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We Love Econs
We Love Econs
We Love Econs
★
Econs uses a lot of graphs, which is actually math in pictures. But going straight to the math
is often clearer, cleaner, and faster to present in essays.
We can plot happiness (H) (y-axis) against units of ice cream (q) (x-axis) to get a curve that
is H
dH d 2H
- Upward sloping: > 0 & getting more gentle: < 0.
dq dq 2
Lets say H is measured in units of money ($). So the profit you get from eating ice cream is
simply your total happiness – cost of the ice cream.
d ( profit ) 1
- To find the maximum profit we differentiate the profit equation: =− −P=0
dq q
1
- Rearranging, P = − which is a downward sloping curve of P against q.
q
This downward sloping curve is your demand curve! No need for cumbersome ‘effective
demand laws’ and such, all we did was to play around with some numbers!
★The Supply Curve
We do the same to obtain the supply curve – differentiate the firm’s profit = revenue – cost.
- Revenue = Money from selling ice-cream = qP
- Cost = q2 because of the Law of Diminishing Marginal Returns (gets increasingly
expensive to produce the next unit of output).
- Profit = qP - q2
d ( profit )
Doing the differentiation again we get = P − 2q = 0 .
dq
Rearranging, 2q = P the upward sloping supply curve.
To find the resultant price and quantity we find the intersection between the two curves.
BUT,
The supply curve we derived applies only for perfect competition, where P doesn’t change
when q changes. This is ok because for DD & SS we assume perfect competition. What
happens if there is a monopoly?
Facts:
d (revenue) d (cos t )
- = Marginal Revenue (MR) - = Marginal Cost (MC)
dq dq
Since Profit = Revenue – Cost,
d ( profit ) d (revenue) d (cos t )
= - = MR – MC = 0
dq dq dq
Therefore we get MR = MC.
There! No need lengthy explanations of “the cost of next unit of output must equate to the
revenue…”.
In Summary:
★Consumer
- Profit = Happiness – Cost = q − qP .
1
- Differentiating, P = − Downward sloping Demand Curve.
q
★Perfectly Competitive Firm
- Profit = Revenue – Cost = qP - q2
- Differentiating, 2q = P Upward sloping Supply Curve.
★Monopoly
- Profit = Revenue – Cost
d ( profit ) d (revenue) d (cos t )
- = - MR = MC
dq dq dq
★Elasticity
% ∆Q
We know that the elasticity of demand = where ∆ means ‘change in’.
% ∆P
∆Q
× 100%
Q ∆Q P
- Rewriting, we get = .
∆P Q ∆P
× 100%
P
∆Q P
- Rearranging we get . .
∆P Q
In summary,
∆Q P 1 P
Elasticity of demand = . = . .
∆P Q slope Q
★Multiplier Effect (National Income Determination)
- Like demand & supply, the national equilibrium occurs when:
National demand = National supply
In other words, AE = Y
1 1
is our multiplier! If G, I, or X increases by 1 unit, Y rises by .
1 − b(1 − t ) + m 1 − b(1 − t ) + m
Furthermore,
0 < t < 1, 0 < 1-t < 1
0 < b < 1 0 < b(1-t) < 1 0<m<1
0 < 1 – b(1-t) < 1
There is thus no need for tedious tables and explanations of the multiplier in your exams,
just present these steps:
Y = AE = C + G + I + X – M
Y = a + G + I + X + b(1-t)Y – mY
1
Y= (a + G + I + X )
1 − b(1 − t ) + m
1
is the multiplier and is greater than 1.
1 − b(1 − t ) + m