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)