Week 10-2 PDF - Final Exam Information

Final Exam Information Date & Time: February 6th (Thursday), starting at 1:00 PM Scope: Content from Week 8 lecture notes (after the midterm) to January 23rd Problem Set: Posted on UNIPA on January 23rd Make-up Lecture University Policy: February 4th and 5th designated as make-up...

Final Exam Information Date & Time: February 6th (Thursday), starting at 1:00 PM Scope: Content from Week 8 lecture notes (after the midterm) to January 23rd Problem Set: Posted on UNIPA on January 23rd Make-up Lecture University Policy: February 4th and 5th designated as make-up days Instead of a make-up lecture, extended office hours are provided, as a lecture immediately before the exam is unlikely to be effective  Office Hours & Questions Office Hours Date: February 4th (Tuesday), 10:30 AM – 5:00 PM Location: Research Building 1, Room A320 Visiting during office hours is strongly recommended No prior notice needed; group visits welcome Email or Q&A For exceptional cases only Deadline: February 4th Only specific questions will be answered Review  The market demand curve Willingness to pay (WTP) = the amount of money a consumer would be willing to pay for a good.  The market supply curve Willingness to accept (WTA) = the amount of money the seller would be willing to trade the good for, also referred to as the seller’s reservation price.  Market clearing At P* = $8: there no tendency for change. Every seller who wants to sell can find a buyer. Every buyer who wants to buy can find a seller. None of them would want to change the price. The market is in equilibrium.  Competitive Equilibrium A market equilibrium where: Quantity supplied = Quantity demanded at the prevailing price. Buyers and sellers are price-takers (cannot influence market price). Conditions Many buyers and sellers: Prevents individual influence on price. Identical goods: Ensures perfect competition. Key Features Price-taking behavior: Trade only at the equilibrium price. No bargaining power: Competition eliminates negotiation leverage. Nash equilibrium: No one benefits by unilaterally changing their strategy. Differentiated Products vs. Competitive Equilibrium Market Type Sellers Buyers Key Features Differentiated One seller Many Seller can set prices higher and still Products (Price Setter) (Price Takers) attract buyers. - Sellers cannot set prices above equilibrium price as buyers will Competitive Many sellers Many switch to alternatives. Equilibrium (Price Takers) (Price Takers) - Buyers cannot offer less than equilibrium price as sellers will switch to other buyers.  Price-Taking Bakery Decisions Price-Taker: Cannot sell above €2.35 (market price) but can sell unlimited loaves at this price. Production Decision: Based on marginal cost (MC) Up to 120 loaves/day: MC = €1.50 (efficient production). Beyond 120 loaves/day: MC = €2.60 (higher costs from overtime and energy).  The individual firm’s choice Profit per Loaf Up to 120 loaves: Surplus = €0.85 (€2.35 − €1.50). Beyond 120 loaves: Loss = €0.25 (€2.60 − €2.35). Profit-Maximizing Quantity : Q* = 120 loaves/day.  The market supply curve 15 bakeries. 50 bakeries.  Competitive equilibrium in the bread market Market-Clearing Price: €2.00. At this price, 5,000 loaves/day are demanded and supplied. Equilibrium Characteristics: Demand Curve = Supply Curve: Determines the market price. Willingness to Pay of the 5,000th consumer = Marginal Cost of the 5,000th loaf = €2.00.  Gains from trade in competitive equilibrium Competitive Equilibrium Quantity: 5,000 loaves sold. Price: €2 per loaf. Surpluses Consumer Surplus: WTP − Price. Producer Surplus: Price − MC. Total Surplus Maximized at equilibrium: No unexploited gains from trade. Fewer Loaves: Unexploited gains (WTP > MC). More Loaves: Negative surplus (MC > WTP).  Gains from trade: Price-taking vs price-setting Under certain conditions, the price-taking equilibrium maximizes total surplus. Market power generally results in deadweight loss.  Pareto efficiency? There is Pareto efficiency in a competitive equilibrium as long as: there are many buyers and sellers of identical goods; the market is at the equilibrium, when all participants are price-takers; when trade in the market has no external effects; and there is a complete contract between each buyer and seller. D. Factors affecting equilibrium  Example: The market for hats If hats become more fashionable, demand for hats increases at every possible price. The demand curve shifts upwards/rightwards. Additional hats produced at higher higher marginal costs. Buyers with WTP between $8- $10 drop out (C to D). New Equilibrium (Point point CC) at higher price and quantity.  Understanding Demand Shifts Increase in Demand Higher demand at all prices → Demand curve shifts outward outward. Equilibrium price rises → Sellers can sell more hats. Sellers respond by increasing supply along the existing supply curve (no shift in supply curve, marginal costs unchanged). Exogenous Shocks External External changes changes affecting the model (e.g., demand or supply shifts). Model shows how equilibrium changes, not why the change occurs.  Example: Improved bread-making technology Suppose bakers now have access to technology that lowers their marginal costs of production. The supply curve shifts downwards/rightwards. Increased Supply: More bread produced at every price. Lower price Lower Price: Reduced costs lead to a drop in bread prices. Higher higher Quantity Sold: Quantity demanded increases due to the price reduction.  Understanding Supply Shifts What Causes a Supply Shift Improved Technology: Reduces production costs. More Firms or Capacity: Expands market supply. Effects on Market Equilibrium Supply Curve Shifts outward outward oror downward. downward Demand Curve Fixed: Quantity demanded changes due to price shifts, not demand changes. E. Applications of the model  Oil Prices and Market Dynamics Low and Stable Prices (Late 1800s–1970s): Technology reduced costs; trade increased supply. 1970s Oil Price Shock OPEC restricted oil access: Operated as a cartel, restricting Middle East oil access.  Restrictions on supply: OPEC Initially the oil market was in Original supply competitive equilibrium. P1 OPEC non-OPEC The OPEC countries worked profits profits together in the 1970s and their Price, c high market share gave them P considerable market power. By jointly restricting their own Demand supply, they raised the price substantially and increased their 0 profit. QOPEC Q1 Q’OPEC Quantity, Q  Cartel and Payoff Matrix Two firms (A & B) sell identical goods, production cost = $1/unit. Pricing strategies: High Price ($4) or Low Price ($2). Key Insights Both charging $4 = Maximum profit ($90) for each. Deviation to $2 = Market capture but lower profit ($72). Both charging $2 = Minimum profit ($36) for each.  Game Theory Insights: Nash Equilibria Two Nash Equilibria: both High Price ($4, $4), both Low Price ($2, $2) Why Cartels Work High-price High-priceequilibrium equilibrium is better for both firms. Deviating to a lower price reduces profits (e.g., $72 vs. $90). Cartel Challenges Firms must coordinate secretly to maintain high prices, as formal agreements are often illegal. Risk of Detection: Governments and customers disapprove of price- fixing, leading to legal and reputational risks.  Cartels and Barriers to Entry Market with Two Firms High Price ($4): Cartel can maintain high prices if no new firms enter. Low Price ($2): Firms avoid loss of customers but earn less profit. Impact of a Third Firm Equal Pricing: High Price: 20 units, $60 profit per firm. Low Price: 24 units, $24 profit per firm. Price Undercut Low-price firm: 72 units, $72 profit. High-price firms: Sell nothing.  Competition Competition destroys a cartel From Cartel to Prisoners’ Dilemma: Prisoner’s dilemma Three firms → Low price is the dominant strategy. Cartel collapses as defection is more profitable. Outcomes: Firms face lower profits, while consumers benefit from lower prices. Policy Implications Reduce Reduce batteries barriers toto entry entry to boost competition. Public policy limits Limitsprice-fixing price fixing to protect consumers.  The effect of a tax Suppose that a sales tax of 30% is imposed on the price of salt. The equilibrium quantity falls from Q* to Q1. Consumers pay P1, producers receive P0, and the government receives the difference (P(P1-P0) 1 – P0).  The effect of a tax on surplus Consumer and producer surplus falls, and total surplus (including tax revenue) is lower. There is deadweight loss. Deadweight loss Tax DWL revenue  Taxes and Social Benefits Total Surplus Taxes transfer surplus to the government but create deadweight loss. If revenue funds public goods, societal gains can outweigh market losses. Modern democracies accept taxes as essential when perceived as fair and beneficial. Taxes on harmful goods (e.g., tobacco) are more effective when demand is elastic. ELASTIC  Is this a useful model? Characteristics of a competitive Conditions for a competitive equilibrium: equilibrium (perfect competition): All transactions take place at the many buyers and sellers, acting same price. This is known as the independently; Law of One Price. identical (homogeneous) goods; The market clears. Perfect information: all buyers and All participants are price-takers. sellers are aware of the prices at which others are trading, and always seek the best price available.  Applications of Competitive Equilibrium Close-to-Ideal Markets Agricultural goods (e.g., wheat, coffee) with many buyers and sellers. Firms act as price-takers due to low market power. Simplified Models Useful even when conditions aren’t perfect (e.g., small shops selling similar goods). Example: 1970s oil market – OPEC had market power but outcomes aligned with supply-demand predictions. Judging when simplified models provide valid insights into real-world scenarios.  Summary 1. Model of price-taking firms Competitive equilibrium where demand = supply Firms maximize profits where MC = Price Perfect competition is a special case Comparison with price-setting firms 2. Used model to show how equilibrium can change Exogenous shocks to demand/supply or market entry Effect of taxation on surplus  Unit 6 THE FIRM AND ITS EMPLOYEES OUTLINE A. Introduction B. Structure of the firm C. Hiring, quitting, and getting work done D. Employment rent and reservation wage E. The labour discipline and wage setting models A. Introduction  From Market Equilibrium to Labor Markets We've explored: Rational firm choices in the market Laws of demand and supply Perfect competition and market-clearing prices How do firms acquire the resources to produce goods and services? Focus on Labor: Labor is a fundamental input in production. Understanding labor markets bridges the gap between firm behavior and the broader economy.  Understanding Labor Markets How do firm contracts differ from market contracts? What is a reservation wage, and why is it important? How does employment rent influence worker behavior? How does the Principal-Agent Problem create incentive misalignment between employers and workers? How do the Labour Discipline and Wage-Setting Models explain wages, effort, and employment levels? B. Structure of the firm  Structure of the Firm Owners decide long-term strategies A problem of asymmetric information between levels in the hierarchy Managers assign workers  Product vs labour contracts Type of Contract Ownership or Authority Duration of Interaction Contracts for Permanently transfer Short-lived, often Products ownership from seller to buyer. not repeated. Contracts for Temporarily transfer authority Long-term, often Labour over activities to a manager. lasting years or decades.  Ownership and Profits Who Owns the Profits? Profits belong to the owners of the firm’s capital goods and assets. Owners aim to maximize profits and asset value by directing firm actions. Profit = Sales Revenue − Input Costs Input costs: raw materials, labor, energy, capital goods. Residual Claimants: Owners receive remaining revenues after paying employees, managers, and taxes.  Small Enterprises vs. Large Corporations Aspect Small Enterprises Large Corporations Owners manage directly (e.g., Managers handle operations and Management menu, marketing). strategy. Profit losses directly affect Shareholders rely on dividends Incentives owners, aligning their goals. and value growth. Single or few owners, often Shareholders own the firm but are Ownership involved in daily operations. not involved in management. Owners make key decisions Managers decide on production, Decision-Making like pricing and hiring. pay, and profit distribution.  Separation of Ownership and Control Separation of ownership and control occurs when managers use owners’ funds to run the firm, potentially creating conflicts of interest. Managers may prioritize personal benefits: Excessive spending (e.g., company credit cards). Higher salaries. Empire-building to boost power and prestige. These actions may reduce profits and harm shareholder interests.  Aligning Manager and Owner Interests The Problem: Separation of Ownership and Control Managers may act in their own interests, not the owners. Solutions Performance-Based Compensation: Managerial pay tied to the firm’s share price to align interests. Board of Directors Oversight: Represents shareholders, monitors managers, and can dismiss them if needed.  More on Why Labour Markets are Different Consumer Goods Markets Buyers and sellers focus on transactions (e.g., bread, T-shirts). No concern for the identity of the buyer or seller. Day Labour Markets: Short-term, precarious jobs with little stability. Workers often from disadvantaged groups (e.g., low education, migrants). Employers benefit from low wages, but productivity suffers due to poor job matches. Why Long-Term Employment Relationships Matter Challenges of Short-Term Work Mismatched skills and lack of training. Workers have little incentive beyond daily pay. High monitoring costs for employers. Benefits of Long-Term Matches Better alignment of worker skills and job needs. Opportunities for learning by doing and relationship building. Employers and workers both gain from continuity. Relationship-Specific or Firm-Specific Assets Skills, networks, and relationships developed within a firm, valuable only while the employee remains in the firm. What Happens When Employees Leave? These assets are lost for both the firm and the employee. Turnover Costs for Firms Recruiting and training new employees. Reduced productivity until new hires perform well. Importance of Retention: Preserves valuable assets and reduces turnover costs.  Labour Markets as Matching Markets Matching Markets Employers care about finding specific workers with desired skills. Workers care about finding jobs that suit their abilities and preferences. Comparison to Marriage Markets Similar to choosing a spouse: identity and characteristics matter. Goal is a durable, mutually beneficial relationship.  Labour market flows Recruitment N employed workers; V U N filled jobs Vacant Unemployed jobs workers Job to job moves Workers leave Jobs destroyed New jobs New workers labour market Quits and lay-offs C. Hiring, quitting and getting work done  Reservation Option and Wage Reservation Option: The next best alternative to accepting a job, such as staying unemployed. Key Factors for Reservation Option Unemployment Income: Benefits or family support. Utility While Unemployed: Study, family time, or feelings like boredom or anxiety. Job Search Time: Expected time to find a better-paying job. Reservation Wage: The minimum wage a worker accepts, matching the value of their reservation option.  Example of Reservation Wage Françoise’s Situation Reservation Option: Staying unemployed, valued at €600/week. Offered Job: €580/week. Decision: Françoise rejects the job because €580 doesn’t exceed her reservation wage of €600.  Example: Language School Workforce The Setting A language school in Paris employs tutors for short-term (6–12 months) roles. Weekly quitting rate: 4% of the workforce. Workforce Dynamics Target workforce: 50 tutors (N = 50). Weekly turnover: 2 tutors leave (0.04 × 50) → 2 must be hired weekly. Hiring depends on tutors’ reservation wages (minimum wage they will accept).  The Hiring line Shows the number of potential hires at different wages. Example: Lowest reservation wage is €550. Hiring at N = 50 To hire 2 tutors per week, the school offers €675. Higher wages attract more tutors with higher reservation wages. Required-Wage Line and Reservation Wage Curve The required-wage line shows the wage needed to employ N workers and the reservation wages of potential employees. The required-wage line is equivalent to the reservation wage curve. It guides the school in setting wages to balance hiring needs and employee retention.