EC1101E notes.pdf

1 Lecture Scarce Deficient in qty compared with DD Insufficient to satisfy unlimited needs/wants Society faces a scarcity of resources 1. Labor 2. Capital: physical, human 3. Land + natural resources 4. Entrepreneurship: able to combine other resources in a pdtive enterpr...

1 Lecture Scarce Deficient in qty compared with DD Insufficient to satisfy unlimited needs/wants Society faces a scarcity of resources 1. Labor 2. Capital: physical, human 3. Land + natural resources 4. Entrepreneurship: able to combine other resources in a pdtive enterprise Economics: study of choice under scarcity How people decide how much to work, what to buy, how much to save, how to invest, etc. How firms decide how much to prod, how many workers to hire, etc. How society decides how to allocate its resources (among national defence, health care, education, scientific research, social safety nets, etc.) Make decisions = compare costs + benefits of alternative choices 1. Explicit cost: monetary sacrifice 2. Implicit cost: non-monetary sacrifice (time). When alternatives to a choice are mutually exclusive, opp cost: value of next best alternative or wtv forgone Jerry is considering attending a concert, ticket P = $85. Cost of driving to concert and parking = $15. In order to attend the concert, he will have to either take time off from his part-time job or forgo studying for an exam scheduled for next morning. He estimates that he will lose 5 hours at work at a wage of $12 per hour or 5 hours of study time. If he considers studying to be best alternative use of his time, opp cost of attending concert = $100 + value of higher exam grade he could earn by studying 5 hours. Five Core Principles 1. Scarcity Implies Trade-Offs Unlimited wants + limited resources, having 1 > of A = < of B 2. Bargaining Strength Comes Through Scarcity Scarce resources command high Ps. Chapter 1: Who Pays for Your Coffee? 3. Compare Costs + Benefits An action only if benefit ≥ cost. 4. People Respond to ∆ in Costs +Benefits Likelihood of taking an action ↑ as benefit ↑ and/or cost ↓. 5. Focus on CA Everyone gains when each individual/country concentrates on activities in which opp cost is lowest. Types of Economics 1. Microeconomics a. Study of how households and firms make decisions + how they interact in mkts b. Effects of rent control on housing, impact of foreign competition on U.S. 2. Macroeconomics a. Study of economy-wide phenomena (inflation, unM, EG) b. Effects of borrowing by federal gov, ∆ over time in economy's rate of unM, alternative policies to promote growth in national living standards Positive Economics Normative Economics Scientists Policy advisors Describe world as it is Prescribe how world should be Evaluated by analyzing evidence on can use data to con Opinion of how world should be and not about how worl / refute this statement can’t be confirmed/refuted Addresses relatively narrow "What is?" qn Addresses much broader "What should be?" qn Ans qns with tools of economics, w/o interjecting any va Ans qns req value judgements. Diff ppl = diff values, our judgement as to whether particular outcome is desirable answers may differ regardless of what theory/facts tell u harmful. about impact of... Positive disagreements - diff in scientific judgments, e.g Normative disagreements - diff in values, e.g. equity. response to taxation. Every normative analysis is based on an underlying positive analysis. Scientific Method: observe, theorize, test Model: a simplification of a > complicated reality 2 types of assumptions: 1. Simplifying assumptions: don’t affect important conclusions 2. Critical assumptions: affect important conclusion pdtion Possibilities Frontier PPF: a graph that shows all combi of 2 goods that can be prod given avail resources and tech. Points on PPF: Possible, Efficient Points under PPF: Possible, Not efficient (unused resources in economy) Points above PPF: Not possible Moving along a PPF involves shifting resources from prod of 1 good to prod of other good. > resources / improvement in tech, economy can prod > iPads, > rice, or any combi in btw. EG shifts PPF outward. Limited resources, getting > of 1 good req sacrificing some of other (Scarcity Implies Trade-Offs). Slope of PPF indicates opp cost of good x in terms of good y. Depends on what happens to opp cost as economy shifts resources from 1 industry to other. Constant opp cost of a good = PPF is a straight line ↑ opp cost of a good as economy prod > of good = PPF is concave: all resources used in prod are not perfectly substitutable so diff resources are suited for diff uses ○ diff resources have diff opp costs of prod 1 good in terms of other good. ○ E.g. diff workers have diff skills. As economy shifts resources from guns to butter: PPF becomes steeper, opp cost of butter ↑. A: most workers are prod guns, even those who are better suited to prod butter. To get > butter, don’t have to give up many guns. B: most workers prod butter. few left in guns are best gun makers. Prod > butter req shifting some of best gun makers away from guns, cause a big drop in o/p of guns. To prod same amnt of butter, req > guns Gains from Trade Interdependence Every day we rely on many people from around world to provide us with G&S we enjoy. Vietnam has 50,000h of labor per month. Prod 1 ton of opium req 100h of labor. Prod 1 ton of rice req 10h of labor. Vietnam has enough labour to prod 500 tons of opium or 5,000 tons of rice or any combi along PPF Myanmar has 30,000h of labor per month. Prod 1 ton of opium req 125h of labor. Prod 1 ton of rice req 25h of labor. Myanmar has enough labour to prod 240 tons of opium or 1,200 tons of rice or any combi along PPF. w/o trade, each country uses ½ its labour to prod each good. Vietnam cons 250 tons of opium and 2,500 tons of rice. Myanmar cons 120 tons of opium and 600 tons of rice. Absolute advantage: ability to prod a good using fewer inputs / lower cost than another producer. A req _h which is < than _h for B, A has AA. OR Since a worker in A prod > x per h () than B(). Comparative advantage: ability to prod a good at a lower opp cost than another producer. opp cost of 1 unit of A = …/ 1 unit A (!! if opp cost of A in x same ratio in y = no one has CA) opp cost of prod 1 unit of A is _ units of B which is lower opp cost of 1 unit of A = 5 units of B/1 unit of A so opp cost of A is 5 units of B OR 1 unit of A = 50h= 5x10h = 5 units of B When each country specialises in good it has CA, ↑ total prod in all countries, ↑ world's economic pie, all countries can gain from trade. Specialise in prod A = all inputs used to prod A, 0 inputs to prod B, trade with others using A 1 person can't have CA for both goods but can for AA for both goods Hobbes and Calvin bakes cookies and makes lemonade but Hobbes is better at both = AA. I. Trade can benefit both Calvin and Hobbes. III. Trade will benefit neither Calvin nor Hobbes. Gains from trade come from CA. 1 has CA in 1 good, another has CA in another good, trade and benefit both. Trade benefit 1 person and not benefit another WONT happen as don’t have to agree to trade unless you get smth out of it. Same opp cost = nobody has CA = no gains from trade. F If X has CA in tea, X has AA in tea. Counter: Y has AA in tea F If X has AA in tea, X has CA in tea. Counter: Y has CA in tea T If X has AA in tea and Y has AA in coffee, X must have CA in tea. Assume hypothesis is true o/p X Y tea 10 5 coffee 1 4 True (cfm true) general proof False (1 counter) Quiz In 1787, British gov hired sea captains to ship convicts to Australia. The death rates were shockingly high; on one voyage, > than a third of the convicts died, and the rest arrived beaten, starved, and sick. The survival rate of the convicts shot up to 99 percent when captains were no longer paid for each convict who boarded the ship in Great Britain; instead, they were paid for each convict who walked off the ship in Australia. One explanation for drop in SOL in Soviet Union during WWII: war led to a movement along its PPF away from civilian goods and towards military goods. Pset Would you expect economists to disagree less about public policy as time goes on? Can their differences be completely eliminated? Expect economists to disagree less about public policy: will have opp to observe diff policies that are put into place. As new policies are tried and evaluated, we know > about effects of diff policies. It's likely that disagreement over public policies will be reduced after they've been tried in practice. For example, many economists thought wage and P controls would keep inflation in check, while other economists disagreed. But when wage and P controls were tried in U.S. in early 1970s, results were disastrous. Wage and P controls interfered with invisible hand of mktplace, shortages developed in many mkts. Most economists are now convinced wage and P controls are unlikely to keep inflation in check. Diff btw economists are unlikely to ever be completely eliminated. Economists differ on too many aspects of how world works, just even as some policies get tried out and are either accepted or rejected, creative economists keep coming up with new ideas. Economists have diff beliefs about how world ought to be, as they have diff values, ethics, and political philosophies. The New York Times. June 26, 2009. "As Plants Close, Teenagers Focus > on College." http://www.nytimes.com/2009/06/26/business/26grads.html The New York Times. July 26, 2013. "College Enrollment Falls as Economy Recovers." http://www.nytimes.com/2013/07/26/education/in-a-recovering-economy-a-decline-in-college-enrollment.html (a) Use the concept of opp cost to explain how the recession, and subsequent recovery, affected college enrollment decisions. (b) Should everyone go to college/ university? Explain in not > than five sentences. (a) Opp cost of college: tuition and fees (explicit cost), foregone wages (implicit cost). 2009: recession, ↑ job insecurity + ↓ job opp for teenagers who graduated from high school. Closure of manufacturing plants + ↑ unM. Low likelihood of earning decent wages during a recession, ↓ opp cost of college (pot loss of Y from not working + money saved from college outweighs skills and knowledge obtained from college improves future job prospects + secures better long-term career stability), ↑ college enrollment rates. 2013: economy recovered, job mkt improved, ↑ job opp. ↑ opp cost of college, ↓ college enrollment rates to capitalize on these immediate employment options. Recession heightened perceived value of college as a means of securing future stability, while economic recovery shifted focus back to immediate earning potential. (b) Not. It depends on individual career goals, financial situation, and personal interests. For some, vocational training or apprenticeships offer a > direct path to fulfilling and well-paying careers. Some jobs do not require skills and knowledge learnt from university. (barista, admin) >over, the rising cost of higher education and potential student debt necessitate careful consideration of the long-term benefits and returns on investment. Ultimately, the decision should align with personal aspirations and the specific skills required for one's chosen field. b) Many people would argue that explicit costs (i.e., money) should not be a barrier to attending college. However, we still have to consider implicit costs as well as benefits. Some people (e.g., LeBronJames) would be giving up high incomes to attend college. Other people (e.g., Steve Jobs)would likely have done just as well in their careers with or w/o a college degree. (AlthoughJobs did not attend college, he did take a variety of college classes such as calligraphy, dance, and Shakespeare, which he credited as having helped him in his very successful career.) (a) Assuming increasing opp costs, draw PPF for guns and butter. (b) Show a point that is impossible for economy to achieve. Show a point that is feasible but inefficient. (c) 2 political parties, Hawks (who want a bigger military) and Doves (who want a smaller military). Suppose an aggressive neighboring country reduces size of its military. As a result, both. Hawks and Doves reduce their desired prod of guns by same amnt. Which party would get bigger "peace dividend," as measured by ↑ in prod of butter? Explain. a) PPF is concave. At H (little butter + many guns), resources best suited to making butter are being used to make guns. To get an extra unit of butter, have to give up only a few guns. Move along PPF to right (↑ prod of butter, ↓ prod of guns), ↑ opp cost of butter. At D (many butter + few guns), resources best suited to making guns are being used to make butter. To get an extra unit of butter, have to give up many guns. (b) A is impossible for the economy to achieve; it is outside PPF. B is feasible but inefficient; it is inside PPF, indicating resources are underutilized. (c) If both Hawks and Doves reduce their desired qty of guns by same amnt, Hawks would get a bigger peace dividend = reduction of a given no. of guns, when starting at H, leads to a much larger ↑ qty of butter prod than when starting at D. At H, most workers are making guns; Hawks will shift gunmakers who are relatively bad at making guns and relatively good at making butter to butter prod, hence gaining a lot of butter. At D, few making guns are best gunmakers (who are relatively bad at making butter); shifting them to butter prod generates only a little butter. New Zealand has 72mh of labor per period, India has 120mh. (c) If India produces 1> rug and exports it to New Zealand, what is the lowest P (measured in tons of wool) that it would accept? What is the highest P that New Zealand would pay? Why? Lowest P at which India is WTS 1 rug: could have prod 0.4 tons of wool. India must receive at least 0.4 tons of wool in ex∆ for 1 rug. Highest P NZ is WTP 1 rug?: could have prod 1.33 tons of wool. NZ is willing to give up at most 1.33 tons of wool in ex∆ for 1 rug. (d) Before trade, each country uses half of its labor to produce wool and half to produce hand-knotted rugs. How many tons of wool and how many hand-knotted rugs would each country produce? (e) After trade opens up, each country specializes in the good in which it has a CA. How many tons of wool and how many hand-knotted rugs would each country produce? (f) Suppose the terms of trade end up at 1 ton of wool for 1 hand-knotted rug. New Zealand decides to export 4 million tons of wool to India. How many rugs will New Zealand import from India? How many tons of wool and how many hand-knotted rugs will each country consume after trade? Lowest P WTS 1 pizza = x beer, Highest P WTB 1 pizza = y beer, trade at any P btw x and y beer per pizza TUE Chapter One. Explain why coffee is expensive in cities like London, New York, Washington, Tokyo, and SG. 1. Prime Location Costs: High foot traffic: constant flow of time-constrained customers who prioritize convenience over price (P-blind). David Ricardo's economic theory of rent: rent is driven by willingness of customers to pay a premium for coffee in convenient locations. 2. Scarcity of Prime Retail Spaces Limited suitable retail spaces, Scarcity gives landlords significant bargaining power, allowing them to charge high rents, which in turn is passed on to consumers in form of expensive coffee. > coffee chains compete for these prime spots, landlords can raise rents, knowing that businesses are willing to pay for these high-traffic areas. 3. Global Brand Influence and Operating Costs Established global brands and operational systems that can justify charging premium prices. Cost of running outlets (rent, wages, utilities) adds to high price of coffee, but brand ensures that many customers are willing to pay more for convenience and perceived quality. The New York Times. November 5, 2013. "Outsource Your Way to Success." http://www.nytimes.com/2013/11/10/magazine/outsource-your-way-to-success.html (a) In your own words, explain why Steinsson and Nakamura hired a personal chef. Opp cost of making 5meals a week: cost of groceries + time spent grocery shopping (+ commute to and from grocery store), prepping, and cooking. Those hours could have been spent on their work (professional success), with son (family time), or any activity they find pleasurable (leisure). (b) Under what circumstances will Steinsson and Nakamura choose to forgo the personal chef? In making a decision, we compare costs + benefits of various options. Likelihood of taking an action rises as the benefit rises, and falls as the cost rises. In deciding whether to hire a personal chef, they compare net benefit of hiring a personal chef (option A) with net benefit of another option such as cooking (option B). They will choose to forgo personal chef if EITHER net benefit of A ↓ (benefit ↓ or cost ↑) such that it is now < net benefit of B OR net benefit of B ↑(benefit ↑or cost ↓) such that it is now greater than net benefit of A. eg: (i) Y (+ expected future Y) takes a hit such that they would rather reallocate money to some other purpose. ↓ WTP a personal chef (which reflects their perceived benefit of a personal chef). (ii) Personal chef ↑ fees such net benefit of hiring personal chef is now < net benefit of another option: cooking. (iii) Develop a newfound love for cooking, net benefit of cooking is now > net benefit of hiring a personal chef. (iv) Advent of food delivery services (Deliveroo, foodpanda, GrabFood in SG; DoorDash, GrubHub, UberEats in U.S.) lowers cost of take-out such that net benefit of ordering take-out > net benefit of hiring a personal chef. Use a PPF to illustrate a society's tradeoff btw cleanliness of env + qty of widgets made in factories. x-axis: widgets y-axis: cleanliness of env. What determines shape and position of PPF? Shape + position of PPF depend on how costly it is to have a clean env. Many things pollute env: factories and cars. As a society shifts resources from ensuring a clean env to making widgets in factories, opp cost of making widgets ↑. When most of resources are spent on ensuring a clean env, we don’t have to give up a lot of cleanliness to make 100 > widgets as we can discard least cost-effective measures. But when a lot of resources are alr spent on making widgets, we will have to give up a lot of cleanliness to make 100 > widgets Show what happens to PPF if engineers develop a 0-emission car engine. Hint: If all resources are spent on making widgets, does a 0-emission car engine affect the pdtion,of widgets? If all resources are spent on ensuring a clean env, does a 0-emission car engine affect the cleanliness of the env? Car engines (people driving on roads) affect cleanliness of env but not prod of widgets. No gains in “widget pdtivity,” x-intercept doesn’t ∆. At x-intercept, all resources are going to making widgets, no resources are going to ensuring cleanliness of env (e.g. no resources are spent on 0-emission car engine even though tech exists). Gains in “enval pdtivity,”: development of a 0-emission car engine, ↑ y-intercept. At y-intercept, all resources are going to improving cleanliness of env, no resources are going to making widgets. When 0 units of widgets are prod, cleanliness of env depends on car emissions but not on factory emissions. PPF pivots on x-intercept outward along y-axis. Suppose a society was originally producing at a point on PPF where it was spending some resources on ensuring a clean env and some resources on making widgets in factories. With development of 0-emission car engine, can society now make > widgets relative to what it was making previouslv? Society can now make > widgets relative to what it was making previously. The New York Times. April 16, 2020. "It's the End of the World Economy as We Know It." https://www.nytimes.com/2020/04/16/upshot/world-economy-restructuring- coronavirus.html (a) What is globalization? Process of increasing interconnectedness and interdependence of economies, cultures, and populations across the world through trade, investment, technology, migration, and the exchange of ideas. It involves the integration of national economies into the global market, facilitated by advancements in transportation and communication. (b) Is global trade likely to disappear? Global trade is unlikely to disappear entirely, but it may undergo significant changes and restructuring. COVID-19 pandemic highlighted vulnerabilities in global SS chains, has been a shift towards de-globalization trends: reshoring and regional trade agreements. However, global trade remains essential for many industries and economies, so it will likely persist, albeit in a diff form. (c) 1. **World War I**: 1914-1918 2. **Spanish Flu pandemic**: 1918-1920 3. **Hyperinflation in Weimar Republic**: 1921-1923 4. **Black Thursday (Start of Great Depression)**: October 24, 1929 5. **Great Depression**: 1929-1939 6. **Adolf Hitler rose to power as Chancellor of Germany**: January 30, 1933 7. **The Holocaust**: 1941-1945 (though Nazi persecution started earlier) 8. **World War II**: 1939-1945 9. **The year U.S. output overtook that of the entire British Empire**: Around 1945 10. **Gas prices hit $4 a gallon in the U.S.**: 2008 11. **Great Recession**: 2007-2009 12. **COVID-19 pandemic**: 2019-present (ongoing as of 2024) 13. **The year Chinese output overtook U.S. output**: 2014 14. **Russian invasion of Ukraine**: 2014 (Crimea) and full-scale invasion in 2022 15. **Israel-Hamas war**: 2023 2 Lecture Mkt Economy SS and DD model shows how SS and DD determine P: in a mkt economy, allocation of resources is decentralized (all make own decisions, choose what + how much to buy/sell, determined by interactions of many self-interested buyers and sellers, decentralized decisions then invisible hand to centralised) A mkt: a group of buyers and sellers of a particular G&S. In perfectly competitive mkts: 1. G+S are practically identical. 2. Many buyers and sellers so no one can affect mkt P — everyone is a P taker. 3. Perfect info 4. No friction (no cost for transaction) Demand Qd: amnt of good buyers are W+A to purchase. Law of DD: As P of a good ↑, Qd ↓, CP. DD schedule: a table that shows r/s btw P of a good and Qd Qd in mkt: sum of Qd by all buyers at each P. DD curve shows how P affects Qd, other things (non-P determinants of DD: things that affect buyers' DD for a good other than good's P) equal DD Curve Shifters ↑ Qd at each P shifts DD curve to right 1. No. of Buyers ↑ 2. Income ↑ Y, ↑ DD for a normal good ↓ Y, ↑ DD for an inferior good 3. P of Related Goods Substitutes: ↑ P of A causes ↑ DD for B. Complements: ↑ P of A causes ↓ DD for B. 4. Tastes 5. Expectations Expect ↑ Y, ↑ DD for meals at expensive restaurants now. If economy sours and people worry about their future job security, ↓ DD for new cars now. Supply Qs: amnt of goods sellers are W+A to sell. Law of SS: As P of a good ↑, Qs ↑, CP. SS curves usually assumed to slope upward: higher P attracts resources from other < valued uses. SS schedule: a table that shows r/s btw P of a good and Qs Qs in mkt: sum of Qs by all sellers at each P. SS curve shows how P affects Qs, other things (non-P determinants of SS” things that affect sellers' SS of a good other than good's P) equal. ∆ SS: shift in SS curve when a non-P determinant of SS ∆ ∆ Qs: movement along SS curve occurs when P ∆ SS Curve Shifters ↑ Qs / firms SS a larger qty at each P, SS curve shifts right 1. No. of Sellers a. ↑ 2. Input P a. ↓ P of raw material, wages, P of machinery, rental P of retail space b. ↓, prod > profitable at each o/p P 3. Technology a. Determines how many units of input is req to prod a unit of o/p. b. Cost-saving technological improvement = ↓ input P 4. Weather a. Important factor in agricultural commodities 5. Expectations affect producers' SS decisions a. Events in Middle East lead to expectations of higher oil P, oil fields in Brunei ↓ SS now, saving some inventory to sell later when P are higher. ↓ SS curve b. Sellers may adjust SS (of non-perishable goods) when expectations of future P ∆. If some piece of information causes sellers to expect P of a non-perishable good to rise in future (want to ensure have enough stock in future to sell when P is high), but buyers take the same info and believe it will have no impact on P (buyers no response), the result is a decrease in SS today. Equilibrium A state in which opposing forces are balanced so that one is not greater than other. Qs = Qd Surplus, sellers ↓ P, ↑ Qd + ↓ Qs, ↓ surplus. P continue to ↓ until mkt reaches eqm. Shortage, sellers ↑ P, ↓ Qd + ↑ Qs, ↓ shortage. P continue to ↑ until mkt reaches eqm. Pset An analyst observes the following eqm P-qty combinations in mkt for restaurant meals in a city over a four-year period. He concludes that mkt defies law of DD. Wrong. Law of DD: P of a good ↑, Qd of a good ↓, all else equal. Analyst is assuming that every other factor that might cause ∆ SS/DD remained constant over four years. ↑ Peqm and ↑ Qeqm imply DD curve shifted right (possibly due to ↑ pop, ↑ Y, ∆ tastes). SS curve could have shifted left or right, ↑ Peqm and ↑ Qeqm as long as effect of shift in DD curve dominated. The New York Times. November 19, 2013. "Why is Turkey Cheaper when DD is Higher?" http://www.nytimes.com/2013/11/24/magazine/why-is-turkey-cheaper-when-DD-is-higher.html (a) What is the expected ∆ P of turkey around Thanksgiving? DD for turkey ↑, expect P of turkey to ↑. (b) How is SS of fresh turkeys diff from SS of frozen turkeys? SS of fresh turkeys is P inelastic — “[f]resh turkeys... are killed just in time for peak DD.” SS of frozen turkeys is P elastic — “turkey sellers start putting frozen birds into cold storage as early as January, so they can stockpile turkeys well ahead of holiday surge (c) What is SS-side explanation for the fall in P of frozen turkeys around Thanksgiving? “Stores advertise very low P — sometimes even lower than they paid their wholesalers —for big-ticket, attention-grabbing pdts in order to get people in the door, in the hope that they buy lots of other stuff. You might get your turkey for a song, but then you also buy potatoes, cranberries and pies at the same supermkt — all at regular (or higher) markups.” (d) Can you think of another good with a similar SS-side pattern? Abalone is canned, so SS can be ↑ very easily in the month leading up to CNY. Grocery stores advertise discounts on abalone, and once you’re in store, you will likely buy other groceries as well. (e) What is DD-side explanation for the fall in the P of frozen turkeys around Thanksgiving? “Consumers might get > P-sensitive during periods of peak DD and do > comparison-shopping, so stores have to drop P if they want to capture sales. Perhaps, during the holidays, the composition of consumers ∆; maybe only rich people or people who really love turkey buy it in July, but just about everybody — including lower-income, P sensitive shoppers — buys it in November. Or maybe everyone becomes > P-sensitive in November because they’re cooking for a lot of other people, not just their nuclear families.” (f) Can you think of another good with a similar DD-side pattern? Think about peanuts, snacks, or drinks during CNY. Buying not for your close family members, but for distant whom you see only once a year, will be > P-sensitive, scouring the newspapers for store advertisements, and stores will compete by offering discounts, likely to buy cheaper brands. TUE Chapter Two. What are diff ways in which companies try to maximize their producer surplus? PS: diff a seller is paid for a good and his cost. To ↑ PS, companies can ↑ amnt they receive or reduce their cost. Companies exploit scarcity by situating themselves in a busy and attractive location with limited resources and options. By being the sole provider of a certain good, that company wields plenty of scarcity power over consumers. They can charge customers higher Ps, ↑ amnt prod is paid, ↑ PS. Companies find ways to “∆” the type of pdts sold to convince consumers that trying new ways to change usual order is worth the extra money. Producers can offer a variety of alternatives made with similar inputs and costs. Additionally, producers can offer pdts in diff quantities or with diff features. Consumers may perceive these diff as significant to justify a higher P when in fact, it costs producers very little to do so. Charging higher P to those W+A to pay > ↑ PA. Companies set P from two extremes. Instead of reducing cost of pdts by a small amount year-round, companies reduce the cost by a significant amount twice a year. Maintaining high Ps during the majority of the time targets customers who are less P sensitive and unaware of discounts. On the other hand, lower Ps attract customers who are > P sensitive and want to get themselves a deal. Companies receive > money during most of the year form lazy consumers and during sales from thrifty consumers, hence increasing PS. CHAT 1. Scarcity Power: Ability of businesses to charge higher prices due to limited availability of G+S. 2. Pricing Dilemma: Higher Prices with Fewer Customers + Lower Prices with More Customers 3. Self-Incrimination Strategy to Identify diff cons WTP by revealing P sensitivity through choices: Fair Trade Coffee: Initially marketed with a premium to appeal to socially conscious customers, allowed Costa to signal higher prices to those who care about ethical sourcing + capture > price-sensitive customers with standard offerings. Starbucks similarly offers a variety of ingredients, sizes, locations Conscious of their selections and compare prices instead of assuming that one store is cheaper than another. Sales as a self-targeting strategy, allowing them to capture bargain hunters + < price-sensitive consumers. By varying prices and sales patterns, stores can maxi profits from diff customer segments. Pdt placements and packaging designed to deter certain customers from choosing lower-priced items so < P-sensitive select more expensive options. Exploit scarcity power—consumers may have limited alternatives, WTP >. pdt Differentiation: Businesses often create perceived diff btw pdts (like slower printers) to justify higher prices for premium offerings, even when prod costs may not differ significantly. A taxi ride regularly costs $13. If mkt is in eqm, then Qd = Qs at that P. DD curve and the SS curve at a “regular” time: D1 and S1. At 1:00 a.m. on New Year’s Day, ↑ DD + ↓ SS of taxi rides. If P were “fixed” at $13, shortage of taxi rides. Uber’s rationale is that by hiking up P to $47, taxi drivers will be induced to SS taxi rides, a movement along the S2. Consumers are still DD taxi rides so D2 un∆. However, someone who is not WTP at least $47 will not be able to get a ride, look for other alternatives such as “hoofing it home free or trying her luck waving her arms at the passing, fixed-P cabs on street.” In graph, $47 is depicted as eqm P (where Qd=Qs), but we don’t know that for a fact, hence writer’s disgruntlement. 3 Elasticity: a measure of responsiveness of Qd /Qs to 1 of its determinants (P, P of a related good, Y). P Elasticity of Demand PED = % ∆ Qd/ % ∆ P measures how much Qd responds to ∆ P measures P-sensitivity of buyers' DD > P elastic > responsive to P ∆ % ∆ = (end value - start value )/midpoint x 100% Tilt it a little to see that Q changes by v little, P changes by a lot so denominator is v big, PED = 0 > PED (alw compare w 1) 1. narrowly defined > broadly defined good a. Narrowly defined good, blue jeans, > sub. b. Boadly defined good, clothing, < sub.  2. luxuries > necessities 3. > close sub avail 4. > expensive 5. LR > SR a. P of petrol rises by 20%. SR: there's not much we can do other than take public transport or carpool. LR: can buy fuel-efficient cars or live closer to our workplace. Qd fall > in SR rev = P x Q PED > 1 % ∆ Qd > % ∆ P ↓ rev from a lower Q dominates ↑ rev from a higher P, ↓ rev PED < 1 % ∆ Q < % ∆ P ↑ rev from a higher P dominates ↓ rev from a lower Q, rev ↑. 1. Find PED value 2. Qn: P or Q inc or dec 3. Law of DD: P and Q effect is opp of each other (P ↑ Q ↓) 4. Which dominates 5. TR Why did luxury brands like Chanel, Louis Vuitton, and Gucci ↑ P? 1. Maintain (or bolster) their positions in terms of exclusivity 2. ↑ rev w/o saturating mkt with too many pdts Max profit = Total rev - total cost = PxQ - TC ↑ P > ↓ Q, PED inelastic (luxury should be elastic but relative to others > elastic so luxury can be inelastic: luxury 0.8, others 0.2), but CP?? (Covid) Veblem goods (status) If a P ↓ results in no change in sellers' total rev, DD is unitary elastic. TR = P x Qd Qd: how many units ppl are WTB, ↑ by same extent as ↓ P Sells apples and oranges for $2.20 each. At these P, store can sell 80 apples and 160 oranges per week. One week, store lowered P per apple to $1.80 and sold 120 apples. Next week, store lowered P per orange to $1.80 (after raising P per apple back to $2.20) and sold 240 oranges. So same PED of apples and of oranges over these P ranges. Can sell (cons are buying)/sold so Qd vs WTS so Qs Qsold = Qd Q can sell = Qs? Same P∆ , same % ∆ Qd, same PED Cross-P Elasticity of Demand Measures how much Qd responds to ∆P of another good. XED = % ∆Qd of good 1 / % ∆P of good 2 Substitutes: XED > 0 + (↑/↑) Complements: XED < 0 - (↓/↑) Income Elasticity of Demand Measures how much Qd responds to ∆ Y. YED = % ∆Qd /% ∆Y Normal goods: YED > 0 + (↑/↑) Inferior goods: YED < 0 - (↓/↑) price elasticity: movements along DD curve, YED, XED: shifts of DD curve DD for good A > price elastic than good B, same % ↑ Qs in both mkt (= shift in DD curve) will cause > ↓ P for good B than for good A. A: cons > responsive to changes in P. ↑ Qs, consumers of good A will respond by purchasing more of it (larger ↑ Qd), so P doesn’t need to ↓ as much to absorb extra SS. P Elasticity of SS PES = % ∆Qs / % ∆P Measures how much Qs responds to ∆ P. Measures P-sensitivity of sellers' SS. Determinants of PES Higher PES 1. > easily sellers can ∆ qty they prod 2. LR: firms can build new factories, or new firms may be able to enter mkt SS is perfectly elastic: time period under consideration > likely to be a short period than a long period FALSE P elasticity of a curve is slope of curve. On a linear DD curve, PED is constant along curve. If slope is constant (assume true), PED is also constant. (evaluate if its alw/sometimes true) OR calc PED of each point see if its same On a linear SS curve going through origin, PES is constant along curve. PED is related to absolute value of inverse of slope of DD curve. Elasticity is a ratio of % ∆, not a ratio of ∆. DD curve with a constant slope of −1 has 3 PED. Efficiency in Mkts P of G&S adjusts to balance SS and DD in a mkt economy. Welfare economics studies how allocation of resources affects economic well-being (gains to buyers and sellers). Allocation of resources: how much of each G&S is prod which producers prod them which consumers cons them Welfare loss in a mkt: dollar value of pot benefits not achieved due to inefficiency in mkt Inefficiency: good is not being cons by buyers who value it most highly + not being prod by lowest-cost producers. Why mkts are efficient: buyers and sellers get signals via P about whether they should buy/sell Willingness to Pay (WTP) max amnt buyer will pay for that good measures how much buyer values good A buyer will buy a good: his WTP (benefit) ≥ P (cost) 1 step = 1 buyer. If many of buyers (a competitive mkt), many tiny steps, curve > smooth. At each Q, height of DD curve = WTP of marginal buyer: buyer who would leave mkt if P were any higher. Consumer Surplus (CS) CS = WTP (how much I value good) - P (how much I give up to obtain) Total CS = area below DD curve, above P from 0 to Q. Cost Value of everything a seller must give up to prod a good (opp cost) = cost of inputs + value of seller's time. A seller will prod and sell a good only if P ≥ cost At each Q, height of SS curve is cost of marginal seller: seller who would leave mkt if P were any lower. Producer Surplus (PS) PS: amnt a seller is paid for a good (Price) - WTS (Cost) Total PS: area above SS curve below P, from 0 to Qeqm Total Surplus CS = Value to Buyers - P (cost to buyers) = buyers' gains from participating in mkt PS = P - Cost to Sellers = sellers' gains from participating in mkt TS = CS + PS = Value to Buyers - Cost to Sellers = total gains from trade TS as a measure of society's well-being, whether mkt's allocation is efficient. Efficiency Allocation of resources is efficient if TS ( = Value to Buyers - Cost to Sellers ) is maxi Efficiency: goods are cons by buyers who value them most highly, goods are prod by sellers with lowest cost. Harford (TUE), Chapter 3: A set of interconnected perfectly competitive mkts results in: 1. Companies making things right way. 2. Companies making right things. 3. Things being made in right proportions. 4. Things going to "right" people Q = 20 cost of producing marginal unit = $35 value to consumers of marginal unit = $20 too many bought+sold so ↑ TS by ↓ Q at any Q>15. Q* (mkt eqm qty) maxi TS. At any other qty, we can ↑ TS by moving Q*. Q = 10 cost of producing marginal unit = $25 value to consumers of marginal unit = $40 10th unit valued at $40. ↑ TS by ↑ Q at any Q incidence of issues (holes in walls or floors, chipped or peeling paint, and loose railings). Landlord POV: Compare Costs (maintenance) and Benefits (rent u charge). If rent is capped at certain amnt, little incentive to spend > than you need Rent control ended in 1995, ↑ value of rent-controlled properties, Pc/rent control is binding, value of non-controlled properties ↑ tool. Non-controlled properties in neighbourhoods with a higher % of rent-controlled properties ↑ value by > non-controlled properties in neighbourhoods with a lower % of rent-controlled properties People Respond to Changes in Costs and Benefits (Benefit (rent) allowed to ↑ to mkt level, landlords have incentive to spend > on maintaining properties, can charge higher rent) Centralised planning Benefit (rent) allowed to increase to mkt level, landlords have incentive to spend more on maintaining properties, can charge higher rent Transform Pc not binding to one that is binding? Pc is binding when it is set below Peqm so need to ↑ Peqm so Pc is below new + higher Peqm for Pc to be binding. Effects: black mkts Goods are sold illegally at Ps above legal ceiling !!! Height of DD curve at every qty tells WTP of marginal buyer Total expenditure by buyer = total rev by seller =PxQ Buyers can’t signal their ↑ DD by bidding P up, sellers have < incentive to ↑ Qs coz can’t ↑ P, shortage P Floor Pf below Peqm is not binding = Peqm legal, Peqm remains at that P = no effect on mkt outcome Pf above Peqm is binding = Peqm illegal, Peqm remains at that P = causes surplus Effects Qs and Qd of T-shirts at various P. If a Pf = $18 is imposed, qty of shirts actually purchased = 6. Pf is binding, new mkt P = Pf, supplier’s WTS x goods > buyer’s WTB y goods so only y goods are bought + sold. Taxes Gov levies taxes on G&S to raise rev to pay for national defense, public schools. Causes DWL: tax induces buyers to cons less and sellers to prod less. A tax drives a wedge btw P buyers pay and P sellers receive. Incidence of a Tax: how burden of a tax is shared btw buyers + sellers. Buyers pay $1.00 >, sellers receive $0.50 elastic than DD. Sellers > responsive to P changes, easier for sellers to leave mkt, buyers bear most of burden of tax. If SS curve is perfectly inelastic, ALL tax paid by sellers. Effects Apply welfare economics to measure gains and losses from a tax. Tax rev can fund beneficial services (education, roads) so include tax rev in TS. Tax, mkt distortion, units btw Qt and Qe not sold as value of these units to buyers (DD curve) > cost of producing them (SS curve). If these units have been traded, there would have been gains (buyers + sellers enjoy surplus) so tax ↓ Qeqm, prevents some mutually beneficial trades, ↓ TS by C + E = DWL of tax LR: external factors, tax influence P you pay Gov should tax G+S with smallest DWL to ↑ rev it needs (bad, so min as much as possible) ↑ PED/S, ↑ DWL of a tax. Inelastic SS, harder for sellers to leave mkt when tax ↓ Ps. tax only ↓ Q a little, < DWL. Elastic SS, easier for sellers to leave mkt when tax ↓ Ps, > Q falls below surplus-maxi qty, > DWL. Inelastic DD, harder for buyers to leave mkt when ↑ tax ↑ Pb, tax only ↓ Q a little, < DWL. Elastic DD, easier it is for buyers to leave mkt when tax ↑ Pb, > Q falls below surplus-maxi qty, > DWL. Consequence of imposing a tax on a good w no - ext? (Assume neither SS nor DD is perfectly price inelastic.) I. A tax leads to losses in surplus for buyers and for sellers that, taken together, exceed tax rev collected by gov. II. A tax distorts incentives of both buyers and sellers. III. A tax prevents some buyers and some sellers from realizing gains from trade. Subsidies Sub to buyers shifts DD curve up by amnt of sub. Sub to sellers shifts SS curve down by amnt of sub. Same effects on P and Q and sub incidence whether sub is paid to buyers or sellers. Effects TS: CS + PS @ og eqm - G (Ps - Pb) x Qsold+bought/Qs G: DWL of sub - fall in TS that results from a mkt distortion DWL induces overconsumption + overproduction Units btw Qe and Qs not sold. Value of these units to buyers < COP, sub induces wasteful trades. Sub ↑ buyers’ WTP to sellers, buyers WTP seller > coz gov pay part of P BUT buyers true WTP unchanged so sub artificially ↓ Ps (P > cost) + ↑ buyers WTP / valuation of good (WTP > P). True cost to society = cost to seller + cost to gov is same Pc: ↑ Qd,↑ suppliers determine newly transacted qty A tax ↑ rev for gov, ↓ Qeqm, ↓ beneficial trade. A sub imposes costs on gov, ↑ Qeqm, ↑ wasteful trade. Quiz You are responsible for economic policy Zaphon. Ophrah decided to cut off all exports of oranges to Zaphon. Abigail suggests that you should impose a binding Pc to avoid a shortage of oranges. Elisabeth, argues that w/o a binding Pf, a shortage will certainly develop. Iscah says that best way to avoid a shortage of oranges is to take no action at all. A: shortage occurs when Qd > Qs E: surplus TRUE I: ↓ SS, Changes to DD/SS = changes in Qeqm = no change to Qd/Qs so Qd=Qs, no shortage/surplus (don’t intervene = mkt adjust itself) Pset “The world urgently needs to expand its use of carbon P.” (a) To keep the rise in global temperature well below 2°C compared with pre-industrial levels, what should the P of greenhouse-gas emissions be? What are the current Ps of greenhouse-gas emissions? (b) When do Ps change behavior? When do Ps not change behavior? Cite examples of each case. (c) What are the different options for using the carbon-tax rev? What are the pros and cons of each option? (d) The first-best option is a single carbon market. Why? (e) In the absence of a single carbon market, “border carbon adjustment” (BCA) mechanisms have been proposed. How do BCA’s work in theory? (f) What challenges do BCA’s face in practice? A good is a public good if it is non-rival and non-excludable. Rivalry is not defined by scarcity; rather, rivalry refers to diminishing utility (either in terms of quantity or quality). Excludability depends on property rights and can be a policy choice. !! public provision of a good ≠ public good. (a) Potable water is a private good. It is rival (my consumption of 1 gallon of water is 1 gallon that you will not be able to consume) and excludable (water supply gets turned off if forget to pay water bill). Provision of potable water, due to high fixed costs and low marginal costs, is a natural monopoly. (b) Education is a private good. It is usually excludable: someone who doesn’t pay can be prevented from taking classes. It may be rival since presence of an additional student in a class may reduce the benefits to others. Justifications for public provision of edu: (i) Edu is crucial in EG. (ii) Undercons of edu is usually due to financial constraints, and not because parents fail to account for external benefits. Private benefits easily outweigh private costs. (iii) Equity: edu can equalize opp. (c) Dissemination of news, due to high fixed costs and low marginal costs, was traditionally a natural monopoly. With advances in info and communications tech, costs of disseminating news have been driven down. Consumption of news is arguably non-rival (except when exploiting info for financial gain) and excludable to a certain degree (cost of a newspaper, broadband subscription, data plan). Classifying dissemination of news as a public good implies news dissemination is funded or subsidized by gov. In many countries, politicians or political parties own or control mass media companies. However, political independence is crucial for good journalism. Suppose gov currently raises $100,000 through a $1 tax on widgets, and another $100,000 through a $100 tax on gadgets. If gov x2 tax rate on widgets and eliminates tax on gadgets, changes to money raised? Gov will raise < money. Gov will only raise same amnt of money should DD/SS curve of widgets be perfectly inelastic else result in ↑ tax rev from widgets < ↓ tax rev from gadgets. It is unlikely for DD/SS curve of widgets to be perfectly inelastic. There will never be a case of > money being raised. Initially, gov raises $100,000 + $100,000 = $200,000 from widgets and gadgets. If tax on gadgets is eliminated, all tax rev must now come from tax on widgets. To raise same amnt, tax rev from widgets must x2. Case 1: Widgets Neither PED/PES=0 Qd/Qs ↓, qty ↓, tax rev not x2 Case 2: Widgets PED/PES = 0 Qty fixed, x2 tax rate, tax rev x2 Change to if/then statements: assume 1st part is true, evaluate whether 2nd part is true (a) F: A tax that has no DWL cannot raise any rev for gov. eg: DD/SS is perfectly inelastic. Tax has neither an effect on qty nor any DWL, but it raises rev. (b) F: A tax that raises no rev for gov cannot have any DWL. eg: 100% tax on sales of good, sellers will not SS any amnt of good, 0 tax rev. Yet tax has a large DWL as it reduces qty sold to 0. (c) F: When deciding whether to levy a corrective tax on cons/prod, gov should be careful to levy tax on side of mkt generating ext. It doesn’t matter whether tax is imposed on cons/prod, tax incidence is identical. Whether ext is caused by cons/prod, a tax on either will lead to same ↓ of qty , same ↑ P paid by cons, and same ↓ P received by prod. The New York Times. August 27, 2000. “A Tale of Two Fisheries.” (a) Use the concept of “tragedy of the commons” to explain why the fish and lobster populations in New England have declined so drastically since the early 1970’s. (b) In what scenarios are harbor gangs effective? Where do harbor gangs fail? (c) How have the Canadian and American govs been helping (or hurting) fishermen? (d) Why is lobstering in Australia > lucrative than lobstering in New England? (e) How did Australia end up with the world’s premier tuna ranches? What are the main negative externalities of driving? How does SG deal with this problem? How do SG’s measures align with the analysis in TUE Chapter Four? Main - ext of driving (exp by people not drivers or passengers in vehicles): Increased illness and no. of deaths due to air pollution caused by particulate matter from car engines Reduced pdtivity and enjoyment due to traffic congestion Increased disturbance and stress due to noise pollution Decreased safety due to high chance of traffic accidents Reduced convenience from being unable and unwilling to walk to and fro places due to traffic To deal with this problem, SG: Implemented Electronic Road Pricing (ERP) in which toll charges are levied on vehicles according to time and congestion levels to discourage drivers from driving during peak hours, hence reducing traffic congestion. Limits no. of vehicles on the road by mandating vehicle owners to bid for a Certificate of Entitlement (COE) in the corresponding vehicle category, which grants them the right to vehicle ownership for 10 years — Quota on the number of private vehicles on the road Invests heavily in public transport and to make it > affordable and convenient compared to private vehicles to encourage usage of public transport countrywide and reduce no. of vehicles on road Harford argues for market-based solutions like road pricing. Drivers then have a choice to either pay compensation or find a way to avoid imposing the cost. As - ext exist, those costs are invisible to the market, but systems such as externality charging provide the missing signal that the cost exists. By charging drivers for the negative externalities they impose on third parties, drivers will internalise the costs of congestion. This is similar to ERP where drivers are incentivised to drive during non-peak hours, hence reducing traffic congestion. Goods should be allocated through P mechanisms. In 1990s, enval Protection Agency (EPA) in US set up an auction for the right to emit sulfur dioxide. Polluters were given a quota of emission permits and could either buy > permits in the auction or reduce their emissions by installing > envally friendly methods. Those willing and able to pay high Ps for the right to produce sulfur dioxide. This is similar to COE system where willing and able to pay high Ps for the right to own a vehicle, hence controlling car ownership and reducing traffic congestion. The New York Times. March 28, 2013. “Thailand Set to Sell Off Huge Stockpile of Rice.” Pf is set above Peqm; thus, at Pf, Qs > Qd. To maintain P floor, gov is compelled to buy up surplus (𝑄s − 𝑄d ). When Thai gov sells off its stockpile of rice, SS curve in global rice mkt shifts right. Peqm falls and Qeqm rises. However, DD from Africa and China may shift right (smaller extent than SS), which would mitigate fall in Peqm. Play Unintended Consequences: (a) What sort of gov intervention is the “guaranteed milk P”? What decisions did you make? What are the consequences of your decisions? ‘guaranteed milk P’ is a P floor. The guaranteed milk P is binding when the market P for milk falls below it. The P floor ensures that the farmers are earning enough to sustain their business, even during off-peak seasons. I chose to implement the ‘guaranteed milk P’ with a quota system implemented on farmers. This helped to keep supply low and Ps high for farmers. Since milk is a necessity, I believe that PED cost-efficient method. 5 Lecture First Fundamental Theorem of Welfare Economics Assumptions for efficient mkt: Mkts and mkt P for all goods exist. All buyers and sellers are competitive P-takers so no one has price setting abilities (MF due to mkt power). Each person's utility depends only on his own consumption, no ext (MF due to +/- ext) Mkt Failures If any of assumptions do not hold, resources may not be allocated efficiently. 1. Mkts are not perfectly competitive (a buyer or seller has mkt power: ability to affect mkt P). 2. Transactions have ext (side effects that affect bystanders). Mkts fail to allocate resources efficiently when property rights are not well established. Externalities By-pdt of cons/prod that affects someone other than buyer or seller. Self-interested buyers and sellers consider only private costs and benefits of their actions; neglect external costs or benefits of their actions. Social Cost = Private Cost + External Cost Welfare Economics mkt eqm maxi CS + PS → no ext SS curve = PMC: costs directly incurred by sellers. DD curve = PMB: value to buyers (P they are WTP) SS’ curve = social marginal cost (SMC) = PMC + EMC external marginal cost (EMC) = value of - impact on bystanders Competitive mkt outcome / mkt eqm (Q=25) > social optimum/efficient: economic well-being maxi (Q=20). To internalize ext, introduce a tax of $1 per gallon, induce private decision-makers to take account of external costs that arise from - ext, shift SS curve up by $1. Q = 25: marginal consumer values this pdt < social cost of producing it. DWL point towards Qs Public Policies Command-and control policies regulate behavior directly Limit amnt of pollution permitted. Req firms adopt a particular tech to reduce emissions Mkt-based policies incentivises private decision-makers too take into account external costs + benefits of their actions 1. Corrective Taxes & Subsidies Ideal corrective tax = EMC Ideal corrective subsidy = EMB Corrective taxes + sub align private incentives w society's interests induce private decision-makers to take into account external costs and benefits of their actions move economy toward > efficient allocation of resources Other taxes and sub distort incentives and move economy away from social optimum. 2. Tradable pollution permits (cap and trade) People Respond to Changes in Costs and Benefits Uni researchers create + ext because what they discover in research labs can be easily learned by others who have not contributed to research costs. What could the government do to equate eqm qty of uni research and Qs of uni research? F Tax university researchers. T Offer grants to university researchers. T Eliminate subsidized student loans. (< pursue higher education and research) Correct + ext, gov implement policies ↑ qty of university research to match Qs. Private Solutions Coase Theorem: if private parties can costlessly bargain over allocation of resources, can solve ext problem on own. Jack owns a dog. Dog's barking disturbs Jill. Socially efficient outcome maxi Jack's + Jill's well-being. If Jack values having Dog > Jill values peace and quiet, Dog should stay. Coase Theoram: Private mkt achieves efficiency regardless of initial distribution of rights. Both cases: private outcome = efficient outcome - Dog stays. Property rights determine dir compensation payments are made. 1: Jack has right to keep Dog, no payment to Jack. 2: Jill has right to peace and quiet, payment € [500, 1000] to Jill. Why Private Solutions Do Not Always Work 1. Transaction costs Costlessness Parties may incur costs in process of agreeing to and following through on a bargain that make it impossible to reach a mutually beneficial agreement. 2. Stubbornness Even if a beneficial agreement is possible, each party may hold out for a better deal. eg: A want to pay ½ but B want A to pay whole. 3. Coordination problems If v large no. of parties, costly, difficult, or impossible to coordinate. Each household has an incentive to free ride off neighbors. Dw put in effort / work / time regardless of whether get to enjoy benefits of outcome. Public Goods + Common Resources Excludable: a person can be prevented from using it Rival: if one person's use of it diminishes other people's use of it. "Priceless" Goods Cons many goods w/o paying: clean air, parks, wi-fi (sometimes), online news. Goods w/o P, mkt forces that normally allocate resources are absent. Private mkt may fail to provide Qs of such goods so gov may improve mkt outcomes. Club Good: Netflix, electricity Common Resource: fish in sea Public Good: flower in one’s garden Public Goods Not excludable = incentive to be free riders: receive benefit of a good w/o paying for it. Firms don’t prod good, even if cost of providing good < collective benefit of good. If benefit of a public good > cost of providing it, gov should provide good and pay for it with a tax on people who benefit from it. Common Resources Not excludable Free riders can’t be prevented from using them. Little incentive for firms to provide them. Role for gov: ensuring they are provided. Rival in consumption Each person's use of a common resource ↓ others' ability to use it. Role for gov: ensuring they are not overused. Tragedy of Commons Illustrates why common resources are overused. To solve: Negotiated agreements → players find a way to align their individual incentives with goals of group as a whole. Agree to keep fishery sustainable by using a tradable permit system. Agree to impose a carbon tax on fossil fuels. They decide that each person will order an item off menu, and they will share all dishes. They will split cost of bill evenly. A tragedy of the commons problem is likely for each of following reasons: each person has an incentive to eat as fast as possible since their individual rate of consumption will not affect their individual cost. when one person eats, he may not take into account how his decision affects his friends. there is an ext associated with eating the food on the table. food on table resembles a common resource. Role of gov: policies to prevent overcons. of common resources (use it, impose - ext on ppl) 1. Privatize resource a. convert land to a private good by dividing + selling parcels to individuals. Few ppl have access to particular resources. 2. Regulate use of resource a. Beijing's license plate policy 3. Impose a corrective tax a. hunting and fishing licenses b. entrance fees for national parks 4. Auction off permits allowing use of resource a. Highest WTP + best A to make Value of ivory threatened extinction of elephant but value of beef has enhanced the survival of cow: Elephants are a common resource, cows are privately owned. Overcrowded highways, overfishing, polluted air, and near-extinction of rhinoceros: result of a failure to establish clear property rights over something of value. STOP Mkt Structure Perfect competition Monopoly Monopolistic competition Oligopoly Profit Maximization Profit = Total rev (amnt a firm receives from sale of its o/p) - Total Cost (mkt value of inputs a firm uses in pdtion) If the cost of an additional cup of coffee (MC) < rev you will get from selling it (MR), then your profits will if you prod >. Prod as long as MR ≥ MC. ATC inc or dec or doesn’t change depends on cost MC: depends on cost structure of seller for that good can ↑ then dec or dec then inc A single-P monopolist is prod 500 units of o/p. At that level, P (per unit) is $200, and ATC (per unit) = $150. Both marginal cost and marginal rev equal $120. Which of the following statements is true? Profit per unit = P - ATC = $200 - $150 = $50 Total profit = (P - ATC) × Quantity = ($200 - $150) × 500 = $50 × 500 = $25,000 Since MR = MC at the current level of o/p (500 units), the firm is already maximizing its profit. ↑ or decreasing o/p would decrease profit. P = ATC → 0 profit Profit Maximization If we ↑ Q by one unit, rev ↑ by MR, cost ↑ by MC. If MR > MC, then ↑ Q to raise profit. If MR < MC, then dec Q to raise profit. profit = $0 but not worse off so take every possibility into account If Pietro's Pizza Parlor knows that the marginal cost of the 500th pizza is $3.00, and that the average total cost of making 499 pizzas is $3.30, then ATC is falling at Q = 500. Perfect Competition In a perfectly competitive mkt: many buyers and sellers, too small to influence entire mkt Sellers offer a standardized pdt. Sellers can freely enter or exit the mkt. Buyers and sellers are well-informed. Thus, each buyer and seller is a P-taker - the P is taken as given. → can’t do anything about it even if sell > units A competitive firm can keep increasing its o/p w/o affecting the mkt P. So, each unit ↑ in Q causes rev to rise by P, i.e., MR = P. MR = P is only true for firms in perfectly competitive mkts. Sell 1 > unit, extra $10 for that unit Imperfectly competitive mkt: MR ≠ P. Sellers are P makers (have some mkt power), can influence P to some degree Efficiency of a Competitive mkt Profit maxi: MR = MC Perfect competition: P = MR So, in competitive eqm: P = MC MC: cost of prod marginal unit. P: value to buyers. So, competitive eqm is efficient; it maxi TS. F: A firm’s marginal cost of producing a good is alw = P of good P is set by my or seller influence it, MC is cost structure of firm structure. F: A firm maximises profit by producing where P = marginal cost Modify statement to Change P to MR or change firm to perfectly competitive firm F: A firm’s MR from selling a good alw = to P of food Only if its perfectly competitive firm, if you have imperfect competition, you have influence over P so MR ≠ P 6 Lecture Monopoly A monopoly: a mkt where only one firm sells a pdt with no close substitutes. A monopoly: single firm that sells in that mkt. A monopoly has mkt power (ability to influence mkt P of pdt it sells). A competitive firm has no mkt power. Bargaining Strength Comes through Scarcity. If you control a scarce resource, you can dictate the terms of transaction, P, qty and quality. ! Control P and Q Why Monopolies Arise Main cause of monopolies is barriers to entry — other firms cannot enter mkt. 3 sources of barriers to entry: 1. A single firm owns a key resource. E.g., DeBeers owns most of the world's diamond mines. 2. Gov gives a single firm the exclusive right to produce the good. E.g., patents, copyright laws. 3. A natural monopoly occurs when a single firm can produce entire mkt Q at lower cost than several firms. E.g., electricity, gas, telecommunications. Very high fixed cost to make up electricity grid so a single girl can prod entire work qty at lower cost than several firms Monopolist's rev Monopoly vs. Competition: DD Curves In a competitive mkt, mkt DD curve slopes downward (law of DD) But DD curve for any individual firm's pdt is horizontal at the mkt P. firm can inc Q w/o dec P, so MR = P for the competitive firm (sell pdt w many sub) Competitive firm is a P taker, can sell as many unit as Pmkt DD p inelastic: if firm inc its P above Pmkt, buyers dw to buy, Qd drop to 0 A competitive firm's DD curve A monopolist is the only seller/sole supplier, so it faces mkt DD curve. To inc Q, monopolist must dec P to meet WTP of next buyer, so MR ≠ P. A monopolist's DD curve In a competitive mkt, MR = P for an individual firm as firm is a P taker. In a monopoly, MR ≠ P as monopolist is a P taker. If monopolist want to sell 1 > unit, have to lower P. P: each buyer pay TR: P x Q MR = change TR / change Q Barstucks is only seller of cappuccino in town. table shows the mkt demand for cappuccino. What is r/s btw P and MR? P>MR for a monopoly as monopolist faces entire mkt DD curve. If monopolist want to sell 1 > unit, have to lower P. If single Pmkt, have to lower P of all units. Competitive firms are P takers (many sellers sell same good so nth an individual firm can do to influence Pmkt) Firm can sell as many units as it ones at Pmkt so P=MR for competitive firm. P: P at each qty = P marginal buyer is WTP MR: change TR as sell 1 > unit Understanding Monopolist's MR Inc Q has two effects on rev: o/p effect: Inc Q => Inc rev P effect: Dec P = Dec rev To sell > units, monopolist must dec the P on all the units it sells. Hence MR < P. MR could even be negative if the P effect dominates the o/p effect (e.g., when Barstucks ↑s Q from 5 to 6). Profit Maximization Like a competitive firm, a monopolist maxi profit by producing qty where MR = MC. Once the monopolist identifies this qty, it sets highest P consumers are WTP for that qty. Monopolist determines this P from DD curve. At each qty, height of DD curve tells WTP of mariginal buyer. profit-maximizing Q at MR = MC. Find P from demand curve at this Q All buyers from 1st to Qth unit are W to pay P ≥ P If there is single Pmkt, P is where every unit he prod will be bought Qs=Qd) MR>MC: P a monopolist set is heights P mkt can bear If a non-discriminating monopolist decides to lower his P to sell one > unit of his pdt, then the net effect on total rev is typically negative since the P must fall. the net effect on total rev is typically 0 since the P must fall. some rev is lost to the extent that units previously sold at a higher P now sell for a lower P; however, the additional unit sold brings in new rev. total rev rises by an amount equal to the P. marginal rev ↑s when total rev ↑s. A firm in a perfectly competitive market determines the quantity of its o/p but not the P of its o/p. Suppose the market for vaccinations is perfectly competitive. Without gov intervention in the vaccination market, which of the following statements is correct? T I. At the equilibrium quantity, the social marginal benefit exceeds the private marginal cost. F II. The equilibrium quantity is efficient because the market is perfectly competitive. T III. A per-shot subsidy could turn an inefficient situation into an efficient one. When a **non-discriminating monopolist** lowers the P to sell one > unit: - Monopolist must reduce P not just for the additional unit, but for **all previous units** sold at the higher P. This results in some **lost rev** on those previously sold units. - However, the additional unit sold brings in **new rev**, which can partially or fully offset the loss. - Therefore, the **marginal rev** (MR) is typically **less than the P** because of the rev lost from lowering the P on all units sold. This dynamic means that the net effect on total rev depends on the balance btw the rev lost on prior units and the new rev from selling the additional unit. Prod as long MR >= MC Profit maxi firms want to charge highest possible P (P buyer is WTP) Non discriminating monopolist / single P monopolist Single P dictated by last buyer Ice-cream vendors at the park fail to cooperate with one another on the quantity of ice-cream they should sell to earn monopoly profits. A consequence of their failure to cooperate is that relative to the outcome they would like, I. the quantity of ice-cream supplied is closer to the socially optimal level. II. the P of ice-cream is closer to marginal cost. III. the ice-cream mkt at the park is less competitive. Let's analyze each statement regarding the consequences of ice-cream vendors failing to cooperate and not acting like a cartel or monopoly: ### I. The quantity of ice-cream supplied is closer to the socially optimal level. - If vendors fail to cooperate, they will not limit o/p to maximize joint profits like a monopoly would. Instead, they will act > independently, leading to a higher total quantity of ice-cream supplied compared to a monopolistic outcome. This ↑d supply can bring the quantity closer to the socially optimal level, where **P = MC**, as opposed to the lower quantity typically supplied under monopolistic behavior. ### II. The P of ice-cream is closer to marginal cost. - w/o cooperation, the mkt will generally see a higher quantity of ice-cream and a lower P compared to a monopoly. Since the P will be closer to marginal cost (MC) when the quantity supplied ↑s and the mkt becomes > competitive, this statement is true. In a non-cooperative mkt, Ps tend to be closer to MC compared to a monopolistic scenario where Ps are higher. ### III. The ice-cream mkt at the park is less competitive. - Failure to cooperate among vendors does not necessarily make the mkt less competitive. In fact, the lack of cooperation often means that the mkt is > competitive, as vendors are acting independently rather than colluding. Therefore, this statement is false. ### Conclusion: The correct statements are: - **I. The quantity of ice-cream supplied is closer to the socially optimal level.** - **II. The P of ice-cream is closer to marginal cost.** Which of the o/p levels shown in the figure below would a monopolist never produce? P Quantity $100 1 $ 90 2 $ 80 3 $ 70 4 $ 60 5 $ 50 6 $ 40 7 A monopolist maximizes profit by producing at the o/p level where MR = MC. MR: change in TR when one > unit is sold: 1. Total rev at quantity 1: 100 x 1 = 200 2. Total rev at quantity 2: 90 x 2 = 180 MR for second unit: 180 - 100 = 80 3. Total rev at quantity 3: 80 x 3 = 240 MR for third unit: 240 - 80 = 160 4. Total rev at quantity 4: \( 70 \times 4 = 280 \) - MR for fourth unit: \( 280 - 240 = 40 \) 5. Total rev at quantity 5: \( 60 \times 5 = 300 \) - MR for fifth unit: \( 300 - 280 = 20 \) 6. Total rev at quantity 6: \( 50 \times 6 = 300 \) - MR for sixth unit: \( 300 - 300 = 0 \) 7. Total rev at quantity 7: 40 x 7 = 280 MR for seventh unit: 280 - 300 = -20 7th qty - MR so prod 7th unit decreases TR and total profit. The monopolist would never produce **7 units** of o/p. Welfare Economics Welfare Cost of Monopoly In a competitive mkt eqm, P (value to consumers)= MR = MC and total surplus is maxi In the monopoly eqm, P > MR = МС. value to buyers of an additional unit (P) exceeds the cost of the resources needed to produce that unit (MC). The monopoly & is too low; total surplus could be ↑d by increasing Q. Thus monopoly results in a deadweight loss. Competitive mkt, firms are P takers, can sell as many units as they want at mkt P so MR = P, MR = DD curve profit max qty DD=MC Competitive eqm: prod where MR ≥ MC quantity = Qc P = МС total surplus is maximized as long as DD curve: consumer’s valuation of unit ≥ MC curve can look like anythign: producer’s cost of supplying the unit, that unit is bought + sold >Qc: producer’s cost of prod that unit is above DD curve so units not transacted Monopoly (MR>P so MR steeper than DD curve) eqm: quantity = Qm P > МС DWL: gains from trade that would make been realised in competitive mkt but gains are not realised in monopoly Qm to Qc: DD curve (valuation of good) above MC (producer’s COP): if units transacted will have gains of trade but monopolist want to maximise profits and single mkt P, so monopolist prod @ Qm Prod as long is MR ≥ MC P>MC: cost is still gg to be lower than next con’s WTP so would have been gains from grade DWL that is associated with a monopolistically competitive mkt is a result of firm operating in a regulated industry. P falling short of marginal cost in order to ↑ mkt share. P > MC Constant entry of new firms, which take away business from existing firms. excessive advertising costs. In monopolistic competition, firms have some degree of mkt power due to pdt differentiation. This allows them to set Ps above marginal cost, leading to an **inefficient allocation of resources** and resulting in deadweight loss. The firm produces less than the socially optimal o/p, where **P = MC**, causing a reduction in total welfare. - **The firm operating in a regulated industry**: Deadweight loss in monopolistic competition is not directly related to regulation but rather to pricing above marginal cost. - **P falling short of marginal cost**: This would not happen in monopolistic competition; the issue is that P exceeds marginal cost. - **The constant entry of new firms**: While new firms entering can reduce profits for existing firms, it does not cause deadweight loss. - **Excessive advertising costs**: Advertising costs can affect profitability, but they are not the direct cause of deadweight loss. P Discrimination Discrimination: treating people differently based on some characteristic (race, gender) P discrimination: selling same good at diff Ps to different buyers. The characteristic used in P discrimination is WTP. A firm can ↑ profit by charging a higher P to buyers with higher WTP. Quantity discount: 2nd degree P discrimination (charge diff prices based on no. of units sold) 3rd degree P discrimination: set P based on likely target grps of consumers 1st degree P discrimination: charge cons based on their W + A to pay Single-P Monopoly monopolist charges same P (PM ) to all buyers. DWL: gains that would have been accrued to cons/prod in perfectly competitive mkt. DD = MC @ perfectly competitive mkt Maximise profit prod @ MR = MC @ Qm then look at Pm Perfect P Discrimination monopolist prod competitive quantity, but charges each buyer his WTP. CS = WTP - P, P = WTP so CS = 0. Monopoly Profit = P - Cost. No DWL. Monopolist capture all CS as profits. Maximise profit: charge buyer his WTP MR of xth unit = P you charge xth buyer DD curve = WTP so MR curve = DD curve In the real world, perfect P discrimination is not possible. No firm knows every buyer's WTP. Buyers do not announce their WTP to sellers. So, firms divide customers into groups based on some observable trait (e.g., age) that is likely related to WTP. A Single P? In Harford (TUE) Chapter 2: What Supermkts Don't Want You to Know. Firms charge different Ps for essentially the same pdt: "Unique target" (first-degree P discrimination) "Group target" (third degree P discrimination) "Self-incrimination" The Prevalence of Monopoly In the real world, pure monopoly is rare. Yet, many firms have mkt power due to: selling a unique variety of a pdt having a large mkt share and few significant competitors In many such cases, the consequences apply: mark-up of P over marginal cost deadweight loss Indicate eqm P and Q, as well as consumer surplus (CS), producer surplus (PS), monopoly profit, and deadweight loss (DWL) for each of the following: A. Perfect competition B. Monopoly w/o P discrimination C. Monopoly with perfect P discrimination Profits= TR-TC PS= P-Cost PS: non sunk SS curve derived from firms MC curve-to find PS MC: how much > money you have to put out for every unit you prod ATC = TC/Q So MC = ATC means fixed cost is 0 so every extra costs of that unit is ATC If there’s fixed costs, profits ≠ PS A. Competitive firms: all firms are p takers Fixed mkt p, firm can’t influence mkt P regardless of how many units you prod Sell 1 > unit, money coming in = Pmkt Extra money coming in from selling 1 unit as MR = P Profit maxi: P= MC at DD=MC to find Pmkt so MR=P at that point So Remove MR curve CS = WTP - P WTP: shown by DD Curve PS = P - cost Cost = MC = $15 so PS = 0 But efficient as max TS, keep prod 401th unit (cons’ WTP lower than prod’s cost of prod that unit: MC) B. Single P (cant discriminate across cons) MR curve is relevant MR = MC Profit maximising qty: want to charge as high as possible so go up DD curve $25CS = WTP - P Cost: MC = $15 DWL: gains that could have gone to someone if they had managed to transact not transacting: @300th unit cons WTP $20 sellers cost $15 Monopolist: max profits not the no. of units sold so he chose P Q combo to maxi profit, sell fewer units can charge higher P If sell 300 units, assuming set 1 P for all buyers, need to set P=$20 True that he would have made some money at P = $20, MC = $15 but losing money (for fist 200unitd used to charge $25 so getting ($5x200 units lower) Charge P dictated by last buyer C: everyone gets charged a diff P Charge their highest possible P WTP to extract all surplus from them So P curve = DD curve MR = extra money coming in when sell 1 > unit P diff for every buyer so MR diff for “” P charged = MR for that unit CS=WTP-P=WTP-WTP=0 Producer extracting all surplus from buyers PS= P-cost P shown by DD curve Cost = MC curve Prod up to 400th buyer (WTP $15, monopolist cost = $15 so PS=0) Because a monopoly is the sole producer in its market, downward-sloping demand curve, and MR MC). Thus, monopoly results in a DWL btw Monopoly & Perfect Competition Two extremes Monopoly: One firm. Perfect competition: Many firms, identical pdts. In btw these extremes: imperfect competition Oligopoly: A few firms, identical/ similar pdts. Monopolistic competition: Many firms, differentiated pdts. Monopolistic Competition In a monopolistically competitive mkt: Many buyers and sellers. Sellers offer differentiated pdts. Sellers can freely enter or exit the mkt. Examples: laptops, jeans, shampoo, restaurant meals, movies, chocolate 2 tables Short run: Under monopolistic competition, firm behaviour is very similar to monopoly. In both mkt, firms have some degree of P setting power. Long run: In monopolistic competition, free entry and exit drive economic profit to 0. Suppose firms are making profits in SR. New firms enter mkt, taking some demand away from existing firms, Ps and profits dec. Suppose firms are making losses in the short run. Some firms exit the mkt, remaining firms enjoy inc demand and Ps. Monopolistic Competition and Welfare The number of firms in the mkt may not be optimal due to external effects from the entry of new firms. The pdt-variety externality: DD-side + ext the surplus that consumers get from text the introduction of new pdts. The business-stealing externality: SS-side, - ext the losses incurred by existing firms when new firms enter the mkt. The inefficiencies of monopolistic competition are subtle and hard to measure. There is no easy way for policymakers to improve the mkt outcome. The Prevalence of Monopolistic Competition Differentiated pdts are everywhere; examples of monopolistic competition abound. The theory of monopolistic competition describes many mkts in the economy, yet offers little guidance to policymakers looking to improve the mkt's allocation of resources. A monopolistically competitive firm has some market power, and faces a downward-sloping DD curve so MR < P. A monopolistically competitive firm produces where MR = MC, and Ps according to DD curve. In the long run (perfect comp), firms earn 0 economic profit due to free entry and exit. Relative to perfect competition, monopolistically competitive Q is dec, monopolistically competitive P is inc (P > MC). So DWL Relative to a monopoly, monopolistically competitive Q is inc monopolistically competitive P is dec Monopolistic firms: worse than perfect competition but better than monopoly Monopolist competition: niche pdts cater to some ppl leave their old pdt so each monopolistic competitive firm gg to have smaller and smaller cons base if don’t expand their reach incentives for firms to enter or exit a mkt are typically determined by the profitability and conditions within that mkt. Here’s a breakdown: ### **When will firms have no incentive to enter a mkt?** Firms will have no incentive to enter a mkt when: 1. **Economic Profits Are 0**: When firms are earning 0 economic profit, meaning their total rev equals their total cost (including opportunity costs), there is no financial incentive to enter the mkt. This situation is characteristic of a long-run equilibrium in perfectly competitive mkts. 2. **Barriers to Entry**: When significant barriers to entry exist, such as high startup costs, strong brand loyalty, or regulatory constraints, potential entrants might be deterred from entering the mkt despite potentially high profits. 3. **Negative Economic Profits**: If existing firms are experiencing losses (negative economic profits), potential entrants will likely be discouraged from entering the mkt, as the prospect of making a profit is low. ### **When will firms have no incentive to exit a mkt?** Firms will have no incentive to exit a mkt when: 1. **Economic Profits Are 0 or Positive**: Firms will remain in the mkt when they are at least covering their total costs, including opportunity costs. If firms are earning 0 or positive economic profits, they have no financial incentive to exit. 2. **Covering Variable Costs**: Even if a firm is experiencing losses in the short run, it may choose to stay in the mkt as long as it can cover its variable costs. This means it is better off continuing operations rather than shutting down and facing fixed costs. 3. **Expectations of Future Profits**: If firms expect that mkt conditions will improve in the future (for example, due to changes in demand or cost structures), they might have no incentive to exit despite current losses. In summary: - Firms have no incentive to enter a mkt when **economic profits are 0** or when **barriers to entry** are high. - Firms have no incentive to exit a mkt when **economic profits are 0 or positive**, or when they can at least **cover their variable costs** and expect future improvements. ?? Existing firms making + profit, new firms want to enter, … Enter and exit until 0 economic profit no incentive to exit In LR like perfect competition Oligopoly N-Firm Concentration Ratio: % of the mkt's total o/p supplied by N largest firms. E.g., four-firm concentration ratio, five-firm concentration ratio, eight-firm concentration ratio. higher concentration ratio, less competition there is. Oligopoly: a mkt structure in which only a few sellers offer similar or identical pdts. A firm's decisions about P or Q can affect other firms and cause them to react. Firm will consider these reactions when making decisions. Game theory: the study of how people behave in strategic situations. Oligopoly: 2 firms that act independently, decisions affect mkt P, Q and hence other firms profit NE: strategies Cut fare for both One possible duopoly outcome: collusion. Collusion: an agreement among firms in a mkt about quantities to produce or Ps to charge. SingTel and StarHub could agree to each produce half of the monopoly o/p: For each firm: Qi = 30, P = $40, profit = $900 Cartel: a group of firms acting in unison, oligopolies collude If a cartel is formed to maxi total profits of its members, it will charge same P and prod same qty as a monopoly. - Cartel: a group of firms that collude to act like a single monopolist, aiming to maxi joint profits so cartel restricts o/p and raises P, just as a monopoly would. - monopoly o/p: qty where MR = MC, monopoly P: set where o/p level intersects SD curve. - A profit-maxi cartel will **produce the monopoly o/p** and **charge monopoly P**, mimicking the behavior of a monopoly. Collusion vs Self-interest Both firms would be better off if they both stick to cartel agreement. But each firm has an incentive to cheat. It is difficult for oligopoly firms to form cartels and honor their agreements. Nash equilibrium: a situation in which players interacting with one another each chooses his best strategy given strategies that all the others have chosen. Our duopoly example has a Nash equilibrium in which each firm produces Qi = 40. Given that SingTel produces Qi = 40, StarHub's best move is to produce Qi = 40. Given that StarHub produces Qi = 40, SingTel's best move is to produce Qi = 40. Perfect competition: best for cons, worst for prod Cartel: >= 2 firms collectively acting as a single unit (best for prod, worst for cons) Monopoly: a single firm (best for prod, worst for cons)  Characteristics Oligopoly Monopolistic Competition Perfect Competition Advertising and Sales Promotion Yes to differentiate their pdts from competitor No as firms sell homogeneo pdts Firms being P takers rather than P No Yes makers Horizontal DD and MR curves No Yes Profit maximisation according to M Yes, applies to all firm structures MC rule Barriers of entry in mkt Yes No A firm wishing to enter a monopoly faces barriers to entry. A firm wishing to enter a perfectly competitive mkt and enter a monopolistically competitive mkt do not. A firm in a perfectly competitive mkt can make 0 economic profit in LR. Free entry and exit of firms drive profits to 0 as firms enter when there are profits and leave when there are losses. P = ATC, and firms earn normal profit (0 economic profit). A firm in a monopoly can earn + economic profit in LR. Monopolies have high barriers to entry, which prevent new firms from entering the mkt and competing away the profit. As a result, a monopoly can maintain economic profit in the long run. A firm in a monopolistically competitive mkt can make 0 economic profit in LR. Similar to perfect competition, absence of significant barriers to entry means that new firms will enter mkt if firms are earning profits, driving profits down to 0. Firms will operate where P = ATC in LR. !!! monopolist vs firms in monopolistic competition Monopolist and a perfectly competitive firm 1. Firm maxi profit by equating P with MC T: a perfectly competitive firm, P taker, MR = P. Profit maxi: MR = MC, so P = MC. F: a monopolist maxi profit by setting MR = MC, but faces a downward-sloping DD curve, P > MC. 2. DD = MR T: a perfectly competitive firm, DD curve is perfectly elastic, DD = MR because the firm is a P taker and can sell any quantity at mkt P. F: a monopolist’s MR < P because it must lower P to sell add units, so DD ≠ MR. 3. AR = P T: a perfectly competitive firm and a monopolist, this is true. AR = TR/qty sold = P at every o/p level. Monopoly alw worst outcome in terms of con’s welfare so when oligopolies act on their own, is gg to be a better outcome than monopoly outcome. Oligopoly and competitive mkt prod identical goods. competitive mkt: so many sellers and buyers than everyone’s a P taker.oligopoly: few of them so can exert mkt power and influence price with their decisions. Fewer no. of firms in an oligopoly, easier to collude. Game Theory Game theory helps us understand oligopoly and other situations where players interact and behave strategically. Dominant strategy: a strategy that is best for a player in a game regardless of the strategies chosen by the other players. Prisoners' dilemma: a game btw two captured criminals that illustrates why cooperation is difficult even when it is mutually beneficial. illustrates how self-interest can prevent people from maintaining cooperation, even when cooperation is mutually beneficial. Nash eqm, each player has chosen a strategy, and no player can benefit by changing his strategy. Game theory: best pay off Repeated game: possible to get a mutually beneficial outcome? : yes Game theory: if …., might not have best allocation DOESNT guranteee best outcome Prisoners' Dilemma Each player's dominant strategy: confess Nash equilibrium: both confess "prisoners' dilemma": any situation with a similar incentive structure. both players have dominant strategies that result in inefficient outcomes. Regardless of what StarHub does, Singtel alw choose Q=40 (dominant strategy). Regardless of what Singtel does, Starhub alw choose Q=40 (dominant strategy). Both cheat, Q=40. Dominant: strictly FAQ dominant 100>80 80>60 (alw better) Week dominance: sometimes better, sometimes same (100>80, 60=60) Examples of the Prisoners' Dilemma  1. Ad wars Two firms spend millions on TV ads to steal business from each other. Each firm's ad cancels out the effects of the other, and both firms' profits fall by the cost of the ads. 2. Organization of Petroleum Exporting Countries Member countries try to act like a cartel, and agree to limit oil pdtion to boost Ps and profits. But agreements sometimes break down when individual countries renege. 3. Arms race btw military superpowers Each country would be better off if both disarm, but each has a dominant strategy of arming. Arms race: each superpower would be better off if cooperate and sign agreement to disarm but self-interest so each will arm itself and all countries worse off (risk of nuclear annihilation, resources cons in arms race could have been used lease where) 4. Common resources All would be better off if everyone conserved common resources, but each person's dominant strategy is overusing the resources. Prisoners' Dilemma and Social Welfare The non-cooperative oligopoly equilibrium: Bad for oligopoly firms: They are prevented from achieving monopoly profits. Good for society: Q is closer to the socially efficient o/p. P is closer to MC. In other prisoners' dilemmas, the inability to cooperate may reduce social welfare, e.g., arms race, overuse of common resources. Why Players Sometimes Cooperate When the game is repeated many times, cooperation may be possible. These strategies may lead to cooperation: Grim: If your rival cheats in one round, you cheat in all subsequent rounds. Tit-for-tat: Whatever your rival does in one round (whether cheat or cooperate), you do in the following round. The group of oligopolists is best off forming a cartel and acting like monopoly. When oligopolists individually choose pdtion to maxi profits, the result is a inc quantity and a dec P than under monopoly outcome. As number of sellers in an oligopoly increases, an oligopoly looks > and > like a competitive mkt. Laura and Ashley are competitors in a local mkt. Each is trying to decide if it is worthwhile to advertise. If both advertise, each will earn a profit of $5,000. If neither advertises, each will make a profit of $10,000. If one advertises and the other doesn't, the one who advertises will make a profit of $12,000 and the one who doesn't will make a profit of $2,000. - If Ashley **advertises**, Laura can either advertise (earn $5,000) or not advertise (earn $2,000). In this case, advertising is better. - If Ashley **does not advertise**, Laura can either advertise (earn $12,000) or not advertise (earn $10,000). In this case, advertising is also better. Since **advertising gives Laura a better outcome regardless of what Ashley does**, advertising is Laura's **dominant strategy**. 2. **If the game is played only once**: - Laura should follow her dominant strategy, which is to **advertise** and earn at least $5,000, regardless of what Ashley does. In a repeated game, Laura and Ashley could potentially cooperate (by **not advertising**) to earn higher profits ($10,000 each). If they recognize the long-term benefits, they might avoid advertising to maximize joint profits over time. Laura should advertise if the game is played only once but should not advertise if the game is repeated many times if she and Ashley agree on cooperation or some sort of mutual understanding Quiz Pset