Econ Exam 3
Four important sources of market failure
(1) imperfect market structure, or noncompetitive behavior [ie P>MR=MC] (2) the existence of public goods (3) the presence of external costs and benefits (4) imperfect information
governments have assumed two basic and contradictory roles with respect to imperfectly competitive industries
1. The promote competition and restrict maker power, primarily through antitrust laws 2. They restrict competition by regulating industry example: licenses can thwart competition
Is land elastic or inelastic
Inelastic because it is completely fixed
the colluding oligopoly will face market demand and produce only up to the point at which
MR=MC, and P>MC
MRP(labor) = _ x _
MRP(labor) = MP(labor) x Px
what happens to MRP when demand and price increase
Product demand increases, product price rises, MRP increases MRP shifts to right
what is the result of producing/using capital on productivity of labor, labor demand and wages
The production and use of capital enhances the productivity of labor and normally increases the demand for labor and drives up wages
nonrival in consumption
a characteristic of public goods: one person's enjoyment of the benefits of a public good does not interfere with another's consumption of it. National defense =nonrival
oligopoly
a form of industry (market) structure characterized by a few dominant firms. Products may be homogeneous (meat packing) or differentiated (washing machines). The behavior of any one firm in an oligopoly depends to a great extent on the behavior of others
price leadership
a form of oligopoly in which one dominant firm sets prices and all the smaller firms in the industry follow its pricing policy.
cartel
a group of firms that get together and makes joint prices and output decisions to maximize join profits
perfectly contestable market
a market in which entry and exit are costless
five force model
a model that helps us understand the five competitive focus that determine the level of competition and profitability in an industry
marginal productivity theory of income distribution
all factors of production receive rewards determined by their productivity as measured by MRP
public choice theory
an economic theory that the public officials who set economic policies and regulate the players act in their own self-interest, just as firms do
pure monopoly
an industry with a single firm that produces a product for which there are no close substitutes and in which significant barriers to entry prevent other firms from entering the industry to compete for profits
MRP will eventually be the firm's _________
input demand curve
methods of indirect regulation designed to induce firms/households to weigh the social costs of their actions against their benefits
taxes, subsidies, legal rules, public auction
factor subsitution effect
tendency of firms to substitute away from a factor whose price has risen and toward a factor whose price has fallen
imperfect information
the absence of full knowledge concerning the product characteristics, available prices, etc
collusion
the act of working with other producers in an effort to limit competition and increase joint profits
marginal revenue product (MRP)
the added revenue a firm earns by employing one additional unit of input. MRP is the value of each additional worker to the firm.
What happens when MRP(labor) > W and MRP(labor)=W
1. Hire more workers 2. At profit maximization
P(L)= P(K)= P(A)=
1. MRP(Labor)=(MP(Labor)xP(x) 2. MRP(K)=(MP(K)xP(x)) 3.MRP(A)=(MP(A)xP(x)) x= output
Firms will hire until: and Firms will produce until:
1. MRP(labor) = W 2. P = MC
All societies answer these basic questions in the design of their economic system
1. What gets produced? 2. How is it produced? 3. Who gets what is purchased?
two implications of rent seeking behavior
1. behavior consumes resources. (economic profits could be completely consumed through rent-seeking behavior that produces nothing of social value; all it does is help to preserve the current distribution of income 2. government failure
tie bout hypothesis implies
1. equal provision of government services may be ineffienct bc ppl have heterogeneous preferences 2. people will move to where the desired government budget is 3. government service provision affects housing values and wages as they affect desirability of locations
the courts are empowered to impose a number of remedies if they find that antitrust law has been violated. Specifically, the courts can:
1. forbid the continuation of illegal acts 2. force the defendants to dispose of the fruits of their wrong 3. restore competitive conditions
4 barriers to entry
1. government franchise 2. patents 3. Ownership of a Scarce Factor of Production 4. Network Effects
5 approaches that have been taken to solving the problem of externalizes
1. government-imposed taxes and subsidies 2. private bargaining and negotiation 3. legal rules and procedures 4. sale or auctioning of rights to impose externalities 5. direct government regulation
monopolistic competition
1. large number of firms 2. no barriers to entry 3. product differnetiation
problems with monopolistic competition efficiency
1. once a firm differentiates a product and achieves market power, it's strategy is to hold down production and change a price above MC P>MC implies loss 2. final equilibrium is to the left of the low point on its average total cost curve; not the most long-run productive point
why are oligopolistic industries likely to be inefficient
1. price is going to be above marginal cost 2. strategically competitive firms can force themselves into deadlocks & waste resources
Pareto efficiency or Pareto optimality
A condition in which no change is possible that will make some members of society better off w/o making some other members of society worse off
Antitrust Division (of Dept. of Justice)
One of two federal agencies empowered to act against violators of antitrust laws. It initiates action against those who violate antitrust laws and decides which cases to prosecute and against whom to bring criminal charge s
patent
a barrier to entry that grants exclusive use of the patented product or process to the inventor. A 20-year monopoly from when the patent is first filed. Society trades off the enhanced incentives to get more invention v the losses to society of having "too little" produced at a high price: say a cancer drug
tit-for-tat strategy
a company's strategy that lets a competitor know the company will follow the competitor's lead. Works remarkably well. good behavior rewarded bad behavior punished
mechanism design
a contract or an institution that aligns the interests of two parties in a transition.
externality
a cost or benefit imposed or bestowed on an individual or a group that is outside, or external to, the transaction
injunction
a court order forbidding the continuation of behavior that leads to damages
kinked demand curve model
a model of oligopoly in which the demand curve facing each individual firm has a kink in it it. The kink results from the assumption that competitor firms will follow if a single firm cuts price but will not follow if a single firm raises its price.
government franchise
a monopoly by virtue of government directive (e.g. license) for example, the government had restricted the local landline phone service to one firm
risk-averse
a person's preference of a certain payoff over an uncertain one with the same expected value
vertical differentiation
a product difference that, from everyone's perspective, makes a product better than rival products
adverse selection
a situation in which asymmetric information results in high quality goods or high quality consumers being squeezed out of transactions bc they cannot demonstrate the quality of the product they are offering for sale
maximin strategy
a strategy chosen to maximize the min. gain that can be earned. Very conservative.
product differentiation
a strategy that firms use to achieve market power accomplished by producing products that have distinct identities in consumers' mind. Can charge a premium price for these products.
dominant strategy
a strategy that is best no matter what the opposition does
market signaling
actions taken by buyers and sellers to communicate quality in a world of uncertainty
rent-seeking behavior
actions taken by households or firms to preserve positive profits by keeping competition out say when taxi drivers or other producers obey to maintain their favored position by government. This results in wasted resources.
commitment device
actions that individuals take in one period to try to control their behavior in a future period firms will take advantage of this... long-term memberships at health clubs or high prices for small quantities for 'bad' things like ice cream
marginal damage cost (MDC)
additional cost to society of producing one more unit through additional negative externalities such as pollution
tiebout hypothesis
an efficient mix of public goods is produced when local land/housing pries and taxes come to reflect consumer preferences just as they do in the market for private goods people show their consumer sovereignty with their feet
market power
an imperfectly competitive firm's ability to raise price without losing all of the quantity demanded for its product
monopoly
an industry composed of only one firm that produces a product for which there are no close substitutes and in which significant barriers exist to prevent new firms from entering the industry. This is the best example of imperfect competition.
imperfect condition
an industry in which single firms have some control over price and competition. Imperfectly competitive industries give rise to an inefficient allocation of resources
imperfectly competitive industry
an industry in which single firms have some control over the price of their output
natural monopoly
an industry that realizes such large economies of scale in producing its product that single-firm production of that good or service is most efficient
game theory
analyzes oligopolistic behavior as a complex series of strategic moves and reactive countermoves among rival firms. firms are assumed to anticipate rival retains
Treble damages
any person or private company that sustains injury or financial loss because of an antitrust violation can recover damages from the guilty party over and above any fines levied
moral hazard
arises when one party to a contract passes the cost of its behavior on to the other party to the contract this causes market failure example: no not a campus bar!
asymmetric information
can occur when a buyer or seller enters into an exchange with another party who has more information
price discrimination
charging different prices to different buyers example: charging different prices (less) for children/seniors at movies
tacit collusion
collusion occurs when price and quantity fixing agreements among producers are explicit. Tacit collusion occurs when such agreements are implicit.
wheeler-lea act
extended the language of the Federal Trade Commission Act to include "deceptive" as well as "unfair" methods of competition
monopolistic competition in the long run
firm's demand curve is tangent to its average total cost curve for pro its to equal 0
consent decrees
formal agreements on remedies among all the parties to an antitrust case that must be approved by the courts. Consent decrees can be signed before, during, or after a trial
drop-in-the-bucket problem
good or service usually so costly that its provision generally does not depend on whether or not any single person pays
public goods or social goods
goods or services that bestow collective benefits o members of society. Generally no one can be excluded from enjoying their benefits. Classic example: national defense
mixed goods
goods that have characteristics that are part public and part private ex: education, roads
acid rain and clean air act
highlights the fact that efficiency analysis ignores the distribution of gains and losses. To establish efficiency we need only to demonstrate that the total value of the gains exceeds the total value of the losses
Ownership of a Scarce Factor of Production
if a production requires a particular input and one firm owns the entire supply of that input, that firm will control the industry
why profits = 0 in MCL
if profits > ) new first enter the industry, driving demand down (lowers the price) continues until P=ATC and 0 profits
monopolistic competition in the short run
increase production until MR from increasing output and selling no longer exceeds MC of producing MR = MC
liability rules
laws that require A to compensate B for damages imposed
contestable markets
markets in which entry and exit are easy enough to hold prices to a competitive level even if no entry actually occurs
perfect price discrimination
occurs when a firm charges the maximum amount that buyers are willing to pay for each unit. Charge everyone the price on the demand curve, or shift the consumer surplus to producer surplus.
Market failure
occurs when resources are misallocated, or allocated inefficiently
government failure
occurs when the government becomes the tool of the rent seeker and the allocation of resources is made even less efficient by the intervention of government (lobbyists and wasted resources)
nonexcludable
once a good is produced, no one can be excluded from enjoying its benefits
Free markets _______ pollution and _______ education
over produce under produce
risk-loving
person's preference for uncertain deal over a certain deal with an equal expected value
horizontal differentiation
products differ in ways that make them better for some people and worse for others
private goods
products produced by firms for sale to individual households private goods can be excluded from people who do not "pay" for the product
risk-neutral
refers to a person's willingness to take a bet with an expected value of zero
barrier to entry
something that prevents new firms from entering and competing in imperfectly competitive industries
marginal product of labor (MP)
the additional output produced by one additional unit of labor example: additional workers provide little new productivity with fixed capital stock
productivity of an input
the amount of output produced per unit of that input
marginal private cost (MPC)
the amount that a consumer pays to consume an additional unit of a particular good. MC
all kinds of oligopolies have one thing in common:
the behavior of any given oligopolistic firm depends on the behavior of the other firms in the industry composing the oligopoly
efficiency
the condition in which the economy is producing what people want at least possible cost
general equilibrium
the condition that exists when all markets in an economy are in simultaneous equilibrium
derived demand
the demand for resources (inputs) that is dependent on the demand for the outputs those resources are/can be used to produce. That is, unless a firm sells their final product, they don't need inputs
When a firm uses only one variable factor of production, that factor's marginal product curve is
the firm's demand curve for that factor
technological change
the introduction of new methods of production or new products intended to increase the productivity of existing inputs or to raise marginal products
risk premium
the max price a risk-averse person will pay to avoid taking a risk
criminal actions
the practice of the antitrust division has been to limit criminal proceedings to outrageous violations, where intent to violate is clear. They try to negotiate first.
demand determined price
the price of a good that is in fixed supply; it is determined exclusively by what firms and households are willing to pay for the good
partial equilibrium analysis
the process of examining the equilibrium conditions in individual markets and for households and firms seperately
nash equilibrium
the result of all players' playing their best strategy given what their competitors are doing
pure rent
the return to any factor of production that is in fixed supply
concentration ratio
the share of industry output in sales or employment accounted for by the top firms
marginal social cost (MSC)
the total cost to society of producing an additional unit of a good or service MSC is equal to the sum of the MC of producing the product and the correctly measured damage costs involved in the process of production
Network externalities
the value of a product to a consumer increases with the number of that product being sold or used in market
theory of public choice
to understand how government functions, we need to look less at the preferences of individual members of society and more at the incentive structures that exist around public officials
coase theorem
under certain conditions, when externalities are present, private parties can arrive at the efficient solution without government involvement
output effect of a factor price increase (decrease)
when a firm decreases (increases) its output in response to a factor price increase (decrease), this decreases (increases) its demand for all factors