Micro Final
Diversification
"don't put all your eggs in one basket"; reducing the risk by combining a large number of small risks whose outcomes are not closely related (invest in many companies)
5 key insights to imperfect competition
1) Market power allows you to pursue independent pricing strategies 2)More competitors leads to less market power 3)Successful product differentiation give 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
profits per unit sold
AR-AC = P-AC
monopoly v monopolize
Being a monopoly is legal; monopolizing a market isn't
Education: human capital vs signaling
Education makes you more productive and adds to your human capital but also serves as a signal of your ability
market power
The extent to which a seller can charge a higher price without losing many sales to competing businesses
What is the efficient outcome?
The one that maximizes total economic surplus in society.
unions and workers' bargaining power
Unions boost the wages of their members by shifting the labor supply curve left/ up; foster communication
wealth Inequality
much more inequality of wealth than income; less inequality in spending than in income
government control of natural monopolies
natural monopoly is a market where it is more efficient for a single firm to serve the whole market (ex. water and electricity services)
utilitarianism
the political philosophy that government should try to maximize total utility in society
Demand shifters
(BITER)- Buyers, Income, Tastes and preferences, Expectations, Related goods
Expected payoff in uncertainty
(Px * X) + (Py * Y)
Supply shifters
(TONERS)- Technology, Other goods, Number of sellers, Expectations, Resource cost, Subsidies and taxes
perfect mobility per quintile
20%
incumbent firm
A firm currently in the market.
regressive tax
A tax where people with lower incomes pay a higher fraction of their income than people with higher incomes. (ex. sales tax)
Why does a firm with market power lead to an inefficient outcome / deadweight loss?
Bc marginal revenue curve is under demand curve. This means that it will cross with the marginal cost curve/ supply curve at a lower quantity and higher price than the demand curve and therefore at a lower quantity/ higher price than what is socially efficient
gathering information
Information is valuable to risk-averse people because it reduces risk by reducing uncertainty
intergenerational mobility
The extent to which the economic status of children is independent of the economic status of their parents; half of your economic advantage comes from your parents other half is up to you
inequality of opportunity
a form of inequality in which laws or official actions deny specific groups social, political, or economic benefits that are available to other groups; measured through intergenerational mobility
fair bet
a gamble that, on average, leaves you with the same amount, expected gains are 0
efficiency wages
a higher wage paid to encourage greater worker productivity; harder to monitor jobs payed more
perfect to imperfect to monopoly
a lot of competition to little competition
natural monopoly
a market in which it is cheapest for a single business to service the market; happens when marginal costs continuously decrease as you expand your output (ex: utility company, water and electricity services, bridges); governments take charge of natural monopolies to prevent market power harm
monopolistic competition
a market with many small businesses competing, each selling differentiated product; markets are both monopolistic and (perfectly) competitive
oligopoly
a market with only a handful of large sellers; have market power but not as much as a monopolists
utility
a measure of a person's well being (unit: utils)
the prisoners dilemma
a paradox in decision analysis in which two individuals acting in their own self-interests do not produce the optimal outcome
insurance
a promise of compensation if something bad happens (ex. medical insurance)
economic profit
accounts for opportunity costs and explicit ones; total revenue - explicit financial costs - entrepreneurs's implicit opportunity costs; whether you are better off
hedging
acquiring an offsetting risk (make safe investment in addition to risky one) ex: "winner buys lunch"
signal
an action that credibly conveys information (ex: a college degree)
collusion
an agreement to limit competition; typically, an agreement by rivals to not compete with each other, but to all charge high prices instead
firm demand curve
an individual firms demand curve, summarizes the quantity that buyers demand from an individual firm as it changes its price
strategic interactions
an interaction where one's best choice depends on what other people choose
relationship-specific investment
an investment that is more valuable if the current relationship continues (ex. car parts company for specific car, common for firms w a few large customers)
inequalities of outcome
annual income, wealth, consumption
positioning trade-off
as many customers as possible vs. being too close to another competitor and having to start price competition
diminishing marginal utility of income
as you get more money, the benefit of one more dollar decreases (marginal principle)
cost changes over time
average costs usually fall then rise (u shaped curve) fixed costs per unit fall variable costs per unit rise
permanent income
average lifetime income; reflection of standard of living; reflected by consumption choices, but difficult to measure as it requires future knowledge
risk spreading
breaking a big risk into many smaller risks so that it can be spread over many people (company goes public, owned by more people - stocks)
systemic risk
can't completely eliminate risk to your stock portfolio by diversifying because what if all or most companies did poorly?
naive rule
choose the option with the highest financial payoff
merger laws
companies have to have government approval to merge (merging restricts competition, but can also enhance it if it's more efficient)
barriers to entry
competitors benefit from less competition, have strategies to stop entry
average cost
cost per unit; total cost/quantity= total fixed cost/quantity + total variable cost/quantity
why advertising is wasteful from society's perspective
cost>benefit, just to steal customers
The Leaky Bucket
costs of redistribution: administrative costs, taxes and means-tested programs reduce the incentive to work, tax avoidance
when new firms enter
decreased demand for incumbent firms, lose customers, demand shift left, lower quantity per firm at each price
Means-tested programs
dependent on income/wealth
antimonopoly rules
designed to promote competition, but some monopolies can be good for consumers bc they provide better services at lower costs
group pricing
different prices for different groups 1) segment demanders into appropriate groups (difference in demand, verifiable, difficult to change) 2) set price by determining demand+MR curve
diminishing marginal utility
each additional dollar yields a smaller boost to your utility- that is, less marginal utility - than the previous dollar; reason why people are risk averse
perfect price discrimination
each person pays the reservation price, no econ surplus for consumer but it is efficient
economic profit vs accounting profit
economic profit best determination for starting a business; economic profit takes into account accounting profit
if average revenue>average cost
economic profit is positive
free exit
ensures industries wont remain unprofitable in long run, pushes price up towards average costs
supply-side barriers to entry
finding cost advantages (better supplier, mass production)
marginal firm
firm with zero economic profit that's on the border of being out of the market
what does hold up problem lead to
firms might not make relationship-specific investments that would be beneficial for fear of hold up
anti-collusion laws
firms not allowed to agree to not compete and have high prices
demand-side barriers to entry
firms try to keep customers; switching costs, reputation, network effect, rewards program
the five forces framework
forces that erode profits 1) competition from existing competitors 2) threats of potential entrants 3) threats of potential substitute products 4) bargaining. power of suppliers 5) bargaining. power of buyers
opportunity cost of starting a business
foregone wages (money you could make doing something else), foregone interest (money made sitting in a bank account), peace of mind/stress
regulatory barriers to entry
get government to make it harder for new firms to enter (ex. patents, licensing, business regulations)
patents
given by government to encourage beneficial innovation but may also cause underproduction of a good
minimum wage laws
goal is to help low-wage workers, but often many of low-wage workers are not poor (ex. teens); raise the wage above equilibrium, creating unemployment (decreasing quantity of labor demanded and increasing quantity of labor supplied)
social insurance (public insurance)
government run programs that you put money in during good times and receive from during bad times (ex. unemployment, disability) (not just for poor people, many poor people aren't eligible)
institutional factors that affect wages
governments regulations, unions and workers' bargaining power, monopsony and employers' bargaining power
price discrimination methods
group pricing, hurdle method
experience good
have to experience to evaluate; persuasive advertising
product positioning
how a firm differentiates its product relative to the competing products (price and product differentiation)
annual income
how much a person earns in a year (not a perfect measure of inequality because can vary a lot for an individual over time)
Consumption
how much a person spends in a year (better measure than income because reflects living standard)
slightly better ceo can result in
huge bonus for company, if it is very large
discount effect
in order to sell one more unit, you have to lower the price; lose some revenue from each additional unit; delta P x Q
profits tend to zero
in the long run
inequality of income
income is distributed unequally; inequality is rising
Taxes for social insurance
income, payroll, corporate; wealthier pay more, helping reduce inequalities
result of price discrimination
increase producer suprlus, increase efficiency for society, decrease some consumers' surplus, increase some consumers' surplus
when firms exit
increased demand, increase in market power
3 types of inequality
inequality of outcomes, inequality of opportunity, inequality of process
Relative poverty
judges poverty relative to the material living standards of your contemporary society (with this view, poverty not just about physical measures of need, but whether you have the resources necessary to participate in society)
Absolute poverty
judges the adequacy of resources relative to an absolute or unchanging standard of living (with this view, poverty line would be the same in US and Zambia)
effects of market power
lead to innovation so beneficial to society but results in DWL so inefficient
costs of market power
leads to: - higher prices than perf competition - inefficiently smaller quantities - larger economic profits for firm - inefficiently high costs
firm expectations
long run profit, they will stay
hurdle method
lower prices for buyers who are willing to overcome an obstacle; find hurdle that reveals the reservation prices, people who are higher will just pay it (ex. timing, hassle, quantity, bundling)
monopoly demand curve
market demand=firm demand
perfect competition
markets in which 1) all firms in an industry sell an identical single good; and 2) there are many buyers and sellers, each of whom is small relative to the size of the market; no market power
licensing laws
need license to do the job, creates hassle for workers but raises their wages after, reduces supply of labor, might raise costs more than benefits
Price takers in a competitive market
no control over price (in perfect comp, sellers and buyers have no market power)
cooperation and perfect competition
no possibility for strategic interactions in perfect competition
free entry
occurs until all firms earn 0 economic profit
price competition
offer lower prices as compared to rivals
hold-up problem
once you have made a relationship-specific investment, the other side may try to renegotiate to get a better deal (ex. car company pays you less)
search good
one you can evaluate before buying; informational advertising
monopsony
only one buyer of a good; ; lower wage because theres no opportunity elsewhere
accounting profit
only out of pocket, explicit financial costs are considered total revenue - explicit financial costs
marginal revenue
output effect (P) (which is the price of the extra item you sell) - discount effect (delta P x Q) (the price cut you'll have to offer x the quantity that gets that price cut)
labor market discrimination
people are paid differently for unrelated reasons to productivity, ex. race, gender, religion
superstars
people with very high wages; operate in labor markets where being a tiny bit better makes a huge difference in your salary
different markets and advertising
perfectly competitive- only group coordinated ad for good monopoly- ads focus on product to increase demand imperfect competition (monopolistic competition)- aggressive ads for specific product/ brand over similar rival's
cooperation
ppl often fail to cooperate, even when there's a project that could make them all better off; cooperation leads to efficiency
types of discrimination
prejudice, implicit bias, statistical discrimination
overall tax system
progressive, tool for income redistribution, making society more equitable, lead to deadweight loss (sacrificing efficiency)
advertising
purpose: to shift out (increase demand) and steepen (less elastic/ price sensitive = customer loyalty ) the demand curve, dependent on the market and product
product differentiation
real or imagined differences between competing products in the same industry; characterized by monopolistic competition
average revenue
revenue per unit; total revenue/quantity= price
strategies to mitigate risk
risk spreading, diversification, insurance, hedging, gather information
deterrence barriers to entry
scare new firms away from entering (war chest; cash to fight new entrants, develop reputation)
rational rule for sellers
sell one more item if the marginal revenue is greater than (or equal to) marginal cost MR>MC, stop when MR=MC
bundling
selling different goods together as a package
price discrimination
selling same good at different price (ex. student tickets)
entry and exit
short run: none long run: yes!
U.S. official poverty line
shows what family of four needs comfortably, if you are below the threshold, you are in poverty (does not include government income); something between absolute and relative poverty line
product differentiation strategy
some might be willing to pay more, gives more market power
Costs of redistribution
taxes create deadweight loss, discourages work, benefits might be reduced for lower incomes (some people might rather have a lower wage with the benefit rather than a higher wage)
bargaining power
the ability to negotiate a better deal; depends on next best alternative
human capital
the accumulated knowledge and skills that make a worker more productive
wage premium
the additional benefit in wage from working an unpleasant job
marginal revenue curve
the additional revenue from one more unit sold; diminishing in imperfect competition (you sell more, but the price lowers)
marginal utility
the additional utility you get from one more dollar
marginal utility of income
the additional utility you get from one more dollar
social safety net
the cash assistance, goods and services provided by the government to better the lives of those at the bottom of the income distribution; means-tested
compensating differential
the difference in wages required to offset the desirable or undesirable aspects of a job; depend on preferences of other workers (interdependence principle)
risk aversion
the dislike or avoidance of uncertainty
wage penalty
the lower wage one is paid due to working a pleasant/desirable job
progressive tax
the more money you make, the higher your tax rate is; federal income taxes are progressive
reservation price
the most one will pay for a good (max WTP)
Poverty rate
the percentage of people whose family income is below the poverty line
game theory
the study of strategic interactions
marginal tax rate
the tax rate on the next dollar you earn
firms can discriminate when
they have market power, can prevent resale, and are able to target the right price to the right customers
statistical discrimination
using observations about average characteristics to make inferences about an individual; on average might work, on individual basis is wrong
wealth
value of all assets
different goods and advertising
very similar- no advertising unique- advertise product imperfect substitutes- advertise their specific product aggressively (ex. coca cola)
expected utility
what your utility will be, on average, if you make a particular choice; Example: expected utility of starting a business: (probability business succeeds x utility if business succeeds) + (probability business fails x utility if business fails)
output effect
when a firm sells one more unit it will get the revenue from that additional unit
monoply
when there is only one seller in the market; have a lot of market power
imperfect competition-
when you face at least some competitors and/or sell products that differ at least a little from you competitors; monopolistic competition and oligopoly are examples
solutions to hold-up problem
write a contract, have a good reputation, vertical integration (car company buys parts supplier)
