Economics I

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Economics - I
Mapping to Curriculum
Reading 13: Demand and Supply Analysis: Introduction Reading 14: Demand and Supply Analysis: Consumer Demand Reading 15: Demand and Supply Analysis: The Firm Reading 16: The Firm and Market Structures
This files has expired at 30-Jun-13 Expect around 12 questions in the exam from todays lecture
Neev Knowledge Management Pristine
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Key Concepts
Shift in Demand and Supply Curve Price Ceiling Elasticity Subsidies Substitution and Income Effect Total, Average and Marginal Revenue Profit Maximization under Imperfect Competition Economic Profit This files has expired at 30-Jun-13 Kinked Demand Curve Oligopoly Games
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Types Of Markets
Types of markets are broadly classified into :
Markets for factors of production, eg : labor Markets for services and finished goods, eg : Clothes Firms are buyers in factors of production and sellers in services and finished goods Intermediate goods are used in production of finished goods and services Capital markets is place where savings are converted into investments. Firms raise capital through these markets in the form of debt or equity
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Demand/ Supply Curve

Why is the demand curve downward sloping?
Diminishing marginal benefits Marginal Benefit (Utility)= Willingness to Pay=Price
Imp
Why is the supply curve upward sloping?
Increasing marginal costs Marginal Cost = Minimum Price
Demand Curve
P=Marginal Benefit
Supply Curve
P=Marginal Cost
Quantity
MB = WTP = Pmax Maximum Price Buyer is willing to pay MC = Pmin
Quantity
Minimum Price Supplier is willing to receive
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Shifts In And Movement Along Demand Curves
Imp
With the change in price, quantity demanded and supplied can be represented by movement along the demand or supply curve Other than price, changes in independent variables will cause shift in demand and supply curves Example : Change in income causes a shift in demand curve Increase in input will lead to decrease in supply
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Movement Along Demand And Supply Curves

With an increase in price from P0 to P1 the quantity demanded decreases from Q0 to Q1 This is represented by movement along the demand curve With an increase in price from P0 to P1 the quantity supplied increases from Q0 to Q1 This is represented by movement along the supply curve
Price Price Supply Curve Demand curve P1 P0
This files has expired at 30-Jun-13 P1

P0
Q1
Q0
Quantity
Q0
Q1
Quantity
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Shift In Demand And Supply Curve

A change in factors like increase/decrease in income causes the demand curve to shift A higher income leads to increase in demand, causing a upward shift in demand curve Shift in supply curves occur when there is change in input cost like labor Suppose that wage rate increases which increases the cost of goods produced leads to a decrease in supply and shift upwards
Price
Price

Increase in demand
Decrease in supply
Original supply curve
Decrease in demand
Increase in supply Original Demand curve
Quantity
Quantity
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Aggregating Demand & Supply

Allocative Efficiency
Price
Allocative Efficiency: It is nothing but efficient

Supply (MC)
allocation of resources AE occurs at an output level where price equals
MB>MC p*
marginal Cost (MC) of production because the

price that consumer's are willing to pay is
This files has expired at 30-Jun-13 equivalent to the marginal utility that they get
MC>MB Demand (MB)
q* Quantity
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Movement Towards Allocative Efficiency

Price, p (Rs/kg) Supply (MC) Supply (MC) Excess supply Price, p (Rs/kg)
p1
p* Falling price Demand (MB) p* p2 Demand (MB) Rising price
Excess demand This files has expired at 30-Jun-13
Quantity, q (kg) qd(p1) q* qs(p1) qs(p2) q* qd(p2)
Quantity, q (kg)
A) Movement towards Allocative efficiency
B) Movement Towards Allocative efficiency
The price is always set by the demand curve & not by the supply curve. Thus, in figure: a) The price will be p1 & quantity will be qd b) The price will be p2 & quantity will be qd
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Stable And Unstable Equilibria

A stable equilibrium is when forces move price and quantity towards equilibrium values, whenever there is deviation. When the supply curve is downward sloping, there is a stable equilibrium as long as the supply curve cuts the demand curve from above. The demand and supply are both negatively sloped
Price Excess supply S S Excess supply
Price

Stable equilibria Excess demand D Quantity
Excess demand
D Quantity
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Stable And Unstable Equilibria

If the demand curve is steeper resulting in the When the supply curve is non linear, there are two supply curve intersecting the demand curve from equilibrium one stable and the other unstable below. So in a price above equilibrium there is excess demand than supply leading prices away from equilibrium, making the equilibrium unstable
Price Price
S
Excess demand
Unstable equilibrium

Unstable equilibrium
Excess supply
Stable equilibrium
S
Quantity
D
Quantity
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Demand And Supply Functions

Example: Given a supply function as : -1600+280P Demand function as : 8640-360P Calculate and interpret the equilibrium price
Solution: We solve the equilibrium price(P) by equating the function equal to each other So,
This -1600+280P=8640-360P
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The equilibrium price is equal to : 16
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Non- Equilibrium Excess Demand And Supply

In the previous if the price is 13 the quantity demanded will be 8640-360(13)= 3960 The quantity supplied at this price will be -1600+280(13)=2040 The excess demand is : 3960-2040 =1920 If the price is 18, the quantity demanded will be 8640-360(18)= 2160 The quantity supplied is : -1600+280(18)= 3440 The excess supply is : 3440-2160= 1280
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Auctions
Auction is a way of determining equilibrium price. Categorized in two types : A) Common value auction B) Private value auction In common value auction the value of a item is same for any bidder, but bidders do not know the value at the time of the auction In a private value auction every bidder places a subjective bid on the item and the value to each bidder differs

Ascending price auction: Bidders in a auction can bid on a value greater than the previous high bid. The bidder with the highest bid wins the item and pays the amount Sealed bid auction : Every bidder provides with their own bid, which is unknown to other bidders, the bidder with the highest bid wins the item and pays the price. Eg: A tender offer Reservation price refers to the highest price that a bidder is willing to pay Second price sealed bid auction : The bidder with the highest bid wins the item but pays the value bid by the second highest bidder Descending price auction(Dutch auction) : This auction begins with a price that is greater than any bidder agrees to pay, the price is slashed until a bidder agrees to pay it.
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Auctions
Auctioning treasury bills with a single price auction : In US Treasury securities, a single price auction is held but bidders can also submit a non-competitive bid indicating that those bidders will accept the amount of treasuries indicated at the price determined by the auction, rather than specifying a maximum price in their bids. The amount of securities specified in the noncompetitive bid is subtracted from the total amount to be sold. Example: Suppose there is $60 billion face value of Treasury bill to be auctioned and there is Noncompetitive bids application of $5 billion face value of bills.
This files expired at 30-Jun-13 Discount Rate (In%) Face Valuehas Cumulative FV
0.1082 0.1088 0.1094 0.1098 0.1106 0.1118 0.1125 9 16 11 12 10 5 5 9 25 36 48 58 63 63
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Solution
The total face value of bills offered is $60 billion, and there are noncompetitive bids for $5 billion So we must select the maximum price, that is the minimum yield for $55 billion($60-$5) face value of bills that can be sold to make bids competitive. So at a discount rate of 0.1098%, $48 billion face value bills can be sold to make bids competitive. The pending $7 billion should be sold at higher rate of 0.1106% The single price for the auction is 0.1106%
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Consumer Surplus (CS)
Imp
Price, p (Rs/kg)
CS
Supply (MC)
CS = V - P
Consumer Surplus = Value what

customer receive - Price what customer pays
p*

Demand (MB)
Quantity, q (kg) q* Consumer surplus (CS)
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Price And Value

Price, P (Rs/kg) 10 9 8 7 6(p*) Market Price Surplus from 3rd kg
Price what is actually paid Value what one is willing to pay p* - Price what the consumer pays (equilibrium Price)
Demand=Marginal Benefit 1 2 3 4 5 Quantity, q (kg)
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Cost, Price & Producer Surplus (PS)
Price, p (Rs/kg)
Supply (MC)
Production Surplus = Price - Cost

p*

Demand (MB)
PS Quantity, q (kg) q* Producer Surplus
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CS, PS And Equilibrium
Imp
Price, p (Rs/kg) CS
Supply (MC)
Allocative Efficient (CS + PS) maximizes Equilibrium
p*

Demand (MB)
PS
Quantity, q (kg)
q* Producer and consumer Surplus
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Causes Of DWL
Monopoly: e.g. OPEC, Indian Railways
Price Controls: rent control, flooring price like minimum wages

Taxes and trade restrictions: subsidies & quotas Externality: e.g. polluting (cost), park (benefit) Public goods: free rider, tragedy of commons e.g. national defense
Government restrictions in the form of taxes, subsidies, quotas, price ceiling, price floor all cause This files has expired at 30-Jun-13 a imbalance in the quantity demanded and quantity supplied. These restriction create a dead weight loss. Inefficiency occurs because of : Price Ceiling : Eg- Rent control Price floor : Eg- Minimum wage Taxes and trade restrictions : In the form of subsidies and quotas Public goods and common resources External Costs External benefits
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Deadweight Loss (DWL)

Situation where people dont buy goods despite
Deadweight Loss Price, p (Rs/kg) CS
marginal benefit are higher than marginal cost OR buy goods when marginal cost is higher than marginal benefit Causes reduction in consumer surplus OR
pq p*
DWL
Supply (MC)
production surplus Price Ceiling: Producers produces less
This files has expiredcausing at 30-Jun-13 underproduction

Price Floor: Producers charges more than
Demand (MB)
pc
what customer is willing to pay
PS
qc q*
Quantity, q (kg)
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Price Ceiling
Price Impact of Price Ceiling Price Impact of Price Floor
Demand
Pw
s
Supply
Dead Weight Loss Ceiling Qtax
Floor Price
Pc

Quantity Qs Qd

Quantity
Qd Qe Qs
An upper limit on the price which a seller can charge

Price ceiling above the equilibrium price (EP): No effect Price ceiling below the Equilibrium Price: Supply will fall short of demand In such a situation consumers will be willing to pay an opportunity cost to make purchases
Causing deadweight losses due to reduction in quantity exchanged
A price floor is a minimum price that a buyer can offer for a good, service, or resource. PF < EP = No effect PF > EP = Supply will exceed demand at the floor price Causes loss of efficiency (deadweight loss) because the quantity actually transacted at PF is less than the efficient equilibrium quantity.
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Incidence Of Tax
Imp
Tax: Difference between what buyers pay and what sellers gets per unit Hence a tax on a good or service
Increases its equilibrium price and decrease its equilibrium quantity because of the deadweight loss created
Tax Revenue = Tax * Equilibrium Quantity Actual and statutory incidence of tax:
Actual: Who actually bears tax buyer in the form of high prices paid or seller in the form of less prices received Statutory: Who is legally responsible to pay tax
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Elasticity Of Supply & Demand Influence The Incidence Of A Tax

High elasticity causes less tax burden on that party hence
If supply is Less elastic (i.e., the supply curve is steeper) than demand, consumers will bear lower taxes than suppliers If demand is Less elastic (i.e., the demand curve is steeper) than supply, opposite occurs
High inelasticity causes less deadweight loss because

It occurs due to lack of substitutes or options with suppliers or /and buyers causing less effect on equilibrium quantity
Elastic Supply Curve Price D Ptax PE Ps Dtax
Tax revenue from buyers
Inelastic Supply Curve Price

D S DWL Ptax PE Ps Dtax
DWL
Tax revenue from sellers
Qtax
QE
Quantity
Qtax
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QE
Quantity
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Demand Elasticity And Incidence Of Taxation

Price D S Ptax PE PS
Stax
Price D
Stax
S Ptax PE PS
DWL
DWL
Quantity Qtax QE Elastic Demand Curve
Quantity Qtax QE Inelastic Demand Curve
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Subsidies
Through subsidiaries, governments compensates producers for difference between actual price of the goods and price at which goods sold. A subsidy raises marginal cost (supply costs curve) above marginal benefits (demand curve) This leads to a deadweight loss from overproduction.
Price, p (Rs/kg) CS Supply (MC)
Price Subsidy Price ($ per ton) S
105 90
S - Subsidy
A
p*
75 30-Jun-13 This files has expired at 60
Demand (MB) PS
45 30
Dead weight loss from over production (C)
$30subsidy
D
Quantity increases Quantity (million of tons (per year)
Quantity, q (kg)
q* Producer and consumer Surplus
15 30
60
90
120
150
180
In equilibrium, Area A= consumer surplus Area B= producer surplus
With Subsidy there is a dead weight loss denoted by area C
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Production Quotas
Govt. imposes an upper limit on the produced quantity of a good over a specified time period.
Causes reduction in the quantity produced leading to an inefficient allocation of resources and a deadweight loss to the economy Increases the market price and lowers the marginal cost of producing the quota quantity
Production Quotas Price ($ per ton) 105 90

MB Quota
S
75
60 45 30 15
MC Quota
Dead weight loss from underproduction

D Quantity produced decreases to quota amount =60 Quantity (million of tons (per year) 60 90 120 150 180
30
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Elasticity
Elasticity
Imp
EP %Demand %Price
Price Elasticity
Income Elasticity
Substitutes: cross elasticity>0

E.g. Airtel and Reliance
Complements: This files has cross elasticity<0
Normal Goods: expired at Elasticity 30-Jun-13 Income >0
Inferior Goods: Income Elasticity<1z E.g. Bus Travel
E.g. Car and gasoline
Necessities: Income Elasticity = 0 to 1 E.g. Bread
Luxuries Income Elasticity > 1 E.g. Car
Note: Price Elasticity for substitutes & complements is known as cross-price elasticity
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Price Elasticity
Price Elasticity
Price
Imp
Price Elasticity of Demand is affected by :
Availability of Substitutes
E.g. wheat and rice, gasoline

Share of Total Budget spent on Good
E.g. Car vs toothpaste

Time
E.g. Oil demand after 1970 oil shock

Value
Perfectly Elastic
Implication
Ed = 0
1 <Ed < 0 Ed = 1
Perfectly inelastic.
Relatively inelastic. Unit (or unitary) elastic.
Relatively Elastic
Relatively Inelastic Perfectly Inelastic
< Ed < 1 Relatively elastic. Ed= Perfectly elastic.
Quantity/Time
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Price Elasticity Of Supply

%Q Supply %Price
Imp
Measure of the responsiveness of the quantity supplied to changes in price Price Elasticity of Supply
Affected by:
Availability of resource substitutes E.g. Gold vs. rice
Supply decision time frame: Short-term Long-term
Momentary (immediate)
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Total Revenue & Price Elasticity

Elasticity along a straight line:
Imp
EA to B = (0 5) / (0+5)/2 = - 5/2.5 = -5 (15 10)/(15+10)/2 5/12.5
Price 15 A
From point A to C, it is the elastic region. Here a price increase will decrease the total revenue because the %decrease in quantity demanded will be greater then the %increase in This price files has expired
B
EB to C = (5 - 10)/ (5+10)/2 = - 5/7.5 = -1 (10 - 5)/ (10+5)/2 5/7.5
at 30-Jun-13
10
Unitary elastic
From point C onwards, it is the inelastic region. Here, a price increase will result in increase in the total revenue because the %decrease in quantity demanded will be lesser then the %increase in price
10
Quantity/Time
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Giffen Goods And Veblen Goods

A normal good is one where consumption increases with decrease in price of the good, other way of saying is when the income effect is positive When the income effect is negative it is an inferior good When the negative income effect is larger than the positive substitution effect for a good, which is the case for a inferior good it is known as a Giffen good When the demand for a good increases with increase in price it is known as Veblen good This goods have a positively sloped demand curve, as the good is more desirable at higher prices
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Questions
1. Adam notices that the percentage change in demand for the shoes that his company produces is smaller than the percent change in price that caused the change in demand. If the company reduces the price of shoes the total revenue for the company will most likely Revenue A B C Increases Reduces Demand Elasticity Inelastic Inelastic

Perfectly Inelastic
Increases
2. The demand for home dcor increases when the average family income of Saunderland increases from $15,000 per annum to $20,000 p.a. The income elasticity for home dcor is
A. Greater than 1
B. Less than 1 C. Between 0 to 1
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Questions (Cont..)
3. If the number of ice cream bars demanded increases from 10 to 17 when the price decreases from $1.50 to $1.00, the price elasticity of demand and type is: A. -1.49 and relatively inelastic B. -1.3 and relatively elastic C. -1.3 and relatively inelastic
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Solutions
1. B. Demand elasticity is inelastic when the quantity demanded changes less than the price change that caused that demand. When demand is inelastic the total revenue reduces when the price is reduced. 2. A. The income elasticity is greater than one when the percentage increase in quantity demanded is greater than the percentage increase in income. When the demand for the product increases with increase in the average income the income elasticity is always greater than one. 3. C. If the number of ice-creams demanded changes from 10 to 17 on the price changes from S1.50 io$1.00. the percentage change in quantity is ((10 -17)/(10+17)/2)) = -0.51change in price is (1.50- 1.00) / (1.5+1.00) / 2] =.40. Thus, price elasticity is -0.51/0.4 = -1.3. Since ED => 1 <Ed < 0 in this case hence it is relatively inelastic
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Agenda
Demand and Supply Analysis: Introduction Demand and Supply Analysis: Consumer Demand Demand and Supply Analysis: The Firm The Firm and Market Structures
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Consumer Choice Theory And Utility Theory

Consumer theory states the consumers wants and preference to goods and services they buy Utility theory analyzes the consumer behavior based on preferences for various combination of goods and services in relation to the satisfaction these goods and services provide The assumption of a utility function is more of a good is preferred than less The utility function can be stated as :
UQa, Qb Qc......Qn
Where the variables are quantities consumed of goods a through n files has expired at 30-Jun-13 Its is assumed that no This quantities are negative Holding all other quantities constant and increasing one will result in greater utility Utility is an ordinal measure
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Properties Of Indifference Curve

Indifference curves cannot cross Good Good Y Indifference curves Slope Downward
5
C
A B
4
A
3
B
I2
1
C D I1
I This files has expired1 at 30-Jun-13 Good X
2 3
4 5 6
7 8
Good X
Indifference curves cannot cross Indifference curve for two goods slopes downwards The figure shows how two indifference curves Indifference curve are convex towards the origin cross each other In the figure when we move to consume more of Two indifference curves for a given individual good Y, we have to compensate by consuming cannot cross because the transitivity less of good X. assumption is violated Slope of the indifference curve is known as That is if U(B)= U(A), and U(B)= U(C), then marginal rate of substitution(MRS) U(A)= U(C)
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Use Of Indifference Curves, Opportunity Sets And Budget Constraints

Based on individuals income a budget constraint can be presented, depending on how he chooses between the goods available to him Suppose a person has a income of $100, he can either buy good X priced at $10 or good Y priced at $20 or a combination of both the products If the individual income increases from $100 to $140, there is a shift in budget as he can afford more of good X and good Y If the price of good X decreases from $10 to $7 the affordability of good X increases

Units of Y Income= $100 PX= $10 PY= $20 Budget Line Units of X 10 7 Units of Y 7 Income= $140 PX= $10 PY= $20 Units of Y Income= $140 PX= $7 PY= $20
Units of X 14
Units of X 14 20
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Consumers Equilibrium
The graph shows consumers budget constraint line and some indifference curves of the consumer The indifference curve which is tangent to the budget line is the most preferred consumption bundle This tangent represents consumers equilibrium bundle of goods, the most preferred combination
Good Y 9
This filesMost has expired at 30-Jun-13 preferred affordable combination
5 I2 I1 I0 6 8 Good X
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Substitution And Income Effect

If the price of a good falls, consumer will consume more of this good relative to other good which is known as substitution effect On the original consumption with the decrease in price of good the total expenditure falls which is known as income effect There can be three scenarios
Good Y
Positive Income Effect
T0 T1
The substitution and income effect are both positive, so consumption of the good increases This files has expired The substitution effect is positive but the income effect is highly negative than the substitution effect, so consumption of the good decreases The substitution effect is positive and the income effect is negative but smaller than the substitution effect, so consumption of this good increases
T2 I1 I0
at 30-Jun-13
B0 Q0 Qs Q1
B1
B2 Good X
Substitution Effect Income Effect
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Substitution And Income Effect
Good Y
Negative Income Effect, Smaller than substitution effect
Good Y
Negative Income Effect, Larger than substitution effect
T2
T2 T0 T1 I1 T1
T0

I1 I0 B0 B1 B2 Good X Substitution Effect Income Effect Q1 Q0 Qs Substitution Effect Income Effect B0 B1 B2 Good X I0
Q0
Q1 Qs
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Agenda
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Opportunity Cost (OC)& Economic Profit

Opportunity Cost
Payments by a firm to purchase productive resources Explicit Costs
Imp
Cost of passing up next best activity
OC of resources made available for production Implicit Costs

Forgone interest Cost of capital Economic depreciation Decrease in value of firms assets
Implied Rental Rate
Normal Profit
Forgone profit on alternative activity which could have taken up
Economic Profit = Revenue Explicit Costs Implicit Costs Accounting Profit: Firm revenue minus expenses over given time period (Does not take implicit costs into
account)
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Economic Profit - Example
Imp
Calculating Economic Profit for ABC Cements Company

Account
Total Revenue Opportunity costs Limestone and other raw material Power Wages paid Interest paid on borrowed funds This files Total explicit costs $150,000 $100,000 $50,000
Amount
$450,000
has $10,000 expired at 30-Jun-13

$310,000
ABC cost of capital - foregone interest

ABC owners salary Economic depreciation on buildings Normal profit Total implicit costs (cost of resources) Total cost Economic profit
$15,000
$15,000 $5,000 $50,000 $85,000 $395,000 $55,000
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Economic Rent Vs. Opportunity Cost

OC of an employee is what he could have earned in his next highest-paying alternative employment Economic Rent = Factor of production's earnings Opportunity Cost Economic rent is similar to the concept of producer's surplus and depends on the shape of resources supply curve and on factor of production
If it is relatively easy to create or supply, economic rent is reduced by competition If a factor of production is very difficult to supply or reproduce (e.g. Sharukh Khan), the factor will
files receive significant This economic rent.

Perfectly Inelastic Supply
Price S
has expired at 30-Jun-13

Perfectly elastic Supply
Price
Upward sloping supply

Price S Economic Rent D
S Economic Rent D Quantity
D
Quantity
Quantity
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Total, Average And Marginal Revenue

Total revenue for a firm that charges a single price to all customers is calculated as :
TR P Q
where: TR= total revenue P= price Q= quantity Average revenue is total revenue divided by quantity sold
Price
AR TR/Q
D= Market Price= MR=AR Quantity
Marginal revenue is increase in total revenue by selling one more unit of a good or service Firms operating in a perfect competitive market will sell all the products at the same price, so that price=AR=MR
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Total, Average And Marginal Revenue

When there is imperfect competition firms face downward sloping demand curves. These firms are price searchers, as they have to decide what price to charge for their product To increase the quantity to be sold firms must reduce the price of the product they are selling Therefore, firms under imperfect competition have marginal revenue less than price for quantity sold greater than one The marginal revenue and average revenue will decline as the quantity sold increases and the average revenue will not equal to marginal revenue in this case Decrease in marginal revenue is more than the decrease in price or average revenue This files Total revenue is maximum when MR=0 has expired at 30-Jun-13
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Example
Imp
Calculate the total revenue, average revenue and marginal revenue given the quantity supplied at each price and the demand curve
Qty
2 65
3 55
4 50
5 45
6 40
7 40
Price
8 35
Total Revenue
130 180 220 250 270 280 280
Price 70
Price 80 70 60 50 40 30 20 10 0 1 2 3
Quantity
Average Revenue
70 65 60 55 50 45 40 35
Marginal Revenue
70 60 50 40 30 20 10 0
1 at 30-Jun-13 70 70 This files has expired 2 3 D 4 5 6 65 60 55 50 45 40 35
MR Quantity 8
7 8
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Firms Factor Of Production

For economic purpose, we consider two inputs that is capital and labor. This can be made into a function which defines the quantity produced with amount of capital and labor, which is known as the production function
Q f ( K , L)
With a given capital an increase in amount of labor employed leads to an increase in total product The output with only one worker is considered the marginal product of the first unit of labor. With the addition of a second labor the total product will increase by the marginal product of the second worker, we can assume marginal product of second labor is likely to be greater than the marginal product of the first and the marginal product of labor is increasing at the lower end of labor input

Total output
Marginal Product Decreasing Marginal Product Negative
Marginal Product Increasing
Production Function
A
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Quantity of labor B
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Operating Costs
Total Fixed Costs, TFC Sum of costs that do not vary with level of output. It also includes normal profit. Total Variable Costs, TVC Sum of costs that change with the level of output. Total Costs TFC + TVC Marginal Cost, MC: MC = TC/Q TC = TFC + TVC Change in total cost required to produce an additional unit of output. Average Costs This files has expired at 30-Jun-13 Average Fixed Cost: AFC = TFC/quantity produced Average Variable Cost: AVC = TVC/quantity produced Average Total Cost: ATC = AFC + AVC = TC/quantity produced Sunk Costs Costs that have already been incurred as the result of past decisions.
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Total Cost Curves
Imp
Cost per day
TC TC=TFC+TVC TVC
120
100 80 60 40
TFC remain constant TVC increases as production increases This files has expired at 30-Jun-13 TC increases as TVC increases
TFC 20 0 0 10 Total Cost Curve 20 30 O/P
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Cost Calculation
Imp
Output TFC TVC TC= TFC + TVC AFC= TFC/Q AVC=TVC/Q ATC=TC/Q MC=/\TC//\Q 0 3 5 9 12 200 200 200 200 200 0 100 200 200 300 400 0 67 40 0 33 40 0 100 80 0 33 50 25 33
This files has expired at 33 30-Jun-13 300 500 22 56

400 600 17 33 50
14
15
200
200
500
600
700
800
14
13
36
40
50
53
50
100
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Cost Curve Relationships

AFC downward slopping ATC and AVC are U-shaped
ATC follows AVC; AVC increases after initial fall due to effect of diminishing return
Costs
Imp
MC always cuts ATC and AVC at their minimum points!
MC = DTC Dq
ATC = AFC + AVC AVC = TVC q
The vertical distance between the ATC and AVC curves is equal to AFC MC declines initially, then increases
MC intersects AVC and ATC at their minimum

AFC = TFC q
points
Quantity, q
When MC < ATC, ATC will fall. When it equals ATC, ATC will be its lowest point and starts to rise as MC rises.
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Product Curves And Cost Curves

O/P per unit of labor
Imp
Cost
AP MP
MP Max MC Min
AP Max AVC Min MC AVC

MP , MC AP , AVC MP , MC AP , AVC L1 L2 MP , MC AP , AVC
Output, Total
Labor Marginal and average Product Curves Q1 Q2 Cost curve
Marginal leads Average. When MP is falling and MC is rising after L1 it maxmizes AP and minimizes AVC at Q2. Post this point, both AP starts to fall and AVC starts to rise.
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Short-Run Loss
In short-run the capital is assumed to be fixed, but in long run all factors of production are variable Break-even output quantity happens: when the total sales cover both fixed and variable costs where P=AR=ATC In the short run a firm would continue operating : If the products are sold for more than its cost AR>AVC If the product is sold for less than its cost, a firm would suffer losses which can be minimized by shutting down the operations If the average revenue is less than the average variable cost the firm is operating at the short-run shutdown point
Price
Short run loss

Economic Loss MC ATC AVC
A firm experiences economic losses when P < ATC When P = AVC, the firm is operating at a shutdown point
MR=P
Quantity A firm will minimize its losses in the short run by continuing to operate when AVC < P < ATC since it
is covering some of its fixed costs from the difference between P and AVC
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Perfect Competition
Imp
Under perfect competition the relation of shut down point and breakeven point can be explained by way of total revenue(TR) and total cost(TC)
TC=TR at the quantities of Q1 and Q2, which is the break-even point Profit is maximized at the Qmax, where the total revenue exceeds the total cost TC>TR leads to economic losses
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Short Run And Long Run Cost Curves

Cost Curves
Short Run
At least one input is fixed
Long Run:
All the inputs are variable, known as planning curves LRAC curve is U-shaped

Downward sloping Shows economies of scale Upward sloping Shows diseconomies of scale
Economies of Scale: Quantity produced increases by one unit, costs increase by less than one unit Diseconomies of Scale: Quantity produced increases by one unit, costs increase by more than one unit
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Economies Of Scale
Long Run average total cost
Average Unit Costs
Downward slopping LRATC occurs due to economies of scale. Which eventually become
upward slopping as diseconomies of scale comes

Economies of scale Minimum efficient scale Diseconomies of scale LRATC
into play.
When average total cost of production is at a
This files has expired at 30-Jun-13 minimum, that is the lowest point of LRATC, the point
is known as minimum efficient scale
Q* =optimal O/P (firm size) Output
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Short-run And Long-run Profit Maximization

The figure below we show the long run average total cost(LRATC) along with short-run average total cost for two firm sizes
The first firm size 1 with a SRATC1 having a market price of P1, can consider to increase its scale of operations to its size of firm 2 This would decrease the SRATC to the level of P2 at the level of SRATC2 The firm will start making economic profits when the market price is P1, but these profits doesnt sustain as every firm has the option to increase its operation to the minimum efficient scale with prices decreasing to P2 A price below P2 leads to economic losses, making some firms exit which reduces supply in market, and This files has expired at 30-Jun-13 increase in prices The exit continues till the price reaches P2
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Profit Maximization Under Imperfect Competition

A price searcher firm faces a downward sloping demand so to increase its revenue the firm must sell its units at reduced prices. We produce a similar table as we did for the price taker by showing marginal revenue, marginal cost and profits
Qty
0 1 2 3 4 5 6 7
Price
150 145 140 135 130 125 120 115
Total revenue
0 145 280 405
Total cost
100 180 305 400
Profits
-100 -35 -25 5
Marginal Revenue(MR)
Marginal Cost(MC)
145 135 125
80 125 95 110 90 95 115
This files has 10expired at 30-Jun-13 520 510 115

625 720 805 600 695 810 25 25 -5 105 95 85
8
9 10
110
105 100
880
945 1000
920
990 1050
-40
-45 -50
75
65 55
110
70 60
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Total Product And Marginal Product
O/P
Marginal Pro.
32 30 28
TP
increasing marginal returns

12
20
decreasing marginal returns = 10 Marginal output/product This files has expired at 30-Jun-13 decrease 8 when additional unit of input is put
6 4
8 0 6 1 2 3 4
Labor (workers per day) 5
MP 2 1 0 6 1 2 3 4 5
Workers per day
Total Product
Marginal Product
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Average Product And Marginal Product

AP & MP 12 10 8 AP 6 4 2 1 0 1 2 3 4 5 MP
Labor (Workers/day)
Maximum avg. Product
Average and Marginal Product of labor
Marginal leads Average. Hence when MP>AP => AP will rise since MP pulls AP up when MP<AP => AP will fall
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Marginal Revenue Product (MRP)

The marginal revenue product is the monetary value of the marginal product of an input. MRP is useful to determine the quantity of each input that should be used to maximize profit.
MRP Factor's marginal product marginal revenue
MRP is the increase in firms total revenue by selling an additional output from employing one more unit of the factor. Profit maximization quantity of an input a is that quantity for which MRPa = Pricea By employing one more unit of an input the firm can increase profits as long as MRPa >Pricea as the revenue earned from this inputfiles is greater than the cost of the input This has expired at 30-Jun-13 If the MRP < Price the firm should decrease the quantity of input employed, even the firm loses revenue but the cost savings are greater MRP of a factor is: marginal product price
The cost minimization function can be defined as :
MP1 MRoutput MP2 MRoutput MPN MRoutput ... P1 P2 PN

where MP= factors marginal product MR= marginal revenue of additional output``
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Questions
1. TVs are taxable and recently there supply has became less elastic than demand, who will bear low taxes and what will be impact on deadweight loss
Party bearing low taxes A. Seller B. Buyer C. Buyer Impact on deadweight loss Increase Increase Decrease
2. Government has recently increased taxes on goods which has demand inelasticity. Such a action This files has expired at high 30-Jun-13 will result
A. No reduction in equilibrium quantity produced / sold B. Small reduction in equilibrium quantity produced / sold C. large reduction in equilibrium quantity produced / sold
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Solutions
1. 2. C. Party with high elasticity will pay low taxes and high inelasticity causes less deadweight loss B. High inelasticity causes less deadweight loss because there is a lack of substitutes causing less effect on equilibrium quantity.
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Agenda
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Characteristics Of Perfect Competition

Large number of both buyers and sellers hence no firm controls prices Prices are determined by market forces (demand and supply) causing
Imp
Price
Firms to become price takers with Demand curves taking shape of perfectly elastic Market price will equal to ATC in long term
Demand
Quantity
Price Taker Demand

Firm will produce until MR=MC MR is the increase in total revenue from selling one more unit of a good. For a price taker, MR = Price (P)
Price MC
Profit-maximizing firm will produce optimum quantity, Q, when MC = MR = P

Q*
D=Market Price=MR Quantity
Profit Maximizing o/p for a Price Taker
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Economic Profit
Economic profit = Total Revenues Opportunity Cost of Production (both explicit costs and implicit costs including cost of capital and normal profit)
Price Economic Profit P MR TR-TC is Maximum MC ATC Revenue (Costs) TC TR

Profit maximizing o/p Profit Maximizing O/P Quantity Q Quantity Q Short run profit Maximization-Total Approach
Short run profit Maximization-Marginal Approach
Figure A illustrates that using marginal approach, economic profit is maximized at Quantity Q when MR = MC = P; Figure B shows that using total approach, profit maximization also occurs at Quantity Q when total revenue exceeds total cost by the maximum amount
Equilibrium In A Perfectly Competitive Market

No firm will earn economic profits in the long run If they can due to no entry barriers new firms will enter industry to earn profits supply (shifts towards right) price until Price = firm's average total cost (ATC) In equilibrium, each firm is producing the quantity for which P = MR = MC = ATC And no firm earns economic profit Each firm is producing the quantity for which ATC is a minimum
Price D
This files has expired at 30-Jun-13 S

Price and costs
MC ATC
P*
P*
MR
Quantity Q* Equilibrium For the Industry

Quantity
Q* Equilibrium For Firm

Short-run Loss In Perfect Competition

Economic losses occur when the price is less than the average total cost(ATC) Firms continue to operate in short run even if ATC >P, but the price > AVC Firm covering variable and to some part of fixed cost will have losses less than its fixed cost, and if the firm covers only its AVC then its operating at the shutdown point If the price never exceeds its ATC, going out of business is a fair choice Long run equilibrium output is where MR=MC=ATC, where the ATC is at a minimum
Short run loss
This files has MCexpired at 30-Jun-13

Price Economic Loss ATC AVC
` MR=P
Quantity
Short-Run Supply Curves

Price MC ATC AVC P2 Price SSHORT-RUN
P1

Quantity Short run supply Curve - Firm Supply Quantity Short run supply Curve - Market Supply
Firm will shut down at a price below P1 as it will not even be able to realise AVC At P2 the firm is earning a normal profit (economic profit = 0) At prices above P2, firm is making supernormal profits
Will expand production along the MC line. Short-run supply curve for a firm is its MC line firm produces by moving up and down along the supply curve as MC = MR = P
SR market (industry) supply curve is horizontal sum of the MC curves for all firms
Figure: Short-run Adjustment To An Increase In Demand

SR Industry Supply Price Price MC=SR firm Supply
P2 P1 D2
P1 P0
MR1 MR0
D1 This files has expired at 30-Jun-13 Quantity Q1 Q2 Q1 FIRM Q2 FIRM Quantity
Market Firm Short run adjusted to an increase in demand under perfect competition
Figure A:
Demand price and quantity .
Figure B:
As Price firm will earn an economic profit in the short run In the long run firms will increase production and/or new firms will enter Demand increases > Price increases > Profit increases
Effects Of A Permanent Increase In Demand

Price
Industry
S0
S1
Price and cost
Firm
MC ATC MR1 MR0
P1
P0
P1 P0
D1 D0 Quantity Quantity q0 q1 This Q1 Q2 files has expired at 30-Jun-13
Q0
The initial equilibrium is at price P0 and quantity Q0 , earning normal profits With a permanent increase in demandThe demand curve shift to D1 The new market price will be P1 (increases as demand increases) output will increase to Q1 (to meet demand)
In short run since P1 > ATC earning an economic profit With positive economic profit new firms enter the industry which increases total industry supply causing the supply curve shift to S1 and decreasing the price back to P0 eliminating the economic profits
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Monopoly
A monopoly is characterized by Only 1 seller Price searchers and have imperfect information regarding market demand Specialized product with no substitutes High Barriers to entry (BTE): Following types Legal barriers: Patents, copyrights, government granted franchises Natural barriers: high capital costs and economies of scale or scope, e.g.: electric utility. Price setting strategies include Single price or Price Discrimination Monopoly has downward sloping demand curve Meaning demand will decrease if high prices are fixed or vice versa profit maximization involves a trade-off between price and quantity To maximize profit, monopolists will expand output until MR = MC Demand curve must lie above ATC to earn profits In LR economic profits can exist unlike pure competition markets
Monopoly Short-run Costs And Revenues

Price Monopoly Profit MC P* ATC* ATC
This files has MR expired at 30-Jun-13

Quantity
Q* Monopolistic Short Run Costs and Revenue
Profit maximizing at the quantity when MR = MC.

The economic profit equal to (P ATC) x Q.
Demand curve must lie above ATC at Q so that price > ATC and firm earn profit Optimal quantity will be in the elastic range of the demand curve.
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Effect Of Price Discrimination

Profit=$2400 Price 100 70 MC=ATC DWL 110 90 70 $2000 Profit=$3200 DWL
Price
$1200
MC=ATC
D MR files has expired at 30-Jun-13 This Quantity 80 Without Price Discrimination 50 110 190
D Quantity
With Price Discrimination
Price discrimination Q , Economic Profit , Example assumes no fixed costs & constant variable costs so that MC=ATC Total profit is increased to $3,200 from $2400 and total Output is increased from 80 units to 110 units. In price discrimination, where total output remains same, some (shaded) part is converted from CS to monopoly profits Where total output increases (shown above), Some part of deadweight loss also converts into monopoly profits
Perfect Competition Vs. Monopoly

In monopoly, consumer surplus is reduced due to
Imp
Price S=MC Consumer Surplus Perfect Competition D=MB Efficient Quantity Quantity S=MC Monopoly DWL
Reduction in output Sum of consumer and producer surplus in monopoly is less than that in Perfect competition High prices paid by consumers compared to perfect competition represented by deadweight loss
Difference between Monopoly profit and DWL Monopoly profit is additional which directly goes to the
PC Producer Surplus Price
producer / monopolist (earlier part ofhas Consumer Surplus at This files expired (CS) in Perfect competition) DWL is the loss due to restricted output (difference in quantities of perfect competition and monopoly) this comes from both CS and producers surplus Price discrimination reduces this inefficiency By increasing output and allocating more resources where MR = MC Firm gains from customers with inelastic demand while still providing goods to customers with more elastic demand
Neev Knowledge Management Pristine 80
30-Jun-13Q
Consumer Surplus PM
Monopolys Gain
PC Producer Surplus QM
MR D=MB Quantity
QC
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Natural Monopoly
Price Market Demand
Imp
Required subsidy (with marginal cost pricing) Pu ATC
PAC PMC
This files has expired MCat 30-Jun-13 D MR

Qu QAC QMC Quantity
Natural monopoly occurs when a single supplier brings maximum efficiency of production (minimum ATC) and distribution due to economies of scale and benefits economy
Natural Monopoly Average Cost & Marginal Cost Pricing
A single-price monopolist will maximize profits by producing where MR = MC, producing quantity Qu & charging Pu. If two firms produced approximately one-half of output QAC
ATC for each firm would be much higher than for a single producer producing QAC Potential gains from monopoly (1) Incentive to innovation (mixed results) (2) Economies of scale and scope
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Characteristics Of Monopolistic Competition

A large number of independent sellers and buyers like perfect competition Each firm has a relatively small market share with no significant power over price. Firms focuses on average marker price not of individual competitors There are too many firms in the industry for collusion (price fixing) to be possible. Product differentiation (products are not similar) but remains a close substitute This causes firms to compete based on marketing, quality and price Marketing is a must to advertise product (differentiating) characteristics Due to close substitution, demand curves are highly elastic Low Barriers to Entry Firms in monopolistic competition face downward sloping demand curves Firms compete on Price, Quality and Marketing Strong correlation between quality and the price that firms can charge. E.g. :- Market for hair oil or soaps; quite similar but differentiation occurs due to taste preferences.
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Short-run Output And Long-run Output

Price Price
Imp
MC
MC
ATC
ATC
P* ATC* D MR Quantity Q Short Run O/P decision for a firm Q MR P*, ATC*
Quantity
Long Run O/P decision for a firm
Firms maximize economic profits at quantity Q production where MR = MC Firm earns positive economic profit because price, P > ATC. Due to Low Barriers to entry competitors will enter the market in long run
New firms entry causes firms demand curve downwards to the point where price equals avg. total cost (P*=ATC*) such that economic profit becomes 0. At this point, there is no longer an incentive for new firms to enter the market creating a LR equilibrium
Firm Output Under Monopolistic And Perfect Competition

Price Price MC
Imp
MC ATC
ATC P D MR Quantity
MR Quantity

Q Firm O/P under Monopolistic Competition
Q Firm O/P under Perfect Competition
In short run, perfect competition firms do not earn economic profit as P=ATC but in monopolistic competition,
firm earns economic profit since P>ATC though optimum quantity occurs when MR = MC in both markets Inefficient allocation of resources : ATC is not at a minimum for the quantity produced Inefficient scale of production: Price is slightly higher than under perfect competition
Mark up = Excess of price over MC, under monopolistic competition

Under Perfect competition, Mark up = 0
Efficiency , Product Innovation & Advertising In Monopolistic Competition
Imp
Efficiency of monopolistic competition is unclear Consumers benefit from advertising make better purchasing decisions But is it worth the additional cost of advertising is largely subjective Impact of Product innovation: it is necessary Firms that bring new and innovative products face less-elastic demand curves, enabling them to increase price and earn economic profits. However, close substitutes and imitations will cause initial economic profit to disappear in long run Advertising expenses: These are high Create or increase a This perception of differences between products files has expired at 30-Jun-13 Generally it increases ATC curve Due to being relatively fixed cost economies of scale Advertising may also reduce ATC When it causes substantial increase in output where economies of scale bring down overall ATC Demand Curve becomes more elastic, because every firm will advertise Overall, Price reduces, Quantity increases (due to more elastic demand curve) and markup reduces
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Kinked Demand Curve Model

Small number of sellers Significant Barriers to entry which often include large economies of scale
High capex and large economies of scale Barriers to entry Less elastic demand curve
MR curve has a break Any movement of MC curve between the break points will not change output Conclusion Small changes in costs are not significant for Oligopoly Demand curve is more elastic above Pk Price This files has expired at 30-Jun-13
If firm increases price above PK it will lose market share
More Elastic
Demand curve Is less elastics below Pk

If firm decreases price below PK, other firms will match the price cut, and all firms will experience a relatively small increase in sales.
Kinked PK Less Elastic MR Quantity QK Kinked Demand Curve Model
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Oligopoly Games
Two suspects, A and B. are believed to have committed a serious crime. However, the prosecutor does not feel that the police have sufficient evidence for a conviction. The prisoners are separated and offered the following deal:
If Prisoner A confesses and Prisoner B remains silent, Prisoner A goes free and Prisoner B receives a 10year prison sentence. If Prisoner B confesses and Prisoner A remains silent, Prisoner B goes free and Prisoner A receives a I0year prison sentence. If both prisoners remain silent, each will receive a 6-month sentence. If both prisoners confess, each will receive a 2-year sentence. has expired at 30-Jun-13 Prisoners' DilemmaThis What files should prisoners do in following case
Prisoner B is silent
Prisoner A is silent
Prison A confesses
Prison B confesses
A gets 10 years B goes free
A gets 2 years B gets 2 years
A gets 6 months B gets 6 months

A goes free B gets 10 years
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Cost And Demand For 2-firm Industry

Impact of Prisoners' Dilemma in oligopoly market
Subsequently, Firm A and Firm B have entered into an collusive agreement to reduce output and earn increased profits. Possible 4 scenarios post this agreement
Firm A Honors
Firm B Honors Firm B Cheats This files has expired at 30-Jun-13

A earns economic profit B earns economic profit
A has an economic loss B earns increased economic profit A earns zero economic profit B earns zero economic profit
Firm A cheats
A earns increased economic profit B has an economic loss
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Dominant Firm Oligopoly Model

Assumes that one of the firm is dominant over others in an oligopoly market due to significant cost advantage over its competitors and It produces a relatively large proportion of the industry's output. Dominant firm sets the price in the oligopoly market Remaining firms are price takers, with little power to set their own prices The dominating firms believes that for other firms the quantity supplied decrease at lower prices
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Firms Supply Function
Imp
Short run market supply curve is constructed by summing quantities supplied at each price across all firms in the market Supply function under perfect competition : Marginal cost curve above the average variable cost curve No well defined supply function under monopolistic competition, oligopoly and monopoly as all these markets face a downward sloping demand curve For every market the quantity supplied is derived by the intersection of marginal cost and marginal revenue The price charged is then derived by the demand curve the firm faces The quantity supplied depends not on the firms marginal cost also on demand and marginal This files has expired atbut 30-Jun-13 revenue
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Firm Concentration Ratio & Market Types

Herfindahl-Hirscham Index (HHI) = Four-firm concentration ratio =
Imp
Sum of squares of the market shares of largest firms Sale of four largest firm Total industry sales Monopolistic competition Large number of owning small market share Oligopoly Monopoly
Market Types: Criteria Market ..type Number of firms Perfect competition Large number of This files firms
has atfirms 30-Jun-13 firms expired with each
Small number of
Single Seller
Product Entry Barriers Four-firm ratio
Similar product Low barriers to entry 0% to 40%
Product differentiation Few barriers to entry & exit 40% to 60%
Producing similar product High entry barriers 60% to 100%
Single producer of the product Very high entry barriers 100%
HHI
< 1000
1000-1800
>1800
10,000
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Characteristics Of Different Market Structures(summary)

Market Structure
Perfect competition Monopolistic competition Oligopoly
Number of Sellers
Many Many
Degree of Product Differentiation

Homogeneous/ Standardized Differentiated
Barriers to Entry
Very Low Low
Pricing Power of Firm

None Some
Non price Competition

None Advertising and Product differentiation Advertising and Product differentiation Advertising
Few
Homogeneous/ Standardized This files has Unique Product
High
expired at
Very High
Some or Considerable 30-Jun-13 Considerable
Monopoly
One
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Questions
1. The HHI for the silicon wafer industry in Saunderland is closest to , where rest of industry constitutes 8 firms each with 2.5% market share Company Market Share
A
B
50%
10%
C
D
10%
5% This files has expired at 30-Jun-13
E
RoI
5%
20%
A. 3150 B. 2800 C. 5950
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Questions (Cont.)
2. The four-firm concentration ratio for the silicon wafer industry in Saunderland is closest to
A. 52% B. 47% C. 75% 3. As a result of increasing labor from 80 to 90 workers, output increased from 800 to 1000 units per day. The marginal product of additional worker is closest to: A. 200 units /day B. 30 units/day C. 20 units/day This files has expired at 30-Jun-13 4. Which of following least accurately describes relationship between different cost curves (ATC= Average Total Cost, AVC = Average Variable Cost and AFC = Average Fixed Costs) A. AFC is downward sloping and ATC and AVC are U Shape B. AFC and ATC is downward slopping and AVC is U shaped C. AFC is downward slopping and ATC follows AVC 5. Marginal product of capital is equal to A. Inputs required for output of on an additional unit B. Additional units of output for one additional unit of capital and labour C. Additional units of output for one additional unit of capital keeping labor constant
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Question (Cont)
6. A natural monopoly will least likely to exist when A. ATC decreases as production increases B. Few firms are engaged in production C. Large economies of scale are present When regulators force monopolist to follow marginal price, which of the situation is most likely to occur A. Price is fixed where ATC curve intersects the demand curve. B. Price is fixed where MC curve intersects the demand curve. C. Price is fixed where MC = ATC This files has expired at 30-Jun-13 In Monopolistic market, consumer surplus is reduced due to A. High prices are charged and efficient quantity is not produced B. High prices are charged and efficient quantity is produced C. Inefficient resource allocation causing zero deadweight loss
7.
8.
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Question (Cont)
9. In a Nash equilibrium, a player A will take the best possible action against the player B, given that player B will not make the most optimal choice. The statement is most likely A. Correct, since player A must always make the best possible action B. Incorrect, Both players act in their own self interest, and make a choice assuming that the other person will also make the most optimal decision C. Correct, player A and B must make differing decision to maintain an equilibrium 10. In monopolistic competition and in short run, A. Product innovation (PI) will lead to earn economic profits (EP) whereas advertising (AD) will cause ATC This files has expired at 30-Jun-13 to rise B. PI will have no impact on EP and AD will cause ATC to fall C. PI will decrease EP due to associated costs and AD will cause ATC to rise 11. The following statement best describes the situation when both firms default in above question A. Economic profit is shared equally by both B. Approach to No economic profit C. Economic profit will be higher to the firm which defaults first
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Question (Cont)
12. Given output of 500 units at total cost of $2,000, fixed cost of $1000 and marginal costs of $2 and market price of $2, to achieve optimum output, a firm operating in perfect competitive markets should
A. Not change its output level B. Reduce output and keep producing C. Increase output to earn high profits keeping price constant 13. Long-run equilibrium condition for a firm in long run can be explained as A. P = MC = ATC. This files has expired at 30-Jun-13 B. P = ATC = TR. C. MC = TR = TC.
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Solutions
1. B. Herfindahl-Hirschman Index is calculated for the industry as follows: HHI = 502 + 102 + 102 + 52 + 52 + 8 * (2.52) = 2,800 2. C. The four-firm concentration ratio is calculated by taking into consideration the market share for the top 4 firms in the industry. Four-firm concentration = 50 + 10 + 10 + 5 = 75% 3. C. Marginal product is change in output divided by change in input (labor). Here output changed by 200 units & labor changed by 10 workers. Thus, marginal product is 200/10 = 20 units per day 4. B. AFC is downward slopping as AFC decreases for each extra unit of output whereas ATC follows AVC as ATC increases with the changes in AVC. This files has expired at 30-Jun-13 5. C. The marginal product of capital is changes in output for one additional unit of capital, holding quantity of labor constant.
6. B. Natural monopoly occurs when a single supplier brings maximum efficiency of production (minimum ATC) and distribution due to economies of scale and benefits economy.
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Solutions
7. B. In marginal price policy, prices are fixed when marginal cost intersects demand curve hence monopolist is not able to recover average total costs 8. A. Monopolists produce less than the optimal quantity and charge high prices than what consumer is willing to pay which causes deadweight loss to occur. 9. B. In a Nash equilibrium the player A takes the best possible action given the action of player B and player B takes the best possible action given the action of player A. 10. A. product innovation enables to charge high prices and earn economic profits whereas advertising causes average total costs to rise This P files expired 30-Jun-13 11. B. when both firms default = MC = has ATC causing zeroat economic profits 12. A. Since MR = MC, increasing production will increase MC higher than MR causing losses and decreasing output will lower down overall profit hence keep output unchanged. 13. A. For a competitive firm, long-run equilibrium is where P = MC = ATC. For price-taker firms, P = MR. Competition eliminates economic profits in the long run so that P = ATC
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Five Minute Recap

Aggregating Demand & Supply: Price MB> MC Allocative Efficiency Key Terms to Remember: Cross-price elasticity Monopolistic Competition Consumer Producer Surplus Opportunity Cost & Economic Profit Total, Average And Marginal Revenue Average Product And Marginal Product Subsidies Production Quotas Perfect Competition and Monopoly Giffen Goods And Veblen Goods Monopolistic Competition Substitution And Income Effect Producer & Consumer Surplus CS Auctions: Ascending price auction Sealed bid auction Second price sealed bid auction Descending price auction Stable And Unstable Equilibria Price S Unstable equilibrium
Supply (MC)
p *
MC> MB
Demand (MB) Quantity

q* Price, p (Rs/kg) D Causes of DWL: Monopoly: e.g. OPEC, Indian Railways Price Controls: rent control, flooring price Taxes & trade restriction: subsidies & quotas Externality: eg. polluting (cost), park (benefit) Public goods: free rider, tragedy of commons
Stable equilibrium
Quantity
pq p * pc DWL Suppl y (MC) Deman d (MB) PS qc 100 q * Quantity, q (kg) Pric e P
K
More Elasti Kinke c d Less Elasti c
EP
%Demand %Price
%Q Supply %Price
MR
Price Elasticity of Supply
Quantit y Q Kinked Demand Curve Model K

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Five Minute Recap

Price Impact of Price Ceiling Price D Pws Pc S Demand DWL Floor Price Ceiling Qtax Causes of reduction in Consumer surplus or PS: Price Ceiling Price Floor Quantity Supply Impact of Price Floor Economic Profit = Revenue Explicit Costs Implicit Costs Accounting Profit: Firm revenue minus expenses over given time period Opportunity Cost: Explicit Costs Implicit Costs
Incidence Of Tax : Actual Statutory
Qs Value Ed = 0 1 <Ed < 0 Ed = 1 Ed=
Qd
Quantity Implication
Qd Qe Qs
Tax Revenue = Tax * Equilibrium Quantity
This files has expired at 30-Jun-13 MC always cuts ATC and AVC
Costs at their minimum points! MC = DTC Dq ATC = AFC + AVC Required subsidy (with marginal cost pricing) Price Market Demand
Perfectly inelastic. Relatively inelastic. Unit (or unitary) elastic. Perfectly elastic.
Pu
< Ed < 1 Relatively elastic.
Total Reveune Price Quantity

Average Revenue Total Revenue
MP 1 MRoutput P1 MP2 MRoutput P2
PAC MR PM
C
ATC D
MC
Qu
Quantity
AFC = TFC q Quantity, q
Quantity
PN
...
MPN MRoutput
QAC QMC Natural Monopoly Average Cost & Marginal Cost Pricing
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Economics I

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Economics I

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Demand/ Supply Curve

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Minimum Price Supplier is willing to receive

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Shifts In And Movement Along Demand Curves

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Movement Along Demand And Supply Curves

Price Price Supply Curve Demand curve P1 P0

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Shift In Demand And Supply Curve

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Original supply curve

Increase in supply Original Demand curve

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Aggregating Demand & Supply

Allocative Efficiency: It is nothing but efficient

allocation of resources AE occurs at an output level where price equals

marginal Cost (MC) of production because the

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Movement Towards Allocative Efficiency

Excess demand This files has expired at 30-Jun-13

Quantity, q (kg) qd(p1) q* qs(p1) qs(p2) q* qd(p2)

A) Movement towards Allocative efficiency

B) Movement Towards Allocative efficiency

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Stable And Unstable Equilibria

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Stable And Unstable Equilibria

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Demand And Supply Functions

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The equilibrium price is equal to : 16

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Non- Equilibrium Excess Demand And Supply

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Consumer Surplus (CS)

Consumer Surplus = Value what

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Quantity, q (kg) q* Consumer surplus (CS)

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Price And Value

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Demand=Marginal Benefit 1 2 3 4 5 Quantity, q (kg)

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Cost, Price & Producer Surplus (PS)

Production Surplus = Price - Cost

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