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Week 4 Notes

by: D S

Week 4 Notes FIN 501

Financial Economics
Tatyana Deryugina

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Week of Notes including Monopoly, Externality, and Price Disrimination
Financial Economics
Tatyana Deryugina
Class Notes
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This 4 page Class Notes was uploaded by D S on Friday September 25, 2015. The Class Notes belongs to FIN 501 at University of Illinois at Urbana-Champaign taught by Tatyana Deryugina in Summer 2015. Since its upload, it has received 28 views. For similar materials see Financial Economics in Finance at University of Illinois at Urbana-Champaign.


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Date Created: 09/25/15
Financial Economics Week 4 Professor Tatyana Derugvina University of Illinois Urbana Champaign Text 1 Externalities and Monopolies De nitions externality is the cost or bene t that affects a party who did not choose to incur that cost or bene t Negative Externalities social bene t 3 private bene t social cost g private cost ex pollution from rare earth mining loud music disrupting neighbors note only con sidered externality when the market level of these things will be larger than the optimal because the externality is not taken into account Positive Externalities social bene t g private bene t social cost 3 private cost ex neighbor helps take take of your lawn note market will underprovide goods with positive externalities Chart on Lecture 7 Slide 5 Higher cost or lower bene t summarizes the top two de ni tions Examples of externalities with explanations vaccination positive consumption since less people will catch the disease if more people of vaccinated Basically one will be indirectly affected by anothers decision Oyster Farming positive production because it is good for the environment The oyster s apparently clean the water from their ltration system Driving negative consumption because of traf c jams and pollution Electricity negative production because of pollution Looked on graphs comparing marginal private cost and marginal social cost with quantity x axis an price y axis These externalities cause Market Failure 1st welfare theorem no longer holds ie not Pareto Optimal To x externalities we used three options Quotas Taxes and Tradeable Permits Walked through explicitly Quota example with full discussion in slides as well as taxation example De nition Public Goods non excludable and non rival ex radio military Common Good non excludable and rival ex public land non toll road Coal Mining Workers Question The rst example with mining practices causing pollution is a negative externality since 3rd party people will be affected In the second case7 it depends on the coal workers since we brought up two cases in class Depends on who has to pay for the medical costs If the workers are already compensated in the medical costs then the cost will already be covered since the mining company will have factored these health costs into their pricing and thus the market will already be adjusted If the workers are not compensated then this would be a negative externality This sickness could negatively impact workers and work times Externalities related to population growth Positive Externality more people increases the probability of more innovative do good people one note don t forget about pecuniary externalities which are effects that work through prices They do not lead to inef ciencies since the market is already being adjusted Is there deadweight loss when quotas or taxes used to solve externality NO point of view of society is that there is no change The externality is trying to get the society optimal these mechanisms ends up internalizing an externality if it implements the Pareto Optimal in the economy 2 Monopoly De nition Monopoly single rm that sells a good Monopoly Pricing Steps 1 Choose a price 2 Let market choose the quantity OR 1 Choose a quantity 2 Go to pq from the market key formula monopolist chooses price p to maximize pro ts qp demand curve cq monopolist s cost function maxppqp cqp Always check the 2nd order condition since it is possible that it make sense to shut down Notes cover most of the math for choosing an optimal 1 Notes also have an explicit algebraic example 3 Monopoly and Pricing inef ciency when we have a single tax rate but heterogeneous rms no not inef cient Whenever there is DWL7 there is an inef ciency7 the tax is use to eliminate the DWL and improve inef ciency pro tpg CiQ tq 029 p MCiOt 0 Thus MC of all rms is equal to each other When M CZ gt M 03 j will need to produce more i will need to reduce product need the total production to stay the same when M CZ M Cj one has hit Pareto Optimal and should not change Causes of DWL due to uniform pricing shown visually in the graphs Lecture 8 Slide 3 Looked into non linear pricing where the monopolist s pro t is equal to the max of the total surplus Thus monopolists get all the surplus Which one could argue the consumers do bene t since the consumers work for a producer Two Part Tariffs Sam s Clubs Costco Structure is that initially there is a xed entrance free Then there is a per unit price p Consumer total payment for q F p gtIlt q Enables max social surplus Price Discrimination 3 types of price discrimination 1 perfect price discrimination charge each consumer their willingness to pay note not really that practical and dif cult to implement given the amount of information needed Amazon tried to do this but there was a large amount of backlash against them for it 2 self selection mechanism know there are different types of consumers but can t or illegal to identify them examples business vs economy airlines basically change the quality of the product to have these different price bundles such that consumers self select into the right spot for them Discussed the pro t and surplus gained from the self selection screenings and all the information on the slides Key takeaway was that thinking on the margin7 always look at the lost revent One should go as far as when marginal gins marginal loss note also distorting quantity has improved pro t Spent a bit of time discussing airline industry How business and economy class have different product offerings such as wi Internet speeds 3 charging different prices to different groups of consumes based on an observable characteristic requires 2 groups who differ in their willingness to pay All notes in the video lecture since it was not discussed in class 4 Side Notes talked about valuation of a human life and that many mechanisms exist to compute this This is a reasonable factor for how a negative externality could impact population talked about natural monopoly Where equilibrium make only 1 product Thus the xed cost is extremely high Examples of natural monopolist local cable expensive infrastructure Mitt Romney 2012 corporation are people everything corporations own goes back to the people talked about extortion Which could be a 1st degree price discrimination


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