wrap-up of econ 1 today: a summary of marginal analysis and equilibrium; a review of the 16 chapters
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Wrap-up of Econ 1
Today: A summary of marginal analysis and
equilibrium; a review of the 16 chapters
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Wrapping up this class
Today’s lecture is meant to do two things Highlight some material you will need
to know for the final exam Help put all of the ideas together so
that you can use the ideas in this class in future classes and the real world
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Marginal analysis
Marginal analysis is almost always important
Average analysis is important sometimes
Recall the following slide from the first lecture…
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What will we do in Econ 1? Think like an
economist does (Almost) always
think in terms of marginal
Opportunity costs typically matter
Sunk costs typically do not matter
Marginal “one additional unit” For example, FB
describe marginal benefit as “the increase in total benefit that results from carrying out one additional unit of an activity” (p. 11)
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Marginal analysis
Marginal analysis will continue to be important if you plan on majoring in anything with economics as a tool
When faced with problems in the real world, try to think marginally with the tools we have learned
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Marginal analysis In most markets, a firm or consumer will
continue an activity as long as its MB ≥ MC
Without market failure, equilibrium is efficient
Market failures with market power and/or externalities Situations exist where government
intervention improves efficiency
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Marginal analysis Finally, marginal analysis applies
to various topics we have discussed in recent weeks Information Labor markets Quality of life issues Public Goods Tax Policy
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What have we covered the past 9+ weeks?
16 chapters that give you a foundation of microeconomics
Let’s highlight each chapter
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Chapter 1: Think like an economist
Usually avoid averages in analysis Don’t ignore opportunity cost Don’t ignore sunk costs Think marginally Try to find Pareto improvements
when possible
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Chapter 1: What should we do with energy drinks?
# of drinks Total benefit ($) MB ($) Avg. benefit
0 0 N/A5
1 5 53
2 8 4
2.53 10.5 3.5
1.54 12 3
-15 11 2.2
We should buy the third energy drink since MB > MC (2.5 > 2)
We should not buy the fourth energy drink since MB < MC (1.5 < 2)
Note that we are NOT maximizing average benefit or total benefit
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Chapter 3: Supply and Demand (introduction)
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Chapter 3: Equilibrium
In equilibrium, there is no incentive to deviate
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Chapter 3: What causes shifts in supply or demand?
Recall difference between a shift in a curve vs. a movement along a curve
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Chapter 5: Marginal utility of bananas
Banana quantity (bananas/hour)
Total utility (utils/hour)
Marginal utility (utils/banana)
0 0
70
1 70
50
2 120
30
3 150
10
4 160
-10
5 150
Note diminishing marginal utility
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Chapter 5: The rational spending rule and demand MU per dollar for the last dollar spent of
each good is the same Suppose the MU per dollar (for the last dollar
spent) was higher for good A than for good B I can spend one more dollar on good A and
one less dollar on good B Since MU per dollar spent is higher for good A
than for good B, total utility must increase Thus, with diminishing MU, any total
purchases that are not consistent with the rational spending rule cannot maximize utility
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Chapter 5: Ind. demand (left & middle); aggregate (right)
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Chapter 5: CS from demand curves Height of triangle
is ($6 – $3), or $3. Length of triangle
is (6 – 0), or 6 Area of triangle is
one-half times length times height
CS = $9
The area of this triangle is a good approximation of CS
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Chapter 6: How many widgets should I build?
MB of 1st hour of work: $15 MB of 2nd hour of work: $13 MB of 3rd hour of work: $11 MB of 4th hour of work: $9 MC of each hour of widget building
is the $10 lost in wages from working at the coffee shop
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Chapter 6: How many widgets should I build?
Is MB ≥ MC? 1st hour? Yes, since $15 > $10 2nd hour? Yes, since $13 > $10 3rd hour? Yes, since $11 > $10 4th hour? No, since $9 < $10
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Chapter 6: Supply using graphs We make this
graph make intuitive sense
We will see that: Profits are positive
at price P1
Profits are negative at prices P2 and P3
Firms will shut down when price is P3
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Chapter 6: Marginal analysis Hire 4 employees/day
# of empl./day
Phones per day
MB ($/phone) MC ($/phone)
0 0
18.00 5.00
1 20
18.00 4.00
2 45
18.00 10.00
3 55
18.00 12.50
4 63
18.00 25.00
5 67
Note that you have to check the shutdown condition after solving this problem
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Chapter 6: Example of producer surplus When P = 25 per
unit, shaded area is approximate producer surplus
Area is a triangle, one-half times length times height: 0.5 10 25 = 125
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Chapter 4: Elasticity Elasticity
Calculated by the percentage change in quantity divided by the percentage change in price
Denominator could be something else, but for now think price
P
QElasticity
%
%
slopeQ
P
P
Q
Q
P
PP
QQ 1
/
/
OR
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Chapter 7: Long-run consequences of rent control Suppose that the
long-run equilibrium of apartments in I.V. is $2,400 per month rent, and 2,000 units rented
With rent control of $1,200/month, we see excess demand
($100s)
(100s units)
12
24excess demand
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Chapter 7: Price ceiling at G Total surplus is
trapezoid ADFE (at most)
ΔCEF is potential surplus that is never gained
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Chapter 7: What happens with a subsidy?
Before the subsidy, price is P2; quantity is Q1
With subsidy, quantity demanded at price P2 is Q2
In short-run, notice new price for apartments is P1
This price is $500 higher than before
All of the subsidy goes to the apartment owners
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Chapter 7: Max, Jill, United Airlines, and efficiency
Going from a first-come, first-served policy to a voluntary incentive system has improved the outcomes of both Max and Jill
Max has improved by $120 and is traveling in style, just the way he wants
Jill is able to make her meeting and save the contract
Recall that United is better off with this policy too
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Chapter 7: Surplus and deadweight loss with taxes Consumer
surplus (top Δ) Producer surplus
(bottom Δ) Tax revenue
generated (rectangle)
Deadweight loss (right Δ)
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Chapter 7: Marginal cost pricing Supply of electricity
8 Mwh (coal) @ 3¢/Kwh
20 Mwh (natural gas) @ 5¢/Kwh
10 Mwh (wind power) @ 9¢/Kwh
6 Mwh (solar power) @ 15¢/Kwh
Suppose that at a price of 9¢/Kwh, 30 Mwh were demanded
All coal capacity and natural gas capacity can be used, and 2 Mwh provided by wind
MC pricing tells us to charge 9 ¢/Kwh in order to maximize surplus
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Chapter 8: What should Jill do? Jill should run a home business if
her economic profit is positive Economic profit is total revenue
minus all costs (including opportunity cost of not working)
Economic profit if she opens business = $200,000 – ($160,000 + $60,000) =– $20,000 Do not open business
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Chapter 8: Long run equilibrium economic profits are 0
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Chapter 8: Present value We can calculate how much a future
payment is by discounting it by interest rate r
We calculate the present value of a future payment as follows Payment of M is received T years from now PV represents present value:
Tr
MPV
)1(
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Chapter 8: Present value of a permanent annual payment Present value of an
annual payment of M every year forever, when the interest rate is r :
r
MPV
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Chapter 2: Absolute advantage and comparative advantage
Absolute advantage “One person has an absolute advantage
over another if he or she takes fewer hours to perform a task than the other person” (F/B p. 36)
Comparative advantage “One person has a comparative advantage
over another if his or her opportunity cost of performing a task is lower than the other person’s opportunity cost” (F/B p. 37)
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Chapter 2: Comparative advantage
To find comparative advantage for each person, find the lowest number in each column
Opportunity cost of cooking
a pizza
Opportunity cost of making a salad
Greg ½ salad 2 pizzas
David ¼ salad 4 pizzas
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Chapter 9: What happens when trade is possible?
Recall that all of the points along PGQ are the efficient points of the production possibilities curve
Recall that this shape occurs due to increasing opportunity costs as more is produced
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Chapter 9: CS and PS w/o imports (left); w/imports (right)
Imports
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Chapter 9: Total surplus and tariff money collected CS PS Tariffs What is
missing? Two triangles
are lost with the imposition of tariffs
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Chapter 10: Marginal revenue Marginal revenue
How much additional is received by selling one more unit of the good?
We must first calculate TR
Notice that for Q > 1, MR < P
P Q TR MR
4 0 0
3
3 1 3
1
2 2 4
-1
1 3 3
-3
0 4 0
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Chapter 10: Market power
How Do Firms Gain Market Power? Exclusive control over important
inputs Patents and copyrights Government licenses or franchises Economies of scale Natural
monopoly Networks
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Chapter 10: Simple monopoly example What is lost?
Triangle EIK is lost, since the monopolist stops producing once quantity reaches A
This triangle is deadweight loss (DWL)
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Chapter 10: Price discrimination Price discrimination can take many
forms Discounts of goods and services that have
little or no value if transferred to another person
Perfect price discrimination, where a different price can be charged to each person
Rebates, which require effort to get a discount
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Chapter 11: How do we find Nash equilibrium (NE)? Step 1: Pretend you are one of the players Step 2: Assume that your “opponent” picks a
particular action Step 3: Determine your best strategy
(strategies), given your opponent’s action Underline any best choice in the payoff matrix
Step 4: Repeat Steps 2 & 3 for any other opponent strategies
Step 5: Repeat Steps 1 through 4 for the other player
Step 6: Any entry with all numbers underlined is NE
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Chapter 11: Nash Equilibrium
Which box(es) have underlines under both numbers?
Person 1 chooses B and Person 2 chooses C
This is the only NE
Action C Action D
Action A
10, 2 8, 3
Action B
12, 4 10, 1
Person 1
Person 2
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Chapter 11: Dominant strategy
A strategy is dominant if that choice is definitely made no matter what the other person chooses
Example: Person 1 has a dominant strategy of choosing B
Action C Action D
Action A
10, 2 8, 3
Action B
12, 4 10, 1
Person 1
Person 2
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Chapter 11: Sequential game
If Person 1 knows that Person 2 is rational, then she will choose yes, since 20 > 10
Person 2 makes a decision from point B, and he will choose yes also
Payout: (20, 20)
A
B
C
Person 1 chooses yes
Person 1 chooses no
Person 2 chooses yes
Person 2 chooses yes
Person 2 chooses no
Person 2 chooses no
20, 20
5, 10
10, 5
10, 10
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Chapter 11: Some classic game theory games Games with inefficient equilibria
Prisoner’s Dilemma Public Goods game
Coordination games Battle of the Sexes Chicken
Zero-sum game Matching pennies
Animal behavior Subordinate pig/Dominant pig
Other games also played as part of activity
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Chapter 12: An unregulated market with externalities
Deadweight loss shaded These units produced have Social MC
greater than Social MB
external cost per unit
(= Social MB)
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Chapter 12: A market with externalities and a tax
The government can set a tax equal to the external cost per unit
external cost per unit
(= Social MB)
With tax equal to distance of vertical arrow: The efficient solution is achieved
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Chapter 12: A market with externalities and permits
Market price for the good will be B, since E units are being produced
external cost per unit
(= Social MB)
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Chapter 12: An algebraic example
Inefficient equilibrium, P = Q P = 50 Socially optimal equilibrium, P = Q + 10 P
= 55
external cost per unit of $10
P = 100 – Q
MC = Q
MCSocial = Q + 10
Price C = 50
Price B = 55
Recall E = 45 and F = 50
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Chapter 12: Highway/bridge problem, what is efficient?
# on bridge Travel time on bridge
Total minutes for
bridge travelers
Total minutes for
highway travelers
Total minutes for all drivers
1 10 10 380 390
2 11 22 360 382
3 12 36 340 376
4 13 52 320 372
55 1414 7070 300300 370370
66 1515 9090 280280 370370
7 16 112 260 372
8 17 136 240 376
9 18 162 220 382
10 19 190 200 390
11 20 220 180 400
Example with 20 people that must travel from point A to point B
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Chapter 12: Income from calves with property rights
Invest as long as marginal income is at least $5
>$5 INVEST
<$5 STOP!
# of calves on the
commons
Price per 2-year-old
cow sold ($)
Income per cow ($ per
year)
Total calf income ($ per year)
Marginal income ($ per year)
30
1 130 30 30
10
2 120 20 40
2
3 114 14 42
2
4 111 11 44
>$5 INVEST
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Chapter 13: Optimal amount of information
Find the point where MB = MC
Example: Use MC1 and MB1 curves Optimal amount
of information is 7 units, at a cost of $15 per unit
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Chapter 13: The internet and information
Assumption Any product that is not good is worthless
If you trust Bloomingdale’s pay $89; know with certainty you get a good product
If you believe that the $50 jacket is good with 50% probability, you would expect to buy 2 (on average) before buying a good jacket
Expected spending: $100
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Chapter 13: Lemons A used car dealer has the following
information about used Yugo limos: Plums are worth
$3,000 to the dealer $1,200 to the owner
Lemons are worth $250 to the dealer $100 to the owner
100 Yugo limos owned privately Example 1: Half of the limos are plums, half are
lemons Example 2: One-quarter of the limos are plums,
three-quarters are lemons
Yugo car
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Chapter 14: MP and VMP to analyze profit maximization
# of empl./day
Phones per day
MP (extra phones per
day)
VMP ($ per day)
0 0
20 360
1 20
25 450
2 45
10 180
3 55
8 144
4 63
4 72
5 67
Hire?
Yes
Yes
Yes
Yes
No
Cost to hire an additional worker is $100 per day
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Chapter 14: Some human capital qualities Education
Direct knowledge Intelligence Signaling
Training Work and life
experiences
Energy level Work habits Trustworthiness Initiative
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Chapter 14: When are unions effective?
Finding qualified workers outside of a union is difficult or impossible Example: Writers’ strike
See “Additional reading” on class website for more on this topic
When a firm is making economic profits
When a unionized firm can hire better workers than nonunionized firms
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Chapter 14: Discrimination A wage gap between men and women’s
pay has existed for decades Some of this can be explained by
controlling for education, experience, and other factors
Some discrimination may be occurring Firms that do discriminate based on factors
such as gender and race are less likely to be competitive in the long run
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Chapter 14: Income distribution
Also note the following ideas John Rawls’ “veil of ignorance”
Shrinking economic pie Income redistribution, including EITC
Quintile 1980 1990 2000Bottom 20 percent
$12,756 $12,625 $14,232
Second 20 percent
$27,769 $29,448 $32,268
Middle 20 percent
$41,950 $45,352 $50,925
Fourth 20 percent $58,200 $65,222 $74,918
Top 20 percent $97,991 $121,212 $155,527
Top 5 percent $139,302 $190,187 $272,349
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Chapter 15: Inefficient levels of health care Inefficient
equilibrium with complete insurance: Red circle
Efficient amount of health care: Green circle
Equilibrium with 20% co-payment: Yellow circle
0.2 MC
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Chapter 15: Smoke abatement costsTons of smoke emitted per day
4 3 2 1 0
Total abatement cost, firm A $0 $14 $30 $50 $75
Total abatement cost, firm B $0 $20 $45 $80 $120
Total abatement cost, firm C $0 $25 $60 $100 $150 Let’s try $30 abatement MC or less
7 green arrows We now have reached the efficient level of 5
tons of emissions
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Chapter 15: Ways to improve safety Safety laws Formation of unions Offer financial incentives
Higher safety Bonuses (money, gift certificates, tickets for prize giveaways)
Increased training Shorter work days
Tired people are more likely to be clumsy and inattentive
Workers’ compensation Insurance system for those injured while working
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Chapter 16: Public goods To find
efficient level of fireworks, set PUBLIC MB = MC 50 – 2Q =
10 Q = 20
MC
PUBLIC MB
PRIVATE MB
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Chapter 16: Government failure Pork barrel legislation
Passes MB/MC test in home district, but not when people outside the district are factored in
Price supports A few win big; many lose a small
amount Rent-seeking
Inefficient amount of lobbying
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Chapter 16: Taxation Laffer curve (at
right) shows that t* is not 100%
Goods with inelastic demand and markets with negative externalities are good markets to tax