ECONOMICS I WS2018119

HockeyStick 3.1
2 Lonely Island

3 Pickyourpoison
4 Goodvibes
5 Taste is relative
6 Goodcompany
7 Oh Dear

8 Bottom line

9 Invisible Hand
10 Res Publica

II PowerPlay
12 GameChanger
 HockeyStick
Robinson Crusoe experiment
Robinson and Friday are stranded on a remote island and mainly live on
fish and coconutwater
the more foodthey can find the higher their utility health overall
wellbeing
fish and coconutwaterneedtobeconsumed in equalamounts
thus utility can be increased byconsumingpairs
Utility Ltime available time spent on gatheringcoconuts time spent on
fishing It 2 pairs
everyday each has 12h tospend however their efficiencies in gathering
differ Friday 0.25ktfish 05h 1coconut
Crusoe 1 ht fish 05h 1coconut
they engage in trade l D both can make trade offers the minimum
ofboth will be realized
Historicalcontext
Zerogrowth GDPpercapita on a constant low level until the late 18h
century
Malthus Law I approach to explain zero growth

TV Equilibrium subsistenceincomes prevail populationconstant

Improvement in technology
Averageoutput per farmer rises

i EEEEEEEEEEEEEEE.EE
farmers incomes fall
it intn
mortauuaecreases

Equilibrium subsistenceincomes prevail populationconstant at in

Inigherle g
HockeyStickGrowth
for a
verylong time living standards did
not grow in anysustained way
when sustained growthoccurred it began
at different times in different countries
to vastdifferences in living
leading
standards
around the world
Adam Smith Conceptof theinvisible hand
individuals pursuing their own interests
promotes interestsof society more effectually than when one really
intends to promotethem
also significantSonne ofprosperity is divisionof labor or specialization
what in turn is constrained by the extend of the market
specialization fosteredbyimprovementof infrastructure and
expansion of foreign trade resultingpropertyexpanded
extent of the market virtuous cycle of economicexpansion
 Technologicalprogress remarkable scientific and technological
advances
occurred at the same time as the upward kink in the Hockeystick
Industrial revolution marked the beginningof a permanent
revolution
technological
the requiredwork time thus allowingsignificant
byreducing increases
in living standards thence populationgrows
Downsides of economic growth noise pollution lower air quality
of the
of waste and global
depletion
resource base impactonglobal warming expansion
pollution over population particularly in urban areas
wealthinequality
Economic models
I start with a
question
la
2 Modelling a simplified descriptionof the real world
what determinespeople'sactions
how theseactionsaffectothers
outcomesrelatedto all possiblecombinations ofactions
necessity gfffjyggafooaiwntoq.een.aandestablishing restrictions

3 Testing doesthemodel in generalperform well

predictedoutcome vs actual outcome
scarcity Overaching model of econ
central tension is based on central

Tonics
tension betweenmaximizing
resources needsI wants what we want and what we
need while there are only
limited resources to achieve
scarcity
than
limited means available to meet our objectives
economists modelthese situations first bydefining all of the feasible
actions then evaluating whichofthese is best given the objectives
Economics economics is the Science whichstudies human behavior as
a relationship between ends and scarce means which have
alternative uses
constraintoptimization maxflx.gl subject to glx.gl s d
f profits health gradeaverage happiness travel time
different foods courses money Leisure Status means of
y transportproducts
x

d limited productioncapacity1budget limited time

scarcity intra personalcompetition
how to make best use of time money
trade offs
scarcity inter personalcompetition
who gets a scarce resource
scarcity allocationproblem
how can resources beallocated efficiently no leftovers
scarcity distributionproblem
how can resources beallocatedfairly
Solvingscarcity
intra personal transformation production
Inter Personal bruteforce first come firstserved lotteryvoting top down
assignment market price priority list testing competing
choosing another
opportunity cost benefits an individual forgoes
by
alternative
value of the most valuable choicenot taken
expressing the basicrelationshipbetweenscarcity and choice
TheParetocriterion desirable attribute of an allocation paretoefficient
allocation assignmentof a resource tospecific individuals
reallocation re assignmentof a resource tospecific individuals
pareto improvement comparedto allocation A allocation Bimproves
the utility of some individuals without hurting
the utilityofothers net welfaregain
pareto efficiency an allocation where no paretoimprovement ispossible
related to the Conceptofproductiveefficiency and allocativeefficiency
Paretodomination according to the pareto criterion allocation A dominate
B if at least one party would be betterof with A than B
and nobodywouldbe worseoff
2 Lonely Island
Trade voluntary impliesPareto improvement interpersonalreallocation
prerequisite heterogeneousopportunitycosts cost of forgoing the next
best alternative
basic economicconceptinvolving the buying and selling of goods1services
with compensation paidby a buyer to a seller or the exchange ofgoods
services betweenparties
Absoluteadvantage
who has the lowerinput to produce one unit ofoutput
who has the higheroutputgiven the same amount ofinputs
party can produce more Ibettergoods
Comparative advantage
who has the lower opportunity coststo produce one unit of output
providesopportunity to sellgoods1services at a lower price than its
competitors

calculating 9
Opportunitycostopportcostote
Input approachOpportunity costgood
C
tmeruntofIIcostltimelforlum.to
Output approach for constant inputs

Producedquantityofgoodsylsacn.tl
Opportunity costgoodX
ProducedquantityofgoodSXLgaein
h
when is trade mutuallybeneficial
In order for trade to be mutually beneficialamong each party involved
the Price of the good 1service must fall between the opportunitycostsof
producers involved in the trade
e
g to produce Inuit of fish Friday has to forgoproducing 0.5 units
of coconut Crusoe has to forgoproducing 2 units of coconut
Friday would sell fish if price 0.5 Coco Crusoe would rather buy
fish if price 2 COCO
Trade is onlypossible if 0.5Coco for 1 fish trefft 2 Coco for 1 fish
FeasibleFrontiers Robinson Crueso experiment
U 12 te tf 2 min c f only pairs fish coconut yieldpost utility
is it worth collecting a pair net marginalutility O
Friday 0.25 0.5 2 I 25 0
Crusoe I 0.5 2 0.5 0
Feasible Frontiers

Friday f Ffs C 48 2C
5
Autarky FÄHIG 94949
Crusoe f t.ec z.o.sc Crusoe c 12 0.5C 8
 60ft Fish CRUESO FRIDAY
Feasible Frontier maximum
potentialefficiencygains attainable outputforgiven
3,48 amount of input
antarky
DIVERSIFICATION D VS bestallocation d resources
F SPECIALIZATION C.FI MRTciF IFbc opp.cat internsoff
µ gggginalrateoftransformation
16 4 F joining
forces fffeasiblea.no slopeoffeasiblefrontier
In 12.2T
8 efficient
howmanyuuitsdoyouhave.co
cocon.us
togiveuptogetauotherunity
24 0SU
absolute advantagelhigheroutputafterkhofwork
comparative advantagelloweropport.usstoproducelunitofoutpuH
compareslopes
joining forces always combine graphsinaway.thatresourcesareuse.cl
wiselyllowopportunitycostsfirst.ie graph with flatter
Slope

Feasible Frontiers with specialization Trade

48 121 05C for OECE24 Optimal behavior
jointly f 2124 241 2C for 24 e 4g Jointly c GEGIE IG
f
Tradeleadstoa Pareto improvement
theywilltradefovavel.priceoflkgoffishY.FI
for 1kg coconuts c
F

Thus slopeof2arrowsis
T.ci c

specialization Trade expand frontier Pareto improvement

Utility Maximizing behavior 4 12 tc tfthx minlc.FI
Fridayc.ru
Autarky 4 12 8 4 2.16 32 U 12 4 8 2.8 16
F C 16 F 8
ff 16F 0.25 4h tf 8F.IE
te 16C 0.5 E 8h itc 8C 0SE 4h
1
Specialization 4 12 4 8 2.20 40 U 12 12 0 2.12 24
F C 20 F 12
Trade TF 320.25 8h tt OF.IE 0h
te 8C 0.5 E 4h etc 24C 0.5 E 12h
AF n 12 sc 12 IF 12 di 12
DavidRicardo
introduced the theoryof comparativeadvantage
suggest that trade is mutually beneficial when trade partners
specialize based on their relative opportunity cost
theory wouldonly be mutually beneficial if Capital were immobile
It Capital mobile can result in offshoring jobloss

PPF productionpossible frontier

shows maximum possibleoutputcombinations of two goods an economy
can achieve when all resources are fully and efficiently employed
3 Pick
your poison
consumptionchoice under scarcity
resources

PPF
I.fr
heedslwantsl.budget
feasible frontiers
preferences

preferences
T can bedescribed
scarcity with thekelpot
T
utility functions
indifference curves
Choice
The BudgetConstraint
available resource income m expenditures Income
price p.foreachunitofqc P 9tpz9zt.vn
price p for each unit ofgz
opportunity costlintevmsofq.la 92 9
921 of I more unit of g
MRI.is MRT.io
a
Pi
available income increases parallelupwards shift
available income decreases parallel downwards shift
pricechange d pricefortunitofonegood intersectionpoint with one
axis changes
pricechanges d prices forbothgoods bothintersectionpoints will vary
utility functions Utility 4 419.9 1
attach to each possibleconsumption baskettbundkantility value
enables to rank bundles
ulAI.nl B A B
UH KIB Ac B
um UCB An B
Marginalutility Mu
decreasing marginalutility Hai 0
Risk aversion behavior d humans especially consumers and investors
who when exposed to uncertainty attempt to lower that uncertainty
it is the hesitation d apersonto agree to a situation with an unknown
payoff rather than another situation with amore predictable payoff
but possibly lower expectedpayoff
 upwardsloped utility function implies alargeramountrecieredyields
higherutility
concavity d utility function implies surequantitywonldalwaysbep.ve
terredoverariskybet
Un Un Un

risk averse
w nrw W
risk affine
w

ri.sk neutral
individual Individual individual

Ordinal utility representing

thepreferencesofanindividualonanordinaryscale
crucialisonlyrankingotoptionseitis
meaningless how much better
Cardinal utility differencesbetweenpreferencearealsoimportant
giving differentchoicesaspecifkutilityvalue
IndifferenceCurves
I Extreme perfectcomplements

lonlyenjoygoodxandytogethevffl
uaazaklq.cz min 9,9
ULIO.IO

y
2 Extreme perfect substitutes
only quantity matters
Klar 921 91 92
u y
Generally well BehavedPreferences
n 1 Completeness consumers caurankallbundles
either preferred notpreferredornindifferent
2 Transitive preferences are consistent A Bebaute
indifference curves never cross
3 Monotonic moreisbetter.lessiswovse neg.slop.ee
4 Convex averagesareweaklybettertha.ir extremes

B üüüüüü.ata suakIsIIYon
da
absolute MRS weakly decreases
with relative consumption duet
MU and MRS
Utility Hula g with marginalutility MU
total derivative of U DU dg da
DU MU da Mhz da
how does utility du Mu Mhz
1 alterst
594 2 da da
on a indifferent curve 4 0 0 MU Mhz

4 9 MRS slope of
indifference
curve

Consumption choice find optimalconsumptionbundle

maximize utility givenbudget
Goal highestindifference curve µ
YYYUC9cn st.p.q pzq am
Interior solution tangency pointof
indifference
curve and budget constraint
MRS MRT 4 Fbi
how am I willing to substitute q for gz
how am I capable of substituting 9 for 921
92n
4 k 13

boundary solution MRSt MRT

occurs with close substitutes
 4 Goodvibes
Yvonne elasticity of Demand
referstothe sensitivity of the quantity demanded fora certain good to
achangeinrealincomeofconsumerstkeepingallotherthingscoust
percentchange in quantity demanded divided bypercentchangein
income

t.IE ityt
InniatginäIIIitifiÄÄFC
depending on value goods can be categorized

NO
O
fasincomerises.mu
dfasincomelnferiorg
goods are Mm4
demanded
rises fewer
inferior
goods are
ry Necessity ateach dropindenrand bought
t.mg good price level goods are substituted
nmlq.IM 0Mmlqkl
consumers consumers
will buy will buygoods
proportion regardless of Gasincomerisestheproportionoftotalcon
sumerexpendituresonnecessities goods
atetymore changes in typically decline
Hagood their income
compared levels
tochangein riseindemand
income
Ila IN
income con na income
consumption sumption
Fähre A
445 slope
normal goodq g bending
luxurygood

towardsq.ua
tmoretnanProPortionIKC
naincome income con na
consumptionsumption
A
Eststope
bending
Äbtissin
A
g
necessitygood awayfrang inferiorgoodq
less than proportional
unfugelcurve
describes how household
expenditure once particular
der
Inferior goodorservicevaries with
income
OR

vices hüüüüüüüüüüüüaries
Superior

Priceelasticitydemand
economic measure ofthechangeinthequantitydemandedorpur
chasedofaproductinrelationtoitspricecha.ge

i
increase in
ordinary
Giffe
lnp.io IeoYwtinttndYrEen nptai.o
1

NormaTFortfüüüüüüüüüüüüüüüüüüüüüüte
good good demand curve risesandviceversa
inlinewithlaw upwardslopingdemand
qmlq.lv nmlqko of demand curve
contradicts lawofdemand
usually donothavellose
snstitutes staplegoods
Total effect I effect
Substitution priceeffect
substitutioneffect economicunderstanding that aspricerisestorin
come decreases consumers will replace more expensive items with less
costly alternatives lalsoviceversa keepingutility level constant
incomeeffect changeindemandforagoodorservicecausedbya
changeina consumer's purchasing powerresultingfromachangein
real income more purchasing power parallelshiftofbudgetline
relpricesheldconstant
 Ordinary normal Ordinary inferior
U U2 Gen
pricep falls p pricep falls p
substitution substitution
meinte
effect
totaleffect
Es 0
nö
totaleffect
E
if SETE 0 Ordinarygood if SETE 0 Ordinarygood
Rp G 0 Rp G 0
GiffenGood inferior E

gar forordinary goodsE SE0 0

pricep falls p normal goods
substitution inferior goods Eco
SEO
infant GEILE dominates
q
effect ECO forgiffen goods SE O.IE 0
totaleffect SETIECO
Mp.la 0
if SETIECO Giffengood
419,1 0

Cross price elasticity Iofdemandl

economic concept that measures the responsiveness in the quantity
demanded ofonegoodwhenthepriceforanothergoodchang.es

i
Substitutes complements
one consumes either Good one consumesGoodland
or Good2lbutrarelyboth Goodhlpreferably together
T 1 T
Mp 921 0 Mp 921 0
whenp.increases.q.in whenp.increases.q.de
creases creases

normal good if Umlad 0 normalgoodifnmlq.IO

inferior good if Mw g 0
 Complement Normal Substitute normal
g priceofothergoodq.nu
increases
Priceofothergood
increases p p
p p
effect
Ht Substitution
µ
substitution
u
Uz income affect income affect
TECO

IECOHSE.IE
g q
0 Complement HSETIE 0 Substitute
Rp.lkcO Mp 921 0
Substitute Inferior
q.mu Priceofothergood ff Forcomplements
SEITE 0
SEO.IE 0
increases p p
i substitutioneffect Up g 0
ÄÄÄÄ incosmioaa.at EFioYmsaYYEiosE
IE 0 inferior IE 0
q SETE 0
ASETIE 0 Substitute 0
hp.cat
Mpla 0
5 Taste is relative
The demand function
Demand Chief economic principle the effective want for something and
the willingness and ability topayfor it
WTP willingnessto max
pay
maximum price at orbelowwhich a consumer willdefinitelybuy one
unit of a product
reservationprice limit on the priceof a goodor a service
on demandside highestprice that a buyeris willing topay
on supplyside lowestprice at which a seller iswillingtosell a goodor
services
consumer surplus economicmeasurementof consumer benefits happens
when theprice that consumers pay for a product or service isless than the
pricethey are willing to pay WFP marketprice
Individual demand function demandof an individual or firm
represents the quantityof a single consumer wouldbuy at a specificprice
point at a specificpoint in time
maximizing utilitygivenbudget ceterisparibus
44,9alst.PHtoppeEM
4
Law of demand ordinarygoods Effi 0 decreasing demand
Priceelasticity
Giffengoods 5 so
demand curve
utilitychangesalong curve Iopt points each is on own in dit curve
each point on curve optimalconsumption Igivenprices and income
each point on curve maximum WFP L for a givenquantity
WTP reservationprice
Stuff
example II in 20 Pi 2 P 2
PLC III P I
III P 0.5
ÄH
c

price1 4 12 20 I
i burgermonth
burger i
i

2.0 D 1

I5 price in relation toquantity

E
O
0.5
burgertmouth
 Price elasticity d demand
Piemont
Lindemandeurvelelasticitychangesalongthe
elastic curve
Mpla 1 price elasticity d demand always negative
decreasingfunctions for ordinarygood Malgio
L

inelastic
Mpla O
Q
extreme cases
somegoodsarevevyinelasticipricesdonotcha.ge very much given
changes in supply ordenrand e g gasoline
ifpriceofgoodrises.demandlikelystaysthesa.me
certaingoodsarevergelasticipricesmovescansessubstaincialchanges
initsdemandorits supply
D
Pn Perfectly das tic Pn Perfectly inelastic
demand demand
T
nplat.co f Mpla O
closesubstitutes house substitutes
a
available a
available

Position ofthedemandenwedependson
prices of other goods
pricefortheothergoodlslp.ee increases
complement substitute
m lhp.to
aspzincveases.optimal.aspzincveases optimal
consumption 9 decreases consumption g increases
demandenweshiftsto demandenweshiftsto
theleft the right

income level
imagine incomem increases

Figo
fNormalgaTUml9
no nmlq.IO
asmincreases.optimal.asmincreases optimal
consumption 9 decreases consumption g increases
demandenweshiftsto demandenweshiftsto
theleft the right
 Aggregated f markettdemandl
to alquantitydemandedbyaKconsumers
horizontaladditionof individual demand lforeachgivenpriceisuw.at
demandedquantity
Comparison to the aggregation d feasiblefrontiers
horizontal andverticalaggregation
NetworkeffectsInetworkexternalities
assumption upto now individual demand independent d other
people's demand
but some goods have network externalities
networkexternalities effectthatauadditionaluserofa.gov servicehas
arthevalneottheproduettoothers
positivenetworkexternalities additional increase
inutilityifotherpeopleusethisgoodaswe.lt
appreciation otgoodrises.sodoesdema.ua
network effectcancreateaba.nowagoneffectasthenetworkbecomes nor
valuable and more peoplejoin positivefeedbackloop
people dosomething primarilybecauseotherpeople are doing I
bandwagon effect can result from technologicalpositiveexternalities
LY 9cYs 09icgaolPositiveexternalities
price
unit demandwithout
go
externalities demandshiftstotherightas
consumers observelexpectothersto
buy this good
of
Ill
eintääääääääääääääää
demand
26080 Quantity lasprklfakst020Qwouldn.se
c tobt withoutnetworkexternality
price bandwagon butarisestosowithnetworkexter
effect effect reality
negativenetworkexternalities decrease
inutilityitotherpeopleusethisgoodaswe.LI
appreciationofgooddedines.sodoesdema.ua
snob effect demandofacertain goodby individuals d a higher
income
level is inversely related tottsdemandbythoseotalowerincome
Levellthemoreothersdemandthelessldenrand
snobeffectcahresultfromtechnologicalnegative externalities and

priceless
psychological
negativeexternalities
unit snobeffect demandwithout demandshiftstotheleftas
externalities consumers observelexpectothersto
Effekt integrating'Änenegnetworkexter

Jaaaa
Da nalityyieldsastepperlmore.in
Da elastic demand
Qwouldrise
Quantity laspricefallstoI5
toll withoutNE but arises
effect only
6 Goodcompany
Production Theoryof the firm
common simplifyingassumptions
I
technology is given no technologicalprogress
2 Firm as price taker cannot influence inputprices
13

Firmasblackboxsmakestdecisionunit.in
that states that firms exist make decisions
general concept and
to maximize profits analogouslytotheory ofconsumers
whichstates that consumersseekto maximize their overall
utility
Productiontechnology ability to transform inputs into outputs
inputs capital Hand buildingsmachinery 1 materials steel plastics
electricity water Labor workers engineersmanagers I
Productionfunction

wput T
gyloutputq.CL
taI qfck.LI input
denotes maximum output
for agiven combination
time horizont
long term all inputfactors are flexible
total factor variation dependent on product
short term some inputs be fixed andtechnology
may
partial factor variation IK as fixed
Production with one variable input IN
marginal productofLabor MR change in output that results in employing
an added unit ofLabor
actual units ofq when L increasesby one unit
MP differencebetweenpriorperiod and now I

Joffre tangent line through a point on the production curve

of labor AR general measure ofOutput per worker
averageproductunits
mit per of L
AR differencebetweenoriginalstate and now dividedbyinput

Kotau throughthe origin and a point on the production curve

increases with technological and with capitalstock
productivity
progress
rises
AR and MR
output D Point A
month Lf T slope of tangent 20 MR D
total product slopeofse.cat 15 AP 15
Point B
J
uo
t.EE steaiaEEsiiIE
Point B

t i Labort
man
slope of tangent 28 MR28
slopeofsl.cat 28 AP 28
Pasta
output
taugen
pea.se
perworkerl
man so www.m.n.pe increasing

L
üüüüüüüüü meins
seca.at
mized.tangeut
and
µ average cragg
product tmargindrivestheave.ua
o i it 6 gdo Labor
month

early phase later phase

stages d production
defineabyaconceptknownaslawofdiminishingmarginal returns
asyonaddmoreworkerstothe productionprocessoutputwillincrease
butthesizeotthisinveasewillgetsmauerwitheachworkeryouadd
atsomepoint.ifyoukeepaddingworkers.outputmaye.ve start
shrinking
Stagelleartyphasetperiodofmostgrowthina company'sproduction
each additional variable input will produce more products
increasing the efficiency with each additional worker specialization
d
and division Labor efficiencygain
Stage 2 marginal returns start to decrease each additional variable
input will still produce additional units butata decreasing rate
totalproduetenweisstillrising average and marginal curves start
to drop
Stagesskaterphaselmarginalreturnsstarttoturn negative adding
more variable inputsbecomescounterproductive
additionalsourceoflaborwilllessen overall production
inefficiencies bureaucracy efficiency loss

7 2 0
 Production withtwovariableinputslk.LI
production functions described
bysetofisoquants.isoquantmaplsoqua.us
d
isoproductcurves similar to indifferent curves d the
theory demand represents allthosefactorcombinationswnichare
capable d producingthesamelevelofontput f production indifferent
curves
showskowoneinputeaubetechnicallysubstitutedby another
90 7593
5592 capital intensive interaction d complementarity
9 production andsubstitutabilityotinputs
E
capital diminishingmarginal returns
year keeping kconst.ea.chadditional

gi.LI
easFHEY.ssp.a.agitionala
piyIE weak convexity mixofinputslk.LI
D
Labor yieldslweaklylhighergtha.net
treues
year
MRTSL.rs marginalrateottechnicalsubstitution
similar totheconceptofmarginalrateofsubstitutioninthe indifference
curve analysisof consumer's demand
indicates therateaturhichfactorscanbesubstituledatthemargin
without alteringthelevelofontput
n tuntsofpitalswhichcanbereplacedbyone.mil d Labor
MRSI.li FypI MPiff MPri

Extreme cases
Inputs perfect substitutes
are Inputs are perfectcomplements
K K

substitutedby
eachunitofkreunitofkca.nu
technically any
quiresspecific units
d Landviceversa
constant units q
q d Landvice
g L versa
f K.LI Kh flk.tn minEK.L
Cobb Douglasproduction curves
A scale factor b how sensitive
Eilligseinstütsätsätsüüüüüüd
1
Returnsto scale
quantitativechange in outputof a firm or industryresulting from a
proportional increase in all inputs
1 Increasing returns to scale f It K t.LI t.flk.LI
output increases more than proportional
2Constant returns to scale f It K t.LI t.flk.LI
output increases exactlyproportional
g Decreasing returns to scale Ht K t.LI t.flk.LI
output increases less than proportional

constant Increasing
IHin A A
6
44 it

u
5 L L

Cobb Douglas Ht K t.LI A t KP It LI

A tb.kb.tl L
fb A Kb L
fb ft
increasing returns to scale b c 1
constant returns to scale b c
decreasing returns to scale b
7 Oh Dear
Productioncosts
Boost Curve showsallcombinationsofimputsgieldingthesamelevelot
k totalcostclsimilartobudget constraint
A higher faulte KE FL
Ost
v wage unit price d Labor
HU r rentalrate unit price d physicalcapital
fVj0stCUWl gametotaIcostforAandB
4 W

Rentalrateofcapitalir
costofusingkicostofreutingk Opportunity Costofowningk
wage increases w iwlsw.ci
Bcannotlongerbeproducedatddcostle.ve
K
producing Bhowimplieshighertotalcoste
IX
E Er
Minimizing costgivenoutput ostminimizingproduction
findtheinputcombinationwiththelowestcost
T TT
minimize total costgiven
OutputLevel
w.L r.ks.t.flk.LI
hjyl 9
find lowestpossible isocosteurve
interior solution
K tangencypointotisocostlineandisoqua.at
t
howamt economicallycapable of substituting kforh
hkhomamlkchndogicakycapa.be d substituting Lfork

boundarysolution MRD
K
occurs with closesubstitutabilityotkandl

µC Cz L
Cost function
K iassignsevevyoutputle.ve qitsminimumcost
for fixed factor prices wir

µ I tw kqw.ca
gg L opt.input combinationalready determined
µ dependentonretpricesandtech conditions

long run and short cost

run
short run apitalinputisfixed
if production should beexpanded gz qincveaseofinputlnecessa.ly
9 short run d optimal
lon9run tangentpoint optima
4 notatangentpointlDI.BY
7

expansion path curreinagraphwithquantitiesoftwoinputs

capitalandlabor typically
pathconnectsoptimatinputcombinationsasthescale d production
expands i e throughout costminimizingpoints
aproducerseekingtoproducethemostnuitsofaproductinthe
cheapestpossible wayattemptstoincreaseproductionalongtheexp
path
K
exPAIIYNPgathuu.at inputs flexible
93 il000 cz 2000,4 3000,9 100,92 200,93 3003
g
totalcosteurve mappingexpansionpathtocost outputsp.ae
long run all inputs flexible
cost imputcombinationsarenddirectly relevant
3000 similar to demand curve
2000
long runtotalcost
1 1
100200300 output
 Costumes TotalcostTCoragt
cost TC
Fixedcosttvariablecost
K
Fixedcost FC CLOD
independent frong
expensesthathavetobepaid independent
Süüüüüüüüüüü.ae eaagoccur
FC.canonlybeavoidedbyshuttingdown
Output
variable cost VCU
varywithoutputg
categoriesdependoutime
horizonetinterestlteshortterm
cost
MarginalcostMCcostofproducingonemore
totoutput
µ
Average TotalkostAHK Ostdividedby
AFC
output levdofoutputA E
Margindrivestheaverage
1 c.cat
Average FixedcostAFC Average variablecostAVC
FCdividedbylevelofoutput.vcdividedbyleve.IO output
IAFC.FI µC
Short Runes long Run Averagecost
SAC Short
runcostlscldependonCOSHQN.gg
unit
SAC
f IQkt Leveloffixedinput
iinthelongrunallinputsare
variable
Why move
ß Aua hofixcosts
Eingefügt areiwealay
Elegie
competition Klateklaki
QIN QIN QQ Output LACCQIESACC9 tl

LACandSACcoincideforitheoutputlevelsqlkilforwhl.ch Kiis the

long run cost
minimizing capital level
LAC are the the different SAC
envelope
 long run
marginalvs averagecost
cost LMC WhenLMC LAC LAC increasing
unit When LMC LAC LACdecreasing
LAC
WIEffälfäftfüIACareminimal
Isameholdsforthe relationshipbetween
Output SMCandSACI
Short run vs.long
runmavginalcost.SACminimatwhens.ME
SAC
LAC minimal when LMC LAC
When LAC SAC LMC SMC
SMCsteepertha.nl
4CduetolowevflexibiLityintheshoH
run

economies of scale
doubling qreqnireslesstha.nooublingofC
LAC decreasing
reasons specialization d workers flexi
economies of diseconomies bility d inputcombinations with varying
scale d scale factorprices abilitytonegotiatebetter
conditions
diseconomiesofscale
doublingqrequiresmorethandoublingofc.LA
increasing
reasons misspecialitation miscommunication bureaucracy inertia
Returns to Scale vs Economics d scale
Returns to scale Economies d scale
obtain.explainsthebehaviovoftherate.us
advantagesenterprises
ofincreaseinoutputrelativetoduetotheirscale.at
operations
associated increaseintheinputs
howmuchdototalcostschangeinthelongrunlinputsx.tt
whenlmultiplytotaloutputbg.tt

füüüüüüüüüüüüüüüant EEEüüüüüüsstuant
2 Constantreturnstoscale 2 Neithereconomiesnordigeconomies
outputsmcreasebyexactlytcostincreaseexaetly.by
3 Decreasing returnstoscale3 Diseconomiesofscale bureaucracy
outputs increase bylessthautcosts increase bymorethaut
E

productionco
Production Technology
Technology factorprices
Profits
cost Profits revenues costs
revenue
profit 341 mqaxtlqle RCGI C.la

increase for MKG Mag

decrease for MRCGICMC.CM
maximal for MRlqt.MG
output
qq.ggqy.o
naecreasingM4ITC9I
Profit maximization in perfectly competitive markets
Perfectcompetition
1 Competing products are
homogeneous products d all competing
firmsinamarketregardedas identical by consumers
perfectsubstitutes

whatisofferedbywhon.at which
price completeinformation
NThemarketisfullytranspaventiallmarkettpautsknow
3 Firmsarepricetakers market prices as given firmsarend capable
d influencing marketpricestmangsmallfirmsinthemarkett

Demandincompetivemarkets
price
o market demand ordinarygood
Mpla
demandfacedbyasinglefirminacompetitive
market perfectly elastic
Output

Profit maximization in competitive markets

cost cg Profits revenues costs
revenue
profit Real
mqaxtlqt RCGI C.la
J9 price takers MR P III
a
Z Real p 9
Ätputprofitmaxquantity of p Mccall
 8 Bottom line
short run supply in competitivemarkets
price.cat short run some inputfactors cannot

qq.EE ansedwhichqmax.profits

P MCl9Iwhichq min losses

Output
lossesavelossest
Casel pc AUCH
price.cat
1
E9t.ES p
maanegativeprofits
costly
losses
shuttingdown producing g O
novariablecosts.butstillftxedcos.IS
p Output
of shutdown whenlossesatopavelarger
revenues thantixedcostsli.e.lossesatq.CI
Since Mc curve
1
füüüüüüseed Esüüüüüü
Aknotmin FC A f
casetiAVClqlcpc
price.cat
tllqIIAClq IP MC.la
negativeprofits losses
sina.ee

t.EE

donotshutdownbutproducea.WS
egqoutput lFC lAC

Case Alcatel 1
t.me

costs
4 output
 Why Mccure supply curve
showsthequantityacom
firm'ssupply Panyiswillingtoproducel
curve topushoutothemarket
Yakeongfeainutonthepricestney

Atf Produce
pismin.priceafirmiswillingtoaccepttosupp.ly

goods reservation price

reservation price indifferent
Produce betweenbuyingandnotbuy
Äffiffgapplyingandnotsup
allpointsonsupplye
Short run profits producersurplus
producersurplus PSI
amountthatprodncersbenefitbysekingataprice.cat
marketpricethatishigherthantheleastthat
theywouldbewillingtosektor
Output
MCl9Dq
pscq.piq.mg p.q AVClqt9 lP
Negnalto

Short market supply

run
market supply curve horizontal addition of individual supply curves
F MC Gil
price Mc AVG.lq.la P
curve
IEIIIPPY
1 quantity
6 14
here Mcgstartslower
firmhaslowevvar.cat
Long run supply in competitive markets
price
LMC run allinputfactorseanbechanged
long
unmortiEEEEEIastEEEEämie
long run flatter betteroptimization duetovaria
supply curve bility
profit maximization p LMC.la
Output LAC Gilep
 Long run equilibrium free marketentry and exit
price einen only mostefficient firms will remain
LMCu.glidenticalcost structures identical individual
supplyGdp
aggregatesupply Qslpt n.gs pl
the more firms the flatter
min
D
Output
at u I exceptionalhighprofits since market competitive other companies
will emerge until satiation is reached
i e no firmyieldsexceptionalhighprofits
anymore
only when profits
market p MC LACmin
are zero there are no incentives to
entry or exit the
Equilibrium QslPI QD pl
zero profits same profits as the profits one couldyield with next best
alternative hopp costs
 9 Invisible Hand
Equilibriumimperfectlycompetitive markets demand supply
Il Demand
Individual demand curve
eachpointoncurve
opt.consumptionlgivenpricesa.no ihcomeI
maxwillingnessto pay WFP forgivenquantity
WFP reservationprice
Market demand Eaggregate demand
horizontal addition d individual
demand

WTP demand
P
not buy
buyers by it and only it WTP P

buy D

2 supply
Profit maximization in competitive markets
cost cg Profits revenues costs
revenue
profit Real
mqaxtlqt RCGI C.la
TY price takers MR P III
a
Z
Real p 9
Ätputprofitmaxquantity of p Mccall

Individual supply whichqmax.pro sIminlosses

Price
cost F McCall
supply
Ära Füüüüüsnutdown
Case2 AVC.la
cpcACC9IP
suve.pvoducedespitelosses
Output case 3 Allalop
produce profits
 Market supply
price 9 horizontal addition of
individual supply curves

auf.name
Pi
6 14
quantity
P
wvtlwiuingnesstoaccePH spy
suseysisaelfaosnfyY.tt
f notsell WTACP
Q

B Demand Supply Equilibrium

P sell
buyers by it
lutsch and only it
seuwersseiFGMarketqeariygpn.ee
tv
bjy and it
only
WTA noincentives to change
a
Q behavior
and I
Whydomarketscouvergetothemarket clearing equilibrium
if market price P is below Rap
P S
etoexcessdemand
adf.rttasa.ge Disequilibrium

Toacquire the product pressured consumers willtry

to outbid eachother driving prices up
shortage atahigherpricept fewer consumers will buy more
upwards pull producers will produce competition
PtP'until Qsfcqqgqyugsfu.gl
ifmarketpricepiijnab EF.tt pfhpanism

saYfPloY douetoexcesssuPPly
ftp.q
Disequilibrium

1 a Tosekthesurplus pressuredproducers will try to

Qi Qi outbid eachother drivingpricesdown
surplus atthatlowerpricept fewer producers will produce
downwards pull more consumers will buy
works only in markets without state intervention
Shocks to Demand and Supply
demand shock sudden surpriseevent that temporarily increases
or decreases demand for particulargoods or services
positive demand shock increase in demand
negative demand shock decrease in demand
effect on pricesofgoods1 services
P
stiekanaat a
new equilibrium
Pi Pi Qi Qi

positive demand shock

supplyshock unexpected event that changes the supplyof a good

resulting
in a sudden change in its price
positivesupply shock increase in supply exertsdownwardpressure
on price
negativesupply shock decrease in supply causes pricetospike
upward
almostalwaysweg

I s.seEessstosuIpyata
new equilibrium
Pc P i Q Q
q_
positivesupply shock

joint shock combination of demand and supplyshock

if both are
neg
p

new equilibrium Qi Q
P P
Q Pp depends on shock
V Respublica
Externalities
anexternalityisapositiveornegativeconsequenceofan economicactivity
experiencedby unrelated third parties
productionOrconsumptionotagoodaffeetathirdparty
almost all externalities are considered tobe technical externalities have
animpacton consumption and productionopportunities d unrelated
third parties butpriceofconsumptiondoesnotindu.de the externalities
results inadifferencebetweenthegainorlossofprivateindividualsand

theaggregategainorlossotthesociety.mg
externalities water pollution traffic noise deforestation
pos externalities health services
price Msc
SMC
neg externalities
marginalexternalcostMEC
L disntilityotthirdpartt.es
marginal social cost
MSEMCTMEC
Egegnüüüüüüt.co nEIutEuta
industryoutput socialoptimum
Q Q netsocialcostofQ.tt
Policyinterventions whether
interventions
useful
minimum prices
dependsonextentitäääääärtnotas
füüüüüüüsse
taxestandsubsidies comparedtoextent
d damagecaused
beginnen
Simplification Lineardemandandsupply
Inversedemandfunction
price Inverse demand
demand function function
how does demand howhighistheWTP
vary with price fortheathuuitofa
YüüüüüÄätaaaawitnoto
good D

an
QM Linear example QLPt f
JPPIQI
a b.ci
 Consumer surplus economicmeasurement d consumer benefits
price happenswhenthepricethatconsumerspayfora
productorserviceislessthantheoricetheyare
priced
willing to pay WFP market
Es area between PCQlandPo
a
ICSIP.li olPlQI Po
quantity Linear
Qcp example QCPIn ab.jp
Pol L QLPd.la Pol

producersurplus amount that producers benefitbysellingata

Price marketpricethatishigherthantheleastthat
a s
they would bewillingtosektor
areabetweenPCQIa.no
QlPo
L
IPS.lt I IolPo MClQI
linear example QCPtd.is
quantity
QM PS Pol_IQlPd Po

Total surplus welfare TIP D PIPI

Minimum prices government thinks setsmin.pricepm.ir P

istoolow
atpminthereisexcesssupplyi.Qz Q.li decreases Oil
reasons reduce consumed quantity
Inegexternalitieststrenghten national economy
pq.ee
5 consumers losetandB CS A B C
Pmin 0 producersgain A bhtloseCLP5 PS.tt
p total welfare loss B 1C market participants
ps.fi D
stateinterventionbecauseitremoresaneg
externality
Msc MC MEC
higher welfare forthirdparty E
quantity

price Msc price Msc

s s
Pmin Pmin Net welfare
Es
µ t.E.IE
D D
quantity Q Entity
Pricesupports govermentthinkspoistoolowkincreasesQ.tt
tomaintainapricepsabovethemarketclearingpricepathe
government
buysaguantityagle.g.mil emarketI demandshock
Ps Po Q 00
reason enhance national independence

price
s Producer gain A B C
p Consumer lose A B
EIEIIEEsss.PE EE
III QgtothepriceofpsQQ.az
quantity
state expenditures
fseffffngyqyetityisincreasecinone.gl

postexternalitiesttriggeringviapricesupport
MSB
price Marginalsocial benefits.MS3 D
s MEBcQg
Ps higher welfare d thirdparties E
Po lowerwelfare d taxpayers B1C
ag total welfare loss L extremecosts
ME D
producer gain A B c
QaQa quantity consumer lose A B
cheaper way tosupportproducers
consumers transfer ATBdirectly to
producers governmentadds c
totalwelfare loss C
2 solution may not feasible in reality consumers rejectfees possible
administrativecosts
ingeneralinvention throughpricesupportsreallyexpensive
Production quotas government thinks Poistoolow
tomaintainapricepsaborethemarket clearingprice Pathegovernment
restrictssupply too sustainability licensing
leg
price g A losec
g producers gain
Ps consumers lose AB
welfare loss B C
poAß
D
quantity
 removing a negexternality marginal socialcost MSEMGMEC

Prices
s higherwelfare d third parties B1C N
Ä
rYetparticipants Btc

44
EYnerawwaeffarreeotgan.in

D
quantity
consumption
price
taxlperunitt.pe unittaxt
paidbyproducers
QIN
cs Ps Pricethatbuyerspay 1
IPsiPricetnatsellersk
1
PS
Pb
quantity
a

price Ps
Qsl Consumer'sloss A B
es producer's loss D
B tax revenue A f q
fg welfare logs B
Bps
Pb
quantity
Qo
91

negativeexternalities renovinganegexternality
price MSC QslPs1 MSCMC

IMECQTP.to
ßµ
Ps
Dp
higher welfare d third parties B IHN
Lower welfare market participants
net welfaregain N

Pb
quantity
 Taxburdenandelasticity
a Tax effects Inelastic demand
1 consumers 2 producers paythetax
paythetax
supply curve
price
es
QKPntfdemandcurve.it
price I marginalcostenne
marginalutility es
B welfareloss Pb e
A Qs A QslPs
p p
PS D PS

Pn Pn
quantity quantity
QQ QQ
Ademandisverginelasticrelative
tosupply.theburdenofthetaxfallsmostlyonbuyers.LA
b Tax effects elastic demand
1 consumers 2 producers paythetax
paythetax
price price
n
0inch Oil
Oils
ES
1A B welfareloss ES AB Welfareloss
44

an
an
PS PS
quantity quantity
QQ QQ
Ademandisvergelastkrelative
tosupply.theburdenofthetaxfallsmostlyonsekers.CI
Other measures to tackle externalities
create anew market for externalities define more precisepropertyrights
lrighttopd.lueI.assumelowtransactioncosts
other reasons for intervention market power
 II Powerplay
Profit maximization in competitive markets
cost cg Profits revenues costs
revenue
profit Real
mqaxtlqt RCGI
CLGY.ly
pricetakers YzRGf
Z
jPg
öiput
prditmax.ge aI9ihEYaEHaa

Monopolymarkets
1 consumersarepricetakers
cannot influence market price
2 Thereisjustonefirmonthemarkettmonopolist
pricesetter
3 Consumeranomity
monopolist knows aggregate demand but not individual WTPs
no pricediscrimination possible

ProfitMaximization d Monopolist
price Profits revenues costs

mqaxtlql RCGI C.la

Po
P
D AR profitmax quantity MRI Mag
A B
monopolist'soutputaffects marketprice
quantity demand _average revenue
9 92
Tradeoffisellhighergatloweiseklowergathigherp

HD ARIF falling Ordinarygood MRM.us bebelowAR

Linear example
Inverse demandfunction plqt a b.q
ARlql.to
alrevenue RlqI plqIq la bqIq aq b9
marginal revenue MRlqt a 2b.cl
MRlqt MClql qn.pro maximIzingquantity
MRlqIsMCl9l qcqniAlostprofitfromtoolittlequ.amityattoohighprice
MRlqtcMClql qsqmiBlostprofitfromtoomuchqu.amityaI toolowpric
 competitivevs monopolisticmarket
Welfare
competitive market
price s MR AR g MC
welfa.ve D Slq p
t9p
µ

f YeDadwei9htlOssyqy
9M of
quality
Gigfemarket
9 9 1 An p
consumers lose A B
c weltagfloss
ProducersgainA
ifeng.pmqgpedistgnac.ie

Monopolypoweranddemandelasticity
market power p Mclainthehigherthemore inelastic demand
price price

pnnaciiif.FI
c

Maaßen AR
MR
quaunity quantity
9M 9M

Typeset Monopoly
Natural monopoly
existsdnetothehighfixedovstart upcostsofcondu.CH'ngabusiness
inaspe.ci
icindustry.occur
whenabusinesstakes advantage d auindustry'shigh
barrierstoentry
technological reasons economiesofscalelhighFC.decreasing ALI
largerfirmsproduceatlowercost offerlowerpricestlowerpurchsing
prices
consumers buyfronlargefirmsluetworkexternalities
largefirmsgroweventarger
smallfirmsunabletocompete shutdown
onlyouefirmremainslottengovernmentistwasdirectly or indirectly
involved
Priceregulation natural monopoly
price
Producer wants to set p MR MCI
in governmentsets max pricepr
P maximize overallwelfare
pr allowingproducertorecoup fixedcost
p
MC
AR D Pr AC
MR
Ä quantity consumers gain AB C
producer loses B gains E
net welfaregain A C E
Patentmonopoly
governmentauthorizes prospectofmonopolyprofits for usually 20years
incentive for R D investments highfixedcosts
dynamicefficiency reasons pushthe technologicalfrontier
tradeoff between static inefficiency monopoliesgenerate welfare losses
and d namic efficiency technological progress government has to allow
firms recouphighfixedcosts
Governmentmonopoly
political reasons public health paternalism externalities government
revenue successfullobbying
reduce competition on supplier side limited numbers of licences1
e
g gambling
Historicalmonopoly
former natural patent or governmentmonopoly
highswitchingcostfor consumers
technological hardware time
psychological trust brand loyalty externalities
deterspotentialcompetitors

Monopsony
market conditions singleplayer on demand side
imperfect market conditions market Power wagenegotiation input
goods andservices
often monopsonies and monopolies are linked
e military UScollegesports
g
 Pricediscrimination
Perfect discrimination
Price variableprofit no discrimination firm can onlycharge
Pmax A when P is charged one price for all consumers
PER ß
affIittfonmal
P

perfectdiscrimination firm chargeshigh

perf discrim price for consumers with WTP P A

Q
quantity firms charges lowerprice for consumers
with WTP P B
Consumersurplus firm offers Q
when singleprice P is charged
3 Degrees of pricediscrimination
Istdegree perfectdiscrimination
firm can observe the individual WTP of each consumer
offerseach consumer an individual price
imperfect firms try to predict individual WTP e g big data pricing
2nddegree Block
pricing
firms cannot observe the individual WTPof each consumer
offerdifferentpricingschemes such that consumers self Select
e quantity discounts
g
3rddegree Group discrimination
firms cannot observe the individual WTPof each consumer but knows
that NTP correlates with certain observablecharacteristics ofgroups
of consumers
openlyoffersdifferentpricesto differentgroups e g studentdiscounts
II Gamechanger
Market failure
possible causes marketpower externalities asymmetricinformation
pnblicgoodslnon rival.non excludab.LI
market failure means discrepancybetweenstatusquoandpossible
optimum

Rivalry andExcludability
rivalry consumptionbegone consumer prevents simultaneous
consumption
byotherconsumersorifconsumptionbyoneparty reduces
theabilityofanotherpartytoconsumeit
excludability agoodiscakedexcludabkifitispossible.to prevent
from havingconsumers
access tot
technologically legally morally

3 common
Pool
private
90001
resource

Public Club
d good good

Low excludability high

Provision d Publicgoods
Privategoods aggregatedemand
price
MC 2consumerswithindividualwTP
D and Da

horizontal addition
4959 14gg
quantity
productioncost MC
efficient Q O
Public good aggregatedemand
price 2 consumers with individual WTP
D and Da
p MC
aggregatedemand vertical addition
Pc
D
basedonnon rivalryinconsumption
production cost MC
quantity efficient QQ
finance atcogtpx P.tl
But nonexdudability individual incentive tonnderstaterealWTP
freeniding
thatisthereasonwhystatechargestaxes
Gametheory
concepts
aga.me 5detinedby setotplayers.decisionseach playerfaces information
eachplayer has whendeciding consequencestontomesofdecisions player's
preferences overall possibleoutcomes

Player2
Left ht
Normalform
upa
Playerl
Down a d
z
y

eachplayersbehaviorisdescribedbystrategy.fm
contingencyplan
ateachpointaplayermighthastodecide
foreachinformationarbelieftheplayermayhaveatthatpoint
dominantstrategies strategythatisoptimalnomatterwhattheother
playerdoes
Pepsi
not Nash equilibrium
1inch each player's

f
giPemnaakFtEEr9aso
caa.com
not 6 to Playoptimal
advertise g 2 no incentives for
anyoneto change
something
lpossibleionehasdominantstrategy.otheronehas.net
 Productchoiceproblem Lorenz
sequential decisions
aggreement
lsweetsaltyswee.to
10
Bahlsen
salty 10 0

Lorenz

compensation payments sweet salty

restructuring
biggercompany wins sweet 0 0 120 101
seniority Bahlsen f
salty 110 2010 0

splitorsteal Player2
indominant
strategies

Player 1
lsplitslespl.it
50 50 0 100
f 100
steal o to NGIdib.inm
indifferent

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