REVIEW FINAL EXAM

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REVIEW FINAL EXAM. 45 40 35 30 25 20 15. 30 25 20 15 10. Sugar (tons). Sugar (tons). 5 10 15 20 25 30. 5 10 15 20. Wheat (tons). Wheat (tons). Wheat. Sugar. USA. 30. 30. (1W costs 1S). (1S costs 1W). Brazil. 10. (1W costs 2S). 20.

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### REVIEW FINAL EXAM

45

40

35

30

25

20

15

30

25

20

15

10

Sugar (tons)

Sugar (tons)

5 10 15 20 25 30

5 10 15 20

Wheat (tons)

Wheat (tons)

Wheat

Sugar

USA

30

30

(1W costs 1S)

(1S costs 1W)

Brazil

10

(1W costs 2S)

20

(1S costs 1/2W)

Which country has a comparative advantage in wheat?

• Which country should EXPORT Sugar?
• Which country should EXPORT Wheat?
• Which country should IMPORT Wheat?
Output Questions:

OOO=

Output: Other goes Over

Input Questions:

IOU=

Input: Other goes Under

Q

%

d

%

P

PRICE ELASTICITY OF DEMAND

Commonly Expressed as…

The percentage change in quantity

P

The percentage change in price

P2

P1

Elasticity is .5

D

Q

Q2

Q1

Pineapples

Kenya

30

10

(1R costs 3 P)

(1P costs 1/3R)

India

40

(1P costs 1R)

40

(1R costs 1P)

If the terms of trade for 1 radio is greater than 3 pineapples then Kenya is worse off and should make radios on their own.

India wants Pineapples

If the terms of trade for 1 radio is less than 1 pineapple then India is worse off and should make pineapples on their own.

What terms of trade benefit both countries?

Pineapples

Kenya

30

10

(1R costs 3 P)

(1P costs 1/3R)

India

40

(1P costs 1R)

40

(1R costs 1P)

If Kenya produces radios by themselves, they give up 3 Pineapples for each radio. If they can trade 2 pineapples for each radio they are better off.

If India produces pineapples by themselves, they give up 1 pineapple for one radio. If they can get 2 pineapples for one radio they are better off.

The countries trade at a lower opportunity cost than if they made the products themselves!

Use the midpoint formula again.
• Elasticity =
• % change in Q =
• % change in Q =
• For the quantities of 10 and 7, the % change in Q is approx. 35.3 percent. (3/8.5 times 100)

Elasticity

Using the Midpoint Formula

Elasticity =

% change in p = times 100.

% change in p =

For the prices \$2 and \$2.50, the % change in p is approx. 22.22 percent.

Elasticity

PRICE ELASTICITY OF DEMAND

Extreme Cases

Perfectly Inelastic Demand

D1

P

Ed = 0

0

Q

Perfectly Elastic Demand

P

D2

Ed = 

Q

0

PRICE ELASTICITY & TOTAL REVENUE

So is total revenue

When prices are low,

P

TR

D

Q

Quantity Demanded

PRICE ELASTICITY & TOTAL REVENUE

Total revenue rises

with price to a

point...

P

TR

D

Q

Quantity Demanded

PRICE ELASTICITY & TOTAL REVENUE

Total revenue rises

with price to a

point...

then declines

P

TR

D

Q

Quantity Demanded

PRICE ELASTICITY & TOTAL REVENUE

Total revenue rises

with price to a

point...

then declines

P

TR

D

Q

Quantity Demanded

PRICE ELASTICITY & TOTAL REVENUE

Total Revenue Test

Total revenue rises

with price to a

point...

then declines

P

TR

D

Q

Quantity Demanded

PRICE ELASTICITY & TOTAL REVENUE

Total revenue rises

with price to a

point...

then declines

P

TR

Inelastic

Demand

D

Inelastic

Demand

Q

Quantity Demanded

PRICE ELASTICITY & TOTAL REVENUE

Total revenue rises

with price to a

point...

then declines

P

TR

Elastic

Demand

Inelastic

Demand

D

Elastic

Demand

Inelastic

Demand

Q

Quantity Demanded

PRICE ELASTICITY & TOTAL REVENUE

Total revenue rises

with price to a

point...

then declines

P

TR

Unit

Elastic

Elastic

Demand

Inelastic

Demand

D

Elastic

Demand

Inelastic

Demand

Q

Quantity Demanded

ECONOMIC COSTS

Economic

Profit

Accounting

Profit

Implicit costs

(including a

normal profit)

Accounting

costs (explicit

costs only)

Explicit

Costs

Profits to an

Economist

Profits to an

Accountant

T

O

T

A

L

R

E

V

E

N

U

E

Economic (opportunity) Costs

SHORT-RUN PRODUCTION

RELATIONSHIPS

Law of Diminishing Returns

Total Product

Total Product, TP

Increasing

Marginal

Returns

Quantity of Labor

Average Product, AP, and

Marginal Product, MP

Average

Product

Marginal

Product

Quantity of Labor

SHORT-RUN PRODUCTION

RELATIONSHIPS

Law of Diminishing Returns

Total Product

Total Product, TP

Diminishing

Marginal

Returns

Quantity of Labor

Average Product, AP, and

Marginal Product, MP

Average

Product

Marginal

Product

Quantity of Labor

SHORT-RUN PRODUCTION

RELATIONSHIPS

Law of Diminishing Returns

Total Product

Total Product, TP

Negative

Marginal

Returns

Quantity of Labor

Average Product, AP, and

Marginal Product, MP

Average

Product

Marginal

Product

Quantity of Labor

UTILITY MAXIMIZING COMBINATION

MU of product B

MU of product A

Price of A

Price of B

16 Utils

8 Utils

=

\$1

\$2

Algebraic Restatement of the

Utility Maximization Rule

=

PRODUCTIVITY AND COST CURVES

Average product and

marginal product

Quantity of labor

Costs (dollars)

Quantity of output

AP

MP

MC

AVC

LONG-RUN PRODUCTION COSTS

The long-run ATC just “envelopes”

all of the short-run ATC curves.

Unit Costs

Output

LONG-RUN PRODUCTION COSTS

Unit Costs

long-run ATC

Output

ECONOMIES AND

DISECONOMIES OF SCALE

• Labor Specialization
• Managerial Specialization
• Efficient Capital
• Other Factors

Diseconomies of Scale

Constant Returns to Scale

graphically presented...

ECONOMIES AND

DISECONOMIES OF SCALE

Economies

of scale

Unit Costs

long-run ATC

Output

ATC decreases as

Output increases

ATC is constant as

Output increases

Constant returns

to scale

Economies

of scale

Unit Costs

long-run ATC

Output

ATC decreases as

Output increases

ATC is constant as

Output increases

ATC increases as

Output increases

Constant returns

to scale

Diseconomies

of scale

Economies

of scale

Unit Costs

long-run ATC

Output

MARGINAL REVENUE-MARGINAL COST APPROACH

Profit Maximization Position

\$200

150

100

50

0

Economic Profit

MC

MR

\$131.00

ATC

Cost and Revenue

AVC

\$97.78

1 2 3 4 5 6 7 8 9 10

MR = MC

Optimum

Solution

MARGINAL REVENUE-MARGINAL COST APPROACH

Profit Maximization Position

\$200

150

100

50

0

Economic Profit

MC

MR

\$131.00

ATC

Cost and Revenue

AVC

\$97.78

1 2 3 4 5 6 7 8 9 10

MARGINAL REVENUE-MARGINAL COST APPROACH

Short-Run Shut Down Point

\$200

150

100

50

0

MC

ATC

Cost and Revenue

AVC

MR

\$71.00

Minimum AVC

is the Shut-Down

Point

1 2 3 4 5 6 7 8 9 10

SHORT-RUN COMPETITIVE EQUILIBRIUM

The Competitive Firm “Takes” its

Price from the Industry Equilibrium

S= MCs

P

P

Economic

Profit

ATC

S=MC

D

\$111

\$111

AVC

D

Q

Q

8

8000

Firm

(price taker)

Industry

SHORT-RUN COMPETITIVE EQUILIBRIUM

long-run?

The Competitive Firm “Takes” its

Price from the Industry Equilibrium

S= MCs

P

P

Economic

Profit

ATC

S=MC

D

\$111

\$111

AVC

D

Q

Q

8

8000

Firm

(price taker)

Industry

PROFIT MAXIMIZATION IN THE LONG RUN

P

P

\$60

50

40

\$60

50

40

Q

Q

100

100,000

Firm

(price taker)

Industry

Temporary profits and the reestablishment

of long-run equilibrium

S1

MC

ATC

MR

D1

P

P

\$60

50

40

\$60

50

40

Q

Q

100

100,000

Firm

(price taker)

Industry

PROFIT MAXIMIZATION IN THE LONG RUN

An increase in demand increases profits…

Economic

Profits

S1

MC

ATC

MR

D2

D1

PROFIT MAXIMIZATION IN THE LONG RUN

P

P

\$60

50

40

\$60

50

40

Q

Q

100

100,000

Firm

(price taker)

Industry

New competitors increase supply, and lower

prices decrease economic profits.

Zero Economic

Profits

S1

S2

MC

ATC

MR

D2

D1

PROFIT MAXIMIZATION IN THE LONG RUN

P

P

\$60

50

40

\$60

50

40

Q

Q

100

100,000

Firm

(price taker)

Industry

Decreases in demand, losses, and the

reestablishment of long-run equilibrium

S1

MC

ATC

MR

D1

P

P

\$60

50

40

\$60

50

40

Q

Q

100

100,000

Firm

(price taker)

Industry

PROFIT MAXIMIZATION IN THE LONG RUN

A decrease in demand creates losses…

Economic

Losses

S1

MC

ATC

MR

D1

D2

P

P

\$60

50

40

\$60

50

40

Q

Q

100

100,000

Firm

(price taker)

Industry

PROFIT MAXIMIZATION IN THE LONG RUN

Competitors with losses decrease supply, and

S3

Economic Profits

S1

MC

ATC

MR

D1

D2

MARGINAL REVENUE-MARGINAL COST APPROACH

Loss Position

\$200

150

100

50

0

Economic Loss

MC

ATC

Cost and Revenue

AVC

\$91.67

MR

\$81.00

1 2 3 4 5 6 7 8 9 10

MONOPOLY REVENUES & COSTS

Elastic

T

\$200

150

200

50

Dollars

MR

D

Q

0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18

\$750

500

250

Dollars

TR

Q

0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18

MONOPOLY REVENUES & COSTS

Elastic

Inelastic

\$200

150

200

50

Inelastic Portion

MR is Negative

Dollars

A Monopolist will always operate on the Elastic Portion of the Demand Curve

MR

D

Q

0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18

\$750

500

250

Dollars

TR

Q

0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18

OUTPUT AND PRICE DETERMINATION

200

175

150

125

100

75

50

25

Price, costs, and revenue

Q

0 1 2 3 4 5 6 7 8 9 10

Profit Maximization Under Monopoly

Remember the MR=MC Rule?

Profit

Per Unit

MC

\$122

Profit

ATC

\$94

D

MR = MC

MR

OUTPUT AND PRICE DETERMINATION

200

175

150

125

100

75

50

25

Loss Minimization?

Price, costs, and revenue

Q

0 1 2 3 4 5 6 7 8 9 10

Profit Maximization Under Monopoly

Profit

Per Unit

MC

\$122

Profit

ATC

\$94

D

MR = MC

MR

OUTPUT AND PRICE DETERMINATION

Since Pm exceeds AVC,

the firm will produce

200

175

150

125

100

75

50

25

Price, costs, and revenue

Q

0 1 2 3 4 5 6 7 8 9 10

Loss Minimization Under Monopoly

Loss

Per Unit

MC

ATC

A

Loss

AVC

Pm

V

D

MR = MC

MR

Qm

OUTPUT AND PRICE DETERMINATION

200

175

150

125

100

75

50

25

What are the

Economic Effects

of Monopoly?

Price, costs, and revenue

Q

0 1 2 3 4 5 6 7 8 9 10

Loss Minimization Under Monopoly

Loss

Per Unit

MC

ATC

A

Loss

AVC

Pm

V

D

MR = MC

MR

Qm

INEFFICIENCY OF PURE MONOPOLY

An industry in pure competition

sells where supply and

demand are equal

P

S = MC

At MR=MC

A monopolist

will sell less

units at a

higher price

than in

competition

Pm

Pc

D

MR

Q

Qm

Qc

INEFFICIENCY OF PURE MONOPOLY

P

S = MC

At MR=MC

A monopolist

will sell less

units at a

higher price

than in

competition

Pm

Pc

Monopoly pricing effectively

creates an income transfer from

D

MR

Q

Qm

Qc

REGULATED MONOPOLY

Dilemma of Regulation

Which Price?

P

MR = MC

Fair-Return Price

Pm

Socially-Optimum

Price

Price and Costs

ATC

Pf

MC

Pr

D

MR

Q

Qm

Qf

Qr

MONOPOLISTIC COMPETITION

AND EFFICIENCY

Price is Not

= Minimum

ATC

Price  MC

MC

Long-Run Equilibrium

ATC

P3

= A3

Price and Costs

D

MR

Q3

Quantity

MONOPOLISTIC COMPETITION

AND EFFICIENCY

• Not Productively Efficient
•  Minimum ATC
• Not Allocatively Efficient
• Price  MC
• Excess Capacity

Graphically…

Dominant Strategy

The Dominant Strategy is the best move to make regardless of what your opponent does

What is each firm’s dominate strategy?

Firm 2

No Dominant Strategy

High

Low

High

\$100, \$50

\$50, \$90

Firm 1

\$80, \$40

\$20, \$10

Low

2007 FRQ #3

Payoff matrix for two competing bus companies

PURELY COMPETITIVE LABOR

MARKET EQUILIBRIUM

Non-

Labor

Costs

Wage Rate (dollars)

Quantity of Labor

Quantity of Labor

S

Includes

Normal

Profit

S = MRC

Wc

(\$10)

\$10

\$10

\$10

\$10

\$10

\$10

Wc

Labor

Costs

D = MRP

( mrp’s)

d = mrp

(1000)

(5)

Individual Firm

Labor Market

PURELY COMPETITIVE LABOR

MARKET EQUILIBRIUM

Marginal Resource

Cost (MRC)will be

constant and equal to

resource price

(the wage rate)

Non-

Labor

Costs

Wage Rate (dollars)

Quantity of Labor

Quantity of Labor

S

Includes

Normal

Profit

S = MRC

Wc

(\$10)

\$10

\$10

\$10

\$10

\$10

\$10

Wc

Labor

Costs

D = MRP

( mrp’s)

d = mrp

(1000)

(5)

Individual Firm

Labor Market

MONOPSONISTICLABOR MARKET

S

In monopsony

MRC lies above

the supply curve.

Wage Rate (dollars)

Quantity of Labor

MONOPSONISTICLABOR MARKET

MRC

S

MRP = MRC

Wage Rate (dollars)

Wm

MRP

Qm units of

labor hired

Qm

Quantity of Labor

MONOPSONISTICLABOR MARKET

MRC

S

The competitive

solution would

result in a higher

wage and greater

employment.

Wage Rate (dollars)

Wc

Wm

MRP

Qm

Qc

Quantity of Labor

OPTIMAL AMOUNT OF A PUBLIC GOOD

P

\$ 9

7

5

3

1

S

Yields the

optimum amount

of the public good

MB = MC

DC

Q

0 1 2 3 4 5

THE LORENZ CURVE

100

80

60

40

20

Lorenz Curve

(actual distribution)

Perfect Equality

Percent of Income

Lorenz curve

after taxes and

transfers

Area between

the lines shows

the degree of

income inequality

Complete

Inequality

0

20 40 60 80 100

Percent of Families