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Microeconomics
James B. Wilcox
Resources provided by:
The University of Southern MississippiCenter for Economic and Entrepreneurship Education,
Mississippi State University, & Virtual Economics
Economics…is the study of how individuals and society choose, with or without the use of money, to employ scarce productive resources to produce various commodities over time and distribute them for consumption, now and in the future, among various people and groups in a society.
The Economic Way of Thinking:Three Activities to Demonstrate Marginal Analysis 2
5
9
12
14
15
15
14
2
3
4
3
2
1
0
-1
99
Production and Costs
• Producers: Maximize profit• Opportunity cost
– All resources have an opportunity cost
• Explicit costs– Payments for resources
• Implicit costs – Opportunity cost of resources owned by
the firm / firm owners
– No cash payment
Alternative Measures of Profit
• Accounting profit– Total revenue minus explicit costs
• Economic profit– Total revenue minus all costs (implicit and
explicit)• Opportunity cost of all resources
• Normal profit– “Accounting profit in excess of normal profit”
• Accounting profit = Economic + Normal profit10
Production in the Short Run
• Variable resources– Can be varied quickly
• Fixed resources – Cannot be altered easily
• Short run– At least one resource is fixed
• Long run – No resource is fixed
11
Law of Diminishing Marginal Returns
• Total product: total output produced • Production function
– Relationship between amount of resources employed and total product
• Marginal product: the change in total product resulting from a one-unit increase in a resource employed by the firm
12
Law of Diminishing Marginal Returns
• Increasing marginal returns: the MP of a variable resource increases as each additional unit of the resource is put into action
• Diminishing marginal returns – Marginal product decreases
• Law of diminishing marginal returns: as more of a variable resource is added to a given amount of a fixed resource, MP eventually begins to decline 13
Exhibit 3The total and marginal product of labor
14
5
10
15
Tot
al p
rodu
ct
(to
ns/d
ay)
5 10 Workers per day0
5 10 Workers per day
1
3
5
Mar
gina
l pro
duct
(to
ns/d
ay)
0
2
4
Total
product
Marginal product
Negative
marginal
returns
Diminishing but
positive
marginal returns
Increasing
marginal
returns
(a) Total product
(b) Marginal product
Costs in the Short Run
• Fixed cost (TFC): any production costs that a firm incurs even when it is not producing output; Ex: overhead—rent, insurance, property taxes
• Variable cost (TVC) any production costs that change as output changes; TVC = 0 when the firm is not producing any output; Ex.: labor costs
15
Costs in the Short Run
• Total cost TC = TFC + TVC• Marginal cost MC = ∆TC/∆q
• Change in TC to produce one more unit of output
– Changes in MC reflect changes in marginal productivity
– Increasing marginal returns• MC falls
– Diminishing marginal returns• MC increases 16
Exhibit 4Short-run TC and MC data for Smoother Mover
17
(1)Tons moved
per day(q)
(2)Fixed cost(FC)
(3)Workers per day
(4)Variable
cost(VC)
(5)Total cost
(TC=FC+VC)
(6)Marginal cost
MC=∆TC/∆q
0259
121415
$200 200 200 200 200 200 200
0123456
$0100200300400500600
18
(1)Tons moved
per day(q)
(2)Fixed cost(FC)
(3)Workers per day
(4)Variable
cost(VC)
(5)Total cost
(TC=FC+VC)
(6)Marginal cost
MC=∆TC/∆q
0259
121415
$200 200 200 200 200 200 200
0123456
$0100200300400500600
$200 300 400 500 600 700 800
-$50.00 33.33 25.00 33.33 50.55 100.00
•SR TC and MC data for Smoother Mover
Exhibit 5TC and MC curves for Smoother Mover
19
200
$500
Tot
al d
olla
rs
25
Cos
t per
ton
$50Marginal cost
9 15 Tons per day0 63 12
Fixed cost
Total cost
Tons per day0 9 1563 12
Variable costFixed
cost
FC = $200 at all levels of output
VC starts from origin; increases slowly at first;
with diminishing returns, VC increases rapidly
TC is the vertical sum of FC and VC
MC first declines: increasing marginal returns;
then increases: diminishing marginal returns
Average Cost in the Short Run
• Average variable cost AVC = VC/q• Average total cost ATC = TC/q• When MC < average cost
– The marginal pulls down the average
• When MC > average cost– The marginal pulls up the average
• U-shape of average cost curves– Law of diminishing marginal returns
20
Exhibit 7Average and marginal cost curves; Smoother Movers
21
0 5 10 15 Tons per day
$150
125
100
75
50
25
Cos
t pe
r to
n
ATC
AVC
MC
ATC and AVC: decline,
reach low points, then rise.
When MC is below AVC (ATC),
AVC (ATC) is falling
When MC = AVC (ATC), AVC (ATC) is at its minimum.
When MC is above AVC (ATC),
AVC (ATC) is increasing.
2323
What is Market Structure?
• Market structure– Number of suppliers
– Product’s degree of uniformity
– Ease of entry into the market
– Forms of competition among forms
• Industry– All firms supplying output to a market
Types of Market Structure
• Perfect Competition: many sellers; horizontal demand curve
• Monopoly: one seller• Monopolistic Competition: many
sellers; downward-sloping demand curve• Oligopoly: few sellers
24
Perfectly Competitive Market Structure
• Many buyers and sellers• Commodity; standardized product• Fully informed buyers and sellers• No barriers to entry• Individual buyer or seller
– No control over priceprice-taker
25
Demand Under Perfect Competition
• Market price– Determined by market demand and
supply. All firms must use this price on their products.
• Demand curve facing one supplier– Horizontal line at the market price
– Perfectly elastic
26
Short Run Profit Maximization
• Maximize economic profit– Choose the quantity at which total
revenue (TR) exceeds total cost (TC) by the greatest amount
– TR = PxQ
• Profit = TR – TC
27
Golden Rule of Profit Maximization
• Marginal revenue: the change in TR from selling an additional unit– ∆TR/∆q
• MR = P = AR (perfect competition)• Golden rule: produce where MR = MC
– Expand output: MR>MC
– Stop before MC>MR
28
Exhibit 2
• Short-run cost and revenue; perfectly competitive firm
29
(1)Bushels of wheat
per day;(q)
(2)MarginalRevenue
(Price); (p)
(3)Total
Revenue(TR=q×p)
(4)TotalCost(TC)
(5)Marginal
CostMC=∆TC/∆q
(6)Average
Total costATC=TC/q
(7)Economic
Profit or LossTR-TC
0123456789
10111213141516
-$5555555555555555
$05
101520253035404550556065707580
$15.0019.7523.5026.5029.0031.0032.5033.7535.2537.2540.0043.2548.0054.5064.0077.5096.00
-$4.753.753.002.502.001.501.251.502.002.753.254.756.509.50
13.5018.50
-$19.7511.758.837.256.205.424.824.414.144.003.934.004.194.575.176.00
-$15.00-14.75-13.50-11.50-9.00-6.00-2.501.254.757.75
10.0011.7512.0010.506.00-2.50-16.00
Barriers to Entry
• Monopoly– Sole supplier of a product with no close
substitutes
• Barriers to entry1.Legal restrictions such as a patent
2.Economies of scale – natural monopoly with a downward sloping LRAC
3.Control of essential resources – EX: DeBeers Consolidated Mines (diamonds)
31
Firm’s Costs and Profit Maximization
• Monopolist– Choose the price
– OR the quantity
– ‘Price maker’
• Profit maximization– TR minus TC
– Supply quantity where TR exceeds TC by the greatest amount
– MR equals MC32
Exhibit 5
• Short-run costs and revenue for a monopolist
33
(1)Diamonds
per day(Q)
(2)Price(AR)(p)
(3)Total
RevenueTR=p×Q
(4)Marginal Revenue
MR=∆TR/∆Q
(5)TotalCost(TC)
(6)Marginal
Cost(MC)
(7)Average
Total costATC=TC/q
(8)Total profit
or loss(=TR-TC)
0123456789
1011121314151617
$7,7507,5007,2507,0006,7506,5006,2506,0005,7505,5005,2505,0004,7504,5004,2504,0003,7503,500
0$7,50014,50021,00027,00032,50037,50042,00046,00049,50052,50055,00057,00058,50059,50060,00060,00059,500
-$7,5007,0006,5006,0005,5005,0004,5004,0003,5003,0002,5002,0001,5001,000500
0-500
$15,00019,75023,50026,50029,00031,00032,50033,75035,25037,25040,00043,25048,00054,50064,00077,50096,000121,000
-$4,7503,7503,0002,5002,0001,5001,2501,5002,0002,7503,2504,7506,5009,500
13,50018,50025,000
-$19,75011,7508,8337,7506,2005,4204,8204,4104,1404,0003,9304,0004,1904,5705,1706,0007,120
-$15,000-12,250-9,000-5,500-2,0001,5005,0008,25010,75012,25012,50011,7509,0004,000-4,500-17,500-36,000-61,500
Monopolistic Competition
• Characteristics– Many producers
– Low barriers to entry
– Slightly different products• A firm that raises prices: lose some
customers to rivals
– Some control over price ‘Price makers’• Downward sloping D curve
– Act independently35
Monopolistic Competition
• Product differentiation– Physical differences
• Appearance; quality
– Location• Spatial differentiation
– Services
– Product image• Promotion; advertising
36
Oligopoly
• Few sellers• Barriers to entry
– Economies of scale
– Legal restrictions
– Brand names
– Control over an essential resource
– High cost of entry• Start-up costs; advertising
• Crowding out the competition37
Collusion and Cartels
• Collusion– Agreement among firms to
• Divide the market• Fix the price
• Cartel– Group of firms that agree to collude
• Act as monopoly• Increase economic profit
• Illegal in U.S.38
Comparisons Across Market Structures
CharacteristicsPerfect Competition
Monopolistic Competition
Oligopoly Monopoly
Sellers Many Many Few One
Products Identical Close substitutes, but not identical
Identical (ex: oil) ORDifferent (ex: cereal)
No close substitutes
Prices Price-taker Price-maker Price-maker Price-maker
Entry and Exit No barriers No barriers Barriers Barriers
Demand horizontal Downward-sloping
Downward-sloping
Downward-sloping
Profits MR=MC MR=MC MR=MC MR=MC
Long-Run Economic Profits
Zero Zero Greater than zero
Greater than zero
39
Characteristics of Pure Public Goods
• Nonrival: more than one person can consume the good or service at the same timeMC of an additional user is zero
• Nonexcludable: difficult or impossible to exclude others from deriving the benefits of the public good
41
Private, Public Goods, and in Between
1. Private goods– Rival in consumption
– Exclusive
– Provided by private sector
2. Public goods– Nonrival in consumption
– Nonexclusive
– Provided by government
42
Private, Public Goods, and in Between
3. Natural monopoly– Nonrival but exclusive
– With congestion: private goods
– Provided by private sector or government
4. Open-access good– Rival but nonexclusive
– Regulated by government
43
Paying for Public Goods
• Tax = marginal valuation– Free-rider problem
• People try to benefit from the public goods without paying for them
– Ability to pay
45
Externality
• Externality—costs or benefits from the production process that are not reflected in the market price and affect the welfare of others not necessarily using the product or service.
• Externalities can be positive (reflecting a benefit) or negative (reflecting a cost.)
47
Negative versus Positive• Person smoking in a crowded room• Firm producing honey located next to an
apple orchard• Person talking loudly on their cell phone
at the table next to yours• Colorful English country garden in your
next door neighbor’s yard• Pollution from a coal-burning utility plant
48
Negative Externality
• Marginal Private Cost (MPC): private costs of production such as wages, costs of materials, rent, insurance, taxes, etc.
• Marginal External Cost (MEC): valuation of marginal damage caused by negative externality
• Marginal Social Cost (MSC):
= MPC + MEC
49
Exhibit 1
50
0.10
$0.14
Dol
lars
per
kilo
wat
t-ho
ur
Marginal
social cost Marginal private cost; 50 million kilowatt-hours of electricity are produced per month.
The marginal external cost of production is imposed on society.
350 Millions of kilowatt-hours
of electricity per month50
Marginal
private cost
D
a
c
Marginal social cost; only 35 millions kilowatts-hour are produced, which is the optimal output.
Marginal social cost curve includes marginal private cost and marginal external cost.
Total social gain
b
Public Responses to Negative Externalities
• Tax the polluter: levy a tax on each level of output produced by the polluter in an amount equal to the MEC inflicted at the socially efficient level of output.
• Subsidize the polluter: pay the polluter not to pollute
• Environmental regulation: Government tells the polluter to reduce pollution or face sanctions (1990 Clean Air Act)
51
Public Responses to Negative Externalities
• Economic efficiency approach: marketable permits—government sells producers permits to pollute (pollution rights)
52
Positive Externality
• Marginal Private Benefit (MPB): private benefits of production or consumption
• Marginal External Benefit (MEB): valuation of marginal benefit created by positive externality
• Marginal social benefit = MPB + MEB
53
Positive Externalities
• Beneficial externalities• Education
– Personal benefits
– Benefits to society• Positive externality
• Public policy– To increase quantity beyond private
optimum
54
Exhibit 7
• Education and positive externalities
55
E0 E’ Quantity of
education per period
Dol
lars
per
uni
t
DMarginal
private benefit
D’
Marginal
social benefit
SMarginal
cost
e’
e
No government intervention: equilibrium quantity of education (E); marginal private benefit of education equals the marginal cost as reflected by the supply curve.
Education also confers a positive externality on the rest of society, so the social benefit exceeds the private benefits.
At E, the marginal social benefit exceeds the marginal cost, so more education increases social welfare.
In this situation, government tries to increase education to E’, where the marginal social benefit equals the marginal cost.
Income Distribution by Quintiles
• Distribution of income– U.S. households
– Ranked by income
– Five groups of equal size (quintiles)
• Percentage of income received in 1970– Poorest 20% of population
• 4.1% of income
– Richest 20% of population• 43.3% of income
57
Income Distribution by Quintiles
• Richest 20% of population– Increased share of income
– Two-earner households
• Poorest 20% of population– Decreased share of income
– Single-parent household
59
The Lorenz Curve
• Lorenz curve: graphical representation of the size of the income distribution
• The diagonal line represents equal distribution or perfect income equality. Each 20 percent of the population receives 20 percent of total income.
60
Exhibit 2: Lorenz Curve
61
Households (cumulative percent)
Inco
me
(cum
ulat
ive
perc
ent)
1970
2005
a
bEqual d
istrib
ution
Lorenz curve: convenient way of showing the % of total income received by any given % of households when households are arrayed from smallest to largest.
Point a: in 1970, the bottom 80% of households received 56.7% of all income.
Point b: in 2005, the share of all income going to the bottom 80% of households was lower than in 1970.
If income were evenly distributed across households, the Lorenz curve would be a straight line.
Why Incomes Differ
• Number of household members working• Education, ability, job experience• Productivity• High-income household
• Well-educated couple; both spouses employed
• Low-income household• One person living alone• Single-parent, female• Poorly educated
62
A College Education Pays More
• Median wage, past 20 years– Only high-school diploma: decreased 6%
• Industry deregulation; declining unionization• Information technology
– College degree: increased 12%• Information technology• Higher rewards for education
63
Redistribution Programs
• Official U.S. poverty level– Family of four: $19,971 in 2005
– $13.70 per person per day
– Pretax money income– Includes cash transfers– Excludes value of non-cash transfers
» Food stamps; Medicaid; Subsidized housing» Employer-provided health insurance
– Recessions: Increase in poverty
• International poverty line: • $1 per person per day 64
Social Insurance
1. Social security
2. Medicare
3. Unemployment insurance
4. Workers’ compensation• Deducted from workers’ pay
– Aimed at people with work history
• Income redistribution • From rich to poor • From young to old 66
Income Assistance
• Welfare programs• Means-tested program: only individuals
with incomes below a certain level qualify
1.Cash transfers programs– Temporary assistance for needy families:
TANF replaced AFDC
– Supplemental security income
– General assistance aid
– Earned-income tax credit67
Income Assistance
2. In-kind transfer programs– Medicaid: basic medical care for the poor
– Food stamps
– Housing assistance
– Support for day care, school lunches
– Energy assistance
– Education and training
68
Welfare Reform
• Welfare-to-work programs• 1997: Temporary assistance for needy
families– States: more control
• Maximum time to receive benefits: 5 years• Work participation rates: must work after 2
years of receiving benefits• Benefit levels are reduced less than dollar
for dollar when one obtains a job
70
Welfare-to-work is working?
• Welfare recipients– Declined 71% below the peak
• Increased employment among mothers – Higher income
• Increased welfare spending per recipient• Earned-income tax credit• Higher price of going on welfare
71
QuickTime™ and aTIFF (Uncompressed) decompressor
are needed to see this picture.
Statistics from U.S. GAO
74
$60
$60
$60
$60
$60
$60
$60
$60
$145
$180
$210
$245
$285
$330
$385
$525
$35
$30
$35
$40
$45
$55
$65
$112
$168
$224
$56
$56
$56
$56
$56
$56
$56
$280
$336
$392
$448
$560
$56
$56
$56
$56
$56
$56
$56
-$49 (loss)-$33 (loss)
$14 (profit)
$35 (profit)
$62 (profit)
$63 (profit)
$54 (profit)
$35 (profit)