BE UTILISED BELOW:

𝑇𝑅  =  𝑃(𝑄)  ∗  𝑄

!"#!"

= 𝑃 ∗  !"!" +  𝑄 ∗   !"

!" 

∴ 𝑀𝑅 = 𝑑𝑇𝑅𝑑𝑄  =  𝑃  +  𝑄 ∗   𝑑𝑃𝑑𝑄

𝑀𝑅 =  𝑃  +  𝑄 ∗   𝑃𝜀∗𝑄 (USE THE INVERSE ELASTICITY FUNCTION TO SUBSTITUTE)

𝑀𝑅  =  𝑃  +  1𝜀 𝑃

𝑀𝑅  =  𝑃 ∗ 1  +  1𝜀 USING MR DEFINED ABOVE, WE CAN HAVE THE FOLLOWING FOR THE PROFIT MAXIMISATION FUNCTION, WHEN MR = MC:

𝑀𝑅  =  𝑃 ∗ 1  +  1𝜀

𝑀𝐶  = 𝑀𝑅  =  𝑃 ∗ 1  +  1𝜀

𝑀𝐶  =  𝑃 ∗ 1  +  1𝜀 TYPES OF MONOPOLY A MONOPOLIST HAS CHOICE VARIABLES THAT ARE ENDOGENOUS VARIABLES. PURE/ NATURAL MONOPOLY, WHICH IS THE CASE ALREADY, COVERED. ONE SUPPLIER, ONE PRICE FOR ALL MARKETS, ONE PLANT ETC. NON-DISCRIMINATING MONOPOLY IS ONE IN WHICH THE MONOPOLIST SELLS GOODS AT ONE PRICE TO THE MARKET A MONOPSONY IS MONOPOLY ON THE DEMAND SIDE. IT’S WHERE ONE BUYER SINGLE-HANDEDLY DOMINATES THE MARKET FOR EXAMPLE GOVTS. CAN BE THE SINGLE BUYER OF ESSENTIAL COMMODITIES LIKE ETHANOL MONOPOLISTIC COMPETITION HAS PROPERTIES OF THE PERFECT COMPETITION AND MONOPOLY MULTI-PLANT MONOPOLY HAS DIFFERENT PLANTS THAT HAVE MULTIPLE COST FUNCTIONS, BUT THE PRICE STAYS CONSTANT ACROSS THE MARKET. LIKE UNILEVER WITH A PACKAGING PLANT IN LONDON AND MANUFACTURING PLANT IN EXETER, EACH PLANT HAS A UNIQUE OUTPUT FOR A MULTI-PLANT, PROFIT IS DERIVED:

IF 𝑅  =  𝑃𝑄

𝑄  =  𝑄!  +  𝑄! 𝐶  =  𝐹(𝑄) Π  =  𝑃(𝑄!  +  𝑄!) –  𝐶(𝑄!  +  𝑄!)      =  𝑃𝑄!  +  𝑃𝑄! –𝐶𝑄! −  𝐶𝑄! 

GET MAXIMUM PROFIT BY PARTIAL DIFFERENTIATION WRT   !"!!!

  , !"!!!

DISCRIMINATING MONOPOLY THE MONOPOLIST SELLS GOODS AT DIFFERENT PRICES TO DIFFERENT CONSUMERS (PRICE DISCRIMINATING). ALTHOUGH THE PRICE FUNCTIONS ARE DIFFERENT FOR THE DIFFERENT CONSUMERS; THE COST FUNCTION STAYS THE SAME

• FIRST DEGREE INVOLVES CHARGING THE CUSTOMER HIS RESERVATION PRICE CAUSING THE PRICES IN A MARKET TO VARY FOR DIFFERENT CONSUMERS. SO ‘MARKET A’ FOR THE GOODS IS DIFFERENT FROM ‘MARKET B’ AND THERE MAY BE REASONS FOR SUCH A STRATEGY FROM THE PRODUCER. E.G.

- GEOGRAPHICAL LOCATION: ‘MARKET A’ MAY BE CLOSER TO RAW MATERIALS WHICH AFFECTS TRANSPORTATION COSTS AND ‘MARKET B’ MAY BE FARTHER.

- INCOME: ‘MARKET A’ MAY BE POPULATED BY PEOPLE OF HIGHER INCOME AND ‘MARKET B’ NOT SO MUCH

HERE 𝑃 >  𝑀𝐶! THE PRODUCER CONTINUES TO SUPPLY UNTIL 𝑃  = 𝑀𝐶! THE MARGINAL REVENUE CONCEPT IS OBSOLETE IN THIS CASE BECAUSE IT IS NOT ALWAYS UNIFORM AND PRICES ARE CHARGED ON DISRETIONARY BASIS FOR EXAMPLE THE OBSERVATION OF THE MARKET SEPARATION OF MARKET: A MARKET IS THE PLACE, MEDIUM OR CHANNEL THAT BRINGS BUYERS AND SELLERS TOGETHER. AN EXAMPLE OF PRICE DISCRIMINATION IS THE UNI OF EXETER WHERE DIFFERENT MARKETS EXIST BETWEEN LECTURERS AND STUDENTS IN THE FORM OF STUDENT DISCOUNT CONSUMER SURPLUS IS THE DIFFERENCE BETWEEN THE AMOUNT THE CONSUMER IS WILLING TO PAY AND WHAT HE ACTUALLY PARTS WITH. FOR EXAMPLE IF I WAS WILLING TO PAY £2 FOR WATER AND THEN I GO TO TESCO AND ONLY HAVE TO PAY 50P, THERE IS A CONSUMER SURPLUS OF £1.50 THE CORROLARY APPLIES FOR PRODUCERS REGARDING THE PRODUCER SURPLUS

• WHEN THE PRODUCER GETS MORE THAN WHAT HE EXPECTED FROM THE CONSUMER, THE EXCESS IS THE PRODUCER SURPLUS

• SIMILARLY, IN UPWARD INTEGRATION TOWARDS THE SUPPLY CURVE, WHEN THE PRODUCER PAYS LESS FOR THE RAW MATERIAL, AND IS PRODUCING A UNIT AT LOWER THAN EXPECTED

FOR SOME ECONOMISTS A COMPETITIVE MARKET FINDS THE BEST PRICE. THIS GUIDES COMMODITY PRICING AND DERIVATIVES. FOR OTHERS NOT SO MUCH DUE TO THE TENDENCIES OF MONOPOLIES

TO OVERWHELM THE MARKET AND FOR CERTAIN LESS PROFITABLE NECESSITY MARKETS TO BE SNOBBED; MAYNARD KEYNES SAID THAT CAPITALISM RULING THE ECONOMY WITHOUT GOVT. INTERVENTION (FREE MARKET) WILL BE AT A DETRIMENT TO SOCIETY SOC IAL COSTS OF MONOPOLY MONOPOLIES ARE USUALLY DEALING WITH NECESSITIES AND NORMAL GOODS. LIKE ELECTRICITY, TELEPHONE LINES AND GAS. GOOD EXAMPLES ARE STANDARD OIL (ROCKERFELLER) AND TESCO TO SOME EXTENT SOCIAL COSTS INCLUDE BOTH MONETARY COST (THIS IS THE ISSUE OF DEAD WEIGHT LOSS) AND OTHER LOSSES. IT CAN LEAD TO DEATH AND REVOLUTIONS. TAX AND GOVT. EXPENDITURE WHO SHOULD AND WHO EVENTUALLY PAYS THE TAX AND WHAT IS THE MOST EFFICIENT WAY OF DOING THIS? PRODUCERS VS CONSUMERS THE IMPART OF SUBSIDIES SUBSIDY IS GIVEN FOR NECESSITY AND NEEDS. FOODS, CLOTHING AND SHELTER. THERE ARE SOME THINGS THAT ARE MORE PROFITABLE THAT PPL WILL GO INTO RATHER THAN A NECESSITY. SO FOR EX. THE GOVT MAY SUBSIDISE THE HEATING OF SOME HOMES. PRICES CAN BRING ABOUT DISRUPTIONS IN THE MARKET.. LUXURIOUS AND NORMAL GOODS. THERE IS A DIFFERENCE BETWEEN NEEDS (NORMAL) AND WANTS (LUXURIOUS). FREE MARKETS DON’T ALWAYS BRING ABOUT EFFECTIVE PRICE ALLOCATION. HENCE THE LORENZ CURVE AND GINI COEFFICIENT, WHICH TRY TO INDUCE EGALITARIANISM TO BRIDGE THE GAP BETWEEN THE RICH AND THE POOR. ALSO, THE GDP MAY BE SKEWED TO THE UPPER CLASS OF SOCIETY. THEN OVER 70% MAY LIVE BELOW THE POVERTY LINE. SO GOVT INTRODUCES MINIMUM WAGE, BUT IT’S EFFECT IS ALWAYS CONTEXT-TIED AND NOT JUST SIMPLE EXAMPLE PINDYCK AND RUBENFELD PG 430, QUES 5

𝑃!  =  15 − 𝑄!  𝑃!  =  25 − 2𝑄! 𝑀𝑅!  =  15  − 2𝑄! 𝑀𝑅!  =  25 − 4𝑄!  𝐶  =  5  +  3𝑄!  +  3𝑄!

SOLUTION • DISCRIMINATING MONOPOLY

𝑀𝐶! =  𝜕𝐶𝜕!!

 =  3

𝑀𝐶! =  𝜕𝐶𝜕!!

 =  3

AT PROFIT MAXIMISING LEVEL OUTPUT, 𝑀𝑅  =  𝑀𝐶  SO 25  −  4𝑄! = 3 25  −  3  = 4𝑄! 22 = 4𝑄! 𝑄!  =  5.5,  𝑃! = 14

 3 =  15 – 2𝑄! 2𝑄!  =  12 𝑄! =  6,𝑃! = 9

WE CALCULATE PROFIT USING 𝛱(𝑄)  =  𝑃 ∗ 𝑄 –  𝐶

 Π!  =  15𝑄! –  𝑄!

! –  5  −  3𝑄!  − 3𝑄!  =  14.5 Π!  =  25𝑄! − 2𝑄!

! − 5 − 3𝑄! − 3𝑄!  =  37.5 TOTAL PROFIT

Π! + Π!  =  $52

• NON-DISCRIMINATING MONOPOLY 𝐶  =  5  +  3(𝑄!  +  𝑄!) THE NON-DISCRIMINATING MARKET MEANS 𝑄 = 𝑄!  +  𝑄! SO 𝐶 =  5 + 3𝑄

𝑄! = 15 −  𝑃! AND 𝑄! =!"!!!!

FROM THE GIVEN VALUES FOR PRICE

𝑄! + 𝑄! =  15 −  𝑃! +!"!!!!

= 15 + !"!− 𝑃! −

!!!

SO 𝑄 = 15 + !"!− 𝑃! −

!!!

SIMILARLY 2𝑄!  =  15 –𝑀𝑅! 𝑄!  =  

!"! –  !"! 

!

𝑄!  =  7.5  − 0.5𝑀𝑅! 4𝑄!  =  25 –𝑀𝑅! 𝑄!  =  6.25  − 0.25𝑀𝑅!

 𝑄 =  7.5 –  0.5𝑀𝑅!  +  6.25 –  0.25𝑀𝑅! ADDING THE 𝑀𝑅! +𝑀𝑅! = 𝑀𝑅 𝑄 = 13.75  − 0.75𝑀𝑅  0.75𝑀𝑅  =  13.75 − 𝑄

SO

𝑀𝑅  =   !".!"!.!"

− !!.!"

𝑄

TOTAL REVENUE IS AN INTEGRAL OF MR OR A PRODUCT OF PQ 𝑃!  =  15 –  𝑄!  𝑃!  =  25  − 2𝑄! 𝑃 = 𝑃! +  𝑃!  =  15 + 25 –  3𝑄  𝑇𝑅 =  40𝑄  − 3𝑄!

𝑇𝑅  =   !!!𝑄 –  !

!𝑄!

Π =   !!!𝑄 –   !

!𝑄!  − 5 − 3𝑄

!!!"=   !!

! –  !

!∗ 𝑄 –  3 =  0

18 !! –  1 !

!∗ 𝑄 –  3  =  0

15 !!  =  1 !

! ∗ 𝑄

𝑄 =  15 !!  ÷  1 !

! 

𝑄 =   !"!∗ !!= 11.5

PLUG Q BACK INTO TR AND TC:

𝑇𝑅 =  122.166 𝑇𝐶 =  39.5 ∴ Π = 𝑇𝑅 − 𝑇𝐶 =  $83.17 𝑃 = 10.666

RESULT SHOWS THAT PROFIT W/O DISCRIMINATION IS GREATER THAN PROFIT WITH DISCRIMINATION CONSUMER SURPLUS PE IS THE AMT THAT SUPPLY EQUALS DEMAND LOST CONSUMER SURPLUS IS ALSO PRODUCER SURPLUS. SO AT EQUILIBRIUM WE HAVE

EFFICIENCY IN THE COMPETITIVE MARKET IS DETERMINED THROUGH CONSUMER AND PRODUCER SURPLUS. IN THE COMPETITIVE MARKET WE TRY TO FIND THE BEST PRICE. PRICE CEILING IS MANDATING A MAXIMUM SELLING PRICE THAT IS BELOW THE EQUILIBRIUM PRICE PRICE FLOOR IS MANDATING A MINIMUM SELLING PRICE THAT IS ABOVE THE EQUILIBRIUM PRICE IF THE GOVT OR PLANNER SETS A MINIMUM PRICE THIS MEANS EXPENSIVE, BUT MAXIMUM PRICE MEANS IT IS CHEAP DEAD WEIGHT LOSS RENT SEEKING BEHAVIOUR MEANS SPENDING EXCESSIVE MONEY TO GAIN UNDUE BUSINESS ADVANTAGE OVER YOUR COMPETITORS THE AMT OF MONEY SPENT USUALLY COMES UNDER ECONOMICS OF CORRUPTION. A MONOPOLIST HAS TO PAY A HUGE PORTION OF THEIR PROFITS TO MAINTAIN A SINGLE-SELLER MARKET, SOMETIMES THROUGH

- ADVERTISING - LOBBYING AND CAMPAIGNS - INTEREST GROUP WITH BANNERS - PICKETTING - BRIBERY

L INEAR EQUATION FOR SUPPLY S IDE OF THE MARKET

𝑄  =  𝑎 − 𝑏𝑃 INVERSE DEMAND FUNCTION (PRICE) 

𝑃  =   !!− !

!𝑄 BUT WE CAN JUST FOR EASE OF NOTATION DENOTE 𝑃  =  𝑎 − 𝑏𝑄

WHEN THERE ARE MULTIPLE FIRMS, SAY n FIRMS, THEN EACH FIRM HAS

𝑄!  =  !! WHERE 𝑖 INDEXES INDIVIDUAL FIRMS {1,…   , 𝑛}

THUS TOTAL COST FOR EACH FIRM IS

!! ∗𝑀𝐶  =  𝜇𝑄 FOR SOME CONSTANT 𝜇 ASSUMING WE HAVE A LINEAR COST FUNCTION

 𝑀𝑅  =  𝑀𝐶!

FOR THE PERFECTLY COMPETITIVE MARKET, PRICE IS EQUAL TO MARGINAL REVENUE SO,

𝑎 − 𝑏𝑄 = !"! 

𝑛(𝑎 − 𝑏𝑄)  =  𝜇𝑄 𝑎𝑛 − 𝑏𝑛𝑄  =  𝜇𝑄 𝑎𝑛 = 𝜇𝑄 + 𝑏𝑛𝑄 𝑎𝑛 = 𝑄(𝜇 + 𝑏𝑛) 𝑄 = !"

!!!"

Q E 

PE 

CONSUMER SURPLUS 

PRODUCER SURPLUS 

DWL = 0  

 𝑀𝐶 = !"

! + 𝑇

!"! + 𝑇 = 𝑎 − 𝑏𝑄

(𝑀𝑈 ∗ 𝑄 + 𝑁𝑇)/𝑁  =  𝐴 − 𝐵𝑄 𝑁(𝐴 − 𝐵𝑄)  =  𝑈𝑄 + 𝑁𝑇 𝐴𝑁 − 𝐵𝑁𝑄  =  𝑈𝑄  + 𝑁𝑇  𝐴𝑁 − 𝑁𝑇  =  𝑈𝑄  +  𝐵𝑁𝑄  𝑁(𝐴 − 𝑇)  =  𝑄(𝑈  +  𝐵𝑁)  𝑄  = 𝑁(𝐴 − 𝑇)/(𝑈 + 𝐵𝑁) 

  

 

THE IDEAL QTY THE MARKET ACTUALLY REQUIRES IS Q1 BUT BECAUSE THE MANUFACTURER WANTS TO SELL HIS PRODUCTS AT A HIGHER PRICE, HE SKEWS THE MARKET EQUILIBRUIM TO SELL QO UNITS AT P0. THERE IS A SHORTAGE AS A RESULT ESPECIALLY IF THIS IS A MONOPOLIST. CONSUMER THEORY IN MICRO THERE IS CONSUMER THEORY AND THEORY OF THE FIRM. UTILITY IS DEFINED AS THE SATISFACTION CONSUMERS DERIVE FROM GOODS AND SERVICES UTILITY FUNCTION MEASURES THE AMOUNT OF SATISFACTION THAT A CONSUMER RECEIVES FROM ANY BASKET OF GOODS WHERE 𝑈(𝑋!,𝑋!) WITH X1 GOOD 1 AND X2 GOOD 2. BASKET IS THE COLLECTION OF GOODS /SERVICES THAT AN INDIVIDUAL MAY CONSUME

CHARACTERISTICS/ ASSUMPTIONS OF UTILITY FUNCTION 1) PREFERENCES ARE COMPLETE: SO CONSUMER PREFERS ‘BASKET A’ TO ‘BASKET B’ OR

PREFERS ‘BASKET B’ TO ‘BASKET C’ 2) PREFERENCES ARE TRANSIT IVE I.E. CONSISTENCY OF CHOICE IF BASKET A ≥ BASKET B

AND BASKET B ≥ BASKET C THEN BY INFERENCE BASKET A ≥ BASKET C 3) NON-SATIAT ION: THE MORE THE CONSUMPTION OF GOODS THE BETTER SO THE MORE

GOODS THE MORE UTILITY 4) CONVEXITY : DIMINISHING MARGINAL UTILITY OF ONE GOOD FOR THE OTHER.

SUBSTITUTION OF ONE GOOD FOR THE OTHER. INDIFFERENCE CURVES MEASURE UTILITY, A SINGLE ONE IS A CURVE THE INDIFFERENCE CURVE, BUT A COMBINATION OF TWO OR MORE INDIFFERENCE CURVES GIVES THE INDIFFERENCE MAP TWO OPINIONS EXIST CONCERNING THE MEASUREMENTS OF INDIFFERENCE CURVES. THE CARDINALIST SAYS IT CAN BE MEASURED IN UNITS WHILE THE ORDINALIST SAYS IT SHOULD BE RANKED NOT MEASURED IN CONSUMER THEORY, IF EVERYTHING FROM THE UTILITY FUNCTION IS WELL APPLIED, THE INDIVIDUAL DEMAND CURVE CAN BE DERIVED FROM THE MARGINAL UTILITY CURVE. THIS IS FOR CONSUMER THEORY ONLY AND NOT PRODUCTION THEORY EXAMPLE IF MY MONTHLY INCOME IS £2000, AND I HAVE FOUR CONSUMPTIONS; FOOD, SHELTER, MINISTRY, CHARITY. EACH GOOD HAS UNIT PRICES. THEN EXPENDITURES ARE: (UNIT PRICE FOOD * QTY FOOD) + (UNIT PRICE MINISTRY * QTY MINISTRY) + (UNIT PRICE SHELTER * QTY SHELTER) + (UNIT PRICE CHARITY * QTY CHARITY) ≤ INCOME

Q 0  Q 1 

P0  

P1  

OPTIMAL POINT F- IS WHERE THE BUDGET LINE IS TANGENT TO INDIFFERENCE CURVE 

BUDGET CONSTRAINT IS SHADED AREA 

F  

PLEASE NOTE THAT IN MICRO WE CANNOT HAVE BORROWING. THE ASSUMPTION IS THAT YOU DON’T HAVE ACCESS TO ANY OTHER FUNDS. HENCE THE INEQUALITY. (UNIT PRICE FOOD * QTY FOOD) + (UNIT PRICE MINISTRY * QTY MINISTRY) = INCOME ANOTHER ASSUMPTION IS WE SIMPLIFY THE EQUATION BY REDUCING THE NO. OF GOODS TO TWO. THIS IS CALLED THE TWO-GOOD MODEL. THIS IS THEN GENERALISED AS:

𝑃!𝑋!  +  𝑃!𝑋!  =  𝑌  P1 IS PRICE OF GOOD 1 X1 IS QTY OF GOOD 1 P2 IS PRICE OF GOOD 2 X2 IS QTY OF GOOD 2 BUDGET LINE SHOWS THE AMOUNT OF GOODS THAT AN INDIVIDUAL MIGHT CONSUME IF HE SPENDS ALL OF HIS INCOME ON THE GOODS. HIS EXPENDITURE IS EQUAL TO HIS INCOME

𝑃!𝑋! +  𝑃!𝑋! = 𝑌 BUDGET CONSTRAINT IS NOT THE SAME AS THE BUGET LINE. IT SHOWS THE AMOUNT OF GOODS AN INDIVIDUAL MIGHT CONSUME GIVEN HIS LIMITED INCOME. IT ASSUMES ALL YOUR CONSUMPTION IS EITHER LESS THAN OR EQUAL TO THE BUDGET LINE

𝑃!𝑋! +  𝑃!𝑋! ≤ 𝑌 TO SKETCH THE EQUATION ON A GRAPH WE HAVE X2 ON X-AXIS AND X1 ON THE Y-AXIS USING

𝑋!  = 𝑌𝑃! −  

 𝑃!𝑃!𝑋! 

THE GRAPH OF 𝑋!  = 𝑓(𝑋!) WITH INDIFFERENCE MAP OF UTILITY FUNCTION 𝑈(𝑋!,𝑋!)

THE GRAPH ALSO SHOWS THE THREE ASSUMPTIONS OF THE CONSUMER THEORY - THE FURTHER AWAY FROM THE ORIGIN THE INDIFFERENCE CURVE LIES THE HIGHER THE

UTILITY - CONSISTENCY OF CHOICE IT DOES NOT CROSS. S1 IS DIFF TO S2 - THE CURVES DENOTE THE DIFF LEVELS OF SATISFACTION

AT THIS POINT (WHERE LINES MEET) THE LEVEL OF GOODS OF X1 AND X2 CONSUMED INDIFFERENCE CURVES IS A LOCUS OF POINTS OF A PARTICULAR COMBO OF GOODS THAT YIED THE SAME LEVEL OF SATISTFACTION SO THAT THE CONSUMER IS INDIFFERENT AS TO THE LEVEL OF COMBINATION OF GOODS HE MAKES (2) THERE IS AN IMPLICIT ASSUMPTION IN MICO THAT YOU DO NOT SPEND BEYOND YOUR GIVEN INCOME. SO C IS NOT FEASIBLE THE OPTIMAL POINT IS E, BUT THERE MUST BE AN INDIFFERENCE CURVE THAT MUST BE TANGENTIAL TO THE BUDGET LINE AT POINT E CONTINUITY THE MORE CONSUMED THE HIGHER THE UTILITY NON-SATIATION THE MORE CONSUMED THE BETTER ALL THE 3 INDIFFERENCE CURVES ARE BADLY BEHAVED. GOES AGAINST THE NORM OF CONVENTION IN ECONS ALGEBRA ALONG THE INDIFERENCE CURVE THE UTILITY IS CONSTANT I.E. 𝑈(𝑋!,𝑋!)  =  𝐶𝑂𝑁𝑆𝑇𝐴𝑁𝑇 SO THAT AT POINT A AND B THE UTILITY IS SIMILAR.

C 

A 

B 

XA1

XB1

XC1

XA2 XB2 XC2 X2

X 1 

X 1 

X 2 

BUT THE UTILITY ACROSS THE CURVES DIFFER The CONSUMER STICKS TO MAXIMISED UTILITY, SUBJECY TO HIS BUDGET. IN MICROECONOMICS THE ASSUMPTION IS WEALTH, INCOME AND BUDGET ARE YOUR EANS. BUT IN MACRO ECONOMISC, YOU CAN BORROW. THE CONSUMER SEEMS TO MAXIMISE UTILITY SUBJECT TO HIS INCOME. BUDGET SET IS ALL THE GOODS A MAN CAN BUY IF THE CONSUMER SPENDS ALL OF HIS INCOME BUDGET CONSTRAINT IS THE AMOUNT OF GOODS THAT CAN BE BOUGHT SUBJECT TO LIMITED RESOURCES. IN MATHS TERMS WE USE INEQUALITIES FOR BUDGET CONSTRAINT, WITH RESPECT TO INCOME IN ECONS WE CALL BUNDLES OR BASKETS COLLECTION OF GOODS. ASSUMPTIONS

1) THE CONSUMER IS ASSUMED TO BE RATIONAL. WANTS HIGHEST UTILITY FOR LIMITED BUDGET

2) THE CONSUMER IS ABLE TO RANK HIS GOODS 3) CONSISTENCY OF CHOICE: THE CONSUMER EITHER SAYS PREFER BUNDLE A TO BUNDLE B.

CANT CHANGE HIS MIND. THERE MUST BE CONSISTENCY. SO IF THERE ARE THREE GOODS, GOOD A IS PREFERRD TO GOOD B, THEN B TO C, THEN BY INFERENCE A TO C.

4) THIS IS A BUNDLE… WE CAN GENERALISE THIS, TO CREATE A 3RD BUNDLE WITH C.

𝑈(𝑋!,𝑋!) WE USE TWO GOODS FOR EASE, SO WE CAN DO CALC. BETTER AND WE DON’T HAVE TO DO 3D OR 4D ETC “2 good model” TE MAP ON PG3: INDIFFERENCE MAP, BUT EACH AN INDIFFERENCE CURVE. THE FURTHER AWAY FROM THE ORIGIN, THE HIGHER THE UTILITY. THE CURVES CAN BE LABELLED IC1, IC2, IC3 AND IC4. IC1>IC2, IC2>IC3 ATC

- WHEN IND CURVE IS NEG SLOPED I.E. CONVEX TO THE ORIGIN. THE MARGINAL UTILITY IS POSITIVE FOR THE TWO GOODS. SO MAR. UTI. FOR GOOD 1 IS POS AND MAR. UTI. FOR GOOD 2 IS POS.

- UTILITY IS DEFINED AS THE SATISFACTION FROM THE CONSUMTION OF A GOOD OR SERVICE

-

- MARGINAL UTILITY IS THE ADDITIONAL OR EXTRA UTILITY DERIVED FROM THE CONSUMPTION OF ONE MORE UNIT OF THAT PARTICULAR GOOD.

CONSTRAINT OPTIMIZATION: 2 COMPONENTS I.E. OBJECTIVE FUNC AND BUDGET CONSTRAINT EQUILIBRUIM ANALYSIS COMPARATIVE STATICTS OPTIMAL BASKET IS THE BASKET OF GOODS THAT BRING ABT HIGHEST LEVEL OF UTILITY LESSER THAN OR EQUAL TO IS B. CONSTRAINT. WHEN ITS EQUAL TO WE HAVE A BUDGET LINE. PAGE 3 OF SLIDE. LOOKING AT THE EQN WE HAVE X2 AS SUBJECT OF THE FORMULA. THEN THE INTERCEPT IS Y/P1 AND THE GRADIENT IS -P2/P1 THERE ARE TWO WAYS OF LOOKING AT OPTIMUM CHOICE I.E OPTIMAL COMBINATION OF GOODS. WE USE TANGENCY CONDITON RULE FOR DETERMINING WHICH POINTS ARE OPTIMAL. GRAPH ON PG 6. C IS NOT ON OUR BUDGET LINE, SO IT’S NOT ATTAINABLE.

A- NOT OPTIMAL, B- NOT OPTIMAL, E IS NOT OPTIMAL BECOS OF TANGENCY CONDITION. THE GRADIENT OF THE INDIFFERNCE CURVE MUST BE EQUAL TO THE GRAD OF THE BUDGET LINE.

PG 8- E IS OPTIMAL. THEN WE CAN TRACE DOWN THE AMT OF X1 GOODS AND X2 GOODS BOUGHT. WELL-BEHAVED PREFERENCES MEANS WHAT IS CONVENTIONAL. WE HAVE 6. O COMPLETENESS (CONSUMERS CAN RANK ALL BUNDLES OF GOODS)THERE IS NO INDECISIVENESS • TRANSITIVITY (IF BUNDLE A IS PREFERRED TO B, AND B IS PREFERRED TO C, THEN A IS PREFERRED TO C. ALSO FOR BORDERLINE CASE OF INDIFFERENCE) • NON-SATIATION (GOODS NEVER BECOME BADS) MEANS ALWAYS BRINGS ABOUT UTILITY TO THE CONSUMER DOESN’T TAKE AWAY SATISFACTION. IF WE HAVE TWO GOODS X1 AND X2. ONE OF THE VALUES MUST NOT BE NEGATIVE. • CONVEXITY (“PREFERENCE FOR AVERAGES”) THIS CONVEXITY, MEANS THE CONSUMER LIKES AVERAGES AND LIKE TO HAVE A PART OF GOOD ONE AND A PART OF GOOD 2. LETS HAVE 2 GOODS ONE FOOD AND THE OTHER CLOTHING, THE CONSUMER WILL LIKE TO HAVE A BIT OF BOTH THAT’S WHAT WE MEAN BY CONVEXITY • CONTINUITY MEANS MORE IS BETTER BADLY BEHAVED PREFERENCES, SO IT VIOLATES THE ASSUMPTIONS ABOVE. INDIFFERENCE CURVES MUST NOT CROSS PG 9 MUST NOT BE CONCAVE TO THE ORIGIN ALGEBRA OF THE TANGENCY CONDITION FOR T.C. TO HOLD WE NEED TWO EQNS: SLOPE OF THE BUDGET LINE AND GRAD HAVE THE INDIFFERENCE CURVE

POINT OF INTERSECTION OF B.L. ND INDIFFERENCE CURVE IS THE LOCUS OF POINTS/ COMBINATION OF POINTS THAT YIELDS THE SAME LEVEL OF UTILITY SO THAT THE CONSUMER IS INDIFFERENNT AS TO THE PARTICULAR COMBINATION OF GOODS HE OR SHE CONSUMES. THE GOODS DEALT WITH ARE BY DEFINITION SUBSTITUES

UT IL ITY MAXIMIZAT ION: 1) INTERIOR OPTIMUM SOLUTION: POINT WHERE SLOPE OF INDIFFERENCE CURVE IS TANGETIAL TO SLOPE OF BUDGET LINE. THE CURVE THAT LIES UNDERNEATH THE LINE IS NOT IDEAL. (THE INDIFFERENCE CURVES HAVE TO DO WITH UTILITY) 2) CORNER POINTS SOLUTION: THE SLOPE OF THE UTILITY CURVE TOUCHES THE END POINTS OF THE BUDGET LINE. THE CORNER POINT SOLUTION SAYS THE MARGINAL UTILITY OF ONE GOOD IS SO HIGH THAT IT’S BETTER TO GET RID OF THE OTHER GOOD.

INCOME EFFECT IF WE HAVE NORMAL GOODS X1 AND X2 AND THE INCOME OF THE CONSUMER TOTAL EFFECT: AS THE PRICE OF A GOOD DROPS RELATIVE TO OTHERS, MORE OF THE GOOD IS PURCHASED WHEN THE PRCE OF A GOD FALLS, THE CONSUMER’S PURCHASING POWER INCREASES. SINCE THE CONSUMER CAN NOW BUY THE SAME BASKET OF GOODS AS BEFORE THE PRICE DECREASE AND STILL HAVE MONEY LEFT OVER TO BUY MORE GOODS, THE CHANGE IN PURCHASING POWER IS INCOME EFFECT. SUBSTITUTUTION EFFECT, WHEN THE PRICE OF A GOOD FALLS THE GOOD IS CHEAPER, RELATIVE TO OTHER GOODS. TE = IE + SEC PRICE CONSUMPTION CURVE- INCOME CONSTANT, PRICE GOOD 1 CONSTANT. PRICE OF GOOD 2 VARIES NEEDS ARE JUST THREE IN ECONOMICS:

1. FOOD 2. SHELTER 3. CLOTHING

WANTS ARE GENERAL DESIRES WETHER THEY ARE IMPORTANT OR NOT. FOR NORMAL GOODS, INCOME EFFECT IS ALWAYS POSITIVE WHILE SUBSTITUTION EFFECT IS ALWAYS NEGATIVE. FOR INFERIOR GOODS IT’S THE OPPOSITE.

X2 

X1 

BUDGET LINE INDIFFERENCE

CURVE

 

X2 

X1 

BUDGET LINE 

INDIFFERENCE CURVE

 

HIGHER UTILITY AS YOU GO ACROSS THE CURVES 

THERE IS NO CHANGE ALONG THE CURVES AND THE RELATIONSHIP THAT EXISTS MEANS THAT THE TWO GOODS CAN BE SUBSTITUTED 

LABOUR SUPPLY

ONE OF THE BRANCHES OF ECONOMICS. IT’S THE APPLICATIUON OF TOOLS AND TECHNIQUES OF ECONOMIC SCIENCE TO LABOUR. THE TOOLS IN PLACE WHERE BUYERS AND SELLERS ARE IN. THE DEMAND FOR LABOUR IS APPLIED DEMAND. LABOUR HOURS OFFERED AT A GIVEN WAGE RATE LABOUR SUPPLY IS THE NUMBER OF HOURS A WORKER IS WILLING AND ABLE TO WORK AT A GIVEN WAGE RATE. LEISURE HOURS IS L: H = 24 – L AS THERE ARE 24HRS IN A DAY THE “PRICE” FOR LABOUR IS THE WAGE-RATE. THE SAME REASONING IN THE INDIFFERENCE CURVE IN LABOUR SUPPLY ECONOMICS IF LINKED TO PRODUCTION THERE IS A WAGE RATE THAT THE WORKER WILL PREFER TO WORK THAN TO BE IN LEISURE THERE IS A LEVEL AT WHICH THE INCREASE IN WAGE RATE WILL NO LONGER INCENTIVISE THE WORKER. THEN AFTER A WHILE YOU NO LONGER WORK AND JUST TAKE LEISURE pC = PRICE PER UNIT X CONSUMPTION OF GOODS CONSUMED BY THE INDIVIDUAL YH = INCOME OF OTHER SOURCES (I.E. BENEFITS, SOCIAL WELFARE, FAMILY) wH = WAGES X HOURS OF LABOUR IF H = 24-L THEN THE TWO-GOOD MODEL OF THE LABOUR SUPPLY 𝑝𝐶  =  𝑌! + 𝑤𝐻 

       = 𝑌! + 𝑤(24 − 𝐿)

⟹ 𝐶 = !!!+ !

!(24 − 𝐿)

⟹ 𝐶 = !!!+ !"!

! − !

!𝐿

SO 𝑝𝐶 = 𝑌! + 𝑤(24 − 𝐿)

𝑝𝐶 = 𝑌! + 24𝑤 − 𝑤𝐿 𝑝𝐶 + 𝑤𝐿  = 𝑌! + 24𝑤

STUDY SHOWS THAT FOR FULL-TIMERS, WHEN W/P RISES THEY WANT TO SUPPLY MORE HOURS FOR PART-TIMERS WHEN W/P RISES THEY WANT TO SUPPLY LESS LABOUR THE INITIAL CONDITIONS ARE WHAT MAKES ALL THE DIFFERENCE

• CAN H=0 BE AN EQUILIBRIUM? • CAN L=0 BE AN EQUILIBRIUM? (IS IT LIKELY?) • IMPACT OF RISE IN YN IF L IS NORMAL VS INFERIOR?

THE GOVERNMENT USES THE BUDGET FOR: * HEALTH * INFRASTRUCTURE * EDUCATION * SOCIAL A CONSUMER MAXIMISES UTILITY SUBJECT TO INCOME AND BUDGET CONSTRAINT A PRODUCER MAXIMISES PROFIT SUBJECT TO RESOURCES, TIME TECHNICAL RELATION BETWEEN INPUT AND OUTPUT OF GOODS AND SERVICES THE TWO FACTORS OF PRODUCTION ARE LABOUR AND CAPITAL ISOQUANTS IS A LOCUS OF POINTS OR COMBINATION OF INPUT THAT BRINGS ABOUT A UNIFORM LEVEL OF OUTPUT SUCH THAT THE PRODUCER IS INDIFFERENT AS TO THE PARTICULAR COMBINATION OF INPIUT ISOCOST IS THE RESOURCE CONSTRAINT FOR THE PRODUCER I.E. LABOUR AND CAPITAL. THE FURTHER AWAY THE ISOQUANT, THE HIGEHR THE LEVEL OF OUTPUT AND B ETTER PROFITS. MPL = INCREASE IN OUTPUT FROM AN EXTRA UNIT OF LABOUR MPK =INCREASE IN OUTPUT FROM AN EXTRA UNIT OF CAPITAL USING CALCULUS MPL =

!"(!,!)!"

MPK = !"(!,!)!"

THE LAW OF DIMINISHING MARGINAL PRODUCTIVITY (LAW OF DIMINISHING RETURNS)

WITH FIXED K, MPL FALLS AS L RISES WITH FIXED L, MPK FALLS AS K RISES AS WE SUBSTITUTE LABOUR FOR MACHINES THEN THE CURVE FLATTENS OUT I.E. L FOR K FIXED POINT RESOURE IS 24HR A TIME L = 0 H = 0 HOMOGENEOUS PRODUCTS ARE THE SAME PRODUCTS ACROSS THE MARKET E.G PETROLEUM AND COMMODITIES THE BUYERS AND SELLERS = MARKET MONOPSONY AND OLIGOPSONY REFER TO THE BUYERS ASPECT OF THE MARKET- THE OTHERS ARE FROM THE SELLERS POINT OF VIEW. GOVT IS A GOOD MONOPSONY. 1. MONOPOLISTIC COMPETITION 2. OLIGOPOLY

i) COURNOT OLIGOPOLY ii) STACKELBERG OLIGOPOLY iii) BERTRAND OLIGOPOLY

5. CARTEL OPEC IS A GOOD EXAMPLE OF A CARTEL. THEY SET PRICE AND ALSO QUANTITY RECALL A MONOPOLY CAN HAVE MULTI PLANTS OR PRICE DISCRIMINATE ACROSS THE MARKET. A DUOPOLY IS TWO ‘MONOPOLIES’ SO TO SPEAK, WHEN THEY ARE MANY THEY SELL SIMILAR PRODUCTS EITHER THAT OR UNIFIED.E.G. PETROL RETAILERS AND WHAT ARE THE CHARACTERISTICS OF THESE COMPANIES. ENTRY BARRIER IS NECESSARY IN A MONOPOLY, PATENTS, COPY RIGHT, LICENCE FEES 1. MONOPOLISTIC COMPETITION HAS THESE PROPERTIES:

I ) MANY F IRMS AND NO BARRIERS TO ENTRY II) EACH FIRM HAS A UNIQUE PRODUCT E.G. STEVE JOBS APPLE III) DOWNWARD SLOPING DEMAND CURVE IV) NOT PRICE TAKER V) THE AMAZON KINDLE, SAMSUNG, IPAD ARE SIMILAR YET THE COST DISPARITY IS

FAR (£150, £200, £500) VI) AC > D MEANS A LOSS VII) AC < D MEANS A PROFIT 7

2. COURNOT OLIGOPOLY IS A DUOPOLY

I) THE INTERSECTION OF TWO REACTION CURVES GIVES THE COURNOT EQUILIBRUM

II) THE TWO REACTION CURVES INTERSECT AT THE COURNOT EQILIBRIUM III) THE SET OF STRATEGIES OR ACTIONS THAT A FIRM EMBARKS UPON GIVEN ITS

COMPETITORS REACTION IV) THERE IS SIMULTANEOUS PRODUCTION V) REACTION CURVE: THE RELATIONSHIP BTW PROFIT MAXIMISING OUTPUT OF A

FIRM AND THE AMOUNT IT THINKS ITS COMPETITORS WILL PRODUCE VI) THE FIRMS WATCH THEMSELVES AND THEN DECIDE HOW TO PRODUCE. THAT IS

WHY THE QUANTITIES ARE A FUNCTION OF ONE ANOTHER. VII) ASSUMPTION: NAÏVE ASSUMPTION IS THAT THE FIRMS HAVE SIMILAR

REACTION FUNCTIONS WHICH WE DERIVE BY SOLVING THE EQUATIONS ALIKE TOTAL QUANTITY (MARKET): FIRM 1 = Q1; FIRM 2 = Q2

Q = Q1 + Q1

C1 = C2 𝜋! = P(Q) x Q1 – C1 PROOF PROFIT MAXIMISING OUTPUT LEVEL OF Q1 GIVEN THE AMOUNT Q2 WILL PRODUCE VARIOUS MARKET Q: A) PERFECT COMPETITION Q=30 B) MONOPOLY Q= 15 C) COURNOT OLIGOPOLY Q= 20 FROM THE PERFECTLY COMPETITIVE FIRM THE ECONOMY BENEFITS MORE: 3. STACKELBERG OLIGOPOLY IS A MORE EXTREME CASE OF COURNOT. THERE ARE LEADERS AND FOLLOWERS. THE DEMAND FUNCTION OF THE LEADER IS WHAT THE FOLLOWER REACTS TO EG SONY MAKES A PRODUCT, THEN THE OTHER FIRMS ACT ON THIS TO CREATE THEIR MARKET BOOK TO PURCHASE: MODERN MICROECONOMICS BY KOUTSOYIANNIS SUBSTITUTE THE REACTION FUNC OF Q1 INTO THE EQN FOR Q2, WE DON’T SOLVE FROM SCRATCH 4. BERTRAND DEALS WITH PRICE WARS PRICE LEADERS AND PRICE TAKERS, NOT APOLOGETIC AND NOT AFRAID OF ANYBODY IN THE MARKET

I) FIRM 1 HAS SET THE PRICE AND FIRM TWO ASSUMES SO AND FIXES PRICES BASED ON THOSE SET BY FIRM 1

II) THE MC ≠ 0, SO COST IS NOT CONSTANT III) THERE IS A PRICE WAR BETWEEN THE TWO COMPANIES IV) THEN FIRM 1 IS THE PRICE LEADER AND FIRM 2 THE PRICE FOLLOWER

V) IF P > MC WE HAVE A LOSS VI) E.G. BRANDED FOODS AND SUPER MARKET BRANDS WHICH ARE HOMOGENOUS BUT

HAVE DIFFERENT PRICES VII) THERE IS A FIRST MOVER ADVANTAGE FOR FIRM 1 VIII) ANOTHER SCENARIO IS PRICE COLLUSION BETWEEN THE TWO FIRMS; IN A COLLUSIVE

OLIGOPOLY, FIRMS DECIDE NOT TO COMPETE- HIGHER LEVEL OF PROFIT, LESS EFFICIENCY, SUPERNORMAL PROFITS AT THE LOSS OF CONSUMER. CONTROLS BOTH THE PRICE AND THE QUANTITY. THE BUYERS STILL HAVE A CHOICE OF BUYING PRODUCT OR NOT.

GAME THEORY THE FOCUS OF GAME THEORY IS STRATEGY FOR DECISION MAKING. WE WILL WORK WITH TWO PARTICIPANTS PLAYER 1 AND PLAYER 2. PAYOFF THE BENEFIT/UTILITY THAT EACH PLAYER ACCRUES THE PLAYERS ARE ASSUMED TO BE SELF-SERVING AND WANT THE HIGHEST PERSONAL BENEFIT, EXCEPT WHEN THERE IS COOPERATION BETWEEN PLAYERS. THIS IS RELYING ON THE ASSUMPTION OF RATIONALITY.

1) ONE-SHOT SIMULTANEOUS GAME- PLAYER 1 TAKES A STEP AND THEN PLAYER 1 TAKES A STEP THERE IS NO KNOWLEDGE OF YOUR OPPONENTS STRATEGY

2) REPEATED GAME: CONTINUES IN PERPETUITY 3) SEQUENTIAL: THE PLAYERS PLAY WITH KNOWLEDGE OF EACHOTHERS STRATEGY

E.G.

PLAYERS 1. MILO 2. BOUNVITA

STRATEGIES

A. CHARGE SAME PRICE B. CHARGE DIFFERENT PRICES

PAYOFFS (PLAYER 1)

• IF PLAYER 1 PLAYS STRATEGY A; AND PLAYER 2 PLAYS A PAYOFF IS 1 FOR PLAYER 1 (A,A)

• IF PLAYER 1 PLAYS STRATEGY A; AND PLAYER 2 PLAYS B PAYOFF IS 0 FOR PLAYER 1 (A,B)

• IF PLAYER 1 PLAYS STRATEGY B; AND PLAYER 2 PLAYS A PAYOFF IS 2 FOR PLAYER 1 (B,A)

• IF PLAYER 1 PLAYS STRATEGY B; AND PLAYER 2 PLAYS B PAYOFF IS 1 FOR PLAYER 1 (B,B)

PAYOFFS (PLAYER 2)

• IF PLAYER 2 PLAYS STRATEGY A; AND PLAYER 1 PLAYS A PAYOFF IS 2 FOR PLAYER 2 (A,A)

• IF PLAYER 2 PLAYS STRATEGY A; AND PLAYER 1 PLAYS B PAYOFF IS 1 FOR PLAYER 1 (A,B)

• IF PLAYER 2 PLAYS STRATEGY B; AND PLAYER 1 PLAYS A PAYOFF IS 1 FOR PLAYER 1 (B,A)

• IF PLAYER 2 PLAYS STRATEGY B; AND PLAYER 1 PLAYS B PAYOFF IS 0 FOR PLAYER 1

THERE ARE N CHOOSE K OPTIONS FOR THE CHOICES AVAILABLE. HERE NCK IS 2 CHOOSE 2 WHICH IS 8 OPTIONS.

DOMINANT STRATEGY A GAME THAT PLAYERS BOTH BENEFIT FROM THE STRATEGY, IRRESPECTIVE OF WHAT THE OTHER PLAYER DOES. ‘DOING THE BEST I CAN NO MATTER WHAT YOU DO’ EQUILIBRIUM OUTCOME IS THE DEDUCTIONS DONE TO COME TO THE RESULT BEST OUTCOME IS AS A RESULT OF COOPERATION PRISONERS DILEMMA IS A GAME WHICH DEPENDS ON THE FACT THAT EACH PERSON IS ACTING IN BEST SELF INTEREST NASH EQUILIBRIUM IS WHERE THE PLAYERS BEST OUTCOME IS CHOSEN AFTER THE OPPONENT HAS PLAYED. ‘DOING THE BEST I CAN BASED ON WHAT YOU DO’ THE EQUILIBRIUM QUANTITY FOR PRICE IS THE NASH EQUILIBRIUM. THE COURT DEMAND CURVE FOR THE MARKET, FOR ANY NUMBER OF FIRMS. FIND FIRM 1 AND 2 REACTON CURVES AND WE FIND THE EQUILIBRIUM QTY. IN BERTRAND SAME AS ABOVE BUT WE USE IT TO FIND PRICE. PRICE EQUIV OF CONOURT IS BERTRAND EQUI. IS THE NASH EQUI. BOTH ARE NAS. WHEN NO COMPETITION, NASH AND DOMINANT IS COMPETITIVE. THE HIGHEST PROFIT/PAYOFF IS FROM COLLUSION. BUT HIGHLY UNLIKELY ESP WITIH NATIONS- ANTI TRUST. OLIGOPOLIES. BUT OPEC AND SOME AGRICULTURAL PRODUCTS EXAMPLE

A B

A 1,2 0,1

B 2,1 1,0

 

A DA

A 10,5 15,0

DA 6,8 10,2

 

ADVERTISE IS DOMINANT STRATEGY MIXED STRATEGY MEANS THAT NO STRATEGIC MOVE THAT HAS BEEN MADE IS ADVANTAGEOUS OR DISADVANTAGEOUS… RANDOM CHOICE BASED ON PROBABILITIES. PAYOFFS AREUSUALLY UNIFORM LOOKING AT IT AL THE FOUR QUADRANTS ARE THE SAME. ADD ALL FIGURES IN THE QUADRANT TO GIVE 0. ONCE WE KNOW THE EXPECTED PAYOFF IS 0, WE USE MIXED STRATEGY, SO THERE ARE MORE THAN 1 EQUILIBRIUM POINT WE CAN ARRIVE AT. WE MUST HAVE AT LEAST ONE NASH EQUI. OUT OF ALL FOUR. PURE STRATEGY A PLAYER MAKES A SPECIFIC CHOICE BATTLE OF THE SEXES A TYPE OF GAME WHERE THERE ARE TWO NASH EQUI. IN PURE STRATEGY TO THIS GAME THIS IS NOT PERFECT SOLUTION BUT IT’S A SOLUTION. THERE IS A MIXED STRATEGY IS USING AN EXPECTED UTILITY FORMULA. MIXED STRATEGY MEANS NO SINGLE UNIT OF SATISFACTION, SO SAME FORMULA AS USED IN BATTLE OF SEXES REPEATED GAMES: ACTIONS ARE CARRIED OUT AND THE PAYOFF REPEATED OVER AND OVER AGAIN. THE PRISONERS DILEMMA CAN BE REPEATED TO GIVE THE PRISONERS . FOR THE 1ST TIME NO COOPERATION ONE SHOT, BUT BETWEEN 2 AND N-1 COOPERATION. THEN THE FINAL ONE NO COOPERATION (FINITE) FOR INFINITE ALWAYS COOPERATE. STACKELBERG HAS FIRST MVER ADVANTAGE ENTRY GAME IT’S A SEQUENTIAL GAME. HOLD UP PROBLEM IS A TYPE OF ENTRY GAME AND THE BEST RESULT IS THAT THE SECOND PLAYER SUCCUMBS AND THE FIRST PLAYER EXTORTS!

T IME

INTEREST RATE IS THE RATE / PERCENTAGE AT WHICH ECONOMIC AGENTS WILL EITHER BORROW OR LEND

BONDS ARE ONE OF THE MONETARY POLICY INSTRUMENTS USED BY THE CENTRAL GOVT. FOR REGULATING THE COSTS AND THE AVAILABILITY OF MONEY FOR REGULATION COOPERATION BONDS USED FOR SOURCING LONG TERM LOANS INFRASTRUCTURAL BONDS USED FOR BUILDING INFRASTRUCTURES HIGHER THE VALUE OF THE BOND THE LOWER THE INTEREST RATES BONDS ARE PROMISORY NOTES WITH THE GOVT. SEAL. CONTRACT IN WHICH A B PLANS TO PAY THE L A STREAM OF MONEY. B = ISSUING COMPANY/ GOVT. L = BUYER OF BOND. VARIOUS TYPES OF AGGREEMENTS. INTEREST RATE ON A BOND IS THE PRICE OF THE BOND OR THE YIELD OF THE BOND. THE HIGHER THE RISK THE HIGHER THE RETURN. USING THE FORMULA PRESENT VALUE = PRINCIPAL x (1 + INTEREST RATE)NO OF YEARS

SHORT FORM

!!!+ !"!

!

EXAMPLE WILL YOU PREFER £3000 NOW OR £5000 IN 2 YEARS TIME? THE INTEREST RATE IS 4O% SOLUTION V = P(1 + r)n HERE P=3000; r=0.4; n=2 SO WE HAVE

a) 3000(1 + 0.4)n = £5880 FUTURE VALUE IN YEAR 2015 b) 5000(1+ 0.4)n = £2551 DISCOUNTED VALUE IN 2013

YOU ARE BETTER OFF TAKING £3000 NOW. COUPO BONDS. THE COUPON IS HOW MUCH I WILL GIVE YOU ON A YEARLY BASIS LOW CREDIT RATINGS MEANS THAT A NATIONS ABILITY TO PAY DEBT IS LOW. IT APPLIES TO A CORPORATION OR A COUNTRY. SO WHEN THERE IS LOW CRED. RATING, THE DEMAND FOR THE BONDS DROPS AND THE NATION REACTS BY SHOOTING UP INTEREST RATES ONCE THERE IS A DOWNGRADE, THAT COUNTRY NOT LIKELY TO PAY BACK HIS DEBT AS AND OF WHEN DUE. THE DEMAND FOR THE BOND REDUCES AS A RESULT. THE SITUATION IN SPAIN AND GREECE, THERE HAS TO BE A BAILOUT.

PERPETUITY IS A FOREVER PAID COUPON. IT’S THE LIFETIME OF PEOPLE USUALLY. PENSION FUND. SUM OF G.P. to infinty = a/(1+r) a = FIRST TERM VALUEING INVESTMENT PROJECTS K= CAPITAL REQUIRED TO GO INTO INVESTMENT TODAY Yt = INCOME IN YEAR t R = INTEREST RATE WHICH ACCOMODATES EXPECTED INFLATION IN THE YEARS TO COME IF WE DISCOUNT THE INCOME REALISABLE YEARLY FOR THE TERM IF THE YEARLY INCOME DISCOUNTED SUMMED OVER THE TENURE IS GREATER THAN K, THEN IT IS A VALID INVESTMENT. NPV IS NET PRESENT VALUE, PRESENT VALUE MINUS K POS. NPV = INVEST NEG. NPV = DON’T INVEST INTERTEMPORAL – MULTIPLE TIME MANS LIFE 20-60 CONSUMPTION> 60-80 CONSUMER LIVES IN MORE THAN ONE PERIOD. UNCERTAINTY THE PROBABILITY OF AN UNFAVOURABLE EVENT NOT KNOWN RISK PROBABILITY OF AN UNFAVOURABLE EVENT KNOWN NO UNCERTAINTY MEANS PERFECT FORESIGHT Y = C + S C IS CONSUMPTION S IS SAVINGS OUR MODEL IS THAT THE CONSUMER LIVES IN TWO TIME PERIODS (MAYBE SINGLE/MARRIED; YOUNG THEN OLD ETC) THE TIME PERIODS ARE PERIODS 1 AND 2 IN PERIOD 1 -> Y1 = C1 + S1

IN PERIOD 2 -> Y2 + (1+R)S1 = C2 + S2

NOW ASSUMING THAT THERE IS NO UTILITY TO SAVE AFTER PERIOD 2, WHICH MAKES SENSE,

S2 = 0 SO IF WE SOLVE FOR C2

S1 = Y1 - C1

HOW TO DESCRIBE A RISKY OUTCOME PROBABILITY: LIKELYHOOD OF AN OUTCOME. THREE WAYS OF DESCRIBING RISKY OUTCOME: 1 PROBABILITY DISTRIBUTIONS 2 EXPECTED VALUES 3 VARIANCE ASSUMPTIONS: SHARE = STOCK UNCERTAINTY = RISK EXAMPLE AN OIL CO. WANTS TO FURTHER EXPLORE, WHICH WILL ACCRUE SOME COSTS. CURRENT PRICE OF STOCKS IS £30 SUCCEED STOCK PRICES =£40 FAIL STOCK PRICES = £20 HISTORY, LAW OF NATURE, P a) EXPECTED VALUE- EXPECTED UTILITY b) VARIABILITY RECALL 2 OPTIONS OPTION 1 = P OPTION 2 = 1 – P PROB OF SUCCESS = (30-40)/40 = ¼ PROB OF FAIL = 1 – ¼ = ¾ EXPECTED VALUE / EXPECTED UTILITY WHICH ACTS AS THE ‘MEAN VALUE’ = P(A)* PAYOFF (A) + P(B)* PAYOFF (B) + P(C)* PAYOFF (C) + … + P(N)* PAYOFF (N) VARIANCE GIVES US VARIABILITY I.E. HOW RISKY IS THE INVESTMENT = P(A)[PAYOFF(A) – EV]2 + P(B)[PAYOFF(B) – EV]2 + … + P(N)[PAYOFF(N) – EV]2 ST PETERSBURG PARADOX TAKING A WAGER THE VALUATION IS INCALCULABLE

AXIOMS OF RAT IONAL CHOICE SELFISHNESS AND I

- CONTINUITY - INDEPENDENCE

LEXICOGRAPHIC PREFERENCE IS IF A BUNDLE OF GOODS IS ALWAYS PREFERRED THEN REGARDLESS OF VARIATION INDEPENDENCE: IF X IS INDEPENDENT TO Y, THEN FOR A THIRD OBJECT Z WITH PROB. P WE HAVE THAT (X WITH Z) IS ALSO INDEPENDENT TO (Y WITH Z) R ISK AVERSION:

1 . RISK AVERSE 2 . RISK LOVING 3 . RISK NEUTRAL

ASSYMETRIC INFO- LEAVE IT TO ME I WILL GIVE YOU £5900 IF YOU GIVE ME £5000. ONE PARTY KNOWS WHAT THE OTHER PARTY DOESN’T EDGEWORTH BOX DEALS WITH THE BEST WAY OF ALLOCATING RESOURCES AND ENDOWMENTS IN THE MOST EFFICIENT WAY. EFFICIENT IS NOT ALWAYS EQUITY SOMETIMES USING THE TOOLS: MARS EB INDIFFERENT CURVES CONTACT CURVES HOW GOODS AND SERVICES ARE EFFICIENTLY ALLOCATED IN AN ECONOMY. NOT ALL EFFICIENT ALLOCATIONS ARE FAIR. POSITIVE AND NORMATIVE NORMATIVE EVALUATION OF MARKETS. ETHICAL EVALUATION OF MARKETS ANDF ALWAYS INVOLVES VALUE JUDGMENT. IN ECONOMICS THERE ARE 4 WAYS OF PERCEIVING EQUITY.:

1. EGALITARIANISM- IDEAL STATE ALL RESOURCES DISTRIBUTED EQUALLY AMONG THE CITIZENS COMMUNISM

2. RAWLSIAN 3. UTILITARIAN 4. MARKET- NOT ALWAYS TAKEN TO BE THE MOST EQUITABLE, PARETO

THE TWO MOST PRACTICAL ONES ARE UTILITARIAN AND RAWLSIAN. SOCIAL WELFARE FUNC. MEASURES THE TOTAL WELFARE OF THE SOCIETY BY ADDING UP THE INDIVIDUAL UTILITY OF THE MEMBERS. PARETO OPTIMALITY AND MARKET ALLOCATION WELFARE ECONOMICS NORMATIVE EVALUATION OF ALL ECONOMIC POLICIES AND ALWAYS INVOLVES VALUE JUDGMENT THERE ARE MULTIPLE WAYS OF ACHIEVING THE SAME RESULT. IN POLICY DEBATE ANALYSIS. THIS IS VERY REAL AND APPLICABLE ECONOMICS. SHOULD EXTRA £ BE ALLOCATED TO HOUSING, NHS, EDUCATION OR FOOD STAMPS. VALUE JUDGMENT, CULTURE BELIEFS AND VALUES OF THE LEADERS DETERMINE WHICH OF THESE SECTORS HAVE THE MOST OF OUR BUDGET FUNDAMENTAL THEORY OF MARKET ALLOCATION WELFARE THEOREM

- IF MARKETS ARE COMPETITIVE THE MARKET ALLOCATION IS PARETO OPTIMAL; FREE MARKET ALA HAYEK, SMITH. THE ECONOMY THAT PRODUCES MOST GOODS IS COMPETITIVE MARKET. INDIVIDUAL TAKES PRICES AS GIVEN SUCH THAT MRS = PRICE RATIO. THE INDIFFERENCE CURVES FOR TWO INDIVIDUALS ARE TANGENT

- BILATERAL BARGAIN USED FOR GAME THEORY OR NASH EQUILIBRIUM. EXCHANGING GOODS TO REACH PERFECT UTILITY. TAKEN PRICE AS GIVEN. THE PROCESS OF DETERMINIG HOW MUC OF MY GOODS WILL MAXIMISE YOUR UTILITY. THE OPTIMA ALLOCATION IS DETERMINED THRU GAME THEORY

- FAIR TRADE MEANS THAT WE WILL PAY ETHICALLY FOR THE FARMERS PRODUCE AS THEY HAD NO CHOICE PREVIOUSLY AS TO HOW MUCH THEY CAN DEMAND

- MRS OF GOOD A MUST BE EQUAL MRS B. HOW DO WE DETERMINE THE EXCHANGE RATE - IF THERE ARE ONLY TWO AGENTS INVOLVED, NO PROBEM. BUT THOUSANDS OF PEOPLE

THEN NOT SO MUCH. - EVERY PARETO EFFICIENT ALLOCATION CAN BE ACHIEVED AS A COMPETITIVE EQUILIBRIUM - DISTRIBUTE INITIAL RESOURCES AND LET COMPETITIVE MARKETS DO THE REST - PARETO OPTIMALITY DEALS WITH PRICINGPARETO EFFICIENCY DEALS WITH UTILITY

GAINED 2ND WELFARE- EFFICIENCY PROBLEMS AND DISTRIBUTIVE CAN BE SEPARATED WE CAN REDISTRIBUTE ENDOWMENT OF GOODS TO DET 1ST AND 2ND THEORY OF WELFARE USUALLY APLICABLE IN TAXATION

DISTORTIONARY AND NON-DISTORTIONARY TAXATION ENDOWMENT IS WHAT YOU HAVE, YOUR POSSESSION WHICH CAN BE USED FOR EXCHANGE LUMP SUM TAXATION E.G. VAT FIXED PERCENTAGE FOR EVERYTHING. COMPARED TO INCOME TAX WHICH IS IN BANDS. NON-DISTORTIONARY THAT IS ALL ARE LIABLE TO PAY IT, SAME PERCENTAGE. DISTORTIONARY IS SUBJECT TO VALUES OF THOSE SETTING IT. MAY MAKE THOSE SUPPLYNG THE LABOUR HOURS NOT TO DO IT 1ST WELFARE PARETO OPTIMALITY 2ND PARETO EFFICIENCY (PRICE MECHANISM) EG. CONCESSIONARY PASS VS FREE MONEY UTILITY POSSIBILTY FRONTIER ALLOCATION AND DISTRIBUTION- UTILITARIAN APPROACH MEANS YOU ARE GOING TO ADD. SOCIAL WELFARE FUNCTION MEANS MAXIMISING THE TOTAL UTILITY OF SOCIETY BY ADDING IND. UTILITY OF MEMBERS MARKET FAILURE LIKE THE CREDIT CRUNCH RECESSION IS REALLY WHEN THERE S TOO MUCH PRODUCTS ON THE MARKET. PRODUCTION GLUT- MORE SUPPLY THAN DEMAND. BOOM, BUST AND RECESSION. JAPAN GROWTH RATE HIGHEST IN THE WORLD IN 70S AND 80S. PILE UP FACTORS OF PRODUCTION. ALL FACTORS OF PRODUCTION BEGINS TO EXPERIENCE DIMINISHING RETURNS. THE UK ONCE THE MOST INDUSTRALISED COUNTRY IN THE WORLD. THE ECONOMY OF GERMANY NOW STRONGER THAN THE UK. LESS DEVELOPED NATIONS CAN CATCH UP, DUE TO STEADY STATE, IN DEVELOPED ECONOMIES WHICH IS WHEN GROWTH RATE IS EQUAL 0 PRODUCTION GLUT BOOM/RECESSION MAKE UP BUSINESS CYCLE CATCH-UP STEADY STATE GROWT RATE IS EQUAL TO ZERO UK IS NOW A SERVICE NATION AS IT HAS REACHED ITS AGE OF MATURATION. ALSO CURRENCY CRISES

NUMBER 1 REASON FOR MARKET FAILURE IS IMPERFECT COMPETITION GREED IS NOT AN ECONOMIC TERM. DON’T BREAK THE LAW NUMBER 2 REASON IS ASYMMETRIC INFORMATION INC MORAL HAZARD NUMBER 3 EXTERNALITIES NUMBER 4 PUBLIC GOODS EXTERNALITIES IS POSITIVE OR NEGATIVE EFFECT SPILLING OVER FROM ANY ECONOMIC ACTIVITY, PRODUCTION, CONSUMPTION, DISTRIBUTION. WHICH IS NOT ACCOUNTED FOR BY PRICES NEG EXTERNALITY: POLLUTION FROM MANUFACTURING POS EXTERNALITY: INFRASTRUCTURE OR TECHNICAL TRANSFER SHELL IN NIGER DELTA STREET LIGHTS ETC PUBLIC GOODS ARE GOODS WITH TWO XTERISTIC. NON RIVALRY, NON-EXCLUDEABLE. EQUAL BENEFIT ON ALL. POLICE FORCE, LEGISLATURE, ARMY