Micro Review!

Efficiency Loss of a Tax Q P Price (Per Bottle) Quantity (Millions of Bottles Per Month) S D S’ Tax $2 Tax Paid by Consumers Tax Paid by Producers Efficiency Loss (or Deadweight Loss) 17-2

3 Tax Incidence (Who pays?) D D D D D Perfectly Inelastic Relatively Inelastic Unit Elastic Relatively Elastic Perfectly Elastic Tax burden paid entirely by consumers Tax burden mostly on consumers Tax burden shared by consumers and producers Tax burden mostly on producers Tax burden paid entirely by producers SSTST SSTST SSTST SSTST SSTST Copyright ACDC Leadership 2015

Efficiency Revisited Productive and allocative efficiency D S Price (Per Bag) P1P1 Q1Q1 Quantity (Bags) Consumer Surplus Producer Surplus Equilibrium Price = $8 6-4

Are Price Controls Good or Bad? To be “efficient” a market must maximize consumers and producers surplus Price CEILING Q P D S PcPc QeQe Q ceiling DEAD WEIGHT LOSS The Lost CS and PS. INEFFICIENT! CS PS 5 Copyright ACDC Leadership 2015

Are Price Controls Good or Bad? To be “efficient” a market must maximize consumers and producers surplus Price FLOOR Q P D S PcPc QeQe Q floor DEAD WEIGHT LOSS INEFFICIENT! Not Maximizing CS and PS CS PS 6 Copyright ACDC Leadership 2015

Graphing Utility Total Utility (Utils) Marginal Utility (Utils) (1) Tacos Consumed Per Meal (2) Total Utility, Utils (3) Marginal Utility, Utils ] ] ] ] ] ] ] TU MU Total Utility Marginal Utility Units Consumed Per Meal 7-7 Let’s go to… How many tacos will you eat? What KEY piece of information are we missing?

Utility Maximizing Rule The consumer’s money should be spent so that the marginal utility per dollar of each goods equal each other. MUx = MUy 8 P x P y You use this rule subconsciously every day! Copyright ACDC Leadership 2015

If you only have $40, what combination of movies and go carts maximizes your utility? Utility Maximization # Times Going Marginal Utility (Movies) MU/P (Price =$10) Marginal Utility (Go Carts) MU/P (Price =$5) 1st nd rd th $10$5 3 Movies and 2 Go Carts Copyright ACDC Leadership 2015

# of Workers (Input) Total Product(TP) PIZZAS Marginal Product(MP) Average Product(AP) Identify the three stages of returns Increasing Marginal Returns Decreasing Marginal Returns Negative Marginal Returns

Total Product, TP Marginal Product, MP TP MP AP Increasing Marginal Returns Diminishing Marginal Returns Negative Marginal Returns Law of Diminishing Returns 8-11

Profit Accounting profit – Total revenue less explicit cost Normal profit – Equal to implicit cost Economic or pure profit – Total revenue less economic cost 8-12

Profits Compared Economic Profit Accounting Costs (Explicit Costs Only) Accounting Profit Explicit Costs Implicit Costs (Including a Normal Profit) Economic (Opportunity) Costs Total Revenue Economic Accounting 8-13

Total Costs FC = Total Fixed Costs VC = Total Variable Costs TC = Total Costs Per Unit Costs AFC = Average Fixed Costs AVC = Average Variable Costs ATC = Average Total Costs MC = Marginal Cost Different Economic Costs 14 Copyright ACDC Leadership 2015

Total Cost Curves Quantity TC Fixed Cost VC FC FC + VC = TC $10 15 Costs Copyright ACDC Leadership 2015

AVC ATC $20 $18 $16 $14 $12 $10 $8 $6 $4 $ MC 16 Costs AFC Copyright ACDC Leadership 2015 Average Fixed Cost ATC and AVC get closer and closer but NEVER touch Quantity

Average Product and Marginal Product Cost (Dollars) Graphical Relationships MP AP MC AVC Quantity of Output Quantity of Labor Production Curves Cost Curves 8-17

Shifts in Cost Curves Practice: Which curves shift and how? – Decrease in union wage requirements? AVC, ATC, MC shift DOWN – Increase in rent? AFC, ATC, shift UP – Increase in cost of materials? AVC, ATC, MC shift UP – More efficient production technology is discovered? AVC, ATC, MC shift DOWN

Long-Run ATC Curve Average Total Costs ATC-1 ATC-2 ATC-3 ATC-4 ATC-5 Output Any number of short-run optimum size cost curves can be constructed 8-19

Long-Run ATC Curve Long-Run ATC Average Total Costs ATC-1 ATC-2 ATC-3 ATC-4 ATC-5 Output The long-run ATC curve just “envelopes” the short run ATCs 8-20

Long Run AVERAGE Total Cost 21 Quantity Cars Costs , ,000 1,000,0000 Long Run Average Cost Curve Economies of Scale Constant Returns to Scale Diseconomies of Scale Copyright ACDC Leadership 2015

Profit Maximization Profit = Total Cost = Fixed Cost + Variable Cost Fixed vs. Variable… examples? – Fixed – rent, loan payments, utilities – Variable – labor, raw materials Firms want TR > TC… But how do they maximize this profit? MARGINAL ANALYSIS!!!! Total Revenue - Total Cost

Profit maximization Marginal Cost = ∆ Price of Inputs / ∆ Output MC = ∆ Variable Cost/ ∆ Quantity Marginal Revenue = MC and MR are PER UNIT measurements Profit Maximization: -As long as MR > MC, producers will continue to produce. -Reach the point where MR = MC Production Function.notebook Price each unit is sold for

Perfect Competition Monopoly Monopolistic Competition Oligopoly Characteristics of Perfect Competition: Many small firms Identical products (perfect substitutes) Low Barriers- Easy for firms to enter and exit the industry Seller has no need to advertise Firms are “Price Takers” The seller has NO control over price. Imperfect Competition 24 Copyright ACDC Leadership 2015 Four Market Structures

Perfect Competition LRATC Example: – Agriculture Output

P Q Demand P Q 10,000 D S Industry Firm (price taker) $7 26 ATC MC Perfect Competition Lets put costs and revenue together to calculate profit. Copyright ACDC Leadership 2015

Total Revenue =$63 $ MC ATC How much output should be produced? How much is Total Revenue? How much is Total Cost? Is there profit or loss? How much? MR=D=AR=P Total Cost=$45 Profit = $18 27 Q P Copyright ACDC Leadership 2015

Total Revenue=$35 Cost and Revenue MC ATC How much output should be produced? How much is Total Revenue? How much is Total Cost? Is there profit or loss? How much? MR=D=AR=P Total Cost = $42 Loss =$7 $ Q

Short-Run Supply Curve P1P1 0 Cost and Revenues (Dollars) Quantity Supplied MR 1 P2P2 MR 2 P3P3 MR 3 P4P4 MR 4 P5P5 MR 5 MC AVC ATC Q2Q2 Q3Q3 Q4Q4 Q5Q5 a b c d e MC Above AVC Becomes the Short-Run Supply Curve S Examine the MC for the Competitive Firm Break-even (Normal Profit) Point Shut-Down Point (If P is Below) Firms produce where MR=MC 9-29

P Q P Q 5000 D S Industry Firm (price taker) $15 Side-by-side graph for perfectly completive industry and firm in the LONG RUN 30 MR=D ATC MC 8 Is the firm making a profit or a loss? Why? Copyright ACDC Leadership 2015

Single FirmMarket Price Quantity 0 0 Long-Run Equilibrium P MR D S QeQe QfQf ATC Productive Efficiency: Price = minimum ATC Allocative Efficiency: Price = MC Pure competition has both in its long-run equilibrium What about in the short run? MC P=MC=Minimum ATC (Normal Profit) P 9-31

Perfect Competition Monopoly Monopolistic Competition Oligopoly Four Market Structures Characteristics of Monopoly: One large firm (the firm is the market) Unique product (no close substitutes) High Barriers- Firms cannot enter the industry Monopolies are “Price Makers” Some advertising – why? Examples: The Electric Company, De Beers 32 Copyright ACDC Leadership 2015

Pure Monopoly LRATC Examples: – Allegheny Power – Monsanto

$ $ Price Total Revenue Monopoly Revenue ElasticInelastic Demand and Marginal-Revenue Curves Total-Revenue Curve D MR TR A monopoly will only produce in the elastic range of it’s Demand Curve!! Why?

Profit Maximization 0 $ Price, Costs, and Revenue Quantity D MR ATC MC MR=MC P m =$122 A=$94 Economic Profit Conclusion: A monopolist produces where MR=MC, but charges the price consumers are willing to pay identified by the demand curve.

Where is CS and PS for a monopoly? 36 Monopolies vs. Perfect Competition Allocative Efficiency Q P D S = MC MR PmPm QmQm CS PS Total surplus falls. Now there is DEADWEIGHT LOSS Copyright ACDC Leadership 2015 Monopolies underproduce and over charge, decreasing CS and increasing PS.

Perfect Competition vs. Monopoly Allocative Efficiency

0 Price and Costs (Dollars) Quantity Dilemma of Regulation Monopoly Price Fair-Return Price Socially Optimal Price (No DWL) PrPr D r f b a PfPf PmPm QmQm QfQf QrQr MR MC ATC Regulated Monopoly What is the problem with the socially optimal price? Why does this problem exist? Economies of Scale…

Characteristics of Monopolistic Competition: Relatively Large Number of Sellers Differentiated Products Some control over price Easy Entry and Exit (Low Barriers) A lot of non-price competition (Advertising) 39 Perfect Competition Pure Monopoly Monopolistic Competition Oligopoly Pure Monopoly Monopolistic Competition Oligopoly Copyright ACDC Leadership 2015

Monopolistic Competition LRATC Examples: – Restaurants – Clothing Stores (as well as most retail…)

D MR MC 41 Q P LONG-RUN EQUILIBRIUM ATC Q LR P LR Quantity where MR =MC up to Price = ATC

D MR MC 42 Q P Long- Run Equilibrium ATC Q LR P LR Not Allocatively Efficient because P  MC Not Productively Efficient because not producing at Minimum ATC Q Socially Optimal Copyright ACDC Leadership 2015 Q Prod Efficient

FOUR MARKET MODELS Characteristics of Oligopolies: A Few Large Producers (Less than 10) Homogeneous or Differentiated Products High Barriers to Entry Control Over Price (Price Maker) Mutual Interdependence Firms use Strategic Pricing Perfect Competition Pure Monopoly Monopolistic Competition Oligopoly Copyright ACDC Leadership

Oligopoly LRATC Examples: – Cell Service – Cars

Because firms are interdependent There are 3 types of Oligopolies 1. Price Leadership (no graph) 2. Colluding Oligopoly 3. Non Colluding Oligopoly Copyright ACDC Leadership

D Q If this firm increases it’s price, other firms will ignore it and keep prices the same P PePe QeQe As the only firm with high prices, Qd for this firm will decrease a lot ( Q e to Q 1 ) P1P1 Q1Q1 Elastic Copyright ACDC Leadership Non- Collusive Oligopoly

Perfectly Competitive Labor Market Characteristics: Many small firms are hiring workers No one firm is large enough to manipulate the market. Many workers with identical skills Wage is constant Workers are wage takers Firms can hire as many workers as they want at a wage set by the industry 48 Perfect Competition Monopsony Resource Markets Copyright ACDC Leadership 2015

SLSL DLDL Wage Q Q IndustryFirm QEQE WEWE QeQe D L =MRP S L =MRC Wage is set by the market Demand/MRP falls Copyright ACDC Leadership

50 Profit Maximizing Rule for Combining Resources MRPx = MRPy = MRCx MRCy 1 This means that the firm is hiring where MRP = MRC for each resource x and y Copyright ACDC Leadership 2015 The least cost rule can be used to minimize cost at any output, but only one output maximizes profits.

Imperfect Competition: Monopsony Characteristics: One firm hiring workers The firm is large enough to manipulate the market Workers are relatively immobile Firm is wage maker To hire additional workers the firm must increase the wage Examples: Central American Sweat Shops Midwest small town with a large Car Plant NCAA 51 Perfect Competition Monopsony Resource Markets Copyright ACDC Leadership 2015

SLSL Wage QEQE WEWE D L =MRP MRC Monopsony If the firm can’t wage discriminate, where is MRC? Copyright ACDC Leadership 2015

The Four Market Failures We will focus on four different market failures: 1.Public Goods 2. Externalities (third person side effects) 3. Monopolies 4. Unfair (inefficient?) distribution of income In each of the above situations, the government steps in to allocate resources efficiently. 53 Copyright ACDC Leadership 2015

P Q D=MSB S=MPC Q Free Market 54 Market for Cigarettes MSC Q Optimal At Q FM the MSC is greater than the MSB. Too much is being produced so there is deadweight loss If the market produces Q FM why is it a market failure? Overallocation Copyright ACDC Leadership 2015

P Q 55 Underallocation S = MSC Marginal Social Benefit Q FM Q Optimal At Q FM the MSC is less than the MSB. Too little is being produced Market for Flu Shots Copyright ACDC Leadership 2015

Percent of Families Percent of Income Perfect Equality Lorenz Curve (actual distribution) 56 The Lorenz Curve The size of the banana shows the degree of income inequality Copyright ACDC Leadership 2015

Gini Ratios Gini Ratio by country Gini Ratio by state

Three Types of Taxes 1. Progressive Taxes -takes a larger percent of income from high income groups (takes more from rich people). Ex: Current Federal Income Tax system 3. Regressive Taxes –takes a larger percentage from low income groups (takes more from poor people). Ex: Sales tax; any consumption tax. 2. Proportional Taxes (flat rate) –takes the same percent of income from all income groups. Ex: 20% flat income tax on all income groups 58