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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 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.

There are three lectures remaining, including this one, and then there will be our final exam.  As in our last Lecture (#11), 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 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.   

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.   

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>

Finally consider what to do if your output is selling at a price P₃.  Are you making a profit at that price point?<ref>Yes.</ref>  Should you stay in business?<ref>Yes, absolutely.  Your price is greater than both your ATC and AVC.  You're making good money at this price point for your output.</ref>

Finally consider what to do if your output is selling at a price P₃.  Are you making a profit at that price point?<ref>Yes.</ref>  Should you stay in business?<ref>Yes, absolutely.  Your price is greater than both your ATC and AVC.  You're making good money at this price point for your output. (But note that output is not at Q₃ in the graph, but is where MC=P₃.)</ref>

== The Law of Comparative Advantage ==

== The Law of Comparative Advantage ==

There is an interesting concept in economics known as the Law of Comparative Advantage.  The CLEP usually asks two questions about it.

There is an interesting concept in economics known as the Law of Comparative Advantage.  The CLEP usually asks two questions about it.

'''''The Law of Comparative Advantage states that if one nation can produce two goods more efficiently than another nation, then the first nation should devote all its resources to producing the good that it makes more efficiently and let the other nation produce the second good, and then trade one for the other.'''''  This Law can apply to individuals and firms as well as countries.

'''''The Law of Comparative Advantage states that if one nation can produce two goods more efficiently than another nation, then the first nation should devote all its resources to producing the good that it makes more efficiently, and let the other nation produce the second good, and then trade one for the other.'''''  This Law can apply to individuals and firms as well as countries.

Note that this is not what you might first expect.  YOu might expect the first nation to produce BOTH goods, since it can produce both goods more efficiently than the other nation.  But upon closer examination it becomes clear that by focusing on what it does best, and produces more efficiently, the first nation can produce more and then trade for the rest, and be better off.  Put another way, "do what you do best!"

Note that this is not what you might first expect.  You might expect the first nation to produce BOTH goods, since it can produce both goods more efficiently than the other nation.  But upon closer examination it becomes clear that by focusing on what it does best, and produces more efficiently, the first nation can produce more and then trade for the rest, and be better off.  Put another way, "do what you do best!"

In sports, sometimes an athlete is good at one sport (e.g., baseball) but great at another sport (e.g., football).  John Elway and Deion Sanders, for example were great at football but only good at baseball.  John Elway did what he did best: he played only professional football, and became one of the greatest quarterbacks ever.  Deion Sanders played both football and baseball, and perhaps did not achieve as much at either as he could have by focusing what he did best.

In sports, sometimes an athlete is good at one sport (e.g., baseball) but great at another sport (e.g., football).  John Elway and Deion Sanders, for example were great at football but only good at baseball.  John Elway did what he did best: he played only professional football, and became one of the greatest quarterbacks ever.  Deion Sanders played both football and baseball, and perhaps did not achieve as much at either as he could have by focusing what he did best.

Economists observe that utilizing the Law of Comparative Advantage can improve the production possibilities.  Suppose your job paid you $9 but you could hire a cook for $6.  Then it might make sense for you to work one more hour and hire someone to save you one hour of cooking.  In the absence of taxes, you would be $3 better off.  Then you could work one-third of an hour less to make the same money (after expenses) as before.  That extra one-third of an hour could be added to your sports or relaxation time.  You have moved your “production possibilities frontier” (the curve of all possibilities) outward, for greater benefit.

Economists observe that utilizing the Law of Comparative Advantage can improve the production possibilities.  Suppose your job paid you $9 but you could hire a cook for $6.  Then it might make sense for you to work one more hour and hire someone to save you one hour of cooking.  In the absence of taxes, you would be $3 better off.  Then you could work one-third of an hour less to make the same money (after expenses) as before.  That extra one-third of an hour could be added to your sports or relaxation time.  You have moved your “production possibilities frontier” (the curve of all possibilities) outward, for greater benefit.

== Example ==

=== Example ===

Suppose this is how much in resources it costs the Yankees and Mets to produce great pitchers or outfielders:

Suppose this is how much in resources it costs the Yankees and Mets to produce great pitchers or outfielders:

Even though the Mets can produce outfielders more efficiently than the Yankees can, the Mets are better off spending all their resources developing pitchers and then trading with the Yankees to obtain outfielders.

Even though the Mets can produce outfielders more efficiently than the Yankees can, the Mets are better off spending all their resources developing pitchers and then trading with the Yankees to obtain outfielders.

[[David Ricardo]] (1772-1823), one of the greatest of the classical (conservative) economists, first developed the Law of Comparative Advantage.  Note that "comparative advantage" is not the same as "competitive advantage," which simply means something that gives you an advantage in competition over someone else, such as a better location for your gas station.

[[David Ricardo]] (1772-1823), one of the greatest classical (conservative) economists, first developed the Law of Comparative Advantage.  Note that "comparative advantage" is not the same as "competitive advantage," which simply means something that gives you an advantage in competition over someone else, such as a better location for your gas station.

==Review: Inputs==

==Review: Inputs==

Marketing and sales also focus on the output of a company.  Marketing consists of advertising and promoting the goods.  Sales, the most important aspect of almost any company, consist of persuading customers to buy the company’s good or service.  The most valued employees of almost any company are its top salesmen and saleswomen.  They are the ones that bring in the money to the company.

Marketing and sales also focus on the output of a company.  Marketing consists of advertising and promoting the goods.  Sales, the most important aspect of almost any company, consist of persuading customers to buy the company’s good or service.  The most valued employees of almost any company are its top salesmen and saleswomen.  They are the ones that bring in the money to the company.

If we were to hold a dinner with a speaker, the output is the seats at the dinner and the sales effort consists of selling the spots and receiving money in return.  In a homeschool course, the output is the lectures and the sales effort consists of selling places in the course.  Colleges compete for students who can pay their tuition and fees.  Many colleges struggle because they have a difficult time attracting enough students to pay tuition.  In fact, very few new colleges have started in the past twenty years.  The new ones have been more conservative than the older ones.

If we were to hold a dinner with a speaker, the output would consist of the seats at the dinner and the sales effort consists of selling the spots and receiving money in return.  In a homeschool course, the output is the lectures and the sales effort consists of selling places in the course.  Colleges, in turn, compete for students who can pay their tuition and fees.  Many colleges struggle because they have a difficult time attracting enough students to pay tuition.  In fact, very few new colleges have started in the past twenty years, and the new ones have been more conservative than the older ones.

But there is another side to every company: its own inputs and the costs they incur.  For a bus trip to D.C., the inputs are the cost of the buses and perhaps some food costs.  Lowering the costs of those inputs makes the project more affordable.

There is another side to every company: its own inputs and the costs they incur.  For a bus trip to D.C., the inputs are the cost of the buses and perhaps some food costs.  Lowering the costs of those inputs makes the project more affordable.

This is like offense and defense in sports.  The people on offense are the salesmen, trying to score points.  The people on defense are the buyers of inputs for the company, trying to keep the expenses down.  They are opposite jobs, often requiring opposite personalities.  Extravagant people make for better salesmen; frugal people are often better buyers of inputs for a company.  

This is like offense and defense in sports.  The people on offense are the salesmen, trying to score points.  The people on defense are the buyers of inputs for the company, trying to keep the expenses down.  They are opposite jobs, often requiring opposite personalities.  Extravagant people make for better salesmen; frugal people are often better buyers of inputs for a company.  

Experienced businessmen will emphasize that profits are made by keeping expenses down.  After all, profits are the main goal of a typical business.  If a company is buying food from supplier number one and can reduce costs by going to supplier number two, then the rational action is to change suppliers.

Experienced businessmen will emphasize that profits are made by keeping expenses down.  After all, profits are the main goal of a typical business.  If a company is buying food from supplier number one and can reduce costs by going to supplier number two, then the rational action is to change suppliers from number one to number two.

Keeping costs down was what made Wal-Mart so powerful.  Its marketing and advertising have only been mediocre.  But it is the best in reducing costs.  It pays its employees relatively little; it opposes unions forming among its workers; and it is ruthless in bargaining down the costs of its suppliers.  Wal-Mart has made immense profits as a result.

Keeping costs down was what made Wal-Mart so powerful.  Its marketing and advertising have only been mediocre.  But it is the best in reducing costs.  It pays its employees relatively little; it opposes unions forming among its workers; and it is ruthless in bargaining down the costs of its suppliers.  Wal-Mart has made immense profits as a result.

Does that seem unfair?  No one has to supply Wal-Mart goods at a low price.  If a supplier does not want to do business with Wal-Mart, then it doesn’t have to.

Does that seem unfair?  No one has to supply Wal-Mart goods at a low price.  If a supplier does not want to do business with Wal-Mart, then it doesn’t have to. No one has to take a job their either!

In general, the demand for inputs by firms is called the “derived demand for inputs,” because it is derived from the consumer demand for the products the company sells.  You want to buy gas from a gas station, and your demand in turns creates a demand by the station for its inputs: the gas and labor.

In general, the demand for inputs by firms is called the “derived demand for inputs,” because it is derived from the consumer demand for the products the company sells.  Because your family wants to buy gas from a gas station, this demand creates a demand by the station for its inputs: the gas and labor.

==Review: Monopsony==

==Review: Monopsony==

'''''A monopsony means only one buyer'''''.  Stated another way, one buyer holds a monopoly on all purchases.

'''''A monopsony means only one buyer'''''.  Stated another way, one buyer holds a monopoly on all purchases.

The best example of a monopsony is when there is only one employer in a small, isolated town.  If you want a job in that town, then your only place to work is at that company.  Of course, very few towns are actually limited to just one employer.  But for certain types of jobs, there may be only one employer, and it has a monopsony over those jobs.

The best example of a monopsony is when there is only one employer in a small, isolated town.  If you want a job in that town, then your only place to work is at that company.  Of course, very few towns are actually limited to just one employer.  But for a certain types of job, there may be only one employer, and it has a monopsony over that type of job.

A monopsony is different from a competitively hiring firm in one significant way.  When a monopsony needs to hire an additional worker, then it has to raise the wages for all its workers at that higher level in order to hire an additional worker.  Its marginal cost for paying for this "factor" (labor), also known as its marginal factor cost (“MFC”), is more than the wage of the additional worker.  MFC equals the W of the additional worker PLUS the increased wage of all the other workers.

A monopsony is different from a competitively hiring firm in one significant way.  When a monopsony needs to hire an additional worker, then it has to raise the wages for all its workers to that higher wage level in order to hire an additional worker.  Its marginal cost for paying for this "factor" (labor), also known as its marginal factor cost (“MFC”), is more than the wage of merely the one additional worker.  MFC equals the W of the additional worker PLUS the increased wage of all the other workers.

For example, if a monopsony can hire 10 workers at $6 or 11 workers at $7, then its MFC of hiring an 11th worker is $7 + (10 x ($7-$6)) = $17.

For example, if a monopsony can hire 10 workers at $6 or 11 workers at $7, then its MFC of hiring an 11th worker is $7 + (10 x ($7-$6)) = $17.

For a competitive firm, in contrast, MFC=W because it can hire all the workers it needs at the market wage, without causing the market wage to rise for all its workers.

For a competitive firm, in contrast, MFC=W because it can hire all the workers it needs at the market wage, without causing the market wage to rise for all its workers.

This example us understand why the marginal revenue (MR) for a monopoly (one seller) when it increases its price is not the same as the price P of the additional good that it sells.  When a monopoly raises its price to obtain more revenue (and more profits), it raises its price on ALL its goods.  MR for that increase in price is not simply P, but it is the increased price on all its goods times the quantity of those goods.  A monopoly sells where MC=MR, but that is not the same place as where MC=P, because MR does not equal P for a monopoly.  MR does equal P for a perfectly competitive firm.

This example helps us understand why the marginal revenue (MR) for a monopoly (one seller) when it increases its price is not the same as the price P of the additional good that it sells.  When a monopoly raises its price to obtain more revenue (and more profits), it raises its price on ALL its goods.  MR for that increase in price is not simply P, but it is the increased price on all its goods times the quantity of those goods.  A monopoly sells where MC=MR, but that is not the same place as where MC=P, because MR does not equal P for a monopoly.  MR does equal P for a perfectly competitive firm.

==Honors: Example==

===Honors: Example===

Let’s start with this simple equation: Profits = Total revenue - Total cost

Let’s start with this simple equation: Profits = Total revenue - Total cost. That’s easy enough.  Now let’s break it down, where P=Price, Q=Quantity, W=Wage, and L=Labor units:

That’s easy enough.  Now let’s break it down, where P=Price, Q=Quantity, W=Wage, and L=Labor units.

Now suppose we add one more worker to our company.  We will have to pay him a wage of W, so the marginal factor cost of one more worker is W (assuming a competitive market).  What is his marginal benefit to our company?  It is P x MP.

When does a company hire that additional worker?  When the change in profit is greater than zero.  That occurs when (P x MP) > W.

 

 

When does a company hire that additional worker?  When the change in profit is greater than zero.   

<br>What occurs when (P x MP) > W

Let’s apply this to an example.  Suppose a firm has a declining marginal product for each additional laborer hired, such that:

Let’s apply this to an example.  Suppose a firm has a declining marginal product for each additional laborer hired, such that:

Skip down to hiring employee number 6.  Then you make (20+18+16+14+12+10) x $5 = 90 x $5 = $450 .  What’s your cost?  6 x $70 = $420.  It’s barely profitable.

Skip down to hiring employee number 6.  Then you make (20+18+16+14+12+10) x $5 = 90 x $5 = $450 .  What’s your cost?  6 x $70 = $420.  It’s barely profitable.

Should you hire one more employee?  That additional employee costs you $70, but only brings in 8 x $5 = $40 in revenue.  You’d be losing money on him.  DON’T HIRE HIM.  Or if you hired him, then fire him and give him a good job reference.

Should you hire one more employee?  That additional employee costs you $70, but only brings in 8 x $5 = $40 in revenue.  You’d be losing money on him.  DON’T HIRE HIM.  Or if you already hired him, then fire him and give him a good job reference.

Let’s back up and see if it makes sense to keep employee number 6 around.  His marginal cost is $70, and he brings in marginal revenue of 10 x 5= $50.  He’s losing money for you also.  You don’t want him on your staff.

Let’s back up and see if it makes sense to keep employee number 6 around.  His marginal cost is $70, and he brings in marginal revenue of 10 x 5= $50.  He’s losing money for you also.  You don’t want him on your staff.

<br>Monopsony is a single buyer.

<br>Monopsony is a single buyer.

<br>If the firm is competitive, then marginal factor cost (MFC) of labor equals the wage of the extra worker: MFC = W.   

<br>If the firm is competitive, then marginal factor cost (MFC) of labor equals the wage of the extra worker: MFC = W.   

<br>What is the benefit of that extra worker?  Marginal benefit (MB) of L is P x MP (price times marginal product)

<br>What is the benefit of that extra worker?  Marginal benefit (MB) of L is P x MP (price times marginal product).

<br>What, then, is the marginal profit of hiring one more worker ?  It is (P x MP) - W

<br>What, then, is the marginal profit of hiring one more worker ?  It is (P x MP) - W.

<br>So when does a competitive firm hire an additional worker?  When P x MP exceeds W.

<br>So when does a competitive firm hire an additional worker?  When P x MP exceeds W.

:What causes Q to increase?  Increased demand by consumers

:What causes Q to increase?  Increased demand by consumers

For Honors only: what is the effect of consumer demand for output on the labor demand by the company?  When consumer demand (demand for output) is more elastic, then labor demand by a company tends to be more elastic.  When it is easy to substitute other inputs for labor (such as machines replacing humans), then labor demand also tends to be more elastic.  Finally, when other inputs are in more elastic supply, then labor demand tends to be more elastic.  And don’t worry if you don’t understand all that.

''For Honors only'': what is the effect of consumer demand for output on the labor demand by the company?  When consumer demand (demand for output) is more elastic, then labor demand by a company tends to be more elastic.  When it is easy to substitute other inputs for labor (such as machines replacing humans), then labor demand also tends to be more elastic.  Finally, when other inputs are in more elastic supply, then labor demand tends to be more elastic.  And don’t worry if you don’t understand all that yet!

==Assignment==

==Assignment==

Read, and reread as needed, the above lecture.  Then answer 6 out of 7 questions below:

Read, and reread as needed, the above lecture.  Then answer 6 out of 7 questions below:

1.  A monopoly is one seller without an competitors.  What is a "monopsony"?

1.  A monopoly is one seller without any competitors.  What is a "monopsony"?

2.  Define, in your own words, what a "production possibilities curve" is.

2.  Define, in your own words, what a "production possibilities curve" is.

3.  Review: how is the elasticity of demand for labor related to the price elasticity of demand for the product of that labor?

3.  Review: how is the elasticity of demand for labor related to the price elasticity of demand for the product of that labor?

4.  Do you think that government policy should give high priority to the Lorenz curve?  Include a sentence or two about what you think government economic policy should be.

4.  Do you think that government policy should give high priority to the Lorenz curve?  Explain the issue that a Lorenz curve addresses, and whether you think that should be a high priority of government economic policy.

5. Look again at Figure A.  What is the opportunity cost of shifting production from B to C?  

5. Look again at Figure A.  What is the opportunity cost of shifting production from B to C?  

6. Review:  explain again what AFC, AVC and ATC are, and how they relate to each other.  When should a firm shut down?

6. Review:  explain again what AFC, AVC and ATC are, and how they relate to each other.  When should a firm shut down in the short run?

7. What is needed to reach point D in Figure A?  (In other words, what causes a production possibilities curve to shift outward?)

7. What is needed to reach point D in Figure A?  (In other words, what causes a production possibilities curve to shift outward?)

Answer 3 out of 4 questions below:

Answer 3 out of 4 questions below:

8.  Look again at Figure C in the lecture (the first one).  At what point is total revenue maximized?

8.  Look again at Figure C in the lecture (the first graph in this Lecture).  At what point is total revenue maximized?

9.  Explain why the production possibilities curve is convex (opening downward like the top of a circle) rather than concave (opening upward like the inside of a bowl) or a straight line.

9.  Explain why the production possibilities curve is convex (opening downward like the top of a circle) rather than concave (opening upward like the inside of a bowl) or a straight line.

10.  Suppose you are a monopsony, and you must pay $9 to hire nine workers, but in order to hire one more worker you must pay $10.  The tenth worker will bring in $15 extra per hour to the firm’s revenue.  Does you hire the tenth worker?

10.  Suppose you are a monopsony, and you must pay $9 per hour ($9/hr) to hire nine workers, but in order to hire one more worker you must pay $10/hr.  The tenth worker will bring in $15 extra per hour to the firm’s revenue.  Do you hire the tenth worker?

11.  In the term "comparative advantage," to what does the adjective "comparative" refer?  What is the term "comparing"?  Explain.

11.  In the term "comparative advantage," to what does the adjective "comparative" refer?  What is the term actually "comparing"?  Explain.

== References ==

== References ==