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ECON 101: EXAM 2
stock
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A certificate that gives the holder a share of the ownership of the firm
Ownership does not demand a fixed return
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Bonds |
An IOU issued by the corporation that promises to pay the holder a fixed sum at the maturity date and other fixed amounts of money (interest payment) every year up to the date of maturity
Debt
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Securities
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Stocks and bonds together
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Arbitrage
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Purchase and/or sale of objects to attain a riskless profit
Not risky (like speculation)
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Speculation
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Can lose big b/c you borrow big - risky
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Patent |
awarded to inventor of a product that says for a certain amount of time nobody can produce your product.
You can sell the license
if you don't sell license, can create a monopoly.
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Price Taker
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A person who tries to change their price and nobody buys
Perfectly competitive firm
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Characteristics of perfectly Competitive firms
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Homogenous product
any increase in price leads to totally elimination of quantity sold
Not entry barriers
Low fixed costs (fixed costs can deter competitors)
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Homogenous Product
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all firms in a specific market have identical products, they are perfect substitutes so demand for the individual good is perfectly elastic
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Economic Rent
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a portion of earning of a factor of production that exceeds minimum necessary to induct that factor to be supplied
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Rent |
when a factor of production has qualities that make it uniquely well suited to production it earns rent
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What happens to economic rent in long run
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nothing because there is no competition for that unique talent
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competition continuum
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· Total competition: competitors looking to attract dollars from your potential customer
· Generic competition: i.e. drinking tap water over bottles
· Product competition: water vs. tea vs. beer
· Brand competition: similar products
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Produce Surplus
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difference b/w the market price of the good and the minimum price at which the producer would provide that good
supply curve is marginal cost curve
diagrammatically: on a graph of market equilibrium, it is that area below the price and above the supply curve
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Market Efficiency
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a market is efficient when MC to consume is = to MC of producer
this is a characteristic of perfect competition
graphically? consumer surplus + producer surplus maximized
can be observed in short OR long run
in the long run, MC is = to ATC, and that is as small as it can be
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How do you know which goods to buy or supply
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optimal spending rule for consumers
MB and MC?
optimal supplier rule for perfect competitors
expand so long as price > than MC
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Perfect competition
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An industry structure in which a large number of firms produce identical products and have no influence over market price.
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Monopolistic Competition
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An industry structure in which a large number of firms produce slightly differentiated products that are reasonably close substitutes for one another.
large number of firms but don't sell same product
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Oligopoly |
An industry structure in which a small number of large firms produce products that are either close or perfect substitutes.
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Monopoly |
The only supplier of a unique product with no close substitutes.
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economies of scale/scale economies
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-economies of mass production which drive down the average total costs
-as a firm gets larger fixed costs can be shared resulting in lower average total costs
-lower cost of production by increasing output (contradicting principle of increasing cost)
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What determines the place in the continuum? Industries move up with...
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Exclusive control over important inputs.
Patents and copyrights.
Government licenses and franchises.
Economies of scale and natural monopolies.
– A production process is said to have
Network economies.
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Market Power
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ability of the firm to push its price higher than MC w/o losing purchasers to competitors
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Profit-maximizing rule for firm w/ market power
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Expand sales so long as the marginal revenue exceeds the marginal cost of the addition to production.
expanding production increases Q sold and reduces price at which product can be sold (on all products, not just last one) - which makes it relatively less attractive (for imperfectly competitive firm)
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Critical point for imperfect competition
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In order to expand the quantity sold, the supplier must lower the price on all units sold.
When the demand curve is inelastic, this falling price leads to falling revenues.
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Optimal supplier rule for a monopoly
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continue to expand production so long as MR exceeds MC
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concentration ratio
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percentage of an industry's output produced by its four largest firms
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Best response
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choosing your optimal decision for each possible choice of your competitors. (best possible outcome to every choice of your competitor)
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Nash equilibrium
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results when each player chooses the best response for the other players response
outcome in which all competitors use best responses
has a feature of equilibrium where no competitor wants to change their choice
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Prisoner's dilemma
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type of Nash equilibrium in which the payoffs to the players equilibrium are worse than if they had not played their best response
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Nash equilibrium
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An outcome of a game in which each player is doing the best he or she can, given the action of the other players.
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definition of MR with market power
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-changes b/c it incorporates the conjectures of firm about the responses of competitors to their decision to change prices
-leads to stickiness of observed prices
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types of competition among oligopolists
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Competition in terms of quantities supplied. Inherently stable in terms of profits.
Competition in terms of prices. Inherently unstable.
You lower price to attract customers.
What is your competitor’s best response
Ultimate outcome of successive applications of best response?
Perfectly contestable markets: profits are zero, even though small number of firms.
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Natural monopoly
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society wants to see production increase more because it lowers cost
also benefits when it is regulated
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regulation of natural monopolies
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must use average-cost pricing b/c if the firm produces efficient (P=MC) then there could be losses for regulated firm
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Average cost pricing
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a method of regulation under which the regulated firm is allowed to charge a price that covers the explicit costs of production plus a mark-up percentage to cover implicit costs.
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cross subsidization
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selling one of the firm’s products at a loss while making a compensating profit on another product.
i.e. health insurance
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economies of scope
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lower average costs of concentrating production of similar goods in a single supplier
bundling of cable programming
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what about other firms with market power? (other than natural monopoly)
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For oligopoly/monopolistic competition: optimal supplier rule is the same as for monopolists.
difference: we calculate marginal revenue based upon the firm’s individual demand curve, not on the industry demand curve. (bc this is where we get MR)
difference: we use beliefs of our competitors’ responses in our choice.
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Externalities
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incidental cost of an activity taken on by somebody else not directly involved in the activity
no corresponding compensation is provided to or paid by those who generate the externality
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Tragedy of the commons
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tendency for a resource that has no price to be used until its marginal benefit falls to zero
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Property right
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right to allocate a resource
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Coase Theorem
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If people can negotiate costlessly the purchase and sale of the right to perform activities that cause externalities, they can always arrive at efficient allocations of the resource.
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marginal private cost
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share of an activity’s marginal cost that is paid for by the persons who carry out the activity. This is just the cost we have been talking about all along
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marginal social cost
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sum of the MPC plus the incidental costs of the activity that are borne by others who receive no compensation for these costs. This is plus external costs associated with the activity.
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marginal private benefit
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share of an activity’s marginal benefit that is received by the persons who carry out the activity.
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marginal social benefit
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sum of the MPB plus the incidental benefits of the activity that are borne by others who do not pay for these benefits.
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optimal supplier rule with an externality
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-reduce to produce so long as MSR is greater than MSC
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command and control
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strict quantitative limits on each producer
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emission taxes
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taxes on quantities of emissions
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emission permits
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licenses issued by government specifying the max amount the license holder is allowed to emit
tradable permit - can be rented to somebody else
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"too big to fail"
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when banks took too many risks b/c they knew the US government would bail them out
a critique of large financial institutions during the recent financial crisis
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Moral hazard
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tendency of insurance to discourage policyholders from protecting themselves from a risk
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outcomes of "too big to fail"
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too much lending
relate to "leverage"
lending to riskier borrowers
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Macroeconomics
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study of the performance of national economies and the policies that governments use to improve that performance
looks at entire nation rather than individual market
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how do we measure our standard of living
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A measure of output: gross domestic product
A measure of prices: consumer price index
A measure of employment: unemployment rate
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gross domestic product
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sum of the money values of the final goods and services produced in the domestic economy and sold on organized markets during a given period
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is GDP a good measure of standard of living?
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what if we produce a lot overseas?
what if we produce a lot of bads?
i.e. weapons for war to be used in other countries
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what causes rise in GDP
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economic growth and expansion
rising prices
rising population
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consumer price index
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For any period, measures the cost in that period of a standard basket of goods and services relative to the cost of the same basket of goods and services in a fixed year (called the base year).
gives us a way to separate nominal and real GDP
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Nominal GDP
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a measure of GDP in which the quantities produced are valued at current-year prices
money value of today's goods and prices. we multiply by today's prices
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Real GDP
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a measure of GDP in which the quantities produced are valued at the prices in a base year rather than at current prices. Real GDP measures the actual physical volume of production.
use prices from a base year sometimes in the past (doesn't include inflation
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what is primary cause of GDP growth
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inflation |
aggregate supply curve
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shows quantity of product that is supplied at each possible value of the price level
supply does not = MC
looking for CPI - as supply goes up, CPI goes up b/c you can sell for higher price
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Aggregate demand curve
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shows quantity of product that is demanded at each possible value of the price level
as prices go down, goods become more attractive to foreing countries
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great recession
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demand reduction: unemployment, deflation, fallen output
ADC shifting left
people have less income so buy less
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Oil price shock
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stagflation
supply shock: unemployment, inflation
ASC shifts up b/c cost of production goes up b/c oil in an input in production
we then see less produciton
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Great society
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excess demand: overfull employment, inflation
demand curve shifts right b/c Vietnam war was expensive and there were job opportunities
output was so high that we could not sustain and it put pressure on wages/prices
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roaring 90s
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Technological progress: greater output at full employment, falling prices
supply curve shifts down bc progress makes each worker able to produce more good
puts downward pressure on prices and upward pressure on output and GDP equilibrium
we get growth and outward pressure on prices
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stabilization policy
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government programs designed to prevent or shorten recessions and counteract inflation
not trying to get faster growth in long term. they are designed to smooth out unemployment and price consequences w/ change
expand expenditures
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Obama Stimulus
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through certain projects we can reduce unemployment and people will have more purchasing power
stabilization policy b/c it was short term (time limited) and in intervention explicitly to reduce imbalance in economy (unemployment)
not design to reduce growth in long term
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employed
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worked full-time or part-time during past week or is on vacation or sick leave from a job. age 16 and up
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unemployed
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did not work during the preceding week but made some effort to find work in the past four weeks
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out of labor force
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did not work in the past week and did not look for work in the past four weeks.
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Labor Force
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the total of those employed and those unemployed at any given time.
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unemployment rate
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the total unemployed divided by the total labor force.
Unemployment among youths is lower than the rest of the population as a whole
4%-5% would be a full employment level
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frictional unemployment
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unemployment due to normal turnover in the labor market.
4-5% of labor force out of work at any point in time
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cyclical unemployment
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unemployment due to a decline in the economy’s total production. It rises during recessions.
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structural unemployment
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unemployment due to workers being displaced by automation and/or not having skills in demand.
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what is the best way to reduce unemployment?
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Government stimulus (Keynesian approach)
Government budget balance (expenditure contraction)
Reduce regulations on businesses
Sit and wait (for an automatic adjustment)
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