Econ Final Review
What are some policy options for managing trusts?
- government ownership and operation - regulation - competitive bids for natural monopoly services - break up
Subsidizing a positive externality
* check out the no subsidy graph on ch 11 slide 22
Taxing Negative Externalities
*check out the no pollution tax graph on ch 11 slide 21
What are the basic elements of a game? players, pay-offs, etc.
- the players - their available strategies, actions or decisions - the payoff to each player for each possible action dominant strategy: one that yields a higher payoff no matter what the other player does dominated strategy: any other strategy available to a player who has a dominant strategy Actions that have payoffs depend on: - the actions - when they are taken - the actions of others
The first part of this unit covered several types of markets. List the 3 of the the 4 market structures we discussed in this section, and then for each list 3 characteristics of that market.
1. MONOPOLY - one firm - no entry - unique products 2. OLIGOPOLY - many large firms - difficult entry - similar products 3. MONOPOLISTIC COMPETITION - many firms - differentiated products - free entry
What are the 2 functions of price in a market? Explain the functions and how the market price accomplishes these functions. (hint: one for consumers, one for producers).
1. RATIONING Function: distribution of a scarce good to consumers who value it the most. Rationing function of price would benefit CONSUMERS because they have the opportunity to receive a good if they place a lot of value in it. 2. ALLOCATIVE Function: directing resources away from an overcrowded market and into markets that are under served. Allocative function benefits PRODUCERS because they exit more competitive markets and enter less competitive ones in order to maximize profit.
what are the 5 sources of market power?
1. exclusive control over inputs 2. patents and copyrights 3. government licenses or franchises 4. economies of scale (natural monopolies) 5. network economies
what are the 4 requirements for perfect competition?
1. many firms (no monopolies) 2 identical products 3. entry/exit (capital mobility) 4. perfect information (buyers know market prices & sellers know all opportunities/tech)
When we discussed perfectly competitive supply, there were 4 critical conditions which must be met for the market to be considered perfectly competitive. List and explain 3 of the 4 conditions (be sure to explain why it's essential to the perfectly competitive market).
3 conditions for a perfectly competitive market: - many firms - identical products - perfect information It is important to have many firms (sellers) because they could compete with one another. A market with no competition would be considered a monopoly. Identical products act as substitutes, so consumers can choose to buy the same product from multiple firms. Perfect information ensures that producers are aware of all opportunities within the market and that consumers know the market price so that they can compare it b/t firms.
production possibilities curve
A graph that describes the maximum amount of one good that can be produced for every possible level of production of the other good. x= inefficient point b= efficient point y= unattainable point
incentive principle
A person is more likely to take an action if its benefit rises, and less likely to take it if its cost rises.
Suppose your friend told you that they wished the gov. would just set a maximum price of zero ($0) for college tuition, so that anyone can attend college for free. Recall our example of PRICE CEILINGS, and the types of UNINTENDED CONSEQUENCES which occurred in that example (it was for rent control). A) What would be some consequences of such a price ceiling on the college education market? (list at least 2) B) would everyone who wants to go to college be able to under this regulation? Draw a regular supply and demand diagram and then add a line at P= $0 to help answer.
A) CONSEQUENCES - quality of education would go down - no additives (no free access to a gym, activities, etc.) - more competition to get classes - higher taxes to cover tuition costs B) no, there would be a shortage
We have discussed several kinds of demand elasticity in class. Write the equations for A) Income Elasticity of Demand and B) Cross price Elasticity of demand. For A) what sign would you expect for a good that is normal?
A) Income Elasticity of Demand %∆Qd ÷ %∆I - normal goods are positive B) Cross price Elasticity of demand %∆Qd (A) ÷ %∆P (B)
Price elasticity of supply dhow how responsive sellers of a good are to changes in the price of that good. - What are 2 reasons/factors for a good to have a low price elasticity of supply? (price inelastic). - What is one example of a good/service which might be price inelastic, and why does it fit your criteria you listed.
A) Two factors of a good that would lead to low price elasticity would include the MOVEMENT OF INPUTS (if a good isn't able to get to where it needs to go, it will be less elastic), and SUBSTITUTION OF INPUTS (if there are less substitutes, it will be less elastic) B) labor elasticity of supply: Since there is a lower supply of workers to replace older ones (substitutes), the quantity supplied is lower and inelastic. If the wages were to change, the quantity of workers would be largely unaffected. Therefore, if the worker asked for a higher wage, they would have a higher chance at keeping their job.
Scarcity Principle
Although we have boundless needs and wants, the resources available to us are limited. So having more of one good thing usually means having less of another.
Property Rights and the Tragedy of Commons
BLACKBERRIES IN THE PARK - sweetness increases as the berry ripens -blackberries are common property --> berries will be eaten before they're fully ripe SHARED MILKSHAKES - milkshakes chill taste buds - decrease appreciation of its flavor -drinking slowly increases appreciation - if 2 people share the shake, it's common good - they will drink faster than if it were a private good
income effect
Buyers' overall purchasing power goes down
Know the Coase theorem, and be able to describe a property rights situation like the "Abercrombie" one.
Coase Theorem: if people can negotiate the right to perform activities that cause externalities, they can always arrive at efficient solutions to problems caused by externalities - negotiations must be costless - sometimes those harmed pay to stop polution (Fitch pays Abercrombie) - sometimes polluter buys the right to pollute (Abercrombie pays Fitch) - the adjustment to the externality is usually done by the party w/the lowest cost
A 3.5% increase in the price of milk causes a 7% reduction in the quantity demanded of chocolate syrup. What is the cross-price elasticity of demand for chocolate syrup w/respect to the price of milk? Show your work w/a formula. Based on your result, are these 2 goods substitutes or complements?
Cross price elasticity of demand: (%∆Qd of A/%∆P of B) -7 / +3.5 = -2 the 2 goods are complements
Prisoner's Dilemma Scenario: 2 prisoners are held in separate cells for a serious crime they did commit. The prosecutor lacks sufficient evidence. Confess (both) - H: 5 yrs - J: 5 yrs Confess (J) - H: 0 yrs - J: 20 yrs Don't Confess (J) - H: 20 yrs - J: 20 yrs Don't Confess (both) - H: 1 yr - J: 1 yr What's the dominant and optimal strategies?
Dominant strategy: both confess; get 5 years each Optimal strategy: both do not confess; get 1 year each
Nash equilibrium scenario: Raise spending (both) - U: 3k - A: 4k Raise spending (AA) - U: 4k - A: 5k No raise (AA) - U: 8k - A: 3k No raise (both) - U: 5k - A: 2k What's the Nash Equilibrium?
Equilibrium: American Airlines will raise spending while United will not raise spending. U will get 4k while A will get 5k
calculate comparative advantage
Find the opportunity cost of producing one item in terms of the loss of the other item in question. The producer with the LOWER opportunity cost will have comparative advantage. ex) bike repairs and web update
determinants of price elasticity of supply
INPUT FLEXIBILITY: uses adaptable inputs, more elastic MOBILITY OF INPUTS: resources move where needed, more elastic PRODUCE SUBSTITUTE INPUTS: alternative inputs easy to find, more elastic TIME: long run, more elastic
low hanging fruit principle
In expanding the production of any good, first employ those resources with the lowest opportunity cost, and only afterward turn to resources with higher opportunity costs. explains upward sloping supply curve
Suppose you are a consumer of 2 goods, X and Y, and you are currently maximizing your utility. Suddenly, the price of good X decreases. What 2 effects are you going to experience due to this price change? For each effect, explain whether it makes you want to buy more or less of good X and good Y.
MUx/↓Px > MUy/Py 1. If the price of good X decreases, consumers will buy more of good X and less of good Y. The tendency to move to a SUBSTITUTE is explained by the idea that a person can buy more of 1 good for less of an expense than a close substitute that has a higher price. 2. Due to the INCOME EFFECT, the buyer will be able to buy more of good X due to an increase in demand, but over time the supply of good X will go down.
what are the 2 functions of price?
rationing function: distributes scarce goods to the consumers who value them most highly allocative function: directs resources away from overcrowded markets to markets that are underserved
Perhaps you would rather be somewhere else, rather than taking this exam. Think about what you would rather be doing now. Define OPPORTUNITY COST, and then using the definition, explain your opportunity cost for taking this exam.
Opportunity cost: the value of something foregone to undertake an activity My example: - the opportunity cost of taking this exam instead of studying for my next exam is losing time studying for my next exam.
what is the profit maximizing rule?
P = MC
Based on ATC, AVC, and price, how will you know if a firm will shutdown, produce at a loss, or earn a profit?
P > ATC (making a profit; more firms join) AVC < P < ATC (produce at a loss; firms exit in the long run) P < AVC (shut down)
Be able to define positive and negative externalities. I will ask you for an example.
POSITIVE externality (external benefit): a benefit of an activity received by people other than those who pursue the activity NEGATIVE externality (external cost): a cost of an activity that falls on people other than those who pursue the activity ex) phoebe harvests and sells honey from her bees. - POS: bees polinate apple orchards; provide free service to local farmers - private costs = private benefits; social costs < than social benefits - NEG: people at a neighboring school are bothered by bee stings; phoebe doesn't pay all the costs of her honeybees - private cost = private benefits; social costs are > social benefits
airline scenario Raise Spending (both) - U: $5.5k - A: $5.5k Raise spending (AA) - U: $2k -A: $8k No raise (AA) - U: $8k - A: $2k No raise (both) - U: 6k - A: 6k
Players: United and American Airlines Strategies: increase advertising by $1k or not Assumption: all payoffs are known to all parties Dominant Strategy: raise advertising spending; if both companies do this, both are worse off. Best strategy overall is to not raise spending.
Suppose your friend is a business owner and tells you that their business brought in $10k last month in revenue and only spent $8.5k on wages, equipment, and rent expenses. They tell you that their profit last month was $1.5k. What type of profit are they referring to? What other expenses might an economist consider before declaring the business profitable?
Revenue = $10k Explicit costs = $8.5k They are referring to ACCOUNTING PROFIT which is total revenue - explicit costs. A business may also consider IMPLICIT costs. Therefore, they would know the business' economic profit, which is total revenue - (explicit + implicit costs).
consider people who supply their time (labor, jobs). Why do more irreplaceable people typically command a higher wage?
Since there is a lower supply of workers to replace older ones (substitutes), the quantity supplied is lower and inelastic. If the wages were to change, the quantity of workers would be largely unaffected. Therefore, if the worker asked for a higher wage, they would have a higher chance at keeping their job.
Sources of Comparative Advantage
Talent, natural resources, cultures or societal norms (languages, institutions - value placed on craftsman ship or support for entrepreneurship)
When the optimal ways (above) aren't feasible, what are some other ways externalities can be reduced? We saw a few examples with policies.
Taxes and Subsidies When transaction costs prohibit negotiation: - negative externalities result in overproduction - positive externalities result in underproduction A per unit tax on output can move the market to the socially optimal output when there is a negative externality - people must pay for the damage they cause a per unit subsidy on output can move the market to the socially optimal output when there is a positive externality - pay people for the benefits they create
When monopoly power exists, sometimes the government will take action against a monopolistic firm. What are the laws/rules associated w/government action against monopolies and market power? Explain the trade-offs (pros/cons) with one particular policy used to curtail market power.
The government issues anti-trust laws to prevent firms from creating monopolies or having transactions that would lessen competition. The government can choose to regulate the monopoly, own and control it, or break it up. Some drawbacks include little incentive for cost-saving innovation and higher prices.
taxes and subsidies in regards to externalities
When transaction costs prohibit negotiation: - Negative externalities result in overproduction - Positive externalities result in underproduction A per unit tax on output can move the market to the socially optimal output when there is a negative externality - People must pay for the damage they cause A per unit subsidy on output can move the market to the socially optimal output when there is a positive externality - Pay people for the benefits they create
How to calculate opportunity cost
You divide the thing you are measuring over the thing you want to find the opportunity cost of. Example: Say a person did 13 sit ups in one minute, and 14 push ups in another, and if you want to find the opportunity for for 1 push up measured in sit ups, you would divide 13/14 to get the answer of .94. * 40 fish=30 coconuts. 1 fish=3/4 coconut.
Nash Equilibrium
any combination of strategies in which each player's strategy is her or his best choice, given the other player's strategies - equilibrium occurs when each player follows his dominant strategy - equilibrium doesn't require a dominant strategy * there is always a Nash equilibrium but not always a dominant strategy
shift of a demand curve
a change in the quantity demanded at any given price, represented by the change of the original demand curve to a new position, denoted by a new demand curve more quantity --> less quantity <-- rise in income --> decrease in income <--
production possibilities frontier
a line on a production possibilities curve that shows the maximum possible output an economy can produce
price ceiling
a maximum price that can be legally charged for a good or service if controlled price is below equilibrium, then: - quantity demanded increases - quantity supplied decreases - a shortage results ex) rent control, gas, food/water
role of the market
a situation in which buyers and sellers are in contact with each other for the purpose of exchange - buyers and sellers signal wants and costs (resources and goods are allocated accordingly) - interaction of supply and demand answer the 3 basic questions
Dominant Strategy
a strategy that yields a higher payoff no matter what the other player does
payoff matrix
a table that shows the payoffs that each firm earns from every combination of strategies by the firms
Refer to the graph. The opportunity cost of increasing production of blueberry pies from 7 to 11 is ______ pies. a. 2 apple b. 4 apple c. 8 apple d. 10 apple
a. 2 apple
The combination of good X and good Y that will maximize your utility will have which of the following properties? a. MUx/Px = MUy/Py b. MUx/Py = MUy/Px c. MUy/Px = MUx/Py d. MUx/Px < MUy/Py
a. MUx/Px = MUy/Py
Which of the following would cause a normal good's demand curve to shift to the left? a. income decreases b. income increases c. the price increases d. the price decreases
a. income decreases
diminishing marginal utility... a. occurs when the additional utility for each good declines as consumption increases b. is the additional satisfaction derived from consuming one more unit of a good or service c. is the combination of goods and services that maximizes utility for a given income d. occurs when a consumer buys more of a good as a result of a relative price change
a. occurs when the additional utility for each good declines as consumption increases
Maximizing utility... a. requires that consumers get the most satisfaction out of every dollar they spend b. always requires that consumers spend more money than they have c. requires that the marginal utility of each good consumed is equal, no matter the price of each good consumed d. requires that the price of each good is equal
a. requires that consumers get the most satisfaction out of every dollar they spend
The production possibilities frontier (PPF) shows a. the trade-off b/t the efficient production of 2 different goods b. the difference b/t microanalysis and macroanalysis c. the difference b/t normative and positive analysis d. how a firm should price a new product
a. the trade-off b/t the efficient production of 2 different goods
The government recently imposed a number of regulations on construction companies that will make it more expensive for companies to hire workers. What consequences will this have on the housing market? a. these regulations raise the cost of labor and shift supply to the left b. these regulations raise the cost of labor and shift supply to the right c. these regulations raise the cost of labor and cause a rightward movement along the supply curve d. these regulations raise the cost of labor and cause a leftward movement along the supply curve.
a. these regulations raise the cost of labor and shift supply to the left
what's the difference between accounting and economic profit?
accounting profit disregards implicit costs while economic profit takes into account both explicit and implicit costs.
Mikhail and Stefan are both artists who can create sculptures or paintings each day. The following table describes their maximum outputs per day: SCULPTURES PAINTINGS - Mikhail: 10 - Mikhail: 5 - Stefan: 6 - Stefan: 2 What is Mikhail's opportunity cost of a sculpture? a. 2 paintings b. 1/2 painting c. 3 paintings d. 1/3 painting
b. 1/2 painting
Mikhail and Stefan are both artists who can create sculptures or paintings each day. The following table describes their maximum outputs per day: SCULPTURES PAINTINGS - Mikhail: 10 - Mikhail: 5 - Stefan: 6 - Stefan: 2 What is Stefan's opportunity cost of a sculpture? a. 1/2 painting b. 1/3 painting c. 3 paintings d. 2 paintings
b. 1/3 painting
A firm's economic profit is always less than its accounting profit because... a. accounting profit considers explicit costs, which economic profit does not b. economic profit considers implicit costs, which accounting profit does not c. economic profit is always zero, no matter what kind of firm it is d. accounting profit considers implicit costs, which economic profit does not.
b. economic profit considers implicit costs, which accounting profit does not
Suppose an airline determines it can charge different prices to people traveling for business/emergencies and leisure travelers who travel for pleasure. The airlines goal is to INCREASE TOTAL REVENUE. The price elasticity for demand for business and emergency travel is -0.80, and the price elasticity of demand for pleasure air travelers is -2.40. Based on the price elasticity of demand for each group of people, how should the airline adjust its price? a. raise the price for pleasure air travelers, and keep the price the same for business and emergency air travel. b. lower the price for pleasure air travelers, and raise the price for business and emergency air travel c. lower the price for pleasure air travelers, and keep the price the same for business and emergency air travel d. raise the price for pleasure air travelers, and lower the price for business and emergency air travel.
b. lower the price for pleasure air travelers, and raise the price for business and emergency air travel
The price elasticity of demand is always a. positive b. negative c. equal to 1 d. equal to 0
b. negative
Economics is concerned with the trade-offs that emerge because of scarcity. The term "trade-offs" refers to a. the buying and selling that occur as unwanted goods are exchanged for goods that are desired b. the alternatives given up when making choices c. recycling and transforming old goods into new goods to reduce scarcity problems d. forcing businesses to produce some goods and services but not others
b. the alternatives given up when making choices
substitution effect
buyers switch to substitutes when price goes up
To earn extra money in the summer, you grow tomatoes and sell them at the local farmer's market for 30 cents per pound. By adding compost to you garden, you can increase your yield as shown in the table below: LBS OF COMPOST: LBS OF TOM: - 0 - 100 - 1 - 120 - 2 - 125 - 3 - 128 - 4 - 130 - 5 - 131 - 6 - 131.5 If compost costs 50 cents per pound and your goal is to make as much profit as possible how many pounds of compost would you add? a. 1 lb b. 3 lbs c. 4 lbs d. 5 lbs
c. 4 lbs
A price-taking firm makes air conditioners. The market price of one of its new air conditioners is $120. The firm's total cost information is given in the table below: Air conditioners/day: Total cost ($/day) 1 100 2 150 3 220 4 310 5 405 6 510 7 650 8 800 How many air conditioners should the firm produce per day if its goal is to maximize its profit? a. 4 units b. 5 units c. 6 units d. 7 units
c. 6 units 7 air conditioners, $650 6 conditioners, $510 650 - 110 = 140, which is over the cost of $120 6 conditioners, $510 5 conditioners, $405 510-405 = 105, which is under $120 they should produce 6 air conditioning units/day.
Refer to the graph. The opportunity cost of increasing production of apple pies from 14 to 16 pies is _______ pies. a. 2 blueberry b. 4 blueberry c. 7 blueberry d. 16 blueberry
c. 7 blueberry
Which of the following is a characteristic of a monopoly but not a characteristic of a competitive market? a. a monopoly contains many firms b. a monopoly produces an efficient level of output c. a producer in a monopoly may earn long-run economic profits d. a producer in a monopoly has no market power
c. a producer in a monopoly may earn long-run economic profits
A firm characterized as a price taker... a. has control over the price it pays, or receives, in the market b. sets the price for the market c. has no control over the price it pays, or receives, in the market d. is not a characteristic of a perfectly competitive market
c. has no control over the price it pays, or receives, in the market
In the short run, under what conditions should the firm shut down? a. average total cost at the minimum point b. price greater than average variable cost c. price less than average variable cost d. marginal revenue greater than marginal cost
c. price less than average variable cost
Like a pure monopoly, an oligopoly is characterized by: a. free entry and exit in the long run b. free entry and exit in the short run c. significant barriers to entry d. all firms in the market producing the socially efficient level of output in the long run.
c. significant barriers to entry
At the current level of output, the following data exists: - Price = $20 - Marginal Cost = $6 - Average Variable Cost = $10 - Average Total Cost = $13 What must be true at this level of output for a perfectly competitive firm? a. the firm should stay at the same level of output b. the firm should shut down c. the firm should increase output d. the firm should decrease output.
c. the firm should increase output
law of demand
consumers buy more of a good when its price decreases and less when its price increases * results in negative slope
regulated monopolies
cost-plus regulation sets price at per unit explicit costs plus a mark-up for implicit costs used for electricity, telephone, and cable disadvantages: - high admin cost - reduced incentive for cost-saving innovation -price > marginal cost
What makes a threat or promise credible, in game theory?
credible THREAT: a threat to take an action that is in the threatener's best interest to carry out credible PROMISE: a promise to take an action that's in the promiser's best interest to carry out. commitment PROBLEM: arises from an inability to make credible threats or promises commitment DEVICE: changes incentives to make threats or promises credible - tips for waiters (higher wages cannot insure good service but tips by customers can)
Refer to graph (milk shakes and smoothies): what point in the corresponding figure represents a combination of smoothies and milk shakes that society CANNOT currently produce? a. point A b. point B c. point C d. point E
d. point E
what happens to firms in competitive markets when there are profits? losses?
profits: attract resources (supply increases) equilibrium = no economic profits losses: resources leave equilibrium = no economic losses
incentive principle regarding excess demand (shortage)
each supplier has an incentive to increase the price in order to sell more higher price decrease shortage - quantity offered for sale increases along supply curve - quantity demanded decreases along the demand curve
incentive principle regarding excess supply (surplus)
each supplier has incentive to decrease the price in order to sell more lower price decreases surplus - quantity decreases along supply curve - quantity demanded increases among demand curve
how do we determine if a market is efficient?
economic efficiency exists when no change could be made to benefit one party w/o harming the other. equilibrium price/quantity are efficient - prices above or below equilibrium are not
exclusive contracting for natural monopolies
gov awards contract to low bidder for natural monopoly services - garbage collection, fire protection, department of defense could achieve MC pricing if gov pays the resulting losses asset transfer for large fixed investment is complex
Be able to work out a sequential game (the car hybrid example in the slides is a good one)
hybrid
How can policy remedy externalities and increase efficiency? What are the optimal ways to do this?
if negotiation is costless, the party w/the lowest cost usually makes the adjustment - private solution is generally adequate when negotiation is not costless, laws may be used to correct for externalities - the burden of the law can be placed on those who have the lowest cost examples: - noise regulation (cars, parties, honking horns) - most traffic laws (car emmision standards and inspections) - zoning laws - building height and footprint regulations (sunshine laws) - air/water pollution laws
demand curve
illustrates the quantity buyers would purchase at each possible price demand curves have a negative slope - consumers buy less at higher prices - consumers buy more at lower prices
supply curve
illustrates the quantity of a good that sellers are willing to offer at each price
shift of a supply curve
increase or decrease in supply resulting from a change in one of the determinants of supply other than the price of the good increase in supply --> (produce/sell large quantity at each price; supply increases when costs of production decrease) decrease in supply <-- (when supply decreases, firms produce/sell a smaller quantity at each price)
how does the market answer the three basic questions?
interaction of supply and demand WHAT: which goods will be produced? How much of each? HOW: which technology? which resources are used? FOR WHOM: how are the outputs distributed (is it based on need or income?)
anti-trust laws
laws that encourage competition in the marketplace sherman act: declared conspiracy to create a monopoly illegal clayton act: outlawed transactions that would "substantially lessen competition"
monopolistic competition
many firms slightly differentiated products * free entry
state-owned natural monopoly
marginal cost is always less than average cost options: - fund losses from tax rev - fixed monthly fee + usage fee limited incentives to innovate & cut costs commonly used for water, post office, and some electricity
What are the types of markets with some market power?
monopoly oligopoly monopolistic competition
monopoly
one seller no close substitutes (unique product) no entry/exit
price elasticity of supply
percentage change in quantity supplied from a 1% change in price %∆Qs ÷ %∆P Always positive
Be able to explain the prisoner's dilemma. Know how to identify and define dominant strategy and Nash equilibrium
prisoner's dilemma: a game in which each player has a dominant strategy, and when each plays it, the resulting payoffs are smaller than if each had played a dominated strategy
Draw and label a supply and demand graph showing the market of corn in the US. The price of fertilizer, something corn producers use in the process of making corn, decreases. Show the effect this has on the market. (hint: 1 line moves). Is the new equilibrium price higher or lower than before?
refer to graph drawn on exam one, question 14. price of fertilizer decreases and quantity demanded increases the quantity of corn supplied increases equilibrium price is lower
Explain how cooperation is possible if we change the context or the number of times the game is played
repeated prisoner's dilemma: the same players repeatedly face the same prisoner's dilemma Both players benefit from collaboration Tit-for-tat: my move this round is whatever your move was in the last round - if you defect, I defect - helps to limit defections (straying from the agreement) Sometimes timing matters - 2nd player can adjust strategy - sequential game - 1st mover advantage (products are different) - last mover advantage (differentiator is time or location)
Review the Abercrombie polluter scenarios in regards to the coarse theorem SCENARIO 1: Abercrombie dumps toxic waste in the river - Fitch can't fish the river and no one else is harmed Abercrombie could install a filter to remove the harm to Fitch - filter imposes costs on Abercrombie but benefits Fitch - the parties don't communicate SCENARIO 2: Communication changes the outcome: - Fitch pays Abercrombie b/t $30 and $50/day to use the filter - net gain in total surplus of $20/day SCENARIO 3: laws prohibit dumping the waste in the river UNLESS Fitch agrees - Abercrombie can pay Fitch up to $50/day for the right to pollute - Fitch will accept any offer over $30/day - in this scenario, polluting is the right thing to do
scenario 1: - Abercrombie doesn't install the filter - margical cost of filter to Abercrombie is $30/day while the marginal benefit to Fitch is $50/day
excess demand is also known as
shortage
oligopoly
small number of large firms (few firms) difficult entry * produces products that are close subs
rational spending rule
spending should be allocated across goods so that the marginal utility per dollar is the same for each good MUx/Px = MUy/Py
How can laws change the outcome in Ambercrombie scenario?
suppose the law makes polluters liable for the cost of cleaning up their pollution - polluters get lower incomes - non-polluters get higher incomes
Excess supply is also known as
surplus
equilibrium price
the PRICE at which the supply and demand curves intersect
Equilibrium quantity
the QUANTITY at which the supply and demand curves intersect
comparative advantage
the ability to produce a good at a lower opportunity cost than another producer
marginal utility
the additional utility from consuming one more MU = change in utility ÷ change in consumption ex) as Sarah eats more ice-cream cones per hour, her total utility goes up, but her marginal utility goes down.
consumer surplus
the amount a buyer is willing to pay for a good minus the amount the buyer actually pays for it ∆ = 1/2bh or 1/2Q(x-P)
producer surplus
the amount a seller is paid for a good minus the seller's cost of providing it ∆ = 1/2bh
buyer's reservation price
the highest price an individual is willing to pay for a good
income elasticity of demand
the percentage change in quantity demanded from a 1% change in income %∆Qd ÷ %∆I normal good: (+) inferior good: (-)
price elasticity of demand
the percentage change in quantity demanded from a 1% change in price %∆Qd ÷ %∆P Always negative E>1 = elastic E<1 = inelastic ex) price of beef decreases 1% and the quantity of beef demanded increases 2% = 2/-1 = -2 (elastic)
cross-price elasticity of demand
the percentage change in the quantity demanded of good A divided by the percentage change in the price of good B %∆Qd (a) ÷ %∆P (b) substitutes: (+) complements: (-) - sign of cross-price elasticity shows relationship b/t the goods Weak subs: (+) but low CED Strong subs: (+) but higher CED Complements are negative because as the price for one item increases, an item closely associated w/that item and necessary for its consumption (tennis racket and balls) decreases b/c the demand for the main good has also dropped. - so if the price of tennis rackets increases, the quantity demanded for balls will decrease as consumers purchase less rackets.
utility
the satisfaction people derive from consumption - well-being, happiness -measured indirectly -can't be compared b/t people people try to allocate their resources (income) to maximize their utility (satisfaction) ex) eating an ice-cream cone or watching a movie
What distinguishes long run from the short run?
the short run is the period of time when at least one of the firm's factors of production is fixed the long run is the period of time in which all inputs are variable
law of diminishing marginal utility
the tendency for the additional utility gained from consuming an additional unit of a good to diminish as consumption increases beyond some point ex) as Sarah eats more ice-cream cones per hour, her marginal utility goes down. doesn't always mean marginal utility is negative
opportunity cost
the value of what must be foregone in order to undertake an activity ex) give up hour of babysitting to go to the movies
economic profit
total revenue - (explicit + implicit costs) implicit cost: opportunity cost of the resources supplied by the firm's owners
What is accounting profit?
total revenue - explicit costs explicit costs are payments firms make to purchase (resources - labor, land, etc & products from other firms) easy to compute and compare across firms
external costs and benefits
when external benefits exist, maximizing private profits produces less than the social optimum when external costs exist, maximizing private profits produces more than the social optimum
movement along the demand curve
when price goes up, quantity demanded goes down when price goes down, buyers move to a new, higher quantity demanded _________________________________________ SHIFT IN DEMAND CURVE - if buyers are willing to buy less at each price, the demand has decreased (shift left) - if buyers are willing to buy more at each price, then demand has increased (shifts right)
movement along the supply curve
when price goes up, quantity supplied goes up - sellers move to a new, higher quantity supplied supply increases (shifts right) when sellers are willing to offer more for sale at each possible price supply decreases (shifts left) when sellers are willing to offer less for sale at each possible price
Be able to explain tragedy of the commons
when use of a communally owned resource has no price, the costs of using it are not considered - use of the property will increase until MB = 0 - this is known as the tragedy of the commons suppose 5 villagers own land suitable for grazing. - each can spend $100 for either a steer or a gov. bond that pays 13%. - villagers know what everyone before them has done -steers graze on the commons - value of the steer in year 2 depends on herd size * look at slides 23-25
