Concepts Description
Demand and Supply Analysis
Elasticity Measure the ratio of the % change in one variable to a % of change in another
Own‐price elasticity: % change in demand ‐ to ‐ % change in its own price
∆
% ∆
% ∆ ∆
Cross‐price elasticity: % change in demand ‐ to ‐ % change in related good price
∆
% ′ ∆
% ∆ ′ ∆ ′
′
Income elasticity: % change in demand ‐ to ‐ % change in income
∆
% ∆
% ∆ ∆
|Own‐price elasticity| > 1 → demand is elas c
|Own‐price elasticity| < 1 → demand is inelas c
Cross‐price elasticity > 0 → related good is a subs tute (could replace each other)
Cross‐price elasticity < 0 → related good is a complement (go with each other, e.g.: car and petrol)
Income elasticity < 0 → Inferior good
Income elasticity > 0 → normal good
Substitution effect, and Substitution effect: When price of a good X decreases, there is a shift in consumption toward good X, and vice versa
income effect Income effect: When price of a good X decreases, there is a shift in consumption toward more or less good X
3 possible outcome:
Substitution effect: Positive + Income effect: Positive → Consump on of Good X increase
Substitution effect: Positive + Income effect: Negative, but smaller than substitution effect → Consump on of Good X increase
Substitution effect: Positive + Income effect: Negative, but larger than substitution effect → Consump on of Good X decrease
Normal good vs. inferior good Normal good: income effect ‐ positive ; income elasticity ‐ positive (increase in income → increase in demand)
Inferior good: income effect ‐ negative ; income elasticity ‐ negative (increase in income → decrease in demand)
Giffen good: negative income effect > substitution effect
Veblen good: Increase in price → increae in demand (e.g.: Rolex, Gucci)
Marginal returns Marginal returns: additional output produced by using one more productive input, given other input constant
As productive quantities increase, they will reach a point of diminishing marginal returns (↑input, ↓marginal returns)
Shutdown and Breakeven Point Perfect competition:
‐ Breakeven point: price = average total cost
‐ Average total cost > Price > Average variable cost → continue to operate in the short run, but shut down in the long run
‐ Average variable cost > Price → Shut down
Imperfect competition:
‐ Breakeven point: Total revenue = total cost
‐ Total cost > Total revenue > Total variable cost → con nue to operate in the short run, but shut down in the long run
Total variable cost > Total revenue → Shut down
Economies and Diseconomies of 1. Larger scale + Long run Average total cost decrease → Economies of scale
Scale 2. Lowest point on Long run Average total cost → Minimum efficient scale
3. Beyond the minimum efficient scale → Larger scale + Long run Average total cost increase
, Concepts Description
Firm Structure ‐ Market Structure
Characteristics of market structure Perfect Monopolistic Oligopoly Monopoly
competition competition
Number of sellers Many firms Many firms Few firms Single firms
Barriers to entry Very low Low High Very high
Nature of substitute products Very good substitutes Good substitutes, but Very good substitutes, or No good substitutes
differentiated differentiated
Nature of competition
Price only Price, marketing, and features Price, marketing, and Advertising
features
Pricing power Some
None Some to significant Significant
Perfect competition Short‐run equilibrium Long‐run equilibrium
In equilibrium:
Marginal revenue = Marginal cost = Price
Perfectly elastic demand curve
Could not earn economic profit in the long‐run, since very low barrier to entry → attract new firms if there is an economic profit
Monopolistic competition Short‐run equilibrium Long‐run equilibrium
In equilibrium:
Marginal revenue = Marginal cost < Price
Highy elastic demand curve (elasticity > 1)
Could not earn economic profit in the long‐run, since very low barrier to entry → attract new firms if there is any economic profit
Oligopoly 4 models:
1. Kinked demand curve:
if a firm increase its price
→ compe tors do not increase price
if a firm decrease price
→ compe tors decrease price
2. Cournot duopoly model: Consider oligopoly with 2 firms, both have identical and constant marginal cost of production. Using the quantity supplied of the other firm in previous
periods, a firm determines its demand curve, marginal revenue curve and profit maximisation quantity. These quantities will change each period until they are equal → stable
equilibrium.
3. Nash equilibrium: applying prisoner's dilemma
Nash equilibrium = both firms cheat on the collusion,
even though the best outcome is to both honor the agreement
4. Stackelberg dominant firm model: a dominant firm with large market share, greater scale an lower cost structure.
↓ price →↓demand of compe tor firms
Dominant firm sets the price as MR of dominant firm = MC of dominant firm (< price)
Competitors takes that as market price
Demand and Supply Analysis
Elasticity Measure the ratio of the % change in one variable to a % of change in another
Own‐price elasticity: % change in demand ‐ to ‐ % change in its own price
∆
% ∆
% ∆ ∆
Cross‐price elasticity: % change in demand ‐ to ‐ % change in related good price
∆
% ′ ∆
% ∆ ′ ∆ ′
′
Income elasticity: % change in demand ‐ to ‐ % change in income
∆
% ∆
% ∆ ∆
|Own‐price elasticity| > 1 → demand is elas c
|Own‐price elasticity| < 1 → demand is inelas c
Cross‐price elasticity > 0 → related good is a subs tute (could replace each other)
Cross‐price elasticity < 0 → related good is a complement (go with each other, e.g.: car and petrol)
Income elasticity < 0 → Inferior good
Income elasticity > 0 → normal good
Substitution effect, and Substitution effect: When price of a good X decreases, there is a shift in consumption toward good X, and vice versa
income effect Income effect: When price of a good X decreases, there is a shift in consumption toward more or less good X
3 possible outcome:
Substitution effect: Positive + Income effect: Positive → Consump on of Good X increase
Substitution effect: Positive + Income effect: Negative, but smaller than substitution effect → Consump on of Good X increase
Substitution effect: Positive + Income effect: Negative, but larger than substitution effect → Consump on of Good X decrease
Normal good vs. inferior good Normal good: income effect ‐ positive ; income elasticity ‐ positive (increase in income → increase in demand)
Inferior good: income effect ‐ negative ; income elasticity ‐ negative (increase in income → decrease in demand)
Giffen good: negative income effect > substitution effect
Veblen good: Increase in price → increae in demand (e.g.: Rolex, Gucci)
Marginal returns Marginal returns: additional output produced by using one more productive input, given other input constant
As productive quantities increase, they will reach a point of diminishing marginal returns (↑input, ↓marginal returns)
Shutdown and Breakeven Point Perfect competition:
‐ Breakeven point: price = average total cost
‐ Average total cost > Price > Average variable cost → continue to operate in the short run, but shut down in the long run
‐ Average variable cost > Price → Shut down
Imperfect competition:
‐ Breakeven point: Total revenue = total cost
‐ Total cost > Total revenue > Total variable cost → con nue to operate in the short run, but shut down in the long run
Total variable cost > Total revenue → Shut down
Economies and Diseconomies of 1. Larger scale + Long run Average total cost decrease → Economies of scale
Scale 2. Lowest point on Long run Average total cost → Minimum efficient scale
3. Beyond the minimum efficient scale → Larger scale + Long run Average total cost increase
, Concepts Description
Firm Structure ‐ Market Structure
Characteristics of market structure Perfect Monopolistic Oligopoly Monopoly
competition competition
Number of sellers Many firms Many firms Few firms Single firms
Barriers to entry Very low Low High Very high
Nature of substitute products Very good substitutes Good substitutes, but Very good substitutes, or No good substitutes
differentiated differentiated
Nature of competition
Price only Price, marketing, and features Price, marketing, and Advertising
features
Pricing power Some
None Some to significant Significant
Perfect competition Short‐run equilibrium Long‐run equilibrium
In equilibrium:
Marginal revenue = Marginal cost = Price
Perfectly elastic demand curve
Could not earn economic profit in the long‐run, since very low barrier to entry → attract new firms if there is an economic profit
Monopolistic competition Short‐run equilibrium Long‐run equilibrium
In equilibrium:
Marginal revenue = Marginal cost < Price
Highy elastic demand curve (elasticity > 1)
Could not earn economic profit in the long‐run, since very low barrier to entry → attract new firms if there is any economic profit
Oligopoly 4 models:
1. Kinked demand curve:
if a firm increase its price
→ compe tors do not increase price
if a firm decrease price
→ compe tors decrease price
2. Cournot duopoly model: Consider oligopoly with 2 firms, both have identical and constant marginal cost of production. Using the quantity supplied of the other firm in previous
periods, a firm determines its demand curve, marginal revenue curve and profit maximisation quantity. These quantities will change each period until they are equal → stable
equilibrium.
3. Nash equilibrium: applying prisoner's dilemma
Nash equilibrium = both firms cheat on the collusion,
even though the best outcome is to both honor the agreement
4. Stackelberg dominant firm model: a dominant firm with large market share, greater scale an lower cost structure.
↓ price →↓demand of compe tor firms
Dominant firm sets the price as MR of dominant firm = MC of dominant firm (< price)
Competitors takes that as market price
