Eco 2/13/18

I. Slide 3: elasticity = buyer and seller responses to change in price or change

in income
a. Elasticity is a measure of the responsiveness of Qd or QS to one of its
determinants, such as its own price, the price of related goods, or
income
b. Responsiveness to the goods own price
c. If price elasticity is high the demand will go down; supply will go up
d.
II. Slide 4: The price elasticity of demand measures how much the quantity
demanded of a good responds to a change in the price of that good
a. How sensitive buyers are to the price of a good
b. Price elasticity of demand (Ep ) = Percentage change in quantity
demanded / Percentage change in price
c. (take the absolute value)
III. S5: Downward slope = negative elasticity
a. Elasticity of demand is always in positive terms
IV. S6: calculating percentage change
a. (End value-start value/start value) * 100
b. Percentage change depends on the direction were going in
V. S8: Midpoint Method: the midpoint is the number halfway between the start
and end values
a. Percentage change = (End value-start value/midpoint)*100
VI. S13: KNOW THE BOTTOM FORMULA
VII. S14: When close subs are avail. The price elasticity is higher
a. Consumers wouldn’t change their demand if the price changes
VIII. S15: Narrowly defined goods have a higher elasticity than broadly defined
ones
IX. S16: Price elasticity is higher for luxuries than for necessities
X. S17: when there is a longer time response, price elasticity is higher
XI. S21: the flatter the curve, the bigger the elasticity
a. The steeper the curved, the smaller the elasticity
XII. S22-26:
a. Perfectly Inelastic Demand – vertical line (price does not change
demand at all)
 b. Inelastic Demand – Steep curve (elasticity is less than 1) – low
sensitivity to price
c. Unit Elastic Demand – intermediate slope (elasticity =1)
d. Elastic Demand – relatively flat (elasticity is greater than 1) – highly
responsive to price change
e. Perfectly Elastic Demand – horizontal (infinite elasticity) – extreme
sensitivity to price
XIII. S30: Total Revenue (TR)= P*Q
a. A price increase = more revenue per unit
b. You sell fewer units (Q) due to law of demand
XIV. S31-32:
a. When D is elastic, a price increase will cause revenue to fall
b. When D is inelastic, a price increase will cause revenue to rise
XV. S39: The price elasticity of supply measures how much the quantity supplied
of a good responds to a change in the price of that good (price sensitivity of
the seller’s supply)
a. Price elasticity of supply (Es)= % change in QS / % change in P
XVI. S42- :
a. Perfectly Inelastic Supply – vertical (elasticity is 0)
b. Inelastic Supply – steep (elasticity is less than 1)
c. Unit Elastic Supply – intermediate (elasticity =1)
d. Elastic Supply – flat (elasticity is greater than 1)
e. Perfectly Elastic Supply – horizontal (infinite elasticity)
XVII. S48:
a. The more easily sellers can change the quantity they produce, the greater price elasticity
of supply
b. Price elasticity of supply is greater in the long run than in the short run
Eco 2/27/18

Lecture 4: Gov Policies, Welfare, and Efficiency

I. S3: price controls
a. Price Ceiling: legal max price of a good or service
i. When the price ceiling is ABOVE the equilibrium price, it is
NOT BINDING – there is no effect on the market
ii. When the price ceiling is BELOW the equilibrium price, it is a
BINDING CONSTRAINT - there is a shortage of goods
(demand is increased)
1. In the long run, price is more elastic, so the shortage gets
larger
b. Price Floor: legal min price of a good or service
i. When price floor is BELOW the equilibrium price, it is NOT
BINDING – no effect on the market
ii. When price floor is ABOVE equilibrium price, it is a
BINDING CONSTRAINT – leads to surplus
S8: Shortages and rationing
a. Sellers ration goods among buyers
a. Leads to long lines and discrimination to seller’s bias
b. Unfair and inefficient
c. When prices are not controlled, the rationing mechanism is
efficient (goods go to buys that value them most highly)
S16: price controls are a mixed bag of reactions
S17: Taxes
a. raise revenue for public projects
b. buyers or sellers pay tax
c. Tax can be a percentage of the good’s price or a specific amount of
unit sold (we analyze per unit taxes for simplicity)
d. Tax on BUYERS shift the DEMAND CURVE down (left)– buyers
pay more, sellers receive less (some goes to gov), equilibrium price
falls
a. Equilibrium price is what sellers get, the rest goes to the gov
 e. Tax on Sellers shift the SUPPLY CURVE up (left) – cost of
production is increasing - buyers pay more, sellers receive less,
equilibrium price falls
a. Impact is the same whether the tax is imposed on buyers or
on sellers
S20: Incidence of a tax captures how the burden of tax is shared among
market participants
II. Elasticity and Tax Incidence
S25: Supply is more elastic than demand
a. Buyers bear more tax burden
S26: Demand is more elastic than supply
a. Sellers bear more tax burden
S?: supply and demand are equally elastic
a. Tax burden is evenly split
III. Welfare Economics – studies how the allocation of resources affects
economic well being
S30: allocation of resources refers to
a. How much of each good is produces
b. Who produces it
c. Who consumes it
S31: Willingness to Pay (WTP) – the max amount each person is willing to
pay for a good
S33: Consumer Surplus (CS) = WTP – P
a. Amount a buyer is willing to pay minus the actual price
b. Area under willingness to pay but above the equi price – area of a
triangle = ½ * h* b
S37: Producer Surplus (PS) = P – Cost
a. Amount a seller paid for the good minus sellers cost
b. Price minus willingness to sell
c. Cost value of everything a seller must give up producing a good
d. Marginal seller – the seller who would leave the market if the
price was any lower
e. PS is the area above the supply curve under the price – also ½
*b*h
Eco 3/6/18
Midterm is Tues 3/20 – review is on 3/18
 Ch 2 – 9
 25-30 MC questions (scantron)
 Similar to post- lecture questions
 Can use a calculator (can’t connect to internet)
 Supply and demand equations and area of a triangle
Lecture 5: Costs of Taxation
I. Effects of a Tax
S5: Causes total surplus to fall by C+E
S6: Deadweight Loss (DWL) – the fall in total surplus that results from
a market distortion such as tax
 DWL = C+E
 DWL = 0 .5(T)(QE-QT)
If the elasticity is the same, the tax incidence is the same
S13: finding DWL algebraically
 To find QE, set the supply and demand price equal to each other
 Add the unit tax to the y-intercept
 Calculate
Elasticity impacts the size of the DWL
S15: when supply is INELASTIC, the DWL is SMALL
S16: when supply is ELASTIC, the DWL is LARGE
S17: demand is INELASTIC, DWL is SMALL
S18: demand is ELASTIC, DWL is LARGE
DWL and the Size of the Tax
S26: initially the tax is T per unit. Doubling the tax to 2T would MORE
THAN DOUBLE the DWL. Tripling to 3T would MORE THAN TRIPLE
the DWL
We have quadratic growth in DWL as tax increases
DWL(cT) = (1/2)(cT)[c(QE-QT)] = c2*DWL(T)
The higher we increase tax, the higher the DWL rises
Laffer Curve -shows the relationship between the size of the tax and tax
revenue
Eco 3/13/18
Lecture 6: International Trade
S3: PD = domestic equilibrium price without trade
PW = world equilibrium prices of a good
When a small country trades with the rest of the world (at the world price)
S4: export the surplus (excess supply where the world price is)
S5: import shortage (demand outnumbers the supply)
S9: Benefits
 Increased variety of goods
 Increases consumer base
 Producers sell to a larger market and may achieve lower costs
through economies of scale
 Competition from abroad may reduce market power which
would increase total welfare
 Trade enhances flow of idea
S11: finding gains from trade algebraically
 Step 1: find QE and PE
o Set supply and demand prices equal to each other
 Step 2: determine QD and QS
o Plug PD into the demand and supply equations
 Step 3: calculate the area of the triangle
S14: Tariff – tax on imports
- Price facing consumers is world price + tariff
S18: import quotes restrict trade
- Import quota : a quantitative limit on imports of goods (much higher
deadweight loss than a tariff)
- Tariffs create revenue for the gov
- Quotes create profits for foreign producers
S21: Production Possibilities Frontier (PPF) : a graph that shows the combos
of two goods the economy can possibly produce given the available
resources and the available technology
S23: Opportunity cost : what must be given up obtaining an item
- The slope of the PPF tells you the opportunity cost of the x-axis good in
terms of the y-axis good
- The steeper the PPF, the less the opportunity cost
Eco 3/27/18
Lecture 7: Theory of Consumer Choice
 People face trade offs
S4: Budget Constraint: the maximum that can be afforded
 Consumption bundles
 The slope of the budget constraint is the relative price of the good on the x-
axis
S9: A fall in income shifts the budget constraint DOWN (parallel shift)
S10: A change in relative price of one good pivots the budget constraint inward
S11: Indifference Curve: shows consumption bundles that give the consumer the
same level of satisfaction
 Four Properties
o Indifference curves are downward sloping
 If one level falls, the other must rise
o Higher indifference curves are preferred to lower ones (since
people always want the most)
o Indifference curves CANNOT cross
 It shows contradiction (S14)
o Indifference curves are bowed inward
 When you have very little of one of the goods, you are
more willing to give up a lot of the other good
S16: Marginal Rate of Substitution (MRS): the rate at which the consumer is
willing to trade one good for another
 Slope of the indifference curve (falls as you move along the curve)
 Extreme Cases
o Perfect Substitutes: two goods with straight line indifference
curves, constant MRS (consume one or the other)
o Perfect Complements: two goods with right angle difference
curves (must consume one good with the other)
 Less Extreme Cases
o Close substitutes (curves are not very bowed) and close
complements (curves are very bowed)
CONTINUED IN NOTEBOOK
Eco 4/10/18
Lecture 8: Externalities and Public Goods
S3: Market Failures
 Externalities: an uncompensated impact of one person’s actions on
the well-being of a bystander
o Negative externality: adverse effect; produce more than the
socially efficient quality
 Ex: pollution, noise from construction, being on phone
while driving, acing an exam in a class with a curve,
smoking
o Positive externality: beneficial effect
 Ex: education, being vaccinated, renovating your house
(increasing property value of neighboring homes)
S8:
 supply curve shows the private cost of the sellers
o Social cost = private + external cost
 External cost = value of the negative impact on
bystanders
 Controlled by taxes
 Over production of goods and services, under
consumption
 Demand curve shows the private value to the buyers (willingness of
buyers to pay)
o Social value = private value + external benefit
 External benefit: the value of the positive impact on
bystanders
 Controlled by subsidy (make it cheaper for each person)
 Over consumption of goods and services, under
production
 Socially optimal quantity: socially acceptable equilibrium
S12:
 Before the externality, TS = CS+PS
  The cost of externality = equilibrium quantity * per unit size of the
externality
 TS then = TS + (or -) the total externality
S13: if the good is taxed $1, the total externality = TR (cancel out in TS)
S14: Internalizing the Externality: altering incentives so people can consider the
external effects of their actions
S18:
 Before the externality TS = CS+PS
 A positive externality = quantity per unit * externality
 The cost of subsidation = total pos externality (cancels out in TS)
S21: private solutions
 Moral codes & social sanctions
o Ex: the golden rule
 Charities
 Contracts btwn market participants & affected bystanders
o Coase theorem: if private parties can bargain w/o cost over the
allocation of resources, they can solve the externalities problem on
their own
 Jane is disturbed by the barking of Lucy’s dog
 Benefit to Lucy having spot = $500
 Cost of barking to Jane = $800
 Socially efficient outcome – spot goes
 Private outcome: Jane pays Lucy btwn $501 - $799, both
are happy; this is the efficient outcome
S27: private solutions don’t always work
 Transaction costs: the costs that parties incur in the process of agreeing to
and following through on a bargain
 When a beneficial agreement is possible, the parties may hold out for a
better deal
 Coordination problems with large parties
S28: public policies
 Command-and-control policies regulate behavior directly
o Ex: limits on quantity of pollution
o Ex: require a firm to adopt tech to reduce emissions
 Market-based policies provided incentives so private decision makers
choose to solve the issue on their own
 Corrective Tax (Pigouvian tax) and Subsidies: a tax designed to induce
private decision makers to take account of the social costs that arise from an
externality
Eco 4/17/18
Lecture 9: Production Costs
S3: Profit = Total Revenue (the amount a firm receives from the sale of outputs) –
Total Cost (the market value of the inputs a firm uses)
Costs
 Explicit Costs – require outlay of money
 Implicit Costs – do not require cash outlay
o Ex: opportunity cost
Profit
 Accounting profit = total revenue minus total explicit costs
 Economic profit = total revenue minus total costs (explicit + implicit)
S8: production function: shows the relationship between the quantity of inputs used
to produce a good and the quantity of outputs of that good
S10: marginal product: the increase in output arising from an additional unit of that
input, holding all other inputs constant
Marginal product of labor = change in Q / change in labor
S13: diminishing marginal product: the marginal product of an input declines the
quantity of the input increases (decreases as labor rises)
S17: marginal cost: the increase in total cost from producing one more unit
MC = change in TC / change in Q
S21: measures of cost
 Fixed costs – do not vary with the quantity of output produced
 Variable costs – vary with the quantity produced
 Total cost = FC + VC
 Average fixed cost (AFC = FC / Q)
 Average variable cost (AVC = VC / Q)
 Average total cost: total cost divided by the quantity of output
Eco 4/24/18
Lecture 10: Firms in competitive markets
S4: Perfectly Competitive market
 Many buyers and sellers
 Identical products
 Firms can freely enter or exit the market
S5: Revenue in a competitive firm
 Total Revenue = price * quantity
 Average revenue = TR / quantity
 Marginal revenue = change in TR / additional unit sold (change in Q)
 No matter how much they are producing, they will always receive the parket
price (MR = P is only true for firms in competitive markets)
S8: maximize profit for Q where MR = MC
S12:
 Shutdown: short run decision not to produce because of market conditions
o Must still pay fixed costs
 Exit: long run decision to leave the market entirely
o Does not have to pay any costs
o Exit is P < AVC (average variable costs) (short run)
o Start up if p > avc (sr)
S15: sunk costs: a cost that has already been committed and cannot be recovers
 Should be ignored when making decisions
 You must pay the regardless of your choice
 In the short run, FC (fixed costs) are sunk costs
S16: exit is P < ATC (long run)
Start up is p > atc (lr)
S20: profit = (p-atc)*q
S22: total loss = (atc – p) *q
S23: assume in the sr # of firms is fixed but in the lr is is variable
S26: If existing firms earn positive economic profit,
– New firms enter
– Short-run market supply curve shifts right
– P falls, reducing firms’ profits
– Entry stops when firms’ economic profits have been
driven to zero
S27: If existing firms incur losses,
- Some will exit the market
- Short-run (SR) market supply curve shifts left
- P rises, reducing remaining firms’ losses
- Exit stops when firms’ economic losses have been
driven to zero
S28: Low-run equilibrium: the process of entry or exit is complete, and all firms
earn zero economic profit
In the lr p=min atc
Eco 5/1/18
Monopoly
S3: Monopoly: a firm that is the sole seller of a product w/o close substitutes
 Has market power: the ability to influence the market price of the product
(sets the price)
o Competitive businesses do not singularly affect the market price
 Arise due to barriers to entry
1. Monopoly resources: a single firm owns a key resource
2. Government regulation: the government gives a single firm the
right to produce a good
3. The production process
 Natural monopoly: a single firm can produce the entire market
Q at a lower cost that could several firms
S6: monopoly vs. competition: demand curves
 In a competitive market, the market demand curve slopes down but the
demand curve of any individual firm’s product is horizontal MR=P
 A monopolist is the only seller, so it follows the market demand curve
o To sell a large Q they must reduce P
S8: A monopolist’s revenue P=AR (as usual) MR<P (in competitive mr=p)
TR=P*Q
AR=TR/Q or just P
MR <P
S11: increasing Q has 2 effects on revenue
 Output effect: higher output raises revenue
 Price effect: lower price reduces revenue
S12: profit maximization happens when MR=MC
Profit = (P-ATC)*Q
S17: a monopoly leads to an output that is too low and there is a deadweight loss
(people are missing out on the product)
S19: price discrimination
  Sell the same good at different prices for different buyers
 Firm can increase profit by charging a higher price to buyers with a higher
willingness to pay
 Requires ability to separate customers according to their willingness to pay
 Can raise economic welfare
 Monopoly firm gets entire surplus (profit)
 No dwl
S27: public policy toward monopolies
 Increasing competition with anit-trust laws
 Regulation: government comes in and set the price
 Public ownership = less desirable outcome
 Do nothing
S31: pure monopolies are rare, but many firms have market power due to:
 Selling a unique variety of a product
 Having large market shares and few significant competitors
 Eco 5/8/18
Monopolistic Competition and Introduction to Game Theory
S3: Market Structures
 Extremes – perfect competition(no market power), monopoly (total market
power)
 Imperfect competition (in between the extremes) – oligopoly (few sellers
with identical products), monopolistic competition (many firms sell similar
but not identical products).
S4: characteristics of monopolistic competition
 Many sellers
 Product differentiation (similar but not identical goods)
o Seller is not a price taker
o Downward sloping demand curves
 Free entry and exit
o 0 economic profit in the long run
S5: examples include apartments, books, clothing, clubs
S6: market structure comparison
Perfect Monopolistic Monopoly
Competition Competition
# of sellers Many Many One
Free entry/exit Yes Yes No
Long-Run 0 0 Positive
economic profits
The products the Identical Differentiated No close
firms sell substitutes
Firm has market None; price taker Yes Yes
power?
Demand curve Horizontal Downward slope Downward slope
facing firm (P=MR)
S7: Short run equilibrium
 Profit maximization occurs where MR=MC
 If P>ATC it is a profit
 If P<ATC it is a loss
  Markup = P-MC
S10: if firms are making profits in the short run, new firms have an incentive to
enter the market (increase in number of products), demand by each firm is reduces
(demand curve shifts left, and prices fall), each firm’s profit declines to 0
If the firms are going through losses in the short run, some firms will exit the
market and the remaining firms will enjoy higher demand and higher prices
S16: advertising
 Incentive: attract more buyers and can sell differentiated products at prices
above marginal cost
 The more differentiated the products, the more advertising firms buy
 Manipulate peoples tastes
 Impedes competition
o Fosters brand loyalty and allows for higher markups (consumers are
less sensitive to price changes so the curve becomes steeper)
 Gives useful info to buyers
 Promotes competition and reduced market power
S21: Brand names
 Spend more on advertising and charges higher prices
 Products are not differentiated, and it is irrational because consumers are
willing to pay more for brand names
S24: Game Theory: the study of strategic interaction
 The outcome of a game for each participant depends on his/her own
behavior and the behavior of other participants
S28: payoff matrix
 A dominant strategy (what happens despite the best case) is not sharing
 Unique equilibrium is the lower right-hand box
 Nash equilibrium: each participant does the best he/she can given the
behavior of all the other participants
Eco 5/15/17
Oligopoly
S3: Oligopoly – a market structure with high concentration ratio where only a few
sellers offer similar or identical products
 Concentration ratio: the percentage of total output in the market supplied by
the four largest firms
 The higher the ration, the less competition there is
S6: Duopoly: an oligopoly with two firms
 The firms can act as competitors or as a monopoly
 Collusion: an agreement among firms in a market about quantities to
produce or prices to charge
 Cartel: a group of firms acting in unison
 Both firms would be better off sticking with the cartel agreement (nash
equilibrium)
S16: output and price effects
 Output effect: if P >MC, increasing output raises profits
 Price effect: raising output increases market quantity
o Reduces price and reduces profit on all units sold
S17: as the number of sellers in an oligopoly increases:
 the price effect becomes smaller
 the oligopoly looks more like a competitive market
 P approaches MC
 The market quantity approaches the socially efficient quantity
 International trade pushes equilibrium P and Q closer to the competitive
equilibrium
S22: when the game is repeated many times, cooperation may be possible
 Two strategies may lead to cooperation
o If your rival reneges in one round, you renege in all subsequent
rounds
o “tit-for-tat” – whatever your rival does in one round, you do in the
next