February 13 2012 I Economics a Price controls 1 Price ceiling 1 Rent control a Example a Non binding price ceiling 1 Market can still achieve equilibrium b Market is efficient 2 Price floor a Minimum wage b Per unit taxes 1 Example a 50 per carton of cigarettes b 10 per carton tax 1 Price consumers pay is 55 a Consumer surplus shrinks 2 Price producers receive is 45 a Producer surplus shrinks c Tax revenue is between 45 and 55 d Market is inefficient because of dead weight loss 1 Not because of tax revenue 2 Example 3 Tax incidence a Who bears the burden of the tax 4 When consumer demand is inelastic consumers pay most of the tax a Example 5 When consumer demand is elastic producers pay most of the tax a Example 6 When there is a perfectly inelastic demand curve consumers pay entire tax a Example c Externalities 1 If the externalities of an activity are not experienced by the decision maker then a Goods with positive externalities produce too little 1 Under produced b Goods with negative externalities produce too much 1 Over produced 2 Problem with externalities a The private costs or benefits of the economic decision maker are not the same as the social costs or benefits 1 Problem of incomplete markets 3 Positive externalities a Value CS PS Externality benefit 4 Negative externalities a Value CS PS Externality cost d Coase Theorem 1 In absence of transactions costs it does not matter who the property right is assigned to for the incomplete market provided the property right is assigned an efficient market will result 2 In practice often the government receives the property right 3 Example a Factory creates pollution 1 Pollution gets sheets dirty a Sheets experience negative externality 2 Property right is clean air e Public goods 1 A good is rival if using the good uses it up 2 A good is non rival if using the good does not use it up 3 A good is excludable if usage can be limited to those who pay for it 4 A good is non excludable if usage cannot be limited to those who pay for it a Any non excludable good will suffer from the public good problem 1 Factors of the public good problem a Voluntarily provision will under provide the public good due to the free rider problem 1 Free rider problem a People often do not contribute voluntarily but instead use the good without paying 5 A pure public good is both non rival and non excludable 6 Common resources a Aquifer b Grassland 1 Property of everyone in town 2 The commons a Tragedy of the commons 1 Individuals overuse common resources since failure to extract the resource f Progressive and regressive taxation will result in a competitor getting it 1 A tax is progressive if the percentage of the tax increases with income a Example 1 U S Income tax 2 A tax is proportional if the percentage of the tax is constant a Also known as a flat tax 3 A tax is regressive if the percentage of the tax decreases with income 1 A constant dollar amount regardless of income 2 Incredibly regressive a Examples 1 Sales tax 2 Gas tax g Lump sum tax h Firm costs 1 Total cost TC a TC FC VC 2 Short run c Rules 1 P MC 2 Shutdown rule 3 p AC q d Example a The period of time in which at least 1 production factor is fixed b Average total cost in the short run 1 Average total cost is U shaped 1 If the firm operates a Quantities 1 p 5 2 AC 20 3 q 80 b Formulas 1 p AC q a 5 20 80 b 1200 c 1200 loss 2 TR p q a TR 5 80 b TR 400 3 TC AC q a TC 20 80 b TC 1600 4 VC AVC q a VC 7 80 b VC 560 5 TC FC VC a 1600 FC 560 b 1040 FC 2 If the firm shuts down a Quantities 1 Q 0 2 VC 0 3 FC 1040 b Formulas 1 TR p q a TR p 0 b TR 0 2 TC FC VC a TC 1040 0 b TC 1040 3 TR TC a 0 1040 b 1040 c 1040 loss 3 Since 1040 is less than 1200 the firm shuts down e Example 1 Q1 0 2 Q2 0 3 Q3 0 4 Q4 0 3 Long run output 1 Example a The period of time in which all production factors are adjusted b Returns to scale are increasing if an x 100 in all inputs results in x increase in Average total cost and returns to scale relation Quantity Average total cost c Returns to scale are constant if an x 100 in all inputs results in an x increase in output 1 Example a No fixed cost b Inputs are doubled Total cost 100 200 Total cost 100 200 4 10 4 8 25 20 25 25 Average total cost and returns to scale relation Quantity Average total cost d Returns to scale are decreasing if an x 100 in all inputs results in x increase in output 1 Example Total cost 100 200 Average total cost and returns to scale relation Quantity Average total cost 4 5 25 40 e Increasing constant and decreasing returns f Long run average cost 1 Formulas a Total cost 1 TC FC VC b Average total cost 1 ATC TC Q 2 In the long run there is no fixed factor of production a No diminishing returns b Marginal cost can be constant c Average variable cost can be constant d Example a Average total cost is L shaped 3 Real world long run average total cost g Perfect competition in the long run 1 Short run equilibrium a SP DD b Profit 1 TR TC a 0 1 Loss 2 Exit b 0 c 0 1 Profit 2 Entry c P MC 2 Long run equilibrium a SP DD b Profit 0 c P MC 1 P Minimum short run average cost d In long run equilibrium no firm can want to leave the industry no loss and no potential firm can want to enter no profit 4 Marginal cost MC a MC TC2 TC1 b The change in total cost when producing one additional unit c The slope along the total cost curve 5 Average total cost ATC a ATC TC Q b Marginal cost and average cost relationship 1 Marginal cost curve crosses average cost curve at minimum average cost 2 Example a Q 5 b Firm wants to operate at minimum average total cost 1 Should Q be increased or decreased a Increased 3 Marginal cost pulls average total cost a If marginal cost is less than average total cost average total cost is being pulled b If marginal cost is greater than average total cost average total cost is being down pulled up 6 Short run and long run average total cost relationship b Long run …