ECON 101 Final
expected utility equation
(prob. success x utility success) + (prob. fail x utility fail)
ways to successfully price discriminate
- group discounts - hurdle method
how to solve the hold up problem
-long-term contracts - reputation - vertical integration
where does price discrimination set the price?
jest below the marginal benefit
Pay‐for‐performance
link workers earnings to measure of performance
Where to position your product?
locate right next to your rival
monopolistic competition= _____ firms, ______ product, _______ market power
many, differentiated, some
perfect competition = _____ firms, ______ product, _______ market power
many, same, no
utility
measure of well-being
if price competition is not intense... (elections)
minimize differences
mixed strategy is used in the real world for ___________ to reduce _____________.
monitoring, moral hazard
how higher market power affects demand curve
more market power = steeper curve
if economic profit is being earned, expect________
new firms to want to enter your market
is the socially optimal outcome always the equilibrium?
no
barriers to entry
obstacles that make it difficult for new firms to enter a market
hold-up problem
once you have made a relationship-specific investment, the other side may try to renegociate to get a better deal
how does moral hazard jeopardize the insurance market?
once you insure something, it becomes more likely to happen, so price goes up and people tend to only buy insurance if they really need it
if you are analyzing the checks for the player in rows,
only one check per column (analyzing based on other player)
common mistakes with uncertainty
overconfidence, availability bias, anchoring bias
experience goods use
persuasive advertising (more suggestive)
if everyone charged the same price, average revenue =
price
free entry continues until...
price = average cost
infinite regress
princess bride scenario
principal-agent problem
problems when a principal hires an agent to work on their behalf, but can't monitor everything they do (hiring someone)
free entry
pushes economic profits to zero
Bertrand Paradox
with no product differentiation, even one competitor can force your economic profits to zero
solving coordination problems
1. communication (only when players want the same thing) 2. focal points (cues from outside game) 3. culture and norms (bow) 4. Laws and regulations (traffic)
four STEPS to making good decisions
1. consider all the possible outcomes (payoff table) 2. think about the what ifs separately 3. play your best response 4. put yourself in other people's shoes
five forces that determine firm profability
1. current competitors (type and intensity of competition) 2. potential entrants (threat of new entry) 3. competitors in other markets (potential substitutes) 4. suppliers (seller bargaining power) 5. customers (buyer bargaining power)
4 ways to create barriers to entry
1. demand-side strategies (customer lock-in) 2. supply-side strategies (mass production, efficiency, relationships) 3. government regulation (patents and licenses) 4. deterrence (be the competitor crusher)
Ways to Solve Hidden Action Problems
1. make observable by monitoring 2. subsidize complements to helpful behavior (health insurance offers gym membership discount) 3. give agent a stake in the outcome 4. laws help with some forms (you can't lie and cheat) 5. pick the right kinds of agents (intrinsic motivation)
5 ways to reduce risk
1. risk spreading (break big risk into smaller risks) 2. diversification (don't put all your eggs in one basket) 3. Hedging (offsetting risks) 4. Insurance 5. Gathering Information
solutions to adverse selection of buyers
1. sellers can use info related to buyers likely costs 2. sellers offer different contracts to separate buyers (high vs. low deductible insurance plans) 3. government can increase information or directly reduce adverse selection
solutions to adverse selection of sellers
1. third-party verifiers 2. government forces sellers to reveal info and maintain quality (FDA) 3. Sellers can signal quality (warranty)
Nash equilibrium
A situation in which each firm chooses the best strategy, given the strategies chosen by other firms. (check from each player)
adverse selection
A situation where sellers have information that buyers don't (or vice versa) about some aspect of product quality.
anchoring bias
relying too much on first impression
willingness to take risks depends on ______________.
risk aversion
systematic risk
risks that are common across the whole economy (recessions, wars, natural disasters)
long run
rivals may expand or contract your production capacity, and rivals may enter/exit
price discrimination
selling the same good at different prices.
advertising as a signal
showing off expensive ads to convince customers that they have enough repeat customers to afford it
when is there no Nash equilibrium?
simple strategies
example of moral hazard
slacking off at work
best to offer a product that better serves the needs of __________ customers
some
payoff table
table which lists your choices in each row and the other players choices in each column
availability bias
tendency to overestimate the frequency of events you remember well, and underestimate frequency of the less memorable ones
market power
the ability to charge higher prices without losing too many customers
normal profits
the return that an entrepreneur could have earned by investing their time and capital elsewhere
accounting profits
total revenue - total costs
mixed strategy
unpredictably mix between alternative actions (most helpful when one wants to coordinate and other wants to anti-coordinate)
next best alternative
value of the best option outside the deal
slightly risk averse
weakly diminishing marginal utility (more likely to risk)
expected utility
what your utility will be on average if you make a particular choice
adverse selection of buyers
when buyers know more than sellers...attracts high cost customers (all-you-can-eat attracts the hungry ones)
vertical integration
when supplier and buyer merge into single company (no incentive to hold each other up)
multiple equilibria
when there is more than one equilibrium
when should you move pre-emptively?
when theres a first mover advantage
strategic interaction
you best choice depends on what others choose
you can only gain first mover advantage if ____________.
you convince your rivals that you'll actually follow through on your plan to act aggressively
experience goods
you have to consume to evaluate (restaurant meals)
bargaining power
your ability to negotiate a better deal
fair bet
a gamble that, on average, will leave you with the same amount of money
economic profits
accounting profit - normal profit
hidden action vs. hidden type problems
action: moral hazard type: adverse selection
moral hazard
actions you take when your actions aren't fully observable and you are partially insulated from their consequences
simultaneous games
all players make their choices without knowing what choice the other has made
search good
any good that you can easily evaluate before buying it
representation bias
assessing how likely someone will be a part of a group based on how similar to the group they are
loss aversion (payoffs)
being more sensitive to losses than gains
anti-coordination game
best response is action different from other player
coordination game
best response is same choice as other player
adverse selection of sellers
buyers can't observe quality of good, so lower quality goods are over-represented
play your best response
checks
prisoner's dilemma
coke and peps advertising -- people often fail to cooperate when theres a project that could make them all better off
when you are a row player, you choose by ______
comparing choices in each column
two COMPETING forces of business strategy
demand (please as many customers as possible) & supply (position product away from rivals)
if price competition is intense... (coke and pepsi)
differentiate your product
how does money relate to well-being?
diminishing marginal benefit (loss is greater than gain)
two perspectives on barriers to entry
entrepreneur wants to build barriers to maximize firm profits. policymaker wants to eliminate barriers to entry to maximize competition and economic surplus.
actuarially fair insurance
expected payouts are equal to premiums
marginal utility
extra utility you get from $1 more in wealth
average cost
firm's total cost divided by quantity produced
how is economic development a coordination game?
firms decide skilled or unskilled, workers decide to get skills or not
average revenue
firms total revenue divided by quantity
focusing illusion (payoffs)
focusing on a salient factor over others
sequential games
games that play out over time
what happens to demand curve when rivals enter?
gets less steep - lower prices -smaller quantity - economic profit decreases
short run
horizon over which the production capacity and number and type of competitors you face can not change
if firms can freely enter and exit
in the long run economic profits zero (nightclubs)
what does advertising do?
increase demand for your product... steepens curve
search goods use
informative advertising
relationship-specific investment
investment that is more valuable if the current business relationship continues
how does insurance relate to moral hazard?
it partially protects you from the consequences of your actions