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REVIEW
FINAL EXAM
PRICE ELASTICITY OF DEMAND
The Price-Elasticity Coefficient and Formula
           Percentage change in quantity
              demanded of product X
  Ed =      Percentage change in price
                   of product X
Or equivalently…
             change in quantity demanded of X
  Ed =        Original quantity demanded of X


                 Change in price of X
                  Original price of X
PRICE ELASTICITY OF DEMAND
Extreme Cases
Perfectly Inelastic Demand
  P                D1

                   Ed = 0

  0                          Q

Perfectly Elastic Demand
  P


                             D2
                    Ed = 
  0                          Q
PRICE ELASTICITY & TOTAL REVENUE
    When prices are   So is total revenue
    low,
P                     TR




                  D
                  Q        Quantity Demanded
PRICE ELASTICITY & TOTAL REVENUE
  Total revenue rises
    with price to a
P        point...
                        TR




                  D
                  Q          Quantity Demanded
PRICE ELASTICITY & TOTAL REVENUE
  Total revenue rises         then declines
    with price to a
P        point...
                        TR




                  D
                  Q          Quantity Demanded
PRICE ELASTICITY & TOTAL REVENUE
  Total revenue rises         then declines
    with price to a
P        point...
                        TR




                  D
                  Q          Quantity Demanded
PRICE ELASTICITY & TOTAL REVENUE
  Total revenue rises         then declines
    with price to a
P        point...
                        TR




 Total Revenue Test


                  D
                  Q          Quantity Demanded
PRICE ELASTICITY & TOTAL REVENUE
  Total revenue rises         then declines
    with price to a
P        point...
                        TR




      Inelastic
      Demand      D                    Inelastic
                                       Demand
                  Q          Quantity Demanded
PRICE ELASTICITY & TOTAL REVENUE
  Total revenue rises         then declines
    with price to a
P        point...
                        TR




  Elastic
  Demand

      Inelastic
      Demand      D          Elastic   Inelastic
                             Demand    Demand
                  Q          Quantity Demanded
PRICE ELASTICITY & TOTAL REVENUE
  Total revenue rises         then declines
    with price to a
P        point...
                        TR




  Elastic                          Unit
                                  Elastic
  Demand

      Inelastic
      Demand      D          Elastic   Inelastic
                             Demand    Demand
                  Q          Quantity Demanded
ECONOMIC COSTS
                               Profits to an          Profits to an
                                Economist             Accountant
                                                  T
Economic (opportunity) Costs




                                   Economic       O
                                     Profit       T
                                                  A       Accounting
                                                  L         Profit
                                 Implicit costs
                                  (including a
                                                  R
                                 normal profit)
                                                  E
                                                  V
                                    Explicit             Accounting
                                                  E
                                     Costs
                                                  N     costs (explicit
                                                  U      costs only)
                                                  E
SHORT-RUN PRODUCTION
       RELATIONSHIPS
Law of Diminishing Returns
           Total Product, TP


                                                   Total Product


                                                     Increasing
                                                      Marginal
Average Product, AP, and




                               Quantity of Labor
 Marginal Product, MP




                                                       Returns

                                                   Average
                                                   Product
                                                   Marginal
                               Quantity of Labor   Product
SHORT-RUN PRODUCTION
       RELATIONSHIPS
Law of Diminishing Returns
           Total Product, TP


                                                   Total Product


                                                   Diminishing
                                                    Marginal
Average Product, AP, and




                               Quantity of Labor     Returns
 Marginal Product, MP




                                                   Average
                                                   Product
                                                   Marginal
                               Quantity of Labor   Product
SHORT-RUN PRODUCTION
       RELATIONSHIPS
Law of Diminishing Returns
           Total Product, TP



                                                   Total Product


                                                      Negative
                                                      Marginal
Average Product, AP, and




                               Quantity of Labor
 Marginal Product, MP




                                                      Returns

                                                   Average
                                                   Product
                                                   Marginal
                               Quantity of Labor   Product
UTILITY MAXIMIZING COMBINATION

Algebraic Restatement of the
  Utility Maximization Rule

MU of product A       MU of product B

   Price of A
                  =      Price of B

    8 Utils              16 Utils

      $1
                  =         $2
PRODUCTIVITY AND COST CURVES




   Average product and
    marginal product
                                                AP
                                              MP
                              Quantity of labor
                                                  MC
            Costs (dollars)




                                                       AVC




                              Quantity of output
LONG-RUN PRODUCTION COSTS
Unit Costs




                        Output
LONG-RUN PRODUCTION COSTS
Unit Costs




                        Output
LONG-RUN PRODUCTION COSTS


             The long-run ATC just “envelopes”
               all of the short-run ATC curves.
Unit Costs




                            Output
LONG-RUN PRODUCTION COSTS
Unit Costs




                             long-run ATC


                        Output
ECONOMIES AND
  DISECONOMIES OF SCALE
•Labor Specialization
•Managerial
 Specialization
•Efficient Capital
• Other Factors
Diseconomies of Scale
Constant Returns to Scale
           graphically presented...
ECONOMIES AND
             DISECONOMIES OF SCALE

             Economies
              of scale
Unit Costs




                           long-run ATC

                         Output
ATC decreases as    ATC is constant as
     Output increases    Output increases




             Economies   Constant returns
              of scale      to scale
Unit Costs




                                      long-run ATC

                                Output
ATC decreases as    ATC is constant as   ATC increases as
             Output increases    Output increases     Output increases




              Economies         Constant returns        Diseconomies
               of scale            to scale                of scale
Unit Costs




                                            long-run ATC

                                      Output
MARGINAL REVENUE-MARGINAL COST APPROACH

 Profit Maximization Position
                      $200
                                  Economic Profit    MC
                      150
 Cost and Revenue




                    $131.00                          MR
                                                     ATC
                      100                            AVC
                     $97.78


                       50


                        0
                              1 2 3 4 5 6 7 8 9 10
MARGINAL REVENUE-MARGINAL COST APPROACH

 Profit Maximization Position
                      $200
                                  Economic Profit    MC
                      150
 Cost and Revenue



                    $131.00                          MR
MR = MC                                              ATC
   100                                               AVC
Optimum
  $97.78

Solution
    50


                        0
                              1 2 3 4 5 6 7 8 9 10
MARGINAL REVENUE-MARGINAL COST APPROACH

 Short-Run Shut Down Point
                     $200
                                                        MC
                     150
 Cost and Revenue




                                                        ATC
                     100                                AVC
                    $71.00                                 MR
                      50                        Minimum AVC
                                              is the Shut-Down
                                                     Point
                       0
                             1 2 3 4 5 6 7 8 9 10
SHORT-RUN COMPETITIVE EQUILIBRIUM
       The Competitive Firm “Takes” its
       Price from the Industry Equilibrium
                                             S= MCs
   P                                P
          Economic
        ATC Profit S=MC

$111                        D    $111



                           AVC
                                                   D
                      8     Q             8000     Q
             Firm                       Industry
           (price taker)
SHORT-RUN COMPETITIVE EQUILIBRIUM
       The Competitive Firm “Takes” its
       Price from the Industry Equilibrium
                                           S= MCs
   P                              P
          Economic
        ATC Profit S=MC

$111
           How about the
                 D             $111

             long-run?
                AVC
                                                 D
                      8    Q            8000     Q
             Firm                     Industry
           (price taker)
PROFIT MAXIMIZATION IN THE LONG RUN
Temporary profits and the reestablishment
of long-run equilibrium
                                                      S1
  P                                    P
                            MC
      ATC


$60                                  $60
 50                                   50
 40                         MR        40



                                                           D1

                  100            Q          100,000        Q
              Firm                         Industry
            (price taker)
PROFIT MAXIMIZATION IN THE LONG RUN
An increase in demand increases profits…
        Economic                                      S1
  P      Profits                       P
                            MC
      ATC


$60                                  $60
 50                                   50
 40                         MR        40
                                                            D2

                                                           D1

                  100            Q          100,000        Q
              Firm                         Industry
            (price taker)
PROFIT MAXIMIZATION IN THE LONG RUN
New competitors increase supply, and lower
prices decrease economic profits.
    Zero Economic                                 S1
  P                                P                   S2
        Profits MC
      ATC


$60                              $60
 50                               50
 40                         MR    40
                                                        D2

                                                       D1

                  100        Q          100,000        Q
              Firm                     Industry
            (price taker)
PROFIT MAXIMIZATION IN THE LONG RUN
Decreases in demand, losses, and the
reestablishment of long-run equilibrium
                                                      S1
  P                                    P
                            MC
      ATC


$60                          MR      $60
 50                                   50
 40                                   40



                                                           D1

                  100            Q          100,000        Q
              Firm                         Industry
            (price taker)
PROFIT MAXIMIZATION IN THE LONG RUN
A decrease in demand creates losses…
        Economic                                      S1
  P      Losses                        P
                            MC
      ATC


$60                          MR      $60
 50                                   50
 40                                   40



                                                           D1
                                                       D2
                  100            Q          100,000        Q
              Firm                         Industry
            (price taker)
PROFIT MAXIMIZATION IN THE LONG RUN
Competitors with losses decrease supply, and
prices return to zero economic profits.S3
     Return to Zero                                   S1
  P Economic Profits                   P
                            MC
      ATC


$60                          MR      $60
 50                                   50
 40                                   40



                                                           D1
                                                       D2
                  100            Q          100,000        Q
              Firm                         Industry
            (price taker)
MARGINAL REVENUE-MARGINAL COST APPROACH

 Loss Minimization Position
                     $200
                                 Economic Loss      MC
                     150
 Cost and Revenue




                                                    ATC
                     100                            AVC
                    $91.67
                    $81.00                          MR
                      50


                       0
                             1 2 3 4 5 6 7 8 9 10
MONOPOLY REVENUES & COSTS
                         Elastic
            $200


             150
  Dollars

             200


              50               MR                              D
                                                                      Q
                    T
                   0 1   2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18


            $750
  Dollars




             500
                                                             TR
             250

                                                                   Q
                   0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18
MONOPOLY REVENUES & COSTS
                                    Elastic              Inelastic
                        $200


                         150                                                        Inelastic
              Dollars                                                               Portion
                         200                                                        MR is Negative

A Monopolist will 50                      MR                             D
always operate on                                                               Q
the Elastic Portion            0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18

of the Demand
                   $750
Curve
              Dollars




                         500
                                                                       TR
                         250

                                                                             Q
                               0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18
OUTPUT AND PRICE DETERMINATION
Profit Maximization Under Monopoly
           Remember the MR=MC Rule?
              200


                                 175                              Profit
                                                                  Per Unit
Price, costs, and revenue




                                 150
                                                                                     MC
                            $122 125

                             $94 100
                                           Profit                                    ATC
                                  75
                                                                                      D
                                  50


                                  25            MR = MC
                                                                                 MR
                                                                                          Q
                                       0    1   2   3     4   5   6    7     8   9   10
OUTPUT AND PRICE DETERMINATION
Profit Maximization Under Monopoly
                                 200


                                 175                              Profit
                                                                  Per Unit
Price, costs, and revenue




                                 150
                                                                                     MC
                            $122 125

                             $94 100
                                           Profit                                    ATC
                                  75
                                                                                      D
                                  50


                                  25            MR = MC
                                                                                 MR
                                                                                          Q
                                       0    1   2   3     4   5   6    7     8   9   10
OUTPUT AND PRICE DETERMINATION
     Loss Minimization Under Monopoly
                                200                               Loss
                                          Since Pm exceeds AVC,   Per Unit
                                175
                                          the firm will produce
Price, costs, and revenue




                                150                                                  MC
                            A                                                         ATC
                              125 Loss
                            Pm                                                         AVC
                                100
                            V
                                 75
                                                                                       D
                                 50


                                 25            MR = MC
                                                                                 MR
                                                                                           Q
                                      0    1   2   3     4   5    6   7      8   9    10
                                                             Qm
OUTPUT AND PRICE DETERMINATION
     Loss Minimization Under Monopoly
                                200                              Loss
                                                                 Per Unit

                            What are the
                                175
Price, costs, and revenue




                                150       MC
                            Economic Effects AVC
                            A
                            Pm125 Loss
                                            ATC

                            of Monopoly?
                            V
                                100


                                 75
                                                                                     D
                                 50


                                 25           MR = MC
                                                                                MR
                                                                                         Q
                                      0   1   2   3     4   5    6   7      8   9   10
                                                            Qm
INEFFICIENCY OF PURE MONOPOLY
     P An industry in pure competition S = MC
       sells where supply and
       demand are equal
                                    At MR=MC
                                    A monopolist
                                    will sell less
                                    units at a
Pm                                  higher price
                                    than in
Pc                                  competition




                                                 D
                               MR
                                                     Q
                 Qm       Qc
INEFFICIENCY OF PURE MONOPOLY
     P                        S = MC

                           At MR=MC
                           A monopolist
                           will sell less
                           units at a
Pm                         higher price
                           than in
Pc                         competition

  Monopoly pricing effectively
creates an income transfer from
      buyers to the seller!   D
                      MR
                                            Q
            Qm   Qc
REGULATED MONOPOLY
                  P   Dilemma of Regulation
                       MR = MC Which Price?

                              Fair-Return Price
Price and Costs



              Pm
                                   Socially-Optimum
                                   Price
              Pf                              ATC
              Pr                            MC

                                               D
                              MR
                         Qm     Qf   Qr           Q
MONOPOLISTIC COMPETITION
                         AND EFFICIENCY
                            Long-Run Equilibrium       MC
                                       Price is Not
                                       = Minimum        ATC
                                           ATC
                   P3
                  = A3
Price and Costs




                         Price  MC


                                                            D
                                                  MR
                                         Q3
                                      Quantity
MONOPOLISTIC COMPETITION
      AND EFFICIENCY
• Not Productively Efficient
    Minimum ATC
• Not Allocatively Efficient
       Price  MC
• Excess Capacity
            Graphically…
OLIGOPOLY BEHAVIOR
            A Game-Theory Overview
                                 RareAir’s Price Strategy

                                     High             Low


                                 A     $12         B        $15
                          High
Uptown’s Price Strategy




                                 $12                $6


                                 C     $6          D        $8
                          Low

                                 $15                $8
OLIGOPOLY BEHAVIOR
            A Game-Theory Overview
                                 RareAir’s Price Strategy

                                     High             Low


                                 A     $12         B        $15    Greatest
                                                                  Combined
                          High                                      Profit
Uptown’s Price Strategy




                                 $12                $6


                                 C     $6          D        $8
                          Low

                                 $15                $8
OLIGOPOLY BEHAVIOR
            A Game-Theory Overview
                                 RareAir’s Price Strategy

                                     High             Low


                                 A     $12         B        $15   Independent
                                                                     Actions
                          High                                      Stimulate
Uptown’s Price Strategy




                                 $12                $6             Response




                                 C     $6          D        $8
                          Low

                                 $15                $8
OLIGOPOLY BEHAVIOR
            A Game-Theory Overview
                                 RareAir’s Price Strategy

                                     High             Low


                                 A     $12         B        $15   Independent
                                                                     Actions
                          High                                      Stimulate
Uptown’s Price Strategy




                                 $12                $6             Response


                                                                  Gravitating
                                 C     $6          D        $8      to the
                          Low                                     Worst Case

                                 $15                $8
OLIGOPOLY BEHAVIOR
            A Game-Theory Overview
                                 RareAir’s Price Strategy

                                     High             Low

                                                                  Collusion
                                 A     $12         B        $15   Invites a
                                                                  Different
                          High                                    Solution.
Uptown’s Price Strategy




                                 $12                $6


                                 C     $6          D        $8
                          Low

                                 $15                $8
OLIGOPOLY BEHAVIOR
            A Game-Theory Overview
                                 RareAir’s Price Strategy

                                     High             Low

                                                                  Collusion
                                 A     $12         B        $15   Invites a
                                                                  Different
                          High                                    Solution.
Uptown’s Price Strategy




                                 $12                $6


                                 C     $6          D        $8
                          Low

                                 $15                $8
OLIGOPOLY BEHAVIOR
            A Game-Theory Overview
                                 RareAir’s Price Strategy

                                     High             Low

                                                                   Collusion
                                 A     $12         B        $15    Invites a
                                                                   Different
                          High                                     Solution.
Uptown’s Price Strategy




                                 $12                $6
                                                                     But, the
                                                                    incentive
                                                                     to cheat
                                 C     $6          D        $8    is very real.
                          Low

                                 $15                $8
PURELY COMPETITIVE LABOR
                         MARKET EQUILIBRIUM
                                              S
                                                                  Includes
                                                                   Normal
                                                                    Profit
Wage Rate (dollars)




                                                        Non-
                                                        Labor
                                                        Costs         S = MRC
                  Wc                   $10         Wc                          ($10)


                                                          Labor
                                       D = MRP
                                                          Costs
                                       ( mrp’s)

                                                                     d = mrp
                                 (1000)                         (5)
                       Quantity of Labor                 Quantity of Labor

                        Labor Market                     Individual Firm
PURELY COMPETITIVE LABOR
                         MARKET EQUILIBRIUM
                                              S
                                                               Includes
                                                                Normal
                          Marginal Resource                      Profit
Wage Rate (dollars)




                          Cost (MRC) will be
                                           Non-
                                           Labor

                  Wc
                         constant and W Costs to
                                 $10
                                         equal     c
                                                                   S = MRC
                                                                            ($10)
                            resource price
                            (the wage rate)
                                 D = MRP
                                             Labor
                                             Costs
                                       ( mrp’s)

                                                                  d = mrp
                                 (1000)                       (5)
                       Quantity of Labor               Quantity of Labor

                        Labor Market                   Individual Firm
MONOPSONISTIC
                      LABOR MARKET
                                               S
Wage Rate (dollars)




                                            In monopsony
                                            MRC lies above
                                           the supply curve.



                       Quantity of Labor
MONOPSONISTIC
                           LABOR MARKET
                                       MRC
                                                S
Wage Rate (dollars)


                                                MRP = MRC

                      Wm
                                                MRP
                                                Qm units of
                                                labor hired
                                  Qm
                            Quantity of Labor
MONOPSONISTIC
                           LABOR MARKET
                                       MRC
                                                  S


                                                 The competitive
Wage Rate (dollars)


                                                 solution would
                                                result in a higher
                      Wc                        wage and greater
                      Wm                          employment.
                                                   MRP




                                  Qm Qc
                            Quantity of Labor
OPTIMAL AMOUNT OF A PUBLIC GOOD
 P
$9                             S

 7                        Yields the
                     optimum amount
                     of the public good
 5
                     MB = MC
 3

 1                              DC

                                   Q
     0   1   2   3    4       5
THE LORENZ CURVE
                    100
                               Lorenz Curve
                                (actual distribution)
                     80

                              Perfect Equality
Percent of Income




                     60

                               Lorenz curve
                              after taxes and                Area between
                     40
                                 transfers                  the lines shows
                                                             the degree of
                                                           income inequality
                     20                                    Complete
                                                           Inequality


                          0
                                    20          40    60        80        100
                                          Percent of Families

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AP Micro Final Exam Review

  • 2. PRICE ELASTICITY OF DEMAND The Price-Elasticity Coefficient and Formula Percentage change in quantity demanded of product X Ed = Percentage change in price of product X Or equivalently… change in quantity demanded of X Ed = Original quantity demanded of X  Change in price of X Original price of X
  • 3. PRICE ELASTICITY OF DEMAND Extreme Cases Perfectly Inelastic Demand P D1 Ed = 0 0 Q Perfectly Elastic Demand P D2 Ed =  0 Q
  • 4. PRICE ELASTICITY & TOTAL REVENUE When prices are So is total revenue low, P TR D Q Quantity Demanded
  • 5. PRICE ELASTICITY & TOTAL REVENUE Total revenue rises with price to a P point... TR D Q Quantity Demanded
  • 6. PRICE ELASTICITY & TOTAL REVENUE Total revenue rises then declines with price to a P point... TR D Q Quantity Demanded
  • 7. PRICE ELASTICITY & TOTAL REVENUE Total revenue rises then declines with price to a P point... TR D Q Quantity Demanded
  • 8. PRICE ELASTICITY & TOTAL REVENUE Total revenue rises then declines with price to a P point... TR Total Revenue Test D Q Quantity Demanded
  • 9. PRICE ELASTICITY & TOTAL REVENUE Total revenue rises then declines with price to a P point... TR Inelastic Demand D Inelastic Demand Q Quantity Demanded
  • 10. PRICE ELASTICITY & TOTAL REVENUE Total revenue rises then declines with price to a P point... TR Elastic Demand Inelastic Demand D Elastic Inelastic Demand Demand Q Quantity Demanded
  • 11. PRICE ELASTICITY & TOTAL REVENUE Total revenue rises then declines with price to a P point... TR Elastic Unit Elastic Demand Inelastic Demand D Elastic Inelastic Demand Demand Q Quantity Demanded
  • 12. ECONOMIC COSTS Profits to an Profits to an Economist Accountant T Economic (opportunity) Costs Economic O Profit T A Accounting L Profit Implicit costs (including a R normal profit) E V Explicit Accounting E Costs N costs (explicit U costs only) E
  • 13. SHORT-RUN PRODUCTION RELATIONSHIPS Law of Diminishing Returns Total Product, TP Total Product Increasing Marginal Average Product, AP, and Quantity of Labor Marginal Product, MP Returns Average Product Marginal Quantity of Labor Product
  • 14. SHORT-RUN PRODUCTION RELATIONSHIPS Law of Diminishing Returns Total Product, TP Total Product Diminishing Marginal Average Product, AP, and Quantity of Labor Returns Marginal Product, MP Average Product Marginal Quantity of Labor Product
  • 15. SHORT-RUN PRODUCTION RELATIONSHIPS Law of Diminishing Returns Total Product, TP Total Product Negative Marginal Average Product, AP, and Quantity of Labor Marginal Product, MP Returns Average Product Marginal Quantity of Labor Product
  • 16. UTILITY MAXIMIZING COMBINATION Algebraic Restatement of the Utility Maximization Rule MU of product A MU of product B Price of A = Price of B 8 Utils 16 Utils $1 = $2
  • 17. PRODUCTIVITY AND COST CURVES Average product and marginal product AP MP Quantity of labor MC Costs (dollars) AVC Quantity of output
  • 20. LONG-RUN PRODUCTION COSTS The long-run ATC just “envelopes” all of the short-run ATC curves. Unit Costs Output
  • 21. LONG-RUN PRODUCTION COSTS Unit Costs long-run ATC Output
  • 22. ECONOMIES AND DISECONOMIES OF SCALE •Labor Specialization •Managerial Specialization •Efficient Capital • Other Factors Diseconomies of Scale Constant Returns to Scale graphically presented...
  • 23. ECONOMIES AND DISECONOMIES OF SCALE Economies of scale Unit Costs long-run ATC Output
  • 24. ATC decreases as ATC is constant as Output increases Output increases Economies Constant returns of scale to scale Unit Costs long-run ATC Output
  • 25. ATC decreases as ATC is constant as ATC increases as Output increases Output increases Output increases Economies Constant returns Diseconomies of scale to scale of scale Unit Costs long-run ATC Output
  • 26. MARGINAL REVENUE-MARGINAL COST APPROACH Profit Maximization Position $200 Economic Profit MC 150 Cost and Revenue $131.00 MR ATC 100 AVC $97.78 50 0 1 2 3 4 5 6 7 8 9 10
  • 27. MARGINAL REVENUE-MARGINAL COST APPROACH Profit Maximization Position $200 Economic Profit MC 150 Cost and Revenue $131.00 MR MR = MC ATC 100 AVC Optimum $97.78 Solution 50 0 1 2 3 4 5 6 7 8 9 10
  • 28. MARGINAL REVENUE-MARGINAL COST APPROACH Short-Run Shut Down Point $200 MC 150 Cost and Revenue ATC 100 AVC $71.00 MR 50 Minimum AVC is the Shut-Down Point 0 1 2 3 4 5 6 7 8 9 10
  • 29. SHORT-RUN COMPETITIVE EQUILIBRIUM The Competitive Firm “Takes” its Price from the Industry Equilibrium S= MCs P P Economic ATC Profit S=MC $111 D $111 AVC D 8 Q 8000 Q Firm Industry (price taker)
  • 30. SHORT-RUN COMPETITIVE EQUILIBRIUM The Competitive Firm “Takes” its Price from the Industry Equilibrium S= MCs P P Economic ATC Profit S=MC $111 How about the D $111 long-run? AVC D 8 Q 8000 Q Firm Industry (price taker)
  • 31. PROFIT MAXIMIZATION IN THE LONG RUN Temporary profits and the reestablishment of long-run equilibrium S1 P P MC ATC $60 $60 50 50 40 MR 40 D1 100 Q 100,000 Q Firm Industry (price taker)
  • 32. PROFIT MAXIMIZATION IN THE LONG RUN An increase in demand increases profits… Economic S1 P Profits P MC ATC $60 $60 50 50 40 MR 40 D2 D1 100 Q 100,000 Q Firm Industry (price taker)
  • 33. PROFIT MAXIMIZATION IN THE LONG RUN New competitors increase supply, and lower prices decrease economic profits. Zero Economic S1 P P S2 Profits MC ATC $60 $60 50 50 40 MR 40 D2 D1 100 Q 100,000 Q Firm Industry (price taker)
  • 34. PROFIT MAXIMIZATION IN THE LONG RUN Decreases in demand, losses, and the reestablishment of long-run equilibrium S1 P P MC ATC $60 MR $60 50 50 40 40 D1 100 Q 100,000 Q Firm Industry (price taker)
  • 35. PROFIT MAXIMIZATION IN THE LONG RUN A decrease in demand creates losses… Economic S1 P Losses P MC ATC $60 MR $60 50 50 40 40 D1 D2 100 Q 100,000 Q Firm Industry (price taker)
  • 36. PROFIT MAXIMIZATION IN THE LONG RUN Competitors with losses decrease supply, and prices return to zero economic profits.S3 Return to Zero S1 P Economic Profits P MC ATC $60 MR $60 50 50 40 40 D1 D2 100 Q 100,000 Q Firm Industry (price taker)
  • 37. MARGINAL REVENUE-MARGINAL COST APPROACH Loss Minimization Position $200 Economic Loss MC 150 Cost and Revenue ATC 100 AVC $91.67 $81.00 MR 50 0 1 2 3 4 5 6 7 8 9 10
  • 38. MONOPOLY REVENUES & COSTS Elastic $200 150 Dollars 200 50 MR D Q T 0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 $750 Dollars 500 TR 250 Q 0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18
  • 39. MONOPOLY REVENUES & COSTS Elastic Inelastic $200 150 Inelastic Dollars Portion 200 MR is Negative A Monopolist will 50 MR D always operate on Q the Elastic Portion 0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 of the Demand $750 Curve Dollars 500 TR 250 Q 0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18
  • 40. OUTPUT AND PRICE DETERMINATION Profit Maximization Under Monopoly Remember the MR=MC Rule? 200 175 Profit Per Unit Price, costs, and revenue 150 MC $122 125 $94 100 Profit ATC 75 D 50 25 MR = MC MR Q 0 1 2 3 4 5 6 7 8 9 10
  • 41. OUTPUT AND PRICE DETERMINATION Profit Maximization Under Monopoly 200 175 Profit Per Unit Price, costs, and revenue 150 MC $122 125 $94 100 Profit ATC 75 D 50 25 MR = MC MR Q 0 1 2 3 4 5 6 7 8 9 10
  • 42. OUTPUT AND PRICE DETERMINATION Loss Minimization Under Monopoly 200 Loss Since Pm exceeds AVC, Per Unit 175 the firm will produce Price, costs, and revenue 150 MC A ATC 125 Loss Pm AVC 100 V 75 D 50 25 MR = MC MR Q 0 1 2 3 4 5 6 7 8 9 10 Qm
  • 43. OUTPUT AND PRICE DETERMINATION Loss Minimization Under Monopoly 200 Loss Per Unit What are the 175 Price, costs, and revenue 150 MC Economic Effects AVC A Pm125 Loss ATC of Monopoly? V 100 75 D 50 25 MR = MC MR Q 0 1 2 3 4 5 6 7 8 9 10 Qm
  • 44. INEFFICIENCY OF PURE MONOPOLY P An industry in pure competition S = MC sells where supply and demand are equal At MR=MC A monopolist will sell less units at a Pm higher price than in Pc competition D MR Q Qm Qc
  • 45. INEFFICIENCY OF PURE MONOPOLY P S = MC At MR=MC A monopolist will sell less units at a Pm higher price than in Pc competition Monopoly pricing effectively creates an income transfer from buyers to the seller! D MR Q Qm Qc
  • 46. REGULATED MONOPOLY P Dilemma of Regulation MR = MC Which Price? Fair-Return Price Price and Costs Pm Socially-Optimum Price Pf ATC Pr MC D MR Qm Qf Qr Q
  • 47. MONOPOLISTIC COMPETITION AND EFFICIENCY Long-Run Equilibrium MC Price is Not = Minimum ATC ATC P3 = A3 Price and Costs Price  MC D MR Q3 Quantity
  • 48. MONOPOLISTIC COMPETITION AND EFFICIENCY • Not Productively Efficient  Minimum ATC • Not Allocatively Efficient Price  MC • Excess Capacity Graphically…
  • 49. OLIGOPOLY BEHAVIOR A Game-Theory Overview RareAir’s Price Strategy High Low A $12 B $15 High Uptown’s Price Strategy $12 $6 C $6 D $8 Low $15 $8
  • 50. OLIGOPOLY BEHAVIOR A Game-Theory Overview RareAir’s Price Strategy High Low A $12 B $15 Greatest Combined High Profit Uptown’s Price Strategy $12 $6 C $6 D $8 Low $15 $8
  • 51. OLIGOPOLY BEHAVIOR A Game-Theory Overview RareAir’s Price Strategy High Low A $12 B $15 Independent Actions High Stimulate Uptown’s Price Strategy $12 $6 Response C $6 D $8 Low $15 $8
  • 52. OLIGOPOLY BEHAVIOR A Game-Theory Overview RareAir’s Price Strategy High Low A $12 B $15 Independent Actions High Stimulate Uptown’s Price Strategy $12 $6 Response Gravitating C $6 D $8 to the Low Worst Case $15 $8
  • 53. OLIGOPOLY BEHAVIOR A Game-Theory Overview RareAir’s Price Strategy High Low Collusion A $12 B $15 Invites a Different High Solution. Uptown’s Price Strategy $12 $6 C $6 D $8 Low $15 $8
  • 54. OLIGOPOLY BEHAVIOR A Game-Theory Overview RareAir’s Price Strategy High Low Collusion A $12 B $15 Invites a Different High Solution. Uptown’s Price Strategy $12 $6 C $6 D $8 Low $15 $8
  • 55. OLIGOPOLY BEHAVIOR A Game-Theory Overview RareAir’s Price Strategy High Low Collusion A $12 B $15 Invites a Different High Solution. Uptown’s Price Strategy $12 $6 But, the incentive to cheat C $6 D $8 is very real. Low $15 $8
  • 56. PURELY COMPETITIVE LABOR MARKET EQUILIBRIUM S Includes Normal Profit Wage Rate (dollars) Non- Labor Costs S = MRC Wc $10 Wc ($10) Labor D = MRP Costs ( mrp’s) d = mrp (1000) (5) Quantity of Labor Quantity of Labor Labor Market Individual Firm
  • 57. PURELY COMPETITIVE LABOR MARKET EQUILIBRIUM S Includes Normal Marginal Resource Profit Wage Rate (dollars) Cost (MRC) will be Non- Labor Wc constant and W Costs to $10 equal c S = MRC ($10) resource price (the wage rate) D = MRP Labor Costs ( mrp’s) d = mrp (1000) (5) Quantity of Labor Quantity of Labor Labor Market Individual Firm
  • 58. MONOPSONISTIC LABOR MARKET S Wage Rate (dollars) In monopsony MRC lies above the supply curve. Quantity of Labor
  • 59. MONOPSONISTIC LABOR MARKET MRC S Wage Rate (dollars) MRP = MRC Wm MRP Qm units of labor hired Qm Quantity of Labor
  • 60. MONOPSONISTIC LABOR MARKET MRC S The competitive Wage Rate (dollars) solution would result in a higher Wc wage and greater Wm employment. MRP Qm Qc Quantity of Labor
  • 61. OPTIMAL AMOUNT OF A PUBLIC GOOD P $9 S 7 Yields the optimum amount of the public good 5 MB = MC 3 1 DC Q 0 1 2 3 4 5
  • 62. THE LORENZ CURVE 100 Lorenz Curve (actual distribution) 80 Perfect Equality Percent of Income 60 Lorenz curve after taxes and Area between 40 transfers the lines shows the degree of income inequality 20 Complete Inequality 0 20 40 60 80 100 Percent of Families