Lectures VII, VIII, IX, X, and XI Flashcards
Functions of the Government
1) To protect – the government maintains a framework of security and order
2) To produce – government sometimes produces products that private markets do not produce at efficient levels
What are the four market failures?
1) A lack of competition
2) Negative and positive externalities
3) Public goods (private markets under-provide public goods)
4) A lack of information
When is there a lack of competition?
1) A monopoly power is present
2) There are anti-competitive practices (such as price fixing, predatory pricing, or merger activity
3) There is a monopsony
Monopoly Power vs. Monopsony Power
1) Monopoly – many buyers, one big seller
2) Monopsony – many sellers, one buyer
Price Fixing
an agreement among competitors to equally change their own prices
Predatory Pricing
when one or more large firms agree to cut prices below costs to drive a small competitor out of business
Merger
an agreement in which two companies join together to form one company
What are the different types of mergers?
1) Horizontal – between companies that are in direct competition with one another
2) Vertical – between companies that are along the same supply chain (ex. car company and tire company)
3) Conglomerate – between companies in unrelated business activities
How does the government intervene when there is a lack of competition?
1) By enforcing anti-trust policies
2) Regulating industries
What are the two types of externalities?
1) External cost – third party is negatively affected by a market transaction (ex. pollution, accidents from drunk driving)
2) External benefit – third party is positively affected by a market transaction (ex. neighbor’s landscaping makes your neighborhood look nicer)
When does the market overprovide and underprovide goods?
1) When a negative externality is present, the market overprovides the good
2) When a positive externality is present, the market underprovides the good
Marginal Social Cost (MSC)
the added cost to society when producing one more of a good or service
Marginal Social Benefit (MSB)
the added benefit to society when consuming one more of a good or service
Socially Optimal Output Level
occurs when the marginal social cost (MSC) is EQUAL to the marginal social benefit (MSB)
How does the government intervene when an externality is present?
1) Insuring private property rights (policies to separate smokers from non-smokers)
2) Taxes (ex. pollution taxes on producers)
3) Subsidies (ex. loans for education)
4) Or doing nothing at all
Public Goods vs. Private Goods vs. Mixed Goods
1) Public good – non-excludable and non-rivalrous (park, street lighting)
2) Private good – excludable and rivalrous (car, slice of pizza)
3) Mixed good – either excludable and non-rivalrous OR non-excludable and rivalrous (healthcare)
Price Elasticity of Demand
a measure that indicates the degree of consumer response to a price change – formula is (percent change in quantity demanded) DIVIDED BY (percent change in price)
When is demand considered elastic?
1) When |elasticity of demand| > 1
2) Quantity demanded changes a lot in response to changes in price (ex. potato chip market)
When is demand considered inelastic?
1) When |elasticity of demand| < 1
2) Quantity demanded does not change much in response to changes in price (ex. cigarette market)
When is demand considered unitary elastic?
when |elasticity of demand| = 1
How is elasticity seen on a graph?
the upper region of a demand curve is elastic and the lower region is inelastic – the point separating the two is unitary elastic
Determinants of Elasticity
1) The availability of substitutes (more substitutes make demand more elastic)
2) Time (the more time buyers have to adjust to price change, the more elastic the demand for that good is)
3) Luxury vs. necessity (luxurious goods are more elastic and necessary goods are more inelastic)
Fundamentals of Individual Choice
1) We make decisions purposefully, acting on “rational self-interest”
2) We face constraints (ex. budget constraints)
3) One good can be substituted for another
4) Consumers must make decisions without perfect information
5) The law of diminishing marginal utility applies
Utility
measure of satisfaction we get from doing something (measured in UTILS)
Facts About Utility
1) Utility is subjective
2) You cannot compare the utility of two people
3) Utility is used to see how one person ranks their consumption choices
What is the primary goal of a firm?
to maximize profit (profit = total revenue - total cost)
Types of Firms
1) Proprietorship – single owner, unlimited liability
2) Partnership – two or more individual owners, unlimited liability
3) Corporation – multiple shareholders, limited liability
Marginal Product (MP)
1) Additional output created as a result of additional input placed into a company (ex. number of additional donuts produced with an added employee)
2) Marginal product typically rises and then falls
How can you increase MP?
through specialization
What are some ways MP decreases?
1) Overcrowded workplace
2) Shirking occurs more as the number of workers increases
Total Fixed Costs (TFC)
business costs that are constant no matter how much of a good is produced (ex. rent)
Total Variable Costs (TVC)
business costs that change depending on how much of a good is produced (ex. raw materials, labor)
Total Costs (TC)
total fixed costs PLUS total variable costs
Marginal Cost (MC)
change in total cost when producing one more unit
LRATC Curve
long run average total cost curve
Characteristics of Perfect Competition
1) All firms sell identical product
2) Consumers are indifferent to different sellers
3) There are many sellers or firms
4) Firms are price-takers (meaning they have very little market power)
5) Free entry and exit
6) Instantaneous entry and exit
7) Complete information
8) Firms maximize profits
Normal Profit
if economic profits are zero – which is okay!
Marginal Revenue
revenue from selling one more unit of the good
Profit Maximizing Condition
To maximize profit, pick output at MR = MC
The Shutdown Rule
Shut down when price is less than the ATC
