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Microeconomics

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POSITIVE ECONOMICS- describes the way things really are. NORMATIVE ECONOMICS- describes the way things should be. The RESOURCES, also called INPUTS and FACTORS OF PRODUCTION include: Labor Human Capital- The knowledge & skills through training and experience Entrepreneurship Land/Resources Capital

Opportunity Costs and Production Possibilities OPPORTUNITY COST- is the value of the next best alternative sacrificed to produce the most valuable product. When we use resources to produce one good or service, the opportunity cost is that we cannot produce another good or service. Production-Possibilities Frontier (PPF)- Describe the opportunity cost of Item1 vs. Item2. (I.e. Chairs vs. Birdcages). The curve of frontier itself represents all of the combinations of the two goods that could be produced using all of the available resources. Points outside the frontier are unobtainable because they demand more resources than are available. Points inside the frontier are attainable but inefficient. Points on the frontier are perfectly efficient. The absolute value of the slope @ any point is the average OPPORTUNITY COST over that interval (for the x-axis good). A curved PFF deals with economies that specialize resources for one type of good, if the PPF is linear; there is no specialization of resources.

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A PPF with multiple lines is a measurement of future capital vs. current consumer goods. Different equalities along the main frontier will cause different future PPF graphs. The largest ones are considered best. Specialization and Comparative Advantage Specialization increases productivity. DIVISION OF LABOR- the ordering of persons into specializations that they are talented in. This allows people to develop expertise in their divisions. (Kobe Bryant-Basketball, Dustin Hoffman-Acting) ABSOLUTE ADVANTAGE- when one country (or group of people) can produce a good for a lower resource cost the other country. COMPARITIVE ADVANTAGE- when a country can produce a good for a lower OPPORTUNITY COST than the other country. The opportunity for two countries to benefit from specialization and trade rests only on the existence of a COMPARATIVE ADVANGTAGE in productions b/t nations. The Functions of an Economic System- What, How, and for Whom? 3 Big Decisions: -What goods and services will be produced? -How much of each input will be used in the production of each good? -Who will receive the final products? These big 3 are determined by a societys economic structure and standard of living. What goods and Services Will Be Produced? The goal is to reach ALLOCATIVE EFFECIENCY- (EFFICIENCY IN OUTPUT) p>mc. MARGINAL COST-The cost of producing one more unit. MARGINAL VALUE- The value of one more unit. P=MC -Price equals MARGINAL COST.

How much of each input will be used in the production of each good? EFFICIENCY IN PRODUCTION- (TECHNICAL EFFICIENCY) when the output of one good cannot be increased w/o decreasing the value of another. MPK/r=MPL/w This equation essentially tells which resource is more valued. If the Labor>Kapital, labor should be invested in and vice versa. When equal, EFFICIENCY IN PRODUCTION has been achieved. WAGE-The price of labor. RENTAL RATE- The price of capital MARGINAL PRODUCT OF LABOR (MPL)- The additional output produced by 1 more unit of labor. MARGINAL PRODUCT OF CAPITAL (MPK)-The additional output by 1 more unit of capital. Who will receive the final products? Utility is the fancy word for satisfaction. MARGINAL UTILITY (MU)- the additional satisfaction from the last unit. Pa/Pb=MUa/MUb (Where P is the price) MARGINAL RATE OF SUBSTITUTION (MRS) the ratio of MU on the right side of the equation. DISTRIBUITIVE EFFICIENCY- (EFFICIENCY IN EXCHANGE) When MRS (pat)=MRS (Chris) Essentially, those who place the highest value on goods should receive them to maximize profit. Systems of Government and Economic Decisions Communism- a system designed to minimize imbalance in wealth via the collective ownership of property. Negative: Lack of extra effort, risk taking, and innovation. Vulnerable to corruption.

Socialism- Communism w/o the single political party. Capitalist- Private Individuals control the supply and demand seeking private profit. Little govt. intervention. The Nature and Functions of Product Markets DEMAND CURVE- displays the relationship between price and the quantity demanded of a good. The purchase of more items yields a lower price per item. Measures the MARGINAL UTILITY of an individual. A DEMAND SCHEDULE is the table of points that makes up the demand curve. (I.e. quantity vs. price) LAW OF DIMINISHING MARGINAL UTILITY-says that the MU gained from successively higher demand decreases, like, saving 50c, then 35c, then 10c etc. LAW OF DEMAND- says that as the price of a good rises the demand for that item falls. And viceversa. SUPPLY CURVE-Show the relationship between price and quantity supplied by a firm within a given period. Like the demand curve the SUPPLY SCHEDULE shows the points associated with the supply curve. THE LAW OF SUPPLY- as price increases, the quantity of a good supplied in a given period will increase. MARGINAL COST- the additional cost of producing and additional unit. Eventually the marginal cost will increase: -The Opportunity Cost will increase -Eventually inferior resources (less bang for buck) cost.

The graph of any single item: Where the two lines meet is EQUILIBRIUM-also called the MARKET CLEARING PRICE, when the demand and supply curves meet is the perfect state of prosperity for business and consumer. A change in quantity demanded results when the supply curve shifts, a change in demand is when the demand curve shifts. Demand increases when: -Tastes change -Prices increase on a competitors brand -Prices on compliments decrease. ($ for gas goes down, Demand for Hummers goes up) -Increase in buyers -Expectation of higher future income (promotion) Also called consumption smoothing. -Expectation of higher prices in the future -Expectation of shortage (apocalypse prep) -Lower taxes, higher subsidies Opposites of these decrease demand. Changes in the price of a good do not change the demand for that good, only the quantity demanded. Ex: Iphones 1 million person demand @ $400 Quantity demanded = 40,000 ppl 1 million person demand @ $200 Quantity demanded = 750,000 ppl Acronym for demand changes: T Tastes and Preferences R Related Goods I Income of Buyers B - # of Buyers E Future Expectations

Supply increases when: -Input costs decrease -Technology improves -Expectation of lower prices -Increases in the # of sellers. -Increases in joint-product sales (Steak+Leather) -Lower taxes/Higher Subsidies -Less govt. regulation Acronym: R Resource Costs O Other goods prices T Taxes and Subsidies T Technology changes E Expectations of other Providers N Number of Suppliers Remember, when it comes to shifts, Left is Less, Right is More. If the Supply Curve and Demand Curve shift, it can get tricky. To know the new equilibrium position, the relative size of the shifts must be known. If so, graph them! If not, then the Quantity is determinate, the Price is indeterminate. PRICE CEILING An artificial cap on a goods price. Only useful if below the equilibrium. PRICE FLOOR Duh, but above the equilibrium point. (Minimum wage) QUEUING COST The cost of waiting in line, common for goods w/ price ceilings.

TOTAL UTILITY The sum of all marginal utilities, MU1 + MU2=TU. Important! (d/dx)(TU)=MU, so When the marginal utility hits (0) the TU graph meets its apex.

CONSUMER SURPLUS The value of a good in excess of what was paid for it. PRODUCER SURPLUS The difference b/t the sale price and the lowest price that would bring profit.

Elasticity the responsiveness of the amount demanded to price changes Elasticity of Demand Increases: -Substitutes (If one brand raises its price, the other similar brands will experience higher demand) -Proportion of income spent on the good (Gum; Not Elastic, Cruises; Elastic) -Time -Lack of importance Acronym: P Proportion of income A Availability of close substitutes I Importance of the good, luxury vs. necessity D the ability to Delay purchase If 50% increase in price causes MORE than 50% drop in amount demanded = elastic. If 50% increase in price causes LESS than 50% drop in amount demanded = inelastic. If 50% increase in price causes EXACTLY 50% drop in amount demanded = unit elastic. Elasticity equation ((Qnew-Qold)/(Qnew+Qold)/2)/((Pnew-Pold)/(Pnew+Pold)/2) Percent Change in Demand/Percent Change in Price If result is b/t: 0-1=inelastic/ necessity 1+=elastic/ luxury REVENUE Price x Demand (Purchases) Elasticity of Supply measures the responsiveness of the quantity supplied to price changes.

((Qnew-Qold)/(Qnew+Qold)/2)/((Pnew-Pold)/(Pnew+Pold)/2) Percent Change in Quantity/Percent Change in Price INCOME ELASTICITY OF DEMAND measures the responsiveness of the quantity demanded to changes in income. NORMAL GOODS Goods that are purchased more of when the income increases and less when income decreases. (Luxuries; Diamonds, Steak, Coats) INFERIOR GOODS opposite of normal goods. (Hot Dogs, no-brand products, and faux pearls) Formula: Percent change in Quantity Demanded/Percent Change in Income Product Type: (-)=Inferior Good (+)=Normal Good CROSS-PRICE ELASTICITY OF DEMAND measures the responsiveness of the quantity demanded of one good to the price of another. (Steak + Leather) If the price of film goes down, camera sales go up! (Inverse relationship) COMPLEMENTS when two products display this type of inverse relationship. SUBSTITUTES When the price of one good and the demand of another move in the same direction (direct correlation). Formula: Percent Change in Quantity Demanded of Good X/Percent Change in Price of Good Y Product Type: (-) = Compliments (+) = Substitutes

Putting it all Together A New Consumer Surplus, reduced because of tax B Portion of Consumer Surplus removed for tax C + D Deadweight loss, excess burden profit that goes neither to the consumer or the producer because the tax removes the option for that revenue. E Portion of Producer Surplus removed for tax F New Producer Surplus. Firm Production, Costs, and Revenues Marginal Product and Diminishing returns MARGINAL PRODUCT is the additional output produced per period when one or more unit of an input is added. Formula: MPL=TP/L, where, MP=Marginal Product, TP=Total Product, L=Labor units Marginal Product Curve(bottom) Marginal Product often increases with the first few workers because they benefit from specialization. However, the LAW OF DIMINISHING RETURNS says that over time, as more inputs are added, the incremental gains in output will eventually decrease. AVERAGE PRODUCT Formula: AP=Total Product/Quantity of Labor Similar. MP=Change in Total Product/Change in Labor Total Product Curve (top) measures the relationship b/t the total amount of output produced and the number of units of an input

used. The slope of the total product curve is: MARGINAL PRODUCT (TP/L) Another Relation! The average slope (From the Origin to L*) is the value of the Average Product of Labor. Average and Marginal Costs and Revenues Production costs are divided into two groups, Fixed and Variable costs, which are added together to find total costs. -Fixed Costs-do not change with a change in output. (Rent, Electricity, Ovens, Mixers) -Variable Costs-change with output. (Ingredients, Raw Materials, Labor) When both are added together you get the TOTAL COST. Formula: TC=TFC+TVC By definition, fixed costs will not change, and are therefore a straight horizontal line. MARGINAL COST- the slope of the TC and TVC graphs (same slope). Formula: MC=TC/Q MC=TVC/Q Law of diminishing returns says that eventually the costs of additional units will increase causing an upward curve. AVERAGEanything=TC or TVC or TFC/Q Average slope from origin to point on TC/TVC/TFC graphs

indicate the point at the same # of goods produced, on the ATC/AVC/AFC. Similarly, the slope of the TC is the point on the MC curve. Long Run Costs and Economies of Scale Long Run: Everything is variable, Inputs, goods, and prices, and thus, nothing is fixed. Short-Run: At least one input must remain the same. In the short run a firm cannot leave the industry. In the short Run, marginal costs will be higher on average if the fixed amount of capital held in the short-run is more or less than the cost-minimizing amount for producing the desired quantity of output. Long-Run/Short-Run Cost Curve (LRAC, SRAC) - .. ECONOMIES OF SCALE - When the LRAC slopes downward because the capital used is only efficient when large amounts of input are used to create large volumes of output. (Combines, tractors, large harvesters) DISECONOMIES OF SCALE exist when LRAC is increasing INCREASING RETURNS TO SCALE exist when a proportional increase in input results in a higher percent increase in output. (Long-run effect) DECREASING RETURNS TO SCALE Opposite. CONSTANT RETURNS TO SCALE When inputs are directly proportional to output. (1/2 input=1/2 output) DIMINISHING MARGINAL RETURNS exist when an additional unit of an input increases total output by less than the previous unit of the input. (Short-Run effect) INCREASING COST FIRM cost to input is beginning to outweigh output DECREASING COST FIRM When the output is beginning to profit over input costs.

INCREASING COST INDUSTRY When production costs for raw materials rise, perhaps because the steel market is under higher demand to supply to the automobile market. CONSTANT COST INDUSTRY relatively no change in the cost of input. If marbles became really really popular, the price of glass wouldnt rise. Causes a horizontal long-run supply curve. DECREASING COST OF INDUSTRY Experiences decreasing input costs. Downward sloped long run supply curve. ECONOMIES OF SCOPE exist when a firms average production costs decrease because multiple products are being produced. This occurs when the production of two or more products are complimentary. It also occurs when several products can share research and development costs. Market and Individual Firm Product Pricing and Outputs Perfect Competition: -Many Sellers -Standardized product -Firms are price takers -Free entry and exit to market PRICE TAKERS- When the market is so large, with so many sellers and buyers, that the firms have little effect on the market price. So the firms take the market price as their selling point. NORMAL PROFITS- When the entrepreneur makes 0 in economic profits. Including opportunity cost. ACCOUNTING PROFITS The calculation of profit excluding the opportunity cost. The real cost. The market price is established by the equilibrium b/t the industry supply and the industry demand curves.(Those are determined by adding the supply and demand curves of each firm together)

TOTAL REVENUE the amount of money taken in by the sale of a good (Quantity x Price) MARGINAL REVENUE is the addition to revenue gained when one more unit of a good is sold.(TR/Q) AVERAGE REVENUE the average revenue gained from every unit of a good. (TR/Q) Profit is the difference b/t total revenue and total cost. Area b/t the two curves (when revenue is above cost) demonstrates profit. The maximum distance b/t the two coordinating points indicates maximum profit. TR(a)>TC(a) Intersections are break even points. Areas b/t the curves when cost is over profit

demonstrates loss. THE INDIVIDUAL FIRM GRAPH shows total profit in terms of Average Profit and Quantity, which when multiplied = total profit. SHUT DOWN DECISION is when a firm in a perfectly competitive industry hinges on whether or not the price covers average variable cost. If: Price > ATC all costs are covered and the firm should remain open. ATC > Price > AVC all variable costs are covered, but not enough is profited to cover fixed costs. Remain open to cover the majority. AVC > Price No benefits. SHUT DOWN. Monopoly A monopoly is a sole provider of a unique product. A monopoly is characteristic of barriers to new firms: -Patents -Control of resources -Economies of scale -Exclusive licenses The marginal revenue for a firm facing a downward-sloping demand curve is the price minus the decrease in revenues resulting from the lower prices on all the units previously sold at a higher price. As a rule, if the demand curve is straight, the Marginal Revenue line is linear, with double the negative slope, halfway b/t the y-axis and the demand curve. Monopolistic firms always operate on the elastic portions of their demand curve. Profit is maximized at MC=MR If demand is below the AC , losses. If AC is below demand, profits. Price Discrimination

Is the charging of different consumers different prices for the same item. Occurs when: -The firm has market power. Cannot be in a perfectly competitive market -Buyers with differing demand elasticities must be seperable, by age, income, location etc. -The firm must prevent resale of its goods at higher prices. Where the MC=MR=No Profit, break even point Basic Steps that firms use to determine maximum profit: -Locate where marginal revenue = marginal cost -Draw a line straight down to the quantity axis to determine optimal quantity -Draw a line vertically to the demand curve of the firm to determine the maximum price to sell for. -If that price is below AVC they shut down, otherwise sell Q for P. -P-ATC=profit/unit (P-ATC)xQ=total profit. Efficiency and Government Policy Toward Imperfect Competition The area b/t the monopolistic point of maximum profit and the Quantity constant is the Dead Weight Loss. Monopolies typically reduce the quality of the market because of this DWL effect that they create. The Sherman Act (1890) Declared attempts to monopolize commerce or restrain trade amongst the states illegal. The Clayton Act (1914) Determined price discrimination, tying contracts, and unlimited mergers to be illegal.

The Robinson-Patman Act (1936) Prohibits price discrimination except when used in good faith to improve the market, or when based on differences in cost. (Farther to travel) The Celler-Kefauver Act (1950) authorized the govt. to ban vertical mergers. (Mergers that would give one firm control over all steps of productions, steel, steel mill, mill workers, sale) Conglomerate Mergers, and horizontal mergers. Factor Markets When the demand for a good increases, the demand for its inputs increases. MARGINAL REVENUE PRODUCT OF LABOR Is used to determine if an investment in capital is worthwile. MRP(L)= MP(L) x P(output)in ($/time) MONOPSONY When a single firm purchases all of the labor in that market (All of the miners in a small town) MARGINAL FACTOR COST The additional cost of hiring one more worker. Unions Unions attempt to increase wages for their members by: -Increasing demand for labor -Decreasing the supply of labor -Negotiating higher wages. BILATERAL MONOPOLY When there is only one buyer, and one seller in a single market. Efficiency Equity and the Role of the Govt. The market can fail for several reasons: -Imperfect competition -Externalities

-Public Goods -Imperfect Information IMPERFECT INFORMATION When the consumers or firms are unaware or prevented from knowing the true state of affairs in the current market. (this effect is curbed by truth-in-advertising agreements) EXTERNALITIES spillover effects (The neighbors barking dogs) NEGATIVE EXTERNALITIES - negative spillover effects POSITIVE EXTERNALITIES duh.