Managerial Economics Flashcards
Change in Qd (formula)
% Change in Qd = ((Change in Qd)/(Initial Qd)) x 100
Change = Delta
initial Qd = quanity demanded at the initial (original) price
Note: Q1 is often used to denote the original quantity and Q2 the new quantity.
Price elasticity of demand (formula)
PED = (% Change in Qd) / (% Change in P)
Qd = demand P = Price
demand curve
The demand curve shows that the demand is higher when the price is lower and the demand is lower when the price is higher
law of demand
there is a negative relationship between price and quantity demanded
what ist Demand?
is the quantity of a good or service that buyers are willing and able to buy at a given price, in a given market, in a given period of time.
PED is equal to:
PED = (Delta Qd / Q1) x (P1 / Delta P)
What is it called when the PED coefficient is greater than one
price elastic
What is it called when the PED coefficient is smaller than one
price inelastic
What are the macroeconomic goals?
- sustainable economic growth • price stability (low inflation) • full employment (low unemployment) • balance of payments equilibrium • sustainable national debt (including low budget deficits) • more equitable distribution of income
Factors that Affect Price Elasticity of Demand
(1) the availability
of close substitutes,
(2) the proportion of income spent on the product/service,
(3) whether
the product/service is a luxury or necessity,
(4) time
examples of inelastic products
- petrol
- salt
- milk
When does a rise in price dont effect the amount of buyings?
When the proportion of income spent on a good is small
examples of luxury goods
- vacation
examples of necessity goods
- water
- bread
- mild
Is the demand for alcohol, cigarettes , and drugs tends are elastic or inelastic?
Inelastic, because there are linked to habit or addiction use.
income elasticity of demand (formula)
YED = (% Change in Demand) / (% Change in Income)
Income elasticity of demand (YED)
measures the percentage change in demand divided by the percentage change in income.
Is the elasticity coefficient for a normal good positive or nagativ?
always positive
Is demand and income related?
Yes, there are positive related.
superior goods
are luxury items that have an income elasticity of demand greater than one
What kind of goods have a negative income of elasticity of demand
inferior goods
Cross price elasticity of demand (XED)
measures how much the demand for one product/ service changes when the price of another product/ service changes.
cross price elasticity of demand (formula)
XED(AB) = (% Change in Demand for Good A) / (% Change in Price of Good B)
What does it mean when the cross price elasticity of demand coefficient is positive or neagtive number?
negative: Then the two goods are substitutes
positive: then the two goods are complementary
What is regression analysis and what does it need?
(1) statistical procedure
(2) relies on using appropriate, relevant, and good data
What do you have to avoid when you collect data from a survey?
you have to avoid sample bias, for instant:
- answers according to the surveying organization wants to hear
- answers to purposely influence the decisions of an organization
What is importent when you want to properly estimate the demand of a good?
- identify all the factors that could influence the demand
What is cross-sectional data?
information obtained
about variables for a specific time period
What is times series data?
represents information about a variable over a period of time
What is the t-test significance acceptable level for estimating demand?
.05 -> 5 %
That means that you can be 95 percent confident that the results
obtained from a sample are representative of the statistical population that you are studying
degrees of freedom (formula)
n - (k + 1)
n = number of observations k = independent variables
The coefficient of
determination (R^2)
indicates the proportion of variation in the dependent variable that is explained by the explanatory (independent) variables.
What is a ‘Coefficient of Determination’ ?
…is a measure used in statistical analysis that assesses how well a model explains and predicts future outcomes.
What are the certain limitations and potential
problems by regression analysis?
(1) misspecification of the equation
(2) multicollinearity
(3) the identification problem
(4) problems with random errors
Misspecification of equation
(1) incorrectly specifying the form
of the regression equation
(2) equation be inadequate - not include important predictors
Multicollinearity
- variables are related to each
other
Identification problem
equilibrium price and quantity in a market are simultaneously determined by demand and supply
-> it difficult to identify the separate and simultaneous effects of demand
and supply
Problems with the random errors
- Every regression equation has a random term
- independent of everything else
(1) Heteroscedasticity - the variance is not constant and changes over time
(2) Serial correlation - random error is affected in one period by its value in the
previous period
What does elasticity measures?
responsiveness
What does it mean when the elasticity of demand coefficient is positive or negative?
(1) positive - Normal and superior goods
(2) negative - Inferior goods
What do Cross price
elasticity of demand measures?
he responsiveness of demand for one good due to a change in the price of another good
What does it mean when the Cross price
elasticity of demand coefficient is positive or negative?
(1) positive - the two goods are substitutes
(2) negative - the goods are complements
Is it possible to estimate demand?
Yes, you can use regression analysis.
What does the regression analysis do to estimate the demand?
It estimates the separate influence of independent (predictor) variables on a dependent variable
Supply
is the quantity of a good or service that producers or sellers are willing and able to offer for sale at different prices over a given period of time in a given market.
Law of supply
states that, ceteris paribus, an increase in price results in an increase in quantity supplied.
What is the supply curve?
graphical representation of the relationship between price and quantity supplied
price rises (supply curve)
extension of supply
price falls (supply curve)
contraction of supply
How is the supply curve build?
x-y-axis and line segments
x-axis - Quantity
y-axis - Price (€)
line segments - supply curve
What are Examples of Non-Price Determinants of Supply?
- weather
- costs of production
- expectations of the future
- prices of other products supplied by the seller
- number of sellers in
the market
Whats happen with the supply curve when the amount of products increase or decrease?
increase - the supply curve shifting to the right
decrease - the supply curve shifting to the left
It is important to understand that the supply curve shifts because the amount offered for sale at different prices changes, as reflected in a new supply schedule
Price elasticity of supply
(PES) measures the percentage change in quantity supplied arising from a given percentage change in price
Price elasticity of supply (formula)
PES = (% Change in Qs) / (% Change in P)
percentage change in quantity supplied (formula)
% Change in Qs = ((Delta in Qs) / (Initial Qs)) x 100
Delta Qs = Q2 - Q1
Note: Q1 is often used to denote the original quantity and Q2 the new quantity.
percentage change in price (formula)
% Change in P = ((Delta in P) / (Initial P)) x 100
Note: P1 is often used to denote the original price and P2 the new price.
PES (Formula)
PES = % Delta in Qs / % Delta in P = (Delta in Qs / Initial Qs) / (Delta in P / Initial P) = (Delta Qs / Q1) x (P1 / Delta P)
When is the supply inelastic?
When the percentage change in quantity
supplied is smaller than the percentage change in price
What is the most important determinant of price elasticity of supply?
time
short-term, if prices rise, firms may not be able to increase (farming)
long-term, supply becomes more price elastic
What is the law of demand?
The law of demand states that there is a negative relationship between price and quantity demanded.
- Price (P) falls, quantity demanded (Qd) rises.
- Price rises, the quantity demanded falls.
What factors determine the demand for a product or service?
- price
- tastes and preferences
- income expectations
- prices of related goods,
- number of buyers
What are the four main determinants of price elasticity of demand?
(1) the availability of close substitutes,
(2) the proportion of income spent on the product/service,
(3) whether the product/service is a luxury or necessity,
(4) time
equilibrium price
Pe = P(Qd = Qs)
What is the name of the point where the demand curve intersect with the supply curve?
equilibrium
x-axis - Quantity
y-axis - Price (€)
demand curve: top-left to down-right
supply curve: down-left to top-right
When does the demand and the price for a good rise?
Its rise when the income of the buyers increase, which led to a higher price
Whats happen with the equilibrium when the demand increases or decreases (ceteris paribus)?
increases - equilibrium price and equilibrium
quantity will both rise
decreases - quilibrium price and equilibrium quantity will both fall
Effect of Changes in Non-Price Determinants of Demand on Market Equilibrium
- Successful advertising
(1) Change in tastes and preferences in favor of good
(2) Increase in income (effect on normal goods)
(3) Increase in the price of substitute goods
(4) Increase in the number of potential buyers
(5) Consumers become more optimistic regarding the future
state of the economy or they expect prices to rise in the future
- > Effect on demand: increases
- > Direction of demand curve shift: shifts to the right
- > Effect on Pe and Qe: rise
Whats happen with the equilibrium when the supply increases or decreases (ceteris paribus)?
increases - equilibrium price will fall and equilibrium
quantity will rise
decreases - quilibrium price will rise and equilibrium quantity will fall
Effect of Changes in Non-Price Determinants of Supply on Market Equilibrium
(1) Favorable weather (mainly for agricultural products)
(2) Decrease in input costs
(3) Advances in technology
(4) Decrease in indirect taxes
(5) Increase in government subsidies
(6) Increase in the number of sellers
(7) Business managers expect prices to fall in the future and want to sell more now
(8) Decrease in the price of other products the firm sells
- >Effect on supply: increases
- >Direction of supply curve shift: shifts to the right
- >Effect on Pe and Qe: rise
When is there a opposing effect on the market price and/or equilibrium quantity?
non-price determinants of demand and supply changing at the same time
Production
is a process during which inputs such as raw materials are transformed into output using other inputs
production function
The production function indicates how much output can be produced within a given time period using a given combination of inputs and level of technology.
short run
The short run is the period of time during which the size or quantity of at least one factor of production cannot be changed.
long run
The long run is the period of time during which the quantity or size of all factor inputs
including capital and land can be increased.
What is the differents between long run and short run?
short run - at least one factor is fixed
long run - there are no fixed factors
Labor productivity
is the averageproduct producedper unit of labor in a given period of time.
TP
Total product
Q_L
Quantity of labor
MP_L
Marginal product
AP_L
Average product
Why do MP_L initially rises by adding more worker to a task and then begin to fall?
It divides the required tasks between the workers and they can specialize (AP_L and MP_L rise)
The declining marginal product that results from adding more and more of a variable
input to a fixed quantity of another input
law of diminishing
marginal returns
states that as more and more units of a variable
input are added to a fixed amount of another input, eventually the marginal product will start to decrease and thus output will begin to rise at a diminishing rate.
How do you plotte a Short Run Total Product Curve?
Stage I) average product of labor rises (MP_L being greater than AP_L)
Stage II) MP_L curve cuts the AP_L curve
Stage III) TP begins to fall as MPL becomes negative
When cuts the MP_L curve the AP_L curve?
AP_L is at its maximum level.
In which case can you use a quadratic
function?
It can be used to represent a situation where there are no increasing returns but rather diminishing returns occur immediately as variable inputs are increased (MPL and APL begin to decrease)
In which stages should a business manager try to engage the capacity planing?
Stage II, because its the most effectively
stage I, they would be underutilizing their fixed inputs
stage III, they would be operating inefficiently in the sense of not being able to utilize further their fixed capacity while employing additional variable inputs
What does experienced increasing returns to scale mean?
output increases proportionately more than its inputs
What does experienced decreasing returns to scale mean?
output increases proportionately less than its inputs
What does experienced constant returns to scale mean?
he percentage increase in output is the same as the percentage increase in all of the inputs
Relevant costs
Relevant costs are the incremental costs (explicit and implicit) of a decision.
Implicit costs
Implicit costs refer to the opportunity cost of resources used.
Opportunity cost
Opportunity cost refer to the benefits foregone of the next best alternative use of a resource.
Sunk costs
Sunk costs are expenses that have already been incurred and cannot be recovered.
cost function
A cost function expresses total cost as a function of a given level of output.
Fixed costs
Fixed costs are costs that remain the same whether output increases or decreases.
Variable costs
Variable costs are costs that vary in relation to output.
profit(s)
Profits are the difference between a firm’s total revenues and total costs.
firm’s total cost
TC
is comprised of all fixed costs and all variable costs
TFC
total fixed cost
TVC
total variable cost
MC
marginal cost is the additional cost of producing one more unit of output.
Marginal cost (formula)
MC = Delta TC / Delta Q = Delta TVC / Delta Q
TC = TFC + TVC
fixed
costs do not change
Average Fixed Cost
AFC = TFC / Q
Average Variable Cost
AVC = TVC / Q
Average Total Cost
ATC = AFC + AVC
Are they fixed costs in the short or in the long run? Why?
short run: there are fixed factors of production and therefore are fixed costs
long run: all factors of production can be varied and therefore there are no fixed costs
Internal economies of scale
Internal economies of scale occur when a firm’s LRAC falls as output
increases
LRAC
long run average cost
diseconomies of scale
diseconomies of scale occur when a firm’s LRAC
rises as output increases.
Internal Economies and Diseconomies of Scale (graph)
x-axis = quantity
y-axis = price
curve - LRAC (long run average cost)
curve decrise - internal economies of scale down to the price minimum
curve incrise - internal diseconomies of scale
What can happen when a firm increases all its inputs and outputs?
(1) commercial economies
(2) financial economies
(3) managerial economies
(4) marketing economies
(5) R&D economies - Research and development
(6) technical economies
commercial economies
economies may arise from discounted prices on bulk purchases of supplies
financial economies
may arise if a large firm is able to obtain a loan at a lower interest rate because it is considered a less risky borrower compared to smaller firms
managerial economies
may arise due to a large firm using specialist managers in different functional areas such as finance, marketing, production, and human resources
marketing economies
may arise due to lower average advertising costs
R&D economies - Research and development
may arise as large firms spread the cost of R&D over a greater level of output
technical economies
may arise from increased specialization and division of labor, or due to the container principle
When does a firm experiences internal diseconomies?
when a firm becomes too big and it experiences managerial diseconomies
of scale
communication and coordination between different departments, divisions, and organizational layers becomes slower and more difficult.
decreased productivity of workers - not being heard or cared for
What are the most popular firm goals?
(1) profit maximization
(2) revenue maximization
(3) sales (output) maximization
(4) profit satisficing
What are the most popular firm goals?
(1) profit maximization
(2) revenue maximization
(3) sales (output) maximization
(4) profit satisficing
What means Marginal revenue?
Marginal revenue is the additional
revenue generated from selling one more unit of output
How long can a firm increase its profit by producing more?
As long as the MR of an additional unit of output is greater than the MC associated with producing and selling that unit
When is equal on the profit maximizing level?
the marginal revenue (MR) of the last unit sold is equal to the marginal cost (MC) of selling that last unit
How long can a firm increase its profit by producing more?
As long as the MR of an additional unit of output is greater than the MC associated with producing and selling that unit
Who assumes that a firm aim to maximize profits?
Neoclassical economics
What do Neoclassical economics argue about managers?
They say that managers make decisions based on heuristics and gut feelings instead of using good data
Normal profit
is the minimum amount of profit that a person is willing to earn to remain in business.
Sales maximization
involves selling as much output as possible without making a loss.
Normal profit
is the minimum amount of profit that a person is willing to earn to remain in business.
Name four market structures
(1) perfect (pure) competition
(2) monopolistic competition
(3) oligopoly
(4) pure monopoly
Name four market structures
(1) perfect (pure) competition
(2) monopolistic competition
(3) oligopoly
(4) pure monopoly
Number of firms
(1) perfect (pure) competition
(2) monopolistic competition
(3) oligopoly
(4) pure monopoly
very large
(e.g., 100)
many
(e.g., 30–40)
few
one
Size of firms
(1) perfect (pure) competition
(2) monopolistic competition
(3) oligopoly
(4) pure monopoly
very small
small
large
large
Control over price
(1) perfect (pure) competition
(2) monopolistic competition
(3) oligopoly
(4) pure monopoly
no control,
price taker
some control
control but interdependent on other firms
large, price maker
Differentiated or homogeneous product
(1) perfect (pure) competition
(2) monopolistic competition
(3) oligopoly
(4) pure monopoly
homogeneous, perfect substitutes
differentiated, close substitutes
differentiated but homogeneous in some industries
no close substitutes
Pricecompetition or non-price competition
(1) perfect (pure) competition
(2) monopolistic competition
(3) oligopoly
(4) pure monopoly
compete on price, no non-price competition
may compete on price but also nonprice competition
mainly non-price competition but also price competition in certain markets
may engage in PR activities or restrictive trade practices
Example
(1) perfect (pure) competition
(2) monopolistic competition
(3) oligopoly
(4) pure monopoly
arguably farming and currency markets
café and restaurant markets
airplane manufacturing industry
electricity provider
Perfect information
refers to the conditions under perfect competition where all producers and consumers have equal access to all available market information and prices accurately reflect all available information.
Perfect information
refers to the conditions under perfect competition where all producers and consumers have equal access to all available market information and prices accurately reflect all available information.
maximize its profits
MR = MC
What means Marginal revenue?
Marginal revenue is the additional
revenue generated from selling one more unit of output
What does a firm need to earn abnormal profits in the short run?
Perfectly Competitive Firm
TR > TC
revenue (TR) total cost (TC)
P > ATC
-average total cost (ATC)
What is happen when new firms enter to compete?
- Perfectly Competitive Firm
- ceteris paribus
- long run
the industry supply increases and the industry supply curve shifts to the right. This makes the equilibrium market price fall, shifting each firm’s individual demand curve down and lowering the price that each firm can charge
long run P is no longer above ATC
productively efficient
A firm is productively efficient when the price
charged by the
firm for the units supplied is equal to the minimum ATC and allocatively efficient when the price charged is equal to marginal cost.
When exist a Allocative efficiency?
P = MC
perfect (pure) competition
What is usually for a monopoly to exist and what are examples?
legal barriers
lectricity and water supply industries are considered
natural monopolies
What do firms aim to achieve?
(1) profit maximization
(2) revenue maximization
(3) sales (output)maximization
(4) profit satisficing
LRAC
long run average cost
What barriers make it difficult to enter as a new firm?
Natural Monopoly
- high capital costs,
- strong brand names of existing firms
- patents
- copyrights
- ownership of a scarce resource
When is a firm considered to be dominant in the market?
40 percent of the market share although in some countries a firm that has over 25% of the market share
When is a firm considered to be dominant in the market?
40 percent of the market share although in some countries a firm that has over 25% of the market share
How can a firm maximize its profit in a monopolistic cometition?
have to charge a price and produce a level of output at which MR = MC
What means Sales maximization?
Sales maximization is not the same as revenue maximization. The goal of sales maximization
is to sell as much output as possible without making a loss.
What means Normal profit?
Normal profit is the minimum amount of profit that a person is willing to earn to remain in
business.
Is the monopolistically competitive or perfectly competitive firm more efficient and which one will charge a lower price?
- monopolistically competitive firm is less efficient than a perfectly competitive one.
- monopolistically competitive firm theoretically will charge a lower price
What possitive effect can have non-price characteristics?
- increase a firm’s demand
- less price elastic
- slightly higher price
- remain competitive
What are Natural monopolies and the barriers to entry?
A natural monopoly is one in which the internal economies of scale are very large and extend
over a large range of output, so large that not even one firm satisfying the whole market
demand produces and sells enough to be able to experience all internal economies of scale.
The existence of high capital costs, strong brand names of existing firms (that may
also be due to high quality), patents and copyrights, ownership of a scarce resource, and
restrictive trade practices such as limit pricing
Explain the Kinked-demand curve model.
According to the kinked-demand curve model, oligopoly
firms will be reluctant to change prices because of the anticipated response of their competitors.According to this model, if an oligopoly firm were to lower its price to attract more customers,
competing firms in the market will also lower their prices to.If, instead of lowering prices, an oligopoly firm were to increase its prices, the kinked-demand
curve model posits that competing firms will not increase their prices in the hope of luring
customers with their relatively lower prices away from the competitor that increased prices.
Call 3 theories for pricing behavior of oligopoly firms.
price leadership model, collusive behavior, and game theory
price leadership model
other firms follow the pricing behavior of the leader therefore the sold is relatively price inelastic
maximize sales revenue
MR = 0
maximize sales of output
harge a price that is equal to ATC
maximize sales revenue
MR = 0
maximize sales of output
harge a price that is equal to ATC
How many Pricing Strategies are there and name them?
1) Barometric price leadership
2) Cartels and price fixing
3) Limit pricing
4) Predatory pricing
5) Price discrimination
6) Cost-plus pricing
7) Multiproduct pricing
8) Transfer pricing
barometric price leadership
in oligopoly market does not have a clear dominant leader
-> the price changes initiated by any oligopoly firm in the industry may act as a barometer that other firms follow.
Limit pricing
they charge a price that is lower than the one that will maximize its profits in order to discourage potential new rivals from entering the market
accept lower profits in the short run to maintain their market share in the long run
Predatory pricing
occurs when a firm charges a price low enough to drive a competitor out of business.
Penetration pricing
occurs when a firm charges a low price in order to establish itself in an industry and obtain a desired market share.
Prestige pricing
occurs when a firm charges a higher price for a product or service as buyers believe that the product or service conveys some level of prestige.
Name the three degrees of price discrimination
- ) charging the maximum price that each buyer is willing to pay for each unit of a good or service
- ) occurs when a firm charges buyers different prices according to how much they purchase
- ) occurs when the seller divides or segments buyers into distinct markets and charges a different price in each market
Consumer surplus
is the difference between the maximum price a buyer is willing to pay for a good and the actual price charged.
Peak-load pricing
is where a firm charges customers a higher price during peak demand and a lower price at offpeak times.
Price skimming
is where a firm charges high prices and earn abnormal profits until new competitors arise.
Intertemporal pricing
is where a firm charges different prices in different time periods.
Two-part tariff
is where a firm charges a fixed access fee plus a usage fee determined by the amount of goods or services consumed.
What is mark-up or cost-plus pricing?
firms etermine their average cost of production and then add a certain percentage (mark-up) for profit
- higher when price inelastic
- lower when price elastic
Full-range pricing
is where a firm sets the price of all complementary and substitute products jointly to maximize profits.
What are transfer pricing and why it could be bad for a firm?
Every profit center has its own profit target. When the product from one center become input to another, then it could preventing the organization from maximizing its profits
The divisional profit target creates a conflict of interest.
What different goals purcue firms?
(1) profit maximization
(2) profit satisficing
(3) revenue maximization
(4) sales maximization
What must a firm do to maximize its profits or total revenue?
profits: produce at an
output MR = MC
revenue: produce
an output MR = 0
perfectly competitive markets,
- no barriers to entry
- many small firms that produce homogeneous goods that are perfect substitutes
- firms are price takers
- earn only normal profits in the long run
- allocative and productive efficiency
What is it called when there is only one firm on the market?
monopoly
pure monopoly
- high barriers
- price maker
- can earn abnormal profits -> short/ long run
- economically inefficient
Where exist imperfect competition?
monopolistically competitive and oligopoly markets
Monopolistically competitive markets
- weak barriers
- many small firms producing differentiated product/ service
- some control over price
- able to earn abnormal profits (short run) / likely to earn normal profits (long run)
Oligopoly markets
- strong barriers
- number of large, interdependent firms
- monitor the behavior of their competitors
- pend large sums of money on advertising and prefer to engage in nonprice competition
MSC
marginal social costs
MSB
marginal social benefits
When is the socially optimal level of output?
MSB = MSC
Positive spillover effects
occur when the consumption of a good or service results in a benefit to a third party
not involved in the production and purchase of that good or service.
MPB
marginal private benefit
Merit goods
are those goods
that would be under-consumed if provided only by the private sector; it is conceived that individuals and
groups should have access to merit goods based on need, rather than ability and willingness to pay.
negative externality
occurs when the production and/ or consumption of a good creates a cost to third
parties external to the production and consumption of that good.
MPC
marginal private cost
When is MSC = MPC?
absence of any negative externality
Why are negative externalities are a form of inefficiency?
- not taken into consideration by a firm’s managers when deciding how much to produce and what price to charge
- When the production and consumption of a good creates an external cost, too much of the good is being produced and consumed
deadweight loss
- occurs when supply and demand are not in equilibrium
- economic inefficiency by productiong more then equilibrium
free-rider
The free-rider problem occurs when those who consume or benefit from a good or service do not pay for it.
Non-excludability
mean that once a good or service has been provided, it is difficulty or too costly to exclude non-payers from benefiting from the good or service
Non-rivalry
Non-rivalry means that the use or consumption of the good or service by one person does
not result in less of the good or service being available for other people.
What kind of public goods exist?
non-excludability and non-rivalry in consumption
Producer surplus
is the difference between the lowest price that a firm is willing to sell a good and the price that it actually receives.
Asymmetric information
refers to the situation under imperfect competition where at least one party in an economic transaction has more information than the other party
SMC
In the absence of externalities, the MC is the SMC curve
Government Policies to Reduce Market Failure
market failures created by externalities, monopoly power, and missing information
-> government is unable to correct the market failures and that in trying to reduce one type of market failure, it may create other inefficiencies.
What can the goverment do to correct market failure?
(1) provide subsidies to firms
(2) provide subsidies to buyers
(3) provide the good itself
Cost-plus pricing
Firms that adopt mark-up or cost-plus pricing determine their average cost of production and
then add a certain percentage (mark-up) for profit.
Full-range pricing
is where a firm sets the price of all complementary and substitute products jointly to maximize profits.
Market Failures
A market failure exists when resources are not allocated efficiently. Resources are allocated
efficiently if an economy produces those goods that its citizens value the most.
The socially optimal level of output is Qs.
MSB = marginal social benefits
MSC=marginal social costs
Positive spillover
effects
occur when the consumption of a good or service results in a benefit to a third party not involved in the production and purchase of that good or service.
Merit goods
are those goods that would be under-consumed if provided only by the private sector; it is conceived that individuals and groups should have access to merit goods based on need, rather than ability and willingness to pay.
For instance: Education and health
negative externality
occurs when the production and/ or consumption of a good creates a cost to third parties external to the production and consumption of that good
what are free-riders?
The free-rider problem occurs when those who consume or benefit from a good or service do not pay for it.
For instance: Street lighting, light houses, etc..
What are Public goods?
Public goods
have two characteristics: non-excludability and non-rivalry in consumption.
Non-excludability: mean that once a good or service has been provided, it is difficulty or too costly to exclude
non-payers from benefiting from the good or service.
Non-rivalry: means that the use or consumption of the
good or service by one person does not result in less of
the good or service being available for other people.
Example: Street lighting, light houses, and national defense are examples of public goods
How much subsidy or tax deduction should the goverment provid?
large enough to increase the MPB (demand) curve of the buyers up to the point where MSB = MSC
How is it possible to decrise the external damage of a product for third parties?
to give them the right to sue for damages
if the firm incur higher costs due to the fines, they will lead to higher prices, lower demand, and lower output
When occurs market failure?
when resources are not allocated in an efficient way
MSB <> MSC
When arise market failure:
(1) positive externalities
(2) negative externalities
(3) missing markets
(4) very large market power
(5) imperfect information
How can negatice externalities be reduced?
(1) imposing regulations
(2) pollution taxes,
(3) issuing tradeable
(4) pollution permits
allowing third parties to sue for damages
zerosum game
In a zero-sum game, one player wins at the expense of the other player
non-zero- sum game
both players win or lose depending on the actions of the other player
What shows a payoff matrix?
the various payoffs for each player (e.g., prisoner) based on the strategy chosen by both players
nash equilibrium
is the outcome that results from the players making their best decision based on what they believe the other player will decide
Nash equilibrium is a stable
Producer surplus
is the difference between the lowest
price that a firm is willing to sell a
good and the price that it actually receives.
Asymmetric information
refers to the situation under imperfect competition
where at least one party in an economic transaction
has more information than the other party.
What ways can the government attempt to increase the output and consumption?
- provide subsidies to firms
Providing subsidies to the firms lowers their costs of production and creates incentives for them to produce more.The lower costs allow the firms in turn to lower their prices.
- provide subsidies to buyers
The government can also give subsidies to the buyers. For instance, the government can give
students who attend private schools and universities a grant that can be used only for tuition
fees. - provide the good itself
The government can also choose to provide public education and operate public hospitals
itself and cover the costs using tax revenues.
Cooperative equilibrium
is where players elect to cooperate in order to jointly maximize their payoff.
Adverse selection
is a problem created by asymmetric information before an agreement or transaction is made.
Moral hazard
occurs when an individual increases their exposure to risk when another party bears the risk.
What kind of procedures and policies create banks/insurance companies to reduce adverse selection and moral hazard problems?
- background check (income, employment and credit history, and asset ownership)
- require collateral from borrowers
- funds available by presenting the invoice
Principal-agent problems
occurs when the agent has an incentive to behave not in the best interests of the principal.
Competitive bidding
is a method of procurement where two or more suppliers submit separate bids to win the available contract.
sealed-bid auction
is where bidders simultaneously submit sealed bids which are unknown to other bidders.
english auction
is a public auction where the auctioned item is sold for the final highest bid.
When do asymmetric information exists?
when one party has more information than the other
To what problems leads asymmetric information?
- adverse selection
- moral hazard
For what can a form use a auction?
- for conducting competitive procurements
- regarding purchasing decisions
- obtain higher prices for their products
Capital budgeting
involves determining which capital projects the firm should invest in, how much this
investment will cost the company, and how the investment expenditure will be financed.
examples of the different types of investment decisions
- the purchase of new capital to produce a new product
- the construction of additional factories, warehouses, and offices to meet increasing demand, or the company’s expansion into other geographic markets
- deciding whether to buy or lease equipment, machines, and vehicles
- deciding whether to produce a product or to outsource its production
- replacing obsolete plants and equipment
time value of money
refers to the fact that the value of a monetary amount today is worth more than in the future.
Present value (PV)
refers to the present- day value of an amount of money, subject to a rate of return that affects its future value.
present value (formula)
cash flow:
PV = CF / (1+i)^n
stream of cash flows:
PV = CF / (1+i) + CF / (1+i)^2 + CF / (1+i)^3 + … + CF / (1+i)^n
i = annual interest rate n = number of years
Name two methods for future cash flows and the time value of money
-net present value (NPV)
-internal rate of
return (IRR)
net present value (formula)
NPV = Sum (t=1 -> n) [Rt / (1+d)^t] - Sum (t=1 -> n) [Et / (1+d)^t]
t = time period (years, months) n = last period of the project Rt = revenues (cash inflows) in period t Et = expenditures (cash outflows) in period t d = discount rate (cost of capital)
profitability index (PI)
is the ratio of payoff to investment for a specific project.
profitability index
PV= PV of the Stream of Future Cash Inflows / Initial Investment Outlay
Risk
is a future event with a measurable probability
Uncertainty
is a future event with an indefinable or incalculable probability.
expected value
is the average of all possible outcomes for a project.
sensitivity analysis
analyzes how different values of variables will affect a project’s NPV.
scenario analysis
analyzes how different values of multiple variables will affect a project’s NPV
What involves capital budgeting?
involves determining which capital projects the firm should invest in, how much this investment will cost, and how the investment expenditure will be financed.
