Book #2 -- Microeconomics

Exciting to have Book #2 almost ready!

Videos for the Micro class .....

For more information on the following economic concepts, click on the links below.

  Scarcity, Choice, Rational Self-Interest, etc.

  Macroeconomics vs. Microeconomics 

  Positive vs. Normative Economics

  Graphs

  Individual PPC

  Opportunity Cost
Just a short note about the definition of "full cost" shown in the Opportunity Cost video.  It should read:
Opportunity Cost = Direct (or Explicit) Cost + Indirect (or Implicit) Cost

  Law of Demand 

  Demand vs. Quantity Demanded

  Law of Supply

  Market Equilibrium

  Price Floors & Price Ceilings

  Price Elasticity of Demand      

  Characteristics that Determine Elasticity

  Diminishing Marginal Utility

  Indifference Curve Analysis

  Producer Theory
   
  Short Run vs. Long Run

  Accounting Cost vs. Economic Cost

  Fixed and Variable Costs

  Cost Curves

  Do we really need all those diagrams?

To my current econ students .....

Remember to bring your answer to the problem I gave in class on Thursday ---

Update the CPI values (all three years) if the base year was 2011 instead of 2010.  Use the market basket totals ($7.50, $5.25, $3.75) and the CPI formulas.  Be sure to multiply by 100.

                                                   

Coming Soon ...

... more mini-lectures on Microeconomics!  Check back for updates and more info and hopefully, the semester is going well so far.

Economies of Scale

Suppose L = 1 and K = 2 and the prices of each input are $10 so that TC = $30.  The Q produced is equal to 5 so that AC = TC/Q = $6.  If both inputs double (i.e., L = 2 and K = 4) and Q triples so that Q = 15, will AC rise, fall, or stay the same?  Is this an example of increasing, decreasing, or constant returns to scale?  Is this an example of a short run or long run concept, and why?

Marketing #5

Economic Rent

Economic rent is the difference in the amount of money that an individual would be willing to work for, and the amount that they are actually paid. Consider a rock star, or a sports figure who earns, say, a million dollars each year, but would actually be willing to work for $100,000/year. Economic rent, then, equals $900,000 which is a payment provided to the individual (or any type of input) due to their "uniqueness". Another way of thinking about this concept is that an increase in wages will not increase the quantity of labor supplied because the equilibrium wage (which ultimately determines economic rent) is primarily a function of DEMAND for an individual input since supply is relatively fixed.

Marketing #4

Backward-bending Labor Supply

An individual's labor supply curve will have an upward-sloping range and then eventually will start to bend backward.

Consider this question:  When you get a pay raise, does the raise cause you to work more hours, or less hours? (With respect to this question, assume that you have the ability to choose how many hours you'd like to work.)

[Note:  Refer to the graph below.]

The labor supply curve begins at point A with what's referred to as a "reservation wage" (i.e., the lowest wage you would be willing to give up your leisure time for).  In the upward-sloping range, as the wage increases, the quantity of labor hours supplied also increases.  (Digression:  W and L are positively related here because the substitution effect between labor and leisure exceeds the income effect of the wage increase.)

However, at a particular wage (and this wage is different for different individuals), the income effect will dominate the substitution effect, and as the wage increases, the quantity of labor supplied will start to decrease.  W and L are inversely related in this region because when the wage rises, the individual feels "richer", and chooses to work less, not more.

Marketing #3

Kinked Demand Curve

The kinked demand curve model shows that oligopolists tend to keep prices stable, and use other means (increased advertising, rebates, and other incentives, etc.) to generate business.

The KDC model comes from analyzing two separate demand curves that the oligopolist faces --- a flat D curve (more elastic) and a steep D curve (more inelastic), and using the relevant portion of each demand curve for potential price increases or decreases.

Consider the idea of "mutual interdependence" among rival firms A, B, and C.  The idea behind this model is that when one of the competing firms (say, Firm A) raises its price, the other firms do NOT follow that action.  Firms B and C intend to increase their own sales and market share by being the lower-priced competition. 

Alternatively, if Firm A lowers its price, then that price decrease will be matched by the other rival firms also with the intent of increasing sales and market share.

[Note:  Show the graph here.]

The "kinked" demand curve gets its name from the fact that for price increases, Firm A's relevant demand curve is "elastic" but for price decreases, the relevant demand curve is "inelastic".  Since TR will fall in either case*, the model concludes that mutually interdependent firms are very likely to keep prices stable.

* Recall that when P rises and demand is elastic, TR will fall and also when P falls and demand is inelastic, TR will also fall.

Marketing #2

Concentration Ratio

One of the characteristics of this model is that of a "high" concentration ratio defined as the percentage market share belonging to the top 4 (top 8, top 20, or top 50) firms in the industry. For example, the CR4 measures the market share of the largest 4 firms in their respective industry, the CR8 measures the market share of the largest 8 firms, and so on .......

The term "high" CR4 is relative (as is the term "few" which measures the number of firms in the industry). In fact, whether an industry is considered "oligopolistic" or not, depends on the combination of two concepts interacting together --- the number of firms in the industry as well as the industry's concentration ratio.

Hypothetically, suppose there are 7 firms in the Chewing Gum Industry (listed in alphabetical order) where the percentage market share of each firm is as follows:

Firm A = 40%
Firm B = 5%
Firm C = 20%
Firm D = 6%
Firm E = 25%
Firm F = 2%
Firm G = 2%

Find the CR4. Find the CR8.

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Answers:  CR4 = 91%, CR8 = 100% and with only 7 firms in the industry (combined with a relatively very high CR4), we can conclude that the Chewing Gum Industry is indeed oligopolistic.

Marketing #1

Long Run Scale of Production

Economies of Scale = Increasing Returns to Scale
Diseconomies of Scale = Decreasing Returns to Scale
Also Constant Returns to Scale --- a very important assumption in economics, in general.

Something to note is that "The Law of Diminishing Marginal Returns" is a short run, not a long run concept, and doesn't apply to the topic of Economies/Diseconomies of Scale.

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Let's assume that a firm doubles its inputs. Instead of L = 1 and K = 1, let's suppose that L = 2 and K = 2. [Note that since all inputs are now "variable", this is a long run, not a short run, situation!]

When inputs (L and K) double, one of three things will potentially happen to output:

Output more than doubles (Q > 2) then AC will fall .... called Economies of Scale
Output less than doubles (Q < 2) then AC will rise ... called Diseconomies of Scale
Output exactly doubles (Q = 2) then AC is constant ... called Constant Returns to Scale

To confirm what happens to AC, first determine why TC rises when inputs double. Remember that AC = TC/Q.

[Note:  Show graph of LRAC here.]

Preparing for the Final!

Christian,
If you have time, and interest, check out the review sheets I left for you at the house with your books; however, if you don't have time to study everything, at least be sure to hit the highlights:


-- scarcity & opportunity cost
-- what factors cause the demand or supply curve to "shift" and the effect on equilibrium price and quantity
-- price ceilings and floors --- persistent shortages or surpluses
-- be able to calculate price elasticity of demand, state whether something is elastic, inelastic, or unit elastic, and determine the effect on total revenue
-- finding MU if given TU
-- determining the optimal purchase
-- Law of Diminishing Marginal Utility
-- short run vs. long run
-- accounting cost (profit) vs. economic cost (profit)
-- what is a production function?  what is a cost function?
-- understand how to determine TC, FC, VC, ATC, AFC, AVC, MC, implicit cost, explicit cost, economic cost, accounting cost, TR, etc.
-- Law of Diminishing (Marginal) Returns
-- economies/diseconomies of scale
-- characteristics of perfect competition (monopoly, oligopoly, etc.)
-- short run (and long run) equilibrium
-- fundamental rule of profit maximization (MR = MC pr P = MC for perfect competition)
-- concentration ratio
-- kinked demand curve
-- Anti-trust Laws
-- negative externalities (MSC > MPC)
-- two characteristics of public goods
-- calculating present value
-- Pareto efficiency, if you got this far


All the best, and love,
mom

Capital, interest, and corporate finance ...

Christian,

This topic should finish up the course --- WOW, last chapter! Just want to say that you did so well this semester as microeconomics is one of those courses that tends to "weed out" the non-serious students, and you worked hard, stayed on task, and got good grades. OK, great grades!

So awesome!

I'll come back to this topic in the next day or two, and until then ...

Love you, and keep studying,
mom

Market Failure --- Government Failure

An aside:

Economists and others can be fully aware of market failures and still be in favor of the market system anyway. Why? Because of government failures, such as lags in identification, decision-making, implementation, etc., not enough information or no incentive to correct the problem, the recognition of unintended consequences, etc., etc., etc.

Market Failure --- Public Goods

Remember the two essential characteristics of pure public goods:


1. non-excludability meaning that no one (not even "non-payers" or what's referred to as "free-riders") can be excluded from consuming the good or service


2. Non-depletability meaning that an additional consumer won't diminish the amount left over for someone else


To be considered a pure public good, both characteristics must hold!


To see the difference between "public" and "private" goods, first consider a private good such as the purchase of a movie ticket. Since non-payers will not be allowed in the theater, non-payers (i.e., free-riders) are excluded from consuming the good; therefore, the non-excludability characteristic does not hold.

Also with private goods, such as a new automobile or a stereo, when someone makes a purchase, there is one less car or stereo left over to sell to someone else; therefore, the non-depletablity characteristic does not hold.


Can you think of a good or service for which only one of the two above characteristics holds? Name any examples that you can think of.

------------------------------------------------

Now consider public tv and radio, both good examples of public goods. Can anyone be excluded from watching public tv or listening to public radio? Does the non-excludability characteristic hold?

If one more person turns on their radio or tv, is there less product available for others? Does the non-depletability characteristic hold?

Can you name some other examples of public goods? There are several.

Market Failure --- Externalities

Christian,

I know you're focused on this topic right now; however, I wrote some things about it earlier on 3/2/10. Positive externalities generally lead to a discussion of public goods, the next topic discussed here on 4/18/10.

Much love,
mom

marginal benefit = marginal cost

An aside:

By this point, it should be clear that all optimal decisions involve setting marginal cost equal to the marginal benefit. Why?
Consider the following .......

If marginal benefit > marginal cost, then it's better to increase production (or consumption)
If marginal benefit < marginal cost, then it's better to decrease production (or consumption)
So, only when marginal benefit = marginal cost, there is no further tendency to make changes ..... and thus the situation is considered to be in equilibrium whether it's the input market, output market, etc. Not convinced that MB = MC is the best outcome? Reread the chapter on perfect competition and remember that this result applies to optimal decisions (production, consumption, number of hours to work, etc.) assuming no externalities. If negative externalities exist, and the MSC > MPC, then the optimal outcome is met when MB = MSC.

[Note: MPC = marginal private cost, MSC = marginal social cost, and MSC > MPC if there are negative externalities]

Value of the Marginal Product

The demand for inputs is considered to be, and referred to as, a "derived demand" since the amount of inputs hired actually comes from demand for the product that the inputs produce. Labor (and, of course, all other inputs) has demand ONLY because of the demand that exists for the end result --- the product (or service) that labor & the other inputs produce. Obviously.

However, the essential point to understand in the input (or resource) market is a concept called the "value of the marginal product". While the idea of the VMP isn't too complicated, it requires a few new graphs, and an understanding of some earlier concepts such as Diminishing Marginal Returns, Marginal Physical Product, and how the price of the output produced is determined. To make the analysis easier, we'll assume some characteristics talked about in perfect competition too.

And, as expected, the concept of elasticity applies to the VMP as well, and its elasticity is affected by factors such as: time, how easily other inputs can be substituted, the price elasticity of the output* produced, and the share of total cost that the input represents.

(*and where the price elasticity of the output also depends on time, the number of substitutes available, the cost of the output relative to other things that could be purchased instead, whether the output is a necessity or a luxury, etc.)


Keep this in mind ---
VMP = MP times the price of the output = MRP

Much more to follow, including a discussion of MRP.

Economic Rent

Economic rent is the difference in the amount of money that an individual would be willing to work for, and the amount of money that they are actually paid. Consider a rock star, or a sports figure who earns, say, a million dollars each year, but would actually be willing to work for $100,000/year. Economic rent, then, equals $900,000 which is a payment provided to the individual (or any type of input) due to their "uniqueness". Another way of thinking about this concept is that an increase in wages does not increase the quantity of labor supplied.

More later as this concept applies to any input, not just labor.

Another note to Christian

Christian,

You'll be wrapping up your micro course this semester by studying a few more international trade topics (recall absolute and comparative advantage, gains from specialization, etc.) such as free trade vs. protectionism, exchange rates, balance of payments, etc..

Since we have a few weeks before these topics become crucial to know, I'm going to back-up and complete some of the previous topics where I may have said "more to follow".

All the information, beginning with "Theory of the Firm" goes together, so we can continue to work on it until it all falls into place for you.

Love you,
mom

Poverty and Income Inequality

There are two types of poverty --- relative poverty and absolute poverty. Know the distinction between these two types and give an example of each. Definitions are in the text.

Also, be sure to take a look at how the "Gini coefficient" is calculated as it measures the range of income inequality in an economy.