ECON EXAM 2

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reservation option

is a persons fallback option. for each point along angels reservation indifference curve she is indifferent between that and government rations.

cost advantages

large firms can purchase inputs on more favorable terms, because they have greater bargaining power when negotiating with suppliers

governments raise more tax revenue by

levying taxes on price in elastic goods.

deadweight loss=

loss of total surplus relative to a parter efficient allocation

MC curve always intersects the AC curve at its

lowest point

total surplus is highest when demand=

marginal cost

firms with ___________ have enough bargaining power set prices without losing customers to competitors

market power

Gini Coefficient

measure of inequality, approximated as the deviation of the Lorenz curve from the perfect equality line Ranges from 0 (perfect equality to 1 (max inequality)

surplus

measuring gains from trade.

a __________ arises when one firm can produce at lower average costs than two or more firms

natural monopoly.

large firms can be more profitable than small firms because of

technological and or cost advantages.

incomplete contracts

the contract between a firm and its employees is incomplete: some tasks depend on future (unknown) events. :some aspects of the job are difficult to measure and base wages on example effort. ........... incomplete contract does not specify in an enforceable way. every aspect of the exchange that affects the interests of parties.

Isocost lines for effort

the cost of effort is the same at all points on an iso cost line.

Marginal cost (MC)

the effect on total cost of producing one additional unit of output. -Calculated as the slope of the cost function at a given point. *

principal-agent models capture interactions under incomplete contacts. example

the firm is the principal and the worker is the agent.. --agent takes action that is hidden from the principal, which is why the principal cannot verify it

One way to increase the cost of job loss is for

the firm to raise wages

Factors that affect the firms choice of price and quantities produced

(costs, price elasticity, market power)

Isoprofit curve

(economic profit) = total revenue- total costs (costs included the opportunity cost of capital)

Institutions

(the rules of the game) matter for social outcomes. Can affect the income that people receive for their work

Wages and effort

- employer can not directly measure to workers effort. large employment rent-> large cost of job loss-> workers put in more effort to reduce chance of getting fire.

feasible allocations are given by the

intersection of feasible frontier and biological survival constraint

employment rent =

-cost of job loss, which includes -lost income while searching for a job -costs required to start new job, relocation -loss of non wage benefits ex medical insurance - social costs (stigma of being unemployed)

incomplete contracts do not only occur in employment relationships.. incomplete contracts arise when....

-information is not verifiable -the relationship covers periods of time -there is uncertainty -there are difficulties with measurement -judiciary is absent -preferences for omitting some information

Firms best response

-to maximise profits, firms want to minimize the costs of production -there is a tradeoff between wages and effort. the employer should find a feasible combination of effort and wage that minimizes the cost per unit of effort.

if firms can't directly measure effort, why do workers work hard?

-work ethic -feelings of responsibility -feeling of gratitude -benefits for measurable output =promotions -fear of being fired

Economics can clarify:

1. How institutions (rules of the game) affect inequality 2. Tradeoffs in the fairness of outcomes 3, Which public policies can address unfairness and how

Allocations can be considered unfair for two reasons

1. substantive judgement of fairness 2. Procedural judgment of fairness

The employment game

1. the employer chooses a wage. as long as the worker works hard enough, she will keep her job at the offered wage. 2. worker chooses a level of work effort, taking into account the costs of losing her job if she does not provide enough effort.

Institutions have to do with what

Bargaining Power and Reservation Option

Demand Curve

Firms feasible frontier (slope=MRT)

Allocation 2- voluntary exchange

How parties divide up the j joint surplus (mutual gains) depends on 1. each party reservation option 2. relative bargaining power between the parties,

Procedural judgement of fairness

How they came about (force vs fair play, equal opportunity, conforming to social norms)

COERCION

Imposing allocations by force. (Suppose Bruno can enforce

there must always be "involuntary unemployment" in the labor discipline model. Why?

In equillibrium, both wages and involuntary unemployment have to be high enough to ensure employment rent is high enough for workers to put in effort.

Slope of isocost curve

MRS- the rate at which the employer is willing to increase wages to get higher effort.

firm maximizes profits by choosing point where

MRS=MRT

slope of best response curve=

MRT

Allocation

Outcome of an economic interaction (describes who does what and who gets what)

Contracts for PRODUCTS sold in markets

PERMANENTLY transfer ownership of the good from the seller to the buyer

Piece Rate Pay

Piece rate work= type of employment in which the worker is paid a fixed amount for each product made --give workers an incentive to exert effort. --difficult to measure output in modern jobs -employees often work as a part of a team

Contracts for LABOR

TEMPORARILY transfer authority over a persons activities from employees to the manager or owner

Rawls veil of ignorance

Taking an impartial perspective

Owners and managers misaligned interests

The firms profits legally belong to the people who own the firms assets... managers action have impact on profits increase thanks to managers work, they will not automatically benefit.----> this creates a misalignment of interest between managers and owners.

contract

a legal document or understanding that specific a set of actions that parties to the contract must undertake

if AC<MC: AC is

increasing

The feasible frontier shows

all the technically feasible outcomes (limited by technology)

Parteo efficient bargaining

allocation chosen will be on the parter efficiency curve.

average cost

average cost per unit produced. calculated as the slope of the ray from the origin to a given point on the cost function. * in this example, average costs decrease at first (economic of scale) but then increase (overtime, machine breakdown)

involuntary employment

being out of work, but preferring to have a job at the wages and working conditions that otherwise identical employed workers have.

competition policy ( limits on market power) can be

beneficial to consumers when firms collude to keep prices high.

firm

business organization which employs people, purchases inputs to produce market goods and services, sets prices greater than the cost of production

Redistributive government policies (income tax and transfers)

can result in a more equal distribution of disposable income.

Marginal revenue (MR)

change in revenue from selling an additional unit (net effect of decreasing price and increasing quantity sold) Firm maximizes profits by choosing point where MR=MC

Substantive judgment of fairness

inequality of final outcome (wealth, well being)

firms can increase their market power by

innovating and advertising. both of these tactics can shift the firms demand curve

Chosen allocation depends on

institutions and policies

if AC> MC: AC is

decreasing

price elasticity of demand

degree of responsiveness ( of consumers) to a price change

Differences in inequality in disposable income across countries

depends on the effectiveness of these policies. ..........income tax and transfers

FIRMs vs markets

division of labor is different

Preferences have to do with

economically feasible allocations, and allocation (outcome) who does what and who gets what.

The effect of good specific taxes depends on

elasticity of demand for those goods

Moral hazard results from information asymmerteries between the principle and the agent

example- amount of effort that an employee chooses to exert. The amount of effort is often left out of a contract rendering the contract incomplete effort is often not observable to the principle.

example of market power

firm selling specialized products * face l little competition and hence have inelastic demand. *set price above marginal cost without losing customers this earning monopoly rent. *form of market failure because there is deadweight loss

Payoffs from employment game

firm- profit=workers output-wage worker- employment rent

iso profit curve

firms indifference curves (slope =MRS)

how labor is different in firms vs markets

firms-concentration of economic power in the hands of the owners/managers allows them to issue commands to workers. markets- power is decentralized in markets so decision are autonomous and voluntary

When is an allocation Pareto efficient?

if nobody can be better off without making somebody worse off

legislation

imagine a legislation that has been passed that limits how much time Angela is allowed to work.

demand advantages

network effects (value of output rises with number of users . example software application

Firm specific assets

network of colleagues, acquisition of skills necessary for the job. Valuable o only when worker remains employed in a particular firm. When relationship ends value is lost to both sides.

structure of a firm

owner decide on long term strategy managers implement their decisions by assigning tasks to workers and monitoring them

Asymmetric information

owners or managers do not always know what their subordinates know or do, not all of their directions or commands are necessarily carried out.

innovating- technological innovation can follow firms to differentiate their products from competitors. firms invent a completely new product may prevent competition through

patents or copyright laws.

iso profit curves shows

price quantity combinations that give same profit. shape of firms cost function affects the shape of their curves

A firms success and ability to grow partly depends. on its

pricing and production decisions.

A firms markup

profit margin as a proportion of the price is inversely proportional to price elasticity of demand

determining wages

profits are maximized at the steepest iso cost line, subsets to the workers best response curve MRS=MRT

Demand curve

quantity that consumers will buy at each price. to make pricing and production decisions, managers also need to know the demand for the firms product.

employees fear getting fired when they are paid more than their ______________

reservation option = they receive employment rent.

Separation of ownership and control

results in managers deciding on the use of other peoples funds.

a firms costs depend on its

scale of production and the type of production technology it has.

cost functions

show how total production costs vary with quantity produced

Combined feasible set

shows all possible allocations (outcomes) of production between two people or parties

economically feasible set

shows all possible allocations that benefit both parties

Biological survival constraint

shows all the biologically feasible outcomes (limited by survival)

Lorenz Curve

shows the extent of inequality and allows comparison of distributions

Workers best response curve

shows the optimal amount of effort workers will exert for each wage offered. - represents the firms feasible frontier for wages and effort.

The allocation that maximizes his economic rent (max bruno can get) is where

slope of the biological constraint (MRS) equals slope of the feasible frontier (MRT) MRS=MRT

demand is relatively inelastic if there are few close

substitutes

Biology and Technology have to do with what

technically fesasible allocation, economically feasible allocations, allocation (outcome) who does what and who gets what.

producer surplus (PS)

the total difference between revenue and marginal cost (profit= PS- fixed costs)

consumer surplus (CS)

the total difference between willingness to pay and purchase price

aligning interests

to solve the conflict of interest between managers and owners. - link the. managers pay to the performance of the company share price. -monitor the managers performance.

Total surplus = consumer surplus + producer surplus =

total gains from trade

Relations within a firm

unlike in markets, relationships within a firm may extend over a long period of time. creation of NETWORK of colleagues. acquisition of SKILLS necessary for the job.

the best response function will shift in reaction to change in

utility of the things that wage can buy, disutility of effort, reservation wage, the probability of getting fired at each effort level.

reservation wage

value of next best option (other employment or un employment benefits)

employment rent=

wage-reservation wage- disutility of effort. -disutility of effort is also know as the cost of effort.

efficiency wage

wages set higher than the reservation wage so workers will care about losing the job and provide more effort.

Interactions between firms and workers determines wages which are part of

which are part of a firms production costs.

a firms profit margin depends o n the elasticity of demand

which is determined by competition.


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