Transcript Microeconomics: Review

Microeconomics: Review
International Trade
• Interdependence and trade allow everyone to enjoy a greater
quantity and variety of goods & services.
• Comparative advantage means being able to produce a good
at a lower opportunity cost. Absolute advantage means being
able to produce a good with fewer inputs.
• When people – or countries – specialize in the goods in which
they have a comparative advantage, the economic “pie”
grows and
trade can make everyone better off.
A C T I V E L E A R N I N G 4:
Absolute & comparative advantage
Argentina and Brazil each have 10,000 hours of labour per
month, and the following technologies:
Argentina
– producing one pound coffee requires 2 hours
– producing one bottle wine requires 4 hours
Brazil
– producing one pound coffee requires 1 hour
– producing one bottle wine requires 5 hours
Which country has an absolute advantage in the production of
coffee? Which country has a comparative advantage in the
production of wine?
3
A C T I V E L E A R N I N G 4:
Answers
Brazil has an absolute advantage in coffee:
– Producing a pound of coffee requires only one
labour-hour in Brazil, but two in Argentina.
Argentina has a comparative advantage in wine:
– Argentina’s opp. cost of wine is two pounds of coffee, because
the four labour-hours required
to produce a bottle of wine could instead produce two pounds
of coffee.
– Brazil’s opp. cost of wine is five pounds of coffee.
4
Markets and Competition
• A market is a group of buyers and sellers of a particular good or
service.
• A competitive market is one in which there are so many buyers
and so many sellers that each has a negligible impact on the
market price.
• A perfectly competitive market:
– all goods are exactly the same
– buyers & sellers so numerous that no one can affect the
market price – each is a “price taker”
• In this chapter, we assume markets are perfectly competitive.
Demand Curve Shifters: Income
• Demand for a normal good is positively related to income.
– An increase in income causes increase
in quantity demanded at each price, shifting the D curve to
the right.
(Demand for an inferior good is negatively related to income.
An increase in income shifts D curves for inferior goods to the
left.)
Summary: Variables That Affect Demand
Variable
A change in this variable…
Price
…causes a movement
along the D curve
No. of buyers
…shifts the D curve
Income
…shifts the D curve
Price of
related goods
…shifts the D curve
Tastes
…shifts the D curve
Expectations
…shifts the D curve
Summary: Variables That Affect Supply
Variable
A change in this variable…
Price
…causes a movement
along the S curve
Input prices
…shifts the S curve
Technology
…shifts the S curve
No. of sellers
…shifts the S curve
Expectations
…shifts the S curve
A C T I V E L E A R N I N G 2:
Supply curve
Draw a supply curve for tax
return preparation software.
What happens to it in each
of the following scenarios?
A. Retailers cut the price of
the software.
B. A technological advance
allows the software to be
produced at lower cost.
C. Professional tax return preparers raise the price
of the services they provide.
2:
A. fall in price of tax return software
ACTIVE LEARNING
Price of
tax return
software
S1
The S curve
does not shift.
Move down
along the curve
to a lower P
and lower Q.
P1
P2
Q2 Q1
Quantity of tax
return software
2:
B. fall in cost of producing the software
ACTIVE LEARNING
Price of
tax return
software
S1
P1
S2
The S curve
shifts to the
right:
at each price,
Q increases.
Q1
Q2 Quantity of tax
return software
2:
C. professional preparers raise their price
ACTIVE LEARNING
Price of
tax return
software
S1
This shifts the
demand curve for
tax preparation
software, not the
supply curve.
Quantity of tax
return software
Surplus:
when quantity supplied is greater than quantity
demanded
P
$6.00
D
$5.00
$4.00
Surplus
S
Facing a surplus,
sellers try to increase sales by
cutting the price.
This causes
QD to rise and QS to fall…
$3.00
…which reduces the
surplus.
$2.00
$1.00
$0.00
Q
0
5
10 15 20 25 30 35
Shortage:
when quantity demanded is greater than quantity
supplied
P
$6.00
S
D
$5.00
Facing a shortage,
sellers raise the price,
causing QD to fall
and QS to rise,
$4.00
…which reduces the
shortage.
$3.00
$2.00
$1.00
Shortage
$0.00
Q
0
5
10 15 20 25 30 35
3:
Changes in supply and demand
ACTIVE LEARNING
Use the three-step method to analyze the effects of each event
on the equilibrium price and quantity of music downloads.
Event A:
A fall in the price of compact discs
Event B:
Sellers of music downloads negotiate a reduction
in the royalties they must pay for each song they
sell.
Event C:
Events A and B both occur.
3:
A. fall in price of CDs
ACTIVE LEARNING
P
The market for
music downloads
S1
STEPS
1. D curve shifts
P1
2. D shifts left
P2
3. P and Q both fall.
D2
Q2 Q1
D1
Q
ACTIVE LEARNING
3:
B. fall in cost of
royalties
P
The market for
music downloads
S1
STEPS
1. S curve shifts
P1
2. S shifts right
P2
S2
(royalties are part
of sellers’ costs)
3. P falls,
Q rises.
D1
Q1 Q2
Q
3:
C. fall in price of CDs
AND fall in cost of royalties
ACTIVE LEARNING
STEPS
1.
Both curves shift (see parts A & B).
2.
D shifts left, S shifts right.
3.
P unambiguously falls.
Effect on Q is ambiguous:
The fall in demand reduces Q,
the increase in supply increases Q.
The Determinants of Price Elasticity:
A Summary
The price elasticity of demand depends on:
 the extent to which close substitutes are available
 whether the good is a necessity or a luxury
 how broadly or narrowly the good is defined
 the time horizon: elasticity is higher in the long run than
the short run.
3:
Elasticity and changes in equilibrium
ACTIVE LEARNING
• The supply of beachfront property is inelastic. The supply of
new cars is elastic.
• Suppose population growth causes
demand for both goods to double
(at each price, Qd doubles).
• For which product will P change the most?
• For which product will Q change the most?
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ACTIVE LEARNING
3:
Answers
When supply
is inelastic,
an increase in
demand has a
bigger impact
on price than on
quantity.
Beachfront property
(inelastic supply):
P
D1 D2
S
B
P2
P1
A
Q1 Q2
Q
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ACTIVE LEARNING
3:
Answers
When supply
is elastic,
an increase in
demand has a
bigger impact
on quantity than
on price.
New cars
(elastic supply):
P
D1 D2
S
P2
P1
B
A
Q1
Q2
Q
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Elasticity and Tax Incidence
CASE 1: Supply is more elastic than demand
In this case,
buyers bear
most of the
burden of the
tax.
P
Buyers’ share of
tax burden
PB
S
Tax
Price if no tax
Sellers’ share of
tax burden
PS
D
Q
Elasticity and Tax Incidence
CASE 2: Demand is more elastic than supply
P
Buyers’ share of
tax burden
S
PB
Price if no tax
Sellers’ share of
tax burden
In this case,
sellers bear
most of the
burden of the
tax.
Tax
PS
D
Q
Other Elasticities
• The income elasticity of demand measures the response of
Qd to a change in consumer income.
Income elasticity of
=
demand
Percent change in Qd
Percent change in income
 Recall from chap.4: An increase in income causes an
increase in demand for a normal good.
 Hence, for normal goods, income elasticity > 0.
 For inferior goods, income elasticity < 0.
Other Elasticities
• The cross-price elasticity of demand measures the response
of demand for one good to changes in the price of another
good.
Cross-price elast.
of demand
=
% change in Qd for good 1
% change in price of good 2
 For substitutes, cross-price elasticity > 0
E.g., an increase in price of beef causes an increase in
demand for chicken.
 For complements, cross-price elasticity < 0
E.g., an increase in price of computers causes
decrease in demand for software.
Evaluating the Market Equilibrium
Market eq’m:
P = $30
Q = 15,000
Total surplus
= CS + PS
Is the market eq’m
efficient?
P
60
S
50
40
CS
30
PS
20
10
D
Q
0
0
5 10 15 20 25 30
ACTIVE LEARNING
1:
Answers to B
CS
= ½ x $150 x 75
= $5,625
A $100 tax on
airplane tickets
P
$ 400
350
300
PS = $5,625
PB = 250
tax revenue
= $100 x 75
= $7,500
200
S
PS = 150
D
100
total surplus
= $18,750
DWL = $1,250
50
Q
0
0
25
50
75 100 125
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Analysis of a Tariff on Cotton Shirts
P
free trade
CS = A + B + C
+D+E+F
PS = G
Total surplus = A + B
+C+D+E+F+G
tariff
CS = A + B
PS = C + G
Revenue = E
Total surplus = A + B
+C+E+G
Cotton shirts
deadweight
loss
=D+F
S
A
B
$30
$20
C
D
E
F
G
25
40
70 80
D
Q
2:
Elasticity and DWL of a tax
ACTIVE LEARNING
Would the DWL of a tax be larger if the
tax were on
A. Rice Krispies or sunscreen?
B. Hotel rooms in the short run or hotel rooms in the long
run?
C. Groceries or meals at fancy restaurants?
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ACTIVE LEARNING
2:
Answers
A. Rice Krispies or sunscreen
From Chapter 5:
Rice Krispies has many more close substitutes than
sunscreen, so demand for Rice Krispies is more price-elastic
than demand for sunscreen.
So, a tax on Rice Krispies would cause a larger DWL than a tax
on sunscreen.
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ACTIVE LEARNING
2:
Answers
B. Hotel rooms in the short run or long run
From Chapter 5:
The price elasticities of demand and supply
for hotel rooms are larger in the long run than
in the short run.
So, a tax on hotel rooms would cause a larger DWL in the
long run than in the short run.
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ACTIVE LEARNING
2:
Answers
C. Groceries or meals at fancy restaurants
From Chapter 5:
Groceries are more of a necessity and therefore less priceelastic than meals at fancy restaurants.
So, a tax on restaurant meals would cause a larger DWL than
a tax on groceries.
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ACTIVE LEARNING
3:
Discussion question
• The government must raise tax revenue to pay for schools,
police, etc. To do this, it can either tax groceries or meals at
fancy restaurants.
• Which should it tax?
34
DWL and the Size of the Tax
Initially, the tax is T
per unit.
P
new
DWL
Doubling the tax
causes the DWL
to more than
double.
S
2T
T
D
initial
DWL
Q2
Q1
Q
DWL and the Size of the Tax
Initially, the tax is T
per unit.
P
new
DWL
Tripling the tax
causes the DWL
to more than
triple.
S
T
3T
D
initial
DWL
Q3
Q1
Q
Revenue and the Size of the Tax
P
When the
tax is small,
increasing it
causes tax
revenue to rise.
PB
S
PB
2T
PS
T
D
PS
Q2
Q1
Q
Revenue and the Size of the Tax
P
PB
PB
When the
tax is larger,
increasing it
causes tax
revenue to fall.
S
3T
2T
D
PS
PS
Q3
Q2
Q
Revenue and the Size of the Tax
The Laffer curve
shows the
relationship
between
the size of the tax
and tax revenue.
Tax
revenue
The Laffer curve
Tax size
EXAMPLE 2: The Various Cost Curves Together
$200
$175
$150
$125
Costs
ATC
AVC
AFC
MC
$100
$75
$50
$25
$0
0
1
2
3
4
Q
5
6
7
ACTIVE LEARNING
3:
Costs
Fill in the blank spaces of this table.
Q
VC
0
1
10
2
30
TC
AFC
AVC
ATC
$50
n.a.
n.a.
n.a.
$10
$60.00
80
3
16.67
4
100
5
150
6
210
150
20
12.50
36.67
8.33
$10
30
37.50
30
260
MC
35
43.33
60
41
ACTIVE LEARNING
3:
Answers
AFC = FC
FC/Q
Use
First, relationship
deduce
ATC
TC/Q
= $50
and useMC
FC +and
VC =TC
TC.
between
AVC
VC/Q
Q
VC
TC
AFC
AVC
ATC
0
$0
$50
n.a.
n.a.
n.a.
1
10
60
$50.00
$10
$60.00
2
30
80
25.00
15
40.00
3
60
110
16.67
20
36.67
4
100
150
12.50
25
37.50
5
150
200
10.00
30
40.00
6
210
260
8.33
35
43.33
MC
$10
20
30
40
50
60
42
The Revenue of a Competitive Firm
• Total revenue (TR)
• Average revenue (AR)
TR = P x Q
AR =
• Marginal Revenue (MR):
The change in TR from
selling one more unit.
MR =
TR
Q
∆TR
∆Q
=P
The Monopolist’s Profit
Costs and
Revenue
As with a competitive
firm,
the monopolist’s
profit equals
MC
P
ATC
ATC
D
(P – ATC) x Q
MR
Q
© 2008 Nelson Education Ltd.
Quantity