Aryaman · I wasn't

HS 101

Microeconomics

Lecture 1

  • Scarcity: means that society has limited resources and therefore cannot produce all the goods and services people wish to have.
  • Economics is the study of how society manages its scarce resources.
  • Efficiency means society gets the most that it can from its scarce resources.
  • Equity means the benefits of those resources are distributed fairly among the members of society.
  • The opportunity cost of an item is what you give up to obtain that item.
  • Marginal changes are small, incremental adjustments to an existing plan of action.
  • A market economy is an economy that allocates resources through the decentralized decisions of many firms and households as they interact in markets for goods and services.
  • Property rights are the ability of an individual to own and exercise control over a scarce resource.
  • Market failure occurs when the market fails to allocate resources efficiently.
  • externality: the impact of one person or firm’s actions on the well-being of a bystander.
  • market power: the ability of a single person or firm to unduly influence market prices.

Lecture 2

  • Circular-flow diagram is a visual model of the economy that shows how dollars flow through markets among households and firms.
  • The production possibilities frontier is a graph that shows the combinations of output that the economy can possibly produce given the available factors of production and the available production technology.
  • Positive statements are statements that attempt to describe the world as it is. Called descriptive analysis.
  • Normative statements are statements about how the world should be. Called prescriptive analysis.

Lecture 3

  • A market is a group of buyers and sellers of a particular good or service.
  • A competitive market is a market in which there are many buyers and sellers so that each has a negligible impact on the market price.
  • Perfect market: products same, many people so no one can change price
  • Monopoly: One seller, and seller controls price
  • Oligopoly: few sellers, not aggressive competition
  • Monopolistic competition: many sellers, slightly different products, each seller own price for their product
  • Quantity demanded is the amount of a good that buyers are willing and able to purchase.
  • The law of demand states that, other things equal, the quantity demanded of a good falls when the price of the good rises.
  • The demand schedule is a table that shows the relationship between the price of the good and the quantity demanded.
  • The demand curve is a graph of the relationship between the price of a good and the quantity demanded.
  • Market demand - sum of all individual demand curves.

Lecture 4

  • As income increases the demand for a normal (inferior) good will increase (decrease).
  • When a fall in the price of one good reduces (increases) the demand for another good, the two goods are called substitutes (complements).
  • Quantity supplied is the amount of a good that sellers are willing and able to sell.
  • The law of supply states that, other things equal, the quantity supplied of a good rises when the price of the good rises.
  • ceteris paribus: used as a reminder that all variables other than the ones being studied are assumed to be constant
  • Equilibrium: refers to a situation in which the price has reached the level where quantity supplied equals quantity demanded.
  • Equilibrium price: refers to a situation in which the price has reached the level where quantity supplied equals quantity demanded.
  • Equilibrium quantity: The quantity supplied and the quantity demanded at the equilibrium price.
  • Law of supply and demand: The claim that the price of any good adjusts to bring the quantity supplied and the quantity demanded for that good into balance.

Lecture 5

  • The (own) price elasticity of demand is a measure of how much the quantity demanded of a good responds to a change in the price of that good.
    • assuming law of demand, this quantity will be negative
  • high elasticity → slight change in price will lead to a lot of change in demand
  • more elastic if:
    • more substitutes
    • good is a luxury
    • time period is longer
  • calculate elasticity using midpoint
  • if 0 <= elasticity < 1, then it’s said to be inelastic
    • perfect inelasticity: elasticity = 0
  • if elasticity > 1, then it’s said to be elastic
    • perfect elasticity: elasticity = infinity
  • unit elastic: elastic = 1
  • price vs quantity graph: flatter = more elastic
  • Total revenue is the amount paid by buyers and received by sellers of a good.
    • TR = P x Q
  • Change of revenue with respect to price increase:
    • if curve is inelastic: revenue increases
    • if curve is elastic: revenue decreases
    • unit elastic: no change
  • Income elasticity of demand measures how much the quantity demanded of a good responds to a change in consumers’ income.
    • for inferior goods: negative
    • for normal goods: positive
    • luxuries: elastic
    • necessities: inelastic
  • Cross-price elasticity of demand: A measure of how much the quantity demanded of one good responds to a change in the price of another good

Lecture 6

  • Price elasticity of supply is a measure of how much the quantity supplied of a good responds to a change in the price of that good.
    • If a demand curve is elastic, total revenue falls when the price rises.
    • If it is inelastic, total revenue rises as the price rises.

Lecture 7

  • price ceiling (floor): a legal maximum (minimum) on the price at which a good can be sold
  • tax incidence is the manner in which the burden of a tax is shared among participants in a market.
    • the study of who bears the burden of a tax.
  • when supply is more elastic than demand: the incidence tax falls more heavily on the consumer
  • the burden of a tax falls more heavily on the side of the market that is less elastic.

Lecture 8

  • total revenue: the amount a firm receives for the sale of its output
  • total cost: the market value of the inputs a firm uses in production
  • profit: total revenue minus total cost
  • opportunity cost of an item: refers to all those things that must be forgone to acquire that item
  • explicit costs: input costs that require an outlay of money by the firm
  • implicit costs: input costs that do not require an outlay of money by the firm
  • economic profit: total revenue minus total cost, including both explicit and implicit costs
  • accounting profit: total revenue minus total explicit cost
  • production function: the relationship between quantity of inputs used to make a good and the quantity of output of that good
  • marginal product: the increase in output that arises from an additional unit of input
  • diminishing marginal product: the property whereby the marginal product of an input declines as the quantity of the input increase
  • fixed costs: costs that do not vary with the quantity of output produced
  • variable costs: costs that do vary with the quantity of output produced
  • average total (fixed/variable) cost: total (fixed/variable) cost divided by the quantity of output
  • average total cost curve is U-shaped
  • marginal cost: the increase in total cost that arises from an extra unit of production
  • efficient scale: the quantity of output that minimizes average total cost

The marginal-cost curve crosses the average-total-cost curve at the efficient scale.

  • For many firms, the division of total costs between fixed and variable costs depends on the time horizon being considered.
    • In the short run, some costs are fixed.
    • In the long run, all fixed costs become variable costs.
  • Because many costs are fixed in the short run but variable in the long run, a firm’s long-run cost curves differ from its short-run cost curves.

Lecture 9

  • economies of scale: the property whereby long-run average total cost falls as the quantity of output increases
  • diseconomies of scale: the property whereby long-run average total cost rises as the quantity of output increases
  • constant returns to scale: the property whereby long-run average total cost stays the same as the quantity of output changes

Lecture 10

  • a competitive market, or a perfectly competitive market, has two characteristics:
    • There are many buyers and many sellers in the market.
    • The goods offered by the various sellers are largely the same
    • sometimes the following is also added: Firms can freely enter or exit the market.
  • result of these conditions:
    • the actions of any single buyer or seller in the market have a negligible impact on the market price.
    • Each buyer and seller takes the market price as given.

Revenue of a competitive firm

  • Total revenue is the selling price times the quantity sold, TR = PQ
  • Total revenue is proportional to the amount of output.
  • average revenue: total revenue divided by the quantity sold
  • marginal revenue: the change in total revenue from an additional unit sold
  • for all firms, average revenue equals the price of the good
  • for competitive firms, marginal revenue equals the price of the good
  • At the profit-maximizing level of output, marginal revenue and marginal cost are exactly equal.
    • If MR > MC, increase Q.
  • Under perfect competition: Price = Marginal Revenue = Average Revenue
  • shutdown: a short-run decision not to produce anything during a specific period of time because of current market conditions
  • exit: a long-run decision to leave the market
  • a firm that shuts down temporarily still has to pay its fixed costs, whereas a firm that exits the market saves both its fixed and its variable costs.
  • the firm shuts down if the revenue that it would get from producing is less than its variable costs of production, i.e., TR < VC
    • Equivalently, it would shut down iff P < AVC.
  • sunk cost: a cost that has already been committed and cannot be recovered
  • in the long run: the firm exits the market if the revenue it would get from producing is less than its total costs, i.e., TR < TC
    • Equivalently, it would exit iff P < ATC
  • Parallel-y, firm will enter if TR > TC or P > ATC.
  • The competitive firm’s short-run (long-run) supply curve is the portion of its marginal cost curve that lies above average (total) variable cost.

Lecture 12

  • While a competitive firm is a price taker, a monopoly firm is a price maker.
  • A firm is considered a monopoly if
    • it is the sole seller of its product
    • its product does not have close substitutes
  • The fundamental cause of monopoly is barriers to entry. This has three main sources
    • A key resource is owned by a single firm.
      • in practice, monopolies rarely arise for this reason.
    • The government gives a single firm the exclusive right to produce some good or service.
      • Patent and copyright laws are two important examples of how the government does this.
    • The costs of production make a single producer more efficient than a large number of producers.
  • natural monopoly: a monopoly that arises because a single firm can supply a good or service to an entire market at a smaller cost than could two or more firms
Monopoly Competition
Is the sole owner Is one of many producers
Faces a downward-sloping demand curve Faces a horizontal demand curve
Is a price maker Is a price taker
Reduces prices to increase sales Sells as much or as little at the same price

Revenue

  • a monopolist’s marginal revenue is always less than the price of the good
    • the demand curve is downward sloping
    • when a monopoly wants to sell more, it must decrease price
  • when a monopoly increases the amount it sells, it has two effect:
    • The output effect—more output is sold, so Q is higher
    • The price effect—price falls, so P is lower
  • A monopoly maximizes profit by producing the quantity at which marginal revenue equals marginal cost. It then uses the demand curve to find the price that will induce consumers to buy that quantity.
  • For a competitive firm, price equals marginal cost
    • P = MR = MC
  • For a monopoly firm, price exceeds marginal cost
    • P > MR = MC
  • All profit maximising firms set MR = MC.

  • Profit = TR - TC = (P - ATC)Q

  • price discrimination: the business practice of selling the same good at different prices to different customers
    • not possible in competitive market. The firm must have some market power.
  • perfect price discrimination: the situation when the monopolist knows exactly the willingness to pay of each customer and can charge each customer a different price.
  • Examples of price discrimination:
    • movie tickets
    • airplane tickets
    • discount coupons
    • financial aid
  • Conclusion:
    • monopolies are common
    • most firms have some control over their prices because of differentiated products
    • firms with substantial monopoly power are rare
    • few goods are truly unique

Lecture 13

  • Imperfect competition refers to those market structures that fall between perfect competition and pure monopoly. Imperfect competition includes industries in which firms have competitors but do not face so much competition that they are price takers.
  • oligopoly: Only a few sellers, each offering a similar or identical product to the others.
  • monopolistic competition: Many firms selling products that are similar but not identical.
  • Because an oligopolistic market has only a small group of sellers, a key feature of oligopoly is the tension between cooperation and self-interest.
  • The group of oligopolists is best off cooperating and acting like a monopolist—producing a small quantity of output and charging a price above marginal cost.
  • collusion: An agreement among firms in a market about quantities to produce or prices to charge.
  • cartel: A group of firms acting in unison.
  • Antitrust laws prohibit explicit agreements among oligopolists as a matter of public policy.
  • When firms in an oligopoly individually choose production to maximize profit, they produce quantity of output greater than the level produced by monopoly and less than the level produced by competition.
    • The oligopoly price is less than the monopoly price but greater than the competitive price (which equals marginal cost).
  • Game theory is the study of how people behave in strategic situations.
  • Nash equilibrium: a situation in which economic actors interacting with one another each choose their best strategy given the strategies that all the others have chosen.
  • Self-interest makes it difficult for the oligopoly to maintain a cooperative outcome with low production, high prices, and monopoly profits.
  • Firms that care about future profits will cooperate in repeated games rather than cheating in a single game to achieve a one-time gain.
  • Cooperation among oligopolists is undesirable from the standpoint of society as a whole because it leads to production that is too low and prices that are too high.

Lecture 14

  • Welfare economics: the study of how the allocation of resources affects economic well-being.
  • Equilibrium in the market results in maximum benefits, and therefore maximum total welfare for both the consumers and the producers of the product.
    • Consumer surplus measures economic welfare from the buyer’s side.
    • Producer surplus measures economic welfare from the seller’s side.
  • Willingness to pay is the maximum amount that a buyer will pay for a good. It measures how much the buyer values the good or service.
    • Consumer surplus is the buyer’s willingness to pay for a good minus the amount the buyer actually pays for it.
    • The market demand curve depicts the various quantities that buyers would be willing and able to purchase at different prices.
    • The area below the demand curve and above the price measures the consumer surplus in the market.
  • Producer surplus is the amount a seller is paid for a good minus the seller’s cost.
    • It measures the benefit to sellers participating in a market.
    • The area below the price and above the supply curve measures the producer surplus in a market.
  • Total surplus = Value to buyers – Cost to sellers
  • efficiency: the property of a resource allocation of maximising the total surplus received by all members of society.
  • equity: the fairness of the distribution of well-being among the various buyers and sellers.
  • Three Insights Concerning Market Outcomes:
    • Free markets allocate the supply of goods to the buyers who value them most highly, as measured by their willingness to pay.
    • Free markets allocate the demand for goods to the sellers who can produce them at least cost.
    • Free markets produce the quantity of goods that maximizes the sum of consumer and producer surplus.
  • Because the equilibrium outcome is an efficient allocation of resources, the social planner can leave the market outcome as he/she finds it.
  • laissez faire: policy of leaving well enough alone
  • externalities:
    • created when a market outcome affects individuals other than buyers and sellers in that market.
    • cause welfare in a market to depend on more than just the value to the buyers and cost to the sellers.
  • When buyers and sellers do not take externalities into account when deciding how much to consume and produce, the equilibrium in the market can be inefficient.

Lecture 15

  • budget constraint: the limit on the consumption bundles that a consumer can afford
  • The slope of the budget constraint line equals the relative price of the two goods, that is, the price of one good compared to the price of the other.
  • indifference curve: a curve that shows consumption bundles that give the consumer the same level of satisfaction
  • The Marginal Rate of Substitution: slope at any point on an indifference curve
    • It is the rate at which a consumer is willing to trade one good for another.
    • It is the amount of one good that a consumer requires as compensation to give up one unit of the other good.
  • Four properties of indifference curves:
    • Higher indifference curves are preferred to lower ones.
    • Indifference curves are downward sloping.
    • Indifference curves do not cross.
    • Indifference curves are bowed inward.
  • Shapes of these curves:
    • Perfect substitutes: Two goods with straight-line indifference curves
    • Perfect complements: Two goods with right-angle indifference curves are perfect complements. (left shoo right shoo lol)
  • Optimisation:
    • Consumers want to get the combination of goods on the highest possible indifference curve. Obviously, it still must be within constraints.
    • Consumer optimum occurs at the point where the highest indifference curve and the budget constraint are tangent. That is, the consumer chooses consumption of the two goods so that the marginal rate of substitution equals the relative price.
  • An increase in income shifts the budget constraint outward.
    • This leads to a new optimum. If the quantity of product X increases, it’s normal. Else, inferior.
  • A fall in the price of any good rotates the budget constraint outward and changes the slope of the budget constraint.
  • income effect: the change in consumption that results when a price change moves the consumer to a higher or lower indifference curve
  • substitution effect: the change in consumption that results when a price change moves the consumer along a given indifference curve to a point with a new marginal rate of substitution

Lecture 16

  • Giffen goods: a good for which an increase in the price raises the quantity demanded
  • For normal goods, both substitution effect (SE) and income effect (IE) work in the same direction. → downward sloping demand
  • For inferior goods, SE and IE work in the opposite direction.
    • If SE > IE, then demand curve is downward sloping.
    • If IE > SE, then demand curve is upward sloping. → Giffen goods
  • Wages: Suppose wage is increased
    • If SE > IE, person will work more (leisure less)
    • If IE > SE, person will work less (leisure more)