Econ 102 Final Dave Brown

Consumer Surplus

the difference between the willingness to pay and the price that is actually paid for the good

Producer surplus

the difference between the price the good is sold at and the lowest price the producer would have sold the good at

Economic welfare

the sum of the producer surplus and the consumer surplus

efficiency

we say the market is efficient if economic welfare is maximized

When prices rise, producers cant sell everything they want because

consumers will buy fewer units

IS it better to maximize welfare or consumer surplus

efficiency vs equity trade off

• If the goal is efficiency → maximize total welfare

• If the goal is equity → prioritize consumer surplus

• Real-world policy balances both, because efficiency without equity can be socially unacceptable, and equity without efficiency can be unsustainable.

dead weight loss

trades that do not occur, inefficiency

reasons for dead weight loss

reduced number in trades, a binding price ceiling/floor, taxes surpluses

Overall loses

used to help specific groups such as farmers and low income families (political)

(deadweight loss) politically motivated policies designed to help specific groups, even though those policies reduce total welfare.

Positive sum (chapter x)

a mutually beneficial trade in which both parties benefit

Price floors and price ceilings

to maximize or minimize consumer surplus and producers surplus

Market structure

all features of the market that affect behavior and preformance of the firms within the market

Why is market structure important

predicts firm behavior, output, cost margins and supply and demand

Entry barrier

makes it difficult or impossible for new firms to enter a market

free entry

anyone can start a firm assuming they have enough money to

Examples of free entry

sandwich shop, craft shop, webpage, photographer, android app

Entry barriers example

car manufaturors, diamond mining,

market power

a firm can influence the price of the product or the terms in which a product is sold

MARKET POWER in a competitive market

there will be little market power

Market power: in a noncompetitive market

there will be few firms with market power

Perfect competition

a market in which the decisions of individual buyers and sellers have no effect on the market price

Perfectly competitive firm

a firm that is such a small part of the total industry that it will not affect the price of the product or service that sells it

Characteristics of Perfect competition

1. large number of buyers and sellers

2. products are perfect substitutes

3. perfect price info for everyone

4. No barriers to entry and exit (free entry)

Price takers

no influence on market price

examples of perfect competition

farming, stock market

what does a price taking firm do

1. maximizes profits by choosing output level based on the market price

2. Chooses output level independently from other firms

The demand curve of the perfect competitor

individual firm faces a perfectrly elastic demand curve a the market price

Perfect competition: total revenue

TR = p times q

Perfect competition: total profit

Profit = TR - TC

if TR > TC

profits are positive

if TR < TC

Profits are negative

if TR = TC

profits are 0

Profits are maximized at

MR= MC

Marginal Revenue eq

MR = change in TR / change in Q

MArignal cost

MC = change in TC / change in q

In a perfect competition

MR = P= MC

Profit maximization happens at

MR = MC

in the long run

Firms will enter if profits are postive and will exit if profits are negative

Total economic profit

profit = q * (P-ATC (in terms of q))

Short run break even price

P= minimum of ATC

Positive economic profits

P> minimum of ATC

negative economic profits

P< minimum of ATC

Short run shut down price

The price that just covers the average variable costs

If P < minimum AVC

firm will shut down and chooses q=0

If AVC is less than or equal to price

firm will still produce q>0 but losses < TFC

allocative efficiency

the marginal value to consumers (price) equals the marginal cost of production

resources used to produce quantity of goods consumers want most

outcome to marginal price costing RULE

Marginal cost pricing

Marginal cost pricing is a pricing rule where the price of a good is set equal to the marginal cost (MC) of producing it.

Allocative inefficiency

P> MC price is equal to MB so MB>mc, some DWL

(could be caused by a monopoly)

market does not produce the quantity of a good that maximizes total surplus.

Productive Efficiency

Goods are produced at the lowest possible cost

Monopoly

A market in which there are many buyers but only one seller.

examples of natural monopoly

Providers of water, natural gas, telecommunications, and electricity are often granted exclusive rights to service specific towns/cities through local governments

Mail corporations' competition is limited or non-existent

Characteristics of a monopoly

1. one firm

2. no competition

3. Firm has market power

4. has entry barriers

economies of scale

as a firm increases output, its average total cost (ATC) decreases. larger firms are more cost efficient than small ones

Created barriers of entry

patents, tariffs, quality standards, buying up all resources, sabotage, predatory pricing

Monopoly demand curve

downward sloping demand curve.

Average revenue curve

AR= P*Q/P= P

Same vertical intercept but twice the slope

UNit elastic point on linear demand curve

MR=0

at Q* level of output in monoploy or monopolistic competiton

P> MR=MC

Monopoly compared to perfect competition

Pmono > Pcomp

Qmono< Q comp (results in deadweight loss)

Examples of economies of scale

utlities and telecom, Energy production (power plants):

• airlines etc

firms are regulated o

t charge lower prices, they cut costs (m)

laying off workers and reducing qualities

Price discrimination

when a firm sells identical unuts of output to at different prices for different prices

examples of price discrimination

senior citizens, kids, military, reduced lunch, early bird special

Why price discriminate?

Attract new customers and increase profits

When is price discrimination possible?

1. firms possess market power

2. identifiable groups of consumers have different willingness to pay for the product

3. arbitrage of the product is not possible

Arbitrage

the process of buying a currency low and selling it high

Perfect price discrimination

Occurs when a firm charges the maximum amount that buyers are willing to pay for each unit.

Example of perfect price discrimination

scalpers, airlines

Types of Price Discrimination

1. Perfect Price Discrimination

2. Bulk discount

3. market segmentation (elastic and inelastic)

Pricing at a premium

set your price higher than competition and convince them your product is higher quality

Pricing low to gain market penetration

pricing low at first and raise price once you have a following

Price skimming

set price high on new products, lower price over time

(used with tech goods)

Surge pricing

firm raises prices due to increase in demand

(uber)

Price leadership

find the largest market share and change your prices to theirs (price matching)

implicit collusion

firms going against compitition and working together

firms decide to keep prices and output stable with no formal agreement

Predatory pricing

pricing below marginal cost

(used to eliminate new comers)

Changing prices

firms wont do it if it costs more than its worth or wont change them as often (menu costs)

monopolistic competition

a market structure in which many companies sell products that are similar but not identical

Characteristics of monopolistic competition

many sellers, product differentiation, advertising, easy entry in the long run

Product differentiation

quality, brand names, location

Product differentiation affect on price

some control on price, costs more to have a variety

examples of Product differentiation

taco bell vs chipotle, nike vs addidas

Why advertise

increase demand, show differentiation, result in increase pricing

examples of monopolistic competition

gas stations, fast food places, retail clothing, motels/ hotels,

monopolistic competition demand curve

slopes downward but very elastic (lots of competition)

Profits maximized where

P

monopolisitc competition short run

Profits could be positive or negative

P< ATC= losses

P> ATC= profits

• Italian, sushi, and burger restaurants in a town.

• Each offers a slightly different experience or recipe.

• In the short run, a well-marketed restaurant may earn profits; a less popular one may incur losses.

monopolisitc competition long run

heads to 0 due to free entry

• Entry and exit continue until all firms earn zero economic profit.

examples:

• small bakery making extra profit because it’s the only one in town.

• Other bakers see this and open shops nearby → customers are spread among all bakeries → each bakery’s profit shrinks → eventually, profit is just enough to cover costs.

Compared to perf comp:

slightly higher prices, little dwl, slightly lower output, slightly higher costs

Oligopoly

A market structure in which a few large firms dominate a market

oligopoly characteristics

small number of large firms, strategic dependence, possible econ. of scale, possibility of network of scale

interdependence

Firm a has to see what firm b is doing because they are both huge market holders

each firm’s decisions about price, output, or strategy directly affect the other firms in the market

• Airline Industry: One airline cuts fares → competitors may match or change routes.

u are directly affected sd is taking competitiors into consideration during descion making

strategic dependence

• Each firm’s decisions depend on the expected actions of other firms.

• Example: If one airline lowers fares, others must decide whether to match the price or maintain theirs.

reaction function

my optimal decision depends on your decision mathematical

showing a firm’s optimal action (price or quantity) for every possible action of rivals.

examples of oligopoly

airlines, cereal, videogames, cell phones

example of reaction function

Pepsi prices depends on coke prices, general motors price depends on ford prices

Why oligopoly occurs

economies of scale (larger firms more efficient), barriers to entry(difficult for new competition), mergers (smaller firms get bought out)

Vertical merger

two firms at different stages of production in the same industry merge.

Amazon + Whole Foods

Example of vertical merger

Ford merges with Goodyear, Pepsi buys a bottling company,

Horizontal merger

The joining of firms that are producing or selling a similar product.

ex: disney and pixar