Firms Firms and nd ma mark rkets Sessions 9–10 PMAP 8141: Microeconomics for Public Policy Andrew Young School of Policy Studies
Plan for today Supply and demand Demand and WTP Supply and WTA Elasticities of demand Scale, location, networks, and time Surplus, taxes, incidence, and DWL Changes in supply and demand Escaping the price taking world
Supply and demand
Demand = WTP = marginal benefit
Supply = WTA = marginal cost
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Supply and demand Demand and willingness to pay (WTP)
Willingness to pay (WTP) How much you value (and would pay) for something Reflects aggregate preferences
Finding WTP “Would you be willing to spend $X for Y?” Count all the people who are willing to pay at each price
8 7 6 Price P : dollars per pound 5 4 3 2 1 0 0 8,000 16,000 24,000 32,000 40,000 48,000 56,000 64,000 72,000 80,000 Quantity Q : pounds of Cheerios
WTP = Demand 8 7 6 Price P : dollars per pound 5 4 3 2 1 0 0 8,000 16,000 24,000 32,000 40,000 48,000 56,000 64,000 72,000 80,000 Quantity Q : pounds of Cheerios
Supply and demand Supply, willingness to accept (WTA), and costs
Different types of costs Stuff that costs money regardless Fixed costs of how many things you produce Stuff that costs money for Variable costs each thing you produce Total cost Fixed costs + variable costs Average cost Total cost / number of things you produce Cost to make one additional thing Marginal cost (also slope or derivative of total cost)
Revenue vs. profits Total revenue Price × quantity Marginal revenue Revenue from selling one additional thing Profit ( π ) Total revenue − total cost Max π : Find where MR = MC
Firms and markets Market supply = all firms’ MCs combined Price comes from where supply and demand meet in the world
Individual firms are price takers and can’t change the price on their own! Market demand Firm demand
Firms and markets If the prevailing market price is lower than a firm’s average variable costs (AVC), they’l ’ll shut down
Elasticities of demand
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ϵ = ∞ = Perfectly elastic Any change in price Identical goods moves quantity to 0 Two vending machines ϵ > 1 = Elastic Changes in price change Goods with substitutes the quantity a lot Diet Coke ϵ = 1 = Unit elastic Changes in price change the quantity the same ϵ < 1 = Inelastic Changes in price change Goods with few substitutes the quantity a little AIDS medicine ϵ = 0 = Perfectly inelastic Changes in price do Survival goods nothing to the quantity Water in the desert
Why do elasticities matter in policy? Taxing things changes their prices Changing prices changes quantities Taxing elastic goods will make quantities go down a lot and decrease tax revenues Taxing inelastic goods will make quantities go down slightly and not hurt revenues
🚩 Warning! 🚩 Elasticities are not the same as the demand curve They’re not even slopes or anything calculus-y! A linear demand curve has lots of elasticities!
Demand $60.00 Elastic $50.00 Unit elastic = midpoint $40.00 $30.00 Inelastic $20.00 $10.00 $0.00 0 2 4 6 8 10 12
Scale, location, networks and time
Size and location Economies of scale Cost to make stuff goes down as you make more stuff Economies of agglomeration Cost to make stuff goes down as you clump together Network effects Cost to make stuff goes down when everyone uses your stuff
Economies of scale If you double the inputs, you get more than double the outputs If you {{increase}} the inputs, you get more than {{that increase in}} the outputs
Average costs and scale
Time and scale SRAC LRAC
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