Demand & supply: Demand: Curves movements Shifts right (demand) Increase demand Shifts left (demand) Decrease demand Slides upward (demand) Higher price = lower demand Slides downward (demand) Lower price = higher demand Shifting + caused by other factors that affect the quantity demanded but price remains constant Sliding up/down in the same position — changes in demand due to change in price only ‘Types of goods Normal goods: a good that when there is an increase/decrease in income will lead to an increase/decrease demand for that good Inferior goods: when one’s income increases, the demand for these goods decrease Consumer surplus - The amount the customers are willing to pay for additional units = Onthe graph: the area above the price paid for the good but below the demand curve - Managers application: use consumer surplus to determine the amount consumers would be willing to pay for multiunit packages ‘Supply: + Producers are willing to produce more units as the price of goods is higher Shift right Producing at a lower quantity when lower price of goods Shift left Producing more when higher price of goodsProducer surplus: - The difference between the price that the producer is willing to receive for a given quantity of goods versus the price that — producers can receive by oe selling at the market price va - Eg, The producers are willing to sell for less than $400 for below 800 units, but they will receive $400 for selling those 800 units, © 10 209 200 40 $00 coo 700 800 80 even if producers are willing to sell the units at lower price Geometrically, producer surplus is the area above the supply curve but below the market price of the good. Thus, the shaded area in Figure 2-9 represents the surplus producers Price A ‘cuaty Market equilibrium: - The intersection where supply and demand curves meet - Determining the price to sell good - Good surplus: - Good shortage: Price ceilings: + The maximum legal price that can be charged Price floor: + The minimum legal price that can be chargedTypes of elasticities: 1) Own elasticities of demand: + Measures the responsiveness of quantity demanded to a change in price * Due to inverse relation between price & quantity => number will be negative +>: elastic + <1: inelastic += 1: unitary elastic 2) Cross price elasticity of demand + responsiveness of a demand for one good due to the changes in price of a related good 3) Income elasticity: + Measures the responsiveness of demand due to the changes in income 4) Advertising elasticity: + measures the elasticity of good X and Y due to the change in advertising directed to product Y Indifference curve: + Acurve that shows the combination in preferences of 2 goods that give consumers the same level of satisfaction + Along the curve, consumer is indifferent between any combination of goods + Different consumer will have a different indifferent curve Marginal rate of substitution: + The rate that consumer is willing to substitute one good for another good and still maintain the same level of satisfa Budget constraint: => slope = -Px/Py + restrict consumers by forcing them to buy the amount of 2 goods that is affordable under the budget line Market rate of substitute: + The exchange rate between the 2 goods in the market and is influenced by market forces supply, demand, prices, market conditions — Changes in income: + Shifts right: increase in income + Shifts left: decrease in income — Changes in price (1 good remains the same price, but the other good's price decreases)+ Reduction in price of good X and price of good Y remains constant will not change the Y intercept + But will change the X intercept => making it tums counterclockwise Consumer equilibrium: + Choosing the consumption bundle that maximises their utility/ satisfaction, that lies inside the budget set and lies on the budget line er Teeter renee Substitution effect: income remains constant, but reflects how consumer moves along the indifference curve due to the CHANGE in PRICE, Income effect: shows the movement from one indifference curve to another from the change in income affected by the change in price + When good X is a normal good and it increases the price => JI + FH => consumer's income fallsProduction and pricing management The produetion function: the maximum amount of output can be produced with a set of inputs Productivity: 1, Total product: The maximum level of output with a given amount of inputs with maximum effort 2. Average product: How much each worker! machine contribute to the total output of firm labor AP ys AP, and the average product of capital (AP,) is AP, 3, Marginal product: The change in additional output due to the change in additional employees/machineries MILyIuLU UY UNL LAE A vapitas. Ay ‘The marginal product of labor (MP2) is the change in total output divided by the change in labor: 40 MP, 1 SL Anegative marginal product = resulting in less Total Product — inefficient Algebraic forms of production function: 1) Linear production function Q=F (KL)=ak + BL a&b = constant: the ratio of capacity Capital and Labour can produce for quantity F (K.L) = units of Capital and Labour Eq. it takes workers 4 hours, while machine can do it in 1 hour => capital is 4 times more effective than labour Q=F KL) =4K +L‘There are 5 units of capital and 2 units of labour Q=F (6,2) = 4(5) + 1(2) = 22 products Overall can produce 22 units of output from the statistics of productivity and units of inputs => assumes that there is a perfect linear relationship with all inputs and total outputs 2) Leontief Production Function Q=F (KL) = min {ak, aL} Implies that inputs are in proportion with outputs eg. the taxi industry => 1 driver and 1 car= 1 ride, 2 2 drivers and 2 cars = 2 rides, and so on. But 1 driver and 5 cars = 1 ride => level of outputs and inputs are 2 proportionate to each other a&b = constant: the ratio of capacity Capital and Labour (b) Leontiet can produce for quantity F (KL) = units of Capital and Labour How many outputs are produced when 2 units of labour and 5 units of capital are employed? Q=F (5,2) = min {3(5), 4(2)} Q= min (15,8) Choosing the minimum which is 8 => we know that 5 inputs of labour and 2 inputs of capital will produce 8 units => Refer to graph: choosing the géc vuéng (Ia doan minimum point) 2 inputs are proportionate 3) Cobb-Douglas production function Q=F(KL)=K*al*b Isoquant: shows the combinations of inputs that will generate the same output => any combination of capital (K) and labour (L) will produce the same level of output + Isoquant shifting to the right => more inputs used Isoquants are convex because capital and labour is not perfectly substitutable — it takes a specific amount of labour to replace a single unit of capital— rate to measure at which labour and capital can replace each other is — concave shape because due to the law of diminishing returns => once the production reaches its optimal level of production capacity —» results in small increases of output Marginal Rate of Technical Substitution (MRTS) — this is the slope of the isoquant -> as this rate also indicate any point along the curve how much capital is needed to replace a unit of labour and vice versa Marginal product of labour (L)/ Marginal product of capital (kK) Calculate slope => Difference in K/ Difference in L Isocosts: the straight line that shows the combination of inputs that will cost the producer the same amount of money Isocost slope: Straight line function: yeax+b Calculation for isocost C=wl ak C = amount spending w= wage rate of labour r= rental rate of capital Since the Y-a is capital and X-axis is Labour —> re-arrange as the following rk =C+wl K=Cir- (with => isocost shifting to the right => increase in input = increase in Total cost => shifting left => reduce in input ‘To maximise costs, producers need to minimize costs as much as possible => For a firm to do that, they should produce at the tangent point, where the isoquant curve touches the isocost line => the slopes of both are the sameMPLiw = MPKir => wit If MPLiw > MPKir => labour is more effective than capital, firm should use less capital and more labour to reduce cost Optimal input substitution: To minimize costs of input when there is a : rise in price of labour/capital, managers 1 should use more of the other input when that. input's price rises Iflabour price incteases => make the line rotate counterclockwise => managers should choose the tangent point where isoquant curve touches the new line of isocost a eel ongen 4 Figure 5-10Cost function: ‘Types of short-run costs: Total cost = sum of fixed and variable costs Fixed costs: Costs that do not change with changes in output eg. machinery maintenance costs Variable costs: Costs that changes with output Average Fixed Cost = FC/Q ‘Average Variable Cost = VCIQ Average Total Cost = TC/Q Marginal Cost: the cost of producing one additional output Sunk cost: the cost that is lost forever once it has been paid — people say that sunk cost is irrelevant in decision making because it is non-refundable, but it can be related to profit (irrelevance of sunk costs) Algebraic forms of cost functions: Cubic production functions: Average Total Costs: Types of long-run costs: Economies of scale: — producing in large quantity can reduce production cost — as materials are bought in bulks, can earn discounts, ete. — from 0 - Q* = economies of scale — higher output = lower costs — from Q* and beyond = diseconomies of scale —> increasing size of operation increase the minimum average cost Economies Diseconomies‘Accounting costs: = Direct payment to labour and capital to produce outputs + costs that appear on the financial statement of the firm Economic costs: - The potential costs that managers use to assess the investment is worth the expenditure Multiproduct cost function: (for firms with economies of scope: a firm that produces many types of products) C(Q1,Q2) = Costs of both output from product 1, and from product 2 Economies of scope exists when: total costs of producing both produce 1+2 is less than the total cost of producing product 1 or 2 separately Cost complementary: when the marginal cost of producing 1 type of output decreases due to the increase of another type of output quantity Competitions 1. Perfect competitive market: PRODUCE AT OUTPUT PRICE = MARGINAL COST + Key conditions: - Many sellers and buyers in the market, each has relative small share in the market - Each firm makes homogenous products - Have perfect information + consumers know the quality and price of each firm's product - No transaction cost (eg. transportation cost) - if one firm charge slightly higher price -+ consumer would not shop and look for a cheaper firm- Free entry and exit from the market - can enter if they earn economic profit & can exit when earn losses In perfect competition: price is determined bythe, , interaction of all buyers and sellers in the market => a manager's pricing decision is based on the intersection of the market supply and demand — because the market's demand and supply curves depend on the market sellers and buyers, + The firm's demand curve with be a perfectly straightline — perfectly elastic — any rise in price above the market = would sell nothing set the price that other firms set Maximizing profit: om Revenu Di=P=MR = Price x Quantity (R=PQ) Price = the market price In perfect competition: MR = P of the market Marginal revenue (MR): the change in revenue attributable to the last unit of output Profit-maximized when: MR = MC . Area of profit - the intersection of MC and MR 1 e parallels to that position on the ATC curve \ " Q* = The amount of quantity that maximizes the output Minimizing losses:If the profit- maximization point (where MR = MC) is still below the ATC = Making losses However in the graph, price still exceeds the AVC => each unit sold is still generating more profit than the variable inputs — béi vi, Price vn exceed de Variable Cost, thés nén variable cost dc covered, ma ATC I& fixed cost + variable cost => nhiing cai loss la twong dong véi lvgng tién cila fixed cost => day chi a short-run loss Shutdown rule: khi ma chay profit-maximised price ma van below AVC => phai shutdown Short-tun firm and industry curves: => In perfect competition, the short run supply curve is the curve of MC above the minimum point of AVC + Firm will produce at the output quantity when P=MC. The quantity supplied at different prices => In the short-run, firms would try to cover the variable costs, but in the long-run they should try to cover all operation costs and consider making profits 2) Monopoly: a firm serves an entire market for a good that has no close substitute + Monopolistic => the firm's demand curve is also the t same for the market's demand curve (because of producing homogeneous products) + Monopolistics are restricted to price-quantity combinations along the curve => a monopolistic cannot have both high price & high quantity, high quantity can only achieved at lower price, or else consumers would not buy at all Sources of monopoly power: Economies of scale ‘© Economies of scope ‘© Cost complementarity‘* Patents and other legal barriers Maximizing profit: Monopolistic Marginal Revenue ‘Marginal Revenue for inverse demand function MR=a+2bQ ‘Suppose the inverse demand function for a monopolist's product is given by P= 10 - 2 What is the maximum price per unit a monopolist can charge to be able to sell 3 units? What is marginal revenue when Q = 3? — finding price: P=10-2(3)=$4 — apply into the MR for inverse demand function formula MR = 10 - 2x2x3 = -2 Output decision: => choosing the output level at MR = MC => choosing the intersection of MR and MC. => Monopoly Pricing Rule: from that intersection point, moves towards the demand curve and cross it to the Price axis that is the profit maximization price => the price on the demand curve correspond to the profit maximizing Q Deadweight loss in Monopoly: Social welfare/ deadweight loss due to producing ' below the competitive level3) Monopolistic competition: + There are many sellers and buyers + Each firm produce differentiated products => products are close but are not substitutes + Free entry and exit from the industry + has a downward sloping demand curve - demand curve of an individual firm (because of differentiated products) Profit maximization: Point where MR =MC PEI Suppose ams ora monoplisially compte fm hae esd inven demand uve as P= 100-20 cgi=s+20 ers pti-msiniing pie and quay ad eh maxinum os seth MR = 100 ~2)2K0) = 100-40 Mom? MC = 2=> DERIVE FROM C(Q)!!IIHIt Long-run equilibrium: - Due to free entry & exit nature + when a firm’s demand is above the ATC => earning Positive economic profit => lures competitors in => customers substituting the firm's product => shifts the demand curve to the left where it is tangent to the ATC curve => at this point => firm's economic profit is zero => no additional incentive for other firms to enter => they exit - So the demand product by the firm remaining in the market will increase - => in the long-run equilibrium, firms will sometimes have to 1, P>MC or 2, P=ATC To increase the firm's product differentiation, firms in monopolistic competition would invest in advertising:1. Comparative advertising + Differentiating its products from other brands 2. Brand equity + Additional value that the brand adds to its products, 3, Niche marketing + advertising new products that fullfl special needs in the market 4. Green marketing + a form of niche marketing that firms target segment that concerns about the environment 5. Brand myopic + a manager that is satisfied with the existing products and brand, slow to launch new products and changes upon trends Optimal advertising decision + Advertising costs can lead to incremental revenue, additional units sold after advertising + To determine the optimal advertising rate: Ratio of sales-to-advertising: E, \'s expenditure for advertising/ Firm's sales or revenue A QA = Product's own PED/ Advertising elasticity of demand for the firm's Ro —Eg.p Product + Firms with market power (monopoly or monopolistic Josie competition) face a demand curve To fad he pofit-maxinizing advertising oss ratio, we simply lus Ea, that is not perfectly elastic => if ome il ering consumers preference/ demand grea can be influenced => firms can ‘Thus, Corps Industries’ optial advertsng-o-sles rai is 2 percea—to maximize profi, te engage in some degree of fc sto pend 2 perso revenveson aver advertising => the spendings on advertising should be depended on the quantitative impact on advertising demand + The more sensitive the advertising demand greater advertising demand => the greater additional sales sold due to increase in advertising expenditures = greater optimal advertising-to-sales ratioOligopoly models Oligopoly: like monopoly but instead of 1 dominating firm, there are many dominating firms (2-10 firms) + Products can be homogeneous or differentiated + In this market, competitors will match the price change => managers should reduce price in order to sell more Profit maximization: ‘Sweezy Oligopoly + How firms will react to price increase and reduction + Characteristics ‘A few firms in the market serving the customers. Produce differentiated products Each firm believes that competitors will cut their prices during price reduction, but will not raise their price when there is a price increase Barriers to entry & exit + The demand curve of Sweezy model is kinked + Ifthe marginal cost is reduced, the profit-maximizing quantity remains the same at QO and still be sold at PO time Cournot Oligopoly + Determining firm's output levels compared to the other's firm output level at the same + Characteristics ‘A few firms in the market serving consumers Differentiated or homogenous products Believes that rivals will hold heir output constant, not considering adjustments or dynamics overtime Barriers to entry & exitReaction function & equilibrium: Reaction function: shows the relationship between the quantity firm should produce to maximise profit and the amount it assumes other firms will make Equilibrium: intersection of 2 firms — firms will decide to stop changing their output quantity until they both meet this point, because they believe that in this situation neither the firms will have the incentive to change output + The profitemaximization quantity of 1 firm is dependent on firm 2's output level Marginal Revenue for Cournot Oligopoly: MR =P - MR\(Q1, Q2) MRJ{Qy Q2) Isoprofit curves + The combinations of outputs of all firms that yield a given firm the same level of profit on + Every point on the curve will yield firm 1 with the same amount of profit + If point is closer to the monopoly point => firm earns more profits + isoprofit curves do not intersect each other + Khi Fim 2 produce at Q2* thi firm 1 nen produce o profit-maximization quantityReduction in marginal costs: + IFMC increases, in Cournot, managers still should produce at the same quantity as before Collusion: * The area in which firms are allowed charge higher price or restrict output and would still be agreed by consumers - because the market is owned by a few firms 3) Stackleberg oligopoly + Operates like in a Cournot oligopoly + But there will be a “leader” firm to set/decide its profit: maximizing output, then the rest of followers" will react to this output decision + The followers’ profit-maximizing level of output is determined by the leader's reaction function Finding the equilibrium output Fermuta:Equlirium Outputs in Stackelberg Oligopoly. For the lina Givers) de and market price: ‘mand funtion Paa-HQ,+09 snd ost functions ‘The leader's utp is 1. Inverse function will be given for both firms, and also their cost functions.DEMONSTRATION PROBLEM 9-6 ‘Suppose the inverse demand function fr two firms ina homogencous-product Stackelberg oligopoly is given by ~ +0) and cost functions forthe two firms are Fi 1s the Tear, ar im 2s the Follower, 1 Whats im 2's reaction function? 2 Whatisirm T's coup? 3, Whatis Frm 2s cup? 44. Whatis the market rie? 1) Firm's 2 reaction reaction function ‘sep? ‘Sincere only answer up 133 quot and pei he other subpar (opto) you'd ike aoe. 1. The reaction fant of fim 2 ca be computed 0-4020,-0.2 1820.0, ‘There cin fn fn 282 ANSWER: 1. Using the formula for the fllowe's eatin function, we Fd 1 0:=740))=24— 70) 2. Using he formula given forthe Stacktbere leader, we find so42—4 2 3. By plugging the answer to part? into the reaction function n part 1, we find the fllone's output tobe a= ey Pas -(12424)=144) Bertrand Oligopoly +A market assumes that the firms sell identical products and customers are willing to pay for the monopoly price + Characteristics: - A few firms in the market serving many customers - Firms produce products at the constant marginal cost - Firms engage in price competitions and react optimally to prices charged by the competitors — all consumers will purchase from firm charging the lowest price - Consumers have perfect information and no transactional costs - Barriers to entry and exit + Firms in bertrand oligopoly would charge price low but the minimum price is when P1 = P2 = MC, below MC would make a loss * But price is too high = would sell nothing the Bertrand trap: making many firms have to use advertisement to differentiate their products so if higher prices are applied —> will not lose customers 5) Contestable market + All firms have access to the same technology + Consumers respond quickly to the price changes + Existing firms cannot respond quickly to entry by lowering price + No sunk cost So that. + Existing firms has no market power over consumers + Firms eam no economic profit + Equilibrium price = marginal cost Because firms can enter the market and consumers quickly react to price changes, sunk costs are a definite payment by new entry firms. If they enter by offering lower prices than the existing firms, it eams profit. But then if incumbent firms charge lower price => new entrants would not have any customers left => sunk costs must be covered by profit immediately. Pricing strategies: + Deal with pricing strategies decisions for firms with market power in monopoly, monopolistic competitions and oligopoly REMEMBER:+ Firms with market power faces a downward-sloping demand curve => the higher the price the less amount of goods sold + Profit-maximizing P and Q = where MR = MG Monopoly & Monopolistic competition MR from own price elasticity of demand: => because in these competitive markets, MR = P But also because MR = MC ep +B | = MC __ inprofit-maximizing, we are solving for P Ep P= M T+ EMC The price that maximizes profit is K times MC P=KxMC In which K = Efi(1+Ef) => this is profit-maximizing markup factor Eg. For a clothing store, the manager estimates that the elasticity of demand is -4.1 => K = 4 1I(14 4.1) = 1.32 Profit maximizing price is 1.32 times marginal cost = 1.32MC MARK-UP PRICING STRATEGY: + The more elastic the demand is the lower mark-up price should be made + In perfectly competition, if elastic is perfect, mark-up should equal to the MC Example: The manager of a convenience store competes in a monopolistically competitive market and buys cola from a supplier at a price of $1.25 per liter. After some experimentation with her pricing and conversations with managers in different markets, she perceives that the elasticity of demand for cola sold by her store is -4. What price should the manager charge for a liter of cola to maximize profits‘The marginal cost of cola to the firm is $1.25, or 5/4, per liter and K = 4/3. Using the pricing rule for a monopolistically competitive firm, the profit-maximizing price is P= lid=3 or about $1.67 per liter. Pricing strategy Mark-up for Cournot Oligopoly: + Because in Count Oligopoly,there are a few firms and those will have their output quantity dependent on other firms in the market Profit-Maximizing Markup for Cournot Oligopoly If there are W identical firms in a Cournot oligopoly, the profit-mi smatket is 1g price fora firm inthis [hue +NEu| where Nis the numberof firms in the industry, Ey isthe market elasticity of demand, end MC is marginal cost. For Cournot oligopoly firms selling identical products: - An individual firm's demand is N times the market elasticity of demand Er = NEy Eg. Suppose three firms compete in a homogeneous-product Cournot industry. The market elasticity of demand for the product is ~2, and each firm's marginal cost of production is $50. What is the profit-maximizing equilibrium price? 3-2)! (1+(8(-2))] x 50= $60 YIELDING GREATER PROFITS + Enables producers to extract additional surplus from consumers 1) Price discrimination ‘© Charging different maximum price to different types of customers + First-degree price discrimination - Charging the maximum price for each customers based on how much they are willing to pay for each unit / but it would require firms to know exactly price each customer is willing to pay - The customer's willingness to pay lies within the consumer surplus area, managers can charge the maximum price discrimination price for a small incremental of 0-5 additional units - Can occur only if managers have PERFECT INFORMATION about customers’ willingness for each incremental of output + Second-degree price discrimination ‘Charging discrete schedule of dectining prices for different ranges of quantities © Eg, electricity companies charge higher for the first 100 kW usage than the subsequent capacity => makes customers sort themselves according to their willingness to pay for alternatives of quantities => does not need to know specific characteristics of customers + Third-degree price discrimination © When firms recognize that there are different demands for different customer segments => eams profit by charging different customer groups different prices Eg. Theme parks charge different prices for adults and children MR of 2 groups should be equal to each other“Fel 1+E, [2] Ey 2) Two-part pricing * Charging a fixed fee for the product, but in addition with per-unit charged with each product purchased © Eg. Fitness club/ Golf course —> customers had to pay membership fees + a charge to use the facilities © Consider the consumer surplus as well Here: + The firm’s profit is Profits = 16 (6-2) x4= $12 ve (@) Standard monopoly pricing Meanwhile consumer surplus is: ((10-6) x 4y2= $8 => customers receive $8 for 4 units of purchase => each unit they receive is $2 => TO CONSIDER THE CONSUMER SURPLUS => SHOULD CONSIDER THE WHOLE BIG TRIAGLE AREA INSIDE WHERE DEMAND AND MC INTERSECTS => [(10-2) X 8/2 = $32 Fonte St piNon-graph example Suppose the total monthly demand for golf services is Q = 20 - P. The marginal cost to the firm of each round is $1. If this demand function is based on the individual demands of 10 golfers, what is the optimal two-part pricing strategy for this golf services firm? How much profit will the firm earn? 1) Two-part price: Quantity = 20 - 1 = 19 — the base of the triangle Height of triangle: because MC = $1 and MC is the minimum point for price to be set Price on the demand equation = $20 = 20 - 1 = height => area of triangle [(20-1) x 1992 = $180.5, Individually = 180.5/10 = $18.5 per golfer => firm’s profit is $180.5 per month - fixed costs 3) Block pricing Identical products are packaged together to enhance profits to force consumers buy all or none © Eg, Toilet paper package, sodas in a six-packProblem: 1 ‘Suppose a consumer's (inverse) demand function for gum produced by a firm with market power is given by P = 0.2 ~ 0,04Q and the marginal cost is zero, What price should the firm charge for a package containing five pieces of qum? Q=5, P =0.2— imagine on the graph => [(0.2-0) x 5/2 = $0.50 => firm extracts all of the surplus by charging $0.50 for 5 pieces of gum It will sell 8 units to the customers, what is the amount of suitable block pricing? P=10,Q= Calculate: Quantity = Base of the triangle = 8 Height = 10 - 2 because $2 is the minimum point of MC and price should be charged above MC => [(10-2) x 8) 2 = $32 for 8 units Commodity Bundling + Bundling several different products together and selling them at single bundle price + Eg, Airlines offering airfare, hotels, meals at bundled price+ Managers would need to know how much each customer is willing to pay for each product within the bundle aE) Cm Commodity Bundling Valuation of Computer ‘Valuation of Monitor $200 300 + Ifa computer is charged at $2000, firm will only be able to sell to consumer 1 not 2, the same for monitor being sold at $200. Only consumer 1 will buy not consumer 2 + But if Computer is sold at $1500 and monitor at $200 => can sell to both consumers => earns $3400 + But firms can charge a bundle price of $1800 (Computer + Monitor) => which is a profit-maximizing price below/ or equal to both consumer's valuation => they would buy + Firm earns $3600 => earning $200 in extra to not bundling PRICING STRATEGIES FOR SPECIAL DEMAND STRUCTURES AND COST: 1. Peak load pricing © Charge a higher price during peak hour (demand) than during off-peak 2. Cross-subsidies Whenever the demand for 2 products produced are interrelated through cost and demand => firms may induce profit through cross-subsidization — selling 1 product at or below cost and the other product above cost Charging 1 below cost stimulates demand for the other complementary product Eg. Kindle - to read ebooks user can download the Kindle App for free and purchase book on the app, but they also offer Kindle reading tablet along with the app 3, Transfer pricing ‘This pricing is for internal transaction * The upstream division selling inputs to downstream division © Upper division would try to NOT follow the incentive to maximize their division's profit when selling to lower divisions, because it would lower the overall firm's profit => CONSIDER A FAIR PRICEFOR MARKETS WITH INTENSE PRICE COMPETITION 1. Price matching * A firm offering a price to match any lower price offered by a competitor + But setting price matching strategies managers will need to consider their MC, because if the price is lower than the MC => make a loss + Eg. A TV firm's MC is $300 and yours is $400 => they set price at $300, you cannot set at the ssame amount because you will make a loss 2. Induce brand loyalty (for Bertrand competition) + Suitable for Bertrand where firms compete primarily on price + Inducing brand loyalty, so customers would stay even if other companies offer a lower price + Reduce number of customers who switch to other firms + This strategy would work if consumers see the product as distinct rather than perfect substitute 3. Randomized pricing (Bertrand oligopoly) +A firm varies its price hours to hours and days to days + Creates uncertainties for customers as prices are randomized => making it unpredictable for customers to know which firm as the lowest price in the day => demotivates consumers to actively compare prices => firms are less vulnerable to losing customers to low-priced rivals + In Bertrand, rivals try to undercut the firm's prices to attract customers => randomized pricing makes in unpredictable for a rivals to precisely predict and undercut the firm's pricing strategy => reduce price competition and firm would earn more potential profitabilMACRO. GROSS DOMESTIC PRODUCT (GDP) 1. Define gross domestic product (GDP) and explain why it i macroeconomic activity. an important measure of GDP: The market value of all inal goods and services produced in a nation during a period of time usually a year Its importance: + Itis the measure of a nation’s economic performance + The GDP tells how much a nation is producing => telling how the economy is doing => because when an economy is doing well meaning it is producing more, prospect of job is improved and living standard can rise + Since GDP measures in the nation’s currency not the quantity produced it can effectively, evaluate the monetary value of products * GDP would only take account of: 1, New Domestic Production ‘* Which only include Current Transactions (not Secondhand Transactions) - only newly produced goods that add to the existing stock of goods 2. Would not take account of Nonproductive Financial Transaction ‘© Exclude nonproductive financial transactions - like Transfer Payment: welfare, social security, unemployment benefits granted by the government as they are not current and new output 3. Counts only the final goods ‘GDP only counts towards the final goods - finished products distributed tousers2. Compare and contrast how GDP can be measured using the expenditure and income approaches To measure GDP — The Circular Flow Model - the diagram that shows the exchange of money, products, and resources between households and businesses + The upperhalf = the Product Markets - households exchange products produced by firms. ‘© Red apply = all finished products and the value of goodsiservices produced, sold and delivered to customers ©The blue demand = why businesses must produce goods to satisfy customers ‘© Consumers will contribute to the Circular Flow Model using dollars it shows the flow of expenditure ‘This partis the demand and supply (graph) determine the price and quantity sold without government interference + Bottom hald - the Factor (Resource) Market: where firms demand the natural resources, labout, capital and entrepreneurship neded to produce goods and services ‘@ The model assumes that supply resources come from household and businesses must purchase all their resources from the households — blue demand arrow = payment to households for these resources — households would earn income — the factor (resource) payment is also using the market supply and demand to determine the price and quantity “iI This model assumes there is no saving by household —- they spend all of their income +11 This model assumes that all businesses spend their profits/income to then again purchase resources from the Factor Market => This model fails to mirror the real world + This model demonstrates a flow rather than stock — it shows the rate of change and tell nothing about the total amount of goods, service, money... in the economy = Flow: rate of change in a quantity during a given time period —» units: per time period Eg. number of games purchased per day - Stock: quantity measured at one point in time FORMULA TO CALCULATE GDP: GDP =C+1I+G+(X—M)This is The Expenditure Approach - The national income accounting method to measure GDP by adding all the spending for final goods during a time period 1, C+ Personal Consumption Expenditures ‘* Household's spending for durable goods (automobiles, appliances, etc. => last longer than 3 years) and non-durable goods (used and last less than 3 years) and services 2, 1+ Gross Private Domestic Investment ‘© Accounts of the income account include all private companies domestic spendings by businesses for investment in capital assets that are expected to earn profits in the future ‘© _Itis the sum of Fixed Investment Expenditure (machinery, tools, computers...) and Change in Business inventories 3. Government Consumption Expenditures and Gross investment (6) ‘© Government spendings on the value of goods and services that government at all levels purchase — eg. highways, bridgos © But EXCLUDE spendings for Transfer Payment - welfare, social security, unemployment benefits 4, Net Exports (X-M) © X= Export © M= Import ‘* Negative Net Exports can reduce GDP - when import > export II, The Income Approach GDP FORMULA: GDP = compensation of employees + rents + profits + net interest + indirect taxes + depreciation 1. Compensation of Employees + Income eamed by wages, salaries for labour 2. Rental Income + Income from rent received by property owners who permit others to use their assets during a time period 3. Profits + Proprietor's income: Forms of incorporated incomes, setf-income propietorships and partnerships who own their business and pays themselves + Corporate profits: all income earned by stockholders and corporations —+ these are BEFORE TAX 4, Net interest + The interests receive and pay by households 5. Indirect Business Taxes+ Taxes levied as a percentage of goods sold and collected as a part of firm's revenue 6. Depreciation * Measuring the wor out level of on consumption of fixed capital, machineries or buildings will decrease its value over time => businesses will have to pay for the depreciated rate 3. Outline the shortcomings (disadvantages) of GDP as a measure of economic well-being. 4. Nonmarket Transaction * GDP only includes only market transactions and exclude unpaid activities - taking care of children, homemaker production, the do-it-yourself home repairs and services Eg. bringing the clothes to the dry cleaner, GDP includes the bill paid but exclude laundering the same clothes if you wash them yourselves at home => The final GDP proposes an imprecise measure of the actual efforts and money put into do: unpaid services and products yourself > However, if GDP includes these => unfair comparison for one nation to other countries, because nations in less developed countries, they might do-it-themselvces services more than going out and hire other people to do it 2. Distribution, Kind, and Quality of Products + The qualitative differences of firms are not considered in the GDP, for example, a firm may appear to be economically well-off because they are only consumed by a few rich people, while the rest of the countries are stil poor. + Or that the quality products and kinds of goods produced between companies are also not included in the GDP => cannot compare each company’s GDP precisely and matching the comparison for similar criteria to more effectively evaluation 3. Neglect quality of lfe + GDP does not include quality of life - leisure time employees are choosing over work contributes to less compensation of employees in the economy 4, The underground economy + The final goods with a value determined in the black markets, ilegal gambling, prostitution, illegal guns or drugs, avoid paying tax => the current measure of GDP does not cover the society entirely + Some economists measured that the underground sector is 9% of the GDP 5. Negative Externalities + The imposed costs on the society - pollution caused by chemical plants, air, water, noise pollution => not considering these downsides = GDP is overstating the nation’s well-being GDP Alternat+ To value more diverse economic activities - Measure of Economic Welfare (MEW) or Genuine Progress Indicator (GP!) 4, Summarize other national income accounts beyond GDP. National income (NI) = GDP - depreciation (the consumption of fixed capital that is worn out in the production process) - do not include transfer payment Personal Income (Pl) = The total income received by households that is available for consumption, saving and personal payment of taxes - this includes transfer payment Disposable Personal Income (Dl) = The amount households have, to spend or save after paying taxes 5. Distinguish nominal and real GDP and explain why GDP is a better measure of economic activity over time Nominal GDP: the value of all final goods based on the existing prices during production - unadjusted for other factors like inflation Real GDP: the value of all final goods produced during a given time based on the prices existing in a selected based year - value adjusted for inflation or deflation GDP chain price index/ GDP Deflator: a broad price index to convert nominal GDP to real GDP. —+ a measure that compares changes in the price of all final goods produced in a given time period Real GDP nominal GDP __ 199 GDP chain price index Over time: - We can use the calculations to assess the GDP Chain Price Index over time, using a specific year as a base year to compare with the current year’s nominal GDP and the base year's GDP Chain Price Index to calculate the current year's real GDP => Can show the increase or decrease in price over time - Chain price > 100 dollar(currency) to fall ~ Chain price <100 = prices falls causing the real purchasing power of dollar (currency) to be higher than the base year rices rised since that base year causing the real purchasing power of INFLATION1. Define inflation and deflation. Inflation: an increase of general (average) price of goods and services in the economy Deflation: a decrease of general (average) price of goods and services in the economy 2. Describe how the consumer price index (CP!) is used to measure the rate of inflation. Consumer Price Index (CPI) + Itis used to measure the rate of inflation * This index measures the changes in average price of the goods consumed by consumers + To determine how rising prices change the purchasing power of consumers Calculation: + Choose a cost of the same market of the current year-price and the same market of a base year-price to compare cost of market basket of products at current-year (2022) prices opr = —Coet Ot market Basket oF proces at current year (2002) prices _ cost of same market basket of products at base-year (1982) prices The cost of market basket of products is calculated as: + The price of that year x purchased quantity + Total up the market basket cost of each product category oR CPI in given year ~ CPI in previous year CPI in previous year Annual rate of inflation 100 + Negative rate = deflation+ A fall of inflation rate between 2 years is called Disinflation 3. Outline some of the criticisms of the CPI as a measure of inflation. 1. CPlis based on the standard market basket of goods => standard and general —> do not reflect with the actual purchases of customers. Eg. A person's spending is concentrated on Hotdogs, jeans, lemonade, but the prices of these decrease while the overall inflation rate is 5% => CPI could be exaggerating also not reflect accurately to specific consumer demographics. Old people would spend more ‘on medicals than normal families and medical products tend to increase more quickly than the price of other things we buy, the inflation rate for other things may seem mare moderate — the general CPI rate underestimates the real inflation rate that old people would have to normally pay for 2. Quality - sometimes products’ prices are reasonabl increased because the quality of product is improved from its old version (ald car vs new car). But in the general CPI, itis hard to determine how much of the price going up is allocated to quality or how much is it because of inflation? 3. Using the calculation with comparing with the base year, ignores the law of demand. According to the demand law, when prices increase, consumers will purchase substitutes, But the CPI, uses the market basket cost that takes into account of the PURCHASED QUANTITY => and the number does not automatically change to the actual shift in demand due to price changes The CPI sticks to a fixed quantity purchased by consumers and not changing the quantity due to shift in demand => seems like prices are changing because they are going up because they are 4, Summarize why some people are hurt while others benefit from inflation. 4. Inflation shrinks income: - Reduces living standards by deciining one’s purchasing power of money, the higher inflation = the higher the decline in goods that can be purchased using one’s nominal income (the actual wage received after a period of time), real income (the actual income received adjusted for changes in CPI) = If CPlincreases, nominal income remains the same, but real income falls Calculating real income: Suppose your nominal income in Year 1 was $50,000 and the CPI value for this year is 258.8. Your real income relative to a base year is nominal income Realincome ~ Cpy (as decimal, or CPI/100) 0.000 19,319.94 2.588 ‘Year I Real income ==> Calculate real income changes: (Difference in 2 years/ Real Income of original year) x 100 Positive difference in real income = standard of living has risen because of having extra to spend Can also use this formula Percentage Percentage Percentage ‘change in = | change in — | change in real income ‘nominal income| cP Calculating salary with statistics of CPI: Now suppose someone asks you the following question: In 1932, Babe Ruth, the [New York Yankees home run slugger, earned $80,000. How much did he earn in 2020 dollars? Economists convert a past salary into a salary today by using this formula: : _£P lin given year Salary in given year = salary in previous ee" * Cor; Devious year 258.8 Salaryin2020 dollars = $80,000 x “5° = $1,511,241 2. Infla mand Wealth ‘Wealth is the value of stocks of asset owned at some point in time, eg. cars, homes, cash, etc. Rich people buy a house for $200,000 and due to inflation a few years later, they can sell it at $300,000 => ideal for rich people © But inflation is disadvantageous for less economically well ones 3. Infla n & Real Interest Rate + The nominal interest rate is the interest rate that is unadjusted + The real interest rate is adjusted to the inflation Real interest rate = Nominal interest rate — Inflation rate * Which can make those who borrow money from the bank to enjoy a lower interest rate have to be paid because real interest rate will be less than nominal interest rate 4.Inflation causing social rampage + During hyperinflation (extremely rapid rise in general price) - about 100% per year causes:1, People will rush to spend their money quickly to avoid losing its value 2, Unanticipated huge rise in inflation can harm forms of savings (mortgages, life insurance policies, credit cards). Eg. if nominal interest rate rise unexpectedly responding to the high inflation, borrower will find it dificult to make their monthly payment 3. Hyperinflation set wage-price spiral + inflation will push the wage rates to be set higher, but inflation can increase more due to increase in labour income —+ setting a spiral of inflation 4, Because future inflation rate is unpredictable, people will tun to more speculative investments that can yield higher income, invest into like gold, jewelry, arts, antiques rather than new factories cor machineries to expand the economy. 5. Distinguish demand-pull and cost-push inflation. Demand-pull inflation: occurs due to excess of total spending so general prices are raised = Sellers are unable to supply all the goods to meet the excessive demand, so sellers respond by raising the price of goods => when aggregate demand is high + During: close to full employment, when the economy is operating at a near full potential capacity of GDP Cost-push inflation: an increase in general price due to increase in cost of production - labour, raw materials, equipments, etc. FISCAL POLICY The use of government spending and taxes to influence nation’s output, employment and price level Explain how expansionary discretionary fiscal policy can be used to combat a Discretionary fiscal policy: the use of government spendings and taxes to alter aggregate demand and to stabilize the economyMoving from AD1 to AD2 => shifting the aggregate demand helps to cure recession In the graph: the country's GDP is at its recession at equilibrium point E1 Goverments can increase spendings to improve employment The full employment point is 14 trillion, but right now the economy is operating at 13, trillion => $1 trilion under But the distance from AD1 to AD2 is $2 trilion Formula to calculate how much more additional government spending needed to shift the demand curve to the right to establish new full-employment GDP equilibrium: Initial change in government spending (AG) X spending multiplier = change in aggregate demand (total spending) Spending multiplier implies that: + The spending multiplier is 2. But due to calculations government wil just have to invest $1 tilion, this will make business selling more, more employment and more income. + Eventhough the real investment is only $1 trillion but it has the overall impact of $2 trillion => government spendings have a ripple impact on the economy => as it produce more than the initial investment Marginal prosperity to consume (MPC): change in consumption spendin; “ec =e ere change in income ‘The change in spending resulting from a change in given income New* Spending multiplier - taking account of MPC: 1 Spending multiplier = — 55 2. Distinguish the spending and tax multipliers.‘Tax multiplier = how big of a change in tax will change in real GDP. Tax multipl always a negative number ‘Tax multiplier = 1 — spending multiplier Using Expansionary Fiscal Policy can create Budget deficit: + When the additional spending of government exceeds the government revenue, more than the taxe amounts its collect, leading to a national debt 3. Explain how contractionary discretionary fiscal policy can be used to combat inflation. + Discretionary fiscal policy can combat inflation by governments reducing their spending in the economy to shift the demand curve to the left => when there is less demand = less incentive to raise the price Pc eve om) (eins ot or eye Decree in Drees Desease Sic tntee™ |{ | demandcore ||| pn ee sHere we can see that — with the same level of AS curve, the initial price was at 220 = INFLATED + Governments need to cut its spendings to shift left the aggregate demand + less demand = lowered price level Contradictory fiscal policy (entail decreas in government spending) can create fiscal surplus: Budget surplus occurs when government income exceeds goverment expenditure4, Describe how the automatic stabi ers work to moderate fluctuations in the macroeconomy. Automatic stabilizers: federal expenditures and tax revenues that automatically change and stabilize an economic expansion or contraction Federal expenditures - unemployment welfare, compensation (transfer payments) will decrease when economy expands because that is when real GDP rises and vice versa when GDP falls, ‘Tax revenue - when GDP increases, higher employment, more income -> governments will implement more tax on individuals and vice versa when GDP falls, 5. Contrast supply-side and Keynesian fiscal policy effects on the economy. *Supply-side policy Government policies that increase aggregate supply, to achieve long-run growth in real-output and at lower price level => used during inflation and high in unemployment => when governments spending more on supply => more real output and shift the supply curve rightward => can achieve new full employment GDP equilibrium and lower the price During tax rate cuts: People are motivated because of having high disposable income — firms will invest more in new venture and increase job output -» aggregate supply curve shifts -» employment increases, economy expands & lower price *Keynesian Demand-side policy Higher government spending and lower operate tax, that shift the aggregate demand to the right => when spending more expenditure and cutting taxes using the multiplier effect => this policy can help to shift the demand curve => reach full employment GDP equilibrium BUT lead to an INCREASE in pric causing DEMAND-PUL INFLATION During tax rate cuts Higher disposable income for for spending -» people will spend more income on goods -» aggregate demand shifts + economy expand, employment rises but higher goods prices MONETARY POLICY *A set of actions that nation's central bank has to control the money supply to the nation’s banks, consumers and businesses => to sustain the economy and keep unemployment rate low1. Explain how interest rates are determined. Determined through 1, Transaction demand for money - the amount of money people hold to pay thelr Predictable expenses (groceries, buying lunch) 2. Precautionary demand - the amount of money people hold to pay for unpredictable expenses - for unforeseen events (car breakdown, etc.) 3. Speculative demand - the amount of money people hold to take advantage of expected {future changes in price (bonds, stocks or nonmoney financial asset) The interest rate during a time period is the Interest Rate Equilibrium = Demand (MD) and Money Supply (MS) meet where Money Money Supply: total amount of money available in the economy Money Demand: individual's desire to hold money Ifinterest rate is low + excess money demand —> people earn more by selling (bonds/ nonmoney asset) interest rate is high + excess money supply —» people would not want to hold cash but instead putting it ina bank to see the amount of money grow due to high interest rate 2. Describe the caus ffect relationship through which a change in the money supply impacts the macroeconomy from the Keynesian perspective. Change in monetary policy > change in money supply — change in interest rate + change in investment -» change in aggregate demand curve —» Change in prices, real GDP and employment => when bond prices are low => people are demotivated from buying it => central bank increase interest rate so people's money demand decrease (they would want to keep their money in the bank —+ so the initial amount can grow and later when they get their money back they can get back more money because of the additional amount of interest rate) ‘When MS is high = when there is more money in the economy —> people will have the urge to do more transactions, buying more, investing more —+ pushes the aggregate demand and causing price to rise => there is a reverse relationship between MS and interest rate so people would decrease their investment 3. Distinguish the Keynesian and monetarist's views of how monetary policy impacts the macroeconomy. 4, Summarize the similarities and the differences between the classical, Keynesian, and monetarist macroeconomic theories.=> Khi tién tng 6 trong 1 nén kinh té tht inflation occurs => thé nén d& gidm bot s6 tién trong nén kinh té => ngn hang nha nuéc sé increase interest rate => d& thu bét tin vao => tai vi suat cao hon thi nhiéu ngwdi sé cho tién vao ngan hang dé nhn lai => Khi tin Money Supply gidm trong 1 nén kinh té => thi dé tang sé tién 06 trong 1 nén kinh t8 => ngan hang sé gidm interest rate => moi ngurdi sé ko cho vao tiét kiém nia => nhidu ti8n flow ra khéi ngan hang hon