ap microeconomics course notes
TRANSCRIPT
AP Microeconomics Course Notes
Assetsasset - provides flow of money/services to its owner
capital gain - increase in value of asset o unrealized until asset is sold
capital loss - decrease in value of asset risky asset - random monetary flow, could rise or fall riskless asset - pays certain monetary flow, such as bonds
o usually grows slower than risky assets return - total monetary flow an asset yields
o includes either capital gain/loss as fraction of its price (given in percentages)o real return - return after taking into account inflationo investments should grow faster than inflation, or worthless o higher expected return usually means
investment portfolio - determines how much to invest in each asset R = bR1 + (1-b)R2 = R2 + b(R1-R2)
Asymmetric Information, Insurancebuyer information - seller often knows more about good than buyer medical insurance - insurance companies need to cover their losses
patients know more about their health than company patients with worse health buy insurance >> insurance costs rise >> patients w/ better health no
longer buy insurance >> health companies screwed o in response, insurance companies offer insurance at companies, to include
healthy/unhealthy patientso a sort of bundling w/ the job
moral hazard - those w/ insurance more susceptible to doing risky things
Budget Constraints budget line - indicates all combinations where total spent is equal to income
I = PA A + PB B slope = negative ratio of prices of 2 goods intercepts on the graph represent how much of each good you could buy if you only bought that
certain good income change >> changes vertical/horizontal intercepts, not slope
o increase >> shifts outward; decrease >> shifts inward o income consumption curve positive >> normal good (quantity increases w/ income) o income consumption curve negative >> inferior good (less desire w/ increased income,
ex. hamburger vs steak) price change >> slope change (or none if both prices change by same rate)
o changes intercept of one of the axes (or both of both prices changed) o may not change consumption of other good
purchasing power - determined by income and prices
original budget line possible income changes possible price changes both price changes could change in such a way that it appears to be an income change (increase
in purchasing power through either income increase or price decrease) maximizing basket - must fulfill 2 conditions
(1) located on budget line - can’t go past budget line, can’t leave income unused o assuming that satisfaction from goods now exceeds saving income for goods later o can’t spend more, can’t spend less
(2) must give consumer more preferred combination of goods o goes w/ the highest indifference curve
satisfaction maximized where marginal rate of substitution (MRS) equal to ratio of prices o marginal benefit = marginal cost o MRS = PA/PB = -B /Ao if MRS doesn’t equal PA/PB, than utility can be increased
corner solutions - when 1 good is not consumed at all. o in this case, MRS doesn’t necessarily equal price ratio (only holds true when positive
quantities of goods are consumed) o restrictions can change shape of budget line
most satisfying basket lies on the intersection between the indifference curve offering the highest
good and the budget line indifference curves found through utility function can use both the budget line formula and given utility function to find most satisfying basket
Bundling, Advertisingbundling - combining 2 or more products in a sale to gain a pricing advantage
sometimes customers want 1 product but not the other conditions for bundling:
o heterogeneous customerso can't price discriminate (and profit at the same time)o demands negatively correlated
consumers will buy bundle if the cost of the entire bundle is less than the the sum of the amount they're willing to pay for both goods individually
o ie. if customer is willing to pay $4 for good A and $6 for good B, then as long as the bundle costs $10 or less, they'll purchase it
o also, this bundle would also appeal to customer willing to pay $1 for good A and $9 for good B
best used when customers each really only want 1 of the goods in the package examples of bundling: features in cars (sunroof, anything non-standard), hotel w/ airfare,
premium channels advertising - only done by firms w/ market power
no point for price takers to make advertisements new demand function Q(P,A)
o quantity demanded not a function of price (P) and amount spent on advertising (A) profit = PQ(P,A) - C[Q(P,A)] - A
o revenue = price x quantity demandedo cost = calculated by quantityo subtract A for amount spent on advertising (another fixed cost)
if demand price inelastic and advertising effective >> advertise more o ie. diamond (Kay's jewelers)
Capital Marketsstock vs flow -
stock - instantaneous amount owned by a firm o ie. capital
flow - variable inputs/outputs o amount needed/used over a time period
capital, if not used, can gain interest o firms calculate how much capital in the future is worth todayo determines whether or not it's a good investment
future flow of income worth less today than at that timepresent discounted value (PDV)
future dollar value = M(1+R)n o M = amount of capital nowo R = interest rateo n = time period (usually in years)
present value = M / (1+R)n stream of payment w/ smallest present value is best
bond - contract where borrower (issuer) pays a stream of income to lender (holder) gov't could issue bond where they would pay $100 every year for 10 years
o results in $1000 total after 10 yearso but remember that $100 paid before 10 years can still have time to grow o lender (bondholder) would pay less than that $1000 in the beginning o that $1000 has present value of: 100/(1+R) + 100/(1+R)2 + ... 100/(1+R)9 + 100/(1+R)10
net present value = -C + profit1/(1+R) + ... + profitn/(1+R)n profit can be negative if firm is operating in a loss
risk premium paid in form of higher yield for riskier bonds/stocks (ie. tech stocks) and lower yield for more stable/dependable bonds (ie. gov't bonds)
Competition vs Collusiongame theory - where firms make strategic decisions
firms try to get the best possible outcome/payoff strategy - plan for going through the game
o optimal strategy - gives the best payoff noncooperative game - negotiation between firms not possible
o no binding contracts cooperative game - firms negotiate, work together
o have binding contract to dictate how they should behaveo pursued in joint interest to help both sides
cooperative collusion - firms don't react to one another find the quantity/price at equilibrium where MR=MC
o no need to find reaction curves results in less output and higher profits than Cournot equilibrium
o firms not in competition in this case competitive equilibrium >> P = MC >> zero profit Cournot equilibrium >> reaction curves set equal collusion >> MC = MR >> best outcome
reaction curves Q = q1+q2
Consumer Behavior, Market Baskets market baskets (bundles) - group of goods
how/why consumers decide how much of each good to buy assumptions about preferences - consumers often behave erratically, but assumptions must be
made for models o completeness - all goods are ranked (either above/below, or tied for a rank) o transitivity - if A preferred to B and B preferred to C, then A preferred to C o more > less - consumers always want more for less
indifference curve - all combinations of market baskets providing same satisfaction matches up market baskets where there’s more of 1 good and less of another from the preferred
basket market baskets above/right of curve is preferred to any basket on curve must slope downward (or else violates assumption that more > less)
Consumer Surplus market demand - sum of individual demands
more consumers enter market >> market demand curve shifts more to the right
factors influence consumer demands >> also affect market demands if individual demands are all the same, then market demand is just some multiple of the
individual demands elasticity of demand = (Q/Q) / (P/P) = (P/Q) (Q/P)
inelastic >> demand relatively unresponsive to price changes o for goods that people need, willing to pay more foro consumers may buy less, but ultimately spend the same or more
elastic >> demand decreases as price goes up o consumers will buy/spend less
isoelastic >> elasticity of demand stays constant point elasticity of demand = (P/Q) (1/slope)
o instantaneous price elasticity at some point on the demand curve arc elasticity = (Pavg/Qavg) (Q/P)
o elasticity over a range of prices consumer surplus - difference between what consumer is willing to pay and what consumer actually pays
calculated by area between demand curve and market price (triangular shape)
there will always be consumers willing to pay more than equilibrium market price there will always be producers willing to sell for less than equilibrium market price as a result, a surplus arises
price floor changes the amount of surplus relatively, it increases the supplier surplus, as compared to before
consumer is indifferent between baskets A, B, or C, since they lie on the same indifference curve A, B, C preferred to basket E, not as preferred as basket D baskets on an indifference curve have more of 1 good but less of another when compared to
other baskets on the curve
indifference map - describes preference for all combinations o set of indifference curves, can’t intersect
marginal rate of substitution - max amount of 1 good that consumer is willing to give up for 1 extra unit of another good
o calculated w/ respect to vertical axis o convex indifference curves >> decreasing marginal rate of substitution
perfect substitute >> linear line graph >> constant marginal rate of substitution if 1 good is the same as another, it doesn't matter how many of each you have only the total number matters
U = A + B
perfect complement >> need both to gain satisfaction >> right angle graph ex. buying left/right shoes it doesn't matter how many right shoes you have if you don't have a left shoe to match consumer indifferent between a basket containing 1 right and 1 left shoe and another basket
containing 1 right and 15 left shoes U = min(A,B)
utility function - assigns numerical values to market baskets Cost Functioncost function - relates cost to output level for future prediction
VC = bQ o linear function, implies constant marginal cost
VC = bQ + gQ2 o quadratic function, implies linear marginal cost
VC = bQ + gQ2 + dQ3 o cubic function, implies quadratic (U-shaped) marginal cost
Cobb-Douglas cost/production function - when production in form Q = AKaLb C(Q) = wL(Q) + rK(Q)
o use production function and MRTS to find L and K functions in terms of Q MRTS = w/r = MPL / MPK
o w/r = (AbKaLb-1) / (AaKa-1Lb) = (bK) / (aL)o waL = rbKo L = (rb)K / (wa)o K = (wa)L / (rb)o substitute these back into the production function to find both L and K in terms of Qo no need to use lagrangian method
substitute L and K functions back into the initial cost function to get final outcome note that in short-run, either K or L will be fixed
o leaves the production function in terms of just K or L and makes it easy to solveo in finding total cost, don't forget to calculate the fixed cost as well
Economies of Scale/Scope, Learning Curveeconomies/diseconomies of scale
input proportions change >> expansion path no longer a straight line firm can double output for less than twice the cost >> economies of scale firm needs more than twice the cost to double output >> diseconomies of scale EC (cost-output elasticity) = MC/AC
o EC < 1 >> economy of scaleo EC > 1 >> diseconomies of scale
o EC = 1 >> neither economies or diseconomies of scale economies/diseconomies of scope
joint output of single firm is greater than output by 2 separate firms >> economies of scope joint output of single firm is less than output by 2 separate firms >> diseconomies of scope
o if production of 1 product conflicted w/ production of 2nd when both produced together jointly
SC = [C(Q1) + C(Q2) - C(Q1,Q2)] / C(Q1,Q2) o measures degree of economies of scopeo SC > 0 >> economies of scopeo SC < 0 >> diseconomies of scope
learning curve - long term introduces new information to increase efficiency workers/managers can become better adapted to their jobs, more experienced, more efficient >>
long-term average cost can decrease learning curve describes relation between output and amount of inputs needed for each output L = A + BN-
o N = units of output producedo L = labor input per output unito A, B, constants (where A, B positive and 0 < < 1)o larger >> more important learning effect
economies of scale moves along the average cost curve, learning curve shifts the average cost curve downwards
Effect of Elasticities on Surpluslong-run effects - elasticities can change in the long run
elasticity - generally the slope of the curves o will alter the shape of the triangles and areas between the curves and market clearing
price change elasticity >> change relative amount of surplus demand and supply have same elasticities >> tax split evenly between consumers and producers
o demand grows more elastic >> demand curve gets flatter >> less of tax falls on consumero demand grows more inelastic >> demand curve gets steeper >> more of tax falls on
consumero same applies for supply curve
fraction of tax paid by consumer fraction of tax paid by producer
demand curve gets more elastic notice that the equilibrium stays at the same point and tax (pb - ps) remains the same everything merely shifts fraction of tax paid by consumer now exceeds fraction of tax paid by producer
Elasticityelasticity - measures how much curves change w/ respect to other curve
percent change in 1 variable per 1 percent change in other variable, measures sensitivity independent to units that price/quantity are measured notice that the derivatives are w/ respect to P, not Q more elastic >> more reactive to changes
o perfectly elastic >> the smallest change could drive demand to 0 less elastic >> less reactive to changes
o perfectly inelastic >> consumers willing to pay any price for good (ie drug addiction) price elasticity of demand - E = %ΔQ / %ΔP = PdQ / QdP = (P/Q) (dQ/dP)
dQ/dP = partial derivative of Q function w/ respect to P o for arc elasticity, dQ/dP is a given average change o normally calculated as point elasticity w/ derivatives
elasticity of demand - usually negative number o price increases >> quantity desired decreases, price decreases >> quantity desired
increases o availability of substitutes - primary determinant of price o linear demand curve >> elasticity not constant, more elastic up top, near 0 at bottom
constant elasticity demand function - takes away linear possibility (unrealistic) o expenditure = Q x P >> d(exp) / dP = Q + P x dQ/dP = Q(1+elasticity)
income elasticity of demand = I/Q x dQ/dI
o % that quantity changes w/ % income change o luxuries = income elastic o basic necessities = income inelastic
cross-price elasticity of demand - same as elasticity of demand, but w/ different goods o negative for complements (ie tires/cars) o positive for substitutes
perfectly elastic slightest price change will make demand go to 0 obviously very responsive to price changes
perfectly inelastic demand stays stable for any change in price obviously not at all responsive to price changes
Engel Curves engel - essentially just demand curves, except w/ respect to income
axes changes to income and just 1 good normal good - increased income >> increased consumption inferior good - increased income >> decreased consumption take demand curve C = (4/5) (I/PC) for instance
o C changes w/ I >> linear relationshipo I is independent variable, C is dependent o engel curve would be linear line
income consumption curve for an inferior good consumption of good 1 decreases w/ increasing income by the 3rd budget line >> good 1 is an
inferior good consumption of good 2 increases w/ increasing income >> normal good
Income-Substitution Effects price change effect on consumption - broken down into 2 parts
prices change >> income, prices both change relatively substitution effect - price changes >> relative prices of good changes
o willing to buy more of good that became relatively cheaper o price change for 1 good relatively effects the other good as well o utility stays constant, price declines >> demand increases o causes shift along indifference curve (to point where more of one good bought than
before) income effect - price falls >> relative income increases >> increase in real purchasing power
o price held constant (as if income increased), quantity demanded depends on whether good is inferior/normal
o outward or inward shift to new demand curve o inferior good >> inward shift >> may or may not overtake substitution effect o may be large enough to cause demand to slope upward (stop consuming some other good
completely substitution effect indifference curve initial budget line new, relative budget line though the absolute price of good 2 doesn't change, a price decrease for good 1 makes good 2
relatively more expensive >> new relative budget line
income effect price decrease for good 1 leads to an overall increase in purchasing power new budget line shifts outward from relative budget line found in last step negative income effect >> inferior good Giffen good - causes demand curve to slope upward due to very large income effect (very rare) overall change as expected, a price decrease for good 1 leads to more of good 1 and less of good 2 being bought
Intro to Microeconomicseconomics - social science studying behavior/interaction
microeconomics - behavior of individual economic units o how units interact to form larger units (consumers/owners >> markets/industries)
about making tradeoffs, choices originally about how to allocate resources to increase nation’s wealth (optimization) tradeoffs made for best/optimum output (balance between everything)
o use capital or labor? invest in machines or labor? o lower price >> sell more >> less profit per unit o higher price >> sell less >> more profit per unit o making the most out of given limits
consumer theory - how consumers maximize preferences o limited income/time, how/when to consume o job security vs advancement o labor vs leisure
producer theory - how firms maximize profits, how/when/what to produce o statistics/econometrics - tests accuracy of predictions/models
economic variables - stocks vs flows flow variables - measured per unit of time (ie income)
o production/consumption - units made/consumed annually stock variables - not measured w/ respect to time
o price, wealth, inventories expenditure = total price = unit price x consumption revenue = unit price x production consumption = expenditure / price index price index = cost of materials nominal price - absolute/current dollar price of good/service when it is sold real price - price relative to others in relation to time, corrects for inflation
o consumer price index ( CPI ) - measures aggregate prices altogether, computed from wide market
o CPI percent changes = rate of inflation o real price = CPIbase year / CPI current year x nominal price
theories - used to explain observations w/ set of basic rules/assumptions used to make predictions quality of predictions >> validity of theory tested by conducting experiments, comparing data imperfect, but gives insight into observations models - created from theories
o mathematical representations used to make quantitative predictions positive analysis - statements describing cause/effect
o deals w/ explanation/prediction
normative analysis - questions what should happen o tries to find best potential scenario, deals more w/ comparison
Isocost Lineisocost - line showing all combos of labor and capital bought for a given cost
rental rate - r, given to certain equipment to quantify capital C = wL + rK
o MPL/MPK = w/r = MRTS cost-minimization - finding lowest isocost curve intersecting given isoquant
found at point of tangency between isoquant and isocost expansion path - curve passing through cost minimization points (points of tangency between
isocost and isoquant) o long-run total cost curve derived from expansion path o shows combinations of labor/capital that the firm needs at each output level, will increase
if labor/capital increase w/ output Labor Supplychoice of labor - dependent on utility of leisure and money
leisure competes w/ income for utility o wage rate measures price/value of leisure
u(L,Y) o L = hours of leisureo Y = income = who w = wageo h = hours workedo L+h = 24
uL / uY = w at maximum utilityincome/substitution
higher wages >> workers replace hours worked w/ leisure o substitution effecto work hours and leisure shift to satisfy initial utility
higher wages >> workers can purchase more goods o income effecto work hours and leisure shift to obtain highest possible utility
income effect exceeds substitution effect >> backward bending supply curve *examples to come* monopsony power - only 1 firm to buy up labor (ie. gov't, NASA)
marginal value (MV) = marginal expenditure (ME) monopsonist pays same price for each unit >> average expenditure = supply
Long-Run Outputlong-run profit maximization -
marginal costs change now that firm can adjust more inputs in long run economic profit made as long as marginal cost (equal to price) above the average total cost zero economic profit - firm earning a normal (competitive) return on investment
o normal return - equal to investing elsewhere (whether in capital or other industry) high profit >> other firms enter market (assuming free entry) >> increases output >> drives
down prices >> reduces profit long-run competitive equilibrium - when no exit/entry
firms earning zero economic profit >> no incentive to enter or exit all firms must be maximizing profit quantity supplied by industry equal to quantity demanded by consumers
patents act as opportunity cost for firms that have it o can be sold or kept to produce a positive profit
economic rent - willingness of firms to pay for an input less than the minimum amount some firms have natural advantages over others
o land might be beneficial to shippingo materials might be more readily accessible
gives firm an edge >> other firms willing to pay for that edge >> economic rent long-run supply curve - cannot just sum curves like w/ short-run
in long-run, markets and enter/exit, so no way to tell how many total firms are in the market constant-cost industry - horizontal long-run supply curve, very elastic unlike short-run, where 1 input held constant, both inputs can vary in the long-run
o use MRTS to relate wages/rent to marginal labor/capital functions (in terms of Q)o C(Q) = wL(Q) + rK(Q)
curve generally wider than short-run curve o MC-MR intersection located farther to the right
Marginal Utility, Consumer Choice revealed preference - finding preferences based on choices
instead of making choices based on preferences if consumer chooses more expensive basket over another, then chosen market basket is more
preferred creates a more defined indifference curve >> more rankings changing budget lines >> more defined preference area
marginal utility (MU) - measures additional satisfaction from an additional unit of good generally diminishes as more good is consumed
o ex. the 4th or 5th hamburgers aren't quite as satisfying as the 1st same utility on all points of indifference curve MU increase w/ 1 good >> MU decrease w/ other good MUA/MUB = MRS = PA/PB marginal utility is same for each good >> utility maximization (equal marginal principle) UA / PA = UB / PB
o PA/PB = UA/UB = MRS o now you can find the MRS even if price isn't given (or is a variable in your calculations
instead of constant) In buying goods x and y, a consumer has utility function U = 1.5x + 2y and an income of $60, where good x costs $2, and good y costs $3. Find the MRS and the amount of each the consumer would buy if he wanted to maximize his utility
budget constraint >> I = Pxx + Pyy o 60 = 2x + 3y
MRS = Ux/Uy o Uy = 2o Ux = 1.5o MRS = 1.5/2 = 0.75
note that in this case, Px/Py = 2/3, different from the MRS o this indicates a corner solution, where the maximum amount possible of 1 good is
consumed consumer will buy 30 of good x
o gives utility of 45o buying 20 of good y gives utility of 40
o no other combination gives a higher utility cost-of-living indexes - ratio of present cost to past cost
accounts for inflation, price growth (ie CPI ) ideal cost-of-living index - cost of a given level of utility now compared to before Lasapeyres index - amount of money needed to purchase past market basket now divided by
cost before o deals w/ purchases as opposed to preferences o usually overstates true cost-of-living index o assumes that consumers don’t change consumption patterns
Paasche index - like Lasapeyres index, but deals w/ current market baskets (opposed to past) o will understate true cost-of-living index o assumes that consumers used current habits in the past
chain-weighted index - unlike fixed-weight index (Laspeyres/Paasche) o accounts for changes in quantities of goods
Market Equilibrium, Shiftsequilibrium (market-clearing price/quantity) - no shortage/excess demand/supply
everyone can buy/sell at current price >> intersection of demand/supply curves market price above equilibrium >> surplus supply >> inventories pile up
o price must be cut to re-establish equilibrium, make consumers consume, increase demand market price below equilibrium >> excess demand >> not enough to go around
o price must go up to re-establish equilibrium (ie reselling hybrid cars) >> arbitrage prices determined by relative supply/demand
o comparative static analysis - compares new/old equilibrium o comparative dynamic analysis - traces changes over time
raw materials price falls >> suppliers produce more >> surplus >> prices lowered to reach new equilibrium
o travel down demand curve to new intersection income increases >> consumers want to buy more >> shortage >> prices raised to reach new
equilibrium o travel up supply curve to new intersection
equilibrium never shifts as much as demand/supply curves o other curve dampens overall effect
changes in supply/demand - can act together in real world to change equilibrium increases in classroom costs >> decrease in supply increase in people wanting to go to college >> increase in demand demand shifts outward, supply shifts inward >> intersection rises in price more drastically w/ curve shifts, curve shape still stays the same
Given equations for the demand and supply curves, set them equal to each other to find the equilibrium point.
Given: o Qsupply = 100 + 5Psupplyo Qdemand = 200 - 20Pdemand
at equilibrium, Qsupply = Qdemand, and Psupply = Pdemand 100 + 5Psupply = 200 - 20Pdemand
o 100 + 5P = 200 - 20Po 25P = 100o P = 4o Q = 100 + 5P = 120
equilibrium at P=4, Q=120 Monopolistic Price Competitionshort-run vs long-run
few firms in the beginning >> economic profits more firms enter in long run >> price = marginal cost
o each firm's output/price decreaseso overall industry output increases
Cournot equilibrium - firms make decision all at the same time found at the intersection of the 2 firm's reaction curves
o gives respective quantities produced by the 2 firms (in duopoly case) identical firms (identical cost functions) >> same output from each firm
o q1 = q2o plug into reaction functions to find how much each firm produces
Bertrand model - prices decided by firms simultaneously assume the good to be homogeneous follows rules of competitive equilibrium
o P = MC homogeneous good >> consumer only cares about price
o firm charges too much >> can't sell anythingo will assume that other firms behave the same way >> act as if in a competitive
equilibrium Monopoly Powerprice-maker - monopoly offers only 1 source for a given good
firms in competitive market take the price of the market o can't charge higher than market price or else will lose all profit
monopoly forms the entire supply curve in forming a market equilibrium will still maximize profits where MR = MC monopoly promotes barriers to entry
o no longer a monopoly if free entry was possible average revenue = P(q)
o P(q) given by market demando no other competition to decide price
marginal revenue = d[P(q)q]/dqequilibrium price
find quantity that needs to be produced from MR=MC plug that quantity into the market demand function to find market price multiplant production - monopoly has different plants w/ different production
o use total marginal product to find total quantity that needs to be producedo use the price (not market price) that corresponds to total quantity and the marginal cost
functions for each individual plant to find how much each will produce
demand marginal revenue marginal cost p* = market price q = quantity at the intersection of marginal revenue and cost MR = P + P(1/Edemand) more elastic >> price mark-up decreases (p*-p decreases)
monopolistic competition - products still distinct but possibly substitutes ie. soda brands product differentiation - firms try to differentiate their product from that of other firms
o otherwise, each firm bound by prices set by other firms each firm now faces a different demand curve
Monopsonysingle buyer - takes advantage of sellers
oligopsony - market w/ only a few buyers monopsony power - lets buyer pay less than market price for a good marginal value - additional benefit from purchasing another good marginal expenditure - additional cost from purchasing another good
o E = expenditure = P(q)qo but P(q) in this case set by supply curve, not demand curveo AE = avg expenditure = P(q)
quantity bought found at intersection of demand curve and marginal expenditure o price found by dropping down to corresponding price on supply curve
demand supply, avg expenditure, P(q) marginal expenditure
p* = market price degree of monopsony power - depends on # of buyers, interaction between buyers
fewer buyers >> supply becomes less elastic >> more monopsony power buyers compete less >> more monopsony power more elastic supply >> markdown (p-p*) will be less
surplus - works out just opposite of monopoly deadweight loss from smaller quantity desired by buyer(s) producer surplus lost >> increase in consumer surplus
Multiple Inputssubstition effect - comes into play
could cause MPRL to shift more than for a single factor o wage decrease >> more labor demanded >> increases MPK >> firm buys more
machinery >> increases MPL >> firms buys even more labor wage rate decrease >> more labor >> more output >> more units of good in the market >> price
would decrease o wage hardly ever changes w/o affecting market price
input supply - no limit in competitive purchase market firms can buy as much of each input as they want at market price firm will not affect market price of input input supply perfectly elastic >> price (wage/rental) stays constant
Network Externalitiesnetwork externalities - when person’s demand depends on someone else’s demands
positive network externality - to be in style, be like everyone else (bandwagon effect) o marketing to make good popular (not banking on low costs, good quality) o makes consumer willing to spend more on good only because others do o relatively more elastic than neutral network externality o general urge to match up to standards of everyone else
consistency - quantity consumed by individual must be on demand curve associated w/ other consumers’ demands
o forms aggregate demand curve (points of consistency where individual demand matches demand of others)
o assume that others will behave like you >> personal choices can affect others to make choices that come full-circle
bandwagon effect - more often for children's toys more items initially bought if consumers think a large number of other consumers already have it more people buy product >> larger bandwagon effect more people own a product >> higher intrinsic value
o firms will produce more goods/services for that particular producto ex. ipod
makes market demand more elastic individual demand function will have some component proportional to overall market demand
o yindividual = C + kymarketIf the individual demand function is y = 2 - P/30 - Y/30, where P is the price and Y is the market demand, then find the market demand for 30 consumers.
Y = 30y in this case o need to solve for y in terms of P first, and then find Y
y = 2 - P/30 - Y/30 = 2 - P/30 - (30y)/30 = 2 - P/30 - y o 2y = 2 - P/30
o y = 1 - P/60 Y = 30y = 30(1 - P/60)
o Y = 30 - P/2 snob effect - negative network externality, desire to own exclusive goods
more people own a product >> no longer unique less items initially bought if consumers think a large number of other consumers already have it makes market demand less elastic individual demand function will also have some component proportional to negative overall
market demand o yindividual = C - kymarket
Oligopolysmall number of competitors - each has more than negligible effect on the market
possible product differentiation, barrier to entry (patent, technology, economies of scale) decisions based on what competitors are doing
o must decide how to react to competitors' actionso figure out how own actions will affect competitors' reactions
equilibrium - all firms doing the best they can >> prices/quantities set o all firms assume that everyone is taking competitors' actions into accounto nash equilibrium - each competitor doing the best based on what its rivals are doing
Stackelberg equilibrium - leader-follower interaction 1 firm makes production decisions before all others Q = q1 + q2 follower's decision depends on what the leader does
o q2 = f(q1) >> reaction functiono follower will seek to maximize profits
profit maximization where derivative of profit equation equal to 0 o revenue2 = p(Q)q2 = p(q1+q2)q2 o derive w/ respect to q2 in order to solve for reaction function
leader makes decision based on the follower's reaction function o revenue1 = p(q1+q2)q1 = p[q1+f(q1)]q1o derive to find best decision for leader in the market
One Variable Inputfirm decisions - based of benefits on incremental or average basis
total output - can actually decrease after too many workers are employed o too many workers >> workers get in each others' way, entrepeneurship decreases
average product of labor (APL) = Q/L o output per unit of labor o slope of line from origin to point on total product curve
marginal product of labor (MPL) = Q/L o derivative of the production function w/ respect to laboro additional output produced w/ increase in labor by 1 unit
marginal output less than 0 >> decreasing total output marginal output less than average output >> decreasing average output
o marginal output intersects average output at max average output
graph not drawn to scale total output curve average product of labor curve marginal product of labor curve when marginal product curve crosses the x-axis (becomes negative), total output curve reaches a
maximum at intersection of marginal product and average product, average product is at a maximum
law of diminishing marginal returns - additions from input to output gradually decrease increasing input has more effect on output early on than later small labor force >> adding labor affects output considerably
o more workers assigned to specialized tasks, etc larger labor force after adding labor >> adding additional labor doesn't affect output as much as
before o too many workers >> less efficient, more willing to slack
technology improvements >> shifts total output curve >> increases labor productivity as a whole o note however, that diminishing marginal returns still exist o existence of a max total ouput proves existence of diminishing marginal returnso increasing labor productivity >> increases capital flow >> increases standard of living
Perfectly Competitive Marketsprice taking - firms take market price as given
individual firms sell sufficiently small part of total market output firms can't decide what market price is in a perfectly competitive situation consumers also act as price takers individual decisions do not affect the outcome of the whole
product homogeneity - firms produce nearly identical products products essentially perfect substitutes for each other >> very elastic
commodities - homogeneous materials such as raw metals, oil, gasoline, vegetables, fruit o consumers don't really care what specific firm made which
name brands (ie. Nike, Adidas, Bluebell) not taken into consideration in perfectly competitive situations
helps ensure a single market price free entry/exit - no costs for new firm to enter/exit industry
lets consumers switch from 1 supplier to another firms can enter if it sees profit, exit if losing profit medical, high-tech firms not perfectly competitive
o need research, patents, investment (entry costs) to sell in market large number of firms or hight elasticity can lead to high competition
profit maximization - price fixed, so cost needs to be minimized dominates most decisions w/ small firms larger firm >> owners have less contact w/ managers >> managers have more leeway to act on
their own o managers may be more focused on short-run than long-run
profit - difference between total revenue and total cost p(q) = R(q) - C(q)
o R(q) = Pqo profit maximized where difference between revenue and cost is greatest
marginal revenue - slope of revenue curve, change in revenue after one-unit increase in output MR(q) = MC(q) = P
o marginal gain in revenue equals marginal gain in cost at max profit firms in a large market >> face horizontal demand curve
o market demand still downward sloping, but market is so elastic for each firm (price taker) that individual firms face a different demand curve
o marginal revenue, average revenue, price all equal on demand curve for individual firms output rule - if firm produces anything, it should produce at the level where marginal revenue
equals marginal cost
Price Discriminationcapturing consumer surplus - in competitive market, only 1 price set
some consumers willing to pay more than that set price firm would make more money if they could charge people closest to what they're willing to pay
1st degree price discrimination - charging each consumer a different price results in no consumer surplus each consumer charged exactly what he/she is willing to pay marginal revenue no longer comes into play in deciding market price aka perfect price discrimination >> clearly no possible
o firms can't possibly know what each person is willing to pay 2nd degree price discrimination - charges different price for different quantities
willingness to buy decreases as quantity increases firms may offer bulk sales at a lower per-unit price
3rd degree price discrimination - divides consumers into groups each group gets charged a different price
o ie. movie tickets for children, adults, students, seniors marginal revenue should be equal for each group MR1 = MR2 = MC P1 / P2 = (1+E2) / (1+E1)
possible where it's not profitable to sell to a certain group intertemporal price discrimination - charging different prices at different times
divides consumers into those who must have the good immediately and those who are willing to wait (elastic/inelastic division)
peak-load pricing - increasing prices when marginal costs get higher due to limits in capacity (ie. electricity during summer, heating during winter)
Price Supportsagricultural policy - US uses price supports to control domestic market
gov't sets price at level higher than that of free-market gov't buys up any excess quantity that consumers don't buy consumers must buy goods at higher price than if there was a free-market gov't must spend money to buy up excess quantity of goods
o taxes on consumers/public support this, so ultimately the cost falls on the populationo gov't may try to resell the quantity they buy
producers sell more >> gain more revenue o benefit w/o loss
more efficient to just pay the farmers directly o this method would still force gov't to pay, but consumers wouldn't be affected
in this method, note that there are essentially 2 consumers (the public and the gov't) o maximizes the producer surplus by enhancing their market
consumer surplus decreases by A+B producer surplus increases by A+B+C government pays B+C+D net effect = producer surplus - consumer deficit - gov't cost = (A+B+C) - (A+B) - (B+C+D) =
loss of B+D as with most changes, society worse off as a whole
Price/Income Consumption Curves demand functions - calculated from budget line and utility function
MRS calculated by partial derivatives of utility or given prices usually changes w/ respect to price/income of itself or other good only depends on own price >> independent good remember that demand functions slope downward
Find the demand functions for food and clothing if a consumer's utility function for the 2 was U = C0.8F0.2
budget constraint >> I = PCC + PFF o C = (I-PFF) / PC
o F = (I-PCC) / PF
o need to get rid of F to find C demand functiono need to get rid of C to find F demand function
MRS = UC / UF = PC / PF o UC = 0.8C-0.2F0.2
o UF = 0.2C0.8F-0.8
o MRS = (0.8C-0.2F0.2) / (0.2C0.8F-0.8) = 4(F/C) 4F/C = PC / PF
o 4FPF = CPC
substitute that back into the budget constraint equations o C = (I-[CPC/4])/PC = I/PC - C/4 o 5/4 C = I/PC >> C = (4/5) (I/PC) o F = (I-[4FPF]) / PF = I/PF - 4Fo 5F = I/PF >> F = (1/5) (I/PF)
price-consumption curve connects points of equal utility on budget lines formed by changing prices
income-consumption curve connects points of equal utility on budget lines formed by changing income
Probability, Expected Value, Variabilitymeasuring risk - must know all possible outcomes, probability of each outcome
sum of probabilities = 1 objective interpretation - based on past events/experiments subjective interpretation - based on educated guess about future expected value, variability >> characterize payoff/risk expected income (value) = sum of product of probability and payoffs
o probability of each case can change based on personal skills/tendencies
o expected values same >> variability not always the same o E(X) = probability1(X1) + probability2(X2) + ...
deviations - difference between expected and actual payoff o based on deviations from the mean o standard deviation - measures risk, equal to square root of average of squares of
deviations o Ö(probability1(deviation1)2 + probability2(deviation2)2)o people generally want less risk
Product Function, Isoquantsfactors of production - inputs that firm uses to produce
mainly divided into labor, materials, capital o capital - not just money, but also equipment, buildings, machinery
production function - shows highest output for combo of inputs Q = F(K,L)
o K = capital, L = labor (materials left out of function for simplicity)o multiple combinations of K, L can produce any given Q o function will change w/ technology changes (allowing production to occure more
efficiently) possible for firm to produce less than maximum efficiency, but function assumes that firm
produces as much as possible inputs, outputs measured as flow variables (changing w/ time)
isoquant - like indifference curve, shows all input combos for a given output certain amount of capital can replace labor, and vice versa isoquant map - several isoquants combined on a single graph, like an indifference map input flexibility - ability to choose different combinations, depending on their situation
short run vs long run - not based on a set amount of time
different for each firm and situation short run - firm can only change a few of its inputs
o firm can increase labor (add hours), buy more materialso machinery, other tools cannot be changed as quicklyo always a fixed input (unchangeable) in place
long run - firm can change all inputs o more time >> more flexibility
Quotas and Tariffslimiting production - effectively changes the supply curve
like w/ a price ceiling, limits the available supply o remember that price floors don't necessarily limit the supply (especially for stupid
companies)o ie. number of alcohol licenses, New York taxi medallions
ultimately helps the producers o sort of like a combination of a price ceiling (limits supply for sure) and price floor (leads
to an additional producer surplus for the most part)
consumer surplus loses A+B producer surplus increases by A, decreases by C net change = loss of B+C (deadweight)
import restrictions - either w/ tariff (tax) or quota, serves to help domestic market w/o quotas, domestic consumers would buy solely/mostly from abroad instead of domestic
markets to keep domestic markets alive, consumer surplus must suffer domestic markets want the quota to be 0, or for tariffs to be so high that foreign producers won't
interfere w/ domestic market o decreases competition, increases price >> increases revenueo all at the expense of the consumer
main difference between tariff and quota is that gov't earns money through a tariff and can channel that to the consumers
o of course, politically, it may be better for the gov't to use quotas than tariffs
domestic supply curve
pw = world (foreign) market price p* = market price w/ quota p* - pw = tariff that could replace the quota Q1 - Q2 = quota, note what happens when this goes to 0 consumer surplus decreases by A+B+C+D domestic producer surplus increases by A if gov't used tariffs, it would get back C worth of revenue
what happens w/ no quota at all consumer surplus increases dramatically >> consumption increases producer surplus very small, nonexistent if world price less than lowest domestic price
Reducing Riskdiversification - putting resources into different risky situations
can't lose on all investments invesments not too closely correlated >> eliminates some risk negatively correlated - good results for 1 investment means bad results for another investment positively correlated - investments moving in the same direction, in response to economic
changes insurance - uses risk premiums
insurance cost = expected loss law of large numbers - aility to avoid risk by operating on a large scale if insurance premium = expected payout, then actuarially fair
o insurance companies need to profit >> charge more than expected losses Dan has a wealth utility function of U = lnw. He currently has $1200, but there's a 1/8 chance that his car will blow up and he'll lose $1000. However, he could pay insurance 30 cents on the dollar to cover his potential losses. How much insurance should he pay?
you want to maximize expected utility x = amount he covers w/ insurance
o he'll pay 0.3x for the insurance if his car doesn't blow up, he'll have w = 1200 - 0.3x if his car does blow up, he'll have w = (1200-1000) - 0.3x + x
o gets back the x amount he coverso be sure to include the 0.3x amount that he still paid
EU = (7/8) ln(1200 - 0.3x) + (1/8) ln(200 + 0.7x) o d(EU)/dx = 0 = (-2.1/8) / (1200 - 0.3x) + (0.7/8) / (200 + 0.7x) o (2.1/8) / (1200 - 0.3x) = (0.7/8) / (200 + 0.7x)
o 2.1 / (1200 - 0.3x) = 0.7 / (200 + 0.7x)o 420 + 1.47x = 840 - 0.21xo 1.68x = 420o x = $250
value of complete information - difference between expected value of choice w/ and w/o complete information
calculates how much firm would pay for extra information/predictions for sales also dependent on whether firm is risk averse/neutral/loving
Risk Preferencesexpected utility - sum of utilities of all possible incomes weighted by probability
E(u) = (probabilty1)(utility1) + (probability2)(utility2)... different expected values/risks >> depends on individual
o find utility/happiness obtained by risk risk averse - person always prefers given income compared to risky income
o risk >> diminishing marginal utility of income o 1st earned dollar not as attractive as 2nd
risk-loving - prefers uncertain income to certain no preference between certain/uncertain income >> risk neutral (usually never possible)
o has constant marginal utility of income
risk averse risk loving risk neutral
risk premium - max money person willing to give up to avoid risk variability increase >> risk premium increase difference in value between certain value and expected value at the same utility
marginal utility expected value curve expected value certain value risk premium
Short-Run Outputshut-down rule - firms may continue to produce even when losing money
firm could expect to earn a profit in the future shutting down might be costlier than operating in the red product price > average economic cost of production >> firm makes a profit by producing
o assuming no sunk costs, firm should shut down when price of product falls below average total cost
o w/ sunk costs, firm should only shut down when price of product falls below average variable cost
firm short-run supply curve - shows how much firm will produce for each price
supply curve part of marginal curve greater than average cost curve price changes >> firm changes output so that marginal cost equals price higher market price or higher prices for inputs may lead to upward shifts in marginal cost and
market short-run supply curve - sum of all firm supply curves in the market overall prices changes can make adding firm supply curves more difficult
o higher prices >> firms expand output >> demand of inputs increase >> prices of inputs could increase >> firms would then decrease output
o market supply curve might not be as responsive Es = (Q/Q) / (P/P) perfectly inelastic supply - greater output only possible by building new plants perfectly elastic supply - when marginal costs are constant producer surplus - difference between revenue and variable cost
o surplus = R - VC = profit + FC
Short-Run, Long-Run Costshort-run cost - remember that certain inputs are fixed in the short-run
marginal (incremental) cost - increase in cost from producing another unit of output o no need to consider fixed cost (just a function added on)o MC = (VC)/Q = C/Q
average total cost (ATC) - divided into average fixed and variable cost o average fixed cost = FC/Q, decreases as output increaseso average variable cost = VC/Qo difference between average total cost and average variable cost decreases as output
increases (since their difference is equal to the average fixed cost) MC = w/MPL
o eventually increases as output increases marginal cost curve crosses average variable cost and average total cost at their minimum points
long-run cost - firm now allowed to change all its inputs costs/prices sometimes amortized (allocated) across the life of the use of the equipment (ie. plane
bought for $200 million but since it's used for 40 years, it's at a cost of $5 million per year) o also means that the economic value of the plane decreases by $5 million every year (has 0
value after 40 years)o also note that w/o buying the plane, the firm would've had $150 million that could've
gained money through interest (opportunity cost) user cost of capital = economic depreciation + (interest)(value of capital)
o value of capital decreases w/ time long-run marginal cost curve intersects long-run average cost at its minimum, just like w/ short-
run equivalents
Short-run vs Long-run, Price Controls short-run versus long-run
long run lets consumers/producers fully adjust to price change demand - more price elastic in long run
o consumers adjust habits over time o linked to another good that changes over time, more substitutes available later (knock-
offs, competition) o short term - durable goods >> consumers hold onto >> no need to replace >> less demand o no new purchases >> less consumption in short run o over long term, will still need to be replaced >> more elastic
supply - percentage change in quantity supplied due to price change o same concept as demand elasticity o materials shortage >> bottlenecked production >> low elasticity (capacity constraint) o easy to get capital/labor/materials >> high elasticity (long run pattern) o durable goods >> can be refabricated >> smaller long-run elasticity
price controls - price ceiling/minimum set by organization (usually gov’t) ceiling below equilibrium >> excess demand
o normally, suppliers would raise money, but can’t in this situation o could drive price above market price (ceiling) through auction, bribes
minimum (floor) below equilibrium >> no effect ceiling above equilibrium >> no effect minimum (floor) above equilibrium >> excess supply excess demand - difference in quantity of demand and quantity of supply, calculated at the price
ceiling
price ceiling equilibrium can't be reached at price ceiling, quantity demanded exceeds quantity supplied suppliers not allowed to raise prices (legally)
price floor equilibrium can't be reached at price floor, quantity supplied exceeds quantity demanded suppliers can't lower prices
Single Factor Demand (Labor)factor market - shows how much the firm demands units of labor (or other factor)
combines utility, isoquants, and market marginal revenue product of labor (MPRL) - additional revenue from the extra output that
would result from hiring another unit of labor o MPRL = (MR)(MPL) o in competitive market, MR=P >> MPRL = (P)(MPL) o will hire more if extra revenue exceeds the cost o cost = wage = w >> usually constant
cost function MPRL lower cost >> wage shift >> increased demand in labor
Social Costs of Monopoly
demand shifts - will only change price quantity produced by monopoly still stays the same intersection of MR=MC stays the same
tax effect - increases price by less than tax in a competitive market in monopoly, price can sometimes rise higher than the tax MC' = MC + tax
o basically, the marginal cost shifts up by a constant
demand marginal revenue marginal cost marginal cost plus tax
p = price before tax p* = price after tax, increased by more than the tax
deadweight loss - occurs along w/ consumer surplus loss w/ change to monopoly normally in competitive market, price found at intersection of marginal cost and market demand
o price set higher than this in monopoly >> loss of consumer surpluso less quantity produced >> deadweight loss
price regulation can get rid of deadweight loss in a monopoly o sets price minimum in competitive market, sets price maximum in a monopoly market
natural monopoly - has a much more efficient production than other firms makes it unprofitable for other firms to even continue production possible w/ large economies of scale
Special Cases, Returns to Scale
perfect substitutes - linear isoquants isoquants constant MRTS diminishing MRTS doesn't apply not necessarily a one to one exchange though
fixed-proportions production function - like perfect complements in consumer theory
isoquants impossible to make substitutions among inputs (ie. recipes) each output requires a specific combo of inputs both inputs must be increased to increase output >> limited methods of production
returns to scale - shows how output is increased by input increasing returns to scale - output more than doubles when inputs doubled
o for example, Q = KL >> (2K)(2L) = 4KL = 4Qo common in large scale operations (w/ very specialized operations)
constant returns to scale - output doubled when inputs doubled o for example, Q = K+L >> (2K)+(2L) = 2(K+L) = 2Qo size of firm doesn't affect productivity
decreasing returns to scale - output less than doubled when inputs doubled o for example, Q = (KL)1/3 >> (2K x 2L)1/3 = 41/3Q
Specific Taxestax - on a per-unit basis, cost divided between consumer and producer
subsidy - essentially a negative tax treated as an increased cost, this will lead to lower consumption/production
pb = price that consumers pay ps = price that producers receive pb - ps = tax gov't revenue = A+B deadweight loss = C+D consumer surplus decreases by A+C producer surplus decreases by B+D
subsidies - moves to the other side of the graph (scandalous!) ps - pb = subsidy note that the ps and pb have switched locations from before costs the gov't A+B+C+D+E+F consumer surplus increases by D+E producer surplus increases by A+B net deadweight welfare loss of C+F
Supply and Demandsupply curve - relationship between how much producers willing to sell and price
price (x) vs quantity (y) graph, axes can be reversed what price necessary to get designated quantity? what quantity necessary to get designated price? higher price >> firm able/willing to produce more >> slopes upward variables affecting supply curves - labor, capital, raw materials
o lower cost of production >> higher profits >> expand output o supply curve shifts as variables change o shift not caused by change in price (already part of calculated curve) o price only changes mov’t up and down the existing curve
demand curve - relationship between how much consumers willing to buy and price price decreases >> consumers more willing to buy >> slopes downward variables affecting demand curves - income, consumer tastes, price of related/similar goods
o more income >> more willing to buy o substitutes (knock-offs) - increasing price of one >> increasing consumption of other o complements - used together >> increasing price of one >> decreasing consumption of
other demand curve shifts as w/ supply curve
o income increases >> more quantity bought overall (regardless of price) o competition lowers prices >> cheaper substitutes >> shifts inward >> less bought
demand curve supply curve equilibrium point all changes made to move towards equilibrium point move towards equilibrium point >> move along curve
changes in demand curve
increased income substitutes got more expensive complements come free or at reduced price decreased income substitutes got cheaper complements got more expensive
changes in supply curve cost of production (labor/materials/tariffs) increase cost of production decrea
Two Variable Inputslong run - allows for 2 (or more) variable inputs
diminishing marginal returns shown by drawing horizontal or vertical line through isoquant map o shows that each increased unit of capital or labor adds less and less to the total output
marginal rate of technical substitution (MRTS) - like MRS for consumers amount of capital that can be decreased by an extra unit of labor, for a given output level MRTS = -K/L = MPL/MPK
o MP = marginal product (partial derivatives of the production function w/ respect to either labor L or capital K)
units of labor decrease the required capital less and less >> diminishing MRTS o isoquants are convex >> magnitude of the slope decreases (gets more flat) >> ratio of
capital (vertical axis) to labor (horizontal) falls
isoquant equivalent changes in labor lead to less and less change in capital >> diminishing MRTS
Two-part Tariffentry/usage - consumers charged both an entry fee and a usage fee
ie. amusement parks, golf course, resorts will use entry fee to try to capture as much consumer surplus as possible for just 1 consumer, will set usage fee at marginal cost and entry fee to capture all of the
consumer surplus for more than 1 consumer:
o will set usage fee higher than marginal costo will set entry fee to capture all of consumer surplus of consumer w/ the least demand
Types of Costaccounting cost - actual expenses, plus depreciation
more concerned with past performance depreciation expenses calculated for capital equipment more connected to the IRS than economic cost
economic cost - cost of utilizing all resources in production more forward-looking view of the firm concerned w/ what cost will be in the future associated w/ forgone opportunities, includes opportunity cost talks about all the costs/resources that the firm can control/change
opportunity cost - sometimes synonymous w/ economic cost unused opportunities treated as costs (since firms not using resources in the most efficient way) monetary transaction may be absent, but opportunity still there
o for example, company owns a building or space that it doesn't use. since they could've have rented it out or sold it, this is an opportunity cost
o for example, store owner doesn't pay herself, but could have or worked for money elsewhere, so this becomes an opportunity cost
hidden, but need to be considered in economic decisions sunk cost - shouldn't be taken into account in economic decisions
expense that has been made and can't be recovered o visible and recorded, but shouldn't be considered for decisions
certain specialized equipment can't be converted to do any other tasks >> sunk cost when unused o has opportunity cost of 0 since you can't use them for anything else
prospective sunk cost - hasn't been made yet o considered an investment, economical if it can generate enough profit to cover its
expense total cost - made up of fixed and variable cost
fixed cost (FC) - cost that doesn't vary w/ output o paid even when output is 0o only removed when firm goes out of businesso different from sunks costs since sunk costs can't be recovered even when the firm goes
out of business variable cost (VC) - varies w/ output, dependent on Q
Types of Marketsmarket - exchange center, central economic unit
place where buyers/sellers come together to exchange product/good o retail market - buyers = consumers, sellers = retail stores o wholesale markets - buyers = retail stores, sellers = goods producers o factor markets - buyers = goods producers, sellers = workers/capital suppliers
contains different range of products w/ different geographies (extent of market) o used to find actual/potential competitors
arbitrage - buying low, selling high in another market o determines extent of market, due to significant differences in price o complete market (perfectly competitive) - consumers/producers can’t determine/change
price o impossible in real life o large number of buyers/sellers >> hard to influence price o competition keeps different markets’ prices even o no need for market to pay attention to single consumer o no influence from either side on price (fast food is closest real example)
incomplete market (noncompetitive) - either demand or supply affects price o balance between demand and supply o not just one decision marker (economic agent), may be based on brand loyalty/price o producers influence the price individually (w/ monopoly) or cartel (ie OPEC) o oligopoly - sellers combine forces (OPEC, railways, etc) o monopoly - only 1 choice, source >> seller has all power
commodity market - many units of same goods (supermarket) o consumers decide how much to buy
product differentiated markets - buyers purchase fixed number of units o units differ in quality, specifications (ie cereal, cars) o monopolistic competition - ie Mac vs PC >> specialty brands o producers have limited ability to influence price (due to competition from other brands) o new/different brands >> competitive force
market operation - live auctions, sealed bids live auctions -
o sellers starts low, raises price until 1 buyer left o seller starts high, lowers until 1st buyer emerges o buyers place max price orders (allowance), sellers place minimum price requests
sealed bids - o seller says what’s for sale, buyers submit a single bid >> highest bid wins o buyer says what’s needed, buyers submit a single bid >> lowest bid wins
posted prices - difference prices for different quality o compare prices/quality >> look for best trade off o unsold units >> seller cuts prices (w/ sales, discounts)