Micro Econ Chapter 24-Chapter 28 Review

CHAPTER 24

• The four major sources of barriers to entry are economies of scale, government licensing, patents, and control of an essential resource.

• A monopoly is present when there is a single seller of a well-defined product for which there are no good substitutes and the entry barriers into the market are high. Although there are only a few markets in which the entire output is supplied by a single seller, the monopoly model also helps us better understand the operation of markets dominated by a small number of firms.

• Like other price searchers, a profit-maximizing monopolist will lower the price and expand its output as long as marginal revenue exceeds marginal cost. At the maximum-profit output, MR will equal MC. The monopolist will charge the price on its demand curve consistent with that output.

• If a monopolist is earning a profit, high barriers to entry will shield the firm from direct competition, thereby enabling it to earn long-run economic profits. But sometimes demand and cost conditions will be such that even a monopolist will be unable to earn economic profit.

• An oligopolistic market is characterized by (1) a small number of rival firms, (2) interdependence among the sellers, (3) substantial economies of scale, and (4) high entry barriers into the market.

• There is no general theory for the determination of a unique price and output in an oligopolistic market. If rival oligopolists acted totally independently of their competitors, they would drive the price down to the per-unit cost of production. Alternatively, if they colluded perfectly, the price would rise to the level a monopolist would charge. The actual outcome under oligopoly will generally fall between these two extremes.

• Oligopolists have a strong incentive to collude and raise their prices. However, each firm will be able to gain if it (alone) can cut its price (or improve the quality of its product) because the demand curve confronted by the firm is more elastic than the industry demand curve. This introduces a conflict that makes it difficult to maintain collusive agreements, even where no law prohibits them.

• Oligopolistic firms are less likely to collude successfully against the interests of consumers if (1) there are more rival firms in the market, (2) it is costly to prohibit competitors from offering secret price cuts (or quality improvements) to customers, (3) entry barriers are low, (4) market demand conditions tend to be unstable, and/or (5) the threat of antitrust action is present.

• Economists criticize high barriers to market entry because (1) the ability of consumers to discipline producers is weakened, (2) the unregulated monopolist or oligopoly group can often gain by restricting output and raising price, and (3) legal barriers to entry encourage firms to engage in wasteful rent-seeking activities.

• When entry barriers are high and competition among rival firms weak, the major policy alternatives are (1) antitrust action designed to maintain or increase the number of firms in the industry, (2) relaxation of regulations that limit entry and trade, (3) price regulation, and (4) provision of output by government firms. When feasible, option (2) is the most attractive alternative. Under most circumstances, all the other options have shortcomings.

• Despite the growing number of industries seemingly dominated by a few large firms, there is reason to believe that the economy is actually more competitive than it was before the digital age. The rise of the gig economy and platform businesses, increased gains from network effects, improvements in technology that weakened the forces leading to diseconomies of scale, and digital tools that reduce search costs all expand consumer options and increase the competitiveness of markets.

CHAPTER 25

• Productive assets and services are bought and sold in resource markets. There are two broad classes of productive resources: (1) nonhuman capital and (2) human capital.

• The demand for resources is derived from the demand for products that the resources help produce. The quantity of a resource demanded is inversely related to its price because of substitutions made by both producers and consumers.

• The demand curve for a resource, like the demand for a product, can shift. The major factors that increase the demand for a resource are (1) an increase in demand for products that use the resource, (2) an increase in the productivity of the resource, and (3) an increase in the price of substitute resources.

• Profit-maximizing firms will hire additional units of a resource up to the point at which the marginal revenue product (MRP) of the resource equals its price. With multiple inputs, firms will expand their use of each until the marginal product divided by the price (MP/P) is equal across all inputs. When real-world decision makers minimize per-unit costs, the outcome will be as if they had followed these mathematical procedures, even though they may not consciously do so.

• The amount of a resource supplied will be directly related to its price. The supply of a resource will be more elastic in the long run than in the short run. In the long run, investment can increase the supply of both physical and human resources.

• The prices of resources are determined by supply and demand. Changes in the market prices of resources will influence the decisions of both users and suppliers. Higher resource prices give users a greater incentive to turn to substitutes and suppliers a greater incentive to provide more of the resource.

• Resource prices coordinate the actions of resource owners and business firms demanding their services. Changes in resource prices in response to changing market conditions are essential for the efficient allocation of resources in a dynamic world.

CHAPTER 26

• The real earnings of individuals would be equal if (1) all individuals were identical in skills, preferences, attitudes, and background; (2) all jobs were equally attractive; and (3) workers were perfectly mobile among jobs. Earnings differences among individuals result from the absence of these conditions.

• Wage differences play an important allocative role. They generally compensate people for (1) investments in education and training that enhance productivity and the development of highly specialized skills and (2) unfavorable working conditions and/or job locations. Wage differences can also result from differences in workers’ preferences, employment discrimination, and institutional factors that restrict worker mobility.

• Employment discrimination reduces the wages of people being discriminated against by either lowering the demand for their services or restricting their entry into various job categories. Productivity differences also contribute to earnings differentials between groups. Research indicates that the earnings of black and Mexican American men are, respectively, approximately 85 percent and 89 percent those of white men of similar productivity.

• Productivity is the ultimate source of high wages and earnings. Workers in the United States (and other high-income industrial countries) earn high wages because their output per hour is high as the result of (1) greater worker knowledge and skills (human capital) and (2) the use of modern machinery (physical capital).

• Robotics and other labor-saving methods of production will be adopted only if they reduce costs. Although automation might reduce employment in a specific industry, it also releases resources that can be employed in other areas. Improved technology permits us to achieve larger output and income levels than would otherwise be possible.

• Economic theory indicates that productivity and earnings growth will move together. Official statistics indicate that since the mid-1970s, productivity has grown more rapidly than real hourly compensation. However, when the same price index is used to adjust both through time, the gap in the growth rates between the two is largely eliminated.

CHAPTER 27

• We can often produce more consumption goods by first using our resources to produce physical and human capital resources and then using these capital resources to produce the desired consumption goods. Because resources used to produce capital goods will be unavailable for the direct production of consumption goods, saving is necessary for investment.

• The interest rate is the price of earlier availability. It is the premium that borrowers must pay to lenders to acquire goods now rather than later.

• The demand for loanable funds reflects the productivity of capital resources and the positive rate of time preference. The market interest rate will bring the quantity of funds demanded by borrowers into balance with the quantity supplied by lenders.

• During inflationary times, the money rate of interest incorporates an inflationary premium reflecting the expected future increase in the price level. When inflation is expected, the money rate of interest exceeds the real rate of interest.

• The money rate of interest on a specific loan reflects three basic factors—the pure interest rate, an inflationary premium, and a risk premium that is directly related to the probability of default by the borrower.

• The interest rate allows individuals to put a current value on future revenues and costs. The discounting procedure can be used to calculate the present value of an expected net income stream from a potential investment project. If the present value of the expected revenues exceeds the present value of the expected costs—and if things turn out as anticipated—the project will be profitable.

• The present value of expected future net earnings will determine the market value of existing assets. An increase in the expected future earnings of an asset will increase its market value.

• Economic profit plays a central role in allocating capital and determining which investment projects will be undertaken. In a competitive environment, economic profit reflects uncertainty and entrepreneurship—the ability to recognize and undertake profitable projects that have gone unnoticed by others.

• To grow and prosper, a nation must have a mechanism that will attract savings and channel them into investments that create wealth. The capital market performs this function in a market economy.

CHAPTER 28

• In 2018, the bottom 20 percent of families earned 3.8 percent of aggregate income; the top 20 percent of families earned approximately thirteen times that amount (49.4 percent). After taxes and transfers are taken into account, the top quintile of households earn 6.2 times the income of the bottom quintile.

• A substantial percentage of the inequality in annual income reflects differences in age, education, family size, marital status, number of earners in the family, and time worked. Young inexperienced workers, students, single-parent families, and retirees are overrepresented among those with low current incomes. Married couples, college graduates, prime-age earners, and families with multiple market workers are overrepresented among the high-income recipients.

• Income inequality has risen during the last four decades. The following four factors contributed to this increase: (1) an increase in the proportion of both single-parent and dual-earner families, (2) an increase in earnings differentials on the basis of skill and education, (3) more “winner-take-all” markets, and (4) increases in the reported income of those in the top tax brackets due to lower marginal tax rates.

• The tracking of household income over time indicates that there is considerable movement of individuals both up and down the income spectrum. The data on the distribution of income at a particular point in time can be misleading because they do not reflect this movement up and down the income ladder.

• One in eleven American families were officially classified as poor in 2018. Those living in poverty were generally younger, less educated, less likely to be working, and more likely to be living in families headed by a woman than those who were not poor.

• During the last several decades, income transfers—including means-tested transfers—have expanded rapidly both in real dollars and as a share of personal income. As a weapon against poverty, transfers have been relatively ineffective. Even though per capita income more than doubled between 1970 and 2018, there was little reduction in the overall poverty rate during this period.

• Means-tested income transfers will (1) confront low-income recipients with high implicit marginal tax rates and thereby reduce their incentive to earn, (2) encourage behavior that increases the risk of poverty, and (3) crowd out private antipoverty charitable activities.

• Transfer recipients are generally required to meet certain criteria in order to receive the transfers. Meeting these criteria generally results in costs that erode some of the benefits of the recipients. Thus, the net benefits of the recipients are generally less, and often substantially less, than the transfers.

• Positive economics cannot determine how much inequality should be present. The nature of the income-generating process as well as the pattern of income distribution is relevant to the issue of fairness.