BackMicroeconomics Study Notes: Government Actions, Global Markets, Production, and Costs
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Chapter 6 - Government Actions in Markets
Price Ceilings and Price Floors
Government interventions such as price ceilings and price floors are used to regulate market prices, often with significant effects on market outcomes.
Price Ceiling (Price Cap): A regulation that makes it illegal to charge a price higher than a specified level. When applied to housing, it is called a rent ceiling.
Price Floor: A regulation that makes it illegal to trade at a price lower than a specified level. When applied to labor markets, it is called a minimum wage.
Allocation Methods: When price controls create shortages, goods may be allocated by non-price methods such as personal characteristics or first-come, first-served.
Minimum Wage and Labor Markets
The minimum wage is a common example of a price floor in labor markets, with its effects depending on its relation to the equilibrium wage.
If set below equilibrium, the minimum wage has no effect; the market operates as usual.
If set above equilibrium:
Quantity of labor supplied exceeds quantity demanded, creating a labor surplus (unemployment).
Quantity of labor hired is less than in an unregulated market.
The legal wage rate cannot eliminate the surplus, so unemployment persists.
Taxes, Subsidies, and Production Quotas
Government policies such as taxes, subsidies, and quotas affect market efficiency and the distribution of economic welfare.
Tax Incidence: The division of the burden of a tax between buyers and sellers.
Deadweight Loss: Taxes and subsidies can create deadweight loss by making marginal social benefit differ from marginal social cost.
Production Quota: An upper limit on the quantity of a good that may be produced in a specified period. Quotas decrease quantity produced and raise price.
Subsidy: A government payment to producers, which can raise marginal social cost above marginal social benefit, creating inefficiency and deadweight loss.
Markets for Illegal Goods
Government prohibition and legalization of goods (e.g., drugs) have distinct economic effects.
Legalizing and taxing an illegal good can reduce consumption to levels similar to prohibition if the tax equals the penalty under illegality.
Prohibition can alter preferences by increasing the perceived danger of consumption.
Chapter 7 - Global Markets in Action
Comparative Advantage and Trade
International trade is driven by comparative advantage, which arises from differences in opportunity costs between nations.
Comparative Advantage: The ability of a nation to produce a good at a lower opportunity cost than another nation.
Before trade, countries import goods at prices lower than domestic prices and export at prices higher than domestic prices.
Effects of International Trade
Trade affects prices, consumer and producer surplus, and political incentives.
International trade lowers the price of imported goods and raises the price of exported goods.
Buyers of imports benefit from lower prices; sellers of exports benefit from higher prices.
Domestic producers of imported goods lose surplus due to lower prices and reduced sales.
Political lobbying is more intense among groups harmed by free trade than those who benefit.
Trade Restrictions
Countries may restrict trade using various policy tools.
Tariffs: Taxes on imported goods, raising their price.
Import Quotas: Limits on the quantity of a good that can be imported.
Export Subsidies: Payments to domestic producers to encourage exports.
Regulatory Barriers: Health, safety, and environmental regulations that restrict imports.
When a tariff is imposed, the price of the item increases, affecting the quantity demanded and supplied. The amount imported is the difference between domestic quantity demanded and supplied at the new price.
Arguments Against Free Trade
Common arguments for protectionism include dumping, infant industry, and job/environmental concerns.
Dumping: Selling exports below production cost. Difficult to prove and does not justify protection.
Infant Industry Argument: New industries may need temporary protection to become competitive.
Protection is generally inefficient and does not save jobs, the environment, or prevent exploitation.
Chapter 10 - Organizing Production
Firm Objectives and Opportunity Cost
Firms exist to maximize profit, and opportunity cost is central to production decisions.
Profit Maximization: Firms that do not maximize profit are eliminated or taken over.
Opportunity Cost of Production: The value of the best alternative use of resources used in production.
Normal Profit: The expected profit for entrepreneurship, considered an opportunity cost.
Technological and Economic Efficiency
Efficiency in production can be technological or economic, with important distinctions.
Technology: Any method of producing goods or services.
Technological Efficiency: Using the least amount of inputs for a given output.
Economic Efficiency: Producing output at the lowest cost, considering input prices.
Technological efficiency focuses on input quantities; economic efficiency focuses on input costs.
Organizational Structure and Incentives
Firms use a mix of command and incentive systems to coordinate production and solve principal-agent problems.
Command Systems: Hierarchical, used when monitoring is easy or deviations are costly.
Incentive Systems: Used when monitoring is difficult or costly.
Principal–Agent Problem: Aligning the interests of agents (e.g., employees) with principals (e.g., owners).
CEO compensation may include stock to align interests with shareholders.
Market Structures and Concentration
Market structure affects competition and firm behavior.
Perfect Competition: Many firms, identical products.
Monopolistic Competition: Many firms, differentiated products.
Concentration Measures: Quantify market dominance by a few firms, indicating competition level.
Coordination and Economies of Scale
Production requires hiring and coordinating factors of production, with costs determining the method of coordination.
Economies of Scale: Cost per unit falls as output increases.
Economies of Scope: Producing a range of goods at lower cost using specialized inputs.
Economies of Team Production: Teams specializing in mutually supporting tasks increase efficiency.
Chapter 11 - Output and Costs
Short Run and Long Run
Production decisions differ in the short run and long run due to input flexibility.
Short Run: At least one input is fixed (e.g., plant size).
Long Run: All inputs can be varied.
Sunk Cost: A cost already incurred and unchangeable; does not affect current decisions.
Product and Productivity Measures
Output and productivity are measured using total, marginal, and average product concepts.
Total Product (TP): Total output produced in a period.
Marginal Product of Labor (MPL): Change in total product from a one-unit increase in labor, holding other inputs constant.
Average Product of Labor (APL): Total product divided by quantity of labor employed.
Both marginal and average product initially rise with labor, then fall due to diminishing returns.
Cost Concepts
Firms face various types of costs, which behave differently as output changes.
Total Cost (TC): Cost of all factors of production.
Total Fixed Cost (TFC): Cost of fixed inputs (do not change with output).
Total Variable Cost (TVC): Cost of variable inputs (change with output).
Marginal Cost (MC): Increase in total cost from a one-unit increase in output.
MC is typically U-shaped: decreases at low output (specialization), increases at high output (diminishing returns).
Formulas:
Total Cost:
Marginal Cost:
Average Product:
Marginal Product:
Production Function and Returns
The production function describes the relationship between inputs and maximum output.
Production Function: Relationship between maximum output and quantities of capital and labor.
Marginal Product of Capital: Increase in output from a one-unit increase in capital, holding labor constant.
Exhibits diminishing marginal returns to both labor and capital.
Long-Run Average Cost Curve
The long-run average cost (LRAC) curve shows the lowest possible average total cost for each output level when all inputs are variable.
LRAC is a planning curve, composed of segments of short-run ATC curves with the lowest cost for each output.
Once a plant is chosen, costs correspond to the ATC curve for that plant.
Economies and Diseconomies of Scale
Long-run cost behavior is determined by economies and diseconomies of scale.
Economies of Scale: LRAC falls as output increases.
Diseconomies of Scale: LRAC rises as output increases.
Constant Returns to Scale: LRAC remains constant as output increases.
