Econ 202 final

How to Segment your Market?

1. Segment your market into groups whose demand differs. 2. Target your group discounts based on verifiable characteristics. 3. Base group discounts on difficult-to-change characteristics.

Monoploy

1. Very Rare. 2. No competitors. 3. Unique product. 4. Many barriers to entry. MR= Output effect (P) - Discount Effect (change in P x Q)

What is a Relationship-Specific Investment?

An investment that is more valuable if the current firm relationship continues. Ex: Disney, and Pixar "both know they need it and know that each of them needs it".

Average Cost Equation

Average Cost= Total cost/ Quantity. or Average Cost= (Fixed Costs/ Quantity) + (Variable Costs/ Quantity)

Average Revenue Equation

Average Revenue= Total Revenue/Quantity

short run

Firms can't change fixed costs or technology.

What is the Hold-up problem?

Once you have made a relationship-specific investment, the other side may try to renegotiate so that they get a better deal (and you get a worse deal).

Profit Equation

Profit = Total Revenue - Total Cost or Profit= (price-average total cost) x Quantity

Profit Margin Equation

Profit Margin= Price - Average Cost

What is the Signaling Model?

Works under the assumption that education is more costly for low-quality workers. if you're a smart persevering hard working person, a high-quality worker getting a college degree is much easier for you than it is for someone who doesn't have as much talent or is lazy. If getting a college degree is too costly for the low-quality worker then only high-quality workers will get a degree, and employers can safely assume that they're getting a good worker if they hire someone with a degree.

Rational Rule for Entry

You should enter a new market if you expect to earn a positive economic profit, which occurs when the price exceeds your average cost.

Variable Cost (VC)

the sum of the expenses of the firm that vary directly with the quantity of a product that is produced and sold. Ex: hiring more employees.

When are profits maximized?

when MR=MC.

What are the types of Asymmetric Information?

1. Adverse Selection. 2. Moral Hazard.

What are the Entry Deterrence Strategies?

1. Build excess capacity so that your rivals expect fierce competition. 2. Financial resources signal that you can survive a costly fight. 3. Brand proliferation can ensure there are no profitable niches for a rival to exploit.

What are the Solutions to Adverse Selection of Sellers?

1. Buyers can Learn from Third-party Verifiers. 2. Sellers can Signal the quality of their product. 3. Government can increase information or weed out low-quality goods.

What is the Solution to the Principal-Agent Problem?

1. Drafting a contract that aligns incentives. 2. Bonuses. 3. Above Market Wages. 4. The threat of being fired for Shurking.

What type of Barrier to entry is it when governments regulate entry to a market?

Licensing

What is Hurdle Segmenting?

Making it Difficult to purchase a particular Product. Ex: Business Vs. Leisure Travel, The marginal Cost of an Airline seat is basically the same whether it's occupied by a person whose traveling for business or one whos going on vacation but is willing to pay for the business traveler is much higher, the traveler's willingness to pay is lower.

Marginal Cost Equation

Marginal Cost= Change in Total Cost / Change in Quantity

Marginal Revenue Equation

Marginal Revenue= change in total revenue / change in quantity

What type of barrier to entry is it when a Firm mass produces a product?

Mass Production Ex: Mass Production can keep small firms from being competitive entrants.

What type of barrier to entry is it when the value of a firm's product increases with the number of people who use it?

Network Effects

Marginal Principle

New competitors will continue to enter a market until the last competitor that enters (the marginal supplier), which is the company that's right on the cusp of entering or exiting, expects its economic profit to be zero.

Implicit costs

Nonmoney costs like opportunity cost.

What type of Barrier to Entry gives firms the right to be the only producer of a product?

Patents

What is time or handling cost Segmentation?

People with a high opportunity cost of time are less likely to go through the hassle of finding coupons or sending in rebates and will pay full price, while others will segment themselves and get the discount by paying the time or hassle costs.

What is Group Pricing?

Price discrimination by charging different prices to different groups of people. Groups whose demand Differs, Targets based on Verifiable and Difficult to Change Characteristics. The firm doesn't know your actual willingness to pay but it may know that the type of person you are generally has a lower willingness to pay than others. Ex: Student discounts, Senior discounts, Child discounts.

Adverse Selection of Buyers

The tendency for the mix of buyers to be skewed toward more high-cost buyers when sellers don't know the buyers' type. Ex: Market for used cars, the seller knows much more about what works and doesn't work on the car than the buyer does.

Adverse Selection of Sellers

The tendency for the mix of goods to be skewed toward more low-quality goods when buyers can't observe quality. Can cause the market to collapse.

What is Accounting Profit?

The total Revenue a business receives minus out-of-pocket financial costs. Accounting Profit= total revenue - explicit costs

What is Economic Profit?

The total revenue a firm receives minus both explicit and implicit costs. Economic Profit= total revenue - explicit costs - implicit costs

What are the effects of MR<MC?

Then Selling an additional unit loses money.

What are the effects of MR>MC?

Then Selling an additional unit will yield more money than it costs.

Fixed Cost (FC)

cost that does not vary with the level of output and that can be eliminated only by shutting down. Costs that remain constant as output increases.

The Moral Hazard of Insurance:

people with insurance have less incentive to avoid risky behavior so insurance companies solve this by forcing agents to share in some of the costs. Ex: Co-payments, deductibles, co-insurance.

Spectrum Of Competition

perfect competition, monopolistic competition, oligopoly, monopoly.

What is a Pro-Market economy?

trying to get a more competitive environment to increase economic efficiency

What is Asymmetric Information?

when there is an imbalance in information between buyer and seller which can distort choices.

WHat is Game Theory?

The Study of Decision Making when your outcomes are driven by the actions of others.

What is Marginal Revenue?

The amount earned for each unit sold.

What is a Shurk?

A person who slacks off.

Discount/Price Effect

The price cut you'll have to offer × the quantity that gets that price cut.

What are the Competitive Forces

1. Existing Competitors: a.Differentiating. b. More rivals yield more intense competition c. Price Competition: Competing to win customers by offering lower prices. 2. Potential Competitors: a. Threat of Entry: refers not only to entrepreneurs who might launch new start-ups but also to existing businesses that might expand into your market and current competitors that might enter new distribution channels. The threat of entry can intensify competition, which will push down your prices and profits. 3. Competition For Substitutes: a. Substitutes are a bigger threat when switching costs are low. b. Complements can point to new opportunities. 4. Bargaining Power of Buyers: a. Just as suppliers can force you to pay high prices, powerful buyers can also force you to offer lower prices. 5. Bargaining Power of Suppliers: a. When Switching costs are high, the supplier has more bargaining power.

What are the opportunity costs of running a business?

1. Foregone Wages: If you don't launch this start-up, how much will you earn pursuing your next best career option? 2. Foregone Interest: If you don't invest your funds in this start-up, how much annual interest will you earn by investing it elsewhere?

Types Of Barriers to Entry

1. Government Regulation: Patents, Copyrights, Licensing, Regulations. 2. Supply-Side Factors: Control of Key Resources, Cost Advantages, Supplier Relationships, Mass Production. 3. Demand-Side Factors: Network Effects, Switching Costs, Brand Loyalty/Reputation. 4. Natural Monopoly: Economies of Scale.

How Do Firms Segment?

1. Group Pricing. 2. Hurdles. 3. Alternative Versions 4. Time or Handle costs. 5. Quantity Discounts. 6. Tying. 7. Bundling.

Oligopoly

1. Imperfect Competition. 2. Few Competitors. 3. Unique or Differentiated Products. 4. Some Barriers to entry. Ex: Cell Phone Market.

Monopolistic Competition

1. Imperfect Competition. 2. Many Competitors. 3. Differentiated Products. 4. Low/No barrier to entry. Ex: Resturants

What is the Solution to Moral Hazard Problems?

1. Make hidden actions observable by monitoring. 2. Reward things that go along with the actions you want. 3. Give the actor "skin in the game", or a stake in the outcome. a. Pay-for-Performance: linking the income your workers earn to measures of their performance, like commission, bonuses, and promotions. 4. Government rules and social norms can help align incentives. 5. Pick the right kind of agents.

What three conditions are needed for Perfect competition?

1. Many buyers and sellers, all of whom are small. 2. Sell Identical Products. 3. There are NO Barriers to Entry. Firms in a competitive market are price takers. no bargaining power. Marginal Revenue in perfect competition Firms is constant. P=MR and P=MC.

Five Key Insights into Imperfect Competition

1. Market power allows you to pursue independent pricing strategies. 2. More competitors lead to less market power. 3. Successful product differentiation gives you more market power. 4. Imperfect competition among buyers gives them bargaining power. 5. Your best choice depends on the actions that other businesses make.

When can a firm Price Discriminate?

1. Need Market Power. a. impossible in perfect competition. 2. No Resale. a. If people can easily resell your product then it's very hard to price discriminate. 3. Segment the Market and Target Prices. a. In order to charge higher prices to people with greater willingness to pay and lower prices to those who will only buy with a discount, you have to be able to figure out who those people are and then target the prices.

What are the Solutions to Adverse Selection of Buyers?

1. Sellers can use information that is related to the buyer's likely costs. 2. Sellers can offer different contracts so that buyers separate themselves. 3. Government can increase information, offer substitutes, enforce mandates, or provide insurance.

How to Prevent a Death Spiral?

1. Underwriting: an insurance company term that means evaluating the risk of a prospective client. 2. Mandate: where the government enforces people to purchase health insurance through fines.

Perfect Competition

1. Very Rare. 2. Perfectly Elastic Demand. 3. Many Competitors. 4. Identical Products. 5. No barriers to entry. 6. Price Taker.

What is the Principal-Agent Problem?

A specific type of moral hazard. The problems arise when a principal hires an agent to do something on their behalf, but the principal cannot perfectly observe the agent's actions. Your incentives as the principal aren't aligned with the incentives of the agent.

What is a Payoff Matrix?

A table that lists your choices in each row, and the other player's choices in each column, and so shows all possible outcomes, listing the payoffs in each cell.

Average Variable Cost Equation

AVC= Variable Cost/Quantity

Accounting Profit Equation

Accounting Profit = Total Revenue - Explicit Financial Costs

What is Reservation Price?

The Maximum price a customer will pay for a product. It is equal to their Marginal Benefit or Willingness to Pay.

What is Market Power and How can it be used?

Allows Producers to be Price Makers to some extent. Market power is determined by the # of Competitors, the level of Product Differentiation, and the Barriers to Entry. Keeping competitors out of the market is necessary to have market power. Firms with Market Power can Set Price> Marginal Cost. 1. Increases Producer Surplus. 2. Decreases Consumer Surplus. 3. Causes DWL. 4. Higher Prices. 5. Inefficient small Quantity. 6. Larger Economic Profit. 7. Firms Can Survive even with inefficiently high costs.

What is Alternative Version Segmenting?

Alternative Versions of the same product can be a powerful method of segmenting a market. Ex: Paying extra for the VIP section of a concert.

Output/Quantity Effect (P)

An extra unit of output will boost her revenue by an amount equal to the price of the extra item sold, P.

What is a Game?

An interaction between two people whose payoffs depend on each other's actions. Three Elements of a Game: 1. Players. 2. Strategies. 3. Payoffs.

Economic Cost Equation

Economic Cost = Explicit Cost + Implicit Cost

Economic Profit Equation

Economic profit = Total revenue − Explicit financial costs − Implicit opportunity costs

What is Adverse Selection Death Spiral?

Buyers can't easily tell the quality of a used car so they play the averages. An average price, however, means that the owners of higher-quality autos aren't getting a good price for their cars. The owners of high-quality used cars drop out of the market, thereby reducing the average quality of the cars for sale and, in turn, reducing how much buyers are willing to pay. The process continues until only the worst lemons are for sale.

What is Perfect Price Discrimination?

Charging Consumers Exactly their Willingness to Pay, or Reservation Price. Eliminates Deadweight loss. Higher Total Surplus.

What type of Barrier to entry is it when one company owns rights to a key resource?

Control of Key Resources. Ex: there is only one place in the world a certain mineral can be found, call it vibranium, if only one company owns that mountain then it has a monopoly on the production of vibranium.

What type of Barrier to entry gives firms the exclusive rights to produce a product to some degree?

Copyrights

What type of barrier to entry is it when a firm spends lots of money on research and development?

Cost Advantages

What is Signaling?

Costly action that is undertaken to indicate private information to others.

Explicit/Accounting costs

Costs in which firms spend money on buying things.

What type of barrier to entry is it when one firm can supply the entire marker more cheaply than multiple firms?

Economies of scale. Usually occurs when fixed costs are very high. Remember Economies of scale are when the Long Run Average Costs Fall as output increases. More firms reduce production efficiency. Government regulation is often necessary.

Long run

Everything is variable and can be changed to reach equilibrium. Long Run Average Costs fall as the quantity of output increases.

Rational Rule for Exit

Exit the market if you expect to earn a negative economic profit, which occurs if the price is less than your average costs.

What is Adverse Selection?

Hidden Characteristics. When one party knows something about the goods or services that the other doesn't. When an offer conveys negative information about the product being offered. Ex: People who are more likely to submit insurance claims are seeking insurance more often than preferred risks.

Profits In Long Run:

In the long run, if businesses are free to enter and exit, then price equals average cost. If anyone can do it you can't make a profit off of it in the long run. Firm Enters Market: The Market Supply Curve Shifts Right and Price is Driven Down. Firms Exit Market: The Market Supply Curve Shifts Left and Price is Driven Up. Economic Profit= firm entry. Economic Losses: firm exit.

Profits in Short Run:

Profits are maximized when MR=MC. In Perfect Competition MR=MC=P Price>Average Total Cost: Economic Profit. Price<Average Total Cost: Economic Losses. Price=Average Total Cost: Breaks Even, Zero Economic Profit. Price>Average Variable Cost: Stay in Business in the Short Run. Price<Average Variable Cost: Shut Down Immediately. Price=Average Variable Cost: Shut Down Point.

What is a Pro-Business economy?

Protecting specific businesses from competition.

Why Are Curves U shaped?

Reflects Spreading your Fixed Costs, and Rising Variable Costs.

What type of Barrier to entry is it when the government passes rules to enter the market?

Regulations

Rational Rule for Sellers

Sell one more item if the marginal revenue is greater than (or equal to) the marginal cost.

What is Price Discrimination?

Selling the same good at different prices to different buyers. 1. Increases the quantity you sell. 2. Selective discounts solve the underproduction problem.

What type of barrier to entry is it when a firm develops close relationships with its suppliers?

Supplier Relationships

What type of barrier to entry is it when firms make it costly for consumers to switch to buying from another business?

Switching Costs

What is the Human Capital Model?

The more education you get the more productive you are so your wages are higher. You accumulate human capital. Ex: your teachers and universities want you to believe that education makes you more productive and therefore more valuable to employers, because you can do more things better.

What is the Optimal Point?

When MR=MC.

Allocative Efficiency

When Production represents consumer preferences, because price reflects the willingness to pay, in perfect competition production takes place until price equals marginal cost.

What is Tying Segmentation?

When a company sells you a product that can only be used with another product sold by the same company. Ex: Printers and printer ink.

What is the Single Price Monopolist Problem?

When a monopolist can only charge one price to everyone.

What is a Simultaneous move game?

When choices are made simultaneously. Each player has to make his choice without knowing their rival's choice.

Productive Efficiency

When goods and services are produced at the lowest possible cost because firms are always trying to reduce their costs in an effort to increase economic profits.

What is Bundling Segmentation?

When goods are bought together in a package. Ex: Value meals at McDonald's.

What is Moral Hazard?

When one party can do something that's relevant to the transaction but is unobserved by the other. Changing behavior when or because you're not paying the full cost. The actions you take because they are not fully observable and you are partially insulated from their consequences. Ex: slacking off at work when your boss isn't paying attention.

What is Vertical Integration?

When two (or more) companies along a production chain combine to form a single company.

What is imperfect competition?

When you face at least some competitors and/or you sell products that differ at least a little from your competitors. Monopolistic competition and oligopoly are examples.

What is Strategic interaction?

When your best choice may depend on what others choose, and their best choice may depend on what you choose.

What is Quantity Discount Segmentation?

Where buying more means a lower per-unit price or a form of price discrimination. Ex: People who already bought one bottle of soda have a lower willingness to pay for the second one, a quantity discount targets that with a lower price.