Demonstrate that the constant K in Equation 17.23 will have values of 534 and 87.6 for the CPR in units of mpy and mm/yr, respectively.
MicroeconomicExam#2StudyGuide CLASSNUMBER:ECN212ROFESSO:W ILLIAMFOSNOTETAKEPHOEBCHANG 1 R OLE F HE OVERNMENT IFFICULT ASES OR HE F T M ARKET Economic Efficiency • Definition o Efficient use of resource = maximum value of output • Conditions o All activities providing individuals with more benefits than costs o No activities providing individuals with less benefits than costs o Both condition must present = Economic Efficiency • Graph o Marginal cost = supply curve o Marginal benefit = demand curve o o Only Q2 = efficient • Facts o Nothing is worth doing to one’s best ability (time is costly) o Economics = gain stops at some point o Trade-offs = what activity is worthy to do than the others o Principles applies to personal decisions, government, on all o Perfection doesn’t worth the cost Government— Invisible Hand Interference • Two Functions of the Government o Protective function § Protect individuals and their property from the others § Legal structure (laws) needed to maintain / enforce the settlement of di sputes o Productive function § Production of goods and services can’t be easily provided through private markets § Stable Monetary and financial environment is important § E.g. Mail delivery, national defense, national parks, infrastructure etc. • Four Reasons Why the Invisible Hand Fail o Lack of competition § Sellers may gain by restricting output § Sellers may raise price § Too few units will be produced § E.g. Movie theater expensive food / drink § Monopolies • Produce less than equilibrium quantity • Charge more than equilibrium price o Externalities § External Costs • Action of an individual or group harm the others • Property rights are imperfectly defined or enforced • Problems o Too many units produced; valued less o Supply curve understates the true production cost o E.g. Pollution § External Benefits • Action of an individual or group benefits others • Problems o Too few units produced; highly valued o Demand curve understates the true production cost o E.g. Vaccine / Flu shot o Public goods § Jointly Consumed and Non -excludable • All people enjoy the service or good § Can’t keep anyone out § E.g. Clean air, military protection, broadcast, tv signals § Problems • Free rider receives the benefits without helping to pay for its cost • The reason of taxing • Market develops towards providing public good interfer ing self-interest with public interest • Poor information— Not having fully transparency o Consumer information publication (expert evaluation / unbiased information) o Brand names and franchises (Standardized quality and dependability) o Warranties (Promises to repair problems) 2 M ONOPOLY Monopoly Power • Definition o Ability of a firm to raise price above average cost without the fear of other firms entering the market (barriers to entry) o Ability to earn economic profits without causing new firms to enter market o May sometimes be necessary for economic growth o May become inefficient by passing higher costs onto consumers • Sources of monopoly power o Patents § Having the license to produce certain things § Given sole ownership of the right to sell the drug for a lim ited number of years § When it expires, deadweight loss is eliminated & generic equivalents appear quickly § E.g. GlaxoSmithKline on Combivir (slowing HIV effects) o Governmental Laws § Preventing other companies to enter the market § E.g. The U.S. Post Office (lett er sized envelope) o Economies of scale § It requires too much money for firms to do it themselves § E.g. Electricity Transmission, Underground, Major Highway o Exclusive access to an essential input § Input can’t be duplicated easily § E.g. Oil, Luxury brands (Rolex) o Technological innovations § New technology or services § E.g. Uber, Apple iOS system Monopoly and Profit Maximization • Conditions o Having the entire market to one firm o They have control over price and level of output o Lower quantity yet higher price compare to a competitive firm o Dependent on the demand curve of the market o Prefer product to be inelastic • Expand Production o Marginal Revenue = Marginal Cost (MR=MC) o Increase output = decrease market price o Always true for monopoly market: MR < P • Calculation o Monopoly only operate in the elastic portion of demand curve (MC is always positive) o For a linear line demand curve, MR starts at D (same point) yet twice the slope o The steeper the demand curve is, the more inelastic the item is, the bigger profit or raise in price the firm get • Profit o Positive profit § Above normal § P > MC o Zero profit § Normal § P= MC Monopoly and its Deadweight Loss Benefits of Monopoly • Incentives for Research and Development o Lure of above normal profits give a firm incentive to develop new products and technologies o Reduces gains from trade to society o Government regulation can lower the price and reduce (or eliminate) the deadweight loss yet can reduce innovation o Two ways to eliminate deadweight loss yet not reduce the incentive § Patent Buyouts § Government buying the patent from innovative companies § Prizes § E.g. Nobel Prize Natural Monopoly o Conditions § Single firm supply the entire market at low cost comparing to two or more firms § Only one firm tends to exist o Exploit Economies of Scale § Government regulation § Marginal cost pricing policy § (firm will operate at a loss) § Average cost pricing policy § (firm break even yet not elimination of deadweight loss) 3 P RICE ISCRIMINATION General Price Discrimination • Definition o Selling same product at different prices to different customers o Firm with market power can use price discrimination to increase profit o Gives greater profit than single price strategy o The more inelastic of the demand, the higher the profit will be o Monopoly applies when demand curves are different in different markets • Arbitrage o Taking advantage of price differences for the same good in different markets by buying low in one marketing and selling high in another o Increases profits for smugglers o Reduces profits for price discrimination firms o Arbitrage activities must be prevented in order to increase profits § Some are easy to prevent § E.g. Services • Examples for Price Discrimination o Men vs Women products o Coupons o Student/Senior discount o Financial Aid in private colleges o Airline companies— Pay more when shorter notice § Business Traveler (more inelastic demand) § Vacationers (more elastic demand) • Effects o Can increase output = increase total surplus = lesser deadweight loss o PPD can eliminate deadweight loss of monopoly o Can increase incentives to innovate due to lower fixed costs o E.g. University / Movie / Music / Books § Having very different demand curves § Copyright = Monopoly First Degree Price Discrimination • aka Perfect Price Discrimination (PPD) • Almost impossible to happen • Each customers is charged with his/hers maximum willingness to buy o Zero consumer surplus o Zero deadweight loss o All surplus is producer surplus • Everybody pays a different price • E.g. Insurance • Neither perfect competition and perfect price discrimination is inefficient Second Degree Price Discrimination • Schedule of declining prices for different quantities • Lower customer surplus without knowing individuals • E.g. Supermarkets “The more you buy, the more you save” o Discriminates individuals who buy lesser Third Degree Price Discrimination • Predict the elasticity of demand in different types of consumers • E.g. Theaters “Senior / Student discounts” o Old/Young people demand on tickets are more elastic Tying • Base good is tied to a second good (variable good) • Allows firms to charge a higher price to consumers with a high willingness to pay; vice versa • Pricing base good lower than variable good • E.g. Printer (not that expensive) & Printer ink (expensive af) Bundling— Traditional Price Discrimination • Requires products to be bought together in a bundle or package • Used when firms have more demand for the bundle than single parts • Used when arbitrage is too hard to prevent • Price increase without bundle (e.g. phone with carrier) • E.g. Microsoft Office, iWork 4 C OSTS ND ROFIT M AXIMIZATION U NDER OMPETITION Perfect Competition • Competitive Market Conditions o A lot of buyers and sellers o Goods produced by different companies are around the same (perfect substitute) o Few or no barriers to entry and exit o No single seller or buyer has influence on market price o Everyone is selling at the same market price o Demand rise, market price rise, more firms join the industry, each firm produce more • Application o Maximizing profit = minimizing cost (same process) o Stable individual demand (perfectly elastic/flat) o Stable market demand and supply o Firms don’t get to decide about price o Firms do get to decide about quantity o Tiny part of the market (individuals) has no effect on the total market o Examples of competitive markets (different brands = same thing) § Gas § Water § Egg § Gold • Demand shows value, supply shows cost Industry Supply Curve • Increasing Cost Industry o Costs increase when output increases o Upward sloping supply curve o E.g. Pollution deduction / Drilling oil • Constant Cost Industry o Costs don’t change when output increases o Flat supply curve • Decreasing Cost Industry o Costs decrease when output increases o Downward sloping supply curve Maximizing Profit • Terms o Profit = Total revenue - Total cost o Profit = (Price-Average Cost) × Quantity § Positive Profit = Price > Average Cost (MC>AC) § Negative Profit = Price < Average Cost (MC AC o Exit when P < AC o No exit or entry when P=AC § Zero economic profit can be positive accounting profit (not the same thing) § Normal rate of return • Short-run (uncertainty and sunk costs) o Depends on variable cost o Firms stay in operation if fixed cost > variable cost o Should be included the value of time / employees pay etc o Sunk Cost cannot be recovered shouldn’t be included to decision o Lifetime expected profit - alternative resolutio n for the problem for a firm • Entrepreneurs o Chasing profits by entering high profit industries / exiting low profit industries o Needs to innovate to earn above normal profit due to elimination principle o Creative Destruction = those who fail to adapt innovations • Elimination Principle (Profits stays stable) o Above normal profits are eliminated by entry o Below normal profits are eliminated by exit J P ERFECT C OMPETITION CALCULATION QD243-4PQS55+7P MC=2+2q QD181-4PQS69+9P MC=4+4q Howmanyunitswillthefirmchoosetoproduce Howmanyfirmswillexistinthemarket Step1—Q DQ S FindP Step1—Q DQ S FindP Step2—P=MC Findq Step2—P=MC Findq ▯▯▯ Step3—Q (q)=TotalQuantity(Q) 181 − 4 = 69 + 9 = S ▯▯ Step4—Q÷q=Answer ▯▯▯ = 4 + 4 =▯▯ ≈ 1.153 ▯▯▯ ▯▯ ▯▯ 243 − 4 = 55 + 7 = ▯▯ ▯▯▯ ▯▯ = 2 + 2 = ▯▯ ▯▯ Q D178-4PQ S52+6P MC=2+5q ▯▯ ▯▯▯▯ Noothercosts,Whatistheprofit = 55 + 7 ▯ ▯ = ▯▯ ▯▯ Step1—Q DQ S FindP ▯▯▯▯ ▯▯ = ÷ ≈ 23.1 Step2—P=MC Findq ▯▯ ▯▯ Step3—MC=0 FindD Step4—(P-D)xqx0.5=Answer ▯▯▯ 178 − 4 = 52 + 6 = ▯▯ ▯▯▯ ▯▯ = 2 + 5 = 2.12 ( ) 12.6 − 2 ×2.12×0.5 = 11.24 J TAXATION CALCULATION • Profit = Area of the box that is (price - average cost) • Quantity = TR-TC • Consumer Surplus + Producer Surplus + Tax Paid = Total Surplus • Consumer tax paid + Producer tax paid = Tax Paid • Deadweight loss = (Consumer - producer paid tax) × (Q-Q*) × 0.5 = (P*-Px) × (Q-Q*) × 0.5 GeneralWaystoGetDifferentElements Q D=Q S FindP* Q D=Q S FindP S*(P*) FindQ* S(P) FindQ Q*=S FindPx Q DorQ S=0 FindPo