Vincent Lindberg

Student in BLC18

Formulae and concepts

- Formula sheet is in the end of the paper
3 key trade offs

- Which goods to produce

- How to produce

- Who gets the goods and services

The demand function

- 𝑄 = 𝐷(𝑃𝑎,𝑏,𝑐….𝑧 , 𝑌)

𝑟𝑖𝑠𝑒 ∆𝑃
- 𝑠𝑙𝑜𝑝𝑒 = =
𝑟𝑢𝑛 𝛥𝑄

1 1
- 𝑄 = 𝑎 − 𝑏𝑝 → 𝑝 = ∗ (𝑎 − 𝑄) 𝑜𝑟 𝑝 = ∗ (𝑄 − 𝑎)
𝑏 −𝑏

Equilibrium

- A situation in which no one wants to change their behaviour

- Equilibrium price:

o The price at which buyers wants to buy and sellers want to sell

- Equilibrium quantity:

o The quantity at which buyers wants to buy and sellers want to sell

- Excess demand:

o the amount of quantity demanded that exceeds the quantity supplied

- Excess supply:

o the amount of quantity supplied that exceeds the quantity demanded

Equilibrium effects of government interventions

- Policies that shift supply curves;

o bans, quotas

- Policies that cause demand to differ from supply

o Price ceilings: the price of a good may rise above a certain price

o Price floor: the price of a good may not fall below a certain price

Price elasticity

- Elasticity:

o The percentage change in a variable in response to a given percentage change

in another variable

- Price elasticity of demand (ε):

o the percentage change in the quantity demanded in response to a given

percentage change in price

%∆𝑄 𝑝 ∆𝑄
- 𝜀= → 𝜀 = −𝑏 𝑎𝑠 𝑏 =
%∆𝑃 𝑄 ∆𝑝

Elasticity levels

- 1) Perfectly inelastic: 𝜀 = 0, no change in quantity demanded when price changes

- 2) Inelastic: 𝜀 < |1|, 0 > 𝜀 > −1, a small change in quantity demanded when

price changes

- 3) Unitaryelastic: 𝜀 = |1|, 𝜀 = −1, equal change in quantity demanded as in price

change

- 4) Elastic: 𝜀 > |1|, 𝜀 < −1, , a big change in quantity demanded when price

changes
 - 5) Perfectly elastic: 𝜀 = −∞, a huge change in quantity demanded when price

changes

Elasticity in Midpoint calculation

𝑄2 −𝑄1
(𝑄2 −𝑄1 )/2
- 𝜀= 𝑝2 −𝑝1
(𝑝2 −𝑝1 )/2

Sensitivity of quantity demanded to income

%∆𝑄 ∆𝑄 𝑌
- 𝜀= → 𝜀= ∗
%∆𝑌 ∆𝑌 𝑄

- Normal goods: if the quantity demanded is directly related to income

o Income rises → Consumers buy more of the product

- Inferior goods: if the quantity demanded is inversely related to income

o Income rises → Consumers buy less of the product

Taxes

- Ad Valorem tax

o For every dollar the consumer spends the government keeps a fraction (a)

which is the ad valorem tax rate

- Specific tax

o Where a specified dollar amount (t) is collected per unit of output

Consumer Behavior

- Individual preferences determine the amount of pleasure people get from goods and

services

- Consumers face constraints on choices

 - Consumers maximize their well-being or pleasure from consumption

Properties

- Completeness

o When facing a choice between two bundles of goods a consumer can rank

them so that so that the consumer prefers one bundle over the other making

the goods indifferent

- Transitivity

o A consumers preferences over bundles is consistent so that if consumer

weakly prefers “A” to “B” and prefers “B” to “C” he weakly prefers “A” to “C”

- More is better

o All else being the same more of a commodity is better than less of it

o Always wanting more = non satiation

o Good; A commodity for which more is preferred to less, at least some levels

of consumption

o Bad; Something for which less is preferred to more, for example pollution

Preference Maps

- Indifference map

o A complete set of indifference curves that summarize a consumer’s tastes or

preferences

- Indifference curves

o The set of all bundles of goods that a consumer views as being equally

desirable
 - Properties

o Bundles on indifference curves farther from the origin are preferred to those

on indifference curves closer to the origin

o There is an indifference curve through every possible bundle

o Indifference curves cannot cross

o Indifference curves slope downward

Willingness to substitute between goods

- Marginal rate of substitution (MRS)

o The maximum amount of one good a consumer will sacrifice to obtain one

more unit of the other good

∆𝐵
o 𝑀𝑅𝑆 = WHERE B and Z represent two different goods
∆𝑍

o It is the slope of the indifference curve

o The MRS approaches zero the more down we go along the indifference curve

Curvature of indifference curves

- Most indifference curves are convex

- Special cases are “Perfect substitutes” and “perfect complements”

o Perfect substitutes are goods that for a consumer are completely indifferent

as which to consume. This create straight indifference curves

o Perfect complements are goods that a consumer is interested in consuming in

only fixed proportions. This creates right-angled indifference curves

Utility

- A set of numerical values that reflects the relative rankings of various bundles of

goods

- Utility function; 𝑈 (𝑥, 𝑦)

- Marginal utility

o The extra amount of utility that a consumer gets from consuming the last unit

of a good

o It is the slope of the utility function

∆𝑈
o Marginal utility of good Z is 𝑀𝑈𝑍 =
∆𝑍

- The marginal rate of substitution is the ratio of the marginal utilities of two goods

𝑀𝑈𝑌
o 𝑀𝑅𝑆 =
𝑀𝑈𝑋

Budget Constraint

- Budget Line

o The bundles of goods that can be bought if the entire budget is spent on

those goods at given prices

o The budget constraint is given by the equation;

▪ 𝑍 = 𝑋 ∗ 𝑝𝑋 + 𝑌 ∗ 𝑃𝑌

▪ 𝑤ℎ𝑒𝑟𝑒 𝑧 = 𝑡ℎ𝑒 𝑏𝑢𝑑𝑔𝑒𝑡, 𝑥 𝑎𝑛𝑑 𝑦 = 𝑡ℎ𝑒 𝑎𝑚𝑜𝑢𝑛𝑡 𝑜𝑓 𝑟𝑒𝑠𝑝𝑒𝑐𝑡𝑖𝑣𝑒 𝑔𝑜𝑜𝑑

- Opportunity set

o All the bundles a consumer can buy including all the bundles inside the

budget constraint
 o The budget constraint is further developed into

𝑍 𝑝𝑋
▪ 𝑌= −𝑋∗
𝑝𝑌 𝑝𝑌

o The slope of the budget constraint is the ratio of prices

𝑝𝑋
▪ 𝑆𝑙𝑜𝑝𝑒 =
𝑝𝑌

The most optimal bundle

- The most optimal bundle is the bundle that can be afforded and gives the most utility

- It is where the slope of the indifference curve and budget line equal each other

𝑀𝑈𝑋 𝑝𝑋
o At the optimal bundle 𝑀𝑅𝑆 = = = 𝑀𝑅𝑇
𝑀𝑈𝑌 𝑝𝑌

- Maximum utility is achieved where MRS = MRT

Tax incidence

- The specific tax effects depend on elasticity

o Raise in tax: ∆𝑡 = 𝑡2 − 𝑡1

o The price buyers pay increases by

𝑛
▪ ∆𝑝 = ∗ ∆𝑡 n= elasticity if supply
𝑛−𝜀

Price consumption curve

- A line through optimal bundles at each price of one good when the other goods are

kept at constant prices

- The demand curve corresponds to the price consumption curve

Income consumption curve and Engel curve

- Engel Curve

o The relationship between the quantity demanded of a single good and

income holding prices constant

- Income consumption curve

o Shows how consumption of both goods changes when income changes while

prices are held constant

Effects of a price change

- Substitution effect

o The change in the quantity of a good that a consumer demands when the

goods’ price changes, holding other prices and the consumer’s utility constant

- Income effect

o The change in the quantity if a good a consumer demands because of a

change in income, holding other prices constant

Production

- Capital (K)

o Long-lived inputs

o Land, buildings (factories, stores) and equipment (machines, trucks)

- Labor (L)

o Human services

o Managers, skilled workers (architects, economists) and less-skilled workers

(construction laborers, custodians)

 - Production function

o The relationship between the quantities of inputs used and the maximum

quantity of output that can be produced, given current knowledge about

technology and organization

o Q = f (L,K)

- Time and variability

o Short run; A period of time so brief that at least one factor of production

cannot be varied practically

o Long run; A lengthy enough period of time where all inputs can be altered

Products of labor and inputs

- Marginal product of labor (MPL)

o The change in total output, ∆𝑞 resulting from using an extra unit of labor,

∆𝐿 = 1, holding other factors constant

∆𝑞
o 𝑀𝑃𝐿 =
∆𝐿

- Average product of labor (APL)

o The ratio of output, q, to the number of workers ,L, used to produce that

output

𝑞
o 𝐴𝑃𝐿 =
𝐿

- ¨Fixed input

o A factor of production that cannot be varied practically in the short run

 - Variable input

o A factor of production whose quantity can be changed readily by the firm

during the relevant time period

- Law of diminishing marginal returns

o If a firm keeps increasing an input, holding all other inuts and technology

constant, the corresponding increases in input will become smaller eventually

o That is if only one input in increased, the marginal product of that input will

diminish eventually

Isoquants

- Isoquant is a curve that shows the different combinations of labor and capital that

can produce a level of output

- Properties of Isoquants

o The farther the isoquant is from the origin the greater the level of output

o They do not cross each other

o They slope downward

Marginal rate of technical Substitution

- The willingness to exchange an amount of capital and labor and keep the output the

same

𝑐ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑐𝑎𝑝𝑖𝑡𝑎𝑙 ∆𝐾
- 𝑀𝑅𝑇𝑆 = = ’
𝑐ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑙𝑎𝑏𝑜𝑟 ∆𝐿

- Substituability of Inputs and Marginal Products

∆𝐾 𝑀𝑃𝐿
o 𝑀𝑅𝑇𝑆 = − =−
∆𝐿 𝑀𝑃𝐾
Returns to scale

- How much does output change if a firm increases all its inputs proportionally

- Constant returns to scale

o Property of a production whereby when all inputs are increased by a certain

percentage, output increases by that same percentage

o F(2L, 2K) = 2* f( K,L)

- Increasing returns to scale

o Property of a production function whereby output increases more than in

proportion to an equal increase in all outputs

o F(2L, 2K) > 2* f( K,L)

- Decreasing returns to scale

o Property of a production function whereby output rises less than in

proportion to an equal increase in all outputs

o F(2L, 2K) < 2* f( K,L)

Short run cost measures

- Fixed Cost (F)

o A production expense that does not vary

o Capital costs are a fixed cost: 𝐹𝐶 = 𝑟 ∗ 𝐾 where r is the rent of capital

- Variable cost (VC)

o A production expense that changes with the quantity produced

o Labor costs are a variable cost, 𝑉𝐶 = 𝑤 ∗ 𝐿 where w = wage

- Cost (C )

o Total cost; 𝐶 = 𝑉𝐶 + 𝐹
 - Marginal cost (MC)

o The amount by which a firm’s cost changes when it produces one more

output

∆𝐶 ∆𝑉𝐶
o 𝑀𝐶 = since only variable cost changes 𝑀𝐶 =
∆𝑞 ∆𝑞

- Average fixed cost (AFC)

𝐹
o 𝐴𝐹𝐶 =
𝑞

- Average variable cost (AVC)

𝑉𝐶 𝑤𝐿 1 𝑤
o 𝐴𝑉𝐶 = = =𝑤∗ =
𝑞 𝑞 𝐴𝑃𝐿 𝐴𝑃𝐿

- Average cost (AC)

o The average cost for one unit of output

𝐶
o 𝐴𝐶 = = 𝐴𝐹𝐶 + 𝐴𝑉𝐶
𝑞

o A firm will make a profit if 𝐴𝐶 < 𝑝

o If 𝑀𝐶 > 𝐴𝐶 then AC increases as q increases

o If 𝑀𝐶 < 𝐴𝐶 then AC decreases as q increases

Isocost

- All the combinations of inputs that require the same total expenditure

- Total cost equation

o 𝐶 = 𝐹𝐶 + 𝑉𝐶 = 𝑟 ∗ 𝐾 + 𝑤 ∗ 𝐿

𝐶 𝑤
o 𝐾= − ∗𝐿
𝑟 𝑟

𝑤
o = slope of isocost line
𝑟
 - We combine the isoquant and isocost line to minimize the cost of production

Combining Cost and production information

- Tangency rule

o Pick the bundle of inputs where the isoquant is tangent to the isocost line.

Pick the bundle of inputs where the lowest isocost touches the isoquant

𝑀𝑃𝐿 𝑤
o Where = → where 𝑀𝑅𝑇𝑆 = 𝑠𝑙𝑜𝑝𝑒 𝑜𝑓 𝑖𝑠𝑜𝑐𝑜𝑠𝑡
𝑴𝑷𝑲 𝑟

- Last dollar-rule

o Pick the bundle of inputs where the last dollar spent on one input gives as

mich extra output as the last dollar spent on the any other input

𝑀𝑃𝐿 𝑀𝑃𝐾
o Where =
𝒘 𝑟

Cobb-Douglas

- 𝑞 = 𝐾 ∝ ∗ 𝐿1−∝

o ∝ 𝑎𝑛𝑑 (1−∝) 𝑎𝑟𝑒 𝑜𝑢𝑡𝑝𝑢𝑡 𝑒𝑙𝑎𝑠𝑡𝑖𝑐𝑖𝑡𝑦 𝑜𝑓 𝐾 𝑎𝑛𝑑 𝐿

∆𝑞 𝐾∝ 𝐿1−∝ 𝑞
- 𝑀𝑃𝐿 = = (1−∝) ∗ = (1−∝) ∗
∆𝐿 𝑙 𝐿

∆𝑞 𝐾∝ 𝐿1−∝ 𝑞
- 𝑀𝑃𝐾 = = (∝) ∗ = (∝) ∗
∆𝐾 𝐾 𝐾

How long-Run cost varies with output

- Expansion path

o The cost-minimizing combination of labor and capital for each output level

- Economies of scale
 o Property of a cost function whereby average cost of production falls as output

increases

- Diseconomies of scale

o Property of a cost function whereby average cost of production rises as

output increases

- Lower costs in the long run because

o The firm has more flexibility in the long run

o Technological progress occurs

o Workers and managers learn from experience

Fixed vs Sunk costs

- Fixed cost

o Fixed in the short run but variable in the long run

- Sunk cost

o Fixed in the short run and in the long run

Price taking

- A market is competitive if each firm in the market is a price taker

- A firm is a price taker when it cannot significantly affect the market price for its ouput

or the prices at which it buys its inputs

- The price take firm faces a demand curve that is horizontal at the market price

How the firm’s demand curve is horizontal

- Large number of buyers and sellers

- Firms sell identical products

 - Buyers and sellers have full information

- Negligible transaction costs

- Firms freely enter and exit the market

- A market that fills all these requirements is called a perfectly competitive market

Profit maximization

- A firm’s profit is its revenues minus its costs

o 𝜋(𝑞 ) = 𝑅 (𝑞 ) − 𝐶 (𝑞 )

o If a firms profit is negative it is doing a loss

- To maximize profit must answer two questions questions; Output and shutdown

decision

o Output decision is whether if the firm produces output q*, does it minimize

its loss or maximize its profit

o Shutdown decision is whether it is more profitable to produce q* or shut to

shutdown and produce no output

- There are three different output rules that firms use to decide what output to

produce that imply pretty much the same

o 1) The firm sets its output where its profit is maximized

o 2)The firm sets its output where the marginal profit is zero

o 3) A firm sets its output where its marginal revenue equal its marginal cost

Shutdown rules

- Shutdown rule 1

o The firm shuts down only if it can reduce its loss by doing so

- Shutdown rule 2
 o The firm shuts down only if its revenue is less than its avoidable cost

Short run output decision

- Because a competitive firm’s marginal revenue equals the price (MR=p) a profit

maximizoing firm would set it’s output where its marginal cost equals the market

price (MC =p)

Profit per unit

𝜋 𝑅−𝐶 𝑝∗𝑞 𝐶
- = = − = 𝑝 − 𝐴𝐶
𝑞 𝑞 𝑞 𝑞

Short run shutdown decision

- The firm can gain by shutting down only if its revenue is less than its short run

variable cost

o 𝑖𝑓 𝑝 ∗ 𝑞 < 𝑉𝐶 𝑜𝑟 𝑖𝑛 𝑎𝑣𝑒𝑟𝑎𝑔𝑒 𝑡𝑒𝑟𝑚𝑠 𝑖𝑓 𝑝 < 𝐴𝑉𝐶(𝑞)

- A competitive firm shuts down if the market price is less than the minimum of its

short-run average variable cost curve

Short run market supply with identical firms

- As the number of firms grows very large the market supply cruve approaches a

horizontal line at the minimum point of the AVC curve

- Thus; the more firms producing at a given price, the flatter the short-run market

supply at that price

Competition in the long run

- The firm chooses the quantity that maximizes its profit using the same rules as in the

short fun
 - The firm picks the quantity that maximizes long run profit, the difference between

revenue and long run cost

- Shutdown decision

o In the long run, the firm shuts down if it makes an economic loss by operating

- In the long run if

o 𝜋 > 0 ,more firms will enter the market and profit decreases as price

decrease until 𝜋 = 0

o 𝜋 < 0 ,more firms will leave the market and profit decreases as price

increases until 𝜋 = 0

Lon-run market supply with identical firms and free entry

- The long run market supply curve is flat at the minimum of the long run average cost-

curve if firms can freely enter and exit the market as long as an unlimited number of

firms have identical costs and input prices are constant

- When entry into the market is limited

o If the number of firms in a market is limited in the long run the market supply

curve slopes upward

- When firms differ in their costs

o When firms differ in their long run average cost curves and can enter at lower

prices than others it will cause an upward sloping rong-run market supply

curve

- When input prices vary with output

o In markets in which factor prices rise or fall when output increases the long

run supply curve may slope

 - Increasing cost market

o A market in which input prices rise as output increases

o The long run supply curve is upward sloping in an increasing cost market

- Constant cost market

o A market in which input prices remains constant as output increases

o The long run supply curve is flat in aconstant cost market

- Decreasing cost market

o A market in which the factor prices fall as output increases

o The long run supply curve is downward sloping in a decreasing cost market

Monopoly profit maximization

- A monopoly is where there is only one supplier of a good for which there is no close

substitute

- A monopoly can set its own price and is not a price-taker

- Maximizes its profit by setting its marginal revenue to equal its marginal cost

- The marginal revenue differs from a competitive firm since a monopoly’s demand

curve is downward sloping

- This means that the marginal revenue curve lies belo the demand curve at any

positive quantity

∆𝑝
- 𝑀𝑅 = 𝑝 + ∗𝑄
∆𝑄

Marginal revenue and price elasticity of demand

1
- At a given quantity; 𝑀𝑅 = 𝑝(1 + )
𝜀

- Marginal revenue is closer to price as demand becomes more elastic

 - Where the demand curve hits the price axis (Q = 0), the demand curve is perfectly

elastic and so the marginal revenue equals price; MR = P

- Where the demand elasticity is unitary, marginal revenue is zero

- Marginal revenue is negative where the demand curve is inelastic

Choosing price or quantity

- Any firm maximizes profit by setting its marginal revenue equal to its marginal cost

- Unlike a competitive firm, a monopoly ca adjust its price, it has a choice of setting its

price or its quantity to maximize its profit

- The monopoly is however constrained by the market demand curve

- Because of the downward sloping the monopoly faces a trade-off between a higher

price and alower quantity or a lower price and a higher quantity

Market power

- The ability of a firm to charge a price above marginal cost and earn a positive profit

1 𝑝 1
- 𝑀𝑅 = 𝑝 (1 + ) = 𝑀𝐶 → = 1
𝜀 𝑀𝐶 (1+𝜀)

- Sources; All else the demand curve becomes more elastic as

o 1) Better substitutes for the firm’s product are introduced

o 2)More firms enter the market selling the same product

o 3) Firms that provide the service locate closer to this firm

Why are there monopolies?

- Natural monopolies can exist

 o A situation in which one firm can produce the total output of the market at

lower cost than several firms could

o Can be granted monopoly rights government so that private firms can provide

essential goods and services at a lower cost

- When a firm has a Cost advantage over other firms it can create monopolies

- Reasons for cost advantages

o The firm controls a scarce resource that a potential rival does not have access

to

o The firm uses a superior technology or has a better way of producing the

product than its competitors

- Government can create monopolies by:

o 1)Making it difficult for new firms to obtain a license to operate

o 2) Granting a firm, the rights to be a monopoly

o 3)Granting patents which is an exclusive right granted to the inventor of a

new and useful product, process substance or design

▪ The patent allows the inventor to be the sole seller of this product for

a fixed period of time

Oligopoly

- Non-cooperative oligopoly

o Cournot model: Firms at the same time choose quantities without colluding

o Stackelberg model: A leader firm chooses its quantity and the others; follower

firms, chooses their quantities

o Bertrand Model: Firms at the same time choose prices without colluding
- Cournot Model assumptions

o All firms are identical in the sense that they have the same cost functions and

produce identical, undifferentiated products

o We illustrate each of these oligopoly models for a duopoly

o The market lasts for only one period

o Firms set their quantities simultaneously

- Duopoly equilibrium

o A set of actions taken by the firms is a Nash equilibrium if, holding the actions

of all other firms constant, no firm can obtain a higher profit by choosing a

different action.

- Cooperative oligopoly

o Cartels

o Cartels form if members of the cartel believe that they can raise their profits

by coordinating their actions

o There are laws against cartels but they still exist for three main reasons

▪ International cartels and cartels within certain countries operate

legally

▪ Some illegal cartels operate believing that they can remain undetected

or that the punishment is insignificant

▪ Some firms are able to coordinate their activity without explicitly

colluding

o Why cartels fail if

▪ non-cartel members can supply consumers with large quantities of

goods
 ▪ Each member of a cartel has an incentive to cheat on the cartel

agreement

o Maintaining cartels; To keep firms from violating the cartel agreement the

cartel must be able to;

▪ Detect cheating and punish violators

▪ Keep their illegal behavior hidden from customers and government

agencies

o Mergers

▪ U.S. laws restrict the ability of affirms to merge if the effect would be

anti-competitive

- Market structures

o Markets differ according to.

▪ The numbers of firms in the market

▪ The ease with which firms may enter and leave the market

▪ The ability of firms in a market to differentiate their products from

their rivals

Game theory

- Is the study of situation in which the payoffs of one agent depend not only on his/her

actions but also on the actions of others

- Strategy
 o Best response to the strategies of the other player in the game if, taking other

players’ strategy as given, it gives him/her a greater payoff than any other

strategy

- Two assumptions throughout

o Players are interested in maximizing their profit

o All players have common knowledge

- Complete information

o The situation where the payoff function is common knowledge among all

players

- Perfect information

o The situation where the player who is about to move knows the full history of

the play of the game to this point and that information is updated with each

subsequent action

- Dominant strategy

o When a player has the same best response to every possible strategy of the

other player

- Dominant strategy equilibrium

o If the relevant strategy for each player is a dominant strategy

- Nash equilibrium

o A strategy combination if each strategy is a best response to the strategy of

the other player

o No one can change her choice and be better off

FORMULAE

Demand function

- 𝑄 = 𝐷(𝑃𝑎,𝑏,𝑐….𝑧 , 𝑌)

𝑟𝑖𝑠𝑒 ∆𝑃
- 𝑠𝑙𝑜𝑝𝑒 = =
𝑟𝑢𝑛 𝛥𝑄

1 1
- 𝑄 = 𝑎 − 𝑏𝑝 → 𝑝 = ∗ (𝑎 − 𝑄 ) 𝑜𝑟 𝑝 = ∗ (𝑄 − 𝑎)
𝑏 −𝑏

Elasticity

%∆𝑄 𝑝 ∆𝑄
- 𝜀= → 𝜀 = −𝑏 𝑎𝑠 𝑏 =
%∆𝑃 𝑄 ∆𝑝

Elasticity in midpoint calculation

𝑄2 −𝑄1
(𝑄2 −𝑄1 )/2
- 𝜀= 𝑝2 −𝑝1
(𝑝2 −𝑝1 )/2

Sensitivity in quantity demanded relative income

%∆𝑄 ∆𝑄 𝑌
- 𝜀= → 𝜀= ∗
%∆𝑌 ∆𝑌 𝑄

Marginal rate of substitution

∆𝐵
- 𝑀𝑅𝑆 = WHERE B and Z represent two different goods
∆𝑍

Marginal utility of good Z

∆𝑈
- 𝑀𝑈𝑍 =
∆𝑍
Budget Constraint

- 𝑍 = 𝑋 ∗ 𝑝𝑋 + 𝑌 ∗ 𝑃𝑌

o 𝑤ℎ𝑒𝑟𝑒 𝑧 = 𝑡ℎ𝑒 𝑏𝑢𝑑𝑔𝑒𝑡, 𝑥 𝑎𝑛𝑑 𝑦 = 𝑡ℎ𝑒 𝑎𝑚𝑜𝑢𝑛𝑡 𝑜𝑓 𝑟𝑒𝑠𝑝𝑒𝑐𝑡𝑖𝑣𝑒 𝑔𝑜𝑜𝑑

Budget line

𝑍 𝑝𝑋
- 𝑌= −𝑋∗
𝑝𝑌 𝑝𝑌

𝑝𝑋
- 𝑆𝑙𝑜𝑝𝑒 𝑜𝑓 𝑡ℎ𝑒 𝑏𝑢𝑑𝑔𝑒𝑡 𝑙𝑖𝑛𝑒 =
𝑝𝑌

Marginal product of Labor

∆𝑞
- 𝑀𝑃𝐿 =
∆𝐿

Average product of labor

𝑞
- 𝐴𝑃𝐿 =
𝐿

Marginal rate of technical substitution

𝑐ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑐𝑎𝑝𝑖𝑡𝑎𝑙 ∆𝐾
- 𝑀𝑅𝑇𝑆 = =
𝑐ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑙𝑎𝑏𝑜𝑟 ∆𝐿

Cost

- 𝐶 = 𝑉𝐶 + 𝐹

Marginal Cost

∆𝐶 ∆𝑉𝐶
- 𝑀𝐶 = → 𝑀𝐶 =
∆𝑞 ∆𝑞
Average costs

𝐹
- 𝐴𝐹𝐶 =
𝑞

𝑉𝐶
- 𝐴𝑉𝐶 =
𝑞

𝐶
- 𝐴𝐶 =
𝑞

𝑉𝐶 𝑤𝐿 1 𝑤
- 𝐴𝑉𝐶 = = =𝑤∗ =
𝑞 𝑞 𝐴𝑃𝐿 𝐴𝑃𝐿

Cost equation and isocost line

- 𝐶 = 𝐹𝐶 + 𝑉𝐶 = 𝑟 ∗ 𝐾 + 𝑤 ∗ 𝐿

𝐶 𝑤
- 𝐾= − ∗𝐿
𝑟 𝑟

𝑤
- = slope of isocost line
𝑟

Cobb Douglas

- 𝑞 = 𝐾 ∝ ∗ 𝐿1−∝

o ∝ 𝑎𝑛𝑑 (1−∝) 𝑎𝑟𝑒 𝑜𝑢𝑡𝑝𝑢𝑡 𝑒𝑙𝑎𝑠𝑡𝑖𝑐𝑖𝑡𝑦 𝑜𝑓 𝐾 𝑎𝑛𝑑 𝐿

∆𝑞 𝐾∝ 𝐿1−∝ 𝑞
- 𝑀𝑃𝐿 = = (1−∝) ∗ = (1−∝) ∗
∆𝐿 𝑙 𝐿

∆𝑞 𝐾∝ 𝐿1−∝ 𝑞
- 𝑀𝑃𝐾 = = (∝) ∗ = (∝) ∗
∆𝐾 𝐾 𝐾

Firm’s profit

- 𝜋(𝑞 ) = 𝑅 (𝑞 ) − 𝐶 (𝑞 )
Profit per unit in the short run

𝜋 𝑅−𝐶 𝑝∗𝑞 𝐶
- = = − = 𝑝 − 𝐴𝐶
𝑞 𝑞 𝑞 𝑞

Marginal revenue for a monopoly

∆𝑝
- 𝑀𝑅 = 𝑝 + ∗𝑄
∆𝑄

Market power

1 𝑝 1
- 𝑀𝑅 = 𝑝 (1 + ) = 𝑀𝐶 → = 1
𝜀 𝑀𝐶 (1+𝜀)