Wrap-up of Econ 1 Today: A summary of marginal analysis and equilibrium; a review of the 16 chapters.

Wrap-up of Econ 1

Today: A summary of marginal analysis and

equilibrium; a review of the 16 chapters

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

Marginal analysis

Marginal analysis is almost always important

Average analysis is important sometimes

Recall the following slide from the first lecture…

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)

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

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

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

What have we covered the past 9+ weeks?

16 chapters that give you a foundation of microeconomics

Let’s highlight each chapter

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

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

Chapter 3: Supply and Demand (introduction)

Chapter 3: Equilibrium

In equilibrium, there is no incentive to deviate

Chapter 3: What causes shifts in supply or demand?

Recall difference between a shift in a curve vs. a movement along a curve

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

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

Chapter 5: Ind. demand (left & middle); aggregate (right)

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

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

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

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

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

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

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

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

Chapter 7: Price ceiling at G Total surplus is

trapezoid ADFE (at most)

ΔCEF is potential surplus that is never gained

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

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

Chapter 7: Surplus and deadweight loss with taxes Consumer

surplus (top Δ) Producer surplus

(bottom Δ) Tax revenue

generated (rectangle)

Deadweight loss (right Δ)

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

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

Chapter 8: Long run equilibrium economic profits are 0

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(

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

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)

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

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

Chapter 9: CS and PS w/o imports (left); w/imports (right)

Imports

Chapter 9: Total surplus and tariff money collected CS PS Tariffs What is

missing? Two triangles

are lost with the imposition of tariffs

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

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

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)

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

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

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

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

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

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

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)

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

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)

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

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

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

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

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

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

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

Chapter 14: Some human capital qualities Education

Direct knowledge Intelligence Signaling

Training Work and life

experiences

Energy level Work habits Trustworthiness Initiative

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

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

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

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

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

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

Chapter 16: Public goods To find

efficient level of fireworks, set PUBLIC MB = MC 50 – 2Q =

10 Q = 20

MC

PUBLIC MB

PRIVATE MB

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

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