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# Elasticity

Lecture 1: Introduction
Cost-benefit analysis choose the alternative to MAXIMIZE SURPLUS
=

## Lecture 2: Supply & Demand I

Individuals are price takers, take market price as given when deciding how much to
produce/buy. Both curves are aggregate of individual curves, horizontally added.
Demand Curve
=
P<= MB because otherwise they would not buy it, MB<=P otherwise more would be
bought. Marginal Buyers Reservation Price.
Supply Curve
=
Marginal Sellers Reservation Price (OUTPUT RULE)
Lecture 3: Supply & Demand II
Competitive Equilibrium; price determination in a perfectly competitive market\
Theory of perfect competition; price adjusts to where quantity demanded = quantity
supplied (market clearing) individuals are price takers
Excess supply; P falls, Q demanded rises. Excess demand; P rise, Q demanded falls.
Comparative Statics; predict how a change in economic environment will affect a
market.
Wealth Effects
NORMAL GOOD
>0

## Cross Price Effects

Complement
<0

Substitute
>0

Necessity
0<<1

D (shift right)
S (shift right) Q increase, price indetermined
Price increase, Q indetermined
S (shift left)
Lecture 4: Elasticity
Price Elasticity
of demand

/
/

Price Elasticity
of supply

/
/

INFERIOR GOOD
<0

Luxury
>1

D (shift left)
Price decrease, Q indetermined
Q down, Price indetermined

## Cross price Elasticity

of demand

/
/

Income Elasticity of
demand

/
/

## Perfectly elastic Horizontal. Perfectly inelastic vertical.

Elastic demand - price rise causes expenditure (PxQ) to fall, maximum at eps=1.

Law of diminishing returns; in the short run, when at least one factor of production is
fixed, increases in input eventually yield smaller and smaller increments in output. Thus
production of the good eventually requires ever larger increases in the variable factor.

- In short run, profit maximize (until MC is no longer smaller than MB). P=MC.
- Profit >0, where P>ATC. Profit =0, where P=ATC. Profit <0, where P<ATC.
According to Short Run shutdown rule, it will shut down if P<AVC, because cost of
shutting down (fixed cost) is lower than operating cost (fixed cost + loss).
Supply curve is MC > AVC, and is the aggregate (horizontally) of the individual curves.
When calculating from data, the most valueing buyers buy first (highest value) and
lowest valuieng supliers sell first (lowest value)(calc, CS & PS)
P
Q
Revenue CB
CS
PC
PS
TS
Lecture 6: Perfectly Competitive Supply (Long run)
Firms can change all inputs (fixed assets). All costs are variable costs, Free entry and
exit of all firms, All firms will use the same cost minimising technology
= ECONOMIC PROFITS WILL BE DRIVEN TO 0
a) P=MC (profit maximization, firms motivation);
b) P=ATC (zero profit, no incentive, long run market outcome)
Thus seller chooses q such that MC=ATC in the long run. Adam Smith invisible hand.
DC shifts due to population growth, in the short run, price increases and profit is
pos+ (P , q ,Q , profit ). In the long run, firms attracted, supply curve shifts right,
lowering the price. All changes absorbed into Q effect (the long run supply curve is
perfectly elastic) Cost saving benefit of technology is passed to consumers (ie ATC )
In the long run, burden of tax falls on buyers only.
Lecture 7: Efficiency (welfare) efficient if max economic surplus total
TAXES
1. The more elastic S&D, the more DWL & if D/ S is perfectly inelastic, no DWL.
2. Tax burden is shared, The more inelastic side bears more tax burden.
a) If one side is perfectly elastic, the tax falls entirely on the other side.
b) If one side is perfectly inelastic, the tax falls entirely on that side.
To justify the tax, we need some other social benefits that exceed DWL.
Reduction in total economic surplus (in tax due to a reduced
DWL
consumption)

Where each player has dominant strategy, but the resulting payoffs
Prisoners
are smaller than if they played dominated
dilemma
Cournot models in which firms choose quantities simultaneously.
Lecture 10: Externalities
Efficient quantity/price must include externalities. Social efficient equilibrium is;
=
Where;
= +
Achieve efficient by taxing, tax rate should equal the MEC at the efficient quantity.
Taxes are price based, can also do quantity
based like emissions trading scheme may
be more effective because you dont know
what optimal tax is like.
Alternative solutions (besides tax/subsidy) =
ban the good, property rights assignments,
market based instruments. Assignment of
property rights Coase Theorem then all
parties will negotiate to the efficient
solution. (make people pay fees)

Lecture 8: Monopoly
Types of Market Structures perfect, monopoly, oligopoly, monopolistic comp
Monopolistic Competition- several sellers competing, but each is a monopolist in his
own neighbourhood. Many buyers.
=

()

## where R is inverse demand function x Q

Monopolies will maximize profit by producing
output and setting price such that
=
Otherwise you will start getting negative additions
to profit. Ie they will max producer surplus
Dealing with monopolies
Price discrimination (perfect competition
outcome) with the entire surplus appropriated by the

producer
Public policy to increase competition
Regulation of natural monopolies (such that P*=MC, government doesnt
necessarily know MC, difficult to set
Market power A firms ability to raise the price of goods without losing all is sales
-

## Lecture 9: Oligopoly, Duopoly & Game Theory

Interdependence of agents actions, agents act strategically. Using a payoff matrix to
determine Nash equilibria. Assumptions; both are rational, both know the other is
rational. Look at each from each way the payoff could be done. Payoff (0,1) where 0
belongs to horizontal one.
Set of players, strategies, rules & payoffs.
Game
Yields player higher payoff no matter what the other player
Dominant
chooses; dominant strategy equilibrium DSE (type of Nash)
strategy

Non-excludable
Non-rivalry

Cant
exclude
Use by one
does
not
inhibit use
by others

## Free rider problem; no one will buy, too little is provided

To find competitive quantity (Find individually and sum prices [ie vertically]);
=
To find social quantity;
=
Where;
=
To discriminate pricing, calculate the MV for having the efficient number provided. Then
set that as price for each party and multiply by the no. to get totals.
Need provision of public goods, in order of best option; tax negative externalities, LVT.
Intermediation Pay for service of information
Search is costly, what is optimal level (more expensive, longer
Optimal
search)
information
risk, calculate Expected Profit (EP) using sumproduct of
Uncertainty
profit and probability (can pay to improve probability)
Diff info levels, like principal-agent problem (asymmetric, and
Asymmetric
incentives dont align think real-estate agent)
Information
Adverse Select People w bad cars more likely to sell to 2 nd market, lower price
Moral hazard Party takes risk because cost to someone else.