REVIEW FINAL EXAM

Suga

r (to

ns)

Suga

r (to

ns)

45

40

35

30

25

20

15

30

25

20

15 10

5 10 15 20 25 30 5 10 15 20Wheat (tons) Wheat (tons)

USABrazil

Wheat Sugar

30 3010 20

(1W costs 1S) (1S costs 1W)

(1W costs 2S) (1S costs 1/2W)

Which country has a comparative advantage in wheat?

1. Which country should EXPORT Sugar?2. Which country should EXPORT Wheat? 3. Which country should IMPORT Wheat?

2

Output Questions:OOO=

Output: Other goes Over

3

Input Questions:IOU=

Input: Other goes Under

4

The percentage change in priceThe percentage change in quantity

Q

P

P1

P2

Q1Q2

D

Commonly Expressed as…PRICE ELASTICITY OF DEMAND

% P% Q d

Elasticity is .5

Terms of Trade

6

KenyaIndia

Pineapples Radios

30 1040 40

(1P costs 1/3R) (1R costs 3 P)

(1P costs 1R) (1R costs 1P)

Kenya wants RadiosIf the terms of trade for 1 radio is greater than 3 pineapples then Kenya is worse off and should make radios on their own.India wants PineapplesIf the terms of trade for 1 radio is less than 1 pineapple then India is worse off and should make pineapples on their own.

What terms of trade benefit both countries?

Trading 1 radio for 2 pineapples will benefit bothIf Kenya produces radios by themselves, they give up 3 Pineapples for each radio. If they can trade 2 pineapples for each radio they are better off. If India produces pineapples by themselves, they give up 1 pineapple for one radio. If they can get 2 pineapples for one radio they are better off.The countries trade at a lower opportunity cost than

if they made the products themselves!

KenyaIndia

Pineapples Radios

30 1040 40

(1P costs 1/3R) (1R costs 3 P)

(1P costs 1R) (1R costs 1P)

Elasticity slide 9

Use the midpoint formula again.

• Elasticity =

• % change in Q =

• % change in Q =

• For the quantities of 10 and 7, the % change in Q is approx. 35.3 percent. (3/8.5 times 100)

Pin change %Q in change %

Q averageQ in change

100 )Q

Q (MEAN

Elasticity slide 10

Using the Midpoint Formula

Elasticity =

% change in p = times 100.

% change in p =

For the prices $2 and $2.50, the % change in p is approx. 22.22 percent.

Pin change %Q in change %

Paverage Pin change

100 )P

P(MEAN

Extreme CasesPRICE ELASTICITY OF DEMAND

Perfectly Inelastic Demand

Perfectly Elastic DemandP

0

P

0

D1

Ed = 0

D2Ed =

Q

Q

Q

P

D

When prices are low,

TR

Quantity Demanded

PRICE ELASTICITY & TOTAL REVENUE

So is total revenue

http://highered.mcgraw-hill.com/sites/0072819359/student_view0/chapter20/interactive_graphs.html

Q

P

D

Total revenue riseswith price to a

point... TR

Quantity Demanded



Q

P

D


point...

then declinesTR

Quantity Demanded



Q

P

D


point...

then declinesTR

Quantity Demanded


Total Revenue Test


Q

P

D


point...

then declines

InelasticDemand

InelasticDemand

TR

Quantity Demanded



Q

P

D


point...

then declines

ElasticDemand

ElasticDemand

InelasticDemand

TR

Quantity Demanded


InelasticDemand


Q

P

D


point...

then declines

ElasticDemand

ElasticDemand

InelasticDemand

TR

Quantity Demanded


InelasticDemand

UnitElastic


EconomicProfit

Implicit costs(including a

normal profit)

ExplicitCosts

Accountingcosts (explicit

costs only)

AccountingProfit

Econ

omic

(opp

ortu

nity

) Cos

ts TOTAL

REVENUE

Profits to anEconomist

Profits to anAccountant

ECONOMIC COSTS

Law of Diminishing Returns

SHORT-RUN PRODUCTIONRELATIONSHIPS

Tota

l Pro

duct

, TP

Quantity of Labor

Aver

age

Prod

uct,

AP,

and

Mar

gina

l Pro

duct

, MP

Quantity of Labor

Total Product

MarginalProduct

AverageProduct

IncreasingMarginalReturns

http://highered.mcgraw-hill.com/sites/0072819359/student_view0/chapter22/origin_of_the_idea.html



Tota

l Pro

duct

, TP

Quantity of Labor

Aver

age

Prod

uct,

AP,

and

Mar

gina

l Pro

duct

, MP

Quantity of Labor

Total Product

MarginalProduct

AverageProduct

DiminishingMarginalReturns




Tota

l Pro

duct

, TP

Quantity of Labor

Aver

age

Prod

uct,

AP,

and

Mar

gina

l Pro

duct

, MP

Quantity of Labor

Total Product

MarginalProduct

AverageProduct

NegativeMarginalReturns



Algebraic Restatement of theUtility Maximization Rule

MU of product A

Price of A

MU of product B

Price of B=

UTILITY MAXIMIZING COMBINATION

8 Utils

$1

16 Utils

$2=

PRODUCTIVITY AND COST CURVES

Cos

ts (d

olla

rs)

Ave

rage

pro

duct

and

mar

gina

l pro

duct

Quantity of labor

Quantity of output

MPAP

MCAVC

LONG-RUN PRODUCTION COSTSU

nit C

osts

Output

LONG-RUN PRODUCTION COSTS

Uni

t Cos

ts

Output

LONG-RUN PRODUCTION COSTS

The long-run ATC just “envelopes”all of the short-run ATC curves.

Uni

t Cos

ts

Output

LONG-RUN PRODUCTION COSTSU

nit C

osts

Output

long-run ATC

ECONOMIES ANDDISECONOMIES OF SCALE

• Labor Specialization• Managerial

Specialization• Efficient Capital• Other FactorsDiseconomies of ScaleConstant Returns to Scale

graphically presented...

ECONOMIES ANDDISECONOMIES OF SCALE

Uni

t Cos

ts

Output

long-run ATC

Economiesof scale

Uni

t Cos

ts

Output

long-run ATC

Economiesof scale

Constant returnsto scale

ATC decreases as Output increases

ATC is constant as Output increases

Uni

t Cos

ts

Output

long-run ATC

Economiesof scale

Diseconomiesof scale

Constant returnsto scale

ATC decreases as Output increases

ATC is constant as Output increases

ATC increases as Output increases

$200

150

100

50

0

Cos

t and

Rev

enue

1 2 3 4 5 6 7 8 9 10

MC

MR

AVCATC

Economic Profit

$131.00

$97.78

MARGINAL REVENUE-MARGINAL COST APPROACH

Profit Maximization Position


$200

150

100

50

0

Cos

t and

Rev

enue

1 2 3 4 5 6 7 8 9 10

MC

MR

AVCATC

Economic Profit

$131.00

$97.78


MR = MCOptimumSolution

Profit Maximization Position

$200

150

100

50

0

Cos

t and

Rev

enue

1 2 3 4 5 6 7 8 9 10

MC

MR

AVCATC

$71.00


Short-Run Shut Down Point

Minimum AVCis the Shut-Down

Point

P

Q

S=MC

AVC

ATC

8

D

P

Q8000

D

S= MCs

IndustryFirm(price taker)

EconomicProfit

$111$111

SHORT-RUN COMPETITIVE EQUILIBRIUMThe Competitive Firm “Takes” itsPrice from the Industry Equilibrium

P

Q

S=MC

AVC

ATC

8

D

P

Q8000

D

S= MCs


EconomicProfit

$111$111

SHORT-RUN COMPETITIVE EQUILIBRIUMThe Competitive Firm “Takes” itsPrice from the Industry Equilibrium

How about thelong-run?

Temporary profits and the reestablishmentof long-run equilibrium

S1

MCATC

P

Q100

P

Q100,000


$605040

$605040

PROFIT MAXIMIZATION IN THE LONG RUN

MR

D1

An increase in demand increases profits…

MR

D1

MCATC

P

Q100

P

Q100,000


$605040

$605040


D2

EconomicProfits

S1

New competitors increase supply, and lowerprices decrease economic profits.

MR

D1

MCATC

P

Q100

P

Q100,000


$605040

$605040


D2

Zero EconomicProfits

S1

S2

Decreases in demand, losses, and the reestablishment of long-run equilibrium

S1

MCATC

P

Q100

P

Q100,000


$605040

$605040


D1

MR

A decrease in demand creates losses…

MR

D1

MCATC

P

Q100

P

Q100,000


$605040

$605040


D2

EconomicLosses

S1

MR

D1

MCATC

P

Q100

P

Q100,000


$605040

$605040


D2

Return to ZeroEconomic Profits

S1

S3

Competitors with losses decrease supply, andprices return to zero economic profits.

$200

150

100

50

0

Cos

t and

Rev

enue

1 2 3 4 5 6 7 8 9 10

MC

MRAVCATC

Economic Loss

$81.00$91.67


Loss Position

T

MONOPOLY REVENUES & COSTS

Dol

lars

Dol

lars

$200

150

200

50

$750

500

250

MR

Elastic

0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18

DQ

0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18

TR

Q

MONOPOLY REVENUES & COSTS

Q

Dol

lars

Dol

lars

$200

150

200

50

$750

500

250

TR

MR D

InelasticElastic

0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18Q

0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18

A Monopolist will always operate on the Elastic Portion of the Demand Curve

Inelastic PortionMR is Negative

Profit Maximization Under Monopoly

D

MC

ATC

MR

$94

$122

Profit

MR = MC

ProfitPer Unit

OUTPUT AND PRICE DETERMINATION

Q

200

175

150

125

100

75

50

25

0 1 2 3 4 5 6 7 8 9 10

Pric

e, c

osts

, and

reve

nue

Remember the MR=MC Rule?

Profit Maximization Under Monopoly

D

MC

ATC

MR

$94

$122

Profit

MR = MC

ProfitPer Unit


Q

200

175

150

125

100

75

50

25

0 1 2 3 4 5 6 7 8 9 10

Pric

e, c

osts

, and

reve

nue

What About

Loss Minimization?

Loss Minimization Under Monopoly

D

MCATC

MR

APm

Loss

MR = MC

LossPer Unit


Q

200

175

150

125

100

75

50

25

0 1 2 3 4 5 6 7 8 9 10

Pric

e, c

osts

, and

reve

nue

AVC

Qm

V

Since Pm exceeds AVC,the firm will produce

Loss Minimization Under Monopoly

D

MCATC

MR

APm

Loss

MR = MC

LossPer Unit


Q

200

175

150

125

100

75

50

25

0 1 2 3 4 5 6 7 8 9 10

Pric

e, c

osts

, and

reve

nue

AVC

Qm

V

What are theEconomic Effectsof Monopoly?

Q

INEFFICIENCY OF PURE MONOPOLYP

DMR

S = MC

Pc

Pm

QcQm

At MR=MCA monopolistwill sell lessunits at ahigher pricethan incompetition

An industry in pure competitionsells where supply anddemand are equal

Q

INEFFICIENCY OF PURE MONOPOLYP

DMR

S = MC

Pc

Pm

QcQm

At MR=MCA monopolistwill sell lessunits at ahigher pricethan incompetition

Monopoly pricing effectivelycreates an income transfer from

buyers to the seller!

REGULATED MONOPOLY

Q

DMR

MCATC

PPr

ice

and

Cos

tsMR = MC

Fair-Return Price

Socially-OptimumPrice

Qm Qf Qr

Dilemma of RegulationWhich Price?

Pm

Pf

Pr

D

MR

MC

P3 = A3

ATC

Pric

e an

d C

osts

Q3Quantity

Long-Run EquilibriumPrice is Not= Minimum

ATC

Price MC

MONOPOLISTIC COMPETITIONAND EFFICIENCY

MONOPOLISTIC COMPETITIONAND EFFICIENCY

• Not Productively Efficient Minimum ATC

• Not Allocatively EfficientPrice MC

• Excess CapacityGraphically…


Dominant StrategyThe Dominant Strategy is the best move to make

regardless of what your opponent doesWhat is each firm’s dominate strategy?

Firm 2

Firm 1

$100, $50

High Low

High

Low

$50, $90

$80, $40 $20, $10

No Dominant Strategy

2007 FRQ #3Payoff matrix for two competing bus companies

Non-LaborCosts

LaborCosts

PURELY COMPETITIVE LABORMARKET EQUILIBRIUM

Labor Market

S

D = MRP( mrp’s)

Wc

(1000)

Individual Firm

S = MRC

d = mrp

Wc

Quantity of Labor

Wag

e R

ate

(dol

lars

)

Quantity of Labor

($10)

(5)

$10 $10 $10 $10 $10 $10

IncludesNormalProfit


Non-LaborCosts

LaborCosts

IncludesNormalProfit

Labor Market

S

D = MRP( mrp’s)

Wc

(1000)

Individual Firm

S = MRC

d = mrp

Wc

Quantity of Labor

Wag

e R

ate

(dol

lars

)

Quantity of Labor

($10)

(5)

$10 $10 $10 $10 $10 $10

Marginal ResourceCost (MRC) will be

constant and equal toresource price(the wage rate)

PURELY COMPETITIVE LABORMARKET EQUILIBRIUM

Wag

e R

ate

(dol

lars

)S

Quantity of Labor

MONOPSONISTICLABOR MARKET

In monopsonyMRC lies above

the supply curve.

Wag

e R

ate

(dol

lars

)

MRP

S

Wm

Quantity of Labor

MRC

Qm


MRP = MRC

Qm units oflabor hired

Wag

e R

ate

(dol

lars

)

MRP

S

Wm

Quantity of Labor

MRC

Wc

Qm Qc

The competitivesolution would

result in a higherwage and greater

employment.



P

Q

$ 9 7

5

3

1

0 1 2 3 4 5

DC

S

OPTIMAL AMOUNT OF A PUBLIC GOOD

Yields theoptimum amount

of the public good

MB = MC

20 40 60 80 100

100

80

60

40

20

0

Percent of Families

Perc

ent o

f Inc

ome Perfect Equality

CompleteInequality

Lorenz Curve (actual distribution)

Area betweenthe lines shows

the degree ofincome inequality

THE LORENZ CURVE

Lorenz curveafter taxes and

transfers

REVIEW FINAL EXAM

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