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Main Topics for Free Responses Since 1995 Marginal Analysis Perfect Competition Monopoly Externalities Labor Market Comparative Advantage Consumer and Producer Surplus Elasticity Marginal Analysis The marginal benefit is the utility gained by spending an additional $1 on the good. The marginal costs the utility lost by sending a $1 less on another good. MU× P× What about when comparing two goods? MU× > MUү P× Pү How a firm decide what mix of capital, labor, and other factors to use? Apply the marginal decision rule. To determine MB of $1 spent on capital, we divide capital’s marginal product by its price: MPk/Pk. If capital and labor are the only factors, then spending an additional $1 on K while holding total cost constant means taking $1 out of labor. MPL× > MPK PL × PK Perfect Competition How does an individual firm determine its price, and quantity? Where MR =MC. MR is also the firms demand curve. MR= P = D = AR MC is the firms supply curve. What are the three possibilities for a firm in the short run? Economic profits: P>ATC Minimizing losses: ATC> P >AVC Shutdown: P < AVC In the long run the firm has? Zero economic profits Are they efficient, if so what type Both. Allocative and Productive. What will cause Price to change for a firm in Perfect Competition? Anything that causes the supply or the demand in the industry to change. Non-price determinants of demand and supply. Substitutes Income Compliments Taste, Preference # of buyers Future Price expectations Technology Cost of factors of production Price for other goods Taxes or subsidies # of sellers Future price expectations If a firm is in long run equilibrium what will happen if demand increases? Price goes up causing MR to shift up, firm now experiences profits If a firm is in long run equilibrium what will happen if demand decreases? Price goes down causing MR to shift down, firm now experiences losses Monopoly Graph it. How does a monopolist determine price and output? It gets its output where MR = MC. What about price? It goes straight up from the output until it hits the demand curve What is the area of profit? The difference between Price and ATC In what range of the demand curve does the monopolist produce at? The elastic range. Why? In order to sell more he must lower the price. If you lower the price in the inelastic range, TR will go down. How can you determine the elastic and inelastic range? MR is positive in the elastic range and negative in the inelastic range. Is the monopolist efficient, if so which one? No, why? Allocative efficient: P= MC Productive efficient: P = lowest ATC Where would a perfect competitor produce at? MC = Demand What is the area of deadweight loss? What should the government do to a monopoly, tax or subsidize? Monopolistic Competition: think pizza Because a monopolistically competitive firm faces a downwardsloping demand cure, its marginal revenue curve is a downwardsloping line that lies below the demand curves, as in the monopoly model. Graph monopolistic competition. Does a monopolistic competitor earn economic profits? Yes, in the short run but in the long run there are no economic profits. What happens to economic profits in the long run? Firms enter the market, demand and MR shift to the left. What would happen in the long run if a licensing fee was removed? MC would stay the same, ATC would go down, the firm would earn profits. Externalities If a good has a negative externality, that is yields costs to individuals who are neither consumers nor producers of the product. What will the price and output be? Price would be too low, output too high How would you graph this? The supply curve is the Marginal Cost curve. It can be labeled two ways. MPC = S curve with negative externality or MCP The supply curve that includes the cost is MSC or MCe The demand curve is the Marginal Benefit curve. MB or MSB An example would be pollution. So what do you do? You put a per unit tax. Shifts supply to the left. You could also put quantity restrictions, an effective price ceiling, or pollution permits. If the good has a benefit to individuals who are neither consumers nor producers of product. It is a positive externality. If the good has a benefit to individuals who are neither consumers nor producers of product. It is a positive externality. Price and Quantity would be? Price too high, output too low. National Defense is an example of a positive externality. If let to the private market, too little would be produced, not enough resources would be allocated, therefore output would be below the efficient amount. MSB>MSC at the unregulated output MSB>MPB or there is the Free-rider problem. Solutions: Public production of defense, tax to finance production, subsidy, to the private producers. Labor Market To maximize profits, a firm hires additional units of a factor up to the point that the factor’s marginal revenue product (MRP) equals its marginal factor cost (MFC). The firm’s MRP curve is its demand curve for the factor. MRP equals marginal product times price What will change MRP? Changes in the Use of Other Factors of Production: Changes in Technology Changes in Product Demand Changes in the Number of Firms The amount a factor adds to a firm’s total cost per period is its marginal factor cost (MFC). MFC is the supply curve for the firm What will change MFC Changes in income Changes in preferences Change in expectations Labor supply in specific markets Assume that a firm produces output using one fixed input, capital, and one variable input, labor. The firm can sell all of the output it produces at a market price of $2 each, can hire all of the workers it wants at a market wage rate of $8 each, and has fixed costs of $15. it faces the following production schedule. Number of Total Employees Output 0 0 0 1 1 14 2 2 26 3 3 35 4 4 42 5 5 46 Comparative Advantage Absolute Advantage: One nation can produce more output with the same resources as the other. Comparative Advantage: One nation can produce a good at a lower opportunity cost than the other. Examples of Comparative Advantage: Lawyer and secretary, Doctor and Nurse. The number of CDs and beef produced in one hour. CDs Beef Japan 4 2 Canada 4 6 Which nation has an absolute advantage in producing CDs? Neither Which nation has an absolute advantage in producing beef? Canada Who has the comparative advantage in CDs? Beef? The number of hours it takes to produce one loaf of bread and one bushel of corn Bread Corn United States 4 2 France 4 6 Which nation has an absolute advantage in producing bread? Neither Which nation has an absolute advantage in producing corn? U.S. Which nation has an comparative advantage in producing bread? corn? What will each nation gain if France trades a loaf of bread for a bushel of corn? Consumer and Producer Surplus Consumer surplus is the amount by which the total benefit to consumers exceeds their total expenditure. Producer surplus is the difference between the total revenue received by sellers and their total cost. Elasticity Remember, who the tax-burden falls on depends on the elasticity of demand and supply.