ECON QUIZ 2
Nash Equilibrium
"best" choice for both players. solution to the game
Labor demand shifters
-Changes in demand for your product -Changes in the price of capital -Better management and productivity gains -Nonwage benefits and taxes shift demand back
Grim Trigger Strategy
-If the other players have cooperated in all previous rounds, then you'll cooperate -If any player has defected in any previous round, you'll defect forever after
How do firms know what their demand curve looks like?
-Managers might offer different prices to different groups of customers -Managers might offer different prices at different locations -Managers might offer different prices over time
How many cars should one sell? (Optimal price)
-Marginal cost and marginal revenue are plotted -Find Q of MR = MC -Find Price corresponding to that quantity on the demand curve
Rules of Firm Entry and Exit
-New competitors will enter profitable markets -Existing competitors exit unprofitable markets, which helps restore profitability
Why does the market labor supply slope upward?
-New people may be induced to enter the workforce as wages increase -Existing workers may put in more hours as wage rises -Some people may switch occupations to those with higher wages
Four steps to good strategic decisions
1. Consider all possible outcomes 2. Think about "what ifs" separately 3. Play your best response for each "what if" 4. Put yourself in someone else's shoes
Types of barriers to entry
1. Government franchising, licensing or regulation 2. Patents 3. Economies of scale or other cost advantages (high startup costs) 4. Ownership of a scarce factor of production 5. Network effects and switching costs
Solutions to natural monopolies
1. Government provides goods, setting P = MC and tax revenues pay for losses 2. Private sector can supply and P = Average cost
Governments ensure competition in markets by
1. Making laws to ensure competition thrives 2. Making laws that minimize the harm done by businesses exploiting market power
Comparing market power and perfect competition
1. Market power leads to higher prices 2. Market power leads to inefficiently smaller quantity 3. Market power yields larger economic profits 4. Businesses with market power can survive even with inefficiently high costs
How to characterize customers for group pricing
1. Verifiable characteristics (sex, age, student) 2. Difficult-to-change characteristics (can't just get a discount easy peasy)
Conditions for price discrimination
1. Your business must have market power 2. You can prevent resale 3. You can target the right prices to the right customers
Firm
A bundle of contracts. They allow the firm to transform inputs into outputs
Fixed cost
A cost that does not change as quantity produced changes
Focal point
A cue from outside a game that helps you coordinate on a specific equilibrium -ie door problem: signs on doors, norms, laws
Education as a signal
A degree can serve as a signal. You worked hard to get your degree, you must be a good worker.
Coordination game
A game in which all players have a common interest in coordinating their choices
Anti-coordination game
A game in which the best response is to take a different but complementary action to the other player
Prisoners' Dilemma
A game in which the players are prevented from cooperating and in which each has a dominant strategy that leaves them both worse off than if they could cooperate
Strategic plan
A list of instructions that describes how to respond to any possible situation
Quantity discount
A per-unit price that is lower when you buy a larger quantity -Some see buying a bigger quantity to be a hurdle
Prejudice
A preconceived bias against a group that is not based on reason or experience
One-shot game
A strategic interaction that occurs only once
Wage gaps can occur because
Accounting for differences in human capital and job characteristics explains some gaps
Human capital
Accumulated knowledge and skills (education, experience, training, skills)
Collusion
An agreement to limit competition
Signaling
An attempt by the informed side to communicate valuable information that is otherwise hidden
Profit maximizing quantity
At Marginal revenue = Marginal cost
Why does the demand for labor slope downward?
At a high wage, producers want to use less labor and simply produce less to avoid paying higher variable costs. At a low wage, employers are more likely to pay more wages and produce more. -Diminishing marginal product
Why does the supply of labor slope upwards?
At higher wages, people are more willing to work. If wage is too low, employees will prefer to take other jobs. High wages will incentivize more people to join the industry.
Diminishing returns to an input occur when
At least one input is fixed
In the long run, price equals
Average cost
Long-run profitability depends on
Barriers to entry
Institutional discrimination
Bias against disadvantaged groups that is embedded in laws and institutions
Competition is better for consumers because
Businesses will lower their prices and raise quantity to compete with other firms
Thinking like an economist, you should consider a career where
Capital goods are complements
Example of oligopoly
Cellphone providers (AT&T, Verizon, T-mobile, etc)
What shifts individual labor supply
Changing wages in other occupations Changing number of potential workers Changing benefits of not working Nonwage benefits, subsidies, and income taxes
Perfect price discrimination
Charging each customer their reservation price
2 types of mergers
Competitive mergers and anti-competitive mergers
Economy of scale
Costs fall as firm grows
Bundling
Creates a hurdle to getting the second good at a lower price
Competitive merger
Creates a more fearsome competitor. Bad for rivals but could be good for consumers
The income effect is dominating when the supply curve slopes
Downwards
Best responses
Each player's choice is their best response to what they expect the other to choose
Product differentiation
Efforts by sellers to make their products different from those of their competitors
Screening
Employer looks for signals
Efficiency wage
Employers pay workers more to make them more productive. Some jobs will pay more because effort is harder to monitor. It is an incentive.
Free exit
Ensures industries won't remain unprofitable in the long run. Firms will exit until remaining firms once again earn zero economic profit.
Average Revenue
Equals price if everyone is charged the same price.
The opportunity cost of working
Everything you do when you are NOT working
Synonym for input market
Factor market
True or False: Economic profit is important for both long and short run analysis of firm entry and exit
False. Just important for long-run
Average cost
Firm's total costs (fixed and variable) divided by quantity. Total cost / Quantity. Cost per unit.
finitely repeated game
Game in which you face the same strategic interaction a fixed number of times. These often end up the same as one-shot games. Same outcome as one-shot games.
Indefinitely repeated game
Game in which you face the same strategic interaction an unknown number of times
Tit-for-tat strategy
Grim trigger but forgiving. -If the other player has cooperated in the previous round, then you'll cooperate in this round -If the other player has defected in the previous round, you'll defect in the current round
3rd degree price discrimination
Group pricing
Merger Regulation can be evaluated with
Herfindahl-Hirschman Index
Rational Rule for Employers
Hire more workers if the marginal revenue product is greater than or equal to the wage -MRP = Marginal Benefit of Employee -Wage = Marginal cost of employee -Marginal Benefit = Marginal Cost to maximize profits
Employers look for _________ when trying to determine which workers are likely to be more productive
Human capital
2nd degree price discrimination
Hurdle pricing
Marginal revenue will be less than price because
If a firm wants to choose a higher quantity to sell, they must lower prices on ALL UNITS SOLD
Substitution effect
If you can replace labor with capital, your need for workers will fall
Labor demand
In a competitive market, employers pay market wage. They are price takers.
Game theory
In all conflict situations, and thus all games, there are decision makers, rules of the game, and payoffs. Players will choose their strategy without knowledge of how the opposition will play
Maximin strategy
In game theory, a strategy chosen to maximize the minimum gain that can be earned. Players will choose the strategy that has the most attractive "worst case" scenario
Dominant strategy
In game theory, a strategy that is best no matter what the opposition does
Labor supply curve depends on the balance of
Income and substitution effects
Price discrimination _______ efficiency relative to a market without price discrimination
Increases
A woman resigns from her executive position to care for her young children. When her kids are older, she decides to resume her career. She finds her earnings are reduced because of the time she spent outside of the workforce. This is an example of the
Interdependence principle
Natural monopoly
It makes sense sometimes to have a monopoly in certain industries due to economies of scale. The government will allow the monopoly but closely regulate it to minimize harm by market power
Implicit bias
Judgments shaped by the unconscious attribution of particular qualities to specific groups
The price in perfect competition is ______ than the price under imperfect competition. The quantity in perfect competition is ________ than the quantity under imperfect competition
Lower, higher
Tying contracts
Making a customer buy something from someone else in order to be allowed to buy from you
Perfect competition
Markets in which all businesses sell identical goods, with many buyers and sellers. Sellers DO NOT have market power. They are price takers.
Monopolistic competition
Markets in which many small businesses compete, each with differentiated products. Sellers have a LITTLE market power
Monopoly
Markets in which there is only one seller of a product with no close substitutes. Has A LOT of market power
Oligopoly
Markets with only a handful of large sellers. Goods can be homogeneous or differentiated. Sellers have SOME market power
Goal of all firms
Maximizing profits
Income effect (for workers)
Measures how people respond to changes in income and says higher income makes leisure more attractive
Substitution Effect (for workers)
Measures how people respond to changes in relative prices and says that higher wages make work relatively more attractive
Exclusive dealing
Not letting your customers buy from a competitor
Barriers to entry
Obstacles that make it difficult for new firms to enter an industry -Monopolies have the strongest barriers to entry -Oligopolies often have barriers -Perfect and monopolistic competition do not have barriers to entry and thus tend to have zero profit in long run
Strategic Interactions
Occur when your best choices may depend on what others choose and when their best choices may depend on what you choose
Derived demand
Occurs because demand for labor is derived from the demand for the stuff labor makes
Hurdle method
Offering low prices only to buyers who are willing to overcome some hurdle or obstacle -yields self selection -weed out high marginal benefit customers to pay more -hardcover or paperback -haggling for a car. people who dont want to haggle will pay more for a car
Implicit cost
Opportunity cost
Marginal revenue reflects the
Output effect minus discount effect (P - dP*Q)
4 Types of Market Structure
Perfect competition Monopolistic competition Monopoly Oligopoly
Types of discrimination
Prejudice Implicit bias Statistical discrimination Institutional discrimination
Anti-collusion laws
Prevent businesses from agreeing not to compete
Merger laws
Prevent competing businesses from combining to consolidate market power.
Group pricing
Price discrimination by charging different prices to different groups of people -ie: student discount, senior discount, residential versus commercial use
"Just as good as next best option"
Profits = Zero
Examples of natural monopolies
Public utilities Phones used to be
Free entry
Pushes economic profits down to zero in the long run -Occurs when there are no factors making it difficult or costly for a business to enter or exit an industry
Anti-competitive merger
Reduces competition for all sellers. Good for rivals, bad for consumers
Variable cost
Rises as quantity produced rises
Price ceilings limit market power
Set price = marginal cost -Eliminates discount effect and underproduction
Compensating differential
The differences in wages required to offset the desirable and undesirable aspects of a job. Encourage people to take more unpleasant jobs.
Market power
The extent to which a seller can charge a higher price without losing all sales to competing businesses
Marginal product of labor
The extra production that occurs from hiring an extra worker
Short run
The horizon over which the production capacity and the number and type of competitors you face cannot change (fixed factors and costs)
Long run
The horizon over which you or your rivals may expand or contract production capacity and new rivals may enter the market or existing firms may exit -Useful for planning purposes
Marginal revenue product
The marginal revenue from hiring an additional worker -MRP = Marginal Product*Price
Reservation price
The maximum price a customer will pay for a product
Production
The process by which inputs are combined, transformed, and turned into outputs
Output effect
The revenue increase from selling one more unit Price
Discount effect
The revenue loss from cutting the price on all units sold. Change in price*Quantity(old)
Imperfectly competitive market
The situation of facing at least some competitors and/or selling products that differ at least a little from those of competitors
Discrimination
The treating of people differently based on characteristics like their gender, race, ethnicity, sexual orientation, religion, disability, and social class
How do perfectly competitive markets choose the price of their products?
They can't choose the price, so they set the quantity supplied to where price equals marginal cost
Marginal Revenue Calculation
Total revenue / change in quantity
Accounting Profit
Total revenue minus financial costs
Economic Profit
Total revenue minus financial costs minus opportunity costs
The substitution effect is dominating when the supply curve slopes
Upwards
Statistical discrimination
Using observations about the average characteristics of a group to make inferences about an individual
The supply curve looks like this when income and substitution effects offset
Vertical line
Price-fixing
When competitors get together and decide to raise the prices (cartels)
Interlocking directorates
When someone serves on the board for 2 competing firms
Scale effect
When the price of capital declines, you can produce output more cheaply. More workers are needed to produce more things
When does multiple equilibria occur
When there is more than one equilibrium. No dominant strategy.
Repeated game
When you face the same strategic interaction with the same rivals and the same payoffs in successive periods
Rational rule for workers
Work one more hour as long as the wage is at least as large as the marginal benefit of another hour of leisure
Rational Rule for Entry
You should enter a market if you expect to earn a positive economic profit, which occurs when price exceeds average cost
Rational Rule for Exit
You should exit the market if you expect to earn a negative economic profit, which occurs if price is less than average cost
Economic Profit is _________ less than Accounting Profit
always
Market power allows businesses to _______ prices
choose
Indefinitely repeated play helps solve the Prisoners' Dilemma and lead to
collusion
Marginal cost
dTotal cost/dQuantity
If labor becomes more productive,
demand for labor shifts out
True or False: total costs do not include opportunity costs
false. Total costs include opportunity (implicit) costs
Higher education corresponds to
higher earnings
labor choice can be modelled as a tradeoff between
labor and leisure
More competitors = ______ market power
less
WHERE A FIRM MAXIMIZES PROFIT
marginal revenue = marginal cost
Firm's demand curve _______ slope down, depending on market power
might
Market structure with most market power
monopoly
It is often ______ efficient to allow a natural monopoly in certain industries.
more
Successful product differentiation allows you _______ market power
more
Explicit cost
out-of-pocket expenses
Market structure with least market power
perfect competition
For oligopolies, perfectly competitive and monopolistically competitive firms, market demand will always
slope down
Labor Market
the input/factor market in which households supply work for wages to firms that demand labor Price = Wage Quantity = Hours labor supplied
Nonwage benefits and taxes shift demand back because
they add to the cost of labor without affecting wage
Profits Equation
total revenue - total costs (Price*Quantity) - Total Costs
Market power creates ____production
under