Econ Unit 3
Dominant strategy
When it is a players best action regardless of the action taken by the other player Not all games have a dominant strategy - depends on structure of payoff
Gary's Gas and Frank's Fuel are the only two providers of gasoline in Smalltown. Gary summarizes his pricing strategy as, "I'll do to Frank what Frank did to me last time." This is an example of:
A tit for tat strategy
Advance purchase restrictions and Volume discounts
Advance purchase restrictions Prices are lower for those who purchase well in advance (or in some cases those who purchase at the last minute) This seperates those who are likely to shop for better prices from those who wont Volume discounts Often the price is lower if you buy a large quantity - for a consumer who plans to consume a lot of a good- the cost of the last unit- the marginal cost to the consumer is considerably less than the average price. Seperates those who plan to buy a lot- so likely to be more sensitive to price- from those who don't.
Tacit collusion
Agreement setting output levels of two oligopolists isnt just unenforcable- is illegal Overcoming prisoners dilemma- Repeated interaction and Tacit Collusion Oligopolists know that they will be in market for long time and that their decisions will affect them and others in long run Smart ologopolist doesnt decide what to do just based on effect profit in short run Strategic behavior When firm attempts to influence the future behavior of other firms Under some conditions firms who do this can manage to behave as if they had formal agreement to collude When firms limit production and raise prices in a way that raises each others profits, even though they have not made any formal agreement
Equillibrium in labor market graph (look in book) and when description of product market when perf competitive
Demand for labor slopes downward as firms employ fewer workers at higher wages Supply of labor slopes up as people will supply more labor (more people work) at higher wages Market wage= value of marginal product of the last unit of labor hired When product market perf comp wage= VMPL at equillibrium To determine workers has to multiply marginal product of labor by revenue received from selling additional output -- MRPL When a monopolist firm hires an additional worker it has to multiply MPL by the marginal revenue -- called marginal revenue product of labor --- MRPL Price declines as output increases -- what derives marginal revenue curve of monopolist -- important difference
As wages rise do people work more? (supply more labor)
Depends on whether sub effect or income effect dominates Substitution effect: ill sub more hours of leisure for more hours of work as I make more Income effect: at higher level of wages and income, ill work work less and consume more leisure -- takes fewer hours of work to buy things i need Generally speaking -- substituion effect dominates -- usually upward sloping
points on marginal benefit graph
Diff bw MPB and MSB is marg external beneift MSB= MPB+MEB Demand curve is MB to consumers of the good - marg private benefit Socially opt Q of good that generates ext benefits is Qopt- point O at which marg social benefit = marg cost Bc external benefit not accounted for in market decisions (ppl dont think abt others when they get shot) Qmkt is less than Qopt So- left to its own market will bring abt to little production and consumption of a good that generates external benefits AND w out gov intervent the price to consumers is too high at Qmkt
MArginal productivity theory
Each factor of production is paid the value of the output generated by the last unit of that factor employed in the factor market (equillibrium value of the marginal product) Example: When labor market for computer programmers is in equillibrium the wage rate earned by all computer programmers is equal to the markets equillibrium value if the marginal product -- the value of the marginal product of the last computer programmer hired in the market. W=VMP -- hiring just up to point where wage = Value of marginal product
Non price competition and how important is oligopoly
Non price competition Firms that have tacit understanding not to compete on price engage in this using adveritisng and other means to try to increase sales How important is oligopoly Far more common than monopoly or perf comp Analysis far more messy
Two rival firms vigorously compete by spending millions of dollars on product improvements and advertising to promote those improvements. This is an example of firms engaging in:
Non-price competition
price war
Occurs when tacit collusion breaks down and aggresive price competition causes prices to collapse --sellers try to put eachother out of business so prices go so low
Oilgopoly is a market structure charectorized by and An extreme case of oligopoly in which firms collude to raise joint profits is known as a:
Oilgopoly is a market structure charectorized by uncertainty about the behavior of rival firms. An extreme case of oligopoly in which firms collude to raise joint profits is known as a: Cartel
Because of monopoly, consumers typically have: and Because monopoly firms are the only firms in market
higher prices they can maximize total revenue, but cannot maximize profit.
A collective action problem
occurs when all the members of a group would benefit from an action (voting, revolution, group projects, cleaning up a river, etc.) but there is a cost associated with the action that none of the individuals prefers to risk for themselves. Someone in group wants 95 but doesn't want to do work- then they assume everyone else wants to do work- then no one does work-- that is when becomes collective action--- everyone wanted assembly to go well- no one wanted to put in cost to do well- so went horribly -- now different than free rider whole thing just doesnt go well -- if enough people free ride you dont accomplish thing people were trying to free ride
excludable benefits
only ppl who work on announcment can participate Political economy- rational peasants Vietcong chopped off peoples hands who thought were supporting US troops --exclude free riders
By practicing ________, firms openly agree on price and output, and other decisions in order to achieve monopoly profits.
overt collusion
When each factor is paid a payment equal to the value of marginal product of the last unit of that factor employed in the factor market as a whole, this is referred to as:
the marginal productivity theory of income distribution
The efficient quantity of pollution emissions occurs where:
the marginal social benefit of pollution is equal to the marginal social cost of pollution.
If government officials set an emissions tax too high: Laws that restrict or prohibit leaf burning or trash burning is an example of: Pigouvian taxes are taxes designed to reduce:
there will be too little pollution. Environmental standards External costs
Typical monopoly
Anyone wanting to buy product must buy from monopoly -- d monopoly= d industry Unlike perf comp- marginal rev is less than prices w exception of very first unit of course Marginal rev curve looks like a little steeper demand curve Monopolist chosen output- when MR=MC-- need to add MC curve -- can find intersection of MC and MR for Quantity but do not know monoplistic price yet -- to find you have to remember that producer can raise price as high as consumers are willing to pay -- demand reflects buyers willingness to pay so go up to demand curve at that Q for the price Monopolist profit? Nothing happens to monopolist profit when making [rofit in long run bc there are other businesses that will enter the market
Monopolistic comp in short run graph
Because firms have differentiated product, demand for product is downward sloping (remember horizontal only in perf comp) Firm maximizes profit by finding Q- where MR=MC, Price P is found by going vertically to the demand curve. Rectagle of profit is found by locating ATC at the output quantity Firm is earning pos econ profit if P>ATC
Private goods
By definition Private goods are excludable and rival in consumption Wheat- if i consume loaf of bread- no one can consumer same bushel of wheat as i Car- if you want car need to buy it, also only one person can drive car at one time
Product Differentiation and price leadership
Consumers will not all rush to buy cheapest product always Product differentiation Attempt by a firm to convince buyers that its product is different from the products of other firms Use advertising to make it seem special- add add ons Price LEadership One firm sets its price first and other firms follow
Derived demand nurse example
Demand for a factor-- it results from (is derived from) the demand for the output being produced Ex: Nursing is an increasingly popular job in the market for labor as US population ages. (more older people and so nurses are in higher demand) The demand for nurses is DERIVED from the demand for the services they provide. (nursing care for the elderly)--As demand for nursing services increases as population ages, the demand for nurses increases - so demand for nurses is derived from demand for their services
Environmental standards
Enviro protection agency- principal enforcer of economic policy How does country protect enviro? Environmental standards--rules that protect the enviro by specifying limits for or actions by producers and consumers Ex: vehicle that requires catlytic converters -- reduce the emission of chem that can cause smog Or communties need to take care of seage, homes paint w lead free paint etc Clean air act- 1970- air pollution has since fallen by more than a third
Factor distribution of income and marginal revenue product
Factor distribution of income Division of total income among land, labor, capital, and entrepreneuriship Marginal revenue product Additional revenue generated by employing one more unit of that factor
KEY concepts read
Firms in monopolistic comp have downward sloping demand curves because there products are differentiated from the products of their rivals. THis gives firms some pricing power and firms maximize profit by setting output where MR=MC In the short run, firms can earn economic profit if P>ATC, or can incur losses if P<ATC Like comp markets In the long run, entry and exit causes firms to earn normal profit. Long run equil occurs at output where P=ATC and the demand curve is tangent to the ATC curve. -- distinction bw LRE in perf vs monopolistic comp Because firms do not produce the levelof output where ATC is minimized, it is said that monopolistically competitive markets have excess capactity. -- ideally we would want them to produce more Because price exceeds marginal cost, deadweight loss exists, but this inefficiency is offset by the many diverse products from which consumers can choose. -- not really losing other than prices being a little lower
Ther markets for land and capital and rent
Hire up to point VMPL=W Next unit of land or capital employed has a value of marginal product attached to it -- diminishing returns to production ensure that VMP for each is downward sloping - demand curve downward sloping also Firm determines how much land and capital to employ in same way the firm hires labor. If VMPC/L >= MC of employing that unit of capital or land, then use/hire/employ it. MC of next unit is called "rent" MC is like same as W or wage in terms of workers VMPland=Rland VMPcapital=Rcapital Rent can be explicit of implicit Explicit in case of somebody who is renting piece of equipment-- explicit is rental to pay to rent for day- implicit when I rent it out as owner instead of using it
In an oligopolistic market structure, collusion between firms usually leads to higher profits than noncooperative behavior. Which of the following statements accurate describes why formal, overt collusion doesn't usually occur in the United States? I. Formal collusion is illegal. II. There is an incentive for each firm to cheat on a collusive agreement. III. Oligopolistic industries have low barriers to entry.
I and II only
Two Part tariffs
In a discount club like costco (not monopoly but monolitic competitor) you pay an annual fee (the first part of the tarriff) in addition to the price of the items you purchase (second part of tarriff). So full price of first item you buy is in effect much higher than that of subsequent item - making the two part tarriff behave like a volume discount.
Zero profit equillibrium and excess capacity
In the long run a monopolistically competitive industry ends up in this; each firm makes zero profit at its profit maximizing quantity Firms in monopolistically comp industry have this; they produce less than the output at which average total cost is minimized
Factor of production
Input or resource used in the production of goods and services Land: resources provided by nature Labor: work done by humans Capital: physical capital such as tools, machinery and factories, plus human capital such as education and training that goes into making people skilled in order to complete tasks Entrepenueriship: the talent for taking risks to bring together resources for innovative production
Human capital is the improvement in ________ created by ________.
Labor-- education and knowledge
land supply curve is relatively what and why
Land supply curve relatively inelastic bc as demand goes up cant just create more land like they can w capital
Key concepts read!!
Legal forms of price discrimination are the very common practices of selling the same product to to different consumers, at different prices If a firm has monopoly power to engage in a price discrimination, it can increase its profits by doing so. In other words, children to not get discounted movie tickets out of kindness of firms heart Consumer group that has the greatest price elasticity of demand (more price sensitive group) will end up paying lower prices Perfect price discrimination is the special case where firm charges each consumer his/her max willingness to pay. IF succesful consumer surplus is transferred to monopoly profits and deadweight loss is eliminated.
Key concepts read
Legislation, Sherman antitrust act, prohibits most forms of explicit cartel and monopoly behavior Oligopolists may tacitly collude if there are few firms , simple products, similar interests, and buyers who have little bargaining power Firms in oligopolies often compete by differentiating their products so they can raise price above competitive levels If one firm merges as a price leader, tacit collusion will result as other firms set prices based on the prices set by the leader Even if firms do not compete on the basis of price, they may compete in other areas.
MArginal product of labor and value of the marginal product of labor (MPL) and (VMPL)
Marginal product of labor Change in output/ Change in labor MPL graph tells us how much additional output the next worker brings to the firm, but how many dollars will the workers efforts bring into the firm? Value of the marginal product (VMPL) Total monetary benefit of hiring each worker Price of output * MPL (marginal product of labor) (usually decreases) How to take that info and make decisions about labor? Hire a worker if VMPL>= W (wage-- bc unit of input is labor- need to value that unit to compare it) Never hire a worker if VMPL<W Stop hiring workers up to the point VMPL=W Profit maximizing hiring decision for ANY factor (land labor captial entrepenueriship) of production. The last unit of any factor is hired when the value of its marginal product is exactly equal to the marginal cost of hiring it.
outcome of either leftward or rightward shift and
P=ATC so no profit or loss rectangle Only way for P= ATC is for the demand curve to touch ATC at the output Q where MR=MC This happens where downward sloping demand curve is tangent to the ATC curve at the output Q**
Monopolistic graphing points
P=MC at perf comp firms profit maximizing Q of ouput P>MR=MC at monopolistts maximizing quant of output Monopolists profit- go to point Mr= MC- draw line up to D-- will be price-- and then dot down from there to ATC-- that whole side and rectangle made from it is monopoly profit
The legal framework
Railroads- when oligopoly first became issue in US Although their cartels were legal- limit quant of trains so companies could raise prices- werent legally enforcebale-- couldnt ask gov to step in if agreement wasnt working out Rockfellers lawyers came up with trust Shareholders of all major companies in an industry placed their shares in hands of board of trustees-establishes essentially monopoly - was public backlash bc becoming too ppowerful Result: Sherman Anti Trust Act Intended to prevent creation of more monoplies and break up existing ones Antitrust policy Involves government efforts to prevent oligopolistic industries from becoming or behaving like monopolies Earliest action of policy- Breakup of Standard oil Price fixing has gone global as international trade has expanded 1990s- US instituted and amnesty program - price fixer receives a much reduced penalty if provides info on its co-conspirators
Single price monopolist Price Discrimination PErfect price discrimination defs
Single price monopolist Charges all consumers the same price Price discrimination Sellers engage in Price discrimination when they charge different prices to different consumers of the same good Perfect price discrimination Takes place when a monopolist charges each consumer his or her willingness to pay - the max that the consumer will pay (cuts out DWL) different price for every unit consumed Companies want to turn consumer surplus into their profit Haggling people-- so each person is paying their willingess to pay Auctions- bidding on ebay
How do we know monopoly if we see one?
Single seller Someone who sells product for which there is no close substitutes
Tit for tat
Start by behaving cooperatively but then do whateber other player did in previous period Intended to influence future actions of other player Reward for cooperation and punishment for cheating Overtime total money by playing just cheat is less than amount by playing tit for tat Always cheat or tit for tat which strategy depends on 2 things How many years each expects to play Which strategy oponent follows If firm expects to be in business for a while and thinks other firm will play tit for tat -should play tit for tat Firms manage to act as if they have an agreement to limit output
Marginal factor cost of labor and how it is different in monopsony
The additional cost associated with the additional unit of labor is the marginal factor cost of labor, MFCL Factor cost of labor-- cost of that labor as factor to production Marginal cost of labor--additional cost associated w additional unit of labor In perf comp MFCL is always= wage In monopsony the MFCL is higher than the wage. HOWS THAT? Raise wage in order to hire more workers Wage must be payed to all, including all those already employed at a lower wage MFCL includes the higher wage of the marginal worker PLUS the increase in the wage of the workers who were being paid lower wage Ex: MFCL of 4th worker=9 dollars for 4th worker 1 dollar inncrease for workers 1,2, and 3 who were working at a lower wage -- so marginal cost of that worker is 9 you are paying it plus additional 3 dollars you now have to pay previous workers Be careful when doing calculations for the MFCL not to read the earlier employees' original wages (other than for the second employee!) As add more Q of workers wage goes up and then starting after second one you have to go pay previous workers the new wage
What is reason public goods are not able to be efficiently allocated in markets? Why can markets supply only private goods efficiently?
The free rider problem -- rational people will never want to contribute bc ppl know as soon as they pay others will benefit-- will just think they should free ride on someone else's payment Private markets do not want to provide for them bc individuals do not want to pay for them-- so gov provides thm bc free market doesnt want to Quazi public good-- can constrain to those who pay for it by toll , also can be diminishible bc road space diminishes when a lot of ppl on it 3 examples Lighthouse If i owned lighthouse and tried to turn it on and charge only those ships that were willing to pay me it would be impossible bc any ship can pass by and benefit from the light Free riders- those who would consume the good but not have to pay for it Fireworks display People can stand right outside of fence where need to pay inside to watch show and could still see the show Study groups Some or 1 does all of the work but free riders get all notes
Cost minimizing input combo
Theory of income distribution The marginal productivity theory of income distribution The division of income among the economy's factors of production is determined by each factor's marginal productivity at the market equillibrium firms must decide what combination of inputs to use to produce their output -- will look at how firms decide optimal combo of factors for producing desired output Substitutes and complements in factor markets Substitutes- rise in price of one good makes consumers more willing to buy other good Complements-conume goods together In some cases capital and labor are substitues -- can produce same amount of wheat by substituting more tractors for less workers and vise versa Can also be complements when more of one increases marginal product of another -- when farm has a tractor and tractor needs person to drive it -- doctors more productive with modern x-ray machines Wuantity and quality of capital available affect marginal product of labor and thus demand for it
The efficient use and maitenence of a common resource
Want to find a way to have consumer bear full cost of consumption (to get to optimal point) that means they bear their own costs and costs to society In order to find a solution to the overuse of a common resource, econimists need to find ways for the user to bear the full costs of the consumption, including the costs they previously would have imposed upon others 1- tax or otherwise regulate the use of the common resource Having to buy license to take your boat out onto ocean 2- create a system of tradable licenses for the right to use the common resource Fishing licenses- buy license to go catch fish in public areas-- commerical fisherman can trade licenses but quotas are set as to how many licenses a fisherman can have 3- make the common resource excludable and assign property rights to some individuals Public forests- selling public goods to private indiv- saleable public goods
Public ownership
With public ownership Of a monopoly, the good is supplied by the government or by a firm owned by the government USPS- owned and operated by gov -- could get groups- corruption-bribing gov and inefficiencies
Gary's Gas and Frank's Fuel are the only two providers of gasoline in Smalltown. Gary and Frank decide to form a cartel. Later, Gary summarizes his pricing strategy as, "I'll cheat on the cartel because regardless of what Frank does, cheating gives me the best payoff." This is an example of:
a dominant strategy
The largest component of the factor distribution of income in the United States is:
compensation of employees
optimal pigouvian tax on livestock
equal to marg external cost-- moves market to socially opt level of production Qopt Works by raising price paid by consumers to Popt and lowering price received by producers to Pprd::: consumers pay a price equal to what producers receive plus the tax When MSB= S-- no external costs also true that MSB=MPC=MSC Usually better to target pollution directly rather than pigouvian tax bc leads to innovation
An important assumption that underlies the marginal productivity theory of income distribution is that:
factor markets are perfectly competitive.
When external benefits exist from the production and consumption of a good, what will market do? vs opposite with external costs
market will under produce that good -- society would benefit from more but market produces less When my neighbor spends her money investing in her property I am the consumer of that external benefit -- market will underproduce that good Issue of external costs, like pollution, when good is produced and consumed- market over produces such goods -- society would benefit from less but market produces more
Do monopolies neccesarily earn profit? and why do so many people consider them the bad guy
no - just bc only producer of something doesnt guarentee you earn profit -- if cost per unit exceeds price (ATC above) will be loosing money like any other owner -- any producer who is losing money in short run will get out in long run taking resources elsewhere If this person leaves- no longer industry Most people prefer competition In comp mrket market supply and demand determine Q-- in monopoly it doesnt MC cost curve is industry supply curve and monopolist demand curve is industry demand curve-- if perf comp market that intersection would yield eq q and price -- monopolist charges more and provides less product
Network externalities
Has no inherently favorable or adverse effect on society at large-- does effect other users of associated goods Suppose u were only twitter user in world-then it would be worth nothing to you Twitter derives its value only from fact that other ppl use it too -- more people who use twitter- more valuable it is to you Network externality Exists when value to an individual of a good or service depends on how many people use that good or service-- referred to as fax machine effect Congestion creates form of neg externality- worse when more people use same swimming pool
MArket structure questions graphing tips
1st- What market structure is it? Monopoly- single Monopolistic comp- several, many , differentiated 2nd- Title/ Axis (always will be same thing- so know those) 3rd- D, MC and MR curves Start w demand curve bc that creates other curves Monopoly and monopolistic comp graphs same or diff? 4th- Key Q's and Key P's all will produce at MC=MR if not being regulated in any way Key price for monopoly and monopolistic comp-- go up straight to demand where MR=MC Draw curves- find Q where MC=MR and then find price 5th- ATC - dont need ATC to determine profit max Q and price but do need it to determine profit and loss If Q asks to draw monopolists cost curves-- DRaw ATC Case where you draw ATC earlier-- if says constant cost industry-- would be flat line If constant cost what would be true about marg cost-- same curve-- would also be flat
Game theory arrested al and bill scenario
Al and Bill both get arrested seperately and seperately are told their sentences are 2 years - open and shit case- each 2 years if nothing else happens Interviewer now looks at these two and recognizes them as people who commited a large robber armery 2 weeks ago -- just has to go on his suspicion-- so what investigator has to do is provide incentive for them to snitch on eachother Tells them you will both get 2 years for drug dealing but if you confess and the other doesnt than you will get 1 year and the other guy will get 10 years -- guy who is spending 10 in this case has larger sentence bc not cooperating Or says if you deny and other confesses now it switches around- you will get 10 years and the other guy will get 1 bc he cooperated If both confess- both will get 3 years
Ways gov works to prevent monopoly power
Antitrust laws to deal w some monopolies Some monopolies created by massive economies to scale- called natural monopolies Exist when ATC of producing entire market demand is lower if one firm exists than if several smaller existed Local electricity- excel energy- ATC is lower than if gov broke into smaller ones- bc each firm would have to produce massive plants to give amount of energy One way they deal w natural monopoly- public ownership Gov could by it- bc they are not in market trying to make a profit their prices should be lower - they are not in business of maximizing profit and decreasing Q-- theoretically you could do this and there would be no deadweight loss Downsides exist- gov can be wasteful and inefficient- political- may be spending money as a society in ways we dont need to be spending money Another way they can do it- can regulate the market Excel gets to operate but gov dictates the rates. Can demand that monopolist produce at perfectly competitive outcome- MC=MR Drives all profit out of monopolist hands and they would actually then be at price below ATC- so incurring a loss Can regulate so firm earns a normal profit - required to produce at point where ATC= demand-- low end of ATC-- allowing monopolist to make normal profit rather than lose money - so majority of surplus stays w consumers
Significant barriers to entry
Barriers so high no other producer could enter industry What kind of barriers could there be? Patents Unless cell right to use idea to other people Sole ownership of a key resource Large bookstore that owns only book distributor- no other way other book stores get inventory High costs Extremely high fixed costs- economies of scale - actually better of to have only one producer Power line that no needs all of lines all over city-- if just one company incurring all of those fixed costs, that cost firm can spread the quantity out over a large spread of production and cost per unit ends up being very low But if you break this up into 10 smaller firms that are competing-each smaller firm still must incur all of those fixed costs but would have around only 1/10 of the customers - cost per unit ends up being high In economies of scale extreme- more efficient to have only one producer
short run profit v short run loss and what will happen in long run?
Both produce where MC=MR Price determined where straight line above Q Intersects demand curve If P< ATC- short run loss If P> ATC short run profit Area of profit or loss determined by Q * (P-ATC) What will happen in long run? Short run profits attracts entry into the market Demand and marginal revenue for existing firms products declines (shifts to left) as there are more similar products available to the same number of consumers A weaker demand causes prices to fall Lower prices cause economic profits to fall (profit rectangle gets smaller) Entry stops when normal profits are made (firms are breaking even) Short run losses prompt exit from the market Demand and marginal revenue for remaining firms products rises (shifts to right)as there are fewer similar products available to the same number of consumers A stronger demand causes prices to rise Higher prices cause economic losses to fall (rectangle of losses getting smaller Entry stops when normal profits are made- breaking even
Shifts of the labor supply curve
Changes in preferences and social norms WWII- era female employment. Shifted the supply of labor to the right Changes in population Growth in population over time ---working age population to increase--- slowly shift the labor supply curve to the right Changes in opportunities Increase in demand for health care increases demand for jobs in health services (nursing, pharmeceuticals) When more students graduate from college with nursing degrees, collectively they shift the supply of labor to the right in the nursing labor market. Opposite has happened in the manufacturing industries Demand for US manufactured goods decreases--US factories shut down-- demand for manufacturing labor decreases--early retirement, fewer go into manufacturing jobs--supply of manufacturing labor decreases Changes in wealth Wealth is the value of a persons assests- not the current wage they earn Weak stock/housing markets--depressed value of homes and real estate--- level of wealth declines--people go back to work---labor supply shifts to the right
How economic theory suggests pollution should be controlled?
Emissions Taxes Charge polluters an emission tax--taxes that depend on amnt of pollution a firm produces In absence of gov intervention companies have no reason to limit pollution to sociall opt Q -- instead they will push Q up to Q mkt -- where marg social benefit is 0! If companies now are taxed per ton of emissions they produce they face a marginal cost and have a reason to reduce production to Qopt General result: emissions tax equal to marginal social cost at the socially optimal Q of pollution inducers polluters to internalize the externality- to take into account the true cost to society of their actions Why emissions tax is cost efficient way to produce pollution and enviro standards are not? Emissions tax ensures that marg benefit of pollution is equal for all sources of pollution-enviro standard does not An additional plant of pollution costs more to A than to B bc they have higher costs to reduce their pollution Without gov intervent each plant will produce until its own marg benefit of pollution is = to 0 With enviro standards the 2 graphs start at same Q- where intersects x axis but as gov says need to reduce by ½ the lines diverge and the marg benefit for one becomes higher than for another at the same q that has been cut in half Difference in marg benefits bw 2 plants when using enviro standards shows that same Q of overall pollution could be reduced at lower cost by allowing plant B to pollute more than 300 tons but inducing plant a to produce less Want the marg benefit of pollution to be the same for all plants!!-- when each plant values pollution equally- no way to reduce or make better in any way If set tax-- emission tax-- and not q that is produced the plants will produce at the Q needed to max marg benefit at that cost This way you allocate most of reduction to the plant that can reduce emissions at a lower cost
Externalities and public policy--Policies towards pollution
Enviromental standards Early legislation was written with a heavy dose of "thou shalt not" pollute more than ___ amount of gunk in the air, water or soil If companies exceed standard will be fined Emissions taxes Raising the price of polluting Socially optimal quanitity of pollution QOPT is where MSB (marginal social benefit) =MSC (marginal social cost) Tradable emissions permits Licenses to emit limited quantities of pollutants that can be bought and sold by polluters. System works best when different polluters have different costs associated with removing additional units of pollution. System of tradable pollution permits works like this Gov would issue (or auction) 600 permits , each allowing holder to emit 1 ton of pollution. This removes 600 tons of pollution from the environment because 1200 would have been emitted without the permit system. If a firm with high abatement costs found that they needed to pollute more, they would buy permits from a firm with low abatement costs that found they could pollute less Firm buying permits knows it is cheaper to buy permit than to install costly abatement equipment so it profits from this transaction Firm selling permits knows that it is cheaper to install abatement equipment, so it sells excess permits and profits from this transaction High cost polluter and low cost polluter both who own permits and low realizes can sell permits for lower cost than it will cost him to actually ibate or rid of pollution Above 3 policies that can be used to control socially optimal output amount of pollution Controlling effects of production
Excludable Rival in consumption Private good Non-excudable non-rival in consumption
Excludable Good is excludable if the supplier of that good can prevent people who do not pay from consuming it Rival in consumption A good is Rival in consumption if the same unit of the good cannot be consumed by more than one person at the same time Private good Good that is both excludable and rival in competition Non excludable The supplier can not prevent consumption by people who do not pay for it Nonrival in consumption More than one person can consume the same unit of the good at the same time
Some goods, by their nature, cant be efficiently allocated in markets, while others can In order to be efficiently delivered they must be
Excludable: suppliers of the good can prevent people who dont pay from consuming it (if you want this product you need to buy it and if you dont pay for it you cant have it) Rival in consumption: the same unit of the good cannot be consumed by more than one person at the same time The type of a good depends on (whether private good, artifically scarce good, common resource, public good) Whether or not it is excludable - whether or not producer can make you pay for it Whether or not it is a rival in consumption - whether or not multiple people can pay for it at same time
Key economic concepts READ
Factor prices help to allocate resources across the economy and effect the distribution of income across the 4 factors Benefit of hiring the next unit of a particular factor if the marginal product (MP) of that unit multiplied by the price (P) of the product being produced - this is value of VMP value of marginal product VMP curve will shift outward if price of output rises, other factors become more available (worker gets hammer in his hand), and if production technology improves.
Key economic concepts READ
Fixed number of hours in a week and people can choose to either work or leisure -- working provides utility bc wages can be used to buy goods and services -- leisure activities also provide utlility One has found equilibrium mix of work and leisure when the marginal utility of the next hour of work is equal to the marginal utility of the next hour of leisure When wage rises, worker may choose to work more or less -- depends on size of substitution effect compared to income effect If sub effect stronger at higher wages-- person will work more hours (would give upward sloping labor curve) If the income effect is stronger- person will work fewer hours (would give downward sloping labor supply curve)-- likely observed only at very high wages If the product market is imperfectly competitive -- labor demand curve is given by the marginal revenue product and this lies below the value of marginal product curve because the price of the next unit of output is greater than the marginal revenue earned from selling that unit. Equilibirum hiring decision is to hire up to point where MRPL=W If labor market imp comp or monopsonistic, the additional cost of hiring the next unit of labor is greater than the wage paid to that unit of labor -- gives us the result that the marginal factor cost curve lies above the labor supply curve -- equil hiring decision hire up to MRPL= MFCL
Free rider problem public good common resource overuse artificially scarce good
Free- rider problem Individuals have no incentive to pay for their own consumption and instead will take a "free ride" on anyone who does pay Public good Both nonexcludable and nonrival in competition Common resource Nonexcludable and rival in consumption -- cant stop others from consuming and when they consume less is available to you Overuse Depletion of a common resource that occurs when individuals ignore the fact that their use depletes the amount of the resource remaining for others Artificially scarce good Good that is excludable but nonrival in consumption
Game theory, payoff, payoff matrix
Game theory Study of behavior in situations of interdependence Payoff Reward received by a player in a game,such as the profit earned by an oligopolist Payoff Matrix Shows how the payoff to each of the participants in a 2 player game depends on the actions of both. Such a matrix helps us analyze situations of interdependence
PRivate vs. social costs and graph explanations
HUGE amnt of methane produced from livestock To society- cost of livestock farming includes direct production costs and external enviro costs Marginal private cost Marg ocst of producing that good, not including any external costs Marginal social cost Equal to the marg private cost of production plus marginal external cost Marginal External cost Increase in external costs to society created by one or more unit of good MSC= MPC+MEC In absence of gov intervention market equil will be at emkt- yields equil q Qmkt at equil price pmkt Why can we sub demand curve for marg social benefit in this case? Although demand curve represents marg beneift to consumers- marg private benefit- there are no external benefits to seperate marg private benefit from marg social benefit When MSC=D-- no external benefits so MSC=MPB=MSB Market equil Q is greater than Qopt Left to its own market produces too much of a good that generates external cost in production and price to consumers of such a good is too low --pmkt is less than pmsc-- (cost is higher to society than cost needed to pay- so will continue to buy)
Voting- irrational?
Half people vote as senator as winner but all people get him as senator whether you voted for him or not - does your vote count Voting is irrational- what is the chance that your vote was the winning vote- economic arg that your vote didnt matter Vote cost you gas to go to station time you were there Cost (when estimated based on costs above) is higher than chance that your vote has any deciding factor But then collective action happens- if everyone thinks this then no one gets elected- person you probably wanted didnt get elected What could you do- lower cost of voting (put it on your phone to vote), australia (get fined if you dont vote) Peoples marginal benefits are diff (person getting elected has higher marg benefit than normal citizen)-- but if you can build it up so everyone feels they have a significant marg benefit (imagine if your candidate won-- daughter gay had felt attacked-- there is a utility assigned w person you want to win)
When the labor market is not perf competitive
In the case of monopsony, a single employer dominates a market or industry. Unlike perf comp, where any single employer is too small to impact the wage rate, a monopsonist can exert influence over the wage. Charectoristics of a labor market monopsony Only a single buyer of a type of labor Type of labor is immobile (someone in remote mining town who doesnt really have ability to move somewhere else) Firm is a "wage maker" meaning the wage it must pay varies w the number of workers it employs -- in order to incur more workers-- have to increase wage In the case of pure monopsony, firms labor supply curve is same as industry labor supply curve -- bc is market
oligopoly and 2 gas station duopoly
Industry with only a few firms Interdependent and can engage in strategic behavior (actions of one firm have an impact on actions of another) Examples Cellphones Wireless service providers Auto manufacturers Airlines Consider a market w 2 gas stations- called a duopoly and P=MC=1 Each sell 50% of gasoline in town in perf oligopoly and each get relatively same rev by selling same amnt at same price They could get together and say that they are going to charge more- what happens? Revenue went up but agreement won't last - each of two players probs wont cooperate -- one may sell for 50 cents less and then sell a lot more gallons- going to make more rev -- next seller will follow to same price First one will end up selling greater Quant at same price- will actually lose rev -- just going to continue to price down to marginal cost Collusive agreements-hard to hold onto them because an additional profit motive involved -- will be driven down to economic profit of zero Foreshadowing of game theory-in absence of other info- what decisions will participant in market make when info on companies is less than perfect
constraints on tacit collusion
Large numbers (many firms) some might not understand whats going on Easy to cheat cuz hard to detect w many players Product complexity Cell phone and data plans and landline and TV charges- all coming from same company Differences in interests Players have to agree on direct or indirect goal Diff ideas about regional market share Diff costs Bargaining power of buyers Graceries being sold into king soopers then they sell to consumers Walmart plays manufacturers off of eachother Buyer (walmart) may have more bargaining power bc they could just go somewhere else Product differentiation and price leadership (price leader) Make your product look better to charge higher price Price leader sets price and rival firms follow it bc they have enough power and influence - everyone follows tacitly --charge for bags airlines and see if other companies follow Hard to coordinate on high prices LArge numbers More firms- less incentive to behave cooperatively-- dont feel as much of a reprucution from cheating bc not as big price effect Also more firms- harder to see how much Q being made Complex Products and Pricing Schemes Oligopolists usually sell many diff items Hard to see what other firms are making and charging Difference in Interests Firms feel diff about how much they should make- if have been in inddustry for a while feel like you should have more share -- newer firm would also have lower marginal costs Bargaining Power of buyers Large corporations can ask for lowest price and bargain w oligopolists
Price Regulation
Limits the price that a monopolist is allowed to charge Price ceilings Put price ceiling where no DWL AT&T US breaks up regional telephone lines of AT&T into several companies and in 1989 enacted price ceilings so others can compete
Long run equil perf comp vs monopolistic comp
Long Run equilibrium Perf comp graph Long run level of output is where P=MR=MC=ATC Economic profits are zero - normal profit earned P=ATC at min of ATC curve Long run Equil in monopolistic comp Long run level of output is where P=ATC>MR=MC Economic profits zero- normal profit earned P>MC P=ATC on the downward sloping range of the ATC curve (called excess capacity)- not bottom like perf comp
Key concepts READ
Marginal productivity theory of income distribution says that income is distributed across the factors of production based upon the relative marginal productivity of the factors. We have seen that labor has the greatest share of total income. We also know that, within the labor market, there are many types of labor and income inequality exists. Consistent with the theory is that wages differ due to compensating differentials, talent differences, and human capital differences Wages also differ across workers due to market power wielded by unions or employers, by efficiency wages and by discrimination.
Overview of monopolistic competition
Market structure that shares charectoristics w both perfect competition and monopoly Charectoristics Many firms exist in the market, but not as many as perfect competition, you might think of monopolistic competition as measured in dozens of firms , while perf comp is measured in hundreds of firms Product is differentiatied (so advertising works) Each firm has some ability to set price of their product , but there is not an opportunity for tacit collusion No barriers to entry or exit Examples:restaraunts, clothing stores ****below no differences in cost curves shape in PC vs monop (MC and ATC shapes) marg rev slopes downward and even more than demand curve bc price and quantity effect--- (price- in order to sell more you have to reduce price and as good gets cheaper you sell more) as firms enter monopolistic comp firm already in market sees leftward shift of D and MR curves -- opp shift happens if firms exit-- why easy entry and exit important!!
Common resource
Non excludable but rival in consumption Examples: oceans (someone cant pay you to consume or not consume ocean), clean air,clean water, stock of fish (fisherman can go out and fish w out paying-- but if i am out enjoying particle piece of ocean someone else cant enjoy same fish as ones i caught) Overuse occurs when common resources are depleted by individuals without regard on the effect to others (tragedy of the commons-- we all use it until its gone) -- common resources are ripe w overuse exposure bc cost is so low and as i am consuming those goods-- own private cost one person is looking at but not looking at marginal social cost
Oligopoly
Only small number of sellers- few enough that any seller can affect the market Few enough that sellers effect other sellers Can be different product like cars or same like oil Fairly high barriers to entry Price and Output Will result in higher price than either competitive market but not as high as monopoly Potential for profit They will be able to maintain some amount of product if manintained into the long run bc of the barriers to entry Mutual interdependence among firms- each firm keeps eye on other one trying to anticipate and make reactionary plans-- wondering whether someone else will raise or lower their price and if they do- what should i do? When oligopolisitc firm goes to raise its price--- other firms will not follow -- they will gain customers bc they will be driven away by higher firms prices Firm who raised price would see a large decreas in quant demanded--- move along x axis to make a smaller and skinnier rev rectangle If firm lowers price other firms are now aware that they may lose some of their market share- if everyone lowers prices the firm that initiated would see very little change in Q demanded bc customers stayed where they are Can still find where MC=MR If firm makes money in short term- barriers to entry help to protect these profits even in long run -- diff but no impossible to enter market- so may be some loss to rivals If firm loses money in short run- may leave and leave more profit to others Can maintain profit into long run but profit earned isnt quite as high as monopoly
Artificially scarce goods
Pay-per-view movies are artificially scarce because they are excludable but non rival. The cable company can exclude me from watching the movie if i dont pay the price, and if i watch the movie it doesnt deny another household from also watching movie. Marginal cost of providing movie to one more house is zero. Efficient quantity would be quantity where demand curve intersects the horizontal axis and the price would be zero. Of course there is no way the firm can profit if the price is zero, so firm sets price of maybe 5$ and excludes some potential customers. If price is 5$ fewer movies will be ordered than the efficient number. This is why this good is called "artificially scarce"
Key concepts read
Pay-per-view movies are artificially scarce because they are excludable but non rival. The cable company can exclude me from watching the movie if i dont pay the price, and if i watch the movie it doesnt deny another household from also watching movie. Marginal cost of providing movie to one more house is zero. Efficient quantity would be quantity where demand curve intersects the horizontal axis and the price would be zero. Of course there is no way the firm can profit if the price is zero, so firm sets price of maybe 5$ and excludes some potential customers. If price is 5$ fewer movies will be ordered than the efficient number. This is why this good is called "artificially scarce"
How can economy be induced to produce Qopt and technology spillover
Pigouvian subsidy-- payment designed to correct for the effects of external benefits External benefit that results when new tech knowledge spreads among firms
Pigouvian taxes and problems with emissions taxes
Pigouvian taxes Taxes designed to correct for the external costs Prob w emissions taxes Gov officials dont know exactly what to make it If set it too low- too litttle improvement in enviro and too high emissions will be reduced by more than is efficient
Prisoners dilemma explaining scenario above
Prisoners dilemma Game based on 2 premises 1- each player has an incentive to choose an action that benefits itself at the other players expense 2- when both players act in this way- both are worse off than if they had acted cooperatively Optimal bundle- they both deny Assuming that they dont have usual loyalty to eachother-not related or any loyalty pack Will rationally pick non optimal scenario Pay off matrix- drawn in book Rational for them to both confess-- called a NAsh equillibrium Each party has picked an optimal choice given the choices of the other party First person thinks abt whether other person confesses- if other person confesses and he denies- gets 10 years vs if he confesses and first person also confesses- only get 3-- going to lead themt to confessing If assume second person denied- and you also deny- then get two years but if assume other person confessed and you also confess- only get 1 So always optimal to confess- based on thinking about what they are going to do---- unless you both deny which first person doesnt know Confess-optimal choice for 1 person Interesting that they get to nash equillibrium state (3 and 3) rather than globally optimal state - both getting 3 years by both confessing rather than both getting 2 years by both denying The problem w the 2-2 global state is its unstable-- at that at any moment 1 of them can realize that they could improve their sentence -- if one thought that the other was definitely denying then he could move his state to confessing and only get 1 year Nash equillibirum is a very stable state-- either way from this state will actually turn out worse off Both people will pick something that is not optimal globally
Nash equillibrium or noncooperative equillibrium
Result when each player in a game chooses the action that maximizes his or her payoff, given the actions of other players Do not take into account the effect of their actions on others
Graph of VMPL and shifts in the factor demand curve
Same as law of demand so VMPL curve serves as demand curve for labor. For any factor the VMP curve serves as the demand curve for that factor of production. Shifts in the Factor demand Curve 3 external variables that will shift it outward or inward (right or left) Changes in the prices of goods Price rises, demand for labor shifts right Value of marginal product stays under wage number for a longer period of time (bc multiplying by higher number) Changes in the supply of other factors If labor is paired with capital (tools), the labor is usually more productive. If capital (land) is more plentiful , usually the marginal product of each unit of labor is higher, the VMPL curve shifts outward, and more units of labor are hired at all wages. Each unit of labor becoming more productive as labor is paired w other factors Changes in technology Better technology increases production across the board. In some cases, tech replaces certain factors (like machines replacing labor), but in the long run better tech allows a nation's labor force to be more productive and the demand for labor shifts outward. Efficiency increases
Read Key economic concepts!
Simple duopoly is enough to demonstrate mutual interdependence. If these firms compete, they will each receive normal profits. If they cooperate they can act like a monopoly by restricting output, raising prices, and earning positive economic profit. There is an incentive for each duopolist to cheat on a collusive agreement to earn even more profits. Because of this incentive, collusion can be unstable, not to mention, an illegal arrangement. Collusion inside united states is essentially illegal
Tradable emissions permits
Tradable emissions permits -- licenses to emit limited quantities of pollutants that can be bought and sold by polluters Usually issued according to some formula reflectings polluters history These Permits are tradable Firms w diff costs of reducing pollution can now engage in mutally beneficial transactions -- those that find it easier to reduce pollution will sell some of their permits -- so in end those w lowest cost to reduce pollution will reduce it most and sell their permits Known as a cap and trade program Provides polluters w incentive to take marg social cost of pollution into account If market price of permit to emit one ton of pollution is 200$-- every plant has incentive to limit emissions of sulfur dioxide (Q) to point where their marg beneift of emmiting another ton is 200$ Sociall opt Q of pollution can be achieved by tax or this - either system ensures that those who can reduce cheapest are ones who do so Emissions taxes and Tradable emissions permits also provide incentives to create and use tech to emit less pollution -- new tech that lowers socially opt level of pollution Main prob of Tradable emissions permits Bc it is difficult to determine opt Q of pollution- gov can find themselves either issuing too many permits (dont reduce pollution enough) or not enough (reduce pollution too much)
The market for labor explain it who are suppliers etc
We are all suppliers of labor We supply labor to firms who need (demand) it The price at which we supply labor= the going wage-- i will work for whatever going wage is The choice to work is a cost/benefit tradeoff cost=leisure time given up $ that earn that can be used to provide utility (get things you want and need) You will work the next hour if the marginal utility of the wage exceeds the marginal utility of leisure you give up -- if money earning exceeds value of what you could have been doing You wont work the next hour if the marginal utility of the wage is less than the marginal utility of leisure you give up Equillibrium occurs when MUw=MUL
Price Discrimination
When same product is sold to different consumers at different prices Happens all the time around us and firms do it for a very logical- not illegal reason- it increases their profit You and grandparents go to dennys and get same meal- who gets it for cheaper-- elderly price Can put price at where students are willing to pay- bc makes higher profit- but then have senior citizens come in w ID and get discount so you dont lose all of them Seniors pay 4$ while students pay 8$ why? Senior citizen discounts due to price sensitivity- generally on fixed income Children under 12 bc parents are price sensitive to additional cost Business travelers are less sensitive to price than leisure travelers -- if business traveler going to spend a lot more than someone who bought it month ago bc u have to go What makes one group more sensitive Smaller budget (childrens vs. adults at movie theatre) More flexibilty to alter plans (senior (can go some place else) vs. college student at dennys) More substitutes (vacation travelers vs. business travelers- if business in DC have to go to DC) If you buy flight ticket for tomorrow and friend bought it months ago who is paying more? Buying a car- willingness to pay is determined while you are there - can haggle over price Auction- will start bidding products by consumers willing to pay
Private vs social benefits
When the production and consumption of a good provides benefits to third parties, that good is said to provide externalities to society Ex: I consume a chocolate bar - private benefit- neighbors dont receive that If i consume a chicken pox vaccine- my neighbors will benefit from it-wont get sick Sue spending a lot of money to her home provides private benefit but then will spill over as market in neighborhood value will go up --spillover benefit Total social benefit= Total private benefit+Total external benefit On an incremental basis, the next unit of home improvements (or next shot) provides marginal social, private and external benefits Marginal social benefit= marginal private + marginal external benefit or MSB=MPB+MEB Flu shot benefits more than just who got it -- generates positive externality Gov can directly control external costs of pollution bc it can measure emissions but gov cant directly determine reduction in flu cases from your flu shot (external benefits) So if gov wants to influence level of external benefits from flu shot- must target original activity- getting shot From point of view of society- shot has both cost (have ot buy it) and benefit (private and external)-- but you have no incentive to take into account beneficial side effects of decision -- as a result without gov intervention, too few ppl will get shot Without gov intervention- marg cost to society of another shot is equal to marg benefit gained by individ consumer who purchases that flu shot Now there is a diff bw MArginal private benefit Marginal benefit accrued to consumer of a good, not including external benefits MArginal social benefit of a good Marginal private benefit plus marg external benefit Marginal external benefit Addition to external benefits created by one or more unit of good
MArginal productivity and wage inequality
When we look at 2 different people who are paid differently, we see wage inequality. Much of this wage inequality can be attributed to factors that are consistent with the marginal productivity theory of income distribution Three possible explanations why wage inequality may hold consistent w marginal productivity theory Compensating differentials (ex: police officers in diff towns make diff amnts bc more dangerous to work in chicago then vail-- differentials in safety are compensated with higher money) Differences in talent (Drew Brees vs. Richard Bartel) Differences in Human Capital (investment in education in this case) (wage of college graduate vs. highschool dropout--dramatic diff in lifetime based on amnt of human capital invested in person in college) But differences occur among those the theory tells us should make the same (2 police officers in same town, 2 college graduates) 3 possible explanations Market power (employees working in union protected industry could make more than people doing similar work if that particular area doesnt have union work--- retail workers at union shop vs non union shop) Efficiency wages (pay more to stay in your job-- ppl who work in higher skilled jobs employed by ppl who dont want hassle of hiring and retraining someone--childcare worker like nanny-- people will pay a lot for good nanny bc once establish trust dont want that person to leave- may pay extra money to keep that person in job) Discrimination (ethnicity, gender, nationality--)
Determining the optimal input mix
Will select input combo w lowest cost -- known as cost minimization Cost minimization Evaluate cost of each combo and select one that minimizes cost of production Calculate total cost of each alternative combo But if number of combos is very large-- makes more sense to use marginal analysis to find cost minimizing level of output-- brings us to next rule The cost minimization Rule Additional output that results from employing additional unit of input- marginal product (MP) Firms want to receive highest possible marginal product from each dollar spent on inputs Adjust combo of inputs until marginal product per dollar is equal for all inputs (COST MINIMIZATION RULE) If inputs labor and capital-- this equals marginal product of labor per dollar spent on wages to marginal product of capital (MPK) per dollar spent on capital MPL/Wage = MPK/Rental rate To understand equation above If MPL/Wage > MPK/ Rental Rate If marginal product of labor 20 units and marginal product of capital 100 -- wage 10$ and rental rate 100$ Firm receiving 2 additional units of output for each dollar spent on labor and only one for capital -- so firm gets more additional output for its money by hiring labor-- so should hire more labor But because of diminishing returns as firm hires more labor marginal productivity of labor falls (rock activity) Firm will continue to sub labor for capital until falling marg product of labor per dollar meets rising marginal product of capital Like when consumers maximize their utility by choosing combo of goods that marg utility per dollar is equal
Public goods
are NOT (cant be excluded and can be consumed by multiple people) -- benefits not confined to just those who bought it, when we consume amnt for others to consume does not diminish Street or road signs Fire protection- if fire department puts out fire in my neighborhood and they get to house and person hasnt payed for fire protection-- there really is no such thing bc it is paid for through their taxes- fire department cant just say you havent paid we are not gonna put out fire -- also can be consumed by mult people (put out mult houses at one) Sewer treatment plan--- cant stop someone from pouring sewage down plant Lighthouse Public goods are both non-excludable and nonrival. Because they are non excludable, their exchange suffers from the free-rider problem and private firms will not emere to supply them to the market. So how are we going to get important public goods like national defense, enviro protection, and disease prevention? Gov charging a tax We determine how much to provide by determining where MSB=MSC -- important difference bw public and private goods---In special case of public goods, MSB of a unit of the good is equal to the sum of the MPB's (marginal private benefits) enjoyed by all consumers of that unit It is the sum bc people can "consume" the unit simultaneously For example street cleaning services-- the private benefit on individuals is happening almost simultaneously so makes sense to add them
