# No Bull Economics Lessons

## Macroeconomics & Microeconomics Concepts You Must Know

### Essential Questions

#### How does a lump-sum tax affect a firm's level of output?

 Posted on April 17, 2014 at 9:55 AM comments (0)

A lump-sum tax has NO EFFECT on a firm's level of output because a lump-sum tax does not change marginal costs. It increases the firm's fixed costs and therefore shifts the average total cost upward. This will decrease a firm's economic profit, but not change output. If you see lump-sum tax or subsidy, DON'T CHANGE OUTPUT!

AP Microeconomics Unit 2 Product Markets

#### How does a lump-sum subsidy affect a firm's level of output?

 Posted on April 17, 2014 at 9:50 AM comments (0)

A lump-sum subsidy has NO EFFECT on a firm's level of output because a lump-sum subsidy does not change marginal costs. It reduces the firm's fixed costs and therefore shifts the average total cost down. This will increase a firm's economic profits, but not change output. If you see lump-sum subsidy or tax, DON'T CHANGE OUTPUT!

AP Microeconomics Unit 2 Product Markets

#### How does a per-unit tax affect a firm's level of output?

 Posted on April 17, 2014 at 9:45 AM comments (0)

A per-unit tax discourages production by raising marginal costs (MC shifts upward). This will decrease the firm's level of output and reduce economic profits.

The average total cost and average variable cost curves also shift up, but it's the marginal cost curve that changes the profit-maximizing level of output as the MR=MC point has moved to the left.

AP Microeconomics Unit 2 Product Markets

#### How does a per-unit subsidy affect a firm's output?

 Posted on April 17, 2014 at 9:45 AM comments (0)

A per-unit subsidy encourages more production by lowering marginal costs (MC shifts down). This will increase the firm's level of output and increase economic profits.

The average total cost and average variable cost curves also shift down, but it's the marginal cost curve that changes the profit-maximizing level of output as the MR=MC point has moved to the right.

AP Microeconomics Unit 2 Product Markets

#### Where is the monopolist's socially optimal level of output?

 Posted on April 17, 2014 at 9:35 AM comments (0)

If a monopoly was regulated to produce at the socially optimal level of output, it would produce where the price (AKA demand) intersects the marginal cost curve (P=MC).

At this level of output, allocative efficiency is achieved and there is no deadweight loss. This point will maximize the sum of consumer and producer surplus.

See the No Bull Review diagram below to see the precise location of the socially optimal level of output. AP Microeconomics Unit 2 Product Markets

#### Where is the monopolist's fair-return price?

 Posted on April 17, 2014 at 9:30 AM comments (0)

If a monopoly is regulated to break even (AKA earn zero economic profit AKA normal profit), it will produce at a level of output where price (AKA demand) equals the average total cost curve (P=D=ATC).

This is known as the fair-return price. Even though there are no economic profits, accounting profits can be positive due to the presence of opportunity costs.

AP Microeconomics Unit 2 Product Markets

#### Where does a monopoly maximize its total revenue?

 Posted on April 17, 2014 at 9:25 AM comments (0)

There is a big difference between maximizing economic profit (Total Revenue - Total Costs) and maximizing total revenue (Price x Quantity). To maximize profit, an unregulated monopolist will produce where the marginal revenue equals the marginal cost (MR=MC) and the price is above that point on the demand curve.

The monopolist will maximize total revenue at a level of output where marginal revenue equals 0 and the price is above that point on the demand curve. The elasticity of demand will equal 1 (unit elastic).

AP Microeconomics Unit 2 Product Markets

#### What are the characteristics of each market structure?

 Posted on April 17, 2014 at 12:45 AM comments (0)

There are four types of market structures in microeconomics.

1. Perfect Competition: Hundreds of firms selling identical products; market determines price, firm is "price taker"; very easy to enter; allocative (price = marginal cost) and productive efficiency (price = minimum average total cost) in the long run; breaks even in long run; agriculture is a close example.

2. Monopolistic Competition: Many firms selling differentiated, but similar products; firm has some control over price; relatively easy to enter; breaks even in long run, but experiences excess capacity (average total costs can be lower by increasing output); clothing is a close example.

3. Oligopoly: A few powerful firms selling identical or differentiated products; firm has more control over price; can profit in long run; difficult to enter (significant barriers to entry); firms are interdependent; game theory is often used to show a firm's optimal decision and possible paypout; video game consoles are a close example.

4. Monopoly: One firm selling a unique product; firm is a "price maker"; highly inefficient; high barriers to entry; high long run profits; Utilities are a close example, although they are regulated.

AP Microeconomics Unit 2 Product Markets

#### Why are monopolies inefficient?

 Posted on April 17, 2014 at 12:40 AM comments (0)

Monopolies are inefficient compared to perfectly competitive markets because it charges a higher price and produces less output. The term for inefficiency in economics is deadweight loss. Since the monopolist charges a price greater than its marginal cost, there is no allocative efficiency. Society loses the area between the perfectly competitive output and the monopolist output.

This No Bull Review video shows you how to find the area of deadweight loss resulting from a monopolistic market structure.

AP Microeconomics Unit 2 Product Markets

#### How does a monopoly affect consumer surplus?

 Posted on April 17, 2014 at 12:30 AM comments (0)

A monopolist charges a price higher than a competitive market structure and produces fewer units than a competitive market structure. Because of the higher monopoly price, the area of consumer surplus decreases. Part of the original consumer surplus under competitve conditions will be transferred to the producer. The rest becomes part of the deadweight loss.

This No Bull Review video shows the area of consumer surplus under a monopoly and how it compares to consumer surplus under a perfectly competitive market.

AP Microeconomics Unit 2 Product Markets

#### How do you graph a monopoly taking an economic loss?

 Posted on April 17, 2014 at 12:25 AM comments (0)

To graph a monopoly taking an economic loss, the price must be less than the average total cost curve at the marginal revenue equals marginal cost level of output.

This No Bull Review video explains exactly how to graph a monopoly with short-run losses.

AP Microeconomics Unit 2 Product Markets

#### What is a prisoner's dilemma in game theory?

 Posted on April 16, 2014 at 8:45 PM comments (0)

A prisoner dilemma occurs when each firm's respective payouts are greater if each firm does NOT play its dominant strategy. In the game theory matrix below, the dominant strategy for both firms are to play Strategy A and the cell outlined in red is the Nash equilibrium.

However, if both firms play Strategy B then their payout are greater. If the firms collude and agree to play Startegy B, the dilemma is whether each firm can trust the other to play Strategy B and not Strategy A. Without a commitment device, each firm has an incentive to cheat to gain greater profit. The likely outcome is that they will both cheat and end up in the original Nash equilibrium. AP Microeconomics Unit 2 Product Markets

#### How do you find a firm's dominant strategy?

 Posted on April 16, 2014 at 8:30 PM comments (0)

Game theory is an important topic that comes up in the discussion of oligopoly (more specifically for this course, duopoly) behavior. One of your goals is to determine a firm's dominant strategy, or best strategy regardless of the opposing firm's strategy. This will help you find the Nash equilibrium.

When reading a game theory matrix, the firm on the left has its payouts on the left in each cell. The firm on the top typically has its payouts on the right in each cell.

In the diagram below, Totally Inc.'s dominant strategy is Strategy A because \$2,305 > \$2,272 and \$2,350 > \$2,325.

Awesome LLC.'s dominant strategy is also Strategy A because \$2,305 > \$2,272 and \$2,350 > \$2,325.

Therefore, the Nash equilibrium is the cell where both firms play Strategy A. We know that each firm will earn \$2,305 when they play their dominant strategies. As long as one firm has a dominant strategy, you can find the Nash equilibrium. AP Microeconomics Unit 2 Product Markets

#### What is a cartel?

 Posted on April 16, 2014 at 8:25 PM comments (0)

The subject of cartel formation arises when talking about an oligopolistic (a few powerful firms) market structure. If these firms collude and coordinate all business decisions, then a cartel is formed. The cartel acts like a monopoly as it controls the price and output in the industry. It's highly inefficient, the consumers lose, and the cartel's profits rise. OPEC is a cartel.

AP Microeconomics Unit 2 Product Markets

#### What is the relationship between average product and marginal product?

 Posted on April 16, 2014 at 8:15 PM comments (0)

The marginal product and average product curves initially increase then decrease due to the law of diminishing marginal returns.

Marginal product is the change in total product divided by the change in quantity of resources (or inputs).

Average product is the total product divided by the quantity of economic resources (or inputs).

The average product reaches its peak when it intersects the marginal product curve.

See the curves in the No Bull Review graph below. AP Microeconomics Unit 2 Product Markets

#### How do you sketch the cost curves of a firm?

 Posted on April 16, 2014 at 8:05 PM comments (0)

Whether you are drawing a perfectly competitive firm or a monopolist, the per-unit cost curves all look the same. Here is what you should remember when sketching the curves:

1. The marginal cost (MC) curve looks like a check mark (or Nike swoosh) because of the law of diminishing marginal returns.

2. The average total cost (ATC) curve is u-shaped and must intersect the MC curve when ATC is at its lowest point.

3. The average variable cost (AVC) curve is also u-shaped, but must be below the ATC. The AVC will intersect the MC curve at the AVC's minimum. The distance between the AVC and the ATC should narrow as output increases because this distance represents the firm's average fixed costs.

This No Bull Review graph shows what the ATC, AVC, and MC look like. Always begin by drawing the MC curve first. AP Microeconomics Unit 2 Product Markets

#### How do you calculate the per-unit costs of a firm?

 Posted on April 16, 2014 at 8:00 PM comments (0)

There are three types of total costs that all firms face: fixed costs (FC), variable costs (VC), and total costs (TC). Fixed costs must be paid to resource suppliers regardless of output and variable costs change with output. Fixed costs plus variable costs will equal a firm's total cost.

Per-unit costs are used to derive the firm's average cost curves, which you are expected to sketch on the AP Microeconomics exam. To get average costs, simply divide the total costs by the quantities being produced.

Average Fixed Cost = FC/Q

Average Variable Cost = VC/Q

Average Total Cost = TC/Q

Marginal Cost = Change in TC/Change in Q

AP Microeconomics Unit 2 Product Markets

#### How do you graph a firm taking a loss under monopolistic competition?

 Posted on April 16, 2014 at 7:55 PM comments (0)

The cost curves of a monopolistically competitive firm look similar to a monopoly firm's curves. However, by definition monopolistic competition (many firms) is very different from a monopoly (one firm).

To graph a monopolistically competitive firm taking a short-run economic loss, the price must be less than the average total cost curve at the MR=MC level of output. Price must exceed the average variable cost curve.

In the long run, firms will exit the industry casuing the firm to break even.

In this No Bull Review video, you will learn how to graph a firm taking a short-run loss under monopolistic competition.

AP Microeconomics Unit 2 Product Markets

#### How do you graph a monopolistically competitive firm with a short-run profit?

 Posted on April 16, 2014 at 7:45 PM comments (0)

The cost curves of a monopolistically competitive firm look similar to a monopoly firm's curves. However, by definition monopolistic competition (many firms) is very different from a monopoly (one firm).

To graph a monopolistically competitive firm earning a short-run economic profit, the price must exceed the average total cost curve at the MR=MC level of output.

In the long run, more firms will enter the industry casuing the firm to break even.

In this No Bull Review video, you will learn how to graph a firm with a short-run profit under monopolistic competition.

AP Microeconomics Unit 2 Product Markets

#### How do you graph a perfectly competitive firm with economic losses?

 Posted on April 16, 2014 at 7:40 PM comments (0)

When graphing perfect competition, it is a good idea to graph the market and firm side-by-side so that the market equilibrium is lined up with the firm's horizontal marginal revenue curve. The market (or industry) graph is a simple supply and demand graph. For the firm, the price equals the marginal revenue equals the marginal cost output point must be less than the average total cost curve. The price must exceed the average variable cost curve.

In the long run, the least efficient firms will exit the market (supply shifts left) causing the price to increase and the individual firm to break even (AKA normal profit AKA long run equilibrium AKA zero economic profit)

This No Bull Review video shows you how to draw correctly labeled short-run loss graphs for perfect competition.

AP Microeconomics Unit 2 Product Markets
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