1 INTRODUCTION TO KEY IDEAS 3 CLASSICAL MARKETPLACE - DEMAND & SUPPLY Elasticities and Tax Incidence

Specific tax: involves a fixed dollar levy per unit of good sold
Macroeconomics: studies the economy as a system in which Marketplace: buyers and sellers come together to exchange Ad Valorem: percentage tax
feedbacks among sectors determine national output, Demand: quantity of a good or service that buyers wish to purchase
employment and prices at each possible price Tax Incidence with Elastic Supply Tax Incidence with Inelastic Supply
Price
Microeconomics: the study of individual behaviour in the Supply: quantity of a good or service that sellers are willing to sell Supplier increases
Price
St
context of scarcity at each possible price
Buyer price
Supplier pays P
D

D
Markets: play a key role in coordinating the choices of Quantity Demanded: amount purchased at a particular price St Buyer pays P + s S
Incidence is on
individuals with the decisions of business Quantity Supplied: amount supplied at a particular price P
8
buyer P +
6 Supplier pays Pts
+
Buyer pays P+
|_ improves efficiency, trading of skills and goods * All other influences on supply and demand remain the same S Incidence is on
5
Mixed economy: goods and services are supplied both by Equilibrium Price: price when quantity demanded equals quantity Po
5
.
P o
.
supplier
Producer
private suppliers and government supplied Price Demand: P = 10 - Q 4
Supply: P = 1 + 0.5Q P
Model: formalization of theory that facilitates scientific enquiry
s
z
Excess supply: when quantity 10 Excess P s

supply
Theory: logical view of how things work through observation supplied exceeds the quantity above 4
Supply
Outward shift = Quantity Quantity
|_ transform theory into model to test the theory demanded at the going price increased demand Qt Q o Qt Q o

Opportunity cost: choice of what must be sacrificed when a Excess demand: when
choice is made quantity demanded exceeds 4 Demand
Rightward shift =
increased supply
• 5 WELFARE ECONOMICS AND EXTERNALITIES
Excess
Production Possibility Frontier (PPF): the combination of the quantity supplied at the demand Welfare economics: how well the economy allocates its scarce resources
goods that can be produced using all the resources available going price 1
below 4 in accordance with the goals of efficiency and equity
For 36 hours: Quantity
Equity: how society’s goods and rewards are distributed among members
Amanda = 3 fish/h & 2 vegetables/h Zoe = 2 fish/h & 4 vegetables/h 6 10
Efficiency: how well the economy resources are used and allocated
|_ 12F or 18V = 3:2 opportunity cost 18F or 9V = 1:2 opportunity cost Substitute goods: a price reduction/rise for a related product
Consumer surplus (demand): excess of consumer willingness to pay over
Vegetable Vegetable Terms of trade: 1:1 reduces/increases the demand for a primary product
Amanda specialize the market price
Has absolute With specialization and Complementary goods: a price reduction/rise for a related product
18 Producer surplus (supply): excess of market price over the reservation
18 advantage trade they consume increases/reduces the demand for a primary product
along the line joining price of the supplier
Amanda’s specialization points Inferior good: demand falls in response to higher incomes Rent Alex
PPF Demand: P = 1000 - 100Q
Normal good: demand increases in response to higher incomes $900
Supply: P = 250 + 50Q
Zoe specializes, Brian
9 Has absolute Influences of Demand: prices of related goods, buyer incomes,
Cathy Equilibrium ( 1,900 ) ( 2,800 )
Zoe’s PPF
advantage expectations Don
,

Lynn 805.9101=-100 Qtb

Influences of Supply: technology, input costs, competing products p=

18 CS=400 CS=300 CS=200 CS=100 Evan IOOQ

Fish b=lO00→P= 1000 -

12 18 Fish $500
Market Interventions
.

PS=200 PS=150 PS=100 PS=50 Kirin

Amanda initially consumes: {6,9} Amanda consumes: {8, 10}
Price controls: government rules or laws that inhibit the formation of Jeff Frank
Zoe initially consumes: {9, 4.5} Zoe consumes: {10, 8} Ian
Heward
Economy-wide PPF: set of good combinations that can be market-determined prices $300
Gladys Quantity
Price ceilings: suppliers Price floors: sets price above
produced in the economy when all available productive 1 2 3 4 5 6

cannot legally charge more the market clearing price

resources are in use Muti Person PPF
Measuring Surplus
Economy-wide PPF Most efficient
than a specific price Rent

+
C s=
Vegetable With complete specialization the Vegetable fish producer Price Price Alex 5.5200=511250
$900
27 a economy can produce 27V or a
b
Next most efficient Brian efficient

)
18
30F Opportunity
{ fish producer ps= 5.2250=15625
c 18, 18 cost of Cathy use
S
f
producing fish Shift outwards =
Amanda’s
PPF c
economic boom
E° Excess
P+
Excess Cfs Don
Lynn
E°
demand at P P supply at Pf Evan
9
P c
• $500 • .

•
Kirin

c.
E
PS
a
Shift inwards = d P Jeff Frank D
Zoe’s PPF economic recession Ian
Heward
.

$300
Gladys Quantity
Quantity
.

12 18 e 30 Quantity
1 6
.

Fish 2 3 4 5
Fish Q Q C 0
Qf Q 0

Efficient market: maximizes the sum of producer and consumer

Et
Productivity of Labour: output per worker or per hour, depends on: Quotas: physical restrictions on output. Market demand: horizontal sum of

cost
|_ skill, knowledge and experience of the labour force Reduces supply and increases price individual demands surpluses. (Marginal benefit (demand) = marginal cost (supply))
|_ capital stock: buildings, machinery & equipment Price Price Tax Wedge: difference between consumer and producer prices
Sg = supply with quota
|_ technological trends in labour force and capital stock Revenue Burden: amount of tax revenue raised by tax

:
Economy output (Y): Y = (# of workers) x (output/worker) Excess Burden/Deadweight Loss: the component of consumer and
Full Employment Output (Yc): Demand A + B producer surpluses forming a net loss to the whole economy
|_ Yc = (# of workers at full employment) x (output/worker) The efficiency cost of taxation Taxation and labour supply
Economic recession: output falls below the economy’s capacity P E0 Wage
Demand B Price
output St

wag§°Yevenue|pwL
Demand A Depends on
Economic Boom: period of high growth that raises output above Quantity Quantity
elasticity
capacity output Qq Q o S
CS Tax wedge
D
Pt
2 THEORIES MODELS AND DATA 4 MEASURES OF RESPONSE: ELASTICITIES Po tbauxrden
Dwi
EO

D tax
Pts D+
percentage change in quantity demanded
.

Variables: measures that can take on different values Price elasticity PS

Data: recorded values of variables of demand percentage change in price
|_ time series: measurements made at different points in time Quantity Lt Quantity
|_ high/low frequency: series with short/long intervals between p Use average Qt Qo

observations { D= for these

Externality: benefit or cost falling on people other than those involved in
.
=

po p
%
|_ cross-section: values for different variables recorded at a the activity’s market. It can create a difference between private costs or
point in time Arc Elasticity of Demand: consumer responsiveness over a values and social costs or values
|_ longitudinal: follow the same units of observation through segment or arc of the demand curve Negative Externalities and Inefficiency Positive Extenalities
time absolute value of current Elasticity Variation with Linear Demand Limiting Cases of Elasticity Price
Index number: value of a Index = x 100 Price
Price D ✓
Zero .DQ=0→o
Additional Sf S

absolute value of base % DP cost Full social

variable or average of a elasticity Full social
(
supply cost
e= -9 Elastic range Infinite cost
set of variables with Price index = (oil index x 0.6) + (natural elasticity
f3p0÷o→o Subsidy
5
respect to the base value gas index x 0.25) + (coal index x 0.15) Midpoint of D (unit elastic) p* , Po
E = -1 Dh 1 Df
Po 1
•
,
to
Private p*
Inflation rate: annual % increase in consumer price index Inelastic range D’ 1
1

1 supply cost
.

Private value
Deflation rate: annual % decrease in consumer price index E= -0.11 Large total 1 benefit of trades that do
elasticity of trade
Quantity not
Consumer Price Index: Quantity
.

, occur

cost of basket in current year Q* QO Q*

average level for consumer CPI = x 100 Point Elasticity of Demand: elasticity .dQ- Inverted slope Qo
cost of basket in base year
of
←
of demand
goods and services computer at a point on the demand E D= DP curve
* Fix: corrective tax: direct the market towards a more efficient output
curve Other Market Failures: profit seeking monopolies, public goods i.e. radio,
Nominal earnings: earnings measured in current dollars
national defence, health, international externalities
Real earnings: earnings measure in constant dollars to adjust Influences of Elasticity: tastes, ease of substituting goods, one
Environmental Policy and Climate Change
for changes in the general price level brand with substitutes = elastic, group of products = inelastic,
Greenhouse Gases: accumulate excessively in the earth’s atmosphere
Nominal Price Index: current dollar price of a good or service products with no substitutes = inelastic
Price prevent heat from escaping
Real Price Index: nominal
nominal index Total Expenditure = P x Q Kyoto Protocol: committed themselves to reducing GHG emissions
price index divided by the Real Index = x 100
Elastic
CPI Expenditure relative to 1990 by 2012, Canada’s target of 6% reduction in GHGs
consumer price index P
is greatest In elastic region reducing Economic Policies for Climate Change
Econometrics: examining and quantifying relationships P price increases total
B
Midpoint expenditure
Three ways to control polluters: direct controls (warn big emitters),
between economic variables incentives (pollution taxes) or tradable “permits” to pollute
Regression line: average relationship between two variables in In inelastic region reducing
Marginal Damage Curve: costs to society of an addition unit of pollution
P Inelastic price decreases total
a scatter diagram C

Marginal abatement curve: costs to society of reducing quantity of

P expenditure
Intercept of a Line: height of the line on one axis when the E
Quantity pollution by one unit
value of the variable on the other access is zero Q Q Q Q Pollution cost
Marginal Damage
A can ask for
A B C E

Slope of a Line: ratio of the of change in variables Time horizon and inflation: long run = elastic, short run = inelastic Marginal
abatement permits from B =
Positive economics (facts): objective explanation of economy Cross-price % change in quantity demanded cost MACA&B ‘cap and trade’
Normative economics (values): offers recommendations elasticity of % change in price of other product { d(x,y)=%DQx
% Ca
DPY Optimal level of system
Economic Equity: concerned with the distribution of well-being demand • pollution
La Substitutes if positive, complements if negative
Cb MACBMACA
among members of the economy Pollution
quantity
Economics: ideas and methods for betterment of society Income
'

1. DQ
% change in quantity demanded In an ideal world permits could be traded internationally between developed and
|_ markets facilitate exchange and encourage efficiency elasticity of Md= % DI
% change in income developing countries
|_ incentives, humans are not purely mercenary demand
Corrective taxes are called Pigovian taxes = tax package reform, reduce taxes
importance of government policy, governments can best address abuses of Normal good if positive, inferior good if negative in other sectors of the economy to main revenue neutral impact
a

monopolies. Provides a legal framework for a mixed economy. Support (Luxury good) (Necessity)
efficient market function through competition policy, education, international
trade, taxes, welfare * all of this applies to elasticity of supply
 6 INDIVIDUAL CHOICE 7 FIRMS, INVESTORS AND CAPITAL MARKETS Fixed costs: costs that are independent of the level of outputs (capital)
Variable costs: related to output produced (labor & materials)
Cardinal utility: measurable concept of satisfaction Sole Proprietorship: single owner of a business Total costs: sum of fixed cost and variable cost
Total utility: measure of the total satisfaction derived from Partnership: business owned jointly by two or more individuals, who Average Fixed cost: total fixed cost per unit output
consuming a given amount of goods and services share in the profits and are jointly responsible for losses Average Variable cost: total variable cost per unit output
|_ increase at a diminishing rate (each extra unit consumed Corporation/Company: organization with a legal identity separate Average total cost: sum of all costs per unit of output
yields less utility from its owner that produces and trades Cost ($) TC
Marginal utility/$ FC VC
At(=FC+VC

#
Total cost AFC= Avc
Marginal utility: addition to total ATV U Shareholders: invest in corporations and therefore are owners. =

MU=
utility created when more unit DX p They have limited liability personally if the firm incurs losses (W ↳
AV(=W" "
Ak
"
.
'
=

of a good is consumed Dividends: payments made from after-tax profits to company Variable cost
Utils •
shareholders
°

Consumer Equilibrium:
• Capital gains/losses: an individual sells a share at a price higher/ productivity highest when costs are least
fully spent budget in a
•
lower than when the share was purchased Fixed cost
MU . manner that yields the Limited liability: the liability of the company is limited to the value of MCXMPL AVC= APL
Output
• greatest utility the company’s assets
Visits to mountain Marginal Cost: the cost of producing each addition unity of output
Retained earnings: profits retained by a company for reinvestment
and not distributed as dividends DL=W
MC=Ff£
DVC
=W
-

Law of Demand: other things being equal, more of a good is

¥MC
ATC

×
=
C
mm
demanded at a lower price Principal or owner: delegates decisions to an agent or manager minimum

GOODI Ordinal utility: assumes that Agent: a manager who works in a corporation and is directed to MC cuts AVC and ATC at the minimum
50 individuals can rank commodity follow the corporation’s interests If MC < ATC then ATC decreases
AVC
bundles with a level of Principal-agent problem: principal cannot easily monitor actions of If MC > ATC then ATC increases
40
satisfaction the agent who therefore many not act in the best interests of the AFC
* same applies for AVC
30
20
(a) different combinations of goods and principal
.

Sunk cost: fixed cost that has already been incurred and cannot be
.

services yield equal satisfaction Stock option: option to buy the stock of the company at a future
(b) combinations of goods and services yield
more satisfaction than other combinations date for a fixed, predetermined price recovered even by producing a zero output (R&D)
4 GOODZ
3 7
Fair gamble: gain or loss will be zero if played a large number of * Production costs almost always decline when the scale of the
Budget Constraint times operation initially increases = economies of scale
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 Increasing returns to scale (IRS): when all inputs
dispersion of possible outcomes. A greater dispersion in outcomes Fixed capital More capital are increased by a given proportion, output
Snowboarding 51305+15205=51200 PsStPjJ=I implies more risk increases more than proportionately
F=I/ps Risk-averse: person will refuse a fair gamble, regardless of the SAC ]
Constant returns to scale (CRS): output increases
price SAC SACZ in direct proportion to an equal proportion
c) dispersion in outcomes ,

Px
per Risk-neutral: person is interested only in whether the odds yield a
LAC increase in all inputs
unit
Non-affordable
sloptpy
.

set CRS Region of Decreasing returns to scale: equal proportionate

profit on average and ignores dispersion in possible outcomes Region of IRS DRS increase in all inputs leads to a less than
Minimum efficient
Affordable set * As economists, profit maximization accurately describes a firm’s scale MES proportionate increase in output
C =%j objective. They use capital, labor & human expertise to produce a
Jazz
good or supply a service. Long-run average total cost: lower envelope of all short-run LTC

ATC curves (LTC = long run total costs)

=

LAC
Q
Tastes & Indifference * People have diminishing marginal utility so losing $1000 is a lot
Snowboarding less utility than gained by winning $1000 Minimum efficient scale: threshold size of operation such that scale
L is preferred to R since more of each good is
consumed at L, while points such as V are less Risk Pooling: means reducing risk and increasing utility by economies are almost exhausted
preferred than R. Points W and T contain more of
one good and less of the other than R.
aggregating or pooling multiple independent risks Long run marginal cost: increment in cost associated ALTC
W L
Consequently, we cannot say if they are preferred Risk Spreading: insurers spread the potential cost among other with producing one more unit of output when all inputs LMC= DQ
to R without knowing how the consumer trades
R Jazz the goods off
insurers are adjusted in a cost minimizing manner
Total Utility
Risk-averse TV Cost LMC and LAC with returns to scale Cost Technological change and LAC
V T B
Diminishing marginal utility exists, the
#
Minimum LMC
average or expected utility of the event

An
-
Indifference curve: combinations of goods and services that Uncertainty
is less than the utility associated with LAC
yield the same level of satisfaction to the consumer IRS
the average or expected dollar outcome
Indifference map: set of indifference curves where curves C Eliminating
DRS
OBIZ uncertainty
further from origin denote a higher level of satisfaction improves Risk neutral CRS
utility by utility curve MES increases LAC post technology change
Snowboarding $(2500-x)
Further from origin = higher level of satisfaction Output Output
Negatively sloped: more of one good is less of the other
2500 5000 $
Don’t intersect Technological change: innovation that can reduce the cost of production or
•
M
Reflect a diminishing rate of substitution Bond: results from borrowing. Suppose you lend $100 with a
•
R return rate of 4%. 4% is the nominal rate of return, if the inflation bring new products on line
C
N Wont give up as much rate is 1.5% then the real rate of return is 2.5% Globalization: tendency for international markets to be ever more integrated
H
Cluster: group of firms producing similar products or research
•

R
•
SB since don’t have as Real return: nominal return minus rate of inflation
much
Real return on corporate stock: sum of dividend plus capital gain, Learning by doing: reduces costs
Jazz
adjusted for inflation Economies of scope: unit cost of producing particular products is less when
Marginal Rate of Substituion (MC/CR): slope of indifference Capital Market: set of financial institutions that funnels financing combined with the production of other products than when produced alone
curve. Defines the amount of one good the consumer is from investors into bonds and stocks
willing to sacrifice to obtain a given increment of the other Portfolio: combination of assets that is designed to secure an 9 PERFECT COMPETITION
Optimization: highest level of satisfaction possible income from investing and to reduce risk Perfectly Competitive: industry is one in which many suppliers producing
Snowboarding
Budget Consumer Optimum: where the budget Diversification: reduces the total risk of portfolio by pooling risks an identical product face many buyers and no one can influence the market
constraint constraint equals the MRS at one point across several different assets whose individual returns behave Profit maximization: goal of competitive suppliers, they seek to maximize
Not attainable
independently the difference between revenues and costs
MRS
-

PYPY Variance: weighted sum of the deviations between all possible Price taking behaviour: no one firm can impact market price by altering its
•E --

outcomes and the mean, squared Ep ;( x ; µ )2 .

own price or output level

MVIIMUS
-

Attainable
MRS= |_ mutual funds decrease volatility (variance) of investments Market characteristics: must be many firms each small and powerless
Jazz
relative to the entire industry, product is standardized. Buyers have full
8 PRODUCTION AND COST information about product and price, free entry and exit of firms. Demand
Adjusting to income changes: outward shift of budget
curve for each supplier is horizontal and downward sloping for whole
constraint, can attain a higher level of satisfaction Production function: technological relationship that specifies how
industry
Adjusting to price changes: lower level of satisfaction because much output can be produced with specific amounts of inputs total
Marginal revenue: additional revenue to the firm ATR
of less purchasing power Technological efficiency: maximum output is produced with a given MR= revenue

set of inputs (no waste) resulting from the sale of one more unit of output IQ
Income and Price Adjustments
Economic efficiency: production structures that produces output at In perfect competition P = MC = MR
Snowboarding
Price q wasting profits MC

)
least cost
.

Substitution effect: price change is the response of go perfect MC .

Breakeven point
Normal goods
demand to a relative price change that maintains the Short run: period during which at least one factor of production is 05+5 > revenue
92 :c Atc
• Es E
consumer on initial indifference curve ( Eo→E3 ) fixed. If capital is fixed then more output is produced by using p
p=µR pg
•
,
Income effect: price change is the response of Demand facing
. Supplier should produce

• to demand to the change in real income that moves the additional labour. profits individual firm
PZ in short run if fixed costs
are sunk
avc
• Ez individual from the initial level to a new level of utility Long run: period of time that is sufficient to enable all factors of P ,

production to be adjusted Shutdown

Inferior goods Jazz Very long run: period sufficiently long for new technology to develop 92
Quantity point
qiqo
Totat product Q = f(L): relationship between total output (Q) Shut-down price: minimum value of the AVC curve
Subsidy Programs
produced and the number of workers (L) employed for a given Break-even price: minimum of the ATC curve
Income Transfer Price Subsidy
Other goods
amount of capital Short-run supply curve: portion of the MC curve above minimum of AVC
Other goods
Iz Increases slope : Pdaye Output Total Product Curve Law of diminishing returns: increments Price
Deriving Industry Supply Industry Equilibrium
consumption of Pother of a variable factor (labor) are added Price
daycare and other SB=MCB SA MCA

/
--
I ,
to a fixed amount of another factor

j¥a
goods unless one is Consumers spend
EZ inferior S = sum of firm MC
• more on daycare (capital), the marginal product of the Both firms
Market
equilibrium curves
than other goods
•
E .

•E2 variable factor must eventually decline supply

[q
Daycare Daycare
. Pe •
D = sum of individual
Labor Pf Only firm A
supplies demands
Marginal Product of Labour: ,
Output
Intersect when AP is peak
addition to output produced
by each additional worker.
MPEAQ
DL Quantity Quantity
Slope of total product curve QE

_AP MPL
Average Product of Labour:
number of units of output
produced per unit of labor at
different levels of employment
Labor If MP > AP then AP increases
If MP < AP then AP decreases
Normal Profits: required to induce suppliers to supply their Plant size in the long run Competition Number of Firms Ability to Affect Price Entry Barriers
$
goods and services. Reflects opportunity costs and can be D Perfect Very many None None

→
With demand conditions defined by D
considered as a type of cost component '
and MR the optimal plant size is one Imperfect
Economic (supernormal) Profits: profits above normal profits MC
1
Mcz corresponding to point MR=MC in the Monopolistic Many Small Small
, /
.

Acz long run. Q1 is optimal output if plant

that induce firms to enter an industry. Economic profits are AC '
,

Oligopoly Few Bigger Bigger

size AC1 and Q2 is optimal output if
,
,

based on opportunity cost of the resources used in production. plant size is AC2 Monopoly One Very large Very large
LMC
'
LAC :

Accounting Profits: difference between revenues and actual -

* demand and cost interact to determine the number of market participants

'
.
R
costs incurred
Qi QZ Quantity Demand, costs and market structure
Short run profits for the firm
Price MC Profit = PE mkh=OgE .
mk=TR .

TC
$
Atc Monopoly Output Inefficiency
TC
m

PE =TR .

Economic
$ Long run MC for
a cost structure defined by the LAC1 this

#
profits D DWL = ABF
Economic profits will induce new < market has space for many firms, perfect or
h mk monopolist = long run AC
entrepreneurs to set up shop and ,
AC
A industry S for perfect P, monopolistic competition. If costs

LACZ
Normal profits start producing ]
PM competition, assuming corresponds to LAC2 where scale economies
AVC Long-run equilibrium: competitive industry CRS
C A monopolist maximized profit at QM. Here the value are substantial, there many be space for just
required a price equal to to the minimum of marginal output exceeds cost. If output expands to
AT
B
one producer. LAC3 = oligopoly.
point of a firm’s ATC. At this point only Q* a gain arises equal to area ABF. This is the
Ppc
normal profits exists, no incentives for F deadweight loss associated with the output QM rather
9E Quantity firms to enter or exit MR than Q*. If the monopolist’s long-run MC is equivalent iq ,
Q, .
Quantity
to a competitive industry’s supply curve then the DWL
Entry of firms due to economic profits N-firm concentration ratio: sales share of the largest N firms in the
is the cost of having a monopoly instead of a PC
Q*
Price S = sum of existing firms MC QM a market
sector of the economy
curves

S’ = Sum of new and existing firms

Price discrimination: charging different prices to different consumers Monopolistic Competition
MC curves in order to increase profit Differentiated product: one that differs slightly from other products in the
If companies were incurring losses then the |_ seller must segregate the market at a reasonable cost. same market
PE
firms would cease production, closures |_ resale must be impossible or impractical Equilibrium for a monopolistic competitor
would reduce aggregate supply and the
* reduces DWL associated with a monopoly seller
'

p supply curve would move upwards. Long $ Do D0 is the initial

term equilibrium would be the same. Firms C demand facing a
with least cost production will survive Price discrimination at the movies Po (
representative
PE firm
QE Q
'
Quantity $
Profits exist at the initial equilibrium {q0,
ACO
Cost At P=12, 50 prime age individuals P0}. Hence, new firms enter and reduce
demand movie tickets at P=5, 50 the share of the total market faced by each
D
Firm B cannot compete with Firm 12 more seniors and youth demand firm, thereby shifting back their demand
MR
A in the long run given that B has Efficient output = C tickets. Since MC is zero the efficient MRO curve. A final equilibrium is reach when
SACB a less efficient plant size than output is where the demand curve economic profits are eliminated at AC = PE

¥
D

SACA firm A. The equilibrium long-run

pg
takes a zero value, where all 100 and MR = MC
Quantity
.

price equals the minimum of the C customers purchase tickets. Saves a qe go

LAC DWL of $250 Monopolistic competitive equilibrium: long run requires the firm’s demand curve to be
D C Q tangent to the ATC curve at the output where MR=MC, P = ATC
50 100
Oligopoly and Games
Quantity Pricing in segregated markets Collusion: explicit or implicit agreement to avoid competition with a view to increasing profit
$
|_ example: cooperating to form a cartel
Price Long-run dynamics Segregate customers = several groups Conjecture: belief that one firm forms about strategic reaction of another competing firm
Initial short-run supply Increasing and decreasing
D Dz 5 ,
With two separate markets defined by DA Game: situation in which contestants plan strategically to maximize their profits taking
cost industries

µ¥
,
Pz .

sz New short-run supply PA

D3 5
and DB a profit maximizing strategy is to account of rivals’ behaviour
}
DB produce where MC = MRA = MRB and
"
Increasing PB |_ the firms are the players and their payoffs are their profits
Equilibrium long-run cost LR
DA discriminate between the two markets by Strategy: game plan describing how a player acts or moves in each possible situation
-

|Q
PE price = minimum of supply curve MC
1
, long-run AC = long- Constant cost
LR industry
charging prices PA and PB Nash equilibrium: each player chooses the best strategy given the strategies chosen by the
P}
1 1
run supply curve supply curve other player and there is no incentive for the other play to move
1
1
Economic # cost
Decreasing MRA Dominant strategy: player’s best strategy, whatever the strategies adopted by rivals
.

1
,
LR industry RB
1 profits QB QA Q
Payoff Matrix: rewards to each player resulting from particular choices
1
1 supply curve
Losses
3 ! Ql 1 QZ Quantity
Perfect Price Discrimination If will contributes Kate’s
Increasing/decreasing cost: industry where costs rise/fall for Kate’s choice
$ A monopolist who can sell each unit at a maximizing choice involves lazing:
Total revenue for the
each firm because of the scale of industry operation A perfect price different price maximizes profit by Contribute Laze she gets 6 units
Will’s Contribute 2,6 discriminator = OABQ* producing Q*. With each consumer 5,5 If will decides to be lazy Kate’s
Globalization and Technological Change paying a different price the demand
Choice best interest is to be lazy for 3
The cost structure of many firms has been reduced to B Laze
Nash
6,2 equilibrium 3,3 curve becomes the MR curve. The result units of happiness
outsourcing to lower-wage economies, increases the minimum Po is that the monopoly DWL is eliminated
efficient scale for many industries, eliminated industries in the The dominant strategy is for Kate & Will to be lazy regardless of either of them do because the efficient output is produced
developing world and the monopolist appropriates all the
Kate’s choice If Will contributes Kate should consumer surplus
Efficient Resource Allocation a* Q contribute for 5 units
Where the demand and supply prices are equal. If demand is Contribute Laze If Will lazes, Kate should lazy for
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 Contribute 5,5 0,4 3 units
marginal cost then a perfectly competitive market insures that Choice
$ Cartelizing a competitive industry Laze 4,0 3,3
this condition will hold in equilibrium. Perfect competition c=S
results in resources between uses efficiently Assume MC for If MC is the joint supply curve of the There is no dominant strategy, results in two equilibrium one at {5,5} and one at {3,3}
monopolist is the Can make a binding commitment to agree to both contribute at {5,5}
industry supply for cartel, profits are maximized at the
10 MONOPOLY Pm
A
perfect competition output QM where MC=MR. In contrast
Duopoly and Cournot Games
Scale economies define some industries production and cost Pc B if these firms operate competitively
output increases to QC Cournot behaviour: each firm reacting optimally in their choice of output to
structure up to very high output levels and the whole market F .
their competitors’ output decisions
might be supplied by a single firm. D Reaction function: the optimal choice of output conditional upon a rival’s
Natural monopoly: one where ATC of producing any output output choice (optimize profit)
MR
declines with scale of operation. Qm
Qc Q Price
Maintaining Barriers to Entry When one firm B chooses a specific output qB1
Cartel Instability (ILLEGAL) Market demand
Patents and copyrights granted by government, predatory then A’s residual demand DAR is the difference
Depends on the authority that the governing body of the cartel can Po between the market demand and qB1. A’s profit
pricing (drive out potential competition), political lobbying

DAR
exercise over its members and the degree of info it has on ( is maximized at qA1 where MC=MRar. This is
(subsidies to prevent entry), critical networks, some products A

operation of members. Instability lies in the fact that each individual P1 an optimal reaction by A to B’s choice. For all
require large up-front investments 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
Cost
difficult to restict all members from doing so D
MR
One billion dollar A company who avoids R&D Rent Seeking: activity that uses productive resources to
MRAR
9B1 Quantity
← investment
would have a LAC equal to redistribute rather than create output and value q gao ,

A’s output

t€
" LMC and would undecut initial |_lobbying and bribing of politicians (loan guarantees maintain
developer of the drug marketing board) MC=6 Demand :P -24 Q .
-

|_ most prevalent in monopolies when economic profit is greatest,

.fi#aAa+Q
24¥
A’s reaction function B)

11
Magna profit trtc additional cost borne by the producer and increases costs RA .
.

Darofa :p=(
- - - - - -
Technology and Innovation
- - - .
9Ao Equilibrium at RA = RB
MRAR :(24 OTB ) ZQA
Invention: discovery of a new product or process through research 9a1 B’s reaction function
-

11
-

1-
.

TR :P .Q
1

Constant MC 9AE RB
Quantity Product innovation: new or better products or services MC=MR→ 6=24 QI ZQA - -

Process Innovation: new or better production or supply

Demand, marginal revenue and total revenue Reaction f=Qa=( 18 QI )/z
-

Price |_ resource allocation in monopolies is offset by the greater

MR has twice the slope of tendency for monopoly firms to invent and innovate QB=( 18 QAXZ .

Demand :P 16 ZQ B’s output

'
:

demand 9B1
16 Mid point of D: price |_ Patent laws: grant inventors a legal monopoly on use for a fixed 9B0 GBE Ra=RB→Qa=6QB=6 P= $12
4Q elasticity = -1, TR is Profit maximization
MR=l6 period of time (10-15 years). Raise incentive to conduct R&D but
-

max and MR = 0 happens when MC = MR

MC=MR do not establish a monopoly in the long-run Monopolist: MC = MR, Perfect Competitor: P = MC, Duopolist: in between
10 always lies on elastic
Mc=1iQ Individual firm output = market output under competitive behaviour / (N+1)
8 segment of demand curve
11 Imperfect Competition Ex: in a duopoly N=2 and competitive output = 18, yields a firm output of 6
Quantity
Entry, Exit & Potential Competition
3 4 8
Imperfect Competition: face a downward-sloping demand curve and Firms who enter the industry do it if there are enough profit. If potential
Monopoly Equilibrium Monopolist’s Choice of Plant Size their output price reflects the quantity sold new firm has the same marginal and fixed costs by entering the market
$ $ Oligopoly: an industry with a small number of suppliers

B)
elastic portion MC
With CTS doubling output will now be split three ways. This may squeeze the profit margins of all
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
PE
A Mci Mcz have similar characteristics. Monopolistically competitive firms can sufficient to cover fixed costs
ATC AG AG
exert only a small influence on the whole market

WU
1

Deterring entry: make costly investments to scare competitors, advertising

,

Profit
CE
( Duopoly: market or sector with just two firms to build brand loyalty
PEABCE LAELMC
'
'
,
,
-
' .

Quantity
 12 INTERNATIONAL TRADE
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 Terms of trade 1V for 6F

8 US Specializes 8 US Specializes

US PPF US initial Total production

consumption 35V and 8F
5 5
•
15,5 18,5
Canada’s initial
consumption
14,3
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
gains from trade At a word price of $10 the domestic
quantity demanded is QD. The amount
Tariffs and trade QS is supplied by domestic producers
Price and the remainder by foreign
Domestic demand Domestic supply 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
L E F including tariff domestic suppliers (LECJ), and the
P=$12
J C I G
$2 tariff deadweight loss is the sum of triangles
H
P=$10 B
A and B.
World supply
curve
' "

Qs QS QD QD Quantity

Subsidies and Trade

Price
S - domestic supply Qs is supplied domestically
S’ - domestic
and (Qd - Qs) by foreign
supply with suppliers. A per-unit
subsidy subsidy to domestic
suppliers shift the supply

:
DWL
World supply curve to S’, and increases
curve their market share to Qs’

.
'

Qs QS Q Quantity

Quotas and trade At the world price P plus a quota the

supply curve becomes RCUV. This has
Price 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
W T
equilibrium is at T with price Pdom and
Y
Pdom quantity traded Qd’. The free trade

p
d. it DWL
World supply
curve
equilibrium is at G. Of the amount Qd’
quota is supplied by foreign suppliers and
G
the remainder by domestic suppliers. The
J quota increases the price in the domestic
market
R
Quota Government gets no tax revenue from
Q 'D QD Quantity
quotas