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Econ 1014 exam 2 cheat sheet
Principles of Microeconomics (University of Missouri)
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Taxes and Subsidies: <Elasticity= ESCAPE=
● The more elastic side of the market will pay a smaller share of the tax (smaller burden)
● The less elastic (more inelastic) side of the market will pay a greater share of the tax (greater burden)
● When demand is more elastic than supply, suppliers bear more of the burden of a tax and receive more of the benefit of a
subsidy
● Governments are better off taxing goods/services with inelastic supply and demand curves A subsidy is a negative tax
where the government gives money to consumers (or producers)
● Subsidies must be paid for by taxpayers and they create inefficient increases in trade (deadweight loss)
● When demand is more elastic than supply, suppliers bear more of the burden of a tax and receive more of the benefit of a
subsidy
● Are expensive because pays for every unit sold
Deadweight:
● Deadweight Losses are larger
the more elastic the demand curve.
If the demand curve is inelastic,
a tax will not deter as many trades
Speculation:
● Raise prices today but lower prices in the future,
good because resources are moved through time
from lower to higher value users (2 Graphs)
Price Ceiling: Maximum price allowed by law (graph)
● Shortages
● Reductions in product quality
● Wasteful lines and other search costs
● A loss in gains from trade (deadweight loss)
● Misallocation of resources
Price Floor: A minimum price allowed by law (graph)
● Surpluses
● Lost gains from trade (deadweight loss)
● Wasteful increases in quality
● Misallocation of resources
Competitive Market: In a competitive market, firms maximize profits by choosing outputs such that MR=P=MC
● No control over price, market determines each firm's price
● Profit=Total Revenue- Total Cost
● Total Revenue: Price*Quantity (P*Q)
● Total Cost: Fixed and variable costs
● When the firm produces an additional unit there are additional revenues and additional costs:
○ Profit Maximization is about comparing the additional revenues and costs
○ Marginal Revenue (MR)= The addition to total revenue from selling an additional unit of output
○ Marginal Cost (MC)= The additional to total cost from producing an additional unit of output
Profits are Maximized at the level of output where MR=MC
● MR>MC you are not profit maximizing, producing more will add to your profit
● MR<MC you are not profit maximizing, producing less will add to your profit
With a firm in a competitive market, MR is constant and equal to Price because the firm can sell any quantity at the market price
(Elastic)
Firms Maximize profits by:
● Producing at the quantity where P=MC
● Entering an industry if P>AC, profits are above normal. Output in this industry is worth more than inputs. Profit signal says
we want more of this good
● Exiting market is P<A, profits are below normal. Output in this industry is worth less than the inputs. Loss singal says
we want less of this good
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Monopolist:
● MR=MC (same as competitive market)
● A monopolist's is not a small share of the market; since it is selling a unique good it faces the entire downward sloping
market demand curve MR<P
● To determine profit-maximizing price and quantity for a monopolist,
○ 1)Find the point where MR = MC. (Note that MC is assumed to be constant for simplicity.)
○ 2)Go straight down from this point to the x-axis. This is the optimal (profit-maximizing) quantity. (Q* in the above
example.)
○ 3)Then go straight up all the way to the demand curve. Once you reach the demand curve, go straight over to
the y-axis to determine the monopoly price. (P* in the above example.)
● Regulator: AC=Demand Curve
● Efficient production: P=MC (Demand=MC)
○ Value has to equal the cost
Invisible Hand:
● THE INVISIBLE HAND ONLY WORK COMPLETELY IN PERFECTLY COMPETITIVE MARKETS WITH ACCURATE
PRICE SIGNALS (no externalities)
Extras:
Short Run/Long Run
Long Run: P=lowest MC
Long enough so that
● IF Profit > MC THEN firms leave
● IF Profit < MC THEN firms enter
● IF Profit = MC THEN firms do neither
Understanding Graphs
Monopolies
● MC<AC is bad; company will
not produce at equilibrium price
O Consumer Surplus: Above price,
Below demand
O D=MC=Efficiency
O Efficient Quantity: MC=MR
Calculations
Maximizing Profit
● MC=MR; Follow Q to P
● (P-AC)*Q=Profit (Producer Surplus)
Perfect Competition
● MR=D=AR=P
Efficiency in Monopolies
● MC=D to find efficient production
o Regulated P=AC (firm cannot be forced to take losses)
o Area of triangle to right is DWL
· Determines whether a firm should produce or not
· Ask HOW MUCH before IF they should produce
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