ECON Unit 2

Commitment

tie your own hands so that keeping the promise becomes your best response

Reputation

hold a reputation worth more than what breaking the promise would gain

What is the most common type of hand tying device in business?

Contract

Contracts only bind if :

1. the court enforce it

2. the wronged party would actually sue

3. penalty is large enough

A court’s verdict is uncertain if :

When a court makes a decision, you calculate the expected payoff instead of assuming the outcome is certain

what is a court node

represents a situation where a court’s ruling is uncertain in a decision tree

• the threat to enforce a contract is a credibility problem

Nature node

an uncertain event

demand function

number of units it can sell at P. demand slows down, so firms cannot choose price and quantity

Profit

total revenue = total cost

Marginal cost

amount total cost rises when the firm produces one more unit

marginal revenue

firm costs prices to sell that unit, the cut applies to every unit that was already selling, less than the price

Revenue as a rectangle

Own price elasticity

percentage change in quantity sold per 1% change in price

nonlinear pricing

total paid for x units is not a price times x

two part tariff

an entry fee F, then a per unit price P

Bundling

selling two goods together for less than the sun of their separate prices

versioning

sell a high and low version and let the customer choose

binding constraints : high value group must prefer its own version to the cheap one

double marginalization

the good is market up, then marked up again

two part tariff

wholesale price equals to the marginal cost, plus an up fron franchise fee

resale price maintainence

manufacture fixes the retail price

vertical integration

manufacturer buys the retailer

perfectly elastic supply

sellers have an equally good outlet elsewhere, so they supply any amount at that outside price and nothing below it

• at $10 they will supply any amount, below that they wont supply you at all but someone else

perfectly inelastic supply

the quantity is already fixed and comes to market at any price above the fall back

• whatever the price, 100 units come to the market; it just depends on the price is above the fallback - what the seller would get it it didnt sell

supply elasticity

how much sellers change the quantity they offer when the price changes

equilibrium

price where supply = demand

• above = goods sit unsold and sellers undercut

• below = shelvers are empty and buyers bid up

money left over

cash spent here is cash not spent elsewhere, so treat money left over as a good worth one unit of utility per dollar

fixed budget

only be spent there, money has no outside use, no single unit is judged against price

affordable bundles

combination of goods the budget covers, and chooses the one whose total value to her is highest