Carley’s ECO 105 Archived Resources

Tips

Reasons to shift Demand Curve:

  1. Change in tastes and preference of the consumer.
  2. Change in income.
  3. Change in the prices of other goods; complements or substitutes in consumption.
  4. Change in the number of consumers (population).

Reasons to shift the Supply Curve:

  1. Change in the costs of production i.e. the cost of inputs (parts) of the good, better technology, taxes.
  2. Change in the number of producers (size of the market).
  3. Change in prices of other goods. i.e. substitutes or complements in production.
  4. Changes in nature; expectations.

With that said, please give these two questions from your homework a little extra thought, as they are less intuitive and the professor says are the ones students get wrong most often:

PERSONAL COMPUTER MARKET: Intel raises/drops the price by 20% for its popular CPU chip.

STEEL INDUSTRY: researchers find new techniques for manufacturing steel which use 25% fewer materials.

GASOLINE MARKET: the state sales tax on gasoline is eliminated/imposed.

Lastly, REMEMBER:

Increase in supply is a shift to the RIGHT/DOWN and a Decrease is a shift to the LEFT/UP.

Increase in demand is more intuitive, it is a shift to the right/up and decrease is a shift to the left/down.

Perfect elasticities

  • These three graphs show what a PPF with increasing cost, constant, and decreasing cost, respectively. You can click on the image to see in clearer.
  • When it comes to deciding who has the comparative advantage: the country that has the lowest opportunity cost, is the one with the comparative advantage. EX. Country A Opp. cost 1 car for 2 textiles ; 1 textile for 1/2 car | Country B Opp. cost 1 car for 1/2 textile; 1 textile for 2 cars. Country A has the comparative advantage in textiles, Country B has the comparative advantage in cars.
  • The effects of free trade barriers include:
    • Lower cost per job; it costs the country less money to protect it’s domestic jobs because it does not have much foreign labor.
    • Living standards are lowered; when one country with cheap labor trades with a country with expensive labor, that higher the living of standard for both countries. The cheap labor country gets a lot of jobs and and the expensive labor country’s goods are cheaper.
    • Prices of some goods rise for consumer; without being able to use their comparative advantage, the countries have to make all their goods domestically, and that is going to be more expensive. This overall makes the consumer worse off!

Marginal profit and how firms react to it:

A firm in perfect competition as we are learning in now, will always keep producing the next unit if its marginal profit is positive or equal to zero.

I’ve attached a chart to demonstrate visually marginal cost, revenue and profit. The red shows where marginal profit would be zero, and every unit before that the firm would produce because their marginal costs are less than their marginal revenue, giving them a positive marginal profit. This is an important concept to keep in mind when deciding to produce one more unit, one more bundle of units.

An important part of Economics, is understanding that Profit, Revenue and Costs are all three different things calculated three different ways. This is very important in understanding what a question is asking for.

Costs are calculated per unit or per hour usually. They can be explicit or implicit, fixed or variable.

Revenue is calculated by taking the price of the product being sold and multiplying it by the number of units the firm sells. So if a toy factory sells 20 toys for $10 each, they would have made a revenue of $200.

Profit is calculated by taking revenue, and subtracting from it costs.

 

For a perfectly competitive market, the firm will always produce where MR=MC, as you can see that is point “a” on the graph.

From there you just drop a line down, wherever it intersects with the ATC curve, which i point “b”, that is where you would draw to the side to mark the profit box.

 

You can calculate these areas by using the formula A=1/2Base x Height. So for example, we would calculate the producer surplus here as PS= 1/2 5 x 5.

  • Fixed costs, on a graph, are always the quantity where the SRTC curve begins.
  • 99.99% of the time, the example given for a fixed cost will be rent, mortgage, cost of housing, etc.
  • Variable costs are the costs the producer can stop paying if they decided to stop production tomorrow.
    • So if a baker wants to just stop baking cookies tomorrow, he will no longer have to buy flour, sugar, or workers (variable costs). BUT, in the short run, he will have to pay the rent for the space he bought (fixed costs).
  • longrun_ATC_curve
    • In economies of scale, we have increasing returns to scale, so as more quantities are produced, the LRATC decreases.
    • In the middle there are constant returns to scale, so while producing more quantities, the cost remain constant.
    • in the diseconomies of scale we have decreasing returns to scale, so as more quantities are produced, the LRATC increases.
  • In the short run, there is ALWAYS a fixed cost. However in the long run, NOTHING is fixed, everything is variable.
  • TC = FC +VC (same formula for ATC, just need to have Average VC and Average FC).
  • This is the theory behind returns to scale, because some questions on the homework have to do with this.
    • Returns-to-Scale-2
    • So this is increasing returns to scale (IRTS). The idea is that if you double your capital and double your labor, you would more than double your output.
    • Returns-to-Scale-3
    • This is decreasing RTS. The idea is that you double your capital and double your labor, you would less than double your output.
    • I don’t have a picture for constant RTS, but you could imagine what it would look like. Just put an equal sign where the greater than/ less than signs are. The idea is that if you double your capital and double your labor, you would double your output.

 

Some tricks to remember the rules of elasticity:

So OWN PRICE ELASTICITY is (%change in Quantity Demand)/ (Percentage change in Price)

First! Remember when calculating percentage change it is change in price or quantity divided by the average of the quantities or prices.

So when calculating change you just take the new minus the old price or quantity and to get the average you just add the two quantities and divide them by 2. Then you have the percentage change!

So skip forward a little, say you have both of your percentage changes calculated as discussed above, you divide the two, and then take their absolute value; meaning if it is negative you just drop the negative and make it positive.

How do you remember this, it easy:

Inelastic < 1 In- usually means something bad no? There’s usually some sort of negativity associate with the stem in-. Like you bank has insufficient funds… that’s never good a thing. So I associate that with less than 1, because no wants to be less than 1.

Elastic is >1 This is just the opposite.

Now remember the graphs for perfectly elastic and inelastic:

NOTICE: The perfectly Elastic curve kinda looks like an E.

The perfectly Inelastic curve kinda looks like an I.

Perfect elasticities

 

 

 

A general definition of consumer surplus is the difference between what the consumer is wiling to pay and what the market price is.

Producer surplus is the difference between what the producer is willing sell the good for and what the producer actually receives.

We will be building on this topic and loses in consumer and producer surplus, when calculating them just think of how you could use geometry to calculate the areas. Remember regular area is A= Base x Height.

consumer surplus

 

A monopoly is a firm that is the sole producer of a distinct good. Monopolists are price setters to a certain extent, rather than price takers, like in perfect competition.

I want to start with the graph because I think it explains the most. So for monopolies, the optimal point is still MR=MC, then you would draw up to where that point hits the demand curve. All the area between the point and the lowest point on the ATC curve, is the monopoly profit.

Here is a picture to demonstrate:

monopoly

Also, pay attention to the deadweight loss that is created from this. The deadweight loss is the triangle to the right of the profit box.

 

With a price floor, just like a regular floor, you can only stand higher than the floor, you can’t, assuming this a one story house, stand below a floor.  Price ceiling, like a regular ceiling, you must stand below. You can’t go higher than the ceiling.

Here is a graph representation of price ceilings and floors.

floor

 

 

Just remember when a tax is imposed, the SUPPLY curve shifts to the left/up, by that much. Taxing is another way to internalize the externality as well.

Here is a graph of the deadweight loss that is created when a negative externality is imposed on society. I think this graph combines a lot of what we have learned with the formulas on the top right corner.

DWL SS

 

 

The amount of tax that is taken on by the supplier and the demanders, regardless of “who it was imposed on” is determined by how inelastic their supply or demand is. Whoever is more inelastic will take on more of the tax. Think about this. If business a has a very elastic supply, and Bob has a very inelastic demand for sugar (i.e. he NEEDS sugar), then when a tax is imposed on sugar, business A will be somewhat aware of Bob’s inelastic demand, and charge more for the good so that the buyer will pay most of the tax. Bob will keep buying the sugar at this price because he needs sugar.

Here is a graphical representation of this:

tax-incidence-supply-demand-diagrams

Videos and Handouts

Supply and Demand Handout