Microeconomics Final Exam Review Sheet Part 4

○ When prices increases, total revenue increases ○ When price decreases, total revenue decreases ● Unit Elastic Demand- equal to 1 ○ When price increases/decreases, total revenue does not change ● Price Elasticity of Demand- The responsiveness or sensitivity of consumers to price change ○ If consumers are relatively sensitive to price changes → Demand = Elastic Formula: Ed = % change in quantity demanded of X % change in price of X Ed > 1 → Elastic Ed = 1 → Unit Elasticity Ed < 1 → Inelastic ● Perfectly Inelastic Demand- Graphically shown as a line parallel to the Y- Axis ● Perfectly Elastic Demand- Graphically shown as a line parallel to the X- Axis ● Elasticity varies at different price ranges on a demand curve, tending to be elastic in the upper - left segment and inelastic in the lower-right segment ● If total revenue (TR) changes in the opposite direction from price is elastic ● If TR changes in the same direction price is inelastic ● If TR is constant/unchanged price is unit elastic ● Factors that affect Price Elasticity of Demand- 1. Number of Available Substitutes ○ The larger the # of substitutes the greater the elasticity 2. Size of an item’s relative price to one’s budget ○ The higher the price of a good relative to a consumer’s income the greater elasticity 3. Luxury vs Necessity ○ Luxury > Necessity = greater elasticity 4. Length of time to adjust ○ The longer time period the more elastic ● Elasticity of Supply- Depends on how easily producers can shift resources between alternative uses ○ The easier and more rapidly producers can shift resources the greater the price elasticity of supply Formula: ES = % change in quantity supplied of X % change in price of X ● The ease of shifting resources between alternative uses varies directly with the time producers have to adjust to a price ● Cross Elasticity of Demand- Indicates how sensitive the purchase of one product is to changes in price of another product Formula: EXY = % change in quantity demanded of X % change in price of Y ● Positive Cross Elasticity = Substitute Goods ● Negative Cross Elasticity = Complementary Goods ● Income Elasticity of Demand- Indicates the responsiveness of consumer purchases to a change in income Formula: EI = % change in quantity demanded of X % change in price of Income ● Positive = Normal Goods ● Negative = Inferior Goods ○ Industries that sell products that have high income elasticity of demand are particularly hard hit by recessions Microeconomics of Product Markets● Accounting Profit- Total Revenue - Explicit Costs ● Normal Profit - Total Revenue - Total Costs = 0 ● Economic Cost- The value or worth that the resource would have had in its best alternative use Economic Profit = tr- Explicit Costs - implicit Costs ● Explicit Costs- actual dollar payments ○ Examples: rent, electricity, fuel, and transportation services ● Implicit Costs- the opportunity costs to a firm of using resources owned by the firm itself ● Short Run- at least one input is fixed ○ Firm can use its plant more or less intensively by adding or subtracting units of variable resources ■ Does not have sufÏcient time in the short run to alter plant size ● Law of Diminishing Returns- What happens to output as a fixed plant is used more intensively ○ As successive units of a variable resource such as labor are added to a fixed plant, beyond some point the marginal product (MP) associated with each additional unit of resource declines ● Marginal Product- Δ Q / ΔL ● Fixed Inputs- Independent on the level of output; Inputs can’t be changed in a short period of time ● Variable Inputs- Vary with output; Inputs can be changed quickly Total Cost = Fixed Costs + Variable Costs ● Average fixed costs, average variable costs, and average totals costs → fixed, variable, and total costs per unit of output ● Average Fixed Costs (AFC)- Declines continuously as output increases because a fixed sum is being spread over a larger and larger number of units of production ○ U Shaped- Reflecting increasing returns followed by diminishing returns Average Fixed Costs = Total Fixed Costs Output (Q) Average Total Costs (ATC)= Average Fixed Costs + Average Variable Costs ● Also U shaped ● Marginal Costs (MC)- The amount by which TC and TVC change when one more or one less unit of output it produced MC =Δ L / Δ Q ○ Intersects the ATC and AVC curves ■ Lower resource prices shift cost curves downward, as does technological progress ■ Higher input prices shift cost curves upward ● Long Run- A period of time sufÏciently long for a firm to vary the amounts of all resources used, all costs are variable ○ Long Run ATC curve is U shaped ● Economies of Scale- Increasing the size of the firm leads to a decrease in Average Cost ○ First encountered as a small firm expands ○ Greater specialization in the use of labor and management, the ability to use the most efÏcient equipment, and the spreading of start-up costs among more units of output contribute to economies of scale ● Diseconomies of Scale- Increasing the size of the firm leads to an increase in Average Cost ○ Stemming from the managerial complexities that accompany large scale production ● Minimum EfÏcient Scale- The lowest level of output at which it can minimize its long run Average Cost ○ Occurs at such low levels of output that numerous firms can populate the industry Pure Competition in the Short Run● Four Basic Market1. Pure Competition- Involves a very large number of firms producing a standardized product ○ Assumes that firms and resources are mobile among different industries ■ No single firm can influence market price which means that the firm’s demand curve is perfectly elastic ● Profit = Marginal Revenue (MR) ○ Short Run Profit Maximization■ Compare Total Revenue (TR) and Total Costs (TC) ■ A firm maximizes its short run profit by producing output at which TR > TC ○ Profit Maximization using MR and MC■ A competitive firm maximizes it profits or minimizes it loss in the SR by producing output at with MR = MC ■ If AVC > P=AR a competitive firm minimizes losses by shutting down ■ If AVC < P < ATC a competitive firm minimizes its losses by producing P = MC amount of output ■ If P > AVC and P > ATC the firm maximizes its economic profit at the P = MC amount of output ○ Firm’s Short Run MC curve that lies above the firm’s AVC is its short run supply curve ○ Firm will shut down: TVC>TR P< AVC (AR=P) < Minimum AVC ○ The firm produces on the elastic portion of the demand curve ● Firm will produce a profit: P > ATC ● Firm will produce at a loss : AVC < P < ATC 2. Pure Monopoly- One firm is the sole seller of a product or service ○ Power to set price ,Unique nature of product ,Hard entry/exit from the market ○ Barriers to Entry- Economies of Scale, Patent Ownership Research, Ownership or control of essential resources, pricing and other strategic behavior ○ Monopolist demand curve is downsloping, causing the MR curve to lie below the demand curve ■ Maximize Revenue when MR = MC ○ Barriers of entry may permit a monopolist to acquire economic profit even in the long run but ■ Monopolist doesn’t charge “the highest price possible” ■ The price yields maximum total profit to the monopolist rarely coincides with the price that yields maximum unit profit ■ High costs and Low demand prevents monopolists from realizing any profit ■ Avoids the inelastic region of its demand curve ○ Maximizing Output and Price■ WIth same costs, pure monopolists will find it profitable to restrict output and charge a higher price than would sellers in a purely competitive industry ● Restriction of output causes resources to be misallocated because P > MC ■ Monopoly creates deadweight loss ■ Monopolists can charge higher prices so monopolists levy a “private tax” on consumers and obtain substantial economic profits ○ Can increase its profits by price discrimination provided, ■ It can segregate buyers on the basis of elasticities of demand ■ Its product/service cannot be readily transferred between the segregated markets ○ Price regulation can be invoked to eliminate the tendency to underallocated resources and to earn economic profits ○ Socially optimal price is determined where Demand = MC ○ Fair return price is where Demand = ATC 3. Monopolistic Competition- A relatively large number of sellers producing differentiated products 4. Oligopoly- Involves a few sellers of a standardized or differentiated product, so each firm is affected by the decisions of its rivals and must take those decisions into account in determining its own price and output Key Formulas● Marginal Product = △ Q/△L ● Average Product = Q/L ● Total Cost = TFC + TVC ● Average Variable Cost = TVC/Q ● Average Total Cost = AFC + AVC ● Average Fixed Costs- AFC/ Q ● Marginal Cost = Δ TC or ΔTVC / Δ Q ● Total Variable Cost - Wage Rate x # of laborers ● Accounting Profit ● Economic Profit ● Average Revenue = Price ● Marginal Revenue = ΔTR/ Δ Q ● Total Revenue - P x Q ● Total Profit = Total Revenue- Total Cost ● PAge 93, 100 - how to derive demand and supply curves for a perfectly competitive firm The Cost of Production Average Product: Q/L TVC: ($ wage rate) x (# of laborers) TC: TVC+TFC AVC: TVC/Q ATC: AVC+AFC If MC>AVC, then AVC is rising Price and Output Determination Pure Competition ● Pure Competition- numerous firms ○ A large number of buyers and sellers ○ No power to set the price ○ Homogeneous, standardized ○ Consumer and producer know the price ○ Easy entry/exit from the market ● Market Price=MR, AR, & demand ● Average Revenue: product price ● Marginal Revenue: Δ TR / Δ Q ● Marginal Cost: Δ TC / ΔQ ● MR=AR when perfectly competitive ● Market equilibrium where supply and demand cross ● Profit Maximization- MR=MC ○ Total Revenue=(P)x(Q) ○ Total Profit=TR-TC ○ Total Profit=MR-MC ● If MR>MC, then Q rises ● Short Run Profit Maximization○ Find Price and Output where MC=MR ○ TR= (P)x(Q) ○ Read up to ATC curve ○ TC= (ATC)x(Q) ○ Total Profit= TR-TC ○ Read up to AVC curve ○ TVC= (AVC)x(Q) ○ AFC= ATC-AVC ○ How do you find losses ● Response in the long run to an increase in demand: ○ Industry output increases, firm output stays the same ○ Number of firms increases ○ Profits return to zero ○ Produces where ATC is at min Monopoly ● Pure Monopoly- one firm ○ Cross Price Elasticity- % ΔQ/% Δ P ○ Greater than zero is a substitute ○ Less than zero is a complement ● Profit Maximization- MR=MC ○ From Q, read up to the demand curve for Price=AR ○ Read up to AC to find ATC ○ Calculate TR and TC ● When MR is + then elastic demand ● Price of input falls: MC falls, Q rises, P falls ● Deadweight loss associated with Monopoly ○ In the long run there are no fixed costs ○ If you have a monopoly, it will produce less output at a higher price ● EfÏcient when MC=P ● Always MR< AR ● Deadweight Loss- the triangle ● Produces less output and sells at a higher price (Microsoft case)