Exam 2 study guide

Firms and markets

You should understand…

…how demand curves are derived from consumer willingness to pay
…the difference between fixed costs and variable costs
…how to calculate total cost, total revenue, average fixed costs, average variable costs, marginal cost, marginal revenue, and maximum profit
…that maximum profit occurs where marginal revenue is equal to marginal cost (\(MR = MC\))
…that socially optimal quantity occurs when the demand is equal to the marginal cost (\(\text{demand} = MC\))
…how to calculate elasticity of demand (\(-\frac{\Delta Q}{\Delta P} \times \frac{P}{Q}\))
…what elasticity measures and why it is important in public policy and administration
…how a single demand curve can have an overall elasticity and different elasticities at each point
…economies of scale, diseconomies of scale, economies of agglomeration, network effects, and the difference between short-run and long-run costs
…that market equilibria (i.e. optimal price and quantity) occur at the intersection of supply and demand curves
…how government-imposed price floors and price ceilings distort market-clearing equilibria
…and be able to identify the differences between changes in supply/demand and changes in quantity supplied/demanded
…what consumer and producer surplus represent
…the relationship between elasticity of supply and/or demand and the size of consumer and producer surplus
…how taxes impose deadweight loss on society
…how the burden of taxes depends on the elasticity of supply and/or demand
…why governments tax and the philosophical and ethical principles behind who should bear the burden of taxes
…the difference between price-taking and price-making
…how firms try to gain market power, including monopolies, branding, cost controls, regulation, and switching costs
…why firms try to gain market power
…why firms want to price discriminate
…the consequences of monopolistic production (lower Q and higher P than what would happen under perfect competition; deadweight loss)
…how governments can regulate monopolies
…why natural monopolies exist and how governments can induce them to produce at socially optimal levels
…how firms need to be somewhat anti-competitive and anti-capitalist in order to maximize profits, innovate, and (essentially) be more competitive and capitalist

Guides

Important formulas:

Demand:

\[ P = aQ + b \]
Total cost:

\[ \begin{aligned} TC = TFC + TVC \\[10pt] \text{or a formula using } Q \text{, like} \\[10pt] TC = aQ^2 + b \end{aligned} \]
Average cost:

\[ AC = \frac{TC}{Q} \]
Marginal cost:

\[ \begin{aligned} MC &= \frac{\Delta TC}{\Delta Q} \\[10pt] &\text{or} \\[10pt] MC &= \text{First derivative of TC} \\ &= 2aQ \text{ (if } TC = aQ^2 + b) \end{aligned} \]
Total revenue:

\[ \begin{aligned} TR &= PQ \\[10pt] &\text{or} \\[10pt] TR &= (aQ + b)Q \\ &= aQ^2 + bQ \end{aligned} \]
Average revenue:

\[ AR = \frac{TR}{Q} \]
Marginal revenue:

\[ \begin{aligned} MR &= \frac{\Delta TR}{\Delta Q} \\[10pt] &\text{or} \\[10pt] MR &= \text{First derivative of TR} \\ &= 2aQ + b \text{ (if } TR = aQ^2 + bQ) \end{aligned} \]
Maximum profit:

\[ max(\pi): MC = MR \]
Price elasticity of demand (see this guide of how to get to \(- \frac{\Delta Q}{\Delta P} \times \frac{P}{Q}\)):

\[ \varepsilon = -\frac{\% \text{ change in quantity demand}}{\% \text{ change in price}} = - \frac{\Delta Q}{\Delta P} \times \frac{P}{Q} \]

Important graphs:

Consumer surplus, producer surplus, tax revenues, tax burdens, and deadweight loss (use algebra and geometry to figure out the areas of the triangles (\(\frac{1}{2} \times b \times h\)) and rectangles (\(l \times w\))):

Helpful resources:

Derivatives of Exponential Functions (how to calculate derivatives quickly)
Jason Welker, “Natural Monopoly and the Need for Government Regulation”

Institutions, power, and inequality

You should understand…

…why institutions matter for public administration, policy, and governance
…the strengths and weaknesses of and the and general differences between three main theoretical approaches to institutions: institutions as rational behavior, institutions as constraints, and institutions as temporary equilibria
…the difference between informal and formal institutions
…why informal institutions exert influence over our actions even if they’re not officially codified
…the difference between self-enforcing, self-reinforcing, and self-undermining institutions
…the role of path dependency in the emergence of institutions

Market and government failures

You should understand…

…the difference between private goods, club goods, common pool resources, and public goods (and how they can be classified as (non)rivalrous and (non)excludable)
…what a market failure is
…what a government failure is
…what public goods are and how governments, the private sector, and informal institutions can address them
…what common pool resources (CPRs) are and how governments, the private sector, and informal institutions can address them
…the difference between social and private marginal cost (supply) and marginal benefit (demand)
…what externalities are and how governments, the private sector, and informal institutions can address them
…what Coasian bargaining is, when it is advantageous, and why it sometimes fails
…how cap and trade systems can fix externalities (and when they can’t)
…how Pigouvian taxes can fix externalities (and when they can’t)
…how regulation can fix externalities (and when and why it can’t)
…the difference between income and assets
…why shared national identity and strong horizontal networks of institutions are important for a country’s social and economic wellbeing
…how inequitable public policies lead to decreased public goods provision, unequal institutional access, and increased ethnofractionalization
…why slavery and white supremacy have had lasting institutional impacts on the economic system of today and how government policies have contributed to these consequences (specifically in housing and education)