• <b>Federal Trade Commission</b>

Principles of Microeconomics


Production Possibilities Frontier


The prouction possibilities frontier is an graphical illustration of quantities of production of various goods that an economy can produce. Because soceity's resources are not limitless, there exist trade-offs. When an economy is fully utilizing its resources, in order to produce more of one type of good, there must be a reduction in the production of other good(s). When this happens, resources such as labor, land, and/or capital that were used in the production of one type of good are re-assigned to the production of another good.


Supply and Demand


The supply and demand model predicts what quantities of goods will be sold in the market, and what prices these goods will be sold for. Prices and quantities are determined in an equilibrium where the choices for purchases by consumers at given prices (demand) are consistent with the choices of production by businesses at given prices (supply). In these Pencasts, we discuss what other factors besides price that can affect the demand and/or supply of goods and services. The model can be used to predict how prices and quantities of production change in response to changes in the economy.


Elasticity


The concept of elasticity is an important one in economics, both for businesses and policymakers. The basic idea behind the concept of elasticity is simple: it is a measure of how responsive economic agents are to changes in economic conditions. That is, instead of simply determining whether prices and quantities rise or fall in response to an environmental change, the concept of elasticity is focused on determining “how much” prices and quantities rise or fall when economic conditions change. The Pencasts for this topic illustrate the following: how to compute various elasticities of demand and supply, how the elasticity of demand is related to the amount of revenue firms received (equivalently the amount spent by consumers), and how the elasticities of demand and supply impact changes in equilibrium.


Government Intervention


The government’s basic function in a market economy is the provision of property rights. Without property rights, a market economy cannot function properly. But governments sometimes intervene for other reasons. In these Pencasts, we explore the effects of price controls and per-unit taxes. Price controls, although not very common today, are used when government officials deem free-market prices to be unfair. Per-unit taxes are often used as a way to raise revenue, which can also be used as an incentive mechanism to deter behaviors deemed undesirable (e.g., smoking, pollution). The Pencasts for this topic illustrate the following: the effects of binding and nonbinding price floors, the effects of binding and nonbinding price ceilings, the effects of prices controls in the short versus long run, how per-unit taxes affect market outcomes, how the relative elasticities of supply and demand determine tax incidence, and how to identify the tax revenue and deadweight loss generated by a per-unit tax.


Market Efficiency


The concept of market efficiency is an important tool used in the field of welfare economics, which studies whether markets and/or government interventions improve the well-being of society. Put differently, the goals are to determine whether the free-market price is the “right” price and whether the free-market quantity is the “right” quantity. That is, we want to determine whether the equilibrium price of a good is too high, too low or just right. Likewise, we want to know whether the equilibrium quantity is too high, too low or just right. In order to determine whether the price and quantity for a good are optimal, we must use a measure of market efficiency. The measure of efficiency is based on the sum of consumer and producer surpluses, which is simply referred to as total surplus. The Pecasts for this topic include the following: how consumer surplus is defined, identified graphically and computed; how producer surplus is defined, identified graphically and computed; how price changes affect consumer and producer surplus; how total surplus is defined and identified graphically; and the conclusions from such a welfare analysis are qualified based on the assumptions that are made.


Costs of Taxation


This topic applies the tools of welfare analysis to the subject of per-unit taxes. When a per-unit tax is implemented, the definition of total surplus becomes the sum of consumer surplus, producer surplus and tax revenue. But per-unit taxes prevents some mutually-beneficial trades from taking place, which results in a deadweight loss. The Pencasts for this topic examining the following: how per-unit taxes affect market efficiency, the relationship between elasticity and deadweight loss, the relationship between the size of a per-unit tax and the amount of tax revenue the government receives, and the relationship between the size of a per-unit tax and the deadweight loss that per-unit taxes cause.


Costs of Production


This topic covers the costs of production. In particular, the relationship between costs and production are covered, along with details about production and cost functions. While a detailed analysis of the costs of production is not necessary an exciting endeavor, it is imperative to understand these costs in order to understand different market structures (e.g., the number of firms in the market). The Pencasts for this topic cover the following more specific areas of production and costs: short-run production, different short-run cost measures, how the production function and total cost curve are mirror images of one another, the relationship between different short-run cost curves, how per-unit taxes affect a representative firm’s short-run cost curves, how a lump-sum tax affects a representative firm’s short-run cost curves, and how to construct a firm’s long-run cost curve.


Competitive Markets


This topic focuses on the behavior of firms in competitive markets. It is the first topic of three that fall under the classification of industrial organization, which focuses, at least in part, on how market structure affects firm’s pricing and output decisions. While there may not be many perfectly competitive markets, it is still useful to begin our analysis with the perfectly competitive model, as it provides a benchmark with which comparisons to other market structures can be made. The Pencasts for this topic include the following: a discussion of the necessary conditions for a market to be characterized by perfect competition, how an individual firm in a competitive market maximizes profit, how a competitive firm determines whether to operate or to shut down in the short run, how to construct the short-run market supply curve, what determines entry and exit in the long run, how to identify short- and long-run equilibria, and how to identify changes in short- and long-run equilibria when market conditions change.


Monopoly


This topic focuses on the opposite extreme from perfect competition, which is monopoly. In a perfectly competitive market, there are so many firms that no one firm can influence the market price. By contrast, there is only one seller in a monopolistic market; therefore, that firm, together with the market demand curve, determines the market price. The Pencasts on this topic include a comparison of the a monopoly firm to a competitive firm, determining the deadweight loss caused by a monopoly, identifying a monopoly’s profit, how the elasticity of demand determines how much market power a monopoly has, how price discrimination improves market outcomes for everyone (consumers and the monopoly), and how to apply optimal price regulation to a natural monopoly.


Oligopoly


An oligopoly is a market structure in which only a few sellers offer similar or identical products. The study of oligopoly highlights the importance of strategic interactions. Competitive and monopoly firms do not worry about competitors. A firm in a competitive market only worries about their costs and the market price, and a monopoly has no competitors. However, firms in oligopolies must be aware of what prices their competitors are charging and how much they are producing. If they are not aware, they can lose, while their competitors gain. Game theory is a useful tool to apply to strategic interactions. The Pencasts for this topic cover the application of game theory using a payoff matrix.


Externalities


An externality is the uncompensated impact of one person’s actions on the well-being of a bystander. Pollution is a classic example of a negative externality, which imposes external costs on society. Education is a classic example of a positive externality, which imposes external benefits on society. In the Pecasts for this topic, negative and positive externalities will be covered as well as a comparison of regulation to corrective taxes and a comparison of corrective taxes to tradeable permits.