Microeconomics Final Exam

Title Bitches im too tired to describe this

Economic problem

How to allocate scarce resources

Opportunity cost

Choosing how to spend your time between two activities

Three fundamentaal questions about resource allocation

What goods and services will be produced

2. How will the goods and services be produced, by who, and at what cost

3. Who will recieve the goods and services produced and at what price

Two extremes of Economies

Market Based

Centrally Planned

Market-Based Economy

All decisions made by the markets, private producers interact with customers and price is the only allocative mechanism.

Centrally-Planned Economy

All decisions made by the state

Cost

Value of the resources used in production

Benefit

Value to the consumer buying it

Markets

A mechanism where resources are allocated among competing claims

Two Sides to a Market

Demand

Supply

Demand

Individuals or organisations willing to pay to procure a good or service

Marginal Benefit of Consumption

Quantities of a good/service buyers are willing to buy at a maximum price at a given time

Why does Demand Slope Downwards (2)

Income Effect

Substitution Effect

Income Effect

As a good becomes cheaper our purchasing power becomes better, we can buy more goods with out income so the quantity demanded increases

Substitution Effect

As a good becomes cheaper relative to other goods, we shift from other expensive goods to the cheaper goods so the quantity demanded increases

What happens to demand when price changes?

Quantity demand changes along the demand curve

Demand curve does not change

Non Determinants of Demand (5)

Income

Tastes and Preferences

Price of Related Goods

Congestion and Network Effects

Expectations of Future Price Changes

Income - Demand

Willingness to pay

Change in preferences

Tastes and Preferences - Demand

Percieved willingness/benefit to pay

Price of Related Goods - Demand

Substitute goods - As the price of one good rises the demand for another rises

Complement goods - As the price of one good rises the demand for another falls

Congestion and Network Effects - Demand

Network Effect - When a good becomes more useful due to being used by a higher number of people

Congestion Effect - When a good becomes less useful due to being used by a higher number of people

Expectations of Future Price Changes - Demand

Consumers buy more when price is expected to increase but buy less if it is expected to decrease

Supply

Individuals or organisations willing to provide a goodor service for a fee/price

Marginal Cost

The additional cost of producing the last unit of a good/service

Why does supply slope upwards?

Higher prices incentivies firms to increase production

Increased production carries greater marginal costs

• When increasing production, inputs become more scarce which makes them more expensive, requiring prices to rise to entice producers to increase Qs.

Determinants of Supply (6)

Natural Conditions for Production

Prices of Inputs

Productivity and Technology

Prices of Substitutes in Production

Expected Future Prices

Change in Type and Number of Firm

Natural Conditions for Production - Supply

Some production affected by natural conditions

Prices of Inputs - Supply

If the price of inputs rise, the overall cost will change

Productivity and Technology - Suppy

An improvement in technology will decrease the cost of production for firms, shifting the supply curve to the right

Prices of Substitutes in Production

Goods that use the same or smilar inputs

Expected Future Prices

Firms will increase/decrease production based on expectations for uture demand or supply

Change in number and type of firms

The market supply is the sum of the quantity supplies of all sellers in the market

Increase in number of sellers shifts supply to the right

Surplus

Supply is greater than demand, meaning excess units in the market

Supply lowers to meet demand at equilibrium as a result of prices decreasing

Shortage

Demand is greater than supply, so there aren’t enough units in the market

Price increases causing firms to produce more

Equilibrium

When the price sellers are willing to accept matches the price consumers are willing to pay

When to shift along the curve vs moving the curve

If reacting to an increase in price, shift along the curve

If reacting to a non-price determinant, shift the curve

Consumer surplus

Difference between maximum price a consumer is willing to pay and the actual price they do pay

Producer surplus

The difference between the lowest price the seller is willing to sell for vs the price actually recieved for that good

DWL When?

When MB does not equal MC

Three types of Efficiency

Allocative

Productive

Dynamic

Allocative Efficiency

MB=MC

Productive Efficiency

Firms operate at the lowest point on the average cost curve

Dynamic efficiency

Occurs when firms are willing and able to improve production through research and development

Market intervention

When the government takes measures to intefere in the market

Three ways Government can intervene

Price Restrictions

Quantity Restrictions

Taxes and Subsidies

Type of Price Restrictions

Ceiling - Maximum price

Floor - Minimum price

Types of quantity restrictions

Prohibition

Mandates

Quotas

Permits

Tax

Artificial added cost

Increases sellers price and consumers cost (net bad)

When flat, added cost of production

Subsidy

Artificial added benefit

Sellers recieve more and buyers pay less

Elasticity

How sensitive one variable is to changes in another variable

How is Price elasticity in demand calculated

Ed= %change in Qd/Percent change in p

Difference Between Elastic and inelastic

Elastic |ED|>1

• Perfect = Flat

Inelastic |ED|<1

• Perfect = Vertical

Determinants of Price Elasticity of demand

1. Availability of close substitutes

2. Time

3. Neccesities Vs Luxuries

4. Definition of the market

5. Share of budget taken up

Availability of close substitutes meaning

More close substitutes the more people will change

Time meaning

Gives people more time to find suitable alternatives

Neccesities vs Luxuries meaning

Luxuries we can do without and are more responsive for change

Definition of the market meaning

The broader the market the less elastic

Share of the budget taken up meaning

The smaller the fraction of the budget the less elastic demand will be

Different values of ED meaning for TR

• ED>1 then change in p will cause the flip in TR

• ED<1 than change in p will cause the same in TR

• ED=1 than change in p will not affect TR

Comparative Advantage

When a country can produce a good at a lower cost than the world price

For Exports

Price is set above Pc

For Imports

Price set below Pe

Why do countries restrict trade

Protect local jobs

Infant industry

National security

Unfair competition

Protection as a bargaining chip

Externalities

Benefits or costs that affect someone who is not directly involved in the production or consumption of a good or service

Positive or negative

Private costs and benefits

Costs or benefits that are bourne by the individual or firm deciding to consume or produce a good or service

Social Costs or benefits

Costs or benefits that are bourne by the whole society as a result of the individual or firm deciding to consume or produce a good or service

Negative Externalities

When the social cost of consumption or production is greater than the private cost

(COST)

The producers getting more benefits and the consumers getting more costs

Features of Negative Externalities (Production)

MSC>MPC

MPB the same as MSB

Pollution

Features of negative externalities (consumption)

MPB>MSB

MPC=MSC

Alcohol

Positive Externality

When the social benefit of consumption is greater than the private cost of consumption or production

People get less costs and more benefits

Positive externality features (consumption)

MSB>MPB

Positive externality features (Production)

MPC>MSC

What do the supply and demand curves represent

Supply = MC

Demand = MB

Solutions to removing externalities

1. Private bargaining (coase theorum)

2. Command and control

3. Corrective taxes and subsidies

4. Cap and trade

Coase theorem

If transaction costs are low, private bargaining will result in an efficient solution to the problem of externalities

Markets will correct themselves

Bees and fruit trees

Command and Control

The government can ban some goods or activities

Even actions with positive externalities have costs, and negative ones have benefits

Advantages of tradable permits

Overcomes the externality

Promotes progress

Drives out inefficient producers

Makes money for efficient ones

Disadvantages of tradable permits

Issue of getting to the right level in the first place

Possibility of rent seeking

System difficult to agree on 

When correcting externalities

Quality restrictions

Price restrictions

Taxes and subsidies

Quantity restrictions

Only works if quantity is too high

Leads to shortages

Price Restrictions

Targets the problem semi directly

Leads to shortages or surpluses in the market

Taxes and subsidies

Targets the problem indirectly

Profit calculation (+Breakdowns0

Total revenue - total costs

Total revenue = P*Q

Total costs = A function of costs of production

Two types of cost

Explicit

Implicit

Three types of profit

Accounting = TR-Explicit

Economic = TR - Explicit and implicit costs
Normal profit: Accounting profit neccesady to ensure all reasources earn their opportunity cost

Production Function

Relationship between outputs and inputs neccesary for production of that output

How many stages of output increase

3

What is the law of diminishing returns

As long as one of the factors of production is fixed, output must eventually increase by smaller and smaller amounts when added to the fixed factor

Calculations (MISC)

ATC = TC/Q

AVC = AVC/Q

MC = Change in TC or TVC / change in Q

What factors are variable in the long run and why

All of them

Scale efficiencies in the long run

When does market deman = firm demand

If the firm the only supplier

For individual firms in perfect competition

Firms unable to sell identical products

Each furm unable to excersise market power - price takers

The individual firm is perfectly elastic (horizontal)

Marginal revenue

How much the last unit sold adds to the total revenue

Marginal cost

How much the last unit sold adds to the total cost

How does MR=MC come about when not present

MR>MC = The firm produces more and the additional Q adds more revenue than it costs to produce

MC>MR = The firm produces less, the last cost more to produce than it added revenue

What are the 4 Operating positions

Economic profit (P>ATC)
Zero economic profit (P=ATC)

Quasi Loss (ATV>P>AVC)
Shutdown(P<AVC)

Zero economic profit

Coule still be making accounting profit, however in economics represents the opportunity costs aswell

Quasi Loss

Price is still great enough to cover variable costs and some of the total costs

Shut down

Would be cheaper to shut down entirely

What happens in the long run if preferences shift toward the good

Low barriers to entry allow firms to enter

Quantity in the markets rise even though quantity for firms does not

Demand change in short run, supply in long

Return to normal economic profit