Economics Midterm Review 2: October 23rd Class Notes
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What is deadweight loss?
In economics, a deadweight loss (also known as excess burden or allocative inefficiency) is a loss of economic efficiency that can occur when equilibrium for a good or service is not Pareto optimal.
The costs to society created by market inefficiency. Mainly used in economics, deadweight loss can be applied to any deficiency caused by an inefficient allocation of resources. Price ceilings (such as price controls and rent controls), price floors (such as minimum wage and living wage laws) and taxation are all said to create deadweight losses. Deadweight loss occurs when supply and demand are not in equilibrium.
Minimum wage and living wage laws can create a deadweight loss by causing employers to overpay for employees and preventing low-skilled workers from securing jobs. Price ceilings and rent controls can also create deadweight losses by discouraging production and decreasing the supply of goods, services or housing below what consumers truly demand. Consumers experience shortages and producers earn less than they would otherwise. Taxes are also said to create a deadweight loss because they prevent people from engaging in purchases they would otherwise make because the final price of the product will be above the equilibrium market price.
How do you calculate a new demand curve when a dollar is donated when purchasing icecream....?
THe supply function changes, and is inverted from Q=5+2P, invert to P= -7/2+1/2
The supply curve shifts up, the purchaser pays an extra dollar. Plus one.
If it goes down, you subtract
How do you calculate profit?
Revenue - cost
Profit varies with the level of output because
both revenue and cost vary with out put
What are the two key decisions to maximize profit?
- 1. Output decision: What is the output level that maximizes profit or minimizes loss?
- 2.Shutdown decision: Is it more profitable to produce, or to shut down?
Output decision... The extra income from ________.
The extra income from selling one more unit of output must be equal to the extra cost from making that unit of output.
The change in total revenue/ the change in quantity
The change in total cost/ the change in quantity
If marginal revenue is greater than marginal cost... should I produce more?
Yes, because the profit is increased
If I produce more, and marginal revenue is equal to marginal cost... should I produce more?
No, because profit stays the same
Profit is maximized when
marginal revenue - marginal cost = 0
Output decision, shows where marginal revenue - marginal cost = 0
Profits are maximized here... at pie and Q.
What does Pie mean?
What is TR?
What is MR?
What does a triangle signify? (delta)?
Marginal Revenue - Marginal Cost =
Marginal Profit or MPie
what is q*
the amount of output that will maximize profit
What is VC?
Variable cost (i.e. labour, computers, whatever you can buy in the short run)
What is FC?
Fixed cost (i.e. the cost of machinery, etc)
The decision if you should produce or not rests on...
the variable and fixed cost. Break down the profit equation, revenue-costs to revenue-fixed costs-variable costs
Should I produce this?
- For example...
- Q P TR W VC FC PiePRo PieDONT
- 1 5 5 2 2 10 -7 -10
Yes, because you lose money. IF you produce you only lose 7, but if you don't you lose 10.
When do you stop producing?
When the PieProduced is a bigger loss than PieNotProduced
Or.. when the price is lower than the wage.
You should not produce if the revenue can not cover the variable cost of producing those units. You should produce if the total revenue is able to cover the entire variable cost and still cover some of the fixed costs. It can be more harmful if you don't produce in some cases.
In the short run, as long as revenue covers variable
costs and some fixed cost...
no shutdown occurs.
What is PV? FV?
Present Value; Future Value
Money in the future is work ____ than today.
What are the main market structures?
- Perfect competition
- Monopolistic Competition
What is market structure?
n economics, market structure is the number of firms producing identical products which are homogeneous.
- Number of firms in the market
- ease with which firms can enter and leave the market
- ability of firms to differentiate their products from those of their rivals
Describe characteristics of perfect competition
- Characteristic# 1. Large Number of Buyers and Sellers
- ◦If the sellers in a market are small in size and numerous, no single firm can raise or lower the market price.
Characteristic # 3. Full Information
- Characteristic # 2. Identical Products
- ◦Buyers perceive firms sell identical or homogeneous products. Fuji apples are identical, all farmers charge the same price.
◦Buyers know the prices charged by all firms and that products are identical. No single firm can unilaterally raise its price above the market equilibrium price.
- Characteristic # 4. Negligible Transaction Costs
- ◦Buyers and sellers do not have to spend much time and money finding each other or hiring lawyers to write contracts to make a trade.
- ◦Perfectly competitive markets have very low transaction costs.
- Characteristic # 5. Free Entry and Exit
- ◦The ability of firms to enter and exit a market freely in the long run leads to a large number of firms in a market and promotes price taking.
What does perfect competition mean?
In economic theory, perfect competition (sometimes called purecompetition) describes markets such that no participants are large enough to have the market power to set the price of a homogeneous product. Because the conditions for perfect competition are strict, there are few if any perfectly competitive markets.
A situation in which a single company or group owns all or nearly all of the market for a given type of product or service. By definition,monopoly is characterized by an absence of competition, which often results in high prices and inferior products.
DEFINITION of 'Oligopoly' A situation in which a particular market is controlled by a small group of firms. An oligopoly is much like a monopoly, in which only one company exerts control over most of a market. In an oligopoly, there are at least two firms controlling the market.
What is a monopolistic competition?
Monopolistic competition is a type of imperfect competition such that many producers sell products that are differentiated from one another (e.g. by branding or quality) and hence are not perfect substitutes.
What market competitions are price setters?
Monopoly, oligopoly, monopolistic
What market conditions are price takers?
perfect competition. If there are too many suppliers, and you try to sell at a higher price, no one will buy it...
Perfect Competition: Explain... Free entry and exit
The ability of firms to enter and exit a market freely in the long run leads to a large number of firms in a market and promotes price taking.
Perfect competition in the short run - output decision.
THe blue line is flat at 8 which is the price. The supplier (red) will produce 284 units of output at pice e to maximize profits. THe profits will be the difference between how much they can get (8) and the cost (284)... THe average cost is total cost/quantity.
YELLOW is the profit function.
Marginal revenue = equal to price. 6.5 is profit per unit.
Because a competitive firm is a price taker....
Total Revenue = Price x Quantity - Total Cost(Q)
- Q P TR MR
- 1 3 3
- 2 3 6 6-3=3
- 3 3 9 9-6=3
Perfect competition is the only market structure where...
Marginal revenue = equal to price.
BECAUSE perfect condition is a price taker.
Perfect competition - Shutdown decision
AVC = purple, average variable cost... It's the variable cost per unit of output. If the price is above the average cost (green), you make a profit, because the average cost per unit is less than the revenue that you receive. So therefore price needs to be above 6. If price is between 6 and 5, you make a short run loss (coloured orange). If price is LESS than 5, shut down.
Any point on the MC curve (red), is going to be the supply function for this supplier.
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