ECON EXAM 2
reservation option
is a persons fallback option. for each point along angels reservation indifference curve she is indifferent between that and government rations.
cost advantages
large firms can purchase inputs on more favorable terms, because they have greater bargaining power when negotiating with suppliers
governments raise more tax revenue by
levying taxes on price in elastic goods.
deadweight loss=
loss of total surplus relative to a parter efficient allocation
MC curve always intersects the AC curve at its
lowest point
total surplus is highest when demand=
marginal cost
firms with ___________ have enough bargaining power set prices without losing customers to competitors
market power
Gini Coefficient
measure of inequality, approximated as the deviation of the Lorenz curve from the perfect equality line Ranges from 0 (perfect equality to 1 (max inequality)
surplus
measuring gains from trade.
a __________ arises when one firm can produce at lower average costs than two or more firms
natural monopoly.
large firms can be more profitable than small firms because of
technological and or cost advantages.
incomplete contracts
the contract between a firm and its employees is incomplete: some tasks depend on future (unknown) events. :some aspects of the job are difficult to measure and base wages on example effort. ........... incomplete contract does not specify in an enforceable way. every aspect of the exchange that affects the interests of parties.
Isocost lines for effort
the cost of effort is the same at all points on an iso cost line.
Marginal cost (MC)
the effect on total cost of producing one additional unit of output. -Calculated as the slope of the cost function at a given point. *
principal-agent models capture interactions under incomplete contacts. example
the firm is the principal and the worker is the agent.. --agent takes action that is hidden from the principal, which is why the principal cannot verify it
One way to increase the cost of job loss is for
the firm to raise wages
Factors that affect the firms choice of price and quantities produced
(costs, price elasticity, market power)
Isoprofit curve
(economic profit) = total revenue- total costs (costs included the opportunity cost of capital)
Institutions
(the rules of the game) matter for social outcomes. Can affect the income that people receive for their work
Wages and effort
- employer can not directly measure to workers effort. large employment rent-> large cost of job loss-> workers put in more effort to reduce chance of getting fire.
feasible allocations are given by the
intersection of feasible frontier and biological survival constraint
employment rent =
-cost of job loss, which includes -lost income while searching for a job -costs required to start new job, relocation -loss of non wage benefits ex medical insurance - social costs (stigma of being unemployed)
incomplete contracts do not only occur in employment relationships.. incomplete contracts arise when....
-information is not verifiable -the relationship covers periods of time -there is uncertainty -there are difficulties with measurement -judiciary is absent -preferences for omitting some information
Firms best response
-to maximise profits, firms want to minimize the costs of production -there is a tradeoff between wages and effort. the employer should find a feasible combination of effort and wage that minimizes the cost per unit of effort.
if firms can't directly measure effort, why do workers work hard?
-work ethic -feelings of responsibility -feeling of gratitude -benefits for measurable output =promotions -fear of being fired
Economics can clarify:
1. How institutions (rules of the game) affect inequality 2. Tradeoffs in the fairness of outcomes 3, Which public policies can address unfairness and how
Allocations can be considered unfair for two reasons
1. substantive judgement of fairness 2. Procedural judgment of fairness
The employment game
1. the employer chooses a wage. as long as the worker works hard enough, she will keep her job at the offered wage. 2. worker chooses a level of work effort, taking into account the costs of losing her job if she does not provide enough effort.
Institutions have to do with what
Bargaining Power and Reservation Option
Demand Curve
Firms feasible frontier (slope=MRT)
Allocation 2- voluntary exchange
How parties divide up the j joint surplus (mutual gains) depends on 1. each party reservation option 2. relative bargaining power between the parties,
Procedural judgement of fairness
How they came about (force vs fair play, equal opportunity, conforming to social norms)
COERCION
Imposing allocations by force. (Suppose Bruno can enforce
there must always be "involuntary unemployment" in the labor discipline model. Why?
In equillibrium, both wages and involuntary unemployment have to be high enough to ensure employment rent is high enough for workers to put in effort.
Slope of isocost curve
MRS- the rate at which the employer is willing to increase wages to get higher effort.
firm maximizes profits by choosing point where
MRS=MRT
slope of best response curve=
MRT
Allocation
Outcome of an economic interaction (describes who does what and who gets what)
Contracts for PRODUCTS sold in markets
PERMANENTLY transfer ownership of the good from the seller to the buyer
Piece Rate Pay
Piece rate work= type of employment in which the worker is paid a fixed amount for each product made --give workers an incentive to exert effort. --difficult to measure output in modern jobs -employees often work as a part of a team
Contracts for LABOR
TEMPORARILY transfer authority over a persons activities from employees to the manager or owner
Rawls veil of ignorance
Taking an impartial perspective
Owners and managers misaligned interests
The firms profits legally belong to the people who own the firms assets... managers action have impact on profits increase thanks to managers work, they will not automatically benefit.----> this creates a misalignment of interest between managers and owners.
contract
a legal document or understanding that specific a set of actions that parties to the contract must undertake
if AC<MC: AC is
increasing
The feasible frontier shows
all the technically feasible outcomes (limited by technology)
Parteo efficient bargaining
allocation chosen will be on the parter efficiency curve.
average cost
average cost per unit produced. calculated as the slope of the ray from the origin to a given point on the cost function. * in this example, average costs decrease at first (economic of scale) but then increase (overtime, machine breakdown)
involuntary employment
being out of work, but preferring to have a job at the wages and working conditions that otherwise identical employed workers have.
competition policy ( limits on market power) can be
beneficial to consumers when firms collude to keep prices high.
firm
business organization which employs people, purchases inputs to produce market goods and services, sets prices greater than the cost of production
Redistributive government policies (income tax and transfers)
can result in a more equal distribution of disposable income.
Marginal revenue (MR)
change in revenue from selling an additional unit (net effect of decreasing price and increasing quantity sold) Firm maximizes profits by choosing point where MR=MC
Substantive judgment of fairness
inequality of final outcome (wealth, well being)
firms can increase their market power by
innovating and advertising. both of these tactics can shift the firms demand curve
Chosen allocation depends on
institutions and policies
if AC> MC: AC is
decreasing
price elasticity of demand
degree of responsiveness ( of consumers) to a price change
Differences in inequality in disposable income across countries
depends on the effectiveness of these policies. ..........income tax and transfers
FIRMs vs markets
division of labor is different
Preferences have to do with
economically feasible allocations, and allocation (outcome) who does what and who gets what.
The effect of good specific taxes depends on
elasticity of demand for those goods
Moral hazard results from information asymmerteries between the principle and the agent
example- amount of effort that an employee chooses to exert. The amount of effort is often left out of a contract rendering the contract incomplete effort is often not observable to the principle.
example of market power
firm selling specialized products * face l little competition and hence have inelastic demand. *set price above marginal cost without losing customers this earning monopoly rent. *form of market failure because there is deadweight loss
Payoffs from employment game
firm- profit=workers output-wage worker- employment rent
iso profit curve
firms indifference curves (slope =MRS)
how labor is different in firms vs markets
firms-concentration of economic power in the hands of the owners/managers allows them to issue commands to workers. markets- power is decentralized in markets so decision are autonomous and voluntary
When is an allocation Pareto efficient?
if nobody can be better off without making somebody worse off
legislation
imagine a legislation that has been passed that limits how much time Angela is allowed to work.
demand advantages
network effects (value of output rises with number of users . example software application
Firm specific assets
network of colleagues, acquisition of skills necessary for the job. Valuable o only when worker remains employed in a particular firm. When relationship ends value is lost to both sides.
structure of a firm
owner decide on long term strategy managers implement their decisions by assigning tasks to workers and monitoring them
Asymmetric information
owners or managers do not always know what their subordinates know or do, not all of their directions or commands are necessarily carried out.
innovating- technological innovation can follow firms to differentiate their products from competitors. firms invent a completely new product may prevent competition through
patents or copyright laws.
iso profit curves shows
price quantity combinations that give same profit. shape of firms cost function affects the shape of their curves
A firms success and ability to grow partly depends. on its
pricing and production decisions.
A firms markup
profit margin as a proportion of the price is inversely proportional to price elasticity of demand
determining wages
profits are maximized at the steepest iso cost line, subsets to the workers best response curve MRS=MRT
Demand curve
quantity that consumers will buy at each price. to make pricing and production decisions, managers also need to know the demand for the firms product.
employees fear getting fired when they are paid more than their ______________
reservation option = they receive employment rent.
Separation of ownership and control
results in managers deciding on the use of other peoples funds.
a firms costs depend on its
scale of production and the type of production technology it has.
cost functions
show how total production costs vary with quantity produced
Combined feasible set
shows all possible allocations (outcomes) of production between two people or parties
economically feasible set
shows all possible allocations that benefit both parties
Biological survival constraint
shows all the biologically feasible outcomes (limited by survival)
Lorenz Curve
shows the extent of inequality and allows comparison of distributions
Workers best response curve
shows the optimal amount of effort workers will exert for each wage offered. - represents the firms feasible frontier for wages and effort.
The allocation that maximizes his economic rent (max bruno can get) is where
slope of the biological constraint (MRS) equals slope of the feasible frontier (MRT) MRS=MRT
demand is relatively inelastic if there are few close
substitutes
Biology and Technology have to do with what
technically fesasible allocation, economically feasible allocations, allocation (outcome) who does what and who gets what.
producer surplus (PS)
the total difference between revenue and marginal cost (profit= PS- fixed costs)
consumer surplus (CS)
the total difference between willingness to pay and purchase price
aligning interests
to solve the conflict of interest between managers and owners. - link the. managers pay to the performance of the company share price. -monitor the managers performance.
Total surplus = consumer surplus + producer surplus =
total gains from trade
Relations within a firm
unlike in markets, relationships within a firm may extend over a long period of time. creation of NETWORK of colleagues. acquisition of SKILLS necessary for the job.
the best response function will shift in reaction to change in
utility of the things that wage can buy, disutility of effort, reservation wage, the probability of getting fired at each effort level.
reservation wage
value of next best option (other employment or un employment benefits)
employment rent=
wage-reservation wage- disutility of effort. -disutility of effort is also know as the cost of effort.
efficiency wage
wages set higher than the reservation wage so workers will care about losing the job and provide more effort.
Interactions between firms and workers determines wages which are part of
which are part of a firms production costs.
a firms profit margin depends o n the elasticity of demand
which is determined by competition.
