Term Two Flashcards
(128 cards)
1
Q
Give some examples advantages for;
- The Market
- Internal Trade
A
Market:
- Competition Pressure
- Smooth production flow
- Economies of Scale
Internal: -transaction cost savings -Easier access to; Specialised Skills Specialised Equipment.
2
Q
What Internal controls can ensure profit max?
A
- Specify the role of the manager.
- Share holders can vote to fire manager.
- Performanced based pay for management.
- Managers take some of the losses of the firm.
3
Q
What external controls ensure profit max?
A
- Fear of a Take-over bid.
- Competition within the product market.
- Discipline from the capital suppliers.
4
Q
What is monopolistic competition?
A
It is where there are many firms making a slightly differentiated product, each firm’s output is small relative to the total output.
5
Q
What are the assumptions of a perfectly competitive market?
A
- The firm is profit maximiser.
- Many firms and buyers (smallness)
- Homogenous product MRS=1.
- Firms are price takers.
- Firms have no strategic power.
-Perfectly elastic demand curve. (smaller market share the more elastic the demand curve).
efirm=emarket/m)
m=x/X no of firms/market share.
6
Q
Draw a residual demand curve for the firm under PC.
A
You draw vertical to horizontal to downward sloping.
Pe is market price horizontal line.
p’’ you face whole market.
7
Q
Define the individual firm supply curve within a perfectly competitive market.
A
It is the quantity that the PC firm will produce for every given market price.
The firm will produce at the level P=MC. This is the profit max output level.
8
Q
At what point will a firm shut down in the PC market? short run
A
When p
9
Q
What is the supply decision of a pc firm in a Long run market framework?
A
In the long run, all factors are variable. This means AVC =AC
So they produce where MC=P
as long as P>=AC
10
Q
How to find the industry supply of n number of identical firms?
A
You find the individual supply curve for one of the firms, then the industry supply is n times the quantity that they supply.
The more firms that are in the market, the flatter the supply curve.
Then you find the marker price P for PC and that intersection will show you in the industry where the supply and the demand intersect each other.
11
Q
What is the industry supply in the long run of a firm?
A
The more firms in an industry, the flatter the supply curve will be.
You draw the supply for each firm, then the demand.
Any section that lies to the right of the previous supply curve will be included. If it lies to the left it will not be included.
This will give a flat industry supply curve.
12
Q
What is the industry supply in the long run of a firm with increasing output costs.
A
Same as normal long run, the only difference being that the curve curves upwards.
The area under the price and between S and D intersection shows a shaded area.
This shaded area is the producer surplus. This producer surplus goes to the supplier of the industry as the costs go up with output firm firms but not the supplier.
13
Q
Why is long-run supply flat with constant costs?
A
It is because in the long-run, there is free entry and exit of firms to a market and expected to be a very high number of firms.
14
Q
Numerically find the supply curve.
A
Find the MC and then equate it to P.
You must always equate it to P else it will not work.
15
Q
Draw a diagram to simply show total surplus.
Show the derivation of total surplus.
A
Draw a demand curve and supply curve and the space between them, i.e A+B is the total surplus.
Draw demand diagram, all area under its intersection and p is n TW (willingness to pay)
Next diagram draw a supply. area under up to price p is the total cost .
Then draw them together to give the diagram as before.
16
Q
Give a reason why TS is not the best measure of welfare?
A
If you max TS then it is an efficient point to output, however it is by no means an equitable point to output.
17
Q
Draw a diagram to show the normative analysis of rent control.
A
Rent price (y)
Housing quant (x)
Show price fall to Pr.
P1 TS = A+B+C+D+E
Pr TS = A+C+E
Now there is a housing shortage.
It will increase consumer surplus.
it reduces producer surplus.
18
Q
If a tax is collected from producers, does it mean they will feel the full burden of the tax? Explain.
A
It will not feel like they have the full burden, the one who feels the burden of the tax is soley dependent on the elasticity of supply and demand.
19
Q
How do you determine whether the supplier or the consumer feels the burden of the tax.
A
More elastic the demand, the less the consumer will feel the tax.
More elastic the supply, the less the producer will feel the tax.
You can see as
20
Q
how do you find the level of the tax?
A
It is the distance vertically between s and s’, i.e the change in the supply curves.
21
Q
What is the difference between a tax on a consumer and a tax on a producer?
A
Consumer will cause the demand curve to shift back.
Producer will cause the supply curve to shift back.
22
Q
What is the normative sales tax analysis?
A
Before A+B+C+E is TS
After it would normally be A+B
but in this case it is A+B+C because C is given to the government and they will ultimately use it to benefit consumers.
23
Q
What are the assumptions of a Monopoly?
A
- Sellers are price makers in the market.
- Sellers are not strategic behaviors.
- Entry into the market is completely blocked.
- Buyers are price takers.
- Buyers are well informed.
- Substitutability between products is extremely low.
24
Q
What will cause a monopoly in a market?
A
- A patent on a new product.
- Sole ownership of a certain resource.
- Forming a cartel.
- Economies of scale.
- Legal fiat (US postal service)
25
At what point will a monopoly max their profit?
MR = MC
Where MR is found from the derivative of TR.
and TR is DQ or PQ
26
What is marginal revenue?
it is the extra revenue which is received from an increase in the quantity of output by one unit.
You can show this from a price change and the MR as the difference between the gain and the loss in inframarginal units.
27
What does an elastic demand curve mean within a monopoly framework?
It means that the substitutability between goods is at a higher level.
This means the loss in inframarginal units from a change in price will be lower.
28
What is the link between elasticity and marginal revenue?
MR= (dp/dq)q + p
ed =(dq/dp)p/q
-p/ed = (dp/dq)q.
Therefore MR = -p/ed + p
MR = (1-1/ed)
Therefore;
Higher ed, MR is higher as less inframarginal units are lost.
Lower ed, MR is lower as more inframarginal units will be lost.
29
What is the analysis of the equilibrium using elasticity in a monopoly?
MR = MC
MC = p(1-1/ed)
So p = MC/ (1-1/ed)
So if 1/ed = 0,
we would find a perfectly competitive market as p =mc would hold.
30
What is the shut-down rule in a monopoly?
If there is no entry to the market then the shut down does not apply as super normal profits are generated in both the long run and the short run.
31
What effect does process innnovation have on a monopolist?
It will cause their MC curve to fall and increase their profit to A+B.
B> cost, they will innovate.
32
What effect does a unit tax have on a monopolist?
it will shift the MC upwards.
The shift up is the tax t.
A+B+C to A+B for profit.
Some passed onto consumer.
33
What effect does a lump sum tax have on a monopolist.
It will shift up AC curve. So reduces supernormal profit.
None passed onto consumer.
34
What are the assumptions for profitable price discrimination?
- Firm is a price maker.
- Consumers cannot arbitrage to get lower price (no resell)
- Firms can identify different willingness to pay, via elasticity.
35
What are the different degrees of price discrimination?
- First Degree; M exploits all consumer surplus. Charge a different price to all consumers on their willingness to pay.
- Third Degree; M sells q amount to different people for different price p.
However each unit of q sells for the same price p.
- Second Degree; M sells different units of q for different p. However if you buy the same units of q as someone else, you pay the same p.
(price - quantity package)
36
What happens in first degree PD .
MR=D , mc constrant.
Max CS is where they intersect. That is using all of the consumer surplus.
37
What happens in 3rd degree PD?
MC cstat;
The elasticity of demand for each group determines the price for the market.
MC non -cstat:
Find individual MR=MC position.
The the sum of the MR's and Q's will give the entire market.
Recall the MR = MC = P(1-1/ed)
For different groups ed differs.
so there will be different profit max pricing points.
38
What happens in 2nd degree PD.
They cannot find differences between individuals or groups so they offer their own packages. The diagrams are lecture 27 slide 11 but essentially they show different willingness to pay and where best to maximise CS take.
39
What is a natural monopoly?
It is where economies of scale is large enough so that the average cost is lower than possible with more than one firm in the market.
40
Draw a diagram for a natural monopoly.
LEcture 28 slide 7.
Same D and MR,
ATC is downward curve
MC is downward curve.
The two DO NOT intersect.
41
Why can't you regulate a natural monopoly?
Because if you do, the ATC > P
if you set p=mc
Therefore they make an economic loss an leave the market.
42
Give two measures of the monopoly power of firms.
Lerner index; p-mc/p
measures single firm power
Herfindahl index
Is industry
squared of sum of all firms
market share
Higher H more monopoly.
43
How to work out profit max for a monopoly with two firms with differing MC.
At the end unit the MC's will need to be equal. Therefore equate the MC.
Find q1 in terms of q2
Then sub into Qt and solve MR =MC for the q that you chose.
solve for both then ensure to find QT.
44
What are the Assumptions underpinning an Oligopoly?
Sellers are price makers.
Few sellers with large market share
Product is slightly differentiated
Consumers are well informed price takers.
Sellers will work to some strategy.
45
List the four types of Oligopoly (that we look at)
Cournot; Firms have homogenous product and simulataneously choose a quantity.
Stackelberg; Firms choose their quantities but in sequence.
Bertrand; firms choose prices simultaneously.
Price leadership; firms choose their prices in sequence.
46
What are the assumptions of the Cournot model?
It is a duopoly.
No more entry into the market
Identical cost functions.
Costs are constant in the model.
The product sold is completely homogenous.
47
draw a residual demand curve for A from the market demand curve when B supplies 200. (cournot)
lecture 29 slide 6
at 200 A = 0
Market at 450 A = 250
Market at 60 A = 650
48
What happens to A's residual demand if B increases output in the Cournot model?
A's residual demand curve will shift leftward.
This means A's profit max is completely dependent on B's output decision.
49
How do you find the Cournot equilibrium?
It is the point f intersection between the two Reaction Functions.
50
What is an ISO-Profit Function?
It is the combination of production of two firms that result in a given level of profit for one of the firms.
A reaction function will pass through the highest point of an isoprofit curve.
The closer the curve is to the axis, the higher the level of profit available.
For A, they are convex away from x if Qa is x and for B they are convex away from y if Qb is Y.
51
Using a demand diagram show collusion in a cournot and the incentives to cheat.
Show A + B and Monop output
they get Qm/2 each.
if one person increases by 1 unit, they gain C and lose A so might as well.
52
In cournot, what is a contract curve?
it is where firms collude to the extent where you cannot make one person better off without making another person worse off. This points are shown on a contract curve. They are all pareto optimal.
It can be shown by joining points on the most profit isoprofit for B and A.
53
What produces more cournot or PC
As cournot has a downward sloping demand and MR curve, they produce where P>MC, therefore they produce less than PC.
54
Draw a diagram to compare the output of the different market structures.
Slide 11, Lecture 30.
55
What will the effect be on a reaction function if the MC increase.
They will shift inwards.
56
What is the difference between a firm in Bertrand and a firm in Cournot>
Cournot is quantity setting.
Bertrand is price setting.
Both of which will be set simultaneously.
57
What is the residual demand curve for betrand firm for a range of prices?
Pa>Pb Qa = 0 Qb = market.
visa verse
pa = pb Qa = Qb = D /2
58
Draw the bertand - nash equilibrium diagram.
The BNE is the point where the two RF intersect. Slide 16 lecture 30.
It is a strategy where each firm chooses the price which it would want to sell its output for. neither firm wishes to cheat or change their output.
59
Give a real life cournot and bertrand example.
C: hotel, supermarket, planes, tranes.
B: Firms which bid for tenders for example.
60
Explain the Stackelberg model.
It is quantity setting sequentially in a Duopoly.
(Homogenous Goods)
Firm A= leader
Firm B = Follower
A will set quant first, then B will set their quant with the aim of profit max as a result of A.
Outcome:
A will profit max where it's lowest isoprofit is a tangent to the reaction function of B.
i.e; the isoprofit which is closest to the x axis.
Therefore generating the most profit.
61
What are the conclusions of Stakelberg model?
- Leader produces where isoprofit is tangent to B RF.
| - This means leader makes more profit than cournot and follower makes less profit than cournot.
62
What is the only outcome in the Bertrand model?
It is where p=mc
63
Explain the price leadership model.
There are homogenous goods.
The price is set sequentially. .
Leader will set the price and must predict the reaction of the follower as a result.
Costs between firms are constant but marginal costs are not constant.
Residual demand curve for leader given by;
D - Sf
Where Sf is supply by follower.
Leader sets their price where they max profit on own MR curve from residual demand.
NOT market MR curve.
64
Draw the price leadership diagram.
Lecture 31, slide 18
Dd = leader demand
Sf follower supply
D market demand
MRd = MCd is profit max
trace to sf and Dd
give Qd and Qf
Qtotal =QD + Qf
To get Qt trace across to market demand.
Alternative Diagram;
P1 = market equilib.
p3 = Df supply whole market.
p2 = LMC = MR
profit max.
Leader supplies q1 - q2
follower supplies q2.
65
Which models in Oli give highest output and lowest price?
Which gives smaller output?
High ; Bertrand and Perfect Competition
Low; Collusion and cartel
66
How do you find prices from reaction functions?
You sub in q2 into the q1 equation and solve. Add the Q1 and the Q2 together that you get. then sub into p - c
67
What is;
- The Decision Rule
- Best response function
-Decision rule is a strategy that specifies the action that a player will carry out, conditional to what happens earlier in the game.
-Best response function;
Describes the optimal actions of a player for each of the actions the other player may take.
68
What type of game is a sequential game?
It is a dynamic game.
69
# Define the gamer type;
- Imperfect information
- Complete information
- Incomplete information
- Imperfect is where a player must make a move but is unable to observe earlier or simultaneous moves by other players.
- Complete; The payoff function of each player is common knowledge.
Incomplete; A player is unsure of another payoff function
70
What are the various outcomes in game theory?
Dominant Strategy Equilibrium;
Where each player follows an optimal strategy regardless of what everyone else chooses to do.
Nash equilibrium; Where each player chooses optimally, given the choices of another player.
Credibility Condition; Requires that when a player has to make a move, its in their self interest to make the move which is called for by their strategy.
71
How do you know when there is no DSE?
If there are two separate Nash Equilibria
72
How do you know when there is no Nash Equilibria?
It is where there is four different outcomes which will be chosen in a matrix framework.
73
In a game tree, what are the;
Dotted lines
Squares between the lines
triangles at the end of the decisions
Dotted = Simultaneous decisions
Squares = Decision nodes
Triangles = Terminal nodes
74
What is the self-enforcing agreement?
It is where if firms choose something, they have the incentive to cheat.
75
How can you find the Pareto Efficient output point?
It is the point where they are the best off they can both be regards the other.
If you make one better off, the other has to be worse off.
76
What is the subgame perfect equilibrium?
It is when a strategy set satisfies both the Nash condition and the credibility condition.
e.g; if they said that they would choose something no matter what, i.e; go high and then it is in their self interest to go low for a better payoff. They are sticking to the credibility condition if they then do choose to go low.
77
Which PE or SGPE always be dominant?
No, it is not true, SGPE/PE will not always be the dominant outcome.
78
Explain the two decisions for an oligopolist regarding the entry of a firm into the market.
Model this in a game tree (small plant)
High output to depress prices, reducing their economic profit and forcing them out of the market.
Low output if they do not enter the market to ensure high prices and keep profits high.
Lecture 32-34
Slide 35.
79
What could the incumbent (firm already in market) threaten to do to the entering firm?
They could make the threat of building a bigger plant to deter them from entering (Big plant)
80
Draw the diagram for entry game, but with commitment for a plant size dimension.
Lecture 32-34
slide 41
Essentially the sum of diagram 8 and 9.
81
Why could we say that a monopoly is a market without just one firm?
Because even though Glaxo chose not to enter; Pfizer still invested in a large plant, therefore altering the behavior of Pfizer.
82
What is the difference of incomplete information in an entry game framework?
Entering firm does not know the pay off of the other firm.
Entering firm must consider the probability that the firm has either high or low costs.
High cost is low output and low cost is high output
The payoff values will be combined with the probabilities.
The firm which was entering would have to calculate their expected profit level.
83
Explain the expected profit calculation for a firm entering the oligopoly market where they are unsure of costs.
Imagine if firm enters;
High cost payoff will be 4
Prob = p
low cost payoff will be -3
Prob = (1-p)
Expected profit = 4p + -3(1-p) = 0
therefore 7p - 3 = 0
p =3/7
if p is greater or equal to 3/7 the firm should join the market as they will generate positive profit levels.
84
What is a;
- Zero sum game
- Non-zero sum game
- Maximin Strategy
- Minimax Strategy
- Zero Sum;
Where the gains of one firm in the market are equal to the loss of another so there is zero gains to the market.
Non- zero sum;
Game where payoff sum is not equal to zero.
Maximin;
Where A chooses the strategy that maximises their minimum gain in anticipation of B's response.
Minimax;
Is the strategy which is where B chooses the strategy that minimises the maximum gains of A.
85
What do the cells represent in a zero sum game?
They show the amount one party gains and the other party loses in the framework.
86
Explain at what point is there a 'pure strategy' and the game is strictly determined.
It is the point where the minimum of that row coincides with the maximum of that column.
87
What is the problem with strictly dominated strategies?
Each step requires strong assumptions that the players are all rational.
Games may not run as smoothly and conveniently in usual circumstances.
88
What must the game be to have a SPNE?
The game must be sequential in nature.
89
When you state outcome of game theory what must you state?
You must state the choices of the respective players and not the payoff outcomes.
90
What is asymmetric information?
Where one side of an economic relationship has more information than another side.
91
What are hidden characteristics?
where one side of an economic relationship knows more about itself than the other party does.
92
What are hidden actions?
Where one side of a relationship can carry out actions which cannot be observed by the other party.
93
What is Screening?>
It is where the uninformed party sets out a mechanism to sort out the informed party, based on the signals that they are sending out.
94
Explain the going to uni model to get higher earnings.
High ability: MRP = 400 p/w
Low ability: MRP = 200 p/w
Z shaped diagram.
x axis = yr of edu
y axis = amounts of other goods consumed.
At uni degree, jump 200 points.
Indifference curve intercept middle of 400 and 200 named a which is average MRP both workers would get if no one went uni.
Steeper IC for low ability due to higher disutility.
this is not tangent to anything but intercept is at 200.
95
What is adverse selection ?
It is where the uninformed party selects the wrong people to trade with.
The uninformed is said to have made an Adverse selection.
Occurs where there is a hidden characteristics problem
The informed party self select in a way which is harmful to the uninformed party.
96
Explain the adverse selection example.
Find the EV=2000 and discover q.
97
What happens if the expected value is less than the minimum value of the 'peach' good?
Buyers know no peach seller will accept the EV.
No peaches sold
All peach dealers leave the market.
Only lemons left to sell.
Lemons crowd out peaches
98
What is the effect of lemons in a market.
Too many lemons will crowd out peaches from the market.
As no peaches are traded, gains to trade are lost.
Presence of lemons inflicts an external cost on buyers and peach owners.
99
What effects can asymmetric info have on a market?
It can have an adverse effect on efficiency in a market.
In an insurance market; firms will respond the asymmetric information by screening using targeted insurance rates.
100
What ways can the government employ to hidden characteristics?
Public pension programmes
Policies which disseminate information.
101
what are three important features of the principle-agent relationship?
- Agent takes an action which effects the principle.
- The principle can not directly observe the action that the agent took.
- The principle and the agent will disagree on which is the best action for the agent to take.
102
What is moral hazard?
The idea that a party is protected from risk by some insurance hence taking the actions that it does.
103
Draw the shirking diagram
Lecture 36-36 slide 41.
104
What two things can the principal do if the amount of shirking is not observable?
They can consider either;
-A flat salary
- Performance based compensation
Draw these from lecture 35-36 slide 40 -50
105
What equilibrium bundle will owners choose for the performance based pay package of a manager?
Where the manager pays G.
The value where residual equilibrium bundle lies on the Uo indifference curve.
106
Why will a firm not want to cheat consumers?
Because of bad reputation causing a reduction in their amount of sales.
107
What is an externality?
Is where the activity of one entity directly affects the welfare of another in a way which is not transmitted by the market prices.
it violates the first welfare theorem.
108
Why does the first welfare theorem not hold for Pollution problem?
Because there is a missing market for the ownership of clean air.
109
What are the two curves for costs in the pollution model?
Social marginal cost= PMC + marginal damage.
PMC= Private marginal cost.
Cost to the producer.
110
In the negative consumption externality diagram, at what point is the allocation efficient?
Where the two IC curves are tangent to each other in the edgeworth box.
You can draw a line in order to map all of the efficient allocations together.
111
On the negative consumption diagram how can you show optimal consumption for A and B?
A is max money and smoke.
B is max money and zero smoke.
112
How can you solve production and consumption externalities?
By assigning a property right and then allowing to bargain.
No matter who is assigned the right, the returns will always end up at the social optimum
113
Explain the merger solution
- Where the two firms merge, their joint profits will be greater than their individual profits.
- The external effects are then internalised.
This may be achieved by social convention for consumption externalizes as people don't want to do bad to others
114
Explain the process of Coase Bargaining between the fishery and the Steel producer.
STEEL FIRM WITH RIGHTS
MR and PMC is the minimum bribe the steel firm will accept to forgoe produciton of each output unit. (AB)
SMC and S is the minimum bribe the fishery will pay the steel firm to prevent them producing each unit of output.
left of x*: MD MR - PMC
Therefore the agreement is at x*=MD +MR-PMC
FISHERY WITH RIGHTS
Fishery will allow steel firm to output more as long as they pay more than MD.
Steel firm will pay fishery for the right to increase output so long as the amount is less the MR-PMC
therefore x* is final outcome.
Private bargaining leads to the efficient optimal output level
115
What is said by coase theorem?
The same effcient output amount is achieved no matter who is assigned the property rights.
Once the property rights have been established, externalities create no inefficiency in the market.
it does not explain how parties will split the returns from the bargaining process.
116
What point will coase apply for a consumption externality?
It will apply when they have quasi-linear preferences.
This means reallocating income will have no effect on the demand for the good with externality.
The goods can then be traded for using money.
117
What are the problems with Coase Theorem?
- The costs of bargaining are assumed to be zero.
Difficult to get every economic party together to bargain over pollution for example.
- There is a free rider problem.
Individuals have the incentive to do nothing, they will enjoy the benefits of bargains but let others incur the costs of bargaining.
- Difficult to source damage cause for something like acid rain.
- Opportunity to bargain is not common knowledge asymmetric information.
118
explain the payoffs from coase and the prisoner's dillema.
lecture 38 slide 19.
Free-ride is the dominant strategy
119
Explain how regulation by government can solve externality?
It can says to reduce production by certain amount or face sanction.
There slope of the marginal benefit curve of an individual will determine how much they have to reduce production by.
120
Explain how a pigouvian tax will be introduced and the problems that may arise with it.
It is a tax levied on each unit of pollution.
- It is set equal to the level of Marginal damage.
problems;
- hard to estimate the MD function
- Can't find who the pollutants harm.
- Which activities actually harm the environment.
121
Explain how government can create markets for where they are missing.
They will issue permits for the level of pollution that they have decided to be desirable.
The prices of permits can adjust for inflation.
They can make clear what the explicit level of pollution will be.
122
What is a public good?
Non-Excludable;
It is impossible from excluding people from consuming,
Non-Rival;
An increase in one's consumption will not reduce the consumption of another. i.e; street lighting.
123
What point is the efficient provision of a public good?
It is at the point where marginal willingness to pay = Marginal cost of public good
MB is sum of peoples willingness to pay
124
What is the pareto efficient allocation of a public good?
It is where the sum of individual MRS is = to MC.
This can be shown on a diagram where MRS is downward sloping and you add two together.
MC slopes up.
G* is where MC = MRS 1+2
or slide 8 lecture 32.
125
Why can't we just ask people what their marginal willingness to pay is?
Why not get people to vote?
Because if it is linked to cost, they will understate the true value to save money.
Strategic voting: can be used in order for the decsion to buy a certain public good. Lie about their true preferences.
Paradox of Voting; Social preferences of people may not be well defined.
126
What is a pivotal agent?
It is someone who will over or understate their actual want for a good to ensure that it is actually provided.
If someone on their own changes the decision, they are known as a pivotal agent.
If the sum of everyone else is more it does not matter, but if it is they who change it then they are pivotal.
127
Explain the link between pivotal agents and the Groves-Clarke Tax.
1) if the PG is provided, assign a cost to each agent.
2) Agents state net value of what they feel its worth
Net = Val - cost
3) Sum all the net values if positive provide PG.
4) Pivotal agents are required to pay a tax equal to the cost which they have imposed on others. This tax will go to the government.
The pivotal agent must pay a tax equal to the absolute value of the sum of the net valuations of the other individuals in the group.
128
What are the problems of the Groves - Clarke Tax;
- Tax size could be very large.
- No consideration of equity.
- Coalitions can be open to manipulations.
- A person's choice could be affected by the amount that they pay.
