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Microeconomics ECON 1110 Notes up to Final

by: genehan

Microeconomics ECON 1110 Notes up to Final ECON 1110

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Detailed notes for material that is covered from Prelim #2 to the Final for ECON 1110. Please see my other posted notes for a comprehensive set of study guides for Microecon Final.
Introductory Microeconomics
Professor Thomas
Study Guide
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This 7 page Study Guide was uploaded by genehan on Saturday January 30, 2016. The Study Guide belongs to ECON 1110 at Cornell University taught by Professor Thomas in Summer 2015. Since its upload, it has received 40 views. For similar materials see Introductory Microeconomics in Economcs at Cornell University.

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Date Created: 01/30/16
Lecture  #  20  Monopolistic  Competition  November  10,  2015   • A  common  form  of  industry  structure  characterized  by   o Many  firms,  differentiated  products,  “price  maker”,  free  entry  and  exit   o Ruby  Tuesday,  TGI  Fridays,  Chilis,  etc  (a  lot  of  substitutes  but  not  perfect  substitutes  –   there  are  close  substitutes)   • Product  differentiation   o Strategy  that  firms  use  to  achieve  market  power     o Can’t  use  price  and  quantity  decisions  in  isolation     o Accomplished  by  producing  goods  that  differ  from  others  in  the  market   o The  level  of  product  variety  reflects   § Underlying  preferences  of  consumers  (underlying  heterogeneity  of   consumers’  tastes  in  that  market)  (coke  vs  pepsi,  some  people  don’t  care,  etc)   § The  gains  (if  any)  from  coordination   § Cost  economies  from  standardization  (if  large-­‐less  variation  and  more   standardization  of  the  products)   • How  do  firms  differentiate?   o Horizontal  differentiation  –  products  differ  in  ways  that  make  them  better  for  some   people  and  worse  for  others   o Vertical  differentiation  –  a  product  difference  that,  from  everyone’s  perspective,   makes  a  product  better  than  rival  products  (reduction  in  price,  better  quality   material)     • Differentiation  is  due  to  buyers  perceiving  a  difference     o Real  differences  are  usually  minor:   § Differences  in  packaging  (if  packaged  nicely,  people  may  think  inside  has  a   good  product  rather  than  a  badly  packaged  product)   § Differences  in  advertising  theme  (can  target  different  demographics)     o Real  differences  are  not  so  great  as  to  eliminate  other  goods  as  substitutes     § Cross-­‐price  elasticity  of  demand  between  goods  in  monopolistically   competitive  markets  is  positive  (among  substitutes)     § Close  but  imperfect  substitutes     • Major  sources  of  product  differentiation   o Differences  in  quality  which  are  usually  accompanied  by  differences  in  price   § High  quality  à  high  price     o Differences  in  functional  features  or  design   o Ignorance  of  buyers  regarding  the  essential  characteristics  and  qualities  of  goods   they  are  purchasing  (imperfect  information-­‐  consumers  don’t  know  the   characteristics  of  the  product)   o Sales  promotion  activities  of  sellers  (advertising)   o Differences  in  availability  (timing,  location)     • Advertising  can  be  used  to  advertise  real  differences  in  products  and  services   • Freemium  Business  Models   o “give  your  service  away  for  free,  possibly  ad  supported  but  maybe  not,  acquire  a  lot  of   customers  very  efficiently  through  word  of  mouth,  referral  networks,  organic  search   marketing,  etc.,  then  offer  premium  priced  value  added  services  or  an  enhanced   version  of  your  service  to  your  customer  base”  –  Fred  Wilson  (venture  capitalist)   o Freemium  models  are  effective  to  build  a  customer  base  when  the  marginal  cost  of   producing  extra  units  is  low  (apple  apps  top  grossing  are  the  free  apps  due  to  in-­‐app   purchases   Lecture  #21  Monopolistic  Competition  Part  2  November  12,  2015   • Price  and  Output  Decisions   o Monopolistically  competitive  firm  faces  demand  curve     • Short  run  losses  –  oversaturation  of  market  –  too  many  products     • Price  and  Output  Decisions  –  Long  Run   o As  new  firms  enter  a  monopolistically  competitive  industry  in  search  of  profits,  the   demand  curves  of  existing  profit-­‐earning  firms  begin  to  shift  to  the  left,  pushing   marginal  revenue  with  them  as  consumers  switch  to  new  close  substitutes.   § Process  continues  until  profits  are  eliminated     § Demand  and  marginal  revenue  are  shifting  together   • Efficiency  and  allocation   o Entry  is  easy  and  economic  profits  are  eliminated  in  the  long  runàinfer  that   monopolistic  competition  is  efficient  but  there  are  2  problems   § Once  a  firm  achieves  any  degree  of  market  power  by  differentiating,  its  profit-­‐ maximizing  strategy  is  to  hold  down  production  and  charge  a  price  above  MC   § The  final  equilibrium  in  a  monopolistically  competitive  firm  is  to  the  left  of  the   low  point  on  its  ATC  curve  meaning  the  typical  firm  in  the  industry  will  not   realize  all  economies  of  scale  available.     • Inefficienceies  of  monopolistic  competition   o Selling  costs  –  firms  spend  huge  amounts  of  money  on  advertising  and  publicity   § From  a  social  point  of  view,  much  of  this  expenditure  is  wasteful   § Instead  of  spending  money  on  advertising  and  publicity,  producer  could  trim   expenses  reduce  the  price  of  product   o Excess  capacity  –  under  imperfect  competition,  the  installed  capacity  of  every  firm  is   large  but  not  fully  utilized   § Total  output  is  below  full  capacity  level   § Resources  lie  idle   § Total  output  is  less  than  socially  desirable  level  of  output   o Unemployment  –  idle  capacity  leads  to  unemployment   § Unemployment  leads  to  socially  undesirable  characteristics  (poverty)   § If  idle  capacity  were  fully  utilized,  the  problem  of  unemployment  would  be   partially  mitigated   o Lack  of  specialization  –  little  scope  for  specialization  or  standardization   § Product  differentiation  can  lead  to  wasteful  expenditures  on  advertising  and   publicity   § If  fewer  standardized  products  were  produced,  resource  allocation  may  be   improved,  leading  to  a  higher  level  of  economic  welfare   • Perfect  competition   o Many  firms  offering  identical  products   o Free  entry  and  exit  into  industry   o Full  and  symmetric  information   o Positive,  zero,  or  negative  short  run  profits   o Zero  long  run  profits  because  of  firm  entry  or  exit   o P=MC  because  firms  have  no  market  power  and  individual  firms  face  perfectly  elastic   demand   o No  deadweight  loss  so  Pareto  efficient.  In  long  run,  produces  at  minimum  efficiency   scale  (bottom  of  ATC  curve)  so  production  efficient  as  well.     • Simple  monopoly   o One  firm  offering  a  unique  product   o Barriers  –  hard  to  enter  industry  but  easy  to  exit   o Full  and  symmetric  information   o Positive,  zero,  or  negative  short  run  profits   o Positive  or  zero  long  run  profits   o P>MC  because  firm  has  market  power  and  price  according  to  market  demand   o DWL  compared  to  PC  so  not  Pareto  efficient.  In  LR,  may  or  may  not  produce  at  MES,   so  may  or  may  not  be  productive  efficient   • First  degree  price  discrimination  –  single  out  different  demand  curves  –  need  to  know   customers  very  well     o One  firm  offering  a  unique  product   o Barriers  –  hard  to  enter  industry  but  easy  to  exit   o Full  and  symmetric  information   o Positive,  zero,  or  negative  short  run  profits   o Positive  or  zero  long  run  profits   o P>MC  because  firm  has  market  power  and  price  according  to  market  demand   o DWL  compared  to  PC  so  not  Pareto  efficient.  In  LR,  may  or  may  not  produce  at  MES,   so  may  or  may  not  be  productive  efficient   • Monopolistic  competition   o Multiple  firms  offering  competing  differentiated  products  (unique  but  substitutes)   o Free  entry  into  general  product  space  but  can’t  make  the  exact  same  good  as  an   existing  firm.  Free  exit   o Full  and  symmetric  information   o Positive,  zero  or  negative  SR  profits   o Zero  LR  profits  because  entry  of  substitute  goods  eliminates  positive  SR  profits  and   exit  would  occur  if  SR  profits  <0   o P>MC  because  firm  has  market  power  and  price  according  to  market  demand   o DWL  compared  to  PC  so  not  Pareto  efficient.  In  LR,  will  not  produce  at  MES,  is  not   productive  efficient  (to  the  left  of  ATC  curve  where  D  is  tangent  to  ATC  curve)   • Oligopoly   o A  few  firms  offering  competing  differentiated  product  or  same  product   o Some  barrier  to  entry  but  free  to  exit   o Full  and  symmetric  information   o Positive,  zero,  negative  SR  profits     o LR  profits  depend  on  model.  Collusion  can  have  positive  profits,  but  contestable   markets  cannot   o P  vs.  MC  depends  on  model.  For  example,  contestable  markets  have  P=MC,  whereas   collusion  leads  to  monopoly  pricing  where  P>MC   o Efficiency  depends  on  model     Lecture  #22  Externalities,  Public  Goods,  and  Social  Choice   • Externalities   o Actions  of  one  party  imposes  cost  or  benefits  on  a  second  party   o Study  of  externalities  is  a  major  concern  of  environmental  economics   • Marginal  Social  Cost  MSC   o Total  cost  of  society  of  producing  an  additional  unit  of  a  good  or  service   o Equal  to  the  sum  of  the  marginal  costs  of  producing  the  product  and  the  correctly   measured  damage  costs  involved  in  the  process  of  production   • Profit-­‐maximizing  firm  –  externality   o MSC  curve  is  higher  than  MC  (damage)–  distance  between  two  curves  is  the  damage   done  by  social  cost  à  producing  at  Q*  is  inefficient  (too  much)  à  should  produce   where  price  intersects  the  MSC  curve   § MSC  curve  is  lower  than  MC  when  it  is  positive  externalities  (producing  too   little)   • Public  Goods/social  goods/collective  goods   o Nonrival  in  consumption  and  whose  benefits  are  nonexcludable  (public  park)   § Nonrival  in  consumption  –  one  person’s  enjoyment  of  the  benefits  of  a  public   good  does  not  interfere  with  another  person’s  consumption  of  it   o Nonexcludable  (education,  clean  air)   § Once  a  good  is  produced,  no  one  can  be  excluded  from  enjoying  its  benefits     • Free  Rider  Problem   o People  cannot  be  excluded  from  enjoying  the  benefits  of  public  goods  whether  the   pay  for  them  or  not,  they  are  usually  unwilling  to  pay  for  them   • Drop  in  the  bucket  problem   o Good  or  service  is  so  costly  that  its  procision  generally  des  not  depend  on  whether   any  single  person  pays   • Optimal  Provision  of  Public  Goods   o Samuelson-­‐Musgrave  theory  –  demonstrates  that  an  optimal,  or  most  efficient,  level   of  output  exists  for  every  public  good   § An  efficient  economy  produces  what  people  want.  Private  producers  are   constrained  by  the  market  demand  for  their  products.  If  they  cannot  sell  their   products  for  more  than  it  costs  to  produce  them,  they  will  be  out  of  business   o Because  private  goods  permit  exclusion,  firms  can  withhold  their  products  until   households  pay.  Buying  a  product  at  a  posted  price  reveals  that  it  is     worth”  at  least  that  amount  to  you  and  everyone  who  buys  it.  (voting  with  dollars)   • Demand  for  private  goods   o Horizontal  summation  of  household  functions  to  come  up  with  market  function   • Optimal  Provision  of  Public  Goods   o The  level  at  which  society’s  total  willingness  to  pay  per  unit )  is  equal  to  the  MC   A+B of  producing  the  good   o With  public  goods,  there  is  only  one  level  of  output,  and  consumers  are  willing  to  pay   different  amounts  for  each  level  of  output   • Demand  for  public  goods   o Vertical  summation  of  household  demand  curves  to  get  market  demand   • Problematic  assumption  –  government  knows  the  preferences  of  everyone  in  society   • Social  choice   o Problem  of  deciding  what  society  wants   o The  process  for  adding  up  individual  preferences  to  make  a  choice  for  society  as    a   whole   Impossible  to  come  up  with  voting  system  that  is  consistent,  reliable,  repeatable   Lecture  #23  Uncertainty  and  Asymmetric  Information  November  19,  2015   • Expected  Value  –  reported  result  of  10  heads  out  of  10  is  5  more  than  expected     • Deviations  from  expected   o It  is  possible  that  you  were  not  cheated  –  10  heads  out  of  10  flips  is  expected  once  in   1000  games  –  extremely  rare,  but  not  impossible   o Rarely  have  all  the  information  we  need  –  so  we  use  expected  values   • Expected  Value   o Jacob’s  employer  is  trying  a  new  salary  plan  and  Jacob  can  choose  between  two   options   § Earn  $40,000  at  end  of  year   § Manager  tosses  coin  –  heads  à  $60,000  or  tails  à  $20,000   o Expected  value  of  the  two  options  is  the  same   § EV  option  1  =  $40,000   § EV  option  2  =  (20,000  x  0.5)  +  (60,000  x  0.5)  =  40,000   o Expected  Utility  -­‐  How  do  you  decide  which  option  to  choose?   § The  sum  of  utilities  coming  from  all  possible  outcomes  of  a  deal,  weighted  by   the  probability  of  each  occurring   § Assume  Jacob’s  EU  of  receiving  a  guaranteed  payment  is  15  utils   o Less  risk  adverseàless  satisfaction  from  the  more  risky  offer   • Asymmetric  Information   o One  of  parties  to  a  transaction  has  information  relevant  to  the  transaction  that  the   other  party  does  not  have   § Adverse  selection  –  a  situation  in  which  asymmetric  information  results  in   high-­‐quality  goods  or  high-­‐quality  consumers  being  squeezed  out  of   transactions  because  they  cannot  demonstrate  their  quality   • Market  Signaling     • Moral  Hazard   o Unemployment  benefits  –  do  they  change  your  behavior?   • Risk  adverse  –  not  willing  to  risk  the  40,000  for  60,000   Lecture  #24  -­‐-­‐-­‐-­‐-­‐-­‐-­‐  November  24,  2015   Lecture  #25  Economics  of  Taxation  December  1,  2015   • Redistribution  programs  –  social  security,  public  assistance/welfare,  unemployment   compensation,  medicare,  supplemental  nutrition  assistance  program  SNAP,  housing   programs,  earned  income  tax  credit   • US  took  in  $3.5  trillion  in  taxes   • Taxes  on  stocks  vs  taxes  on  flows   o Personal  income  tax   o Consumption  tax  (personal)  (from  households  to  product  market)   o Retail  sales  tax  (from  households  through  firms  into  product  market)   o Payroll  tax  (pretaxed  amount  –  goes  to  fund  medicare,  worker’s  compensation,  etc)     o Profits  (net  income)  tax  (from  firms  back  to  income  into  households)   o Wage  tax  (after  you  get  net  check  and  then  tax  taken  out  after  payroll  tax)   • Tax  Rates   o Average  tax  rate  –  the  total  amount  of  tax  paid  divided  by  total  income     § Avg  rate  =  $2000  taxes  /  $20,000  income  =  10%   o Marginal  tax  rate  –  the  tax  rate  paid  on  the  next  dollar  of  income     § Income  bracket     • $0-­‐29,000  –  5%  tax  rate   • $30,000-­‐59,999  –  7%  tax  rate     • $60,000+  -­‐  10%  tax  rate     o example  –  John  earns  $70,000  per  year   § His  marginal  tax  rate  is  10%     § His  average  tax  rate  is  6.6%     • Tax  Structures   o Progressive  tax  –  a  tax  whose  burden,  expressed  as  a  percentage  of  income,  increases   as  income  increases     § The  more  you  earn,  the  higher  your  base  rate  of  tax  is   o Proportional  tax/flat  tax  –  a  tax  whose  burden  is  the  same  percentage  of  income  for   all  households     o Regressive  tax  –  a  tax  whose  burden,  expressed  as  a  percentage  of  income,  falls  as   income  increases   § In  Alabama,  consumers  pay  a  “sin  tax”  of  9.8  cents  per  beer,  3.4  cents  per  glass   of  wine,  and  21.4  cents  per  shot  of  liquor   • Tax  equity   o Benefits-­‐received  principle  –  a  theory  of  fairness  holding  that  taxpayers  should   contribute  to  government  (through  taxes)  in  proportion  to  the  benefits  they  receive   from  public  expenditures     o Ability  to  pay  principle  –  a  theory  of  fairness  holding  that  citizens  should  bear  tax   burdens  in  line  with  their  ability  to  pay  taxes     § Horizontal  equity  –  those  with  equal  ability  to  pay  should  bear  equal  tax   burdens   § Vertical  equity  –  those  with  greater  ability  to  pay  should  pay  more     • Tax  incidence  –  payroll  tax     o X  axis  –  units  of  labor  and  y  axis  –  wage  rate     o Supply  and  demand  curve  intersect  at  W  and0  L  0 o If  tax  of  T  dollars  per  unit  labor  imposed  à  workers  were  receiving  W0  but  now  firm   has  to  pay  W0+T  then  price  of  labor  goes  up  and  quantity  demanded  of  labor  goes   down  (L0àLD)  so  huge  excess  supply  leads  to  unemploymentàdownward  pressure   on  wage  W0àW1  and  as  workers  respond  to  lower  wages,  labor  supply  curve   contracts  to  L1   o Burden  of  the  tax  –  workers  pay  W0-­‐W1  and  firms  pay  (W1+T)  –W0     o Steeper  supply  curves  àworker  share  of  tax  is  larger  than  firm   § When  labor  supply  is  less  elastic,  a  greater  share  of  the  payroll  tax  is  paid  by   workers   • Excess  burden     o When  taxes  distort  economic  conditions,  they  impose  burdens  on  society  that,  in   aggregate,  exceed  the  revenue  collected  by  government     § Excess  burden/deadweight  loss  –  the  amount  by  which  the  burden  of  a  tax   exceed  the  total  revenue  collected   § Principle  of  neutrality  –  ceteris  paribus,  taxes  that  are  neutral  with  respect  to   economic  decisions  are  generally  preferable  to  taxes  that  distort  economic   decision.  Taxes  that  are  not  neutral  impose  excess  burdens   o Only  time  tax  distortion  is  what  we  want  -­‐  Externalities  and  if  we  already  have  a  tax   that  is  distorting  behavior     • How  do  excess  burdens  arise?   o Area  of  (X0-­‐X1)  x  (P1  (Po+T)  –  (P0=MC)   o Inelastic  demand  (steeper)  –  excess  burden  is  a  lot  smaller     Final  Lecture  December  3,  2015   Big  Ideas     • Three  Economic  Questions     o What,  how,  for  whom  to  produce   • Comparison  of  Market  Structures   o Perfect  competition,  monopolistic  competition,  oligopoly,  monopoly   • Opportunity  Cost   o To  get  something,  you  have  to  give  something   • Price  Mechanism     o What  it  is,  how  it  answers  the  economic  questions   o When  and  how  it  fails   • Profitability     o Revenue  and  costs,  profit  maximization,  existence/persistence  of  economic  profits,   market  factors  affecting  profitability  


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