Final Exam (2nd Half of Course)

Bang for Buck K & L

(MP K / r) = (MP L / w) ; Where marginal product per $ spent on each input (both K & L) are the same ; marginal benefit to cost ratios are equal for K & L

Economic cost

Accounting cost + Opportunity cost ; What firms decisions should be based on

Marginal product (MP)

Additional output firm can produce by using additional unit of input

Marginal revenue (MR)

Additional revenue from selling 1 additional unit of output; in perfect competitive market MR = P

Marginal product of labor

Change in quantity due to 1 unit change in labor while maintaining K constant

Price discrimination (PD)

Charge different price to different consumers to capture all CS; transfers CS to PS and does NOT create DWL; requirements: [1] firm has market power [2] there does not exist resale; types: [1] 1st degree (WTP) [2] 2nd degree (quality and price variation) [3] 3rd degree (consumer groups)

First degree price discrimination

Charge everyone their willingness to pay for each additional unit; consumers pay their entire WTP; types [1] different consumers who have different observable WTP (charge every single consumer their WTP for the good) [2] identical consumer but each consumer has different WTP for each number of goods (options: [a] subscription fee + MC [b] sell goods 1 by 1 and charge consumers WTP; maximizes profits by capturing full surplus

Risk loving

Concave up utility curve

Variable cost (VC)

Cost of inputs that change as firm changes its quantity of output; in long term, are all inputs; short term is labor, payment for input etc; is adjustable

Isocost line

Curve describes all L & K combos that yield cost C; C = rK+wL where r is rental rate and w is rate; slope represent cost consequences of substituting 1 input for another; firms want isocost line closest to origin (min cost); Shows combination of K & L w/ C constant

Isoquant

Curve that describes all combinations of (tradeoff between) K & L s.t. Q(K,L) = Q; Increase distance from origin = Increase Q; Requirements: [1] cannot cross [2] convex to origin ; Steep slope -> MP L > MP K; Flat slope -> MP L < MP K ; Straight curve -> inputs are substitutable; Shows firms production function

Residual demand curve

Demand remaining from firms output given competitor firms production quantity

Accounting (explicit) cost

Direct costs of operating; Everything firm pays out of pocket; $ that explicitly changes hands; payments for factors of production;Ex.) raw materials, wages, rent, services, purchase of goods

Insurance

Economic actor that pays to lower payers economic risk; policyholder pays premium to insurer yield decreased income of insurer for decrease in risk; shifts consumer risk to insurer

Nash equilibrium

Equilibrium where each firm is doing its best conditional on actions taken by other firms; where no firm has incentive to deviate

Actuarially fair

Expected premium = expected payouts Insurance policy with Expected net pay = 0; Yields no profits to insurer

Risk premium

Expected value (EV) - certainty equivalent (CE) Compensation required to bear risk w/out suffering loss in expected utility; extra number of expected income someone must receive to make them as well of when their income is risky as when its guaraneteed

Total cost (TC)

FC + VC

Average fixed cost (AFC)

FC/Q ; FC per unit of output; decreases as Q increases

Cost minimization

Firm's goal: to minimize cost of producing Q goods & Firm's constraint: must produce Q goods; Is constraint optimization problem where must find Q s.t. (slope of isoquant = slope of isocost)

Sunk costs

Fixed costs that are not avoidable & once paid for cannot be recovered; should NOT be considered in business decisions

Reaction curve

Function relates firms best response to its competitors possible action; are downward sloping; intersection of curves is Q at which all firms are both producing optimally given others actions (nash equilibirum

Second degree price discrimination

Generate product variations & price them differently; consumers self select; Is profitable to make value between cheap and expensive option large - done by making low quality item worse to deter those that have high WTP from buying cheap product; is set price structure get each type of consumer to do what producer wants; is incentive compatible because induces higher WTP consumer to buy expensive WTP by charging LEST THAN full WTP

Certainty equivalent

Guaranteed income level at which individual would receive same expected utility level as from uncertain income; certain number $ that is indifferent between certain $ and risk; have same utility value

Moral hazard

How 1 party ACTS once economic relationship has been entered into; effect on insurance: coverage on individual behavior once has policy may yield to less of effort to avoid bad behaviors that are covered by the policyholder; bad incentives; given is hidden action there is no real solution

Constant cost industry

Industry s.t. firms total costs do not change with change of total industry output; requires: [1] all firms have some TC, AC and MC functions [2] position of long run AC function doesnt shift as industry output changes (new firms enter but AC function remains the same)

Increasing cost industry

Industry s.t. firms' total cost increase w/ increase in total industry output

Fixed cost

Input cost that doesnt vary w/ number of output @ event if Q = 0; in short term is capital (ie. rent, supplies, machinery); not adjustable, is fixed

Complete (/full) insurance

Insurance policy that leaves insured individual equally well off regardless of outcome

Production function (Q(K,L))

Maps given capital K & labor L to quantity Q; Describes varieties combinations of K & L that yield output Q

Residual marginal revenue curve (RMR)

Marginal R curve corresponding to residual D curve; firm produces Qe at RMR = MC

Oligopoly

Market structure w/ competition between small number of firms; each producers actions influences what other firms will do so each firm must be doing as well as it can conditional on what other firms are doing (strategic interactions); Requires: [1] identical products [2] few firms [3] barrier to entry [4] low ATC

Long run industry equilibrium

No firm wants to change method/scale of production & profit = 0 so no firm wants to enter/exit

Short run industry equilibrium

Number of plants and firms are fixed; no existing firms want to change method/scale of production; all industries are ALWAYS

Betrand competition

Oligopoly model defined by firms independently choosing price at which to produce; can lead to price war; nash equilibrium is at Qe s.t. P(Qe)=MC(Qe); market outcome is same as competitive market; lowest price supplier serves whole market; is prices are equal market is split equally

Cournot competition

Oligopoly model where each firm simultaneously chooses its production Q; nash equilibrium is at intersection between reaction curves; each competitors profit maximizing output depends on others output; if firms have same cost function then are symmetric; is between monopoly and perfect competition

Stackelberg competition

Oligopoly model where firms make product decisions sequentially; first mover has advantage cause can take into account competitors future moves in current decision = first mover produces more than second producer

TR >= VC (P >= AVC)

Operate

Cartel

Organization formed when firms collide; group of suppliers who jointly max and split profits

Industry equilibrium

P & Q are stable = industry is at rest

Long run

Period of time where capital + labor are variable; variables are fully adjustable

Short run

Period of time where capital is fixed

Risk averse

Prefer guaranteed number to having risk; increase WTP = decrease risk = decrease utility; have concave utility curve for income with diminishing marginal utility of income; have uncertainty equivalent point below income utility curve; + curvature = increase risk premium; prefer U(E[x]) > E[U(x)]; when EV of risky option is higher than EV of guaranteed option could pick either depends on specific numbers and utility function

Profit maximizing quantity

Q s.t. MR(Q) = MC(Q) ; In perfect competitive market where MR=P, MR=MC=P

long-run competitive equilibrium

Q s.t. P = (min ATC = [ATC(Q) = MC(Q)]) Where firms gain no profit = no firms are entering

Average product

Q/L ; Increases when labor input increases

Collusion

Qe is at MR(Qe)=MC(Qe) All firms in oligopoly coordinate production & pricing decisions to collectively act as monopoly and split profits evenly between themselves; Assumes: [1] goods are identical [2] firms agree to coordinate [3] no firm deviates from agreement & produces & prices based on agreement; Yields higher profits then cournot and betrand; there exists an incentive to deviate Requires [1] barrier to entry [2] police agreement

Marginal rate of technical substitution (MRTS)

Rate at which firm can trade input L for K while holding output Q constant; describes firms ability to trade 1 input for another w/ Q constant; MRTS = (MP L / MP K)

Diminishing marginal product

Reduction in incremental output obtained from adding additional labor

Bundling

Selling multiple products in bundle; best when exist negative correlation of values across goods in bundle (Ex. when goods are complements)

TR <= VC (P <= AVC)

Shutdown

Risk neutral

Straight positive sloped utility curve

Diversification

Strategy to lower risk by combining uncertain outcomes; requires risks are not related; making bets that do well when other bets do poorly and vic versa; is ideal for bets to be as perfectly negatively correlated to reduce risk

Industry short run supply curve

Sum of firms short-run S curves; is sum of individual firms outputs at each P; increase P -> Increase Q; K &.L are variable costs; Is MC corve above AC

Firms short run cost function

TC(q) = FC + VC(q) Lowest total cost of producing each Q of product holding K fixed; VC is cost of labor, supplies etc. that can be changed; have to pay fixed cost where FC is sunk in short run cause TC(0) = FC

Average total cost (ATC)

TC/Q; TC per unit of output U shaped curve

Producer surplus (PS)

TR-VC

Average variable cost (AVC)

VC/Q ; VC per unit of production

Opportunity cost

Value would earn on giving up input (lost value) on next best use; value forfeited on giving up input

Expected value of gamble

Weighted average of values of each outcome, weighted by probability of each outcome occurring; doesnt capture everything between uncertainty EV=E[X} = sum(pi*xi)

Adverse selection

When consumer knows more than insurer

Asymmetric problem

When one economic actor knows more than other actor; yields inefficient market which may led to market failure; harms ALL economic actors/participants

P < ATC (R < TC)

[Profit=(P-ATC)Q] < 0

P = ATC (R = TC)

[Profit=(P-ATC)Q] = 0

P > ATC (R > TC)

[Profit=(P-ATC)Q] > 0

Marginal cost (MC)

dC/dQ = dVC/dQ s.t. is always greater than or equal to 0 Firms cost of producing 1 additional unit of output

Third degree price discimination

group people by characteristics and price different by group; requires [1] firm is monopoly of good [2] there exists different WTP [3] no ability to resell; maximizes profits; decrease price = increase elastic consumer; increase price = decrease elastic consumer; solve MR=MC for each group

Cost curve

maps firms production costs to output Q; Measured over particular time period; If fixed cost -> is horizontal line; if variable cost -> positive sloped line

Firm short run supply curve

{ MC(Q) if Q >=q where MC(q) = AVC(q) , 0 else Firms short run MC curve above min AVC