Econ101_W2010_Exam3_ReviewSlides (2).pdf

Economics?101? Microeconomics? University?of?Michigan? Winter?2010? Nico?Ravanilla? Midterm?3? Review?Session? April?24,?2010? April?27,?2010? 2 Lecture 1 1.? Overview?of?Key?Concepts? ?? Public?Goods? ?? Factor?Markets? ?? ProducAon?Costs? ?? Monopoly? 2.? QuesAons? Plan?for?Review?Session? Public?Goods? Public?goods?are?goods?that?are? ?? Non?rival?(not?scarce;?does?not?get?depleted)? ?? Non?excludable?(very?costly?to?prevent?other?people ?from?enjoying?the?public?good)?? Examples:? ?? NaAonal?defense,?lighthouse,?air?quality? ?? Counterexamples:?haircut,?websites,?highway? ?? Why??(private,?club?good,?common?property)? 3 Lecture 1 Public?Goods? [1]?The?e?cient?quanAty?of?public?good?provided?is ?where?supply?(MC)?=?MV society ? ?? MV society? is?just?the?sum?of?all?individual?MV ?? [2]?The?market?will?typically?under?provide?the ?public?good?? [3]?Individuals?only?care?about?their?private?MV? ?? They?do?not?consider?the??posiAve?externality? ?imposed?on?other?individuals? 4 Lecture 1 5 Lecture 1 Q MV, MC MV1 MV2 MV3 Supply (MC) MV SOC Public?Goods? 6 Lecture 1 ?? Only?three?individuals?with?MV?shown?in ?diagram? ?? Good?is?non?rival?and?non?excludable? ?? Supply?(MC)?is?perfectly?elasAc?as?drawn? ?? QuesAons:? ?? What?is?the?socially?e?cient?quanAty?of ?public?good?? ?? How?much?should?each?individual ?contribute?to?provide?the?e?cient ?quanAty?? ?? But?how?much?of?the?good?will?each ?individual?be?willing?to?purchase?? ?? If?market?is?le_?to?its?own?device,?how ?much?public?good?will?actually?be ?provided?? ?? How?much?will?each?individual?end?up ?consuming??? Answers:? E?cient:?Q e?? Each?individual?should?contribute?according?to ?private?MV?at?Q*?(P1,P2,P3)? Consumer?1?and?2?will?not?purchase?anything. ?Consumer?3?will?pruchase?Q*? Market?outcome:?Q*? Each?individual?will?consume?Q*?? Public?Goods? [4]?Problem?of?under?provision?is?made?worse?by??free ?riding??and?underreporAng?of?true?valuaAon? ?? People?cannot?be?prevented?from?consuming?the?good ?and?will?choose?to??free?ride??rather?than?make ?contribuAons? ?? People?have?incenAve?to?lie?about?their?true?valuaAon?of ?the?public?good?to?avoid?having?to?pay?for?it? 7 Lecture 1 Public?Goods? [5]?When?the?good?is??rival??(case?of?common ?property/resources)?problem?becomes?even ?worse!? ?? People?will?over?consume?the?good?and?will?result?in ?the??tragedy?of?the?commons??story? ?? Example:??shing?lakes;?everybody?will?over?sh;?not ?sustainable?since?even?small??sh?will?be?caught;??sh ?resource?will?get?depleted? [6]?Network?externality?has?the?opposite?problem ?(people?will?under?consume)? 8 Lecture 1 Factor?Markets? Goal:?answer?quesAon???how?do??rms?decide?which ?inputs?to?use?and?how?much?? ?? AssumpAon:??rm?is?price?taker?in?both?the?input?and ?output?markets?(takes?output?price?and?input?price ?as?given? [1]?We?already?know?that??rm?will?maximize?pro?ts ?where?P=MC? ?? If?P>MC????rm?should?produce?more?output? ?? If?P?W???hire?more?laborers/workers? ?? If?MRPL?R/MPK???hire?less?labor,?more?capital? ?? If?W/MPL?(W/R) 2 ???factory?1?is?capital?intensive;?factory?2 ?is?labor?intensive? ?? If?(W/R) 1 ??MC?when?AVC?is?falling? ?? AVC?=AVC? [5]?In?the?long?run,??rm?will?stay?in?the?market?for?as?long?as ?P>=ATC? QuesAon:?Where?do?these?condiAons?come?from?? Answer:?Pro?t?maximizaAon.? Firm?pro?t?=?Revenue???Cost?=?P?Q???TC? 17 Lecture 1 Short?run? Long?run? Pro?t?if?stay?in?market? PQ???VC???FC? PQ???TC? Pro?t?if?decide?to?exit? ??FC? 0? Firm?will?stay?only?if:? P?>?VC/Q? P?>??TC/Q? ProducIon?Costs? 18 Lecture 1 P, costs ($) MC ATC AVC CASE 1: Price is as drawn below Q* FC VC Profit Revenue (PxQ) ProducIon?Costs? 19 Lecture 1 P, costs ($) MC ATC AVC CASE 2: Price is as drawn below Q* FC VC Revenue - Profit (Loss) ProducIon?Costs? 20 Lecture 1 P, costs ($) MC ATC AVC CASE 3: Price is as drawn below Q* FC VC Revenue Short-run loss ProducIon?Costs? [6]?In?the?long?run,?since??rms?can?enter?and ?exit?the?market?easily?(all?costs?are ?variable),?compeAAon?will?drive?pro?ts ?down?to?zero.??That?is,?in?the?long?run, ?P=ATC.? [7]?In?the?long?run,??rm?behavior?will?vary?as ?a?result?of?supply?shocks?? [8]?Changes?in?quanAty?available?in?the ?market?is?due?to??rm?entry?and?exit;?not ??rm?producing?di?erent?quanAAes? 21 Lecture 1 ProducIon?Costs? How?does?the?compeAAve?market?respond?to ?supply?shocks?? 22 Lecture 1 Technological? innova6on? Changes?in?input? prices? Environmental? changes? Example? Output?increases? by?20%?for?any? given?variable? input?used? Price?of?labor?(a? variable?factor)? increases? A?tornado?that? destroyed?the? factory?shop?(a? ?xed?input)? E?ect?on?costs? MC,?AVC,?ATC?will? all?shi_?down? MC,?AVC,?ATC?will? all?shi_?up? MC,?AVC?will?not? change;?AFC?and? ATC?will?change? Short?run?e?ect? Compare?new?AVC? with?the?price? Compare?new?AVC? with?the?price? Nothing?happens? in?short?run? Long?run?e?ect? Compare?new?ATC? with?the?price? Compare?new?ATC? with?the?price? Compare?new?ATC? with?the?price? ProducIon?Costs? 23 Lecture 1 P, costs ($) MC ATC AVC An example: Labor costs increased Monopoly? When??rm?is?a?price?taker,?pro?t?maximizing ?condiAon?is:?P=MC? QuesAon:?What?happens?now?if?the??rm?is?NOT?a ?price?taker,?but?actually?a?price?maker?? ?? Firms?output?decision?can?alter?market?prices? ?? Could?happen?because?of?barriers?to?entry:?only?one ??rm?can?exist?in?the?market,?hence?that??rm?can?set ?the?price?the??rm?is?a?monopolist? ?? E.g.?DeBeers?family?of?companies?has?a?monopoly?on ?diamonds?in?the?world.?? 24 Lecture 1 Monopoly? Because?a?monopolist?is ?the?only?seller?in?the ?market,?it?faces?the ?market?demand?curve? ?? Increasing?quanAty?sold ?will?drive?down?the ?price? ?? There?s?a?trade?o? ?between?being?able?to ?sell?more?quanAAes ?and?being?able?to?set?a ?high?price?at?which?to ?sell?these?quanAAes.? 25 Lecture 1 Q P Q Q+1 Demand P 0 P 1 Increase in revenue Decrease in revenue = P 1 = Q . ?P Monopoly? Monopolist?will?therefore?produce?at?the?point?where ?the?marginal?revenue?from?increasing?a?unit?of ?output?is?equal?to?the?marginal?cost?of?that?unit? [1]?The?monopolist?will?produce?quanAty?where ?MR=MC? ?? If?MCMR???monopolist?should?produce?less? 26 Lecture 1 Monopoly? [2]?Graphically,?given?a?linear?demand?curve,?MR?is ?drawn?as?follows:? 27 Lecture 1 P Q demand 20 10 Monopoly? 28 Lecture 1 P Q demand MC AC Q M P M AC profit Monopoly? [3]?RelaAve?to?the?market?outcome,?the?monopolist?quanAty ?is?ine?cient.? 29 Lecture 1 Q P Demand MC (Supply) P comp Q eff P mon Q mon Deadweight Loss MR Lost consumer surplus Gain in producer surplus/profits (transfer from consumers) Nico Ravanilla Econ101_W2010_Exam3_ReviewSlides.ppt