Final Exam Econ (I love you babyyyyy) Flashcards
Perfect competition
many firms, identical products, price takers,
Perfect competition
P = MC
Monopoly
one firm, price maker
Monopoly
P > MC
Two extreme forms of market structures
Perfect competition & Monopoly
in between the extremes - Imperfect competition
Oligopoly & Monopolistic competition
Oligopoly
only a few sellers offer similar or identical products.
Monopolistic competition
many firms sell similar but not identical products.
Oligopoly Concentration ratio
Measure a market’s domination by a small number of firms
The percentage of total output in the market supplied by the four largest firms
Less than 50% for most industries
Greater than 90% in: aircraft manufacturing, tobacco, passenger car rentals, and express delivery services
Monopolistic Competition Characteristics
Numerous firms competing over customers
Product differentiation
Not price takers; D curve slopes downward
Free entry and exit
Zero economic profit in the long run
Monopolistic Examples
Books, video games, restaurants, piano lessons, cookies, clothing
Four types of market structure
Monopoly- one firm
oligopoly- few firm
Monopolistic Competition- many firms, differentiated products
Perfect Competition- many firms, identical products
Short Run Equilibrium
Profit maximization in the short run for the monopolistically competitive firm:
-Produce quantity where MR=MC
-Price is on the demand curve
-If P>ATC: profit
-If P<ATC: loss
-Similar to monopoly
Short run equilibrium example
-To maximize profit, firm produces Q where MR=MC
Long Run equilibrium
If monopolistically competitive firms are making profit in short run:
-new firms: incentive to enter market
-increase number of products
-reduces demand faced by each firm, demand curve shifts left, price falls
-each firms profit declines to zero
If losses in the short run:
-Some firms exit the market, remaining firms enjoy higher demand and prices
Long run equilibrium
Entry and exit until P=ATC and profit=0
Monopolistic Vs. Perfect Competition
-Excess capacity: quantity is not at minimum ATC (it is on the downward-sloping portion of ATC)
-Markup over marginal cost: P > MC
Perfect Competition
-Quantity: at minimum ATC (efficient scale)
-P = MC
Monopolistically Competitive markets
-Do not have all the desirable welfare properties of perfectly competitive markets
Sources of inefficiency
-Markup of price over marginal cost
-Too much or too little entry (number of firms in the market)
Product-variety externality
Business-stealing externality
Markup, P>MC
-Market quantity < socially efficient quantity, Deadweight loss of monopoly pricing
The product-variety externality
-Consumers get extra surplus from the introduction of new products
The business-stealing externality
-Losses incurred by existing firms when new firms enter market
Incentive to advertise
-When firms sell differentiated products and charge prices above marginal cost
-Advertise to attract more buyers
Advertising spending
-Highly differentiated goods: 10-20% of revenue
-Industrial products: little advertising
-Homogenous products: no advertising
Critique of Advertising 1
-Is psychological rather than informational
-Creates a desire that otherwise might not exist
The defense of advertising
-It provides useful information to buyers
-Informed customers make better choices
-Advertising promotes competition, reduces market power
Case Studies Advertising
-Eyeglasses: more expensive in states that prohibited advertising
-Liquor: about 20% cheaper after advertising was allowed
Advertising as a signal of Quality
-Even if contains little apparent information
-The real information offered is a signal
-The willingness to spend large amount of money is a signal about -the quality of the product
Content of advertising = irrelevant
Brand names
-In many markets, brand name products coexist with generic ones.
-Brand names spend more on advertising and charge higher prices than generic substitutes
-As with advertising, there is disagreement about the economics of brand names…
Critics of brand names
-Products are not differentiated
-Irrationality: consumers are willing to pay more for brand names
Defenders of brand names
-Consumers get information about quality
-Firms have an incentive to maintain high quality to protect the reputation of their brand name
Concentration ratio
-Measure a market’s domination by a small number of firms
-The percentage of total output in the market supplied by the four largest firms
-Less than 50% for most industries
Oligopoly
-Market structure in which only a few sellers offer similar or identical products
Strategic behavior in oligopoly
-A firm’s decisions about P or Q can affect other firms and cause them to react
-The firm will consider these reactions when making decisions
Game Theory
-the study of how people behave in strategic situations
Oligopolists
-Make the most profit when they cooperate and together act like one big monopolist
-Strong incentives hinder a group of firms from maintaining the cooperative outcome
Duopoly
-A market with only two sellers
-Simplest type of oligopoly
Collusion
-Agreement among firms in a market about quantities to produce or prices to charge
-One possible duopoly outcome
Cartel
-A group of firms acting in unison
-Once a cartel is formed, the market is in effect served by a monopoly
Collusion vs. Self-Interest
-Both firms would be better off if both stick to the collusion agreement (form a cartel)
Lesson
-It is difficult for oligopoly firms to form cartels and honor their agreements
Nash Equilibrium
-Economic actors interacting with one another, each choose their best strategy
-Given the strategies that all the other actors have chosen
When firms in an oligopoly individually choose production to maximize profit
-Produce Q: greater than monopoly Q, less than competitive Q
-The price: is less than the monopoly P, greater than the competitive P = MC
Increasing output has two effects on a firm’s profits
-Output effect: because P > MC, increasing output raises profits
-Price effect: raising production increases total quantity sold, which reduces price and reduces profit on all units sold
As the number of sellers in an oligopoly increases:
-The price effect becomes smaller
-The oligopoly looks more and more like a competitive market
-The price approaches marginal cost
-The market quantity approaches socially efficient quantity
The Prisoners’ Dilemma
-Particular “game” between two captured prisoners
-Illustrates why cooperation is difficult to maintain even when it is mutually beneficial
Dominant strategy
-Strategy that is best for a player in a game
-Regardless of the strategies chosen by the other players
When oligopolies form a cartel
-Hoping to reach the monopoly outcome, they become players in a prisoners’ dilemma
-The monopoly outcome is jointly rational, but each firm has an incentive to cheat: self-interest makes it hard to maintain the cooperative outcome with low production, high prices, and monopoly profits
Examples of prisoners’ dilemma
-Two firms spend millions on TV ads to steal business from each other.
-Each firm’s ad cancels out the effects of the other, and both firms’ profits fall by the cost of the ads
Non-cooperative oligopoly equilibrium
-May be bad for oligopolists
Prevents them from achieving monopoly profits
-May be bad for society
Examples: Arms race game, Common resource game
-May be good for society
Quantity and price – closer to optimal level
Why people sometimes cooperate
-Two strategies may lead to cooperation
-When the game is repeated many times, cooperation may be possible
Public policy toward oligopolies
-Governments can sometimes improve market outcomes
-Policymakers:
Try to induce firms in an oligopoly to compete rather than cooperate
Move the allocation of resources closer to the social optimum
Sherman Antitrust Act, 1890
-Elevated agreements among oligopolists from an unenforceable contract to a criminal conspiracy
The Clayton Act, 1914
-Further strengthened the antitrust laws
Antitrust laws are used to prevent:
-Mergers that would give a firm excessive market power
-Oligopolists from acting together in ways that would make their markets less competitive
Resale Price Maintenance
-A manufacturer imposes lower limits on the prices retailers can charge
-Often opposed because it appears to reduce competition at the retail level
-Yet, any market power the manufacturer has is at the wholesale level
-No gains from restricting competition at the retail level
Goal of Resale Price Maintenance
-Preventing discount retailers from free-riding on the services provided by full-service retailers
Predatory Pricing
-A firm cuts prices to prevent entry or drive a competitor out of the market
-Illegal under antitrust laws
-Economists debate whether predatory pricing should concern antitrust policymakers
Bundling
-A manufacturer bundles two products together and sells them for one price
-Firms may use bundling for price discrimination
-Bundling cannot change market power
Factors of production
-Inputs used to produce goods and services: labor, land, capital
-Prices and quantities are determined by supply and demand in factor markets
Derived demand for a factor of production
-A firm’s demand for a factor of production is derived from its decision to supply a good in another market.
All markets are competitive
-The typical firm is a price taker
In the market for the good it produces
And in the labor market (factors of production)
Firms care only about maximizing profits
-Each firm’s supply of output and demand for inputs are derived from this goal
Cost of hiring another worker
-The wage=the price of labor
Benefit of hiring another worker
-Produce and sell more output, increasing revenue.
-The size of this benefit depends on the production function: the relationship between the quantity of inputs used to make a good and the quantity of output of that good
Marginal product of labor (MPL)
MPL= change in Q/change in Labor
The increase in the amount of output from an additional unit of labor
Diminishing marginal product
-The marginal product of an input declines as the quantity of the input increases
Value of the marginal product
-Problem:
Cost of hiring another worker is measure in dollars
-Benefit of hiring another worker (MPL) is measured in units of output
-Convert MPL to dollars
Value of the MPL
VMPL= P x MPL
The marginal product of an input times the price of output
VMPL and labor demand
-To maximize profits, hire workers up to the point where VMPL=W
-VMPL curve us the labor demand curve
Changes un the output price, P
-An increase in P increases VMPL, which is the demand curve
Technological change (affects MPL)
-Can increase the MPL, increasing the demand for labor
Marginal Cost
-cost of producing an additional unit of output
-MC = ∆TC/∆Q, where TC = total cost
-In general: MC = W / MPL
Competitive firm’s rule for demanding labor
-P × MPL = W
-Divide both sides by MPL: P = W / MPL
-Substitute MC = W / MPL from previous slide: P = MC
Trade-off between work and leisure
-The more time you spend working, the less time you have for leisure
Wage
-Is the opportunity cost of leisure
-When wage increases, the opportunity cost of enjoying leisure goes up
Labor supply curve
An increase in W is an increase in the opportunity cost of leisure.
Causes that shift Labor-supply curve
-change in preferences
-Change in alternatives opportunities
-immigration
Equilibrium in the labor market
-Wage: adjusts to balance S and D for labor.
-The wage always equals the value of the marginal product of labor (VMPL).
With land and capital, must distinguish between:
-Purchase price: the price a person pays to own that factor indefinitely
-Rental price: the price a person pays to use that factor for a limited period of time
How the rental price of land is determined
-Firms increase the quantity of land to rent until the value of the marginal product (VMP) of land equals the land’s rental price
How the rental price of capital is determined
-Firms increase the quantity of capital to rent until the value of the marginal product (VMP) of capital equals the capital’s rental price.
Buying a unit of capital or land
-Yields a stream of rental income
The rental income in any period
-Equals the value of the marginal product (VMP)
Equilibrium purchase price of a factor
Depends on both the current VMP and the VMP expected to prevail in future periods
Factors of production are used together
-In a way that makes each factor’s productivity dependent on the quantities of the other factors
Example: an increase in the quantity of capital
Neoclassical theory of income distribution
-Theory developed in this chapter
-Factor prices are determined by supply and demand
-Each factor is paid the value of its marginal product
-Used by most economists as a starting point for understanding the distribution of income
Compensating differential
-Difference in wages that arises to offset nonmonetary characteristics of different jobs (unpleasantness, difficulty, safety
Human capital
-Accumulation of investments in people, such as education and on-the-job training
-Affects productivity, labor demand, wages
Increase in international trade
-Domestic demand for skilled labor rises
-domestic demand for unskilled labor falls
Skill-biased technological change
-raise the demand for skilled workers who can use the new machines
-reduce the demand for the unskilled workers whose jobs are replaced by industrial robots
Greater natural ability or effort
-Often command higher pay
-These traits increase workers’ marginal products, making them more valuable to the firm
Wages are also affected by chance
-E.g., new discoveries no one could have predicted make some occupations obsolete, increase demand in others
Ability, effort, and chance
-Are difficult to measure
-It is hard to quantify their effects on wages
-They are probably important, though, since easily measurable characteristics (education, age, etc.) account for less than half of the variation in wages in our economy
Firms use education level to sort between high ability and low ability workers
-The difficulty of earning a college degree demonstrates to prospective employers that college graduates are highly capable
-Yet, the education itself has no impact on productivity or skills
Policy implication
-Increasing general educational attainment would not affect wages
Superstars in their field
-Great public appeal and astronomical incomes
Superstars arise in markets where
-Every customer in the market wants to enjoy the services supplied by the best producers.
-The services are produced with a technology that makes it possible for the best producers to supply every customer at low cost.
Monopsony
-A market that has only one buyer
Labor market dominated by single employer
-The employer: large influence on the going wage
Growing problem: non-complete clauses
-Bar employees from leaving to work for a competitor
-Protect employers’ trade secrets
-Curb competition in the labor market, keeping wages below their equilibrium level
Minimum wage laws
-raise wages above the level they would earn in an unregulated labor market
Market power of labor unions
-Union: worker association that bargains with employers over wages and working conditions
Theory of efficiency wages
-Efficiency wages: above-equilibrium wages paid by firms to increase worker productivity
-Firms may pay higher wages to reduce turnover, increase worker effort, or attract higher-quality job applicants.
Effects of above-equilibrium wages
-Surplus of labor (unemployment)
Discrimination
-Offering of different opportunities to similar individuals who differ only by
Race, ethnicity, gender, age, religion, sexual orientation, or other personal characteristics
Measuring labor-market discrimination
Median Earnings:
Black man: 24% less than white man
Black woman: 16% less than white woman; 10% less than median Black man
White woman: 19% less than white man
Differences in educational attainment
-2019, men aged 25 and older
36% of the white population had a college degree
26% of the black population
Quality of public schools
Historically: public schools in predominantly black areas have been of lower quality than public schools in predominantly white areas
Human Capital
-Women are more likely to interrupt their careers to raise children
Women have less on-the-job experience than men
Population aged 25 to 44
24% of women are out of the labor force
10% of men
Compensating differentials
-Men and women do not always choose the same type of work
-Different working conditions
Competitive market economies
-Natural antidote to employer discrimination: profit motive
Discrimination by Customers
Discrimination by customers may result in discriminatory wage differentials.
Discrimination by Governments
-Some government policies mandate discriminatory practices.
-Such policies prevent the market from correcting discriminatory wage differentials
Wage differentials in competitive markets
-Workers are paid a wage that equals the value of their marginal products
The profit motive can correct
-Discrimination by employers
-But not discrimination by customers or discriminatory policies of governments
Statistical Discrimination
-Arises because an irrelevant but observable personal characteristic is correlated with a relevant but unobservable attribute
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Market Economics
-Usually achieve greater prosperity
-Prosperity is not shared equally
Quintile Ratio
Income share of the highest quintile divided by income share of the lowest quintile
Poverty Rate
Percentage of the population whose family income falls below an absolute level
Poverty Line
Set by the government, three times the cost of adequate diet
Poverty is correlated with race
Blacks and hispanics are more than twice as likely to live in poverty as whites
Standard measure of income distribution and poverty
-Based on families’ pre tax incomes
-Based on monetary incomes
Economic life cycle
-Regular pattern of income variation over a person’s life
-Young adults have low incomes, incomes tend to rise and peak at age 50
-causes inequality in the distribution of annual income
Permanent Income
A person’s normal income
Transitory changes
A family’s ability to buy goods and services depends largely on its permanent income
Economic Mobility
The movement of people among income classes
Variation of income
Many of those below the poverty line are there only temporarily
Political Philosophy
Political philosophies of redistributing income
-utilitarianism
-liberal contractarianism
-Libertarianism
Utility
Measure of happiness or satisfaction
Utilitarianism
Government should choose policies to maximize the total utility of everyone in society
Diminishing marginal utility
As a person’s income rises, the extra well-being derived from an additional dollar of income falls
Liberal contractarianism
The government should choose policies deemed just, as evaluated by impartial observers behind a veil of ignorance
Maximin criterion
Government should aim to maximize the well-being of the worst off person in society
Social insurance
Government policy aimed at protecting people against the risk of adverse events
Libertarianism
Government should punish crimes and enforce voluntary agreements but not redistribute income
Families with low incomes…
Experience: Homelessness, drug dependence, teenage pregnancy, illiteracy, unemployment
-Victims of crimes and commit crimes
Minimum wage laws
Arguments for:
-Helps the working poor without any cost to government
-Little impact on employment (inelastic demand)
Arguments against:
-Elastic labor demand in long run(high unemployment)
-Teens from middle income families will benefit most instead of low income adults
Welfare
Government programs that supplement the incomes of the needy
Welfare critics vs. proponents
Critics:
-Create perverse incentives
-Encourage families to break up
-Encourage birth out of wedlock
Proponents:
-Being poor and a single mother is a difficult existence at best
-Inflation-adjusted welfare benefits as single parent families increased
Negative income tax
-Tax system that collects revenue from high income households and gives subsidies to low income households
-Provides universal basic income
Earned income tax credit
-Applies only to the working poor
-Does not discourage people from working
In-Kind transfers
-Goods or services provided to the needy
-Examples: Soup kitchens, homeless shelters
Budget Constraint
Trade-offs:
-Buying more of one good leaves less income to buy other goods
-Working more hours means more income and more consumption but less leisure
Budget constraint 2
The limit on the consumption bundles that a consumer can afford
Indifference curve
Curve that shows consumption bundles that give the consumer the same level of satisfaction
MRS, marginal rate of substitution
-Rate at which a consumer is willing to trade one good for another on an indifference curve
-Slope of the indifference curve
Four properties of indifference curves
1) Higher indifference curves are preferred to lower ones
2) Indifference curves slope downward
3) Indifference curves do not cross
4) Indifference curves are bowed inward
Shape of an indifference curve
Reveals the consumer’s willingness to trade one good for the other
Perfect substitutes
Two goods with straight-line indifference curves (constant MRS)
Perfect complements
Two goods with right angle indifference curves
Consumer’s optimal choices
-The best possible combination of the two goods
-The combination on the highest possible indifference curve on or below the budget constraint
MRS=Relative price
-The best bundle of the two goods that the consumer can afford
-The point on the budget constraint that touches the highest possible indifference curve
Normal Good
A good for which an increase in income raises the quantity demanded
Inferior good
A good for which an increase in income reduces the quantity demanded
Change in income
-Shifts the budget constraint
-Move on a different indifference curve
The demand curve
-Reflects the consumption decisions
-Shows the quantity demanded of a good for any given price
-Summary of the optimal decisions that arise from the budget constraint and indifference curves
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