Microeconomics
A tax of ARS 90 per unit is paid two-thirds by buyers when demand is inelastic, and one-third when it is very elastic. Who bears a tax is not decided by the law, but by the elasticities.
01The production function
The production function relates the maximum quantity that can be produced to the quantities of factors employed. In the short run some factor is fixed —the plant, the machines— and adding labor increases output less and less: this is the law of diminishing returns. The marginal product, what the last worker contributes, may first grow and then falls; when the marginal product is below the average, the average falls. In the long run all factors are variable, and as the scale increases there may be economies of scale —the average cost falls, as in semiconductor manufacturing— or diseconomies. The resulting costs were covered in costs.
02Supply, demand and equilibrium
Demand relates the price to the quantity that buyers want to purchase: it falls as the price rises. Supply relates the price to the quantity that sellers want to sell: it rises with the price. Where they cross is the equilibrium. The elasticity measures how much the quantity responds to the price:
A per-unit tax separates the price paid by buyers from the one received by sellers. The quantity falls, the government collects revenue, and a surplus that nobody gains is lost: the deadweight loss. How the burden is shared depends on the elasticities: the side of the market that can escape the least pays more.
Demand P = a − bQ (blue) and supply P = 100 + Q (green); with the tax, supply shifts upward (orange). The violet rectangle is the tax revenue and the red triangle, the deadweight loss.
03Types of market
| Market | Sellers | Product | Power over price |
|---|---|---|---|
| Perfect competition | Many | Identical | None: the market sets the price |
| Monopolistic competition | Many | Differentiated | Little, thanks to the brand or the design |
| Oligopoly | Few | Identical or differentiated | Large, but each depends on what the others do |
| Monopoly | One | No close substitutes | Maximum, limited by demand and regulation |
The semiconductor industry, with enormous investments per plant, tends toward oligopoly; common passive components come close to competition. In all cases the firm maximizes its profit by producing where marginal revenue equals marginal cost; in perfect competition marginal revenue is the price.
04The decisions of the agents
The consumer chooses, given income and prices —the budget constraint—, the combination of goods that gives the highest utility: spending so that the last peso yields the same in each good. The firm decides how much to produce and with what combination of factors, seeking the lowest cost for each level of output. The government intervenes with taxes, subsidies, price ceilings or floors and regulation of markets with dominant power; each intervention changes the incentives of the other agents.
05In the laboratory
Measure how many boards are assembled in an hour with one, two, three and four students sharing a single soldering iron, and calculate the marginal product.
With the prices of a component at different distributors and the quantities from the discount lists, estimate the elasticity.
Classify the markets for microcontrollers, resistors, phones and board fabrication services.
06Common mistakes
- Confusing a change in quantity demanded with a change in demand. The first is a movement along the curve; the second, a shift.
- Believing that the tax is paid by whoever remits it. The burden is shared according to the elasticities.
- Identifying the slope with the elasticity. On a straight line the slope is constant, but the elasticity changes at every point.
- Thinking that diminishing returns appear from the first worker. They appear when the fixed factor begins to limit.
07Self-assessment
What is the equilibrium with P = 1000 − 2Q and P = 100 + Q?
Q = 300 and P = 400.
With a tax of ARS 90, how much do buyers pay and how much do sellers receive?
Buyers pay ARS 460 and sellers receive ARS 370; 270 units are sold.
How much does the government collect and how much efficiency is lost?
It collects ARS 24,300 and the deadweight loss is ARS 1350.
Where does a profit-maximizing firm produce?
Where marginal revenue equals marginal cost.
08Further reading
- N. Gregory Mankiw. Principles of Economics. Cengage. (Spanish edition: “Principios de economía”.) Supply, demand, elasticity and tax incidence.
- Robert S. Pindyck and Daniel L. Rubinfeld. Microeconomics. Pearson. (Spanish edition: “Microeconomía”.) Production, costs and market structures in greater depth.
- Hal R. Varian. Intermediate Microeconomics: A Modern Approach. W. W. Norton. (Spanish edition: “Microeconomía intermedia: un enfoque actual”, Antoni Bosch.) Consumer and firm theory with mathematical tools.