No Bull Economics Lessons

In this No Bull Economics lesson, we discuss how to measure the responsiveness, or elasticity, of anything. This video refers to the price elasticity of demand, price elasticity of supply, income elasticity of demand, cross price elasticity of demand, wage elasticity of demand, wage elasticity of supply, interest rate elasticity of savings, and interest rate elasticity of borrowing. After looking at these basic elasticity formulas, you will definitely see a pattern!

The No Bull Economics video below introduces the concept of a budget line or budget constraint. In this example, an individual is deciding how many swimsuits and pairs of flip flops to purchase before beach season. A budget line is comprised of the different combinations of these goods that the consumer can afford. Te consumer can afford any combination on the line and inside the line, but cannot afford any combination outside the line. The main ideas behind an individual's budget line is similar to a constant-cost production possibilities frontier. A budget line looks at the different combinations of goods that an individual can afford while a production possibilities frontier looks at the different combinations of goods that an economy can produce. This is an excellent example of opportunity cost.

To determine the utility-maximizing combination of goods to purchase, use this formula.

Marginal revenue product (MRP) is the change in total revenue divided by the change in quantity of inputs. You can also calculate the MRP by multiplying marginal product (AKA marginal physical product) by the marginal revenue.

MRP = Change in TR / Change in Inputs

or

MRP = MP x MR

AP Microeconomics Unit 3 Resource Markets

When a firm employs two types of resources, we can determine the profit-maximizing quantity of each input by using the following equation:

Marginal Revenue Product of Labor / Price of Labor = Marginal Revenue Product of Capital / Price of Capital = 1

The ratios must be equal to one. If you need the MRP / P to decrease, then hire more units of that resource. This is because of the law of diminishing marginal returns (as inputs hired increases, marginal product and marginal revenue product decreases).

If you need the MRP / P to increase, then hire fewer units of that resource.

AP Microeconomics Unit 3 Resource Markets

When a buyer purchases two types of goods, we can determine the utility-maximizing quantities of each good using the following equation:

Marginal Utility of X / Price of X = Marginal Utility of Y / Price of Y

The ratios must equal one another. If you need the MU / P to decrease, then buy more units of that good. This is because of the law of diminishing marginal utility (as you buy additional units, marginal utility decreases).

If you need the MU / P to increase, then buy less of the good.

AP Microeconomics Unit 1 Basic Economic Concepts

When a firm employs two types of resources, we can determine the cost-minimizing quantity of each input by using the following equation:

Marginal Product of Labor / Price of Labor  =  Marginal Product of Capital / Price of Capital

The ratios must equal one another. If you need the MP / P to decrease, then hire more units of that resource. This is because of diminishing marginal returns (as inputs hired increases, marginal product decreases).

If you need the MP / P to increase, then hire fewer units of that resource.

AP Microeconomics Unit 3 Resource Markets

When graphing perfectly competitive resource markets (such as labor), it is a good idea to graph the market for the resource and the firm hiring the resource side-by-side. The resource market sets the the equilibrium price of the resource (or wage for labor) and the firm takes the price of the resource ("wage taker") from the market.

The resource market consists of a downward sloping demand curve (AKA marginal revenue product) and an upward sloping supply curve. The households supply the resources and businesses demand the resources.

The firm is a "wage taker" so the supply curve is perfectly elastic. This represents the firm's marginal factor cost (AKA marginal resource cost). The firm's demand curve is a downward sloping marginal revenue product curve.

The No Bull Review graph below illustrates a perfectly competitive firm hiring its labor from a perfectly competitive labor market.

AP Microeconomics Unit 3 Resource Markets

Negative externalities exist when the marginal social costs (MSC) exceed the marginal social benefits (MSB). Society is getting too much of the good at too low of a price.

The government can correct a negative externality by imposing per-unit taxes on producers to raise the costs of production. This way the MSC=MSB. Another policy option is to tax buyers so that the MSC=MSB. In the end, the correction will eliminate deadweight loss from the market.

AP Microeconomics Unit 4 Role of Government

Positive externalities exist when the marginal social benefits (MSB) exceed the marginal social costs (MSC). Society is getting too little of the good at too low of a price.

The government can correct a positive externality by offering buyers per-unit subsidies (or incentives) to increase demand so that the MSB=MSC. Another policy option is to offer sellers per-unit subsidies to encourage more production so the MSB=MSC. These policy actions will get rid of the deadweight loss in the market.

AP Microeconomics Unit 4 Role of Government

A negative externality occurs when the marginal social cost (MSC) is greater than the marginal social benefit (MSB). Society is worse off from the production of the good. There is a misallocation of economic resources and deadweight loss. Markets overproduce goods that generate negative externalities.

The No Bull Review graph below illustrates a good that creates negative externalities (MSC>MSB). The area of deadweight loss (inefficiency) is the purple triangle. P1 and Q1 is socially optimal, however the market generates a price of P and quantity of Q. Society is getting too much of the good at too low of a price.

AP Microeconomics Unit 4 Role of Government

An externality occurs when a third party (someone other than the buyer or seller) is affected by a market transaction. This is known as a market failure. Externalities can be positive or negative.

A positive externality occurs when the marginal social benefit (MSB) is greater than the marginal social cost (MSC). Society is benefitting from the production of the good. However, there is a misallocation of economic resources and deadweight loss. Markets underproduce goods that generate positive externalities.

The No Bull Review graph below illustrates a good that creates positive externalities (MSB>MSC). The area of deadweight loss (inefficiency) is the purple triangle. P1 and Q1 is socially optimal, however the market generates a price of P and quantity of Q. Society is getting too little of the good at too low of a price.

AP Microeconomics Unit 4 Role of Government

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

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

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

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

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

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

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

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

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