positive and normative economics -...

Positive and Normative Economics

• Positive economics

• Deals with economic facts

• Normative economics

• A subjective perspective of the economy

Society’s Economizing Problem

• Scarce resources

• Land

• Labor

• Capital

• Entrepreneurial Ability

Production Possibilities Curve

Pizzas

Attainable

0 1 2 3 4 5 6 7 8 9

Unattainable

The law of increasing opportunity costs makes the PPC concave.

Present Choices, Future Possibilities

Goods for the Present

Current Curve

Future Curve

Presentville Futureville

The Five Fundamental Questions

• What goods and services will be produced?

• How will the goods and services be produced?

• Who will get the goods and services?

• How will the system accommodate change?

• How will the system promote progress?

LO3 2-5

The Circular Flow System

RESOURCE MARKET

•Households sell •Businesses buy

PRODUCT MARKET

•Businesses sell •Households buy

BUSINESSES

• buy resources • sell products

HOUSEHOLDS

• sell resources • buy products

LO5 2-6

Changes in Demand

Quantity Demanded (bushels per week)

2 4 6 8 10 12 14 16 18

Determinants of Demand

Table 3.1 Determinants of Demand: Factors That Shift the Demand Curve

Determinant Examples

Change in buyers’ tastes Physical fitness rises in popularity, increasing the

demand for jogging shoes and bicycles; cell phone

popularity rises, reducing the demand for land-line

phones.

Change in the number of buyers A decline in the birthrate reduces the demand for

children’s toys.

Change in income A rise in incomes increases the demand for normal

goods such as restaurant meals, sports tickets, and

necklaces while reducing the demand for inferior

goods such as cabbage, turnips, and inexpensive

Change in the prices of related

A reduction in airfares reduces the demand for bus

transportation (substitute goods); a decline in the price

of DVD players increases the demand for DVD movies

(complementary goods).

Change in consumer expectations Inclement weather in South America creates an

expectation of higher future coffee bean prices,

thereby increasing today’s demand for coffee beans. 3-8

Changes in Supply

Quantity supplied (thousands of bushels per week)

2 4 6 8 10 12 14 16

Change in Quantity Supplied

Change in Supply

Determinants of Supply

Table 3.2 Determinants of Supply: Factors That Shift the Supply Curve

Determinant Examples

Change in resource prices A decrease in the price of microchips increases the

supply of computers; an increase in the price of crude

oil reduces the supply of gasoline.

Change in technology The development of more effective wireless

technology increases the supply of cell phones.

Change in taxes and subsidies An increase in the excise tax on cigarettes reduces the

supply of cigarettes; a decline in subsidies to state

universities reduces the supply of higher education.

Change in prices of other goods An increase in the price of cucumbers decreases the

supply of watermelons.

Change in producer expectations An expectation of a substantial rise in future log prices

decreases the supply of logs today.

Change in the number of suppliers An increase in the number of tattoo parlors increases

the supply of tattoos; the formation of women’s

professional basketball leagues increases the supply

of women’s professional basketball games.

Efficient Allocation

• Productive efficiency • Producing goods in the least costly way

• Using the best technology

• Using the right mix of resources

• Allocative Efficiency • Producing the right mix of goods

• The combination of goods most highly valued by society

LO3 3-11

Government Set Prices

Shortage

ceiling $3.50

Government Set Prices

Surplus

Interpretation of Elasticity of Demand

• Ed > 1 demand is elastic

• Ed = 1 demand is unit elastic

• Ed < 1 demand is inelastic

• Extreme cases

• Perfectly inelastic

• Perfectly elastic

LO1 4-14

Elasticity and Total Revenue

0 1 2 3 4 5 6 7 8

Quantity Demanded

rs) $20 18 16 14 12 10

8 6 4 2

Elastic Ed > 1

Unit Elastic Ed = 1

Inelastic Ed < 1

Summary of Price Elasticity of Demand

Price Elasticity of Demand: A Summary

Absolute Value

of Elasticity

Coefficient Demand Is: Description

Impact on Total Revenue of a:

Price Increase Price Decrease

Greater than 1

(Ed > 1)

Elastic or

relatively

elastic

Qd changes by a

larger

percentage than

does price

Total Revenue

decreases

Total Revenue

increases

Equal to 1

(Ed = 1)

Unit or unitary

elastic

Qd changes by

the same

percentage as

does price

Total revenue

is unchanged

Total revenue

is unchanged

Less than 1

(Ed < 1)

Inelastic or

relatively

inelastic

Qd changes by a

smaller

percentage than

does price

Total revenue

increases

Total revenue

decreases

Determinants of Elasticity of Demand

• Substitutability • More substitutes, demand is more elastic

• Proportion of Income • Higher proportion of income, demand is more

elastic

• Luxuries vs. Necessities • Luxury goods, demand is more elastic

• Time • More time available, demand is more elastic

LO1 4-17

Efficiency Revisited

Quantity (bags)

Consumer surplus

Producer surplus

Quantity (bags)

Efficiency Losses

Efficiency loss from underproduction

Efficiency Losses

Quantity (bags)

Efficiency loss from overproduction

Government Intervention

Methods for Dealing with Externalities

Problem

Resource Allocation

Outcome Ways to Correct

Negative externalities

(spillover costs)

Overproduction of output

and therefore

overallocation of

resources

1. Private bargaining

2. Liability rules and lawsuits

3. Tax on producers

4. Direct controls

5. Market for externality rights

Positive externalities

(spillover benefits)

Underproduction of output

and therefore

underallocation of

resources

1. Private bargaining

2. Subsidy to consumers

3. Subsidy to producers

4. Government provision

Utility Maximizing Rule

• Consumer allocates his or her income so that the last dollar spent on each product yields the same amount of extra (marginal) utility

• Algebraically

MU of product A MU of product B

Price of A Price of B

Economic Profit

Explicit costs

Accounting costs (explicit costs

Implicit costs (including a

normal profit)

Economic profit Accounting profit

s Tota

Per-Unit, or Average, Costs

1 2 3 4 5 6 7 8 9 10 0 Q

ATC AVC

Marginal Cost

1 2 3 4 5 6 7 8 9 10 0 Q

ATC AVC

MC and Marginal Product

MC AVC

Quantity of Output

Quantity of Labor

Production Curves

Cost Curves

Firm Size and Costs

ATC-3 ATC-4

Output

The Long-Run Cost Curve

Long-run ATC

ATC-3 ATC-4

Output

MES and Industry Structure

Output

Long-run ATC

Economies Of Scale

Constant Returns To Scale

Diseconomies Of Scale

Output

Economies Of Scale

Long-run ATC

Output

s Long-run ATC

Economies Of Scale

Four Market Models

Characteristics of the Four Basic Market Models

Characteristic

Competition

Monopolistic

Competition Oligopoly Monopoly

Number of firms A very large

number

Many Few One

Type of product Standardized Differentiated Standardized or

differentiated

Unique; no

close subs.

Control over

None Some, but within rather

narrow limits

Limited by mutual

inter-dependence;

considerable with

collusion

Considerable

Conditions of

Very easy, no

obstacles

Relatively easy Significant

obstacles

Blocked

Nonprice

Competition

None Considerable emphasis

on advertising, brand

names, trademarks

Typically a great

deal, particularly

with product

differentiation

Mostly public

relation

advertising

Examples Agriculture Retail trade, dresses,

Steel, auto, farm

implements

Local utilities

Average, Total, and Marginal Revenue

• Average Revenue

• Revenue per unit

• AR = TR/Q = P

• Total Revenue

• TR = P X Q

• Marginal Revenue

• Extra revenue from 1 more unit

• MR = ΔTR/ΔQ

LO3 8-33

Profit Maximization: MR-MC Approach

0 1 2 3 4 5 6 7 8 9 10

Output

Economic Profit MR = P

MC MR = MC

P=$131

A=$97.78

Shutdown Case

0 1 2 3 4 5 6 7 8 9 10

Output

MR = P

V = $74

Short-Run Shut Down Point P < Minimum AVC

$71 < $74

Marginal Cost and Short-Run Supply

Quantity Supplied

P2 MR2

P3 MR3

P4 MR4

P5 MR5

Q2 Q3 Q4 Q5

Shut-Down Point (If P is Below)

3 Production Questions

Output Determination in Pure Competition in the Short Run

Question Answer

Should this firm produce? Yes, if price is equal to, or greater than,

minimum average variable cost. This

means that the firm is profitable or that

its losses are less than its fixed cost.

What quantity should this firm produce? Produce where MR (=P) = MC; there,

profit is maximized (TR exceeds TC by

a maximum amount) or loss is

minimized.

Will production result in economic

profit?

Yes, if price exceeds average total cost

(TR will exceed TC). No, if average

total cost exceeds price (TC will exceed

Firm and Industry: Equilibrium

Economic Profit

s = MC

$111 $111

S = ∑ MC’s

8 8000

Entry Eliminates Economic Profits

(a) Single Firm

(b) Industry

q Q 0 0 100 90,000 80,000 100,000

Exit Eliminates Losses

(a) Single Firm

(b) Industry

q Q 0 0 100 90,000 80,000 100,000

LR Supply: Constant-Cost Industry

0 Q 90,000 100,000 110,000

Q3 Q1 Q2

S Z1 Z2 Z3

D3 D1 D2

LR Supply: Increasing-Cost Industry

0 Q 90,000 100,000 110,000

Q3 Q1 Q2

$50 P1

$55 P2

LR Supply: Decreasing-Cost Industry

0 Q 90,000 100,000 110,000

Q3 Q1 Q2

$50 P1

$55 P3

Pure Competition and Efficiency

Single Firm Market

Quantity Quantity

MC P=MC=Minimum ATC (Normal Profit)

Consumer Surplus

Producer Surplus

Monopoly Demand

• Marginal Revenue < Price

• Monopolist is a price maker

• Monopolist sets prices in elastic region of demand curve

LO2 10-45

Output and Price Determination

2 4 6 8 10 12 14 16 18

Elastic Inelastic

Demand and Marginal-Revenue Curves

Total-Revenue Curve

50 Pri

1 2 3 4 5 6 7 8 9 10 Quantity

Output and Price Determination

MR=MC A=$94

Economic Profit

Pm=$122

Misconceptions of Monopoly Pricing

Quantity

AVC Pm

Economic Effects of Monopoly

(a) Purely Competitive Market

(b) Pure Monopoly

S=MC MC

P=MC= Minimum

Pure competition is efficient Monopoly is inefficient

Consumer surplus

Deadweight loss

Monopoly profit

Perfect Price Discrimination vs. Single Price Monopoly

Here, the monopolist charges the same price (PM) to all buyers.

A deadweight loss results.

Quantity

Regulated Monopoly

Quantity

Monopoly Price

Fair-Return Price

Socially Optimal

Qm Qf Qr

Comparing Perfect & Monop. Competition

yes none, price-taker firm has market power?

downward-

sloping horizontal D curve facing firm

differentiated identical the products firms sell

zero zero long-run econ. profits

yes yes free entry/exit

many many number of sellers

Monopolistic

competition

Perfect

competition

Comparing Monopoly & Monop. Competition

yes yes firm has market power?

downward-

sloping

downward-sloping

(market demand) D curve facing firm

many none close substitutes

zero positive long-run econ. profits

yes no free entry/exit

many one number of sellers

Monopolistic

competition Monopoly

Monopolistically Competitive

• Industry concentration

• Measured by:

• Four-firm concentration ratios

•Percentage of 4 largest firms

• Herfindahl index

• Sum of squared market shares

4-Firm CR = Output of four largest firms Total output in the industry

HI = (%S1)2 + (%S2)2 + (%S3)2 + …. + (%Sn)2

The Short Run: Profit or Loss

Quantity

MR = MC

Economic Profit

The Short Run: Profit or Loss

Quantity

MR = MC

The Long Run: Only a Normal Profit

Quantity

P3= A3

MR = MC

Monopolistic Competition: Efficiency

Quantity

MR = MC

P3= A3

P=MC=Min ATC for pure competition (recall)

Price is Lower

Excess Capacity at Minimum ATC

Monopolistic competition is not efficient 11-58

Oligopoly

• A few large producers

• Homogeneous or differentiated products

• Limited control over price

• Mutual interdependence

• Strategic behavior

• Entry barriers

• Mergers

LO3 11-59

•Rule for employing resources:

• MRP = MRC

Marginal Revenue Product

= Change in Total Revenue

Unit Change in Resource Quantity

Marginal Resource

Cost =

Change in Total (Resource) Cost

Unit Change in Resource Quantity

• Marginal Revenue Product (MRP)

• Marginal Resource Cost (MRC)

Resource Demand

LO1 12-60

The Least Cost Rule

• Minimize cost of producing a given output

• Last dollar spent on each resource yields the same marginal product

Marginal Product Of Labor (MPL)

Price of Labor (PL)

Marginal Product Of Capital (MPC)

Price of Capital (PC) =

LO3 12-61

Profit Maximizing Rule

• MRP of each resource equals its price

PC = = 1

MRPL PL = MRPC PC = and

LO3 12-62

($10) WC

Labor Market

Quantity of Labor

Individual Firm

Quantity of Labor

(1000)

Competitive Labor Market

D=MRP (∑ mrp’s)

• Examples of monopsony power Monopsony Model

Quantity of Labor

LO3 13-64

Bilateral Monopoly Model

Quantity of Labor

Economic Rent

Acres of Land

LO1 14-66

Loanable Funds Theory

Quantity of Loanable Funds

i = 8%

The equilibrium interest rate

LO2 14-67

Government and the Circular Flow

(1) Costs

RESOURCE MARKET

PRODUCT MARKET

BUSINESSES

HOUSEHOLDS

(4) Goods and services

(7) Expenditures

(8) Resources

Goods and services

Net taxes (12)

Net taxes (11)

(3) Consumption expenditures (3) Revenues

GOVERNMENT

(1) Money income (rents, wages, interest, profits)

(2) Land, labor, capital

Entrepreneurial Ability

(2) Resources

(5) Expenditures (6) Goods and services

Efficiency Loss of a Tax

Quantity (Millions of Bottles Per Month)

Tax $2

Tax paid by consumers

5 10 15 20 25 Q

14 12 10 8 6 4 2 0

Tax paid by producers

Efficiency loss (or deadweight loss)

LO3 16-69

Mergers

Automobiles Blue Jeans

Blue Jeans

Denim Fabric

A C B D E F

Z Y X W V U T

Horizontal Merger

Conglomerate Merger

Vertical Merger

LO2 18-70

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