Microeconomics ECON 1110 Notes up to Final
Microeconomics ECON 1110 Notes up to Final ECON 1110
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This 7 page Study Guide was uploaded by genehan on Saturday January 30, 2016. The Study Guide belongs to ECON 1110 at Cornell University taught by Professor Thomas in Summer 2015. Since its upload, it has received 40 views. For similar materials see Introductory Microeconomics in Economcs at Cornell University.
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Date Created: 01/30/16
Lecture # 20 Monopolistic Competition November 10, 2015 • A common form of industry structure characterized by o Many firms, differentiated products, “price maker”, free entry and exit o Ruby Tuesday, TGI Fridays, Chilis, etc (a lot of substitutes but not perfect substitutes – there are close substitutes) • Product differentiation o Strategy that firms use to achieve market power o Can’t use price and quantity decisions in isolation o Accomplished by producing goods that differ from others in the market o The level of product variety reflects § Underlying preferences of consumers (underlying heterogeneity of consumers’ tastes in that market) (coke vs pepsi, some people don’t care, etc) § The gains (if any) from coordination § Cost economies from standardization (if large-‐less variation and more standardization of the products) • How do firms differentiate? o Horizontal differentiation – products differ in ways that make them better for some people and worse for others o Vertical differentiation – a product difference that, from everyone’s perspective, makes a product better than rival products (reduction in price, better quality material) • Differentiation is due to buyers perceiving a difference o Real differences are usually minor: § Differences in packaging (if packaged nicely, people may think inside has a good product rather than a badly packaged product) § Differences in advertising theme (can target different demographics) o Real differences are not so great as to eliminate other goods as substitutes § Cross-‐price elasticity of demand between goods in monopolistically competitive markets is positive (among substitutes) § Close but imperfect substitutes • Major sources of product differentiation o Differences in quality which are usually accompanied by differences in price § High quality à high price o Differences in functional features or design o Ignorance of buyers regarding the essential characteristics and qualities of goods they are purchasing (imperfect information-‐ consumers don’t know the characteristics of the product) o Sales promotion activities of sellers (advertising) o Differences in availability (timing, location) • Advertising can be used to advertise real differences in products and services • Freemium Business Models o “give your service away for free, possibly ad supported but maybe not, acquire a lot of customers very efficiently through word of mouth, referral networks, organic search marketing, etc., then offer premium priced value added services or an enhanced version of your service to your customer base” – Fred Wilson (venture capitalist) o Freemium models are effective to build a customer base when the marginal cost of producing extra units is low (apple apps top grossing are the free apps due to in-‐app purchases Lecture #21 Monopolistic Competition Part 2 November 12, 2015 • Price and Output Decisions o Monopolistically competitive firm faces demand curve • Short run losses – oversaturation of market – too many products • Price and Output Decisions – Long Run o As new firms enter a monopolistically competitive industry in search of profits, the demand curves of existing profit-‐earning firms begin to shift to the left, pushing marginal revenue with them as consumers switch to new close substitutes. § Process continues until profits are eliminated § Demand and marginal revenue are shifting together • Efficiency and allocation o Entry is easy and economic profits are eliminated in the long runàinfer that monopolistic competition is efficient but there are 2 problems § Once a firm achieves any degree of market power by differentiating, its profit-‐ maximizing strategy is to hold down production and charge a price above MC § The final equilibrium in a monopolistically competitive firm is to the left of the low point on its ATC curve meaning the typical firm in the industry will not realize all economies of scale available. • Inefficienceies of monopolistic competition o Selling costs – firms spend huge amounts of money on advertising and publicity § From a social point of view, much of this expenditure is wasteful § Instead of spending money on advertising and publicity, producer could trim expenses reduce the price of product o Excess capacity – under imperfect competition, the installed capacity of every firm is large but not fully utilized § Total output is below full capacity level § Resources lie idle § Total output is less than socially desirable level of output o Unemployment – idle capacity leads to unemployment § Unemployment leads to socially undesirable characteristics (poverty) § If idle capacity were fully utilized, the problem of unemployment would be partially mitigated o Lack of specialization – little scope for specialization or standardization § Product differentiation can lead to wasteful expenditures on advertising and publicity § If fewer standardized products were produced, resource allocation may be improved, leading to a higher level of economic welfare • Perfect competition o Many firms offering identical products o Free entry and exit into industry o Full and symmetric information o Positive, zero, or negative short run profits o Zero long run profits because of firm entry or exit o P=MC because firms have no market power and individual firms face perfectly elastic demand o No deadweight loss so Pareto efficient. In long run, produces at minimum efficiency scale (bottom of ATC curve) so production efficient as well. • Simple monopoly o One firm offering a unique product o Barriers – hard to enter industry but easy to exit o Full and symmetric information o Positive, zero, or negative short run profits o Positive or zero long run profits o P>MC because firm has market power and price according to market demand o DWL compared to PC so not Pareto efficient. In LR, may or may not produce at MES, so may or may not be productive efficient • First degree price discrimination – single out different demand curves – need to know customers very well o One firm offering a unique product o Barriers – hard to enter industry but easy to exit o Full and symmetric information o Positive, zero, or negative short run profits o Positive or zero long run profits o P>MC because firm has market power and price according to market demand o DWL compared to PC so not Pareto efficient. In LR, may or may not produce at MES, so may or may not be productive efficient • Monopolistic competition o Multiple firms offering competing differentiated products (unique but substitutes) o Free entry into general product space but can’t make the exact same good as an existing firm. Free exit o Full and symmetric information o Positive, zero or negative SR profits o Zero LR profits because entry of substitute goods eliminates positive SR profits and exit would occur if SR profits <0 o P>MC because firm has market power and price according to market demand o DWL compared to PC so not Pareto efficient. In LR, will not produce at MES, is not productive efficient (to the left of ATC curve where D is tangent to ATC curve) • Oligopoly o A few firms offering competing differentiated product or same product o Some barrier to entry but free to exit o Full and symmetric information o Positive, zero, negative SR profits o LR profits depend on model. Collusion can have positive profits, but contestable markets cannot o P vs. MC depends on model. For example, contestable markets have P=MC, whereas collusion leads to monopoly pricing where P>MC o Efficiency depends on model Lecture #22 Externalities, Public Goods, and Social Choice • Externalities o Actions of one party imposes cost or benefits on a second party o Study of externalities is a major concern of environmental economics • Marginal Social Cost MSC o Total cost of society of producing an additional unit of a good or service o Equal to the sum of the marginal costs of producing the product and the correctly measured damage costs involved in the process of production • Profit-‐maximizing firm – externality o MSC curve is higher than MC (damage)– distance between two curves is the damage done by social cost à producing at Q* is inefficient (too much) à should produce where price intersects the MSC curve § MSC curve is lower than MC when it is positive externalities (producing too little) • Public Goods/social goods/collective goods o Nonrival in consumption and whose benefits are nonexcludable (public park) § Nonrival in consumption – one person’s enjoyment of the benefits of a public good does not interfere with another person’s consumption of it o Nonexcludable (education, clean air) § Once a good is produced, no one can be excluded from enjoying its benefits • Free Rider Problem o People cannot be excluded from enjoying the benefits of public goods whether the pay for them or not, they are usually unwilling to pay for them • Drop in the bucket problem o Good or service is so costly that its procision generally des not depend on whether any single person pays • Optimal Provision of Public Goods o Samuelson-‐Musgrave theory – demonstrates that an optimal, or most efficient, level of output exists for every public good § An efficient economy produces what people want. Private producers are constrained by the market demand for their products. If they cannot sell their products for more than it costs to produce them, they will be out of business o Because private goods permit exclusion, firms can withhold their products until households pay. Buying a product at a posted price reveals that it is worth” at least that amount to you and everyone who buys it. (voting with dollars) • Demand for private goods o Horizontal summation of household functions to come up with market function • Optimal Provision of Public Goods o The level at which society’s total willingness to pay per unit ) is equal to the MC A+B of producing the good o With public goods, there is only one level of output, and consumers are willing to pay different amounts for each level of output • Demand for public goods o Vertical summation of household demand curves to get market demand • Problematic assumption – government knows the preferences of everyone in society • Social choice o Problem of deciding what society wants o The process for adding up individual preferences to make a choice for society as a whole Impossible to come up with voting system that is consistent, reliable, repeatable Lecture #23 Uncertainty and Asymmetric Information November 19, 2015 • Expected Value – reported result of 10 heads out of 10 is 5 more than expected • Deviations from expected o It is possible that you were not cheated – 10 heads out of 10 flips is expected once in 1000 games – extremely rare, but not impossible o Rarely have all the information we need – so we use expected values • Expected Value o Jacob’s employer is trying a new salary plan and Jacob can choose between two options § Earn $40,000 at end of year § Manager tosses coin – heads à $60,000 or tails à $20,000 o Expected value of the two options is the same § EV option 1 = $40,000 § EV option 2 = (20,000 x 0.5) + (60,000 x 0.5) = 40,000 o Expected Utility -‐ How do you decide which option to choose? § The sum of utilities coming from all possible outcomes of a deal, weighted by the probability of each occurring § Assume Jacob’s EU of receiving a guaranteed payment is 15 utils o Less risk adverseàless satisfaction from the more risky offer • Asymmetric Information o One of parties to a transaction has information relevant to the transaction that the other party does not have § Adverse selection – a situation in which asymmetric information results in high-‐quality goods or high-‐quality consumers being squeezed out of transactions because they cannot demonstrate their quality • Market Signaling • Moral Hazard o Unemployment benefits – do they change your behavior? • Risk adverse – not willing to risk the 40,000 for 60,000 Lecture #24 -‐-‐-‐-‐-‐-‐-‐ November 24, 2015 Lecture #25 Economics of Taxation December 1, 2015 • Redistribution programs – social security, public assistance/welfare, unemployment compensation, medicare, supplemental nutrition assistance program SNAP, housing programs, earned income tax credit • US took in $3.5 trillion in taxes • Taxes on stocks vs taxes on flows o Personal income tax o Consumption tax (personal) (from households to product market) o Retail sales tax (from households through firms into product market) o Payroll tax (pretaxed amount – goes to fund medicare, worker’s compensation, etc) o Profits (net income) tax (from firms back to income into households) o Wage tax (after you get net check and then tax taken out after payroll tax) • Tax Rates o Average tax rate – the total amount of tax paid divided by total income § Avg rate = $2000 taxes / $20,000 income = 10% o Marginal tax rate – the tax rate paid on the next dollar of income § Income bracket • $0-‐29,000 – 5% tax rate • $30,000-‐59,999 – 7% tax rate • $60,000+ -‐ 10% tax rate o example – John earns $70,000 per year § His marginal tax rate is 10% § His average tax rate is 6.6% • Tax Structures o Progressive tax – a tax whose burden, expressed as a percentage of income, increases as income increases § The more you earn, the higher your base rate of tax is o Proportional tax/flat tax – a tax whose burden is the same percentage of income for all households o Regressive tax – a tax whose burden, expressed as a percentage of income, falls as income increases § In Alabama, consumers pay a “sin tax” of 9.8 cents per beer, 3.4 cents per glass of wine, and 21.4 cents per shot of liquor • Tax equity o Benefits-‐received principle – a theory of fairness holding that taxpayers should contribute to government (through taxes) in proportion to the benefits they receive from public expenditures o Ability to pay principle – a theory of fairness holding that citizens should bear tax burdens in line with their ability to pay taxes § Horizontal equity – those with equal ability to pay should bear equal tax burdens § Vertical equity – those with greater ability to pay should pay more • Tax incidence – payroll tax o X axis – units of labor and y axis – wage rate o Supply and demand curve intersect at W and0 L 0 o If tax of T dollars per unit labor imposed à workers were receiving W0 but now firm has to pay W0+T then price of labor goes up and quantity demanded of labor goes down (L0àLD) so huge excess supply leads to unemploymentàdownward pressure on wage W0àW1 and as workers respond to lower wages, labor supply curve contracts to L1 o Burden of the tax – workers pay W0-‐W1 and firms pay (W1+T) –W0 o Steeper supply curves àworker share of tax is larger than firm § When labor supply is less elastic, a greater share of the payroll tax is paid by workers • Excess burden o When taxes distort economic conditions, they impose burdens on society that, in aggregate, exceed the revenue collected by government § Excess burden/deadweight loss – the amount by which the burden of a tax exceed the total revenue collected § Principle of neutrality – ceteris paribus, taxes that are neutral with respect to economic decisions are generally preferable to taxes that distort economic decision. Taxes that are not neutral impose excess burdens o Only time tax distortion is what we want -‐ Externalities and if we already have a tax that is distorting behavior • How do excess burdens arise? o Area of (X0-‐X1) x (P1 (Po+T) – (P0=MC) o Inelastic demand (steeper) – excess burden is a lot smaller Final Lecture December 3, 2015 Big Ideas • Three Economic Questions o What, how, for whom to produce • Comparison of Market Structures o Perfect competition, monopolistic competition, oligopoly, monopoly • Opportunity Cost o To get something, you have to give something • Price Mechanism o What it is, how it answers the economic questions o When and how it fails • Profitability o Revenue and costs, profit maximization, existence/persistence of economic profits, market factors affecting profitability
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