Professional Documents
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Economics- The science of scarcity; the science of how individuals and societies deal with the fact that
wants are greater than the limited resources available to satisfy those wants.
Topic Definitions
Opportunity Cost- The most highly valued opportunity or alternative forfeited when a choice is made.
Scarcity - when wants exceed our ability to satisfy
Decisions at the Margin- Decision making characterized by weighing the additional (marginal) benefits
of a change against the additional (marginal) costs of a change with respect to current conditions.
Efficiency- Exists when marginal benefits equal marginal costs
Equilibrium- Equilibrium means "at rest"; it is descriptive of a natural resting place
Ceteris Paribus- A Latin term meaning "all other things constant," or "nothing else changes."
Micro economics
• Individual (referred to as consumer) level economic activity
• Individual Firms Behavior
o "The Firm" is generic term for a single business unit
• Industry of similar firms
• Single markets, comprised of individuals or firms within a similar business sector
Macro economics
• The economy at large
o The nation's economy
o World economic growth
• An economic market not subdivided into industry groups
• Issues may involve exchange rates, capital investment, mass labor markets, or trade.
Scarcity
• How do we better describe our response to scarcity. If there exists something capable of relieving
our cravings, then we have attained
• Utility = satisfaction of our want (good)
• The car we drive to work
• A new shirt that makes you feel stylish
• Goods = those items providing utility
• To achieved the desired utility, we expend our available resources on goods.
o These goods may be tangible or intangible
• Tangible
Objects or specific service
• Intangible
Happiness
Well-being
• But if something causes us harm or dissatisfaction, we have then encountered a "BAD"
o Tangible
• Pollution
• Sewage
o Intangible
• Pain and misery
• Goods must be produced, requiring resources
o The car won't appear by itself
• Disutility- The dissatisfaction one receives from a bad
• Bad- Anything from which individuals received disutility or dissatisfaction
• 4 TYPES OF RESOURCES
o Land (physical space; natural resources)
o Labor (talents people contribute to production process)
o Capital (Money)
o Entrepreneurship (business savvy)
• Resources are utilized in differing combinations for each and every good
• Resources used as inputs in good production are scarce, as well. Therefore, goods can not be
produced in unlimited quantities
o Everyone wants a Filet, but there just is not enough tenderloin to go around
• How then do we determine who will receive the good, and who will not?
• Rationing Devices are introduced
o Such devices may take the form of a price, expressed in currency or exchange, or a
deterrence, such as a line
o These are naturally occurring
• EX: Someone yells "Free Spock Ears" at a Trekkie Convention. Throngs of
fanatics appear to grab a pair.
What conditions exist, and what is likely the outcome?
• Rationing Device- a means for deciding who gets what of available resources and goods.
o Ex. Money (currency)
o Looks, "if only the pretty people were let into the game"
• Competition exists because of scarcity.
Opportunity Cost
• The highest valued alternative forfeited
• NOT the cost of your choice
• The reward lost when choosing against that which it would offer it
• "PRICE is RIGHT" Examples
o With the first spin at the wheel, you land the $1.00 spot, assuring a place in the Showcase
Showdown
o The decision of the showcase is the opportunity cost
• Teaching example
o Sleep 3 days a week
o Work on some consulting project
o Hang our at Starbucks
• Now, neuro-surgeon Example
o Get paid very well, but must work until 5 in morning
o Sleep and rest take a higher value in my life
o Thus, the opportunity cost of teaching is likely to subside
No such thing as a Free Lunch
o All choices entail someone picking one over the other
o Resources will be spent in every action; meaning they could have been invested in an
alternative action. The result is an opportunity foregone
Efficiency
• Taking our analysis one step further
o If each costs and benefits are increasing marginally, then there will exist some point where
costs exceed benefit
o But before that, there is a level where MB= MC
o This intersection point is the ideal level of consumption, and is said to be "Efficient"
o In economics, the "right amount" of anything is the "optimal" or "efficient" amount and the
efficient amount is the amount for which the marginal benefits equal the marginal costs.
o Why do we want to continue exercising our choice until reaching Efficiency?
• B/c we seek to maximize Utility (benefit, satisfaction)
• If we stop before MB=MC, there remains Utility to be gained, greater than cost
o Remember, the consumer faces scarcity, and has wants greater than needs. It would be
irrational to stop attaining net positive utility when it is available
• Back to graph
Unintended Consequences
• Decisions and choices exercised may produce secondary results not intended by the deciding party
• Economists frequently discuss this concept when speaking of government policy and law
o If unemployment benefits were raised very high, more people would have less incentive to
work
• Suppose all students were told LSU would no longer require any exams. Who would study?
• Society places a value on the appearance of beauty and health. People resort to tactics that are
neither pretty nor healthy
• EX.
o Boy makes $5.15 an hour. If minimum wage gets raised to $7.50 the boy will make more, but
the unintended consequence is that the employer might not want to employ the boy anymore
because he cannot afford it. So the unintended effect of raising minimum wage is the boy
losing his job.
Equilibrium
• Economic activity tends toward a natural level, known as an equilibrium
• A market reaches equilibrium when supply equals demand
• Prices may be set by markets seeking equilibrium
• Ex.
o Painter has a painting for sell for $5,000. Three people are willing to pay that much. Two
people are willing to pay $6,000. And one person is willing to pay $6,500. In other words, the
bidding activity of the buyers has moved the price of the painting to its natural resting place or
to an equilibrium price of $6,500.
• Look at the MC/MB graph, the third hour of studying would be equilibrum
Ceteris Paribus
• "All Other Things Held Constant" (Ceteris Paribus): The effect of a change in an assumption or
condition may only be measured if all else is equal
• The relationship between variables will be tested holding conditions ceteris paribus
• Ex.
o Romper Room, a new bar targeting freshmen who like lots of sweet drinks and fighting, is
trying to determine where the right cover charge should be set
o The manager, a 34 year old dropout who never left Tigertown, heard you took econ and asks
for your help
o What would you advise?
• Keep conditions of bar the same
Unemployed Resources
• Should output fall beneath the frontier, then it is likely there are unemployed resources
• Something is not being utilized if attained output is less than its potential
Economic Growth
• Refers to the increased productive capabilities of an economy.
• Two factors that affect economic growth?
o Increase in the quantity of resources
o Advance in technology
• Technology- The body of skills and knowledge concerning the use of resources in
production. An advance in technology commonly refers to the ability to produce more
output with a fixed amount of resources or the ability to produce the same output with
fewer resources
• Should improved technology, increased productivity, or other business advance be gained, the effect
will be an outward (rightward) shift on the PPF
• Why, because using the same inputs, more may be produced, expanding the frontier.
Chapter 3
Monday, September 12, 2005
9:40 AM
into being the interaction between those who want, and those who have to
offer.
• The ensuing behavior creates the phenomenon known as a "Market".
• Market - The two sided nature of transactions, featuring an exchange
Demand
• Those who want, and are allocating their own scarce resources to attain,
demand
• This observed behavior has precise meaning in economics, and refers to
• Those who want, but are unwilling or unable to part with resources, are not
considered demanders
o Ex.
vacation home and goes shopping for a car to pick up girls half his
age, is a demander.
• If a given good is known to provide utility, and is known to be the object of
demanders, who seek the utility offered, then it stands to reason the
following
o The quantity demanded will be higher when the price is lower.
Law of Demand
o Law of Demand - Quantity demanded is the number of units of a
good that individuals are willing and able to buy at a particular price
during some period of time.
o The price of a good, and the quantity demanded are inversely related,
all things equal.
o This may be expressed in one of four ways:
i. Words: the definition
ii. Symbols: P(up) QD(down) : P(down) QD(up)
iii. Demand Schedule
iv. Demand Curve
30000/2000 = 15
You would give up 15 computers to buy a car
ο Relative price of a computer in terms of a care would be 1/15
2000/30000 = 1/15
A person gives up 1/15 of a car to buy a computer.
ο If absolute price rises, and nothing else changes, then the relative
derived from each subsequent unit is less than the unit consumed right
before.
• So then, what would be most valuable, the first piece of pizza, or
the eighth?
o Therefore, if the first consumed is most valuable, and the last the least
valuable, than the same good in a small quantity will fetch a higher
price than when available in large quantities.
o Consumers implicitly understand that something offering higher utility
is worth more than something of less. There is no need to pay higher
prices for goods available in large quantities.
• Ex
At the grocery store, the travel size costs the most per
quantity measured, family size, the least.
Aside from packaging costs, shelf space, etc, bulk is
cheaper because the marginal utility of the nth unit is
less. Consumers will only demand if the price is less.
rises.
• This is the type of good most individuals imagine when discussing
"goods".
• Generally speaking, consumers will allocate more resources to this
I may not own more homes, cars, or shirts, but the ones I do
items
• Ex
inexpensive good
There is on notable exception to an inferior good
• Whitney Houston still likes crack
o Neutral Good-Those goods for which demand does not react with
changes in income.
• Barring extremes, there is little shift in consumption of certain
would be deodorant
In this country at least, consumers demand relatively similar
other, demand will shift towards the good featuring a lower price
• Ex.
the other. Sometimes the flow goes both ways, other times, not
• Ex.
a crack pipe
•
substitute goods.
• For complements, the shift in demand will likely be in the same
direction
• For substitutes, the shift will be in opposing directions.
o When we speak of "price chagnes", we are referring to those changes
making a pronounced effect on market dynamics. These effect demand
across all price ranges, not quantity demanded
o Ex
other substitute
o Increase in price of a complement, decreases the demand for
are around, demand will be greater across all price levels. The reverse
is also true. This can effect all goods
• Ex
behavior in the present. Overall demand will shift, as people await the
new price structure.
• Ex.
mortgages increases.
When consumers anticipate car rebate programs, demand
Supply
• Supply in economic terms, is a specific term relating to those who utilize
resources in such manner they produce goods. Like demand, there are
three key points
1. The willingness and ability of sellers to produce and offer goods, in
different quantities
2. At different prices
3. During a specific time period
• Does this mean a seller who makes only one good must offer it at different
prices?
o No, rather, they react to different prices set by the market
• Law of Supply:
o Law of Supply- The quantity of a good produced directly related to
payout
individuals suppliers.
o If the market consists of Bob, Joe, and others, than the supply
change in supply
• As with demand, these do not mean the same thing
• Change in Quantity supplies:
- own price
• Change in Supply:
production costs.
• If such changes allow more efficient production (i.e.
in supply
3.Number of sellers
• More producers yields more supply. Less
6.Government Restrictions
• Regulation has a negative effect upon supply
• The supply curve will shift inward with
surplus condition
• Graph
willing and able buyers as there are units supplied by willing and
able producers. The amount produced is the amount sold -no
leftover unit and no let out buyers.
• Auctions: the search for Equilibrium - Live
o Ex: The government is auctioning off lease territory.
demanders
• The final price must ensure all are sold
• How will this work
• The Search For Equilibrium
o Markets don't necessarily have readily apparent supply and demand
experience.
o This process may be ongoing, as a single market is not insulated from
sale. At the current price, supply is exhausted before all buyers have
consumed
o Suppliers will not produce more units because the price does not
other inefficient prices. Given these units sell at a price both greater
than the producers minimum, and less than the consumers maximum,
both the consumer and the producers achieve a benefit
o The difference is referred to as the "Surplus"
o Consumer's Surplus- the difference between the Max. buying price
I would have paid up to $20 for a large pizza. But because the
market set an equilibrium price of $14. I saved $6. This
savings represents the surplus gained
• Price Controls:
o Arbitrary mechanisms by which the government sets a price, despite
available goods
o Nonprice Rationing Devices result, adding inefficiency to the
Chapter 5
Wednesday, September 21, 2005
10:13 AM
Elasticity of Demand
Price Elasticity of Demand
• When discussing Consumer reactions to price changes, and the subsequent
10%
o If 10, then quantity demanded will be 20
denominator
o Ed > 1
o Percentage Change in QD > Percentage change in Price
o 20/10 = 2
denominator
o Ed < 1
o Percentage Change in QD < Percentage change in Price
o 4/10= 2/5
denominator
o Percentage Change in QD = Percentage change in Price
o Ed = 1
o 10/10 = 1
each, and if price rises to $11 each, then buyers will still buy a 100
units
• Perfectly Elastic and Perfectly Inelastic Demand Curves
o In the real world, there are no demand curves that are perfectly elastic
• (up) P -> TR
• (down) P -> TR
• Price Elasticity on Straight Line Demand Curve:
o Varies from highly elastic to highly inelastic
o A straight line may feature a constant slope, where the trade off
elastic or inelastic
• Then it stands to reason we can easily determine how to adjust price along
the demand curve in such a way that TR is maximized
• Ex.
There are more substitutes for Economic Textbooks, than for
textbooks
More substitutes for Coke a Cola, than for softdrinks
o The more narrowly defined the good, the greater the substitutes
o If one can move in and out of a particular type of good, attaining
demand
• Good's Relation to Overall Budget:
o Consumer price sensitivity is greater for those goods commanding the
highest allocation. Price increases for these goods could have dire
consequences on a budget.
• If rent increased by 50%, one would be very concerned
• If the price of a movie concession increases, the change is not so
significant
o Buyers are (and thus quantity demanded is) more responsive to price
the larger the percentage of their budgets that goes for the purchase
of a good
o The greater the % of one's budget that goes to purchase a good, the
Elasticity of Supply
• Price Elasticity of Supply- measures the responsiveness of quantity
price
• Price Elasticity of Supply measures the responsiveness of the QS to
changes in price
• ES = (% Change in QS) / (% Change in Price)
• The Extremes:
o Perfectly Elastic- Should ES = ∞, then the smallest of price changes
Consumer Choice
Utility Theory
• Utility- a measure of satisfaction, happiness, or benefit that results from
of goods
• Example
TU = total utility
Q = quantity consumed of a good
• Q is usually equal to one
• Law of Diminishing Utility
o Law of Diminishing Utility-The marginal utility (downward sloping)
least urgently
• Total utility can increase as marginal utility decreases
• Interpersonal Utility Comparison- comparing the utility one person
derives from a good with the utility another person derives from consuming
the same good
o It is impossible to quantify and objectively make this comparison
goods purchased
• Changing consumption levels thereafter will only reduce the utility attained
• Recall the Law of Demand - the QD increases when price decreases
• In terms of MU, a change in price will alter the MU per dollar a consumer
receives
• If price decreases, the MU per dollar increases. This creates an imbalance
in the MU per dollar across the basket of goods
• To correct, more of the good will be purchased
Chapter 8
Monday, October 10, 2005
10:01 AM
operation, and also recognizes the costs of alternate uses for the
resources employed
o It is usually lower than accounting profit
Production
• The production of goods requires resources, or, inputs.
o These may be either
being variable, than the Marginal Product will focus upon labor
change
• With more complex examples featuring numerous variable inputs,
return sets in
o The behavior MP and MC exhibit are related
o For every added input, there is both an added measure of output and
an added cost
o Given that variable inputs suffer diminishing returns, then the MP will
rise then fall following the increasing and decreasing productivity
o MC will reflect the same increase and decrease in productivity
o Production costs, as measured by MC capture the cost side of changes
in the productivity measured by MP
o When productivity rises, marginal costs will decrease.
o When productivity declines, marginal costs increase
o Thus, MP and MC move in related, but opposite directions
o As the MP curve rises, the MC curve falls; As the MP curve falls, the MC
curve rises
• Average Productivity
o Average productivity measures the quantity level of output per variable
input
• Whereas MP measures the output per additional unit, average
50 * 10 = 500
The AVC curve declines and then rises
• Average Total Cost: a measurement of total costs (FC + VC) in
terms of quantity of output
ATC = TC / Q
ATC = AFC + AVC
• The ATC curve falls and then rises
•
o The behavior of the MC curve is related to the shape of the AVC and
ATC curves
• Understand that averages are effected with each new observation
downward
MC > AVC, or MC > ATC, then the curves will slope
upward
•
In Graph A
• In Region 1, the MC < AVC, so AVC is declining
• In Region 2, the MC > AVC, so AVC is inclining
In Graph B
• In Region 1, the MC < ATC, so ATC is declining
• In Region 2, the MC > ATC, so ATC is inclining
efficient
o The grouping of SRATC into a LRATC begins to resemble one giant
SRATC. The shape begins to tell something about production
o Long-Run Average Total Cost Curve (LRATC): a curve that shows
the lowest (unit) cost at which the firm can produce any given level of
output
o Economies of Scale: A condition whereby unit inputs may be
increased by X percent and output increases by a greater percent.
Because productivity is rising, unit costs decrease
o When output levels are low, one can witness Economies of Scale,
increasing inputs, and lowering production costs
o All good things don't last forever
o Constant Returns to Scale: Exist when inputs are increased by some
percentage and output increases by an equal percentage, causing unit
costs to remain constant
o Constant returns to scale occur next within the LRATC.
• Here an X percent increase in inputs leads to the same X percent
costs
An upward shift in the MC curve
•
of production
Rising variable costs will shift the relevant cost curves
Chapter 9
Monday, October 17, 2005
10:07 AM
Perfect Competition
• Market Basics
o Market Structure: The environment and setting in which a particular
firm operates. This has great influence upon pricing and output
decisions
• 4 kinds of Market Structure
Perfect Competition
Monopoly
Monopolistic Competition
Oligopoly
o Chapter 9 will study Perfect Competition
o Every Firm must answer the following
• Perfect Competition:
• Perfect Competition: a theory of market structure based on four
selling a product
4.Firms have easy entry and exit. There are no barriers to
entry such as high investment costs or government
regulations
Supplies are Price Takers:
Price Taker: a seller that does not have the ability to control the
price of the product it sells, it takes the price determined in the
market
"A perfectly competitive firm"
A firm is a price taker if it finds itself one among many firms
where its supply is small relative to the total market supply, and it
sells a homogenous product, in an environment where buyers and
sellers have all relevant information
Within this market structure, no one can influence the price set by
market force. They accept the market price
Recall, there are many firms, producing an indistinguishable
product - no one can set price
Any firm raising price will suffer from no demand. Any firm
lowering the price will forfeit profit - they already sell what can be
produced, and will not set the market
Demand Curve is Horizontal (Perfectly Elastic):
• Recall Downward Sloping Demand Curves - these were for the
Market, not a single Firm
• Perfectly Competitive Firms sell at Equilibrium Price
Why?
• B/c the firms sells a homogenous product, its supply is
(P=MR)
Therefore the marginal revenue curve for the perfectly
one more unit will cost more for the firm to produce than it
will receive given the price
♣ If MR = MC, then any other level means:
At a lower output level, MR > MC, and the firm is giving up
MR = MC
•
shut down
There are 3 scenarios to Review
attain profit
• If price is above average total cost for the
marginal cost curve that lies above the average variable cost
curve
• The short run Supply curve is simply the portion of its marginal
(which in turn equals price). Thus, the firms supply curve will
follow the MC curve
•
• For the Market:
• Short-Run Market (Industry) Supply Curve: the horizontal
assumptions
Before, however, understand that in a competitive market firms may
come and go. The number of firms present in the short run may differ
from the long run.
• Why
• Because a market where firms attain economic profit will
attract new firms. The market might attract so many firms
that some are now unprofitable.
One might view the market as having a surplus or shortage of firms,
and that over time, an equilibrium will be reached
Once reached, no firm will attain economic profit
Conditions of LR Competitive Equilibrium
• Economic Profit is Zero
• P = MC = SRATC = LRATC
• As mentioned previously, a different price would either create
MC
• No firm has any incentive to change plant size. Thus,
equilibrium, the firm has attained the ideal plant size, where
the SRATC = LRATC
•
price
• The Long Run Supply Curve is downward sloping
•
When firms enter an industry chasing profits, prices will fall as the
market becomes more competitive. The industry, itself, might achieve
greater economies of scale as more production influences the cost of
inputs
• Ex.
• Over time, Demand for PCs drives the cost of computer chips
down
Long Run (Industry) Supply Curve (LRS): graphic representation
of the quantities of output that the industry is prepared to supply at
different prices after the entry and exit of firms is completed
Chapter 10
Monday, October 24, 2005
10:04 AM
Monopoly
• Theory of Monopoly
o Monopoly: a theory of market structure based on three assumptions:
the inputs. No competitor can buy the inputs needed to make the
product.
Aluminum made from bauxite
Diamonds
their product. After all, they control supply. They can not dictate
perfectly, though, as consumers still maintain control over
demand.
• Because the Monopolist (M) is not a price taker, demand is
market specific views. There exists only one firm, who provides
the single source for the product.
• Thus, for the monopolist, the firm supply and demand is the same
as the market.
o If price is greater than MR, and the Price determines the quantity
demanded, then logic dictates the Demand Curve (which plots p and
quantity demanded) will lie above the MR curve.
o When D is flat, P=MR. When D is downward sloping, then P>MR.
• Thus, at zero output, both D and MR have the same point of
Allocative efficient.
•
•
Efficient
o Though M can exert some control over Price, M is not guaranteed a
profit
• Given that MR = MC, and the P > MR, this level will only produce a
there exists only fixed costs, cost does not change over a
range of output
current price
This represents pricing levels some consumers might have been
surplus
• If some firm offers some output, even at a price level higher than PC
the scenes to win concessions buried deep within the tax code.
o No one simply gives away M POWER
• Rent seekers try and attain through surly methods this power
• That effort, in turn, is forever squandered
• What might the world attain with thousands of lobbyists and tax
• Price Discrimination
o Price Discrimination: occurs when the seller charges different prices
for the product it sells and the price differences do not reflect cost
differences
o So far, it has been assumed all products are sold for the same price
o What if the firm had the power to segment who paid what?
o Price discrimination occurs when a seller charges different prices for
• For each unit produced, the seller can charge the highest price
for a given quantity. The price declines per unit as the quantity
purchased increases
• The Buy in Bulk rationale
o Third Degree Price Discrimination:
• The seller charges different prices to different markets or to
management.
• Were they to become careless, competitors would take their place.
Should the market prove very profitable, new firms will likely
enter.
• However, given there will exist differentiation, there are times
flight.
Thus, when consumers have specific needs, they might find
differences.
• The Monopolistic Competitor's Demand Curve
• If the PC firm faced perfect elasticity, where the good sold had many
perfect substitutes
• The PC demand curve reflected such and was horizontal.
• M was the sole supplier, and elasticity was low, because there were no
perfect substitutes
• The M demand curve was downward sloping.
• MC, then, is somewhat between the two. There are substitutes, but
not perfect ones. Some elasticity, but not perfect either.
• Therefore, the Demand Curve for MC will be downward sloping.
as what M enjoys.
suffer losses.
This depends upon ATC.
•
conditions will allow new entrants seeking profit, as is the case in PC.
• This is not absolute, however, but depends greatly on the market
•
• Excess Capacity: What is it, and is it "Good" or "Bad"?
o Excess Capacity Theorem:- a monopolistic competitor in equilibrium
produces an output smaller than one that would minimize its cost of
production
• Recall, the lowest unit cost of production occurs at the bottom of
the ATC curve. In perfect competition, the firm will provide output
where P = MC, but also where MC = ATC
• Even in the LR, the firm will not be producing where ATC is lowest
o Why?
• Oligopoly
o Given the pure markets, PC and M, there are those structures which lie
somewhere in between
• MC is a dynamic market, where ease of entry will likely eliminate
• Few sellers and many buyers. The sellers are independent, yet
two points, the product need not be unique in order for it to be for
consumers to find less choice
o Examples of such a market
• Automobiles:
There will likely never be another newly formed domestic
manufacturer. The products are somewhat differentiated. The
marketing and sales methods, production, and labor relations
of one greatly influences the others
• Gasoline
•
• It can, however, be difficult to enact a Cartel, even if the benefits seem obvious at
first glance.
1. Forming a cartel may be outright illegal in some countries.
The organizational effort and cost must be borne by the members, but some
barriers.
4. Cheating.
• Once the cartel is formed, and an output level with subsequent pricing targets
output in a cartel will offer profit, but only by controlling output, So if one
member cheats in a controlled environment, they will enjoy even greater
profits.
• If all cheat, then the LR will resemble competition.
• The individual firm faces a horizontal demand curve, because the cartel sets the price.
Each firm does not control price.
• So, here, if one firm cheats, it can sell more oil at the cartel set price, and make even
greater profit.
• Thus, we see both incentive to create a cartel, and the incentive each firm has to cheat on
the agreement once the cartel has formed.
•
• If oligopoly presents a market structure with few sellers, situations may arise where
one of the few is dominant.
• That is, there may be X number of sources, but only on firm is large enough to
really impact the market. This one firm’s output represents such a significant share
of the overall market that changes will impact price.
• Further, because this one firm has such power, it will take the lead in setting price
smaller firms are price takers, accepting what the dominant has set.
• Note, however, the Dominant Firm does not operate in complete isolation from the fringe
firms. Rather, the dominant firm observes their behavior, and thereafter decides a pricing
strategy.
• How does this work?
• 1. The DF (Dominant Firm) determines how the market would operate without its
presence. It finds where the equilibrium price and quantity would reach. At this
point, however, the DF is excluded.
• 2. For the DF to enter the market therefore, it must introduce output available at a
lower price. At the current Eq, all output is sold, Only a lower price will trigger
additional Q demanded.
• 3. Given that only lower priced goods will create room for the DF, it then
determines a demand curve based upon all prices below the existing Eq price.
Because it is taken after, DF’s demand curve is often called the “Residual Demand
Curve.”
• 4. After setting a demand curve of the lower prices, the DF selects a production
level where MR = MR.
• 5. When the DR introduces this new supply into the market, the price falls to the
level it targeted. After all, consumers will only move out of an Eq with a lower
price.
• 6. The fringe firms produce less output, and target their production where P = MC.
Why, because they are price takers, and witness a flat demand curve.
•
Chapter 12
Monday, November 28, 2005
4:05 PM
Government and Product Markets (Antitrust and Regulation)
Antitrust
• If monopoly situations give rises to:
their development
o Some believe this on theoretical grounds, others may point to specific
• Example
lines for shipping. But to one large geographic area, only one
oil company and one rail line serviced customers. Through
whatever means, they have established a corner on the
market, creating a monopoly
rival products
3.Tying contracts
• Arrangements whereby the sale of one product is dependent on
Concentration Ratios
• Herfindahl Index: Measures the degree of concentration in an industry. It
is equal to the sum of the squares of the market shares of each firm in the
industry
o Herfindahl Index = (S )2 + (S )2 + … + (S )2
1 2 n
• A measure intended to gauge the level of competitiveness within an
industry
o The Justice dept. may bring antitrust actions if the index rises by a set
formula
1.Horizontal
2.Vertical
3.Conglomerate
• Horizontal Merger: a merger between firms that are selling similar
Network Monopolies
• Network Good: a good whose value increases as the expected number of
share of market
• Why?
• Obviously there are certain networks where it would
Regulation
• Recall that some monopolies form b/c the environment will be unprofitable
economies of scale
o The cost are such that if there were more than one firm, none would
additional firm would face ATC severely higher than existing firms
• The idea is to attain a position where resource allocative efficiency
losses
o This yields a high output level, but firm loses
costs. It will simply let cost rise and petition regulators to allow a
greater price
•
• Output Regulation: gov't mandates the level of output
o Here, M will enjoy some economic profit. Knowing it has no
promise to serve
• Difficulties with regulation frequently center around the unintended
consequences
o Regulated monopolies are typically slow to innovate. They may have
no incentive to control cost
o Utilities may over-invest in infrastructure (itself lacking proper cost
controls) knowing the consumer will be around for 30 years to pay for
it
• If utilities can pass on costs of resources, then they have less incentive to
adapt and change
o Consumers are typically at odds with regulated monopolies
costs change and when the regulatory agency adjusts prices for the
natural monopoly
• Ex
Theories of Regulation
• Given regulators are individuals who do not operate in a vacuum, and are
subject to many interest and pressures, there exists theories which
attempt to explain the regulator's behavior
1. Capture Theory of Regulation: no matter what the original intent
and purpose of a regulatory agency may be, over time, the agency will
become "captured" by the special interest and elements of the
targeted industry
2. Public Interest Theory: Here, the idealistic view of a regulator
holds. That is, the regulator has the incentive to look after the public,
and will perform as intended
3. Public Choice Theory of Regulation: the regulators are incentivized
to act according to their own interests. This is similar to a profit
motive, but here, the regulator seeks power, authority, and a greater
budget
Chapter 13
Tuesday, November 29, 2005
5:34 PM
Factor Markets
Factors
• Factors of production experience supply and demand similar to that of
finished products
• Why do firms purchase factors?
o To produce products to sell
• The demand for a factor is often the result of increased demand for a
finished good
o Derived Demand: Demand that is the result of some other demand
• Ex.
MRP = MR x MPP
• An important thing to notice. MR can be constant or change
MR is constant
• When P > MR, VMP will be > MRP
•
o Marginal Factor Cost- additional cost incurred when employing an
additional factor unit
• MFC = Δ TC / Δ QF
o Factor Price Taker- a firm able to buy all of a factor needed, at a
price set by the market (equilibrium). The Firm will face a horizontal
supply curve
•
So given there is MRP and MFC, a firm can now decide how many units
of a factor to utilize
• Intuitively, one might say that a factor unit would be increased until
Most situations will not involve one factor, but a variety that will be
consumed in different quantities
o Least Cost Rule: helps determine a combination of factors which will
Labor Market
• Labor Market: the labor market is a unique factor given the many
dynamics involved.
• The demand curve for labor will reflect the price of the good
produced.
• Should the price fall, the demand curve will shift left.
• Should the price increase, the demand curve will shift right,
a factor, higher labor costs will shift the production curve and
causes price increases in the market. The MRP will shift
accordingly.
• The double effect of:
1. A change in wage
2. A change in product price
• Makes a simple horizontal summation incorrect
Elasticity of Demand for Labor
• Elasticity of Demand for Labor: The percentage change in the
labor is 1.5
• Recall when E>1, this is known as elastic, when E<1 this is
inelastic.
• EL = (% Change in quantity demanded of Labor) / (%
higher the wage rate, the greater the amount of labor units (hours, days,
etc.) individuals are willing to contribute.
•
• Individual Labor Supply:
• A single person will have two opposing forces acting upon them as a
• Substitution Effect:
• Given a higher wage for working, an individual may elect to
allocate more time working and less time for leisure. Because the
monetary reward for work has increased, the relative leisure
derives is now worth less.
• Income Effect:
• Given there is a higher wage, some may opt to work less, and are
90's)
2.Other aspects of a labor sector
• Certain labor markets may enjoy appeal or disfavor.
• No one seeks work that is socially frowned upon, unless the
run wage differentials across markets. Over time ,workers would flow in
and out of markets until a balance is achieved.
1.Demand for all labor skills is the same
2.There exist no special, non-income considerations
3.The labor force is homogeneous, and training costs are
negligible
4.All labor is mobile at zero cost
• Obviously, these conditions are almost completely unrealistic in practice.
However, the failure to maintain said conditions explain why wage rates
may differ across sectors and markets
• Demand and Supply for Labor will differ across markets
for labor
2. Each individual works differently, impacting their own MPP.
o As such, demand for labor may differ person to person
• Supply of Labor
2. Supply reflects those who are willing and able to perform the given task
3. Training costs may deter some who have natural ability from attaining
necessary knowledge and skills
4. Geography can create wage differentials.
o Less desirable or hard to reach locales may require higher wage levels
1. Given a firm is a factor price taker, then MFC is constant. Thus MFC =
P, or MFC = W (if labor)
2. The firm will attain a factor in a quantity where MFC = MRP (where the
factor cost equals its Marginal Revenue of the product)
3. Given these equations, then we can set the following
• If W = MFC, and MFC = MRP then MRP = W
never changes
5. Finally, if MRP=VMP, and MRP=W, then VMP=W
• Why does this really mean anything?
o In competitive environments, wages are equal to the contribution
Chapter 15
Wednesday, November 30, 2005
10:19 AM
Income Distribution
• When studying income distribution, the overall personal income as it
spread about the population
• As we all know, some earn more income than others
o That is, they receive a greater distribution
• Income may be studied before or after taxes, and with or without transfer
payments
o Transfer Payments: payments to individuals without expectation of
taxes
o Not everyone will receive transfer payments, and not everyone will pay
taxes
• The effects of age on income.
o As every one knows, people have a tendency to earn more as their
career develops. This trend will continue, if at different rates.
Eventually, people retire, and they will begin receiving social security
and possibly earn investment income, hold part-time positions, etc.
Lorenz Curve
o A graph of income distribution expressing the relationship between the
B/c comparing Lorenz curves which are close but not equal
Perfect equality = 0
Perfect Inequality = 1
• The larger the GINI coefficient , the higher the degree of income
inequality and the smaller the Gini coefficient, the lower the
degree of income inequality
• The Gini Coefficient can't tell us what is happening in different
quintiles
o One Caveat: the Lorenz curve can show what is happening in the
various quintiles. The Gini only refers to the entire distribution, so no
determination can be made about specific quintiles using the Gini
alone
Why income inequality?
1.Innate Abilities and Attributes
• Individuals are not all born with the same innate abilities and
5.Luck
• When individuals can't explain what is happing to them
6.Wage Discrimination
• Exists when individuals of equal ability and productivity, as
measured by their MRP, are paid different wage rates by the same
employer
Income Differences
• When studying the differences which may exist with income, one can
labor, this helps better explain why two graduates of the same college,
with the same major might experience entirely different lifetime
earnings
• Some degree of income inequality occurs b/c individuals are innately
revenue products
o Here, an individual's income is based entirely upon their contribution.
utility.
o Taking from wealthy does not reduce utility by the same magnitude as
•
Poverty:
o Absolute definition vs. Relative definition
• Absolute: any family earning less than "X" per year is poor
• Relative: Those in the bottom 10% are poor
o The U.S. uses absolute terms, but inflation adjusted
o Poverty Income Threshold Line:
• Aka the Poverty Line - the income level below which people are
Chapter 17
Monday, December 05, 2005
10:05 AM
undesirable outcomes
o Market Failure: a situation in which the market does not provide the
• Externalities
• Public Goods
• Asymmetric Information
Externalities
• The side effects which may arise through the production and
Costs (MEC)
• Supposing President Bush loved to travel in the US. He sent at
least 3 days of the week flying Air Force Once through major
national airports. What would be the MSC?
They would shut down airports
o Likewise, overall impact is incomplete without benefits.
• MSB = Marginal Private Benefits (MPB) + Marginal External
Benefits (MEB)
• Comparing the MSC and MSB can give offer an overall outlook on
MSB
Three Categories of Activities
All activities may be categorized whether there are:
• No externalities
Should the MSC > MPC, then a negative externality exists for which
supply has not properly accounted. The supply curve will exist father
outward, and overproduction will result
• The Socially Optimal Output would capture MSC, and the supply curve
• Should the MSB > MPB then a positive externality exits that demand is
not fully exploiting. The demand curve lies further inward than it should,
and the resulting output level is less than what the Socially Optimal level
might suggest
• If MSB were to be captured, demand would shift rightward, raising
• When analyzing the difference between the market output level and the
Socially Optimal point, a comparison must be drawn between the benefits
and costs of moving from Q2 (socially optimal) to Q1 (market output)
• This difference will form a triangle, representing the net social cost of
• Key Point:
• The Socially Optimal Point is only preferred if the benefits of Q2
Internalizing Externalities
• It is possible to capture the externality into cost-benefit calculations
o Internalizing Externalities is a process by which those who create the
"I'm sorry, I didn't know we were keeping you awake," versus, "I'm sorry,
we're really enjoying ourselves and have no plans of stopping"
•