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{{Economics_Lectures}}

{{Economics_Lectures}}

There are three lectures remaining, including this one, and then there will be our final exam.  As we did last, week, we will review some important concepts first, and then learn some new ones. The review will help you prepare both for the final exam and, if you choose, the CLEP exam.

There are three lectures remaining, including this one, and then there will be our final exam.  As in our last lecture, we will review some important concepts while also learning some new ones. The review will help you prepare both for the final exam and, if you choose, the CLEP exam.

But first let's address a superb question asked by a student last week.  He wondered whether the "economic rent" (the extra amount charged by a company above its costs, perhaps because it is a monopoly) is the same as the "deadweight loss."  The answer is "yes":  "economic rent" is a type of deadweight loss.  Any time the price of a good is raised above its price in a perfectly competitive market, there will be buyers who will not pay the higher price and thus will lose out on the consumer surplus between the higher price and lower, competitive price.  That loss in consumer surplus is a deadweight loss.   

But let's first address a superb question asked by a student last week.  He wondered whether the "economic rent" (the extra amount charged by a company above its costs, perhaps because it is a monopoly) is the same as the "deadweight loss."  The answer is "yes":  "economic rent" is a type of deadweight loss.  Any time the price of a good is raised above its price in a perfectly competitive market, there will be buyers who will not pay the higher price and thus will lose out on the consumer surplus between the higher price and lower, competitive price.  That loss in consumer surplus is a deadweight loss.   

When the price is increased due to taxes, then both the buyers and the sellers lose out, and there is a deadweight loss that is even greater because it includes both a consumer surplus lost by the buyer and a producter surplus lost by the seller.  So while higher prices due to monopolies are bad, higher prices due to taxes are even worse.  Feel free to review the lecture and graph that discussed consumer surplus and producer surplus to understand this further.

When the price is increased due to taxes, then both the buyers and the sellers lose out, and there is a deadweight loss that is even greater because it includes both a consumer surplus lost by the buyer and a producer surplus lost by the seller.  So while higher prices due to monopolies are bad, higher prices due to taxes are even worse.  You could review Lecture 7 and its graph to understand this further.

To show you how recent the theories of economics are, the term "rent seeking" behavior was introduced only 40 years ago.  It describes actions by firms to increase their prices and obtain economic rent above the free market, competitive price.  Such behavior is not good for the public, because it causes a deadweight loss (lost consumer surplus).

To show you how recent the theories of economics are, the term "rent seeking" behavior was introduced only 40 years ago.  It describes actions by firms to increase their prices and obtain economic rent above the free market, competitive price.  Such behavior is not good for the public, because it causes a deadweight loss (lost consumer surplus).

[[Image:Econ13c.jpg|right|250px|thumb|Figure C]]

[[Image:Econ13c.jpg|right|250px|thumb|Figure C]]

A monopolist has no supply curve, because he is the only supplier.  There is only a demand curve, a marginal revenue curve, and some cost curves for a monopolist.  If given a graph with these curves, simply find where the marginal revenue curve intersects the marginal cost curve, and that '''''determines the quantity'''''.

A monopolist has no supply curve, because he is the only supplier.  There is only a demand curve, a marginal revenue curve, and some cost curves for a monopolist.  If given a graph with these curves, simply find where the marginal revenue curve intersects the marginal cost curve, and that '''''determines the quantity sold'''''.

On the graph to the right (Figure C), there is no supply curve so you know that this represents a monopolist.  A typical question is to ask you where the monopolist sets his price in order to maximize his profits.  To find this price point, recall that a monopolist sets his price where MC=MR.  The graph gives you curves for both MC and MR, so find where they intersect:  point A.  But that point gives you the quantity supplied, not the price demanded.  To find the demand price at the quantity supplied, you have to find the corresponding price point on the demand curve.  You trace a line vertically from the quantity to find the price on the demand curve:  point D in Figure C.

On the graph to the right (Figure C), there is no supply curve so you know that this represents a monopolist.  A typical question is to ask you where the monopolist sets his price in order to maximize his profits.  To find this price point, recall that a monopolist sets his price where MC=MR.  The graph gives you curves for both MC and MR, so find where they intersect:  point A.  But that point gives you the quantity supplied, not the price demanded.  To find the demand price at the quantity supplied, you have to find the corresponding price point on the demand curve.  You trace a line vertically from point A to find the price on the demand curve:  point D in Figure C.

That is the answer to a question about where a monopolist sets his price, but that is not the best price for the public.  It is higher than the price the public would enjoy if the market were fully competitive.  Another question on a CLEP exam might ask where the competitive price would be, also known as the "allocatively efficient" price because it represents the most efficient allocation of resources.  That price (and quantity) is where the MC curve intersects the demand curve:  point B in Figure C.

That is the answer to a question about where a monopolist sets his price, but that is not the best price for the public.  It is higher than the price the public would enjoy if the market were fully competitive.  Another question on a CLEP exam might ask where the competitive price would be, also known as the "allocatively efficient" price because it represents the most efficient allocation of resources.  That price (and quantity) is where the MC curve intersects the demand curve:  point B in Figure C.

Figure C also has a curve for average total cost (ATC).  Recall that a firm shuts down in the long run when ATC>P; and the firm shuts down in the short run when AVC>P, but keeps operating in the short run when AVC<P but P<ATC.  This is because "variable cost" is a short run issue, while "total cost" is a long run issue.  Does the firm in Figure C shut down?  No, because we determined above that the monopolist can sell at point D, and there ATC=P.  He is covering (paying for) all his costs.  The firm can continue in business.

Figure C also has a curve for average total cost (ATC).  Recall that a firm shuts down in the long run when ATC>P; and the firm shuts down in the short run when AVC>P, but keeps operating in the short run when AVC<P<ATC.  This is because "variable cost" is a short run issue, while "total cost" is a long run issue.  Does the firm in Figure C shut down?  No, because we determined above that the monopolist can sell at point D, and there ATC=P.  He is covering (paying for) all his costs.  The firm can continue in business.

Here are some other common graphical questions:

Here are some other common graphical questions:

*optimal market price:  where supply meets demand, or (for a monopolist that has no supply curve) where MC intersects demand curve (MC=P), as explained above

*'''''optimal''''' market price:  where the supply curve intersects the demand curve, or (for a monopolist that has no supply curve) where MC intersects demand curve (MC=P), as explained above

*consumer surplus (the benefit to the consumer where the demand curve is higher than price paid, because the buyers pay less than they were willing to pay, as when you would have paid $15 to see a movie but the charge was only $10: your consumer surplus is $5)

*consumer surplus (the benefit to the consumer where the demand curve is higher than price paid, because the consumers pay less than they were willing to pay, as when you would have paid $15 to see a movie but the charge was only $10: your consumer surplus is $5)

*deadweight loss: the lost consumer surplus explained above AND (in the case of a tax) the lost producer surplus (benefit to the seller who was willing to produce at a price less than what he sold it for)

*deadweight loss: the lost consumer surplus explained above AND (in the case of a tax) the lost producer surplus (benefit to the seller who was willing to produce at a price less than what he sold it for)

== Government Policy ==

== Government Policy ==

As mentioned in a prior election, 10% of the CLEP iexam is on government policy.  With an ear tuned for political bias, student can rack up many correct answers here.  But if the student's ear is slightly off-key, he can lose far more points here than he should.

As mentioned in a prior Lecture, 10% of the CLEP exam is on government policy.  With an ear tuned for politics, a student can rack up many correct answers here.  But if a student's political ear is off-key, he can lose far more points here than he should.

* market distribution of income (Lorenz curve)

* market distribution of income (Lorenz curve)

* market failure and imbalances in information

* market failure and imbalances in information

The Lorenz curve (also known as the Lorenz diagram) is a graph displaying a comparison of the actual distribution of income in a society against a hypothetical equal distribution of income.  This could be done by plotting the percent of overall income on the y-axis and the percent of families on the x-axis.  A hypothetical (imaginary) equal distribution of income would be a straight line at 45 degrees (the line y=x).  But the actual distribution of income would be closer to a step function:  going from the lowest 0 to 20% of families would have almost no increase in cumulative income on the y-axis, and then from 20% to 80% would show a big increase, and then from 80% to 100% would show a leveling again in cumulative income.

The Lorenz curve (also known as the Lorenz diagram) is a graph displaying a comparison of the actual distribution of income in a society against a hypothetical '''''equal''''' distribution of income.  This could be done by plotting the percent of overall income on the y-axis and the percent of families on the x-axis.  A hypothetical (imaginary) '''''equal''''' distribution of income would be a straight line at 45 degrees (the line y=x).  But the actual distribution of income would be closer to a step function:  going from the poorest 0% to 20% of families would have almost no increase in cumulative income on the y-axis, and then from 20% to 80% would show a big increase, and then from 80% to 100% would show a leveling again in cumulative income.

On the CLEP exam, a question about the Lorenz curve is probably going to to be asked in a favorable way, suggesting that it is a proper role of government to try to equalize the income for everyone.

On the CLEP exam, a question about the Lorenz curve is probably going to to be asked in a favorable way, suggesting that it is a proper role of government to try to equalize the income for everyone.

Not everyone agrees.  Churches used to play the role of "sharing the wealth," and they did it better than government does.  Do we want government to replace churches?  Usually not.

Not everyone agrees.  Churches once played a bigger role in "sharing the wealth," and they did it better than government does.  Do we want government to replace churches?  Of course not.

But government may have a proper role in correcting for imbalances in information, in order to make sure that people have a better understanding of what they are buying.  Food products are required by government to disclose their contents, and how much fat they contain.  Cigarette companies are required to say that their product causes cancer and hurts people.  In some states abortionists are required to disclose some of the harm that abortion causes.  Government regulations that improve the knowledge of the public may be beneficial, and may help reduce negative externalities.

But government may have a proper role in correcting for imbalances in information, in order to make sure that people have a better understanding of what they are buying.  Food products are required by government to disclose their contents, and how much fat they contain.  Cigarette companies are required to say that their product causes cancer and hurts people.  In some states abortionists are required to disclose some of the harm that abortion causes.  Government regulations that improve the knowledge of the public may be beneficial, and may even help reduce negative externalities.

Sometimes markets fail to work at all, as when competition disappears and there is only one supplier.  Imagine the only gas station in town after a hurricane wipes out all his competitors.  Or when the biggest banks fail, all at once.  The "bail out" before the 2008 elections was an example of government trying to prevent a total market failure.  Many disagree with government interference in cases of "market failure," however.  What's your view?

Sometimes markets fail to work entirely, as when competition disappears and there is only one supplier.  Imagine the only gas station in town after a hurricane wipes out all his competitors.  Or when the biggest banks fail, all at once.  The "bail out" before the 2008 elections was an example of government trying to prevent a total market failure.  Many disagree with government interference in cases of "market failure," however.  What's your view?

== Production Possibilities ==

== Production Possibilities ==

Nearly 5% of CLEP exam is devoted to questions about "production possibilities."  These are easy points to earn.

Nearly 5% of CLEP exam is devoted to questions about "production possibilities."  These are easy points to earn toward your total score.

"Production possibilities, or "Possibilities of production," means all the different combinations of goods a nation can produce.  The United States can produce X cars and Y trucks, for example.  Or it could produce more than X cars and fewer than Y trucks.  We could graph the number of cars on the Y-axis and the number of trucks on the X-axis, and draw a “production possibility” curve through all the possible combinations.  It would be downward sloping: more cars means less trucks, and vice-versa.  The opportunity cost of producing more cars is the loss in production of trucks.  In the production possibility curve for cars and boats shown in Figure A (below), the opportunity cost of moving from point A to point B is 100 cars.   

"Production possibilities, or "Possibilities of production," means all the different combinations of goods a nation can produce.  The United States can produce X cars and Y trucks, for example.  Or it could produce more than X cars and fewer than Y trucks.  We could graph the number of cars on the Y-axis and the number of trucks on the X-axis, and draw a “production possibility” curve through all the possible combinations.  It would be downward sloping: more trucks means fewer cars, and vice-versa.  The opportunity cost of producing more cars is the loss in production of trucks.  In the production possibility curve for cars and boats shown in Figure A (below), the opportunity cost of moving from point A to point B is 100 cars.   

The shape of the production possibilities curve is dictated by the high opportunity cost of trying to convert a nation's factories from making one type of good to making another type.  Imagine having a car factory and a truck factory, and then trying to convert the entire truck factory such that it makes only cars.  At a fixed level of expense, the truck factory is not going to be able to make as many cars as the trucks it was designed to make.  So converting the nation from, for example, a level of 500 cars and 500 trucks to as many cars as possible will probably not be able to reach a level of 1000 cars and zero trucks.  Instead, it will probably top off at a number less than 1000, and hence the tapering of the production possibilities curve near the two axes.

The shape of the production possibilities curve (or "frontier") is dictated by the high opportunity cost of trying to convert a nation's factories from making one type of good to making another type.  Imagine having a car factory and a truck factory, and then trying to convert the entire truck factory such that it makes only cars.  At a fixed level of expense, the truck factory is not going to be able to make as many cars as the trucks it was designed to make.  So converting the nation from, for example, a level of 500 cars and 500 trucks to as many cars as possible will probably not be able to reach a level of 1000 cars and zero trucks.  Instead, it will probably top off at a number less than 1000, and hence the tapering of the production possibilities curve near the two axes.

If the overall number of workers or investment capital increased, then you could produce more of everything.  The entire production possibilities graph (or “production possibilities frontier”) would shift upward and to the right.  An improvement in technology would have the same effect.  An increase in bureaucracy or administrative costs, however, would have the opposite effect, forcing a contraction in overall production.

If the overall number of workers or investment capital increased, then you could produce more of everything.  The entire production possibilities graph (or “production possibilities frontier”) would shift upward and to the right.  An improvement in technology would have the same effect.  An increase in bureaucracy or administrative costs, however, would have the opposite effect, forcing a contraction in overall production.

*there are only two goods, and production is a trade-off between the goods: making more of one means making less of the other.

*there are only two goods, and production is a trade-off between the goods: making more of one means making less of the other.

*the economy is efficient and there is no waste; if there is waste, then the point of production is somewhere inside the curve rather than on it.

*there is no increase in waste or regulation; if there is new waste or costly regulation, then the point of production moves to somewhere inside the curve rather than on it.

*the same fixed resources are used for making the same two goods, and technology does not improve

*the same fixed resources are used for making the same two goods, and technology does not improve

*there is "full employment," such that adding workers requires taking them away from another task

*there is "full employment," such that adding workers requires taking them away from another task

== Review:  Cost Measures==

== Review:  Cost Measures==

Consider Figure B to the above right.  In order to master Economics, develop of habit of asking yourselves what you would do if you were the owner of a firm with these costs.  Ask yourself:  if your output is selling at a price of P₁, are you making a profit?<ref>No.</ref>  Should you stay in business?<ref>No, because the price is less than both AVC and ATC.</ref>

Consider Figure B to the above right.  In order to master economics, develop a habit of asking yourself what you would do if you were the owner of a firm with these costs.  Ask yourself:  if your output is selling at a price of P₁, are you making a profit?<ref>No.</ref>  Should you stay in business?<ref>No, because the price is less than both AVC and ATC.</ref>

Next consider if your output is selling at a price of P₂.  Are you making a profit there?<ref>You are making a daily profit because P>AVC, but losing money when all your fixed costs are included because P<ATC.</ref>  Should you stay in business?<ref>Yes, because P>AVC so you are making a marginal profit, but not covering all your original costs.</ref>

Next consider if your output is selling at a price of P₂.  Are you making a profit there?<ref>You are making a daily profit because P>AVC, but losing money when all your fixed costs are included because P<ATC.</ref>  Should you stay in business?<ref>Yes, because P>AVC so you are making a marginal profit, but not covering all your original costs.</ref>