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Study Guide for Exam 3

by: Julia kelley

Study Guide for Exam 3 ECON 22060-007

Marketplace > Kent State University > Economcs > ECON 22060-007 > Study Guide for Exam 3
Julia kelley
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This is my detailed study guide for Exam 3. This guide covers these topics: Game Theory Anti-trust Information Externalities and Public Goods Decision-making and Behavioral Economics Lab...
Principles of Economics: Microeconomics
Curtis Reynolds (P)
Study Guide
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This 17 page Study Guide was uploaded by Julia kelley on Sunday December 6, 2015. The Study Guide belongs to ECON 22060-007 at Kent State University taught by Curtis Reynolds (P) in Spring 2015. Since its upload, it has received 45 views. For similar materials see Principles of Economics: Microeconomics in Economcs at Kent State University.


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Date Created: 12/06/15
Microeconomics Exam 3 Study Guide Game Theory - Oligopoly: firms with market power o More firms than monopoly, less than monopolistic competition - Game theory: branch of mathematics and economics that studies strategic behavior. o A study that identifies how firms act and how they determine how their opponent acts. - Strategies o Best response: the best decision for you which takes into account all the moves of ALL opponents o Dominant response: ONE response which takes into account and solves all dilemmas proposed by opponents - Prisoner’s dilemma: o if you and your partner get arrested for the same crime and are put in separate rooms one of three things happens:  1. If one confesses and rats out other first then that guy is of free and the other serves 10 years  2. If no one confesses you both get one year of something  3. If the police knows, then both go to jail - How to tackle simultaneous decisions o Payoff matrix: B Confess Don’t confess A = 5 A = 0 B = 5 B = 10 confe ss A A = 10 A = 1 B = 0 B = 1 confe ss - Nash Equilibrium: o No player has an incentive to deviate the other o How do we find this?  When we are both making the same choice, that is  Equilibrium - Example of dominant strategy: o In both cases if B confesses he will get a better result: so it is a dominant response because it works best in all situations - Collude game: o If two firms compete, then they only get 3 million o If two firms collude (work together) Then they both get 15 million o Collusion is hard  in one time interaction it is hard  if opponents compete for a long time then collusion becomes more attractive Regulations Primary vs. General Election - Primary: Candidates have to win their party - General: Candidates have to win over general population, win against other party - Gerrymandering: Every 10 years districts are redrawn to match population changes o Drawing districts that only one party can win, is gerrymandering - Swing state: even balance of democrats and republicans History - Anti-trust rules were created in response to anti-competitive behavior (example: Rockefeller and oil) o Used bi-products from oil to create new products (good) o Created secret agreements with railroad companies until he owned railroad companies. Owns refineries and shipment of refineries (bad) o Created a monopoly, this is why anti-trust laws were created o He acquired or destroyed 32 out of 35 competitor refineries in Cleveland, OH. - Sherman act of 1890 o Made it illegal to “restrict competition” o Supreme Court later came out with “rule of reason” that said you could be a monopoly but you could not use monopolistic power against competitors. From this law, Standard Oil (Rockefeller’s company was forced to split into 34 companies and compete) - Clayton Act of 1914: o Corrected some problems with Sherman act, and added additional restrictions on monopolies  Specifically on merging What is illegal? - Collusion: when firms agree to set prices high and not compete with each other. - Predatory Pricing: Charging artificially low prices to prevent other firms from entering the market. These prices are below the shutdown price ( P < AVC) How can we measure monopoly? - What is the market? o Determining what they label as their market:  Example: beer market ( large merge - monopoly) or beverage market (smaller merge) - How concentrated is the market? o Determining how close to a monopoly a market is  Dependent on market share.  If small firm (small share)  If large firm (large shares) o One method of market concentration is the top 4 – firms concentration ratio (sum of market shares for top 4) o Another method ( HHI) sum of squared market share of all firms  Puts more weight on large firm versus the 4-ratio Example of both methods Number of Market shares 4 – firm ratio HHI firms 5 20,20,20,20,20 80 2,000 5 80,5,5,5,5 95 6.500 10 Each 10 40 1,000 HHI and Merger Policy - The HHI is one thing that the FTC uses to device whether or not to allow a merger Regulation - Regulation can improve market but there are tradeof o Regulate firms to increase efficiency Topic 8 Insurance and Information ­ With the case of insurance, insurance companies do not know if the drivers are good or bad drivers ­ Drivers may drive recklessly because they have insurance Insurance and adverse selection ­ With adverse selection, only the worst drivers buy insurance. ­ They give safe drivers a discount to allow them to outweigh the risky drivers Adverse Selection: The choice of giving something to someone is based on the information you already have or don’t have on that person. ­ People who get sick more often are more likely to buy health insurance ­ People who are worse drivers have to pay more for insurance because they are more likely to buy insurance Moral Hazard: Giving someone something changes the action that they take `- giving someone insurance makes them a bad driver Health Insurance: Both adverse selection and moral hazard apply ­ People who think they need health insurance (more sick) will buy it ­ People who don’t think that they need it have to pay the fees of emergency room  Patient protection and affordable healthcare  Exists as a way of solving the adverse selection  So that healthy people can’t opt out  Keeping premiums on insurance low  Heathy people outweigh the sick people  There was a tradeof  Insurance companies used to be able to charge or deny care based on pre-existing conditions  Banished those because of individual mandate  Now people have to have insurance, BUT insurance companies can no longer deny care based on pre-existing conditions Information Problems and the Financial Crisis ­ No one knew where the bad mortgage backs securities were  Adverse selection: only securities sold were bad, only people who would buy them had debt, so the mortgages banks wouldn’t sell them  Moral Hazard: They would not bail firms out because it was seen as a risk to let them make more bad decisions (go in debt again)  Not bailing them out caused the crisis Topic 9 Sharing & spillovers Spillovers: when a decision that you make afects other people ­ Ex: texting and driving, illegal because it does not just afect you it afects other people. Marginal cost and marginal benefit Externality: when there is an additional cost or benefit from producing or consuming a good which is not included in the marginal cost or marginal benefit ­ True (public) cost is different than the individual cost (private) Negative externality: There is a cost to someone else ­ Not included in the supply curve Marginal social cost (MSC) MC + E……where E = cost to society (spillover) ­ Ex: pollution, producing a product that harms others  Health costs of those around are not calculated into supply curve ­ On curve:  Supply curve meets demand at a higher point on supply curve because it takes (MSC) into account  There is a deadweight loss  All of the extra cost above benefit  THERE ARE ALWAYS AN EXTRA COST CURVE (MSC)  Adding the MSC changes quantity, but deals to be made in the area of MSC are too expensive so they are not made (deadweight loss)  Market is no longer inefficient:  There is a deadweight loss  There is more shared costs, but they are not considered because no one is paying them directly to one another. Positive externality: When there is positive externality from producing or consuming a good ­ The benefit of externality is not included in the demand curve ­ Marginal social benefit (MSB) MB + e = benefit to society ­ With the positive externality of the benefit to society is greater than the simple benefit to the individual consumer.  Example: vaccinations, if everyone gets a flu shot, not only will the individual who got the shot benefit, but people around them do to because they will not get sick. Spillovers: people are more productive, and healthy, so schools and institutions function better ­ On graph  This is where the market does not produce enough  The MSB is above D (demand)  The deadweight loss Is caused by inefficiency (not enough produced)  The benefit received is by those not in the market who experience the spillovers from those in the market  THERE ARE ALWAYS TWO DEMAND CURVES What can we do? ­    Coase theorem: through bargaining, an efficient outcome will occur if:  Property is well defined  There is no costs of bargaining Example: if you are playing music too loud, your neighbor can pay you to turn it down. And visa-versa, you can pay your neighbor to allow you to play music loud. ­    Government intervention: the government is needed to define property rights, but they can also help markets to be efficient, by allowing more or less to be supplied in the market. Negative externality: gov could lower Positive externality: gov could raise ­    Taxes and subsidies Government can tax people for the cost of the spillover. Example: Spillover costs $10  Nobody cares Government taxes people $10  People care Overall: taxes and subsidies make an external problem internal Pollution ­ Pollution is an example of a negative externality.  The government has considered reducing pollution by taxing gas (set price at $4) so that people will drive less, and help the environment by eliminating pollution. ­ Important that: it is NOT efficient to eliminate all pollution.  The opportunity cost of eliminating all pollution outweighs the gains of eliminating the pollution.  Ex: eliminating all pollution would take away too many benefits that we gain from using pollution ­ Cap and trade has tried to create a market for pollution, in order to make it more efficient. (similar to coast theorem)  Example: if we only wanted 100 tons of pollution, then  you have to have a permit to pollute  there can only be 100 permits  BUT you can trade and sell pollution permits,  so if someone wants to pollute but they don’t have a permit, they can purchase one, and if someone wants to sell theirs, they must stop polluting.  better than a tax: because it doesn’t require everyone to pay a tax, and pollution is only a payment made by those creating it.  Worse than a tax: harder to manage than a tax, can only implement at the level of businesses and not households, helps globally and nationally but not locally (firms in town paying to pollute)  Only works if number of permits is retired (if pollution is reduced) o If someone buys a permit, only to not use it, so that it is one less that a business can have Private goods ­ Rivalry: only one person can consume the good (can’t share) ­ Excludable: that a person can be prevented from consuming the good, (does not have to be shared) Public Goods ­ Non-rivalrous: can be shared ­ Non-excludable: have to be shared  Example:  Radio, national defense, public parks ­ The problem of the public buying public goods:  Example:  stoplight, only worth $10 to person, but cost $500  if 1000 people value at $10, then the town actually values it at $500 So, not enough of the public good is privately provided  Example: what if,  Now the town values the stoplight at $600, and it was $500  But, people still won’t pay because if someone else buys it then they have more surplus ­ Free-rider problem: people would rather not pay anything, and gain surplus of the good from other people paying. But, once people realize others are not paying, they no longer want to pay. Common Resource ­ Rivalrous ­ Non excludable  People cannot be excluded from consuming a good, but one person’s consumption lowers the consumption of another person. ­ Tragedy of the commons:  When there is a common ground for everyone to do something on, the land is non-excludable, but when one person uses the land, it diminishes the land being used by someone else.  Eventually, the common resource gets over utilized, and no one can use it.  Similar to a negative externality, because one’s use of the good hurts someone else. Example  Fishing:  Too many people fishing, within 50 years there will be no seafood.  Solution:  Quota on fishing Topic 16 – decision making and behavioral analysis Risk: ­ Does not mean that the outcome will be bad, it just means uncertainty  Consider this choice  1. You receive $10 for sure  2. You get a 50% chance of getting $20, or 50% of getting $0  Calculated risk is $10 for both ( (1.00)10, or (0.5) 20 )  Most people will chose option 1  Referred to as risk aversion: people do not like risk  Risk aversion increases as the stake goes up  Risk averse people will actually take less guaranteed than the potential of a risk.  Risk premium: there is a higher potential return when taking a risk Stocks and Bonds The diference in predicting risk varies between stocks and bonds ­ Bonds less risky ­ Stocks more risky Risk Types 1. Risk-averse: do not take risk 2. Risk-neutral: do not care either way, when there is the same expected value 3. Risk-loving: love taking risk ­    Loss aversion: people do not like to lose (not just avoiding risk) Utility will go up and down depending on losing or winning ($10 won, utility up / $10 loss, utility down) ­    Prospect Theory: if there is a loss or win of a numerical change, the amount will be the same, just in the opposite direction. (Ex: if an item goes from $10 - $11, purchases drop (they have lost) If you start at $11 - $10, purchases increase (people win)) -- dependent on reference point Reference point: the point at which you base your decision of of, example if $10 is guaranteed, then risk is based of of that point (Should I go for $20 if I can get $10? Should I go for $0 if I can get $10?) Real Estate ­ house put on market ­ one half of real estates agents were told the sellers price was high ­ one half was told that the sellers price was low  people who saw a higher price, paid higher  people who saw lower point, paid lower (Reference point) Labor Economics Labor demand ­ cost vs. benefit analysis for workers  Marginal revenue product of labor: the extra revenue that comes from hiring an extra worker Change in TR (total revenue)  MRPL =____________ Change in Labor  if the firm makes the same or more revenue from hiring an employee than the cost of hiring that employee, they are maximizing their profits  firms maximize profits where MRPL = W (wage)  essentially, MR = MC Labor Demand Graph ­ labor demand increases if  MR or P increases  Firm is making more per unit  Workers become more productive (better education or more capitol/technology) W demand curve Demand curve shifts to right when one of these two things happen L Returns to Education: human capital ­ Education and training are referred to as human capital ­ Education is referred to as general human capital  This increases productivity across diferent jobs  (creative and critical thinking skills)  Often confused with, Specific human capital  (how to perform a specific job/ how to use specific machinery and interact with clients) Returns to Education: signaling ­ Even if it does not make you more productive, it can still increase your wages because it “signals” that you are already productive.  Since education costs time, efort and money, only the most productive people will put this in. Equilibrium ­ Where labor demand intersects with wage, is where the equilibrium Example: Therefore, when workers are educated they are more W productive which means that there is a higher demand for them and that they get paid more. Illegal immigration debate ­ Part of the debate is if illegal immigrants hurt the american workers L ­ The key issue, is what kind of jobs the immigrants do  Any illegal immigrant will increase L, which pushes wages down.  They take low skill jobs ­ Low skilled workers tend to make skilled workers more productive SO, wages of skilled (productive) workers will rise  This is because, it is cheap to higher low skilled workers, and more capital is put toward high skilled workers (to make them more productive) Minimum Wage ­ a minimum wage is a Price Floor  so you get excess supply ­ more people want to work, less people want to hire W W min W* L* L Unemployment depends on the inelasticity of wages within individual firms Ex: ­ Best buy can aford to pay its employees more, they are more elastic. ­ A firm with less profit cannot aford to pay its employees that much, therefore, if they “have” to pay more to their employees ($8 vs $15) then they can’t hire as many workers.  This is where unemployment MAY become a problem Unemployment rate ­ The rate is calculated as unemployed U = ______________ Unemployed + Employed u + e = labor force) ­ Unemployed is defined as people who want a job and are failing to find a job Unemployment ­ Only accounts for people who are in the labor force, trying to find a job and cannot find a job. ­ U3 : rate accounts for all people in labor force even those discouraged to find work ­ U6: rate does not account for people who are discouraged to work ­ Principal Agent Problem When one side does not agree with the incentives of the other. Solution to this: Incentive pay  Stock options  Pay people for productivity ­ Problem with incentives:  Perverse incentives: workers meet incentive, but this doesn’t mean that they are being productive Incentive pay for teachers ­ everyone agrees that teachers should be paid well in k-12 ­ BUT,  Teachers are paid of of there “good teaching”  But what is this?  Test scores  Attention  How do you measure? ­ The problem is that teachers try to meet these test scores, so teachers will focus more on having students get good scores instead of actually learn material (i.e.: grade easy) Inequality ­ top 1% making more than everyone WHY? Technology ­  People who are trained in technology are in high demand, so they are making more. ­  But this means, workers who used to do routine jobs, are now being replaced by technology. Taxes and Transfers (topic 18) ­ The tax system redistributes money, from one person to the next. ­ The debate is, who do we trade it off to?  Equity: what is fair  Efficiency: best use of resources th Most tax systems argue tsttake the income from the top 5 quartile of income to the bottom 1 . The question: who gets hurt the most? / Who’s price moves the most?  Tax burden: how much of the tax revenue paid by each group  If after the tax, consumers pay $30 and producers pay $15, so, the consumer hurts more ­ Overall, who gets hit more depends on the elasticity of the supply and demand curves. Whichever curve is steeper, that curve sees higher increase in price (is demand or supply curve higher)  If consumers are most inelastic to the price change, then consumer hurt. How taxing works If a firm and a consumer are both elastic, then they have more tax revenue and less deadweight loss If a firm and a consumer are both inelastic, then they have less tax revenue and more deadweight loss, because people are not buying.  hence, if people want to tax something and earn money, then they should tax inelastic goods Federal Budget ­ deficit: when the government spends more money than they have ­ national debt: what the government actually owes Revenue: how the government makes money Payroll taxes vs. income taxes  income taxes came about in 1970  cities and states have to pay income taxes, which means that people have to pay more taxes if they live there  extremely complicated people don’t pay tax on all assets because of, o exemptions: when you pay a lot to someone else and get an exemption (a dollar amount subtracted for each person) o and deductions : When you spend it on something that id deductible (charity) (mortgage payments) If you spend $1,000 on burritos you pay more tax than if you pay $1,000 on charity Average vs. Marginal Tax Rates ­    Average, how much you get taxed in total income. ­    Marginal, how much you get taxed for the last thing you earned. Average is usually more than marginal.


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