Mikro- och Allokeringsteori, Kurs 404
Denna sammanfatting är inte helt färdig. Men jag antar att
det är bättre att lägga upp den nu än att lägga upp den efter
omtentan =) (2004-01-03)
Har kollat igenom den en gång nu så de flesta fel har nu
blivit korrigerade. Märkte också att jag råkade sammafatta
kapitel 14 som inte är med på tentan. Har dock inte tagit
bort den. (2004-01-05)
Claes Melander, 19701
1
Sammanfatting av Mikroekonomikursen
Av Claes Melander 19701, 2004-01-02
Källor: ”Microeconomics” Perloff, third edition samt föreläsningsmaterial
Chapter 1 – Introduction
Microeconomics: the allocation of scarce resources – how the individual or the company
allocate his resources to receive the most benefits.
Society’s three main allocation decisions:
 Which goods are produced
 How they are produced
 Who gets the goods
Positive statement: testable hypothesis about cause and effect. (Faktabaserade teorier)
Normative statement: Value judgements, cannot be tested. (Åsiktsbaserade teorier)
Chapter 2 – Supply and Demand
Supply function depends on cost (such as interest rates, wage rates, and the cost of raw
materials, production cost), rules and regulations
Demand function depends on price of the good, price of similar goods, income, taste, rules
and regulations
Law of Demand – Demand curves slope downward
Shocking the equilibrium: A change in an underlying factor other than price causes a shift ot
the supply or demand curve, which alters the equilibrium.
Price Control
Maximipris (Price ceiling) - Kan leda till överskottsefterfrågan (Excess demand) då priset
sätts lägre än vad det skulle vara utan statlig inblandning.
Minimilön (Price floor) – Kan leda till utbudsöverskott (Excess supply) eller arbetslösthet
som är fallet med minimilön.
Perfectly competitive markets
 Everyone is a price taker: Because no consumer or firm is a very large part of the
market, no one can affect the market price. Easy entry of firms into the market, which
leads to a large number of firms, is usually necessary to ensure that firms are price
takers.
 Firms sell identical products: Consumers do not prefer one firm’s good to another
 Everyone has full information about the price and quality of goods: Consumers
know if a firm is charging a price higher than the price others set, and they know if a
firm tries to sell them inferior-quality goods.
 Costs of trading are low: It is not time consuming, difficult, or expensive for a buyer
to find a seller and make a trade or for a seller to find and trade with a buyer
Claes Melander, 19701
2
Chapter 3 - Applying the Supply-and-Demand Model
Om en input som påverkar efterfråge- eller utbudskurvan ändras, så ändras också
jämviktspriset.
En skiftning av utbudskurvan ger en förflyttning längs efterfrågekurvan, och vice versa.
Elasticities of Supply and Demand
 Generally, elasticity is a measure of the sensitivity of one variable to another.
 It tells us the percentage change in one variable in response to a one percent change in
another variable.
Oelastisk: 0 >  > -1
Elastisk:  < -1
Perfekt Oelastisk: = 0 Vertikal kurva.
(Ger oändlig skillnad i pris vid förändring i utbudet/efterfrågan, men ingen skillnad i
efterfråga. Exempelvis livsnödvändiga medikament)
Perfekt elastisk: = -∞ Horisontell kurva
(Ger oändlig skillnad i kvantitet vid förändring i utbudet, men ingen skillnad i pris. Omfattas
av relativt ”onödiga” varor)
Inelastisk: Låg förändring (i kvantitet vid prisförändring)
Elastisk: Stor förändring (i kvantitet vid prisförändring)
Långsiktig elasticitet är oftast större än kortsiktig, på grund av substitutionsfaktorer och
lagringsmöjligheter. Om varan lätt kan lagras, är dock kortsiktiga mer elastiska än långsiktiga,
Efterfrågans priselasticitet
Efterfrågekvantitetens känslighet vid ändringar i pris.
Measures the sensitivity of quantity demanded to price changes.
 It measures the percentage change in the quantity demanded for a good or service that
results from a one percent change in the price.
The primary determinant of price elasticity of demand is the availability of substitutes.
 Many substitutes: demand is price elastic
 Few substitutes: demand is price inelastic
 = procentuell förändring i efterfrågekvantitet = ( Q/Q) =
procentuell förändring i pris
( p/p)
Linjär efterfrågekurva, ger  =
Claes Melander, 19701
Q p = D´(p)* p
pQ
Q
Q p = -b*p där -b är lutningen på kurvan
pQ
Q
3
Då på en linjär efterfrågekurva har vi en Unitary elasticity: A 1% increase in price
causes a 1% fall in quantity.
Law of Demand  Minskat utbud vid prisökning
visas genom negativ priselasticitet.
Perfectly Elastic Demand
Consumers very sensitive to price change
If the price increases even slightly above p*,
demand falls to zero. Thus a small increase in
price causes an infinite drop in quantity, so the
demand curve is perfectly elastic
Perfectly Inelastic Demand
Consumers not sensitive to price change
If price goes up, the quantity demanded is
unchanged, so the elasticity of the demand must
be zero.
A demand curve is vertical for essential goods
Inkomstelasticitet (av efterfrågan)
Efterfrågans känslighet mot förändringar i inkomst
Income elasticity of demand measures the percentage change in quantity demanded resulting
from a one percent change in income.
 =
procentuell förändring i efterfrågekvantitet = ( Q/Q) =
procentuell förändring i inkomst
( I/I)
Q I
IQ
Korspriselasticitet (av efterfrågan)
Efterfrågans känslighet mot prisändringar hos en annan vara.
procentuell förändring i efterfrågekvantitet = ( Q/Q) =
procentuell förändring i en annan varas pris
( pL/pL)
Q pL
pL Q
Negativ elasticitet: Komplementvaror (När andra varan ökar i pris köps mindre av vår vara)
Positiv elasticitet: Substitut (När andra varan ökar i pris köps mer av vår vara)
Utbudets priselasticitet:
Utbudets känslighet vid ändringar i pris.
 = procentuell förändring i utbudskvantitet =
procentuell förändring i pris
Claes Melander, 19701
Q/Q =
p/p
Qp
pQ
4
Skatt
Ad Valorem
Exempelvis moms. Staten tar en viss procent av det betalda priset.
Specificerad/enhetsskatt
Fördelning av skattebördan

p = ( - ) * 

Staten tar en viss summa per såld enhet.
Effekter på jämvikten:
Enhetsskatt höjer jämviktspriset och sänker därmed utbudet.
Ju högre elasticitet på efterfrågan, desto mindre ändring i jämviktspriset vid pålägg av skatt.
(utbudetselasticiteten hålls konstant)
Under perfekt konkurrens vältras inte hela förändringen över i priset.
Högre övervältring när utbudselasticiteten är hög och när efterfrågeelasticiteten är låg.
Påverkan av en skatt bestäms av relativiteten efterfråga/utbud.
Hur mycket av skatten som betalas av konsumenterna ges av
 =
utbudselasticitet
.
( - ) utbudselasticitet – efterfrågeelasticitet
Om efterfrågekurvan har negativ lutning (neråt) och utbudet positiv (uppåt), betalas pålagd
skatt inte enbart av konsumenterna.
Claes Melander, 19701
5
Chapter 4 - Consumer Choice
 Konsumentens preferenser bestämmer hur stor nytta denne har av en vara/service.
(Individual tastes or preferences determine the amount of pleasure people derive from
the goods and services they consume.)
 Konsumenten möts av begränsningar.
(Consumers face constraints of limits on their choices.)
 Konsumenten maximerar sin nytta utifrån dessa begränsningar.
(Consumers maximize their well-being or pleasure from consumption, subject to the
constraints they face.)
PREFERENSER
 Completeness – The consumer prefers the first bundle to the second, prefers the second
to the first, or is indifferent between them. (Kompletta)
 Transitivity – A>B and B>C therefore A>C (Transitiva)
 More is Better – More ”Goods” are preferred to less ”Goods”. Less “Bads” are
preferred to more “Bads” (Always wanting more is known as nonsatiation)
Indifferenskurva
Olika kombinationer av två varor som ger samma nivå av nytta, dvs anses likvärdiga.
Egenskaper
 Större nytta ju längre bort från origo.
 Alla kombinationer av varor ger en viss nyttonivå, dvs det går en differenskurva genom
varje varukorg
 Indifferenskurvor kan inte korsa varandra, inte vara ’tjocka’
 Lutar neråt.
 Konvexa vid konsumerande av positiva kvantiteter.
 Kan även vara koncava
Bytesförhållanden
 Perfekta substitute - Kännetecknas av linjära indifferenskurvor
 Perfekta komplement - Mer av vara x bara värdefullt tillsammans med mer av vara y.
Claes Melander, 19701
6
NYTTA
Nyttofunktion (Utility fuction)
En formel som visar den totala nyttan associerad med en varukorg
Marginalnytta (Marginal Utlility)
Marginalnyttan av en viss vara är den extra nytta som individen får av att konsumera
ytterligare en enhet av den varan. Lutningen på nyttofunktionen. Positiv, men avtagande.
Konsumentens begränsade val
Att välja den varukorg som maximerar nyttan
Marginal Rate of Substitution
Lutningen på differenskurvan. Den talar om hur mycket individen är villig att avstå av y för
att få en extra x, givet samma nytta.
MRS = -MUX
MUY
BUDGETRESTRIKTION
Alla kombinationer av varor som kan köpas. Mäter ej nyttan, bara budgeten.
Budgetrestriktion vid inkomsten I och köp av vara y och vara x.
I = px * x + py *y

y = I / py – (px / py)x
Marginal Rate of Transformation
Lutningen på budgetrestriktionen
Derivatan av budgetrestriktionskurvan  MRT = - pX
Py
Interior solution - When optimum Indifference curve lies as a combination of the two goods.
Corner Solution - When optimum Indifference curve lies by axis consisting of only one good
BEGRÄNSAT VAL FÖR KONSUMENTEN
Maximeringspunkt
 Indifferenskurvan tangerar budgetrestriktionen
 Konsumenten väljer den högsta indifferenskurvan
 MRT = MRS (Derivatan av budgetrestriktionskurvan = Derivatan av
indifferanskruvan)
 Sista kronan som läggs på vara 1, ger lika mycket nytta som den sista kronan som
läggs på vara 2
MRT = MRS  - pX = - MUX
Py
MU
Claes Melander, 19701
MUX = pX
MUY
pY
eller
MUX = MUY
pX
pY
7
Chapter 5 - Applying Consumer Theory
INKOMSTELASTICITET
 =
procentuell förändring i efterfrågekvantitet = ( Q/Q) =
procentuell förändring i inkomst
( I/I)
Q I
I Q
Normal vara
Större efterfrågan vid ökad inkomst.

Inferiör vara
Lägre efterfrågan vid ökad inkomst.

Härledning av efterfrågekurvan
Visar hur efterfrågan ändras när budgetrestriktionen ändras. I det här fallet skiftar
budgetrestriktionen på grund av ett sjunkande öl-pris.
Pris-konsumtionskurvan
 Uppåtlutande kurva visar på
positiva inkomstelasticiteter
för vara x och y.
 Bakåtlutande kurva visar att
vara y är normal och vara x
inferiör.
 Neråtlutande mot x-axeln
visar att vara y är inferiör och
vara x normal.
Båda varor kan inte vara inferiöra.
En vara kan variera mellan inferiör
och normal efter olika inkomstnivåer.
Exempelvis arbetsutbudskurvan.
Inkomst-konsumtionskurva
Samma som pris-konsumtionskurvan
men här ändras inkomst och inte pris
på en vara. (se fig nästa sida)
Claes Melander, 19701
8
Engelkurva
Visar relationen efterfrågekvantitet – inkomst, när priserna hålls konstanta
Prisfall har två effekter på efterfrågan
 Substitutionseffekten (e1  e*) (SE)
Konsumenten köper mer av varan för att den är billigare i jämförelse med andra
varor på marknaden. Konsumenten substituerar, väljer den billigare varan.
Visar ändring i efterfrågad kvantitet från en kompenserad ändring i varans pris.
 Inkomsteffekten (e*  e2) (IE)
Inkomsten blir för högre än varans pris, varans sänkta pris driver upp konsumentens
köpkraft. Inkomst effektens riktning beror på inkomstelasticiteten.
Ändring i efterfrågan av en vara beroende av inkomsten, där priset är hållt konstant.
Claes Melander, 19701
9
Total effekt
Räknas ut genom att dra den nya budgetrestriktionen (L2) och därmed flytta till en högre
indifferenskurva (I2), därefter ritar man in en imaginär kurva (L*) med samma lutning som
den nya budgetrestriktionen (L2) så att den tangerar den nya indifferenskurvan (I1). Flytten
från jämvikten e1 till e* visar då substitutionseffekten, varefter inkomsteffekten kan studeras i
flytten från e* till jämvikten e2. Den totala effekten kan därefter bedömas.




Normal (Fig 5.5)
(SE och IE går åt samma håll)
Positiv inkomsteffekt + positiv substitutionseffekt = positiv total effekt.
Efterfrågas mer när inkomsten ökar eller priset på varan minskar.
Exempel: Kläder, restaurantbesök.
Inferiör
(IE motverkar SE, går åt olika håll)
Negativ inkomsteffekt + positiv substitutionseffekt = negativ eller positiv total effekt.
Efterfrågas mindre när inkomsten ökar. Skapar en uppåtlutande efterfrågekurva
Exempel: Nudlar, blodpudding.
Giffen (Fig 5.6)
(IE motverkar SE och IE>SE)
Negativ inkomsteffekt + positiv substitutionseffekt = negativ total effekt.
Efterfrågas mindre när priset på varan minskar. (Motsäger Law of Demand, dock är
lagen endast en emprisk regularitet och inte ett teoretiskt faktum)
Exempel: När priset på bio faller kan Erik gå och se fler bio filmer, trots detta lägger
Erik ner mer pengar på att köpa fotbollsmatchbiljetter och mindre på biobiljetter.
Biobijetter efterfrågas alltså mindre trots att priset sjunker i Eriks fall. (bio = Giffen)
OBS! En giffen-vara är alltid inferiör, medan en inferiör vara inte behöver vara en
giffen-vara
Konsumentprisindex och lönekompensation
Applicera ovanstående teorier och se att full lönekompensation för KPI är en
överkompensation. Gör ett true cost-of-living index (inflationsindex där nytta
(indifferencekurvan) är hållt konstant över tiden) med hjälp av tekniken för att identifiera
substitions- och inkomsteffekt.
Arbete – Fritid
En ökad lön leder till såväl inkomstsom substitutionseffekter.
Inkomsteffekten leder till ökad mängd
arbetstid om det är en normal vara,
substitutionseffekten leder till ökad
mängd fritid om fritid är en normal vara.
Depending on whether leisure is an
inferior or normal good, the supply
curve of labor may be upward sloping or
backward bending
Sparande
Kan också beräknas som en vara.
Claes Melander, 19701
10
Chapter 6 - Firms and Production
Kortsiktigt
Period då vissa insatsfaktorer är fasta medans andra är variabla.
Långsiktigt
Period då alla insatsfaktorer är variabla.
Produktionsfunktionen q = f(L, K)
Beskriver största tekniskt möjliga produktionsvolym vid olika (minimala) kombinationer av
produktionsfaktorer.
Produktion med en insatsfaktor (Kortsikt)
Produktionsfunktionen
q = F(L)
Genomsnittsprodukten - APL (Average Product of Labor)
Förhållandet arbetskraft och totalproduktion ges av Total produktion/antalet arbetare
APL = q
APL = F(L)
L
L
Marginalprodukten - MPL (Margianl Product of Labor)
Ändringen av produktionen när man ökar arbetskraften med en enhet.
Ges av tangenten till Total Produktion vid en given punkt.
MPL = f
L
MPL = F’(L)
Total produktion (TP)
Hur stor output som kan
produceras av en viss mängd
av inputen.
Figur 6.1 Produktion
när arbetskraft är en
variabel insatsfaktor
Law of Diminishing
Marginal Returns
Om ett företag endast ökar en
input samtidigt som de andra
faktorer hållna konstanta blir
ökningarna i output
marginellt lägre och lägre.
Claes Melander, 19701
11
Produktion med två insatsfaktorer (Långsikt)
Isokvant
Samma kvantitet
Jämför indifferenskurvor.
Visar olika kombinationer av K och L som precis kan producera en given nivå av en vara.
Uttrycker möjliga tekniska bytesförhållanden i företaget, mellan K och L, utan att q (output)
ändras.
MRTS (Marginal Rate of Technical Substution)
Marginella tekniska substitutionskvoten = lutningen på isokvanten.
Hur många enheter K som krävs för att substituera för L, och ge samma output.
MRTS = _ förändring i K = _ K
förändring i L
L
Diminishing MRTS
Skalavkastning
Skalavkastning är ett uttryck för vad som händer med åtgången på produktionsfaktorer när
företaget ändrar sin produktionsvolym. Antag att företaget fördubblar insatsen av alla
produktionsfaktorer (
 Konstant skalavkastning: Produktionen fördubblas
F(L, K) = F(K, L) för >1
 Avtagande skalavkastning: Produktionen ökar mindre än dubbelt
F(L, K) < F(K, L) för >1
 Tilltagande skalavkastning: Produktionen ökar mer än dubbelt
F(L, K) > F(K, L) för >1
Claes Melander, 19701
12
Diseconomies of Scale
När ett företags genomsnittskostnad ökar då output ökar
1. The Ownership and management of firms:
 Sole proprietorships
o smaller firms, owners run firm
 Partnerships
o smaller firms, owners run firm
 Corporations
o Owners hire managers
o Owners want to maximize profits
6. Productivity and technical change:
 Relative productivity
o Firms output q, Most productive firms output q*
o 100q/q* = Relative productivity
 Technical Progress
o Neutral Technical change – Produce more with same inputs
o Nonneutral Technical change – Production proportions altered




Long-run average cost curve: the lower bound of all the short-run average cost
curves. Its shape is tied closely to returns to scale.
Economies of scale: long-run average costs fall as output rises.
Diseconomies of scale: long-run average costs rise as output rises.
Economies of scope: less expensive to produce goods jointly than separately.
Claes Melander, 19701
13
Chapter 7 - Costs
Alternativkostnad



Economic or Opportunity cost
o The value of the best alternative use of a resources
Det man måste avstå ifrån för att få det man faktiskt väljer
Vad en resurs kan ge i bästa alternativa användning
Explicit costs
 A firm’s direct, out of the pocket payments for inputs to production during a given
time period
Implicit costs
 Work time value of owner’s and value of other resources used but not purchased
Kortsiktiga kostnader
Fast kostnad (F)
Är en produktionsutgift som inte är en variabel till output. Kan inte varieras kortsiktigt.
Exempel; stora maskiner, plantage
Variabel kostnad (VC)
Kostnaden för variabla inputs, kan justeras efter output kvantitet.
Exempel; arbete och material
Total kostnad (C)
C = VC + F
Marginell kostnad (MC)
Lutningen på kostnadskurvan C. (För kortsiktighet även samma som VC)
Där MC skär AVC fås minimumpunkten till AC.
MC = C
eller MC = VC
q
q
Genomsnittlig fast kostnad (AFC)
AFC = F
q
Genomsnittlig variabel kostnad (AVC)
AVC = VC
q
Genomsnittlig kostnad (AC)
AC = AFC + AVC eller
AC = C
q
Claes Melander, 19701
14
Långsiktiga kostnader
Isokost
Kostnaderna är dem samma för alla punkter utmed isokost kruvan
Illustrerar alla kombinationer av K och L som kan köpas till givna relativpriser (pL/pK), för
en specifik totalkostnad.
C=wL + rK
Kan jämföras med budgetrestriktions kurvan men viktigt att skilja är att konsumenter endast
har budgetrestriktions kruva då företag kan ha flera isokostkurver beroende på deras
produktion.
- w/r lutningen på isokosten. Visar hur företaget måste substituera mellan K och L givet en
viss produktionskostnad.
Totalkostnadsekvationen
TC = pK * K + pL * L
=> K = TC - pL * L (linjära isokost ekvationen)
pK
pK
Kostnadsminimering
Lägsta totala kostnad utifrån K och L. Den isokost som ligger närmast origo.
Den sista kronan som spenderas på kapital bidrar lika mycket till produktionen som den sista
kronan som spenderas på arbetskraft.
Isokost och Isokvant tangering
 Lowest-isocost rule
o Pick the bundle of inputs where the lowest isocost line touches the isoquant.
 Tangency rule
o Pick the bundle of inputs where the lowest isoquant is tangent to the isocost
line
MRTS = -w/r  MPL/MPK = w/r
 Last-dollar rule
o Pick the bundle of inputs where the last dollar spent on one input gives as
much extra output as the last dollar spent on any other input. (MPL/w = MPK/r)
Faktorpris förändring
Om faktorpriset fallar för en
insatsvara kan samma isokvant
nås genom en förskjuta
tangeringspunkten dit man
använder mer av den nu
billigare instatsvaran
Claes Melander, 19701
15
Chapter 8 - Competitive Firms and Markets
Competitive market - Firm is a price taker
 Consumers believe that all firms in the market sell identical products
 Firms freely enter and exit the market
 Buyers and sellers know the prices charged by firms
 Transaction costs – the expenses of finding a trading partner and making a trade for a
good or service other than the price paid for that good or service – are low
Price taker: a firm that can't significantly affect market price for its output or inputs.
Perfectly competitive market
 Homogeneous or undifferentiated products
Imperfectly competitive market
 Heterogeneous or differentiated products
Residual demand curve  Dr(p)
The demand curve that an individual firm faces in a competitive market
Dr(p) = D(p) – So(p)
D(p) = Demand curve
in the market
So(p) = Supply curve
for all other firms in the
market
Elasticity of residual demand curve
Om det finns n identiska företag i marknaden kommer efterfrågeelasiteten för företaget vara i
i = nn – 1)o
market elasticity of demand (a negative number)
o = Elasticity of supply of the other firms (normally a positive number)
n – 1 = the number of other firms
Ekvationen visar att Dr(p) är mer elastisk då:
 Det finns fler företag, n i marknaden
 Efterfråge elatisiteten,  är större
 Utbuds elatisiteten av de andra företegen, o är större
Claes Melander, 19701
16
Vinst maximering
R – C   > 0 ger vinst
 < 0 ger förlust
Economic profit (Normally referred to as profit)
 Revenue – economic cost (opportunity cost, explicit and implicit)
Business profit (Normally referred to as Business profit)
 Revenue – only explicit costs
Output decision
The firm produces, what output level, q, maximizes its profit or minimizes its loss
Output rules
1. The firm sets output where its profit maximized
2. A firm sets its output where its marginal profit is zero
3. A firm sets its output where its marginal revenue equals its marginal cost
´(qR´(q) – C´(q) = 0  R´(q) = C´(q)  MR = MC
Shutdown decision
If it’s more profitable to shut down than to produce, q, it will shut down
Shutdown rules
1. The firm shuts down only if it can reduce its loss by doing so
2. The firm shuts down only if its revenues is less than its avoidable cost
Competition in the short run
First, the competitive firm
determines the output that
maximizes its profit (or
minimizes its loss) when its
marginal cost equals the
market price:
MC(q) = p
Claes Melander, 19701
17
Second, the firm chooses
to produce that quantity
unless it would lose
more by operating than
by shutting down. The
firm shuts down only if
the market price is less
than the minimum of its
average variable cost:
p < AVC(q)
Short-Run Firm Supply Curve
The competitive firm’s supply curve is its marginal cost curve above its minimum average
variable cost
Short-Run Market Supply Curve
The more identical firms producing at a given price, the flatter (more elastic) the short-run
market supply curve at that price.
Number of firms, n is fixed
Claes Melander, 19701
18
Specifik skatt
Om förtaget skattas med  per enhet flyttas MC (Supply) och AC kurverna upp med och MC
får en ny skärningspunkt med p, som man tillsammans med AC kan räkna ut vinsten efter
skatten
Competition in the long run
Profit maximization
 Output that maximizes profits – MRL = MCL
 Shuts down if revenue is less than variable cost. In the long run all costs are variable.
 Very similar to short run except for all costs are variable
The Short-Run and Long-Run Supply Curves
Claes Melander, 19701
19



Entry and exit of the market will occur until firms in the market are making zero longrun profit
Competitive firm's long-run supply curve: its marginal cost curve above the minimum
of its long-run average cost.
Long-run market supply curve is horizontal at the minimum long-run average cost if
firms have free entry and exit; all firms have identical costs; and input prices are
constant.
Increasing-cost market: input prices rise as output rises  Upward sloping supply curve
Constant-cost market: Input prices stay constant as output rises  Flat supply curve
Decreasing-cost market: Input prices falls as output rises  Downward sloping supply curve
Zero profit in the long run
In the long-run firms in a competitive market make zero economic profit therefore
competitive firms must maximize their profits in order to survive
Claes Melander, 19701
20
Chapter 9 - Applying the Competitive Model
Consumer surplus (CS)
The difference between what consumers are willing to pay and what the good actually costs.
Calculated as the area under the demand curve and above the market price up to the quantity
consumers buy.
Producer surplus (PS)
The amount a firm is paid minus its variable cost of production, which is profit in the long
run. PS is the area below the price and above the supply curve up to the quantity that firm
sells.
PS = R - VC
Welfare of society (W)
W= CS + PS + (tax)
Deadweight loss (DWL)
The net reduction in welfare from loss of surplus by one group that is not offset by gain to
another group from an action that alters a market equilibrium. With DWL reasoning one can
claim that competition maximizes welfare because it drives price to equal marginal cost at
equilibrium.
P1  j1
CS = A + B +C
PS = D + E
P2  j2
CS = A
PS = B + D
DWL = ∆W = – C – E
Claes Melander, 19701
21
Government policies that alter the equilibrium
Taxes, price ceilings and price floor create a gap between the price consumers pay and the
price firms receive. These policies force price above marginal cost, which raises the price to
consumers and lowers the amount consumed. The wedge between price and marginal cost
results in a deadweight loss
Tariff
A tax levied on imported goods
Quota
A statutory limit on the amount imported.
An import quota and a tariff have the same affects for consumers and producers. The
difference is that using a tariff the government collects revenue where import quota benefits
the firms allowed to sell their goods in the market.
Claes Melander, 19701
22
Chapter 10 – General Equilibrium and Economic Welfare
General Equilibrium
Partial-equilibrium analysis
Examination of equilibrium and changes in equilibrium in one market in isolation. All other
prices and goods are held fixed, meaning that we implicitly assume that no other market is
affected.
General-equilibrium analysis
Study of how equilibrium is determined in all markets simultaneously
Spillover effect
An event in one market may have a spillover effect on other related markets, therefore you
may receive a more accurate result using a general-equilibrium analysis instead of a partial
Example:
Corn Market – Soybean Market
1. (a) U0m and E0m j0m
2. Price of corn falls due foreign
demand decrease
3. U0m and E1m j1m
4. Because of low corn price
consumers substitute toward corn
away from soybeans  Demand for
soybeans falls and supply for
soybeans decrease (spillover effect)
5. (b) E0s falls to E2s and U0s falls to U2s
 j0s falls to j2s
6. (a) U0m  U3m  j1m  j3m
7. (b) E2s  E4s  j2s  j4s
Using a partial analysis we stop at 3.
with the general analysis we see that the
equilibrium point in the corn market
changes even further.
Claes Melander, 19701
23
Trading between two people
Pareto efficient
An allocation of goods or services is Pareto efficient if any possible reallocation would harm
at least one person; no one can
be made better off without
making someone worse off
Om Denise och Janes handlar
med varandra kommer båda få
det bättre då alla punkter inom
arean B är en förbättring
gentemot jämnvikten i e. Alla
punkter i arean B sägs vara
Pareto effektiva.
Vid punkten f kommer de bådas
indifference kurver tangera varandra,
alltså bådas Marginal rate of substitution
(RS) är lika vid f.
Tar man ut flera sådana punkter och drar
ett linje emellan får vi en kontraktskurva.
Vid denna kurva kommer ingen av
parterna vara villiga att ingå i nån mer
handel.
Competitive exchange
First Theorem of Welfare Economics
The competitive equilibrium is Pareto efficient
Under perfekt konkurrens är alla jämvikter effektiva.
Second Theorem of Welfare Economics
Any Pareto-efficient equilibrium can be obtained by competition, given an appropriate
endowment
Varje effektiv resursfördelning kan realiseras som en jämvikt under perfekt konkurrens, för
något val av initial fördelning.
•Antaganden: Perfekt information, konventionella preferenser, privata varor
Claes Melander, 19701
24
Jämvikt under perfekt konkurrens
• I en bytesekonomi där alla tar priserna för givna råder det jämvikt om alla kan köpa och
sälja så mycket de vill till dessa priser.
• Jämvikten definieras av den slutgiltiga resursfördelningen och priserna.
Competition, in which all traders are price takers, leads to an allocation in which the ratio of
relative prices equals the marginal rates of substitution of each person
When
MRSj = -Pc/Pö = MRSd
We will receive a competitive
equilibrium such as f
Although if the price ratio would be
something else then we would not end up
with a competitive equilibrium
Production and trading
Comparative advantage
Two people can achieve a better combined
production if they trade. That combined
production is summarized by PPF-curve
Efficiency and equity
The Pareto efficiency criterion reflects a value judgement that a change from one allocation to
another is desirable if it makes someone better off without harming anyone else. This criterion
does not allow all allocations to be ranked, because some people may be better off with one
allocation and others may not be better off with another. Majority voting may not allow
society to produce a consensus, transitive ordering of allocations either. Economists,
philosophers, and others have proposed many criteria for ranking allocations as summarized
in welfare functions. Society may use such a welfare function to choose among Paretoefficient (or other) allocations.
Effektiva fördelningar (3 versioner)
• En resursfördelning f är effektiv under följande tre ekvivalenta villkor.
– Parternas marginella substitutionskvoter är identiska.
– Det finns inget utrymme för ömsesidigt gynnsam handel.
– Det existerar inga Pareto-förbättringar.
Claes Melander, 19701
25
Chapter 11 – Monopoly
Monoploy Profit Maximization
Profit max
MR = MC
Marginal Revenue Curve for Monopoly
 Under perfect competition MR = demand curve. That is not the case for monopoly!
 The monopoly’s marginal revenue curve lies below the demand curve
o The relationship between the two depends on the shape of the demand curve
 Linear demand curves always have the same relationship to MR curve
o The slope of MR is twice the slope of demand curve
o If Demand has slope -1 and hits Q = 24 when price is 0
Then MR has slope -2 and hits Q = 12 when price is 0
Price Elasticity of Demand
MR = p (1 + 1/)




MR equals zero where the demand curve has a unitary elasticity, = -1
Monopoly profit is maximized in the elastic portion of demand curve
A monopoly never operates in the inelastic portion of its demand curve
fig. b
Shutdown Decision
Short run shutdown if:
AVC > p
Long run shutdown if:
AC > p
Claes Melander, 19701
26
Market Power
The ability of a firm to charge a price above marginal cost and earn a positive profit
Elasticity
The more elastic the demand the monopoly faces at the quantity at which it maximizes its
profit, the closer the price is to its marginal cost
Lerner Index (Price markup)
p – MC = -1
p

The more elastic the demand is, the closer (p – MC)/p is to zero, and the competitive level
Effects of a shift of the demand curve
A monopoly does not have a supply curve; therefore a shift in demand on a monopoly’s
output depends on the shape of both its marginal cost curve and its demand curve. As a
monopoly’s demand curve shifts, price and output may change in the same direction or
different directions.
Competition
Monopoly
Welfare effects of monopoly
Because a monopoly’s price is above its marginal cost, too little is produced creating a
deadweight loss. As a result the monopoly makes higher profit and consumers are worse off.
Deadweight loss
Area: C + E
Claes Melander, 19701
27
Cost advantages that create monopolies
Natural Monopoly
A market has a natural monopoly if one firm can produce the total output of the market at
lower cost than several firms could.
Government actions that create monopolies
Barriers of entry
Governments make it difficult for new firms to obtain a license to operate
Patents
Nations grant patents, which
give inventors monopoly
rights for a limited period if
time.
Patent is an incentive for
inventors and investors to
develop new products that
have a lot of R&D costs.
Because the patent gives the
monopoly higher profits
returns.
Government actions that reduce market power
A government can eliminate the deadweight loss created by monopoly firms by regulating the
price through e.g. a price ceiling. In the diagram we se a monopoly that has been optimum
regulated. In the real world these types of regulations are hard to accomplish when
governments usually lack the information necessary to set the price at the right level. A better
way of achieving an optimum equilibrium is facilitate entry of new firms in the market
Claes Melander, 19701
28
Chapter 12 – Pricing
Why and how firms price discriminate
A firm can discriminate if it has market power, knows which customers will pay more for
each unit of output, and can prevent customers who pay low prices from reselling to those
who pay high prices
Nonuniform prices
 A firm earns higher profit from price discrimination than uniform pricing
 The firm captures some or all of the consumer surplus of customers who are willing to
pay more than the uniform price
 The firm sells to some people who would not buy at the uniform price
Types of discrimination
Perfect price discrimination
First-degree price discrimination
Quantity discrimination and Block-pricing
Second-degree price discrimination
Multimarket price discrimination
Third-degree price discrimination
(Price discrimination often refers to multimarket price discrimination)
Perfect price discrimination
The firm charges customers the maximum each is willing to pay for each unit of output, the
monopoly captures all potential consumer surplus and sells the efficient (competitive) level of
output.

The firm’s marginal revenue curve is its demand curve for a perfect price
discriminating firm
Quantity discrimination
All customers pay the same price
for a given quantity. A firm may
quantity discriminate by charging
customers who make large
purchases less per unit than those
who make small purchases
Block-pricing
A firm charge one price for the
first few units (a block) of usage
and a different price for
subsequent blocks (fig a).
(Fig b; normal monopoly pricing)
Claes Melander, 19701
Ads
Only
Take
s
Cust
omer
s
from
Rival
s
29
Multimarket price discrimination
Firm profit-maximize by charging groups of consumers prices in proportion to their
elasticities of demand, the group of consumers with the least elastic demand paying the
highest price. The US consumers pay a higher price due to its less elastic demand curve. In
each market firms profit-maximize by setting MRJ = MC = MRUS
Welfare is less under multimarket price discrimination than under competition or perfect price
discrimination but may be greater or less than that single-price monopoly.
Two-part tariffs
The firm charges a consumer a lump-sum fee (first tariff) for the right to purchase goods or
services at a specified price (second tariff). E.g. telephone companies charge a monthly fee
(first tariff) then they charge for calls per minute (second tariff)
This method may capture all consumer surplus if consumers have identical demand curves. If
consumer not are identical or the firm does not know each customer’s demand curve or can
vary the two-part tariff across customers, it can use a two-part tariff to make larger profit than
it can get if it set a single price.
Claes Melander, 19701
30
Nonidentical consumer
Profit max (consumer 1 demand)
 p = $10, & = $2450  п = $4900 (consumer 1 $2450, consumer 2 $2450)
Profit max (consumer 2 demand)
 p = $10, & = $4050  п = $4050 (consumer 1 $0, consumer 2 $4050)
Profit max (both consumers)
 p = $20, & = $1800  п = $5000 (consumer 1 $2400, consumer 2 $2600)
Tie-in sales
Allows customers to buy one product if they also promise to purchase another one
Requirement tie-in sale
Customer who buy one product from a firm are required to make all their purchases of
another product from that firm
Bundling (package tie-in sale)
A firm sells only a bundle of two goods so that customers cannot buy either good separately.
Paket (Bundling)
 Kund A är villig att betala 1000 kronor för Word och 600 kronor för Excel
 Kund B är villig att betala 600 för Word och 1000 kronor för Excel
 Antag att det inte är möjligt att sätta olika priser för de två kunderna
 Visa att Microsoft bör paketera Word+Excel
Kund A
Kund B
Om pris är:
Vinst



Word
1000kr
600kr
1000kr
1000kr
Excel
600kr
1000kr
1000kr
1000kr
Paket
1600kr
1600kr
1600kr
3200kr
Om både Word och Excel skulle kostat 1000kr skulle kund A inte köpa Excel och vice
versa, alltså blir vinsten 2000kr (1000 för Word + 1000 för Excel)
Om de paketeras tillsammans köper kunderna båda programmen, alltså blir vinsten
3200kr (1600 * två paket)
3200kr > 2000kr alltså bör Microsoft paketera sina produkter
Claes Melander, 19701
31
Chapter 13 – Oligopoly and Monopolistic Competition
Monopolistic
Monopoly
Oligopoly
MR = MC
MR = MC
MR = MC
p = MR = MC
Ability to set price
Price setter
Price setter
Price setter
Price taker
Market power
p>MC
p>MC
p>MC
p=MC
Entry conditions
No entry
Limited entry
Free entry
Free entry
Number of firms
1
Few
Few or many
Many
Long-run profit
≥0
≥0
0
0
Profit-maximization
condition
Strategy dependent
on individual rival
No (has no
rivals)
firms’ behavior
Competition
No (cares
Yes
Yes
about market
price only)
Single
May be
May be
product
differentiated
differentiated
Local natural
Automobile
Plumbers in a
gas utility
manufacturers
small town
Products
Example
Competition
Undifferentiated
Apple farmers
Game Theory
The set of tools that economists use to analyze conflict and cooperation between firms
Each oligopolistic and monopolistically competitive firm adopts a strategy to compete with
other firms. Firms may use different strategies depending on whether they compete in a
single-period game or in multiperiod games.
Nash equilibrium (Oligopolistic equilibrium)
No firm wants to change strategy given what everyone else is doing. Holding the strategies of
all other players (firms) constant, no player can obtain a higher payoff by choosing a different
strategy.
Dominant strategy
If one strategy strictly dominates (makes better profit) all other strategies, regardless of the
actions chosen by rival firms, the firm should choose the dominate strategy
Single-period game
In a single period game none of the firms will cooperate to make higher joint profit when each
firm has a substantial profit incentive to cheat on the agreement. We have a prisoners’
dilemma game. All players have dominant strategies that lead to a profit that is inferior to
what they could achieve if they cooperated and pursued alternative strategies.
Multiperiod games
In a repeated game, a firm can influence its rival’s behavior by signaling and threatening to
punish.
Claes Melander, 19701
32


A firm will produce the output beneficial if both firms pursue it as long as the other
firm follows (signaling)
If the other firm cheats the collusion in period t, the firm can produce the less
profitable output for both in a period t + 1 and all subsequent periods (threatening to
punish)
Cooperative oligopoly models
Cartels
If firms successfully collude, they produce the monopoly output and collectively earn the
monopoly level of profit. Although their collective profits rise if all firms collude, each firm
has an incentive to cheat on a cartel arrangement so as to raise its own profit even higher. For
cartel prices to remain high, cartel members must be able to detect and prevent cheating, and
noncartel firms must not be able to supply very much output.
Laws against cartels
When antitrust laws or competition policies prevent firms from colluding, firms may try to
merge if permitted by law.
Cournot model of noncooperative oligopoly
Cournot equilibrium
A Nash equilibrium, in which firms choose quantities, is also called a Cournot equilibrium:
A set of quantities sold by firms such that, holding the quantities of all other firms constant,
no firm can obtain a higher profit by choosing a different quantity.
Q = 339 - p


qA = Q(p) - qU = (339 - p) - qU
p = 339 - qA - qU
MRr = 339 - 2 qA - qU  MRr = 339 - 2 qA - qU = 147 = MC  qA = 96 - 0,5 qU
qU = 96 - 0,5 qA 
qA = 96 - 0,5 (96 - 0,5 qA)
P, $/pax

qA = 64


 qU = 64
P, $/pax
339
Monopoly
Duopoly
339
211
243
147
MC
147
MC
qU = 64
D
MR
96
339
QA, Thousand American Airlines
passengers per quarter
Claes Melander, 19701
MRr
64
128
137,5
D
Dr
275
QA, Thousand American Airlines
passengers per quarter
33
339
Best-response Curve
Show the output each firm picks to maximize its profit, give its belief about its rival’s output.
The Cournot equilibrium occurs at the intersection of the best-response curves
Deriving the Best-response curve
 If United sets MR = p its output is 192 (192 at y-axis)  Americans best response
(blue curve) will be 0 output other wise it will lose money.
 If United didn’t produce at all (0 at y-axis)  Americans best response (blue curve)
would be to produce 96 which will make them a monopoly profit.
Stackelberg model of noncooperative behavior
Much like the Cournot model but here one firm sets its output before the other firm, that firm
is known as the Stackelberg leader, and the firm setting its price after is know as the
Stackelberg follower. The leader will use its market position to manipulate the follower and
make as large profit as possible. The leader will therefore choose an output where if the
follower profit-maximize the leader will still make a larger profit.
What output will the leader choose?
Through the best-response curve the leader can estimate their rivals output at each output the
firm produces. Using the best-response curve we can derive the residual demand for the
leader. The leader will set its output where its residual marginal revenue is equal to its
marginal cost.
MRr = MC
Government intervention
A government may subsidize a domestic oligopoly firm so that it produces the Stackelberg
leader quantity, which it sells in an international market. Such intervention has many
problems and other government can retaliate causing loss of both countries.
Claes Melander, 19701
34
Comparison of Collusive, Cournot, Stackelberg and Competitive
Equilibria
Monopoly
qA
96
qU
0
Q = qA + qU
96
p
$243
$9.2
A
$0
U
$9.2
 = A + U
Consumer surplus, CS $13.8
$13.8
Welfare, W = CS + 
Deadweight loss, DWL $4.6
Cartel
48
48
96
$243
$4.6
$4.6
$9.2
$4.6
$13.8
$4.6
Cournot
64
64
128
$211
$4.1
$4.1
$8.2
$8.2
$16.4
$2.0
Stackelberg
96
48
144
$195
$4.6
$2.3
$6.9
$10.4
$17.3
$1.2
Price Taking
96
96
192
$147
$0
$0
$0
$18.4
$18.4
$0
qU, Thousand United passengers per quarter
American’s best-response curve
Contract
curve
Price-taking equilibrium
Cournot equilibrium
Stackelberg equilibrium
Cartel
equilibrium
United’s best-response curve
qA, Thousand American passengers per quarter
Claes Melander, 19701
35
Monopolistic Competition
Two conditions hold in a monopolistically competitive equilibrium:
 MR = MC (firms set output to maximize profit)
 p = AC (new firms enter until no further profitable entry is possible)
This shows that: the lower the fixed costs, the more firms there are in the monopolistically
competitive equilibrium
Monopolistic vs. competitive markets
Firms in both markets make zero profits in the long-run.
Competitive firms
 Horizontal residual demand curves
 Charge prices equal to marginal cost
Monopolistically competitive firms
 Downward-sloping residual demand curves
 Charge prices above marginal cost
Bertrand price-setting model
In many oligopolistic or monopolistically competitive markets, firms set prices instead of
quantities
Bertrand equilibrium
A Nash equilibrium, in which firms choose prices, is also called a Bertrand equilibrium:
A set of prices such that no firm can obtain a higher profit by choosing a different price if the
other firms continue to charge these prices.
Identical products
If the product is homogeneous and firms set prices, the Bertrand equilibrium price equals
marginal cost.
Bertrand vs. Cournot for identical products
When firms produce identical products and have a constant marginal cost, the Cournot model
is more plausible than the Bertrand. The latter model appears inconsistent with the real world.
Therefore economists use the Cournot model to study market in which firms produce identical
goods.
Differentiated products
If the products are differentiated, the Bertrand equilibrium price is above marginal cost.
Typically, the markup of price over marginal cost is greater the more the goods are
differentiated.
Claes Melander, 19701
36
Chapter 14 – Strategy (OBS! Inte på tentan)
Preventing entry: Simultaneous decissions
Dominant strategy
If it is more profitable to enter a market than staying out then the dominant strategy is entering
Pure strategy
The firm chooses an action with certainty
Mixed strategy
The firm chooses between its possible actions with given probabilities
Simultaneous decision entry game
If firms make simultaneous entry decisions, their actions depend on the market size and the
possibility for success. If the market is large enough that two firms can make a profit, both
enter. If only one firm can profitably produce, there are many possible Nash Equilibria.
Preventing entry: Sequential decisions
If an incumbent tries to prevent entry depends on:
 Does it pay for an incumbent to act to prevent entry?
 When can an incumbent prevent entry?
 What strategic acts and threats of future actions can an incumbent use to prevent
entry?
Does it pay to take action?
 Blockaded entry: Market conditions are such that no additional firm can profitably
enter the market, even if the incumbent produces the monopoly output – so it is
unnecessary for the incumbent to act strategically to prevent entry
 Deterred entry: The incumbent acts to prevent an additional firm from entering
because it pays to do so
 Accommodated entry: Because it doesn’t pay for the incumbent to prevent entry
through strategic action, it does nothing to prevent entry but reduces its output (or
price) from monopoly to duopoly level to maximize its post-entry profit
Credible threat
An incumbent with first-mover advantage prevents entry by making a credible threat: It
commits to taking an action (whether or not entry occurs) that lower potential entrant’s profit.
Claes Melander, 19701
37
Commitment and Fixed Costs
Which action the incumbent decides to pick depends on two key factors: the ability to commit
and the entrants fixed costs. If the fixed cost is below the level where entry is blockaded the
incumbent has following options:



Cournot equilibrium: If the incumbent can’t commit – so both firms are on an equal
footing – the incumbent produces the Cournot equilibrium quantity (No benefits
compared to other actions, but an option)
Stackelberg (accommodated-entry) equilibrium: If the incumbent can commit and
the fixed cost of entry is relatively low, the incumbent commits to the Stackelberg
leader quantity (larger than the Cournot quantity)
Deterred-entry equilibrium: If the incumbent can commit and the fixed cost of entry
is relatively high, it commits to a large enough quantity (larger than the Stackelberg)
to deter entry.
Cournot equ. Stackelberg equ. Deterred-entry equ.
No
Yes
Yes
Ability to commit
High
Entrants fixed cost Not important Low
Conclusion:
 If the fixed cost is relatively low or zero, the incumbent commits to the Stackelberg
leader quantity.
 If the fixed cost is relatively high, the incumbent commits to a larger output to deter
entry
Creating and Using Cost Advantages
Lowering Marginal Cost while Raising Total Cost
If a firm by investing in an expensive e.g. robotic arm for production; raises its total cost and
lowers its marginal cost, the firm credibly commits to producing relatively large levels of
output and thereby discourages entry. Thus firms benefit from lowering their marginal costs
relative to those of rivals.
Learning by Doing
Firms may raise output in first period to be able to take advantages from the gained
experience in future periods.
Raising Rival’s Costs
Direct Methods: By interfering with its rivals’ production or selling methods
Indirect Methods: Incumbent firms may lobby for a government regulation that
disproportionately affects new firms. Incumbent may buy up market supplies of scarce
resources to prevent rivals from using them.
Raising All Firms’ Costs
There is always worth more to the monopoly to keep the entrant out than it is worth to the
entrant to enter. Thus, raising all firms’ costs is worse for entrants than incumbents.
Claes Melander, 19701
38
Advertising
Monopoly Advertising
 A monopoly advertises to raise its profit
 A monopoly advertises only if it expects its net profit (gross profit minus the cost of
advertising) to increase
 A monopoly sets advertises to the amount where Marginal Benefit equals Marginal
Cost
 MB = MC
(MB is the extra gross profit from one more units of advertising or
the marginal revenue from one more unit of output)
Strategic Advertising
Advertising may either help or hurt rivals
 When advertising causes an increase in demand to rise for all firms in the market, your
ad helps your rivals. Therefore rivals may cooperate to run advertising campaigns.
 When advertising differentiate your product from those of rivals it may benefit your
firm at expense of your rivals, therefore hurting rivals
Empirical Evidence
 Cigarette ads increases market demand, helps rivals
 Coca Cola ads gain from the ads at the expense of rivals, hurts rivals
 Saltine crackers lies in between these extremes
Strategic Advertising Equilibria
Whether ads hurts or helps rivals may affect the ad strategies that firms use.
First Payoff Matrix: The Nash equilibrium is for both firms to advertise. This game is an
example of a prisoners’ dilemma. Both would be better off if they colluded and agreed not to
advertise
Second Payoff
Matrix:
Advertising is a
dominant
strategy for
both firms
Ads Attracts New Customer to the Market
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Chapter 18 – Externalities, Commons, and Public Goods
Externalities
An externality occurs when a consumer’s well-being or firm’s production capabilities are
directly affected by the actions of other consumers or firms rather than indirectly through
changes in prices.
Negative externality
Harms someone, consumers (people) and/or firms.
E.g. A chemical plant that dumps its waste products into a lake, spoiling the lake’s beauty,
harms a firm that rents boats for use on that waterway
Positive externality
Benefits others, consumers (people) and/or firms.
E.g. By installing outdoor sculptures around its plant, a firm provides positive externalities to
its neighbours.
The inefficiency of competition with externalities
Competitive firms and consumers do not have to pay (if not government regulated) for the
harms of their negative externalities, therefore they do not calculate with the cost of negative
externalities when they profit/utility maximize.
Supply-and-Demand Analysis
A competitive market produces excessive pollution because the firms’ private cost is less than
their social cost.
Private cost – The cost of production, not including externalities
Social cost – The true cost which is the private cost plus the cost of the harms from
externalities, e.g. pollution
MKF – Marginal cost of pollution (the negative exernality)
MKP – Private marginal cost
MKS – Social marginal cost
eS = Optimum equ.
eC = Competitive equ.
E = Deadweight loss
By ignoring externality
costs we do not maximize
welfare
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This diagram illustrates two main results:
1. A competitive market produces excessive negative externalities
2. The optimal amount of pollution is greater than zero
Taxes
 If the government has sufficient information about demand, production cost and the
harm of externality, it can use taxes or quotas to force the competitive market to
produce the social optimum. Thus internalizing the externality for the firms.
Conclusion
 It is usually optimal to have some negative externalities, because eliminating all of
them requires eliminating desirable outputs and consumption activities as well.
Market Structure and Externalities
A monopoly sets its output where MR = MC,
Competitive firms sets its output where MC = p
With a negative externality, a non-competitive equilibrium may be closer to than a
competitive equilibrium to the socially optimal equilibrium.
A tax that increases the welfare for a competitive market, could in fact lower the welfare in a
non-competitive market if output already was set lower than the optimal output
Allocating Property Rights to Reduce Externalities
Property right
An exclusive privilege to use an asset
Coase Theorem
Externalities arise because property rights are not clearly defined. According to the Coase
Theorem, allocating property rights to either of two parties results in an efficient outcome if
the parties can bargain.



If there are no impediments to bargaining, assigning property rights results in the
efficient outcome at which joint profits are maximized
Efficiency is achieved regardless of who receives the property rights
Who gets the property rights affects income distribution. The property rights are
valuable. The party without the property rights may be compensated by the other party
Private Good
 Rivalry and Exclusion
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Common Property/Good (Allmän egendom/ gemensamma resurer)




Resources to which everyone has free access
Common property resources are overexploited because Private MC < private MB
Taxes and quotas may reduce or eliminate overuse
Example
o Roads – If too many drivers want to drive on the same road it leads to
congestion (a negative externality)
o Common pools – Petroleum and other fluids, first person who removes fluid
from the pool gains ownership the good
o Fisheries – The fish are accessible to all when they are in the water but as soon
as someone catches them there someone property. The lack of clearly defined
property rights leads to overfishing
Public Goods (Kollektiva varor)





A commodity or service whose consumption by one person does not prelude others
from also consuming it (No Rivalry)
Once a public good is provided to anyone, it can be provided to others at no additional
cost.
A public good produces a positive externality, and excluding anyone from consuming
a public good is inefficient
Public Goods often have a capacity roof, which if reached introduces rivalry e.g. A
public swimming pool gets crowded.
A Public good with rivalry can be seen as a Common good
Public Goods without Exclusion (Rent kollektiva varor)


A public good without a capacity roof that creates rivalry
Example – National military defence, air
Public Goods with Exclusion / Club Good (Klubbvara)



A public good with exclusion
As long as everyone pays there is no rivalry
There is a capacity roof here as well
Rivalry
No Rivalry
Exclusion
Private Good: candy bar, pencil, aluminium foil
Public good with exclusion: cable television,
club good (concert, tennis club)
No Exclusion
Common-access resources: fishery,
hunting, road
Public good without exclusion:
National defense, clean air
Free Riding
Many people are unwilling to pay for their share of a public good. They try to get others to
pay for it, so they can free ride: benefit from the actions of others without paying. That is,
they want to benefit from a positive externality
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Chapter 19 – Asymmetric Information
Problems due to Asymmetric Information
Asymmetric information causes market failures when informed parties engage in
opportunistic behaviour at the expense of uniformed parties. The resulting failures include the
elimination of markets and pricing above marginal cost. Two types of problems arise from
opportunism:
Adverse selection
Adverse selection is opportunism characterized by an informed person’s benefiting from
trading or contracting with a less informed person who does not know about an unobserved
characteristic of the informed person.
Moral hazard
Moral hazard is opportunism characterized by an informed person’s taking advantage of a
less-informed person through an unobserved action.
Differences between Adverse selection and Moral hazard
Differences between unobserved characteristic and unobserved action
E.g. George and Marge are going to get life insurances. Unknown to the company is that they
skydive.
 George will skydive whether or not he has a life insurance
o George’s unobserved characteristic leads to adverse selection for the comany
 Marge will skydive only if she has life insurance
o Marge’s unobserved action is a moral hazard for the insurance company
Responses to Adverse Selection
To avoid adverse selection problems requires restricting the opportunistic behaviour or
eliminating the information asymmetry (equalize information)
Restricting the opportunistic behaviour
A government can avoid adverse selection by providing insurance to everyone or by forcing
everyone to buy insurance. Resulting in that not only the high risk people buy insurance and
therefore spreading the risk for the insurance companies and lowers the adverse selection.
Equalizing Information
Screening – Uniformed people screen to determine the information of informed people or
their products
Signaling – Informed people send signals to uniformed people, or third parties such as the
government or independent test centrals provide information
How ignorance about quality drives out high-quality goods
If consumers cannot distinguish between good and bad products before purchase, bad
products may drive goods ones out of the market. This is a problem due to adverse selection.
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Methods of dealing with this problem
Laws to Prevent Opportunism – If there is a law saying that firms are liable to correct
defective products, consumers don’t need worry about adverse selection
Consumer Screening – Consumers may screen themselves or buy the information from
objective experts, such as a mechanics to appraise a used car. Consumers may be affected by
the firm’s reputation from other consumers or observation
Standards and Certification – This way consumer can be sure that they receive a minimum
quality level.
Signaling by Firms – Though signals are only effective if the are credible. Some firms use
brand name as a signal of quality. Others provide guarantees or warranties.
Price Discrimination due to False Beliefs about Quality
Firms can price discriminate by charging different prices to differently informed consumers.
They charge more to the less in informed and vice versa.
Same product, different brand name
Firms can exploit ignorant customers by creating noise: selling virtually the same product
under different brand names, charging a different price for each.
Market Power from price ignorance
If consumers don’t know how prices vary across firms, a firm can raise its price without
losing all its customers. Thus if consumers have limited information about price, an
equilibrium in which all firms charge the full-information competitive price is impossible and
therefore gives them market power.
Furthermore in this type of market where consumers have asymmetric information and when
search costs and the number of firms are large, the only possible single-price equilibrium is at
the monopoly price.
Problems arising from ignorance when hiring
Companies use signaling and screening to try to eliminate information asymmetries in hiring.
Where prospective employees and firms share common interests – such as assigning the right
worker to the right task – everyone benefits from eliminating the information asymmetry by
having informed job candidates honestly tell the firms – through cheap talk – about their
abilities. When two parties do not share common interests, cheap talk does not work. Potential
employees may inform employers about their abilities by using expensive signals such as
college degree. If these signals are unproductive (as when education serves only as a signal
and provides no training), they may be privately beneficial but socially harmful. If the signals
are productive (as when education provides training or leads to greater output due to more
fitting job assignments), they may be both privately and socially beneficial.
Firms may also screen. Job interviews, objective tests, and other screening devices that lead to
a better matching of workers and jobs may be socially beneficial. Screening by statistical
discrimination, however, is harmful to discriminated-against groups. Employers who
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discriminate on the basis of a particular group characteristic may never learn that their
discrimination is based on false beliefs because they never test these beliefs.
Chapter 20 – Contracts and Moral Hazards
Principal-Agent Problem
A principal (employer) contracts with an agent (employee) to perform some task
The profits made depends on the principal’s assets, the actions of the agent and the state of
nature
   a 
a = number of hours,
 = random variable (e.g. weather),
The principal’s assets = The actual equation
Only agent dependent     a
Only State of nature dependent     
If the principal cannot observe the agent’s actions, the agent may engage in opportunistic
behaviour. This moral hazard reduces the joint profit. An efficient contract leads to efficiency
in production (joint profit is maximized by eliminating moral hazards) and efficiency risk
bearing (the less-risk-averse party bears more of the risk).
Risk averse – individual who don’t like bearing risk. Will pay preemie to be relived from the
risk.
Risk neutral – Individual who don’t mind bearing risk
Types of contracts
Fixed-fee contract – The payment to the principal is a fixed sum, F, and the agent receives
the residual profit,  a  - F. There is also a possibility that the agent receives the fixed sum
and vice versa.
Hire contract – Two types, hourly rate (wage per hour) and piece rate (payment per unit
sold). Principal’s residual profit is  a  - wa, where w is the wage per hour and a number
of hours worked.
Contingent contract – Payoff depend on the state of nature. One type is a splitting or sharing
contract as in a house sale the estate agent charges a commission of 7 % on the sales price.
Agent receives 0,07 a , Principal receives 0,93 a 
Production efficiency
Production efficiency is achieved by maximizing the total or joint profit.
Contract properties
 There has to be a large enough payoff for both parts to be willing to participate in the
contract
 It has to be incentive compatible so that agent don’t engage in opportunistic
behaviour
An agent with a fixed-fee rental or profit-sharing contract gets the entire marginal profit and
produces optimally without monitoring.
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Contract
Fixed-fee rental contract
Rent (to principal)
Hire contract, per unit pay
Pay equals marginal cost
Pay is greater than marginal cost
Contingent contract
Share revenue
Share profit
Full Information
Production
Efficiency
Asymmetric Information
Production
Moral Hazard
Efficiency
Problem
Yes
Yes
No
Noa
Noc
Nob
No
Yes
Yes
No
Yes
Nob
Nob
Yes
Yes
a
The agent may not participate and has no incentive to sell the optimal number of goods. Efficiency can be
achieved only is the principal supervises.
b Unless the agent steals all the revenue (or profit) from extra sale, inefficiency results.
c The agent sells too many or the principal directs the agent to sell too few goods.
Trade-off between efficiency in production and in risk bearing
Usually a contract does not achieve efficiency in production and in risk bearing.
A principal and an agent may agree to contract that strikes a balance between reducing moral
hazards and allocating risk optimally. Contracts that eliminate moral hazards require the agent
to bear the risk. If the agent is more risk averse than the principal, the parties may trade off a
reduction in production efficiency to lower risk for the agent.
Payments linked to production and profit
To reduce shirking, employers may reward employees for greater individual or group
productivity.
Paying employees by piece (output produced) instead of time (hours worked) is proven to be
effective but not practical in all markets.
Three problems with Piece Rates
 Measuring output
 Eliciting the desired behavior
 Persuading workers to accept piece rates
Piece rates are normally used for low-paying industries. Another incentive scheme is needed
for managers, corporate directors and others whose productivity is difficult to quantify,
especially those who work as part of a team.


Year-end bonus – A lump-sum based on the firm’s performance or that group of
workers within the firm
Stock options – (Options program), blir värdefulla om företagets aktie går bra annars
blir optionerna värdelösa då inlösedagen kommer.
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Monitoring
Because of asymmetric information an employers must normally monitor workers’ efforts to
prevent shirking. Less monitoring is necessary as the employee’s interest in keeping the job
increases. The employer may require the employee to post a large bond that is forfeited if the
employee is caught shirking, stealing, or otherwise misbehaving. If an employee cannot afford
to post a bond the employer may use deferred payments or efficiency wages – unusually high
wages – to make it worthwhile for the employee to keep the job.
Checks on principals
Often both agents and principals can engage in opportunistic behavior. If a firm must reveal
its actions to its employees, it is less likely to be able to take advantage of the employees. To
convey information, an employer may let employees participate in decision-making meetings
or audit the company’s books. Alternatively, an employer may make commitments so that it is
in the employer’s best interest to tell employees the truth. These commitments, such as laying
off workers rather than reducing wages during downturns, may reduce moral hazards but lead
to nonoptimal production.
Contract choice
A principal may be able to obtain valuable information from an agent by offering a choice of
contracts. Employers avoid moral hazard problems by preventing adverse selection. For
example, they may present potential employees with a choice of contracts, prompting
hardworking job applicants to choose one contract and lazy candidates to choose another.
Chapter 15.4 – Vertical integration
Vertically integration – participate in more than one successive stage of the production or
distribution of goods or services
Quasi-vertically integrate – use contracts or other means to control firms with which is has
vertical relation
A firm may vertically integrate or buy from a factor market. Depending on which is more
profitable, a firm vertically integrates and produces input itself or buys the input from others.
Because vertical integration is costly, firms integrate only if there are significant benefits.
Possible Benefits with vertical integration
 Lowering transaction costs
 Ensuring a steady supply
 Avoiding government restrictions
 Extending market power to another market
 Eliminating market power of rivals
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