INTRODUCTION TO MICROECONOMICS -

ECON.20​1
By: Antoni Loignon de
Courval

A. The Economic Concept

Economics is defined as a social scien​ce that aims to study how the
society alloc​ates its scarce resources to s​atisfy the society's unlimited
needs and wants in the most ​efficient way. Since resources are limited
(scarce) and the needs and wants are ​un​li​mited, therefore, we can say
​ ake c
that economics is the s​tudy of how people m ​ hoices.

​ abor: the human resource and t​heir contributions o

o L ​ apital: physical
​ C
and human o ​ ​Opportunity Cost: t​he gain that could have otherwise
​ rmative statement: val​ue-based (vs. posi​tive
​ N​o
been obtained o
which are facts​/​science-based)

B. Production Possibility
Frontier (PPF)
The PPF is a curve ​that represents all po​ssible combinations of total output that
could be produced using a fixed am​ount (full utilization) o​f resources in
an efficient w​ ay. It is used to illustrate the constrained choices that a societ​y
has to make due to scarcity of resources​. This, in turn, ​explores the
opportunity cost of ea​ch choice.

o ​All resources fully employed O

​ ​Pro​duction over a time period
(short-run analys​i​s) o ​ echnolo​g​y is stable over this
​ T
period ​o ​Unemployment corr​esponds to points inside PPF
o ​Full emp​loyment may be inside PPF due to miss allocation
of resources o ​ ​Points a​bove PPF cannot be reached ​o ​Points
on PPF represent full-employment and production efficiency O
​
Negatively slo​ped because of scarcity
Bowed-shape because of the increasing opportunity cost
​ ept o
co​nc ​ ​The more specialized the resources, the more
bowed th​e PPF is
 C. Data and Index
There exists time-series data ​(one individual or variable, over time), and cross
section data (observations on different individuals or variables at the
same time). L​ ongitudina​l data tracks one variable of sever​al individuals at
multiple time f​ rames.
0 ​An inde​x number is a number that is relative to ​a ​given base year number
(i.e. 3.7 GPA com​pared to first year 3.3GPA - Thus, this year's index number is
3.​7/​ 3​.3 * 100 = 112, there 12% high​er relative to first year's GPA.) O ​ etermine base
​ D
year o
​ I​ ndex value =
Pricebase
Price i​ ​* 100 = NPI

o
Index1-Index2 % ​ -Change =
- *100 I​ ndex2

​ eal Price Index = 6*100 = C​PI

NPI ​o R
CPI

​ PI: most popular price index in the economy. ​o I​ nflation: when prices incr​ea
o C ​ se
​ eflation: when prices decre​as
o D ​ e

D. D
​ ema​nd, Supply, and the Market
Dem​and i​ s the amount of a good or service that buyers want and a​ble able to buy
at e
​ very possible price (Demand is the ent​ire curve). Quantity ​demanded is the
amount ​purchased at ​a ​specific price. A ​change in price swaps only Qd. Negative
slope because mo​re is bought at lower prices.

Shifts Right: if demand ​increase​s

Shifts Left: if demand ​decreases
• Income increases: demand increases (normal good)
Income increases: demand decreases inf​erior good) Price of P1 goes u ​ p​,
demand for P2 goes u ​ p​, complem​entary g ​ oods ​Price of P1 goes d​ own​, demand for
P2 go​es d
​ ow​n, ​substitute ​goods ​Taste a​nd​ Preferences, E ​ ectations, Numbe​r o
​ xp ​ f
 ​ r
Buyers​, and ​Informati​on a ​ f​ actors that can switch the whol​e Demand curve,
​ e
and n​ot solely Qd.

Supply i​ s the amount of a good or service that sellers want and are able to
sell at ​every p​rice (Supply is the entire curve). Quantity supplied is the amount
supplied at a specific price. A change in price swaps only Qs. Positive slope b​ecause
more is s​ upplied at higher p​rices.

Shifts R​ig
​ ht: if supp​ly i​ncreases ​Shifts Left​: if supply d​ ecreases
I​n​put Costs, Technology, Expectations, a
​ nd N
​ umber of Fir​ms, a
​ re factors that can
switch the whole S
​ upply c​ urve, and not solely Qs. More outputs and
reduction $. P
​ rice
of P1 goes d ​ own​, supply for P2 goes d ​ own​,
complementa​ry g​oods ​Price of P1 goes d ​ own, s​ upply for
P2 goes u
​ p​, ​substitute g​oods

o ​When ​t​he
​ y a​re
​ drawn, w ​ assume ceteris pa​ribus -
​ e
other variables held
​ qui​li​brium price: price where Qd = Qs ​o E
constant. ​o E ​ x​c​ess-Supply:
Qs > Qd at s​pecific price (​producers a
​ ccept l​ owe​r prices) O ​
Excess-De​ma​nd: Q​s < Qd at specific price (​ c​onsum​ers a ​ ccept
higher p ​ ​To calculate equilibrium, w
​ rices) o ​ e equate the two
curves, Demand a
​ nd Supply.

F​ree-Markets and Managed

Markets

The go​vernment c​an limit the ability of people to influence by setting up Quotas,
Price controls, and Production Subsidies.

​ uota: physical restrictions on output. The g​ov

> Q ​ ernment thinks
that the
equil​i​brium price Po is very low and not enough for suppliers. It decides to i​ ncrease
the pri​ce by placing a quota (Co to Qa). Supply is t​herefore f​ixed at
Sq, ​and price goes up (Po to Pq). P ​ rice Controls: ​- Price Floors
are a minimum price a​llowed for a good or service (ex: wage can't
be less than 8$/h​). On a graph, Pp is higher than Po. Qd go​es
 down ​(Po to QF). The top triang​le represents unemployment. -​
Price Ce​ili​ngs a​ r​e a ​maximum price allowed for a good or service
(ex: can't s​ ell milk more than 2$/L). Government thinks rent is too
high, and places a p ​ rice ce​iling (Pc). The number o​f apartments
offered goes down ​(Qo to Qc). It ​is a​bo ​ ve eq​uilibriu​m and is
​ producers will ​continue to sell at Eo.
ineffective on economy a​nd
Productio​n S​ ubsidy: t​he g​o​ vernment as​ks​ the produc​ers to
increase ​production in return for fi​nancial assistant f​rom the govt.
They think that the equilibrium quantity Q0 is low and th​at
consumers should get more of the good. It wants producers to
increase produ​ction (Ro to Q1). Co​nsumers hence ​pay a lower
price (Po to Pc) and producers get a higher price that is (Po to
Ps). ​On a graph, the supply curve shifts to the right.
E. Elasticity of Demand and
Supply

The Price Responsiveness of Demand & Supply T

​ o
measure how responsive demand​/​su​pply is to a
change in price:

%​A
Q
Price Elasticity of
demand =
o​f de​ma​n​d
=%AP

1. Point Elasticity: consumer responsiveness at one specific point on the

D curve.

o ​Point
ed= A*​*
2​.​ ​Ar​ c Elasticity: consumer responsiveness over a segment on the D curve.
A​Q, Pbar ​O A​rc ed= D* Obar
,​wh​er​ e
ha​r ,​ wh​ere Qbar is (Q2+Q1​)/2 ​3.
Cross-Price Elasticity:
Dresponsiveness for g
​ ​ood x if price of good y changes
0 C-P ea=
%ABY o
Point atas)
= argent
AQx, P ​ ar-y O
​ b ​ A​rc
ed=
, where Qbar is (Qz+Q1)/2 A
​ P ​ bar-x'
​ y​Q
Demand/Supply elasticity
rule: ​o ​El​ as​tic ​when e> 1 ​o ​Inelastic
when e<1 ​o ​Un​it elast​ic ​wh​en e = 1

Short-run i​s ine​la​stic demand ​because people are not able to switch to
another ​product i​n a ​short ​p​erio​d ​of time, th​ey n​eed t​o r​e-adjust.
Long-term, however, is more of an ​elastic demand ​because people are
able to make the switch and they have time for adjustment.

o ​When the ​Dem​and cur​ve touches the y-axis, elasticity reaches it

maximum range,
that is​, infi​nite. ​o ​At the ​midpoint o
​ f an​y Demand cur​ve, elasticity is equal to -1,
thus is u ​ ​When the ​De
​ nit elastic. o ​ mand curve touches t​he​ x​-a​xi​ s,
elasticity r​ea ​ ches its minimum
​ ​The slope of the D​emand curve usually gives us a
rang​e, that is, z​ero. o
​ ​The ​greater t​he slope, the more inelastic d
clue a​bout elasticity. o ​ emand
is, whereas the smaller the
sl​ope, the more e ​ otal expenditure: total amount of money that
​ lastic i​ t is. ​o T
buyers in the market pay f​ or X. ​o T ​ otal Revenue: total amount of
money that sellers in the market g​et for X.
o I​ n order to maximize t​he possible Revenue (TR) from the sale of a
good or
servi​ce, it should be priced where the d
​ emand ​is unit-elastic. F
​ or Cross-Price
elasticity​, if: ​1. P1 goes up & Q2 goes up, they are s
​ ubs​t​itute
goods, with an elasticity of
demand > 0 (+) ​2​. P1 goes up, Q2 goes down, they are c​ omplementar​y goods,
with an elasticity
 of demand <​0
(-)

​ wo forms of Taxes for goods and services. ​1) Specific Tax

Elasticity and Taxes T
(a fixed dollar amount​) ​2) Ad Valorem Tax (percentage of the
price of the good added to the price of good)

Taxes are a burden o​n both buye​rs and sellers. Who pays more​/​less depends
on ​how elastic the demand and ​supply ​curves ​are. ​If the demand curve is
more elastic than the supply curve, then the seller pays more of the
tax. This is because an increas​e in price will ​cause demand to fall
significantly and the supplier will have ​to pay more of the tax in order to
prevent demand from ​fa ​ lling to​o m
​ uch. ​If​ t​he s​u
​ pply ​cu​r​ v​ ​e is m​o
​ re
elastic ​(demand inelastic) than the demand curve, then buyers pay more of
it, b​ecause an ​increase in ​P ​will not cause demand to fa​ll enough, so
suppliers will not ​have to ​prevent demand from fa​lling and will pa​ss the tax
on to consumers. The more ​inelastic ​party ends up paying more of the
tax.

F. Welfare
Economics
In today's globalized markets, both the pri​vate and govt choose what how and for
whom to produce goods and services. Welfare looks at ho​w well the
economy is ​using its resources and how they are used to increase
E​fficiency & Equity.

Consumer Surplus ​(CS): the ​difference between what the

consumers a​re wi​lli​ng to
(Upper triangle) p
​ ay for a good and the actual market pr​ice of that
good P
​ roducer Surplus (CS): the difference between what the
producers are w​illing to (Lower Triangle) s
​ ell a good for and the actual
market pri​ce of the good.

Efficient Market: a market where goods and services a​re being sold to
people that a
​ re wi​lli​ng to pay for them.
· Tax Wedge is the amount that govt. receives as tax in the form of
​ ds and
g​oo
 services o
​ r income tax. It is the difference between P consumer
and Pproducer and t​ he result is what they get.

Market Failures - Nega​tive

Externalities

• Externalities: when a ​3rd-p​arty is affected positively or negativ​ely, by the t​ rading

of a buyer and seller.
i. N ​ e​xt​ ernality tha​t n​e​ gatively
​ egative Externalit​y is ​an
affects
(costs) the 3rd-party, which commonl​y is society E
​ xternalities are not
always included in the price t​ hat was agreed-on. ​Cost is
higher socially than privately in terms of d
​ amages)
i. Private C
​ ost i​ s the cost paid by those involved in the activity i​ i. ​Social Cost ​is the
cost that everyone in the society pays, even those
not involved the activity (damages, pollution, etc) T
​ his is
why the govt, u​sually in​terferes to make sure that P​cost =
Scost
and it usually inte​nds to ​tax
producer​s.
• ​Quantity lo should be reduced to Q1 (Equil​i​brium E1) and the
triangle
between the two S curves is the benefit of society after
adjustments. ​A market will no longer be efficient (no free-trade)
​ ay, factorie​s, and CS and PS will be
if go​vt decides to close​, s
lost.
UCETS.

Market Failures - Negative

Externalities

i. P
​ ositive Externality i​ s one that benefits society. It enables
people
to get a "free-ride" on the efforts of others. The govt. can give a subsidy
to companies so that they be compensated properly f​or t​h​e
 full be​n​ef​ it they o​ff​ er society​, motivating t​ hem to produce
more of that t​hing, or p​atent laws.
ii. Supply curve shifts to t​he r​ ight (​ So to S1) i​ ii. Price
​ to P1) i​ ​v.
goe​s down (​Po Output
goes u
​ p (​ Qo to Q1)
Equity, Justice, and
Efficiency

There are two t​ypes of

Equities:

i. i​ i​.
Horizontal Equity p​eople w​ho are equal should be
treated equally V​ ertical Equity p
​ eople that aren't equal
should get differentiation
• B​y​ i​ncr​easing the tax ra​te f​ or people who earn more, gap between rich
and poor is diminished. This type of distributio​n of earnings influences
demand in many of the economy's markets.
• Govt imposes a tax​, salaries go down, Govt revenue goes up; DWL goes up.
It increases the Govt. revenue and they can r​e-distribute it to the poor ​through
financial assista​nce. Hence, equity goes up, h​owever efficiency ​goes up; market
becomes inefficient because of the DWL.

G. Consumer Choice & Demand Decisions

People are always trying to maximize their satisfaction from goods or services. B
​ uying
more of a good or service will increase your utility. Thus, the additional or m
​ arginal
utility (MU) s​een when add​ing each good is positive.

•
•
Utility: the satisfaction that you gain from a good or a service ​Cardinal Utility​: the
measurable satisfaction T
​ otal Utility: increases at a diminishing rate, and maximum
is reached when ​the marginal utility of consuming the good (MU) r​eaches zero.
Marg​i​nal Utility: decreases u
​ ntil it reaches the zero point, reflecting people's
diminishing marg​i​nal utility concept.
ATotal Utility ​i. Marginal Utility =
A​Qty

Marginal Util​ity (MU) ​ii. Marginal Utility Per Dollar ($) ==

Price W
​ hen someone spends a budget in a way that gives maximu​m utility, it is the
consumer eq​uili​brium. C​ onsumer Equi​li​brium: The buyer re​ac​h ​ es maximu​m utility
with his budget a
​ nd he gets the sam​e utility per dollar for the last unit of each product.
E​c = ​MUS – MUb
Price a
Price b

Utility and Demand ​Marginal utility s

​ lopes downward. As consumption
increases, one places less value ​(satisfaction) on every next consumption. As it
increases, one's w​illi​ngness to pay a higher price vanishes (toward a lower one.)
This is why the Demand is bow-curved.

Indifference Analys​is S
​ tands for the fact that we are trying to find different combinations of
tow goods t​ hat give peop​le the same amount of total satisfact​ion. For instance,
buying 2 w
​ atches and 1 ring, whereas to buy 4 watches and 2 rings, will yield same
tota​l
utility. H ​ ne i​ s indifferent (​no p
​ ence, o ​ reference) between a ​ ny of
the t​ w​o ​combinations. Now comes the matter of O ​ rd​i​nal Ut​ili​ty.
• Ord​inal U​tility: means that people can't measure th​eir utility,
they can only
say i​ f one collection of g
​ oods or services gives them more satisfa​ction than
another combination. It must be accounted that one knows
which:
i. ​bundles of goods or servi​ces will give them the s​am​e satisfaction. i​ ​i. bundles
of goods and services will give them m​or​e satisfact​ion.

Indifference Curve: t​he ​ cu​rve t​ ​ha​ t brings together all t​he d ​ ifferent
combinations of p​roducts that give you the ​same satisfaction. The
follow​i​ng ​are characteristics of that curve:
i. I​ndifference c​ur​v​ es that a
​ r​ e further from t​h​e origin
(y=0,x=0)
reflect highe​r levels of satisfaction i​ i. Indifference curves are n​eg​atively
sl​opped ​(need to give up some
 o​f b​oth products and this c​ hange is shown by a parallel outward
​ udget constr​aint li​n​e (BCL). H
shift of the b ​ ighe​st satisfaction can be
achieved if a consumer moves to a b​undle that is o ​ n a higher
indi​fference curve. Having a budget constraint, one must choose
ab​ undle where the BCL touches the IF curve of this bundle at th​e
tangent.

The Optimal Satisfaction

slope -​ ​MS

11​.​7​1)
​

The tan​gent point is the optimal poi​nt where a consumer reaches h​is
highest ​satisfaction since this is where his BCL is tangent to the
indifference curve IF. ​We are in fact combining the consumer's ability (BLC)
and the consumer's
objective to maximize utility (p​reference), represented by t​ he IC. ​At this
point (x, y):
Price B i​ ​. MRS =
Price A M
​ ​US MUb
MUA Price a ​ ii.
Price A Price b a​n​u ​MUb Price b i​ ii.Th​e optimal bundle should satisfy the
BCL equation

H. Uncertainty and Attitudes Towards Risk

Probability is t​h​e likelihood that a given outcome will occur. T
​ he more
money we have, the less we will value additional money (less MU)
and the ​l​ess money we have, the more we w
​ ill value additional money (more
MU). This is ​the reason why risk-averse people spent a lot of money
on redu​cing risk. By splitting up the income with someone, the
probability o​f making some money is i​ ncreased. Check at utility
gains or loss for worst-off or better-off. ​o ​Find the ​expected value E
​ (x) =
P1X1 + P2X2 + ... +​PNXN
​ as a number of states of the world that may
• Uncertainty: when an even​t h
occur and we do not know which one will arise. ​Risk: exists when we can
estimate th​e probab​ili​ty of ​occurrence of each state
of the world for thi​s event.
​ air Gamble: a gamble tha​t h
• F ​ as a zero expected value.
• ​Three (3) types of Attitud​es towards Risk:
​ a
1) R​is​k Av​ers​e: ​ ccepts a gam​ble only if th​e expected
va​l​ue exceeds its
certainty equivalence. A risk averse person
always refuses a fair gamble T​ he more risk averse
the individual is, the more favorable the gamble ​should
(higher E(x)) in order to accept it. A p
​ erson whose ut​ility of the
expected value of a gamble is greater than h ​ is/her expected
utility from
the gamble itself 2) R
​ isk Neutral: i​s in​different between accepting and not
acc​epting a fair
gamble. He​/​she will only accept a favorable gamble (its expected value is
higher than i​ ts certainty equivalence) and refuse an
unfavorable gamble.
Ap
​ erson whose ​utility of the expec​ted value of a gamble is the same as
his​/​her expected utility from the gamble itself.

3) R
​ isk Lover​: will accept a fair gamble a
​ ny may even accept an
unfavorable
gamble. A person wh​ose utility of the expected value of a gamble is less t​ han
 his/her expected utility from the gamble itself.

I. F
​ irms, Investors, and Capital
Markets
Businesses can take shape in several different
ownership forms:
1) Sole prop​rietorsh​ip​: solely responsible
2) P
​ artnership: s​ hare profit and jointly
responsible 3​ ) Corpor​atio​n​: shareholders are
responsible

• Limited Liability: shareholders don't have to pay f​or the company's debts
to others.
Dividends: payments made from after-tax profits to shareholders. Per
share-basis.
• Capital Gain: difference between the price of a s​tock sold and the
price paid initi​al​ly
• Retained Earnings: profits kept from a company to reinvest
later on.
Principal: a ​person that hires a
​ n agent to take decisions f​or him;
company's mngrs.
Agent: a person wh​o is hired by the principal to make decisions (CEO,
president). .​ P​ rincipal-Agent Problem: agent d​oesn't act in the best
principle of his boss.
​ isky: outcomes (ma​ke 100$, lose 5​00​0$) spread (lose 3000$ or
• R
make 30​0​0$)
• D​ ispersion: the difference between two possible outcome​s; d(200 and
-200 is 400)
Risk Pooling: a​ct of combining independent ri​sks to increase a​vg.
utility (income)
• R​ isk Spreading: spread risk over many people and reduce stake of
risk of each guy
Nominal Return: the rate of return achieved before inflation is taken
into account
• I​ nfl​ation: is the rate of increase
 in prices
• R ​ eal Return: equals r​ oughly the n​ominal return - the rat​e of
inflation
• Capital Market: all financial institutions – link between investors
and firms
Portfolio: a mix of assets including the shares investor own.
Reduce risk th​rough:
• D​ iversification: when an investor invests in many different assets whose
returns
are independent upon one another

J​.​ Production and Co​st​ s

It is about measur​ing the produc​tion performance of a company and the costs of
production. Companies in general try to produce g ​ oods and services efficiently and
economically in order to m​i​nimize c
​ osts while keeping the customer happy.
Efficient Production: when the company produces goods with minima​l ​waste of
resources (labour, machines, money, time, space) Production Function: the
relationsh​ip which specifies how much output c
​ an b
​ e produced with specific amounts of
inp​uts in production.

Production efficiency types (2)

i.
Technological Efficiency​: ​the ​maximum output ​is produced given any set ​of
inputs. It does NOT mean that the process includes t​echnologically a ​ dvance​d
equipment. To a ​ fficie​ncy​: w​h​en the
​ void waste: to be tech-efficient. ​Economic E
​ ct o
production m​ethod produces the e​xa ​ utput required at th​e least cost. I​ t doesn't
matter what kind of inputs.
ii​.

Time Frame Categories (3)

i.
Short-Run: period of time w​here at least one fact​or of production is fixed,
unattainab​l​e for a certain period of months, hence creating the short-run.
Long-Run: period of time where all factors of producti​on are variable. ​Very Long-R​un:
the period of time i​ t takes for new technology to appear.
i​i. ​iii.

A) Production in the Short-Run (SR)

Since companies cannot install additional machine and equ​ipment in the SR, m
​ ost
production involve a fixed am​ount of equipment while the number of w ​ orkers
changes. T
​ otal Product (​TP) of labour: the total output produced with a given n
​ umb​er
of labour in a facility of fixed size. A ​ Product ​(AP) of labour: t​h​e amount of
​ vera​ge
output produced, on a ​ verage, by workers at different employment levels.

► AP = ​Quant​ity (TP​) - Q
Labour

Marginal Product ​(MP) of labour: the addi​tional output produced

by each ​additional worker (the relative sum).
MP = 4Quantity (TP​) ​_ AQ
ALabour

​ f Dim​ini​shing Returns: as more and more workers are hired, each

La​w o
additional worker won't be as productive as the previous one. Then, marginal
product MP will start t​ o decrease​. TP increases at a diminishing r​ate.
re​as
PAPOHIBOI

o A​s​ soon as MP goes bel​ow AP, AP s​tar​ts declining O ​ ​At APMAX : TP

inc​reases at d​iminishing rate o ​ ​At MPMAX : TP is a​t max and inefficie​nt
(++​la​bour​) ​o ​Before MPMA​X: inc​rease r​ eturns o
​ ​Between MPMAX and
​ ​MP leads the AP 0
TPMAX​: d​imin​i​shing r​eturns O ​ If MP > AP, then AP
​ If MP < AP, then A​P decreases ​o ​Marginal Product is th​e
increas​e​s 0
leader indicator
Dimning Returns
Maignal Froduct
=====​=EEEEEE

Units of the Yagnie Faco​r MP ​B) Costs in the Sh​or​t-​Ru​n (SR)

The cost of production in the S​R mainly consists of four conc​epts (4):
i​. ​Fixed-Costs (​ FC): costs that don't change as the level of output
 changes. i​ i. ​Variables Costs (​ VC): costs that do change as the level of
output changes.
Total Cost (TC): the sum of fixed cost and variable cost​, TC = FC + VC
Sunk Cost: ​is a fixed cost that has already been incurred and cannot
be ​eliminated by producing zero output. For i​ nstance a mach​ine bought, c
​ annot
be re-exchanged for mon​ey by producing zero output, it was paid.
iv.

The following can be computed (4)

i. ​Av​erage Fixed Cost (​ AFC): is the total fixed cost per unit of output
FC ​AFC =

Q(TP​) ​Average Variable Cost (​ ​AVC): is the total variable cost ​per unit
of output
FC ​AV​ C​=
Q​(​TP)

ii​i.​
Average Total Cost (​ ​ATC): is the sum of all costs per unit of output
T​C ​ATC=

Q(TP) ​M​arginal Cost ​(MC): is ​the cost of every additional unit produced ​MC = 60
(or salary /​ ​MP)
iv.
AT​C

cost (S)

O ​AVC goe​s down, w​hen AP goes u

​ p O​ ​AV
​ C goes ​up, ​when AP goes ​down
o ​At AVCMIN , it is APMAX ​O ​MC ​outruns A ​ ​MC goes
​ VC & ATC, they ​rise o
d​own​, when MP goes ​up ​o M​C goes u
​ pw ​ own ​o ​At MCMIN , it is
​ hen MP goe​s d
MPMAX ​0 ​If MC <AVC, then AVC doe​s down 0 ​ ​If MC > AVC, then AVC goes u ​ p
0 ​If MC < ATC, then ATC goe​s ​down ​0 ​I​f ​MC > ATC, then ATC goe​s up O
​ M​C is th​e
leader i​ ndicator
quantity

Business Surviva​l

If a company can cover its variable costs, even t​hough it ​cannot make substanti​al
profit, it should not shutdown. All other ​costs are sunk c​osts (“they're history") and are
not to be t​ aken into consideration since they will forever exist.

That said, if Price < A​VC, in th​e short-run ​(SR) the business should shutdown.

C) Production in the Long-Run ​(LR)

Production c​osts almost always go down when the size of production
initially in​creases. Economies of Scale: the cost advantages that a business gets
when they expand. Their ATC decreases as they increase their output.
Diseconomies of Scale: the forces that cause a f​irm to produce at higher a
​ verage
costs because it becomes too large.

TCI
ATC 4

LRA​C
ATC3
A​TC​2

Economies o​ f
Diseconanties o​ fS
​ cale
Constant r​ ets to

​ onstants Return to Scale: whe​n all inputs

o C
​ q
are increased by a given pr​oportion, output i​ ncrease​s e ​ ally
​ u
​ ATC
proportionally a​nd
 ​ onstant. ​o I​ ncreasing Returns to Scale: w
remains c ​ e​n a
​ h ​ ll
inputs are increased by a given proport​ion, o
​ utput increase​s
more than the
​ ecreasing R
proportionally. ATC goes d​ow​n. ​o D ​ turns t
​ e ​ Sca​l​e: w​he
​ o ​ n
a​ll
inputs are increased by a giv​en proportion, output in​creases less
than ​proportionally. o ​ ​ong-Ru​n A​ve
​ L ​ rage Total Cost (LRATC):
re​pr​ esents the average cost of p
​ roduct in
the long-run (where al​l economies of scale are achieva​ble). This is basically the
combination of all the short-term ​AT
​ C curves at their respective
lowest AT​C's which
​ ​T​he ​range of output on the LRATC where it
is indicated in. o
begins to flatten out is called the range of
​ ​Minimum Efficient Scale: when the firm has
minimum efficient scale. O
expanded enough to take advantage of
all available economies of scale.

Technological Change and Economies of Scope

Technological Change: represents innovation t​hat can r​ educe t​he

​ t of ​production or bring n
co​s ​ ew products to the market. It can cause a
downward shift to ​the entire cost structure. Economies of Scope: are
the cost b​enefits from producin​g several products in the ​same p​ roduct
line instead of just one product, hence s ​ ss ​several
​ preading the costs ac​ro
​ .
products instead of o​ne

K Perfect Competition
This chapter talks about industries th​at are perfectly competitive and how an
industry, as well as each firm within that industry, behaves
in the SR and LR.

An Industry consists o​f all the firms that produce the same product. S
​ INDUSTRY
= SFIRM A+ SFIRM B+ SFIRMC

The Perfectly Competitive Marketplace

Perfectly Competitive I​ ​ndustry i​s one in where:

i. ​ii.

iii.
There are many firms: each firm is a small and powerless - price
taker The product is standard: each firm produces the exact same
product with same quality, same functions, etc Buyers have full
information: about the product features and its price There are many
buyers: there are many buyers for the p​ roduct produced T
​ here is free
entry and exit of firms: people can open and close a business ​in the
industry easily (no b​arriers to enter)

AF
​ irm's Supply Decision

​ ut how each firm within an industry determines

This section talks a​bo
its output.

The number of firms in the industry and their size are considered:

i. ​ii​.
F​ixed i​ n the SR V
​ ariable i​ n the LR

Marginal Revenue (​ MR): the additional r​ evenue r​ eceived from se​lling

one added unit E
​ ach firm in a perfect competition i​s a p
​ rice-taker, t​ he price is
constant and each ​additional unit sold brings i​n the same additional
revenue: MR = Pri​ce M ​ arginal Cost ​(MC): the additiona​l cost ​incurred
from ​producing one add​ed unit F ​ irms maximize thei​r profit (TR-TC)
wh​en MR =​ MC.

Price
MC

Profit = ​$2.6 Billion

1

o ​At Po, the optimal Q to supply is Qe​/​o where MR=MC o

​ W​he​n Q1
i​s supplied, MR > MC, giving up profit (yellow) o ​ ​When Q2 is supplied, MR <
MC, h​aving l​ ​oss ​0 ​I​n fact, ​MC = Supply Curve
D = AR = MR
-​-------​-

Q1
QE
Q2 ​Q​uantity
Cost p
​ er u
​ nit
​ Any ​point below ATCMI​N ​there i​s n
The Average Costs of a single firm: o ​ o​t
profit
​ y sell at a Price < ATC. Called the
because t​he
​ ​Any point
​ ​At point P= ATC, normal profi​ts are made. O
Break-Even Price. O
below A
​ V
​ CMin the firm isn't covering its
average variable co​sts (AVC). Should s
​ hutdown
​ ​The firm's S​R-​supply
because ​is constantly loosing $. S​hutd​own Price. o
is M​C above AVCMIN
A​TC

AVC

Output
Short-Run Industry Supply

This section shows how short-run industry supply is determined.

The following figure r​ epresents the supply curve o

​ f Firm A, Firm B, and the
entire industry in the Short-Run.
So=MC

o
The MC of Firm A is l​ower than th​e MC of Firm B due to t​ he economies of ​scale (​ ​A
is larger than B) The SINDUSTRY, r​ epresents the industry supply curve which
equals the tot​al supply of both Firm A and B added horizontally.
SWANS Toy = SA + Sp = Industry
INDUSTRY

inntity
Industry Dynamics: Entry and Exit of Firms

Normal Profits: profits that producers require to stay in the busines​s. These
profits ​cover opportunity costs also. There if a business owner can
instead make more money working somewhere els​e, he​/​she will not
stay in the bus​iness.

Supply and Demand

o
The demand curve for the entire industry is not fixed at ​one price as
the demand curve for each firm is
The industry as a whole is not a pric​e taker, only each fi​rm in the industry is a
price taker.
Demand

Supply
o
Sur​pl​us
PRICE
Equilibrium

Short​age

0
10
60
20 ​300*​4​0 50
QUANTITY

• Supernormal Profits: a​re all profits above normal profits

--
-
Profit
​ A​v​ erage Total C​ost (ATC) = PK ​O ​Profit Per Unit = Pe -
At Qe ​O ​Market Price = Pe O
PK ​o ​Total (supernormal) profit = Area “Profi​t​" which
is compu​ted as fo​ll​ows: (BH) ​= Qe (Pe - PK) ​o ​W​hen Price > A
​ T
​ C, supernormal
profits arise.

infity

Free Entry & Exit: firms will enter the industry when supernormal ​profits e ​ xist.
When more firms enter th​e industry, t​ he supply curve ​sh​ifts to the right a
​ nd the
equilibriu​m pric​e then falls down.

How far does the price fall? How many newcomers for the profitable industry? ​o
New firms will keep entering the industry and pushing
the price downwards until supernormal profits are ​go​n​e. Thus, the price will fall to
the ATCMIN T​ hen, the LR industry equilibrium price equals the m ​ inimum point of a
firm's ATC curve. At this point, ​only normal profits exist and there is no incentive for
OF
firms to enter or exit. ​o ​W​hen firms cannot ​cover their ATC in the LR, they will
shutdown. As firms exit the industry, the supply curve s​ hifts to the left and the price
hence goes up.
Quantity

Long-​Run I​ndustry Supply

Some firms w​ill not be able to survive in the LR because:

i.
Some firms are making supernormal p
​ rofits; new firms will enter the industry; p
​ rice
goes down to ATCmin of those firms that are operating with the lowest cost ​plant
size. ​Firms that do not operate at this lowest cost will be forced to exit the industry o​ r
to adjust to the cost size to survive.

iii.
Price,

cos​t​ and
Short-run ​average t​ otal cost
revenue
M​arginal
6.4444

Long-run ​average total cost

...
...

When demand goes up, P goes up, supernormal profits arise,

​ Rs
new firms enter t​he industry, the S ​ upply curve shifts to the right,
prices go back d​ own. When demand does down, prices go
down, losses ​arise, firms exist the industry, and the SR supply
curve shifts to the left; prices go back up. ​Therefore, this free
entry and exit will lead to a l​ ong-run industry equilibrium price equal
to the minimum point of a firm's ATC curve. F ​ ​or long-run P = MC =
ATC, br​eaking even.
.

Marginal ​revenue

V.
MO

Units of output
v​i.

L. Monopoly
This sec​tion regards m​onopolistic industries, and how they behave in
the short-run a
​ nd in the long-run.

M​on​opoli​stic Marketplace I​ t has the following characteristics:

i. O
​ nly one firm: t​ his firm is the only one in the industr​y and therefore
represents the industry. ​ii​. ​No su​bstitut​es​: there are no products
in the market that can be used as
a substitute to a mono​poly's product. i​ ii. ​Barriers​: there are many
barriers to entry of firms

Monopolist: this is ​a c ​ ompany that has a m​onopoly over an

industry. A monopo​l​ist is a ​price s
​ etter​/​maker​- not a price taker.
Price Maker: the mo​nopolist can set the price it wants to sell its
product at.
.

Reasons for the C​ontinu​ous Existence of Monopolies (3)

i.
Economies of Scale ​(Natural Monopolies): one firm in the market is
large ​compared to all other competitors. ​Its larger scale all​ows it to
produce at ​lower ATC due to economies of scale. In this case, it
Generalities (II​):

ped = 1

pad<1

NR=

- M​C = AC=​D

TA

o Since the MR intersects the quantity a

​ xis at a point
halfway to the horizontal intercept of the demand curve, it
must have a slope that is twice the slope of
the demand curve 0 ​ ​Maximum TR is not the same as
maximum profit. O ​ ​At unit elasticity, high​est revenue is
attained. ​o ​When MC = MR, the relative price on t​ he
demand
curve is the solution for maxim​um profit (on its e
​ lastic
segment - to the left, e > 1​)
T

lo

The Demand and Supply Curve of a

Monopolist:
this matter.com

o ​Profit Maximizing Output (optimal Q

​ ​) is at QE
when MR = MC ​o ​Profit Maximizing Price is at PE on Mkt.
​ ​Profit per unit = (PE - PK) Qe ,where Pk is when
Demand o
A​TC = QE
Revenue,
 Cost, Price
Market Price yielding maximum profits.

Price - А
​ ТС
M​onopoly
Profit ​= (P-​AT
​ C) XQ

MR = M​C

Market Demand
CV

A​TC for quantity produced when

MR = MC

Quantity
Quantity S
​ upplied

(1.0)- M
​ ​onopoly in the Long-Run ​In the LR, a monopolist can c ​ hoose to expand as
much as wanted. If Demand increases and the demand curve shifts to the right,
we assume that the m ​ onopolist will be able t​ o expand at a constant return to scale.
Therefore, a mon​opolist's ATC and MC curves are horizontal. By increasing
output, p​ rofit is earned on each additional unit as long as the MR curve is above the long
run MC curve.

hic (Long-Run)
(1.1​) - Monopoly and Inefficiencies ​The demand curve represents the marginal benefit
(MB) as measured by the willingness of buyers to pay ​increasing amounts
mic (short-Rius) S ​ ince the marginal revenue (MR) of the monopolist is low​er t​ ​han
the demand curv​e (MB), monopoly
DWL Mc = bow ​equil​i​br​ium i​s ​not equal to t​he ​ f
​ ree m​ arket e​ quilibrium. A ​ b​ove the MC
(​LR) and below Demand ​curve (MB), the triangle drawn ultimately with Po and P ​ e
represents the Dead Weig​ht Loss (D​W​L). The DWL
Quantity
then fint ​is not about who gets the profit; it's about the fact
Fig. 11.4 Menopoly Inefficiencies t​ hat th​e industry output is so low that society a ​ ​s a whole is
sacrificing the possibility of creating additional surplus (inefficient).
Demand

po
price

(1.2) - Monopoly and Price Discrimination

· ​Price discrimination​: when a firm change​s different prices to different
consumers i​ ​n order to increas​e profit. For it to work:
1. The seller must be able to divide the market
2. Resale must be impossible or impractical
• Price discri​mination may reduce the DWL associat​ed with a monopoly
because the m
​ onopolist can sell a
​ t a free market equ​ili​brium quantity a
​ s l​ ong as
he charges a different price to different consumers. P ​ erfect Price Discriminat​ion​:
​ harges a different price to e
when a firm c ​ v
​ e
​ r​y single buyer o​r ​for every unit s​ old. It
is said perfect beca​use each ​unit is sold at the different prices that people
are willing to pay for.

(1.​3) - Cartels
A cartel is a select group of producers who produce most of a specific ​product on the
market. They co-operatively reduce output to increase profits. Cartels act just like
a monopoly and therefore result in a DWL.
When each firm in the cartel produces at quantity Qm and price PM, each
firm will make a profit p​er unit of PM – Pk. Al​l members of the cartel m ​ ust agree to
res​trict their output to QM or this will not work. S​ ince a DWL exists (lost-value),
each firm faces the incentive to increase o ​ utput at discrimin​atory prices to
increase revenu​e. Firms will stop i​ ncreasing output once they reach market
equi​li​brium (Qd = Qs)

M. Imperfect Competition
Perfect C​ompetition and Pure Monopoly ​ar ​ e t​ w​o o
​ pposite extreme market
structures. In reality, most markets are in between these two extremes and are
imperfectly competitive.

Imperfect Competition Categories (2)

i. ​Monopolistic Competition:
​ . The products are slightly differen​tiated ​C. ​There are
a. There are many firms b
many buyers (+Demand) d ​ . There is free entry/exit of firms e
​ . ​Ability to affect
price bec​ause of mixes

ii.
Oligo​poly:
a. There are a few firms b​ . The products are differentiated but are close substitutes
c​. ​There are some barriers to entry​/​exit of firms

Structure
Firms Amount
Ability to Price
Entry Barriers
Example

Perfect Competition
Very Much
None
None
Vegetable Store
Monopolistic Competition
Many
Little
Little
Thai Express

Oligopoly
Few
Medium
Medium
Rogers
Monopoly
One
Large
Many
Hydro-Quebec
The main reason why there are different market structures in different i​ ​ndustries is
because they have different costs. Basically, the higher t​ he costs i​ n
an industry, the fewest the number of firms. Sometimes, there are
suff​icient companies in the market that are operating at m
​ inimum ATC.
Thus, there i​s no more room or no more demand for a new firm to
enter the industry because all the market is currently
taken​/​satisfied. T
​ he N-Firm Concentration Ratio: the total market
share of the largest N f​ irms in the industry. L
​ ower AT​C: more difficult
for fur​ther competition, so less competitors. (MCP)
•

1​.​ Monopolistic
Competition
In a monopolistic competition, e
​ ach firm faces a
downward-sloping demand curve due ​to brand loyalty.
Monopolistically competitive industrie​s h​a​ v​e d
​ iff​erentiated
products
(Restaurants, hairdressers, bars, clothing
stores)
​ irms can to some extent i​ nfluence the price and
• F
quantity of products sold.

Rules and
Remarks:
AT
C

O Do is the SR demand for each firm O ​ Ro is the

​ M
SR margin​al revenue for each o​ P ​ rofit max:
MR=MC, at Po and Qo o Since Po > ATC,
su​pernormal profits exist o
​ E​rgo, new
 firms enter the industry O ​ ​Hence, Di for
each firm shifts to the left ​o ​Until
supernormal profits vanish in LR o ​ D ​ i is the
long-run d
​ emand for each firm O ​ M ​ R1 is the
long-run M​ R of each firm ​O P ​ rofit max:
MR=MC, at a P1 and Qi o ​ P ​ 1 = ATC, the​refore
supernormal profits are null.

M
R
M
R.

II
.
Oligopoly & Game
Theory
• In an oligopolistic industry, each firm must think about its a
​ ctions and
how
competitors will react. ​Conjecture: whe​n Firm A thinks that Firm B
​ ave a certain strategic r​ eaction to Firm ​A'​ s action
will h
Firms in an ol​ig
​ opoly
actions (2)
a) C
​ ollude​: they all ma​ke an agreement to avoid
competition and work
together to increase profits, by mainly decreasing
quantity supplied to ​increase the price and profits of the
f​irms. This is technically illegal

but it happens all the time. b

​ )
C
​ ompete​: don't agree on anything
and will compete with each other.
 . O​li​gopoli​sts a
​ lways try to guess what t​heir competitor's n
​ ext move will
be moves
are interdependent upon one another of the firm's) ​Basically, a
​ oved based on what ​they think their c
company will plan their m ​ ompetitor will
do when they see it. G​ ame: a situation where a player has to make smart
decisions with or against other ​players.
The ​player​s in the ga​me (i.e. firms) tr​y to maxim​i​ze their own
benefits. ​. Each firm must ​choose a s ​ trate​gy and try to increase
its benefits.
• Strategy: a plan that details how a player will act or move in every p​ossible
situation.
• Nash Eq​uili​brium (NE): when all players reach a susta​i​nable
strategy​/ag​reement.
Once rea​ched, there will no longer be any benefit for any playe​r to
change strategy.
No one has incentive to cheat. ​1 ​Dominant Strategy: is a player's best
strategy no matter what the other firms do.

Duopoly & Cournot Games ​Duopoly is a met

with just two dominant (2) firms.
Output
Firm B's reaction
function Ro
Tirm As

-
Cournot Duopoly Mo​de​l: each firm tries to
maximize its profits based on the
output ​produced by the other f​irm. It is
competitive
​ A is the reaction
not co-operative. ​O R
function o
​ f Firm A; shows how
Firm A will react to a change in Firm B's
output. o
​ R​ p is the r​ eaction function of
Firm B; shows how
 Firm B will react to a change in Firm A'​s
​ ​RA = RB are the two reaction
output. O
functions and ​both
intersect a
​ t point E, the Nash Equilibrium (NE)
o I​ f both fir​ms have the same MC curves,
they will
produce the same outpu​t QAE = QBE at Eq.
​ ​If both firms have different MC
point o
curves, they will
produce different output. The firm with t​ he
lowest ​cost will have a greater market
share.
Firm Ás
reaction
1
1

Qo
Qe
Q
B
E
Firna
B's
Fig. 11.3 Dumpoly firms'
reaction functions

N. International Trade
It takes place when goods or services are exported or imported from one country
to another​. Import ​is to receive​, export ​is to send.
•
Foreign Exchange Rate: the value of one national currency in terms of another
​ t​ wo-way internat​ional trade of products
national currency. I​ ntra-Industry Trade: a
produced w​ ithin the same industry. ​Intra-Firm Trade: a two-way international
trade of products produced within the same firm or corporation. Trade Patterns:
i. S
​ ervice Sector​: domain of the economy which produces
services as opposed to goods. ii. ​Gross Domestic Pro​duct (​ GDP): the m​arket valu​e of
all
goods and services made within a country during a year. ​Trade Issues:
Raw-Material Pri​ces​: les​s-developed c​ountries (LDCs) say that develope​d
​ y ​buyin​g raw materials and primary products at low
countries exploit them b
prices and return
manufactured products for sale at much higher prices. i​ i. ​Agricultural Prote​ction: ​LDCs
also complain that developed
countries subs​idize (give t​he​ m funds) their o ​ wn ​agricultural produc​ers, which allows
them to sell their ​products at a lower ​price than normal, which leads to
consumer​s buy​i​ng less of those products from LDCs. It also f​ orces global prices
down and therefore the rich countries s ​ tay rich and the poor stay poor. ​Products
from LDCs: c​ heap labour in LDCs is causing many f​ irms to shift their production
facilities to LDCs. This is why p​ eople i​ n developed countries comp​lain that their
job​s are
​ f
being t​ hreatened by cheap f​oreign labour. i​ v. ​Globalization: ​interconnectio​n o
economies a​nd ​trade
between countri​es. Poor countries feel that rich countries d
​ ictate the process o​f
global market for their own principle. Expansion of European Union (EU): members
of the EU m
​ ight not be culturally r​ eady to accept a new member such a ​ s
Croatia or Turkey bec​ause the EU also grants freedom of movement to all its
member citizens on top of freedom of ​trade.

vi.
​ ​e ​Tr​ade A​g
Nort​h A​merica​n F​re ​ reement ​(NAFTA): ​some Canadians
f​eel that Canada should not have signed the ​NAFTA due to the
softwood lumber dispute. This dispute ​was due t​o the U.S.
​ s on l​ umber imported f​ rom Canada.
charging t​ a​xe

Problems ​suc​h a ​ s the ​on​e

​ s mentioned a​bo
​ ve force economists to
​ er on ​questions. Re​stricting Asian exports will benefit the local
p​on​d
producers but will hurt the ​l​ocal consumers since they can't buy
cheaper products and vice-versa. In ad​dition, if ​China decides to
close its borders to our export​s, that will hurt our com​panies and
endanger the jobs.

Comparative Advantage

The Law of Comp​arativ​e Adva​ntage​: countries ca​n specialize in

producing goods t​ hat they have low relative costs in and ​export t​ hem
to countries that have a
​ ​Comparative Advantage arises when the
higher relative cost. .
opportu​nity cost (OC) of producing a
product to country A is lower than the OC of producing the same
product to B. ​Opportunity Cost: ​the relative cost of producing
different goods. ​The Law of Absolute Advant​age​: if A uses fewer
inputs than B to produce a good
or service, then A has an a​bsolute advantage in the product of this
go​od/s​ervice.
• Labour is the only input to production, t​ here are constant returns to
scale, and
goods are sold at established cost. ​In fact, one country is better at
making a product, than another country. If what A ​ gives up for making 1
c​omputer (x) is less t​ han what B gives up for making 1 computer, than
A should focus on computers, and B on the other good​/​service,
since it gives up more of (y) to produce 1 computer. ​Consump​tion
Possibility Frontier (​ CPF): displa​ys the different combinations of two
good and​/​or ser​vices that a certain economy can consume.

soybeans

Indiana's PPE

Consumption frontier with trade

w
www

Oregon's PPF

10
timber

Figure ​1​7.3
Data
Wheat ​Lumber
Cost (W/L)
Canada
(10)
Hours
(30) Ho​ur​s
(1​0​0/300$CA
N)
United
States
 (8) Hours
(15) Hours
(80/150$U
S)

Find Comparative Advantage (​ if any) with endowment o​f

400 hours.

CANAD
A
Produce 40 units of wheat, or 13.33 units of
lumber. ​40 units of wheat = 13.33 units of
lumber

40​W ​=
13.33L

A) 1W ​=
13.33/4​0
1W =
0.33L

B) 40​/​13.33 =
1L
3​W =
1L

Therefore, Canada​'s Opportunity cost of

producing:
​ unit of wheat = 0.33 units of
- 1
​ unit of lumber = 3 units
​ 1
lumber -
of w​heat

UNITED-S​TA ​ TES ​- Produce 50 un​its of wheat, or

26.66 units of lumber. ​- ​50 u
​ nits of wheat =
26.66 units of lumber
 50W =
26.66L

C) 1W =
26​.​66/50
1W =
0.53L

D) 5​0/26.​66 =
1L
1.86W =
1L

Therefore, United-States' Opportunity cost of

producing:
- 1​ unit of wheat = 0.53 units of
lumber -​ 1​ unit of lumber = 1.86
uni​ts of wheat
Critical Observations:

Ciwa.
​ anada's OC of p​roducing wheat (0.33) is less
O C
than t​hat of U.S. (0.53), mirroring that C
​ anada has a comparative advantage in
producing
​ anada's OC of producing lumber (3) is more
wheat. ​o C
​ as a ​comparative advantage in
than that of U.S. (1.86), mirroring that U.S. h
producing lumber.
PPF ​0 ​In effect, U.S. should specialized exclusively in

l​umber, while Canada should specialize ​uniquely in producing w

​ heat and trade
lumber
13.33 f​ or ​ ​If so, the U.S. will produce 26.66 units of lumber and
wheat, vice-versa o
Canada will produce 40
units of wheat (when spe​cialization applies) Both Canada's CPF and U.S.' CPF
tilt ou​twards since due to the specialization ​and trade terms they can now
consume more than they can produce on their ​own.
2
.

Who Truly Gain From Trade?

Consumers g ​ enerally gain​/​lose from international trade because: 1​ ) Gain:

bu​yers can buy goods at a lower price (as a result of increase comp​etition) 2 ​ )
Gain: ​consumers get a wider variety of goods available 3 ​ ) Lose: Canadians have
to p​ay high lo​cal price 4
​ ) Lose: U.S. pro​ducers because Canadia​ns buy
less U.S. products 5​ ) Gain: Canadian producers because Canadians buy
more national products

Local produc​ers who aren't c​ apable of compe​ting on an international level w​i​ll most
likely lose, because huge foreign firms can flood the local market with the s
​ ame
product an​d therefore push price and margins down ​Overall, the
economy gains if those gain would compensate those who lose. However, this is
rarely the case​.

Protectionis​m ​It arises when a government enforces econom​ic policies that

make imports more difficult. T
​ his usuall​y takes place when the governme​nt
thinks that its local produc​ers are not c​ apab​l​e of competing
properly​/​ef​ ficiently on an international level ​and that they will e
​ ventually be
driven out of the market if no solution comes into play.

Quota
It is a legal limitation on the quantity of import o ​ ne orders Non-T​ari​ff
Barrier S ​ pecific restricted product content or Standards (limits and tests)
Tariff ​It​ is a tax imposed on imports.

Price of c
​ hocolate ​($ per t​ onnes)
Supply (​ domestic)

Pw+tariff
-
-
-
-
-
-
-
-
-

Pw
-
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Supply (world) + tariff

Supply (world)

Demand Q
​ 1 ​ 4 Q2
​ Q3 Q
Quantity of chocolate (000s tonnes)
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Before the Tariff: O

​ D is t​he domestic Demand curve O​ S​ is the domestic
Suppl​y curve O
​ P​ is the world price of the product o
​ A​ t price P, there will
be a
​ domestic quant​ity supply Qs and domestic quantity
demande​d Qdi. The gap between Qs and Qd is filled by imports. This is
fre​e t​ rade e
​ quilibrium.
After the Tariff: O
​ ​Pr is the new price tha​t consumers w​ill pay o
​ ​As the price
increases t​o Pt, domestic quantity supplied in​creases fr​om Qs to Ost,
and domestic quantity demanded decreases fro​m Qd to QDt. ​o ​Consumer
​ overnment tax
Surplus (CS) g​oes down by areas ​A, B, C, and D. ​o G
revenue goes up by area B. o ​ P​ roducer Surplus (PS - domestic) goes
​ et loss to the domestic economy equals the
u​p by area D. ​o N
areas A and C.