Microeconomics Cheat Sheet

Macroeconomics: studies the economy as a system in which feedbacks among sectors determine national output, employment and prices Microeconomics: the study of individual behaviour in the context of scarcity Markets: play a key role in coordinating the choices of individuals with the decisions of business |_ improves efficiency, trading of skills and goods Mixed economy: goods and services are supplied both by private suppliers and government Model: formalization of theory that facilitates scientific enquiry Theory: logical view of how things work through observation |_ transform theory into model to test the theory Opportunity cost: choice of what must be sacrificed when a choice is made Production Possibility Frontier (PPF): the combination of goods that can be produced using all the resources available Quantity For 36 hours: Amanda = 3 fish/h & 2 vegetables/h Zoe = 2 fish/h & 4 vegetables/h |_ 12F or 18V = 3:2 opportunity cost 18F or 9V = 1:2 opportunity cost Vegetable 18 Vegetable Amanda specialize Has absolute advantage With specialization and trade they consume along the line joining specialization points Amanda’s PPF 9 Zoe’s PPF 12 6 Terms of trade: 1:1 18 Zoe specializes, Has absolute advantage 18 18 Fish Fish Amanda consumes: {8, 10} Zoe consumes: {10, 8} Amanda initially consumes: {6,9} Zoe initially consumes: {9, 4.5} Economy-wide PPF: set of good combinations that can be produced in the economy when all available productive resources are in use Economy-wide PPF Vegetable With complete specialization the Vegetable economy can produce 27V or a 27 a 30F Opportunity 18 c 18, 18 cost of Muti Person PPF Most efficient fish producer b a price reduction/rise for a related product reduces/increases the demand for a primary product : a price reduction/rise for a related product increases/reduces the demand for a primary product I demand falls in response to higher incomes demand increases in response to higher incomes Influences of Demand: prices of related goods, buyer incomes, expectations Influences of Supply: technology, input costs, competing products Market Interventions Price controls: government rules or laws that inhibit the formation of market-determined prices sets price above suppliers the market clearing price cannot legally charge more than a specific price Tax Incidence with Elastic Supply Price P Shift inwards = economic recession Producer P P Quantity Q e 30 Fish Rent Alex $900 Q Demand: P = 1000 - 100Q Supply: P = 250 + 50Q Brian Cathy Equilibrium Don $500 Lynn CS=400 CS=300 CS=200 CS=100 Evan PS=200 PS=150 PS=100 PS=50 Jeff Kirin Ian $300 Gladys Frank Heward Quantity Measuring Surplus Alex P E Don Excess supply at P E Fish Ian Q Q Q : physical restrictions on output. Reduces supply and increases price Price Price Demand A + B E Demand B Demand A Quantity Gladys Jeff Frank Heward Quantity Q Market demand: horizontal sum of individual demands S = supply with quota P Lynn Evan Kirin $500 Quantity Quantity Productivity of Labour: output per worker or per hour, depends on: |_ skill, knowledge and experience of the labour force |_ capital stock: buildings, machinery & equipment |_ technological trends in labour force and capital stock Economy output (Y): Y = (# of workers) x (output/worker) Full Employment Output (Yc): |_ Yc = (# of workers at full employment) x (output/worker) Economic recession: output falls below the economy’s capacity output Economic Boom: period of high growth that raises output above capacity output Q Cathy P d Quantity Q Welfare economics: how well the economy allocates its scarce resources in accordance with the goals of efficiency and equity Equity: how society’s goods and rewards are distributed among members Efficiency: how well the economy resources are used and allocated Consumer surplus (demand): excess of consumer willingness to pay over the market price Producer surplus (supply): excess of market price over the reservation price of the supplier $300 18 Supplier pays P Buyer pays P Incidence is on supplier P P P $900 P Excess demand at P E P 12 Price Supplier increases price Supplier pays P Buyer pays P Incidence is on buyer Buyer Brian Shift outwards = economic boom 9 Tax Incidence with Inelastic Supply Price Rent Price c Zoe’s PPF 10 Elasticities and Tax Incidence Specific tax: involves a fixed dollar levy per unit of good sold Ad Valorem: percentage tax Next most efficient fish producer producing fish Amanda’s PPF Marketplace: buyers and sellers come together to exchange Demand: quantity of a good or service that buyers wish to purchase at each possible price Supply: quantity of a good or service that sellers are willing to sell at each possible price Quantity Demanded: amount purchased at a particular price Quantity Supplied: amount supplied at a particular price * All other influences on supply and demand remain the same Equilibrium Price: price when quantity demanded equals quantity Price Demand: P = 10 - Q supplied Supply: P = 1 + 0.5Q Excess Excess supply: when quantity 10 supply Supply supplied exceeds the quantity above 4 Outward shift = increased demand demanded at the going price Excess demand: when Rightward shift = 4 Demand quantity demanded exceeds increased supply Excess the quantity supplied at the demand below 4 going price 1 Efficient market: maximizes the sum of producer and consumer surpluses. (Marginal benefit (demand) = marginal cost (supply)) Tax Wedge: difference between consumer and producer prices Revenue Burden: amount of tax revenue raised by tax Excess Burden/Deadweight Loss: the component of consumer and producer surpluses forming a net loss to the whole economy The efficiency cost of taxation Taxation and labour supply Wage Price Depends on elasticity Quantity Q Q Tax wedge percentage change in quantity demanded Variables: measures that can take on different values Price elasticity percentage change in price Data: recorded values of variables of demand |_ time series: measurements made at different points in time Use average |_ high/low frequency: series with short/long intervals between for these observations |_ cross-section: values for different variables recorded at a point in time Arc Elasticity of Demand: consumer responsiveness over a |_ longitudinal: follow the same units of observation through segment or arc of the demand curve time Limiting Cases of Elasticity Elasticity Variation with Linear Demand absolute value of current x 100 Price Index number: value of a Index = D Zero Price absolute value of base elasticity variable or average of a Elastic range Infinite Price index = (oil index x 0.6) + (natural set of variables with elasticity Midpoint of D (unit elastic) respect to the base value gas index x 0.25) + (coal index x 0.15) Quantity Quantity Externality: benefit or cost falling on people other than those involved in the activity’s market. It can create a difference between private costs or values and social costs or values Negative Externalities and Inefficiency Additional cost Full social supply cost Positive Extenalities Price Full social cost Subsidy D Inelastic range Inflation rate: annual % increase in consumer price index Deflation rate: annual % decrease in consumer price index Quantity Consumer Price Index: average level for consumer CPI = cost of basket in current year x 100 Point Elasticity of Demand: elasticity cost of basket in base year goods and services computer at a point on the demand curve Nominal earnings: earnings measured in current dollars Real earnings: earnings measure in constant dollars to adjust for changes in the general price level Nominal Price Index: current dollar price of a good or service Real Price Index: nominal nominal index x 100 price index divided by the Real Index = CPI consumer price index Econometrics: examining and quantifying relationships between economic variables Regression line: average relationship between two variables in a scatter diagram Intercept of a Line: height of the line on one axis when the value of the variable on the other access is zero Slope of a Line: ratio of the of change in variables P : objective explanation of economy Normative economics (values): offers recommendations Economic Equity: concerned with the distribution of well-being among members of the economy Economics: ideas and methods for betterment of society |_ markets facilitate exchange and encourage efficiency |_ incentives, humans are not purely mercenary Price Total Expenditure = P x Q Elastic P P Expenditure is greatest Midpoint In elastic region reducing price increases total expenditure In inelastic region reducing price decreases total expenditure Inelastic Quantity Q Q Q Q Time horizon and inflation: long run = elastic, short run = inelastic Cross-price % change in quantity demanded elasticity of % change in price of other product demand Substitutes if positive, complements if negative Income elasticity of demand % change in quantity demanded % change in income importance of government policy, governments can best address abuses of (Necessity) monopolies. Provides a legal framework for a mixed economy. Support (Luxury good) efficient market function through competition policy, education, international * all of this applies to elasticity of supply trade, taxes, welfare Private value Quantity Inverted slope of demand curve Influences of Elasticity: tastes, ease of substituting goods, one brand with substitutes = elastic, group of products = inelastic, products with no substitutes = inelastic P P Private supply cost D’ Large elasticity * Fix: corrective tax: direct the market towards a more efficient output Other Market Failures: profit seeking monopolies, public goods i.e. radio, national defence, health, international externalities Environmental Policy and Climate Change Greenhouse Gases: accumulate excessively in the earth’s atmosphere prevent heat from escaping Kyoto Protocol: committed themselves to reducing GHG emissions relative to 1990 by 2012, Canada’s target of 6% reduction in GHGs Economic Policies for Climate Change Three ways to control polluters: direct controls (warn big emitters), incentives (pollution taxes) or tradable “permits” to pollute Marginal Damage Curve: costs to society of an addition unit of pollution Marginal abatement curve: costs to society of reducing quantity of pollution by one unit Pollution cost Marginal Damage Marginal abatement cost Optimal level of pollution Pollution quantity A can ask for permits from B = ‘cap and trade’ system In an ideal world permits could be traded internationally between developed and developing countries Corrective taxes are called Pigovian taxes = tax package reform, reduce taxes in other sectors of the economy to main revenue neutral impact Cardinal utility: measurable concept of satisfaction Total utility: measure of the total satisfaction derived from consuming a given amount of goods and services |_ increase at a diminishing rate (each extra unit consumed yields less utility Sole Proprietorship: single owner of a business Partnership: business owned jointly by two or more individuals, who share in the profits and are jointly responsible for losses Corporation/Company: organization with a legal identity separate from its owner that produces and trades Marginal utility/$ Shareholders: invest in corporations and therefore are owners. Marginal utility: addition to total They have limited liability personally if the firm incurs losses utility created when more unit Dividends: payments made from after-tax profits to company of a good is consumed shareholders Utils Consumer Equilibrium: Capital gains/losses: an individual sells a share at a price higher/ fully spent budget in a lower than when the share was purchased manner that yields the Limited liability: the liability of the company is limited to the value of greatest utility the company’s assets Visits to mountain Retained earnings: profits retained by a company for reinvestment and not distributed as dividends Law of Demand: other things being equal, more of a good is Principal or owner: delegates decisions to an agent or manager demanded at a lower price Ordinal utility: assumes that Agent: a manager who works in a corporation and is directed to individuals can rank commodity follow the corporation’s interests bundles with a level of Principal-agent problem: principal cannot easily monitor actions of satisfaction the agent who therefore many not act in the best interests of the principal (a) different combinations of goods and services yield equal satisfaction Stock option: option to buy the stock of the company at a future (b) combinations of goods and services yield date for a fixed, predetermined price more satisfaction than other combinations Fair gamble: gain or loss will be zero if played a large number of Budget Constraint times All bundles of goods that the consumer can afford at a budget Risk: associated with an investment can be measured by the Ex: income: $200, $30 snowboard & $20 jazz dispersion of possible outcomes. A greater dispersion in outcomes Snowboarding implies more risk Risk-averse: person will refuse a fair gamble, regardless of the dispersion in outcomes Non-affordable Risk-neutral: person is interested only in whether the odds yield a set profit on average and ignores dispersion in possible outcomes * As economists, profit maximization accurately describes a firm’s Affordable set objective. They use capital, labor & human expertise to produce a Jazz good or supply a service. * People have diminishing marginal utility so losing $1000 is a lot Tastes & Indifference Snowboarding less utility than gained by winning $1000 L is preferred to R since more of each good is Risk Pooling: means reducing risk and increasing utility by consumed at L, while points such as V are less preferred than R. Points W and T contain more of aggregating or pooling multiple independent risks one good and less of the other than R. W Consequently, we cannot say if they are preferred Risk Spreading: insurers spread the potential cost among other to R without knowing how the consumer trades insurers the goods off R Jazz Total Utility Risk-averse T Indifference curve: combinations of goods and services that yield the same level of satisfaction to the consumer Indifference map: set of indifference curves where curves further from origin denote a higher level of satisfaction Snowboarding Further from origin = higher level of satisfaction Negatively sloped: more of one good is less of the other Don’t intersect Reflect a diminishing rate of substitution Wont give up as much SB since don’t have as much Jazz Marginal Rate of Substituion (MC/CR): slope of indifference curve. Defines the amount of one good the consumer is willing to sacrifice to obtain a given increment of the other Optimization: highest level of satisfaction possible Snowboarding Consumer Optimum: where the budget constraint equals the MRS at one point Budget constraint Not attainable Attainable Eliminating uncertainty improves utility by $(2500-x) Snowboarding Normal goods Substitution effect: price change is the response of demand to a relative price change that maintains the consumer on initial indifference curve Income effect: price change is the response of demand to the change in real income that moves the individual from the initial level to a new level of utility Inferior goods Jazz Subsidy Programs Income Transfer Other goods Price Subsidy Other goods Increases consumption of daycare and other goods unless one is inferior Daycare Consumers spend more on daycare than other goods Total cost Variable cost productivity highest when costs are least Fixed cost Output Marginal Cost: the cost of producing each addition unity of output MC cuts AVC and ATC at the minimum If MC < ATC then ATC decreases If MC > ATC then ATC increases * same applies for AVC Sunk cost: fixed cost that has already been incurred and cannot be recovered even by producing a zero output (R&D) * Production costs almost always decline when the scale of the operation initially increases = economies of scale Fixed capital Increasing returns to scale (IRS): when all inputs are increased by a given proportion, output increases more than proportionately Constant returns to scale (CRS): output increases in direct proportion to an equal proportion increase in all inputs Region of Decreasing returns to scale: equal proportionate DRS increase in all inputs leads to a less than proportionate increase in output More capital CRS Region of IRS Minimum efficient scale MES Long-run average total cost: lower envelope of all short-run ATC curves (LTC = long run total costs) Minimum efficient scale: threshold size of operation such that scale economies are almost exhausted Long run marginal cost: increment in cost associated with producing one more unit of output when all inputs are adjusted in a cost minimizing manner L eturns to scale Minimum CRS Technological change and LAC DRS MES increases Output Bond: results from borrowing. Suppose you lend $100 with a return rate of 4%. 4% is the nominal rate of return, if the inflation rate is 1.5% then the real rate of return is 2.5% Real return: nominal return minus rate of inflation Real return on corporate stock: sum of dividend plus capital gain, adjusted for inflation Capital Market: set of financial institutions that funnels financing from investors into bonds and stocks Portfolio: combination of assets that is designed to secure an income from investing and to reduce risk Diversification: reduces the total risk of portfolio by pooling risks across several different assets whose individual returns behave independently Variance: weighted sum of the deviations between all possible outcomes and the mean, squared |_ mutual funds decrease volatility (variance) of investments Cost LMC LAC IRS Risk neutral utility curve Jazz Adjusting to income changes: outward shift of budget constraint, can attain a higher level of satisfaction Adjusting to price changes: lower level of satisfaction because of less purchasing power Income and Price Adjustments Cost ($) Cost Diminishing marginal utility exists, the average or expected utility of the event is less than the utility associated with the average or expected dollar outcome Uncertainty Fixed costs: costs that are independent of the level of outputs (capital) Variable costs: related to output produced (labor & materials) Total costs: sum of fixed cost and variable cost Average Fixed cost: total fixed cost per unit output Average Variable cost: total variable cost per unit output Average total cost: sum of all costs per unit of output LAC post technology change Output Technological change: innovation that can reduce the cost of production or bring new products on line Globalization: tendency for international markets to be ever more integrated Cluster: group of firms producing similar products or research Learning by doing: reduces costs Economies of scope: unit cost of producing particular products is less when combined with the production of other products than when produced alone Perfectly Competitive: industry is one in which many suppliers producing an identical product face many buyers and no one can influence the market Profit maximization: goal of competitive suppliers, they seek to maximize the difference between revenues and costs Price taking behaviour: no one firm can impact market price by altering its own price or output level Market characteristics: must be many firms each small and powerless relative to the entire industry, product is standardized. Buyers have full information about product and price, free entry and exit of firms. Demand curve for each supplier is horizontal and downward sloping for whole industry Marginal revenue: additional revenue to the firm resulting from the sale of one more unit of output In perfect competition P = MC = MR Production function: technological relationship that specifies how much output can be produced with specific amounts of inputs Technological efficiency: maximum output is produced with a given set of inputs (no waste) Economic efficiency: production structures that produces output at Price least cost Breakeven point Short run: period during which at least one factor of production is fixed. If capital is fixed then more output is produced by using Supplier should produce Demand facing additional labour. in short run if fixed costs are sunk individual firm Long run: period of time that is sufficient to enable all factors of production to be adjusted Shutdown point Very long run: period sufficiently long for new technology to develop Quantity Totat product Q = f(L): relationship between total output (Q) Shut-down price: minimum value of the AVC curve produced and the number of workers (L) employed for a given Break-even price: minimum of the ATC curve amount of capital Short-run supply curve: portion of the MC curve above minimum of AVC Output Total Product Curve Law of diminishing returns: increments Industry Equilibrium Price Deriving Industry Supply Price of a variable factor (labor) are added to a fixed amount of another factor S = sum of firm MC Market (capital), the marginal product of the curves Both firms equilibrium variable factor must eventually decline supply Daycare Labor Output Intersect when AP is peak Labor Marginal Product of Labour: addition to output produced by each additional worker. Slope of total product curve Average Product of Labour: number of units of output produced per unit of labor at different levels of employment If MP > AP then AP increases If MP < AP then AP decreases Only firm A supplies D = sum of individual demands Quantity Quantity Normal Profits: required to induce suppliers to supply their goods and services. Reflects opportunity costs and can be considered as a type of cost component Economic (supernormal) Profits: profits above normal profits that induce firms to enter an industry. Economic profits are based on opportunity cost of the resources used in production. Accounting Profits: difference between revenues and actual costs incurred Plant size in the long run With demand conditions defined by D and MR the optimal plant size is one corresponding to point MR=MC in the long run. Q1 is optimal output if plant size AC1 and Q2 is optimal output if plant size is AC2 Profit = Quantity Long-run equilibrium: competitive industry required a price equal to to the minimum point of a firm’s ATC. At this point only normal profits exists, no incentives for firms to enter or exit Entry of firms due to economic profits Price S = sum of existing firms MC curves S’ = Sum of new and existing firms MC curves If companies were incurring losses then the firms would cease production, closures would reduce aggregate supply and the supply curve would move upwards. Long term equilibrium would be the same. Firms with least cost production will survive Small Bigger Very large Many Few One Long run MC for DWL = ABF monopolist = long run industry S for perfect competition, assuming CRS A monopolist maximized profit at QM. Here the value of marginal output exceeds cost. If output expands to Q* a gain arises equal to area ABF. This is the deadweight loss associated with the output QM rather than Q*. If the monopolist’s long-run MC is equivalent to a competitive industry’s supply curve then the DWL is the cost of having a monopoly instead of a PC market Quantity N-firm concentration ratio: sales share of the largest N firms in the sector of the economy Price discrimination: charging different prices to different consumers Monopolistic Competition Differentiated product: one that differs slightly from other products in the in order to increase profit same market |_ seller must segregate the market at a reasonable cost. |_ resale must be impossible or impractical Equilibrium for a monopolistic competitor * reduces DWL associated with a monopoly seller D0 is the initial $ demand facing a representative firm Price discrimination at the movies At P=12, 50 prime age individuals demand movie tickets at P=5, 50 more seniors and youth demand tickets. Since MC is zero the efficient output is where the demand curve takes a zero value, where all 100 customers purchase tickets. Saves a DWL of $250 Cost Long-run dynamics Initial short-run supply New short-run supply Losses Equilibrium long-run price = minimum of long-run AC = longrun supply curve Economic profits Quantity Efficient output = C Pricing in segregated markets Quantity Price Segregate customers = several groups With two separate markets defined by DA and DB a profit maximizing strategy is to produce where MC = MRA = MRB and discriminate between the two markets by charging prices PA and PB Increasing and decreasing cost industries Increasing cost LR supply curve Constant cost LR industry supply curve Decreasing cost LR industry supply curve Increasing/decreasing cost: industry where costs rise/fall for each firm because of the scale of industry operation Small Bigger Very large a cost structure defined by the LAC1 this market has space for many firms, perfect or monopolistic competition. If costs corresponds to LAC2 where scale economies are substantial, there many be space for just one producer. LAC3 = oligopoly. Quantity Firm B cannot compete with Firm A in the long run given that B has a less efficient plant size than firm A. The equilibrium long-run price equals the minimum of the LAC Ability to Affect Price Entry Barriers None None Demand, costs and market structure $ Monopoly Output Inefficiency Economic profits Economic profits will induce new entrepreneurs to set up shop and Normal profits start producing Number of Firms Very many * demand and cost interact to determine the number of market participants Quantity Short run profits for the firm Price Competition Perfect Imperfect Monopolistic Oligopoly Monopoly Quantity Monopolistic competitive equilibrium: long run requires the firm’s demand curve to be tangent to the ATC curve at the output where MR=MC, P = ATC Oligopoly and Games Collusion: explicit or implicit agreement to avoid competition with a view to increasing profit |_ example: cooperating to form a cartel Conjecture: belief that one firm forms about strategic reaction of another competing firm Game: situation in which contestants plan strategically to maximize their profits taking account of rivals’ behaviour |_ the firms are the players and their payoffs are their profits Strategy: game plan describing how a player acts or moves in each possible situation Nash equilibrium: each player chooses the best strategy given the strategies chosen by the other player and there is no incentive for the other play to move Dominant strategy: player’s best strategy, whatever the strategies adopted by rivals Payoff Matrix: rewards to each player resulting from particular choices Perfect Price Discrimination Total revenue for the perfect price discriminator = OABQ* Profits exist at the initial equilibrium {q0, P0}. Hence, new firms enter and reduce the share of the total market faced by each firm, thereby shifting back their demand curve. A final equilibrium is reach when economic profits are eliminated at AC = PE and MR = MC Kate’s choice A monopolist who can sell each unit at a different price maximizes profit by producing Q*. With each consumer Contribute Laze If will contributes Kate’s maximizing choice involves lazing: she gets 6 units Will’s Contribute 5,5 If will decides to be lazy Kate’s 2,6 Globalization and Technological Change paying a different price the demand best interest is to be lazy for 3 Choice Nash The cost structure of many firms has been reduced to curve becomes the MR curve. The result units of happiness 6,2 equilibrium 3,3 Laze outsourcing to lower-wage economies, increases the minimum is that the monopoly DWL is eliminated The dominant strategy is for Kate & Will to be lazy regardless of either of them do because the efficient output is produced efficient scale for many industries, eliminated industries in the and the monopolist appropriates all the developing world If Will contributes Kate should consumer surplus Kate’s choice Efficient Resource Allocation contribute for 5 units Laze Contribute If Will lazes, Kate should lazy for Where the demand and supply prices are equal. If demand is Contribute 5,5 3 units 0,4 a measure of marginal benefit and supply is a measure of Cartel: a group of suppliers that collude to operate like a monopolist Will’s Choice marginal cost then a perfectly competitive market insures that Cartelizing a competitive industry 3,3 Laze 4,0 this condition will hold in equilibrium. Perfect competition results in resources between uses efficiently Assume MC for There is no dominant strategy, results in two equilibrium one at {5,5} and one at {3,3} If MC is the joint supply curve of the monopolist is the industry supply for perfect competition Scale economies define some industries production and cost structure up to very high output levels and the whole market might be supplied by a single firm. Natural monopoly: one where ATC of producing any output declines with scale of operation. Maintaining Barriers to Entry Patents and copyrights granted by government, predatory pricing (drive out potential competition), political lobbying (subsidies to prevent entry), critical networks, some products require large up-front investments cartel, profits are maximized at the output QM where MC=MR. In contrast if these firms operate competitively output increases to QC Can make a binding commitment to agree to both contribute at {5,5} Duopoly and Cournot Games Cournot behaviour: each firm reacting optimally in their choice of output to their competitors’ output decisions Reaction function: the optimal choice of output conditional upon a rival’s output choice (optimize profit) Price When one firm B chooses a specific output qB1 Market demand Cartel Instability (ILLEGAL) then A’s residual demand DAR is the difference Depends on the authority that the governing body of the cartel can between the market demand and qB1. A’s profit exercise over its members and the degree of info it has on is maximized at qA1 where MC=MRar. This is an optimal reaction by A to B’s choice. For all operation of members. Instability lies in the fact that each individual possible choices of B, A can form a similar member of the cartel has an incentive to increase its output, it is Fixed cost and constant marginal cost optimal response difficult to restict all members from doing so Cost Rent Seeking: activity that uses productive resources to One billion dollar A company who avoids R&D Quantity investment redistribute rather than create output and value would have a LAC equal to A’s output LMC and would undecut initial |_lobbying and bribing of politicians (loan guarantees maintain developer of the drug marketing board) |_ most prevalent in monopolies when economic profit is greatest, A’s reaction function RA additional cost borne by the producer and increases costs Equilibrium at RA = RB Technology and Innovation B’s reaction function Invention: discovery of a new product or process through research Constant MC RB Product innovation: new or better products or services Quantity Process Innovation: new or better production or supply Demand, marginal revenue and total revenue Price |_ resource allocation in monopolies is offset by the greater MR has twice the slope of tendency for monopoly firms to invent and innovate B’s output demand |_ Patent laws: grant inventors a legal monopoly on use for a fixed Mid point of D: price elasticity = -1, TR is Profit maximization period of time (10-15 years). Raise incentive to conduct R&D but max and MR = 0 happens when MC = MR Monopolist: MC = MR, Perfect Competitor: P = MC, Duopolist: in between do not establish a monopoly in the long-run always lies on elastic Individual firm output = market output under competitive behaviour / (N+1) segment of demand curve Ex: in a duopoly N=2 and competitive output = 18, yields a firm output of 6 Entry, Exit & Potential Competition Quantity Imperfect Competition: face a downward-sloping demand curve and Firms who enter the industry do it if there are enough profit. If potential their output price reflects the quantity sold Monopoly Equilibrium Monopolist’s Choice of Plant Size new firm has the same marginal and fixed costs by entering the market Oligopoly: an industry with a small number of suppliers will now be split three ways. This may squeeze the profit margins of all With CTS doubling output elastic portion involves doubling costs Monopolistic competition: market with many sellers of products that three suppliers to such an extent that the operating margins are no longer have similar characteristics. Monopolistically competitive firms can sufficient to cover fixed costs exert only a small influence on the whole market Deterring entry: make costly investments to scare competitors, advertising Profit Duopoly: market or sector with just two firms to build brand loyalty Quantity Trade Issues Agricultural protections: protects developed economy farmers, hurts farmers from Least Developed Countries (LDC) Globalization: outsource manufacturing to LDCs Access to markets: NAFTA & EU trade agreements Absolute advantage: one economy uses fewer inputs than another economy to produce a good or service Principle of Comparative Advantage: if one country has an absolute advantage in producing both goods, gains to specialization and trade still materialize, provided the opportunity cost of producing the goods differs between economies Comparative advantage - production Comparative advantage - consumption Vegetable Vegetable US Specializes 8 US PPF Terms of trade 1V for 6F US Specializes 8 US initial consumption Total production 35V and 8F 5 5 18,5 Canada’s initial consumption 17,3 Canada PPF Canada specializes 35 40 Fish Canada specializes 35 40 Fish Comparative advantage shows gains to trade are to be reaped by an efficient economy, by trading with an economy that may be less efficient in producing each good Terms of trade: the rate at which goods trade internationally Consumption possibility frontier: what an economy can consume after production specialization and trade Trade Barriers: tariffs, subsidies and quotas Tariff: tax on an imported product that is designed to limit trade in addition to generating tax revenue. Quota: quantitative limit on an imported product Trade subsidy: domestic manufacturer reduces the domestic cost and limits imports Non-tariff barriers: product content requirements, limit the At a word price of $10 the domestic gains from trade Tariffs and trade Price Domestic demand P=$12 P=$10 quantity demanded is QD. The amount QS is supplied by domestic producers and the remainder by foreign producers. A tariff increases the world price to $12. This reduces demand to QD’, the modestic component of supply increases to QS’. The total loss in consumer surplus (LFGJ), tariff World supply revenue (EFHI), increased surplus for including tariff domestic suppliers (LECJ), and the $2 tariff deadweight loss is the sum of triangles A and B. World supply curve Quantity Domestic supply Subsidies and Trade Price Qs is supplied domestically and (Qd - Qs) by foreign suppliers. A per-unit subsidy to domestic suppliers shift the supply World supply curve to S’, and increases curve their market share to Qs’ S - domestic supply S’ - domestic supply with subsidy Quantity Quotas and trade Price World supply curve Quota Quantity At the world price P plus a quota the supply curve becomes RCUV. This has three segments: (i) domestic suppliers who can supply below P, (ii) quota and (iii) domestic suppliers who can only supply at a price above P. The quota equilibrium is at T with price Pdom and quantity traded Qd’. The free trade equilibrium is at G. Of the amount Qd’ quota is supplied by foreign suppliers and the remainder by domestic suppliers. The quota increases the price in the domestic market Government gets no tax revenue from quotas