Micro Final Exam Hammock FSU

economics

study of how people respond to incentives

scarcity

stuff is limited --> choice

opportunity cost

the value of the next best thing you have to give up to do something

- aka tradeoffs

Rational Self Interest Assumption

assume people will do things in their own self-interest in a rational way

Ceteris paribus

"other things equal, or other things the same"

positive economics

fact, the way the world is

normative economics

the way the world ought to be

benefits of trade

- increase variety of goods

- increased competition

- technology transfer

- more efficient large-scale production

law of demand

as price increases, quantity demanded decreases

consumer surplus

the difference between what the consumers are willing to pay vs. what they actually pay

what changes quantity demanded?

price

what changes demand?

- change in info

- natural disasters

- change in income

- change in price of complements & substitutes

-change in expectations

normal goods

as income increases, demand increases

(Lexus)

inferior goods

as income increases, demand decreases (Ramen)

law of supply

as the price increases, the quantity demanded decreases

producer surplus

the difference between the price and the marginal cost of output

- area above the supply curve & below the price

if price is above equilibrium =

SURPLUS

if price is below equilibrium =

SHORTAGE

Total surplus =

PS + CS

economic efficiency

1. total surplus is maximized.

2. marginal benefit = marginal cost

3. every unit that is produced has a benefit to consumers that is greater than (or equal to) the cost of its production

classifying own-price elasticity of demand

- If E > 1 = demand is elastic

- If E = 1 = demand is unit elastic

- If E < 1 = demand is inelastic

classifying arc cross-price elasticity of demand

E > 0 = substitutes

E = 0 = unrelated

E < 0 = complements

classifying arc income elasticity of demand

E > 0 = normal

E = 0 = unrelated

E < 0 = inferior

classifying arc price elasticity of supply

E > 1 = elastic

E = 1 = unit elastic

E < 1 = inelastic

Is supply & demand more elastic in the long run or short run? Why?

Long run...

because changes take time and the long run provides the time necessary for big adjustments

price ceilings

a maximum legal price

if below equilibrium ... SHORTAGE

price floors

a minimum legal price

if above equilibrium ... SURPLUS

effects of price ceilings

1. reduced quality, or even reduced supply

2. black market association

3. discrimination by sellers is more likely

4. failure to allocate goods to their highest-valued uses

5. resources diverted to litigating & arbitrating disputes

6. time wasted standing in queues

effects of price floors

1. increases in quality

2. discrimination by buyers is more likely

3. if govt buys us surplus output, it requires tax rev.

4. black market allocation

5. higher minimum prices for inputs (such as labor) encourage firms to reduce output, or substitute other inputs

tax on producers

- supply decreases

- causes tax revenue & DWL

tax on consumers

- demand decreases

- causes tax revenue & DWL

who bears more of the burden of a tax?

the one with the most inelastic curve

Inputs/Factors of production

1. Land

2. Labor

3. Capital: physical (machinery) & human (knowledge)

4. Entrepreneurship: risk taking

short run

period during which some inputs are fixed

long run

period during which all inputs are variable

law of diminishing returns

when we add more of available input, while other inputs are fixed, marginal product will eventually fall

explicit costs (accounting costs)

costs you might see in a balance statement

implicit costs (opportunity costs)

value of giving up the next best use of resources

sunk costs

costs that have already been incurred

when MC < AVC =

AVC falls

when MC > AVC =

AVC rises

when MC < ATC =

ATC falls

when MC > ATC =

ATC rises

Long Run Average Total Cost Curve

3 options:

1. economies of scale

2. neither economies or diseconomies of scale

3. diseconomies of scale

economies of sales

As a firm expands operations, ATC falls.

neither economies nor diseconomies of scale

ATC doesn't rise or fall

diseconomies of scale

As a firm expands operations, ATC rises.

positive economic profit

TR > TC

negative economic profit

TR < TC

zero economic profit

TR = TC

3 Characteristics of Perfect Competition

1. homogeneous goods (identical products)

2. many buyers & sellers (no buyer or seller can affect market price)

3. free entry (firms can easily enter market)

profit maximizing output for perfect competition

MC = MR

Shutdown Rule

- if a firm gets negative profits, it will exit the market eventually. in the short run, they're stuck with their fixed costs.

- sometimes better to produce in the short run. you cannot eliminate fixed costs in the short run.

- if you get enough revenue to cover your variable costs, you should keep producing until you can get rid of your fixed costs and exit.

Increasing-cost industry

Version A: as firms enter, and industry output increases, *costs increase*

Version B: as firms exit, and industry output decreases, *costs decrease*

constant-cost industry

costs stay the same no matter if firms enter or exit

decreasing-cost industry

Version A: as firms enter & industry output increases, *costs decrease*

Version B: as firms exit & industry output decreases, *costs increase*

Demand rises in an increasing-cost industry

long run supply

connect your starting and ending points on supply&Demand diagram

characteristics of a monopoly

1. one firm, many customers

2. high barriers to entry

why would a monopoly (lack of competition) occur?

1. legal barriers (ex. occupational licensing, patent)

2. control of a key resource (ex. oil?)

3. network externalities

4. natural monopoly

natural monopoly

the firm that gets biggest has a cost advantage (economies of scale)

when the monopolist cuts the price, 2 things happen:

1. quantity rises

2. price falls

the firm gives up some revenue every time it cuts the price to sell more

For a straight-line demand curve, MR is...

2x as steep as demand

efficient amount of output by a monopoly

MC = D (MB)

static inefficiency

- ex. monopoly

- doesn't change (remains inefficient)

- DWL (high prices)

dynamic efficiency

- changing over time

- faster technology progress

if a monopoly is inefficient... solutions

1. antitrust law

2. marginal cost pricing

3. ATC pricing

antitrust law

prevents some mergers & acquisitions or in cases of bad behavior, breakup firms

marginal cost pricing

charge at MC = D

ATC pricing

charge at ATC = D

TR = TC --> Zero profit

price discrimination can only happen if...

1. consumers have different own-price elasticity of demand

2. consumers cannot easily resell products

3. firms face downward sloping demand (cannot be a perfectly competitive market)

ex. movies (senior citizen discounts)

1st degree price discrimination

"telepathic monopolist"

- charge almost exactly the consumer's willingness to pay

2nd degree price discrimination

quality-based pricing

-charge high price and if they want more, charge less for more products

ex. printer & ink cartridges

3rd degree price discrimination

charging different prices to people with differing observable characteristics

ex. movie tickets (lose $$ on tickets, gain $ on food)

characteristics of monopolistic competition

1. many firms & many consumers

*2. differentiated (or heterogeneous) products

3. low barriers to entry

characteristics of an oligopoly

1. only a "few" firms, which means first are price searchers

2. there are high (not crazy) barriers to entry

3. firms are probably not producing identical goods

oligopolists face 2 fundamental temptations:

1. Collude: work together to reduce output & raise price

2. Cheat: firms are tempted to cheat by cutting price or selling more

price taker

all MR is the same in a chart

perfect competition

price searcher

monopoly

oligopoly

monopolistic competition

negative externalities

the actions of some people (maybe buyers&sellers) impose costs on a 3rd party

ex. pollution, drinking & driving

SOLUTION:

- tax (causes supply to shift left) --> will eliminate DWL

- "cap & trade"

positive externalities

our actions provide benefits to a 3rd party

ex. education

SOLUTIONS: subsidies (pay people) --> demand will shift right

public goods are...

1. non rivalrous: my consumption doesn't reduce yours

2. non excludable: people who do not pay cannot be prevented from consuming the good

ex. National Defense

free riders

people who consume without paying

the lemons problem

when sellers can't prove quality to buyers, high quality goods are driven off market

-private solutions: reputations, warranties, inspection

-public solutions: licensing, regulation, inspection

adverse selection

consumers (usually of insurance) who buy a good are more likely to need & use it

moral hazard

people who are protected from a risk take fewer precautions

tragedy of the commons

when a resource is owned in common or unowned, people tend to overuse it

ex. fishery, elephants

SOLUTIONS:

- privatize the common property

- Individual Tradable Quotas (ITQs)

tragedy of the anticommons

a resource is underused because too many people have the power to prevent its use

-ex: patent trolling

SOLUTIONS:

-income inequality vs. poverty

- eliminate polices that increase inequality

- redistribute income

public choice

individuals making collective decisions through government

private choice

individuals or businesses making choices about buying & selling

2 basic views of government

1. public interest view

2. public choice view

public interest view

governments use voting to figure out & create beneficial policy

public choice view

government policies are determined by the incentives facing people who interact in "political markets"

voters

want policies that benefit them at minimum cost

rational ignorance

most voters rationally choose to be poorly informed about polices & politicians

rational absention

many voters rationally choose not to vote

anti foreign bias

a transaction between citizens is acceptable but is unacceptable if one of them is a foreigner

antimarket bias

harmful or wrong for people to do, trade, or produce things for profit or other self-interested motives

-ex: helping homeless man and both receiving profit

make-work bias

the view that the purpose of an economy is to produce jobs, rather than goods & services

pessimistic bias

the past was pretty good & the future will be terrible