Microeconomics: Spring Term Flashcards
(120 cards)
1
Q
What is partial equilibrium analysis?
A
Focusing on individual markets (no cross-market spillovers which is unrealistic)
2
Q
What is general equilibrium analysis?
A
A study of market behavior that incorporates cross-market influences to determine the equilibrium
3
Q
Why did the price of other commodity crops increase when demand for biofuels increased?
A
As demand for corn increases, the price increases so consumers turn to substitutes. As demand for substitutes increases, the demand for corn increases further
4
Q
Why might the price of other commodity crops increase when the demand for corn increases?
A
As the price of corn increases, farmers will shift land to corn production reducing the supply of other commodities and increasing prices. This increase in price will lead farmers to shift land back to those commodities
5
Q
What is the Kern County example of general equilibrium 1924?
A
1924: Campaign to kill predators killing their livestock
1926: Bumper crop of grain. Mice invasion as no predators to eat them!!
6
Q
What is the social welfare function?
A
Function combines individuals’ utility levels into a single measure of society’s total utility which allows comparisons of
outcomes that have varying impacts on disparate groups
7
Q
What is the utilitarian social welfare function/
A
give equal weight to all individuals in an economy, and simply add up utility functions
8
Q
What is the problem with the utilitarian social welfare function?
A
Relative indifference to inequality
9
Q
What is the Rawlsian social welfare function?
A
Function that computes society’s welfare as the welfare of the worst-off individual
10
Q
What is an egalitarian social welfare function?
A
Belief that the ideal society is one in which each individual is equally well off
11
Q
Complicating factors for social welfare functions?
A
- Must make judgments on the preferences of a “representative agent” and the aversion to inequality.
- Needs a monetary value for the impact of policies- not always easy!
12
Q
What is Pareto efficiency?
A
An economic allocation of goods in which the goods cannot be reallocated without making at least one individual worse off
13
Q
3 conditions for markets to result in pareto-efficient allocations?
A
- Exchange: efficient allocation of goods for consumers
- Input: efficient allocation of inputs for producers
- Output: efficient allocation of inputs and productive outputs for the economy
14
Q
What is an edgeworth box?
A
A diagram of an economy with two economic actors and two goods that is used to analyze market efficiency
15
Q
What do indifference curves show on an edgeworth box?
A
Complete sets of allocations, as they move away from the origin utility increases
16
Q
When does a pareto efficient allocation occur in an edgeworth box?
A
Occurs at a tangency between indifference curves, when the marginal rate of substitution is the same for each consumer (equal to ratio of prices)
17
Q
What effect will exchange efficiency have on price ratios?
A
A market with exchange efficiency will result in the goods’ price ratios equaling consumers’ marginal rates of substitution for those goods
18
Q
What is the consumption contract curve?
A
Curve that shows all possible Pareto-efficient allocations of two goods across consumers
19
Q
For an efficient allocation what must be the same for each consumer?
A
The marginal rate of substitution
20
Q
What is the marginal rate of substitution equal to?
A
The ratio of prices
21
Q
What do we plot on a production Edgeworth box?
A
The firm’s isoquants (combinations of inputs the yield the same level of output)
22
Q
Why are the isoquants (edgeworth box) bowed outwards from the origin?
A
Assumption of diminishing marginal rate of technical substitution
23
Q
What is MRTS?
A
Marginal rate of technical substitution: The slope of the isoquant, the rate the two inputs can be traded maintaining constant production
24
Q
How do firms minimise their MRTS?
A
Set the ratio of input prices = to MRTS
MRTS = Wage/ rental rate of captial
25
What is a production possibilities frontier?
Curve connecting all possible efficient output combinations of two goods. Bowed outward from the origin due to diminishing returns to scale
26
How is MRTS calculated using Marginal products
MPL / MPK
27
What is the slope of the PPF called?
The marginal rate of transformation
28
What is the MRT showing?
The amount of X that must be given up to obtain more Y.
MRTxy = MPLxi/ MPLyi
29
Is exchange and input efficiency enough for economic efficiency?
No: they can have different rates of substitution
30
What is output efficiency?
When the trade offs for consumption and production sides of the economy are equal
MRS = MRT
31
Can output efficiency be achieved?
Consumers max utility =MRS. Firms max profits = MRTS.
In a PC market P=MC and the ratios of price and cost ratios are equal, satisfying output efficiency, while preserving input and exchange efficiency
32
What is the first welfare theorem?
Perfectly competitive markets in general equilibrium distribute resources in a Pareto-efficient way
33
Assumptions of the first welfare theorem?
- No market power for consumers/firms (price given)
- Full information, rational actors
- Absence of externalities, public goods etc
34
What is the second welfare theorem?
Any Pareto-efficient allocation in a PC market is a general equilibrium outcome for an initial allocation.
If equity is a concern, society can reallocate some inputs across society and still not sacrifice the efficiency of markets
35
How can we move from one pareto efficient allocation to another?
- Lump sum redistribution
| - Taxation to change the price ratio (efficiency loss)
36
What is the law of one price?
The competitive equilibrium the prices for a given commodity are equalised across markets (necessary for Pareto)
37
What is arbitrage?
Taking advantage of a price difference in one or more markets
38
What did Jensen discover in Kerala? (2007)
-Before mobiles law of one price didn't hold. After their introduction it did almost all the time. Must be a mechanism which allows sellers to learn about price differentials
39
What is asymmetric information?
A situation in which there is an imbalance of information across participants in an economic transaction
40
What is the lemon problem?
Problem when the seller knows more about the quality of the good than the buyer
41
Economist George Akerlof, "lemon problem" example about cars?
50% Good cars (plums) sell for £10,000 (Sellers £8000) 50% bad cars (lemons). Worthless.
If information is asymmetric buyers will only offer expected value (10,000 x p) + (0 x (1-p) = 5000. No cars sell
42
What is adverse selection?
market characteristics lead to more low-quality goods and fewer high-quality goods being put on the market
43
Examples of markets with information asymmetry?
- Online markets for used merchandise
- Markets for home improvement and vehicle repairs
- Insurance markets
44
How do institutions try to limit information asymmetry affects?
- Direct solution: Give buyers the ability to observe quality characteristics prior to purchase
- Punish sellers who misrepresent their lemons as plums
- Incentivise plum selling
45
What was the Yelp effect?
Anderson and Magruder (2012) tested importance of Yelp reviews on restaurant popularity at the boundaries between 1/2 star ratings, 19% increase in sell out of tables
46
How have firms tried to mitigate adverse selection for insurance?
- Screening
- Group policies (law of large numbers)
- Denying coverage
47
What is a moral hazard?
Knowing you are insured may make you more willing to take risks, since part of your risk is being borne by a third party
48
How can the market mitigate against moral hazard?
- Conditions to the insurance e.g. working smoke detectors
- Reward good behaviour (NCB)
- Premiums fall if behaviour changes e.g.quit smoking
49
Difference between adverse selection and moral hazard?
Adverse selection: the asymmetry exists pre-transaction
Moral Hazard: The asymmetry exists post-transaction
50
What is a principal agent relationship?
Involve one party hiring a second party to perform a task, while being unable to perfectly observe the effort of the latter
51
What causes the principal-agent dilemma to develop?
Not just asymmetry must also be a divergence between incentives and preferences
52
How can the principal agent problem be viewed as a sequential game?
1st: Principal chooses between set of contracts
2nd: Agent sets effort level (payoffs for both)
The goal: Contract that means the agent exerts high effort
53
What is incentive pay?
Pay linked to revenue: Both parties share the risk, but agent is incentivised to put in the effort to benefit the principal
54
Utility of worker choosing their effort level equation?
s(y) - c(x) = s(f(x)) - c(x)
Salary to produce y - cost of effort = salary x output produced minus cost of effort.
55
What is the participation constraint?
Incentive scheme must give the worker at least the same utility from working elsewhere
s(f(x)) - c(x) > u
56
What is the employer's problem equation when setting wage incentives?
𝑚𝑎𝑥: 𝑥𝑓(𝑥)−𝑠(𝑓(𝑥))
s.t 𝑠(𝑓(𝑥))−𝑐(𝑥)>= u
57
How many people does the UK government directly employ?
Around 15% of the population
58
Why is public sector pay different to the private sector?
Multitasking: Teachers not just grades, good citizens.
| Implicit incentives: Not just about financial rewards e.g. helping people
59
What did the the Burgess, Propper, Ratto and Tominey (2016) study into public sector incentives reveal?
Incentive scheme for staff at UK Job Centre, quantity and quality measures.
The incentive only worked in small teams (properly structured pay) no effects for quality only quantity
60
What is free riding? Why was it evident in the jobcentre example?
Incentive to shirk in a team, contribution is 1/N. Individual measures would target one, but as N rises the incentive to shirk also rises
61
Problem with principal agent problems for good agents/products?
The good things are non-identifiable and cannot command full value
62
What is signalling?
Actors attempt to signal their “quality” by undertaking a costly action to prove something hard to observe. To credibly signal high quality, a signal must be less costly for high-quality than low-quality agents
63
Why is education an example of signalling?
Cannot just say you are productive, try to use a degree to prove this (difficult, time, cost etc) Useful skills developed. The third party accreditation is a credible signal to the employer
64
What did Keys, Mukherjee, Seru, Vig (2010) discover about sub prime loans?
(<620 is considered bad credit rating)
Risk of default 10-25% higher 621 compared to 619. Evidence that securitization did adversely affect screening incentives of subprime lenders
65
What is imperfect competition?
Market structures with characteristics between those of perfect competition and monopoly (strategic behaviour etc)
66
Type of market for a monopoly?
- Market demand curve, no competition.
| - Only way to sell more is to lower the price
67
If a firm has market power (monopoly) how will its demand curve look? MR?
Downward sloping. MR = MC
Equilibrium price is higher and quantity is lower in a monopolist compared to PC
68
What is an oligopoly?
Competition between a small number of firms
69
What is the prisoners dilemma?
A situation in which the Nash equilibrium outcome is worse for all involved than another (unstable) outcome
70
What is the cartel/collusion phenomenon?
Oligopoly behavior in which firms coordinate and collectively act as a monopoly to gain monopoly profits
71
Why are collusion agreements unstable?
As firms have an incentive to cheat the agreement
72
What makes it easier to sustain collusive agreements?
- Easy to detect/ punish cheaters
- Similar MC (as it is difficult to share profit if MC varies)
- Long time horizon (defection more costly, as future monopoly profits are given more weight)
73
What is the Bertrand competition model?
Oligopoly in which each firm chooses the price of its product
Strategic interaction ensues, with each firm responding to its rivals’ price decision (assumed prices set simultaneously)
74
Nash equilibrium in a Bertrand model?
Even though there is imperfect competition the equilibrium with by P = MC as then they cannot undercut each other further
75
What is a cournot competition model?
Oligopoly model in which each firm chooses its production quantity (due to capacity constraints)
76
What is the equilibrium output in a cournot model?
Differs depending on the choice of other parties
77
What is the residual demand curve?
The demand left over taking the other country’s output choice as given
78
Compare output, market price and profit under cournot, collusion and bertrand oligopoly?
Output: Qco < Qc < Qb
Price: Pb < Pc < Pco
Profit: Pib =0
79
Can an oligopoly reach an efficient outcome?
- Set price: Bertrand, P=MC similar to PC
- Bertrand, collude: Achieve monopoly prices/profit
- Cournot: Capacity constraints, profits in between monopoly and PC
80
How to solve a Cournot model?
```
Let Q = q1 + q2
Calculate total revenue from the price.
Differentiate for MR
Set MR = MC and solve
Profit = q1 (P - C)
```
81
What is a Stackelberg competition?
Oligopoly model in which firms make production decisions sequentially (compete on quantity, one chooses first)
82
Why is there a first mover advantage for the Stackelberg model?
In Stackelberg competition, the advantage is gained by the initial firm in setting its production quantity. as the curves are downward slope (other firm better to reduce output)
83
How to calculate the Stackelberg model?
- Find the reaction curves (MR = MC)
- Sub reaction curve into market demand curve to get first mover inverse demand curve
- Set MR = MC using new curve. Solve
84
What is a differentiated product market?
A market with multiple varieties of a common product
85
How do we calculate equilibrium in a differentiated products bertrand market?
- Unique demand curves
- Set price to max profit
- Get reaction curves
- Plug other reaction curve in to get equilibrium price
86
What is monopolistic competition?
A market structure characterized by many firms selling a differentiated product and with no barriers to entry
87
Why does price not equal marginal cost in a Monopolistically Competitive Market?
The firms always face a downward-sloping demand curve. Entry will occur until demand is tangent with the average total cost curve (profit it exhausted)
88
What costs does an efficient market account for?
All costs and benefits, both private and social
89
What is an externality?
A cost or benefit that affects a third party not directly involved in an economic transaction
90
What is external marginal cost/benefit?
The cost/benefit imposed on a third party when an additional unit of a good is produced or consumed
91
What are social costs in the presence of externalities?
The cost of an economic transaction to society, equal to the private cost plus the external marginal cost
92
What causes the deadweight loss on the graph for externalities?
The market doesn't take external marginal cost into account when setting its quantity of output, it ends up producing more electricity QMKT than is the socially optimal quantity Q*, resulting in a deadweight loss from overproduction equal to the shaded triangle
93
What are market interventions which help to prevent externalities?
Some work through their effect on prices (e.g., taxes)
Some target the quantity produced and consumed
94
Whats the marginal abatement cost?
The marginal abatement cost (MAC), in general, measures the cost of reducing one more unit includes tech cost and forgone production(Marginal cost = Marginal benefit)
95
Why does the marginal cost curve slope upwards for pollution?
Low levels, one extra unit has relatively little effect. High levels, extra units are more costly as damage more severe.
96
Why does the marginal benefit of pollution curve (MBP) slope downward?
High levels of pollution = high production level = low prices
The marginal value of pollution is lower
As pollution is reduced, the cost of reducing pollution even further increases because easy pollution-reduction methods are exhausted
97
What is a Pigouvian tax?
A tax that equals the external marginal cost imposed by an externality, designed to fix market failure and improve societal welfare
98
What is a quota?
A regulation mandating that the production or consumption of a certain quantity of a good or externality be limited (negative externality) or required (positive externality)
99
What happened to the private marginal cost curve when a quota is introduced to limit production?
It becomes vertical at the intersection with the social marginal cost at the optimal quantity and price
100
What was the problem with total allowable catches for fishing? And limited entry?
- Firms invested in better boats/more crew as they were limited on the number of boats
- Also fished as fast as they could even in bad weather etc
- Hard to enforce TAC
101
What was the individual vessel quota system? Did it work?
Yearly share of TAC, can use at any time in 8 months. Self funded enforcement through tax. Tradeable allowances
- Safer, increased fish prices, profits grew
- Reduced employment
- Is it not a public good?
102
Difficulties controlling externalities without perfect information are?
- Hard to calculate the marginal abatement cost
| - Benefits hard to estimate
103
What happens if Marginal abatement costs turn out to be larger than expected?
- Permit system firms forced to abate a fixed amount
- Under a tax system abate less pollution (they will limit pollution until the additional cost of reducing one more unit of pollution is equal to the tax, and then they will simply pay the tax)
104
What happens to the outcomes under taxes and permits when the marginal benefits of reducing pollution (MCP) are greater than expected?
Nothing! Polluting firms operating under a pollution tax system will only change their pollution control efforts in response to a change in MAC. Reduced external costs don't benefit the firm.
Benefit uncertainty does not alter the equivalence between price and quantity interventions
105
When are quantity- based interventions preferable to price-based interventions?
When MAC is flat relative to Marginal cost pollution, the quantity-based intervention is preferable to the price mechanism
106
When are priced- based interventions preferable to quantity-based interventions?
When MAC is steep relative to the marginal cost of pollution MCP, the price mechanism is preferable to the quantity mechanism
107
Why do some regulators use tradable permits to control externalities?
In theory, effective in achieving allocative efficiency: marginal abatement costs equalized across firms
108
How do we solve for an efficient allocation of costs?
Set the marginal abatement costs equal and solve
109
Why do we need tradable permits and not just a regulator?
Difficult for regulators to calculate firms’ costs of reducing pollution (firms may be unsure).
There is the problem of moral hazard: firms have an incentive to overstate costs to regulators, hoping to reduce their financial liability
110
What is the Tragedy of the Commons?
A common resource is used more intensively than it would be if it were privately owned
111
What is nonexcludability?
consumers cannot be prevented from consuming the good once it is available
112
What is the Coase Theorem?
Costless negotiation among market participants will lead to the efficient market outcome regardless of who holds legal property rights
113
What did Newell say about ITQ fishing systems?
can be effective in both controlling fishing effort and improving the economic performance (efficiency) of fisheries
114
What are public goods?
Good that benefits the individual consumer even as others consume it. These goods remain just as valuable to the consumer, even as other people consume them
115
Features of private goods?
Excludable
| Rival
116
Features of club goods (TV services, private parks)?
Excludable
| Non-Rival
117
Features of public goods (Fireworks, national defence)?
Non-Excludable
| Non-Rival
118
Features of common resources (Fisheries, motorways)?
Non-Excludable
| Rival
119
Why will markets under provide public goods?
- People only buy until the point when private MB=MC. Efficient level is when TMB=MC
- Free rider problem
120
Solutions to the free rider problem?
- Govs have the ability to tax citizens and use this to fund services
- Groups of private citizens can form to provide public goods (e.g., homeowners associations for condo buildings)
- Not always free riding, as private motivations are not always rational
