Unit 2 - Behavioral Economics and Labor Markets Flashcards
“benevolent social planner”
would pick Qeqm over any other Q and gov’t should not intervene
caveat: perfect competition & no market failure assumed
slope of BC
reflects rate at which you can trade between 2 goods, slope is constant
slope of IC
rate at which you are willing to trade between 2 goods, slope is not constant
draw the best bundle change when BC changes
- original BC (start with intercepts)
- draw new BC
- is there an income effect?
step 2 - draw new BC
increase income -> parallel shift
increase price of M –> rotation
is there an income effect?
if you can afford more bundles than before (richer) or fewer (poorer)
richer income effect
more of normal goods and less of inferior goods
poorer income effect
less of normal goods and more of inferior goods
substitution effect
occurs when there is a change in relative prices
assumption to increase consumption
of goods that become cheaper
“Homo Economicus”
Rational, forward-looking, utility-maximizing consumer;
weighs costs and benefits when making decisions
Behavioral economics
Subfield of economics that incorporates insights from
psychology into human behavior to explain economic
decision-making
Why might people not act like HE?
People rely on automatic system not reflective system
Limited rationality
Limited willpower
limited rationality
people do not have unlimited time and processing capacity; use rules of thumb
limited willpower
people know optimal outcome but fail to achieve it because of self-control problems
Anchoring bias
relying too much on an early, irrelevant piece of information
Availability bias
relying too much on information that comes to mind easily (e.g., because an event happened
recently or had an emotional impact)
Representativeness heuristic
making a judgement about how likely it is that A belongs to category B based on how similar A is to our image/stereotype of B
Optimism bias
Overestimating the probability of experiencing positive events and underestimating probability of negative events
Loss aversion
Evaluating utility based on your reference point – did you
gain or lose, relative to your earlier position – and not only
on the ultimate outcome
Status quo bias
Putting too much weight on current situation
Framing
Being influenced by way in which information is presented (e.g., equivalent information treated differently depending on what aspects are emphasized)
To an economist, what is the optimal choice?
maximizes utility, given your preferences and the constraints you face (e.g., HE’s choice)
* People acting as HE can make different choices
How do we know their choices are not optimal?
Many lab studies in psych/behavioral econ validate biases
Many studies of people’s real choices find behavior
inconsistent with HE
More likely to struggle to make an optimal choice when decisions:
Involve tradeoffs between present costs and future
benefits (limited willpower)
* Involve complicated calculations (limited rationality)
* Are made infrequently
* Offer little feedback
* Are unclear as to consequences of the choice
nudge
can be used to encourage individuals to make an optimal decision
an intervention meant to change behavior without restricting choices or changing financial
incentives
Examples: defaults
Pros of nudges
Can be powerful tool to improve decisions at little/no cost
* Does not limit choices
Cons of nudges
What is optimal? Design based on typical person, but could move some people away from their best choice
* Paternalistic government may bother some people
How to pick the best Q?
- maximize profits
- set MR = MC
profits
TR - TC
TR
P*Q
perfect competition
many small buyers & sellers
price takers
homogenous good
marginal revenue (MR)
additional revenue from selling 1 more unit of good
change in profits
Why does MR = P?
perfect competition
Marginal cost
change in total cost
profits formula
Q(P-ATC)
where does the firm produce?
where MR = MC
may not be the same Q as min ATC
What if firm is making losses?
still in business b/c they will not shut down immediately
smallest possible loss
can break even to cover input costs (workers, CELL, opportunity cost of alternative jobs/salaries)
key features of firm’s production decision in short run
P < AVC –> immediate short run shutdown
AVC < P < ATC
accountants
profits + Explicit cost = TR
economists
profits + implicit costs + explicit costs = TR
firm’s supply curve
MC curve above min ATC
S curve slopes up
Why does S curve slope up?
S = MC (above min ATC) and MC is using beyond same point
P > ATC
firm makes profits in SR
AVC<P<ATC
firm is making losses but still produce in short run (Q* > 0)
P<AVC
shut down immediately/Q* = 0
Short run S curve
MC above min AVC
above min AVC b/c below min AVC is shut down point
Why is the MC curve = S?
P his MC curve, setting MR = MC (check that P > AVC)
also means P = MC b/c the firm is a price taker
Firm is making profits
P>ATC
new firms will enter
small business chooses best Q* given price
new firms enter: S shifts out (price decreases)
entry continues until profits=0, P=min ATC
firm LR competitive equilibrium
profits = 0
Why are firms iwlling to be in business if profit = 0?
ECONOMIC profits = 0
profit = TR - TC
TR = TC
TR = explicit & implicit costs
can earn enough to cover explicit & implicit, can pay yoruself same amount as next best opportunity
only profits can only exist in short run (breaking even)
many firms chasing profit
What is the LR market S curve?
perfeclty elastic S
1 P1, any Q
exists b/c # of firms adjust from A –> C (no other P can exist)
Long run PC firm
P = min ATC –> good produced at min cost in LR
consumer side: good gets produced as cheap as possible, pay less than monopoly (prefer LR equilibrium)
price taker in labor market
PC firm
VMPL
value of MPL = P x MPL
production function
total product
Ho mw many workers should firm hire?
to the point where wage = 1 /MPC
where is firm’s D ofor labor?
= 1/MPC
market D for labor
horizontal sum of indivdiual firms’ D curves
causes for market D for labor shifts?
D shifts or MPL changes
change in P of output
D shifts out
tech change that increases MPL
D shifts out
why do wages increase over time?
tech change –> shift out of D –> increase wage
TC
TFC + TVC
AFC
TFC/Q
AVC
TVC/Q
ATC
TC/Q
MC
change in TC/change in Q
where the firm continues to produce in the short run despite losses
AVC<P<ATC
firm shuts down immediately
at the Q where the smallest negative loss is made
price isn’t even sufficient to cover costs
MC curve
tells us what quantity the firm wants to produce at any given price
Fixed costs
do not depend on Q (must pay even if Q=0)
Variable costs
depend on the number of units produced. need to buy more inputs to make more outputs.
Implicit costs
require the use of resources the firm owns rather than an outlay of cash. don’t need to pay for it like other costs
Explicit costs
require an outlay of money by the firm
A perfectly competitive market
- many small buyers and sellers
- homogenous good
- price takers
Long-run competitive equilibrium
where P=min ATC and economic
profits=0; there are no economic profits drawing new firms into the industry or economic losses leading firms to leave
monopoly
market structure w/ only one seller
monopolistic
the one firm
monopsony
market structure w/ only 1 buyer
use power to get a lower price
sources of monopoly
in PC, SR profits –> new firms enter –> S curve shifts out, P decreases –> LR competitive equilibrium, P = min ATC
barriers to entry
natural monopoly/economies of scale
patent/copyright
ownership of key input
gov’t-granted franchise
natural monopoly/economies of scale
large fixed costs
ex: tech giants, utilities/power, water, electricity
patent/copyright
period of exclusive use of tech
ex: Rx drug
ownership of key input
ex: diamonds (De Bears owns 85%)
gov’t-granted franchise
ex: grueling license process in India, gov’t licenses for radio frequencies/other goods & services (otherwise will be shut down)
PC firm goal
max profits
by: setting MR = MC
MR = P (price-takers)
monopolist
goal: max profits
by: setting MR = MC. MR < MC decreases profits by making that unit. If MR > MC, increase profits by making that unit.
price-maker
calculate P and TR from D curve
Profits = Q(P-ATC)
TC must be given
TR
P X Q
MR
change in TR as Q increases by 1 unit
monopolist
satisfies whole market demand
MR<P
What is best Q for PC firm?
D curve doesn’t belong on graph
Q* where MC interesects MR
MC upward sloping parabola-like, MR horizontal
What is best Q for monopoly?
D curve belongs on graph b/c satisfy whole market D
MC upward sloping parabola-like, D downward sloping, MR goes into negative region slightly
set MR = MC –> Qm
go up to D –> Pm
monopolist prices
are constrained by D
monopolist picks (p, q) point on D curve to max profits
PC firm - market S & D
determine P, pick best Q based on MR = P
monopoly versus PC outcomes
Pm > Ppc
Qm< Qpc
where S goes in the end
Qpc
Why don’t monopolists care about social surplus?
they want max profit
are there profits in PC?
yes in short run depending on P
SR profits –> entry of new firms –> S shifts out –> P decreases –> profits go to 0 (economic profits)
P=min ATC
good produced at min cost and that’s what consumers pay
What about monopoly?
can be profits in short & long run b/c barriers to entry
ATC above P
per unit loss
P = MC
min ATC in LR
Why we don’t like monopoly
consumers pay markup and it doesn’t get competed away
DWL
not getting to min ATC
Government responses to monopoly?
antitrust policy, regulate prices of monopolist, require firms to offer access to their critical infrastructure network (sell space in pipeline/etc)
antitrust policy
prevent monopolization of industry –> block mergers if make market too concentrated
sue firms for anti-competitive behavior (as defined by laws like Sherman Act/case law)
regulate prices of monopolist
ex: utilities (rate-setting process)
natural monopoly (large fixed costs)
gov’t try to set P @ Ppc –> monopolist is a price taker –> pick Qpc
oligopoly
homogenous good
few large firms
barriers to entry
limits to P monopolists can charge
they couldn’t charge a P so high that the Qd would be 0 (that would make no sense). In practice, the best P is determined by picking Q where MR=MC and then going up to the P on the D curve at that point, and this will be a higher P than in the perfectly competitive market
PC
many small firms, homogenous goods, no barriers to entry, no LR profits
monopoly
1 seller, homogenous goods from 1 firm, barriers to entry, LR profits
oligopoly
few large firms, homogenous goods (i.e. oil), barriers to entry, LR profits depends on competition
monopolistic competition
many sellers (esp in long run), no homogenous goods, no barriers to entry, no LR profits
market outcome with many competitors under PC
1 firm develops new product, have monopoly in SR. P = MC. P>min ATC in LR.
market outcome with many competitors under monopolistic competition
1 firm develops new product, have monopoly in SR. P>MC, P>min ATC
market outcome w/ many competitors (long run)
entry from competing firms w/ small products
shift in of D for original firm (still monopolist –> only few w/ their specific product)
entry continues only until profits = 0
