Econ 221 Midterm #2

Oligopoly market

-3 features: 1. A few large companies 2. Significant barriers to entry 3. Interconnected prices -Market power much greater than if they operated in a perfectly competitive market -Pricing interconnected: each firm must take into account what its competitors do so prices tend to be similar to one another -Able to generate the highest combined revenue when they collude and split the market -When companies have an incentive to break an agreement, they often do so but end up making themselves worse off

Profit maximization rule

-A firm maximizes profits at the point in which marginal revenue = marginal cost -Profits maximized when price intersects marginal cost curve

Perfect price discrimination

-Able to negotiate a final price exactly equal to each buyer's willingness to pay -Impractical for selling most goods

Marginal product

-Additional output from adding an input = ▲total output/▲ input

Payoff matrix

-All of the possible strategies and payoffs in a table

Market supply of labor

-Always upward sloping bc of other workers entering the market -Demographic changes, nonmoney aspects (office perks), nonwage income, and the availability of other jobs w/ transferrable skills can cause the market supply of labor to change

Perfectly competitive firms

-Are price takers, in that they must charge the market price for a good/service

Positive economic profits

-Area between price and ATC (short-run equilibrium)

Diminishing marginal return

-As long as all workers share fixed inputs, adding more workers will have less of an impact -Typically set in as more variable inputs are added to a fixed input -Output increases at a slowing rate and once output reaches its peak, any additional inputs would decrease output, creating negative returns -Marginal product depends on output of last worker, so if output goes from 25 to 35 when increasing 2 to 3 workers it is still decreasing

Ways to overcome prisoner's dilemma

-By establishing a level of cooperation over time w/o explicitly colluding -Engaging in repeated activities -Ability to retaliate in a repeated game increases the likelihood of achieving a mutually beneficial outcome -Repeated interaction & tacit collusion

Marginal revenue

-Change in revenue/change in quantity -Marginal revenue > marginal cost -> profits rise as output increases -Marginal revenue < marginal cost -> increase profits by reducing output

Marginal cost

-Change in total costs/change in quantity

Wage

-Changes in wage determined by factors that affect the market demand and supply for labor -Wage differences can be explained by factors such as job preferences, job safety, and levels of education and training -When discrimination occurs bc of race, gender, or other factors, supply of "preferred" workers shifts to the left while supply of "non-preferred" workers shifts to the right, creating a wage gap

Monopolist

-Charges a higher price and sells a lower quantity of output

Price discrimination

-Charging different prices to different customers for the same product 3 criteria: 1. Firm must have some market power and hence some control over pricing 2. Must prevent buyers from reselling the good to each other -Encourages sellers to sell more output compared to a market w/o price discrimination and society benefits from this higher output -Causes producer surplus to replace consumer surplus and also replace DW loss, resulting in more efficient market -As output increases, DW loss falls and total surplus increases

Computer example (flipit)

-Combination of greater consumer demand and fierce competition leads to better products and lower prices

Indifference curve

-Connects the different combinations that provide a consumer with the same satisfaction -2 important assumptions: consumer will prefer bundles of goods farther from the origin on the curve bc those bundles contain more of at least 1 good AND slope is negative bc bundle that contains more of Good A has less of Good B -Negatively sloped bc consumers prefer more goods than fewer and convex to the origin bc value of any good decreases as we consume more of it -Bundle on the highest indifference curve on the budget line maximizes satisfaction

Diminishing marginal utility

-Consumer's marginal utility diminishes as they consume more of the same good

Fixed inputs

-Cost does not change based on the quantity of output produced

Sunk cost

-Cost that can't be recovered once spent

Fixed costs

-Costs of inputs that do not change as the output changes -short run time period: fixed cost

Average fixed cost curve

-Decreases as output increases

Profits of a large firm

-Depend heavily on the actions taken by other large firms

Optimal consumption

-Depends not only on price for the good but also on your preference which is why gift cards go unused -Gift cards increase marginal utility per dollar

Autonomy

-Desire to be self-directed

Market demand for a good

-Downward sloping

Poverty

-Earning a level of income that is not sufficient to buy basic necessities including food, housing, clothing, and medical care -Exists in wealthy cities bc unequal distribution of income -Is a relative measure that varies across cities and income inequality exists as a result of differences in education and govt

Firm

-Economic institution that uses resources and transforms them into goods and services -Can be single owner or multinational companies

Price-match

-Eliminates the incentive for either store to charge a low price -In stores' best interest to keep prices high -Nash equilibrium changes to both firms charging higher prices and making more profits

Loyalty cards

-Extend budget line outward -Consumer reaches higher indifference curve and changes optimal consumption

Price-taking firms

-Face a horizontal demand curve at the market price -To maximize profits, produce at point where marginal revenue = marginal costs

Imperfect price discrimination

-Firm is estimating a buyer's willingness to pay according to certain characteristics -Most common type -Different pricing according to quantity of goods purchased (coupons, season discounts)

Demand for labor

-Firm's demand for labor depends on the marginal revenue product, which will eventually decrease as more labor is added due to diminishing marginal returns -A change in the demand for the firm's product changes the price and hence the firm's demand for labor -Increases in labor productivity also change firm's demand for labor (increases marginal revenue product which subsequently leads to greater demand for labor) -Change in the price of a product or in labor productivity will shift the demand curve for labor -Firm's demand for labor dependent on MRP which tells the firm how many workers to hire at different wages

Collusion

-Firms agreeing on a price and quantity to sell -When firms collude, they become part of a cartel and operate like a single firm monopoly -Firms cooperating to raise each other's profits

Noncooperative behavior

-Firms ignoring the effects of their actions on each other's profits

Monopolistic competition

-Market w/ many sellers, each selling a product somewhat different from one another -More incentive to reduce the price to sell more units in a monopoly than a perfectly competitive firm -Price higher in monopoly markets than competitive markets -Some people cannot purchase items in a monopoly market, so loss of potentially beneficial transactions due to a monopoly results in inefficiency in the market (social cost) or DW loss

Market structures

-Markets classified into 4 major categories based on 2 main questions: how many sellers exist in that market and how unique is the product in question

Marginal cost

-Measures how total cost increases as firm produces one more unit of output -Is equal to change in variable costs -Change in total cost solely result of change in variable costs -Because of diminishing marginal returns, marginal cost will fall, then rise slowly, only to be followed by a rapid rise -Marginal cost curve intersects both avg cost curves at their lowest points (efficient scale of production because each outpu produced at lowest cost) -When marginal cost is above average cost, average cost will rise -Marginal cost below average cost, average cost will fall ▲total cost/▲ Q (output)

Concept of utility

-Measures the amount of enjoyment or satisfaction a buyer receives from consuming different goods -Consumer will always prefer to consume more goods than fewer -More goods = more utility

Price-taker

-Must accept market price

Competition in the long run

-New firms enter the market and are positive and existing firms leave the market when profits are negative -Market price changes as firms enter and exit the market until economic profits are 0 in the long run -Economic profits already include the opportunity cost of running a business -As new firms enter the market, market supply curve shifts to the right, reducing market price for a good and profits -As more firms of a certain kind enter a market, market price continues to fall until economic profits are eliminated (perfectly competitive firms earn 0 profits in LR equilibrium)

Income inequality

-Occurs as a result of differences in education levels among workers -Differences in education lead to differences in wages earned by workers -Existence of wage discrimination results in income inequality -Major consequence of income inequality is how it affects those at the bottom of income distribution

Nash equilibrium

-Occurs when each company follows its best strategy given the strategies of the other

Production process

-Occurs when inputs are combined in some way to produce output

Utility maximization rule

-Outcome which results in the highest utility given a limited budget -Consumer will max their satisfaction when they consume at a level where marginal utility per dollar for each good is the same -Plotting 2 points in the demand for 1 good can be connected to derive a demand curve for that good: describes the relationship between price and quantity demanded in that market

Poverty rate

-Percentage of residents, within a city or country living below poverty threshold -Societies have different views about what is sufficient, so poverty rates differ across countries -Many cities and countries differ in the level of social services provided to their residents

Production function

-Process by which inputs turn into outputs -Outputs depend on the choice of inputs a firm uses and the way in which a firm combines these inputs in the production function -Inputs of production are classified according to how difficult it it is to adjust their quantities

Government policy & income inequality

-Progressive income tax helps to reduce variations in income -Income assistance programs and minimum wage aim to reduce income inequality

Cartel

-Quantities each firm agrees to produce add up to what a monopolist would produce -Strongest form of collusion -Restrict output in order to increase joint profits -Faux monopoly

Marginal rate of substitution

-Rate at which a consumer trades 1 good for another -Equal to the slope of the indifference curve -To find utility maximizing bundle using indifference curves, choose the point at which the indifference curve and budget line are tangent to each other -When satisfaction is maxed, marginal rate of substitution is exactly the same as the ratio of the prices of the 2 goods

Deadweight loss area

-Represents lost benefit from potential transactions that do not occur as a result of higher price charged -Monopoly power results in lower total output and higher prices, creating DW loss -Area of potential consumer or producer surplus that could have been created if more units had been sold

Opportunity cost of leisure

-Rises as wages increase

Competition in the short run

-Some inputs are fixed

Oligopoly behavior

-Studying oligopoly behavior is complicated bc it's not a single firm considering its cost and pricing in a vacuum (like perfectly competitive firms and monopolies) -Oligopolists often avoid competing directly on price, engaging in nonprice competition through advertising and other means instead

Marginal product of the variable input

-Tells us how much output is added w/ each additional unit and is calculated by the change in output/change in variable unit -Is equal to slop of production curve in the graph

Variable costs

-The costs of inputs as the output changes -time period long run: variable cost

Budget line

-The graph representing all possible combinations of 2 goods you can buy w/ limited amount of money -More money shifts budget line to the right -If there is a change in the price of a good, budget line would pivot along that axis

Leisure

-Time available for purposes other than earning money to buy marketed goods

Tacit collusion

-Unspoken agreements -Limited by a # of factors: less concentration, complex products and pricing scheme, differences in interests, bargaining power of buyers

Game theory

-Used to analyze the behavior of firms operating in oligopoly markets -Dominant strategy to break an agreement happens when one person's optimal strategy is to sell more of a good/service than the other -Study of behavior in situations of interdependence

Lorenz curve

-Used to illustrate the effects of varying incomes -Horizontal axis measures percentage of households, starting w/ poorest on left -Vertical axis measures total percentage of income controlled by each percentage of the population -Farther the Lorenz curve bows below the 45 degree line, the greater the level of income inequality

Long run time period

-Variable cost variable costs = total costs

Budget constraint

-What you can afford -When buying 2 goods w/ limited amount of money, you can draw a graph comparing max # of each you can buy

Prisoner's dilemma

-When a Nash equilibrium results in an inferior outcome for both players -Often occurs when oligopoly companies try to outsmart their competitors but instead end up in an inferior situation -Found in a variety of situations in which cooperation is either difficult to achieve or is illegal due to laws against collusion

Barriers to entry

1. Control of a scarce resource or input 2. Increasing returns to scale -Natural monopoly exists when increasing returns to scale (economies of scale) provide a large cost advantage to a single firm 3. Technological superiority 4. Network externality- value of a good/service to an individual increasing as more others use the same good/service 5. Govt created patent -Patent gives an inventor a temporary monopoly in the use or sale of an invention -Copyright gives the creator of a literary or artistic work sole rights to profit from that work

Profit maximization

Marginal revenue = marginal cost to maximize profit -2 steps to profit maximization: 1. Choose a quantity (MR=MC) 2. Choose a price (highest price consumers will pay for that quantity) *pick a quantity and follow graph to the demand curve which will tell you price

Total cost of production

variable costs + fixed costs

Short run time period

-Fixed cost variable costs + fixed costs = total costs

Perfectly competitive markets

-Generally have many sellers of a nearly identical good/service

Natural monopoly

-High level of fixed costs provides an incentive for companies to merge in order to lower avg cost of production

LR supply curve

-Horizontal -Any changes in the market will not have any effect on the market price in the long run -Shape of LR supply curves depends on relationships between changes in supply and ATC of production

Firm demand

-Horizontal line at the market price

Economies of scale (long run)

-If business expands, total costs will rise but not by as much, which allows avg costs to fall -Firms can often reduce avg costs of production by increasing the scale (and output)

Labor productivity

-Increase in labor productivity responsible for higher standard of living -Increases in productivity raises marginal product of labor, which leads to greater demand for labor and higher wages

Constant cost industries

-Industries w/ a horizontal LR supply curve -Reason why horizontal: ATC of production do not change as more suppliers enter the industry

Increasing cost industries

-Industries w/ upward sloping LR supply curves -Increase in demand will increase market price in the LR

Individual labor supply curve

-Influences of substitution and income effect -Above w2: income effect, below w2: substitution effect -Rising wages leads to more hours worked, however, once curve bends backward, income effect begins to dominate and they will work less hours

Variable inputs

-Inputs that are easy to vary in quantity (amount depends on quantity produced)

Herfindahl-Hirschman Index (HHI)

-Is used to get a better picture of the market structure -HHI for an industry is the sum of the squares of each firm's share of the market sales -If monopoly, 100^2 = 10,000 HHI

Oligopoly market

-Just a few sellers selling a unique product

Decreasing cost industries

-LR supply curve downward sloping -Most common industries

Income effect

-Leads to a negative relationship between wages and # of hours worked -More leisure one can afford, less they will want to work -Amount of hours one works depends on whether substitution or income effect is stronger -If wages increase (decrease) we feel wealthier (poorer) and so we can and will buy more (less) leisure, therefore negative relationship

Substitution effect

-Leads to a positive relationship between wages and # of hours worked -If wages increase (decrease), the "price" of leisure increases (decreases) compared to working and we'll substitute toward the cheaper good: more (less) working and less (more) leisure therefore positive relationship between wages and hours of labor supplied

Poverty threshold

-Level of income that varies based on the # of persons living in a household, and changes each year based on avg prices of goods and services -Is an absolute

Marginal utility per dollar

-Looking at the additional utility received for every extra dollar spent on a good -Calculated by marginal utility/price -Always purchase the good that gives the most utility per dollar

Optimal output rule

-Marginal revenue = marginal cost -Marginal cost always increases after some point

Market w/ free entry

-Market w/ free entry and exit leads to individual firms earning 0 economic profits

Gini coefficient

Area A/Area A+B -Popular method of comparing income inequality between cities or countries by measuring the ration of the area between the Lorenz curve and the 45 degre line to the total area beneath the 45 degree line -Greater the Gini coeffcient, the more unequal the distribution of income

Average total costs of production

Avg total costs of production = Avg fixed costs + avg variable costs

Average variable cost

Avg variable cost = variable costs/level of output -Initially falls but then rises -Has a U shape for most firms bc diminishing marginal returns sets in -Decision whether or not to close a business is dependent on variable costs of opening it -As long as avg variable cost (AVC) of producing a good is less than the price , firm should stay open to minimize losses -Firm should shut down only if price < AVC

Monopolies

Industry = firm -If market was a monopoly and had just 1 firm, the firms demand curve would equal the market demand curve -Downward sloping curve represents the fact that the monopoly must lower the price in order to sell more output -Marginal unit of revenue will decrease as the firm sells more units -Charge highest possible prices consumers are willing to pay -When MR exceeds MC, monopolist should increase production to max profits -Barriers prevent firms from entering market -Government can create barriers to entry by providing one company w/ exclusive right to sell product (power protected from potential competition) -Profits will not persist in the long run unless there is a barrier to entry

Economic profit

Revenue - resources - opportunity cost (total revenue - all costs)

Accounting profit

Total revenue - explicit costs only