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Chapter 1 - Exploring Economics

Tuesday, September 03, 2013

12:03 AM

Bush and Obama turned to ideas from the 1930s to provide policy guidance for 2008-9 financial
crisis/recession
British economist John Maynard Keynes created the field of macroeco in 1936
Analysis of the broad economy
Suggested the solution to the great depression which was increase gov spending and lower taxes
Real Gross Domestic Product is roughly $15 trillion for the US, largest in world
EU is second
Growth is so large that if you took 1% from growth rate each year from 80 years, we it would cut
econ in half
Real GDP vs Real GDP per capita, second is a better measure
Highly productive countries have the following characteristics:
Most are democracies
Most have high environmental standards
Most have cool climates
Most enjoy freedom of expression
Women's rights and freedoms are better protected
Most enjoy better health
Population is taller
Government is less corrupt
Income inequality is lower
Inflation is lower
Population is more literate
Most have fewer trade restrictions
Population growth is lower
Property rights are more secure
Jared Diamond suggested that weather and flora/fauna contributed to the high eco growth
It could take a whole century for a country with the right programs/policies to catch up to us
Currently many are concerned about outsourcing, globalization, and international trade
May help an underdeveloped country grow
Improvements in computing, transportation, and communications are all accelerating the development
process. Will help a developing country accelerate their eco growth.

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What is Economics About?


Wednesday, September 04, 2013

5:25 PM

Economics is a way of thinking about how people make rational decisions


Economics may look at the factors to raise the cost of a crime to criminals, like linger prison sentences

Microeconomics vs Macroeconomics
Microec deals with decision making by individuals, business firms, industries and governments
Ex: which OJ, which job, where for vacation
Macroec focuses on broader issues faced as a nation
Care for prices of all goods and services and inflation
Uses some microeco tools but has main focus on broad aggregate variables of the eco
Deals with business cycles, recession, depression, unemployment, and job creation rates
Economics is a social science
Overlap between the two, use supply and demand analysis to understand both indiv markets and
general econ

Economic Theories and Reality


Model Building
Boil down facts to their basic relevant elements and use assumptions to create a simple model to
analyze the issue

Ceteris Paribus: All Else Held Constant


Assumption called Ceteris Paribus, "Holding all other things equal"

Efficiency vs Equity
Efficiency deals with how well resources are used and allocated
Production efficiency occurs when goods are produced at the lowest possible cost
Allocative efficiency occurs when individuals who desire a product the most get those goods and
services (measured by their willingness to pay)
Equity is the fairness of various issues and policies
Clash between efficiency and equity, economists leave equity up to politicians and philosophers

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Key Ideas of Economics


Wednesday, September 04, 2013

5:45 PM

Choice and Scarcity Force Tradeoffs


We all have limited resources, some more than others, but everyone is limited in time
Wants greater than resources, face scarcity
Must make tradeoffs in nearly everything
Economics often defined as the study of the allocation of scarce resources to competing wants

Opportunity Costs Dominate Our Lives


Discipline that weights the benefits against the costs
Opportunity Costs: What you give up to do or purchase something

Rational Behavior Requires Thinking at the Margin


Eat more at a buffet
People are rationally responding to the price of additional food

People Follow Incentives


Tax policy rests on the idea that people follow their incentives
Save for retirement, tax credits for investment, education savings account
Use commuter trains during non-rush-hour times by having an off-peak discount
Early bird specials at 5 than 8 at a restaurant

Markets are Efficient


Private markets and incentives provided are best mechanisms today for providing products and services
Markets bring buyers and sellers together
Prices and Profits discipline/drives markets
When prices and profits get too high in any market, new firms jump in with lower prices

Government Must Deal With Market Failure


Government regulation is often used to protect consumers
For example, when there is a monopoly
Sometimes have to intervene when there is pollution

Information is Important
Efficient b/c people make rational choices
Need information to make the choice
Laws are used to prevent people from getting unfair advantage over other stockholders
Ex: Martha Stewart convicted of lying about selling stock based on inside info

Specialization and Trade Improve Our Lives


Trading with other countries leads to better products for consumers at lower prices
David Ricardo laid out the rationale for international trade almost two centuries ago

Productivity Determines Our Standard of Living


Hire the more productive worker who is willing to work for 50% of the salary over the other
Goes in hand with movie stars because they are worth it to the movie producer
Same with nations: Highest average per capita income are also the most productive
Labor forces are highly skilled, firms are willing to place huge amounts of capital with these
workforces because this results in immense productivity
Workers will earn high wages
High productivity growth>Solid economic growth, high wages, and income>Higher standards of
living

Government Can Smooth the Fluctuations in the Overall Economy


Originally thought that overall economy was a self-correcting mechanism if left to itself
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Originally thought that overall economy was a self-correcting mechanism if left to itself
Great depression proved wrong, solution was government intervention

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Adam Smith (1723-1790)


Wednesday, September 04, 2013

6:58 PM

Graduated from the University of Glasgow


Named Professor of Moral Philosophy at the UoG
Met French economists, became interested in political economy
Wrote An Inquiry Into the Nature and Causes of the Wealth of Nations
His genius was in taking the disparate forms of economic analysis his contemporaties were then
developing and putting them together in systematic and comprehensive fashion, thereby making sense
of the national economy as a whole
Free market for individuals enhacaed the welfare of all
Led by an invisible hand? Which would have its produce may be of the greatest value
Called the "father of political economy"

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Appendix: Working With Graphs and Formulas


Wednesday, September 04, 2013

7:26 PM

Rules to reading a graph:


Read the title
Look at the label for the horizontal axis, check units and scale
Look at the label for the vertical axis
Look at the graph itself to see if it makes sense logically
Ceteris Paribus: All Else Equal
All other influences are held constant
Linear equations represented by Y=a +bX
Correlation Is Not Causation
The two variables seem related or appear related on a scatter plot does not mean one causes another

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Chapter 2 - Production, Economic Growth, and Trade


Wednesday, September 04, 2013

7:19 PM

Driver of economic growth:


Consumption, technological change (fiber optics), and trade
Consumption is a way for people to better themselves or enrich their lives
Technological change allows long distance calls and for cheaper
Trade expands opportunities for consumptions and production by its people

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Basic Economic Questions and Production


Wednesday, September 04, 2013

8:29 PM

Basic Economic Questions


What goods and services are to be produced?
Depends on the goods and services a society wants (communist state, gov decides)
How are these goods and services to be produced?
How labor, capital, and land should be combined to produce the desired products
Who will receive these goods and services?
Distribution refers to the way an economy allocates to consumers the goods and services it
produces

Economic Systems
To answer the three questions, it depends on who owns the three factors of production (land, labor,
capital, and entrepreneurship)
Capitalist/Market, private individuals and firms own most of the resources
Producers and consumers are free to choose
Government just protects property rights, enforces contracts between private parties, providing
national public goods like national defense, and establishing and ensuring the appropriate operating
environment
US is not pure laissez-faire or "leave it alone", more of a mixed econ
Planned economies are systems where most of the productive resources are owned by the state and
eco decisions are made by central governments

Resources, Production, and Efficiency


Production involves turning resources into products and services that people want

Land
Land and all other natural resources that are used in production
Payment to land is rent

Labor
A factor of production includes both the mental and physical talents of people
Improve labor: training, eductation, apprenticeship programs
Labor paid in wages

Capital
All manufactured products that are used to produce other goods and services
Drill presses, blast furnaces, computers, trucks and automobiles
Capital earns interest

Entrepreneurial Ability
Entrepreneurs combine land, labor, and capital to produce goods and services, and they assume the
risks associated with running a business
Also manage
Earn profits

Production and Efficiency


Production turns resources into products and services
Production efficiency occurs when the mix of goods society decides to produce is produced at the
lowest possible resource or opportunity cost or produce the most amount of output with the given
amount
Use the best technology available and combine the other resources to produce products at the lowest
cost to society
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cost to society
Allocative efficiency occurs when the mix of goods and services produced is the most desired by society
Every economy faces constraints or limitations (land, labor, capital, and entrepreneurship)

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Production Possibilities and Economic Growth


Wednesday, September 04, 2013

8:49 PM

Production Possibilities
Production possibilities frontier shows different levels of production
What is attainable by the economy is on the line or left

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Beyond is unattainable

Full Employment
On the line is maximum output or full employment

Opportunity Cost
Reallocating resources to change production pattern at a price, called opportunity cost

Increasing Opportunity Costs


Most cases, land, labor, and capital cannot easily be shifted from producing one good or service to
another

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More realistic PPF is bowed out from the origin since opportunity costs rise as more factors are used to
produce increasing quantities of one product (can't just convert a truck into a plow)

Economic Growth
Shift the PPF to the right is growth
Can make assumptions, expanding resources or improved technologies
Ex: lightbulb

Expanding Resources
Capital and labor are principal resources that can be changed through government action
Land and entrepreneurial talent are important factors of production but can't be changed via gov
policies
Increasing Labor and Human Capital
Increase in population shifts PPF outward, could be births, immigration, or willingness to enter the
workforce
Labor factor can also be increased by improving worker skills (investment in human capital)
Capital Accumulation
Additional capital makes each unit of labor more productive and results in higher possible production
throughout the econ

Technological Change
Can shift the potential output in one direction for specific industries
Such as computer microchips

Estimating the Sources of Economic Growth


Greater investment by business (physical capital), higher levels of education (human capital), higher
levels of R&D, lower inflation rates, reduced tax burdens, and greater levels of international trade all
result in higher standards of living (per capita GDP).
1% increase in business investment as a percent of GDP leads to an increase in per capita GDP of 1.3%
An additional 1 year increase in average edu levels increases per capita GDP by 4-7%
A 0.1 percentage point increase in R&D as a percent of GDP increases per capita GDP by 1.2%
Reducing both the level and variability of inflation by percentage point leads to an increase in per capita
GDP of 2.3%
A 1 percentage point decrease in the tax burden as a percent of GDP leads to a 0.3% increase in per
capita GDP
An increase in trade exposure (a combined measure of imports and exports as a percent of GDP) of 10
percentage points increases per capita GDP by 4%

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Chapter 3 - Supply and Demand


Thursday, September 05, 2013

3:46 PM

Foundation of economics: Supply and demand analysis


Prices are determined by "what the market will bear."
Economic concepts:
Markets
Law of demand
Demand curves
Determinants of demand
Law of supply
Supply curves
Determinants of supply
Equilibrium
Surpluses
Shortages

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Markets
Thursday, September 05, 2013

4:04 PM

A market is an institution that enables buyers and sellers to interact and transact with one another

The Price System


Exchange money for goods and services, accepting and rejecting, communicate individual desires
Communication is accomplished mostly through the price
Prices give buyers an easy mean of comparing goods that can substitute
Because of this, economists call our market econ the price system

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Demand
Thursday, September 05, 2013

4:10 PM

A purchase is a "vote"
Easy to determine a want than a need
Wants or desires that are expressed through purchases are known as demands

The Relationship between Quantity Demanded and Price


Demand refers to the goods and services people are willing and able to buy during a certain period of
time at various prices, holding all other relevant factors constant
Price +, Demand -

The Law of Demand


Holding all other relevant factors constant, as price increases, quantity demanded falls and vice-versa
Time is an important in the demand for many products, not just money

The Demand Curve

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Line is the demand curve

Market Demand Curves


Much more important to economists
Able to be used to predict changes in product price and quantity
Sum of the individual demands
Process is known as horizontal summation

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Determinants of Demand
What affects demand
They are:
1: Tastes and preferences
2: income
3: prices of related goods
4: the number of buyers
5: expectations regarding future prices, income, and product availability

Tastes and Preferences


Demand curve shifted right when crocs became a fad
When fad died, it actually went left of the original curve
When tastes/preferences change, the entire curve shifts

Income
As income rises, demand for most goods will increase
When income rises and demand for these goods increase, these are normal goods
Opposite is inferior good, a good for which an increase in income results in declining demand
(public transportation when you have a car ramen when you graduate from college)

Prices of Related Goods


Movies, concerts, plays, and sporting events are good examples of substitute goods
Substitute goods: Goods consumers will substitute for one another depending on their relative
prices. When the price of one good rises, and the demand for another good increases, they are
substitute goods, and vice versa.
Complementary goods: Goods that are typically consumed together. If the price of the
complementary good rises, the demand for the other good declines and vice versa
So if movies cost more and you see fewer movies, your consumption of popcorn will decline
(demand of popcorn decreases, shifts to left)

The Number of Buyers


More people live longer, demands for medical services increases (shift right)
More people want smartphones, fewer will want plain-vanilla cell phones

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Expectations about future prices, incomes, and product availability


If they expect shortages or increases in the near future, they tend to rush out to buy these products
immediately (demand curve shifts to the right)
Increase in income or pay later can also do the same

Changes in Demand Versus Changes in Quantity Demanded


When the price of a product rises, consumers buy less of that product
Movement along the existing demand curve
Changes in demand occur when one or more of the determinants of demand changes, shown by a shift
in the entire curve
Change in quantity demanded occurs when the price of the product changes shown as a movement
along an existing demand curve

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Supply
Monday, September 09, 2013

10:57 PM

The Relationship between Quantity Supplied and Price


Supply is the max amt of product that producers are willing and able to offer for sale at various prices,
all other relevant factors being held constant
Producing more units makes it more expensive for producers to produce each individual unit (overtime,
additional workers)

The Law of Supply


Holding all other relevant factors constant, as price increases, quantity supplied will rise, and as price
declines quantity supplied will fall
Price + , Supply +

The Supply Curve

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Shows the maximum quantity of computer games the producers will offer for sale over some defined
period of time.

Market Supply Curves


Compute Market Supply: horizontally summing the supplies of individual producers
Same as market demand curve

Determinants of Supply
1: production technology
2: costs of resources
3: prices of other commodities
4: expectations
5: the number of sellers (producers) in the market
6: taxes and subsidies

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Production Technology
If a factory is outfitted with newer, more advanced equipment then the firm can supply more of its
product at the same price or even at a lower price
A shift from S0 to S1

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Advances in microprocessing and miniaturization brought a wide array of products to the market

Costs of Resources
Resource costs affect production costs and supply
Raw materials/labor +, production costs + and supply -

Prices of Other Commodities


A farmer has limited land
If the price in celery rises, then farmers will start growing more celery and that will reduce supply
in other items
Radishes shift leftward while celery shifts right

Expectations
Expect prices of goods to increase then increase production (supply to the right)
However, price cuts can also temporarily increase the supply of goods on the market as producers try to
sell off their inventories

Number of Sellers
Everything else held constant, if the number of sellers in a particular market increases, market supply of
their product increases

Taxes and Subsidies


Increases in taxes (property, excise, or other fees) shift supply to the left and reduce it. Subsidies are the
opposite of taxes, shift to the right

Changes in Supply Versus Changes in Quantity Supplied


Change in supply results from a change in one or more of the determinants of supply
Change in quantity supplied results from price of the product changes, moving along the existing curve
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Change in quantity supplied results from price of the product changes, moving along the existing curve

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Market Equilibrium
Tuesday, September 10, 2013

12:25 AM

Both are needed to determine prices and quantities of goods bought and sold
Equilibrium market forces are in balance when the quantities demanded by consumers just equal the
quantities supplied by producers
Amount of product willing and able to be purchased is matched by producers willing and able to
sell
Equilibrium price market equilibrium price is the price that results when the quantity demanded is just
equal to quantity supplied
Equilibrium quantity market equilibrium quantity is the output that results when quantity demanded is
just equal to the quantity supplied

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b-a=surplus
d-c=shortage
When there is a surplus (occurs when the price is above the market equilibrium and quantity supplied
exceeds quantity demanded), or excess supply, most firms cut production while some reduce prices to
increase sales
When there is a shortage (occurs when the price is below the market equilibrium, and quantity
demanded exceeds quantity supplied), buyers will begin to bidding up, and firms will raid prices and
increase production until equilibrium is restored

Moving to a New Equilibrium: Changes in Supply and Demand


Stay in balance until external factor changes
Equilibrium shifts when supply/demand curve shift

Predicting the New Equilibrium When One Curve Shifts


Easy to predict when only supply or only demand changes

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Changes in Supply

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Supply grows from S0 to S1


Supply declines when S0 to S2
Changes in Demand

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Predicting the New Equilibrium When Both Curves Shift

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Alfred Marshall (1842-1924)


Tuesday, September 10, 2013

12:36 AM

British economist, father of modern theory of supply and demand


Noted that the two go together like blades of a scissor that cross at an equilibrium
Changes in quantity demanded were affected by changes in price, all other constant
As a boy, suffered from headaches cured by chess, but swore off of it and got support form his uncle
Went to St. John's College, Cambridge to study math/physics, but later pursued political economy when
he saw the poverty in European cities
1890, published Principles of Economics at age 48
Marshall was a teacher of Keynes

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Price Ceilings and Price Floors


Tuesday, September 10, 2013

1:20 AM

Businesses provide consumers with the quantity of goods they want to purchase at the established
prices; no shortages or surpluses
Sometimes the government intervenes for political/social reasons and set limits
Keep things below or above market equilibrium

Price Ceilings
Price ceiling: A government-set maximum price that can be charged for a product or service.
A legal maximum

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Affordable housing in this situation


Fair to whom?

Price Floors
Price floor: A government-mandated minimum price that can be charged for a product or service
Product price cannot legally fall below this level

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Agricultural price supports have been used to try to smooth out the income of farmers due to wild
fluctuations in annual variations in crop prices

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Chapter 4 - Market Efficiency, Market Failure, and Government


Tuesday, September 10, 2013

1:40 AM

The typical market does not meet all of the criteria for a truly competitive market
Will have to temper analysis to fit specific conditions of the markets studied
Efficient markets are rationing devices, ensuring that those who value a product the most are the ones
who get it

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Markets and Efficiency


Tuesday, September 10, 2013

3:05 PM

Efficient Market Requirements


John McMillan suggests 5 institutional requirements for workable markets:
1: information is widely available ("Information flows smoothly")
2: property rights are protected
3: private contracts are enforced such that "people can be tursted to live up to their promises"
4: spillovers from other actors are limited, or "side effects of third parties are curtailed"
5: competition prevails

Accurate Information is Widely Available


Efficient markets=low transaction costs=accurate and readily available info
Smoother negotiation
Info is needed to make good choices

Property Rights Are Protected


The clear delineation of ownership of property backed by government enforcement
Powerful incentive for the optimal use of resources, not to waste
If cannot be identified, cannot make people pay debts, easily turn resources into money, etc

Contract Obligations Are Enforced


Well-functioning legal system makes doing business easier, and essential to large-scale business activity
w/o it, can't determine credit-worthy or trustworthy people

There Are No External Costs or Benefits


External costs could be like when you drive on a crowded highway and add to congestion and pollution
External benefits are like when you attend a private college to become a better citizen, etc
Called externalities, markets operate most efficiently when they are minimalized

Competitive Markets Prevail


Competitive markets must be open to entry and exit
No seller can raise its price above its competitiors

The Discipline of Markets


Markets impose discipline on consumers and producers
Sellers would like to cut costs, charge higher prices, and get greater profits
Consumers would like to drive better cars, luxary goods, etc, but not possible
Market rations us out of such goods except on occasions
Rationing: Given limited resources, we decide which products are most important
High prices=valued highly=high profits=attracts new firms=increases supply=reduces prices

Consumer and Producer Surplus: A Tool for Measuring Economic


Efficiency
Consumer Surplus: The difference between market price and what consumers would be willing to pay. It
is equal to the area above the market price and below the demand curve
Producer surplus: The difference between market price and the price at which firms are willing to supply
the product. It is equal to the area below the market price and above the supply curve

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Chapter 5 - Elasticity
Tuesday, September 10, 2013

3:36 PM

Elasticity is the responsiveness of one variable to changes in another


Contains information about demand for specific products
"When prices rise, quantity demanded falls", but by how much?

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Elasticity of Demand
Tuesday, September 10, 2013

3:49 PM

Price of elasticity of demand (


Is a measure of how responsive quantity demanded is to a change in price, equal to the percentage
change in quantity demanded divided by the percentage change in price
Example: Prices of strawberries +5% and sales fall 10%

Often not given percentage changes so need to find percentage change

Example: Old price of gasoline was $2/gal and new price is $3/gal

Price Elasticity of Demand as an Absolute Value


Because the price and quantity demanded are inverse to each other, it always results in a negative value
for price elasticity
Economists just use the absolute value of the computed value

Measuring Elasticity with Percentages


Measuring elasticity in percentage terms rather than specific units enables economists to compare the
characteristics of various unrelated products
Dollar increase in gasoline is different from a BMW
Gives us a relative measure to compare products with widely different prices and output measures

Elastic and Inelastic Demand


People are more responsive to changes in the prices of some products than others
Labeled as elastic, inelastic, unitary elastic

Elastic
The absolute value of the price elasticity of demand is greater than 1. Elastic demands are very
responsive to changes in price. The percentage change in quantity demanded is greater than the
percentage change in price.
Perfectly elastic:

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Many products with close substitutes face highly elastic demand curves
For example, raise the price of Charmin and sales quickly fall as people switch to Northern or Scott
(elasticity could range from 2.0 to 4.5)

Inelastic
Absolute value of the price elasticity of demand is less than 1. Inelastic demands are not very responsive
to changes in price. The percentage change in quantity demanded is less than the percentage change in
price.
Products that see little change in sales even when prices change dramatically
Medication for life-threatening illnesses, gasoline, tobacco, spices
Note: Demand for gasoline is inelastic, but elasticity for specific brands of gasoline is elastic

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Unitary Elasticity
Absolute value of the price elasticity of demand is equal to 1. The percentage change in quantity
demanded is just equal to the percentage change in price.
Meaning that the percentage change in quantity demanded is precisely equal to the percentage change
in price
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in price

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Determinants of Elasticity
Four basic determinants of a product's elasticity of demand:
1: Availability of substitute products
2: The percentage of income or household budget spent on the product
3: The time period being examined
4: The difference between luxuries and necessities

Substitutability
The more close substitutes a product has, the easier it is for consumers to switch to a competing
product and the more elastic the demand
Beef and chicken, Coke, Pepsi and RC Cola
Few substitutes like insulin or tobacco, elasticity lower

Proportion of Income Spent on a Product


The proportion/percentage of household income spent on a product.
The smaller percent spent on a product, the lower the elasticity of demand
Even if salt price increased by 25%, it would not impact your consumption much

Time Period
When consumers have to adjust their consumption patterns, the elasticity of demand becomes more
elastic. When little time, elasticity is more inelastic.
When gasoline prices rise suddenly, most consumers cannot immediately change their
transportation patterns so gasoline sales do not drop significantly
If they remain high, then consumer behavior may change

Luxuries Versus Necessities


Luxuries tend to have demands that are more elastic than do necessities

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Computing Price Elasticities


Elasticity is computed between two points will result in the calculated value differing depending on
whether the price is increasing or decreasing

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When price increases from $1.00 to $2.00

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Using Midpoints to Compute Elasticity


Use to avoid getting different results due to different directions.

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Elasticity and Total Revenue

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Elasticity measures the responsiveness of quantity sold to changes in price, which has an impact on the
total revenues of the firm
Total revenue(TR)= P X Q

Inelastic Demand
Consumers continue to buy a product even when its price goes up

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Total revenue rises, gained>lost


Demand for the firm's product is inelastic
Might suggest that firms always want products to be elastic, but if supply increases then the sales only
increase moderately

Elastic Demand
Sales change dramatically due to small price changes

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Advantage is that if say a restaurant has a buy one get one free special and other discounts, sales have
the potential to expand rapidly and increase revenue

Unitary Elasticity
Increase in price results in the same percentage reduction in quantity demanded
Total revenue is unaffected

Elasticity and Total Revenue Along a Straight-Line Demand Curve


Elasticity on this curve varies
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Elasticity on this curve varies


Some parts elastic, unitary elastic, inelastic

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Upper portion is elastic, a midpoint is unitary, and a lower part is inelastic


Elasticity is the ratio of the percentage change in one variable to another, so when the price is low, 1
unit change in price is great while change in quantity demanded is small. When the price is high, a 1 unit
change in price is a small percentage change but the percentage change in quantity is large

Other Elasticities of Demand


Income Elasticity of Demand
Income Elasticity of demand Ey measures how responsive quantity demanded is to changes in consumer
income

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Normal good: income elasticity is positive but less than one. As income rises, QD increases as well, but
not as fast as the rise in income
Income doubles, buy more sporting goods but not double
Luxury goods: income elasticity greater than 1. As income rises, QD grows faster than income
Mercedes, caviar, fine wine, and visits to EU spas are examples
Inferior goods: income elasticity is negative. As income rises, the QD for these fall
Include potatoes, beans, compact cars, and public transportation
Some firms produce all three types of goods to switch when economic conditions favor

Cross Elasticity of Demand


Eab or Cross elasticity of demand measures how responsive the quantity demanded of one good
(product a) is to changes in the price of another (product b)

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Products A and B are substitutes if their cross elasticity of demand is positive (Eab>0)
Beef price increase, substitute with chicken
Products A and B are complements if their cross elasticity of demand is negative (Eab<0)
Goods and services which are consumed together such as gasoline and large SUVs
Price of gas rises, QD for SUVs declines
If two goods are not related, then cross elasticity of demand is 0 or near 0

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Elasticity of Supply
Monday, September 16, 2013

7:52 PM

Price of elasticity of supply (Es) measures the responsiveness of quantity supplied to changes in the price
of the product.

Screen clipping taken: 9/16/2013 7:54 PM

An elastic supply curve has elasticity greater than 1, and inelastic, less than 1
Time is the most important determinant of the elasticity of supply

Screen clipping taken: 9/16/2013 7:58 PM

Elastic supply: Percentage change in Qs is greater than the percentage change in price
Inelastic supply: Percentage change in Qs is less than the percentage change in price
Unitary elastic supply: The percentage change in Qs is equal to the percentage change in price

Screen clipping taken: 9/16/2013 8:03 PM

S1 is an inelastic supply, when price changes and the percentage change in quantity supplied is smaller
than the percentage change in price
S2 is unitary elastic supply curve, % change output = % change price
S3 is elastic, % change output > % change price

The Market Period


Time period so short that the output and the number of firms are fixed.
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Time period so short that the output and the number of firms are fixed.
Firms have not time to change their production levels in response to changes in product price.
Agricultural products at harvest time face market periods.
Products that become instant hits face market periods (lag between when the firm has a hit and when
the inventory can be replaced)

The Short Run


Time period when plant capacity and the number of firms in the industry cannot change. Firms can
employ more people, use overtime with existing employees, or hire part-time employees to produce
more, but this is done in an existing plant

The Long Run


Time period long enough for firms to alter their plant capacities and for the number of firms in the
industry to change. Existing firms can expand or build new plants, or firms can enter or exit the industry

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Chapter 6 - Consumer Choice and Demand


Monday, September 16, 2013

10:42 PM

Demand analysis rests on an important assumption: People are rational decision makers
We have to choose. Finite quantity of resources at our command.
Utility theory or utilitarianism: Theory holds that rational consumers will allocate their limited incomes
so as to maximize their happiness or satisfaction.
Higher incomes should lead to more choices and greater happiness in theory

Coremicroeconomics Page 40

Marginal Utility Analysis


Monday, September 16, 2013

10:48 PM

Benthan and Jevons developed it to solve the riddles of consumer behavior


It is a theoretical framework underlying consumer decision making. This approach assumes that
satisfaction can be measured and that consumers maximize satisfaction when the marginal utilities per
dollar are equal for all products and services

The Budget Line


Example of a college student that expects to improve life intellectually and financially
Lifetime earnings to be triple of a high school grad
Only have 50 bucks a week at present, choose pizza or wall climbing
Can plot it, similar to PPF

Screen clipping taken: 9/16/2013 10:53 PM

Preferences and Utility


Utility is a hypothetical measure of consumer satisfaction
Quantify utility from consuming pizza or wall climbing

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Total and Marginal Utility


Total utility: the total satisfaction that a person receives from consuming a given amount of goods and
services
Marginal utility: the satisfaction received from consuming an additional unit of a given product or
service
See in the table above that total increases by the marginal utility, which declines with each additional
unit

The Law of Diminishing Marginal Utility


As we consume more of a given product, the added satisfaction we get from consuming an additional
unit declines

Maximizing Utility
When consumption of additional units of two products provide equal satisfaction, they are indifferent to
which one they choose
You should allocate your budget so that marginal utilities per dollar are equal for the last units of the
products consumed
Utility maximizing rule: MU=marginal utility and P=price

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Where the marginal utility per dollar is equal for all products

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Using Marginal Utility Analysis


Tuesday, October 01, 2013

12:36 AM

Deriving Demand Curves


MU/P also includes changes in price
Consumer choices respond to changes in product prices
Consumer surplus: The difference between what consumers are willing to pay and what they actually
pay for a product in the market
So if a car was sold for 30k, but they were willing to buy it for 60k, their marginal benefit would be 30k.
The consumer got 30k more in surplus.

Consumer Surplus

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The Consumer Surplus can be seen as a nice "bonus"


It is the area under the triangle essentially

Marginal Utility Analysis: A Critique


Marginal Utility Theory assumes that consumers are able to measure the utility they derive from various
sorts of consumption
Not possible in real life

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Health Reading
Tuesday, October 01, 2013

2:16 AM

What is healthcare reform?


One side believes that reform would mean gov. takeover
Other side believes that gov. should be more involved and surrent reforms are insufficient
Countries must decide how to use their limited resources for the benefit of the most people, called an
optimization problem
Different health care systems due to policy choices under resource constraints
Different from gov-run or market-based
Issue of quality vs quantity

Demand for Health Care


Cost of health care has increased significantly
$2.5 trillion on these services
Two major gov (public) programs are funded by taxes, Medicare (65+) and Medicaid (low incomes or
assets)
Nearly 35% of total healthcare expenditures
Growth in expenditures is caused by things like genetic makeup, living environment, dietary habits,
lifestyle choices, and luck
Also includes population demographics like baby boomers entering retirement and new
cures/treatments extending lives

Types of Health Care Services


Three types of services needed:
Preventative Care: Health care services that are undertaken to prevent illnesses from occurring and to
diagnose diseases before they become severe. Include immunizations, screenings, examinations,
physicals, and treatment of common illnesses like flu or sinus infections
Specialty care/Acute care: Health care services that treat diseases and illnesses once they have been
diagnosed. Includes treatment for injuries as well.
Elective care: Health care services that are not critical for one's health, but are undertaken to improve
one's appearance, self-esteem, or to achieve a specific health goal (laser eye, cosmetic, etc)

Who Determines the Willingness to Pay for Health Care?


Unique aspect affecting demand, third-party payers
They are either third-party insurance companies or the government
Increase consumption of a good as long as marginal private benefit exceeds marginal private cost
Third party is paying most of the health care costs so private costs are reduced, so he will consume
more health care services
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more health care services


Health care decisions are shared by patients, doctors, managed care companies, government, and thirdparty insurance companies
Treatments ultimately decided by patient
Personal preferences, income and wealth factors because of deductible and co-payments
Health care is a normal good, higher income shifts demand to the right
Doctors also affect demand by recommendations of treatment
Patients and doctors limited to what will be paid by health care plan

Population Growth and Medical Tourism Increase the Number of Buyers


Population growth, all else equal, demand grows
New/advanced treatments generate their own demand as well
Some foreign patients have a service export, get treatment in US, "medical tourism"
Can happen for US citizens too, may go get elective care in another country because it's cheaper there,
foreign countries recognize this "med tourism"

Socioeconomic Factors Affecting Health Care Demand


Can also include income, religion, obesity, risky activities, and crime rates

Supply of Health Care


Supply curve represents the willingness of businesses to provide goods and services, which is influenced
by their cost
Change in a factor increases supply, quantity supplied at each price increases, leading to a lower market
price and a higher market quantity for that good or service
Several key providers:
Physicians and nurses, pharmaceutical and medical device industries, insurance and government
programs
Managed care organization: Health care organizations that provide a variety of health care plans to
companies and other groups. Premium costs are controlled by regulating the compensation given to
doctors and services covered under each plan
Almost all employer-provided health care is this

Providers of Health Care Coverage


Provided by employers and by gov usually (for 65+ or low income/assets)
Others may get it through other public or private options, but usually at a premium

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Health Care Labor Market


American Medical Association maintains significant control over the health care labor market by
restricting the supply of physicians

Health Care for Profit


Difficulty in determining if it should be for-profit and maximizing cost efficiencies and lobbying for fewer
regulations
Danger of "unprofitable" patients not getting health care
As a result, some believe it should be a regulated natural monopoly, nonprofit organization, or
gov. run
Issues include:
Cream skimming: A strategy to seek out less costly patients and avoid high-cost patients in order to
maximize profits. Cream skimming leads to a restricted supply of health care because patients deemed
to be higher risk are required to pay higher insurance premiums or are denied coverage
Medical underwriting: The use of health evaluations by insurance providers to determine the estimated
cost of providing health care to an applicant. It is used to determine whether to offer or deny coverage
and the premium to be charged or an insurance policy.

The Role and Cost of Health Care Technology


Tradeoff between cost of medical innovation and outcomes
Some research aimed at finding less expensive ways to cure people, reducing the cost of delivering
health care as supply of health care increases
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health care as supply of health care increases


Other medical technologies are aimed at finding treatments to improve the probability of curing rarer
diseases, which can raise the cost of health care when the marginal benefit is small relative to the added
cost

Medical Malpractice Insurance and Regulations


Largest expenses facing hospitals and private practice physicians is the cost of medical malpractice
insurance
Can cost more than physician's salary, burden on hospital owners and private practices
Risk of malpractice cases cause health care professionals to engage in defensive medicine by taking
greater precautions in treating patients, such as ordering more expensive tests. It leads to higher health
care costs but often with little marginal benefit
Medical malpractice laws can lead to a shortage of doctors in certain specialties

Improving Efficiency by Reducing Waste and Fraud


Many inefficiencies in supply of health care, including hand-written medical records which are hard to
share
Developed health information management: An industry whose objective is to improve the efficiency of
managing medical records
Much insurance fraud, costing US as much as $100 billion in 2010
Common form in fabricating claims processing, where insurance claims are filed for services not
performed
Will cause higher cost of health care for everyone
Waste and fraud will shift supply to the left and reduce the quality of health care available

Defining Health Care Systems


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Defining Health Care Systems


Difference between various systems is the role of the government
Greatest gov. control include government-run and single-payer systems where the government acts as
the primary insurance provider and sets prices health care providers must accept
Two-tier systems: Features both private and public health care options, where there is a basic level of
guaranteed coverage and offers additional policies for those wishing to purchase more extensive
coverage
Managed competition: A health care system in which private doctors and insurance companies function
within a competitive market, but are subject to various government rules and regulations

The U.S. Health Care Reform Debate


Many satisfied with existing coverage were reluctant to change that could reduce quantity or quality of
care
Problems:
1.) nearly 50 million Americans are without health care
2.) costs of health care in total and per capita are expected to rise even faster as population grows and
ages
Debate:
1.) how to increase the number insured
2.) how to deal with costs of insuring persons with preexisting conditions
3.) how to deal with rescission, the practice by insurance companies of dropping a person's health
insurance coverage after an illness arises
4.) whether to allow lifetime limits on coverage
5.) how to ensure that choice of doctors is maintained
6.) whether to reform malpractice and tort laws, such as reducing maximum lawsuit damages
7.) how to increase competition among providers and implement personal patient responsibility
8.) how to contain the growth of health care costs
Affordable Care for America Act on March 23, 2010:
1.) preventing children from being denied health insurance due to preexisting conditions
2.) eliminating lifetime limits on coverage
3.) extending the age that one can remain on a parent's health care plan from 19 (or when one
graduates college) to age 26
4.) toughening rules against rescission
5.) expanding coverage for preventative care services
One of the most controversial is an insurance mandate, requiring all individuals to purchase health care
insurance starting in 2014 or face penalties up to 2.5% of one's income

Spectrum of Health Care Systems

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Chapter 11 - Theory of Input Markets (p262-266)


Tuesday, October 01, 2013

1:14 AM

Competitive Labor Supply


Work means giving up leisure
Economists assume that people prefer leisure, leisure encompasses all activities that do not involve paid
work

Individual Labor Supply


Supply of labor: The amount of time an individual is willing to work at various wage rates
Most people can work is 24 hours, but need rest and sleep
High wages probably means willing to work horrendous hours for a short time
Wages are low enough means you might not be willing to work at all

Screen clipping taken: 10/1/2013 1:42 AM

Substitution Effect
Substitution effect: Higher wages mean that the value of work has increased, and the opportunity costs
of leisure are higher, so work is substituted for leisure
Sub effect for consumer products is negative (price falls and consumption rises) while it is always
positive for labor (wages rise and the supply of labor increases)

Income Effect
Income effect: Higher wages mean you can maintain the same standard of living by working fewer
hours. The impact on labor supply is generally negative.
Higher wages may lead to fewer hours worked. This is why the graph above is backward bending.
Higher wages mean higher income and makes leisure look more attractive.

Market Labor Supply Curves


The labor supply for any occupation or industry is upward sloping; higher wages for a job mean more
inquiries and job applications.
Changes in wage rates change the quantity of labor supplied

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Factors that Change Labor Supply


Include: Demographic changes, nonwage benefits of jobs, wages paid in other occupations, and
nonwage income

Demographic Changes
Includes changes in population, immigrations patterns, and labor force participation rates Anything
that alters # people qualified for work
Other demographic changes have shifted curve by modifying the labor-leisure preferences among
workers like health improvements (lengthens life)

Nonmoney Aspects of Jobs


Changes in the nonwage benefits of an occupation will similarly shift the supply labor in that market
(increase pleasantness, safety, or status of a job, supply will increase)

Wages in Alternative Jobs


Skills may be easy to transfer, wages paid in other market may affect the first industry
All labor markets have some influence other the other, rising wages in growth industries will shrink the
supply of labor available to firms in other industries

Nonwage Income
Changes in income from other sources than working will change the supply of labor
Nonwage rises, supplied hours declines
Market labor supply curves normally positively sloped, even though individual's labor supply curve may
be backward bending

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Chapter 7 - Production and Cost


Wednesday, October 02, 2013

7:25 PM

Profits motivate firms to do what they do


For entrepreneurs, the idea comes first and they perceive a market need

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Firms, Profits, and Economic Costs


Wednesday, October 02, 2013

8:15 PM

Firms produce the products and services that you purchase

Firms
Firm: An economic institution that transforms resources (factors of production) into outputs for
consumers
Often begin as family enterprises or small partnerships, then evolve into corporations
Before making goods, must determine a market need
Must decide what quantity of output to produce, how to produce it, and what inputs to employ
Last two depend on production technology the firm selects

Entrepreneurs
Someone must assume the risk of raising the required capital, assembling workers and raw materials,
producing the product, and offering it for sale to provide a service or product
In the US, 12% from 18 to 64 classify themselves as entrepreneurs, half in Europe, 2% or less in Japan
Three basic business structures:
Sole proprietorship (one owner)
Partnerships (two or more owners)
Corporations (many stockholders)
20% of American businesses are corporations, but sell nearly 90% of all products and services in the US

Sole Proprietors
Sole Proprietor: Represent the most basic form of business organization, wehre there is a one owner
who supervises and manages the business and is subject to unlimited liability
Easy to establish and manage, less paperwork
Limited in ability to raise capital and usually all management responsibilities fall on this person
Own a pizza place and someone slips, get sued and probably don't have enough insurance

Partnerships
Partnership: Similar to a sole proprietorship, but involves more than one owner who shares
management of the business. Also subject to unlimited liability for all of the business.
Usually requires signing a legal partnership document.
Easier to raise capital and spread management responsibilities
Responsible for your partner if he leaves for vacation
Death of a partner will dissolve a partnership unless other arrangements have been made ahead of time

Corporations
Corporation: A business structure that has most of the legal rights of individuals, and in addition, the
corporation can issue stock to raise capital. Stockholders' liability is limited to the value of their stock.
They possess most of the legal rights of individuals
As a result, they have the advantage that they can raise large amounts of capital due to limited liability

Profits
Entrepreneurs and firms have a goal to make a profit
Profit: Equal to the difference between the total revenue and total cost
Total revenue: The amount of money a firm receives from the sales of its products. It is equal to the
price per unit times the number of units sold
TR = p x q
Total Cost: Includes both out-of-pocket expenses and opportunity costs
Economists assume that firms proceed rationally and have the maximization

Economic Costs
Economists separate costs into explicit costs, or out of pocket expenses, and implicit costs, or
Coremicroeconomics Page 54

Economists separate costs into explicit costs, or out of pocket expenses, and implicit costs, or
opportunity costs
Economic costs: the sum of explicit and implicit costs
Explicit costs: expenses paid directly to some other economic entity. Include wages, lease payments,
expenditures for raw materials, taxes, utilities, and so on.
Can determine this by summing all of the checks it has written.
Implicit costs: All of the opportunity costs of using resources that belong to the firm. Include
depreciation, depletion of business assets, and opportunity costs of the firm's capital employed in the
business.

Sunk Costs
Sunk costs: costs that have been incurred and cannot be recovered, including, for example, funds spent
on existing technology that have become obsolete and past advertising that has run in the media
(tuition, previous bets on a poker hand)
They are gone and should be ignored in future business decisions

Economic and Normal Profits


Economists define a normal rate of return on the capital invested in a firm as the return just sufficient to
keep investors satisfied, and thus just sufficient to keep capital in the business over the long run.
If not, invest somewhere else (like interest in a bank's savings account)
Economists include both explicit and implicit costs in their analysis of business profits
Economic Profits: Profits in excess of normal profits. These are profits in excess of both explicit and
implicit costs.
Occurs when a firm is generating profits in excess of zero once implicit costs are factored in.
Excess of a normal rate of return
Normal Profits: The return on capital necessary to keep investors satisfied and keep capital in the
business over the long run
Zero economic profits and normal profits are equated and each just enough to keep capital in the
firm in the long run, anything above that is a true economic profit. Anything below is a loss.
Still, a firm can still be earning accounting profits but still suffer economic costs because taxable income
doesn't reflect all implicit costs
For example, an entrepreneur opens a small restaurant and earns $30000 accounting profit a year
but could have earned $35000 elsewhere, resulting in a $5000 economic loss

Short Run Versus Long Run


Not really defined in terms of time
Defined by the ability of firms to adjust the quantities of various resource they are employing
Short Run: A period of time over which at least one factor of production (resource) is fixed, or cannot be
changed
Assumption that plant capacity is fixed in the short run
Long Run: A period of time sufficient for a firm to adjust all factors of production, including plant
capacity. The firm can enter/exit the industry as well
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capacity. The firm can enter/exit the industry as well

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Production in the Short Run


Monday, October 07, 2013

5:07 PM

Production: The process of turning inputs into outputs


Can be produced using a variety of different technologies, can be labor or capital intensive
Simplified model: firms can vary output only by altering the amount of labor they employ, because plant
capacity is fixed in the short run
Follows the general pattern of the production function as an individual firm
Output for an existing plant varies by the amount of labor employed, output referred to as total product

Total Product

Output varies with the number of people employed


Beyond 12 people, begin to have negative returns because it has become overly crowded, output falls
but cost still rise

Marginal and Average Product


Marginal Product (MP): the change in output that results from a change in labor

Generally, input is labor


Average Product (AP): output per worker, found by dividing total output by the number of workers
employed to produce that output

Increasing and Diminishing Returns


Portion where average and marginal products are both rising, called the increasing marginal returns
A new worker hired adds more total to the output than the previous worker hired, so that both AP
and MP are rising.

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When marginal product exceeds average product--when a new worker adds more to output than the
average of the previous workers--hiring an additional worker increases average productivity
Eventually you face diminishing marginal returns, where an additional worker adds to total output but at
a diminishing rate (past point a)
Negative marginal returns occur when adding a worker that actually leads to less total output than with
the previous worker hired, rational firms generally won't do this

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Costs of Production
Monday, October 07, 2013

5:31 PM

Short-Run Costs
Production costs are determined by the productivity of workers
For example, 10 pizzas produced an hour and the worker is paid $8/hr, then each pizza costs 80
cents, the cost of labor
But ignoring other costs would neglect business expenses known as overhead

Fixed and Variable Costs


Fixed costs: or overhead, are costs that do not change as a firm's output expands or contracts. These
include items such as lease payments, administrative expenses, property taxes, and insurance.
They do not rise or fall as a firm alters production to meet market demands
Variable costs: Costs that vary with output fluctuations, including expenses such as labor and material
costs
Making more products requires hiring more workers and purchasing more raw materials

In the long run, all costs are variable, so TFC = 0 since given enough time, a firm can expand or close its
plan, enter or leave an industry

Average Costs
Sometimes a firm wants to get a breakdown of how much labor, raw material, plant overhead, and sales
costs are imbedded in each unit of the product
Cost per unit of output (average cost), average fixed cost, and average variable cost is fine

Average fixed cost (AFC): Equal to total fixed cost divided by output (TFC/Q)
Average amount of overhead for each unit of output
Average variable cost (AVC): Equal to the total variable cost divided by the output (TVC/Q)
The labor and raw materials expenses that go into each unit of output
Adding AFC and AVC results in average total cost (ATC).

Marginal Cost
Because of increasing and decreasing returns associated with typical production processes, average
costs vary with the level of output
Marginal Cost: The change in total costs arising from the production of additional units of output (

Since fixed costs do not change with output, marginal costs are the change in variable costs associated
with additional production(

Because fixed costs do not vary with changes in output,

Coremicroeconomics Page 59

L = Labor
Q = Output
MP = Marginal Product (Difference in output at each level)
AP = Average Product (Amount of Output per Labor)
TFC = Total Fixed Cost (Generally can't be changed in SR, like rent on a barn)
TVC = Total Variable Cost (Changed in the SR, cost/wage for workers)
TC = Total Cost (TFC+TVC)
ATC = Average Total Cost (Same as above but per unit of output/Q)
AVC = Average Variable Cost
AFC = Average Fixed Cost
MC = Marginal Cost (The cost of producing one more unit of output)

Short-Run Cost Curves


Average Fixed Cost (AFC)
Average fixed costs decrease as production increases, due to total fixed costs not changing in the short
run

Average Variable Cost (AVC)/Average Total Cost (ATC)


Bowl shaped, when the curves slope downward, there is an increase in returns as average costs drops
When production levels rise, the average costs start to climb back up, diminishing returns set in

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Marginal Cost (MC)


The cost of producing one more unit of output
Intersects the minimum point on AVC and ATC curve

When the cost to produce another unit is less than the average of the previous units produced, average
costs will fall.
When the cost to produce another unit exceeds the average cost for all previous output, average costs
will rise.

Long-Run Costs
Firms can adjust all factor inputs to meet the needs of the market

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Plant 1 has the fewest machines and least output capacity


At Q1, plant 2 can enjoy the benefits of economies of scale because plant to can produce Q1 for AC1,
where as the machines get overwhelmed at this level of output
Neither plant 1 or plant 2 can reach Q2

Long-Run Average Total Cost


Long-Run Average Total Cost: Firms can adjust their plant sizes so that the LRATC is the lowest unit cost
at which any particular output can be produced in the long run

Green represents the lowest cost to produce any given output in the long run and represents the LRATC
curve

Economies and Diseconomies of Scale


As a firm's output increases, its LRATC tends to decrease.
This is because as a firm grows in size, economies of scale result from such items as specialization of
Coremicroeconomics Page 62

This is because as a firm grows in size, economies of scale result from such items as specialization of
labor and management, better use of capital, and increased possibilities for making several products
that utilize complementary production techniques
Larger firms can afford to purchse larger, more specialized capital equipment whereas smaller firms
mush often rely on more labor-intensive methods

Many industries with a wide range of output where ATC are relatively constant
Examples include upscale restaurants, fast-food, and automotive service operations
Have steady average costs because the cost to replicate their business is relatively constant
Constant returns to scale: A range of output where average total costs are relatively constant
As firms continue to grow, they eventually encounter diseconomies of scale, where a range of output
where ATC tend to increase. Firms often become so big that management becomes bureaucratic and
unable to efficiently control its operations

Economies of Scope
Economies of scope: by producing a number of products that are interdependent, firms are able to
produce and market these goods at lower costs
Firms can produce another product when the production processes are interdependent essentially

Role of Technology
Technology plays a role in altering the LRATC curve
Modern communications and computers have permitted firms to become huge before diseconomies are
reached

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Chapter 8 - Competition
Monday, October 07, 2013

6:53 PM

Competition means more than just competing against one or two other firms
With so many businesses, a single firm's behavior is irrelevant to its competitors
Firms in this competitive climate lack discretion over pricing and must perform efficiently

Coremicroeconomics Page 65

Market Structure Analysis


Monday, October 07, 2013

7:41 PM

Market Structure Analysis: By observing a few industry characteristics such as number of firms in the
industry or the level of barriers to entry, economists can use this information to predict pricing and
output behavior of the firm in the industry
Four factors determining the intensity of competition in an industry:
Number of firms in the industry
Many firms or a large firm like Wal-Mart that can control prices
Nature of the industry's product
Homogeneous product like salt where no consumer will pay a premium or leather hand
backs where consumers can pick
Barriers to entry
Low start-up and maintenance costs or a lot (a plant)?
Extent to which individual firms can control prices

Primary Market Structures


Competition
Many buyers and sellers
Homogeneous (standardized) products
No barriers to market entry or exit
No long-run economic profits
No control over price

Monopolistic Competition
Many buyers and sellers
Differentiated products
No barriers to market entry or exit
No long-run economic profits
Some control over price

Oligopoly
Fewer firms (such as the auto industry0
Mutually interdependent decisions
Substantial barriers to market entry
Potential for long-run economic profits
Shared market power and considerable control over price

Monopoly
One firm
No close substitutes for product
Nearly insuperable barriers to entry
Potential for long-run economic profit
Substantial market power and control over price

Defining Competitive Markets


Competition: Exists when there are many relatively small buyers and sellers (so they can't individually
influence a product's price), a standardized product, with good information to both buyers and sellers,
and no barriers to entry to exit
Price Taker: Individual firms in competitive markets get their prices from the market since they are so
small they cannot influence market price. For this reason, competitive firms are price takers and can
produce and sell all the output they produce at market -determined prices
If there is an equilibrium price of 200 for a competitive product, it has no reason to sell below that and it
will sell nothing above that.

The Short Run and the Long Run (A Reminder)


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The Short Run and the Long Run (A Reminder)


The short run is where one factor of production if fixed, usually the plant size and they cannot exit the
industry nor can new ones enter
The long run is where all factors are variable

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Competition: Short-Run Decisions


Monday, October 07, 2013

7:55 PM

Marginal Revenue
Marginal revenue: The change in total revenue from selling an additional unit of output. Since
competitive firms are price takers, P = MR for competitive firms

In a competitive market, price will not change, so MR is just equal to the price

Profit Maximizing Output

Profit Maximizing Rule: Firms maximize profit by producing output where MR=MC. No other level of
output produces higher profits

Economic Profits
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Normal Profits

Normal Profits: Equal to zero economic profits; where P = ATC


This is where there is enough income to keep investor capital in the business
No pressure to enter or leave industry
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No pressure to enter or leave industry

Loss Minimization and Plant Shutdown


Loss minimization (still profit maximization) requires output where MR=MC

Shutdown occurs when revenue drops to a level equal to variable costs. Can pay employees but not
overhead

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Shutdown point: When price in the short run falls below the minimum point on the AVC curve, the firm
will minimize losses by closing its doors and stopping production. Since P<AVC, the firm's variable costs
are not covered, so by shutting the plant, losses are reduced to fixed costs only.

Short-Run Supply Curve

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Short-run supply curve: The marginal cost curve above the minimum point on the average variable cost
curve
Simply the horizontal summation of the supply curves of the industry's individual firms

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Competition: Long-Run Adjustments


Monday, October 07, 2013

8:25 PM

Adjusting to Profits and Losses in the Short Run


Firms earning profits in short-run mean more people will enter in the long-run, existing firms my
increase scale

Equilibrium at a, results in (economic/supernormal) profits in Panel B in short run


Results in other firms entering the industry, increased supply
This forces prices down, and the firms only get normal profits at b

Current equilibrium point is result in short-run economic losses


Results in some firms leaving the industry
In the long run, at b, the supply had decreased and the firm starts to earn normal profits

Competition and the Public Interest


Market price in the long run is PLR.
P = MR = MC = SRATCmin (Short run average total cost) = LRATCmin (Long run average total cost)

Coremicroeconomics Page 73

Competition means that consumers get what they want since price reflects their desires at the lowest
possible
Both consumer surplus and producer surplus is maximized
Exhibits productive efficiency: goods and services are sold to consumers at their lowest resource
(opportunity) cost
Second, allocative efficiency: the mix of goods and services produced are just what society desires. The
price that consumers pay is equal to the marginal cost and is equal to the least average total cost

Long-Run Industry Supply


Economies or diseconomies of scale determine the shape of the LRATC curve for individual firms
LRATC curve slopes down for economies of scale
LRATC curve will show average costs rising as output rises for diseconomies of scale
Increasing cost industry: An industry that in the long run, faces higher prices and costs as industry
output expands. Industry expansion puts upward pressure on resources (inputs), causing higher costs in
the long run.

Panel A:
Shows when demand increases in the short run (a -> b)
Firms then enter the industries in the long run, resulting in upward pressure on industry inputs (b -> c)
Panel B:
Faces no economies or diseconomies, constant
Constant cost industry: An industry that in the long run, faces roughly the same prices and costs as
industry output expands. Some industries can virtually clone their operations in other areas without
putting undue pressure on resources prices, resulting in constant operating costs as they expand in the
long run
Examples: semiconductor industry, demand increases,
Panel C:
Expansions leads to external economies and so there are lower prices and higher output
Decreasing cost industry: An industry that in the long run, faces lower prices and costs as industry
output expands. Some industries enjoy economies of scale as they expand in the long run, typically the
result of technological advances
Coremicroeconomics Page 74

result of technological advances


Examples: Wal-Mart, fast-food, retail stores, etc

Coremicroeconomics Page 75

Chapter 9 - Monopoly (p207-218)


Saturday, October 12, 2013

9:10 PM

Monopoly have pricing power unlike competitive firms


M$ word gets to price 10 times the amount of the cost of printing a CD-ROM with packaging
Monopolies do not have the public interest in mind
Other extreme of the competitive model

Coremicroeconomics Page 76

Monopoly Markets
Saturday, October 12, 2013

9:13 PM

Monopoly: A one-firm industry with no close product substitutes and with substantial barriers to entry
The market has just one seller, one firm is the industry
No close substitutes exist for the monopolist's product
Significant barriers to entry so no competition even in the long run
Monopolists are instead price makers unlike price takers for the competitive firms

Sources of Monopoly Power


Monopoly Power: A firm with monopoly power has some control over price

Economies of Scale
Economies of scale: As the firm expands in size, average total costs decline
Can become so large that demand supports only one firm

One firm can earn economic profits by producing between Q0 and Q1 at D0. However, if there were two
firms, demand for each would be at D2, and neither firm can remain in business without suffering losses
Referred to as a natural monopoly
Intel is an example of one, 9 billion in annual sales to support a plant that costs 1 billion to
open+research+development+marketing
Utilities as well since it's inefficient to have several different serving

Control over a Significant Factor of Production


Such as an input
Like when Alcoa Aluminum had control over bauxite ore to produce aluminum over 50 years ago, and
then the Justice department moved against them

Government Franchises, Patents, and Copyrights


A government may give permission to a firm to provide specific goods/services while prohibiting others
USPS has exclusivity to mailboxes
Patents are extended to firms and individuals who invent new products and processes
20 years, holder legally protected from competition in production of the patented product
Give incentive to individuals/firms to invent/innovate
Protection for investment on research and development
Copyrights give individuals/firms exclusive right to produce or reproduce certain types of intellectual
property for an extended period
Include books, art, piece of software code
Due to M$ legal case of 1990s and allowed Windows to be protected
Only a handful know how to blend coke
Coremicroeconomics Page 77

Only a handful know how to blend coke

Monopoly Pricing and Output Decisions


Competitive firms maximize profits by producing at a level of output where MR = MC
Monopoly doesnt have to follow this, Q produced affects market price

MR < P for Monopoly


MR is less than P because monopolies control market price with output
Industry's demand is the monopolist's demand

Panel A shows d = MR = P, at the price of 10, it can sell all it wants, for each unit sold, revenue increases
by 10
Panel B shows the demand curve for a monopolist
Constitutes the entire industry, so it has a downward sloping demand curve
Sell more output, sell for less price

Equilibrium Price and Output


Profit maximizing is found at MR=MC
Look vertically for the point on demand curve and ATC, subtract the two and multiply the output for
profit

Monopoly Does Not Guarantee Economic Profits


Same situation as competitive firms, have to at least earn normal profits

Maximizes profits by producing where MR=MC, price? still exceeds AVC


Coremicroeconomics Page 78

Maximizes profits by producing where MR=MC, price? still exceeds AVC


If fall below AVC, shut down

Comparing Monopoly and Competition


We want fewer monopolies and more competition

Higher Prices and Lower Output from Monopoly

If MCmonopoly = Supply Curvecompetitive, results in deadweight loss from monopoly


Monopoly output is lower and monopoly price is higher

Rent Seeking and X-Inefficiency


Monopolies earn more by charging more and producing less than competitive firms

Inefficient, Results in loss of consumer surplus


Rent seeking: Resources expended to protect a monopoly position. These are used for such activities
such as lobbying, extending patents, and restricting the number of licenses permitted.
X-inefficiency: Protected from competitive pressures, monopolies do not have to have to act efficiently.
Spending on corporate jets, travel, and other perks of business represent x-inefficiency
Monopolies are possibly have benefits, but generally no
Coremicroeconomics Page 79

Monopolies are possibly have benefits, but generally no


Pure monopolies are rare due to public policy and antitrust law
Difficult for google, yahoo, microsoft or amazon, apple, sony dominate each other
There are a large amount of resources wasted to maintaining the monopoly

Coremicroeconomics Page 80

Monopoly Market Issues


Sunday, October 13, 2013

12:16 AM

When firms have some monopoly power, they will try to charge different customers different prices,
called price discrimination
Used to increase profit

Price Discrimination
Senior citizens might pay less for a movie ticket than you do
For successful price discrimination:
Sellers much have some monopoly (or market) power or some control over price
Sellers mush be able to separate the market into different consumer groups based on their
elasticities of demand
Sellers must be able to prevent arbitrage; that is, it must be impossible or prohibitively expensive
for low-price buyers to resell to higher-price buyers
Three types of price discrimination:
Perfect or first-degree: Charging each customer the maximum price each is willing to pay
Second-degree: Charging different customers different prices based on the quantities of the
product they purchase
High initial price
Third-degree: Charging different groups of people different prices
Occurs with airline, bus, and theater tickets

Perfect Price Discrimination

Best exemplified by flea market


Haggle over prices
Can earn profits greater than the above MC/ATC
Earn the entire shaded triangle than just at PM

Second-Degree Price Discrimination


Involves charging consumers for different blocks of consumption
Usually utility companies do this

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Because consumers are charged between Qo and Q1, it is equal to the area shaded above.

Third-Degree Price Discrimination


AKA imperfect
Example would be airline flights
Business people have lower elasticities of demand for flights than do vacationers
Purchasing several weeks in advance like vacationers do results in a much lower price, while business
people might not be able to
Arbitrage ( low-cost buyers selling to higher-price buyers) is prevented by having rules that only allow
tickets in their own name
Another example is different prices for children, adults, seniors at the movies
Student discounts

This type of price discrimination allows two segments of a market with different demand elasticities to
be satisfied, maximize profits

Coremicroeconomics Page 82

Chapter 10 - Monopolistic Competition, Oligopoly, and Gamer


Theory
Saturday, October 19, 2013

9:41 PM

Pure competition/monopoly rarely exist


Extremes of market structure, most exist in between like monopolistic competition and oligopoly
Competitive markets are defined by homogeneous products, like microchips and agricultural products,
but most products we purchase are clearly not homogeneous
Monopoly analysis required only one firm and competition required a standardized product, but most
markets actually have only a few firms offering different products
Monopolistic competition: Many firms offer products that are different
Oligopoly: Only a few firms operate
Most firms begin small in competitive environments, and some bring unique products, and develop
newer versions or introduce new products later

Coremicroeconomics Page 83

Monopolistic Competition
Saturday, October 19, 2013

9:47 PM

Until 1920s, competition and monopoly were the only models of market structure that economists had
in their toolbox
If economies were large relative to the market, one of a few firms would expand and eventually take
over the market
Chamberlain and Robinson discover "imperfect" markets
Monopolistic Competition: nearer to the competitive end of the spectrum and is defined by:
A large number of small firms. Like Competition, have an insignificantly small market share.
Individually, they cannot appreciably affect the market, and ignore the reactions of their rivals.
Independent of a competitor's reactions
Entry and exit is easy
Products are different unlike competition. Each firm produces something that is different from its
competitors or something that is perceived to be different by consumers. "Product
differentiation"

Product Differentiation and the Firm's Demand Curve


Most firms sell products that are differentiated from their competitors
Could be superior location. Could be a branded product so they can increase price w/o losing all
customers
Product differentiation gives the firm some modest control over prices
Considerably more elastic
Still many substitutes, so increase in price can have decrease in output demanded

Product differentiation: One firm's product is distinguished from another's through advertising,
innovation, location, and so on.
Intended to increase demand of reduce the elasticity of demand and generate loyalty to the
product or service

The Role of Advertising


A way to differentiate products
Two ways: Informational and persuasive
Informational lets consumers know about products and reduce search costs
Relatively inexpensive to let people know about price/quality
Enhance competition by making consumers aware of other subs/competitors
Advertising also has the potential to reduce costs by increasing sales, bringing about economies of scale
Advertising can drive up the prices of many products due to being mostly persuasive, shift buyers among
competitors
Persuasive ads often have little informational content
Many ads move to internet instead of TV/conventional media because more effective
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Many ads move to internet instead of TV/conventional media because more effective
Methods allow product differentiation and so have control over price to some extent
Profit maximizing decisions will be a little different

Price and Output under Monopolistic Competition


Profit maximization in the short run a lot like monopolist, firm's size will result in different profits
Monopolistic competitive demand curve is quite elastic, and economic profits are diminished
Profits are maximized where MR=MC

If profitable, new firms will want to enter


New firms will enter, soaking up some industry demand and reducing demand to each firm
In the long-run, where demand will be tangent to long-run AVC, each firm earns normal profits:

No more entry or exit at this point.

Comparing Monopolistic Competition to Competition

Coremicroeconomics Page 85

Long-run equilibrium is at point b for competitive firms and a for monopolistically competitive firms.
Equilibrium price is a little higher, and output is a little lower for the monopolistically competitive firm.
These represent the real costs we, as consumers, pay for product differentiation
Gives some justification for the costs
Key is to differentiate the product to obtain a higher price, but price advantage evaporates over the long
run for monopolistically competitive firms

Coremicroeconomics Page 86

Oligopoly
Saturday, October 19, 2013

10:34 PM

Oligopoly: A market with just a few firms dominating the industry where
1) Each firm recognizes that it must consider its competitors reactions when making its own
decisions (mutual interdependence)
2) There are significant barriers to entry into the market
Could be selling a homogeneous product (gasoline, sugar) or differentiated product (automobiles,
pharmaceuticals)
Could be an industry with a dominant firm and a few smaller firms (microcomputer OSes, cell phones),
or could be a few similarly sized firms (automobiles and tobacco)

Defining Oligopoly
Assumptions:
There are only a few dominant firms in the industry
Each firm recognizes that it must take into account the behavior of its competitors when it makes
decisions, referred to as mutual interdependence
Significant barriers to entry into the market
Only a few firms so actions of one will affect the ability of others to successfully sell or price their output
One firm changes specs of product or increases advert budget, then the other will respond
Example: New driver assist system in Mercedes, consider whether or not Lexus will immediately
offer it as well
Few firms means entry scale is often huge, brand preferences are strong

Cartels: Joint Profit Maximization


One oligopoly model is a cartel, a collusive joint profit maximization, an agreement between firms (or
countries) in an industry to formally collude on price and output, then agree on the distribution of
production
OPEC is an example, Organization of Petroleum Exporting Countries, Middle Eastern countries agree to
establish a price and output level each member can produce
Cartels are inherently unstable because there is incentive to cheat by individual members
Economic profits shared, but not maximized
Any firm could sell additional output for a price above the marginal cost and earn additional profits
Stability is enhanced when there are fewer members with similar goals
Have legal provisions (government protection)
Nonprice competition is not possible
If products and cost structures are similar and they are not secretive with one another
Significant barriers will let the cartel not worry about new entrants

Coremicroeconomics Page 87

Game Theory
Saturday, October 19, 2013

11:01 PM

Game theory: An approach to analyzing oligopoly behavior using mathematics and simulation by making
different assumptions about the players, time involved, level of information, strategies, and other
aspects of the game
Developed from analysis of imperfect competition.
Antoine Cournot looked at doupolist and analyzed how one firm would react to output changes from its
rival
Model of mutual interdependence was the precursor to game theory
Modern game theory from John von Neumann, sophistocated mathematical and simulation science

Types of Games
Characteristics:
Cooperation: Permit players to collude on prices, output, or other variables, like OPEC
Noncooperative games are opposite, no communication and collusion
Players: Simple games only involve two players, many modern simulation games involve
multiplayer environments
Time: In static games, all players choose their strategies at the same time. Dynamic games involve
sequential decision making.
Ex: One firm sets a price and the other responds to this price
Information: Could have complete (perfect) information or incomplete (imperfect) information.
Firms often have good information about themselves but not equal for the other
Asymmetric is also possible (Used cars, sellers>buyers)
Strategies: Many games have discrete strategies where players choose from a few choices such as
"advertise or do no advertise", "confess or do not confess", "enter the industry or do not".
Continuous strategies typify business-constant-pricing decisions where firms often have a large
number of prices and products that are subjected to various (and sometimes random) events
Repetition: Whether the game is one-off decision or will be repeated introduces another level of
complexity. In a one-off game, players only have to consider the payoffs (impacts) on that one
decision. In repeated games, players can react to the other player's past strategies
Profit-Loss: In a zero-sum game (poker, duels, most sports), each winner is essentially paired with
a loser. If non-zero-sum, both players stand to benefit

The Prisoner's Dilemma


Noncooperative game: player imagines how his opponent intends to paly the game
Impossible for players to communicate or collaborate in decisions or strategies
Prisoner's Dilemma: A noncooperative game where players cannot communicate or collaborate in
making their decisions about whether to confess or not, which results in inferior outcomes for both
players. Many oligopoly decisions can be framed as a Prisoner's Dilemma.

Must make a decision but the prisoners don't know what the other has done
Both will logically confess despite the fact both would be better off if neither did. Think that the other
will confess and get off.
Result is due to the structure of payoffs

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Nash Equilibrium
John von Neumann's focus was on two-person zero-sum games
Amount won=Amount lost
Nash equilibrium: An important proof that an n-person game where each player chooses his optimal
strategy, given that all players have done the same, has a solution. This was important because
economists now knew that even complex models (or games) had an equilibrium, or solution

One-Off Games: Applying Game Theory


How game theory can be used to model oligopoly decisions. Static games and dynamic games involved.

Static Games
One-off games (not repeated) where decisions by the players are made simultaneously and are
irreversible
Could be an extension of Prisoner's Dilemma
Dueling advertising campaigns, decisions about R&D, or price changes
Price Discounting:

Both firms see that they will stand to earn more by lowering price, but if both lower price, then they
both lose a bit
They will logically decide to lower in anticipation for the other to lower
Advertising:

Both have to gain market share and profits, have to advertise


Both will stand to earn more by advertising, will both decide to advertise

Dynamic Games
Sequential or repeated games where the players can adjust their actions based on the decisions of other
players in the past.
Most markets are dynamic, firms are constantly trying new prices and other sales techniques to increase
profits
Price Discounting:
Now the decision is a sequential process
Each player has perfect knowledge and knows the payoff, will wait for the other firm to alter price
Profits remain at 100,000, neither inclined to lower price
Advertising:
Dynamic and sequential
Lowe's and Home Depot tend to be located near each other
Advertise only at specific times of the years
Both tend to focus on competing on the basis of service and somewhat on price
Both come to the conclusion that spending huge on advertising does not pay
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Both come to the conclusion that spending huge on advertising does not pay

Predatory Pricing
Selling below cost to customers in the short run, hoping to eliminate competitors so that prices can be
raised in the longer run to earn economic profits
Can happen when firms with monopoly power in a market can use price wars or threaten their use to
keep firms from entering the market

Without entry of low-cost, American earns 400k


Entry, then both parties 100k
Can choose to compete with lower prices, more flights, -100k
Lower-capitalized carriers probably cannot sustain, so they leave and prices and routes can return to
original states
Brings question as to whether or not American was just dropping fares to meet competition or
predatory behavior
Going back to high prices will provide incentive for others to come back, can be a repeatable game

Repeated Game Strategies


Games can be repeated infinitely
Opens game to different strategies not available in one-off game
Cooperate or defect from the beginning, leaves at the mercy of opponent
Unfavorable outcome where both firms earn less or suffer losses
Trigger strategies: Action is taken contingent on your opponent's past decisions

Grim Trigger
An oligopoly is earning profits. All of a sudden, the other firm lowers its price, maybe because it's in
financial trouble and wants to increase sales right away
Under this rule, other firms permanently lower prices making the financial condition of the original firm
who reduced prices even more severe
"Any decision by your opponent to defect (choose an unfavorable outcome) is met by a permanent
retaliatory decision forever"
Subject to misreading, competition lowered price to attempt to gain market share at your expense or
market softened for the product in general?
Quickly leads to Prisoner's Dilemma
Avoid this problem by developing the next strategy

Trembling Hand Trigger


Allows for one mistake by your opponent before you retaliate forever. Reduces misreads, can do
additional defects, but can be exploited by clever opponents who can get away with a few mistakes
before retaliation

Tit-for-Tat
Simple strategies that repeat the prior move of competitors. If your opponent lowers price, you do the
same. This approach has the efficient quality that it rewards cooperation and punishes unfavorable
strategies (defections)

Coremicroeconomics Page 90

Summary of Market Structures


Sunday, October 20, 2013

12:38 AM

Coremicroeconomics Page 91

Chapter 9 - Monopoly (p218-229)


Sunday, October 27, 2013

8:44 PM

Regulating the Natural Monopolist


Natural monopoly: Large economies of scale mean that the minimum efficient scale of operations is
roughly equal to market demand
Efficient production can only be accomplished if the industry lies in the hands of one firm, monopolist
Public utilities and water departments are examples, policymakers have to prevent natural monopolist
from abusing market dominance
1) Can be publicly owned
2) Can remain in or transferred to private ownership but be subjected to external constraints in the
form of price and quantity regulation
3) Firms desiring to obtain a monopoly right may be forced to compete for it

If purely a private firm, produce only QM and PM (A)


Earn economic or monopoly profits, consumers would be harmed, lower output at a higher price
The principal rationale for regulating natural monopolies to produce (B)

Marginal Cost Pricing Rule


Marginal Cost Pricing Rule: Regulators would prefer to have natural monopolists price where P = MC but
this would result in losses (long term) because ATC > MC. Thus, regulators often must use an average
cost pricing rule
Would like to price at Pc and Qc but that is under the average cost of production resulting in losses
between c and d driving it out of business
Could subsidy to allow it to earn a normal return

Average Cost Pricing Rule


Most common approach
Average Cost Pricing Rule: Requires a regulated monopolist to produce and sell output where price
equals average total costs. This permits the regulated monopolist to earn a normal return on investment
over the long term and so remain in business
Illustrated by point b where demand curve intersects the ATC curve, earn normal return
Customers do lose something that they have to pay a higher price for less output than they would be
under idealized competitive conditions

Regulation in Practice
Regulation accepted as lesser of two evils
Immense difficulty to find a point like b because it's inexact
Must often turn to rate of return or price cap regulation
Rate of return regulation: Permits product pricing that allows the firm to earn a normal return on capital
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Rate of return regulation: Permits product pricing that allows the firm to earn a normal return on capital
invested in the firm
Increases the regulations on acceptable items that can be included in costs/capital expenditures
Firms want to include more expenses, regulators want to include fewer
Alternatively, Price caps: Maximum price at which a regulated firm can sell its product. They are often
flexible enough to allow for changing cost conditions.
Can be adjusted due to changing cost conditions, including labor costs, productivity, technology,
and raw material prices
Can be disastrous if regulated firm's output is not self-produced but purchased on the open
market
California energy market, whole sale prices for energy went through the roof, price caps
prevented private utilities from raising the retail price of electricity
Regulation imposes costs on the market, costs are less than the costs of private monopolies

Coremicroeconomics Page 93

Antitrust Policy
Sunday, October 27, 2013

9:14 PM

Competition is the market structure that offers consumers the greatest product selection at the lowers
prices
Monopolies have potential to restrict output and increase prices
Antitrust law: Laws designed to maintain competition and prevent monopolies from developing
Antitrust policy has targeted monopolies as threats to economic efficiency

Brief History of Antitrust Policy


Econ changed dramatically after Civil War
Farms to factories
Western territories opened up w/ rails following
Telephone replaces telegraph
Markets grow from local to regional
Resulted in many large firms engaging in brutal practices to drive competitors from the market
Largest firms established trusts, which brought many firms under one organizational structure that
could set price and output
By 1890, Sherman Act put in place
Legislators became more concerned with equal distribution of wealth and income, health of small
businesses, than competition and allocative efficiency
Robber barons like John D Rockerfeller (Standard Oil) and Jay Gould (railroads and stock manipulation)
were resented and feared

The Major Antitrust Laws


The Sherman Act (1890)
Section 1: Every contract, combination in the form of trust or otherwise, or conspiracy, in restraint of
trade or commerce among the several states, or with foreign nations, is hereby declared to be illegal
Section 2: Every person who shall monopolize, or attempt to monopolize, or combine or conspire with
any other person or persons, to monopolize any part of the trade or commerce among the several
states, or with foreign nations, shall be deemed guilty of a felony
Felony, up to 10 million for corporations, 350k for individuals, and/or 3 years prison
Section 1 focuses on restraint of trade whereas section 2 targets monopolization and the attempt to
monopolize

The Clayton Act (1914)


Section 2: It shall be unlawful for any person engaged in commerce to discriminate in price between
different purchasers of commodities of like grade and quality where the effect of such discrimination
may be substantially to lessen competition or tend to create a monopoly in any line of commerce, or to
injure, destroy, or prevent competition
Section 3: It shall be unlawful for any person engaged in commerece to make a sale or contract for sale
of goods or other commodities on the condition that the lessee or purchaser thereof shall not use or
deal in the goods or other commodities of a competitor or competitors of the seller where the effect of
each lease, sale or contract may be to substantially lessen competition or tend to create a monopoly in
any line of commerce
Section 7: That no corporation engaged in commerce shall acquire, directly or indirectly, the whole or
any part of the stock or other share capital and no corporation subject of the jurisdiction of the Federal
Trade Commission shall acquire the whole or any part of the assets of another corporation engaged also
in commerce, where in any line of commerce in any section of the country, the effect of such acquisition
may be substantially to lesson competition, or tend to create a monopoly
Forbids tying contracts, agreements whereby the sale of one product is contingent upon the purchase of
Coremicroeconomics Page 94

Forbids tying contracts, agreements whereby the sale of one product is contingent upon the purchase of
another product
Illegal to acquire a competing company's stock and have interlocking directorates (directors sitting on
boards of competing companies)

Federal Trade Commission Act (1914)


Section 5a1: Unfair methods of competition in or affecting commerce and unfair or deceptive acts or
practices in or affecting commerce are hereby declared unlawful
Establishes the FTC, independent
Gave power to enforce Clayton act and Robinson-Patman Act

Other Antitrust Acts


Robinson-Patman Act amended the Clayton Act in 1936 to prohibit price discrimination. Passed in the
middle of the depression, protect mom and pop stores from chains and supermarkets
1950 Celler-Kefauver Antimerger Act closed a merger loophole in Clayton Act
Clayton forbid company from holding stock of competitors
Did not prohibit anticompetitive mergers through asset acquisition

Defining the Relevant Market and Monopoly Power


Industry moves from competition to monopoly, pricing power rises from zero to total
Difficult to develop one measure that accurately reflects market power or concentration for all market
structures
Industries that become more concentrated increase the losses to society

Defining the Market


To measure the market power and the concentration of a market, we need to determine the limits of
the market, geographically and defined by the product itself
Concrete has high transport costs, dry cleaning should be local
Other markets are national in scope, like airlines, breakfast cereals, and electronics

Concentration Ratios
Concentration Ratios: the share of industry shipments or sales accounted for by the top four or eight
firms
The n-firm concentration ratio is the share of industry sales accounted for by the industry's n largest
firms, usually 4/8
Two top four firms:
65,10,5,5
25,20,20,20
Both have the same concentration ratio, but do not exhibit the same level of monopoly power, 65
controlled by one firm
Not overly informative without more info, but can point out extreme contrasts

Herfindahl-Hirshman Index
Herfindahl-Hirshman Index: A way of measuring industry concentration, equal to the sum of the squares
of market shares for all firms in the industry
HHI = (s1)2 + (S2)2 + (S3)2 + + (Sn)2
S is a percentage of market shares of each firm in the industry
HHI is the sum of the squares of each market share
HHI is consistent with out intuitive notion of market power. Industry with several competitors of roughly
equal size will be more competitive than an industry in which one firm controls a substantial share of
the market

Applying the HHI


Hart-Scott-Rodino Act requires prenotification of large proposed mergers to the FTC and antitrust
division of the Justice Department
Allows for review and prevent mergers
Some agreements have complex rules, if no agreement is reached, agencies can challenge the merger in
court, when cannot be reached, merger is off

Coremicroeconomics Page 95

1992, merger guidelines based on HHI:


HHI < 1000, industry unconcentrated
1000 < HHI < 1899, industry is moderately concentrated
HHI > 1800, industry is highly concentrated
Below 1000, often approved, between, closely evaluated, challenged if merger raises by 100 points,
exceeds 1800, a postmerger rise in HHI of 50 points is enough to spark a challenge
Guidelines work well

Contestable Markets
Contestable markets: Markets that look monopolistic but where entry costs are so low that the sheer
threat of entry keeps prices low
Linux, Mac OS X, and Unix probably keep Microsoft from significantly overcharging for Windows

Future of Antitrust Policy


American antitrust legislation grew out of economic concentration and resulting predatory behavior
over a century ago
Microsoft case the first real attempt to apply old antitrust rules to "new economy"
Network externalities: Markets in which the network becomes more valuable as more people are
connected to the network

Coremicroeconomics Page 96

Chapter 11 - Theory of Input Markets (p267-272)


Saturday, November 02, 2013

6:25 AM

Coremicroeconomics Page 97

Competitive Labor Demand


Saturday, November 02, 2013

6:25 AM

Demand of Labor: Derived from the demand for the firm's product and the productivity of labor

Marginal Revenue Product


Marginal physical product of labor(MPPL): The additional output a firm receives from employing an
added unit of labor (MPPL = )
Hire an additional worker, produces 15 units
Get $10 per unit, so last worker hired is $150 or less (normal profit included in wage)
If the wage rate exceeds 150, will not hire
Marginal revenue product (MRPL ): The value of another worker to the firm is equal to the marginal
physical product of labor times the marginal revenue
(MPPL X MR)

Value of marginal product is equal to the marginal physical product of labor


The firm will hire seven workers if wages are equal to 100

Value of the Marginal Product


Competitive firms are price takers for whom marginal revenue is equal to the price of the product (MR =
P)
Value of the marginal product (VMPL): is equal to the price multiplied by the marginal physical cost of
labor
(P X MMPL)
MR = P, hence VMPL = MRPL in the competitive case
Would hire 7 workers rather than 3 in above figure because value of marginal product is greater than
wage rate for workers to maximize gains

Factors That Change Labor Demand


Demand for labor is derived from product demand and labor productivity
How much people will pay for the product and how much each unit of labor can produce

Change in Product Demand


Decline in product demand will lead to lower market prices, reducing VMPL and vice versa
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Decline in product demand will lead to lower market prices, reducing VMPL and vice versa
Will shift labor demand to the left if decline
Anything that changes the price of the product in competitive markets will shift firm's demand for labor

Changes in Productivity
Usually increases, but can come about from improving technology or because a firm uses more capital
or land
As MPPL rises, demand for marginal worker rises, willing to pay higher wages for same size or expand
workforce at the same rate
Capital-intensive industries often employ fewer workers, but usually high-skill high-wage

Changes in the Prices of Other Inputs


An increase in the price of capital will drive up the demand for labor
Expensive capital, substitute labor for it, so demand increases
More labor will be hired when wages fall, but amount depends on elasticity of demand for labor

Elasticity of Demand for Labor


Elasticity of demand for labor: The percentage change in the quantity of labor demanded divided by the
change in the wage rate

Same as price elasticity of demand for products except use wage instead of price of product
Measures how responsive quantity of labor demanded is to changes in wages
|EL|< 1, Inelastic
|EL|> 1, Elastic
The time firms have to adjust to changing wages will affect elasticity
Short run, demand more inelastic because labor is the only truly variable factor (Will hire more or less
despite changes in wages)
Long run, elasticity of demand for labor tends to be more elastic because all production factors can be
adjusted

Factors That Affect the Elasticity of Demand for Labor


Elasticity of Demand for the Product
The more elastic the price elasticity of demand for a product, the greater the elasticity of demand for
labor
Higher wages -> Higher product prices -> More easily consumers substitute -> The greater number of
employees that will become to wage rates
Employment is more responsive to wage rates when elastic
Ease of Input Substitutability
The more difficult it is to substitute capital for labor, the more inelastic the demand for labor will be
Computers cannot substitute for pilots in airplanes, inelastic demand for pilots
Pilots can secure high wages from airlines as a result
Easier it is to substitute, less bargaining power workers have, labor demand tends to be more elastic
Labor's Share of Total Production Costs
The share of total costs associated with labor is another factor determining the elasticity of demand for
labor.
If share is small, demand for labor will tend to be inelastic
For example, percentage of costs going to pilot wages is small, like 10%, then an increase in pilot wages
would only increase ticket prices a very small amount
Change in demand for air travel will be small, so demand for pilot labor is small

Competitive Labor Market Equilibrium


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Market supply for labor is the horizontal sum of individual labor supply curves
Not for demand though
When wages fall, it affects all firms
All want to hire more labor and produce more output
Figure above shows that at a wage rate of 100, market labor is 300 workers, individual firms hire six
workers

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Imperfect Labor Markets and Other Input Markets


Saturday, November 02, 2013

6:25 AM

Other inputs have some effect, capital, land, entrepreneurship

Imperfect Labor Markets


Product markets and labor markets contain monopolistic and oligopolistic elements
When a market contains only one buyer of a resource, the lone buyer is a monopsonist
Monopsony power is control over the input supply that the monopsonist enjoys
Monopsony: A labor market with one employer

Monopoly Power in Product Markets


Firms that have monopoly powers, price makers
P>MR, so VMPL>MRPL

Competitive: Equate wages and VMPL so LC at W0 (Pt C)


Monopoly: Equate wages and MRPL, so L0 at W0 (Pt A)
Same wage, but monopoly hires less workers
Workers have a much higher VMPL at this than they are paid, value to the firm is at B but only paid at A,
difference is known as monopolistic exploitation of labor: When a firm has monopoly power in the
product market, MR<P, so the firm hires up to MRPL = wage. MRPL is less than VMPL so workers are paid
less than the value of their marginal product

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Chapter 11 - Theory of Input Markets (p277-281)


Saturday, November 02, 2013

6:22 AM

Coremicroeconomics Page 102

Imperfect Labor Markets and Other Input Markets


Saturday, November 02, 2013

7:29 AM

Capital Markets
Capital includes all manufactured products that are used to produce goods and services.
Capital markets are those markets which firms obtain financial resources to purchase capital goods.
Resources can come from savings of households and other firms.
Suppliers of funds and demanders of these funds interact through loanable funds market
Each individual firm determines how many workers to employ, and the loanable funds market
determines interest rates, leaving individual firms to calculate how much they should borrow
Demand and supply curve of loanable funds
Demand, downward, price of funds decline, as interest rates go down, then quantity of funds demanded
rises
Supply, upward, willing to supply more when price (interest rate) is higher

Invest in I0 until cost of capital is equal to MRPK

Investment
Once market determines an equilibrium rate of interest, an individual firm like in panel B will take rate
of interest, or cost of capital, and determine how much to invest
Marginal revenue product of capital (MRPK) is downward sloping, showing that returns a firm earns on
investments diminish as more capital is invested
Invest until cost of capital is equal to marginal revenue product of capital

Present Value Approach


Considering upgrading capital, must evaluate returns it can expect over time
Invest today, takes years for returns
Compare investments having different income streams and different levels of required investment, firms
look at net present value: The value of an investment (future stream of income) today. The higher the
discount rate, the lower the present value today, and vice versa.
One hundred dollars a year from now is worth less than the one hundred dollars today. Can earn
interest on this money but would still end up with 100
Annuity is a financial instrument that pays the bearer a certain dollar amount forever
Suppose make 1000 a year indefinitely
Answer is through formula PV = X/I
Where X is the annual income and I is the market interest rate
So you would pay 20,000 on the annuity, 20000=1000/.05
Valuing future income today by that process is known as discounting
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Valuing future income today by that process is known as discounting


For example, someone wants to pay you 500 in two years and the interest rate is 5%
Use:
Where PV is the present value of the future payment, X is the future payment of 500, I is the interest
rate, n is the number of years into the future before the payment is made
So you would be willing to only pay 453.51 for the payment in two years of 500
However, more complicated if future streams of income are involved, must computed present value for
each individual future payment
Use:
Sigma is "sum of" Xn is the individual payment received at year n
So if you want payments of 500, 800, and 1200 over the next 3 years and interest rate is still 5%, it
would look like this:

Show that payments in the future are worth a lower dollar amount today
Use Present Value Analysis to determine if potential investments are worth while
Assume machine yields a stream of income exceeding operating costs over a given period
Present value of this income is compared to the cost of the machine
Machine's net present value (NPV) is equal to the difference between the present value of the income
stream and the cost of the machine
NPV positive, invest; NPV negative, dont invest
Interest rates high, firms will find fewer investment opportunities where NPV is positive since higher
discount rate reduces the value of income streams for investments
As interest rates fall, more investment is undertaken by firms

Rate of Return Approach


Alternative approach to determining whether an investment is worthwhile involves computing the
investment's rate of return
Known as firm's marginal efficiency of capital, or internal rate of return:
Uses the present value formula, but subtracts costs, then finds the interest rate (discount rate) at which
this investment would break even
Formula:

C represents cost of capital


At what rate of interest (i) will investment just break even?
Find where present value equals zero

Land
Natural resources that are inelastically supplied
Rent: The return to land as a factor of production. Sometimes called economic rent.
Some instances, supply of land is perfectly inelastic
Land isn't always perfectly fixed in supply. Land can be improved (irrigation in deserts, clear jungles,
drain swamps, etc)

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Land is fixed at L0
Rent is dependent on how demand rises and falls

Entrepreneurship
Profits are rewards that entrepreneurs receive for
1) Combining land, labor, and capital to produce goods and services
2) Assuming the risks associated with producing these goods and services
Must combine and manage all inputs, make day to day production, finance, and marketing decisions,
innovate constantly, and bear the risks of failure and bankruptcy

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Chapter 12 - Labor Market Issues


Tuesday, December 10, 2013

4:36 PM

Why some people are paid more than others?


Education?
Discrimination?
Different occupations?
Unions?
Unions in the 21st century
Legal associations of employees that bargain with employers over terms and conditions of work
Strikes and threats of strikes to achieve goals

Coremicroeconomics Page 106

Investment in Human Capital


Tuesday, December 10, 2013

4:40 PM

Role of education and on the job training(OJT)


Workers, students, and firms invest in themselves or employees to increase productivity
Called investment in human capital
Sometimes invest by taking lower wages for apprenticeships
Students invest by buying books and paying tuition, forgoing job opportunities, to learn new skills
Firms invest in their workers through OJT and in-house training programs that involve workers being
paid to attend classes

Education and Earnings


Increase income through education is one of the most certain methods

Education is a good investment, but must be balanced against the cost of obtaining that education

Education as Investment

High School directly into labor market


Vs
High School into college into labor market (has direct costs and forgone earnings)
Benefits show up in difference in earnings
2007, median earnings of college grads over 80% of HS grads
Benefits also show up in rate of return
Average return at nearly 20%, grads around the world earn on average nearly 20% more per year over
the course of their working lifetime than HS grads, taking costs of college as well

Equilibrium Levels of Human Capital


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Equilibrium Levels of Human Capital


Decision to invest in ourselves depends on supply and demand
Supply of and demand for funds to be used for human capital investment

Demand for human capital investment slopes down and to the right, reflecting the diminishing returns
of more education and that more time in school leaves you less time to earn back its costs
Ph.D. or med degree often well into age 30s
Need more money to bring their rates of return up above college-educated workers
Supply of investable funds is positively sloped since students will use the lowest-cost funds first (mom
and dad, government subsidized funds, then private market funds)
The most important factor determining the supply of investable funds for students consists of family
resources
Reduction in federally subsidized lower interest students will shift the supply curve left, lower
investments in human capital as a result
Demand for human capital is influenced by individual's abilities and learning capacity: more able the
person, the larger the expected benefits of human capital and investment
Discrimination in the labor market also plays a role
Expected earnings are affected by wage or occupational discrimination
People with reduced wage due to wage discrimination would have their demand curve shift to the left
because of reduced return on investment in human capital

Implications of Human Capital Theory


Investment -> More productivity -> More earnings
Younger people are more likely to invest, have longer earning horizons
Workers getting older earn more and have experience, opportunity cost for college is higher and have a
smaller post college earning period
Greater the difference between HS and college grads, more people will attend college
Reductions in cost of education lead to greater educational investment
People with high discount rates often are not willing to pursue doctoral or medical degrees because the
time between the beginning of the training process and the point when earnings begin is simply too long

Human Capital as Screening or Signaling


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Human Capital as Screening or Signaling


Investment -> Improving productivity -> higher wages
Acts as a screening/signaling device for employers
An argument that higher education simply lets employers know that the prospective employee is
intelligent and trainable and has the discipline to potentially be a good employee
Implication of this view is the controversial suggestion that social benefits for more public spending on
education is low. Meaning college doesn't enhance productivity, just competitive pursuits for resume
items, then return to public funds will be low
Doubtful that screening is the only purpose by higher education
If it were, the high costs of college and higher wage employers must pay college graduates would create
tremendous incentives for workers and employers to develop a less expensive screening device

On-the-job Training
Training done by employers, ranging from suggestions at work to sophisticated seminars
OJT can take many different forms
Often nothing more than instructions from a supervisor on how to help customers, operate a machine,
or retrieve items from inventory
Sometimes takes place in more formal setting away from job, like a college course
OJT costs approaches 80 billion a year, including training costs and the wages paid to employees during
training
OJT costs usually borne by employers, but workers may also bear some of the costs through reduced
wages through training period
OJT->more productive workers and competitive workers

General Versus Specific Training


General training: improves productivity in all firms (learning to use computers, word processors,
spreadsheets)
True for a college education as well as for the apprenticeships electricians, plumbers, and carpenters
undertake
Specific training: improves productivity only within the particular firm
Might cover the way a firm handles such issues such as order flow, inventory control and purchasing, or
familiarization of workers within the firm's specific products
Firms usually will not provide general training, workers have to acquire at their own expense
OJT must equal or exceed rate of return must be greater than other investments

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OJT is general training, workers expected to accept reduced wages during the training period, and then
earn higher wages than without training once completed
Specific training is usually handled differently. Because training increases productivity only within the
firm providing the training, firm will usually absorb the cost of this training keeping wages constant until
completed where it then increases
Dual labor market hypothesis splits the labor market into primary and secondary sectors
Primary: High wages, good working conditions, job stability, chances of advances, equity and due
process in administration of work rules
Secondary: Low wages, fringe benefits, poor working conditions, high labor turnover, little chance
of advancement, and often arbitrary and capricious supervision
Job crowding hypothesis breaks occupations into predominantelt male and female jobs. Pressure
of male trade unions appears to be largely responsible for crowding women into a comparatively
few occupations which is universally recognized as a main factor in the depression of their wages
Insider-outsider theory maintains that workers are segregated into those who belong to unions
and those who are not employed or non-union workers
All above hypothesis predict that separate job markets emerge for different groups

Without discrimination, equilibrium wages for everyone would be We


Once such a wage differential is established, the firms have no rea lincentive to eliminate the gap
Some people may simply prefer one occupation to another
Wages vary between occupations because of differences in attractiveness, difficulty, riskiness,
social status, and human capital investments required
Markets may naturally gravitate toward different equilibrium wage levels for different occupations
Occupations may require the same skills and effort, but be calued differently by consumers
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Occupations may require the same skills and effort, but be calued differently by consumers
Occupational segregation may also arise from disparate degrees of labor force attachment
Female labor force participation is often interrupted when women take a break from working to
have children
Will affect choice of women and employer for specific training
For women who anticipate spells out of labor force, prefer general training--nursing, teaching,
retail sales, secretarial or administrative work-- may look attractive. Do not have long career
ladders, can leave job easily and return or find new emploter
Most of these do not have high wages though
Some are result of socialization
"Men's work" and "women's work"
Many women may prefer occupations that are complementary to parenting

Public Policy to Combat Discrimination


The Equal Pay Act of 1963
Amended the Fair Labor Standards Act of 1938.
Requires that men and women receive equal pay for equal work
Equal work defined as work performed under similar circumstances requiring equal effort, skill,
and responsibility.
Some argue that it was a hollow victory because occupational segregation forced women into specific
occupations, causing them to earn less than men for essentially comparable work

Civil Rights Act of 1964


Made it unlawful to refuse to hire or discharge any individual or otherwise to discriminate against any
individual with respect to his compensation, terms, conditions, or privileges of employment because of
such individual's race, color, religion, sex, or national origin
Discrimination defined as an employment practice that has unequal impact on members of a minority
group compared to others

Executive Order 11246--Affirmative Action


Firms doing business with government at least 50k, then must submit an affirmative action program that
includes a detailed analysis of their labor force
Critics saw it as enforced quotas
Supporters saw them as breaking down discriminatory hiring barriers
Adding numerical adjustment for minorities is unacceptable, taking race into account to improve
diversity is

Age and Disabilities Acts


Protects workers over the age of 40 from discrimination based on age
Prohibits discrimination against people with a physical or mental disability who could still perform a job
with reasonable accommodation by an employer

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Economic Discrimination
Tuesday, December 10, 2013

5:43 PM

Economic Discrimination: takes place whenever workers of equal ability and productivity are paid
different wages or are otherwise discriminated against in the workplace because of their race, color,
religion, gender, age, national origin, or disability
Two theories:
Rests on notion that bias is articulated in the discriminatory tastes of employers, workers, and
consumers
Segmented markets approach, maintains that labor markets are divided into segments based on
race, gender, or some other category (often referred to as the job crowding hypothesis or dual
labor market hypothesis)

Becker's Theory of Economic Discrimination


Gary Becker's main contribution was that he broadened the issues that economists study
Prior, economists focused almost exclusively on the production and exchange of material goods and
services
1955, audience perplexed when speaking about discrimination based on race for the prices of goods
charged by businesses
Economics of Discrimination (1957) was not warmly received, recognized after civil rights movement
gained momentum in mid 1960s
Becker challenged discrimination benefiting the person who discriminates
Argued that employers who discriminate against women lose market share and profit
opportunities, do not hire the best employees available and because they pay mostly high-wage
male employees
Nondiscriminating firms would have lower labor costs and therefore higher profits
Wage discrimination still exists
Adjustment costs of firing unproductive workers giving them severance pay and then recruiting and
training new workers can be extremely high, especially with protections by unions and legal system
Women may be less mobile than men when it comes to work, less willing to move to accommodate
employer preferences, taking lower wage positions
If women continue to choose more occupations with more flexible career paths that do not heavily
penalize extended absences from labor market, wage differentials between men and women may
always exist

Segmented Labor Markets


Segmented labor markets: labor markets split into separate parts. This leads to different wages paid to
different sectors even though both markets are highly competitive.

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