Economic 1010 B Notes
sept 4/08
-Economics- is the study of how individuals, firms and governments make
optimal choices from among a set of alternatives when facing scarce resources.
-optimal- the assumption that consumers will do what is best for:
consumers, seek their own satisfaction.
firms, profit, profit, profit
governments, social welfare
-Choices - w/o choice there is no role for economics
-scarcity - w/o scarcity there is no role for economics
3 kinds of economic systems:
Free market
Mixed Free Market
Communist
Any economic system must solve 3 central coordination problems
-what to produce
-how to produce it
-who to produce it for
-Marginal Cost - the additional cost to you over and above the costs you have
already incurred
-Sunk Costs - non-recoverable costs in the past, irrelevant to the decision
-Marginal benefits - the additional benefits to you, over and above benefits you
have already received
If the relevant marginal benefits exceed the marginal costs do it
if the Marginal costs exceed the marginal benefits, don’t do it.
Opportunity cost- the value of the next best alternative to the activity you have
chosen
Price doesn’t mean cost. price is the dollar figure and cost means what you have
to give up for a good or service
Rationing is the mechanism for determining who gets what
Governments rationing
price mechanism
Economic Reality is controlled by Three Forces
Economic forces- invisible hand
social and cultural forces
political and legal forces
A Market Force is an economic force that is given free rein by a society to work
through the market. market forces ration by price
The invisible hand guides resources to their most valued use.
-Positive Economics- the study of what is and how the economy works
-Normative Economics- the study of what the goals of an economy should be.
Capitalism needs a legal system to enforce property rights. Socialism doesn’t
need this as no one has any property rights.
While most economists believe that the market economy is a the best way to
coordinate individuals needs they also recognize that it is not always fair.
Problems with capitalism
income distribution- income is accumulated by a relatively small percentage
of the population
public goods- non-profitable goods that society needs to function i.e. fire
halls justice system, armed forces.
externalities- crime, pollution, etc.
September 11 2008
output- is a result of an activity.
input - is what you to put into a production process to achieve an output
-Production Possibility Curve will demonstrate
Scarcity- to produce more of one good we must give up some amount of
another good
Opportunity Cost
Efficiency- producing the MAXIMUM output for a fixed amount of inputs
kinds of input
Capital- intermediate goods used in the production of other goods
labour
raw materials
energy
output = F(inputs) where F=function
PPC shows the maximum combination of outputs that can be achieved from a
given number of inputs. With Scarcity the PPC slopes downward from left to
right.
Comparative advantage- why opportunity costs increase as the consumption of a
good increases . Some resources are better suited for producing a good than
producing another type off good.
-we should always pursue comparative advantage and specialize in producing a
good
for PPC we assume
we have a fixed amount of inputs
we use the inputs efficiently
Laws of increasing Opportunity Costs - as more and more inputs are directed to
a single good, away from another, it becomes more and more costly. The most
productive resources to produce good B are always removed from the production
of Good A but as more and more resources are directed at Good A they become
less and less efficient at being made into Good A
Absolute advantage- what can be produces cheapest is produced without any
other market considerations
With Trade you can move out past the PPC
Principle of increasing marginal costs(the cost of the alternative good or service)
states that the opportunity costs increase the more you concentrate on an activity
Any point within the PPC represents inefficiency it means either
correct inputs are there but the wrong productions techniques are employed
correct production techniques are employed but the wrong amount of inputs
-PPC’s can shift outward if
technology is improved
more resources are employed
economic institutions get better at fulfilling our wants
trade
neutral Technology change- new technology that works better for the production
of all goods
biased technology change - new technology only helps in the production of one
or a few goods.
collaboration and specialization can make society better off. this leads to trade
which allow production totals to rise.
Markets allow specialization and the division of labour.
September, 16 2008
chapter 4
Households supply factors of production to business and are paid for doing so.
businesses produce goods and services and sell them to households and
governments.
Governments have two roles
The Actors - they collect taxes some of which they spend n government
projects and the rest of which is redistributed back to the people.
the Referee’s - set the rules that determine the interaction b/w households
and businesses
governments do the latter through two broad regulations.
the Competition Act - spells out illegal business practices like Price fixing
and price discrimination
The Bank Act - spells out what banks can and cannot do.
there are two principles of taxation
Ability to pay - or a progressive tax system. the more money you make the
more money you pay in taxes. Canadian income tax is a progressive tax.
Equitable tax system - everyone pays the same this is the same as the flat
tax we pay in alberta.
business is the name given to private firms producing units for our society. There
are three types of businesses:
Sole proprietorships- a single owner owns the company. he makes all the
money but also is on the line for all the risk. 95% of all business in Canada are
single owner but only about 10% survive. it is very high risk and also difficult to
come up with the start up capital.
Limited Partnership - more than one owner who divide profit and loss risk
according to agreed shares. easier to raise capital and you can go out and
acquire partners with a different skill set than yourself.
Corporation- many owners. Profit is given to shareholders in the form of
dividends shareholders and not the original owner are liable for debts. it is the
easiest way to raise capital but the original owner looses control of his company.
Consumer Sovereignty - means that consumers wishes control what is produced
by businesses and what it costs.
profit is what is left over from total revenue after all appropriate costs have been
paid.
economic profit is different it is Revenue - Operating Costs - Opportunity Cost =
Profit.
Households are groups of individuals living together and making joint economic
decisions. house holds make money mainly from wages and salaries.
Sept 18, 2008
Law of Demand- there is an inverse relationship b/w the price and the quantity of
Demand.
Other factors constant (Ceteris Paribus) As price falls quantity demanded
increases and Vice Versa
The Demand curve will give MAXIMUM price consumers will pay for a certain
good.
Giffen Goods - goods that appear to violate the Law of Demand as the price
increases demand increases.
Demand Curves slope down from left to right
Ceteris Paribus - means that all other factors that affect quantity demand are
assumed to remain constant, whether or not they actually remain constant or not.
Incomes are constant- higher incomes shift the demand curve to the right
and lower incomes shift it to the left.
taste/style remain constant
Prices of substitute goods remain constant.
Change in Price causes change in quantity demanded and is represented by a
move along the original demand curve.
a change in demand shifts the demand curve due to a change in one of the
assumed constants (other than price)
A Market demand curve is a horizontal sum of all individual demand curves.
Individuals control the factors of production
Law of Supply - there is a direct relationship b/w the price and the quantity
supplied.
as the producer increases output production costs rise (excluding sunk
costs such as set up and R&D) and thus a higher price must be charged.
the supply curve gives the MINIMUM price the producer needs to produce a
certain quantity of output (break-even)
as the price increases the quantity of supply increases ceteris paribus and
Vice Versa
changes in price cause changes in the quantity of supply represented by
movement along a fixed supply curve.
changes in supply cause a shift in the curve up or down.
Sept, 23 2008
other factors besides prices affect how much will be supplied.
prices of inputs used in the production of a good. i.e. energy and raw
materials
technology- producer can produce more w/ the same inputs supply curve
shifts down
expectations by both the consumer and the supplier
taxes and subsidies.
The market supply curve is derived by the horizontal sum of individual supply
curves.
Equilibrium Price- the price toward which the invisible hand drives the market.
OR the intersection of Supply and Demand. Everyone who wishes to buy a
product @ equilibrium price can do so. there is no shortage or surplus
Any movement away from the equilibrium price in a market economy will cause a
movement back to it.
Equilibrium quantity - the amount that producers producer at equilibrium price/
surplus sends a signal to a producer to lower output. As output falls so do costs
and the minimum price also falls.
as price falls consumers are enticed to buy until the equilibrium price in reached.
Sept, 25 2008
Elasticity is a measure of responsiveness of one variable to another.
The greater the elasticity, the greater the response
Price Elasticity of demand is the percentage change in quantity demanded
divided by the percentage change in price.
Ed=((Q1-Q0)/((Q1-Q0)/2))
((P1-P0)/((P1-P0)/2))
Revenue =price *quantity
Initial revenue = P0*Q0
new revenue = P1*Q1
if the Absolute value of Ed is greater than 1 than it is an elastic relation and as the
price goes up, revenue goes down or as Price goes down then revenue goes up.
If the Absolute value of Ed is less than one then it in an unelastic relationship and
as price goes up so does revenue and vice versa
price elasticity of demand is always a negative as price and quantity are inversely
related
Economists use the average of the end points to calculate percentage change/
The elasticity or inelasticity of a point can change as one moves along the
demand curve.
we cannot talk about the elasticity of a curve only a point or a small section of the
curve
When Ed =1 it is called unit elastic and at unit elastic revenue is left unchanged
when small price changes are made. Unit elastic is the maximum revenue at that
demand.
Sept, 30 2008
How many substitutes a good has is affected by many factors
time to adjust
luxuries vs necessities
narrow or broad definition
budget proportion.
a perfectly inelastic demand curve is a vertical line and a perfect elastic demand
curve is a horizontal line
if demand is elastic, a rise in price results in a fall in total revenue
if demand is inelastic, a rise in price results in a a rise in total revenue.
the bottom (right side) of a demand curve is most often inelastic, the middle is
where unit elastic can be found and the left side or top is elastic.
income elasticity of demand - is the % change in demand / % change in income
if it is greater than 0 it is a normal good. the more money you make the more of
that good you will buy. most goods are normal goods
if it is less than 0 it is called an inferior good. as income increases you will buy a
higher quality good instead of more of that good.
cost price elasticity of demand - is the % change in Q demanded / % change in P
of another good.
measures the degree of substitutability of 2 goods
when E^xy is less than 0 the goods are compliments and the more negative the
value the stronger the complimentation
when E^xy is more than 0 the goods are substitutable and the greater the
number the greater the substitutability.
price elasticity of supply is calculated as the % change in Q supplied / % change
in P
E^s greater than one it is elastic supply
E^s is less than one it is inelastic supply.
Oct, 2 2008
Role of the Government in the Market
Provide a stable institutional framework
legal- to protect property rights
armed forces
Promote effective and workable competition
federal competition bureau
correct for externalities
ensure economic stability and growth
provide public goods
adjust for undesired market results
an externality is the effect of a decision on a third party not taken into account by
the decision maker.
unless they are required to do so, parties in an exchange are unlikely to take into
account any externalities.
negative externalities lead to over use. this can be controlled by taxes, tolls and
quotas.
Public goods are goods whose consumption by one individual doesn’t limit or
prevent their consumption by another consumer. Goods that could not produce a
profit for a company. i.e. armed forces, fire departments, justice system
A progressive tax is one who’s rates increase as a persons income increases.
i.e. Canadian federal income tax
a regressive tax is one who’s rates decrease as a persons income increases.
(often proportional to their total income) i.e. GST
A proportional tax is one who’s rates are constant at all income levels, regardless
of income. i.e. alberta income tax
Demerit goods and activities are those considered to be bad for a person,
although they may like it. i.e. drugs and crime
market failures are reasons for governments to intervene
market failures are situations where the market does not lead to a desired result
Consumer surplus - the difference b/w what the consumer is willing to pay for an
item and what they actually pay. on a demand and supply curve it is the area b/w
the demand curve and the market (equilibrium) price.
Producer Surplus - the difference b/w what it costs to produce a good for and
what the producer can sell it for. on a demand supply curve it is the area b/w the
supply curve and the market price.
Oct, 7 2008
the sum of the consumer surplus and the producer surplus will be at its maximum
at the equilibrium point.
dead weight-loss represents a loss in output that could be produced and that
consumers are willing to purchase but is simply not produced or bought. This is
also called a welfare loss triangle - a geometric representation of welfare loss in
terms of misallocated resources caused by a deviation from a supply - demand
equilibrium
The Benefit principle states that the individuals who receive the benefits from a
good or service should pay the cost (tax) of the resources used to produce the
good. User Pay eg gasoline tax, airport fees, cigarette taxes.
the ability-to-pay principle - individuals who are most able to bear the burden of
the tax should pay it. eg canadian income tax
Goal of the Government
Most effective when
-Raise revenue and
-Demand or supply is inelastic
limit dead weight loss
Change Behavior
-demand or supply is elastic
when you tax an inelastic good you raise a lot of tax revenue w/o a large dead
weight loss as people cannot as easily substitute away to a different good.
consumers pay the tax when you tax a inelastic good.
when you tax an elastic good people will substitute away to another good and
therefore not a lot of tax revenue is raised. There is a large dead weight loss and
the producer must pay most of the tax.
the person who physically pays the tax is not always the person who bears its
burden
the burden of the tax depends on the relative elasticity of the good being taxed.
the burden of taxation is rarely shared equally as elasticity is rarely equal.
Oct, 9 2008
A price ceiling is a set maximum price that the market price cannot exceed.
Generally set below the equilibrium price.
a price ceiling is an implicit tax on producers and an implicit subsidy on
consumers
the Hope is that price ceilings will help consumers who have lower incomes.
Rent Seeking behavior - One group tries to obtain surplus from another group.
Usually it is producers taking surplus from consumers as they can organize
easier.
A Price Floor is a set minimum price set above the equilibrium price.
It is an implicit tax on consumers and an implicit subsidy to producers. Surplus is
transfered from the consumer to the producer.
To maintain a Price ceiling or Floor a quota system must be enforced.
When demand is inelastic, producers have incentive to lobby the government to
restrict supply.
In the long run, supply and demand tend to be much more elastic than inelastic
and price controls lead to large shortages or surpluses.
Oct 14, 2008
According to economists we behave the way we do because of rational self
interest.
rational - when facing identical conditions (income and price) the consumer
will always make the same choice
self interest - people only care about their own welfare, however, your
welfare may depend on the welfare of others (children and parents etc)
individuals want to maximize the amount of their own satisfaction they realize
through the consumption of goods and services.
total utility refers to the satisfaction one gets from consumption of a product.
marginal utility is the increase in utility from consuming and additional unit of the
good.
there are 2 important properties of utility
more is always preferred to less - utility rises with consumption
utility rises at a diminishing rate.
the principle of diminishing marginal utility - after some point, the marginal utility
received from each additional unit of a good will begin to decrease with each
additional unit consumed.
we maximize total utility when MUx/Px=MUy/Py
if MUx/Px>MUy/Py then we consume more of good x
opportunity cost is essentially the marginal utility per dollar you forgo.
Bounded rationality - means rationality based on rules of thumb. we employ a
variety of simple rules to make some of our decisions
price conveys information (quality)
follow the leader
habits/customs/traditions
budget constraints represent all combinations of two goods that a person could
afford to buy with a given given income AKA the income constraint or budget line
PxX+PyY=M
PxX=M-PyY
X=(M/Px)-(PyY/Px)
M is total income
as y increases x must decrease
indifference curve - a curve that shows combinations of goods amongst which an
individual is indifferent as any point along the curve has the same utility to the
consumer.
Oct, 21 2008
any point along the budget line represents all income being spent.
the slope of the budget line is the ratio of the prices. slope changes when price
changes.
budget lines can shift with changes in income.
an indifference curve is downward sloping as an increase in one good must lead
to a decrease in the other good to remain at the same utility.
the slope of the indifference curve is the ratio of the marginal utilities of the two
goods.
indifference curve is also called the marginal rate of substitution MRS
the indifference curve is the rate at which one good must be added when the
other is taken away in order to keep the individual indifferent b/w the 2
combinations.
indifference curves CANNOT cross.
The best combination of goods is the point where the indifference curve with the
highest utility and the budget line are tangent.
when this happens we see that
MUpop/MUbars=Ppop/Pbars
then divide both sides by Ppop and multiply both sides by MUbars so you
get
MUpop/Ppop=MUbars/Pbars
thus the slope of the indifference curve and the budget are equal at an
intersecting point and this is the best combination of goods.
the income expansion path shows us what we buy at different levels of income
with normal goods as income increases the consumption of both goods increase.
with an inferior good as income increases the consumption of one good
increases in consumption but the inferior good doesn’t increase in consumption
Engel Curve
assumes that with an increase in income you will spend all the increase on one
good.
when that one good is an income elastic normal good it is called a luxury good
and as income increases then consumption of the good increases more than the
increase in income.
when that one good is an income inelastic normal good it is called a necessity
and as income increases consumption of the good will increase less than the
increase in income.
when that good is an inferior good the consumption of the good increases as
increases but only to a point and at that point of income increase consumption
will decrease.
Price expansion path.
shows the consumption of two goods using budget lines and indifference curves
as the price of a good changes.
using cross price elasticity we can see if the goods are complimentary or
substitute.
the slope of the price expansion path tells us if the goods are substitute or
complimentary.
income effect - reflects the purchasing power change as a result of the change in
price.
for price changes we can distinguish b/w the income and the substitution effect
substitution effect- you always substitute to the good with the lower relative
price
income effect - you factor in all costs related to purchasing the good.
Oct, 23 2008
a firm is an economic institution that transforms factors of production into
consumer goods.
inputs=> production function => outputs
production function can be used to calculate the maximum amount of outputs
from a given set of inputs.
firms organize factors of production, produce goods and services, and sell them
how an economy operates depends on transaction costs - the costs of
undertaking trades through the market
contract fees, legal fees, service fees.
the boundary of the size of a firm is where the market has lower transaction costs
than a firm i.e. buying all the parts vs buying a car from a dealership.
a long run decision is a decision in which the firm can choose the least expensive
method of producing from among all possible production techniques. all inputs
can be changed and the firm isn’t constrained in any way.
Short run decisions - the firm is constrained by past choices in regard to what
production decisions can be made. in the short run flexibility is limited. One or
more factors of production are fixed usually it is capital.
Oct, 28 2008
Production function - a curve that describes the relationship b/w the inputs and
the outputs.
the production function tells the max. amount of output for a given set of inputs.
MP=Change in Output/Change in input (usually labour)
MP is the slope of the total production curve for a small increase in input.
the MP curve peaks at the inflection point of the total production curve.
The MP peaks slightly before the Average product curve
the law of diminishing marginal productivity - as more and more of a variable
input is added to an existing fixed input, after some point the additional output
one gets from the additional input will fall.
firms never operate where MP<0 since outputs can be increased by cutting
costs.
Firms never operate where MP is rising since profit will not be maximized.
fixed costs are costs that don’t change regardless of output
loan payments,
utilities etc.
Variable costs are costs that change as output changes labour and materials.
in the long run we assume that there are no fixed costs since all costs are
variable
TC=FC+VC
ATC=TC/Q output
AFC=FC/Q
AVC=VC/Q
ATC=AFC+AVC
MC is the increase in total cost of increasing the level of output by one unit.
MC=Change TC/Change Q
in deciding how much output to produce the most important variable is MC
The MC curve intersects the AVC and ATC at their minimum value
the shape of the cost curves are a mirror image of the shapes of the
corresponding productivity curves.
since costs (labour) rise slower than the output, MC and AC decline even though
total costs are rising.
When MC exceed average costs the average cost must be rising
When AC exceeds MC the MC must be rising.
Oct, 30 2008
My Birthday
economic efficiency means producing a given amount of goods at the lowest
possible cost.
technical efficiency is using fewest number of inputs to produce a set amount of
outputs.
economic efficiency is the least cost technically efficient process.
There are economies of scale (EOS) when the long run average cost decreases
as output increases. We find that initially at small levels of output ATC tends to
fall b/c there are usually high start up costs so that ATC is very high at small
levels of output but the MC are low.
EOS (increasing returns of scale) are cost savings associated w/ larger scales of
production
and indivisible setup cost is the cost of an indivisible input for which a certain min
amount of production must be undertaken before the input becomes
economically feasible to use.
EOS means that outputs are rising faster than costs.
the minimum efficient scale of production is the amount of production that
spreads setup costs out sufficiently for firms to undertake production profitably.
Increasing Returns to Scale is where long run ATC fall as output increases
example Air Canada Telus and Enmax
Constant Returns to Scale is where the long run ATC does not change as output
increases example is a home industry
Decreasing Returns of Scale - a decrease in productivity which occurs when
there are equal increases of all inputs. Where the long run ATC curve is upward
sloping meaning that AC is increasing.
As a firms size increases, monitoring costs generally increase.
monitoring costs- costs incurred by the organizer of production seeing to it that
the employees do what they are supposed to.
Diseconomies (DRS) occur for a number of reasons as firm size increases.
at planned output levels, short run ATC equals long run ATC
at all other levels of output short run ATC is higher than the long run ATC
entrepreneur - an individual who sees an opportunity to sell an item at a price
higher than the AC of producing it.
Problems of using cost analysis in the real world
Economies of scope - when the cost of producing goods are interdependent so
that it is less costly for a firm to produce one good when it is already producing
another.
TC(Q1Q2)<TC(Q1)+TC(Q2) - when this happens the firm must choose the
lowest cost combination of Q1 and Q2
Learning by doing - means that as we do something, we learn what works and
what doesn’t, so productivity can increase over time for the same cost resulting in
lower ATC
External economies - present in all ind. - external forces at work which are
capable of reducing costs for all firms in the ind. example is High tech firms in the
silicon valley and orchards in the Okanogan.
technological change - is an increase in the range of production techniques that
provides new ways of producing goods.
Final is from here down.
Nov, 13 2008
The concept of competition is used in 2 ways in economics.
competition as a process is a rivalry among firms
compete with prices, quality, store location, and service.
competition as a market structure
perfect competition - most competitive structure.
monopolies - least competitive as there is only one firm in an industry and
dominates the market.
imperfect competition - a handful of firms in the industry means there is
competition but each firm can display some market power.
a perfectly competitive market is one in which economic forces operate
unimpeded
it has highly restrictive assumptions which provide us with a reference point we
can use in comparing different markets.
In a perfectly competitive market
the number is firms is large - there is no single or group of firms that can
dominate the market with changes in quantities produced.
The firms produce the same product - the different firms products are
homogenous
the consumer is indifferent between the different brands of the same product.
There is very easy entrance and exit from the industry (no barriers to entrance or
exit)
there is complete information.
consumers can costlessly measure price, quality, store location , etc.
firms are profit maximizers
both buyers and sellers are cost takers.
the demand curve facing the firm is different from the industry demand curve.
a perfectly competitive firm’s demand curve is perfectly elastic and horizontal.
Firms cannot raise their prices as they are set by the world price.
marginal revenue (MR) - the change in total revenue associated with a one unit
increase in quantity.
to maximize profits a firm must set output where, MR=P=MC
the supply curve for a firm is given by the positively slopped portion of the
marginal cost curve because it gives the profit maximizing output for any price.
MR=MC this is maximum profit
firms seek to maximize total profit, not profit per unit they don’t care about that.
As long as an increase in output leads to an increase in profit no matter how
small profit maximizing firms will increase output.
in a perfectly competitive industry economic profit is driven to zero. As a people
see that every company is making money more and more firms will enter the
market. this will lower the market price and will continue to fall until there is no
longer any economic profit in the industry. Only then will companies stop entering
the market and price will bottom out.
the shutdown point is the point at which a firm would be better off to shutdown
than if it stayed in business.
when P=AVC a company has reached the shutdown cost as it is recording an
economic loss and can no longer cover variable expenses. It is a result of to
many firms entering the market.
Nov, 18 2008
A monopoly is a market structure in which a single firm makes up the entire
market.
They are difficult to define.
geographically - Canada, Alberta, Lethbridge.
define the product - for Telus the phone line to a house vs. communication
services.
monopolies exist b/c of barriers to entry into a market that prevents competition.
legal barriers - such as patents
sociological and traditional barriers - entry is prevented by customs and
traditions
natural barriers - the firm has a unique ability to produce what other firms
can’t duplicate. often b/c of physical location to a market of resource.
technological barriers - the size of the market can support only one firm. Or
special expensive technology limits entry.
a competitive firms MR is the market price.
a monopolies MR is not its price. It takes into account that in order to sell more it
has to decrease the price of its product.
for a monopoly the market demand curve isn’t flat but sloped so that MR<P
If MR>MC the monopolist gains profit by increasing output. If MR<MC they gain
profit by reducing output.
If MR=MC the monopolist is maximizing profit same as a firm in perfect
competition.
The MR=MC condition determines the quantity a monopoly produces.
when MR=0 TR is maximized and represents the point at which Q is at its max.
monopolies restrict output and charge more.
They make a profit when P>ATC and a loss when P<ATC
monopolies often lead to a deadweight loss and if there is no deadweight loss it
is probably because using price discrimination they have taken all of the
consumer surplus for the firm.
the Area below the MC is the TC
Price discrimination - is the ability to charge different prices to different
individuals or groups of individuals for the same product. ex auctions - each
person pays the max amount of what they are willing to pay.
in order to price discriminate, a monopoly must
identify groups of customers who have different elasticities of demand
separate these groups
limit their ability to resell its products b/w groups
a price discriminating monopolist can increase both output and profit. It can
charge customers w/ more inelastic demands higher prices and customers with
more elastic demand a lower price.
Nov, 20 2008
price discriminating monopolies can sell units to everyone on the demand curve
above the MC curve by charging different prices and offering discounts off the
normal price.
price discrimination is illegal but nearly impossible to stop or enforce.
a natural monopoly is an industry in which one firm can produce at a lower cost
than can two or more firms. they operate w/ increasing returns to scale (AC is
declining)
natural monopolies can prevent new firms from entering a market by increasing
output and lowering prices. They will still earn a profit doing this just won’t be
maximizing profit.
natural monopolies never really reach minimum efficiency scale as Ac declines
w/ increases in output.
there is no welfare loss in a natural monopoly situation. In fact there can be
welfare gain b/c a single firm is much more efficient than several firms producing
the good or service.
fair return pricing - governments enforce a price below the monopoly price but
above the ATC so that the firm still profits but doesn’t profit too much.
barriers to entrance
high set up costs - the industry may be capital intensive, requiring a large
investment in expensive, highly specialized equipment. ex. Oil refineries and
Mines.
Advertising costs - in some industries a lot of money is spent on advertising.
Heavy advertising creates a barrier as it is very expensive. ex. Auto makers and
perfume.
Legislation - monopolies can exist b/c of government charters (Canada Post) or
through patents on a special good.
ownership of resources - if a company owns all the resources of factors of
production they can control an industry. Standard oil in the 1900’s
the public doesn’t like monopolies as they take away consumer surplus for
themselves.
Where MR is zero, elasticity is at unit elastic.
Nov, 25 2008
Monopolistic Competition/companies = MonCom
cross price elasticity is one way to classify a market - define industries by what
products they produce and the degree of substitutability
North American Industry Classification System (NAICS) is a classification system
of industry used by Canada Mexico and US it was adopted in 1997
The concentration ration is the percentage of the industry sales by the top four or
five firms.
the herfindahl index is an index of the market concentration calculated by adding
the squared values of the individual market shares of all the firms in an industry.
It is more sensitive to larger firms. the max value of the index is 10000(monopoly
100% of the ind)
the four distinguishing characteristics of a MonCom
many sellers
differentiated products - usually results in heavy advertising as firms try to
distinguish themselves.
multiple dimensions of competition - not just price based competition.
easy entry of new firms in the long run.
A MonCom firm produces in the same manner as a monopoly - to maximize profit
it chooses to produce the quantity where MC=MR
having determined the output the firm will charge what consumers are willing to
pay as determined by the demand curve.
if price exceeds ATC the firm will earn a positive economic profit. these profits
attract new firms to the industry
as some customers switch from existing firms to new ones the demand curve for
each firm moves to the left thus in the long run they are driven to 0 economic
profit.
MonCom are inefficient b/c they cannot achieve minimum efficiency scale (lowest
ATC). And money that should be spent on new technologies to cut costs is spent
on advertising.
Both MonCom and perfectly competitive firms make zero economic profit in the
long run but a MonCom will produce less and charge more.
the excess capacity theorem indicates that a MonCom will have excess capacity
in the long run equilibrium. it occurs b/c of product differentiation.
Oligopolies are made up of a small number of large firms. the key ingredient of
an oligopoly is strategic thinking => how will competitors react to pricing
decisions.
products may be homogeneous or differentiated.
firms are mutually interdependent - decisions of one will affect all.
in the cartel model of an oligopoly:
oligopolies act as if they were monopolies.
firms have assigned output quotas to individual firms
total output is consistent w/ joint profit maximization.
formal collusion is illegal in Canada but informal is permitted (think gas prices)
implicit price collusion exists when multiple firms make the same price decisions
w/o deciding on a price together. They are all reacting to the same market forces.
Nov, 27 2008
kinked demand curve- firms will always follow one firm that lowers its prices.
these forms operate on the inelastic demand curve when they lower their prices
thus total revenue goes down. If one firm raises its price none of the other firms
will follow suit. thus the demand curve is elastic and firm looses total revenue.
contestable market model - barriers to entry and barriers to exit determine a firms
price and output decision.
if there is a credible threat of entry of new firms into a market existing firms will
lower prices to where they equal MC so they can maintain market share.
both cartels and contestable markets use strategic pricing decisions - firms
set their prices based on the expected reaction of other firms.
if the firms in a cartel cooperate all can profit. however, there is an incentive to
cheat to try and increase revenue.
the dominant strategy is one which always yields the highest payoff for a firm no
matter what the other firm(s) do.
Nash equilibrium is where the dominant strategies intersect. a non-cooperative
equilibrium in which no firm can achieve better outcome by switching strategies
given the strategy of the other firms.
Dec, 2 2008
there are two cases when the market doesn’t yield an appropriate outcome.
market failure - where markets fail to produce the right amount of output or
charge the correct price. the profit maximizing price and output instead of the
socially optimal quantity and price.
market outcome failure - where the market outcome although efficient is not
socially optimal.
when there is a negative externality marginal social costs are greater than
marginal private costs MSC>MPC
MSC includes the MPC as the firm is part of society and also things like pollution.
when there are negative externalities the price is too low and the equilibrium
output too high to maximize social welfare.
Marginal social benefit equals the marginal private benefit of consuming a good
plus the positive externalities resulting form consuming that good.
direct regulation - the amount of a good people are allowed to consume or
produce is directly limited by the government. The most inefficient and hardest to
enforce and measure correct amounts.
A tax incentive program uses a tax to create incentives for individuals to structure
their activities in a way that is consistent with the goals of the tax. Tax programs
more often yield the desired outcome and are more efficient than direct
regulation. The problem with it is the formation of a large expensive bureaucracy
and knowing the correct amount of tax to charge.
the market incentive program is the most efficient way to reduce negative
externalities. Individuals who reduce consumption by more than the required
amount receive marketable certificates that can be sold to others.
Dec 4, 2008
property rights are a set of use and ownership rules in society which dictate who
may use or enjoy a particular resource.
the problem with externalities is usually that no one owns the resource that is
being negatively affected.
if we could apply ownership to the resources someone would have the incentive
to stop the negative externality.
Coase theorem - the idea that the optimal allocation of resources (equilibrium)
can always be achieved through market forces, regardless of the initial
assignment of property rights.
rival goods are good that other people can automatically be prevented from
consuming (a shirt, an apple)
goods are excludable if access to them can be controlled.
non-rival excludable goods don’t trade well in an ordinary market. These goods
can be jointly consumed and access to them can be controlled (movie in a
theater, art gallery)
common property - non-excludable goods are difficult for markets to handle b/c
non-payers cannot be stopped from consuming the good (radio waves)
a public good is a non-excludable and non-rival good. everyone can consume it
and benefit and consumption by one doesn’t restrict consumption by others.
public goods are a problem b/c consumers won’t pay a price for them but still
want to be able to consume the good.
asymmetric information is a situation is which one person has information
relevant to the exchange, but the other person doesn’t. can be a cause of market
failure.
Moral hazard - occurs when one of the parties to the exchange misrepresent
their intentions and behave differently than what was agreed to. can lead to
market failures. Example - airbags lead to an increased sense of security and
thus people drive more recklessly which actually leads to an increase in mortality.