ECON 1B03 EXAM REVIEW
ECON 1B03
EXAM REVIEW
OPPORTUNITY COST = what you give up to get something else - the best forgone alternative EXAMPLE: To get 3 CDs, give up 1 DVD To get 1 CD, give up 1/3 DVD => Opp. Cost of a CD is 1/3 DVD COMPARATIVE ADVANTAGE = you have it if your opp. cost of producing a good is lower than someone else’s => specialization and gains from trade ABSOLUTE ADVANTAGE = your economy is more productive in all goods CHANGE IN DEMAND = shift of the demand curve due to a change in income, taste, population, prices of related goods, expectations CHANGE IN QUANTITY DEMANDED = movement along the demand curve due to a change in the price of the good CHANGE IN SUPPLY = shift of the supply curve due to a change in production costs, number of firms, expectations, prices of related goods produced CHANGE IN QUANTITY SUPPLIED = movement along the supply curve due to a change in the price of the good NORMAL GOOD = when income increases, demand increases
INFERIOR GOOD = when income increases, demand decreases ELASTICITY = measures the responsiveness of quantity of a good demanded (or supplied) to a change in: - price of the good - income - if positive, normal good - if negative, inferior good - price of a related good - if positive, goods are substitutes - if negative, goods are compliments Elastic = highly responsive, | E | > 1 Inelastic = not very responsive, | E | between 0 and 1 (fraction) If a good is inelastic, an increase in price => increase in TR If a good is elastic, an increase in price => decrease in TR
FIXED COSTS -do not vary with output VARIABLE COSTS -depend on quantity produced MARGINAL PRODUCT OF LABOUR = change in Q change in labour AP intersects MP when AP is at its maximum. Total Product Q is maximized when MP = 0.
SOME COST AND REVENUE RELATIONSHIPS: TC = TFC + TVC ATC = AFC + AVC MC = change in TC change in Q TR = PQ MR = change in TR change in Q PROFIT = TR – TC and
PROFIT = (P – ATC)Q
Any profit-maximizing firm will produce Q such that MR = MC. PERFECT COMPETITION (COMPETITION) -many firms -homogeneous goods -firms are price takers -free entry or exit -P = MR = AR = D -firms max profit where P = MC since P = MR -supply curve is MC above min AVC -SR temporary shutdown if P < minAVC -LR exit if P < minATC; entry if P > min ATC Example:
Market price is P = $70 Firm’s MC = 30 + 2Q Firm’s TC = 30Q + Q2 Set P = MC 70 = 30 + 2Q Q = 20 Firm’s profit = TR – TC = 1400 – 1000 = 400
Since profit > 0, entry => not in LR equilibrium
-LR eqm when P = min SR ATC = SR MC = min LRAC -no entry or exit of firms -society’s welfare is maximized in a competitive market -CS and PS are maximized
MONOPOLY -one firm serves entire market -sets P > MC and produces Q < competitive Q -deadweight loss due to monopoly (lost CS and PS) -profit is maximized where MR = MC -firm has no supply curve EXAMPLE: Firm’s MC = 30 + Q Firm’s TC = 30Q + Q2 Firm’s MR = 40 – Q Market demand is P = 40 - .5Q Set MR = MC 40 – Q = 30 + 2Q 10 = 2Q Q=5 P = 40 - .5(5) P = 37.5 ATC = 30 + Q = 35 Profit = (P – ATC)Q = (37.5 – 35)*5 = 12.5
For DWL, need the area of the shaded triangle: Need P, MC, Q monopoly produces, Q produced if this were a competitive market.
MC 37.5 Set MC = P to get Q=6.67 35
MR 5
D
6.67
DWL = .5 *2.5*1.67 = 2.09
MONOPOLISTIC COMPETITION -many firms -price setters -free entry or exit -differentiated products -max profit where MR = MC -LR eqm where P = ATC (no entry or exit) -in LR, produce at excess capacity (not at minATC) -heavy advertising
OLIGOPOLY -few firms, usually big -usually homogeneous products -barriers to entry -firms are price setters We can model oligopoly as -kinked demand model -prisoner’s dilemma -results in Nash Equilibrium (sub-optimal) Some try to collude (form cartel), but there is temptation to cheat. FACTOR MARKETS -firms hire labour so that W = VMPL = MP*P CONSUMER THEORY -consumers constrained by income => budget constraint -want to maximize Total Utility given Budget Constraint -will consume where highest indifference curve just tangent to BC -optimal consumption bundle where Slope of IC = Slope of BC MRS = Px/Py MUx = Px MUy Py -price change in a good leads to -Income Effect: changes purchasing power (move to different IC) -Substitution Effect: buy more of relatively cheaper good (move along original IC) -price changes => BC rotates -income changes => parallel shift of BC DON’T FORGET ABOUT: price ceilings and floors, taxes, consumer and producer surplus, finding market equilibrium and all calculations. KNOW ALL YOUR DIAGRAMS!
EXAM REVIEW
OPPORTUNITY COST = what you give up to get something else - the best forgone alternative EXAMPLE: To get 3 CDs, give up 1 DVD To get 1 CD, give up 1/3 DVD => Opp. Cost of a CD is 1/3 DVD COMPARATIVE ADVANTAGE = you have it if your opp. cost of producing a good is lower than someone else’s => specialization and gains from trade ABSOLUTE ADVANTAGE = your economy is more productive in all goods CHANGE IN DEMAND = shift of the demand curve due to a change in income, taste, population, prices of related goods, expectations CHANGE IN QUANTITY DEMANDED = movement along the demand curve due to a change in the price of the good CHANGE IN SUPPLY = shift of the supply curve due to a change in production costs, number of firms, expectations, prices of related goods produced CHANGE IN QUANTITY SUPPLIED = movement along the supply curve due to a change in the price of the good NORMAL GOOD = when income increases, demand increases
INFERIOR GOOD = when income increases, demand decreases ELASTICITY = measures the responsiveness of quantity of a good demanded (or supplied) to a change in: - price of the good - income - if positive, normal good - if negative, inferior good - price of a related good - if positive, goods are substitutes - if negative, goods are compliments Elastic = highly responsive, | E | > 1 Inelastic = not very responsive, | E | between 0 and 1 (fraction) If a good is inelastic, an increase in price => increase in TR If a good is elastic, an increase in price => decrease in TR
FIXED COSTS -do not vary with output VARIABLE COSTS -depend on quantity produced MARGINAL PRODUCT OF LABOUR = change in Q change in labour AP intersects MP when AP is at its maximum. Total Product Q is maximized when MP = 0.
SOME COST AND REVENUE RELATIONSHIPS: TC = TFC + TVC ATC = AFC + AVC MC = change in TC change in Q TR = PQ MR = change in TR change in Q PROFIT = TR – TC and
PROFIT = (P – ATC)Q
Any profit-maximizing firm will produce Q such that MR = MC. PERFECT COMPETITION (COMPETITION) -many firms -homogeneous goods -firms are price takers -free entry or exit -P = MR = AR = D -firms max profit where P = MC since P = MR -supply curve is MC above min AVC -SR temporary shutdown if P < minAVC -LR exit if P < minATC; entry if P > min ATC Example:
Market price is P = $70 Firm’s MC = 30 + 2Q Firm’s TC = 30Q + Q2 Set P = MC 70 = 30 + 2Q Q = 20 Firm’s profit = TR – TC = 1400 – 1000 = 400
Since profit > 0, entry => not in LR equilibrium
-LR eqm when P = min SR ATC = SR MC = min LRAC -no entry or exit of firms -society’s welfare is maximized in a competitive market -CS and PS are maximized
MONOPOLY -one firm serves entire market -sets P > MC and produces Q < competitive Q -deadweight loss due to monopoly (lost CS and PS) -profit is maximized where MR = MC -firm has no supply curve EXAMPLE: Firm’s MC = 30 + Q Firm’s TC = 30Q + Q2 Firm’s MR = 40 – Q Market demand is P = 40 - .5Q Set MR = MC 40 – Q = 30 + 2Q 10 = 2Q Q=5 P = 40 - .5(5) P = 37.5 ATC = 30 + Q = 35 Profit = (P – ATC)Q = (37.5 – 35)*5 = 12.5
For DWL, need the area of the shaded triangle: Need P, MC, Q monopoly produces, Q produced if this were a competitive market.
MC 37.5 Set MC = P to get Q=6.67 35
MR 5
D
6.67
DWL = .5 *2.5*1.67 = 2.09
MONOPOLISTIC COMPETITION -many firms -price setters -free entry or exit -differentiated products -max profit where MR = MC -LR eqm where P = ATC (no entry or exit) -in LR, produce at excess capacity (not at minATC) -heavy advertising
OLIGOPOLY -few firms, usually big -usually homogeneous products -barriers to entry -firms are price setters We can model oligopoly as -kinked demand model -prisoner’s dilemma -results in Nash Equilibrium (sub-optimal) Some try to collude (form cartel), but there is temptation to cheat. FACTOR MARKETS -firms hire labour so that W = VMPL = MP*P CONSUMER THEORY -consumers constrained by income => budget constraint -want to maximize Total Utility given Budget Constraint -will consume where highest indifference curve just tangent to BC -optimal consumption bundle where Slope of IC = Slope of BC MRS = Px/Py MUx = Px MUy Py -price change in a good leads to -Income Effect: changes purchasing power (move to different IC) -Substitution Effect: buy more of relatively cheaper good (move along original IC) -price changes => BC rotates -income changes => parallel shift of BC DON’T FORGET ABOUT: price ceilings and floors, taxes, consumer and producer surplus, finding market equilibrium and all calculations. KNOW ALL YOUR DIAGRAMS!
