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Productive Efficiency
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Producing goods in the least costly way
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Allocative Efficiency
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Resources are used for providing what society wants
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Relationship between Productive and Allocative Efficiency
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Productive can occur without allocative, allocative needs productive
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Reasons for a shift right in the PPC
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Economic growth - increase in resources, improved resources, technological advancements
How to experience economic growth? Produce more capital goods!
How to experience economic growth? Produce more capital goods!
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Why does PPC bow outwards from the origin?
answer
Increasing opportunity costs - 1st resources to be switched over when producing the other good are easily adaptable, become more specialized over time
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Where to produce for allocative efficiency
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MB = MC
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Absolute Advantage
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When one party produces more of one product given the same resources
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Comparative Advantage
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When one party produces a good at a lower opportunity cost (used to determine specialization)
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Substitution Effect
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Shows change in demand due to price change of a product (consumers will replace items with less expensive ones)
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Income Effect
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Shows change in demand due to change in purchasing power/real income
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Price Ceiling
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Maximum price is set, creates a shortage
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Price Floor
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Minimum price is set, creates a surplus
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How to Shift Demand
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Change in...
- Consumer tastes
- # Buyers
- Income
- Expectations
- Substitutes/compliments
- Consumer tastes
- # Buyers
- Income
- Expectations
- Substitutes/compliments
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How to Shift Supply
answer
Change in...
- Resource prices
- Production Technology
- Taxes/subsidies
- # Sellers
- Expectations
- Price of other goods produced using same resources
- Resource prices
- Production Technology
- Taxes/subsidies
- # Sellers
- Expectations
- Price of other goods produced using same resources
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Price elasticity of demand
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% ∆ Quantity Demanded
----------------------------
% ∆ Price
----------------------------
% ∆ Price
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Price elasticity of demand - Elastic, Inelastic or Unit Elastic?
answer
E > 1, elastic
E < 1, inelastic
E = 1, unit elastic
E < 1, inelastic
E = 1, unit elastic
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Elasticity on Linear demand curve
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Top --> Elastic
Middle --> Unit
Bottom --> Inelastic
Middle --> Unit
Bottom --> Inelastic
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Total Revenue Test
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TR = P x Q
If TR changes in opposite direction of price --> Elastic
Same direction --> Inelastic
Doesn't change --> Unit Elastic
If TR changes in opposite direction of price --> Elastic
Same direction --> Inelastic
Doesn't change --> Unit Elastic
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Cross Elasticity of Demand (Substitutes or Compliments)
answer
% ∆ Quantity of Good X
---------------------------
% ∆ Price of Good Y
---------------------------
% ∆ Price of Good Y
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Substitute or Compliment? (Using Cross Elasticity)
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Positive --> Substitutes
Negative --> Compliments
Zero --> Independent
Negative --> Compliments
Zero --> Independent
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Income Elasticity (Normal or Inferior)
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% ∆ Quantity Demanded
----------------------------
% ∆ in Income
----------------------------
% ∆ in Income
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Normal or Inferior? (Using Income Elasticity)
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Positive --> Normal/Superior
Negative --> Inferior
Negative --> Inferior
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Total Utility
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Total consumer benefit from all units
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Marginal Utility
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Extra benefit from last unit (∆ total utility/∆ price)
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Utility Maximizing Combination
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MUa MUb
----- = ------
Price a Price b
(To make one side go down, buy more of it)
----- = ------
Price a Price b
(To make one side go down, buy more of it)
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Producer Surplus
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Area above supply curve, under price line
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Consumer Surplus
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Area below demand curve, above price line
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Normal Profit
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Zero economic profit; no incentive to change behavior
Total revenue = Total costs
Total revenue = Total costs
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Short Run resources
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Some fixed, some variable (barrier to exit)
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Long Run resources
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All variable (free exit)
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Law of Diminishing Marginal Returns
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Adding input leads to less output
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Total revenue
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Price x Quantity sold
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Total cost
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AFC + AVC
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Average Variable Cost
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Total Variable cost / Quantity
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Average Fixed Cost
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Total Fixed cost / Quantity
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Marginal Cost
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∆ Total Cost / ∆ Quantity
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Marginal Revenue
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∆ Total Revenue / ∆ Quantity
*Equivalent to MVC, MFC is always 0
*Equivalent to MVC, MFC is always 0
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Total costs graphically
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Space between TC and TVC is TFC, TFC is constant
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ATC always intersects MC at...
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The minimum of ATC
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Economic Profit
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Price > ATC
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Economic Loss
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Price < ATC, variable costs still covered
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Shut Down
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Price < all costs
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Economies of Scale
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Cost per unit decreases
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Constant Returns to Scale
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Costs stay the same
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Diseconomies of Scale
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Cost per unit increases
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Economies of Scale for small firms
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Quickly exhausted --> Diminishing marginal returns
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Profit Maximizing Output
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MR = MC
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Profit Equation
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Profit = (P-ATC) x Quantity
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Long Run Equilibrium in Perfect Competition
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MR = MC = ATC
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Deadweight loss in Monopolies
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Area between Quantity monopoly produces and Equilibrium Quantity (Between MR = MC and D = MC)
Points in direction society wants it to go
Points in direction society wants it to go
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Price Discrimination in Monopolies
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Used to increase profit, everyone pays what they are willing to pay
MR = Demand curve, no deadweight loss because socially optimal output is achieved ( MC = D, same thing as S = D)
MR = Demand curve, no deadweight loss because socially optimal output is achieved ( MC = D, same thing as S = D)
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Long Run outcome for Monopolistic Competition
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Normal Profit
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Excess Capacity
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Difference between minimum ATC output and profit maximizing output
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Dominant Strategy
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A player's best strategy regardless of what the other player does
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Nash Equilibrium
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An outcome that both sides wouldn't deviate from (when both dominant strategies are achieved)
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Tit-For-Tat
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Player cooperates at first, then just emulates what the other player did in the last round
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Marginal Revenue Product (MRP)
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∆ TR / ∆ L
In perfectly competitive markets, MP x Price output
In perfectly competitive markets, MP x Price output
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Marginal Resource Cost (MRC)
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∆ TC / ∆ L
In perfectly competitive markets, Wage rate
In perfectly competitive markets, Wage rate
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Why does MRP slope downwards?
answer
Diminishing marginal returns - you wouldn't want to hire someone who brings in less than they cost you
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How to Shift the Demand Curve for Labor
answer
Changes in...
- Demand for product
- Productivity of resource
- Price of other resources (substitutes/compliments)
- Demand for product
- Productivity of resource
- Price of other resources (substitutes/compliments)
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Profit Maximizing Combination (Labor v. Capital)
answer
MRP l MRP c
------- = -------
P l P c
------- = -------
P l P c
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Least Cost Output (Labor v. Capital)
answer
MP l MP c
------ = ------
P l P c
------ = ------
P l P c
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Why is MRC above Supply in Monopsony?
answer
When wages increase for one person, they have to increase for everyone
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Demand Enhancement Union
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Increases wages by increasing demand
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Exclusive/Craft Union
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Increases wages by decreasing supply (leads to fewer hires)
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Inclusive/Industrial Union
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Won't settle for less than demanded wage (creates surplus)
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Effect of Minimum Wage
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Labor surplus (demand outweighs supply)
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Public Goods are...
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Nonrival (one person's benefit doesn't reduce that of others)
Nonexcludable (those who don't pay can still enjoy)
Nonexcludable (those who don't pay can still enjoy)
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Optimal amount of a public good
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MB = MC
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Negative Externality
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Marginal social cost > Marginal private cost (too much output produced)
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Positive Externality
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Marginal social benefit > Marginal private benefit (too little output produced)
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Horizontal Equity
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Equally situated people taxed equally
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Vertical Equity
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Unequally situated people taxed unequally (ability-to-pay)
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Tax burden with Inelastic Demand
answer
Falls on consumers
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Tax burden with Elastic Demand
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Falls on producers
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Gini Ratio
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Area between curve & diagonal
-----------------------------------
Total area below diagonal
Higher ratio = more inequality
-----------------------------------
Total area below diagonal
Higher ratio = more inequality
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Economic Rent
answer
Extra payment for labor that doesn't change the quantity supplied (difference between what you're willing to work for and what you get)
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