MBA 1

Study Units
Microeconomics Page
1. Fundamentals 2
2. Demand and Supply 5
3. Elasticity: Measuring Responsiveness 17
4. Production and Costs in the Firm 28
5. Market Structures

MBA 2
Study Unit 1
Fundamentals
MBA 3
Fundamentals of Economics
What is Economics
Unlimited Wants/Needs + Scarce Resources
Economic Problems
Define Economics
The study of how people choose to use
their scarce resources in an attempt to
satisfy their unlimited wants/needs
The study of choice when scarcity exists

MBA 4
Fundamentals of Economics
Opportunity Cost (of A Chosen
Item/Activity)
The value of the best alternative forgone
when an item/activity is chosen
Marginal Principles of Decision Making
Economic choice is based on a comparison of
expected marginal costs and marginal benefits
of the change under consideration.
Sunk costs are irrelevant in decision making.

MBA 5
Study Unit 2
Demand and Supply
MBA 6
The Demand Curve
Demand schedule Demand curve
Price
Quantity
Demanded
1.25 $ 8
1.00 $ 14
0.75 $ 20
0.50 $ 26
0.25 $ 32
$-
$0.25
$0.50
$0.75
$1.00
$1.25
2 8 14 20 26 32
Quantity
P
r
i
c
e
D
The demand
curve slopes
downward
because of the
law of demand
MBA 7
The Determinants of Demand
Changes in demand can be caused by changes
in
Consumer Income
The prices of substitute and complementary
goods
Ex. peanut butter & margarine; coffee & tea;
computer hardware & software; tortillas & salsa;
leather jacket and Harley Davidson motorcycle
Consumer expectations about future prices
The number of consumers in the market
Consumer tastes

MBA 8
A Change in Demand (D to D)
Q
P
D
D
D
Increase
Decrease
MBA 9
The Supply Curve
Supply schedule Supply curve
Price
Quantity
Supplied
1.25 $ 28
1.00 $ 24
0.75 $ 20
0.50 $ 16
0.25 $ 12
$-
$0.25
$0.50
$0.75
$1.00
$1.25
8 12 16 20 24 28
Quantity
P
r
i
c
e
S
The supply
curve slopes
upward because
of the law of
supply
MBA 10
The Determinants of Supply
Changes in supply can be caused by changes in,
Production technology
The prices of inputs/resources used in production
Ex. Price of leather increases Supply of leather
jacket ?
The prices of alternative goods using the same inputs
Ex. Corn price increases Supply of soybeans ?
Producer expectations about future price
The number of producers

MBA 11
A change in Supply (S to S)
Q
P
S
S
S
Increase
Decrease
MBA 12
Market Equilibrium
In equilibrium, the
plans of buyers
match the plans of
sellers. Quantity
supplied equals
quantity demanded
Q (Millions of qts)
P (Price per qt)
S
D
0.5
1.0
14 16 20 24 26
0.75
Surplus at
$1 price
Shortage at
$0.5 price
MBA 13
Market Effects of an Increase
in Demand
Q
P
S
D
D
20 24 30
0.75
1.00
a b
c
MBA 14
Quiz #1
MBA 15
Problem #1
MBA 16
Study Unit 3
Elasticity: Measuring Consumer
Responsiveness
MBA 17
Price Elasticity of Demand (E
D
)
Measure of the responsiveness of
quantity demanded to a price change; the
percent change in quantity demanded
divided by the percent change in price


Q
P
2.50
2.20

80 100
Demand curve
MBA 18
Price Elasticity of Demand (E
D
)
741 . 1
%
%
2 2
= =
=
|
.
|

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|
+

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old
p
new
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old
p
new
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old
D
q
new
D
q
old
D
q
new
D
q
old
p
new
p
old
p
new
p
old
D
q
new
D
q
old
D
q
new
D
q
D
E
ice in Change Percent
Demanded Quantity in Change Percent
E
D
Pr
=
MBA 19
Categories of Price Elasticity of
Demand
Inelastic Demand (-1 < E
D
< 0, e.g., -0.5):
The percent change in quantity demanded is less than
the percent change in price

Unit Elastic Demand (E
D
= -1):
A percent change in price causes an equal (but of
opposite sign) percent change in quantity demanded

Elastic Demand (E
D
< -1, e.g., -2):
The percent change in quantity demanded exceeds the
percent change in price
MBA 20
Applications of Price Elasticity
of Demand
Predicting changes in quantity demanded when
price changes
Predicting what happens to total revenue when
price changes
MBA 21
Elasticity and Total Revenue
Change in Effect of Higher
Type of Quantity Versus Price on
Demand Change in Demand Total Revenue

Elastic Larger % change Lower total
(E
D
=-2) in quantity revenue

Unit elastic Equal % change No change
(E
D
=-1)

Inelastic Smaller % change Higher total
(E
D
=-0.75) in quantity revenue


MBA 22
Price Elasticity of Supply (E
S
)
Measure of the responsiveness of
quantity supplied to a price change; the
percent change in quantity supplied
divided by the percent change in price
Q
P
2.50

2.20

Supply curve
80 100
MBA 23
Price Elasticity of Supply (E
S
)
741 . 1
%
%
2 2
= =
=
|
.
|

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|
+

|
.
|

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|
+

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old
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new
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old
p
new
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old
S
q
new
S
q
old
S
q
new
S
q
old
p
new
p
old
p
new
p
old
S
q
new
S
q
old
S
q
new
S
q
S
E
ice in Change Percent
Supplied Quantity in Change Percent
S
E
Pr
=
MBA 24
Categories of Price Elasticity of
Supply
Inelastic Supply (0 < E
S
< 1, e.g., 0.5):
The percent change in quantity supplied is less than
the percent change in price

Unit Elastic Supply (E
S
= 1):
A percent change in price causes an equal percent
change in quantity supplied

Elastic Supply (E
S
> 1, e.g., 2):
The percent change in quantity supplied exceeds the
percent change in price
MBA 25
Study Unit 4
Production and Costs in the Firm
MBA 26
Analysis of Short-Run
Production
Total product is the total
output produced by a
firm
Marginal product is the
change in total product
that occurs when the
usage of a particular
resource increases by
one unit, all other
resources constant
Units of the
Variable
Resource
Total
Product
Marginal
Product
0 0
1 2 2
2 5 3
3 9 4
4 12 3
5 14 2
6 15 1
7 15 0
8 14 -1
MBA 27
Analysis of Short-Run
Production
2
5
9
12
14
15 15
14
2
3
4
3
2
1
0
-1
-2
0
2
4
6
8
10
12
14
16
0 1 2 3 4 5 6 7 8
Labor per day
Total
Product
Marginal
Product
MBA 28
Analysis of Short-Run
Production
Increasing marginal returns occurs when
marginal product increases when another
unit of a particular resource is employed, all
other resources constant

The law of diminishing marginal return
states that when more and more of a
variable resource is added to a given
amount of a fixed resource, the resulting
change in output will eventually diminish
and could become negative

MBA 29
Analysis of Short-Run Cost
A fixed cost (FC) is any production cost that
is independent of the firms rate of output
A variable cost (VC) is any production cost
that increases as output increases
Total cost (TC) = Fixed cost + Variable cost
Marginal cost (MC) is the change in total
cost resulting from a one-unit change in
output
the change in total (variable) cost divided by
the change in output (MC = ATC or AVC/ Aq)

MBA 30
Short-Run Production Costs
Tons
per Day
Fixed
Cost
Workers
per Day
Variable
Cost
Total
Cost
Marginal
Cost
0 $200 0 $0 $200
2 $200 1 $100 $300 $50.00
5 $200 2 $200 $400 $33.33
9 $200 3 $300 $500 $25.00
12 $200 4 $400 $600 $33.33
14 $200 5 $500 $700 $50.00
15 $200 6 $600 $800 $100.00
MBA 31
Fixed, Variable, and Total Cost
Curves
$0
$100
$200
$300
$400
$500
$600
$700
$800
0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15
Tons per day
Fixed
Cost
Variable
Cost
Total
Cost
Variable Cost
Total Cost
Fixed
Cost
Fixed
Cost
MBA 32
The Marginal Cost Curve
$-
$10
$20
$30
$40
$50
$60
$70
$80
$90
$100
0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15
Tons per day
Marginal
Cost
MBA 33
Short-Run Marginal Cost and
Average Costs
$-
$10
$20
$30
$40
$50
$60
$70
$80
$90
$100
0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16
Tons per day
Marginal
Cost
Average
Fixed Cost
Average
Variable
Cost
Average
Variable
Cost
ATC
AVC
AFC
MC
MBA 34
In-class Assignment
Quiz #2
MBA 35
In-class Assignment
Problem #2
MBA 36
Production and Cost in the
Long Run
Output per period
$
Long-run
average cost
S
S
M M
L
L
MBA 37
Economies and Diseconomies
of Scale
The long-run
average cost
curve is a curve
that indicates the
average cost of
production at
each output level
when the size of
the firm or the
production facility
is allowed to vary.
Output
Cost per unit
LRAC
Economies
of scale
Diseconomies
of scale
MBA 38
Study Unit 5
Market Structure
MBA 39
Study Unit 5
Market Structure
MBA 40
Categories of Market Structure
Perfect
Competition
Monopolistic
Competition
Oligopoly Monopoly
Number of
Firms
Many Many A few or many with
a few dominating
firms
One
Product
Homogeneity
Perfect homo-
geneity/substitutes
Close substitutes
(some
differentiation)
Could be perfect or
close substitutes
No close
Substitutes
Barriers to
Entry and Exit
Very low Very low High Highest
Firms control
over price
None Little High Highest
Examples Global commodity
market, stock
market
Cold Remedies,
Soaps, Shampoo,
Gas stations,
Clothing stores,
Economic
textbooks.
Airlines, Phone
Service, Steel,
Computer chip
makers, Beverage,
Auto industry,
Tobacco
De Beers
until 2001,
Alcoa until
WWII,
OPEC.,
Campus
bookstore
MBA 41
Output Decision & Profit
Maximization
Marginal Revenue (MR)
The change in total revenue resulting from a
one-unit change in sales. That is, MR = 6TR/
6q.
The Golden Rule of Profit Maximization
To maximize profit (or minimize loss), a firm
should produce at the level of output where
marginal revenue (MR) equals marginal cost
(MC).

MBA 42
Output Decision & Profit
Maximization
Marginal Revenue (MR)
The change in total revenue resulting from a
one-unit change in sales. That is, MR = 6TR/
6q.
The Golden Rule of Profit Maximization
To maximize profit (or minimize loss), a firm
should produce at the level of output where
marginal revenue (MR) equals marginal cost
(MC).

MBA 43
Marginal Revenue & Profit
Maximization
Quantity Price (MR)
Total
Revenue
Total
Cost
Marginal
Cost
Ave. Total
Cost
Economic
Profit
0 $0 $15.00 -$15.00
1 $5 $5 $19.75 $4.75 $19.75 -$14.75
2 $5 $10 $23.50 $3.75 $11.75 -$13.50
3 $5 $15 $26.50 $3.00 $8.83 -$11.50
4 $5 $20 $29.00 $2.50 $7.25 -$9.00
5 $5 $25 $31.00 $2.00 $6.20 -$6.00
6 $5 $30 $32.50 $1.50 $5.42 -$2.50
7 $5 $35 $33.75 $1.25 $4.82 $1.25
8 $5 $40 $35.25 $1.50 $4.41 $4.75
9 $5 $45 $37.25 $2.00 $4.14 $7.75
10 $5 $50 $40.00 $2.75 $4.00 $10.00
11 $5 $55 $43.25 $3.25 $3.93 $11.75
12 $5 $60 $48.00 $4.75 $4.00 $12.00
13 $5 $65 $54.50 $6.50 $4.19 $10.50
14 $5 $70 $64.00 $9.50 $4.57 $6.00
15 $5 $75 $77.50 $13.50 $5.17 -$2.50
16 $5 $80 $96.00 $18.50 $6.00 -$16.00
MBA 44
If price < average variable cost
The firm will shut down and be better off.
The firm incurs a shut-down loss equal to the
fixed cost.
If price > average variable cost
The firm will produce at a loss rather than shut
down.
The firm will be able to cover all of its variable
cost and a portion of its fixed cost. As a
result, the operating loss is less than the shut-
down loss.

Short Run Loss and the Shut-
Down Decision
MBA 45
Barriers to Entry: Key to
Monopoly Power
Legal Patent and License
Economies of Scale
Natural monopoly
Control of Essential Input
De Beers controlled 75% of the world
supply of rough diamonds.
MBA 46
Price Discrimination
Selling the same good for different prices
to different consumers as a way to
increase profit
Conditions for price discrimination must
include,
The firm has some control over the price
The firm must be able to identify at least two
classes of customers who value the product
differently
The product cannot be resold

MBA 47

MBA 48
Game Theory Exercise
Suppose there are only two automobile companies, Ford and GM. Ford believes that GM will
match any price it sets. Use the following price and profit data to answer the following
questions. Assuming Ford makes the first move.

If Ford and GM Fords profits GMs profits
sells for sells for (millions) (millions)
$4,000 $4,000 $8 $8
4,000 8,000 12 6
4,000 12,000 14 2
8,000 4,000 6 12
8,000 8,000 7 7
8,000 12,000 12 6
12,000 4,000 2 14
12,000 8,000 6 12
12,000 12,000 10 10

A. What price will Ford charge?
B. What price will GM charge?
C. What is Fords profit after GMs response?
D. If the two firms collaborated to maximize joint profits, what prices would they set?
E. Given your answer to part D, how could undetected cheating on price cause the cheating
firms profit to rise?