Heating Oil
Oil .F P1 A OOO -Output varies Opportunity cost goes Over
MBS Q IOU - Input varies Opportunity cost goes Under
The Economic Problem ← Q2 Q1 Prompt: Refinery EM produces 33 gal. gasoline or 30 gal. heating oil
* Resources (also called Factors of Gasoline per barrel of crude oil. Refinery ST produces 32 gal. gasoline or 24
Production or Inputs) are scarce. Two Choices are Trade-Off’s gal. heating oil per barrel of crude oil. Should they specialize & trade?
Resources Incomes Gasoline is the opportunity
Economic Analysis cost of heating oil. 30
land (natural) rent 1. A-allocative efficiency (P1=MCS1) Heating Oil Gasoline
labor wages Point F = inefficient use of
2. ∆ - cold winter resources 24 30 1 HO= 33 1 G =
capital interest Oil EM 33/30 = 1.1G 30/33=.9HO
3. B –short run give up gasoline Point G = unattainable in SR
entrepreneurship profits 24 1 HO = 32 1G =
to get heating oil ⇒ new All points on Ppc curve - full-
* Peoples’ wants and needs for Goods and ST 32/24 = 1.3G 24/32=.75HO
allocative efficiency (P2=MCS2) employment & production Gasoline 32 33
Services (Outputs) are unlimited.
Gasoline 32 33
A Change in Price causes a change in A Change in Anything but P Elastic Demand’s Elasticity Coefficients based on percent of
Quantity Demanded. Move along curve. Price causes a change in slope: ∆Q>∆P⇒flatter change (%∆)
∆P⇒∆QD Demand. Shift the curve. D3 Perfect elastic-horizontal Price Elasticity of Demand Formulas
P 1. A at P1, Q1 ∆ Determinant⇒∆D D2 D1 P BMW * Ed = %∆QDx ÷ %∆Px (No neg. #)
P2 .B 2. ∆ ↑ Price of Typical Determinants or Less ↔ More Q P2 B * Ed = __∆QDx ÷ ∆Px
P1 A cup of coffee Ceteris Paribus Conditions are Cups of Coffee P1 A original QDx original Px
D ⇒ ↓ quantity ∆ Buyer tastes/preferences Economic Analysis D * midpoint (arc) formula: Ed = ∆Q ÷ ∆P
Q2 Q1 Q demanded ∆ Number of buyers / 1. D1 Q2 Q1 Q ΣQ/2 ΣP/2
Cups of Coffee 3. B: P↑, Q↓ population 2. ∆ Population ↑ ⇒ * luxury Elasticity & Total Revenue Test
∆ Income people drink more coffee * close substitute Elastic >1 if P↓⇒TR↑ (opposites)
Law of Diminishing Marginal Utility—The ∆ Price of related goods in Houston. * large % income Unit elastic =1 if ∆P⇒no ∆TR
more of a good a consumer already has, the (substitutes & compliments) 3. D3↑ (QD↑ at every P) * longer time
Inelastic <1 if P↓⇒TR↓ (same direction)
lower the extra (marginal) utility (satisfaction) P
provided by each extra unit. Why the demand curve slopes downward—What causes Inelastic Demand’s
P1 Ed>1 TR=P x Q
a util = a unit of satisfaction the inverse relationship between price and quantity slope: ∆Q<∆P⇒steeper P2 Ed=1
TU demanded? Move along the curve. Perfectly inelastic-vertical Ed<1
TU 1. The Law of Diminishing Marginal P P D Electricity
Consumers . . D
Utility P2 B
* want to Q
2. Income Effect—a lower price has P1
maximize their TR
Q the effect of increasing money P2 P1 A
total utility TR
MU * want the most income⇒buy more of other things D Q2 Q1 Q Q 1 Q2 QD
for their money 3. Substitution Effect—a lower price Q1 Q2 Q * necessity Cross Elasticity Exy=%∆QDx ÷ %∆Py
* MUX = MUY cause people to switch to the purchase Shoes * no close substitute
Income Elasticity EY=%∆QDx ÷ %∆Y
Q PX PY of the “better deal”. * small % income
(Y=income)
Snicker Bars MU * Σ MU = TU 4. Common sense—buy more if price is lower * shorter time
Supply & Supply Elasticity A Change in Anything but P S2 S1 Elasticity of supply No TR test * Long Run P
Price causes a change in S3 --Slope of Curve All resources can S
Supply. Shift the curve. P S change P1,2
∆ Determinant⇒∆S * Immediately P2 Elastic supply
Typical Determinants or Inelastic supply P1 Horizontal, flat Q 1 Q2 Q
A Change in Price causes a change in Quantity Q
Ceteris Paribus conditions Vertical or steep
Supplied. Move along curve.
∆ resource (factor) prices Less ↔ More Q1&2 Q The key determinant of price elasticity
∆P⇒∆QS Eco Analysis Cups of Coffee * Short Run
∆ technology or technique of supply is the amount of time a seller
P S 1. A at P1, QS1 Economic Analysis More elastic due to P S
∆ taxes/subsidies has to change the amount of the good
P2 B 2. ∆ ↑ Price of 1. S1 firm´s intense use of P2
∆ price of other goods ⇒ they can produce (or supply).
P1 A cup of coffee 2. ∆ Starbucks opens fixed resources P1
production substitution Price Elasticity Coefficient of Supply
⇒ ↑Quantity more stores⇒# sellers↑ (upslopiing)
∆ Price expectations based on % of change, not slope
Q1 Q2 Q supplied 3. S3↑ (QS↑ at every P) Q1 Q2 Q
∆ Number of sellers ES = %∆QSx / %∆Px
Cups of Coffee 3. B: P2↑, QS2↑
Perfect Competition – The Firm Short Run Loss Minimization Shut Down Decision Long Run Equilibrium Industry and Firm in an Expanding Industry
MR=MC, P>AVC P<AVC MR=MC=min. ATC=P P p
Characteristics Profit Maximization Rule p MC p MC p MC ATC S1 MC ATC
**Very large MR=MC ATC ATC P1 A S2 p1 A MR=d
number of firms p P=MC ATC ATC e AVC AVC ATC
Profits
m
**Standardized MC p Loss f MR=d p MR=d P2 B p2 B MR=d
products p e MR=d D
**Price takers ATC
Economic profit
f p MR=d Q1 Q2 Q q2 q1 q
**Easy entry into
Analysis Industry Firm
and easy exit Firm q q Firm q q Firm q q 1. A--Industry at P1, Q1 equilibrium ⇒ firm price
from market *p=MR=d=AR for firm *p=MR=d=AR for the firm *p=MR=d=AR for the firm
**No non-price Firm q q taker at p1, MR=MC at q1, earns economic profits
*q where MR=MC *q where MR=MC *q where MR=MC
competition *p=MR=d=AR for firm (p1,m,A,ATC)
*loss area (ATC,e,f,p)--price *shut down because fixed *firm in long run equilibrium
(advertising) *q where MR=MC 2. ∆—Other producers see profits and enter the
below ATC & above AVC costs (ATC-AVC=AFC) are where P=MC at min. ATC
**Ex: Agriculture *economic profits area *Fixed costs are covered the least loss possible market⇒number of firms↑⇒industry supply↑ to S2
(p,e,f,ATC) (space between ATC & AVC). 3. B--P↓,Q↑ (industry) ⇒ firm price taker at p2 = MC
=MR at q2 (allocative efficiency), no economic profits
Monopoly – THEORY OF FIRM p2= min. ATC (productive efficiency)
Profit Maximizing Rule Regulated Monopoly Price Discrimination—The
MR=MC *Typically Natural Monopolies practice of selling a product Monopoly becomes Competitive
Characteristics Why Demand and P/C MC with Economies of Scale at more than one price not P Pm > MC ⇒ Pc=MC
**One firm=industry MR aren’t the same: *Fair-Return Price: Pf=ATC ⇒ justified by cost differences.
**Unique product MR<P b/c to sell Q↑, Pm e ATC monopolist breaks even Due to *monopoly power, pm A MC ATC Eli Lily produces
with no close Monopolist P↓ on all ATC
Profits
*Socially Optimal Price: Pr=MC *Ed segregates market, pc B Prozac
substitutes units⇒TR↑ in elastic f
⇒subsidies to monopolist ⇒ *buyers can’t resell product. D
**Price maker P elastic range MR=MC D allocative efficiency Examples: airlines, movies
**Many barriers, unit elastic P/C P varies; MR=D qm qc Q
entry blocked inelastic Qm MR Q Profits above ATCxQm MR
**Little advertising D Q **Qm where MR=MC Pm 1. A P1, Q1 – Monopoly with profits, efficiency loss
P/C MC
except for public MR **Pm where Qm intersects D Pf ATC 2. ∆ The patent protecting Prozac runs out and
ATC
relations PxQ=TR **Eco Profit = (Pm-ATC)Qm Pr MC Profits other firms now produce the generic drug ⇒
**Ex: local utilities, TR or Economic Profit=TR-TC D competition ⇒ firm becomes price taker
ATC MR=D
patented drugs TR Q **Efficiency loss (e, f, MR=MC) MR Q 3. B ↓pc, ↑qc
Qm Q