ECONOMICS FINAL 1000%

entry/exit

- "Entry, Exit, and Long-run Profitability" o Consider the market for widgets o The market is in imperfect competition o Over time, some new firms enter and some existing firms exit the market o What determines if a new firm enters or an existing firm exits the market? Profitability - Intro Question o You quit your job in which you made $100k/year to start your own bakery o Your annual revenue from the bakery is $400k/year o Your costs are: o o Are you glad you started your bakery? § The accounting profit is $50k § Yet in some more important sense you have lost $50k

decisions involving uncertainty

- A lot of decisions don't know cost or benefit- go to grandma's house during pandemic- think about uncertainty- bet with 50 chance of winning 100 and 50 change of losing 100 - Expected value- Px x X + Py x Y- X is the good outcome, Y is bad outcome, Px is probablility of X and Py is probability of Y - Just apply the formula

assess inequality

- But- perhaps inequality of annual income is not the inequality you care about most- an individual's annual income can vary a lot over time- according to individual current annual income, most full-time Georgetown are very poor- should policymakers be worried about them? - Many people have high-earning years and low-earning years- temporary periods of not working - Another way to assess inequality- food spending

group pricing

- Cheaper tickets for children, students, seniors- helping them sell more- practicing a form of price discrimination known as group pricing- charging different prices to different segments of people- doesn't know reservation prices, so uses proxy- group membership- to tailor prices to different segments of customers- group pricing involves offering different prices to groups that differ by their age, location, purchase history, identifiable characteristic- academic pricing of technology, cheaper books abroad, lower prices for residential services, pink versions sold for higher price, discounts for new customers, military or veterans- group pricing anytime company offers higher/lower price to one group- describe in terms of group discounts, not higher prices - Different prices based on location of internet connection- can try to change this, put in cart and then wait for discount email

spreading 2

- Make nearly risk-neutral choices when the stakes are small- wealth won't change much, marginal utility pretty similar in each case, life won't change much- marginal utility of dollars next to each other aren't exactly the same but very similar- marginal utility of each dollar is pretty much the same whether you gain or lose a few dollars- life won't change much either way- gain almost twice as much from winning 2 as losing 1- if marginal utility didn't change at all, it would be exactly twice as large- even when measured in terms of utility the benefit of winning small stakes bet nearly double cost of losing so take it- risk averse but low-stakes- when stakes as small enough that your marginal utility is roughly the same whether you win or lose, you should act as if you're nearly risk neutral- that is, as if you neither like nor dislike uncertainty- indifferent to risk- only care about whether a choice offers positive financial returns on average- small enough take any risk that's a fair bet

spreading 3

- Never buy extended warranty- extremely profitable, take in twice as mhuch money as they pay out- when stakes are high be risk averse- but small chance to replace printer is not high stakes- small stakes don't worry much about risk, save enough to fix devices without warranty - Risk spreading explains why big investments require a lot of shareholders- could borrow money and be sole owners but that means bearing all risk of expansion not working out- too big of a risk- selling many shares, buy slice of action, breaks large risk into much smaller risk, risk worth taking for owners when risk spread across thousands of owners- makes many risky investments possibly by allowing risk to be spread across many shareholders

Perfect competition

- Perfect Competition is an Extreme case that is very rare in real life o The market for gold, oil, wheat, and livestock are relatively close to PC o But the markets for most goods are not very close to PC, because of § Number of sellers (or buyers) is small · Monopoly- when there is a single seller of a good · Oligopoly- when there are only a few large sellers of a good § Product differentiation- there may be many firms, but the goods are not identical · Smartphones, jeans, breakfast cereals · Those markets are characterized by monopolistic competition, where various firms sell similar but differentiated goods- monopoly over market for iphones but not over smartphones

efficiency equity tradeoff

- Redistribute income may put dollars in hands who value most but costly because distort incentives- equal incomes may come at cost of lower average incomes- this is the equality-efficiency trade-off - If all redistributed- no incentive to work or innovate, total production would plummet, equal of really small pie- none- incentives to work high, size grow but many very destitute, many on crumbs can't move- cost is each other - Greater equality doesn't always mean less efficiency- trade off not hard and fast, no efficiency cost sometimes to increasing equality- inequality may create violence which makes more money having to be spend on prisons and defense- unproductive waste- inequality concentrates political power which can increase tax cuts for rich- weaker economic growth and corruption- social benefits can encourage investments like paid leave and women working, racial gap in education- sometimes still trade offs- how much has to leak out of bucket for it to be worth it

mitigating risk

- Risk aversion- not mean eliminate all risk- super costly and difficult- always a risk- complete isolation - Risk Mitigation Strategy 1- risk spreading- breaking a big risk into many smaller risks so it can be spread over many people- starting a business- get a bunch of investors because borrowing means you have to pay it back but a bunch of investors is small risk for you- giving up gains if it takes off but if didn't spread wouldn't try to start company- company's "go public" when they want to expand their business, they need money to expand their business- could've gone to bank but had to pay back so raise money by finding a bunch of people to pay them cash but give away some of proceeds if business becomes successful - NO DIVERSIFICATION AND REST

risk aversion

- Should you work for a company or start a startup with a lot of risk- tough choice but one of many risky decisions- - need to make good decisions even when consequenes of each choice are uncertain, extend cost-benefit principle to guide without exact consequences

setting prices

- What to charge balancing act- trade-off between selling a larger quantity of items versus making more money on each item you sell- firm's demand curve, which summarizes market power, and marginal revenue curve, which measures incentive to increase production

axel uncertainty

Expected value: the expected payoff of getting different outcomes Px * X + Py * Y, where X, Y = outcomes and Px,y = probability of getting outcomes X or Y A fair bet: a gamble that, on average, leaves you with the same amount of money (whose expected gains are 0) To account for uncertainty, we expect individuals to make the choice with the highest expected utility You calculate expected utility the same way you calculate expected value!

axel market power

Market Power: the ability of a firm to set (raise) its own prices Perfect competition What we've seen throughout the majority of class, where demanders and suppliers are price takers (agree on prices decided by market forces) All goods in the market are the same (homogenous) The price of a good is driven down towards the marginal cost of the good Imperfect competition: Occurs whenever firms have market power (the ability to set their own prices) Different (heterogeneous) goods The price of a good is set by a firm (monopolist) with market power Product differentiation: occurs when goods are not identical (a.k.a. Heterogeneous) Characterized by monopolistic competition

axel monopolies

Monopoly: when there is a single seller of a good Oligopoly: when there are only a few large sellers of a good Firm demand curve: the demand curve a firm faces Marginal Revenue Curve: shows the additional revenue a firm gets from selling one more unit of a good The marginal revenue curve always has half the slope of the demand curve The Rational Rule for Sellers: The firm will want to keep selling goods until MR = MC How to find profit maximizing price and quantity for a monopolist (picture above) Step 1: Find where MR = MC Step 2: From that point, look down at your profit maximizing quantity Step 3: From the same point, look up to your firm demand curve to find the price How to find a firm's profit: π = total revenues - total costs Total revenues = p * q, Total costs = MC * q

axel redistribution

Redistribution: we can make society as a whole better by redistribution income from richer to poorer folk (in terms of taxes) Costs of redistribution: taxes create deadweight loss Generally, you should redistribute money from people with higher incomes to people with lower incomes, since richer people experience higher diminishing marginal utility of incomes

axel mitigating risk

Risk spreading: breaking a big risk into many smaller risks spread across many people

axel utility

Utility: a measure of a person's wellbeing (think: a measure of how useful an individual finds something) Marginal utility of income: the extra utility you gain from an extra dollar in your pocket Diminishing marginal utility of income: the process in which the extra utility you gain from an extra dollar in your pocket gets smaller and smaller (think: your 100,000th dollar of income helps you less than your 50,000th which helps you less than your 10,000th) Well being curve (pictured above): shows the average level of utility (satisfaction) at each level of income → extremely important to understand for the exam

group pricing example

o Military discounts o International versions of textbooks o Business-class vs economy flights o Men vs women's haircuts o New customer discounts

economic profit versus accounting profit

- Accounting profit is total revenue less out-of-pocket financial costs- accounting profit- the total revenue your business receives minus your total outlays, which we call your explicit financial costs- all the income from all sources- explicit financial costs are all the money that leaves your business, including rent, wages for employees, cost of raw materials- track all money that goes in and out- number reported on bottom line of proft-and-loss statement and printed in annual report - Accounting profit= total revenue - explicit financial costs - The opportunity cost of running a business includes forgone wages and interest- even with positive accounting profit, it still depends on alternatives- give up income, should I start a new business or what? Time and money- forgone wages, forgone interest- next best career option, annual interest by investing elsewhere - Employer benefits, job satisfaction- think of sum of all these opportunity costs as annual payment and cost for starting new business - Economic profits account for both explicit financial costs and implicit opportunity costs- economic profit- total revenue less both explicit financial costs and implicit opportunity cost of time and money- if economic profit positive, do it - Accountants and economists are answering different questions- different conceptions of profit- accountant- where did my money go last year? Focus on explicit financial costs, which are any outlays where money left your business, including rent, the wages you pay your workers, cost of stuff, electric bill

market power

- All firms are price-takers if in perfect competition- no sales if it went above market price, no incentive to sell lower than price - Recall Perfect Competition o A market in perfect competition has § A single good that does not vary in quality or features § Many sellers and buyers, each of whom is small relative to the size of the market § Question- is the market for cell hpone service perfectly competitive? What about the market for gasoline?- not perfectly competitive- gasoline is closer- people less picky about what brand of gas they get for most people- gas closer than phones

permanent income

- An Ideal Income Measure?: Permanent Income o Permanent income: "your average lifetime income"- or a measure of income that helps you understand a person's income over their lifetimes- people's consumption decisions probably reflect permanent income more than current income § Suppose you had zero income now but knew you would make a lot of money starting next year- if you could borrow money this year to pay back next year, you probably would- borrow from the future- suppose you make a lot this year, but are worried about losing your job next year- you would probably save a lot this year § Unfortunately it's difficult to measure (estimate) permanent income because it depends on future income- but helpful concept for considering economic decisions

average cost 2

- Average costs matter because they determine the profitability of the marginal supplier- centrality of average costs to determiningprices might seem surprising since marginal principle led us to focus on marginal costs- average costs follows directly from applying the marginal principle to a long-run analysis- short run- one more unit- marginal cost/benefit- one more business will enter or exit- profitability of the marginal supplier- the company right on the cusp of entering or exiting- profit margin depends on average costs- marginal principle to focus on average costs- even threat of entry can cause them to cut prices - Long run profitability depends on barriers to entry- free entry and exit, long run economic profits eliminated and price equal average cost- focus on if- won't necessarily happen

risk-reward trade off

- Aversion does not mean avoid all risks- take risks when beenfits exceed costs- measure in terms of utility- more likely to happen when greater risk means greater reward- don't eliminate all risk- necessary for daily life - There's a trade-off between risk and reward- avoid some risks but not altogether, often worth taking calculated risks- simply whether rewards outweigh the risk, risk-reward tradeoff, take risk based on reward, risk aversion lead you to not make investment if upside potential is equal to downside potential- re-evaluate if has better prospects than thought- if succeed, get 30k and if fail 10k- 50% chance still- comparing a higher utility gain to a lower loss so investment is just as risky- difference in your wealth between good and bad outcome is still 40k- payoffs are high, based on utility this one would be worth it- cost benefit principle- the greater the reward the more willing you should be to make a risky investment - People willing to make risky investments only if potential returns are high enough- graph, reward- average annual return or yearly increase in wealth from investment- horizontal axis- how risky each is- lots of people willing to invest in something despite low average return because not very risky, buying stocks in newly emergying or small companies risky but high return- only take this risk if expect high return

expected utility

- Bet of investing 20k- 50% chance of getting 40k back, 50% chance of getting 0 back- expected financial value: .5(20) + .5(-20) = 0- either make or lose 20k- is 50 50 chance worth it- not if you are risk averse, if utility over income curve looks like typical one- if you win utility goes up but less than it will go down if you lose 20k- losing hurts you more than winning helps you - Expected utility- utility if take bet= chance (utility if lose) + chance (utility if win)- do same with don't take bet- compare to the graph to see if you should take it or not- sometimes best is expected utility of not doing anything, current utility - Do risk averse people ever take risks, yes- only some risks are worth it- bet changes to win 30k lose 10k- calculate expected utility- compare to initial wealth - Some people are more risk averse than others- not irrational to be more or less risk averse than others- not smarter, just more cautious- show up in curves- Imani will take bet and Lucas won't by the shape- see the gaps on the graph in how they would lose utility- is jump bigger than potential fall if it's 50/50 - Your Own Risk Aversion depends on how high the stakes are- if you lose impoverished forever, if you win you get nicer house and car but already comfortable life- most would avoid - Most would take smaller bet- if you lose on raffle you have to give up weekly date night for month but win get extra food at restaurant for a year- why does risk aversion depend on how high the stakes are- small bets not going to change utility a lot- the bigger the bet the bigger the gap in utility and with diminishing utility drop becomes worse

exit entry timeline

- Blue demand curve is firm demand curve- of customers- new firm enters- lose existing customers to new firm, shifts down/left and slope changes- blue reflects willingness to pay of various customers, when new firms others will try other bakery- losing customers at every price, fewer customers at every given price- blue demand curve reflects greater market power than red curve- market power- the ability to change price without losing business/selling less quantity- shallower curve means more market power- stepper curve, looking at vertical axis, loses less business- shallow is less market power- bad for you- demand and market power reduced- exit is good for you - When existing firms/competitors exit the market- increase demand and strengthen market power- what happens if third firm enters market- more more down/left and shallower- rotating in- keep doing for each - Free entry ceases when demand curve hits average cost curve- straight line is average revenue curve/demand curve is above average cost curve- AR>AC then firm has profit- gap between lines- there is economic profit - AR>AC means economic profit - AR * Q > AC * Q - Total revenue > total cost - Total revenue - total cost > 0- definition of economic profit- needs to be space where average revenue greater than total revenue - At line just indifferent to staying in market, average revenue equals average cost- once this happens to one firm- entry will stop- the best a firm can have is 0 economic profit- all will stay but no one new will enter

oligopoly

- Cellphone service by Verizon, ATT, T mobile which together control almost entire cellular service market- example of oligopoly- a market dominated by a handful of large sellers - Managers of these businesses in strategic battle for market share- rival decisions have a big impact on your bottom line- think how rivals will respond to your choices, your best choices depend on how your rivals will respond - Has substantial market power but not as much as a monopoly- raises prices loses some customers but not all of them- rivals may also hike their prices, unreliable, strong preferences, hastle of switching

charging prices

- Charge different prices- generalization of two prices- a bunch of prices - Charge every customer their willingness to pay- perfect price discrimination- red is all producer surplus- consumer surplus is none because everyone paid exactly what you're willing to pay- think of college as trying to capture all your producer surplus- charge you maximum amount you're willing to pay- financial aid good for colleges- can't get people we want with everyone at same price- perfect price discrimination - When can a firm price discriminate- firm's dream- needs to have market power- can prevent resale- would get resold for higher price so would be losing profit- no one would pay the original price- target the right prices to the right customers - Price discrimination- consumer surplus increases, extra producer surplus is square associated with price discrimination - Perfect price discrimination- bad for consumer's, no increase in consumer surplus- firm captures all the surplus- efficient- no deadweight loss, but firm is getting all surplus - Doesn't know every individual's willingness to pay and would have a problem even if it did- what would happen- someone would resell to someone else to make a good deal for both customers and firm would never get the higher price from the person with the higher WTP- wouldn't be much sale of non-student tickets- figure out right price for right kind of customer- how can we identify this group - Group pricing- like student tickets and non student tickets, call it a discount but just as true to call others penalty or premium

rational rule for sellers

- Choose your quantity by selling until your marginal revenue equals your marginal cost- how many, marginal, cost-benefit- as long as marginal benefit which is marginal revenue is at least as large as marginal cost - Rational rule- sell one more unit if the marginal revenue is at least as large as the marginal cost- sell if doing so boosts your revenue by at least as much as it boosts your costs- when exactly equal profits stay same but still sell last item- keep selling until marginal revenue=marginal cost- to figure out what quantity to sell, keep selling until marginal revenue equals marginal cost - Choose your price by looking up to the demand curve- highest price you can sell with quantity you decided- look up to see what price to charge- not where the curves cross- look to where marginal revenue and marginal cost cross to figure out quantity to produce- not for price- look at what customers are willing to pay- look up to the demand curve at the quantity- marginal revenue cuts marginal cost, look down to quantity and up to find best price - When businesses have market power, the market outcome does not maximize total economic surplus

price discrimination

- College- different prices for different people, price you pay may differ- grants and scholarships are effiectvely a form of highly targeted discounts- following a sophisticated pricing strategy- can get more money and better students by charging different prices for same product How Price Discrimination Works - Price discrimination- the strategy of selling the same product at different prices- discounts from sticker price - Set prices close to (and just below) marginal benefit- charge each individual customer the highest price you can get them to pay- we call the maximum price that a customer will pay their reservation price - Follow cost benefit right up to marginal benefit- charge each customer a price just below but as close as possible to their reservation price, which is also their marginal benefit- willing to purchase product but just barely - The case in which you get this targeting exactly right- so that you charge each customer their reservation price- is known as perfect price discrimination- succeed at this and you'll achieve two profit-boosting objectives- charging the highest price you possible can on each sale; and make every possible sale where there's a customer whose marginal benefit exceeds your marginal cost - Practically difficult to sort out how much each customer is willing to pay, no one wants to admit so you charge them more- because demand curve is MB curve, it reveals each customer's reservation price- set just below demand curve

7/11

- Commute and would pass a bunch of 7/11s- some new ones would open (entry), or close (exit)- this is determined by economic profit- economic profit is 100- yes you should open- 100 dollars better than next alternative- different than accounting profit would be 100 dollars- wouldn't do it- explicit financial costs 100 less than benefits- good, better than having losses but something else you could do with your time that would lead to higher accounting profit- think about economic profit - "Entry, Exit, and Long-run Profitability"

strategic management

- Compete on price- same/similar goods for lower price- tough because lower and make less money- avoid competitng on price by competing on features- non-price discrimination- differenetiating product from other products- jeans- different materials, cuts, denim, etc- lower cost are also differentiating- not targeting the high end market, looking for different market- separating themselves to maintain market power and make more profit - Where to position the product- literally locating it on this street here- suppose people just go to nearest coffee vendor- position at D- get A, B, C, D- some of D- wouldn't do as well if positioned at A- in real life how to position- more delicious, hotter, different flavors - A few other streets- cereals going for different parts of the market, is it always better to try to position so it appeals to richer people/higher WTP? No- bigger audience - Advertising- two things- increase demand for product- shift demand out- at any given price more people- - shift out and steepen- make them less sensitive to change in prices- less elastic- Gucci ad- wouldn't answer why???? - De Beers- used to have lock on diamond industry, monopoly- advertise with almost no branding because they know if you want to buy a diamond they'll buy from you- just increase demand for product- when more market power branding is more conspicuous- lot of competition like MM with other candy firms- not advertising chocolate but specifically their product- difference is the market structure

price discrimination feasible

- Condition 1- your business has market power- changing prices won't work, will leave, can already sell whatever quantiy you want at price - Condition 2- you can prevent resale- discount could sell for a higher price, sell to resellers and won't be able to sell at higher prices- prevent products from being resold- less discounts- higher prices across countries and prevents importing so it won't work in different countries, digital platforms can prevent- more aggressively the business price discriminates, more important to prevent resale- make it illegal to import, different design- maintain different prices, limit quantity each customer can buy, show ID, some things can't be resold - Condition 3- you can target the right prices to the right customers- figure out who, can't just ask- offer different prices to people in identifiably different groups

expected utility

- Decision to take risk depends on size of the risk relative to the reward, whether the stakes are high or low, and your degree of risk aversion- different choices for different people, no outside expert can judge without knowing your utility function - Expected utility is just your average utility- choices with no risk- choose whatever makes you happiest or yields most utility- but when choosing among risky alternatives- don't know what outcome will be- utility could be high or low- can calculate what it will be on average - Expected utility- measures what your utility will be, on average, if you make a particular choice- calculate it as weighted average of the different utility levels associated with each possible outcome, weighted by the probability that the outcome occurs- expected utility = probability business succeeds x utility if business succeeds + probability business fails x utility if business fails - When calculating expected utility- you're not plugging in the monetary gain, you're plugging in your individual utility at that gain because it's about your personal utility- depends on function- compare this with your current utility by finding your current wealth on graph and looking horizontally for utility- compare the values- choose the options with the largest expected utility to yield highest well-being - Gambling- risk loving- preferring uncertainty- like it willing to lose money to experience it- find it form of entertainment for a fun night

marginal revenue curve

- Demand curve explains trade off of changing price, good decisions focus on marginal revenue- marginal principle- break big decisions into smaller marginal- should you sell one more- decide this based on marginal revenue- addition to total revenue from selling one more - Calculate marginal revenue as the change in total revenue from selling one more unit- calculate total revenue (price times quantity)- marginal evenue (change from selling additional)- plot results to get marginal revenue curve - Marginal revenue reflects the output effect, minus the discount effect- marginal revenue is less than the price- true for all businesses operating in imperfectly competitive markets- two forces affecting marginal revenue- the output effect- if sell one more, revenue will rise by the price she gets- boost revenue by amount equal to price- the discount effect- to sell that one extra, will have to lower price a bit, which cuts into revenue- applies to all products so definitely declines revenue- this discount effect is equal to the discount she needs to give up to sell one more car times quantity at that price cut- under PC, can sell whatever quantity without needing to change your price, so discount effect is zero - Marginal revenue is output effect (price) - discount effect (delta P x Q- price cut to offer times quantity)- summarizes the trade off- how much gain from selling more units, output effect, less revenue you'll lose- discount effect- output minus discount, balance between forces

barrier 2 supply-side strategies

- Deter entry of new rivals by gaining cost advantages newcomers cannot easily replicate- marginal principle- competitors will continue to enter until the last competitor that enters- the marginal supplier, which is the company that's right on the cusp of entering or exiting- expects its economic profit to be zero- that doesn't mean your economic profits will be zero- long-run equilibrium where price is equal to average cost of marginal supplier, so no more competitors will enter- if business has lower costs than the marginal supplier, then you'll continue to earn economic profits, even if the marginal supplier is earning zero profit - If cost advantages are large enough, can effectively scare away potential entrants because cost advantage signals to potential entrants that your company- and probably not theirs- can survive a price war without sustaining major losses- long-run profitability depends on maintaining cost advantage, only possible if rivals can't just copy your cost-cutting techniques- unique cost advantages that others simply can't copy - Your experience can yield efficiency gains through learning by doing- learn how to streamline operations by producing more, learning by doing as an advantage to become market leader - The benefits of mass production can make it hard for small entrants to compete with you- beenfits to mass production few entrants will succeed- small production puts them at cost disadvantage- Etsy designers vs Shein

barriers deterrence

- Deterrence strategies o The key here is to scare away new firms from entering, for example by § Having a war chest- a lot of cash on hand to fight any new entrants § Developing a reputation as a fighter- that might scare off some firms from entering o The amazon vs diapers.com episode shows this- at one point diapers executives took what they knew about shipping rates, factored in prices, and calculated that amazon was on track to lose 100 million over three months in the diaper category alone

measuring inequality

- Disagreements about how much inequality and poverty and what to do- survey the data- many ways to assess extent with different insights Income Inequality - Income- the money you receive in a period of time, such as a year- income is distributed unequally- sort families from high to low and divide into five equal-sized groups called quintiles- bottom fifth receives 3.7% of total income, highest-income earns half of income- income inequality is rising- highest income quintile has increased share of income by 10% in 50 years but share of income in other quntiles has declined- getting smaller slices, but size of the pie grew just fastest for those at top of distribution- the rich are getting richer- top 5% of families receive 1/3 of all income and richest 1% get 1/5 and 0.1% get 1/10 of income- similar level of inequality in 1920s and fell through 1950s and then rose again - The United States is more unequal than most developed countries- gap between 10th and 90th percentile is largest in US- rich are richer here- the distribution of income around the world is even more unequal- high and low income countries, few hundred dollars or a dollar a day and then billions

extra hassle/bad service/imperfect goods

- Discounted goods at outlet stores in places hard to get to- part of pricing strategy- lower reservation prices - Coupons and rebates are hurdles- willing to clip coupons, electronics stores sometimes offer lower price if willing to claim a rebate- hassle is a hurdle for getting lower prices, others will avoid and pay higher price- targets price cuts - Slightly worse service is a hurdle- long lines, economy much worse than business class- hurdle to getting lower rpice is being willing to put up with subpar service- leads only bargain-motivated customers to leap hurdle required to get lower rpcies- those with higher prices pay more - Imperfect goods are hurdles- two versions of same cr but one needed to be charged more often- for budget conscious this is better but for more devoted/wealthier would choose higher price

setting group prices

- Divides one market into smaller market segments by group, different demand curves and prices- set the price separately for each group- what price should you charge this lower group to earn largest possible profit- step 1- what quantity should you produce- rational rule for sellers, keep selling until marginal revenue equals marginal cost- what price should you charge- look at demand curve for each segment to find highest price you can set and still sell this quantity- tailor to each demand curve- separately for each segment - Set different prices for different groups- demand curve for lower group is going to be lower and flatter because more responsive to prices/elastic- treat as separate market - Quantity to where marginal revenue equals marginal cost- look up to demand curves - Charge higher prices to groups that value product more- higher MB/reservation price - Charge lower prices to groups that are especially price senstivie- market power matters and less market power with lower groups because greater elasticity, lower price

utility choices

- Economic theory of making choices under uncertainty- choose option with highest expected utility, not highest expected wealth/financial value- going for utility- we expect people make the choice with the highest expected utility - Highest financial payoff- naïve, wrong, lead us astray- a million dollar bet with slight expected payoff- naïve rule tells you to take this bet, expected value is 20,000 but most people even rich won't take because risk of losing 1 million- even though expected financial payoff is bigger very few will take this bet - Depends on the expected utility - People are risk averse- they don't like risk, most people- would prefer certainty, even if earning less money- certain hundred of uncertain 100- obviously certain- certain 10 million or uncertain 20 million- people don't like risk- reason why people don't just care about expected value of payoff- because risk averse, afraid of losing this money- why? Diminishing marginal utility of income - Utility over income graph with the concave curve- shows diminishing marginal utility of income- utility of income is increasing but marginal utility- decreasing- one 10k jump increases utility less than previous - Green curve- with opposite slope getting steeper show increasing marginal utility of income- according to this curve- give 10K to the person with more money, richer person to increase utility of society- doesn't make sense for society - Blue also shows diminishing marginal utility - Straight line does not show diminishing marginal utility- need curves to bend down - This is why people are risk averse- diminishing marginal utility of income

profit 2

- Economist- what is my best decision- evaluating whether or not to start new business, make good decision only if you account for other opportunities- include all relevant costs, implicit and explicit- business pay for time and money - Economic profit determine whether it's worth starting a business- news reports about profits and profit and loss statements- reporting accounting profits- deciding whether to start business- economic profits or businesses already in the market- stay in business only if they expect to earn positive economic profits- assume economic

effective advertising

- Effective advertising depends on market structure o If products are very similar (perfect competition) then individual firms will tned not to advertise- because of the free-rider problem- example o If product if unique (monopoly) then can advertise the product rather than the brand (a diamond is forever)- if product has imperfect substitutes (monopolistic competition), then firms advertise their specific products aggressively- aggressively because they also want to grab rivals' customers- MMs ads don't focus on the deliciousness of chocolate generally- they focus on the wonder of MMs specifically - Effective advertising depends on the type of good o A search good is one that you can easily evaluate before buying (by searching for information about it)- charginc able for a smartphone, a low cost hotel o Contrast it with an experience good which you need to experience to properly evaluate- chocolate bar, clothing, music, etc o If a firm sells a search good it might do informational advertising, which provides information about a product- law firm ad mentions partner has a Georgetown JD clerked for SC, etc o If it sells an experience good it might run persuasive advertising, which contains very little information about the product- coke ad that says taste the future - Is Advertising Socially Inefficient? o A lot of advertising, in particular persuasive advertising, is probably wasteful from society's perspective § Ie the social cost of the advertising is greater than its social benefit § Because a lot of it just serves to steal customers from competitiors- society benefits when people and firms to have economic surplus- society doesn't care if it gets that surplus from Coke or Pepsi- suppose coke and pepsi both agree to cut their advertising budgets by half- there might not be much change in total sales

barrier 4 entry deterrence strategies

- Entry deterrence strategies- convince potential rivals that if they do enter market, you will crush them, will prevent them from earning profit- may or may not be true, make threat credible by showing you can take lower rpices - Build excess capacity to signal you're ready for a fight- show capacity to increase production and flood market, invested to start a price war and win, incurring higher fixed costs today will enable lower marginal cost in the future if rival enters, sunk costs- committing to staying in the market to fight rivals - Financial resources signal that you can survive a fight- mountain of cash is scary - Brand proliferation can ensure there are no profitable niches for a rival to exploit- breakfast cereals- prevent profitable niche - A reputation for fighting can be helpful too- set up to track prices and match, if you hear about reputation you might not enter- deters others from trying

role of advertising

- Essential part of successful product positioning strategy- spend hundreds on it every year - Advertising aims to shift and steepen your firm demand curve- increases demand by convincing more people product Is great and shift right- second if it builds brand loyalty then stick even if raise prices so less elastic and increase market power and steeper slope and larger profit margins- possible to sell larger quantity at higher price, boosting profits - Market structure shapes your advertising strategy- structure of competition shapes impact of advertising and messages to emphasize- perfectly competitive market advertising doesn't make sense- just a tiny part, campaign will benefit others and whole industry more than it benefits you- only makes sense when by industry association - Monopolies use advertising to shift market demand curve for product- advertising focuses on the product rather than on the brand and gets all the profit - Imperfect competition- worth advertising aggressively because extra incentive beyond increasing demand- can help you steal customers from rivals- emphasize your particular product positioning and unique value of your product- MMs not just advertising chocolate - Search goods lend themselves to informative advertising- a search good is any good that you can easily evaluate before buying it- a desktop computer, read specificications to figure out whether it provides good value for money- Pepsi is not because taste to evaluate - Search goods lend themselves to informative advertising- inform you about a product- provide potential customers with hard data about specific attributrs of your product- components, qualfiications, recent performances- better information to make better choices- firms and companies

diminishing marginal utility

- Evaluate risky choice- think in terms of marginal benefits rather than just dollar amounts- way to enjoy better life, how much dollar helps you/improves your well being- economists use the word utility to describe your level of well being- if ultimate objective is to live the best life, should make utility rather than money central to how you evaluate your courses Marginal utility declines as your wealth grows- utility is closely related to your wealth- greater wealth enables you to make choices to make you happier and enjoy more ultilyu, whether to buy, more stuff, work less, help those you love, donate to charity, more wealth leads to more utility- utility doesn't rise one for one with wealth- if earning less money then winning bet increases utility more than if you have a lot of money- utility function typically starts off steep- each dollar raises utility by a lot and then flattens out, because at high levels of wealth - more money has less of an impact Marginal principle- reminds you to think at the margin, diminishing marginal benefit from extra dollar, each dollar is less useful than the last- marginal utility- the boost to utility you get from one more dollar- each additional dollar yields a smaller boost to your well-being, you have diminishing marginal utility, marginal utility may be large when you are poor but gets smaller as you get richer, reason why utility function gets flatter - Diminishing marginal utility makes you risk averse- gain in utility is smaller than loss of utility of same amount of money- apply cost benefit and evaluate costs/benefits in terms of utility, costs of fair bet exceed beenfits- look at utility over money, upside won't fix downside of utility loss- dislike risk because stand to gain money that has low marginal utility but lose money with higher marginal utility so more val

review

- Every problem on exam can be solved with concepts discussed in lecture- open and go through lecture slides- be reward for people who really understand point- book and slides very close but slides more important- practice problems- a few more questions but less- time less of constraint on final than on midterm - Efficiency o The efficient outcome maximizes total economic surplus in society- outcome A more efficient than Outcome B if economic surplus of outcome A greater than economic surplus of B- NOTHING TO DO WITH EQUITY DON'T WORRY ABOUT HOW PIE IS SPLIT- efficient outcome has the potential to make every individual better off if redistribution os possible- makes everyone better off- flase- your slice could shrink if you're worse off- everyone could be better if redistribution is possible- if you can- in practice is difficult- perfect price discrimination is efficient- true or false- yes is efficient but not good for consumers- maximizes economic surplus- pie gets bigger as consumer slice or pie gets smaller- total size o Market power not efficient-efficient quantity is where supply and demand curves interest and you're selling too little at too high price- perfect price- no dead weight loss but no surplus for consumers- whole triangle Some advertising is efficient- yes- consequences of coke advertising it hopes to shift demand curve out- shift demand curve out and increases market power- line goes out and steeper- trying to go from green to blue- spends some money to increase demand- if successful increases scope for economic surplus- advertising not good- effect could be weak, too much money for increase- if cost bigger than increase in shad of area than inefficient

risk 2

- Everyone has different degrees of risk aversion, think about your own risks and rewards - More risk averse people will accept fewer risks- willingness to accept risk-reward combo depends on risk aversion- on your temperament and life situation- one person is well-off and excited by risks and wouldn't have to change her life much if she lost but could get a lot f she won- diminishing marginal utility but not diminishing very rapidly- marginal utility at low levels of wealth is only a little bit higher than at high levels of wealth- not very risk averse and doesn't flatten too much- gain from winning exceeds utility loss form losing- cost-beneift says good risk - Other has less money, lots of responsibilities, very worried, lots of expenses and family to take care of- doing just as well but has to spend his necessities on more important things and not just himself- real hardship if wealth decreases- very risk averse, utility function initially very steep then flattens out quickly because rapidly declining marginal utility- not enough- cost benefit says no - Risk aversion motivates many choices you make- different domains of life- more risk averse less risky decisions in all safety areas, less likely to invest or start business or move or change jobs, same logic- lower utility associated with downside outweighs potentially higher utility from upside

increasing competition can lead to better outcomes

- Find way to reduce market power- stop patents, more can compete and lower price- competition leads to lower prices and a higher quantity and save lives- market power is bad for society- the underproduction problem- creates market failure because supplies a smaller quantity than society's best interest- people go without- patents present a trade-off between a lower quantity for existing drugs and innovation- patents can still provide incentive for research, stopping them and interfering with market power is a balance- how can government intervene

regressive taxes

- Finishing Lecture 20 o Regressive Taxes? § Some taxes are regressive: people with less income tend to pay a higher share of their income on taxes (have a higher effective tax rate)- sales taxes are regressive- poorest fifth pays 11 percent of income on sales taxes; richest fifth pays 7 percent § Nonetheless, overall, the tax system is progressive (except perhaps at the very top 1 percent) § Connection between progressive taxes and inequality- reduce inequality- regressive increases inequality

price equals average cost

- Free entry pushes the price down toward average cost- price exceeds average cost, making economic profit- new will enter and reduce profits and shift left and rob market power until rational rule for entry says not worth entering- profits are zero, price equal to average cost - Free exit pushes price up toward average cost- market unprofitable- exit, increase profitability and market power and shift right until rational rule for exit says no longer- profits return to zero, price equal to average cost - Long run with free entry and exit price equals average cost- average costs will be dominant factor determining prices in long run- market power will be undercut eventually- new startups enter the market and older businesses exit- creative destruction- rate of entrance and exit about the same - Firm's demand curve just touches your average cost curve- curves touch- one point is to set price equal to average cost - If lies above or below will move- demand curve vs average cost curve- two touch best a company can do is make zero economic profits, long-run equilibrium- neither expand nor contract

PC

- Gas station at intersection with other competitng stations likely in perfectly competitive market- occurs when your competitors sell an identical good and there are many sellers and many buyers, each of whom is small relative to the size of the market - PC market- no market power- charge more, lose customers to rivals with identical product at lower rpice- can always sell at market price so don't sell less- lowing price lower profit margin- best choice is to be a price-taker- simply take the market price as given and follow along, charging the prevailing market price - Gas stations at intersections, agricultural markets, commodities like gold, oil, livestock, stock market are PC - PC is relatively rare- most products not identical, many markets have handful of dominant players- managers try to accumulate market power by differentiating their products, squeezing out rivals, deterring new entrants- simpler to first learn PC markets, supply demand built on it, all markets still involve some degree of competition - Market power- don't want to be a passive price-taker- price that works best for your company considering your market power- figure out how market structure shapes market power to make more profitable decisions- spectrum

the tax system

- Goods and services, social insurance, safety net programs funded by government paid for by taxpayers- fight poverty, reduce inequality - Federal income taxes are progressive- income taxes are taxes collected on all income, regardless of its source- income from wages and unearned income like investment income, pensions, gifts- higher income, higher tax rate you pay on each additional dollar you earn- - Some wealthier people pay less of their income in taxes than poorer people- why? - Some investment gains are excluded from income taxes- capital gains treated differently on assets- capital gains tax is like max 20% so lower than higher icome tax - Higher income people get bigger tax breaks- special exemptions to reduce how much income counts as taxable income- save for retirement, buy a house, student- reduce the taxable income of highest earners the most because spend more money on these expenses- a tax where those with lower incoems pay a higher share of their income on the tax compared to people with higher incomes- based on things you buy rather than money you earn- spend similar share of income but lower income so regressive- poorest fifth pay 11% of income on state/local taxes, while richest fifth of householders pay around 7% - Taxes that fund most social insurance programs are not progressive- more proportional, all pay same percent of income regardless of what we earn- regressive at top because cap amount of income subject to tax- social security taxes only on first 150k wages - Overall, tax system is progressive- most taxes people pay are not federal income and those favor the rich but tax system still remains progressive- richest fifth pays about 30% and poorest around 16%

barrier 3 regulatory strategies/government policy

- Government regulate who can enter a market because trying to counter some kind of market failure, when politicians are swayed by corporate lobbyists- patents prevent anyone else form selling your invention- no other company can use your idea or invention without your permission- copyright and trademark- monopoly over selling your intellectual property, provides incentive for innovation, keep it a secret - Regulations make it difficult for new businesses to enter your market- procedures to register business and fees, barriers not too high in US- US regulates some sectors like child care center, hospital, marijuana, charter school - Compulsory government licenses can limit competition- radio station licenses- directly regulates entry - Businesses lobby to create new regulatory barriers- millions to lobby, sometimes for common good but often to put plans to stop new entrants- raise costs on potential entrants, insulate from competition, argue it's to protect public- agree to get support of company

imperfect competition insights

- Having more competitors leads to less market power- many alternatives can take your market share and power- can compete away all our profits- rivals who enter, barriers preventing entry of new businesses and how porous- result of strategic choices to keep competitors out - Market power allows you to pursue independent pricing strategies- set own price- raise to boost profit margin on each item but also reduce number of items you well- balancing act to get profit- charge different people different prices also to boost profit margin on most devoted customers - Successful product differentiation gives you more market power- more different, less likely go to competitors if raise price- choose yourself how to position your products to boost market power- marketing function - Imperfect competition among buyers gives them bargaining power- competition among limited number of buyers, important to keep most valuable clients- can demand lower prices and better deal with suppliers- both sides trying to get best deal - Best choice depends on actions that other businesses make- interdependence principle- everyone's decisions affect everyone's- pricing, entry, positioning, bargaining- prices offered and whether trying to steal customers

alternative measures of inequality

- Income not necessarily best measure- varies by year, future earnings and age - Much more inequality of wealth than income- total purchasing power and your economic resources may be better represented by your own wealth than your income- refers to all assets including savings, cars, a home that you currently have- considered a stock, which is something that is measured at one specific time and represents the amount of assets you have at that time- income is a flow, since the money flows in over time- wealth more unequally distributed than income- poorest half of households share only 1% of all wealth- debt and negative shares of wealth, millionaires make up 76%- wealthiest 1% holds 37% of all wealth- reflects that wealth accumulates and is passed from generation to generation, permanent income may be a better measure of living standards- economists believe living standards largely reflect your permanent income- average lifetime income rather than income in a given year- less inequality in permanent income than in measured annual income because some annual inequality reflects temporary ups and downs and not long-run economic situation- patterns as you age- less when young and more when old- borrow and save- permanent income is a better predictor of what you can afford to consume than annual income, consume more today by borrowing from your future while still having higher future consumption- save when doing well financially because will need them for later

economic profits tend to zero

- Industry is profitable- new rivals enter, extra competition reduce market share/power of existing businesses, sell smaller quantity at lower price, which reduces profitability- - Work in reverse- negative economic profits lead to exit, reduces competition, increases market share/power of remaining businesses, sell larger quantity at higher price, restore profitability- - Free entry pushes economic profits down to zero in the long run- free entry- no factors making it particularly difficult or costly for a new business to enter/exit the market- follow rational rule for entry and enter- drive everyone's profits down a bit, continue to enter as long as economic profits are positive and push down profits- process continues until there's no longer any incentive for new businesses to enter your market- occurs when economic profits available to new entrants fall to zero- - Free exit ensures your market won't remain unprofitable in the long run- rivals may exit means if currently unprofitable will eventually improve- prospect of ongoing losses will follow Rational Rule for Exit and leave market- fewer competitors, profitability increase, keep exiting until profitable- zero- - Economic profits tend toward zero in the long run- entering and exiting push profit in long run- not a problem means doing as well as next best alternative- just not great- desirable opportunities tend to disappear- free entry tends to eliminate especially desirable opportunities like positive economic profits- joining the shortest line at grocery store- free entry in every area of life and disappating profits- amazing food truck brings more customers, best surf spots, picking classes, moving to cities

poverty

- Inequality- abundance of rich and poverty of poor, define poverty Defining Poverty - Differences in defining- US- officially in poverty if family income is below the poverty line/threshold- somewhat arbitrary, set in 1963 based on family purchases in 1955- poverty line set at three times the cost of a low-cost food plan- updated for inflation- 275000 for family of four - Official poverty rate is the share of people whose family income falls below the poverty line- 11.4% of population- 1/9 people in poverty - Official poverty rate has not changed much over time- those at bottom have not shared in rising prosperity - Official poverty rate- calculated using measure of income that reflects money income- everything you earn or paid to you, unemployment insurance and Social Security payments but no tax credits and noncash benefits to those in poverty- rate doesn't adequately capture resources available to those living in poverty but highlights success of unemployment insurance during Covid in preventing poverty from spiking

insight

- Insight 3- supply side considerations suggest positioning your product away from your rival to reduce price competition- close to customers- rivals might respond- interdependence principle and prices- think gas station example- push down prices and profits and no market power- position away from rival to give you market power and less downward pressure on your prices- choose a further location- small price cut won't lead htem to change locations- differentiating to reduce incentive to cut prices - Product positioning choices can help reduce incentive for rivals to undercut your price- more different means more market power and high prices and profits - There is a product positioning trade-off- differentiate question is about how best to position your product- supply the underserved part of the market o Demand sie- position product so closer than rival to preferences of as many customers as possible, being close to rival, be similar to maximize customers o Supply side- competitiors- minimize incentive to undercut price- opposite force to position away from rivals and soften price cut competition to get market power and larger profit margins - Together positioning product closer to your rival can help increase the quantity you sell while positioning it further away boosts market power and profit margin on each item- difficult tradeoff because quantity and profit margin come together to determine overall profitability- rules to balance- if price competition is particularly intense like between neighboring stations you should try to differentiate, if price competition is subdued then try to minimize differences to appeal to as many people as possible

monopolistic competition

- Jeans shopping- many styles and washes and colors- seeking market power through a strategy called product differentiation- by making their products differ from those offered by their competitors, sellers hope to make each of their varieties especially attractive to a particular group of customers- gives the seller market power because many customers willing to pay a bit more to get the variety that suits them best - Products may also be differentiated by brand image, quality, store location, customer service, return policies, shipping, packaging- can create even when hundreds of sellers because of your precise item and will pay a little more- more distinct, the less your rivals' products will be close substitutes - Monopolitistic competition- when there are many competing businesses, each selling somewhat differentiated products- both monopolistic and competitive- only one seller making each specific model but competitive because dozens competing to sell you the product

income redistribution

- Left wing- usually more redistribution, right wing- usually less The Economic Logic of Redistribution - Well-being- utility- marginal princiel reminds you to think at the margin- diminishing marginal benefit also applies to money- 50,000th dollar yields smaller boost than 10,000th dollar- spend on clothes vs food and shelter- marginal utility- the boost in utility you get from an extra dollar- because each additional dollar yields a smaller boost to your well-being, you have diminishing marginal utility- may be large when you have a low income and smaller as you get richer- billionare cigar vs medication for poor person- poor person has higher marginal utility for that extra dollar - Redistribution can increase total well-being- rate well being 0-10 and graph against level of income- upward sloping- people with more income are happier than those with less income- slope of the curve- flattens out as income rises- slope is extra benefit from a change in income- extra benefit of an extra dollar is higher the poorer you are- shows diminishing marginal benefit- - Add up people's well being scores to see total well-being- see how changing 25,000 and giving to low income raises the well-being of lower a lot and lowers the high one only a little- raises overall well being- subtract to find the difference - The idea of maximizing total well-being comes from utilitarianism- political philosophy that government should try to maximize total utility in society is utilitarianism- government redistribution is beneficial because transferring wealth from high to low will make societal well-being or utility higher- rich to poor

more inequality

- Less inequality in spending than in income- living standards largely determined by goods and services you actually buy and consume, inequaliyu in living standards may be better measured by focusing on what people spend, rather than on what they early- top quintile of population receives 13x as much income as bottom quintile- but differences in spending much less stark- spends on 4x as much- save more, temporarily high or low drive much of measured inequaity in income- temporarily high incomes are saving because they know that their good times won't last- temporarily low incomes often dip into savings to prevent consumption from falling as much as their income- less consumption inequality - Intergenerational mobility and inequality of opportunity- inequality in current income, wealth, permanent income, consumption are inequality in outcome- inequality in opportunity- regardless of socioeconomic status, same opportunity to succeed- intergenerational mobility- the extent to which your economic circumstances are independent of those of your parents- half of economic advantage/disadvantage transmitted to you- same with disadvantage- parents matter, but your own hard work, investments, luck matter- less intergenerational mobility in US, varies within the US and across cities- - People don't actually perceive extent of wealth inequality, underestimate, lack of knowledge of facts, cherry-pick statistics- official poverty rate calculated using measure of income that reflects money income- everything you earn or paid to you including unemployment ensurance and social security- doesn't account for tax credits and noncash benefits of government programs so doesn't capture resources available but shows how we prevented poverty during Covid

hurdle shopping around

- Look for bargains, discounts, stock up- save a lot of money but hard work- by design- hassle is hurdle that less price sensitive aren't willing to leap over- price discriminates because only price conscious gets good deals - Fluctuating prices are a hurdle- grocery store changing prices- hurdle- those who really love and have high reservation price won't wait for sale to buy- hurdle is willing to wait till it's cheaper - Haggling is a hurdle- don't pay sticker price for car- convince them reservation price is low to get bargain- car sellers price discriminate, evaluate you to try to guess your reservation price- only cut if they think that's needed for the sale= convince low willingness to pay, spend long time and show priority is saving money, happy to buy any car- marginal benefit is small- shop around- haggling is hurdle and more normal than expected- tell how you can do better elsewhere, customer service- whatever necessary to keep you as customer

exit increases demand and your profits

- Losses drives existing competitors to exit your market - Existing competitors exist unprofitable amrkets, which helps restore profitability for those who remain- stay or leave, cost benefit says leave if costs of continuing exceed benefits- if economic profit is negative- the rational rule for exit- exit a market if you expect to earn a negative economic profit, which occurs if the price is less than your average costs- exit unprofitable markets doesn't just mean shut down- pivot towards profit opportunities in other markets - If a rival exists market- get more market share back and their customers- increase in demand shifts curve to the right, fewer rivals and more market power, demand curve will be steeper and more inelastic- rivals exit- profits recover because you'll sell a larger quantity (due to increase in demand) at a higher price (exploit enhanced market power)

marginal/long run

- Marginal firms- firms closest to entering or exiting, profits closest to 0- marginal firm in market has no profits- the almost marginal firm outside the market would have negative profits- no entry or exit - Long run- long term it will reach balance, equilibrium, long term profit is pushed towards zero- price tends towards average cost of the marginal firm- keep lowering price for marginal to stay in business- competition driving price down to average cost of marginal firm - Firms in market don't like entry- try to erect barriers to entry- demand-side strategies- making smartphones, keep customers- switching costs- lock customers in- annoying to switch from Apple to Android- spend time setting up and learning how to use new operating system- Apple refusal to adopt new system as imposing switching costs- texting colors is like a network effect- giving stamps from one boba place/loyalty programs as switching cost- reputation and goodwill, acting nice, smile at you, strengthen attachment to firm - Supply-side- finding cost advantages to retain profit, lower costs, find cheaper inputs, experience is helpful, mass production, how is individual carpenter supposed to compete with Ikea- can't on price because of mass production, increasing competition costs- hire all the best workers- hard for startups to get good programmers because Facebook Apple Google offers really high salaries- offer high salaries yourself to compete - Regulatory strategies- licensing requirements- to cut hair you need a government stamp of approval, can't just privately open up without license, good for existing firms- raises the cost of entering the market - Cut out deterrence strategies

marginal revenue curve 2

- Marginal revenue lies below the demand curve, and it declines faster- firm's demand curve is downward-sloping (raising price=losing some quantity), marginal revenue curve lies below demand curve (sell one more=cut price, so marginal revenue is price for that extra item minus discount effect), marginal revenue curve declines more sharply than demand curve- discount effect is bigger at larger quantity so wedge gets larger- straight line starts at same point but declines twice as sharply - Marginal revenue is not same as firm demand curve

market power worse 2

- Market power yields larger economic profits- profit margin is difference between price you charge and average per unit cost of your production- unit cost is total cost/quantity- market power price exceeds per unit cost so makes a profit- larger than what could earn under PC- choosing high price low quantity outcome because more profitable- earn larger profits, why people try to enhance market power - Businesses with market power can survive even with inefficiently high costs- less pressure for cost-saving measures, PC are inefficient- loss and close but profitable but inefficient business with MP can stay Consequences of market power- possible to sell cheaper, higher prices lead to lower quantity which harms people, exploting market power- won't want to solve underproduction problem because of higher profits, inefficient production

market structure determines market power

- Market structure determines market power, least market power when in PC market- many small businesses sell identical products- monopolies have most market power because only business selling unique product- spectrum of market power - You have more market power when you have fewer competitors and when your products are more unique - Perfect competition and monopoly are both rare- few businesses populate the extremes of this spectrum, PC is rare because products are rarely identical- even gas can be slightly different- pure monpoloy is rare- broaden definition of market will almost always find others - Most businesses operate in imperfectly competitive markets- imperfect competition- includes monopolistic competition and oligopoly- you will face competition but it will be imperfect- either because few competitors and because sell somewhat different products than your competitors - Modern economists believe industries don't neatly fit into one category or antoher, structure of markets constantly evolving- spectrum of market power- number and type of rivals and how different their products are- not static market structure, evolves in response to strategies by dueling businesses, best depend on particulars of your specific market- forces that shape market power and strategies pursued

intergenerational mobility

- Measuring Inequality of Opportunity: Intergenerational Mobility o Consider (in)equality of opportunity to succeed- one way to measure this is to look at how the economic status of children depends on the economic status of parents- if children's outcomes are independent of their parents that suggest high intergenerational mobility- studies suggest that about half of your economic advantage or disadvantage comes from your parents- the other half is up to you! o US intergenerational mobility is low compared to many other rich countries o And within the US there is lots of variation o 20%- would be perfect equality of opportunity

social safety net

- Minimum material standard of living for those at bottom of income distribution- redistribution of wealth through social safety-net programs - Safety net programs designed to help those with low incomes are means-tested- benefits only reach those truly in need- means-tested- eligibility depends on your income- asset tests to ensure idle wealthy don't get benefits- elderly and disabled protected by Supplemental Security Income, working families by Earned Income Tax Credit, single parents with cash assistance, jobless with food stamps, Medicaid helps all these groups, housing assistance but long waiting lists- some get several programs, others fall through cracks and get nothing - The safety net helps support a lot of families- 1/3-1/4 families receive some assistance, larger portion will need some assistance at some point, supports a lot of population- - Safety net programs provide minimal support- not super generous but often enough to raise above poverty line- poverty line calculated excluding mosy benefits- including benefits lifts about 1/3 out of poverty line - Safety net programs include cash assistance, tax breaks, in-kind transfers- provide specific goods- in kind transfers like cards and vouchers, economists say just give them cash- prevents bad choices like gambling, care about reducing specific societal problems, more likely those who truly need assistance will get it, complement to work

market power leads to worse outcomes

- Monopolies charging too much can charge poor people their lives Market Power Leads to Worse Outcomes - Drugs not expensive to make- research costs a lot, but not production/manufacturing- reason is market power- sellers exploit their market power- patent- inventor the right to be the only seller of the good they invent for a period of time, around 20 years, gives them a large profit and prospect drives investment- patents create monopolistic power - Compare market power and perfect competition- managers follow rational rule for sellers- sell this quantity at highest price they can get, looking up to their firm's demand curve- market power outcome - Under PC- price equals marginal cost- PC outcome - Market power leads to higher prices- trade off with larger profit margin and larger quantity- market power means get big margin on customers who can pay high price even if losing unwilling/unable to pay as much - Market power leads to an inefficienctly smaller quantity- market power quantity is less than PC quantity- demand curve lies above MC curve- marginal benefit is higher than marginal cost- would be better if larger quantity produced- market power supply less than efficient quantity- underproduction problem, PC is efficient quantity - Market power leads to supply less because of discount effect- reluctant to lower price because less revenue from existing customers- society- better if managers ignored discount effect- not a net cost to society, revenue company loses due to lower prices is exactly offset by benefit those lower prices confer on existing customers- no discount effect in PC because supply is only small part of market and can sell whatever quantity they want at market price without offering discounts

monopoly

- Monopoly- the only seller in the market- if you're a monopolist, you have a lot of market power because you can raise your price without losing customers to competitors because no direct competitors

public policy to restrain market power

- More competition yields better outcomes for society as a whole, but less competition yields more market power and larger profits for incumbent businesses- businesses try to stifle competition even though makes society worse off- governments regulate markets to ensure they serve public interest- policies that ensure competition thrives, and minimize harmful ways that businesses might exploit their market power Policies to Ensure Competition Thrives - Competition policy- laws/regulations designed to ensure markets remain competitive- antitrust policy - Anti-collusion laws prevent businesses from agreeing not to compete- not to lower prices or better products- collusion- an agreement to limit competition- agree to act like a single monopolist rather than cut-throat competitors- raises profits for them at expense of consumers- government made many types of collusion illegal like agreeing to keep prices high, restrict quantity product, rigging bids, divvying up market - Merger laws prevent competing businesses from combining to consolidate market power- merging might create cost savings which could eventually lower prices- bad is greater market power so less need to cut prices- cost saving benefit society, increase market power harm society- no mergers allowed which would reduce competition or create a monopoly - Being a monopoly is legal; monopolizing a market isn't- not illegal to hold market power or charge high prices, sometimes rivals are outcompeted- illegal to attempt to monopolize by excluding/preventing competitiors- exclusionary, predatory, pressures, predatory pricing by charging so low- illegal if part of strategy to eliminate competition and raise price later - Encouraging international trade fosters competition- makes it difficult to acquire market power, more competitiors

the hurdle method

- No easily observable characteristics- if you tweak incentives, can induce customers to sort themselves into groups with higher/lower reservation prices- hurdle method- offer lower prices only to those buyers who are willing to overcome some hurdle, or obstacle- design a hurdle only customers with low reservation prices will leap over, so only ones who get the discount- must be too difficult or costly for customers with high reservation price to bother with- willing to pay the higher rpice instead- choosing to save a few dollars by streaming low resolution version of movie Alternative Versions and Timing - First in line for movie- high marginal benefit for seeing it right away, high reservation price- opening weekends have no discounts/passes policy- biggest fans not price sensitive, offer lower prices on older/less popular movies through discount programs- hurdle- to get a lower price you have to wait to see the latest release- longer you wait to see a movie the less you have to pay- available through streaming- pricer for recent releases, have to be a subscriber to service to get it- eventually regular part of streaming service and very low marginal cost - Alternative versions can create hurdles- higher prices to business travelers and less to leisure- charges differently based on timing to target different reservation prices

leaky bucket

- No easy way to redistribute- leaky bucket- money gets lost along the way- why? - Administrative costs subtract from what you can redistribute- applications processed, auditors, policies enforced, payments made, government officials paid- administrative costs distort- relatively small, other more important costs - Taxes and means-tested programs reduce the incentive to work- reduce rewards from working so might choose to work less- high earners work less means less money can be redistributed- social safety net also reduces incentive to work- opportunity cost is what you must give up to work- cost of work is beenfits from everything else you would do instead and benefit is the wage- when you work you may lose cash or in-kind benefits- safety net makes you more likely to turn down a job- reduce incentives to seek higher paying work- means-tested benefits reduce as earn more and lose benefits- sum of higher taxes and reduced benefits accruing from each dollar you earn is your effective marginal tax rate- people with low incomes might not improve their living standards by working more with high effective marginal tax rates- better off earning less is known as poverty trap - Higher taxes means more tax avoidance, tax evasion, and fraud- make income appear as low, accounting tricks to lower bill- tax avoidance- doing things explicitly to try to reduce the taxes you owe by taking advantage of loopholes in he tax system- tax evasion- not honeslty reporting all your income- people always take advantage - How leaky is the bucket? Redistribution distorts incentives, depends on how much people respond to incentives- greater cost

strategic management slide

- Non-price competition o Competing on price tends to erode a firm's profits- especially if the good being sold by competitirs is very similar, the firm doesn't have a cost advantage- why might a firm with a cost advantage welcome price competition? o Many firms look to non-price competition, which is competing to win customers by differentiating the product - Product differentiation yields market power o If a firm differentiates its product then the product might appeal more to some people § Those people would be willing to pay more for the product- think coke v pepsi- many coke drinkers buy coke even if pepsi is cheaper- they just like coke more and so are willing to pay more for it- even though both are sweet colas o When products are differentiated there is less price competition and firms have more market power- indeed there are higher profit margins in the cola market than in the gasoline market - Product positioning o Product positioning refers to how a firm differentiates its product relative to the competing products o With all those dimensions in the previous slide, how should a firm position its product? Should its product be festure-rich or simple? High quality or value? Especially good customer service? Etc - The Street- where would you position a coffee cart? You plan to open a coffee cart on campus, imagine all potential customers are evenly spaced along the same street- for now, suppose people go to the nearest coffee vendor- clearly too simple- IRL quality of coffee and price would also be relevant- where should you position your coffee cart relative to your rival? D

differentiation 2

- Non-price competition through product differentiation yields market power- irristable incentive to undercut price when businesses sell identical goods- large incentive when identical products because small price advantage means large change in quantity- weaken incentive to undercut price- non-price competition comes in- position so that it better suits some of your customers, then keep buying from you even if price not lowest and gain market power- compare to market for soda- competition and much more profitable because different type of competition- market experience as real magic- positioned to get devoted following regardless of price- customers stick- blunt incentive to undercut price since won't equal new customers- makes competition less fierce so sell prices well above marginal cost, competing on price means selling price closer to marginal cost- large profit margins is importance of differentiating - There are many ways to differentiate your product- finding other ways than lower price to get customers- different features, quality, customer service, design, style, reliability, location and convenenience, advertising, fierce competition on these margins- not fixed characteristics but strategic choices to position to create more loyal customers and redraw demand curve more profitably

positioning your product

- Offer product that better serves their needs- still buy products even if price is slightly higher- choosing set of attributes- features, service, brand image, that distinguish your porudct from those of your rivals- delicate trade-off between demand-side considerations, positioning good attractive to as many customers as possible, supply side- positioning to be as different from your competitiors as possible- balancing act with big implications- position too close to rivals or too similar and risk more intense price comepittion with lower prices and profits but position too far away and too hard to get customers from rivals - Position your ice cream cart on the beach - Position cart so most convenient one for as many customers as possible - Business's position is a metaphor for the type of product you offer- sort out important dimensions in which competitiors differ and then choosing where to locate product relative to competitiors - Product positioning insight 1: supply the underserved part of the market- figure out where rival is and serve elsewhere - 2- demand side pressures suggest positioning your product next to your rival to get the most customers- how far away from rival? Be just next to them when one rival- position your offering as close as possible to them- the closer the more customers- closer you get the more customers you get in the space between you and rival- marginal customers win by moving a little closer- means positioning yourself next to your rival- think politics and close to preferences of as many voters as possible- try to serve underserved end of pool, converging in middle both trying to win centrist votes- median voter theorem- center for party for primary then center for country for election

absolute vs relative poverty

- Official US poverty rate compares incomes today with living standards in 1950s- comparisons over time- absolute poverty- a measure of the adequacy of resources relative to an absolute or unchanging standard- relative poverty- a measure that compares resources relative to the material living standards of your contemporary society- absolute is universal for assessing whether basic needs are met, doesn't change over time, same across countries and times, relative thinks about ability to participate in your society- essential depends on what others have, takes into account living standards of those around you- most measures are not purely absolute/relative- something in between but where - US poverty line is neither purely absolute or relative standard- relative- reflects fact US is higher income country, absolute because set at level 50 years ago, only adjusted for inflation- advantage is tracks through time unchanging standard, disadvantage is that living stadnards rise so official line is less relevant - Relative poverty measures show higher levels of poverty- one common relative measure says you are poor if your family income is below half the median family income- this was true when line was set in 1963- originally was relative, but has stayed there as income increases is what makes it absolute- another approach- surveying public about what they think you need to get by- amount rises over time, most people think relative - Absolute poverty is a global perpsecitve- UN standards, what's needed for human survival in modern times

charging prices 2

- Other examples- military discounts- not just price discrimination- good for firm only if military people had lower WTP- not obvious they would have lower WTP- is optimal price lower- must be because they continue to do it- other reason- public image- men's vs women's haircuts- illegally to different charge for same product but not for haircuts- claim different service- different demand curves, WTP - Think of different groups and segments with different demands, split demanders up into these two groups- students vs non students- based on verifiable characteristics- can't just be a really big fan of Barbie when kid- everyone would just claim, show a student ID, proof of military status, difficult-to-change characteristics- if easy to change then would- not if you wear glasses- find groups, verify they belong to these groups, set the appropriate price - Hurdle method- offer lower prices to buyers willing to jump hurdle/overcome obstacle- cheaper hotel stays if you book on weekend- business travelers have higher demand, less elastic demand- timing- coupons and rebates- sites that give you small percent off- price discrimination on that site- Spirit airlines- worse service- black Friday shopping - Bundling- football tickets problem on upcoming problem set - Student discounts- not being nice but doing what's best for them- can be best for certain customers too

barrier 1 demand-side strategies

- Prevent them from getting your customers- customer lock-in, shape demand- demand-side strategies - Use switching costs to lock your customers in- switching costs- refer to any impediment that makes it difficult or costly for your customers to buy from another business instead—switching iPhones means getting new versions of everything, hastle, savvy managers actively create switching costs, make it easy to stay with them like autopay, frequent flyer points, lock in customers - Earn goodwill to keep your customers loyal- build a good reputation with clients, long-time relationship with a doctor - Develop network effects so that your product becomes more useful as more people adopt it- WhatsApp- more people using makes it better- network effect- which occurs whenever a product becomes more useful when others also adopt it- writing reviews to future customers, others buy same cars so spare parts everywhere- networks can even help bad products succeed- so many useful programs and so many use it

price discrimination 2

- Price discrimination leads to higher prices for some and lower prices for others- market power chooses quantity at point where marginal revenue equals marginal cost and price by looking up to demand curve- with no price discrimination everyone pays this price- the stepped line reveals that successful price discrimination involves charging higher prices to those who will pay them, offering selective discounts to induce new customers to buy - Charge higher prices to those who will pay them- higher MB and higher reservation price, stepped ine up- as long as it doesn't exceed marginal benefit will still buy and you will get higher profit margin- customers won't be happy- reduces consumer surplus- gap between marginal benefit and price they pay, boosts producer surplus- higher prices redistributes economic surplus from buyers to sellers but doesn't increase the total amount of economic surplus Offer selective discounts to induce new customers to buy- discounts/lower prices to those with lower MB- stepped down line- cut enough so below reservation price you will increase quantity, price remains above marginal cost, - extra sales will increase profits- using selective discounts to induce additional sales increases the economic surplus that both your business and your new customers enjoy- gain producer surplus because selling at price above MC, customers gain consumer surplus because below MB- if close to MB will only gain a small amount

quantity discounts

- Quantity discount- the per-unit price is lower when you buy a larger quantity, and it's another form of price discrimination- targets with lower willingness to pay- those who already have first- hurdle to getting second pair cheaply is buying the first- different types of customers buy different quantities- price-sensitive large families and restaurants vs small apartment people- lower price per ounce in larger targets price sensitive- hurdles are being able to store and use it before it expires - Bundling creates a hurdle to getting the second good at a lower rpice- bundling- involves selling different goods together as a package- sold for a lower rpice than if bought separately so people will buy it- lower price is form of price discrimination- needs to sell the other product to more people- sell bundle that includes both- big discount for the other product- hurdle is willing to buy one at original price and only those who want it are willing- people who get a lower marginal benefit from one part of the bundle/need discount are same who get a high marginal benefit from the other/willing to leap over hurdle required to get discount- bundle like with dislike- streaming services- need to buy them all, not just shows you like

diminishing marginal utility of income

- Recall- diminishing marginal utility of income- do you remember the graph of satisfaction over income? - Diminishing marginal utility of income- you're 100,000th dollar of income beenfits you less than your 50,000th dollar, which benefits you less than your 10,000th dollar- winning 10,000 benefits you less than losing 10,000 harms you- diminishing marginal utility is why people are risk averse - Using Utility to Understand Why a Rational Person Would Reject a Fair bet o Example- suppose you can invest 20k in company with 50 chance you get 40k back (gain 20k) and 50 chance you get 0 back (lose 20k)- what's expected financial value- is the 50 percent chance of losing 20k worth the 50 percent chance of gaining 20k? not if you have diminishing marginal utility of income o o Rather than comparing the expected financial winnings, compare the expected utility- using the utility units I've added to the graph, we see- E(utility if take bet) = .5(utility if lose) + .5(utility if win)- another way to see this- losing 20k hurts you more than gaining 20k helps you - Risk Averse People Do Take Risks o You should only take risky bets when the reward is high enough- suppose instead of win 20k or lose 20k with 50 percent probability, the bet was win 30k or lose 10k- hence the probability of losing is the same as before (50 percent) but the amount of utility lost or gained is different- note- here the expected financial value of the bet is positive- but what matters is that the expected utility is higher

fairness and redistribution

- Redistribution is also a debate about fairness- equity or efficiency- different ideas of fairness- different intuitions- is fairness about equal outcomes or equality of opportunity- level playing field to compete for higher incomes, no discrimination- may require redistributing resources- is fairness about the process? Differences can be ok as long as process is fair- or is fairness about what you deserve- what you contribute to society- who deserves money- luck vs hard work and how that impacts perception of who we should take from - Is fairness best judged behind the veil of ignorance- maybe a different kind of luck- her drive and upbringing, pretend you don't know circumstances you would be born into and ask what you want- veil of ignorance- is fairness about power and class differences

policies to minimize harm of market power

- Regulate how businesses act to try to reduce consumer harm - A price ceiling limits abuse of market power- eliminates the incentive to restrict production- set equal to marginal cost, can induce businesses to produce same quantity they would if in PC market- create issues- sometimes let price be equal to marginal costs but this doesn't provide incentive to eliminate costs, loses incentive to produce high-quality product - Natural monopolies often lead to government intervention- natural monopoly- a single business can service the whole market at a lower cost than multiple businesses can- marginal costs decrease as output expands so competition won't work and new entrants always at disadvantage- government could insist price equal MC- might lead monopoly to take a loss or quit industry- end up funding these services, paying for losses with tax revenue - Public policy can't eliminate market power, but it can limit abuses- don't ban the winners, balancing act to limit abuses and foster productivity

risk mitigation

- Risk Mitigation Strategy 1- risk spreading o Risk spreading- breaking a big risk into many smaller risks so that it can be spread over many people o Suppose if you start a business you have a 50 percent chance of losing 100k, 50 percent chance of making 200k- the expected gains are .5 x 100 + .5 x 200 = 50k- but (unless you are very wealthy) you probably are too risk averse for this- what about a 50 percent chance of losing 100, 50 percent chance of gaining 200- the expected gains are 50- even if not very wealthy you might take that bet- so revisit the first high stakes bet- which you refusd- and spread it over 1000 people and the business gets started- what if you don't take the second bet- spread it more thinly so that you could lose 10 or gain 20 - Application- Companies Going Public o Suppose you run a company and you need to make a 10M investment in the company to make it competitive- you could borrow 10M from the bank, but if the company fails you'll be indebted for life- or you could sell 10k shares of the company for 1,000 each- if the company fails the shareholders lose 1000 (for each share)- that's not quite how this actually works- for one thing, you'd probably have a diffciult time finding a bank to loan you 10M- and if you did and the company failed the shareholders will lose 1000 (for each share0- not quite how this actually works- for one thing, you'd probably have a difficult time finding a bank to loan you 10M- and if you did and the company failed, you'd probably declare bankruptcy which would remove your debt after a time

understanding risk

- Risk whenever you don't know what outcome will be with certainty- can't elimate risk, take account of risks - Risk is a set of probabilities and payoffs- strip down to two essential elements- probabilities and payoffrisks- look at proboabilty of each outcome and the payoff from each outcome- if your winnings offset your losses on average, it's a fair bet- depends on how you feel about uncertainty, making a bet, a fair bet- a gamble that, on average, will leave you with the same amount of money- in any instance, your wealth will change- won't actually be the average amount, but on average the gains and losses will cancel out leaving your wealth unchanged - Risk-averse people reject fair bets- risk- better off avoiding it- most people are risk averse- means that they dislike uncertainty, will neer take a fair wealth because takes current level of wealth and adds further uncertainty, often pay good money to avoid risk- that's what insurance markets are all about - Risk aversion through cost-benefit- refuse a fair bet if costs exceed beenfits- probabilities and money the same but risk averse people fine that the decline in well being from losing exceeds the benefit or gain in well-being when wealth level increases- thinking about costs and benefits of well being

strategic management 2

- Search good vs experience good- not as clear cut- search- can learn about a good from looking around, googling, searching, don't need to test it out before buying it- experience good- need to try to properly evaluate, need to know preferences- firm is search good- see more informational advertising- searchable info toc onvince, criteria/credentials, persuasive advertising- don't explain it to you or info about the good, just trying to get it in your mind- Gucci- not informational, doesn't tell you much about quality or products but shifting out demand curve and strengthen market power by getting feeling in me, weird- feel more special than average customer, exotic, more interesting - Why would advertising not be efficient- maximizes total economic surplus- to steal from customers- if everyone cut their advertising a little their sales wouldn't change much- increase total size of pi- is all advertising wasteful? How could it be efficient? Makes you buy something- let you know about a good that made you better off you wouldn't have known about otherwise- some efficient, some not- understand why- effective if it increases demand and makes demand less elastic

price discrimination notes

- Selling the same good at different prices- overrides assumption that you need to just charge one price, what if it could get away with charging different prices- why would it be hard to do- selling cars at different prices- no one would want to buy the first car- single price- relaxing this assumption - Student price tickets- type of price discrimination- amusement parks for younger kids, senior discounts- senior menu with lower prices- children under two fly free in Southwest- makes parent more likely to fly, cost of college- depends on who you are, high sticker price not what it sounds like- not that many pay whole price - Producer surplus- above supply curve beneath price out to quantity- PS- beneath demand curve out to price above quantity- CS- market power not efficient- efficient would be where demand and MC intersect- deadweight loss is tip of triangle- consequences of price discrimination- two-price case- existing customers and new customers- high WTP and low WTP- reservation price- WTP, needs to charge lower than reservation price- relative to the one-price situation there could be higher quantity, higher PS, higher CS for some consumers - New customers get a discount- charge one price going to sell this one price- add P1 and P2 together- additional producer surplus- firm is doing better- more consumer surplus?- brown is consumer surplus- new extra triangle

risk aversion degree

- Some People Are More Risk-Averse Than Others o Some people are (much) more risk-averse than others- this is not necessarily a matter of right and wrong, rational and irrational, etc- it's just a special feature of you o Suppose Lucas is more risk averse thanImani- then Imani might take a bet that Lucas rejects- not because one is smarter than the other- just because Lucas is more cautious than Imani o - Your Risk-Aversion Depends on How High the Stakes Are o Suppose you have a comfortable house, comfortable car, life etc- and then you are offered a big bet- if you take a bet and lose, you will be impoverished, if you take the bet and win, you will have a nicer house and a nicer car etc- you probably won't take that bet o Suppose instead you are offered a small bet- if you take the bet and lose, you might have to skip your weekly date night for a month- if you take the bet and win, you can order extra appetizers and dessert at your weekly date night for a year- you will take the bet - Mitigating Risk - Risk Aversion Does Not Mean You Should Elimiante All Risk o Eliminating all risk would be incredibly costly- what is the price of guaranteeing you are never in a car accident- never getting in a car, never crossing a street, etc- what is the price of guaranteeing you never catch a cold- complete isolation

barriers to entry

- Some businesses have been around for decades and still have huge profits and market power- forces of entry and exit haven't pushed profits to zero- why?- remained profitable because potential new rivals face barriers to entry- obstacles that make it difficult for new suppliers to enter the market- barriers have prevented new entrants from competing away their profits- strategic- resources to preventing rivals- not just happenstance, focus on threat posed by potential new entrants and outcompete and deter them- find ways to create customer lock (demand-side strategies), develop unique cost advantages (spply-side strategies), enlist government policy to prevent entry (regulatory strategies), scare off potential entrants (deterrence strategies)

social insurance programs

- Some safety net programs are not means tested but insurance programs that cover everyone, regardless of income- renters, homeowners, car insurance- pay small amount each month for it to be fixed, protect against risks, other risks like losing job, disabled, medical bills, outliving savings- difficult for private companies to provide profitably- government provides instead- social insurance- provided socially, by fellow taypayers rather than private- - Benefits are based on certain bad outcomes- injuries, spells of unemployment, disability- provides payment, income in retirement, stream of income for elderly for rest of lives to prevent outliving savings and benefits to survivors, some form of life insurance, Medicare- health insurance - People pay into social insurance programs- regular payments from paychecks or employers, employment insurance taxes on workers - Benefits are based on your past earnings- earned more have paid more in and eligible to receive more benefits, explicitly not means-tested- everyone gets access

firm demand curve

- Summarizes how the quantity that buyers demand from your individual firm varies as you change your price (firm is for-profit business)- demand curve focus on quantity demanded from your specific business- market demand curve is quantity demanded across all firms in entire market, also different from individual demand curve - Your market power determines the shape of your firm's demand curve- PC and no market power- lose everyone if raise price and win everyone if you lower- demand curve is essentially flat because miniscule change in price leads to enormous change in quantity - Monopoly- quantity demanded from firm is same as quantity demanded by entire market- monopolist firm demand curve is also market demand curve- higher price will still elad quantity demanded to be lower even without competitors because option to not buy product- close link between market structure, market power, and price elasticity of demand- two extremes of PC and PM (pure monopoly) bracket realistic imperfect competition- some market power, but limited- can raise prices without losing all customers- unlike monopolist- face some competitors so raising price will lead you to lose your market share- shape influenced by market power- if you don't have much power, raising price sharply reduces quantity you sell and firm's demand curve is relatively flat/highly elastic- lot of market power- price hike would be lose very few sales and firm's demand curve is relatively steep/quite inelastic - Experiment with your price to discover your firm's demand curve- changing prices and seeing how quantity changes, pricing experiments, different pricers to different groups and compare quantity demanded to find curve, different prices at different locations- plot, prices at different times to reveal

entry + exit

- Summary: Economic profits in a market tend to zero in the long run - If economic profits are positive, new rivals enter, market share down, market power of existing firms down, decrease quantity and decrease price, decrease economic profits- positive economic profits decline - If economic profits are negative, some rivals exist, increase market share, increase market power of existing firms, increase quantity, increase price, increase economic profit- economic profits become less negative - Relaxing the Assumption that all firms have the same AC Curve: the marginal firm o If all firms have the same costs, there's not much difference between firms- but that's not so realistic- so now let's assume firms have different cost curves- there are some firms in the market- there are some firms that are not in the market but might join the market- the marginal firm is the firm that is closest to the edge of being in the market- so some firms in the market could enjoy economic profits, but the marginal firm tends to have zero economic profits - Example- Entry over time o There are incumbents and potential entrants- the number indicates the profits the firms have or would have had

types of markets

- Tailor strategy to competitive environment you face- a lot or few competitiors, are products exactly same, how does quality compare- describe the structure and organization of the market and extent and type of competition - Market structure or industrial organization- competitive environment in which your doing business- market structure shapes your market power, which is the ability to raise your price without losing many sales to competing businesses- the more market power you have, the higher the price you can charge- only gas station in town has a lot of market power but if one of four at intersection have almost none because can go elsewhere

social protections

- Taxes and transfers- the cash, goods, and services the government provides some people- into account- less poverty and less inequality because governments take action to reduce - Fund the social safety net- cash assistance, goods, services provided by government to improve the lives of those living in or near poverty- government programs that insure you against bad outcomes like unemployment, illness, work-limiting disability, outliving your savings- these are called social insurane because it's insurance, but provided socially by everyone in society rather than a private insurance company - Government raises the money for the safety net through taxes- themselves are an equalizing force, since our overall system of taxation is progressive- progressive tax is a tax in which those with more income tend to pay a higher share of their income in taxes

many price case

- The Many-Price Case o Here the firm is able to set many prices for many different groups of consumers o o What area reflects the producer surplus? - Perfect Price Discrimination o Perfect price discrimination- charging each customer their reservation price o Draw the producer surplus on a graph o - Under What Conditions Can a Firm Price Discriminate? o If it has market power § If no market power, no ability to set price § If it can prevent resale (why is this important?) § The firm can target the right prices to the right customers · The firm must be able to identify o Which customers have higher reservation prices and be able to charge them o Which customers have lower reservation prices and be able to charge them lower prices · There are a few ways it can do this...

social insurance

- The Social Safety Net and Social Insurance: How the Government Can Address Inequality and Poverty o The Safety Net- social safety net- cash assistance, goods, and services provided by the government to help people who are at the bottom of the income distribution- safety net programs are means tested- it depends on one's means (income or wealth) - Social Insurance o Social insurance programs are government-run programs that you pay into during good times and will help you during bad times- they insure you against difficult outcomes- unemployment (unemployment insurance), inability to work (disability insurance), running out of savings (Social Security retirement benefits o Unlike the means-tested safety net programs, these are not just for the poor (and many poor people are not eligible for them) - Taxes Pay for the Safety Net and Social Insurance Programs o There are many different taxes- income tax, payroll tax, capital gains tax, corporate tax, sales tax, property tax, inheritance tax o Taxes fund safety net and social insurance programs o Wealthier people tend to pay more in taxes, thereby helping to reduce inequality - General Tax Concepts o Income tax rates are progressive- the more you make in income, the higher your tax rate is- marginal tax rate- the tax rate on the next dollar you earn There are some exceptions and loopholes to income taxes o Different tax rate on each dollar- less on first dollars - Jump ahead

US poverty

- The US poor are not members of the global poor- global line has 1.90 per day as measure of extreme poverty- extreme poverty in US has risen recently but most will get assistance or only spend a few months, in developing better off with poverty than elsewhere- 95% people in developing world get by on less than US poverty line, throughout history way less, suggests in US better to focus on relative - Majority of people in poverty will spend much of their lives in poverty, most people will spend some time in poverty during their lives, children and single moms most likely and people of color - Most poverty spells are short, but most low-income people are in long-term poverty- millions enter and escape yearly, some spend whole lives, hard times or short term sacrifices like college students living on their own, spells of poverty are temporary and half last less than a year but long-term- more than half of all people whose incomes are currently below the US official poverty rate are in spell of eight years or more- small proportion of those who enter and large share of poor at any time- poverty is often recurrent, those who escape will return - Some groups more likely to experience poverty than others- certain minorities more likely but overall 60% in poverty are white, varies by age- older than 65 have low because of social security, child poverty common, single parents extremely high poverty, disadvantages accumulate between single parent and race, lack of full time employment more likely to be in poverty - Household and employment changes can trigger a spell of poverty- losing a job, divorce or separation, birth, death, and young adults- all susceptible and without warning, more than half of Americans will experience at some point, social insurance

entry decreases demand and your profits

- Think about what would lead you to enter a specific market - New competitors will enter profitable markets- the cost benefit principle provides clear guidance- worth entering market if benefits exceed the costs- benefit is the revenue you'll earn- costs are explicit financial costs and implicit opportunity costs like forgone wages and interest- economic profit measures the difference between these benefits and these costs - Rational rule for entry- enter a new market if you expect to earn a positive economic profit, which occurs when the price exceeds your average cost- opportunity to earn economic profit, you should take it- profits are powerful incentive and many will respond- if industry is profitable others will try to compete - New competitors make your market less profitable- lose market share, customers, decrease in demand- sell a smaller quantity at any given price, curve shift to the left- arrival of new competitors gives customers more choices so less likely to choose you if you raise the price- price elasticity depends on availability of substitutes- less market price, demand curve is flatter or relatively more elastic, less market power charge a lower price, earn lower profit margin - Entry of new rivals decrease profits because you sell smaller quantity at lower price with lower profit margin

thought experiment

- Thought experiment: the red button- suppose if you press this red button you will double the income of the poorest 10 percent of the population and triple the income of the richest 10 percent of the population - Inequality of what? There are different types of inequality- inequality of outcomes, inequality of opportunity o There are different ways of measuring inequality- for example, consider inequality of outcomes- which outcomes? § Annual income- how much a person earns in a year § Wealth- value of all assets (car, home, saving in banks, stocks in portfolio, etc) you have § Consumption- how much a person spends in a year-o Note how only the second picture has the time dimension

betting

- Wanna Bet? Choosing in the Face of Uncertainty o A fair bet is a gamble that, on average, elaves you with the same amount of money- alternatively a fair bet is a gamble whose expected gains are 0- would you take a 1 fair bet? 10? 100? 1000? - How to take account of uncertainty o Previously we've understood a person's choices by comparing costs and benefits- if someone chooses to do action X we assum that the beenfits of doing X were greater than the costs of doing X- how do we understand someone's choices if the costs and benefits are uncertain? We assume people make the choice with the highest expected utility- to study decisions with uncertainty, we will start by focusing on the simplest risky choices: simple bets - A Naïve Rule for Making Choices Involving Uncertainty o One potential rule- make the choice that has the highest expected financial payoff- that is, if the expected financial payoff of choice 1 is greater than the expected financial payoff of choice 2, then choose choice 1- is that a good rule? Does it describe how people make choices?

determining economic profit

- What Determines Economic Profit? o Economic profit = total revenue - total (economic) cost o It will be helpful to think in terms of average revenue and average cost o Average Revenue = Total Revenue/Quantity = Price o Average Cost = Total Cost/Quantity = Total Fixed Cost/Quantity + Total Variable Cost/Quantity o Recall: § Fixed costs are costs that do not vary with quantity- rent, cost of equipment, etc. § Variable costs are costs that do vary with quantity- labor, materials, etc. o If AR > AC, then economic profit is positive! - Aside: We Assume Firms Maximize Profits. But Does Every Firm Really Try to Maximize profit? o One response: Maybe not every single firm, but it is a helpful way to view firms. § There probably are firms that sacrifice some profit for its values. § But when your favorite clothing store has a sale, its probably most accurate to interpret that as helping the clothing store make money somehow. · The store knows that you like a sale, but the reason they have a sale is the store thinks its good for the store. o Another response: it depends exactly how you measure profit. If it is the difference between all benefits and ALL costs, then yes. § Consider an econ/music double major who after graduation starts a chamber music company § She knows her company is unlikely to make much money § Ut for her the psychological cost of NOT committing her life to music is enormous § So the economic profits to her of choosing any other career are negative

continue to enter

- What Happens When Firms Continue to Enter the Market? o For now, assume that each firm or potential firm has the same average cost curve § This is a bit unrealistic: IRL some firms probably have lower costs because they are better managed, more efficient, etc o Also assume that the firms in the market are earning economic profits o What happens? - If all firms have same costs, free entry occurs until all firms earn zero economic profit

new firm enters

- What Happens to An Existing Firm When New Competitors Enter its Market? o Suppose you run a bakery. You and other bakeries in town have been turning a nice economic profit. In the long-run, this attracts new firms to the market. What happens to your firm as new firms enter? § Decreased demand § Lose some existing customers to the new firm § Shifts demand curve left (less quantity for each price) § Reduced market power § Customers have more choices § Demand curve becomes flatter § Your profit margin shrinks

firm exits

- What Happens to an Existing Firm When Competitors Exit its Market? o Effect of exit of existing firms for incumbents o Increased demand- gain some customers from the exiting firm- shift demand curve right- more quantity for each price o Increases your market power- customers have fewer choices- demand curve becomes steeper o Your profit margin grows

opportunity cost of starting a business

- What Is the Opportunity Cost of Starting a Business? o Foregone wages o Foregone interest § You have $100k in a bank account earning 5% interest a year § You use that money to start a new business § Part of the cost of that business is $5k in foregone interest o Foregone peace of mind § You gave up your comfortable job to start a new business, which has been very stressful o You should think of the sum of all these opportunity costs as the annual payment you need for it to be worth investing your time and money as an entrepreneur. Don't accept a penny less, or else you'll end up worse off. - Accounting vs. Economic Profits o Accounting profits tell you "where the money went"Economic profits tell you whether you're better off o Economic profits are the key to understanding entry and exit o Question: If a firm has accounting profits, will it also have economic profits? o Question: Suppose you start a firm and your economic profits are very small. Do you regret starting the firm?

how to segment your market

- What groups to target- find groups with different demand curves, whose membership can be easily verified, and whose membership is difficult to change - Segment market into groups whose demand differs- closest to reservation price, observable proxies related to reservation price- one that closest captures differences in reservation price- students have less spending money, only segment when demand differs- segment only as far as you know your customers- colleges know a lot, movies know a little- find the divisions - Target your group discounts based on verifiable characteristics- age, student status, address, can't lie, ID, edu, difficult to do by income for businesses Base group discounts on difficult to change characteristics- can't switch for lower price, children, students, some people lie to get discounts

overcoming barriers to entry

- What tools depend on structure of market, type of barriers - Entrepreneurs need to overcome these barriers to entry- Tesla- overcome barriers to entry- demand-side strategies can combat customer lock-in- create your own network and parts to help your product, building network effects and creating smaller competition - Supply-side strategies can overcome cost disadvantages- partner to reduce manufacturing costs, learn by doing and refine tech- falter over time and get investors, invest in research for cost advantages - Using regulatory strategies to secure government help- complying with regulation from onset, see regulations as opportunity, get government loans and subsidies and special access - Overcoming deterrence strategies to fight the big guys- people who come in with money or expertise

long run equilibrium

- When Entry and Exit Ceases: the long run equilibrium o Entry occurs when a firm not in the market thinks it could have positivie economic profits if it were in the market o Exit coccurs when a firm currently in the market believes it will have negative economic profits o This means in the long-run § Economic profit for the marginal firm is 0 § Economic profit for all existing firms is pushed towards 0- because as more firms enter, existing firms' profits shrink § Price tends towardshte average cost of the marginal firm- if prices were higher there would be profit and entry, if price were lower, there would be losses and exit, if a firm has lower costs than the marginal firm then it can maintain a profit

the efficiency of price discrimination

- When companies exploit market power to set higher prices, sell less than efficient quantity- underproduction problem- price discrimination can solve this - Price discrimination increases the quantity you sell- selective discounts induces additional purchases- sell larger quantity, no underproducing- selective dicounts help solve underproduction problem- marginal principle- when don't discriminate- marginal revenue reduced a lot because of the discount- large discount effect- when you price discriminate- only discount right people and make extra sale- marginal revenue depends on the buyer- more precisely discounts are targeted, smaller discount effect will be, and les syou'll underproduce relative to best interest, keep offering in best case until marginal cost equal to last customer's marginal benefit- efficient quantity- reduce underproduction problem Ex- college tuititon skyrocketing- actually doing more price discrimination- charge higher prices to those who'll pay them- wealthy families have high reservation prices, raise sticker prices, discounts/financial aid, free for some- led more to apply- increase in applicants - even though average price around the same, stronger students, new customers

advertising 2

- When customers are uncertain about quality branding can help- on the road and see random diner but don't know quality so pick McDonalds- branding provides information to consumers about quality offered- self-reinforcing cycle because stronger reputation for quality means investing in maintaining that quality because greater stake in maintaining that reputation - Persuasive advertising aims to persuade- lots of ads have very little info- persuasive advertising- persuade or manipulate into believing you will enjoy particular product- exploit emotions and not true claims- Real Magic- doesn't necessary lead to better decisions - A lot of advertising may be wasteful- goal is to win business from rival- business-stealing effect- privately profitable to advertise but wasteful to society because one gains offset other's loses- only stealing business doesn't help- just doing it because the other does it- arms race - Product positioning is about non-price competition- threat by bargaining power of suppliers and customers

exit entry effects

- Why is it that quantity and price fall? Prove it? To tell optimal price would need quantity- how to choose price- where profit is greatest- maximize profit- don't know from just AC and D1=AR- MR>MC- keep selling as long as this is true- keep lowering price as long as this is true- look for MR=MC- don't have MR or MC curve in average cost and average revenue curve- need new curves- MR curve is always beneath demand curve but start at same point- MC determined by firms costs- find quantity where MR=MC and charge price above that on the demand curve- what changes if there's entry- demand shift down and become less steep- find new optimal price- look up to D2- when the demand curve changes the marginal cost curve doesn't change but the marginal revenue curve changes- demand and MR tied together- MR is always beneath demand but starting from same point- MR shifts- when this happens both price and quantity fell- so economic profits fall- selling fewer at a lower price- this story runs in reverse - We made assumption that all curves have same costs, all same average costs curve- unrealistic- some manage better, more productive, better deals- lower costs- allow firms to have different cost curves- the marginal firm is the firm that is closest to the edge of being in the market- so some firms in market could enjoy economic profits, but the marginal firm tends to have zero economic profits- no one entering of exiting- market is in equilibrium

barrier 2 2

- You can create cost advantages through research and development- find lower cost ways to make existing products, field of management science and ways of organizing workplace to create cost savings - Leverage your relationships with suppliers to get a better deal- develop close relationships wit suppliers to become partner, use buying power to get discounts- takes time to develop this cost advantage - Limiting access to key inputs can freeze your competitors out- sign deals that lock others out of market, access to gates- typing up key inputs often through long-term contracts make it difficult for new entrants to succeed, typing up talent, sign noncompete agreeings- can't work for direct competitor- barrier for new entrants

average revenue/cost/profit margin

- Your average revenue is the price- your revenue per unit, calculated as your company's total revenue from selling a product, divided by quantity supplied- charge everyone same price, average revenue is price for each unit- average revenue = total revenue/quantity = price- demand curve is also average revenue curve - Average cost is the per unit cost, or total costs divided by quantity- average cost is cost per unit, calculated as business's total costs from making a product, divided by quantity produced- average cost = total costs/quantity = fixed costs/quantity + variable costs/quantity- average cost per unit is based on your total costs- fixed costs- like cost of land and capital equipment and other expenses that don't vary with quantity you produce- as well as your variable costs- raw material, electricity, worker time, cost of variable inputs- fixed costs include opportunity cost of time and money- U shaped pattern is common for average cost curve because: - Spreading your fixed costs- increase production from low level, average costs typically fall initially- pay for fixed costs just to set up business- fixed costs at beginning constitute a lot per unit sold- produce a larger quantity, the fixed cost gets spread over more and more units, smaller on a per-unit basis- decline in fixed costs often leads average costs to fall - Rising variable costs- variable costs due to inefficiencies, rising input costs per unit- pay staff more, also diminishing marginal product reducing productivity of workers like crowding- average costs rise as quantity produce increases

importance of product differentiation

- Your product probably similar to competitors and different from others- not innate to product- choose product design, services, style, advertise, where it's sold- choose how to position to differentiate it from competing products offered by rivals- key strategic decision that will shape market power and profitability The Importance of Product Differentiation - Without price discrimination- gas stations on corner- gasoline nearly identical between places and same service and credit cards- pure price discrimination can drive your economic profits to zero- both with keep dropping prices to get all the rival's customers- all customers and lower price or no customers and gas sold- keep going until price equals marginal cost or perhaps right above and neither will cut because that would mean a loss on every gallon and not going to raise because lose all customers- neither makes economic profit- if sell identical goods then competition from even just one rival can force price so low it eliminates your economic profits

average 2

- Your profit margin per unit is the price less average cost- average revenue (equal to price) and average cost are important because determine your profit margin, which measures your profit per unit sold: o Profit margin= price/average revenue - average cost - Critical to business success- positive means earning profit- total is per unit profit times quantity- if price exceeds average cost- demand curve/average revenue curve and average costs- profit margin per unit is price you charge minus average costs- profit margin is gap between curves - Demand curve above average cost curve- opportunity for profit - Economic profit is important for long-run analysis of business entry and exit- short run- face a fixed set of competitors with given production capacity, and your job is simply to outcompete these existing rivals- short-run decisions important but long-run is who is sustainable- long run- time horizon over which new suppliers may enter or expand into your market, and existing suppliers can shrink or exit the market- long run analysis is important for strategic decisions about production capacity and where you should enter or exit- economic profits help decide- different industries are different lengths- planning purposes

axel accounting vs economic profit

Accounting profit: Total revenue - total financial costs Focuses only on out of pocket costs Economic profit: Total revenue - total economic costs Includes opportunity costs Tells you whether you're better off Generally, if AR (average revenue) > AC (average cost), economic profit is positive Recall: AR = total revenue/quantity = price Recall: AC = total cost/quantity = total fixed cost/quantity + total variable cost/quantity Fixed costs: do not vary with quantity (think: rent, cost of equipment) Variable costs: vary with quantity (think: labor, ingredients, etc.)

average revenue/cost curve and profit margin

Average Revenue (AR) = Total Revenue/Q = P*Q/Q = Price The curve shows the average revenue per unit for each quantity that you sell So the average revenue curve is just the demand curve the firm faces (the "firm demand curve") Average Cost (AC) = Total Cost/Total Quantity = Fixed Cost per Unit + Variable Cost per Unit Profit Margin per Unit: AR - AC = P - AC (price that you sell at minus the average cost)

axel barriers to entry

Barriers to entry: things that make it harder for firms to enter a market Four kinds: 1) demand-side, 2) supply-side, 3) regulatory Demand-side strategy Switching costs: make it more costly for customers to switch products Reputation: make your customers loyal by treating them well Network effects: be the most popular good (Think: Google) Supply-side strategy Lower costs = higher profits Mass production to outdo competition Find cheaper inputs Make suppliers' input more expensive (think: hire all the best workers so that other firms find it more expensive to produce output) Regulatory strategy: government makes it harder for firms to enter a market Patents, new business regulations, licensing requirements, lobbying

axel entry and exit

Firms enter when P > AC Short run vs. long-run In the short-run, there is not entry and exit In the long-run, firms can enter and exit a market If a firm expects economic profit, it will enter the market (see graph above) If a firm expects to have zero or negative economic profit, it would leave the market Effect on incumbent (existing) firms when new competitors enter its market 1) Decreased demand (demand shifts left): lose some customers to entrant firm 2) Reduced market power: customers have more choices, demand curve becomes flatter (elasticity) because customers are now more sensitive to price changes 3) Profit margin shrinks Effect on incumbent (existing) firms when competitors leave its market 1) Increased demand: gain customers from exiting firm 2) Increased market power, demand curve becomes steeper (elasticity) 3) Profit margin grows In the long-run, if all firms have the same costs, free entry occurs until all firms earn zero economic profit (AC = AR) The Marginal Firm: assuming firms have different cost curves, the marginal firm is the firm that is closest to the edge of being in the market Tends to have zero economic profits

axel solutions (government) to market power

Goal: increase (maximize) surplus Competitors are not permitted to collude (agree to keep prices high) Companies need government approval to merge (become one company) Companies must abide by anti monopoly rules that promote competition Governments take charge of natural monopolies: markets where it is most efficient for a single business to serve the whole market (think: water and electricity)

axel the problem with market power

Identify how (and why) market power is inefficient Remember, under perfect competition, the price of a good is driven down towards the MC of the hood (but this isn't the case under situations of market power!) With market power: Prices are higher Quantity is lower The profit for a firm with market power is higher The firms with market power might not be efficient

axel long-run equilibrium

In the long-run, entry and exit cease to exit Economic profit for the marginal firm is zero Economic profit for all existing firms is pushed towards zero More firms enter → existing firm profits shrink Price tends towards the average cost of the marginal firm (P = AC, like before when P = MC)

axel inequality

Income inequality versus wealth inequality Permanent income: a measure of income that helps you understand a person's income over their lifetime Intergenerational mobility: how the economic outcomes of children depend on the economic status of their parents

axel strategic management

Non-price competition: competing to win customers over by differentiation (making different) the product, by means other than raising or lowering prices Product differentiation (different products) = market power (Think: coke vs. pepsi) Different products = less competition = more market power Product positioning: how a firm makes its product different relative to competing products Feature-rich vs. simple, high-quality vs. 'value,' etc. Advertising: a tool for positioning Purpose: shift out and stipend the demand curve the firm faces If products are very similar, then individual firms will tend not to advertise to avoid the free-rider problem If a product is unique, then monopolies can advertise the product If a product has imperfect substitutes (coke vs. pepsi) then firms advertise their products aggressively to capture their rivals' customers Search good: a good you can easily evaluate before buying (by Googling it) Experience good: a good for which you need experience to properly evaluate Information advertising: if a firm sells a search good, it might provide information about the product through advertising Persuasive advertising: if a firm sells an experience good, it might run an add which contains very little information about the product Advertising is socially inefficient

axel poverty

Official poverty: number calculated annually by the government If a person's household income is less than that number, they are "officially poor" Absolute poverty: when an individual does not have the financial means to sustain life Relative poverty: refers to the standard of living compared to those living within the same surroundings

axel output vs discount effects

Output effect: the additional revenue a firm gets when it sells one more unit Discount effect: to sell an additional unit, a firm must lower the price on all units, so it loses some revenue from each additional unit sold Tradeoff: sell an additional unit vs. lower the price on all units being sold

axel price discrimination

Price discrimination: selling the same good at different prices for different "types" of customers Can lead to increased profits Can lead to social efficiency Some consumers are worse off, some are better off Reservation price: a customer's willingness to pay Under perfect price discrimination, a monopolist charges a specific "type" of consumer prices equal to their reservation price Pro-tip: by continuing to charge different consumers their reservation price, the monopolist eventually absorbs all consumer surplus! Conditions for Price Discrimination Firm has market power Firm can prevent resale Firm can target the right prices to the right customers Methods for price discrimination: Group pricing: price discrimination by charging different prices to different groups of people (old vs. young people) Then, set a price for each group according to its demand and MR curve The Hurdle Method: offer lower prices to buyers who are willing to overcome some obstacle Bundling: selling different goods together as a package

axel risk and risk aversion

Risk aversion: the dislike or avoidance of uncertainty Risk aversion is why people don't just care about expected payoff Why are people risk averse? Because of diminishing marginal utility of income: getting less satisfaction from your 1,000,000th dollar than your 1000th dollar Understand how to use utility to understand why a rational person would reject a fair bet If you have diminishing marginal utility of income, there's a good chance you'll be risk averse But when the reward is high enough, risk averse people can also take risks 🙂 Finally, some people are more risk averse than others, depending on how strong their diminishing marginal utility of income is

axel social safety net/social insurance

Social safety net: cash assistance, goods, and services provided by the government to people who are poor (think: Food Stamp program) Social insurance: government-run programs that you pay into to alleviate financial burdens during bad times (think: unemployment insurance, social security, etc.) Taxes pay for the safety net and for social insurance programs Progressive tax: taxes that are higher for individuals with higher levels of income Regressive tax: taxes that are higher for individuals with lower levels of income

reducing risk risk spreading

Transforming Big Risks into Small Risks - Good idea and 50% chance of high payoff and high loss- even though better than fair bet most would say no because of lost utility being too great- other approach- start business but take on co-owners/shareholders who would also take a share of your financial risk- issue a lot then each shareholder now faces a smaller gamble and can get more to invest- breaking big bet into many smaller bets to transform investment too risky for one individual to make into a sound investment for many to share- risk spreading- taking a large risk and spreading it out over more people- ensure that stakes for each person are low and that makes them willing to take a share of it- won't prevent a profitable investment from being made as long as willing to spread thin enough - Make risk averse choices when the stakes are large- most people don't want to make risky investment but more if stakes are small- difference is wealth and power, marginal utility of each dollar you stand to lose is a lot larger than the marginal utility of each dollar you stand to gain- such a gamble feel much more pain from lost than satisfaction from each dollar gained, decline of 100k could wipe out wealth, increase isn't good enough to justify how bad the alternative if- most people refuse

two views of profit

o Accounting Profit: § Accounting profit = total revenue - total financial costs · All of the money that goes into and out of a business · Focused only on out-of-pocket costs · o Economic Profit: § Economic profit = TR - total economic costs · Accounts for opportunity costs- next best use of entrepreneur's time · Next best use of entrepreneur's money · Relevant to deciding whether to start a business

average cost

o As usual we assume the cost curve reflects ALL Costs, not just financial costs o o Average cost- firm's total cost divided by quantity produced- total cost/total quantity = fixed cost per unit + variable cost per unit o Average costs often fall then rise (U shaped) § Fixed costs per unit fall as costs are spread over more units § Eventually variable costs per units rise as inefficiencies arise- o Profit Margin per unit= AR - AC = P - AC

review 3

o Block Party- benefits some people 1000- hurts other people and hurts them 500- having the party is efficient o Cheat sheet but don't rely on it o PPD- captures all the surplus- none for consumers- think of supply and demand as reflecting marginal social cost- cost society what it costs seller, benefit as marginal social benefit- after that inefficient to produce any more- at efficient outcome- thinks cheat sheet might not help this- need to understand, not definitions- what is marginal revenue curve for a firm that can perfectly price discriminate- for market power it's always beneath demand curve- discount and output effect means the additional cargives them less than the price- for PPD marginal revenue curve is the demand curve- how much more money do I get- willingness to pay of person with next highest WTP

poverty definition

o Definitions vary- in US, official poverty is based on a number that comes from a formula first implemented in 1963 and updated annually- if your household income is less than that number, you are officially poor- the 2019 US official poverty rate was 11.5% of people- that measure of income does not include any government benefits o Official poverty rate suggests no progress but consumption and looking at government benefits shows progress

positioning tradeoff

o Demand side- on the one hand you want as many customers as possible- this pushes you to position your business close to your rival o Supply side- on the other hand you don't want to start a price competition with your rival- this pushes you to position your business away from your rival o So if price competition could be intense, try to locate away from rivals- coke and pepsi- both colas yet they've somehow made themselves seem like different products to many customers o A few other streets o Advertising o Advertising- a tool for positioning- the purpose of advertising- to shift out and steepen the demand curve the firm faces- shift at each price more demand for the firm's good- steepen- demand becomes less elastic, that is, less sensitive to price

how to group price

o First segment the demanders into appropriate groups § What are appropriate groups? · Demand differs between different groups- does it make sense for movie theater to segment by gender (no) does it make sense to segment by age (yes) · groups should be based on verifiable characteristics- must show student ID to get student price · groups should be based on difficult to change characteristics- student discounts sort of pass this test because pretty unlikely start going to college to get 4 off price of movie tickets o then for each group set the appropriate price- determine the demand curve (and MR curve) for each group- set the price for each group according to its demand and MR curve- remember- first set MR=MC to find the Q- then look to the demand curve to find the P that corresponds to that Q - Price Discrimination Method 2: The Hurdle Method o Hurdle method- offer lower prices to buyers who are willing to overcome some obstacle- the trick is to find a hurdle that separate customers with higher reservation prices from customers with lower ones- so that customers wit high reservation prices won't bother with the hurdle and instead pay higher prices - Many types of hurdles o Timing- cheaper hotel stays if you stay over a weekend o Extra hassle- coupons and rebates, black Friday shopping, worse service - Bundling o Bundling- selling different goods together as a package- Netflix subscription bundles all its content together, suppose I only have a high WTP to watch Sinfeld but I have a low WTP to watch Netflix's other content- if I could pay 8/month just to watch Seinfeld, I would, but that's not an option- so I pay 12/month to watch Seinfeld and other stuff- Netflix has extracted more money out of me- see football tickets problem on upcoming problem set

attacking the naive rule

o In some cases the naïve rule makes sense- eg with a .9 perent probability win 10, with 10 percent probability lose 10- you'd probably take this bet, just like the naïve rule tell you to take this bet o But not always- suppose I offered you a bet- with 51% probability you win 1M and 49 probability you lose 1M- E(payoff) = 0.51(1) + .49(-1) = 0.2- the naïve rule tells you to take the bet because the expected payoff of taking the bet is greater than the expected payoff of not taking the bet (0.2 vs 0) o And consider the bets from the poll- each bet had an expected winning of 0, but many people chose to take some bets but not others- what explains why you'd take some bets with a certain expected payoff but not others? - Risk Aversion o Risk aversion- the dislike or avoidance of uncertainty- obviously you prefer a certain 100 to an uncertain 100- but you probably also would prefer a certain 10M to an uncertain 50-50 chance of winning 20M (or winning 0) o Risk aversion is why people don't just care about the expected payoff- some people are more risk averse than others, in some settings you might be more risk averse than in other settings- eg when the stakes are small, you are probably more willing to go take a risk than when they are large- why are people risk averse?

cell phone service and gasoline

o In the US, the vast majority of consumers have cell phone service through Verizon, T Mobile, ATT- few others- while these firms are very competitive with each other, the market for cell hpone service is not a perfectly competitive market- how many firms does it take to make perfect competition? How similar does a product need to be perfectly competitive?- purchasing gasoline is different- most people don't think much about which gas station they go to- so this is much closer to a perfectly competitive market - Price-taking and Market Power o In a perfectly competitive market, suppliers and demanders are price-takers § They have no control over the market price and no incentive to charge or pay anything other than the market price o Sellers and buyers in a perfectly competitive market have no market power § That is, no ability to change the price of the goods they sell or buy in a way that benefits them

marginal revenue curves

o Marginal revenue- the additional revenue a firm gets from selling one more unit § This is the MB for a firm- so it's very important- the firm will want to keep selling goods as long as... MB> MC or, equivalently, MR > MC- we have said that as Q increases MC increases...so eventually the firm does not want to sell anymore- what about the MR? For a firm in PC what is the MR? it's the price- but for a firm in imperfect competition, MR is NOT the price

review 2

o Neighbor installled 10k glass sculpture in front yard and hates looking at it any day- glass sculpture is inefficient- false, don't know- don't know each person's MB and MC- could be efficient if they're benefit is greater than your harm o Policy A- increased surplus by 10M o Policy B- increase surplus by 5M o Mayor chooses policy B- know she doesn't just care about efficiency- mayor only cares about equity? No, could be true but can't be sure- we don't know which policy is more equitable- not necessarily true- Mayor cannot redistribute however she likes was the difficult answer- why? If she could split up new pie however she wanted she would always pick the bigger pie- she would choose 10m if she could customize, take it and distribute so that's how we know- why is answer mayor doesn't only care about efficiency???? Why is this not the answer???

price discrimination slide

o Price discrimination- selling the same good at different prices o So far we have assumed that there is assingle price for a good o We'll see that IF a firm can practice price discrimination, THEN: § The firm can increase its profits § The outcome can be more socially efficient § Some consumers are worse and some are better off - This is real! Examples abound... o Student tickets o Senior discount o Children under two fly free o Cost of college o - Recall How a Firm with Market Power Behaves o Find the Q where MR=MC (call it Q*) o Find the P on the demand curve that will let it sell Q* (call it P*) o Enjoy profit > 0 § Where is the producer surplus reflected on a graph? Where is the consumer surplus reflected on the graph? Where is the DWL reflected on the graph? § - Suppose the Firm Could Charge Different Customers Different Prices: The Two-Price Case o Reservation price- a customer's WTP o Suppose the firm could charge customers with high reservation prices (ie, high WTPs) a relatively high price and customers with low reservation prices a relatively low price o Then, relative to the "one-price situation," there could be § Higher quantity/new customers § Higher PS for the firm § Lower CS for some and higher CS for other consumers - A Two-Price Picture o Suppose in addition to P* the firm could price discriminate and charge just new customers a lower price (P2) § Relative to the "one-price situation": · Quantity is larger · Producer surplus is larger · More consumer surplus · Difficult Q- suppose a firm can price discriminate- does optimal choice of two-prices always lead to 1, 2, 3?

entry and exit

o Short-run vs long-run § In the short-run there is no entry and exit § In the long-run, firms can enter and exit a market o Question- how long is the short-run? § It depends on the market o Economic profit explains who enters and who exits § If a firm knows (expects) it will have economic profit, it would enter or stay in the market § If a firm knows if it will have zero or negative economic profit, it would leave the market

average revenue

o So average revenue is the price: § Average revenue = TR/Q = P x Q / Q = P - how is AR different from MR? o What's the "average revenue curve"? § The AR curves shows the AR per unit for each quantity that you might sell... § So the AR curve is · The demand curve the firm faces (the firm demand curve)

barriers entry

o So far we have assumed free entry- firms can enter or exit the market at will o But existing firms often try to make it hard to enter- why? There are four categories of barriers to entry § Demand side § Supply side § Regulatory § Deterrence - Demand-side strategies o The key here is for existing firms to keep their customers- so that when new firms enter, existing firms are unaffected o How to keep customers? § Impose switching costs, impediemnts that make it costly for customers to switch products- it's annoying to switch from iPhone to Android- I have to mail a letter to Planet Fitness to cancel my membership § Reputation and goodwill- make your customers loyal by treating them well § Network effects- if a lot of people use a company's good, then other people might want to as well - Supply-side strategies o The key here is finding cost advantages- recall even if the marginal firm is earning zero profits, another firm with lower costs could earn positive profits- if existing firms have much lower costs than potential entrants, those potential entrants won't enter o How to get a cost advantage? Learning by doing- through experience, a firm can produce goods at lower cost than others- mass production- eg individual woodworkers can't compete with Ikea, find cheaper inputs, make suppliers' inputs more expensive- eg hire all the best workers - Regulatory strategies o The key here is to get the government to make it harder for new firms to enter: § Patents, which prevent competition for a specified time § New business regulations- hoops a firm has to jump through before it can open for business § Licensing requirements- this makes it harder to open a new firm § Lobbying

utility

o Utility- a measure of a person's wellbeing- not the same as income- what are the units? Some economists call them utils- you might think of it as units of life satisfaction o Marginal utility of income- the boost to your wellbeing from an extra dollar o Diminishing marginal utility of income- refers to the fact that your 100,000th dollar of income helps you less than your 50,000th which helps you less than your 10,000th- utilitarianism- belief that we should act to maximize total utility in society o o Costs of Redistribution § Taxes are the primary way the government moves money from richer to poorer people- taxes create DWL!- that is because taxes discourage work- what if we put a 90% tax on wealthy- they might work a lot less, and therefore contribute to society much less, including paying less in taxes- reducing benefits at a certain income level can also discourage work- suppose people lose welfare benefits once they earn 10,000- you might see a lot of people earning 9,999 then quitting work

decisions involving uncertainty slide

o We've been making choices without considering uncertainty- David has this MB curve over cookies- how many cookies will David consume if P=5 o But IRL uncertainty is a feature of many important choices- should I go to grandma's house for Thanksgiving during a pandemic, should I invest my savings in facebook stock- here's a simpler one- should I make a gamble where I win 100 with 50 percent probability or lose 100 with 50 percent probability - Expected Value o Let Px be the probability you get a payoff X and let py be the probability you get payoff Y- then the expectd value of the payoff is Px x X + Py x Y - Examples of Expected Values o Suppose with 50 percent probability you lose 100 and with 50 percent probability you gain 200- then the expected value of gains (or expected gains) are .50(-100) + .5(200) =50 o Suppose with 75 percent probability you lose 100 and with 25 percent probability you gain 200- then expected gains are 0.75(-100) +.5(100_ =0 o Suppose with 50 percent probability you lose 100 and with 50 percent probability you gain 100- then expected gains are 0.5(-100) + 05(100)=0 o Suppose with 50 percent probability you have wealth 10,000 and with 50 percent probability you have wealth 20,000- then your expected wealth is- 0.5(10,000) + 05(20,000) = 15,000

utility measure

o a measure of a person's wellbeing § Not the same as income- what are the units- some economists call them utils- you might think of it as units of life satisfaction- marginal utility of income- the boost to your wellbeing from an extra dollar § Diminishing marginal utility of income- refers to the fact that your 100,000thdollar of income helps you less than your 50,000th, which helps you less than your 10,000th § KEY GRAPH TO UNDERSTAND · Vertical is utiles, horizontal is annual income · Concave · Can't both be better off- no change- take money from wealthier and give to less rich · Shows diminishing marginal benefit of income

imperfect competition

§ Oligopolies and firms in monopolistic competition still face competition but it is different than perfect competition o Examples of Imperfect competition- Apple and Lenovo sell laptops- but the laptops are different- Apple could raise its price and still sell its laptops- but if it raises its price too much, too many customers will switch to Lenovo (or another firm)- similarly, Lenovo can lower its prices or add features to try to lure away Apple customers What best reflects the demand curve faced by a firm in a perfectly competitive market? The firm is small, the market is large- there is a single price which the firm has no control over- o The demand curve a firm faces- what is the demand curve for iPhones that Apple faces? Apple is not a price-taker, but it can't sell as many phones as it wants at a high price- B- perfectly elastic o Slope or elasticity is relevant

costs of redistribution

§ Taxes are the primary way the government moves the money from richer to poorer people § Taxes create DWL § That is because taxes discourage work- 90% tax on wealthy makes them work a lot less and contribute to society much less overall, including paying less in taxes § Reducing benefits at a certain income level can also discourage work- lose welfare benefits at 10k- a lot of people earning 9,999 and then quitting

taxes are a tool for income redistribution

§ The basic idea is that we can make society as a whole better off if we can redistribute income from richer to poorer people § We've seen that taxes induce deadweight loss- so what do we mean by make society as a whole better off- think about efficiency- the size of the pie/economic surplus decreases- it's inefficient (unless it's correcting a negative externality)- make it more equitable, distribution of the slices