Professional Documents
Culture Documents
Comparative Statics
The Three Questions
Examples
Elasticity
Price Elasticity of Demand
Elastic and Inelastic Curves
Calculating Elasticity: The Midpoint Formula
Elasticity and Slope
Other Elasticities
Cross-Price Elasticity of Demand
Income Elasticity of Demand
Price Elasticity of Supply
Individual Demand
Lower Case q"
D
0
Market Demand
Capital Q"
D
0
QD = 24 3P
$6.00
$5.00
$4.00
$3.00
$2.00
$1.00
$0.00
Q
0
10
15
20
25
$0.00
1.00
2.00
3.00
4.00
5.00
6.00
Qd
(Market)
24
21
18
15
12
9
6
QD = 24 3P
P = 8 QD
$6.00
$5.00
$4.00
$3.00
$2.00
$1.00
$0.00
Q
0
10
15
20
25
$0.00
1.00
2.00
3.00
4.00
5.00
6.00
Qd
(Market)
24
21
18
15
12
9
6
P
$6.00
$5.00
$4.00
$3.00
$2.00
$1.00
$0.00
Q
0
10
15
20
25
$0.00
1.00
2.00
3.00
4.00
5.00
6.00
Qd
(Market)
24
21
18
15
12
9
6
P
$6.00
P = 8 QD
$5.00
$4.00
$3.00
$2.00
$1.00
$0.00
Q
0
10
15
20
25
$0.00
1.00
2.00
3.00
4.00
5.00
6.00
Qd
(Market)
24
21
18
15
12
9
6
P
$6.00
P = 8 QD
P = 8 (9)
$5.00
$4.00
$3.00
$2.00
$1.00
$0.00
Q
0
10
15
20
25
$0.00
1.00
2.00
3.00
4.00
5.00
6.00
Qd
(Market)
24
21
18
15
12
9
6
P
$6.00
P = 8 QD
P = 8 (9)
=5
$5.00
$4.00
$3.00
$2.00
$1.00
$0.00
Q
0
10
15
20
25
$0.00
1.00
2.00
3.00
4.00
5.00
6.00
Qd
(Market)
24
21
18
15
12
9
6
P
$6.00
$5.00
$4.00
$3.00
$2.00
$1.00
$0.00
Q
0
10
15
20
25
$0.00
1.00
2.00
3.00
4.00
5.00
6.00
Qd
(Market)
24
21
18
15
12
9
6
P
$6.00
P = 8 QD
P = 8 (18)
= 2
$5.00
$4.00
$3.00
$2.00
$1.00
$0.00
Q
0
10
15
20
25
$0.00
1.00
2.00
3.00
4.00
5.00
6.00
Qd
(Market)
24
21
18
15
12
9
6
D
0
D
0
D
0
24
a
Inverse Demand Function:
b
a 1 D
P= Q
b b
Slope = 1/b
D
0
P = f 1 (Q D )
dP
Slope =
dQ D
D
0
P
$6.00
$5.00
$4.00
$3.00
$2.00
$1.00
$0.00
Q
0
10
15
20
25
$0.00
1.00
2.00
3.00
4.00
5.00
6.00
Qd
(Market)
24
21
18
15
12
9
6
P
$6.00
QDold
$0.00
24
$4.00
1.00
21
$3.00
2.00
18
3.00
15
4.00
12
5.00
6.00
$5.00
$2.00
$1.00
$0.00
Q
0
10
15
20
25
P
$6.00
QDold
QDnew
$0.00
24
28
$4.00
1.00
21
25
$3.00
2.00
18
22
3.00
15
19
4.00
12
16
5.00
13
6.00
11
$5.00
$2.00
$1.00
$0.00
Q
0
10
15
20
25
P
$6.00
QDold
QDnew
$0.00
24
28
$4.00
1.00
21
25
$3.00
2.00
18
22
3.00
15
19
4.00
12
16
5.00
13
6.00
11
$5.00
$2.00
$1.00
$0.00
Q
0
10
15
20
25
P
$6.00
QDold
QDnew
$0.00
24
28
$4.00
1.00
21
25
$3.00
2.00
18
22
3.00
15
19
4.00
12
16
5.00
13
6.00
11
$5.00
$2.00
$1.00
$0.00
Q
0
10
15
20
25
P
$6.00
QDold
QDnew
$0.00
24
28
$4.00
1.00
21
25
$3.00
2.00
18
22
3.00
15
19
4.00
12
16
5.00
13
6.00
11
$5.00
$2.00
$1.00
$0.00
Q
0
10
15
20
25
P
$6.00
QDold
QDnew
$0.00
24
28
$4.00
1.00
21
25
$3.00
2.00
18
22
3.00
15
19
4.00
12
16
5.00
13
6.00
11
$5.00
$2.00
$1.00
$0.00
Q
0
10
15
20
25
P
$6.00
QDold
QDnew
$0.00
24
28
$4.00
1.00
21
25
$3.00
2.00
18
22
3.00
15
19
4.00
12
16
5.00
13
6.00
11
$5.00
$2.00
$1.00
$0.00
Q
0
10
15
20
25
P
$6.00
QDold
QDnew
$0.00
24
28
$4.00
1.00
21
25
$3.00
2.00
18
22
3.00
15
19
4.00
12
16
5.00
13
6.00
11
$5.00
$2.00
$1.00
$0.00
Q
0
10
15
20
25
P
$6.00
QDold
QDnew
$0.00
24
28
$4.00
1.00
21
25
$3.00
2.00
18
22
3.00
15
19
4.00
12
16
5.00
13
6.00
11
$5.00
$2.00
P = 8 QD
$1.00
$0.00
Q
0
10
15
20
25
P
$6.00
$5.00
P = 9 QD
$4.00
$3.00
$2.00
P = 8 QD
$1.00
$0.00
Q
0
10
15
20
25
QDold
QDnew
$0.00
24
28
1.00
21
25
2.00
18
22
3.00
15
19
4.00
12
16
5.00
13
6.00
11
P QD
A
An increase in quantity
demanded is a
movement down along
the demand curve
B
$1.00
D
0
12
14
Increase in Demand
One of the non-price determinants of D changes, causing the curve to shift right
D2
D1
0
P QD
B
An decrease in
quantity demanded is a
movement up along
the demand curve
A
$1.00
D
0
12
14
Decrease in Demand
One of the non-price determinants of D changes, causing the curve to shift left
D1
D2
0
Price
Input Prices
Technology
Expectations
Price
Input Prices
Technology
Expectations
Number of Sellers
QS
P
(Market)
$0.00
0
1.00
5
2.00
10
3.00
15
4.00
20
25
Q 5.00
30
10 15 20 25 30 35 6.00
QS
P
(Market)
$0.00
0
1.00
5
2.00
10
3.00
15
4.00
20
5.00
25
Q
6.00
30
10 15 20 25 30 35
P
$6.00
QS = 5P
$5.00
$4.00
$3.00
$2.00
$1.00
$0.00
Q
0
10 15
20 25 30
35
P
$6.00
QS = 5P
P = (1/5)QS
$5.00
$4.00
$3.00
$2.00
$1.00
$0.00
Q
0
10 15
20 25 30
35
QS
P
(Market)
$0.00
0
1.00
5
2.00
10
3.00
15
4.00
20
5.00
25
Q
6.00
30
10 15 20 25 30 35
P
$6.00
$5.00
$4.00
$3.00
$2.00
$1.00
$0.00
0
QS
P
(Market)
$0.00
0
1.00
5
2.00
10
3.00
15
S
P = (1/5)Q
4.00
20
= (1/5)10
=2
5.00
25
Q
6.00
30
10 15 20 25 30 35
P
$6.00
$5.00
$4.00
$3.00
$2.00
$1.00
$0.00
0
S
Q
P
P = (1/5)QS
(Market)
= (1/5)25
$0.00
0
=5
1.00
5
2.00
10
3.00
15
S
P = (1/5)Q
4.00
20
= (1/5)10
=2
5.00
25
Q
6.00
30
10 15 20 25 30 35
P
$6.00
$5.00
$4.00
$3.00
$2.00
$1.00
$0.00
0
QS
P
(Market)
$0.00
0
1.00
5
2.00
10
3.00
15
4.00
20
5.00
25
Q
6.00
30
10 15 20 25 30 35
P
QSold QSnew
$0.00
0
1.00
5
2.00
10
3.00
15
4.00
20
5.00
25
6.00
30
Q
$6.00
$5.00
$4.00
$3.00
$2.00
$1.00
$0.00
0
10 15
20 25 30
35
P
QSold QSnew
$0.00
0
1.00
5
0
2.00
10
3.00
15
4.00
20
5.00
25
6.00
30
Q
$6.00
$5.00
$4.00
$3.00
$2.00
$1.00
$0.00
0
10 15
20 25 30
35
P
QSold QSnew
$0.00
0
1.00
5
0
2.00
10
5
3.00
15
4.00
20
5.00
25
6.00
30
Q
$6.00
$5.00
$4.00
$3.00
$2.00
$1.00
$0.00
0
10 15
20 25 30
35
P
QSold QSnew
$0.00
0
1.00
5
0
2.00
10
5
3.00
15
10
4.00
20
5.00
25
6.00
30
Q
$6.00
$5.00
$4.00
$3.00
$2.00
$1.00
$0.00
0
10 15
20 25 30
35
P
QSold QSnew
$0.00
0
1.00
5
0
2.00
10
5
3.00
15
10
4.00
20
15
5.00
25
20
6.00
30
25
Q
$6.00
$5.00
$4.00
$3.00
$2.00
$1.00
$0.00
0
10 15
20 25 30
35
P
QSold QSnew
$0.00
0
1.00
5
0
2.00
10
5
3.00
15
10
4.00
20
15
5.00
25
20
6.00
30
25
Q
$6.00
$5.00
$4.00
$3.00
$2.00
$1.00
$0.00
0
10 15
20 25 30
35
P
QSold QSnew
$0.00
0
1.00
5
0
2.00
10
5
3.00
15
10
4.00
20
15
5.00
25
20
6.00
30
25
Q
$6.00
$5.00
$4.00
$3.00
$2.00
P = (1/5)QS
$1.00
$0.00
0
10 15
20 25 30
35
P
$6.00
P
QSold QSnew
$0.00
0
1.00
5
0
2.00
10
5
3.00
15
10
4.00
20
15
5.00
25
20
6.00
30
25
Q
P = 1 + (1/5)QS
$5.00
$4.00
$3.00
$2.00
P = (1/5)QS
$1.00
$0.00
0
10 15
20 25 30
35
S
B
$3.00
$1.00
P QS
An increase in
quantity supplied
is a movement
up along the
supply curve
Increase in Supply
One of the non-price determinants of S changes, causing the curve to shift right
Technology improves
S1
Input prices
Change in expectations
S2
Number of producers
S
A
$3.00
$1.00
P QS
A decrease in
quantity
supplied is a
movement
down along the
supply curve
Q
Decrease in Supply
One of the non-price determinants of S changes, causing the curve to shift left
Technology deteriorates
S2
Input prices
Change in expectations
S1
Number of producers
Equilibrium
Point at which QS = QD
At equilibrium E = (Q*,P*),
P*
D
0
Q*
P
S
Surplus
PH
P*
D
0
QD
Q*
QS
P
S
Surplus
PH
P*
D
0
QD
Q*
QS
P
S
P*
PL
Shortage
D
0
QS
Q*
QD
P
S
P*
PL
Shortage
D
0
QS
Q*
QD
Equilibrium
Point at which QS = QD
At equilibrium E = (Q*,P*),
P*
D
0
Q*
Equilibrium
Point at which QS = QD
D
0
Equilibrium
Point at which QS = QD
D
0
Equilibrium
Point at which QS = QD
P*
D
0
Q*
Equilibrium
Point at which QS = QD
P*
D
0
Q*= 15
Equilibrium
Point at which QS = QD
P*= 55
D
0
Q*= 15
Comparative Statics
Start at equilibrium
Comparative Statics
Start at equilibrium
Change the value of one of the non-price
determinants of supply or demand
Comparative Statics
Start at equilibrium
Change the value of one of the non-price
determinants of supply or demand
Compare the new equilibrium to the old one
P1*
E1
D
0
Q1*
P1*
E1
D2
D1
Q1*
E2
P2*
P1*
E1
D2
D1
Q1*
Q2*
Algebraically, eD =
P
%P
P
Q
P
Q
Algebraically, eD =
P
%P
Q D P
P
Q D
%Q D
Q D P
Q D P
QD
Algebraically, eD =
D
P
%P
Q P
P Q D
P
DI
0
DE
0
P2
P1
DE
0
DI
QEl
QIn Q1
DPI
0
DPE
% Q D
% P
Calculating eD
P
D
0
10
Calculating eD
P
6 10
10
D
6 10
QOld
FromQADNewtoB,
eD 10
=
46 2
D
10
QOld
6 2
4
PNew POld
2
24
24
POld
= .4
D
0
10
Calculating eD
P
D
Q DNew QOld
D
QOld
From PANewtoB,
POldeD
POld
6 10
10
6 10
10
6 10
42
=
244 2
24 2
= .4
D
0
10
Calculating eD
P
D
Q DNew QOld
QD
From PA toOldB,
POldeD
New
POld
6 10
66 10
10
10
62 10
=
42
44 2
24 2
= .4
10 6
6
From B to A, eD= 2 4
4
D
0
10
= 1.33
D
New
D
New
D
Old
D
Old
Calculating eD
P
D
0
10
Calculating eD
P
6 10
10
6
6 106
Q Q
10
D
QOld
From
A to B,10
eD = 4 22
6
42
PNew POld
24
42
24
POld
2
D
New
D
Old
= .75
D
0
10
Calculating eD
P
D
Q DNew QOld
D to B,
FromQAOld
PNew POld
POld
6 10
10
6
6
4
2
2
4
2
4
eD10=
= .75
From B to A, eD=
D
0
6 10
6 10
2
42
42
2
10
Calculating eD
P
D
Q DNew QOld
D to B,
FromQAOld
PNew POld
POld
= .75
From B to A, eD=
D
0
6 10
10
6
6
4
2
2
4
2
4
eD10=
6 10
6 10
2
42
42
2
10
10 6
10 6
2
24
24
2
= .75
Elastic
Elastic
Unit elastic
Elastic
Unit elastic
Inelastic
P = 100 QD
D
0
P = 100 QD
D
0
P = 100 QD
80
D
0
20
P = 100 QD
80
70
D
0
20 30
P = 100 QD
A
B
D
0
20 30
P = 100 QD
A
B
From A to B, eD =
30 20
30 20
2
70 80
70 80
2
= 3.00
D
0
20 30
P = 100 QD
A
eD=3
B
From A to B, eD =
30 20
30 20
2
70 80
70 80
2
= 3.00
D
0
20 30
P = 100 QD
A
eD=3
B
40
30
0
C
D
60 70
P = 100 QD
A
eD=3
70 60
70 60
2
From C to D, eD = 30 40
30 40
2
= .538
40
30
0
eD=.538
D
60 70
P = 100 QD
A
eD=3
B
eD=1
C
eD=.538
Unit Elastic
D
0
Inelastic Curve
P
Unit Elastic
Elastic Curve
P
Unit Elastic
CEREAL
PRICE ELASTICITY
OF DEMAND
-2.5
-1.8
-0.9
Other Elasticities
Cross-price elasticity of demand
Income elasticity of demand
Price Elasticity of supply
Other Elasticities
Income elasticity of demand: measures the response
of Qd to a change in consumer income
Percent change in Qd
Income elasticity
=
of demand
Percent change in income
% Q
eS =
% P
D
0
Utility
Utility = happiness, satisfaction or well-being
Utility
Utility = happiness, satisfaction or well-being
# of Pizza
Slices
Total
Utility
Utility
Utility = happiness, satisfaction or well-being
# of Pizza
Slices
0
Total
Utility
0 utils
Utility
Utility = happiness, satisfaction or well-being
# of Pizza
Slices
0
1
Total
Utility
0 utils
150 utils
Utility
Utility = happiness, satisfaction or well-being
# of Pizza
Slices
0
1
Total
Utility
0 utils
150 utils
250 utils
Utility
Utility = happiness, satisfaction or well-being
# of Pizza
Slices
0
1
Total
Utility
0 utils
150 utils
250 utils
325 utils
Utility
Utility = happiness, satisfaction or well-being
# of Pizza
Slices
0
1
Total
Utility
0 utils
150 utils
250 utils
3
4
325 utils
375 utils
Utility
Utility = happiness, satisfaction or well-being
# of Pizza
Slices
0
1
Total
Utility
0 utils
150 utils
250 utils
3
4
5
325 utils
375 utils
400 utils
Utility
Utility = happiness, satisfaction or well-being
Marginal Utility (MU) = the additional utility you get
from one additional unit of a good or service
U
Marginal Utility of X = MU X
X
Marginal Utility
U
Marginal Utility of X = MU X
X
# of Pizza
Slices
0
1
Total
Utility
0 utils
150 utils
2
3
4
5
250 utils
325 utils
375 utils
400 utils
Marginal
Utility
Marginal Utility
U
Marginal Utility of X = MU X
X
# of Pizza
Slices
0
1
Total
Utility
0 utils
150 utils
2
3
4
5
250 utils
325 utils
375 utils
400 utils
Marginal
Utility
U=150
Marginal Utility
U
Marginal Utility of X = MU X
X
# of Pizza
Slices
0
1
Total
Utility
0 utils
150 utils
2
3
4
5
250 utils
325 utils
375 utils
400 utils
Marginal
Utility
U=150
X=1
Marginal Utility
U
Marginal Utility of X = MU X
X
# of Pizza
Slices
0
1
Total
Utility
0 utils
150 utils
2
3
4
5
250 utils
325 utils
375 utils
400 utils
Marginal
Utility
U 150
150
1
X
Marginal Utility
U
Marginal Utility of X = MU X
X
# of Pizza
Slices
0
1
Total
Utility
0 utils
150 utils
2
3
4
5
250 utils
325 utils
375 utils
400 utils
Marginal
Utility
150 utils
Marginal Utility
U
Marginal Utility of X = MU X
X
# of Pizza
Slices
0
1
2
3
4
5
Total
Utility
0 utils
150 utils
250 utils
325 utils
375 utils
400 utils
Marginal
Utility
150 utils
U 100
100
X
1
Marginal Utility
U
Marginal Utility of X = MU X
X
# of Pizza
Slices
Marginal
Utility
0
1
Total
Utility
0 utils
150 utils
2
3
4
5
250 utils
325 utils
375 utils
400 utils
100 utils
150 utils
Marginal Utility
U
Marginal Utility of X = MU X
X
# of Pizza
Slices
Marginal
Utility
0
1
Total
Utility
0 utils
150 utils
2
3
4
5
250 utils
325 utils
375 utils
400 utils
100 utils
75 utils
150 utils
Marginal Utility
U
Marginal Utility of X = MU X
X
# of Pizza
Slices
Marginal
Utility
0
1
Total
Utility
0 utils
150 utils
2
3
4
5
250 utils
325 utils
375 utils
400 utils
100 utils
75 utils
50 utils
150 utils
Marginal Utility
U
Marginal Utility of X = MU X
X
# of Pizza
Slices
Marginal
Utility
0
1
Total
Utility
0 utils
150 utils
2
3
4
5
250 utils
325 utils
375 utils
400 utils
100 utils
75 utils
50 utils
25 utils
150 utils
Utility
Utility = happiness, satisfaction or well-being
Marginal Utility (MU) = the additional utility you get
from one additional unit of a good or service
U
Marginal Utility of X = MU X
X
Diminishing Marginal Utility
When I dont have much of good X, MUX is high
When I am already consuming a lot of good X, MUX is low
Marginal Utility
U
Marginal Utility of X = MU X
X
# of Pizza
Slices
Marginal
Utility
0
1
Total
Utility
0 utils
150 utils
2
3
4
5
250 utils
325 utils
375 utils
400 utils
100 utils
75 utils
50 utils
25 utils
150 utils
Consumption Possibilities
A
90 min. to
France
45 min. to
France
10 min. to
France
120 min. to
France
10 min.
home
45 min.
home
90 min.
home
90 min.
home
Consumption Possibilities
A
90 min. to
France
45 min. to
France
10 min. to
France
120 min. to
France
10 min.
home
45 min.
home
90 min.
home
90 min.
home
Consumption Possibilities
A
90 min. to
France
45 min. to
France
10 min. to
France
120 min. to
France
10 min.
home
45 min.
home
90 min.
home
90 min.
home
Minutes to France
Consumption Possibilities
A
90 min. to
France
45 min. to
France
10 min. to
France
120 min. to
France
10 min.
home
45 min.
home
90 min.
home
90 min.
home
90
Minutes to France
Consumption Possibilities
A
90 min. to
France
45 min. to
France
10 min. to
France
120 min. to
France
10 min.
home
45 min.
home
90 min.
home
90 min.
home
10
90
Minutes to France
Consumption Possibilities
A
90 min. to
France
45 min. to
France
10 min. to
France
120 min. to
France
10 min.
home
45 min.
home
90 min.
home
90 min.
home
45
B
A
45
Minutes to France
Consumption Possibilities
A
90 min. to
France
45 min. to
France
10 min. to
France
120 min. to
France
10 min.
home
45 min.
home
90 min.
home
90 min.
home
90
C
B
A
10
Minutes to France
C
B
A
Minutes to France
Consumption Possibilities
A
90 min. to
France
45 min. to
France
10 min. to
France
120 min. to
France
10 min.
home
45 min.
home
90 min.
home
90 min.
home
100 Utils
Consumption Possibilities
A
90 min. to
France
45 min. to
France
10 min. to
France
120 min. to
France
10 min.
home
45 min.
home
90 min.
home
90 min.
home
Consumption Possibilities
A
90 min. to
France
45 min. to
France
10 min. to
France
120 min. to
France
10 min.
home
45 min.
home
90 min.
home
90 min.
home
C
B
A
Minutes to France
C
B
A
Indifference
curve
0
Minutes to France
C
B
A
100 Utils
0
Minutes to France
Consumption Possibilities
A
90 min. to
France
45 min. to
France
10 min. to
France
120 min. to
France
10 min.
home
45 min.
home
90 min.
home
90 min.
home
Consumption Possibilities
A
90 min. to
France
45 min. to
France
10 min. to
France
120 min. to
France
10 min.
home
45 min.
home
90 min.
home
90 min.
home
D
C
200 Utils
B
A
100 Utils
0
Minutes to France
I4=400 utils
I3= 300 utils
I2= 200 utils
I1= 100 utils
Minutes to France
I4=400 utils
I3= 300 utils
I2= 200 utils
I1= 100 utils
Minutes to France
Minutes to France
100 Utils
45
15
0
30
45
Minutes to France
(Bad)
C
D
0
Indifference
curve, I1
Minutes to France
From A to B, MRS = 10
From C to D, MRS = .5
80
10
9.5
C
20
21
90
100 Utils
D
91 Minutes to France
80
B
At C: MUF is lowsay 5 utils; and
MUH is highsay 10 utils
MRS = MUF / MUH = 5 utils / 10 utils =
Slope of IC at C = MRS =
10
9.5
20
21
90
100 Utils
D
91 Minutes to France
I1
0
I2
2
I3
3
Dimes
I2
I1
Right Shoes
Budget Constraint
Minutes
Home
PMin. France = 30
B
PF
PMin. HomePB = 10
H
Budget=B= $30
B
PF
Minutes to France
PMin. France = 30
B
PF
PMin. HomePB = 10
H
Budget=B= $30
B
PF
Minutes to France
PMin. France = 30
PMin. HomePB = 10
B
PF
Budget=B= $30
B
PF
B/PF= 100
Minutes to France
PMin. France = 30
PMin. HomePB = 10
B
PF
Budget=B= $30
Slope = PF/PH
= 30/10
=3
B
PF
B/PF= 100
Minutes to France
PX = Price of X
B
PY = Price
of Y
P
B
PF
B = Budget
Slope = PX/PY
B
PF
B/PX= 100
PX = Price of X
B
PY = Price
of Y
P
B
PF
B = Budget
B
PF
B/PX
Consumer Optimum
Y
Y*
IC
BC
X*
Consumer Optimum
Y
At O: Slope of IC = Slope of BC
Y*
IC
BC
X*
Consumer Optimum
Y
At O: Slope of IC = Slope of BC
MRS = PX/PY
Y*
IC
BC
X*
Consumer Optimum
Y
At O: Slope of IC = Slope of BC
MRS = PX/PY
MUX/MUY = PX/PY
Y*
IC
BC
X*
Consumer Optimum
Y
At O: Slope of IC = Slope of BC
MRS = PX/PY
MUX/MUY = PX/PY
Rearranging:
Y*
MUX/PX = MUY/PY
IC
BC
X*
Consumer Optimum
Minutes
Home
B/PH=300
120
MUF/PF = MUH/PH
MUF/30 = MUH/10
For examplesatisfied if MUF = 60, MUH = 20.
IC
BC
60
B/PF=100
Minutes to France
BC
I1
I2
I3
Minutes to France
BC
I1
I2
I3
Minutes to France
B
0
BC
I1
I2
I3
Minutes to France
B
0
BC
I1
I2
I3
Minutes to France
O
C
B
0
BC
I1
I2
I3
Minutes to France
O
C
B
0
BC
I1
I2
I3
Minutes to France
D
O
C
B
0
BC
I1
I2
I3
Minutes to France
D is not affordableit is
outside the BC
D
O
C
B
0
BC
I1
I2
I3
Minutes to France
D
O
C
B
0
BC
I1
I2
I3
Minutes to France
Practice Questions
JoAnne is trying to decide how many books and how many movies to consume
each month. She has $136 to spend on the two goods. Movies cost $8 each, and
books cost $20 each. Each good can only be purchased in whole numbers (not
fractions of a good).
JoAnnes preferences for movies and books are summarized by the following
table:
Movies
No. per Total
Marginal
Month Utility Utility MU/$
1
50
2
80
3
100
4
110
5
116
6
121
7
123
Books
No. per Total
Marginal
Month Utility Utility MU/$
1
22
2
42
3
52
4
57
5
60
6
62
7
63
a. Fill in the figures for marginal utility and for marginal utility per dollar
spent for both movies and books.
Books
Practice Questions
JoAnne is trying to decide how many books and how many movies to consume
each month. She has $136 to spend on the two goods. Movies cost $8 each, and
books cost $20 each. Each good can only be purchased in whole numbers (not
fractions of a good).
JoAnnes preferences for movies and books are summarized by the following
table:
Movies
No. per Total
Marginal
Month Utility Utility MU/$
1
50
2
80
3
100
4
110
5
116
6
121
7
123
Books
No. per Total
Marginal
Month Utility Utility MU/$
1
22
2
42
3
52
4
57
5
60
6
62
7
63
Books
Practice Questions
JoAnne is trying to decide how many books and how many movies to consume
each month. She has $136 to spend on the two goods. Movies cost $8 each, and
books cost $20 each. Each good can only be purchased in whole numbers (not
fractions of a good).
JoAnnes preferences for movies and books are summarized by the following
table:
Movies
No. per Total
Marginal
Month Utility Utility MU/$
1
50
2
80
3
100
4
110
5
116
6
121
7
123
Books
No. per Total
Marginal
Month Utility Utility MU/$
1
22
2
42
3
52
4
57
5
60
6
62
7
63
c. Given her budget of $136, what quantity of books and what quantity of
movies will maximize JoAnnes utility? Explain how you arrived at your
answer.
Books
Books
Graphical Question on
Optimal Consumption
At her present levels of consumption of goods X and Y,
Dana is spending her entire budget, and her
MRSX,Y = 5. PX = $9 and PY = $2.
Is Dana consuming the optimal amount of goods X and Y?
Graphical Question on
Optimal Consumption
At her present levels of consumption of goods X and Y,
Dana is spending her entire budget, and her
MRSX,Y = 5. PX = $9 and PY = $2.
Is Dana consuming the optimal amount of goods X and Y?
Consumer Optimum
Y
At O: Slope of IC = Slope of BC
MRS = PX/PY
MUX/MUY = PX/PY
Rearranging:
Y*
MUX/PX = MUY/PY
IC
BC
X*
Graphical Question on
Optimal Consumption
At her present levels of consumption of goods X and Y,
Dana is spending her entire budget, and her
MRSX,Y = 5. PX = $9 and PY = $2.
Is Dana consuming the optimal amount of goods X and Y?
At O: Slope of IC = Slope of BC
MRS = PX/PY
MUX/MUY = PX/PY
Rearranging:
MUX/PX = MUY/PY
MRS = PX / PY
MRS = PX / PY
5 = PX / PY
5
9/2
BC
I1
I2
I3
Changes in Prices
Effect on the Budget Constraint
Income and Substitution Effects
Consumer Optimum
Y
Y*
IC
BC
X*
Consumer Optimum
Y
At O: Slope of IC = Slope of BC
Y*
IC
BC
X*
Consumer Optimum
Y
At O: Slope of IC = Slope of BC
MRSX,Y = PX/PY
Y*
IC
BC
X*
Consumer Optimum
Y
At O: Slope of IC = Slope of BC
MRSX,Y = PX/PY
MUX/MUY = PX/PY
Y*
IC
BC
X*
Consumer Optimum
Y
At O: Slope of IC = Slope of BC
MRSX,Y = PX/PY
MUX/MUY = PX/PY
Rearranging:
Y*
MUX/PX = MUY/PY
IC
BC
X*
PX = Price of X
B
PY = Price
of Y
P
B
PF
B = Budget
Slope = PX/PY
B
PF
B/PX
PMin. France = 30
PMin. HomePB = 10
B
PF
Budget=B= $30
Slope = PF/PH
= 30/10
=3
B
PF
B/PF= 100
Minutes to France
A Change in Budget
What if the prices of calls stay the same, but
consumers budget for phone calls doubles?
PMin. France = 30
PMin. HomePB = 10
B
PF
New Budget=B=
$60
Will the slope of the
Budget Constraint
Change?
B
PF
Minutes to France
PMin. France = 30
PMin. HomePB = 10
B
PF
New Budget=B=
$60
Slope = PF/PH
B
PF
= 30/10
=3
Minutes to France
PMin. France = 30
PMin. HomePB = 10
B
PF
New Budget=B=
$60
Slope = PF/PH
B
PF
= 30/10
=3
Minutes to France
PMin. France = 30
PMin. HomePB = 10
B
PF
New Budget=B
B/PH=300
= $60
B
PF
B/PF=100
B/PF= 200
Minutes to France
PMin. France = 30
PMin. HomePB = 10
B
PF
New Budget=B
B/PH=180
= $18
B
PF
B/PF=60
B/PF= 100
Minutes to France
A Change in Budget
What happens to consumers calls to France and
calls home when the budget for phone calls
increases?
240
150
O
O
IC
BC
BC
50
120
IC
IC
B/PF=200
Minutes to France
240
150
IC
BC
50 75
IC
BC
B/PF=200
Minutes to France
240
150
(QD when B)
IC
BC
50 75
IC
BC
B/PF=200
Minutes to France
240
150
O
IC
BC
BC
50
120
IC
B/PF=200
Minutes to France
240
150
O
IC
BC
BC
50
120
IC
B/PF=200
Minutes to France
BC
B/PF=100
Minutes to France
BC
B/PH=200
BC
B/PF=100
Minutes to France
A Change in Prices
What happens to consumers optimum
consumption bundle when the price of calls
home goes up to 15?
BC
B/PH=200
BC
IC
IC
B/PF=100
Minutes to France
BC
BC
B/PF=100
B/PF=300
Minutes to France
IC
BC
IC
BC
B/PF
Minutes to France
Calls to
France
Comments
Calls to
France
Comments
Calls to
France
Comments
These are
always
opposite
Income
Effect
Combined
Effect
Calls to
France
Comments
These are
always
opposite
Calls to
France
Comments
These are
always
opposite
These are
always the same
if both goods are
normal
Calls to
France
Comments
These are
always
opposite
These are
always the same
if both goods are
normal
IC
BC
IC
BC
B/PF
Minutes to France
Combined if IE > SE
Effect if SE > IE
Calls to
France
Comments
These are
always
opposite
These are
always the same
if both goods are
normal
IC
BC
IC
BC
B/PF
Minutes to France
180
120
PF by 30
IC
IC
BC
BC
20
50
60
100
Minutes to France
Calls to France
SE: O O
200
by 5
Calls Home
by 80
O
SE
120
PF by 30
IC
IC
BC
BC
55
60
Minutes to France
200
180
IE
by 5
Calls Home
by 80
IE O O
O
SE
120
PF by 30
IC
IC
BC
BC
20
55
60
Minutes to France
200
180
Calls to France
IE
SE O O
by 5
IE O O
by 35
Calls Home
by 80
SE
120
PF by 30
IC
IC
BC
BC
20
55
60
Minutes to France
200
180
IE
Calls Home
SE O O
by 5
by 80
IE O O
by 35
by 20
SE
120
PF by 30
IC
IC
BC
BC
20
55
60
Minutes to France
200
180
IE
Calls Home
SE O O
by 5
by 80
IE O O
by 35
by 20
SE
Net
120
PF by 30
IC
IC
BC
BC
20
55
60
Minutes to France
200
180
Calls to France
IE
SE
Net
120
Calls Home
SE O O
by 5
by 80
IE O O
by 35
by 20
Net Effect
O O
PF by 30
IC
IC
BC
BC
20
55
60
Minutes to France
200
180
IE
SE
Net
120
Calls Home
SE O O
by 5
by 80
IE O O
by 35
by 20
Net Effect
by 40
O O
PF by 30
IC
IC
BC
BC
0 20
55
60
Minutes to France
200
180
IE
SE
Net
120
Calls Home
SE O O
by 5
by 80
IE O O
by 35
by 20
Net Effect
by 40
by 60
O O
PF by 30
IC
IC
BC
BC
0 20
55
60
Minutes to France
200
180
IE
SE
Net
120
Calls Home
SE O O
by 5
by 80
IE O O
by 35
by 20
Net Effect
by 40
by 60
O O
PF by 30
IC
IC
BC
BC
0 20
55
60
Minutes to France
PX=P1
IC1
X1
Demand Curve
P
P1
X1
PX=P1
O
O
PX=P2
X1 X2
IC2
IC1
Demand Curve
P
P1
P2
X1
X2
PX=P1
O
IC3
PX=P2
IC2
PX=P3
X1 X2 X3
IC1
Demand Curve
P
P1
P2
P3
0
X1
X2
X3
Demand Curve
P
P1
P2
P3
0
D
X1
X2
X3
Demand Curve
P
P1
P2
P3
0
D
X1
X2
X3
Calls to
France
Comments
Calls to
France
Substitution
Effect
Income
Effect
Combined
Effect
Comments
Calls to
France
Substitution
Effect
Income
Effect
Combined
Effect
Comments
Calls to
France
Comments
Calls to
France
Comments
Calls to
France
Comments
When P,
SE always
makes Q
Calls to
France
Substitution
Effect
Income
Effect
Combined
Effect
Comments
When P,
SE always
makes Q
Calls to
France
Substitution
Effect
Income
Effect
Combined
Effect
if IE > SE
if SE > IE
Comments
When P,
SE always
makes Q
Calls to
France
Substitution
Effect
Income
Effect
Combined
Effect
if IE > SE
if SE > IE
Comments
When P,
SE always
makes Q
If IE>SE, PF
and QD goes
downthis is a
Giffen Good
D
0
Calls to
France
Comments
Calls to
France
Substitution
Effect
Income
Effect
Combined
Effect
Comments
Calls to
France
Substitution
Effect
Income
Effect
Combined
Effect
Comments
Calls to
France
Comments
Calls to
France
Comments
Calls to
France
Comments
When P,
SE always
makes Q
Calls to
France
Substitution
Effect
Income
Effect
Combined
Effect
Comments
When P,
SE always
makes Q
Calls to
France
Substitution
Effect
Income
Effect
Combined
Effect
if IE > SE
if SE > IE
Comments
When P,
SE always
makes Q
Calls to
France
Substitution
Effect
Income
Effect
Combined
Effect
if IE > SE
if SE > IE
Comments
When P,
SE always
makes Q
If IE>SE, PF
and QD goes
downthis is a
Giffen Good
D
0
Expected Value
Expected Value (EV)
= Probability of Outcome 1 Value of Outcome 1
+ Probability of Outcome 2 Value of Outcome 2
+ Probability of Outcome 3 Value of Outcome 3
+ .......
+ Probability of Outcome N Value of Outcome N
Expected Value
Example
Lottery with
Outcome 1: Win $10,000
Outcome 2: Win
$0
P(1) = .1
P(2) = .9
Another Example of EV
Two Possible Summer Jobs
Option I: Work on the Local Newspaper:
Pays $2,000 for sure
Another Example of EV
Two Possible Summer Jobs
Option I: Work on the Local Newspaper:
Pays $2,000 for sure
EV(Option I) = 1 $2,000 = $2,000
Another Example of EV
Two Possible Summer Jobs
Option I: Work on the Local Newspaper:
Pays $2,000 for sure
EV(Option I) = 1 $2,000 = $2,000
Another Example of EV
Two Possible Summer Jobs
Option I: Work on the Local Newspaper:
Pays $2,000 for sure
EV(Option I) = 1 $2,000 = $2,000
Another Example of EV
Two Possible Summer Jobs
Option I: Work on the Local Newspaper:
Pays $2,000 for sure
EV(Option I) = 1 $2,000 = $2,000
Expected Utility
Expected Utility (EU)
= Probability of Outcome 1 Utility from Outcome 1
+ Probability of Outcome 2 Utility from Outcome 2
+ Probability of Outcome 3 Utility from Outcome 3
+ .......
+ Probability of Outcome N Utility from Outcome N
Risk Aversion
Money
U(4,000)
U(2,500)
EU
U(1,000)
1,000
EV = 2,500
4,000
Money
U(4,000)
U(2,500)
EU
U(1,000)
1,000
CE
2,500 = EV
4,000
Money
Risk Aversion
Risk Neutrality
U(2,500)
U(1,000)
1,000
EV = 2,500
4,000
Money
U(2,500)
= EU
U(1,000)
1,000
EV = 2,500
4,000
Money
U(2,500)
= EU
U(1,000)
1,000
EV = 2,500
= CE
4,000
Money
Risk Aversion
Risk Neutrality
Risk Loving
U(4,000)
EU
U(2,500)
U(1,000)
1,000
2,500=EV
4,000
Money
U(4,000)
EU
U(2,500)
U(1,000)
1,000
2,500=EV
CE 4,000
Money
Insurance Example
Income = $30,000
10% chance of becoming ill, and having
$20,000 in medical bills
EV of her income = .9 ($30,000)
+.1 ($10,000)
= $28,000
U(30,000)
EU = U(27,000)
U(10,000)
CE=27K 28K = EV
30,000
Money
Economies of Scope
Firms Costs
Total, Average and Marginal Costs
Fixed and Variable Costs
Production Function
The Production Function
The production function shows the relationship
between quantity of inputs used to make a
good and the quantity of output of that good.
q=f(K, L, X)
Example: q = 2K + 3L + 4X
When K = 4, L = 2 and X = 1, q = 18
Production Function
The Production Function
The production function shows the relationship
between quantity of inputs used to make a good and
the quantity of output of that good.
q=f (K, L, X)
Example: q = 2K + 3L + 4X
When K = 4, L = 2 and X = 1, q = 18
q AK L
Returns to Scale
q = f (K, L, X)
What happens when K, L and X double?
Constant Returns to Scale
(CRTS)
If output more than doubles Increasing Returns to Scale
(IRTS)
If output less than doubles Decreasing Returns to Scale
(DRTS)
Example: q = f (K, L, X) = 2K + 3L + 4X
K = 4, L = 2, X = 1 q = 18
Double K, L and X to K = 8, L = 4, X = 2;
Now q = 36 = 2q
Output doubled when inputs doubled CRTS
If output doubles
q f ( K , L) AK L
q f (2 K , 2 L)
A(2 K ) (2 L)
A2 K 2 L
2 AK L
2 q
q f (2 K , 2 L) 2
1 f (2 K , 2 L) 2q
CRTS
1 IRTS
1 DRTS
Returns to Scale
vs. Marginal Product
Returns to Scale: What happens to output when
all inputs are changed. . . . .
By the same proportion
Simultaneously
Marginal product: What happens to output when
one input is changed. . . . .
By itself
Holding all other inputs constant
Economies of Scope
economies of scope Situation in
which joint output of a single firm is
greater than output that could be
achieved by two different firms when
each produces a single product.
Economies of Scope
To measure the degree to which there are economies of
scope, we should ask what percentage of the cost of
production is saved when two (or more) products are
produced jointly rather than individually.
$5 $10 $8
$8
7
.875
8
SC > 0
SC < 0
q
Example: average product of labor
L
q
average product of capital
K
q
Example: marginal product of labor
L
q
marginal product of capital
K
Average
Product (q/L)
Marginal
Product (q/L)
Amount
of Capital (K)
Total
Output (q)
10
10
10
10
10
10
30
15
20
10
60
20
30
10
80
20
20
10
95
19
15
10
108
18
13
10
112
16
10
112
14
10
108
12
10
10
100
10
Total Cost
Total Cost = TC = the total cost of producing q
units of output
Example: TC = 10q
q
TC
0
0
1
10
2
20
3
30
4
40
TC
0
10
20
30
40
TC
TC=10q
Total Cost
Example: TC = q3 + 2q2 + 3q + 5
TC
TC
Average Cost
Average Cost = AC = TC/q
10
AC=10
Marginal Cost
Marginal Cost = MC = TC / q
= cost of producing an
additional unit of ouput
10
MC=AC=10
MC
MC>AC AC is rising
MC
AC
MC<AC AC is falling
MC=AC AC is flat
Summary of Costs
Total
Total
Average
Marginal
Fixed
Variable
Summary of Costs
Total
Total
TC
Average
Marginal
Fixed
Variable
Summary of Costs
Total
Fixed
TC
TFC=costs
that do not
vary with q
Total
Average
Marginal
Variable
5
q
Summary of Costs
Total
Fixed
Variable
TC
TFC=costs
that do not
vary with q
TVC=costs
that do vary
with q
Total
Average
Marginal
Cost Equations
TC = TFC + TVC
Summary of Costs
Total
Total
TC
Average
Marginal
AC = TC / q
Fixed
TFC=costs
that do not
vary with q
Variable
TVC=costs
that do vary
with q
Summary of Costs
Total
Total
TC
Average
Marginal
AC = TC / q
Fixed
TFC=costs
that do not
vary with q
AFC=TFC/q
Variable
TVC=costs
that do vary
with q
AFC
q
Summary of Costs
Total
Total
TC
Average
Marginal
AC = TC / q
Fixed
Variable
TFC=costs
that do not
vary with q
TVC=costs
that do vary
with q
AFC=TFC/q
AVC=TVC/q
Cost Equations
AC = AFC + AVC
AC
AVC
AFC
q
Summary of Costs
Total
Total
TC
Average
AC = TC / q
Marginal
MC = TC/q
Fixed
Variable
TFC=costs
that do not
vary with q
TVC=costs
that do vary
with q
AFC=TFC/q
AVC=TVC/q
Summary of Costs
Total
Total
TC
Average
Marginal
AC = TC / q
Fixed
Variable
TFC=costs
that do not
vary with q
TVC=costs
that do vary
with q
AFC=TFC/q
AVC=TVC/q
MC = TC/q MFC=TFC/q
Summary of Costs
Total
Total
TC
Average
Marginal
AC = TC / q
Fixed
Variable
TFC=costs
that do not
vary with q
TVC=costs
that do vary
with q
AFC=TFC/q
AVC=TVC/q
MC = TC/q MFC=TFC/q
=0
Summary of Costs
Total
Total
TC
Average
Marginal
AC = TC / q
Fixed
Variable
TFC=costs
that do not
vary with q
TVC=costs
that do vary
with q
AFC=TFC/q
AVC=TVC/q
=MC
Cost Equations
MC = MFC + MVC
= 0 + MVC
= MVC
AC
AVC
AFC
q
Cost Equations
TC = TFC + TVC
AC = AFC + AVC
MC = MFC + MVC
= 0 + MVC
= MVC
Revenue Concepts
Short-run Equilibrium for a Perfectly
Competitive Firm
The Shut-Down Rule
Revenue Concepts
Total Revenue (TR) = p q, where p is the price
per unit and q is the number of units sold
Revenue Concepts
Total Revenue (TR) = p q, where p is the price
per unit and q is the number of units sold
Example: A gas station sells 1000 gals. of gas
at $3.00 per gallon.
TR = $3,000
Revenue Concepts
Total Revenue (TR) = p q, where p is the price
per unit and q is the number of units sold
Example: A gas station sells 1000 gals. of gas
at $3.00 per gallon
TR = $3,000
Average Revenue (AR) = TR/q = (p q) / q =
p; so AR is just a fancy name for price
\
Revenue Concepts
Total Revenue (TR) = p q, where p is the price per unit and q
is the number of units sold
Example: A gas station sells 1000 gals. of gas at $3.00 per
gallon.
TR = $3,000
Average Revenue (AR) = TR/q = (p q) / q = p; so AR is just a
fancy name for price
Marginal Revenue (MR) =TR/ q = the additional revenue
received from selling the last unit
Example: The 110th widget is sold for $40; so TR = 40, q=
1, so the MR of the 110th unit = 40.
Perfect Competition:
Three Conditions
Many buyers and sellers
Complete information
Well-specified property rights
Characteristics of
Perfectly Competitive Firm
Homogeneous products
Ease of entry and exit
Price-taking behavior
Market
P*
P*
Firm
P*
Market
P*
P*
Firm
P*= D
Market
P*
P*
Firm
P*= D = AR
Market
P*
P*
Firm
P*= D = AR = MR
Profit
Profit = = TR TC
P*
MC
MR (=P*= D = AR)
At q*, MR = MC
q*
MC
P*
MR (=P*= D = AR)
At q*, MR = MC
q* qA
MC
At qA, MC > MR
A
MR (=P*= D = AR)
At q*, MR = MC
q*
qA
MC
At qA, MC > MR
P*
A
MR (=P*= D = AR)
At q*, MR = MC
B
qB
q*
qA
MC
At qA, MC > MR
P*
MR (=P*= D = AR)
At q*, MR = MC
At qB, MR > MC
B
MCB
qB
q*
qA
q TC
0
1
2
3
4
5
6
100
150
170
190
240
300
380
q TC
0
1
2
3
4
5
6
100
150
170
190
240
300
380
q TC MC
0
1
2
3
4
5
6
100
150
170
190
240
300
380
q TC MC
0
1
2
3
4
5
6
100
150
170
190
240
300
380
50
q TC MC
0
1
2
3
4
5
6
100
150
170
190
240
300
380
50
20
q TC MC
0
1
2
3
4
5
6
100
150
170
190
240
300
380
50
20
20
q TC MC
0
1
2
3
4
5
6
100
150
170
190
240
300
380
50
20
20
50
q TC MC
0
1
2
3
4
5
6
100
150
170
190
240
300
380
50
20
20
50
60
q TC MC
0
1
2
3
4
5
6
100
150
170
190
240
300
380
50
20
20
50
60
80
q TC MC
0
1
2
3
4
5
6
100
150
170
190
240
300
380
50
20
20
50
60
80
Profit
Profit = = TR TC
Profit
Profit = = TR TC
= q (TR/q TC/q)
Profit
Profit = = TR TC
= q (TR/q TC/q)
= q (AR AC)
Profit
Profit = = TR TC
= q (TR/q TC/q)
= q (AR AC)
= q (p AC)
MC
AC
P*
P = MR = AR
q*
MC
AC
P*
P = MR = AR
O
P AC at q*
q*
MC
AC
P*
P = MR = AR
O
P AC at q*
Profits
q*
P*
MC
AC
P = MR = AR
q*
MC
AC
At q*, AC > P, so
P*
q*
P AC < 0
MC
AC
O
P*
Losses
At q*, P AC < 0
so the firm is
making losses
q*
MC
P4*
O4
P3*
P2*
P1*
O3
O2
O1
MC
P4*
O4
P3*
P2*
P1*
O3
O2
O1
MC
AC
O
P*
Losses
At q*, P AC < 0
so the firm is
making losses
q*
q TC MC
0
1
2
3
4
5
6
100
150
170
190
240
300
380
50
20
20
50
60
80
q TC MC
0
1
2
3
4
5
6
100
150
170
190
240
300
380
50
20
20
50
60
80
100
150
170
190
240
300
380
50
20
20
50
60
80
100
100
100
100
100
100
100
100
150
170
190
240
300
380
50
20
20
50
60
80
100
100
100
100
100
100
100
0
50
70
90
140
200
280
100
150
170
190
240
300
380
50
20
20
50
60
80
100
100
100
100
100
100
100
0
50
70
90
140
200
280
50
35
30
35
40
46.67
100
150
170
190
240
300
380
50
20
20
50
60
80
100
100
100
100
100
100
100
0
50
70
90
140
200
280
50
35
30>25
35
40
46.67
100
150
170
190
240
300
380
50
20
20
50
60
80
100
100
100
100
100
100
100
0
50
70
90
140
200
280
50
35
30>25
35
40
46.67
MC
AC
AVC
MC
Supply
$2.00
$2.00
1.00
1.00
100
200
Quantity (firm)
100,000
Market
S
$/unit
Firm
P*
P*
MC
P*= MR = D
q*
Market
S
$/unit
Firm
MC
AC
P*
P*
P*= MR = D
q*
At q*, P*= MC = AC,
so P* AC = profits = 0
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Where Harvard
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Accounting Costs
Accounting Costs
Labor
Accounting Costs
Accounting Costs
Labor
Raw materials
Accounting Costs
Accounting Costs
Labor
Raw materials
Equipment
Accounting Costs
Accounting Costs
Labor
Raw materials
Equipment
$ 500
Accounting Costs
Accounting Costs
Labor
Raw materials
Equipment
$ 500
$1000
Accounting Costs
Accounting Costs
Labor
Raw materials
Equipment
$ 500
$1000
$ 200
Accounting Costs
Accounting Costs
Labor
Raw materials
Equipment
Total Accounting Costs
$ 500
$1000
$ 200
$1700
Accounting Costs
Accounting Costs
Labor
Raw materials
Equipment
Total Accounting Costs
$ 500
$1000
$ 200
$1700
Accounting Costs
Accounting Costs
Labor
Raw materials
Equipment
Total Accounting Costs
$ 500
$1000
$ 200
$1700
Accounting Profit
Accounting Costs
Labor
Raw materials
Equipment
Total Accounting Costs
$ 500
$ 1000
$ 200
$ 1700
Economic Costs
Implicit Costs
Foregone salary
Foregone interest
Total implicit costs
costs
$ 4,000
$
15
$ 4,015
Economic Costs
Implicit Costs
Foregone salary
Foregone interest
Total implicit costs
costs
$ 4,000
$
15
$ 4,015
Economic Costs
Implicit Costs
Foregone salary
Foregone interest
Total implicit costs
costs
$ 4,000
$
15
$ 4,015
Economic Costs
Implicit Costs
Foregone salary
Foregone interest
Total implicit costs
costs
$ 4,000
$
15
$ 4,015
Economic Profits
Total Economic Costs = $5,715
Economic Profits
Total Economic Costs = $5,715
Economic Profit = TR Total Economic Costs
Economic Profits
Total Economic Costs = $5,715
Economic Profit = TR Total Economic Costs
= $5,000 $5,715
Economic Profits
Total Economic Costs = $5,715
Economic Profit = TR Total Economic Costs
= $5,000 $5,715
= $715
AC
AVC
AFC
q
Market
S
$/unit
Firm
MC
AC
P*
P*
P*= MR = D
q*
Market
S
Firm
$/unit
P1
P1
MC
AC
P*= MR
Profits
Q1
q1
Market
S
Firm
$/unit
S
P1
P2
P1
P2
MC
AC
P2= MR
Profits
D
Q1 Q2
q2 q1
Market
S
$/unit
Firm
S
S
P1
P2
P3
P1
P2
P3
P***= MR
D
Q1 Q2 Q3
MC
AC
q3 q2 q1
Market
$/unit
Firm
MC
AC
P*
P*
D
Q*
Losses
q*
Market
$/unit
S
MC
AC
P2
P2
P1
P1
D
Q2 Q1
Firm
Losses
q1 q2
Market
S
S
$/unit
Firm
MC
AC
P3
P2
P1
P3
P2
P1
D
Q3Q2Q1
q1q2q3
LR Equilibrium
P
Market
S
$/unit
Firm
AC
P*
P*
MC
P*= MR = D
D
q*
Q
P*LR = min AC for a typical firm
P*
LR
SLR
In the LR, S is perfectly elastic at the
min of AC for a typical firm; there is
only one possible price:
P*LR = min AC
Toner Market
S
$/unit
Toner Firm
MC
AC
P*
P*
P*= MR = D
D
Q*
q*
Toner Market
S
$/unit
Toner Firm
MC
AC
P*
P*
P*= MR = D
D
Q*
q*
Toner Market
S
$/unit
P2
P1
P2
P1
Toner Firm
MC
AC
Profits
D
D
Q1 Q2
q1 q2
Toner Market
S
$/unit
Toner Firm
AC
P2
P1
P2
P1
MC
D
D
Q1 Q2 Q3
q1 q2
Monopoly
Monopoly
Price Discrimination
First Degree
Second Degree
Third Degree
Monopolistic Competition
Product Differentiation
Attributes of a monopolistically competitive
market
Profit Maximizing Quantity
Long-run Equilibrium
Very many
Price taker
Barriers to Entry/
Exit
No
SR Profit
Positive, zero,
or negative
LR Profit
Zero
Advertising
Never
One
Firm
Monopoly
Tap water
Cable TV
Identical
Products
Perfect
Competition
Wheat
Milk
(1)One Seller
(1)One Seller
(2)Barriers to Entry
Sources of Monopoly
Sources of Monopoly
AC
Q
Perfectly
Competitive Firm
$/unit
Monopoly
D=AR=P*
Perfectly
Competitive Firm
$/unit
Monopoly
D=AR=P*
Perfectly
Competitive Firm
$/unit
Monopoly
D=MR=AR=P*
Perfectly
Competitive Firm
$/unit
Monopoly
D=MR=AR=P*
MR
q
D
Q
Nickelback
CDs per Day
$20
D
10
TR
$20
10
$200
Nickelback
CDs per Day
$20
D
10
11
TR
$20
10
$200
Nickelback
CDs per Day
$20
$19
D
10
11
TR
$20
10
$200
Nickelback
CDs per Day
$20
$19
TR
$20
10
$200
$19
11
$209
D
10
11
MR
Nickelback
CDs per Day
$20
$19
TR
$20
10
$200
$19
11
$209
D
10
11
MR
$9
Nickelback
CDs per Day
$20
$19
TR
$20
10
$200
$19
11
$209
$9
D
10
11
MR
$9
Nickelback
CDs per Day
$20
$19
$9
TR
$20
10
$200
$19
11
$209
$9
$18
12
$216
$7
D
10
11
12
MR
Nickelback
CDs per Day
$20
$19
$9
TR
$20
10
$200
$19
11
$209
$9
$18
12
$216
$7
$7
10
11
12
MR
Nickelback
CDs per Day
$20
$19
$9
TR
$20
10
$200
$19
11
$209
$9
$18
12
$216
$7
$7
10
11
12
MR
MR
Monopoly
MR
D
Q
QUANTITY (Q)
TOTAL
REVENUE (R)
MARGINAL
REVENUE (MR)
AVERAGE
REVENUE (AR)
$6
$0
$5
$5
MR
At Q*, MR = MC
MR
QMon
MR
At Q*, MR = MC
MR
QMon
MR
At Q*, MR = MC
MR
QMon
PMon
MR
At Q*, MR = MC
MR
For a monopoly,
MR<P at Q*
QMon
MR
MR
QMon
PMon
MR
MR
QMon
PMon
MR
MR
QMon
PMon
P AC at QMon
AC
MR
MR
QMon
PMon
AC
Profits
P AC at QMon
MR
MR
QMon
PMon
MR
MR
QMon
PMon
MR
MR
QMon
PMon
P AC < 0
MR
MR
QMon
PMon
Losses
P AC < 0
MR
MR
QMon
Nickelback
CDs per Day
$20
$19
TR
$20
10
$200
$19
11
$209
$9
D
10
11
MR
$9
Price Discrimination
price discrimination Practice of charging
different prices to different consumers for
similar goods.
If a firm can charge only one price
for all its customers, that price will
be P* and the quantity produced
will be Q*.
Ideally, the firm would like to
charge a higher price to
consumers willing to pay more
than P*.
The firm would also like to sell to
consumers willing to pay prices
lower than P*, but only if doing so
does not entail lowering the price
to other consumers.
In that way, the firm could earn
additional profits by selling to
consumers represented by region
B of the demand curve.
Price Discrimination
First degree price discrimination
Price Discrimination
First degree price discrimination
Second degree price discrimination
Price Discrimination
First degree price discrimination
Second degree price discrimination
Third degree price discrimination
Nonusers
Users
Toilet tissue
0.60
0.66
Stuffing/dressing
0.71
0.96
Shampoo
0.84
1.04
Cooking/salad oil
1.22
1.32
0.88
1.09
Cake mix
0.21
0.43
Cat food
0.49
1.13
Frozen entrees
0.60
0.95
Gelatin
0.97
1.25
Spaghetti sauce
1.65
1.81
Creme rinse/conditioner
0.82
1.12
Soups
1.05
1.22
Hot dogs
0.59
0.77
First Class
Unrestricted Coach
Discounted
Price
0.3
0.4
0.9
Income
1.2
1.2
1.8
Perfect
Competition
Monopoly
Very many
One
--
View of Pricing
Price taker
Price maker
Barriers to Entry/
Exit
No
Yes
MR = MC
P > MC
q* below pt. of min AC
SR Profit
Positive, zero,
or negative
Positive, zero,
or negative
LR Profit
Zero
Positive
Advertising
Never
Sometimes: PR Type
One
Firm
Many
Firms
Type of Products
Differentiated
Products
Identical
Products
Monopoly
(Chapter 15)
Monopolistic
Competition
(Chapter 17)
Perfect
Competition
(Chapter 14)
Tap water
Cable TV
Household Goods
Movies
Wheat
Milk
Monopolistic Competition
A monopolistically competitive market has two key
characteristics:
1. Firms compete by selling differentiated products that are
highly substitutable for one another but not perfect substitutes.
Monopolistic Competition
A monopolistically competitive market has two key
characteristics:
1. Firms compete by selling differentiated products that are
highly substitutable for one another but not perfect
substitutes.
In other words, the cross-price elasticities of demand are
large but not infinite.
2. There is free entry and exit: It is relatively easy for new firms
to enter the market with their own brands and for existing
firms to leave if their products become unprofitable.
Monopolistic Competition as a
Hybrid Market Structure
Many sellers
Like perfect
competition
Free entry and exit
Downward sloping demand Like
monopoly
curve
Product differentiation (Unlike perfect competition)
Demand curve much more elastic than
monopoly
TABLE 12.1
Colas
RC Cola
Coke
Ground coffee
ELASTICITY OF DEMAND
2.4
5.2 to 5.7
Folgers
6.4
Maxwell House
8.2
3.6
With the exception of RC Cola and Chock Full o Nuts, all the colas and
coffees are quite price elastic. With elasticities on the order of 4 to 8,
each brand has only limited monopoly power. This is typical of
monopolistic competition.
MR
At QMC,MR = MC D
MR
qMC
PMC
MR
At QMC,MR = MC D
MR
qMC
PMC
AC
MR=MC
P AC at QMC
Profits
MR
qMC
MR
MR
PMC=AC
min AC
MR=MC
MR
qMC
MC
PMC
MR=MC
MR
qMC
MC
AC
PMC
Losses
P AC < 0
MR=MC
MR
qMC
MC
MR
MR
PMC=AC
min AC
MR=MC
MR
qMC
Price
MC
MC
AC
AC
Markup
P
P = MR
(demand
curve)
MC
MR
Quantity
produced
Efficient
scale
Demand
Quantity
At equilibrium:
P > MC
q < q at min AC
Quantity produced =
Efficient scale
Quantity
At equilibrium:
P = MC
q = q at min AC
Monopolistic
Competition
Monopoly
Very many
Many
One
Differentiated
--
View of Pricing
Price taker
Price maker
Price maker
Barriers to Entry/
Exit
No
No
Yes
q* at min AC
MR = MC
P > MC
q* below pt. of min AC
MR = MC
P > MC
q* below pt. of min AC
SR Profit
Positive, zero,
or negative
Positive, zero,
or negative
Positive, zero,
or negative
LR Profit
Zero
Zero
Positive
Advertising
Never
Always
Sometimes: PR Type
Number of Firms
Oligopoly
Four-four concentration ratios
The Cournot Model
The Stackelberg Model
One
Firm
Few
Firms
Many
Firms
Type of Products
Differentiated
Products
Monopoly
(Chapter 15)
Oligopoly
(Chapter 16)
Monopolistic
Competition
(Chapter 17)
Tap water
Cable TV
Tennis balls
Crude oil
Household Goods
Movies
Identical
Products
Perfect
Competition
(Chapter 14)
Wheat
Milk
Concentration
ratio
100%
100%
99%
94%
93%
92%
92%
89%
88%
85%
82%
79%
Oligopoly
Oligopoly: a market structure in which only a
few sellers offer similar or identical products.
Strategic behavior in oligopoly:
A firms decisions about P or Q can affect other
firms and cause them to react. The firm will
consider these reactions when making
decisionsstrategic interdependence
Game theory: the study of how people behave
in strategic situations.
Oligopoly
In monopolistic competition:
Many firms
Free entry and exit
In oligopoly:
Few firms (High concentration ratios)
Barriers to entry
Excess capacity
q > q which maximizes profit
(p < p consistent with profit maximization)
Equilibrium in Oligopoly
vs. Other Market Structures
In perfect competition, monopoly, and
monopolistic competition:
Firms find profit-maximizing q where MR = MC
Any other firms in the market can be ignored
In oligopoly:
Strategic interdependence
Optimal decisions about p, q, or anything else
depend on competitors decisions
Sohow do we find equilibrium?
Equilibrium in Oligopoly
Regardless of market structure, equilibrium is
where a firm is doing the best that it can, and has
no incentive to change output or price
In oligopoly, a firm also does the best that it can
in equilibrium . . . . . .
Cournot Model
Researches on the Mathematical
Principles of the Theory of Wealth
(1838)
Cournot Model
Assumptions:
Two firms
Homogeneous good
Firms know the market demand curve
The two firms decide simultaneously how
much to produce
Each firm treats the output of its competitors
as fixed
Cournot Model
Market Demand: P = 75 2Q
Total Cost: TC = 10 + 3Q
Marginal Cost: MC = 3
Cournot Outcome
Firm L: TRL = PqL= (75 2Q)qL
= 75qL 2(qL + qF)qL
= 75qL 2qL2 2qFqL
MRL = 75 4qL 2qF = MC = 3
75 4qL 2qF = 3 4qL = 72 2qF
* = 18 q
q
F
L
Cournot Model
Market Demand: P = 75 2Q
Total Cost: TC = 10 + 3q
Marginal Cost: MC = 3
Cournot Outcome
Firm F: TRF = PqF= (75 2Q)qF
= 75qF 2(qL + qF)qF
= 75qF 2qLqF 2qF2
MRF = 75 2qL 4qF = MC = 3
75 2qL 4qF = 3 4qF = 72 2qL
* = 18 q
q
L
F
Cournot Model
Firm Ls Reaction Function: qL* = 18 qF
Firm Fs Reaction Function: qF* = 18 qL
Find qL*: qL*= 18 qF*
= 18 (18 qL*)
= 18 9 + qL*)
qL*= 9
qL*= 12
qF*= 12
Cournot Model
qL* = qF* = 12
Q* = qL* + qF* = 24
P* = 75 2Q*
= 75 2(24)
P* = 27
TRL= TRF= P*qL*= P*qF* = (27)(12) = 324
TCL= TCF= 10 + 3qL* = 10 + 3qF* = 10 + 3(12) = 46
ProfitsL= ProfitsF = 324 46 = 278
q1 15 1 q2
2
q1 q2 10
q2 15 1 q1
2
Cournot Model
If the two firms collude, then the total profit-maximizing
quantity can be obtained as follows:
Total revenue for the two firms: R = PQ = (30 Q)Q =
30Q Q2, then MR = R/Q = 30 2Q
Setting MR = 0 (the firms marginal cost) we find that
total profit is maximized at Q = 15.
Then, q1 + q2 = 15 is the collusion curve.
If the firms agree to share profits equally, each will
produce half of the total output:
q1 = q2 = 7.5
Cournot Model
Duopoly Example
Stackelberg Model
Cournot: The two firms make their output decisions
simultaneously
Stackelberg Model
Cournot: The two firms make their output decisions
simultaneously
Stackelberg: One of the firms can set its output first
Stackelberg Model
Two firms: A leader and a follower
Leader produces quantity qL
Follower produces quantity qF
What would be the outcome if one of the firms
(firm L, the leader) sets its output first?
Stackelberg Model
Firm L sets its output first
Stackelberg Model
Firm L sets its output first
Firm F then sets its output based on firm Ls output
Stackelberg Model
Firm L sets its output first
Firm F then sets its output based on firm Ls output
Firm L takes firm Fs reaction into consideration when
it sets its output first
Stackelberg Model
Firm L sets its output first
Firm F then sets its output based on firm Ls output
Firm L takes firm Fs reaction into consideration when
it sets its output first
Since firm F sets output after firm L, it treats firm Ls
output as fixedjust like in the Cournot model
Stackelberg Outcome
Firm L: TRL = PqL= (75 2Q)qL
= 75qL 2(qL + qF)qL
= 75qL 2qL2 2qLqF
Firm Fs Reaction Function: qF* = 18 qL
TRL = 75qL 2qL2 2qL(18 qL)
= 75qL 2qL2 36qL + qL2
= 75qL 36qL qL2
= 39qL qL2
MRL = 39 2qL = MC = 3
2qL*= 36
qL*= 18
Stackelberg Outcome
Firm Fs Reaction Function: qF* = 18 qL
qF*= 18 qL*
qL*= 18
qF*= 18 (18)
qF*= 9
Stackelberg Outcome
qL* = 18
qF* = 9
Q* = qL* + qF* = 27
P* = 75 2Q*
= 75 2(27)
P* = 21
TRL= P*qL*= (21)(18) = 378
TCL= 10 + (3)(18) = 64
Stackelberg Outcome
qL* = 12
qL* = 18
qF* = 12
qF* = 9
Q* = qL* + qF* = 24
Q* = qL* + qF* = 27
P* = 27
P* = 21
ProfitsL= 278
ProfitsL= 314
ProfitsF= 278
ProfitsF= 152
qF* = 18 qL
Substitute for qF
in leaders TR function
Set MRL = MC
Firm L: TRL = PqL= (75 2Q)qL
= 75qL 2(qL + qF)qL
= 75qL 2qL2 2qLqF
Firm Fs Reaction Function: qF* = 18 qL
TRL = 75qL 2qL2 2qL(18 qL)
= 75qL 2qL2 36qL + qL2
= 75qL 36qL qL2
= 39qL qL2
MRL = 39 2qL = MC = 3
Substitute qL*
into Expression for qF*
Firm Fs Reaction Function: qF* = 18 qL
qF*= 18 qL*
qL*= 18
qF*= 18 (18)
qF*= 9
Find Q*
qL* = 18
qF* = 9
Q* = qL* + qF* = 27
Find P*
qL* = 18
qF* = 9
Q* = qL* + qF* = 27
P* = 75 2Q*
= 75 2(27)
P* = 21
Bertrand Model
Competition based on setting prices
not quantities (like Cournot)
Two variants:
Homogeneous goods
Differentiated goods
Bertrand Model
with Homogeneous Products
Market demand curve: P = 30 Q
Q = q 1 + q2
MC1 = MC2 = 3
Good is homogeneous Buyers only care
about price
Outcome: Both firms will charge $3
Total output will be Q = 27 q1 = q2 = 13.5
1 = 2 = 0
Bertrand Model
with Differentiated Products
Firm 1s Demand: Q1 = 12 2P1 + P2
Firm 2s Demand: Q2 = 12 2P2 + P1
TFC = $20
TVC = 0
Bertrand Model
with Differentiated Products
Firm 1s reaction curve: P1 = 3 + P2
Firm 2s reaction curve: P2 = 3 + P1
To find the Nash Equilibrium:
P1 = 3 + P2
= 3 + (3 + P1)
3 3 4 116 P1
1516 P1 15 4
P1 4
Firm 2s
reaction curve
Firm 1s
reaction curve
$4
Nash
Equilibrium
$4
P2
Components of a Game
Players
Example: Coke and Pepsi
Components of a Game
Players
Example: Coke and Pepsi
Small
Large
Large
Components of a Game
Players
Example: Coke and Pepsi
Payoffs
Cokes
Spending on
Advertising
Small
Large
Small
C = +8
Large
Cokes
Spending on
Advertising
Small
Large
Small
C = +8
P = +8
Large
Cokes
Spending on
Advertising
Small
Large
Small
C = +8
P = +8
Large
C = 2
Cokes
Spending on
Advertising
Small
Large
Small
C = +8
P = +8
Large
C = 2
P = +13
Cokes
Spending on
Advertising
Small
Small
C = +8
P = +8
Large
C = 2
P = +13
Large
C = +13
P = 2
C = +3
P = +3
Cokes
Spending on
Advertising
Small
Small
C = +8
P = +8
Large
C = 2
P = +13
Large
C = +13
P = 2
C = +3
P = +3
Cokes
Spending on
Advertising
Small
Small
C = +8
P = +8
Large
C = 2
P = +13
Large
C = +13
P = 2
C = +3
P = +3
Cokes
Spending on
Advertising
Small
Small
C = +8
P = +8
Large
C = 2
P = +13
Large
C = +13
P = 2
C = +3
P = +3
Cokes
Spending on
Advertising
Small
Small
C = +8
P = +8
Large
C = 2
P = +13
Large
C = +13
P = 2
C = +3
P = +3
Nash Equilibrium
Pepsis Spending
On Advertising
Cokes
Spending on
Advertising
Small
Small
C = +8
P = +8
Large
C = 2
P = +13
Large
C = +13
P = 2
C = +3
P = +3
Cokes
Spending on
Advertising
Small
Small
C = +8
P = +8
Large
C = 2
P = +13
Large
C = +13
P = 2
C = +3
P = +3
Cokes
Spending on
Advertising
Small
Small
C = +8
P = +8
Large
C = 2
P = +13
Large
C = +13
P = 2
C = +3
P = +3
Cokes
Spending on
Advertising
Small
Small
C = +8
P = +8
Large
C = 2
P = +13
Large
C = +13
P = 2
C = +3
P = +3
Cokes
Spending on
Advertising
Small
Small
C = +8
P = +8
Large
C = 2
P = +13
Large
C = +13
P = 2
C = +3
P = +3
Repeated Games
repeated game Game in which actions are taken and payoffs
received over and over again.
PRICING PROBLEM
Firm 2
Firm 1
Low price
High price
Low price
10, 10
100, 50
High price
50, 100
50, 50
Suppose this game is repeated over and over againfor example, you and
your competitor simultaneously announce your prices on the first day of every
month. Should you then play the game differently? 13.8
TIT-FOR-TAT STRATEGY
In the pricing problem above, the repeated game strategy that works best is the
tit-for-tat strategy.
tit-for-tat strategy Repeated-game strategy in which a player responds in
kind to an opponents previous play, cooperating with cooperative opponents
and retaliating against uncooperative ones.
Welfare Economics
What Does
Consumer Surplus Measure?
Consumer surplus, the amount that buyers are
willing to pay for a good minus the amount they
actually pay for it, measures the benefit that
buyers receive from a good as the buyers
themselves perceive it.
Consumer Surplus
Consumer Surplus
= Value to buyers Amount paid by buyers
Consumer
surplus
P1
Demand
Q1
Quantity
Initial
consumer
surplus
P1
P2
C
B
Consumer surplus
to new consumers
F
D
E
Additional consumer
surplus to initial
consumers
Q1
Demand
Q2
Quantity
Producer Surplus
Consumer Surplus
= Value to buyers Amount paid by buyers
Producer Surplus
= Amount received by sellers Cost to sellers
P1
B
Producer
surplus
A
0
Q1
Quantity
Additional producer
surplus to initial
producers
P2
P1
E
F
B
Initial
producer
surplus
Producer surplus
to new producers
A
0
Q1
Q2
Quantity
Social Surplus
Social surplus
= Consumer surplus + Producer surplus
Supply
Consumer
surplus
Equilibrium
price
E
Producer
surplus
Demand
C
0
Equilibrium
quantity
Quantity
Supply
Consumer
surplus
Social
Equilibrium
price
E
Producer
Surplus
surplus
Demand
C
0
Equilibrium
quantity
Quantity
Efficiency
Efficiency is the property of a resource
allocation of maximizing the total surplus
received by all members of society.
V(1)
V(2)
V(3)
C(Q*+1)
V(Q*) =C(Q*)
V(Q*+1)
C(3)
C(2)
C(1)
Q* Q*+1
Pareto Efficiency
(or Pareto Optimality)
A situation in which nobody can be made better
off without making somebody else worse off
P*
PC
Shortage
D
0
QS
Q*
QD
A
P*
CS
B
D
PS
SS
PC
E
D
0
QS
Q*
QD
After Price
Ceiling
Change
A
P*
CS
B
D
A+B
PS
SS
PC
E
D
0
QS
Q*
QD
After Price
Ceiling
Change
A
P*
B
D
CS
A+B
PS
C+D+E
SS
PC
E
D
0
QS
Q*
QD
After Price
Ceiling
Change
A
P*
B
D
PC
CS
A+B
PS
C+D+E
SS
A+B+C
+D+E
E
D
0
QS
Q*
QD
After Price
Ceiling
Change
A
P*
B
D
PC
Before Price
Ceiling
After Price
Ceiling
CS
A+B
A+C
PS
C+D+E
SS
A+B+C
+D+E
E
D
0
QS
Q*
QD
Change
A
P*
B
D
PC
Before Price
Ceiling
After Price
Ceiling
CS
A+B
A+C
PS
C+D+E
SS
A+B+C
+D+E
E
D
0
QS
Q*
QD
Change
A
P*
B
D
PC
Before Price
Ceiling
After Price
Ceiling
CS
A+B
A+C
PS
C+D+E
SS
A+B+C
+D+E
A+C+E
E
D
0
QS
Q*
QD
Change
A
P*
B
D
PC
Before Price
Ceiling
After Price
Ceiling
Change
CS
A+B
A+C
+CB
PS
C+D+E
SS
A+B+C
+D+E
A+C+E
E
D
0
QS
Q*
QD
A
P*
B
D
PC
Before Price
Ceiling
After Price
Ceiling
Change
CS
A+B
A+C
+CB
PS
C+D+E
CD
SS
A+B+C
+D+E
A+C+E
E
D
0
QS
Q*
QD
A
P*
B
D
PC
Before Price
Ceiling
After Price
Ceiling
Change
CS
A+B
A+C
+CB
PS
C+D+E
CD
SS
A+B+C
+D+E
A+C+E
BD
E
D
0
QS
Q*
QD
A
P*
B
D
PC
Before Price
Ceiling
After Price
Ceiling
Change
CS
A+B
A+C
+CB
PS
C+D+E
CD
SS
A+B+C
+D+E
A+C+E
BD
E
D
0
QS
Q*
QD
SS = B D
A
P*
B
D
PC
Before Price
Ceiling
After Price
Ceiling
Change
CS
A+B
A+C
+CB
PS
C+D+E
CD
SS
A+B+C
+D+E
A+C+E
BD
E
D
0
QS
Q*
QD
SS = B D
DWL = SS = (BD)
Q =B+D
QD = 200
QS = 120
$1000
$950
Shortage = 80
$800=
$700
$600 PC
=
P*
Shortage
D
0
100
QS
QD
PF
P*
D
0
QD
Q*
QS
Surplus
A
B
P*
G
H
F
F
D
QD
Q*
QS
Surplus
A
B
Before
Price
Floor
CS
PS
P*
After Price
Floor
SS
H
F
F
D
QD
Q*
QS
Change
Surplus
A
B
Before
Price
Floor
CS A+B+C
PS
P*
After Price
Floor
SS
H
F
F
D
QD
Q*
QS
Change
Surplus
A
B
Before
Price
Floor
CS A+B+C
PS
P*
After Price
Floor
G+H
SS
G
H
F
F
D
QD
Q*
QS
Change
Surplus
A
B
Before
Price
Floor
CS A+B+C
PS
P*
G+H
SS A+B+C
+G+H
H
F
F
D
QD
After Price
Floor
Q*
QS
Change
Surplus
A
B
Before
Price
Floor
CS A+B+C
PS
P*
G+H
+G+H
H
F
F
D
QD
SS A+B+C
After Price
Floor
Q*
QS
Change
Surplus
A
B
Before
Price
Floor
CS A+B+C
PS
P*
G+H
B+H
+G+H
H
F
F
D
QD
SS A+B+C
After Price
Floor
Q*
QS
Change
Surplus
A
B
Before
Price
Floor
CS A+B+C
PS
P*
G+H
SS A+B+C
G
F
B+H
A+B+H
F
D
QD
+G+H
After Price
Floor
Q*
QS
Change
Surplus
A
B
Before
Price
Floor
CS A+B+C
PS
P*
G+H
SS A+B+C
G
F
BC
B+H
A+B+H
F
D
QD
Change
+G+H
After Price
Floor
Q*
QS
Surplus
A
B
Before
Price
Floor
CS A+B+C
PS
P*
G+H
SS A+B+C
G
F
BC
B+H
+BG
A+B+H
F
D
QD
Change
+G+H
After Price
Floor
Q*
QS
Surplus
A
B
Before
Price
Floor
CS A+B+C
PS
P*
G+H
SS A+B+C
G
F
BC
B+H
+BG
A+B+H
CG
F
D
QD
Change
+G+H
After Price
Floor
Q*
QS
Surplus
A
B
Before
Price
Floor
CS A+B+C
PS
P*
G+H
SS A+B+C
G
F
BC
B+H
+BG
A+B+H
CG
F
D
QD
Change
+G+H
After Price
Floor
Q*
QS
Surplus
A
B
P*
G
H
F
F
D
QD
Q*
QS
Surplus
A
B
Before
Price
Floor
CS
PS
P*
Gov
H
F
SS
D
0
QD
After Price
Floor
Q*
QS
Change
Surplus
A
B
Before
Price
Floor
CS A+B+C
PS
P*
Gov
H
F
SS
D
0
QD
After Price
Floor
Q*
QS
Change
Surplus
A
B
Before
Price
Floor
CS A+B+C
PS
P*
G+H
Gov
G
H
SS
F
D
After Price
Floor
QD
Q*
QS
Change
Surplus
A
B
Before
Price
Floor
CS A+B+C
PS
P*
Gov
G
H
G+H
---
SS
F
D
After Price
Floor
QD
Q*
QS
Change
Surplus
A
B
Before
Price
Floor
CS A+B+C
PS
P*
Gov
G
H
G+H
---
SS A+B+C
+G+H
D
0
After Price
Floor
QD
Q*
QS
Change
Surplus
A
B
Before
Price
Floor
CS A+B+C
PS
P*
Gov
G
H
G+H
---
SS A+B+C
+G+H
D
0
After Price
Floor
QD
Q*
QS
Change
Surplus
A
B
Before
Price
Floor
CS A+B+C
PS
P*
Gov
H
F
G+H
QD
B+C+D+G
+H
SS A+B+C
F
Q*
---
+G+H
After Price
Floor
QS
Change
Surplus
A
B
Before
Price
Floor
CS A+B+C
PS
P*
Gov
H
F
QD
B+C+D+G
+H
---
C D E
F G
SS A+B+C
F
Q*
G+H
+G+H
After Price
Floor
QS
Change
Surplus
A
B
Before
Price
Floor
CS A+B+C
PS
P*
Gov
H
F
B+C+D+G
+H
---
C D E
F G
+G+H
QD
Q*
QS
G+H
SS A+B+C
After Price
Floor
A+B+H
E F
Change
Surplus
A
B
Before
Price
Floor
CS A+B+C
PS
P*
Gov
H
F
QD
Q*
B C
---
C D E
F G
+G+H
QS
A
B+C+D+G
+H
Change
G+H
SS A+B+C
After Price
Floor
A+B+H
E F
Surplus
A
B
Before
Price
Floor
PS
Gov
H
F
Change
B C
G+H
B+C+D+G
+H
+B+C+D
---
C D E
F G
CS A+B+C
P*
After Price
Floor
SS A+B+C
+G+H
QD
Q*
QS
A+B+H
E F
Surplus
A
B
Before
Price
Floor
PS
Gov
H
F
Change
B C
G+H
B+C+D+G
+H
+B+C+D
---
C D E
F G
C D E
F G
CS A+B+C
P*
After Price
Floor
SS A+B+C
+G+H
QD
Q*
QS
A+B+H
E F
Surplus
A
B
Before
Price
Floor
PS
Gov
H
F
Change
B C
G+H
B+C+D+G
+H
+B+C+D
---
C D E
F G
C D E
F G
A+B+H
E F
C E
F G
CS A+B+C
P*
After Price
Floor
SS A+B+C
+G+H
QD
Q*
QS
Surplus
A
B
Before
Price
Floor
PS
Gov
H
F
After Price
Floor
Change
B C
G+H
B+C+D+G
+H
+B+C+D
---
C D E
F G
C D E
F G
A+B+H
E F
C E
F G
CS A+B+C
P*
DWL = C+E+F+G
SS A+B+C
+G+H
QD
Q*
QS
PMon
PPC
MR
MR
QMon QPC
A
PMon
PPC
B
D
C
E
MR
MR
QMon QPC
PMon
PPC
CS
PS
C
E
MR
MR
QMon QPC
Monopoly
SS
Change
PMon
PPC
CS
PS
C
E
MR
MR
QMon QPC
Monopoly
A+B+C
SS
Change
PMon
PPC
CS
A+B+C
PS
D+E
C
E
MR
MR
QMon QPC
Monopoly
SS
Change
PMon
PPC
CS
A+B+C
PS
D+E
SS
A+B+C
+D+E
C
E
MR
MR
QMon QPC
Monopoly
Change
PMon
PPC
Perfect
Competition
Monopoly
CS
A+B+C
PS
D+E
SS
A+B+C
+D+E
C
E
MR
MR
QMon QPC
Change
PMon
PPC
Perfect
Competition
Monopoly
CS
A+B+C
PS
D+E
B+D
SS
A+B+C
+D+E
C
E
MR
MR
QMon QPC
Change
PMon
PPC
Perfect
Competition
Monopoly
CS
A+B+C
PS
D+E
B+D
SS
A+B+C
+D+E
A+B+D
C
E
MR
MR
QMon QPC
Change
PMon
PPC
Perfect
Competition
Monopoly
Change
B C
CS
A+B+C
PS
D+E
B+D
SS
A+B+C
+D+E
A+B+D
C
E
MR
MR
QMon QPC
PMon
PPC
Perfect
Competition
Monopoly
Change
CS
A+B+C
B C
PS
D+E
B+D
+B E
SS
A+B+C
+D+E
A+B+D
C
E
MR
MR
QMon QPC
PMon
PPC
Perfect
Competition
Monopoly
Change
CS
A+B+C
B C
PS
D+E
B+D
+B E
SS
A+B+C
+D+E
A+B+D
C E
C
E
MR
MR
QMon QPC
PMon
PPC
DWL = C + E
MC
Perfect
Competition
Monopoly
Change
CS
A+B+C
B C
PS
D+E
B+D
+B E
SS
A+B+C
+D+E
A+B+D
C E
C
E
MR
MR
QMon QPC
PMon
PPC
DWL = C + E
MC
Perfect
Competition
Monopoly
Change
CS
A+B+C
B C
PS
D+E
B+D
+B E
SS
A+B+C
+D+E
A+B+D
C E
C
E
MR
MR
QMon QPC
Price
10,000
$1.00
12,500
$1.50
15,000
$2.00
17,500
$2.50
20,000
$3.00
22,500
$3.50
25,000
$4.00
Price
10,000
$1.00
$2.00
12,500
$1.50
15,000
$2.00
17,500
$2.50
20,000
$3.00
22,500
$3.50
25,000
$4.00
Price
10,000
$1.00
$2.00
12,500
$1.50
$2.50
15,000
$2.00
17,500
$2.50
20,000
$3.00
22,500
$3.50
25,000
$4.00
Price
10,000
$1.00
$2.00
12,500
$1.50
$2.50
15,000
$2.00
$3.00
17,500
$2.50
20,000
$3.00
22,500
$3.50
25,000
$4.00
Price
10,000
$1.00
$2.00
12,500
$1.50
$2.50
15,000
$2.00
$3.00
17,500
$2.50
$3.50
20,000
$3.00
22,500
$3.50
25,000
$4.00
Price
10,000
$1.00
$2.00
12,500
$1.50
$2.50
15,000
$2.00
$3.00
17,500
$2.50
$3.50
20,000
$3.00
$4.00
22,500
$3.50
25,000
$4.00
Price
10,000
$1.00
$2.00
12,500
$1.50
$2.50
15,000
$2.00
$3.00
17,500
$2.50
$3.50
20,000
$3.00
$4.00
22,500
$3.50
$4.50
25,000
$4.00
Price
10,000
$1.00
$2.00
12,500
$1.50
$2.50
15,000
$2.00
$3.00
17,500
$2.50
$3.50
20,000
$3.00
$4.00
22,500
$3.50
$4.50
25,000
$4.00
$5.00
Tax on Producers
P
S + Tax
$4.00
S
Tax
$3.00
20,000
Tax on Producers
P
S + Tax
$3.00
S
$1=Tax
PC
$1=Tax
$2.00
PP
D
QTax 15,000
Price
20,000
$1.00
17,500
$1.50
15,000
$2.00
12,500
$2.50
10,000
$3.00
7,500
$3.50
5,000
$4.00
Max willing to
pay with $1 tax
Price
Max willing to
pay with $1 tax
20,000
$1.00
$0
17,500
$1.50
15,000
$2.00
12,500
$2.50
10,000
$3.00
7,500
$3.50
5,000
$4.00
Price
Max willing to
pay with $1 tax
20,000
$1.00
$0
17,500
$1.50
$.50
15,000
$2.00
12,500
$2.50
10,000
$3.00
7,500
$3.50
5,000
$4.00
Price
Max willing to
pay with $1 tax
20,000
$1.00
$0
17,500
$1.50
$.50
15,000
$2.00
$1.00
12,500
$2.50
10,000
$3.00
7,500
$3.50
5,000
$4.00
Price
Max willing to
pay with $1 tax
20,000
$1.00
$0
17,500
$1.50
$.50
15,000
$2.00
$1.00
12,500
$2.50
$1.50
10,000
$3.00
7,500
$3.50
5,000
$4.00
Price
Max willing to
pay with $1 tax
20,000
$1.00
$0
17,500
$1.50
$.50
15,000
$2.00
$1.00
12,500
$2.50
$1.50
10,000
$3.00
$2.00
7,500
$3.50
5,000
$4.00
Price
Max willing to
pay with $1 tax
20,000
$1.00
$0
17,500
$1.50
$.50
15,000
$2.00
$1.00
12,500
$2.50
$1.50
10,000
$3.00
$2.00
7,500
$3.50
$2.50
5,000
$4.00
Price
Max willing to
pay with $1 tax
20,000
$1.00
$0
17,500
$1.50
$.50
15,000
$2.00
$1.00
12,500
$2.50
$1.50
10,000
$3.00
$2.00
7,500
$3.50
$2.50
5,000
$4.00
$3.00
Tax on Consumers
P
$3.00
$1=Tax
$2.00
D
D with Tax
10,000
Tax on Consumers
P
S
PC
Tax
$2.00
E
Tax
PP
D
$1.00
D with Tax
0
QTax
15,000
Tax Incidence
P
S with Tax
S
PC
Tax
P*
PP
D
D with Tax
0
QTax
Q*
S with Tax
S
PC
Tax
P*
Burden on consumers = PC P*
Tax
Burden on producers = P* PP
Wedge
Tax
PP
D
D with Tax
0
QTax
Q*
Tax
Burden on consumers
P*
Burden on producers
Tax Wedge
PC
Burden on consumers = PC P*
is greater than
Burden on producers = P* PP
PP
D
QTax Q*
S + Tax
S
PC
Tax
Burden on consumers = PC P*
= Tax
Burden on consumers
Burden on producers = P* PP = 0
PP= P*
D
0
QTax= Q*
Tax
PC
PP=
Burden on consumers = PC P*
Burden on consumers
= Tax
P*
Burden on producers = P* PP = 0
D
0
QTax
Q*
Burden on consumers = PC P*
Burden on consumers
Tax
P*
Burden on producers
Tax Wedge
PC
PP
is less than
Burden on producers = P* PP
QTax Q*
PC= P*
Tax
PP
D with Tax
0
QTax= Q*
PC= P*
Burden on consumers = PC P* = 0
Tax
PP
QTax
Q*
S with Tax
S
PC
Tax
P*
PP
D
D with Tax
0
QTax
Q*
PC
Before
Tax
P*
CS
After Tax
PS
Gov
SS
PP
F
0
D
QTax
Q*
Change
PC
Before
Tax
P*
CS A+B+C
After Tax
PS
Gov
SS
PP
F
0
D
QTax
Q*
Change
PC
Before
Tax
P*
CS A+B+C
After Tax
PS D+E+F
Gov
SS
PP
F
0
D
QTax
Q*
Change
PC
Before
Tax
P*
CS A+B+C
After Tax
PS D+E+F
Gov
---
SS
PP
F
0
D
QTax
Q*
Change
A
PC
Before
Tax
P*
CS A+B+C
After Tax
PS D+E+F
Gov
---
SS A+B+C
+D+E+F
PP
F
0
D
QTax
Q*
Change
A
PC
Before
Tax
P*
CS A+B+C
PS D+E+F
Gov
After Tax
---
SS A+B+C
+D+E+F
PP
F
0
D
QTax
Q*
Change
A
PC
Before
Tax
P*
CS A+B+C
PS D+E+F
Gov
After Tax
---
SS A+B+C
+D+E+F
PP
F
0
D
QTax
Q*
Change
A
PC
Before
Tax
P*
CS A+B+C
PS D+E+F
Gov
After Tax
---
B+D
SS A+B+C
+D+E+F
PP
F
0
D
QTax
Q*
Change
A
PC
Before
Tax
P*
CS A+B+C
PS D+E+F
Gov
---
B+D
SS A+B+C
A+B+D+F
+D+E+F
PP
F
0
After Tax
D
QTax
Q*
Change
A
PC
Before
Tax
P*
After Tax
Change
CS A+B+C
B C
PS D+E+F
Gov
---
B+D
SS A+B+C
+D+E+F
PP
F
0
A+B+D+F
D
QTax
Q*
A
PC
Before
Tax
P*
After Tax
Change
CS A+B+C
B C
PS D+E+F
D E
Gov
---
B+D
SS A+B+C
+D+E+F
PP
F
0
A+B+D+F
D
QTax
Q*
A
PC
Before
Tax
P*
After Tax
Change
CS A+B+C
B C
PS D+E+F
D E
B+D
+B+D
Gov
---
SS A+B+C
+D+E+F
PP
F
0
A+B+D+F
D
QTax
Q*
A
PC
Before
Tax
P*
After Tax
Change
CS A+B+C
B C
PS D+E+F
D E
B+D
+B+D
A+B+D+F
C E
Gov
---
SS A+B+C
+D+E+F
PP
F
0
D
QTax
Q*
DWL = C + E
A
PC
Before
Tax
P*
After Tax
Change
CS A+B+C
B C
PS D+E+F
D E
B+D
+B+D
A+B+D+F
C E
Gov
---
SS A+B+C
+D+E+F
PP
F
0
D
QTax
Q*
Moral Hazard
Principal-Agent Problem
Auto Depreciation
Moral hazard
Moral hazard
Occurs after a market transaction
Moral hazard
Occurs after a market transaction
Principal-agent problem
A variant of moral hazard
Auto Depreciation
Min price
wanted by
sellers
Min price
wanted by
sellers
Min price
wanted by
sellers
$17,000
Min price
wanted by
sellers
$17,000
Min price
wanted by
sellers
Peaches $20,000
$17,000
Lemons $10,000
$ 8,000
Min price
wanted by
sellers
Peaches $20,000
$17,000
Prob (Peach) = 50%
Lemons $10,000
$ 8,000
Min price
wanted by
sellers
Peaches $20,000
$17,000
Prob (Peach) = 50%
Lemons $10,000
$ 8,000
Prob (Lemon) = 50%
Branding
Guarantees and warranties
Education
Signals on the job
Branding
Guarantees and warranties
Education
Signals on the job
Reputation
Branding
Guarantees and warranties
Education
Signals on the job
Reputation
Gifts
Principal-agent problem
Principal-agent problem
A variant of moral hazard
Principal-agent problem
Principal-agent problem
A variant of moral hazard
Two conditions necessary for a principal-agent
problem
Principal-agent problem
Principal-agent problem
A variant of moral hazard
Two conditions necessary for a principal-agent
problem
(1) Asymmetric informationit must be difficult
or costly for the principal to monitor the
actions of the agent
Principal-agent problem
Principal-agent problem
A variant of moral hazard
Two conditions necessary for a principal-agent
problem
(1) Asymmetric informationit must be difficult
or costly for the principal to monitor the
actions of the agent
(2) Divergent interestsprincipal and agent must
have different interests or goals
Principal-agent problem
Principal-agent problem
A variant of moral hazard
Two conditions necessary for a principal-agent
problem
(1) Asymmetric informationit must be difficult
or costly for the principal to monitor the
actions of the agent
(2) Divergent interestsprincipal and agent must
have different interests or goals
Examples and Remedies