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