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Review

Review. Exam 3. Office Hours. Today 11 to 11:30 2:30 – 3:30 pm Tomorrow (Wednesday) 1:30 to 2:30. Announcements. Exam has same basic format as last two exams. Covers chapters 6,7, and 8. Exam 3 Covers. Chapter 6 Chapter 7 Chapter 8 (the material I covered in class). Homework 3.

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Review

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  1. Review Exam 3

  2. Office Hours • Today 11 to 11:30 2:30 – 3:30 pm • Tomorrow (Wednesday) 1:30 to 2:30

  3. Announcements • Exam has same basic format as last two exams. • Covers chapters 6,7, and 8

  4. Exam 3 Covers • Chapter 6 • Chapter 7 • Chapter 8 (the material I covered in class)

  5. Homework 3 Answer key

  6. Problem 1 Problem 3: MC = Py at 30 units of input.

  7. More information What is the shutdown price? At what output? What is the zero-profit price? At what output?

  8. More information To find the shutdown price, find the smallest number in the AVC column.

  9. More information To find the zero-profit price, find the smallest number in the AC column.

  10. More information What is the shutdown price? At what output? What is the zero-profit price? At what output? $0.60 100 $.90 100

  11. Problem 2 Output Price * Output = TR Profit = TR- TC

  12. Problem 4 .

  13. 5) 5 pts. Find the profit-maximizing input level . 30 units of input. Py = $1.00 6) 2 pts. Calculate profit at the profit-maximizing point above. 70*$1-120 = $-50. Loss is lower than fixed costs so producer would produce at a loss.

  14. Average and Marginal Cost Points deducted if MC doesn’t intersect AC and AVC at each minimum. Points deducted if AC doesn’t get closer to AVC as output increases MC AC AVC Output (y)

  15. Problem 8 Fill in the blank for a firm that is using inputs following the least-cost rule Marginal Product of last unit Price Amount Input 1 200 10 $1.0 Input 2 300 20_ $2.0

  16. Problem 9 Fill in the blank for a firm that is using inputs following the least-cost rule Amount Marginal Product of last unit Price Input 1 300 60 $5.0 Input 2 400 36_ $3.0

  17. Problem 10 Assume that the following situation exists for a firm producing 100 widgets. Amount Marginal Product of last unit Price Input 1 100 20 $4.0 Input 2 110 30 $2.0 Which of the following statements is true? (Circle the correct statement.) a) The firm is currently producing 100 widgets with the least-cost combination of inputs. b) The firm could reduce its cost of producing 100 widgets by using more of input 1 and less of input 2. c) The firm could reduce its cost of producing 100 widgets by using less of input 1 and more of input2.

  18. working the problem input 1: 20/4 = 5 input 2: 30/2 = 15 The ratio from input 2 is higher, so use less input 1 and more input 2.

  19. Problem 11 a) Surplus before tax = CS + PS CS = ½(8)*(10-6) = 16 PS = ½(8)*(6-0) = 16 TS = 16=16 =32 S + tax • New inverse supply curve P= (2+2) + ½ Q • Set equal to original inverse demand • 4 + ½ Qnew = 10 – ½ Qnew Qnew = 6 • Pnew = 4 + ½ Qnew = 7

  20. c) 4 points. What is market economic surplus (consumer and producer surplus) after the tax is imposed? CS = (10-7)*(6)*1/2 = 9 PS = (7-4) *(6)*1/2 = 9 Total CS+PS = 18 d) 4 points. How much tax revenue would be collected? Tax Revenue = $2*6 = 12 e) 4 points. Calculate the deadweight loss. (Hint: Add together the market surplus after the tax, plus the tax revenue collected. Subtract the sum from the original market surplus.) 32– (18+12) = 2

  21. Some Questions Market Efficiency: The market is “efficient” under perfect competition in the absence of externalities. It is efficient because price = MC. Reservation prices of the marginal buyer = reservation price of the marginal seller and all relevant costs and benefits are captured by the market.

  22. Externalities If there are externalities, the market equilibrium is not efficient because it does not capture all relevant costs (or all relevant benefits in the case of positive externalities). If there are externalities people outside the market are affected by the transactions in the market but their welfare is not represented in CS or PS.

  23. Suppose that a firm is located along a river. The firm uses water from the river to cool its machinery and returns the water to the river several degrees warmer, which has led to a decline in the fish population downstream of the firm. The externality (the dead fish) is a relevant cost of production that is not captured by the market equilibrium. If a relevant cost is ignored, that means the market price is too low and market quantity too high. If the firm had to pay the cost for the dead fish, supply would decrease. In this case, if the government fines the firm to account for society’s cost of the dead fish, efficiency in this market would increase.

  24. Suppose that an increase in the college-educated population increases job opportunities and community well-being for everyone. In this case, the externality (increased job growth for all) is a relevant benefit of consumption that is not captured by the market equilibrium. If a relevant benefit is ignored, that means the market price is too high and market quantity too low. In this case, to reach the socially optimal level of output, the government will employ strategies to decrease the price of education to those who consume it and to increase the quantity. They can do this via reduced-cost loans or grants to students to defray tuition costs, or by building state-subsidized universities.

  25. The supply and demand for parking spaces on the campus of What'sAMatterU is illustrated in the figure. Suppose the administration chooses to "price" spaces on a first come first served basis (i.e., parking permits are free) in the interests of poor students. Quantity demanded will be______ and quantity supplied will be_____.

  26. A first come, first served pricing policy for parking at What'sAMatterU, i.e., free parking, results in    (1 point) a.  all students having access to parking spaces. b.  an efficient market outcome. c.  quantity supplied exceeding quantity demanded. d.  inefficiency because quantity demanded exceeds quantity supplied. e.  a need to build more parking.

  27. The administration at What'sAMatterU rejected charging a price for parking spaces on the grounds it would favor the wealthier student. Which of the following types of students does the first come, first served allocation favor?    (1 point) a.  Students who work full time for minimum wage .b.  Students who work full time for more than minimum wage .c.  Students who are taking a large number of credit hours. d.  Students who are unemployed. e.  Students who need parking the most.

  28. Under the What'sAMatterU administration's first come, first served policy, instead of price determining who gets a parking space, ______ determines who gets a space.    (1 point) a.  income b.  opportunity cost of time c.  reservation price for a permit. d.  need for parking e.  random chance

  29. Under the first come, first served pricing policy for parking at What'sAMatterU, i.e., free parking, the deadweight loss is represented by _Q1AQ4______.

  30. Chapter 6 Concepts • Supplier’s Reservation Price and Opportunity Costs • Diminishing Returns • Cost Concepts • Perfect Competition • Profit Maximization

  31. Chapter 7 Concepts • Market equilibrium and efficiency • Welfare loss from price ceilings and price floors • Sales taxes and efficiency • Subsidies and efficiency

  32. Chapter 8 Concepts • Accounting Profit versus Economic Profit • Responses to profit and loss and the allocative function of price • Long-run equilibrium under perfect competition

  33. Opportunity Costs • In determining their reservation price, suppliers consider their opportunity costs. • If Jamie can earn $7 an hour at her job, she will normally not be willing to give up work and baby-sit for less than that.

  34. The Production Function The production function relates inputs to output in physical terms. The production function, along with input prices, will determine the costs of producing output.

  35. Average Product To find average product, divide total product (or output) by the input level.

  36. Marginal Product Marginal product tells you how much extra output you get from each extra unit of input. To calculate marginal product, take the change in total product (or output) and divide by the change in input.

  37. Example

  38. Costs • Total Cost (TC) = Variable Costs (VC) + Fixed Costs (FC) • AC (ATC) = TC divided by output or AC= AVC + AFC • AVC = VC divided by output • AFC = FC divided by output

  39. Variable Costs Total variable costs = the amount spent on variable inputs. Price of input 1 X Amount of variable input 1 + Price of input 2 X Amount of variable input 2 + Price of input 3 X Amount of variable input 3 etc. In our homework, there was only one variable input.

  40. Variable Cost Variable cost is what is spent on variable inputs. If there is only one variable input, VC = Px*X Where Px is the input price and X is the amount used. Some books use “TVC” for “VC” where T stands for “total.”

  41. More on Variable Cost If there are two or more variable inputs: VC = Px1*X1 + Px2*X2 + Px3*X3 . .. Where Px1 is the input price for one of the variable inputs and X1 is the amount of that input used, Px2 is the input price for the next variable input and X2 is the amount of the second input used, and so on.

  42. Average Variable Cost AVC = Variable Cost divided by output.

  43. Fixed Cost Fixed cost doesn’t change as output changes, in the short run. .

  44. Average Fixed Cost AFC = FC/output. Some books used “TFC” for FC AFC falls as output increases.

  45. Marginal Cost Marginal cost is the change in VC divided by the change in output. It can also be calculated using the change in TC divided by the change in output.

  46. Profit-Maximizing Decision Rule In perfect competition, the rule is: MC = output price If there are two points where MC=Py then pick the one with higher output. Also, check that Py>AVC (else firm should shut down)

  47. Perfect Competition: Illustration of firm-level demand P P S d D q Q Entire Market One firm

  48. Marginal Revenue Marginal revenue is the extra amount a firm will earn from selling one more unit of its output. Under perfect competition, the marginal revenue will therefore by equal to ___________. product price Formal definition: Marginal revenue is the change in total revenue resulting from a one unit increase in output.

  49. Goal of Profit Maximizing The firm’s goal is assumed to be maximizing profit. Remember that profit is: Firm Profit = Py*Y - TC Where Y is firm output.

  50. On the graph We find the point where Marginal Revenue or price (as shown by the flat demand curve, d), hits MC. The profit-maximizing output is found at this point. Profit, or loss, per unit is the vertical distance between MR and AC at that point. On the following graph, the unit profit is shown by the solid orange line.

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