Intermediate Microeconomics

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The nature and role of theory

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-A theory shows how facts are related to one another
-Theory is based on certain assumptions
-Theory can be used to predict as well as explain real world outcomes
-A good theory: one that successfully explains and predicts the phenomena that it is intended to

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Analysis:
Positive vs. Normative

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Positive: assessment of objective outcomes; draws on accepted rules of logic and evidence
Normative: a nonscientific value judgement; subjective- what ought to be

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Opportunity Costs:
Explicit vs. Implicit

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Explicit cost: money used in the pursuit of a goal that could otherwise have been spent on an alternative objective

Implicit cost: costs associated with the individuals use of her own time (next best alternative)

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Economic cost

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Explicit cost + implicit cost

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Basic Assumptions: market participants

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1)Goal oriented: interested in fulfilling their own, personal goals
2)Rational behavior: behavior is based on a careful, deliberate process that weighs expected costs and benefits
3)Scare resources: availability of resources is insufficient for individuals to satisfy all desires

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Preferences

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1) preferences are complete
2) preferences are transitive
3) more of any good is preferred to less

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Indifference curve

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A curve that plots all the market baskets that a consumer views as being equally satisfactory (have the same utility, but different amounts of goods)
-Slope= -MUx/MUy
Characteristics:
-Downward sloping if both goods are desirable (a 'good')
-A curve that is father from the origin is preferred to one that is closer (higher utility)
-Two curves cannot intersect
-Convex to the origin: because the have a diminishing marginal rate of substitution (MRS)

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Indifference map

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A set of indifference curves
-represents an ordinal ranking

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Marginal Rate of Substitution (MRS)

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A consumers willingness to give up less and less of some other good to obtain still more of the first good
-Is the slope of the indifference curve at each point

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Categories of Goods

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-'Good': when more is preferred to less
-'Bad': when less is preferred to more
-'Neuter': indifferent towards the good

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Perfect Substitutes

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When a consumer is willing to substitute one good for another at some constant rate and remain equally well off
-constant MU for both goods
-only substitution effect and NO income effect

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Perfect Complements

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When goods must be consumer together in a precise combination in order for the consumer to remain equally well off
-Only income effect and NO substitution effect-because have to consumer both goods together

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Total Utility

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The total satisfaction a consumer receives from a given level of consumption

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Marginal Utility

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The amount by which total utility rises when consumption increases by one unit

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Diminishing Marginal Utility

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The assumption that as more of a given good is consumed, the marginal utility associated with the consumption of additional unites tends to decline, other things held constant

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The Budget Constraint

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A line that shows the combinations of goods that can be purchased at the specified prices and assuming that all of the consumers income is expended

-Intercepts: indicates the maximum amount of one good that can be purchased if none of the other good is bought

-The slope: indicates how much of one good must be given up to buy one more of the other good (=-Px/Py)

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Budget Constraint: shifts

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1) Income changes: a change in income with constant prices produces a parallel shift in the line

2)Price changes: a change in the price of one good with income and price of other good held constant causes the line to rotate about one of the intercepts (the one with the price change)

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The consumers choice

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1) To maximize utility, the ratio of marginal utilities equals the ratio of prices
2) MRS= slope of the budget line
3) The optimal choice must line on the budget line

-The Consumers optimal choice is one for which the consumer allocates income so that the marginal utility divided by the goods price is equal for every good purchased (MUx/Px=MUy/Py)

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A Corner Solution

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When the consumers optimal choice is not characterized by an equality between the MRS and the price ration
-Only one good purchased

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Income and Consumption

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Income-Consumption curve: the curve that joins all the optimal consumption point generated by income
1) Normal goods:
-curve slopes upward
-curve shifts right for an increase in income
2) Inferior goods:
-curve slopes backward
-curve shifts left for an increase in income

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The Consumers Demand Curve

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-Depends on the consumers preferences as expressed in the utility function `
-The consumers level of well-being varies along the curve
-The prices of other goods are held constant along the curve, but the quantities purchased of these other goods can vary
-At each point on the curve, the consumers optimal condition is satisfied: MRSx,y=Px/Py

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Price Change:
Income vs. Substitution effect

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Income: a change in a consumers real purchasing power brought about by a change in the price of a good

Substitution: an incentive to increase consumption of a good whose price falls, at the expense of other, now relatively more expensive good

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Income and Substitution effect: Normal good

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Both the income and substitution effect imply more consumption at a lower price and less consumption at a higher price

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Income and Substitution effect: Inferior good

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Two possibilities:
1) Substitution effect > income effect
-curve slopes downward
2) Substitution effect < income effect
-curve slopes upward (Giffen good)

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Individual --> Market Demand

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Horizontal summation: add qualities of individual demand curves at each price to obtain the market demand curve

-If the Individual curves slope downward then so will the market curve
-If some of the individual curves slope upward the market may still slope downward

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Consumer Surplus (CS)

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A measure of the net gain to consumers from purchasing a good arising from its cost being below the max price that consumers are willing to pay (reservation price)

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Total and Marginal Benefit

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Total: the total value a consumer derives from a particular amount of a good and thus the max price the consumer would be willing to pay for that amount of good

Marginal: the incremental value a consumer derives from consuming an additional unit of a good and thus the max amount the consumer would pay for that additional unit

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Price Elasticity of Demand

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The change in quantity demand of a good associated with its change in price

IeI > 1 elastic
IeI = 1 unit elastic
IeI < 1 inelastic
IeI = 0 perfectly inelastic

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Income Elasticity of Demand

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The change in quantity demanded of a good associated with the change in income

Ei < 0 inferior good
Ei > 0 normal good

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Cross Price Elasticity of Demand

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The change in quantity demand of good x associated with the change in price of good y

Exy < 0 complements
Exy > 0 substitutes

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Inputs:
Fixed vs. Variable

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Fixed: variables that cannot be changed due to time constraints- mainly capital- only happens in SR

Variable: all inputs can be changed- happens in both SR and LR

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Diminishing Marginal Returns

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Holds that beyond some level, the marginal product of the variable input will decrease as more of the input is used

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Isoquants

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Depict all input combinations that will produce a given output level. Shows the relationship between inputs and output when all inputs can be varied
-Similar to indifference curve and have the same characteristics

-A set of isoquants is effectively a graphical representation of the firms production function

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Isocost line

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A line that identifies all the combinations of capital and labor that can be purchased at a given total cost
-Similar to budget constraint

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Marginal Rate of Technical Substitution (MRTS)

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Shows the technological feasibility of trading one input for another and is equal to the slope of an isoquant

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Returns to Scale

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Refers to the relationship between a proportionate change in all inputs and the associated change in output.
Three types:
1) Constant: 2x+2y=2Q
2) Increasing: 2x+2y=4Q
-common at low levels of production
3) Decreasing: 2x=2y=1.5Q
-common at high levels of production

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Returns to Scale: Cobb Douglas Function

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Q=L^aK^b
Look at the exponents:
-If a+b > 1 increasing
-If a+b = 1 constant
-If a+b < 1 decreasing

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The Cost of Production

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The cost is ultimately associated with the use of inputs that have alternative uses
-cost=opportunity cost: sacrificed alternatives when inputs are used to produce one product rather than some other product

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The Short Run

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Firms have some fixed inputs, so output can only be altered by the variable inputs
-The shape of the MC curve is dictated by the law of diminishing returns
-The MC curve rises beyond the point at which diminishing marginal returns set in and it intersects the U-shaped variable and average total cost curves at their minimum points

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The Long Run

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All inputs are variable

Expansion path: shows the least costly combinations of inputs required to produce various levels of output.
-Identifies the lowest total cost at which each output can be produced when all inputs are variable
-This is also conveyed by the firms LR cost curve

*If input proportions are held constant: the shape of the cost curve is determined by returns to scale

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Economies of Scale

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When a firms output increases more than proportionally with a change in total input cost

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Diseconomies of Scale

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When a firm can increase its output more than proportionally to its total cost

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Individual Cost Curves

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Are based on the assumption that input prices are given
-A change in one or more input prices causes the cost curve to shift

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Cost:
SR vs. LR

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SR cost is usually higher than LR because in LR there is greater flexibility in input usage (no fixed inputs) as well as any advantages associated with learning by doing (have more time to figure what works and what doesn't)

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Economies of Scope

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A case where it is cheaper for a single firm to produce an array of products than it is for an array of separate firms to independently produce distinct products

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Diseconomies of Scope

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A case where it is cheaper for separate products to be produced independently than for one firm to produce the same products jointly

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Minimum efficient scale

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The scale of operations at which average cost per unit reaches a min

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New entrant/survivor technique

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A method for determining the minimum efficient scale of production in an industry, based on investigating the plant sizes either being built or used by firms in the industry

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Costs

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TFC= total fixed cost (capital)
TVC= total variable cost (labor)
TC= FC+VC
AFC= FC/Q
AVC= VC/Q
ATC= TC/Q
MC= change in TC/1 (change in Q=1unit)

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Perfect Competition

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1) A lot of buyers and sellers-price takers
2) No barriers to entry and exit
3) Homogeneous products
4) Perfect information
5) Zero economic profit

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Demand for Perfect Competition

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Since the products are homogenous- the firms cannot individually chose their price- instead they are price takers and have to take market price
-So the demand curve is a horizontal line at the price-Q does not affect the price (MR=P)

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Perfect Competition
Optimal Output

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Where P=MR=MC
-BUT P must be at least as high as AVC or the firm suffers a loss in excess of TFV

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Perfect Competition
The Supply Curve: Short Run

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-Is the MC curve as long as MC>AVC

-Is upward sloping because the law of diminishing returns implies that each firms MC slopes up

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Perfect Competition
The Supply Curve: Long Run

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-Firms have the time to change capital (K) and to enter or leave the industry
-The curve takes this into account along with the assumption that are always guided by the search for profits

-All point along the curve: economic profit=0, because only when there is no profit there is no incentive for firms to enter or leave the industry

Shifts:
-Input supply curves and technology are assumed as given in deriving the curve
-changes in these factors shift the curve

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Perfect Competition
Profit-max assumption

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Firms select an output level in order to max profit!
Allows us to predict how a competitive firm will respond to changes in the product price or input price.
1) Increase Product Price: (unchanged cost curve) will lead the firm to expand output as it moves up the MC curve
2) Increase input price: (unchanged product price) will shift the cost curve downward and so will lead the firm to expand output

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Perfect Competition
LR industry supply curve: shape

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Two shapes: (most likely)
1) An increasing cost industry has an upward sloping curve, reflecting the increase in the prices of one or more inputs as the industry expands

2) A constant cost industry has a horizontal curve, reflecting a situation where the industry can expand its use of inputs without affecting their prices

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Survivor principle

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The observation that in perfect competitive markets, firms that do not estimate profit-max behavior fail and survivors are those firms that intentionally or not, make the appropriate profit-max decisions

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Revenue and Profit

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TR: PxQ
AR: TR/Q
MR: delta TR/delta Q(=1 unit)

TP(pi): TR-TC
AP: TP(pi)/Q

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Perfect Competition
SR: shut down point

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When P < AVC -operations will cease in the SR

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Perfect Competition
LR: equilibrium

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The most profitable output level
-LMC=MR=P
-LAC=AR so no economic profit

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Perfect Competition
Long Run Industry Supply Curve

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LRISC: the LR relationship between price and industries Q, which depends on if input prices are constant, increasing, or decreasing as the industry expands or contracts:
Constant:
-inc.Q no = inc. P
-LAC unchanged
-LRISC is horizontal

Increasing:
-inc.Q = inc. p
-Inc. LAC
-LRISC slopes upward

Decreasing: (unusual)
-inc. Q= dec. P
-dec. LAC
-LRISC slopes downward

Shifts:
-technological advances = LRISC dec. = dec. P , inc. Q

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Perfect Competition
SR firm supply curve

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A graph of the systematic relationship between a products price and a firms most profitable output level

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Perfect Competition
SR industry supply curve

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Is the horizontal summation of the SR MC curves (above AVC) of an industry's firms

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Zero economic profit

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The point at which total profit is zero since price equals the average cost of production

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Producer Surplus

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Gains to producers from the sale of output to consumers, arising from the price exceeding the min necessary to compensate the seller

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Total Surplus

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Consumer Surplus + Producer Surplus

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Efficiency in output

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The condition in which output is expanded to the point where marginal benefit equals marginal cost

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Deadweight loss

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A measure of the aggregate loss in well-being of participants in a market resulting from output not being at the efficient level

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Excess burden

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The deadweight loss produced by a tax
-An excise tax results in a lower output level than usual in a PC. Restricts the output level to where the products marginal benefit exceeds the marginal cost of production

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Excise tax: effects

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SR: all firms incur a loss and have incentive to decrease output, thus increasing price

LR: some firms will exit the industry, output drops further, and the final price ends up being higher than in the short run

More inelastic demand: greater the tax burden on consumers, smaller burden on producers, and the smaller the reduction in output

Perfectly elastic supply: the price to consumers rises by the amount of the tax/unit-regardless of the elasticity of demand

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Price ceilings

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A set max price of the good (by the gov)
-result in a deadweight loss-which is the aggregate loss in well-being of all participants

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Types of taxes

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On producers: leads to higher price and lower output
(Results in loss neg. profit in SR)

Specific: depends on q (gas tax)
-affects MC, VC, TVC, TC, ATC
-shifts ATC by tax/q amt.
-WILL affect the q produced-dec. (b/c MC changed)

Lump sum: does not depend on q (license fee)
-only affects FC-increase, ATC-shifts up by tax amt.
-shifts the S curve y-intercept by the tax amt. (shifts left)
-WILL NOT affect the q produced SR (b/c MC unchanged) only FC is changed-not dependent on q
-LR: q will decrease-with P higher-because firms are exiting the market->drive profit back to zero

Ad valorem: a % of product price (sales tax)
-Can be converted to specific tax-same effects

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Types of subsidies

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On producers: leaders to lower price and higher output. (Results in economic profit in SR b/c ATC<P)

Specific: depends on q
-affects MC, VC, AVC,TC,ATC
-shifts ATC by sub./q amt.
-WILL affect the q produced-inc. (b/c MC changed)

Lump Sum: does not depend on q
-only affects FC-decrease, ATC-shifts down by sub. amt.
-shifts the S curve y-intercept by the sub. amt. (shifts to the right)
-WILL NOT affect the q produced SR (b/c MC unchanged) only FC is changed-not dependent on q
-LR: q will increase-with P lower-because more firms are entering the market->drive profit back to zero

Ad valorem: a % of product price
-Can be converted to specific sub.

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Tax burden

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Who takes the burden depends on: elasticity of supply and demand

*Inelastic supply: producer will produce same amt. no matter the price.
-if demand inelastic: consumer takes the burden (no other option so still consumer-just at the higher price.
-if demand elastic: producer takes the burden (ppl can choose to consume another good-that is now relatively cheaper)

*Elastic supply: burden is shared between producer and consumer-in varying amounts

1 of 74

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The nature and role of theory

answer

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Analysis:
Positive vs. Normative

answer

Positive: assessment of objective outcomes; draws on accepted rules of logic and evidence
Normative: a nonscientific value judgement; subjective- what ought to be

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Opportunity Costs:
Explicit vs. Implicit

answer

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Economic cost

answer

Explicit cost + implicit cost

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Basic Assumptions: market participants

answer

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Preferences

answer

1) preferences are complete
2) preferences are transitive
3) more of any good is preferred to less

question

Indifference curve

answer

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Indifference map

answer

A set of indifference curves
-represents an ordinal ranking

question

Marginal Rate of Substitution (MRS)

answer

A consumers willingness to give up less and less of some other good to obtain still more of the first good
-Is the slope of the indifference curve at each point

question

Categories of Goods

answer

-'Good': when more is preferred to less
-'Bad': when less is preferred to more
-'Neuter': indifferent towards the good

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Perfect Substitutes

answer

When a consumer is willing to substitute one good for another at some constant rate and remain equally well off
-constant MU for both goods
-only substitution effect and NO income effect

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Perfect Complements

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Total Utility

answer

The total satisfaction a consumer receives from a given level of consumption

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Marginal Utility

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The amount by which total utility rises when consumption increases by one unit

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Diminishing Marginal Utility

answer

The assumption that as more of a given good is consumed, the marginal utility associated with the consumption of additional unites tends to decline, other things held constant

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The Budget Constraint

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Budget Constraint: shifts

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The consumers choice

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A Corner Solution

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When the consumers optimal choice is not characterized by an equality between the MRS and the price ration
-Only one good purchased

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Income and Consumption

answer

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The Consumers Demand Curve

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Price Change:
Income vs. Substitution effect

answer

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Income and Substitution effect: Normal good

answer

Both the income and substitution effect imply more consumption at a lower price and less consumption at a higher price

question

Income and Substitution effect: Inferior good

answer

Two possibilities:
1) Substitution effect > income effect
-curve slopes downward
2) Substitution effect < income effect
-curve slopes upward (Giffen good)

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Individual --> Market Demand

answer

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Consumer Surplus (CS)

answer

A measure of the net gain to consumers from purchasing a good arising from its cost being below the max price that consumers are willing to pay (reservation price)

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Total and Marginal Benefit

answer

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Price Elasticity of Demand

answer

The change in quantity demand of a good associated with its change in price

IeI > 1 elastic
IeI = 1 unit elastic
IeI < 1 inelastic
IeI = 0 perfectly inelastic

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Income Elasticity of Demand

answer

The change in quantity demanded of a good associated with the change in income

Ei < 0 inferior good
Ei > 0 normal good

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Cross Price Elasticity of Demand

answer

The change in quantity demand of good x associated with the change in price of good y

Exy < 0 complements
Exy > 0 substitutes

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Inputs:
Fixed vs. Variable

answer

Fixed: variables that cannot be changed due to time constraints- mainly capital- only happens in SR

Variable: all inputs can be changed- happens in both SR and LR

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Diminishing Marginal Returns

answer

Holds that beyond some level, the marginal product of the variable input will decrease as more of the input is used

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Isoquants

answer

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Isocost line

answer

A line that identifies all the combinations of capital and labor that can be purchased at a given total cost
-Similar to budget constraint

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Marginal Rate of Technical Substitution (MRTS)

answer

Shows the technological feasibility of trading one input for another and is equal to the slope of an isoquant

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Returns to Scale

answer

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Returns to Scale: Cobb Douglas Function

answer

Q=L^aK^b
Look at the exponents:
-If a+b > 1 increasing
-If a+b = 1 constant
-If a+b < 1 decreasing

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The Cost of Production

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The Short Run

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The Long Run

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Economies of Scale

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When a firms output increases more than proportionally with a change in total input cost

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Diseconomies of Scale

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When a firm can increase its output more than proportionally to its total cost

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Individual Cost Curves

answer

Are based on the assumption that input prices are given
-A change in one or more input prices causes the cost curve to shift

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Cost:
SR vs. LR

answer

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Economies of Scope

answer

A case where it is cheaper for a single firm to produce an array of products than it is for an array of separate firms to independently produce distinct products

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Diseconomies of Scope

answer

A case where it is cheaper for separate products to be produced independently than for one firm to produce the same products jointly

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Minimum efficient scale

answer

The scale of operations at which average cost per unit reaches a min

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New entrant/survivor technique

answer

A method for determining the minimum efficient scale of production in an industry, based on investigating the plant sizes either being built or used by firms in the industry

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Costs

answer

TFC= total fixed cost (capital)
TVC= total variable cost (labor)
TC= FC+VC
AFC= FC/Q
AVC= VC/Q
ATC= TC/Q
MC= change in TC/1 (change in Q=1unit)

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Perfect Competition

answer

1) A lot of buyers and sellers-price takers
2) No barriers to entry and exit
3) Homogeneous products
4) Perfect information
5) Zero economic profit

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Demand for Perfect Competition

answer

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Perfect Competition
Optimal Output

answer

Where P=MR=MC
-BUT P must be at least as high as AVC or the firm suffers a loss in excess of TFV

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Perfect Competition
The Supply Curve: Short Run

answer

-Is the MC curve as long as MC>AVC

-Is upward sloping because the law of diminishing returns implies that each firms MC slopes up

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Perfect Competition
The Supply Curve: Long Run

answer

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Perfect Competition
Profit-max assumption

answer

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Perfect Competition
LR industry supply curve: shape

answer

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Survivor principle

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Revenue and Profit

answer

TR: PxQ
AR: TR/Q
MR: delta TR/delta Q(=1 unit)

TP(pi): TR-TC
AP: TP(pi)/Q

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Perfect Competition
SR: shut down point

answer

When P < AVC -operations will cease in the SR

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Perfect Competition
LR: equilibrium

answer

The most profitable output level
-LMC=MR=P
-LAC=AR so no economic profit

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Perfect Competition
Long Run Industry Supply Curve

answer

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Perfect Competition
SR firm supply curve

answer

A graph of the systematic relationship between a products price and a firms most profitable output level

question

Perfect Competition
SR industry supply curve

answer

Is the horizontal summation of the SR MC curves (above AVC) of an industry's firms

question

Zero economic profit

answer

The point at which total profit is zero since price equals the average cost of production

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Producer Surplus

answer

Gains to producers from the sale of output to consumers, arising from the price exceeding the min necessary to compensate the seller

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Total Surplus

answer

Consumer Surplus + Producer Surplus

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Efficiency in output

answer

The condition in which output is expanded to the point where marginal benefit equals marginal cost

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Deadweight loss

answer

A measure of the aggregate loss in well-being of participants in a market resulting from output not being at the efficient level

question

Excess burden

answer

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Excise tax: effects

answer

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Price ceilings

answer

A set max price of the good (by the gov)
-result in a deadweight loss-which is the aggregate loss in well-being of all participants

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Types of taxes

answer

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Types of subsidies

answer

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Tax burden

answer

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Intermediate Microeconomics

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