Econ 001 Final

collusion

cooperation that is mutually beneficial is difficult to maintain b/c cooperation is individually irrational; this cooperation among oligopolists for the purpose of increasing profits is called collusion

How do firms differentiate their products?

(1) By style or type - food court offers diff. types of foods (2) By Location - more convenient to go to a gas station near your home, work, or wherever you need gas (3) By quality - consumers vary in what they are WTP, firms can differentiate their products by quality

Adverse Selction

- arises when buyers and sellers in the market have different amounts of information about their quality of risk characteristics and prices are set based only on an average or easily observable characteristics ex. health insurance: some people are healthier than others auto insurance: some people are better drivers than others - buyers of insurance know more about their risk levels than the insurance companies do - if an insurance company doesn't know who is high risk and who is low risk, it has to charge the same premium to everyone (this premium would be a bargain to high risk people and probably not for low risk people) - people with low risk might find that insurance is not worth it if the premiums charged are based on average risk and drop out of the market - but without the low risk people in the market this causes the insurance premium to increase even more so that insurance firms can still cover their costs - this is called an insurance death spiral, which could cause the market for insurance to collapse

targeted cash benefits (cont.)

- don't want peoples income to fall below a level G - but as soon as their income rises above G, people no longer receive a transfer benefit they get = G - (w x h) - if earning are 0, get G - if earnings are w x h, and that is less than G, then get G - (w x h) - if earnings w x h > G, then get 0 - this system would be perfectly targeted at the poor bc benefits only go to those below the poverty line PROBLEM: - this government transfer program will change people's behavior --> likely to reduce hours worked to 0 hours and move to higher IC so that can increase both leisure and consumption - essentially this type of welfare system imposes a 100% implicit marginal tax rate on recipients; no incentive to increase hours - could also affect the behavior of individuals originally above the poverty line - bc this system has such a large implicit tax rate, we expect it to cause pretty large distortions to peoples labor supply decisions - one possibility might be to reduce the marginal tax rate (reduce the rate at which we tax away peoples benefits) B = G - (t x w x h) t benefit reduction rate (also called the phase out rate) - before t = 1, now set it to 0.5 - system still reduces person A to 0 hours - but now person C does not reduce labor supply to 0, still reduces hours but not by as much - this may help w the moral hazard problem 2 MAJOR CONCERNS: 1. program is now more expensive: we are providing benefits to those above the poverty line 2. now because people are eligible for benefits at higher levels of income, we are creating distortions for higher income folks as well

information problems in auctions: winners curse

- in some auctions, neither bidder nor seller has complete info about what is being auctioned ex: government auctioning off land for oil dwelling winners curse: winner in certain auctions may have overestimated the value of the good; thus end up worse off than the losers - winners curse does NOT apply to all auctions: common value assets: (oil fields) would be given same value bu all bidders if they had perfect info private value assets: value depends on individual preferences (eBay) WINNERS CURSE ONLY APPLIES TO COMMON VALUE ASSETS!!

purpose of insurance company

- insurance company realizes that you could get better E [u] from a guaranteed income between the good and bad states - could offer you a deal: - pay premium before you know what state of the world you will be in, then if bad state the company will pay you a benefit of b; if the good state then they pay you nothing without insurance: - bad state = Z1 - good state = Z2 with insurance: - bad state = Z1 - P + B - good state = Z2 - P - if good state = bad state under insurance then full insurance (perfect smoothing of consumption across good and bad states)

why do we have policies for redistribution?

- it can increase SW (aid to the poor can fix some market failures) - threshold effects: without sufficient basic caloric intake, individuals cant be productive workers - externalities associates with income distribution: could reduce crime, increase political stability, positive external benefits - public good nature of income distribution: individuals may want to live in a society with a particular distribution of income, may have tastes for equality - missing market for insurance: adverse selection, only those most likely to have a bad shock will purchase insurance; market will not exist; redistribution could be a form of social insurance

monopolistic competition

- many competing producers - each producers sells a differentiated product - there is free entry and exit from the industry in the LR

monopolistic competition graph in the SR

- since each firms product is differentiates, it faces a downward sloping demand curve and decreasing MR (like monopolist) - produce the quantity where MC=MR and charge what consumers are WTP for that quantity Profits: P > ATC Losses: P < ATC zero profit: P = ATC - P = ATC, NOT P = min ATC, like in perfect competition

modeling discrimination

- two groups A and B, equally productive, but employers don't like hiring Bs - leads to reduction in demand for less favored workers, will drive their wage down - but then non-discriminating firms can hire Bs at a discount; gives them a comparative advantage - thus, if there are enough non-discriminating firms and if markets are competitive, discrimination cannot exist in the LR --> discriminating firms will be driven out of business - but if markets are not perfectly competitive or if discrimination is on the part of fellow coworkers or customers, discrimination could exist in the LR - there could also be feedback mechanisms, where past discrimination affects worker characteristics --> B workers realize there is little benefit to acquiring human capital since they will not be fully rewarded for it in the labor market --> obtain less human capital even though the two groups are equally productive, end up w/ less human capital

insurance

- the reason people value insurance is because they have diminishing MU of consumption - people prefer to have smooth consumption across possible states of the world, rather than to have highly variable consumption - ex. $15 gain is worth less than -$15 loss in terms of utility - for this reason we say that people with diminishing MU of consumption are risk averse; all other things equal, they prefer certainty and would like to avoid risk - this assumption is realistic for gamble where potential loss is large, but for relatively small gambles like buying a lottery ticket, the entertainment value you get from gambling may outweigh utility costs - sometimes utility is higher when you avoid the gamble completely - in this case there would be some amount of money that you would be willing to pay to avoid the gamble

perfectly competitive labor market

-Many small firms are hiring workers -Many workers with identical skills -Wage is constant (no one has control over wage) -Workers are wage takers - the firms should continue to hire as long as VMP (MB) > wage (MC) - firm can hire as many workers as it wants at the market wage

shifts in labor supply curve

1. Changes in preferences and social norms 2. Changes in population 3. Changes in opportunities 4. Changes in wealth ex. influx of women in the labor force over the last 30 years; increase in the amount of immigrants allowed laboor supply increase: - CS increases (firms better off) - PS (gain to workers who did not have jobs before, loss to existing workers who now get lower wage) - SW as a whole better off but there are distributional issues

2 concepts of fairness

1. horizontal equity: - individuals who are identical in all relevant respects are treated the same - caveat: health: 2 individuals with the same income, one higher medical expenses, are they equally well off? should they be taxed the same? 2. vertical equity: - how the system treats individuals at different level of well-being - related to ability to pay taxation - problem: how do we determine ability to pay? How much more should someone with a higher ability to pay pay?

why do different groups get paid different wages?

1. productivity - in a perfectly competitive labor market, employees should be paid the value of their marginal product (VMP) - if one employee has a higher MPL, should receive a higher wage - this can also help explain patterns we see over a persons life cycle 2. labor unions - collective bargaining over higher wages, better benefits, working conditions - union members earn more all else equal than their non-unionized counterparts 3. Education - college graduates earn more than high school grads than high school dropouts - 2 separate explanations: 1. HUMAN CAPITAL MODEL: education, ability inputs into production/ productivity; says that education has a causal effect: increasing education would increase productivity and national income 2. SIGNALING MODEL: higher ability find it easier to get into and progress through college, so they are more likely to be college graduates; firms use college degree as a way of sorting between high ability and low ability; signaling model says that education has no effect on productivity 4. Compensating differentials - higher wages that compensate workers for unpleasant aspects of a job 5. Winner take all markets - markets in which small differences in talent or performance often translate into enormous differences in economic rewards (ex. sports, entertainment)

3 taxation systems

1. progressive - taxes paid/income increases as income increases 2. proportional - taxes paid/income is constant 3. regressive - taxes paid/income decreases as income increases

Gini Coefficient

A measure of income inequality within a population, ranging from zero for complete equality, to one if one person has all the income. gini coefficient = shaded area / area of big triangle

Monopoly vs. Perfect Competition

A monopoly produces a smaller quantity, charges a higher price, and earns profits in long-run equilibrium, unlike firms in perfect competition. - both produce the quantity of output at which the MC of producing the last unit equals MR (MC = MR) - although the optimal output rule holds tru for all firms, its application leads to different profit maximizing output levels for a monopolist compared to a firm in perfect competition. the difference comes from the slope of the demand curve faced by different firms - a perfectly competitive firm is so small relative to the market that it must take the market price as given, thus demand is perfectly elastic - but a monopoly is the only seller in the marker; faces entire market demand curve, so demand is normal downward sloping curve - so to sell an additional unit, a monopolist must reduce price on that next unit and all previous units as well - monopolist MR is decreasing as quantity increases - unlike the demand curve, the MR curve can go below the x-axis (MR can be negative) - since MR is the additional revenue that results from adding a unit, graph at the midpoint - for any monopolist with a straight line demand curve, the MR curve has the same y-intercept but is twice as steep - to maximize profit, the monopolists compares MC and MR, using the optimal output rule - at that quantity, choose the maximum price that consumers are willing to pay - SW is lower and we have DWL - output produced is too low for social efficiency

price-discriminating monopoly

A monopoly that sells different units of a good or service for different prices not related to cost differences. (different prices to different consumers)

expected value

E [x] = pX1 + (1-p)X2 - the sum over all states of the world, of the value x in each possible state, times the probability that stae will occur

principle of comparative advantage

Everyone does best when each person (or each country) concentrates on the activities for which his or her opportunity cost is lowest

Lorenz Curve

Graph showing how much the actual distribution of income differs from an equal distribution (shows level of inequality) - graphs income distribution: how much of the total income goes to a given percentage of the population - economy w perfect equality: everyone would earn the same amount of money; lowest 20% earn 20% of income, etc . . . --> line of perfect equality - the most unequal society would be one where one person earns all the income --> bottom 20% earns no income, etc - real economies are somewhere in the middle - the shaded area represents the deviation from perfect equality

Imperfect Price Discrimination

Groups of consumers are charged different prices. -Profits are increased relative to using a single price, but not as high as using perfect price discrimination. -Consumer surplus is decreased, but consumer surplus is not equal to zero. - imperfect price discrimination more likely in real world (monopolist does not know WTP of each consumer)

VMP of labor

MP times output price

Monopsony

Market with only one buyer ex. the only employer in a local labor market - the labor supply curve facing the company is the labor supply curve (faces entire upward sloping labor supply curve) - there is no market wage; the monopsonist decides what wage to offer - similar to a monopolist --> to sell extra units of the good, monopolist must lower the price, not just on the marginal unit, but on all units --> in order to hire extra workers, a monopsonist has to pay higher wages not just to the next worker, but to all previous hired as well - but the rule is the same (VMP > MC) - but now MC IS NOT EQUAL to wage and MC is increasing with the number of workers hired

alternative philosophy to utilitarianism

Rawls --> maximize the utility of the worst off person in society - sometimes even if the market outcome maximizes SW, we might also be concerned about the distribution of SW - the government may have a role in redistributing income, either through antipoverty programs or through a progressive tax program

decision of how much leisure to consume can be analyzed in terms of the income and substitution effects

Substitution effect: - the higher the wage, the higher the relative price of leisure, will shift towards more work Income effect; - if wages increase, now ill have more income for all goods - assuming leisure is a normal good, will want to consume more leisure and hours will fall substitution effect and income effect work in opposite directions - tells us that the relationship between the quantity of labor supplied and the wage is ambiguous w/o more information - if the substitution effect dominates, as wages increase, the quantity of labor supplied will increase = upward sloping labor supply - if the income effect dominates, as wages increase, the quantity of labor supplied will decrease = downward sloping labor supply - if income effect = to substitution effect = vertical labor supply curve (perfectly inelastic) - also could be that slope depends on the quantity of labor already supplied: backward bending labor supply (substitution effect is larger to a point where income effect takes over) - also varies by type of labor: - female labor supply traditionally more elastic than men's

Tariffs

Taxes on imported goods - only relevant if importing the good - shift the world price horizontally by the amount of the tax - the increase in domestic price reduces the quantity demanded to the new quantity and increases the quantity supplied to the new quantity - reduces amount of imports - reduces CS (since now a higher price and consumers buying fewer units) - increases PS (since suppliers now getting a higher price and producing more units) - creates government revenue (amount of the tariff x quantity of imports) - creates DWL

redistribution of income

The transfer of income through government taxation, spending and assistance programs targeted at particular income groups. The goal is to transfer money from higher-income groups to lower-income groups. 1. in-kind benefits: non-cash benefits - food stamps (SNAP) - public health insurance - housing subsidies 2. cash benefits: - means tested programs to those w financial resources below a particular level

Moral Hazard

When the act of insuring an event increases the likelihood that the event will happen - insurance may change peoples behavior in a way that makes the bad outcome more likely; by reducing the penalty for the bad outcome, insurance weakens the incentive to do things that would help avoid the bad outcome (ex. unemployment insurance

Monopolist

a firm that is the only producer of a good that has no close substitutes

Determinants of Labor Demand

a firm wants to undertake an action when the MB > MC

actuarially fair gamble

a gamble with an expected value of 0

import quota

a legal limit on the quantity of a good that can be imported - government issues import licenses which allow a certain quantity of imports - this causes the supply curve above the world price to be shifted by the amount of the quota (supply shifts right) - price of good rises to the point where new supply (both domestic plus imported) intersects demand (b/c the price increases, quantity demanded will fall, and quantity supplied will increase) - imports fall - consumers worse off due to higher prices -domestic producers better off bc higher prices - creates DWL

Oligopoly

a market structure in which only a few sellers offer similar or identical products - each firm must think about how its rivals will react to their actions

Autarky

a situation in which a country does not trade with other countries

asymmetric information

a situation in which one party to an economic transaction has less information than the other party 2 problems (market failures) caused by asymmetric information: 1. adverse selection 2. moral hazard

dominant strategy

a strategy that is best for a player in a game regardless of the strategies chosen by the other players

poverty line

an estimate of the minimum amount of annual income required for a family to avoid severe economic hardship poverty rate: percentage of individuals (families_ below the poverty line poverty gap: difference between people's income and the poverty line

moral hazard in the financial sector

any situation in which one party decides how much risk to take, while another party bears the cost if things go badly - bailouts of banks - if companies know that the government is likely to bail them out when they get into trouble, they are more likely to take actions that will get them into trouble

Where does comparative advantage come from?

at the individual level: - natural ability - training, experience, education at the national level: - natural resources (land, oil, water) - climate (ski are vs. beaches) - institutions (colleges) - language

Why do monopolies exist?

because of barriers to entry that prevent other firms from entering the market 1. control of a scarce resource or input (diamond industry) 2. government created barrier - a patent (gives investor temporary monopoly in the use or sale of an invention) - a copyright (gives the creator of a literary or artistic work sole rights to profit from that work) - patents encourage investment and innovation, but give owners monopoly power 3. natural monopoly - situation where it is cheaper for a single firm to produce the entire amount of output than it is for several firms to produce parts of it (ECONOMIES OF SCALE) (ex. market for natural fas; telephone land lines)

MP of labor

change in quantity/change in labor - decreases bc of law of diminishing marginal returns

World Price < Domestic Price

country does NOT have a comparative advantage in producing this good - trade forces the domestic price down; country imports the good CS --> increased (price has fallen and they get more units) PS --> decreased (price has fallen) SW --> increased overall

Quintile

dividing a group into fifths, a method often used to look at distribution of income

individual vs economy wide PPF

even if all the individuals in the economy have linear PPFs (constant OC), as we aggregate them into an economy wide PPF, it becomes bowed out - we produce initial units of x with those workers who are relatively most efficient at producing x, only then turn to those who are relatively less efficient (THIS IMPLIES INCREASING OPPORTUNITY COST)

if trade takes place, what determines the price of the good?

general rule: for both parties to gain from trade, the price must be between the two opportunity costs - this does NOT tell us exactly what price they will trade at, just gives us a range, actual price chosen may depend on things like bargaining power

increasing inequality and increasing poverty over time explanations

globalization: high value of US dollar in 1980s made US exports more expensive and imports cheaper, reducing demand for manufacturing output in the US - increase in demand for skilled workers due to technological change - reduction in importance of unions

Targeted cash benefits

graph: consumption vs hours of leisure weekly hours = 24 x 7 = 168 consumption = 168 x wage - if spend all hours on leisure, get 168 hours of leisure and zero consumption - if spend all time in labor force, get 168 x wage dollars of consumption and zero hours of leisure - there is some set of indifference curves that represents out preferences over consumption and leisure, and we choose the point where our IC is tangent to our BC

compensating differentials

higher wages that compensate workers for unpleasant aspects of a job (ex. garbage collection) - if two jobs are identical but one provides positive, non pecuniary benefits, the pleasant job should require lower wages (ex. health insurance, generous vacation, job security)

Utilitarianism

idea that the goal of society should be to bring about the greatest happiness for the greatest number of people - this implies that we weight the utility of each member of society equally - but bc of diminishing MU of income, the effect of taking 100 from one person and the effect of giving another those 100 depend on their existing levels of income - under some assumptions, utilitarianism implies complete equalization of incomes (not a Pareto improvement) - however, it is likely that total income in a society is NOT fixed - as we tax one person to give to another, we have distorted incentives in two ways 1. the one we taxed will work less since he keeps less of every dollar he earns 2. the one who receives the benefit may work less since working may reduce his benefits - redistributive taxes and transfers can cause DWL, reducing efficiency and economic surplus

Production Possibilities Frontier (PPF)

illustrates tradeoffs facing an economy that produces only 2 goods - illustrates important economic concepts: 1. scarcity --> slope of PPF is negative, thus producer must give up units of one good to produce another 2. opportunity cost --> absolute value of slope gives the ratio of how much of one good must be given up for the other (if =1, then only have to give up one of x for one of y --> constant opportunity cost) 3. efficiency, inefficiency, and impossibility - a point inside PPF is inefficient (could produce more) - a point on the PPF is efficient - a point outside the PPF is impossible (not enough resources) - PPF is not fixed in the long run --> changes in tech can shift PPF out - economic growth results in an outward shift of the PPF because the production opportunities are expanded - sources of economic growth: increase in factors of production, technology

perfect competition vs. monopsony

in the case of monopsony, the profit maximizing level is LOWER than the level that would maximize total economic surplus

labor market

labor supply = workers labor demand = firms equilibrium price of labor = wage

adverse selection in the market for used cars

lemons problem: sellers of used cars always have more info on the true condition of the car than buyers - buyers may offer average of good vs bad car - PROBLEM: sellers know whether the car is good or not and happy to sell bad cars at average but wont sell good cars at average - as a result most of the cars on the market for used cars will be lemons

Opportunity costs of x

loss in y / gain in x (units = the good you are giving up)

world price > domestic price

means that this country can produce the good at a lower cost than other countries (this country has a comparative advantage in producing this good) - trade forces the domestic price up to the world price: country exports their surplus CS --> since price has increased, CS has fallen (area below demand and above price all the way to the quantity demanded) PS --> since both price has increased on existing units and selling more units, PS has increased (area above supply, below price, over to the quantity that the firms supply) SW --> has increased overall

policies that restrict trade

put in place for countries that are importing to help protect domestic producers 1. tariffs 2. import quotas - both tariffs and quotas increase price and make domestic consumers worse off; domestic producers are better off and generate DWL DIFFERENCE: tariff generates government revenue, quota does NOT - but if import licenses were sold off and government kept the revenue, tariff and quota will be equivalent

types of market structures

perfect competition, monopolistic competition, oligopoly, monopoly differences are based on 2 dimensions: 1. number of producers in the market 2. whether the goods are identical or differentiated perfect competition: many; no monopoly: one; no monopolistic competition: many; yes oligopoly: few; no and yes perfect competition: - lots of buyers and sellers - identical product - no barriers to entry or exit - perfect information profit maximizing conditions: - MR = MC, firms use this to choose what quantity to produce - firm can sell as many units as they want at the market price: MR = MC = P

Monopolist Profit

profit = TR - TC profit = (P x Q) - (ATC x Q)

Monopolistic competition in the long run

profit: new firms will enter, driving down Demand for firms already in the market, until there is no economic profit (long-run equilibrium) loss: firms will leave, driving up the demand for firms already in the market (mechanism works through the DEMAND curve, not the supply curve like in perfect competition) - demand and MR shift at the same time zero-profit equilibrium!!

domestic demand curve

shows how the quantity of a good demanded by domestic consumers depends on the price of that good

domestic supply curve

shows how the quantity of a good supplied by domestic producers depends on the price of that good

Sequential games are used to analyze

situations in which one firm acts and other firms respond.

expected utility

sum of the utilities associated with all possible outcomes, weighted by the probability that each outcome will occur E(u) = pU(C1) + (1-p)U(C2) - C1 and C2 represent consumption

perfect price discrimination

takes place when a monopolist charges each consumer his or her willingness to pay—the maximum that the consumer is willing to pay - for a perfectly discriminating monopoly, there is no efficiency loss; all buyers are served who are willing to pay a price high enough to cover MC - if monopolist can perfectly discriminate: no CS, no DWL

market power

the ability of a single economic actor (or small group of actors) to have a substantial influence on market prices

comparative advantage

the ability to produce a good at a lower opportunity cost than another producer

absolute advantage

the ability to produce a good using fewer inputs or hours than another producer, and or can produce more units in the same amount of time

decision making under uncertainty

the decision maker does not know all the alternatives, the risks associated with each, or the consequences of each alternative

Interdependence

the fact that costs and benefits of my actions might also depend upon what other actors do

reservation wage

the lowest wage a worker would accept for a given job

what is the price of leisure

the opportunity cost of not working = the wage budget = 24 hrs 24 = L + H

world price

the price of a good that prevails in the world market for that good - set by the worlds supply and demand curves intersection

production function

the relationship between quantity of inputs used to make a good and the quantity of output of that good Q = f (k, l) k = capital l = labor constant returns to scale --> if a firm doubles all factors of production (uses twice as much labor and capital) and output doubles, constant returns to scale economies of scale/ increasing returns to scale --> if a firm doubles their factors of production, output will more than double with economies of scale, the large factory would be more efficient than 2 smaller factories. this is likely to be the case if fixed costs (start up costs) are important ex. software production: initially developing software is hard; making additional copies very easy

Nash equilibrium (noncooperative equilibrium)

the result when each player in a game chooses the action that maximizes his or her payoff, given the actions of other players - every dominant strategy equilibrium is a nash equilibrium, but every NE is NOT a DSE

game theory

the study of how people behave in strategic situations

age-earnings profile

the wage path over the life cycle - increase steeply then level off - if job has a learning curve, likely that productivity increases most with early years

Iron Triangle of Welfare Programs

there is no way to reform this welfare program that does all 3 things at the same time: 1. encourage work 2. redistribute income 3. reduce costs

when do we gain most from specialization?

when differences in opportunity costs are largest

a redistribution increases total utility of a society if:

Σi [change in ES) (MU)] > 0 - change in ES is the change in economic surplus of an individual i - MU is the MU oof $1 for individual i - Σi sum over all individuals in society