Principles of Micro

2019 Note Packet

Kaycee Washington
Basic Definitions

Economics - _Social_ Science that studies the __choices_____ individuals and

societies make regarding the use of their __resources_.
Microeconomics studies the decisions of: Individuals, households, and
firms make.
Macroeconomics focuses on entire nations at a time
It uses economic aggregates such as: unemployment rate, inflation rate,
GDP.
Positive Economics- fact based, “grass grows green”
Normative Economics – opinion statement, uses word should

The Fundamental Economic Problem

Scarcity – not enough resources to satisfy everyones wants and needs as a

society
Four basic resources (AKA Inputs/Factors of Production)
• Land – anything that’s a natural resource, water, trees, land, oil
• Labor – humans being an input to production process
• Capital (not $$$) – tools and infrastructure, buildings, computers,
chairs, phone (money is a tool to buy capital)
• Entrepreurial Ability – ability to open, run, and design a business.
When Using Resources you have to think about Opportunity Cost
Cost Benefit Analysis Compare marginal benefit to marginal cost. If benefit
outweighs cost should keep going.
Marginal Benefit: what is the end benefit
Marginal Cost: what is the end cost.
Economic Models and Theory

Models ___simplification of___ reality by using __assumptions____.

Cetaris Paribus Assumption: “All other things equal”

Causation and Pitfalls:

• Fallacy of False Cause: Assume that because 2 things happen together

that one thing caused the other.

• Fallacy of division: Incorrectly assumes that what is good for the

whole is good for each of the parts.

• Fallacy of Composition: What is good for one may not be good for all.

The Circular Flow Model

Two Sectors
• Households
• Businesses

Two Markets
• Product Market
• Resource Market

Households are demanders in the __product__market and suppliers in the

_resource_ market.

Businesses are demanders in the __resource__market and suppliers in the

_product_ market.

Production Possibilities Frontier

A PPF shows the _possible__ combinations of products that can be made

assuming : fixed resources, fully employed, and efficient production

A straight line PPF has a constant tradeoff between the two goods
This is constant opportunity cost . Points on the line are all
_efficient_. Points inside the line are __inefficient___ and consistent with
__unemployment within the economy__.
A Bowed PPF
Increasing opportunity costs: resources are not well suited to all types of
production

A good rule of thumb is that opportunity cost is what you give up for
what you get.

From point A to point B the opportunity cost of 10 Pounds of butter is

__5_ guns.

From point C to point D the opportunity cost of 10 Pounds of butter is

__50_ guns.
The __slope___ of the PPF is the Marginal Rate of Transformation.

Economic Growth
Points outside the PPF are not humanly possible to achieve! In order to
achieve production at a point outside the PPF, you must have economic
growth.

This is achieved by increasing __resources__ or

__technology___ or both.

Wheat

PPF1 PPF2
Automobiles

This shows an increase in the ability to make both Wheat and Autos
which might happen if your population increases.

If there is technological progress in only one industry, then only that

side will swing out.

Draw A PPF that would be consistent with the invention of fertilizer:

International Trade
Imports:

Exports:

Trade Deficit: __________________ exceed ____________________ Trade

Surplus: __________________ exceed ____________________ Trade

Barriers:

Quota: Legal limit on the amount of a good that may be ______________.

Tariff: A tax on ___________________________.

Absolute Advantage: A country can produce __________ of a good than

another country.

Comparative Advantage: A country can produce at a ______________

opportunity cost than another country.

Free Trade is based on the principle of ____________________________ and

specialization.
All countries _______ gain from trade if they specialize in the item in which
they have comparative advantage (lower opportunity cost).
Steps to working a Trade Problem:
1. Draw Matrix
Country Item 1 Item 2 Opportunity Cost Opportunity Cost
of Item 1 of Item 2

2. Plug in possible quantities.

3. Who has Absolute Advantage?

4. Calculate Opportunity Costs.

5. Decide who has Comparative Advantage.

Remember Opportunity Cost is “What You Give up for What You Get!”
Country Food Clothing Opportunity Cost Opportunity Cost
of Food of Clothes
Island

Beachland

_________________ has absolute advantage in food.

_________________ has absolute advantage in clothing.

_________________ has comparative advantage in food.

_________________ has comparative advantage in clothing.

Island will produce _______ units of ________________ and Beachland will

produce _______ units of ___________.
A country can benefit from trade anywhere between these opportunity
costs. Let’s say that Island trades 1.5 units of food for each unit of
clothing that Beachland provides.

If each country specializes and Island trades 15 units of Food to

Beachland for 10 units of clothes:

Island starts with ________ units of food. They give up 15 units of food to
Beachland which leaves them with _________ units of food. They get 10
units of clothes from Beachland.

Island: _______ food & ______ clothes.

Beachland starts with ________ units of clothes. They give up 10 units of

clothes to Island which leaves them with _________ units of clothes. They
get 15 units of food from Island.

Beachland: _______ food & ______ clothes.

This allows each country to consume outside of their production

possibilities frontier.

You can do this same analysis if you know how long it takes for each
country to produce a good.

Assume a 40 hour work week

Country Food Clothing Opportunity Cost Opportunity Cost
of Food of Clothes
Island ½ hour 1 hour

Beachland 2 2/3 hours 2 2/3 hours

Supply and Demand

Law of Demand: As price increases the QUANTITY DEMANDED

____________________.

Law of Supply: As price increases, the QUANTITY SUPPLIED

_____________________.

Demand Line is ____________________ sloping. Supply line is _____________________

sloping.

Market Supply and Demand are the sum of individuals supply and
demand schedules.

X marks the spot! You achieve Equilibrium when the lines intersect and
___________________ demanded equals _____________________ supplied.

When Price Changes you MOVE ALONG an existing supply or demand

line.
Words Matter! Demand and Quantity Demanded are two different
things! Same thing goes for Supply and Quantity Supplied.

Shortages and Surpluses

Surplus: At any given price you have more goods supplied than
demanded.

Shortage: At any given price you have more goods demanded than
supplied.

Price changes to clear both surpluses and shortages. When this happens,
buyers and sellers ________________________________________ their supply and
demand curves changing _______________________ demanded and Quantity
Supplied.

Steps to clearing a surplus/shortage.

1. Identify QS and QD at a given price.

2. Is it a surplus or shortage?

3. How much?

4. What will happen to prices?

5. What will happen to QS and QD?

To calculate a surplus or shortage you go to the relevant price and
evaluate quantity demanded vs. quantity supplied.

At P= 8, you have a ___________________________ of _________________________. Price

will adjust ____________________ and Quantity Supplied will __________________.
Quantity Demanded will ______________________ until you reach
___________________ at $________________ and __________________ units.

At P=2, you have a ___________________________ of _________________________. Price

will adjust ____________________ and Quantity Supplied will __________________.
Quantity Demanded will ______________________ until you reach
___________________ at $________________ and __________________ units.

This is the market clearing Price and Quantity.

Changes in Demand and Supply

When something changes and the amount of a good supplied or
demanded changes AT ANY GIVEN PRICE then you have a __________________
in supply or demand. Whenever a line moves, you will create either a
surplus or a shortage and end up with a new equilibrium.

An increase in the amount of goods available for sale at a given price

shifts supply to the _____________.

This causes a ______________________ and price will ___________________ while the

Quantity _______________ _______________________.

An decrease in the amount of goods available for sale at a given price

shifts supply to the _____________.

This causes a ______________________ and price will ___________________ while the

Quantity _______________ _______________________.

An increase in the amount of goods desired at a given price shifts

demand to the _____________.
This causes a ______________________ and price will ___________________ while the
Quantity _______________ _______________________.

A decrease in the amount of goods desired at a given price shifts demand

to the _____________.

This causes a ______________________ and price will ___________________ while the

Quantity _______________ _______________________.

Hint: If both lines move, draw two graphs and see what happens in each
situation.
Demand Shifters
Tastes and Preferences:
When popularity increases, Demand _____________.

Income: Normal vs. Inferior

Normal Goods: Income increases cause Demand to _________________.

Inferior Goods: Income increases cause Demand to _________________.

Number of Buyers Increase, then Demand ________________________.

Price of Related goods: Substitutes vs. Compliments

When the price of a substitute increases, demand for the item you
are evaluating ________________.

When the price of a compliment increases, demand for the item

you are evaluating ________________.

Expectations:
Supply Shifters
Cost of Production:
When cost of production increases, supply _____________.

Production Technology:
When production technology increases, supply _____________.

Price of other Producible Goods:

When price of other producible goods increases, supply of the good you
are analyzing _____________.

Number of Sellers:
When the number of sellers increases, supply _____________.

Expectations:

Taxes and Subsidies:

When the taxes on the business increase, supply _____________.

When subsidies reduce cost, supply _____________.

Acts of Nature:

Elasticity
Elasticity measures the responsiveness of one variable to a change in
another variable.

Price elasticity of Demand quantifies the relationship between price and

quantity demanded and estimates in percentage terms how much
quantity demanded will change given a percentage change in price.

Understanding Elasticity of Demand for a given product can help a

company understand how a change in price will affect their total
revenue.

Elasticity of Demand = ______________ of % Change in QD/% Change in Price

When calculating Percent Change for the purposes of elasticity we are

going to use the midpoint formula: Difference/Average of two

% Change in Price:
(12-10)/____

% Change in Quantity:
(500-400)/_____
Elasticity of Demand: |____/_____|
Ranges of Elasticity of Demand:

• Elastic Demand: Elasticity of Demand Coefficient ____ 1

o This means that buyers are relatively responsive to a change in

price over a given range of prices.

• Unit Elastic Demand: Elasticity of Demand Coefficient ____ 1

o This means that a 2% change in price will cause a 2% change

in demand.

• Inelastic Demand: Elasticity of Demand Coefficient _____ 1

o This means that buyers are relatively un-responsive to a

change in price over a given range of prices.

Hint: Necessities have_________________ Demand, Luxuries have

_________________ Demand

Elasticity changes as you move on a downward sloping demand curve!

At higher prices, demand is price ________________. At the midpoint, demand is

__________ elastic. At lower prices, demand is price ____________________.

Draw your graph here:

Perfectly Inelastic Demand: There is no change in quantity demanded regardless

of a change in price.
Customers will be price takers!

Cheat: If your demand curve looks like an I – you have inelastic demand!

Perfectly Elastic Demand: Your Demand Curve will be Horizontal. Items

will only be sold at one price! Your change in price will be equal to zero so
it gives you an Elasticity of Demand Coefficient of Infinity.

Firms are price takers!

Cheat: If your demand curve looks like the middle bar of an E – you have elastic
demand!

Price Elasticity of Demand and Total Revenue

Total Revenue = Price X Quantity

Elastic,
ED Unit
Using TR Rise
Total Elastic,
Midpoint /Fall
Quantity Revenue (P Formula
Or
Price Demanded X Q) Inelastic

$36 10

$28 30
 $20 50

$12 70

$4 90
Assuming a Downward Sloping Demand Curve:

Elastic Demand: P causes ________ in Total Revenue Inelastic

Demand: P causes ________ in Total Revenue

Notice Revenue is Maximized at the Point of Unit Elasticity

What Determines Price Elasticity of

Demand?

• Availability of Substitutes

• Luxury or Necessity

• Share of Budget

• Time
ALTERNATE MEASURES OF ELASTICITY

Income Elasticity: Identifies a Good as Normal or Inferior

% Change in Quantity Demanded / % Change in Income

Normal Goods (BMW): Income Elasticity is ____________________.

Inferior Goods(Beater): Income Elasticity is ____________________.

Cross Price Elasticity: Identifies Goods as Compliments or Substitutes

% Change in Quantity Demanded of Good X / % Change in Price of Good Y

Substitutes (Hot Dogs & Burgers) : Cross Price Elasticity is ____________________.

Compliments (Hot Dogs & Buns) : Cross Price Elasticity is ____________________.

Price Elasticity of Supply: Identifies Responsiveness of Quantity Supplied to

Changes in Price

Price Elasticity of Supply quantifies the relationship between price and quantity
supplied and estimates in percentage terms how much quantity supplied will
change given a percentage change in price.

Elasticity of Supply = ______________ of % Change in QS/% Change in Price

Ranges of Elasticity of Supply:

• Elastic Supply: Elasticity of Supply Coefficient ____ 1

• Inelastic Supply: Elasticity of Supply Coefficient _____ 1

Perfectly Inelastic Supply: There is no change in quantity supplied regardless
of a change in price.

Time is an important factor when it comes to Elasticity of Supply. With additional

time capacity can be added and supply becomes more elastic!

Utility

The goal of a rational consumer is to maximize utility

(___________________________) subject to a limited amount of resources.

Cardinal Approach to Measuring Utility uses a unit of measure called the

____________ to measure the satisfaction a consumer gets from a product.

Law of Diminishing Marginal Utility: As you consume additional units of a

good, the satisfaction or utility you get from each additional item
declines.

______________________ Utility tells you the total amount of satisfaction you get from
consuming all of the items you consume. ___________________ Utility tells you how
much satisfaction you get from consuming each additional unit of the good.

Quantity of Eggs Total Utility Marginal Utility

1 20
2 35
3 45
 4 50

Surplus & Efficiency

Marginal _____________________ is a measure of the value of each additional unit to

the consumer in terms of how much money they would pay. In a perfectly
competitive market, an individual’s _________________ curve tracks Marginal
Benefit.

CONSUMER SURPLUS

Maximum amount a consumer is willing to pay minus what they _________________

pay.

Consumer Surplus can be calculated for an individual or a market.

Difference between price at the top of the demand curve and market price:
$_______ Number of units sold at equilibrium price: ____________

Consumer Surplus = ½ (_______)(________)

Marginal _____________________ is a measure of the additional cost associated with

producing each additional unit of output. In a perfectly competitive market, a
firm’s _________________ curve tracks Marginal Cost.

PRODUCER SURPLUS
Minimum amount a producer is willing to accept minus what they
_________________ receive.

Producer Surplus can be calculated for an individual firm or a market.

Difference between price at the bottom of the supply curve and market
price: $_______ Number of units sold at equilibrium price: ____________

Producer Surplus = ½ (_______)(________) EFFICIENCY

When a market is operating efficiently ___________________ surplus is maximized.

Total Surplus = Consumer Surplus + Producer Surplus.

Total Surplus =

At a price of $15

Consumer Surplus = $
 Producer Surplus = $

Total Surplus = $

Deadweight Loss = $

Remember in a competitive market that your demand curve tracks marginal

_______________ and your supply curve tracks marginal ______________. You can also
say that you are producing efficiently as long as MB = MC.

Price Ceilings and Floors

A price ceiling is a legal __________________ price.

An example of a price ceiling is:

For a price ceiling to be effective or binding it must be set ____________

market price.

A price floor is a legal __________________ price.

An example of a price floor is:

For a price floor to be effective or binding it must be set ____________
market price.

Elasticity impacts the degree of the market failure when an effective

price ceiling or floor is imposed. The more elastic supply and demand are
the more severe the market
shortage or surplus will be.

If a price ceiling is imposed

at
$40, there will be a market
__________________ of ___________
units.

If the market were allowed to operate without intervention, the market

clearing price would be $______ and quantity would be __________.

Consumer surplus without intervention would be $___________________.

Consumer surplus with a price ceiling at $40 would be $___________________.

Producer surplus without intervention would be $__________________.

Producer surplus with a price ceiling at $40 would be $_________________.

Total surplus without intervention would be $__________________.

Total surplus with a price ceiling at $40 would be $__________________.

Deadweight loss with a price ceiling at $40 would be $_________________.

A price ceiling adds to ____________________ surplus and reduces

_________________ surplus.

If a price floor is imposed

at
$80, there will be a market
__________________ of ___________
units.

If the market were allowed to operate without intervention, the market

clearing price would be $______ and quantity would be __________.

Consumer surplus without intervention would be $___________________.

Consumer surplus with a price floor at $80 would be $___________________.

Producer surplus without intervention would be $__________________.

Producer surplus with a price floor at $80 would be $_________________.

Total surplus without intervention would be $__________________.

Total surplus with a price floor at $80 would be $__________________.

Deadweight loss with a price floor at $80 would be $_________________.

An effective price floor adds to ____________________ surplus and reduces
_________________ surplus while resulting in a net _________________.

Commodity Taxes

A commodity tax is a tax on a good or service.

Statutory Burden: The person or entity with the_______________________ to pay

the tax bears the statutory burden of the tax.

Economic Burden: The person or ends up footing the bill for the
additional cost of the tax.

Elasticity affects who bears the economic burden of the tax.

Per unit: Tax is charged per unit sold. ___________ Tax is an example of a per
unit tax.

Ad valorem: Tax is charged as a percentage of the value of the item.

______________ tax is an example of ad valorem tax.

EFFICIENCY LOSS
If the market were allowed to operate without intervention, the market
clearing price would be $______ and quantity would be __________.

Consumer surplus without the tax would be $___________________.

Consumer surplus with the tax would be $___________________.

Producer surplus without the tax would be $__________________.

Producer surplus with the tax would be $_________________. Total

surplus without the tax would be $__________________.

Total surplus with the tax would be $__________________.

Deadweight loss with the tax would be $________________. Consumers will

have lost $_________________ and producers will have lost $_________________.

Income Tax
 Average Tax Rate: Taxes Paid / Income

Progressive - _________________ earning individuals pay a higher percentage

of their income in taxes.

Regressive - _________________ earning individuals pay a higher percentage

of their income in taxes.

Proportional - ________________ Tax – Everyone pays the same percentage of

income.

The United States has a ____________________ tax system.

Marginal Tax Rate: ∆ in Taxes / ∆ in Income

Taxable Income Marginal Tax Rate
0 - $20,000 10 percent
$20,001 - $40,000 15 percent
$40,001 - $80,000 25 percent
A person who earns $50,000 will pay __________ on the first $20,000 they
earn. They will pay $_______ on the next $20,000 they earn and $________ on
the last $10,000 that they earn. They pay $_____________ total in tax and
their average tax rate is _______________ while their marginal tax rate is
________.

Market Failures and Government Intervention

Market ________________________ the market economy leads to too many or

too few resources being produced.

Reasons for Market Failure:

• Imperfect (________________________) Information: Buyers and sellers
use information to make their decisions. If they have different or
inaccurate information a market failure can occur. o
Government can help correct with certain ________________ such as
the Truth in Lending Act.
o The goal is ______________________________________.

• __________________________ Competitive Markets: Supply and Demand

model is based on ____________________ competition. With imperfectly
competitive markets sellers can restrict output so that they can
charge higher prices. This leads to an inefficient outcome. o
Government can help correct this by passing anti-trust legislation
to prevent acts such as price ________________________.
o Federal __________________________ Commission

• Externalities: Costs or Benefits can

________________________ to third parties. o Positive:
 Marginal Social Benefit:

 Positive externalities mean that the free

market yields a ____________________________
output than is socially efficient.
  Government Provides
____________________________ directly
• Public Education
 Government Provides Subsidies
• ________________________________
o Negative Externalities:
 Marginal Social Cost

• Negative externalities mean that the free market yields a

____________________________ output than is socially efficient.

• Government can ______________________.

• Government can regulate. Compliance creates _________________.

This is referred to as internalization.
Property Rights –

When regulation or taxation don’t eliminate negative externalities,

clearly defined property rights can eliminate externalities.

Coase Theorem – with sufficiently low transaction costs, clearly defined

property rights can ensure an efficient transaction.

• Public Goods and Common Resources

o Public Goods - They are ___________________________ and

_____________________________.

 Non-Rival: One person’s use does not prevent someone

else from using it.

 Non-Excludable: Once provided you cannot prevent

people from using them.

 Example:

 Free Rider Problem:

o Common Resources: Resources are _______________________ but not

excludable
 Tragedy of the Commons

Functions of Government

• Provide a legal framework

• Promote Competition and Regulate Business

• Correct Externalities

• Providing Public Goods and Regulating Common Resources

• Assisting Families in Poverty

• Promoting Economic Growth and Stabilization

The Firm: Classification and Profit

The objective of a firm is to _____________________________ profit.

Two ways to Classify:

o Legal Organization

 Sole Proprietorship: One owner - gains all profits and

responsible for ALL liabilities of the firm (Individually
Liable)

 Partnership: Two or more owners that split profit and

liability

 Corporation: A legal entity. Considered a “person” legally.

Stock Owners share in profits and liabilities – but no
individual liability. The most you can lose is your
investment.

o Market Structure – Level of competition defines market

structure.
 Perfect Competition: Identical Products, many firms, no
barriers to entry in the long run.

 Monopolistic Competition

 Oligopoly

 Monopoly: One firm produces a good for which there are no

close substitutes. Significant barriers to entry.

Profit
Profit: Total Revenue – Total Cost (Money going in – Money coming out)

Two types of profit: Accounting vs. Economic Profit

Accounting Profit= Total Revenue – Explicit (hard) costs

Economic Profit= Total Revenue – Explicit (hard) costs – Implicit

(opportunity) costs

Accounting profit will always be greater than economic profit.

In the long run, perfectly competitive firms will earn NORMAL (ZERO)
Economic profit. If they were earning more than other firms would come
in and drive their profit down. If they were earning less than they would
exit the industry eventually.

When you earn Normal Profit your accounting profit is just enough to
cover implicit (opportunity) costs.

The Production Function

Production Function - shows the relationship between

______________________________ and ______________________________________.

Quantity of Labor (L) Output per Time (Q)

0 0 1 7 2 18
3 33 4 44
5 48
6 46
Short Run – one or more inputs are ____________________________________.

Marginal Product – Output obtained from one additional unit of an input.

If labor is your only variable input, then the marginal product of labor
can be calculated as:

MPL = change in output = ∆Q = Q2 – Q1

change in labor ∆L L2 – L 1

and the average product of labor can be calculated as:

APL = Output = Q
Labor L

Quantity of Labor Output per Time Marginal Product Avg. Product

L Q MP = ∆Q/∆L AP =
Q/L

0 0 -- --

1 7 ______ ______

2 18 ______ ______

3 33 ______ ______

4 44 ______ ______

5 48 ______ ______

6 46 ______ ______
 Notice that as long as Marginal Product is greater than Average
Product, Average product is increasing. When Marginal Product is lower
than Average product will decrease.

Marginal Product will cross through the _________________________ of the

Average Product curve.

Cost of Production

Total Cost = Total Fixed Cost + Total Variable Cost

o TC=TFC+TVC

Average Total Cost = Average Fixed Cost + Average Variable Cost

o ATC=AFC+AVC

o ATC= Total Cost/Q o AVC= Total Variable Cost/Q o AFC=

Total Fixed Cost/Q

Q TC TFC TVC ATC=TC/Q AVC=TVC/Q AFC=TFC/Q MC

0 ______ $100 $ 0 --- --- ---

1 ______ ______ 60 $_______ $_______ $_______ $_______

2 ______ ______ 110 $_______ $_______ $_______ $_______

3 ______ ______ 160 $_______ $_______ $_______ $_______

4 ______ ______ 220 $_______ $_______ $_______ $_______

5 ______ ______ 310 $_______ $_______ $_______ $_______

6 ______ ______ 420 $_______ $_______ $_______ $_______

7 ______ ______ 580 $_______ $_______ $_______ $_______

Average Fixed Cost Declines as output increases

Average Fixed Cost is the vertical distance between ATC and AVC

Marginal Cost Intersects through the minimum of ATC and AVC

At 50 units:

ATC= TC= MC =

AVC= TVC=

AFC = TFC=

At 100 units:

ATC= TC= MC =

AVC= TVC=

AFC = TFC=

LONG RUN Costs

 • Returns to Scale describes the long run relationship between inputs
and outputs.

Economies of Scale (Increasing Returns to Scale) – Increasing Inputs

increases output by a greater percentage

Constant Returns to Scale – Increasing inputs increases output by the

same percentage

Diseconomies of Scale (Decreasing Returns to Scale) – Increasing inputs

increases output by a smaller percentage.

Long Run Average Cost: Tracks Average Cost per unit in the long-run.

Perfect Competition

• Large number of small firms

 • Identical (Homogenous) Products – makes one firms product a
________________________________ for another firm’s product.

• Freedom of entry and exit in the long-run

• No barriers to entry

• Consumers have perfect information

• Firms are price takers

Profit Maximization in the Short-Run

To maximize profit a firm must decide

 How much output to produce

 How to _______________________ it

 How much of each ___________________________to demand

Maximizing Profit: Total Revenue – Total Cost approach

P (Q) (TR = P x Q) (TC) (TR – TC)
$12 0 $0 $5 ________

$12 1 ________ 13 ________

$12 2 ________ 19 ________

$12 3 ________ 29 ________

$12 4 ________ 43 ________

Profit is maximized at __________ units

Maximizing Profit: Marginal Revenue = Marginal Cost Approach

• Marginal Revenue= Change in TR/Change in Quantity = Price

• Marginal Cost= Change in TC/Change in Quantity = Change in

TVC/Change in Quantity

P (Q) MR TC MC

$12 0 $0 $5

$12 1 ________ 13 ________

$12 2 ________ 19 ________

$12 3 ________ 29 ________

$12 4 ________ 43 ________

Profit is maximized at __________ units

If Market Conditions change, you can determine the profit maximizing

level of output.

Short –run Profit Possibilities:

Positive Economic Profit

Normal Economic Profit

Negative Economic Profit

Shut Down in the short-run when Price is below AVC

Long Run Equilibrium

In the long run, perfectly competitive firms will earn NORMAL (ZERO)
Economic profit.

Firms must produce at _____________________efficient scale – smallest scale to

achieve economies of scale.

Long run average cost must be the same for all firms.

The condition for long run equilibrium is:

P = MR = MC = ATC = minimum LRAC

Monopoly

• One Firm

• No Close Substitutes

• Very high barriers to entry

o Can earn profit in the long run if barriers can be maintained

o Sources: gov’t franchises, licenses, patents, copyrights, sole

ownership of key resource, economies of scale

 Natural Monopoly

o Rent seeking behavior to maintain barriers: hiring lobbyists

etc.
 • Firms are price makers

Pricing Strategies

Single Price Monopoly

P (Q) (TR = P x Q) MR

$10 0 $0

$9 1 ________ ________

$8 2 ________ ________

$7 3 ________ ________

$6 4 ________ ________

$5 5 ________ ________

$4 6 ________ ________
Marginal Revenue curve will be below the demand curve for a single price
monopoly.
Profit Maximizing firm will produce where marginal revenue equals marginal
cost.

This leaves a positive economic profit equal to the difference between ATC
and Price times the quantity sold.

If ATC = 7, Price =10, and Quantity = 10 when profit is maximized, then Profit
= _________________.

Perfect Price Discrimination

In order to price discriminate you must be able to break customers into groups
with different ____________________________ of demand and prevent ____________________
among groups.
 P (Q) TR MR

$10 0 $0

$9 1 ________ ________

$8 2 ________ ________

$7 3 ________ ________

$6 4 ________ ________

$5 5 ________ ________

$4 6 ________ ________
Marginal Revenue curve and the demand curve will be the same with perfect
price discriminating monopoly.

Profit

Shor-run: Positive, Normal, Negative Economic profit are all possible. Just
like with perfect competition, firms will produce as long as Price is
greater than ____________________.
If Price is less than AVC the firm will ___________________ as they aren’t covering
any fixed costs.

Long Run: Unlike Perfect Competition a monopoly can maintain positive profit
in the long run as long as it maintains __________________________________.

Firms will engage in rent seeking behavior to ensure that barriers to entry
are maintained.

If a firm is losing money, they may choose to exit the industry or invest in
marketing activities to increase demand.

Inefficiency

When a monopoly profit maximizes they produce where MR = MC.

The Quantity produced will be ______ and Price will be ________.

If the market were competitive, the Quantity produced would be _________ and
the Price would be ________.

The benefit which is lost with production of the lower quantity is the deadweight
loss. This is measured by the area:

Monopolistic Competition

• Many Firms

• Differentiated Products with Close Substitutes

• No barriers to entry in the long run o Normal (zero) profit in the

long run

• Firms face Downward Sloping Demand Curve – Marginal Revenue

will be ________________ demand curve.

• Firms are price makers – Use marketing and advertising to

manipulate the demand curve that their firm faces. Goal is to make
Price elasticity of Demand ____________ elastic which will make the
demand curve steeper.

Profit
Profit maximizing firm will produce where marginal revenue equals
marginal cost.

This leaves a positive economic profit equal to the difference between

ATC and Price times the quantity sold.

If a firm uses advertising successfully how will this affect their profit?

Short-run: Positive, Normal, Negative Economic profit are all possible.

Just like with perfect competition, firms will produce as long as Price is
greater than ____________________.

If Price is less than AVC the firm will ___________________ as they aren’t
covering any fixed costs.
Q= ________ P=___________ ATC= ____________ Profit= _________ Operate? _______

Q= ________ P=___________ ATC= ____________ Profit= _________ Operate? _______

AVC= ________ AFC=___________ TFC= __________

Q= ________ P=___________ ATC= ____________ Profit= _________ Operate? _______

AVC= ________ AFC=___________ TFC= __________

Long Run: Economic Profit will be driven down to zero. As new firms
enter the industry it will push the market such that the demand curve
becomes tangent to the ATC curve.

Since Price is greater than Marginal Cost we are not meeting the socially
optimal requirement that MB = Marginal Cost and there will be
deadweight loss associated with monopolistic competition.
Oligopoly

• Small Number of Large Firms o Barriers to entry,

Economies of Scale

o Oligopoly by Merger
 __________________ Merger: Firm and Supplier Merge 
Horizontal Merger: Competitors Merge

o Concentration Ratio’s: % of industries sales by top 4 or 8 firms.

Firm 1: $100 Firm 2: $80 Firm 3: $60 Firm 4: $40

Firm 5-8: $20 Top 4 Firms Sales: $ Total Sales: $
Concentration Ratio: ________%

• Herfindahl-Hirschman Index (HHI)- Sum of the squared

percentage of sales of all firms in an industry. o Monopoly’s

HHI: 1002 = o 100 Firms with 1% of Sales: 12 x 100 = o 3

Firms with 50%, 25% and 25% of sales = 502 +252 + 252 =

• Interdependence/Strategic Dependence o One firm

changing output, product price or quality, advertising etc.
affects actions of other firms.
• __________________ Function: Describes how one firm reacts to
another’s actions.

Oligopoly Models:
Cartel: Formal agreement where each member restricts output to keep product
price_________________.

Price Leadership: Dominant firm sets relatively high price and smaller firms
follow suit to prevent a price _______________.

Kinked Demand: Predicts that rival firms will reach an

__________________________ with very stable prices due to concerns that pricing changes
could reduce profits.

Game Theory: Explains a firm’s best strategy assuming they _____________________

the actions of rival firms.

Contestable Markets – assumes firms choose a __________ product price because

they believe that high profits will attract new entrants.

Game Theory and Strategic Behavior

• Types of games

o _______________sum game: One firms gains are offset by another’s losses

o _______________sum game: Player’s as a group lose

o _______________sum game: Player’s as a group come out ahead

o _________________________ game: Players explicitly cooperate-

 Collusion
 Cartel: Firms act as one
 Agree to common prices and output controls – allows them
to simulate a monopoly
 Difficult to maintain in the long run because firms have
incentive to enter market and undercut cartel and During
downturns members have incentive to cheat and try to
undercut on price or production.

o _________________________ game: No negotiation or cooperation

• Using Game Theory to make Decisions: Prisoner’s Dilemma

Colton's Strategies

Confess Don’t Confess

Colton gets Colton gets
5 years 10 years
Confess
Grant's Grant gets Grant goes
Strategies 5 years free

Colton goes Colton gets

Don’t free 2 years
Confess
Grant gets Grant gets
10 years 2 years

o If Colton confesses, Grant gets ________ if he confesses and ________ if he

doesn’t.
o If Colton doesn’t confess, Grant gets ________ if he confesses and
________ if he doesn’t o Regardless of what Colton does, it
makes sense for Grant to
 __________________.
o If Grant confesses, Colton gets ________ if he confesses and ________ if he
doesn’t.
o If Grant doesn’t confess, Colton gets ________ if he confesses and
________ if he doesn’t o Regardless of what Grant does, it
makes sense for Colton to
__________________.

Nash Equilibrium: Combination of Strategies that results from analyzing the

payoff matrix and determining what each player will likely do.

Grant and Colton will ______________________ .

This strategy can be applied to pricing, output and marketing decisions as

well.
Alpha's Strategies
Leave
Raise Spending Spending Unchanged
Alpha earns Alpha earns
Raise $2,000 $1,000
Spending
Beta's Beta earns Beta earns Strategies $2,000 $4,000

Leave Alpha earns Alpha earns

Spending $4,000 $3,000
Unchanged
Beta earns Beta earns
$1,000 $3,000

• If Alpha Raises their Advertising Spending they will earn __________ if

Beta Increases its spending and __________ if they don’t.
• If Alpha doesn’t change their Advertising Spending they will earn
__________ if Beta Increases its spending and __________ if they don’t.
 • In either case Alpha will _________________________ because they are better
off regardless of what Beta does.

• If Beta Raises their Advertising Spending they will earn __________ if

Alpha Increases its spending and __________ if they don’t.
• If Beta doesn’t change their Advertising Spending they will earn
__________ if Alpha Increases its spending and __________ if they don’t.
• In either case Beta will _________________________ because they are better off
regardless of what Beta does.

Nash Equilibrium:

Resource Markets

• Derived Demand

o The demand for a resource is derived from the demand of the

product it is used to produce.

• Labor Market o Supply is

Workers o Demand is ___________

▪ Demand shifts right as a result of product price

increases, labor productivity, or a decrease in the cost
of other resources

o The Price is the ______________ rate

 o Market supply and demand reach equilibrium and determine
the market wage.

o An individual firm is known as a wage taker and faces a

perfectly elastic supply of labor at the _______________ wage.

• Value of Marginal Product of

Labor o VMPL = MPL x Priceoutput

• Hire an additional worker if o

VMPL > Wage