Econ Exam 3

Four important sources of market failure

(1) imperfect market structure, or noncompetitive behavior [ie P>MR=MC] (2) the existence of public goods (3) the presence of external costs and benefits (4) imperfect information

governments have assumed two basic and contradictory roles with respect to imperfectly competitive industries

1. The promote competition and restrict maker power, primarily through antitrust laws 2. They restrict competition by regulating industry example: licenses can thwart competition

Is land elastic or inelastic

Inelastic because it is completely fixed

the colluding oligopoly will face market demand and produce only up to the point at which

MR=MC, and P>MC

MRP(labor) = _ x _

MRP(labor) = MP(labor) x Px

what happens to MRP when demand and price increase

Product demand increases, product price rises, MRP increases MRP shifts to right

what is the result of producing/using capital on productivity of labor, labor demand and wages

The production and use of capital enhances the productivity of labor and normally increases the demand for labor and drives up wages

nonrival in consumption

a characteristic of public goods: one person's enjoyment of the benefits of a public good does not interfere with another's consumption of it. National defense =nonrival

oligopoly

a form of industry (market) structure characterized by a few dominant firms. Products may be homogeneous (meat packing) or differentiated (washing machines). The behavior of any one firm in an oligopoly depends to a great extent on the behavior of others

price leadership

a form of oligopoly in which one dominant firm sets prices and all the smaller firms in the industry follow its pricing policy.

cartel

a group of firms that get together and makes joint prices and output decisions to maximize join profits

perfectly contestable market

a market in which entry and exit are costless

five force model

a model that helps us understand the five competitive focus that determine the level of competition and profitability in an industry

marginal productivity theory of income distribution

all factors of production receive rewards determined by their productivity as measured by MRP

public choice theory

an economic theory that the public officials who set economic policies and regulate the players act in their own self-interest, just as firms do

pure monopoly

an industry with a single firm that produces a product for which there are no close substitutes and in which significant barriers to entry prevent other firms from entering the industry to compete for profits

MRP will eventually be the firm's _________

input demand curve

methods of indirect regulation designed to induce firms/households to weigh the social costs of their actions against their benefits

taxes, subsidies, legal rules, public auction

factor subsitution effect

tendency of firms to substitute away from a factor whose price has risen and toward a factor whose price has fallen

imperfect information

the absence of full knowledge concerning the product characteristics, available prices, etc

collusion

the act of working with other producers in an effort to limit competition and increase joint profits

marginal revenue product (MRP)

the added revenue a firm earns by employing one additional unit of input. MRP is the value of each additional worker to the firm.

What happens when MRP(labor) > W and MRP(labor)=W

1. Hire more workers 2. At profit maximization

P(L)= P(K)= P(A)=

1. MRP(Labor)=(MP(Labor)xP(x) 2. MRP(K)=(MP(K)xP(x)) 3.MRP(A)=(MP(A)xP(x)) x= output

Firms will hire until: and Firms will produce until:

1. MRP(labor) = W 2. P = MC

All societies answer these basic questions in the design of their economic system

1. What gets produced? 2. How is it produced? 3. Who gets what is purchased?

two implications of rent seeking behavior

1. behavior consumes resources. (economic profits could be completely consumed through rent-seeking behavior that produces nothing of social value; all it does is help to preserve the current distribution of income 2. government failure

tie bout hypothesis implies

1. equal provision of government services may be ineffienct bc ppl have heterogeneous preferences 2. people will move to where the desired government budget is 3. government service provision affects housing values and wages as they affect desirability of locations

the courts are empowered to impose a number of remedies if they find that antitrust law has been violated. Specifically, the courts can:

1. forbid the continuation of illegal acts 2. force the defendants to dispose of the fruits of their wrong 3. restore competitive conditions

4 barriers to entry

1. government franchise 2. patents 3. Ownership of a Scarce Factor of Production 4. Network Effects

5 approaches that have been taken to solving the problem of externalizes

1. government-imposed taxes and subsidies 2. private bargaining and negotiation 3. legal rules and procedures 4. sale or auctioning of rights to impose externalities 5. direct government regulation

monopolistic competition

1. large number of firms 2. no barriers to entry 3. product differnetiation

problems with monopolistic competition efficiency

1. once a firm differentiates a product and achieves market power, it's strategy is to hold down production and change a price above MC P>MC implies loss 2. final equilibrium is to the left of the low point on its average total cost curve; not the most long-run productive point

why are oligopolistic industries likely to be inefficient

1. price is going to be above marginal cost 2. strategically competitive firms can force themselves into deadlocks & waste resources

Pareto efficiency or Pareto optimality

A condition in which no change is possible that will make some members of society better off w/o making some other members of society worse off

Antitrust Division (of Dept. of Justice)

One of two federal agencies empowered to act against violators of antitrust laws. It initiates action against those who violate antitrust laws and decides which cases to prosecute and against whom to bring criminal charge s

patent

a barrier to entry that grants exclusive use of the patented product or process to the inventor. A 20-year monopoly from when the patent is first filed. Society trades off the enhanced incentives to get more invention v the losses to society of having "too little" produced at a high price: say a cancer drug

tit-for-tat strategy

a company's strategy that lets a competitor know the company will follow the competitor's lead. Works remarkably well. good behavior rewarded bad behavior punished

mechanism design

a contract or an institution that aligns the interests of two parties in a transition.

externality

a cost or benefit imposed or bestowed on an individual or a group that is outside, or external to, the transaction

injunction

a court order forbidding the continuation of behavior that leads to damages

kinked demand curve model

a model of oligopoly in which the demand curve facing each individual firm has a kink in it it. The kink results from the assumption that competitor firms will follow if a single firm cuts price but will not follow if a single firm raises its price.

government franchise

a monopoly by virtue of government directive (e.g. license) for example, the government had restricted the local landline phone service to one firm

risk-averse

a person's preference of a certain payoff over an uncertain one with the same expected value

vertical differentiation

a product difference that, from everyone's perspective, makes a product better than rival products

adverse selection

a situation in which asymmetric information results in high quality goods or high quality consumers being squeezed out of transactions bc they cannot demonstrate the quality of the product they are offering for sale

maximin strategy

a strategy chosen to maximize the min. gain that can be earned. Very conservative.

product differentiation

a strategy that firms use to achieve market power accomplished by producing products that have distinct identities in consumers' mind. Can charge a premium price for these products.

dominant strategy

a strategy that is best no matter what the opposition does

market signaling

actions taken by buyers and sellers to communicate quality in a world of uncertainty

rent-seeking behavior

actions taken by households or firms to preserve positive profits by keeping competition out say when taxi drivers or other producers obey to maintain their favored position by government. This results in wasted resources.

commitment device

actions that individuals take in one period to try to control their behavior in a future period firms will take advantage of this... long-term memberships at health clubs or high prices for small quantities for 'bad' things like ice cream

marginal damage cost (MDC)

additional cost to society of producing one more unit through additional negative externalities such as pollution

tiebout hypothesis

an efficient mix of public goods is produced when local land/housing pries and taxes come to reflect consumer preferences just as they do in the market for private goods people show their consumer sovereignty with their feet

market power

an imperfectly competitive firm's ability to raise price without losing all of the quantity demanded for its product

monopoly

an industry composed of only one firm that produces a product for which there are no close substitutes and in which significant barriers exist to prevent new firms from entering the industry. This is the best example of imperfect competition.

imperfect condition

an industry in which single firms have some control over price and competition. Imperfectly competitive industries give rise to an inefficient allocation of resources

imperfectly competitive industry

an industry in which single firms have some control over the price of their output

natural monopoly

an industry that realizes such large economies of scale in producing its product that single-firm production of that good or service is most efficient

game theory

analyzes oligopolistic behavior as a complex series of strategic moves and reactive countermoves among rival firms. firms are assumed to anticipate rival retains

Treble damages

any person or private company that sustains injury or financial loss because of an antitrust violation can recover damages from the guilty party over and above any fines levied

moral hazard

arises when one party to a contract passes the cost of its behavior on to the other party to the contract this causes market failure example: no not a campus bar!

asymmetric information

can occur when a buyer or seller enters into an exchange with another party who has more information

price discrimination

charging different prices to different buyers example: charging different prices (less) for children/seniors at movies

tacit collusion

collusion occurs when price and quantity fixing agreements among producers are explicit. Tacit collusion occurs when such agreements are implicit.

wheeler-lea act

extended the language of the Federal Trade Commission Act to include "deceptive" as well as "unfair" methods of competition

monopolistic competition in the long run

firm's demand curve is tangent to its average total cost curve for pro its to equal 0

consent decrees

formal agreements on remedies among all the parties to an antitrust case that must be approved by the courts. Consent decrees can be signed before, during, or after a trial

drop-in-the-bucket problem

good or service usually so costly that its provision generally does not depend on whether or not any single person pays

public goods or social goods

goods or services that bestow collective benefits o members of society. Generally no one can be excluded from enjoying their benefits. Classic example: national defense

mixed goods

goods that have characteristics that are part public and part private ex: education, roads

acid rain and clean air act

highlights the fact that efficiency analysis ignores the distribution of gains and losses. To establish efficiency we need only to demonstrate that the total value of the gains exceeds the total value of the losses

Ownership of a Scarce Factor of Production

if a production requires a particular input and one firm owns the entire supply of that input, that firm will control the industry

why profits = 0 in MCL

if profits > ) new first enter the industry, driving demand down (lowers the price) continues until P=ATC and 0 profits

monopolistic competition in the short run

increase production until MR from increasing output and selling no longer exceeds MC of producing MR = MC

liability rules

laws that require A to compensate B for damages imposed

contestable markets

markets in which entry and exit are easy enough to hold prices to a competitive level even if no entry actually occurs

perfect price discrimination

occurs when a firm charges the maximum amount that buyers are willing to pay for each unit. Charge everyone the price on the demand curve, or shift the consumer surplus to producer surplus.

Market failure

occurs when resources are misallocated, or allocated inefficiently

government failure

occurs when the government becomes the tool of the rent seeker and the allocation of resources is made even less efficient by the intervention of government (lobbyists and wasted resources)

nonexcludable

once a good is produced, no one can be excluded from enjoying its benefits

Free markets _______ pollution and _______ education

over produce under produce

risk-loving

person's preference for uncertain deal over a certain deal with an equal expected value

horizontal differentiation

products differ in ways that make them better for some people and worse for others

private goods

products produced by firms for sale to individual households private goods can be excluded from people who do not "pay" for the product

risk-neutral

refers to a person's willingness to take a bet with an expected value of zero

barrier to entry

something that prevents new firms from entering and competing in imperfectly competitive industries

marginal product of labor (MP)

the additional output produced by one additional unit of labor example: additional workers provide little new productivity with fixed capital stock

productivity of an input

the amount of output produced per unit of that input

marginal private cost (MPC)

the amount that a consumer pays to consume an additional unit of a particular good. MC

all kinds of oligopolies have one thing in common:

the behavior of any given oligopolistic firm depends on the behavior of the other firms in the industry composing the oligopoly

efficiency

the condition in which the economy is producing what people want at least possible cost

general equilibrium

the condition that exists when all markets in an economy are in simultaneous equilibrium

derived demand

the demand for resources (inputs) that is dependent on the demand for the outputs those resources are/can be used to produce. That is, unless a firm sells their final product, they don't need inputs

When a firm uses only one variable factor of production, that factor's marginal product curve is

the firm's demand curve for that factor

technological change

the introduction of new methods of production or new products intended to increase the productivity of existing inputs or to raise marginal products

risk premium

the max price a risk-averse person will pay to avoid taking a risk

criminal actions

the practice of the antitrust division has been to limit criminal proceedings to outrageous violations, where intent to violate is clear. They try to negotiate first.

demand determined price

the price of a good that is in fixed supply; it is determined exclusively by what firms and households are willing to pay for the good

partial equilibrium analysis

the process of examining the equilibrium conditions in individual markets and for households and firms seperately

nash equilibrium

the result of all players' playing their best strategy given what their competitors are doing

pure rent

the return to any factor of production that is in fixed supply

concentration ratio

the share of industry output in sales or employment accounted for by the top firms

marginal social cost (MSC)

the total cost to society of producing an additional unit of a good or service MSC is equal to the sum of the MC of producing the product and the correctly measured damage costs involved in the process of production

Network externalities

the value of a product to a consumer increases with the number of that product being sold or used in market

theory of public choice

to understand how government functions, we need to look less at the preferences of individual members of society and more at the incentive structures that exist around public officials

coase theorem

under certain conditions, when externalities are present, private parties can arrive at the efficient solution without government involvement

output effect of a factor price increase (decrease)

when a firm decreases (increases) its output in response to a factor price increase (decrease), this decreases (increases) its demand for all factors