final Flashcards
externality
side effect on third party whose interest aren’t fully taken into account
- lead to market failure
negative externality
side effects that harms bystanders
- ex: car exhaust harm bystander who breathe it in
positive externality
side effect that benefit bystanders
- ex: you decide to get covid vaccine
(that decisions protect you and your classmate
private interest
cost n benefits you personally incur
- if ur choices dont affect others, private interest correspond w society
society interest
all cost n benefits, where they accrue to you or others
marginal private cost
seller extra cost to produce 1 more
(supply curve)
marginal external cost
extra cost imposed on bystanders from producing 1 more
external cost
cost seller impose on bystanders
marginal social cost
all marginal cost
marginal social cost = marginal private cost + marginal external cost
marginal private benefits
Buyer extra benefit from buying 1 more
(demand curve)
marginal external benefits
extra benefits enjoyed by bystanders from 1 more
marginal social benefits
all marginal benefits
marginal social benefits = marginal private benefits + marginal external benefits
socially optimal quantity
quantity that’s most efficient for society as a whole
rational rule for society
produce 1 more as long as marginal social benefit > marginal social cost
steps to analyze externalities
- predict equilibrium quantity to forecast what you think will happen
- asses what externalities are involves
- find socially optimal quantity
- compare equilibrium w socially optimal quantity
SOLUTION 1
solve externality problems
private bargaining & coase theorem
coase theorem
if bargain is costless & property rights are established, then external problems is solved by private bargain
SOLUTION 2
solve externality problems
corrective taxes & subsidies
corrective taxes
design to induce ppl to take account of negative externalities they cause
- set corrective taxes = to marginal external cost
-fix negative externalities
corrective subsidy
design to induce people to take account of positive externalities
- set subsidy = to marginal external benefit
SOLUTION 3
solve externality problems
cap & trade
- CAP (quota) negative externalities using quantity regulation
- increase efficiency by allowing TRADES
cap and trade proposal
Company have a cap on pollution permit (how much pollution they can produce). If they use little pollution permit, they can trade the extra permit to other company
SOLUTION 4
solve externality problems
laws, rules, and regulations
SOLUTION 5
solve externality problems
government support public goods
SOLUTION 6
solve externality problems
assign ownership rights for common resources problem
common resources
goods that are rival but nonexcludable
- lead to tragedy of the commons
- ex: fish, water, air
tragedy of the commons
tendency to overconsume a common resources
- assigning ownership rights SOLVE it
nonexcludable
goods that cant exclude a person from using it
non rival
can be enjoyed or used by many people at the same time
- free-rider problem
free-ride problem
enjoy benefits of a good w/out bearing cost
rival good
can only be used by 1 person
- no free rider problem
public good
nonrival good that is nonexcludable
- free rider problem
- market underproduce public goods
club goods
excludable, but nonrival good
- goods that u have to pay for
You can be prevented from using it but you using it does not reduce the availability for another person
Ex: Spotify, toll road, etc
labor demand (employers)
wage ↓ demand for labor ↑
(owner want to hire more worker when its low wage)
marginal product of labor
extra production occur from hiring 1 extra worker
marginal cost
(Marginal product of labor)
↑ from hiring 1 more
marginal benefit
(Marginal product of labor)
extra revenue from the addition of 1 more
marginal revenue product
measure marginal revenue from hiring 1 more
marginal revenue product = marginal product of labor x price
rational rule for employers
hire 1 more if marginal revenue product > wage
labor demand shift 1
changes in demand for your product
derived demand
Demand for a good increase because demand for a related good increase
Ex: demand for wood and steel increase (input) because of the increase demand for house
labor demand shift 2
changes in price of physical capital
scale effect
Price of capital good↓ which mean business can produce more quantity which↑ demand for workers bcuz they require more workers
- scale effect dominate = labor n capital are compliments
( increase quantity require more workers to sells those)
substitution effect
(Labor demand)
machine price ↓ demand for worker ↓
- substitute effect dominate = labor n capital are substitute
(machine price ↓ they want less worker cuz machine take over)
labor demand shift 3
better management & productivity gains
- improve management & technology ↑ productivity
(meaning worker produce more) - labor demand
↑ worker marginal product = ↑
labor demand
labor demand shift 4
nonwage benefit, subsidies, & taxes
- these r extra cost
labor supply
wage increase, more ppl want to work
rational rules for workers
work 1 more hr if wage > marginal benefit of another hr of leisure
Substitution effect
( sub vs income effect)
describe how people respond to relative price change
↑ wage ↑ incentive to work
individual labor supply
allocating ur time between labor n leisure
- opportunity cost of working is the things you can do when ur not workings
income effect
↑ wage (raise income) ↓ work hours
income & substitution effect offset
at high wage,
substitution effect ↑ work hours
income effect ↓ work hours
backward-bending labor supply curve
low wage = substitution effect dominates ‘
high wage = income effect dominate
price elasticity of labor supply
measures worker’s responsiveness to wage
market labor supply curve
high wage = more willing to work
Reason why it’s upward slopping
1. new people enter workforce
↑ wage convince ppl to work
- existing workers, work more hours
↑ wage ↑ work hrs - ppl switch jobs
↑ job A wage ↑ demand for job A (leave job B)
Labor supply shift 1
change wage in other occupations
ex: hair and skin care
↑ skin care wage ↓ worker supplied for hair
Labor supply shift 2
change in # of potential workers
↑ population ↑ worker supplied
Labor supply shift 3
change benefits of not working
↑ marginal benefit of not working ↓ worker supplied
Labor supply shift 4
nonwage benefits, subsidies, and income tax
physical capital
machines, tools, structures
market power
ability to raise price w out losing sales to competitor
perfect competition
multiple business sells identical goods
LEAST MARKET POWER
- many competitor
- same products
↑ price = lose revenue
↓ price = gain revenue
imperfect competition
market w few competitors and limited competition
monopoly
only seller in the market
MOST MARKET POWER
- no competitor
- unique product
↑ ↓ price = no change
oligopoly
market dominate by large seller w little competitor
MIDDLE MARKET POWER
- few competitors
↑ price = small Q ↓
↓ price = small Q ↑
monopolistic competition
market w many business competing, each selling different products
MIDDLE MARKET POWER
- different products
- ex: jeans, many competitor but different products cuz mom jeans crop jeans rip jeans…..
↑ price = small Q ↓
↓ price = small Q ↑
Imperfect competition insight 2
market power allow seller to pursue individual pricing
Imperfect competition insight 1
more competitor = less market power
Imperfect competition insight 3
successful product differentiation = more market power
Imperfect competition insight 4
imperfect competition gives buyers bargaining power
Imperfect competition insight 5
best choice depends on actions other business make
firm’s demand curve
show how buyers demand quantity varies as price change
marginal revenue
addition to total revenue from selling 1 more
MR = output effect - discount effect
output effect
price of extra item you sold
discount effect
price cut you’ll have to offer
△P x Q
rational rule for sellers
sells 1 more if MR > MC
Market power problem (MP) 1
market power lead to worse outcome
- seller exploit MP
MP lead to higher price
- MP price > competitive price
MP lead to inefficiently smaller quantity
- MP Q < competitive quantity
MP yield larger economic profit
- firm w MP earn large profit margin
- profit margin = MP price - average per unit cost
Market power problem 2
↑ competition = better outcome
- competition lead to lower price
Public Policy to Restrain MP 1
policies to ensure competition thrives
- being a monopoly = legal
- monopolizing = illegal
(Prevent competition and new competition)
competition policy
(antitrust policy)
law n regulation designed to ensure market remain in competition
collusion
agreement by rivals to limit competition w each other
anti-collusion
prevent business from agreeing to not compete
Public Policy to Restrain MP 2
minimize MP harm
- price ceiling limit MP abuse
natural monopoly
single business can service the whole market at lower cost than multiple business
accounting profit
= total revenue - explicit financial cost
- explicit financial cost: money that leave the business
- rent
- wage
- raw material
forgone wages
(accounting profit opportunity cost)
if you dont launch this business, how much will you earn pursuing a different path?
forgone interest
(accounting profit opportunity cost)
if you dont invest, how much annual interest will you earn investing elsewhere
economic profit
determine if its worth to start a business
= total revenue - explicit financial cost - implicit OP cost
implicit OP cost
= forgone wage + interest
ex: 60000 + (5% x 1000)
average revenue
revenue per unit
total revenue
——————–
quantity
- firms demand curve = average revenue curve
average cost
cost per unit
quantity
quantity =
fixed variable
cost cost
——— + ———-
Q Q
spreading fixed cost
↑ production from low level ↓ average cost
- # produce small quantity ——> gradually produce large Q↓fixed cost ↓average cost
cuz fixed cost is “spread” over more units meaning smaller cost per unit
rising variable cost
↑ variable cost due to emerging inefficiencies = ↑ average cost
profit margin
measure profit per unit sold
= price - avg cost
(average rev)
short run
productivity capacity & number or type of competitor face is fixed
long run
new supplier may enter or expand into ur market n existing supplier can shrink market
rational rule for entry
enter a market if you expect to earn a positive economic profit
positive economic profit = price > avg cost
what does ENTRY do to demand and profit?
entry ↓ demand n profit
- new competitor will enter profitable markets
- # new competitors make market less profitablemake u lose MP
what does EXIT do to demand and profit?
exit ↑ demand n profit
- rival leaves = more MP
rational rule for exist
exit if you expect to earn a negative economic profit
negative economic profit = price < avg cost
free entry
when there are no factors making it particularly difficult or costly for business to enter or exist
- push price down to avg cost
free exit
ensures ur market won’t remain unprofitable in long-run
- push price up to avg cost
barriers to entry
obstacle making difficult for new firm to enter market
Barrier 1
demand side strategic
( customer lock in to prevent them from leaving)
switch cost
(Barrier 1)
impediment that makes it costly for customers to switch to another sellers
network effect
(Barrier 1)
develop network make more people buy the product
product becomes more useful
Barrier 2
supply-side strategies
(prevent rival entry by gaining cost advantage that newcomers cant replicate)
learning by doing
(Barrier 2)
increase production → lower cost → gain market share
Barrier 3
regulatory strategies
(gov policies to prevent entry
ex: patents, regulation, license…
Barrier 4
deterrence strategies
(scare off rivals)
overcome barriers to entry
- demand-side strategies -combat customer lock in
- supply-side strategies overcome cost disadvantages
- regulatory strategies secure gov help
- overcome deterrence strategies to fight big guys
price discrimination
selling same product at different prices
- set price close/below MB
- goals: reservation price
reservation price
max price customer will pay for a product
perfect price discrimination
charging each customer their reservation price
2 profit boosting objective
- charge highest price for each sale
- make every possible sale where customers MB > ur MC
efficiency of price discrimination
solve underproduction problem
- price discrimination ↑ quantity sold
selective discount
- no price discrimination: charge everyone the same price so discount applies to ALL
- price discrimination: select you want to give discount to
price discrimination feasible (easy)
- ur business have MP
- u can prevent resale
- u can target right prices to right customers
group pricing
price discrimination by charging different prices to different groups
setting group price
- set price separately for each group
a. what quantity should you produce
- produce quantity where MR=MC
b. what price to charge
- look up to demand curve - set different prices for different groups
segment market
Dividing the market into group
CRITERIA
1. segment market into groups who demand differs
2. target group discount based on verifiable characteristics
3. base group discount on difficult-to-change characteristic
hurdle method
offer lower price only to customers who are willing to overcome some hurdle
ex:
- alternative versions
- fluctuating price
- haggle (bargain)
- coupons
- worse service
- imperfect goods
- quantity discount
- bundling
quantity discount
per-unit price is lower when buying larger Q
bundling
selling different goods together as a package
