Week 1

Efficiency

• Comparison of benefits and costs

• efficient if benefits > costs

• cost effectiveness: costs only

• change is effecient if total benefits > total costs

• value is measured by willingness to pay

Limitations of efficiency

• does not mean equity: focus on total welfare, not distribution

• does not mean fairness: considers outcomes, not process

• also not about maximising happiness: its based on willingness to pay not utility

Transaction costs

• costs related to …

• information

• bargaining

• monitoring

• enforcing

Pareto-efficiency

• An allocation is efficient when one person is made better off without making someone else worse off (win-win)

• strict requirement → nobody can be made worse off

Kaldor-Hicks efficiency

• An allocation can be efficient even if someone loses, as long as the winner(s) could compensate the loser(s) (potential win-win).

  • by what margin could the winners compensate the losers and still be better off?

  • actual compensation not taken into account → focus on potential compensation to offset loss

Welfare

• Welfare = utility = satisfying desires

• (non)monetary

• subjective & indifferent

• scarcity = limited means (time, money, labour)

Transaction

• Usually in markets, transaction happens = transfer of property rights

• simultaneous legal and economic exchange

  • physical / digital transfer

  • economic transfer of money

  • legal transaction of property rights

Measuring costs benefits

• don’t forget opportunity costs

• ignore sunk costs

• focus on the additional costs and benefits

  • additional features should only be added until MR = MC

Opportunity costs

• the value of the next-best alternative that must be forgone in order to undertake an activity

Sunk costs

• those costs that will be incurred whether or not an action is taken, therefore are irrelevant to a decision of whether to take action.

Market failure

• imperfect competition

• external effects

• public goods: not provided by the market

• information asymmetries

Regulatory failure

• Market failure? → government regulation needed

• what if the regulation fails?

• incomplete information

• lobbying

• short time horizons

• corruption

• budget maximisation

Characteristics of perfect competition

• Many suppliers and consumers (price is fixed)

• Homogenous (the same) goods

• No transaction costs (perfectly transparent, property rights defined and free entry and exit for suppliers)

Demand curve

• Always decreasing (higher the price, lower the quantity demand), people's willingness to pay

Price elasticity

• with how many percent does the demanded quantity of good x change if the price of good x changes by 1%

• elastic demand: effect on q is large

• inelastic demand: effect on q is small

Supply

• in perfect completion: price is given

• individual producers cannot influence the market price

• → producers are quantity adjusters

• → want to maximise profit (revenue - costs)

Revenues (PC)

• = p * q

• since producers in PC are only quantity adjusters, price is always given

• MR is exactly the same for each additional price because it doesn’t change per quantity increase

• thus P = MR

Costs (PC)

• FC + VC

• certain deployment of labour generates a certain # of goods that can be produced

Average variable costs & AFC

• TVC = average wage rate * # of workers

• AVC = TVC / q

• for each extra unit, margin of profit decreases

• leads to ‘too many cooks in the kitchen’

• AFC = FC/q

• ATC = AVC + AFC

Equilibrium

• The interaction of maximizing actors.

Stable equilibrium

• one that does not change unless outside forces intervene.

Consumer surplus

• Difference between price that consumers are willing to pay and equilibrium price.

Producer surplus

• Difference between the equlibrium price and the price that producers want to receive

Trade

• = win - win

• both consumers & producers are better off (both WF gain)

• mention Pareto- efficiency

  • equilibrium:

    • remains if nothing happens

    • changes: consumer preferences or technologies changes

Changing demand

• shifts:

  • preferences change

  • # of consumers change

  • income distribution changes

  • price of another good changes

• less demand: shifts left

• more demand: shifts right

• *mention up or down movement

Changing Supply

• shifts:

  • number of suppliers change

  • price of some production factors change

  • technology changes

• more S or lower costs: S curve to the right

• MC decrease or producing more @ same lvl

Monopoly

• One supplier that is the price setter

• reasons for a monopoly:

  • technical: unique availability

  • natural: scale advantages, high FC compared to AtC

  • legal: patent

Natural monopoly

• a market that runs most efficiently when one large firm supplies all of the output

• scale advantages: invested so much & become so big it doesn’t make sense for others to join

Where MR = MC

• Point where profit is maximised, because the marginal cost (as the supply curve) equals to the marginal revenues.

When MR >MC

• should increase output for more profit

When MR < MC

• should decrease output

Oligopoly

• few suppliers

• homogenous = identical products (steel/oil)

• heterogenous = non-identical / differentiated products

• each producing ½ yields higher price & profit

• preferably no price competition → risk of retaliation leading to lower prices

• cartel: oligopolists acting as a monopoly (unstable)

Monopolistic completion

• many suppliers, but heterogeneity creates a monopolistic situation

• not just price but other product characteristics

• product has its own small submarket where producer behaves as a monopolist

• welfare increasing because consumer choice

Mono comp in the short term

• maximum profit where MR = MC (excess profit ABCD)

• invokes new entry by firms

Mono comp in the long term

• newcomers take away demand from existing firms

• individual D curve shifts left

• still DWL, but no more excess profits