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Questions and Answers
At what price can a price-taking bakery sell unlimited loaves?
At what price can a price-taking bakery sell unlimited loaves?
What is the profit per loaf for a bakery producing up to 120 loaves a day?
What is the profit per loaf for a bakery producing up to 120 loaves a day?
What happens when a bakery produces more than 120 loaves a day?
What happens when a bakery produces more than 120 loaves a day?
What is the market-clearing price in the bread market?
What is the market-clearing price in the bread market?
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Which condition is NOT required for Pareto efficiency in a competitive equilibrium?
Which condition is NOT required for Pareto efficiency in a competitive equilibrium?
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How does an increase in the popularity of hats affect the demand curve?
How does an increase in the popularity of hats affect the demand curve?
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What is the total quantity sold at market equilibrium?
What is the total quantity sold at market equilibrium?
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What represents gains from trade in a competitive equilibrium?
What represents gains from trade in a competitive equilibrium?
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What happens to the demand curve when there is an increase in demand?
What happens to the demand curve when there is an increase in demand?
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What is the immediate effect on equilibrium price when demand increases?
What is the immediate effect on equilibrium price when demand increases?
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Which of the following factors can cause a rightward shift in the supply curve?
Which of the following factors can cause a rightward shift in the supply curve?
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How do exogenous shocks affect the equilibrium in the market?
How do exogenous shocks affect the equilibrium in the market?
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What effect does a decrease in marginal costs have on market supply?
What effect does a decrease in marginal costs have on market supply?
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What was the likely cause of the 1970s oil price shock?
What was the likely cause of the 1970s oil price shock?
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What generally results from a decrease in production costs due to improved technology?
What generally results from a decrease in production costs due to improved technology?
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What best describes the market dynamics in the late 1800s to 1970s regarding oil prices?
What best describes the market dynamics in the late 1800s to 1970s regarding oil prices?
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What happens to consumer and producer surplus when a tax is imposed?
What happens to consumer and producer surplus when a tax is imposed?
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What effect does a 30% sales tax on salt have on the equilibrium quantity?
What effect does a 30% sales tax on salt have on the equilibrium quantity?
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How does taxation affect total surplus?
How does taxation affect total surplus?
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In a competitive equilibrium, which of the following is true?
In a competitive equilibrium, which of the following is true?
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Which characteristic is a requirement for a perfect competition market?
Which characteristic is a requirement for a perfect competition market?
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What is deadweight loss in the context of taxation?
What is deadweight loss in the context of taxation?
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Why are taxes on harmful goods more effective when demand is elastic?
Why are taxes on harmful goods more effective when demand is elastic?
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What does it mean for firms to maximize profits where marginal cost equals price in a competitive market?
What does it mean for firms to maximize profits where marginal cost equals price in a competitive market?
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What was a primary strategy used by OPEC countries in the 1970s to increase their profits?
What was a primary strategy used by OPEC countries in the 1970s to increase their profits?
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In a situation where both firms price their products at $4, what is the maximum profit each can achieve?
In a situation where both firms price their products at $4, what is the maximum profit each can achieve?
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What is the outcome when both firms decide to charge a low price of $2?
What is the outcome when both firms decide to charge a low price of $2?
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What is the primary challenge faced by cartels in maintaining high prices?
What is the primary challenge faced by cartels in maintaining high prices?
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What happens to the profits of firms if a third firm enters the market and matches the high price?
What happens to the profits of firms if a third firm enters the market and matches the high price?
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What is considered the dominant strategy for firms in a prisoner’s dilemma scenario with three firms?
What is considered the dominant strategy for firms in a prisoner’s dilemma scenario with three firms?
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How can competition impact the sustainability of a cartel?
How can competition impact the sustainability of a cartel?
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What policy implication is suggested to improve competition in markets affected by cartels?
What policy implication is suggested to improve competition in markets affected by cartels?
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What is a primary conflict of interest that arises from the separation of ownership and control?
What is a primary conflict of interest that arises from the separation of ownership and control?
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What is one proposed solution to align manager and owner interests?
What is one proposed solution to align manager and owner interests?
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Which of the following best describes the characteristics of day labor markets?
Which of the following best describes the characteristics of day labor markets?
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What is one major challenge associated with short-term employment?
What is one major challenge associated with short-term employment?
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What happens to relationship-specific or firm-specific assets when an employee leaves a company?
What happens to relationship-specific or firm-specific assets when an employee leaves a company?
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Which characteristic is NOT typical of shareholder relations in corporations with single or few owners?
Which characteristic is NOT typical of shareholder relations in corporations with single or few owners?
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What is a likely consequence of high turnover costs for firms?
What is a likely consequence of high turnover costs for firms?
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Why is aligning manager's interests with those of the owners crucial for shareholder value?
Why is aligning manager's interests with those of the owners crucial for shareholder value?
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What is the primary consideration for employers in a matching labor market?
What is the primary consideration for employers in a matching labor market?
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How does the concept of reservation wage impact a worker's job acceptance?
How does the concept of reservation wage impact a worker's job acceptance?
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What can be inferred about Françoise's decision regarding the offered job?
What can be inferred about Françoise's decision regarding the offered job?
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In the example of the language school, what is the weekly turnover rate of tutors?
In the example of the language school, what is the weekly turnover rate of tutors?
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What does the required-wage line represent in terms of hiring dynamics?
What does the required-wage line represent in terms of hiring dynamics?
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How does a higher wage influence the hiring process in a labor market?
How does a higher wage influence the hiring process in a labor market?
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What happens to employed workers when there are job destructions in the labor market?
What happens to employed workers when there are job destructions in the labor market?
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What is indicated by a weekly hiring need of 2 tutors in the language school scenario?
What is indicated by a weekly hiring need of 2 tutors in the language school scenario?
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Study Notes
Final Exam Information
- Date and time: February 6th (Thursday), 1:00 PM
- Scope: Week 8 lecture notes (after the midterm) to January 23rd
- Problem Set: Posted on UNIPA January 23rd
- Make-up Lecture: February 4th and 5th are make-up days
- Extended office hours will be provided instead of a make-up lecture, as a lecture immediately before the exam is not effective.
Office Hours & Questions
- Date: February 4th (Tuesday), 10:30 AM – 5:00 PM
- Location: Research Building 1, Room A320
- Visiting during office hours is recommended; no prior notice needed; group visits welcome
- Email or Q&A: For exceptional cases only; deadline February 4th; only specific questions answered
Review
- No detail provided
The Market Demand Curve
- Willingness to pay (WTP) is the amount of money a consumer would be willing to pay for a good.
- The graph shows a downward-sloping demand curve, reflecting the law of demand, where as price increases, the quantity demanded decreases.
The Market Supply Curve
- Willingness to accept (WTA) is the amount of money a seller would be willing to trade the good for (seller's reservation price).
- The graph depicts an upward-sloping supply curve, illustrating that as price increases, the quantity supplied increases.
Market Clearing
- At P* = $8, there's no tendency for change.
- Every seller wants to sell, and every buyer wants to buy, so no one wants to change the price.
- The market is in equilibrium.
Competitive Equilibrium
- Equilibrium is where quantity supplied equals quantity demanded at a prevailing price.
- Buyers and sellers are price takers (not influencing the market price).
- Many buyers and sellers, and identical goods, ensure perfect competition.
- Price-taking behavior occurs where trade happens only at the equilibrium price (no bargaining power).
- The trading is a Nash equilibrium, meaning no one benefits by changing their strategy.
Differentiated Products vs. Competitive Equilibrium
- In differentiated products, a single seller can set higher prices and still attract buyers.
- Sellers cannot set prices above the equilibrium price or buyers won't switch to alternatives.
- Buyers cannot offer less than the equilibrium price, or sellers will switch to another buyer.
Price-Taking Bakery Decisions
- Price takers cannot sell above the market price (€2.35).
- Production based on marginal cost (MC).
- Up to 120 loaves/day: MC = €1.50 (efficient production).
- Beyond 120 loaves/day: MC = €2.60 (cost of overtime/energy).
The Individual Firm's Choice
- Profit maximized for up to 120 loaves: Surplus = €0.85.
- Beyond 120 loaves: Loss = €0.25.
- Maximal quantity (Q*) is 120 loaves/day.
The Market Supply Curve
- Different numbers of bakeries (15 and 50 bakeries) show diverse supply curves and price variations.
Competitive Equilibrium in the Bread Market
- Market clearing price is €2.00.
- At this price, 5,000 loaves/day are demanded and supplied.
- Demand Curve = Supply Curve (determining the market price).
- Willingness to pay of 5,000th consumer = marginal cost of the 5,000th loaf = €2.00.
Gains from Trade in Competitive Equilibrium
- Quantity: 5,000 loaves sold; Price: €2 per loaf
- Surpluses: Consumer surplus = WTP – Price; Producer surplus = Price – MC
- Total surplus is maximized at equilibrium.
- Fewer loaves: unexploited gains (WTP > MC)
- More loaves: negative surplus (MC > WTP)
Gains from Trade: Price-Taking vs. Price-Setting
- Price-taking equilibrium maximizes total surplus under certain conditions.
- Market power typically results in deadweight loss.
Pareto Efficiency?
- Pareto efficiency in competitive equilibrium requires numerous buyers and sellers of identical goods; price-taking behavior from all market participants; no external effects resulting from trade; and complete contract between buyers & sellers.
Factors Affecting Equilibrium
- No detail provided
Example: The Market for Hats
- If hats become more fashionable, demand increases (shifts upward).
- Additional hats produced at higher marginal costs.
- Buyers with WTP between $8 and $10 drop out.
- New equilibrium at a higher price and quantity.
Understanding Demand Shifts
- Increase in demand shifts the demand curve outward.
- Equilibrium price rises.
- Sellers can sell more hats by increasing supply along the existing supply curve (no shift).
- Exogenous shocks affect the model (e.g., shifts in demand or supply), and the model demonstrates how equilibrium changes, not the reasons behind those changes.
Example: Improved Bread-Making Technology
- Lowering marginal costs (technological advancements) shifts the supply curve downwards/rightwards.
- Increased supply: More bread is produced at every price.
- Drop in price: Reduced costs lead to a decrease in bread prices.
- Higher quantity sold: Quantity demanded increases due to the price reduction.
Understanding Supply Shifts
- Factors that shift the supply curve: Improved technology (lower costs of production) or more firms/capacity increase market supply.
- Equilibrium shifts when the supply curve shifts, and outward/downward shifts affect the equilibrium.
- Demand curve remains fixed during a supply shift.
Applications of the Model
- No detail provided
Oil Prices and Market Dynamics
- Stable oil prices (late 1800s to 1970s): Technology reduced costs, increasing supply through increased trade.
- Oil price shock (1970s): OPEC restricted market access, acting as a cartel that limited Middle East oil availability.
Restrictions on Supply: OPEC
- Initially, the oil market was in competitive equilibrium.
- OPEC countries coordinated to restrict supply (1970s), gaining market power due to high market share.
- Limiting supply increased prices, boosting OPEC profits.
Cartel and Payoff Matrix
- Two firms (A & B) sell identical goods with a production cost of $1 per unit.
- Potential pricing strategies: high price ($4) or low price ($2).
- Both charging $4 results in maximum profit of $90 for each firm.
- Deviation to a low price captures the market but decreases profit to $72.
- Both charging $2 results in minimum profit of $36 for each firm.
Game Theory Insights: Nash Equilibria
- Two Nash equilibria in the model demonstrate the incentive for firms to undercut the high price due to higher profits.
- High-price equilibrium is better for both firms, yet deviating to a lower price reduces profits to $72.
- Firms must coordinate secretly to maintain high prices. Formal agreements are often illegal.
- Price-fixing leads to legal and reputational risks.
- Governments and consumers disapprove of price-fixing.
Cartels and Barriers to Entry
- Market with two firms: High price ($4) maintains price if no new firms enter; Low price ($2) avoids loss of customers but yields lower profit.
- Impact of a third firm: Equal pricing (high price = $60 profit/firm and low price = $24 profit/firm).
- Price undercut: Low-price firm captures 72 units with $72 profit.
Competition Destroys A Cartel
- Cartel collapses when defection (lowering prices) becomes more profitable, leading to lower profits for each firm.
- Consumers benefit from lower prices from competition.
- Reduce market entry barriers to boost competition.
- Public policy limits price-fixing (to protect consumers).
The Effect of a Tax
- Equilibrium quantity falls from Q* to Q1 with a 30% sales tax on salt.
- Consumers pay P1, producers receive P0, and the government receives (P1 - P0).
The Effect of a Tax on Surplus
- Consumer and producer surplus decrease due to tax, and total surplus (including tax revenue) is lower.
- Deadweight loss appears between the market supply and demand curves, resulting from the tax.
Taxes and Social Benefits
- Taxes transfer surplus to the government but create deadweight losses.
- Societal gains from public goods might outweigh market losses if tax revenue funds public goods.
- Taxes are accepted in modern democracies when considered fair and beneficial.
- Taxes on harmful goods (e.g., tobacco) are more effective with elastic demand.
Is This a Useful Model?
- Characteristics of a competitive equilibrium: all transactions occur at the same price (Law of One Price), market clears, and participants act independently.
- Conditions for a competitive (perfect competition) equilibrium: multiple buyers and sellers of homogeneous goods; perfect information, meaning buyers and sellers are aware of prices and always seek the best prices.
Applications of Competitive Equilibrium
- Close-to-ideal markets: Agricultural goods (e.g., wheat, coffee) with multiple buyers and sellers, wherein firms typically act as price takers due to their low market power.
- Simplified models are useful even in less perfect settings such as small shops selling similar goods, despite firms' market power.
- 1970s oil market: OPEC had market power, but outcomes (like price predictions) aligned with the model.
Summary
- Model of price-taking firms: Competitive equilibrium occurs where demand meets supply with firms maximizing profits at MC = Price.
- Useful as a special case for perfect competition.
- Model comparison with price-setting firms.
- Utilization of the Model: Examining how exogenous shocks affect equilibrium, supply/demand/market entry, and effect of taxation on surplus.
Unit 6: The Firm and its Employees
- Introduction
- Firm structure
- Hiring, quitting, and getting work done
- Employment rent and reservation wage
- Labour discipline and wage setting models
From Market Equilibrium to Labor Markets
- Rational firm choices in the market
- Laws of demand & supply
- Perfect competition & market-clearing prices
- Firm resource acquisition (labor as a factor)
Understanding Labor Markets
- Differences between firm & market contracts
- Reservation wage definition & importance
- Employment rent's impact on worker behavior
- How the principal-agent problem causes incentive misalignment
- Labour discipline & wage-setting models' wage/effort/employment-level explanation
Structure of the Firm
- No specific detail provided
Product vs Labor Contracts
- Contracts for products permanently transfer ownership from seller to buyer (short-lived, often non-repetitive).
- Contracts for labor temporarily transfer authority to a manager over activities (long-term, often lasting years or decades).
Ownership and Profits
- Profits belong to firm owners.
- Owners aim to maximize profits and asset value, directing firm actions.
- Input costs (raw materials, labor, energy, capital goods).
- Owners receive remaining revenues after paying employees, managers, and paying taxes.
Small Enterprises vs. Large Corporations
- Small enterprises: Owners manage directly (e.g., menu/marketing). Profit losses directly affect owners.
- Large corporations: Managers handle operations & strategy. Shareholders rely on dividends & value growth when determining ownership
Separation of Ownership and Control
- Separation of ownership and control occurs when managers use owner funds for firm operation and potentially create issues.
- Managerial prioritization of personal benefits, such as excessive company expenses, high salaries, and empire-building (boosting power/prestige).
- These actions might reduce profits and harm shareholder interests.
Aligning Manager and Owner Interests
- Problem: Separation of ownership and control (managers acting in their own interests, not the owners).
- Solutions: Performance-based compensation when aligning managerial pay with the firm's share price and board of director oversight to represent shareholders and oversee/dismiss managers as needed.
More on Why Labour Markets are Different
- Consumer goods markets focus solely on transactions (e.g., bread, T-shirts).
- Day labor markets: Short-term, precarious jobs focused on worker identity/ability, likely with workers from disadvantaged backgrounds and/or with poor job matches.
- Employer benefits from minimal wages, but productivity suffers from poor job matches.
Why Long-Term Employment Relationships Matter
- Challenges of short-term work: Mismatched skills, lack of training, and workers with little incentive beyond daily pay, with high monitoring costs for employers.
- Benefits of long-term matches: Alignment of worker skills and job needs, opportunities for learning/relationship building, and continuity benefits for employers and workers.
Specific or Firm-Specific Assets
- Skills, networks, and relationships developed only while the employee remains in the firm - valuable assets for both employer and employee.
- These assets are lost if employees leave.
- Firms need to take steps to avoid losing valuable assets (recruiting/training, improved employee retention/productivity, and reduces turnover costs).
Labour Markets as Matching Markets
- Employers find specific employees with desired skills, matching workers and suitable jobs based on individual abilities and preferences in labor markets.
- Similar to choosing spouses, labor market matching considers both identity and characteristics.
- Matching (in the job-finding sense) is a goal.
Labour Market Flows
- Recruitment: Flows of employed workers and vacant jobs.
- New jobs created can be filled from the recruitment pool or, conversely, jobs destroyed when workers quit or get laid off.
Hiring, Quitting, and Getting Work Done
- No specific detail available
Reservation Option and Wage
- Reservation option: Staying unemployed when evaluating job offers (e.g., considering unemployment income, feelings like boredom, and job-searching time).
- Key factors affecting the reservation option: Unemployment income; Utility while unemployed; and Job search time.
- Reservation wage: A worker's desired minimum wage for a job offer, matching the value of their reservation option).
Example of Reservation Wage
- Françoise's situation: Reservation option valued at €600/week.
- Offered job: €580/week.
- Decision: Françoise does not accept the job offer (reservation wage of €600 is not met by €580).
Example: Language School Workforce
- Language school in Paris hires tutors for 6-12 months; weekly quitting rate = 4% of the workforce.
- Workforce dynamics: 50 tutors (N = 50); 2 tutors leave each week (weekly turnover); hiring is based on tutors' acceptance of the minimum wage.
The Hiring Line
- Shows potential hires at different wages.
- Example: Lowest reservation wage is €550.
- Hiring at N=50: To hire 2 tutors weekly, schools offer wages that meet the reservation wage to compensate for higher quitting rates.
- Higher wages attract more tutors with higher reservation wages).
Required-Wage Line and Reservation Wage Curve
- Required-wage line shows wages needed to employ/retain N number of workers (potentially indicating the reservation wages that employers may have to meet to retain their workforce).
- It should guide schools in adjusting wages for hiring and retention.
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Description
Test your knowledge of key microeconomic concepts such as market equilibrium, demand and supply shifts, and Pareto efficiency. This quiz covers various scenarios faced by bakeries in a competitive market and evaluates the impact of changes in market conditions on price and quantity. Challenge yourself with questions related to production costs and consumer demand!
